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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 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)
Securities registered pursuant to Section 12(b) of the Act: Name of Exchange on Which Registered:
CLASS B 9.74 % CUMULATIVE CONVERTIBLE PREFERRED STOCK, NEW YORK STOCK EXCHANGE
PAR VALUE $0.01 PER SHARE
(Title of Class)
COMMON STOCK, PAR VALUE $0.01 PER SHARE NEW YORK STOCK EXCHANGE
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
At March 27, 2001 the aggregate market value of the voting stock held by
non-affiliates of the Registrant was $180,480,853.
The number of shares of the Registrant's Common Stock outstanding on March 27,
2001 was 8,868,838.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement issued in connection
with the 2001 Annual Meeting of Stockholders are incorporated by reference into
Part III.
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REDWOOD TRUST, INC.
2000 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
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PART I
Item 1. BUSINESS ..................................................... 3
Item 2. PROPERTIES ................................................... 25
Item 3. LEGAL PROCEEDINGS ............................................ 25
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .......... 25
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS .............................. 26
Item 6. SELECTED FINANCIAL DATA ...................................... 27
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS ................ 28
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ..... 55
Item 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE ....................... 55
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ........... 55
Item 11. EXECUTIVE COMPENSATION ....................................... 55
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT ........................................ 55
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ............... 55
PART IV
Item 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENTS SCHEDULES AND
REPORTS ON FORM 8-K .......................................... 55
CONSOLIDATED FINANCIAL STATEMENTS ...................................... F-1
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PART I
ITEM 1. BUSINESS
"Safe Harbor" Statement under the Private Securities Litigation Reform
Act of 1995: Certain matters discussed in this 2000 annual report on
Form 10-K may constitute forward-looking statements within the meaning
of the federal securities laws that inherently include certain risks and
uncertainties. Actual results and the timing of certain events could
differ materially from those projected in or contemplated by the
forward-looking statements due to a number of factors, including, among
other things, credit results for our mortgage assets, our cash flows and
liquidity, changes in interest rates and market values on our mortgage
assets and borrowings, changes in prepayment rates on our mortgage
assets, general economic conditions, particularly as they affect the
price of mortgage assets and the credit status of borrowers, and the
level of liquidity in the capital markets, as it affects our ability to
finance our mortgage asset portfolio, and other risk factors outlined in
this Form 10-K (see Risk Factors below). Other factors not presently
identified may also cause actual results to differ. We continuously
update and revise our estimates based on actual conditions experienced.
It is not practicable to publish all such revisions and, as a result, no
one should assume that results projected in or contemplated by the
forward-looking statements included herein will continue to be accurate
in the future.
Throughout this Form 10-K and other company documents, the words
"believe", "expect", "anticipate", "intend", "aim", "will", and similar
words identify "forward-looking" statements.
REDWOOD TRUST
Redwood Trust, Inc. is a real estate finance company specializing in
owning, financing, and credit-enhancing high-quality jumbo residential
mortgage loans nationwide.
High-quality jumbo residential mortgage loans of the type that we own
and credit-enhance have a long and stable history of strong credit
results relative to other types of consumer and commercial lending.
Jumbo residential loans have loan balances that exceed the financing
limit imposed on Fannie Mae and Freddie Mac--the government-sponsored
real estate finance companies. Most of the loans that we finance have
loan balances between $275,000 and $1 million.
There are approximately $800 billion of high-quality jumbo loans in
America. At December 31, 2000, we assisted in the financing of over $24
billion of these. We are involved in the financing of one out of every
32 of the more valuable houses in the country that have a jumbo-sized
mortgage loan.
We finance high-quality jumbo residential loans in two ways.
In our residential credit-enhancement portfolio, we enable the
securitization and funding of loans in the capital markets by
committing our capital to partially credit-enhance the loans. We
do this by structuring and acquiring subordinated
credit-enhancement interests that are created at the time the
loans are securitized. After we have credit-enhanced these
loans, AAA rated mortgage backed securities can be created and
sold into global capital markets to fund the mortgages. In
essence, we perform a type of guarantee or insurance function
with respect to these loans.
In our residential retained loan portfolio, we acquire loans and
hold them on our balance sheet to earn interest income. We
typically fund the purchase of these loans through the issuance
of long-term amortizing debt.
To create jumbo loan financing opportunities for our credit-enhancement
portfolio and our residential retained loan portfolio, we work actively
with mortgage origination companies that are selling newly originated
loans and with banks that are selling seasoned loan portfolios.
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We also finance U.S. real estate in a number of other ways, including
through our investment portfolio (mortgage-backed securities) and our
commercial loan portfolio.
In 2000, pricing levels were attractive in the jumbo loan market. We
currently expect attractive pricing to continue into 2001, as the supply
of loans and credit-enhancement opportunities is expected to increase
(as new mortgage origination increases and banks increasingly seek to
sell seasoned loan portfolios). In addition, we believe that competition
to acquire or credit-enhance these loans will remain subdued.
Our credit results have been excellent. We believe that our mortgage
delinquency rates and mortgage credit losses are lower than those of the
residential mortgage portfolios of Fannie Mae and Freddie Mac and of the
large jumbo residential finance companies such as Bank of America and
Washington Mutual.
We have elected, and intend to continue to elect, to be taxed as a REIT.
As a REIT, we distribute the bulk of our net earnings to stockholders as
dividends. Assuming that we retain REIT status, we will not pay most
types of corporate income taxes.
Redwood Trust, Inc. was incorporated in the State of Maryland on April
11, 1994 and commenced operations on August 19, 1994. Our principal
executive offices are located at 591 Redwood Highway, Suite 3100, Mill
Valley, CA 94941, telephone 415-389-7373.
At March 30, 2001, Redwood had outstanding 8,868,838 shares of common
stock (New York Stock Exchange, Symbol "RWT") and 902,068 shares of
Class B Cumulative Convertible Preferred Stock (New York Stock Exchange,
Symbol "RWT-PB").
For more information about Redwood, please visit www.redwoodtrust.com.
For a description of important risk factors, among others, that could
affect our actual results and could cause our actual consolidated
results to differ materially from those expressed in any forward-looking
statements made by us, see "Risk Factors" commencing on Page 11 of this
Form 10-K.
COMPANY BUSINESS AND STRATEGY
Redwood's objective is to produce attractive growth in earnings per
share and dividends per share for stockholders through the efficient
financing and management of high-quality jumbo residential loans.
An increasing proportion of the high-quality jumbo residential loan
market is financed through securitization in the capital markets rather
than by the deposit bases maintained by banks and thrifts. As a
non-depository finance company funded in the capital markets, Redwood is
positioned to benefit from and to promote this trend. We have been
gaining market share in this segment of the finance business at the
expense of banks and thrifts, and we expect to continue to do so.
While banks and thrifts are our competitors in one sense, for the most
part they are our customers and partners. Most banks are interested in
earning fees from mortgage origination, and also are interested in
maintaining relationships with households so that they can cross-sell
multiple financial products. As a pure mortgage finance company, we
compliment their efforts. We buy residential mortgage loans from them,
thus helping them to divest of assets that they find unattractive to
hold on their balance sheet. When they sell us loans, they continue to
originate new loans (and keep the fees) and continue to service the
loans that they have sold to us (and thus keep the household
relationships). By working together in this fashion, both Redwood and
our bank and thrift partners meet their goals.
An integral part of our objective is growth. We believe that our
earnings per share and dividends per share are likely to benefit from
growth in our equity capital base and in the amount of jumbo loans that
we finance. As we become a larger company, we believe we will benefit
from operating expense leverage (revenues will grow more quickly than
operating expenses). We also believe we will benefit from a lower
effective cost of borrowed funds, and from an improved ability to make
commitments to and form deeper relationships with mortgage originators
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and bank portfolio sellers. In addition, earnings and dividends per
share will likely benefit to the extent that equity offerings at prices
in excess of book value increase average book value per share.
We can grow through internal cash generation and asset appreciation.
Typically our cash flows exceed our dividend, working capital, and
capital expenditure requirements; by retaining this free cash flow, we
can grow. Additionally, absent a poor credit cycle, the market value of
our credit-sensitive assets may increase over time as our loans season
and our risks are reduced. Increased market values for these assets add
to our equity base and allow us to increase our jumbo loan asset
commitments.
We will also seek to increase the size of our capital base through
issuing new equity securities. We will do so when we believe we have
attractive business opportunities and when we believe such issuance is
likely to benefit our per share earnings, dividends, and stock price.
Since we currently assist in the financing of approximately 3% of the
high-quality jumbo residential loans in the U.S., we have the potential
ability to grow for many years by increasing our market share. In
addition, the dollar amount of jumbo loans outstanding in America
typically grows at 6% to 10% per year.
From the founding of Redwood in 1994 through December 31, 2000,
stockholder wealth (consisting of book value per share, dividends
received, and reinvestment of dividends) has increased at a compound
annual rate of 18%. Much of this increase in stockholder wealth was
achieved through the beneficial effects of growth, both
internally-funded growth and externally-funded growth.
PRODUCT LINES
At December 31, 2000, Redwood had four mortgage portfolios representing
its four product lines. Our current intention is to focus on the
management and growth of these four existing product lines.
We operate our four product lines as a single business segment of real
estate finance, with common staff and management, commingled financing
arrangements, and flexible capital commitments.
RESIDENTIAL CREDIT-ENHANCEMENT PORTFOLIO
In a manner analogous to the guarantee programs of Fannie Mae and
Freddie Mac, Redwood credit enhances pools of mortgage loans to enable
their securitization.
By assuming some of the risk of credit loss of these loans, we enable
these loans to be funded in the capital markets. Sellers of mortgage
loans, by taking advantage of our credit-enhancement services, can fund
their originations by creating and selling mortgage-backed securities
with a credit rating of AAA. These AAA securities are sold to a wide
variety of buyers that are willing to fund mortgage assets, but are not
willing to build the operations necessary to manage mortgage credit
risk.
We credit enhance high-quality jumbo residential loans through
structuring and acquiring subordinated credit-enhancement interests that
are created at the time the loans are securitized. Sometimes we buy
these credit-enhancement interests in the secondary market for mortgage
assets; sometimes we work with seller/securitizers directly to choose
loans that will be included in a pool and to structure the terms of the
credit-enhancement interest for that pool.
Generally, we credit-enhance loans from the top 15 high-quality national
mortgage origination firms plus a few other smaller firms that
specialize in very high-quality jumbo residential loan originations. We
also work with large banks that are sellers of seasoned portfolios of
high-quality jumbo loans. We either work directly with these customers,
or we work in conjunction with an investment bank on these transactions.
The pricing that we receive for providing credit-enhancement is a
function of supply and demand (as well as perception of risk). Supply is
largely a function of the number of jumbo mortgage loans originated, the
number of seasoned bank portfolios for sale, and the percentage of such
loans that are securitized. Generally, supply is
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increasing over time as the outstanding balance of jumbo mortgages grows
and as the share of jumbo mortgages that are securitized increases.
Demand also affects the attractiveness of pricing in our market. Demand
is a function of competition. In the two periods in which we increased
our credit-enhancement business at a rapid pace (1994 to 1996 and 1999
to 2000), competition was subdued. Because of the relative lack of
demand, pricing was attractive.
In 1997 and 1998, many financial institutions (including banks, thrifts,
insurance companies, Wall Street firms, and hedge funds) entered this
business. Many of these new entrants had relatively inefficient balance
sheets for this particular business, lacked mortgage credit management
infrastructure, lacked prudence in their asset/liability management
practices, or lacked focus. Most have now exited this business,
improving pricing for specialist firms such as ourselves.
During the 1997 to 1998 period, the entrance of many new firms into our
business increased demand and generally made pricing unattractive. Our
response was to halt growth of our credit-enhancement portfolio and sell
a portion of our credit-enhancement interests. Because of aggressive
pricing in mortgage credit-enhancement, our new asset commitments during
this period were generally in our investment portfolio.
When pricing improved in 1999, we resumed growth in the jumbo market,
although our largest capital commitment during that year was to our
common stock repurchase program. During 2000, we increased the size of
our credit-enhancement portfolio and commitments from $8 billion to $25
billion.
We credit-enhance fixed rate, adjustable rate, and hybrid mortgage
loans. For our credit-enhancement portfolio, a "fixed rate" market
(where the percentage of newly originated mortgages that are fixed rate
is relatively high) is generally favorable. Since most fixed rate loans
are securitized, we are likely to have an increased supply of
credit-enhancement opportunities in a fixed rate market.
Substantially all of the $23 billion of loans that we added to our
credit-enhancement portfolio in 1999 and 2000 were "A" or "prime"
quality loans. We do not seek to credit-enhance "B", "C", or "D" quality
loans (sub-prime loans).
Our goal is to post credit results for our mortgage portfolio that equal
or exceed the credit results of Fannie Mae, Freddie Mac, and the large
"A" quality jumbo portfolio lenders such as Bank of America and
Washington Mutual.
The amount of capital that we hold to credit enhance our credit
enhancement portfolio loans (the principal value of the
credit-enhancement interests that we acquire) is determined by the
credit rating agencies (Moody's Investors Service, Standard & Poor's
Ratings Services, and Fitch IBCA). These credit agencies examine each
pool of mortgage loans in detail. Based on their review of individual
loan characteristics, they determine the credit-enhancement capital
levels necessary to award AAA ratings to the bulk of the securities
formed from these mortgages. Once we provide this credit-enhancement
capital, the credit-enhanced AAA securities can be sold to a wide
variety of capital market participants.
Typically the principal value of the credit-enhancement interests that
we acquire is equal to 0.5% to 2.0% of the initial principal value of
the mortgages. Our capital requirements are greater than the 0.45% of
loans that Fannie Mae and Freddie Mac are required by regulation to hold
as capital for similar quality smaller-than-jumbo mortgages. However,
our capital requirements are less than the 4.0% of loan balances that
banks and thrifts are required by their regulators to hold as capital
for high-quality residential loans (of any size) if held unsecuritized
on their balance sheets. Thus, by financing in the capital markets, our
capital structure can be more capital efficient than that of the banks
and thrifts that are our competitors in the jumbo market.
Although the principal value of our credit-enhancement interests is
equal to 0.5% to 2.0% of the loans that we credit enhance, our actual
investment (and our risk) is less than this amount since we acquire
these interests at a price which is at a discount to principal value. A
portion of this discount we designate as our credit reserve for future
losses; the remainder we amortize into income over time.
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The loans that we credit-enhance in this portfolio do not appear as
assets on our balance sheet. Rather, our net basis in credit-enhancement
interests is shown as a balance sheet asset. At December 31, 2000, the
principal value of our credit-enhancement interests was $125 million and
our basis in these assets was $81 million.
Our first defense against credit loss is the quality of our loans.
Compared to most corporate and consumer loans, the mortgage loans that
we credit-enhance have a much lower loss frequency (they tend not to
default) and a much lower loss severity (the amount of the loan that we
lose when they do default is low).
Our borrowers typically have stable sources of income. Debt service
payments of all types usually consume less than one-third of their
income (or else there are other favorable underwriting characteristics
in the loan that serve as compensating factors to higher debt ratios).
Our borrowers generally have liquid assets. They have proven their
credit-worthiness in a number of ways, including generally having an
unblemished credit record and a credit (FICO) score at origination of
greater than 680.
Our loans are secured by the borrowers' homes. On average, we estimate
that our loan balances are less than 63% of the current market value of
the homes (and other collateral and credit-enhancements) securing these
loans. In the rare instances when a homeowner defaults, we work with our
mortgage servicing partners to mitigate losses, which may include
foreclosing on and selling the house. While we cannot always avoid a
credit loss through our loss mitigation efforts, when we do incur a loss
it is usually a small one relative to our loan balance.
Our exposure to the credit risks of the mortgages that we credit-enhance
is further limited in a number of respects:
(1) Representations and warranties: As the credit-enhancer
of a mortgage securitization, we benefit from
representations and warranties received from the sellers
of the loans. In limited circumstances, the sellers are
obligated to re-purchase delinquent loans from our
credit-enhanced pools, thus reducing our potential
exposure.
(2) Mortgage insurance: A portion of our credit-enhanced
portfolio consists of loans with initial loan-to-value
(LTV) ratios in excess of 80%. For the vast majority of
these higher LTV loans, we benefit from primary mortgage
insurance provided on our behalf by the mortgage
insurance companies or from pledged asset accounts.
Thus, for what would otherwise be our most risky loans,
we have passed much of the risk on to third parties and
our effective loan-to-value ratios are much lower than
80%.
(3) Risk tranching: A typical mortgage securitization has
three credit-enhancement interests -- a "first loss"
security and securities that are second and third in
line to absorb credit losses. Of Redwood's net
investment in credit-enhancement assets, $12 million, or
15%, was directly exposed to the risk of mortgage
default at December 31, 2000. The remainder of our net
investment, $69 million, was in the second or third loss
position and benefited from credit-enhancements provided
by others (through ownership of credit-enhancement
interests junior to our positions) totaling $87 million.
Credit enhancement varies by specific asset.
(4) Limited maximum loss: Our potential credit exposure to
the mortgages that we credit-enhance is limited to our
investment in the credit-enhancement securities that we
acquire.
(5) Credit reserve established at acquisition: We acquire
credit-enhancement interests at a discount to their
principal value. We set aside some of this discount as a
credit reserve to provide for future credit losses. In
most economic environments, we believe that this reserve
should be large enough to absorb future losses. Thus,
typically, most of our credit reserves are established
at acquisition and are, in effect, paid for by the
seller of the credit-enhancement interest.
(6) Acquisition discount: For many of our credit-enhancement
interests, the discount that we receive at purchase
exceeds anticipated future losses and thus exceeds our
designated credit reserve. Since we own these assets at
a discount to our credit reserve adjusted value, the
income statement effect of any credit losses in excess
of our reserve would be mitigated.
We believe that the outlook for our jumbo mortgage credit enhancement
portfolio line in 2001 is excellent, as the supply of credit-enhancement
opportunities is expected to increase as mortgage originations and
mortgage securitizations increase. We expect pricing to remain
favorable, as we expect demand from competitors will remain subdued. We
expect to achieve continued growth with attractive pricing in this
product line.
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RESIDENTIAL RETAINED PORTFOLIO
We anticipate that the bulk of our growth, in terms of loans financed in
the jumbo residential loan market, is most likely to be in our
credit-enhancement portfolio. Nevertheless, we continuously seek to
create the more specialized situations that allow us to add value by
undertaking securitizations on our balance sheet and thus add to our
residential retained loan portfolio.
Our net retained interests from our securitizations are the assets of
our residential retained portfolio less the long-term debt that we
issue. These retained interests that we create are functionally and
structurally similar to the credit-enhancement interests that we
acquire. In each case, we are using our capital to credit-enhance
high-quality jumbo residential loans so that AAA securities backed by
these loans can be created and sold in the capital markets. For our
retained portfolio, we acquire whole loans and undertake the
securitization of the loans ourselves (structured as an issuance of long
term debt). For our credit-enhancement portfolio, the seller of the
mortgages undertakes the securitization of the loans and we acquire the
credit-enhancement interest from them. Although we have greater control
over mortgage underwriting and servicing in our retained portfolio than
we do sometimes with our acquisitions of credit enhancement interests,
creating retained loan portfolio interests entails certain risks. We
undertake securitizations ourselves only when we believe that we have a
distinct advantage in doing so relative to the alternative of allowing
the seller to undertake the securitization.
At December 31, 2000, our basis in our net retained interests from our
securitizations totaled $37 million and our basis in our portfolio of
acquired credit-enhancement interests totaled $81 million. These assets
are shown in a different manner on our balance sheet. For our
residential retained portfolio securitizations, we show both the
underlying residential whole loans (residential whole loans of $1.13
billion at December 31, 2000) and the securities that we issue (long
term debt of $1.09 billion) on our balance sheet. For acquired
credit-enhancement interests, we show only the net amount ($81 million)
as an asset.
The process of adding to our retained loan portfolio commences when we
underwrite and acquire mortgage loans from sellers. For our retained
portfolio, we generally acquire loans in bulk purchases so that we can
quickly build a portfolio large enough (usually $200 million or more) to
support an efficient issuance of long-term debt. Although there is a
limited supply of large portfolios for sale, competition to acquire
portfolios of this size is also limited. We source our portfolio
acquisitions primarily from large, well-established mortgage originators
and the larger banks and thrifts.
We believe that competition in the jumbo whole loan market is
substantially reduced from its peak in 1997 to 1998. There were several
thrifts and banks that were active buyers of high-quality jumbo
residential loan portfolios. Most of these thrifts and banks are now out
of the market, as they have been acquired by other depository
institutions with different asset gathering strategies or they have
changed strategies to focus on building portfolios of other asset types.
Several other mortgage REITs were also active buyers of large
portfolios, but appear to be less interested now due to severe financial
difficulties, a change in strategy, or a change in ownership.
We generally seek to acquire "A" quality adjustable-rate and hybrid
loans for our retained loan portfolio. The securitization process for
fixed-rate loans is highly efficient; we usually believe that there is
little that we can add by securitizing these loans ourselves.
Securitization of adjustable-rate and hybrid loans is less common, and
is less well understood by many market participants. As the ultimate
buyer of the credit-enhancement interests, and one of the leaders in
developing the technology of securitizing adjustable rate and hybrid
loans, we can sometimes add value by acquiring and securitizing these
loans ourselves.
Bulk sales of residential whole loan portfolios that meet our
acquisition criteria and that are priced attractively relative to our
long-term debt issuance levels have been rare in recent years. Many
banks have portfolios of adjustable-rate and hybrid loans that they
intend to sell. If interest rates drop, a greater supply of such
portfolios may become available. When banks and mortgage originators are
ready to sell, they may sell their portfolios as whole loans, in which
case we would likely have the opportunity to acquire loans for our
retained portfolio. Alternatively, they may hire a Wall Street firm to
assist them with a securitization, in which case we would likely have
the opportunity to acquire credit-enhancement interests for our
credit-enhancement portfolio.
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We fund our loan acquisitions initially with short-term debt. When we
are ready to issue long-term debt, we contribute these loans to our
100%-owned, special purpose-financing subsidiary ("Sequoia"). Sequoia,
through a trust, then issues mostly AAA rated long term debt that
generally matches the interest rate and prepayment characteristics of
the loans and remits the proceeds of this offering back to us. Our net
investment equals our basis in the loans less the proceeds that we
received from the sale of long-term debt. The amount of equity that we
invest in these trusts to support our long-term debt issuance is
determined by the credit rating agencies, based on their review of the
loans and the structure of the transaction.
The net interest income that we generate per dollar of loan financed in
our retained portfolio is higher than it is for our credit-enhancement
portfolio. In our retained portfolio, we are generally both
credit-enhancing the loans and earning the spread between the yield on
the mortgages and the cost of funds of our long-term debt. The amount of
capital that we employ as a percentage of the underlying loans in our
retained portfolio is also generally higher than in our
credit-enhancement portfolio. The returns on equity that we generate
from our retained portfolio can be higher than we earn from our
credit-enhancement portfolio, but also can be more variable with respect
to market factors such as changes in interest rates and mortgage
prepayment rates.
We plan to accumulate more high-quality jumbo residential loans when
loans are available on attractive terms relative to our anticipated
costs of issuing long-term debt.
INVESTMENT PORTFOLIO
In our investment portfolio, we finance real estate through acquiring
and funding mortgage securities. Generally these securities have high
credit ratings. The substantial majority of this portfolio is rated AAA
or AA, or effectively has a AAA rating through a corporate guarantee
from Fannie Mae or Freddie Mac.
Since we can fund these securities with a low cost of funds in the
collateralized short-term debt (repo) markets, and since we have an
efficient tax-advantaged corporate structure, we believe that we have
some advantages in the mortgage-backed securities market relative to
many other capital market investors.
The maintenance of an investment portfolio serves several functions for
us:
(1) Given our balance sheet characteristics, tax status, and
the capabilities of our staff, mortgage securities
investments can earn an attractive return on equity,
(2) Using a portion of our capital to fund mortgage assets
with low levels of credit risk acts as a diversification
for our balance sheet,
(3) The high level of current cash flow from these
securities (including principal receipts from mortgage
prepayments) and the general ability to sell these
assets into active trading markets has attractive
liquidity characteristics for asset/liability management
purposes, and
(4) Our investment portfolio can be an attractive place to
employ capital (and earn rates of return that are higher
than cash) when our capital is not immediately needed to
support our credit-related product lines or when we need
flexibility to adjust our capital allocations.
The bulk of our investment portfolio consists of adjustable-rate and
floating rate mortgage securities funded with floating rate short-term
debt. We do own some fixed rate assets in this portfolio that are either
hedged or that we hold unhedged to counter-balance certain other
characteristics of our balance sheet.
The substantial majority of our investment portfolio securities are
backed by high-quality residential mortgage loans. We do have smaller
positions in residential securities backed by less than high-quality
loans (when the securities are substantially credit-enhanced relative to
the risks of the loans and thus qualify for investment grade debt
ratings), in commercial mortgage securities, and in non-real estate
related securities (such as U.S. Treasuries and non-real estate
asset-backed securities).
Although we have the ability to hold these securities to maturity, and
our average holding period is quite long, we do sell securities from
time to time. We do this either as part of our management of this
portfolio or in order to
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free capital for other uses. Because of this flexible approach, we
manage this portfolio on a total-rate-of-return basis, taking into
account both prospective income and prospective market value trends in
our investment analysis. To preserve management flexibility, we
generally use mark-to-market accounting for this portfolio. As a result
of market value fluctuations, quarterly reported earnings from our
investment portfolio can be variable.
We compete in the high-grade mortgage securities market with a great
number of capital markets participants. In 1997 and 1998, competition
increased significantly and asset prices rose. We responded by halting
the growth of this portfolio and selling certain assets. Pricing in this
market again became attractive in late 1998 as a result of capital
market turmoil. Pricing has generally remained attractive through the
end of 2000. In 1999 and 2000, our investment portfolio has ranged in
size from $0.8 billion to $1.3 billion, depending on the capital needs
of the rest of our balance sheet.
Our current plan is to reduce the relative importance of our investment
portfolio in our asset mix over time as we acquire residential credit
assets. We currently plan to add to this portfolio when prospective
returns are attractive relative to our other opportunities and, on a
temporary basis, when we raise new equity capital.
COMMERCIAL RETAINED PORTFOLIO
Redwood's primary business focus is on residential real estate finance.
On a limited basis, we also pursue opportunities in the commercial real
estate loan market. For several years, we have been originating
commercial real estate loans. Currently, our goal is to originate loans
for portfolio, although we also seek to sell our commercial loans from
time to time. We finance our commercial portfolio with committed bank
lines, and we are seeking to diversify our funding sources through
selling senior participations in our loans. We may acquire other types
of commercial mortgage assets in the future. Total commercial loans,
including those owned by our affiliate, RWT Holdings, Inc. ("Holdings"),
were $76 million at December 31, 2000.
OPERATIONS
Our portfolio management staff forms flexible interdisciplinary product
management teams that work to develop our four product lines and to
increase our profitability over time. Our finance staff participates on
these teams, and manages our overall balance sheet, borrowings, cash
position, accounting, finance, tax, equity issuance, and investor
relations.
We build and maintain relationships with mortgage originators, banks
that are likely to sell mortgage loan portfolios, Wall Street firms that
broker mortgage product, mortgage servicing companies that process
payments for us and assist with loss mitigation, technology and
information providers that can help us conduct our business more
effectively with the banks and Wall Street firms that provide us credit
and assist with the issuance of our long-term debt, and with commercial
property owners.
We evaluate, underwrite, and execute asset acquisitions and commercial
mortgage originations. We also evaluate potential asset sales. Some of
the factors that we take into consideration are: asset yield
characteristics; liquidity; anticipated credit losses; expected
prepayment rates; the cost of funding; the amount of capital necessary
to carry that investment in a prudent manner and to meet our internal
risk-adjusted capital guidelines; the cost of any hedging that might be
employed; potential market value fluctuations; contribution to our
overall asset/liability goals; potential earnings volatility in adverse
scenarios; and cash flow characteristics.
We monitor and actively manage our credit risks. We work closely with
our residential and commercial mortgage servicers, especially with
respect to all delinquent loans. While procedures for working out
troubled credit situations for residential loans are relatively
standardized, we still find that an intense focus on assisting and
monitoring our servicers in this process yields good results. We work to
enforce the representations and warranties of our sellers, forcing them
to repurchase loans if there is a breach of the conditions established
at purchase. If a mortgage pool starts to under-perform our
expectations, or if a servicer is not fully cooperative with our
monitoring efforts, we will often seek to sell a credit-enhancement
investment at the earliest opportunity before its market value is
diminished.
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Prior to acquisition of a credit-enhancement interest, we typically
review origination processes, servicing standards, and individual loan
data. In many cases, we underwrite individual loan files and influence
which loans are included in a securitization. Prior to acquisition of
whole loans for our residential retained loan portfolio, we conduct a
legal document review of the loans, review individual loan
characteristics, and underwrite loans that appear to have higher risk
characteristics. We only acquire the loans that we feel comfortable
with.
We actively monitor and adjust the asset/liability characteristics of
our balance sheet. We follow our internal risk-adjusted capital
guidelines, seeking to make sure that we are sufficiently capitalized to
hold our assets to maturity through periods of market fluctuation. We
intensely monitor our cash levels, the liquidity of our assets, the
stability of our borrowings, and our projected cash flows and market
values to make sure that we remain well funded and liquid. We generally
seek to match the interest rate characteristics of our assets and
liabilities within a range. If we cannot achieve our matching objectives
on-balance sheet, we use interest rate hedge agreements to adjust our
overall asset/liability mix. We monitor potential earnings fluctuations
and cash flow changes from prepayments. We project credit losses and
cash flows from our credit sensitive assets, and reassess our credit
provisions and reserves, based on information from our loss mitigation
efforts, borrower credit trends, and housing price trends. We regularly
monitor the market values of our assets and liabilities by reviewing
pricing from external and internal sources.
We initiate new short-term borrowings on a regular basis with a variety
of counter-parties. We structure long-term debt issuance. We model
potential securitizations as market conditions fluctuate, allowing us to
price potential loan acquisitions intended to be funded via long-term
debt in our retained loan portfolio. We work with the credit rating
agencies to determine credit-enhancement levels required to issue new
long-term debt. In cases where we intend to acquire a credit-enhancement
interest in a securitization performed by others, we sometimes assist
them with maximizing the efficiency of the structuring of their
securitization.
RISK FACTORS
The following is a summary of the risk factors that we currently believe
are important and that could cause our results to differ from
expectations. This is not an exhaustive list; other factors not listed
here could be material to our results.
We can provide no assurances with respect to projections or
forward-looking statements made by us or by others with respect to our
future results. Any one of the factors listed here, or other factors not
so listed, could cause actual results to differ materially from
expectations. It is not possible to accurately project future trends
with respect to these factors, or to project which factors will be most
important in determining our results, or to project what our future
results will be.
Throughout this Form 10-K and other company documents, the words
"believe", "expect", "anticipate", "intend", "aim", "will", and similar
words identify "forward-looking" statements.
Mortgage loan delinquencies, defaults, and credit losses could reduce
our earnings. We have other types of credit risk that could also cause
losses. Credit losses could reduce our cash flow and access to
liquidity.
As a core part of our business, we assume the credit risk of mortgage
loans. We do this in each of our portfolios. We may add other product
lines over time that may have different types of credit risk than are
described here. We are generally not limited in the types of assets that
we can own or in the types of credit risk or other types of risk that we
can undertake.
Credit losses on residential mortgage loans can occur for many reasons,
including: poor origination practices (leading to losses from fraud,
faulty appraisals, documentation errors, poor underwriting, legal
errors, etc.); poor servicing practices; weak economic conditions;
declines in the values of homes; special hazards; earthquakes and other
natural events; over-leveraging of the borrower; changes in legal
protections for lenders; reduction in personal incomes; job loss; and
personal events such as divorce or health problems.
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Of our total net investment in our credit-enhancement portfolio, 15%
($12 million) was in a first loss position with respect to the
underlying loans. We generally expect that the entire amount of these
first loss investments will be subject to credit loss, potentially even
in healthy economic environments. Our ability to make an attractive
return on these investments depends on how quickly these expected losses
occur. If the losses occur more quickly than we anticipate, we may not
recover our investment and/or our rates of return may suffer.
Second loss investments, which are subject to credit loss when the
entire first loss investment (whether owned by us or by others) has been
eliminated by credit losses, make up 26% ($21 million) of our net
investment in credit enhancement interests. Third loss investments, or
other investments that themselves enjoy various forms of material
credit-enhancement, make up 59% ($48 million) of our net investment in
credit enhancement interests. Given our normal expectations for credit
losses, we would anticipate some future losses on many of our second
loss interests but no losses on investments in the third loss or similar
position. If credit losses are greater than, or occur sooner than,
expected, our expected future cash flows will be reduced and our
earnings will be negatively affected. Credit losses and delinquencies
could also affect the cash flow dynamics of these securitizations and
thus extend the period over which we will receive a return of principal
from these investments. In most cases, this would reduce our economic
and accounting returns. From time to time, we may pledge these interests
as collateral for borrowings: a deterioration of credit results in this
portfolio may adversely affect the terms or availability of these
borrowings, and thus our liquidity.
In our credit-enhancement portfolio, we may benefit from credit rating
upgrades or restructuring opportunities through re-securitizations or
other means in the future. If credit results deteriorate, these
opportunities may not be available to us, or may be delayed.
In anticipation of future credit losses, we designate a portion of the
purchase discount associated with many of our credit enhancement
interests as a form of credit reserve. The remaining discount is
amortized into income over time via the effective yield method. If the
credit reserve we set aside at acquisition proves to be insufficient, we
may need to reduce our effective yield income recognition in the future
or we may adjust our basis in these interests, thus reducing earnings.
We are considering adopting EITF 99-20 during the first quarter of 2001.
Generally, under EITF 99-20, if prospective cash flows from certain
investments deteriorate even slightly from original expectations (due to
changes in anticipated credit losses, prepayment rates, and so forth),
then the asset will be marked-to-market (if the market value is lower
than our basis). Mark-to-market adjustments under EITF 99-20 will reduce
earnings.
In our residential retained loan portfolio, we assume the direct credit
risk of residential mortgages. Realized credit losses will reduce our
earnings and future cash flow. We have a credit reserve for these loans
and we may continue to add to this reserve in the future. There can be
no assurance that our credit reserve will be sufficient to cover future
losses. We may need to reduce earnings by increasing our
credit-provisioning expenses in the future. Prospective changes in
accounting rules may alter, limit, or eliminate our ability to create
such credit reserves.
Despite our efforts to manage our credit risk (as described in "Company
Business and Strategy: Operations"), there are many aspects of credit
that we cannot control, and there can be no assurance that our quality
control and loss mitigation operations will be successful in limiting
future delinquencies, defaults, and losses. Our underwriting reviews may
not be effective. The representations and warranties that we receive
from sellers may not be enforceable. We may not receive funds that we
believe we are due to us from mortgage insurance companies. We rely on
our servicers; they may not cooperate with our loss mitigation efforts,
or such efforts may otherwise be ineffective. Various service providers
to securitizations (such as trustees, bond insurance providers,
custodians, etc.) may not perform in a manner that promotes our
interests. The value of the homes collateralizing our loans may decline.
