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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Introduction
Redwood Trust, Inc., together with its subsidiaries, is a financial institution focused on investing in, financing, and managing residential and commercial real estate loans and securities. We seek to invest in assets that have the potential to provide attractive cash flows over a long period of time and support our goal of distributing attractive levels of dividends to our stockholders. For tax purposes, we are structured as a real estate investment trust, or REIT. We are able to pass through substantially all of our earnings generated at our REIT to our stockholders without paying income tax at the corporate level. We pay income tax on the REIT taxable income we retain and on the income we earn at our taxable subsidiaries. Redwood was incorporated in the State of Maryland on April 11, 1994, and commenced operations on August 19, 1994. Our executive offices are located at One Belvedere Place, Suite 300, Mill Valley, California 94941.
References herein to “Redwood,” the “company,” “we,” “us,” and “our” include Redwood Trust, Inc. and its consolidated subsidiaries, unless the context otherwise requires. Financial information concerning our business is set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial statements and the notes thereto, and the supplemental financial information, which is included in Part I, Items 1 and 2 of this Quarterly Report on Form 10-Q.
Our website can be found atwww.redwoodtrust.com. We make available, free of charge through the investor information section of our website, access to our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the U.S. Securities Exchange Act of 1934, as well as proxy statements, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (SEC). We also make available, free of charge, access to our Corporate Governance Standards, charters for our Audit Committee, Compensation Committee, and Corporate Governance and Nominating Committee, our Corporate Governance Standards, and our Code of Ethics governing our directors, officers, and employees. Within the time period required by the SEC and the New York Stock Exchange, we will post on our web site any amendment to the Code of Ethics and any waiver applicable to any executive officer, director, or senior officer (as defined in the Code). In addition, our web site includes information concerning purchases and sales of our equity securities by our executive officers and directors, as well as disclosure relating to certain non generally accepted accounting principles (GAAP) financial measures (as defined in the SEC’s Regulation G) that we may make public orally, telephonically, by webcast, by broadcast, or by similar means from time to time. The information on our website is not part of this Quarterly Report on Form 10-Q.
Our Investor Relations Department can be contacted at One Belvedere Place, Suite 300, Mill Valley, CA 94941, Attn: Investor Relations, telephone (866) 269-4976.
Cautionary Statement
This Quarterly Report on Form 10-Q and the documents incorporated by reference herein contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve numerous risks and uncertainties. Our actual results may differ from our beliefs, expectations, estimates, and projections and, consequently, you should not rely on these forward-looking statements as predictions of future events. Forward-looking statements are not historical in nature and can be identified by words such as “anticipate,” “estimate,” “will,” “should,” “expect,” “believe,” “intend,” “seek,” “plan” and similar expressions or their negative forms, or by references to strategy, plans, or intentions. These forward-looking statements are subject to risks and uncertainties, including, among other things, those described in our 2008 Annual Report on Form 10-K under the caption “Risk Factors.” Other risks, uncertainties, and factors that could cause actual results to differ materially from those projected are described below and may be described from time to time in reports we file with the SEC, including reports on Forms 10-Q and 8-K. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
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Statements regarding the following subjects, among others, are forward-looking by their nature: (i) credit protection we expect to be able to rely on, the effect of prepayment speeds, potential returns on investments we make, and our expectation of future cash flows from investments; (ii) the potential effect of government initiatives and programs and whether or not we would participate in such programs; (iii) our expected rate of capital deployment and our future capital needs and sources; (iv) our views on the potential effects of changes in accounting standards; (v) our belief that some of the securities we own have the potential to produce earnings in excess of our current expectations; (vi) the types of investments we may make, including that we may acquire commercial real estate mortgage assets; (vii) the intention of our board of directors to pay a regular dividend of $0.25 per share per quarter in 2009 and our expectations that: dividends paid in 2009 will constitute a return of capital, and we will report a taxable loss for 2009; (viii) our view of trends in the housing market, mortgage delinquencies, and credit losses; and (ix) our expectation that a deconsolidation event in the second quarter with respect to one of our Sequoia entities may occur and that we would, as a result, reverse a related allowance for loan losses.
Important factors, among others, that may affect our actual results include: changes in interest rates; changes in mortgage prepayment rates; the timing of credit losses within our portfolio; our exposure to adjustable-rate and negative amortization mortgage loans; the state of the credit markets and other general economic conditions, particularly as they affect the price of earning assets and the credit status of borrowers; the concentration of the credit risks we are exposed to; the ability of counterparties to satisfy their obligations to us; legislative and regulatory actions affecting the mortgage industry or our business; the availability of high quality assets for purchase at attractive prices; declines in home prices and commercial real estate prices; increases in mortgage payment delinquencies; changes in the level of liquidity in the capital markets which may adversely affect our ability to finance our real estate asset portfolio; changes in liquidity in the market for real estate securities, the re-pricing of credit risk in the capital markets, inaccurate ratings of securities by rating agencies, rating agency downgrades of securities, and increases in the supply of real estate securities available-for-sale, each of which may adversely affect the values of securities we own; the extent of changes in the values of securities we own and the impact of adjustments reflecting those changes on our income statement and balance sheet, including our equity; our ability to maintain the positive stockholders’ equity necessary to enable us to pay the dividends required to maintain our status as a real estate investment trust for tax purposes; our ability to generate the amount of cash flow we expect from our investment portfolio; changes in our investment, financing, and hedging strategies and the new risks that those changes may expose us to; changes in the competitive landscape within our industry, including changes that may affect our ability to retain or attract personnel; our failure to manage various operational risks associated with our business; our failure to maintain appropriate internal controls over financial reporting; our failure to properly administer and manage our securitization entities; risks we may be exposed to if we expand our business activities, such as risks relating to significantly increasing our direct holdings of loans; limitations imposed on our business due to our REIT status and our status as exempt from registration under the Investment Company Act of 1940; our ability to successfully deploy the proceeds from our recent common equity offering and raise additional capital to fund our investing activity; and other factors not presently identified. Fair values for our securities and asset-backed securities (ABS) issued are dependent upon a number of market-based assumptions including future interest rates, prepayment rates, discount rates, credit loss rates, and the timing of credit losses. We use these assumptions to generate cash flow estimates and internal values for each individual security.
This Quarterly Report on Form 10-Q may contain statistics and other data that in some cases have been obtained from or compiled from information made available by servicers and other third-party service providers.
Our Business
Redwood Trust, Inc., together with its subsidiaries, is a financial institution focused on investing in, financing, and managing residential and commercial real estate loans and securities. We seek to invest in assets that have the potential to provide attractive cash flows over a long period of time and support our goal of distributing attractive levels of dividends to our stockholders. For tax purposes, we are structured as a real estate investment trust, or REIT. We are able to pass through substantially all of our earnings generated at our REIT to our stockholders without paying income tax at the corporate level. We pay income tax on the REIT taxable income we retain and on the income we earn at our taxable subsidiaries.
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Our primary source of income is net interest income, which consists of the interest income we earn from our investments in loans and securities less the interest expenses we incur on our borrowed funds and other liabilities. We assume a range of risks in our investments and the level of risk is influenced by the manner in which we finance our purchase and derive income from our investments. Our primary real estate investments include investments in real estate loans and securities, an investment in a private fund that we sponsor — Redwood Opportunity Fund, LP (the Fund) — and investments in the securitization entities that we sponsor — Sequoia and Acacia.
Our direct investments in residential, commercial, and collateralized debt obligations (CDO) securities are currently financed with equity and long-term debt, although we may use short-term debt financing to acquire securities and loans from time to time. These investments are primarily senior and subordinate mortgage-backed securities backed by high-quality residential and commercial real estate loans. “High-quality” real estate loans are loans that typically have low loan-to-value ratios, borrowers with strong credit histories, and other indications of quality relative to the range of loans within U.S. real estate markets as a whole. The long term focus of our operations is to invest in subordinate securities (often below investment grade) that have concentrated structural credit risk. More recently, we have been investing in senior securities (often investment-grade), which have the first right to cash flows in a securitization and therefore less concentrated credit risk than subordinate securities.
The entities that we sponsor — the Fund, Sequoia, and Acacia — invest in real estate assets. Assets held at the Fund include senior securities backed by non-prime residential and CDO collateral, which were funded through the sale of limited partnership interests to us and to third party investors. The offer and sale of these interests were privately placed and were not registered under the federal securities laws in reliance on an exemption from registration. Assets held at the Sequoia entities include residential real estate loans, which are funded through the issuance of ABS to us and to third party investors. Assets held at the Acacia entities include real estate securities, and some loans and other mortgage related investments, which are funded through the issuance of ABS and equity to us and to third party investors.
Our investments in each of these entities are currently financed with equity and long-term debt. Our capital at risk is limited to these investments as each entity is independent of Redwood and of each other and the assets and liabilities are not owned by and are not obligations of Redwood. For financial reporting purposes, we are generally required to consolidate these entities’ assets, liabilities, and noncontrolling interests.
Recent Developments
During the first quarter of 2009, our investment cash flows remained strong, we took advantage of attractive investment opportunities, and housing and credit fundamentals remained in line with our modeling expectations.
Since the beginning of the year, we have invested $240 million in residential mortgage-backed securities that we believe have the potential to generate attractive unlevered returns. We invested $98 million during the first quarter of 2009 and $142 million in the second quarter through May 1, 2009. The vast majority of these investments were in senior residential securities backed by pre-2006 prime or near prime loans that are well protected from a credit standpoint and well positioned to benefit from any uptick in prepayments. We have not acquired any commercial real estate assets since early 2007, but we have been actively monitoring developments and may identify investments that are adequately protected from loss and have the potential to provide stable, long-term cash flows, at attractive yields.
From the middle of 2007 through November 2008, trading activity between willing buyers and sellers of residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS) was light, and prices for virtually all mortgage-backed assets headed in one direction — down. This steady, steep decline was fueled by rapidly deteriorating credit fundamentals and was exacerbated by the extraordinary deleveraging that took place in the financial markets. The chart below illustrates the prices that investors were paying to compensate for the perceived credit risk of RMBS and CMBS over the last two years.
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RMBS and CMBS Prices
![[GRAPHIC MISSING]](https://capedge.com/proxy/10-Q/0001144204-09-024142/v146260_chrt-rmbscmbs.jpg)
Source: Credit Suisse, JPMorgan Chase, Redwood Trust
Since November 2008, prices for senior residential and commercial mortgage-backed securities have been on a roller coaster ride, as buyers’ and sellers’ sentiment has shifted back and forth from focusing on negative credit fundamentals (causing prices to move lower and trading activity to decline) to focusing on the potential positive technical benefits from government programs (causing prices to move higher and trading activity to increase). In contrast to price movements in senior securities, prices for subordinate residential and commercial securities have only moved lower, as the focus has been solely on the fundamentals. We believe residential subordinate securities are likely to be negatively impacted by the government’s loan modification initiatives.
From November 2008 through the end of January 2009, prices for senior mortgage-backed securities increased based on a positive market reaction to the initial high-level outline of government initiatives for legacy assets. By February 2009, in the absence of actionable details on these initiatives and with a pall looming over the health of banks, fear re-gripped the financial markets. As a consequence, trading activity fell dramatically and investor focus turned back to the negative credit fundamentals. Prices for senior securities dropped to a point where prices dipped below the November lows.
In mid-March, the government announced the outline of its Public-Private Investment Program (PPIP), designed to spur the purchase of up to $1 trillion of legacy residential assets (loans and securities), and signaled that it would expand the existing $1 trillion Term Asset-Backed Securities Loan Facility (TALF) to provide financing for the purchase of senior legacy residential and commercial mortgage-backed securities. In response to these announcements, prices for senior residential and commercial securities began to rise, although, by quarter-end, prices generally remained below year-end levels. As a result, we were required under GAAP to reflect additional negative market valuation adjustments in our first quarter financial statements. Since March 31, 2009, trading activity has been robust and prices for senior securities have continued to rise. In the near term it is difficult to anticipate the direction of prices since we believe they will depend largely on the success of PPIP, TALF, and other government programs.
In an attempt to stabilize or increase asset values, the government has indicated that it is considering offering what appears on the surface to be very attractive, non-recourse financing under TALF to potential acquirers of banks’ legacy securitized assets. Some of our competitors, including hedge funds and other market participants, have been actively buying senior securities in anticipation of leveraging these investments through financing provided under TALF, and hopefully increasing investment returns. So far, the details on TALF are limited, however, and key terms and potential regulatory restrictions imposed on program participants have not yet been disclosed by the government.
We would consider using TALF as a source of leverage if we became comfortable with the resulting liquidity risk and any operating restrictions that may be imposed by the government. It has long been our policy to avoid liquidity risk and that policy has enabled us to withstand this current crisis. Leverage does not improve the performance of the underlying collateral. As a matter of fact, the extensive use of leverage
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contributed to the current crisis. Furthermore, one of our competitive advantages has been our ability to operate in an entrepreneurial manner without government-imposed constraints; we are reluctant to compromise that ability. Until enough of the details on TALF are disclosed to allow us to make an informed judgment on the impact of the program on our balance sheet and operations, we will continue to acquire assets based upon unlevered return expectations.
Another program that deserves comment is PPIP. Here again, the details of the program have yet to be fully disclosed. Conceptually, the U.S. Treasury will select private-sector firms to manage new investment funds to be formed to acquire legacy loans and securities. The government will provide equity funding to be invested alongside the private investors in these funds, as well as non-recourse financing up to certain limits. We have thought long and hard about whether Redwood Asset Management (a Redwood subsidiary) should become a manager under the PPIP program. Redwood is well positioned to be a manager given our successful 15-year track record of managing residential credit risk, and we have the people, systems, and resources to proceed. There are positives, negatives, and unknowns associated with participation. Although it could significantly increase assets under management, the actual economics of such a mandate currently do not appear compelling. Moreover, there are questions relating to the Treasury’s share of the economics and potential limitations that could prevent us from capitalizing on attractive investment opportunities for Redwood shareholders. For now, the balance tips on the side of not participating, but we continue to monitor the situation and will re-evaluate our decision if warranted. Regardless of whether Redwood Asset Management participates in PPIP, we remain firmly committed to our third-party asset management initiative and are moving forward to grow the business, as it represents an important source of capital for us to acquire and manage additional assets.
In addition to the significant government actions taken during the first quarter of 2009, mark-to-market accounting standards will change in the second quarter based upon two new financial statement positions (FSPs) issued by the Financial Accounting Standards Board (FASB) in April 2009. These new FSPs will affect our future GAAP earnings; however, they will not affect our future cash flow, book value, or economic returns. The first FSP clarifies how to measure fair value in an inactive market. We do not expect this first FSP to have much of an impact on our pricing process or future earnings. The second FSP revises previous FASB guidance for measuring new impairments and eliminates the “recapture” of previously taken impairment charges that subsequently proved to be unnecessary. This second FSP will have positive and negative impacts on our future GAAP earnings. On the positive side, the guidance will likely reduce the amount of new future impairment charges against earnings. On the negative side, it will limit some of the future recapture of prior impairment charges, which under existing guidance, would have flowed through our income statement. Instead, previously recorded impairment charges that prove to have been unnecessary will be recorded as a positive equity adjustment. In the end, the benefit will still be reflected in book value, but it will not flow through earnings. We will adopt this standard in the second quarter; it is too early to estimate the impact.
Outlook
We remain focused on cash flows, capitalizing on investment opportunities, staying abreast of government initiatives and determining if and when to participate in those initiatives. We enter the second quarter with strong cash flow from our investment portfolio, increased prepayment activity, firming prices for senior securities and increased trading volume in the market, and ample to cash to invest.
At our current rate of capital deployment, we would expect to invest our excess capital over the course of the next few months. In deciding whether to raise additional capital, we must consider both our future capital needs and alternative sources of capital. The “needs side” of the capital equation involves an analysis of both the near-term — how much capital we need to capitalize on secondary investment opportunities, and the long-term — how much capital we need for investment in our core business in the years ahead. Alternative methods of raising capital include generating capital internally through asset sales or re-securitizations, raising third-party funds through private placements to expand our asset management business, or accessing the equity markets through the sale of common stock. We may reduce our capital needs if we are able to leverage some of our investments through TALF, although, as we noted above, it is too early to determine whether it makes sense for us to participate in that program.
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Decisions around capital require speculation on future market conditions and investment opportunities. As markets continue to remain fluid, it is difficult to predict the actions we will take. Our highest near-term priority is to get our arms around the level and attractiveness of secondary market investment opportunities. We will remain true to our core values and consider raising additional common equity only if we believe there are attractive investment opportunities that with the potential to lead us to higher levels of earnings and dividends per share over the long-term.
We expect that GAAP earnings will remain volatile in the near term due to mark-to-market (MTM) adjustments. We may recognize additional GAAP impairment losses on residential, commercial, and CDO securities held at Redwood and the Fund. Negative MTM balance sheet write-downs that have not yet been realized through our income statement totaled $75 million at March 31, 2009. Future income statement impairment charges related to these unrealized losses will be ameliorated by the recently announced FSP discussed above and, in any event, will not affect GAAP book value since these MTM losses were already deducted from equity at March 31, 2009. The fair value accounting principles we follow for the assets and liabilities at Acacia may also contribute to future MTM volatility.
Actual REIT taxable income in 2009 will depend on the timing of credit losses and the level of taxable income generated by our new and existing investments. We currently expect that taxable income will continue to be pressured by the realization of credit losses in 2009 and it is highly probable that taxable income for 2009 will be negative. In November 2008, our Board of Directors announced its intention to distribute a regular dividend of $0.25 per share per quarter during 2009.
Summary of Results of Operations and Financial Condition
Our reported GAAP net loss was $35 million ($0.65 per share) for the first quarter of 2009 as compared to a GAAP net loss of $172 million ($5.28 per share) for the first quarter of 2008. Our GAAP book value per common share was $8.40 at March 31, 2009, a decrease from $9.02 at December 31, 2008. We declared a regular dividend of $0.25 per share for the first quarter of 2009 and $0.75 per share for the first quarter of 2008.
The following table presents the components of our GAAP net loss for the first quarter of 2009 and 2008.
