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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
------------------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31,JUNE 30, 2001
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)
Indicate by check mark whether the Registrant (1) has filed all documents
and 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 [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of stock, as of the last practicable date.
Class B Preferred Stock ($.01 par value).................... 902,068 as of May 11,August 13, 2001
Common Stock ($.01 par value)............................... 8,923,50910,034,052 as of May 11,August 13, 2001
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REDWOOD TRUST, INCINC.
FORM 10-Q
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements -- Redwood Trust, Inc.Inc
Consolidated Balance Sheets at March 31,June 30, 2001 and December
31, 2000.................................................. 32000 ................................................... 1
Consolidated Statements of Operations for the three and six
months ended March 31,June 30, 2001 and March 31, 2000..................... 4June 30, 2000 ............... 2
Consolidated Statements of Stockholders' Equity for the
three and six months ended March 31, 2001........................... 5June 30, 2001 ................... 3
Consolidated Statements of Cash Flows for the three and six
months ended March 31,June 30, 2001 and March 31, 2000..................... 6June 30, 2000 ............... 4
Notes to Consolidated Financial Statements.................. 75
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................... 24Operations.................................................. 22
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................................................ 44Risk....... 45
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 45Proceedings................................................ 46
Item 2. Changes in Securities....................................... 45Securities............................................ 46
Item 3. Defaults Upon Senior Securities............................. 45Securities.................................. 46
Item 4. Submission of Matters to a Vote of Security Holders......... 45Holders.............. 46
Item 5. Other Information........................................... 45Information................................................ 46
Item 6. Exhibits and Reports on Form 8-K............................ 45
SIGNATURES...........................................................8-K................................. 46
SIGNATURES............................................................... 47
2i
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PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
MARCH 31,JUNE 30, DECEMBER 31,
2001 2000
----------- ------------
(UNAUDITED)
Net Investment In Residential Credit Enhancement Interests:
Mortgage securities available-for-sale.................... $ 49,62162,156 $ 48,495
Mortgage securities available-for-sale, pledged........... 51,22896,548 32,269
---------- ----------
100,849158,704 80,764
Residential Retained Loan Portfolio:
Mortgage loans held-for-investment........................ 1,067,295980,318 1,124,339
Mortgage loans held-for-sale.............................. 372115 531
Mortgage loans held-for-sale, pledged..................... 4,15280,037 6,127
---------- ----------
1,071,8191,060,470 1,130,997
Investment Portfolio:
Mortgage securities trading............................... 58,64746,933 57,450
Mortgage securities trading, pledged...................... 926,575661,024 702,162
Mortgage securities available-for-sale.................... 14,18830,264 5,163
Mortgage securities available-for-sale, pledged........... 1,202966 --
---------- ----------
1,000,612739,187 764,775
Commercial Retained Loan Portfolio:
Mortgage loans held-for-investment........................ 24,05922,549 5,177
Mortgage loans held-for-investment, pledged............... 13,27513,317 17,717
Mortgage loans held-for-sale.............................. 7821,373 14,325
Mortgage loans held-for-sale, pledged..................... 31,96129,804 19,950
---------- ----------
70,07767,043 57,169
Cash and cash equivalents................................... 14,47718,009 15,483
Restricted cash............................................. 5,1615,063 5,240
Interest rate agreements.................................... 7779 66
Accrued interest receivable................................. 15,26312,946 15,797
Principal receivable........................................ 5,4379,357 7,986
Investment in RWT Holdings, Inc............................. -- 1,899
Other assets................................................ 2,1372,630 1,939
---------- ----------
Total Assets....................................... $2,285,909$2,073,488 $2,082,115
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt............................................. $ 992,597861,226 $ 756,222
Long-term debt, net......................................... 1,056,212971,365 1,095,835
Accrued interest payable.................................... 4,7434,592 5,657
Accrued expenses and other liabilities...................... 5,5556,701 4,180
Dividends payable........................................... 5,1295,590 4,557
---------- ----------
Total Liabilities.................................. 2,064,2361,849,474 1,866,451
---------- ----------
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01 per share; Class B 9.74%
Cumulative Convertible 902,068 shares authorized, issued
and outstanding ($28,645 aggregate liquidation
preference)............................................... 26,517 26,517
Common stock, par value $0.01 per share; 49,097,932 shares
authorized; 8,896,8388,924,789 and 8,809,500 issued and
outstanding............................................... 89 88
Additional paid-in capital.................................. 243,650244,305 242,522
Accumulated other comprehensive income...................... 2,5592,691 (89)
Cumulative earnings......................................... 34,43541,579 27,074
Cumulative distributions to stockholders.................... (85,577)(91,167) (80,448)
---------- ----------
Total Stockholders' Equity......................... 221,673224,014 215,664
---------- ----------
Total Liabilities and Stockholders' Equity......... $2,285,909$2,073,488 $2,082,115
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
31
4
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
------------------------SIX MONTHS ENDED JUNE
JUNE 30, 30,
----------------------- -----------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
Interest Income
Net Investment In Residential Credit Enhancement
Interests:
Mortgage securities available-for-sale..................available-for-sale................ $ 2,6423,403 $ 1,6152,135 $ 6,045 $ 3,750
Residential Retained Loan Portfolio:
Mortgage loans held-for-investment...................... 19,742 17,218held-for-investment.................... 16,293 22,916 36,035 40,134
Mortgage loans held-for-sale............................ 144 6,520held-for-sale.......................... 134 217 278 6,737
---------- ---------- 19,886 23,738---------- ----------
16,427 23,133 36,313 46,871
Investment Portfolio:
Mortgage securities trading............................. 16,939 17,060trading........................... 16,143 17,199 33,082 34,259
Mortgage securities available-for-sale.................. 109available-for-sale................ 419 -- 528 --
---------- ---------- 17,048 17,060---------- ----------
16,562 17,199 33,610 34,259
Commercial Retained Loan Portfolio:
Mortgage loans held-for-investment...................... 607held-for-investment.................... 1,092 -- 1,699 --
Mortgage loans held-for-sale............................ 1,326 211held-for-sale.......................... 869 393 2,195 604
---------- ---------- 1,933 211
Cash and cash equivalents................................. 312 314
---------- ----------
Total interest income..................................... 41,821 42,938
Interest Expense
Short-term debt........................................... (13,444) (19,164)
Long-term debt............................................ (17,838) (15,359)
---------- ----------
Total interest expense.................................... (31,282) (34,523)
Net interest rate agreements expense...................... (131) (408)1,961 393 3,894 604
Provision for credit losses on residential mortgage
loans held-for-investment..................................... (184) (119)held-for-investment............................. (164) (128) (348) (247)
Cash and cash equivalents............................... 264 276 576 590
---------- ---------- ---------- ----------
Total interest income after provision for credit
losses................................................ 38,453 43,008 80,090 85,827
Interest Expense
Short-term debt......................................... (11,625) (13,987) (25,069) (33,151)
Long-term debt.......................................... (15,167) (20,927) (33,005) (36,286)
Net interest rate agreements expense.................... (218) (219) (349) (627)
---------- ---------- ---------- ----------
Total interest expense and interest rate agreement
expense............................................... (27,010) (35,133) (58,423) (70,064)
Net Interest Income After Provision For Credit Losses..... 10,224 7,888Losses... 11,443 7,875 21,667 15,763
Net unrealized and realized market value gains (losses)
Loans and securities.................................... 3,132 (1,077)securities.................................. (471) (856) 2,661 (1,933)
Interest rate agreements................................ (491) (147)agreements.............................. 58 (503) (433) (650)
---------- ---------- ---------- ----------
Total net unrealized and realized market value gains
(losses)............................................... 2,641 (1,224)............................................ (413) (1,359) 2,228 (2,583)
Operating expenses........................................ (3,136) (2,147)expenses...................................... (3,886) (2,239) (7,022) (4,386)
Other income..............................................income............................................ -- 1521 -- 36
Equity in losses of RWT Holdings, Inc.....................Inc................... -- (568)(531) -- (1,099)
---------- ---------- ---------- ----------
Net income before preferred dividend and change in
accounting principle.................................... 9,729 3,964principle.................................. 7,144 3,767 16,873 7,731
Less dividends on Class B preferred stock.................stock............... (681) (681) (1,362) (1,362)
---------- ---------- ---------- ----------
Net income before change in accounting principle.......... 9,048 3,283principle........ 6,463 3,086 15,511 6,369
Cumulative effect of adopting EITF 99-20 (See Note 2)........ -- -- (2,368) --
---------- ---------- ---------- ----------
Net Income Available to Common Stockholders...............Stockholders............. $ 6,6806,463 $ 3,2833,086 $ 13,143 $ 6,369
========== ========== ========== ==========
Earnings per Share:
Basic Earnings Per Share:
Net income before change in accounting principle........principle...... $ 1.020.73 $ 0.370.35 $ 1.75 $ 0.72
Cumulative effect of adopting EITF 99-20................99-20.............. $ (0.26)-- $ -- $ (0.27) $ --
Net income..............................................income............................................ $ 0.760.73 $ 0.370.35 $ 1.48 $ 0.72
Diluted Earnings Per Share:
Net income before change in accounting principle........principle...... $ 1.000.70 $ 0.370.35 $ 1.70 $ 0.72
Cumulative effect of adopting EITF 99-20................99-20.............. $ (0.26)-- $ -- $ (0.27) $ --
Net income..............................................income............................................ $ 0.740.70 $ 0.370.35 $ 1.44 $ 0.72
Weighted average shares of common stock and common stock
equivalents:
Basic..................................................... 8,838,964 8,785,017
Diluted................................................... 9,065,221 8,844,606Basic................................................... 8,888,999 8,789,376 8,864,120 8,787,197
Diluted................................................. 9,184,195 8,883,651 9,121,108 8,862,505
The accompanying notes are an integral part of these consolidated financial
statements.
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REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
CLASS B ACCUMULATED
PREFERRED STOCK COMMON STOCK ADDITIONAL OTHER CUMULATIVE
---------------- ------------------ PAID-IN COMPREHENSIVE CUMULATIVE DISTRIBUTIONS TO
SHARES AMOUNT SHARES AMOUNT CAPITAL INCOME EARNINGS STOCKHOLDERS
------- ------ --------- ------ ---------- ------------- ---------- ----------------
Balance, December 31, 2000......2000..... 902,068 26,517 8,809,500 88 242,522 (89) 27,074 (80,448)
------- ------ --------- -- ------- ----- ------ -------
Comprehensive income:
Net income before preferred
dividend....................dividend................... 7,361
Reclassification adjustment
due to adoption of EITF
99-20.......................99-20...................... -- -- -- -- -- 2,368 -- --
Net unrealized lossgain on assets
available-for-sale..........available-for-sale......... -- -- -- -- -- 280 -- --
Total comprehensive income....income... -- -- -- -- -- -- -- --
Issuance of common stock........stock....... -- -- 87,338 1 1,128 -- -- --
Dividends declared:
Preferred.....................Preferred.................... -- -- -- -- -- -- -- Common........................(681)
Common....................... -- -- -- -- -- -- -- (4,448)
------- ------ --------- -- ------- ----- ------ -------
Balance, March 31, 2001.........2001........ 902,068 26,517 8,896,838 89 243,650 2,559 34,435 (85,577)
------- ------ --------- -- ------- ----- ------ -------
Comprehensive income:
Net income before preferred
dividend................... 7,144
Net unrealized gain on assets
available-for-sale......... -- -- -- -- -- 132 -- --
Total comprehensive income... -- -- -- -- -- -- -- --
Issuance of common stock....... -- -- 27,951 -- 655 -- -- --
Dividends declared:
Preferred.................... -- -- -- -- -- -- -- (681)
Common....................... -- -- -- -- -- -- -- (4,909)
------- ------ --------- -- ------- ----- ------ -------
Balance, June 30, 2001......... 902,068 26,517 8,924,789 89 244,305 2,691 41,579 (91,167)
======= ====== ========= == ======= ===== ====== =======
CUMULATIVE
DISTRIBUTIONS TO
STOCKHOLDERS TOTAL
----------------
-------
Balance, December 31, 2000...... (80,448)2000..... 215,664
-------
-------
Comprehensive income:
Net income before preferred
dividend....................dividend................... 7,361
Reclassification adjustment
due to adoption of EITF
99-20....................... --99-20...................... 2,368
Net unrealized lossgain on assets
available-for-sale.......... --available-for-sale......... 280
-------
Total comprehensive income.... --income... 10,009
Issuance of common stock........ --stock....... 1,129
Dividends declared:
Preferred.....................Preferred.................... (681)
(681)
Common........................Common....................... (4,448) (4,448)
-------
-------
Balance, March 31, 2001........ 221,673
-------
Comprehensive income:
Net income before preferred
dividend................... 7,144
Net unrealized gain on assets
available-for-sale......... 132
-------
Total comprehensive income... 7,276
Issuance of common stock....... 655
Dividends declared:
Preferred.................... (681)
Common....................... (4,909)
-------
Balance, June 30, 2001......... (85,577) 221,673
=======224,014
=======
The accompanying notes are an integral part of these consolidated financial
statements.
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REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
2001 2000 2001 2000
--------- --------- --------- ---------
Cash Flows From Operating Activities:
Net income available to common stockholders before
preferred dividend......................................dividend................................. $ 7,3617,144 $ 3,9643,767 $ 14,505 $ 7,731
Adjustments to reconcile net income to net cash
(used in)
provided by operating activities:
Depreciation and amortization........................... 1,291 1,131amortization........................ 2,319 457 3,610 1,588
Provision for credit losses............................. 184 119losses.......................... 164 128 348 247
Non-cash stock compensation............................. 143compensation.......................... 108 -- 251 --
Equity in losses of RWT Holdings, Inc. .................Inc................ -- 568531 -- 1,099
Net unrealized and realized market value (gains)
losses................................................. (2,641) 1,224losses............................................. 413 1,359 (2,228) 2,583
Cumulative effect of adopting EITF 99-20................99-20............. -- -- 2,368 --
Purchases of mortgage loans held-for-sale............... -- (25,734)held-for-sale............ (77,714) (9,800) (77,714) (35,534)
Proceeds from sales of mortgage loans
held-for-sale..... 238 405,616held-for-sale...................................... 3,386 17,298 3,624 422,914
Principal payments on mortgage loans held-for-sale...... 1,934 14,287held-for-sale... 255 4,906 2,189 19,193
Purchases of mortgage securities trading................trading............. -- (14,286) (296,907) (165,264)(179,550)
Proceeds from sales of mortgage securities trading...... 7,963 49,372trading... 162,753 27,937 170,716 77,309
Principal payments on mortgage securities trading....... 65,726 56,789trading.... 113,042 101,731 178,767 158,520
Net (purchases) sales of interest rate agreements....... (658) 117agreements.... (115) (1,002) (773) (885)
Decrease (increase) in accrued interest receivable...... 534 (1,676)
Decrease (increase)receivable... 2,317 (1,119) 2,851 (2,795)
(Increase) decrease in principal receivable............. 2,549 (838)
Decrease (increase)receivable.......... (3,920) 101 (1,371) (737)
(Increase) decrease in other assets..................... 913 (1,896)assets.................. (586) 2,051 308 155
(Decrease) increase in accrued interest payable......... (914) 253payable...... (151) 267 (1,065) 520
Increase (decrease) in accrued expenses and other liabilities............................................ 1,375 451liabilities... 1,146 1,311 2,521 1,762
--------- --------- --------- ---------
Net cash (used in) provided by operating activities......................................... (208,542) 338,483activities..... 210,561 135,637 2,000 474,120
--------- --------- --------- ---------
Cash Flows From Investing Activities:
Net assets acquired in purchase of RWT Holdings, Inc.
common stock............................................ (19) --
Purchases of mortgage loans held-for-investment...........held-for-investment...... (100) -- (100) (384,328)
Proceeds from sales of mortgage loans
held-for-investment..................................... 1,660held-for-investment................................ 718 -- 2,378 --
Principal payments on mortgage loans
held-for-investment..................................... 60,779 35,876held-for-investment................................ 86,617 56,827 147,396 92,703
Purchases of mortgage securities
available-for-sale....... (33,814) (9,151)available-for-sale................................. (77,246) (22,475) (111,060) (31,626)
Proceeds from sales of mortgage securities available-for-sale...................................... 3,034available-
for-sale........................................... 1,772 -- 4,806 --
Principal payments on mortgage securities available-for-sale...................................... 1,022 306available-
for-sale........................................... 2,078 343 3,100 649
Net decrease in restricted cash........................... 79 2,939cash...................... 98 (1,176) 177 1,763
Loans to RWT Holdings, Inc., net of repayments............repayments....... -- 5,1001,400 -- 6,500
Increase in receivable from RWT Holdings, Inc.............Inc........ -- (101)573 -- 472
--------- --------- --------- ---------
Net cash provided by (used in) investing
activities......................................... 32,741 (349,359)activities.................................. 13,937 35,492 46,697 (313,867)
--------- --------- --------- ---------
Cash Flows From Financing Activities:
Net (repayments) borrowings (repayments) on short-term debt............ 218,175 (331,160)debt....... (131,371) (115,762) 86,804 (446,922)
Proceeds from issuance of long-term debt.................. 16,948debt............. 85 -- 17,033 375,844
Repayments on long-term debt.............................. (56,756) (38,318)debt......................... (85,099) (55,239) (141,856) (93,557)
Net proceeds from issuance of common stock................ 986stock........... 548 -- 1,534 45
Dividends paid............................................ (4,557) (2,877)paid....................................... (5,129) (3,757) (9,686) (6,634)
--------- --------- --------- ---------
Net cash provided byused in financing activities.......... 174,795 3,534activities......... (220,966) (174,758) (46,171) (171,224)
--------- --------- --------- ---------
Net decreaseincrease (decrease) in cash and cash equivalents................... (1,006) (7,342)equivalents... 3,532 (3,629) 2,526 (10,971)
Cash and cash equivalents at beginning of period............period....... 14,477 12,539 15,483 19,881
--------- --------- --------- ---------
Cash and cash equivalents at end of period..................period............. $ 14,47718,009 $ 12,5398,910 $ 18,009 $ 8,910
========= ========= ========= =========
Supplemental disclosure of cash flow information:
Cash paid for interest....................................interest............................... $ 32,33027,991 $ 34,27034,647 $ 60,321 $ 68,917
========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
64
7
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31,JUNE 30, 2001
(UNAUDITED)
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. On January 1, 2001, Redwood Trust acquired 100% of the voting
common stock of Holdings and exchanged its preferred stock interest for
additional voting common stock in Holdings. As a result of this transaction,
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. For financial reporting purposes, references to the "Company" mean
Redwood Trust, Sequoia, and Holdings.
Redwood Trust, together with its affiliates, is a real estate finance
company specializing in owning, financing, and credit enhancing high-quality
jumbo residential mortgage loans nationwide. Redwood Trust also finances real
estate through its investment portfolio (mortgage securities) and its commercial
loan portfolio. Redwood Trust's primary source of revenue is monthly payments
made by homeowners on their mortgages, and 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 accompanying consolidated financial statements as of March 31,June 30, 2001 and
2000 are unaudited. The unaudited interim consolidated financial statements have
been prepared on the same basis as the annual consolidated financial statements
and, in the opinion of management, reflect all adjustments, which include only
normal recurring adjustments, necessary to present fairly the Company's
financial position, results of operations and cashflowscash flows as of March 31,June 30, 2001 and
2000. These consolidated financial statements and notes thereto, are unaudited
and should be read in conjunction with the Company's audited consolidated
financial statements included in the Company's Form 10-K for the year ended
December 31, 2000. The results for the threesix months ended March 31,June 30, 2001 are not
necessarily indicative of the expected results for the year ended December 31,
2001.
The March 31,June 30, 2001 consolidated financial statements include the accounts of
Redwood Trust, Sequoia and Holdings. The December 31, 2000 consolidated
financial statements include the accounts of Redwood Trust and Sequoia, and
Redwood Trust's equity interest in Holdings. Substantially all of the assets of
Sequoia, consisting primarily of residential whole loans shown as part of the
Residential Retained Loan Portfolio, are 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 which are 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 intercompany balances and
transactions with Sequoia and Holdings have been eliminated in the consolidation
of the Company at March 31,June 30, 2001. Certain amounts for prior periods have been
reclassified to conform to the March 31,June 30, 2001 presentation.