The frequency of default, and the loss severity on our loans upon
default, may be greater than we anticipated. Interest-only loans,
negative amortization loans, loans with balances over $1 million, and
loans that are partially collateralized by non-real estate assets may
have special risks. Our geographical diversification may be ineffective
in reducing losses. If loans become REO (real estate owned), we, or our
agents, will have to manage these properties and may not be able to sell
them. Changes in consumer behavior, bankruptcy laws, and the like may
exacerbate our losses. In some states and circumstances, we have
recourse against the borrower's other assets and income; but,
nevertheless, we may only be able to look to the value of the underlying
property for any
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recoveries. Expanded loss mitigation efforts in the event that defaults
increase could be costly. It is likely, in many instances, that we will
not be able to anticipate increased credit losses in a pool soon enough
to allow us to sell such credit-enhancement interests at a reasonable
price.
Most of our investment portfolio assets (99% at December 31, 2000) were
effectively rated AAA or AA. These assets benefit from various forms of
corporate guarantees from Fannie Mae, Freddie Mac, and other companies
and/or from credit enhancement provided by third parties (usually
through their ownership of subordinated credit enhancement interests).
Thus, our investment portfolio assets are protected from currently
expected levels of credit losses. However, in the event of greater than
expected future delinquencies, defaults, or credit losses, or a
substantial deterioration in the financial strength of Fannie Mae,
Freddie Mac, or other corporate guarantors, our results would likely be
adversely affected. We may experience credit losses. Deterioration of
the credit results or guarantees of these assets may reduce the market
value of these assets, thus limiting our borrowing capabilities and
access to liquidity. Generally, we do not control or influence the
underwriting, servicing, management, or loss mitigation efforts with
respect to these assets. Results could be affected through credit rating
downgrades, market value losses, reduced liquidity, adverse financing
terms, reduced cash flow, experienced credit losses, or in other ways.
To the extent that we invest in non-investment grade assets in our
investment portfolio (1% of our investment portfolio at December 31,
2000), our protection against credit loss is smaller and our credit
risks and liquidity risks are increased. If we acquire equity
securities, results may be volatile.
The loans in our commercial retained loan portfolio may have higher
degrees of credit and other risks than do our residential mortgage
loans, including various environmental and legal risks. The net
operating income and market values of income-producing properties may
vary with economic cycles and as a result of other factors, so that debt
service coverage is unstable. The value of the property may not protect
the value of the loan if there is a default. Our commercial loans are
not geographically diverse, so we are at risk for regional factors: at
December 31, 2000, $56 million (73%) of our loan balances that we held
at Redwood and Holdings were on commercial properties located in
California. Many of our commercial loans are not fully amortizing, so
the timely recovery of our principal is dependent on the borrower's
ability to refinance at maturity. We lend against income-properties that
are in transition. Such lending entails higher risks than traditional
commercial property lending against stabilized properties. Initial debt
service coverage ratios, loan-to-value ratios, and other indicators of
credit quality may not meet standard commercial mortgage market
criteria. The underlying properties may not transition or stabilize as
expected. Personal guarantees and forms of cross-collateralization may
not be effective. We generally do not service our loans; we rely on our
servicers to a great extent to manage our commercial assets and work out
loans and properties if there are delinquencies or defaults. This may
not work to our advantage. Our loans are illiquid; if we choose to sell
them, we may not be able to do so in a timely manner or for a reasonable
price. Financing these loans may be difficult, and may become more
difficult if credit quality deteriorates. We may sell senior
participations in our loans, or similarly divide our loan assets so that
the asset we retain is junior and has concentrated credit and other
risks. We have directly originated our commercial loans. This may expose
us to certain credit, legal, and other risks that may be greater than is
usually present with acquired loans. We have sold commercial mortgage
loans. The representations and warranties we made on these sales are
limited, but could cause losses in some circumstances. We may invest in
other types of commercial loan assets, such as mezzanine loans, second
liens, credit-enhancement interests of commercial loan securitizations,
junior participations, collateralized bond obligations (CBO's), and so
forth, that may entail other types of risks.
Aside from mortgage credit risk, we have other credit risks that are
generally related to the counter-parties with which we do business. In
the event a counter-party to our short-term borrowings becomes
insolvent, we may fail in recovering the full value of our collateral,
thus reducing our earnings and liquidity. In the event a counter-party
to our interest rate agreements becomes insolvent, our ability to
realize benefits from hedging may be diminished, and any cash or
collateral that we pledged to these counter-parties may be
unrecoverable. We may be forced to unwind these agreements at a loss. In
the event that one of our servicers becomes insolvent or fails to
perform, loan delinquencies and credit losses may increase. We may not
receive funds to which we are entitled. In various other aspects of our
business, we depend on the performance of third parties that we do not
control. We attempt to diversify our counter-party exposure and to limit
our counter-party exposure to strong companies with investment-grade
credit ratings, but we are not always able to do so. Our counter-party
risk management strategy may prove ineffective.
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Tax and GAAP accounting for credit losses differ. We have not reduced
our past and current taxable income to provide for a reserve for future
credit losses. Thus, if credit losses occur in the future, taxable
income may be reduced relative to GAAP income. When taxable income is
reduced, our minimum dividend distribution requirements under the REIT
tax rules are reduced. We could reduce our dividend rate in such a
circumstance. Alternatively, credit losses in our assets may be capital
losses for tax. Unless we had offsetting capital gains, our minimum
dividend distribution requirement would not be reduced by these credit
losses, but eventually our cash flow would be. This could reduce our
free cash flow and liquidity.
If we incur increased levels of credit losses, our earnings might be
reduced, but also our cash flows, asset market values, and access to
borrowings might be reduced. The amount of capital and cash reserves
that we hold to help us manage credit and other risks may prove to be
insufficient to protect us from earnings volatility, liquidity, and
solvency issues.
Fluctuations in our results may be exacerbated by the leverage that we
employ and by liquidity risks.
We employ substantial financial leverage on our balance sheet relative
to many non-financial companies (although we employ less leverage than
most banks, thrifts, and other financial institutions). We believe the
amount of leverage that we employ is appropriate, given the risks in our
balance sheet, the financing structures that we employ, and our
management policies. In order to operate our business successfully, we
require continued access to debt on favorable terms with respect to
financing costs, capital efficiency, covenants, and other factors. We
may not be able to achieve the optimal amount of leverage.
Given the degree of leverage that we employ, earnings fluctuations, and
liquidity and financial soundness issues could arise in the future. Due
to our leverage, relatively small changes in asset quality, asset yield,
cost of borrowed funds, and other factors could have relatively large
effects on our company and our stockholders. Our use of leverage may not
enhance our returns.
Although we do not have a corporate debt rating, the
nationally-recognized credit rating agencies have a strong influence on
the amount of capital that we hold relative to the amount of credit risk
we take. The rating agencies determine the amount of net investment we
must make to credit-enhance the long-term debt (mostly rated AAA) that
we issue to fund our residential retained loan portfolio. They also
determine the amount of principal value required for the
credit-enhancement interests we acquire. The credit-rating agencies,
however, do not have influence over how we fund our net credit
investments nor do they determine or influence many of our other capital
and leverage policies. With respect to our short-term debt, our lenders
(typically large commercial banks and Wall Street firms) limit the
amount of funds that they will advance versus our collateral. We
typically employ far less leverage than would be permitted by our
lenders. However, lenders can reduce the amount of leverage that they
will permit us to undertake, or the value of our collateral may decline,
thus reducing our liquidity.
Unlike banks, thrifts, and the government-sponsored real estate finance
companies, we are not regulated by national regulatory bodies. Thus, the
amount of financial leverage that we employ is largely controlled by
management, and by the risk-adjusted capital policies approved by our
Board of Directors.
In the period in which we are accumulating residential whole loans in
order to build a portfolio of efficient size to issue long-term debt,
variations in the market for long-term debt issuance could affect our
results. Ultimately we may not be able to issue long term debt, the cost
of such debt could be greater than we anticipated, the net investment in
our financing trust required by the rating agencies could be greater
than anticipated, certain of our loans could not be accepted into the
financing trust, or other negative effects could occur.
We borrow on a short-term basis to fund our investment portfolio, to
fund residential loans prior to the issuance of long-term debt, to
employ a certain amount of leverage with respect to our net investments
in credit-enhancement interests, to fund our commercial loan portfolio,
to fund working capital and general corporate needs, and for other
reasons. We borrow short-term by pledging our mortgage assets as
collateral. We usually borrow via uncommitted borrowing facilities for
the substantial majority of our short-term debt funded assets that are
generally liquid, have active trading markets, and have readily
discernible market prices. The term of these borrowings can range from
one day to one year. To fund less liquid or more specialized assets, we
typically utilize committed
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credit lines from commercial banks and finance companies with a one to
two year term. Whether committed or not, we need to roll over short-term
debt on a frequent basis; our ability to borrow is dependent on our
ability to deliver sufficient market value of collateral to meet lender
requirements. Our payment of commitment fees and other expenses to
secure committed borrowing lines may not protect us from liquidity
issues or losses. Variations in lenders' ability to access funds, lender
confidence in Redwood, lender collateral requirements, available
borrowing rates, the acceptability and market values of our collateral,
and other factors could force us to utilize our liquidity reserves or to
sell assets, and thus affect our liquidity, financial soundness, and
earnings. In recent years, we believe that the marketplace for our type
of secured short-term borrowing has been more stable than the commercial
paper market (corporate unsecured short-term borrowing) utilized by much
of corporate America, but there is no assurance that such stability will
continue.
Various of our borrowing arrangements subject us to debt covenants.
While these covenants have not been restrictive through December 31,
2000, they could be restrictive or harmful to stockholder interests in
the future. Should we violate debt covenants, we may incur expenses,
losses, or reduced ability to access debt.
Preferred stock makes up a portion of our equity capital base (12% at
December 31, 2000). Our Class B Preferred Stock has a dividend rate of
at least $0.755 per share per quarter, and has certain rights to
dividend distributions (and preferences in liquidation) that are senior
to common stockholders. Having preferred stock in our capital structure
is a form of leverage, and such leverage may or may not work to the
advantage of common stockholders.
Changes in the market values of our assets and liabilities can adversely
affect our earnings, stockholders' equity, and liquidity.
The market values of our assets, liabilities, and hedges are affected by
interest rates, the shape of yield curves, volatility, credit quality
trends, mortgage prepayment rates, supply and demand, capital markets
trends and liquidity, general economic trends, expectations about the
future, and other factors. For the assets that we mark-to-market through
our income statement and/or balance sheet, such market value
fluctuations will affect our earnings and book value. To the extent that
our basis in our assets is thus changed, future income will be affected
as well. If we sell an asset that has not been marked-to-market through
our income statement at a reduced market price relative to our basis,
our earnings will be reduced. Market value reductions of the assets that
we pledge for short-term borrowings may reduce our access to liquidity.
Generally, reduced asset market values for the assets that we own may
have negative effects, but might improve our opportunities to acquire
new assets at attractive pricing levels. Increases in the market values
of our existing assets may have positive effects, but may mean that
acquiring new assets at attractive prices becomes more difficult.
Changes in mortgage prepayment rates may affect our earnings, liquidity,
and the market values of our assets.
Mortgage prepayment rates are affected by interest rates, consumer
behavior and confidence, seasoning of loans, the amount of equity in the
underlying properties, prepayment terms of the mortgages, the ease and
cost of refinancing, the housing turnover rate, media awareness of
refinancing opportunities, and many other factors.
Changes in prepayment rates may have multiple effects on our operations.
Faster mortgage prepayment rates may lead to increased premium
amortization expenses for premium assets, increased working capital
requirements, reduced market values for certain types of assets, adverse
reductions in the average life of certain assets, and an increase in the
need to reinvest cash to maintain operations. Premium assets may
experience faster rates of prepayments than discount assets. Slower
prepayment rates may lead to reduced discount amortization income for
discount assets, reduced market values for discount and other types of
assets, extension of the average life of certain investments at a time
when this would be contrary to our interests, a reduction in cash flow
available to support operations and make new investments, and a
reduction in new investment opportunities (since the volume of new
origination and securitizations would likely decline). Slower prepayment
rates may lead to increased credit losses.
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The amount of premium and discount we have on our books, and thus our
net amortization expenses, can change over time as we mark-to-market
assets or as our asset composition changes through principal repayments
and asset purchases and sales.
Interest rate fluctuations can have various effects on our company, and
could lead to reduced earnings and / or increased earnings volatility.
Our balance sheet and asset/liability operations are complex and diverse
with respect to interest rate movements, so it is not possible to
describe all the possible effects of changing interest rates. We do not
seek to eliminate all interest rate risk. Changes in interest rates, and
in the interrelationships between various interest rates, could have
negative effects on our earnings, the market value of our assets and
liabilities, mortgage prepayment rates, and our access to liquidity.
Changes in interest rates can also affect our credit results.
Generally, rising interest rates could lead to reduced asset market
values and slower prepayment rates. Initially, our net interest income
may be reduced if short-term interest rates increase, as our cost of
funds would likely respond to this increase more quickly than would our
asset yields. Within 3 to 12 months of a rate change, however, asset
yields for our adjustable rate mortgages may increase commensurately
with the rate increase. Higher short-term interest rates may reduce
earnings in the short-term, but could lead to higher long-term earnings,
as we earn more on the equity-funded portion of our balance sheet. To
the extent that we own fixed rate assets that are funded with floating
rate debt, our net interest income from this portion of our balance
sheet would be unlikely to recover until interest rates dropped again or
the assets matured. Many of our adjustable-rate mortgages have periodic
caps that limit the extent to which the coupon we earn can rise or fall
(usually a 2% annual cap) and life caps that set a maximum coupon
(averaging 11.43% for our portfolio). If short-term interest rates rise
rapidly or rise so that our mortgage coupons reach their life caps, the
ability of our asset yields to rise along with market rates would be
limited, but there would be no such limits on the increase in our
liability costs.
Falling interest rates can also lead to reduced asset market values in
some circumstances, particularly for prepayment sensitive assets and for
many types of interest rate agreement hedges. Decreases in short-term
interest rates can be positive for earnings in the near-term, as our
cost of funds may decline more quickly than our asset yields would. For
longer time horizons, falling short-term interest rates can reduce our
earnings, as we may earn lower yields from the assets that are
equity-funded on our balance sheet.
Changes in the interrelationships between various interest rates can
reduce our net interest income even in the absence of a clearly defined
interest rate trend. If the short-term interest rate indices that drive
our asset yields were to decline relative to the short-term interest
rate indices that determine our cost of funds, our net interest income
would be reduced.
Hedging activities may reduce long-term earnings and may fail to reduce
earnings volatility or to protect the capital of the company in
difficult economic environments.
Hedging against interest rate movements using interest rate agreements
and other instruments usually has the effect over long periods of time
of lowering long-term earnings. To the extent that we hedge, it is
usually to protect the company from some of the effects of a rapid or
prolonged increase in short-term interest rates or to lower short-term
earnings volatility. Such hedging may not be in the long-term interest
of stockholders, and may not achieve its desired goals. For instance,
hedging costs may rise as interest rates increase, without an offsetting
increase in hedging income. In a rapidly rising interest rate
environment, the market values of hedges may not increase as predicted.
Using interest rate agreements to hedge may increase short-term earnings
volatility, particularly since we employ mark-to-market accounting for
all our hedges. Reductions in market values of interest rate agreements
may not be offset by increases in market values of the assets or
liabilities being hedged. Changes in market values of interest rate
agreement hedges may require us to pledge collateral or cash.
Maintaining REIT status may reduce our flexibility.
To maintain REIT status, we must follow rules and meet certain tests. In
doing so, our flexibility to manage our operations may be reduced.
Frequent asset sales (acting as a "dealer") may be inconsistent with
REIT regulations.
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Certain types of hedging may produce income that is limited under the
REIT rules. Our ability to own non-real estate related assets and earn
non-real estate related income is limited. Meeting minimum REIT dividend
distribution requirements may reduce our liquidity. Because we
distribute much of our earnings as dividends, we may need to raise new
equity capital in order to grow operations at a rapid pace. Stock
ownership tests may limit our ability to raise significant amounts of
equity capital from one source. Failure to meet REIT requirements may
subject us to taxation, penalties, and / or loss of REIT status. REIT
laws and taxation could change in a manner adverse to our operations. To
pursue our business plan as a REIT, we generally need to avoid becoming
a Registered Investment Company (RIC). To avoid RIC restrictions, we
generally need to maintain at least 55% of our assets in whole loan form
or in other related forms of assets that qualify for this test. Meeting
this test may restrict our flexibility. Failure to meet this test would
limit our ability to leverage and would impose other restrictions on our
operations. Our ability to operate a taxable subsidiary is limited under
the REIT rules. Our REIT status affords us certain protections against
take-over attempts; these take-over restrictions may not always work to
the advantage of stockholders.
Our cash balances and cash flows may become limited relative to our cash
needs.
We need cash to meet our working capital needs, preferred stock
dividend, and minimum REIT dividend distribution requirements. Cash
could be required to pay down our borrowings in the event that the
market values of our assets that collateralize our debt decline, the
terms of short-term debt become less attractive, or for other reasons.
Cash flows from principal repayments could be reduced should prepayments
slow or credit quality trends deteriorate (for certain of our assets,
credit tests must be met for us to receive cash flows). For some of our
assets, cash flows are "locked-out" and we receive less than our
pro-rata share of principal payment cash flows in the early years of the
investment. Operating cash flow generation could be reduced if earnings
are reduced, if discount amortization income significantly exceeds
premium amortization expense, or for other reasons. Our minimum dividend
distribution requirements could become large relative to our cash flow
if our income as calculated for tax purposes significantly exceeds our
cash flow from operations. Generally, our cash flow has materially
exceeded our cash requirements. We generally maintain what we believe
are ample cash balances and access to borrowings to meet projected cash
needs. In the event, however, that our liquidity needs exceed our access
to liquidity, we may need to sell assets at an inopportune time, thus
reducing our earnings. In a serious situation, our REIT status or our
solvency could be threatened.
Increased competition could reduce our acquisition opportunities or
affect our operations in a negative manner.
We believe that our principal competitors in our business of real estate
finance are depositories such as banks and thrifts, mortgage and bond
insurance companies, other mortgage REITs, hedge funds and private
investment partnerships, life insurance companies, government entities
such as Fannie Mae, Freddie Mac, Ginnie Mae, and the Federal Home Loan
Banks, mutual funds, pension funds, mortgage originators, and other
financial institutions. We anticipate that we will be able to compete
effectively due to our relatively low level of operating costs, relative
freedom to securitize our assets, our ability to utilize leverage,
freedom from certain forms of regulation, focus on our core business,
and the tax advantages of our REIT status. Nevertheless, most of our
competitors have greater operating and financial resources than we do.
Competition from these entities, or new entrants, could raise mortgage
prices, reduce our acquisition opportunities, or otherwise materially
effect our operations in a negative manner.
Mortgage assets may not be available at attractive prices, thus limiting
our growth and / or earnings.
In order to reinvest proceeds from mortgage principal repayments, or to
deploy new equity capital that we may raise in the future, we need to
acquire new mortgage assets. If pricing of mortgage assets is
unattractive, or if the availability of mortgage assets is much reduced,
we may not be able to acquire new assets at attractive prices. Our new
assets may generate lower returns than the assets that we have on our
balance sheet. Generally, unattractive pricing and availability of
mortgage assets is a function of reduced supply and / or increased
demand. Supply can be reduced if originations of a particular product
are reduced, or if there are few sales in the secondary market of
seasoned product from existing portfolios. The supply of securitized
mortgages appropriate for our balance sheet could be reduced if the
economics of securitization become unattractive or if a form of
securitization that is not favorable for our balance sheet predominates.
Also, assets with a favorable risk/reward ratio may not be available
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if the risks of owning mortgages increase substantially relative to
market pricing levels. Increased competition could raise prices to
unattractive levels.
Accounting conventions can change, thus affecting our reported results
and operations.
Accounting rules for the various aspects of our business change from
year to year. While we believe we use conservative accounting methods,
changes in accounting rules can nevertheless affect our reported income
and stockholders' equity.
Our policies, procedures, practices, product lines, risks, and internal
risk-adjusted capital guidelines are subject to change.
Our company is operated by its management and Board of Directors. In
general, we are free to alter our policies, procedures, practices,
product lines, leverage, risks, internal risk-adjusted capital
guidelines, and other aspects of our business. We can enter new
businesses, or pursue acquisitions of other companies. In most cases, we
do not need to seek stockholder approval to make such changes. We will
not necessarily notify stockholders of such changes.
We depend on key personnel for successful operations.
We depend significantly on the contributions of our executive officers
and staff. Many of our officers and employees would be difficult to
replace. The loss of any key personnel could materially affect our
results.
Investors in our common stock may experience losses, volatility, and
poor liquidity.
Our earnings, cash flow, book value, and dividends can be volatile and
difficult to predict. Investors should not rely on predictions.
Fluctuations in our current and prospective earnings, cash flow, and
dividends, as well as many other factors such as perceptions, economic
conditions, stock market conditions, and the like, can affect our stock
price. Investors may experience volatile returns and material losses. In
addition, liquidity in the trading of our stock may be insufficient to
allow investors to sell their stock in a timely manner or at a
reasonable price.
RWT HOLDINGS, INC BUSINESS AND STRATEGY
RWT Holdings, Inc. ("Holdings") was formed in 1998 to originate and sell
commercial mortgages. Holdings also engaged in other mortgage finance
businesses that were closed in 1999. On January 1, 2001, the common
stockholders of Holdings sold their stock to Redwood, thus giving
Redwood the 1% economic interest in Holdings that it did not already
own. Starting in 2001, Redwood will operate Holdings as a 100%-owned
subsidiary and will consolidate Holdings' financial statements with its
own financial statements. See Redwood's Business and Strategy:
Commercial Retained Portfolio, Risk Factors, and Management's Discussion
and Analysis: Results of Operations: Commercial Retained Portfolio as
well as Holdings' Management's Discussion and Analysis for more
information.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The following discussion summarizes certain Federal income tax
considerations to Redwood Trust and its stockholders. This discussion is
based on existing Federal income tax law, which is subject to change,
possibly retroactively. This discussion does not address all aspects of
Federal income taxation that may be relevant to a particular stockholder
in light of its personal investment circumstances or to certain types of
investors subject to special treatment under the Federal income tax laws
(including financial institutions, insurance companies, broker-dealers
and, except to the extent discussed below, tax-exempt entities and
foreign taxpayers) and it does not discuss any aspects of state, local
or foreign tax law. This discussion assumes that stockholders will hold
their Common Stock as a "capital asset" (generally, property held for
investment) under the Code. Stockholders are advised to
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consult their tax advisors as to the specific tax consequences to them
of purchasing, holding and disposing of the Common Stock, including the
application and effect of Federal, state, local and foreign income and
other tax laws.
GENERAL
Redwood Trust has elected to become subject to tax as a REIT, for
Federal income tax purposes, commencing with the taxable year ending
December 31, 1994. Management currently expects that Redwood Trust will
continue to operate in a manner that will permit Redwood Trust to
maintain its qualifications as a REIT. This treatment will permit
Redwood Trust to deduct dividend distributions to its stockholders for
Federal income tax purposes, thus effectively eliminating the "double
taxation" that generally results when a corporation earns income and
distributes that income to its stockholders.
There can be no assurance that Redwood Trust will continue to qualify as
a REIT in any particular taxable year, given the highly complex nature
of the rules governing REITs, the ongoing importance of factual
determinations and the possibility of future changes in the
circumstances of Redwood Trust. If Redwood Trust failed to qualify as a
REIT in any particular year, it would be subject to Federal income tax
as a regular, domestic corporation, and its stockholders would be
subject to tax in the same manner as stockholders of such corporation.
In this event, Redwood Trust could be subject to potentially substantial
income tax liability in respect of each taxable year that it fails to
qualify as a REIT and the amount of earnings and cash available for
distribution to its stockholders could be significantly reduced or
eliminated.
The following is a brief summary of certain technical requirements that
Redwood Trust must meet on an ongoing basis in order to qualify, and
remain qualified, as a REIT under the Code.
STOCK OWNERSHIP TESTS
The capital stock of Redwood Trust must be held by at least 100 persons
and no more than 50% of the value of such capital stock may be owned,
directly or indirectly, by five or fewer individuals at all times during
the last half of the taxable year. Under the Code, most tax-exempt
entities including employee benefit trusts and charitable trusts (but
excluding trusts described in 401(a) and exempt under 501(a)) are
generally treated as individuals for these purposes. Redwood Trust must
satisfy these stock ownership requirements each taxable year. Redwood
Trust must solicit information from certain of its stockholders to
verify ownership levels and its Articles of Incorporation provide
restrictions regarding the transfer of Redwood Trust's shares in order
to aid in meeting the stock ownership requirements. If Redwood Trust
were to fail either of the stock ownership tests, it would generally be
disqualified from REIT status, unless, in the case of the "five or
fewer" requirement, the "good faith" exemption is available.
ASSET TESTS
For tax years beginning before December 31, 2000, Redwood Trust must
generally meet the following asset tests (the "REIT Asset Tests") at the
close of each quarter of each taxable year:
(a) at least 75% of the value of Redwood Trust's total assets
must consist of Qualified REIT Real Estate Assets, government
securities, cash, and cash items (the "75% Asset Test"); and
(b) the value of securities held by Redwood Trust but not taken
into account for purposes of the 75% Asset Test must not exceed
either (i) 5% of the value of Redwood Trust's total assets in
the case of securities of any one non-government issuer, or (ii)
10% of the outstanding voting securities of any such issuer.
For tax years beginning after December 31, 2000, Redwood Trust must
generally meet the following REIT Asset Tests at the close of each
quarter of each taxable year:
(a) the 75% Asset Test;
(b) not more than 25% of the value of Redwood Trust's total
assets is represented by securities (other than those includible
under the 75% Asset Test);
(c) not more than 20% of the value of Redwood Trust's total
assets is represented by securities of one or more taxable REIT
subsidiary; and
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(d) the value of securities held by Redwood Trust, other than
those of a taxable REIT subsidiary or taken into account for
purposes of the 75% Asset Test, must not exceed either (i) 5% of
the value of Redwood Trust's total assets in the case of
securities of any one non-government issuer, or (ii) 10% of the
outstanding vote or value of any such issuer's securities.
Redwood Trust expects that substantially all of its assets will be
Qualified REIT Real Estate Assets. In addition, Redwood Trust does not
expect that the value of any non-qualifying security of any one entity,
including interests in taxable affiliates, would ever exceed 5% of
Redwood Trust's total assets, and Redwood Trust does not expect to own
more than 10% of the vote or value of any one issuer's securities.
Redwood Trust intends to monitor closely the purchase, holding and
disposition of its assets in order to comply with the REIT Asset Tests.
In particular, Redwood Trust intends to limit and diversify its
ownership of any assets not qualifying as Qualified REIT Real Estate
Assets to less than 25% of the value of Redwood Trust's assets, to less
than 5%, by value, of any single issuer and to less than 20%, by value,
of any taxable REIT subsidiaries. If it is anticipated that these limits
would be exceeded, Redwood Trust intends to take appropriate measures,
including the disposition of non-qualifying assets, to avoid exceeding
such limits.
GROSS INCOME TESTS
Redwood Trust must generally meet the following gross income tests (the
"REIT Gross Income Tests") for each taxable year:
(a) at least 75% of Redwood Trust's gross income must be derived
from certain specified real estate sources including interest
income and gain from the disposition of Qualified REIT Real
Estate Assets or "qualified temporary investment income" (i.e.,
income derived from "new capital" within one year of the receipt
of such capital) (the "75% Gross Income Test"); and,
(b) at least 95% of Redwood Trust's gross income for each
taxable year must be derived from sources of income qualifying
for the 75% Gross Income Test, or from dividends, interest, and
gains from the sale of stock or other securities (including
certain interest rate swap and cap agreements, options, futures
and forward contracts entered into to hedge variable rate debt
incurred to acquire Qualified REIT Real Estate Assets) not held
for sale in the ordinary course of business (the "95% Gross
Income Test").
Redwood Trust intends to maintain its REIT status by carefully
monitoring its income, including income from hedging transactions and
sales of mortgage assets, to comply with the REIT Gross Income Tests. In
accordance with the code, Redwood Trust will treat income generated by
its interest rate caps and other hedging instruments as qualifying
income for purposes of the 95% Gross Income Tests to the extent the
interest rate cap or other hedging instrument was acquired to reduce the
interest rate risks with respect to any indebtedness incurred or to be
incurred by Redwood Trust to acquire or carry real estate assets. In
addition, Redwood Trust will treat income generated by other hedging
instruments as qualifying or non-qualifying income for purposes of the
95% Gross Income Test depending on whether the income constitutes gains
from the sale of securities as defined by the Investment Company Act of
1940. Under certain circumstances, for example, (i) the sale of a
substantial amount of mortgage assets to repay borrowings in the event
that other credit is unavailable or (ii) unanticipated decrease in the
qualifying income of Redwood Trust which may result in the
non-qualifying income exceeding 5% of gross income, Redwood Trust may be
unable to comply with certain of the REIT Gross Income Tests. See " -
Taxation of Redwood Trust" below for a discussion of the tax
consequences of failure to comply with the REIT Provisions of the Code.
DISTRIBUTION REQUIREMENT
For tax years before 2001, Redwood Trust must generally distribute to
its stockholders an amount equal to at least 95% of Redwood Trust's REIT
taxable income before deductions of dividends paid and excluding net
capital gain. Beginning with the 2001 tax year, this REIT distribution
requirement is reduced to 90%.
The IRS has ruled that if a REIT's dividend reinvestment plan allows
stockholders of the REIT to elect to have cash distributions reinvested
in shares of the REIT at a purchase price equal to at least 95% of the
fair market value of such shares on the distribution date, then such
distributions qualify under the distribution requirement.
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Redwood Trust maintains a Dividend Reinvestment and Stock Purchase Plan
("DRP") and intends that the terms of its DRP will comply with this
ruling.
QUALIFIED REIT SUBSIDIARIES
Redwood Trust currently holds some of its assets through Sequoia
Mortgage Funding Corporation, a wholly-owned subsidiary, which is
treated as a "Qualified REIT Subsidiary". As such its assets,
liabilities and income are generally treated as assets, liabilities and
income of Redwood Trust for purposes of each of the above REIT
qualification tests.
TAXABLE REIT SUBSIDIARIES
Effective January 1, 2001, RWT Holdings, Inc. ("Holdings") and Redwood
Trust elected to treat Holdings as a "taxable REIT subsidiary" of
Redwood Trust. As a "taxable REIT subsidiary", Holdings is not subject
to the asset, income and distribution requirements of Redwood Trust nor
are its assets, liabilities or income treated as assets, liabilities or
income of Redwood Trust for purposes of each of the above REIT
qualification tests. "Taxable REIT subsidiaries" are prohibited from,
directly or indirectly, operating or managing a lodging or healthcare
facility or providing to any person, under franchise, license or
otherwise, rights to any lodging or healthcare facility brand name. In
addition, Redwood Trust will be subject to a 100% penalty tax on any
rent or other charges that it imposes on any taxable REIT subsidiary in
excess or an arm's length price for comparable services. Redwood Trust
expects that any rents and charges imposed on Holdings or any taxable
REIT subsidiary will be at arm's length prices.
TAXATION OF REDWOOD TRUST
In any year in which Redwood Trust qualifies as a REIT, Redwood Trust
will generally not be subject to Federal income tax on that portion of
its REIT taxable income or capital gain that is distributed to its
stockholders. Redwood Trust will, however, be subject to Federal income
tax at normal corporate income tax rates upon any undistributed taxable
income or capital gain.
Notwithstanding its qualification as a REIT, Redwood Trust may also be
subject to tax in certain other circumstances. If Redwood Trust fails to
satisfy either the 75% or the 95% Gross Income Test, but nonetheless
maintains its qualification as a REIT because certain other requirements
are met, it will generally be subject to a 100% tax on the greater of
the amount by which Redwood Trust fails either the 75% or the 95% Gross
Income Test. Redwood Trust will also be subject to a tax of 100% on net
income derived from any "prohibited transaction" (which includes
dispositions of property classified as "dealer" property) and if Redwood
Trust has (i) net income from the sale or other disposition of
"foreclosure property" which is held primarily for sale to customers in
the ordinary course of business or (ii) other non-qualifying income from
foreclosure property, it will be subject to Federal income tax on such
income at the highest corporate income tax rate. In addition, if Redwood
Trust fails to distribute during each calendar year at least the sum of
(i) 85% of its REIT ordinary income for such year and (ii) 95% of its
REIT capital gain net income for such year, Redwood Trust would be
subject to a 4% Federal excise tax on the excess of such required
distribution over the amounts actually distributed during the taxable
year, plus any undistributed amount of ordinary and capital gain net
income from the preceding taxable year. Redwood Trust may also be
subject to the corporate alternative minimum tax, as well as other taxes
in certain situations not presently contemplated.
If Redwood Trust fails to qualify as a REIT in any taxable year and
certain relief provisions of the Code do not apply, Redwood Trust would
be subject to Federal income tax (including any applicable alternative
minimum tax) on its taxable income at the regular corporate income tax
rates. Distributions to stockholders in any year in which Redwood Trust
fails to qualify as a REIT would not be deductible by Redwood Trust, nor
would they generally be required to be made under the Code. Further,
unless entitled to relief under certain other provisions of the Code,
Redwood Trust would also be disqualified from re-electing REIT status
for the four taxable years following the year in which it became
disqualified.
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Redwood Trust intends to monitor on an ongoing basis its compliance with
the REIT requirements described above. In order to maintain its REIT
status, Redwood Trust will be required to limit the types of assets that
Redwood Trust might otherwise acquire, or hold certain assets at times
when Redwood Trust might otherwise have determined that the sale or
other disposition of such assets would have been more prudent.
TAXABLE AFFILIATES
Redwood Trust intends to undertake certain hedging activities, the
creation of mortgage securities through securitization, and may
originate, sell and manage residential and commercial mortgage loans and
other assets through its taxable affiliates. Redwood Trust has not
elected to treat these taxable affiliates as "taxable REIT
subsidiaries." In order to ensure that Redwood Trust does not violate
the more than 10% stock of a single issuer limitation described above,
Redwood Trust owns (or will own) only 10% or less of the vote or value
of such taxable affiliate's stock and the other persons own (or will
own) all of the remaining stock of such taxable affiliates. The value of
Redwood Trust's investment in such taxable affiliates must also be
limited to less than 5% of the value of Redwood Trust's total assets at
the end of each calendar quarter so that Redwood Trust can also comply
with the 5% of value, single issuer asset limitation described above
under " - General - Asset Tests." The taxable affiliates do not elect
REIT status and distribute only net after-tax profits to their
stockholders, including Redwood Trust. Before Redwood Trust engages in
any hedging or securitization activities or uses any such taxable
affiliates, Redwood Trust will obtain an opinion of counsel to the
effect that such activities or the formation and contemplated method of
operation of such corporation will not cause Redwood Trust to fail to
satisfy the REIT Asset and REIT Gross Income Tests.
TAXATION OF STOCKHOLDERS
Distributions (including constructive distributions) made to holders of
Common Stock other than tax-exempt entities (and not designated as
capital gain dividends) will generally be subject to tax as ordinary
income to the extent of Redwood Trust's current and accumulated earnings
and profits as determined for Federal income tax purposes. If the amount
distributed exceeds a stockholder's allocable share of such earnings and
profits, the excess will be treated as a return of capital to the extent
of the stockholder's adjusted basis in the Common Stock, which will not
be subject to tax, and thereafter as a taxable gain from the sale or
exchange of a capital asset.