Table 1 Net Income
 | | | | |
| | Three Months Ended
March 31, |
| (In Thousands, Except Share Data) | | 2009 | | 2008 |
| Interest income | | $ | 81,438 | | | $ | 176,064 | |
| Interest expense | | | (47,642 | ) | | | (127,300 | ) |
| Net interest income | | | 33,796 | | | | 48,764 | |
| Provision for loan losses | | | (16,032 | ) | | | (8,058 | ) |
| Market valuation adjustments, net | | | (43,242 | ) | | | (193,932 | ) |
| Net interest loss after provision and market valuation adjustments | | | (25,478 | ) | | | (153,226 | ) |
| Operating expenses | | | (10,539 | ) | | | (16,348 | ) |
| Realized gains on sales and calls, net | | | 462 | | | | 42 | |
| Provision for income taxes | | | (105 | ) | | | (1,800 | ) |
| Less: Net loss attributable to noncontrolling interest | | | (716 | ) | | | 255 | |
| Net Loss | | $ | (34,944 | ) | | $ | (171,587 | ) |
| Diluted weighted average common shares outstanding | | | 53,632,132 | | | | 32,511,445 | |
| Net loss per share | | $ | (0.65 | ) | | $ | (5.28 | ) |
Our net loss of $35 million for the first quarter of 2009 included net negative market valuation adjustments (MVA) of $43 million on real estate securities and derivatives, a reduction from net negative MVA of $194 million for the first quarter of 2008. This reduction was primarily due to fewer impairment charges on securities. Our provision for loan losses at Sequoia was $16 million for the first quarter of 2009, as compared to $8 million for the first quarter of 2008. As of March 31, 2009, we have an allowance for loan
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losses for one of the Sequoia entities that exceeds our economic investment in that entity by $15 million. Upon the occurrence of certain events, which may occur in the second quarter, we will be permitted to deconsolidate that Sequoia entity and upon deconsolidation, will record a gain to the extent of the excess allowance for loan losses.
Net interest income was $34 million for the first three months of 2009 as compared to $49 million for the first three months of 2008. Net interest income at Redwood declined by $12 million due to higher credit losses, slower prepayments, and lower interest rates on securities. Net interest income at Sequoia declined by $4 million due to lower interest rates on adjustable rate loans. These declines were partially offset by $1 million increase in net interest income generated on securities at the Fund during the first quarter of 2009. Net interest income at Acacia was $2 million for both the first quarters of 2009 and 2008.
Operating expenses decreased by $6 million in the first quarter of 2009 as compared to the first quarter of 2008 primarily due to a reduction in headcount and fewer legal and consulting expenses.
The Results of Operations section of this Management’s Discussion and Analysis contains a detailed discussion and analysis of the components of net income.
Our estimated total taxable loss was $14 million ($0.22 per share) for the first quarter of 2009, as compared to our estimated total taxable income of $26 million ($0.79 per share) for the first quarter of 2008. Our estimated REIT taxable loss was $9 million ($0.14 per share) for the first quarter of 2009, as compared to our estimated REIT taxable income of $25 million ($0.76 per share) for the first quarter of 2008. Our REIT taxable income is that portion of our total taxable income that we earn at Redwood and its qualifying REIT subsidiaries and determines the minimum amount of dividends we must distribute to shareholders in order to maintain our tax status as a REIT.
The decrease in REIT taxable income for the first quarter of 2009 as compared to the first quarter of 2008 was primarily due to an increase in realized credit losses on subordinate securities. For tax purposes, we are not permitted to establish credit reserves on securities and do not record impairments or other changes in the fair value of financial assets or liabilities. Realized credit losses at the REIT for tax purposes for the first quarters of 2009 and 2008 were $48 million and $14 million, or $0.80 and $0.41 per share, respectively.
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Book Value
The Financial Condition, Liquidity, and Capital Resources section of this Management’s Discussion and Analysis contains a detailed discussion and analysis of the components of GAAP book value at March 31, 2009 and December 31, 2008. The following supplemental non-GAAP components of book value addresses our assets and liabilities at March 31, 2009, as reported under GAAP and as estimated by us using fair values for our investments. We show our investments in the Fund, and the Sequoia and Acacia entities as separate line items to highlight our specific ownership interests, as the underlying assets and liabilities of these entities are legally not ours. Our estimated economic value is calculated using bid-side asset marks, as required to determine fair value under GAAP. This method of calculating economic value more closely represents liquidation value and does not represent the higher amount we would have to pay at the offered-side to replace our existing assets. For additional information to consider when reviewing the following supplemental non-GAAP components of book value, please see “Factors Affecting Management’s Estimate of Economic Value” below.
Table 2 Book Value
| | | | | | |
| | March 31, 2009 |
| (In Millions, Except per Share Data) | | As Reported | | Adjustments | | Management’s
Estimate of
Economic
Value |
| Cash and cash equivalents | | $ | 333 | | | | | | | $ | 333 | |
Real estate securities at Redwood
| | | | | | | | | | | | |
| Residential | | | 195 | | | | | | | | 195 | |
| Commercial | | | 23 | | | | | | | | 23 | |
| CDO | | | 3 | | | | | | | | 3 | |
| Subtotal real estate securities | | | 221 | | | | | | | | 221 | |
| Investments in the Fund | | | 22 | | | | | | | | 22 | |
| Investments in Sequoia | | | 70 | | | | (9)(a) | | | | 61 | |
| Investments in Acacia | | | 7 | | | | (2)(b) | | | | 5 | |
| Total securities and investments | | | 320 | | | | | | | | 309 | |
| Long-term debt | | | (150 | ) | | | 108 | (c) | | | (42 | ) |
| Other assets/liabilities, net(d) | | | 3 | | | | | | | | 3 | |
| Stockholders’ Equity | | $ | 506 | | | | | | | $ | 603 | |
| Book Value Per Share | | $ | 8.40 | | | | | | | $ | 10.01 | |
| (a) | Our Sequoia investments consist of senior and subordinate securities and interest-only securities issued by Sequoia entities. We calculated the $61 million estimate of economic value for these securities using the same valuation process that we followed to fair value our other real estate securities. In contrast, the $70 million of GAAP carrying value of these investments represents the difference between residential real estate loans owned by the Sequoia entities and the asset-backed securities (ABS) issued by these entities to third-party investors. Under GAAP, we account for these loans and ABS issued at cost. |
| (b) | Our Acacia investments consist of ABS issued and equity interests; we also have management agreements with each entity. The $5 million estimate of economic value of our investments in Acacia entities represents the value of the ABS acquired plus the net present value of projected cash flows from our Acacia management fees discounted at 45%. We valued our equity interests at zero. In contrast, the $7 million GAAP value of these investments represents the difference between securities owned by the Acacia entities and the ABS issued by these entities to third-party investors. Under GAAP, we account for these securities and ABS issued at fair value. |
| (c) | We have issued $150 million of 30-year long-term debt at an interest rate of LIBOR plus 225 basis points. Under GAAP, these notes are carried at cost. Economic value is difficult to estimate with precision as the market for the notes is currently inactive. We estimated the $42 million economic value using the same valuation process used to fair value our other financial assets and liabilities. Estimated economic value is $108 million lower than our GAAP carrying value because given the significant overall contraction in credit availability and re-pricing of credit risk, if we had issued this long-term debt at March 31, 2009, investors would have required a substantially higher interest rate. |
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| (d) | Other assets/liabilities, net are comprised of $3 million of real estate loans, $3 million of deferred taxes, $6 million of accrued interest receivable, and $16 million of other assets, less dividends payable of $15 million and accrued interest and other liabilities of $10 million. |
During prior periods, we presented our securities based on their current ratings, i.e. investment grade securities (IGS) and credit enhancement securities (CES). Given current market conditions, we believe that these ratings have become less meaningful and we now categorize our securities by their payment priority within a securitization capital structure. Senior securities are those interests in a securitization that have the first right to cash flows and are last in line to absorb losses. Subordinate securities are all interests below senior securities. Subordinate securities may not necessarily be in first-loss position.
For comparability purposes, the tables below present the carrying value of our real estate securities at Redwood by vintage at March 31, 2009, using our new presentation as well as the prior one. The first table reflects our prior presentation categories of IGS and CES and the second table reflects our new presentation using senior and subordinate securities categories.
Table 3 Securities at Redwood by Vintage, as a Percentage of Total Securities
March 31, 2009
| | | | | | | | | | |
| (In Thousands) | | 2004 &
Earlier | | 2005 | | 2006 – 2008 | | Total | | % of Total
Securities |
Residential
| | | | | | | | | | | | | | | | | | | | |
IGS
| | | | | | | | | | | | | | | | | | | | |
| Prime | | $ | 13,334 | | | $ | 67,387 | | | $ | 17,182 | | | $ | 97,903 | | | | 44 | % |
| Non-prime | | | 26,519 | | | | 20,143 | | | | 10,656 | | | | 57,318 | | | | 26 | % |
| Total IGS | | | 39,853 | | | | 87,530 | | | | 27,838 | | | | 155,221 | | | | 70 | % |
CES
| | | | | | | | | | | | | | | | | | | | |
| Prime | | | 12,749 | | | | 4,438 | | | | 1,688 | | | | 18,875 | | | | 9 | % |
| Non-prime | | | 642 | | | | 17,827 | | | | 3,133 | | | | 21,602 | | | | 10 | % |
| Total CES | | | 13,391 | | | | 22,265 | | | | 4,821 | | | | 40,477 | | | | 19 | % |
| Total Residential | | | 53,244 | | | | 109,795 | | | | 32,659 | | | | 195,698 | | | | 89 | % |
| Commercial | | | 8,712 | | | | 4,462 | | | | 9,741 | | | | 22,915 | | | | 10 | % |
| CDO | | | 49 | | | | 2,578 | | | | 30 | | | | 2,657 | | | | 1 | % |
| Total Securities at Redwood | | $ | 62,005 | | | $ | 116,835 | | | $ | 42,430 | | | $ | 221,270 | | | | 100 | % |
March 31, 2009
| | | | | | | | | | |
| (In Thousands) | | 2004 &
Earlier | | 2005 | | 2006 – 2008 | | Total | | % of Total
Securities |
Residential
| | | | | | | | | | | | | | | | | | | | |
Senior
| | | | | | | | | | | | | | | | | | | | |
| Prime | | $ | 4,567 | | | $ | 67,003 | | | $ | 16,196 | | | $ | 87,766 | | | | 40 | % |
| Non-prime | | | 26,519 | | | | 36,514 | | | | 11,350 | | | | 74,383 | | | | 34 | % |
| Total Senior | | | 31,086 | | | | 103,517 | | | | 27,546 | | | | 162,149 | | | | 74 | % |
Subordinate
| | | | | | | | | | | | | | | | | | | | |
| Prime | | | 21,516 | | | | 4,822 | | | | 2,674 | | | | 29,012 | | | | 13 | % |
| Non-prime | | | 642 | | | | 1,456 | | | | 2,439 | | | | 4,537 | | | | 2 | % |
| Total Subordinate | | | 22,158 | | | | 6,278 | | | | 5,113 | | | | 33,549 | | | | 15 | % |
| Total Residential | | | 53,244 | | | | 109,795 | | | | 32,659 | | | | 195,698 | | | | 89 | % |
| Commercial | | | 8,712 | | | | 4,462 | | | | 9,741 | | | | 22,915 | | | | 10 | % |
| CDO | | | 49 | | | | 2,578 | | | | 30 | | | | 2,657 | | | | 1 | % |
| Total Securities at Redwood | | $ | 62,005 | | | $ | 116,835 | | | $ | 42,430 | | | $ | 221,270 | | | | 100 | % |
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All subsequent tables with securities-related information reflect the senior and subordinate categories rather than the credit rating categories.
Our investment profile for real estate securities has shifted over the past year to residential prime and near prime senior cash flows with a comfortable margin of safety to protect against escalating credit losses. The fair value of our residential senior securities at March 31, 2009, was $162 million, representing 74% of our total portfolio, an increase from 49% at December 31, 2008, and an increase from 2% at March 31, 2008. This percentage change in the components of our total portfolio was also the result of declines in the fair value of our subordinate securities, as discussed below.
Our returns on these investments in senior securities will be based upon how much principal and interest we ultimately receive and how quickly we receive it. We fully expect, and base our analysis of the attractiveness of the new investments on, more bad things happening in housing. We expect housing prices to continue to decline about 20% on average, more in some areas and less in others, over the next year, and delinquencies and foreclosures to increase. Our target investment objective profile has been to achieve mid- to high-teen returns in the unlevered base case, well-protected stress case returns, and exceptional upside returns if we benefit from faster prepayments or lower credit losses. We model these profiles based upon our forecasts of the underlying collateral cash flows and the level of subordination protecting against future credit losses. We do not rely on credit ratings as part of our investment decision process. We emphasize this point because in 2009, we expect significant rating agency downgrades of prime and non-prime AAA-rated residential senior securities issued from 2005 through 2008. The overall credit performance of loans underlying these vintages is significantly worse than the rating agency original expectations. In many cases, we expect securities currently rated AAA to be downgraded below investment grade, and in some cases downgraded to CCC.
As our senior securities investments primarily represent senior cash flows, we do not expect a high level of losses. Our senior securities returns are generally more sensitive to changes in prepayment rates than they are to credit. As has been well-publicized, many borrowers are currently having difficulty refinancing due to high non-agency mortgage rates, insufficient home equity, and stringent underwriting. A pick-up in refinance activity either from lower non-agency mortgage rates or from the government’s initiatives to stimulate refinancing would benefit our senior securities returns.
The fair value of our residential subordinate securities portfolio was $34 million, representing 15% of our total portfolio at March 31, 2009, down from 27% at December 31, 2008 and down from 49% a year ago. This decline resulted from a reduction in market values due to negative mark-to-market adjustments and from our decision to redirect our investment focus to senior securities. We acquire subordinate securities at a significant discount to principal value as credit losses could reduce or eliminate the principal value of these bonds. In an ideal environment, we would experience fast prepayments and low credit losses allowing us to recover a substantial part of the discount as income. Conversely, a less beneficial environment is the environment we are currently experiencing with slow prepayments and high credit losses.
Our residential subordinate securities from 2004 and prior total $22 million and are carried at a fair value representing 2% of face value. From a credit standpoint, those vintages are generally performing in line with or better than our initial expectations. Our subordinate securities investments with vintages from 2005 to 2008 are carried at a fair value of $11 million, representing 2% of face value. Based on the poor credit trends underlying these vintages, we expect that future credit losses will eliminate virtually all of the principal or face amount of these securities. Therefore, the value ascribed to these securities is derived from the present value of future interest we expect to collect before actual credit losses are realized.
Our commercial subordinate securities represent 10% of our securities portfolio at March 31, 2009, down from 22% at December 31, 2008, and down from 43% a year ago. We have not purchased commercial securities since the first quarter of 2007. Due to a continuing deterioration in the fundamentals (increasing vacancies, falling rents) and an increasingly weakening economy (slowdown in consumer spending, increase in unemployment), we wrote down our commercial subordinate securities to $23 million, or 4% of face value in the first quarter of 2009.
The GAAP value (which equals fair value) of our investments in the Fund was $22 million at March 31, 2009. These investments represent a 52% interest in the Fund, which closed in March 2008 and is
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fully-invested. The Fund is managed by a subsidiary of Redwood. All of the Fund’s cash flow (excluding expenses and management fees) is distributed to the limited partners quarterly.
The GAAP value and fair value of our investments in Sequoia was $70 million and $61 million at March 31, 2009, respectively. These investments consist primarily of interest-only securities (IOs) and to a lesser extent senior securities and subordinate securities. Our returns on these investments are most sensitive to prepayments although material changes in interest rates also have a short term impact on cash flows generated.
The GAAP value and fair value of our investments in Acacia was $7 million and $5 million at March 31, 2009, respectively. These investments represent equity interests and ABS issued from our Acacia CDO securitization entities and the management fees we receive from those entities. Due to various provisions in each CDO securitization, all but one of our equity interests are cut off from cash flows and we only expect limited returns on the ABS issued we own. We value the management fees at $4 million, which equals our projected fees discounted at a 45% rate.
Capital and Liquidity
We continue to maintain our strong balance sheet and liquidity. At March 31, 2009, we had $333 million in cash and cash equivalents, or $5.53 per share. All of our cash and cash equivalents are invested in U.S. Treasury Bills or FDIC-insured bank deposits. At March 31, 2009, our total capital was $656 million, which consisted of $506 million of common equity and $150 million of 30-year long-term debt due in 2037. We had no short-term debt at March 31, 2009, and do not anticipate adding any in the current environment since our anticipated acquisitions are generally illiquid and subject to volatile market value changes. We fund these investments with permanent capital (equity and long-term debt) that will enable us to hold the securities to maturity without the risk of margin calls or forced redemptions.
Our quarterly sources and uses of our cash is one of the financial metrics on which we focus. Therefore, as a supplement to the Consolidated Statement of Cash Flows included in this Quarterly Report on Form 10-Q, we show in the table below (i) the beginning cash balance at December 31, 2008, and the ending cash balance at March 31, 2009, which are GAAP amounts, and (ii) the components of sources and uses of cash organized in a manner consistent with the way management analyzes them. The presentation of our sources and uses of cash for the first quarter of 2009 is derived by aggregating and netting all items within our GAAP Consolidated Statement of Cash Flows that were attributable to the first quarter of 2009.
Table 4 Redwood Sources and Uses of Cash
| | |
| (In Millions) | | Three Months Ended
March 31, 2009 |
| Beginning Cash Balance at 12/31/08 | | $ | 126 | |
Business cash flows:
| | | | |
| Cash flow from investments | | | 57 | |
| Asset management fees | | | 1 | |
| Operating expenses | | | (11 | ) |
| Interest expense on Redwood debt | | | (2 | ) |
| Total Business Cash Flows | | | 45 | |
Other sources and uses:
| | | | |
| Proceeds from asset sales | | | 1 | |
| Proceeds from equity issuance | | | 285 | |
| Changes in working capital | | | 1 | |
| Acquisitions | | | (98 | ) |
| Dividends paid | | | (27 | ) |
| Total Other Sources | | | 162 | |
| Net Sources of Cash | | | 207 | |
| Ending Cash Balance at 3/31/09 | | $ | 333 | |
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Our cash flow was strong during the first quarter of 2009. We generated $57 million of cash flow from investments during the quarter, an increase from $40 million generated in the prior quarter, as shown in the table below. Of this cash flow, $53 million was generated by assets we owned as of the beginning of the quarter and $4 million was generated by assets acquired during the quarter. The increase was primarily driven by favorable interest rate resets on our IO investments, and faster prepayments. Cash flow from investments does not include the gross cash flows generated by the Fund and by the Sequoia and Acacia securitization entities that are not available to Redwood, but does include the cash flow generated by our investments in these entities.