During March 1998, the Company acquired an equity interest in Holdings.
Prior to January 1, 2001, the Company owned all of the preferred stock and had a
non-voting, 99% economic interest in Holdings. The Company accounted for its
investment in Holdings under the equity method. Under this method, original
equity investments in Holdings were 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 acquired 100% of the voting
75
8
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31,JUNE 30, 2001
(UNAUDITED)
common stock of Holdings for $300,000 in cash consideration from two officers of
Holdings, and Holdings became a wholly-owned consolidated subsidiary of the
Company. This transaction did not have a material effect on the consolidated
financial statements of the Company.
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 valuesvalueS presented in Notes 3, 7 and 10.
Reserve for Credit Losses. A reserve for credit losses for the residential
retained loan portfolio is maintained at a level deemed appropriate by
management to provide for known losses, as well as potential losses inherent in
these mortgage loans. The reserve is based upon management's assessment of
various factors affecting its residential mortgage loans, including current and
projected economic conditions, delinquency status, and credit protection. 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. Reserves may also be
established if and when deemed necessary for the commercial retained loan
portfolio. 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 March 31,June 30, 2001 and December 31, 2000, 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 and has elected to not seek hedge
accounting for any of it's interest rate agreements.
ADOPTION OF EITF 99-20
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.
8
9
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED) EITF 99-20 establishes new
income and impairment recognition standards for interests in certain securitized
assets. Under the provisions of EITF 99-20, the holder of beneficial interests
should recognize the excess of all estimated cash flows attributable to the
beneficial interest estimated at the acquisition date over the initial
investment (the accretable yield) as interest income over the life of the
beneficial interest using the effective yield method. If the estimated cash
flows change, then the holder of the beneficial interest should recalculate
6
9
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
the accretable yield and adjust the periodic accretion recognized as income
prospectively. If the fair value of a beneficial interest has declined below its
carrying amount, an other-than-temporary decline is considered to exist if there
has been a decline in estimated future cash flows and the difference between the
carrying value and fair value of the beneficial interest is recorded as an
impairment loss through the income statement.
The Company adopted the provisions of EITF 99-20 effective January 1, 2001.
At that date, the Company held certain beneficial interests in which the fair
value had declined below their carrying value and current projections of cash
flows were less than cash flows anticipated at acquisition. Accordingly, the
Company recorded a $2.4 million charge through the Statement of Operations
during the quarter ended March 31, 2001 as a cumulative effect of a change in
accounting principle for certain mark-to-market adjustments on these beneficial
interests that had previously been recorded as unrealized losses through
Accumulative Other Comprehensive Income as a component of Stockholders' Equity.
Since this was a reclassification of declines in market values that had already
been recognized in the Company's balance sheet and stockholders' equity
accounts, there was no change in book value upon adoption. Any subsequent
income statementimpairment 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."assets" on the Consolidated Statement of Operations.
MORTGAGE ASSETS
The Company's mortgage assets consist of mortgage loans and mortgage
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 the effective yield method. Gains or
losses on the sale of Mortgage Assets are based on the specific identification
method.
Mortgage Loans: 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 has secured financing
through the term of the loan or otherwise has the intent and the ability to hold
to maturity, are classified as held-for-investment.
Mortgage Loans: Held-for-Sale
Mortgage loans held-for-sale (residential and commercial) 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."
Some of the commercial mortgage loans held by the Company are committed for
sale by the Company to Holdings, or a subsidiary of Holdings, under Master
Forward Commitment Agreements at December 31,
9
10
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
2000. As forward commitment agreements were entered into on the same date that
the Company committed 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 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.
7
10
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
Mortgage Securities: Available-for-Sale
Mortgage 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, aremay be recognized in income and the
carrying value of the mortgage security ismay be adjusted. Under the provisions of
EITF 99-20, other-than-temporary unrealized losses for certain mortgage
securities are based on 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 or an other-than-temporary 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. If future credit losses are less than the Company's original estimate,
the yield over the remaining life of the security may be adjusted.
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 of the Company includes principal and interest payments on
mortgage loans held as collateral for the Company's Long-Term Debt, cash pledged
as collateral on certain interest rate 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.
10
11
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
INTEREST RATE AGREEMENTS
The Company maintains an overall interest-rate risk-management strategy
that may incorporate the use of derivative interest rate agreements for a
variety of reasons, including minimizing significant fluctuations in earnings
that may be caused by interest-rate volatility. Interest rate agreements the
Company may use as part of its 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 (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
8
11
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
Company's adoption of SFAS No. 133 in 1998, the Company has elected not to seek
hedge accounting for its Interest Rate Agreements. 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.
DEBT
Short-Term Debt 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")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 90% 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
State 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 year, 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 the fourth quarter 2000, which
were paid in January 2001, are considered taxable income to stockholders in
2000, the year declared. All 2000 dividends were ordinary income to the
Company's preferred and common stockholders.
11
12
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
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.
NET INCOME PER SHARE
Basic net income per share is computed by dividing net income available to
common stockholders by the weighted average number of common shares outstanding
during the period. Diluted net income per share is computed by dividing the net
income 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
9
12
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
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.
The following tables provide reconciliations of the numerators and
denominators of the basic and diluted net income per share computations.
THREE MONTHS ENDED MARCH 31,
------------------------JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2001 2000 ---------- ----------2001 2000
------------ ------------ ----------- -----------
(IN THOUSANDS, EXCEPT SHARE DATA)
NUMERATOR:
Numerator for basic and diluted earnings per
share --
Net income before preferred dividend and
change in accounting principle...................................principle............ $ 9,7297,144 $ 3,9643,767 $ 16,873 $ 7,731
Cash dividends on Class B preferred stock.................stock.... (681) (681) (1,362) (1,362)
---------- ---------- ---------- ----------
Net income before change in accounting
principle.......... 9,048 3,283principle................................. 6,463 3,086 15,511 6,369
Cumulative effect of adopting EITF 99-20..................99-20..... -- -- (2,368) --
---------- ---------- ---------- ----------
Basic and Diluted EPS -- Net income available
to common stockholders...........................................stockholders.................... $ 6,6806,463 $ 3,2833,086 $ 13,143 $ 6,369
========== ========== ========== ==========
DENOMINATOR:
Denominator for basic earnings per share
Weighted average number of common shares
outstanding during the period...................................... 8,838,964 8,785,017period............. 8,888,999 8,789,376 8,864,120 8,787,197
Net effect of dilutive stock options...................... 226,257 59,589options......... 295,196 94,275 256,988 75,308
---------- ---------- ---------- ----------
Denominator for diluted earnings per share.................. 9,065,221 8,844,606share..... 9,184,195 8,883,651 9,121,108 8,862,505
========== ========== ========== ==========
BASIC EARNINGS PER SHARE:
Net income before change in accounting
principle............principle.................................... $ 1.020.73 $ 0.370.35 $ 1.75 $ 0.72
Cumulative effect of adopting EITF 99-20.................... (0.26)99-20....... -- -- (0.27) --
---------- ---------- ---------- ----------
Net income per share........................................share........................... $ 0.760.73 $ 0.370.35 $ 1.48 $ 0.72
========== ========== ========== ==========
DILUTED EARNINGS PER SHARE:
Net income before change in accounting
principle............principle.................................... $ 1.000.70 $ 0.370.35 $ 1.70 $ 0.72
Cumulative effect of adopting EITF 99-20....................99-20....... -- -- (0.26) --
---------- ---------- ---------- ----------
Net income per share........................................share........................... $ 0.740.70 $ 0.370.35 $ 1.44 $ 0.72
========== ========== ========== ==========
At March 31,June 30, 2001, the number of common equivalent shares issued by the
Company that were anti-dilutive totaled 743,143719,984 and were not included in the
calculation of diluted earnings per share.
12
13
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
COMPREHENSIVE INCOME
Current 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 March 31,June 30,
2001 and December 31, 2000, the only component of Accumulated Other
Comprehensive Income was net unrealized gains and losses on assets
available-for-sale.
10
13
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
RECENT ACCOUNTING PRONOUNCEMENTS
During March 2000,In July 2001, the Financial Accounting Standards Board ("FASB") issued FASB InterpretationSFAS No. 44, Accounting for Certain Transactions Involving Stock
Compensation -- an interpretation141
Business Combinations and SFAS 142 Goodwill and Other Intangible Assets. SFAS
No. 141, among other things, eliminates the use of APB Opinion No. 25 ("FIN 44"). FIN 44
clarifies the applicationpooling of APB Opinion No. 25 by expanding upon a numberinterests
method of
issues not specifically addressed in APB Opinion No. 25, such as the definition
of an employee and the accounting for modificationsbusiness combinations. Under the provisions of SFAS No.
142, goodwill will no longer be amortized, but will be subject 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 Companyperiodic
test for impairment based upon the adoption of FIN 44.
In September 2000, FASB issued Statement of Financial Accounting Standards
("FAS")fair values. SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments 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. 140141 is effective for transfers and servicingall
business combinations initiated after June 30, 2001. SFAS No. 142 will be
effective for the Company beginning January 1, 2002. The adoption of these
statements is not expected to have a material effect on the Company's 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.statements.
NOTE 3. MORTGAGE ASSETS
At March 31,June 30, 2001 and December 31, 2000, 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. 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 March 31,June 30, 2001 and December 31, 2000, the annualized effective yield
after taking into account the amortization expense due to prepayments on the
Mortgage Assets was 7.42%6.80% and 8.01%, respectively, based on the reported cost of
the assets. At March 31,June 30, 2001, 80%77% of the Mortgage Assets owned by the Company
were adjustable-rate mortgages, 14%16% were hybrid mortgages, and 6%7% were
fixed-rate mortgages. 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 March 31,June 30, 2001 and December 31, 2000, the coupons
on 61%54% and 59% 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 March 31,June 30, 2001 and December 31, 2000, the weighted average
lifetime cap on the adjustable-rate Mortgage Assets was 11.64%11.50% and 11.43%,
respectively.
13
14
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
At March 31,June 30, 2001 and December 31, 2000, Mortgage Assets consisted of the
following:
NET INVESTMENT IN RESIDENTIAL CREDIT ENHANCEMENT INTERESTS
MARCH 31,JUNE 30, 2001 DECEMBER 31, 2000
MORTGAGE SECURITIES MORTGAGE SECURITIES
AVAILABLE-FOR-SALE AVAILABLE-FOR-SALE
------------------- -------------------
(IN THOUSANDS)
Current Face.............................................. $155,233$266,004 $124,878
Unamortized Discount...................................... (21,137)(31,824) (16,883)
Portion Of Discount Designated As A Credit Reserve........ (35,722)(78,170) (27,052)
-------- --------
Amortized Cost............................................ 98,374156,010 80,943
Gross Unrealized Gains.................................... 3,4164,603 2,646
Gross Unrealized Losses................................... (941)(1,909) (2,825)
-------- --------
Carrying Value............................................ $100,849$158,704 $ 80,764
======== ========
As the Company purchases residential credit enhancement interests, 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.11
14
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
security, or may designate additional discount as reserve, thus lowering the
realized yield. If future credit losses are less than the Company's original
estimate, the yield over the remaining life of the security may be adjusted.adjusted
upward. At March 31,June 30, 2001 and December 31, 2000, the Company designated $35.7$78.2
million and $27.1 million as a credit reserve on its residential credit
enhancement interests, respectively.
The Company adopted the provisions of EITF 99-20 on January 1, 2001, and
recorded a $2.4 million charge during the quarter ended March 31, 2001 through
the Consolidated Statement of Operations as a cumulative effect of a change in
accounting principle for certain mark-to-market adjustments that had previously
been recorded as unrealized losses through Accumulative Other Comprehensive
Income as a component of Stockholders' Equity. Since this was a reclassification
of declines in market values that had previously been recognized in the
Company's balance sheet and stockholders' equity accounts, there was no change
in book value upon adoption. 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." The gains and losses on
the sales 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.
During the three and six months ended June 30, 2001, the Company purchased
residential credit enhancement interests of $61.2 million and $81.9 million,
respectively. During the three and six months ended June 30, 2000, the Company
purchased residential credit enhancement interests classified as available for
sale of $22.5 million and $31.6 million, respectively. During both the three and
six months ended June 30, 2001, the Company sold residential credit enhancement
interests for proceeds of $1.8 million, resulting in no net gain or loss on the
sales.
RESIDENTIAL RETAINED LOAN PORTFOLIO
MARCH 31,JUNE 30, 2001 DECEMBER 31, 2000
----------------------------------- -----------------------------------
HELD-FOR- HELD-FOR- HELD-FOR- HELD-FOR-
SALE INVESTMENT TOTAL SALE INVESTMENT TOTAL
--------- ---------- ---------- --------- ---------- ----------
(IN THOUSANDS)
Current Face................... $4,609 $1,059,024 $1,063,633Face.................... $79,890 $973,268 $1,053,158 $6,784 $1,115,386 $1,122,170
Unamortized Discount........... (85)Discount............ (296) -- (85)(296) (126) -- (126)
Unamortized Premium............ -- 13,239 13,239Premium............. 558 12,170 12,728 -- 13,767 13,767
------ ----------------- -------- ---------- ------ ---------- ----------
Amortized Cost................. 4,524 1,072,263 1,076,787Cost.................. 80,152 985,438 1,065,590 6,658 1,129,153 1,135,811
Reserve for Credit Losses......Losses....... -- (4,968) (4,968)(5,120) (5,120) -- (4,814) (4,814)
------ ----------------- -------- ---------- ------ ---------- ----------
Carrying Value................. $4,524 $1,067,295 $1,071,819Value.................. $80,152 $980,318 $1,060,470 $6,658 $1,124,339 $1,130,997
====== ================= ======== ========== ====== ========== ==========
The Company recognized gains of $0.1 million and losses of $0.1 million
during the three and six months ended March 31,June 30, 2000 as a result of LOCOM
adjustments on residential mortgage loans held-for-sale. No such losses were
recorded during the 14
15
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
three and six months ended March 31,June 30, 2001. During the three
and six months ended March 31,June 30, 2001, the Company purchased residential retained
loans classified as held-for-sale for $76.3 million. No such purchases were made
during the three and six months ended June 30, 2000. During the six months ended
June 30, 2000, the Company sold to Holdings residential mortgage loans
held-for-sale for proceeds of $380.5 million, resulting in no net gain or loss.
These assets were subsequently transferred to Sequoia during the threesix months
ended March 31,June 30, 2000, and are classified as part of Mortgage Loans Held-For-InvestmentHeld-For-
Investment and are Bond Collateral for Long-Term Debt (see Note 8).
12
15
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
INVESTMENT PORTFOLIO
MARCH 31,JUNE 30, 2001 DECEMBER 31, 2000
-------------------------------------------------------------------------------------- ------------------------------------------
MORTGAGE MORTGAGE MORTGAGE MORTGAGE
SECURITIES SECURITIES SECURITIES SECURITIES
TRADING AVAILABLE-FOR-SALE TOTAL TRADING AVAILABLE-FOR-SALE TOTAL
---------- ------------------ ------------------ ---------- ------------------ --------
(IN THOUSANDS)
Current Face............ $974,430 $13,040 $ 987,470Face.............. $699,434 $26,348 $725,782 $751,449 $5,500 $756,949
Unamortized Discount.... (165) (314) (479)Discount...... (176) (304) (480) (388) (427) (815)
Unamortized Premium..... 10,957 2,580 13,537Premium....... 8,699 5,189 13,888 8,551 -- 8,551
-------- ------- ------------------ -------- ------ --------
Unamortized Cost........ 985,222 15,306 1,000,528Cost.......... 707,957 31,233 739,190 759,612 5,073 764,685
Gross Unrealized Gains.................Gains.... -- 91 91153 153 -- 105 105
Gross Unrealized Losses................Losses... -- (7) (7)(156) (156) -- (15) (15)
-------- ------- ------------------ -------- ------ --------
Carrying Value.......... $985,222 $15,390 $1,000,612Value............ $707,957 $31,230 $739,187 $759,612 $5,163 $764,775
======== ======= ================== ======== ====== ========
Agency.................. $488,735Agency.................... $437,560 -- $ 488,735$437,560 $521,204 -- $521,204
Non-Agency.............. 496,487 15,390 511,877Non-Agency................ 270,397 31,230 301,627 238,408 5,163 243,571
-------- ------- ------------------ -------- ------ --------
Carrying Value.......... $985,222 $15,390 $1,000,612Value............ $707,957 $31,230 $739,187 $759,612 $5,163 $764,775
======== ======= ================== ======== ====== ========
For the three and six months ended March 31,June 30, 2001, the Company recognized
net market value losses of $0.4 million and net market value gains of $0.4
million on mortgage securities classified as trading, respectively. For the
three and six months ended June 30, 2000, the Company recognized anet market
value gainlosses of $0.7$0.9 million and a market value loss of $0.9$1.8 million on mortgage securities classified as
trading, respectively.
During the threesix months ended March 31,June 30, 2001, the Company purchased investment
portfolio securities classified as trading for $296.9 million. During the three
and six months ended June 30, 2000, the Company purchased investment portfolio
securities classified as trading for $14.2 million and $179.6 million,
respectively. During the three and six months ended June 30, 2001, the Company
sold mortgageinvestment portfolio securities classified as trading for proceeds of
$8.0$162.8 million and $49.0$170.7 million, respectively. During the three and six months
ended March 31,June 30, 2000, the Company sold investment portfolio securities classified
as trading for proceeds of $27.9 million and $77.3 million, respectively.
During the three and six months ended June 30, 2001, the Company purchased
investment portfolio securities classified as available-for-sale for $16.0
million and $29.2 million, respectively. No such purchases were made during the
three and six months ended June 30, 2000. During the six months ended June 30,
2001, the Company sold mortgageinvestment portfolio securities classified as
available-for-sale for proceeds of $3.0 million, resulting in a net gain of $0.1
million. No such sales were made during the first quarter ofsix months ended June 30, 2000. The
market value adjustments are reflected as a component of "Net unrealized and
realized market value gains (losses)" on the Consolidated Statements of
Operations.
COMMERCIAL RETAINED LOAN PORTFOLIO
MARCH 31,JUNE 30, 2001 DECEMBER 31, 2000
-------------------------------- -----------------------------------------------------------------
HELD-FOR- HELD-FOR- HELD-FOR- HELD-FOR-
SALE INVESTMENT TOTAL SALE INVESTMENT TOTAL
--------- ---------- ------- ------------------- ---------- -------
(IN THOUSANDS)
Current Face........................... $33,557 $37,694 $71,251$31,821 $36,144 $67,965 $34,275 $23,425 $57,700
Unamortized Discount................... (814) (360) (1,174)(644) (278) (922) -- (531) (531)
------- ------- ------- ------- ------- -------
Carrying Value......................... $32,743 $37,334 $70,077$31,177 $35,866 $67,043 $34,275 $22,894 $57,169
======= ======= ======= ======= ======= =======
The13
16
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
During the three and six months ended June 30, 2001, the Company sold
a commercial mortgage loanloans classified as held-for-investment for sales proceeds
of $1.7$0.7 million during the three months ending March 31, 2001,and $2.4, resulting in no net gain or loss on the sale. No such
sales occurred during the three and six months ended March
31,June 30, 2000. During the
three and six months ended March 31,June 30, 2001, the Company originated commercial
retained loans classified as held-for-sale for $1.4 million. During the three
and six months ended June 30, 2000, the Company originated commercial retained
loans classified as held-for-sale for $9.8 million and $35.5 million,
respectively.
During the six months ended June 30, 2000, Redwood Trust sold commercial
mortgage loans to Redwood Commercial Funding ("RCF"), a subsidiary of Holdings,
for proceeds of $8.4$25.3 million. Pursuant to
15
16
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED) Master Forward Commitment Agreements,
all commercial mortgage loans purchased by Redwood Trust were sold to RCF at the
same price for which the Redwood Trust acquires the commercial mortgage loans
(see Note 12). While Master Forward Sales Agreements are still in place, such
activity is not reflected in the March 31,June 30, 2001 consolidated financial
statements. Accordingly, there were no LOCOM adjustments or gains on sales
related to commercial mortgage loans sold to RCF during the three months ended
March 31,June 30, 2001 and 2000.
