<PAGE> 1
Rule 424(b)(5)
Registation No. 333-11665
PROSPECTUS SUPPLEMENT
(TO PROSPECTUS DATED SEPTEMBER 19, 1996)
1,250,000 SHARES
RWT
REDWOOD TRUST, INC.
COMMON STOCK
All of the shares of Common Stock offered hereby are being sold by Redwood
Trust, Inc. (the "Company"). The Company's Common Stock is traded on the
over-the-counter market and is quoted on the Nasdaq National Market under the
symbol "RWTI." On November 18, 1996, the last reported sales price per share of
Common Stock, as reported by Nasdaq, was $31.75. See "Market Prices and Dividend
Data."
SEE "RISK FACTORS" COMMENCING ON PAGE S-13 FOR A DISCUSSION OF CERTAIN FACTORS
THAT
SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE SHARES OF COMMON STOCK
OFFERED HEREBY.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
------------------------
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
- -----------------------------------------------------------------------------------------
Underwriting
Price to Discounts and Proceeds to
Public Commissions(1) Company(2)
- -----------------------------------------------------------------------------------------
Per Share................................ $31.750 $0.375 $31.375
Total.................................... $39,687,500 $468,750 $39,218,750
- -----------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------
</TABLE>
(1) See "Underwriting" for information concerning indemnification of the
Underwriter and other matters.
(2) Before deducting expenses payable by the Company estimated at $25,000.
The shares of Common Stock are offered by the Underwriter named herein,
when, as and if delivered to and accepted by the Underwriter, and subject to its
right to reject any order in whole or in part. It is expected that delivery of
the certificates representing the shares of Common Stock will be made against
payment therefor at the offices of Montgomery Securities on or about November
22, 1996.
------------------------
MONTGOMERY SECURITIES
November 19, 1996
<PAGE> 2
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF
THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN THE
OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE
DISCONTINUED AT ANY TIME.
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITER MAY ENGAGE IN PASSIVE
MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN
ACCORDANCE WITH RULE 10B-6A UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED (THE "EXCHANGE ACT"). SEE "UNDERWRITING."
CERTAIN INFORMATION CONTAINED IN THIS PROSPECTUS SUPPLEMENT, THE RELATED
PROSPECTUS AND THE DOCUMENTS INCORPORATED BY REFERENCE HEREIN AND THEREIN
CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE
SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND SECTION 21E OF
THE EXCHANGE ACT, WHICH CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING
TERMINOLOGY SUCH AS "MAY," "WILL," "EXPECT," "ANTICIPATE," "ESTIMATE" OR
"CONTINUE" OR THE NEGATIVE THEREOF OR OTHER VARIATIONS THEREON OR COMPARABLE
TERMINOLOGY. THE STATEMENTS IN "RISK FACTORS" CONTAINED WITHIN THIS PROSPECTUS
SUPPLEMENT CONSTITUTE CAUTIONARY STATEMENTS IDENTIFYING IMPORTANT FACTORS,
INCLUDING CERTAIN RISKS AND UNCERTAINTIES, WITH RESPECT TO SUCH FORWARD-LOOKING
STATEMENTS THAT COULD CAUSE THE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF
THE COMPANY TO DIFFER MATERIALLY FROM THOSE REFLECTED IN SUCH FORWARD-LOOKING
STATEMENTS.
S-2
<PAGE> 3
PROSPECTUS SUPPLEMENT SUMMARY
The following summary is qualified in its entirety by the more detailed
information and the financial statements (including notes thereto) appearing
elsewhere in this Prospectus Supplement and the accompanying Prospectus or
incorporated herein or therein by reference. Capitalized terms used but not
defined herein shall have the meanings ascribed thereto in the Glossary to the
Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995
which is incorporated herein by reference.
THE COMPANY
Redwood Trust, Inc. ("Redwood Trust" or the "Company") commenced operations
on August 19, 1994 and completed its initial public offering of common stock,
par value $0.01 per share ("Common Stock") on August 4, 1995 at a price of
$15.50 per share. On April 19, 1996 the Company completed its second public
offering of 2,875,000 shares of Common Stock at a price of $20.25 per share. On
August 8, 1996 the Company completed its public offering of 1,006,250 shares of
Class B 9.74% Cumulative Convertible Preferred Stock (the "Class B Preferred
Stock") at a price of $31.00 per share.
The Company specializes in acquiring and managing 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"). To date, a majority
of the Company's acquisitions have been Mortgage Securities. The Company
acquires Mortgage Assets that are secured by single-family real estate
properties located throughout the United States with a special emphasis on
properties located in the State of California, and may in the future acquire
Mortgage Assets secured by multi-family and commercial real estate properties.
Because the Company has elected to be subject to tax as a real estate investment
trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"),
it will generally not be subject to tax on its Federal income to the extent that
it distributes its earnings to its stockholders and it maintains its
qualification as a REIT. The Company is self-advised and self-managed.
The goal of the Company is to be an efficient long-term holder of Mortgage
Assets and to seek to benefit from any improvement in the real estate markets in
California and the United States. Substantially all of the Company's Mortgage
Assets are adjustable rate, bearing interest rates that adjust at least annually
based on changes in short-term market interest rates. The Company intends to
acquire additional Mortgage Assets through (i) selected purchases of Mortgage
Securities and (ii) acquisitions of Mortgage Loans from conduits and mortgage
loan originators. The Company also may create Mortgage Securities by using its
Mortgage Assets as collateral. The Company finances its purchases with the
proceeds of equity offerings and borrowings (primarily under reverse repurchase
agreements) whose interest rates also reflect changes in short-term market
interest rates. 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 (within a range of one to six months)
to the interest rate adjustment indices and interest rate adjustment periods of
the adjustable-rate Mortgage Assets purchased by the Company.
The Company was founded in 1994 by George E. Bull (Chairman and Chief
Executive Officer), Douglas B. Hansen (President and Chief Financial Officer)
and Frederick H. Borden (Vice Chairman and Secretary). This management team has
extensive experience in managing portfolios of Mortgage Assets, arranging
collateralized borrowings and utilizing asset/liability management techniques to
hedge balance sheet risks. Additionally, they have served in various capacities
in the banking, insurance, investment banking and investment management
industries and have managed both healthy and troubled financial institutions as
well as both performing and non-performing Mortgage Assets. This management team
founded Redwood Trust with the objective of building a company that could
compete favorably with its competitors by maintaining low operating expenses,
utilizing the team's expertise in managing Mortgage Assets and electing to be
subject to tax on its Federal income as a REIT.
From the commencement of operations on August 19, 1994 through September
30, 1996, the Company acquired Mortgage Assets that had a carrying value at
September 30, 1996 of approximately $1.38 billion. The Company carries Mortgage
Assets on its books at market value. All Mortgage Assets held at September 30,
S-3
<PAGE> 4
1996 were adjustable rate single-family residential Mortgage Loans or
securitized interests in pools of such Mortgage Loans. As of September 30, 1996,
97% of the Company's Mortgage Assets were investment grade equivalent (i.e., one
of the four highest rating levels by one or more nationally recognized mortgage
security rating agencies or the equivalent as determined by the Company), and
the Mortgage Asset portfolio had an average credit rating equivalent of AA+, as
determined by the Company.
All of these Mortgage Assets were acquired in the secondary market for
mortgage loans or directly from mortgage origination firms.
BUSINESS AND STRATEGY
The Company's principal business objective is to produce net interest
income on its Mortgage Assets while maintaining strict cost controls in order to
generate net income for distribution to stockholders. The Company seeks to
distribute dividends to stockholders at levels that generally adjust, following
a lag period, with changes in short-term market interest rates and that may
increase over time in the event of improvements in the single-family,
multifamily and commercial real estate markets. To achieve its business
objective and generate dividend yields that provide a relatively attractive rate
of return for stockholders, the Company's strategy is:
- to purchase Single-Family, Multifamily and Commercial Mortgage Assets,
the majority of which are currently expected to have adjustable interest
rates based on changes in short-term market interest rates and the
majority of which are expected to represent mortgage interests in
California real estate;
- to manage the credit risk of its Mortgage Assets through, among other
activities: (i) carefully selecting Mortgage Assets to be acquired,
including an underwriting review of Mortgage Loans and lower-rated
Mortgage Securities, (ii) following the Company's policies with respect
to credit risk concentration which, among other things, require the
Company to maintain a Mortgage Asset portfolio with a weighted average
rating level of A- or better, (iii) actively monitoring the ongoing
credit quality and servicing of its Mortgage Assets, and (iv) maintaining
appropriate capital levels and allowances for possible credit losses;
- to finance such purchases with the proceeds of equity offerings and, to
the extent permitted by the Company's capital and liquidity policies, to
utilize leverage to increase potential returns to stockholders through
borrowings, when possible the interest rates on these borrowings will be
structured to match the interest rate characteristics of the Mortgage
Assets;
- to attempt to structure its borrowings to have interest rate adjustment
indices and interest rate adjustment periods that, on an aggregate basis,
generally correspond (within a range of one to six months) to the
interest rate adjustment indices and interest rate adjustment periods of
the adjustable-rate Mortgage Assets purchased by the Company;
- to utilize interest rate caps, swaps and similar instruments to mitigate
the risk of the cost of its variable rate liabilities increasing at a
faster rate than the earnings on its Mortgage Assets during a period of
rising interest rates;
- to seek to minimize prepayment risk by structuring a diversified
portfolio with a variety of prepayment characteristics and through other
means;
- to apply securitization techniques designed to enhance the value and
liquidity of the Company's Mortgage Assets acquired in the form of
Mortgage Loans by securitizing them into Mortgage Securities that are
tailored to the Company's objectives;
- to re-securitize portions of its Mortgage Securities portfolio when the
underlying Mortgage Loans have improved in credit quality through
seasoning or rising underlying property values, or when the credit
quality of a junior class of security improves due to the prepayment of
more senior classes, as such re-
S-4
<PAGE> 5
securitization transactions may result in improved credit ratings, higher
market values and lowered borrowing costs; and
- to strive to become more cost-efficient over time.