Table 5 Cash Flow from Investments
| | | | | | |
| | Three Months Ended | | |
| (In Millions) | | December 31, 2008 | | March 31, 2009 | | Change |
| Redwood | |
| Residential principal | | $ | 10 | | | $ | 15 | | | $ | 5 | |
| Residential interest | | | 11 | | | | 15 | | | | 4 | |
| Commercial | | | 5 | | | | 5 | | | | — | |
| Total Redwood | | | 26 | | | | 35 | | | | 9 | |
| Investments in Sequoia | | | 9 | | | | 18 | | | | 9 | |
| Investments in Acacia | | | 2 | | | | 1 | | | | (1 | ) |
| Investments in the Fund | | | 3 | | | | 3 | | | | — | |
| Total Cash Flow from Investments | | $ | 40 | | | $ | 57 | | | $ | 17 | |
The $57 million of cash flow from investments for the first quarter included $39 million of coupon interest and $18 million of principal payments.
The following table details the source of our cash flow from investments, by vintage, for the first quarter. Most of our cash flows are generated by more seasoned investments with vintage of 2004 and earlier, which generally continue to perform within our expectations.
Table 6 Cash Flow from Investments by Vintage
| | | | | | | | | | | | |
| | Vintage |
Three Months Ended March 31, 2009
(In Millions) | | 2004 &
Earlier | | 2005 | | 2006 | | 2007 | | 2008 | | Total |
| Redwood | | $ | 13 | | | $ | 8 | | | $ | 5 | | | $ | 9 | | | | — | | | $ | 35 | |
| The Fund | | | 2 | | | | 1 | | | | — | | | | — | | | | — | | | | 3 | |
| Sequoia | | | 12 | | | | — | | | | — | | | | 6 | | | | — | | | | 18 | |
| Acacia | | | 1 | | | | — | | | | — | | | | — | | | | — | | | | 1 | |
| Total Cash Flow by Vintage | | $ | 28 | | | $ | 9 | | | $ | 5 | | | $ | 15 | | | | — | | | $ | 57 | |
Future increases in cash flow could be generated by successfully reinvesting the cash flow from our existing investments, and deploying our remaining unrestricted cash. The amount of cash flow from investments could be volatile from quarter to quarter depending on prepayment patterns, changes in interest rates, and the level of credit losses.
Factors Affecting Management’s Estimate of Economic Value
In reviewing the non-GAAP supplemental components of book value, which are included herein and which we also refer to as management’s “estimate of economic value,” there are a number of important factors and limitations to consider. The estimated fair value of our stockholders’ equity is calculated as of a particular point in time based on our existing assets and liabilities and does not incorporate other factors that may have a significant impact on that value, most notably the impact of future business activities and cash flows. As a result, the estimated economic value of our stockholders’ equity does not necessarily represent an estimate of our net realizable value, liquidation value, or our market value as a whole. Amounts we ultimately
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realize from the disposition of assets or settlement of liabilities may vary significantly from the estimated economic values presented in our non-GAAP supplemental components of book value. Because temporary changes in market conditions can substantially affect the economic value of our stockholders’ equity, we do not believe that short-term fluctuations in the economic value of our assets and liabilities are necessarily representative of the effectiveness of our investment strategy or the long-term underlying value of our business. When quoted market prices or observable market data are not available to estimate fair value, we rely on Level 3 inputs. Because assets and liabilities classified as Level 3 are generally based on unobservable inputs, the process of calculating economic value is generally more subjective and involves a high degree of management judgment and assumptions. These assumptions may have a significant effect on our estimates of economic value, and the use of different assumptions as well as changes in market conditions could have a material effect on our results of operations or financial condition.
Results of Operations
The following discussion is based upon management’s consolidating results for Redwood, the Fund, Sequoia, and Acacia and acts as a supplement to our GAAP results for the three months ended March 31, 2009 and 2008.
Table 7 Consolidating Income Statements
| | | | | | | | | | | | |
| | Three Months Ended March 31, 2009 |
| (In Thousands) | | Redwood
Parent Only | | The
Fund | | Sequoia | | Acacia | | Intercompany
Adjustments | | Redwood
Consolidated |
| Interest income | | $ | 21,827 | | | $ | 2,816 | | | $ | 33,635 | | | $ | 22,537 | | | $ | 623 | | | $ | 81,438 | |
| Management fees | | | 1,032 | | | | — | | | | — | | | | — | | | | (1,032 | ) | | | — | |
| Interest expense | | | (1,808 | ) | | | — | | | | (25,114 | ) | | | (20,772 | ) | | | 52 | | | | (47,642 | ) |
| Net interest income | | | 21,051 | | | | 2,816 | | | | 8,521 | | | | 1,765 | | | | (357 | ) | | | 33,796 | |
| Provision for loan losses | | | — | | | | — | | | | (16,032 | ) | | | — | | | | — | | | | (16,032 | ) |
| Market valuation adjustments, net | | | (26,286 | ) | | | (3,889 | ) | | | (700 | ) | | | (12,367 | ) | | | — | | | | (43,242 | ) |
| Net interest loss after provision and market valuation adjustments | | | (5,235 | ) | | | (1,073 | ) | | | (8,211 | ) | | | (10,602 | ) | | | (357 | ) | | | (25,478 | ) |
| Operating expenses | | | (10,460 | ) | | | (430 | ) | | | (6 | ) | | | — | | | | 357 | | | | (10,539 | ) |
| Realized gains on sales and calls, net | | | 337 | | | | — | | | | 125 | | | | — | | | | — | | | | 462 | |
| Loss from the Fund | | | (787 | ) | | | — | | | | — | | | | — | | | | 787 | | | | — | |
| Loss from Sequoia | | | (8,092 | ) | | | — | | | | — | | | | — | | | | 8,092 | | | | — | |
| Loss from Acacia | | | (10,602 | ) | | | — | | | | — | | | | — | | | | 10,602 | | | | — | |
| Noncontrolling interest | | | — | | | | 716 | | | | — | | | | — | | | | — | | | | 716 | |
| Net loss before provision for taxes | | | (34,839 | ) | | | (787 | ) | | | (8,092 | ) | | | (10,602 | ) | | | 19,481 | | | | (34,839 | ) |
| Provision for income taxes | | | (105 | ) | | | — | | | | — | | | | — | | | | — | | | | (105 | ) |
| Net (Loss) Income | | $ | (34,944 | ) | | $ | (787 | ) | | $ | (8,092 | ) | | $ | (10,602 | ) | | $ | 19,481 | | | $ | (34,944 | ) |
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| | | | | | | | | | | | |
| | Three Months Ended March 31, 2008 |
| (In Thousands) | | Redwood
Parent
Only | | The
Fund | | Sequoia | | Acacia | | Intercompany
Adjustments | | Redwood
Consolidated |
| Interest income | | $ | 33,789 | | | $ | 1,773 | | | $ | 95,182 | | | $ | 47,467 | | | $ | (2,147 | ) | | $ | 176,064 | |
| Management fees | | | 1,613 | | | | — | | | | — | | | | — | | | | (1,613 | ) | | | — | |
| Interest expense | | | (2,715 | ) | | | — | | | | (82,734 | ) | | | (45,456 | ) | | | 3,605 | | | | (127,300 | ) |
| Net interest income | | | 32,687 | | | | 1,773 | | | | 12,448 | | | | 2,011 | | | | (155 | ) | | | 48,764 | |
| Provision for loan losses | | | — | | | | — | | | | (8,058 | ) | | | — | | | | — | | | | (8,058 | ) |
| Market valuation adjustments, net | | | (166,660 | ) | | | — | | | | (419 | ) | | | (26,853 | ) | | | — | | | | (193,932 | ) |
| Net interest (loss) income after provision and market valuation adjustments | | | (133,973 | ) | | | 1,773 | | | | 3,971 | | | | (24,842 | ) | | | (155 | ) | | | (153,226 | ) |
| Operating expenses | | | (16,208 | ) | | | (249 | ) | | | (46 | ) | | | — | | | | 155 | | | | (16,348 | ) |
| Realized gains on sales and calls, net | | | 39 | | | | — | | | | — | | | | 3 | | | | — | | | | 42 | |
| Income from the Fund | | | 1,269 | | | | — | | | | — | | | | — | | | | (1,269 | ) | | | — | |
| Income from Sequoia | | | 3,925 | | | | — | | | | — | | | | — | | | | (3,925 | ) | | | — | |
| Loss from Acacia | | | (24,839 | ) | | | — | | | | — | | | | — | | | | 24,839 | | | | — | |
| Noncontrolling interest | | | — | | | | (255 | ) | | | — | | | | — | | | | — | | | | (255 | ) |
| Net (loss) income before provision for taxes | | | (169,787 | ) | | | 1,269 | | | | 3,925 | | | | (24,839 | ) | | | 19,645 | | | | (169,787 | ) |
| Provision for income taxes | | | (1,800 | ) | | | — | | | | — | | | | — | | | | — | | | | (1,800 | ) |
| Net (Loss) Income | | $ | (171,587 | ) | | $ | 1,269 | | | $ | 3,925 | | | $ | (24,839 | ) | | $ | 19,645 | | | $ | (171,587 | ) |
Results of Operations — Redwood
The following table presents the net interest loss after provision and MVA at Redwood for the first quarter of 2009 and 2008.
Table 8 Net Interest Loss after Provision and MVA at Redwood
| | | | | | | | | | | | |
| | Three Months Ended March 31, |
| | | 2009 | | 2008 |
| (Dollars in Thousands) | | Total
Interest
Income/
(Expense) | | Average
Amortized
Cost | | Yield | | Total
Interest
Income/
(Expense) | | Average
Amortized
Cost | | Yield |
Interest Income
| | | | | | | | | | | | | | | | | | | | | | | | |
| Real estate loans | | $ | 64 | | | $ | 2,762 | | | | 9.27 | % | | $ | 99 | | | $ | 4,758 | | | | 8.32 | % |
| Trading securities | | | 2,972 | | | | 5,668 | | | | 209.75 | % | | | 4,191 | | | | 53,408 | | | | 31.39 | % |
| Available-for-sale securities | | | 18,750 | | | | 259,777 | | | | 28.87 | % | | | 27,264 | | | | 385,773 | | | | 28.27 | % |
| Cash and cash equivalents | | | 41 | | | | 304,872 | | | | 0.05 | % | | | 2,235 | | | | 269,354 | | | | 3.32 | % |
| Total Interest Income | | | 21,827 | | | | | | | | | | | | 33,789 | | | | | | | | | |
| Management fees | | | 1,032 | | | | | | | | | | | | 1,613 | | | | | | | | | |
Interest Expense
| | | | | | | | | | | | | | | | | | | | | | | | |
| Short-term debt | | | — | | | | — | | | | — | | | | (182 | ) | | | 21,477 | | | | (3.39 | )% |
| Long-term debt | | | (1,808 | ) | | | 147,193 | | | | (4.91 | )% | | | (2,533 | ) | | | 146,242 | | | | (6.93 | )% |
| Total Interest Expense | | | (1,808 | ) | | | | | | | | | | | (2,715 | ) | | | | | | | | |
| Net Interest Income | | | 21,051 | | | | | | | | | | | | 32,687 | | | | | | | | | |
| Market valuation adjustments, net | | | (26,286 | ) | | | | | | | | | | | (166,660 | ) | | | | | | | | |
| Net Interest Loss After MVA at Redwood | | $ | (5,235 | ) | | | | | | | | | | $ | (133,973 | ) | | | | | | | | |
Net interest loss after MVA at Redwood was a loss of $5 million in the first quarter of 2009 as compared to a loss of $134 million in the first quarter of 2008, a decrease in the loss of $129 million. The primary
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reason for the lower loss was a decrease in negative MVA of $141 million in the first quarter of 2009 over the first quarter of 2008. We detail MVA in a separate Mark-to-Market Adjustments section below.
Net interest income at Redwood was $21 million in the first quarter of 2009 as compared to $33 million in the first quarter of 2008, a decline of $12 million. The primary reasons for this decline included reduced discount amortization income due to lower projected cash flows on many subordinate securities and some senior securities, reduced coupon interest income due to lower benchmark LIBOR rates on adjustable rate securities, and slower prepayment rates.
Interest income at Redwood was $22 million in the first quarter of 2009, as compared to $34 million in the first quarter of 2008, a decline of $12 million. The following table details how interest income changed as a result of changes in average earning asset balances (“volume”) and changes in interest yields (“rate”).
Table 9 Interest Income at Redwood — Volume and Rate Changes
| | | | | | |
| | Change in Interest Income
Three Months Ended
March 31, 2009 vs. March 31, 2008 |
| (In Thousands) | | Volume | | Rate | | Total Change |
| Real estate loans | | $ | (42 | ) | | $ | 7 | | | $ | (35 | ) |
| Trading securities | | | (3,746 | ) | | | 2,527 | | | | (1,219 | ) |
| Available-for-sale securities | | | (9,365 | ) | | | 851 | | | | (8,514 | ) |
| Cash and cash equivalents | | | 295 | | | | (2,489 | ) | | | (2,194 | ) |
| Total Interest Income | | $ | (12,858 | ) | | $ | 896 | | | $ | (11,962 | ) |
Interest income declined in the first quarter of 2009 as compared to the first quarter of 2008 primarily because of lower volume due to impairments on securities that reduced average asset balances. Interest income on AFS securities was $19 million for the first quarter of 2009 as compared to $27 million for the first quarter of 2008, a decline of $8 million. We reduced the cost basis of many of our AFS securities through impairment charges during the first quarter of 2009 and throughout 2008 and increased the amount of current principal face designated as credit reserves. Higher credit reserves designated on securities reduce the amount of discount that we amortize into income over time. The adequacy of these credit reserves is based upon the long term performance of these securities and is subject to change over time. Thus, although short-term LIBOR index rates were lower during the first quarter of 2009 as compared to the first quarter of 2008, the yields we accrete on many available-for-sale (AFS) securities have not decreased.
The following table presents the components of the interest income we earned on AFS securities in the three months ended March 31, 2009 and 2008.
Table 10 Interest Income — AFS Securities at Redwood
Three Months Ended March 31, 2009
| | | | | | | | | | | | | | |
| | | | | | | | | | Yield as a Result of |
| (Dollars in Thousands) | | Interest
Income | | Discount
(Premium)
Amortization | | Total
Interest
Income | | Average
Amortized
Cost | | Interest
Income | | Discount
(Premium)
Amortization | | Total
Interest
Income |
Senior
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential | | $ | 2,787 | | | $ | 3,322 | | | $ | 6,109 | | | $ | 164,200 | | | | 6.79 | % | | | 8.09 | % | | | 14.88 | % |
| Total Senior | | | 2,787 | | | | 3,322 | | | | 6,109 | | | | 164,200 | | | | 6.79 | % | | | 8.09 | % | | | 14.88 | % |
Subordinate
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential | | | 8,691 | | | | 3,440 | | | | 12,131 | | | | 49,170 | | | | 70.70 | % | | | 27.98 | % | | | 98.68 | % |
| Commercial | | | 4,550 | | | | (4,050 | ) | | | 500 | | | | 46,382 | | | | 39.24 | % | | | (34.93 | )% | | | 4.31 | % |
| CDO | | | 10 | | | | — | | | | 10 | | | | 25 | | | | 160.00 | % | | | — | | | | 160.00 | % |
| Total Subordinate | | | 13,251 | | | | (610 | ) | | | 12,641 | | | | 95,577 | | | | 55.46 | % | | | (2.55 | )% | | | 52.91 | % |
| Total AFS Securities | | $ | 16,038 | | | $ | 2,712 | | | $ | 18,750 | | | $ | 259,777 | | | | 24.70 | % | | | 4.18 | % | | | 28.88 | % |
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Three Months Ended March 31, 2008
| | | | | | | | | | | | | | |
| | | | | | | | | | Yield as a Result of |
| (Dollars in Thousands) | | Interest
Income | | Discount
(Premium)
Amortization | | Total
Interest
Income | | Average
Amortized
Cost | | Interest
Income | | Discount
(Premium)
Amortization | | Total
Interest
Income |
Subordinate
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential | | $ | 10,490 | | | $ | 11,633 | | | $ | 22,123 | | | $ | 200,751 | | | | 20.90 | % | | | 23.18 | % | | | 44.08 | % |
| Commercial | | | 6,523 | | | | (1,522 | ) | | | 5,001 | | | | 183,446 | | | | 14.22 | % | | | (3.32 | )% | | | 10.90 | % |
| CDO | | | 140 | | | | — | | | | 140 | | | | 1,576 | | | | 35.53 | % | | | — | | | | 35.53 | % |
| Total Subordinate | | | 17,153 | | | | 10,111 | | | | 27,264 | | | | 385,773 | | | | 17.79 | % | | | 10.48 | % | | | 28.27 | % |
| Total AFS Securities | | $ | 17,153 | | | $ | 10,111 | | | $ | 27,264 | | | $ | 385,773 | | | | 17.79 | % | | | 10.48 | % | | | 28.27 | % |
The most significant economic factor affecting the performance of senior securities is the rate of principal repayments. As these investments primarily represent senior cash flows, we currently do not expect a high level of credit losses. Our senior securities returns are therefore more sensitive to changes in prepayment rates than they are to credit. A pick-up in refinance activity due to lower mortgage rates or other factors would benefit our senior securities returns. Average prepayment speeds on prime residential senior securities were 15% CPR in the first quarter of 2009.
The most significant economic factors affecting the performance of subordinate securities are the timing and amount of credit losses and the rate of principal repayments. In general, lower credit losses and higher prepayment speeds benefit subordinate securities that we buy at a significant discount to face value. Over the past year, delinquencies have been rising and prepayments have been slower. Serious delinquencies on prime residential subordinate securities (loans that are 90+ days delinquent) were 2.44% of current balances as of March 31, 2009, as compared to 1.59% of current balances as of December 31, 2008. Serious delinquencies on commercial subordinate securities (loans that are 60+ days delinquent) were 1.41% of current balances as of March 31, 2009, as compared to 1.15% of current balances as of December 31, 2008. Average prepayment speeds on prime residential subordinate securities declined to 11% CPR in the first quarter of 2009, as compared to 16% CPR in the first quarter of 2008. There are generally no prepayments on commercial subordinate securities.
The following table details how interest expense at Redwood changed as a result of changes in average debt balances (“volume”) and interest yields (“rate”).