Distributions designated by Redwood Trust as capital gain dividends will
generally be subject to tax as long-term capital gain to stockholders,
to the extent that the distribution does not exceed Redwood Trust's
actual net capital gain for the taxable year. Distributions by Redwood
Trust, whether characterized as ordinary income or as capital gain, are
not eligible for the corporate dividends received deduction. In the
event that Redwood Trust realizes a loss for the taxable year,
stockholders will not be permitted to deduct any share of that loss.
Further, if Redwood Trust (or a portion of its assets) were to be
treated as a taxable mortgage pool, any "excess inclusion income" that
is allocated to a stockholder would not be allowed to be offset by a net
operating loss of such stockholder.
Dividends declared during the last quarter of a taxable year and
actually paid during January of the following taxable year are generally
treated as if received by the stockholder on the record date of the
dividend payment and not on the date actually received. In addition,
Redwood Trust may elect to treat certain other dividends distributed
after the close of the taxable year as having been paid during such
taxable year, but stockholders will be treated as having received such
dividend in the taxable year in which the distribution is made.
Generally, a dividend distribution of earnings from a REIT is considered
for estimated tax purposes only when the dividend is made. However,
recently enacted legislation, effective December 15, 1999, requires any
person owning at least 10% of the vote or value of a closely-held REIT
to accelerate recognition of year-end dividends received from the REIT
in computing estimated tax payments.
Upon a sale or other disposition of the Common Stock, a stockholder will
generally recognize a capital gain or loss in an amount equal to the
difference between the amount realized and the stockholder's adjusted
basis in such stock, which gain or loss generally will be long-term if
the stock was held for more than twelve months. Any loss on the sale or
exchange of Common Stock held by a stockholder for six months or less
will generally be treated as a long-term capital loss to the extent of
designated capital gain dividends received by such stockholder.
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DRP participants will generally be treated as having received a dividend
distribution, subject to tax as ordinary income, in an amount equal to
the fair value of the Common Stock purchased with the reinvested
dividends generally on the date Redwood Trust credits such Common Stock
to the DRP participant's account.
Redwood Trust is required under Treasury Department regulations to
demand annual written statements from the record holders of designated
percentages of its Capital Stock disclosing the actual and constructive
ownership of such stock and to maintain permanent records showing the
information it has received as to the actual and constructive ownership
of such stock and a list of those persons failing or refusing to comply
with such demand.
In any year in which Redwood Trust does not qualify as a REIT,
distributions made to its stockholders would be taxable in the same
manner discussed above, except that no distributions could be designated
as capital gain dividends, distributions would be eligible for the
corporate dividends received deduction, the excess inclusion income
rules would not apply, and stockholders would not receive any share of
Redwood Trust's tax preference items. In such event, however, Redwood
Trust would be subject to potentially substantial Federal income tax
liability, and the amount of earnings and cash available for
distribution to its stockholders could be significantly reduced or
eliminated.
TAXATION OF TAX-EXEMPT ENTITIES
Subject to the discussion below regarding a "pension-held REIT," a
tax-exempt stockholder is generally not subject to tax on distributions
from Redwood Trust or gain realized on the sale of the Securities,
provided that such stockholder has not incurred indebtedness to purchase
or hold its Securities, that its shares are not otherwise used in an
unrelated trade or business of such stockholder, and that Redwood Trust,
consistent with its present intent, does not hold a residual interest in
a REMIC that gives rise to "excess inclusion" income as defined under
section 860E of the Code. However, if Redwood Trust was to hold residual
interests in a REMIC, or if a pool of its assets were to be treated as a
"taxable mortgage pool," a portion of the dividends paid to a tax-exempt
stockholder may be subject to tax as unrelated business taxable income
("UBTI"). Although Redwood Trust does not believe that Redwood Trust, or
any portion of its assets, will be treated as a taxable mortgage pool,
no assurance can be given that the IRS might not successfully maintain
that such a taxable mortgage pool exists.
If a qualified pension trust (i.e., any pension or other retirement
trust that qualifies under Section 401 (a) of the Code) holds more than
10% by value of the interests in a "pension-held REIT" at any time
during a taxable year, a substantial portion of the dividends paid to
the qualified pension trust by such REIT may constitute UBTI. For these
purposes, a "pension-held REIT" is a REIT (i) that would not have
qualified as a REIT but for the provisions of the Code which look
through qualified pension trust stockholders in determining ownership of
stock of the REIT and (ii) in which at least one qualified pension trust
holds more than 25% by value of the interest of such REIT or one or more
qualified pension trusts (each owning more than a 10% interest by value
in the REIT) hold in the aggregate more than 50% by value of the
interests in such REIT. Assuming compliance with the Ownership Limit
provisions in Redwood Trust's Articles of Incorporation it is unlikely
that pension plans will accumulate sufficient stock to cause Redwood
Trust to be treated as a pension-held REIT.
Distributions to certain types of tax-exempt stockholders exempt from
Federal income taxation under Sections 501 (c)(7), (c)(9), (c)(17), and
(c)(20) of the Code may also constitute UBTI, and such prospective
investors should consult their tax advisors concerning the applicable
"set aside" and reserve requirements.
STATE AND LOCAL TAXES
Redwood Trust and its stockholders may be subject to state or local
taxation in various jurisdictions, including those in which it or they
transact business or reside. The state and local tax treatment of
Redwood Trust and its stockholders may not conform to the Federal income
tax consequences discussed above. Consequently, prospective stockholders
should consult their own tax advisors regarding the effect of state and
local tax laws on an investment in the Common Stock.
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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS APPLICABLE TO
FOREIGN HOLDERS
The following discussion summarizes certain United States Federal tax
consequences of the acquisition, ownership and disposition of Common
Stock or Preferred Stock by an initial purchaser that, for United States
Federal income tax purposes, is a "Non-United States Holder". Non-United
States Holder means: not a citizen or resident of the United States; not
a corporation, partnership, or other entity created or organized in the
United States or under the laws of the United States or of any political
subdivision thereof; or not an estate or trust whose income is
includible in gross income for United States Federal income tax purposes
regardless of its source. This discussion does not consider any specific
facts or circumstances that may apply to particular non-United States
Federal tax consequences of acquiring, holding and disposing of Common
Stock or Preferred Stock, as well as any tax consequences that may arise
under the laws of any foreign, state, local or other taxing
jurisdiction.
DIVIDENDS
Dividends paid by Redwood Trust out of earnings and profits, as
determined for United States Federal income tax purposes, to a
Non-United States Holder will generally be subject to withholding of
United States Federal income tax at the rate of 30%, unless reduced or
eliminated by an applicable tax treaty or unless such dividends are
treated as effectively connected with a United States trade or business.
Distributions paid by Redwood Trust in excess of its earnings and
profits will be treated as a tax-free return of capital to the extent of
the holder's adjusted basis in his shares, and thereafter as gain from
the sale or exchange of a capital asset as described below. If it cannot
be determined at the time a distribution is made whether such
distribution will exceed the earnings and profits of Redwood Trust, the
distribution will be subject to withholding at the same rate as
dividends. Amounts so withheld, however, will be refundable or
creditable against the Non-United States Holder's United States Federal
tax liability if it is subsequently determined that such distribution
was, in fact, in excess of the earnings and profits of Redwood Trust. If
the receipt of the dividend is treated as being effectively connected
with the conduct of a trade or business within the United States by a
Non-United States Holder, the dividend received by such holder will be
subject to the United States Federal income tax on net income that
applies to United States persons generally (and, with respect to
corporate holders and under certain circumstances, the branch profits
tax).
For any year in which Redwood Trust qualifies as a REIT, distributions
to a Non-United States Holder that are attributable to gain from the
sales or exchanges by Redwood Trust of "United States real property
interests" will be treated as if such gain were effectively connected
with a United States business and will thus be subject to tax at the
normal capital gain rates applicable to United States stockholders
(subject to applicable alternative minimum tax) under the provisions of
the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA").
Also, distributions subject to FIRPTA may be subject to a 30% branch
profits tax in the hands of a foreign corporate stockholder not entitled
to a treaty exemption. Redwood Trust is required to withhold 35% of any
distribution that could be designated by Redwood Trust as a capital
gains dividend. This amount may be credited against the Non-United
States Holder's FIRPTA tax liability. It should be noted that mortgage
loans without substantial equity or shared appreciation features
generally would not be classified as "United States real property
interests."
GAIN ON DISPOSITION
A Non-United States Holder will generally not be subject to United
States Federal income tax on gain recognized on a sale or other
disposition of its shares of either Common or Preferred Stock unless (i)
the gain is effectively connected with the conduct of a trade or
business within the United States by the Non-United States Holder, (ii)
in the case of a Non-United States Holder who is a nonresident alien
individual and holds such shares as a capital asset, such holder is
present in the United States for 183 or more days in the taxable year
and certain other requirements are met, or (iii) the Non-United States
Holder is subject to tax under the FIRPTA rules discussed below. Gain
that is effectively connected with the conduct of a United States Holder
will be subject to the United States Federal income tax on net income
that applies to United States persons generally (and, with respect to
corporate holders and under certain circumstances, the branch profits
tax) but will not be subject to withholding. Non-United States Holders
should consult applicable treaties, which may provide for different
rules.
Gain recognized by a Non-United States Holder upon a sale of either
Common Stock or Preferred Stock will generally not be subject to tax
under FIRPTA if Redwood Trust is a "domestically-controlled REIT," which
is defined generally as a REIT in which at all times during a specified
testing period less than 50% in value of its shares were held directly
or indirectly by non-United States persons. Because only a minority of
Redwood Trust's
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stockholders are expected to be Non-United States Holders, Redwood Trust
anticipates that it will qualify as a "domestically-controlled REIT."
Accordingly, a Non-United States Holder should not be subject to United
States Federal income tax from gains recognized upon disposition of its
shares.
INFORMATION REPORTING AND BACKUP WITHHOLDING
Redwood Trust will report to its U.S. stockholders and the Internal
Revenue Service the amount of distributions paid during each calendar
year, and the amount of tax withheld, if any. Under the backup
withholding rules, a stockholder may be subject to backup withholding at
the rate of 31% with respect to distributions paid unless such holder
(a) is a corporation or comes within certain other exempt categories
and, when required, demonstrates that fact; or (b) provides a taxpayer
identification number, certifies as to no loss of exemption from backup
withholding, and otherwise complies with applicable requirements of the
backup withholding rules. A stockholder that does not provide Redwood
Trust with its correct taxpayer identification number may also be
subject to penalties imposed by the Internal Revenue Service. Any amount
paid as backup withholding will be creditable against the stockholder's
income tax liability. In addition, Redwood Trust may be required to
withhold a portion of dividends and capital gain distributions to any
stockholders that do not certify under penalties of perjury their
non-foreign status to Redwood Trust.
EMPLOYEES
As of March 27, 2001, we employed twenty-four people at Redwood and its
subsidiaries.
ITEM 2. PROPERTIES
Redwood Trust and Holdings lease space for their executive and
administrative offices at 591 Redwood Highway, Suites 3100, and 3280,
Mill Valley, California 94941, telephone (415) 389-7373.
ITEM 3. LEGAL PROCEEDINGS
At December 31, 2000, there were no pending legal proceedings to which
Redwood Trust was a party or of which any of its property was subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of Redwood Trust's stockholders
during the fourth quarter of 2000.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Effective January 28, 1998, Redwood Trust's Common Stock was listed and
traded on the New York Stock Exchange under the symbol RWT. Prior to
that date, Redwood Trust's Common Stock was traded on the
over-the-counter market and was quoted on the NASDAQ National Market
under the symbol RWTI. Redwood Trust's Common Stock was held by
approximately 330 holders of record on March 27, 2001 and the total
number of beneficial stockholders holding stock through depository
companies was approximately 2,800. The high and low closing sales prices
of shares of the Common Stock as reported on the New York Stock Exchange
or the NASDAQ National Market composite tape and the cash dividends
declared on the Common Stock for the periods indicated below were as
follows:
Common Dividends Declared
----------------------------------------
Stock Prices Record Payable Per
High Low Date Date Share
---- --- ---- ---- -----
Year Ended
December 31, 2001
First Quarter (through
March 27, 2001) $20.44 $16.81 3/30/01 4/23/01 $0.50
Year Ended
December 31, 2000
Fourth Quarter $17.94 $15.06 12/29/00 1/22/01 $0.44
Third Quarter $15.94 $13.63 9/29/00 10/23/00 $0.42
Second Quarter $14.94 $13.50 6/30/00 7/21/00 $0.40
First Quarter $14.81 $11.94 3/31/00 4/21/00 $0.35
Year Ended
December 31, 1999
Fourth Quarter $13 1/4 $11 5/16 12/31/99 1/21/00 $0.25
Third Quarter $17 1/2 $12 3/4 11/8/99 11/22/99 $0.15
Second Quarter $17 9/16 $14 1/2 -- -- --
First Quarter $17 3/8 $13 1/2 -- -- --
Year Ended
December 31, 1998
Fourth Quarter $16 1/16 $11 1/16 -- -- --
Third Quarter $17 5/8 $12 3/4 -- -- --
Second Quarter $25 5/8 $17 9/16 8/6/98 8/21/98 $0.01
First Quarter $23 1/2 $18 5/8 5/7/98 5/21/98 $0.27
Redwood Trust intends to pay quarterly dividends so long as the minimum
REIT distribution rules require it. Redwood Trust intends to make
distributions to its stockholders of all or substantially all of its
taxable income each year (subject to certain adjustments) so as to
qualify for the tax benefits accorded to a REIT under the Code. All
distributions will be made by Redwood Trust at the discretion of the
Board of Directors and will depend on the taxable earnings of Redwood
Trust, financial condition of Redwood Trust, maintenance of REIT status
and such other factors as the Board of Directors may deem relevant from
time to time. No dividends may be paid on the Common Stock unless full
cumulative dividends have been paid on the Preferred Stock. As of
December 31, 2000, the full cumulative dividends have been paid on the
Preferred Stock.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data is for the years ended December
31, 2000, 1999, 1998, 1997 and 1996. It is qualified in its entirety by,
and should be read in conjunction with the more detailed information
contained in the Consolidated Financial Statements and Notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results
of Operations" included elsewhere in this Form 10-K.
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
------------ ------------ ------------ ------------ ------------
STATEMENT OF OPERATIONS DATA:
Interest income after provisions for
credit losses $ 169,261 $ 145,964 $ 221,684 $ 195,674 $ 65,588
Interest expense and interest rate
agreement expense (138,603) (119,227) (199,638) (164,018) (50,349)
Net interest income after provision
for credit losses 30,658 26,737 22,046 31,656 15,239
Equity in earnings (losses) of
RWT Holdings, Inc. (1,676) (21,633) (4,676) -- --
Operating expenses (7,850) (3,835) (5,876) (4,658) (2,554)
Other income 98 175 139 -- --
Net unrealized/realized market
value gains (losses) (2,296) 284 (38,943) 563 --
Dividends on Class B preferred stock (2,724) (2,741) (2,747) (2,815) (1,148)
Change in accounting principle -- -- (10,061) -- --
Net income (loss) available to
common stockholders $ 16,210 $ (1,013) $ (40,118) $ 24,746 $ 11,537
Core earnings: ongoing operations
before mark-to market and
non recurring expenses $ 18,585 $ 16,622 $ 12,666 $ 24,746 $ 11,537
Average common shares - "diluted" 8,902,069 9,768,345 13,199,819 13,680,410 8,744,184
Diluted net income (loss) per share $ 1.82 $ (0.10) $ (3.04) $ 1.81 $ 1.32
Core earnings per share $ 2.08 $ 1.71 $ 0.96 $ 1.81 $ 1.32
Dividends declared per Class B
preferred share $ 3.02 $ 3.02 $ 3.02 $ 3.02 $ 1.14
Dividends declared per common share $ 1.61 $ 0.40 $ 0.28 $ 2.15 $ 1.67
BALANCE SHEET DATA: END OF PERIOD
Mortgage assets $ 2,033,705 $ 2,362,806 $ 2,658,428 $ 3,354,510 $ 2,138,364
Total assets $ 2,082,115 $ 2,419,928 $ 2,832,448 $ 3,444,197 $ 2,184,197
Short-term debt $ 756,222 $ 1,253,565 $ 1,257,570 $ 1,914,525 $ 1,953,103
Long-term debt $ 1,095,835 $ 945,270 $ 1,305,560 $ 1,172,801 --
Total liabilities $ 1,866,451 $ 2,209,993 $ 2,577,658 $ 3,109,660 $ 1,973,192
Total stockholders' equity $ 215,664 $ 209,935 $ 254,790 $ 334,537 $ 211,005
Number of Class B preferred
shares outstanding 902,068 902,068 909,518 909,518 1,006,250
Number of common shares outstanding 8,809,500 8,783,341 11,251,556 14,284,657 10,996,572
Book value per common share $ 21.47 $ 20.88 $ 20.27 $ 21.55 $ 16.50
OTHER DATA:
Average assets $ 2,296,641 $ 2,293,238 $ 3,571,889 $ 3,036,725 $ 999,762
Average borrowings $ 2,070,943 $ 2,046,132 $ 3,250,914 $ 2,709,208 $ 861,316
Average equity $ 213,938 $ 237,858 $ 307,076 $ 307,029 $ 131,315
Interest rate spread after provision
for credit losses 0.86% 0.79% 0.28% 0.59% 0.90%
Net interest margin after provision
for credit losses 1.33% 1.17% 0.62% 1.04% 1.52%
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes.
SAFE HARBOR STATEMENT
"Safe Harbor" Statement under the Private Securities Litigation Reform
Act of 1995: Certain matters discussed in this 2000 annual report Form
10-K may constitute forward-looking statements within the meaning of the
federal securities laws that inherently include certain risks and
uncertainties. Actual results and the timing of certain events could
differ materially from those projected in or contemplated by the
forward-looking statements due to a number of factors, including, among
other things, credit results for our mortgage assets, our cash flows and
liquidity, changes in interest rates and market values on our mortgage
assets and borrowings, changes in prepayment rates on our mortgage
assets, general economic conditions, particularly as they affect the
price of mortgage assets and the credit status of borrowers, and the
level of liquidity in the capital markets, as it affects our ability to
finance our mortgage asset portfolio, and other risk factors outlined in
this Form 10-K (see Risk Factors above.) Other factors not presently
identified may also cause actual results to differ. We continuously
update and revise our estimates based on actual conditions experienced.
It is not practicable to publish all such revisions and, as a result, no
one should assume that results projected in or contemplated by the
forward-looking statements included above will continue to be accurate
in the future.
Throughout this Form 10-K and other company documents, the words
"believe", "expect", "anticipate", "intend", "aim", "will", and similar
words identify "forward-looking" statements.
RESULTS OF OPERATIONS
EARNINGS SUMMARY
Core earnings were $0.62 per share for the fourth quarter of 2000 and
$2.08 per share for fiscal year 2000, in each case a new record for
Redwood. Increases in core earnings per share were 29% for the fourth
quarter and 22% for the full year of 2000 as compared to the same
periods in 1999. Core earnings are earnings from ongoing operations
before mark-to-market adjustments and non-recurring items.
Reported earnings per share were $0.55 for the fourth quarter 2000 and
$1.82 for the year 2000. We paid $1.61 per common share in dividends in
year 2000. Book value rose from $20.88 to $21.47 per share during 2000.
REVENUES SUMMARY
Most of our revenue comes from the monthly mortgage payments that
homeowners make on their mortgage loans. To a lesser degree, we also
earn revenues from commercial mortgage loans.
Total revenues increased from $146 million in 1999 to $169 million in
2000. Our average balance of earning assets remained constant at $2.2
billion, while our average asset yield increased from 6.62% to 7.55%.
Asset yields increased because we shifted our asset mix towards higher
yielding products, coupon rates on our adjustable rate mortgages rose in
conjunction with increases in short-term interest rates, premium
amortization expenses declined as mortgage prepayment rates slowed, and
credit provision expenses declined due to strong portfolio credit
performance.
From 1998 to 1999, revenues declined from $222 million to $146 million.
Asset yields increased from 6.42% to 6.62%, but average earning assets
declined from $3.5 billion to $2.2 billion as we utilized a significant
portion of our capital to repurchase our common stock. Asset yields
rose, despite a decrease in mortgage coupon rates, due to a significant
decline in premium amortization expenses. Premium amortization expenses
declined as a result of significantly reduced premium balances and
slower mortgage prepayment rates.
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In 2001, we expect that revenues may decline from the $169 million that
we earned in 2000, although we currently expect that interest expenses
may decline faster than revenues and that our net interest income may
benefit in the short-term. We expect revenues to decline as asset yields
decline along with falling short-term interest rates and as premium
amortization expenses increase along with faster mortgage prepayment
rates.
Our average earning assets could decline, leading to reduced revenues,
should we acquire additional credit-enhancement interests or other
assets that require a greater amount of capital per dollar of revenue
generated. Declining revenues from such a change in asset mix would not
necessarily imply a decline in net interest income, for liabilities
would decline under such a strategy as well.
If we raise additional equity capital in 2001, we plan to acquire
additional assets, and revenues would likely increase.
TABLE 1
TOTAL INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
NET TOTAL
AVERAGE PREMIUM CREDIT INTEREST EARNING
EARNING COUPON AMORTIZATION PROVISION INCOME ASSET
ASSETS INCOME EXPENSE EXPENSE REVENUES YIELD
---------- ------ ------------ --------- -------- -------
Q1: 1999 $2,551,046 $44,006 $(2,274) $(345) $41,387 6.49%
Q2: 1999 2,208,554 37,722 (1,632) (371) 35,719 6.47%
Q3: 1999 2,054,558 35,337 (782) (416) 34,139 6.65%
Q4: 1999 2,011,107 35,407 (474) (214) 34,719 6.91%
Q1: 2000 2,368,090 43,461 (522) (119) 42,820 7.23%
Q2: 2000 2,287,179 43,091 45 (128) 43,008 7.52%
Q3: 2000 2,192,390 42,959 (1,040) (240) 41,679 7.60%
Q4: 2000 2,123,648 42,816 (818) (244) 41,754 7.86%
1998 $3,451,611 $250,597 $(27,793) $(1,120) $221,684 6.42%
1999 2,204,421 152,472 (5,162) (1,346) 145,964 6.62%
2000 2,242,363 172,327 (2,335) (731) 169,261 7.55%
We operate in the single business segment of real estate finance, with
common staff and management, commingled financing arrangements, and
flexible capital commitments. We allocate our staff and capital
resources in a fluid manner to our real estate finance product lines as
we seek the highest risk-adjusted returns.
To provide a greater level of detail on our revenue trends, we discuss
revenue and portfolio characteristics by product line below. The
following discussion of our assets contains statistics that in some
cases have been obtained from or compiled from information made
available by servicing entities and information service providers.
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RESIDENTIAL CREDIT-ENHANCEMENT PORTFOLIO
We actively added to our residential credit-enhancement portfolio during
2000, increasing our commitments by over 200%. Pricing in this market
was attractive due to reduced competition. We were able to structure a
number of attractive transactions involving seasoned loans (which
generally have less credit risk than newly originated loans). In many of
our transactions, with both new and seasoned loans, we were able to work
with sellers to underwrite loans prior to securitization and to remove
the more risky loans from the loan pools that we agreed to finance.
Substantially all of the $23 billion of loans that we added to our
credit-enhancement portfolio in 1999 and 2000 were "A" quality loans.
Credit-enhancement revenues were $3.0 million in 1998, $4.2 million in
1999, and $8.5 million in 2000. Much of this revenue goes directly to
net interest income, as we utilize a relatively high percentage of
equity to fund this portfolio. Increases in revenues were largely a
result of increases in our credit-enhancement portfolio. Our
credit-enhancement portfolio increased from under $1 billion at the end
of 1998 to $6 billion at the end of 1999 and $23 billion at the end of
2000. The principal value of our credit-enhancement interests increased
from $17 million to $49 million to $125 million, and our net basis in
these assets increased from $8 million to $28 million to $81 million at
the end of 1998, 1999, and 2000, respectively.
The yield on our net credit-enhancement assets decreased from 26% in
1998 to 23% in 1999 to 14% in 2000. Given favorable credit results,
yields on credit-enhancement assets should increase over time. Our
yields on the credit-enhancement interests that we acquired from 1994 to
1997 have been growing. Our returns on these assets were further
increased when we resecuritized these assets in December 1997. Our
average yield for all of our credit-enhancement assets has decreased
over time as we have acquired new credit-enhancement interests and
booked them at relatively low initial yields. In addition, we have
increased the percentage of second and third loss positions in our mix
of credit-enhancement assets; these assets have less risk but also lower
yields. Given favorable credit results, we would expect to be able to
increase the yields of our newer assets over time. After a few years, we
may be able to resecuritize these interests, thus further increasing
their yields.
TABLE 2
CREDIT ENHANCEMENT PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
AVERAGE NET
AVERAGE AVERAGE NET DISCOUNT TOTAL
PRINCIPAL CREDIT DISCOUNT AVERAGE COUPON AMORTIZATION INTEREST
VALUE RESERVE BALANCE BASIS INCOME INCOME INCOME YIELD
--------- ------- -------- ------- ------ ------------ -------- -----
Q1: 1999 $21,096 $(6,096) $(1,887) $13,113 $334 $469 $803 24.51%
Q2: 1999 21,624 (6,107) (2,023) 13,494 341 518 859 25.46%
Q3: 1999 27,020 (5,774) (1,931) 19,315 478 583 1,061 21.97%
Q4: 1999 41,946 (9,263) (5,693) 26,989 747 732 1,479 21.92%
Q1: 2000 56,439 (11,567) (6,758) 38,114 1,048 567 1,615 16.95%
Q2: 2000 77,173 (16,361) (7,654) 53,158 1,412 723 2,135 16.07%
Q3: 2000 100,857 (21,484) (11,956) 67,417 1,928 356 2,284 13.55%
Q4: 2000 113,370 (24,596) (12,514) 76,260 2,144 346 2,490 13.06%
1998 $22,077 $(7,275) $(3,265) $11,537 $1,627 $1,336 $2,963 25.68%
1999 27,976 (7,068) (2,639) 18,269 1,900 2,302 4,202 23.00%
2000 87,070 (18,527) (9,734) 58,809 6,532 1,992 8,524 14.49%
Credit losses in this portfolio (reductions in principal value of our
interests) were $3.3 million in 1998, $1.1 million in 1999, and $0.8
million in 2000. To date, credit losses on our credit-enhancement
interests acquired from 1994 to 1997 have been slightly higher than we
originally anticipated; credit losses on credit-enhancement interests
acquired from 1998 through the present have been lower than we
originally anticipated.
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We charged these losses against our credit reserve for these assets. We
designate a portion of the purchase discount that we book upon
acquisition as credit reserve to provide for estimated future credit
losses. This effectively reduces our discount balances, and thus reduces
discount amortization income and the yields that we recognize on these
assets. Our designated credit reserve for our credit-enhancement
portfolio was $6 million at the end of 1998, $11 million at the end of
1999, and $27 million at the end of 2000.
Some of our credit-enhancement assets are themselves credit-enhanced by
securitized interests held by others (often the originator) that are
junior to us, i.e., we do not always hold a first loss position. The
first loss positions held by others are a form of credit reserve for us
with respect to loan losses within our credit-enhancement portfolio. The
principal value of interests junior to our positions at December 31,
2000 was $87 million. Together with our credit reserve of $27 million,
our effective protection against credit losses in our credit-enhancement
portfolio at December 31, 2000 was $114 million, or 50 basis points
(0.50%) of the current balance of the loans at that time, on average.
Reserves, credit-protection, and risks vary by asset, so we are still
subject to loss on certain assets even with this high level of average
overall credit protection.
If future credit losses exceed our expectations, we will increase our
credit reserve on a specific asset basis. We can do this by lowering the
yield that we recognize on the asset (by designating more of the
purchase discount as reserve) or, under new EITF 99-20 accounting rules
to be adopted in 2001, by reducing our basis in an asset by marking it
to market through the income statement.
Serious delinquencies in our credit enhancement portfolio were $26
million at the end of 1998, $48 million at the end of 1999, and $52
million at the end of 2000. Serious delinquencies were 0.23% of the
current balance of credit-enhanced loans at December 31, 2000.
TABLE 3
CREDIT ENHANCEMENT PORTFOLIO -- CREDIT RESULTS
(AT PERIOD END, ALL DOLLARS IN THOUSANDS)
ADDITIONS
UNDERLYING SERIOUS SERIOUS TOTAL REDWOOD'S TO ENDING
MORTGAGE DELINQUENCIES DELINQUENCIES CREDIT CREDIT CREDIT CREDIT
LOANS % $ LOSSES LOSSES RESERVE RESERVE
---------- ------------- ------------- -------- --------- --------- -------
Q1: 1999 $467,114 4.74% $22,141 $(1,762) $(518) $(289) $5,952
Q2: 1999 1,427,355 1.36% 19,475 (656) (166) 310 6,262
Q3: 1999 3,794,055 0.42% 15,785 (377) (365) 1,024 7,286
Q4: 1999 6,376,571 0.71% 45,451 (346) (97) 3,955 11,241
Q1: 2000 8,539,491 0.58% 49,731 (813) (270) 652 11,893
Q2: 2000 20,925,931 0.22% 45,999 (1,537) (187) 8,936 20,829
Q3: 2000 21,609,785 0.27% 58,102 (590) (245) 1,310 22,139
Q4: 2000 22,633,860 0.23% 51,709 (1,568) (56) 4,913 27,052
1998 $542,558 4.86% $26,350 $(10,773) $(3,318) $(1,869) $6,241
1999 6,376,571 0.71% 45,451 (3,141) (1,146) 5,000 11,241
2000 22,633,860 0.23% 51,709 (4,508) (758) 15,811 27,052
At December 31, 2000, we credit-enhanced 63,675 loans with a total
principal value of $23 billion. Of these, 58% were fixed-rate loans, 7%
were hybrid loans (loans that become adjustable after a 3 to 10 year
fixed rate period), and 35% were adjustable-rate loans. The average size
of the loans that we credit-enhanced was $355,500. We credit-enhanced
983 loans with principal balances in excess of $1 million; these loans
had an average size of $1.4 million and a total loan balance of $1.4
billion. Loans over $1 million were 2% of the total number of loans and
6% of the total balance of loans that we credit-enhanced at year-end.
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The geographic dispersion of our credit-enhancement portfolio closely
mirrors that of the jumbo residential market as a whole. At December 31,
2000, our loans were most concentrated in the following states:
California 50%, New York 6%, New Jersey 4%, Texas 3%, and Massachusetts
3%. No other state had more than 3%.
Most of the loans that we credit-enhance are seasoned. Generally, the
credit risk for these loans is reduced as property values have
appreciated and the loan balances have amortized. In effect, the current
loan-to-value ratio for seasoned loans is often much reduced from the
loan-to-value ratio at origination. Only 16% of the loans we financed at
December 31, 2000 were originated in year 2000. Of our California-based
loans, 12% were originated in 2000.
Loans with loan-to-value ratios ("LTV") at origination in excess of 80%
made up 10% of loan balances; we benefit from primary mortgage insurance
("PMI") on 99% of these loans. With this insurance, our effective LTV on
these loans is substantially reduced. Our average effective LTV at
origination (including the effect of PMI, pledged collateral, and other
credit-enhancements) was 70%. Given housing appreciation and loan
amortization, we estimate the average current effective LTV for the
loans that we credit-enhance is less than 61%.
TABLE 4
CREDIT ENHANCEMENT PORTFOLIO -- UNDERLYING COLLATERAL CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
DECEMBER DECEMBER DECEMBER
1998 1999 2000
-------- ---------- -----------
CREDIT-ENHANCEMENT PORTFOLIO $542,558 $6,376,571 $22,633,860
CREDIT-ENHANCED LOANS 2,576 19,318 63,675
ADJUSTABLE % 100% 11% 35%
HYBRID % 0% 14% 7%
FIXED % 0% 75% 58%
FIRST LOSS POSITION, FACE VALUE $17,281 $20,546 $34,959
SECOND LOSS POSITION, FACE VALUE 0 5,840 30,703
THIRD LOSS POSITION, FACE VALUE 0 22,241 59,216
NET FACE VALUE: CREDIT-ENHANCEMENT INTERESTS 17,281 48,627 124,878
FIRST LOSS POSITION, REPORTED VALUE $7,707 $8,279 $12,080
SECOND LOSS POSITION, REPORTED VALUE 0 3,418 21,109
THIRD LOSS POSITION, REPORTED VALUE 0 16,436 47,576
NET INVESTMENT: CREDIT-ENHANCEMENT INTERESTS 7,707 28,133 80,764
CALIFORNIA % 61% 43% 50%
NEW YORK 3% 1% 6%
NEW JERSEY 3% 2% 4%
MASSACHUSETTS 3% 2% 3%
TEXAS 2% 6% 3%
OTHER STATES 28% 47% 34%
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RESIDENTIAL RETAINED LOAN PORTFOLIO
We have not added to our residential retained loan portfolio since we
acquired a $390 million portfolio in December 1999. Several transactions
that we worked on in 2000 that started as whole loan acquisition
opportunities for our retained portfolio ended up becoming opportunities
for our credit-enhancement portfolio. Instead of buying the whole loans,
we credit-enhanced the loans by acquiring credit-enhancement interests
from the seller after the seller securitized the loans.
TABLE 5
RESIDENTIAL RETAINED PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
ANNUAL
MORTGAGE NET
AVERAGE NET PREPAYMENT PREMIUM CREDIT TOTAL
PRINCIPAL PREMIUM RATE COUPON AMORTIZATION PROVISION INTEREST
BALANCE BALANCE (CPR) INCOME EXPENSE EXPENSE INCOME YIELD
---------- ------- ---------- ------ ------------ --------- -------- -----
Q1: 1999 $1,268,383 $15,604 32% $22,049 $(1,477) $(345) $20,227 6.30%
Q2: 1999 1,145,096 14,903 29% 19,091 (1,119) (371) 17,601 6.07%
Q3: 1999 1,067,716 12,121 21% 18,431 (614) (416) 17,401 6.45%
Q4: 1999 985,932 13,000 16% 17,494 (705) (214) 16,575 6.64%
Q1: 2000 1,337,428 16,061 14% 24,378 (640) (119) 23,619 6.98%
Q2: 2000 1,276,340 15,372 16% 23,648 (515) (128) 23,005 7.12%
Q3: 2000 1,202,056 14,760 22% 23,118 (829) (240) 22,049 7.25%
Q4: 2000 1,141,624 14,141 16% 22,316 (611) (244) 21,461 7.43%
1998 $1,806,167 $28,596 26% $131,519 $(10,272) $(1,120) $120,127 6.55%
1999 1,115,874 13,895 25% 77,065 (3,915) (1,346) 71,804 6.36%
2000 1,238,993 15,080 17% 93,460 (2,595) (731) 90,134 7.19%
Revenues from our residential retained portfolio increased from $72
million in 1999 to $90 million in 2000 on a higher average balance ($1.3
billion versus $1.1 billion) and an increased yield (7.19% versus
6.36%). Yields increased due to increases in short-term interest rates,
reduced premium amortization expenses as prepayment rates slowed, and
reduced credit provision expenses.