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:
THREE MONTHS ENDED MARCH 31,SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ----------------
2001 2000 2001 2000
------- ------- ------ ------
(IN THOUSANDS)
Balance at beginning of period.............................period.................. $4,968 $4,244 $4,814 $4,125
Provision for credit losses................................ 184 119
Charge-offs................................................ (30) --losses..................... 164 128 348 247
Charge-offs..................................... (12) (29) (42) (29)
------ ------ ------ ------
Balance at end of period................................... $4,968 $4,244period........................ $5,120 $4,343 $5,120 $4,343
====== ====== ====== ======
There is no reserve for credit losses at March 31,June 30, 2001 or December 31, 2000
for the commercial retained mortgage loan held-for-investment portfolio.
NOTE 5. COLLATERAL FOR LONG-TERM DEBT
The Company has collateral as security for Long-Term Debt issued in the
form of collateralized mortgage bonds ("Bond Collateral") and certain commercial
mortgage loans held-for-investment. The 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 and certain
commercial mortgage loans is limited to its net investment, as the Long-Term
Debt is non-recourse to the Company.
1614
17
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31,JUNE 30, 2001
(UNAUDITED)
The components of the collateral for the Company's long-term debt are
summarized as follows:
MARCH 31,JUNE 30, DECEMBER 31,
2001 2000
---------- ------------
(IN THOUSANDS)
Residential Mortgage Loans:
Residential Retained Loan Portfolio Held-For-Sale...................................Held-For-Sale........ $ 15578 $ 315
Residential Retained Loan Portfolio
Held-For-Investment............................. 1,067,295Held-For-Investment................................... 980,318 1,124,339
Restricted cash...................................... 2,770cash............................................ 2,444 3,729
Accrued interest receivable.......................... 5,995receivable................................ 4,985 7,010
---------- ----------
Total Residential Collateral......................... $1,076,215Collateral............................... $ 987,825 $1,135,393
Commercial Mortgage Loans Held-For-Investment........Held-For-Investment.............. $ 20,52620,626 $ --
---------- ----------
Total Long-Term Debt Collateral...................... $1,096,741Collateral............................ $1,008,451 $1,135,393
========== ==========
For presentation purposes, the various components of the Bond Collateral
summarized above are reflected in their corresponding line items on the
Consolidated Balance Sheets.
NOTE 6. INTEREST RATE AGREEMENTS
The Company reports its Interest Rate Agreements at fair value, and has not
elected to obtain hedge accounting treatment on any of its Interest Rate
Agreements.
During the three and six months ended March 31,June 30, 2001, the Company recognized
net market value gains of $0.1 million and net market value losses of $0.4
million on Interest Rate Agreements. During the three and six months ended June
30, 2000, the Company recognized net market value losses of $0.5 million and
$0.1$0.7 million on Interest Rate Agreements. The market value gains and losses are
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. The credit exposure reflects the fair market value of any
cash and collateral of the Company held by counterparties. The cash and
collateral held by counterparties are included in "Restricted Cash" and
"Mortgage Securities Trading" on the Consolidated Balance Sheets.
NOTIONAL AMOUNTS CREDIT EXPOSURE
-------------------------- ------------------------- MARCH 31,-----------------------
JUNE 30, DECEMBER 31, MARCH 31,JUNE 30, DECEMBER 31,
2001 2000 2001 2000
---------- ------------ ----------------- ------------
(IN THOUSANDS)
Interest Rate Options Purchased........................ $1,385,800Purchased......... $1,207,300 $1,490,300 -- --
Sold............................. 3,500 -- -- --
Interest Rate Swaps................Swaps..................... 55,000 5,000 $4,771$4,154 $2,814
Interest Rate Futures and Forwards......................... 147,000Forwards...... 133,000 506,600 705863 948
---------- ---------- ------ ------
Total.............................. $1,591,300Total................................... $1,395,300 $2,001,900 $5,476$5,017 $3,762
========== ========== ====== ======
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
15
18
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
yield of the specified index is below (above) the strike rate at the time of the
option expiration. The maximum
17
18
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED) 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
losses are partially offset by the 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 (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.
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 incurs 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 7. 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 March 31,June 30, 2001, the Company had $1.0 billion$0.9 million of Short-Term Debt
outstanding with a weighted-average borrowing rate of 5.28%4.45% and a
weighted-average remaining maturity of 170119 days. This debt was
16
19
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
collateralized with $1.0 billion$0.9 million of Mortgage Assets. At December 31, 2000, the
Company had $0.8 billion of
18
19
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED) 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 $0.8 billion of Mortgage Assets.
At March 31,June 30, 2001 and December 31, 2000, the Short-Term Debt had the
following remaining maturities:
MARCH 31,JUNE 30, DECEMBER 31,
2001 2000
----------------- ------------
(IN THOUSANDS)
Within 30 days....................................... $ 89,033$129,765 $100,885
31 to 90 days........................................ 255,013398,888 268,867
Over 90 days......................................... 648,551332,573 386,470
-------- --------
Total Short-Term Debt................................ $992,597$861,226 $756,222
======== ========
For both the three and six months ended March 31,June 30, 2001, the average balance
of Short-Term Debt was $0.9 billion with a weighted-average interest cost of
4.82% and 5.35%, respectively. For the three and six months ended June 30, 2000,
the average balance of Short-Term Debt was $0.9 billion and $1.2$1.0 billion with a
weighted-average interest cost of 5.91%6.47% and 6.25%6.34%, respectively. The maximum
balance outstanding during the threesix months ended March 31,June 30, 2001 and 2000, was $1.0
billion and $1.3 billion, respectively. The Company met all of it debt covenants
for its short-term borrowing arrangements and credit facilities during the threesix
months ended March 31,June 30, 2001 and 2000.
In addition to the committed facilities listed below, the Company has
uncommitted facilities with credit lines in excess of $4$4.4 billion at March 31,June 30,
2001. It is the intention of the Company's management to renew committed and
uncommitted facilities, if and as needed.
In March 2000, the Company entered into a $50 million committed revolving
mortgage warehousing credit facility. The facility is intended to finance newly
originated commercial mortgage loans. In September 2000, this facility was
extended through August 2001 and was increased to $70 million. At March 31,June 30, 2001,
the Company had borrowings under this facility of $34.2$31.2 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. Borrowings
under this facility bear interest based on a specified margin over the London
Interbank Offered Rate ("LIBOR"). At March 31,June 30, 2001, the weighted average
borrowing rate under this facility was 7.01%5.76%. This committed facility expires in
August 2001.
In July 2000, the Company 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. At March 31,June 30, 2001, the Company
had borrowings under this facility of $7.2 million. Borrowings under this
facility bear interest based on a specified margin over LIBOR. At March 31,June 30, 2001,
the weighted average borrowing rate under this facility was 6.66%5.31%. This
committed facility expiresexpired in July 2001.2001 and was not renewed by the Company.
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 March 31,June 30, 2001, the Company had
borrowings under these facilities of $30.6$36.3 million. Borrowings under these
facilities bear interest based on a specified margin over LIBOR. At March 31,June 30,
2001, the weighted average borrowing rate under these facilities was 5.98%4.76%.
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
17
20
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
investment grade ratings. In May 2001, this facility was increased to $30
million. At March 31,June 30, 2001, the Company had borrowings under this facility of
$14.4$29.9 million. Borrowings under this facility bear interest based on a specified
margin over LIBOR. At March 31,June 30, 2001, the
19
20
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED) weighted average borrowing rate under
this facility was 6.25%5.08%. This committed facility expires in October 2001.
NOTE 8. LONG-TERM DEBT
Long-Term Debt in the form of collateralized mortgage bonds is secured by
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.
For the three and six months ended March 31,June 30, 2001, 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 5.96% and
6.32%, respectively. For the three and six months ended June 30, 2000, 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 6.65% and 6.32%6.51%, respectively. At March 31,June 30, 2001 and December 31,
2000, accrued interest payable on Long-Term Debt was $2.6$2.3 million and $3.5$3.1
million, respectively, and is reflected as a component of Accrued Interest
Payable on the Consolidated Balance Sheets. For both the three and six months
ended March 31,June 30, 2001, and 2000, the average balance of Long-Term Debt was $1.1$1.0 billion. For
the three and six months ended June 30, 2001, the average balance of Long-Term
Debt was $1.3 billion and $1.0$1.1 billion, respectively.
The components of the Long-Term Debt at March 31,June 30, 2001 and December 31, 2000
along with selected other information are summarized below:
MARCH 31,JUNE 30, DECEMBER 31,
2001 2000
------------- ----------------------------- ---------------
(IN THOUSANDS)
Residential Long-Term Debt..................Debt................ $ 1,039,152954,054 $ 1,095,909
Commercial Long-Term Debt................... 16,948Debt................. 17,033 --
Unamortized premium on Long-Term Debt....... 2,934Debt..... 2,685 3,045
Deferred bond issuance costs................ (2,822)costs.............. (2,407) (3,119)
------------- ----------------------------- ---------------
Total Long-Term Debt..............Debt............ $ 1,056,212971,365 $ 1,095,835
============= ============================= ===============
Range of weighted-average interest rates,
by series -- residential..................... 5.34%residential................ 4.45% to 6.66%6.35% 6.35% to 7.20%
Stated residential maturities...............maturities............. 2017 - 2029 2017 - 2029
Number of residential series................series.............. 4 4
Weighted-average interest
rates -- commercial....................... 8.58commercial..................... 7.13% --
Stated commercial maturities................maturities.............. 2002 - 2003 --
Number of commercial series.................series............... 2 --
18
21
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
NOTE 9. INCOME TAXES -- HOLDINGS
The current provision for income taxes for Holdings for the three and six
months ended March 31,June 30, 2001 and 2000 was $3,200.$3,200 and is a component of "Operating
Expenses" on the Consolidated Statement of Operations. These amounts represent
the minimum California franchise taxes. No additional tax provision has been
recorded for the three and six months ended March 31,June 30, 2001 and 2000, as Holdings
reported a loss in years prior to 2001, and did not recognize a significant amount of net income
during the first threesix months of 2001.
In addition, due to the uncertainty of realization of net operating losses, no
deferred tax benefit has been
20
21
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED) 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 March 31,June 30, 2001 and December 31, 2000. At
both March 31,June 30, 2001 and December 31, 2000, the deferred tax assets and associated
valuation allowances were approximately $9.9 million and $9.5 million.million,
respectively. At both March 31,June 30, 2001 and December 31, 2000, Holdings had net operating
loss carryforwards of approximately $25.6 million and $24.6 million for federal
tax purposes, and $11$11.2 million and $11.0 million for state tax purposes.purposes,
respectively. The federal loss carryforwards and a portion of the state loss
carryforwards expire between 2018 and 2020,2021, while the largest portion of the
state loss carryforwards expire between 2003 and 2005.2006.
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 March 31,June 30, 2001 and December 31, 2000.
MARCH 31,JUNE 30, 2001 DECEMBER 31, 2000
--------------------------- ---------------------------
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
-------------- ---------- -------------- ----------
(IN THOUSANDS)
Assets
Mortgage Loans
Residential: held-for-sale......held-for-sale....... $ 4,52480,152 $ 4,52480,152 $ 6,658 $ 6,658
Residential:
held-for-investment........... 1,067,295 1,056,838held-for-investment............ 980,318 978,239 1,124,339 1,113,389
Commercial: held-for-sale....... 32,743 32,743held-for-sale........ 31,177 31,177 34,275 34,275
Commercial:
held-for-investment........... 37,334 37,334held-for-investment............ 35,866 35,866 22,894 22,894
Mortgage Securities
Residential: trading............ 985,222 985,222trading............. 707,957 707,957 759,612 759,612
Residential:
available-for-sale............ 15,390 15,390available-for-sale............. 31,230 31,230 85,927 85,927
Interest Rate Agreements........... 77 77Agreements............ 79 79 66 66
Investment in RWT Holdings, Inc....Inc..... -- -- 1,899 1,989
Liabilities
Short-Term Debt.................... 992,597 992,597Debt..................... 861,226 861,226 756,222 756,222
Long-Term Debt..................... 1,056,212 1,047,194Debt...................... 971,365 968,203 1,095,835 1,085,368
The carrying values of all other balance sheet accounts as reflected in the
consolidated 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
19
22
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
(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
made on the Common Stock. At both March 31,June 30, 2001 and December 31, 2000, 96,732
shares of the Preferred Stock have been converted into 96,732 shares of the
Company's Common Stock.
21
22
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
In March 1999, the Company's Board of Directors approved the repurchase of
up to 150,000 shares of the Company's Preferred Stock. The Company did not
repurchase any shares of Preferred Stock during the three and six months ended
March 31,June 30, 2001 and 2000. At March 31,June 30, 2001, there remained 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.
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. Of these 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 March 31,June 30, 2001 and December 31, 2000, 441,304437,975 and 476,854 shares of
Common Stock, respectively, were available for grant. At March 31,June 30, 2001, 28,000
shares of restricted stock had been granted. No restricted stock had been
granted prior to December 31, 2000. At March 31,June 30, 2001 and December 31, 2000,
331,652324,152 and 328,152 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 and
restricted stock awarded under the Plan vest no earlier than ratably over a
four-year period from the date of grant or award and all stock options granted
expire within ten years after the date of grant.
The Company has granted stock options that 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 past. To the extent the Company
increases its common dividends or the market price of the Common Stock
increases, such operating expenses may increase. For the three and six months
ended March 31,June 30, 2001, and 2000, the Company accrued cash and stock DER expenses of $1.0
million and $0.4$1.7 million, respectively. For the three and six months ended June
30, 2000, the Company accrued cash and stock DER expenses of $0.5 million and
$1.0 million, respectively. Stock DERs represent shares of stock which are
issuable to holders of stock options when the holders exercise the underlying stock options.options and are
considered to be variable stock awards under the provisions of Accounting
Principles Board ("APB") Opinion 25. For the three and six months ended June 30,
2001, the Company recognized variable stock option expense of $0.5 million and
$0.7 million, respectively. 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. At March 31,June 30, 2001 and December 31,
2000, there were 166,459170,318 and 166,451 unexercised options with stock DERs under
the Plan, respectively. Cash DERs are
20
23
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
accrued and paid based on the level of the Company's common stock dividend. At
March 31,June 30, 2001 and December 31, 2000, there were 1,155,3721,159,372 and 1,180,797
unexercised options with cash DERs under the Plan, respectively. At March 31,June 30,
2001 and December 31, 2000, there were 154,550150,019 and 147,550 outstanding stock
options that did not have DERs, respectively.
22
23
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
A summary of the status of the Company's stock options issued under the
Plan as of March 31June 30 and changes during the three months ending on that date is
presented below.
MARCH 31, 2001 MARCH 31, 2000THREE MONTHS ENDED SIX MONTHS ENDED
---------------------------- ----------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
--------- ---------------- --------- ----------------
(IN THOUSANDS, EXCEPT SHARE DATA)
Outstanding options at January
1..............................beginning of
period........................... 1,476,381 $22.40 1,494,798 $22.32
1,713,836 $21.97
Options granted................ 4,000 $20.02 11,000 $12.55granted.................. 10,469 $18.16 14,469 $18.67
Options exercised..............exercised................ -- -- (25,967) $14.00
(6,035) $ 3.02
Options canceled............... (500) $18.94 (144,225) $14.04canceled................. (11,000) $23.44 (11,500) $23.25
Dividend equivalent rights
earned...................... 4,050earned........................ 3,859 -- 3,5567,909 --
--------- ---------
Outstanding options at March
31............................. 1,476,381 $22.40 1,578,132 $22.66June 30,
2001............................. 1,479,709 $22.30 1,479,709 $22.30
========= =========
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 three months ended March 31,June 30, 2001 and 2000. At March 31,June 30, 2001, there
remained 1,000,000 shares available under the authorization for repurchase.
Common stock previously repurchased has been returned to the Company's
authorized but unissued shares of Common Stock.
NOTE 12. COMMITMENTS AND CONTINGENCIES
At March 31,June 30, 2001, the Company had entered into commitments to purchase $1.6$19
million of residential mortgage securitiesloans for settlement during April and
MayJuly 2001. At March 31,June
30, 2001, the Company has committed to fund an additional $4 million on its
commercial mortgage loans to existing borrowers, provided the borrowers meet
certain conditions.
At June 30, 2001, the Company is obligated under non-cancelable operating
leases with expiration dates through 2006. The total future minimum lease
payments under these non-cancelable leases is $3.0$3.2 million and is expected to be
recognized as follows: 2001 -- $0.5 million; 2002 -- $0.6$0.7 million; 2003 -- $0.6$0.7
million; 2004 -- $0.6 million; 2005 -- $0.5 million; 2006 -- $0.2 million.
23NOTE 13. SUBSEQUENT EVENTS
In July 2001, the Company completed a secondary offering of 1,092,500
shares of common stock for net proceeds of $24 million to fund the expansion of
its residential loan finance business.
On August 9, 2001, the Company's Board of Directors declared both a special
and a regular common stock dividend for the third quarter of 2001. The special
third quarter cash dividend of $0.18 per common share is payable on August 31,
2001 to shareholders of record on August 20, 2001. The regular quarterly cash
dividend for the third quarter of $0.57 per common share is payable on October
22, 2001 to shareholders of record as of September 28, 2001. The Board of
Directors also declared the third quarter preferred dividend of $0.755 per
share, payable on October 22, 2001, to preferred shareholders of record as of
September 28, 2001.
21
24
ITEM 2. MANAGEMENT'S2.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: Certain matters discussed in this Form 10-Q may constitute
forward-looking statements within the meaning of the federal securities laws
that inherently include certain risks and uncertainties. We undertake no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise. In light of these
risks, uncertainties and assumptions, any forward-looking events discussed
herein might not occur. Actual results and the timing of certain events could
differ materially from those projected in or contemplated by the forward-looking
statements due to a number of factors, including, among other things, credit
results for our mortgage assets, our cash flows and liquidity, 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 the Company's Form 10-K.10-K for the year ended December 31, 2000. Other
factors not presently identified may also cause actual results to differ. 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 above will continue to be accurate in the
future. Throughout this Form 10-Q and other company documents, the words
"believe", "expect", "anticipate", "intend", "aim", "will", and similar words
identify "forward-looking" statements.
RESULTS OF OPERATIONS
Consolidation of Financial Statements
On January 1, 2001, Redwood Trust, Inc. ("Redwood") acquired 100%This Form 10-Q contains statistics and other data that in some cases have
been obtained from, or compiled from, information made available by servicing
entities and information service providers. In addition, some of the common stock of RWT Holdings, Inc., ("Holdings") equivalent to a 1% economic
interest in Holdings. As a result, Redwood now presents the financial statements
of Redwood and Holdings on a consolidated basis. Thus, assets and liabilities of
Holdings now appear on our consolidated statements as assets and liabilities,
instead of being netted against our equity investment in Holdings. In accordance
with generally accepted accounting principles, the financial statements for
prior yearshistorical
presentations contained herein have not been restated to conform to current formats.
REDWOOD TRUST
Redwood Trust is a real estate finance company specializing in owning,
financing, and credit enhancing high-quality jumbo residential mortgage loans
nationwide. Jumbo residential loans have mortgage balances that exceed the
consolidated formatfinancing limit imposed on Fannie Mae and Freddie Mac, both of which are United
States government-sponsored real estate finance entities. Most of the loans that
we finance have mortgage loan balances between $275,000 and $600,000.
We finance high-quality jumbo loans in two ways -- through our residential
credit enhancement portfolio and our residential retained loan portfolio. In our
residential credit enhancement portfolio, we enable the securitization and
funding of mortgage loans in the capital markets by committing our capital to
partially credit enhance the mortgage loans. We do this by structuring and
acquiring subordinated credit enhancement interests that are created at the time
the mortgage loans are securitized. After we have credit enhanced these mortgage
loans, collateralized mortgage-backed securities can be created with investment
grade debt ratings and then sold into the global capital markets to fund the
underlying mortgages. In essence, we perform the equivalent of a guarantee or
insurance function with respect to these mortgage loans. At June 30, 2001, the
aggregate principal value of the loans we credit enhanced in our credit
enhancement portfolio was $38 billion.
