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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM_______TO_______
COMMISSION FILE NUMBER: 1-13759
REDWOOD TRUST, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 68-0329422
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
591 REDWOOD HIGHWAY, SUITE 3100
MILL VALLEY, CALIFORNIA 94941
(Address of principal executive offices) (Zip Code)
(415) 389-7373
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all
documents and reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of stock, as of the last practicable date.
Class B Preferred Stock ($.01 par value) 902,068 as of May 10, 2000
Common Stock ($.01 par value) 8,789,376 as of May 10, 2000
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REDWOOD TRUST, INC.
FORM 10-Q
INDEX
Page
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PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements - Redwood Trust, Inc.
Consolidated Balance Sheets at March 31, 2000 and December 31, 1999 ............. 3
Consolidated Statements of Operations for the three months ended
March 31, 2000 and March 31, 1999 ............................................... 4
Consolidated Statements of Stockholders' Equity for the three months ended
March 31, 2000 ................................................................. 5
Consolidated Statements of Cash Flows for the three months ended
March 31, 2000 and March 31, 1999 .............................................. 6
Notes to Consolidated Financial Statements ...................................... 7
Consolidated Financial Statements - RWT Holdings, Inc.
Consolidated Balance Sheets at March 31, 2000 and December 31, 1999 ............ 20
Consolidated Statements of Operations for the three months ended
March 31, 2000 and March 31, 1999 .............................................. 21
Consolidated Statements of Stockholders' Equity for the three months ended
March 31, 2000 ................................................................. 22
Consolidated Statements of Cash Flows for the three months ended
March 31, 2000 and March 31, 1999 .............................................. 23
Notes to Consolidated Financial Statements ...................................... 24
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ....................................... 30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ................................................................... 46
Item 2. Changes in Securities ............................................................... 46
Item 3. Defaults Upon Senior Securities ..................................................... 46
Item 4. Submission of Matters to a Vote of Security Holders ................................. 46
Item 5. Other Information ................................................................... 46
Item 6. Exhibits and Reports on Form 8-K .................................................... 46
SIGNATURES .................................................................................. 47
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PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
March 31, 2000 December 31, 1999
-------------- -----------------
(Unaudited)
ASSETS
Mortgage loans
Residential: held-for-sale $ 13,040 $ 415,880
Residential: held-for-investment, net 1,316,508 968,709
Commercial: held-for-sale 16,865 8,437
----------- -----------
1,346,413 1,393,026
Mortgage securities
Residential: trading 1,004,862 946,373
Residential: available-for-sale, net 36,994 28,006
----------- -----------
1,041,856 974,379
Cash and cash equivalents 12,539 19,881
Restricted cash 2,445 5,384
Interest rate agreements 1,189 2,037
Accrued interest receivable 14,920 13,244
Investment in RWT Holdings, Inc. 2,822 3,391
Loans to RWT Holdings, Inc. 1,400 6,500
Receivable from RWT Holdings, Inc. 573 472
Other assets 3,446 1,614
----------- -----------
Total Assets $ 2,427,603 $ 2,419,928
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt $ 922,405 $ 1,253,565
Long-term debt, net 1,282,756 945,270
Accrued interest payable 5,715 5,462
Accrued expenses and other liabilities 3,270 2,819
Dividends payable 3,757 2,877
----------- -----------
Total Liabilities 2,217,903 2,209,993
----------- -----------
Commitments and contingencies (See Note 13)
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01 per share; Class B 9.74% Cumulative
Convertible 902,068 shares authorized, issued and outstanding
($28,645 aggregate liquidation preference) 26,517 26,517
Common stock, par value $0.01 per share;
49,097,932 and 49,090,482 shares authorized;
8,783,341 and 11,251,556 issued and outstanding 88 88
Additional paid-in capital 242,139 242,094
Accumulated other comprehensive income (3,835) (3,348)
Cumulative earnings 12,104 8,140
Cumulative distributions to stockholders (67,313) (63,556)
----------- -----------
Total Stockholders' Equity 209,700 209,935
----------- -----------
Total Liabilities and Stockholders' Equity $ 2,427,603 $ 2,419,928
=========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
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REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
(Unaudited)
Three Months Ended March 31,
-------------------------------------
2000 1999
------------ ------------
INTEREST INCOME
Mortgage loans
Residential: held-for-sale $ 6,520 $ 4,287
Residential: held-for-investment 17,218 16,285
Commercial: held-for-sale 211 76
------------ ------------
23,949 20,648
Mortgage securities
Residential: trading 17,060 18,974
Residential: available-for-sale 1,615 803
------------ ------------
18,675 19,777
U.S. Treasury securities: trading -- 533
Cash and cash equivalents 314 773
------------ ------------
Total interest income 42,938 41,731
INTEREST EXPENSE
Short-term debt (19,164) (14,750)
Long-term debt (15,359) (18,741)
------------ ------------
Total interest expense (34,523) (33,491)
Net interest rate agreements expense (408) (333)
------------ ------------
NET INTEREST INCOME 8,007 7,907
Net unrealized and realized market value gains (losses)
Loans and securities (1,077) 2,990
Interest rate agreements (147) (821)
------------ ------------
(1,224) 2,169
Provision for credit losses (119) (345)
------------ ------------
NET REVENUES 6,664 9,731
Operating expenses (2,147) (714)
Other income 15 8
Equity in earnings (losses) of RWT Holdings, Inc. (568) (2,484)
------------ ------------
Net income before preferred dividend 3,964 6,541
Less cash dividends on Class B preferred stock (681) (687)
------------ ------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 3,283 $ 5,854
============ ============
EARNINGS PER SHARE:
Basic $ 0.37 $ 0.54
Diluted $ 0.37 $ 0.54
Weighted average shares of common stock and common stock equivalents:
Basic 8,785,017 10,778,159
Diluted 8,844,606 10,861,774
The accompanying notes are an integral part of these
consolidated financial statements.
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REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
(Unaudited)
Class B
Preferred stock Common stock Additional
--------------------------------------------------- paid-in
Shares Amount Shares Amount capital
- --------------------------------- --------- --------- --------- --------- ---------
Balance, December 31, 1999 902,068 $ 26,517 8,783,341 $ 88 $ 242,094
- --------------------------------- --------- --------- --------- --------- ---------
Comprehensive income:
Net income before
preferred dividend -- -- -- -- --
Net unrealized loss on assets
available-for-sale -- -- -- -- --
Total comprehensive income -- -- -- -- --
Issuance of common stock -- -- -- -- 45
Dividends declared:
Preferred -- -- -- -- --
Common -- -- -- -- --
- --------------------------------- --------- --------- --------- --------- ---------
Balance, March 31, 2000 902,068 $ 26,517 8,783,341 $ 88 $ 242,139
- --------------------------------- --------- --------- --------- --------- ---------
Accumulated
other Cumulative
comprehensive Cumulative distributions to
income earnings stockholders Total
- --------------------------------- --------- --------- --------- ---------
Balance, December 31, 1999 $ (3,348) $ 8,140 $ (63,556) $ 209,935
- --------------------------------- --------- --------- --------- ---------
Comprehensive income:
Net income before
preferred dividend -- 3,964 -- 3,964
Net unrealized loss on assets
available-for-sale (487) -- -- (487)
---------
Total comprehensive income -- -- -- 3,477
Issuance of common stock -- -- -- 45
Dividends declared:
Preferred -- -- (681) (681)
Common -- -- (3,076) (3,076)
- --------------------------------- --------- --------- --------- ---------
Balance, March 31, 2000 $ (3,835) $ 12,104 $ (67,313) $ 209,700
- --------------------------------- --------- --------- --------- ---------
The accompanying notes are an integral part of these
consolidated financial statements.
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REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Ended March 31,
2000 1999
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income before preferred dividend $ 3,964 $ 6,541
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 1,131 2,521
Provision for credit losses 119 345
Equity in (earnings) losses of RWT Holdings, Inc. 568 2,484
Net unrealized and realized market value (gains) losses 1,224 (2,169)
Purchases of mortgage loans: held-for-sale (25,734) (6,412)
Proceeds from sales of mortgage loans: held-for-sale 405,616 42,629
Principal payments on mortgage loans: held-for-sale 14,287 35,249
Purchases of mortgage securities: trading (165,264) --
Proceeds from sales of mortgage securities: trading 49,372 --
Principal payments on mortgage securities: trading 56,014 168,982
Purchases of U.S. Treasury securities: trading -- (45,844)
Proceeds from sales of U.S. Treasury securities: trading -- 58,442
Purchases of interest rate agreements (222) (409)
Proceeds from sales of interest rate agreements 339 --
(Increase) decrease in accrued interest receivable (1,676) 3,070
Increase in other assets (1,896) (987)
Increase (decrease) in accrued interest payable 253 (5,125)
Increase (decrease) in accrued expenses and other liabilities 451 (1,411)
--------- ---------
Net cash provided by operating activities 338,546 257,906
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of mortgage loans: held-for-investment (384,328) --
Principal payments on mortgage loans: held-for-investment 35,876 107,362
Purchases of mortgage securities: available-for-sale (9,151) --
Principal payments on mortgage securities: available-for-sale 243 58
Net decrease in restricted cash 2,939 1,366
(Loans) to RWT Holdings, Inc., net of repayments 5,100 (7,200)
(Increase) decrease in receivable from RWT Holdings, Inc. (101) 303
--------- ---------
Net cash provided by (used in) investing activities (349,422) 101,889
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments on short-term debt (331,160) (223,928)
Proceeds from issuance of long-term debt 375,844 --
Repayments on long-term debt (38,318) (134,136)
Net proceeds from issuance of common stock 45 1
Repurchases of common stock -- (16,035)
Dividends paid (2,877) (686)
--------- ---------
Net cash provided by (used in) financing activities 3,534 (374,784)
--------- ---------
Net decrease in cash and cash equivalents (7,342) (14,989)
Cash and cash equivalents at beginning of period 19,881 55,627
--------- ---------
Cash and cash equivalents at end of period $ 12,539 $ 40,638
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 34,270 $ 38,616
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
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REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
(UNAUDITED)
NOTE 1. THE COMPANY
Redwood Trust, Inc. ("Redwood Trust") was incorporated in Maryland on April 11,
1994 and commenced operations on August 19, 1994. During 1997, Redwood Trust
formed Sequoia Mortgage Funding Corporation ("Sequoia"), a special-purpose
finance subsidiary. Redwood Trust acquired an equity interest in RWT Holdings,
Inc. ("Holdings"), a taxable affiliate of Redwood Trust, during the first
quarter of 1998. For financial reporting purposes, references to the "Company"
mean Redwood Trust, Sequoia, and Redwood Trust's equity interest in Holdings.
Redwood Trust, together with its affiliates, is a finance company specializing
in the mortgage portfolio spread lending business. The Company's primary
activity is the acquisition, financing, and management of high-quality
residential mortgage loans with funds raised through long-term debt issuance.
The Company also acquires, finances, and manages residential mortgage securities
and originates and sells commercial mortgage loans.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying interim consolidated financial statements are unaudited. In the
opinion of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the quarter ended March 31, 2000 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2000. The
accompanying consolidated financial statements should be read in conjunction
with the consolidated financial statements and related notes included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1999.
The consolidated financial statements include the accounts of Redwood Trust and
Sequoia. Substantially all of the assets of Sequoia are pledged or subordinated
to support long-term debt in the form of collateralized mortgage bonds
("Long-Term Debt") and are not available for the satisfaction of general claims
of the Company. The Company's exposure to loss on the assets pledged as
collateral for Long-Term Debt is limited to its net equity investment in
Sequoia, as the Long-Term Debt is non-recourse to the Company. All significant
inter-company balances and transactions with Sequoia have been eliminated in the
consolidation of the Company. Certain amounts for prior periods have been
reclassified to conform to the 2000 presentation.
During March 1998, the Company acquired an equity interest in Holdings, which
originates and sells commercial mortgage loans. The Company owns all of the
preferred stock and has a non-voting, 99% economic interest in Holdings. As the
Company does not own the voting common stock of Holdings or control Holdings,
its investment in Holdings is accounted for under the equity method. Under this
method, original equity investments in Holdings are recorded at cost and
adjusted by the Company's share of earnings or losses and decreased by dividends
received.
USE OF ESTIMATES
The preparation of financial statements in conformity with Generally Accepted
Accounting Principles requires management to make estimates and assumptions that
affect the reported amounts of certain assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of certain revenues and expenses during the reported
period. Actual results could differ from those estimates. The primary estimates
inherent in the accompanying consolidated financial statements are discussed
below.
Fair Value. Management estimates the fair value of its financial instruments
using available market information and other appropriate valuation
methodologies. The fair value of a financial instrument, as defined by Statement
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of Financial Accounting Standards ("SFAS") No. 107, Disclosures about Fair Value
of Financial Instruments, is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation sale. Management's estimates are inherently subjective in
nature and involve matters of uncertainty and judgement to interpret relevant
market and other data. Accordingly, amounts realized in actual sales may differ
from the fair valueS presented in Notes 3, 7 and 10.
Reserve for Credit Losses. A reserve for credit losses is maintained at a level
deemed appropriate by management to provide for known losses, as well as
potential losses inherent in its mortgage loan portfolio. The reserve is based
upon management's assessment of various factors affecting its mortgage loans,
including current and projected economic conditions, delinquency status, and
credit protection. In determining the reserve for credit losses, the Company's
credit exposure is considered based on its credit risk position in the mortgage
pool. These estimates are reviewed periodically and, as adjustments become
necessary, they are reported in earnings in the periods in which they become
known. The reserve is increased by provisions, which are charged to income from
operations. When a loan or portions of a loan are determined to be
uncollectible, the portion deemed uncollectible is charged against the reserve
and subsequent recoveries, if any, are credited to the reserve. The Company's
actual credit losses may differ from those estimates used to establish the
reserve. Summary information regarding the Reserve for Credit Losses is
presented in Note 4.
MORTGAGE ASSETS
The Company's mortgage assets consist of mortgage loans and mortgage securities
("Mortgage Assets"). Interest is recognized as revenue when earned according to
the terms of the loans and securities and when, in the opinion of management, it
is collectible. Discounts and premiums relating to Mortgage Assets are amortized
into interest income over the lives of the Mortgage Assets using methods that
approximate the effective yield method. Gains or losses on the sale of Mortgage
Assets are based on the specific identification method.
Mortgage Loans: Held-for-Sale
The Company classifies certain short-funded mortgage loans as held-for-sale.
These mortgage loans are carried at the lower of original cost or market value
("LOCOM"). Realized and unrealized gains and losses on these loans are
recognized in "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations.
Some of the mortgage loans purchased by the Company for which securitization or
sale is contemplated are committed for sale by the Company to Holdings, or a
subsidiary of Holdings, under a Master Forward Commitment Agreement. As the
forward commitment is entered into on the same date that the Company commits to
purchase the loans, the price which Holdings will pay to purchase the loans
under the forward commitment is the same as the price that the Company paid for
the mortgage loans, as established by the external market. Fair value is
therefore equal to the commitment price, which is the carrying value of the
mortgage loans. Accordingly, no gain or loss is recognized on the subsequent
sales of these mortgage loans to Holdings or subsidiaries of Holdings.
Mortgage Loans: Held-for-Investment
All of the assets of Sequoia that are pledged or subordinated to support the
Long-Term Debt are classified as held-for investment. Mortgage loans classified
as held-for-investment are carried at their unpaid principal balance adjusted
for net unamortized premiums or discounts, and net of the related allowance for
credit losses.
Mortgage Securities: Trading
The Company classifies all of its mortgage securities with a rating of AA or
higher as trading. Mortgage securities classified as trading are accounted for
in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and
Equity Securities. Accordingly, such securities are recorded at their estimated
fair market value. Unrealized and realized gains and losses on these securities
are recognized as a component of "Net unrealized and realized market value gains
(losses)" on the Consolidated Statements of Operations.
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Mortgage Securities: Available-for-Sale
The Company classifies all mortgage securities rated A or lower as
available-for-sale. All mortgage securities classified as available-for-sale are
carried at their estimated fair value. Current period unrealized gains and
losses are excluded from net income and reported as a component of Other
Comprehensive Income in Stockholders' Equity with cumulative unrealized gains
and losses classified as Accumulated Other Comprehensive Income in Stockholders'
Equity.
