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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________ .
COMMISSION FILE NUMBER: 1-13759
REDWOOD TRUST, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MARYLAND 68-0329422
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
591 REDWOOD HIGHWAY, SUITE 3100
MILL VALLEY, CALIFORNIA 94941
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(415) 389-7373
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the Registrant (1) has filed all documents
and reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the Registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of stock, as of the last practicable date.
Class B Preferred Stock ($.01 par value).................... 902,068 as of May 11, 2001
Common Stock ($.01 par value)............................... 8,923,509 as of May 11, 2001
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REDWOOD TRUST, INC
FORM 10-Q
INDEX
PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements -- Redwood Trust, Inc.
Consolidated Balance Sheets at March 31, 2001 and December
31, 2000.................................................. 3
Consolidated Statements of Operations for the three months
ended March 31, 2001 and March 31, 2000..................... 4
Consolidated Statements of Stockholders' Equity for the
three months ended March 31, 2001........................... 5
Consolidated Statements of Cash Flows for the three months
ended March 31, 2001 and March 31, 2000..................... 6
Notes to Consolidated Financial Statements.................. 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 24
Item 3. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 44
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 45
Item 2. Changes in Securities....................................... 45
Item 3. Defaults Upon Senior Securities............................. 45
Item 4. Submission of Matters to a Vote of Security Holders......... 45
Item 5. Other Information........................................... 45
Item 6. Exhibits and Reports on Form 8-K............................ 45
SIGNATURES........................................................... 46
2
3
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
MARCH 31, DECEMBER 31,
2001 2000
----------- ------------
(UNAUDITED)
Net Investment In Residential Credit Enhancement Interests:
Mortgage securities available-for-sale.................... $ 49,621 $ 48,495
Mortgage securities available-for-sale, pledged........... 51,228 32,269
---------- ----------
100,849 80,764
Residential Retained Loan Portfolio:
Mortgage loans held-for-investment........................ 1,067,295 1,124,339
Mortgage loans held-for-sale.............................. 372 531
Mortgage loans held-for-sale, pledged..................... 4,152 6,127
---------- ----------
1,071,819 1,130,997
Investment Portfolio:
Mortgage securities trading............................... 58,647 57,450
Mortgage securities trading, pledged...................... 926,575 702,162
Mortgage securities available-for-sale.................... 14,188 5,163
Mortgage securities available-for-sale, pledged........... 1,202 --
---------- ----------
1,000,612 764,775
Commercial Retained Loan Portfolio:
Mortgage loans held-for-investment........................ 24,059 5,177
Mortgage loans held-for-investment, pledged............... 13,275 17,717
Mortgage loans held-for-sale.............................. 782 14,325
Mortgage loans held-for-sale, pledged..................... 31,961 19,950
---------- ----------
70,077 57,169
Cash and cash equivalents................................... 14,477 15,483
Restricted cash............................................. 5,161 5,240
Interest rate agreements.................................... 77 66
Accrued interest receivable................................. 15,263 15,797
Principal receivable........................................ 5,437 7,986
Investment in RWT Holdings, Inc............................. -- 1,899
Other assets................................................ 2,137 1,939
---------- ----------
Total Assets....................................... $2,285,909 $2,082,115
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt............................................. $ 992,597 $ 756,222
Long-term debt, net......................................... 1,056,212 1,095,835
Accrued interest payable.................................... 4,743 5,657
Accrued expenses and other liabilities...................... 5,555 4,180
Dividends payable........................................... 5,129 4,557
---------- ----------
Total Liabilities.................................. 2,064,236 1,866,451
---------- ----------
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01 per share; Class B 9.74%
Cumulative Convertible 902,068 shares authorized, issued
and outstanding ($28,645 aggregate liquidation
preference)............................................... 26,517 26,517
Common stock, par value $0.01 per share; 49,097,932 shares
authorized; 8,896,838 and 8,809,500 issued and
outstanding............................................... 89 88
Additional paid-in capital.................................. 243,650 242,522
Accumulated other comprehensive income...................... 2,559 (89)
Cumulative earnings......................................... 34,435 27,074
Cumulative distributions to stockholders.................... (85,577) (80,448)
---------- ----------
Total Stockholders' Equity......................... 221,673 215,664
---------- ----------
Total Liabilities and Stockholders' Equity......... $2,285,909 $2,082,115
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
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4
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
------------------------
2001 2000
---------- ----------
Interest Income
Net Investment In Residential Credit Enhancement
Interests:
Mortgage securities available-for-sale.................. $ 2,642 $ 1,615
Residential Retained Loan Portfolio:
Mortgage loans held-for-investment...................... 19,742 17,218
Mortgage loans held-for-sale............................ 144 6,520
---------- ----------
19,886 23,738
Investment Portfolio:
Mortgage securities trading............................. 16,939 17,060
Mortgage securities available-for-sale.................. 109 --
---------- ----------
17,048 17,060
Commercial Retained Loan Portfolio:
Mortgage loans held-for-investment...................... 607 --
Mortgage loans held-for-sale............................ 1,326 211
---------- ----------
1,933 211
Cash and cash equivalents................................. 312 314
---------- ----------
Total interest income..................................... 41,821 42,938
Interest Expense
Short-term debt........................................... (13,444) (19,164)
Long-term debt............................................ (17,838) (15,359)
---------- ----------
Total interest expense.................................... (31,282) (34,523)
Net interest rate agreements expense...................... (131) (408)
Provision for credit losses on residential mortgage loans
held-for-investment..................................... (184) (119)
---------- ----------
Net Interest Income After Provision For Credit Losses..... 10,224 7,888
Net unrealized and realized market value gains (losses)
Loans and securities.................................... 3,132 (1,077)
Interest rate agreements................................ (491) (147)
---------- ----------
Total net unrealized and realized market value gains
(losses)............................................... 2,641 (1,224)
Operating expenses........................................ (3,136) (2,147)
Other income.............................................. -- 15
Equity in losses of RWT Holdings, Inc..................... -- (568)
---------- ----------
Net income before preferred dividend and change in
accounting principle.................................... 9,729 3,964
Less dividends on Class B preferred stock................. (681) (681)
---------- ----------
Net income before change in accounting principle.......... 9,048 3,283
Cumulative effect of adopting EITF 99-20 (See Note 2)..... (2,368) --
---------- ----------
Net Income Available to Common Stockholders............... $ 6,680 $ 3,283
========== ==========
Earnings per Share:
Basic Earnings Per Share:
Net income before change in accounting principle........ $ 1.02 $ 0.37
Cumulative effect of adopting EITF 99-20................ $ (0.26) $ --
Net income.............................................. $ 0.76 $ 0.37
Diluted Earnings Per Share:
Net income before change in accounting principle........ $ 1.00 $ 0.37
Cumulative effect of adopting EITF 99-20................ $ (0.26) $ --
Net income.............................................. $ 0.74 $ 0.37
Weighted average shares of common stock and common stock
equivalents:
Basic..................................................... 8,838,964 8,785,017
Diluted................................................... 9,065,221 8,844,606
The accompanying notes are an integral part of these consolidated financial
statements.
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REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
CLASS B ACCUMULATED
PREFERRED STOCK COMMON STOCK ADDITIONAL OTHER
---------------- ------------------ PAID-IN COMPREHENSIVE CUMULATIVE
SHARES AMOUNT SHARES AMOUNT CAPITAL INCOME EARNINGS
------- ------ --------- ------ ---------- ------------- ----------
Balance, December 31, 2000...... 902,068 26,517 8,809,500 88 242,522 (89) 27,074
------- ------ --------- -- ------- ----- ------
Comprehensive income:
Net income before preferred
dividend.................... 7,361
Reclassification adjustment
due to adoption of EITF
99-20....................... -- -- -- -- -- 2,368 --
Net unrealized loss on assets
available-for-sale.......... -- -- -- -- -- 280 --
Total comprehensive income.... -- -- -- -- -- -- --
Issuance of common stock........ -- -- 87,338 1 1,128 -- --
Dividends declared:
Preferred..................... -- -- -- -- -- -- --
Common........................ -- -- -- -- -- -- --
------- ------ --------- -- ------- ----- ------
Balance, March 31, 2001......... 902,068 26,517 8,896,838 89 243,650 2,559 34,435
======= ====== ========= == ======= ===== ======
CUMULATIVE
DISTRIBUTIONS TO
STOCKHOLDERS TOTAL
---------------- -------
Balance, December 31, 2000...... (80,448) 215,664
------- -------
Comprehensive income:
Net income before preferred
dividend.................... 7,361
Reclassification adjustment
due to adoption of EITF
99-20....................... -- 2,368
Net unrealized loss on assets
available-for-sale.......... -- 280
-------
Total comprehensive income.... -- 10,009
Issuance of common stock........ -- 1,129
Dividends declared:
Preferred..................... (681) (681)
Common........................ (4,448) (4,448)
------- -------
Balance, March 31, 2001......... (85,577) 221,673
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
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REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------
2001 2000
--------- ---------
Cash Flows From Operating Activities:
Net income available to common stockholders before
preferred dividend...................................... $ 7,361 $ 3,964
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Depreciation and amortization........................... 1,291 1,131
Provision for credit losses............................. 184 119
Non-cash stock compensation............................. 143 --
Equity in losses of RWT Holdings, Inc. ................. -- 568
Net unrealized and realized market value (gains)
losses................................................. (2,641) 1,224
Cumulative effect of adopting EITF 99-20................ 2,368 --
Purchases of mortgage loans held-for-sale............... -- (25,734)
Proceeds from sales of mortgage loans held-for-sale..... 238 405,616
Principal payments on mortgage loans held-for-sale...... 1,934 14,287
Purchases of mortgage securities trading................ (296,907) (165,264)
Proceeds from sales of mortgage securities trading...... 7,963 49,372
Principal payments on mortgage securities trading....... 65,726 56,789
Net (purchases) sales of interest rate agreements....... (658) 117
Decrease (increase) in accrued interest receivable...... 534 (1,676)
Decrease (increase) in principal receivable............. 2,549 (838)
Decrease (increase) in other assets..................... 913 (1,896)
(Decrease) increase in accrued interest payable......... (914) 253
Increase (decrease) in accrued expenses and other
liabilities............................................ 1,375 451
--------- ---------
Net cash (used in) provided by operating
activities......................................... (208,542) 338,483
--------- ---------
Cash Flows From Investing Activities:
Net assets acquired in purchase of RWT Holdings, Inc.
common stock............................................ (19) --
Purchases of mortgage loans held-for-investment........... -- (384,328)
Proceeds from sales of mortgage loans
held-for-investment..................................... 1,660 --
Principal payments on mortgage loans
held-for-investment..................................... 60,779 35,876
Purchases of mortgage securities available-for-sale....... (33,814) (9,151)
Proceeds from sales of mortgage securities
available-for-sale...................................... 3,034 --
Principal payments on mortgage securities
available-for-sale...................................... 1,022 306
Net decrease in restricted cash........................... 79 2,939
Loans to RWT Holdings, Inc., net of repayments............ -- 5,100
Increase in receivable from RWT Holdings, Inc............. -- (101)
--------- ---------
Net cash provided by (used in) investing
activities......................................... 32,741 (349,359)
--------- ---------
Cash Flows From Financing Activities:
Net borrowings (repayments) on short-term debt............ 218,175 (331,160)
Proceeds from issuance of long-term debt.................. 16,948 375,844
Repayments on long-term debt.............................. (56,756) (38,318)
Net proceeds from issuance of common stock................ 986 45
Dividends paid............................................ (4,557) (2,877)
--------- ---------
Net cash provided by financing activities.......... 174,795 3,534
--------- ---------
Net decrease in cash and cash equivalents................... (1,006) (7,342)
Cash and cash equivalents at beginning of period............ 15,483 19,881
--------- ---------
Cash and cash equivalents at end of period.................. $ 14,477 $ 12,539
========= =========
Supplemental disclosure of cash flow information:
Cash paid for interest.................................... $ 32,330 $ 34,270
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
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REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
NOTE 1. THE COMPANY
Redwood Trust, Inc. ("Redwood Trust") was incorporated in Maryland on April
11, 1994 and commenced operations on August 19, 1994. During 1997, Redwood Trust
formed Sequoia Mortgage Funding Corporation ("Sequoia"), a special-purpose
finance subsidiary. Redwood Trust acquired an equity interest in RWT Holdings,
Inc. ("Holdings"), a taxable affiliate of Redwood Trust, during the first
quarter of 1998. On January 1, 2001, Redwood Trust acquired 100% of the voting
common stock of Holdings and exchanged its preferred stock interest for
additional voting common stock in Holdings. As a result of this transaction,
Redwood Trust owns 100% of the voting common stock of Holdings and Holdings
became a wholly-owned subsidiary of Redwood Trust on January 1, 2001.
Subsequently, Holdings elected to become a taxable REIT subsidiary of Redwood
Trust. For financial reporting purposes, references to the "Company" mean
Redwood Trust, Sequoia, and Holdings.
Redwood Trust, together with its affiliates, is a real estate finance
company specializing in owning, financing, and credit enhancing high-quality
jumbo residential mortgage loans nationwide. Redwood Trust also finances real
estate through its investment portfolio (mortgage securities) and its commercial
loan portfolio. Redwood Trust's primary source of revenue is monthly payments
made by homeowners on their mortgages, and its primary expense is the cost of
borrowed funds. As Redwood Trust is structured as a Real Estate Investment Trust
("REIT"), the majority of net earnings are distributed to shareholders as
dividends.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements as of March 31, 2001 and
2000 are unaudited. The unaudited interim consolidated financial statements have
been prepared on the same basis as the annual consolidated financial statements
and, in the opinion of management, reflect all adjustments, which include only
normal recurring adjustments, necessary to present fairly the Company's
financial position, results of operations and cashflows as of March 31, 2001 and
2000. These consolidated financial statements and notes thereto, are unaudited
and should be read in conjunction with the Company's audited financial
statements included in the Company's Form 10-K for the year ended December 31,
2000. The results for the three months ended March 31, 2001 are not necessarily
indicative of the expected results for the year ended December 31, 2001.
The March 31, 2001 consolidated financial statements include the accounts
of Redwood Trust, Sequoia and Holdings. The December 31, 2000 consolidated
financial statements include the accounts of Redwood Trust and Sequoia, and
Redwood Trust's equity interest in Holdings. Substantially all of the assets of
Sequoia, consisting primarily of residential whole loans shown as part of the
Residential Retained Loan Portfolio, are subordinated to support long-term debt
in the form of collateralized mortgage bonds ("Long-Term Debt") and are not
available for the satisfaction of general claims of the Company. The Company's
exposure to loss on the assets which are collateral for Long-Term Debt is
limited to its net equity investment in Sequoia, as the Long-Term Debt is
non-recourse to the Company. All significant intercompany balances and
transactions with Sequoia and Holdings have been eliminated in the consolidation
of the Company at March 31, 2001. Certain amounts for prior periods have been
reclassified to conform to the March 31, 2001 presentation.
During March 1998, the Company acquired an equity interest in Holdings.