The Company believes that the current economic environment is favorable for
the Company's business strategy. The Company is located in California and a
majority of its non-agency Mortgage Assets currently are and are expected to be
represented by mortgage interests on real property located in California. The
Company believes that there are attractive Mortgage Asset acquisition
opportunities in Northern and Southern California today due to the diversity of
the economy and the size, depth and liquidity of its real estate property
markets, and that there may be significant potential for appreciation in real
estate values in California in the future. At December 31, 1995 and September
30, 1996, approximately 71% and 69%, respectively, of the Company's non-agency
Mortgage Assets represented interests in mortgages on residential real property
located in California.
The Company believes that its principal competition in the business of
acquiring and managing Mortgage Assets are financial institutions such as banks,
savings and loans, life insurance companies, institutional investors such as
mutual funds and pension funds, and certain other mortgage REITs. While many of
these entities have significantly greater resources than the Company, the
Company anticipates that it will be able to compete effectively 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 Company believes it is and will continue to be a "low cost producer"
compared to most of its competitors in the business of holding Mortgage Assets.
Accordingly, the Company believes that it will be able to generate relatively
attractive earnings and dividends while holding Mortgage Assets of higher credit
quality and maintaining a lower interest rate risk profile as compared to its
principal competitors. Nevertheless, the Company will strive to become even more
cost-efficient over time. The Company will attempt to do so by: (i) seeking to
raise additional capital from time to time in order to increase its ability to
invest in Mortgage Assets as operating costs are not anticipated to increase as
quickly as Mortgage Assets and because growth will increase the Company's
purchasing influence with suppliers of Mortgage Assets; (ii) striving to lower
its effective borrowing costs over time through seeking direct funding with
collateralized lenders rather than using Wall Street intermediaries and
investigating the possibility of using commercial paper and medium term note
programs; (iii) improving the efficiency of its balance sheet structure by
investigating the issuance of various forms of debt and capital; and (iv)
utilizing information technology to the fullest extent possible in its business,
which technology the Company believes can be developed to improve the Company's
ability to monitor the performance of its Mortgage Assets, improve its ability
to assess credit risk, improve hedge efficiency and lower operating costs.
MORTGAGE ASSETS
The Mortgage Assets to be purchased by the Company will consist primarily
of Single-family, Multifamily and Commercial Mortgage Assets. Although all of
the Company's Mortgage Assets purchased through September 30, 1996 were
Single-Family Mortgage Assets, the Company expects to acquire Multifamily
Mortgage Assets and Commercial Mortgage Assets from time to time in the future
when this strategy is consistent with its Asset Acquisition/Capital Allocation
Policies. The Company expects substantially all of its Mortgage Assets to bear
adjustable interest rates. However, fixed rate Mortgage Assets also may be
acquired when they satisfy the Company's Asset Acquisition/Capital Allocation
Policies and management believes they will contribute to the Company's business
objectives with respect to desired levels of income and dividend distributions.
From time to time, the Company may also acquire common stock in other REITs that
invest primarily in Mortgage Assets if the Company believes the returns on such
common stock are good and such opportunities are more favorable than investing
in Mortgage Assets directly, provided such common stock is traded on a national
securities exchange or quoted on the Nasdaq National Market. The Company may
also acquire its own stock, when permitted by applicable securities and state
corporation laws.
S-5
<PAGE> 6
The Company expects that a majority of its Mortgage Assets will have
investment grade ratings (the four highest rating levels) from one or more
nationally recognized mortgage security rating agencies or be deemed by the
Company to be of comparable credit quality. Based upon the Company's investment
strategy and the guidelines under the Company's Asset Acquisition/Capital
Allocation Policies, the Company expects that the weighted average rating of its
Mortgage Assets (including the Company's deemed equivalent ratings for unrated
Mortgage Assets) will be at least an "A-" rating level under the Standard &
Poor's Corporation ("S&P") rating system or at a comparable level under other
rating systems.
In no event will the Company acquire or retain any real estate mortgage
investment conduit ("REMIC") residual interest that may give rise to "excess
inclusion" income as defined under Section 860E of the Code.
At September 30, 1996, the Company's Mortgage Assets consisted of the
following:
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1996(1)
------------------------------------------------------
PERCENT OF
MORTGAGE ASSETS RATING SCALE(3)
CARRYING VALUE --------------- ---------------
--------------
(DOLLARS IN
THOUSANDS)
<S> <C> <C> <C>
Whole Loans(2)........................... $ 127,695 9.3% 1.5
AAA -- Agency............................ 879,513 63.9% 1.0
AAA...................................... 118,309 8.6% 1.0
AA....................................... 199,066 14.5% 2.0
A........................................ 18,672 1.4% 3.0
BBB...................................... 7,076 0.5% 4.0
BB....................................... 11,116 0.8% 5.0
B........................................ 13,789 1.0% 6.0
Other.................................... 634 0.0% 6.0
---------- ----- ----
Total/Weighted Average................... 1,375,870 100% 1.37
Weighted Average Rating.................. AA+
Percentage Investment Grade.............. 97%
Weighted Average Rating on Non-agency
Portfolio.............................. AA 1.88
Percentage Investment Grade of Non-agency
Portfolio.............................. 93%
</TABLE>
- ---------------
(1) All Mortgage Assets are rated by one or more of the four nationally
recognized rating agencies or are assigned a rating deemed equivalent by
the Company. When rating agencies have assigned different ratings to the
same Mortgage Asset, management has assigned that Mortgage Asset to the
category it believes is most appropriate.
(2) If rated, management believes that 90-95% of these Mortgage Loans would
receive investment grade ratings. For inclusion in the overall averages,
94% are assumed to be investment grade, producing an average rating of AA+.
(3) For purposes of computing a weighted average portfolio rating, management
has assigned a number to each rating level, with AAA being a "1" and B or
below being a "6," as indicated in the foregoing table.
Among the Mortgage 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 the anticipated cashflows from the Mortgage Asset, (ii) the Company's ability
to pledge the Mortgage Asset to secure 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 Mortgage Asset, and (iv) the costs of financing, hedging, managing,
securitizing and reserving for the Mortgage Asset. Prior to acquisition,
potential returns on capital employed are assessed over the life of the Mortgage
Asset and in a variety of interest rate, yield spread, financing cost, credit
loss and prepayment scenarios.
S-6
<PAGE> 7
Credit Risk Management Policies
The Company reviews credit risk, interest rate risk and other risk of loss
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. The Board of Directors
monitors the overall portfolio risk and determines appropriate levels of
provision for loss.
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 Mortgage Assets and the nature and level of credit enhancements
supporting such securities. Most of the Mortgage Assets acquired by the Company
have some degree of protection from normal credit losses. At December 31, 1995
and September 30, 1996, 55.8% and 63.9%, 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 (GNMA, FNMA and FHLMC)
("Agency Certificates").
An additional 38.1% and 26.8% of the Company's Mortgage Assets at December
31, 1995 and September 30, 1996, respectively, were Privately Issued
Certificates and represented interests in pools of residential mortgage loans
with partial credit enhancement; of these amounts, 85% and 93% were rated
investment grade equivalent, respectively. 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 though
other means. The degree of credit protection varies substantially among the
Privately Issued Certificates held by the Company. While most Privately Issued
Certificates held by the Company have some degree of credit enhancement, the
majority of such Mortgage Assets 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. At September 30, 1996, the amount of realized
credit losses a particular pool of mortgages represented by Privately Issued
Certificates would have to experience before the Company would bear
responsibility for any credit losses ranged from 0% to 46% of the pool balance.
The Company has undertaken an independent underwriting review of a sample of the
loans underlying the Privately Issued Certificates that are rated below BBB.
All of the Company's Mortgage Assets have received a credit rating from one
or more nationally recognized rating agencies or have been assigned a rating
deemed equivalent by the Company. At September 30, 1996, the average rating of
the Company's Mortgage Assets, as adjusted to a single format and weighted by
carrying value, was AA+. At September 30, 1996, the average rating of the
non-agency Mortgage Assets was AA.
At September 30, 1996, the Company owned $127.7 million of whole Mortgage
Loans, which comprised 9.3% of the Company's total Mortgage Assets at such date.
In preparation for purchases of Mortgage Assets in the form of Mortgage Loans,
the Company developed a quality control program to monitor the quality of loan
underwriting at the time of acquisition and on an ongoing basis. The Company
conducts 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 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. In addition, the Company or its agents will underwrite all
Multifamily and Commercial Mortgage Loans. 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
obligations or guarantees.
S-7
<PAGE> 8
Capital and Leverage Policies
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 during adverse market conditions. The Company has established a
"Risk-Adjusted Capital Policy" which limits management's ability to acquire
additional Mortgage Assets during times when the actual capital base of the
Company is less than a required amount defined in the policy. 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 less the book value of total collateralized borrowings. The
actual capital base, as so defined, represents the approximate liquidation value
of the Company and approximates the market value of assets that can be pledged
or sold to meet over-collateralization requirements for the Company's
borrowings. The unpledged portion of the Company's actual capital base is
available to be pledged or sold as necessary to maintain over-collateralization
levels for the Company's borrowings.
Management is prohibited from acquiring additional Mortgage Assets during
periods when the actual capital base of the Company is less than the minimum
amount required under the Risk-Adjusted Capital Policy (except when such
Mortgage Asset acquisitions may be necessary to maintain REIT status or the
Company's exemption from the Investment Company Act of 1940). In addition, when
the actual capital base falls below the Risk-Adjusted Capital Policy
requirements, management is required to submit to the Board a plan for bringing
the actual capital base into compliance with the Risk-Adjusted Capital Policy
requirements. It is anticipated that in most circumstances this goal will be
achieved over time without overt management action through the natural process
of mortgage principal repayments and increases in the market values of Mortgage
Assets as their coupon rates adjust upwards to market levels. Management
anticipates that the actual capital base is likely to exceed the Risk-Adjusted
Capital requirement during periods following new equity offerings and during
periods of falling interest rates and that the actual capital base may fall
below the Risk-Adjusted Capital Policy requirement during periods of rising
interest rates.