Table 11 Interest Expense at Redwood — Volume and Rate Changes
| | | | | | |
| | Change in Interest Expense
Three Months Ended
March 31, 2009 vs. March 31, 2008 |
| (In Thousands) | | Volume | | Rate | | Total Change |
| Short-term debt | | $ | (182 | ) | | $ | — | | | $ | (182 | ) |
| Long-term debt | | | 16 | | | | (741 | ) | | | (725 | ) |
| Total Interest Expense | | $ | (166 | ) | | $ | (741 | ) | | $ | (907 | ) |
Interest expense decreased primarily because the benchmark LIBOR interest rates on our long term debt have declined since first quarter of 2008.
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The following table presents the components of operating expenses at Redwood for the three months ended March 31, 2009 and 2008.
Table 12 Operating Expenses at Redwood
| | | | |
| | Three Months Ended
March 31, |
| (In Thousands) | | 2009 | | 2008 |
| Fixed compensation expense | | $ | 4,028 | | | $ | 5,674 | |
| Variable compensation expense | | | 556 | | | | 1,857 | |
| Equity compensation expense | | | 1,795 | | | | 3,306 | |
| Severance expense | | | 28 | | | | — | |
| Total compensation expense | | | 6,407 | | | | 10,837 | |
| Systems | | | 1,594 | | | | 2,141 | |
| Due diligence | | | 7 | | | | 10 | |
| Office costs | | | 1,750 | | | | 1,514 | |
| Accounting and legal | | | 559 | | | | 1,101 | |
| Other operating expenses | | | 222 | | | | 745 | |
| Total Operating Expenses | | $ | 10,539 | | | $ | 16,348 | |
Operating expenses in the first quarter of 2009 were lower than for the same period in 2008 primarily due to a decrease in compensation expenses, stemming from the decrease in headcount reductions in the fourth quarter of 2008. Lower system development and consulting costs and fewer non-recurring legal expenses also contributed to the decline.
The following table details the components of realized gains on sales and calls, net, for the first quarter of 2009 and 2008.
Table 13 Realized Gains and Losses on Sales and Calls, Net
| | | | |
| | Three Months Ended
March 31, |
| (In Thousands) | | 2009 | | 2008 |
Realized gains (losses) on sales of:
| | | | | | | | |
| Real estate loans | | $ | — | | | $ | (3 | ) |
| Real estate securities | | | 337 | | | | — | |
| Interest rate agreements | | | — | | | | — | |
| Total gains (losses) on sales | | | 337 | | | | (3 | ) |
| Net gains on extinguishment of debt | | | 125 | | | | — | |
| Net gains on calls | | | — | | | | 45 | |
| Total Realized Gains on Sales and Calls, Net | | $ | 462 | | | $ | 42 | |
Realized gains on sales and calls, net, were $462 thousand during the first quarter of 2009 as compared to $42 thousand during first quarter of 2008. This increase reflects a gain on extinguishment of debt and gains on sales of securities.
Results of Operations — The Fund
The Fund was established to capitalize on the dislocation in the non-prime residential and CDO markets. The Fund received $96 million in commitments from investors, including a $50 million commitment from Redwood. As the majority owner and manager of the Fund, we consolidate the Fund’s assets, liabilities, and noncontrolling interest for financial reporting purposes. The Fund became fully invested in the third quarter of 2008.
Net interest income at the Fund was $3 million in the first quarter of 2009, an increase of $1 million from the first quarter of 2008. This increase was due higher interest income from the Fund’s acquisition of additional AFS securities during 2008.
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The following table presents the components of interest income at the Fund in the first quarter of 2009.
Table 14 Interest Income — AFS Securities at the Fund
Three Months Ended March 31, 2009
| | | | | | | | | | | | | | |
| | | | | | | | | | Yield as a Result of |
| (Dollars in Thousands) | | Interest
Income | | Discount
Amortization | | Total
Interest
Income | | Average
Amortized
Cost | | Interest
Income | | Discount
Amortization | | Total
Interest
Income |
Senior
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential | | $ | 207 | | | $ | 1,808 | | | $ | 2,015 | | | $ | 36,606 | | | | 2.26 | % | | | 19.76 | % | | | 22.02 | % |
| CDO | | | 147 | | | | 37 | | | | 184 | | | | 6,310 | | | | 9.32 | % | | | 2.35 | % | | | 11.67 | % |
| Total Senior | | | 354 | | | | 1,845 | | | | 2,199 | | | | 42,916 | | | | 3.30 | % | | | 17.20 | % | | | 20.50 | % |
Subordinate
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential | | | 86 | | | | 287 | | | | 373 | | | | 11,930 | | | | 2.88 | % | | | 9.62 | % | | | 12.50 | % |
| CDO | | | 170 | | | | 73 | | | | 243 | | | | 7,473 | | | | 9.10 | % | | | 3.91 | % | | | 13.01 | % |
| Total Subordinate | | | 256 | | | | 360 | | | | 616 | | | | 19,403 | | | | 5.28 | % | | | 7.42 | % | | | 12.70 | % |
| Total AFS Securities | | $ | 610 | | | $ | 2,205 | | | $ | 2,815 | | | $ | 62,319 | | | | 3.92 | % | | | 14.15 | % | | | 18.07 | % |
Three Months Ended March 31, 2008
| | | | | | | | | | | | | | |
| | | | | | | | | | Yield as a Result of |
| (Dollars in Thousands) | | Interest
Income | | Discount
Amortization | | Total
Interest
Income | | Average
Amortized
Cost | | Interest
Income | | Discount
Amortization | | Total
Interest
Income |
Senior
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| CDO | | $ | 274 | | | $ | 29 | | | $ | 303 | | | $ | 10,050 | | | | 10.91 | % | | | 1.15 | % | | | 12.06 | % |
| Total Senior | | | 274 | | | | 29 | | | | 303 | | | | 10,050 | | | | 10.91 | % | | | 1.15 | % | | | 12.06 | % |
Subordinate
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential | | | 81 | | | | 319 | | | | 400 | | | | 5,437 | | | | 5.96 | % | | | 23.47 | % | | | 29.43 | % |
| CDO | | | 650 | | | | 405 | | | | 1,055 | | | | 17,693 | | | | 14.70 | % | | | 9.16 | % | | | 23.86 | % |
| Total Subordinate | | | 731 | | | | 724 | | | | 1,455 | | | | 23,130 | | | | 12.64 | % | | | 12.52 | % | | | 25.16 | % |
| Total AFS Securities | | $ | 1,005 | | | $ | 753 | | | $ | 1,758 | | | $ | 33,180 | | | | 12.12 | % | | | 9.08 | % | | | 21.20 | % |
The following table details the components of the change in interest income at the Fund that were attributable to changes in average earning asset balances (“volume”) and changes in interest yields (“rate”).
Table 15 Interest Income at the Fund — Volume and Rate Changes
| | | | | | |
| | Change in Interest Income
Three Months Ended
March 31, 2009 vs. March 31, 2008 |
| (In Thousands) | | Volume | | Rate | | Total Change |
| Available-for-sale securities | | $ | 1,544 | | | $ | (487 | ) | | $ | 1,057 | |
| Cash and cash equivalents | | | 2 | | | | (16 | ) | | | (14 | ) |
| Total Interest Income | | $ | 1,546 | | | $ | (503 | ) | | $ | 1,043 | |
As many of the assets held at the Fund were purchased during the first quarter of 2008, the change in interest income is primarily attributed to an increase in volume.
Results of Operations — Sequoia
Sequoia is our brand name for the residential real estate loan securitization entities that we sponsor. Although our exposure to the loans collateralizing these entities is limited to our investments in each Sequoia securitization, we are required under GAAP to consolidate the assets and liabilities of most Sequoia entities on
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our consolidated balance sheets. Our investment in each Sequoia entity is separate and independent, thus diminished performance on one of our investments would have no effect on our investments in the other Sequoia entities. Sequoia loans and ABS issued are reported on an amortized cost basis. The net interest income reported represents the GAAP earnings we record on our investments in these entities and any net interest earned during the accumulation of loans for securitization.
The following table presents the net interest (loss) income after provision and MVA at Sequoia for the three months ended March 31, 2009 and 2008.
Table 16 Net Interest (Loss) Income after Provision and MVA at Sequoia
Three Months Ended March 31, 2009
| | | | | | | | | | |
| (Dollars in Thousands) | | Interest
Income | | (Premium)
Discount
Amortization | | Total
Interest
Income | | Average
Amortized
Cost | | Yield |
Interest Income
| | | | | | | | | | | | | | | | | | | | |
| Real estate loans | | $ | 41,092 | | | $ | (7,459 | ) | | $ | 33,633 | | | $ | 3,007,022 | | | | 4.47 | % |
| Cash and cash equivalents | | | 2 | | | | — | | | | 2 | | | | 304 | | | | 2.63 | % |
| Total Interest Income | | | 41,094 | | | | (7,459 | ) | | | 33,635 | | | | | | | | | |
Interest Expense
| | | | | | | | | | | | | | | | | | | | |
| ABS issued | | | (24,875 | ) | | | (218 | ) | | | (25,093 | ) | | | 4,460,962 | | | | (2.25 | )% |
| Interest rate agreements | | | (21 | ) | | | — | | | | (21 | ) | | | | | | | | |
| Total Interest Expense | | | (24,896 | ) | | | (218 | ) | | | (25,114 | ) | | | | | | | | |
| Net Interest Income | | | 16,198 | | | | (7,677 | ) | | | 8,521 | | | | | | | | | |
| Provision for loan losses | | | (16,032 | ) | | | — | | | | (16,032 | ) | | | | | | | | |
| Market valuation adjustments, net | | | (700 | ) | | | — | | | | (700 | ) | | | | | | | | |
| Net Interest (Loss) Income After Provision and MVA at Sequoia | | $ | (534 | ) | | $ | (7,677 | ) | | $ | (8,211 | ) | | | | | | | | |
Three Months Ended March 31, 2008
| | | | | | | | | | |
| (Dollars in Thousands) | | Interest
Income | | (Premium)
Discount
Amortization | | Total
Interest
Income | | Average
Amortized
Cost | | Yield |
Interest Income
| | | | | | | | | | | | | | | | | | | | |
| Real estate loans | | $ | 102,664 | | | $ | (7,511 | ) | | $ | 95,153 | | | $ | 6,895,279 | | | | 5.52 | % |
| Cash and cash equivalents | | | 29 | | | | — | | | | 29 | | | | 479 | | | | 24.20 | % |
| Total Interest Income | | | 102,693 | | | | (7,511 | ) | | | 95,182 | | | | | | | | | |
Interest Expense
| | | | | | | | | | | | | | | | | | | | |
| ABS issued | | | (82,668 | ) | | | 90 | | | | (82,578 | ) | | | 6,745,557 | | | | (4.90 | )% |
| Interest rate agreements | | | (156 | ) | | | — | | | | (156 | ) | | | | | | | | |
| Total Interest Expense | | | (82,824 | ) | | | 90 | | | | (82,734 | ) | | | | | | | | |
| Net Interest Income | | | 19,869 | | | | (7,421 | ) | | | 12,448 | | | | | | | | | |
| Provision for loan losses | | | (8,058 | ) | | | — | | | | (8,058 | ) | | | | | | | | |
| Market valuation adjustments, net | | | (419 | ) | | | — | | | | (419 | ) | | | | | | | | |
| Net Interest (Loss) Income After Provision and MVA at Sequoia | | $ | 11,392 | | | $ | (7,421 | ) | | $ | 3,971 | | | | | | | | | |
Net interest (loss) income after provision and MVA at Sequoia was a loss of $8 million in the first quarter of 2009 as compared to income of $4 million in the first quarter of 2008, a decline of $12 million. The primary reason for this decline was higher loan loss provision expenses recorded during the first quarter of 2009. The provision for loan losses was $16 million for the first quarter of 2009, as compared to $8 million for first quarter of 2008, an increase of $8 million. The allowance for loan losses increased to $48 million or
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1.06% of the residential loan balance at March 31, 2009, from $36 million or 0.77% at December 31, 2008. Serious delinquencies (90+ days delinquent) increased to $158 million, or 3.50% of residential loan balances at March 31, 2009, from $120 million, or 2.61% at December 31, 2008.
Although we report our provision, allowance, and delinquency information on a consolidated basis, the credit performance of each Sequoia securitization is separate and independent and may vary significantly from the credit performance of other Sequoia securitizations. We may be required for GAAP reporting purposes to record an allowance for loan losses on certain pools of loans that in aggregate exceeds our investment at risk in those pools. As of March 31, 2009, we had recorded a loan loss allowance that exceeded the outstanding face amount of our subordinate investments in one of these pools by $15 million. Upon the occurrence of certain events, which may occur in the second quarter, we will be permitted to deconsolidate that Sequoia entity and, upon deconsolidation, would record a gain to the extent of the excess allowance for loan losses. To the extent actual and expected losses on the collateral pools increase, the disparity between the reported GAAP book value of our investments and their economic value could grow during 2009.
Net interest income at Sequoia was $9 million in the first quarter of 2009 as compared to $12 million in the first quarter of 2008, a decline of $3 million. The reasons for this decline were lower benchmark LIBOR rates on adjustable rate residential loans and lower average residential loan balances.
Interest income at Sequoia was $34 million in the first quarter of 2009, as compared to $95 million in the first quarter of 2008, a decline of $61 million. The following table details how interest income changed as a result of changes in average earning asset balances (“volume”) and changes in interest yields (“rate”).
Table 17 Interest Income at Sequoia — Volume and Rate Changes
| | | | | | |
| | Change in Interest Income
Three Months Ended
March 31, 2009 vs. March 31, 2008 |
| (In Thousands) | | Volume | | Rate | | Total Change |
| Real estate loans | | $ | (32,113 | ) | | $ | (29,407 | ) | | $ | (61,520 | ) |
| Cash and cash equivalents | | | (11 | ) | | | (16 | ) | | | (27 | ) |
| Total Interest Income | | $ | (32,124 | ) | | $ | (29,423 | ) | | $ | (61,547 | ) |
Interest income declined because of lower volume and lower benchmark interest rates during the first quarter of 2009 as compared to the first quarter of 2008. Average loan balances at Sequoia decreased to $4.6 billion in the first quarter of 2009, from $6.9 billion in the first quarter of 2008. This decline was due to loan principal repayments, lack of new loan acquisition activity, and the derecognition of certain Sequoia entities during the fourth quarter of 2008. The average prepayment rate for Sequoia loans was 9% during the first quarter of 2009 as compared to 25% in the first quarter of 2008. At March 31, 2009, 85% of loan principal outstanding consisted of one-month or six-month LIBOR ARMs and 15% of loan principal outstanding consisted of hybrid ARMs.
A significant offset to interest income is the loan premium amortization that we expense each period to reduce the net unamortized purchase premium for loans at Sequoia. Loan premium amortization was $7 million for the first quarter of 2009 as compared to $8 million in the first quarter of 2008. As a percent of gross interest income, loan premium amortization was 22% for the first quarter of 2009 and 8% for the same period of 2008. The amount and timing of periodic amortization has historically been volatile due to the GAAP accounting elections we apply. For the last several years, loan premium amortization has not kept pace with loan prepayments due to the amortization method we apply for a portion of loans at Sequoia. This method more closely links amortization to short-term interest rates and resulted in lower premium expenses during prior periods when LIBOR increased. Since LIBOR remained relatively stable during the first quarter of 2009, we expect premium amortization expenses to be lower in the second quarter than in the first quarter.
The following table details how interest expense at Sequoia changed as a result of changes in average debt balances (“volume”) and interest yields (“rate”).
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Table 18 Interest Expense at Sequoia — Volume and Rate Changes
| | | | | | |
| | Change in Interest Expense
Three Months Ended
March 31, 2009 vs. March 31, 2008 |
| (In Thousands) | | Volume | | Rate | | Total Change |
| ABS Issued | | $ | (27,940 | ) | | $ | (29,670 | ) | | $ | (57,610 | ) |
| Total Interest Expense | | $ | (27,940 | ) | | $ | (29,670 | ) | | $ | (57,610 | ) |
Interest expense declined due to lower average borrowings and lower interest rates during the first quarter of 2009 as compared to the first quarter of 2008. The reduction in volume was due to the derecognition of certain Sequoia entities in the fourth quarter of 2008 and paydowns on ABS issued with no new issuances over the past year.
The following table presents the cost of funds at Sequoia for the three months ended March 31, 2009 and 2008.
Table 19 Cost of Funds of Asset-Backed Securities Issued by Sequoia
| | | | |
| | Three Months Ended
March 31, |
| (Dollars in Thousands) | | 2009 | | 2008 |
| Interest expense | | $ | 24,875 | | | $ | 82,986 | |
| Issuance premium amortization, net | | | (335 | ) | | | (2,183 | ) |
| Deferred bond issuance amortization | | | 553 | | | | 2,093 | |
| Interest rate agreements, net | | | 21 | | | | 156 | |
| Total ABS Issued Interest Expense | | $ | 25,114 | | | $ | 83,052 | |
| Average balance of ABS issued | | $ | 4,460,962 | | | $ | 6,475,557 | |
| Interest expense | | | 2.23 | % | | | 4.92 | % |
| Issuance premium amortization, net | | | (0.03 | )% | | | (0.13 | )% |
| Deferred bond issuance amortization | | | 0.05 | % | | | 0.12 | % |
| Interest rate agreements, net | | | — | | | | 0.01 | % |
| Cost of Funds of ABS Issued | | | 2.25 | % | | | 4.92 | % |
Sequoia ABS issued generally pay interest based on one or six-month LIBOR, or in some instances, passes through the weighted average interest earned on the underlying assets. Interest expense declined due to lower average balances of ABS and lower interest rates. Some of the ABS issued was sold at a premium, which we amortize as a component of interest expense over time. We also defer and amortize Sequoia ABS issuance costs over time as a component of interest expense.
Results of Operations — Acacia
Acacia is our brand name for the CDO securitization entities that we sponsor. The assets held by Acacia entities primarily consist of senior securities and some subordinate securities. These securities are backed by prime and non-prime residential real estate loans and commercial real estate loans. Acacia also owns other real estate assets such as real estate CDO securities, corporate debt issued by equity REITs, real estate loans, and synthetic real estate assets. Although our exposure to the assets collateralizing these entities is limited to our investments in each Acacia securitization, we are required under GAAP to consolidate the assets and liabilities of Acacia entities on our consolidated balance sheets. Our investment in each Acacia entity is separate and independent, thus diminished performance on one of our investments would have no effect on our investments in the other Acacia entities.