Prior to January 1, 2001, the Company owned all of the preferred stock and had a
non-voting, 99% economic interest in Holdings. The Company accounted for its
investment in Holdings under the equity method. Under this method, original
equity investments in Holdings were recorded at cost and adjusted by the
Company's share of earnings or losses and decreased by dividends received. On
January 1, 2001, the Company acquired 100% of the voting
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REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
common stock of Holdings for $300,000 in cash consideration from two officers of
Holdings, and Holdings became a wholly-owned consolidated subsidiary of the
Company. This transaction did not have a material effect on the consolidated
financial statements of the Company.
USE OF ESTIMATES
The preparation of financial statements in conformity with Generally
Accepted Accounting Principles requires management to make estimates and
assumptions that affect the reported amounts of certain assets and liabilities
and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of certain revenues and expenses during the
reported period. Actual results could differ from those estimates. The primary
estimates inherent in the accompanying consolidated financial statements are
discussed below.
Fair Value. Management estimates the fair value of its financial
instruments using available market information and other appropriate valuation
methodologies. The fair value of a financial instrument, as defined by Statement
of Financial Accounting Standards ("SFAS") No. 107, Disclosures about Fair Value
of Financial Instruments, is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation sale. Management's estimates are inherently subjective in
nature and involve matters of uncertainty and judgement to interpret relevant
market and other data. Accordingly, amounts realized in actual sales may differ
from the fair values presented in Notes 3, 7 and 10.
Reserve for Credit Losses. A reserve for credit losses for the residential
retained loan portfolio is maintained at a level deemed appropriate by
management to provide for known losses, as well as potential losses inherent in
these mortgage loans. The reserve is based upon management's assessment of
various factors affecting its residential mortgage loans, including current and
projected economic conditions, delinquency status, and credit protection. These
estimates are reviewed periodically and, as adjustments become necessary, they
are reported in earnings in the periods in which they become known. The reserve
is increased by provisions, which are charged to income from operations. When a
loan or portions of a loan are determined to be uncollectible, the portion
deemed uncollectible is charged against the reserve and subsequent recoveries,
if any, are credited to the reserve. The Company's actual credit losses may
differ from those estimates used to establish the reserve. Reserves may also be
established if and when deemed necessary for the commercial retained loan
portfolio. Summary information regarding the Reserve for Credit Losses is
presented in Note 4.
Individual mortgage loans are considered impaired when, based on current
information and events, it is probable that a creditor will be unable to collect
all amounts due according to the contractual terms of the loan agreement. When a
loan is impaired, impairment is measured based upon the present value of the
expected future cash flows discounted at the loan's effective interest rate, the
loan's observable market price, or the fair value of the underlying collateral.
At March 31, 2001 and December 31, 2000, there were no impaired mortgage loans.
ADOPTION OF SFAS NO. 133
The Company adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, effective July 1, 1998 and has elected to not seek hedge
accounting for any of it's interest rate agreements.
ADOPTION OF EITF 99-20
During 1999, the Emerging Issues Task Force ("EITF") issued EITF 99-20,
Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets.
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REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
EITF 99-20 establishes new income and impairment recognition standards for
interests in certain securitized assets. Under the provisions of EITF 99-20, the
holder of beneficial interests should recognize the excess of all estimated cash
flows attributable to the beneficial interest estimated at the acquisition date
over the initial investment (the accretable yield) as interest income over the
life of the beneficial interest using the effective yield method. If the
estimated cash flows change, then the holder of the beneficial interest should
recalculate the accretable yield and adjust the periodic accretion recognized as
income prospectively. If the fair value of a beneficial interest has declined
below its carrying amount, an other-than-temporary decline is considered to
exist if there has been a decline in estimated future cash flows and the
difference between the carrying value and fair value of the beneficial interest
is recorded as an impairment loss through the income statement.
The Company adopted the provisions of EITF 99-20 effective January 1, 2001.
At that date, the Company held certain beneficial interests in which the fair
value had declined below their carrying value and current projections of cash
flows were less than cash flows anticipated at acquisition. Accordingly, the
Company recorded a $2.4 million charge through the Statement of Operations as a
cumulative effect of a change in accounting principle for certain mark-to-market
adjustments on these beneficial interests that had previously been recorded as
unrealized losses through Accumulative Other Comprehensive Income as a component
of Stockholders' Equity. Since this was a reclassification of declines in market
values that had already been recognized in the Company's balance sheet and
stockholders' equity accounts, there was no change in book value upon adoption.
Any subsequent income 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."
MORTGAGE ASSETS
The Company's mortgage assets consist of mortgage loans and mortgage
securities ("Mortgage Assets"). Mortgage loans and securities pledged as
collateral under borrowing arrangements in which the secured party has the right
by contract or custom to sell or repledge the collateral have been classified as
"pledged" in the accompanying Consolidated Balance Sheets. Interest is
recognized as revenue when earned according to the terms of the loans and
securities and when, in the opinion of management, it is collectible. Discounts
and premiums relating to Mortgage Assets are amortized into interest income over
the lives of the Mortgage Assets using the effective yield method. Gains or
losses on the sale of Mortgage Assets are based on the specific identification
method.
Mortgage Loans: Held-for-Investment
Mortgage loans classified as held-for-investment are carried at their
unpaid principal balance, adjusted for net unamortized premiums or discounts,
and net of the related allowance for credit losses. All of the Sequoia assets
that are pledged or subordinated to support the Long-Term Debt are classified as
held-for-investment. Commercial loans that the Company has secured financing
through the term of the loan or otherwise has the intent and the ability to hold
to maturity, are classified as held-for-investment.
Mortgage Loans: Held-for-Sale
Mortgage loans held-for-sale (residential and commercial) are carried at
the lower of original cost or aggregate market value ("LOCOM"). Realized and
unrealized gains and losses on these loans are recognized in "Net unrealized and
realized market value gains (losses)" on the Consolidated Statements of
Operations. Real estate owned ("REO") assets of the Company are also presented
as "Mortgage loans held-for-sale."
Some of the commercial mortgage loans held by the Company are committed for
sale by the Company to Holdings, or a subsidiary of Holdings, under Master
Forward Commitment Agreements at December 31,
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REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
2000. As forward commitment agreements were entered into on the same date that
the Company committed to purchase the loans, the price under the forward
commitment is the same as the price that the Company paid for the mortgage
loans, as established by the external market. Fair value is therefore equal to
the commitment price, which is the carrying value of the mortgage loans.
Accordingly, no gain or loss is recognized on the subsequent sales of these
mortgage loans to Holdings or subsidiaries of Holdings.
Mortgage Securities: Trading
Mortgage securities classified as trading are accounted for in accordance
with SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities. Accordingly, such securities are recorded at their estimated fair
market value. Unrealized and realized gains and losses on these securities are
recognized as a component of "Net unrealized and realized market value gains
(losses)" on the Consolidated Statements of Operations.
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. Under the provisions of
EITF 99-20, other-than-temporary unrealized losses are based on various factors
affecting the expected cash flow from the mortgage securities, including an
other-than-temporary deterioration of the credit quality of the underlying
mortgages and/or the credit protection available to the related mortgage pool or
an other-than-temporary change in the prepayment characteristics of the
underlying collateral.
Interest income on mortgage securities available-for-sale is calculated
using the effective yield method based on projected cash flows over the life of
the security. Yields on each security vary as a function of credit results,
prepayment rates, and interest rates, and may also vary depending on the mix of
first, second and third loss positions the Company holds. As the Company
purchases these securities, a portion of the discount for each security is
designated as a credit reserve, with the remaining portion of the discount
designated to be amortized into income over the life of the security using the
effective yield method. If future credit losses exceed the Company's original
expectations, the Company may take a charge to write down the basis in the
security. If future credit losses are less than the Company's original estimate,
the yield over the remaining life of the security may be adjusted.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid
investments with original maturities of three months or less.
RESTRICTED CASH
Restricted cash of the Company includes principal and interest payments on
mortgage loans held as collateral for the Company's Long-Term Debt, cash pledged
as collateral on certain interest rate agreements, and cash held back from
borrowers until certain loan agreement requirements have been met. The
corresponding liability for cash held back from borrowers is reflected as a
component of "Accrued expenses and other liabilities" on the Consolidated
Balance Sheets.
10
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REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
INTEREST RATE AGREEMENTS
The Company maintains an overall interest-rate risk-management strategy
that may incorporate the use of derivative interest rate agreements for a
variety of reasons, including minimizing significant fluctuations in earnings
that may be caused by interest-rate volatility. Interest rate agreements the
Company may use as part of its interest-rate risk management strategy include
interest rate options, swaps, options on swaps, futures contracts, options on
futures contracts, forward sales of fixed-rate Agency mortgage securities
("MBS"), and options on forward purchases or sales of MBS (collectively
"Interest Rate Agreements"). On the date an Interest Rate Agreement is entered
into, the Company designates the interest rate agreement as (1) a hedge of the
fair value of a recognized asset or liability or of an unrecognized firm
commitment ("fair value" hedge), (2) a hedge of a forecasted transaction or of
the variability of cash flows to be received or paid related to a recognized
asset or liability ("cash flow" hedge), or (3) held for trading ("trading"
instruments). Since the Company's adoption of SFAS No. 133 in 1998, the Company
has elected not to seek hedge accounting for its Interest Rate Agreements.
Accordingly, such instruments are recorded at their estimated fair market value
with changes in their fair value reported in current-period earnings in "Net
unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
Net premiums on interest rate options are amortized as a component of net
interest income over the effective period of the interest rate option using the
effective interest method. The income and/or expense related to interest rate
options and swaps are recognized on an accrual basis.
DEBT
Short-Term Debt and Long-Term Debt are carried at their unpaid principal
balances, net of any unamortized discount or premium and any unamortized
deferred bond issuance costs. The amortization of any discount or premium is
recognized as an adjustment to interest expense using the effective interest
method based on the maturity schedule of the related borrowings. Bond issuance
costs incurred in connection with the issuance of Long-Term Debt are deferred
and amortized over the estimated lives of the Long-Term Debt using the interest
method adjusted for the effects of prepayments.
INCOME TAXES
The Company has elected to be taxed as a Real Estate Investment Trust
("REIT") under the Internal Revenue Code (the "Code") and the corresponding
provisions of State law. In order to qualify as a REIT, the Company must
annually distribute at least 90% of its taxable income to stockholders and meet
certain other requirements. If these requirements are met, the Company generally
will not be subject to Federal or State income taxation at the corporate level
with respect to the taxable income it distributes to its stockholders. Because
the Company believes it meets the REIT requirements and also intends to
distribute all of its taxable income, no provision has been made for income
taxes in the accompanying consolidated financial statements.
Under the Code, a dividend declared by a REIT in October, November or
December of a calendar year and payable to shareholders of record as of a
specified date in such year, will be deemed to have been paid by the Company and
received by the shareholders on the last day of that calendar year, provided the
dividend is actually paid before February 1st of the following calendar year,
and provided that the REIT has any remaining undistributed taxable income on the
record date. Therefore, the dividends declared in the fourth quarter 2000, which
were paid in January 2001, are considered taxable income to stockholders in
2000, the year declared. All 2000 dividends were ordinary income to the
Company's preferred and common stockholders.
11
12
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
Taxable earnings of Holdings are subject to state and federal income taxes
at the applicable statutory rates. Holdings provides for deferred income taxes
if any, to reflect the estimated future tax effects under the provisions of SFAS
No. 109, Accounting for Income Taxes. Under this pronouncement, deferred income
taxes, if any, reflect the estimated future tax effects of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and such amounts as measured by tax laws and regulations.
NET INCOME PER SHARE
Basic net income per share is computed by dividing net income available to
common stockholders by the weighted average number of common shares outstanding
during the period. Diluted net income per share is computed by dividing the net
income available to common stockholders by the weighted average number of common
shares and common equivalent shares outstanding during the period. The common
equivalent shares are calculated using the treasury stock method, which assumes
that all dilutive common stock equivalents are exercised and the funds generated
by the exercise are used to buy back outstanding common stock at the average
market price during the reporting period.
The following tables provide reconciliations of the numerators and
denominators of the basic and diluted net income per share computations.
THREE MONTHS ENDED
MARCH 31,
------------------------
2001 2000
---------- ----------
(IN THOUSANDS,
EXCEPT SHARE DATA)
NUMERATOR:
Numerator for basic and diluted earnings per share --
Net income before preferred dividend and change in
accounting principle................................... $ 9,729 $ 3,964
Cash dividends on Class B preferred stock................. (681) (681)
---------- ----------
Net income before change in accounting principle.......... 9,048 3,283
Cumulative effect of adopting EITF 99-20.................. (2,368) --
---------- ----------
Basic and Diluted EPS -- Net income available to common
stockholders........................................... $ 6,680 $ 3,283
========== ==========
DENOMINATOR:
Denominator for basic earnings per share
Weighted average number of common shares outstanding
during the period...................................... 8,838,964 8,785,017
Net effect of dilutive stock options...................... 226,257 59,589
---------- ----------
Denominator for diluted earnings per share.................. 9,065,221 8,844,606
========== ==========
BASIC EARNINGS PER SHARE:
Net income before change in accounting principle............ $ 1.02 $ 0.37
Cumulative effect of adopting EITF 99-20.................... (0.26) --
---------- ----------
Net income per share........................................ $ 0.76 $ 0.37
========== ==========
DILUTED EARNINGS PER SHARE:
Net income before change in accounting principle............ $ 1.00 $ 0.37
Cumulative effect of adopting EITF 99-20.................... (0.26) --
---------- ----------
Net income per share........................................ $ 0.74 $ 0.37
========== ==========
At March 31, 2001, the number of common equivalent shares issued by the
Company that were anti-dilutive totaled 743,143 and were not included in the
calculation of diluted earnings per share.
12
13
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
COMPREHENSIVE INCOME
Current period unrealized gains and losses on assets available-for-sale are
reported as a component of Comprehensive Income on the Consolidated Statements
of Stockholders' Equity with cumulative unrealized gains and losses classified
as Accumulated Other Comprehensive Income in Stockholders' Equity. At March 31,
2001 and December 31, 2000, the only component of Accumulated Other
Comprehensive Income was net unrealized gains and losses on assets
available-for-sale.
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
Extinguishments of Liabilities. FAS No. 140 replaces FAS No. 125, revises the
standards for accounting for securitizations and other transfers of financial
assets, and requires certain new disclosures, while carrying over most of FAS
No. 125's provisions. FAS No. 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.
NOTE 3. MORTGAGE ASSETS
At March 31, 2001 and December 31, 2000, investments in Mortgage Assets
consisted of interests in adjustable-rate, hybrid or fixed-rate mortgage loans
on residential and commercial properties. The hybrid mortgages have an initial
fixed coupon rate for three to ten years followed by annual adjustments. The
original maturity of the majority of the Mortgage Assets is thirty years; the
actual maturity is subject to change based on the prepayments of the underlying
mortgage loans.
At March 31, 2001 and December 31, 2000, the annualized effective yield
after taking into account the amortization expense due to prepayments on the
Mortgage Assets was 7.42% and 8.01%, respectively, based on the reported cost of
the assets. At March 31, 2001, 80% of the Mortgage Assets owned by the Company
were adjustable-rate mortgages, 14% were hybrid mortgages, and 6% were
fixed-rate mortgages. At December 31, 2000, 79% of the Mortgage Assets owned by
the Company were adjustable-rate mortgages, 17% were hybrid mortgages, and 4%
were fixed-rate mortgages. At March 31, 2001 and December 31, 2000, the coupons
on 61% and 59% of the adjustable-rate Mortgage Assets were limited by periodic
caps (generally interest rate adjustments are limited to no more than 1% every
six months or 2% every year), respectively. The majority of the coupons on the
adjustable-rate and hybrid Mortgage Assets owned by the Company are limited by
lifetime caps. At March 31, 2001 and December 31, 2000, the weighted average
lifetime cap on the adjustable-rate Mortgage Assets was 11.64% and 11.43%,
respectively.
