1
================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO _____________
COMMISSION FILE NUMBER: 1-13759
REDWOOD TRUST, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 68-0329422
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
591 REDWOOD HIGHWAY, SUITE 3100
MILL VALLEY, CALIFORNIA 94941
(Address of principal executive offices) (Zip Code)
(415) 389-7373
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: Name of Exchange on Which Registered:
CLASS B 9.74 % CUMULATIVE CONVERTIBLE PREFERRED STOCK, NEW YORK STOCK EXCHANGE
PAR VALUE $0.01 PER SHARE
(Title of Class)
COMMON STOCK, PAR VALUE $0.01 PER SHARE NEW YORK STOCK EXCHANGE
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
At March 17, 1999 the aggregate market value of the voting stock held by
non-affiliates of the Registrant was $148,352,257.
The number of shares of the Registrant's Common Stock outstanding on March 17,
1999 was 10,331,817.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement issued in connection
with the 1999 Annual Meeting of Stockholders are incorporated by reference into
Part III.
================================================================================
2
REDWOOD TRUST, INC.
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
----
PART I
Item 1. BUSINESS ...................................................... 3
Item 2. PROPERTIES .................................................... 32
Item 3. LEGAL PROCEEDINGS ............................................. 32
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ........... 32
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS ............................... 33
Item 6. SELECTED FINANCIAL DATA ....................................... 34
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS ................. 35
Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ...... 98
Item 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE ...................................... 98
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ............ 98
Item 11. EXECUTIVE COMPENSATION ........................................ 98
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT ......................................... 98
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ................ 98
PART IV
Item 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENTS SCHEDULES AND
REPORTS ON FORM 8-K ........................................... 98
CONSOLIDATED FINANCIAL STATEMENTS ....................................... F-1
2
3
PART I
ITEM 1. BUSINESS
THE COMPANY
Redwood Trust, Inc (the "Company"), together with its affiliate RWT Holdings,
Inc. ("Holdings"), provide funding to diverse segments of the U.S. mortgage
market. Mortgage production operations at Holdings originate and acquire
mortgage loans for subsequent sale to mortgage investors as loan portfolios or
mortgage securities. The Company's portfolio investment operations own and
manage a portfolio of mortgage loans and mortgage securities ("Mortgage Assets")
funded with equity and with mortgage-backed bonds and other debt. The Company's
portfolio acquires Mortgage Assets from Holdings and from other mortgage
originators, mortgage processors and secondary mortgage market participants.
The Company funded the start-up of mortgage production operations at Holdings in
1998. At the end of 1998, Holdings was building three new businesses, each
conducted in a separate subsidiary of Holdings. Redwood Residential Funding,
Inc. ("RRF") acquires newly originated residential loans from mortgage bankers.
Redwood Commercial Funding, Inc. ("RCF") originates small balance commercial
mortgages. Redwood Financial Services, Inc. ("RFS") acts as a principal in whole
loan acquisition, sale and securitization transactions, typically involving
banks and thrifts as customers. After processing its mortgage loan acquisitions,
each of these entities then sells loans and mortgage securities to banks,
thrifts, Wall Street firms, mortgage REITs and other mortgage investors.
Holdings profits to the extent that it sells mortgage assets at prices that will
cover the acquisition costs of the loans plus overhead and taxes.
Holdings is an unconsolidated affiliate of the Company. The Company owns a 99%
economic interest in Holdings through its ownership of Holdings' non-voting
preferred stock. At December 31, 1998, the book value of this investment was
$15.1 million; the Company expects to make substantial new investments in
Holdings in 1999. Holdings reported a loss during 1998 due to the start-up
nature of its operations.
Mortgage investment operations at the Company earn a profit to the extent that
interest income and net asset appreciation gains generated by the Mortgage Asset
portfolio exceed interest expenses on borrowings and the cost of operations and
hedging. The Company elects Real Estate Investment Trust ("REIT") status for
income tax purposes. As a result, the Company does not pay tax on net mortgage
investment income or on any dividends received from taxable affiliates so long
as the Company distributes its taxable income as dividends and meets certain
other REIT tests. See "Certain Federal Income Tax Considerations" commencing on
page 25 of this Form 10-K.
Statements in this report regarding the Company's business and the business of
the Holdings units which are not historical facts are "forward-looking
statements" as contemplated in the Private Securities Litigation Reform Act of
1995. Such statements should be read in light of the risks and uncertainties
attendant to the business of the Company and Holdings. For a complete
description of the risks associated with the business of the Company and
Holdings, see "Risk Factors" commencing on page 16 of this Form 10-K.
Reference is made to the Glossary commencing on page 101 of this report for
definitions of terms used in the following description of the Company's and
Holdings' businesses and elsewhere in this report.
COMPANY BUSINESS AND STRATEGY
The business and strategy of the Company with respect to the mortgage production
operations of its affiliate is discussed below under "RWT Holdings Business and
Strategy" commencing on page 11.
The objective of the Company's mortgage investment operations is to generate
earnings for shareholders by acquiring or creating subordinated mortgage
securities or other types of mortgage equity interests (thus using its capital
to credit-enhance mortgage loans to facilitate the process of turning mortgage
loans into AAA-rated mortgage securities), by acting as a financial intermediary
in holding mortgage loans in portfolio and issuing to investors AAA-rated
callable long-term debt collateralized by those mortgages, and by otherwise
being an
3
4
efficient and productive investor in Mortgage Assets. Since all mortgage
investment operations at December 31, 1998 were conducted at the Company, which
enjoys REIT tax status, the Company endeavors to find those areas of the
mortgage investment business that are most advantaged by the Company's tax
status and corporate structure. To achieve its business objective, the Company's
strategy is to focus on the following elements of mortgage investment
operations.
- Asset Acquisition
- Risk Management
- Capital and Leverage Utilization
ASSET ACQUISITION
TYPES OF ASSETS
The Mortgage Assets purchased by the Company may consist of Single-Family,
Multi-Family and Commercial Mortgage Assets. At the end of 1998, 76% of the
Mortgage Assets acquired by the Company bore adjustable interest rates. Hybrid
mortgages assets, with an initial period to the first rate adjustment greater
than one year, made up 23% of Mortgage Assets. The remaining 1% of Mortgage
Assets were fixed-rate mortgages. The Company may also acquire common stock,
preferred stock and/or debt in other REITs. The Company may also acquire its own
common or preferred stock, when permitted by applicable securities and state
corporation laws.
The majority of the Company's Mortgage Assets at December 31, 1998 consisted of
mortgage loans and pass-through mortgage securities. The Company may acquire,
without limitations, other types of mortgage assets, including potentially,
structured mortgage securities that are relatively illiquid and have leveraged
risk with respect to mortgage credit, prepayment and other risks. The Company
generally intends to increase its credit risk profile by providing
credit-enhancement to, and thus retaining some of the credit risk of,
residential and commercial loans produced by Holdings and others. The Company
does not plan to acquire or retain any Real Estate Mortgage Investment Conduit
("REMIC") residual interest that may give rise to the distribution to
shareholders of "excess inclusion" income as defined under Section 860E of the
Code. See "Certain Federal Income Tax Considerations - Taxation of Tax-Exempt
Entities."
The Company's Asset Acquisition/Capital Allocation Policies utilize a return on
equity calculation that includes adjustments for credit risk, borrowing costs,
hedging and the Risk-Adjusted Capital Policy requirements. The relative
attractiveness of various asset types will vary over time. The Company may
acquire its Mortgage Assets in the secondary mortgage market or upon origination
pursuant to arrangements with loan originators, other secondary mortgage market
participants or from Holdings. The Company may issue Commitments to originators
and other sellers of Mortgage Loans and Mortgage Securities. These Commitments
will obligate the Company to purchase Mortgage Assets for a specific period of
time, in a specific aggregate principal amount and at a specified price or
margin. In addition, the Company may issue Commitments to sell Mortgage Assets
held by it to another entity, including Holdings. Following the issuance of
Commitments, the Company may be exposed to risks of interest rate fluctuations
and other risks.
PORTFOLIO MANAGEMENT
The Company only acquires those Mortgage Assets for which the Company believes
it has the necessary expertise to evaluate and manage and which are consistent
with the Company's balance sheet guidelines and risk management objectives.
Since the intention of the Company is generally to hold its Mortgage Assets
until maturity, the Company generally does not seek to acquire assets whose
investment returns are only attractive in a limited range of scenarios. The
Company believes that future interest rates and mortgage prepayment rates are
very difficult to predict. Therefore, the Company seeks to acquire Mortgage
Assets that the Company believes will provide acceptable returns over a broad
range of interest rate and prepayment scenarios.
Among the asset choices available to the Company, the Company acquires those
Mortgage Assets which the Company believes will generate the highest returns on
capital invested, after considering (i) the amount and nature of anticipated
cash flows from the asset, (ii) the Company's ability to pledge the asset to
secure short-term or long-term collateralized borrowings, (iii) the increase in
the Company's risk-adjusted capital requirement determined by the Company's
Risk-Adjusted Capital Policy resulting from the purchase and financing of the
asset, and (iv) the costs of financing, hedging, managing, securitizing, and
reserving for the
4
5
asset. Prior to acquisition, potential returns on capital employed are assessed
over the life of the asset and in a variety of interest rates, yield spread,
financing cost, credit loss and prepayment scenarios.
Management also gives consideration to balance sheet management and risk
diversification issues. A specific asset which is being evaluated for potential
acquisition is deemed more (or less) valuable to the Company to the extent it
serves to decrease (or increase) certain interest rate or prepayment risks which
may exist in the balance sheet, to diversify (or concentrate) credit risk, and
to meet (or not meet) the cash flow and liquidity objectives management may
establish for the balance sheet from time to time. Accordingly, an important
part of the evaluation process is a simulation, using the Company's risk
management model, of the addition of a potential asset and its associated
borrowings and hedges to the balance sheet and an assessment of the impact this
potential asset acquisition would have on the risks in and returns generated by
the Company's balance sheet as a whole over a variety of scenarios.
The Company acquires floating-rate, adjustable-rate, hybrid and fixed-rate
Mortgage Assets. The Company generally intends to acquire fixed-rate loans when
such loans can meet its return and other standards when funded on a long-term
basis, financed with equity only, funded on a short-term basis with a
comprehensive hedging program, or funded short-term and unhedged as part of an
overall asset-liability management strategy. Generally it is anticipated that
any such long-term financing or comprehensive hedging program will serve to
reduce the risk that could arise from the funding of term fixed-rate assets.
The Company may also purchase the debt or the common or preferred stock of other
mortgage REITs or other companies when the Company believes that such purchases
will yield attractive returns on capital employed. REIT or other debt securities
may be undervalued at points in the economic cycle. When the stock market
valuations of companies are low in relation to the market value of their assets,
stock purchases can be a way for the Company to acquire an interest in a pool of
Mortgage Assets or other types of assets at an attractive price. Also, REITs and
other companies may have attractive mortgage finance or other businesses in
which the Company may want to become a partial owner. The Company does not,
however, presently intend to invest in the securities of other issuers for the
purpose of exercising control or to underwrite securities of other issuers.
The Company may seek to acquire or create mortgage finance or other businesses
when management deems such activities to be in the best interest of the
Company's shareholders.
The Company intends to acquire new Mortgage Assets, and will also seek to expand
its capital base in order to further increase the Company's ability to acquire
new assets, when the potential returns from new investments appear attractive
relative to the return expectations of stockholders. The Company may in the
future acquire Mortgage Assets by offering its debt or equity securities in
exchange for such Mortgage Assets.
The Company generally intends to hold Mortgage Assets to maturity. In addition,
the REIT provisions of the Code limit in certain respects the ability of the
Company to sell Mortgage Assets. See "Certain Federal Income Tax Considerations
- - General - Gross Income Tests" and " - Taxation of the Company." However,
management may decide to sell assets from time to time for a number of reasons
including, without limitation, to dispose of an asset as to which credit risk
concerns have risen beyond levels the Company wishes to manage, to reduce
interest rate risk, to substitute one type of Mortgage Asset for another, to
improve yield, to maintain compliance with the 55% requirement under the
Investment Company Act, to effect a change in strategy, or generally to
re-structure the balance sheet when management deems such action advisable.
Management will select any Mortgage Asset to be sold according to the particular
purpose such sale will serve. The Board of Directors has not adopted a policy
that would restrict management's authority to determine the timing of sales or
the selection of Mortgage Assets to be sold.
As a requirement for maintaining REIT status, the Company, will distribute to
stockholders aggregate dividends equaling at least 95% of its taxable income.
See "Certain Federal Income Tax Considerations - General - Distribution
Requirement." The Company's current policy is to seek to distribute 100% of its
taxable income as dividends over time.
5
6
RISK MANAGEMENT
CREDIT RISK MANAGEMENT
The Company reviews the credit risk associated with each investment and
determines the appropriate allocation of capital to apply to such investment
under its Risk-Adjusted Capital Policy. In addition, the Company attempts to
diversify its investment portfolio to avoid undue geographic and other types of
concentrations. Management monitors the overall portfolio risk and determines
appropriate levels of provision for credit loss and provides such information to
the Board of Directors.
With respect to its Mortgage Securities, the Company is exposed to various
levels of credit and special hazard risk, depending on the nature of the
underlying mortgages and the nature and level of credit enhancements supporting
such securities. Most of the Mortgage Securities owned by the Company at
December 31, 1998 had some degree of protection from normal credit losses. At
December 31, 1998 and December 31, 1997, 23% and 29%, respectively, of the
Company's Mortgage Assets were Mortgage Securities covered by credit protection
in the form of a 100% guarantee from a government-sponsored entity ("Agency
Certificates").
An additional 25% of the Company's Mortgage Assets at December 31, 1998 and
December 31, 1997 were Privately-Issued Certificates and represented interests
in pools of residential mortgage loans with partial credit enhancement; of these
amounts, 99% were rated AAA or AA. Credit loss protection for Privately-Issued
Certificates is achieved through the subordination of other interests in the
pool to the interest held by the Company, through pool insurance or through
other means. The degree of credit protection varies substantially among the
Privately-Issued Certificates held by the Company. While 99% of the
Privately-Issued Certificates held by the Company have some degree of credit
enhancement, some of these credit-enhanced Mortgage Securities are, in turn,
subordinated to other interests. Thus, should such a Privately-Issued
Certificate experience credit losses, such losses could be greater than the
Company`s pro rata share of the remaining mortgage pool, but in no event could
exceed the Company's investment in such Privately-Issued Certificate.
The Company also acquires unsecuritized Mortgage Loans. At December 31, 1998 and
December 31, 1997, 53% and 46% of the Company's Mortgage Assets were Mortgage
Loans, respectively. The Company has developed a quality control program to
monitor the quality of loan underwriting at the time of acquisition and on an
ongoing basis. The Company may conduct, or cause to be conducted, a legal
document review of each Mortgage Loan acquired to verify the accuracy and
completeness of the information contained in the mortgage notes, security
instruments and other pertinent documents in the file. As a condition of
purchase, the Company will generally select a sample of Mortgage Loans targeted
to be acquired, focusing on those Mortgage Loans with higher risk
characteristics, and submit them to a third party, nationally recognized
underwriting review firm for a compliance check of underwriting and review of
income, asset and appraisal information; The Company also may perform these
functions with Company or Holdings employees. In addition, the Company or its
agents will generally underwrite all Multifamily and Commercial Mortgage Loans
that the Company acquires. During the time it holds Mortgage Loans, the Company
will be subject to risks of borrower defaults and bankruptcies and special
hazard losses (such as those occurring from earthquakes or floods) that are not
covered by standard hazard insurance. The Company will generally not obtain
credit enhancements such as mortgage pool or special hazard insurance for its
Mortgage Loans, although individual loans may be covered by FHA insurance, VA
guarantees or private mortgage insurance and, to the extent securitized into
Agency Certificates, by such government-sponsored entity ("GSE") obligations or
guarantees.
ASSET/LIABILITY MANAGEMENT
To the extent consistent with its election to qualify as a REIT, the Company
follows an interest rate risk management program intended to protect principally
against the effects of substantial increases or decreases in interest rates.
Specifically, the Company's interest rate risk management program is formulated
with the intent to offset the potential adverse effects resulting from interest
rate fluctuations, including changes in market value, changes in prepayment
rates, and the differences between earning asset yield and cost of funds of its
Mortgage Assets and related borrowings. The Company's interest rate risk
management program encompasses a number of procedures. The Company attempts to
structure its borrowings to have interest rate adjustment indices and interest
rate adjustment periods that, on an aggregate basis, generally correspond to the
interest rate adjustment indices and interest rate adjustment periods of the
adjustable-rate, hybrid and fixed-rate Mortgage Assets
6
7
purchased by the Company. By doing so, the Company generally intends to reduce
the differences between interest rate adjustment periods of Mortgage Assets and
related borrowings that may occur.
The Company purchases and sells, from time to time, interest rate agreements in
the form of interest rate caps, interest rate floors, interest rate swaps,
interest rate futures, options on interest rate futures, mortgage and Treasury
securities and other cash instruments to attempt to mitigate interest rate and
related risks. The Company also may use such instruments to modify the
characteristics of any loan issuance or sales or to hedge the anticipated
issuance of future liabilities or the market value of certain assets. In this
way, the Company intends generally to hedge as much of the interest rate risk as
management determines is in the best interest of the stockholders of the
Company, given the cost of such hedging transactions and the need to maintain
the Company's status as a REIT. See "Certain Federal Income Tax Considerations -
General - Gross Income Tests." This determination may result in management
electing to have the Company bear a level of interest rate risk that could
otherwise be hedged when management believes, based on all relevant facts, that
bearing such risk is prudent in light of competing tax and market risks. The
Company utilizes financial futures contracts, options and forward contracts to
the extent consistent with its compliance with the REIT Gross Income Tests and
Maryland law. The Company obtained no-action relief from the Commodities Futures
Trading Commission permitting the Company to invest a small percentage of the
Company's total assets in certain financial futures contracts and options
thereon without registering as a commodity pool operator under the Commodity
Exchange Act, provided that the Company uses such instruments solely for bona
fide hedging purposes.
The Company seeks to build a balance sheet and undertake an interest rate risk
management program that is likely, in management's view, to enable the Company
to generate positive earnings and maintain an equity liquidation value
sufficient to maintain operations given a variety of potentially adverse
circumstances. Accordingly, the hedging program addresses both income
preservation and capital preservation concerns. To monitor risks of fluctuations
in earnings and in the liquidation value of the Company's equity due to market
value changes of balance sheet items, the Company models the impact of various
economic scenarios on the market value of the Company's Mortgage Assets,
liabilities and interest rate agreements. The Company believes that the existing
hedging programs will allow the Company to maintain operations throughout a wide
variety of potentially adverse circumstances without further management action.
Nevertheless, in order to further preserve the Company's capital base during
periods when management believes an adverse trend has been established,
management may decide to increase hedging activities and/or sell assets. Each of
these types of actions may lower the earnings of the Company in the short term
in order to further the objective of maintaining attractive levels of earnings
and dividends over the long term.
In all of its interest rate risk management transactions, the Company follows
certain procedures designed to limit credit exposure to counterparties,
including dealing only with counterparties whose financial strength meets the
Company's requirements.
The Company may elect to conduct a portion of its hedging operations through
Holdings or a similarly structured affiliate. Such affiliate would be subject to
Federal and state income taxes. A taxable subsidiary would not elect REIT status
and may or may not distribute any net profit after taxes to the Company and its
other stockholders. Any dividend income received by the Company from any such
taxable affiliates (combined with all other income generated from the Company's
assets, other than Qualified REIT Real Estate Assets) must not exceed 25% of the
gross income of the Company. See "Certain Federal Income Tax Considerations -
General - Gross Income Tests."
At December 31, 1998, the Company's weighted average assets and liabilities were
matched within a twelve-month period in terms of adjustment frequency and speed
of adjustment to market conditions. Looking at these two factors only (and thus
ignoring periodic and life caps for adjustable-rate mortgage assets and other
risks such as basis, liquidity and prepayment risk), the Company's net interest
spread should be stable over time periods greater than twelve months. The
majority of the Company's Mortgage Assets at December 31, 1998 had coupon rates
that adjust to market levels at least every twelve months, with a weighted
average term to reset of approximately four months. The majority of the
Company's borrowings at December 31, 1998 will either mature or adjust to a
market interest rate level within six months of such date. The short-term
borrowings had a weighted average term to rate reset of 23 days at December 31,
1998. Both changes in coupon rates earned on
7
8
adjustable-rate assets and in the rates paid on borrowings are expected to be
highly correlated with changes in LIBOR and/or Treasury rates (subject to the
effects of periodic and lifetime caps).
In the third quarter of 1998, the Company adopted mark-to-market accounting for
most of its assets and all of its interest rate agreements. Changes in the
market value of mark-to-market assets could have a large effect on the Company's
earnings. The Company's interest rate hedging activities may partially offset
changes in asset market values in some circumstances. However, market values can
change for a wide variety of reasons, many of which are not linked to interest
rate changes or which are otherwise not hedgeable.
Although the Company believes it has developed a cost-effective asset/liability
management program to provide a level of protection against interest rate, basis
and prepayment risks, no strategy can completely insulate the Company from the
effect of interest rate changes, prepayment risks, mortgage credit losses,
defaults by counterparties, or liquidity risk. Further, certain of the Federal
income tax requirements that the Company must satisfy to qualify as a REIT limit
the Company's ability to fully hedge its interest rate and prepayment risks. The
Company monitors carefully, and may have to limit, its asset/liability
management program to assure that it does not realize excessive hedging income,
or hold hedging assets having excess value in relation to total assets, which
would result in the Company's disqualification as a REIT or, in case of excess
hedging income, the payment of a penalty tax for failure to satisfy certain REIT
income tests under the Code, provided such failure was for reasonable cause. See
"Certain Federal Income Tax Considerations - General." In addition,
asset/liability management involves transaction costs that increase dramatically
as the period covered by the hedging protection increases. Therefore, the
Company may be prevented from effectively hedging its interest rate and
prepayment risks over the long-term.
PREPAYMENT RISK MANAGEMENT
The Company seeks to minimize the effects of faster or slower than anticipated
prepayment rates through structuring a diversified portfolio with a variety of
prepayment characteristics, investing in Mortgage Assets with prepayment
prohibitions and penalties, investing in certain Mortgage Securities structures
which have prepayment protections, passing on prepayment risk to the buyers of
its mortgage-backed debt and, when possible, balancing Mortgage Assets purchased
at a premium with Mortgage Assets purchased at a discount when such types of
assets are available in the marketplace and are otherwise attractive for
acquisition. In certain operating environments, including most of 1997 and 1998,
however, it was not possible for the Company to acquire attractive assets with a
zero net balance of discount and premium. In addition, changes in market values
subsequent to acquisition can effect the Company's premium and discount balances
to the extent such market value changes are reflected in earnings and assets'
basis. In these types of circumstances, net mortgage premium or discount
balances may rise and the risk of earnings variability resulting from changes in
prepayment rates may increase. The Company may purchase interest-only strips,
principal-only strips and/or other financial assets such as floors, calls,
swaptions and futures, as a hedge against prepayment risks. The Company may also
seek to create and sell interest-only and principal-only strips from existing
assets to help manage prepayment risk. Management and the Board of Directors
monitor prepayment risk through periodic review of the impact of a variety of
prepayment scenarios on the Company's revenues, net earnings, dividends, cash
flow and net balance sheet market value.
The Company owns a variety of non-agency Mortgage Securities which are
structured so that for several years they receive either less than or more than
a pro rata share of principal repayments experienced in the underlying mortgage
pool as a whole. In such Mortgage Securities, one or more classes of Senior
Securities are ordinarily entitled to receive all principal prepayments on the
underlying pool of loans until such Senior Securities have been paid down to a
specified amount determined by formula. To illustrate, a Mortgage Security
totaling $100 million of aggregate principal balance may be structured so that
there is (i) $92 million face value of Senior Securities, (ii) Mezzanine
Securities with a face value of $2 million providing credit support for the
Senior Securities, (iii) Subordinated Securities, or mortgage equity interests,
with a face value of $6 million providing credit support for the Mezzanine
Securities and the Senior Securities, and (iv) the $100 million face value of
Senior Securities, Mezzanine Securities and Subordinated Securities had been
issued in this format, the Mezzanine Securities or the Subordinated Securities
would receive no principal prepayments on the underlying loans until the $92
million face value of Senior Securities had been paid down to a
formula-determined amount, which would normally be expected to occur within a
range of three to ten years depending on the rate of
8
9
prepayments and other factors. The Company owns interests that are similar to
the Senior Securities, Mezzanine Securities and Subordinated Securities in this
example. The Company intends to increase its investment in Subordinated
Securities and other forms of mortgage equity interests.
During 1998, the Company received $1.6 billion in principal payments on its
Mortgage Assets. One commonly used measure of the average annual rate of
prepayment of mortgage principal is the conditional prepayment rate ("CPR"). The
CPR for the Company's Mortgage Assets was 30% for 1998. In addition to
prepayments, the Company also receives scheduled mortgage principal payments
(payments representing the normal principal amortization of a 30-year mortgage
loan) and other principal repayments from calls of mortgage securities and
accelerated principal payment structures of securities. Thus, the total amount
of repayments of mortgage principal received each month may exceed a pro rata
level of prepayments. The basis of the Company's Mortgage Assets at December 31,
1998 was equal to 100.57% of the face value of the assets; the net premium was
0.57%. The smaller the level of net discount or premium, the less risk there is
that fluctuations in prepayment rates will affect net interest income or net
asset appreciation income. The Company may use interest rate agreements and
other means to seek to mitigate the risk that premium and discount amortization
expenses and income and net asset appreciation income may rise or fall as
mortgage prepayments increase or decrease in falling or rising interest rate
environments.
In the third quarter of 1998, the Company moved to mark-to-market accounting for
a majority of its assets. For these assets, increases and decreases in market
values will be recorded in income and the basis of the asset will be adjusted
accordingly. As a result, the net mortgage premium or discount balances on the
Company's records will vary with market values, thus affecting future
amortization income and expense.
CAPITAL AND LEVERAGE UTILIZATION
The Company's goal is to strike a balance between the under-utilization of
leverage, which reduces potential returns to stockholders, and the
over-utilization of leverage, which could reduce the Company's ability to meet
its obligations or execute its business plan during adverse market conditions.
The Company has established a Risk-Adjusted Capital Policy which limits
management's ability to acquire additional assets during times when the actual
capital base of the Company is less than a required amount defined in the policy
(subject to certain permitted exceptions when the proceeds of additional equity
issuances must be invested). In this way, the use of balance sheet leverage is
controlled. The actual capital base as defined for the purpose of the Risk
Adjusted Capital Policy is equal to the market value of total assets funded
short-term less the book value of total collateralized short-term borrowings
plus the actual investment on a historical amortized cost basis in subsidiary
trusts ("mortgage equity interests") wherein Mortgage Assets are funded with
non-recourse, long-term debt less the book value of any parent-level debt
associated with these mortgage equity interests, less any unsecured debt.
Approximately half of the Company's assets at December 31, 1998 were funded with
equity or with long-term non-recourse debt. The Company's capital requirement
for these assets is generally equal to 100% of the equity invested, thus
equaling the total amount the Company could lose.
Mortgage interests that have some external protection from credit losses but
which are not rated as high as AAA or AA may be leveraged. These interests,
together with mortgage loans not yet securitized and AAA and AA rated mortgage
securities, are typically funded with short-term debt. There are two components
to the capital requirements the Company establishes for short-term funded
assets.
The first component of the Company's capital requirements with respect to
short-term funded assets is the current aggregate over-collateralization amount
or "haircut" that lenders require the Company to hold as capital. The haircut
for each such Mortgage Asset is determined by the lender and is subject to
change when short-term debt matures and rolls-over. Haircut levels on individual
borrowings range from 2% to 25%, and currently average 3% to 5% for the Company
as a whole. Should the market value of the pledged assets decline or haircut
requirements increase, the Company will be required to deliver additional
collateral to the lenders in order to maintain a constant over-collateralization
level on its short-term borrowings.
The second component of the Company's capital requirement with respect to
short-term funded assets is the "liquidity capital cushion." The liquidity
capital cushion is an additional amount of capital, in excess of the haircut,
which is maintained by the Company in order to meet the demands for additional
collateral by the short-
9
10
term lenders should the market value of the Company's short-term funded Mortgage
Assets decline or haircut levels increase. The aggregate liquidity capital
cushion equals the sum of liquidity cushion amounts assigned under the
Risk-Adjusted Capital Policy to each of the Company's short-term funded Mortgage
Assets. Liquidity capital cushions are assigned to each short-term funded
Mortgage Asset based on management's assessment of that Mortgage Asset's market
price volatility, credit risk, liquidity and attractiveness for use as
collateral by short-term lenders. The process of assigning liquidity capital
cushions relies on management's ability to identify and weigh the relative
importance of these and other factors. Consideration is also given to hedges
associated with the short-term funded Mortgage Asset and any effect such hedges
may have on reducing net market price volatility, concentration or
diversification of credit and other risks in the balance sheet as a whole and
the net cash flows that can be expected to arise from the interaction of the
various components of the Company's balance sheet. The Board of Directors
reviews on a periodic basis various analyses prepared by management of the risks
inherent in the Company's balance sheet, including an analysis of the effects of
various scenarios on the Company's net cash flow, earnings, dividends, liquidity
and net market value. Should the Board of Directors determine that the minimum
required capital base set by the Company's Risk-Adjusted Capital Policy is
either too low or too high, the Board of Directors may raise or lower the
capital requirement accordingly.
The Company expects that its aggregate minimum capital requirement under the
Risk-Adjusted Capital Policy will approximate 3% to 15% of the market value of
the Company's short-term funded Mortgage Assets plus the net equity value of its
long-term funded Mortgage Assets funded with long term debt or equity. This
percentage will fluctuate over time, and may fluctuate out of the expected
range, as the composition of the balance sheet changes, haircut levels required
by lenders change, the market value of short-term funded Mortgage Assets
changes, as liquidity capital cushions set by the Board of Directors are
adjusted over time, and as the balance of funding between short-term and
long-term changes. As of December 31, 1998, the aggregate Risk-Adjusted Capital
Requirement was 6.55% of total assets. The Company's actual capital base was
9.00% of total assets at December 31, 1998; thus the Company was not utilizing,
at that time, all of the leverage potential available to the Company under its
Risk-Adjusted Capital policies.
Less than 50% of the Company's borrowings were short-term at December 31, 1998.
The Company's short-term borrowings have consisted of collateralized borrowing
arrangements of various types (reverse repurchase agreements, notes payable, and
revolving lines of credit). As of December 31, 1998, all short-term borrowings
were reverse repurchase agreements. The Company's long-term borrowings at
December 31, 1998 consisted of non-recourse, floating and fixed rate,
collateralized mortgage-backed bonds. In the future, however, the Company's
borrowings may also be obtained through loan agreements, Dollar-Roll Agreements
(an agreement to sell a security for delivery on a specified future date and a
simultaneous agreement to repurchase the same or a substantially similar
security on a specified future date) and other credit facilities with
institutional lenders, the issuance of long-term collateralized debt or similar
instruments in the form of collateralized mortgage bonds, collateralized bond
obligations, REMICs, FASITs or other forms, and the issuance of secured and
unsecured debt securities such as commercial paper, medium-term notes and senior
or subordinated notes. The Company may also seek to fund its current balance
sheet or future growth through the issuance of preferred stock, common stock or
other forms of equity.
In early 1999, the Company extended the maturity of some of its short-term
borrowings out to the year 2000, and may continue to extend the maturities of
some of its short-term borrowings. The Company may also seek committed
short-term borrowing facilities. The Company enters into reverse repurchase
agreements primarily with national broker/dealers, commercial banks and other
lenders that typically offer such financing. The Company enters into short-term
collateralized borrowings only with financial institutions meeting credit
standards approved by the Company's Board of Directors, including approval by a
majority of Independent Directors, and monitors the financial condition of such
institutions on a regular basis. The Company's Bylaws do not limit its ability
to incur borrowings, whether secured or unsecured.
MORTGAGE LOAN SECURITIZATION TECHNIQUES
The Company contracts with conduits, financial institutions, mortgage bankers,
investment banks, Holdings and others to purchase Mortgage Loans that they are
originating or holding in their portfolio. The Company intends to enhance the
value and liquidity of most of the Mortgage Loans it acquires by securitizing
the loans into Mortgage Securities or pledging the loans to secure the issuance
of long-term, mortgage-backed debt in the manner which will best meet its own
needs.
10
11
In addition to creating Mortgage Securities and issuing long-term debt with the
Mortgage Loans in its portfolio, the Company also may "re-securitize" portions
of its Mortgage Securities portfolio. In a re-securitization transaction,
Mortgage Securities rather than Mortgage Loans are used as collateral to create
new Mortgage Securities. This would typically be done as the Mortgage Loans
underlying the Mortgage Securities improve in credit quality through seasoning,
as values rise on the underlying properties, when the credit quality of junior
classes of Mortgage Securities improve due to prepayment of more senior classes
or when the Company desires to replace short-term debt with long-term debt. Such
transactions can result in improved credit ratings, higher market values,
lowered borrowing costs and/or reduced liquidity risk. In December 1997, the
Company completed its first re-securitization in its "SMFC 94-A Trust".
The Company may conduct its securitization activities through one or more
taxable or REIT-qualifying subsidiaries formed for such purpose. In 1997, the
Company formed Sequoia Mortgage Funding Corporation ("Sequoia"), a
REIT-qualifying subsidiary, to carry out securitizations. Since then, Sequoia
has completed three securitizations, issuing non-recourse, mortgage-backed debt
with outstanding balances as of December 31, 1998 of $1.3 billion.
COMPANY POLICIES
The Board of Directors has established the investment policies and strategies
summarized in this report. The Board of Directors has the power to modify or
waive such policies and strategies without the consent of the stockholders to
the extent that the Board of Directors determines that such modification or
waiver is in the best interests of stockholders. Among other factors,
developments in the market which affect the policies and strategies mentioned
herein or which change the Company's assessment of the market may cause the
Board of Directors to revise the Company's policies and strategies.
The Company at all times intends to conduct its business so as not to become
regulated as an investment company under the Investment Company Act.
Accordingly, the Company does not expect to be subject to the restrictive
provisions of the Investment Company Act. The Investment Company Act exempts
entities that are "primarily engaged in the business of purchasing or otherwise
acquiring mortgages and other liens on and interests in real estate"
("Qualifying Interests"). Under the current interpretation of the staff of the
Securities and Exchange Commission, in order to qualify for this exemption, the
Company must maintain at least 55% of its assets directly in Mortgage Loans,
qualifying pass-though Certificates and certain other qualifying interests in
real estate. In addition, unless certain Mortgage Securities represent all the
Certificates issued with respect to an underlying pool of mortgages, such
Mortgage Securities may be treated as securities separate from the underlying
Mortgage Loans and, thus, may not qualify as Qualifying Interests for purposes
of the 55% requirement. Therefore, the Company's ownership of certain Mortgage
Assets may be limited by the provisions of the Investment Company Act.
RWT HOLDINGS, INC. BUSINESS AND STRATEGY
REDWOOD RESIDENTIAL FUNDING, INC.
GENERAL
RRF was formed as a subsidiary of Holdings in 1998 to engage in mortgage conduit
operations in order to meet the needs of mortgage investors seeking investments
in high-quality, newly-originated residential mortgage assets. RRF will purchase
non-agency eligible mortgage loans from correspondents. These correspondents,
herein referred to as "Sellers", may be savings and loan associations,
commercial banks, mortgage bankers or other regulated mortgage lenders. RRF will
sell acquired loans to its investor customers as loan portfolios or mortgage
securities.
RRF believes that the price spread between the acquisition cost of individual
whole loans and the sales value of tailored loan portfolios and securities
created from acquired loans is likely to afford an attractive return for its
conduit operations.
MARKETING STRATEGY
RRF's marketing strategy will: (1) attract a geographically diverse group of
both large and small correspondents (2) create value for these correspondents by
reducing their costs or improving their revenue opportunities, and
11
12
(3) create value for investors through acquisition of attractive mortgage
assets. In order to accomplish this, the Company will design efficient processes
and offer loan products that are attractive to potential non-conforming
borrowers as well as to end-investors in non-conforming mortgage loans and
mortgage-backed securities.
MORTGAGE LOANS ACQUIRED
A substantial portion of the mortgage loans to be purchased by RRF are expected
to be non-conforming mortgage loans. Currently, the maximum principal balance
for conforming loans is $240,000. RRF will typically purchase non-conforming
loans that comply in all material respects with FNMA and FHLMC guidelines, with
the exception of loan balance. Such non-conforming loans may involve some
greater risk as a result of liquidity, which is less than that of conforming
loans. Generally, RRF will not acquire mortgage loans with principal balances
above $1,100,000.
RRF's focus on the acquisition of non-conforming loans may affect RRF's
financial performance. For example, the purchase market for non-conforming loans
has typically provided for higher interest rates in order to compensate for the
lower liquidity of such loans, thereby potentially enhancing the interest income
RRF could earn during the accumulation phase for loans held for sale and during
the holding period for loans held for investment. In addition, due to the lower
level of liquidity in the non-conforming and other loan markets, RRF may realize
higher returns upon securitization of such loans than would by realized upon
securitization of conforming loans. On the other hand, such lower level of
liquidity introduces hedging and other risks that may from time to time cause
RRF to sell loans at a loss.
RRF's purchase activities are expected to focus on those regions of the country
where higher volumes of non-conforming mortgage loans are originated, including
California, Colorado, Florida, Hawaii, Illinois, Maryland, Massachusetts, New
Jersey, New York, Oregon and Washington.
SELLER ELIGIBILITY REQUIREMENTS
RRF will acquire mortgage loans originated by various Sellers, including savings
and loan associations, commercial banks, mortgage bankers and other regulated
mortgage lenders. Sellers will be required to meet certain regulatory,
financial, insurance and performance requirements established by RRF before they
are eligible to participate in its mortgage loan purchase program. Sellers must
also submit to periodic reviews by RRF to ensure continued compliance with these
requirements. RRF's criteria for Seller participation will generally include a
minimum tangible net worth requirement, approval as a FNMA or FHLMC
Seller/Servicer in good standing and a HUD approved mortgagee in good standing
or a financial institution that is insured by the FDIC or comparable federal or
state agency and that the Seller is examined by a federal or state authority. In
addition, Sellers are required to have comprehensive loan origination quality
control procedures. Sellers enter into an agreement that generally provides for
recourse by RRF against the Seller in the event of a breach of a representation
or warranty made by the Seller with respect to any fraud or misrepresentation
during the mortgage loan origination process or upon early payment default on
such loans.
PRICING AND COMMITMENT PROCESS
RRF will acquire mortgage loans on a bulk or flow basis pursuant to a delivery
option, a servicing option and a commitment term selected by the seller. Sellers
who wish to sell the mortgage loans on a flow basis are typically smaller
originators of mortgage loans who do not generate the volume or possess large
enough credit limits to aggregate volume for bulk deliveries. The seller will be
able to price and sell loans electronically via ELWOOD (Electronic Loan
Web-based Origination and Optimization Domain), a proprietary system developed
by RRF. ELWOOD will receive loan data from Sellers, provide a risk-based price
on the mortgage loan's individual characteristics and market data, and then
allow the lender to commit to sell the mortgage loan to RRF.
RRF will use a risk-based pricing model to price individual loans. For each loan
submitted, the model will measure credit risk, anticipated subordination levels
and anticipated securities structure. The model will then derive the value of
each mortgage in a security, add RRF's required returns and generate a purchase
price. ELWOOD then passes this price to the Seller who may elect to commit to
sell the loan to RRF.
Sellers may request a commitment for up to two and one-half minutes after
receiving pricing. If a commitment is requested within the time allowed it is
issued electronically and recorded in ELWOOD.
12
13
RRF will confirm each agreement to purchase a mortgage loan by transmitting to
the Seller a commitment confirmation. The provisions of RRF's Mortgage Loan
Purchase and Sale Agreement and Servicing Guide (collectively, the "Agreements")
will be incorporated in each commitment confirmation.
Commitments will be offered on a mandatory and a best efforts basis.
Mandatory basis. The mandatory delivery option will require the Seller to
deliver a mortgage loan(s) to RRF within a specific commitment term, regardless
of whether the loans are actually originated by the Seller or whether
circumstances beyond the Seller's control prevent delivery. RRF is required to
purchase all mortgage loans delivered pursuant to the terms of the commitment at
the purchase price established in the commitment. The delivered mortgage file
pertaining to each mortgage loan should reflect the mortgage loan information
specified in the commitment confirmation. In the event that the information
contained in the mortgage file does not reflect the mortgage loan information
contained in the commitment confirmation, RRF, at its sole option, reserves the
right to adjust the purchase price or to refuse purchase of any such mortgage
loan. If the Seller substitutes a mortgage loan in place of an ineligible
mortgage loan prior to the closing date, RRF may adjust the purchase price to
reflect the mortgage loan information pertaining to the substitute mortgage
loan. If a Seller fails to deliver a committed mortgage loan or acceptable
substitute mortgage loans under a mandatory commitment, the Seller will be
obligated to pay RRF a penalty that will compensate RRF for any costs incurred.
Best Efforts. In contrast, mortgage loans sold on a best efforts basis must be
delivered to RRF only if the Seller closes the mortgage loan. The best effort
delivery option provides Sellers with an effective way to sell loans during the
origination process without any penalty for failing to close loans committed for
sale.
UNDERWRITING AND QUALITY CONTROL
RRF has developed comprehensive purchase guidelines for the acquisition of
mortgage loans. Each loan purchased must conform to the loan eligibility
requirements and credit definitions specified in RRF's Seller/Servicer Guide
with respect to, among other things, loan amount, type of property,
loan-to-value ratio, type and amount of insurance, credit history of the
borrower, income ratios, sources of funds, appraisals and loan documentation.
These standards are generally very similar to those used by FNMA. RRF also
performs a documentation review prior to the purchase of any mortgage loan. RRF
delegates the underwriting function to its Sellers.
RRF has established a delegated underwriting program that is similar in concept
to the delegated underwriting programs established by FNMA and FHLMC. Delegated
underwriting is standard practice in the industry. Under this program, qualified
Sellers are required to underwrite loans in compliance with RRF's loan
eligibility standards and credit definitions as set forth in RRF's
Seller/Servicer Guide. If the seller meets RRF's financial and performance
criteria, the seller will be approved for the delegated underwriting program. In
connection with its approval, the seller must represent and warrant to RRF that
all mortgage loans sold to RRF will comply with RRF's credit standards. The
criteria for Seller participation in this program generally include a minimum
net worth requirement, delegated underwriting authority from a major national
conduit and from a mortgage insurance company and verification of the Seller's
good standing with FNMA or FHLMC.
Ongoing quality control reviews will be conducted by RRF to ensure that the
mortgage loans purchased meet its quality standards. The type and extent of the
quality control review depend on the nature of Seller and the characteristics of
the loans. RRF will review on a post-purchase basis a portion of all loans
submitted to determine that the loan was purchased in compliance with the
guidelines set forth by RRF. RRF will review a higher portion of certain
categories of mortgage loans, such as loans with property value above
$1,000,000, cash out refinances and loans above $650,000 in principal amount. In
performing a quality control review on a loan, RRF will analyze the underlying
property appraisal and examine the credit and income history of the borrower.
SECURITIZATION AND SALE PROCESS
When a sufficient volume of mortgage loans with similar characteristics has been
accumulated, generally $300 to $400 million, RRF intends to securitize them
through the issuance of mortgage-backed securities in the form of REMICs or CMOs
or to resell them in bulk whole loan sales. The length of time between the
commitment to purchase a mortgage loan and the time frame in which RRF will sell
or securitize such mortgage loan will generally range from 15 to 120 days,
depending on certain factors, including the length of the purchase
13
14
commitment period, the loan volume by product type and the securitization
process. RRF may sell loans or securities to the Redwood Trust portfolio from
time to time.
Any decision to form REMICs or CMOs or to sell the loans in bulk by RRF may be
influenced by a variety of factors. REMIC securities consist of one or more
classes of "regular interests" and a single class of "residual interest." The
regular interest classes are tailored to the needs of investors and may be
issued in multiples with varying maturities, average lives and interest rates.
The residual class represents the remainder of the cash flows from the mortgage
loans (including, in some instances, reinvestment income) over and above what is
required to be distributed to the regular interest classes. RRF does not intend
to retain regular or residual interest classes.
As an alternative to REMIC sales, RRF may issue CMOs from time to time based on
the its current and future investment needs, market conditions and other
factors. CMOs, however, do not offer RRF the structuring flexibility of REMICs
and are expected to be a secondary method of securitizing the mortgage loans.
Credit Enhancement. Any REMICs or CMOs created by RRF are expected to be
structured so that one or more of the classes of such securities are rated
investment grade by at least one nationally recognized rating agency. In
contrast to Agency Certificates in which the principal and interest payments are
guaranteed by the U.S. Government or an agency thereof, securities created by
RRF will not benefit from any such guarantee. The ratings for the RRF
mortgage-backed securities will be based on the perceived credit risk by the
applicable rating agency of the underlying mortgage loans, the structure of the
securities and the associated level of credit enhancement. Credit enhancement is
designed to provide protection to the security holders in the event of borrower
defaults and other losses including those associated with fraud or reductions in
the principal balances or interest rates on mortgage loans as required by law or
a bankruptcy court. RRF can utilize multiple forms of credit enhancement,
including special hazard insurance, reserve funds, letters of credit, surety
bonds and subordination or any combination thereof.
In determining whether to provide credit enhancement through subordination or
other credit enhancement methods, RRF will take into consideration the costs
associated with each method. RRF anticipates principally providing credit
enhancement through the issuance of mortgage-backed securities in
senior/subordinated structures or over-collateralization of its mortgage-backed
securities. The subordinated securities will be sold.
Each series of mortgage-backed securities will typically be fully payable from
the mortgage assets underlying such series, and the recourse of investors will
be limited to such assets and any associated credit enhancement features, such
as senior/subordinated structures. Generally, any losses in excess of the credit
enhancement obtained will be borne by the security holders, except in the case
of a breach of the standard representations and warranties made by RRF.
Typically, RRF will have recourse to the Sellers of loans for any such breaches,
but there can be no assurance of the Sellers' abilities to honor their
respective obligations.
Ratings of mortgage-backed securities are based primarily upon the underlying
mortgage loans' pool characteristics and associated credit enhancement. A
decline in the credit quality of such pools (including delinquencies and/or
credit losses above initial expectations), or of any third party credit
enhancements, as well as adverse developments in general economic trends
affecting real estate values or the mortgage industry, could result in
downgrades of such ratings.
REDWOOD COMMERCIAL FUNDING, INC.
GENERAL
RCF was formed as a subsidiary of Holdings in 1998 to meet the needs of banks
and other investors seeking to acquire commercial mortgage assets. RCF
originates and services high quality commercial mortgage loans nationwide,
providing funding to owners of apartment buildings, office buildings, light
industrial, mobile home parks, and retail properties. RCF originates through
commercial loan brokers or through direct borrower contact. RCF also acquires
portfolios of commercial mortgage loans. RCF generates revenues from the sale of
loans to its customers.
RCF lends to credit-worthy borrowers who nearly always provide personal
guarantees. RCF generally requires that a property be held in a bankruptcy
remote entity and typically requires a loan-to-value ratio of 65% or less and a
debt service coverage ratio of at least 1.25 to 1.00.
14
15
COMMERCIAL MORTGAGE LOANS ORIGINATED
Most of the commercial mortgage loans to be originated by RCF are expected to
have a principal balance of $10 million or less, with an anticipated average
size of $2 million to $5 million. RCF may acquire or originate larger loans from
time to time. Loans can have fixed and floating interest rates, or a combination
of the two. Floating rate loans will typically adjust quarterly or semi-annually
off the corresponding LIBOR index; annual and life caps will typically be 2% and
5%, respectively. Floor rates will typically be the start rate. Fixed rate loans
will typically have interest rates 350 to 500 basis paints over the 5-year
corresponding treasury.
RCF competes in the commercial loan origination market by offering speed,
reliability, and flexibility. RCF typically structures loan prepayment penalties
to meet the needs of its borrowers and its investors. These penalties are
typically not of the yield maintenance or lock-out variety but rather may
involve, for example, a 5%, 4%, 3%, 2%, 1% penalty structure for the first five
years of the loan. RCF is creative in structuring loans to meet special borrower
and investor needs.
SALES PROCESS
RCF plans to sell the loans it originates through whole loans sales to
depository institutions, mortgage REITs, underwriters of commercial mortgage
backed securities, and others, through private placements of loans or
participations with investors, or through securitization. Except for the
retention of servicing, RCF will not retain interests in its loans on a
long-term basis. RCF may sell loans or interests in loans to the Redwood Trust
portfolio from time to time.
The length of time between when RCF originates a commercial mortgage loan and it
sells or securitizes such mortgage loan will generally range from 15 to 180
days. If market conditions are favorable and the risk to RCF's balance sheet is
minimal, this period of time may lengthen. RCF may seek to market individual
loans during or after the origination process. RCF may also seek to make bulk
sales, in which case it will typically build portfolios in the $10 to $25
million range before going to market. If securitizations or forward sales are
contemplated, then larger portfolios may be assembled. RCF's current target is
to produce approximately $15 million of loans per month.
REDWOOD FINANCIAL SERVICES, INC.
GENERAL
RFS, formed in 1998, provides value-added services to financial institutions
with residential mortgage and other types of loan portfolios. RFS generates
revenues by buying and selling loans and providing fee-based due diligence,
analytics, consulting and securitization services.
RFS' business strategy is to assist commercial banks and thrifts meet their
goals and reduce risk through active management of their mortgage loan
portfolios. Industry trends and market events have combined to disrupt the
portfolio profiles of these depository institutions. The consolidation of the
banking and thrift industry through mergers and acquisitions has left many of
the newly combined entities with residential portfolio profiles that are
significantly different than the targeted profile of the pre-merger institution.
Similarly, the dramatic decline in mortgage rates spawned rapid prepayments
within residential portfolios. The result of both events has effected a
transition in residential portfolio profiles. RFS provides residential portfolio
managers with a comprehensive assessment, addressing the interest rate,
prepayment, liquidity and credit risks existing within the portfolio. Action
steps are presented that can modify their portfolio to the desired profile.
In the event that depository institutions desire to modify their portfolio
profiles, RFS can apply its loan trading capability to effect desired
transactions. RFS provides complete support from transaction design to eventual
capital market settlement so as to conduct these transaction strategies with
limited impact on the client's operational resources.
In order to provide these services, RFS has developed software that streamlines
its operations and tracks each loan through the entire process of portfolio
evaluation, identification of risks and opportunities, strategy assessment, loan
due diligence, securitization and sale. RFS provides competitively superior
service to its clients by keeping its sales, marketing, service and due
diligence operations focused and productive, utilizing technology efficiently,
maintaining an efficient and well-hedged warehouse function and accessing the
capital markets in an assertive and innovative manner to find the best whole
loan or securitization execution.
15
16
RISK FACTORS
In addition to the other information contained in this Form 10-K, you should
carefully consider the following risk factors in evaluating our Company and its
businesses.
COMPANY OPERATIONS RISKS
Although we generally hedge a portion of our interest rate risk, the results of
our operations are affected by various other factors, many of which are beyond
our control. The results of our operations depend on, among other things, the
level of net interest income generated by our mortgage assets, the market value
of such assets, the supply of and demand for such mortgage assets and conditions
in debt markets. Our net interest income and net asset appreciation gains can
vary as a result of changes in short-term and long-term interest rates, supply
and demand trends, market liquidity, credit results, borrowing costs and
prepayment rates, the behavior of which involve various risks and uncertainties
as set forth below. Prepayment rates, interest rates, borrowing costs and credit
losses depend on the nature and terms of the mortgage assets, the geographic
location of the properties securing the mortgage loans included in or underlying
the mortgage assets, conditions in financial markets, the fiscal and monetary
policies of the United States government and the Board of Governors of the
Federal Reserve System, international economic and financial conditions,
competition and other factors, none of which can be predicted with any
certainty. Because changes in interest and prepayment rates may significantly
affect our activities, our operating results depend, in large part, upon our
ability to effectively manage our interest rate and prepayment risks while
maintaining our status as a REIT.
We employ substantial leverage and face potential net interest and operating
losses in connection with borrowings.
We intend to continue to employ our financing strategy of borrowing a
substantial portion of the market value or, in the case of certain forms of
long-term debt, face value of our mortgage assets. The portion borrowed may vary
depending upon the mix of the mortgage assets in our portfolio and the
application of the risk-adjusted capital policy requirements to such mix of
mortgage assets. We expect generally to maintain a ratio of our total book
capital base to book value of total mortgage assets of between 3% and 15%,
although the percentage may vary from time to time depending upon the market
conditions and other factors deemed relevant by management. Book capital base is
the book value of capital accounts, retained earnings and subordinated debt
deemed by management to qualify as capital for this purpose, taking into account
market value adjustments. However, we are not limited under our bylaws in
respect of the amount of our borrowings, whether secured or unsecured. Also, the
aggregate percentage of total equity capital could at times be outside the range
of our borrowings. We may experience net income losses if the returns on the
mortgage assets purchased with borrowed funds fail to cover the cost of the
borrowings. In addition, we may not be able to achieve the degree of leverage we
believe to be optimal. Increases in haircuts, decreases in the market value of
our mortgage assets, increases in interest rate volatility, availability of
financing in the market, and rating agency and bond insurer requirements for
long-term financing and circumstances then applicable in the lending market are
some of the factors that would prevent us from achieving the optimal degree of
leverage. If we are not able to achieve the degree of leverage we believe to be
optimal, the results of our operations may be less profitable than they might be
otherwise.
Failure to refinance outstanding borrowings may adversely affect our ability to
achieve our investment objectives.