Prior to 2008, we were required under GAAP to record most of the assets at Acacia at their estimated fair values and their paired liabilities at their amortized cost. This created an accounting discrepancy that resulted in a significant disparity between the GAAP book value and the economic value of our investments in Acacia. As of January 1, 2008, we elected to adopt FAS 159 to value both the assets and liabilities of the Acacia entities, which significantly reduced the amount of this disparity.
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The following table presents the net interest (loss) income after MVA at Acacia for the three months ended March 31, 2009 and 2008.
Table 20 Net Interest (Loss) Income After MVA at Acacia
| | | | | | | | | | | | |
| | Three Months Ended March 31, |
| | | 2009 | | 2008 |
| (Dollars in Thousands) | | Total
Interest
Income | | Average
Balance | | Yield | | Interest
Income | | Average
Amortized
Cost | | Yield |
Interest Income
| | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial real estate loans | | $ | 272 | | | $ | 11,144 | | | | 9.76 | % | | $ | 371 | | | $ | 21,941 | | | | 6.76 | % |
| Trading securities | | | 22,103 | | | | 318,094 | | | | 27.79 | % | | | 45,462 | | | | 1,339,201 | | | | 13.58 | % |
| Other investments | | | 76 | | | | 75,359 | | | | 0.40 | % | | | 732 | | | | 78,771 | | | | 3.72 | % |
| Cash and cash equivalents | | | 86 | | | | 39,426 | | | | 0.87 | % | | | 902 | | | | 128,620 | | | | 2.81 | % |
| Total Interest Income | | | 22,537 | | | | | | | | | | | | 47,467 | | | | | | | | | |
Interest Expense
| | | | | | | | | | | | | | | | | | | | | | | | |
| ABS issued | | | (19,695 | ) | | | 325,392 | | | | (24.21 | )% | | | (44,367 | ) | | | 1,456,506 | | | | (12.18 | )% |
| Interest rate agreement expense | | | (1,077 | ) | | | | | | | | | | | (1,089 | ) | | | | | | | | |
| Total Interest Expense | | | (20,772 | ) | | | | | | | | | | | (45,456 | ) | | | | | | | | |
| Net Interest Income | | | 1,765 | | | | | | | | | | | | 2,011 | | | | | | | | | |
| Market valuation adjustments, net | | | (12,367 | ) | | | | | | | | | | | (26,853 | ) | | | | | | | | |
| Net Interest Loss After MVA at Acacia | | $ | (10,602 | ) | | | | | | | | | | $ | (24,842 | ) | | | | | | | | |
Net interest loss after MVA at Acacia was a loss of $11 million in the first quarter of 2009 as compared to a loss of $25 million in the first quarter of 2008, a decline in loss of $14 million. The primary reason for this decline in loss was lower negative MVA. Negative MVA was lower by $14 million in the first quarter of 2009 compared to the first quarter of 2008. We detail these adjustments in a separate Mark-to-Market Adjustments section. Net interest income at Acacia was $2 million in both the first quarters of 2009 and 2008 as lower interest income was offset by lower interest expense.
We received $1 million of cash distributions from our Acacia equity investments during the first quarter of 2009. As of the first quarter of 2009, nine of ten Acacia equity investments stopped receiving cash distributions due to performance deficiencies (consisting primarily of rating agency downgrades on securities held at Acacia entities), which significantly affected the yield we expect to earn on these investments.
Interest income at Acacia was $23 million in the first quarter of 2009, as compared to $48 million in the first quarter of 2008, a decline of $25 million. The following table details how interest income changed as a result of changes in average earning asset balances (“volume”) and changes in interest yields (“rate”).
Table 21 Interest Income at Acacia — Volume and Rate Changes
| | | | | | |
| | Change in Interest Income
Three Months Ended
March 31, 2009 vs. March 31, 2008 |
| (In Thousands) | | Volume | | Rate | | Total Change |
| Real estate loans | | $ | (183 | ) | | $ | 84 | | | $ | (99 | ) |
| Trading securities | | | (34,664 | ) | | | 11,305 | | | | (23,359 | ) |
| Other investments | | | (32 | ) | | | (624 | ) | | | (656 | ) |
| Cash and cash equivalents | | | (626 | ) | | | (190 | ) | | | (816 | ) |
| Total Interest Income | | $ | (35,505 | ) | | $ | 10,575 | | | $ | (24,930 | ) |
Interest income declined primarily because of lower volume due to impairment charges on securities which reduced average balances. Partially offsetting lower volume is that the yields we accrete on many securities have increased as a result of lower market values, despite generally lower short-term LIBOR index rates during the first quarter of 2009 as compared to the first quarter of 2008.
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Interest expense at Acacia was $21 million in the first quarter of 2009, as compared to $46 million in the first quarter of 2008, a decline of $25 million. The following table details how interest expense at Acacia changed as a result of changes in average debt balances (“volume”) and interest yields (“rate”).
Table 22 Interest Expense at Acacia — Volume and Rate Changes
| | | | | | |
| | Change in Interest Expense
Three Months Ended
March 31, 2009 vs. March 31, 2008 |
| (In Thousands) | | Volume | | Rate | | Total Change |
| ABS Issued | | $ | (35,301 | ) | | $ | 10,617 | | | $ | (24,684 | ) |
| Total Interest Expense | | $ | (35,301 | ) | | $ | 10,617 | | | $ | (24,684 | ) |
Interest expense declined primarily because of lower volume due to lower average borrowings. Although interest rates have generally been lower during the first quarter of 2009 than the first quarter of 2008, the market value decreases on Acacia liabilities have increased the yields we recognize for interest expense.
Mark-to-Market Adjustments
Negative mark-to-market adjustments continue to be the most significant factor affecting our earnings. Mark-to-market adjustments are changes in the fair values of financial assets and liabilities, and REO properties. The accounting rules that determine the measurement of fair values and the timing and amount of market valuation adjustments that flow through our consolidated statements of (loss) income are complex and may not clearly reflect the timing, nature, and extent of economic changes impacting the fair values of our investments during any specific reporting period. The Recent Developments section details the economic factors that impacted the fair values of our investments during the quarter.
The following tables detail the mark-to-market adjustments that occurred in the three months ended March 31, 2009 and 2008, and their effect on our consolidating income statements and balance sheets.
Table 23 Mark-to-Market Adjustments Impact on Consolidating Income Statement and Balance Sheet
| | | | | | | | | | |
| | Three Months Ended March 31, 2009 |
| (In Millions) | | Redwood | | The Fund | | Sequoia | | Acacia | | Total |
Income Statement Impact
| | | | | | | | | | | | | | | | | | | | |
| Changes in fair value assets | | $ | (1 | ) | | $ | — | | | $ | (1 | ) | | $ | (44 | ) | | $ | (46 | ) |
| Changes in fair value liabilities | | | — | | | | — | | | | — | | | | 32 | | | | 32 | |
| Impairment on AFS securities | | | (25 | ) | | | (4 | ) | | | — | | | | — | | | | (29 | ) |
| Total income statement impact | | | (26 | ) | | | (4 | ) | | | (1 | ) | | | (12 | ) | | | (43 | ) |
Balance Sheet Impact
| | | | | | | | | | | | | | | | | | | | |
| Net change in OCI | | | (28 | ) | | | (4 | ) | | | — | | | | — | | | | (32 | ) |
| Total Mark-to-Market Adjustments | | $ | (54 | ) | | $ | (8 | ) | | $ | (1 | ) | | $ | (12 | ) | | $ | (75 | ) |
| | | | | | | | | | |
| | Three Months Ended March 31, 2008 |
| (In Millions) | | Redwood | | The Fund | | Sequoia | | Acacia | | Total |
Income Statement Impact
| | | | | | | | | | | | | | | | | | | | |
| Changes in fair value assets | | $ | (23 | ) | | $ | — | | | | — | | | $ | (837 | ) | | $ | (860 | ) |
| Changes in fair value liabilities | | | — | | | | — | | | | — | | | | 810 | | | | 810 | |
| Impairment on AFS securities | | | (144 | ) | | | — | | | | — | | | | — | | | | (144 | ) |
| Total income statement impact | | | (167 | ) | | | — | | | | — | | | | (27 | ) | | | (194 | ) |
Balance Sheet Impact
| | | | | | | | | | | | | | | | | | | | |
| Net change in OCI | | | 20 | | | | 1 | | | | — | | | | — | | | | 21 | |
| Total Mark-to-Market Adjustments | | $ | (147 | ) | | $ | 1 | | | | — | | | $ | (27 | ) | | $ | (173 | ) |
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Mark-to-Market Adjustments at Redwood
At Redwood, we classify most securities (excluding our investments in Sequoia and Acacia) as AFS and report these securities at their fair values in accordance with FAS 115. Net mark-to-market adjustments were negative $54 million in the first quarter of 2009, as compared to negative $147 million in the first quarter of 2008.
We recorded $25 million of the total mark-to-market adjustments as other-than-temporary impairments through our income statement for the three months ended March 31, 2009, primarily due to changes in the market’s expectation of cash flows and credit. We continue to expect impairments to occur and the levels of impairments may vary significantly from quarter to quarter.
The following tables detail the mark-to-market adjustments on Redwood securities by underlying collateral type and by vintage for the three months ended March 31, 2009.
Table 24 Mark-to-Market Adjustments by Underlying Collateral Type at Redwood
| | | | | | | | | | |
| | Three Months Ended March 31, 2009 |
| (In Millions) | | Senior | | Subordinate | | Loans, &
Derivatives | | Total | | MTM(1)
Percentage |
Residential
| | | | | | | | | | | | | | | | | | | | |
| Prime | | $ | (9 | ) | | $ | (11 | ) | | | — | | | $ | (20 | ) | | | (14 | )% |
| Non-prime | | | (16 | ) | | | (2 | ) | | | — | | | | (18 | ) | | | (18 | )% |
| Residential total | | | (25 | ) | | | (13 | ) | | | — | | | | (38 | ) | | | | |
| Commercial | | | — | | | | (15 | ) | | | — | | | | (15 | ) | | | (37 | )% |
| CDO | | | — | | | | (1 | ) | | | — | | | | (1 | ) | | | (21 | )% |
| Interest rate agreements & other derivatives | | | — | | | | — | | | | — | | | | — | | | | | |
| Total Mark-to-Market Adjustments | | $ | (25 | ) | | $ | (29 | ) | | | — | | | $ | (54 | ) | | | | |
| (1) | This percentage represents the mark-to-market adjustments taken as a percentage of the reported market values at the beginning of the period, or the purchase price if acquired during the period. |
Table 25 Mark-to-Market Adjustments by Vintage on Securities at Redwood
Three Months Ended March 31, 2009
| | | | | | | | | | | | | | |
| | Vintage | | | | |
| (In Millions) | | 2004 &
Earlier | | 2005 | | 2006 | | 2007 | | 2008 | | Loans &
Derivatives | | Total |
| Mark-to-Market Adjustments | | $ | (12 | ) | | $ | (21 | ) | | $ | (10 | ) | | $ | (11 | ) | | | — | | | | — | | | $ | (54 | ) |
Mark-to-Market Adjustments at the Fund
At March 31, 2009, all of the investments held by the Fund were classified as AFS securities. During the first quarter of 2009, there were $8 million of negative mark-to-market adjustments, of which $4 million were deemed other-than-temporary impairments.
The following tables detail the mark-to-market adjustments on securities at the Fund by underlying collateral type.
Table 26 Market-to-Market Adjustments by Underlying Collateral Type at the Fund
| | | | | | | | |
| | Three Months Ended March 31, 2009 |
| (In Millions) | | Senior | | Subordinate | | Total | | MTM(1)
Percentage |
| Residential non-prime | | $ | (4 | ) | | $ | — | | | $ | (4 | ) | | | (11 | )% |
| CDO | | | — | | | | (4 | ) | | | (4 | ) | | | (36 | )% |
| Total Mark-to-Market Adjustments | | $ | (4 | ) | | $ | (4 | ) | | $ | (8 | ) | | | | |
| (1) | This percentage represents the mark-to-market adjustments taken as a percentage of the reported market values at the beginning of the period, or the purchase price if acquired during the period. |
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Mark-to-Market Adjustments at Sequoia
All of the investments held by Sequoia were classified as held-for-investment loans or REO as of March 31, 2009. We had $1 million of negative mark-to-market adjustments during the first quarter of 2009 stemming from a decrease in the fair value of REO.
Mark-to-Market Adjustments at Acacia
During the first quarter of 2009, the net change in fair values of Acacia assets and liabilities was negative $12 million.
Table 27 Mark-to-Market Adjustments by Underlying Collateral Type at Acacia
| | | | | | | | | | |
| | Three Months Ended March 31, 2009 |
| (In Millions) | | Senior | | Subordinate | | Loans,
Liabilities &
Derivatives | | Total | | MTM(1)
Percentage |
Residential
| | | | | | | | | | | | | | | | | | | | |
| Prime | | $ | (1 | ) | | $ | — | | | $ | — | | | $ | (1 | ) | | | (1 | )% |
| Non-prime | | | (6 | ) | | | (7 | ) | | | — | | | | (13 | ) | | | (7 | )% |
| Residential total | | | (7 | ) | | | (7 | ) | | | — | | | | (14 | ) | | | | |
| Commercial | | | — | | | | (25 | ) | | | (2 | ) | | | (27 | ) | | | (37 | )% |
| CDO | | | — | | | | (6 | ) | | | — | | | | (6 | ) | | | (27 | )% |
Interest rate agreements &
other derivatives | | | — | | | | — | | | | 3 | | | | 3 | | | | | |
| ABS Issued | | | — | | | | — | | | | 32 | | | | 32 | | | | | |
| Total Mark-to-Market Adjustments | | $ | (7 | ) | | $ | (38 | ) | | $ | 33 | | | $ | (12 | ) | | | | |
| (1) | This percentage represents the mark-to-market adjustments taken as a percentage of the reported market values at the beginning of the period, or the purchase price if acquired during the period. |
Estimated Taxable Income (Loss)
The following table details our estimated taxable income and distribution detail for the three months ended March 31, 2009 and 2008.
Table 28 Estimated Taxable (Loss) Income and Distributions to Shareholders
| | | | |
| | Three Months Ended
March 31, |
| (In Thousands, Except per Share Data) | | 2009 | | 2008 |
Estimated Taxable (Loss) Income
| | | | | | | | |
| REIT taxable (loss) income | | $ | (8,701 | ) | | $ | 24,734 | |
| Taxable REIT subsidiary (loss) income | | | (4,846 | ) | | | 1,088 | |
| Total Estimated Taxable (Loss) Income | | $ | (13,547 | ) | | $ | 25,822 | |
| Distributed to shareholders | | $ | 15,087 | | | $ | 24,724 | |
| Undistributed REIT Taxable Income | | | — | | | $ | 64,582 | |
| Undistributed REIT Taxable Income Per Share | | | — | | | $ | 1.97 | |
For the three months ended March 31, 2009, we paid a regular quarterly dividend of $0.25. Since we currently expect a tax loss in 2009, the dividends we pay to shareholders in 2009 will likely be characterized as return of capital. Dividends characterized as return of capital are not taxable and reduce the basis of shares held at each quarterly distribution date. For the three months ended March 31, 2008, we paid $0.75 per share in dividends.
Our estimated taxable income for the first quarter of 2009 was negative $14 million ($0.22 per share) and included $53 million in credit losses. This compared to estimated taxable income for the first quarter of 2008 of positive $26 million ($0.79 per share), which included $14 million of credit losses. We continue to expect credit losses to be the primary factor in our taxable income (loss) results for 2009.
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The tables below reconcile our GAAP and tax income for the first three months of 2009 and 2008.
Table 29 Differences between GAAP Net (Loss) Income and Estimated Taxable Income
| | | | | | |
| | Three Months Ended March 31, 2009 |
| (In Thousands, Except per Share Data) | | GAAP | | Tax | | Differences |
| Interest Income | | $ | 81,438 | | | $ | 50,484 | | | $ | (30,954 | ) |
| Interest Expense | | | (47,642 | ) | | | (1,330 | ) | | | 46,312 | |
| Net Interest Income | | | 33,796 | | | | 49,154 | | | | 15,358 | |
| Provision for loan losses | | | (16,032 | ) | | | — | | | | 16,032 | |
| Realized credit losses | | | — | | | | (52,613 | ) | | | (52,613 | ) |
| Market valuation adjustments, net | | | (43,242 | ) | | | — | | | | 43,242 | |
| Operating expenses | | | (10,539 | ) | | | (10,088 | ) | | | 451 | |
| Realized gains on sales and calls, net | | | 462 | | | | — | | | | (462 | ) |
| Provision for income taxes | | | (105 | ) | | | — | | | | 105 | |
| Less: Net loss attributable to noncontrolling interest | | | (716 | ) | | | — | | | | 716 | |
| Net Loss | | $ | (34,944 | ) | | $ | (13,547 | ) | | $ | 21,397 | |
| Estimated taxable earnings per share | | $ | (0.65 | ) | | $ | (0.22 | ) | | $ | 0.43 | |
| | | | | | |
| | Three Months Ended March 31, 2008 |
| (In Thousands, Except per Share Data) | | GAAP | | Tax | | Differences |
| Interest Income | | $ | 176,064 | | | $ | 57,036 | | | $ | (119,028 | ) |
| Interest Expense | | | (127,300 | ) | | | (2,014 | ) | | | 125,286 | |
| Net Interest Income | | | 48,764 | | | | 55,022 | | | | 6,258 | |
| Provision for loan losses | | | (8,058 | ) | | | — | | | | 8,058 | |
| Realized credit losses | | | — | | | | (13,564 | ) | | | (13,564 | ) |
| Market valuation adjustments, net | | | (193,932 | ) | | | — | | | | 193,932 | |
| Operating expenses | | | (16,348 | ) | | | (14,995 | ) | | | 1,353 | |
| Realized gains on sales and calls, net | | | 42 | | | | — | | | | (42 | ) |
| Provision for income taxes | | | (1,800 | ) | | | (641 | ) | | | 1,159 | |
| Less: Net loss attributable to noncontrolling interest | | | 255 | | | | — | | | | (255 | ) |
| Net Loss | | $ | (171,587 | ) | | $ | 25,822 | | | $ | 197,409 | |
| Estimated taxable earnings per share | | $ | (5.28 | ) | | $ | 0.79 | | | $ | 6.07 | |
Significant differences between GAAP and tax accounting include: (i) net interest income for tax is higher due to the fact we cannot anticipate future credit losses in determining the current period yield for an asset; we generally amortize more of an asset’s purchase discount into income for tax than for GAAP prior to anticipated credit losses occurring, (ii) for GAAP, we take credit provisions for loan losses while for tax we cannot establish loan loss reserves for future anticipated events; (iii) realized credit losses are expensed when incurred for tax; for GAAP, these losses are anticipated through lower yields on assets or through the loan loss provisions; and, (iv) the timing, and for some expenses, the amount, of some of our compensation expenses are different under GAAP accounting than for tax accounting, and (v) for tax purposes, we do not consolidate noncontrolling interests as we do under GAAP.