13
14
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
At March 31, 2001 and December 31, 2000, Mortgage Assets consisted of the
following:
NET INVESTMENT IN RESIDENTIAL CREDIT ENHANCEMENT INTERESTS
MARCH 31, 2001 DECEMBER 31, 2000
MORTGAGE SECURITIES MORTGAGE SECURITIES
AVAILABLE-FOR-SALE AVAILABLE-FOR-SALE
------------------- -------------------
(IN THOUSANDS)
Current Face.............................................. $155,233 $124,878
Unamortized Discount...................................... (21,137) (16,883)
Portion Of Discount Designated As A Credit Reserve........ (35,722) (27,052)
-------- --------
Amortized Cost............................................ 98,374 80,943
Gross Unrealized Gains.................................... 3,416 2,646
Gross Unrealized Losses................................... (941) (2,825)
-------- --------
Carrying Value............................................ $100,849 $ 80,764
======== ========
As the Company purchases residential credit enhancement interests, a
portion of the discount for each security is designated as a credit reserve,
with the remaining portion of the discount designated to be amortized into
income over the life of the security using the effective yield method. If future
credit losses exceed the Company's original expectations, the Company may take a
charge to write down the basis in the security. If future credit losses are less
than the Company's original estimate, the yield over the remaining life of the
security may be adjusted. At March 31, 2001 and December 31, 2000, the Company
designated $35.7 million and $27.1 million as a credit reserve on its
residential credit enhancement interests, respectively.
The Company adopted the provisions of EITF 99-20 on January 1, 2001, and
recorded a $2.4 million charge through the Statement of Operations as a
cumulative effect of a change in accounting principle for certain mark-to-market
adjustments that had previously been recorded as unrealized losses through
Accumulative Other Comprehensive Income as a component of Stockholders' Equity.
Since this was a reclassification of declines in market values that had
previously been recognized in the Company's balance sheet and stockholders'
equity accounts, there was no change in book value upon adoption. Any subsequent
income statement adjustments under the provisions of EITF 99-20 will be
recognized as mark-to-market adjustments under "Realized and unrealized gain or
loss on assets." The gains and losses on the sales of mortgage securities
available-for-sale are reflected as a component of "Net unrealized and realized
market value gains (losses)" on the Consolidated Statements of Operations.
RESIDENTIAL RETAINED LOAN PORTFOLIO
MARCH 31, 2001 DECEMBER 31, 2000
----------------------------------- -----------------------------------
HELD-FOR- HELD-FOR- HELD-FOR- HELD-FOR-
SALE INVESTMENT TOTAL SALE INVESTMENT TOTAL
--------- ---------- ---------- --------- ---------- ----------
(IN THOUSANDS)
Current Face................... $4,609 $1,059,024 $1,063,633 $6,784 $1,115,386 $1,122,170
Unamortized Discount........... (85) -- (85) (126) -- (126)
Unamortized Premium............ -- 13,239 13,239 -- 13,767 13,767
------ ---------- ---------- ------ ---------- ----------
Amortized Cost................. 4,524 1,072,263 1,076,787 6,658 1,129,153 1,135,811
Reserve for Credit Losses...... -- (4,968) (4,968) -- (4,814) (4,814)
------ ---------- ---------- ------ ---------- ----------
Carrying Value................. $4,524 $1,067,295 $1,071,819 $6,658 $1,124,339 $1,130,997
====== ========== ========== ====== ========== ==========
The Company recognized losses of $0.1 million during the three months ended
March 31, 2000 as a result of LOCOM adjustments on residential mortgage loans
held-for-sale. No such losses were recorded during the
14
15
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
three months ended March 31, 2001. During the three months ended March 31, 2000,
the Company sold to Holdings residential mortgage loans held-for-sale for
proceeds of $380.5 million, resulting in no net gain or loss. These assets were
subsequently transferred to Sequoia during the three months ended March 31,
2000, and are classified as part of Mortgage Loans Held-For-Investment and are
Bond Collateral for Long-Term Debt (see Note 8).
INVESTMENT PORTFOLIO
MARCH 31, 2001 DECEMBER 31, 2000
-------------------------------------------- ------------------------------------------
MORTGAGE MORTGAGE MORTGAGE MORTGAGE
SECURITIES SECURITIES SECURITIES SECURITIES
TRADING AVAILABLE-FOR-SALE TOTAL TRADING AVAILABLE-FOR-SALE TOTAL
---------- ------------------ ---------- ---------- ------------------ --------
(IN THOUSANDS)
Current Face............ $974,430 $13,040 $ 987,470 $751,449 $5,500 $756,949
Unamortized Discount.... (165) (314) (479) (388) (427) (815)
Unamortized Premium..... 10,957 2,580 13,537 8,551 -- 8,551
-------- ------- ---------- -------- ------ --------
Unamortized Cost........ 985,222 15,306 1,000,528 759,612 5,073 764,685
Gross Unrealized
Gains................. -- 91 91 -- 105 105
Gross Unrealized
Losses................ -- (7) (7) -- (15) (15)
-------- ------- ---------- -------- ------ --------
Carrying Value.......... $985,222 $15,390 $1,000,612 $759,612 $5,163 $764,775
======== ======= ========== ======== ====== ========
Agency.................. $488,735 -- $ 488,735 $521,204 -- $521,204
Non-Agency.............. 496,487 15,390 511,877 238,408 5,163 243,571
-------- ------- ---------- -------- ------ --------
Carrying Value.......... $985,222 $15,390 $1,000,612 $759,612 $5,163 $764,775
======== ======= ========== ======== ====== ========
For the three months ended March 31, 2001 and 2000, the Company recognized
a market value gain of $0.7 million and a market value loss of $0.9 million on
mortgage securities classified as trading, respectively. During the three months
ended March 31, 2001 and 2000, the Company sold mortgage securities classified
as trading for proceeds of $8.0 million and $49.0 million, respectively. During
the three months ended March 31, 2001, the Company sold mortgage securities
classified as available-for-sale for proceeds of $3.0 million, resulting in a
net gain of $0.1 million. No such sales were made during the first quarter of
2000. The market value adjustments are reflected as a component of "Net
unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
COMMERCIAL RETAINED LOAN PORTFOLIO
MARCH 31, 2001 DECEMBER 31, 2000
-------------------------------- ---------------------------------
HELD-FOR- HELD-FOR- HELD-FOR- HELD-FOR-
SALE INVESTMENT TOTAL SALE INVESTMENT TOTAL
--------- ---------- ------- ---------- ---------- -------
(IN THOUSANDS)
Current Face........................... $33,557 $37,694 $71,251 $34,275 $23,425 $57,700
Unamortized Discount................... (814) (360) (1,174) -- (531) (531)
------- ------- ------- ------- ------- -------
Carrying Value......................... $32,743 $37,334 $70,077 $34,275 $22,894 $57,169
======= ======= ======= ======= ======= =======
The Company sold a commercial mortgage loan for sales proceeds of $1.7
million during the three months ending March 31, 2001, resulting in no net gain
or loss on the sale. No such sales occurred during the three months ended March
31, 2000.
During the three months ended March 31, 2000, Redwood Trust sold commercial
mortgage loans to Redwood Commercial Funding ("RCF"), a subsidiary of Holdings,
for proceeds of $8.4 million. Pursuant to
15
16
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
Master Forward Commitment Agreements, all commercial mortgage loans purchased by
Redwood Trust were sold to RCF at the same price for which the Redwood Trust
acquires the commercial mortgage loans (see Note 12). While Master Forward Sales
Agreements are still in place, such activity is not reflected in the March 31,
2001 consolidated financial statements. Accordingly, there were no LOCOM
adjustments or gains on sales related to commercial mortgage loans sold to RCF
during the three months ended March 31, 2001 and 2000.
NOTE 4. RESERVE FOR CREDIT LOSSES
The Reserve for Credit Losses on Residential Mortgage Loans
Held-For-Investment is reflected as a component of Mortgage Assets on the
Consolidated Balance Sheets. The following table summarizes the Reserve for
Credit Losses on Residential Mortgage Loans Held-For-Investment activity:
THREE MONTHS ENDED
MARCH 31,
------------------
2001 2000
------- -------
(IN THOUSANDS)
Balance at beginning of period............................. $4,814 $4,125
Provision for credit losses................................ 184 119
Charge-offs................................................ (30) --
------ ------
Balance at end of period................................... $4,968 $4,244
====== ======
There is no reserve for credit losses at March 31, 2001 or December 31,
2000 for the commercial retained mortgage loan held-for-investment portfolio.
NOTE 5. COLLATERAL FOR LONG-TERM DEBT
The Company has collateral as security for Long-Term Debt issued in the
form of collateralized mortgage bonds ("Bond Collateral") and certain commercial
mortgage loans held-for-investment. The Bond Collateral consists primarily of
adjustable-rate and hybrid, conventional, 30-year mortgage loans secured by
first liens on one- to four-family residential properties. All Bond Collateral
is pledged to secure repayment of the related Long-Term Debt obligation. All
principal and interest (less servicing and related fees) on the Bond Collateral
is remitted to a trustee and is available for payment on the Long-Term Debt
obligation. The Company's exposure to loss on the Bond Collateral and certain
commercial mortgage loans is limited to its net investment, as the Long-Term
Debt is non-recourse to the Company.
16
17
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
The components of the collateral for the Company's long-term debt are
summarized as follows:
MARCH 31, DECEMBER 31,
2001 2000
---------- ------------
(IN THOUSANDS)
Residential Mortgage Loans:
Residential Retained Loan Portfolio
Held-For-Sale................................... $ 155 $ 315
Residential Retained Loan Portfolio
Held-For-Investment............................. 1,067,295 1,124,339
Restricted cash...................................... 2,770 3,729
Accrued interest receivable.......................... 5,995 7,010
---------- ----------
Total Residential Collateral......................... $1,076,215 $1,135,393
Commercial Mortgage Loans Held-For-Investment........ $ 20,526 $ --
---------- ----------
Total Long-Term Debt Collateral...................... $1,096,741 $1,135,393
========== ==========
For presentation purposes, the various components of the Bond Collateral
summarized above are reflected in their corresponding line items on the
Consolidated Balance Sheets.
NOTE 6. INTEREST RATE AGREEMENTS
The Company reports its Interest Rate Agreements at fair value, and has not
elected to obtain hedge accounting treatment on any of its Interest Rate
Agreements.
During the three months ended March 31, 2001 and 2000, the Company
recognized net market value losses of $0.5 million and $0.1 million on Interest
Rate Agreements. The market value gains are reflected as a component of "Net
unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
The following table summarizes the aggregate notional amounts of all of the
Company's Interest Rate Agreements as well as the credit exposure related to
these instruments. The credit exposure reflects the fair market value of any
cash and collateral of the Company held by counterparties.
NOTIONAL AMOUNTS CREDIT EXPOSURE
-------------------------- -------------------------
MARCH 31, DECEMBER 31, MARCH 31, DECEMBER 31,
2001 2000 2001 2000
---------- ------------ --------- ------------
(IN THOUSANDS)
Interest Rate Options
Purchased........................ $1,385,800 $1,490,300 -- --
Sold............................. 3,500 -- -- --
Interest Rate Swaps................ 55,000 5,000 $4,771 $2,814
Interest Rate Futures and
Forwards......................... 147,000 506,600 705 948
---------- ---------- ------ ------
Total.............................. $1,591,300 $2,001,900 $5,476 $3,762
========== ========== ====== ======
Interest Rate Options purchased (sold), which may include caps, floors,
call and put corridors, options on futures, options on MBS forwards, and
swaption collars (collectively, "Options"), are agreements which transfer,
modify or reduce interest rate risk in exchange for the payment (receipt) of a
premium when the contract is initiated. Purchased interest rate cap agreements
provide cash flows to the Company to the extent that a specific interest rate
index exceeds a fixed rate. Conversely, purchased interest rate floor agreements
produce cash flows to the Company to the extent that the referenced interest
rate index falls below the agreed upon fixed rate. Purchased call (put)
corridors will cause the Company to incur a gain to the extent that the yield of
the specified index is below (above) the strike rate at the time of the option
expiration. The maximum
17
18
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
gain or loss on a purchased call (put) corridor is equal to the up-front
premium. Call (put) corridors that are sold will cause the Company to incur a
loss to the extent that the yield of the specified index is below (above) the
strike rate at the time of the option expiration. Such losses are partially
offset by the up front premium received. The maximum gain or loss on a call
(put) corridor sold is determined at the time of the transaction by establishing
a minimum (maximum) index rate. The Company will receive cash on the purchased
options on futures/forwards if the futures/forward price exceeds (is below) the
call (put) option strike price at the expiration of the option. For the written
options on futures/forwards, the Company receives an up-front premium for
selling the option, however, the Company will incur a loss on the written option
if the futures/ forward price exceeds (is below) the call (put) option strike
price at the expiration of the option. Purchased receiver (payor) swaption
collars will cause the Company to incur a gain (loss) should the index rate be
below (above) the strike rate as of the expiration date. The maximum gain or
loss on a receiver (payor) swaption is established at the time of the
transaction by establishing a minimum (maximum) index rate. The Company's credit
risk on the purchased Options is limited to the carrying value of the Options
agreements. The credit risk on options on futures is limited due to the fact
that the exchange and its members are required to satisfy the obligations of any
member that fails to perform.
Interest Rate Swaps ("Swaps") are agreements in which a series of interest
rate flows are exchanged over a prescribed period. The notional amount on which
the interest payments are based is not exchanged. Most of the Company's Swaps
involve the exchange of one floating interest payment for another floating
interest payment based on a different index. Most of the Swaps require that the
Company provide collateral, such as mortgage securities, to the counterparty.
Should the counterparty fail to return the collateral, the Company would be at
risk for the fair market value of that asset.
Interest Rate Futures and Forwards ("Futures and Forwards") are contracts
for the purchase or sale of securities or cash in which the seller (buyer)
agrees to deliver (purchase) on a specified future date, a specified instrument
(or the cash equivalent), at a specified price or yield. Under these agreements,
if the Company has sold (bought) the futures/forwards, the Company will
generally receive additional cash flows if interest rates rise (fall).
Conversely, the Company will generally pay additional cash flows if interest
rates fall (rise). The credit risk inherent in futures and forwards arises from
the potential inability of counterparties to meet the terms of their contracts,
however, the credit risk on futures is limited by the requirement that the
exchange and its members make good on obligations of any member that fails to
perform.