In our residential retained mortgage loan portfolio, we acquire mortgage
loans and hold them on our balance sheet to earn interest income. We typically
fund the purchase of these mortgage loans through the issuance of long-term
amortizing debt. At June 30, 2001, the aggregate principal value of loans in our
residential retained loan portfolio was $1 billion.
We have elected and anticipate that we will continue to be used in 2001 and beyond.organized as a
real estate investment trust ("REIT"). As a REIT, we distribute substantially
all of our net taxable earnings to stockholders as dividends. As long as we
retain our REIT status, we will not pay most types of corporate income taxes.
22
25
RESULTS OF OPERATIONS
Earnings Per Share Summary
Core earnings were $0.71$0.80 per share for the firstsecond quarter of 2001, an
increase of 39%57% over firstsecond quarter of 2000 core earnings of $0.51 per share.
Reported earnings per share for the firstsecond quarter of 2001 were $0.74, a 100%
increase over the firstdoubled to $0.70 from
second quarter of 2000 reported earnings per share of $0.37.$0.35. Reported earnings
include mark-to-market adjustments.adjustments to certain assets, hedges, and variable stock
options.
Core earnings for the first six months of 2001 were $1.53 per share, an
increase of 50% over core earnings for the first six months of 2000 of $1.02 per
share.
Reported earnings for the first six months in 2001 doubled to $1.44 per
share from the $0.72 per share we reported for the first six months of 2000.
Our regular common stock dividend was $0.50 for the first quarter of 2001
was $0.50 per
share. Book valueand $0.55 per share and for the second quarter of 2001. For the third quarter of
2001, the Board of Directors at its meeting on August 9, 2001, declared both a
regular cash dividend of $0.57 per common share and a special cash dividend of
$0.18 per common share.
Net Interest Income After Credit Expenses
Net interest income after credit expenses rose from $21.47 to $21.94 during the quarter.
Revenues Summary
Revenues declined from $42.8$7.9 million in the
firstsecond quarter of 2000 to $41.6$11.4 million in the firstsecond quarter of 2001. We
benefited from our continuing strategy of increasing our high-quality jumbo
residential mortgage loan business, a business where we believe we have a solid
competitive position and favorable long-term market trends. We also benefited
from rapidly falling interest rates in the second quarter of 2001, as our cost
of funds declined faster than our asset yields. Net interest income divided by
average equity increased from 14.78% in the second quarter of 2000 to 20.76% in
the second quarter of 2001.
We believe that we have reduced the potential sensitivity of our net
interest income and earnings to changes in interest rates and prepayment rates,
although earnings are still sensitive to such market factors. We generally
maintained or increased our portfolio margins last year when short-term interest
rates increased. Although averagewe believe that over time we have increased the
stability of our margins, as part of our asset/liability strategy we have
allowed for the possibility of increased margins on a temporary basis following
periods of short-term interest rate decline. This allowed us to benefit in the
first half of 2001 from the recent fall in short-term interest rates. We
currently expect that earnings per share in the second half of 2001 may decline
from the $1.53 per share of core earnings we generated in the first half of 2001
as the exceptional benefit we are currently experiencing from falling short-term
interest rates may prove to be temporary.
The ongoing changes we continue to make in our product mix, emphasizing
residential loan products rather than the mortgage securities in our investment
portfolio, are designed to increase our normalized, sustainable, long-term rate
of earnings, cash flow, and dividends.
23
26
TABLE 1
NET INTEREST INCOME
(ALL DOLLARS IN THOUSANDS)
TOTAL NET INTEREST INTEREST
INTEREST INTEREST RATE RATE NET
INCOME COST OF INCOME COST OF SPREAD MARGIN INTEREST
REVENUES FUNDS AFTER EARNING FUNDS AFTER AFTER INCOME/
AFTER CREDIT PLUS CREDIT ASSET PLUS CREDIT CREDIT AVERAGE
PROVISIONS HEDGING PROVISIONS YIELD HEDGING PROVISIONS PROVISIONS EQUITY
------------ -------- ---------- ------- ------- ---------- ---------- --------
Q2: 2000.............. $43,008 $(35,133) $ 7,875 7.54% 6.62% 0.92% 1.34% 14.78%
Q3: 2000.............. 41,679 (34,694) 6,985 7.62% 6.87% 0.75% 1.25% 13.10%
Q4: 2000.............. 41,755 (33,845) 7,910 7.88% 6.96% 0.92% 1.46% 14.68%
Q1: 2001.............. 41,637 (31,413) 10,224 7.72% 6.34% 1.38% 1.85% 18.83%
Q2: 2001.............. 38,453 (27,010) 11,443 7.18% 5.45% 1.73% 2.06% 20.76%
Six Months: 2000...... $85,827 $(70,064) $15,763 7.39% 6.48% 0.91% 1.32% 14.77%
Six Months: 2001...... 80,090 (58,423) 21,667 7.45% 5.90% 1.55% 1.95% 19.80%
Revenues Summary
Interest income revenues (after credit expenses) declined from $43.0
million in the second quarter of 2000 to $38.5 million in the second quarter of
2001. Average earning assets yields increaseddecreased from 7.25%7.54% to 7.72%7.18% with risingfalling
interest rates, and our average balance of earning assets (as reported
on-balance sheet) fell from $2.4$2.3 billion to $2.2$2.1 billion. In general, unless we increase our capital base, ourRevenues of $80.1
million for the first six months of 2001 were lower than revenues may continueof $85.8
million in the first six months of 2000 due to decline aslower average balance of earning
assets.
If we continue to shift our product mix towards our credit enhancement
portfolio. If we continue with this change in product mix,portfolio, our reported assets and revenues may continue to decline. Recent
declines in short-term interest rates may also reduce our revenue levels as our
adjustable rate asset yields adjust to lower index levels. However, we would
also expect that borrowings and interest expenses would decline, and that the
net result may be favorablean increase in net interest income over time.
24
25
TABLE 12
TOTAL INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
RESIDENTIAL
RETAINED
NET PORTFOLIO TOTAL
AVERAGE PREMIUM CREDIT INTEREST EARNING
EARNING COUPON AMORTIZATION PROVISION INCOME ASSET
ASSETS INCOME EXPENSE EXPENSE REVENUES YIELD
---------- --------------- ------------ ----------- -------- -------
Q1: 2000.......................... $2,363,903Q2: 2000............................ $2,282,889 $43,091 $ 43,460 $ (522) $ (119) $ 42,819 7.25%
Q2: 2000.......................... 2,282,889 43,091 45 (128) 43,008$(128) $43,008 7.54%
Q3: 2000..........................2000............................ 2,187,936 42,959 (1,040) (240) 41,679 7.62%
Q4: 2000..........................2000............................ 2,118,952 42,817 (818) (244) 41,755 7.88%
Q1: 2001..........................2001............................ 2,156,741 42,690 (869) (184) 41,637 7.72%
1999.............................. $2,200,916 $152,472 $(5,162) $(1,346) $145,964 6.63%
2000.............................. 2,237,956 172,327 (2,335) (731) 169,261 7.56%Q2: 2001............................ 2,142,496 40,502 (1,885) (164) 38,453 7.18%
Six Months: 2000.................... $2,323,396 $86,551 $ (477) $(247) $85,827 7.39%
Six Months: 2001.................... 2,149,579 83,192 (2,754) (348) 80,090 7.45%
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
discussionEach 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.product
lines is a component of our single business segment of real estate finance.
24
27
Residential Credit Enhancement Portfolio
The balance of residential loans that we credit enhance increased from $23$27
billion to $27$38 billion during the firstsecond quarter of 2001. These loans do not
appear on our reported balance sheet; only our net investment in the credit
enhancement interests for these loans appear on our balance sheet. Credit
enhancement revenue increased to $2.7$3.4 million in the second quarter of 2001 from
$2.1 million in the second quarter of 2000 as our net investment in credit
enhancement assets increased. We
acquired $31 million principal value of credit enhancement assets in the first
quarter of 2001 at a cost of $21 million. At March 31, 2001, the total principal
value of our credit enhancement interests was $155 million. We acquired these
interests at an adjusted cost of $101 million. Of the $54 million difference
between principal value and amortized costs, $36 million is designated as credit
reserve and $18 million is designated as a purchase discount to be amortized
into income over time.
We continue to establish what we believe to be an appropriate level of
credit reserves upon acquisition of these assets. Should we experience better
than projected future credit results, some of these credit reserves may be
reduced, thereby positively affecting future yields on this portfolio. We expect
solid growth in this portfolio in the second quarter of 2001. If favorable market conditions continue, we expect
to pursue growth in this portfolio throughout the year. However, asset growth
was exceptional in the second quarter of 2001 as we closed several large credit
enhancement transactions involving high-quality seasoned jumbo residential
loans. We would not normally expect to continue future growth at this rate.
At June 30, 2001, we owned $266 million face value of credit enhancement
interests at a cost basis of $159 million. Of the $107 million difference
between principal value and our cost, $78 million is designated as credit
reserve and $29 million is designated as a purchase discount to be amortized
into income over time.
Our credit enhancement portfolio yield after the effect of credit reserves
was 12.32%11.97% during the firstsecond quarter of 2001. The average yield on this portfolio has declined2001, a decline from 16.95%16.07% in the
firstsecond quarter of 20002000. This is due primarily to the acquisition of new assets for which we set up
relatively large initial reserves and thus relatively low initial yields.
Additionally, we have acquired an increased
proportion of third loss interests that have lower yields than first or second
loss interests due to their lower risk levels. In today's environment, accountingFor the same reason, yields initially booked on these assetsfor
this portfolio fell from 16.43% during the first six months of 12%2000 to 13% (after setting aside credit reserves) generally allow returns on
equity capital employed before overhead12.11%
during the first six months of 14%2001.
We continue to 15% after our modest use of
leverage. Actual long-term returns on this capital couldestablish what we believe to be lower or higher as a
function of a number of factors, with the principal factor being future credit
results. At March 31, 2001, we had set aside $36 millionan appropriate level of
credit reserves forupon acquisition of these assets. If future credit results are
satisfactory, we may not need all of 25
26
these reserves. Should this be determined,
we canwill then reverse somedesignate a portion of theseour internal reserves into income over time,as discount rather
than credit reserve, thus increasing ourfuture discount amortization income and
future asset yields.
Although we do
expect material credit losses, it may be useful to note that our long-term
return on equity before overhead from this current portfolio, assuming our
modest use of leverage, expected prepayment rates, and so forth, could be as
high as 20% to 23% in the event that there are no credit losses or credit losses
are very minor. Thus, assuming credit losses are not greater than implied by our
reserve levels, a reasonable expectation of long-term returns from this current
portfolio might be 14% to 23% return on equity before overhead. However,
achieving such returns is subject to many factors.
TABLE 23
CREDIT ENHANCEMENT PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
AVERAGE NET TOTAL
AVERAGE AVERAGE NET DISCOUNT INTEREST
PRINCIPAL CREDIT DISCOUNT AVERAGE COUPON AMORTIZATION INCOME
VALUE RESERVE BALANCE BASIS INCOME INCOME REVENUES YIELD
--------- -------- -------- --------------- ------ ------------ -------- ------------
Q1:Q2: 2000............. $ 56,439 $(11,567)77,173 $(16,361) $ (6,758) $38,114 $1,048(7,654) $ 567 $1,615 16.95%
Q2: 2000............. 77,173 (16,361) (7,654) 53,158 1,412$1,412 $ 723 2,135$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%
Q1: 2001............. 135,471 (31,415) (18,260) 85,796 2,516 126 2,642 12.33%
1999.................12.32%
Q2: 2001............. 184,472 (48,845) (21,920) 113,707 3,242 161 3,403 11.97%
Six Months: 2000..... $ 27,97666,806 $(13,964) $ (6,816)(7,206) $ (2,891) $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%45,636 $2,460 $1,290 $3,750 16.43%
Six Months: 2001..... 160,106 (40,178) (20,100) 99,828 5,758 287 6,045 12.11%
Credit losses for the entire $27$38 billion portfolio that we credit enhanced
at March 31,June 30, 2001 declined in the first quarter of 2001 to $0.6 million from
$1.5totaled $1.0 million in the previous quarter.second quarter of 2001. The
annualized rate of credit loss was
less than 1 basis point (0.01%) of the portfolio. Of
this loss, $550,000$0.8 million was borne by the external credit enhancements to our
positions and $55,000$0.2 million was incurred by us and charged against our internal
reserves. At quarter-end, we had $86$91 million of external credit enhancements and
$36$78 million of internal credit reserves for this portfolio. External credit
reserves serve to protect us from credit losses on our $27 billion credit enhancement portfolio on a specific asset basis. It representsbasis and
represent the principal value of first and second loss interests that are junior
to us and are owned by others. Total reserves of $122$169 million represented 4544
basis points (0.45%(0.44%) of our credit enhancement portfolio.portfolio of $38 billion.
Reserves, credit protections, and risks are specific to each asset. Unlike
general reserves, specific reserves cannot be reallocated to other assets.credit-enhancement
interest.
Delinquencies (over 90 days, foreclosure, bankruptcy, and REO) in our
credit enhancement portfolio increased from 0.23% of the current balances at
December 31, 2000 to 0.24%0.26% at June 30, 2001. This increase was largely the
result of the current balances at March 31, 2001.acquisitions of credit enhancement interests on seasoned loan pools
that had
25
28
delinquency levels higher than those of our average portfolio. We expect
delinquency and loss rates for our whole loan portfolio to continue to increase
from their current modest levels, given the weakening economy and the natural seasoning
pattern of these loans. 26
27Potential future acquisitions of seasoned pools of loans
may also increase our average delinquency rate.
TABLE 34
TOTAL RESIDENTIAL CREDIT ENHANCEMENT PORTFOLIO -- CREDIT RESULTS
(AT PERIOD END, ALL DOLLARS IN THOUSANDS)
ANNUALIZEDLOSSES TOTAL
REDWOOD'S TO CREDIT REDWOOD'S
UNDERLYING DELINQUENCIES SHARE OF EXTERNAL TOTAL LOSSES AS
SHARE OF
MORTGAGE --------------- CREDIT CREDIT CREDIT % OF CREDITLOANS
LOANS $ % LOSSES LOANSENHANCEMENT LOSSES (ANNUALIZED)
----------- ------- --------- --------- ----------- ------- ---------- ---------------------
Q1: 2000.................... $ 8,539,491 $49,731 0.58% $ (813) 0.04% $ (270)
Q2: 2000.................... 20,925,931 45,9992000................. $20,925,931 $45,999 0.22% (1,537)$(187) $(1,350) $(1,537) 0.03%
(187)
Q3: 2000....................2000................. 21,609,785 58,102 0.27% (245) (345) (590) 0.01%
(245)
Q4: 2000....................2000................. 22,633,860 51,709 0.23% (56) (1,512) (1,568) 0.03%
(56)
Q1: 2001....................2001................. 27,081,361 63,893 0.24% (55) (550) (605) 0.01%
(55)
1999........................Q2: 2001................. 38,278,631 98,287 0.26% (196) (824) (1,020) 0.01%
Six Months: 2000......... $20,925,931 $45,999 0.22% $(457) $(1,893) $(2,350) 0.03%
Six Months: 2001......... 38,278,631 98,287 0.26% (251) (1,374) (1,625) 0.01%
Most of the loans we credit enhance are "A+" quality loans. We refer to
loans as A+ quality when they generally meet the secondary mortgage market
standards for top quality loans. We also credit enhance a smaller amount of
"Alt-A" loans. Generally, Alt-A loans are A-quality loans made to A-quality
borrowers that have specific requirements that are exceptions to standard A+
jumbo underwriting criteria. Alt-A loan pools, for instance, may contain higher
levels of self-employed borrowers, limited documentation loans, second homes,
investor properties, and 2-4 family properties. The following two tables present
the credit performance for these two subsets of our total credit enhancement
portfolio.
TABLE 5
CREDIT ENHANCEMENT PORTFOLIO - CREDIT RESULTS FOR ALT-A LOANS
(AT PERIOD END, ALL DOLLARS IN THOUSANDS)
LOSSES TOTAL
REDWOOD'S TO CREDIT
UNDERLYING DELINQUENCIES SHARE OF EXTERNAL TOTAL LOSSES AS
MORTGAGE -------------- CREDIT CREDIT CREDIT % OF LOANS
LOANS $ 6,376,571 $45,451% LOSSES ENHANCEMENT LOSSES (ANNUALIZED)
---------- ------- ---- --------- ----------- ------- ------------
Q2: 2000.................... $649,090 $32,981 5.08% $(181) $(1,329) $(1,510) 0.93%
Q3: 2000.................... 613,682 36,010 5.87% (241) (277) (518) 0.34%
Q4: 2000.................... 562,696 28,990 5.15% (54) (858) (912) 0.65%
Q1: 2001.................... 512,025 26,836 5.24% (53) (546) (599) 0.47%
Q2: 2001.................... 439,077 25,754 5.87% (184) (348) (532) 0.48%
Six Months: 2000............ $649,090 $32,981 5.08% $(450) $(1,869) $(2,319) 0.71%
$(3,141) 0.05% $(1,146)
2000........................ 22,633,860 51,709 0.23% (4,508) 0.02% (758)Six Months: 2001............ 439,077 25,574 5.87% (237) (894) (1,131) 0.52%
Delinquencies as a percentage of current loan balances for Alt-A loans
appear high in part because these are highly seasoned pools where most of the
original loans in these pools have prepaid. Credit losses in these pools have
been declining. Our total internal and external credit reserves for this sub-set
of our credit-enhancement portfolio were $22.2 million at June 30, 2001.
For the A+ loans in our credit enhancement portfolio, delinquencies as a
percentage of current loan balances rose slightly in the second quarter of 2001
largely due to the acquisition of credit-enhancement interests in seasoned
portfolios.
26
29
TABLE 6
CREDIT ENHANCEMENT PORTFOLIO -- CREDIT RESULTS FOR A+ LOANS
(AT PERIOD END, ALL DOLLARS IN THOUSANDS)
LOSSES TOTAL
REDWOOD'S TO CREDIT
UNDERLYING DELINQUENCIES SHARE OF EXTERNAL TOTAL LOSSES AS
MORTGAGE -------------- CREDIT CREDIT CREDIT % OF LOANS
LOANS $ % LOSSES ENHANCEMENT LOSSES (ANNUALIZED)
----------- ------- ---- --------- ----------- ------ ------------
Q2: 2000................... $20,276,841 $13,018 0.06% $ (6) $ (21) $ (27) 0.00%
Q3: 2000................... 20,996,103 22,092 0.11% (4) (68) (72) 0.00%
Q4: 2000................... 22,071,164 22,719 0.10% (2) (654) (656) 0.01%
Q1: 2001................... 26,569,336 37,057 0.14% (2) (4) (6) 0.00%
Q2: 2001................... 37,839,554 72,533 0.19% (12) (476) (488) 0.01%
Six Months: 2000........... $20,276,841 $13,018 0.06% $ (7) $ (24) $ (31) 0.00%
Six Months: 2001........... 37,839,554 72,533 0.19% (14) (480) (494) 0.01%
At March 31,June 30, 2001, we credit-enhancedcredit enhanced over 77,000105,700 loans with(with a total principal
value of $27 billion.$38 billion) in our total credit enhancement portfolio. Of these, 61%
were fixed-rate loans, 11%20% were hybrid loans (loans that become adjustable after
a 3 to 10 year fixed rate period), and 28%19% were adjustable-rate loans. The
average size of the loans that we credit-enhanced was $351,700.$362,100. At June 30,
2001, loans with principal balances of $600,000 or less comprised 92% of the
total number of such loans and 81% of the total balance of such loans. We
credit-enhanced 1,1191,269 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 $1.5$1.7
billion. Loans over $1 million were 1% of the total number of loans and 6%4% of
the total balance of loans that we credit-enhanced at year-end.quarter-end.