From 1998 to 1999, revenue decreased from $120 million to $72 million.
Average balances declined from $1.8 billion to $1.1 billion due to loan
sales and principal repayments. Yields dropped from 6.55% to 6.36% due
to declining interest rates and changes in portfolio characteristics
resulting from purchase and sale activity.
Annual realized credit losses in this portfolio have been less than one
basis point (.007%) of the current balance of the portfolio per year on
average during 1998, 1999, and 2000. Realized credit losses in 2000 were
$42,000. Cumulative losses during the time we have owned these loan
pools equal $0.3 million, or 1.3 basis points (.013%) of the original
balance of the loans.
During the three years of 1998 to 2000, seriously delinquent loans in
this portfolio ranged from $4 million to $7 million, yet total realized
losses for the three years were $0.2 million. Many of our seriously
delinquent loans cure without going into foreclosure. When these loans
do default, we do not necessarily incur a credit loss, as we often have
realized substantial value from the sale of the underlying property or
from the result of other loss mitigation efforts. For defaults where we
did incur a credit loss, our average loss severity (credit loss as a
percentage of loan balance) during these three years was 9%.
We took credit provisions of $0.7 million during 2000 for our
residential retained loan portfolio, equaling 6 basis points (0.06%) of
our average loan balance during the year. We ended the year with a
credit reserve for this portfolio of $4.8 million. The year-end reserve
equals 43 basis points (.43%) of our year-end loan balances. The
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reserve is based upon our assessment of various factors affecting our
mortgage loans, including current and projected economic conditions,
delinquency status, and credit protection. We are cautious about credit
in the current economic environment, but we are comforted by the quality
and seasoning of our portfolio and the size of our reserves. We
currently expect realized credit losses to increase somewhat in the
future, based on current delinquency levels, the natural seasoning of
the portfolios (losses are more likely to occur in years two through
five), and the weakening economic environment. Losses on our assets have
historically been substantially lower than our original expectations. If
losses increase substantially, we would, if necessary, increase our
credit-provisioning rate.
TABLE 6
RESIDENTIAL RETAINED PORTFOLIO - CREDIT RESULTS
(AT PERIOD END, ALL DOLLARS IN THOUSANDS)
SERIOUSLY REALIZED CREDIT ENDING
DELINQUENT GROSS LOSS CREDIT PROVISION CREDIT
LOANS DEFAULTS SEVERITY LOSSES EXPENSE RESERVE
---------- -------- -------- -------- --------- -------
Q1: 1999 $5,961 $0 0.0% $0 $(345) $3,129
Q2: 1999 6,728 0 0.0% 0 (371) 3,500
Q3: 1999 3,832 145 3.8% (5) (416) 3,911
Q4: 1999 4,635 0 0.0% 0 (214) 4,125
Q1: 2000 5,338 0 0.0% 0 (119) 4,244
Q2: 2000 4,968 450 9.3% (42) (128) 4,330
Q3: 2000 4,330 0 0.0% 0 (240) 4,570
Q4: 2000 5,667 0 0.0% 0 (244) 4,814
1998 $3,926 $1,913 10.0% $(191) $(1,120) $2,784
1999 4,635 145 3.8% (5) (1,346) 4,125
2000 5,667 450 9.3% (42) (731) 4,814
At December 31, 2000, we owned 3,633 residential loans with a total
value of $1.1 billion. These were all "A" quality or "prime" quality
loans at origination. Of these, 71% were adjustable rate loans and 29%
were hybrid loans. Our hybrid loans have fixed rate coupons until
December 2002, on average, and then will become adjustable rate loans.
The average loan size was $311,000. We owned 81 loans with a loan
balance over $1 million; the average size of these loans was $1.5
million. Loans with balances over $1 million made up 2% of the loans and
11% of the balances of our total retained loan portfolio. California
loans were 25% of the total. All of the loans were originated in 1999 or
earlier. Loans where the original loan balance exceeded 80% of the value
of the house and other pledged collateral (loan to value, or "LTV", over
80%) made up 7% of loan balances; we benefit from primary mortgage
insurance ("PMI") on 99% of these loans (serving to substantially lower
our effective LTVs). Average effective LTV at origination for our
residential retained portfolio (including the effect of PMI, pledged
collateral, and other credit-enhancements) was 71%. Given housing
appreciation and loan amortization, we estimate the current effective
LTV of our retained loan portfolio is less than 63%.
Serious delinquencies remained at low levels at $5.7 million, or 0.50%
of the current balance of the loans and 0.24% of the original balance of
the loans. Included in this amount are five real estate owned ("REO")
properties with an estimated value of $0.5 million.
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TABLE 7
RETAINED RESIDENTIAL PORTFOLIO - LOAN CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
DECEMBER DECEMBER DECEMBER
1998 1999 2000
---------- ---------- ----------
BOOK VALUE $1,397,213 $1,385,589 $1,130,997
NUMBER OF LOANS 4,760 4,348 3,633
AVERAGE LOAN SIZE $ 294 $ 319 $ 311
ADJUSTABLE % 58.1% 70.1% 71.3%
HYBRID % 41.9% 29.3% 28.7%
FIXED % 0.0% 0.6% 0.0%
FUNDED WITH SHORT-TERM DEBT 19% 30% 1%
FUNDED WITH LONG-TERM DEBT 81% 70% 99%
LONG-TERM DEBT $1,035,560 $ 945,270 $1,095,835
NET INVESTMENT IN SEQUOIA $ 40,253 $ 36,618 $ 37,166
CALIFORNIA % 32% 26% 25%
FLORIDA 8% 9% 9%
NEW YORK 6% 8% 8%
NEW JERSEY 5% 5% 5%
TEXAS 4% 5% 5%
GEORGIA 4% 5% 5%
OTHER STATES 41% 42% 43%
YEAR 2000 ORIGINATION n/a n/a 0%
YEAR 1999 ORIGINATION n/a 19% 19%
YEAR 1998 ORIGINATION 33% 32% 32%
YEAR 1997 ORIGINATION 48% 37% 37%
YEAR 1996 OR EARLIER ORIGINATION 19% 12% 12%
For 2001, we are actively seeking high-quality jumbo residential loan
acquisition opportunities that are priced attractively relative to our
long-term debt issuance costs. We are seeking to acquire loans both on a
bulk basis and a flow basis. As we evaluate and structure a portfolio
acquisition transaction, we may prefer to acquire the loans as whole
loans and issue long-term debt to fund the acquisition (thus adding to
our residential retained loan portfolio). Or, we may prefer to have the
seller securitize the loans and sell us the credit-enhancement interest
(thus adding to our credit-enhancement portfolio).
INVESTMENT PORTFOLIO
Our investment portfolio revenues increased from $66 million in 1999 to
$67 million in 2000. Our asset yields increased from 6.56% to 7.53%.
Yields increased as coupon rates rose with short-term interest rates and
as premium amortization expenses were reduced with slower mortgage
prepayments. Average investment portfolio assets declined from $1.0
billion during 1999 to $0.9 billion during 2000. Although opportunities
for growth in our investment portfolio were attractive in 2000, we
allocated an increased amount of our capital to our residential
credit-enhancement business.
Investment portfolio revenues declined from $96 million in 1998 to $66
million in 1999. Our average investment portfolio balance dropped from
$1.5 billion to $1.0 billion as we allocated capital to other portfolios
and reduced our capital base through our common stock repurchase
program. Our investment portfolio yields increased from
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6.15% in 1998 to 6.56% in 1999, in spite of falling interest rates, due
to reductions in premium amortization expenses as a result of
significantly reduced premium balances and slower mortgage prepayment
rates.
TABLE 8
INVESTMENT PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
AVERAGE MORTGAGE NET
AVERAGE NET PREPAYMENT PREMIUM TOTAL
EARNING PREMIUM RATES COUPON AMORTIZATION INTEREST
ASSETS BALANCE (CPR) INCOME EXPENSE INCOME YIELD
---------- ---------- ---------- ---------- ------------ ---------- ----------
Q1: 1999 $1,179,689 $ 9,961 33% $ 20,773 $ (1,266) $ 19,507 6.56%
Q2: 1999 979,909 10,431 28% 17,500 (1,031) 16,469 6.65%
Q3: 1999 900,339 7,878 28% 15,265 (751) 14,514 6.39%
Q4: 1999 943,641 8,467 21% 16,231 (502) 15,729 6.61%
Q1: 2000 944,301 8,118 19% 17,510 (450) 17,060 7.16%
Q2: 2000 902,265 7,225 20% 17,362 (163) 17,199 7.56%
Q3: 2000 868,159 8,946 20% 17,278 (572) 16,706 7.62%
Q4: 2000 822,452 9,595 19% 16,832 (591) 16,241 7.81%
1998 $1,534,270 $ 32,437 34% $ 115,270 $ (18,858) $ 96,412 6.15%
1999 999,972 9,177 27% 69,769 (3,550) 66,219 6.56%
2000 884,081 8,475 20% 68,982 (1,776) 67,206 7.53%
At December 31, 2000, we owned $765 million of mortgage securities,
almost all of which were rated AAA or AA. The majority of our
investments were residential adjustable-rate or floating rate
securities.
TABLE 9
INVESTMENT PORTFOLIO CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
DECEMBER DECEMBER DECEMBER
RATING 1998 1999 2000
---------- ---------- ---------- ----------
AGENCY ADJUSTABLE "AAA" $ 600,803 $ 574,711 $ 532,578
AGENCY CMO FLOATERS "AAA" 16,621 6,248 0
JUMBO ADJUSTABLE AAA or AA 550,990 290,658 191,047
JUMBO SHORT FIXED CMOS AAA or AA 19,254 15,554 0
HOME EQUITY FLOATERS AAA or AA 53,972 47,111 23,015
HOME EQUITY FIXED AAA to BBB 15,668 11,889 17,044
INTEREST-ONLY (IO) AAA or AA 347 126 113
US TREASURIES FIXED AAA 48,009 0 0
CBO EQUITY B or NR 0 0 978
TOTAL INVESTMENT PORTFOLIO $1,305,664 $ 946,247 $ 764,775
REALIZED CREDIT LOSES 0 0 0
We added assets to our investment portfolio in the first quarter of
2001. Although opportunities for this portfolio currently appear
attractive, it is possible that we might reduce the size of this
portfolio later in the year to fund investments in our residential
credit-enhancement and residential retained loan portfolios. If we raise
additional equity capital during 2001, we would likely add assets and
capital to this portfolio, at least initially.
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COMMERCIAL RETAINED LOAN PORTFOLIO
In conjunction with our affiliate, Holdings, we originated or acquired
commercial mortgage loans totaling $8 million in 1998, $42 million in
1999, and $73 million in 2000. After loan sales and pay offs, we owned a
total of $76 million of commercial loans at December 31, 2000. Of these,
$57 million were owned by Redwood and $19 million were owned by
Holdings.
Commercial revenues at Redwood increased from $0.1 million in 1998 to
$1.0 million in 1999 to $2.0 million in 2000 as the number of loans held
at Redwood increased and the average yield of our commercial loans
increased from 8.83% in 1998 to 9.70% in 1999 to 10.61% in 2000. The
increases in yields were primarily the result of an improved mix of
commercial mortgage loans in the portfolio.
TABLE 10
COMMERCIAL PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
AVERAGE
AVERAGE NET DISCOUNT CREDIT TOTAL
PRINCIPAL DISCOUNT COUPON AMORTIZATION PROVISION INTEREST
VALUE BALANCE INCOME INCOME EXPENSE INCOME YIELD
--------- -------- ------- ------------ --------- -------- -------
Q1: 1999 $ 3,154 $ (13) $ 76 $ 0 $ 0 $ 76 9.67%
Q2: 1999 13,100 0 293 0 0 293 8.94%
Q3: 1999 17,953 0 453 0 0 453 10.09%
Q4: 1999 10,245 (1) 259 0 0 259 10.11%
Q1: 2000 8,710 (13) 211 0 0 211 9.70%
Q2: 2000 15,418 (30) 393 0 0 393 10.21%
Q3: 2000 13,982 (265) 367 5 0 372 10.85%
Q4: 2000 38,020 (477) 987 39 0 1,026 10.93%
1998 $ 1,161 $ (6) $ 102 $ 0 $ 0 $ 102 8.83%
1999 11,151 (3) 1,081 0 0 1,081 9.70%
2000 19,071 (197) 1,958 44 0 2,002 10.61%
To date, we have not experienced any delinquencies or credit losses in
our commercial loan portfolio, nor do we anticipate any credit problems
at this time. We have not established a general credit reserve for
commercial loans. The slowing economy, and factors particular to each
loan, could cause credit issues in the future. If so, we would provide
for future losses and create a specific credit reserve on an asset by
asset basis.
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TABLE 11
COMMERCIAL PORTFOLIO LOAN CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
DECEMBER DECEMBER DECEMBER
1998 1999 2000
-------- -------- --------
HELD AT REDWOOD $ 8,287 $ 8,437 $57,153
HELD AT HOLDINGS 0 29,309 18,936
TOTAL COMMERCIAL $ 8,287 37,746 76,089
NUMBER OF LOANS 8 13 19
AVERAGE LOAN SIZE $ 1,036 $ 2,904 $ 4,005
SERIOUS DELINQUENCY $ 0 0 0
SERIOUS DELINQUENCY % 0% 0% 0%
SERIOUS DELINQUENCY % 0% 0% 0%
REALIZED CREDIT LOSSES 0 0 0
CALIFORNIA % 84% 74% 73%
Our primary focus in 2001 is improving our financing of these loans
through extending the maturities of our committed bank lines and through
selling senior participations. We are not actively originating new
loans, although we may do so later in the year. We believe our
commercial operations have a good chance of being highly profitable in
2001. Our current intention is to seek profitable ways to expand our
ownership of commercial mortgage assets (loans and securities) over
time.
INTEREST EXPENSE
Interest and hedging expenses increased from $119 million in 1999 to
$139 million in 2000. Average borrowings increased slightly, from $2.0
billion to $2.1 billion, and our cost of funds increased from 5.83% to
6.69% as interest rates rose. Net hedging costs decreased as interest
rates increased and we earned hedge income to offset expenses.
Interest and hedging expenses decreased from $200 million in 1998 to
$119 million in 1999 as a result of a decline in average borrowings
($3.3 billion to $2.0 billion) and a decline in our cost of funds (6.14%
to 5.83%).
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TABLE 12
INTEREST EXPENSE
(ALL DOLLARS IN THOUSANDS)
LONG LONG SHORT SHORT TOTAL TOTAL
AVERAGE TERM TERM AVERAGE TERM TERM INTEREST COST OF
LONG DEBT DEBT SHORT DEBT DEBT EXPENSE FUNDS
TERM INTEREST COST OF TERM INTEREST COST OF COST OF AND AND
DEBT EXPENSE FUNDS DEBT EXPENSE FUNDS HEDGING HEDGING HEDGING
---------- -------- ------- ---------- -------- ------- ------- -------- -------
Q1: 1999 $1,243,474 $18,740 6.03% $1,152,635 $14,751 5.12% 0.06% $33,824 5.65%
Q2: 1999 1,117,790 16,657 5.96% 937,942 11,880 5.07% 0.14% 29,273 5.70%
Q3: 1999 1,031,629 15,503 6.01% 859,429 11,887 5.53% 0.10% 27,848 5.89%
Q4: 1999 971,707 14,885 6.13% 877,634 12,859 5.86% 0.12% 28,282 6.12%
Q1: 2000 972,338 15,359 6.32% 1,225,562 19,163 6.25% 0.07% 34,931 6.36%
Q2: 2000 1,258,859 20,928 6.65% 865,068 13,987 6.47% 0.04% 35,133 6.62%
Q3: 2000 1,191,730 20,448 6.86% 827,114 14,053 6.80% 0.04% 34,694 6.87%
Q4: 2000 1,125,898 19,559 6.95% 819,160 14,152 6.91% 0.03% 33,845 6.96%
1998 $1,275,048 $81,361 6.38% $1,975,866 $114,763 5.81% 0.11% $199,638 6.14%
1999 1,090,242 65,785 6.03% 955,890 51,377 5.37% 0.10% 119,227 5.83%
2000 1,137,324 76,294 6.71% 933,619 61,355 6.57% 0.05% 138,603 6.69%
Our mix of funding remained steady, with long-term debt representing 53%
to 55% of our borrowings from 1999 to 2000. While long-term debt is more
expensive than short-term debt, it provides us a higher level of
stability and attractive liquidity characteristics. Through using
long-term debt, we can utilize a greater degree of leverage in a prudent
manner.
TABLE 13
LONG-TERM DEBT CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
LONG INTEREST
TERM ORIGINAL ESTIMATED OUTSTANDING RATE AT
DEBT DEBT ISSUE ISSUE STATED CALLABLE AT YEAR-END DECEMBER
ISSUE RATING DATE AMOUNT INDEX MATURITY DATE 2000 31, 2000
- ----- ------ ------- -------- ----------- -------- -------- ----------- --------
SEQUOIA 1 A1 AAA 7/29/97 $334,347 1m LIBOR 2/15/28 Called $0 n/a
SEQUOIA 1 A2 AAA 7/29/97 200,000 Fed Funds 2/15/28 Called 0 n/a
SEQUOIA 2 A1 AAA 11/6/97 592,560 1y Treasury 3/30/29 2004 289,996 7.21%
SEQUOIA 2 A2 AAA 11/6/97 156,600 1m LIBOR 3/30/29 2004 76,639 6.99%
SEQUOIA 3 A1 AAA 6/26/98 225,459 Fixed 5/31/28 Retired $0 n/a
SEQUOIA 3 A2 AAA 6/26/98 95,000 Fixed 5/31/28 Retired $0 n/a
SEQUOIA 3 A3 AAA 6/26/98 164,200 Fixed 5/31/28 2002 161,268 6.35%
SEQUOIA 3 A4 AAA 6/26/98 121,923 Fixed 5/31/28 2002 121,923 6.25%
SEQUOIA 3 M1 AA 6/26/98 16,127 Fixed 5/31/28 2002 16,127 6.80%
SEQUOIA 3 M2 A 6/26/98 7,741 Fixed 5/31/28 2002 7,741 6.80%
SEQUOIA 3 M3 BBB 6/26/98 4,838 Fixed 5/31/28 2002 4,838 6.80%
SEQUOIA 1A A1 AAA 5/4/99 157,266 1m LIBOR 2/15/28 2003 92,085 7.20%
SEQUOIA 4 A AAA 3/21/00 377,119 1m LIBOR 8/31/24 2008 325,292 7.02%
Should the trend towards lower short-term interest rates continue, we
currently expect that our overall cost of funds will decline in 2001.
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NET INTEREST INCOME AFTER CREDIT EXPENSES
Net interest income after credit expenses increased from $22 million in
1998 to $27 million in 1999 to $31 million in 2000. For these same
years, our net interest spread after credit expenses increased from
0.28% to 0.79% to 0.86%. This measure shows the profitability of the
leveraged portion of our balance sheet; it equals the yield on our
assets less our cost of funds and hedging. Our net interest margin after
credit expenses increased from 0.62% to 1.17% to 1.33% in 1998, 1999 and
2000, respectively. This measure is net interest income divided by
assets; it is higher than our spread as it includes income generated
from equity-funded assets.
Our spreads and margins increased in 2000, despite a rapid increase in
short-term interest rates, due to our interest rate management
activities and beneficial changes in asset mix. Total net interest
income also benefited from an increased net investment in our
portfolios, made possible by the retention and reinvestment of the free
cash flow that we generated in excess of our dividend.
TABLE 14
NET INTEREST INCOME
(ALL DOLLARS IN THOUSANDS)
NET INTEREST INTEREST RETURN
INTEREST RATE RATE ON
TOTAL COST OF INCOME COST OF SPREAD MARGIN TOTAL
INTEREST FUNDS AFTER EARNING FUNDS AFTER AFTER CAPITAL
INCOME PLUS CREDIT ASSET PLUS CREDIT CREDIT BEFORE
REVENUES HEDGING PROVISIONS YIELD HEDGING PROVISIONS PROVISIONS OVERHEAD
-------- ------- ---------- ----- ------- ---------- ---------- --------
Q1: 1999 $41,387 $(33,824) $7,563 6.49% 5.65% 0.84% 1.14% 12.09%
Q2: 1999 35,719 (29,273) 6,446 6.47% 5.70% 0.77% 1.12% 10.54%
Q3: 1999 34,139 (27,848) 6,291 6.65% 5.89% 0.76% 1.18% 10.73%
Q4: 1999 34,719 (28,282) 6,437 6.91% 6.12% 0.79% 1.24% 11.58%
Q1: 2000 42,820 (34,931) 7,889 7.23% 6.36% 0.87% 1.30% 14.76%
Q2: 2000 43,008 (35,133) 7,875 7.52% 6.62% 0.90% 1.34% 14.78%
Q3: 2000 41,679 (34,694) 6,985 7.60% 6.87% 0.73% 1.25% 13.10%
Q4: 2000 41,754 (33,845) 7,909 7.86% 6.96% 0.90% 1.46% 14.68%
1998 $221,684 $(199,638) $22,046 6.42% 6.14% 0.28% 0.62% 7.16%
1999 145,964 (119,227) 26,737 6.62% 5.83% 0.79% 1.17% 11.24%
2000 169,261 (138,603) 30,658 7.55% 6.69% 0.86% 1.33% 14.33%
We expect that the decreases in short-term interest rates that occurred
in early 2001, and any additional decreases in short-term interest
rates, will tend to boost our net interest income, interest rate spread,
and interest rate margin on a near term basis. As short-term interest
rates drop, our cost of funds should generally decline more quickly than
our asset yield.
While decreases in short-term interest rates should be beneficial for
earnings in 2001, our primary focus is on increasing our normalized rate
of income generation through growth in our high-quality jumbo
residential credit-enhancement and retained loan portfolios and through
retention of free cash flow in excess of our dividend requirements.
Our average return on capital employed before overhead expenses was
14.33% in 2000; this measure equals net interest income divided by total
capital. Returns have improved as we reduced our capital at Holdings,
improved our capital utilization rate, reduced our premium amortization
expenses, and increased our residential credit-enhancement and retained
portfolios relative to our investment portfolio. The competitive
environment also has improved markedly since 1997 and 1998 as other
financial institutions pulled back from the residential real estate
finance market. This allowed us to expand our activities through
acquisition and credit-enhancement of loans at attractive pricing
levels. We believe that our current marginal return on new capital
employed may equal or exceed the average return on capital employed of
14.68% that we earned in the fourth quarter of 2000.
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EQUITY IN EARNINGS OF RWT HOLDINGS
For the year 2000, a portion of our commercial loan origination and
portfolio finance activities were conducted at Holdings, our 99%-owned,
unconsolidated affiliate. Most of our commercial loan revenues were
earned by Redwood. Redwood's share of Holdings' loss for the year was
$1.7 million. See Management's Discussion and Analysis for Holdings
below.
For year 2001 and beyond, Holdings will be consolidated into Redwood for
accounting purposes as a result of Redwood's acquisition of the
remainder of Holdings it did not already own. This consolidation will
reduce expenses.
OPERATING EXPENSES
We incur operating expenses at Redwood and at our unconsolidated
affiliate, Holdings. A significant portion of these operating expenses
in prior years were associated with business units that have since been
closed. Combined operating expenses rose from 1998 to 1999 as we started
new residential mortgage, finance and commercial mortgage loan
origination operations at Holdings. Some of these operations were
restructured in 1999, and the operating expenses incurred in 1999
include costs associated with the closing of these operations. Total
combined operating expenses declined from $26 million in 1999 to $10
million in 2000. Expenses associated with ongoing operations rose from
$8.5 million in 1999 to $10 million in 2000 as we expanded our
loan-based activities and paid higher performance-based compensation as
earnings and dividends increased.
TABLE 15
OPERATING EXPENSES
(ALL DOLLARS IN THOUSANDS)
CLOSED
BUSINESS
REDWOOD HOLDINGS COMBINED ONGOING UNITS
------- -------- -------- ------- --------
Q1: 1999 $714 $3,264 $3,978 $1,600 $2,378
Q2: 1999 939 4,204 5,143 2,242 2,901
Q3: 1999 964 6,256 7,220 2,727 4,493
Q4: 1999 1,218 8,543 9,761 1,917 7,844
Q1: 2000 2,146 865 3,011 2,814 197
Q2: 2000 2,238 590 2,828 2,828 0
Q3: 2000 2,066 536 2,602 2,602 0
Q4: 2000 1,400 400 1,800 1,800 0
1998 $5,876 $5,235 $11,111 $7,215 $3,896
1999 3,835 22,267 26,102 8,486 17,616
2000 7,850 2,391 10,241 10,044 197
We focused during 2000 on reducing fixed costs, and we expect to benefit
from these cost reductions going forward. A large portion of our
expenses are variable compensation expenses (that depend on earnings per
share and dividends per share) and stock option expenses (that depend on
our stock price). Despite a reduction in fixed costs, our total ongoing
combined operating expenses will likely increase in 2001 if our
performance is strong.
We believe that we currently have the staff and systems that we will
need to manage a much larger company. Thus, we believe that we are
likely to benefit from substantial operating leverage in the event that
we can raise additional equity capital in 2001. With growth in our
portfolios and capital employed following an equity offering, we believe
revenue growth will exceed growth in operating expenses. This could
would result in an increase in earnings per share and dividends per
share.
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CORE EARNINGS
Core earnings are earnings from ongoing operations before mark-to-market
adjustments and non-recurring items.
From 1998 to 2000, annual core earnings increased from $13 million to
$17 million to $19 million. Core earnings increased from $0.96 per share
in 1998 to $1.71 per share in 1999 to $2.08 per share in 2000.
The table below reconciles core earnings to reported GAAP earnings,
showing Holdings and Redwood using the 2001 format for presentation
(i.e., as if Holdings had been consolidated with Redwood for the periods
shown).
TABLE 16
CORE EARNINGS AND GAAP EARNINGS
(ALL DOLLARS IN THOUSANDS)
COMBINED COMBINED COMBINED
INCOME OVERHEAD MARKET CLOSED REPORTED
BEFORE ONGOING PREFERRED CORE VALUE BUSINESS GAAP
OVERHEAD OPERATIONS DIVIDENDS EARNINGS CHANGES UNITS EARNINGS
-------- ---------- --------- -------- -------- ----- --------
Q1: 1999 $7,780 $(1,600) $(687) $5,493 $2,170 $(1,808) $5,855
Q2: 1999 6,622 (2,242) (687) 3,693 1,412 (2,597) 2,508
Q3: 1999 6,595 (2,727) (686) 3,182 (2,075) (4,845) (3,738)
Q4: 1999 6,852 (1,917) (681) 4,254 (1,469) (8,423) (5,638)
Q1: 2000 8,028 (2,814) (681) 4,533 (1,164) (89) 3,280
Q2: 2000 8,014 (2,828) (681) 4,505 (1,452) 43 3,096
Q3: 2000 7,229 (2,602) (681) 3,946 927 0 4,873
Q4: 2000 8,082 (1,800) (681) 5,601 (640) 0 4,961
1998 $22,628 $(7,215) $(2,747) $12,666 $(49,004) $(3,781) $(40,118)
1999 27,849 (8,486) (2,741) 16,622 38 (17,673) (1,013)
2000 31,353 (10,044) (2,724) 18,585 (2,329) (46) 16,210
The table below reconciles core earnings per share to reported GAAP
earnings per share.
TABLE 17
CORE EARNINGS AND GAAP EARNINGS
(DOLLARS PER SHARE)
AVERAGE MARKET CLOSED REPORTED
DILUTED CORE VALUE BUSINESS GAAP
SHARES EARNINGS CHANGES UNITS EARNINGS
----------- ----------- ----------- ----------- -----------
Q1: 1999 10,861,774 $ 0.51 $ 0.20 $ (0.17) $ 0.54
Q2: 1999 10,172,960 0.36 0.14 (0.26) 0.25
Q3: 1999 9,570,933 0.33 (0.22) (0.51) (0.39)
Q4: 1999 8,810,348 0.48 (0.17) (0.96) (0.64)
Q1: 2000 8,848,966 0.51 (0.13) (0.01) 0.37
Q2: 2000 8,883,652 0.51 (0.16) 0.00 0.35
Q3: 2000 8,908,399 0.44 0.10 0.00 0.55
Q4: 2000 8,962,950 0.62 (0.07) 0.00 0.55
1998 $13,199,819 $ 0.96 $ (3.71) $ (0.29) $ (3.04)
1999 9,768,345 1.71 $ 0.00 (1.81) (0.10)
2000 8,902,069 2.08 (0.26) (0.00) 1.82
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MARKET VALUE CHANGES
In 2000, net mark-to-market adjustments recorded in our financial
statements were a positive $1.0 million. Assets and liabilities that
were marked-to-market through the balance sheet accounts (including
stockholders' equity) in 2000 appreciated by $3.3 million. Assets and
liabilities that were marked-to-market through our income statement
declined in value by $2.3 million. The net result of mark-to-market
adjustments for 2000 was a decrease in our reported earnings of $0.26
per share but an increase in our book value of $0.11 per share.
During the year ended December 31, 1999, our portfolio of assets that
were marked-to-market for income statement purposes increased in
estimated market value by $0.3 million. Assets and liabilities that were
marked-to-market through the balance sheet declined in value by $3.0
million. Net mark-to-market adjustments to our financial statements of
negative $2.7 million resulted in an increase in reported earnings per
share of $0.03 and a decrease in book value per share of $0.28.
We adopted SFAS No. 133 and other mark-to-market accounting principles
in the third quarter of 1998. Shifting to mark-to-market accounting
resulted in earnings charges relating to cumulative market value changes
to that point of $50 million ($3.81 per share) in the third quarter of
1998. For the year 1998 as a whole, income statement mark-to-market
adjustments were negative $49 million and balance sheet mark-to-market
adjustments were positive $10 million. The result was to lower reported
earnings by $3.71 per share and to increase book value (exclusive of the
effect of reported earnings) by $0.73 per share. The net result was a
decrease in book value of $2.98 per share from these changes in
accounting principles.
TABLE 18
MARKET VALUE CHANGES
(ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NET NET
INCOME BALANCE
STATEMENT SHEET TOTAL
MARKET MARKET MARKET
ADJUST PER SHARE ADJUST PER SHARE ADJUSTMENTS PER SHARE
--------- --------- -------- --------- ----------- ---------
Q1: 1999 $ 2,153 $ 0.20 $ (412) $ (0.04) $ 1,741 $ 0.16
Q2: 1999 1,412 0.14 (1,136) (0.11) 276 0.03
Q3: 1999 (2,069) (0.22) 66 0.01 (2,003) (0.21)
Q4: 1999 (1,212) (0.14) (1,496) (0.17) (2,708) (0.31)
Q1: 2000 (1,225) (0.14) (487) (0.06) (1,712) (0.19)
Q2: 2000 (1,359) (0.15) (886) (0.10) (2,245) (0.25)
Q3: 2000 927 0.10 720 0.08 1,647 0.18
Q4: 2000 (639) (0.07) 3,912 0.44 3,273 0.37
1998 $(49,004) $ (3.71) $ 9,701 $ 0.73 $(39,303) $ (2.98)
1999 284 0.03 (2,978) (0.30) (2,694) (0.28)
2000 (2,296) (0.26) 3,259 0.37 963 0.11
We currently intend to adopt EITF 99-20 in the first quarter of 2001.
Under these new accounting rules, in certain circumstances we will make
mark-to-market adjustments through our income statement on our
credit-enhancement and certain other assets that formerly were only
marked-to-market through our balance sheet. We will mark these through
the income statement if the discounted present value of current cash
flows deteriorates relative to our original assumptions. Only negative
income statement mark-to-market adjustments are allowed under EITF
99-20. Any initial mark-to-market adjustments that we take upon adoption
of EITF 99-20 will be recorded as a cumulative effect of a change in
accounting principle; any subsequent EITF 99-20 adjustments will be
included in our income statement under "Net realized and unrealized
gains and losses" with our other mark-to-market adjustments. For each of
our credit-enhancement interests and other assets subject to EITF 99-20
(with the
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exception of one set of assets described below), we currently believe
that projected cash flows have improved relative to our original
assumptions, and, in most cases, market values have increased.
We have been marking to market, through our balance sheet, the assets
that we retained from our resecuritization of the credit-enhancement
interests that we acquired from 1994 to 1997. The market values for
these assets that we have been using for our balance sheet estimates are
lower than our basis. They reflect what we believe is an estimate of
realizable sale value that is conservative and takes into consideration
the unique and complex nature of the assets and their illiquidity. We
currently project that credit losses for these assets will be somewhat
higher than we had originally projected. Accordingly, upon adoption of
EITF 99-20, we will mark these assets, through our income statement, to
the estimated market values that we use for our balance sheet. We
currently estimate that this mark-to-market adjustment would be
approximately $2.4 million if we make the adjustment in the first
quarter of 2001. This adjustment will lower earnings in the quarter that
we adopt EITF 99-20 and will increase the asset yield and cumulative
future earnings that we will recognize over the remaining life of these
assets (relative to what they would have been without the adjustment).
Since we have already been marking these assets to market on our balance
sheet, book value per share will be unaffected by this change in
accounting principle.
With falling interest rates in the first half of 2001, we would
generally expect that the net market values of our asset and liabilities
could increase as spread earnings opportunities increase. Net market
values may decline later in the year should interest rates stabilize and
spreads return to normalized levels.
SHAREHOLDER WEALTH
In the 6.25 years since the founding of Redwood, cumulative shareholder
wealth, as described below, has grown at a compound rate of 18% per
year. We define shareholder wealth as growth in tangible book value per
share, plus dividends received, plus reinvestment earnings on dividends.
In calculating shareholder wealth, we assume that dividends are
reinvested through the purchase of additional shares of Redwood at book
value. With this assumption, shareholder wealth creation at Redwood can
be compared to book value per share growth at a non-REIT company that
retains its earnings and compounds book value within the company. This
is a measure of management value-added, not a measure of shareholder
returns.
Book value per share was $11.67 in September 1994 when Redwood commenced
operations. We increased book value to $21.47 per share by December 31,
2000 through the retention of cash by keeping dividends lower than cash
flow, changes in market values of assets, issuance of stock at prices
above book value, and repurchases of stock below book value. Since we
mark-to-market most of our assets through our balance sheet, reported
book value is a good approximation of real intrinsic value in the
company. Cumulative dividends paid during this period were $7.32 per
share, and reinvestment earnings on those dividends were $4.11 per
share. Thus, cumulatively, shareholder wealth has increased from $11.67
per share to $32.90 per share during this 6.25-year period. A company
that earned an 18% after-tax return on equity and retained all its
earnings would have shown a similar amount of shareholder wealth growth
during this period.
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TABLE 19
SHAREHOLDER WEALTH
(DOLLARS PER SHARE)
BOOK CUMULATIVE
VALUE REINVESTMENT CUMULATIVE
PER ANNUAL CUMULATIVE EARNINGS ON SHAREHOLDER
SHARE DIVIDENDS DIVIDENDS DIVIDENDS WEALTH
------ --------- ---------- ------------ -----------
SEP-94 $11.67 $ 0.00 $ 0.00 $ 0.00 $11.67
DEC-94 10.82 0.25 0.25 0.00 11.07
DEC-95 12.38 0.96 1.21 0.09 13.68
DEC-96 16.50 1.67 2.88 1.07 20.45
DEC-97 21.55 2.15 5.03 3.07 29.65
DEC-98 20.27 0.28 5.31 2.67 28.25
DEC-99 20.88 0.40 5.71 3.07 29.66
DEC-00 21.47 1.61 7.32 4.11 32.90
DIVIDENDS
The dividends that we paid out cumulatively through the end of 2000 were
close to the minimum amount that we needed to pay under the REIT
distribution rules. If taxable income increases in 2001, we will need to
raise our dividend rate. We paid $1.61 per share in common stock
dividends in 2000, all of which was ordinary income. We declared a $0.50
per share common dividend for the first quarter of 2001.