In general, the Company incurs credit risk to the extent that the
counterparties to the Interest Rate Agreements do not perform their obligations
under the Interest Rate Agreements. If one of the counterparties does not
perform, the Company would not receive the cash to which it would otherwise be
entitled under the Interest Rate Agreement. In order to mitigate this risk, the
Company has only entered into Interest Rate Agreements that are either a)
transacted on a national exchange or b) transacted with counterparties that are
either i) designated by the U.S. Department of the Treasury as a "primary
government dealer", ii) affiliates of "primary government dealers", or iii)
rated BBB or higher. Furthermore, the Company has entered into Interest Rate
Agreements with several different counterparties in order to diversify the
credit risk exposure.
NOTE 7. SHORT-TERM DEBT
The Company has entered into repurchase agreements, bank borrowings, and
other forms of collateralized short-term borrowings (collectively, "Short-Term
Debt") to finance acquisitions of a portion of its Mortgage Assets. This
Short-Term Debt is collateralized by a portion of the Company's Mortgage Assets.
At March 31, 2001, the Company had $1.0 billion of Short-Term Debt
outstanding with a weighted-average borrowing rate of 5.28% and a
weighted-average remaining maturity of 170 days. This debt was collateralized
with $1.0 billion of Mortgage Assets. At December 31, 2000, the Company had $0.8
billion of
18
19
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
Short-Term Debt outstanding with a weighted-average borrowing rate of 6.85% and
a weighted-average remaining maturity of 122 days. This debt was collateralized
with $0.8 billion of Mortgage Assets.
At March 31, 2001 and December 31, 2000, the Short-Term Debt had the
following remaining maturities:
MARCH 31, DECEMBER 31,
2001 2000
--------- ------------
(IN THOUSANDS)
Within 30 days....................................... $ 89,033 $100,885
31 to 90 days........................................ 255,013 268,867
Over 90 days......................................... 648,551 386,470
-------- --------
Total Short-Term Debt................................ $992,597 $756,222
======== ========
For the three months ended March 31, 2001 and 2000, the average balance of
Short-Term Debt was $0.9 billion and $1.2 billion with a weighted-average
interest cost of 5.91% and 6.25%, respectively. The maximum balance outstanding
during the three months ended March 31, 2001 and 2000, was $1.0 billion and $1.3
billion, respectively. The Company met all of it debt covenants for its
short-term borrowing arrangements and credit facilities during the three months
ended March 31, 2001 and 2000.
In addition to the committed facilities listed below, the Company has
uncommitted facilities with credit lines in excess of $4 billion at March 31,
2001. It is the intention of the Company's management to renew committed and
uncommitted facilities, if and as needed.
In March 2000, the Company entered into a $50 million committed revolving
mortgage warehousing credit facility. The facility is intended to finance newly
originated commercial mortgage loans. In September 2000, this facility was
extended through August 2001 and was increased to $70 million. At March 31,
2001, the Company had borrowings under this facility of $34.2 million. In
addition, a portion of this facility allows for loans to be financed to the
maturity of the loan, which may extend beyond the expiration date of the
facility. Borrowings under this facility bear interest based on a specified
margin over the London Interbank Offered Rate ("LIBOR"). At March 31, 2001, the
weighted average borrowing rate under this facility was 7.01%. This committed
facility expires in August 2001.
In July 2000, the Company renewed for one year, a $30 million committed
master loan and security agreement with a Wall Street Firm. The facility is
intended to finance newly originated commercial mortgage loans. In September
2000, this facility was increased to $50 million. At March 31, 2001, the Company
had borrowings under this facility of $7.2 million. Borrowings under this
facility bear interest based on a specified margin over LIBOR. At March 31,
2001, the weighted average borrowing rate under this facility was 6.66%. 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 March 31, 2001, the Company had
borrowings under these facilities of $30.6 million. Borrowings under these
facilities bear interest based on a specified margin over LIBOR. At March 31,
2001, the weighted average borrowing rate under these facilities was 5.98%.
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 March 31, 2001, the Company had borrowings under this facility of
$14.4 million. Borrowings under this facility bear interest based on a specified
margin over LIBOR. At March 31, 2001, the
19
20
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
weighted average borrowing rate under this facility was 6.25%. This committed
facility expires in October 2001.
NOTE 8. LONG-TERM DEBT
Long-Term Debt in the form of collateralized mortgage bonds is secured by
Bond Collateral. As required by the indentures relating to the Long-Term Debt,
the Bond Collateral is held in the custody of trustees. The trustees collect
principal and interest payments on the Bond Collateral and make corresponding
principal and interest payments on the Long-Term Debt. The obligations under the
Long-Term Debt are payable solely from the Bond Collateral and are otherwise
non-recourse to the Company.
Each series of Long-Term Debt consists of various classes of bonds at
variable rates of interest. The maturity of each class is directly affected by
the rate of principal prepayments on the related Bond Collateral. Each series is
also subject to redemption according to the specific terms of the respective
indentures. As a result, the actual maturity of any class of a Long-Term Debt
series is likely to occur earlier than its stated maturity.
For the three months ended March 31, 2001 and 2000, the average effective
interest cost for Long-Term Debt, as adjusted for the amortization of bond
premium, deferred bond issuance costs, and other related expenses, was 6.65% and
6.32%, respectively. At March 31, 2001 and 2000, accrued interest payable on
Long-Term Debt was $2.6 million and $3.5 million, respectively, and is reflected
as a component of Accrued Interest Payable on the Consolidated Balance Sheets.
For the three months ended March 31, 2001 and 2000, the average balance of
Long-Term Debt was $1.1 billion and $1.0 billion, respectively.
The components of the Long-Term Debt at March 31, 2001 and December 31,
2000 along with selected other information are summarized below:
MARCH 31, DECEMBER 31,
2001 2000
------------- --------------
(IN THOUSANDS)
Residential Long-Term Debt.................. $ 1,039,152 $ 1,095,909
Commercial Long-Term Debt................... 16,948 --
Unamortized premium on Long-Term Debt....... 2,934 3,045
Deferred bond issuance costs................ (2,822) (3,119)
------------- --------------
Total Long-Term Debt.............. $ 1,056,212 $ 1,095,835
============= ==============
Range of weighted-average interest rates, by
series -- residential..................... 5.34% to 6.66% 6.35% to 7.20%
Stated residential maturities............... 2017 - 2029 2017 - 2029
Number of residential series................ 4 4
Weighted-average interest
rates -- commercial....................... 8.58 --
Stated commercial maturities................ 2002 - 2003 --
Number of commercial series................. 2 --
NOTE 9. INCOME TAXES -- HOLDINGS
The current provision for income taxes for Holdings for the three months
ended March 31, 2001 and 2000 was $3,200. These amounts represent the minimum
California franchise taxes. No additional tax provision has been recorded for
the three months ended March 31, 2001 and 2000, as Holdings reported a loss in
years prior to 2001, and did not recognize a significant amount of net income
during the first three months of 2001. In addition, due to the uncertainty of
realization of net operating losses, no deferred tax benefit has been
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21
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
recorded. A valuation allowance has been provided to offset the deferred tax
assets related to net operating loss carryforwards and other future temporary
deductions at March 31, 2001 and December 31, 2000. At both March 31, 2001 and
December 31, 2000, the deferred tax assets and associated valuation allowances
were approximately $9.5 million. At both March 31, 2001 and December 31, 2000,
Holdings had net operating loss carryforwards of approximately $24.6 million for
federal tax purposes, and $11 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 10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values
of the Company's financial instruments at March 31, 2001 and December 31, 2000.
MARCH 31, 2001 DECEMBER 31, 2000
--------------------------- ---------------------------
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
-------------- ---------- -------------- ----------
(IN THOUSANDS)
Assets
Mortgage Loans
Residential: held-for-sale...... $ 4,524 $ 4,524 $ 6,658 $ 6,658
Residential:
held-for-investment........... 1,067,295 1,056,838 1,124,339 1,113,389
Commercial: held-for-sale....... 32,743 32,743 34,275 34,275
Commercial:
held-for-investment........... 37,334 37,334 22,894 22,894
Mortgage Securities
Residential: trading............ 985,222 985,222 759,612 759,612
Residential:
available-for-sale............ 15,390 15,390 85,927 85,927
Interest Rate Agreements........... 77 77 66 66
Investment in RWT Holdings, Inc.... -- -- 1,899 1,989
Liabilities
Short-Term Debt.................... 992,597 992,597 756,222 756,222
Long-Term Debt..................... 1,056,212 1,047,194 1,095,835 1,085,368
The carrying values of all other balance sheet accounts as reflected in the
consolidated financial statements approximate fair value because of the
short-term nature of these accounts.
NOTE 11. STOCKHOLDERS' EQUITY
Class B 9.74% Cumulative Convertible Preferred Stock
On August 8, 1996, the Company issued 1,006,250 shares of Class B Preferred
Stock ("Preferred Stock"). Each share of the Preferred Stock is convertible at
the option of the holder at any time into one share of Common Stock. Effective
October 1, 1999, the Company can either redeem or, under certain circumstances,
cause a conversion of the Preferred Stock. The Preferred Stock pays a dividend
equal to the greater of (i) $0.755 per share, per quarter or (ii) an amount
equal to the quarterly dividend declared on the number of shares of the Common
Stock into which the Preferred Stock is convertible. The Preferred Stock ranks
senior to the Company's Common Stock as to the payment of dividends and
liquidation rights. The liquidation preference entitles the holders of the
Preferred Stock to receive $31.00 per share plus any accrued dividends before
any distribution is made on the Common Stock. At both March 31, 2001 and
December 31, 2000, 96,732 shares of the Preferred Stock have been converted into
96,732 shares of the Company's Common Stock.
21
22
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
In March 1999, the Company's Board of Directors approved the repurchase of
up to 150,000 shares of the Company's Preferred Stock. The Company did not
repurchase any shares of Preferred Stock during the three months ended March 31,
2001 and 2000. At March 31, 2001, there remained 142,550 shares available under
the authorization for repurchase.
Stock Option Plan
The Company has adopted a Stock Option Plan for executive officers,
employees, and non-employee directors (the "Plan"). The Plan authorizes the
Board of Directors (or a committee appointed by the Board of Directors) to grant
"incentive stock options" as defined under Section 422 of the Code ("ISOs"),
options not so qualified ("NQSOs"), deferred stock, restricted stock,
performance shares, stock appreciation rights, limited stock appreciation rights
("Awards"), and dividend equivalent rights ("DERs") to such eligible recipients
other than non-employee directors. Non-employee directors are automatically
provided annual grants of NQSOs with DERs pursuant to a formula under the Plan.
The number of shares of Common Stock available under the Plan for options
and Awards, subject to certain anti-dilution provisions, is 15% of the Company's
total outstanding shares of Common Stock. The total outstanding shares are
determined as the highest number of shares outstanding prior to any stock
repurchases. Of these shares of Common Stock available for grant, no more than
500,000 shares of Common Stock shall be cumulatively available for grant as
ISOs. At March 31, 2001 and December 31, 2000, 441,304 and 476,854 shares of
Common Stock, respectively, were available for grant. At March 31, 2001, 28,000
shares of restricted stock had been granted. No restricted stock had been
granted prior to December 31, 2000. At March 31, 2001 and December 31, 2000,
331,652 and 328,152 ISOs had been granted, respectively. The exercise price for
ISOs granted under the Plan may not be less than the fair market value of shares
of Common Stock at the time the ISO is granted. All stock options granted and
restricted stock awarded under the Plan vest no earlier than ratably over a
four-year period from the date of grant or award and all stock options granted
expire within ten years after the date of grant.
The Company has granted stock options that accrue and pay stock and cash
DERs. This feature results in current operating expenses being incurred that
relate to long-term incentive grants made in the past. To the extent the Company
increases its common dividends or the market price of the Common Stock
increases, such operating expenses may increase. For the three months ended
March 31, 2001 and 2000, the Company accrued cash and stock DER expenses of $1.0
million and $0.4 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 March 31, 2001 and December 31,
2000, there were 166,459 and 166,451 unexercised options with stock DERs under
the Plan, respectively. Cash DERs are accrued and paid based on the level of the
Company's common stock dividend. At March 31, 2001 and December 31, 2000, there
were 1,155,372 and 1,180,797 unexercised options with cash DERs under the Plan,
respectively. At March 31, 2001 and December 31, 2000, there were 154,550 and
147,550 outstanding stock options that did not have DERs, respectively.
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23
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2001
(UNAUDITED)
A summary of the status of the Company's Plan as of March 31 and changes
during the three months ending on that date is presented below.
MARCH 31, 2001 MARCH 31, 2000
---------------------------- ----------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
--------- ---------------- --------- ----------------
(IN THOUSANDS, EXCEPT SHARE DATA)
Outstanding options at January
1.............................. 1,494,798 $22.32 1,713,836 $21.97
Options granted................ 4,000 $20.02 11,000 $12.55
Options exercised.............. (25,967) $14.00 (6,035) $ 3.02
Options canceled............... (500) $18.94 (144,225) $14.04
Dividend equivalent rights
earned...................... 4,050 -- 3,556 --
--------- ---------
Outstanding options at March
31............................. 1,476,381 $22.40 1,578,132 $22.66
========= =========
Common Stock Repurchases
Since September 1997, the Company's Board of Directors has approved the
repurchase of 7,455,000 shares of the Company's Common Stock. Pursuant to this
repurchase program, the Company did not repurchase any shares of Common Stock
during the three months ended March 31, 2001 and 2000. At March 31, 2001, there
remained 1,000,000 shares available under the authorization for repurchase.
Common stock previously repurchased has been returned to the Company's
authorized but unissued shares of Common Stock.
NOTE 12. COMMITMENTS AND CONTINGENCIES
At March 31, 2001, the Company had entered into commitments to purchase
$1.6 million of residential mortgage securities for settlement during April and
May 2001.
At March 31, 2001, the Company is obligated under non-cancelable operating
leases with expiration dates through 2006. The total future minimum lease
payments under these non-cancelable leases is $3.0 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.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes.
SAFE HARBOR STATEMENT
"Safe Harbor" Statement under the Private Securities Litigation Reform Act
of 1995: Certain matters discussed in this Form 10-Q may constitute
forward-looking statements within the meaning of the federal securities laws
that inherently include certain risks and uncertainties. Actual results and the
timing of certain events could differ materially from those projected in or
contemplated by the forward-looking statements due to a number of factors,
including, among other things, credit results for our mortgage assets, our cash
flows and liquidity, changes in interest rates and market values on our mortgage
assets and borrowings, changes in prepayment rates on our mortgage assets,
general economic conditions, particularly as they affect the price of mortgage
assets and the credit status of borrowers, and the level of liquidity in the
capital markets, as it affects our ability to finance our mortgage asset
portfolio, and other risk factors outlined in the Company's Form 10-K. Other
factors not presently identified may also cause actual results to differ. We
continuously update and revise our estimates based on actual conditions
experienced. It is not practicable to publish all such revisions and, as a
result, no one should assume that results projected in or contemplated by the
forward-looking statements included above will continue to be accurate in the
future.
Throughout this Form 10-Q and other company documents, the words "believe",
"expect", "anticipate", "intend", "aim", "will", and similar words identify
"forward-looking" statements.
RESULTS OF OPERATIONS
Consolidation of Financial Statements
On January 1, 2001, Redwood Trust, Inc. ("Redwood") acquired 100% of the
common stock of RWT Holdings, Inc., ("Holdings") equivalent to a 1% economic
interest in Holdings. As a result, Redwood now presents the financial statements
of Redwood and Holdings on a consolidated basis. Thus, assets and liabilities of
Holdings now appear on our consolidated statements as assets and liabilities,
instead of being netted against our equity investment in Holdings. In accordance
with generally accepted accounting principles, the financial statements for
prior years have not been restated to conform to the consolidated format to be
used in 2001 and beyond.