Potential GAAP Earnings Volatility
We expect quarter-to-quarter GAAP earnings volatility from our business activities at Redwood and our consolidated entities. This volatility can occur for a variety of reasons, including the timing and amount of purchases, sales, calls, and repayment of consolidated assets, changes in the fair values of consolidated assets and liabilities, and certain non-recurring events. In addition, volatility may occur because of technical accounting issues, some of which are described below.
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Changes in Premium Amortization for Loans at Sequoia
The unamortized premium for loans owned by Sequoia was $60 million at March 31, 2009. The amount of periodic premium amortization expense we recognize is volatile and dependent on a number of factors, including credit performance of the underlying loans, changes in prepayment speeds, and changes in short-term interest rates. Loan premium amortization was $7 million in the first quarter of 2009, compared to $1 million in the fourth quarter of 2008, and $8 million in the first quarter of 2008. We expect loan premium amortization in the second quarter of 2009 to be below the first quarter’s level,
Changes in Discount Amortization for Securities at Redwood and the Fund
The unamortized discount, net of designated credit reserves, for securities owned at Redwood and the Fund was $232 million at March 31, 2009. The amount of periodic discount amortization income we recognize is volatile and dependent on a number of factors, including credit performance of the underlying loans, changes in prepayment speeds, and changes in short-term interest rates. Discount amortization on securities was $5 million in the first quarter of 2009, compared to negative $1 million in the fourth quarter of 2008, and $11 million in the first quarter of 2008, illustrating the volatility of this income. We expect discount amortization income in the second quarter of 2009 to be higher than in the first quarter.
Changes in Fair Values of Securities
All of the securities owned at Redwood and consolidated entities are classified as either trading or available-for-sale (AFS) securities, and in both cases are carried on our consolidated balance sheets at their estimated fair values. For trading securities, changes in fair values are recorded in the consolidated statements of (loss) income. Periodic fluctuations in the values of these investments are inherently volatile and thus can lead to significant GAAP earnings volatility each quarter.
For AFS securities, cumulative unrealized gains and losses are recorded as a component of accumulated other comprehensive (loss) income in our consolidated statements of equity. Unrealized gains and losses are not charged against current earnings to the extent they are temporary in nature. Certain factors may require us however, to recognize these amounts as other-than-temporary impairments and record them through our current earnings. Factors that currently determine other than temporary impairment include a change in our ability or intent to hold assets, adverse changes to projected cash flows of assets, or the likelihood that declines in the fair values of assets would not return to their previous levels within a reasonable time. Impairments on securities are generally non-recurring and can lead to significant GAAP earnings volatility each quarter. New accounting standards that are effective in the second quarter changes the impairment process and accounting impact.
As of January 1, 2008, we elected to adopt a new accounting standard, FAS 159, to record the assets and liabilities in Acacia and certain other assets at Redwood at fair value with changes in fair value recorded as a component of market valuation adjustments, net, in our consolidated statements of (loss) income. We may also elect the fair value option for certain new acquisitions in the future. Our FAS 159 elections significantly reduced the disparity that existed between the GAAP carrying value of our Acacia equity investments and our estimate of their economic value. However, valuation changes in these financial instruments are inherently volatile and can lead to significant GAAP earnings volatility each quarter.
Changes in Fair Values of Derivative Financial Instruments
We can experience significant earnings volatility from our use of derivatives. We generally use derivatives to hedge cash flows on assets and liabilities that have different coupon rates (fixed rates versus floating rates, or floating rates based on different indices). The nature of the instruments we use and the accounting treatment for the specific assets, liabilities, and derivatives may lead to volatile periodic earnings, even when we are meeting our hedging objectives.
All derivatives are currently accounted for as trading instruments and their changes in market values flow through our consolidated statements of (loss) income. The assets and liabilities we hedge may not be similarly accounted for as our hedging derivatives (e.g., they may be reported at cost, or only impairments may be reported through our consolidated statements of (loss) income). This could lead to reported income and book values in specific periods that do not necessarily reflect the economics of our hedging strategy. Even when the
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assets and liabilities are similarly accounted for as trading instruments, periodic changes in their value may not coincide as other market factors (e.g., supply and demand) may affect certain instruments and not others at any given time.
Future Changes in Accounting Principles
Changes in accounting principles can have a significant impact on the amount or timing of our reported GAAP earnings.
Potential Taxable Income Volatility
We expect quarter-to-quarter estimated taxable income volatility for a variety of reasons, including the timing of credit losses and prepayments on our investments and the tax accounting for equity awards, as described below.
Credit Losses on Securities and Loans at Redwood
To determine estimated taxable income we are not permitted to anticipate, or reserve for, credit losses on investments which are generally purchased at a discount. For tax purposes, we accrete the entire purchase discount on a security into taxable income over the expected life of the security. Estimated taxable income is only reduced when actual credit losses occur. For GAAP purposes, we establish a credit reserve and only accrete a portion of the purchase discount, if any, into income. We are also required to write-down securities that become impaired for GAAP. Our income recognition is therefore faster for tax as compared to GAAP, especially in the early years of owning a security (when there are generally few credit losses). At March 31, 2009, the cumulative difference between the GAAP and tax amortized costs basis of our residential, commercial, and CDO subordinate securities (excluding our investments in Sequoia and Acacia) was $501 million. In addition, as of March 31, 2009, we had an allowance for loan losses (GAAP) of $48 million for our consolidated residential and commercial loans. As we have no credit reserves or allowances for tax, any future credit losses on securities or loans will have a more significant impact on tax earnings than on GAAP earnings and may create significant taxable income volatility to the extent the level of credit losses fluctuates during reporting periods.
Income Recognition on Interest-Only Securities (IOs) at Sequoia
As part of our investment in Sequoia securitization entities, we may retain interest-only (IOs) securities at the time they are issued. Our current tax basis in these securities is $33 million. The return on IO securities is sensitive to prepayments. Typically, fast prepayments reduce yields and slow prepayments increase yields. We are not permitted to recognize a negative yield under tax accounting rules, so during periods of fast prepayments our periodic premium expense for tax purposes can be relatively low and the tax cost basis for these securities may not be significantly reduced. In periods prior to 2008, we did experience fast prepayments on these loans. More recently, prepayments have been slowing, and our tax basis is now below the fair values for these IOs. Many of our Sequoia securitizations are callable or will become callable over the next two years, although we do not currently anticipate calling any Sequoia securitizations in 2009 or 2010. If we do call a Sequoia, the remaining tax basis in the IOs is written off creating an ordinary loss at the call date.
Compensation Expense at Redwood
The total tax expense for equity award compensation is dependent upon varying factors such as the timing of payments of dividend equivalent rights, the exercise of stock options, the distribution of deferred stock units, and the deferrals to and withdrawals from our Executive Deferred Compensation Plan. For GAAP, the total expense associated with an equity award is determined at the award date and is generally recognized over the vesting period. For tax, the total expense is recognized at the date of distribution or exercise and not the award date. In addition, some compensation may not be deductible for tax if it exceeds certain levels and is not performance-based. The total amount of compensation expense could therefore be significantly different for tax than for GAAP in addition to any differences in timing.
Financial Condition
The consolidating balance sheet presents our financial condition at Redwood, including our investments in the Fund, Sequoia, and Acacia entities. We consolidate these entities for GAAP reporting purposes; they are
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not separate business segments. The following presentation highlights the impact from the consolidation of those entities on our overall financial condition. A discussion of significant balance sheet accounts is provided in the section that follows.
Table 30 Consolidating Balance Sheet
March 31, 2009
| | | | | | | | | | | | |
| (In Millions) | | Redwood Parent Only | | The Fund | | Sequoia | | Acacia | | Intercompany
Adjustments | | Redwood
Consolidated |
| Real estate loans | | $ | 3 | | | $ | — | | | $ | 4,528 | | | $ | 10 | | | $ | — | | | $ | 4,541 | |
Real estate securities, at fair value:
| | | | | | | | | | | | | | | | | | | | | | | | |
| Trading securities | | | 4 | | | | — | | | | — | | | | 260 | | | | — | | | | 264 | |
| Available-for-sale securities | | | 217 | | | | 38 | | | | — | | | | 72 | | | | (72 | ) | | | 255 | |
| Other investments | | | — | | | | — | | | | — | | | | 62 | | | | — | | | | 62 | �� |
| Cash and cash equivalents | | | 333 | | | | — | | | | — | | | | — | | | | — | | | | 333 | |
| Investment in the Fund | | | 22 | | | | — | | | | — | | | | — | | | | (22 | ) | | | — | |
| Investment in Sequoia | | | 70 | | | | — | | | | — | | | | — | | | | (70 | ) | | | — | |
| Investment in Acacia | | | 7 | | | | — | | | | — | | | | — | | | | (7 | ) | | | — | |
| Total earning assets | | | 656 | | | | 38 | | | | 4,528 | | | | 404 | | | | (171 | ) | | | 5,455 | |
| Other assets | | | 25 | | | | 4 | | | | 38 | | | | 59 | | | | — | | | | 126 | |
| Total Assets | | $ | 681 | | | $ | 42 | | | $ | 4,566 | | | $ | 463 | | | $ | (171 | ) | | $ | 5,581 | |
| Short-term debt | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| Other liabilities | | | 25 | | | | 2 | | | | 6 | | | | 165 | | | | — | | | | 198 | |
| Asset-backed securities issued – Sequoia | | | — | | | | — | | | | 4,490 | | | | — | | | | (72 | ) | | | 4,418 | |
| Asset-backed securities issued – Acacia | | | — | | | | — | | | | — | | | | 291 | | | | — | | | | 291 | |
| Long-term debt | | | 150 | | | | — | | | | — | | | | — | | | | — | | | | 150 | |
| Total liabilities | | | 175 | | | | 2 | | | | 4,496 | | | | 456 | | | | (72 | ) | | | 5,057 | |
| Stockholders’ equity | | | 506 | | | | 22 | | | | 70 | | | | 7 | | | | (99 | ) | | | 506 | |
| Noncontrolling interest | | | — | | | | 18 | | | | — | | | | — | | | | — | | | | 18 | |
| Total equity | | | 506 | | | | 40 | | | | 70 | | | | 7 | | | | (99 | ) | | | 524 | |
| Total Liabilities and Equity | | $ | 681 | | | $ | 42 | | | $ | 4,566 | | | $ | 463 | | | $ | (171 | ) | | $ | 5,581 | |
At March 31, 2009, our stockholders’ equity totaled $506 million and we had unrestricted cash of $333 million and no short-term debt.
Residential Real Estate Loans at Sequoia and Redwood
We did not acquire any residential real estate loans during the first quarter of 2009. We may resume acquiring residential real estate loans on a bulk or flow basis from originators once the economics for securitization improve. Prior to 2006, our loan purchases were predominately comprised of short reset LIBOR-indexed ARMs. Beginning in 2006, we expanded our acquisitions to include hybrid loans (loans with a fixed-rate coupon for a period of two to ten years before becoming adjustable).
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The following table provides details of our residential real estate loans activity the first quarter of 2009. Loans are predominantly owned at Sequoia securitization entities and our reported activity is predominantly associated with those loans. The residential loans held at Redwood totaled $3 million at March 31, 2009.
Table 31 Residential Real Estate Loans at Sequoia and Redwood — Activity
| | |
| (In Millions) | | Three Months Ended
March 31, 2009 |
| Balance at beginning of period | | $ | 4,647 | |
| Principal repayments | | | (85 | ) |
| Charge-offs, net | | | 4 | |
| Transfers to REO | | | (12 | ) |
| Premium amortization | | | (7 | ) |
| Provision for credit losses | | | (16 | ) |
| Balance at End of Period | | $ | 4,531 | |
Our residential real estate loan balance declined to $4.5 billion at March 31, 2009, from $4.6 billion at December 31, 2008. At March 31, 2009, 85% of residential loans (by unpaid principal balance) were one-month or six-month LIBOR ARMs and the remaining 15% were hybrid ARMs.
Real Estate Securities at Redwood
The following table provides details of our real estate securities activity at Redwood for the three months ended March 31, 2009.
Table 32 Real Estate Securities Activity at Redwood
Three Months Ended March 31, 2009
| | | | | | | | | | |
| | Residential |
| (In Millions) | | Senior | | Subordinate | | Commercial | | CDO | | Total |
| Balance at beginning of period | | $ | 94 | | | $ | 51 | | | $ | 42 | | | $ | 4 | | | $ | 191 | |
| Acquisitions | | | 98 | | | | — | | | | — | | | | — | | | | 98 | |
| Sales | | | (1 | ) | | | — | | | | — | | | | — | | | | (1 | ) |
| Principal repayments (including calls) | | | (7 | ) | | | (8 | ) | | | — | | | | — | | | | (15 | ) |
| Recognized gains on calls, net | | | — | | | | — | | | | — | | | | — | | | | — | |
| Discount amortization | | | 3 | | | | 3 | | | | (4 | ) | | | — | | | | 2 | |
| Fair value adjustments, net | | | (25 | ) | | | (13 | ) | | | (15 | ) | | | (1 | ) | | | (54 | ) |
| Balance at End of Period | | $ | 162 | | | $ | 33 | | | $ | 23 | | | $ | 3 | | | $ | 221 | |
Prime securities are residential mortgage-backed securities backed by high credit quality loans. Many of these loans are jumbo loans, with loan balances greater than existing conforming loan limits. Prime securities typically have relatively high weighted average FICO scores (700 or higher), low weighted average loan-to-value ratios (75% LTV or less), and limited concentrations of investor properties.
Non-prime securities are residential mortgage-backed securities that are not backed by high credit quality loans. Most of the borrowers backing non-prime loans have lower FICO scores or impaired credit histories, but exhibit the ability to repay the loan. To compensate for the greater risks and higher costs to service non-prime loans, borrowers often pay higher interest rates, and possibly higher origination fees. We use loss assumptions that are significantly higher when acquiring securities backed by non-prime loans than we use when acquiring securities backed by prime loans.
The following table presents the carrying value (which equals fair value) as a percent of face value for securities owned at Redwood at March 31, 2009 and December 31, 2008. In aggregate, the fair value of these securities is 14% of face value.
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The following table presents the components of carrying value (which equals fair value) at March 31, 2009 and December 31, 2008, for residential senior securities.
Table 34 Senior Securities at Redwood
March 31, 2009
| | | | |
| (In Millions) | | Residential |
| | Prime | | Non-Prime |
| Current face of AFS securities | | $ | 160 | | | $ | 174 | |
| Credit reserve | | | (1 | ) | | | (4 | ) |
| Net unamortized (discount) premium | | | (64 | ) | | | (69 | ) |
| Amortized cost | | | 95 | | | | 101 | |
| Gross unrealized market value gains | | | — | | | | — | |
| Gross unrealized market value losses | | | (7 | ) | | | (28 | ) |
| Carrying value of AFS securities | | | 88 | | | | 73 | |
| Carrying value of trading securities | | | — | | | | 1 | |
| Total Carrying Value of Senior Securities | | $ | 88 | | | $ | 74 | |
December 31, 2008
| | | | |
| (In Millions) | | Residential |
| | Prime | | Non-Prime |
| Current face of AFS securities | | $ | 90 | | | $ | 100 | |
| Credit reserve | | | — | | | | (4 | ) |
| Net unamortized (discount) premium | | | (42 | ) | | | (42 | ) |
| Amortized cost | | | 48 | | | | 54 | |
| Gross unrealized market value gains | | | 3 | | | | — | |
| Gross unrealized market value losses | | | — | | | | (12 | ) |
| Carrying value of AFS securities | | | 51 | | | | 42 | |
| Carrying value of trading securities | | | — | | | | 1 | |
| Total Carrying Value of Senior Securities | | $ | 51 | | | $ | 43 | |
Our residential senior securities portfolio totaled $162 million at March 31, 2009, an increase from $94 million at December 31, 2008. This increase was the result of net acquisitions of $98 million, partially offset by decreases in the fair values and paydowns of these securities. Of the $98 million of senior securities acquired in the first quarter of 2009, 50% were prime securities and 50% were non-prime securities.
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The following table details our residential subordinate securities portfolios by the product type and collateral vintage at March 31, 2009 and December 31, 2008.
Table 37 Residential Subordinate Securities at Redwood — Product and Vintage
March 31, 2009
| | | | | | | | |
| | Vintage |
| (In Millions) | | 2004 &
Earlier | | 2005 | | 2006 – 2008 | | Total |
Prime
| | | | | | | | | | | | | | | | |
| ARM | | $ | 1 | | | $ | — | | | $ | — | | | $ | 1 | |
| Hybrid | | | 15 | | | | 5 | | | | 1 | | | | 21 | |
| Fixed | | | 5 | | | | — | | | | 2 | | | | 7 | |
| Total prime | | | 21 | | | | 5 | | | | 3 | | | | 29 | |
Non-prime
| | | | | | | | | | | | | | | | |
| Option ARM | | | 1 | | | | 1 | | | | 2 | | | | 4 | |
| Total non-prime | | | 1 | | | | 1 | | | | 2 | | | | 4 | |
| Total Residential Subordinate Securities | | $ | 22 | | | $ | 6 | | | $ | 5 | | | $ | 33 | |
December 31, 2008
| | | | | | | | |
| | Vintage |
| (In Millions) | | 2004 &
Earlier | | 2005 | | 2006 | | Total |
Prime
| | | | | | | | | | | | | | | | |
| ARM | | $ | 3 | | | $ | — | | | $ | — | | | $ | 3 | |
| Hybrid | | | 24 | | | | 7 | | | | 2 | | | | 33 | |
| Fixed | | | 6 | | | | — | | | | 2 | | | | 8 | |
| Total prime | | | 33 | | | | 7 | | | | 4 | | | | 44 | |
Non-prime
| | | | | | | | | | | | | | | | |
| Option ARM | | | 1 | | | | 1 | | | | 3 | | | | 5 | |
| Hybrid | | | — | | | | — | | | | 1 | | | | 1 | |
| Fixed | | | — | | | | — | | | | 1 | | | | 1 | |
| Total non-prime | | | 1 | | | | 1 | | | | 5 | | | | 7 | |
| Total Residential Subordinate Securities | | $ | 34 | | | $ | 8 | | | $ | 9 | | | $ | 51 | |
The loans underlying all of our residential subordinate securities totaled $110 billion at March 31, 2009, and consist of $94 billion prime and $16 billion non-prime. These loans are located nationwide with a large concentration in California (46%). During the first quarter of 2009, realized residential credit losses were $137 million of principal value, a rate that equals 50 basis points (0.50%) of current loan balances on an annualized basis. Serious delinquencies (90+ days, in foreclosure or REO) at March 31, 2009 were 5.22% of current balances. These delinquencies were 2.44% of current balances for loans in prime pools and 21.75% of current balances for loans in non-prime pools.