We do not plan to acquire, create, or retain any Real Estate Mortgage
Investment Conduit ("REMIC") or Collateralized Mortgage Obligation
("CMO") residual interests that would cause the distribution of excess
inclusion income or unrelated business taxable income to investors. As a
result, we qualify as an eligible investment for tax exempt investors,
such as pension plans, profit sharing plans, 401(k) plans, Keogh plans,
and Individual Retirement Accounts. See "Certain Federal Income Tax
Considerations - Taxation of Tax-Exempt Entities."
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
Our cash flow from operations generally exceeds our earnings. Cash flow
from operations was $25 million in 2000, consisting of earnings of $16
million plus non-cash depreciation and amortization of $5 million plus
non-cash mark-to-market adjustments of $4 million. Our free cash flow,
after investment in working capital, property, plant, equipment, and
other non-earning assets, was $21 million. In addition, we received $7
million from our investment in Holdings and we issued $0.4 million in
new common stock. We used the available cash from these sources to fund
our common stock dividend of $12 million and to increase our investment
in our portfolio activities by $16 million.
Cash flow from operations was $28 million in 1999. Free cash flow was
$44 million as we reduced our working capital requirements. We decreased
our investment in our portfolio operations by $5 million, paid $1
million in common stock dividends, invested $10 million in Holdings, and
repurchased $37 million of common stock.
Cash flow from operations was $47 million in 1998. Free cash flow was
$61 million. We decreased our investment in our portfolio operations by
$20 million, paid $10 million in common stock dividends, invested $27
million in Holdings, and repurchased $45 million of common stock.
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TABLE 20
CASH FLOW
(ALL DOLLARS IN THOUSANDS)
(INVESTMENT)
IN
CASH WORKING FUNDS
FLOW CAPITAL FREE (INVESTMENT) (PURCHASE)/ AVAILABLE FOR
FROM AND OTHER CASH IN COMMON SALE PORTFOLIO
OPERATIONS ASSETS FLOW HOLDINGS DIVIDENDS OF STOCK INVESTING
---------- ------------ -------- ---------- -------- ---------- -------------
Q1: 1999 $ 9,036 $ (3,087) $ 5,949 $ (6,897) $ 0 $(16,034) $(16,982)
Q2: 1999 7,092 9,321 16,413 1,733 0 (3,997) 14,149
Q3: 1999 6,308 3,785 10,093 (17,496) 0 (15,004) (22,407)
Q4: 1999 6,019 5,162 11,181 12,733 (1,323) (2,299) 20,292
Q1: 2000 6,325 71 6,396 4,999 (2,196) 45 9,244
Q2: 2000 5,562 1,435 6,997 1,973 (3,076) 0 5,894
Q3: 2000 5,957 (2,315) 3,642 0 (3,516) 381 507
Q4: 2000 7,239 (3,113) 4,126 0 (3,700) 2 428
0
1998 $ 46,728 $ 13,903 $ 60,631 $(26,745) $ (8,946) $(45,384) $(20,444)
1999 28,455 15,181 43,636 (9,927) (1,323) (37,334) (4,948)
2000 25,083 (3,922) 21,161 6,972 (12,488) 428 16,073
For 2001, we generally expect that the cash flows that we generate from
operations are likely to exceed our minimum dividend requirement under
the REIT tax rules and our other cash needs. As a result, we currently
expect to be able to make an additional net investment in our portfolio
operations and/or to be able to pay a dividend in excess of our minimum
dividend requirements in the next year.
At December 31, 2000, we had over a dozen uncommitted facilities for
short-term collateralized debt, with credit approval for over $4 billion
of borrowings. We had no difficulty securing short term borrowings on
favorable terms during 2000. Outstanding borrowings under these
agreements were $0.7 billion at year-end 2000 and $1.2 billion at year
end 1999.
We had three committed borrowing facilities for residential assets
totaling $80 million and two borrowing facilities for commercial assets
totaling $100 million. There are certain restrictions regarding the
collateral for which these committed facilities can be used, but they
generally allow us to fund either our commercial mortgage loans or our
residential credit-enhancement interests. We had no difficulty during
2000 in meeting the debt covenant tests required by our committed bank
credit facility agreements, or in extending these facilities or
negotiating new lines. Outstanding borrowings under these committed
agreements, including borrowings by Holdings, were $88 million at year
end 2000 and $19 million at year end 1999.
Under our internal risk-adjusted capital system, we maintain liquidity
reserves in the form of cash and unpledged liquid assets. These
liquidity reserves may be needed in the event of a decline in the market
value or in the acceptability to lenders of the collateral we pledge to
secure short-term borrowings, or for other liquidity needs. We
maintained liquidity reserves at or in excess of our policy levels
during 2000. At December 31, 2000, we had $54 million of unrestricted
cash and highly liquid (unpledged) assets available to meet potential
liquidity needs. Total available liquidity equaled 7% of our short-term
debt balances. At December 31, 1999, we had $71 million of liquid
assets, equaling 6% of our short-term debt balances.
At this time, we see no material negative trends that would affect our
access to short-term borrowings or bank credit lines, that would suggest
that our liquidity reserves would be called upon, or that would be
likely to cause us to be in danger of a covenant default. However many
factors, including ones external to us, may affect our liquidity in the
future.
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The $1.1 billion of long-term debt on our December 31, 2000 balance
sheet is non-recourse debt. The holders of our long-term debt can look
only to the cash flow from the mortgages specifically collateralizing
this debt for repayment. By using this source of financing, our
liquidity risks are limited. Our special purpose financing subsidiaries
that issue this debt have no call on our general liquidity reserves, and
there is no debt rollover risk as the loans are financed to maturity.
The market for AAA rated long-term debt of the type that we issue is a
large, global market that has been relatively stable for many years. At
this time, we know of no reason why we would not be able to issue more
of this debt on reasonable terms in 2001 if we should choose to do so.
Excluding short and long term collateralized debt, we are capitalized
entirely by common and preferred equity capital. Our equity base
increased from $210 million to $216 million during 2000 as a result of
internal operations and stock issuance of $0.4 million. We do plan to
raise new equity capital in the future when opportunities to expand our
business are attractive and when such issuance is likely to benefit
earnings and dividends per share.
We have not, to date, issued unsecured corporate debt. In the future, we
may consider issuing longer-term unsecured corporate debt to supplement
our capital base and improve the efficiency of our capital structure.
The amount of portfolio assets that can be supported with a given
capital base is limited by our internal risk-adjusted capital policies.
Our risk-adjusted capital policy guideline amounts are expressed in
terms of an equity-to-assets ratio and vary with market conditions and
asset characteristics. At December 31, 2000, our minimum capital amounts
were: 62% of residential credit-enhancement portfolio interests; 100% of
net retained interests in residential retained loan portfolio after
long-term debt issuance; 15% of short-term debt funded residential whole
loans; 9% of investment portfolio securities; and 36% of commercial
retained loan portfolio. Our total risk-adjusted capital guideline
amount for assets on our balance sheet was $186 million (9% of asset
balances) at December 31, 2000. Capital required for commitments for
asset purchases settling in 2001 was $13 million. Total capital was $216
million; our capital exceeded our internal risk-adjusted capital policy
guideline minimum amount by $17 million at December 31, 2000.
At December 31, 2000, our capital base of $216 million supported at-risk
assets (excluding long-term funded residential loans owned by financing
trusts) of $983 million funded with short-term debt of $756 million.
Excluding non-recourse debt and related assets, our equity-to-assets
ratio was 22% and our debt to equity ratio was 3.5 times at year end
2000. At year end 1999, our equity-to-assets ratio was 14% and our debt
to equity ratio was 6.0 times.
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TABLE 21
RECOURSE ASSETS
(ALL DOLLARS IN THOUSANDS)
EQUITY
AT TO RECOURSE
RISK RECOURSE AT-RISK DEBT TO
ASSETS DEBT EQUITY ASSETS EQUITY
---------- ---------- ---------- ---------- ----------
Q1: 1999 $1,288,485 $1,033,643 $ 244,198 18.95% 4.2
Q2: 1999 1,169,880 922,745 241,574 20.65% 3.8
Q3: 1999 1,100,480 854,465 222,898 20.25% 3.8
Q4: 1999 1,471,570 1,253,565 209,935 14.27% 6.0
Q1: 2000 1,141,241 922,405 209,700 18.37% 4.4
Q2: 2000 1,026,281 806,643 208,384 20.30% 3.9
Q3: 2000 1,055,032 822,389 210,664 19.97% 3.9
Q4: 2000 983,097 756,222 215,663 21.94% 3.5
1998 $1,523,280 $1,257,570 $ 254,789 16.73% 4.9
1999 1,471,570 1,253,565 209,935 14.27% 6.0
2000 983,097 756,222 215,663 21.94% 3.5
RWT HOLDINGS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RWT Holdings, Inc. ("Holdings") was incorporated in Delaware in February
1998 and commenced operations on April 1, 1998. Holdings' start-up
operations have been funded primarily by Redwood Trust, which has a
significant investment in Holdings. Prior to January 1, 2001, Redwood
owned all of Holdings' non-voting preferred stock. Redwood Trust's
senior management owned all of Holdings' voting common stock. We refer
you to "Note 1. The Company" in the Notes to the Consolidated Financial
Statements of RWT Holdings, Inc. and taxable subsidiaries for additional
information on Holdings' initial capitalization. On January 1, 2001,
Redwood acquired the common stock of Holdings and intends to operate
Holdings in the future as a wholly-owned taxable subsidiary with
consolidated financial statements.
Holdings originated commercial mortgage loans for sale to institutional
investors through its Redwood Commercial Funding, Inc. ("RCF")
subsidiary. RCF originated $73 million of commercial mortgage loans in
2000, $42 million in 1999, and $8 million in 1998. After loan sales and
payoffs, remaining commercial mortgage loans originated by RCF totaled
$76 million at December 31, 2000, of which $57 million were owned by
Redwood and $19 million were owned by Holdings.
In 2000, Holdings sold $44 million of commercial loans, some of them to
Redwood. In addition, Holdings sold the remaining residential loans that
its wholly-owned residential mortgage finance subsidiaries had
previously acquired. Net gains on sales recognized by Holdings in 2000
totaled $0.4 million which were offset by unrealized losses on assets of
$0.2 million.
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 million during
the year ended December 31, 1999, and a significant reduction in the
headcount and ongoing operating expenses at Holdings. This contributed
to Holdings recording a net loss of $22 million in 1999. In 1998, the
initial start up expenses associated with these operations resulted in a
net loss of $5 million.
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Holdings recorded a net loss of $1.5 million in 2000. This was based on
net interest income of $0.7 million, net gains on sales of $0.2 million
and operating expenses of $2.4 million. Most of the commercial loans
originated by RCF were owned by Redwood for most of the year, so
Holdings did not benefit from the net interest income on these loans.
At December 31, 2000, Holdings had net operating loss carryforwards of
approximately $25 million for federal tax purposes and $11 million for
state income tax purposes. The federal loss carryforwards and a portion
of the state loss carryforwards expire between 2018 and 2020, while the
largest portion of the state carryforwards expire between 2003 and 2005.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We seek to manage the risks inherent in all financial institutions --
interest rate, market value, liquidity, prepayment, and credit risks --
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.
We seek, to the best of our ability, to only assume risks that can be
quantified from historical experience, to actively manage such risks, to
earn sufficient compensation to justify the taking of such risks, and to
maintain capital levels consistent with the risks we do undertake.
MARKET VALUE RISK
At December 31, 2000, we owned mortgage securities and loans totaling
$0.8 billion that we account for on a mark-to-market basis (in the case
of mortgage loans, on a lower-of-cost-or-market basis) for purposes of
determining reported earnings. Of these assets, 98% had adjustable-rate
coupons and 2% had fixed-rate coupons. All of our $2.0 billion in
notional amounts of interest rate agreements are marked-to-market for
income statement purposes. Market value fluctuations of these assets and
interest rate agreements not only affect our earnings, but also can
affect our liquidity, especially to the extent they are funded with
short-term borrowings.
At December 31, 2000, we owned $86 million of assets that are
marked-to-market on our balance sheet. Market value fluctuations of
these assets can affect the reported value of our stockholders' equity
base
INTEREST RATE RISK
At December 31, 2000, we owned $2.1 billion of assets and had $1.9
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.
At December 31, 2000, we owned hybrid mortgage assets (with fixed-rate
coupons for 3 to 7 years and adjustable-rate coupons thereafter)
totaling $0.3 billion. We had debt with interest rate reset
characteristics matched to the hybrid mortgages totaling $0.3 billion.
At December 31, 2000, we owned $0.5 billion of adjustable-rate mortgage
assets with coupons that adjust monthly as a function of one-month LIBOR
interest rates, funded with equity and with debt that also adjusts
monthly as a function of one-month LIBOR interest rates. The spread
between the coupon rates on these assets and the cost of funds of our
liabilities has been stable.
For other parts of our balance sheet, our net income may fluctuate as
the yield curve between one-month interest rates and six- and
twelve-month interest rates varies, and as the differences between U.S.
Treasury rates, the 11th District cost of funds rate (COFI), and LIBOR
rates vary. At December 31, 2000, we owned $0.5 billion of
adjustable-rate mortgage assets with interest rates that adjust every
six months as a function of six-month LIBOR
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interest rates funded with equity and with debt that had an interest
rate that adjusts monthly as a function of one-month LIBOR interest
rates. Adjustable-rate assets with earnings rates dependent on one-year
U.S. Treasury rates with annual adjustments totaled $0.6 billion at
December 31, 2000. These Treasury-based assets were effectively funded
with equity and with $0.3 billion of liabilities with a cost of funds
dependent on one-year U.S. Treasury rates with annual adjustments. The
remainder of the liabilities associated with these assets had a cost of
funds dependent on one-month LIBOR rates or the daily Fed Funds rate.
At December 31, 2000, we owned a total of $81 million of fixed rate
assets funded, in part, with short-term variable rate debt which is only
partially hedged. Holding these positions should mitigate earnings
declines caused by lower yields on equity-funded assets as interest
rates fall. As interest rates rise, net earnings on these assets should
fall, but this would likely be offset, in part, by the beneficial effect
of higher yields on equity-funded assets.
Interest rates and related factors can affect our spread income and our
mark to market results. 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.
At December 31, 2000, we had $0.8 billion of short-term debt.
PREPAYMENT RISK
At December 31, 2000, mortgage premium balances were $22 million. Most
of this premium, $14 million, was associated with our residential
retained loan portfolio, and the rest, $8 million, with our investment
portfolio. Total mortgage discount balances were $44 million, primarily
all of which was associated with our credit-enhancement portfolio. Of
this total discount amount, we are currently amortizing $17 million into
income over time in a manner dependent on mortgage prepayment rates. The
remainder, $27 million, we have designated as a credit reserve to
provide for future losses. We will realize this portion of our discount
as income only if future credit losses are less than projected. Our net
premium balance for our whole balance sheet, after removing the
designated credit reserve, was $5 million.
CREDIT RISK
Our principal credit risk comes from residential mortgage loans in our
retained portfolio and credit-enhancement portfolio and from our
commercial mortgage loan portfolio. A small amount of our investment
portfolio is currently exposed to credit risk; the bulk of this
portfolio has very high credit ratings and would not normally be
expected to incur credit losses. We have credit risk with
counter-parties with whom we do business.
It should be noted that the establishment of a credit reserve for GAAP
purposes for our residential retained portfolio or a designated credit
reserve under the effective yield method for our credit-enhancement
portfolio does not reduce our taxable income or our dividend payment
obligations as a REIT. For taxable income, many of our credit expenses
will be recognized only as incurred. Thus, the timing of recognition of
credit losses for GAAP and tax, and for our earnings and our dividends,
may differ.
The method that we use to account for future credit losses depends upon
the type of asset that we own. For our credit enhancement portfolio, we
effectively are provided with a credit reserve upon the acquisition of
such assets. We designate a portion of our discount as a credit reserve.
In addition, first loss and other credit-enhancement interests that are
junior to our positions that we do not own act as a form of credit
reserve for us on a specific asset basis. For our retained residential
mortgage loan portfolio, we establish a credit reserve based on
anticipation of losses. For our investment portfolio, most of the assets
do not have material credit risk, and no credit reserves are generally
established. When we acquire any assets for this portfolio where credit
risk exists, we will establish the appropriate reserve as necessary. For
our commercial retained portfolio, we take credit reserves on a specific
asset basis when specific circumstances may warrant such a charge for a
particular loan. Management constantly monitors the performance of all
of its assets and takes appropriate actions to mitigate potential losses
to the extent
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possible. Regardless of how we account for future credit loss
expectations, there can be no assurance that our estimates will be prove
to be correct, and thus we may need to adjust the amounts of credit
reserves we have established.
CAPITAL RISK
Our capital levels, and thus our access to borrowings and liquidity, may
be tested, particularly if the market value of our assets securing
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, residential credit-enhancement
interests, retained interests from our Sequoia securitizations of our
residential retained portfolio assets, and commercial mortgage whole
loans are generally higher than for higher-rated residential securities
and residential whole loans. Capital requirements for these less-liquid
assets depend chiefly on our access to secure funding for these assets,
the number of sources of such funding, the funding terms, and on the
amount of extra capital we decide to hold on hand to protect against
possible liquidity events with these assets. Capital requirements for
most of our retained interests in Sequoia generally equal our net
investment. The sum of the capital adequacy amounts for all of our
mortgage assets is our aggregate capital adequacy guideline amount.
Generally, 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 requiring more capital, such as commercial
mortgage loans and residential credit-enhancement interests.
We do not expect that our actual capital levels will always exceed the
guideline amount. If interest rates were to rise in a significant
manner, our capital guideline amount may rise, as the potential interest
rate risk of our mortgages would increase, at least on a temporary
basis, due to periodic and life caps and slowing prepayment rates. We
measure all of our mortgage assets funded with short-term debt at
estimated market value for the purpose of making risk-adjusted capital
calculations. Our actual capital levels, as determined for the
risk-adjusted capital policy, would likely fall as rates increase 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.
INFLATION RISK
Virtually all of our assets and liabilities are financial in nature. As
a result, interest rates, changes in interest rates and other factors
drive our performance far more than does inflation. Changes in interest
rates do not necessarily correlate with inflation rates or changes in
inflation rates.
Our financial statements are prepared in accordance with GAAP and our
dividends must equal at least 95% (90% for years 2001 and after) of our
net income as calculated for tax purposes. In each case, our activities
and balance sheet are measured with reference to historical cost or fair
market value without considering inflation.
QUANTITATIVE INFORMATION ABOUT MARKET RISK
The information presented in the table on the following pages includes
all of our interest rate sensitive assets and liabilities. We acquire
interest-rate sensitive assets, fund them with interest-rate sensitive
liabilities and also utilize
51
52
interest-rate sensitive derivative financial instruments. We designate
some of these assets as "trading." The designation of an asset as
"trading" does not necessarily imply that we have a short-term intended
holding period for that asset.
The table below includes information about the possible future
repayments and interest rates of our assets and liabilities and
constitutes a "forward-looking statement." There are many assumptions
used to generate this information and there can be no assurance that
assumed events will occur as assumed. Other events will occur and will
affect the outcomes. Furthermore, future sales, acquisitions, calls, and
restructurings could materially change our interest rate risk profile.
For interest-rate sensitive assets, the table presents principal cash
flows and related average interest rates by year of maturity. The
forward curve (future interest rates as implied by the yield structure
of debt markets) as of December 31, 2000 was used to project the average
interest rates for each year, based on the existing characteristics of
the portfolio. The maturity of cash flows includes assumptions on the
prepayment speeds of these assets based on their recent prepayment
performance; actual prepayment speeds will vary.
52
53
QUANTITATIVE INFORMATION ON MARKET RISK
(ALL DOLLARS IN THOUSANDS)
INTEREST RATE SENSITIVE ASSETS
PRINCIPAL AMOUNTS MATURING AND EFFECTIVE RATES DURING PERIOD
----------------------------------------------------------------
2001 2002 2003 2004 2005 THEREAFTER
------- ------- ------- ------- ------- ----------
RESIDENTIAL CREDIT ENHANCEMENT INTERESTS Principal 441 502 528 589 1,984 36,152
ADJUSTABLE RATE Interest Rate 8.48% 8.20% 8.41% 8.53% 8.53% 9.00%
Principal 226 243 262 957 2,063 10,045
HYBRID Interest Rate 7.25% 7.25% 7.25% 7.20% 7.14% 7.61%
Principal 854 916 983 1,054 1,130 65,948
FIXED RATE Interest Rate 7.02% 7.02% 7.02% 7.02% 7.02% 7.02%
RETAINED RESIDENTIAL LOAN PORTFOLIO Principal Value 247,598 172,757 120,197 82,381 56,510 122,741
ADJUSTABLE RATE RESIDENTIAL MORTGAGE LOANS Interest Rate 7.51% 7.23% 7.46% 7.59% 7.59% 7.80%
Principal Value 157,183 93,581 31,690 17,216 9,337 10,979
HYBRID RESIDENTIAL MORTGAGE LOANS Interest Rate 6.79% 6.82% 7.49% 7.37% 7.29% 7.72%
INVESTMENT PORTFOLIO Principal Value 252,420 162,532 105,159 68,649 45,152 89,383
ADJUSTABLE RATE MORTGAGE SECURITIES Interest Rate 7.67% 7.07% 7.18% 7.20% 7.12% 7.45%
Principal Value 2,062 5,656 6,668 7,305 4,794 7,168
FIXED RATE MORTGAGE SECURITIES Interest Rate 7.38% 7.42% 7.43% 7.43% 7.41% 7.37%
COMMERCIAL RETAINED LOAN PORTFOLIO Principal Value 13,226 16,243 22,675 0 0 0
ADJUSTABLE RATE MORTGAGE LOANS Interest Rate 10.63% 9.49% 9.50% n/a n/a n/a
Principal Value 74 82 883 84 92 4,340
HYBRID MORTGAGE LOANS Interest Rate 9.50% 9.50% 9.50% 9.51% 9.56% 9.92%
INTEREST-RATE SENSITIVE LIABILITIES
SHORT-TERM DEBT Principal 756,222 0 0 0 0 0
REVERSE REPURCHASE AGREEMENTS Interest Rate 6.85% n/a n/a n/a n/a n/a
AND BANK WAREHOUSE FACILITIES
LONG-TERM DEBT Principal 244,165 171,058 119,359 81,968 56,306 111,156
VARIABLE RATE Interest Rate 6.39% 5.97% 6.15% 6.24% 6.21% 6.45%
Principal 157,183 93,581 31,690 17,216 9,337 2,890
HYBRID (FIXED TO DECEMBER 2002) Interest Rate 6.35% 6.40% 6.60% 7.16% 7.36% 7.51%
AT DECEMBER 31, 2000
--------------------------------
PRINCIPAL REPORTED EST. MARKET
VALUE VALUE VALUE
--------- -------- -----------
RESIDENTIAL CREDIT ENHANCEMENT INTERESTS Principal 40,196 28,206 28,206
ADJUSTABLE RATE Interest Rate 70.17% 70.17%
Principal 13,797 7,419 7,419
HYBRID Interest Rate 53.77% 53.77%
Principal 70,885 45,140 45,140
FIXED RATE Interest Rate 63.68% 63.68%
RETAINED RESIDENTIAL LOAN PORTFOLIO Principal Value 802,183 811,927 801,605
ADJUSTABLE RATE RESIDENTIAL MORTGAGE LOANS Interest Rate 101.21% 99.93%
Principal Value 319,986 319,069 318,442
HYBRID RESIDENTIAL MORTGAGE LOANS Interest Rate 99.71% 99.52%
INVESTMENT PORTFOLIO Principal Value 723,295 731,529 731,529
ADJUSTABLE RATE MORTGAGE SECURITIES Interest Rate 101.14% 101.14%
Principal Value 33,654 33,246 33,246
FIXED RATE MORTGAGE SECURITIES Interest Rate 98.79% 98.79%
COMMERCIAL RETAINED LOAN PORTFOLIO Principal Value 52,144 51,992 51,992
ADJUSTABLE RATE MORTGAGE LOANS Interest Rate 99.71% 99.71%
Principal Value 5,556 5,177 5,177
HYBRID MORTGAGE LOANS Interest Rate 93.19% 93.19%
INTEREST-RATE SENSITIVE LIABILITIES
SHORT-TERM DEBT Principal 756,222 756,222 756,222
REVERSE REPURCHASE AGREEMENTS Interest Rate 100.00% 100.00%
AND BANK WAREHOUSE FACILITIES
LONG-TERM DEBT Principal 784,012 784,462 777,624
VARIABLE RATE Interest Rate 100.06% 99.19%
Principal 311,897 311,373 307,843
HYBRID (FIXED TO DECEMBER 2002) Interest Rate 99.83% 98.70%
54
QUANTITATIVE INFORMATION ON MARKET RISK
(ALL DOLLARS IN THOUSANDS)
(CONTINUED)
INTEREST RATE AGREEMENTS
(INTEREST RATE AGREEMENTS WHICH REPRESENT MIRRORING
TRANSACTIONS ARE NOT INCLUDED IN THIS TABLE.)
NOTIONAL AMOUNTS MATURING AND EFFECTIVE RATES DURING PERIOD
---------------------------------------------------------------------------
2001 2002 2003 2004 2005 THEREAFTER
--------- --------- --------- --------- --------- ----------
INTEREST RATE CAPS -
(SEE BELOW FOR DETAILS) Notional 851,000 309,900 5,800 59,600 84,000 12,000
(PURCHASED) Strike Rate 8.81% 10.31% 7.14% 6.49% 8.23% 7.35%
FLOORS Notional 0 5,000 2,000 1,000 5,000 5,000
(PURCHASED) Strike Rate n/a 5.33% 5.33% 5.33% 5.62% 6.00%
EURODOLLAR FUTURES Notional 101,000 61,000 56,000 56,000 22,000 10,000
(SOLD) Sale Price 93.20% 93.36% 93.20% 92.86% 92.95% 92.35%
5 YEAR TREASURY NOTE FUTURES Notional 600 0 0 0 0 0
(SOLD) Sale Price 101.88% n/a n/a n/a n/a n/a
PUT OPTIONS ON EURODOLLAR FUTURES Notional 125,000 0 0 0 0 0
(PURCHASED) Strike Price 93.06% n/a n/a n/a n/a n/a
CALL OPTIONS ON EURODOLLAR FUTURES Notional 25,000 0 0 0 0 0
(PURCHASED) Strike Price 93.00% n/a n/a n/a n/a n/a
FORWARD RATE AGREEMENT Notional 200,000 0 0 0 0 0
(SOLD) Strike Rate 7.00% n/a n/a n/a n/a n/a
INTEREST RATE SWAPS Notional 0 0 0 0 0 5,000
(PURCHASED) Strike Rate n/a n/a n/a n/a n/a 6.29%
DETAIL OF INTEREST RATE CAPS
(TOTALED ABOVE)
with Strike Rates < 6% Notional 0 0 0 0 0 0
Strike Rate n/a n/a n/a n/a n/a n/a
with Strike Rates of 6% to 7% Notional 80,000 4,000 0 54,000 0 2,000
Strike Rate 6.69% 6.25% n/a 6.32% n/a 6.63%
with Strike Rates of 7% to 8% Notional 270,000 0 5,000 0 18,000 10,000
Strike Rate 7.59% n/a 7.00% n/a 7.40% 7.50%
with Strike Rates of 8% to 9% Notional 0 5,000 0 5,000 54,000 0
Strike Rate n/a 8.60% n/a 8.00% 8.34% n/a
with Strike Rates of 9% to 10% Notional 201,000 900 800 600 12,000 0
Strike Rate 9.53% 9.00% 9.00% 9.00% 9.00% n/a
with Strike Rates of 10% to 11% Notional 300,000 200,000 0 0 0 0
Strike Rate 10.00% 10.10% n/a n/a n/a n/a
with Strike Rates > 11% Notional 0 100,000 0 0 0 0
Strike Rate n/a 11.00% n/a n/a n/a n/a
AT DECEMBER 31, 2000
-------------------------------------
NOTIONAL REPORTED EST. MARKET
VALUE VALUE VALUE
--------- --------- -----------
INTEREST RATE CAPS -
(SEE BELOW FOR DETAILS) Notional 1,322,300 591 591
(PURCHASED) Strike Rate 0.04% 0.04%
FLOORS Notional 18,000 272 272
(PURCHASED) Strike Rate 1.51% 1.51%
EURODOLLAR FUTURES Notional 306,000 (775) (775)
(SOLD) Sale Price -0.25% -0.25%
5 YEAR TREASURY NOTE FUTURES Notional 600 (10) (10)
(SOLD) Sale Price -1.69% -1.69%
PUT OPTIONS ON EURODOLLAR FUTURES Notional 125,000 2 2
(PURCHASED) Strike Price 0.00% 0.00%
CALL OPTIONS ON EURODOLLAR FUTURES Notional 25,000 69 69
(PURCHASED) Strike Price 0.28% 0.28%
FORWARD RATE AGREEMENT Notional 200,000 0 0
(SOLD) Strike Rate 0.00% 0.00%
INTEREST RATE SWAPS Notional 5,000 (83) (83)
(PURCHASED) Strike Rate -1.65% -1.65%
DETAIL OF INTEREST RATE CAPS
(TOTALED ABOVE)
with Strike Rates < 6% Notional 0 0 0
Strike Rate n/a n/a
with Strike Rates of 6% to 7% Notional 140,000 282 282
Strike Rate 0.20% 0.20%
with Strike Rates of 7% to 8% Notional 303,000 185 185
Strike Rate 0.06% 0.06%
with Strike Rates of 8% to 9% Notional 64,000 108 108
Strike Rate 0.17% 0.17%
with Strike Rates of 9% to 10% Notional 215,300 17 17
Strike Rate 0.01% 0.01%
with Strike Rates of 10% to 11% Notional 500,000 0 0
Strike Rate 0.00% 0.00%
with Strike Rates > 11% Notional 100,000 0 0
Strike Rate 0.00% 0.00%
55
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Company and Holdings and
the related Notes, together with the Reports of Independent Accountants
thereon, are set forth on pages F-1 through F-42 of this Form 10-K and
incorporated herein by reference.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 as to directors and executive
officers of the Company is incorporated herein by reference to the
definitive Proxy Statement to be filed pursuant to Regulation 14A under
the headings "Election of Directors" and "Management of the Company."
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference
to the definitive Proxy Statement to be filed pursuant to Regulation 14A
under the heading "Executive Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by reference
to the definitive Proxy Statement to be filed pursuant to Regulation 14A
under the heading "Security Ownership of Certain Beneficial Owners and
Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference
to the definitive Proxy Statement to be filed pursuant to Regulation 14A
under the heading "Executive Compensation -- Certain Relationships and
Related Transactions."
PART IV
ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON
FORM 8-K
(a) Documents filed as part of this report:
(1) Consolidated Financial Statements
(2) Schedules to Consolidated Financial Statements: All
Consolidated Financial Statements schedules not included
have been omitted because they are either inapplicable
or the information required is provided in the Company's
Consolidated Financial Statements and Notes thereto,
included in Part II, Item 8, of this Annual Report on
Form 10-K.
55
56
(3) Exhibits:
Exhibit
Number Exhibit
- ------- -------
3.1 Articles of Amendment and Restatement of the Registrant (a)
3.1.1 Certified Certificate of Amendment of the Charter of Registrant (l)
3.2 Articles Supplementary of the Registrant (a)
3.3 Amended and Restated Bylaws of the Registrant (b)
3.3.1 Amended and Restated Bylaws, amended December 13, 1996 (g)
3.3.2 Amended and Restated Bylaws, amended March 15, 2001
3.4 Articles Supplementary of the Registrant, dated August 14, 1995 (d)
3.4.1 Articles Supplementary of the Registrant relating to the Class B
9.74% Cumulative Convertible Preferred Stock, filed August 9, 1996
(f)
4.2 Specimen Common Stock Certificate (a)
4.3 Specimen Class B 9.74% Cumulative Convertible Preferred Stock
Certificate (f)
4.4 In May 1999, the Bonds issued pursuant to the Indenture, dated as of
June 1, 1997, between Sequoia Mortgage Trust 1 and First Union
National Bank, as Trustee, were redeemed, restructured, and
contributed to Sequoia Mortgage Trust 1A, interests in which were
then privately placed with investors (i)
4.4.1 Indenture dated as of October 1, 1997 between Sequoia Mortgage Trust
2 (a wholly-owned, consolidated subsidiary of the Registrant) and
Norwest Bank Minnesota, N.A., as Trustee (j)
4.4.2 Sequoia Mortgage Trust 1A Trust Agreement, dated as of May 4, 1999
between Sequoia Mortgage Trust 1 and First Union National Bank (m)
9.1 Voting Agreement, dated March 10, 2000
10.1 Purchase Terms Agreement, dated August 18, 1994, between the
Registrant and Montgomery Securities (a)
10.2 Registration Rights Agreement, dated August 19, 1994, between the
Registrant and Montgomery Securities (a)
10.3 [Reserved]
10.4 Founders Rights Agreement, dated August 19, 1994, between the
Registrant and the original holders of Common Stock of the
Registrant (a)
10.5 Form of Reverse Repurchase Agreement for use with Agency
Certificates, Privately-Issued Certificates and Privately-Issued
CMOs (a)
10.5.1 Form of Reverse Repurchase Agreement for use with Mortgage Loans (d)
10.6.1 [Reserved]
10.7 [Reserved]
10.8 Forms of Interest Rate Cap Agreements (a)
10.9 [Reserved]
10.9.2 [Reserved]
10.9.3 Custodian Agreement (U.S. Custody), dated December 1, 2000, between
the Registrant and Bankers Trust Company
10.10 Employment Agreement, dated August 19, 1994, between the Registrant
and George E. Bull (a)
10.11 Employment Agreement, dated August 19, 1994, between the Registrant
and Douglas B. Hansen (a)
10.12 [Reserved]
10.13 [Reserved]
10.13.1 Employment Agreement, dated March 13, 2000, between the Registrant
and Harold F. Zagunis (o)
10.13.2 Employment Agreement, dated March 23, 2001, between the Registrant
and Andrew I. Sirkis
10.13.3 Employment Agreement, dated April 20, 2000, between the Registrant
and Brett D. Nicholas
10.14 1994 Amended and Restated Executive and Non-Employee Director Stock
Option Plan (c)
10.14.1 1994 Amended and Restated Executive and Non-Employee Director Stock
Option Plan, amended March 6, 1996 (d)
56
57
10.14.2 Amended and Restated 1994 Executive and Non-Employee Director Stock
Option Plan, amended December 13, 1996 (h)
10.14.3 Amended and Restated Executive and Non-Employee Director Stock
Option Plan, amended March 4, 1999 (p)
10.14.4 Amended and Restated Executive and Non-Employee Director Stock
Option Plan, amended January 18, 2001
10.27 [Reserved]
10.29 [Reserved]
10.29.1 Form of Dividend Reinvestment and Stock Purchase Plan (g)
10.30 Office Building Lease (d)
10.30.1 Amendment to Office Building Lease (k)
10.31 RWT Holdings, Inc. Series A Preferred Stock Purchase Agreement,
dated March 1, 1998 (n)
10.32 Administrative Personnel and Facilities Agreement dated as of April
1, 1998, between Redwood Trust, Inc. and RWT Holdings, Inc. (n)
10.32.1 First Amendment to Administrative Personnel and Facilities Agreement
dated as of April 1, 1998, between Redwood Trust, Inc. and RWT
Holdings, Inc. (n)
10.33 Lending and Credit Support Agreement dated as of April 1, 1998,
between RWT Holdings, Inc., Redwood Residential Funding, Inc.,
Redwood Commercial Funding, Inc., and Redwood Financial Services,
Inc., and Redwood Trust, Inc. (n)
10.34 Form of Master Forward Commitment Agreements for RWT Holdings, Inc.,
Residential Redwood Funding, Inc., Redwood Commercial Funding, Inc.
and Redwood Financial Services, Inc. (n)
11.1 Statement re: Computation of Per Share Earnings
21 List of Subsidiaries
23 Consent of Accountants
- ----------------------
(a) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (33-92272)
filed by the Registrant with the Securities and Exchange
Commission on May 19, 1995.