Earnings Summary
Core earnings were $0.71 per share for the first quarter of 2001, an
increase of 39% over first quarter of 2000 core earnings of $0.51 per share.
Reported earnings per share for the first quarter of 2001 were $0.74, a 100%
increase over the first quarter of 2000 reported earnings per share of $0.37.
Reported earnings include mark-to-market adjustments.
Our common stock dividend for the first quarter of 2001 was $0.50 per
share. Book value per share rose from $21.47 to $21.94 during the quarter.
Revenues Summary
Revenues declined from $42.8 million in the first quarter of 2000 to $41.6
million in the first quarter of 2001. Although average earning assets yields
increased from 7.25% to 7.72% with rising interest rates, our average balance of
earning assets (as reported on-balance sheet) fell from $2.4 billion to $2.2
billion.
In general, unless we increase our capital base, our revenues may continue
to decline as we continue to shift our product mix towards our credit
enhancement portfolio. If we continue with this change in product mix, our
reported assets and revenues may continue to decline. However, we would also
expect that borrowings and interest expenses would decline, and that the net
result may be favorable over time.
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25
TABLE 1
TOTAL INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
RESIDENTIAL
RETAINED
NET PORTFOLIO TOTAL
AVERAGE PREMIUM CREDIT INTEREST EARNING
EARNING COUPON AMORTIZATION PROVISION INCOME ASSET
ASSETS INCOME EXPENSE EXPENSE REVENUES YIELD
---------- -------- ------------ ----------- -------- -------
Q1: 2000.......................... $2,363,903 $ 43,460 $ (522) $ (119) $ 42,819 7.25%
Q2: 2000.......................... 2,282,889 43,091 45 (128) 43,008 7.54%
Q3: 2000.......................... 2,187,936 42,959 (1,040) (240) 41,679 7.62%
Q4: 2000.......................... 2,118,952 42,817 (818) (244) 41,755 7.88%
Q1: 2001.......................... 2,156,741 42,690 (869) (184) 41,637 7.72%
1999.............................. $2,200,916 $152,472 $(5,162) $(1,346) $145,964 6.63%
2000.............................. 2,237,956 172,327 (2,335) (731) 169,261 7.56%
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.
Residential Credit Enhancement Portfolio
The balance of loans that we credit enhance increased from $23 billion to
$27 billion during the first quarter of 2001. These loans do not appear on our
balance sheet; only our net investment in the credit enhancement interests for
these loans appear on our balance sheet. Credit enhancement revenue increased to
$2.7 million as our net investment in credit enhancement assets increased. We
acquired $31 million principal value of credit enhancement assets in the first
quarter of 2001 at a cost of $21 million. At March 31, 2001, the total principal
value of our credit enhancement interests was $155 million. We acquired these
interests at an adjusted cost of $101 million. Of the $54 million difference
between principal value and amortized costs, $36 million is designated as credit
reserve and $18 million is designated as a purchase discount to be amortized
into income over time.
We continue to establish what we believe to be an appropriate level of
credit reserves upon acquisition of these assets. Should we experience better
than projected future credit results, some of these credit reserves may be
reduced, thereby positively affecting future yields on this portfolio. We expect
solid growth in this portfolio in the second quarter of 2001. If favorable
market conditions continue, we expect to pursue growth in this portfolio
throughout the year.
Our credit enhancement portfolio yield was 12.32% during the first quarter
of 2001. The average yield on this portfolio has declined from 16.95% in the
first quarter of 2000 due to acquisition of new assets for which we set up
relatively large initial reserves and thus relatively low initial yields.
Additionally, we have acquired an increased proportion of third loss interests
that have lower yields than first or second loss interests due to their lower
risk levels.
In today's environment, accounting yields initially booked on these assets
of 12% to 13% (after setting aside credit reserves) generally allow returns on
equity capital employed before overhead of 14% to 15% after our modest use of
leverage. Actual long-term returns on this capital could be lower or higher as a
function of a number of factors, with the principal factor being future credit
results. At March 31, 2001, we had set aside $36 million of credit reserves for
these assets. If future credit results are satisfactory, we may not need all of
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26
these reserves. Should this be determined, we can then reverse some of these
reserves into income over time, thus increasing our asset yields. Although we do
expect material credit losses, it may be useful to note that our long-term
return on equity before overhead from this current portfolio, assuming our
modest use of leverage, expected prepayment rates, and so forth, could be as
high as 20% to 23% in the event that there are no credit losses or credit losses
are very minor. Thus, assuming credit losses are not greater than implied by our
reserve levels, a reasonable expectation of long-term returns from this current
portfolio might be 14% to 23% return on equity before overhead. However,
achieving such returns is subject to many factors.
TABLE 2
CREDIT ENHANCEMENT PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
AVERAGE NET TOTAL
AVERAGE AVERAGE NET DISCOUNT INTEREST
PRINCIPAL CREDIT DISCOUNT AVERAGE COUPON AMORTIZATION INCOME
VALUE RESERVE BALANCE BASIS INCOME INCOME REVENUES YIELD
--------- -------- -------- ------- ------ ------------ -------- -------
Q1: 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%
Q1: 2001............. 135,471 (31,415) (18,260) 85,796 2,516 126 2,642 12.33%
1999................. $ 27,976 $ (6,816) $ (2,891) $18,269 $1,900 $2,302 $4,202 23.00%
2000................. 87,070 (18,527) (9,734) 58,809 6,532 1,992 8,524 14.49%
Credit losses for the entire $27 billion portfolio that we credit enhanced
at March 31, 2001 declined in the first quarter of 2001 to $0.6 million from
$1.5 million in the previous quarter. The annualized rate of credit loss was
less than 1 basis point (0.01%) of the portfolio. Of this loss, $550,000 was
borne by the external credit enhancements to our positions and $55,000 was
incurred by us and charged against our internal reserves. At quarter-end, we had
$86 million of external credit enhancements and $36 million of internal credit
reserves for this portfolio. External credit reserves serve to protect us from
credit losses on our $27 billion credit enhancement portfolio on a specific
asset basis. It represents the principal value of first and second loss
interests that are junior to us and are owned by others. Total reserves of $122
million represented 45 basis points (0.45%) of our credit enhancement portfolio.
Reserves, credit protections, and risks are specific to each asset. Unlike
general reserves, specific reserves cannot be reallocated to other assets.
Delinquencies (over 90 days, foreclosure, bankruptcy, and REO) in our
credit enhancement portfolio increased from 0.23% at December 31, 2000 to 0.24%
of the current balances at March 31, 2001. We expect delinquency and loss rates
to increase from their current modest levels, given the weakening economy and
the natural seasoning pattern of these loans.
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TABLE 3
CREDIT ENHANCEMENT PORTFOLIO -- CREDIT RESULTS
(AT PERIOD END, ALL DOLLARS IN THOUSANDS)
ANNUALIZED
TOTAL
CREDIT REDWOOD'S
UNDERLYING DELINQUENCIES TOTAL LOSSES AS SHARE OF
MORTGAGE --------------- CREDIT % OF CREDIT
LOANS $ % LOSSES LOANS LOSSES
----------- ------- ---- ------- ---------- ---------
Q1: 2000.................... $ 8,539,491 $49,731 0.58% $ (813) 0.04% $ (270)
Q2: 2000.................... 20,925,931 45,999 0.22% (1,537) 0.03% (187)
Q3: 2000.................... 21,609,785 58,102 0.27% (590) 0.01% (245)
Q4: 2000.................... 22,633,860 51,709 0.23% (1,568) 0.03% (56)
Q1: 2001.................... 27,081,361 63,893 0.24% (605) 0.01% (55)
1999........................ $ 6,376,571 $45,451 0.71% $(3,141) 0.05% $(1,146)
2000........................ 22,633,860 51,709 0.23% (4,508) 0.02% (758)
At March 31, 2001, we credit-enhanced over 77,000 loans with a total
principal value of $27 billion. Of these, 61% were fixed-rate loans, 11% were
hybrid loans (loans that become adjustable after a 3 to 10 year fixed rate
period), and 28% were adjustable-rate loans. The average size of the loans that
we credit-enhanced was $351,700. We credit-enhanced 1,119 loans with principal
balances in excess of $1 million; these loans had an average size of $1.4
million and a total loan balance of $1.5 billion. Loans over $1 million were 1%
of the total number of loans and 6% of the total balance of loans that we
credit-enhanced at year-end.
The geographic dispersion of our credit enhancement portfolio closely
mirrors that of the jumbo residential market as a whole. At March 31, 2001, our
loans were most concentrated in the following states: California 47%, New York
6%, New Jersey 4%, Texas 4%, and Massachusetts 4%. 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 credit enhanced at March 31, 2001 were
originated in year 2000 or 2001.
For loans in which a FICO credit score was obtained at origination and is
available, the average FICO score for our credit enhancement portfolio was 733
at March 31, 2001. Borrowers with FICO scores over 720 comprised 61% of the
portfolio, those with scores between 680 and 720 comprised 22%, those with
scores between 620 and 680 comprised 15% and those with scores below 620
comprised 2% of our credit enhancement portfolio.
Given housing appreciation and loan amortization, we estimate the average
current effective LTV for the loans that we credit-enhance is 61%. Loans with
loan-to-value ratios ("LTV") at origination in excess of 80% made up 10% of loan
balances; we benefit from primary mortgage insurance ("PMI") on 99% of these
loans. With this insurance, our effective LTV 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%.
For the loans that we credit enhance where the property is in Northern
California, (23% of the total portfolio), the average loan balance was $386,400,
the average FICO score is 728, and the average LTV at origination was 71%. On
average, these loans have 38 months of seasoning.
For 24% of our loans where the properties are located in Southern
California, the average loan balance was $376,200, the average FICO score was
722 and the average LTV at origination was 72%. These loans have 50 months of
seasoning, on average.
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TABLE 4
CREDIT ENHANCEMENT PORTFOLIO -- UNDERLYING COLLATERAL CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
MARCH JUNE SEPTEMBER DECEMBER MARCH
2000 2000 2000 2000 2001
---------- ----------- ----------- ----------- -----------
Credit enhancement
portfolio.............. $8,539,491 $20,925,931 $21,609,785 $22,633,860 $27,081,361
Credit enhanced loans.... 26,934 59,779 61,756 63,675 77,011
Adjustable %............. 9% 36% 34% 35% 28%
Hybrid %................. 16% 3% 3% 7% 11%
Fixed %.................. 75% 61% 63% 58% 61%
Face Value:
First loss position...... $ 17,718 $ 28,262 $ 30,782 $ 34,959 $ 41,156
Second loss position..... 11,528 18,089 20,597 30,703 37,197
Third loss position...... 31,632 49,280 54,793 59,216 76,880
Net Face Value........... 60,878 95,631 106,172 124,878 155,233
Net investment:
First loss position...... $ 8,106 $ 9,666 $ 10,231 $ 12,080 $ 13,191
Second loss position..... 5,180 12,700 14,168 21,109 25,106
Third loss position...... 23,708 36,527 41,719 47,575 62,552
Net Investment........... 36,994 58,893 66,118 80,764 100,849
Net Face Value........... $ 60,878 $ 95,631 $ 106,172 $ 124,878 $ 155,233
Internal Credit
Reserves............... (11,893) (20,829) (22,139) (27,052) (35,722)
Discount to be
amortized.............. (11,991) (15,909) (17,915) (17,062) (18,662)
Net Investment........... 36,994 58,893 66,118 80,764 100,849
Internal Credit
Reserves............... $ 11,893 $ 20,829 $ 22,139 $ 27,052 $ 35,722
External Credit
Enhancement............ 34,311 79,404 78,564 86,840 86,601
Total Credit
Protection............. 46,204 100,233 100,703 113,892 122,323
As % of Portfolio........ 0.54% 0.48% 0.47% 0.50% 0.45%
California %............. 37% 52% 50% 50% 47%
New York................. 9% 6% 6% 6% 6%
New Jersey............... 5% 3% 4% 4% 4%
Massachusetts............ 5% 3% 3% 3% 4%
Texas.................... 4% 3% 3% 3% 4%
Other states............. 40% 33% 34% 34% 35%
Residential Retained Loan Portfolio
Revenues declined in this portfolio over the last year, from $23.6 million
in the first quarter of 2000 to $19.7 million in the first quarter of 2001.
Yields rose during this time period due to rising interest rates, but the
average balance of the portfolio was lower due to principal repayments. We are
evaluating several acquisition opportunities and may add to this portfolio later
in 2001. Otherwise, we would expect revenue to decline as yields decline along
with short-term interest rates, and as the existing portfolio continues to pay
off.
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TABLE 5
RESIDENTIAL RETAINED PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
ANNUAL NET TOTAL
AVERAGE AVERAGE NET AVERAGE MORTGAGE PREMIUM CREDIT INTEREST
PRINCIPAL PREMIUM CREDIT PREPAYMENT COUPON AMORTIZATION PROVISION INCOME
BALANCE BALANCE RESERVE RATE (CPR) INCOME EXPENSE EXPENSE REVENUES YIELD
---------- ----------- ------- ---------- ------- ------------ --------- -------- -----
Q1: 2000............. $1,337,428 $16,061 $(4,187) 14% $24,378 $ (640) $ (119) $23,619 7.00%
Q2: 2000............. 1,276,340 15,372 (4,290) 16% 23,648 (515) (128) 23,005 7.15%
Q3: 2000............. 1,202,056 14,760 (4,454) 22% 23,118 (829) (240) 22,049 7.27%
Q4: 2000............. 1,141,624 14,141 (4,696) 16% 22,316 (611) (244) 21,461 7.46%
Q1: 2001............. 1,083,943 13,519 (4,895) 21% 20,371 (485) (184) 19,702 7.21%
1999................. $1,115,874 $13,895 $(3,505) 25% $77,065 $(3,915) $(1,346) $71,804 6.38%
2000................. 1,238,993 15,080 (4,408) 17% 93,460 (2,595) (731) 90,134 7.21%
Credit losses were $30,000 in this portfolio in the first quarter of 2001
as we liquidated one Real Estate Owned property and experienced a 13% loss
severity (the percentage of our loan balance that represents a loss upon
liquidation, including all foregone interest). Our annualized loss rate was 1
basis point (0.01%) of current portfolio balances. We charged our $30,000 loss
against our credit reserve for this portfolio, which ended the quarter at $5.0
million (0.46% of the portfolio). Delinquencies in this portfolio increased to
0.59% of the portfolio from 0.50% at the end of the previous quarter. We expect
delinquencies and losses to increase from their current rates if the economy
continues to weaken.