Commercial Subordinate Securities at Redwood
Our commercial subordinate securities totaled $23 million at March 31, 2009, as compared to $42 million at December 31, 2008, a decline of $19 million. This decline was primarily due to declines in the fair values of securities, as there were no acquisitions or sales of commercial subordinate securities during the first quarter of 2009. We may acquire commercial securities in the future if pricing for these securities becomes attractive to us relative to the risks taken.
At March 31, 2009, commercial subordinate securities provided credit enhancement on $48 billion of underlying loans on office, retail, multifamily, industrial, and other income-producing properties nationwide. Seriously delinquent loans underlying commercial subordinate securities were $684 million at March 31, 2009, an increase of $122 million from December 31, 2008. Many of the delinquencies are concentrated within a
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few securities for which we have increased our credit reserves and impaired through our income statement. We consider our credit reserve of $498 million to be adequate as of March 31, 2009.
Securities at the Fund
The fair value of securities held at the Fund was $38 million at March 31, 2009, which includes $20 million of unrealized losses due to declining fair values of securities. We recognized $4 million of other-than-temporary impairments on these securities in the first quarter of 2009. The following table provides information on the activity at the Fund for the three months ended March 31, 2009.
Table 38 Securities at the Fund — Activity
Three Months Ended March 31, 2009
| | | | | | | | | | |
| (In Millions) | | Residential | | | | | | |
| | Senior | | Subordinate | | Commercial | | CDO | | Total |
| Balance at beginning of period | | $ | 27 | | | $ | 10 | | | | — | | | $ | 11 | | | $ | 48 | |
| Acquisitions | | | — | | | | — | | | | — | | | | — | | | | — | |
| Sales | | | — | | | | — | | | | — | | | | — | | | | — | |
| Recognized gains on sales, net | | | — | | | | — | | | | — | | | | — | | | | — | |
| Principal repayments (including calls) | | | (3 | ) | | | (1 | ) | | | — | | | | — | | | | (4 | ) |
| Recognized gains on calls, net | | | — | | | | — | | | | — | | | | — | | | | — | |
| Discount amortization | | | 2 | | | | — | | | | — | | | | — | | | | 2 | |
| Fair value adjustments, net | | | (4 | ) | | | — | | | | — | | | | (4 | ) | | | (8 | ) |
| Balance at End of Period | | $ | 22 | | | $ | 9 | | | | — | | | $ | 7 | | | $ | 38 | |
The following table presents the carrying value (which equals fair value) as a percent of face value at March 31, 2009 and December 31, 2008, for the securities at the Fund. In aggregate, the fair value of these securities is 24% of principal value at March 31, 2009.
Table 39 Fair Value as Percent of Principal Value for Real Estate Securities at the Fund
March 31, 2009
| | | | | | | | | | | | | | | | |
| | Vintage |
| | 2004 & Earlier | | 2005 | | 2006 – 2008 | | Total |
| (Dollars in Millions) | | Value | | % | | Value | | % | | Value | | % | | Value | | % |
Residential
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Senior non-prime | | $ | 10 | | | | 48 | % | | $ | 11 | | | | 30 | % | | $ | 1 | | | | 20 | % | | $ | 22 | | | | 35 | % |
| Subordinate non-prime | | | 9 | | | | 53 | % | | | — | | | | — | | | | — | | | | — | | | | 9 | | | | 53 | % |
| Total | | | 19 | | | | 50 | % | | | 11 | | | | 30 | % | | | 1 | | | | 20 | % | | $ | 31 | | | | 38 | % |
| CDO | | | 3 | | | | 6 | % | | | 4 | | | | 14 | % | | | — | | | | — | | | | 7 | | | | 9 | % |
| Total Securities at the Fund | | $ | 22 | | | | | | | $ | 15 | | | | | | | $ | 1 | | | | | | | $ | 38 | | | | | |
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The following table presents the carrying value (which equals fair value) as a percent of face value at March 31, 2009 and December 31, 2008, for securities owned by Acacia entities. In the aggregate, the fair value of these securities is 9% of face value at March 31, 2009.
Table 41 Fair Value as Percent of Principal Value for Securities at Acacia
March 31, 2009
| | | | | | | | | | | | | | | | |
| | Vintage |
| | 2004 & Earlier | | 2005 | | 2006 – 2008 | | Total |
| (Dollars in Millions) | | Value | | % | | Value | | % | | Value | | % | | Value | | % |
Residential Senior
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Prime | | $ | — | | | | — | | | $ | 2 | | | | 25 | % | | $ | 1 | | | | 12 | % | | $ | 3 | | | | 18 | % |
| Non-prime | | | 5 | | | | 41 | % | | | 5 | | | | 31 | % | | | 76 | | | | 32 | % | | | 86 | | | | 33 | % |
| Total | | | 5 | | | | 41 | % | | | 7 | | | | 29 | % | | | 77 | | | | 32 | % | | | 89 | | | | 32 | % |
Residential Subordinate
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Prime | | | 27 | | | | 14 | % | | | 7 | | | | 4 | % | | | 3 | | | | 2 | % | | | 37 | | | | 6 | % |
| Non-prime | | | 42 | | | | 20 | % | | | 30 | | | | 8 | % | | | 5 | | | | 1 | % | | | 77 | | | | 5 | % |
| Total | | | 69 | | | | 17 | % | | | 37 | | | | 6 | % | | | 8 | | | | 1 | % | | $ | 114 | | | | 5 | % |
| Commercial | | | 16 | | | | 18 | % | | | 17 | | | | 9 | % | | | 9 | | | | 5 | % | | | 42 | | | | 9 | % |
| CDO | | | 12 | | | | 11 | % | | | 1 | | | | 3 | % | | | 2 | | | | 2 | % | | $ | 15 | | | | 6 | % |
| Total Securities at Acacia | | $ | 102 | | | | | | | $ | 62 | | | | | | | $ | 96 | | | | | | | $ | 260 | | | | | |
December 31, 2009
| | | | | | | | | | | | | | | | |
| | Vintage |
| | 2004 & Earlier | | 2005 | | 2006 – 2008 | | Total |
| (Dollars in Millions) | | Value | | % | | Value | | % | | Value | | % | | Value | | % |
Residential Senior
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Prime | | $ | 5 | | | | 85 | % | | $ | 3 | | | | 35 | % | | $ | 4 | | | | 26 | % | | $ | 12 | | | | 41 | % |
| Non-prime | | | 6 | | | | 44 | % | | | 5 | | | | 33 | % | | | 80 | | | | 35 | % | | | 91 | | | | 35 | % |
| Total | | | 11 | | | | 57 | % | | | 8 | | | | 34 | % | | | 84 | | | | 34 | % | | | 103 | | | | 36 | % |
Residential Subordinate
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Prime | | | 33 | | | | 16 | % | | | 8 | | | | 4 | % | | | 4 | | | | 2 | % | | | 45 | | | | 7 | % |
| Non-prime | | | 50 | | | | 23 | % | | | 39 | | | | 10 | % | | | 8 | | | | 1 | % | | | 97 | | | | 6 | % |
| Total | | | 83 | | | | 20 | % | | | 47 | | | | 8 | % | | | 12 | | | | 1 | % | | | 142 | | | | 6 | % |
| Commercial | | | 22 | | | | 24 | % | | | 28 | | | | 16 | % | | | 18 | | | | 10 | % | | | 68 | | | | 15 | % |
| CDO | | | 16 | | | | 16 | % | | | 2 | | | | 4 | % | | | 3 | | | | 3 | % | | | 21 | | | | 9 | % |
| Total Securities at Acacia | | $ | 132 | | | | | | | $ | 85 | | | | | | | $ | 117 | | | | | | | $ | 334 | | | | | |
Derivative Financial Instruments
We enter into interest rate agreements to manage some of our interest rate risks. We hold these agreements with highly rated counterparties and maintain certain risk management policies limiting our exposure concentrations to any counterparty. At March 31, 2009, Redwood was party to interest rate agreements with an aggregate notional value of $14 million and fair value of negative $3 million. At March 31, 2009 the Acacia entities were party to interest rate agreements with an aggregate notional value of $1.7 billion and a fair value of negative $86 million. These are all accounted for as trading instruments and all changes in value and any net payments and receipts are recognized through our consolidated statements of (loss) income through market valuation adjustments, net.
One Acacia entity entered into credit default swaps (CDS) in the first quarter of 2007. At March 31, 2009, these CDS had a $62 million notional balance and a fair value of negative $62 million. At December 31, 2008, these CDS had a notional balance of $78 million and a fair value of negative
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$78 million. During the first quarter of 2009, the reference securities underlying our CDS experienced principal losses resulting in a $17 million obligation. The decrease in fair value on CDS is included in market valuation adjustments, net, in our consolidated statements of (loss) income.
Asset-Backed Securities Issued — Sequoia and Acacia
Through our sponsored securitization entities, we have securitized the majority of the assets shown on our consolidated balance sheets. These entities acquire assets and issue asset-backed securities (ABS) in order to fund these acquisitions. The residential whole loan securitization entities we sponsor are called Sequoia and the CDO securitization entities we sponsor are called Acacia. These securitization entities are bankruptcy-remote from us, so that our liabilities cannot become liabilities of the securitization entities, and the ABS issued by the securitization entities cannot become obligations of ours. Nevertheless, GAAP requires us to consolidate the assets and liabilities from Sequoia and Acacia entities for financial statement reporting purposes.
At March 31, 2009, there was $4.5 billion of loans owned by Sequoia securitization entities and reported at cost, which were funded with $4.4 billion of Sequoia ABS issued that were also reported at cost. At March 31, 2009, there were $260 million of securities owned by Acacia securitization entities and reported at fair value, which were funded with $291 million of Acacia ABS issued that were also reported at fair value. In total, the assets of these two programs represent 92% of our consolidated earning assets and the liabilities (ABS issued) of these programs represent 95% of our consolidated liabilities.
The following table provides detail on the activity for asset-backed securities for the three months ended March 31, 2009.
Table 42 ABS Issued Activity — Sequoia and Acacia
| | | | | | | | | | |
| | Three Months Ended March 31, 2009 |
| (In Thousands) | | December 31,
2008 | | Paydowns | | Amortization | | Valuation
Adjustments | | March 31,
2009 |
| Sequoia ABS issued with principal value, net | | $ | 4,484,595 | | | $ | (88,308 | ) | | $ | (335 | ) | | $ | — | | | $ | 4,395,952 | |
| Sequoia ABS interest only issued | | | 23,532 | | | | — | | | | (1,132 | ) | | | — | | | | 22,400 | |
| Total Sequoia ABS Issued | | | 4,508,127 | | | | (88,308 | ) | | | (1,467 | ) | | | — | | | | 4,418,352 | |
| Acacia ABS Issued | | | 346,931 | | | | (28,834 | ) | | | — | | | | (27,452 | ) | | | 290,645 | |
| Total ABS Issued | | $ | 4,855,058 | | | $ | (117,142 | ) | | $ | (1,467 | ) | | $ | (27,452 | ) | | $ | 4,708,997 | |
Long-term Debt
In 2006, we issued $100 million of long-term debt in the form trust preferred securities through Redwood Capital Trust I, a wholly-owned Delaware statutory trust, in a private placement transaction. These trust preferred securities require quarterly distributions at a floating rate equal to three-month LIBOR plus 2.25% until the notes are redeemed in whole, which will be no later than January 30, 2037. The earliest optional redemption date without a penalty is January 30, 2012. In 2007, we issued $50 million of long-term debt in the form of subordinated notes, which require quarterly distributions at a floating rate equal to three-month LIBOR plus 2.25% until the notes are redeemed, no later than July 30, 2037. The earliest optional redemption date without penalty is July 30, 2012. We may from time to time seek to purchase outstanding long-term debt in open market purchases, privately negotiated transactions, or otherwise. Any such repurchase would depend on numerous factors including, without limitation, pricing, market conditions, and our capital requirements.
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Contractual Obligations and Commitments
The following table presents our contractual obligations and commitments as of March 31, 2009, as well as the obligations of the securitization entities that we sponsor and consolidate for financial reporting purposes.
Table 43 Contractual Obligations and Commitments as of March 31, 2009
| | | | | | | | | | |
| | Payments Due or Commitment Expiration by Period |
| (In Millions) | | Total | | Less Than
1 Year | | 1 to 3
Years | | 3 to 5
Years | | After 5
Years |
Redwood Obligations:
| | | | | | | | | | | | | | | | | | | | |
| Short-term debt | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| Long-term debt | | | 150 | | | | — | | | | — | | | | — | | | | 150 | |
| Anticipated interest payments on long-term debt | | | 213 | | | | 5 | | | | 13 | | | | 15 | | | | 180 | |
| Accrued interest payable | | | 1 | | | | 1 | | | | — | | | | — | | | | — | |
| Operating leases | | | 14 | | | | 2 | | | | 4 | | | | 3 | | | | 5 | |
| Purchase commitments | | | — | | | | — | | | | — | | | | — | | | | — | |
| Total Redwood Obligations and Commitments | | $ | 378 | | | $ | 8 | | | $ | 17 | | | $ | 18 | | | $ | 335 | |
Obligations of Securitization Entities:
| | | | | | | | | | | | | | | | | | | | |
| Consolidated ABS(1) | | $ | 7,506 | | | $ | — | | | $ | — | | | $ | — | | | $ | 7,506 | |
| Anticipated interest payments on ABS(2) | | | 5,301 | | | | 254 | | | | 463 | | | | 626 | | | | 3,958 | |
| Accrued interest payable | | | 14 | | | | 14 | | | | — | | | | — | | | | — | |
| Total obligations of securitization entities | | $ | 12,821 | | | $ | 268 | | | $ | 463 | | | $ | 626 | | | $ | 11,464 | |
| Total Consolidated Obligations and Commitments | | $ | 13,199 | | | $ | 276 | | | $ | 480 | | | $ | 644 | | | $ | 11,799 | |
| (1) | All consolidated ABS issued are collateralized by real estate loans and securities. Although the stated maturity is as shown, the ABS obligations will pay down as the principal of these real estate loans or securities pay down. The amount shown is the face value of the ABS issued and not necessarily the value reported in our consolidated financial statements. |
| (2) | The anticipated interest payments on consolidated ABS issued is calculated based on the contractual maturity of the ABS and therefore assumes no prepayments of the principal outstanding as of March 31, 2009. |
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Critical Accounting Policies
See the “Critical Accounting Policies” section inManagement’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2008, for a detailed discussion of the Company’s critical accounting policies. Since the issuance of our Annual Report on Form 10-K for the year ended December 31, 2008, there have been no material changes to our critical accounting policies or the methodologies or assumptions we apply under them. We describe below certain recent accounting pronouncements that will ammed the critical accounting policies we apply in future periods.
Recent FASB Pronouncement on Fair Value Accounting
In April 2009, the FASB issued Financial Statement of Position FAS 157-4,Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly(FSP 157-4), which provides additional guidance to highlight and clarify the factors that should be considered in estimating fair value when there has been a significant decrease in market activity for an asset or liability. In addition, the FASB issued Financial Statement of Position FAS 107-1 and APB 28-1,Interim Disclosure about Fair Value of Financial Instruments (FSP 107-1), to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. Both FSPs are effective for interim and annual periods ending after June 15, 2009, with early adoption permitted. We will adopt FSPs 157-4 and 107-1 on April 1, 2009, for the six months ending June 30, 2009.
FSP FAS 157-4 clarifies that when determining the fair value of an asset or liability that is not a Level 1 fair value measurement, an entity should assess whether the volume and level of activity for the asset or liability have significantly decreased when compared with normal market conditions. If the entity concludes that there has been a significant decrease in the volume and level of activity, a quoted price may not be determinative of fair value and may require a significant adjustment. FAS 157 does not prescribe a specific approach for calculating the adjustment and indicates that significant judgment is involved. However, FSP 157-4 clarifies that as part of this judgment, an entity may deem it necessary to change the valuation technique or use multiple valuation techniques in determining fair value when there has been a significant decline in the volume and level of activity. When using multiple valuation techniques, an entity needs to consider the reasonableness of the range of results provided by the valuation techniques and use the point within that range that is most representative of fair value under current market conditions. In addition, a wide range of results provided by multiple valuation techniques may indicate that further analysis is required.
FSP 157-4 emphasizes that entities need to include an adequate risk adjustment in the fair value measurement, since a market participant would demand a higher return if there is uncertainty in the cash flows. However, such a risk premium must be representative of an orderly transaction under current market conditions. FASB also asserts that a fair value measurement is not an entity-specific measurement but a market-based measurement. Further, in identifying transactions that are not orderly, an entity cannot assume that the observable transaction price is not orderly when the volume and level of activity for the asset or liability have significantly declined. Instead, an entity must perform an analysis to determine whether the observable price is representative of a transaction that is not orderly. In making this determination, an entity cannot ignore information that is available without undue cost and effort, but is also is not required to undertake all possible efforts. We do not anticipate the implementation of this standard to have a material impact on our consolidated financial position and results of operations as our existing methodology is consistent with the FASB’s clarification.
FSP 157-4 also requires enhanced disclosures for interim and annual periods with regard to the input and valuation techniques used to measure fair value. An entity is also required to qualitatively discuss the changes in valuation techniques and related assumptions in both interim and annual financial statement if there is a change to the valuation technique or related assumptions in measuring fair value. Additionally, FSP 107-1 expands the fair value disclosures required for all financial instruments within the scope of FAS 107 to interim periods for publicly traded entities. Further, the FSP requires entities to disclose the method(s) and significant assumptions used to estimate the fair value of financial instruments in financial statements on an interim basis and to highlight any changes of the methods and significant assumptions from prior periods.