TABLE 7
CREDIT ENHANCEMENT PORTFOLIO RESERVES
(AT PERIOD END, ALL DOLLARS IN THOUSANDS)
JUN. SEP. DEC. MAR. JUN.
2000 2000 2000 2001 2001
-------- -------- -------- -------- --------
Total Credit Enhancement Portfolio
Internal Credit Reserves............ $ 20,829 $ 22,139 $ 27,052 $ 35,722 $ 78,170
External Credit Enhancement......... 79,403 78,564 86,840 86,600 91,004
-------- -------- -------- -------- --------
Total Credit Protection............. $100,232 $100,703 $113,892 $122,322 $169,174
As % of Total Portfolio............. 0.48% 0.47% 0.50% 0.45% 0.44%
"Alt-A" Portfolio
Internal Credit Reserves............ $ 4,128 $ 3,925 $ 3,789 $ 4,565 $ 4,061
External Credit Enhancement......... 25,315 24,493 22,011 20,250 18,098
-------- -------- -------- -------- --------
Total Credit Protection............. $ 29,443 $ 28,418 $ 25,800 $ 24,815 $ 22,159
As % of "Alt-A" Portfolio........... 4.54% 4.63% 4.59% 4.85% 5.05%
"A+" Portfolio
Internal Credit Reserves............ $ 16,701 $ 18,214 $ 23,263 $ 31,157 $ 74,109
External Credit Enhancement......... 54,088 54,071 64,829 66,350 72,906
-------- -------- -------- -------- --------
Total Credit Protection............. $ 70,789 $ 72,285 $ 88,092 $ 97,507 $147,015
As % of "A+" Portfolio.............. 0.35% 0.34% 0.40% 0.37% 0.39%
27
30
The geographic dispersion of our credit enhancement portfolio closelygenerally
mirrors that of the jumbo residential market as a whole. At March 31,June 30, 2001, our
loans were most concentrated in the following states: California 47%54%, New York
6%5%, New Jersey 4%3%, Texas 4%3%, and Massachusetts 4%3%. No other state had more than
3%.
Most of the loans that we credit-enhancecredit enhance are seasoned. On average, our
credit-enhanced loans have 31 months of seasoning. 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% ofOf the
loans we credit enhanced at March 31,June 30, 2001, 21% were originated in year 2001, 14%
were originated in 2000, and 65% were originated in 1999 or 2001.earlier.
For 75% of the loans in whichour portfolio, a FICO credit score was obtained at
origination and is available,available. For these loans, the average FICO score for our credit enhancement portfolio was 733
at March 31, 2001.723.
Borrowers with FICO scores over 720 comprised 61%58% of the portfolio, those with
scores between 680 and 720 comprised 22%, those with scores between 620 and 680
comprised 15%17%, and those with scores below 620 comprised 2%3% of our credit
enhancement portfolio.
Given housing appreciation and loan amortization, we estimate the average
current effective LTV for the loans that we credit-enhance is 61%.
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 at origination on
these loans is substantially reduced. Our average effective LTV at origination
for all the loans we credit enhance (including the effect of PMI, pledged
collateral, and other credit enhancements) was 70%71%. Given housing appreciation
and loan amortization, we estimate the average current effective LTV for these
loans is roughly 53%.
For the loans that we credit enhance where the property is in Northern
California (23%(26% of the total portfolio), at June 30, 2001 the average loan
balance was $386,400,$386,200, the average FICO score is 728,was 724, and the average LTV at
origination was 71%. On average, these Northern California loans have 3836 months
of seasoning.seasoning, with 22% originated in year 2001, 14% in year 2000, and 64% in
years 1999 or earlier. At June 30, 2001, Northern California loans with
principal balances of $600,000 or less comprised 91% of the total number of
Northern California loans and 81% of the total balance of such loans. At June
30, 2001, 320 of such loans had principal balances in excess of $1 million;
these loans had an average size of $1.4 million and a total loan balance of $450
million. They represented 1% of the total number of Northern California loans
and 5% of the total balance of Northern California loans. Delinquencies in our
Northern California residential credit enhancement portfolio at June 30, 2001
were 0.08% of current loan balance.
For 24%the 28% of our loans where the propertieshomes are located in Southern
California, the average loan balance at June 30, 2001 was $376,200,$383,600, the average
FICO score was 722718, and the average LTV at origination was 72%73%. These Southern
California loans have 5044 months of seasoning, on average.
27average, with 17% originated in
year 2001, 13% in year 2000, and 70% in years 1999 or earlier. At June 30, 2001,
Southern California loans with principal balances of $600,000 or less comprised
90% of the total number of loans and 77% of the total balance of loans. At June
30, 2001, 414 of these loans had principal balances in excess of $1 million;
these loans had an average size of $1.4 million and a total loan balance of $595
million. They represented 2% of the total number of Southern California loans
and 6% of the total balance of Southern California loans. Delinquencies in our
Southern California residential credit enhancement portfolio at June 30, 2001
were 0.24% of current loan balance.
28
2831
TABLE 48
CREDIT ENHANCEMENT PORTFOLIO --- UNDERLYING COLLATERAL CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
MARCH JUNE SEPTEMBER DECEMBER MARCH
2000JUN. SEP. DEC. MAR. JUN.
2000 2000 2000 2001 ----------2001
----------- ----------- ----------- ----------- -----------
Credit enhancement portfolio.............. $8,539,491portfolio........... $20,925,931 $21,609,785 $22,633,860 $27,081,361 Credit enhanced loans.... 26,934$38,278,631
Number of credit-enhanced loans........ 59,779 61,756 63,675 77,011 105,721
Adjustable %............. 9%%........................... 36% 34% 35% 28% 19%
Hybrid %................. 16%%............................... 3% 3% 7% 11% 20%
Fixed %.................. 75%%................................ 61% 63% 58% 61% Face Value:61%
First loss position...... $ 17,718position, principal value... $ 28,262 $ 30,782 $ 34,959 $ 41,156 $ 76,386
Second loss position..... 11,528position, principal
value................................ 18,089 20,597 30,703 37,197 67,700
Third loss position...... 31,632position, principal value... 49,280 54,793 59,216 76,880 Net Face Value........... 60,878 95,631 106,172 124,878 155,233
Net investment:
First loss position...... $ 8,106 $ 9,666 $ 10,231 $ 12,080 $ 13,191
Second loss position..... 5,180 12,700 14,168 21,109 25,106
Third loss position...... 23,708 36,527 41,719 47,575 62,552
Net Investment........... 36,994 58,893 66,118 80,764 100,849
Net Face Value........... $ 60,878121,918
----------- ----------- ----------- ----------- -----------
Total principal value.................. $ 95,631 $ 106,172 $ 124,878 $ 155,233 $ 266,004
First loss position, net investment.... $ 8,666 $ 9,231 $ 12,080 $ 13,191 $ 18,956
Second loss position, net investment... 12,700 14,168 21,109 25,106 43,733
Third loss position, net investment.... 36,527 41,719 47,575 62,552 96,015
----------- ----------- ----------- ----------- -----------
Net investment......................... $ 57,893 $ 65,118 $ 80,764 $ 100,849 $ 158,704
Principal value (face value)........... $ 95,631 $ 106,172 $ 124,878 $ 155,233 $ 266,004
Internal Credit
Reserves............... (11,893) (20,829) (22,139)credit reserves............... (21,829) (23,139) (27,052) (35,722) Discount(78,170)
Premium/(Discount) to be amortized.............. (11,991)amortized..... (15,909) (17,915) (17,062) (18,662) (29,130)
----------- ----------- ----------- ----------- -----------
Net Investment........... 36,994 58,893 66,118investment......................... $ 57,893 $ 65,118 $ 80,764 $ 100,849 Internal Credit
Reserves............... $ 11,893 $ 20,829 $ 22,139 $ 27,052 $ 35,722
External Credit
Enhancement............ 34,311 79,404 78,564 86,840 86,601
Total Credit
Protection............. 46,204 100,233 100,703 113,892 122,323
As % of Portfolio........ 0.54% 0.48% 0.47% 0.50% 0.45%158,704
California %............. 37%%........................... 52% 50% 50% 47% 54%
New York................. 9%York............................... 6% 6% 6% 6% 5%
New Jersey............... 5%Jersey............................. 3% 4% 4% 4% Massachusetts............ 5%3%
Massachusetts.......................... 3% 3% 3% 4% Texas.................... 4%3%
Texas.................................. 3% 3% 3% 4% 3%
Other states............. 40%states........................... 33% 34% 34% 35% 32%
Year 2001 Origination.................. 0% 0% 0% 7% 21%
Year 2000 Origination.................. 5% 10% 19% 21% 14%
Year 1999 Origination.................. 39% 38% 35% 29% 36%
Year 1998 Origination.................. 18% 17% 16% 18% 13%
Year 1997 Origination.................. 1% 1% 1% 1% 1%
Year 1996 or earlier Origination....... 37% 34% 29% 24% 15%
Residential Retained Loan Portfolio
RevenuesIn conjunction with declining yields and a decline in total loan balances,
revenues in our residential retained loan portfolio declined in this portfolio over the last year
from $23.6$23.0 million in the firstsecond quarter of 2000 to $19.7$16.3 million in the firstsecond
quarter of 2001. Yields rose during this time period due to rising interest rates, but the
average balanceThe size of the portfolio was lower due to principal repayments.repayments
not being completely replaced by new purchases. Yields fell during this time
period due to falling interest rates. Late in the second quarter of 2001, we
acquired $76 million of high-quality jumbo residential whole loans. We are
evaluatinghave
acquired additional residential whole loans in the third quarter of 2001 and
continue to evaluate several additional acquisition opportunities and may addopportunities. Due to these
acquisitions, revenues in this portfolio latermay increase over the next few
quarters, in 2001. Otherwise, we would expect revenue tospite of expected falling yields on our existing portfolio as a
result of the recent decline as yields decline along
within short-term interest rates, and as the existing portfolio continues to pay
off.
28rates.
29
2932
TABLE 59
RESIDENTIAL RETAINED PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
ANNUAL
AVERAGE MORTGAGE NET TOTAL
AVERAGE AVERAGE NET AVERAGE MORTGAGEPREPAY PREMIUM CREDIT INTEREST
PRINCIPAL PREMIUM CREDIT PREPAYMENTRATE COUPON AMORTIZATION PROVISION INCOME
BALANCE BALANCE RESERVE RATE (CPR) INCOME EXPENSE EXPENSE REVENUES YIELD
---------- ----------- ------- ----------------- -------- ------- ------------ --------- -------- -----
Q1: 2000............. $1,337,428 $16,061 $(4,187) 14% $24,378 $ (640) $ (119) $23,619 7.00%
Q2: 2000............. 1,276,340 15,372 (4,290)$1,276,340 $15,372 $(4,290) 16% 23,648$23,648 $ (515) (128) 23,005$(128) $23,005 7.15%
Q3: 2000............. 1,202,056 14,760 (4,454) 22% 23,118 (829) (240) 22,049 7.27%
Q4: 2000............. 1,141,624 14,141 (4,696) 16% 22,316 (611) (244) 21,461 7.46%
Q1: 2001............. 1,083,943 13,519 (4,895) 21% 20,371 (485) (184) 19,702 7.21%
1999................. $1,115,874 $13,895 $(3,505) 25% $77,065 $(3,915) $(1,346) $71,804 6.38%
2000................. 1,238,993 15,080 (4,408) 17% 93,460 (2,595) (731) 90,134 7.21%Q2: 2001............. 1,007,227 12,747 (5,051) 24% 17,492 (1,065) (164) 16,263 6.41%
Six Months: 2000..... $1,306,884 $15,717 $(4,239) 15% $48,026 $(1,155) $(247) $46,624 7.07%
Six Months: 2001..... 1,045,373 13,131 (4,974) 23% 37,863 (1,550) (348) 35,965 6.83%
Credit losses were $30,000$12,000 in this portfolio in the firstsecond quarter of 2001
as we liquidated one Real Estate Owned property and2001.
We experienced a 13%an average 14% loss severity (the percentage of our liquidated
loan balancebalances that represents a lossbecame credit losses upon liquidation, including all foregone
interest). Our annualized credit loss rate was less than 1 basis point (0.01%)
of current portfolio balances. We charged our $30,000$12,000 loss against our credit
reserve for this portfolio, which ended the quarter at $5.0$5.1 million (0.46%(0.48% of
the portfolio). Delinquencies in this portfolio increaseddecreased to 0.59%0.46% of the
portfolio from 0.50% at the end of the previous quarter.2000. We expect that delinquencies and losses
toon the current portfolio may increase from their current rates iflevels as a result of a
weaker economy and the economy
continues to weaken.further seasoning of these loans.
TABLE 610
RESIDENTIAL RETAINED PORTFOLIO -- CREDIT RESULTS
(AT PERIOD END, ALL DOLLARS IN THOUSANDS)
LOSS SEVERITY REALIZED ANNUALIZED ENDING
ENDING DELINQUENT GROSS LOSS REALIZEDDELINQUENT ON LIQUIDATED CREDIT ENDING
LOANS DEFAULTS SEVERITY CREDIT LOSSES PROVISION EXPENSE CREDIT
BALANCE LOANS LOAN % LOANS LOSSES AS % OF LOANS RESERVE
---------- ------------------ ---------- ------------- -------- ------------- ----------------- ---------------------
Q1: 2000............. $5,338 $ 0 0% $ 0 $ (119) $4,244
Q2: 2000............. 4,968 4502000.............. $1,267,780 $4,968 0.39% 9% (42) (128)$(42) 0.01% 4,330
Q3: 2000.............2000.............. 1,186,799 4,330 00.36% 0% 0 (240)0.00% 4,570
Q4: 2000.............2000.............. 1,130,997 5,667 00.50% 0% 0 (244)0.00% 4,814
Q1: 2001.............2001.............. 1,071,819 6,371 2380.59% 13% (30) (184)0.01% 4,968
1999................. $4,635 $145 4% $ (5) $(1,346) $4,125
2000................. 5,667 450Q2: 2001.............. 1,060,470 4,913 0.46% 14% (12) 0.00% 5,120
Six Months: 2000...... $1,267,780 $4,968 0.39% 9% $(42) 0.00% $4,330
Six Months: 2001...... 1,060,470 4,913 0.46% 13% (42) (731) 4,8140.01% 5,120
At March 31,June 30, 2001, we owned 3,4333,306 residential loans with a total value of
$1.1 billion. These were all "A" quality or "prime" quality loans at origination. Of these, 71%the total, 73%
were adjustable rate loans and 29%27% were hybrid loans. Our hybrid loans have
fixed rate coupons until December 2002, on average, andaverage. They will then will become
adjustable rate loans. The average loan size of our retained portfolio was
$312,100.$320,800. At June 30, 2001, retained loans with principal balances of $600,000
or less comprised 89% of the total number of such loans and 68% of the total
balance of such loans. We owned 78 loans with a loan balance over $1 million;
the average size of these loans was $1.4$1.5 million. Loans with balances over $1
million made up 2% of the loans and 11% of the balances of our total retained
loan portfolio. Northern California loans were 24%13% of the total and Southern
California loans were 10% of the total. All of the loans wereLoans originated in 1999 or earlier.earlier were
93% of the total. Loans where the original loan balance exceeded 80% LTV made up
7% of loan balances; we benefit from 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%68%. Given housing appreciation
and loan amortization, we estimate the current effective LTV of our retained
loan portfolio is less than 63%roughly 54%.
30
33
We fund most of our residential retained loan portfolio through the
issuance of long-term debt through our special purpose subsidiary, Sequoia
Mortgage Funding Corporations ("Sequoia"). The financing is non-recourse to
Redwood, and ourRedwood. Our exposure to theselong-term financed loans is limited to our investment
in Sequoia, which, at March 31,June 30, 2001, was $35$32 million or 3.2%3.3% of the loan
balances.
Residentialbalances financed with long-term debt. Short-term funded residential mortgage
loans that are included in this portfolio, but are funded
byretained at June 30, 2001 were $80 million. Our current intention is to
replace the short-term borrowings, represent less than one percentfunding of these retained loans with long-term debt
through a Sequoia transaction currently scheduled for the total loans at
29
30
March 31,fourth quarter of
2001.
For these short-term funded loans, we set aside capital based on
our internal risk adjusted capital guidelines that take into consideration
characteristics of our loans and our financing facilities.
TABLE 711
RETAINED RESIDENTIAL PORTFOLIO -- LOAN CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
MARCH JUNE SEPTEMBER DECEMBER MARCHJUN. SEP. DEC. MAR. JUN.
2000 2000 2000 20002001 2001
---------- ---------- ---------- ---------- ----------
Book value.................... $1,330,674Principal Value (Face Value)..... $1,257,108 $1,177,111 $1,122,170 $1,063,633 $1,053,158
Internal Credit Reserves......... (4,342) (4,573) (4,814) (4,968) (5,120)
Premium/(Discount) to be
amortized...................... 15,014 14,261 13,641 13,154 12,432
---------- ---------- ---------- ---------- ----------
Retained Residential Loans....... $1,267,780 $1,186,799 $1,130,997 $1,071,819 $1,060,470
Number of loans............... 4,207loans.................. 4,021 3,804 3,633 3,433 3,306
Average loan size............. $ 316size................ $ 315 $ 312 $ 311 $ 312 $ 321
Adjustable %..................%..................... 71% 71% 71% 71% 71%73%
Hybrid %......................%......................... 29% 29% 29% 29% 29%27%
Fixed %.......................%.......................... 0% 0% 0% 0% 0%
Funded with short-term debt... 1% 1% 1% 1% 1%
Funded with long-term debt.... 99% 99% 99% 99% 99%
Long-term debt................ $1,282,756 $1,227,546 $1,148,519 $1,095,835 $1,039,264
Net investment in Sequoia..... $ 42,437 $ 40,659 $ 38,803 $ 37,166 $ 34,982
California %.................. 26%%..................... 25% 25% 25% 24% Florida.......................23%
Florida.......................... 9% 9% 9% 9% 9%
New York......................York......................... 8% 8% 8% 8% 8%9%
New Jersey....................Jersey....................... 5% 5% 5% 5% 6%
Texas............................ 5% 5% 5% 5% 5%
Texas.........................Georgia.......................... 5% 5% 5% 5% 5%
Georgia....................... 5% 5% 5% 5% 5%4%
Other states.................. 42%states..................... 43% 43% 43% 44% 44%
Year 2001 origination............ 0% 0% 0% 0% 7%
Year 2000 origination.........origination............ 0% 0% 0% 0% 0%
Year 1999 origination......... 19%origination............ 19% 19% 19% 18% 17%
Year 1998 origination.........origination............ 32% 32% 32% 32% 32%29%
Year 1997 origination......... 37%origination............ 37% 37% 37% 38% 36%
Year 1996 or earlier
origination.................origination.................... 12% 12% 12% 12% 12%11%
31
34
Combined Residential Loan Portfolios
The tables below show certain attributes of our residential credit
enhancement portfolio and our residential retained loan portfolio on a combined
basis.