TABLE 6
RESIDENTIAL RETAINED PORTFOLIO -- CREDIT RESULTS
(AT PERIOD END, ALL DOLLARS IN THOUSANDS)
DELINQUENT GROSS LOSS REALIZED CREDIT ENDING
LOANS DEFAULTS SEVERITY CREDIT LOSSES PROVISION EXPENSE CREDIT RESERVE
---------- -------- -------- ------------- ----------------- --------------
Q1: 2000............. $5,338 $ 0 0% $ 0 $ (119) $4,244
Q2: 2000............. 4,968 450 9% (42) (128) 4,330
Q3: 2000............. 4,330 0 0% 0 (240) 4,570
Q4: 2000............. 5,667 0 0% 0 (244) 4,814
Q1: 2001............. 6,371 238 13% (30) (184) 4,968
1999................. $4,635 $145 4% $ (5) $(1,346) $4,125
2000................. 5,667 450 9% (42) (731) 4,814
At March 31, 2001, we owned 3,433 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 $312,100. We
owned 78 loans with a loan balance over $1 million; the average size of these
loans was $1.4 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 24% of the total. All of the loans were originated in 1999 or
earlier. Loans where the original loan balance exceeded 80% LTV made up 7% of
loan balances; we benefit from PMI on 99% of these loans (serving to
substantially lower our effective LTVs). Average effective LTV at origination
for our residential retained portfolio (including the effect of PMI, pledged
collateral, and other credit enhancements) was 71%. Given housing appreciation
and loan amortization, we estimate the current effective LTV of our retained
loan portfolio is less than 63%.
We fund most of our residential retained loan portfolio through the
issuance of long-term debt through our special purpose subsidiary, Sequoia
Mortgage Funding Corporations ("Sequoia"). The financing is non-recourse to
Redwood, and our exposure to these loans is limited to our investment in
Sequoia, which, at March 31, 2001 was $35 million, or 3.2% of the loan balances.
Residential mortgage loans that are included in this portfolio, but are funded
by short-term borrowings, represent less than one percent of the total loans at
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March 31, 2001. For these short-term funded loans, we set aside capital based on
our internal risk adjusted capital guidelines that take into consideration
characteristics of our loans and our financing facilities.
TABLE 7
RETAINED RESIDENTIAL PORTFOLIO -- LOAN CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
MARCH JUNE SEPTEMBER DECEMBER MARCH
2000 2000 2000 2000 2001
---------- ---------- ---------- ---------- ----------
Book value.................... $1,330,674 $1,267,780 $1,186,799 $1,130,997 $1,071,819
Number of loans............... 4,207 4,021 3,804 3,633 3,433
Average loan size............. $ 316 $ 315 $ 312 $ 311 $ 312
Adjustable %.................. 71% 71% 71% 71% 71%
Hybrid %...................... 29% 29% 29% 29% 29%
Fixed %....................... 0% 0% 0% 0% 0%
Funded with short-term debt... 1% 1% 1% 1% 1%
Funded with long-term debt.... 99% 99% 99% 99% 99%
Long-term debt................ $1,282,756 $1,227,546 $1,148,519 $1,095,835 $1,039,264
Net investment in Sequoia..... $ 42,437 $ 40,659 $ 38,803 $ 37,166 $ 34,982
California %.................. 26% 25% 25% 25% 24%
Florida....................... 9% 9% 9% 9% 9%
New York...................... 8% 8% 8% 8% 8%
New Jersey.................... 5% 5% 5% 5% 5%
Texas......................... 5% 5% 5% 5% 5%
Georgia....................... 5% 5% 5% 5% 5%
Other states.................. 42% 43% 43% 43% 44%
Year 2000 origination......... 0% 0% 0% 0% 0%
Year 1999 origination......... 19% 19% 19% 19% 18%
Year 1998 origination......... 32% 32% 32% 32% 32%
Year 1997 origination......... 37% 37% 37% 37% 38%
Year 1996 or earlier
origination................. 12% 12% 12% 12% 12%
Combined Residential Loan Portfolios
The tables below show certain attributes of our residential credit
enhancement portfolio and our residential retained loan portfolio on a combined
basis.
TABLE 8
RESIDENTIAL LOAN PORTFOLIO -- CREDIT PROTECTION
(ALL DOLLARS IN THOUSANDS)
RESIDENTIAL RESIDENTIAL REDWOOD'S AS % OF
CREDIT RETAINED TOTAL RESIDENTIAL EXTERNAL TOTAL TOTAL
ENHANCEMENT LOAN RESIDENTIAL CREDIT CREDIT CREDIT RESIDENTIAL
PORTFOLIO PORTFOLIO LOANS RESERVE ENHANCEMENT PROTECTION LOANS
----------- ----------- ----------- ----------- ----------- ---------- -----------
Q1: 2000............. $ 8,539,491 $1,330,674 $ 9,870,165 $16,137 $34,310 $ 50,447 0.51%
Q2: 2000............. 20,925,931 1,267,780 22,193,711 25,159 79,403 104,563 0.47%
Q3: 2000............. 21,609,785 1,186,799 22,796,584 26,709 78,564 105,273 0.46%
Q4: 2000............. 22,633,860 1,130,997 23,764,857 31,866 86,840 118,706 0.50%
Q1: 2001............. 27,081,361 1,071,819 28,153,180 40,690 86,600 127,290 0.45%
1999................. $ 6,376,571 $1,385,589 $ 7,762,160 $15,366 $26,111 $ 41,477 0.53%
2000................. 22,633,860 1,130,997 23,764,857 31,866 86,840 118,706 0.50%
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TABLE 9
RESIDENTIAL LOAN PORTFOLIO -- CREDIT PERFORMANCE
(ALL DOLLARS IN THOUSANDS)
LOSSES AS % OF
AS % OF TO TOTAL
TOTAL TOTAL REDWOOD'S EXTERNAL TOTAL RESIDENTIAL
RESIDENTIAL RESIDENTIAL CHARGE CREDIT CREDIT LOANS
LOANS DELINQUENCIES LOANS OFFS ENHANCEMENT LOSSES (ANNUALIZED)
----------- ------------- ----------- --------- ----------- ------ ------------
Q1: 2000............. $ 9,870,165 $55,069 0.56% $ 270 $ 543 $ 813 0.03%
Q2: 2000............. 22,193,711 50,967 0.23% 229 1,350 1,579 0.03%
Q3: 2000............. 22,796,584 62,432 0.27% 245 345 590 0.01%
Q4: 2000............. 23,764,857 57,376 0.24% 56 1,512 1,568 0.03%
Q1: 2001............. 28,153,180 70,264 0.25% 85 550 635 0.01%
1999................. $ 7,762,160 $50,086 0.65% $1,151 $1,995 $3,146 0.02%
2000................. 23,764,857 57,376 0.24% 800 3,750 4,550 0.02%
Investment Portfolio
We acquired $310 million of mortgage securities and sold $11 of million
mortgage securities in our investment portfolio in the first quarter of 2001.
This portfolio was smaller in size at $874 million average assets than it was a
year ago at $944 million as principal pay downs and sales exceeded acquisitions.
Although yields were higher with higher interest rates (7.71% versus 7.16%),
revenues were flat due to the smaller portfolio. Although we may increase the
size of our investment portfolio on a temporary basis if market conditions
change or if we raise new equity capital, our longer-term plan is to reduce the
role of the investment portfolio on our balance sheet. We expect yields on this
portfolio to drop rapidly in the coming months due to declining interest rates
and faster prepayment speeds.
TABLE 10
INVESTMENT PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
AVERAGE MORTGAGE NET TOTAL
AVERAGE NET PREPAYMENT PREMIUM INTEREST
EARNING PREMIUM RATES COUPON AMORTIZATION INCOME
ASSETS BALANCE (CPR) INCOME EXPENSE REVENUES YIELD
-------- ------- ---------- ------- ------------ -------- -----
Q1: 2000...................... $944,301 $ 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%
Q1: 2001...................... 874,307 10,164 19% 17,634 (586) 17,048 7.71%
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 March 31, 2001, we owned $1.0 billion of mortgage securities, an
increase from $0.8 billion at December 31, 2000. Substantially all of these
assets were rated AAA or AA. The majority of our investments were residential
adjustable-rate or floating rate securities.
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TABLE 11
INVESTMENT PORTFOLIO CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
MARCH JUNE SEPTEMBER DECEMBER MARCH
RATING 2000 2000 2000 2000 2001
---------- ---------- -------- --------- -------- ----------
Agency Adjustable........... AAA $ 665,201 $618,964 $624,918 $532,578 $ 488,735
Agency CMO Floaters......... AAA 6,193 0 0 0 0
Jumbo Adjustable............ AAA or AA 283,982 214,470 200,037 191,047 475,947
Jumbo Short Fixed CMOs...... AAA or AA 14,808 14,260 13,843 0 0
Home Equity Floaters........ AAA or AA 22,914 23,015 23,015 23,015 19,277
Home Equity Fixed........... AAA to BBB 11,692 12,110 12,314 17,044 13,062
Interest-Only -- Residential... AAA or AA 72 233 216 113 71
Interest-Only -- Commercial... AAA or AA 0 0 0 0 2,534
CBO Equity.................. B or NR 0 0 0 978 986
Total Investment Portfolio.............. $1,004,862 $883,052 $874,343 $764,775 $1,000,612
Realized Credit Loses................... 0 0 0 0 0
Commercial Retained Loan Portfolio
The amount of commercial loans shown on our balance sheet increased in the
first quarter of 2001 due to the consolidation of Holdings. However, our total
combined commercial loan portfolio declined from $76 million to $70 million due
to payoffs and sales. We are not adding to our commercial portfolio at this
time, although we may acquire additional commercial assets later in the year.
Unless we make additional acquisitions, portfolio balances should continue to
decline.
TABLE 12
COMMERCIAL PORTFOLIO INTEREST INCOME AND YIELDS
(ALL DOLLARS IN THOUSANDS)
AVERAGE
AVERAGE NET DISCOUNT CREDIT TOTAL
PRINCIPAL DISCOUNT COUPON AMORTIZATION PROVISION INTEREST
VALUE BALANCE INCOME INCOME EXPENSE INCOME YIELD
--------- -------- ------ ------------ --------- -------- -----
Q1: 2000.................... $ 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%
Q1: 2001.................... 73,836 (1,208) 1,857 76 0 1,933 10.65%
1999........................ $11,151 $ (3) $1,081 $ 0 $0 $1,081 9.69%
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. A
slowing economy, and factors particular to each loan, could cause credit issues
in the future. If this occurs, we may need to provide for future losses and
create a specific credit reserve on an asset by asset basis for our commercial
loans held for investment, or reduce the reported market value for our loans
held for sale. Other factors may also affect the market value of these loans.
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TABLE 13
COMMERCIAL PORTFOLIO LOAN CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
MARCH JUNE SEPTEMBER DECEMBER MARCH
2000 2000 2000 2000 2001
------- ------- --------- -------- -------
Held at Redwood......................... $16,865 $ 9,800 $32,308 $57,169 N/A
Held at Holdings........................ 17,636 42,482 32,333 18,913 N/A
Total Commercial $...................... 34,501 52,282 64,641 76,082 70,077
Number of Loans......................... 11 14 17 20 18
Average Loan Size....................... $ 3,136 $ 3,734 $ 3,802 $ 3,804 $ 3,893
Serious Delinquency $................... 0 0 0 0 0
Serious Delinquency %................... 0% 0% 0% 0% 0%
Serious Delinquency %................... 0% 0% 0% 0% 0%
Realized Credit losses.................. 0 0 0 0 0
California %............................ 71% 61% 69% 73% 71%
Interest Expense
Interest expense declined over the last year, from $34.9 million in the
first quarter of 2000 to $31.4 million in the first quarter of 2001, as we
reduced our average borrowings from $2.2 billion to $2.0 billion. Our cost of
funds was flat on a year over year basis but declined sharply in the first
quarter of 2001 from the previous quarter as short-term interest rates declined.
TABLE 14
INTEREST EXPENSE
(ALL DOLLARS IN THOUSANDS)
LONG LONG SHORT SHORT TOTAL TOTAL
AVERAGE TERM TERM AVERAGE TERM TERM INTEREST COST OF
LONG DEBT DEBT SHORT DEBT DEBT EXPENSE FUNDS
TERM INTEREST COST OF TERM INTEREST COST OF COST OF AND AND
DEBT EXPENSE FUNDS DEBT EXPENSE FUNDS HEDGING HEDGING HEDGING
---------- -------- ------- ---------- -------- ------- ------- -------- -------
Q1: 2000............. $ 972,338 $15,359 6.32% $1,225,562 $19,164 6.25% 0.07% $ 34,931 6.36%
Q2: 2000............. 1,258,859 20,927 6.65% 865,068 13,987 6.47% 0.04% 35,133 6.62%
Q3: 2000............. 1,191,730 20,449 6.86% 827,114 14,053 6.80% 0.04% 34,694 6.87%
Q4: 2000............. 1,125,898 19,559 6.95% 819,160 14,151 6.91% 0.03% 33,845 6.96%
Q1: 2001............. 1,072,172 17,838 6.65% 910,515 13,444 5.91% 0.03% 31,413 6.34%
1999................. $1,090,242 $65,785 6.03% $ 955,890 $51,377 5.37% 0.10% $119,227 5.83%
2000................. 1,137,324 76,294 6.71% 933,619 61,355 6.57% 0.05% 138,603 6.69%
Short-term debt balances rose slightly during the first quarter of 2001 to
fund the increase in our investment portfolio. All of our long-term debt for our
residential loans was issued through our special purpose financing subsidiary,
Sequoia. Long-term debt declined slightly as a result of principal repayments
received in our residential retained portfolio. We issued $17 million of new
long-term debt during the quarter to fund two of our commercial loans to
maturity. We may issue more long-term debt in 2001, especially if we acquire
portfolios of residential loans. In April 2001, the credit rating on three of
our debt issues, Sequoia 3 M1 to M3, were each upgraded by Fitch IBCA rating
agency.
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TABLE 15
LONG-TERM DEBT CHARACTERISTICS
(ALL DOLLARS IN THOUSANDS)
PRINCIPAL
OUTSTANDING INTEREST
ESTIMATED AT RATE AT
DEBT ISSUE ORIGINAL STATED CALLABLE MARCH 31, MARCH 31,
LONG TERM DEBT ISSUE RATING DATE ISSUE AMOUNT INDEX MATURITY DATE 2001 2001
- -------------------- ------ ------- ------------ ----------- -------- --------- ----------- ---------
Sequoia 1 A1......... AAA 7/29/97 $ 334,347 1m LIBOR 2/15/28 Called $ 0 N/A
Sequoia 1 A2......... AAA 7/29/97 200,000 Fed Funds 2/15/28 Called 0 N/A
Sequoia 2 A1......... AAA 11/6/97 592,560 1y Treasury 3/30/29 2004 280,674 6.99%
Sequoia 2 A2......... AAA 11/6/97 156,600 1m LIBOR 3/30/29 2004 74,176 5.39%
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 146,228 6.35%
Sequoia 3 A4......... AAA 6/26/98 121,923 Fixed 5/31/28 2002 121,923 6.25%
Sequoia 3 M1......... AA/AAA 6/26/98 16,127 Fixed 5/31/28 2002 16,127 6.79%
Sequoia 3 M2......... A/AA 6/26/98 7,741 Fixed 5/31/28 2002 7,741 6.79%
Sequoia 3 M3......... BBB/A 6/26/98 4,838 Fixed 5/31/28 2002 4,838 6.79%
Sequoia 1A A1........ AAA 5/4/99 157,266 1m LIBOR 2/15/28 2003 83,204 5.69%
Sequoia 4 A.......... AAA 3/21/00 377,119 1m LIBOR 8/31/24 2008 304,242 5.34%
Commercial 1......... N/A 3/30/01 8,628 1m LIBOR 11/1/02 N/A 8,628 8.58%
Commercial 2......... N/A 3/30/01 8,320 1m LIBOR 10/1/03 N/A 8,320 8.58%
Total L-T Debt....... $2,470,128 $1,056,100 6.15%
Net Interest Income After Credit Expenses
Net interest income after credit expenses rose from $7.9 million in the
first quarter of 2000 to $10.2 million in the first quarter of 2001. We
benefited from rapidly falling interest rates in the first quarter of 2001, as
our cost of funds declined faster than our asset yields. In addition, we
benefited from increased portfolio investment made possible by retention of free
cash flow generated in excess of our dividend requirements. Net interest income
divided by equity increased from 14.76% in the first quarter of 2000 to 18.83%
in the first quarter of 2001.