(b) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (33-97946)
filed by the Registrant with the Securities and Exchange
Commission on October 10, 1995.
(c) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (33-94160)
filed by the Registrant with the Securities and Exchange
Commission on June 30, 1995.
(d) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (333-02962)
filed by the Registrant with the Securities and Exchange
Commission on March 26, 1996.
(e) [Reserved]
(f) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (333-08363)
filed by the Registrant with the Securities and Exchange
Commission on July 18, 1996.
(g) Incorporated by reference to the Registration Statement on Form
S-3 (333-18061) filed by the Registrant with the Securities and
Exchange Commission on January 2, 1997.
(h) Incorporated by reference to the correspondingly numbered
exhibit to Form 8-K (000-26436) filed by the Registrant with the
Securities and Exchange Commission on January 7, 1997.
57
58
(i) Incorporated by reference to the Form 8-K filed by Sequoia
Mortgage Funding Corporation with the Securities and Exchange
Commission on August 12, 1997.
(j) Incorporated by reference to the Form 8-K filed by Sequoia
Mortgage Funding Corporation with the Securities and Exchange
Commission on November 18, 1997.
(k) Incorporated by reference to the Form 10-K (1-13759) filed by
the Registrant with the Securities and Exchange Commission for
the fiscal year ended December 31, 1997.
(l) Incorporated by reference to the Form 8-K (1-13759) filed by the
Registrant with the Securities and Exchange Commission on July
20, 1998.
(m) Incorporated by reference to the Form 10-Q (0-26436) filed by
the Registrant with the Securities and Exchange Commission for
the fiscal quarter ended June 30, 1999.
(n) Incorporated by reference to the Form 10-K (1-13759) filed by
the Registrant with the Securities and Exchange Commission for
the fiscal year ended December 31, 1998.
(o) Incorporated by reference to the Form 10-Q (1-13759) filed by
the Registrant with the Securities and Exchange Commission for
the fiscal quarter ended March 31, 2000.
(p) Incorporated by reference to the Form 10-K (1-13759) filed by
the Registrant with the Securities and Exchange Commission for
the fiscal year ended December 31, 1999
(b) Reports on Form 8-K:
None.
58
59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
REDWOOD TRUST, INC.
Dated: March 27, 2001 By: /s/ George E. Bull
----------------------------------
George E. Bull
Chairman and Chief
Executive Officer
Pursuant to the requirements the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
/s/ George E. Bull George E. Bull March 27, 2001
- --------------------------- Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
/s/ Douglas B. Hansen Douglas B. Hansen March 27, 2001
- --------------------------- Director, President
/s/ Harold F. Zagunis Harold F. Zagunis March 27, 2001
- --------------------------- Chief Financial Officer, Secretary,
Treasurer and Controller
(Principal Financial and Accounting Officer)
/s/ Richard D. Baum Richard D. Baum March 27, 2001
- --------------------------- Director
/s/ Thomas C. Brown Thomas C. Brown March 27, 2001
- --------------------------- Director
/s/ Mariann Byerwalter Mariann Byerwalter March 27, 2001
- --------------------------- Director
/s/ Thomas F. Farb Thomas F. Farb March 27, 2001
- --------------------------- Director
/s/ Charles J. Toeniskoetter Charles J. Toeniskoetter March 27, 2001
- --------------------------- Director
/s/ David L. Tyler David L. Tyler March 27, 2001
- --------------------------- Director
59
60
REDWOOD TRUST, INC.
CONSOLIDATED FINANCIAL STATEMENTS AND
REPORT OF INDEPENDENT ACCOUNTANTS
FOR INCLUSION IN FORM 10-K
ANNUAL REPORT FILED WITH
SECURITIES AND EXCHANGE COMMISSION
DECEMBER 31, 2000
F-1
61
REDWOOD TRUST, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Consolidated Financial Statements - Redwood Trust, Inc.:
Consolidated Balance Sheets at December 31, 2000 and 1999...................... F-3
Consolidated Statements of Operations for the years ended
December 31, 2000, 1999 and 1998.......................................... F-4
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2000, 1999 and 1998.......................................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998.......................................... F-6
Notes to Consolidated Financial Statements..................................... F-7
Report of Independent Accountants................................................... F-28
F-2
62
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31,
2000 1999
----------- -----------
ASSETS
Net Investment In Residential Credit Enhancement Interests:
Mortgage securities available-for-sale $ 48,495 $ 23,237
Mortgage securities available-for-sale, pledged 32,269 3,762
----------- -----------
80,764 26,999
Residential Retained Loan Portfolio:
Mortgage loans held-for-investment 1,124,339 969,709
Mortgage loans held-for-sale 531 7,639
Mortgage loans held-for-sale, pledged 6,127 408,241
----------- -----------
1,130,997 1,385,589
Investment Portfolio:
Mortgage securities trading 57,450 60,878
Mortgage securities trading, pledged 702,162 880,903
Mortgage securities available-for-sale 5,163 --
----------- -----------
764,775 941,781
Commercial Retained Loan Portfolio:
Mortgage loans held-for-investment 5,177 --
Mortgage loans held-for-investment, pledged 17,717 --
Mortgage loans held-for-sale 14,325 8,437
Mortgage loans held-for-sale, pledged 19,950 --
----------- -----------
57,169 8,437
Cash and cash equivalents 15,483 19,881
Restricted cash 5,240 5,384
Interest rate agreements 66 2,037
Accrued interest receivable 15,797 13,244
Principal receivable 7,986 4,599
Investment in RWT Holdings, Inc. 1,899 3,391
Loans to RWT Holdings, Inc. -- 6,500
Receivable from RWT Holdings, Inc. -- 472
Other assets 1,939 1,614
----------- -----------
Total Assets $ 2,082,115 $ 2,419,928
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt $ 756,222 $ 1,253,565
Long-term debt, net 1,095,835 945,270
Accrued interest payable 5,657 5,462
Accrued expenses and other liabilities 4,180 2,819
Dividends payable 4,557 2,877
----------- -----------
Total Liabilities 1,866,451 2,209,993
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01 per share; Class B 9.74% Cumulative
Convertible 902,068 shares authorized, issued and outstanding
($28,645 aggregate liquidation preference) 26,517 26,517
Common stock, par value $0.01 per share; 49,097,932 shares authorized;
8,809,500 and 8,783,341 issued and outstanding 88 88
Additional paid-in capital 242,522 242,094
Accumulated other comprehensive income (89) (3,348)
Cumulative earnings 27,074 8,140
Cumulative distributions to stockholders (80,448) (63,556)
----------- -----------
Total Stockholders' Equity 215,664 209,935
----------- -----------
Total Liabilities and Stockholders' Equity $ 2,082,115 $ 2,419,928
=========== ===========
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
63
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
Years Ended December 31,
2000 1999 1998
------------ ------------ ------------
INTEREST INCOME
Net Investment In Residential Credit Enhancement Interests:
Mortgage securities available-for-sale $ 8,524 $ 4,202 $ 2,963
Residential Retained Loan Portfolio:
Mortgage loans held-for-investment 83,815 65,930 112,242
Mortgage loans held-for-sale 7,050 7,220 9,005
------------ ------------ ------------
90,865 73,150 121,247
Investment Portfolio:
Mortgage securities trading 67,055 65,300 46,162
Mortgage securities available-for-sale 151 -- 49,675
U.S. Treasury securities trading -- 919 575
------------ ------------ ------------
67,206 66,219 96,412
Commercial Retained Loan Portfolio:
Mortgage loans held-for-investment 520 -- --
Mortgage loans held-for-sale 1,482 1,081 102
------------ ------------ ------------
2,002 1,081 102
Cash and cash equivalents 1,395 2,658 2,080
------------ ------------ ------------
Total interest income 169,992 147,310 222,804
INTEREST EXPENSE
Short-term debt (61,355) (51,377) (114,763)
Long-term debt (76,294) (65,785) (81,361)
------------ ------------ ------------
Total interest expense (137,649) (117,162) (196,124)
Net interest rate agreements expense (954) (2,065) (3,514)
Provision for credit losses on residential mortgage
loans held-for-investment (731) (1,346) (1,120)
------------ ------------ ------------
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 30,658 26,737 22,046
Net unrealized and realized market value gains (losses)
Loans and securities 1,060 (1,700) (33,034)
Interest rate agreements (3,356) 1,984 (5,909)
------------ ------------ ------------
Total net unrealized and realized market value gains (losses) (2,296) 284 (38,943)
Operating expenses (7,850) (3,835) (5,876)
Other income 98 175 139
Equity in losses of RWT Holdings, Inc. (1,676) (21,633) (4,676)
------------ ------------ ------------
Net income (loss) before preferred dividend and change
in accounting principle 18,934 1,728 (27,310)
Less dividends on Class B preferred stock (2,724) (2,741) (2,747)
------------ ------------ ------------
Net income (loss) before change in accounting principle 16,210 (1,013) (30,057)
Cumulative transition effect of adopting SFAS No. 133 (See Note 2) -- -- (10,061)
------------ ------------ ------------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $ 16,210 $ (1,013) $ (40,118)
============ ============ ============
Earnings (Loss) per Share:
Basic Earnings (Loss) Per Share:
Net income (loss) before change in accounting principle $ 1.84 $ (0.10) $ (2.28)
Cumulative transition effect of adopting SFAS No. 133 $ -- $ -- $ (0.76)
Net income (loss) $ 1.84 $ (0.10) $ (3.04)
Diluted Earnings (Loss) Per Share:
Net income (loss) before change in accounting principle $ 1.82 $ (0.10) $ (2.28)
Cumulative transition effect of adopting SFAS No. 133 $ -- $ -- $ (0.76)
Net income (loss) $ 1.82 $ (0.10) $ (3.04)
Weighted average shares of common stock and common stock equivalents:
Basic 8,793,487 9,768,345 13,199,819
Diluted 8,902,069 9,768,345 13,199,819
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
64
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
Class B Accumulated Cumulative
Preferred stock Common stock Additional other distributions
-------------------------------------- paid-in comprehensive Cumulative to
Shares Amount Shares Amount capital income earnings stockholders Total
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 909,518 26,736 14,284,657 143 324,555 (10,071) 43,783 (50,609) 334,537
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net loss before preferred
dividend and change in
accounting principle - - - - - - (27,310) - (27,310)
Reclassification adjustment
due to adoption of
SFAS No. 133 - - - - - 19,457 - - 19,457
Net unrealized loss
on assets available-
for-sale - - - - - (9,756) - - (9,756)
--------
Total comprehensive income - - - - - - - - (17,609)
Cumulative transition effect
of adopting SFAS No. 133 - - - - - - (10,061) - (10,061)
Issuance of common stock - - 98,399 1 1,563 - - - 1,564
Repurchase of common stock - - (3,131,500) (31) (46,917) - - - (46,948)
Dividends declared:
Preferred - - - - - - - (2,747) (2,747)
Common - - - - - - - (3,946) (3,946)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 909,518 26,736 11,251,556 113 279,201 (370) 6,412 (57,302) 254,790
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income before
preferred dividend - - - - - - 1,728 - 1,728
Net unrealized loss
on assets available-
for-sale - - - - - (2,978) - - (2,978)
--------
Total comprehensive loss - - - - - - - - (1,250)
Repurchase of preferred stock (7,450) (219) - - - - - - (219)
Issuance of common stock - - 15,285 - 22 - - - 22
Repurchase of common stock - - (2,483,500) (25) (37,129) - - - (37,154)
Dividends declared:
Preferred - - - - - - - (2,741) (2,741)
Common - - - - - - - (3,513) (3,513)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 902,068 $ 26,517 8,783,341 $ 88 $242,094 $ (3,348) $ 8,140 $ (63,556) $209,935
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income before
preferred dividend - - - - - - 18,934 - 18,934
Net unrealized income
on assets available-
for-sale - - - - - 3,259 - - 3,259
--------
Total comprehensive income - - - - - - - - 22,193
Issuance of common stock - - 26,159 - 428 - - - 428
Dividends declared:
Preferred - - - - - - - (2,724) (2,724)
Common - - - - - - - (14,168) (14,168)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 902,068 $ 26,517 8,809,500 $ 88 $242,522 $ (89) $ 27,074 $ (80,448) $ 215,664
- -----------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
65
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Years Ended December 31,
2000 1999 1998
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) before preferred dividend and
change in accounting principle $ 18,934 $ 1,728 $ (27,310)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 4,170 6,773 32,046
Provision for credit losses 731 1,346 1,120
Equity in losses of RWT Holdings, Inc. 1,676 21,633 4,676
Net unrealized and realized market value losses (gains) 2,296 (284) 38,943
Purchases of mortgage loans held-for-sale (92,532) (516,408) (8,296)
Proceeds from sales of mortgage loans held-for-sale 455,389 153,303 688,941
Principal payments on mortgage loans held-for-sale 20,598 59,782 202,965
Purchases of mortgage securities trading (302,585) (170,723) (149,934)
Proceeds from sales of mortgage securities trading 205,472 7,668 --
Principal payments on mortgage securities trading 277,489 460,508 433,637
Purchases of U.S. Treasury securities trading -- (45,844) (49,704)
Proceeds from sales of U.S. Treasury securities trading -- 90,519 --
Net (purchases) sales of interest rate agreements (2,810) 276 (11,604)
(Increase) decrease in accrued interest receivable (2,553) 5,238 4,637
(Increase) decrease in principal receivable (3,387) 7,836 (323)
(Increase) decrease in other assets (365) 195 595
Increase (decrease) in accrued interest payable 195 (5,358) (3,656)
Increase (decrease) in accrued expenses and other liabilities 1,361 (203) 850
----------- ----------- -----------
Net cash provided by operating activities 584,079 77,985 1,157,583
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of mortgage loans held-for-investment (407,204) -- (1,596,673)
Proceeds from sales of mortgage loans held-for-investment -- -- 369,119
Principal payments on mortgage loans held-for-investment 226,179 310,892 475,905
Purchases of mortgage securities available-for-sale (58,306) (17,691) (231,167)
Proceeds from sales of mortgage securities available-for-sale 2,897 -- 9,296
Principal payments on mortgage securities available-for-sale 1,875 442 443,057
Net decrease in restricted cash 144 7,473 11,800
Investment in RWT Holdings, Inc., net of dividends received -- (9,900) (19,800)
Loans to RWT Holdings, Inc., net of repayments 6,500 -- (6,500)
Decrease (increase) in receivable from RWT Holdings, Inc. 472 (27) (445)
----------- ----------- -----------
Net cash (used in) provided by investing activities (227,442) 291,189 (545,408)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments on short-term debt (497,343) (4,005) (656,955)
Proceeds (costs) from issuance of long-term debt 375,844 (337) 635,193
Repayments on long-term debt (225,434) (359,180) (502,601)
Net proceeds from issuance of common stock 428 22 1,564
Repurchases of preferred stock -- (202) --
Repurchases of common stock -- (37,154) (46,948)
Dividends paid (14,531) (4,064) (11,693)
----------- ----------- -----------
Net cash used in financing activities (361,036) (404,920) (581,440)
----------- ----------- -----------
Net (decrease) increase in cash and cash equivalents (4,398) (35,746) 30,735
Cash and cash equivalents at beginning of period 19,881 55,627 24,892
----------- ----------- -----------
Cash and cash equivalents at end of period $ 15,483 $ 19,881 $ 55,627
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 137,454 $ 122,520 $ 199,762
=========== =========== ===========
The accompanying notes are an integral part of these consolidated
financial statements.
F-6
66
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
NOTE 1. THE COMPANY
Redwood Trust, Inc. ("Redwood Trust") was incorporated in Maryland on April 11,
1994 and commenced operations on August 19, 1994. During 1997, Redwood Trust
formed Sequoia Mortgage Funding Corporation ("Sequoia"), a special-purpose
finance subsidiary. Redwood Trust acquired an equity interest in RWT Holdings,
Inc. ("Holdings"), a taxable affiliate of Redwood Trust, during the first
quarter of 1998. For financial reporting purposes, references to the "Company"
mean Redwood Trust, Sequoia, and Redwood Trust's equity interest in Holdings.
Redwood Trust, together with its affiliates, is a real estate finance company
specializing in owning, financing, and credit enhancing high-quality jumbo
residential mortgage loans nationwide. Redwood Trust also finances real estate
through its investment portfolio (mortgage securities) and its commercial loan
portfolio. Redwood Trust's primary source of revenue is monthly payments made by
homeowners on their mortgages, and its primary expense is the cost of borrowed
funds. As Redwood Trust is structured as a Real Estate Investment Trust
("REIT"), the majority of net earnings are distributed to shareholders as
dividends.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Redwood Trust and
Sequoia. Substantially all of the assets of Sequoia, consisting primarily of
residential whole loans shown as part of the Residential Retained Loan
Portfolio, are pledged or subordinated to support long-term debt in the form of
collateralized mortgage bonds ("Long-Term Debt") and are not available for the
satisfaction of general claims of the Company. The Company's exposure to loss on
the assets pledged as collateral for Long-Term Debt is limited to its net equity
investment in Sequoia, as the Long-Term Debt is non-recourse to the Company. All
significant intercompany 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. The
Company accounts for its investment in Holdings under the equity method. Under
this method, original equity investments in Holdings were recorded at cost and
adjusted by the Company's share of earnings or losses and decreased by dividends
received. On January 1, 2001, the Company purchased the common stock of
Holdings, and Holdings became a wholly-owned consolidated subsidiary of the
Company (See Note 14).
USE OF ESTIMATES
The preparation of financial statements in conformity with Generally Accepted
Accounting Principles requires management to make estimates and assumptions that
affect the reported amounts of certain assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of certain revenues and expenses during the reported
period. Actual results could differ from those estimates. The primary estimates
inherent in the accompanying consolidated financial statements are discussed
below.
Fair Value. Management estimates the fair value of its financial instruments
using available market information and other appropriate valuation
methodologies. The fair value of a financial instrument, as defined by Statement
of Financial Accounting Standards ("SFAS") No. 107, Disclosures about Fair Value
of Financial Instruments, is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation sale. Management's estimates are inherently subjective in
nature and involve matters of uncertainty and judgement to interpret relevant
market and other data. Accordingly, amounts realized in actual sales may differ
from the fair valueS presented in Notes 3, 7 and 10.
F-7
67
Reserve for Credit Losses. A reserve for credit losses is maintained at a level
deemed appropriate by management to provide for known losses, as well as
potential losses inherent in its residential mortgage loan portfolio. The
reserve is based upon management's assessment of various factors affecting its
residential mortgage loans, including current and projected economic conditions,
delinquency status, and credit protection. These estimates are reviewed
periodically and, as adjustments become necessary, they are reported in earnings
in the periods in which they become known. The reserve is increased by
provisions, which are charged to income from operations. When a loan or portions
of a loan are determined to be uncollectible, the portion deemed uncollectible
is charged against the reserve and subsequent recoveries, if any, are credited
to the reserve. The Company's actual credit losses may differ from those
estimates used to establish the reserve. Summary information regarding the
Reserve for Credit Losses is presented in Note 4.
Individual mortgage loans are considered impaired when, based on current
information and events, it is probable that a creditor will be unable to collect
all amounts due according to the contractual terms of the loan agreement. When a
loan is impaired, impairment is measured based upon the present value of the
expected future cash flows discounted at the loan's effective interest rate, the
loan's observable market price, or the fair value of the underlying collateral.
At December 31, 2000 and 1999, there were no impaired mortgage loans.
ADOPTION OF SFAS NO. 133
The Company adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, effective July 1, 1998. In accordance with the transition
provisions of SFAS No. 133, the Company recorded a net-of-tax
cumulative-effect-type transition adjustment of $10.1 million (loss) in earnings
to recognize at fair value the ineffective portion of all interest rate
agreements that were previously designated as part of a hedging relationship.
The Company, upon its adoption of SFAS No. 133, also reclassified $1.5 billion
of mortgage securities from available-for-sale to trading. This reclassification
resulted in an $11.9 million reclassification loss adjustment, which was
transferred from other comprehensive income to current earnings effective July
1, 1998. Under the provisions of SFAS No. 133, such a reclassification does not
call into question the Company's intent to hold current or future debt
securities to their maturity. Upon the adoption of SFAS No. 133 and the
reclassification, the Company elected to not seek hedge accounting for any of
the Company's interest rate agreements.
MORTGAGE ASSETS
The Company's mortgage assets consist of mortgage loans and mortgage securities
("Mortgage Assets"). Mortgage loans and securities pledged as collateral under
borrowing arrangements in which the secured party has the right by contract or
custom to sell or repledge the collateral have been classified as "pledged" in
the accompanying Consolidated Balance Sheets. Interest is recognized as revenue
when earned according to the terms of the loans and securities and when, in the
opinion of management, it is collectible. Discounts and premiums relating to
Mortgage Assets are amortized into interest income over the lives of the
Mortgage Assets using the effective yield method. Gains or losses on the sale of
Mortgage Assets are based on the specific identification method.
Mortgage Loans: Held-for-Investment
Mortgage loans classified as held-for-investment are carried at their unpaid
principal balance, adjusted for net unamortized premiums or discounts, and net
of the related allowance for credit losses. All of the Sequoia assets that are
pledged or subordinated to support the Long-Term Debt are classified as
held-for-investment. Commercial loans that the Company has secured financing
through the term of the loan or otherwise has the intent and the ability to hold
to maturity, are classified as held-for-investment.
Mortgage Loans: Held-for-Sale
Mortgage loans held-for-sale are carried at the lower of original cost or
aggregate market value ("LOCOM"). Realized and unrealized gains and losses on
these loans are recognized in "Net unrealized and realized market value gains
(losses)" on the Consolidated Statements of Operations. Real estate owned
("REO") assets of the Company are also presented as "Mortgage loans
held-for-sale."
F-8
68
Some of the commercial mortgage loans held by the Company are committed for sale
by the Company to Holdings, or a subsidiary of Holdings, under Master Forward
Commitment Agreements at December 31, 2000 and 1999. As the forward commitment
agreements were entered into on the same date that the Company committed to
purchase the loans, the price under the forward commitment is the same as the
price that the Company paid for the mortgage loans, as established by the
external market. Fair value is therefore equal to the commitment price, which is
the carrying value of the mortgage loans. Accordingly, no gain or loss is
recognized on the subsequent sales of these mortgage loans to Holdings or
subsidiaries of Holdings.
Mortgage Securities: Trading
Mortgage securities classified as trading are accounted for in accordance with
SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities.
Accordingly, such securities are recorded at their estimated fair market value.
Unrealized and realized gains and losses on these securities are recognized as a
component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations.
Mortgage Securities: Available-for-Sale
Mortgage securities classified as available-for-sale are carried at their
estimated fair value. Current period unrealized gains and losses are excluded
from net income and reported as a component of Other Comprehensive Income in
Stockholders' Equity with cumulative unrealized gains and losses classified as
Accumulated Other Comprehensive Income in Stockholders' Equity.
Unrealized losses on mortgage securities classified as available-for-sale that
are considered other-than-temporary, are recognized in income and the carrying
value of the mortgage security is adjusted. Other-than-temporary unrealized
losses are based on management's assessment of various factors affecting the
expected cash flow from the mortgage securities, including an
other-than-temporary deterioration of the credit quality of the underlying
mortgages and/or the credit protection available to the related mortgage pool
and a significant change in the prepayment characteristics of the underlying
collateral.
Interest income on mortgage securities available-for-sale is calculated using
the effective yield method based on projected cash flows over the life of the
security. Yields on each security vary as a function of credit results,
prepayment rates, and interest rates, and may also vary depending on the mix of
first, second and third loss positions the Company holds. As the Company
purchases these securities, a portion of the discount for each security is
designated as a credit reserve, with the remaining portion of the discount
designated to be amortized into income over the life of the security using the
effective yield method. If future credit losses exceed the Company's original
expectations, the Company may take a charge to write down the basis in the
security, and may adjust the yield over the remaining life of the security.
U.S. TREASURY SECURITIES
U.S. Treasury securities include notes issued by the U.S. Government. Interest
is recognized as revenue when earned according to the terms of the Treasury
securities. Discounts and premiums are amortized into interest income over the
life of the security using the effective yield method. U.S. Treasury securities
are classified as trading and, accordingly, are recorded at their estimated fair
market value with unrealized gains and losses recognized as a component of "Net
unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of three months or less.
F-9
69
RESTRICTED CASH
Restricted cash of the Company includes principal and interest payments on
mortgage loans held as collateral for the Company's Long-Term Debt, cash pledged
as collateral on certain interest rate agreements, and cash held back from
borrowers until certain loan agreement requirements have been met. The
corresponding liability for cash held back from borrowers is reflected as a
component of "Accrued expenses and other liabilities" on the Consolidated
Balance Sheets.
INTEREST RATE AGREEMENTS
The Company maintains an overall interest-rate risk-management strategy that may
incorporate the use of derivative interest rate agreements for a variety of
reasons, including minimizing significant fluctuations in earnings that may be
caused by interest-rate volatility. Interest rate agreements the Company may use
as part of its interest-rate risk management strategy include interest rate
options, swaps, options on swaps, futures contracts, options on futures
contracts, forward sales of fixed-rate Agency mortgage securities ("MBS"), and
options on forward purchases or sales of MBS (collectively "Interest Rate
Agreements"). On the date an Interest Rate Agreement is entered into, the
Company designates the interest rate agreement as (1) a hedge of the fair value
of a recognized asset or liability or of an unrecognized firm commitment ("fair
value" hedge), (2) a hedge of a forecasted transaction or of the variability of
cash flows to be received or paid related to a recognized asset or liability
("cash flow" hedge), or (3) held for trading ("trading" instruments). Since the
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 Debt and Long-Term Debt are carried at their unpaid principal
balances, net of any unamortized discount or premium and any unamortized
deferred bond issuance costs. The amortization of any discount or premium is
recognized as an adjustment to interest expense using the effective interest
method based on the maturity schedule of the related borrowings. Bond issuance
costs incurred in connection with the issuance of Long-Term Debt are deferred
and amortized over the estimated lives of the Long-Term Debt using the interest
method adjusted for the effects of prepayments.
INCOME TAXES
The Company has elected to be taxed as a Real Estate Investment Trust ("REIT")
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 2000 which were paid in January
2001 are considered taxable income to stockholders in 2000, the year declared.
All 2000 dividends were ordinary income to the Company's preferred and common
stockholders.
F-10
70
NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed by dividing net income (loss)
available to common stockholders by the weighted average number of common shares
outstanding during the period. Diluted net income (loss) per share is computed
by dividing the net income (loss) available to common stockholders by the
weighted average number of common shares and common equivalent shares
outstanding during the period. The common equivalent shares are calculated using
the treasury stock method, which assumes that all dilutive common stock
equivalents are exercised and the funds generated by the exercise are used to
buy back outstanding common stock at the average market price during the
reporting period. Due to the net loss available to common stockholders for both
the years ended December 31, 1999 and 1998, the addition of potential dilutive
shares is anti-dilutive and therefore, the basic and diluted net loss per share
are the same.
The following tables provide reconciliations of the numerators and denominators
of the basic and diluted net income (loss) per share computations.
(IN THOUSANDS, EXCEPT SHARE DATA) YEARS ENDED DECEMBER 31,
2000 1999 1998
------------ ------------ ------------
NUMERATOR:
Numerator for basic and diluted earnings per share--
Net income (loss) before preferred dividend and
change in accounting principle $ 18,934 $ 1,728 $ (27,310)
Cash dividends on Class B preferred stock (2,724) (2,741) (2,747)
------------ ------------ ------------
Net income (loss) before change in accounting principle 16,210 (1,013) (30,057)
Cumulative transition effect of adopting SFAS No. 133 -- -- (10,061)
------------ ------------ ------------
Basic and Diluted EPS - Net income (loss)
available to common stockholders $ 16,210 $ (1,013) $ (40,118)
============ ============ ============
DENOMINATOR:
Denominator for basic earnings (loss) per share--
Weighted average number of common shares
outstanding during the period 8,793,487 9,768,345 13,199,819
Net effect of dilutive stock options 108,582 -- --
------------ ------------ ------------
Denominator for diluted earnings (loss) per share-- 8,902,069 9,768,345 13,199,819
============ ============ ============
BASIC EARNINGS (LOSS) PER SHARE:
Net income (loss) before change in accounting principle $ 1.84 $ (0.10) $ (2.28)
Cumulative transition effect of adopting SFAS No. 133 -- -- (0.76)
------------ ------------ ------------
Net income (loss) per share $ 1.84 $ (0.10) $ (3.04)
============ ============ ============
DILUTED EARNINGS (LOSS) PER SHARE:
Net income (loss) before change in accounting principle $ 1.82 $ (0.10) $ (2.28)
Cumulative transition effect of adopting SFAS No. 133 -- -- (0.76)
------------ ------------ ------------
Net income (loss) per share $ 1.82 $ (0.10) $ (3.04)
============ ============ ============
COMPREHENSIVE INCOME
Current period unrealized gains and losses on assets available-for-sale are
reported as a component of Comprehensive Income on the Consolidated Statements
of Stockholders' Equity with cumulative unrealized gains and losses classified
as Accumulated Other Comprehensive Income in Stockholders' Equity. At December
31, 2000 and 1999, the only component of Accumulated Other Comprehensive Income
was net unrealized gains and losses on assets available-for-sale.
F-11
71
RECENT ACCOUNTING PRONOUNCEMENTS
During March 2000, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation -- an interpretation of APB Opinion No. 25 ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 by expanding upon a number of
issues not specifically addressed in APB Opinion No. 25, such as the definition
of an employee and the accounting for modifications to a previously fixed stock
option award. FIN 44 was effective July 1, 2000. There was no material impact on
the operating results of the Company upon the adoption of FIN 44.
In September 2000, FASB issued Statement of Financial Accounting Standards
("FAS") No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguisments of Liabilities. FAS No. 140 replaces FAS No. 125, revises the
standards for accounting for securitizations and other transfers of financial
assets, and requires certain new disclosures, while carrying over most of FAS
No. 125's provisions. FAS No. 140 is effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after March 31,
2001. The Company adopted the disclosure requirements of FAS No. 140 effective
December 31, 2000.
During 1999, the Emerging Issues Task Force ("EITF") issued EITF 99-20,
Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets. EITF 99-20 establishes new
income and impairment recognition standards for interests in certain securitized
assets. Under the provisions of EITF 99-20, if the discounted value of probable
future cash flows deteriorates from original assumptions, the securitized
interest should be marked-to-market through the income statement. Only negative
mark-to-market adjustments are allowed under EITF 99-20. As the Company's
accounting for credit-enhancement interests and certain other assets will be
affected by EITF 99-20, the Company is conducting an ongoing review of these
assets with respect to the provisions of EITF 99-20. Upon adoption of EITF
99-20, the Company estimates that approximately $2.4 million of its market
valuation adjustments on its credit-enhancement interests that have been
recognized as a component of Accumulated Other Comprehensive Income in
stockholders' equity, may need to be taken as a charge in the Statement of
Operations. Since this is a reclassification of declines in market values that
have already been recognized in the Company's balance sheet and stockholders'
equity accounts, there will be no change in book value upon adoption. The
Company is considering adopting EITF 99-20 effective January 1, 2001; if it does
so, first quarter 2001 results would be affected. Initial mark-to-market
adjustments made at the time of adoption will be recognized as a cumulative
effect of a change in accounting principle. Any subsequent income statement
adjustments under the provisions of EITF 99-20 will be recognized as
mark-to-market adjustments under "Realized and unrealized gain or loss on
assets."
NOTE 3. MORTGAGE ASSETS
At December 31, 2000 and 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. The original
maturity of the majority of the Mortgage Assets is thirty years; the actual
maturity is subject to change based on the prepayments of the underlying
mortgage loans.
At December 31, 2000 and 1999, the annualized effective yield after taking into
account the amortization expense due to prepayments on the Mortgage Assets was
8.01% and 7.00%, respectively, based on the reported cost of the assets. At
December 31, 2000, 79% of the Mortgage Assets owned by the Company were
adjustable-rate mortgages, 17% were hybrid mortgages, and 4% were fixed-rate
mortgages. At December 31, 1999, 81% of the Mortgage Assets owned by the Company
were adjustable-rate mortgages, 17% were hybrid mortgages, and 2% were
fixed-rate mortgages. At December 31, 2000 and 1999, the coupons on 59% 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
December 31, 2000 and 1999, the weighted average lifetime cap on the
adjustable-rate Mortgage Assets was 11.43% and 11.64%, respectively.
F-12
72
At December 31, 2000 and 1999, Mortgage Assets consisted of the following:
NET INVESTMENT IN RESIDENTIAL CREDIT ENHANCEMENT INTERESTS
DECEMBER 31, DECEMBER 31,
2000 1999
(IN THOUSANDS) MORTGAGE MORTGAGE
SECURITIES SECURITIES
AVAILABLE-FOR-SALE AVAILABLE-FOR-SALE
------------------ ------------------
Current Face $ 124,878 $ 48,620
Unamortized Discount (43,935) (18,273)
Unamortized Premium -- --
--------- ---------
Amortized Cost 80,943 30,347
Gross Unrealized Gains 2,646 166
Gross Unrealized Losses (2,825) (3,514)
--------- ---------
Carrying Value $ 80,764 $ 26,999
========= =========
During the year ended December 31, 2000 and 1998, the Company sold mortgage
securities classified as available-for-sale for proceeds of $2.9 million and
$9.3 million, respectively, resulting in a net gain of $0.2 million in 2000, and
no gain recognized in 1998. No such sales were made during 1999. No write-downs
of available-for-sale mortgage securities occurred during the years ended
December 31, 2000 and 1999. During the year ended December 31, 1998, the Company
recognized a $0.7 million loss on the write-down of certain mortgage securities
available-for-sale. The gains and losses on the sales and write-downs of
mortgage securities available-for-sale are reflected as a component of "Net
unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
RESIDENTIAL RETAINED LOAN PORTFOLIO
DECEMBER 31, 2000 DECEMBER 31, 1999
(IN THOUSANDS) HELD-FOR- HELD-FOR- HELD-FOR- HELD-FOR-
SALE INVESTMENT TOTAL SALE INVESTMENT TOTAL
----------- ----------- ----------- ----------- ----------- -----------
Current Face $ 6,784 $ 1,115,386 $ 1,122,170 $ 412,456 $ 960,928 $ 1,373,384
Unamortized Discount (126) -- (126) (305) -- (305)
Unamortized Premium -- 13,767 13,767 3,729 12,906 16,635
----------- ----------- ----------- ----------- ----------- -----------
Amortized Cost 6,658 1,129,153 1,135,811 415,880 973,834 1,389,714
Reserve for Credit Losses -- (4,814) (4,814) -- (4,125) (4,125)
----------- ----------- ----------- ----------- ----------- -----------
Carrying Value $ 6,658 $ 1,124,339 $ 1,130,997 $ 415,880 $ 969,709 $ 1,385,589
=========== =========== =========== =========== =========== ===========
The Company recognized losses of $0.1 million during the year ended December 31,
2000, gains of $0.3 million during the year ended December 31, 1999, and losses
of $6.5 million during the year ended December 31, 1998 as a result of LOCOM
adjustments on residential mortgage loans held-for-sale. Also during the years
ended December 31, 2000, 1999, and 1998, the Company sold residential mortgage
loans held-for-sale for proceeds of $397.6 million, $103.0 million, and $688.9
million, respectively. These sales resulted in no net gain or loss recognized in
2000, and net gains of $0.1 million, and $4.6 million in 1999 and 1998,
respectively. The LOCOM adjustments and net gains on sales are reflected as a
component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations.