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 will raise or lower the capital requirement accordingly.
The Company expects that its aggregate minimum capital requirement under
the Risk-Adjusted Capital Policy will approximate 6% to 15% of the market value
of the Company's Mortgage Assets. 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 the
Mortgage Assets changes and as liquidity capital cushion percentages set by the
Board of Directors are adjusted over time. As of September 30, 1996 the
aggregate Risk-Adjusted Capital Policy requirement was 10.3% of Mortgage Assets,
and the Company's actual capital base was 11.7% of Mortgage Assets.
The Risk-Adjusted Capital Policy also stipulates that at least 50% of the
capital base maintained to satisfy the liquidity capital cushion shall be
invested in Agency Certificates, AAA-rated adjustable-rate Mortgage Securities
or Mortgage Assets with similar or better liquidity characteristics.
Pursuant to the Company's overall business strategy, a substantial portion
of the Company's borrowings are short term or adjustable-rate. The Company's
borrowings currently are implemented primarily through reverse repurchase
agreements (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 interest on
the borrowing), but in the future may also be obtained through loan agreements,
lines of credit, 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 and issuance of debt
securities such as commercial paper, medium-term notes, CMOs and senior or
subordinated notes.
S-8
<PAGE> 9
ASSET/LIABILITY MANAGEMENT PROGRAMS
Interest Rate Risk Management Program
To the extent consistent with its election to qualify as a REIT, the
Company follows an interest rate risk management program intended to protect
against the effects of major interest rate changes. Specifically, the Company's
interest rate risk management program is formulated with the intent to offset
the potential adverse effects resulting from rate adjustment limitations on its
Mortgage Assets and the differences between interest rate adjustment indices and
interest rate adjustment periods of its adjustable-rate Mortgage Assets and
related borrowings. The Company's interest rate risk management program
encompasses a number of procedures, including: (i) 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 Mortgage Assets purchased by the Company, so as to limit
mis-matching of such aggregates to a range of one to six months, and (ii) the
Company attempts to structure its borrowing agreements relating to
adjustable-rate Mortgage Assets to have a range of different maturities and
interest rate adjustment periods (although substantially all reverse repurchase
agreements will be less than one year). As a result, the Company expects to be
able to adjust the average maturity/adjustment period of such borrowings on an
ongoing basis by changing the mix of maturities and interest rate adjustment
periods as borrowings come due and are renewed. Through use of these procedures,
the Company intends to minimize differences between interest rate adjustment
periods of adjustable-rate Mortgage Assets and related borrowings that may
occur.
The Company purchases interest rate caps, interest rate swaps and similar
instruments to attempt to mitigate the risk of the cost of its variable rate
liabilities increasing at a faster rate than the earnings on its Mortgage Assets
during a period of rising rates. In this way, the Company intends generally to
hedge as much of the interest rate risk as management determines is in the best
interests of the Company, given the cost of such hedging transactions and the
need to maintain the Company's status as a REIT, among other factors. 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 advisable. The Company
may also, to the extent consistent with its compliance with the REIT Gross
Income Tests, Maryland law and the no-action relief discussed below, utilize
financial futures contracts, options and forward contracts as a hedge against
future interest rate changes. The Company obtained no-action relief from the
Commodities Futures Trading Commission permitting the Company to invest a small
percentage of the Company's Mortgage 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 which 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, as discussed in the first part of this section, and capital
preservation concerns. With regard to the latter, the Company monitors its
"equity duration." This is the expected percentage change in the Company's
equity (measured as the carrying value of total assets less book value of total
liabilities) that would be caused by a 1% change in short and long term interest
rates. To date, the Company believes that it has met its goal of maintaining an
equity duration of less than 15%. To monitor its equity duration and the related
risks of fluctuations in the liquidation value of the Company's equity, 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 program 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 (and lower its equity duration)
during periods when management believes a trend of rapidly rising interest rates
has been established, management may decide to increase hedging activities
and/or sell assets. Each of these types of actions may lower the earnings and
dividends 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.
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<PAGE> 10
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.
Although the Company believes it has developed a cost-effective
asset/liability management program to provide a level of protection against
interest rate and prepayment risks, no strategy can completely insulate the
Company from the effects of interest rate changes, prepayments and defaults by
counterparties. 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.
Prepayment Risk Program
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, and balancing Mortgage Assets
purchased at a premium with Mortgage Assets purchased at a discount. In
addition, the Company has purchased and may in the future purchase additional
interest-only strips to a limited extent as a hedge against prepayment risk.
Prepayment risk is monitored by management and the Board of Directors 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.
DIVIDEND POLICY AND DISTRIBUTIONS
The Company intends to distribute to stockholders each year substantially
all of its net taxable income (which does not ordinarily equal net income as
calculated in accordance with GAAP) so as to qualify for the tax benefits
accorded to REITs under the Code. The Company intends to make dividend
distributions on the Common Stock at least quarterly; provided, however, that no
dividends will be paid or set apart for payment on shares of Common Stock unless
full cumulative dividends have been paid on the Class B Preferred Stock.
The Company has adopted a Dividend Reinvestment Plan ("DRP") that allows
stockholders to have their dividends reinvested automatically in shares of
Common Stock at 97% of the then current market price. The shares of Common Stock
to be acquired for distribution under the DRP will be purchased on the open
market or directly from the Company, at the option of the Company.
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<PAGE> 11
SUMMARY FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS PERIOD FROM
ENDED FOR THE AUGUST 19,
SEPTEMBER 30, YEAR ENDED 1994 TO
------------------- DECEMBER 31, DECEMBER 31,
1996 1995 1995 1994
------- ------- --------------- ------------
<S> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Interest Income............................. $41,403 $ 9,116 $ 15,726 $ 1,296
Interest and Hedge Expenses................. 30,480 6,365 10,947 768
Net Interest Income......................... 10,923 2,751 4,779 528
Net Income Available to Common
Stockholders.............................. 7,453 1,845 3,155 382
Primary Earnings per Share.................. $ 0.90 $ 0.67 $ 0.85 $ 0.20
Dividends Declared per Class A Preferred
Share(1).................................. $ 0.000 $ 0.500 $ 0.500 $ 0.250
Dividends Declared per Class B Preferred
Share(2).................................. $ 0.386 $ 0.000 $ 0.000 $ 0.000
Dividends Declared per Common Share......... $ 1.260 $ 0.200 $ 0.460 $ 0.000
</TABLE>
<TABLE>
<CAPTION>
AT AT
SEPTEMBER 30, DECEMBER 31,
1996 1995
--------------- ------------
<S> <C> <C> <C> <C>
BALANCE SHEET DATA (AT PERIOD END):
Total Mortgage Assets............................................ $ 1,375,870 $432,244
Total Assets..................................................... 1,403,478 441,557
Short-term Borrowings............................................ 1,225,094 370,316
Stockholders' Equity............................................. 163,517 68,290
</TABLE>
- ---------------
(1) All shares of Class A Preferred Stock were converted into Common Stock in
August 1995.
(2) All shares of Class B Preferred Stock were issued in August 1996.
RECENT DEVELOPMENTS
On November 15, 1996, the Company committed to acquire an approximate $411
million portfolio of seasoned "A"-quality single-family adjustable-rate
first-lien whole mortgage loans from a commercial bank. The portfolio, which is
subject to change before the scheduled acquisition closing date of December 15,
1996, currently consists of 1,725 mortgage loans with an average balance of
$238,300. The average mortgage coupon of 7.86% is close to the fully-indexed
rate of the loans. On average, the coupons on the loans adjust annually to a net
margin of 2.46% over the one year Treasury (CMT) index, subject to a 2% annual
periodic cap and a life cap of 11.67%. The properties securing the loans are
located in California (30%), Maryland (10%), Florida (6%) and Virginia (5%). No
other state accounts for more than 5% of the portfolio. No more than 0.7% of the
properties securing the loans are located in any one zip code. Approximately,
94% of the loans were originated in 1994 or earlier. The average original
loan-to-value ratio of the loans is 76.5%. Loans with a loan-to-balance ratio
over 80% make up 23% of the portfolio; the effective loan-to-value ratio to the
Company on these loans is 75% or less as all such loans have primary mortgage
insurance. Currently, there are no delinquent loans in the portfolio.
Between the end of the third quarter on September 30, 1996 and November 15,
1996, the Company also acquired or committed to acquire $210 million of other
single-family, adjustable-rate Mortgage Assets. These acquisitions, when
completed, will consist of approximately $23 million of "A" quality whole
Mortgage Loans, approximately $150 million of FNMA- and FHLMC-guaranteed
Mortgage Securities, and approximately $37 million of private-label Mortgage
Securities rated AAA or AA.
Although closing on the remaining acquisitions discussed above is
contingent on several factors, the Company currently believes all of these
transactions are likely to close as planned during the months of
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<PAGE> 12
November and December 1996. The Company believes it currently has sufficient
liquidity and borrowing capacity to close all these transactions.
The Company believes that its fourth quarter asset acquisitions, in
conjunction with the completion of this offering, will be beneficial over time
on both earnings and dividends per share. The net impact of these activities for
fourth quarter earnings per share depends on a variety of factors and is not
expected to be material. The net impact of this offering on the Company's fourth
quarter dividend per share declaration is likely to be somewhat negative as the
share base on which dividends will be payable will expand by approximately 10%.
The total asset size of the Company upon the completion of these fourth
quarter transactions will be approximately $1.94 billion and the Company's
Risk-Adjusted Capital Policy guideline will be approximately $200 million. The
Company is seeking to complete this offering of approximately $40 million to
raise its equity base from the current $164 million to a level above the
Risk-Adjusted Capital Policy guideline.