We believe that we have reduced the potential sensitivity of our net
interest income and earnings to changes in interest rates and prepayment rates,
although earnings are still sensitive to such market factors. We generally
maintained or increased our portfolio margins last year when short-term interest
rates increased. Although we believe that over time we have increased the
stability of our margins, as part of our asset/liability strategy we did allow
for the possibility of increased margins on a temporary basis following periods
of short-term interest rate decline. We expect to benefit from declining
interest rates in the second and third quarters of 2001, although probably not
to the same degree as we did in the first quarter.
While falling short-term interest rates may boost earnings temporarily,
lower levels of interest rates will generally lead to lower earnings after a few
quarters as the benefit of lower cost of funds is more than offset by lower
asset yields. Even if yields decline by the same amount as our cost of funds, we
have more assets than liabilities, so the overall results would normally be
lower net interest income. Ongoing changes in our product mix, emphasizing
residential loan products rather than the investment portfolio, and changes in
our asset/ liability mix to include more fixed-rate loans, may mitigate this
effect.
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TABLE 16
NET INTEREST INCOME
(ALL DOLLARS IN THOUSANDS)
NET INTEREST INTEREST
INTEREST RATE RATE NET
TOTAL INCOME COST OF SPREAD MARGIN INTEREST
INTEREST COST OF AFTER EARNING FUNDS AFTER AFTER INCOME/
INCOME FUNDS PLUS CREDIT ASSET PLUS CREDIT CREDIT AVERAGE
REVENUES HEDGING PROVISIONS YIELD HEDGING PROVISIONS PROVISIONS EQUITY
-------- ---------- ---------- ------- ------- ---------- ---------- --------
Q1: 2000............. $ 42,819 $ (34,931) $ 7,888 7.25% 6.36% 0.89% 1.30% 14.76%
Q2: 2000............. 43,008 (35,133) 7,875 7.54% 6.62% 0.92% 1.34% 14.78%
Q3: 2000............. 41,679 (34,694) 6,985 7.62% 6.87% 0.75% 1.25% 13.10%
Q4: 2000............. 41,755 (33,845) 7,910 7.88% 6.96% 0.92% 1.46% 14.68%
Q1: 2001............. 41,637 (31,413) 10,224 7.72% 6.34% 1.38% 1.85% 18.83%
1999................. $145,964 $(119,227) $26,737 6.63% 5.83% 0.80% 1.17% 11.24%
2000................. 169,261 (138,603) 30,658 7.56% 6.69% 0.87% 1.33% 14.33%
Operating Expenses
Fixed operating expense (expenses excluding performance-based compensation)
declined from $1.7 million in the first quarter of 2000 to $1.6 million in the
first quarter of 2001. Variable operating expenses (compensation based on return
on equity and dividends) are accrued each quarter based on that quarter's
profitability; with record results in the first quarter of 2001, variable
expenses were $1.6 million. Included in variable operating expenses was $0.2
million of variable stock option expense recorded due to the increase in our
stock price to $19.75 at March 31, 2001. We estimate variable stock option
expense will be approximately $0.2 million ($0.02 per share) for each $1.00
increase in our stock price. Variable stock option expense may be reversed
(benefiting income) should our stock price fall.
TABLE 17
OPERATING EXPENSES
(ALL DOLLARS IN THOUSANDS)
ONGOING ONGOING ONGOING
REDWOOD CLOSED TOTAL FIXED VARIABLE
AND BUSINESS ONGOING ONGOING ONGOING EXPENSE/ EXPENSE/ EXPENSE/
HOLDINGS UNITS TOTAL FIXED VARIABLE EQUITY EQUITY EQUITY
-------- -------- ------- ------- -------- -------- -------- --------
Q1: 2000................. $ 2,999 $ 197 $ 2,802 $1,718 $1,084 5.24% 3.21% 2.03%
Q2: 2000................. 2,823 0 2,823 1,703 1,120 5.30% 3.20% 2.10%
Q3: 2000................. 2,597 0 2,597 1,833 764 4.87% 3.44% 1.43%
Q4: 2000................. 1,798 0 1,798 1,401 397 3.34% 2.60% 0.74%
Q1: 2001................. 3,136 0 3,136 1,561 1,575 5.78% 2.88% 2.90%
1999..................... $25,879 $17,393 $ 8,486 $7,811 $ 675 3.57% 3.27% 0.30%
2000..................... 10,217 197 10,020 6,655 3,365 4.68% 3.11% 1.57%
We believe that we currently have the staff and systems that we will need
to manage a much larger company. We believe that we are likely to benefit from
substantial operating leverage in the event that we raise additional equity
capital. With growth in our portfolios and capital employed following an equity
offering, we believe revenue growth will exceed growth in fixed operating
expenses. This could result in an increase in earnings per share and dividends
per share. However, our variable expenses could increase as a result of stronger
performance in income and dividends or by an increase in our stock price.
Variable expenses will increase and decrease from quarter to quarter based on
quarterly performance and our stock price.
As a result of our potential operating leverage, we believe that $0.15 to
$0.20 per share annually after approximately three quarters is a reasonable
current estimate of potential earnings per share improvement (relative to what
earnings would otherwise be) should we complete an equity offering of $50
million and profitably employ the proceeds in our real estate finance business.
As always, there are risks. Any such benefits
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may not be achieved. In addition, such an equity offering would likely dilute
earnings for several quarters until the new capital is employed profitably.
Core Earnings
Core earnings are earnings from ongoing operations before mark-to-market
adjustments.
Our core earnings were $6.4 million in the first quarter of 2001, an
increase of 41% from the $4.5 million earned in the first quarter of 2000 and an
increase of 14% from the $5.6 million earned in the fourth quarter of 2000.
The table below reconciles core earnings to reported GAAP earnings, showing
Holdings and Redwood using the 2001 format for presentation (i.e., as if
Holdings had been consolidated with Redwood for the periods shown).
TABLE 18
CORE EARNINGS AND GAAP EARNINGS
PRESENTED AS IF HOLDINGS WAS CONSOLIDATED IN ALL QUARTERS
(ALL DOLLARS IN THOUSANDS)
TOTAL NET
INTEREST OPERATING
INCOME EXPENSES
AFTER OF MARKET CLOSED REPORTED
CREDIT ONGOING PREFERRED CORE VALUE BUSINESS GAAP
PROVISIONS OPERATIONS DIVIDENDS EARNINGS CHANGES UNITS EARNINGS
---------- ---------- --------- -------- ------- -------- --------
Q1: 2000............. $ 8,019 $ (2,802) $ (681) $ 4,536 $(1,164) $ (89) $ 3,283
Q2: 2000............. 8,000 (2,823) (681) 4,496 (1,452) 43 3,087
Q3: 2000............. 7,229 (2,597) (681) 3,951 927 0 4,878
Q4: 2000............. 8,082 (1,798) (681) 5,603 (640) 0 4,963
Q1: 2001............. 10,224 (3,136) (681) 6,407 273 0 6,680
1999................. $27,849 $ (8,486) $(2,741) $16,622 $ 38 $(17,673) $(1,013)
2000................. 31,329 (10,020) (2,724) 18,585 (2,329) (46) 16,210
Throughout 2001, we currently expect net interest income and core earnings
to decline from first quarter 2001 levels due to falling short-term interest
rates. Lower short-term interest rates also are likely, we believe, to put
downward pressure on year 2002 core earnings. Positive offsets to this trend
could be an increase in our residential loan portfolios relative to our
investment portfolio and potential earnings accretion caused by operating
leverage if an equity offering is completed.
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The table below reconciles core earnings per share to reported GAAP
earnings per share.
TABLE 19
CORE EARNINGS PER SHARE AND GAAP EARNINGS PER SHARE
PRESENTED AS IF HOLDINGS WAS CONSOLIDATED IN ALL QUARTERS
(DOLLARS PER SHARE)
AVERAGE MARKET CLOSED REPORTED
DILUTED CORE VALUE BUSINESS GAAP
SHARES EARNINGS CHANGES UNITS EARNINGS
--------- -------- ------- -------- --------
Q1: 2000.................................. 8,844,606 $0.51 $(0.13) $(0.01) $ 0.37
Q2: 2000.................................. 8,883,651 0.51 (0.16) 0.00 0.35
Q3: 2000.................................. 8,908,399 0.44 0.11 0.00 0.55
Q4: 2000.................................. 8,962,950 0.62 (0.07) 0.00 0.55
Q1: 2001.................................. 9,065,221 0.71 0.03 0.00 0.74
1999...................................... 9,768,345 $1.71 $ 0.00 $(1.81) $(0.10)
2000...................................... 8,902,069 2.08 (0.26) (0.00) 1.82
Core earnings is not a measure of earnings in accordance with generally
accepted accounting principles. It is calculated as GAAP earnings from ongoing
operations less mark-to-market adjustments. Management believes that core
earnings provides relevant and useful information regarding Redwood's results of
operations in addition to GAAP measures of performance. Because all companies
and analysts do not calculate non-GAAP measures such as core earnings in the
same fashion, core earnings as calculated by us may not be comparable to
similarly titled measures reported by other companies.
Market Value Changes
In the first quarter of 2001, assets marked-to-market through the income
statement increased in value by $2.6 million and assets marked-to-market through
the balance sheet increased in value by $0.1 million. Thus, the total
mark-to-market adjustments for the quarter totaled positive $2.7 million.
However, as a result of adopting EITF 99-20 in the first quarter of 2001, we
reclassified certain cumulative mark-to-market adjustments from prior years from
the balance sheet to the income statement.
Under the provisions of EITF 99-20, if the discounted value of probable
future cash flows deteriorates from original assumptions, certain securitized
interests should be marked-to-market through the income statement. Only negative
mark-to-market adjustments are allowed under this principle. For a set of assets
that we acquired prior to 1997, credit performance has not been as strong as we
originally assumed, causing an adverse change to future cash flows. Upon
adoption of EITF 99-20, we took the market valuation adjustment on these assets
that we had previously recorded through our balance sheet and recognized the
loss through our income statement. Any subsequent adjustments under the
provisions of EITF 99-20 will be recognized as negative mark-to-market
adjustments through our income statement.
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TABLE 20
MARKET VALUE CHANGES
(ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
NET NET CUMULATIVE NET
INCOME CUMULATIVE INCOME BALANCE EFFECT BALANCE
STATEMENT EFFECT UPON STATEMENT SHEET UPON SHEET TOTAL
MARKET ADOPTING MARKET MARKET ADOPTING MARKET MARKET
ADJUST. EITF 99-20 ADJUST. ADJUST. EITF 99-20 ADJUST. ADJUST.
--------- ----------- --------- ------- ---------- ------- -------
Q1: 2000.............. $(1,225) $ 0 $(1,225) $ (487) $ 0 $ (487) $(1,712)
Q2: 2000.............. (1,359) 0 (1,359) (886) 0 (886) (2,245)
Q3: 2000.............. 927 0 927 720 0 720 1,647
Q4: 2000.............. (639) 0 (639) 3,912 0 3,912 3,273
Q1: 2001.............. 2,641 (2,368) 273 100 2,368 2,468 2,741
1999.................. $ 284 $ 0 $ 284 $(2,978) $ 0 $(2,978) $(2,694)
2000.................. (2,296) 0 (2,296) 3,259 0 3,259 963
Asset market values increased in part due to short-term rate declines. When
short-term interest rates stabilize or increase, asset values may decline from
their current levels. Many other factors affect market values.
Shareholder Wealth
In the 6.5 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 $21.94 per share by March 31, 2001
through the retention of cash by keeping dividends lower than cash flow, changes
in market values of assets, issuance of stock at prices above book value, and
repurchases of stock below book value. Since we mark-to-market most of our
assets through our income statement or balance sheet, reported book value is a
good approximation of real intrinsic value in the company. Cumulative dividends
paid during this period were $7.82 per share, and reinvestment earnings on those
dividends were $4.62 per share. Thus, cumulatively, shareholder wealth has
increased from $11.67 per share to $34.38 per share during this 6.5-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 21
SHAREHOLDER WEALTH
(DOLLARS PER SHARE)
BOOK YEAR TO CUMULATIVE
VALUE DATE OR REINVESTMENT CUMULATIVE
PER ANNUAL CUMULATIVE EARNINGS ON SHAREHOLDER
SHARE DIVIDENDS DIVIDENDS DIVIDENDS WEALTH
------ --------- ---------- ------------ -----------
Sep-94.............................. $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
Mar-01.............................. 21.94 0.50 7.82 4.62 34.38
Dividends
We increased our common stock dividend from $0.44 per share in the fourth
quarter of 2000 to $0.50 per share in the first quarter of 2001. We believe the
outlook for further increases in our dividend rate is positive. As a REIT, our
minimum dividend rate is determined by our taxable income. Currently, we expect
that our taxable income may exceed our core earnings in 2001 and perhaps in 2002
as well, although there are many GAAP -- Tax differences which cannot
necessarily be predicted. In general, we note that reduction of income through
credit provisions for our residential retained loan portfolio, and reductions in
effective yield through the setting aside of credit reserves upon acquisition of
credit enhancement interests, are not allowed in the calculation of taxable
income. Thus, as our credit-based activities, our credit provisions, and our
credit reserves grow, there may be an increasing tendency for our taxable
income, and our dividends, to exceed our core earnings.
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
Over the past several quarters, our cash flow from operations has exceeded
our earnings and our dividend distributions. In the first quarter of 2001, cash
flow from operations was $8.0 million, consisting of earnings of $6.7 million
plus non-cash depreciation, amortization, compensation, and mark-to-market
adjustments of $1.3 million. Our free cash flow, after reduction in working
capital, property, plant, equipment, and other non-earning assets, was $12.5
million. In addition, we issued $1.0 million in new common stock. We used the
available cash from these sources to fund our common stock dividend of $3.9
million and to increase our investment in our portfolio activities by $9.6
million.
Our ability to retain significant amounts of the free cash flow that we
generate may be diminished in the future should our minimum dividend
distribution requirements increase relative to core earnings (see the discussion
on "Dividends" above).