There were no sales of residential mortgage loans held-for-investment for the
years ended December 31, 2000 and 1999. During the year ended December 31, 1998,
the Company sold held-for-investment residential mortgage loans with an
amortized cost of $370.1 million for proceeds of $369.1 million. The net
realized loss of $1 million is reflected as a component of "Net unrealized and
realized market value gains (losses)" on the Consolidated Statements of
Operations.
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73
INVESTMENT PORTFOLIO
DECEMBER 31, 2000 DECEMBER 31, 1999
MORTGAGE MORTGAGE
(IN THOUSANDS) MORTGAGE SECURITIES MORTGAGE SECURITIES
SECURITIES AVAILABLE- SECURITIES AVAILABLE-
TRADING FOR-SALE TOTAL TRADING FOR-SALE TOTAL
--------- --------- --------- --------- --------- ---------
Current Face $ 751,449 $ 5,500 $ 756,949 $ 934,351 -- $ 934,351
Unamortized Discount (388) (427) (815) (3,548) -- (3,548)
Unamortized Premium 8,551 -- 8,551 10,978 -- 10,978
--------- --------- --------- --------- --------- ---------
Unamortized Cost 759,612 5,073 764,685 941,781 -- 941,781
Gross Unrealized Gains -- 105 105 -- -- --
Gross Unrealized Losses -- (15) (15) -- -- --
--------- --------- --------- --------- --------- ---------
Carrying Value $ 759,612 $ 5,163 $ 764,775 $ 941,781 -- $ 941,781
========= ========= ========= ========= ========= =========
Agency $ 521,204 -- $ 521,204 $ 576,980 -- $ 576,980
Non-Agency 238,408 5,163 243,571 364,801 -- 364,801
--------- --------- --------- --------- --------- ---------
Carrying Value $ 759,612 $ 5,163 $ 764,775 $ 941,781 -- $ 941,781
========= ========= ========= ========= ========= =========
For both of the years ended December 31, 2000 and 1999, the Company recognized
market value gains of $1.2 million on mortgage securities classified as trading.
During the years ended December 31, 2000 and 1999, the Company sold mortgage
securities classified as trading for proceeds of $205.5 million and $7.7
million, respectively. During the year ended December 31, 1998, the Company
elected to reclassify a majority of its short-funded mortgage securities from
available-for-sale to trading (see Note 2). As a result of this
reclassification, the Company recognized a reclassification loss of $11.9
million, which was transferred from other comprehensive income to current
earnings, and a market value loss of $17.5 million on mortgage securities
classified as trading. The market value adjustments are reflected as a component
of "Net unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
COMMERCIAL RETAINED LOAN PORTFOLIO
DECEMBER 31, 2000 DECEMBER 31, 1999
(IN THOUSANDS) HELD-FOR- HELD-FOR- HELD-FOR- HELD-FOR-
SALE INVESTMENT TOTAL SALE INVESTMENT TOTAL
-------- -------- -------- -------- -------- --------
Current Face $ 34,275 $ 23,425 $ 57,700 $ 8,450 $ -- $ 8,450
Unamortized Discount -- (531) (531) (13) -- (13)
======== ======== ======== ======== ======== ========
Carrying Value $ 34,275 $ 22,894 $ 57,169 $ 8,437 $ -- $ 8,437
======== ======== ======== ======== ======== ========
During the years ended December 31, 2000 and 1999, the Company sold commercial
mortgage loans to Redwood Commercial Funding ("RCF"), a subsidiary of Holdings,
for proceeds of $57.8 million and $50.3 million, respectively. Pursuant to
Master Forward Commitment Agreements, all commercial mortgage loans purchased by
the Company are sold to RCF at the same price for which the Company acquires the
commercial mortgage loans (see Note 12). Accordingly, there were no LOCOM
adjustments or gains on sales related to commercial mortgage loans during the
years ended December 31, 2000 and 1999.
F-14
74
NOTE 4. RESERVE FOR CREDIT LOSSES
The Reserve for Credit Losses on Residential Mortgage Loans Held-For-Investment
is reflected as a component of Mortgage Assets on the Consolidated Balance
Sheets. The following table summarizes the Reserve for Credit Losses on
Residential Mortgage Loans Held-For-Investment activity:
YEARS ENDED DECEMBER 31,
(IN THOUSANDS) 2000 1999 1998
------- ------- -------
Balance at beginning of year $ 4,125 $ 2,784 $ 1,855
Provision for credit losses 731 1,346 1,120
Charge-offs (42) (5) (191)
------- ------- -------
Balance at end of year $ 4,814 $ 4,125 $ 2,784
======= ======= =======
NOTE 5. U.S. TREASURY SECURITIES
The Company did not hold any U.S. Treasury securities at December 31, 2000 or
1999. At December 31, 1998, the Company owned $45 million face value of U.S.
Treasury securities at a carrying value of $48 million. The Company did not hold
any U.S. Treasury securities during 2000. For the years ended December 31, 1999
and 1998, the Company recognized market value losses of $3.3 million and market
value gains of $0.1 million on U.S. Treasury securities, respectively. During
the year ended December 31, 1999, the Company sold U.S. Treasury securities for
proceeds of $90.5 million. The market value adjustments are reflected as a
component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations.
NOTE 6. COLLATERAL FOR LONG-TERM DEBT
The Company has collateral as security for Long-Term Debt issued in the form of
collateralized mortgage bonds ("Bond Collateral"). This Bond Collateral consists
primarily of adjustable-rate and hybrid, conventional, 30-year mortgage loans
secured by first liens on one- to four-family residential properties. All Bond
Collateral is pledged to secure repayment of the related Long-Term Debt
obligation. All principal and interest (less servicing and related fees) on the
Bond Collateral is remitted to a trustee and is available for payment on the
Long-Term Debt obligation. The Company's exposure to loss on the Bond Collateral
is limited to its net investment, as the Long-Term Debt is non-recourse to the
Company.
The components of the Bond Collateral are summarized as follows:
(IN THOUSANDS) DECEMBER 31, DECEMBER 31,
2000 1999
----------- -----------
Mortgage loans
Residential: held-for-sale $ 315 $ 174
Residential: held-for-investment, net 1,124,339 968,709
Restricted cash 3,729 4,783
Accrued interest receivable 7,010 5,633
----------- -----------
$1,135,393 $ 979,299
========== ==========
For presentation purposes, the various components of the Bond Collateral
summarized above are reflected in their corresponding line items on the
Consolidated Balance Sheets.
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NOTE 7. INTEREST RATE AGREEMENTS
At December 31, 2000 and 1999, all of the Company's Interest Rate Agreements
were classified as trading, and therefore, reported at fair value.
During the years ended December 31, 2000 and 1999, the Company recognized net
market value losses of $3.4 million and net market value gains of $2.0 million
on Interest Rate Agreements classified as trading. The market value gains are
reflected as a component of "Net unrealized and realized market value gains
(losses)" on the Consolidated Statements of Operations.
During the year ended December 31, 1998, as a result of adopting SFAS No. 133,
the Company recorded a net-of-tax cumulative-effect-type transition adjustment
of $10.1 million loss in earnings to recognize at fair value the ineffective
portion of Interest Rate Agreements that were previously designated as part of a
hedging relationship (see Note 2). This loss is reflected on the Consolidated
Statements of Operations as "Cumulative Transition Effect of Adopting SFAS No.
133." Approximately $7.6 million of this transition adjustment was transferred
from other comprehensive income to current earnings. Additionally, during the
year ended December 31, 1998, the Company recognized a net market value loss of
$5.9 million on Interest Rate Agreements classified as trading. This loss is
reflected as a component of "Net unrealized and realized market value gains
(losses)" on the Consolidated Statements of Operations.
The following table summarizes the aggregate notional amounts of all of the
Company's Interest Rate Agreements as well as the credit exposure related to
these instruments. The credit exposure reflects the fair market value of all
cash and collateral of the Company held by counterparties.
NOTIONAL AMOUNTS CREDIT EXPOSURE
(IN THOUSANDS) DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2000 1999 2000 1999
----------- ----------- ----------- -----------
Interest Rate Options
Purchased $1,490,300 $2,960,900 -- --
Interest Rate Swaps 5,000 250,000 $ 2,814 $ 2,632
Interest Rate Futures and 506,600 630,000 948 593
Forwards
---------- ---------- ----------- -----------
Total $2,001,900 $3,840,900 $ 3,762 $ 3,225
========== ========== ========== ==========
Interest Rate Options purchased (sold), which may include caps, floors, call and
put corridors, options on futures, options on MBS forwards, and swaption collars
(collectively, "Options"), are agreements which transfer, modify or reduce
interest rate risk in exchange for the payment (receipt) of a premium when the
contract is initiated. Purchased interest rate cap agreements provide cash flows
to the Company to the extent that a specific interest rate index exceeds a fixed
rate. Conversely, purchased interest rate floor agreements produce cash flows to
the Company to the extent that the referenced interest rate index falls below
the agreed upon fixed rate. Purchased call (put) corridors will cause the
Company to incur a gain to the extent that the yield of the specified index is
below (above) the strike rate at the time of the option expiration. The maximum
gain or loss on a purchased call (put) corridor is equal to the up-front
premium. Call (put) corridors that are sold will cause the Company to incur a
loss to the extent that the yield of the specified index is below (above) the
strike rate at the time of the option expiration. Such losses are partially
offset by the up front premium received. The maximum gain or loss on a call
(put) corridor sold is determined at the time of the transaction by establishing
a minimum (maximum) index rate. The Company will receive cash on the purchased
options on futures/forwards if the futures/forward price exceeds (is below) the
call (put) option strike price at the expiration of the option. For the written
options on futures/forwards, the Company receives an up-front premium for
selling the option, however, the Company will incur a loss on the written option
if the futures/forward price exceeds (is below) the call (put) option strike
price at the expiration of the option. Purchased receiver (payor) swaption
collars will cause the Company to incur a gain (loss) should the index rate be
below (above) the strike rate as of the expiration date. The maximum gain or
loss on a receiver (payor) swaption is established at the time of the
transaction by establishing a minimum (maximum) index rate. The Company's credit
risk on the purchased Options is limited to the carrying value of the Options
agreements. The credit risk on options on futures is limited due to the fact
that the exchange and its members are required to satisfy the obligations of any
member that fails to perform.
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76
Interest Rate Swaps ("Swaps") are agreements in which a series of interest rate
flows are exchanged over a prescribed period. The notional amount on which the
interest payments are based is not exchanged. Most of the Company's Swaps
involve the exchange of one floating interest payment for another floating
interest payment based on a different index. Most of the Swaps require that the
Company provide collateral, such as mortgage securities, to the counterparty.
Should the counterparty fail to return the collateral, the Company would be at
risk for the fair market value of that asset.
Interest Rate Futures and Forwards ("Futures and Forwards") are contracts for
the purchase or sale of securities or cash in which the seller (buyer) agrees to
deliver (purchase) on a specified future date, a specified instrument (or the
cash equivalent), at a specified price or yield. Under these agreements, if the
Company has sold (bought) the futures/forwards, the Company will generally
receive additional cash flows if interest rates rise (fall). Conversely, the
Company will generally pay additional cash flows if interest rates fall (rise).
The credit risk inherent in futures and forwards arises from the potential
inability of counterparties to meet the terms of their contracts, however, the
credit risk on futures is limited by the requirement that the exchange and its
members make good on obligations of any member that fails to perform.
In general, the Company incurs credit risk to the extent that the counterparties
to the Interest Rate Agreements do not perform their obligations under the
Interest Rate Agreements. If one of the counterparties does not perform, the
Company would not receive the cash to which it would otherwise be entitled under
the Interest Rate Agreement. In order to mitigate this risk, the Company has
only entered into Interest Rate Agreements that are either a) transacted on a
national exchange or b) transacted with counterparties that are either i)
designated by the U.S. Department of the Treasury as a "primary government
dealer", ii) affiliates of "primary government dealers", or iii) rated BBB or
higher. Furthermore, the Company has entered into Interest Rate Agreements with
several different counterparties in order to diversify the credit risk exposure.
NOTE 8. SHORT-TERM DEBT
The Company has entered into repurchase agreements, bank borrowings, and other
forms of collateralized short-term borrowings (collectively, "Short-Term Debt")
to finance acquisitions of a portion of its Mortgage Assets. This Short-Term
Debt is collateralized by a portion of the Company's Mortgage Assets.
At December 31, 2000, the Company had $756 million of Short-Term Debt
outstanding with a weighted-average borrowing rate of 6.85% and a
weighted-average remaining maturity of 122 days. This debt was collateralized
with $778 million of Mortgage Assets. At December 31, 1999, the Company had $1.3
billion of Short-Term Debt outstanding with a weighted-average borrowing rate of
6.22% and a weighted-average remaining maturity of 96 days. This debt was
collateralized with $1.3 billion of Mortgage Assets.
At December 31, 2000 and 1999, the Short-Term Debt had the following remaining
maturities:
(IN THOUSANDS) DECEMBER 31, DECEMBER 31,
2000 1999
----------- -----------
Within 30 days $ 100,885 $ 163,394
31 to 90 days 268,867 385,729
Over 90 days 386,470 704,442
========== ==========
Total Short-Term Debt $ 756,222 $1,253,565
========== ==========
For the years ended December 31, 2000, 1999 and 1998, the average balance of
Short-Term Debt was $0.9 billion, $1.0 billion and $2.0 billion with a
weighted-average interest cost of 6.57%, 5.35%, and 5.81%, respectively. The
maximum balance outstanding during both of the years ended December 31, 2000 and
1999, was $1.3 billion. The maximum balance outstanding during the year ended
December 31, 1998 was $2.5 billion. The Company met all of it debt covenants for
its short-term borrowing arrangements and credit facilities during the years
ended December 31, 2000 and 1999.
F-17
77
In addition to the committed facilities listed below, the Company has
uncommitted facilities with credit lines in excess of $4 billion at December 31,
2000. It is the intention of the Company's management to renew committed and
uncommitted facilities, if and as needed.
In March 2000, the Company entered into a $50 million committed revolving
mortgage warehousing credit facility. The facility is intended to finance newly
originated commercial mortgage loans. Holdings may borrow under this facility as
a co-borrower. In September 2000, this facility was extended through August 2001
and was increased to $70 million. At December 31, 2000, the Company and Holdings
had borrowings under this facility of $16.5 million and $18.2 million,
respectively. In addition, a portion of this facility allows for loans to be
financed to the maturity of the loan, which may extend beyond the expiration
date of the facility. Borrowings under this facility bear interest based on a
specified margin over the London Interbank Offered Rate ("LIBOR"). At December
31, 2000, the weighted average borrowing rate under this facility was 8.57%.
This committed facility expires in August 2001.
In July 2000, the Company renewed for one year, a $30 million committed master
loan and security agreement with a Wall Street Firm. The facility is intended to
finance newly originated commercial mortgage loans. In September 2000, this
facility was increased to $50 million. Holdings may borrow under this facility
as a co-borrower. At December 31, 2000, the Company had borrowings under this
facility of $26.7 million. Holdings did not have borrowings under this facility
at December 31, 2000. Borrowings under this facility bear interest based on a
specified margin over LIBOR. At December 31, 2000, the weighted average
borrowing rate under this facility was 8.23%. This committed facility expires in
July 2001.
In September 2000, the Company entered into two separate $30 million committed
master repurchase agreements with a bank and a Wall Street Firm. These
facilities are intended to finance residential mortgage-backed securities with
lower than investment grade ratings. At December 31, 2000, the Company had
borrowings under these facilities of $22.7 million. Borrowings under these
facilities bear interest based on a specified margin over LIBOR. At December 31,
2000, the weighted average borrowing rate under these facilities was 7.43%.
These committed facilities expire in September 2001.
In October 2000, the Company entered into a $20 million committed master
repurchase agreement with a Wall Street Firm. This facility is intended to
finance residential mortgage-backed securities with lower than investment grade
ratings. At December 31, 2000, the Company had borrowings under this facility of
$3.6 million. Borrowings under this facility bear interest based on a specified
margin over LIBOR. At December 31, 2000, the weighted average borrowing rate
under this facility was 7.56%. This committed facility expires in October 2001.
In July 1999, the Company entered into a one-year, $90 million committed
revolving mortgage warehousing credit facility with two banks. At the Company's
request, this line was reduced to $20 million in December 1999. This facility
expired in February 2000. The facility was primarily intended to finance newly
originated residential mortgage loans. Holdings was a co-borrower under this
facility. At December 31, 1999, the Company had borrowings under this facility
of $6.4 million. Holdings did not have borrowings under this facility at
December 31, 1999. Borrowings under this facility bore interest based on a
specified margin over LIBOR. At December 31, 1999, the weighted-average
borrowing rate under this facility was 6.87%.
F-18
78
In July 1999, the Company entered into a one-year, $350 million committed master
loan and security agreement with a Wall Street firm. This facility expired in
June 2000, but was renewed as a one-year, $30 million committed commercial loan
facility in July 2000 as previously discussed above. The Company renewed a
residential portion of this facility for one year in June 2000 on an uncommitted
basis. The $350 million committed facility entered into in July 1999, was
primarily intended to finance newly originated commercial and residential
mortgage loans. Holdings was a co-borrower under this facility. At December 31,
1999, the Company and Holdings had borrowings under this facility of $119.9
million and $19.8 million, respectively. Borrowings under this facility bore
interest based on a specified margin over LIBOR. At December 31, 1999, the
weighted-average borrowing rate under this facility was 5.72%.
NOTE 9. LONG-TERM DEBT
Long-Term Debt in the form of collateralized mortgage bonds is secured by Bond
Collateral. As required by the indentures relating to the Long-Term Debt, the
Bond Collateral is held in the custody of trustees. The trustees collect
principal and interest payments on the Bond Collateral and make corresponding
principal and interest payments on the Long-Term Debt. The obligations under the
Long-Term Debt are payable solely from the Bond Collateral and are otherwise
non-recourse to the Company.
Each series of Long-Term Debt consists of various classes of bonds at variable
rates of interest. The maturity of each class is directly affected by the rate
of principal prepayments on the related Bond Collateral. Each series is also
subject to redemption according to the specific terms of the respective
indentures. As a result, the actual maturity of any class of a Long-Term Debt
series is likely to occur earlier than its stated maturity.
During the second quarter of 1999, the Company exercised its right to call the
Long-Term Debt of Sequoia Mortgage Trust 1 ("Sequoia 1"), a series of debt
issued by Sequoia. This Long-Term Debt was called on May 4, 1999. In conjunction
with this call, the Company restructured and contributed the Sequoia 1 debt to
Sequoia Mortgage Trust 1A ("Sequoia 1A"), a newly formed trust, and Sequoia 1A
issued Long-Term Debt collateralized by Sequoia 1 debt. As a result, the $154
million of Bond Collateral in the form of mortgage loans held-for-sale was
reclassified to mortgage loans held-for-investment.
For the years ended December 31, 2000, 1999, and 1998, the average effective
interest cost for Long-Term Debt, as adjusted for the amortization of bond
premium, deferred bond issuance costs, and other related expenses, was 6.71%,
6.03%, and 6.38%, respectively. At December 31, 2000 and 1999, accrued interest
payable on Long-Term Debt was $3.1 million and $3.0 million, respectively, and
is reflected as a component of Accrued Interest Payable on the Consolidated
Balance Sheets. For the years ended December 31, 2000, 1999, and 1998, the
average balance of Long-Term Debt was $1.1 billion for both 2000 and 1999, and
$1.3 billion for 1998.
The components of the Long-Term Debt at December 31, 2000 and 1999 along with
selected other information are summarized below:
(IN THOUSANDS) DECEMBER 31, DECEMBER 31,
2000 1999
----------- -----------
Long-Term Debt $ 1,095,909 $ 944,225
Unamortized premium on Long-Term Debt 3,045 3,881
Deferred bond issuance costs (3,119) (2,836)
----------- -----------
Total Long-Term Debt $ 1,095,835 $ 945,270
=========== ===========
Range of weighted-average interest rates, by 6.35% to 7.20% 6.21% to 6.88%
series
Stated maturities 2017 - 2029 2017 - 2029
Number of series 4 3
F-19
79
NOTE 10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values of
the Company's financial instruments at December 31, 2000 and 1999.
(IN THOUSANDS) DECEMBER 31, 2000 DECEMBER 31, 1999
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
---------------------------- -----------------------------
Assets
Mortgage Loans
Residential: held-for-sale $ 6,658 $ 6,658 $ 415,880 $ 415,880
Residential: held-for-investment 1,124,339 1,113,389 968,709 955,653
Commercial: held-for-sale 34,275 34,275 8,437 8,437
Commercial: held-for-investment 22,894 22,894 -- --
Mortgage Securities
Residential: trading 759,612 759,612 941,781 946,373
Residential: available-for-sale 85,927 85,927 26,999 28,006
Interest Rate Agreements 66 66 2,037 2,037
Investment in RWT Holdings, Inc. 1,899 1,989 3,391 3,675
Liabilities
Short-Term Debt 756,222 756,222 1,253,565 1,253,565
Long-Term Debt 1,095,835 1,085,368 945,270 928,449
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. 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 December 31, 2000 and 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. The Company did not repurchase
any shares of Preferred Stock during 2000, and, pursuant to the repurchase
program, repurchased 7,450 shares of its Preferred Stock for $0.2 million during
1999. At December 31, 2000, there remained 142,550 shares available under the
authorization for repurchase.
STOCK OPTION PLAN
The Company has adopted a Stock Option Plan for executive officers, employees,
and non-employee directors (the "Plan"). The Plan authorizes the Board of
Directors (or a committee appointed by the Board of Directors) to grant
"incentive stock options" as defined under Section 422 of the Code ("ISOs"),
options not so qualified ("NQSOs"), deferred stock, restricted stock,
performance shares, stock appreciation rights, limited stock appreciation rights
("Awards"), and dividend equivalent rights ("DERs") to such eligible recipients
other than non-employee directors. Non-employee directors are automatically
provided annual grants of NQSOs with DERs pursuant to a formula under the Plan.
F-20
80
The number of shares of Common Stock available under the Plan for options and
Awards, subject to certain anti-dilution provisions, is 15% of the Company's
total outstanding shares of Common Stock. The total outstanding shares are
determined as the highest number of shares outstanding prior to any stock
repurchases. Of these shares of Common Stock available for grant, no more than
500,000 shares of Common Stock shall be cumulatively available for grant as
ISOs. At December 31, 2000 and 1999, 476,854 and 283,975 shares of Common Stock,
respectively, were available for grant. At December 31, 2000 and 1999, 328,152
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 has granted stock options that accrue and pay stock and cash DERs.
This feature results in current operating expenses being incurred that relate to
long-term incentive grants made in the past. To the extent the Company increases
its common dividends, such operating expenses may increase. For the years ended
December 31, 2000, 1999, and 1998, the Company accrued cash and stock DER
expenses of $2.1 million, $0.5 million, and $0.2 million, respectively. Stock
DERs represent shares of stock which are issuable to holders of stock options
when the holders exercise the underlying stock options. The number of stock DER
shares accrued is based on the level of the Company's common stock dividends and
on the price of the common stock on the related dividend payment date. At
December 31, 2000, there were 166,451 unexercised options with stock DERs under
the Plan. Cash DERs are accrued and paid based on the level of the Company's
common stock dividend. At December 31, 2000, there were 1,180,797 unexercised
options with cash DERs under the Plan. At December 31, 2000, there were 147,550
outstanding stock options that did not have cash or stock DERs.
A summary of the status of the Company's Plan at year end and changes during the
years ending on that date is presented below.
DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998
---------------------- ---------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
(IN THOUSANDS, EXCEPT SHARE DATA) SHARES PRICE SHARES PRICE SHARES PRICE
--------- ------- --------- ------ --------- ------
Outstanding options at January 1 1,713,836 $21.97 1,739,787 $23.68 840,644 $29.79
Options granted 163,050 $16.90 371,950 $13.37 929,125 $16.73
Options exercised (26,158) $12.26 (15,285) $ 0.68 (29,723) $ 0.11
Options canceled (372,070) $18.11 (387,990) $21.50 (2,699) $29.81
Dividend equivalent rights earned 16,140 -- 5,374 -- 2,440 --
---------- ---------- ----------
Outstanding options at December 31 1,494,798 $22.32 1,713,836 $21.97 1,739,787 $23.68
========== ========== ==========
Options exercisable at year-end 644,098 $25.47 401,697 $26.89 336,121 $25.95
Weighted average fair value of options
granted during the year $1.64 $1.33 $1.63
F-21
81
The following table summarizes information about stock options outstanding at
December 31, 2000.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------- -----------------------------
WEIGHTED-AVERAGE
RANGE OF NUMBER REMAINING WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE PRICE
LIFE PRICE
- --------------- ----------- ---------------- ---------------- ------------ ---------------
$0 to $10 48,109 4.7 $ 0.57 48,109 $ 0.57
$10 to $20 712,903 8.2 $14.43 181,967 $16.39
$20 to $30 349,614 7.0 $22.37 171,311 $22.44
$30 to $40 283,200 6.0 $37.49 189,724 $37.57
$40 to $50 93,472 6.6 $45.03 47,363 $45.04
$50 to $53 7,500 6.5 $52.25 5,625 $52.25
--------- -------
$0 to $53 1,494,798 7.3 $22.32 644,099 $25.47
========= =======
At December 31, 2000, the Company had one Stock Option Plan, which is described
above. The Company applies Accounting Principles Board ("APB") Opinion 25 and
related interpretations in accounting for this plan. Had compensation cost for
the Company's Plan been determined consistent with SFAS No. 123, Accounting for
Stock-Based Compensation, the Company's net income (loss) and earnings (loss)
per share would have been reduced to the pro forma amounts indicated below:
YEAR ENDED DECEMBER 31,
2000 1999 1998
------- -------- ---------
Net income (loss) As reported $16,210 $(1,013) $(40,118)
(in thousands) Pro Forma $15,611 $(1,687) $(40,674)
Basic net income (loss) As reported $1.84 $(0.10) $(3.04)
per share Pro Forma $1.78 $(0.17) $(3.08)
Diluted net income (loss) As reported $1.82 $(0.10) $(3.04)
per share Pro Forma $1.75 $(0.17) $(3.08)
For purposes of determining option values for use in the above tables, the
values are based on American valuation using the Black-Scholes option pricing
model as of the various grant dates, using the following principal assumptions:
expected stock price volatility 33%, risk free rates of return based on the 5
year treasury rate at the date of grant, and a dividend growth rate of 10%. The
actual value, if any, that the option recipient will realize from these options
will depend solely on the increase in the stock price over the option price when
the options are exercised.
COMMON STOCK REPURCHASES
Since September 1997, the Company's Board of Directors has approved the
repurchase of 7,455,000 shares of the Company's Common Stock. Pursuant to this
repurchase program, the Company did not repurchase any shares of Common Stock
during the year ended December 31, 2000, repurchased 2,483,500 shares for $37
million at an average price of $14.96 per share during the year ended December
31, 1999, and repurchased 3,131,500 shares of its Common Stock for $47 million
at an average price of $14.99 per share during the year ended December 31, 1998.
At December 31, 2000, there remained 1,000,000 shares available under the
authorization for repurchase. The repurchased shares have been returned to the
Company's authorized but unissued shares of Common Stock.
NOTE 12. RELATED PARTY TRANSACTIONS
PURCHASES AND SALES OF MORTGAGE LOANS
During the years ended December 31, 2000 and 1999, the Company sold $58 million
and $50 million of commercial mortgage loans to Redwood Commercial Funding
("RCF"), respectively, pursuant to Master Forward Commitment Agreements. There
were no such sales during the year ended December 31, 1998. The Company sold the
mortgage loans to RCF at the same price for which the Company acquired the
mortgage loans. At December 31, 2000 and 1999, under the terms of Master Forward
Commitment Agreements, the Company had committed to sell $34 million and $8
million of commercial mortgage loans to RCF for settlement during the first
quarter of 2001 and 2000, respectively.
F-22
82
During the year ended December 31, 2000, the Company purchased commercial
mortgage loans from RCF aggregating $18 million, which were not subject to the
terms of Master Forward Commitment Agreements. The Company made no such
purchases from RCF during the years ended December 31, 1999 or 1998. The Company
intends to hold these commercial loans through maturity. All such commercial
mortgage loans purchased by the Company from RCF are purchased at the market
price at the time of the sale. Accordingly, any inter-company gains or losses
recorded on the sale of the commercial mortgage loans from RCF to the Company
are eliminated against the basis of the commercial mortgage loan purchased by
the Company. During the year ended December 31, 2000, Redwood's 99% interest of
such gains recognized by Holdings was $0.2 million.
During the years ended December 31, 2000 and 1999, the Company sold $17 million
and $61 million of residential mortgage loans to Redwood Residential Funding
("RRF"), a subsidiary of Holdings. There were no such sales during the year
ended December 31, 1998. Pursuant to Master Forward Commitment Agreements, the
Company sold the mortgage loans to RRF at the same price for which the Company
acquired the mortgage loans. As RRF ceased operations in 1999, there were no
remaining outstanding commitments at December 31, 2000. At December 31, 1999,
RRF had committed to purchase $16 million or residential mortgage loans from the
Company during the first and second quarters of 2000, pursuant to the terms of
Master Forward Commitment Agreements.
During December 1999, Holdings purchased $390 million of residential mortgage
loans and subsequently sold a participation agreement on the mortgage loans to
the Company. Pursuant to the terms of the Mortgage Loan 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
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.
OTHER
Under a revolving credit facility arrangement, the Company may loan funds to
Holdings to finance certain mortgage loans owned by Holdings. These loans are
typically unsecured and are repaid within six months. Such loans bear interest
at a rate of 3.50% over the LIBOR interest rate. At December 31, 2000, the
Company had no such loans to Holdings. At December 31, 1999, the Company had
loaned $6.5 million to Holdings in accordance with the provisions of this
arrangement. During the years ended December 31, 2000, 1999 and 1998, the
Company earned $0.3 million, $1.1 million and $18,000, respectively, in interest
on loans to Holdings.
The Company shares many of the operating expenses of Holdings, including
personnel and related expenses, subject to full reimbursement by Holdings.
During the years ended December 31, 2000, 1999 and 1998, $0.2 million, $3.0
million and $2.3 million, respectively, of Holdings' operating expenses were
paid by the Company, and were subject to reimbursement by Holdings.
The Company may provide credit support to Holdings to facilitate Holdings'
financings from third-party lenders and/or hedging arrangements with
counterparties. As part of this arrangement, Holdings is authorized as a
co-borrower under some of the Company's Short-Term Debt agreements subject to
the Company continuing to remain jointly and severally liable for repayment.
Accordingly, Holdings pays the Company credit support fees on borrowings subject
to this arrangement. At December 31, 2000 and 1999, the Company was providing
credit support on $18.2 million and $22.4 million of Holdings' Short-Term Debt.
During each year ended December 31, 2000, 1999 and 1998, the Company recognized
$0.1 million in credit support fee income. Credit support fees are reflected as
a component of "Other Income" on the Consolidated Statements of Operations.
Holdings may borrow under several of Redwood Trust's Short-Term Debt agreements
as a co-borrower (see Note 4). At December 31, 2000 and 1999, Holdings had
borrowings of $18.2 million and $22.4 million subject to these arrangements.
F-23
83
NOTE 13. COMMITMENTS AND CONTINGENCIES
At December 31, 2000, the Company had entered into commitments to purchase
$100.4 million of residential mortgage securities for settlement during January
and February 2001. At December 31, 2000, the Company had also entered into
Master Forward Agreements to sell $34.3 million of commercial mortgage loans to
RCF during the first quarter of 2001.
At December 31, 2000, the Company is obligated under non-cancelable operating
leases with expiration dates through 2006. The total future minimum lease
payments under these non-cancelable leases is $3.0 million and is expected to be
recognized as follows: 2001 - $0.5 million; 2002 - $0.6 million; 2003 - $0.6
million; 2004 - $0.6 million; 2005 -- $0.5 million; 2006 - $0.2 million.
NOTE 14. SUBSEQUENT EVENTS
Effective December 15, 1999, the United States Congress enacted the Real Estate
Investment Trust ("REIT") Modernization Act (RMA) which, among other things,
permits REITs to own 100% of the outstanding voting securities of a taxable REIT
subsidiary beginning after December 31, 2000. Accordingly, on January 1, 2001,
Redwood Trust acquired 100% of the voting common stock of Holdings for $300,000
in cash consideration from two officers of Holdings. Redwood Trust's Audit
Committee determined the purchase price based on an independent appraisal
obtained by the Audit Committee and through negotiations with the two officers,
taking into account projected cost savings to Redwood Trust from being able to
consolidate Holdings into Redwood Trust's future financial statements and other
potential benefits to Redwood Trust and its stockholders.
Following Redwood Trust's acquisition of the voting common stock of Holdings,
Redwood Trust transferred its preferred stock interest in exchange for
additional voting common stock in Holdings as part of the Holdings equity
recapitalization. As a result of these transactions, Redwood Trust owns 100% of
the voting common stock of Holdings and Holdings became a wholly-owned
subsidiary of Redwood Trust on January 1, 2001. Subsequently, Holdings elected
to become a taxable REIT subsidiary of Redwood Trust.
Prior to the Company's acquisition of 100% of the voting common stock of
Holdings, Holdings was operated and managed independently of the Company, as the
Company is subject to tax as a REIT and Holdings is not. Holdings' activities
resulted in it being characterized as a taxable, non-qualified REIT subsidiary.
To qualify as a REIT, the Company, among other things, was unable to own greater
than 10% of the outstanding voting securities of any non-qualified REIT
subsidiary.
The transaction has been accounted for using the purchase method of accounting.
The assets and liabilities of Holdings have been recorded by the Company at
their fair market value. The transaction did not have a material impact on the
financial statements of the Company. Goodwill of $0.3 million was recorded by
the Company as a result of this transaction and will be amortized on a
straight-line basis over four years beginning in January 2001.