Unrealized losses on mortgage securities classified as available-for-sale that
are considered other-than-temporary, are recognized in income and the carrying
value of the mortgage security is adjusted. Other-than-temporary unrealized
losses are based on management's assessment of various factors affecting the
expected cash flow from the mortgage securities, including an
other-than-temporary deterioration of the credit quality of the underlying
mortgages and/or the credit protection available to the related mortgage pool
and a significant change in the prepayment characteristics of the underlying
collateral.
U.S. TREASURY SECURITIES
U.S. Treasury securities include notes issued by the U.S. Government. Interest
is recognized as revenue when earned according to the terms of the Treasury
securities. Discounts and premiums are amortized into interest income over the
life of the security using the effective yield method. U.S. Treasury securities
are classified as trading and, accordingly, are recorded at their estimated fair
market value with unrealized gains and losses recognized as a component of "Net
unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of three months or less.
RESTRICTED CASH
Restricted cash of the Company includes principal and interest payments on
mortgage loans held as collateral for the Company's Long-Term Debt, and cash
pledged as collateral on certain interest rate agreements.
INTEREST RATE AGREEMENTS
The Company maintains an overall interest-rate risk-management strategy that
incorporates the use of derivative interest rate agreements to minimize
significant unplanned fluctuations in earnings that are caused by interest-rate
volatility. Interest rate agreements that are used as part of the Company's
interest-rate risk management strategy include interest rate options, swaps,
options on swaps, futures contracts, options on futures contracts, forward sales
of fixed-rate Agency mortgage securities ("MBS"), and options on forward
purchases or sales of MBS' (collectively "Interest Rate Agreements"). On the
date an Interest Rate Agreement is entered into, the Company designates the
Interest Rate Agreement as (1) a hedge of the fair value of a recognized asset
or liability or of an unrecognized firm commitment ("fair value" hedge), (2) a
hedge of a forecasted transaction or of the variability of cash flows to be
received or paid related to a recognized asset or liability ("cash flow" hedge),
or (3) held for trading ("trading" instruments). Since the adoption of SFAS No.
133, the Company has elected to designate all of its Interest Rate Agreements as
trading instruments. Accordingly, such instruments are recorded at their
estimated fair market value with changes in their fair value reported in
current-period earnings in "Net unrealized and realized market value gains
(losses)" on the Consolidated Statements of Operations.
Net premiums on interest rate options are amortized as a component of net
interest income over the effective period of the interest rate option using the
effective interest method. The income and/or expense related to interest rate
options and swaps are recognized on an accrual basis.
DEBT
Short-Term and Long-Term Debt are carried at their unpaid principal balances,
net of any unamortized discount or premium and any unamortized deferred bond
issuance costs. The amortization of any discount or premium is recognized as an
adjustment to interest expense using the effective interest method based on the
maturity schedule of the related borrowings. Bond issuance costs incurred in
connection with the issuance of Long-Term Debt are
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deferred and amortized over the estimated lives of the Long-Term Debt using the
interest method adjusted for the effects of prepayments.
INCOME TAXES
The Company has elected to be taxed as a Real Estate Investment Trust ("REIT")
under the Internal Revenue Code (the "Code") and the corresponding provisions of
State law. In order to qualify as a REIT, the Company must annually distribute
at least 95% of its taxable income to stockholders and meet certain other
requirements. If these requirements are met, the Company generally will not be
subject to Federal or state income taxation at the corporate level with respect
to the taxable income it distributes to its stockholders. Because the Company
believes it meets the REIT requirements and also intends to distribute all of
its taxable income, no provision has been made for income taxes in the
accompanying consolidated financial statements.
Under the Code, a dividend declared by a REIT in October, November or December
of a calendar year and payable to shareholders of record as of a specified date
in such month, will be deemed to have been paid by the Company and received by
the shareholders on the last day of that calendar year, provided the dividend is
actually paid before February 1st of the following calendar year, and provided
that the REIT has any remaining undistributed taxable income on the record date.
Therefore, the dividends declared in December 1999 which were paid in January
2000 are considered taxable income to shareholders in 1999, the year declared.
NET INCOME (LOSS) PER SHARE
Net income per share for the three months ended March 31, 2000 and 1999 is shown
in accordance with SFAS No. 128, Earnings Per Share. Basic net income per share
is computed by dividing net income available to common stockholders by the
weighted average number of common shares outstanding during the period. Diluted
net income per share is computed by dividing the net income available to common
stockholders by the weighted average number of common shares and common
equivalent shares outstanding during the period. The common equivalent shares
are calculated using the treasury stock method, which assumes that all dilutive
common stock equivalents are exercised and the funds generated by the exercise
are used to buy back outstanding common stock at the average market price during
the reporting period.
The following tables provide reconciliations of the numerators and denominators
of the basic and diluted net income per share computations.
(IN THOUSANDS, EXCEPT SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
----------------------------------
2000 1999
------------ ------------
NUMERATOR:
Numerator for basic and diluted earnings per share--
Net income before preferred dividend $ 3,964 $ 6,541
Cash dividends on Class B preferred stock (681) (687)
------------ ------------
Basic and Diluted EPS - Net income
available to common stockholders $ 3,283 $ 5,854
============ ============
DENOMINATOR:
Denominator for basic earnings per share--
Weighted average number of common shares
outstanding during the period 8,785,017 10,778,159
Net effect of dilutive stock options 59,589 83,615
------------ ------------
Denominator for diluted earnings per share-- 8,844,606 10,861,774
============ ============
Net income per share - basic $ 0.37 $ 0.54
============ ============
Net income per share - diluted $ 0.37 $ 0.54
============ ============
COMPREHENSIVE INCOME
SFAS No. 130, Reporting Comprehensive Income, requires the Company to classify
items of "other comprehensive income" by their nature in a financial statement
and display the accumulated balance of other
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comprehensive income separately from retained earnings and additional paid-in
capital in the equity section of the balance sheet. In accordance with SFAS No.
130, current period unrealized gains and losses on assets available-for-sale are
reported as a component of Comprehensive Income on the Consolidated Statements
of Stockholders' Equity with cumulative unrealized gains and losses classified
as Accumulated Other Comprehensive Income in Stockholders' Equity. At March 31,
2000 and December 31, 1999, the only component of Accumulated Other
Comprehensive Income was net unrealized gains and losses on assets
available-for-sale.
RECENT ACCOUNTING PRONOUNCEMENT
During March 2000, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation - an interpretation of APB Opinion No. 25 ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 by expanding upon a number of
issues not specifically addressed in the Opinion such as the definition of an
employee for purposes of applying APB Opinion No. 25 and the accounting for
modifications to a previously fixed stock option award. FIN 44 is effective July
1, 2000. The impact on the Company of adopting FIN 44 has not yet been
determined.
NOTE 3. MORTGAGE ASSETS
At March 31, 2000 and December 31, 1999, investments in Mortgage Assets
consisted of interests in adjustable-rate, hybrid, or fixed-rate mortgage loans
on residential and commercial properties. The hybrid mortgages have an initial
fixed coupon rate for three to ten years followed by annual adjustments. Agency
mortgage securities ("Agency Securities") represent securitized interests in
pools of adjustable-rate mortgages from the Federal Home Loan Mortgage
Corporation and the Federal National Mortgage Association. The Agency Securities
are guaranteed as to principal and interest by these United States
government-sponsored entities. The original maturity of the majority of the
Mortgage Assets is thirty years; the actual maturity is subject to change based
on the prepayments of the underlying mortgage loans.
At March 31, 2000 and December 31, 1999, the annualized effective yield after
taking into account the amortization expense due to prepayments on the Mortgage
Assets was 7.29% and 7.00%, respectively, based on the reported cost of the
assets. At March 31, 2000, 82% of the Mortgage Assets owned by the Company were
adjustable-rate mortgages, 16% were hybrid mortgages, and 2% were fixed-rate
mortgages. At December 31, 1999, 81% of the Mortgage Assets owned by the Company
were adjustable-rate mortgages, 17% were hybrid mortgages, and 2% were
fixed-rate mortgages. At March 31, 2000 and December 31, 1999, the coupons on
62% and 61% of the adjustable-rate Mortgage Assets were limited by periodic caps
(generally interest rate adjustments are limited to no more than 1% every six
months or 2% every year), respectively. The majority of the coupons on the
adjustable-rate and hybrid Mortgage Assets owned by the Company are limited by
lifetime caps. At March 31, 2000 and December 31, 1999, the weighted average
lifetime cap on the adjustable-rate Mortgage Assets was 11.65% and 11.64%,
respectively.
At March 31, 2000 and December 31, 1999, Mortgage Assets consisted of the
following:
MORTGAGE LOANS: RESIDENTIAL
MARCH 31, 2000 DECEMBER 31, 1999
HELD-FOR- HELD-FOR- HELD-FOR- HELD-FOR-
(IN THOUSANDS) SALE INVESTMENT TOTAL SALE INVESTMENT TOTAL
----------- ----------- ----------- ----------- ----------- -----------
Current Face $ 13,340 $ 1,305,963 $ 1,319,303 $ 412,456 $ 960,928 $ 1,373,384
Unamortized Discount (325) -- (325) (305) -- (305)
Unamortized Premium 25 15,789 15,814 3,729 12,906 16,635
----------- ----------- ----------- ----------- ----------- -----------
Amortized Cost 13,040 1,321,752 1,334,792 415,880 973,834 1,389,714
Reserve for Credit Losses -- (5,244) (5,244) -- (5,125) (5,125)
----------- ----------- ----------- ----------- ----------- -----------
Carrying Value $ 13,040 $ 1,316,508 $ 1,329,548 $ 415,880 $ 968,709 $ 1,384,589
=========== =========== =========== =========== =========== ===========
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The Company recognized losses of $0.1 million during both the quarters ended
March 31, 2000 and 1999, as a result of LOCOM adjustments on residential
mortgage loans held-for-sale. The LOCOM adjustments are reflected as a component
of "Net unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations. During the three months ended March 31, 2000, the
Company sold to Holdings $380.5 million participation agreement on residential
mortgage loans for proceeds of $380.5 million (see Note 12). Additionally,
during the three months ended March 31, 2000, the Company sold residential
mortgage loans to Redwood Residential Funding ("RRF"), a subsidiary of Holdings,
for proceeds of $16.7 million. Pursuant to the terms of the Master Forward
Commitment Agreement, the mortgage loans are sold to RRF at the same price for
which the Company acquires the commercial mortgage loans (see Note 12).
Accordingly, there were no LOCOM adjustments or gains on sales related to the
RRF sales transactions. During the three months ended March 31, 1999, the
Company sold residential mortgage loans held-for-sale for proceeds of $34.3
million.
There were no sales of residential mortgage loans held-for-investment during the
three months ended March 31, 2000 and 1999.
MORTGAGE LOANS: COMMERCIAL
MARCH 31, 2000 DECEMBER 31, 1999
(IN THOUSANDS) HELD-FOR-SALE HELD-FOR-SALE
------------- -------------
Current Face $ 16,899 $ 8,450
Unamortized Discount (34) (13)
-------- --------
Carrying Value $ 16,865 $ 8,437
======== ========
During the three months ended March 31, 2000 and 1999, the Company sold
commercial mortgage loans to Redwood Commercial Funding ("RCF"), a subsidiary of
Holdings, for proceeds of $8.4 million and 8.3 million, respectively. To date,
pursuant to the Master Forward Commitment Agreement, all commercial mortgage
loans purchased by the Company are sold to RCF at the same price for which the
Company acquires or originates the commercial mortgage loans (see Note 12).
Accordingly, there are no LOCOM adjustments or gains on sales related to
commercial mortgage loans.
MORTGAGE SECURITIES: RESIDENTIAL
MARCH 31, 2000 DECEMBER 31, 1999
AVAILABLE- AVAILABLE-
(IN THOUSANDS) TRADING FOR-SALE TOTAL TRADING FOR-SALE TOTAL
----------- ----------- ----------- ----------- ----------- -----------
Current Face $ 995,442 $ 60,878 $ 1,056,320 $ 938,943 $ 48,627 $ 987,570
Unamortized Discount (2,789) (19,363) (22,152) (3,548) (16,444) (19,992)
Unamortized Premium 12,209 -- 12,209 10,978 -- 10,978
----------- ----------- ----------- ----------- ----------- -----------
Amortized Cost 1,004,862 41,515 1,046,377 946,373 32,183 978,556
Reserve for Credit Losses -- (686) (686) -- (829) (829)
Gross Unrealized Gains -- 352 352 -- 166 166
Gross Unrealized Losses -- (4,187) (4,187) -- (3,514) (3,514)
----------- ----------- ----------- ----------- ----------- -----------
Carrying Value $ 1,004,862 $ 36,994 $ 1,041,856 $ 946,373 $ 28,006 $ 974,379
=========== =========== =========== =========== =========== ===========
Agency $ 671,395 -- $ 671,395 $ 580,958 -- $ 580,958
Non-Agency 333,467 $ 36,994 370,461 365,415 $ 28,006 393,421
----------- ----------- ----------- ----------- ----------- -----------
Carrying Value $ 1,004,862 $ 36,994 $ 1,041,856 $ 946,373 $ 28,006 $ 974,379
=========== =========== =========== =========== =========== ===========
For the three months ended March 31, 2000 and 1999, the Company recognized a
market value loss of $0.9 million and a market value gain of $4.9 million on
mortgage securities classified as trading, respectively. The market value
adjustments are reflected as a component of "Net unrealized and realized market
value gains
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(losses)" on the Consolidated Statements of Operations. The Company also sold
mortgage securities classified as trading for proceeds of $49 million during the
quarter ended March 31, 2000.
There were no sales of available-for-sale mortgage securities during the three
months ended March 31, 2000 and 1999. Any gains and losses on the sales and
write-downs of mortgage securities available-for-sale are reflected as a
component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations.
NOTE 4. RESERVE FOR CREDIT LOSSES
The Reserve for Credit Losses is reflected as a component of Mortgage Assets on
the Consolidated Balance Sheets. The following table summarizes the Reserve for
Credit Losses activity:
THREE MONTHS ENDED MARCH 31,
----------------------------
(IN THOUSANDS) 2000 1999
----------- -----------
Balance at beginning of $ 5,954 $ 4,973
period
Provision for credit losses 119 345
Charge-offs (143) (121)
------- -------
Balance at end of period $ 5,930 $ 5,197
======= =======
NOTE 5. U.S. TREASURY SECURITIES
The Company did not hold any U.S. Treasury securities at March 31, 2000 or
December 31, 1999. During the three months ended March 31, 1999, the Company
recognized a market value loss of $1.9 million on U.S. Treasury securities and
received proceeds of $58.4 million on sales of U.S. Treasury securities. The
market value adjustments are reflected as a component of "Net unrealized and
realized market value gains (losses)" on the Consolidated Statements of
Operations.
NOTE 6. COLLATERAL FOR LONG-TERM DEBT
The Company has pledged collateral in order to secure the Long-Term Debt issued
in the form of collateralized mortgage bonds ("Bond Collateral"). This Bond
Collateral consists primarily of adjustable-rate and hybrid, conventional,
30-year mortgage loans secured by first liens on one- to four-family residential
properties. All Bond Collateral is pledged to secure repayment of the related
Long-Term Debt obligation. All principal and interest (less servicing and
related fees) on the Bond Collateral is remitted to a trustee and is available
for payment on the Long-Term Debt obligation. The Company's exposure to loss on
the Bond Collateral is limited to its net investment, as the Long-Term Debt is
non-recourse to the Company.
The components of the Bond Collateral are summarized as follows:
(IN THOUSANDS) MARCH 31, 2000 DECEMBER 31, 1999
-------------- -----------------
Mortgage loans
Residential: held-for-investment, net $1,316,508 $ 968,709
Restricted cash 1,881 4,791
Accrued interest receivable 6,229 5,633
---------- ----------
$1,324,618 $ 979,133
========== ==========
For presentation purposes, the various components of the Bond Collateral
summarized above are reflected in their corresponding line items on the
Consolidated Balance Sheets.
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NOTE 7. INTEREST RATE AGREEMENTS
At March 31, 2000 and December 31, 1999, all of the Company's Interest Rate
Agreements were classified as trading, and therefore, reported at fair value.
For the three months ended March 31, 2000 and 1999, the Company recognized
market value losses of $0.1 million and $0.8 million on Interest Rate Agreements
classified as trading, respectively. The market value gains and losses are
reflected as a component of "Net unrealized and realized market value gains
(losses)" on the Consolidated Statements of Operations. The Company sold
Interest Rate Agreements classified as trading for proceeds of $0.3 million
during the quarter ended March 31, 2000.