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TABLE 22
CASH FLOW
(ALL DOLLARS IN THOUSANDS)
CHANGES
IN FUNDS
CASH WORKING (INVESTMENT IN)/ AVAILABLE
FLOW CAPITAL FREE DIVIDENDS (PURCHASE)/ FOR
FROM AND OTHER CASH FROM COMMON SALE PORTFOLIO
OPERATIONS ASSETS FLOW HOLDINGS DIVIDENDS OF STOCK INVESTING
---------- --------- ------- ---------------- --------- ----------- ---------
Q1: 2000.............. $ 6,325 $ (767) $ 5,558 $ 4,999 $ (2,196) $ 45 $ 8,406
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 (2,275) 4,964 0 (3,700) 2 1,266
Q1: 2001.............. 8,006 4,457 12,463 0 (3,876) 986 9,573
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
At March 31, 2001, 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 first quarter of 2001. Outstanding borrowings under these
agreements were $0.9 billion at March 31, 2001, an increase from $0.7 billion at
year-end 2000 due to net acquisitions in our investment portfolio.
We had three committed borrowing facilities for residential assets totaling
$80 million and two borrowing facilities for commercial assets totaling $100
million at March 31, 2001. There are certain restrictions regarding the
collateral that we can pledge to secure these committed facilities but they
generally allow us to fund either our commercial mortgage loans or our
residential credit enhancement interests. We continue to meet the debt covenant
tests required by our committed bank credit facility agreements and have not
experienced difficulty in extending these facilities or negotiating new lines.
Outstanding borrowings under these committed agreements were $86 million at
March 31, 2001, a decrease from the $88 million at December 31, 2000.
Under our internal risk-adjusted capital system, we maintain liquidity
reserves in the form of cash and unpledged liquid assets. These liquidity
reserves may be needed in the event of a decline in the market value, or in the
acceptability to lenders of the collateral we pledge to secure short-term
borrowings, or for other liquidity needs. We maintained liquidity reserves at or
in excess of our policy levels during the first quarter of 2001. At March 31,
2001, we had $53 million of unrestricted cash and highly liquid (unpledged)
assets available to meet potential liquidity needs. Total available liquidity
equaled 6% of our short-term, uncommitted debt balances. At December 31, 2000,
we had $54 million of liquid assets, equaling 7% of our short-term debt
balances.
At this time, we see no material negative trends that we believe would
affect our access to short-term borrowings or bank credit lines, that would
suggest that our liquidity reserves would be called upon, or that would likely
cause us to be in danger of a covenant default. However, many factors, including
ones external to us, may affect our liquidity in the future.
The $1.1 billion of long-term debt on our March 31, 2001 balance sheet is
non-recourse debt. Substantially all this debt was issued through our special
purpose financing subsidiaries and is collateralized by residential mortgage
loans. The remaining $17 million of this debt is backed by commercial loans and
was created through the sale of senior participations. The holders of our
long-term debt can look only to the cash flow from the mortgages specifically
collateralizing the debt for repayment. By using this source of financing, our
liquidity risks are limited. Our special purpose financing subsidiaries that
issue debt have no call on Redwood's general liquidity reserves, and there is no
debt rollover risk as the loans are financed to maturity. The market for AAA
rated long-term debt of the type that we issue through our special purpose
financing subsidiaries is a large, global market that has been relatively stable
for many years. At this time, we know of no
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41
reason why we would not be able to issue more of this debt on reasonable terms
if we should choose to do so. The market for senior participations on commercial
loans of the types in our portfolio is not large and there can be no assurance
that we will be able to sell any future participations.
Excluding short and long term collateralized debt, we are capitalized
entirely by common and preferred equity capital. Our equity base increased from
$216 million to $222 million thus far in 2001 as a result of asset appreciation,
retention of cash flow, and stock issuance of $1 million. We 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 March 31, 2001, 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;
18% of short-term debt funded residential whole loans; 10% of investment
portfolio securities; and 31% of commercial retained loan portfolio.
Our total risk-adjusted capital guideline amount for assets on our balance
sheet was $215 million (9% of asset balances) at March 31, 2001. Capital
required for outstanding commitments at March 31, 2001 for asset purchases
settling later in 2001 was $1 million. Total capital available was $222 million;
our available capital exceeded our internal risk-adjusted capital policy
guideline minimum amount of $216 million by $6 million at March 31, 2001.
At March 31, 2001, our capital base of $222 million supported at-risk
assets (excluding long-term funded residential loans owned by financing trusts)
of $1.2 billion funded with short-term debt of $1.0 billion. Excluding
non-recourse debt and related assets, our equity-to-assets ratio was 18% and our
debt to equity ratio was 4.5 times. During the first quarter of 2001, our
leverage on recourse assets increased primarily due to our acquiring assets in
our investment portfolio. At year-end 2000, our equity-to-assets ratio was 22%
and our debt to equity ratio was 3.5 times. Over the past year, we have
generally maintained these ratios within the ranges stated above. In the future,
our leverage may increase for a period of time from increases in our investment
portfolio following issuance of additional equity or following the acquisition
of residential loans we eventually intend to securitize. Loans that we acquire
for securitization are funded with short-term debt between acquisition and
securitization so our leverage ratios may increase while these loans are held
for securitization.
TABLE 23
RECOURSE ASSETS
(ALL DOLLARS IN THOUSANDS)
AT RISK RECOURSE EQUITY TO RECOURSE DEBT
ASSETS DEBT EQUITY AT-RISK ASSETS TO EQUITY
---------- ---------- -------- -------------- -------------
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
Q1: 2001............................ 1,226,851 992,597 221,671 18.07% 4.5
1999................................ $1,471,570 $1,253,565 $209,935 14.27% 6.0
2000................................ 983,097 756,222 215,663 21.94% 3.5
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RISK MANAGEMENT
We seek to manage the risks inherent in all financial
institutions -- interest rate, market value, liquidity, prepayment, and credit
risks -- in a prudent manner designed to insure our longevity. At the same time,
we endeavor to provide our shareholders an opportunity to realize 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 March 31, 2001, we owned mortgage securities and loans totaling $1.1
billion that we account for on a mark-to-market basis (in the case of mortgage
loans, on a lower-of-cost-or-market basis) for purposes of determining reported
earnings. Of these assets, 96% had adjustable-rate coupons and 4% had fixed-rate
coupons. All of our $1.6 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 these assets are funded with
short-term borrowings.
At March 31, 2001, we owned $0.1 billion of assets that were
marked-to-market on our balance sheet. Market value fluctuations of these assets
can affect the reported value of our stockholders' equity base.
Interest Rate Risk
At March 31, 2001, we owned $2.3 billion of assets and had $2.1 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. Over periods of time longer than a few quarters, we
generally earn less in a lower short-term interest rate environment and may earn
more over time in a higher short-term interest rate environment.
At March 31, 2001, we owned hybrid mortgage assets (with fixed-rate coupons
for 3 to 7 years and adjustable-rate coupons thereafter) totaling $0.3 billion.
We had debt with interest rate reset characteristics matched to the hybrid
mortgages totaling $0.3 billion.
At March 31, 2001, we owned $0.5 billion of adjustable-rate mortgage assets
with coupons that adjust 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 March 31, 2001, we
owned $0.5 billion of adjustable-rate mortgage assets with interest rates that
adjust every six months as a function of six-month LIBOR interest rates funded
with equity and with debt that had an interest rate that adjusts monthly as a
function of one-month LIBOR interest rates. Adjustable-rate assets with earnings
rates dependent on one-year U.S. Treasury rates with annual adjustments totaled
$0.7 billion at March 31, 2001. These Treasury-based assets were effectively
funded with equity and with $0.3 billion of liabilities with a cost of funds
dependent on one-year U.S. Treasury rates with annual adjustments. The remainder
of the liabilities associated with these assets had a cost of funds dependent on
one-month LIBOR rates or the daily Fed Funds rate.
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At March 31, 2001, we owned a total of $0.1 billion of fixed rate assets
funded, in part, with short-term variable rate debt that is only partially
hedged. Holding these positions should mitigate earnings declines caused by
lower yields on equity-funded assets as interest rates fall. As interest rates
rise, net earnings on these assets should fall, but this would likely be offset,
in part, by the beneficial effect of higher yields on equity-funded assets.
Interest rates and related factors can affect our spread income and our
mark-to-market results. 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 March 31, 2001, we had $1.0
billion of short-term debt.
Prepayment Risk
One measure of prepayment risk is the amount of net premium balance that we
carry on our balance sheet. At March 31, 2001 our net premium balance was $3.8
million, which was slightly lower than our net premium balance of $4.0 million
at December 31, 2001. However, in some cases our gross premium levels before
netting with discount balances may be a better measure of our risks relating to
faster mortgage prepayment levels. The amount of gross premium on our balance
increased in the first quarter of 2001, from $22 million to $27 million, as a
result of acquisitions in our investment portfolio and positive mark-to-market
adjustments. Our gross discount balance also increased during the quarter, from
$18 million to $22 million, as a result of acquisitions in our credit
enhancement portfolio.
We could have material net premium amortization expenses even if we have a
very low net premium balance or a net discount balance. This could occur because
our premium mortgage assets generally prepay at a faster rate than do our
discount mortgage assets, and because the yields of our premium assets are
generally more sensitive to prepayment rates due to their securitization
structure.
TABLE 24
UNAMORTIZED PREMIUM AND DISCOUNT BALANCES
(ALL DOLLARS IN THOUSANDS)
NET AVERAGE NET
RESIDENTIAL RESIDENTIAL COMMERCIAL PREM/(DISC) MORTGAGE PREMIUM
GROSS GROSS GROSS ON LONG- NET PREPAYMENT AMORTIZATION
PREMIUM DISCOUNT DISCOUNT TERM DEBT PREMIUM SPEED (CPR) EXPENSE
----------- ----------- ---------- ----------- ------- ------------ ------------
Q1: 2000............. $28,023 $(12,145) $ (34) $ 270 $16,114 17% $ (522)
Q2: 2000............. 25,379 (14,166) -- 240 11,453 17% 45
Q3: 2000............. 25,849 (16,599) (438) 166 8,979 17% (1,040)
Q4: 2000............. 22,319 (17,825) (531) 74 4,036 21% (818)
Q1: 2001............. 26,532 (21,672) (959) (112) 3,790 20% (869)
1999................. $27,612 $(10,886) $ (13) $(1,045) $15,669 27% $(5,162)
2000................. 22,319 (17,825) (531) 74 4,036 18% (2,335)
Credit Risk
Our principal credit risk comes from residential mortgage loans in our
retained portfolio and credit enhancement portfolio and from our commercial
mortgage loan portfolio. A small amount of our investment portfolio is currently
exposed to credit risk; the bulk of this portfolio has very high credit ratings
and would not normally be expected to incur credit losses. We have credit risk
with counter-parties with whom we do business.
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It should be noted that the establishment of a credit reserve for GAAP
purposes for our residential retained portfolio or a designated credit reserve
under the effective yield method for our credit enhancement portfolio does not
reduce our taxable income or our dividend payment obligations as a REIT. For
taxable income, many of our credit expenses will be recognized only as incurred.
Credit losses may be capital losses rather than a reduction in ordinary income.
Thus, the timing 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 establish a
credit reserve upon the acquisition of such assets. In addition, first loss and
other credit enhancement interests that are junior to our positions that we do
not own act as a form of credit reserve for us on a specific asset basis. For
our retained residential mortgage loan portfolio, we establish a credit reserve
based on anticipation of losses by taking credit provisions through our income
statement over time. For our investment portfolio, most of the assets do not
have material credit risk, and no credit reserves are generally established.
When we acquire assets for this portfolio where credit risk exists, we will
establish the appropriate reserve as necessary. For our commercial retained
portfolio, we take credit reserves on a specific asset basis when specific
circumstances may warrant such a charge for a particular loan. Management
constantly monitors the performance of all of its assets and takes appropriate
actions to mitigate potential losses to the extent possible. Regardless of how
we account for future credit loss expectations, there can be no assurance that
our estimates will prove to be correct, and thus we may need to adjust the
amounts of credit reserves we have established.
Capital Risk
Our capital levels, and thus our access to borrowings and liquidity, may be
tested, particularly if the market value of our assets securing our short-term
borrowings declines or the market for short-term borrowings changes in an
adverse manner.
Through our risk-adjusted capital policy, we assign a guideline capital
adequacy amount, expressed as a guideline equity-to-assets ratio, to each of our
mortgage assets. For short-term funded assets, this ratio will fluctuate over
time, based on changes in that asset's credit quality, liquidity
characteristics, potential for market value fluctuation, interest rate risk,
prepayment risk, and the over-collateralization requirements for that asset set
by our collateralized short-term lenders. Capital requirements for residential
mortgage securities 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 has declined over the
last few years as we have eliminated some of the risks of short-term debt
funding through issuing long-term debt. In the most recent quarters, however,
the guideline ratio has increased as we have acquired new types of assets
requiring more capital, such as commercial mortgage loans and residential credit
enhancement interests.
We do not expect that our actual capital levels will always exceed the
guideline amount. If interest rates were to rise in a significant manner, our
capital guideline amount may rise, as the potential interest rate risk of our
mortgages would increase, at least on a temporary basis, due to periodic and
life caps and slowing prepayment rates. We measure all of our mortgage assets
funded with short-term debt at estimated market value for the purpose of making
risk-adjusted capital calculations. Our actual capital levels, as determined for
the risk-adjusted capital policy, would likely fall as rates increase and as the
market values of our mortgages, net of mark-to-market gains on hedges, decrease.
(Such market value declines may be temporary, as future coupon adjustments on
adjustable-rate mortgage loans may help to restore some of the lost market
value.)
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In this circumstance, or any other circumstance in which our actual capital
levels decreased below our capital adequacy guideline amount, we would generally
cease the acquisition of new mortgage assets until capital balance was restored
through prepayments, interest rate changes, or other means. In certain cases
prior to a planned equity offering or other circumstances, the Board of
Directors may authorize management to acquire mortgage assets in a limited
amount beyond the usual constraints of our risk-adjusted capital policy.
Inflation Risk
Virtually all of our assets and liabilities are financial in nature. As a
result, interest rates, changes in interest rates and other factors drive our
performance far more than does inflation. Changes in interest rates do not
necessarily correlate with inflation rates or changes in inflation rates.
Our financial statements are prepared in accordance with GAAP and our
dividends must equal at least 90% of our net income as calculated for tax
purposes. In each case, our activities and balance sheet are measured with
reference to historical cost or fair market value without considering inflation.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For a discussion on the qualitative disclosures about market risk, please
refer to our Risk Management presentation in Management's Discussion and
Analysis. Our quantitative risk has not materially changed from our disclosures
in our Year 2000 Form 10-K included in our Annual Report.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
At March 31, 2001, there were no pending legal proceedings to which the
Company was a party or of which any of its property was subject.
ITEM 2. CHANGES IN SECURITIES
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 11.1 to Part I -- Computation of Earnings Per Share for the three
months ended March 31, 2001 and 2000.
(b) Reports
Form 8-K filed on January 10, 2001, regarding the Company's acquisition of
100% of RWT Holdings, Inc. voting common stock.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
REDWOOD TRUST, INC.
Dated: May 11, 2001 By: /s/ DOUGLAS B. HANSEN
------------------------------------
Douglas B. Hansen
President
(authorized officer of registrant)
Dated: May 11, 2001 By: /s/ HAROLD F. ZAGUNIS
------------------------------------
Harold F. Zagunis
Vice President, Chief Financial
Officer
Secretary, Treasurer and Controller
(principal financial and accounting
officer)
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