Our ability to achieve our investment objectives depends not only on our ability
to borrow money in sufficient amounts and on favorable terms but also on our
ability to renew or replace on a continuous basis our maturing short-term
borrowings. At December 31, 1998, we relied on short-term borrowings to fund 49%
of our mortgage assets. We have utilized short-term borrowings to fund
adjustable-rate, hybrid and fixed-rate mortgage assets. We have not, at the
present time, entered into any long-term commitment agreements under which a
lender would be required to enter into new borrowing agreements during a
specified period of time;
16
17
however, we may enter into one or more of such commitment agreements in the
future if deemed favorable to us. In the event we are not able to renew or
replace maturing borrowings, we could be required to sell mortgage assets and
related interest rate agreements under adverse market conditions and could incur
losses as a result. An event or a development such as a sharp increase or
decrease in interest rates or increasing market concern about the value or
liquidity of a type or types of mortgage loans or mortgage securities which are
short-term funded will reduce the market value of the mortgage assets. This
would likely cause lenders to require additional collateral. At the same time,
the market value of the unpledged collateral kept on hand to meet calls for
additional collateral pledges may have decreased. A number of such factors in
combination may cause us difficulties, including a possible liquidation of a
major portion of our mortgage assets at disadvantageous prices with consequent
losses. This could have a materially adverse effect on us and our solvency.
Decline in market value of mortgage assets may limit our ability to borrow,
result in lenders initiating margin calls, and require us to sell mortgage
assets in adverse market conditions.
Some of our mortgage assets may be cross-collateralized to secure our multiple
borrowing obligations from a single lender. A decline in the market value of our
portfolio of mortgage assets may limit our ability to borrow or result in
lenders initiating margin calls. A lender's margin call requires a pledge of
cash or additional mortgage assets to re-establish the ratio of the amount of
the borrowing to the value of the collateral. We may acquire fixed-rate or
hybrid mortgage assets pursuant to our asset acquisition/capital allocation
policies. Such fixed-rate mortgage assets, if funded with short-term debt, may
be more susceptible to margin calls because increases in interest rates tend to
more negatively affect the market value of fixed-rate or hybrid mortgage assets
than adjustable-rate mortgage assets. This remains true despite effective
hedging against such fluctuations because the hedging instruments may not be
part of the collateral securing the collateralized borrowings.
Additionally, it may be difficult to realize the full value of the hedging
instrument when desired for liquidity purposes due to the applicable REIT
provisions of the Code. We could be required to sell mortgage assets under
adverse market conditions in order to maintain liquidity. Management may effect
such sales when deemed by it to be necessary in order to preserve our capital
base. If these sales were made at prices lower than the basis of the mortgage
assets, we would experience losses.
A default by us under our short-term or long-term collateralized borrowings
could also result in a liquidation of the collateral, including any
cross-collateralized assets, and a resulting loss of the difference between the
value of the collateral and the amount borrowed.
Additionally, in the event of our bankruptcy, most reverse repurchase agreements
will qualify for special treatment under the bankruptcy laws. This will allow
the creditors under such agreements to avoid the automatic stay provisions of
the bankruptcy laws and to liquidate the collateral under such agreements
without delay. Conversely, in the event of the bankruptcy of a party with whom
we had a reverse repurchase agreement, we might experience difficulty recovering
the collateral subject to such agreement. In addition, the Company's claims and
creditors could be subject to significant delay. Recoveries, if and when
received, may be substantially less than the damages we actually suffered.
To the extent that we are compelled to liquidate mortgage assets that are
qualified REIT real estate assets to repay borrowings, we may be unable to
comply with the REIT provisions of the Code regarding assets and sources of
income requirements. This would ultimately jeopardize our status as a REIT.
Failure to maintain REIT status would eliminate our competitive advantage over
non-REIT competitors and subject us to federal taxation.
Interest rate fluctuations may result in a decrease in net interest income
and/or may result in a decline in the market value of mortgage assets.
We cannot perfectly match the maturities and interest rate adjustment
frequencies of our assets and liabilities. We cannot hedge away all such
mis-matches. We may not choose to match or hedge assets and liabilities to the
full extent possible. Thus, the spread between interest income and interest
expense may vary, or go negative, as
17
18
interest rates fluctuate. In addition, since earnings also consist of
appreciation and depreciation of market values of assets as well as interest
income, overall earnings may be volatile as compared to the cost of borrowing
and funding the Company.
Changes in prepayment characteristics of mortgage assets may result in a
decrease in net interest income and/or may result in a decline in the market
value of mortgage assets.
Mortgage asset prepayment rates vary from time to time and may cause changes in
the amount of our net interest income and asset appreciation income. Prepayments
of adjustable-rate, fixed rate and hybrid mortgage loans and mortgage securities
backed by adjustable-rate, fixed-rate and hybrid mortgage loans usually can be
expected to increase when mortgage interest rates fall below the then-current
interest rates on such assets and decrease when mortgage interest rates exceed
the then-current interest rate on the assets, although such effects are not
fully predictable. Prepayment experience may also be affected by changes in
consumer behavior, the geographic location of the property securing the mortgage
loans, the assumability of the mortgage loans, advances in technology and
reduction of costs with respect to refinancing mortgages, conditions in the
housing and financial markets, general economic conditions and other factors.
Mortgage securities backed by single family mortgage loans are often structured
so that certain classes are provided protection from prepayments for a period of
time. However, in a period of extremely rapid prepayments, during which
earlier-paying classes may be retired faster than expected, the protected
classes may receive unscheduled payments of principal earlier than expected and
would have average lives that, while longer than the average lives of the
earlier-paying classes, would be shorter than originally expected. Commercial
mortgages and some residential mortgages are structured with prepayment
penalties. However, these loans can still prepay, and the cost to the Company of
such prepayment may exceed the penalties received. We will seek to minimize
prepayment risk through a variety of means, which may include, to the extent
capable of being implemented at reasonable cost at various points in time,
structuring a diversified portfolio with a variety of prepayment
characteristics, investing in mortgage assets with prepayment prohibitions and
penalties, investing in certain mortgage securities structures which have
prepayment protection, balancing assets purchased at a premium with mortgage
assets purchased at a discount and prepayment hedging. In many operating
environments, however, it will not be possible for us to acquire assets with a
zero net balance of discount and premium. Even if we do have low levels of net
mortgage premium or discount, changes in prepayment rates can affect earnings by
affecting the market values of assets. We may choose not to hedge prepayment
risk, and any such hedges we do make may not be effective. In such
circumstances, the risk of earning variability resulting from changes in
prepayment rates may rise. In addition, we have purchased and/or created
interest-only and principal-only strips. These securities are leveraged with
respect to prepayment risk although they may also serve as prepayment hedges. No
strategy can completely insulate us from prepayment risks arising from the
effects of interest rate changes while simultaneously meeting returns acceptable
to shareholders.
Changes in anticipated prepayment rates of mortgage assets could affect us in
several adverse ways. The faster than anticipated prepayment of any adjustable-,
hybrid or fixed-rate mortgage asset that we purchased at a premium would
generally result in higher premium amortization expense. In addition, increased
prepayments may be a disadvantage to us in environments where we can only
acquire assets with lower returns than our existing assets. Slower than
anticipated prepayment rates will decrease discount amortization income for
discount mortgage assets and will reduce the Company's ability to invest in new
mortgage assets with higher yields when such assets are available. In addition,
depending on asset type or characteristics, slowing or increasing mortgage
prepayment rates may reduce market values and thus asset appreciation income.
Failing to hedge against interest rate changes effectively may adversely affect
results of operations.
Our operating strategy subjects us to interest rate risks as described above. We
follow an asset/liability management program intended to partially protect
against interest rate changes and prepayments. Nevertheless, developing an
effective asset/liability management strategy is complex and no strategy can
completely insulate us from risks associated with interest rate changes and
prepayments. Also, we do not attempt to hedge all such risks. In addition, there
is no assurance that our hedging activities will have the desired beneficial
impact on our operating results or financial condition. Hedging typically
involves costs, including transaction costs, which increase dramatically as the
period covered by the hedge increases and which also increase during periods of
rising and volatile interest rates.
18
19
We may increase our hedging activity, and thus increase our hedging costs,
during such periods when interest rates are volatile or rising and/or when
hedging costs have increased. Moreover, federal tax laws applicable to REITs may
substantially limit our ability to engage in asset/liability management
transactions. Such federal tax laws may prevent us from effectively implementing
hedging strategies that we determine, absent such restrictions, would best
insulate us from the risks associated with changing interest rates and
prepayments.
We use mark-to-market accounting for all of our interest rate agreements,
whereas, not all of our hedged assets and liabilities are marked-to-market in a
similar manner. As a result of the use of different accounting treatments
between assets, liabilities and their hedges, earnings volatility may result.
We purchase and sell from time to time interest rate caps, interest rate swaps,
interest rate futures and similar instruments to attempt to mitigate the risk of
the spread between the yield on earning assets and the cost of funds narrowing
as interest rates change. We also attempt to hedge, to some degree, the market
values of balance sheet items. Also, we purchase and sell interest rate caps,
interest rate swaps, interest rate futures and similar instruments to attempt to
modify the characteristics of any fixed-rate loan issuance, or to hedge the
anticipated issuance of future liabilities or the market value of certain
assets. We may also buy or sell US Treasury securities or other cash instruments
as part of our hedging strategy. In this way, we intend generally to hedge as
much of the interest rate risk and prepayment risk as management determines is
in our best interests given the cost of such hedging transactions and the need
to maintain our status as a REIT. The amount of income we may earn from our
interest rate caps and other hedging instruments is subject to substantial
limitations under the REIT provisions of the Code. In particular, when we earn
income under such instruments, we will seek advice from tax counsel as to
whether such income constitutes qualifying income for purposes of the 95% gross
income test and as to the proper characterization of such arrangements for
purposes of the REIT asset tests. This determination may result in management
electing to have us bear a level of interest rate risk that could otherwise be
hedged when management believes, based on all relevant facts, that bearing such
risk is advisable.
Hedging poses a credit risk.
In the event that we purchase interest rate caps or floors or enter into other
contractual interest rate agreements to hedge against lifetime and periodic rate
or payment caps, and the provider of interest rate agreements becomes
financially unsound or insolvent, we may be forced to unwind our interest rate
agreements with such provider and may take a loss on such interest rate
agreements. There is no assurance that we can avoid such third party risks.
Difference in performance between the hedging instrument and hedged items may
adversely affect results of operations.
We also accept basis risk in entering into interest rate swap and cap agreements
and other hedges. Basis risk occurs as the performance of hedged items and/or
hedging instruments vary from expectations and differ in performance from each
other. For instance, we hedge our liabilities to mitigate interest rate risk of
mortgage assets that are fixed or reprice at different times or are based on
different indices. Although the hedging item may reduce interest rate risk,
mortgage borrowers may prepay at speeds that vary from initial expectation.
Absent proper monitoring, we could have a hedging instrument in place without an
underlying hedged liability. We also, to a partial degree, may seek to hedge
changes in asset market values. Basis risk arises because asset market values
can change for many other reasons than are hedgeable. Any differences from
original expectations in basis, prepayment rates, market values or other factors
may have a material adverse effect on results of our operations.
We face credit loss exposure on mortgage assets.
A substantial portion of our investment portfolio at December 31, 1998 consisted
of single-family mortgage loans or mortgage assets evidencing interests in
single-family mortgage loans. At December 31, 1998, 52% of the mortgage assets
we owned were single-family mortgage loans and 47% were single-family mortgage
securities. Commercial mortgage loans totaled $8 million, or 0.3% of assets. We
will bear the risk of credit loss on any residential or commercial mortgage
assets we purchase in the secondary mortgage market or through our mortgage
lending
19
20
business. To the extent third parties have been contracted to provide the credit
enhancement, we are dependent in part upon the credit worthiness and
claims-paying ability of the insurer and the timeliness of reimbursement in the
event of a default on the underlying obligations. Further, the insurance
coverage for various types of losses is limited in amount and losses in excess
of the limitation would be borne us.
Prior to securitization, we generally do not intend to obtain credit
enhancements such as mortgage pool or special hazard insurance for our
residential and commercial mortgage loans, other than FHA insurance, VA
guarantees and private mortgage insurance, in each case relating only to
individual residential mortgage loans. Accordingly, during the time we hold such
mortgage loans for which third party insurance or other credit enhancements are
not obtained, we will be subject to risks of borrower defaults and bankruptcies
and special hazard losses that are not covered by standard hazard insurance,
such as those occurring from earthquakes or floods. In the event of a default on
any mortgage loan held by us, including, without limitation, resulting from
higher default levels as a result of declining property values and worsening
economic conditions, among other factors, we would bear the risk of loss of
principal to the extent of any deficiency between the value of the related real
property, plus any payments from an insurer or guarantor, and the amount owing
on the mortgage loan. Defaulted mortgage loans would also cease to be eligible
collateral for short-term borrowings and, to the extent not funded with
long-term, non-recourse debt, would have to be financed by us out of other funds
or funded with equity until ultimately liquidated, resulting in increased
financing costs and reduced net income or a net loss.
We lack voting control of our taxable affiliates.
We formed Holdings to serve as a holding company for our taxable affiliates to
legally separate the conduit, trading, advisory and commercial lending lines of
business from the REIT entity. This was done for regulatory, tax, risk
management and other reasons. George E. Bull III and Douglas B. Hansen,
executive officers of Redwood Trust, Inc., own 100% of the voting common stock
of Holdings while we own 100% of Holdings' nonvoting preferred stock. The common
stock is entitled to one percent of dividend distributions of Holdings and the
preferred stock is entitled to 99% of such distributions. Holdings wholly owns
RRF, RFS and RCF. Without voting control of Holdings and its subsidiaries, we
cannot assure you that their business activities and policies may not differ
from those that would be followed if we did have voting control. In addition,
while Holdings and Messrs. Bull and Hansen have entered into an agreement of
shareholders which contains certain management and control provisions and
restrictions on transfer of the common stock of Holdings, you cannot be assured
that the agreement will be enforced in a timely manner against the individuals,
their heirs or representatives.
Recent proposed tax legislation may adversely affect our ability to engage in
non-qualifying activities through Holdings or other affiliates.
The President's recently released 2000 budget plan includes certain proposed
legislative changes that, if enacted, could affect our ability to engage in
certain activities. Under the President's proposals, the Company may be able to
acquire and own the common stock of Holdings directly so long as this investment
does not exceed 15% of the Company's assets. There may be, however, restrictions
on Holdings' businesses and on inter-company transactions that would not be
beneficial. It is impossible to predict at this time whether any REIT
legislation will be adopted as well as whether the final form of any such
legislation will be generally harmful or helpful to us.
HOLDINGS OPERATIONS RISKS
The three business units of Holdings -- RRF, RCF and RFS -- will be subject to
operations risks including the following:
RRF faces the risks of a start-up business since it is a recently formed
enterprise.
RRF was incorporated in the State of Delaware on August 18, 1998. RRF
immediately commenced establishing its conduit operations by hiring personnel,
procuring computer systems and other equipment and contracting with vendors for
key software packages. RRF may be adversely impacted if it is unable to
coordinate all of the
20
21
activities required to operate a mortgage conduit. In addition, any significant
delays in achieving an effective operation, which may occur due to vendor delay
beyond the control of RRF, may cause cost over-runs and require increased
investment in RRF by Holdings.
RRF could be adversely impacted if the components of its conduit operation fail
to inter-relate in the manner desired or if any one component fails to address
successfully its assigned task. For example, losses may result if the risk
management software and risk management processes fail to hedge effectively the
interest rate risk prior to securitization. In addition, RRF may be adversely
impacted if the risk management system assumes that a securitization will take
place on a specific date and hedges accordingly, but the securitization is
delayed due to delays in the loan underwriting or securitization functions.
We cannot assure you that RRF will be able to profitably operate its mortgage
conduit activities.
Competition with other prospective purchasers of mortgage assets may result in
fluctuations in volume and cost of acquiring mortgage assets.
RRF competes in its business of purchasing non-conforming mortgage loans and
issuing securities backed by such loans with established mortgage conduit
programs, investment banking firms, savings and loan associations, banks, thrift
and loan associations, finance companies, mortgage bankers, insurance companies,
other lenders and other entities purchasing mortgage assets. Many of the
institutions with which RRF will compete in these operations have significantly
greater financial resources than RRF. Fluctuations in the volume and cost of
acquiring mortgage assets resulting from competition from other prospective
purchasers of mortgage assets could adversely affect the profitability of RRF's
conduit operations.
Consolidation in the mortgage banking industry may reduce RRF's customer base
and negatively impact RRF's conduit operations.
Continued consolidation in the mortgage banking industry may also reduce the
number of sellers to RRF's conduit operations. This would reduce RRF's potential
customer base, and result in RRF purchasing a larger percentage of mortgage
loans from a smaller number of sellers. Such changes could negatively impact
RRF's conduit operations.
RRF faces the risk that third party vendors will not perform as anticipated.
RRF depends on third party vendors to perform many functions critical to its
successful operation, such as servicing and underwriting its mortgage loans and
maintaining its on-line, inter-active computer system. Without control over
third party vendors, RRF is dependent upon such vendors to perform according to
their contractual obligations. If third party vendors do not perform their
required functions effectively, RRF's results of operations could be materially
adversely affected.
Competition from other investment opportunities available to investors may
adversely affect investment in RRF's securities.
Mortgage-backed securities issued through RRF's conduit operations face
competition from other investment opportunities available to prospective
investors. To the extent RRF cannot find an investor, it faces the risk of
having to retain securities of any class that cannot be fully sold when it
issues each new deal. RRF then faces the risk that any retained class of
security, particularly any interest-only security or subordinated security with
respect to credit risk, will fall in value before it can be sold. This could
result in a decrease in earnings for RRF.
RRF conduit operations may be adversely impacted by changes in interest rates.
RRF's earnings will be affected by changes in market interest rates. RRF will be
subject to the risk of rising mortgage interest rates between the time it
commits to purchase mortgage loans at a fixed price and the time it
21
22
sells or securitizes those mortgage loans. An increase in interest rates will
generally result in a decrease in market value of loans that RRF has committed
to purchase at a fixed price, but has not yet sold or securitized.
Changes in interest rates may increase or decrease the number of loans delivered
to RRF under best effort delivery program terms, and such variation may result
in losses. Higher rates of interest may discourage potential mortgagors from
refinancing mortgage loans, borrowing to purchase a home or seeking a second
mortgage loan. The result would be a decrease in the volume of mortgage loans
available to be purchased through RRF's conduit operations. In addition, an
increase in short-term interest rates may decrease or eliminate or, under
certain circumstances, cause to be negative, RRF's net interest spread during
the accumulation of mortgage loans held for sale. Should short-term interest
rates exceed long-term interest rates, commonly referred to as an "inverted
yield curve" scenario, a negative effect on RRF's net interest spread would
likely result.
Demand for residential mortgage loans and RRF's non-conforming loan products may
inhibit RRF's ability to obtain sufficient mortgage loans for successful results
of operations.
The availability of mortgage loans meeting RRF's criteria is dependent upon,
among other things, the size of and level of activity in the residential real
estate lending market and, in particular, the demand for non-conforming mortgage
loans. The size and level of activity in the residential real estate lending
market depend on various factors, including the level of interest rates,
regional and national economic conditions, inflation and deflation in
residential property values and the general regulatory and tax environment as it
relates to mortgage lending. RRF's business will be adversely affected to the
extent RRF is unable to obtain sufficient mortgage loans meeting its criteria.
Fannie Mae and Freddie Mac, formerly known as FNMA and FHLMC, are not currently
permitted to purchase single-family mortgage loans with original principal
balances above $240,000 ($360,000 in Alaska and Hawaii). If this dollar
limitation is increased without a commensurate increase in home prices so that
the size of the non-conforming mortgage loan market is reduced, RRF's ability to
maintain or increase its current acquisition levels could be adversely affected.
Also, FNMA and FHLMC would be in a position to purchase a greater percentage of
the mortgage loans in the secondary market than they currently acquire. In
addition, FNMA and FHLMC have recently instituted programs under which they will
purchase mortgage loans whose borrowers have lower credit ratings compared to
those required by FNMA and FHLMC in the past, each thereby further increasing
their share of the secondary market.
In general, lower interest rates prompt greater demand for mortgage loans. This
is true because more individuals can afford to purchase residential properties,
and refinancing and second mortgage loan transactions increase. However, if low
interest rates are accompanied by a weak economy and high unemployment, demand
for housing and residential mortgage loans may decline. Conversely, higher
interest rates and lower levels of housing finance and refinance activity may
decrease mortgage loan purchase volume levels. Decreased mortgage loan purchase
volume levels would result in decreased economies of scale and higher costs per
unit, reduced fee income, smaller gains on the sale of non-conforming mortgage
loans and lower net income during the accumulation phase.
Breach of representations and warranties could adversely impact RRF.
RRF may engage in securitizations or bulk whole loan sales in connection with
its conduit operations. RRF expects that in connection with any of its issuances
of mortgage-backed securities, such securities will be non-recourse to RRF,
except in the case of a breach of the standard representations and warranties
made by RRF when mortgage loans are securitized. While RRF expects that it will
have recourse to the sellers of mortgage loans for any such breaches, there can
be no assurance of the sellers' abilities to honor their respective obligations.
Also, RRF may engage in bulk whole loan sales pursuant to agreements that
generally provide for recourse by the purchaser against it in the event of a
breach of a representation or warranty made by it, any fraud or
misrepresentation during the mortgage loan origination process or upon early
default on such mortgage
22
23
loans. RRF will generally limit the remedies of such purchasers to the remedies
RRF receives from persons from whom it purchased such mortgage loans. However,
in some cases, the remedies available to a purchaser of mortgage loans from RRF
may be broader than those available to RRF against its seller. Thus, should a
purchaser exercise its rights against RRF, RRF may not always be able to enforce
whatever remedies it may have against its sellers.
Lack of geographic diversification of properties underlying mortgage loans may
subject such mortgage loans to greater risk of default in event of hazards that
affect such region.
RRF seeks geographic diversification of the properties underlying its mortgage
loans. Nevertheless, properties underlying such mortgage loans may be located in
the same or a limited number of geographical regions. To the extent that
properties underlying such mortgage loans are located in the same geographical
region, such mortgage loans may be subject to a greater risk of default than
other comparable mortgage loans in the event of adverse economic, political or
business developments and natural hazard risks that may affect such region and,
ultimately, the ability of property owners to make payments of principal and
interest on the mortgage loans.
RRF's dependence upon the proper functioning of the securitization market can
result in significant liquidity constraints.
RRF's results are dependent upon its ability to securitize its mortgage loans on
a frequent basis and in large transactions. Adverse changes in the
securitization market could impair RRF's ability to acquire and finance mortgage
loans through securitizations on a favorable or timely basis. Any such
impairment could have a material adverse effect upon RRF's results of operations
and financial condition. In the fourth quarter of 1998, the secondary mortgage
market experienced a liquidity crisis that disrupted the securitization market.
Subordinated classes of securities and interest-only securities either could not
be sold or could be sold only at unattractive prices. Comparable disruptions of
the market in the future could materially adversely impact RRF's results of
operations and financial condition.
RCF faces the risks of a start-up business.
RCF is a start-up business since it is a recently formed enterprise. We cannot
assure you when or if RCF will achieve profitability. RCF plans to expand and
develop its business. There can be no assurance that such activities will be
effective.
RCF may be adversely impacted by credit losses.
RCF faces risk of loss on its small commercial mortgage loans due to default of
the borrowers for credit or other reasons. Small commercial mortgage loans of
the type originated by RCF are generally subject to higher levels of credit and
other risks compared to residential mortgage loans. In the event of default, the
collateral securing such loans may not be adequate to fully discharge the
amounts due. RCF bears directly the risk of loss on loans being held by it for
sale to investors. RCF relies on being able to originate and acquire commercial
loans at prices lower than its investors will buy these loans. Credit concerns
from delinquent or defaulted loans, as well as other factors such as interest
rate variations, failure to hedge effectively, supply and demand considerations
in the market place, and the like, can reduce or eliminate RCF's ability to
realize a gain on sale. In addition, RCF bears risks tied to the representations
and warranties it makes to investors upon sale. Even where no breach of
representations and warranties has occurred, if the loans sold by RCF perform
poorly, RCF's ability to continue to sell loans to investors could be
significantly diminished and cause RCF to curtail or suspend its lending
activities.
RFS faces the risks of a start-up business.
RFS is a start-up business since it is a recently formed enterprise. We cannot
assure you when or if RFS will achieve profitability. RFS plans to expand and
develop its business. There can be no assurance that such activities will be
effective.
23
24
Limited availability of product to purchase or sell and other factors may
adversely affect RFS' results of operations.
RFS is dependent upon the willingness of banks and thrifts to sell or buy
mortgage loans or mortgage securities with RFS. RFS may be adversely impacted if
banks and thrifts decide not to sell loans or securities or if RFS cannot find
attractive loans or securities to sell to clients willing to buy assets. The
willingness of banks and thrifts to sell or buy loans may be diminished from
time to time by regulatory influences, unstable market conditions or changing
interest rates. RFS faces the risk that financial institutions do not wish to
have their portfolio's analyzed or do not seek to restructure their portfolio
after such analysis. RFS may not be able to generate profits in some cases if it
is not able to assist in the execution of such restructurings.
RFS may be adversely impacted by market and credit risk.
RFS may maintain inventory positions in residential mortgage loans or securities
purchased from depository institutions. In addition, RFS may enter into
commitments to purchase or sell mortgage loans or securities and may hold loans
or securities on a temporary basis pending resale. As such, RFS is exposed to
market and credit risk. Market risk includes the risk of decrease in market
value of the inventoried assets due to interest rate changes or other factors
and the risk of reduced net interest income or losses from prepayment levels
higher than anticipated or increased funding costs. RFS limits market value risk
by employing hedging and other strategies. There can be no assurance that such
hedging strategies will be effective and RFS may incur a loss on the hedged
asset as well as the hedge instrument due to movements in market values and
interest rates. In addition, counterparties to loan purchase and sale
commitments may not be able or willing to complete transactions, thus
potentially exposing RFS to loss. RFS may intend to securitize loans through
Fannie Mae or Freddie Mac. If it cannot do so, it may realize a lower than
expected price upon sale. During the time it holds loans or securities, RFS will
bear any losses on such assets due to credit defaults.
RFS is dependent on the availability of borrowings.
In order to facilitate its purchases of loans and securities, RFS will rely on
collateralized borrowing arrangements. RFS has not yet entered into any such
arrangements and the cost and availability of such funding may affect RFS'
profitability and ability to maximize returns on the opportunities it creates.
OTHER RISKS
We depend on key personnel for successful operations.
Both our operations and those of Holdings and its affiliates depend
significantly upon the contributions of their respective executive officers.
Many of such executive officers would be difficult to replace. The loss of any
key person could materially adversely affect business and operating results.
Capital stock price volatility may negatively impact liquidity of our common
stock and may cause investors in our common stock to experience losses.
Capital stock price volatility may adversely affect the market price of our
common stock. With respect to the public market for our common stock, it is
likely that the market price of the common stock will be influenced by earnings
volatility and by the market's perception of our ability to achieve earnings
growth. Our earnings result from activities at the Company and at Holdings. They
are dependent on revenues, which consist primarily of net asset appreciation,
net gain on sale and interest income, exceeding expenses, consisting primarily
of interest expense, hedging expenses, credit expenses, operating expenses and,
in the case of Holdings, taxes. All of these elements can be volatile with
respect to a variety of internal and external factors and are particularly
uncertain given the start-up nature of Holdings' businesses. Liquidity and
capital issues will have large effects. The Company's dividend, and practices
with respect to paying a dividend, may also effect the stock price. In addition,
if the market price of other REIT stocks decline for any reason, or if there is
a broad-based decline in real estate values or in the value of our mortgage
assets and the market price of our common stock has been
24
25
adversely affected due to any of the foregoing reasons, the liquidity of our
common stock may be negatively impacted and investors who may desire or be
required to sell shares of common stock may experience losses.
COMPETITION
THE COMPANY
The Company believes that its principal competition in the business of
acquiring, managing, credit-enhancing and financing Mortgage Assets and issuing
mortgage-backed debt to investors are financial institutions such as banks,
savings and loans, life insurance companies, bond insurance companies, mortgage
insurance companies, GSEs, institutional investors such as mutual, pension and
hedge funds, and certain other mortgage REITs. While most of these entities have
significantly greater resources than the Company, the Company anticipates that
it will be able to compete effectively and generate relatively attractive rates
of return for stockholders due to its relatively low level of operating costs,
relative freedom to securitize its assets, ability to utilize prudent amounts of
leverage through accessing the wholesale market for collateralized borrowings,
freedom from certain forms of regulation and the tax advantages of its REIT
status. The existence of these competitive entities, as well as the possibility
of additional entities forming in the future, may increase the competition for
the acquisition of Mortgage Assets resulting in higher prices and lower yields
on such Mortgage Assets. The Company believes it is and plans to continue to be
a "low cost producer" compared to most of its competitors in the business of
holding, credit-enhancing and financing Mortgage Assets. Accordingly, the
Company plans to generate relatively attractive earnings.
RWT HOLDINGS, INC.
Holdings' business units compete in their businesses of originating, purchasing
and selling mortgage loans and issuing securities backed by such loans with
established mortgage correspondent programs, investment banking firms,
securities broker-dealers, savings and loan associations, banks, finance
companies, mortgage bankers, mortgage brokers, insurance companies, other
lenders and other entities purchasing and selling mortgage assets. RCF competes
with other originators and sellers of commercial mortgage loans and other
assets. Many of the institutions with which Holdings will compete in these
operations have significantly greater financial resources than Holdings.
Fluctuations in the volume and cost of acquiring mortgage assets resulting from
competition from other prospective purchasers of mortgage assets could adversely
affect the profitability of Holdings operations. Mortgage-backed securities
issued through Holdings' operations and Holdings' sales of mortgage loans face
competition from other investment opportunities available to prospective
investors.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The following discussion summarizes certain Federal income tax considerations to
the Company and its stockholders. This discussion is based on existing Federal
income tax law, which is subject to change, possibly retroactively. This
discussion does not address all aspects of Federal income taxation that may be
relevant to a particular stockholder in light of its personal investment
circumstances or to certain types of investors subject to special treatment
under the Federal income tax laws (including financial institutions, insurance
companies, broker-dealers and, except to the extent discussed below, tax-exempt
entities and foreign taxpayers) and it does not discuss any aspects of state,
local or foreign tax law. This discussion assumes that stockholders will hold
their Common Stock as a "capital asset" (generally, property held for
investment) under the Internal Revenue Code of 1986, as amended (the "Code").
Stockholders are advised to consult their tax advisors as to the specific tax
consequences to them of purchasing, holding and disposing of the Common Stock,
including the application and effect of Federal, state, local and foreign income
and other tax laws.
GENERAL
The Company has elected to become subject to tax as a REIT, for Federal income
tax purposes, commencing with the taxable year ending December 31, 1994.
Management currently expects that the Company will continue to operate in a
manner that will permit the Company to maintain its qualifications as a REIT.
This treatment will permit the Company to deduct dividend distributions to its
stockholders for Federal income tax purposes, thus effectively eliminating the
"double taxation" that generally results when a corporation earns income and
distributes that income to its stockholders.
25
26
There can be no assurance that the Company will continue to qualify as a REIT in
any particular taxable year, given the highly complex nature of the rules
governing REITs, the ongoing importance of factual determinations and the
possibility of future changes in the circumstances of the Company. If the
Company failed to qualify as a REIT in any particular year, it would be subject
to Federal income tax as a regular, domestic corporation, and its stockholders
would be subject to tax in the same manner as stockholders of such corporation.
In this event, the Company could be subject to potentially substantial income
tax liability in respect of each taxable year that it fails to qualify as a REIT
and the amount of earnings and cash available for distribution to its
stockholders could be significantly reduced or eliminated.
The following is a brief summary of certain technical requirements that the
Company must meet on an ongoing basis in order to qualify, and remain qualified,
as a REIT under the Code.
STOCK OWNERSHIP TESTS
The capital stock of the Company must be held by at least 100 persons and no
more than 50% of the value of such capital stock may be owned, directly or
indirectly, by five or fewer individuals at all times during the last half of
the taxable year. Under the Code, most tax-exempt entities including employee
benefit trusts and charitable trusts (but excluding trusts described in 401(a)
and exempt under 501(a)) are generally treated as individuals for these
purposes. The Company must satisfy these stock ownership requirements each
taxable year. The Company must solicit information from certain of its
shareholders to verify ownership levels and its Articles of Incorporation
provide restrictions regarding the transfer of the Company's shares in order to
aid in meeting the stock ownership requirements. If the Company were to fail
either of the stock ownership tests, it would generally be disqualified from
REIT status, unless, in the case of the "five or fewer" requirement, the
recently enacted "good faith" exemption is available.
ASSET TESTS
The Company must generally meet the following asset tests (the "REIT Asset
Tests") at the close of each quarter of each taxable year:
(a) at least 75% of the value of the Company's total assets must consist of
Qualified REIT Real Estate Assets, government securities, cash, and cash
items (the "75% Asset Test"); and
(b) the value of securities held by the Company but not taken into account
for purposes of the 75% Asset Test must not exceed either (i) 5% of the
value of the Company's total assets in the case of securities of any one
non-government issuer, or (ii) 10% of the outstanding voting securities of
any such issuer.
The Company expects that substantially all of its assets will be Qualified REIT
Real Estate Assets. In addition, the Company does not expect that the value of
any non-qualifying security of any one entity, including interests in taxable
affiliates, would ever exceed 5% of the Company's total assets, and the Company
does not expect to own more than 10% of any one issuer's voting securities.
The Company intends to monitor closely the purchase, holding and disposition of
its assets in order to comply with the REIT Asset Tests. In particular, the
Company intends to limit and diversify its ownership of any assets not
qualifying as Qualified REIT Real Estate Assets to less than 25% of the value of
the Company's assets and to less than 5%, by value, of any single issuer. If it
is anticipated that these limits would be exceeded, the Company intends to take
appropriate measures, including the disposition of non-qualifying assets, to
avoid exceeding such limits.
GROSS INCOME TESTS
The Company must generally meet the following gross income tests (the "REIT
Gross Income Tests") for each taxable year:
(a) at least 75% of the Company's gross income must be derived from certain
specified real estate sources including interest income and gain from the
disposition of Qualified REIT Real Estate Assets or "qualified temporary
investment income" (i.e., income derived from "new capital" within one year
of the receipt of such capital) (the "75% Gross Income Test");
(b) at least 95% of the Company's gross income for each taxable year must
be derived from sources of income qualifying for the 75% Gross Income Test,
or from dividends, interest, and gains from the sale of stock or other
securities (including certain interest rate swap and cap agreements,
options, futures and
26
27
forward contracts entered into to hedge variable rate debt incurred to
acquire Qualified REIT Real Estate Assets) not held for sale in the
ordinary course of business (the "95% Gross Income Test"); and
(c) for the four years prior to 1998, less than 30% of the Company's gross
income must have been derived from the sale of Qualified REIT Real Estate
Assets held for less than four years, stock or securities held for less
than one year (including certain interest rate swaps and cap agreements
entered into to hedge variable rate debt incurred to acquire Qualified REIT
Real Estate Assets) and certain "dealer" property (the "30% Gross Income
Test").
The Company intends to maintain its REIT status by carefully monitoring its
income, including income from hedging transactions and sales of Mortgage Assets,
to comply with the REIT Gross Income Tests. In particular, the Company will
treat income generated by its interest rate caps and other hedging instruments
as non-qualifying income for purposes of the 95% Gross Income Tests unless it
receives advice from counsel that such income constitutes qualifying income for
purposes of such test. Under certain circumstances, for example, (i) the sale of
a substantial amount of Mortgage Assets to repay borrowings in the event that
other credit is unavailable or (ii) unanticipated decrease in the qualifying
income of the Company which may result in the non-qualifying income exceeding 5%
of gross income, the Company may be unable to comply with certain of the REIT
Gross Income Tests. See " Taxation of the Company" below for a discussion of the
tax consequences of failure to comply with the REIT Provisions of the Code.
DISTRIBUTION REQUIREMENT
The Company must generally distribute to its stockholders an amount equal to at
least 95% of the Company's REIT taxable income before deductions of dividends
paid and excluding net capital gain.
The IRS has ruled that if a REIT's dividend reinvestment plan allows
stockholders of the REIT to elect to have cash distributions reinvested in
shares of the REIT at a purchase price equal to at least 95% of the fair market
value of such shares on the distribution date, then such distributions qualify
under the 95% distribution requirement. The Company maintains a Dividend
Reinvestment and Stock Purchase Plan ("DRP") and intends that the terms of its
DRP will comply with this ruling.
QUALIFIED REIT SUBSIDIARIES
The Company currently holds some of its assets through Sequoia Mortgage Funding
Corporation, a wholly-owned subsidiary, which is treated as a "Qualified REIT
Subsidiary". As such its assets, liabilities and income are generally treated as
assets, liabilities and income of the Company for purposes of each of the above
REIT qualification tests.
TAXATION OF THE COMPANY
In any year in which the Company qualifies as a REIT, the Company will generally
not be subject to Federal income tax on that portion of its REIT taxable income
or capital gain that is distributed to its stockholders. The Company will,
however, be subject to Federal income tax at normal corporate income tax rates
upon any undistributed taxable income or capital gain.
Notwithstanding its qualification as a REIT, the Company may also be subject to
tax in certain other circumstances. If the Company fails to satisfy either the
75% or the 95% Gross Income Test, but nonetheless maintains its qualification as
a REIT because certain other requirements are met, it will generally be subject
to a 100% tax on the greater of the amount by which the Company fails either the
75% or the 95% Gross Income Test. The Company will also be subject to a tax of
100% on net income derived from any "prohibited transaction" (which includes
dispositions of property classified as "dealer" property) and if the Company has
(i) net income from the sale or other disposition of "foreclosure property"
which is held primarily for sale to customers in the ordinary course of business
or (ii) other non-qualifying income from foreclosure property, it will be
subject to Federal income tax on such income at the highest corporate income tax
rate. In addition, if the Company fails to distribute during each calendar year
at least the sum of (i) 85% of its REIT ordinary income for such year and (ii)
95% of its REIT capital gain net income for such year, the Company would be
subject to a 4% Federal excise tax on the excess of such required distribution
over the amounts actually distributed during the taxable year, plus any
undistributed amount of ordinary and capital gain net income from the preceding
taxable year. The Company may also be subject to the corporate alternative
minimum tax, as well as other taxes in certain situations not presently
contemplated.
27
28
If the Company fails to qualify as a REIT in any taxable year and certain relief
provisions of the Code do not apply, the Company would be subject to Federal
income tax (including any applicable alternative minimum tax) on its taxable
income at the regular corporate income tax rates. Distributions to stockholders
in any year in which the Company fails to qualify as a REIT would not be
deductible by the company, nor would they generally be required to be made under
the Code. Further, unless entitled to relief under certain other provisions of
the Code, the Company would also be disqualified from re-electing REIT status
for the four taxable years following the year in which it became disqualified.
The Company intends to monitor on an ongoing basis its compliance with the REIT
requirements described above. In order to maintain its REIT status, the Company
will be required to limit the types of assets that the Company might otherwise
acquire, or hold certain assets at times when the Company might otherwise have
determined that the sale or other disposition of such assets would have been
more prudent.
TAXABLE SUBSIDIARIES
The Company intends to undertake certain hedging activities and the creation of
Mortgage Securities through securitization through its taxable affiliates. In
order to ensure that the Company does not violate the more than 10% voting stock
of a single issuer limitation described above, the Company owns (or will own)
only nonvoting preferred, nonvoting common stock or 10% or less of the voting
common stock and the other persons own (or will own) all of the remaining voting
common stock of such taxable affiliates. The value of the Company's investment
in such taxable affiliates must also be limited to less than 5% of the value of
the Company's total assets at the end of each calendar quarter so that the
Company can also comply with the 5% of value, single issuer asset limitation
described above under " - General - Asset Tests." The taxable affiliates do not
elect REIT status and distribute only net after-tax profits to their
stockholders, including the Company. Before the Company engages in any hedging
or securitization activities or uses any such taxable affiliates, the Company
will obtain an opinion of counsel to the effect that such activities or the
formation and contemplated method of operation of such corporation will not
cause the Company to fail to satisfy the REIT Asset and REIT Gross Income Tests.
There is currently proposed legislation in Congress (described below) which
could, if passed, restrict or eliminate the Company's ability to use taxable
affiliates.
TAXATION OF STOCKHOLDERS
Distributions (including constructive distributions) made to holders of Common
Stock other than tax-exempt entities (and not designated as capital gain
dividends) will generally be subject to tax as ordinary income to the extent of
the Company's current and accumulated earnings and profits as determined for
Federal income tax purposes. If the amount distributed exceeds a stockholder's
allocable share of such earnings and profits, the excess will be treated as a
return of capital to the extent of the stockholder's adjusted basis in the
Common Stock, which will not be subject to tax, and thereafter as a taxable gain
from the sale or exchange of a capital asset.
Distributions designated by the Company as capital gain dividends will generally
be subject to tax as long-term capital gain to stockholders, to the extent that
the distribution does not exceed the Company's actual net capital gain for the
taxable year. Distributions by the Company, whether characterized as ordinary
income or as capital gain, are not eligible for the corporate dividends received
deduction. In the event that the Company realizes a loss for the taxable year,
stockholders will not be permitted to deduct any share of that loss. Further, if
the Company (or a portion of its assets) were to be treated as a taxable
mortgage pool, any "excess inclusion income" that is allocated to a stockholder
would not be allowed to be offset by a net operating loss of such stockholder.
Future Treasury Department regulations may require that the stockholders take
into account, for purposes of computing their individual alternative minimum tax
liability, certain tax preference items of the Company.
Dividends declared during the last quarter of a taxable year and actually paid
during January of the following taxable year are generally treated as if
received by the stockholder on the record date of the dividend payment and not
on the date actually received. In addition, the Company may elect to treat
certain other dividends distributed after the close of the taxable year as
having been paid during such taxable year, but stockholders will be treated as
having received such dividend in the taxable year in which the distribution is
made.
28
29
Upon a sale or other disposition of the Common Stock, a stockholder will
generally recognize a capital gain or loss in an amount equal to the difference
between the amount realized and the stockholder's adjusted basis in such stock,
which gain or loss generally will be long-term if the stock was held for more
than twelve months. Any loss on the sale or exchange of Common Stock held by a
stockholder for six months or less will generally be treated as a long-term
capital loss to the extent of designated capital gain dividends received by such
stockholder.
DRP participants will generally be treated as having received a dividend
distribution, subject to tax as ordinary income, in an amount equal to the fair
value of the Common Stock purchased with the reinvested dividends generally on
the date the Company credits such Common Stock to the DRP participant's account.
The Company is required under Treasury Department regulations to demand annual
written statements from the record holders of designated percentages of its
Capital Stock disclosing the actual and constructive ownership of such stock and
to maintain permanent records showing the information it has received as to the
actual and constructive ownership of such stock and a list of those persons
failing or refusing to comply with such demand.
In any year in which the Company does not qualify as a REIT, distributions made
to its stockholders would be taxable in the same manner discussed above, except
that no distributions could be designated as capital gain dividends,
distributions would be eligible for the corporate dividends received deduction,
the excess inclusion income rules would not apply, and stockholders would not
receive any share of the Company's tax preference items. In such event, however,
the Company would be subject to potentially substantial Federal income tax
liability, and the amount of earnings and cash available for distribution to its
stockholders could be significantly reduced or eliminated.
TAXATION OF TAX-EXEMPT ENTITIES
Subject to the discussion below regarding a "pension-held REIT," a tax-exempt
stockholder is generally not subject to tax on distributions from the Company or
gain realized on the sale of the Securities, provided that such stockholder has
not incurred indebtedness to purchase or hold its Securities, that its shares
are not otherwise used in an unrelated trade or business of such stockholder,
and that the Company, consistent with its present intent, does not hold a
residual interest in a REMIC that gives rise to "excess inclusion" income as
defined under section 860E of the Code. However, if the Company was to hold
residual interests in a REMIC, or if a pool of its assets were to be treated as
a "taxable mortgage pool," a portion of the dividends paid to a tax-exempt
stockholder may be subject to tax as unrelated business taxable income ("UBTI").
Although the Company does not believe that the Company, or any portion of its
assets, will be treated as a taxable mortgage pool, no assurance can be given
that the IRS might not successfully maintain that such a taxable mortgage pool
exists.
If a qualified pension trust (i.e., any pension or other retirement trust that
qualifies under Section 401 (a) of the Code) holds more than 10% by value of the
interests in a "pension-held REIT" at any time during a taxable year, a
substantial portion of the dividends paid to the qualified pension trust by such
REIT may constitute UBTI. For these purposes, a "pension-held REIT" is a REIT
(i) that would not have qualified as a REIT but for the provisions of the Code
which look through qualified pension trust stockholders in determining ownership
of stock of the REIT and (ii) in which at least one qualified pension trust
holds more than 25% by value of the interest of such REIT or one or more
qualified pension trusts (each owning more than a 10% interest by value in the
REIT) hold in the aggregate more than 50% by value of the interests in such
REIT. Assuming compliance with the Ownership Limit provisions in the Company's
Articles of Incorporation it is unlikely that pension plans will accumulate
sufficient stock to cause the Company to be treated as a pension-held REIT.
Distributions to certain types of tax-exempt stockholders exempt from Federal
income taxation under Sections 501 (c)(7), (c)(9), (c)(17), and (c)(20) of the
Code may also constitute UBTI, and such prospective investors should consult
their tax advisors concerning the applicable "set aside" and reserve
requirements.
STATE AND LOCAL TAXES
The Company and its stockholders may be subject to state or local taxation in
various jurisdictions, including those in which it or they transact business or
reside. The state and local tax treatment of the Company and its stockholders
may not conform to the Federal income tax consequences discussed above.
Consequently,
29
30
prospective stockholders should consult their own tax advisors regarding the
effect of state and local tax laws on an investment in the Common Stock.
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS APPLICABLE TO FOREIGN
HOLDERS
The following discussion summarizes certain United States Federal tax
consequences of the acquisition, ownership and disposition of Common Stock or
Preferred Stock by an initial purchaser that, for United States Federal income
tax purposes, is a "Non-United States Holder". Non-United States Holder means:
not a citizen or resident of the United States; not a corporation, partnership,
or other entity created or organized in the United States or under the laws of
the United States or of any political subdivision thereof; or not an estate or
trust whose income is includible in gross income for United States Federal
income tax purposes regardless of its source. This discussion does not consider
any specific facts or circumstances that may apply to particular non-United
States Federal tax consequences of acquiring, holding and disposing of Common
Stock or Preferred Stock, as well as any tax consequences that may arise under
the laws of any foreign, state, local or other taxing jurisdiction.
DIVIDENDS
Dividends paid by the Company out of earnings and profits, as determined for
United States Federal income tax purposes, to a Non-United States Holder will
generally be subject to withholding of United States Federal income tax at the
rate of 30%, unless reduced or eliminated by an applicable tax treaty or unless
such dividends are treated as effectively connected with a United States trade
or business. Distributions paid by the Company in excess of its earnings and
profits will be treated as a tax-free return of capital to the extent of the
holder's adjusted basis in his shares, and thereafter as gain from the sale or
exchange of a capital asset as described below. If it cannot be determined at
the time a distribution is made whether such distribution will exceed the
earnings and profits of the Company, the distribution will be subject to
withholding at the same rate as dividends. Amounts so withheld, however, will be
refundable or creditable against the Non-United States Holder's United States
Federal tax liability if it is subsequently determined that such distribution
was, in fact, in excess of the earnings and profits of the Company. If the
receipt of the dividend is treated as being effectively connected with the
conduct of a trade or business within the United States by a Non-United States
Holder, the dividend received by such holder will be subject to the United
States Federal income tax on net income that applies to United States persons
generally (and, with respect to corporate holders and under certain
circumstances, the branch profits tax).
For any year in which the Company qualifies as a REIT, distributions to a
Non-United States Holder that are attributable to gain from the sales or
exchanges by the Company of "United States real property interests" will be
treated as if such gain were effectively connected with a United States business
and will thus be subject to tax at the normal capital gain rates applicable to
United States stockholders (subject to applicable alternative minimum tax) under
the provisions of the Foreign Investment in Real Property Tax Act of 1980
("FIRPTA"). Also, distributions subject to FIRPTA may be subject to a 30% branch
profits tax in the hands of a foreign corporate stockholder not entitled to a
treaty exemption. The Company is required to withhold 35% of any distribution
that could be designated by the Company as a capital gains dividend. This amount
may be credited against the Non-United States Holder's FIRPTA tax liability. It
should be noted that Mortgage Loans without substantial equity or shared
appreciation features generally would not be classified as "United States real
property interests."
GAIN ON DISPOSITION
A Non-United States Holder will generally not be subject to United States
Federal income tax on gain recognized on a sale or other disposition of its
shares of either Common or Preferred Stock unless (i) the gain is effectively
connected with the conduct of a trade or business within the United States by
the Non-United States Holder, (ii) in the case of a Non-United Stated Holder who
is a nonresident alien individual and holds such shares as a capital asset, such
holder is present in the United States for 183 or more days in the taxable year
and certain other requirements are met, or (iii) the Non-United States Holder is
subject to tax under the FIRPTA rules discussed below. Gain that is effectively
connected with the conduct of a United States Holder will be subject to the
United States Federal income tax on net income that applies to United States
persons generally (and, with respect to corporate holders and under certain
circumstances, the branch profits tax) but will not be subject to withholding.
Non-United States Holders should consult applicable treaties, which may provide
for different rules.
30
31
Gain recognized by a Non-United States Holder upon a sale of either Common Stock
or Preferred Stock will generally not be subject to tax under FIRPTA if the
Company is a "domestically-controlled REIT," which is defined generally as a
REIT in which at all times during a specified testing period less than 50% in
value of its shares were held directly or indirectly by non-United States
persons. Because only a minority of the Company's stockholders is expected to be
Non-United States Holders, the Company anticipates that it will qualify as a
"domestically-controlled REIT." Accordingly, a Non-United States Holder should
not be subject to United States Federal income tax from gains recognized upon
disposition of its shares.
INFORMATION REPORTING AND BACKUP WITHHOLDING
The Company will report to its U.S. shareholders and the Internal Revenue
Service the amount of distributions paid during each calendar year, and the
amount of tax withheld, if any. Under the backup withholding rules, a
shareholder may be subject to backup withholding at the rate of 31% with respect
to distributions paid unless such holder (a) is a corporation or comes within
certain other exempt categories and, when required, demonstrates that fact; or
(b) provides a taxpayer identification number, certifies as to no loss of
exemption from backup withholding, and otherwise complies with applicable
requirements of the backup withholding rules. A shareholders that does not
provide the Company with its correct taxpayer identification number may also be
subject to penalties imposed by the Internal Revenue Service. Any amount paid as
backup withholding will be creditable against the shareholder's income tax
liability. In addition, the Company may be required to withhold a portion of
dividends and capital gain distributions to any shareholders that do not certify
under penalties of perjury their non-foreign status to the Company.
PROPOSED TAX LEGISLATION
The President's 2000 Budget Plan (released on February 1, 1999) includes certain
tax proposals applicable to REITs that may be relevant to the Company. These
proposals are variations on proposals made but not enacted last year. In
particular, one proposal would change the requirement that a REIT not own more
than 10% of the voting power of a corporation (other than a "Qualified REIT
Subsidiary") to a requirement based on a 10% of vote or value limit, except in
the case of certain qualified taxable subsidiaries ("QTS's") engaged in specific
types of activities. The combined value of all QTS's, however, would be limited
to no more than 15% of the total value of a REIT's assets (and no more than 5%
in the case of QTS's performing services to tenants of the REIT). In addition,
significant other limitations would apply with respect to transactions between
the REIT and the QTS, including that the QTS would not be able to deduct
interest paid directly or indirectly to the REIT (or with respect to debt
guaranteed by the REIT). This proposal is intended to be effective upon
enactment.
Another proposal would generally expand the "five or fewer" stock ownership test
to also limit entities (other than another REIT) from owning or controlling 50
percent or more of a REIT's stock.
It is unclear whether these or any of the President's other tax proposals will
be enacted, and if so, in what form. It is therefore unclear whether (i) the
Company will in fact be able to continue to utilize its taxable affiliates to
achieve its intended benefits or (ii) will otherwise be adversely effected by
the President's tax proposals.
31
32
EMPLOYEES
As of March 17, 1999, the Company employed twenty-eight people, RFS employed
twenty-four, RRF employed eighteen and RCF employed eight.
ITEM 2. PROPERTIES
The Company and Holdings lease space for their executive and administrative
offices at 591 Redwood Highway, Suites 3100,3120 and 3140, Mill Valley,
California 94941, telephone (415) 389-7373.
RFS leases space for its mortgage portfolio evaluation services at 110 E.
Broward, Blvd., Ft. Lauderdale, Florida 33301, telephone (954) 463-0900.
RRF leases space for its residential mortgage banking operations at 125 E. Sir
Francis Drake Blvd. #300, Larkspur, California 94939, telephone (415) 464-5780.
In addition, RRF leases a corporate apartment near its office building for use
by its out of state salesforce.
RCF leases space for its commercial mortgage banking operations at 6880 South
McCarran Blvd. #3, Reno, Nevada 89509, telephone (775) 448-9200. Additionally,
RCF leases three offices, all located in California, for use by its offsite loan
production officers.
ITEM 3. LEGAL PROCEEDINGS
At December 31, 1998, there were no pending legal proceedings to which the
Company was a party or of which any of its property was subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholders during the
fourth quarter of 1998.