The Company has generally grown in the past by issuing equity and then
seeking to acquire Mortgage Assets over time in order to fully employ the
capital raised. In order to employ new capital more efficiently, the Board of
Directors approved a permanent modification to the Company's Risk-Adjusted
Capital Policy on October 31, 1996. Management is now able to acquire Mortgage
Assets when attractive opportunities present themselves in excess of the level
at which the Company's capital base would have been fully employed under the
pre-existing Risk-Adjusted Capital Policy. As a result, when additional equity
is raised, the new capital will already be fully employed at the time that new
shares are issued. Such excess asset acquisitions are subject to a variety of
limitations, including (i) that additional asset growth not increase the balance
sheet size by more than 10% beyond the point at which capital has been fully
employed under the pre-existing Risk-Adjusted Capital Policy guidelines, and
(ii) that the Company seek to issue additional equity to bring the Company into
compliance with the pre-existing Risk-Adjusted Capital Policy guidelines.
In addition, the Board also approved a special temporary waiver to the
newly modified Risk-Adjusted Capital Policy, again subject to certain
limitations and with an expiration date of December 31, 1996 which allowed the
Company to make arrangements to acquire the $411 million portfolio described
above. Once this offering is completed, this temporary waiver will also allow
the Company to bid to acquire other large portfolios of Mortgage Assets should
they become available for sale in the fourth quarter of 1996.
An allowance for credit losses is maintained at a level deemed appropriate
by management to provide for known 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 non-agency 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.
In the past, the Company has provided for a 30 basis point allowance for
credit losses immediately upon the acquisition of whole Mortgage Loans as a
method to estimate its resource requirements. For the $411 million portfolio the
Company has committed to acquire, this practice would result in a fourth quarter
charge to earning of $1.233 million, or approximately $0.12 per share. The
Company believes that a full reserve charge taken in this up-front manner would
not be reflective of the likely timing of anticipated credit losses; this
portfolio, for example, will have no delinquent loans at closing so credit
losses in the first year, given information available today, are expected to be
minor. Accordingly, the Company plans to maintain an allowance for credit losses
as described above, and will recognize credit provisions over time, as credit
risk factors require. The Company expects that a 30 basis point allowance for
credit risk will be built over a 24 month period. The negative earnings impact
from the provisions for this portfolio are anticipated to be less than $0.02 per
share per quarter for the next eight quarters. For future whole loan
acquisitions, the Company also intends to build a reserve over 24 months so long
as the rate of credit loss is anticipated to be lower than this provisioning
schedule. The Company will continue to monitor the credit quality trends of its
Mortgage Assets and may increase or decrease its rate of provisioning
accordingly. The Company currently anticipates that its credit reserve at
December 31, 1996 will exceed $2 million.
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<PAGE> 13
USE OF PROCEEDS
The net proceeds to be received by the Company from the sale of the
1,250,000 shares of Common Stock being offered hereby by the Company are
estimated to be approximately $39,193,750 after deducting underwriting discounts
and commissions and estimated expenses. The net proceeds, together with
borrowings, will be used to purchase Mortgage Assets as described herein. See
"Prospectus Supplement Summary -- Recent Developments." Pending use of the
proceeds to purchase such Mortgage Assets, the net proceeds will be used to
reduce borrowings. The Company intends to increase its investment in Mortgage
Assets by borrowing against existing Mortgage Assets and using the proceeds to
acquire additional Mortgage Assets. The Company's borrowings are secured by the
Mortgage Assets owned by the Company. Until the proceeds are fully utilized
along with borrowings in this manner, the Company's net earnings are expected to
be lower than would be the case if this financing strategy were fully
implemented.
RISK FACTORS
In addition to the other information contained in this Prospectus
Supplement, the following risk factors should be carefully considered in the
evaluating the Company and its business before purchasing any of the shares of
Common Stock offered hereby.
OPERATIONS RISKS
GENERAL
The results of the Company's operations are affected by various factors,
many of which are beyond the control of the Company. The results of the
Company's operations depend on, among other things, the level of net interest
income generated by the Company's Mortgage Assets, the market value of such
Mortgage Assets and the supply of and demand for such Mortgage Assets. The
Company's net interest income varies primarily as a result of changes in
short-term interest rates, 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 upon 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
rates may significantly affect the Company's activities, the operating results
of the Company depend, in large part, upon the ability of the Company to
effectively manage its interest rate and prepayment risks while maintaining its
status as a REIT.
RISKS OF SUBSTANTIAL LEVERAGE AND POTENTIAL NET INTEREST AND
OPERATING LOSSES IN CONNECTION WITH BORROWINGS
General
The Company intends to continue to employ its financing strategy to
increase the size of its Mortgage Asset investment portfolio by borrowing a
substantial portion (which may vary depending upon the mix of the Mortgage
Assets in the Company's portfolio and the application of the Risk-Adjusted
Capital Policy requirements to such mix of Mortgage Assets) of the market value
of its Mortgage Assets. The Company expects generally to maintain a ratio of its
total book capital base (book value of capital accounts, retained earnings and
subordinated debt deemed by management to qualify as capital for this purpose,
taking into account valuation adjustments) to book value of total Mortgage
Assets of between 10% and 20%, although the percentage may vary from time to
time depending upon market conditions and other factors deemed relevant by
management. However, the Company is not limited under its Bylaws in respect of
the amount of its borrowings, whether secured or unsecured, and the aggregate
percentage of total equity capital could at times be lower than 10%. If the
returns on the Mortgage Assets purchased with borrowed funds fail to cover the
cost of the borrowings, the Company will experience net interest losses and may
experience net losses. In addition, through increases in haircuts, decreases in
the market value of the Company's Mortgage Assets, increases in
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<PAGE> 14
interest rate volatility, availability of financing in the market, circumstances
then applicable in the lending market and other factors, the Company may not be
able to achieve the degree of leverage it believes to be optimal, which may
cause the Company to be less profitable than it would be otherwise.
Risk of Failure to Refinance Outstanding Borrowings
Additionally, the ability of the Company to achieve its investment
objectives depends not only on its ability to borrow money in sufficient amounts
and on favorable terms but also on the Company's ability to renew or replace on
a continuous basis its maturing short-term borrowings. The Company's business
strategy relies on short-term borrowings to fund Mortgage Assets with
adjustable-rate coupons and long-term maturities. The Company has not at the
present time entered into any commitment agreements under which a lender would
be required to enter into new borrowing agreements during a specified period of
time; however, the Company may enter into one or more of such commitment
agreements in the future if deemed favorable to the Company. In the event the
Company is not able to renew or replace maturing borrowings, the Company could
be required to sell Mortgage Assets under adverse market conditions and could
incur losses as a result. In addition, in such event, the Company may be
required to terminate hedge positions, which could result in further costs to
the Company. An event or development such as a sharp rise in interest rates or
increasing market concern about the value or liquidity of a type or types of
Mortgage Loans or Mortgage Securities in which the Company's portfolio is
concentrated will reduce the market value of the Mortgage Assets, which would
likely cause lenders to require additional collateral. At the same time, the
market value of the Mortgage Assets in which the Company's liquidity capital is
invested may have decreased. A number of such factors in combination may cause
difficulties for the Company, including a possible liquidation of a major
portion of the Company's Mortgage Assets at disadvantageous prices with
consequent losses, which could have a materially adverse effect on the Company
and its solvency.
Risk of Decline in Market Value of Mortgage Assets; Margin Calls
Certain of the Company's Mortgage Assets may be cross-collateralized to
secure multiple borrowing obligations of the Company to a single lender. A
decline in the market value of such Mortgage Assets may limit the Company's
ability to borrow or result in lenders initiating margin calls (i.e., requiring
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). In the event that the
Company acquires fixed-rate Mortgage Assets pursuant to its Asset
Allocation/Capital Allocation Policies, such fixed-rate Mortgage Assets may be
more susceptible to margin calls as increases in interest rates tend to more
negatively affect the market value of fixed-rate Mortgage Assets than
adjustable-rate Mortgage Assets. This remains true despite effective hedging
against such fluctuations as 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. The
Company could be required to sell Mortgage Assets under adverse market
conditions in order to maintain liquidity. Such sales may be effected by
management when deemed by it necessary in order to preserve the capital base of
the Company. If these sales were made at prices lower than the amortized cost of
the Mortgage Assets, the Company would experience losses. A default by the
Company under its 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 a bankruptcy of the Company, certain
reverse repurchase agreements may qualify for special treatment under the
Bankruptcy Code, the effect of which is, among other things, to allow the
creditors under such agreements to avoid the automatic stay provisions of the
Bankruptcy Code and to liquidate the collateral under such agreements without
delay.
To the extent the Company is compelled to liquidate Mortgage Assets
qualifying as Qualified REIT Real Estate Assets to repay borrowings, the Company
may be unable to comply with the REIT Provisions of the Code regarding assets
and sources of income requirements, ultimately jeopardizing the Company's status
as a REIT.
S-14
<PAGE> 15
RISK OF DECREASE IN NET INTEREST INCOME DUE TO INTEREST RATE FLUCTUATIONS;
PREPAYMENT RISKS OF MORTGAGE ASSETS
The Company's Mortgage Assets bear, and the Company expects that a
substantial portion of the Company's Mortgage Assets in the future will bear,
adjustable interest or pass-through rates based on short-term interest rates,
and substantially all of the Company's borrowings will bear interest at
short-term rates and have and will have maturities of less than one year.
Consequently, changes in short-term interest rates may significantly influence
the Company's net interest income. While increases in short-term interest rates
will generally increase the yields on the Company's adjustable-rate Mortgage
Assets, rising short-term rates will also increase the costs of borrowings by
the Company which will be utilized to fund the Mortgage Assets and, to the
extent such costs rise more rapidly than the yields, the Company's net interest
income may be reduced or a net loss may result. Conversely, decreases in
short-term interest rates may decrease the interest cost on the Company's
borrowings more rapidly than the yields on the Mortgage Assets and hence may
increase the Company's net interest income. No assurance can be given as to the
amount or timing of changes in interest rates or their effect on the Company's
Mortgage Assets or net interest income.