The following table summarizes the aggregate notional amounts of all of the
Company's Interest Rate Agreements as well as the credit exposure related to
these instruments.
NOTIONAL AMOUNTS CREDIT EXPOSURE (a)
-------------------------------------- ---------------------------------------
(IN THOUSANDS) MARCH 31, 2000 DECEMBER 31, 1999 MARCH 31, 2000 DECEMBER 31, 1999
-------------- ----------------- -------------- -----------------
Interest Rate Options
Purchased $2,210,800 $2,960,900 -- --
Interest Rate Swaps -- 250,000 $ 2,390 $ 2,632
Interest Rate Futures and Forwards 843,000 630,000 524 593
---------- ---------- ---------- ----------
Total $3,053,800 $3,840,900 $ 2,914 $ 3,225
========== ========== ========== ==========
(a) Reflects the fair market value of all cash and collateral of the Company
held by counterparties.
Interest Rate Options purchased (sold), which may include caps, floors, call and
put corridors, options on futures, options on MBS forwards, and swaption collars
(collectively, "Options"), are agreements which transfer, modify or reduce
interest rate risk in exchange for the payment (receipt) of a premium when the
contract is initiated. Purchased interest rate cap agreements provide cash flows
to the Company to the extent that a specific interest rate index exceeds a fixed
rate. Conversely, purchased interest rate floor agreements produce cash flows to
the Company to the extent that the referenced interest rate index falls below
the agreed upon fixed rate. Purchased call (put) corridors will cause the
Company to incur a gain to the extent that the yield of the specified index is
below (above) the strike rate at the time of the option expiration. The maximum
gain or loss on a purchased call (put) corridor is equal to the up-front
premium. Call (put) corridors that are sold will cause the Company to incur a
loss to the extent that the yield of the specified index is below (above) the
strike rate at the time of the option expiration. Such loss, if any, will, in
part, be offset by upfront premium received. The maximum gain or loss on a call
(put) corridor sold is determined at the time of the transaction by establishing
a minimum (maximum) index rate. The Company will receive cash on the purchased
options on futures/forwards if the futures/forward price exceeds (is below) the
call (put) option strike price at the expiration of the option. For the written
options on futures/forwards, the Company receives an up-front premium for
selling the option, however, the Company will incur a loss on the written option
if the futures/forward price exceeds (is below) the call (put) option strike
price at the expiration of the option. Purchased receiver (payor) swaption
collars will cause the Company to incur a gain (loss) should the index rate be
below (above) the strike rate as of the expiration date. The maximum gain or
loss on a receiver (payor) swaption is established at the time of the
transaction by establishing a minimum (maximum) index rate. The Company's credit
risk on the purchased Options is limited to the carrying value of the Options
agreements. The credit risk on options on futures is limited due to the fact
that the exchange and its members are required to satisfy the obligations of any
member that fails to perform.
Interest Rate Swaps ("Swaps") are agreements in which a series of interest rate
flows are exchanged over a prescribed period. The notional amount on which the
interest payments are based is not exchanged. Most of the Company's Swaps
involve the exchange of one floating interest payment for another floating
interest payment based on a different index. Most of the Swaps require that the
Company provide collateral, such as mortgage securities, to the counterparty.
Should the counterparty fail to return the collateral, the Company would be at
risk for the fair market value of that asset.
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Interest Rate Futures and Forwards ("Futures and Forwards") are contracts for
the purchase or sale of securities or cash in which the seller (buyer) agrees to
deliver (purchase) on a specified future date, a specified instrument (or the
cash equivalent), at a specified price or yield. Under these agreements, if the
Company has sold (bought) the futures/forwards, the Company will generally
receive additional cash flows if interest rates rise (fall). Conversely, the
Company will generally pay additional cash flows if interest rates fall (rise).
The credit risk inherent in futures and forwards arises from the potential
inability of counterparties to meet the terms of their contracts, however, the
credit risk on futures is limited by the requirement that the exchange and its
members make good on obligations of any member that fails to perform.
In general, the Company has incurred credit risk to the extent that the
counterparties to the Interest Rate Agreements do not perform their obligations
under the Interest Rate Agreements. If one of the counterparties does not
perform, the Company would not receive the cash to which it would otherwise be
entitled under the Interest Rate Agreement. In order to mitigate this risk, the
Company has only entered into Interest Rate Agreements that are either a)
transacted on a national exchange or b) transacted with counterparties that are
either i) designated by the U.S. Department of the Treasury as a "primary
government dealer", ii) affiliates of "primary government dealers", or iii)
rated BBB or higher. Furthermore, the Company has entered into Interest Rate
Agreements with several different counterparties in order to diversify the
credit risk exposure.
NOTE 8. SHORT-TERM DEBT
The Company has entered into repurchase agreements, bank borrowings, and other
forms of collateralized short-term borrowings (collectively, "Short-Term Debt")
to finance acquisitions of a portion of its Mortgage Assets. This Short-Term
Debt is collateralized by a portion of the Company's Mortgage Assets.
At March 31, 2000, the Company had $0.9 billion of Short-Term Debt outstanding
with a weighted-average borrowing rate of 6.19% and a weighted-average remaining
maturity of 83 days. This debt was collateralized with $1.0 billion of Mortgage
Assets. At December 31, 1999, the Company had $1.3 billion of Short-Term Debt
outstanding with a weighted-average borrowing rate of 6.22% and a
weighted-average remaining maturity of 96 days. This debt was collateralized
with $1.3 billion of Mortgage Assets.
At March 31, 2000 and December 31, 1999, the Short-Term Debt had the following
remaining maturities:
(IN THOUSANDS) MARCH 31, 2000 DECEMBER 31, 1999
-------------- -----------------
Within 30 days $ 257,383 $ 163,394
30 to 90 days 197,267 385,729
Over 90 days 467,755 704,442
---------- ----------
Total Short-Term Debt $ 922,405 $1,253,565
========== ==========
For the three months ended March 31, 2000 and 1999, the average balance of
Short-Term Debt was $1.2 billion with a weighted-average interest cost of 6.25%
and 5.12%, respectively. The maximum balance outstanding during both the three
months ended March 31, 2000 and 1999 was $1.3 billion.
In July 1999, the Company entered into a one-year, $90 million revolving
mortgage warehousing credit facility with two banks. The facility was primarily
intended to finance newly acquired residential mortgage loans. At the Company's
request, this line was cancelled during the first quarter of 2000. Therefore,
there were no outstanding borrowings at March 31, 2000 under this facility. At
December 31, 1999, the Company had outstanding borrowings of $6.4 million under
this facility, which were reflected as a component of Short-Term Debt. Holdings
had no outstanding borrowings under this facility at December 31, 1999.
Borrowings under this facility bore interest based on a specified margin over
the London Interbank Offered Rate ("LIBOR"). At December 31, 1999, the
weighted-average borrowing rate under this facility was 6.87%. The Company and
Holdings were in
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compliance with all material representations, warranties, and covenants under
this credit facility at December 31, 1999.
In July 1999, the Company entered into a one-year, $350 million master loan and
security agreement with a Wall Street firm. The facility is primarily intended
to finance newly originated commercial and acquisitions of residential mortgage
loans. At March 31, 2000 and December 31, 1999, the Company had outstanding
borrowings of $4.3 million and $119.9 million, respectively, under this
facility, which are reflected as a component of Short-Term Debt. Holdings may
borrow under this facility as a co-borrower. At March 31, 2000 and December 31,
1999, Holdings had outstanding borrowings of $11.6 million and $19.8 million
under this facility, respectively. Borrowings under this facility bear interest
based on a specified margin over LIBOR. At March 31, 2000 and December 31, 1999,
the weighted-average borrowing rate under this facility was 6.61% and 5.72%,
respectively. The Company and Holdings were in compliance with all material
representations, warranties, and covenants under this credit facility at March
31, 2000 and December 31, 1999.
In March 2000, the Company established a $50 million revolving commercial
mortgage loan warehouse facility with Residential Funding Corporation. The
committed facility provides additional financing for RCF's commercial mortgage
loan origination business. At March 31, 2000, the Company had outstanding
borrowings of $8.0 million under this facility, which are reflected as a
component of Short-Term Debt. RCF may borrow under this facility as a
co-borrower. At March 31, 2000, RCF had outstanding borrowings of $2.4 million
under this facility. Borrowings under this facility bear interest based on a
specified margin over LIBOR. At March 31, 2000, the weighted-average borrowing
rate under this facility was 8.01%. The Company and Holdings were in compliance
with all material representations, warranties, and covenants under this credit
facility at March 31, 2000.
NOTE 9. LONG-TERM DEBT
Long-Term Debt in the form of collateralized mortgage bonds is secured by a
pledge of Bond Collateral. As required by the indentures relating to the
Long-Term Debt, the Bond Collateral is held in the custody of trustees. The
trustees collect principal and interest payments on the Bond Collateral and make
corresponding principal and interest payments on the Long-Term Debt. The
obligations under the Long-Term Debt are payable solely from the Bond Collateral
and are otherwise non-recourse to the Company.
Each series of Long-Term Debt consists of various classes of bonds at variable
rates of interest. The maturity of each class is directly affected by the rate
of principal prepayments on the related Bond Collateral. Each series is also
subject to redemption according to the specific terms of the respective
indentures. As a result, the actual maturity of any class of a Long-Term Debt
series is likely to occur earlier than its stated maturity.
The components of the Long-Term Debt at March 31, 2000 and December 31, 1999
along with selected other information are summarized below:
(IN THOUSANDS) MARCH 31, 2000 DECEMBER 31, 1999
-------------- -----------------
Long-Term Debt $ 1,283,026 $ 944,225
Unamortized premium on Long-Term Debt 3,655 3,881
Deferred bond issuance costs (3,925) (2,836)
------------- -------------
Total Long-Term Debt $ 1,282,756 $ 945,270
============= =============
Range of weighted-average coupon rates, by series 6.34% to 6.46% 6.21% to 6.88%
Stated maturities 2017 - 2029 2017 - 2029
Number of series 4 3
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For the three months ended March 31, 2000 and 1999, the average effective
interest cost for Long-Term Debt, as adjusted for the amortization of bond
premium, deferred bond issuance costs, and other related expenses, was 6.32% and
6.03%, respectively. At March 31, 2000 and December 31, 1999, accrued interest
payable on Long-Term Debt was $3.5 million and $3.0 million, respectively, and
is reflected as a component of Accrued Interest Payable on the Consolidated
Balance Sheets.
NOTE 10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values of
the Company's financial instruments at March 31, 2000 and December 31, 1999.
MARCH 31, 2000 DECEMBER 31, 1999
---------------------------- -----------------------------
(IN THOUSANDS) CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
-------------- ---------- --------------- -----------
Assets
Mortgage Loans
Residential: held-for-sale $ 13,040 $ 13,040 $ 415,880 $ 415,880
Residential: held-for-investment, net $1,316,508 $1,301,787 $ 968,709 $ 955,653
Commercial: held-for-sale $ 16,865 $ 16,865 $ 8,437 $ 8,437
Mortgage Securities
Residential: trading $1,004,862 $1,004,862 $ 946,373 $ 946,373
Residential: available-for-sale, net $ 36,994 $ 36,994 $ 28,006 $ 28,006
Interest Rate Agreements $ 1,189 $ 1,189 $ 2,037 $ 2,037
Investment in RWT Holdings, Inc. $ 2,822 $ 3,060 $ 3,391 $ 3,675
Liabilities
Long-Term Debt $1,282,756 $1,265,560 $ 945,270 $ 928,449
The carrying values of all other balance sheet accounts as reflected in the
financial statements approximate fair value because of the short-term nature of
these accounts.
NOTE 11. STOCKHOLDERS' EQUITY
CLASS B 9.74% CUMULATIVE CONVERTIBLE PREFERRED STOCK On August 8, 1996, the
Company issued 1,006,250 shares of Class B Preferred Stock ("Preferred Stock").
Each share of the Preferred Stock is convertible at the option of the holder at
any time into one share of Common Stock. Effective October 1, 1999, the Company
can either redeem or, under certain circumstances, cause a conversion of the
Preferred Stock. The Preferred Stock pays a dividend equal to the greater of (i)
$0.755 per share, per quarter or (ii) an amount equal to the quarterly dividend
declared on the number of shares of the Common Stock into which the Preferred
Stock is convertible. The Preferred Stock ranks senior to the Company's Common
Stock as to the payment of dividends and liquidation rights. In the event of a
liquidation or dissolution of the Company, the liquidation preference entitles
the holders of the Preferred Stock to receive $31.00 per share plus any accrued
dividends before any distribution is made on the Common Stock. As of March 31,
2000 and December 31, 1999, 96,732 shares of the Preferred Stock have been
converted into 96,732 shares of the Company's Common Stock.
In March 1999, the Company's Board of Directors approved the repurchase of up to
150,000 shares of the Company's Preferred Stock. There were no preferred stock
repurchases during the three months ended March 31, 2000 and 1999. At March 31,
2000 and December 31, 1999, there were 142,550 shares available for repurchase.
STOCK OPTION PLAN
The Company has adopted a Stock Option Plan for executive officers, employees,
and non-employee directors (the "Plan"). The Plan authorizes the Board of
Directors (or a committee appointed by the Board of Directors) to
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grant "incentive stock options" as defined under Section 422 of the Code
("ISOs"), options not so qualified ("NQSOs"), deferred stock, restricted stock,
performance shares, stock appreciation rights, limited stock appreciation rights
("Awards"), and dividend equivalent rights ("DERs") to such eligible recipients
other than non-employee directors. Non-employee directors are automatically
provided annual grants of NQSOs with DERs pursuant to a formula under the Plan.
The number of shares of Common Stock available under the Plan for options and
Awards, subject to certain anti-dilution provisions, is 15% of the Company's
total outstanding shares of Common Stock. The total outstanding shares are
determined as the highest number of shares outstanding prior to any stock
repurchases. At March 31, 2000 and December 31, 1999, 413,644 and 283,975 shares
of Common Stock, respectively, were available for grant. Of the shares of Common
Stock available for grant, no more than 500,000 shares of Common Stock shall be
cumulatively available for grant as ISOs. At March 31, 2000 and December 31,
1999, 382,305 and 389,942 ISOs had been granted, respectively. The exercise
price for ISOs granted under the Plan may not be less than the fair market value
of shares of Common Stock at the time the ISO is granted. All stock options
granted under the Plan vest no earlier than ratably over a four-year period from
the date of grant and expire within ten years after the date of grant.
The Company's Plan permits certain stock options granted under the plan to
accrue stock DERs. Stock DERs represent shares of stock which are issuable to
holders of stock options when the holders exercise the underlying stock options.
The number of stock DER shares accrued is based on the level of the Company's
dividends and on the price of the stock on the related dividend payment date.
For the three months ended March 31, 2000, the stock DERs accrued on NQSOs that
had a stock DER feature resulted in charges to operating expenses of $0.1
million. There were no such charges for the three months ended March 31, 1999.
A summary of the status of the Company's Plan as of March 31 and changes during
the periods ending on that date is presented below.
2000 1999
--------------------------- ---------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
(IN THOUSANDS, EXCEPT SHARE DATA) SHARES PRICE SHARES PRICE
---------- ---------- ---------- ----------
Outstanding options at January 1 1,713,836 $ 21.97 1,739,787 $ 23.68
Options granted 11,000 $ 12.55 42,000 $ 14.43
Options exercised (6,035) $ 3.02 (12,361) $ 0.11
Options canceled (144,225) $ 14.04 (141,520) $ 28.96
Stock dividend equivalent rights earned 3,556 -- -- --
---------- ----------
Outstanding options at March 31 1,578,132 $ 22.66 1,627,906 $ 23.16
========== ==========
COMMON STOCK REPURCHASES
Since September 1997, the Company's Board of Directors has approved the
repurchase of 7,455,000 shares of the Company's Common Stock. At March 31, 2000
and December 31, 1999, there were 1,000,000 shares authorized for repurchase.
The repurchased shares have been returned to the Company's authorized but
unissued shares of Common Stock.