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Recent FASB Pronouncement on Other-Than-Temporary Impairments
In April 2009, the FASB issued Financial Statement of Position FAS 115-2 and FAS 124-2,Recognition and Presentation of Other-Than-Temporary Impairments (FSP 115-2), which establishes a new method of recognizing and reporting other-than-temporary impairments of debt securities. Under the FSP, the primary change to the other-than-temporary impairment (OTTI) model for debt securities is the change in focus from an entity’s intent and ability to hold a security until recovery. Instead, an OTTI is triggered if (1) an entity has the intent to sell the security, (2) it is more likely than not that it will be required to sell the security before recovery, or (3) it does not expect to recover the entire amortized cost basis of the security. The FSP is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted. We will adopt FSP 115-2 on April 1, 2009.
To evaluate whether a debt security is other-than-temporarily impaired, an entity must first determine whether the fair value of the debt security is less than its amortized cost basis at the balance sheet date. If the fair value is less than the amortized cost, the security is impaired, and the holder must then assess whether it intends to sell the security. If an entity intends to sell the security, an OTTI is considered to have occurred. Even if an entity does not intend to sell the security, an OTTI has occurred if the entity does not expect to recover the entire amortized cost basis (i.e., there is a credit loss). Under this analysis, the entity compares the present value of the cash flows expected to be collected to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the security’s amortized cost, an OTTI exists, regardless of whether the entity will be required to sell the security.
If an OTTI has occurred, an entity must then determine the amount of the loss to be recorded in earnings. If the entity intends to sell the security or it is more likely than not that it will be required to sell the security, the entire impairment loss is recorded in earnings. The impairment loss is the difference between the debt security’s amortized cost basis and its fair value as of the measurement date. In contrast, if the entity (1) does not intend to sell the security and it is not more likely than not that it will be required to sell the security and (2) does not expect to recover the amortized cost basis of the security, the impairment loss is separated into the amount representing the credit loss and the amount related to other factors. The amount of the impairment loss representing the credit loss is recognized in earnings and the amount due to other factors is recognized in other comprehensive income. The portion of other-than-temporary impairment recognized in earnings would decrease the amortized cost basis of the debt security, and subsequent recoveries in the fair value of the debt security would not result in a write-up of the amortized cost basis. The following diagram details the process for evaluating impairments on AFS securities under FSP 115-2.
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![[GRAPHIC MISSING]](https://capedge.com/proxy/10-Q/0001144204-09-024142/v146260_chrt-flow.jpg)
The FSP provides two methodologies for determining the credit loss. The first is to consider the methodology in paragraphs 12-16 of FAS 114: discount the expected cash flows of the security by using the effective interest rate of the security as of the date it was acquired. The FSP also notes that for beneficial interests in securitized financial assets within the scope of EITF 99-20, an entity applies the guidance in paragraph 12(b) of EITF 99-20 to determine the present value of the expected cash flows to be collected. That is, the entity would discount the estimated cash flows at a rate equal to the current yield used to accrete the beneficial interest.
For available-for-sale securities, any subsequent unrealized changes in the fair value of the security (other than further OTTIs) are recorded in other comprehensive income. For held-to-maturity debt securities, the amount of OTTI recorded in other comprehensive income for the noncredit portion of a previous OTTI should be amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security. That is, a portion of the OTTI recorded in OCI will be amortized out of OCI and will increase the carrying value of the asset until the security matures or is sold or a subsequent OTTI is recognized in earnings.
FSP 115-2 requires entities to initially apply the provisions of the standard to previously other-than-temporarily impaired debt securities (i.e., debt securities that the entity does not intend to sell and that the entity is not more likely than not required to sell before recovery), existing as of the date of initial adoption, by making a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The cumulative-effect adjustment reclassifies the noncredit portion of a previously other-than-temporarily impaired debt security held as of the date of initial adoption from retained earnings to accumulated other comprehensive income. We are in the process of evaluating all securities we have deemed other-than-temporarily impaired, in order to ascertain the cumulative adjustment to retained earnings and other comprehensive.
Market Risks
We seek to manage the risks inherent in our business — including but not limited to credit risk, interest rate risk, prepayment risk, liquidity risk, and fair value risk — in a prudent manner designed to enhance our
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earnings and dividends and preserve our capital. In general, we seek to assume risks that can be quantified from historical experience, to actively manage such risks, and to maintain capital levels consistent with these risks.
Credit Risk
Integral to our core business is assuming the credit risk of real estate loans primarily through the ownership of residential and commercial real estate loans and securities. Some of our capital base is employed in owning credit enhancement securities that have below investment-grade credit ratings due to their concentrated credit risks with respect to underlying real estate loans and investment-grade securities. We believe that many of the loans underlying these securities are above-average in credit quality as compared to U.S. real estate loans in general, but the balance and percentage of loans with special risk factors (higher risk commercial loans, interest-only and negative amortization residential loan types, and Alt-A and subprime residential loans) has increased and continues to increase. We may also own residential real estate loans that are not securitized.
Credit losses from the loans in securitized loan pools, in general, first reduce the principal value of and economic returns on the lower-rated securities in these pools. Credit losses on real estate loans can occur for many reasons, including: poor origination practices; fraud; faulty appraisals; documentation errors; poor underwriting; legal errors; poor servicing practices; weak economic conditions; decline in the value of homes, businesses, or commercial properties; special hazards; earthquakes and other natural events; over-leveraging of the borrower or on the property; reduction in market rents and occupancies and poor property management practices; changes in legal protections for lenders; reduction in personal incomes; job loss; and personal events such as divorce or health problems. In addition, if the U.S. economy or the housing market weakens further than we have anticipated, our credit losses could increase beyond levels that we have anticipated. Credit losses on real estate loans can vary for reasons not related to the general economy.
With respect to most of the loans securitized by securitization entities sponsored by us and for a portion of the loans underlying residential loan securities we have acquired from securitizations sponsored by others, the interest rate is adjustable. Accordingly, when short-term interest rates rise, required monthly payments from homeowners may rise under the terms of these loans, and this may increase borrowers’ delinquencies and defaults.
We also acquire securities backed by negative amortization adjustable-rate loans made to residential borrowers, some of which are prime-quality loans while many are Alt-A quality loans (and a few are subprime loans). We invest in these riskier loan types with the expectation of significantly higher delinquencies and losses as compared to regular amortization loans, but believe these securities offer us the opportunity to generate attractive risk-adjusted returns as a result of attractive pricing and the manner in which these securitizations are structured. Nevertheless, there remains substantial uncertainty about the future performance of these assets.
The large majority of the commercial loans we credit-enhance are fixed-rate loans, some of which are interest-only loans. In general, these loans are not fully amortizing and therefore require balloon payments at maturity. Consequently, we could be exposed to credit losses at the maturity of these loans if the borrower is unable to repay or refinance the borrowing with another third party lender.
We will experience credit losses on residential and commercial loans and securities, and to the extent the losses are consistent with the amount and timing of our assumptions, we expect to earn attractive returns on our investments. We manage our credit risks by understanding the extent of the risk we are taking and insuring the appropriate underwriting criteria are met, and we utilize systems and staff to continually monitor the ongoing credit performance of each loan and security. To the extent we find the credit risks on specific assets are changing adversely, we will take actions (including selling the assets) to mitigate potential losses. However, we may not always be successful in foreseeing adverse changes in credit performance or in effectively mitigating future credit losses.
In addition to residential and commercial subordinate securities, Redwood, the Fund, and Acacia own senior and other securities issued by securitization entities that are sponsored by others. A risk we face with
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respect to these securities is that we do not generally control or influence the underwriting, servicing, management, or loss mitigation with respect to these underlying loans.
The Acacia entities, the Fund, and Redwood also own securities backed by subprime and Alt-A residential loans that have substantially higher credit risk characteristics than prime-quality loans. Consequently, we can expect these lower-quality loans to have higher rates of delinquency and loss, and if such losses differ from our assumptions, Acacia, the Fund, and Redwood could suffer losses.
The Acacia entities also own certain senior securities and subordinate securities purchased from the Sequoia securitization entities we sponsor. If the pools of residential and commercial loans underlying these securities were to experience poor credit results, these securities could suffer decreases in fair value, or could experience principal losses. If any of these events occurs, it would likely reduce our returns from these investments.
Interest Rate Risk
Interest rates and the shape of the yield curve can affect the cash flows and fair values of our assets, liabilities, and interest rate agreements, and consequently, affect our earnings and reported equity. Our general strategy with respect to interest rates is to maintain an asset/liability posture (including hedges) on a consolidated basis that assumes some interest rate risks but not to such a degree that the achievement of our long-term goals would likely be affected by changes in interest rates. Accordingly, we are willing to accept short-term volatility of earnings and changes in our reported equity in order to accomplish our goal of achieving attractive long-term returns.
To implement our interest rate risk strategy, we may use interest rate agreements in an effort to maintain a close match between pledged assets and debt, as well as between the interest rate characteristics of the assets in the securitization entities and the corresponding ABS issued. However, we generally do not attempt to completely hedge changes in interest rates, and at times, we may be subject to more interest rate risk than we generally desire in the long term. Changes in interest rates will have an impact on the values and cash flows of our assets and corresponding liabilities.
Prepayment Risk
We seek to maintain an asset/liability posture that benefits from investments in prepayment-sensitive assets while limiting the risk of adverse prepayment fluctuations to an amount that, in most circumstances, can be absorbed by our capital base while still allowing us to make regular dividend payments.
Prepayments affect GAAP earnings in the near-term primarily through the timing of the amortization of purchase premium and discount and through triggering market valuation adjustments. For example, amortization income from discount assets may not necessarily offset amortization expense from premium assets, and vice-versa. In addition, variations in current and projected prepayment rates for individual assets and changes in interest rates (as they affect projected coupons on ARMs and other assets and thus change effective yield calculations) may cause net premium amortization expense or net discount amortization income to vary substantially from quarter to quarter. Moreover, the timing of premium amortization on assets may not always match the timing of the premium amortization on liabilities even when the underlying assets and liabilities are in the same securitization and pay down at the same rate.
Prepayment risks exist in the assets and associated liabilities consolidated on our balance sheets. In general, discount securities benefit from faster prepayment rates on the underlying real estate loans while premium securities (such as IOs) benefit from slower prepayments on the underlying loans. We are currently biased in favor of faster prepayment speeds with respect to the long-term economic effect of residential loan prepayments. However, in the short-term, increases in residential loan prepayment rates could result in GAAP earnings volatility.
With respect to securities backed by residential mortgage loans (and in particular, IOs), changes in prepayment forecasts by market participants could affect the market values of those securities sold by securitization entities, and thus could affect the profits we earn from securitizing assets.
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Our credit results and risks can also be affected by prepayments. For example, credit risks for the securities we own are reduced each time a loan prepays. All other factors being equal, faster prepayment rates should reduce our credit risks on our existing portfolio.
We caution that prepayment rates are difficult to predict or anticipate, and variations in prepayment rates can materially affect our earnings and dividend distribution requirements. ARM prepayment rates, for example, are driven by many factors, one of which is the steepness of the yield curve. As the yield curve flattens (short-term interest rates rise relative to longer-term interest rates), ARM prepayments typically increase.
Fair Value and Liquidity Risks
The securities that we sponsor are generally funded with equity with no associated recourse debt that might affect our liquidity position. On January 1, 2008 we elected the fair value option under FAS 159 for assets and liabilities at Acacia, with all changes in market values now being recorded through our income statement. Though this adds to our potential earnings volatility, the securities and ABS issued by Acacia entities have no recourse to us that would otherwise affect our liquidity position. Changes in the fair values (or ratings downgrades) of assets owned by an Acacia entity may also create differences between our reported GAAP and taxable income. However, we do not currently believe this will create liquidity issues for us.
Most of the real estate loans that we consolidate are accounted for as held-for-investment and reported at amortized cost. Most of these loans have been sold to Sequoia entities and, thus, changes in the fair value of the loans do not have an impact on our liquidity. However, changes in fair values during the accumulation period (while these loans are funded with short-term debt before they are sold to a Sequoia entity) may have a short-term effect on our liquidity. We may also own some real estate loans accounted for as held-for-sale and adverse changes in their value would be recognized through our income statement and may have an impact on our ability to obtain financing for them.
Our consolidated obligations consist primarily of ABS issued. Changes in fair value of ABS issued generally have no impact on our liquidity. ABS issued by Sequoia are reported at amortized cost as are the residential loans collateralizing these ABS. Beginning January 1, 2008, we report at fair value the ABS issued by Acacia and also report the underlying securities collateralizing the ABS issued at fair value. In either case, the resulting net equity (assets less liabilities) may not necessarily be reflective of the fair value of our interests in these securitization entities. However, since the ABS issued can only look to the cash flows generated by the assets within that securitization for payments of interest and repayments of the face value of the ABS, the changes in fair value do not have an effect on Redwood. Only to the extent that changes in fair values affect the timing of the cash flows we might receive on our investments in the Acacia entities, is there an effect to Redwood from changes in fair values of these securities. There are no such considerations in the Sequoia securitization entities.
We may fund some assets with a combination of short-term debt and equity (generally prior to securitization) that is recourse to Redwood. This generally increases our fair value and liquidity risks. We manage these risks by maintaining what we believe to be conservative capital levels under our internal risk-adjusted capital and risk management policies and by ensuring we have a variety of financing facilities available to fund each of our assets.
Inflation Risk
Virtually all of our consolidated assets and liabilities are financial in nature. As a result, 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. Our activities and balance sheets are measured with reference to historical cost or fair value without considering inflation.
Effect of Government Initiatives on Market Risks
Recent market and economic conditions have been unprecedented and challenging, with tighter credit conditions and slower growth through the end of 2008. Continued concerns about the systemic impact of inflation or deflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage
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market, and the declining real estate market in the U.S. have contributed to increased market volatility and diminished expectations for the U.S. economy.
These market and economic conditions have spurred government initiatives and interventions designed to address them. For example, in February 2009 the President announced a “Homeowner Affordability and Stability Plan,” which is primarily focused on reducing foreclosures through loan modifications, and increasing refinancing opportunities for homeowners with mortgages that conform to governmental agency criteria. Given the size and scope of the government actions, they will affect many of the market risks described above, although the total impact is not yet fully known. As these initiatives are further developed and their effects become more apparent we will continue to seek to take them into account in managing the risks inherent in our business.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Information concerning market risk is incorporated herein by reference to Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2008, as supplemented by the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Market Risks” above. Other than developments described under Management’s Discussion and Analysis of Financial Condition and Results of Operations above, including changes in the fair values of our assets, there have been no other material changes in our quantitative or qualitative exposure to market risk since December 31, 2008.
Item 4. Controls and Procedures
We have adopted and maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed on our reports under the Securities Exchange Act of 1934, as amended (the Exchange Act) is recorded, processed, summarized, and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms and that the information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluation the cost-benefit relationship of possible controls and procedures.
As required by Rule 13a-15(b) of the Exchange Act, we have carried out an evaluation, under the supervision and with the participation of management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level.
There have been no changes in our internal control over financial reporting during the first quarter of 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II
Item 1. Legal Proceedings
There are no material pending legal proceedings to which we or any of our subsidiaries is a party or of which our property is the subject.
Item 1A. Risk Factors
Our risk factors are discussed under Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2008.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
During the three months ended March 31, 2009, we did not sell any equity securities that were not registered under the Securities Act of 1933, as amended. We announced a stock repurchase plan on November 5, 2008 for the repurchase of up to a total of 5,000,000 shares. This plan replaced all previous share repurchase plans and has no expiration date. There were no repurchases under the new stock repurchase plan during the first quarter of 2009 and as of March 31, 2009, 4,658,344 shares remained available for repurchase under this plan.
The following table contains information on the shares of our common stock that we purchased during the three months ended March 31, 2009.
| | | | | | | | |
| | Total Number
of Shares
Purchased | | Average
Price per
Share Paid | | Total Number of
Shares Purchased as
Part of Publicly
Announced
Plans or
Programs | | Maximum
Number (or
Approximate
Dollar Value) of Shares that May
Yet be Purchased
Under the Plans
or Programs |
| January 1, 2009 – January 31, 2009 | | | 2,642 | (1) | | $ | 14.91 | | | | — | | | | 4,658,344 | |
| February 1, 2009 – February 28, 2009 | | | — | | | | — | | | | — | | | | 4,658,344 | |
| March 1, 2009 – March 31, 2009 | | | — | | | | — | | | | — | | | | 4,658,344 | |
| Total | | | 2,642 | | | $ | 14.91 | | | | 341,656 | | | | 4,658,344 | |
| (1) | The 2,642 shares purchased for the three months ended March 31, 2009 represent shares required to satisfy tax withholding requirements on the vesting of restricted shares. |
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
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Item 6. Exhibits
| | |
Exhibit
Number | | Exhibit |
| 10.1 | | Amended and Restated Employment Agreement, as of March 31, 2009, by and between George E. Bull, III and the Registrant |
| 10.2 | | Amended and Restated Employment Agreement, as of March 31, 2009, by and between Martin S. Hughes and the Registrant |
| 10.3 | | Amended and Restated Employment Agreement, as of March 31, 2009, by and between Brett D. Nicholas and the Registrant |
| 10.4 | | Amended and Restated Employment Agreement, as of March 31, 2009, by and between Harold F. Zagunis and the Registrant |
| 31.1 | | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 31.2 | | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 32.1 | | Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2 | | Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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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. |
| Date: May 4, 2009 | | By: /s/George E. Bull, III
George E. Bull, III
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer) |
| Date: May 4, 2009 | | By: /s/Martin S. Hughes
Martin S. Hughes
President, Co-Chief Operating Officer, and
Chief Financial Officer
(Principal Financial Officer) |
| Date: May 4, 2009 | | By: /s/Christopher J. Abate
Christopher J. Abate
Managing Director and Controller
(Principal Accounting Officer) |
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INDEX TO EXHIBITS
| | |
Exhibit
Number | | Exhibit |
| 10.1 | | Amended and Restated Employment Agreement, as of March 31, 2009, by and between George E. Bull, III and the Registrant |
| 10.2 | | Amended and Restated Employment Agreement, as of March 31, 2009, by and between Martin S. Hughes and the Registrant |
| 10.3 | | Amended and Restated Employment Agreement, as of March 31, 2009, by and between Brett D. Nicholas and the Registrant |
| 10.4 | | Amended and Restated Employment Agreement, as of March 31, 2009, by and between Harold F. Zagunis and the Registrant |
| 31.1 | | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 31.2 | | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 32.1 | | Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2 | | Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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