Mortgage Asset prepayment rates vary from time to time and may cause
changes in the amount of the Company's net interest income. Prepayments of ARMs
and Mortgage Securities backed by ARMs usually can be expected to increase when
mortgage interest rates fall below the then-current interest rates on such ARMs
and decrease when mortgage interest rates exceed the then-current interest rates
on the ARMs, although such effects are not predictable. Prepayment experience
also may be affected by the geographic location of the property securing the
Mortgage Loans, the assumability of the Mortgage Loans, conditions in the
housing and financial markets and general economic conditions. In addition,
prepayments on ARMs are affected by the ability of the borrower to convert an
ARM to a fixed-rate loan and by conditions in the fixed-rate mortgage market. If
the interest rates on ARMs increase at a rate greater than the interest rates on
fixed-rate Mortgage Loans, prepayments on ARMs may tend to increase. In periods
of fluctuating interest rates, interest rates on ARMs may exceed interest rates
on fixed-rate Mortgage Loans, which may tend to cause prepayments on ARMs to
increase at a rate greater than anticipated. The Company seeks to minimize
prepayment risk through a variety of means, including 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, and balancing Mortgage
Assets purchased at a premium with Mortgage Assets purchased at a discount. In
addition, the Company has purchased and may in the future purchase additional
interest-only strips to a limited extent. However, no strategy can completely
insulate the Company from prepayment risks arising from the effects of interest
rate changes.
Changes in anticipated prepayment rates of Mortgage Assets could affect the
Company in several adverse ways. The faster than anticipated prepayment of any
Mortgage Asset that had been purchased at a premium by the Company would
generally result in a faster than anticipated write-off of any remaining
capitalized premium amount and consequent reduction of the Company's net
interest income by such amount. In addition, a portion of the adjustable-rate
Single-Family Mortgage Loans acquired or to be acquired by the Company (either
directly as Mortgage Loans or through Mortgage Securities backed by ARMs) have
or will have been recently originated and will still bear initial interest rates
which are lower than their "fully-indexed" rates (the applicable index plus
margin). In the event that such an ARM is prepaid faster than anticipated prior
to or soon after the time of adjustment to a fully-indexed rate, the Company
will have experienced an adverse effect on its net interest income during the
time it held such ARM compared with holding a fully-indexed ARM and will have
lost the opportunity to receive interest at the fully-indexed rate over the
expected life of the ARM. These effects may be mitigated to the extent such ARMs
were acquired at a discount.
RISK OF FAILING TO HEDGE AGAINST INTEREST RATE CHANGES EFFECTIVELY;
RISK OF LOSSES ASSOCIATED WITH HEDGING; COUNTERPARTY RISKS
The Company's operating strategy subjects it to interest rate risks as
described above. The Company follows an asset/liability management program
intended to protect against interest rate changes and prepayments. Nevertheless,
developing an effective asset/liability management strategy is complex and no
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<PAGE> 16
strategy can completely insulate the Company from risks associated with interest
rate changes and prepayments. In addition, there can be no assurance that the
Company's hedging activities will have the desired beneficial impact on the
Company's results of operations 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. The Company may increase its hedging
activity, and thus increase its hedging costs, during such periods when interest
rates are volatile or rising and hedging costs have increased. Moreover, Federal
tax laws applicable to REITs may substantially limit the Company's ability to
engage in asset/liability management transactions. Such Federal tax laws may
prevent the Company from effectively implementing hedging strategies that the
Company determines, absent such restrictions, would best insulate the Company
from the risks associated with changing interest rates and prepayments.
The Company purchases from time to time interest rate caps, interest rate
swaps and similar instruments to attempt to mitigate the risk of the cost of its
variable rate liabilities increasing at a faster rate than the earnings on its
assets during a period of rising rates. In this way, the Company intends
generally to hedge as much of the interest rate risk as management determines is
in the best interests 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. In
this regard, the amount of income the Company may earn from its interest rate
caps and other hedging instruments is subject to substantial limitations under
the REIT Provisions of the Code. In particular, when the Company earns income
under such instruments, it 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
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
advisable.
In the event that the Company purchases interest rate caps or other
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, the Company may be forced to unwind its interest rate agreements
with such provider and may take a loss on such interest rate agreements.
Although the Company intends to purchase interest rate agreements only from
financially sound institutions and to monitor the financial strength of such
institutions on a periodic basis, no assurance can be given that the Company can
avoid such third party risks.
RISK OF LOSS ON SINGLE-FAMILY MORTGAGE ASSETS
Ninety-one percent (91%) of the Mortgage Assets the Company had acquired as
of September 30, 1996 were Mortgage Securities. The Company bears the risk of
loss on any Mortgage Securities it purchases in the secondary mortgage market or
otherwise. However, such Mortgage Securities, including all Mortgage Securities
purchased as of December 31, 1995, are either Agency Certificates or are
generally structured with one or more types of credit enhancement. To the extent
third parties have been contracted to provide the credit enhancement, the
Company is dependent in part upon the creditworthiness 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 by the Company. The Company expects that a substantial portion of its
Single-Family Mortgage Assets in the future may constitute Mortgage Loans and
Mortgage Securities acquired in exchange for such Mortgage Loans as explained
below. The Company generally does not intend to obtain credit enhancements such
as mortgage pool or special hazard insurance for its Single-Family Mortgage
Loans, other than FHA insurance, VA guarantees and private mortgage insurance,
in each case relating only to individual Mortgage Loans. Accordingly, during the
time it holds such Mortgage Loans for which third party insurance is not
obtained, the Company 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 Single-Family Mortgage Loan held by the Company, including,
without limitation, any event of default resulting from higher default levels as
a result of declining property values and worsening economic conditions, among
other factors, the Company would bear the risk of loss of principal to the
extent of any deficiency between the value of the related mortgage property,
plus any
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<PAGE> 17
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
borrowings and would have to be financed by the Company out of other funds until
ultimately liquidated, resulting in increased financing costs and reduced net
income or a net loss.
RISK OF FUTURE REVISIONS IN POLICIES AND STRATEGIES BY BOARD OF DIRECTORS
The Board of Directors has established the investment policies and
operating policies and strategies set forth in this Prospectus as the investment
policies and operating policies and strategies of the Company. However, these
policies and strategies may be modified or waived by the Board of Directors,
subject in certain cases to approval by a majority of the Independent Directors,
without stockholder consent. The ultimate effect of changes in these policies
and strategies may be positive or negative. See "Prospectus Supplement Summary
- -- Recent Developments" for a description of a recent change to the
Risk-Adjusted Capital Policy.
LEGAL AND OTHER RISKS
DEPENDENCE ON KEY PERSONNEL
The Company's operations depend in significant part upon the contributions
of its executive officers many of whom would be difficult to replace. Although
all executive officers currently have employment agreements with the Company,
there can be no assurance of the continued employment of all such officers. The
loss of any key person could have a material adverse effect on the Company's
business and results of operations.
CAPITAL STOCK PRICE VOLATILITY RISK
With respect to the public market for the Common Stock, it is likely that
the market price of the Common Stock will be influenced by any variation between
the net yield on the Company's Mortgage Assets and prevailing market interest
rates and by the market's perception of the Company's ability to achieve
earnings growth. The Company's earnings will be derived primarily from any
positive spread between the yield on the Company's Mortgage Assets and the cost
of the Company's borrowings. The positive spread between the yield on the
Company's Mortgage Assets and the cost of borrowings will not necessarily be
larger in high interest rate environments than in low interest rate environments
regardless of the Company's business strategy to achieve such result.
Accordingly, in periods of high interest rates, the net income of the Company,
and therefore the dividend yield on the Common Stock, may be less attractive
compared with alternative investments, which could negatively impact the price
of the Common Stock. If the anticipated or actual net yield on the Company's
Mortgage Assets declines or if prevailing market interest rates rise, thereby
decreasing the positive spread between the net yield on the Mortgage Assets and
the cost of the Company's borrowings, the market price of the Common Stock may
be adversely affected. In addition, if the market price of other REIT stocks
decline for any reason, or there is a broad-based decline in real estate values
or in the value of the Company's portfolio of Mortgage Assets, the market price
of the Common Stock may be adversely affected. During any period when the market
price of the Common Stock has been adversely affected due to any of the
foregoing reasons, the liquidity of the Common Stock may be negatively impacted
and investors who may desire or be required to sell shares of Common Stock may
experience losses.
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<PAGE> 18
MARKET PRICES AND DIVIDEND DATA
The following table sets forth, for the periods indicated, the high and low
sales prices per share of the Common Stock as reported on the Nasdaq National
Market composite tape and the cash dividends paid per share of outstanding
Common Stock.
<TABLE>
<CAPTION>
PRICE PER SHARE CASH
OF COMMON STOCK DIVIDENDS
---------------------- DECLARED
HIGH LOW PER SHARE
------- ------- ---------
<S> <C> <C> <C>
1996
Fourth Quarter (through November 18, 1996)............ $ 33.38 $ 31.25 (1)
Third Quarter......................................... 32.25 23.25 $0.40
Second Quarter........................................ 28.00 19.38 0.40
First Quarter......................................... 21.75 18.75 0.46
1995
Fourth Quarter........................................ $ 22.00 $ 18.00 $0.26
Third Quarter(2)...................................... 22.00 16.88 0.20
</TABLE>
- ---------------
(1) As of the date of this Prospectus Supplement, the Company had not yet
declared a dividend for the fourth quarter.
(2) The Company's Common Stock began trading on August 4, 1995.
On November 18, 1996, the last reported sales price for the Common Stock
was $31.75 per share. As of September 30, 1996 the Company's 9,069,653 shares of
Common Stock were held by approximately 175 holders of record.