TABLE 812
RESIDENTIAL LOAN PORTFOLIO -- CREDIT PROTECTION
(ALL DOLLARS IN THOUSANDS)
RESIDENTIAL RESIDENTIAL REDWOOD'S AS % OF
CREDIT RETAINED
TOTAL RESIDENTIAL EXTERNAL TOTAL TOTAL
ENHANCEMENT LOAN RESIDENTIAL CREDIT CREDIT CREDIT RESIDENTIAL
PORTFOLIO PORTFOLIO LOANS RESERVE ENHANCEMENT PROTECTION LOANS
----------- -----------
----------- ----------- ----------- ---------- -----------
Q1: 2000............. $ 8,539,491 $1,330,674 $ 9,870,165 $16,137 $34,310 $ 50,447 0.51%
Q2: 2000............. 20,925,931 1,267,780 22,193,711 25,159 79,403 104,563Jun. 2000........................... $22,193,711 $25,159 $79,403 $104,562 0.47%
Q3: 2000............. 21,609,785 1,186,799Sep. 2000........................... 22,796,584 26,709 78,564 105,273 0.46%
Q4: 2000............. 22,633,860 1,130,997Dec. 2000........................... 23,764,857 31,866 86,840 118,706 0.50%
Q1: 2001............. 27,081,361 1,071,819Mar. 2001........................... 28,153,180 40,690 86,600 127,290 0.45%
1999................. $ 6,376,571 $1,385,589 $ 7,762,160 $15,366 $26,111 $ 41,477 0.53%
2000................. 22,633,860 1,130,997 23,764,857 31,866 86,840 118,706 0.50%Jun. 2001........................... 39,339,101 83,290 91,004 174,294 0.44%
30
31
TABLE 913
RESIDENTIAL LOAN PORTFOLIO -- CREDIT PERFORMANCE
(ALL DOLLARS IN THOUSANDS)
LOSSES TOTAL
AS % OF REDWOOD'S TO CREDIT
TOTAL SHARE OF EXTERNAL TOTAL LOSSES AS
RESIDENTIAL CREDIT CREDIT CREDIT % OF TO TOTAL
TOTAL TOTAL REDWOOD'S EXTERNAL TOTAL RESIDENTIAL
RESIDENTIAL RESIDENTIAL CHARGE CREDIT CREDIT LOANS LOANS
DELINQUENCIES LOANS OFFSLOSSES ENHANCEMENT LOSSES (ANNUALIZED)
-----------
------------- ----------- --------- ----------- ------------- ------------
Q1: 2000.............Q2: 2000.................. $ 9,870,165 $55,069 0.56% $ 270 $ 543 $ 813 0.03%
Q2: 2000............. 22,193,711 50,967 0.23% 229 1,350 1,579$(229) $(1,350) $(1,579) 0.03%
Q3: 2000............. 22,796,5842000.................. 62,432 0.27% 245 345 590(245) (345) (590) 0.01%
Q4: 2000............. 23,764,8572000.................. 57,376 0.24% 56 1,512 1,568(56) (1,512) (1,568) 0.03%
Q1: 2001............. 28,153,1802001.................. 70,264 0.25% 85 550 635(85) (550) (635) 0.01%
1999.................Q2: 2001.................. 103,200 0.26% (208) (824) (1,032) 0.01%
Six Months: 2000.......... $ 7,762,160 $50,086 0.65% $1,151 $1,995 $3,14650,967 0.23% $(499) $(1,893) $(2,392) 0.02%
2000................. 23,764,857 57,376 0.24% 800 3,750 4,550 0.02%Six Months: 2001.......... 103,200 0.26% (293) (1,374) (1,667) 0.01%
Investment Portfolio
We acquired $310 millionOur investment portfolio, which consists primarily of AAA and AA rated
mortgage securities, and sold $11was reduced by $0.3 million from March 31, 2001 to June 30,
2001, reflecting our long-term strategy of million
mortgage securities inemphasizing loan products. The
average balance of our investment portfolio induring the firstsecond quarter of 2001.
This portfolio2001,
however, was smallerhigher than in size at $874 million average assets than it was a
year ago at $944 million as principal pay downs and sales exceeded acquisitions.
Although yields were higher with higher interest rates (7.71% versus 7.16%),
revenues were flatrecent quarters, due to the smallertiming of various
acquisitions and sales of assets within this portfolio. Although weWe may increase the size
of our investment portfolio on a temporary basis if market conditions change or
if we raise new equity capital, our longer-term plan is to reduce the
role of the investment portfolio on our balance sheet. We expectcapital.
The yields on this portfolio to drop rapidly infell during the coming monthssecond quarter of 2001 due to
declining interest rates and faster prepayment speeds. We expect the coupon
rates to continue to decrease over the remainder of 2001 as coupons reset as a
result of lower short-term interest rates. Prepayment speeds may continue to be
high, further suppressing yields in this portfolio.
32
35
TABLE 1014
INVESTMENT PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
AVERAGE MORTGAGE NET TOTAL
AVERAGE NET PREPAYMENT PREMIUM INTEREST
EARNING PREMIUM RATES COUPON AMORTIZATION INCOME
ASSETS BALANCE (CPR) INCOME EXPENSE REVENUES YIELD
-------- ------- ---------- ------- ------------ -------- -----
Q1: 2000...................... $944,301Q2: 2000................ $902,265 $ 8,118 19% $17,510 $ (450) $17,060 7.16%
Q2: 2000...................... 902,265 7,225 20% 17,362$17,362 $ (163) 17,199$17,199 7.56%
Q3: 2000......................2000................ 868,159 8,946 20% 17,278 (572) 16,706 7.62%
Q4: 2000......................2000................ 822,452 9,595 19% 16,832 (591) 16,241 7.81%
Q1: 2001......................2001................ 874,307 10,164 19% 17,634 (586) 17,048 7.71%
1999.......................... $999,972Q2: 2001................ 910,793 14,013 31% 17,648 (1,086) 16,562 7.16%
Six Months: 2000........ $923,283 $ 9,177 27% $69,769 $(3,550) $66,219 6.56%
2000.......................... 884,081 8,4757,671 20% 68,982 (1,776) 67,206 7.53%$34,872 $ (613) $34,259 7.36%
Six Months: 2001........ 892,651 12,099 25% 35,282 (1,672) 33,610 7.43%
At March 31, 2001, we owned $1.0 billion of mortgage securities, an
increase from $0.8 billion at December 31, 2000. Substantially all of these
assets were rated AAA or AA.
The majority of our investments wereinvestment portfolio consists of residential
adjustable-rate or floating rate securities. 31
32The table below presents our investment portfolio by
asset category.
TABLE 1115
INVESTMENT PORTFOLIO CHARACTERISTICS
(RESIDENTIAL MORTGAGE-BACKED SECURITIES, UNLESS NOTED)
(ALL DOLLARS IN THOUSANDS)
MARCH JUNE SEPTEMBER DECEMBER MARCHCREDIT JUN. SEP. DEC. MAR. JUN.
RATING 2000 2000 2000 2000 2001 ----------2001
--------- -------- -------- -------- ---------- -------- --------- -------- ----------
Agency Adjustable........... AAA $ 665,201Adjustable............. "AAA" $618,964 $624,918 $532,578 $ 488,735 Agency CMO Floaters......... AAA 6,193 0 0 0 0$437,560
Jumbo Adjustable............Adjustable.............. AAA or AA 283,982 214,470 200,037 191,047 475,947 267,893
Jumbo Short Fixed CMOs......CMOs........ AAA or AA 14,808 14,260 13,843 0 0 0
Home Equity Floaters........Floaters.......... AAA or AA 22,914 23,015 23,015 23,015 19,277 14,600
Home Equity Fixed...........Fixed............. AAA to BBB 11,692or AA 12,110 12,314 17,044 13,062 Interest-Only -- Residential...13,026
Interest-Only................. AAA or AA 72 233 216 113 71 60
Interest-Only -- Commercial... AAA or AA 0 0 0 0 2,534 5,082
CBO Equity..................Equity -- Mixed........... B or NR 0 0 0 978 986 966
-------- -------- -------- ---------- --------
Total Investment Portfolio.............. $1,004,862Portfolio.... $883,052 $874,343 $764,775 $1,000,612 $739,187
Realized Credit Loses...................Loses During
the Quarter................. $ 0 $ 0 $ 0 $ 0 $ 0
Commercial Retained Loan Portfolio
The amount ofOur commercial loans shown on our balance sheet increased in the
first quarter ofloan portfolio decreased from December 31, 2000 to June 30,
2001 due to the consolidation of Holdings. However, our total
combined commercial loan portfolio declined from $76 million to $70 million due
to payoffssales and sales.payoffs. We are not adding to our commercial portfolio at this
time, although we may acquire additional commercial assets
later in thethis year. Unless we make additional acquisitions, portfolio balances should
continue to decline.decline as loans pay off or we sell some assets. Our yield on our
commercial mortgage loans increased primarily due to earlier than expected
payoffs, allowing us to recognize deferred origination fees.
33
36
TABLE 1216
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: 2000....................Q2: 2000.............. $15,418 $ 8,710(30) $ (13) $ 211393 $ 0 $0 $ 211 9.70%
Q2: 2000.................... 15,418 (30) 393 0 0 393 10.21%
Q3: 2000....................2000.............. 13,982 (265) 367 5 0 372 10.85%
Q4: 2000....................2000.............. 38,020 (477) 987 39 0 1,026 10.93%
Q1: 2001....................2001.............. 73,836 (1,208) 1,857 76 0 1,933 10.65%
1999........................ $11,151Q2: 2001.............. 70,279 (878) 1,857 104 0 1,961 11.30%
Six Months: 2000...... $12,064 $ (3) $1,081(22) $ 604 $ 0 $0 $1,081 9.69%
2000........................ 19,071 (197) 1,958 44$ 604 10.03%
Six Months: 2001...... 72,048 (1,042) 3,714 180 0 2,002 10.61%3,894 10.97%
To date, we have not experienced any delinquencies or credit losses in our
commercial loan portfolio, nor do we anticipate any credit problems at this
time.portfolio. We have not established a general credit reserve for
commercial loans. A slowing economy, and factors particular to each loan, could
cause credit issues in the future. If this occurs, we may need to provide for
future losses and create a specific credit reserve on an asset by asset basis
for our commercial loans held for investment, or reduce the reported market
value for our loans held for sale. Other factors may also affect the market
value of these loans.
32
33Our goal is to secure long-term, non-recourse debt for our commercial
mortgage loans. We accomplished this by obtaining $17 million of debt for $21
million of our loans in the first half of 2001. We are currently funding the
remaining loans with a combination of equity and short and medium-term credit
facilities. We continue to seek more permanent funding for this portfolio.
TABLE 1317
COMMERCIAL PORTFOLIO LOAN CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
MARCH JUNE SEPTEMBER DECEMBER MARCH
2000JUN. SEP. DEC. MAR. JUN.
2000 2000 2000 2001 -------2001
------- --------- -------- ------- -------
Held at Redwood......................... $16,865 $ 9,800 $32,308 $57,169 N/A
Held at Holdings........................ 17,636 42,482 32,333 18,913 N/A
Total Commercial $...................... 34,501 52,282 64,641 76,082 70,077Commercial*....................... $52,282 $64,641 $76,082 $70,077 $67,043
Number of Loans......................... 11 14 17 20 18 16
Average Loan Size....................... $ 3,136 $ 3,734 $ 3,802 $ 3,804 $ 3,893 $ 4,190
Serious Delinquency $................... $ 0 $ 0 $ 0 $ 0 $ 0
Serious Delinquency %................... 0% 0% 0% 0% 0%
Serious Delinquency %................... 0% 0% 0% 0% 0%
Realized Credit losses.................. $ 0 $ 0 $ 0 $ 0 $ 0
California %............................ 61% 69% 73% 71% 61% 69% 73% 71%68%
- ---------------
* Includes loans held at RWT Holdings, Inc., which was consolidated with our
financials as of January 1, 2001.
Interest Expense
InterestTotal interest expense declined over the last year from $34.9$35.1 million in
the firstsecond quarter of 2000 to $31.4$27.0 million in the firstsecond quarter of 2001. This
sharp decline was due to the rapid and significant fall in short-term interest
rates. For instance, the one-month LIBOR interest rate, which averaged 6.47%
during the second quarter of 2000, decreased from 6.56% to 3.86% during the
first half of 2001 as we
reducedand averaged 4.27% during the second quarter of 2001. As a
result, our average borrowings from $2.2 billion to $2.0 billion. Our cost of funds was flat on a year over year basis but declined sharply indecreased to 5.45% for the firstsecond quarter of 2001 from
6.62% for the previoussecond quarter as short-term interest rates declined.of 2000. Similarly, our cost of funds for the first
six months of 2001 was 5.90%, a decrease from our cost of funds of 6.48% in the
first six months of 2000.
34
37
TABLE 1418
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: 2000............. $ 972,338 $15,359 6.32% $1,225,562 $19,164 6.25% 0.07% $ 34,931 6.36%
Q2: 2000............. 1,258,859 20,927$1,258,859 $20,927 6.65% $ 865,068 13,987$13,987 6.47% 0.04% 35,133$35,133 6.62%
Q3: 2000............. 1,191,730 20,449 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 14,151 6.91% 0.03% 33,845 6.96%
Q1: 2001............. 1,072,172 17,838 6.65% 910,515 13,444 5.91% 0.03% 31,413 6.34%
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%Q2: 2001............. 1,018,646 15,167 5.96% 964,543 11,625 4.82% 0.04% 27,010 5.45%
Six Months: 2000..... $1,115,598 $36,286 6.51% $1,045,315 $33,151 6.34% 0.06% $70,064 6.48%
Six Months: 2001..... 1,044,925 33,005 6.32% 937,140 25,069 5.35% 0.04% 58,423 5.90%
Short-term debt average balances rose slightly during the first quarterhalf of
2001 to fund temporary increases in our investment portfolio. However,
short-term debt outstanding at $0.9 billion at June 30, 2001 was lower than the
outstanding balance of $1.0 billion at March 31, 2001. Short-term debt may
increase temporarily in the second half of 2001 as we acquire residential whole
loans in anticipation of a future securitization and these increases offset a
projected decline in our investment portfolio.
All of our long-term non-recourse debt for our residential loans was issued
through our special purpose financing subsidiary, Sequoia.Sequoia Mortgage Funding
Corporation ("Sequoia"). Long-term debt declined slightlyduring the second quarter of
2001 as a result of principal repayments received in our residential retained
portfolio. We issued $17 million of new long-term debt during the quarterfirst half to
fund two of our commercial loans to maturity. We mayhope to issue more long-term
debt in the fourth quarter of 2001. In the second quarter of 2001, especially if we acquire
portfolios of residential loans. In April 2001,Fitch IBCA
rating agency upgraded the credit ratingratings on three of our debt issues, Sequoia 3
M1 to M3, were each upgraded by Fitch IBCA rating
agency.
33M3.
35
3438
TABLE 1519
LONG-TERM DEBT CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
PRINCIPAL OUTSTANDING INTEREST
ESTIMATED ATOUTSTANDING RATE AT
DEBT ISSUE ORIGINAL STATED CALLABLE MARCH 31, MARCH 31,AT JUNE 30, JUNE 30,
LONG TERM DEBT ISSUE RATING DATE ISSUE AMOUNT INDEX MATURITY DATE 2001 2001
- -------------------- ------ ------- ------------ ------------------------- -------- --------- ----------- -----------------
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 280,674 6.99%257,871 6.46%
Sequoia 2 A2......... AAA 11/6/97 156,600 1m LIBOR 3/30/29 2004 74,176 5.39%68,149 4.15%
Sequoia 3 A1......... AAA 6/26/98 225,459 Fixed to 12/02 5/31/28 Retired 0 N/A
Sequoia 3 A2......... AAA 6/26/98 95,000 Fixed to 12/02 5/31/28 Retired 0 N/A
Sequoia 3 A3......... AAA 6/26/98 164,200 Fixed to 12/02 5/31/28 2002 146,228122,990 6.35%
Sequoia 3 A4......... AAA 6/26/98 121,923 Fixed to 12/02 5/31/28 2002 121,923 6.25%
Sequoia 3 M1......... AA/AAA 6/26/98 16,127 Fixed to 12/02 5/31/28 2002 16,127 6.79%6.80%
Sequoia 3 M2......... A/AA 6/26/98 7,741 Fixed to 12/02 5/31/28 2002 7,741 6.79%6.80%
Sequoia 3 M3......... BBB/A 6/26/98 4,838 Fixed to 12/02 5/31/28 2002 4,838 6.79%6.80%
Sequoia 1A A1........ AAA 5/4/99 157,266 1m LIBOR 2/15/28 2003 83,204 5.69%72,761 4.46%
Sequoia 4 A.......... AAA 3/21/00 377,119 1m LIBOR 8/31/24 2008 304,242 5.34%281,654 4.19%
Commercial 1......... N/A 3/30/01 8,6288,713 1m LIBOR 11/1/02 N/A 8,628 8.58%8,713 7.13%
Commercial 2......... N/A 3/30/01 8,320 1m LIBOR 10/1/03 N/A 8,320 8.58%7.13%
---------- --------
Total L-T Debt....... $2,470,128 $1,056,100 6.15%Long-Term
Debt............... $2,470,213 $971,087 5.47%
Net Interest Income After CreditOperating Expenses
Net interest income after creditCore operating expenses rose from $7.9(including Holdings on an as-if consolidated basis
in 2000, while excluding closed business units and mark to market adjustments
related to variable stock options) were $3.4 million in the second quarter of
2001, $3.0 million in the first quarter of 2000 to $10.22001, and $2.8 million in the firstsecond
quarter of 2001. We
benefited from rapidly falling interest rates in the first quarter of 2001,2000. Fixed expenses remained relatively constant during these
periods. Higher performance-based compensation incurred as our cost of funds declined faster than our asset yields. In addition, we
benefited from increased portfolio investment made possible by retention of free
cash flow generated in excess of our dividend requirements. Net interest income
divided by equity increased from 14.76% in the first quarter of 2000 to 18.83%
in the first quarter of 2001.
We believe that we have reduced the potential sensitivity of our net
interest income and earnings to changes in interest rates and prepayment rates,
although earnings are still sensitive to such market factors. We generally
maintained or increased our portfolio margins last year when short-term interest
rates increased. Although we believe that over time we have increased the
stability of our margins, as part of our asset/liability strategy we did allow
for the possibilitya result of increased
margins on a temporary basis following periodsprofitability and accounted for most of short-term interest rate decline. We expect to benefit from declining
interest rates in the second and third quarters of 2001, although probably not
to the same degree as we did in the first quarter.
While falling short-term interest rates may boost earnings temporarily,
lower levels of interest rates will generally lead to lower earnings after a few
quarters as the benefit of lower cost of funds is more than offset by lower
asset yields. Even if yields decline by the same amount as our cost of funds, we
have more assets than liabilities, so the overall results would normally be
lower net interest income. Ongoing changes in our product mix, emphasizing
residential loan products rather than the investment portfolio, and changes in
our asset/ liability mix to include more fixed-rate loans, may mitigate this
effect.
34
35
TABLE 16
NET INTEREST INCOME
(ALL DOLLARS IN THOUSANDS)
NET INTEREST INTEREST
INTEREST RATE RATE NET
TOTAL INCOME COST OF SPREAD MARGIN INTEREST
INTEREST COST OF AFTER EARNING FUNDS AFTER AFTER INCOME/
INCOME FUNDS PLUS CREDIT ASSET PLUS CREDIT CREDIT AVERAGE
REVENUES HEDGING PROVISIONS YIELD HEDGING PROVISIONS PROVISIONS EQUITY
-------- ---------- ---------- ------- ------- ---------- ---------- --------
Q1: 2000............. $ 42,819 $ (34,931) $ 7,888 7.25% 6.36% 0.89% 1.30% 14.76%
Q2: 2000............. 43,008 (35,133) 7,875 7.54% 6.62% 0.92% 1.34% 14.78%
Q3: 2000............. 41,679 (34,694) 6,985 7.62% 6.87% 0.75% 1.25% 13.10%
Q4: 2000............. 41,755 (33,845) 7,910 7.88% 6.96% 0.92% 1.46% 14.68%
Q1: 2001............. 41,637 (31,413) 10,224 7.72% 6.34% 1.38% 1.85% 18.83%
1999................. $145,964 $(119,227) $26,737 6.63% 5.83% 0.80% 1.17% 11.24%
2000................. 169,261 (138,603) 30,658 7.56% 6.69% 0.87% 1.33% 14.33%
Operating Expenses
Fixed operating expense (expenses excluding performance-based compensation)
declined from $1.7 million in the first quarter of 2000 to $1.6 million in the
first quarter of 2001. Variable operating expenses (compensation based on return
on equity and dividends) are accrued each quarter based on that quarter's
profitability; with record results in the first quarter of 2001, variable
expenses were $1.6 million. Included in variable operating expenses was $0.2
million of variable stock option expense recorded due to the increase in our
stock price to $19.75 at March 31, 2001. We estimate variable stock option
expense will be approximately $0.2 million ($0.02 per share) for each $1.00
increase in our stock price. Variable stock option expense may be reversed
(benefiting income) should our stock price fall.operating costs during
the 2001 periods.