32
33
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Effective January 28, 1998, the Company's Common Stock was listed and traded on
the New York Stock Exchange under the symbol RWT. Prior to that date, the
Company's Common Stock was traded on the over-the-counter market and was quoted
on the Nasdaq National Market under the symbol RWTI. The Company's Common Stock
was held by approximately 400 holders of record on March 17, 1999 and the total
number of beneficial shareholders holding stock through depository companies was
approximately 4,000. The high and low closing sales prices of shares of the
Common Stock as reported on the New York Stock Exchange or the Nasdaq National
Market composite tape and the cash dividends declared on the Common Stock for
the periods indicated below were as follows:
Common Dividends Declared
------------------------------------
Stock Prices Record Payable Per
High Low Date Date Share
-------- -------- -------- -------- --------
Year Ended
December 31, 1999
First Quarter (through
March 17, 1999) $17 3/8 $13 1/2 -- -- --
Year Ended
December 31, 1998
First Quarter $23 1/2 $18 5/8 5/7/98 5/21/98 $ 0.27
Second Quarter $25 5/8 $17 9/16 8/6/98 8/21/98 $ 0.01
Third Quarter $17 5/8 $12 3/4 -- -- --
Fourth Quarter $16 1/16 $11 1/16 -- -- --
Year Ended
December 31, 1997
First Quarter $56 3/4 $36 1/2 3/31/97 4/21/97 $ 0.60
Second Quarter $57 1/8 $39 1/4 6/30/97 7/21/97 $ 0.60
Third Quarter $50 $27 7/8 9/30/97 10/21/97 $ 0.60
Fourth Quarter $31 3/4 $19 9/16 12/31/97 1/21/98 $ 0.35
The Company intends to pay quarterly dividends so long as the minimum REIT
distribution rules require it. The Company intends to make distributions to its
stockholders of all or substantially all of its taxable income each year
(subject to certain adjustments) so as to qualify for the tax benefits accorded
to a REIT under the Code. All distributions will be made by the Company at the
discretion of the Board of Directors and will depend on the taxable earnings of
the Company, financial condition of the Company, maintenance of REIT status and
such other factors as the Board of Directors may deem relevant from time to
time. No dividends may be paid on the Common Stock unless full cumulative
dividends have been paid on the Preferred Stock. As of December 31, 1998, the
full cumulative dividends have been paid on the Preferred Stock.
33
34
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data is for the years ended December 31, 1998,
1997, 1996 and 1995 and for the period from commencement of operations on August
19, 1994 to December 31, 1994. It is qualified in its entirety by, and should be
read in conjunction with the more detailed information contained in the
Consolidated Financial Statements and Notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere in this Form 10-K.
- --------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
PERIOD
FROM
AUGUST 19,
YEARS ENDED DECEMBER 31, 1994 TO
DECEMBER 31,
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------ ------------
STATEMENT OF OPERATIONS DATA:
Interest income $ 222,804 $ 198,604 $ 67,284 $ 15,726 $ 1,296
Interest expense 196,124 160,277 49,191 10,608 760
Interest rate agreement expense 3,514 3,741 1,158 339 8
Net interest income 23,166 34,586 16,935 4,779 528
Provision for credit losses 1,120 2,930 1,696 493 --
Equity in (earnings) losses of
RWT Holdings, Inc. 4,676 -- -- -- --
Operating expenses (a) 4,656 4,658 2,554 1,131 146
Net unrealized and realized
gains (losses) on assets (38,943) 563 -- -- --
Net income (loss) available to
common stockholders $ (40,118) $ 24,746 $ 11,537 $ 3,155 $ 382
Net taxable income $ 2,859 $ 29,964 $ 15,168 $ 3,832 $ 354
Net taxable income available to
common stockholders $ 112 $ 27,149 $ 14,020 $ 3,832 $ 354
Weighted average shares of
common stock and common stock
equivalents - "diluted" 13,199,819 13,680,410 8,744,184 3,703,803 1,916,846
Diluted earnings (loss) per share $ (3.04) $ 1.81 $ 1.32 $ 0.85 $ 0.20
Dividends declared per Class A
preferred share -- -- -- $ 0.500 $ 0.250
Dividends declared per Class B
preferred share $ 3.020 $ 3.020 $ 1.141 N/A N/A
Dividends declared per common share $ 0.280 $ 2.150 $ 1.670 $ 0.460 N/A
BALANCE SHEET DATA:
Mortgage assets $ 2,670,863 $ 3,366,622 $ 2,153,428 $ 432,244 $ 117,477
Total assets $ 2,832,448 $ 3,444,197 $ 2,184,197 $ 441,557 $ 121,528
Short-term debt $ 1,257,570 $ 1,914,525 $ 1,953,103 $ 370,316 $ 100,376
Long-term debt $ 1,305,560 $ 1,172,801 -- -- --
Total liabilities $ 2,577,658 $ 3,109,660 $ 1,973,192 $ 373,267 $ 101,248
Total stockholders' equity $ 254,790 $ 334,537 $ 211,005 $ 68,290 $ 20,280
Number of Class A preferred
shares outstanding -- -- -- -- 1,666,063
Number of Class B preferred
shares outstanding 909,518 909,518 1,006,250 -- --
Number of common shares outstanding 11,251,556 14,284,657 10,996,572 5,517,299 208,332
OTHER DATA:
Average assets (amortized cost) $ 3,571,889 $ 3,036,725 $ 999,762 $ 220,616 $ 58,414
Average borrowings $ 3,250,914 $ 2,709,208 $ 861,316 $ 174,926 $ 37,910
Average equity $ 307,076 $ 307,029 $ 131,315 $ 43,349 $ 20,137
Interest rate spread 0.34% 0.68% 1.09% 1.11% 0.72%
Net interest margin 0.65% 1.14% 1.69% 2.17% 2.50%
Operating expenses as a % of
net interest income (a) 20.09% 13.47% 15.08% 23.66% 27.73%
Operating expenses as a % of
average assets (a) 0.13% 0.15% 0.26% 0.51% 0.69%
Operating expenses as a % of
average equity (a) 1.52% 1.52% 1.94% 2.61% 2.01%
Return on average assets (1.05%) 0.91% 1.27% 1.43% 1.81%
Average assets/average equity 11.63x 9.89x 7.61x 5.09x 2.93x
Return on average equity (12.17%) 8.98% 9.66% 7.28% 5.25%
Credit reserves $ 4,972 $ 4,931 $ 2,180 $ 490 --
Actual credit losses $ 1,079 $ 179 $ 6 $ 4 --
(a) Excludes one-time termination expense of $1.2 million for 1998.
34
35
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes.
SAFE HARBOR STATEMENT
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995: Statements in this discussion regarding Redwood Trust, Inc. (the "Company"
or "Redwood Trust") and its business which are not historical facts are
"forward-looking statements" that involve risks and uncertainties. For a
discussion of such risks and uncertainties, which could cause actual results to
differ from those contained in the forward-looking statements, see "Risk
Factors" commencing on Page 16 of this 1998 Annual Report.
COMPANY OVERVIEW
Redwood Trust, together with its affiliates, is a mortgage finance company
providing funding to diverse segments of the U.S. mortgage market. The Company
originates, acquires, processes, aggregates, and credit-enhances high-quality
residential and commercial mortgage loans for sale to institutional investors as
tailored loan portfolios, mortgage securities, and mortgage-backed bonds. In
addition, the Company invests in mortgage assets on a long-term basis for its
own account.
For more information about the Company, please visit the Company's Web site on
the Internet at: http://www.redwoodtrust.com.
In the third quarter of 1998, the Company adopted FAS 133 and moved to full
mark-to-market or lower-of-cost-or-market accounting for many of its assets. As
discussed herein and in the Notes to the Consolidated Financial Statements, the
Company took a significant charge to earnings as a result of these changes in
accounting policies and methodologies. Most of these charges were non-cash
accounting adjustments; in and of themselves, these changes had no direct effect
on the Company's capital, liquidity or cash flow.
Redwood Trust earnings for the fourth quarter of 1998 were $5.8 million and
earnings per share were $0.51. Relative to the fourth quarter of 1997, net
income increased by 32% and earnings per share increased by 70%. This strong
increase in quarterly earnings per share was due to an increase in net interest
income from REIT portfolio operations, a gain on sale of mortgage loans, and a
reduction in the number of common shares outstanding due to Company share
repurchases.
For the full year 1998, the Company reported a net loss of $40.1 million and a
loss per share of $3.04. For the full year 1997, the Company reported net income
of $24.7 million and earnings per share of $1.81. For the full year 1996, the
Company reported net income of $11.5 million and earnings per share of $1.32.
In 1998, mortgage prepayment rates accelerated as homeowners refinanced their
mortgages in record numbers. This acceleration was the primary reason the
Company reported a loss in 1998. Prepayment acceleration had two negative
impacts on earnings. First, prepayment acceleration caused a decline in the
market value of the Company's assets. This reduction in market value was
recognized as a reduction in earnings under the mark-to-market accounting
methodologies the Company adopted in the third quarter of 1998 for the majority
of its assets. Second, accelerated mortgage prepayment rates increased mortgage
premium amortization expenses.
Financial markets went through a period of turmoil and reduced liquidity in the
second half of 1998. The Company entered the liquidity crisis with a strong
balance sheet, a strong liquidity position, a significant portion of its
borrowings in the form of non-recourse long-term debt, and relatively modest
effective leverage. As a result, the Company was largely unaffected by the
liquidity crisis except to the extent which earnings were reduced by
mark-to-market adjustments as the market values of portfolio assets fell during
the crisis.
35
36
The Company's common stock price declined in 1998 to a level below tangible book
value per share. Because of its strong balance sheet position, the Company was
able to enhance liquidity for selling shareholders and enhance value for
remaining shareholders through its common stock repurchase program. The Company
repurchased 22% of its outstanding common stock in 1998.
The Company's core strategy since its founding in 1994 has been to become a
highly productive and efficient investor in mortgage loan portfolios. As part of
this strategy, the Company developed mortgage loan production and securitization
operations designed to manufacture attractive mortgage loan investments and
credit-enhancement opportunities for the Company's portfolio and to use its
balance sheet to create mortgage-backed bonds for sale to investors.
In 1998, the Company contributed its loan production operations to RWT Holdings,
Inc. ("Holdings"). The Company is funding the expansion of Holdings' loan
production operations to enable Holdings to efficiently manufacture mortgage
investments for sale to all mortgage investors, including the Company's REIT
portfolio. This expansion of the Company's strategy is designed to generate fee
income to compliment the net interest income earned from mortgage portfolio
operations. This expansion should also give the Company's REIT portfolio
significant additional opportunities to acquire attractive mortgage assets. In
addition, asset quality control for the portfolio will be enhanced, as
investments will be produced by the Company's affiliate.
Holdings has three new subsidiaries. Each subsidiary sources mortgage loans for
aggregation and subsequent re-sale to mortgage investors as loan portfolios or
as mortgage securities. Redwood Financial Services, Inc. buys and sells seasoned
loan portfolios and other mortgage assets with banks and thrifts as their
primary customer. Redwood Residential Funding, Inc. acquires newly originated
residential loans from mortgage bankers and sells them as loans or securities to
a variety of institutional investors. Redwood Commercial Funding, Inc.
originates small balance commercial mortgages for sale to banks and other
finance companies. More generally, each of these units is prepared to both buy
and sell mortgage assets from and to its client base within its area of product
expertise. Collectively, these companies are capable of buying or selling almost
any type of high quality mortgage loan in a professional manner, and adding
value to the process through their operations.
The Company believes that each of Holdings' new businesses has the potential to
generate a return on equity equal to or greater than the return on equity
generated by the Company's REIT portfolio operations. However, these new
businesses are all in their start-up phases so additional operating loses will
occur in 1999 prior to these business generating such profits. These losses will
be reflected in the Company's income statements. Furthermore, the Company plans
to allocate an increasing percentage of its capital to Holdings' mortgage
production businesses during 1999. To free capital for Holdings, the Company
plans to reduce the size of its REIT mortgage portfolio. As a result, earnings
potential from the REIT portfolio will decline even if REIT portfolio margins
remain healthy. Overall Company profitability will likely be reduced until
Holdings' new businesses achieve their profitability targets.
FINANCIAL CONDITION
At December 31, 1998, the Company's reported balance sheet had $2.8 billion of
assets funded with $2.6 billion of borrowings and $255 million of equity.
Included on the reported balance sheet at December 31, 1998 were $1.4 billion of
assets and $1.3 billion of debt consolidated from the balance sheets of three
"Sequoia" trusts. The Company acts as a financial intermediary by holding
mortgage loans in Sequoia and issuing mortgage-backed bonds through Sequoia. The
Company, through its ownership of the Sequoia trusts, credit-enhances the
mortgage-backed bonds and earns the spread between the mortgage rate and the
bond rate.
The Sequoia trusts are "bankruptcy-remote" with respect to the Company. As a
result, the Company is not responsible for the repayment of Sequoia debt and
Sequoia has no call on the liquidity of the Company. The Company's credit risk
with respect to Sequoia's mortgage assets is limited to the Company's investment
in the
36
37
equity of these trusts. At December 31, 1998, this investment had a reported
basis of $43 million. The individual assets and liabilities of Sequoia had a net
estimated market value of $32 million.
Subtracting out those Sequoia assets and liabilities for which the Company's
risk is limited, the Company's "at-risk" balance sheet at December 31, 1998
consisted of $1.5 billion of assets (including its $43 million investment in
Sequoia equity) funded with $1.3 billion of borrowings and $255 million of
equity. The ratio of equity to at-risk assets was 16.7%.
At December 31, 1997, the Company reported $3.4 billion in assets, of which $2.3
million were at-risk, and $3.1 billion of liabilities, of which $1.9 million
were at-risk. Equity capital was $335 million. The ratio of equity to at-risk
assets was 14.5%.
At December 31, 1996, the Company reported $2.2 billion in assets and $2.0
billion of liabilities. The Company did not have any Sequoia mortgage equity
interests at that time, so all the assets and liabilities were at-risk. Equity
capital was $211 million. The ratio of equity to at-risk assets was 9.7%.
CASH
The Company had $56 million, $25 million, and $11 million of unrestricted cash
at year-end 1998, 1997 and 1996, respectively.
Cash owned by the Sequoia trusts totaled $13 million at year-end 1998 and $25
million at year-end 1997. In consolidating Sequoia assets on its balance sheet,
the Company includes this cash and labels it as restricted cash as it is not
available to the Company.
U.S. TREASURY SECURITIES
The Company acquired ten-year Treasury notes in 1998 for balance sheet asset and
liability management purposes. The Company marks these securities to market for
income statement and balance sheet purposes. The market value was $48 million at
December 31, 1998.
MORTGAGE SECURITIES: MARK-TO-MARKET
With the exception of its interest in SMFC 94-A (the Company's December 1997
re-Remic which is held for long-term investment and funded with equity) the
Company's mortgage securities portfolio was marked-to-market for income
statement and balance sheet purposes in 1998. For the mark-to-market securities,
estimated bid-side market value was $1.3 billion at December 31, 1998: these
appear on the Company's balance sheet as "Mortgage Securities:
Trading."
The Company owned $1.8 billion in market value of these securities at December
31, 1997 and $1.6 billion at December 31, 1996. These securities were then
carried on the Company's balance sheet as "Mortgage Securities:
Available-For-Sale." This portfolio was marked-to-market for balance sheet
purposes during those periods but changes in value were not recognized on the
income statement.
At December 31, 1998, 47% of this residential mortgage securities portfolio
consisted of residential adjustable-rate mortgage securities issued and
credit-enhanced by Fannie Mae or Freddie Mac and effectively rated "AAA." These
securities totaled $0.6 billion, $1.0 billion, and $1.0 billion at year-end
1998, 1997, and 1996, respectively.
At December 31, 1998, 1% of the residential mortgage securities portfolio
consisted of floating-rate CMO mortgage securities issued by Fannie Mae or
Freddie Mac and effectively rated "AAA." These securities totaled $17 million at
year-end 1998. The Company did not own any such securities prior to 1998.
At December 31, 1998, 44% of the residential mortgage securities portfolio
consisted of residential adjustable-rate mortgage securities issued by
private-label security issuers. These were credit-enhanced through subordination
or other means and were rated "AAA" or "AA." The value of these securities was
$0.6 billion, $0.8 billion, and $0.7 billion at year-end 1998, 1997, and 1996,
respectively.
37
38
At December 31, 1998, 0.03% of the residential mortgage securities portfolio
consisted of Interest-Only securities rated "AAA" or "AA." The value of these
securities was $0.4 million, $1.5 million, and $2.5 million at year-end 1998,
1997, and 1996, respectively.
At December 31, 1998, 2% of the residential mortgage securities portfolio
consisted of fixed-rate, private label CMO mortgage securities rated "AAA" or
"AA" with average lives of 1 to 2 years. The value of these securities was $19
million at year-end 1998. The Company did not own any such securities prior to
1998.
At December 31, 1998, 1% of the residential mortgage securities portfolio
consisted of fixed-rate private label mortgage securities rated "AA" and backed
by residential mortgage loans with loan-to-value ratios in excess of 100%. The
value of these securities was $12 million at year-end 1998. The Company did not
own any such securities prior to 1998.
At December 31, 1998, 5% of the residential mortgage securities portfolio
consisted of home equity ("HEL") mortgage securities rated "AAA" or "AA." The
value of these securities was $71 million at year-end 1998; floating-rate HEL
securities were $68 million and fixed-rate HEL securities were $3 million. The
Company did not own any such securities prior to 1998.
SMFC 94-A
In 1994 and 1995, the Company acquired a portfolio of subordinated mortgage
securities. These securities were the interests in pools of residential
mortgages that served as the credit-enhancement for the "AAA" and other
securities issued from those pools. Through ownership of these securities, the
Company assumed most of the credit risk of the underlying mortgages. These
securities were either not rated or were rated "A" through "B."
The value of these securities was $51 million at December 31, 1996. The Company
sold these subordinated securities to a Sequoia trust subsidiary, SMFC 97-A, in
December 1997. SMFC 97-A issued mortgage securities to fund its acquisition of
this portfolio.
The Company acquired from SMFC 97-A the most subordinated of the mortgage
interests it issued. In effect, the Company acquired the equity of SMFC 97-A.
Changes in market valuations of SMFC 97-A are not included in the Company's
income statement as this asset is funded long-term with equity. These mortgage
equity interests were valued on the Company's balance sheet at historical
amortized cost (less credit reserve) of $8 million at December 31, 1998 and $9
million at December 31, 1997.
At December 31, 1998, these securities effectively bore most of the credit risk
related to $0.5 billion of underlying mortgages. Through the creation and
retention of the SMFC 94-A interests, the Company used its capital to extend
credit guarantees on these mortgage securities in order to facilitate the
creation and sale of higher rated mortgage securities. The Company's credit risk
from SMFC 97-A is limited to its investment of $8 million. The assets and
liabilities of SMFC 97-A are not consolidated on the Company's balance sheet.
COMMERCIAL MORTGAGE LOANS
The Company acquired commercial mortgages for the first time in the fourth
quarter of 1998. These loans were carried on the Company's December 31, 1998
balance sheet as "Mortgage Loans: Held for Sale." They were valued at that time
at the lower-of-cost-or-market of $8 million. At December 31, 1998, the Company
had committed to sell these loans to Holdings.
RESIDENTIAL MORTGAGE LOANS
The Company owned $68 million residential mortgage loans at December 31, 1998.
These were carried on the Company's balance sheet at the lower-of-cost-or-market
as "Mortgage Loans: Held for Sale." The Company reduced its mortgage loan
portfolio in 1998 through sales to the Sequoia trusts and to other mortgage
investors.
The Company owned $359 million residential mortgage loans at December 31, 1997
and $525 million residential mortgage loans at December 31, 1996. These were
carried on the Company's balance sheet in those years at historical amortized
cost less credit reserve in the "Mortgage Loans: Held for Investment" category.
38
39
SEQUOIA MORTGAGE TRUST 1 RESIDENTIAL MORTGAGE LOANS
Sequoia Mortgage Trust 1 ("Sequoia 1") owned $197 million in principal value of
residential mortgage loans and $13 million of cash at December 31, 1998 funded
with $203 million of mortgage-backed bonds. The Company consolidated the assets
and liabilities of Sequoia 1 on its balance sheet: these appeared on the
Company's balance sheet as part of "Mortgage Loans: Held for Sale," "Restricted
Cash," and "Long-term Debt."
The Company's credit risk with respect to these loans was limited at December
31, 1998 to the Company's investment in the equity of Sequoia 1. The reported
basis of this investment was $8 million at December 31, 1998. While the
estimated market value of this investment in the form of equity in Sequoia 1
Trust was unknown, the net market value of Sequoia 1's individual assets and
liabilities was also $8 million. As the equity owner of Sequoia 1, the Company
is entitled to distributions of the net earnings of the trust, which principally
consists of the interest income earned from Sequoia 1 mortgages less the
interest expense on Sequoia 1 debt.
Starting in the first quarter of 1999, the Company had the right, but not the
obligation, to call Sequoia 1's debt. If beneficial, the Company could exercise
this call. It could then keep or reissue Sequoia 1 debt or, alternatively, it
could collapse the trust to effectively re-acquire Sequoia 1's loans.
At December 31, 1997, the principal value of Sequoia 1's loans, as reflected on
the Company's balance sheet, totaled $425 million and were included as part of
"Mortgage Loans: Held for Investment." The Company formed Sequoia 1 in June
1997. At that time, the Company sold $543 million of principal value of its loan
portfolio to Sequoia and Sequoia issued $534 million of long-term amortizing
mortgage-backed debt rated "AAA" to fund the purchase.
SEQUOIA MORTGAGE TRUST 2 RESIDENTIAL MORTGAGE LOANS
Sequoia Mortgage Trust 2 ("Sequoia 2") owned $579 million of principal value of
residential mortgage loans at December 31, 1998 funded with $571 million of
mortgage-backed bonds. The Company consolidated the assets and liabilities of
Sequoia 2 on its balance sheet: these appeared on the Company's balance sheet as
part of "Mortgage Loans: Held for Investment" and "Long-term Debt." As the
equity owner of Sequoia 2, the Company is entitled to receive distributions of
its net income.
The Company's credit risk with respect to these loans was limited at December
31, 1998 to the Company's investment in the equity of Sequoia 2. The reported
basis of this equity interest was $22 million; the estimated net market value of
Sequoia 2's assets and liabilities was $14 million.
The Company will have the right to call Sequoia 2's debt and re-acquire Sequoia
2's loans when certain conditions have been met. It most likely will be several
years before the Company gains this right.
At December 31, 1997, Sequoia 2's loans, as reflected on the Company's balance
sheet, totaled $740 million and were included as part of Mortgage Loans: Held
for Investment. Sequoia 2 was formed by the Company in November 1997. At that
time, the Company sold $757 million of principal value of its loan portfolio to
Sequoia and Sequoia issued $749 million of long-term amortizing debt rated "AAA"
to fund the purchase.
SEQUOIA MORTGAGE TRUST 3 RESIDENTIAL MORTGAGE LOANS
Sequoia Mortgage Trust 3 ("Sequoia 3") owned $540 million of principal value of
residential mortgage loans at December 31, 1998 funded with $530 million of
mortgage-backed bonds. The Company consolidated the assets and liabilities of
Sequoia 3 on its balance sheet: these appeared on the Company's balance sheet as
part of "Mortgage Loans: Held for Investment" and "Long-term Debt." The Company
owns the equity of Sequoia 3 and is entitled to its earnings distributions.
The Company's credit risk with respect to these loans was limited at December
31, 1998 to the Company's investment in the equity of Sequoia 3. This investment
had a reported basis of $12 million. The estimated net market value of Sequoia
3's assets and liabilities was $9 million.
39
40
The Company will have the right to call Sequoia 3's debt and re-acquire Sequoia
3's loans when certain conditions have been met. The Company is not likely to
gain this right prior to December 2002.
The Company formed Sequoia 3 in June 1998. At that time, Sequoia acquired $645
million of principal value of loans from the Company and Holdings and Sequoia
issued $635 million of long-term amortizing mortgage-backed debt rated "AAA" to
"BBB" to fund the purchase.
INTEREST RATE AGREEMENTS
The Company's interest rate agreements are carried on its balance sheet at
estimated market value, which was $2.5 million at December 31, 1998, $2.1
million at December 31, 1997, and $2.6 million at December 31, 1996. Please see
"Note. 2 Summary of Significant Accounting Policies", "Note 6. Interest Rate
Agreements" and "Note 10. Fair Value of Financial Instruments" in the Notes to
Consolidated Financial Statements and "Item 7(a): Quantitative and Qualitative
Disclosures about Market Risk" for additional details about the Company's
interest rate agreements.
INVESTMENT IN RWT HOLDINGS, INC.
The Company does not consolidate the assets and liabilities of Holdings on its
balance sheet.
The Company's preferred stock investment in Holdings was carried on the
Company's balance sheet as a $15.1 million asset at December 31, 1998.
In 1998, the Company made its original investments of $19.9 million in the
equity of Holdings; the carrying value of this investment has been reduced by
the Company's share of the operating losses at Holdings.
At December 31, 1998, the Company's assets also included a loan to Holdings of
$6.5 million and a receivable from Holdings of $0.4 million.
OTHER ASSETS
Other assets include accrued interest receivable, fixed assets, leasehold
improvements and prepaid expenses. These totaled $21 million, $26 million, and
$17 million at the end of 1998, 1997 and 1996, respectively.
SHORT-TERM DEBT
Short-term borrowings totaled $1.3 billion at December 31, 1998. The Company
pledged a portion of its mortgage security portfolio and mortgage loan portfolio
to secure this debt. Short-term debt totaled $1.9 billion at December 31, 1997
and $2.0 billion at December 31, 1996. Maturities on this debt typically range
from one month to one year.
LONG-TERM DEBT
At December 31, 1998, Sequoia 1 had $202 million, Sequoia 2 had $574 million,
and Sequoia 3 had $530 million of long-term mortgage-backed debt outstanding,
net of unamortized premiums on bonds and deferred bond issuance costs.
At December 31, 1997, Sequoia 1 had $429 million and Sequoia 2 had $736 million
of long-term debt outstanding. There was no Sequoia 3 debt outstanding in 1997
and no Sequoia debt outstanding in 1996.
Sequoia debt is non-recourse to the Company. The debt is consolidated on the
Company's balance sheet and is carried as long-term debt at historical amortized
cost.
OTHER LIABILITIES
Other liabilities include accrued interest payable, accrued expenses, and
dividends payable. The net balance of these accounts totaled $15 million, $22
million, and $20 million at the end of 1998, 1997 and 1996, respectively.
40
41
SHAREHOLDERS' EQUITY
Total equity capital totaled $255 million at December 31, 1998. Reported common
equity totaled $228 million, or $20.27 per common share outstanding.
In reporting equity at December 31, 1998, the Company marked-to-market all
earning assets and interest rate agreements except mortgage assets funded with
equity or funded to maturity with an expected long-term holding period (Sequoia
2 and Sequoia 3). In accordance with Generally Accepted Accounting Principles,
no liabilities were marked-to-market.
If the Company had marked-to-market all of its assets and liabilities, equity
capital would have been $248 million at December 31, 1998. After subtracting out
the preference value of the preferred stock, common equity on a full
mark-to-market basis was $220 million and the net mark-to-market value per
common share was $19.53.
Reported equity capital was $335 million at December 31, 1997 and $211 million
at December 31, 1996. Reported common equity was $308 million at December 31,
1997 and $181 million at December 31, 1996. For those dates, reported book value
per common share was $21.55 and $16.50 and the net mark-to-market value per
common share was $21.47 and $16.37.
Equity capital was reduced in 1998 due to a reduction in the market value of
marked-to-market assets and the Company's common stock repurchase program. The
Company acquired 3,131,500 shares of its common stock in 1998 at an average
price of $14.99 per share.
RESULTS OF OPERATIONS
REIT INTEREST INCOME
Net earnings from assets include interest income, net asset appreciation as
discussed in "REIT Net Unrealized and Realized Gains and Losses on Assets" and
credit expenses as discussed in "REIT Credit-Related Expenses."
Interest income generated by the Company's REIT portfolio (including
consolidated Sequoia assets) was $223 million in 1998. The portfolio had average
earning assets of $3.5 billion and earned an average yield of 6.48%.
The Company started to reduce the size of its portfolio in the third quarter of
1998 in order to free up capital to support growth of Holding's mortgage banking
businesses. In 1998, average earning assets were $3.3 billion in the first
quarter, $3.5 billion in the second quarter, $3.8 billion in the third quarter,
and $3.1 billion in the fourth quarter. At December 31, 1998, earning assets
were $2.8 billion.
The Company's earning asset yield rose in the second half of the year. For the
four quarters of 1998, the earning asset yield was 6.49%, 6.10%, 6.42%, and
6.87%, respectively. The earning asset yield in December 1998 was 6.95%.
The earning asset yield rose despite falling interest rates, which contributed
to an acceleration of mortgage prepayment rates (26%, 34%, 29% and 32% on an
annualized basis for the four quarters of 1998) and reduced mortgage cash coupon
rates (7.65%, 7.52%, 7.22% and 7.17% for the four quarters of 1998). By December
1998, the prepayment rate was 33% and the average mortgage coupon was 7.21%.
The earning asset yield rose during 1998 as the Company reduced net mortgage
premium balances and thus reduced net premium amortization expenses. The Company
reduced its mortgage premium balances through reducing the basis of retained
assets, amortization, sales of assets with high premiums, and acquisition of
assets with lower premiums. The Company also has reduced effective mortgage
premium by issuing Sequoia mortgage-backed debt at a premium. The Company wrote
down mortgage premium when it adopted mark-to-market accounting for the majority
of its assets in the third quarter of 1998.
The Company's net premium balances, including effective premium and discount on
long-term debt (and excluding the premium on the U.S. Treasuries), were $71
million, $62 million, $17 million, and $13 million at
41
42
the end of the four quarters of 1998, respectively. Net asset premium
amortization was $8.2 million, $11.0 million, $6.9 million, and $1.8 million in
those four quarters. The reduction in net earning asset yield caused by premium
amortization was 0.99%, 1.26%, 0.72%, and 0.23%, respectively.
By year-end 1998, the net premium balance was $13 million, or 0.5% of mortgage
asset principal value. The reduction in yield caused by premium amortization was
0.21% in December 1998.
From 1997 to 1998, interest income increased from $199 million to $223 million
as the average portfolio of earning assets grew to $2.9 billion to $3.4 billion.
The net yield on earning assets declined during this period, from 6.74% in 1997
to 6.48% in 1998. The two principal drivers of changes in portfolio yield were
changes in the average mortgage coupon rate and changes in mortgage premium
amortization expenses. Mortgage coupon rates generally tracked changes in
short-term interest rates, although with a lag. The average coupon was 7.72% in
1997 and 7.42% in 1998.
Premium amortization expenses rose from $23 million in 1997 to $28 million in
1998 as the Company's premium balances increased and mortgage prepayment rates
accelerated. Average mortgage premium was $61 million and $49 million in 1997
and 1998, respectively, or, 2.1% and 1.5% of average mortgage asset principal
value. Average prepayment rates were 25% in 1997 and 30% in 1998. The reduction
in earning asset yield due to premium amortization was 0.81% in 1997, and 0.82%
in 1998.
From 1996 to 1997, interest income increased from $67 million to $199 million as
the average portfolio of earning assets grew from $1.0 billion to $2.9 billion.
The net yield on earning assets declined during this period, from 6.93% in 1996
to 6.74% in 1997. The average mortgage coupon was 7.55% in 1996 and 7.72% in
1997.
Premium amortization expenses rose from $5 million in 1996 to $23 million in
1997 as the Company's premium balances increased while mortgage prepayment rates
remained at the same level. Average mortgage premium as a percentage of average
mortgage asset principal value was 0.7% in 1996 and 2.1% in 1997. Average
prepayment rates were 25% in both years. The reduction in earning asset yield
due to premium amortization was 0.55% in 1996 and 0.81% in 1997.
REIT INTEREST EXPENSE
Interest expense in 1998 was $196 million. The Company funded its REIT portfolio
with an average of $304 million of equity and $3.3 billion of borrowings
(including consolidated Sequoia debt). The Company paid an average cost of funds
of 6.03% for these borrowings.
In 1998, interest expense was $46 million in the first quarter, $50 million in
the second quarter, $56 million in the third quarter, and $44 million in the
fourth quarter. Average borrowings were $3.1 billion, $3.3 billion, $3.7
billion, and $3.0 billion. The average cost of funds was 6.01%, 6.06%, 6.15%,
and 5.89%, respectively.
The cost of funds rose in the first three quarters of 1998 as short-term
borrowing costs rose from 5.77% to 5.88% to 5.93%. In addition, the percentage
of long-term debt funding, which is more expensive, changed from 37% to 32% to
42%. The cost of long-term debt was stable, averaging 6.45%.
In the fourth quarter of 1998, borrowing costs declined in conjunction with
falling short-term interest rates. The cost of short-term borrowings dropped to
5.59% and the cost of long-term borrowings, most of which are adjustable-rate,
dropped to 6.23%. Average long-term borrowings were 47% of total borrowings in
the fourth quarter.
For December 1998, the overall cost of borrowing was 5.87%, short-term
borrowings cost 5.58%, long-term borrowings cost 6.14%, and average long-term
borrowings were 51% of total borrowings.
From 1997 to 1998, interest expense increased from $160 million to $196 million
as average borrowings increased from $2.7 billion to $3.3 billion. The overall
cost of funds was 5.92% in 1997 and 6.03% in 1998.
42
43
The Company's cost of funds rose from 1997 to 1998 primarily as the cost of
long-term debt rose and as the Company utilized an increased percentage of the
more expensive long-term debt. The cost of short-term debt generally tracked
changes in short-term interest rates, which were relatively stable throughout
these periods. The cost of short-term debt was 5.86% in 1997 and 5.81% in 1998.
The Company started issuing long-term mortgage-backed debt through Sequoia
trusts in 1997. The cost of Sequoia debt was 6.31% in 1997 and 6.38% in 1998.
The effective cost of long-term debt rose slightly as the Company issued some
fixed-rate, rather than adjustable-rate debt. In addition, the Company reduced
its prepayment risk by structuring some prepayment risk into the debt issued,
which increased the cost of the debt. The percentage of average debt that was
long-term debt rose from 12% in 1997 to 39% in 1998.
From 1996 to 1997, interest expense increased from $49 million to $160 million
as average borrowings increased from $0.9 billion to $2.7 billion. The overall
cost of funds was 5.71% in 1996 and 5.92% in 1997.
The Company's cost of funds rose from 1996 to 1997 as the cost of short-term
debt rose and as the Company utilized an increased percentage of more expensive
long-term debt. The cost of short-term debt generally tracked changes in
short-term interest rates, although with a lag. This cost was 5.71% in 1996 and
5.86% in 1997. The Company started issuing long-term debt through Sequoia trusts
in 1997. In 1997, the cost of Sequoia debt was 6.31% and average long-term debt
was 12% of total debt.
REIT INTEREST RATE AGREEMENT EXPENSE
Hedging expenses include interest rate agreement expenses and changes in market
value of interest rate agreements. Interest rate agreement expense presented in
the income statement consists of both cash flow costs and amortization expenses.
Changes in the market value of interest rate agreements are included in "REIT
Net Unrealized and Realized Gains and Losses on Assets" as discussed below.
Interest rate agreement expense was $3.5 million in 1998, or 0.11% of average
borrowings. In the four quarters of 1998, interest rate agreement expense was
$1.4 million, $1.6 million, $0.2 million, and $0.3 million, respectively.
Expressed as a percentage of the Company's borrowings, interest rate agreement
expense was 0.18%, 0.19%, 0.03% and 0.04%, respectively.
In adopting mark-to-market accounting for its interest rate agreements in the
third quarter of 1998 through the early adoption of SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, the Company wrote down its basis
in its interest rate agreements. While this market value adjustment reduced
overall third quarter 1998 income, it had the effect of reducing interest rate
agreement amortization expense starting in that quarter.
Interest rate agreements expense was $3.7 million in 1997 and $3.5 million in
1998. As a percentage of borrowings, interest rate agreement expense was 0.14%
in 1997 and 0.11% in 1998. Interest rate agreement expense was reduced in 1998
due to a change to mark-to-market accounting.
Interest rate agreements expense was $1.2 million in 1996 and $3.7 million in
1997. As a percentage of borrowings, interest rate agreement expense was 0.13%
in 1996 and 0.14% in 1997. Interest rate agreement expense increased as the size
of the Company's balance sheet increased.
See "Note 6. Interest Rate Agreements" in the Notes to Consolidated Financial
Statements for additional details.
REIT NET INTEREST INCOME
Net interest income (interest income less interest expense and interest rate
agreement expense) was $23 million in 1998. Net interest income was $6 million
in the first quarter, $2 million in the second quarter, $5 million in the third
quarter, and $10 million in the fourth quarter.
For the four quarters of 1998, the interest rate spread (yield on earning assets
less cost of funds and hedging) was 0.30%, -0.15%, 0.24%, and 0.94% and the net
interest margin (net interest income divided by average assets)
43
44
was 0.75%, 0.22%, 0.52%, and 1.19%, respectively. The spread and margins
increased in the later part of 1998 in spite of accelerated prepayment rates.
This was due to the changes in accounting methodologies, which lowered
amortization expense and thereby increased asset yields, and a reduction in
short-term interest rates, which lowered the short-term cost of funds.
Net interest income was $34 million in 1997 and $23 million in 1998. The
interest rate spread was 0.68%, and 0.34% and the interest rate margin was
1.14%, and 0.65%, respectively. The decrease in spreads and margins reflect the
flattening of the yield curve which resulted in faster prepayments and a
reduction in coupon rates on six- and twelve-month adjustable-rate assets
relative to rates on one-month funding.
Net interest income was $17 million in 1996 and $34 million in 1997. The
interest rate spread was 1.09% and 0.68% and the interest rate margin was 1.69%
and 1.14%, respectively. The decrease in spreads and margins reflect the
Company's increased used of more expensive long-term debt and a higher premium
balance which reduced the yield on assets.
REIT CREDIT-RELATED EXPENSES
Credit-related expenses include credit provisions for loans and securities that
are not marked-to-market and credit-related valuation adjustments for assets
that are accounted for on a lower-of-cost-or-market basis. The credit-related
valuation adjustments are included in "Net unrealized and realized gains
(losses) on assets" on the Company's income statement.
In 1998, total credit-related expenses were $2.3 million, including $1.1 million
of credit provisions and $1.2 million of credit-related mark-to-market
adjustments. Total credit-related reserves were $6.1 million at December 31,
1998, including $4.9 million of credit reserves and $1.2 million of
credit-related mark-to-market reserve.
Total actual realized credit losses during 1998 were $1.1 million, including
$0.2 million in losses on loans and $0.9 million in losses on securities (SMFC
97-A).
Credit provisions were $0.6 million in the first quarter of 1998 and $0.8
million in the second quarter of 1998. In the third quarter of 1998, the Company
adopted mark-to-market accounting methodologies for many of its assets. The
Company established a mark-to-market credit reserve of $1.6 million in that
quarter and reversed $0.6 million of credit provision expenses. Fourth quarter
1998 credit-related expenses netted to zero as the Company took $0.4 million
credit provisions and reversed $0.4 million of its mark-to-market credit-related
adjustments.
The Company's overall credit results have been excellent through December 31,
1998. Serious delinquencies have remained below 0.30% of loans and loan loss
severities have averaged less than 10%.
Total credit-related expenses were $2.9 million in 1997 and $2.3 million in
1998. The decrease occurred, primarily because the Company reduced its credit
expenses for SMFC 94-A from $0.4 million in 1997 to zero in 1998. The Company
deems the reserve for SMFC 94-A to be sufficient to cover likely future credit
losses.
Total credit-related expenses were $1.7 million in 1996 and $2.9 million in
1997. The increase was due to the increase in the size of the Company's loan
portfolio.
The Company has generally taken credit provisions at an annual rate of 0.15% for
residential loans held-to-maturity, has written down the basis of delinquent
lower-of-cost-or-market loans to estimated bid-side market value, and has
established a credit reserve for its interests in SMFC 97-A to cover estimated
future losses from that source.
REIT NET UNREALIZED AND REALIZED GAINS AND LOSSES ON ASSETS
The net loss on asset market valuations was $49.0 million in 1998. This net loss
consisted of $3.6 million net realized gains on sale of mortgage loans and
securities, $35.4 million market value loss on portfolio earning assets that
were retained and marked-to-market, $1.2 million to build a credit-related
mark-to-market reserve, $5.6
44
45
million realized loss on sale of interest rate agreements, and $10.4 million
market value loss on retained interest rate agreements.
In accordance with the transition provisions of SFAS No. 133, the Company
recorded a net-of-tax cumulative-effect-type transition loss of $10.1 million to
recognize at fair value the ineffective portion of all interest rate agreements
that were previously designated as part of a hedging relationship. The remaining
$38.9 million of asset valuation adjustments for 1998 was reported under "Net
Unrealized and Realized Gains (Losses) on Assets."
In the first quarter of 1998, the Company wrote down all of its interest-only
mortgage securities by $0.7 million to their estimated market value. The Company
also sold $9 million of mortgage securities for a gain of $6,000. There were no
realized or unrealized gains or losses in the second quarter of 1998.
The Company adopted mark-to-market accounting methodologies for the majority of
its assets and all its interest rate agreements in the third quarter of 1998.
Due primarily to accelerated mortgage prepayments, portfolio assets values had
been declining since the second half of 1997. The market value losses that were
recognized in income in the third quarter of 1998 as a result of the adoption of
new accounting methodologies represented the cumulative losses incurred to date
at that point.
The third quarter of 1998 asset value loss, representing this cumulative
adjustment, was $50.4 million. This consisted of $1.0 million loss on sale of
mortgage loans, $31.3 million market value loss on portfolio earning assets that
were retained and marked-to-market, $1.6 million to build a credit-related
mark-to-market reserve, $5.6 million realized loss on interest rate agreements,
and $10.9 million market value loss on retained interest rate agreements.
In August and September of 1998, before the brunt of the financial crisis hit,
the Company committed to sell $679 million of residential mortgage loans in a
series of transactions. Since these transactions closed in October and November,
the Company recognized the $4.6 million gain on sale of these loans in the
fourth quarter of 1998.
Market values for the Company's retained mortgage portfolio and other assets
continued to fall in the fourth quarter of 1998 due to a liquidity crisis in
worldwide financial markets and due to continued rapid mortgage prepayment
rates.
Total net market value income for the fourth quarter of 1998 was $2.0 million.
This included a $4.6 million gain on sale of mortgage loans, a $3.5 million loss
of value on portfolio earning assets that were retained and marked-to-market, a
$0.4 million mark-to-market gain in the credit-related mark-to-market reserve,
and $0.5 million market value gains on interest rate agreements.
Total gain on assets in 1997 was $0.6 million. There was no gain or loss on
assets in 1996. The Company was not utilizing mark-to-market accounting in these
years, so these gains were generated only upon the sale of assets.
REIT NET INVESTMENT INCOME
Net investment income is earnings from portfolio operations before operating
expenses. It is total asset earnings less the all-in costs of borrowing and
hedging. For 1998, net investment income was negative $27 million.
Total asset earnings in 1998 were $189 million (interest income of $223 million
less credit-related expenses of $2 million less negative mark-to-market
adjustments on mortgage assets of $32 million). Interest expenses on borrowing
were $196 million. Hedging expenses were $20 million ($4 million interest rate
agreement expense plus $16 million mark-to-market adjustments on interest rate
agreements).
For the four quarters of 1998, net investment income was $5 million, $1 million,
negative $45 million, and $11 million, respectively. The reason for the changes
in net investment from quarter to quarter are discussed above.
Net investment income was $15 million in 1996 and $32 million in 1997. The
increase from year to year was due to the growth in the Company's balance sheet.
45
46
REIT OPERATING EXPENSES
Total operating expenses for the REIT for 1998 were $5.9 million; this includes
one-time termination expenses in the fourth quarter of $1.2 million. On going
operating expenses were $4.7 million in 1998.
For the four quarters of 1998, on going operating expenses were $1.9 million,
$0.6 million, $1.0 million, and $1.1 million, respectively. On going operating
expenses as a percentage of assets were 0.22%, 0.06%, 0.10%, and 0.14%,
respectively, and operating expenses as a percentage of equity were 2.24%, 0.69,
1.41%, and 1.75%, respectively. On going operating expenses declined after the
first quarter as the Company transferred its loan production operations to its
affiliate.
On going operating expenses were $4.7 million in 1997 and in 1998. In 1998, as
compared to 1997, bonus-related compensation and stock-option related dividend
equivalent right payments were reduced as a percentage of salaries, while
headcount and base salaries increased. On going operating expenses were 0.15%
and 0.13% of assets. As a percentage of equity, on going operating expenses were
1.52% in both 1997 and 1998.
On going operating expenses were $2.6 million in 1996 and $4.7 million in 1997.
Expenses grew as assets grew and the Company expanded its operational
capabilities. In these years, respectively, on going operating expenses were
0.26% and 0.15% of assets. As a percentage of equity, on going operating
expenses were 1.94% in 1996 and 1.52% in 1997.
REIT NET EARNINGS FROM PORTFOLIO OPERATIONS
Net earnings generated by the Company's REIT portfolio were negative $33 million
in 1998. The REIT portfolio earned $3 million in the first quarter, $1 million
in the second quarter, lost $46 million in the third quarter, and made $9
million in the fourth quarter.
REIT portfolio earnings totaled $28 million in 1997 and $13 million in 1996.
INCOME FROM THE INVESTMENT IN RWT HOLDINGS, INC.
The Company's share of the losses generated by Holdings, the Company's start-up
non-REIT mortgage production affiliate, was $4.7 million in 1998.
Holdings commenced operations in the second quarter of 1998. The Company
recognized operating losses from Holdings of $0.6 million in the second quarter
of 1998, $1.6 million in the third quarter of 1998, and $2.5 million in the
third quarter of 1998.
See Holdings' Consolidated Financial Statements and Notes, and Holdings'
Management's Discussion and Analysis incorporated herein.
NET INCOME
Net income for the Company was negative $37.4 million for 1998. After preferred
dividends of $2.7 million, net income for common shareholders was negative $40.1
million.
After paying quarterly preferred dividends of $0.7 million, net income to common
shareholders was $2.5 million in the first quarter, negative $0.5 million in the
second quarter, negative $47.9 million in the third quarter and $5.8 million in
the fourth quarter of 1998.
In 1997, net income was $27.5 million, preferred dividends were $2.8 million and
net income to common shareholders was $24.7 million.
In 1996, net income was $12.7 million, preferred dividends were $1.2 million and
net income to common shareholders was $11.5 million.
46
47
EARNINGS PER SHARE
Average diluted shares outstanding were 14.2 million in the first quarter, 14.3
million in the second quarter, 13.3 million in the third quarter, and 11.4
million in the fourth quarter of 1998. For the four quarters of 1998, diluted
earnings per share were $0.17, negative $0.03, negative $3.61, and $0.51,
respectively.
Average diluted common shares outstanding were 13.7 million in 1997 and 13.2
million in 1998. Shares outstanding declined as a result of the Company's common
share repurchase program. Diluted earnings per share were $1.81 in 1997 and
negative $3.04 in 1998.
Average diluted common shares outstanding were 8.7 million in 1996 and 13.7
million in 1997. Shares outstanding increased as a result of the Company's
secondary stock offerings. Diluted earnings per share were $1.32 in 1996 and
$1.81 in 1997.
DIVIDENDS
The Company paid common stock dividends of $0.27 in the first quarter of 1998
and $0.01 in the second quarter of 1998. No dividends were paid in the third and
fourth quarter of 1998. These 1998 common stock dividends totaled $3.9 million.
In 1997, the Company paid $28.8 million common stock dividends, or $2.15 per
share. In 1996, the Company paid $14.1 million common stock dividends, or $1.67
per share.
The Company was not required under the minimum REIT dividend distribution rules
to declare a common stock dividend in the third and fourth quarters of 1998, so
no such dividend was declared. While the Company had more than ample liquidity
and balance sheet strength to pay a dividend in those quarters, the Company
chose to retain its capital to use for its operations and its common stock
repurchase program.
RISK MANAGEMENT
MARKET RISKS
The Company's market risks include changes in market valuations, changes in net
interest income, liquidity risk, prepayment risk, credit risk and others.
Management's discussion and selected information on these risks is included in
"Item 7(a) Quantitative and Qualitative Disclosures About Market Risk" in this
Form 10-K.
LIQUIDITY
In the fourth quarter of 1998, the Company entered into several new short-term
borrowing commitments with higher haircuts and higher spreads between the cost
of these borrowings and LIBOR rates than typically had been the case in the
past. In addition, in at least one instance, a short-term lender to the Company
indicated that, due to their own internal issues, they would not be able to
renew certain borrowings as they became due; the Company met its financing needs
with other lenders. These were symptoms of the nationwide "liquidity crunch"
which impacted financial markets in general, including the mortgage market and
the short-term lenders supplying funds to the mortgage market.
At December 31, 1998, the Company's short-term borrowings and borrowing
commitments all had maturities in 1999, mostly in the first quarter of 1999. The
Company's ability to roll over these borrowings as they become due depends on
many factors, including any continued effects of the liquidity crunch. If new
financing is unavailable to the Company, or only available with onerous terms,
the Company may be forced to liquidate assets. If the spread between the cost of
new financing and LIBOR rates increases, lower earnings than would otherwise
have been the case could result. If new financings have lower advance rates
(higher haircuts) than has typically been the case in the past, the Company's
liquidity reserves could be reduced or eliminated and its ability to grow and
fund its business plan could be diminished. In the first quarter of 1999, the
Company extended some of its short-term debt to mature in 2000. Liquidity
conditions generally improved in early 1999 from the fourth quarter of 1998.
At December 31, 1998, $1.3 billion of mortgage assets served as collateral for
Sequoia's long-term debt. The remaining mortgage assets, which had a market
value of $1.3 billion, were available to collateralize the Company's short-term
debt. The Company estimates it had additional borrowing capacity in excess of
its current requirements of $61 million at year-end. In addition, the Company
had $56 million of unrestricted cash. These
47
48
amounts together represented 9% of short-term borrowings at that time. The
monthly principal and interest payments received on the mortgages which serve as
collateral to the long-term debt are held in trust until the bond payment date
and are included in the Company's cash balances as "restricted cash."
At December 31, 1997, $1.2 billion of the mortgage assets served as collateral
for Sequoia's long-term debt with the remaining $2.2 billion in mortgage assets
available to collateralize the Company's short-term debt. The Company estimates
it had additional borrowing capacity in excess of its current requirements of
$183 million. In addition, the Company had $25 million of unrestricted cash.
Together, these balances equaled 11% of short-term borrowings at that time.
At December 31, 1996, the Company had borrowings equaling 91% of the $2.2
billion market value of its mortgage assets available to collateralize such
borrowings. The Company estimates it had additional borrowing capacity at that
time of $124 million, as well as $11 million of unrestricted cash for a total
balance equaling 7% of short-term borrowings at that time.
CAPITAL RESOURCES
Through its Risk-Adjusted Capital Policy, the Company assigns a guideline
capital adequacy amount (expressed as a guideline equity-to-assets ratio) to
each of its 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 the Company's collateralized short-term lenders. Capital requirements for
mortgage equity interests (assets funded with long-term debt) generally equal
the Company's net investment. The sum of the capital adequacy amounts for all of
the Company's mortgage assets is the Company's aggregate guideline capital
adequacy amount.
The total guideline equity-to-assets ratio capital amount has declined as the
Company has eliminated some of the risks of short-term debt funding through the
creation of mortgage equity interests by issuing long-term debt.
The Company does not expect that its actual capital levels will always exceed
the guideline amount. The Company measures all of its mortgage assets funded
with short-term debt at estimated market value for the purpose of making
Risk-Adjusted Capital calculations. If interest rates were to rise in a
significant manner, the Company's capital guideline amount would rise (as the
potential interest rate risk of its mortgages would increase, at least on a
temporary basis, due to periodic and life caps and slowing prepayment rates)
while its actual capital levels as determined for the Risk-Adjusted Capital
Policy would likely fall as the market values of its mortgages, net of
mark-to-market gains on hedges, decreased (market value declines may be
temporary as well, as future coupon adjustments on ARMs may help to restore some
of the lost market value). In this circumstance, or any other circumstance in
which the Company's actual capital levels decreased below the Company's capital
adequacy guideline amount, the Company would generally cease the acquisition of
new mortgage assets until capital balance was restored through prepayments,
interest rate changes, or other means. In certain cases prior to a planned
equity offering or other circumstances, the Board of Directors has authorized
management to acquire mortgage assets in a limited amount beyond the usual
constraints of the Company's Risk-Adjusted Capital Policy.
Growth in assets and earnings may be limited when the Company's access to new
equity capital is limited. Holdings and the Company can benefit over time from
the re-investment of any retained earnings at Holdings. Redwood REIT, however,
is generally required to distribute at least 95% of its taxable income as
dividends.
INFLATION
Virtually all of the Company's assets and liabilities are financial in nature.
As a result, interest rates, changes in interest rates and other factors drive
the Company's performance far more than does inflation. Changes in interest
rates do not necessarily correlate with inflation rates or changes in inflation
rates.
The Company's financial statements are prepared in accordance with Generally
Accepted Accounting Principles and the Company's dividends are generally
determined based on the Company's net income as calculated for tax purposes. In
each case, the Company's activities and balance sheet are measured with
reference to historical cost or fair market value without considering inflation.
48
49
YEAR 2000 READINESS DISCLOSURE
In 1998, Redwood Trust established a Year 2000 Project. The goal of this on
going project is to ensure that its communications, data and information systems
are ready for the Year 2000 and to employ prudent management to minimize any
potential negative impact of the Year 2000 on the Company's business partners
and its investors. Senior management has taken an active role in the Year 2000
Project and provides updates to the Company's Board of Directors as necessary.
This update and disclosure pertain to Redwood Trust, Inc. and its affiliates,
though it is not universally applicable.
Our definition of "Readiness for the Year 2000" includes testing 100% of our
internal systems (hardware and software) to ensure that Year 2000 dates are
retained and correctly roll from December 31, 1999 to January 1, 2000 and from
February 28, to February 29, to March 1, 2000. It also includes having an
enterprise-wide contingency and disaster recovery plan for any known Year 2000
issues (and to the extent possible, other unforeseeable circumstances).
Our project management strategies include system risk assessment, system
upgrades or workarounds, and contingency planning. The Company believes it is
devoting the necessary resources to address all appropriate Year 2000 issues.