The Company intends to pay quarterly dividends. The Company intends to make
distributions to its stock holders of all or substantially all of its taxable
income in 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 earnings of the Company, the 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 will be paid or set apart for payment
on shares of Common Stock unless full cumulative dividends have been paid on the
Class B Preferred Stock.
CAPITALIZATION
The following table sets forth the capitalization of the Company at
September 30, 1996, and as adjusted to give effect to the sale by the Company of
1,250,000 shares of Common Stock at the Price to Public set forth on the cover
page of this Prospectus Supplement.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
----------------------
ACTUAL AS ADJUSTED
-------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
STOCKHOLDERS' EQUITY
Class B Preferred Stock, par value $0.01 per share:
1,006,250 shares authorized; 1,006,250 shares outstanding............. $ 29,712 $ 29,712
Common Stock, par value $0.01 per share: 48,993,750 shares authorized,
9,069,653 and 10,319,653 shares issued and outstanding................ 91 103
Additional paid-in capital.............................................. 138,081 177,263
Net unrealized loss on assets available for sale........................ (2,060) (2,060)
Dividends in excess of income (1)....................................... (2,307) (2,307)
-------- -----
Total Stockholders' Equity............................................ $163,517 $ 202,711
</TABLE>
- ---------------
(1) Because the Company is a REIT, the dividends declared are based on taxable
income, which differs from GAAP income as reported in the financial
statement.
S-18
<PAGE> 19
SELECTED FINANCIAL DATA
The following selected financial data are derived from the audited
financial statements of the Company for the year ended December 31, 1995 and the
period from commencement of operations on August 19, 1994 to December 31, 1994
and from the unaudited financial information at and for the nine months ended
September 30, 1996 and September 30, 1995. The unaudited information has been
derived from unaudited financial statements; however, in the opinion of
management, such information reflects all adjustments necessary for a fair
statement of the results of operations for such interim periods. The results of
operations of any interim period are subject to year end audit and adjustments
and are not necessarily indicative of the results of operations for the full
year. See the Company's Annual Report on Form 10-K for the year ended December
31, 19985 and the Company's Quarterly Reports on Form 10-Q for the quarters
ended March 31, June 30, and September 30, 1996 incorporated by reference
herein.
<TABLE>
<CAPTION>
FOR THE NINE MONTHS PERIOD FROM
ENDED FOR THE AUGUST 19,
SEPTEMBER 30, YEAR ENDED 1994 TO
---------------------- DECEMBER 31, DECEMBER 31,
1996 1995 1995 1994
---------- --------- ------------ ------------
<S> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
OPERATING DATA
Interest income................................. $ 41,403 $ 9,116 $ 15,726 $ 1,296
Interest expense................................ 29,724 6,155 10,608 760
Interest rate agreement expense................. 756 210 339 8
------ ------ ------ ------
Net interest income............................. 10,923 2,751 4,779 528
Provision for credit losses..................... 1,324 143 493 0
------ ------ ------ ------
Net interest income after provision for credit
losses........................................ 9,599 2,608 4,286 528
Operating expenses.............................. 1,758 763 1,131 146
------ ------ ------ ------
Net income...................................... 7,841 1,845 3,155 382
Less cash dividends on Class B Preferred
Stock......................................... 388 -- -- --
------ ------ ------ ------
Net income available to holders of Common
Stock......................................... $ 7,453 $ 1,845 $ 3,155 $ 382
====== ====== ====== ======
Net taxable income.............................. $ 3,832 $ 353
Primary earnings per share...................... $ 0.90 $ 0.67 $ 0.85 $ 0.20
Dividends declared per Class A preferred
share......................................... -- $ 0.50 $ 0.50 $ 0.25
Dividends declared per Class B preferred
share......................................... $ 0.386 -- -- --
Dividends declared per Common share............. $ 1.26 $ 0.20 $ 0.46 --
Weighted average shares of Common Stock and
Common Stock equivalents...................... 8,246,815 2,747,642 3,703,803 1,916,846
</TABLE>
<TABLE>
<CAPTION>
AT SEPTEMBER 30 AT DECEMBER 31
---------------------- ---------------------------
1996 1995 1995 1994
---------- --------- ------------ ------------
<S> <C> <C> <C> <C>
BALANCE SHEET DATA
Mortgage assets................................. $1,375,870 $ 298,785 $ 432,244 $ 117,477
Total assets.................................... 1,403,478 303,394 441,557 121,528
Short-term borrowings........................... 1,225,094 228,826 370,316 100,376
Total liabilities............................... 1,239,961 230,921 373,267 101,248
Stockholders' equity............................ 163,517 72,473 68,290 20,280
Number of Class A preferred shares
outstanding................................... 0 0 0 1,666,063
Number of Class B preferred shares
outstanding................................... 1,006,250 0 0 0
Number of common shares outstanding............. 9,069,653 5,516,313 5,517,299 208,332
</TABLE>
S-19
<PAGE> 20
FEDERAL INCOME TAX CONSIDERATIONS
GENERAL
The Code provides special tax treatment for organizations that qualify and
elect to be taxed as REITs. The discussions below and in the Prospectus dated
September 19, 1996 under the heading "Federal Income Tax Considerations"
summarize the material federal income tax provisions applicable to the Company
as a REIT and to investors in connection with their ownership of the Company's
Common Stock. However, it is impractical to set forth in this Prospectus
Supplement all aspects of federal, state, local and foreign tax law that may
have tax consequences with respect to an investor's purchase of the Company's
Common Stock. The discussions of various aspect of Federal income taxation
contained herein and in the Prospectus are based on the Code, Treasury
regulations, judicial decisions, administrative rulings and practice, all of
which are subject to change.
In brief, if certain detailed conditions imposed by the Code are met,
entities that invest primarily in real estate investments and mortgage loans,
and that otherwise would be taxed as corporations are, with certain limited
exceptions, not taxed at the corporate level on their taxable income that is
currently distributed to their shareholders. This treatment eliminates most of
the "double taxation" (at the corporate level and then again at the shareholder
level when the income is distributed) that typically results from investment in
public corporations. If the Company fails to meet the requirements of the Code
for REIT qualification in any taxable year, it would become subject to federal
and state income taxation on its taxable income at regular corporate rates. In
such an event, the after tax earnings available for distribution to the
shareholders would be reduced.
The Company believes that it has complied, and intends to comply in the
future, with the requirements for qualification as a REIT under the Code. In the
opinion of Giancarlo & Gnazzo, A Professional Corporation, special tax counsel
to the Company ("Special Tax Counsel"), the Company has been organized and
operated in a manner that qualifies it as a REIT under the Code since the
commencement of its operations on August 19, 1994 through September 30, 1996,
the date of the Company's most recent unaudited financials reviewed by Special
Tax Counsel, and the Company's current and contemplated methods of operation, as
represented by the Company, will enable it to continue to so qualify. This
opinion is based on various assumptions relating to the organization and
operation of the Company to date and in the future and is conditioned upon
certain representations made by the Company as to certain factual matters. Such
opinion is not binding on the Internal Revenue Service or the courts and there
can be no assurance that the Company will in fact maintain compliance with those
assumptions and requirements at all times.
TAXATION OF HOLDERS OF THE COMPANY'S COMMON STOCK
The Company will notify shareholders after the close of the Company's
taxable year as to the portions of the distributions that constitute ordinary
income, return of capital and capital gain. Dividends and distributions declared
in the last quarter of any year payable to shareholders of record on a specified
date in such quarter will be deemed to have been received by the shareholders
and paid by the Company on December 31 of the record year, provided that such
dividends are paid before February 1 of the following year. Distributions of the
Company will not be eligible for the dividends received deduction for
corporations that are shareholders. Shareholders may not deduct any net
operating losses or capital losses of the Company.
PROSPECTIVE INVESTORS ARE URGED TO CONSULT THE UNDERLYING PROSPECTUS AND
THEIR TAX ADVISORS WITH RESPECT TO THE SPECIFIC TAX CONSEQUENCES TO THEM OF THE
SECURITIES.
S-20
<PAGE> 21
UNDERWRITING
Montgomery Securities (the "Underwriter") has agreed, subject to the terms
and conditions set forth in an underwriting agreement (the "Underwriting
Agreement"), to purchase from the Company 1,250,000 shares of Common Stock at
the Price to Public, less the Underwriting Discounts and Commissions set forth
on the cover page of this Prospectus Supplement. The Underwriting Agreement
provides that the obligations of the Underwriter are subject to certain
conditions precedent and that the Underwriter is committed to purchase all of
such shares of Common Stock if any are purchased.
The Underwriter has advised the Company that it proposes initially to offer
the Common Stock to the public on the terms set forth on the cover page of this
Prospectus Supplement.
The Underwriting Agreement provides that the Company will indemnify the
Underwriter against certain civil liabilities, including civil liabilities under
the Securities Act, or will contribute to payments the Underwriter may be
required to make in respect thereof.
The Underwriter has in the past performed, and may continue to perform,
investment banking services, broker-dealer and financial advisory services for
the Company and has received customary compensation therefor.
The Underwriter has informed the Company that it does not expect to make
sales to accounts over which it exercises discretionary authority in excess of
5% of the number of shares of Common Stock offered hereby.
In connection with this offering, the Underwriter may engage in passive
market-making transactions in the Common Stock on the Nasdaq National Market
immediately prior to the commencement of sales in this Offering, in accordance
with Rule 10b-6A under the Exchange Act, Passive market-making consists of
displaying bids on the Nasdaq National Market limited by the bid prices of
independent market-makers and purchases limited by such prices and effected in
response to order flow. Net purchases by a passive market-maker on each day are
limited to a specific percentage of the passive market-maker's average daily
trading volume in the Common Stock during a specified prior period and must be
discontinued when such limit is reached. Passive market-making may stabilize the
market price of the Common Stock at a level above that which might otherwise
prevail and, if commenced, may be discontinued at any time.