NOTE 12. RELATED PARTY TRANSACTIONS
PURCHASES AND SALES OF MORTGAGE LOANS
During December 1999, Holdings purchased $390 million of residential mortgage
loans and subsequently sold a participation agreement on the mortgage loans to
the Company. Pursuant to the terms of the Mortgage Loan Participation Purchase
Agreement, the Company purchased a 99% interest in the mortgage loans, and
assumed all related risks of ownership. Holdings did not recognize any gain or
loss on this transaction. During March 2000, the Company sold the participation
agreement back to Holdings for proceeds of $380.5 million. Holdings
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simultaneously sold $384 million of residential mortgage loans to Sequoia for
proceeds of $384 million. Sequoia pledged these loans as collateral for a new
issue of Long-Term Debt.
During the three months ended March 31, 2000 and 1999, the Company sold $8.4
million and $8.3 million of commercial mortgage loans to RCF, respectively.
Pursuant to the Master Forward Commitment Agreement, the Company sold the
mortgage loans to RCF at the same price for which the Company acquired the
mortgage loans. At March 31, 2000 and December 31, 1999, under the terms of the
Master Forward Commitment Agreement, the Company had committed to sell $16.9
million and $8.4 million of commercial mortgage loans to RCF for settlement
during the first half of 2000, respectively.
During the three months ended March 31, 2000, the Company sold $16.7 million of
residential mortgage loans to Redwood Residential Funding ("RRF"), a subsidiary
of Holdings. Pursuant to the Master Forward Commitment Agreement, the Company
sold the mortgage loans to RRF at the same price for which the Company acquired
the mortgage loans. There were no such sales during the three months ended March
31, 1999. At March 31, 2000 and December 31, 1999, under the terms of the Master
Forward Commitment Agreement, the Company had committed to sell $0.4 million and
$16.7 million of residential mortgage loans to RRF during the first half of
2000, respectively.
OTHER
Under a revolving credit facility arrangement, the Company may loan funds to
Holdings to finance Holdings' operations. These loans are unsecured,
subordinated, and are repaid within six months. Such loans bear interest at a
rate of 3.50% over the LIBOR interest rate. At March 31, 2000 and December 31,
1999, the Company had loaned $1.4 million and $6.5 million to Holdings,
respectively, in accordance with the provisions of this arrangement. During the
three months ended March 31, 2000 and 1999, the Company earned $0.1 million and
$0.2 million, respectively, in interest on loans to Holdings.
The Company shares many of the operating expenses of Holdings, including
personnel and related expenses, subject to full reimbursement by Holdings.
During the years three months ended March 31, 2000 and 1999, $0.1 million and
$0.6 million, respectively, of Holdings' operating expenses were paid by the
Company, and were subject to reimbursement by Holdings.
The Company may provide credit support to Holdings to facilitate Holdings'
financings from third-party lenders and/or hedging arrangements with
counterparties. As part of this arrangement, Holdings is authorized as a
co-borrower under some of the Company's Short-Term Debt agreements subject to
the Company continuing to remain jointly and severally liable for repayment.
Accordingly, Holdings pays the Company credit support fees on borrowings subject
to this arrangement. At March 31, 2000 and December 31, 1999, the Company was
providing credit support on $13.9 million and $22.4 million of Holdings'
Short-Term Debt. During both the three months ended March 31, 2000 and 1999, the
Company recognized approximately $0.1 million in credit support fee income.
Credit support fees are reflected as a component of "Other Income" on the
Consolidated Statements of Operations.
NOTE 13. COMMITMENTS AND CONTINGENCIES
At March 31, 2000, the Company had entered into commitments to purchase $0.1
million of interest rate agreements for settlement in April 2000. At March 31,
2000, the Company had also entered into commitments to sell $16.9 million of
commercial mortgage loans to RCF and $0.4 million of residential mortgage loans
to RRF for settlement during the second quarter of 2000.
At March 31, 2000, the Company is obligated under non-cancelable operating
leases with expiration dates through 2003. The total future minimum lease
payments under these non-cancelable leases is $582,893 and is expected to be
recognized as follows: 2000 - $259,891; 2001 - $171,856; 2002 - $53,546; 2003 -
$43,601.
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RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
March 31, 2000 December 31, 1999
-------------- -----------------
(Unaudited)
ASSETS
Mortgage loans: held-for sale
Commercial $ 17,636 $ 29,605
Residential -- 4,399
-------- --------
17,636 34,004
Cash and cash equivalents 3,624 1,999
Restricted cash 92 50
Accrued interest receivable 155 1,520
Property, equipment and leasehold improvements, net 102 299
Other assets 18 1,081
-------- --------
Total Assets $ 21,627 $ 38,953
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt $ 13,936 $ 22,427
Loans from Redwood Trust, Inc. 1,400 6,500
Payable to Redwood Trust, Inc. 573 472
Accrued interest payable 10 831
Accrued restructuring charges 2,285 4,039
Accrued expenses and other liabilities 572 1,259
-------- --------
Total Liabilities 18,776 35,528
-------- --------
Commitments and contingencies (See Note 10)
STOCKHOLDERS' EQUITY
Series A preferred stock, par value $0.01 per share; 10,000 shares
authorized; 5,940 issued and outstanding
($5,940 aggregate liquidation preference) 29,700 29,700
Common stock, par value $0.01 per share;
10,000 shares authorized; 3,000 issued and outstanding -- --
Additional paid-in capital 300 300
Accumulated deficit (27,149) (26,575)
-------- --------
Total Stockholders' Equity 2,851 3,425
-------- --------
Total Liabilities and Stockholders' Equity $ 21,627 $ 38,953
======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
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RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
(Unaudited)
Three Months Ended March 31,
----------------------------
2000 1999
-------- --------
REVENUES
Interest income
Mortgage loans: held-for-sale
Commercial $ 500 $ 126
Residential 67 53
------- -------
567 179
Mortgage securities: trading -- 207
Cash and cash equivalents 32 108
------- -------
Total interest income 599 494
Interest expense
Short-term debt (300) (107)
Credit support fees (15) (8)
Loans from Redwood Trust, Inc. (89) (159)
------- -------
Total interest expense (404) (274)
Net interest income 195 220
Net unrealized and realized market value gains (losses) 92 478
Other income -- 57
------- -------
Net revenues 287 755
EXPENSES
Compensation and benefits (585) (2,259)
General and administrative (276) (1,005)
------- -------
Total expenses (861) (3,264)
------- -------
NET LOSS $ (574) $(2,509)
======= =======
The accompanying notes are an integral part of these
consolidated financial statements.
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RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
(Unaudited)
Series A
Preferred stock Common stock Additional
------------------- ------------------------ paid-in Accumulated
Shares Amount Shares Amount capital deficit Total
-------- -------- -------- ------------- ------------- -------- --------
Balance, December 31, 1999 5,940 $ 29,700 3,000 $ -- $ 300 $(26,575) $ 3,425
- ---------------------------------- -------- -------- -------- ------------- ------------- -------- --------
Comprehensive income:
Net loss -- -- -- -- -- (574) (574)
Issuance of preferred stock -- -- -- -- -- -- 0
Issuance of common stock -- -- -- -- -- -- 0
- ---------------------------------- -------- -------- -------- ------------- ------------- -------- --------
Balance, March 31, 2000 5,940 $ 29,700 3,000 $ -- $ 300 $(27,149) $ 2,851
================================== ======== ======== ======== ============= ============= ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
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RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Ended March 31,
----------------------------
2000 1999
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (574) $ (2,509)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 8 103
Net unrealized and realized market value (gains) losses (92) (478)
Purchases of mortgage loans: held for sale (406,583) (102,343)
Proceeds from sales of mortgage loans: held for sale 422,869 17,841
Principal payments on mortgage loans: held for sale 179 30
Proceeds from sales of mortgage securities: trading -- 10,502
Principal payments on mortgage securities: trading -- 518
(Increase) decrease in accrued interest receivable 1,365 (115)
(Increase) decrease in other assets 1,058 (1,235)
Increase (decrease) in amounts due to Redwood Trust 101 (303)
Increase (decrease) in accrued interest payable (821) 113
Decrease in accrued restructuring charges (1,754) --
Increase (decrease) in accrued expenses and other liabilities (687) 102
--------- ---------
Net cash provided by (used in) operating activities 15,069 (77,774)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Purchases) sales of property, equipment and leasehold improvements, net 189 (830)
Net increase in restricted cash (42) --
--------- ---------
Net cash provided by (used in) investing activities 147 (830)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of short-term debt (net of repayments) (8,491) 72,313
Loans from Redwood Trust, Inc. (net of repayments) (5,100) 7,200
--------- ---------
Net cash provided by (used in) financing activities (13,591) 79,513
--------- ---------
Net increase in cash and cash equivalents 1,625 909
Cash and cash equivalents at beginning of period 1,999 9,711
--------- ---------
Cash and cash equivalents at end of period $ 3,624 $ 10,620
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest expense $ 2,994 $ 2,518
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
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RWT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
(UNAUDITED)
NOTE 1. THE COMPANY
RWT Holdings, Inc. ("Holdings") was incorporated in Delaware on February 13,
1998 and commenced operations on April 1, 1998. Holdings originates and sells
commercial mortgage loans. Redwood Trust, Inc. ("Redwood Trust") owns all of the
preferred stock and has a non-voting, 99% economic interest in Holdings. The
consolidated financial statements include the three wholly-owned subsidiaries of
Holdings. Redwood Commercial Funding, Inc. ("RCF") originates commercial
mortgage loans for sale to institutional investors. Redwood Residential Funding,
Inc. ("RRF") and Redwood Financial Services, Inc. ("RFS") were start-up ventures
that ceased operations in 1999. Holdings and its subsidiaries currently utilize
both debt and equity to finance acquisitions. References to Holdings in the
following footnotes refer to Holdings and its subsidiaries.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying interim consolidated financial statements are unaudited. In the
opinion of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the quarter ended March 31, 2000 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2000. The
accompanying consolidated financial statements should be read in conjunction
with the consolidated financial statements and related notes included in the
Annual Report on Form 10-K filed by Redwood Trust for the year ended December
31, 1999.
The consolidated financial statements include the accounts of Holdings and its
subsidiaries. All significant intercompany balances and transactions with
Holdings' consolidated subsidiaries have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with Generally Accepted
Accounting Principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reported period. Actual
results could differ from those estimates. The primary estimates inherent in the
accompanying consolidated financial statements are discussed below.
Fair Value. Management estimates the fair value of its financial instruments
using available market information and other appropriate valuation
methodologies. The fair value of a financial instrument, as defined by Statement
of Financial Accounting Standards ("SFAS") No. 107, Disclosures about Fair Value
of Financial Instruments, is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation sale. Management's estimates are inherently subjective in
nature and involve matters of uncertainty and judgement to interpret relevant
market and other data. Accordingly, amounts realized in actual sales may differ
from the fair values presented in Note 6.
MORTGAGE ASSETS
Holdings' mortgage assets consist of mortgage loans and mortgage securities
("Mortgage Assets"). Interest is recognized as revenue when earned according to
the terms of the loans and when, in the opinion of management, it is
collectible.
Mortgage Loans: Held-for-Sale
Mortgage loans are recorded at the lower of cost or market value ("LOCOM"). Cost
generally consists of the loan principal balance net of any unamortized premium
or discount and net loan origination fees. Interest income
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is accrued based on the outstanding principal amount of the mortgage loans and
their contractual terms. Realized and unrealized gains or losses on the loans
are based on the specific identification method and are recognized in "Net
unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
Some of the mortgage loans purchased by Redwood Trust for which securitization
or sale is contemplated are committed for sale by Redwood Trust to Holdings, or
a subsidiary of Holdings, under a Master Forward Commitment Agreement. As the
forward commitment is entered into on the same date that Redwood Trust commits
to purchase the loans, the price which Holdings will pay to purchase the loans
under the forward commitment is the same as the price Redwood Trust paid for the
mortgage loans, as established by the external market.
Mortgage Securities: Trading
Mortgage securities classified as trading are accounted for in accordance with
SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities.
Accordingly, such securities are recorded at their estimated fair market value.
Unrealized and realized gains and losses on these securities are recognized as a
component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations.
LOAN ORIGINATION FEES
Loan fees, discount points, and certain direct origination costs are recorded as
an adjustment to the cost of the loan and are recorded in earnings when the loan
is sold.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of three months or less.
INTEREST RATE AGREEMENTS
During 1999 and the first quarter of 2000, Holdings utilized interest rate
agreements to mitigate the risks that a change in interest rates would result in
a change in the value of the Mortgage Assets. Holdings designated all interest
rate agreements as trading instruments. Accordingly, such instruments were
recorded at their estimated fair market value with unrealized and realized gains
and losses on these instruments recognized as a component of "Net unrealized and
realized market value gains (losses)" on the Consolidated Statements of
Operations. At March 31, 2000, there were no outstanding interest rate
agreements. At December 31, 1999, Holdings had entered into $1 million notional
value of forward contracts for the sale of mortgage loans.
INCOME TAXES
Taxable earnings of Holdings are subject to state and federal income taxes at
the applicable statutory rates. Holdings provides for deferred income taxes if
any, to reflect the estimated future tax effects under the provisions of SFAS
No. 109, Accounting for Income Taxes. Under this pronouncement, deferred income
taxes, if any, reflect the estimated future tax effects of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and such amounts as measured by tax laws and regulations.
COMPREHENSIVE INCOME
SFAS No. 130, Reporting Comprehensive Income, requires Holdings to classify
items of "other comprehensive income" by their nature in a financial statement
and display the accumulated balance of other comprehensive income separately
from retained earnings and additional paid-in capital in the equity section of
the balance sheet. As of March 31, 2000, there was no other comprehensive
income.
RECENT ACCOUNTING PRONOUNCEMENT
During March 2000, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation - an interpretation of APB Opinion No. 25 ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 by expanding upon a number of
issues not specifically addressed in the Opinion such as the definition of an
employee for purposes of applying APB Opinion No. 25 and the accounting for
modifications to a previously fixed stock option award. FIN 44 is effective July
1, 2000. The impact on the Holdings of adopting FIN 44 has not yet been
determined.
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NOTE 3. MORTGAGE ASSETS
At March 31, 2000 and December 31, 1999 Mortgage Assets consisted of the
following:
MORTGAGE LOANS: HELD-FOR-SALE
DECEMBER 31, 1999
MARCH 31, 2000 ------------------------------------------
(IN THOUSANDS) COMMERCIAL RESIDENTIAL COMMERCIAL TOTAL
-------- ----------- ---------- --------
Current Face $ 18,547 $ 4,995 $ 30,324 $ 35,319
Unamortized Premium (Discount) (911) (596) (719) (1,315)
-------- -------- -------- --------
Carrying Value $ 17,636 $ 4,399 $ 29,605 $ 34,004
======== ======== ======== ========
Holdings recognized gains of $0.1 million and losses of $0.1 million during the
quarters ended March 31, 2000 and 1999, respectively, as a result of LOCOM
adjustments on mortgage loans held-for-sale. The LOCOM adjustments are reflected
as a component of "Net unrealized and realized market value gains (losses)" on
the Consolidated Statements of Operations. Additionally, during the three months
ended March 31, 2000, Holdings sold residential mortgage loans to Sequoia
Mortgage Funding Corporation, a subsidiary of Redwood Trust ("Sequoia"), for
proceeds of $384 million. Holdings also sold other residential and commercial
mortgage loans for proceeds of $39 million during the three months ended March
31, 2000. During the three months ended March 31, 1999, Holdings sold mortgage
loans held-for-sale for proceeds of $18 million.
MORTGAGE SECURITIES: TRADING
Holdings did not own any mortgage securities at March 31, 2000 and December 31,
1999. For the three months ended March 31, 1999, Holdings recognized market
value gains of $0.6 million on mortgage securities classified as trading. This
gain is reflected as a component of "Net unrealized and realized market value
gains (losses)" on the Consolidated Statements of Operations. Also during the
three months ended March 31, 1999, Holdings sold mortgage securities classified
as trading for proceeds of $10.5 million.
NOTE 4. SHORT-TERM DEBT
Holdings has entered into reverse repurchase agreements and other forms of
collateralized short-term borrowings (collectively, "Short-Term Debt") to
finance acquisitions of a portion of its Mortgage Assets. This Short-Term Debt
is collateralized by a portion of Holdings' mortgage loans.
At March 31, 2000, and December 31, 1999, Holdings had $13.9 million and $22.4
million of Short-Term Debt outstanding with a weighted-average borrowing rate of
7.70% and 7.02%, respectively. The average balance of Short-Term Debt
outstanding during the quarters ended March 31, 2000 and 1999 was $17 million
and $8 million with a weighted-average interest cost of 7.23% and 5.28%,
respectively. The maximum balance outstanding during the three months ended
March 31, 2000 and 1999 was $22 million and $88 million, respectively.