The Company does not anticipate incurring costs related to the Year 2000 issue
that would be material to its financial position, results of operations, or cash
flows in future periods.
The Company commenced operations within the past five years and has built its
internal systems on a client-server model. Thus, we are not aware of any
internal "legacy" computer systems or software issues.
In the third quarter of 1998, internal computer systems were successfully
tested. Hardware testing included forward date testing of the December 31, 1999
to January 1, 2000 rollover and leap year 2000. Critical software applications,
used to manage the Company's businesses, were also successfully tested.
As systems are modified or new hardware or software systems are implemented in
the normal course of business, the Company's policy is to receive certification
of Year 2000 compliance and to test for Year 2000 compliance upon installation.
The Company continues to gather and assess information of its business partners'
Y2K readiness. We will monitor public disclosures by key business partners into
the New Year and solicit disclosures directly through our own Year 2000
questionnaire and subsequent discussions. Direct data collection should be
substantially completed by June 30, 1999.
Business partners that provide the Company information or services through
externally controlled or externally coordinated systems have been identified.
Joint testing of certain systems has been initiated. External joint testing is
targeted for completion by September 30, 1999.
The Company and its affiliates are developing contingency plans and workaround
systems for critical systems. Workarounds may include substituting compliant
business partners for those who are non-compliant. The benefit to the Company of
this contingency plan is likely to be limited due to the lack of the Company's
control on external vendors and the lack of the Company's ability to replace
certain business partners efficiently.
Management believes the Company is devoting the necessary technical and
management resources to address the Year 2000 issues over which it has control.
While it is inherently difficult to assess the impact our vendors (and their
vendors) may have on the Company in the event they are unable to successfully
manage their own year 2000 issues, the Company believes it is on plan to reach
its Year 2000 Project goals by October 1999.
RWT HOLDINGS, INC.
RWT Holdings, Inc. ("Holdings") was formed in Delaware in February 1998 and
commenced operations on April 1, 1998. Holdings' start-up operations have been
primarily funded by Redwood, which has a significant
49
50
investment in Holdings' preferred stock. See Note 1 in the Notes to the
Consolidated Financial Statements of RWT Holdings, Inc. and Subsidiaries for
additional information on Holdings' initial capitalization.
Holdings conducts mortgage production operations - originating, acquiring,
aggregating and reselling mortgage loans - through three wholly owned
subsidiaries: Redwood Financial Services, Inc., Redwood Residential Funding,
Inc., and Redwood Commercial Funding, Inc.
Redwood Financial Services, Inc. ("RFS") provides asset and liability management
and portfolio evaluation services to commercial banks and other large holders of
seasoned mortgage loan portfolios and seeks to acquire or assist in the sale or
securitization of portions of such portfolios. RFS also seeks to provide other
services to its customers including sales of mortgage loans and other assets to
clients to meet their investment needs.
Redwood Residential Funding, Inc. ("RRF") will acquire newly originated
residential loans from mortgage bankers. It will establish correspondent loan
purchase operations and add value to its lender group through consistent and low
cost execution, risk-based pricing and other technology oriented, value added
services. It will sell its loans to its investor clients as tailored loan
portfolios or as structured mortgage securities.
Redwood Commercial Funding, Inc. ("RCF") acquires, originates and services
commercial mortgage loans typically ranging in size from $0.5 million to $5.0
million. Loans will be made to credit-worthy borrowers on a variety of
commercial property types. These loans will be sold to investor clients,
typically banks and savings and loan institutions.
At December 31, 1998, Holdings owned $12.2 million of residential mortgage loans
that had been acquired by Redwood Financial Services. Holdings also had $9.7
million in cash and $0.8 million in other assets for total assets of $22.8
million. Holdings had a commitment to acquire $8 million of commercial loans
from Redwood Trust in the first quarter of 1999.
The loans owned by Holdings were funded with short-term borrowings and equity.
Subordinated short-term debt was $6.5 million and other liabilities totaled $1.0
million.
Total equity at December 31, 1998 was $15.3 million reflecting the $20.0 million
of initial capital less the $4.7 million in operating losses incurred during the
year.
For 1998, interest income on loans totaled $2.8 million, most of which occurred
in the second quarter of the year as Holdings acquired and sold over $500
million in residential mortgage loans. The Company generated net gains on sale
for the year of $18,000 primarily on the sales transacted in the second quarter.
Holdings earned $0.4 million in interest on its cash balances. Holdings had
total interest expenses for the year of $2.7 million consisting of interest
expenses on short-term borrowings, interest expenses on subordinated debt, and
credit support fees. Net interest income totaled $0.5 million
Operating expenses at Holdings totaled $5.2 million in 1998.
Holdings losses in 1998 were $4.7 million. Each of the Holdings' operations is
still in start-up mode. Holdings currently expects these operations to become
profitable in aggregate during the second half of 1999.
50
51
ITEM 7(a). QUANTATITVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company seeks to manage the interest rate, market value, liquidity,
prepayment and credit risks inherent in all financial institutions in a prudent
manner designed to insure the longevity of the Company. At the same time, the
Company's endeavors to provide its shareholders an opportunity to realize an
attractive total rate of return through stock ownership of the Company. The
Company does not seek to avoid all risks. It does seek, to the best of its
ability, to assume risk that can be quantified from historical experience, to
actively manage such risk, to earn sufficient compensation to justify the taking
of such risks, and to maintain capital levels consistent with the risks it does
undertake.
The Company's strategy for managing some of these risks includes the use of
derivative interest rate agreements. Please see "Note 2. Summary of Significant
Accounting Policies" for additional discussions on the use of interest rate
agreements and their designation as "trading" instruments.
INTEREST RATE RISK
At December 31, 1998, the Company (together with the Sequoia trusts) had $2.0
billion adjustable-rate assets and $2.0 billion adjustable-rate liabilities.
Hybrid mortgage assets, with fixed-rate coupons for 3 to 7 years and
adjustable-rate coupons thereafter, were $606 million. Debt that had interest
rate reset characteristics matched to these hybrid mortgages totaled $530
million.
Fixed-rate assets were $35 million; there were no fixed-rate liabilities.
On average, the Company's cost of funds had the ability to rise or fall more
quickly than did the earning rate on the assets. The risk of reduced earnings in
rising interest rate environment is mitigated to some extent by the Company's
interest rate agreement hedging program.
At December 31, 1998, the Company owned $2.0 billion of adjustable-rate
mortgages with interest rates that adjust every 1, 6 or 12 months. A majority of
the Company's matching debt has an interest expense that adjusts at least once
per month. As a result, the Company's net income may vary somewhat as the yield
curve between one-month interest rates and six and twelve-month interest rates
varies.
Adjustable-rate assets with earnings rates dependent on U.S. Treasury rates
totaled $0.8 billion at December 31, 1998. Liabilities with a cost of funds
dependent on U.S. Treasury rates totaled $0.5 billion at that time. As part of
its hedging program, the Company also had $0.3 billion notional amount of basis
swaps that, in effect, increased the Company's U.S. Treasury-based liabilities
to $0.8 billion. At December 31, 1998, the Company had little earnings risk with
respect to the risk of U.S. Treasury rates deviating from LIBOR market rates.
MARKET VALUE RISK
The market value of the Company's assets can fluctuate due to changes in
interest rates and other factors. These fluctuations effect the Company's
earnings.
At December 31, 1998, the Company and Sequoia 1 together owned mortgage
securities and loans that the Company accounts for on a mark-to-market basis
(including the lower-of-cost-or-market for loans) totaling $1.5 billion. Of
these assets, 93% had adjustable-rate coupons and 7% were hybrid mortgage
assets.
The Company's interest rate agreement hedging program may offset some asset
market value fluctuations due to interest rate changes. All of the Company's $4
billion in notional amounts of interest rate agreements are marked-to-market for
income statement purposes.
51
52
LIQUIDITY RISK
The primary liquidity risk of the Company arises from financing long maturity
mortgage assets with short-term debt. Although the interest rate adjustments of
these assets and liabilities are well matched, maturities are not matched.
The Company's assets that it pledges to secure short-term borrowings are
high-quality, liquid assets. As a result, the Company has not had difficulty
rolling over its short-term debt as it matures, even during the financial market
liquidity crisis of the fourth quarter of 1998. Still, the Company cannot give
assurances that it will always be able to roll over its short-term debt.
At December 31, 1998, the Company had unrestricted cash of $56 million. In
addition, the Company had $61 million in market value of unpledged "AAA" rated
mortgage securities available to secure additional borrowings. The resources the
Company had available to meet margin calls on short-term debt that could be
caused by asset value declines or changes in lender over-collateralization
requirement thus equaled $117 million, or 9.3% of short-term debt.
PREPAYMENT RISK
As the Company receives repayments of mortgage principal, it amortizes into
income its mortgage premium balances as an expense and its mortgage discount
balances as income. Mortgage premium balances arise when the Company acquires
mortgage assets at a price in excess of the principal value of the mortgages, or
when an asset appreciates and is marked-to-market at a price above par. Mortgage
discount balances arise when the Company acquires mortgage assets at a price
below the principal value of the mortgages, or when an asset depreciates and is
marked-to-market at a price below par. At December 31, 1998, mortgage premium
balances were $27 million and mortgage discount balances were $12 million.
Net mortgage premium was $15 million.
Long-term (Sequoia) debt had associated deferred bond issuance costs, which are
amortized as an expense as the bonds are paid off with mortgage principal
receipts. These deferred costs totaled $4 million at December 31, 1998. In
addition, premium received upon bond issuance at prices over principal value is
amortized as income as the bond issues pay down. These balances totaled $6
million at December 31, 1998. The combined effect of these two items was to
reduce the Company's effective mortgage-related premium by $2 million.
Net premium for the Company at December 31, 1998 for assets and liabilities
effected by the rate of mortgage principal receipt was $13 million. This net
premium equaled 5.7% of total common equity. Amortization expense and income
will vary as prepayment rates on mortgage assets vary. In addition, changes in
prepayment rates will effect the market value of the Company's assets and its
earnings. Changes in the basis of the Company's assets will also affect future
amortization expense.
CREDIT RISK
The principal credit risk in the Company comes from loans owned by Sequoia,
loans held in portfolio and the SMFC 94-A securities.
The Company owned $68 million in residential loans at December 31, 1998. Of
these, $0.2 million, or 0.28% were seriously delinquent.
The Company also owned $8 million in commercial loans. These commercial loans
were all current.
The three Sequoia whole loan trusts owned $1.3 billion in residential mortgage
loans at December 31, 1998. The Company's total credit risk from these trusts is
limited to its equity investment in these trusts. These investments had a
reported value of $43 million. At year-end, $3.7 million of these loans, or
0.28%, were seriously delinquent.
At December 31, 1998, the Company had $3.8 million credit reserves and $1.2
million mark-to-market credit reserves to provide for potential future credit
losses from Company and Sequoia loans. Total credit-related reserves were $5.0
million and total seriously delinquent loans were $3.9 million.
52
53
At December 31, 1998, the Company had $1.2 million credit reserves for its SMFC
97-A mortgage securities. The Company's total potential credit exposure from
these securities after this credit reserve was $8 million.
TABULAR PRESENTATION
The information presented in the table below includes all the Company's interest
rate sensitive assets and liabilities. The Company acquires interest-rate
sensitive assets, funds them with interest-rate sensitive liabilities and also
acquires interest-rate sensitive derivative financial instruments. The Company
designates some of these assets as "trading" and others as "non-trading." The
designation of an asset as "trading" does not necessarily imply that the Company
has a short-term intended holding period for that asset.
The table below includes information about the possible future repayments and
interest rates of Company's assets and liabilities and constitutes a
"forward-looking statement." There are many assumptions used to generate this
information and there can be no assurance that assumed events will occur as
assumed or that other events will occur that would affect the outcomes.
Furthermore, future sales, acquisitions, calls, and restructurings could
materially change the Company's interest rate risk profile.
For interest-rate sensitive assets, the table presents principal cash flows and
related average interest rates by year of maturity. The forward curve (future
interest rates as implied by the yield structure of markets) as of December 31,
1998 was used to project the average interest rates for each year, based on the
existing characteristics of the portfolio. The maturity of cash flows includes
assumptions on the prepayment speeds of these assets based on their recent
prepayment performance; actual prepayment speeds will vary.
As of December 31, 1998, all short-term interest-rate sensitive liabilities were
scheduled to mature in 1999. The balance of long-term interest-rate sensitive
liabilities is amortized with the receipt of principal payments from the
mortgages securing such debt. Thus, long-term liability maturities are presented
based on the principal maturities of the underlying mortgages at assumed
prepayment rates. Weighted average interest rates for the year are based on the
forward curve and the characteristics of such debt.
Information presented on derivative financial instruments includes the notional
amounts of such instruments by maturity date and the effective strike, pay or
receive rates by the year in which instruments mature. For those instruments
with a variable-rate component, the applicable average forward rates for the
term of the contract are provided. The information includes all of the Company's
derivative instruments owned as of December 31, 1998, regardless of whether they
were effective at December 31, 1998 or were scheduled to become effective at a
later date.
53
54
TABULAR PRESENTATION
-----------------------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) PRINCIPAL / NOTIONAL AMOUNTS MATURING AND EFFECTIVE RATES DURING PERIOD
1999 2000 2001 2002 2003 THEREAFTER
-----------------------------------------------------------------------
"NON-TRADING" ASSETS, LIABILITIES AND DERIVATIVE
FINANCIAL INSTRUMENTS
INTEREST-RATE SENSITIVE ASSETS
Adjustable-Rate Residential Mortgage Loans
SEQUOIA 1 LOANS Principal Value 100,440 49,206 24,128 11,892 5,911 6,155
Interest Rate 7.21% 6.67% 6.88% 7.28% 7.37% 7.40%
SEQUOIA 2 LOANS Principal Value 144,671 108,504 81,378 63,832 48,371 131,930
Interest Rate 6.90% 6.94% 7.00% 7.11% 7.26% 7.38%
REDWOOD TRUST LOANS Principal Value 25,879 15,092 9,160 5,787 3,795 8,861
Interest Rate 6.93% 6.85% 6.81% 6.79% 6.66% 6.78%
ADJUSTABLE-RATE COMMERCIAL MORTGAGE LOANS
COMMERCIAL LOANS Principal Value 93 104 113 123 134 7,756
Interest Rate 9.30% 9.21% 9.24% 9.31% 9.34% 9.84%
HYBRID RESIDENTIAL MORTGAGE LOANS
SEQUOIA 3 LOANS Principal Value 166,150 115,241 79,871 55,313 38,177 84,937
Interest Rate 6.82% 6.82% 6.82% 6.82% 7.28% 7.55%
ADJUSTABLE-RATE RESIDENTIAL MORTGAGE SECURITIES
SMFC 97-A Principal 228 252 267 281 300 15,953
Interest Rate 6.91% 6.43% 6.61% 6.97% 7.06% 7.17%
FIXED-RATE OTHER INVESTMENTS
US TREASURIES Principal 0 0 0 0 0 45,000
Interest Rate 5.63% 5.63% 5.63% 5.63% 5.63% 5.63%
INTEREST-RATE SENSITIVE LIABILITIES
SHORT-TERM DEBT
REPOS Principal 1,257,570 0 0 0 0 0
Interest Rate 5.62% n/a n/a n/a n/a n/a
LONG-TERM DEBT
SEQUOIA 1 DEBT Principal 100,440 49,206 24,128 11,892 5,911 10,710
Interest Rate 5.73% 5.90% 5.94% 6.00% 6.16% 6.46%
SEQUOIA 2 DEBT Principal 144,671 108,504 81,378 63,832 48,371 124,362
Interest Rate 5.79% 5.33% 5.53% 5.90% 5.98% 6.10%
SEQUOIA 3 DEBT Principal 166,150 115,241 79,871 55,313 38,177 75,249
Interest Rate 6.50% 6.37% 6.36% 6.37% 6.14% 6.41%
-----------------------------------------------------------------------
------------------------
PRINCIPAL EST. MARKET
TABULAR PRESENTATION VALUE AT VALUE AT
(All Dollars in Thousands) DEC. 31, DEC. 31,
1998 1998
------------------------
"NON-TRADING" ASSETS, LIABILITIES AND DERIVATIVE
FINANCIAL INSTRUMENTS
INTEREST-RATE SENSITIVE ASSETS
Adjustable-Rate Residential Mortgage Loans
SEQUOIA 1 LOANS Principal Value 197,732 197,647
Interest Rate 99.96%
SEQUOIA 2 LOANS Principal Value 578,686 580,734
Interest Rate 100.35%
REDWOOD TRUST LOANS Principal Value 68,574 68,267
Interest Rate 99.55%
ADJUSTABLE-RATE COMMERCIAL MORTGAGE LOANS
COMMERCIAL LOANS Principal Value 8,324 8,388
Interest Rate 100.77%
HYBRID RESIDENTIAL MORTGAGE LOANS
SEQUOIA 3 LOANS Principal Value 539,689 539,637
Interest Rate 99.99%
ADJUSTABLE-RATE RESIDENTIAL MORTGAGE SECURITIES
SMFC 97-A Principal 17,281 7,707
Interest Rate 44.60%
FIXED-RATE OTHER INVESTMENTS
US TREASURIES Principal 45,000 47,672
Interest Rate 105.94%
INTEREST-RATE SENSITIVE LIABILITIES
SHORT-TERM DEBT
REPOS Principal 1,257,570 1,257,570
Interest Rate 100.00%
LONG-TERM DEBT
SEQUOIA 1 DEBT Principal 202,286 202,224
Interest Rate 99.97%
SEQUOIA 2 DEBT Principal 571,117 571,668
Interest Rate 100.10%
SEQUOIA 3 DEBT Principal 530,002 532,063
Interest Rate 100.39%
------------------------
54
55
----------------------------------------------------------------
TABULAR PRESENTATION (CONTINUED)
(ALL DOLLARS IN THOUSANDS) PRINCIPAL / NOTIONAL AMOUNTS MATURING AND
EFFECTIVE RATES DURING PERIOD
1999 2000 2001 2002 2003 THEREAFTER
----------------------------------------------------------------
"TRADING" ASSETS, LIABILITIES AND DERIVATIVE
FINANCIAL INSTRUMENTS
INTEREST-RATE SENSITIVE ASSETS
ADJUSTABLE-RATE RESIDENTIAL MORTGAGE SECURITIES
AGENCY SECURITIES Principal Value 221,134 141,717 90,282 57,402 36,521 62,770
Interest Rate 6.91% 6.43% 6.61% 6.97% 7.06% 7.17%
PRIVATELY-ISSUED SECURITIES Principal 269,771 149,749 82,904 45,836 25,330 31,041
Interest Rate 6.99% 6.79% 6.90% 7.14% 7.26% 7.30%
FIXED-RATE RESIDENTIAL MORTGAGE SECURITIES
PRIVATELY-ISSUED SECURITIES Principal 4,122 3,693 3,306 2,960 2,648 19,563
Interest Rate 6.95% 6.95% 6.95% 6.95% 6.95% 6.95%
INTEREST-RATE SENSITIVE DERIVATIVE FINANCIAL INSTRUMENTS
(ALL DERIVATIVES WERE PURCHASED, UNLESS OTHERWISE NOTED.)
INTEREST RATE CAPS - TOTAL Notional 1,612,000 846,000 520,000 305,000 0 147,700
(see below for details) Average Strike Rate 6.68% 8.11% 9.71% 10.37% n/a 7.58%
PERIODIC CAPS Notional 20,000 0 0 0 0 0
Strike Rate on Caps 5.49% n/a n/a n/a n/a n/a
FLOORS Notional 30,000 0 0 0 0 4,000
Strike Rate on Floors 5.35% n/a n/a n/a n/a 5.60%
COLLARS Notional 20,000 0 0 0 0 0
(CAPS PURCHASED, FLOORS SOLD) Strike Rate on Caps 7.50% n/a n/a n/a n/a n/a
Strike Rate on Floors 5.91% n/a n/a n/a n/a n/a
BASIS SWAPS Notional 80,000 250,000 0 0 0 0
Average Pay Rate 4.68% 4.65% n/a n/a n/a n/a
Average Receive Rate 5.01% 4.95% n/a n/a n/a n/a
PERIODIC SWAPS Notional 110,000 0 0 0 0 0
Average Pay Rate 4.95% n/a n/a n/a n/a n/a
Average Receive Rate 4.70% n/a n/a n/a n/a n/a
PUT SWAPTIONS Notional 21,500 0 0 0 0 0
Strike Rate 5.86% n/a n/a n/a n/a n/a
TREASURY CALL OPTIONS Notional 0 11,000 0 0 0 0
Strike Rate n/a 5.10% n/a n/a n/a n/a
TREASURY CALL OPTION SPREADS Notional 0 32,000 0 0 0 0
Strike Rate n/a 5.46% n/a n/a n/a n/a
Stopout Rate n/a 4.96% n/a n/a n/a n/a
TREASURY PUT OPTION SPREADS (SOLD) Notional 0 21,000 0 0 0 0
Strike Rate n/a 5.46% n/a n/a n/a n/a
Stopout Rate n/a 5.91% n/a n/a n/a n/a
-----------------------------------------------------------------
--------------------------
PRINC./NTNL. EST. MARKET
TABULAR PRESENTATION (CONTINUED) VALUE AT VALUE AT
(ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31,
1998 1998
--------------------------
"TRADING" ASSETS, LIABILITIES AND DERIVATIVE
FINANCIAL INSTRUMENTS
INTEREST-RATE SENSITIVE ASSETS
ADJUSTABLE-RATE RESIDENTIAL MORTGAGE SECURITIES
AGENCY SECURITIES Principal Value 609,826 617,423
Interest Rate 101.25%
PRIVATELY-ISSUED SECURITIES Principal 604,630 604,437
Interest Rate 99.97%
FIXED-RATE RESIDENTIAL MORTGAGE SECURITIES
PRIVATELY-ISSUED SECURITIES Principal 36,292 35,795
Interest Rate 98.63%
INTEREST-RATE SENSITIVE DERIVATIVE FINANCIAL INSTRUMENTS
(ALL DERIVATIVES WERE PURCHASED, UNLESS OTHERWISE NOTED.)
INTEREST RATE CAPS - TOTAL Notional 3,430,700 904
(see below for details) Average Strike Rate 0.03%
PERIODIC CAPS Notional 20,000 0
Strike Rate on Caps 0.00%
FLOORS Notional 34,000 137
Strike Rate on Floors 0.40%
COLLARS Notional 20,000 (119)
(CAPS PURCHASED, FLOORS SOLD) Strike Rate on Caps -0.60%
Strike Rate on Floors
BASIS SWAPS Notional 330,000 734
Average Pay Rate 0.22%
Average Receive Rate
PERIODIC SWAPS Notional 110,000 (215)
Average Pay Rate -0.20%
Average Receive Rate
PUT SWAPTIONS Notional 21,500 47
Strike Rate 0.22%
TREASURY CALL OPTIONS Notional 11,000 463
Strike Rate 4.21%
TREASURY CALL OPTION SPREADS Notional 32,000 567
Strike Rate 1.77%
Stopout Rate
TREASURY PUT OPTION SPREADS (SOLD) Notional 21,000 included above
Strike Rate in Treasury Call
Stopout Rate Option Spreads
-------------------------------
INTEREST RATE AGREEMENTS WHICH REPRESENT MIRRORING TRANSACTIONS
ARE NOT INCLUDED IN THIS TABLE.
55
56
----------------------------------------------------------
TABULAR PRESENTATION (CONTINUED)
(ALL DOLLARS IN THOUSANDS) PRINCIPAL / NOTIONAL AMOUNTS MATURING AND
EFFECTIVE RATES DURING PERIOD
1999 2000 2001 2002 2003 THEREAFTER
----------------------------------------------------------
DETAIL OF INTEREST RATE CAPS (TOTALED ABOVE)
with Strike Rates < 6% Notional 685,000 245,000 0 0 0 0
Average Strike Rate 5.50% 5.67% n/a n/a n/a n/a
with Strike Rates of 6% to 7% Notional 105,000 0 0 0 0 56,000
Average Strike Rate 6.35% n/a n/a n/a n/a 6.33%
with Strike Rates of 7% to 8% Notional 650,000 0 20,000 0 0 10,000
Average Strike Rate 7.40% n/a 7.13% n/a n/a 7.50%
with Strike Rates of 8% to 9% Notional 142,000 406,000 0 5,000 0 64,000
Average Strike Rate 8.50% 8.61% n/a 8.60% n/a 8.28%
with Strike Rates of 9% to 10% Notional 0 125,000 200,000 0 0 17,700
Average Strike Rate n/a 9.40% 9.53% n/a n/a 9.00%
with Strike Rates of 10% to 11% Notional 20,000 20,000 300,000 200,000 0 0
Average Strike Rate 10.00% 10.00% 10.00% 10.10% n/a n/a
with Strike Rates > 11% Notional 10,000 50,000 0 100,000 0 0
Average Strike Rate 12.00% 12.00% n/a 11.00% n/a n/a
------------------------
NOTIONAL EST. MARKET
TABULAR PRESENTATION (CONTINUED) VALUE AT VALUE AT
(ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31,
1998 1998
------------------------
DETAIL OF INTEREST RATE CAPS (TOTALED ABOVE)
with Strike Rates < 6% Notional 930,000 191
Average Strike Rate 0.02%
with Strike Rates of 6% to 7% Notional 161,000 280
Average Strike Rate 0.17%
with Strike Rates of 7% to 8% Notional 680,000 162
Average Strike Rate 0.02%
with Strike Rates of 8% to 9% Notional 617,000 148
Average Strike Rate 0.02%
with Strike Rates of 9% to 10% Notional 342,700 40
Average Strike Rate 0.01%
with Strike Rates of 10% to 11% Notional 540,000 69
Average Strike Rate 0.01%
with Strike Rates > 11% Notional 160,000 13
Average Strike Rate 0.01%
56
57
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 1
INCOME STATEMENT FOR THREE MONTHS ENDING
-----------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1998 1998 1998 1998
-------- -------- -------- --------
Mortgage Assets - Residential
Coupon Income $ 53,848 $ 67,964 $ 64,348 $ 61,635
Amortization of Discount Balances 550 414 450 185
Amortization of Premium Balances (2,256) (7,280) (11,470) (8,343)
-------- -------- -------- --------
Total Interest Income From Mortgage Assets - Residential 52,142 61,098 53,328 53,477
Mortgage Assets - Commercial
Coupon Income 102 0 0 0
Amortization of Discount Balances 1 0 0 0
Amortization of Premium Balances 0 0 0 0
-------- -------- -------- --------
Total Interest Income From Mortgage Assets - Commercial 103 0 0 0
U.S. Treasuries
Coupon Income 619 0 0 0
Amortization of Discount Balances 0 0 0 0
Amortization of Premium Balances (44) 0 0 0
-------- -------- -------- --------
Total Interest Income From U.S. Treasuries 575 0 0 0
Interest Income: Cash Balances 782 460 455 384
-------- -------- -------- --------
Total Interest Income 53,602 61,558 53,783 53,861
Interest Expense on Short-Term Debt (21,951) (31,528) (33,282) (28,003)
Interest Expense on Long-Term Debt (21,738) (24,642) (16,887) (18,094)
-------- -------- -------- --------
Total Interest Expense (43,689) (56,170) (50,169) (46,097)
Interest Rate Agreement Expense (709) (322) (1,652) (1,426)
Interest Rate Agreement Income 443 75 28 48
-------- -------- -------- --------
Net Interest Rate Agreement Expense (266) (247) (1,624) (1,378)
Net Interest Income 9,647 5,142 1,990 6,386
Provision for Potential Credit Losses
Mortgage Loans (394) 638 (763) (601)
Mortgage Securities 0 0 0 0
-------- -------- -------- --------
Total Credit Provision (394) 638 (763) (601)
Equity in Earnings of RWT Holdings, Inc. (2,520) (1,575) (581) 0
Operating Expenses
Compensation and Benefits Expense (609) (390) (145) (1,048)
One-time Charges (1,220) 0 0 0
Dividend Equivalent Rights Expense 6 0 (6) (195)
Other Operating Expenses (508) (639) (438) (682)
-------- -------- -------- --------
Total Operating Expenses (2,331) (1,029) (589) (1,925)
Other Income (Expenses) 0 0 139 0
-------- -------- -------- --------
Income before Unrealized and Realized Gains (Losses) on Assets 4,402 3,175 196 3,860
Net Unrealized and Realized Gains (Losses) on Assets 2,074 (40,293) 0 (723)
-------- -------- -------- --------
Income Before Preferred Dividends and Change in Accounting Principle 6,476 (37,118) 196 3,137
Preferred Dividends (687) (687) (687) (687)
-------- -------- -------- --------
Income Before Change in Accounting Principle 5,789 (37,804) (491) 2,450
SFAS No. 133 Adjustments 0 (10,061) 0 0
-------- -------- -------- --------
Income before Corporate Income Tax Expense 5,789 (47,866) (491) 2,450
Corporate Income Tax Expense 0 0 0 0
-------- -------- -------- --------
Net Income to Common Shareholders $ 5,789 $(47,866) $ (491) $ 2,450
======== ======== ======== ========
GAAP Net Income Before Preferred Dividends $ 6,476 $(47,179) $ 196 $ 3,137
Mortgage Amortization and Income Differences (5,446) (4,452) (268) 43
Credit Provisions less Actual Losses 163 (938) 299 552
Net Unrealized and Realized Gains (Losses) on Assets Differences 2,515 41,741 15 729
Equity in earnings of RWT Holdings, Inc. net of Dividends to Redwood REIT 2,520 1,575 581 0
Operating Expense Differences 507 13 15 67
-------- -------- -------- --------
Taxable Income Before Preferred Dividend $ 6,735 $ (9,240) $ 838 $ 4,528
======== ======== ======== ========
57
58
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 1 (CONTINUED)
INCOME STATEMENT FOR THREE MONTHS ENDING
--------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1997 1997 1997 1997
-------- -------- -------- --------
Mortgage Assets - Residential
Coupon Income $ 61,506 $ 62,556 $ 54,353 $ 42,224
Amortization of Discount Balances 258 376 417 272
Amortization of Premium Balances (8,179) (6,888) (5,527) (4,090)
-------- -------- -------- --------
Total Interest Income From Mortgage Assets - Residential 53,585 56,044 49,243 38,406
Mortgage Assets - Commercial
Coupon Income 0 0 0 0
Amortization of Discount Balances 0 0 0 0
Amortization of Premium Balances 0 0 0 0
-------- -------- -------- --------
Total Interest Income From Mortgage Assets - Commercial 0 0 0 0
U.S. Treasuries
Coupon Income 0 0 0 0
Amortization of Discount Balances 0 0 0 0
Amortization of Premium Balances 0 0 0 0
-------- -------- -------- --------
Total Interest Income From U.S. Treasuries 0 0 0 0
Interest Income: Cash Balances 399 499 266 162
-------- -------- -------- --------
Total Interest Income 53,984 56,543 49,509 38,568
Interest Expense on Short-Term Debt (31,964) (40,318) (38,958) (28,900)
Interest Expense on Long-Term Debt (14,567) (5,570) 0 0
-------- -------- -------- --------
Total Interest Expense (46,531) (45,888) (38,958) (28,900)
Interest Rate Agreement Expense (1,281) (1,064) (912) (602)
Interest Rate Agreement Income 12 26 73 7
-------- -------- -------- --------
Net Interest Rate Agreement Expense (1,269) (1,038) (839) (595)
Net Interest Income 6,184 9,617 9,712 9,073
Provision for Potential Credit Losses
Mortgage Loans (1,516) (473) (299) (215)
Mortgage Securities 1,000 (470) (477) (480)
-------- -------- -------- --------
Total Credit Provision (516) (943) (776) (695)
Equity in Earnings of RWT Holdings, Inc. 0 0 0 0
Operating Expenses
Compensation and Benefits Expense (413) (441) (516) (529)
One-time Charges 0 0 0 0
Dividend Equivalent Rights Expense (145) (361) (358) (203)
Other Operating Expenses (570) (346) (341) (435)
-------- -------- -------- --------
Total Operating Expenses (1,128) (1,148) (1,215) (1,167)
Other Income (Expenses) 0 0 0 0
-------- -------- -------- --------
Income before Unrealized and Realized Gains (Losses) on Assets 4,540 7,526 7,721 7,211
Net Unrealized and Realized Gains (Losses) on Assets 543 20 0 0
-------- -------- -------- --------
Income Before Preferred Dividends and Change in Accounting Principle 5,083 7,546 7,721 7,211
Preferred Dividends (686) (687) (687) (755)
-------- -------- -------- --------
Income Before Change in Accounting Principle 4,397 6,859 7,034 6,456
SFAS No. 133 Adjustments 0 0 0 0
-------- -------- -------- --------
Income before Corporate Income Tax Expense 4,397 6,859 7,034 6,456
Corporate Income Tax Expense 0 0 0 0
-------- -------- -------- --------
Net Income to Common Shareholders $ 4,397 $ 6,859 $ 7,034 $ 6,456
======== ======== ======== ========
GAAP Net Income Before Preferred Dividends $ 5,083 $ 7,546 $ 7,721 6 $ 7,211
Mortgage Amortization and Income Differences 105 (95) (103) (87)
Credit Provisions less Actual Losses 475 875 747 653
Net Unrealized and Realized Gains (Losses) on Assets Differences (190) 0 0 0
Equity in earnings of RWT Holdings, Inc. net of Dividends to Redwood REIT 0 0 0 0
Operating Expense Differences 113 (175) (50) 135
-------- -------- -------- --------
Taxable Income Before Preferred Dividend $ 5,586 $ 8,151 $ 8,315 $ 7,912
======== ======== ======== ========
58
59
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 1 (CONTINUED)
INCOME STATEMENT FOR THREE MONTHS ENDING
--------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1996 1996 1996 1996
-------- -------- -------- --------
Mortgage Assets - Residential
Coupon Income $ 27,875 $ 20,557 $ 13,722 $ 9,445
Amortization of Discount Balances 217 271 245 177
Amortization of Premium Balances (2,425) (1,707) (1,268) (707)
-------- -------- -------- --------
Total Interest Income From Mortgage Assets - Residential 25,666 19,121 12,699 8,914
Mortgage Assets - Commercial
Coupon Income 0 0 0 0
Amortization of Discount Balances 0 0 0 0
Amortization of Premium Balances 0 0 0 0
-------- -------- -------- --------
Total Interest Income From Mortgage Assets - Commercial 0 0 0 0
U.S. Treasuries
Coupon Income 0 0 0 0
Amortization of Discount Balances 0 0 0 0
Amortization of Premium Balances 0 0 0 0
-------- -------- -------- --------
Total Interest Income From U.S. Treasuries 0 0 0 0
Interest Income: Cash Balances 215 250 202 217
-------- -------- -------- --------
Total Interest Income 25,881 19,371 12,901 9,131
Interest Expense on Short-Term Debt (19,467) (14,447) (9,075) (6,202)
Interest Expense on Long-Term Debt 0 0 0 0
-------- -------- -------- --------
Total Interest Expense (19,467) (14,447) (9,075) (6,202)
Interest Rate Agreement Expense (403) (350) (255) (151)
Interest Rate Agreement Income 1 0 0 0
-------- -------- -------- --------
Net Interest Rate Agreement Expense (402) (350) (255) (151)
Net Interest Income 6,012 4,574 3,571 2,778
Provision for Potential Credit Losses
Mortgage Loans (35) (178) (140) 5
Mortgage Securities (337) (338) (337) (336)
-------- -------- -------- --------
Total Credit Provision (372) (516) (477) (331)
Equity in Earnings of RWT Holdings, Inc. 0 0 0 0
Operating Expenses
Compensation and Benefits Expense (343) (309) (305) (234)
One-time Charges 0 0 0 0
Dividend Equivalent Rights Expense (137) (81) (79) (85)
Other Operating Expenses (316) (281) (210) (174)
-------- -------- -------- --------
Total Operating Expenses (796) (671) (594) (493)
Other Income (Expenses) 0 0 0 0
-------- -------- -------- --------
Income before Unrealized and Realized Gains (Losses) on Assets 4,844 3,387 2,500 1,954
Net Unrealized and Realized Gains (Losses) on Assets 0 0 0 0
-------- -------- -------- --------
Income Before Preferred Dividends and Change in Accounting Principle 4,844 3,387 2,500 1,954
Preferred Dividends (760) (388) 0 0
-------- -------- -------- --------
Income Before Change in Accounting Principle 4,084 2,998 2,500 1,954
SFAS No. 133 Adjustments 0 0 0 0
-------- -------- -------- --------
Income before Corporate Income Tax Expense 4,084 2,998 2,500 1,954
Corporate Income Tax Expense 0 0 0 0
-------- -------- -------- --------
Net Income to Common Shareholders $ 4,084 $ 2,998 $ 2,500 $ 1,954
======== ======== ======== ========
GAAP Net Income Before Preferred Dividends $ 4,844 $ 3,387 $ 2,500 $ 1,954
Mortgage Amortization and Income Differences 131 61 82 175
Credit Provisions less Actual Losses 365 516 477 331
Net Unrealized and Realized Gains (Losses) on Assets Differences 0 0 0 0
Equity in earnings of RWT Holdings, Inc. net of Dividends to Redwood REIT 0 0 0 0
Operating Expense Differences 89 84 83 89
-------- -------- -------- --------
Taxable Income Before Preferred Dividend $ 5,429 $ 4,048 $ 3,142 $ 2,549
======== ======== ======== ========
59
60
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 1 (CONTINUED)
INCOME STATEMENT FOR YEAR ENDING
------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31, DEC. 31, DEC. 31,
1998 1997 1996 1995
--------- --------- --------- ---------
Mortgage Assets - Residential
Coupon Income $ 247,796 $ 220,639 $ 71,598 $ 15,138
Amortization of Discount Balances 1,600 1,323 909 919
Amortization of Premium Balances (29,350) (24,684) (6,107) (563)
--------- --------- --------- ---------
Total Interest Income From Mortgage Assets - Residential 220,046 197,278 66,400 15,494
Mortgage Assets - Commercial
Coupon Income 102 0 0 0
Amortization of Discount Balances 1 0 0 0
Amortization of Premium Balances 0 0 0 0
--------- --------- --------- ---------
Total Interest Income From Mortgage Assets - Commercial 103 0 0 0
U.S. Treasuries
Coupon Income 619 0 0 0
Amortization of Discount Balances 0 0 0 0
Amortization of Premium Balances (44) 0 0 0
--------- --------- --------- ---------
Total Interest Income From U.S. Treasuries 575 0 0 0
Interest Income: Cash Balances 2,080 1,326 884 232
--------- --------- --------- ---------
Total Interest Income 222,804 198,604 67,284 15,726
Interest Expense on Short-Term Debt (114,763) (140,140) (49,191) (10,608)
Interest Expense on Long-Term Debt (81,361) (20,137) 0 0
--------- --------- --------- ---------
Total Interest Expense (196,124) (160,277) (49,191) (10,608)
Interest Rate Agreement Expense (4,108) (3,859) (1,159) (339)
Interest Rate Agreement Income 594 118 1 0
--------- --------- --------- ---------
Net Interest Rate Agreement Expense (3,514) (3,741) (1,158) (339)
Net Interest Income 23,166 34,586 16,935 4,779
Provision for Potential Credit Losses
Mortgage Loans (1,120) (2,503) (348) (79)
Mortgage Securities 0 (427) (1,348) (414)
--------- --------- --------- ---------
Total Credit Provision (1,120) (2,930) (1,696) (493)
Equity in Earnings of RWT Holdings, Inc. (4,676) 0 0 0
Operating Expenses
Compensation and Benefits Expense (2,192) (1,899) (1,191) (463)
One-time Charges (1,220) 0 0 0
Dividend Equivalent Rights Expense (196) (1,067) (382) (54)
Other Operating Expenses (2,268) (1,692) (981) (614)
--------- --------- --------- ---------
Total Operating Expenses (5,876) (4,658) (2,554) (1,131)
Other Income (Expenses) 139 0 0 0
--------- --------- --------- ---------
Income before Unrealized and Realized Gains (Losses) on Assets 11,633 26,998 12,685 3,155
Net Unrealized and Realized Gains (Losses) on Assets (38,943) 563 0 0
--------- --------- --------- ---------
Income Before Preferred Dividends and Change in Accounting Principle (27,310) 27,561 12,685 3,155
Preferred Dividends (2,747) (2,815) (1,148) 0
--------- --------- --------- ---------
Income Before Change in Accounting Principle (30,057) 24,746 11,537 3,155
SFAS No. 133 Adjustments (10,061) 0 0 0
--------- --------- --------- ---------
Income before Corporate Income Tax Expense (40,118) 24,746 11,537 3,155
Corporate Income Tax Expense 0 0 0 0
--------- --------- --------- ---------
Net Income to Common Shareholders $ (40,118) $ 24,746 $ 11,537 $ 3,155
========= ========= ========= =========
GAAP Net Income Before Preferred Dividends $ 6,476 $ (47,179) $ 196 $ 3,137
Mortgage Amortization and Income Differences (5,446) (4,452) (268) 43
Credit Provisions less Actual Losses 163 (938) 299 552
Net Unrealized and Realized Gains (Losses) on Assets Differences 2,515 41,741 15 729
Equity in earnings of RWT Holdings, Inc. net of Dividends to Redwood REIT 2,520 1,575 581 0
Operating Expense Differences 507 13 15 67
--------- --------- --------- ---------
Taxable Income Before Preferred Dividend $ 6,735 $ (9,240) $ 838 $ 4,528
========= ========= ========= =========
60
61
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 2 AT
-----------------------------------------------------------
BALANCE SHEETS DEC. 31, SEP. 30, JUN. 30, MAR. 31,
(ALL DOLLARS IN THOUSANDS) 1998 1998 1998 1998
----------- ----------- ----------- -----------
Mortgage Assets - Residential
Principal Value $ 2,652,327 $ 3,725,916 $ 3,745,697 $ 3,578,995
Unamortized Premium 27,369 30,653 75,158 85,048
Unamortized Discount (12,163) (11,669) (10,650) (12,131)
Real Estate Owned 384 171 266 497
Reserve For Credit Losses (4,972) (4,826) (5,784) (5,484)
Market Valuation Account (370) 321 (10,497) (4,375)
----------- ----------- ----------- -----------
Total Mortgage Assets - Residential 2,662,576 3,740,566 3,794,190 3,642,549
Mortgage Assets - Commercial
Principal Value 8,324 0 0 0
Unamortized Premium / (Discount) (37) 0 0 0
----------- ----------- ----------- -----------
Total Mortgage Assets - Commercial 8,287 0 0 0
U.S. Treasuries
Principal Value 45,000 0 0 0
Unamortized Premium / (Discount) 3,009 0 0 0
----------- ----------- ----------- -----------
Total U.S. Treasuries 48,009 0 0 0
Unrestricted Cash 55,627 3,811 11,354 6,468
Restricted Cash 12,857 19,675 21,560 25,734
----------- ----------- ----------- -----------
Total Cash and Cash Equivalents 68,484 23,486 32,914 32,202
Interest Rate Agreements 2,517 2,285 9,938 10,337
Market Valuation Account 0 0 (7,520) (8,710)
----------- ----------- ----------- -----------
Total Interest Rate Agreements 2,517 2,285 2,418 1,627
Accrued Interest Receivable 18,482 25,050 21,554 23,886
Investment in RWT Holdings, Inc. 15,124 7,744 9,319 9,900
Due From RWT Holdings, Inc. 6,945 776 831 0
Fixed Assets, Leasehold, Org. Costs 929 768 725 551
Prepaid Expenses and Other Receivables 1,095 1,541 4,976 2,975
----------- ----------- ----------- -----------
Other Assets 42,575 35,879 37,405 37,312
Total Assets $ 2,832,448 $ 3,802,216 $ 3,866,927 $ 3,713,691
=========== =========== =========== ===========
Short-Term Borrowings $ 1,257,570 $ 2,067,166 $ 1,936,158 $ 2,288,018
Long-Term Borrowings 1,305,560 1,465,888 1,593,344 1,081,279
Accrued Interest Payable 10,820 9,152 13,675 12,212
Accrued Expenses and Other Payables 3,022 1,781 2,192 1,797
Dividends Payable 686 687 687 687
----------- ----------- ----------- -----------
Total Liabilities 2,577,658 3,544,674 3,546,056 3,383,993
----------- ----------- ----------- -----------
Preferred Stock 26,736 26,736 26,736 26,736
Common Stock 113 118 141 141
Additional Paid-in Capital 279,201 287,046 320,687 320,282
Accumulated Other Comprehensive Income (370) 321 (18,017) (13,085)
Cumulative Earnings 6,412 (63) 47,253 50,729
Cumulative Distributions to Shareholders (57,302) (56,616) (55,929) (55,104)
----------- ----------- ----------- -----------
Total Stockholders' Equity 254,790 257,542 320,871 329,698
----------- ----------- ----------- -----------
Total Liabilities plus Stockholders' Equity $ 2,832,448 $ 3,802,216 $ 3,866,927 $ 3,713,691
=========== =========== =========== ===========
61
62
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 2 (CONTINUED) AT
--------------------------------------------------------------
BALANCE SHEETS DEC. 31, SEP. 30, JUN. 30, MAR. 31,
(ALL DOLLARS IN THOUSANDS) 1997 1997 1997 1997
----------- ----------- ----------- -----------
Mortgage Assets - Residential
Principal Value $ 3,298,499 $ 3,358,993 $ 3,290,215 $ 2,555,729
Unamortized Premium 86,173 86,934 87,661 65,107
Unamortized Discount (12,442) (14,387) (15,091) (15,641)
Real Estate Owned 713 220 346 128
Reserve For Credit Losses (4,931) (4,456) (3,580) (2,833)
Market Valuation Account (1,390) 10,619 3,603 2,224
----------- ----------- ----------- -----------
Total Mortgage Assets - Residential 3,366,622 3,437,923 3,363,154 2,604,714
Mortgage Assets - Commercial
Principal Value 0 0 0 0
Unamortized Premium / (Discount) 0 0 0 0
----------- ----------- ----------- -----------
Total Mortgage Assets - Commercial 0 0 0 0
U.S. Treasuries
Principal Value 0 0 0 0
Unamortized Premium / (Discount) 0 0 0 0
----------- ----------- ----------- -----------
Total U.S. Treasuries 0 0 0 0
Unrestricted Cash 24,892 28,758 29,425 12,985
Restricted Cash 24,657 28,938 0 0
----------- ----------- ----------- -----------
Total Cash and Cash Equivalents 49,549 57,696 29,425 12,985
Interest Rate Agreements 10,781 11,708 12,233 7,879
Market Valuation Account (8,681) (8,782) (7,366) (2,106)
----------- ----------- ----------- -----------
Total Interest Rate Agreements 2,100 2,926 4,867 5,773
Accrued Interest Receivable 23,119 23,859 24,065 17,722
Investment in RWT Holdings, Inc. 0 0 0 0
Due From RWT Holdings, Inc. 0 0 0 0
Fixed Assets, Leasehold, Org. Costs 539 358 257 259
Prepaid Expenses and Other Receivables 2,268 2,490 2,738 1,611
----------- ----------- ----------- -----------
Other Assets 25,926 26,707 27,060 19,592
Total Assets $ 3,444,197 $ 3,525,252 $ 3,424,506 $ 2,643,064
=========== =========== =========== ===========
Short-Term Borrowings $ 1,914,525 $ 2,639,773 $ 3,102,784 $ 2,373,279