LEGAL MATTERS
Certain legal matters relating to the Common Stock will be passed on for
the Company by Tobin & Tobin, a professional corporation, San Francisco,
California. Legal matters relating to the tax status of the Company as a REIT
will be passed on by Giancarlo & Gnazzo, A Professional Corporation, San
Francisco, California. Certain legal matters will be passed upon for the
Underwriter by O'Melveny & Myers LLP, San Francisco, California. Tobin & Tobin,
a professional corporation, Giancarlo & Gnazzo, A Professional Corporation and
O'Melveny & Myers LLP will rely as to all matters of Maryland law upon the
opinion of special Maryland counsel to the Company, Piper & Marbury L.L.P.,
Baltimore, Maryland.
S-21
<PAGE> 22
COMMON STOCK, PREFERRED STOCK WARRANTS,
AND SHAREHOLDER RIGHTS TO PURCHASE COMMON STOCK AND PREFERRED STOCK
875,000 SHARES
RWT
REDWOOD TRUST, INC.
------------------------
Redwood Trust, Inc., a Maryland corporation ("Redwood Trust" or the
"Company"), specializes in acquiring and managing real estate mortgage loans.
Such loans are originated by others to the Company's specifications or to
specifications approved by the Company. The Company has acquired mortgage loans
secured by single-family real estate properties throughout the United States,
with a special emphasis on properties located in the State of California, and
may in the future acquire mortgage loans secured by multifamily and commercial
real estate properties. The Company's mortgage loans may be acquired as whole
loans or as mortgage securities evidencing interests in pools of mortgage loans
(collectively, "Mortgage Assets"). The Company is self-advised and self-managed
and its principal business objective is to generate net income for distribution
to stockholders. The Company has elected to be subject to tax as a real estate
investment trust ("REIT") under the Internal Revenue Code of 1986, as amended
(the "Code"), and generally will not be subject to tax on its Federal income to
the extent that it distributes its earnings to its stockholders and it maintains
its qualification as a REIT.
The Company, directly or through agents, dealers or underwriters designated
from time to time, may issue and sell from to time one or more of the following
types of its securities (the "Securities"): (i) shares of its common stock, par
value $0.01 per share ("Common Stock"); (ii) shares of its preferred stock, in
one or more classes or series ("Preferred Stock"), (iii) warrants to purchase
shares of Common Stock ("Common Stock Warrants"); (iv) warrants to purchase
Preferred Stock ("Preferred Stock Warrants"); (v) rights to purchase shares of
Common Stock or Preferred Stock issued to shareholders ("Shareholders Rights");
and (vi) any combination of the foregoing, either individually or as units
consisting of one or more of the foregoing types of Securities. The Securities
offered pursuant to this Prospectus may be issued in one or more class or
series, in amounts, at prices and on terms to be determined at the time of the
offering of each such class or series and set forth in a supplement to this
Prospectus (a "Prospectus Supplement"). The Securities offered by the Company
pursuant to this Prospectus will be limited to $200,000,000.00 aggregate initial
public offering price, including the exercise price of any Common Stock
Warrants, Preferred Stock Warrants (collectively, "Securities Warrants") or
Shareholders Rights.
The specific terms of each offering of Securities in respect of which this
Prospectus is being delivered will be set forth in an accompanying Prospectus
Supplement relating to such offering of Securities. Such specific terms include,
without limitation, to the extent applicable (1) in the case of any class or
series of Preferred Stock, the specific designations, rights, preferences,
privileges and restrictions of such class or series of Preferred Stock,
including the dividend rate or rates or the method for calculating same,
dividend payment dates, voting rights, liquidations preferences, and any
conversion, exchange, redemption or sinking fund provisions; (2) in the case of
the Securities Warrants, Preferred Stock or Common Stock, as applicable, for
which each such warrant is exercisable, the exercise price, duration,
detachability and call provisions of each such warrant; (3) in the case of
Shareholder Rights, which entitles the shareholder to purchase Preferred Stock
or Common Stock, as applicable, the subscription price, duration,
transferabilities and the over subscription privilege of each of the Shareholder
Rights; and (4) in the case of any offering of Securities, to the extent
applicable, the initial public offering price or prices, listing on any
securities exchange, certain federal income tax consequences and the agents,
dealers or underwriters, if any, participating in the offering and sale of the
Securities.
The Company's Common Stock is currently quoted on the Nasdaq National Market
("Nasdaq") under the symbol "RWTI." On September 18, 1996, the last reported
sales price for the Common Stock was $29.75 per share. The Company also
currently has one class of authorized, issued and outstanding Preferred Stock,
the Class B 9.74% Cumulative Convertible Preferred Stock (the "Class B Preferred
Stock"), which is quoted on the Nasdaq National Market under the symbol "RWTIP,"
and an issue of Stock Purchase Warrants, quoted under the symbol "RWTIW." On
September 18, 1996, the last reported sales price for the Class B Preferred
Stock and Stock Purchase Warrants was $33.875 per share and $14.00 per share,
respectively. The shares of Common Stock and Class B Preferred Stock, and the
securities offered herein, are subject to repurchase by the Company under
certain conditions and are subject to certain restrictions on ownership and
transferability which prohibit any person (either alone or with others as a
group) from owning a number of shares in excess of 9.8% of the outstanding
shares of the Company's capital stock, subject to certain exceptions. See
"Description of Securities -- Repurchase of Shares and Restrictions on Transfer"
and "Plan of Distribution."
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------------
THE ATTORNEY GENERAL OF THE STATE OF NEW YORK HAS NOT PASSED
ON OR ENDORSED THE MERITS OF THIS OFFERING. ANY
REPRESENTATION TO THE CONTRARY IS UNLAWFUL.
------------------------
This Prospectus may not be used to consummate sales of Securities unless
accompanied by a Prospectus Supplement. The delivery in any jurisdiction of this
Prospectus together with a Prospectus Supplement relating to specific Securities
shall not constitute an offer in such jurisdiction of any other Securities
covered by this Prospectus but not described in such Prospectus Supplement.
------------------------
The date of this Prospectus is September 19, 1996.
<PAGE> 23
AVAILABLE INFORMATION
The Company is subject to the information requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports and other information with the Securities and Exchange
Commission (the "Commission" or "SEC"). Reports, proxy statements and other
information filed by the Company may be inspected and copied at the public
reference facilities maintained by the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the Commission's regional offices located at
Seven World Trade Center, 13th Floor, New York, New York 10048, and at 500 West
Madison Street, Chicago, Illinois 60661. Copies may also be obtained from the
Public Reference section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. The Common Stock, Stock Purchase
Warrants and Class B Preferred Stock of the Company are currently quoted on the
Nasdaq National Market. Reports, proxy statements and other information
concerning the Company may be inspected at the National Association of
Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006. In
addition, holders of the Common Stock and Class B Preferred Stock will receive
annual reports containing audited financial statements with a report thereon by
the Company's independent certified public accountants, and quarterly reports
containing unaudited summary financial information for each of the first three
quarters of each fiscal year.
The Company files information electronically with the Commission, and the
Commission maintains a Web Site that contains reports, proxy and information
statements and other information regarding registrants (including the Company)
that file electronically with the Commission. The address of the Commission's
Web Site is <http://www.sec.gov>.
Copies of the Registration Statement on Form S-3 of which this Prospectus
forms a part and exhibits thereto are on file at the offices of the Commission
pursuant to the Securities Act of 1933, as amended (the "Securities Act"). This
Prospectus omits certain of the information contained in the Registration
Statement, and reference is hereby made to the Registration Statement for
further information with respect to the Company and the Securities offered
hereby. Statements contained in this Prospectus as to the contents of any
contract or other document referred to are not necessarily complete, and in each
instance reference is made to a copy of such contract or other document filed as
an exhibit to the Registration Statement or otherwise filed with the SEC and
incorporated by reference herein. Each such statement is qualified in its
entirety by such contract or other document reference.
The Company currently furnishes its shareholders with annual reports
containing financial statements audited by its independent auditors and with
quarterly reports containing unaudited summary financial information for each of
the first three quarters of each fiscal year.
INCORPORATION OF CERTAIN INFORMATION BY REFERENCE
There are incorporated herein by reference the following documents
heretofore filed by the Company with the Commission:
(a) The Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995.;
(b) The Company's Quarterly Report on Form 10-Q for the fiscal
quarters ended March 31, 1996 and June 30, 1996;
(c) The description of the Company's Common Stock contained in the
Company's Registration Statement on Form 8-A, as amended (Reg. No.
0-26436), filed July 17, 1996, under the Exchange Act.
All documents filed by the Company pursuant to Sections 13(a), 13(c), 14 or
15(d) of the Exchange Act subsequent to the date of this Prospectus and prior to
the termination of the offering of the Securities made hereby shall be deemed to
be incorporated by reference into this Prospectus.
Any statement contained herein or in a document incorporated or deemed to
be incorporated by reference herein shall be deemed to be modified or superseded
for purposes of the Registration Statement and this Prospectus to the extent
that a statement contained in the Registration Statement, this Prospectus, or
any
2
<PAGE> 24
other subsequently filed document that is also incorporated by reference herein
modified or supersedes that statement. Any statement so modified or superseded
shall not be deemed, except as so modified or superseded, to constitute a part
of this Prospectus.
The Company hereby undertakes to provide without charge to each person,
including any beneficial owner, to whom a Prospectus is delivered, upon written
or oral request of that person, a copy of any document incorporated herein by
reference (other than exhibits to those documents unless the exhibits are
specifically incorporated herein by reference into the documents that this
Prospectus incorporates by reference). Requests should be directed to Ms. Vickie
L. Rath, Vice-President, Treasurer and Controller, Redwood Trust, Inc., 591
Redwood Highway, Suite 3100, Mill Valley, California 94941, telephone (415)
389-7373.