TABLE 1720
OPERATING EXPENSES
(ALL DOLLARS IN THOUSANDS)
ONGOING ONGOING ONGOINGVARIABLE
STOCK
REDWOOD OPTION CORE CORE CORE
AND CLOSED MARK-TO- TOTAL FIXED VARIABLE
ANDHOLDINGS BUSINESS ONGOING ONGOING ONGOINGMARKET CORE CORE CORE EXPENSE/ EXPENSE/ EXPENSE/
HOLDINGSCOMBINED UNITS ADJUSTMENTS TOTAL FIXED VARIABLE EQUITY EQUITY EQUITY
-------- -------- ------- ------------------ ------ ------ -------- -------- -------- --------
Q1: 2000.................
Q2: 2000............. $2,823 $ 2,9990 $ 197 $ 2,802 $1,718 $1,084 5.24% 3.21% 2.03%
Q2: 2000................. 2,823 0 2,823 1,703 1,120$2,823 $1,703 $1,120 5.30% 3.20% 2.10%
Q3: 2000.................2000............. 2,597 0 0 2,597 1,833 764 4.87% 3.44% 1.43%
Q4: 2000.................2000............. 1,798 0 0 1,798 1,401 397 3.34% 2.60% 0.74%
Q1: 2001.................2001............. 3,136 0 3,136156 2,980 1,561 1,575 5.78%1,419 5.49% 2.88% 2.90%
1999..................... $25,879 $17,3932.61%
Q2: 2001............. 3,886 0 508 3,378 1,754 1,624 6.13% 3.18% 2.95%
Six Months: 2000..... $5,822 $197 $ 8,486 $7,811 $ 675 3.57% 3.27% 0.30%
2000..................... 10,217 197 10,020 6,655 3,365 4.68% 3.11% 1.57%0 $5,625 $3,421 $2,204 5.27% 3.21% 2.06%
Six Months: 2001..... 7,022 0 664 6,358 3,315 3,043 5.81% 3.03% 2.78%
We believe that we currently have the staff and systems that wea portion of our operating expenses will need
to manage a much larger company. We believe that we are likely to benefit from
substantial operating leverageremain relatively
fixed in the event that we raise additionalincrease our equity capital. With growth incapital base and increase our
portfolios and capital employed following anreal estate finance activities over the next year. Thus, as we
36
39
grow, we would expect our ratio of fixed core operating expenses to equity offering, we believe revenue growth will exceed growth in fixedto
decline. This operating expenses. This could result in an increase inleverage would potentially benefit our earnings per share and
dividends per share. However, our variable expenses could increase as a result of stronger
performance in income and dividends or by an increase in our stock price.
Variable expenses will increase and decrease from quarter to quarter based on
quarterly performance and our stock price.
As a result of our potential operating leverage, we believe that $0.15 to
$0.20 per share annually after approximately three quarters is a reasonable
current estimate of potential earnings per share improvement (relative to what
earnings would otherwise be) should we complete an equity offering of $50
million and profitably employ the proceeds in our real estate finance business.
As always, there are risks. Any such benefits
35
36
may not be achieved. In addition, such an equity offering would likely dilute
earnings for several quarters until the new capital is employed profitably.
Core Earnings
Core earnings are earnings from ongoing operations before mark-to-market
adjustments.adjustments on certain assets, hedges, and variable stock options.
Our core earnings were $6.4 million$0.80 per share in the firstsecond quarter of 2001, an
increase of 41%57% from the $4.5 million$0.51 per share we earned in the firstsecond quarter of
2000 and2000. For the first six months of 2001, core earnings were $1.53 per share, an
increase of 14%50% from the $5.6 million earned$1.02 per share in core earnings generated in the fourth quarterfirst
six months of 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)in 2000).
TABLE 1821
CORE EARNINGS AND GAAP EARNINGS
PRESENTED AS IF HOLDINGS WAS CONSOLIDATED IN ALL QUARTERS
(ALL DOLLARS IN THOUSANDS)
TOTAL NET
INTEREST OPERATING
INCOME EXPENSES
AFTER OF MARKETCERTAIN VARIABLE
ASSET AND STOCK
HEDGES OPTION REPORTED
MARK-TO- MARK-TO- CLOSED REPORTED CREDIT ONGOING PREFERREDAVERAGE CORE VALUEGAAP
CORE MARKET MARKET BUSINESS GAAP PROVISIONS OPERATIONS DIVIDENDSDILUTED EARNINGS CHANGESEARNINGS
EARNINGS ADJUSTMENTS ADJUSTMENTS UNITS EARNINGS ---------- ----------SHARES PER SHARE PER SHARE
-------- ----------- ----------- -------- -------- --------- -------- ------- -------- ----------------- ---------
Q1: 2000.............
Q2: 2000.............. $ 8,0194,495 $(1,452) $ (2,802)0 $ (681)43 $ 4,536 $(1,164) $ (89) $ 3,283
Q2: 2000............. 8,000 (2,823) (681) 4,496 (1,452) 43 3,0873,086 8,883,651 $0.51 $0.35
Q3: 2000............. 7,229 (2,597) (681)2000.............. 3,951 927 0 0 4,878 8,908,399 0.44 0.55
Q4: 2000............. 8,082 (1,798) (681)2000.............. 5,603 (640) 0 0 4,963 8,962,950 0.62 0.55
Q1: 2001............. 10,224 (3,136) (681) 6,4072001.............. 6,563 273 (156) 0 6,680 1999................. $27,8499,065,221 0.73 0.74
Q2: 2001.............. 7,384 (413) (508) 0 6,463 9,184,195 0.80 0.70
Six Months: 2000...... $ (8,486) $(2,741) $16,6229,031 $(2,616) $ 38 $(17,673) $(1,013)
2000................. 31,329 (10,020) (2,724) 18,585 (2,329) (46) 16,2100 $(46) $ 6,369 8,862,505 $1.02 $0.72
Six Months: 2001...... 13,947 (140) (664) 0 13,143 9,121,018 1.53 1.44
ThroughoutFor the remainder of 2001, we currently expect net interest income and core
earnings to be strong but to decline from first quarterhalf 2001 levels due to falling short-term interest
rates. Loweran
expected decrease in the rate at which short-term interest rates alsohave been
falling. Long-term earnings trends, we believe, are likely we believe, to put
downward pressure on year 2002 core earnings. Positive offsets to this trend
could be an increasedriven more by
credit results, growth, and competition factors in ourthe jumbo residential loan portfolios relative to our
investment portfolio and potential earnings accretion causedmarkets
than by operating
leverage if an equity offering is completed.
36
37
The table below reconciles core earnings per share to reported GAAP
earnings per share.
TABLE 19
CORE EARNINGS PER SHARE AND GAAP EARNINGS PER SHARE
PRESENTED AS IF HOLDINGS WAS CONSOLIDATED IN ALL QUARTERS
(DOLLARS PER SHARE)
AVERAGE MARKET CLOSED REPORTED
DILUTED CORE VALUE BUSINESS GAAP
SHARES EARNINGS CHANGES UNITS EARNINGS
--------- -------- ------- -------- --------
Q1: 2000.................................. 8,844,606 $0.51 $(0.13) $(0.01) $ 0.37
Q2: 2000.................................. 8,883,651 0.51 (0.16) 0.00 0.35
Q3: 2000.................................. 8,908,399 0.44 0.11 0.00 0.55
Q4: 2000.................................. 8,962,950 0.62 (0.07) 0.00 0.55
Q1: 2001.................................. 9,065,221 0.71 0.03 0.00 0.74
1999...................................... 9,768,345 $1.71 $ 0.00 $(1.81) $(0.10)
2000...................................... 8,902,069 2.08 (0.26) (0.00) 1.82
interest rate factors.
Core earnings isare not a measure of earnings in accordance with generally
accepted accounting principles. It is calculated as GAAP earnings from ongoing
operations less mark-to-market adjustments.adjustments on certain assets, hedges, and
variable stock options. Management believes that core earnings providesprovide relevant
and useful information regarding Redwood'sour results of operations in addition to GAAP
measures of performance. Because all companies and analysts do not calculate
non-GAAP measures such as core earnings in the same fashion, core earnings as
calculated by us may not be comparable to similarly titled measures reported by
other companies.
Market Value Changes
InMark-to-Market Adjustments
Mark-to-market adjustments on certain of our assets, hedges, and variable
stock options reduced reported net income by $0.9 million, or $0.10 per share,
in the firstsecond quarter of 2001 assets marked-to-market throughand $0.8 million, or $0.09 per share, in the income
statement increased in value by $2.6 million and assets marked-to-market through
the balance sheet increased in value by $0.1 million. Thus, the totalfirst
half of 2001. The largest negative mark-to-market adjustments in the first half
were $0.7 million for the quarter totaled positive $2.7 million.
However,variable stock options as a result of adoptingan increase in our
common stock price and $2.4 million as a result of the cumulative effect of the
adoption of new accounting rules under EITF 99-2099-20. The value of our
mark-to-market assets and hedges increased by $2.2 million during the first half
of 2001, generally as a result of falling interest rates.
37
40
Negative mark-to-market adjustments of $1.5 million ($0.16 per share) for
the second quarter of 2000 and $2.6 million ($0.30 per share) for the first half
of 2000 reflect decreases in the first quartermarket values of 2001, we
reclassified certain cumulativeour mark-to-market adjustments from prior years from
the balance sheet to the income statement.
Under the provisionsassets and
hedges, generally as a result of EITF 99-20, if the discounted value of probable
future cash flows deteriorates from original assumptions, certain securitized
interests should be marked-to-market through the income statement. Only negative
mark-to-market adjustments are allowed under this principle. For a set of assets
that we acquired prior to 1997, credit performance has not been as strong as we
originally assumed, causing an adverse change to future cash flows. Upon
adoption of EITF 99-20, we took the market valuation adjustment onrising interest rates during these assets
that we had previously recorded through our balance sheet and recognized the
loss through our income statement. Any subsequent adjustments under the
provisions of EITF 99-20 will be recognized as negative mark-to-market
adjustments through our income statement.
37
38periods.
TABLE 2022
MARKET VALUE CHANGESADJUSTMENTS
PRESENTED AS IF HOLDINGS WAS CONSOLIDATED IN ALL QUARTERS
(ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NET NETCERTAIN VARIABLE
ASSET AND STOCK TOTAL
HEDGES CUMULATIVE NET
INCOME CUMULATIVE INCOME BALANCE EFFECT BALANCE
STATEMENTOPTION TOTAL MARK-TO-
MARK-TO- EFFECT UPON STATEMENT SHEET UPON SHEET TOTAL
MARKET ADOPTINGMARK-TO- MARK-TO- MARKET
MARKET ADOPTING MARKET MARKET ADJUST.ADJUSTMENTS
ADJUSTMENTS EITF 99-20 ADJUST. ADJUST. EITF 99-20 ADJUST. ADJUST.
---------ADJUSTMENTS ADJUSTMENTS PER SHARE
----------- --------- ------- ---------- ------- ------------------ ----------- ----------- -----------
Q1: 2000.............. $(1,225) $ 0 $(1,225) $ (487)Q2: 2000............................... $(1,452) $ 0 $ (487) $(1,712)
Q2: 2000.............. (1,359) 0 (1,359) (886) 0 (886) (2,245)$(1,452) $(0.16)
Q3: 2000..............2000............................... 927 0 0 927 7200.10
Q4: 2000............................... (640) 0 720 1,647
Q4: 2000.............. (639) 0 (639) 3,912 0 3,912 3,273(640) (0.07)
Q1: 2001..............2001............................... 2,641 (2,368) 273 100 2,368 2,468 2,741
1999.................. $ 284(156) 117 0.01
Q2: 2001............................... (413) 0 (508) (921) (0.10)
Six Months: 2000....................... $(2,616) $ 0 $ 284 $(2,978) $ 0 $(2,978) $(2,694)
2000.................. (2,296) 0 (2,296) 3,259 0 3,259 963$(2,616) $(0.30)
Six Months: 2001....................... 2,228 (2,368) (664) (804) (0.09)
Asset market values increased in part due to short-term rate declines. When
short-term interest rates stabilize or increase, asset values may decline from
their current levels. Many other factors affect market values.
Shareholder Wealth
In the 6.56.8 years since the foundingcommencement of operations at 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,paid, plus a measure of 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 actual shareholder returns.
Book value per share was $11.67 in September 1994 when Redwood commenced
operations. We increased book value to $21.94$22.13 per share by March 31,at June 30, 2001 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 mostmany of our
assets through our income statement or balance sheet, reported book value is a good approximation of
real intrinsictangible value in the company. Cumulative dividends paid during this period were
$7.82$8.37 per share, and reinvestment earnings on those dividends were $4.62$5.04 per
share. Thus, cumulatively, shareholder wealth has increased from $11.67 per
share to $34.38$35.54 per share during this 6.5-yearnearly 6.8-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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3941
TABLE 2123
SHAREHOLDER WEALTH
(DOLLARS PER SHARE)
BOOK YEAR TO CUMULATIVE
VALUE DATE OR REINVESTMENT CUMULATIVE
PER ANNUAL CUMULATIVE EARNINGS ON SHAREHOLDER
SHARE DIVIDENDS DIVIDENDS DIVIDENDS WEALTH
------ --------- ---------- ------------ -----------
Sep-94..............................Sep. 94..................................... $11.67 $0.00 $0.00 $0.00 $11.67
Dec-94..............................Dec. 94..................................... 10.82 0.25 0.25 0.00 11.07
Dec-95..............................Dec. 95..................................... 12.38 0.96 1.21 0.09 13.68
Dec-96..............................Dec. 96..................................... 16.50 1.67 2.88 1.07 20.45
Dec-97..............................Dec. 97..................................... 21.55 2.15 5.03 3.07 29.65
Dec-98..............................Dec. 98..................................... 20.27 0.28 5.31 2.67 28.25
Dec-99..............................Dec. 99..................................... 20.88 0.40 5.71 3.07 29.66
Dec-00..............................Dec. 00..................................... 21.47 1.61 7.32 4.11 32.90
Mar-01.............................. 21.94 0.50 7.82 4.62 34.38Jun. 01..................................... 22.13 1.05 8.37 5.04 35.54
Taxable Income and Dividends
Our REIT taxable income excludes taxable income earned at our non-REIT
subsidiary, Holdings. REIT taxable income differs from reported GAAP income in
many material respects; trends in taxable income may differ from trends in core
or reported GAAP income. All taxable income results quoted herein should be
considered to be current estimates subject to revision.
We increasedgenerally intend to distribute as preferred and common stock dividends
100% of our REIT taxable income over time. In order to avoid excise taxes under
the REIT tax rules, we anticipate that we will typically seek to declare
dividends within each calendar year (including the fourth quarter dividends
which are declared in fourth quarter and paid in the following year) equal to at
least 85% of REIT taxable income earned during that calendar year plus 100% of
the excess of cumulative REIT taxable income over cumulative dividend
distributions from the prior year. Our undistributed taxable income (the excess
of cumulative REIT taxable income over cumulative dividend distributions) at
December 31, 2000 was $2 million.
For year 2001, through the second quarter, we have declared $10.7 million
in preferred and common stock dividends. On August 9, 2001, our Board of
Directors declared an increase in our regular quarterly common stock dividend
rate for the third quarter of 2001 to $0.57 per share. This dividend is payable
on October 22, 2001 to shareholders of record on September 28, 2001. On August
9, 2001, our Board of Directors also declared a special dividend of $0.18 per
common share to be paid on August 31, 2001 to shareholders of record on August
20, 2001. We currently estimate that the third quarter dividends on our
preferred and common stock will total $8.2 million, assuming we do not issue
additional equity prior to September 28, 2001.
In years such as 2001, when REIT taxable income levels may be exceptional,
the Board may declare one or more special dividends in order to meet the annual
minimum dividend distribution requirements necessary under the REIT rules to
avoid excise taxes while at the same time maintaining a regular common stock
dividend rate at a rate that we believe is likely to be sustainable, given our
anticipated normalized levels of cash flow generation for the reasonably
foreseeable future.
Our dividend policy with respect to our common stock is subject to revision
at the discretion of the Board of Directors. Each distribution will be made at
the discretion of the Board of Directors and will depend on our taxable and GAAP
earnings, our cash flows and overall financial condition, maintenance of REIT
status, and such other factors as the Board of Directors deems relevant. No
dividends will be paid or set apart for payment on shares of our common stock
unless full cumulative dividends have been paid on our Class B 9.74% Cumulative
Convertible Preferred Stock. As of June 30, 2001, full cumulative dividends have
been paid on preferred stock. On August 9, 2001, our Board of Directors declared
a preferred dividend from $0.44of $0.755 per share infor the fourththird quarter of 20002001, payable
on October 22, 2001 to $0.50 per share inpreferred shareholders of record on September 28, 2001.
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42
Distributions to our stockholders will generally be subject to tax as
ordinary income, although a portion of such distributions may be designated by
us as capital gain or may constitute a tax-free return of capital. Our Board of
Directors may elect to maintain a steady dividend rate during periods of
fluctuating taxable income. In such event, the first quarterBoard may choose to declare
dividends that include a return of 2001.capital. We believewill annually furnish to each
stockholder a statement setting forth distributions paid during the outlook for further increasespreceding
year and their characterization as ordinary income, capital gains or return of
capital. For a discussion of the Federal income tax treatment of our
distributions, see "Federal Income Tax Considerations -- Taxation of Holders of
Redwood Trust's Common Stock" in our dividend rate is positive. As a REIT, our
minimum dividend rate is determined by our taxable income. Currently, we expect
that our taxable income may exceed our core earnings in 2001 and perhaps in 2002
as well, although there are many GAAP -- Tax differences which cannot
necessarily be predicted. In general, we note that reduction of income through
credit provisions for our residential retained loan portfolio, and reductions in
effective yield through the setting aside of credit reserves upon acquisition of
credit enhancement interests, are not allowed in the calculation of taxable
income. Thus, as our credit-based activities, our credit provisions, and our
credit reserves grow, there may be an increasing tendency for our taxable
income, and our dividends, to exceed our core earnings.Year 2000 Annual Report Form 10-K.
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
Over the past several quarters, our cash flow from operations has exceeded
our earnings and our dividend distributions. In the firstsecond quarter of 2001, cash
flow from operations was $8.0$9.5 million, consisting of earnings of $6.7$6.5 million
plus non-cash depreciation, amortization, compensation, and mark-to-market
adjustments of $1.3$3.0 million. Our free cash flow, after reductionchanges in working
capital, property, plant, equipment, and other non-earning assets, was $12.5$8.4
million. In addition, we issued $1.0$0.5 million in new common stock.stock during the
quarter. We used the available cash from these sources to fund our common stock
dividend of $3.9$4.4 million and to increase our investment in our portfolio
activities by $9.6$4.5 million.
Our ability to retain significant amounts of the free cash flow that we
generate may be diminished in the future should our minimum dividend
distribution requirements increase relative to core earningsour free cash flow (see the
discussion on "Dividends""Taxable Income and Dividends" above).