Long-Term Borrowings 1,172,801 497,367 0 0
Accrued Interest Payable 14,476 20,216 18,153 14,962
Accrued Expenses and Other Payables 2,172 2,129 1,743 1,262
Dividends Payable 5,686 9,433 8,638 7,899
----------- ----------- ----------- -----------
Total Liabilities 3,109,660 3,168,918 3,131,318 2,397,402
----------- ----------- ----------- -----------
Preferred Stock 26,736 26,733 26,733 29,383
Common Stock 143 146 133 119
Additional Paid-in Capital 324,555 333,841 274,420 219,461
Accumulated Other Comprehensive Income (10,071) 1,837 (3,762) 118
Cumulative Earnings 43,783 38,700 31,154 23,433
Cumulative Distributions to Shareholders (50,609) (44,923) (35,490) (26,852)
----------- ----------- ----------- -----------
Total Stockholders' Equity 334,537 356,334 293,188 245,662
----------- ----------- ----------- -----------
Total Liabilities plus Stockholders' Equity $ 3,444,197 $ 3,525,252 $ 3,424,506 $ 2,643,064
=========== =========== =========== ===========
62
63
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 2 (CONTINUED) AT
--------------------------------------------------------------
BALANCE SHEETS DEC. 31, SEP. 30, JUN. 30, MAR. 31,
(ALL DOLLARS IN THOUSANDS) 1996 1996 1996 1996
----------- ----------- ----------- -----------
Mortgage Assets - Residential
Principal Value $ 2,117,048 $ 1,361,062 $ 1,005,764 $ 573,807
Unamortized Premium 54,317 32,607 22,690 12,790
Unamortized Discount (16,093) (16,338) (16,608) (16,854)
Real Estate Owned 196 0 0 0
Reserve For Credit Losses (2,180) (1,814) (1,298) (821)
Market Valuation Account 139 353 (3,068) (3,763)
----------- ----------- ----------- -----------
Total Mortgage Assets - Residential 2,153,428 1,375,871 1,007,480 565,159
Mortgage Assets - Commercial
Principal Value 0 0 0 0
Unamortized Premium / (Discount) 0 0 0 0
----------- ----------- ----------- -----------
Total Mortgage Assets - Commercial 0 0 0 0
U.S. Treasuries
Principal Value 0 0 0 0
Unamortized Premium / (Discount) 0 0 0 0
----------- ----------- ----------- -----------
Total U.S. Treasuries 0 0 0 0
Unrestricted Cash 11,068 14,599 10,407 9,705
Restricted Cash 0 0 0 0
----------- ----------- ----------- -----------
Total Cash and Cash Equivalents 11,068 14,599 10,407 9,705
Interest Rate Agreements 6,200 3,286 2,835 2,534
Market Valuation Account (3,599) (2,413) (1,484) (1,301)
----------- ----------- ----------- -----------
Total Interest Rate Agreements 2,601 873 1,351 1,233
Accrued Interest Receivable 14,134 10,781 7,292 4,496
Investment in RWT Holdings, Inc. 0 0 0 0
Due From RWT Holdings, Inc. 0 0 0 0
Fixed Assets, Leasehold, Org. Costs 257 265 233 198
Prepaid Expenses and Other Receivables 2,709 1,090 1,567 522
----------- ----------- ----------- -----------
Other Assets 17,100 12,136 9,092 5,216
Total Assets $ 2,184,197 $ 1,403,478 $ 1,028,331 $ 581,312
=========== =========== =========== ===========
Short-Term Borrowings $ 1,953,103 $ 1,225,094 $ 896,214 $ 508,721
Long-Term Borrowings 0 0 0 0
Accrued Interest Payable 14,060 10,379 4,052 1,616
Accrued Expenses and Other Payables 761 472 361 290
Dividends Payable 5,268 4,016 3,408 2,540
----------- ----------- ----------- -----------
Total Liabilities 1,973,192 1,239,961 904,035 513,167
----------- ----------- ----------- -----------
Preferred Stock 29,579 29,712 0 0
Common Stock 110 91 85 55
Additional Paid-in Capital 187,507 138,081 130,441 73,926
Accumulated Other Comprehensive Income (3,460) (2,060) (4,553) (5,065)
Cumulative Earnings 16,222 11,378 7,991 5,491
Cumulative Distributions to Shareholders (18,954) (13,685) (9,669) (6,261)
----------- ----------- ----------- -----------
Total Stockholders' Equity 211,005 163,517 124,295 68,146
----------- ----------- ----------- -----------
Total Liabilities plus Stockholders' Equity $ 2,184,197 $ 1,403,478 $ 1,028,330 $ 581,313
=========== =========== =========== ===========
63
64
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 2 (CONTINUED) AT
--------------------------------------------------------------
BALANCE SHEETS DEC. 31, DEC. 31, DEC. 31, DEC. 31,
(ALL DOLLARS IN THOUSANDS) 1998 1997 1996 1995
----------- ----------- ----------- -----------
Mortgage Assets - Residential
Principal Value $ 2,652,327 $ 3,298,499 $ 2,117,048 $ 443,625
Unamortized Premium 27,369 86,173 54,317 9,644
Unamortized Discount (12,163) (12,442) (16,093) (17,032)
Real Estate Owned 384 713 196 0
Reserve For Credit Losses (4,972) (4,931) (2,180) (490)
Market Valuation Account (370) (1,390) 139 (3,502)
----------- ----------- ----------- -----------
Total Mortgage Assets - Residential 2,662,576 3,366,622 2,153,428 432,244
Mortgage Assets - Commercial
Principal Value 8,324 0 0 0
Unamortized Premium / (Discount) (37) 0 0 0
----------- ----------- ----------- -----------
Total Mortgage Assets - Commercial 8,287 0 0 0
U.S. Treasuries
Principal Value 45,000 0 0 0
Unamortized Premium / (Discount) 3,009 0 0 0
----------- ----------- ----------- -----------
Total U.S. Treasuries 48,009 0 0 0
Unrestricted Cash 55,627 24,892 11,068 4,825
Restricted Cash 12,857 24,657 0 0
----------- ----------- ----------- -----------
Total Cash and Cash Equivalents 68,484 49,549 11,068 4,825
Interest Rate Agreements 2,517 10,781 6,200 2,521
Market Valuation Account 0 (8,681) (3,599) (1,974)
----------- ----------- ----------- -----------
Total Interest Rate Agreements 2,517 2,100 2,601 547
Accrued Interest Receivable 18,482 23,119 14,134 3,270
Investment in RWT Holdings, Inc. 15,124 0 0 0
Due From RWT Holdings, Inc. 6,945 0 0 0
Fixed Assets, Leasehold, Org. Costs 929 539 257 206
Prepaid Expenses and Other Receivables 1,095 2,268 2,709 465
----------- ----------- ----------- -----------
Other Assets 42,575 25,926 17,100 3,941
Total Assets $ 2,832,448 $ 3,444,197 $ 2,184,197 $ 441,557
=========== =========== =========== ===========
Short-Term Borrowings $ 1,257,570 $ 1,914,525 $ 1,953,103 $ 370,316
Long-Term Borrowings 1,305,560 1,172,801 0 0
Accrued Interest Payable 10,820 14,476 14,060 1,290
Accrued Expenses and Other Payables 3,022 2,172 761 227
Dividends Payable 686 5,686 5,268 1,434
----------- ----------- ----------- -----------
Total Liabilities 2,577,658 3,109,660 1,973,192 373,267
----------- ----------- ----------- -----------
Preferred Stock 26,736 26,736 29,579 0
Common Stock 113 143 110 55
Additional Paid-in Capital 279,201 324,555 187,507 73,895
Accumulated Other Comprehensive Income (370) (10,071) (3,460) (5,476)
Cumulative Earnings 6,412 43,783 16,222 3,537
Cumulative Distributions to Shareholders (57,302) (50,609) (18,954) (3,721)
----------- ----------- ----------- -----------
Total Stockholders' Equity 254,790 334,537 211,005 68,290
----------- ----------- ----------- -----------
Total Liabilities plus Stockholders' Equity $ 2,832,448 $ 3,444,197 $ 2,184,197 $ 441,557
=========== =========== =========== ===========
64
65
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 3
DETAIL OF INTEREST INCOME AND BALANCES FOR AT OR FOR THREE MONTHS ENDING
RESIDENTIAL MORTGAGE ASSETS --------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1998 1998 1998 1998
----------- ----------- ----------- -----------
INTEREST INCOME ON RESIDENTIAL MORTGAGE ASSETS
Mortgage Loans - Held for Sale
Coupon Income $ 8,858 $ 0 $ 0 $ 0
Amortization of Discount Balances 146 0 0 0
Amortization of Premium Balances 0 0 0 0
----------- ----------- ----------- -----------
Interest Income: Mortgage Loans - Held for Sale $ 9,004 $ 0 $ 0 $ 0
Mortgage Loans - Held for Investment
Coupon Income $ 20,218 $ 40,614 $ 33,523 $ 28,306
Amortization of Discount Balances 0 1 1 0
Amortization of Premium Balances (1,284) (3,021) (3,619) (2,496)
----------- ----------- ----------- -----------
Interest Income: Mortgage Loans - Held for Investment $ 18,934 $ 37,594 $ 29,905 $ 25,810
Mortgage Securities - Trading
Coupon Income $ 24,406 $ 26,962 $ 0 $ 0
Amortization of Discount Balances 0 26 0 0
Amortization of Premium Balances (972) (4,259) 0 0
----------- ----------- ----------- -----------
Interest Income: Mortgage Securities - Trading $ 23,434 $ 22,728 $ 0 $ 0
Mortgage Securities - Available for Sale
Coupon Income $ 366 $ 389 $ 30,825 $ 33,330
Amortization of Discount Balances 404 388 449 185
Amortization of Premium Balances 0 0 (7,851) (5,848)
----------- ----------- ----------- -----------
Interest Income: Mortgage Securities -Available for Sale $ 770 $ 777 $ 23,423 $ 27,667
RESIDENTIAL MORTGAGE ASSET BALANCES
Mortgage Loans - Held for Sale
Principal Value $ 265,922 $ 1,031,058 $ 0 $ 0
Unamortized Premium 666 2,326 0 0
Unamortized Discount (1,059) (1,369) 0 0
Real Estate Owned 384 171 0 0
Reserve For Credit Losses 0 0 0 0
Market Valuation Account 0 0 0 0
----------- ----------- ----------- -----------
Total Mortgage Loans - Held for Sale $ 265,915 $ 1,032,186 $ 0 $ 0
Mortgage Loans - Held for Investment
Principal Value $ 1,118,375 $ 1,234,075 $ 2,191,501 $ 1,837,020
Unamortized Premium 16,708 17,993 35,660 37,943
Unamortized Discount 0 0 0 (27)
Real Estate Owned 0 0 266 497
Reserve For Credit Losses (3,784) (3,390) (4,079) (3,449)
Market Valuation Account 0 0 0 0
----------- ----------- ----------- -----------
Total Mortgage Loans - Held for Investment $ 1,131,299 $ 1,248,678 $ 2,223,348 $ 1,871,984
Mortgage Securities - Trading
Principal Value $ 1,250,749 $ 1,442,574 $ 0 $ 0
Unamortized Premium 9,995 10,334 0 0
Unamortized Discount (3,089) (1,272) 0 0
Reserve For Credit Losses 0 0 0 0
Market Valuation Account 0 0 0 0
----------- ----------- ----------- -----------
Total Mortgage Securities - Trading $ 1,257,655 $ 1,451,636 $ 0 $ 0
Mortgage Securities - Available for Sale
Principal Value $ 17,281 $ 18,209 $ 1,554,196 $ 1,741,975
Unamortized Premium 0 0 39,498 47,105
Unamortized Discount (8,015) (9,028) (10,650) (12,104)
Reserve For Credit Losses (1,189) (1,436) (1,705) (2,035)
Market Valuation Account (370) 321 (10,497) (4,375)
----------- ----------- ----------- -----------
Total Mortgage Securities - Available for Sale $ 7,707 $ 8,066 $ 1,570,842 $ 1,770,566
65
66
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 3 (CONTINUED)
DETAIL OF INTEREST INCOME AND BALANCES FOR AT OR FOR THREE MONTHS ENDING
--------------------------------------------------------
RESIDENTIAL MORTGAGE ASSETS DEC. 31, SEP. 30, JUN. 30, MAR. 31,
(ALL DOLLARS IN THOUSANDS) 1997 1997 1997 1997
----------- ----------- ----------- -----------
INTEREST INCOME ON RESIDENTIAL MORTGAGE ASSETS
Mortgage Loans - Held for Sale
Coupon Income $ 0 $ 0 $ 0 $ 0
Amortization of Discount Balances 0 0 0 0
Amortization of Premium Balances 0 0 0 0
----------- ----------- ----------- -----------
Interest Income: Mortgage Loans - Held for Sale $ 0 $ 0 $ 0 $ 0
Mortgage Loans - Held for Investment
Coupon Income $ 24,911 $ 21,432 $ 14,474 $ 10,784
Amortization of Discount Balances 0 1 8 11
Amortization of Premium Balances (2,088) (1,803) (1,462) (940)
----------- ----------- ----------- -----------
Interest Income: Mortgage Loans - Held for Investment $ 22,823 $ 19,630 $ 13,020 $ 9,855
Mortgage Securities - Trading
Coupon Income $ 0 $ 0 $ 0 $ 0
Amortization of Discount Balances 0 0 0 0
Amortization of Premium Balances 0 0 0 0
----------- ----------- ----------- -----------
Interest Income: Mortgage Securities - Trading $ 0 $ 0 $ 0 $ 0
Mortgage Securities - Available for Sale
Coupon Income $ 36,595 $ 41,124 $ 39,879 $ 31,440
Amortization of Discount Balances 258 375 409 261
Amortization of Premium Balances (6,091) (5,085) (4,065) (3,150)
----------- ----------- ----------- -----------
Interest Income: Mortgage Securities -Available for Sale $ 30,762 $ 36,414 $ 36,223 $ 28,551
RESIDENTIAL MORTGAGE ASSET BALANCES
Mortgage Loans - Held for Sale
Principal Value $ 0 $ 0 $ 0 $ 0
Unamortized Premium 0 0 0 0
Unamortized Discount 0 0 0 0
Real Estate Owned 0 0 0 0
Reserve For Credit Losses 0 0 0 0
Market Valuation Account 0 0 0 0
----------- ----------- ----------- -----------
Total Mortgage Loans - Held for Sale $ 0 $ 0 $ 0 $ 0
Mortgage Loans - Held for Investment
Principal Value $ 1,519,124 $ 1,348,619 $ 1,111,029 $ 716,009
Unamortized Premium 34,844 30,852 25,442 15,951
Unamortized Discount 0 0 (123) (131)
Real Estate Owned 713 220 346 128
Reserve For Credit Losses (2,855) (1,363) (929) (630)
Market Valuation Account 0 0 0 (1,291)
----------- ----------- ----------- -----------
Total Mortgage Loans - Held for Investment $ 1,551,826 $ 1,378,328 $ 1,135,765 $ 730,035
Mortgage Securities - Trading
Principal Value $ 0 $ 0 $ 0 $ 0
Unamortized Premium 0 0 0 0
Unamortized Discount 0 0 0 0
Reserve For Credit Losses 0 0 0 0
Market Valuation Account 0 0 0 0
----------- ----------- ----------- -----------
Total Mortgage Securities - Trading $ 0 $ 0 $ 0 $ 0
Mortgage Securities - Available for Sale
Principal Value $ 1,779,375 $ 2,010,374 $ 2,179,186 $ 1,839,720
Unamortized Premium 51,329 56,082 62,219 49,156
Unamortized Discount (12,442) (14,387) (14,968) (15,510)
Reserve For Credit Losses (2,076) (3,093) (2,651) (2,203)
Market Valuation Account (1,390) 10,619 3,603 3,516
----------- ----------- ----------- -----------
Total Mortgage Securities - Available for Sale $ 1,814,796 $ 2,059,595 $ 2,227,389 $ 1,874,679
66
67
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 3 (CONTINUED)
DETAIL OF INTEREST INCOME AND BALANCES FOR AT OR FOR THREE MONTHS ENDING
--------------------------------------------------------
RESIDENTIAL MORTGAGE ASSETS DEC. 31, SEP. 30, JUN. 30, MAR. 31,
(ALL DOLLARS IN THOUSANDS) 1996 1996 1996 1996
----------- ----------- ----------- -----------
INTEREST INCOME ON RESIDENTIAL MORTGAGE ASSETS
Mortgage Loans - Held for Sale
Coupon Income $ 0 $ 0 $ 0 $ 0
Amortization of Discount Balances 0 0 0 0
Amortization of Premium Balances 0 0 0 0
----------- ----------- ----------- -----------
Interest Income: Mortgage Loans - Held for Sale $ 0 $ 0 $ 0 $ 0
Mortgage Loans - Held for Investment
Coupon Income $ 2,582 $ 1,656 $ 749 $ 479
Amortization of Discount Balances 11 7 11 2
Amortization of Premium Balances (189) (62) (43) (19)
----------- ----------- ----------- -----------
Interest Income: Mortgage Loans - Held for Investment $ 2,404 $ 1,601 $ 717 $ 462
Mortgage Securities - Trading
Coupon Income $ 0 $ 0 $ 0 $ 0
Amortization of Discount Balances 0 0 0 0
Amortization of Premium Balances 0 0 0 0
----------- ----------- ----------- -----------
Interest Income: Mortgage Securities - Trading $ 0 $ 0 $ 0 $ 0
Mortgage Securities - Available for Sale
Coupon Income $ 25,292 $ 18,901 $ 12,973 $ 8,965
Amortization of Discount Balances 206 264 234 175
Amortization of Premium Balances (2,236) (1,645) (1,225) (688)
----------- ----------- ----------- -----------
Interest Income: Mortgage Securities -Available for Sale $ 23,262 $ 17,520 $ 11,982 $ 8,452
RESIDENTIAL MORTGAGE ASSET BALANCES
Mortgage Loans - Held for Sale
Principal Value $ 0 $ 0 $ 0 $ 0
Unamortized Premium 0 0 0 0
Unamortized Discount 0 0 0 0
Real Estate Owned 0 0 0 0
Reserve For Credit Losses 0 0 0 0
Market Valuation Account 0 0 0 0
----------- ----------- ----------- -----------
Total Mortgage Loans - Held for Sale $ 0 $ 0 $ 0 $ 0
Mortgage Loans - Held for Investment
Principal Value $ 514,837 $ 126,426 $ 69,154 $ 24,831
Unamortized Premium 12,389 1,535 686 191
Unamortized Discount (142) (153) (160) (171)
Real Estate Owned 196 0 0 0
Reserve For Credit Losses (428) (393) (214) (74)
Market Valuation Account (1,377) 279 200 84
----------- ----------- ----------- -----------
Total Mortgage Loans - Held for Investment $ 525,475 $ 127,694 $ 69,666 $ 24,861
Mortgage Securities - Trading
Principal Value $ 0 $ 0 $ 0 $ 0
Unamortized Premium 0 0 0 0
Unamortized Discount 0 0 0 0
Reserve For Credit Losses 0 0 0 0
Market Valuation Account 0 0 0 0
----------- ----------- ----------- -----------
Total Mortgage Securities - Trading $ 0 $ 0 $ 0 $ 0
Mortgage Securities - Available for Sale
Principal Value $ 1,602,212 $ 1,234,636 $ 936,611 $ 548,976
Unamortized Premium 41,928 31,072 22,004 12,599
Unamortized Discount (15,951) (16,185) (16,448) (16,683)
Reserve For Credit Losses (1,752) (1,421) (1,084) (747)
Market Valuation Account 1,516 74 (3,269) (3,847)
----------- ----------- ----------- -----------
Total Mortgage Securities - Available for Sale $ 1,627,953 $ 1,248,176 $ 937,814 $ 540,298
67
68
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 3 (CONTINUED)
DETAIL OF INTEREST INCOME AND BALANCES FOR AT OR FOR YEAR ENDING
--------------------------------------------------------
RESIDENTIAL MORTGAGE ASSETS DEC. 31, DEC. 31, DEC. 31, DEC. 31,
(ALL DOLLARS IN THOUSANDS) 1998 1997 1996 1995
----------- ----------- ----------- -----------
INTEREST INCOME ON RESIDENTIAL MORTGAGE ASSETS
Mortgage Loans - Held for Sale
Coupon Income $ 8,858 $ 0 $ 0 $ 0
Amortization of Discount Balances 146 0 0 0
Amortization of Premium Balances 0 0 0 0
----------- ----------- ----------- -----------
Interest Income: Mortgage Loans - Held for Sale $ 9,004 $ 0 $ 0 $ 0
Mortgage Loans - Held for Investment
Coupon Income $ 122,661 $ 71,601 $ 5,466 $ 379
Amortization of Discount Balances 2 20 31 4
Amortization of Premium Balances (10,421) (6,293) (313) (4)
----------- ----------- ----------- -----------
Interest Income: Mortgage Loans - Held for Investment $ 112,242 $ 65,328 $ 5,184 $ 379
Mortgage Securities - Trading
Coupon Income $ 51,367 $ 0 $ 0 $ 0
Amortization of Discount Balances 26 0 0 0
Amortization of Premium Balances (5,231) 0 0 0
----------- ----------- ----------- -----------
Interest Income: Mortgage Securities - Trading $ 46,162 $ 0 $ 0 $ 0
Mortgage Securities - Available for Sale
Coupon Income $ 64,910 $ 149,038 $ 66,131 $ 14,759
Amortization of Discount Balances 1,426 1,303 879 915
Amortization of Premium Balances (13,698) (18,391) (5,794) (559)
----------- ----------- ----------- -----------
Interest Income: Mortgage Securities -Available for Sale $ 52,638 $ 131,949 $ 61,216 $ 15,115
RESIDENTIAL MORTGAGE ASSET BALANCES
Mortgage Loans - Held for Sale
Principal Value $ 265,922 $ 0 $ 0 $ 0
Unamortized Premium 666 0 0 0
Unamortized Discount (1,059) 0 0 0
Real Estate Owned 384 0 0 0
Reserve For Credit Losses 0 0 0 0
Market Valuation Account 0 0 0 0
----------- ----------- ----------- -----------
Total Mortgage Loans - Held for Sale $ 265,915 $ 0 $ 0 $ 0
Mortgage Loans - Held for Investment
Principal Value $ 1,118,375 $ 1,519,124 $ 514,837 $ 26,411
Unamortized Premium 16,708 34,844 12,389 210
Unamortized Discount 0 0 (142) (172)
Real Estate Owned 0 713 196 0
Reserve For Credit Losses (3,784) (2,855) (428) (79)
Market Valuation Account 0 0 (1,377) 80
----------- ----------- ----------- -----------
Total Mortgage Loans - Held for Investment $ 1,131,299 $ 1,551,826 $ 525,475 $ 26,450
Mortgage Securities - Trading
Principal Value $ 1,250,749 $ 0 $ 0 $ 0
Unamortized Premium 9,995 0 0 0
Unamortized Discount (3,089) 0 0 0
Reserve For Credit Losses 0 0 0 0
Market Valuation Account 0 0 0 0
----------- ----------- ----------- -----------
Total Mortgage Securities - Trading $ 1,257,655 $ 0 $ 0 $ 0
Mortgage Securities - Available for Sale
Principal Value $ 17,281 $ 1,779,375 $ 1,602,212 $ 417,214
Unamortized Premium 0 51,329 41,928 9,433
Unamortized Discount (8,015) (12,442) (15,951) (16,860)
Reserve For Credit Losses (1,189) (2,076) (1,752) (411)
Market Valuation Account (370) (1,390) 1,516 (3,582)
----------- ----------- ----------- -----------
Total Mortgage Securities - Available for Sale $ 7,707 $ 1,814,796 $ 1,627,953 $ 405,794
68
69
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 4
MORTGAGE ASSET CHARACTERISTICS AT OR FOR THREE MONTHS ENDING
----------------------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1998 1998 1998 1998
------------- ------------- ------------- -------------
Average Characteristics of Loans and Securities
(Residential Mortgage Assets) at End of Period
Single-Family Properties 100% 100% 100% 100%
Short-Term Adjustable Rate Mortgage Assets (First
reset in 12 months or less) 77% 62% 77% 91%
Hybrid Loans (First reset in more than 12 months) 23% 38% 23% 9%
First Lien 100% 98% 100% 100%
Home Equity Loans (AAA and AA securities) 0% 2% 0% 0%
Average Credit Rating Equivalent AA+ AA+ AA+ AA+
Reported Basis as % of Principal Value 100.57% 100.51% 101.72% 102.04%
Coupon Rate 7.21% 7.24% 7.42% 7.59%
Months to Next Coupon Adjustment (Short-Term
Adjustable Rate Mortgage Assets) 4 4 4 4
Months to Next Coupon Adjustment (Hybrid Loans) 53 58 56 52
------------- ------------- ------------- -------------
Months to Next Coupon Adjustment (Total Mortgage Assets) 15 24 15 8
For Short-Term Adjustable-Rate Residential
Mortgage Assets
Coupon Rate 7.33% 7.37% 7.59% 7.67%
Level of Index 4.90% 4.87% 5.61% 5.61%
Net Margin 1.94% 2.03% 1.98% 2.02%
Fully Indexed Coupon Rate 6.84% 6.90% 7.59% 7.63%
Coupon Rate Versus Fully-Indexed Rate 0.49% 0.47% 0.00% 0.04%
Net Life Cap 11.48% 11.63% 12.09% 12.09%
Percentage of Residential Mortgage Assets by
Credit Type, by Reported Basis
Mortgage Loans 52.5% 61.0% 58.5% 51.3%
Mortgage Securities: AAA/AA 47.2% 38.8% 41.3% 48.4%
Mortgage Securities: A/BBB 0.0% 0.0% 0.0% 0.0%
Mortgage Securities: Below BBB 0.3% 0.2% 0.2% 0.3%
------------- ------------- ------------- -------------
Total Residential Mortgage Assets (%) 100.0% 100.0% 100.0% 100.0%
Total Residential Mortgage Assets (Reported
Basis) $ 2,667,916 $ 3,745,071 $ 3,810,471 $ 3,652,409
Percentage of Residential Mortgage Assets by
Index, Adjustment Frequency, and Annualized
Periodic Cap, By Principal Value
1 Month LIBOR, adjusts monthly, no periodic cap 15.5% 11.3% 18.8% 20.2%
6 Month LIBOR, adjusts every 6 months, 2%
periodic cap 17.5% 14.4% 16.2% 20.0%
6 Month LIBOR, adjusts every 6 months, no
periodic cap 10.8% 8.2% 10.4% 11.6%
6 Month CD, adjusts every 6 months, 2% annualized
periodic cap 0.9% 0.8% 0.9% 1.0%
6 Mo. Treasury, adjusts every 6 months, 2%
annualized periodic cap 0.6% 0.4% 0.4% 0.5%
6 Month Treasury, adjusts every 6 months, no
periodic cap 0.4% 0.3% 0.4% 0.4%
3/1 Hybrid: 12 Month Treasury with 3 year initial
coupon 1.1% 1.0% 1.1% 1.3%
5/1 Hybrid: 12 Month Treasury with 5 year initial
coupon 20.4% 33.1% 21.5% 8.1%
7/1 Hybrid: 12 Month Treasury with 7 year initial
coupon 1.3% 3.8% 21.5% 0.0%
12 Month Treasury, adjusts annually, 2% periodic cap 29.0% 24.6% 28.7% 35.2%
12 Month Treasury, adjusts annually, no periodic cap 0.0% 0.0% 0.3% 0.3%
Other 2.5% 2.1% 1.3% 1.4%
------------- ------------- ------------- -------------
Total Mortgage Assets (%) 100.0% 100.0% 100.0% 100.0%
Total Mortgage Assets (Principal Value) $ 2,652,711 $ 3,726,087 $ 3,745,963 $ 3,579,492
Net Residential and Commercial Mortgage Asset and
U.S. Treasuries Growth
Mortgage and U.S. Treasuries Acquisitions $ 72,217 $ 764,918 $ 594,836 $ 603,803
Mortgage Principal Repayments (409,118) (414,719) (425,292) (306,112)
Amortization (1,749) (6,866) (11,020) (8,158)
Mark-to-Market Adjustments (3,012) (32,873) 0 0
Writedowns 0 0 0 (729)
Credit Losses (248) (320) (462) (49)
Sales (678,949) (375,539) 0 (9,289)
------------- ------------- ------------- -------------
Change in Mortgage Assets and U.S. Treasuries
(Reported Basis) $ (1,020,859) $ (65,399) $ 158,062 $ 279,466
69
70
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 4 (CONTINUED)
MORTGAGE ASSET CHARACTERISTICS AT OR FOR THREE MONTHS ENDING
----------------------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1997 1997 1997 1997
------------- ------------- ------------- -------------
Average Characteristics of Loans and Securities
(Residential Mortgage Assets) at End of Period
Single-Family Properties 100% 100% 100% 100%
Short-Term Adjustable Rate Mortgage Assets (First
reset in 12 months or less) 98% 98% 98% 98%
Hybrid Loans (First reset in more than 12 months) 2% 2% 2% 2%
First Lien 100% 100% 100% 100%
Home Equity Loans (AAA and AA securities) 0% 0% 0% 0%
Average Credit Rating Equivalent AA+ AA+ AA+ AA+
Reported Basis as % of Principal Value 102.23% 102.16% 102.21% 101.94%
Coupon Rate 7.71% 7.75% 7.73% 7.70%
Months to Next Coupon Adjustment (Short-Term
Adjustable Rate Mortgage Assets) 4 4 4 5
Months to Next Coupon Adjustment (Hybrid Loans) 21 24 27 30
------------- ------------- ------------- -------------
Months to Next Coupon Adjustment (Total Mortgage Assets) 4 4 5 5
For Short-Term Adjustable-Rate Residential
Mortgage Assets
Coupon Rate 7.73% 7.77% 7.75% 7.71%
Level of Index 5.68% 5.65% 5.77% 5.98%
Net Margin 2.05% 2.10% 2.15% 2.20%
Fully Indexed Coupon Rate 7.73% 7.75% 7.92% 8.18%
Coupon Rate Versus Fully-Indexed Rate 0.00% 0.02% -0.17% -0.47%
Net Life Cap 12.07% 12.01% 11.99% 11.88%
Percentage of Residential Mortgage Assets by
Credit Type, by Reported Basis
Mortgage Loans 46.1% 40.2% 33.8% 28.1%
Mortgage Securities: AAA/AA 53.6% 58.2% 64.5% 69.8%
Mortgage Securities: A/BBB 0.0% 0.7% 0.8% 1.0%
Mortgage Securities: Below BBB 0.3% 0.9% 0.9% 1.1%
------------- ------------- ------------- -------------
Total Residential Mortgage Assets (%) 100.0% 100.0% 100.0% 100.0%
Total Residential Mortgage Assets (Reported Basis) $ 3,372,943 $ 3,431,760 $ 3,363,131 $ 2,605,323
Percentage of Residential Mortgage Assets by
Index, Adjustment Frequency, and Annualized
Periodic Cap, By Principal Value
1 Month LIBOR, adjusts monthly, no periodic cap 20.2% 12.4% 8.9% 2.6%
6 Month LIBOR, adjusts every 6 months, 2% periodic cap 21.5% 26.2% 27.5% 32.4%
6 Month LIBOR, adjusts every 6 months, no periodic cap 11.2% 11.4% 7.4% 1.9%
6 Month CD, adjusts every 6 months, 2% annualized
periodic cap 1.2% 1.3% 1.5% 1.9%
6 Mo. Treasury, adjusts every 6 months, 2%
annualized periodic cap 0.6% 0.6% 0.6% 0.8%
6 Month Treasury, adjusts every 6 months, no
periodic cap 0.5% 0.5% 0.5% 0.7%
3/1 Hybrid: 12 Month Treasury with 3 year initial
coupon 1.6% 1.7% 1.8% 2.4%
5/1 Hybrid: 12 Month Treasury with 5 year initial
coupon 0.0% 0.0% 0.0% 0.0%
7/1 Hybrid: 12 Month Treasury with 7 year initial
coupon 0.0% 0.0% 0.0% 0.0%
12 Month Treasury, adjusts annually, 2% periodic cap 41.6% 44.5% 50.3% 55.4%
12 Month Treasury, adjusts annually, no periodic cap 0.1% 0.1% 0.1% 0.1%
Other 1.5% 1.3% 1.4% 1.8%
------------- ------------- ------------- -------------
Total Mortgage Assets (%) 100.0% 100.0% 100.0% 100.0%
Total Mortgage Assets (Principal Value) $ 3,299,212 $ 3,359,213 $ 3,290,562 $ 2,555,857
Net Residential and Commercial Mortgage Asset and
U.S. Treasuries Growth
Mortgage and U.S. Treasuries Acquisitions $ 342,283 $ 369,463 $ 962,890 $ 627,075
Mortgage Principal Repayments (347,427) (252,398) (199,945) (173,362)
Amortization (7,921) (6,512) (5,109) (3,818)
Mark-to-Market Adjustments 0 0 0 0
Writedowns 0 0 0 0
Credit Losses (40) (68) (28) (41)
Sales (45,712) (41,856) 0 0
------------- ------------- ------------- -------------
Change in Mortgage Assets and U.S. Treasuries
(Reported Basis) $ (58,817) $ 68,629 $ 757,808 $ 449,854
70
71
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 4 (CONTINUED)
MORTGAGE ASSET CHARACTERISTICS AT OR FOR THREE MONTHS ENDING
-------------------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1996 1996 1996 1996
------------- ------------- ------------- -------------
Average Characteristics of Loans and Securities
(Residential Mortgage Assets) at End of Period
Single-Family Properties 100% 100% 100% 100%
Short-Term Adjustable Rate Mortgage Assets (First
reset in 12 months or less) 100% 100% 100% 100%
Hybrid Loans (First reset in more than 12 months) 0% 0% 0% 0%
First Lien 100% 100% 100% 100%
Home Equity Loans (AAA and AA securities) 0% 0% 0% 0%
Average Credit Rating Equivalent AA+ AA+ AA+ AA+
Reported Basis as % of Principal Value 101.81% 101.20% 100.60% 99.29%
Coupon Rate 7.75% 7.55% 7.42% 7.59%
Months to Next Coupon Adjustment (Short-Term
Adjustable Rate Mortgage Assets) 5 4 4 3
Months to Next Coupon Adjustment (Hybrid Loans) n/a n/a n/a n/a
------------- ------------- ------------- -------------
Months to Next Coupon Adjustment (Total Mortgage Assets) 5 4 4 3
For Short-Term Adjustable-Rate Residential Mortgage Assets
Coupon Rate 7.75% 7.55% 7.42% 7.59%
Level of Index 5.58% 5.70% 5.72% 5.47%
Net Margin 2.24% 2.21% 2.21% 2.11%
Fully Indexed Coupon Rate 7.82% 7.91% 7.93% 7.58%
Coupon Rate Versus Fully-Indexed Rate -0.07% -0.36% -0.51% 0.01%
Net Life Cap 11.73% 11.69% 11.71% 11.53%
Percentage of Residential Mortgage Assets by Credit Type,
by Reported Basis
Mortgage Loans 24.5% 9.3% 6.9% 4.4%
Mortgage Securities: AAA/AA 73.0% 86.8% 87.7% 86.1%
Mortgage Securities: A/BBB 1.2% 1.8% 2.5% 4.6%
Mortgage Securities: Below BBB 1.3% 2.1% 2.9% 4.9%
------------- ------------- ------------- -------------
Total Residential Mortgage Assets (%) 100.0% 100.0% 100.0% 100.0%
Total Residential Mortgage Assets (Reported Basis) $ 2,155,469 $ 1,377,331 $ 1,011,847 $ 569,743
Percentage of Residential Mortgage Assets by Index,
Adjustment Frequency, and Annualized Periodic Cap, By
Principal Value
1 Month LIBOR, adjusts monthly, no periodic cap 1.4% 2.3% 3.3% 6.6%
6 Month LIBOR, adjusts every 6 months, 2% periodic cap 36.2% 45.9% 54.4% 63.2%
6 Month LIBOR, adjusts every 6 months, no periodic cap 0.0% 0.0% 0.0% 0.0%
6 Month CD, adjusts every 6 months, 2% annualized periodic cap 2.5% 2.4% 3.3% 8.7%
6 Mo. Treasury, adjusts every 6 months, 2% annualized
periodic cap 1.1% 1.7% 2.4% 0.0%
6 Month Treasury, adjusts every 6 months, no periodic cap 0.9% 1.3% 1.9% 3.6%
3/1 Hybrid: 12 Month Treasury with 3 year initial coupon 0.0% 0.0% 0.0% 0.0%
5/1 Hybrid: 12 Month Treasury with 5 year initial coupon 0.0% 0.0% 0.0% 0.0%
7/1 Hybrid: 12 Month Treasury with 7 year initial coupon 0.0% 0.0% 0.0% 0.0%
12 Month Treasury, adjusts annually, 2% periodic cap 55.7% 45.0% 32.8% 14.6%
12 Month Treasury, adjusts annually, no periodic cap 0.0% 0.0% 0.0% 0.0%
Other 2.2% 1.4% 1.9% 3.3%
------------- ------------- ------------- -------------
Total Mortgage Assets (%) 100.0% 100.0% 100.0% 100.0%
Total Mortgage Assets (Principal Value) $ 2,117,244 $ 1,361,062 $ 1,005,764 $ 573,807
Net Residential and Commercial Mortgage Asset and U.S.
Treasuries Growth
Mortgage and U.S. Treasuries Acquisitions $ 875,968 $ 443,860 $ 496,184 $ 166,852
Mortgage Principal Repayments (95,610) (76,942) (53,058) (32,814)
Amortization (2,209) (1,436) (1,023) (531)
Mark-to-Market Adjustments 0 0 0 0
Writedowns 0 0 0 0
Credit Losses (7) 0 0 0
Sales (5) 2 1 0
------------- ------------- ------------- -------------
Change in Mortgage Assets and U.S. Treasuries
(Reported Basis) $ 778,138 $ 365,484 $ 442,104 $ 133,507
71
72
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 4 (CONTINUED)
MORTGAGE ASSET CHARACTERISTICS AT OR FOR YEAR ENDING
--------------------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31, DEC. 31, DEC. 31,
1998 1997 1996 1995
------------- ------------- ------------- -----------
Average Characteristics of Loans and Securities
(Residential Mortgage Assets) at End of Period
Single-Family Properties 100% 100% 100% 100%
Short-Term Adjustable Rate Mortgage Assets
(First reset in 12 months or less) 77% 98% 100% 100%
Hybrid Loans (First reset in more than 12 months) 23% 2% 0% 0%
First Lien 100% 100% 100% 100%
Home Equity Loans (AAA and AA securities) 0% 0% 0% 0%
Average Credit Rating Equivalent AA+ AA+ AA+ AA+
Reported Basis as % of Principal Value 100.57% 102.23% 101.81% 98.33%
Coupon Rate 7.21% 7.71% 7.75% 7.50%
Months to Next Coupon Adjustment (Short-Term
Adjustable Rate Mortgage Assets) 4 4 5 3
Months to Next Coupon Adjustment (Hybrid Loans) 53 21 n/a n/a
------------- ------------- ------------- -----------
Months to Next Coupon Adjustment (Total Mortgage Assets) 15 4 5 3
For Short-Term Adjustable-Rate Residential
Mortgage Assets
Coupon Rate 7.33% 7.73% 7.75% 7.50%
Level of Index 4.90% 5.68% 5.58% 5.44%
Net Margin 1.94% 2.05% 2.24% 2.08%
Fully Indexed Coupon Rate 6.84% 7.73% 7.82% 7.52%
Coupon Rate Versus Fully-Indexed Rate 0.49% 0.00% -0.07% -0.02%
Net Life Cap 11.48% 12.07% 11.73% 11.54%
Percentage of Residential Mortgage Assets by
Credit Type, by Reported Basis
Mortgage Loans 52.5% 46.1% 24.5% 6.1%
Mortgage Securities: AAA/AA 47.2% 53.6% 73.0% 81.5%
Mortgage Securities: A/BBB 0.0% 0.0% 1.2% 5.8%
Mortgage Securities: Below BBB 0.3% 0.3% 1.3% 6.6%
------------- ------------- ------------- -----------
Total Residential Mortgage Assets (%) 100.0% 100.0% 100.0% 100.0%
Total Residential Mortgage Assets (Reported Basis) $ 2,667,916 $ 3,372,943 $ 2,155,469 $ 436,236
Percentage of Residential Mortgage Assets by
Index, Adjustment Frequency, and Annualized
Periodic Cap, By Principal Value
1 Month LIBOR, adjusts monthly, no periodic cap 15.5% 20.2% 1.4% 7.6%
6 Month LIBOR, adjusts every 6 months, 2%
periodic cap 17.5% 21.5% 36.2% 60.3%
6 Month LIBOR, adjusts every 6 months, no
periodic cap 10.8% 11.2% 0.0% 0.0%
6 Month CD, adjusts every 6 months, 2% annualized
periodic cap 0.9% 1.2% 2.5% 12.2%
6 Mo. Treasury, adjusts every 6 months, 2%
annualized periodic cap 0.6% 0.6% 1.1% 0.0%
6 Month Treasury, adjusts every 6 months, no
periodic cap 0.4% 0.5% 0.9% 4.9%
3/1 Hybrid: 12 Month Treasury with 3 year initial
coupon 1.1% 1.6% 0.0% 0.0%
5/1 Hybrid: 12 Month Treasury with 5 year initial
coupon 20.4% 0.0% 0.0% 0.0%
7/1 Hybrid: 12 Month Treasury with 7 year initial
coupon 1.3% 0.0% 0.0% 0.0%
12 Month Treasury, adjusts annually, 2% periodic cap 29.0% 41.6% 55.7% 12.3%
12 Month Treasury, adjusts annually, no periodic cap 0.0% 0.1% 0.0% 0.0%
Other 2.5% 1.5% 2.2% 2.7%
------------- ------------- ------------- -----------
Total Mortgage Assets (%) 100.0% 100.0% 100.0% 100.0%
Total Mortgage Assets (Principal Value) $ 2,652,711 $ 3,299,212 $ 2,117,244 $ 443,625
Net Residential and Commercial Mortgage Asset and
U.S. Treasuries Growth
Mortgage and U.S. Treasuries Acquisitions $ 2,035,774 $ 2,301,711 $ 1,982,864 $ 354,572
Mortgage Principal Repayments (1,555,240) (973,132) (258,424) (38,824)
Amortization (27,794) (23,361) (5,200) 357
Mark-to-Market Adjustments (35,885) 0 0 0
Writedowns (729) 0 0 0
Credit Losses (1,079) (179) (7) (4)
Sales (1,063,778) (87,565) 0 0
------------- ------------- ------------- -----------
Change in Mortgage Assets and U.S. Treasuries
(Reported Basis) $ (648,731) $ 1,217,474 $ 1,719,233 $ 316,101
72
73
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 5 AT
------------------------------------------------------------
RESIDENTIAL MORTGAGE LOAN SUMMARY DEC. 31, SEP. 30, JUN. 30, MAR. 31,
(ALL DOLLARS IN THOUSANDS) 1998 1998 1998 1998
------------ ------------ ------------ ------------
Number of Loans 4,760 7,299 7,032 5,939
Principal Value $ 1,384,681 $ 2,265,305 $ 2,191,767 $ 1,837,518
Reported Basis before Credit Reserve 1,400,996 2,284,254 2,227,427 1,875,433
Reported Basis after Credit Reserve 1,397,213 2,280,864 2,223,348 1,871,984
Estimated Bid-Side Market Value 1,386,290 2,283,738 2,219,772 1,872,775
Short-Term Adjustable Rate Loans (Initial reset in 12 months or less) 58.1% 37.6% 61.8% 81.6%
Hybrid Loans (Initial reset in more than 12 months) 41.9% 62.4% 38.2% 18.4%
Single-Family 100.0% 100.0% 100.0% 100.0%
"A" Quality Underwriting 100.0% 100.0% 100.0% 100.0%
First Lien 100.0% 100.0% 100.0% 100.0%
Primary Residence (Owner-Occupied) 91.0% 93.7% 90.6% 89.3%
Second Home 6.9% 4.9% 7.1% 7.9%
Investor Property 2.1% 1.4% 2.3% 2.8%
Average Loan Size $ 291 $ 310 $ 312 $ 309
Loan Balance < Conventional Loan Balance Limit ($227,150 in 1998) 18.3% 12.6% 15.9% 18.8%
Loan Balance Greater Than $500,000 29.5% 25.9% 32.9% 36.4%
Original Loan-To-Value Ratio 76.4% 74.6% 76.1% 77.0%
Original Loan-to-Value Ratio > 80% 32.3% 24.3% 30.8% 34.6%
% of Original Loan-to-Value Ratio > 80% with Primary Mortgage 97.0% 97.3% 97.0% 96.5%
Insurance or Pledged Account Collateral
Effective Average Original Loan-to-Value Ratio Including Primary 66.9% 68.0% 67.3% 66.8%
Mortgage Insurance or Pledged Account Collateral
Year of Origination
1995 and Prior Years' Origination 12.0% 8.7% 11.3% 16.6%
1996 7.1% 4.9% 5.9% 8.1%
1997 48.0% 34.2% 51.6% 63.8%
1998 32.9% 52.2% 31.2% 11.5%
Average Seasoning in Months 22 15 15 16
Geographic Distribution of Properties Securing Loans
Northern California 16.5% 24.7% 18.0% 12.6%
Southern California 15.7% 19.2% 16.9% 17.2%
Florida 7.8% 5.5% 7.5% 8.8%
New York 6.1% 4.2% 5.6% 6.7%
New Jersey 4.8% 3.8% 4.2% 4.2%
Other States (each less than 4% at December 31, 1998) 49.1% 42.5% 47.8% 50.5%
73
74
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 5 (CONTINUED) AT
----------------------------------------------------------
RESIDENTIAL MORTGAGE LOAN SUMMARY DEC. 31, SEP. 30, JUN. 30, MAR. 31,
(ALL DOLLARS IN THOUSANDS) 1997 1997 1997 1997
------------ ------------ ------------ ----------
Number of Loans 5,041 4,651 3,983 2,795
Principal Value $ 1,519,837 $ 1,348,839 $ 1,111,376 $ 716,137
Reported Basis before Credit Reserve 1,554,681 1,379,691 1,136,694 731,957
Reported Basis after Credit Reserve 1,551,826 1,378,328 1,135,765 730,035
Estimated Bid-Side Market Value 1,552,586 1,379,166 1,136,004 729,561
Short-Term Adjustable Rate Loans (Initial reset in 12 months or less) 96.4% 95.9% 94.8% 91.6%
Hybrid Loans (Initial reset in more than 12 months) 3.6% 4.2% 5.2% 8.4%
Single-Family 100.0% 100.0% 100.0% 100.0%
"A" Quality Underwriting 100.0% 100.0% 100.0% 100.0%
First Lien 100.0% 100.0% 100.0% 100.0%
Primary Residence (Owner-Occupied) 88.6% 90.6% 91.9% 94.3%
Second Home 8.5% 7.2% 6.0% 4.0%
Investor Property 2.9% 2.4% 2.1% 1.7%
Average Loan Size $ 301 $ 290 $ 279 $ 256
Loan Balance < Conventional Loan Balance Limit ($227,150 in 1998) 18.1% 19.3% 19.8% 19.7%
Loan Balance Greater Than $500,000 36.5% 32.6% 27.0% 14.3%
Original Loan-To-Value Ratio 77.7% 76.5% 77.7% 73.7%
Original Loan-to-Value Ratio > 80% 37.5% 34.5% 32.8% 24.3%
% of Original Loan-to-Value Ratio > 80% with Primary Mortgage 94.9% 95.6% 93.8% 94.5%
Insurance or Pledged Account Collateral
Effective Average Original Loan-to-Value Ratio Including Primary 66.1% 66.3% 69.2% 68.5%
Mortgage Insurance or Pledged Account Collateral
Year of Origination
1995 and Prior Years' Origination 22.7% 28.6% 39.3% 68.0%
1996 11.1% 13.9% 18.2% 29.9%
1997 66.2% 57.5% 42.5% 2.1%
1998 n/a n/a n/a n/a
Average Seasoning in Months 18 19 22 33
Geographic Distribution of Properties Securing Loans
Northern California 11.2% 12.5% 12.8% 16.9%
Southern California 18.2% 19.1% 20.9% 24.4%
Florida 9.4% 8.6% 8.2% 4.6%
New York 7.2% 6.4% 5.3% 3.8%
New Jersey 4.4% 4.2% 3.9% 3.2%
Other States (each less than 4% at December 31, 1998) 49.6% 49.0% 49.0% 47.2%
74
75
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 5 (CONTINUED) AT
--------------------------------------------------
RESIDENTIAL MORTGAGE LOAN SUMMARY DEC. 31, SEP. 30, JUN. 30, MAR. 31,
(ALL DOLLARS IN THOUSANDS) 1996 1996 1996 1996
---------- ---------- --------- ---------
Number of Loans 2,172 478 257 101
Principal Value $ 515,033 $ 126,426 $ 69,154 $ 24,831
Reported Basis before Credit Reserve 527,280 127,808 69,680 24,851
Reported Basis after Credit Reserve 525,475 127,694 69,666 24,861
Estimated Bid-Side Market Value 525,475 127,694 69,666 24,861
Short-Term Adjustable Rate Loans (Initial reset in 12 months or less) 100.0% 100.0% 100.0% 100.0%
Hybrid Loans (Initial reset in more than 12 months) 0.0% 0.0% 0.0% 0.0%
Single-Family 100.0% 100.0% 100.0% 100.0%
"A" Quality Underwriting 100.0% 100.0% 100.0% 100.0%
First Lien 100.0% 100.0% 100.0% 100.0%
Primary Residence (Owner-Occupied) 94.4% 99.0% 98.6% 100.0%
Second Home 4.0% 1.0% 1.4% 0.0%
Investor Property 2.0% 0.0% 0.0% 0.0%
Average Loan Size $ 237 $ 264 $ 269 $ 246
Loan Balance < Conventional Loan Balance Limit ($227,150 in 1998) 21.7% 14.7% 12.9% 27.2%
Loan Balance Greater Than $500,000 7.6% 12.0% 13.1% 24.9%
Original Loan-To-Value Ratio 76.8% 77.5% 75.8% 77.0%
Original Loan-to-Value Ratio > 80% 25.3% 32.2% 22.8% 27.0%
% of Original Loan-to-Value Ratio > 80% with Primary Mortgage 96.6% 100.0% 100.0% 100.0%
Insurance or Pledged Account Collateral
Effective Average Original Loan-to-Value Ratio Including Primary 73.2% 72.8% 72.5% 72.9%
Mortgage Insurance or Pledged Account Collateral
Year of Origination
1995 and Prior Years' Origination 92.3% 82.3% 65.5% 100.0%
1996 7.7% 17.7% 34.5% 0.0%
1997 n/a n/a n/a n/a
1998 n/a n/a n/a n/a
Average Seasoning in Months 37 9 4 7
Geographic Distribution of Properties Securing Loans
Northern California 17.5% 34.1% 29.7% 30.0%
Southern California 26.0% 50.7% 42.8% 46.0%
Florida 4.2% 0.4% 0.7% 1.2%
New York 3.1% 0.0% 0.0% 0.0%
New Jersey 2.8% 0.3% 0.0% 1.3%
Other States (each less than 4% at December 31, 1998) 46.5% 14.6% 26.7% 21.4%
75
76
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 5 (CONTINUED) AT
-----------------------------------------------------------
RESIDENTIAL MORTGAGE LOAN SUMMARY DEC. 31, DEC. 31, DEC. 31, DEC. 31,
(All dollars in thousands) 1998 1997 1996 1995
------------ ------------ ---------- ----------
Number of Loans 4,760 5,041 2,172 109
Principal Value $ 1,384,681 $ 1,519,837 $ 515,033 $ 26,411
Reported Basis before Credit Reserve 1,400,996 1,554,681 527,280 26,449
Reported Basis after Credit Reserve 1,397,213 1,551,826 525,475 26,450
Estimated Bid-Side Market Value 1,386,290 1,552,586 525,475 26,450
Short-Term Adjustable Rate Loans (Initial reset in 12 months or less) 58.1% 96.4% 100.0% 100.0%
Hybrid Loans (Initial reset in more than 12 months) 41.9% 3.6% 0.0% 0.0%
Single-Family 100.0% 100.0% 100.0% 100.0%
"A" Quality Underwriting 100.0% 100.0% 100.0% 100.0%
First Lien 100.0% 100.0% 100.0% 100.0%
Primary Residence (Owner-Occupied) 91.0% 88.6% 94.4% 100.0%
Second Home 6.9% 8.5% 4.0% 0.0%
Investor Property 2.1% 2.9% 2.0% 0.0%
Average Loan Size $ 291 $ 301 $ 237 $ 242
Loan Balance < Conventional Loan Balance Limit ($227,150 in 1998) 18.3% 18.1% 21.7% 11.3%
Loan Balance Greater Than $500,000 29.5% 36.5% 7.6% 12.8%
Original Loan-To-Value Ratio 76.4% 77.7% 76.8% 76.0%
Original Loan-to-Value Ratio > 80% 32.3% 37.5% 25.3% 26.0%
% of Original Loan-to-Value Ratio > 80% with Primary Mortgage 97.0% 94.9% 96.6% 100.0%
Insurance or Pledged Account Collateral
Effective Average Original Loan-to-Value Ratio Including Primary 66.9% 66.1% 73.2% 72.4%
Mortgage Insurance or Pledged Account Collateral
Year of Origination
1995 and Prior Years' Origination 12.0% 22.7% 92.3% 100.0%
1996 7.1% 11.1% 7.7% n/a
1997 48.0% 66.2% n/a n/a
1998 32.9% n/a n/a n/a
Average Seasoning in Months 22 18 37 4
Geographic Distribution of Properties Securing Loans
Northern California 16.5% 11.2% 17.5% 30.0%
Southern California 15.7% 18.2% 26.0% 44.0%
Florida 7.8% 9.4% 4.2% 1.1%
New York 6.1% 7.2% 3.1% 0.0%
New Jersey 4.8% 4.4% 2.8% 1.2%
Other States (each less than 4% at December 31, 1998) 49.1% 49.6% 46.5% 23.7%
76
77
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 6 AT
------------------------------------------------
COMMERCIAL MORTGAGE LOAN SUMMARY DEC. 31, SEP. 30, JUN. 30, MAR. 31,
(ALL DOLLARS IN THOUSANDS) 1998 1998 1998 1998
------- ------- ------- --------
INTEREST INCOME ON COMMERCIAL MORTGAGE ASSETS
Commercial Mortgage Loans - Held for for Sale
Coupon Income $ 102 $ 0 $ 0 $ 0
Amortization of Discount Balances 1 0 0 0
Amortization of Premium Balances 0 0 0 0
------- ------- ------- -------
Interest Income: Mortgage Securities -Available for Sale $ 102 $ 0 $ 0 $ 0
COMMERCIAL MORTGAGE ASSET BALANCES
Commercial Mortgage Loans - Held for Sale
Principal Value $ 8,324 $ 0 $ 0 $ 0
Unamortized Premium 0 0 0 0
Unamortized Discount (37) 0 0 0
Real Estate Owned 0 0 0 0
Reserve For Credit Losses 0 0 0 0
Market Valuation Account 0 0 0 0
------- ------- ------- -------
Total Mortgage Loans - Held for Sale $ 8,287 $ 0 $ 0 $ 0
COMMERCIAL MORTGAGE LOAN CHARACTERISTICS
Number of Loans 8 0 0 0
Average Loan Size $ 1,036 $ 0 $ 0 $ 0
Original Debt Service Coverage Ratio 1.32x 0 0 0
Original Loan-to-Value Ratio 70% 0% 0% 0%
Term 9 0 0 0
Prepay Protection (Years) 4 0 0 0
Average Seasoning in Months 7 0 0 0
Average Property Age 16 0 0 0
Lt. Industrial/Warehouse/R&D 37% 0% 0% 0%
Hopitality 37% 0% 0% 0%
Restaurant 10% 0% 0% 0%
Multi-Family 9% 0% 0% 0%
Office 8% 0% 0% 0%
Retail 0% 0% 0% 0%
Industrial 0% 0% 0% 0%
Geographic Distribution of Properties Securing Loans
California 77% 0% 0% 0%
Nevada 8% 0% 0% 0%
North Carolina 12% 0% 0% 0%
Texas 4% 0% 0% 0%
Other States (no other states as of December 31, 1998) 0% 0% 0% 0%
Index
6-month LIBOR 51% 0% 0% 0%
5-year Treasury 40% 0% 0% 0%
Other 9% 0% 0% 0%
Coupon Rate 9.71% 0% 0% 0%
Net Margin 3.88% 0% 0% 0%
Net Life Cap 13.45% 0% 0% 0%
Net Life Floor (for loans with life floors) 8.99% 0% 0% 0%
Months to Next Coupon Adjustment 37 0 0 0
INFORMATION FOR PRIOR YEARS IS NOT INCLUDED AS THE COMPANY DID
NOT OWN ANY SUCH ASSETS PRIOR TO 1998.