In July 1999, Redwood Trust entered into a one-year, $350 million master loan
and security agreement with a Wall Street firm. The facility is primarily
intended to finance newly originated commercial and residential mortgage loans.
Holdings may borrow under this facility as a co-borrower. At March 31, 2000 and
December 31, 1999, Holdings had outstanding borrowings of $11.6 million and
$19.8 million, respectively, under this facility. Borrowings under this facility
bear interest based on a specified margin over the London Interbank Offered Rate
("LIBOR"). At March 31, 2000 and December 31, 1999, the weighted-average
borrowing rate under this facility was 7.63% and 7.23%, respectively. Redwood
Trust and Holdings were in compliance with all material representations,
warranties, and covenants under this credit facility at March 31, 2000 and
December 31, 1999.
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In March 2000, Redwood Trust established a $50 million revolving commercial
mortgage loan warehouse facility with Residential Funding Corporation. This
committed facility provides additional financing for RCF's commercial mortgage
loan origination business. RCF may borrow under this facility as a co-borrower.
At March 31, 2000, RCF had outstanding borrowings of $2.4 million under this
facility. Borrowings under this facility bear interest based on a specified
margin over LIBOR. At March 31, 2000, the weighted-average borrowing rate under
this facility was 8.01%. The Company and Holdings were in compliance with all
material representations, warranties, and covenants under this credit facility
at March 31, 2000
Redwood Trust may provide credit support to Holdings to facilitate Holdings'
financings from third-party lenders and/or hedging arrangements with
counterparties. As part of this arrangement, Holdings is authorized as a
co-borrower under some of Redwood Trust's Short-Term Debt agreements subject to
Redwood Trust continuing to remain jointly and severally liable for repayment.
Accordingly, Holdings pays Redwood Trust credit support fees on borrowings
subject to this arrangement. At March 31, 2000 and December 31, 1999, Redwood
Trust was providing credit support on $13.9 million and $22.4 million of
Holdings' Short-Term Debt, respectively. These expenses are reflected as "Credit
support fees" on the Consolidated Statements of Operations (see Note 9).
NOTE 5. RESTRUCTURING CHARGE
During the year ended December 31, 1999, Holdings recognized $8.4 million in
restructuring charges as a result of the closure of two of its subsidiaries, RRF
and RFS. Restructuring charges were determined in accordance with the provisions
of Staff Accounting Bulletin No. 100 "Restructuring and Impairment Charges",
Emerging Issues Task Force No. 94-3 "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity", and other relevant
accounting guidance. The restructuring accrual includes costs associated with
existing contractual and lease arrangements at both subsidiaries which have no
future value. In addition, as a result of the closure of the two subsidiaries,
certain assets utilized in these businesses were determined to have little or no
realizable value, resulting in impairment losses. These assets included software
developed for use at RRF and certain fixed assets at both subsidiaries. The
following table provides a summary of the primary components of the
restructuring liability.
TOTAL REMAINING LIABILITY
------------------------------------
(IN THOUSANDS) MARCH 31, 2000 DECEMBER 31, 1999
-------------- -----------------
Payroll, severance, and termination $1,309 $2,431
benefits
Asset impairments -- --
Lease and other commitments 931 1,068
Other 45 540
------ ------
Total $2,285 $4,039
Holdings expects to pay the majority of the remaining restructuring costs during
the year 2000. The remaining liability for restructuring costs is reflected as
"Accrued restructuring charges" on the Consolidated Balance Sheets.
NOTE 6. INCOME TAXES
The provision for income taxes for both the quarters ended March 31, 2000 and
1999 was $3,200 and represents minimum California franchise taxes. No tax
provision was recorded for the quarters ended March 31, 2000 and 1999, as
Holdings reported a loss for the period. Due to the uncertainty of realization
of net operating losses, no tax benefit has been provided against the loss for
the period. In addition, a valuation allowance has been provided to eliminate
the deferred tax asset related to net operating loss carryforwards at March 31,
2000 and December 31, 1999. At both March 31, 2000 and December 31, 1999, the
valuation allowance was approximately $8.0 million. At December 31, 1999
Holdings had net operating loss carryforwards of approximately $21 million for
federal tax purposes, and $11 million for state tax purposes. The federal loss
carryforwards and a portion of the
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state loss carryforwards expire through 2019, while the largest portion of the
state loss carryforwards expire through 2004.
NOTE 7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values of
Holdings' financial instruments at March 31, 2000 and December 31, 1999.
(IN THOUSANDS) MARCH 31, 2000 DECEMBER 31, 1999
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
-------------- ---------- -------------- ----------
Assets
Mortgage loans:
held-for-sale
Commercial $17,636 $17,876 $29,605 $29,876
Residential -- -- $ 4,399 $ 4,415
The carrying amounts of all other balance sheet accounts as reflected in the
financial statements approximate fair value because of the short-term nature of
these accounts.
NOTE 8. STOCKHOLDERS' EQUITY
The authorized capital stock of Holdings consists of Series A Preferred Stock
("Preferred Stock") and Common Stock. Holdings is authorized to issue 10,000
shares of Common Stock, each having a par value of $0.01, and 10,000 shares of
Preferred Stock, each having a par value of $0.01. All voting power is vested in
the common stock.
Holdings has issued a total of 5,940 shares of Preferred Stock to Redwood Trust.
The Preferred Stock entitles Redwood Trust to receive 99% of the aggregate
amount of any such dividends or distributions made by Holdings. The holders of
the Common Stock are entitled to receive the remaining 1% of the aggregate
amount of such dividends or distributions. The Preferred Stock ranks senior to
the Common Stock as to the payment of dividends and liquidation rights. The
liquidation preference entitles the holders of the Preferred Stock to receive
$1,000 per share liquidation preference before any distribution is made on the
Common Stock. After the liquidation preference, the holders of Preferred Stock
are entitled to 99% of any remaining assets.
NOTE 9. RELATED PARTY TRANSACTIONS
PURCHASES AND SALES OF MORTGAGE LOANS
During December 1999, Holdings purchased $390 million of residential mortgage
loans and subsequently sold a participation agreement on the mortgage loans to
Redwood Trust. Pursuant to the terms of the Mortgage Loan Participation Purchase
Agreement, Redwood Trust purchased a 99% interest in the mortgage loans, and
assumed all related risks of ownership. Holdings did not recognize any gain or
loss on this transaction. During March 2000, Redwood Trust sold the
participation agreement back to Holdings for proceeds of $380.5 million.
Holdings simultaneously sold $384 million of residential mortgage loans to
Sequoia for proceeds of $384 million.
During both the three months ended March 31, 2000 and 1999, RCF purchased $8.4
million of commercial mortgage loans from Redwood Trust. Pursuant to the Master
Forward Commitment Agreement, RCF purchased the mortgage loans from Redwood
Trust at the same price for which Redwood Trust acquired the mortgage loans. At
March 31, 2000 and December 31, 1999, under the terms of the Master Forward
Commitment Agreement, Redwood Trust had committed to sell $16.9 million and $8.4
million of commercial mortgage loans to RCF for settlement during the first half
of 2000, respectively.
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During the three months ended March 31, 2000, RRF purchased $16.7 million of
residential mortgage loans from Redwood Trust. Pursuant to the Master Forward
Commitment Agreement, RRF purchased the mortgage loans from Redwood Trust at the
same price for which Redwood Trust acquired the mortgage loans. There were no
such purchases during the three months ended March 31, 1999. At March 31, 2000
and December 31, 1999, under the terms of the Master Forward Commitment
Agreement, Redwood Trust had committed to sell $0.4 million and $16.7 million of
residential mortgage loans to RRF during the first half of 2000, respectively.
OTHER
Under a revolving credit facility arrangement, Redwood Trust may loan funds to
Holdings to finance Holdings' operations. These loans are unsecured,
subordinated, and are repaid within six months. Such loans bear interest at a
rate of 3.50% over the LIBOR interest rate. At March 31, 2000 and December 31,
1999, Holdings had borrowed $1.4 million and $6.5 million from Redwood Trust,
respectively, in accordance with the provisions of this arrangement. During the
three months ended March 31, 2000 and 1999, Holdings incurred $0.1 million and
$0.2 million, respectively, in interest expense on loans from Redwood Trust.
Redwood Trust shares many of the operating expenses of Holdings, including
personnel and related expenses, subject to full reimbursement by Holdings.
During the years three months ended March 31, 2000 and 1999, $0.1 million and
$0.6 million, respectively, of Holdings' operating expenses were paid by Redwood
Trust, and were subject to reimbursement by Holdings.
Redwood Trust may provide credit support to Holdings to facilitate Holdings'
financings from third-party lenders and/or hedging arrangements with
counterparties. As part of this arrangement, Holdings is authorized as a
co-borrower under some of Redwood Trust's Short-Term Debt agreements subject to
Redwood Trust continuing to remain jointly and severally liable for repayment.
Accordingly, Holdings pays Redwood Trust credit support fees on borrowings
subject to this arrangement. At March 31, 2000 and December 31, 1999, Redwood
Trust was providing credit support on $13.9 million and $22.4 million of
Holdings' Short-Term Debt. During both the three months ended March 31, 2000 and
1999, Holdings recognized approximately $0.1 million in credit support fee
expense.
NOTE 10. COMMITMENTS AND CONTINGENCIES
At March 31, 2000, RCF is obligated under non-cancelable operating leases with
expiration dates through 2006. The total future minimum lease payments under
these non-cancelable leases is $419,821 and is expected to be recognized as
follows: 2000- $56,341; 2001 - $85,240; 2002 - $87,472; 2003 - $89,772; 2004
through 2006 - $83,388.
At March 31, 2000, RCF had entered into commitments to purchase $16.9 million of
commercial mortgage loans from Redwood Trust for settlement during the second
quarter of 2000.
At March 31, 2000, RRF had entered into commitments to purchase $0.4 million of
residential mortgage loans from Redwood Trust for settlement during the second
quarter of 2000.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes.
SAFE HARBOR STATEMENT
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995: Statements in this discussion regarding Redwood Trust, Inc., or "Redwood
Trust", and our business which are not historical facts are "forward-looking
statements" that involve risks and uncertainties. For a discussion of such risks
and uncertainties, which could cause actual results to differ from those
contained in the forward-looking statements, we refer you to "Company Business
and Strategy" beginning on Page 4 and "Risk Factors" commencing on Page 13 of
our 1999 Form 10-K included in our 1999 Annual Report.
OVERVIEW
Redwood Trust is a finance company specializing in the mortgage portfolio
lending business. Our primary activity is the acquisition, financing, and
management of high-quality jumbo residential mortgage loans. We fund our loans
chiefly through the issuance of long-term debt. We also manage a portfolio of
residential mortgage securities and, through our affiliates, originate
commercial mortgage loans for sale to other financial institutions.
Our core business of mortgage finance is conducted through Redwood Trust, Inc.,
which is a qualified real estate investment trust ("REIT"). In general, our REIT
status allows us to avoid corporate income taxes by distributing to our
shareholders an amount equal to at least 95% of taxable income.
We also own a 99% economic interest in a taxable affiliate company, RWT
Holdings, Inc. ("Holdings"). Our investment in Holdings is accounted for under
the equity method. Holdings originates commercial mortgage loans for sale to
institutional investors through its Redwood Commercial Funding, Inc. ("RCF")
subsidiary. RCF typically originates shorter-term floating-rate commercial
mortgage loans to borrowers who require more flexible borrowing arrangements
than are usually offered by life insurance companies or commercial mortgage
conduit lending programs.
For more information, please visit our Web site at: www.redwoodtrust.com.
SIGNIFICANT ACTIVITY DURING THE QUARTER
During March 2000, we issued $377 million of long-term debt through our
special-purpose finance subsidiary, Sequoia Mortgage Funding Corporation
("Sequoia"). This issuance is the fourth series in our on-going program of
issuing AAA-rated, non-recourse, callable, long-term debt to finance our
high-quality residential mortgage loan portfolio. The debt certificates are
supported by a $381 million pool of high-quality adjustable-rate residential
mortgage loans. The proceeds from this debt issuance were used to reduce
short-term debt.
FINANCIAL CONDITION
Our balance sheet presents our mortgage finance assets and liabilities. It also
includes, as one line item, our net investment in Holdings. Holdings' balance
sheet and financial condition are presented separately with discussion and
analysis beginning on Page 44.
At March 31, 2000, we owned $1.4 billion mortgage loans and $1.0 billion
mortgage securities. We owned similar amounts at December 31, 1999. Our mix of
debt changed over this period, as we financed these mortgage assets with $0.9
billion of short-term debt, $1.3 billion of long-term debt, and $210 million of
equity at March
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31, 2000, as compared to $1.3 billion of short-term debt, $0.9 billion of
long-term debt, and $210 million of equity at December 31, 1999. This increase
in long-term debt and reduction in short-term debt was the result of our
issuance of long-term debt in the first quarter of 2000.
Our exposure to credit loss from our mortgage loans is limited, to some degree,
by the methods we use to finance these loans. The long-term debt we issue is
non-recourse to us; as a result, our credit exposure to our long-term debt
financed loans is limited to our net investment remaining after the issuance of
such debt. A total of $1.3 billion of non-recourse assets and liabilities are
owned by trusts created by Sequoia. The trusts are "bankruptcy-remote" with
respect to Redwood Trust. Although the net earnings of the trusts accrue to
Redwood Trust, Redwood Trust is not responsible for the repayment of Sequoia
debt and Sequoia has no call on the liquidity of Redwood Trust. Likewise, the
assets of these trusts are pledged to secure the related debt of each trust and
accordingly, are not available for general creditors of Redwood Trust. Our
recourse exposure to Sequoia's mortgage assets is limited to our equity
investments in these trusts. At March 31, 2000, these equity investments had a
reported net value of $41 million.
At March 31, 2000, the portion of our balance sheet that was subject to recourse
was $1.1 billion of assets, $0.9 billion of borrowings, and $0.2 billion of
equity. The ratio of equity-to-recourse-assets was 18.4%. The ratio of
recourse-debt-to-equity was 4.4 to 1.0.
At December 31, 1999, we reported $2.4 billion in assets, of which $1.5 billion
were recourse, and $2.6 billion of liabilities, of which $1.3 billion were
recourse. Equity capital was $0.2 billion. The ratio of
equity-to-recourse-assets was 14.8% and the ratio of recourse-debt-to-equity was
6.0 to 1.0. The improvement in our debt-based ratios during the first quarter of
2000 was due to our issuance of long-term debt.
EARNING ASSETS
At March 31, 2000 and December 31, 1999, we owned $2.4 billion of earning
assets. During the first quarter of 2000, we acquired $204 million in assets and
sold $75 million in assets. We received $106 million in mortgage principal
paydowns during the quarter.
MORTGAGE LOANS
At March 31, 2000, $953 million carrying value, or 40% of our total mortgage
asset portfolio, were high-quality residential mortgage loans with
adjustable-rate coupons with a principal value of $942 million. Our carrying
value of these loans, after $2.9 million of credit reserves, was 101.18% of the
face or principal value of the loans. At December 31, 1999, we owned $993
million carrying value of these loans, or 42% of our portfolio, at a carrying
value of 101.21% of the $981 million principal value (net of a $2.8 million
credit reserve). Seriously delinquent loans (over 90 days delinquent, in
foreclosure, or REO) in this portion of our portfolio were $4.6 million at March
31, 2000 and $3.4 million at December 31, 1999.
At March 31, 2000, $377 million carrying value and principal value, or 16% of
our total mortgage asset portfolio, were high-quality residential mortgage loans
with hybrid coupons. Our hybrid mortgage loans have an initial fixed coupon rate
for three to ten years followed by annual coupon adjustments. On average, these
loans become floating-rate in December 2002. Our carrying value of these loans,
after $2.2 million of credit reserves, was 99.81% of face value. At December 31,
1999 we owned $391 million carrying value of these loans, or 17% of our
portfolio, at a carrying value of 99.84% of the $392 million principal value
(net of a $2.3 million credit reserve). Seriously delinquent loans in this
portion of our portfolio were $0.7 million at March 31, 2000 and $1.3 million at
December 31, 1999. This portion of our portfolio is matched to the $368 million
of long-term debt we have issued that is fixed-rate debt until December 2002.