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40
TABLE 2224
CASH FLOW
(ALL DOLLARS IN THOUSANDS)
CHANGES
IN FUNDS
CASH WORKING (INVESTMENT IN)/ AVAILABLE
FLOW CAPITAL FREE DIVIDENDSINVESTMENT (PURCHASE)/ FOR
FROM AND OTHER CASH FROMIN COMMON SALE PORTFOLIO
OPERATIONS ASSETS FLOW HOLDINGS DIVIDENDS OF STOCK INVESTING
---------- --------- ------- -------------------------- --------- ----------- ---------
Q1: 2000..............Q2: 2000................... $ 6,3255,562 $ (767)1,435 $ 5,5586,997 $1,973 $(3,076) $ 4,9990 $ (2,196) $ 45 $ 8,406
Q2: 2000.............. 5,562 1,435 6,997 1,973 (3,076) 0 5,894
Q3: 2000..............2000................... 5,957 (2,315) 3,642 0 (3,516) 381 507
Q4: 2000..............2000................... 7,239 (2,275) 4,964 0 (3,700) 2 1,266
Q1: 2001..............2001................... 8,006 4,457 12,4634,536 12,542 0 (3,876) 986 9,573
1999.................. $28,455 $15,181 $43,636 $(9,927)9,652
Q2: 2001................... 9,467 (1,096) 8,371 0 (4,448) 548 4,471
Six Months: 2000........... $11,886 $ (1,323) $(37,334) $(4,948)
2000.................. 25,083 (3,922) 21,161 6,972 (12,488) 428 16,073668 $12,554 $6,972 $(5,272) $ 45 $14,299
Six Months: 2001........... 17,492 3,421 20,913 0 (8,324) 1,534 14,123
At March 31,June 30, 2001, we hadhave 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 termshort-term borrowings on favorable
terms during first quarterhalf of 2001. Outstanding borrowings under these agreements
were $0.9$0.8 billion at March 31,June 30, 2001, an increase from $0.7 billion at year-end
2000 due to net acquisitions in our investment portfolio.portfolio, but a decrease from
the $0.9 billion at March 31, 2001 due to paydowns and sales.
We had three committed borrowing facilities for residential assets totaling
$80$90 million and two borrowing facilities for commercial assets totaling $100
million at March 31,June 30, 2001. There are certain restrictions regarding the
collateral that we can pledge to secure these committed facilities but they
generally allow us to fund either our commercial mortgage loans or our
residential credit enhancement interests. We continue to meet the debt covenant
tests required by our committed bank credit facility agreements and have not
experienced difficulty in extending these facilities or negotiating new lines.
Outstanding borrowings under these committed agreements were $86$105 million at
March 31,June 30, 2001, a decreasean increase from the $88 million at December 31, 2000.2000, due to net
acquisitions in our credit enhancement portfolio.
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43
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 the first quarterhalf of 2001. At March 31,June 30, 2001,
we had $53$47 million of unrestricted cash and highly liquid (unpledged) assets
available to meet potential liquidity needs. Total available liquidity equaled
6%5% of our short-term uncommitted debt balances. At December 31, 2000, we had $54 million of
liquid assets, equaling 7% of our short-term debt balances.
At this time, we see no material negative trends that we believe 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 likely
cause us to be in danger of a covenant default. However, many factors, including
ones external to us, may affect our liquidity in the future.
The $1.1$1.0 billion of long-term debt on our March 31,June 30, 2001 balance sheet is
non-recourse debt. Substantially all this debt was issued through our special
purpose financing subsidiaries and is collateralized by residential mortgage
loans. The remaining $17 million of this debt is backed by commercial loans and
was created through the sale of senior participations. The holders of our
long-term debt can look only to the cash flow from the mortgages specifically
collateralizing the debt for repayment. By using this source of financing, our
liquidity risks are limited. Our special purpose financing subsidiaries that
issue debt have no call on Redwood's general liquidity reserves, and there 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 to fund residential loans through
our special purpose financing subsidiaries is a large, global market that has
been relatively stable for many years. At this time, we know of no
40
41 reason why we
would not be able to issue more of this debt on reasonable terms if we should
choose to do so. The market for senior participations on commercial loans of the
types in our portfolio is not large and there can be no assurance that we will
be able to sell any future participations.
Excluding short and long term collateralized debt, we are capitalized
entirely by common and preferred equity capital. Our equity base increased from
$216 million to $222$224 million thus far in 2001 as a result of asset appreciation,
retention of cash flow, and stock issuance of $1 million.$2 million (through our dividend
reinvestment program and exercises of stock options). We planraised $24 million of
new equity capital in July of 2001. We seek to raise newadditional equity capital
in the future when opportunities to expand our business are attractive and when
such issuance is likely to benefit long-term earnings and dividends per share.
We have not, to 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 given 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 March 31,June 30, 2001, our minimum capital amounts were: 62%63% of
residential credit enhancement portfolio interests; 100% of net retained
interests in residential retained loan portfolio after long-term debt issuance;
18%issuance (Sequoia
equity); 7% of short-term debt funded residential whole loans; 10%9% of investment
portfolio securities; and 31%28% of commercial retained loan portfolio.
Our total risk-adjusted capital guideline amount for assets on our balance
sheet was $215$221 million (9%(11% of asset balances) at March 31,June 30, 2001. Capital
required for outstanding commitments at March 31,June 30, 2001 for asset purchases
settling later in 2001 was $1$3 million. TotalAt June 30, 2001, we were fully utilizing
our capital as our total capital available was $222 million;and our availabletotal capital exceeded our internal risk-adjusted capital policy
guideline minimum amount of $216 million by $6 million at March 31, 2001.committed were
both $224 million.
At March 31,June 30, 2001, our capital base of $222$224 million supported at-risk assets
(excluding long-term funded residential loans owned by financing trusts) of $1.2$1.0
billion funded with short-term debt of $1.0$0.9 billion. Excluding non-recourse debt
and related assets, our equity-to-assets ratio was 18%22% and our debt to equity
ratio was 4.53.8 times. During the first quarter of 2001, our
leverage on recourse assets increased primarily due to our acquiring assets in
our investment portfolio. At year-end 2000, our equity-to-assets ratio was 22% and
our debt to equity ratio was 3.5 times. Over the past year, we have generally
maintained these ratios within the ranges stated above.an 18% to 22% range. In the future, our
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44
leverage may increase for a period of time from increases in our investment
portfolio following issuance of additional equity or following the acquisition
of residential loans we eventually intend to securitize.
Loans that we acquire
for securitization are funded with short-term debt between acquisition and
securitization so our leverage ratios may increase while these loans are held
for securitization.
TABLE 2325
RECOURSE ASSETS
(ALL DOLLARS IN THOUSANDS)
AT RISK RECOURSE EQUITY TO RECOURSE DEBT
ASSETS DEBT EQUITY AT-RISK ASSETS TO EQUITY
---------- ------------------ -------- -------------- -------------
Q1:Jun. 2000............................ $1,141,241 $ 922,405 $209,700 18.37% 4.4
Q2:$1,026,281 $806,643 $208,384 20.3% 3.9X
Sep. 2000............................ 1,026,281 806,643 208,384 20.30% 3.9
Q3: 2000............................ 1,055,0321,043,621 822,389 210,664 19.97% 3.9
Q4:20.2% 3.9X
Dec. 2000............................ 983,097 756,222 215,663 21.94% 3.5
Q1:21.9% 3.5X
Mar. 2001............................ 1,226,8511,226,951 992,597 221,671 18.07% 4.5
1999................................ $1,471,570 $1,253,565 $209,935 14.27% 6.0
2000................................ 983,097 756,222 215,663 21.94% 3.518.2% 4.5X
Jun. 2001............................ 1,009,885 861,226 224,014 22.2% 3.8X
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RISK MANAGEMENT
We seek to manage the risks inherent in all financial
institutions -- interest rate, market value, liquidity, prepayment, and credit
risks -- in a prudent manner designed to insure our longevity. At the same time,
we endeavor to provide our shareholders an opportunity to realize a high,
steady, and rising dividend and an attractive total rate of return through stock
ownership in our company. We seek, to the best of our ability, to only assume
risks that can be quantified from historical experience, to actively manage such
risks, to earn sufficient compensation to justify the taking of such risks, and
to maintain capital levels consistent with the risks we do undertake.take.
Market Value Risk
At March 31,June 30, 2001, we owned mortgage securities and loans totaling $1.1$0.8
billion that we account for on a mark-to-market basis (in the case of mortgage
loans, on a lower-of-cost-or-market basis) for purposes of determining reported
earnings. Of these assets, 96%97% had adjustable-rate coupons and 4%3% had fixed-rate
coupons. All of our $1.6$1.4 billion in notional amounts of interest rate agreements
are marked-to-market for income statement purposes. Market value fluctuations
for all of theseour assets and interest rate agreements not only affect our reported
earnings, but also can affect our liquidity, especially to the extent these
assets are funded with short-term borrowings.
At March 31,June 30, 2001, we owned $0.1$0.2 billion of assets that were
marked-to-market on our balance sheet. Market value fluctuations of these assets
can affect the reported value of our stockholders' equity base.
Interest Rate Risk
At March 31,June 30, 2001, we owned $2.3 billionthe interest rate characteristics of our assets and had $2.1 billionfunded
with debt generally matched the interest rate characteristics of our
liabilities.
The majority ofAdjustable rate assets are generally matched with floating rate debt. Asset
yields may adjust to market conditions more slowly than the assets were adjustable-rate, as were a majority
of the liabilities.
On average, our cost of funds hasfloating
rate debt, thus potentially creating a temporary decrease in margins when
short-term interest rates rise and potentially creating a temporary increase in
margins when short-term interest rates fall (as occurred in the abilityfirst half of
2001). With respect to rise or fall more quickly
as a result of changesany single change in short-term interest rates, than does the earningmargins
on adjustable rate assets funded with floating rate debt should, in most such
circumstances, largely return to "normalized" levels within six months.
Periodic caps on some of our assets. In addition,adjustable rate assets may magnify and extend
such negative and positive trends in the caseevent of a large and rapid increase or
decrease in short-term interest rates, periodic and lifetime caps for arates. A portion of our assets could
limit increases inand liabilities
have maximum rate life caps; since life cap assets exceed similar liabilities,
margins may decline for extended periods of time if short-term interest income.rates
were to rise well above current levels.
Our remaining assets, after matching like assets with like liabilities, are
funded with equity. Our equity effectively funded a mixture of adjustable,
hybrid, and fixed rate assets at June 30, 2001. In order to further
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45
stabilize earnings through periods of fluctuating interest rates, we have been
increasing the portion of our equity-funded assets that have fixed rate or
hybrid coupons. At June 30, 2001, 94% of our equity effectively funded such
assets.
The risktable below shows the effective matching of reduced earnings in a risingour portfolios at June 30,
2001 without giving effect to interest rate environment may be mitigated to some extentagreement hedges. In this table,
assets are matched with like liabilities, not necessarily with the liabilities
that are actually secured by that asset type.
TABLE 26
ASSET/LIABILITY MATCHING
(ALL DOLLARS IN THOUSANDS)
ONE MONTH ONE YEAR NON-INTEREST TOTAL
ASSET LIBOR TREASURY HYBRID BEARING LIABILITIES
ASSET TYPE AMOUNT LIABILITIES LIABILITIES LIABILITIES LIABILITIES EQUITY AND EQUITY
---------- ---------- ----------- ----------- ----------- ------------ -------- -----------
Cash (unrestricted)......... $ 18,009 $ 18,009 $ 0 $ 0 $ 0 $ 0 $ 18,009
One Month LIBOR............. 477,398 477,398 0 0 0 0 477,398
Six Month LIBOR............. 511,532 511,532 0 0 0 0 511,532
COFI/Other ARM.............. 106,993 106,993 0 0 0 0 106,993
One Year Treasury........... 459,262 186,703 258,689 0 0 13,870 459,262
Hybrid...................... 324,784 0 0 273,267 0 51,517 324,784
Fixed....................... 145,435 0 0 0 0 145,435 145,435
Other Assets/Liabilities.... 30,075 0 0 0 16,883 13,192 30,075
---------- ---------- -------- -------- ------- -------- ----------
Total....................... $2,073,488 $1,300,635 $258,689 $273,267 $16,883 $224,014 $2,073,488
As we reduce our leverage, short-term debt, and interest rate exposure by
reducing our investment portfolio and increasing our emphasis on loan products,
and as we move more closely towards achieving our desired asset/liability mix
on-balance sheet, we have been reducing our hedging activities. In the second
and third quarters of 2001, we sold most of our remaining interest rate
agreements hedging program and by any concurrent slowing of mortgage prepayment
rates that may occur. Over periods of time longer than a few quarters, we
generally earn less in a lower short-termhad economic value. We intend to continue to use interest rate
environment and may earn
more over time in a higher short-term interest rate environment.
At March 31, 2001, 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 March 31, 2001, we owned $0.5 billion of adjustable-rate mortgage assets
with coupons that adjust monthlyagreements 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 fundspart of our liabilities has been stable.
For other parts ofasset/liability strategy in the future, but we do not
currently require hedging instruments to meet our balance sheet, our net income may fluctuate 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 March 31, 2001, we
owned $0.5 billion of adjustable-rate mortgage assets with interest rates that
adjust every six months as a function of six-month LIBOR interest rates funded
with equity and with debt that had an interest rate that adjusts monthly as a
function of one-month LIBOR interest rates. Adjustable-rate assets with earnings
rates dependent on one-year U.S. Treasury rates with annual adjustments totaled
$0.7 billion at March 31, 2001. 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 with annual adjustments. The remainder
of the liabilities associated with these assets had a cost of funds dependent on
one-month LIBOR rates or the daily Fed Funds rate.
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43
At March 31, 2001, we owned a total of $0.1 billion of fixed rate assets
funded, in part, with short-term variable rate debt that 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 beneficial effect of higher yields on equity-funded assets.
Interest rates and related factors can affect our spread income and our
mark-to-market results.asset/liability objectives.
Changes in interest rates also affectcan have many affects on our business aside from
those discussed in this section, including affecting our liquidity, market
values, and mortgage prepayment rates
(see below) and influence other factors that may affect our results.rates.
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. At March 31,June 30, 2001, we had $1.0$0.9
billion of short-term debt.
Prepayment Risk
One measure of prepayment risk is the amount of net premium or discount
balance that we carry on our balance sheet. At March 31,We had a net discount balance of
$7.2 million at June 30, 2001 our net premium balance was $3.8
million, which was slightly lower than ourand a net premium balance of $4.0 million at
December 31, 2001.2000. However, in some cases our gross premium levels before
netting with discount balances may be a
better measure of our risks relating to faster mortgage prepayment levels. The
amount of gross premium on our balance increased in the first quarterhalf of 2001, from $22$25
million to $27$29 million, as a result of acquisitions in our investment portfolio and positive mark-to-market
adjustments. Our gross discount balance also increased during the quarter,first half of
2001, from $18$21 million to $22$36 million, as a result of acquisitions in our credit
enhancement portfolio.
We could have material net premium amortization expenses even if we have a
very low net premium balance or a net discount balance. This could occur because
our premium mortgage assets generally prepay at a faster rate than do our
discount mortgage assets, and because the yields of our premium assets are
generally more sensitive to changes prepayment rates due to their securitization
structure.than are the yields of our
discount assets.
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TABLE 2427
UNAMORTIZED PREMIUM AND DISCOUNT BALANCES
(ALL DOLLARS IN THOUSANDS)
NET AVERAGE NET
RESIDENTIAL RESIDENTIAL COMMERCIAL PREM/(DISC)NET MORTGAGE PREMIUM
GROSS GROSS GROSS ON LONG- NETPREMIUM/ PREPAYMENT AMORTIZATION
PREMIUM DISCOUNT DISCOUNT TERM DEBT PREMIUM SPEED (CPR) EXPENSE
----------- ----------- ---------- ----------- ------- -------------------- -------- ----------- ------------
Q1: 2000............. $28,023 $(12,145) $ (34) $ 270 $16,114Q2: 2000.................................. $29,068 $(17,602) $11,466 17% $ (522)
Q2: 2000............. 25,379 (14,166) -- 240 11,453 17% 45
Q3: 2000............. 25,849 (16,599) (438) 1662000.................................. 29,202 (20,223) 8,979 17% (1,040)
Q4: 2000............. 22,319 (17,825) (531) 74 4,0362000.................................. 25,437 (21,400) 4,037 21% (818)
Q1: 2001............. 26,532 (21,672) (959) (112) 3,7902001.................................. 29,598 (25,809) 3,789 20% (869)
1999................. $27,612 $(10,886)Q2: 2001.................................. 29,046 (36,230) (7,184) 29% (1,885)
Six Months: 2000.......................... $29,068 $(17,602) $11,466 17% $ (13) $(1,045) $15,669 27% $(5,162)
2000................. 22,319 (17,825) (531) 74 4,036 18% (2,335)(477)
Six Months: 2001.......................... 29,046 (36,230) (7,184) 26% (2,754)
Credit Risk
Our principal credit risk comes from residential mortgage loans in our
retained portfolio and credit enhancement portfolio and from our commercial
mortgage 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 have credit risk
with counter-parties with whom we do business.
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44
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.
Credit losses may be capital losses rather than a reduction in ordinary income.
Thus, the timing ofand recognition amount of credit losses for GAAP and tax, and
for our earnings and our dividends, may differ.
The method that we use to account for future credit losses depends upon the
type of asset that we own. For our credit enhancement portfolio, we establish a
credit reserve upon the acquisition of such assets. 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 loan portfolio, we establish a credit reserve
based on anticipation of losses by taking credit provisions through our income
statement over time.as our estimate of losses changes. For our investment portfolio, most
of the assets do not have material credit risk, and, thus, no credit reserves
are generally established. When we acquire 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 possible.
Regardless of how we account for future credit loss expectations, there can be
no assurance that our estimates will prove to be correct, and thus we may need
to adjust the amounts of credit reserves we have 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 our short-term
borrowings declines or the market for short-term borrowings changes in an
adverse manner.
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 residential
mortgage securities
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rated below AA, residential credit enhancement interests, retained interests
from our Sequoia securitizations of our residential retained portfolio assets,
and commercial mortgage whole loans, and retained commercial mortgage junior
participants 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
generally equal our net investment. The sum of the capital adequacy amounts for
all of our mortgage assets is our aggregate capital adequacy guideline amount.
Generally,In recent quarters, our total guideline equity-to-assets ratio 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 guideline ratio has
increased as we have acquired new types of assets requiring more capital, such
as commercial mortgage loans and 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 and as the
market values of our mortgages, net of mark-to-market gains on hedges, decrease.
(Such market value declines may be temporary, as future coupon adjustments on
adjustable-rate mortgage loans may help to restore some of the lost market
value.)
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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 may authorize management to acquire mortgage assets in a limited
amount beyond the usual constraints of our risk-adjusted capital policy.
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 GAAP and our
dividends must equal at least 90% 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For a discussion on the qualitative disclosures about market risk, please
refer to our Risk Management presentation in Management's Discussion and
Analysis. Our quantitative risk has not materially changed from our disclosures
in our Year 2000 Form 10-K included in our Annual Report.
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4648
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
At March 31,June 30, 2001, there were no pending material legal proceedings to which
the Company was a party or of which any of its property was subject.
ITEM 2. CHANGES IN SECURITIES
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.(a) The Annual Meeting of Shareholders of the Company was held on May 3,
2001.
(b) The following matters were voted on at the Annual Meeting:
VOTES
-------------------------------
FOR AGAINST ABSTAIN
--------- ------- -------
1. Election of Directors:
Richard D. Baum 7,908,734 100,354 --
Mariann Byerwalter 7,905,902 103,186 --
David L. Tyler 7,908,784 100,304 --
The following Directors' terms of office continue after the
meeting:
Thomas C. Brown
George E. Bull
Thomas F. Farb
Douglas B. Hansen
Charles J. Toeniskoetter
VOTES
-------------------------------
FOR AGAINST ABSTAIN
--------- ------- -------
2. Ratification of PricewaterhouseCoopers LLP
as the Company's independent public
accountants for the fiscal year ending
December 31, 2001........................ 8,002,496 4,658 1,934
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 3.3.3 Amended and Restated Bylaws, amended June 21, 2001.
Exhibit 11.1 to Part I -- Computation of Earnings Per Share for the
three and six months ended March 31,June 30, 2001 and June 30, 2000.
(b) Reports
Form 8-K filed on January 10, 2001, regarding the Company's acquisition of
100% of RWT Holdings, Inc. voting common stock.None
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4749
SIGNATURES
Pursuant to the requirements of 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: May 11,August 13, 2001 By: /s/ DOUGLAS B. HANSEN
------------------------------------
Douglas B. Hansen
President
(authorized officer of registrant)
Dated: May 11,August 13, 2001 By: /s/ HAROLD F. ZAGUNIS
------------------------------------
Harold F. Zagunis
Vice President, Chief Financial
Officer,
Secretary, Treasurer and Controller
(principal financial and accounting
officer)
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