77
78
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 7
EARNING ASSET YIELD, INTEREST RATE SPREAD FOR THREE MONTHS ENDING
-----------------------------------------------
AND INTEREST RATE MARGIN DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1998 1998 1998 1998
------- ------- ------- --------
Coupon Rate (All Mortgage Assets & U.S. Treasuries) 7.17% 7.22% 7.52% 7.65%
Reported Basis as % of Principal Value 100.63% 101.13% 101.98% 102.21%
Coupon Yield on Reported Basis 7.12% 7.14% 7.37% 7.49%
Effect of Premium/Discount Amortization -0.23% -0.72% -1.26% -0.99%
Mortgage Assets and U.S. Treasuries Yield 6.89% 6.42% 6.11% 6.50%
Cash Yield 5.54% 5.68% 5.23% 5.51%
------- ------- ------- -------
Earning Asset Yield 6.87% 6.42% 6.10% 6.49%
Cost of Funds of Short-Term Borrowings 5.59% 5.93% 5.88% 5.77%
Cost of Funds of Long-Term Borrowings 6.23% 6.46% 6.45% 6.44%
------- ------- ------- -------
Total Cost of Funds 5.89% 6.15% 6.06% 6.01%
Cost of Hedging (as % of Borrowings) 0.04% 0.03% 0.19% 0.18%
Interest Rate Spread 0.94% 0.24% -0.15% 0.30%
Net Interest Margin (Net Interest Income/Assets) 1.19% 0.52% 0.22% 0.75%
Net Interest Income/Average Equity 15.23% 7.04% 2.33% 7.45%
SELECTED OPERATING RATIOS AND RETURN ON EQUITY
Credit Provisions as a % of Residential Mortgage Loans 0.05% -0.06% 0.08% 0.07%
Credit Provisions as a % of Equity 0.62% -0.87% 0.89% 0.70%
Operating Expenses (excluding one-time charges) to Average Assets 0.14% 0.10% 0.06% 0.22%
Operating Expenses (excluding one-time charges) to Average Equity 1.75% 1.41% 0.69% 2.24%
Efficiency Ratio (Op. Exp. (exc. one-time charges)/Net Int. Income) 11.51% 20.03% 29.65% 30.14%
GAAP Return on Common Equity 10.22% -72.19% -0.62% 3.10%
Taxable Income Return on Common Equity 10.68% -14.97% 0.19% 4.86%
GAAP Return on Assets 0.80% -4.76% 0.02% 0.37%
PREPAYMENT RATES
Average Annual Conditional Prepayment Rate (CPR) of Underlying
Mortgages in Mortgage Securities Pools and Mortgage Loans 32% 29% 34% 26%
Average Annual Conditional Prepayment Rate (CPR) of Underlying
Mortgages in Mortgage Securities Pools 33% 37% 40% 29%
Average Annual Conditional Prepayment Rate (CPR) of Mortgage Loans 31% 23% 28% 22%
78
79
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 7 (CONTINUED)
EARNING ASSET YIELD, INTEREST RATE SPREAD FOR THREE MONTHS ENDING
-----------------------------------------------
AND INTEREST RATE MARGIN DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1997 1997 1997 1997
------- ------- ------- --------
Coupon Rate (All Mortgage Assets & U.S. Treasuries) 7.70% 7.77% 7.74% 7.70%
Reported Basis as % of Principal Value 102.20% 102.22% 102.15% 101.84%
Coupon Yield on Reported Basis 7.53% 7.60% 7.57% 7.56%
Effect of Premium/Discount Amortization -0.98% -0.79% -0.71% -0.68%
Mortgage Assets and U.S. Treasuries Yield 6.55% 6.81% 6.86% 6.88%
Cash Yield 5.59% 5.60% 5.52% 5.33%
------- ------- ------- -------
Earning Asset Yield 6.54% 6.80% 6.86% 6.87%
Cost of Funds of Short-Term Borrowings 5.96% 5.98% 5.86% 5.62%
Cost of Funds of Long-Term Borrowings 6.40% 6.28% n/a n/a
------- ------- ------- -------
Total Cost of Funds 6.09% 6.02% 5.86% 5.62%
Cost of Hedging (as % of Borrowings) 0.17% 0.14% 0.13% 0.12%
Interest Rate Spread 0.28% 0.64% 0.87% 1.13%
Net Interest Margin (Net Interest Income/Assets) 0.72% 1.12% 1.31% 1.57%
Net Interest Income/Average Equity 7.06% 11.13% 13.25% 15.30%
SELECTED OPERATING RATIOS AND RETURN ON EQUITY
Credit Provisions as a % of Residential Mortgage Loans 0.06% 0.11% 0.10% 0.12%
Credit Provisions as a % of Equity 0.59% 1.09% 1.06% 1.17%
Operating Expenses (excluding one-time charges) to Average Assets 0.13% 0.13% 0.16% 0.20%
Operating Expenses (excluding one-time charges) to Average Equity 1.29% 1.33% 1.66% 1.97%
Efficiency Ratio (Op. Exp. (exc. one-time charges)/Net Int. Income) 18.25% 11.93% 12.51% 12.86%
GAAP Return on Common Equity 5.43% 8.60% 10.65% 12.44%
Taxable Income Return on Common Equity 6.06% 9.36% 11.55% 13.79%
GAAP Return on Assets 0.59% 0.88% 1.04% 1.25%
PREPAYMENT RATES
Average Annual Conditional Prepayment Rate (CPR) of Underlying
Mortgages in Mortgage Securities Pools and Mortgage Loans 27% 24% 23% 24%
Average Annual Conditional Prepayment Rate (CPR) of Underlying
Mortgages in Mortgage Securities Pools 30% 25% 22% 23%
Average Annual Conditional Prepayment Rate (CPR) of Mortgage Loans 24% 23% 28% 24%
79
80
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 7 (CONTINUED)
EARNING ASSET YIELD, INTEREST RATE SPREAD FOR THREE MONTHS ENDING
-----------------------------------------------
AND INTEREST RATE MARGIN DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1996 1996 1996 1996
------- ------- ------- --------
Coupon Rate (All Mortgage Assets & U.S. Treasuries) 7.58% 7.52% 7.47% 7.73%
Reported Basis as % of Principal Value 101.41% 100.98% 99.95% 98.85%
Coupon Yield on Reported Basis 7.48% 7.44% 7.48% 7.82%
Effect of Premium/Discount Amortization -0.59% -0.52% -0.56% -0.44%
Mortgage Assets and U.S. Treasuries Yield 6.89% 6.92% 6.92% 7.38%
Cash Yield 5.31% 5.30% 5.61% 5.93%
------- ------- ------- -------
Earning Asset Yield 6.87% 6.90% 6.90% 7.34%
Cost of Funds of Short-Term Borrowings 5.76% 5.78% 5.57% 5.69%
Cost of Funds of Long-Term Borrowings n/a n/a n/a n/a
------- ------- ------- -------
Total Cost of Funds 5.76% 5.78% 5.57% 5.69%
Cost of Hedging (as % of Borrowings) 0.12% 0.14% 0.16% 0.14%
Interest Rate Spread 0.99% 0.98% 1.17% 1.51%
Net Interest Margin (Net Interest Income/Assets) 1.55% 1.58% 1.85% 2.17%
Net Interest Income/Average Equity 13.01% 12.40% 12.14% 14.92%
SELECTED OPERATING RATIOS AND RETURN ON EQUITY
Credit Provisions as a % of Residential Mortgage Loans 0.10% 0.18% 0.25% 0.26%
Credit Provisions as a % of Equity 0.81% 1.40% 1.62% 1.78%
Operating Expenses (excluding one-time charges) to Average Assets 0.21% 0.23% 0.31% 0.38%
Operating Expenses (excluding one-time charges) to Average Equity 1.72% 1.82% 2.02% 2.64%
Efficiency Ratio (Op. Exp. (exc. one-time charges)/Net Int. Income) 13.23% 14.69% 16.63% 17.71%
GAAP Return on Common Equity 10.53% 9.06% 8.50% 10.50%
Taxable Income Return on Common Equity 12.03% 11.06% 10.69% 13.69%
GAAP Return on Assets 1.25% 1.17% 1.30% 1.52%
PREPAYMENT RATES
Average Annual Conditional Prepayment Rate (CPR) of Underlying
Mortgages in Mortgage Securities Pools and Mortgage Loans 23% 24% 29% 26%
Average Annual Conditional Prepayment Rate (CPR) of Underlying
Mortgages in Mortgage Securities Pools 22% 24% 29% 26%
Average Annual Conditional Prepayment Rate (CPR) of Mortgage Loans 32% 19% 28% 19%
80
81
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 7 (CONTINUED)
EARNING ASSET YIELD, INTEREST RATE SPREAD FOR YEAR ENDING
-----------------------------------------------
AND INTEREST RATE MARGIN DEC. 31, DEC. 31, DEC. 31, DEC. 31,
1998 1997 1996 1995
------- ------- ------- --------
Coupon Rate (All Mortgage Assets & U.S. Treasuries) 7.42% 7.72% 7.55% 7.16%
Reported Basis as % of Principal Value 101.47% 102.13% 100.68% 99.02%
Coupon Yield on Reported Basis 7.31% 7.56% 7.50% 7.23%
Effect of Premium/Discount Amortization -0.82% -0.81% -0.55% 0.17%
Mortgage Assets and U.S. Treasuries Yield 6.49% 6.75% 6.95% 7.40%
Cash Yield 5.48% 5.53% 5.51% 5.43%
------- ------- ------- -------
Earning Asset Yield 6.48% 6.74% 6.93% 7.36%
Cost of Funds of Short-Term Borrowings 5.81% 5.86% 5.71% 6.06%
Cost of Funds of Long-Term Borrowings 6.38% 6.31% n/a n/a
------- ------- ------- -------
Total Cost of Funds 6.03% 5.92% 5.71% 6.06%
Cost of Hedging (as % of Borrowings) 0.11% 0.14% 0.13% 0.19%
Interest Rate Spread 0.34% 0.68% 1.09% 1.11%
Net Interest Margin (Net Interest Income/Assets) 0.65% 1.14% 1.69% 2.17%
Net Interest Income/Average Equity 7.54% 11.27% 12.90% 11.03%
SELECTED OPERATING RATIOS AND RETURN ON EQUITY
Credit Provisions as a % of Residential Mortgage Loans 0.03% 0.10% 0.17% 0.22%
Credit Provisions as a % of Equity 0.36% 0.95% 1.29% 1.14%
Operating Expenses (excluding one-time charges) to Average Assets 0.13% 0.15% 0.26% 0.51%
Operating Expenses (excluding one-time charges) to Average Equity 1.52% 1.52% 1.94% 2.61%
Efficiency Ratio (Op. Exp. (exc. one-time charges)/Net Int. Income) 20.09% 13.47% 15.08% 23.66%
GAAP Return on Common Equity -14.31% 8.87% 9.61% 7.28%
Taxable Income Return on Common Equity 0.04% 9.73% 11.68% 8.84%
GAAP Return on Assets -1.05% 0.91% 1.27% 1.43%
PREPAYMENT RATES
Average Annual Conditional Prepayment Rate (CPR) of Underlying
Mortgages in Mortgage Securities Pools and Mortgage Loans 30% 25% 25% 19%
Average Annual Conditional Prepayment Rate (CPR) of Underlying
Mortgages in Mortgage Securities Pools 35% 25% 24% 19%
Average Annual Conditional Prepayment Rate (CPR) of Mortgage Loans 26% 24% 26% 5%
81
82
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 8
AVERAGE DAILY BALANCE SHEET AT OR FOR THREE MONTHS ENDING
-----------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1998 1998 1998 1998
----------- ----------- ----------- -----------
Cash $ 56,467 $ 32,316 $ 34,833 $ 27,907
Residential Mortgage Loans 1,867,851 2,332,743 1,867,851 1,546,869
Residential Mortgage Securities 1,144,012 1,472,594 1,622,388 1,745,368
Credit Reserve (4,728) (5,733) (5,677) (5,126)
Market Valuation Adjustment, Mortgage Assets 110 1,295 (4,401) (4,272)
Commercial Mortgage Loans 5,137 0 0 0
Other Investments 48,050 0 0 0
Interest Rate Agreements 2,715 679 9,995 10,394
Market Valuation Adjustment, Interest Rate Agreements 0 0 (8,246) (8,863)
Other Assets 114,020 128,846 136,765 98,835
----------- ----------- ----------- -----------
Total Assets 3,233,634 3,962,741 3,653,508 3,411,112
----------- ----------- ----------- -----------
Short-Term Borrowings 1,571,775 2,127,967 2,263,697 1,942,426
Long-Term Borrowings 1,395,639 1,526,785 1,047,828 1,124,190
Other Liabilities 12,806 14,737 13,464 14,602
----------- ----------- ----------- -----------
Total Liabilities 2,980,220 3,669,488 3,324,989 3,081,218
----------- ----------- ----------- -----------
Preferred Stock 26,736 26,736 26,736 26,736
Common Stock 280,504 305,633 321,266 321,420
Market Valuation Adjustment 110 1,295 (12,647) (13,136)
Retained Earnings, after Dividend (53,936) (40,411) (6,836) (5,127)
----------- ----------- ----------- -----------
Stockholders' Equity $ 253,414 $ 293,253 $ 328,519 $ 329,894
=========== =========== =========== ===========
Reported Basis of Total Assets $ 3,233,524 $ 3,961,446 $ 3,666,155 $ 3,424,247
Equity, before Market Valuation Adjustments 253,304 291,958 341,166 343,029
BORROWING COMPOSITION (AT END OF PERIOD)
Short-Term Borrowings: 1 to 6 Month LIBOR, no caps 49.1% 58.5% 54.9% 67.9%
Long-Term Borrowings: 1 Month LIBOR, 10% cap 9.6% 8.0% 9.3% 11.3%
Long-Term Borrowings: Federal Funds, 10% cap 2.9% 2.6% 3.2% 4.2%
Long-Term Borrowings: 1 Year Treasury, 10% cap 17.7% 13.7% 14.7% 16.6%
Long-Term Borrowings: Fixed Rate until December 2002 20.7% 17.2% 18.0% 0.0%
----------- ----------- ----------- -----------
Total Borrowings % 100.0% 100.0% 100.0% 100.0%
Total Borrowings $ $ 2,563,130 $ 3,533,054 $ 3,529,502 $ 3,369,297
LIQUIDITY (AT END OF PERIOD)
Unrestricted Cash $ 55,627 $ 3,811 $ 11,354 $ 6,468
Estimated Borrowing Capacity 61,647 113,764 145,285 174,702
----------- ----------- ----------- -----------
Total Liquidity $ 117,274 $ 117,575 $ 156,639 $ 181,170
Total Liquidity as Percent of Short-Term Borrowings 9% 6% 8% 8%
NET MORTGAGE ASSETS PREMIUM AS % OF EQUITY AND
ASSETS (AT END OF PERIOD) (EXCLUDING U.S.
TREASURIES)
Unamortized Premium of Mortgage Assets $ 27,369 $ 30,653 $ 75,158 $ 85,048
Unamortized Discount of Mortgage Assets (12,126) (11,669) (10,651) (12,131)
Unamortized Deferred Bond Issuance Cost of
Long-Term Debt 3,628 4,140 4,704 3,300
Net Unamortized Premium of Long-Term Debt (5,783) (6,451) (6,970) (5,551)
----------- ----------- ----------- -----------
Net Premium $ 13,088 $ 16,673 $ 62,242 $ 70,666
Net Premium as Percent of Equity (before Market
Value Adjustments) 5.1% 6.5% 18.8% 21.2%
Net Premium as Percent of Common Equity (before
MV Adjustments) 5.7% 7.2% 20.4% 23.0%
Net Premium as Percent of Assets (Reported Basis) 0.5% 0.4% 1.6% 1.9%
82
83
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 8 (CONTINUED)
AVERAGE DAILY BALANCE SHEET AT OR FOR THREE MONTHS ENDING
-----------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1997 1997 1997 1997
----------- ----------- ----------- -----------
Cash $ 28,592 $ 35,647 $ 19,307 $ 12,147
Residential Mortgage Loans 1,360,029 1,155,099 758,445 574,781
Residential Mortgage Securities 1,914,118 2,136,442 2,111,832 1,658,629
Credit Reserve (4,679) (3,873) (3,083) (2,394)
Market Valuation Adjustment, Mortgage Assets 5,937 6,072 1,913 1,022
Commercial Mortgage Loans 0 0 0 0
Other Investments 0 0 0 0
Interest Rate Agreements 11,207 11,943 11,185 6,899
Market Valuation Adjustment, Interest Rate Agreements (8,792) (8,640) (4,576) (4,004)
Other Assets 117,643 85,689 75,928 58,856
----------- ----------- ----------- -----------
Total Assets 3,424,055 3,418,379 2,970,951 2,305,936
----------- ----------- ----------- -----------
Short-Term Borrowings 2,144,794 2,695,438 2,659,914 2,056,051
Long-Term Borrowings 910,870 355,028 0 0
Other Liabilities 20,912 24,714 20,530 15,691
----------- ----------- ----------- -----------
Total Liabilities 3,076,576 3,075,181 2,680,444 2,071,742
----------- ----------- ----------- -----------
Preferred Stock 26,733 26,733 28,946 29,545
Common Stock 328,384 321,492 265,561 208,426
Market Valuation Adjustment (2,855) (2,568) (2,663) (2,982)
Retained Earnings, after Dividend (4,783) (2,458) (1,337) (795)
----------- ----------- ----------- -----------
Stockholders' Equity $ 347,479 $ 343,199 $ 290,507 $ 234,194
=========== =========== =========== ===========
Reported Basis of Total Assets $ 3,426,910 $ 3,420,947 $ 2,973,614 $ 2,308,918
Equity, before Market Valuation Adjustments 350,334 345,767 293,170 237,176
BORROWING COMPOSITION (AT END OF PERIOD)
Short-Term Borrowings: 1 to 6 Month LIBOR, no caps 62.0% 84.1% 100.0% 100.0%
Long-Term Borrowings: 1 Month LIBOR, 10% cap 13.8% 9.9% 0.0% 0.0%
Long-Term Borrowings: Federal Funds, 10% cap 5.3% 6.0% 0.0% 0.0%
Long-Term Borrowings: 1 Year Treasury, 10% cap 18.9% 0.0% 0.0% 0.0%
Long-Term Borrowings: Fixed Rate until December 2002 0.0% 0.0% 0.0% 0.0%
----------- ----------- ----------- -----------
Total Borrowings % 100.0% 100.0% 100.0% 100.0%
Total Borrowings $ $ 3,087,326 $ 3,137,140 $ 3,102,784 $ 2,373,279
LIQUIDITY (AT END OF PERIOD)
Unrestricted Cash $ 24,893 $ 28,758 $ 29,425 $ 12,985
Estimated Borrowing Capacity 182,713 206,442 160,338 140,561
----------- ----------- ----------- -----------
Total Liquidity $ 207,606 $ 235,200 $ 189,763 $ 153,546
Total Liquidity as Percent of Short-Term Borrowings 11% 9% 6% 6%
NET MORTGAGE ASSETS PREMIUM AS % OF EQUITY AND ASSETS
(AT END OF PERIOD) (EXCLUDING U.S. TREASURIES)
Unamortized Premium of Mortgage Assets $ 86,173 $ 86,934 $ 87,661 $ 65,107
Unamortized Discount of Mortgage Assets (12,442) (14,387) (15,091) (15,641)
Unamortized Deferred Bond Issuance Cost of Long-Term Debt 3,703 1,492 0 0
Net Unamortized Premium of Long-Term Debt (5,795) 0 0 0
----------- ----------- ----------- -----------
Net Premium $ 71,639 $ 74,039 $ 72,569 $ 49,466
Net Premium as Percent of Equity (before Market Value Adjustments) 21.3% 21.4% 25.1% 20.3%
Net Premium as Percent of Common Equity (before MV Adjustments) 23.2% 23.2% 27.6% 23.1%
Net Premium as Percent of Assets (Reported Basis) 2.1% 2.1% 2.1% 1.9%
83
84
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 8 (CONTINUED)
AVERAGE DAILY BALANCE SHEET AT OR FOR THREE MONTHS ENDING
-----------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1996 1996 1996 1996
----------- ----------- ----------- -----------
Cash $ 16,137 $ 18,854 $ 14,402 $ 14,639
Residential Mortgage Loans 143,368 93,991 45,313 25,279
Residential Mortgage Securities 1,347,617 1,010,853 688,697 457,841
Credit Reserve (1,952) (1,491) (1,002) (594)
Market Valuation Adjustment, Mortgage Assets 603 (2,279) (3,865) (3,880)
Commercial Mortgage Loans 0 0 0 0
Other Investments 0 0 0 0
Interest Rate Agreements 4,681 3,185 2,737 2,503
Market Valuation Adjustment, Interest Rate Agreements (3,513) (1,352) (1,080) (1,836)
Other Assets 41,430 30,129 21,566 13,094
----------- ----------- ----------- -----------
Total Assets 1,548,371 1,151,890 766,768 507,046
----------- ----------- ----------- -----------
Short-Term Borrowings 1,351,510 999,229 651,643 435,979
Long-Term Borrowings 0 0 0 0
Other Liabilities 14,898 8,728 2,472 2,324
----------- ----------- ----------- -----------
Total Liabilities 1,366,408 1,007,957 654,115 438,303
----------- ----------- ----------- -----------
Preferred Stock 29,671 15,179 0 0
Common Stock 156,594 132,924 117,695 73,998
Market Valuation Adjustment (2,910) (3,631) (4,945) (5,716)
Retained Earnings, after Dividend (1,392) (539) (97) 461
----------- ----------- ----------- -----------
Stockholders' Equity $ 181,963 $ 143,933 $ 112,653 $ 68,743
=========== =========== =========== ===========
Reported Basis of Total Assets $ 1,551,281 $ 1,155,521 $ 771,713 $ 512,762
Equity, before Market Valuation Adjustments 184,873 147,564 117,598 74,459
BORROWING COMPOSITION (AT END OF PERIOD)
Short-Term Borrowings: 1 to 6 Month LIBOR, no caps 100.0% 100.0% 100.0% 100.0%
Long-Term Borrowings: 1 Month LIBOR, 10% cap 0.0% 0.0% 0.0% 0.0%
Long-Term Borrowings: Federal Funds, 10% cap 0.0% 0.0% 0.0% 0.0%
Long-Term Borrowings: 1 Year Treasury, 10% cap 0.0% 0.0% 0.0% 0.0%
Long-Term Borrowings: Fixed Rate until December 2002 0.0% 0.0% 0.0% 0.0%
----------- ----------- ----------- -----------
Total Borrowings % 100.0% 100.0% 100.0% 100.0%
Total Borrowings $ $ 1,953,103 $ 1,225,094 $ 896,214 $ 508,721
LIQUIDITY (AT END OF PERIOD)
Unrestricted Cash $ 11,068 $ 14,599 $ 10,407 $ 9,705
Estimated Borrowing Capacity 123,995 99,126 69,581 29,153
----------- ----------- ----------- -----------
Total Liquidity $ 135,063 $ 113,725 $ 79,988 $ 38,858
Total Liquidity as Percent of Short-Term Borrowings 7% 9% 9% 8%
NET MORTGAGE ASSETS PREMIUM AS % OF EQUITY AND
ASSETS (AT END OF PERIOD) (EXCLUDING U.S. TREASURIES)
Unamortized Premium of Mortgage Assets $ 54,318 $ 32,607 $ 22,690 $ 12,790
Unamortized Discount of Mortgage Assets (16,093) (16,338) (16,608) (16,854)
Unamortized Deferred Bond Issuance Cost of Long-Term Debt 0 0 0 0
Net Unamortized Premium of Long-Term Debt 0 0 0 0
----------- ----------- ----------- -----------
Net Premium $ 38,225 $ 16,270 $ 6,082 $ (4,064)
Net Premium as Percent of Equity (before Market
Value Adjustments) 18.1% 10.0% 4.8% -5.7%
Net Premium as Percent of Common Equity (before
MV Adjustments) 21.1% 12.2% 4.8% -5.7%
Net Premium as Percent of Assets (Reported Basis) 1.7% 1.2% 0.6% -0.7%
84
85
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 8 (CONTINUED)
AVERAGE DAILY BALANCE SHEET AT OR FOR YEAR ENDING
-----------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31, DEC. 31, DEC. 31,
1998 1997 1996 1995
----------- ----------- ----------- -----------
Cash $ 37,944 $ 24,001 $ 16,016 $ 4,272
Residential Mortgage Loans 1,905,883 964,768 77,215 5,006
Residential Mortgage Securities 1,494,378 1,956,452 877,907 204,284
Credit Reserve (5,316) (3,514) (1,262) (92)
Market Valuation Adjustment, Mortgage Assets 306 (1,134) (2,347) (78)
Commercial Mortgage Loans 1,295 0 0 0
Other Investments 12,111 0 0 0
Interest Rate Agreements 5,910 10,325 3,280 2,039
Market Valuation Adjustment, Interest Rate Agreements (3,354) (2,482) (1,948) (1,046)
Other Assets 119,684 84,693 26,606 5,107
----------- ----------- ----------- -----------
Total Assets 3,568,841 3,033,108 995,467 219,492
----------- ----------- ----------- -----------
Short-Term Borrowings 1,975,866 2,390,132 861,316 174,926
Long-Term Borrowings 1,275,048 319,076 0 0
Other Liabilities 13,899 20,488 7,131 2,342
----------- ----------- ----------- -----------
Total Liabilities 3,264,813 2,729,696 868,447 177,268
----------- ----------- ----------- -----------
Preferred Stock 26,736 27,978 11,274 0
Common Stock 307,089 281,405 120,436 43,390
Market Valuation Adjustment (3,048) (3,617) (4,295) (1,124)
Retained Earnings, after Dividend (26,749) (2,354) (395) (42)
----------- ----------- ----------- -----------
Stockholders' Equity $ 304,028 $ 303,412 $ 127,020 $ 42,224
=========== =========== =========== ===========
Reported Basis of Total Assets $ 3,571,889 $ 3,036,725 $ 999,762 $ 220,616
Equity, before Market Valuation Adjustments 307,076 307,029 131,315 43,349
BORROWING COMPOSITION (AT END OF PERIOD)
Short-Term Borrowings: 1 to 6 Month LIBOR, no caps 49.1% 62.0% 100.0% 100.0%
Long-Term Borrowings: 1 Month LIBOR, 10% cap 9.6% 13.8% 0.0% 0.0%
Long-Term Borrowings: Federal Funds, 10% cap 2.9% 5.3% 0.0% 0.0%
Long-Term Borrowings: 1 Year Treasury, 10% cap 17.7% 18.9% 0.0% 0.0%
Long-Term Borrowings: Fixed Rate until December 2002 20.7% 0.0% 0.0% 0.0%
----------- ----------- ----------- -----------
Total Borrowings % 100.0% 100.0% 100.0% 100.0%
Total Borrowings $ $ 2,563,130 $ 3,087,326 $ 1,953,103 $ 370,316
LIQUIDITY (AT END OF PERIOD)
Unrestricted Cash $ 55,627 $ 24,893 $ 11,068 $ 4,825
Estimated Borrowing Capacity 61,647 182,713 123,995 38,698
----------- ----------- ----------- -----------
Total Liquidity $ 117,274 $ 207,606 $ 135,063 $ 43,523
Total Liquidity as Percent of Short-Term Borrowings 9% 11% 7% 12%
NET MORTGAGE ASSETS PREMIUM AS % OF EQUITY AND ASSETS
(AT END OF PERIOD) (EXCLUDING U.S. TREASURIES)
Unamortized Premium of Mortgage Assets $ 23,614 $ 86,173 $ 54,318 $ 9,644
Unamortized Discount of Mortgage Assets (8,371) (12,442) (16,093) (17,032)
Unamortized Deferred Bond Issuance Cost of
Long-Term Debt 3,628 3,703 0 0
Net Unamortized Premium of Long-Term Debt (5,783) (5,795) 0 0
----------- ----------- ----------- -----------
Net Premium $ 13,088 $ 71,639 $ 38,225 $ (7,389)
Net Premium as Percent of Equity (before Market
Value Adjustments) 5.1% 21.3% 18.1% -10.3%
Net Premium as Percent of Common Equity (before
MV Adjustments) 5.7% 23.2% 21.1% -10.3%
Net Premium as Percent of Assets (Reported Basis) 0.5% 2.1% 1.7% -1.7%
85
86
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 9
ESTIMATED PERIOD-END BID-SIDE MARKET VALUE / AT OR FOR THREE MONTHS ENDING
REALIZABLE VALUE ----------------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1998 1998 1998 1998
------------- ------------- ------------- -------------
Cash $ 68,484 $ 23,486 $ 32,914 $ 32,202
Residential Mortgage Loans 1,386,290 2,283,738 2,219,772 1,872,775
Residential Mortgage Securities 1,265,362 1,459,702 1,570,842 1,770,566
Commercial Mortgage Loans 8,388 0 0 0
Other Investments 48,009 0 0 0
Interest Rate Agreements 2,517 2,285 7,397 11,294
Other Assets 41,393 34,824 36,476 36,521
Short-Term Borrowings 1,257,570 2,067,166 1,936,158 2,288,018
Long-Term Borrowings 1,302,330 1,464,947 1,591,961 1,080,530
Other Liabilities 12,568 10,094 22,774 21,998
------------- ------------- ------------- -------------
"Mark-To-Market" of Total Equity 247,975 261,828 316,507 332,812
Preference Value of Preferred Equity 28,195 28,195 28,195 28,195
------------- ------------- ------------- -------------
"Mark-To-Market" of Common Equity $ 219,780 $ 233,633 $ 288,312 $ 304,617
"Mark-To-Market" of Common Equity / Common Share Outstanding $ 19.53 $ 19.74 $ 20.48 $ 21.65
Reported Common Equity Per Common Share Outstanding $ 20.27 $ 19.51 $ 20.89 $ 21.53
AVERAGE BALANCE SHEET UTILIZATION DURING PERIOD VERSUS
RISK-ADJUSTED CAPITAL GUIDELINES
Actual Average Equity/Assets 7.83% 7.37% 9.31% 10.02%
"At-Risk" Assets at Period End $ 1,523,280 $ 2,358,524 $ 2,299,199 $ 2,662,466
"At-Risk" Equity/Assets at Period End 16.73% 10.92% 13.96% 12.38%
Average Risk-Adjusted Capital Guideline 6.33% 6.43% 7.37% 7.76%
Average Balance Sheet Capacity Utilization 81% 87% 79% 77%
Ending Actual Equity/Assets 9.00% 6.77% 8.30% 8.88%
Ending Risk-Adjusted Capital Guideline 6.55% 6.08% 6.48% 7.59%
Excess Capital $ 50,226 $ 25,559 $ 64,465 $ 49,552
INVESTMENT OF RISK-ADJUSTED CAPITAL
Equity Invesments in Assets with Short-Term Funding
Agencies 18.7% 20.6% 19.9% 22.1%
Mortgage Securities Rated "AAA" or "AA" 25.8% 30.7% 26.3% 28.0%
Mortgage Securities Rated "A" or below 0.0% 0.0% 0.0% 0.0%
Commercial Mortgage Loans 3.2% 0.0% 0.0% 0.0%
US Treasuries 1.3% 0.0% 0.0% 0.0%
Residential Mortgage Loans 5.3% 17.0% 12.6% 18.2%
------------- ------------- ------------- -------------
Equity Investment in Assets with Short-Term Funding 54.3% 68.3% 58.8% 68.3%
Equity Investment in Assets with Long-Term, Non-Recourse
Funding (Mortgage Equity Interests)
SMFC 97-A 3.6% 3.6% 2.9% 2.8%
Mortgage Loans in Sequoia 16.5% 18.1% 17.8% 14.1%
------------- ------------- ------------- -------------
Equity Investment in Assets with Long-Term, Non-Recourse Funding 20.1% 21.7% 20.7% 16.9%
Equity Investment in RWT Holdings, Inc. 5.9% 3.0% 3.0% 3.0%
Excess Capital 19.7% 7.0% 17.5% 11.8%
------------- ------------- ------------- -------------
Total Market-Value of Capital % 100.0% 100.0% 100.0% 100.0%
Total Capital Available per Risk-Adjusted Capital $ 255,438 $ 256,571 $ 314,679 $ 331,548
Capital Utilization at Period-end 80% 93% 82% 88%
86
87
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 9 (CONTINUED)
AT OR FOR THREE MONTHS ENDING
ESTIMATED PERIOD-END BID-SIDE MARKET VALUE / -----------------------------------------------------------------
REALIZABLE VALUE DEC. 31, SEP. 30, JUN. 30, MAR. 31,
(ALL DOLLARS IN THOUSANDS) 1997 1997 1997 1997
------------- ------------- ------------- -------------
Cash $ 49,549 $ 57,696 $ 29,425 $ 12,985
Residential Mortgage Loans 1,552,586 1,379,166 1,136,004 729,561
Residential Mortgage Securities 1,814,796 2,059,595 2,227,389 1,874,679
Commercial Mortgage Loans 0 0 0 0
Other Investments 0 0 0 0
Interest Rate Agreements 10,203 10,951 11,572 7,879
Other Assets 25,156 26,048 25,857 19,291
Short-Term Borrowings 1,914,525 2,639,773 3,102,784 2,373,279
Long-Term Borrowings 1,172,938 497,465 0 0
Other Liabilities 29,882 39,410 34,881 25,518
------------- ------------- ------------- -------------
"Mark-To-Market" of Total Equity 334,945 356,808 292,582 245,598
Preference Value of Preferred Equity 28,195 28,195 28,195 30,989
------------- ------------- ------------- -------------
"Mark-To-Market" of Common Equity $ 306,750 $ 328,613 $ 264,387 $ 214,610
"Mark-To-Market" of Common Equity/Common Share Outstanding $ 21.47 $ 22.54 $ 19.95 $ 18.03
Reported Common Equity Per Common Share Outstanding $ 21.55 $ 22.61 $ 20.11 $ 18.17
AVERAGE BALANCE SHEET UTILIZATION DURING PERIOD VERSUS
RISK-ADJUSTED CAPITAL GUIDELINES
Actual Average Equity/Assets 10.22% 10.11% 9.86% 10.27%
"At-Risk" Assets at Period End $ 2,300,353 $ 3,057,821 $ 3,424,506 $ 2,643,064
"At-Risk" Equity/Assets at Period End 14.54% 11.65% 8.56% 9.29%
Average Risk-Adjusted Capital Guideline 8.07% 9.04% 9.52% 10.10%
Average Balance Sheet Capacity Utilization 79% 89% 96% 98%
Ending Actual Equity/Assets 9.71% 10.12% 8.55% 9.28%
Ending Risk-Adjusted Capital Guideline 7.51% 8.59% 9.41% 10.09%
Excess Capital $ 76,589 $ 53,027 $ (27,047) $ (20,519)
INVESTMENT OF RISK-ADJUSTED CAPITAL
Equity Invesments in Assets with Short-Term Funding
Agencies 24.0% 25.7% 35.7% 37.0%
Mortgage Securities Rated "AAA" or "AA" 27.6% 28.6% 36.3% 37.1%
Mortgage Securities Rated "A" or below 0.0% 5.9% 6.4% 7.6%
Commercial Mortgage Loans 0.0% 0.0% 0.0% 0.0%
US Treasuries 0.0% 0.0% 0.0% 0.0%
Residential Mortgage Loans 8.2% 17.9% 30.8% 26.6%
------------- ------------- ------------- -------------
Equity Investment in Assets with Short-Term Funding 59.8% 78.1% 109.2% 108.3%
Equity Investment in Assets with Long-Term, Non-Recourse
Funding (Mortgage Equity Interests)
SMFC 97-A 2.7% 0.0% 0.0% 0.0%
Mortgage Loans in Sequoia 14.7% 7.1% 0.0% 0.0%
------------- ------------- ------------- -------------
Equity Investment in Assets with Long-Term, Non-Recourse
Funding 17.4% 7.1% 0.0% 0.0%
Equity Investment in RWT Holdings, Inc. 0.0% 0.0% 0.0% 0.0%
Excess Capital 22.8% 14.9% -9.2% -8.3%
------------- ------------- ------------- -------------
Total Market-Value of Capital % 100.0% 100.0% 100.0% 100.0%
Total Capital Available per Risk-Adjusted Capital $ 335,345 $ 355,797 $ 294,952 $ 246,109
Capital Utilization at Period-end 77% 85% 109% 108%
87
88
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 9 (CONTINUED)
ESTIMATED PERIOD-END BID-SIDE MARKET VALUE / AT OR FOR THREE MONTHS ENDING
REALIZABLE VALUE -----------------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1996 1996 1996 1996
------------- ------------- ------------- -------------
Cash $ 11,068 $ 14,599 $ 10,407 $ 9,705
Residential Mortgage Loans 525,475 127,694 69,666 24,861
Residential Mortgage Securities 1,627,953 1,248,176 937,814 540,298
Commercial Mortgage Loans 0 0 0 0
Other Investments 0 0 0 0
Interest Rate Agreements 6,200 3,286 2,835 2,534
Other Assets 16,778 11,766 8,864 4,987
Short-Term Borrowings 1,953,103 1,225,094 896,214 508,721
Long-Term Borrowings 0 0 0 0
Other Liabilities 23,129 16,871 9,005 5,542
------------- ------------- ------------- -------------
"Mark-To-Market" of Total Equity 211,241 163,557 124,366 68,123
Preference Value of Preferred Equity 31,194 31,194 0 0
------------- ------------- ------------- -------------
"Mark-To-Market" of Common Equity $ 180,047 $ 132,363 $ 124,366 $ 68,123
"Mark-To-Market" of Common Equity / Common Share Outstanding $ 16.37 $ 14.59 $ 14.60 $ 12.34
Reported Common Equity Per Common Share Outstanding $ 16.50 $ 14.75 $ 14.59 $ 12.34
AVERAGE BALANCE SHEET UTILIZATION DURING PERIOD VERSUS
RISK-ADJUSTED CAPITAL GUIDELINES
Actual Average Equity/Assets 11.92% 12.77% 15.24% 14.52%
"At-Risk" Assets at Period End $ 2,184,197 $ 1,403,478 $ 1,028,331 $ 581,313
"At-Risk" Equity/Assets at Period End 9.66% 11.65% 12.09% 11.72%
Average Risk-Adjusted Capital Guideline 10.22% 10.74% 11.37% 12.81%
Average Balance Sheet Capacity Utilization 86% 84% 75% 88%
Ending Actual Equity/Assets 9.66% 11.65% 12.09% 11.72%
Ending Risk-Adjusted Capital Guideline 9.97% 10.32% 10.77% 11.72%
Excess Capital $ (7,835) $ 18,664 $ 13,566 $ 26
INVESTMENT OF RISK-ADJUSTED CAPITAL
Equity Invesments in Assets with Short-Term Funding
Agencies 43.2% 48.0% 44.9% 36.0%
Mortgage Securities Rated "AAA" or "AA" 35.8% 22.2% 24.4% 33.6%
Mortgage Securities Rated "A" or below 0.0% 11.4% 14.8% 27.1%
Commercial Mortgage Loans 0.0% 0.0% 0.0% 0.0%
US Treasuries 0.0% 0.0% 0.0% 0.0%
Residential Mortgage Loans 25.1% 7.0% 5.0% 3.3%
------------- ------------- ------------- -------------
Equity Investment in Assets with Short-Term Funding 104.1% 88.6% 89.1% 100.0%
Equity Investment in Assets with Long-Term, Non-Recourse
Funding (Mortgage Equity Interests)
SMFC 97-A 0.0% 0.0% 0.0% 0.0%
Mortgage Loans in Sequoia 0.0% 0.0% 0.0% 0.0%
------------- ------------- ------------- -------------
Equity Investment in Assets with Long-Term, Non-Recourse
Funding 0.0% 0.0% 0.0% 0.0%
Equity Investment in RWT Holdings, Inc. 0.0% 0.0% 0.0% 0.0%
Excess Capital -4.1% 11.4% 10.9% 0.0%
------------- ------------- ------------- -------------
Total Market-Value of Capital % 100.0% 100.0% 100.0% 100.0%
Total Capital Available per Risk-Adjusted Capital $ 191,496 $ 163,557 $ 124,366 $ 68,123
Capital Utilization at Period-end 104% 89% 89% 100%
88
89
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 9 (CONTINUED)
ESTIMATED PERIOD-END BID-SIDE MARKET VALUE / AT OR FOR YEAR ENDING
REALIZABLE VALUE ---------------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31, DEC. 31, DEC. 31,
1998 1997 1996 1995
------------- ------------- ------------- -----------
Cash $ 68,484 $ 49,549 $ 11,068 $ 4,825
Residential Mortgage Loans 1,386,290 1,552,586 525,475 26,450
Residential Mortgage Securities 1,265,362 1,814,796 1,627,953 405,794
Commercial Mortgage Loans 8,388 0 0 0
Other Investments 48,009 0 0 0
Interest Rate Agreements 2,517 10,203 6,200 2,521
Other Assets 41,393 25,156 16,778 3,671
Short-Term Borrowings 1,257,570 1,914,525 1,953,103 370,316
Long-Term Borrowings 1,302,330 1,172,938 0 0
Other Liabilities 12,568 29,882 23,129 4,803
------------- ------------- ------------- -----------
"Mark-To-Market" of Total Equity 247,975 334,945 211,241 68,142
Preference Value of Preferred Equity 28,195 28,195 31,194 0
------------- ------------- ------------- -----------
"Mark-To-Market" of Common Equity $ 219,780 $ 306,750 $ 180,047 $ 68,142
"Mark-To-Market" of Common Equity / Common Share Outstanding $ 19.53 $ 21.47 $ 16.37 $ 12.35
Reported Common Equity Per Common Share Outstanding $ 20.27 $ 21.55 $ 16.50 $ 12.38
AVERAGE BALANCE SHEET UTILIZATION DURING PERIOD VERSUS
RISK-ADJUSTED CAPITAL GUIDELINES
Actual Average Equity/Assets 8.60% 10.11% 13.13% 19.65%
"At-Risk" Assets at Period End $ 1,523,280 $ 2,300,353 $ 2,184,197 $ 441,557
"At-Risk" Equity/Assets at Period End 16.73% 14.54% 9.66% 15.47%
Average Risk-Adjusted Capital Guideline 6.98% 9.09% 10.93% 13.45%
Average Balance Sheet Capacity Utilization 81% 90% 83% 68%
Ending Actual Equity/Assets 9.00% 9.71% 9.66% 15.47%
Ending Risk-Adjusted Capital Guideline 6.55% 7.51% 9.97% 12.59%
Excess Capital $ 50,226 $ 76,589 $ (7,835) $ 12,117
INVESTMENT OF RISK-ADJUSTED CAPITAL
Equity Invesments in Assets with Short-Term Funding
Agencies 18.7% 24.0% 43.2% 29.3%
Mortgage Securities Rated "AAA" or "AA" 25.8% 27.6% 35.8% 22.7%
Mortgage Securities Rated "A" or below 0.0% 0.0% 0.0% 26.7%
Commercial Mortgage Loans 3.2% 0.0% 0.0% 0.0%
US Treasuries 1.3% 0.0% 0.0% 0.0%
Residential Mortgage Loans 5.3% 8.2% 25.1% 3.5%
------------- ------------- ------------- -----------
Equity Investment in Assets with Short-Term Funding 54.3% 59.8% 104.1% 82.2%
Equity Investment in Assets with Long-Term, Non-Recourse
Funding (Mortgage Equity Interests)
SMFC 97-A 3.6% 2.7% 0.0% 0.0%
Mortgage Loans in Sequoia 16.5% 14.7% 0.0% 0.0%
------------- ------------- ------------- -----------
Equity Investment in Assets with Long-Term, Non-Recourse
Funding 20.1% 17.4% 0.0% 0.0%
Equity Investment in RWT Holdings, Inc. 5.9% 0.0% 0.0% 0.0%
Excess Capital 19.7% 22.8% -4.1% 17.8%
------------- ------------- ------ ------- ----------
Total Market-Value of Capital % 100.0% 100.0% 100.0% 100.0%
Total Capital Available per Risk-Adjusted Capital $ 255,438 $ 335,345 $ 191,496 $ 68,232
Capital Utilization at Period-end 80% 77% 104% 82%
89
90
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 10
CREDIT PROVISIONS AND CREDIT RESERVES AT OR FOR THREE MONTHS ENDING
(ALL DOLLARS IN THOUSANDS) ------------------------------------------------
DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1998 1998 1998 1998
------- ------- ------- --------
RESIDENTIAL MORTGAGE LOANS
Credit Provision During Period $ 394 $ (638) $ 763 $ 601
Actual Losses During Period 0 51 133 7
Cumulative Actual Losses 267 267 216 83
Residential Mortgage Loan Credit Reserve at
End of Period 3,784 3,390 4,079 3,450
Residential Mortgage Loan Credit-Related
Mark-to-Market Reserves 1,185 1,686 0 0
Annualized Residential Mortgage Loan Credit
Provision as % of Average
Reported Basis of Residential Mortgage
Loans Held for Investment 0.17% -0.22% 0.16% 0.16%
Residential Mortgage Loan Credit-Related
Reserves as % of Reported Basis
of Residential Mortgage Loans at Period End 0.35% 0.22% 0.18% 0.18%
Non-Performing Assets: 90+ Days Delinquent,
Foreclosures, Bankruptcies, and REO
Number of Loans 14 17 21 19
Non-Performing Assets Loan Balance $ 3,926 $ 4,862 $ 4,947 $ 4,358
Non-Performing Assets as % of Reported Basis
of Mortgage Loans 0.28% 0.21% 0.22% 0.23%
Non-Performing Assets as % of Reported Basis
of Total Assets 0.11% 0.13% 0.13% 0.12%
Residential Mortgage Loan Credit-Related
Reserves as % of Non-Performing Assets 127% 104% 82% 79%
Credit Experience of Residential Mortgage Loans
Liquidated Defaulted Loans (Cumulative) 14 14 9 7
Average Loss Severity Experience (Cumulative) 9% 9% 11% 6%
Scenario Analysis of Potential Credit Losses
Over Next 12 Months
If All Current (But No Future) Non-Performing
Mortgage Loans
At 10% Loss Severity $ 394 $ 460 $ 504 $ 444
At 20% Loss Severity 788 920 1,009 888
At 30% Loss Severity 1,182 1,380 1,513 1,331
At 40% Loss Severity 1,576 1,840 2,017 1,775
Residential Mortgage Loan Credit-Related
Reserves at End of Period 4,969 5,076 4,079 3,450
RESIDENTIAL MORTGAGE SECURITIES
Credit Provision During Period $ 0 $ 0 $ 0 $ 0
Actual Losses During Period 248 268 329 42
Cumulative Actual Losses 1,001 753 485 156
Residential Mortgage Securities Credit Reserve
at End of Period 1,189 1,436 1,705 2,035
Annualized Residential Mortgage Securities
Credit Provision as % of Average
Reported Basis of Residential Mortgage
Securities Rated < BBB 0.0% 0.0% 0.0% 0.0%
Residential Mortgage Securities Credit Reserve
as % of Reported Basis of
Residential Mortgage Securities Rated
< BBB at End of Period 12.8% 15.6% 18.7% 22.3%
Reported Basis of Res. Mortgage Securities
Rated < BBB at End of Period $ 9,266 $ 9,182 $ 9,116 $ 9,137
Credit Experience of Loans in Pools Underlying
Residential Mortgage Securities Rated
< BBB (Since Acquisition)
Resolved Defaulted Loans (Cumulative) 476 424 351 284
Average Loss Severity Experience (Cumulative) 22% 22% 21% 21%
Scenario Analysis of Potential Credit Losses
Over Next 12 Months If All Current (But No
Future) Seriously Delinquent Loans in
Mortgage Pools Underlying < BBB
Rated Securities Default:
At 10% Loss Severity $ 215 $ 312 $ 429 $ 480
At 20% Loss Severity 627 555 712 951
At 30% Loss Severity 1,117 958 910 1,170
At 40% Loss Severity 1,627 1,405 1,385 1,824
Residential Mortgage Securities Credit Reserve
at End of Period $ 1,189 $ 1,436 $ 1,705 $ 2,035
90
91
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 10 (CONTINUED)
CREDIT PROVISIONS AND CREDIT RESERVES AT OR FOR THREE MONTHS ENDING
(All dollars in thousands) ------------------------------------------------
DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1997 1997 1997 1997
------- ------- ------- --------
RESIDENTIAL MORTGAGE LOANS
Credit Provision During Period $ 1,516 $ 473 $ 299 $ 215
Actual Losses During Period 23 40 0 13
Cumulative Actual Losses 76 53 13 13
Residential Mortgage Loan Credit Reserve at
End of Period 2,855 1,363 929 630
Residential Mortgage Loan Credit-Related
Mark-to-Market Reserves 0 0 0 0
Annualized Residential Mortgage Loan Credit
Provision as % of Average
Reported Basis of Residential Mortgage Loans
Held for Investment 0.45% 0.16% 0.16% 0.15%
Residential Mortgage Loan Credit-Related
Reserves as % of Reported Basis of
Residential Mortgage Loans at Period End 0.18% 0.10% 0.08% 0.09%
Non-Performing Assets: 90+ Days Delinquent,
Foreclosures, Bankruptcies, and REO
Number of Loans 17 13 12 6
Non-Performing Assets Loan Balance $ 3,903 $ 2,792 $ 2,366 $ 1,220
Non-Performing Assets as % of Reported Basis
of Mortgage Loans 0.25% 0.20% 0.21% 0.17%
Non-Performing Assets as % of Reported Basis
of Total Assets 0.11% 0.08% 0.07% 0.05%
Residential Mortgage Loan Credit-Related
Reserves as % of Non-Performing Assets 73% 49% 39% 52%
Credit Experience of Residential Mortgage Loans
Liquidated Defaulted Loans (Cumulative) 6 4 1 1
Average Loss Severity Experience (Cumulative) 7% 6% 7% 7%
Scenario Analysis of Potential Credit Losses
Over Next 12 Months
If All Current (But No Future) Non-Performing
Mortgage Loans
At 10% Loss Severity $ 396 $ 283 $ 241 $ 124
At 20% Loss Severity 793 567 481 248
At 30% Loss Severity 1,189 850 722 372
At 40% Loss Severity 1,586 1,133 962 496
Residential Mortgage Loan Credit-Related
Reserves at End of Period 2,855 1,363 929 630
RESIDENTIAL MORTGAGE SECURITIES
Credit Provision During Period $(1,000) $ 470 $ 477 $ 480
Actual Losses During Period 17 28 29 29
Cumulative Actual Losses 113 97 69 40
Residential Mortgage Securities Credit Reserve
at End of Period 2,076 3,093 2,651 2,203
Annualized Residential Mortgage Securities
Credit Provision as % of Average
Reported Basis of Residential Mortgage
Securities Rated < BBB -20.9% 6.4% 6.6% 6.6%
Residential Mortgage Securities Credit Reserve
as % of Reported Basis of
Residential Mortgage Securities Rated
< BBB at End of Period 22.8% 10.6% 9.1% 7.6%
Reported Basis of Res. Mortgage Securities
Rated < BBB at End of Period $ 9,109 $29,189 $29,113 $28,955
Credit Experience of Loans in Pools Underlying
Residential Mortgage Securities Rated
<BBB (Since Acquisition)
Resolved Defaulted Loans (Cumulative) 256 182 137 90
Average Loss Severity Experience (Cumulative) 21% 23% 24% 25%
Scenario Analysis of Potential Credit Losses
Over Next 12 Months If All Current (But
No Future) Seriously Delinquent Loans in
Mortgage Pools Underlying < BBB
Rated Securities Default:
At 10% Loss Severity $ 389 $ 724 $ 109 $ 80
At 20% Loss Severity 894 2,286 1,488 792
At 30% Loss Severity 1,163 3,789 3,702 2,845
At 40% Loss Severity 1,825 6,437 6,410 5,103
Residential Mortgage Securities Credit
Reserve at End of Period $ 2,076 $ 3,093 $ 2,651 $ 2,203
91
92
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 10 (CONTINUED)
CREDIT PROVISIONS AND CREDIT RESERVES AT OR FOR THREE MONTHS ENDING
(All dollars in thousands) --------------------------------------------------
DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1996 1996 1996 1996
-------- -------- -------- --------
RESIDENTIAL MORTGAGE LOANS
Credit Provision During Period $ 35 $ 178 $ 140 $ (5)
Actual Losses During Period 0 0 0 0
Cumulative Actual Losses 0 0 0 0
Residential Mortgage Loan Credit Reserve at
End of Period 428 393 214 74
Residential Mortgage Loan Credit-Related
Mark-to-Market Reserves 0 0 0 0
Annualized Residential Mortgage Loan Credit
Provision as % of Average
Reported Basis of Residential Mortgage
Loans Held for Investment 0.10% 0.76% 1.23% -0.08%
Residential Mortgage Loan Credit-Related
Reserves as % of Reported Basis of
Residential Mortgage Loans at Period End 0.08% 0.31% 0.31% 0.30%
Non-Performing Assets: 90+ Days Delinquent,
Foreclosures, Bankruptcies, and REO
Number of Loans 7 3 2 1
Non-Performing Assets Loan Balance $ 1,249 $ 404 $ 279 $ 190
Non-Performing Assets as % of Reported Basis
of Mortgage Loans 0.24% 0.32% 0.40% 0.77%
Non-Performing Assets as % of Reported Basis
of Total Assets 0.06% 0.03% 0.03% 0.03%
Residential Mortgage Loan Credit-Related
Reserves as % of Non-Performing Assets 34% 97% 77% 39%
Credit Experience of Residential Mortgage Loans
Liquidated Defaulted Loans (Cumulative) 0 0 0 0
Average Loss Severity Experience (Cumulative) 0% 0% 0% 0%
Scenario Analysis of Potential Credit Losses
Over Next 12 Months
If All Current (But No Future) Non-Performing
Mortgage Loans
At 10% Loss Severity $ 127 $ 41 $ 28 $ 19
At 20% Loss Severity 253 82 56 39
At 30% Loss Severity 380 123 85 58
At 40% Loss Severity 506 164 113 77
Residential Mortgage Loan Credit-Related
Reserves at End of Period 428 393 214 74
RESIDENTIAL MORTGAGE SECURITIES
Credit Provision During Period $ 337 $ 338 $ 337 $ 336
Actual Losses During Period 7 -- -- --
Cumulative Actual Losses 11 4 4 4
Residential Mortgage Securities Credit Reserve
at End of Period 1,752 1,421 1,084 747
Annualized Residential Mortgage Securities
Credit Provision as % of Average
Reported Basis of Residential Mortgage
Securities Rated < BBB 4.7% 4.7% 4.7% 4.7%
Residential Mortgage Securities Credit Reserve
as % of Reported Basis of
Residential Mortgage Securities Rated
< BBB at End of Period 6.1% 4.9% 3.8% 2.7%
Reported Basis of Res. Mortgage Securities
Rated < BBB at End of Period $ 28,935 $ 28,906 $ 28,858 $ 28,051
Credit Experience of Loans in Pools Underlying
Residential Mortgage Securities Rated
<BBB (Since Acquisition)
Resolved Defaulted Loans (Cumulative) 59 28 15 4
Average Loss Severity Experience (Cumulative) 27% 22% 16% 10%
Scenario Analysis of Potential Credit Losses
Over Next 12 Months If All Current (But
No Future) Seriously Delinquent Loans in
Mortgage Pools Underlying < BBB
Rated Securities Default:
At 10% Loss Severity $ 63 $ 61 $ 40 $ 20
At 20% Loss Severity 608 123 91 39
At 30% Loss Severity 2,040 1,131 1,364 597
At 40% Loss Severity 3,647 3,041 3,148 2,162
Residential Mortgage Securities Credit
Reserve at End of Period $ 1,752 $ 1,421 $ 1,084 $ 747
92
93
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 10 (CONTINUED)
CREDIT PROVISIONS AND CREDIT RESERVES AT OR FOR YEAR ENDING
--------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31, DEC. 31, DEC. 31,
1998 1997 1996 1995
-------- -------- -------- --------
RESIDENTIAL MORTGAGE LOANS
Credit Provision During Period $ 1,120 $ 2,503 $ 349 $ 79
Actual Losses During Period 191 76 0 0
Cumulative Actual Losses 267 76 0 0
Residential Mortgage Loan Credit Reserve at
End of Period 3,784 2,855 428 79
Residential Mortgage Loan Credit-Related
Mark-to-Market Reserves 1,185 0 0 0
Annualized Residential Mortgage Loan Credit
Provision as % of Average
Reported Basis of Residential Mortgage
Loans Held for Investment 0.06% 0.26% 0.45% 1.58%
Residential Mortgage Loan Credit-Related
Reserves as % of Reported Basis of
Residential Mortgage Loans at Period End 0.35% 0.18% 0.08% 0.30%
Non-Performing Assets: 90+ Days Delinquent,
Foreclosures, Bankruptcies, and REO
Number of Loans 14 17 7 0
Non-Performing Assets Loan Balance $ 3,926 $ 3,903 $ 1,249 $ 0
Non-Performing Assets as % of Reported Basis
of Mortgage Loans 0.28% 0.25% 0.24% 0.00%
Non-Performing Assets as % of Reported Basis
of Total Assets 0.11% 0.11% 0.06% 0.00%
Residential Mortgage Loan Credit-Related
Reserves as % of Non-Performing Assets 127% 73% 34% n/a
Credit Experience of Residential Mortgage Loans
Liquidated Defaulted Loans (Cumulative) 14 6 0 0
Average Loss Severity Experience (Cumulative) 9% 7% 0% 0%
Scenario Analysis of Potential Credit Losses
Over Next 12 Months
If All Current (But No Future) Non-Performing
Mortgage Loans
At 10% Loss Severity $ 394 $ 396 $ 127 $ 0
At 20% Loss Severity 788 793 253 0
At 30% Loss Severity 1,182 1,189 380 0
At 40% Loss Severity 1,576 1,586 506 0
Residential Mortgage Loan Credit-Related
Reserves at End of Period 4,969 2,855 428 79
RESIDENTIAL MORTGAGE SECURITIES
Credit Provision During Period $ 0 $ 427 $ 1,348 $ 414
Actual Losses During Period 888 104 7 4
Cumulative Actual Losses 1,001 113 11 4
Residential Mortgage Securities Credit
Reserve at End of Period 1,189 2,076 1,752 411
Annualized Residential Mortgage Securities
Credit Provision as % of Average
Reported Basis of Residential Mortgage
Securities Rated < BBB 0.0% 1.7% 4.7% 2.9%
Residential Mortgage Securities Credit
Reserve as % of Reported Basis of
Residential Mortgage Securities Rated
< BBB at End of Period 12.8% 22.8% 6.1% 1.4%
Reported Basis of Res. Mortgage Securities
Rated < BBB at End of Period $ 9,266 $ 9,109 $ 28,935 $ 28,869
Credit Experience of Loans in Pools Underlying
Residential Mortgage Securities Rated <BBB
(Since Acquisition)
Resolved Defaulted Loans (Cumulative) 476 256 59 2
Average Loss Severity Experience (Cumulative) 22% 21% 27% 9%
Scenario Analysis of Potential Credit Losses
Over Next 12 Months If All Current (But No
Future) Seriously Delinquent Loans in
Mortgage Pools Underlying < BBB
Rated Securities Default:
At 10% Loss Severity $ 215 $ 389 $ 63 $ 15
At 20% Loss Severity 627 894 608 29
At 30% Loss Severity 1,117 1,163 2,040 103
At 40% Loss Severity 1,627 1,825 3,647 768
Residential Mortgage Securities Credit Reserve
at End of Period $ 1,189 $ 2,076 $ 1,752 $ 411
93
94
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 11
SHARES OUTSTANDING AND PER SHARE DATA AT OR FOR THREE MONTHS ENDING
--------------------------------------------------------------------
(ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1998 1998 1998 1998
------------ ------------ ------------ ------------
Common Shares Outstanding at Period End 11,251,556 11,832,956 14,078,933 14,070,557
Shares Entitled to Dividends
Common (RWT) 11,251,556 11,832,956 13,768,056 14,107,100
Class A Preferred (converted 9/95) 0 0 0 0
Class B Preferred (RTW-PB) 909,518 909,518 909,518 909,518
------------ ------------ ------------ ------------
Total 12,161,074 12,742,474 14,677,574 15,016,618
Common Dividend Declared $ 0.000 $ 0.000 $ 0.010 $ 0.270
Class A Preferred Dividend Declared n/a n/a n/a n/a
Class B Preferred Dividends Declared $ 0.755 $ 0.755 $ 0.755 $ 0.755
Common Dividend Total $ 0 $ 0 $ 138 $ 3,809
Class A Preferred Dividend Total 0 0 0 0
Class B Preferred Dividends Total 687 687 687 687
------------ ------------ ------------ ------------
Total Dividend $ 687 $ 687 $ 825 $ 4,496
Taxable Income Earned $ 6,735 $ (9,240) $ 838 $ 4,528
Dividend Pay-Out Ratio for Period 10% -7% 98% 99%
Cumulative Dividend Pay-Out Ratio 110% 125% 102% 102%
Warrants Outstanding at Period End (expired 12/31/97) 0 0 0 0
Average Shares Outstanding During Period
Common 11,350,536 13,247,908 14,106,828 14,123,951
Class A Preferred 0 0 0 0
Class B Preferred 909,518 909,518 909,518 909,518
------------ ------------ ------------ ------------
Total 12,260,054 14,157,426 15,016,346 15,033,469
Calculation of "Diluted" Common Shares
Average Common Shares 11,350,536 13,247,908 14,106,828 14,123,951
Potential Dilution Due to Warrants 0 0 0 0
Potential Dilution Due to Options 59,038 0 149,030 110,474
------------ ------------ ------------ ------------
Total Average "Diluted" Common Shares 11,409,574 13,247,908 14,255,858 14,234,425
Net Income to Common Shareholders $ 5,789 $ (47,866) $ (491) $ 2,450
Total Average "Diluted" Common Shares 11,409,574 13,247,908 14,255,858 14,234,425
------------ ------------ ------------ ------------
Earnings Per Share ("Diluted") $ 0.51 $ (3.61) $ (0.03) $ 0.17
Earnings Per Share ("Basic") $ 0.51 $ (3.61) $ (0.03) $ 0.17
94
95
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 11 (CONTINUED)
SHARES OUTSTANDING AND PER SHARE DATA AT OR FOR THREE MONTHS ENDING
--------------------------------------------------------------
(ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1997 1997 1997 1997
----------- ----------- ----------- -----------
Common Shares Outstanding at Period End 14,284,657 14,576,477 13,251,847 11,905,957
Shares Entitled to Dividends
Common (RWT) 14,284,657 14,576,477 13,251,847 11,905,957
Class A Preferred (converted 9/95) 0 0 0 0
Class B Preferred (RTW-PB) 909,518 909,518 909,518 999,638
----------- ----------- ----------- -----------
Total 15,194,175 15,485,995 14,161,365 12,905,595
Common Dividend Declared $ 0.350 $ 0.600 $ 0.600 $ 0.600
Class A Preferred Dividend Declared n/a n/a n/a n/a
Class B Preferred Dividends Declared $ 0.755 $ 0.755 $ 0.755 $ 0.755
Common Dividend Total $ 5,000 $ 8,746 $ 7,951 $ 7,144
Class A Preferred Dividend Total 0 0 0 0
Class B Preferred Dividends Total 686 687 687 755
----------- ----------- ----------- -----------
Total Dividend $ 5,686 $ 9,433 $ 8,638 $ 7,899
Taxable Income Earned $ 5,586 $ 8,151 $ 8,315 $ 7,912
Dividend Pay-Out Ratio for Period 102% 116% 104% 100%
Cumulative Dividend Pay-Out Ratio 103% 103% 100% 98%
Warrants Outstanding at Period End (expired 12/31/97) 0 149,466 236,297 272,304
Average Shares Outstanding During Period
Common 14,375,992 14,316,678 12,997,566 11,605,171
Class A Preferred 0 0 0 0
Class B Preferred 909,518 909,518 990,725 1,005,515
----------- ----------- ----------- -----------
Total 15,285,510 15,226,196 13,988,291 12,610,686
Calculation of "Diluted" Common Shares
Average Common Shares 14,375,992 14,316,678 12,997,566 11,605,171
Potential Dilution Due to Warrants 57,139 130,489 182,137 258,422
Potential Dilution Due to Options 99,383 177,434 291,227 253,274
----------- ----------- ----------- -----------
Total Average "Diluted" Common Shares 14,532,514 14,624,601 13,470,930 12,116,867
Net Income to Common Shareholders $ 4,397 $ 6,859 $ 7,034 $ 6,456
Total Average "Diluted" Common Shares 14,532,514 14,624,601 13,470,930 12,116,867
----------- ----------- ----------- -----------
Earnings Per Share ("Diluted") $ 0.30 $ 0.47 $ 0.52 $ 0.53
Earnings Per Share ("Basic") $ 0.31 $ 0.48 $ 0.54 $ 0.56
95
96
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 11 (CONTINUED)
SHARES OUTSTANDING AND PER SHARE DATA AT OR FOR THREE MONTHS ENDING
--------------------------------------------------------------
(ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1996 1996 1996 1996
----------- ----------- ----------- -----------
Common Shares Outstanding at Period End 10,996,572 9,069,653 8,520,116 5,521,376
Shares Entitled to Dividends
Common (RWT) 10,996,572 9,069,653 8,520,116 5,521,376
Class A Preferred (converted 9/95) 0 0 0 0
Class B Preferred (RTW-PB) 1,006,250 1,006,250 0 0
----------- ----------- ----------- -----------
Total 12,002,822 10,075,903 8,520,116 5,521,376
Common Dividend Declared $ 0.410 $ 0.400 $ 0.400 $ 0.460
Class A Preferred Dividend Declared n/a n/a n/a n/a
Class B Preferred Dividends Declared $ 0.755 $ 0.386 n/a n/a
Common Dividend Total $ 4,508 $ 3,628 $ 3,408 $ 2,540
Class A Preferred Dividend Total 0 0 0 0
Class B Preferred Dividends Total 760 388 0 0
----------- ----------- ----------- -----------
Total Dividend $ 5,268 $ 4,016 $ 3,408 $ 2,540
Taxable Income Earned $ 5,429 $ 4,048 $ 3,142 $ 2,549
Dividend Pay-Out Ratio for Period 97% 99% 108% 100%
Cumulative Dividend Pay-Out Ratio 98% 98% 98% 93%
Warrants Outstanding at Period End (expired 12/31/97) 412,894 1,076,431 1,563,957 1,665,063
Average Shares Outstanding During Period
Common 9,705,138 8,732,326 7,813,974 5,521,376
Class A Preferred 0 0 0 0
Class B Preferred 1,006,250 514,063 0 0
----------- ----------- ----------- -----------
Total 10,711,388 9,246,389 7,813,974 5,521,376
Calculation of "Diluted" Common Shares
Average Common Shares 9,705,138 8,732,326 7,813,974 5,521,376
Potential Dilution Due to Warrants 570,415 621,455 603,426 443,984
Potential Dilution Due to Options 176,919 162,393 182,832 164,227
----------- ----------- ----------- -----------
Total Average "Diluted" Common Shares 10,452,472 9,516,174 8,600,232 6,129,587
Net Income to Common Shareholders $ 4,084 $ 2,998 $ 2,500 $ 1,954
Total Average "Diluted" Common Shares 10,452,472 9,516,174 8,600,232 6,129,587
----------- ----------- ----------- -----------
Earnings Per Share ("Diluted") $ 0.39 $ 0.32 $ 0.29 $ 0.32
Earnings Per Share ("Basic") $ 0.42 $ 0.34 $ 0.32 $ 0.35
96
97
SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 11 (CONTINUED)
SHARES OUTSTANDING AND PER SHARE DATA AT OR FOR YEAR ENDING
-------------------------------------------------------------------
(ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) DEC. 31, DEC. 31, DEC. 31, DEC. 31,
1998 1997 1996 1995
------------ ------------ ------------ ------------
Common Shares Outstanding at Period End 11,251,556 14,284,657 10,996,572 5,517,299
Shares Entitled to Dividends
Common (RWT) 11,251,556 14,284,657 10,996,572 5,517,299
Class A Preferred (converted 9/95) 0 0 0 0
Class B Preferred (RTW-PB) 909,518 909,518 1,006,250 0
------------ ------------ ------------ ------------
Total 12,161,074 15,194,175 12,002,822 5,517,299
Common Dividend Declared $ 0.280 $ 2.150 $ 1.670 $ 0.460
Class A Preferred Dividend Declared n/a n/a n/a $ 0.500
Class B Preferred Dividends Declared $ 3.020 $ 3.020 $ 1.141 n/a
Common Dividend Total $ 3,947 $ 28,840 $ 14,084 $ 2,537
Class A Preferred Dividend Total 0 0 0 833
Class B Preferred Dividends Total 2,747 2,815 1,148 0
------------ ------------ ------------ ------------
Total Dividend $ 6,694 $ 31,655 $ 15,232 $ 3,370
Taxable Income Earned $ 2,861 $ 29,964 $ 15,168 $ 3,832
Dividend Pay-Out Ratio for Period 234% 106% 100% 88%
Cumulative Dividend Pay-Out Ratio 110% 103% 98% 89%
Warrants Outstanding at Period End (expired 12/31/97) 0 0 412,894 1,665,063
Average Shares Outstanding During Period
Common 13,199,819 13,334,163 7,950,175 2,487,857
Class A Preferred 0 0 0 826,185
Class B Preferred 909,518 953,435 382,155 0
------------ ------------ ------------ ------------
Total 0 14,287,598 8,332,330 3,314,042
Calculation of "Diluted" Common Shares
Average Common Shares 13,199,819 13,334,163 7,950,175 3,314,042
Potential Dilution Due to Warrants 0 191,513 618,618 221,112
Potential Dilution Due to Options 0 154,734 175,391 168,649
------------ ------------ ------------ ------------
Total Average "Diluted" Common Shares 13,199,819 13,680,410 8,744,184 3,703,803
Net Income to Common Shareholders $ (40,117) $ 24,746 $ 11,537 $ 3,155
Total Average "Diluted" Common Shares 13,199,819 13,680,410 8,744,184 3,703,803
------------ ------------ ------------ ------------
Earnings Per Share ("Diluted") $ (3.04) $ 1.81 $ 1.32 $ 0.85
Earnings Per Share ("Basic") $ (3.04) $ 1.86 $ 1.45 $ 0.95
97
98
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Company and Holdings and the
related Notes, together with the Reports of Independent Accountants thereon, are
set forth on pages F-1 through F-34 of this Form 10-K and incorporated herein by
reference.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 as to directors and executive officers of
the Company is incorporated herein by reference to the definitive Proxy
Statement to be filed pursuant to Regulation 14A under the headings "Election of
Directors" and "Management of the Company."