At March 31, 2000, $16.9 million carrying value, or 0.7% of our total mortgage
asset portfolio, were commercial mortgage loans originated by our affiliate,
RCF. Our carrying value of these loans was 99.80% of principal value. At
December 31, 1999, we owned $8.4 million carrying value of these loans, or 0.4%
of our portfolio, at a carrying value of 99.85% of principal value. All of these
loans were current at March 31, 2000 and December 31, 1999. The amount of
commercial loans on our balance sheet will vary over time as RCF originates and
sells
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commercial mortgage loans, and will depend on the amount of RCF's warehouse that
we finance at Redwood as opposed to at Holdings.
We own residential mortgage loans on real estate properties located throughout
the United States. At March 31, 2000 and December 31, 1999, the geographic
distribution of our mortgage loan portfolio was as follows: California 26%;
Florida 9%; New York 8%; New Jersey 5%; Texas 5%; Georgia 5%. The remaining 42%
of our investments were in states located throughout the country, with no one
state greater than 5%. At March 31, 2000, our loan portfolio consisted of 4,207
loans, with an average loan size of $313,600. At December 31, 1999, we owned
4,366 loans with an average loan size of $315,700.
At March 31, 2000, the geographic distribution of our commercial mortgage loan
portfolio was as follows: California 82%; New York 8%. At December 31, 1999,
100% of our commercial loans were secured by properties located in California.
At March 31, 2000, our commercial loan portfolio consisted of 6 loans, with an
average loan size of $2.8 million. At December 31, 1999, we owned 3 loans with
an average loan size of $2.8 million.
For presentation purposes, the $1.3 billion at March 31, 2000 and the $1.0
billion at December 31, 1999 of residential mortgage loans that are financed
with long-term debt in Sequoia trusts are classified as "Mortgage Loans:
held-for investment" on our balance sheets and are carried at amortized cost.
The remaining residential and commercial mortgage loans that are funded with
short-term debt and equity ($30 million at March 31, 2000 and $424 million at
December 31, 1999) are classified as "Mortgage Loans: held-for-sale" on our
balance sheets and are carried at the lower-of-cost-or-market, with any related
market value adjustments recorded through the income statement.
MORTGAGE SECURITIES
At March 31, 2000, 28% of our total mortgage asset portfolio, or $671 million
carrying value with a principal value of $660 million, consisted of residential
mortgage securities issued and credit-enhanced by Fannie Mae or Freddie Mac and
effectively rated "AAA". The majority of these securities, $654 million or 99%,
were adjustable-rate securities with the remaining 1% fixed-rate securities. The
carrying value of these securities was 101.72% of principal value. At December
31, 1999, we owned $575 million carrying value of these securities, or 24% of
our portfolio, at a carrying value of 101.73% of the $565 million principal
value.
At March 31, 2000, 12% of our total mortgage asset portfolio, or $284 million
carrying and principal value, consisted of adjustable-rate residential mortgage
securities issued by private-label security issuers. These securities were
credit-enhanced through subordination or other means and were rated "AAA" or
"AA". The carrying value of these securities was 100.03% of face value. At
December 31, 1999, we owned $291 million carrying value and principal value of
these securities, or 12% of our portfolio, at a carrying value of 99.86%.
At March 31, 2000, 2% of our mortgage asset portfolio, or $37 million carrying
value with a principal value of $61 million, consisted of lower-rated,
residential mortgage securities issued by private-label security issuers. Due to
their subordinated status, these securities bore some degree of credit risk and
were rated "A" or below. The loans underlying these securities were, with minor
exceptions, high-quality loans. The carrying value of these securities, after
$0.8 million of credit reserves, was 60.77% of face value. At December 31, 1999,
we owned $28 million carrying value of these securities, or 1% of our portfolio,
at a carrying value, after credit reserves, of 57.85% of the $49 million face
value. We intend to continue to increase our investment in lower-rated,
subordinated residential mortgage securities backed by high-quality loans in the
future.
At March 31, 2000, 1% of our total mortgage asset portfolio, or $23 million
carrying value and principal value, consisted of residential floating-rate
mortgage securities rated "AAA" or "AA" which were backed by home equity loans,
or "HEL". The carrying value of these securities was 99.50% of face value. At
December 31, 1999, we owned $47 million carrying value of these securities, or
2% of our portfolio, at a carrying value of 98.79% of the $48 million principal
value.
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At March 31, 2000, 1% of our mortgage asset portfolio, or $15 million carrying
and principal value, consisted of fixed-rate, private-label mortgage securities.
These are commonly called "CMOs". They were rated "AAA" or "AA" and had average
lives of 1 to 2 years. The carrying value of these securities was 95.91% of
principal value. At December 31, 1999, we owned $16 million carrying value and
principal value of these securities, or 1% of our portfolio, at a carrying value
of 97.28% of principal value.
At March 31, 2000, 0.5% of our mortgage asset portfolio, or $12 million carrying
value with a principal value of $13 million, consisted of fixed-rate,
credit-enhanced private-label mortgage securities rated "AA" and backed by
residential mortgage loans with loan-to-value ratios in excess of 100%. The
carrying value of these securities was 89.88% of face value. At December 31,
1999, we owned $12 million carrying value of these securities, or 0.5% of our
portfolio, at a carrying value of 91.00% of the $13 million principal value. The
average life of these assets was 7.9 years at March 31, 2000 and 8.2 years at
December 31, 1999
At March 31, 2000, 0.3% of our total mortgage asset portfolio, or $6 million
carrying and face value, consisted of floating-rate CMO mortgage securities
issued by Fannie Mae or Freddie Mac and effectively rated "AAA". The carrying
value of these securities was 99.03% of principal value. At December 31, 1998,
we owned $6 million carrying value and principal value of these securities, or
0.3% of our portfolio, at a carrying value of 99.88% of the principal value.
At March 31, 2000, 0.003% of our mortgage asset portfolio, or $0.1 million
carrying value with no principal value, consisted of interest-only mortgage
securities rated "AAA" or "AA". At December 31, 1998, we owned $0.1 million
carrying value of these securities, or 0.005% of our portfolio.
For presentation purposes, all of the mortgage securities except for the
lower-rated securities are classified as "Mortgage Securities - trading" on our
balance sheets and are carried at their estimated fair market value, with any
related market value adjustments recorded through the income statement. The $37
million at March 31, 2000 and $28 million at December 31, 1999, of lower-rated
mortgage securities are classified as "Mortgage Securities - available-for-sale"
on our balance sheets and are also carried at their estimated fair market value.
Market value adjustments on these securities, however, are not recorded through
the income statement but are included in "accumulated other comprehensive
income" in the equity portion of the balance sheet.
CASH
We had $13 million of unrestricted cash at March 31, 2000 and $20 million at
year-end 1998.
Sequoia held cash totaling $2 million at December 31, 1999 and $5 million at
year-end 1999. In consolidating Sequoia assets on our balance sheet, we reflect
this cash as "Restricted Cash" since it will be used for the specific purpose of
making payments to Sequoia bondholders and is not available for general
corporate purposes.
The amount of liquidity we maintain is only measured in part by the amount of
cash we show on our balance sheet at the end of each reporting period. Please
refer to the discussion regarding our liquidity beginning on page 41.
INTEREST RATE AGREEMENTS
Our interest rate agreements are carried on our balance sheet at estimated
market value, which was $1.2 million at March 31, 2000 and $2.5 million at
December 31, 1999. Please see "Note 2. Summary of Significant Accounting
Policies", "Note 7. Interest Rate Agreements" and "Note 10. Fair Value of
Financial Instruments" in the Notes to Consolidated Financial Statements for
more information.
INVESTMENT IN RWT HOLDINGS, INC.
We do not consolidate the assets and liabilities of Holdings on our balance
sheet. We reflect the net book value of our investment in one line item on our
balance sheet labeled "Investment in RWT Holdings, Inc." We refer you to
Holdings' "Consolidated Financial Statements and Notes" and Holdings'
"Management's Discussion and Analysis" below for more information on Holdings.
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The carrying value of our equity investment in Holdings was $2.8 million at
March 31, 2000 and $3.4 million at December 31, 1999.
At March 31, 2000, our assets also included loans to Holdings of $1.4 million
and a receivable from Holdings of $0.6 million. We expect that we will continue
to provide liquidity to Holdings. At December 31, 1999, loans to Holdings
totaled $6.5 million and receivables from Holdings were $0.5 million.
OTHER ASSETS
Our other assets include accrued interest receivables, other receivables, fixed
assets, leasehold improvements and prepaid expenses. These totaled $18.2 million
at March 31, 2000 and $14.9 million at December 31, 1999.
SHORT-TERM DEBT
Short-term borrowings totaled $0.9 billion at March 31, 2000, or 42% of our
total debt. At December 31, 1999, short-term borrowings were $1.3 billion, or
57% of our total debt. The level of short-term borrowings was reduced in the
first quarter of 2000 as we issued long-term debt and used the proceeds to
reduce short-term debt. We pledge a portion of our mortgage securities
portfolio, mortgage loan portfolio, and other assets to secure our short-term
debt. Maturities on this debt typically range from one month to one year. The
interest rate on most of this debt adjusts monthly to a spread over or under the
one-month LIBOR interest rate, with some of it adjusting daily based on the Fed
Funds interest rate.
LONG-TERM DEBT
At March 31, 2000, we owned $1.3 billion of residential mortgage loans that were
financed with long-term debt through trusts owned by our financing subsidiary,
Sequoia. The amount of outstanding Sequoia long-term debt amortizes as the
underlying mortgages pay down. As the equity owner of these trusts, we are
entitled to distributions of the net earnings of the trusts, which principally
consist of the interest income earned from mortgages in each trust less the
interest expense of the debt of each trust. Sequoia debt is non-recourse to
Redwood Trust. The debt is consolidated on our balance sheet and is reflected as
long-term debt, which is carried at historical amortized cost. The original
scheduled maturity of this debt was approximately thirty years. Since these debt
balances are retired over time as principal payments are received on the
underlying mortgages, the expected average life of this debt is two to six
years.
At March 31, 2000, 58% of our total debt, or $1.3 billion, was long-term
mortgage-backed debt. Of this long-term debt, $577 million had a floating-rate
based on one-month LIBOR and $338 million had a floating-rate based on the
twelve-month average of the one-year Treasury rate. An additional $368 million
was fixed-rate until December 2002 with a floating-rate coupon thereafter; this
debt is matched to our portfolio of hybrid fixed/floating residential mortgage
loans.
At December 31, 1999, 43% of our total debt, or $945 million, was long-term
mortgage-backed debt. Of this long-term debt, $212 million had a floating-rate
based on one-month LIBOR, $351 had a floating-rate based on the twelve-month
average of the one-year Treasury rate, and $382 million had a fixed-rate until
December 2002 with a floating-rate coupon thereafter.
OTHER LIABILITIES
Our other liabilities include accrued interest payable, accrued expenses, and
dividends payable. The net balance of these accounts totaled $12.7 million at
December 31, 1999 and $11.2 million at December 31, 1999.
STOCKHOLDERS' EQUITY
At March 31, 2000, total equity capital was $210 million, preferred stock equity
was $27 million, and reported common equity totaled $183 million, or $20.84 per
common share outstanding.
In reporting equity, we mark-to-market all earning assets and interest rate
agreements except mortgage loans that were financed to maturity (Sequoia). In
accordance with Generally Accepted Accounting Principles ("GAAP"), no
liabilities were marked-to-market.
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If we had marked-to-market all of our assets and liabilities, total equity
capital would have been reported as $212 million at March 31, 2000. After
subtracting out the preference value of the preferred stock, common equity on a
full mark-to-market basis was $184 million and the net mark-to-market value, or
"intrinsic" value, per common share was $20.89.
At December 31, 1999, reported equity capital was $210 million, preferred stock
equity was $27 million, and reported common equity was $183 million, or $20.88
per common share outstanding. Mark-to-market common equity was $185 million, or
$21.07 intrinsic value per common share.
During the first quarter of 2000, our equity, book value per share, and
intrinsic value per share declined slightly after accruing for our $0.35 common
dividend. Despite a rising interest rate environment, we had a relatively small
net market valuation adjustment on all our assets and liabilities, with the
average net decline in our assets being 0.12% of principal value.
RESULTS OF OPERATIONS
Our operating results include all of the reported income of our mortgage finance
operations plus, as one line item on our income statement, our share of the
after-tax results of operations at Holdings. Detailed results at Holdings are
discussed separately below. Please see "RWT Holdings, Inc. - Management
Discussion and Analysis of Financial Condition and Results of Operations"
commencing on page 44 of this Form 10-Q for further discussion of Holdings'
financial position and performance.
INTEREST INCOME
For the quarter ended March 31, 2000, interest income generated by our mortgage
finance operations was $43 million. Our portfolio had average earning assets of
$2.4 billion and earned an average yield of 7.24%. During this quarter, the
average coupon rate, or the cash-earning rate on mortgage principal, was 7.35%.
The average value of assets included a net unamortized premium of 0.25% of
mortgage principal totaling $6 million. We write off this net premium balance as
an expense over the life of our assets. Net premium amortization expense for the
quarter was $0.5 million, which reduced our earning asset yield by 0.08%. The
annualized prepayment rate on our mortgage assets, which drives the rate at
which we write off net premium balances, was 17% Conditional Prepayment Rate
("CPR") during the quarter. Other factors reduced the earning asset yield by
0.03%.
For the preceding quarter (ended December 31, 1999), interest income was $35
million. Our portfolio had average earning assets of $2.0 billion and earned an
average yield of 6.88%. The average coupon rate was 7.01%. The average reported
value of assets included a 0.33% net premium, or $7 million. Net premium
amortization expense was $0.5 million, which reduced earning asset yield by
0.10%. Prepayments during the quarter averaged 19% CPR. Other factors reduced
the earning asset yield by 0.03%.
From the fourth quarter of 1999 to the first quarter of 2000, our yield on
assets rose by 0.36%, from 6.88% to 7.24%, due to rising short-term interest
rates. Most of our mortgage assets are adjustable rate mortgages and the coupons
rise as the underlying indices rise. Short-term interest rates have risen by
1.00% to 1.50% since the beginning of 1999, and as our loans reset, our coupon
rates are increasing. In addition, prepayment speeds slowed from quarter to
quarter, further benefiting our yield. Total interest income increased on a
successive quarter basis due to higher yields and a larger average portfolio
size in the first quarter of 2000.
For the quarter ended March 31, 1999, interest income was $42 million. Our
portfolio had average earning assets of $2.5 billion and earned an average yield
of 6.55%. The average coupon rate was 6.99%. The reported value of assets
included a 0.71% net premium, or $18 million. Net premium amortization expense
was $2.2 million, which reduced earning asset yield by 0.37%. Prepayments during
the quarter were 33% CPR. Other factors reduced the earning asset yield by
0.07%.
Total interest income increased from the first quarter of 1999 to the first
quarter of 2000, despite a decrease in average portfolio size, as our yields
increased. Year-over-year yields increased by 0.69%, from 6.55% in the
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first quarter of 1999 to 7.24% in the first quarter of 2000. This increase was a
result of higher coupon rates on our loans (due to rising short-term interest
rates) and slower prepayment speeds.
INTEREST EXPENSE
Interest expense for the quarter ended March 31, 2000 was $35 million. We funded
our mortgage portfolio and other assets with an average of $210 million of
equity and $2.2 billion of borrowings. We paid an average cost of funds of 6.29%
for these borrowings. Short-term debt averaged 56% of total debt and cost us
6.25%. Long-term debt averaged 44% of total debt and cost us 6.32%.
In the previous quarter (the fourth quarter of 1999), interest expense was $28
million. We funded our mortgage portfolio with an average of $219 million of
equity and $1.8 billion of borrowings. We paid an average cost of funds of 5.89%
for these borrowings. Short-term debt averaged 47% of total debt and cost us
5.68%. Long-term debt averaged 53% of total debt and cost us 6.13%.
Total interest expense was higher in the first quarter of 2000 than in the
previous quarter due to an increase in borrowings needed to fund our larger
portfolio of assets and due to a higher cost of funds. Our cost of funds rose
from quarter to quarter by 0.40%, from 5.89% to 6.29%. This was primarily a
result of increases in one-month LIBOR, our main borrowing rate.
For the quarter ended March 31, 1999, interest expense was $33 million. We
funded our mortgage portfolio with an average of $250 million of equity and $2.4
billion of borrowings. We paid an average cost of funds of 5.59% for these
borrowings. Short-term debt averaged 48% of total debt and cost us 5.12%.