F-24
84
The following are the pro forma consolidated balance sheet and a statement of
operations at December 31, 2000 and for the year ended December 31, 2000,
respectively, as if the Company had owned 100% of Holdings.
REDWOOD TRUST, INC.
CONSOLIDATED BALANCE SHEET (UNAUDITED)
(PRO FORMA) DECEMBER 31, 2000
(IN THOUSANDS) ----------------------------- REDWOOD TRUST
REDWOOD TRUST RWT HOLDINGS CONSOLIDATION CONSOLIDATED
------------- ------------ ------------- -------------
ASSETS
Residential Credit Enhancement Interests:
Mortgage securities available-for-sale $ 80,764 $ -- $ -- $ 80,764
Residential Retained Loan Portfolio:
Mortgage loans held-for-investment 1,124,339 -- -- 1,124,339
Mortgage loans available-for-sale 6,658 -- -- 6,658
----------- ----------- ----------- -----------
1,130,997 -- -- 1,130,997
Investment Portfolio:
Mortgage securities trading 57,450 -- -- 57,450
Mortgage securities available-for-sale 707,325 -- -- 707,325
----------- ----------- ----------- -----------
764,775 -- -- 764,775
Commercial retained loan portfolio:
Mortgage loans held-for-investment 22,894 -- -- 22,894
Mortgage loans held-for-sale 34,275 18,913 -- 53,188
----------- ----------- ----------- -----------
57,169 18,913 -- 76,082
Cash and cash equivalents 15,483 1,892 (300) 17,075
Restricted cash 5,240 1,119 -- 6,359
Accrued interest receivable 15,797 169 -- 15,966
Investment in RWT Holdings, Inc. 1,899 -- (1,899) --
Goodwill -- -- 281 281
Other assets 9,991 38 -- 10,029
----------- ----------- ----------- -----------
Total Assets $ 2,082,115 $ 22,131 $ (1,918) $ 2,102,328
=========== =========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt $ 756,222 $ 18,200 $ -- $ 774,422
Long-term debt 1,095,835 -- -- 1,095,835
Accrued interest payable 5,657 134 -- 5,791
Accrued expenses and other liabilities 8,737 1,879 -- 10,616
----------- ----------- ----------- -----------
1,866,451 20,213 -- 1,886,664
----------- ----------- ----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock 26,517 -- -- 26,517
Series A preferred stock -- 29,700 (29,700) --
Common stock 88 -- -- 88
Additional paid-in-capital 242,522 300 (300) 242,522
Accumulated other comprehensive income (89) -- -- (89)
Cumulative earnings (deficit) 27,074 (28,082) 28,082 27,074
Cumulative distributions to stockholders (80,448) -- -- (80,448)
----------- ----------- ----------- -----------
Total Stockholder's Equity 215,664 1,918 (1,918) 215,664
----------- ----------- ----------- -----------
Total Liabilities and Stockholders' Equity $ 2,082,115 $ 22,131 $ (1,918) $ 2,102,328
=========== =========== =========== ===========
F-25
85
REDWOOD TRUST, INC.
CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
(PRO FORMA) YEAR ENDED DECEMBER 31, 2000
(IN THOUSANDS) ---------------------------- REDWOOD TRUST
REDWOOD TRUST RWT HOLDINGS CONSOLIDATION CONSOLIDATED
------------- ------------ ------------- -------------
INTEREST INCOME
Residential Credit Enhancement Interests:
Mortgage securities available-for-sale $ 8,524 $ -- $ -- $ 8,524
Residential Retained Loan Portfolio:
Mortgage loans held-for-investment 83,815 -- -- 83,815
Mortgage loans held-for-sale 7,050 69 -- 7,119
--------- --------- --------- ---------
90,865 69 -- 90,934
Investment Portfolio:
Mortgage securities trading 67,055 -- -- 67,055
Mortgage securities available-for-sale 151 -- -- 151
--------- --------- --------- ---------
67,206 -- -- 67,206
Commercial Retained Loan Portfolio:
Mortgage loans held-for-investment 520 -- -- 520
Mortgage loans held-for-sale 1,482 3,301 -- 4,783
--------- --------- --------- ---------
2,002 3,301 -- 5,303
Cash and cash equivalents 1,395 122 (343) 1,174
--------- --------- --------- ---------
Total interest income 169,992 3,492 (343) 173,141
INTEREST EXPENSE
Short-term debt (61,355) (2,316) -- (63,671)
Long-term debt (76,294) -- -- (76,294)
Credit support fees -- (98) 98 --
Loans from Redwood Trust, Inc. -- (343) 343 --
--------- --------- --------- ---------
Total interest expense (137,649) (2,757) 441 (139,965)
Net interest rate agreements expense (954) -- -- (954)
Provision for credit losses (731) -- -- (731)
--------- --------- --------- ---------
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 30,658 735 98 31,491
Net unrealized and realized market value gains
(losses)
Loans and securities 1,060 149 (186) 1,023
Interest rate agreements (3,356) -- -- (3,356)
--------- --------- --------- ---------
Total net unrealized and realized market value (2,296) 149 (186) (2,333)
gains (losses)
Operating expenses (7,850) (2,391) -- (10,241)
Other income 98 -- (98) --
Equity in losses of RWT Holdings, Inc. (1,676) -- 1,676 --
--------- --------- --------- ---------
Net income before preferred dividend 18,934 (2,391) 1,490 18,917
Less dividends on Class B preferred stock (2,724) -- -- (2,724)
--------- --------- --------- ---------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 16,210 $ (1,507) $ 1,490 $ 16,193
========= ========= ========= =========
Basic Earnings Per Share $ 1.84 $ 1.84
Diluted Earnings Per Share $ 1.82 $ 1.82
F-26
86
On March 15, 2001, the Company declared a $0.50 per share common stock dividend
and a $0.755 preferred stock dividend for the first quarter of 2001. The common
and preferred stock dividends are payable on April 23, 2001 to common and
preferred shareholders of record on March 30, 2001.
NOTE 15. QUARTERLY FINANCIAL DATA - UNAUDITED
Selected quarterly financial data follows:
(IN THOUSANDS, EXCEPT SHARE DATA) THREE MONTHS ENDED
-------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
--------- -------- ------------ -----------
2000
Operating results:
Interest income $ 42,939 $ 43,136 $ 41,919 $ 41,998
Interest expense (34,522) (34,915) (34,501) (33,711)
Provision for credit losses (119) (128) (240) (244)
Interest rate agreement expense (409) (218) (193) (134)
Net interest income after provision for credit losses 7,889 7,875 6,985 7,909
Net income (loss) available to common stockholders 3,280 3,096 4,873 4,961
Per share data:
Net income (loss) - diluted $ 0.37 $ 0.35 $ 0.55 $ 0.55
Dividends declared per common share (a) $ 0.35 $ 0.40 $ 0.42 $ 0.44
Dividends declared per preferred share $ 0.755 $ 0.755 $ 0.755 $ 0.755
1999
Operating results:
Interest income $ 41,732 $ 36,090 $ 34,555 $ 34,933
Interest expense (33,491) (28,537) (27,390) (27,744)
Provision for credit losses (345) (371) (416) (214)
Interest rate agreement expense (333) (736) (458) (538)
Net interest income after provision for credit losses 7,563 6,446 6,291 6,437
Net income (loss) available to common stockholders 5,855 2,508 (3,738) (5,638)
Per share data:
Net income (loss) - diluted $ 0.54 $ 0.25 $ (0.39) $ (0.64)
Dividends declared per common share (a) -- -- $ 0.15 $ 0.25
Dividends declared per preferred share $ 0.755 $ 0.755 $ 0.755 $ 0.755
(a) Reflects period for which the common dividend was declared. Reported
dividends may have been declared during the following quarter.
F-27
87
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Redwood Trust, Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of Redwood
Trust, Inc. (the Company) at December 31, 2000 and 1999 and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audit. We conducted our audit
of these statements in accordance with auditing standards generally accepted in
the United States of America which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In July 1998, the Company adopted Financial Accounting Standards Board Statement
No. 133. Accounting of Derivative Instruments and Hedging Activities. This
change is discussed in Note 2 to the consolidated financial statements.
/s/ PricewaterhouseCoopers LLP
San Francisco, California
February 15, 2001
F-28
88
RWT HOLDINGS, INC.
CONSOLIDATED FINANCIAL STATEMENTS AND
REPORT OF INDEPENDENT ACCOUNTANTS
For Inclusion in Form 10-K
Annual Report Filed with
Securities and Exchange Commission
December 31, 2000
F-29
89
RWT HOLDINGS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Consolidated Financial Statements - RWT Holdings, Inc.
Consolidated Balance Sheets at December 31, 2000 and 1999.......................................... F-31
Consolidated Statements of Operations for the years ended December 31, 2000 and 1999,
and for the period from April 1, 1998 (commencement of operations) to December 31, 1998..... F-32
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 2000 and 1999, and for the period from
April 1, 1998 (commencement of operations) to December 31, 1998............................. F-33
Consolidated Statements of Cash Flows for the years ended December 31, 2000 and 1999,
and for the period from April 1, 1998 (commencement of operations) to December 31, 1998..... F-34
Notes to Consolidated Financial Statements......................................................... F-35
Report of Independent Accountants........................................................................ F-42
F-30
90
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31,
2000 1999
-------- --------
ASSETS
Mortgage loans: held-for sale
Residential $ -- $ 4,399
Commercial, pledged 18,913 29,605
-------- --------
18,913 34,004
Cash and cash equivalents 1,892 1,999
Restricted cash 1,119 50
Accrued interest receivable 169 1,520
Property, equipment and leasehold improvements, net -- 299
Other assets 38 1,081
-------- --------
Total Assets $ 22,131 $ 38,953
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt $ 18,200 $ 22,427
Loans from Redwood Trust, Inc. -- 6,500
Payable to Redwood Trust, Inc. -- 472
Accrued interest payable 134 831
Accrued restructuring charges 430 4,039
Accrued expenses and other liabilities 1,449 1,259
-------- --------
Total Liabilities 20,213 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 (28,082) (26,575)
-------- --------
Total Stockholders' Equity 1,918 3,425
-------- --------
Total Liabilities and Stockholders' Equity $ 22,131 $ 38,953
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-31
91
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
For the period
from April 1, 1998
(commencement of
Year Ended Year Ended operations) to
December 31, 2000 December 31, 1999 December 31, 1998
----------------- ----------------- ------------------
REVENUES
Interest income
Mortgage loans: held-for-sale
Residential $ 69 $ 1,955 $ 2,803
Commercial 3,301 1,555 --
-------- -------- --------
3,370 3,510 2,803
-------- -------- --------
Mortgage securities: trading -- 1,021 --
Cash and cash equivalents 122 330 350
-------- -------- --------
Total interest income 3,492 4,861 3,153
-------- -------- --------
Interest expense
Short-term debt (2,316) (2,457) (2,503)
Credit support fees (98) (149) (139)
Loans from Redwood Trust, Inc. (343) (1,118) (18)
-------- -------- --------
Total interest expense (2,757) (3,724) (2,660)
-------- -------- --------
Net interest income 735 1,137 493
-------- -------- --------
Net unrealized and realized market value gains (losses) 149 (747) 18
Other income -- 26 --
EXPENSES
Compensation and benefits (1,485) (8,414) (3,395)
General and administrative (906) (5,430) (1,840)
Restructuring charge -- (8,423) --
-------- -------- --------
Total expenses (2,391) (22,267) (5,235)
-------- -------- --------
NET LOSS $ (1,507) $(21,851) $ (4,724)
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-32
92
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
Series A
Preferred stock Common stock Additional
--------------------------------------------- paid-in Accumulated
Shares Amount Shares Amount capital deficit Total
- -----------------------------------------------------------------------------------------------------------------------------
Balance, April 1, 1998 -- $ -- -- $ -- $ -- $ -- $ --
- -----------------------------------------------------------------------------------------------------------------------------
Net loss -- -- -- -- -- (4,724) (4,724)
Issuance of preferred stock 3,960 19,800 -- -- -- -- 19,800
Issuance of common stock -- -- 2,000 -- 200 -- 200
- -----------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 3,960 19,800 2,000 -- 200 (4,724) 15,276
- -----------------------------------------------------------------------------------------------------------------------------
Net loss -- -- -- -- -- (21,851) (21,851)
Issuance of preferred stock 1,980 9,900 -- -- -- -- 9,900
Issuance of common stock -- -- 1,000 -- 100 -- 100
- -----------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 5,940 $ 29,700 3,000 $ -- $ 300 $(26,575) $ 3,425
- -----------------------------------------------------------------------------------------------------------------------------
Net loss -- -- -- -- -- (1,507) (1,507)
- -----------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 5,940 $ 29,700 3,000 $ -- $ 300 $(28,082) $ 1,918
- -----------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
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RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the period
from April 1, 1998
(commencement of
Year Ended Year Ended operations) to
December 31, 2000 December 31, 1999 December 31, 1998
----------------- ----------------- ------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,507) $ (21,851) $ (4,724)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 31 829 27
Net unrealized and realized market value
(gains) losses (149) 747 (18)
Write-off of property, equipment and leasehold
improvements, net 82 3,131 --
Purchases of mortgage loans: held for sale (508,642) (657,295) (543,296)
Proceeds from sales of mortgage loans: held for sale 509,784 533,743 525,418
Principal payments on mortgage loans: held for sale 14,099 1,614 5,622
Purchases of mortgage securities: trading -- (4,619) --
Proceeds from sales of mortgage securities: trading -- 99,488 --
Principal payments on mortgage securities: trading -- 3,549 --
Decrease (increase) in accrued interest receivable 1,351 (1,442) (78)
Decrease (increase) in other assets 1,043 54 (55)
(Decrease) increase in amounts due to Redwood Trust (472) 27 445
(Decrease) increase in accrued interest payable (697) 828 3
(Decrease) increase in accrued restructuring charges (3,609) 4,039 --
Increase in accrued expenses and other liabilities 190 705 554
--------- --------- ---------
Net cash provided by (used in) operating activities 11,504 (36,453) (16,102)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales (purchases) of property, equipment and leasehold
improvements, net 185 (3,636) (687)
Net increase in restricted cash (1,069) (50) --
--------- --------- ---------
Net cash used in investing activities (884) (3,686) (687)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (repayments) proceeds from issuance of short-term debt (4,227) 22,427 --
Loans from Redwood Trust, Inc. (net of repayments) (6,500) -- 6,500
Net proceeds from issuance of preferred stock -- 9,900 19,800
Net proceeds from issuance of common stock -- 100 200
--------- --------- ---------
Net cash (used in) provided by financing activities (10,727) 32,427 26,500
--------- --------- ---------
Net (decrease) increase in cash and cash equivalents (107) (7,712) 9,711
Cash and cash equivalents at beginning of period 1,999 9,711 --
--------- --------- ---------
Cash and cash equivalents at end of period $ 1,892 $ 1,999 $ 9,711
========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest expense $ 3,454 $ 2,810 $ 2,518
Non-cash transaction:
Securitization of mortgage loans into mortgage securities $ -- $ 98,315 $ --
========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
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RWT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
NOTE 1. THE COMPANY
RWT Holdings, Inc. ("Holdings") was incorporated in Delaware on February 13,
1998 and commenced operations on April 1, 1998. Holdings originates and sells
commercial mortgage loans. Redwood Trust, Inc. ("Redwood Trust") owns all of the
preferred stock and has a non-voting, 99% economic interest in Holdings. The
consolidated financial statements include the three subsidiaries of Holdings.
Redwood Commercial Funding, Inc. ("RCF") originates commercial mortgage loans
for sale to Redwood Trust and other institutional investors. Redwood Residential
Funding, Inc. ("RRF") and Redwood Financial Services, Inc. ("RFS") were start-up
ventures that ceased operations in 1999. Holdings and its subsidiaries currently
utilize both debt and equity to finance acquisitions. References to Holdings in
the following footnotes refer to Holdings and its subsidiaries. On January 1,
2001, Redwood Trust acquired 100% of the voting common stock of Holdings, as
further discussed in Note 11.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Holdings and its
subsidiaries. All significant intercompany balances and transactions with
Holdings' consolidated subsidiaries have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with Generally Accepted
Accounting Principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reported period. Actual
results could differ from those estimates. The primary estimates inherent in the
accompanying consolidated financial statements are discussed below.
Fair Value. Management estimates the fair value of its financial instruments
using available market information and other appropriate valuation
methodologies. The fair value of a financial instrument, as defined by Statement
of Financial Accounting Standards ("SFAS") No. 107, Disclosures about Fair Value
of Financial Instruments, is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation sale. Management's estimates are inherently subjective in
nature and involve matters of uncertainty and judgement to interpret relevant
market and other data. Accordingly, amounts realized in actual sales may differ
from the fair values presented in Note 7.
ADOPTION OF SFAS NO. 133
Holdings adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, effective July 1, 1998. Upon the adoption of SFAS No. 133, Holdings
did not record a transition adjustment, as there were no outstanding derivative
instruments. Holdings elected to not seek hedge accounting for any of its
derivative financial instruments employed for hedging activities.
MORTGAGE ASSETS
Holdings' mortgage assets consist of mortgage loans and mortgage securities
("Mortgage Assets"). Interest is recognized as revenue when earned according to
the terms of the loans and when, in the opinion of management, it is
collectible.
Mortgage Loans: Held-for-Sale
Mortgage loans are recorded at the lower of cost or aggregate market value
("LOCOM"). Cost generally consists of the loan principal balance net of any
unamortized premium or discount and net loan origination fees. Interest income
is accrued based on the outstanding principal amount of the mortgage loans and
their contractual terms. Realized and unrealized gains or losses on the loans
are based on the specific identification method and are recognized in "Net
unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
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Some of the mortgage loans purchased by Redwood Trust are committed for sale by
Redwood Trust to Holdings, or a subsidiary of Holdings, under Master Forward
Commitment Agreements. As a forward commitment is entered into on the same date
that Redwood Trust commits to purchase the loans, the price under a forward
commitment is the same as the price Redwood Trust paid for the mortgage loans,
as established by the external market.
Mortgage Securities: Trading
Mortgage securities classified as trading are accounted for in accordance with
SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities.
Accordingly, such securities are recorded at their estimated fair market value.
Unrealized and realized gains and losses on these securities are recognized as a
component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations.
LOAN ORIGINATION FEES
Loan fees, discount points and certain direct origination costs are recorded as
an adjustment to the cost of the loan and are recorded in earnings when the loan
is sold.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of three months or less.
RESTRICTED CASH
Restricted cash includes cash held back from borrowers until certain loan
agreement requirements have been met. The corresponding liability for this cash
is reflected as a component of "Accrued expenses and other liabilities" on the
Consolidated Balance Sheets.
DERIVATIVE FINANCIAL INSTRUMENTS
Holdings utilizes derivative financial instruments to mitigate the risks that a
change in interest rates will result in a change in the value of the Mortgage
Assets. At December 31, 2000, Holdings had no derivative financial instruments.
At December 31, 1999, Holdings had entered into forward contracts for the sale
of mortgage loans which had an aggregate notional value of $1 million. Holdings
designates all derivative financial instruments as trading instruments.
Accordingly, such instruments are recorded at their estimated fair market value
with unrealized and realized gains and losses on these instruments recognized as
a component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations. During the year ended December 31, 2000,
Holdings recognized market value losses on derivative financial instruments of
$5,000. During the year ended December 31, 1999, Holdings recognized market
value gains on derivative financial instruments of $1.0 million. There were no
derivative financial instruments outstanding during the period ended December
31, 1998.
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.
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96
NOTE 3. MORTGAGE ASSETS
At December 31, 2000 and 1999 Mortgage Assets consisted of the following:
MORTGAGE LOANS: HELD-FOR-SALE
(IN THOUSANDS) DECEMBER 31, 2000 DECEMBER 31, 1999
RESIDENTIAL COMMERCIAL TOTAL RESIDENTIAL COMMERCIAL TOTAL
----------- ---------- -------- ----------- ---------- --------
Current Face $ -- $ 19,883 $ 19,883 $ 4,995 $ 30,324 $ 35,319
Unamortized Premium (Discount) -- (970) (970) (596) (719) (1,315)
-------- -------- -------- -------- -------- --------
Carrying Value $ -- $ 18,913 $ 18,913 $ 4,399 $ 29,605 $ 34,004
======== ======== ======== ======== ======== ========
For the years ended December 31, 2000, 1999 and 1998, Holdings recognized losses
of $0.2 million, $1.8 million and $11,000 respectively, as a result of LOCOM
adjustments on mortgage loans held-for-sale. During the years ended December 31,
2000, 1999 and 1998, Holdings recognized gains on sales of mortgage loans of
$0.4 million, $1.0 million, and $29,000, respectively. These losses are
reflected as a component of "Net unrealized and realized market value gains
(losses)" on the Consolidated Statements of Operations.
MORTGAGE SECURITIES: TRADING
Holdings did not own any mortgage securities during 2000 or 1998. For the year
ended December 31, 1999, Holdings recognized a market value gain of $0.1 million
on mortgage securities classified as trading. This gain is reflected as a
component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations. During the year ended December 31, 1999,
Holdings sold mortgage securities classified as trading for proceeds of $99.5
million.
NOTE 4. SHORT-TERM DEBT
Holdings has entered into reverse repurchase agreements and other forms of
collateralized short-term borrowings (collectively, "Short-Term Debt") to
finance acquisitions of a portion of its Mortgage Assets. This Short-Term debt
is collateralized by a portion of Holdings' mortgage loans.
At December 31, 2000, and December 31, 1999, Holdings had $18.2 million and
$22.4 million of Short-Term Debt outstanding with a weighted-average borrowing
rate of 8.51% and 7.02%, respectively. The average balance of Short-Term Debt
outstanding during the years ended December 31, 2000 and 1999 was $28 million
and $42 million, with a weighted-average interest cost of 8.40% and 6.22%,
respectively. The maximum balance outstanding during the years ended December
31, 2000 and 1999 was $44 million and $397 million, respectively.
Redwood Trust and Holdings were in compliance with all material representations,
warranties and covenants under all its credit facilities. It is the intention of
management to renew committed and uncommitted facilities, if and as needed.
In March 2000, Redwood Trust entered into a $50 million committed revolving
mortgage warehousing credit facility. The facility is intended to finance newly
originated commercial mortgage loans. Holdings may borrow under this facility as
a co-borrower. In September 2000, this facility was extended through August 2001
and was increased to $70 million. In addition, a portion of this facility allows
for loans to be financed to the maturity of the loan, which may extend beyond
the expiration date of the facility. At December 31, 2000, Redwood Trust and
Holdings had outstanding borrowings of $16.5 million and $18.2 million,
respectively, under this facility. Borrowings under this facility bear interest
based on a specified margin over the London Interbank Offered Rate ("LIBOR"). At
December 31, 2000, the weighted average borrowing rate under this facility was
8.57%. This committed facility expires in August 2001.
In July 2000, Redwood Trust renewed for one year, a $30 million committed master
loan and security agreement with a Wall Street Firm. The facility is intended to
finance newly originated commercial mortgage loans. In September 2000, this
facility was increased to $50 million. Holdings may borrow under this facility
as a co-borrower. At December 31, 2000, Holdings had no outstanding borrowings
under this facility. Borrowings under
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this facility bear interest based on a specified margin over LIBOR. At December
31, 2000, the weighted average borrowing rate under this facility was 8.06%.
This committed facility expires in July 2001.
In July 1999, Redwood Trust entered into a one-year, $90 million committed
revolving mortgage warehousing credit facility with two banks. This facility
expired in February 2000. The facility was primarily intended to finance newly
originated residential mortgage loans. Holdings was a co-borrower under this
facility. At Redwood Trust's request, this line was reduced to $20 million in
December 1999. At December 31, 1999, Holdings had no outstanding borrowings
under this facility.
In July 1999, Redwood Trust entered into a one-year, $350 million committed
master loan and security agreement with a Wall Street firm. This facility
expired in June 2000. The facility was primarily intended to finance newly
originated commercial and residential mortgage loans. Holdings was a co-borrower
under this facility. At December 31, 1999, Holdings had outstanding borrowings
of $19.8 million under this facility. 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 7.23%.
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. During the years ended December 31, 2000, 1999 and
1998, Holdings paid Redwood Trust credit support fees of $98,000, $149,000 and
$139,000, respectively. At December 31, 2000 and 1999, Redwood Trust was
providing credit support on $18.2 million and $22.4 million, respectively, of
Holdings' Short-Term Debt. These expenses are reflected as "Credit support fees"
on the Consolidated Statements of Operations.
NOTE 5. RESTRUCTURING CHARGE
During the year ended December 31, 1999, Holdings recognized $8.4 million in
restructuring charges as a result of the closure of two of its subsidiaries, RRF
and RFS. Restructuring charges were determined in accordance with the provisions
of Staff Accounting Bulletin No. 100 "Restructuring and Impairment Charges",
Emerging Issues Task Force No. 94-3 "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity", and other relevant
accounting guidance. The restructuring accrual includes costs associated with
existing contractual and lease arrangements at both subsidiaries which have no
future value. In addition, as a result of the closure of the two subsidiaries,
certain assets utilized in these businesses were determined to have little or no
realizable value, resulting in impairment losses. These assets included software
developed for use at RRF and certain fixed assets at both subsidiaries. The
following table provides a summary of the primary components of the
restructuring liability.
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(IN THOUSANDS) 1999 ACTUAL 2000 ACTUAL DECEMBER 31, 2000
TOTAL ESTIMATED PAYMENTS/ PAYMENTS/ ACCRUED
LIABILITY/IMPAIRMENTS CHARGE-OFFS CHARGE-OFFS RESTRUCTURING
--------------------- ----------- ------------ -----------------
Payroll, severance, and termination benefits $3,511 $1,080 $2,431 $ --
Asset Impairments 2,858 2,858 -- --
Lease and other commitments 1,314 246 643 425
Other 740 200 535 5
------ ------ ------ ------
Total $8,423 4,384 3,609 $ 430
The Company expects to pay the remaining restructuring costs during the year
2001. The remaining liability for restructuring costs at December 31, 2000 and
1999 of $0.4 million and $4.0 million, respectively, is reflected as "Accrued
restructuring charges" on the Consolidated Balance Sheets.
NOTE 6. INCOME TAXES
The current provision for income taxes for the years ended December 31, 2000,
1999 and 1998 was $3,200 for both 2000 and 1999, and $2,400 for 1998. These
amounts represent the minimum California franchise taxes. No additional tax
provision has been recorded for the years ended December 31, 2000, 1999 and
1998, as Holdings reported a loss in each of these years, and due to the
uncertainty of realization of net operating losses, no deferred tax benefit has
been recorded. A valuation allowance has been provided to offset the deferred
tax assets related to net operating loss carryforwards and other future
temporary deductions at December 31, 2000 and 1999. At December 31, 2000 and
1999, the deferred tax assets and associated valuation allowances were
approximately $9.5 million and $8.9 million, respectively. At December 31, 2000
and 1999, Holdings had net operating loss carryforwards of approximately $24.6
million and $19.5 million for federal tax purposes, and $11 million and $9
million for state tax purposes. The federal loss carryforwards and a portion of
the state loss carryforwards expire between 2018 and 2020, while the largest
portion of the state loss carryforwards expire between 2003 and 2005.
NOTE 7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values of
Holdings' financial instruments at December 31, 2000 and 1999.
(IN THOUSANDS) DECEMBER 31, 2000 DECEMBER 31, 1999
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
-------------- ---------- -------------- ----------
Assets
Mortgage loans: held-for-sale
Residential $ -- $ -- $ 4,399 $ 4,415
Commercial $18,913 $19,004 $29,605 $29,876
Liabilities
Short-term debt $18,200 $18,200 $22,427 $22,427
Loans from Redwood Trust, Inc. $ -- $ -- $ 6,500 $ 6,500
The carrying amounts of all other balance sheet accounts as reflected in the
financial statements approximate fair value because of the short-term nature of
these accounts.
NOTE 8. STOCKHOLDERS' EQUITY
The authorized capital stock of Holdings consists of Series A Preferred Stock
("Preferred Stock") and Common Stock. Until January 1, 2001, Holdings was
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 was vested in the common stock.
Holdings issued a total of 5,940 shares of Preferred Stock to Redwood Trust. The
Preferred Stock entitled Redwood Trust to receive 99% of the aggregate amount of
any such dividends or distributions made by Holdings. The holders
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99
of the Common Stock were entitled to receive the remaining 1% of the aggregate
amount of such dividends or distributions. The Preferred Stock ranked senior to
the Common Stock as to the payment of dividends and liquidation rights. The
liquidation preference entitled the holders of the Preferred Stock to receive
$1,000 per share liquidation preference before any distribution was made on the
Common Stock. After the liquidation preference, the holders of Preferred Stock
were entitled to 99% of any remaining assets. At January 1, 2001, Redwood Trust
acquired the Common Stock of Holdings. For more information on this subsequent
event, see Note 11.
NOTE 9. RELATED PARTY TRANSACTIONS
PURCHASES AND SALES OF MORTGAGE LOANS
During the years ended December 31, 2000, and 1999, RCF purchased $58 million
and $50 million of commercial mortgage loans from Redwood Trust, respectively.
There were no such purchases during the year ended December 31, 1998. Pursuant
to Master Forward Commitment Agreements, RCF purchased the mortgage loans from
Redwood Trust at the same price for which Redwood Trust acquired the mortgage
loans. At December 31, 2000 and 1999, under the terms of Master Forward
Commitment Agreements, RCF had committed to purchase $34 million and $8 million
of commercial mortgage loans from Redwood Trust for settlement during the first
quarter of 2001 and 2000, respectively.
During the year ended December 31, 2000, RCF sold commercial mortgage loans
aggregating $18 million to Redwood Trust which were not subject to terms of the
Master Forward Commitment Agreements. All such commercial mortgage loans sold by
RCF to Redwood Trust are sold at the market price at the time of the sale.
During the year ended December 31, 2000, the gains recognized by Holdings on
such sales of RCF assets were $0.2 million and are recorded on the Holdings'
Statements of Operations under "net unrealized and realized market value gains
(losses)." No such sales were made by RCF to Redwood Trust during the years
ended December 31, 1999 and 1998.
During the years ended December 31, 2000 and 1999, RRF purchased $17 million and
$61 million of residential mortgage loans from Redwood Trust, respectively.
There were no such purchases during the year ended December 31, 1998. Pursuant
to Master Forward Commitment Agreements, RRF purchased the mortgage loans from
Redwood Trust at the same price for which Redwood Trust acquired the mortgage
loans. As RRF ceased operations in 1999, there were no remaining outstanding
commitments at December 31, 2000. At December 31, 1999, RRF had committed to
purchase $16 million of residential mortgage loans from Redwood Trust during the
first and second quarters of 2000, pursuant to the terms of Master Forward
Commitment Agreements.
During December 1999, Holdings purchased $390 million of residential mortgage
loans and subsequently sold a participation agreement on the mortgage loans to
Redwood Trust. Pursuant to the terms of the Mortgage Loan Participation Purchase
Agreement, Redwood Trust purchased a 99% interest in the mortgage loans, and
assumed all related risks of ownership. Holdings did not recognize any gain or
loss on this transaction. During March 2000, Redwood Trust sold the
participation agreement back to Holdings for proceeds of $381 million. Holdings
simultaneously sold $384 million of residential mortgage loans to Sequoia for
proceeds of $384 million.
OTHER
Under a revolving credit facility arrangement, Redwood Trust may loan funds to
Holdings to finance certain Mortgage Assets owned by Holdings. These loans are
typically unsecured and are repaid within six months. Such loans bear interest
at a rate of 3.50% over LIBOR. At December 31, 2000, Holdings had no such
borrowings from Redwood Trust. At December 31, 1999, Holdings had borrowed $6.5
million from Redwood Trust in accordance with the provisions of this
arrangement. During the years ended December 31, 2000, 1999 and 1998, Holdings
incurred $0.3 million, $1.1 million and $18,000, respectively, in interest on
loans from Redwood Trust.
Redwood Trust shares many of the operating expenses of Holdings, including
personnel and related expenses, subject to full reimbursement by Holdings.
During the years ended December 31, 2000, 1999 and 1998, Redwood Trust paid $0.2
million, $3.0 million and $2.3 million, respectively, of Holdings' operating
expenses which were subject to reimbursement by Holdings.
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100
Holdings may borrow under several of Redwood Trust's Short-Term Debt agreements
as a co-borrower (see Note 4). At December 31, 2000 and 1999, Holdings had
borrowings of $18.2 million and $22.4 million subject to these arrangements.
NOTE 10. COMMITMENTS AND CONTINGENCIES
At December 31, 2000, RCF is obligated under non-cancelable operating leases
with expiration dates through 2004. The total future minimum lease payments
under these non-cancelable leases is $580,185 and is expected to be paid as
follows: 2001 -- $345,715; 2002 -- $78,214; 2003 -- $80,499; 2004 - $75,757.
At December 31, 2000, RCF had entered into commitments to purchase $34 million
of commercial mortgage loans from Redwood Trust for settlement during the first
quarter of 2001.
At December 31, 2000, RCF had entered into commitments to provide for additional
loan fundings, subject to the borrowers meeting certain conditions, aggregating
$2.9 million.
NOTE 11. SUBSEQUENT EVENTS
On January 1, 2001, Redwood Trust acquired 100% of the voting common stock of
Holdings for $300,000 in cash consideration from two officers of Holdings.
Redwood Trust's Audit Committee determined the purchase price based on an
independent appraisal obtained by the Audit Committee and through negotiations
with the two officers, taking into account projected cost savings to Redwood
Trust from being able to consolidate Holdings into Redwood Trust's future
financial statements and other potential benefits to Redwood Trust and its
stockholders.
Following Redwood Trust's acquisition of the voting common stock of Holdings,
Redwood Trust transferred its preferred stock interest in exchange for
additional voting common stock in Holdings as part of the Holdings equity
recapitalization. As a result of these transactions, Redwood Trust owns 100% of
the voting common stock of Holdings and Holdings became a wholly-owned
subsidiary of Redwood Trust. Subsequently, Holdings has elected to become a
taxable REIT subsidiary of Redwood Trust.
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REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder of
RWT Holdings, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of RWT
Holdings, Inc.(the Company) at December 31, 2000 and 1999 and the results of its
operations and its cash flows for the years ended December 31, 2000 and 1999 and
for the period April 1, 1998 (inception) to December 31, 1998, in conformity
with accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audit. We conducted our audit of these statements in accordance with
auditing standards generally accepted in the United States of America which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
San Francisco, California
February 15, 2001
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102
REDWOOD TRUST, INC.
INDEX TO EXHIBIT
Exhibit
Number
- -------
3.3.2 Amended and Restated Bylaws, amended March 15, 2001
9.1 Voting Agreement, dated March 10, 2000
10.9.3 Custodian Agreement (U.S. Custody), dated December 1, 2000, between
the Registrant and Bankers Trust Company
10.13.2 Employment Agreement, dated March 23, 2001, between the Registrant
and Andrew I. Sirkis
10.13.3 Employment Agreement, dated April 20, 2000, between the Registrant
and Brett D. Nicholas
10.14.4 Amended and Restated Executive and Non-Employee director Stock
Option Plan, amended January 18, 2001
11.1 Computation of Earnings per Share
21 List of Subsidiaries
23 Consent of Accountants