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference to the
definitive Proxy Statement to be filed pursuant to Regulation 14A under the
heading "Executive Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by reference to the
definitive Proxy Statement to be filed pursuant to Regulation 14A under the
heading "Security Ownership of Certain Beneficial Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference to the
definitive Proxy Statement to be filed pursuant to Regulation 14A under the
heading "Executive Compensation - Certain Relationships and Related
Transactions."
ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON
FORM 8-K
(a) Documents filed as part of this report:
(1) Consolidated Financial Statements
(2) Schedules to Consolidated Financial Statements: All
Consolidated Financial Statements schedules not included
have been omitted because they are either inapplicable or
the information required is provided in the Company's
Consolidated Financial Statements and Notes thereto,
included in Part II, Item 8, of this Annual Report on Form
10-K.
98
99
(3) Exhibits:
Exhibit
Number Exhibit
------ -------
3.1 Articles of Amendment and Restatement of the Registrant (a)
3.2 Articles Supplementary of the Registrant (a)
3.3 Amended and Restated Bylaws of the Registrant (b)
3.3.1 Amended and Restated Bylaws, amended December 13, 1996 (g)
3.4 Articles Supplementary of the Registrant, dated August 14,
1995 (d)
3.4.1 Articles Supplementary of the Registrant relating to the
Class B 9.74% Cumulative Convertible Preferred Stock, filed
August 9, 1996 (the "Preferred Stock") (f)
4.2 Specimen Common Stock Certificate (a)
4.3 Specimen Class B 9.74% Cumulative Convertible Preferred
Stock Certificate (f)
4.4 Indenture dated as of June 1, 1997 between Sequoia Mortgage
Trust 1 (a wholly-owned, consolidated subsidiary of the
Registrant) and First Union National Bank, as Trustee (i)
4.4.1 Indenture dated as of October 1, 1997 between Sequoia
Mortgage Trust 2 (a wholly-owned, consolidated subsidiary of
the Registrant) and Norwest Bank Minnesota, N.A., as Trustee
(j)
10.1 Purchase Terms Agreement, dated August 18, 1994, between the
Registrant and Montgomery Securities (a)
10.2 Registration Rights Agreement, dated August 19, 1994,
between the Registrant and Montgomery Securities (a)
10.4 Founders Rights Agreement, dated August 19, 1994, between
the Registrant and the original holders of Common Stock of
the Registrant (a)
10.5 Form of Reverse Repurchase Agreement for use with Agency
Certificates, Privately-Issued Certificates and
Privately-Issued CMOs (a)
10.5.1 Form of Reverse Repurchase Agreement for use with Mortgage
Loans (d)
10.6.1 [Reserved]
10.7 [Reserved]
10.8 Forms of Interest Rate Cap Agreements (a)
10.9 [Reserved]
10.9.2 Clearance Agreement, dated December 1, 1996, between the
Registrant and Bankers Trust Company (d)
10.10 Employment Agreement, dated August 19, 1994, between the
Registrant and George E. Bull (a)
10.11 Employment Agreement, dated August 19, 1994, between the
Registrant and Douglas B. Hansen (a)
10.12 [Reserved]
10.13 [Reserved]
10.14 1994 Amended and Restated Executive and Non-Employee
Director Stock Option Plan (c)
10.14.1 1994 Amended and Restated Executive and Non-Employee
Director Stock Option Plan, amended March 6, 1996 (d)
10.14.2 Amended and Restated 1994 Executive and Non-Employee
Director Stock Option Plan, amended December 13, 1996 (h)
10.27 [Reserved]
10.29 Form of Dividend Reinvestment Plan (b)
10.29.1 Form of Dividend Reinvestment and Stock Purchase Plan (g)
10.30 Office Building Lease (d)
10.30.1 Amendment to Office Building Lease (k)
10.31 RWT Holdings, Inc. Series A Preferred Stock Purchase
Agreement, dated March 1, 1998
10.32 Administrative Personnel and Facilities Agreement dated as
of April 1, 1998, between Redwood Trust, Inc. and RWT
Holdings, Inc.
10.32.1 First Amendment to Administrative Personnel and Facilities
Agreement dated as of April 1, 1998, between Redwood Trust,
Inc. and RWT Holdings, Inc.
99
100
10.33 Lending and Credit Support Agreement dated as of April 1,
1998, between RWT Holdings, Inc., Redwood Residential
Funding, Inc., Redwood Commercial Funding, Inc., and Redwood
Financial Services, Inc., and Redwood Trust, Inc.
10.34 Form of Master Forward Commitment Agreements for RWT
Holdings, Inc., Residential Redwood Funding, Inc., Redwood
Commercial Funding, Inc. and Redwood Financial Services,
Inc.
11.1 Statement re: Computation of Per Share Earnings
21 List of Subsidiaries (k)
23 Consent of Accountants
27 Financial Data Schedule
----------------------
(a) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (33-92272)
filed by the Registrant with the Securities and Exchange
Commission on May 19, 1995.
(b) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (33-97946)
filed by the Registrant with the Securities and Exchange
Commission on October 10, 1995.
(c) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (33-94160)
filed by the Registrant with the Securities and Exchange
Commission on June 30, 1995.
(d) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (333-02962)
filed by the Registrant with the Securities and Exchange
Commission on March 26, 1996.
(e) [Reserved]
(f) Incorporated by reference to the correspondingly numbered
exhibit to the Registration Statement on Form S-11 (333-08363)
filed by the Registrant with the Securities and Exchange
Commission on July 18, 1996.
(g) Incorporated by reference to the Registration Statement on
Form S-3 (333-18061) filed by the Registrant with the
Securities and Exchange Commission on January 2, 1997.
(h) Incorporated by reference to the correspondingly numbered
exhibit to Form 8-K (000-26436) filed by the Registrant with
the Securities and Exchange Commission on January 7, 1997.
(i) Incorporated by reference to the Form 8-K filed by Sequoia
Mortgage Funding Corporation with the Securities and Exchange
Commission on August 12, 1997.
(j) Incorporated by reference to the Form 8-K filed by Sequoia
Mortgage Funding Corporation with the Securities and Exchange
Commission on November 18, 1997.
(k) Incorporated by reference to the Form 10-K (1-13759) filed by
the Registrant with the Securities and Exchange Commission for
the fiscal year ended December 31, 1997.
(b) Reports on Form 8-K:
None.
100
101
GLOSSARY
As used in this document, the capitalized and other terms listed below have the
meanings indicated.
"Agency" means GNMA, FNMA or FHLMC.
"Agency Certificates" means GNMA, FNMA and FHLMC Certificates.
"amortized cost" means, with respect to Mortgage Assets, the purchase price as
adjusted for subsequent amortization of discount or premium and for principal
repayments.
"ARM" means a Mortgage Loan or any Mortgage Loan underlying a Mortgage Security
that features adjustments of the underlying interest rate at predetermined times
based on an agreed margin to an established index. An ARM is usually subject to
periodic interest rate and/or payment caps and a lifetime interest rate cap.
"Asset Acquisition/Capital Allocation Policies" means the policies established
by the Board of Directors, including a majority of the Independent Directors,
establishing the guidelines for management in the type and quantity of Mortgage
Assets that may be purchased by the Company, which policies include, without
limitation, the asset acquisition policies, the credit risk management policies
and the capital and leverage policies.
"Capital Stock" means the Common Stock, Preferred Stock, and any additional
classes of Capital Stock authorized by the Board of Directors in the future.
"reported basis" means the value placed on an asset or liability for balance
sheet presentation purposes.
"CMOs" or "Collateralized Mortgage Obligations" means adjustable-hybrid- or
fixed-rate debt obligations (bonds) that are collateralized by Mortgage Loans or
mortgage certificates. CMOs are structured so that principal and interest
payments received on the collateral are sufficient to make principal and
interest payments on the bonds. Such bonds may be issued by United States
government-sponsored entities or private issuers in one or more classes with
fixed or adjustable interest rates, maturities and degrees of subordination
which are characteristics designed for the investment objectives of different
bond purchasers.
"Code" means the Internal Revenue Code of 1986, as amended.
"Commercial Mortgage Assets" means Commercial Mortgage Loans and Commercial
Mortgage Securities.
"Commercial Mortgage Loans" means Mortgage Loans secured by commercial property.
"Commercial Mortgage Securities" means Mortgage Securities representing an
interest in, or secured by, Commercial Mortgage Loans.
"Commodity Exchange Act" means the Commodity Exchange Act, as amended (7 U.S.C.
** 1 et seq.)
"Common Stock" means the Company's shares of Common Stock, $0.01 par value per
share.
"Company" means Redwood Trust, Inc., a Maryland corporation.
"Conforming Mortgage Loan" means Single-Family Mortgage Loans that either comply
with requirements for inclusion in credit support programs sponsored by FHLMC or
FNMA or are FHA or VA Loans.
"coupon rate" means, with respect to Mortgage Assets, the annualized cash
interest income actually received from the asset, expressed as a percentage of
the face value of the asset. The difference between the gross margin and the net
margin reflects loan servicing fees and other pre-determined contractual
deductions. The fully-
101
102
indexed gross coupon rate equals the current yield on the ARM index (six month
LIBOR, one year Treasury, etc.) plus the gross margin. The actual coupon rate
paid by the borrower may be lower than the fully-indexed gross rate at the
initiation of the loan if originated at a "teaser rate" or during periods of
rising interest rates due to the limitations of the ARM adjustment schedule and
the periodic and life caps. If so, the coupon rate paid by the borrower would
move towards the fully-indexed gross rate over time.
"DERs" means dividend equivalent rights under the Company's Stock Option Plan.
"DRP" means the Dividend Reinvestment and Stock Purchase Plan adopted by the
Company.
"ERISA" means the Employee Retirement Income Security Act of 1974.
"Exercise Price" means the price payable to the Company to exercise an
outstanding Warrant or Stock Option.
"face value" means, with respect to Mortgage Assets, the outstanding principal
balance of Mortgage Loans or Mortgage Securities comprising the Mortgage Assets.
In the absence of credit losses, the face value equals the sum of the principal
repayments that will be received by the Company over the life of the Mortgage
Asset.
"FASB" means the Financial Accounting Standards Board.
"FHA" means the United States Federal Housing Administration.
"FHLMC" or "Freddie Mac" means the Federal Home Loan Mortgage Corporation.
"FNMA" or "Fannie Mae" means the Federal National Mortgage Association.
"fully-indexed coupon rate" means, with respect to ARMs, the rate that would be
paid by the borrower ("gross") or received by the Company as owner of the
Mortgage Asset ("net") if the coupon rate on the ARM were able to adjust
immediately to a market rate without being subject to adjustment periods,
periodic caps, or life caps. It is equal to the current yield of the ARM index
plus the gross or net margin.
"GAAP" means Generally Accepted Accounting Principles.
"GNMA" means the Government National Mortgage Association.
"gross margin" means, with respect to ARMs, the amount to be added to the
underlying index to determine the coupon rate to be paid by the borrower. The
term "gross" is used to differentiate payments made by the borrower with the
lower "net" payments actually received by the Company after the acquisition of a
Mortgage Asset.
"GSE" means government-sponsored entity, such as FNMA or FHLMC.
"hybrid mortgage loans" means a type of mortgage loan with an initial period to
the first rate adjustment greater than one year.
"haircut" means the over-collateralization amount required by a lender in
connection with certain collateralized borrowings.
"HUD" means the Department of Housing and Urban Development.
"Independent Director" means a director of the Company who is not an officer or
employee of the Company.
"interest-only strip" or "IO" means a type of mortgage security which receives a
portion of the interest payments from an underlying pool of mortgage loans but
will receive little or no principal payments.
102
103
"interest rate adjustment indices" means, in the case of Mortgage Assets, any of
the objective indices based on the market interest rates of a specified debt
instrument (such as United States Treasury Bills in the case of the Treasury
Index and United States dollar deposits in London in the case of LIBOR) or based
on the average interest rate of a combination of debt instruments (such as the
11th District Cost of Funds Index), used as a reference base to reset the
interest rate for each adjustment period on the Mortgage Asset, and in the case
of borrowings, is used herein to mean the market interest rates of a specified
debt instrument (such as reverse repurchase agreements for Mortgage Securities)
as well as any of the objective indices described above that are used as a
reference base to reset the interest rate for each adjustment period under the
related borrowing instrument.
"interest rate adjustment period" means, in the case of Mortgage Assets, the
period of time set forth in the debt instrument that determines when the
interest rate is adjusted and, with respect to borrowings, is used to mean the
term to reset or maturity of a short-term, fixed-rate debt instrument (such as a
30-day reverse repurchase agreement) as well as the period of time set forth in
a long-term, adjustable-rate debt instrument that determines when the interest
rate is adjusted.
"Interest Rate Agreements" means interest rate options, interest rate swaps,
interest rate swaptions, interest rate futures and options on interest rate
futures.
"Investment Company Act" means the Investment Company Act of 1940, as amended.
"ISOs" means qualified incentive stock options granted under the Stock Option
Plan, which meet the requirements of Section 422 of the Code.
"LIBOR" means London Inter-Bank Offered Rate as it may be defined, and for a
period of time specified, in a Mortgage Asset or borrowing of the Company.
"lifetime interest rate cap" or "life cap" means, with respect to adjustable
rate Mortgage Assets, in the case of an adjustable-rate Mortgage Loan, the
maximum coupon rate that may accrue during any period over the term of such
Mortgage Loan as stated in the governing instruments evidencing such Mortgage
Loan, and in the case of an adjustable-rate Mortgage Security, the maximum
average coupon rate that may accrue during any period over the term of such
Mortgage Security as stated in the governing instruments thereof. With respect
to certain long-term borrowings, the maximum coupon rate that may accrue during
any period over the term of such borrowing.
"liquidity capital cushion" is a term defined in the Company's Risk-Adjusted
Capital Policy. It represents a portion of the capital the Company is required
to maintain as part of this policy in order to continue to make asset
acquisitions. The liquidity capital cushion is that part of the required base
which is in excess of the Company's haircut requirements.
"Long-Term Debt" means, generally, debt with maturities greater than one year.
"Mezzanine Securities" means Mortgage Securities rated below the two highest
levels but no lower than a single "B" level under the S&P rating system (or
comparable level under other rating systems) and are supported by one or more
classes of Subordinated Securities which bear Realized Losses prior to the
classes of Mezzanine Securities.
"Mortgage Assets" means (i) Single-Family Mortgage Assets, (ii) Multifamily
Mortgage Assets, and (iii) Commercial Mortgage Assets.
"Mortgage Equity Interest" means the ownership of the equity portion of a
mortgage spread lending subsidiary trust wherein the assets of the trust are
funded with long-term debt, the debt and other liabilities of the trust are
non-recourse to the Company, and liquidity risk is essentially eliminated.
103
104
"Mortgage Loans" means Single-Family Mortgage Loans, Multifamily Mortgage Loans
and Commercial Mortgage Loans.
"Mortgage Note" means a promissory note evidencing a Mortgage Loan.
"Mortgage Securities" means (i) Pass-Through Certificates and (iii) CMOs.
"Multifamily Mortgage Loans" means Mortgage Loans secured by multifamily (in
excess of four units) property.
"Multifamily Mortgage Securities" means Mortgage Securities representing an
interest in, or secured by, Multifamily Mortgage Loans.
"Net Income" is the income of the Company as calculated using Generally Accepted
Accounting Principles (GAAP); Net Income may differ from taxable income.
"net margin" is part of the calculation of the coupon rate to be received by the
Company as owner of an ARM. The term "net" is used to differentiate payments
actually received by the Company from a Mortgage Asset from the higher "gross"
payment made by the borrower.
"Nonconforming Mortgage Loans" means conventional Single-Family and Multifamily
Mortgage Loans that do not conform to one or more requirements of FHLMC or FNMA
for participation in one or more of such agencies' mortgage loss credit support
programs.
"NQSOs" means options to acquire Company Common Stock granted pursuant to the
Stock Option Plan, which do not meet the requirements of Section 422 of the
Code.
"Ownership Limit" means 9.8% of the outstanding shares of Capital Stock, as may
be increased or reduced by the Board of Directors of the Company.
"Pass-Through Certificates" means securities (or interests therein) evidencing
undivided ownership interests in a pool of Mortgage Loans, the holders of which
receive a "pass-through" of the principal and interest paid in connection with
the underlying Mortgage Loans in accordance with the specific pool structure.
"periodic interest rate cap" or "periodic cap" means, with respect to ARMs, the
maximum change in the coupon rate permissible under the terms of the loan at
each coupon adjustment date. Periodic caps limit both the speed by which the
coupon rate can adjust upwards in a rising interest rate environment and the
speed by which the coupon rate can adjust downwards in a falling rate
environment.
"Preferred Stock" means the Class B 9.74% Cumulative Convertible Preferred
Stock.
"principal-only strip" or "PO" means a type of mortgage security which receives
a portion of the principal payments from an underlying pool of mortgage loans
but will receive little or no interest payments.
"Privately-Issued Certificates" means privately-issued Pass-Through Certificates
issued by the Company or an affiliate of the Company or other third party
issuer.
"Qualified REIT Real Estate Assets" means Pass-Through Certificates, Mortgage
Loans, Agency Certificates, and other assets of the type described in section
856(c) (6) (B) of the Code.
"Qualified REIT Subsidiary" means a corporation whose stock is entirely owned by
the REIT at all times during such corporation's existence.
"Qualifying Interests" means "mortgages and other liens on and interests in real
estate," as defined in Section 3(c) (5) (C) under the Investment Company Act.
104
105
"rating" means (i) the rating assigned to an asset by one or more of the four
nationally-recognized rating agencies as adjusted to the rating scale under the
S&P rating system, (ii) in the case of assets rated differently by such rating
agencies, the rating deemed by management to most appropriately reflect such
asset's credit quality or (iii) for unrated assets, the Company's deemed
comparable rating.
"Realized Losses" means losses incurred in respect of Mortgage Assets upon
foreclosure sales and other liquidations of underlying mortgaged priorities that
result in failure to recover all amounts due on the loans secured thereby.
"Redwood Commercial Funding, Inc." or "RCF" means a wholly-owned subsidiary of
Holdings, a taxable affiliate of the Company.
"Redwood Financial Services, Inc." or "RFS" means a wholly-owned subsidiary of
Holdings, a taxable affiliate of the Company.
"Redwood Residential Funding, Inc." or "RFS" means a wholly-owned subsidiary of
Holdings, a taxable affiliate of the Company.
"REIT" means Real Estate Investment Trust.
"REMIC" means Real Estate Mortgage Investment Conduit.
"residuals" means the right to receive the remaining or residual cash flows from
a pool of Mortgage Loans or Mortgage Securities after distributing required
amounts to the holders of interests in or obligations backed by such loans or
securities and after payment of any required pool expenses.
"reverse repurchase agreement" means a borrowing device evidenced by an
agreement to sell securities or other assets to a third-party and a simultaneous
agreement to repurchase them at a specified future date and price, the price
difference constituting the interest on the borrowing.
"Risk-Adjusted Capital Policy" means the policy established by the Company,
which limits management's ability to acquire additional assets during such
times, that the actual capital base of the Company is less than a required
amount defined in the policy. The required amount is the sum of the haircuts
required by the Company's secured lenders (the required haircut) and the
additional capital levels called for under the policy which are determined with
reference to the various risks inherent in the Company's Mortgage Assets (the
liquidity capital cushion).
"RWT Holdings, Inc." or "Holdings" means a taxable affiliate of the Company.
"SEC" means the United States Securities and Exchange Commission.
"Senior Securities" means a class of Mortgage Security that has a priority right
to receive principal and/or interest from the underlying pool of Mortgage Loans.
"Senior-Subordinated Mortgage Securities" means a series of Pass-Through
Certificates of CMOs in which one or more classes have a priority right to
receive principal and/or interest payments from the underlying pool of Mortgage
Loans.
"Sequoia" means the special-purpose finance subsidiary of Redwood Trust, Inc.
"Servicer" means a servicer or subservicer of the Mortgage Loans pursuant to a
servicing agreement with the Company or other third-parties.
"SFAS" means Statement of Financial Accounting Standards issued by the FASB.
105
106
"Short-Term Debt" means reverse repurchase agreements, notes payable, revolving
lines of credit and/or any other collateralized short-term borrowings.
"Single-Family Mortgage Assets" means Single-Family Mortgage Loans and
Single-Family Mortgage Securities.
"Single-Family Mortgage Loans" means Mortgage Loans secured by single-family
(one- to four-units) residential property.
"Single-Family Mortgage Securities" means Mortgage Securities representing an
interest in, or secured by, Single-Family Mortgage Loans.
"Stock Option Plan" means the Amended and Restated 1994 Executive and
Non-employee Stock Option Plan adopted by the Company.
"Subordinated Securities" means a class of Mortgage Securities that is
subordinated to one or more other classes of Mortgage Securities, all of which
classes share the same collateral.
"Treasury Department" means the United States Department of Treasury.
"UBTI" means "unrelated business taxable income" as defined in Section 512 of
the Code.
"VA" means the United States Department of Veterans Affairs.
"VA Loans" means Mortgage Loans partially guaranteed by the VA under the
Servicemen's Readjustment Act of 1944, as amended.
106
107
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
REDWOOD TRUST, INC.
Dated: March 17, 1999 By: /s/ George E. Bull
------------------------------
George E. Bull
Chairman and Chief Executive
Officer
Pursuant to the requirements the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ George E. Bull George E. Bull March 17, 1999
- ------------------------------ Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
/s/ Douglas B. Hansen Douglas B. Hansen March 17, 1999
- ------------------------------ Director, President and
Chief Financial Officer
(Principal Financial Officer)
/s/ Vickie L. Rath Vickie L. Rath March 17, 1999
- ------------------------------ Vice President, Treasurer and
Controller
(Principal Accounting Officer)
/s/ Thomas C. Brown Thomas C. Brown March 17, 1999
- ------------------------------ Director
/s/ Marianne Byerwalter Mariann Byerwalter March 17, 1999
- ------------------------------ Director
/s/ Dan A. Emmett Dan A. Emmett March 17, 1999
- ------------------------------ Director
/s/ Thomas F. Farb Thomas F. Farb March 17, 1999
- ------------------------------ Director
/s/ Nello Gonfiantini Nello Gonfiantini March 17, 1999
- ------------------------------ Director
/s/ Charles J. Toeniskoetter Charles J. Toeniskoetter March 17, 1999
- ------------------------------ Director
107
108
(THIS PAGE INTENTIONALLY LEFT BLANK)
109
REDWOOD TRUST, INC.
CONSOLIDATED FINANCIAL STATEMENTS AND
REPORT OF INDEPENDENT ACCOUNTANTS
FOR INCLUSION IN FORM 10-K
ANNUAL REPORT FILED WITH
SECURITIES AND EXCHANGE COMMISSION
DECEMBER 31, 1998
F-1
110
Page
----
Consolidated Financial Statements - Redwood Trust, Inc.:
Consolidated Balance Sheets at December 31, 1998 and 1997 ........... F-3
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996 ...................... F-4
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996 ...................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 ...................... F-6
Notes to Consolidated Financial Statements .......................... F-7
Report of Independent Accountants ..................................... F-22
F-2
111
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31,
1998 1997
----------- -----------
ASSETS
Mortgage loans: held-for-sale
Residential $ 265,914 $ --
Commercial 8,287 --
----------- -----------
274,201 --
----------- -----------
Mortgage loans: held-for-investment, net
Residential 1,131,300 1,551,826
----------- -----------
1,131,300 1,551,826
----------- -----------
Mortgage securities: trading 1,257,655 --
Mortgage securities: available-for-sale, net 7,707 1,814,796
US Treasury securities 48,009 --
Cash and cash equivalents 55,627 24,892
Restricted cash 12,857 24,657
Interest rate agreements 2,517 2,100
Accrued interest receivable 18,482 23,119
Investment in RWT Holdings, Inc. 15,124 --
Loan to RWT Holdings, Inc. 6,500 --
Receivable from RWT Holdings, Inc. 445 --
Other assets 2,024 2,807
----------- -----------
$ 2,832,448 $ 3,444,197
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt $ 1,257,570 $ 1,914,525
Long-term debt, net 1,305,560 1,172,801
Accrued interest payable 10,820 14,476
Accrued expenses and other liabilities 3,022 2,172
Dividends payable 686 5,686
----------- -----------
2,577,658 3,109,660
----------- -----------
Commitments and contingencies (See Note 12)
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01 per share; Class B 9.74% Cumulative
Convertible 909,518 shares authorized, issued and outstanding
($28,882 aggregate liquidation preference) 26,736 26,736
Common stock, par value $0.01 per share;
49,090,482 shares authorized;
11,251,556 and 14,284,657 issued and outstanding 113 143
Additional paid-in capital 279,201 324,555
Accumulated other comprehensive income (370) (10,071)
Cumulative earnings 6,412 43,783
Cumulative distributions to stockholders (57,302) (50,609)
----------- -----------
254,790 334,537
----------- -----------
$ 2,832,448 $ 3,444,197
=========== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
F-3
112
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
Years Ended December 31,
1998 1997 1996
------------ ------------ ------------
INTEREST INCOME
Mortgage loans: held-for-sale
Residential $ 9,005 $ -- $ --
Commercial 102 -- --
------------ ------------ ------------
9,107 -- --
------------ ------------ ------------
Mortgage loans: held-for-investment
Residential 112,242 65,328 5,184
------------ ------------ ------------
112,242 65,328 5,184
------------ ------------ ------------
Mortgage securities: trading 46,162 -- --
Mortgage securities: available-for-sale 52,638 131,950 61,240
US Treasury securities 575 -- --
Cash and cash equivalents 2,080 1,326 860
------------ ------------ ------------
Total interest income 222,804 198,604 67,284
------------ ------------ ------------
INTEREST EXPENSE
Short-term debt 114,763 140,140 49,191
Long-term debt 81,361 20,137 --
------------ ------------ ------------
Total interest expense 196,124 160,277 49,191
------------ ------------ ------------
Net interest rate agreements expense 3,514 3,741 1,158
------------ ------------ ------------
NET INTEREST INCOME 23,166 34,586 16,935
Provision for credit losses 1,120 2,930 1,696
Equity in (earnings) losses of RWT Holdings, Inc. 4,676 -- --
Operating expenses 5,876 4,658 2,554
Other (income) expenses (139) -- --
------------ ------------ ------------
Income before unrealized and realized gains (losses) on assets 11,633 26,998 12,685
Net unrealized and realized gains (losses) on assets (38,943) 563 --
------------ ------------ ------------
Income (loss) before preferred dividend and change in accounting principle (27,310) 27,561 12,685
Less cash dividends on Class B preferred stock 2,747 2,815 1,148
------------ ------------ ------------
Income (loss) before change in accounting principle (30,057) 24,746 11,537
Cumulative transition effect of adopting SFAS No. 133 (See Note 2) (10,061) -- --
------------ ------------ ------------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $ (40,118) $ 24,746 $ 11,537
============ ============ ============
EARNINGS PER SHARE:
Basic:
Income (loss) before change in accounting principle $ (2.28) $ 1.86 $ 1.45
Cumulative transition effect of adopting SFAS No. 133 $ (0.76) $ -- $ --
Net income (loss) $ (3.04) $ 1.86 $ 1.45
Diluted:
Income (loss) before change in accounting principle $ (2.28) $ 1.81 $ 1.32
Cumulative transition effect of adopting SFAS No. 133 $ (0.76) $ -- $ --
Net income (loss) $ (3.04) $ 1.81 $ 1.32
Weighted average shares of common stock and common stock equivalents:
Basic 13,199,819 13,334,163 7,950,175
Diluted 13,199,819 13,680,410 8,744,184
The accompanying notes are an integral part of
these consolidated financial statements.
F-4
113
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
Class B Accumulated
Preferred stock Common stock Additional other
--------------------------- --------------------------- paid-in comprehensive
Shares Amount Shares Amount capital income
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 -- $ -- 5,517,299 $ 55 $ 73,895 $ (5,476)
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Income (loss) before
preferred dividend -- -- -- -- -- --
Net unrealized gain on
assets available-for-sale -- -- -- -- -- 2,016
Total comprehensive income -- -- -- -- -- --
Issuance of preferred stock 1,006,250 29,579 -- -- -- --
Issuance of common stock -- -- 5,479,273 55 113,612 --
Dividends declared:
Preferred -- -- -- -- -- --
Common -- -- -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 1,006,250 29,579 10,996,572 110 187,507 (3,460)
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Income (loss) before
preferred dividend -- -- -- -- -- --
Net unrealized loss on
assets available-for-sale -- -- -- -- -- (6,611)
Total comprehensive income -- -- -- -- -- --
Conversion of preferred stock (96,732) (2,843) 96,732 1 2,842 --
Issuance of common stock -- -- 4,031,353 41 157,321 --
Repurchase of common stock -- -- (840,000) (9) (23,115) --
Dividends declared:
Preferred -- -- -- -- -- --
Common -- -- -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 909,518 26,736 14,284,657 143 324,555 (10,071)
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Income (loss) before
preferred dividend and
change in accounting principle -- -- -- -- -- --
Reclassification adjustment
due to adoption of SFAS
No. 133 -- -- -- -- -- 19,457
Net unrealized loss on
assets available-for-sale -- -- -- -- -- (9,756)
Total comprehensive income -- -- -- -- -- --
Cumulative transition effect
of adopting SFAS 133 -- -- -- -- -- --
Issuance of common stock -- -- 98,399 1 1,563 --
Repurchase of common stock -- -- (3,131,500) (31) (46,917) --
Dividends declared:
Preferred -- -- -- -- -- --
Common -- -- -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 909,518 $ 26,736 11,251,556 $ 113 $ 279,201 $ (370)
===================================================================================================================================
Cumulative
Cumulative distributions to
earnings stockholders Total
- -----------------------------------------------------------------------------------
Balance, December 31, 1995 $ 3,537 $ (3,721) $ 68,290
- -----------------------------------------------------------------------------------
Comprehensive income:
Income (loss) before
preferred dividend 12,685 -- 12,685
Net unrealized gain on
assets available-for-sale -- -- 2,016
-----------
Total comprehensive income -- -- 14,701
Issuance of preferred stock -- -- 29,579
Issuance of common stock -- -- 113,667
Dividends declared:
Preferred -- (1,148) (1,148)
Common -- (14,084) (14,084)
- -----------------------------------------------------------------------------------
Balance, December 31, 1996 16,222 (18,953) 211,005
- -----------------------------------------------------------------------------------
Comprehensive income:
Income (loss) before
preferred dividend 27,561 -- 27,561
Net unrealized loss on
assets available-for-sale -- -- (6,611)
-----------
Total comprehensive income -- -- 20,950
Conversion of preferred stock -- -- 0
Issuance of common stock -- -- 157,362
Repurchase of common stock -- -- (23,124)
Dividends declared:
Preferred -- (2,815) (2,815)
Common -- (28,841) (28,841)
- -----------------------------------------------------------------------------------
Balance, December 31, 1997 43,783 (50,609) 334,537
- -----------------------------------------------------------------------------------
Comprehensive income:
Income (loss) before
preferred dividend and
change in accounting principle (27,310) -- (27,310)
Reclassification adjustment
due to adoption of SFAS
No. 133 -- -- 19,457
Net unrealized loss on
assets available-for-sale -- -- (9,756)
-----------
Total comprehensive income -- -- (17,609)
Cumulative transition effect
of adopting SFAS 133 (10,061) -- (10,061)
Issuance of common stock -- -- 1,564
Repurchase of common stock -- -- (46,948)
Dividends declared:
Preferred -- (2,747) (2,747)
Common -- (3,946) (3,946)
- -----------------------------------------------------------------------------------
Balance, December 31, 1998 $ 6,412 $ (57,302) $ 254,790
===================================================================================
The accompanying notes are an integral part of
these consolidated financial statements.
F-5
114
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Years Ended December 31,
1998 1997 1996
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) available to common stockholders $ (40,118) $ 24,746 $ 11,537
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 32,046 27,066 6,042
Provision for credit losses on mortgage assets 1,120 2,930 1,696
Equity in (earnings) losses of RWT Holdings, Inc. 4,676 -- --
Net unrealized and realized (gains) losses on assets 38,943 (563) --
Cumulative effect of adopting SFAS No. 133 10,061 -- --
Purchases of mortgage loans: held-for-sale (8,296) -- --
Proceeds from sales of mortgage loans: held-for-sale 688,941 -- --
Principal payments on mortgage loans: held-for-sale 202,965 -- --
Purchases of mortgage securities: trading (149,934) -- --
Principal payments on mortgage securities: trading 433,314 -- --
Purchases of US Treasury securities (49,704) -- --
Purchases of interest rate agreements (12,349) -- --
Proceeds from sales of interest rate agreements 2,769 -- --
(Increase) decrease in accrued interest receivable 4,637 (8,985) (12,267)
(Increase) decrease in other assets 595 11 (985)
Increase (decrease) in accrued interest payable (3,656) 416 12,770
Increase in accrued expenses and other liabilities 850 1,411 534
----------- ----------- -----------
Net cash provided by operating activities 1,156,861 47,032 19,327
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of mortgage loans: held-for-investment (1,596,673) (1,322,732) (527,597)
Proceeds from sales of mortgage loans: held-for-investment 369,119 -- --
Principal payments on mortgage loans: held-for-investment 475,905 288,982 26,482
Purchases of mortgage securities: available-for-sale (231,167) (978,979) (1,455,267)
Proceeds from sales of mortgage securities: available-for-sale 9,296 88,284 --
Principal payments on mortgage securities: available-for-sale 443,057 684,150 231,942
Purchases of interest rate agreements (2,024) (7,892) (4,427)
Net (increase) decrease in restricted cash 11,800 (24,657) --
Investment in RWT Holdings, Inc., net of dividends received (19,800) -- --
Loans to RWT Holdings, Inc., net of repayments (6,500) -- --
Increase in receivable from RWT Holdings, Inc. (445) -- --
----------- ----------- -----------
Net cash used in investing activities (547,432) (1,272,844) (1,728,867)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of (repayments on) short-term debt (656,955) (38,578) 1,582,787
Proceeds from issuance of long-term debt 635,193 1,285,197 --
Repayments on long-term debt (502,601) (112,798) --
Net proceeds from issuance of preferred stock -- -- 29,579
Net proceeds from issuance of common stock 1,564 157,362 113,667
Repurchases of common stock (46,948) (23,124) --
Increase (decrease) in dividends payable - preferred -- (73) 760
Dividends paid on common stock (8,946) (28,350) (11,010)
----------- ----------- -----------
Net cash provided by (used in) financing activities (578,693) 1,239,636 1,715,783
----------- ----------- -----------
Net increase in cash and cash equivalents 30,735 13,824 6,243
Cash and cash equivalents at beginning of year 24,892 11,068 4,825
----------- ----------- -----------
Cash and cash equivalents at end of year $ 55,627 $ 24,892 $ 11,068
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 199,762 $ 160,690 $ 36,831
=========== =========== ===========
Non-cash transactions
Conversion of preferred stock $ -- $ 2,843 $ --
=========== =========== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
F-6
115
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
NOTE 1. THE COMPANY
Redwood Trust, Inc. ("Redwood Trust") was incorporated in Maryland on April 11,
1994 and commenced operations on August 19, 1994. During 1997, Redwood Trust
formed Sequoia Mortgage Funding Corporation ("Sequoia"), a special-purpose
finance subsidiary. Redwood Trust acquired an equity interest in RWT Holdings,
Inc. ("Holdings"), a taxable affiliate of Redwood Trust, during the first
quarter of 1998. For financial reporting purposes, references to the "Company"
mean Redwood Trust, Sequoia and the equity interest in Holdings. The Company
acquires and manages real estate mortgage assets ("Mortgage Assets") which may
be acquired as whole loans ("Mortgage Loans") or as mortgage securities
representing interests in or obligations backed by pools of mortgage loans
("Mortgage Securities"). The Company currently acquires Mortgage Assets that are
secured by single-family or commercial real estate properties throughout the
United States. The Company utilizes both debt and equity to finance its
acquisitions. The Company may also use other securitization techniques to
enhance the value and liquidity of the Company's Mortgage Assets and may sell
Mortgage Assets from time to time.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Redwood Trust and
Sequoia. Substantially all of the assets of Sequoia are pledged or subordinated
to support long-term debt in the form of collateralized mortgage bonds
("Long-Term Debt") and are not available for the satisfaction of general claims
of the Company. The Company's exposure to loss on the assets pledged as
collateral is limited to its net investment, as the Long-Term Debt is
non-recourse to the Company. All significant inter-company balances and
transactions with Sequoia have been eliminated in the consolidation of the
Company. Certain amounts for prior periods have been reclassified to conform to
the 1998 presentation.
During March 1998, the Company acquired an equity interest in Holdings, which
originates, acquires, accumulates, services and sells residential and commercial
Mortgage Loans. The Company owns all of the preferred stock and has a
non-voting, 99% economic interest in Holdings. As the Company does not own the
voting common stock of Holdings or control Holdings, its investment in Holdings
is accounted for under the equity method. Under this method, original equity
investments in Holdings are recorded at cost and adjusted by the Company's share
of earnings or losses and decreased by dividends received.
USE OF ESTIMATES
The preparation of financial statements in conformity with Generally Accepted
Accounting Principles requires management to make estimates and assumptions that
affect the reported amounts of certain assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of certain revenues and expenses during the reported
period. Actual results could differ from those estimates. The primary estimates
inherent in the accompanying consolidated financial statements are discussed
below.
Fair Value. Management estimates the fair value of its financial instruments
using available market information and other appropriate valuation
methodologies. The fair value of a financial instrument, as defined by Statement
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, 6 and 9.
F-7
116
Allowance for Credit Losses. An allowance for credit losses is maintained at a
level deemed appropriate by management to provide for known, future losses as
well as unidentified potential losses in its Mortgage Asset portfolio. The
allowance is based upon management's assessment of various factors affecting its
Mortgage Assets, including current and projected economic conditions,
delinquency status and credit protection. In determining the allowance for
credit losses, the Company's credit exposure is considered based on its credit
risk position in the mortgage pool. These estimates are reviewed periodically
and, as adjustments become necessary, they are reported in earnings in the
periods in which they become known. The reserve is increased by provisions,
which are charged to income from operations. When a loan or portions of a loan
are determined to be uncollectible, the portion deemed uncollectible is charged
against the allowance and subsequent recoveries, if any, are credited to the
allowance. The Company's actual credit losses may differ from those estimates
used to establish the allowance. Summary information regarding the Allowance for
Credit Losses is presented in Note 4.
ADOPTION OF SFAS NO. 133
The Company adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, effective July 1, 1998. In accordance with the transition
provisions of SFAS No. 133, the Company recorded a net-of-tax
cumulative-effect-type transition adjustment of $10.1 million (loss) in earnings
to recognize at fair value the ineffective portion of all interest rate
agreements that were previously designated as part of a hedging relationship.
The Company, upon its adoption of SFAS No. 133, also reclassified $1.53 billion
of mortgage securities from available-for-sale to trading. This reclassification
resulted in an $11.9 million reclassification loss adjustment, which was
transferred from other comprehensive income to current earnings effective July
1, 1998. Under the provisions of SFAS No. 133, such a reclassification does not
call into question the Company's intent to hold current or future debt
securities to their maturity. Immediately after the adoption of SFAS No. 133 and
the reclassification, the Company elected to not seek hedge accounting for any
of the Company's interest rate agreements.
MORTGAGE ASSETS
The Company's Mortgage Assets consist of Mortgage Loans and Mortgage Securities.
Interest is recognized as revenue when earned according to the terms of the
loans and when, in the opinion of management, it is collectible. Discounts and
premiums relating to Mortgage Assets are amortized into interest income over the
lives of the Mortgage Assets using methods that approximate the effective yield
method. Gains or losses on the sale of Mortgage Assets are based on the specific
identification method.
Mortgage Loans: Held-for-Sale
Effective September 30, 1998, the Company elected to reclassify certain
short-funded Mortgage Loans from held-for-investment to held-for-sale. These
Mortgage Loans are carried at the lower of cost or aggregate market value.
Realized and unrealized gains and losses on these loans are recognized in "Net
Unrealized and Realized Gains (Losses) on Assets" on the Consolidated Statements
of Operations.
Some of the Mortgage Loans purchased by the Company for which securitization or
sale is contemplated are committed for sale by the Company to Holdings, or a
subsidiary of Holdings, under a Master Forward Commitment Agreement. As the
forward commitment is entered into on the same date that the Company purchases
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 sales
to Holdings or subsidiaries of Holdings.
Mortgage Loans: Held-for-Investment
Mortgage Loans held-for-investment are carried at their unpaid principal balance
adjusted for net unamortized premiums or discounts, and net of the related
allowance for credit losses.