Long-term debt averaged 52% of total debt and cost us 6.03%.
The increase in interest expense from year to year is the result of increases in
one-month LIBOR and other short-term interest rates during this time. Interest
expense increased even though average borrowings declined.
INTEREST RATE AGREEMENTS EXPENSE
We use interest rate agreements in order to strengthen our balance sheet,
increase liquidity, and dampen potential earnings volatility. In the third
quarter of 1998, as a result of early adopting SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, we elected to classify all of our
interest rate agreements as trading instruments. Total interest rate agreement
expense (hedging expense) may change over time as the mix of our assets and
liabilities changes. We refer you to "Note 7. Interest Rate Agreements" in the
Notes to Consolidated Financial Statements for additional details.
Net interest rate agreements expense, before any market value adjustments which
are reflected in the Statement of Operations line item "Realized and Unrealized
Market Value Gains (Losses)", was $0.4 million for the quarter ended March 31,
2000, $0.5 million for the quarter ended December 31, 1999, and $0.3 million for
the quarter ended March 31, 1999. As a percent of average borrowings, net
interest rate agreements expense was 0.07% during the first quarter of 2000,
0.11% during the fourth quarter of 1999, and 0.06% during the first quarter of
1999. Net hedging expenses vary as a result of various asset/liability
strategies we employ.
NET INTEREST INCOME
Net interest income, which equals interest income less interest expense less
interest rate agreements expense, was $8.0 million for the quarter ended March
31, 2000. Our interest rate spread, which equals the yield on earning assets
less the cost of funds and hedging, was 0.88%. Our net interest margin, which
equals net interest income divided by average assets, was 1.32%. Our net
interest income as a percent of average equity was 15.2% during this quarter.
For the fourth quarter of 1999, net interest income was $6.7 million, our
interest rate spread was 0.88%, and our net interest margin was 1.28%. Net
interest income as a percent of average equity was 12.1%.
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Net interest income increased from the fourth quarter of 1999 to the first
quarter of 2000 primarily due to an increase in assets as we more fully utilized
our capital during the later period. In addition, with higher asset yields, we
earned a greater return on that portion of our balance sheet that is funded with
equity rather than debt.
For the quarter ended March 31, 1999, net interest income was $7.9 million, our
interest rate spread was 0.90%, and our net interest margin was 1.19%. Net
interest income as a percent of average equity was 12.7%.
We earned more net interest income in the first quarter of 2000 ($8.0 million)
than we did in the first quarter of 1999 ($7.9 million). This is despite the
fact that in the earlier period we had more equity ($250 million in 1999 versus
$210 million in 2000), more assets ($2.5 billion versus $2.4 billion), and a
wider spread (0.90% versus 0.88%). The key factor is asset yield, which was
7.24% in the first quarter of 2000 and 6.55% in the first quarter of 1999. With
a higher asset yield, we earn a greater amount on that portion of our balance
sheet that is funded with equity rather than debt. As a result of this factor,
and better utilization of our equity base, our net interest margin increased
from 1.19% in the first quarter of 1999 to 1.32% in the first quarter of 2000
and our net interest income increased despite a smaller balance sheet.
NET UNREALIZED AND REALIZED MARKET VALUE GAINS AND LOSSES
We report many of our mortgage assets and all of our interest rate agreements at
market value, with any market valuation adjustments being recognized as a gain
or loss in our income statements. Please see "Note 2. Summary of Significant
Accounting Policies", "Note 3. Mortgage Assets", and "Note 7. Interest Rate
Agreements" in the Notes to Consolidated Financial Statements for more
information.
During the first quarter of 2000, our portfolio of assets that were
marked-to-market for income statement purposes decreased in estimated market
value by $1.2 million. This net loss consisted of $1.1 million market value loss
on mortgage assets and $0.1 million market value loss on interest rate
agreements. Market values for our mortgage assets fell as interest rates rose.
Since most of these assets are adjustable rate, the coupon rates will reset to
higher levels. The market values may, in the future, adjust accordingly. Losses
in our interest rate agreements portfolio were due to falling volatility and
other factors. The net combined market valuation adjustment loss of $1.1 million
represents 0.12% of our portfolio of assets that is marked to market.
Total net realized losses on assets during the quarter ended December 31, 1999
were $1.2 million. This net loss consisted of $1.1 million realized losses on
mortgage assets and $0.1 million realized losses on interest rate agreements.
The net gain on our portfolio of assets that were marked-to-market in the first
quarter of 1999 was $2.2 million. This net gain consisted of $3.0 million market
value gain on mortgage assets and other securities and $0.8 million market value
loss on interest rate agreements.
As a result of changes in accounting methodologies instituted in 1998, we record
both realized and unrealized market value gains and losses on many of our
mortgage securities, short-term funded mortgage loans, and interest rate
agreements as an item in our income statement. We believe it is beneficial to
show shareholders the changes in the market values of our liquid portfolio
assets. In addition, our freedom to manage and hedge our portfolio is enhanced
by the use of these accounting techniques.
However, very few other financial institutions use these accounting methods; as
a result, direct comparisons of our reported earnings with those of other
companies on an apples-to-apples basis may be more difficult.
Relatively small changes in portfolio market values can have a significant
impact on our reported earnings per share. In our opinion, quarter-to-quarter
fluctuations in mark-to-market earnings adjustments are probably of less import
than would be a cumulative positive or negative adjustment established over a
longer period of time that was large relative to our asset base. For example,
our cumulative mark-to-market earnings adjustment since the beginning of 1999 is
negative $0.9 million ($0.11 per share). This is a minor amount compared to the
size of our portfolio.
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Excluding these mark-to-market adjustments, our total earnings were $4.5 million
($0.51 per share) in the first quarter of 2000, negative $4.4 million (negative
$0.50 per share) in the fourth quarter of 1999, and $3.7 million ($0.34 per
share) in the first quarter of 1999.
PROVISION FOR CREDIT LOSSES
We take credit provision expenses on our mortgage loans held for investment,
which are those loans financed with long-term debt and accounted for on an
amortized cost basis. During the quarter ended March 31, 2000, credit provisions
were $0.1 million. In the quarter ended December 31, 1999, credit provisions
were $0.2 million. In the first quarter of 1999, credit provisions were $0.3
million. Credit provisions have decreased over time as the credit performance
outlook of our loans continues to improve. We have reduced our provision rates
on older loans. We have not incurred any credit losses on our mortgage loans
over the last two quarters. However, credit provision expense will increase in
the future as we acquire additional mortgage loans that are held for investment
and may increase if credit conditions deteriorate. In addition, in the second
quarter of 2000 we will begin taking credit provisions for the $384 million of
loans underlying our most recent Sequoia long-term debt issuance.
Prior to 1998, we also expensed credit provisions on a portfolio of subordinated
mortgage securities. We stopped taking credit provisions on this pool of
securities in December 1997 when we restructured and reduced our credit risk on
these securities through a resecuritization transaction ("SMFC re-REMIC
securities"). The existing reserve for the SMFC re-REMIC securities is $0.7
million at March 31, 2000. Actual realized taxable credit losses against these
securities were $0.1 million in the first quarter of 2000, $0.1 million in the
fourth quarter of 1999, and $0.1 million in the first quarter of 1999. We
continually monitor the credit performance of these assets and will make
appropriate changes to our credit provision policy should the need arise.
We have purchased, and intend to continue to purchase, mortgage-backed
securities that have risk of credit loss. In acquiring such assets, we project
cash flows and resulting yields under a variety of potential loss scenarios as
well as other factors (e.g., interest rates, prepayment speeds.) These
securities are purchased at a discount, in part because of the credit risk
inherent in these assets. We anticipate a yield on such assets after factoring
in anticipated losses. Thus, we do not plan to build a credit reserve for such
assets, as such losses are already imbedded in the price paid and resulting
yields on such assets. The amount of discount amortized into income is based on
the projected future cash flows, after credit losses, on such asset. Once
acquired, we continue to review the projected losses on each asset. Should
projected credit losses change (which can occur for a variety of reasons), the
effective yield earned over the remaining life of the asset will change
accordingly.
OPERATING EXPENSES
Total operating expenses recognized at Redwood were $2.1 million in the first
quarter of 2000, $1.2 million in the fourth quarter of 1999, and $0.7 million in
the first quarter of 1999. Due to changes in amounts of expense allocated and
recognized between Redwood and Holdings, a more useful number for understanding
trends in operating expenses is the total operating expenses of Redwood and
Holdings combined. Combined operating expenses were $3.0 million in the first
quarter of 2000, $3.6 million in the fourth quarter of 1999, and $4.0 million in
the first quarter of 1999.
Some of these expenses were associated with business units that have been
closed. Combined operating expenses for on-going operations -- Redwood portfolio
lending and RCF -- were $2.8 million in the first quarter of 2000, $1.9 million
in the fourth quarter of 1999, and $1.6 million in the first quarter of 1999. We
have expanded our residential whole loan operations, increased dividend
equivalent rights payments to employees as a result of our increasing dividend,
and built origination and sales staff at RCF.
NET EARNINGS FROM MORTGAGE FINANCE OPERATIONS
Net earnings from mortgage finance operations include all revenue and expense
items except for the losses from Holdings and preferred dividends. For the
quarter ended March 31, 2000, net earnings from mortgage finance operations were
$4.5 million, or $0.51 per share. Net earnings from mortgage finance operations
were $4.1 million for the quarter ended December 31, 1999, or $0.46 per share.
For the quarter ended March 31, 1999, net earnings were $9.0 million, or $0.83
per share.
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Net earnings per share increased in the first quarter of 2000 over the fourth
quarter of 1999 due to larger portfolio size and higher yields. These gains were
partially offset by higher operating expenses. From the first quarter of 1999 to
the first quarter of 2000, net earnings per share from mortgage finance
operations decreased primarily due to the differences in market valuation
adjustments. In the first quarter of 1999, the market value adjustment was
positive $2.2 million as compared to a negative $1.2 million market valuation
adjustment for the same period in 2000.
EQUITY IN EARNINGS (LOSSES) OF RWT HOLDINGS, INC.
In the first quarter of 2000, our share of the losses generated by Holdings was
$0.6 million. This included $0.1 million of net expense for the shut down of
Redwood Residential Funding, Inc. We shut down this operation in December 1999
and accounted for many of the costs as a restructuring charge in 1999. However,
under GAAP, some operating expenses could not be included in the restructuring
charge accrual and are being expensed as incurred in 2000. The remaining loss at
Holdings represents losses reported at RCF. The accounting loss at Holdings'
subsidiary RCF is not representative of the profitability of our overall
commercial operations because it does not include related income recorded at
Redwood Trust.
In the fourth quarter of 1999, we recognized losses from Holdings of $9.0
million, which included $6.2 million of restructuring charges at RRF. In the
first quarter of 1999, we recognized losses from Holdings of $2.5 million
representing start-up expenses from the three business units operating at
Holdings at that time.
We refer you to Holdings' "Consolidated Financial Statements and Notes" and
Holdings' "Management's Discussion and Analysis" below for more information on
Holdings.
NET INCOME
For the quarter ended March 31, 2000, net income for all of our operations was
$4.0 million. After preferred dividends of $0.7 million, net income available to
common stockholders was $3.3 million. For the quarter ended December 31, 1999,
net losses for all of our operations were $4.9 million. After preferred
dividends of $0.7 million, net income available to common stockholders was
negative $5.6 million. For the quarter ended March 31, 1999, net income for all
of our operations was $6.6 million. After preferred dividends of $0.7 million,
net income available to common stockholders was $5.9 million.
EARNINGS PER SHARE
Average diluted common shares outstanding were 8.8 million for the quarter ended
March 31, 2000, 9.0 million for the fourth quarter of 1999, and 10.9 million for
the first quarter of 1999. Earnings per share were positive $0.37 for first
quarter of 2000, negative $0.64 for fourth quarter of 1999, and positive $0.54
for the first quarter of 1999.
Shares outstanding declined over the past year as a result of our common stock
repurchase program. We repurchased 2.5 million shares during 1999. We did not
acquire any of our own shares in the first quarter of 2000.
DIVIDENDS
We declared common stock dividends of $0.35 per share for the quarter ended
March 31, 2000 and $0.25 per share for the quarter ended December 31, 1999. No
common stock dividend was declared for the quarter ended March 31, 1999.
We continue to pay $0.755 per share in quarterly preferred stock dividends.
RISK MANAGEMENT
We seek to manage the interest rate, market value, liquidity, prepayment, and
credit risks inherent in all financial institutions in a prudent manner designed
to insure our longevity. At the same time, we endeavor to provide our
shareholders an opportunity to realize an attractive total rate of return
through stock ownership in our company.
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We do not seek to avoid risk. We do seek, to the best of our ability, to assume
risk that can be quantified from historical experience, to actively manage such
risk, to earn sufficient compensation to justify the taking of such risks, and
to maintain capital levels consistent with the risks we do undertake.
Our strategy for managing some of these risks includes the use of derivative
interest rate agreements. Please see "Note 2. Summary of Significant Accounting
Policies" for additional discussions on our use of interest rate agreements and
their designation as "trading" instruments.
In April and May of 2000, short-term interest rates continued to rise, and debt
markets signaled that expectations for further increases in short-term interest
rates in 2000 and 2001 are continuing to increase. As we have frequently noted,
rapid and sustained increases in short-term interest rates are likely to reduce
our net interest income for some period of time following such increases. Such
interest rate increases, if they occur, would also likely cause negative
mark-to-market adjustments to our reported earnings. Mark-to-market adjustments
on all our assets, if negative, would reduce our capital base, book value per
share, intrinsic value per share, and our liquidity reserve.
MARKET VALUE RISK
The market value of our assets can fluctuate due to changes in interest rates,
prepayment rates, liquidity, financing, supply and demand, credit, and other
factors. These fluctuations affect our earnings.
At March 31, 2000, we owned mortgage securities and loans totaling $1.0 billion
that we account for on a mark-to-market basis or, in the case of mortgage loans,
on a lower-of-cost-or-market basis, for purposes of determining reported
earnings. Of these assets, 98% had adjustable-rate coupons and 2% had fixed-rate
coupons.
Our interest rate agreements hedging program may offset some asset market value
fluctuations due to interest rate changes, or, in some cases, may exacerbate
such fluctuations. All of our $3.1 billion in notional amounts of interest rate
agreements are marked-to-market for income statement purposes.
Market value fluctuations of assets and interest rate agreements, especially to
the extent assets are funded with short-term borrowings, can also affect our
access to liquidity.
INTEREST RATE RISK
At March 31, 2000, we owned $2.4 billion of assets and had $2.2 billion of
liabilities. The majority of the assets were adjustable-rate, as were a majority
of the liabilities.
On average, our cost of funds has the ability to rise or fall more quickly as a
result of changes in short-term interest rates than does the earning rate on our
assets. In addition, in the case of a large increase in short-term interest
rates, periodic and lifetime caps for a portion of our assets could limit
increases in interest income. The risk of reduced earnings in a rising interest
rate environment may be mitigated to some extent by our interest rate agreements
hedging program and by any concurrent slowing of mortgage prepayment rates that
may occur.
Hybrid mortgage assets (with fixed-rate coupons for 3 to 7 years and
adjustable-rate coupons thereafter) totaled $0.4 billion. We had debt with
interest rate reset characteristics matched to the hybrid mortgages totaling
$0.4 billion.
Our net income may vary somewhat as the yield curve between one-month interest
rates and six- and twelve-month interest rates vary. At March 31, 2000, we
effectively owned $0.6 billion of adjustable-rate mortgage assets with interest
rates that adjust every six months as a function of six-month LIBOR interest
rates funded with equity and debt that had an interest rate that adjusts monthly
as a function of one-month LIBOR interest rates.
At March 31, 2000, we owned $0.6 billion of adjustable-rate mortgage assets that
adjust monthly as a function of one-month LIBOR interest rates, funded with
equity and debt that also adjusts monthly as a function of one-month LIBOR
interest rates.
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Adjustable-rate assets with earnings rates dependent on one-year U.S. Treasury
rates with annual adjustments totaled $0.8 billion at March 31, 2000. These
Treasury-based assets were effectively funded with equity and $0.3 billion of
liabilities with a cost of funds dependent on one-year U.S. Treasury rates with
annual adjustments, and the remainder funded with liabilities with a cost of
funds dependent on one month LIBOR rates or the daily Fed Funds rate. To the
extent our Treasury-based assets are not funded with Treasury-based liabilities,
we incur basis risk. Such risk arises because changes in Treasury rates may
differ significantly from changes in the Fed Funds, LIBOR, or Euro-dollar
interest rates.