Mortgage Securities: Trading
Effective July 1, 1998, concurrent with the adoption of SFAS No. 133, the
Company elected to reclassify all of its short-funded Mortgage Securities from
available-for-sale to trading. Mortgage Securities classified as trading are
F-8
117
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 Gains (Losses) on Assets" on the Consolidated Statements of Operations.
Mortgage Securities: Available-for-Sale
Prior to the adoption of SFAS No. 133, the Company, in accordance with SFAS No.
115, classified all of its Mortgage Securities as available-for-sale investments
as the Company, from time to time, sold some of its Mortgage Securities as part
of its overall management of its balance sheet. Effective July 1, 1998, the
Company reclassified all of its short-funded Mortgage Securities as trading
investments, while all equity-funded Mortgage Securities remained in the
available-for-sale classification. All Mortgage Securities classified as
available-for-sale are carried at estimated fair value. Current period
unrealized gains and losses are excluded from net income and reported as a
component of Other Comprehensive Income in stockholders' equity with cumulative
unrealized gains and losses classified as Accumulated Other Comprehensive Income
in stockholders' equity.
Unrealized losses on Mortgage Securities classified as available-for-sale that
are considered other-than-temporary, are recognized in income and the carrying
value of the Mortgage Security is adjusted. Other-than-temporary unrealized
losses are based on management's assessment of various factors affecting the
expected cash flow from the Mortgage Securities, including an
other-than-temporary deterioration of the credit quality of the underlying
mortgages and/or the credit protection available to the related mortgage pool
and a significant change in the prepayment characteristics of the underlying
collateral.
US TREASURY SECURITIES
US Treasury securities include notes issued by the US Government. Interest is
recognized as revenue when earned according to the terms of the Treasury
securities. Discounts and premiums are amortized into interest income over the
life of the security using methods that approximate the effective yield method.
Such securities are recorded at their estimated fair market value with
unrealized gains and losses recognized as a component of "Net Unrealized and
Realized Gains (Losses) on Assets" on the Consolidated Statements of Operations.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of three months or less. As of December 31, 1998, cash
equivalents include $25 million in repurchase agreements.
RESTRICTED CASH
Restricted cash of the Company includes principal and interest payments on
mortgage loans held as collateral for the Company's Long-Term Debt, and cash
pledged as collateral on certain interest rate agreements.
INTEREST RATE AGREEMENTS
The Company maintains an overall interest-rate risk-management strategy that
incorporates the use of derivative interest rate agreements to minimize
significant unplanned fluctuations in earnings that are caused by interest-rate
volatility. Interest rate agreements that are used as part of the Company's
interest-rate risk management strategy include interest rate options, swaps,
options on swaps, futures contracts, and options on futures contracts
(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). Concurrent with the adoption of SFAS No. 133, the
Company has elected to designate all of its existing Interest Rate Agreements as
trading instruments.
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.
F-9
118
Interest Rate Agreements Classified as Trading
Interest Rate Agreements that are designated as trading are not linked to
specific assets and liabilities or to a forecasted transaction, or otherwise are
not designated and, therefore do not qualify for hedge accounting. Accordingly,
interest rate agreements classified as trading are reported at their estimated
fair value with changes in their fair value reported in current-period earnings
in "Net Unrealized and Realized Gains (Losses) on Assets" on the Consolidated
Statements of Operations.
Interest Rate Agreements Classified as Hedges
Interest Rate Agreements that are designated as hedges are linked to specific
assets and liabilities on the balance sheet or to a forecasted transaction, or
otherwise qualify for hedge accounting. The Company currently does not have any
Interest Rate Agreements classified as hedges.
Prior to the adoption of SFAS No. 133, Interest Rate Agreements that were
hedging Mortgage Securities available-for-sale were carried at fair value with
unrealized gains and losses reported as a component of Accumulated Other
Comprehensive Income in stockholders' equity, consistent with the reporting of
unrealized gains and losses on the related securities. Similarly, Interest Rate
Agreements that were used to hedge Mortgage Loans, Short-Term Debt or Long-Term
Debt were carried at amortized cost. Realized gains and losses from the
settlement or early termination of Interest Rate Agreements were deferred and
amortized into net interest income over the remaining term of the original
Interest Rate Agreement, or, if shorter, over the remaining term of the
associated hedged asset or liability, as adjusted for estimated future principal
repayments.
DEBT
Short-Term and Long-Term Debt are carried at their unpaid principal balances,
net of any unamortized discount or premium and any unamortized deferred bond
issuance costs. The amortization of any discount or premium is recognized as an
adjustment to interest expense using the effective interest method based on the
maturity schedule of the related borrowings. Bond issuance costs incurred in
connection with the issuance of Long-Term Debt are deferred and amortized over
the estimated lives of the Long-Term Debt using the interest method adjusted for
the effects of prepayments.
INCOME TAXES
The Company has elected to be taxed as a Real Estate Investment Trust ("REIT")
under the Internal Revenue Code (the "Code") and the corresponding provisions of
State law. In order to qualify as a REIT, the Company must annually distribute
at least 95% of its taxable income to stockholders and meet certain other
requirements. If these requirements are met, the Company generally will not be
subject to Federal or state income taxation at the corporate level with respect
to the taxable income it distributes to its stockholders. Because the Company
believes it meets the REIT requirements and also intends to distribute all of
its taxable income, no provision has been made for income taxes in the
accompanying consolidated financial statements.
Under the Internal Revenue Code of 1986, a dividend declared by a REIT in
October, November or December of a calendar year and payable to shareholders of
record as of a specified date in such month, will be deemed to have been paid by
the Company and received by the shareholders on the last day of that calendar
year, provided the dividend is actually paid before February 1st of the
following calendar year, and provided that the REIT has any remaining
undistributed taxable income on the record date. Because the Company had already
distributed more dividends than it had earned in taxable income as of December
31, 1998, the preferred dividend paid in January 1999 is not considered taxable
income to shareholders in 1998.
NET INCOME PER SHARE
Net income per share for the years ended December 31, 1998, 1997 and 1996 is
shown in accordance with SFAS No. 128, Earnings Per Share, which was effective
for fiscal years ended after December 15, 1997 and requires restatement of prior
period earnings per share ("EPS"). 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
F-10
119
that all dilutive common stock equivalents are exercised and the funds generated
by the exercise are used to buy back outstanding common stock at the average
market price during the reporting period.
The following tables provide reconciliations of the numerators and denominators
of the basic and diluted net income per share computations.
(IN THOUSANDS, EXCEPT SHARE DATA) YEARS ENDED DECEMBER 31,
1998 1997 1996
------------------------------------------------
NUMERATOR:
Numerator for basic and diluted earnings per share--
Income (loss) before preferred dividend and
change in accounting principle $ (27,310) $ 27,561 $ 12,685
Cash dividends on Class B preferred stock (2,747) (2,815) (1,148)
------------------------------------------------
Income (loss) before change in accounting principle (30,057) 24,746 11,537
Cumulative transition effect of adopting SFAS No. 133 (10,061) -- --
------------------------------------------------
Basic and Diluted EPS - Net income (loss) available
to common stockholders $ (40,118) $ 24,746 $ 11,537
================================================
DENOMINATOR:
Denominator for basic earnings per share--
Weighted average number of common shares
outstanding during the period 13,199,819 13,334,163 7,950,175
Net effect of dilutive stock options -- 191,513 175,391
Net effect of dilutive stock warrants (a) -- 154,734 618,618
------------------------------------------------
Denominator for diluted earnings per share-- 13,199,819 13,680,410 8,744,184
================================================
BASIC:
Income (loss) before change in accounting principle $ (2.28) $ 1.86 $ 1.45
Cumulative transition effect of adopting SFAS No. 133 $ (0.76) -- --
Net income per share $ (3.04) $ 1.86 $ 1.45
DILUTED:
Income (loss) before change in accounting principle $ (2.28) $ 1.81 $ 1.32
Cumulative transition effect of adopting SFAS No. 133 $ (0.76) -- --
Net income per share $ (3.04) $ 1.81 $ 1.32
(a) The stock warrants expired on December 31, 1997.
COMPREHENSIVE INCOME
SFAS No. 130, Reporting Comprehensive Income, requires the Company to classify
items of "other comprehensive income", such as unrealized gains and losses on
assets available-for-sale, by their nature in a financial statement and display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of the balance
sheet. In accordance with SFAS No. 130, current period unrealized gains and
losses on assets available-for-sale are reported as a component of Comprehensive
Income on the Statement of Stockholders' Equity with cumulative unrealized gains
and losses classified as Accumulated Other Comprehensive Income in stockholders'
equity. As of December 31, 1998 and December 31, 1997, the only component of
Accumulated Other Comprehensive Income is unrealized gains and losses on assets
available-for-sale.
RECENT ACCOUNTING PRONOUNCEMENT
In October 1998, the Financial Accounting Standards Board issued SFAS No. 134,
Accounting for Mortgage-Backed Securities Retained after the Securitization of
Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. SFAS No. 134
amends SFAS No. 65, Accounting for Certain Mortgage Backed Securities, to
require that after an entity that is engaged in mortgage banking activities has
securitized mortgage loans that are held for sale, it must classify the
resulting retained mortgage-backed securities or other retained interests based
on its ability and intent to sell or hold those investments. This statement is
effective for the first fiscal quarter beginning after December 15, 1998, with
earlier application encouraged. At this time, the impact of adopting this
statement is not known.
F-11
120
NOTE 3. MORTGAGE ASSETS
At December 31, 1998 and 1997, investments in Mortgage Assets consisted of
interests in adjustable-rate, hybrid or fixed-rate mortgages on residential and
commercial properties. The hybrid mortgages have an initial fixed coupon rate
for three to ten years followed by annual adjustments. Agency Mortgage
Securities ("Agency Securities") represent securitized interests in pools of
adjustable-rate mortgages from the Federal Home Loan Mortgage Corporation and
the Federal National Mortgage Association. The Agency Securities are guaranteed
as to principal and interest by these United States government-sponsored
entities. The original maturity of the majority of the Mortgage Assets is thirty
years; the actual maturity is subject to change based on the prepayments of the
underlying mortgage loans.
At December 31, 1998 and 1997, the average annualized effective yield after
taking into account the amortization expense due to prepayments on the Mortgage
Assets was 6.95% and 6.86%, respectively, based on the reported cost of the
assets. Of the Mortgage Assets owned by the Company at December 31, 1998, 76%
are adjustable-rate mortgages, 23% are hybrid mortgages and 1% are fixed-rate
mortgages. The coupons on 64% of the adjustable-rate Mortgage Assets are limited
by periodic caps (generally interest rate adjustments are limited to no more
than 1% every six months or 2% every year) while another 36% are not limited by
such periodic caps. Most of the coupons on the adjustable-rate Mortgage Assets
owned by the Company are limited by lifetime caps. At December 31, 1998 and
1997, the weighted average lifetime cap on the adjustable-rate Mortgage Assets
was 11.48% and 12.08%, respectively.
At December 31, 1998 and 1997 Mortgage Assets consisted of the following:
MORTGAGE LOANS: HELD-FOR-SALE
(IN THOUSANDS) DECEMBER 31, 1998
-----------------
Current Face $ 274,630
Unamortized Discount (1,099)
Unamortized Premium 670
---------
Carrying Value $ 274,201
=========
At September 30, 1998, the Company elected to reclassify certain short-funded
Mortgage Loans from held-for-investment to held-for-sale. As a result, the
Company recognized a lower of cost or market loss adjustment of $6.5 million for
the year ended December 31, 1998. Also during the year ended December 31, 1998,
the Company sold Mortgage Loans held-for-sale with an amortized cost of $684.4
million for proceeds of $689.0 million, resulting in a net gain of $4.6 million.
There were no such sales during the years ended December 31, 1997 and 1996. The
lower of cost or market adjustments and net gains on sales are reflected as a
component of "Net Unrealized and Realized Gains (Losses) on Assets" on the
Consolidated Statements of Operations.
MORTGAGE LOANS: HELD-FOR-INVESTMENT
(IN THOUSANDS) DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- -----------------
Current Face $ 1,118,375 $ 1,519,837
Unamortized Discount -- --
Unamortized Premium 16,709 34,844
----------- -----------
Amortized Cost 1,135,084 1,554,681
Allowance for Credit Losses (3,784) (2,855)
----------- -----------
Carrying Value $ 1,131,300 $ 1,551,826
=========== ===========
During the year ended December 31, 1998, the Company sold Mortgage Loans
held-for-investment with an amortized cost of $370.1 million for proceeds of
$369.1 million, resulting in a net loss of $1.0 million. There
F-12
121
were no such sales during the years ended December 31, 1997 and 1996. This loss
is reflected as a component of "Net Unrealized and Realized Gains (Losses) on
Assets" on the Consolidated Statements of Operations.
MORTGAGE SECURITIES: TRADING
DECEMBER 31, 1998
(IN THOUSANDS) AGENCY NON-AGENCY TOTAL
----------- ----------- -----------
Current Face $ 609,826 $ 640,923 $ 1,250,749
Unamortized Discount (5) (3,084) (3,089)
Unamortized Premium 7,602 2,393 9,995
----------- ----------- -----------
Carrying Value $ 617,423 $ 640,232 $ 1,257,655
=========== =========== ===========
Effective July 1, 1998, the Company elected to reclassify all of its
short-funded Mortgage Securities from available-for-sale to trading (see Note
2). As a result of this reclassification, the Company recognized an $11.9
million reclassification loss adjustment (gross gains of $0.4 million, gross
losses of $12.3 million), which was transferred from other comprehensive income
to current earnings effective July 1, 1998. Additionally, for the year ended
December 31, 1998, the Company recognized a mark-to-market loss of $17.5 million
on Mortgage Securities classified as trading. The entire net unrealized loss of
$29.4 million is reflected as a component of "Net Unrealized and Realized Gains
(Losses) on Assets" on the Consolidated Statements of Operations.
MORTGAGE SECURITIES: AVAILABLE-FOR-SALE
DECEMBER 31, 1998 DECEMBER 31, 1997
(IN THOUSANDS) AGENCY NON-AGENCY TOTAL AGENCY NON-AGENCY TOTAL
----------- ----------- ----------- ----------- ----------- -----------
Current Face -- $ 17,281 $ 17,281 $ 953,937 $ 825,438 $ 1,779,375
Unamortized Discount -- (8,015) (8,015) (174) (12,268) (12,442)
Unamortized Premium -- -- -- 32,722 18,606 51,328
----------- ----------- ----------- ----------- ----------- -----------
Amortized Cost -- 9,266 9,266 986,485 831,776 1,818,261
Allowance for Credit Losses -- (1,189) (1,189) -- (2,076) (2,076)
Gross Unrealized Gains -- 313 313 2,598 3,984 6,582
Gross Unrealized Losses -- (683) (683) (4,286) (3,685) (7,971)
----------- ----------- ----------- ----------- ----------- -----------
Carrying Value -- $ 7,707 $ 7,707 $ 984,797 $ 829,999 $ 1,814,796
=========== =========== =========== =========== =========== ===========
During the years ended December 31, 1998 and 1997, the Company sold Mortgage
Securities available-for-sale with an amortized cost of $9.3 million and $87.6
million, respectively. Proceeds and realized gains and losses on the sales of
Mortgage Securities available-for-sale for the years ended December 31, 1998 and
1997 are presented below. No such sales occurred for the year ended December 31,
1996.
(IN THOUSANDS) 1998 1997
-------- --------
Proceeds from sales $ 9,296 $ 88,284
Gross gains $ 6 $ 746
Gross losses -- (28)
Write-down on related interest rate agreements -- (155)
-------- --------
Net gain on sales $ 6 $ 563
======== ========
The Company also recognized a $0.7 million loss on the write-down of certain
Mortgage Securities available-for-sale during the first quarter of 1998. The
gains and losses on the sales and write-downs of Mortgage Securities
available-for-sale are reflected as a component of "Net Unrealized and Realized
Gains (Losses) on Assets" on the Consolidated Statements of Operations.
F-13
122
NOTE 4. ALLOWANCE FOR CREDIT LOSSES
The following table summarizes the Allowance for Credit Losses activity:
YEARS ENDED DECEMBER 31,
(IN THOUSANDS) 1998 1997 1996
------- ------- -------
Balance at beginning of year $ 4,931 $ 2,180 $ 490
Provision for credit losses 1,120 2,930 1,696
Charge-offs (1,078) (179) (6)
------- ------- -------
Balance at end of year $ 4,973 $ 4,931 $ 2,180
======= ======= =======
The Allowance for Credit Losses is reflected as a component of Mortgage Assets
on the Consolidated Balance Sheets.
NOTE 5. COLLATERAL FOR LONG-TERM DEBT
The Company has pledged collateral in order to secure the Long-Term Debt issued
in the form of collateralized mortgage bonds ("Bond Collateral"). This Bond
Collateral consists primarily of adjustable-rate and hybrid, conventional,
30-year mortgage loans secured by first liens on one- to four-family residential
properties. All Bond Collateral is pledged to secure repayment of the related
Long-Term Debt obligation. All principal and interest (less servicing and
related fees) on the Bond Collateral is remitted to a trustee and is available
for payment on the Long-Term Debt obligation. The Company's exposure to loss on
the Bond Collateral is limited to its net investment, as the Long-Term Debt is
non-recourse to the Company.
The components of the Bond Collateral are summarized as follows:
(IN THOUSANDS) DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- -----------------
Mortgage loans: held-for-sale $ 197,646 --
Mortgage loans: held-for-investment, net 1,131,300 $1,191,487
Restricted cash 12,857 24,657
Accrued interest receivable 7,707 7,401
---------- ----------
$1,349,510 $1,223,545
========== ==========
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
At December 31, 1998, all of the Company's Interest Rate Agreements were
classified as trading, and therefore, reported at fair value. The amortized cost
and carrying value of the Company's Interest Rate Agreements classified as
hedges at December 31, 1997 are summarized as follows:
(IN THOUSANDS) DECEMBER 31, 1997
-----------------
Amortized Cost $ 10,781
Gross Unrealized Gains 650
Gross Unrealized Losses (9,331)
--------
Carrying Value $ 2,100
========
F-14
123
On July 1, 1998, as a result of adopting SFAS No. 133, the Company recorded a
net-of-tax cumulative-effect-type transition adjustment of $10.1 million loss in
earnings to recognize at fair value the ineffective portion of Interest Rate
Agreements that were previously designated as part of a hedging relationship
(see Note 2). This loss is reflected on the Consolidated Statements of
Operations as Cumulative Transition Effect of Adopting SFAS No. 133.
Approximately $7.6 million of this transition adjustment was transferred from
other comprehensive income to current earnings. Additionally, during the year
ended December 31, 1998, the Company recognized a net loss of $5.9 million as a
result of mark-to-market adjustments on interest rate agreements classified as
trading. This loss is reflected as a component of "Net Unrealized and Realized
Gains (Losses) on Assets" 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.
NOTIONAL AMOUNTS CREDIT EXPOSURE (a)
(IN THOUSANDS) DECEMBER 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- ----------------- ----------------- -----------------
Interest Rate Options $3,569,200 $4,862,200 -- --
Interest Rate Swaps 440,000 473,000 $ 8,673 $ 12,392
Interest Rate Futures -- 58,000 -- 46
========== ========== ========== ==========
Total $3,915,200 $5,393,200 $ 8,673 $ 12,438
========== ========== ========== ==========
(a) Reflects the fair market value of all cash and collateral of the Company
held by counterparties.
Interest Rate Options, which may include caps, floors, call and put corridors,
options on futures and swaption collars (collectively, "Options"), are
agreements which transfer, modify or reduce interest rate risk in exchange for
the payment of a premium when the contract is initiated. Interest rate cap
agreements provide cash flows to the Company to the extent that a specific
interest rate index exceeds a fixed rate. Conversely, 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. Call (put) corridors
will cause the Company to incur a gain (loss) to the extent that the yield of
the specified index is below (above) the strike rate at the time of the option
expiration. The maximum gain or loss on a call or put corridor is established at
the time of the transaction by establishing minimum and maximum index rates. The
Company will receive cash on the options on futures if the futures price exceeds
(is below) the call (put) option strike price at the expiration of the option.
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 Company's
credit risk on the Options is limited to the carrying value of the Options
agreements. The credit risk on options on futures is limited due by 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 either fixed interest payments for floating interest
payments or 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 ("Futures") are contracts for the delivery of securities
or cash in which the seller agrees to deliver 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, 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). Similar to options on futures, 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.
F-15
124
In general, the Company has incurred credit risk to the extent that the
counterparties to the Interest Rate Agreements do not perform their obligations
under the Interest Rate Agreements. If one of the counterparties does not
perform, the Company would not receive the cash to which it would otherwise be
entitled under the Interest Rate Agreement. In order to mitigate this risk, the
Company has only entered into Interest Rate Agreements that are either a)
transacted on a national exchange or b) transacted with counterparties that are
either i) designated by the U.S. Department of the Treasury as a "primary
government dealer", ii) affiliates of "primary government dealers", or iii)
rated BBB or higher. Furthermore, the Company has entered into Interest Rate
Agreements with several different counterparties in order to diversify the
credit risk exposure.
NOTE 7. SHORT-TERM DEBT
The Company has entered into reverse repurchase agreements and other forms of
collateralized short-term borrowings (collectively, "Short-Term Debt") to
finance acquisitions of a portion of its Mortgage Assets. This Short-Term Debt
is collateralized by a portion of the Company's Mortgage Assets and US Treasury
securities.
At December 31, 1998, the Company had $1.3 billion of Short-Term Debt
outstanding with a weighted average borrowing rate of 5.62% and a weighted
average remaining maturity of 48 days. This debt was collateralized with $1.3
billion of Mortgage Assets and US Treasury securities. At December 31, 1997, the
Company had $1.9 billion of Short-Term Debt outstanding with a weighted average
borrowing rate of 6.00% and a weighted average remaining maturity of 64 days.
This debt was collateralized with $2.0 billion of Mortgage Assets.
Holdings may borrow under several of the Company's Short-Term Debt agreements as
a co-borrower. As of December 31, 1998, Holdings had no outstanding borrowings
under these agreements.
At December 31, 1998 and December 31, 1997, the Short-Term Debt had the
following remaining maturities:
(IN THOUSANDS) DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- -----------------
Within 30 days $ 428,292 $ 823,545
30 to 90 days 714,114 533,543
Over 90 days 115,164 557,437
---------- ----------
Total Short-Term Debt $1,257,570 $1,914,525
========== ==========
For the years ended December 31, 1998, 1997 and 1996, the average balance of
Short-Term Debt was $2.0 billion, $2.4 billion and $0.9 billion with a weighted
average interest cost of 5.81%, 5.86% and 5.71%, respectively. The maximum
balance outstanding during the years ended December 31, 1998, 1997 and 1996 was
$2.5 billion, $3.1 billion and $2.0 billion, respectively.
NOTE 8. LONG-TERM DEBT
Long-Term Debt in the form of collateralized mortgage bonds is secured by a
pledge of Bond Collateral. As required by the indentures relating to the
Long-Term Debt, the Bond Collateral is held in the custody of trustees. The
trustees collect principal and interest payments on the Bond Collateral and make
corresponding principal and interest payments on the Long-Term Debt. The
obligations under the Long-Term Debt are payable solely from the Bond Collateral
and are otherwise non-recourse to the Company.
Each series of Long-Term Debt consists of various classes of bonds at variable
rates of interest. The maturity of each class is directly affected by the rate
of principal prepayments on the related Bond Collateral. Each series is also
subject to redemption according to the specific terms of the respective
indentures. As a result, the actual maturity of any class of a Long-Term Debt
series is likely to occur earlier than its stated maturity.
F-16
125
The components of the Long-Term Debt at December 31, 1998 and 1997 along with
selected other information are summarized below:
(IN THOUSANDS) DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- -----------------
Long-Term Debt $ 1,303,405 $ 1,170,709
Unamortized premium on Long-Term Debt 5,783 5,795
Deferred bond issuance costs (3,628) (3,703)
----------- -----------
Total Long-Term Debt $ 1,305,560 $ 1,172,801
=========== ===========
Range of weighted-average interest rates, by series 5.75% to 6.55% 6.06% to 6.50%
Stated maturities 2017 - 2029 2024 - 2029
Number of series 3 2
For the years ended December 31, 1998 and 1997, 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 6.38% and 6.31%,
respectively. At December 31, 1998 and 1997, interest payable on Long-Term Debt
was $4.2 million and $2.6 million, respectively, and is reflected as a component
of Accrued Interest Payable on the Consolidated Balance Sheets.
NOTE 9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values of
the Company's financial instruments at December 31, 1998 and 1997.
(IN THOUSANDS) DECEMBER 31, 1998 DECEMBER 31, 1997
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
-------------- ---------- -------------- ----------
Assets
Mortgage Loans: held-for-sale $ 274,201 $ 274,302 -- --
Mortgage Loans: held-for-investment $1,131,300 $1,120,376 $1,551,826 $1,552,585
Mortgage Securities: trading $1,257,655 $1,257,655 -- --
Mortgage Securities: available-for-sale $ 7,707 $ 7,707 $1,814,796 $1,814,796
US Treasury Securities $ 48,009 $ 48,009 -- --
Interest Rate Agreements $ 2,517 $ 2,517 $ 2,100 $ 1,522
Investment in RWT Holdings, Inc. $ 15,124 $ 15,124 -- --
Liabilities
Long-Term Debt $1,305,560 $1,302,330 $1,172,801 $1,172,938
The carrying values of all other balance sheet accounts as reflected in the
financial statements approximate fair value because of the short-term nature of
these accounts.
NOTE 10. 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. After
September 30, 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 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
F-17
126
Preferred Stock to receive $31.00 per share plus any accrued dividends before
any distribution is made on the Common Stock.
As of December 31, 1998 and 1997, 96,732 shares of the Preferred Stock have been
converted into 96,732 shares of the Company's Common Stock. At December 31, 1998
and 1997, there were 909,518 shares of the Preferred Stock outstanding.
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 and limited stock appreciation
rights ("Awards") and dividend equivalent rights ("DERs") to such eligible
recipients other than non-employee directors. Non-employee directors are
automatically provided annual grants of NQSOs with DERs pursuant to a formula
under the Plan.
The number of shares of Common Stock available under the Plan for options and
Awards, subject to certain anti-dilution provisions, is 15% of the Company's
total outstanding shares of Common Stock. The total outstanding shares are
determined as the highest number of shares outstanding prior to any stock
repurchases. At December 31, 1998 and 1997, 273,312 and 1,158,404 shares of
Common Stock, respectively, were available for grant. Of the shares of Common
Stock available for grant, no more than 500,000 shares of Common Stock shall be
cumulatively available for grant as ISOs. At December 31, 1998 and 1997, 381,298
and 354,265 ISOs had been granted, respectively. The exercise price for ISOs
granted under the Plan may not be less than the fair market value of shares of
Common Stock at the time the ISO is granted. All stock options granted under the
Plan vest no earlier than ratably over a four-year period from the date of grant
and expire within ten years after the date of grant.
The Company's Plan permits certain stock options granted under the plan to
accrue stock DERs. For the years ended December 31, 1998, 1997 and 1996, the
stock DERs accrued on NQSOs that had a stock DER feature resulted in charges to
operating expenses of $55,222, $437,393 and $328,374, 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 dividends and on the price
of the stock on the related dividend payment date.
A summary of the status of the Company's Plan as of December 31 and changes
during the years ending on those dates is presented below.
1998 1997 1996
----------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
(IN THOUSANDS, EXCEPT SHARE DATA) SHARES PRICE SHARES PRICE SHARES PRICE
---------- -------- ---------- --------- ---------- --------
Outstanding options at January 1 840,644 $29.79 421,583 $19.05 310,857 $ 9.48
Options granted 929,125 $16.73 460,328 $37.08 141,300 $36.01
Options exercised (29,723) $ 0.11 (54,485) $ 0.89 (42,083) $ 0.11
Options canceled (2,699) $29.81 -- -- -- --
Dividend equivalent rights earned 2,440 -- 13,218 -- 11,509 --
---------- ---------- ----------
Outstanding options at December 31 1,739,787 $23.68 840,644 $29.79 421,583 $19.05
========== ========== ==========
Options exercisable at year-end 336,121 $25.95 81,774 $22.10 27,109 $24.48
Weighted average fair value of options
granted during the year $ 1.63 $ 3.17 $ 2.34
F-18
127
The following table summarizes information about stock options outstanding at
December 31, 1998.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- -----------------------------------
WEIGHTED-AVERAGE
RANGE OF NUMBER REMAINING WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
-------------------------------------------------------------------------- -----------------------------------
$0 to 8 55,948 6.6 $ 1.00 42,629 $ 0.89
12 to 19 737,745 9.2 $ 15.18 94,738 $ 18.18
20 to 30 445,192 8.9 $ 22.12 35,403 $ 22.39
36 to 38 379,800 8.0 $ 37.45 158,642 $ 37.43
45 to 53 121,102 8.5 $ 45.68 4,709 $ 48.97
--------- ---------
$0 to 53 1,739,787 8.7 $ 23.49 336,121 $ 25.95
========= =========
At December 31, 1998, the Company had one Stock Option Plan, which is described
above. The Company applies Accounting Principles Board ("APB") Opinion 25 and
related interpretations in accounting for this plan. Accordingly, no
compensation cost has been recognized for its Plan. Had compensation cost for
the Company's Plan been determined consistent with SFAS No. 123, the Company's
net income and earnings per share would have been reduced to the pro forma
amounts indicated below:
YEAR ENDED DECEMBER 31,
1998 1997 1996
---------------------------------------------------
Net income (loss) As reported $ (40,118) $ 24,746 $ 11,537
(IN THOUSANDS) Pro Forma $ (40,674) $ 24,504 $ 11,535
Basic net income (loss) As reported $ (3.04) $ 1.86 $ 1.45
per share Pro Forma $ (3.08) $ 1.84 $ 1.45
Diluted net income (loss) As reported $ (3.04) $ 1.81 $ 1.32
per share Pro Forma $ (3.08) $ 1.79 $ 1.32
For purposes of determining values for use in the above tables, the 1998 values
are based on American valuation using the Black/Scholes option pricing model as
of the various grant dates, using the following principal assumptions: expected
stock price volatility 33%, risk free rates of return based on the 5 year
treasury rate at the date of grant and a post-option dividend growth rate of
10%. No adjustments have been made for forfeitures or non-transferability. The
actual value, if any, that the option recipient will realize from these options
will depend solely on the increase in the stock price over the option price when
the options are exercised.
STOCK REPURCHASES
In 1997, the Company's Board of Directors approved the repurchase of 1,455,000
shares of the Company's Common Stock. In 1998, the Company's Board of Directors
approved the repurchase of an additional 4,000,000 shares of the Company's
Common Stock. Pursuant to this repurchase program, the Company repurchased
3,131,500 shares of its Common Stock for $46.9 million during 1998 and 840,000
shares of its Common Stock for $23.1 million during 1997. The repurchased shares
have been returned to the Company's authorized but unissued shares of Common
Stock.
NOTE 11. RELATED PARTY TRANSACTIONS
PURCHASES OF MORTGAGE LOANS
During the second quarter of 1998, the Company purchased $525.4 million of
Mortgage Loans from Holdings. The Company purchased the Mortgage Loans at their
fair market value on the trade date.
F-19
128
SALE OF MORTGAGE LOANS
During December 1998, the Company purchased $8.3 million of commercial mortgage
loans. Pursuant to the Master Forward Commitment Agreement with Redwood
Commercial Funding ("RCF"), a subsidiary of Holdings, the Company committed to
sell the Mortgage Loans to RCF during the first quarter of 1999 at the same
price for which the Company acquired the Mortgage Loans.
OTHER
Under a revolving credit facility arrangement, the Company may loan funds to
Holdings to finance certain Mortgage Loans owned by Holdings. These loans are
typically unsecured and are repaid within six months. Such loans bear interest
at a rate of 3.5% over the London Interbank Offered Rate ("LIBOR"). At December
31, 1998, the Company had loaned $6.5 million to Holdings in accordance with the
provisions of this arrangement.
The Company shares many of the operating expenses of Holdings, including
personnel and related expenses, subject to full reimbursement by Holdings.
During the year ended December 31, 1998, a total of $2.3 million of Holdings'
operating expenses were paid by the Company and $1.9 million was reimbursed by
Holdings. At December 31, 1998, amounts due to the Company from Holdings for
operating expenses totaled $444,831.
The Company may provide credit support to Holdings to facilitate Holdings'
financings from third-party lenders and/or hedging arrangements with
counterparties. As part of this arrangement, Holdings is authorized as a
co-borrower under some of the Company's Short-Term Debt agreements subject to
the Company continuing to remain jointly and severally liable for repayment.
Accordingly, Holdings pays the Company credit support fees on borrowings subject
to this arrangement. At December 31, 1998, there were no amounts due to the
Company from Holdings for credit support fees.
NOTE 12. COMMITMENTS AND CONTINGENCIES
At December 31, 1998, the Company had entered into commitments to purchase
$393,750 of Interest Rate Agreements for settlement in January 1999 and sell
$8.3 million of Mortgage Loans to RCF for settlement in February 1999.
At December 31, 1998, the Company is obligated under non-cancelable operating
leases with expiration dates through 2001. The future minimum lease payments
under these non-cancelable leases are as follows: 1999 through 2000 - $311,528;
2001 - $122,625.
NOTE 13. SUBSEQUENT EVENT
On March 4, 1999, the Company's Board of Directors authorized the repurchase of
additional shares of its Common Stock pursuant to its stock repurchase program.
The maximum number of additional shares authorized for repurchase under this new
program is 1,000,000. During the first quarter of 1999 through March 17, 1999,
pursuant to its stock repurchase program (see Note 10), the Company repurchased
932,100 shares of the Company's Common Stock for $13.9 million.
F-20
129
NOTE 14. QUARTERLY FINANCIAL DATA - UNAUDITED
Selected quarterly financial data follows:
(IN THOUSANDS, EXCEPT SHARE DATA) THREE MONTHS ENDED
---------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
---------------------------------------------------------
1998
Operating results:
Interest income $ 53,861 $ 53,783 $ 61,558 $ 53,602
Interest expense 46,097 50,169 56,170 43,688
Interest rate agreement expense 1,378 1,624 247 265
Net interest income 6,386 1,990 5,141 9,649
Income (loss) before change in accounting principle 2,450 (491) (37,805) 5,789
Cumulative transition effect of adopting SFAS No. 133 -- -- (10,061) --
Net income (loss) available to common stockholders 2,450 (491) (47,866) 5,789
Per share data:
Income (loss) before change in accounting principle - diluted 0.17 (0.03) (2.85) 0.51
Cumulative transition effect of adopting SFAS No. 133 -- -- (0.76) --
Net income (loss) - diluted 0.17 (0.03) (3.61) 0.51
Dividends declared per common share (a) 0.270 0.010 -- --
Dividends declared per preferred share 0.755 0.755 0.755 0.755
1997
Operating results:
Interest income $ 38,568 $ 49,509 $ 56,543 $ 53,984
Interest expense 28,900 38,958 45,888 46,531
Interest rate agreement expense 595 839 1,038 1,269
Net interest income 9,073 9,712 9,617 6,184
Net income (loss) available to common stockholders 6,456 7,034 6,859 4,397
Per share data:
Net income (loss) - diluted 0.530 0.520 0.470 0.300
Dividends declared per common share 0.600 0.600 0.600 0.350
Dividends declared per preferred share 0.755 0.755 0.755 0.755
(a) Reflects period for which the common dividend was declared. Reported
dividends may have been declared during the following quarter.
F-21
130
[PRICEWATERHOUSECOOPERS, LLP LETTERHEAD]
REPORT OF INDEPENDENT ACCOUNTANTS
February 18, 1999
To The Board of Directors and Shareholders
Redwood Trust, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of Redwood
Trust, Inc. and Subsidiary (the Company) at December 31, 1998 and 1997, and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
In July 1998, the Company adopted Financial Accounting Standards Board Statement
No. 133, Accounting for Derivative Instruments and Hedging Activities. This
change is discussed in Notes 2, 3 and 6 of the Notes to Consolidated Financial
Statements.
/s/ PRICEWATERHOUSECOOPERS, LLP
F-22
131
RWT HOLDINGS, INC.
CONSOLIDATED FINANCIAL STATEMENTS AND
REPORT OF INDEPENDENT ACCOUNTANTS
FOR INCLUSION IN FORM 10-K
ANNUAL REPORT FILED WITH
SECURITIES AND EXCHANGE COMMISSION
DECEMBER 31, 1998
F-23
132
RWT HOLDINGS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Consolidated Financial Statements - RWT Holdings, Inc.
Consolidated Balance Sheet at December 31, 1998 ......................... F-25
Consolidated Statement of Operations for the period from
April 1, 1998 (commencement of operations) to December 31, 1998 ..... F-26
Consolidated Statement of Stockholders' Equity for the period from
April 1, 1998 (commencement of operations) to December 31, 1998 ..... F-27
Consolidated Statement of Cash Flows for the period from
April 1, 1998 (commencement of operations) to December 31, 1998 ..... F-28
Notes to Consolidated Financial Statements .............................. F-29
Report of Independent Accountants .......................................... F-34
F-24
133
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(In thousands, except share data)
December 31, 1998
-----------------
ASSETS
Residential mortgage loans: held-for-sale $ 12,247
Cash and cash equivalents 9,711
Accrued interest receivable 78
Other assets 742
--------
$ 22,778
========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Loan from Redwood Trust, Inc. $ 6,500
Payable to Redwood Trust, Inc. 445
Accrued expenses and other liabilities 557
--------
7,502
--------
Commitments and contingencies (See Note 9)
STOCKHOLDERS' EQUITY
Series A preferred stock, par value $0.01 per share; 10,000 shares
authorized; 3,960 issued and outstanding
($3,960 aggregate liquidation preference) 19,800
Common stock, par value $0.01 per share;
10,000 shares authorized; 2,000 issued and outstanding --
Additional paid-in capital 200
Accumulated deficit (4,724)
--------
15,276
--------
$ 22,778
========
The accompanying notes are an integral part of
these consolidated financial statements.
F-25
134
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands, except share data)
For the period
April 1, 1998
(commencement of
operations) to
December 31, 1998
-----------------
INCOME
Interest Income - Mortgage loans $ 2,803
Interest Income - Cash and cash equivalents 350
Net unrealized and realized gains on assets 18
-------
3,171
-------
INTEREST EXPENSE
Short-term debt 2,503
Credit support fees 139
Loans from Redwood Trust, Inc. 18
-------
2,660
-------
Total Income after Interest Expense 511
OPERATING EXPENSES
Compensation and benefits 3,395
General and administrative 1,840
-------
5,235
-------
NET LOSS $(4,724)
=======
The accompanying notes are an integral part of
these consolidated financial statements.
F-26
135
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the period April 1, 1998
(commencement of operations) to December 31, 1998
(In thousands, except share data)
Series A Accumulated
Preferred stock Common stock Additional other
--------------------- --------------------- paid-in comprehensive Accumulated
Shares Amount Shares Amount capital income deficit Total
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, April 1, 1998 -- $ -- -- $ -- $ -- $ -- $ -- $ --
- -----------------------------------------------------------------------------------------------------------------------------------
Issuance of preferred stock
Series A 3,960 19,800 -- -- -- -- -- 19,800
Issuance of common stock -- -- 2,000 -- 200 -- -- 200
Comprehensive income:
Net loss -- -- -- -- -- -- (4,724) (4,724)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 3,960 $ 19,800 2,000 $ -- $ 200 $ -- $ (4,724) $ 15,276
- -----------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of
these consolidated financial statements.
F-27
136
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
For the period
April 1, 1998
(commencement of
operations) to
December 31, 1998
-----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (4,724)
Adjustments to reconcile net loss to net cash used in
operating activities:
Purchases of mortgage loans: held for sale (543,296)
Proceeds from sales of mortgage loans: held for sale 525,418
Principal payments on mortgage loans 5,622
Amortization of mortgage asset premium and discount, net 27
Net unrealized and realized gains on assets (18)
Increase in accrued interest receivable (78)
Increase in other assets (742)
Increase in amounts due to Redwood Trust 445
Increase in accrued expenses and other liabilities 557
---------
Net cash used in operating activities (16,789)
---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term debt 519,347
Repayments on short-term debt (519,347)
Loans from Redwood Trust 10,500
Repayment of loans from Redwood Trust (4,000)
Net proceeds from issuance of preferred stock 19,800
Net proceeds from issuance of common stock 200
---------
Net cash provided by financing activities 26,500
---------
Net increase in cash and cash equivalents 9,711
Cash and cash equivalents at beginning of period --
---------
Cash and cash equivalents at end of period $ 9,711
=========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 2,518
=========
The accompanying notes are an integral part of
these consolidated financial statements.
F-28
137
RWT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
NOTE 1. THE COMPANY
RWT Holdings, Inc. ("Holdings") was incorporated in Delaware on February 13,
1998 and commenced operations on April 1, 1998. Holdings' first fiscal year-end
is December 31, 1998. Holdings originates, acquires, accumulates, services and
sells real estate mortgage loans ("Mortgage Loans"). Redwood Trust, Inc.
("Redwood Trust") owns all of the preferred stock and has a non-voting, 99%
economic interest in Holdings. Holdings has three subsidiaries which are
included in the consolidated financial statements. Redwood Financial Services,
Inc. ("RFS") acquires seasoned loan portfolios from banks and thrifts. Redwood
Residential Funding, Inc. ("RRF") acquires newly-closed residential loans from
mortgage bankers. Redwood Commercial Funding, Inc. ("RCF") originates small
balance commercial mortgages. Holdings and its subsidiaries currently utilize
both debt and equity to finance acquisitions. Assets are sold as loans or as
mortgage securities following securitization. References to Holdings in the
following footnotes refer to Holdings and its subsidiaries.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements for the period ended December 31, 1998
include the accounts of Holdings and its subsidiaries. All significant
intercompany balances and transactions with Holdings' consolidated subsidiaries
have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reported period. Actual
results could differ from those estimates. The primary estimates inherent in the
accompanying consolidated financial statements are discussed below.
Fair Value. Management estimates the fair value of its financial instruments
using available market information and other appropriate valuation
methodologies. The fair value of a financial instrument, as defined by Statement
of Financial Accounting Standards ("SFAS") No. 107, Disclosures about Fair Value
of Financial Instruments, is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation sale. Management's estimates are inherently subjective in
nature and involve matters of uncertainty and judgement to interpret relevant
market and other data. Accordingly, amounts realized in actual sales may differ
from the fair values presented in Note 6.
ADOPTION OF SFAS NO. 133
Holdings adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, effective July 1, 1998. Upon the adoption of SFAS No. 133, Holdings
did not record a transition adjustment, as there were no outstanding derivative
instruments. Immediately after the adoption of SFAS No. 133, Holdings elected to
not seek hedge accounting for any of its Interest Rate Agreements.
MORTGAGE LOANS: HELD-FOR-SALE
Mortgage Loans are recorded at the lower of cost or aggregate market value. Cost
generally consists of the loan principal balance net of any unamortized premium
or discount. Interest income is accrued based on the outstanding principal
amount of the Mortgage Loans and their contractual terms. Realized and
unrealized gains or losses on the loans are based on the specific identification
method and are recognized in "Net unrealized and realized gains on assets" on
the Consolidated Statement of Operations.
F-29
138
Some of the Mortgage Loans purchased by Redwood Trust for which securitization
or sale is contemplated are committed for sale by Redwood Trust to Holdings, or
a subsidiary of Holdings, under a Master Forward Commitment Agreement. As the
forward commitment is entered into on the same date that Redwood Trust purchases
the loans, the price under the forward commitment is the same as the price
Redwood Trust paid for the Mortgage Loans, as established by the external
market.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of three months or less. The carrying amount of cash
equivalents approximates their fair value.
INTEREST RATE AGREEMENTS
Holdings maintains an overall interest-rate risk-management strategy that
incorporates the use of derivative Interest Rate Agreements to minimize
significant unplanned fluctuations in earnings that are caused by interest-rate
volatility. Holdings currently designates Interest Rate Agreements as trading
instruments. There were no outstanding Interest Rate Agreements at December 31,
1998.
INCOME TAXES
Taxable earnings of Holdings are subject to state and federal income taxes at
the applicable statutory rates. Holdings provides for deferred income taxes if
any, to reflect the estimated future tax effects under the provisions of SFAS
No. 109, Accounting for Income Taxes. Under this pronouncement, deferred income
taxes, if any, reflect the estimated future tax effects of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and such amounts as measured by tax laws and regulations.
COMPREHENSIVE INCOME
SFAS No. 130, Reporting Comprehensive Income, requires Holdings to classify
items of "other comprehensive income" by their nature in a financial statement
and display the accumulated balance of other comprehensive income separately
from retained earnings and additional paid-in capital in the equity section of
the balance sheet. As of December 31, 1998 there was no other comprehensive
income.
RECENT ACCOUNTING PRONOUNCEMENT
In October 1998, the Financial Accounting Standards Board issued SFAS No. 134,
Accounting for Mortgage-Backed Securities Retained after the Securitization of
Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. SFAS No. 134
amends SFAS No. 65, Accounting for Certain Mortgage Backed Securities, to
require that after an entity that is engaged in mortgage banking activities has
securitized mortgage loans that are held for sale, it must classify the
resulting retained mortgage-backed securities or other retained interests based
on its ability and intent to sell or hold those investments. This statement is
effective for the first fiscal quarter beginning after December 15, 1998, with
earlier application encouraged. At this time the impact of adopting this
statement is not known.
NOTE 3. MORTGAGE ASSETS
At December 31, 1998 Mortgage Assets consisted of the following:
MORTGAGE LOANS: HELD-FOR-SALE
DECEMBER 31,
(IN THOUSANDS) 1998
-----------
Current Face $12,072
Unamortized Premium 175
-------
Carrying Value $12,247
=======
F-30
139
These Mortgage Loans are carried at the lower of cost or market. As a result,
Holdings recognized a lower of cost or market loss adjustment of $11,118 which
is reflected as a component of "Net unrealized and realized gains on assets" on
the Consolidated Statement of Operations.
NOTE 4. SHORT-TERM DEBT
During the second quarter of 1998, Holdings entered into reverse repurchase
agreements ("Short-Term Debt") in order to finance acquisitions of a portion of
its Mortgage Loans. The average balance of Short-Term Debt outstanding during
the period April 1, 1998 to December 31, 1998 was $54.6 million with a weighted
average borrowing rate of 6.30%. The maximum balance outstanding during the
period April 1, 1998 to December 31, 1998 was $367 million. Holdings did not
enter into reverse repurchase agreements in the third and fourth quarters.
Holdings may borrow under several of Redwood Trust's Short-Term Debt agreements
as a co-borrower. As of December 31, 1998, Holdings had no outstanding
borrowings under these agreements.
NOTE 5. INCOME TAXES
The provision for income taxes for the period from April 1, 1998 (commencement
of operations) through December 31, 1998 amounted to $ 2,400 and represents
minimum California franchise taxes. The effective tax rate differs from the
statutory federal income tax rate primarily due to state limitations on
recognizing the benefit of net operating losses (NOL).
The primary components of temporary differences that give rise to deferred taxes
at December 31, 1998 are:
(IN THOUSANDS) DECEMBER 31,
1998
-------------
Deferred tax assets:
Tax benefit of NOL $ 1,890
-------
Total deferred tax assets 1,890
Valuation allowance (1,890)
-------
Net deferred tax asset --
=======
Due to the uncertainty of realization of the NOL, a valuation allowance has been
provided to eliminate the deferred tax assets at December 31, 1998. The increase
in the valuation allowance amounted to $1.9 million for the period ended
December 31, 1998.
At December 31, 1998, Holdings had net operating loss carryforwards of
approximately $4.7 million for both federal and state income tax purposes. The
federal and state carryforwards expire through 2013 and 2003, respectively.
NOTE 6. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values of
Holdings' financial instruments at December 31, 1998.
(IN THOUSANDS) DECEMBER 31, 1998
------------------------------
CARRYING VALUE FAIR VALUE
------------------------------
Assets
Mortgage Loans: held-for-sale $12,247 $12,255
F-31
140
The carrying amounts of all other balance sheet accounts as reflected in the
financial statements approximate fair value because of the short-term nature of
these accounts.
NOTE 7. STOCKHOLDERS' EQUITY
The authorized capital stock of Holdings consists of Series A Preferred Stock
("Preferred Stock") and Common Stock. Holdings is authorized to issue 10,000
shares of Common Stock, each having a par value of $0.01, and 10,000 shares of
Preferred Stock, each having a par value of $0.01. All voting power is vested in
the common stock.
Holdings issued 3,960 shares of Preferred Stock to Redwood Trust, 1,980 shares
on April 1, 1998 and 1,980 shares on October 29, 1998. The Preferred Stock
entitles Redwood Trust to receive 99% of the aggregate amount of any such
dividends or distributions made by Holdings. The holders of the Common Stock are
entitled to receive the remaining 1% of the aggregate amount of such dividends
or distributions. The Preferred Stock ranks senior to the Common Stock as to the
payment of dividends and liquidation rights. The liquidation preference entitles
the holders of the Preferred Stock to receive $1,000 per share liquidation
preference before any distribution is made on the Common Stock. After the
liquidation preference, the holders of Preferred Stock are entitled to 99% of
any remaining assets.
NOTE 8. RELATED PARTY TRANSACTIONS
SALE OF MORTGAGE LOANS
During the second quarter of 1998, Holdings sold Mortgage Loans for $525.4
million. Of this amount, $161.8 million and $363.6 million of Mortgage Loans
were sold to Redwood Trust and Sequoia Mortgage Funding Corporation (a
subsidiary of Redwood Trust), respectively. The components of the sales
transaction for the period ended December 31, 1998 are presented below.
(IN THOUSANDS) DECEMBER 31,
1998
-----------
Proceeds from sales $525,418
Cost basis of loans 525,396
========
Net gain on sales $ 22
========
PURCHASE OF MORTGAGE LOANS
During December 1998, Redwood Trust purchased $8.3 million of commercial
mortgage loans. Pursuant to the Master Forward Commitment Agreement with Redwood
Trust (See Note 2), RCF committed to purchase the Mortgage Loans during the
first quarter of 1999 at the same price for which Redwood Trust acquired the
Mortgage Loans.
OTHER
Under a revolving credit facility arrangement, Redwood Trust may loan funds to
Holdings to finance certain Mortgage Loans owned by Holdings. These loans are
typically unsecured and are repaid within six months. Such loans bear interest
at a rate of 3.5% over the London Interbank Offered Rate ("LIBOR"). At December
31, 1998, Holdings had borrowed $6.5 million from Redwood in accordance with the
provisions of this arrangement.
Redwood Trust shares many of the operating expenses of Holdings, including
personnel and related expenses, subject to full reimbursement by Holdings.
During the period ended December 31, 1998, a total of $2.3 million of Holdings'
operating expenses were paid by Redwood Trust and $1.9 million was reimbursed by
Holdings. As of December 31, 1998, amounts due to Redwood Trust from Holdings
for operating expenses totaled $444,831.
Redwood Trust may provide credit support to Holdings to facilitate Holdings'
financings from third-party lenders and/or hedging arrangements with
counterparties. As part of this arrangement, Holdings is authorized as a
co-borrower under some of Redwood Trust's Short-Term Debt agreements subject to
Redwood Trust continuing to remain jointly and severally liable for repayment.
Accordingly, Holdings pays Redwood Trust credit support fees, which are
reflected in the
F-32
141
accompanying Consolidated Statement of Operations, on borrowings subject to this
arrangement. These fees are consistent with industry standards. At December 31,
1998, there were no amounts due to Redwood Trust for credit support fees.
NOTE 9. COMMITMENTS AND CONTINGENCIES
At December 31, 1998, Holdings is obligated under non-cancelable operating
leases with expiration dates through 2003. The future minimum lease payments
under these non-cancelable leases are as follows: 1999 - $526,625; 2000 -
$504,577; 2001 - $460,120; 2002 - $290,376; 2003 - $266,178.
Rent expense was $192,113 for the period ended December 31, 1998.
At December 31, 1998, RCF had entered into a commitment to purchase $8.3 million
of Mortgage Loans from Redwood Trust for settlement in February 1999.
NOTE 10. SUBSEQUENT EVENT
RFS operated as a division of Holdings during 1998. Effective January 1, 1999,
RFS commenced operations as a wholly-owned subsidiary of Holdings.
F-33
142
[PRICEWATERHOUSECOOPERS LLP LETTERHEAD]
REPORT OF INDEPENDENT ACCOUNTANTS
February 18, 1999
To The Board of Directors and Shareholders
RWT Holdings, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of RWT
Holdings, Inc. and Subsidiaries (the Company) at December 31, 1998, and the
results of its operations and its cash flows for the period from April 1, 1998
(commencement of operations) to December 31, 1998 in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audit. We conducted our audit
of these statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS, LLP
F-34
143
REDWOOD TRUST, INC.
INDEX TO EXHIBIT
Sequentially
Exhibit Numbered
Number Page
- ------- ---------
10.31 RWT Holdings, Inc. Series A Preferred Stock Purchase Agreement, dated
March 1, 1998
10.32 Administrative Personnel and Facilities Agreement, dated as of April
1, 1998, between Redwood Trust, Inc. and RWT Holdings, Inc.
10.32.1 First Amendment to Administrative Personnel and Facilities Agreement,
dated as of April 1, 1998 between Redwood Trust, Inc. and RWT
Holdings, Inc.
10.33 Lending and Credit Support Agreement, dated as of April 1, 1998,
between RWT Holdings, Inc., Redwood Residential Funding, Inc.,
Redwood Commercial Funding, Inc., Redwood Financial Services, Inc.
and Redwood Trust, Inc.
10.34 Form of Master Forward Commitment Agreements for RWT Holding, Inc.,
Redwood Residential Funding, Inc., Redwood Commercial Funding, Inc.
and Redwood Financial Services, Inc.
11.1 Computation of Earnings per Share
23 Consent of Accountants
27 Financial Data Schedule