Interest rates and related factors can affect our spread income and our mark to
market results. Changes in interest rates also affect prepayment rates (see
below) and influence other factors that may affect our results.
LIQUIDITY RISK
Our primary liquidity risk arises from financing long-maturity mortgage assets
with short-term debt. Even if the interest rate adjustments of these assets and
liabilities are well matched, maturities may not be matched. In addition, trends
in the liquidity of the U.S. capital markets in general may affect our ability
to rollover short-term debt.
The assets that we pledge to secure short-term borrowings are generally
high-quality, liquid assets. As a result, we have not had difficulty refinancing
our short-term debt as it matures, even during the financial market liquidity
crisis in late 1998. Still, changes in the market values of our assets, in our
perceived credit worthiness, in lender over-collaterization requirements, and in
the capital markets can impact our access to liquidity.
At March 31, 2000, we had $75 million of highly liquid assets which were
unpledged and available to meet margin calls on short-term debt that could be
caused by asset value declines or changes in lender over-collateralization
requirements. These assets consisted of unrestricted cash and unpledged "AAA"
rated mortgage securities. Total available liquidity, including unrestricted
cash, equaled 8% of our short-term debt balances.
We currently have two committed lines of short-term financing, one for
residential and commercial mortgage loans and one solely for commercial. There
are certain restrictions regarding the collateral for which these lines can be
used, but they generally allow us to fund whole loan acquisitions for the term
of the commitments. There is no assurance that we will be able to renew or wish
to renew such lines upon expiration.
We will continue to pursue additional sources of financing in order to enhance
the liquidity of our portfolio.
PREPAYMENT RISK
As we receive repayments of mortgage principal, we amortize into income our
mortgage premium balances as an expense and our mortgage discount balances as
income. Mortgage premium balances arise when we acquire mortgage assets at a
price in excess of the principal value of the mortgages. Premium balances are
also created when an asset appreciates and is marked-to-market at a price above
par. Mortgage discount balances arise when we acquire mortgage assets at a price
below the principal value of the mortgages, or when an asset depreciates in
market value and is marked-to-market at a price below par. At March 31, 2000,
mortgage premium balances were $28.0 million and mortgage discount balances were
$22.5 million. Net mortgage premium was $5.5 million. Since the prepayment
characteristics of our premium and discount mortgage assets may vary, gross
premium levels, net premium levels, and other factors may influence our
earnings.
Sequoia's long-term debt has associated deferred bond issuance costs. These
capitalized costs are amortized as an expense as the bonds are paid off with
mortgage principal receipts. These deferred costs totaled $3.9 million at March
31, 2000. In addition, premium received from the issuance of bonds at prices
over principal value is amortized as income as the bond issues pay down. These
balances totaled $3.6 million at March 31, 2000. The combined effect of these
two items was to increase our effective mortgage-related premium by $0.3
million.
Our net premium at March 31, 2000 for assets and liabilities affected by the
rate of mortgage principal receipts was $5.8 million. This net premium equaled
3.2% of common equity. Amortization expense and income will vary as prepayment
rates on mortgage assets vary. In addition, changes in prepayment rates will
effect the market
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value of our assets and our earnings. Changes in the value of our assets, to the
extent they are incorporated into the basis of our assets, will also affect
future amortization expense.
CREDIT RISK
Our principal credit risk comes from mortgage loans owned by Sequoia, mortgage
loans held in portfolio, and our lower-rated mortgage securities. We also have
credit risk with counter-parties with whom we do business.
Not including mortgage loans owned by Sequoia, we owned $13 million in
residential mortgage loans at March 31, 2000. Of these, $0.3 million were
seriously delinquent (delinquent over 90 days, in foreclosure, in bankruptcy, or
real estate owned). We also owned $17 million in commercial mortgage loans.
These commercial mortgage loans were all current at March 31, 2000.
The four Sequoia trusts owned $1.3 billion in residential mortgage loans at
March 31, 2000. Our total credit risk from these trusts is limited to our equity
investment in these trusts. These equity investments had a reported value of $41
million, net of related credit reserves, at March 31, 2000. At that time, $5.0
million of the underlying loans, or 0.38%, were seriously delinquent.
At March 31, 2000, we had $5.1 million of credit reserves to provide for
potential future credit losses from our mortgage loans held for investment by
the Sequoia trusts. The reserve is based upon our assessment of various factors
affecting our mortgage loans, including current and projected economic
conditions, delinquency status, and credit protection. Total seriously
delinquent loans had a loan balance of $5.3 million. To date, our realized
credit losses from defaulted residential mortgage loans have averaged 9% of the
loan balance of the defaulted loans. Delinquencies, defaults, and loss
severities may increase in the future, however, particularly if real estate
values decline or the general U.S. economy weakens. We believe our current level
of reserve and credit provision policy is reasonable.
At March 31, 2000, we also had $0.7 million credit reserves for our SMFC
re-REMIC securities. Our total potential credit exposure from these securities
(after this credit reserve) is our net cost basis of $6.6 million.
It should be noted that the establishment of a credit reserve for GAAP purposes
does not reduce our taxable income or our dividend payment obligations as a
REIT. For taxable income, credit expenses are recognized as incurred, and will
have the effect of reducing dividends at that point.
CAPITAL RISK
Our capital levels, and thus our access to borrowings and liquidity, may be
tested, particularly if the market value of our assets securing short-term
borrowings declines.
Through our risk-adjusted capital policy, we assign a guideline capital adequacy
amount, expressed as a guideline equity-to-assets ratio, to each of our mortgage
assets. For short-term funded assets, this ratio will fluctuate over time, based
on changes in that asset's credit quality, liquidity characteristics, potential
for market value fluctuation, interest rate risk, prepayment risk, and the
over-collateralization requirements for that asset set by our collateralized
short-term lenders. Capital requirements for residential mortgage securities
rated below AA and commercial mortgage whole loans are generally higher than for
higher-rated residential securities and residential whole loans. Capital
requirements for these less-liquid assets depend chiefly on our access to secure
funding for these assets, the number of sources of such funding, the funding
terms, and on the amount of extra capital we decide to hold on hand to protect
against possible liquidity events with these assets. Capital requirements for
equity interests in Sequoia generally equal our net investment. The sum of the
capital adequacy amounts for all of our mortgage assets is our aggregate
guideline capital adequacy amount.
Generally, our total guideline equity-to-assets ratio capital amount has
declined over the last few years as we have eliminated some of the risks of
short-term debt funding through issuing long-term debt. In the most recent
quarters, however, the guideline ratio has increased as we have acquired new
types of assets such as commercial mortgage loans and lower-rated mortgage
securities. This increase was partially offset in the first quarter of 2000 by
the issuance of new long-term debt replacing short-term debt.
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We do not expect that our actual capital levels will always exceed the guideline
amount. If interest rates were to rise in a significant manner, our capital
guideline amount may rise, as the potential interest rate risk of our mortgages
would increase, at least on a temporary basis, due to periodic and life caps and
slowing prepayment rates. We measure all of our mortgage assets funded with
short-term debt at estimated market value for the purpose of making
risk-adjusted capital calculations. Our actual capital levels, as determined for
the risk-adjusted capital policy, would likely fall as rates increase as the
market values of our mortgages, net of mark-to-market gains on hedges,
decreased. (Such market value declines may be temporary as well, as future
coupon adjustments on adjustable-rate mortgage loans may help to restore some of
the lost market value.)
In this circumstance, or any other circumstance in which our actual capital
levels decreased below our capital adequacy guideline amount, we would generally
cease the acquisition of new mortgage assets until capital balance was restored
through prepayments, interest rate changes, or other means. In certain cases
prior to a planned equity offering or other circumstances, the Board of
Directors has authorized management to acquire mortgage assets in a limited
amount beyond the usual constraints of our risk-adjusted capital policy.
Growth in assets and earnings may be limited when our access to new equity
capital is limited. Holdings can benefit over time from the re-investment of
retained earnings at Holdings. Our mortgage finance operation, however, is
generally required to distribute at least 95% of taxable income as dividends due
to its REIT status.
INFLATION RISK
Virtually all of our assets and liabilities are financial in nature. As a
result, interest rates, changes in interest rates and other factors drive our
performance far more than does inflation. Changes in interest rates do not
necessarily correlate with inflation rates or changes in inflation rates.
Our financial statements are prepared in accordance with Generally Accepted
Accounting Principles and our dividends must equal at least 95% of our net
income as calculated for tax purposes. In each case, our activities and balance
sheet are measured with reference to historical cost or fair market value
without considering inflation.
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RWT HOLDINGS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
RWT Holdings, Inc. ("Holdings") was incorporated in Delaware in February 1998
and commenced operations on April 1, 1998. Holdings' start-up operations have
been funded by Redwood Trust, which has a significant investment in Holdings
through the ownership of all of Holdings' non-voting preferred stock, and by
Redwood Trust's senior management, who own Holding's voting common stock. We
refer you to "Note 1. The Company" in the Notes to the Consolidated Financial
Statements of RWT Holdings, Inc. and Subsidiaries for additional information on
Holdings' initial capitalization.
Holdings originates commercial mortgage loans for sale to institutional
investors through its Redwood Commercial Funding, Inc. ("RCF") subsidiary.
Holdings had two other operating businesses, Redwood Financial Services, Inc.
("RFS") and Redwood Residential Funding ("RRF"). Due to a variety of start-up
difficulties with these units, operations were closed at RFS in the third
quarter of 1999 and at RRF in the fourth quarter of 1999. These closures
resulted in restructuring charges of $8.4 million during the year ended December
31, 1999, and a significant reduction in the headcount and ongoing operating
expenses at Holdings.
FINANCIAL CONDITION
At March 31, 2000, Holdings owned $17.6 million of commercial mortgage loans.
Holdings also had $3.7 million in cash, $0.2 million of accrued interest
receivable, and $0.1 million in other assets, for total assets of $21.6 million.
Holdings had commitments to acquire $16.9 million of commercial mortgage loans
from Redwood Trust for settlement during the second quarter of 2000. Holdings
intends to sell these loans in 2000.
The loans owned by Holdings were funded with short-term borrowings and equity.
Short-term debt was $13.9 million, loans from Redwood Trust were $1.4 million,
receivables due Redwood Trust totaled $0.6 million, accrued restructuring
charges were $2.3 million, and other liabilities totaled $0.6 million, for total
liabilities of $18.8 million. Redwood Trust expects to continue to provide
liquidity to Holdings, when necessary, during the year 2000. Total equity at
March 31, 2000 was $2.9 million.
At December 31, 1999, Holdings owned $4.4 million of residential mortgage loans,
$29.6 million of commercial mortgage loans, $2.0 million in cash, and $1.3
million in other assets, for total assets of $39.0 million. Short-term debt
totaled $22.4 million, loans from Redwood Trust totaled $6.5 million,
receivables due Redwood Trust were $0.5 million, accrued restructuring charges
totaled $4.0 million, other liabilities were $2.1 million, and total equity
totaled $3.4 million.
RESULTS OF OPERATIONS
For the quarter ended March 31, 2000, net interest income for Holdings was $0.2
million, including interest income of $0.6 million and interest expense of $0.4
million. Holdings also had net gains as a result of commercial and residential
mortgage loan sales and market value adjustments of $0.1 million during the
first quarter of 2000, resulting in net revenues of $0.3 million. Operating
expenses at Holdings totaled $0.9 million for the first three months of 2000.
Holdings' net loss for the quarter ended March 31, 2000 was $0.6 million.
In the first quarter of 2000, RCF originated $8 million of commercial mortgage
loans and sold $12 million. In the first quarter of 1999, RCF originated $2.9
million of commercial mortgage loans. Total 1999 commercial loan originations
were $42 million; total 1999 sales were $11.3 million. At March 31, 2000,
commercial mortgage
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loans originated or acquired by RCF that had not yet been sold totaled $35
million, of which $17 million were held by Redwood Trust and $18 million were
held at Holdings. These loans are all held for future sale.
RCF recorded net revenue for the first three months of 2000 of $0.2 million. Net
interest income at RCF does not include interest on loans that RCF has a
commitment to purchase from Redwood. For the quarter ended March 31, 2000,
direct RCF operating expenses were $0.5 million and operating expenses
reimbursable by RCF to Redwood Trust totaled $0.1 million. RCF expects to
recognize sale revenues upon the sale of the commercial loan portfolio.
For the quarter ended December 31, 1999, net interest income for Holdings was
$0.3 million, including interest income of $2.1 million and interest expenses of
$1.8 million. Holdings also had net losses as a result of mortgage asset sales
and market value adjustments of $0.9 million during the fourth quarter of 1999,
resulting in net revenues of negative $0.6 million. Operating expenses at
Holdings totaled $2.3 million for this quarter. Restructuring charges related to
the closure of RRF totaled $6.2 million. Holdings' net loss for the quarter
ended December 31, 1999 was $9.1 million.
The net operating expense, including on-going operating expenses and
restructuring charges, relating to closed operations was $0.9 million in the
first quarter of 2000 and $8.5 million in the fourth quarter of 1999. This
explains the large improvement in Holdings' results from quarter to quarter. Net
losses recognized at Holdings attributable to the on-going operations of RCF
were $0.5 million in the first quarter of 2000 and $0.6 million in the fourth
quarter of 1999. This does not represent the profit or loss of the combined
commercial mortgage operations of Redwood and Holdings, as some of the income on
the loans during this period accrued to Redwood.
For the quarter ended March 31, 1999, net interest income for Holdings was $0.2
million, including interest income of $0.5 million and interest expense of $0.3
million. Holdings also had net gains as a result of commercial and residential
mortgage loan sales and market value adjustments of $0.6 million during the
first quarter of 1999, resulting in net revenues of $0.8 million. Operating
expenses at Holdings totaled $3.3 million for the first three months of 1999.
Holdings' net loss for the quarter ended March 31, 1999 was $2.5 million.
Holdings' losses in the first quarter of 2000 were much lower than in the first
quarter of 1999 due to the shut down of operations at RRF and RFS during 1999.
In the first quarter of 1999, these operations were incurring significant
operating expenses. These operations were subsequently closed and the net loss
associated with these operations in the first quarter of 2000 was minor.
At March 31, 2000, Holdings had net operating loss carryforwards of
approximately $21 million for federal tax purposes and $11 million for state
income tax purposes. The federal carryforwards expire through 2018 and the state
carryforwards expire through 2004.
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PART II OTHER INFORMATION
Item 1. Legal Proceedings
At March 31, 2000, there were no pending legal proceedings to which the
Company as a party or of which any of its property was subject.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 3.3.2 - Amended and Restated Bylaws, amended March 9,
2000 (Incorporated by reference to the Form 8-K filed March 14,
2000 referred to below).
Exhibit 4.4.3 - Pooling and Servicing Agreement, dated as of
March 1, 2000, among Merrill Lynch Mortgage Investors, Inc.,
Sequoia Mortgage Funding Corporation, Merrill Lynch Credit
Corporation and Norwest Bank Minnesota, N.A. (Incorporated by
reference to the Form 8-K filed by Merrill Lynch Mortgage
Investors, Inc. (333-81429) on April 4, 2000).
Exhibit 10.14 - Employment Agreement, dated March 13, 2000,
between the Company and Harold F. Zagunis.
Exhibit 11.1 to Part I - Computation of Earnings Per Share for
the three months ended March 31, 2000 and March 31, 1999.
Exhibit 27 - Financial Data Schedule
(b) Reports
Form 8-K filed by the Company on March 14, 2000, attaching
Amended and Restated Bylaws, amended March 9, 2000.
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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.
Dated: May 10, 2000 By: /s/ Douglas B. Hansen
--------------------------------------------
Douglas B. Hansen
President
(authorized officer of registrant)
Dated: May 10, 2000 By: /s/ Harold F. Zagunis
--------------------------------------------
Harold F. Zagunis
Vice President, Chief Financial Officer
Secretary, Treasurer and Controller
(principal financial and accounting officer)
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REDWOOD TRUST, INC.
INDEX TO EXHIBIT
Sequentially
Exhibit Numbered
Number Page
------- ------------
10.14 Employment Agreement, dated March 13, 2000 between
the Company and Harold F. Zagunis...................................... 49
11.1 Computations of Earnings per Share for the three months ended
March 31, 2000 and March 31,
1999................................................................... 72
27 Financial Data Schedule................................................ 73
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