3
<PAGE> 25
THE COMPANY
The Company was incorporated in the State of Maryland on April 11, 1994 and
commenced operations on August 19, 1994. It invests in Mortgage Assets financed
by the proceeds of equity offerings and by borrowings. The Company produces net
interest income on Mortgage Assets qualifying as Qualified REIT Real Estate
Assets while maintaining strict cost controls in order to generate net income
for distribution to its stockholders. The Company intends to continue operating
in a manner that will permit it to maintain its qualification as a REIT for
Federal income tax purposes. Assuming it retains such REIT status, the Company
will generally not be subject to tax on its Federal income to the extent that it
distributes that income to stockholders in the form of dividends. The principal
executive offices of the Company are located at 591 Redwood Highway, Suite 3100,
Mill Valley, California 94941, telephone (415) 389-7373.
The Company is self-advised and self-managed. The management of the Company
manages the day-to-day operations of the Company, subject to the supervision of
the Company's Board of Directors. The management team of the Company has
considerable expertise in the acquisition and management of Mortgage Assets,
mortgage finance, asset/liability management and the management of corporations
in the real estate lending business, including banks, savings and loans and life
insurance companies. In addition to working with healthy real estate assets and
healthy real estate lending institutions, the management of the Company also has
experience managing the assets of several failed life insurance companies during
rehabilitation, managing and advising a number of troubled savings and loans and
banks, and overseeing the workout and liquidation process for large portfolios
of troubled commercial real estate mortgages and equity investments. Reference
to the "Company" herein shall include any taxable or Qualified REIT Subsidiaries
through which the Company may conduct its business.
Additional information regarding the Company, including the audited
financial statements of the Company and descriptions of the Company's currently
outstanding common and preferred stock and warrants, is contained in the
documents incorporated by reference herein. See "Incorporation of Certain
Information by Reference," above.
USE OF PROCEEDS
Unless otherwise specified in the applicable Prospectus Supplement for any
offering of Securities, the net proceeds from the sale of Securities offered by
the Company will be available for the general corporate purposes of the Company.
These general corporate purposes may include, without limitation, repayment of
maturing obligations, redemption of outstanding indebtedness, financing future
acquisitions (including, but not limited to, acquisitions of Mortgage Assets and
other mortgage related products), capital expenditures and working capital.
Pending any such uses, the Company may invest the net proceeds from the sale of
any Securities or may use them to reduce short-term indebtedness. If the Company
intends to use the net proceeds from a sale of Securities to finance a
significant acquisition, a related Prospectus Supplement will describe the
material terms of such acquisition.
DESCRIPTION OF SECURITIES
The following is a brief description of the material terms of the Company's
Securities. This description does not purport to be complete and is subject in
all respects to applicable Maryland law and to the provision of the Company's
Articles of Incorporation and Bylaws, including any applicable amendments or
supplements thereto, copies of which are on file with the Commission as
described under "Available Information" and are incorporated by reference
herein.
GENERAL
The Company may offer under this Prospectus one or more of the following
categories of its Securities: (i) shares of its Common Stock, par value $0.01
per share; (ii) shares of its Preferred Stock, in one or more classes or series;
(iii) Common Stock Warrants; (iv) Preferred Stock Warrants; (v) Shareholder
Rights; and (vi) any combination of the foregoing, either individually or as
units consisting of one or more of the foregoing
4
<PAGE> 26
types of Securities. The terms of any specific offering of Securities, including
the terms of any units offered, will be set forth in a Prospectus Supplement
relating to such offering.
The Company's current authorized equity capitalization consists of 50
million shares which may be comprised of Common Stock and Preferred Stock. The
Common Stock and the only currently issued, authorized and outstanding Preferred
Stock, the Class B Preferred Stock, are listed on the Nasdaq National Market,
and the Company intends to list any additional shares of its Common Stock or
Preferred Stock which are issued and sold hereunder, as described in the
Prospectus Supplement relating to such Common Stock or any class or series of
Preferred Stock. The Company's sole outstanding issue of warrants is the series
of Stock Purchase Warrants issued in connection with the Company's 1994 private
placement. Such warrants are exercisable for Common Stock and are listed on the
Nasdaq National Market. As of August 7, 1996, 1,362,257 such warrants remained
outstanding.
COMMON STOCK
As of August 7, 1996, there were 8,783,641 outstanding shares of Common
Stock held by 166 holders of record. Holders of Common Stock are entitled to
receive dividends when, as and if declared by the Board of Directors, out of
funds legally available therefor. In the case of the Class B Preferred Stock and
possibly in the event any future class or series of Preferred Stock is issued,
dividends on any outstanding shares of Preferred Stock are required to be paid
in full before payment of any dividends on the Common Stock. Upon liquidation,
dissolution or winding up of the Company, holders of Common Stock are entitled
to share ratably in assets available for distribution after payment of all debts
and other liabilities and subject to the prior rights of any holders of any
Preferred Stock then outstanding. There are no preemptive or other subscription
rights, conversion rights, or redemption or sinking fund provisions with respect
to shares of Common Stock.
Holders of Common Stock are entitled to one vote per share with respect to
all matters submitted to a vote of shareholders and do not have cumulative
voting rights. Accordingly, holders of a majority of the Common Stock entitled
to vote in any election of directors may elect all of the directors standing for
election, subject to the voting rights (if any) of any class or series of
Preferred Stock that may be outstanding from time to time. The Company's
Articles of Incorporation and Bylaws contain no restrictions on the repurchase
by the Company of shares of the Common Stock. All the outstanding shares of
Common Stock are, and additional shares of Common Stock will be, validly issued,
fully paid and nonassessable.
PREFERRED STOCK
Subject to the terms of the outstanding Class B Preferred Stock, the Board
of Directors is authorized to designate with respect to each class or series of
Preferred Stock the number of shares in each such class or series, the dividend
rates and dates of payment, voluntary and involuntary liquidation preferences,
redemption prices, if any, whether or not dividends shall be cumulative, and, if
cumulative, the date or dates from which the same shall be cumulative, the
sinking fund provisions if any, and the terms and conditions on which shares can
be converted into or exchanged for shares of another class or class or series,
and the voting rights, if any. As of the date hereof, there are 1,006,250 shares
of Class B Preferred Stock issued and outstanding.
Any Preferred Stock issued will rank prior to the Common Stock as to
dividends and as to distributions in the event of liquidations, dissolution or
winding up of the Company. The ability of the Board of Directors to issue
Preferred Stock, while providing flexibility in connection with possible
acquisitions and other corporate purposes, could, among other things, adversely
affect the voting powers of holders of Common Stock. The Class B Preferred Stock
is, and any future shares of Preferred Stock will be, validly issued, fully paid
and nonassessable.
SECURITIES WARRANTS
The Company may issue Securities Warrants for the purchase of Common Stock
or Preferred Stock. Such warrants are referred to herein as Common Stock
Warrants and Preferred Stock Warrants, as appropriate. Securities Warrants may
be issued independently or together with any other Securities covered by the
Registration Statement offered by this Prospectus and any accompanying
Prospectus Supplement and may
5
<PAGE> 27
be attached to or separate from such other Securities. Each issuance of
Securities Warrants will be issued under a separate agreement ("Securities
Warrant Agreement") to be entered into between the Company and a bank or trust
company, as agent ("Securities Warrant Agent"), all as set forth in the
Prospectus Supplement relating to the particular issue of offered Securities
Warrants. Each issue of Securities Warrants will be evidenced by warrant
certificates (the "Securities Warrant Certificates"). The Securities Warrant
Agent will act solely as an agent of the Company in connection with the
Securities Warrant Certificates and will not assume any obligation or
relationship of agency or trust for or with any holders of Securities Warrant
Certificates or beneficial owners of Securities Warrants.
If future Securities Warrants are offered pursuant to this prospectus, the
applicable Prospectus Supplement will describe the terms of such Securities
Warrants, including the following where applicable: (i) the offering price; (ii)
the aggregate number of shares purchasable upon exercise of such Securities
Warrants, and in the case of Securities Warrants for Preferred Stock, the
designation, aggregate number and terms of the class or series of Preferred
Stock purchasable upon exercise of such Securities Warrants; (iii) the
designation and terms of the Securities with which such Securities Warrants are
being offered and the number of such Securities Warrants being offered with each
such Security; (iv) the date on and after which such Securities Warrants and the
related Securities will be transferable separately; (v) the number of shares of
Preferred Stock or shares of Common Stock purchasable upon exercise of each such
Securities Warrant and the price at which such number of shares of Preferred
Stock of such class or series or shares of Common Stock may be purchased upon
such exercise; (vi) the date on which the right to exercise such Securities
Warrants shall commence and the expiration date on which such right shall
expire, (vii) certain federal income tax consequences; and (viii) any other
material terms of such Securities Warrants.
No Rights as Shareholders. Holders of future Securities Warrants, if any,
will not be entitled by virtue of being such holders, to vote, to consent, to
receive dividends, to receive notice as shareholders with respect to any meeting
of shareholders for the election of directors of the Company or any other
matter, or to exercise any rights whatsoever as shareholders of the Company.
SHAREHOLDER RIGHTS
General. The Company may issue, as a dividend at no cost, Shareholder
Rights to holders of record of the Company's Securities or any class thereof on
the applicable record date. If Shareholder Rights are so issued to existing
holders of Securities each Shareholder Right will entitle the registered holder
thereof to purchase the Securities pursuant to the terms set forth in the
applicable Prospectus Supplement.
If Shareholder Rights are issued, the applicable Prospectus Supplement will
describe the terms of such Shareholder Rights including the following where
applicable: (i) record date; (ii) the subscription price; (iii) Subscription
Agent; (iv) the aggregate number of shares of Preferred Stock or shares of
Common Stock purchasable upon exercise of such Shareholder Rights and in the
case of Shareholder Rights for Preferred Stock, the designation, aggregate
number and terms of the class or series of Preferred Stock purchasable upon
exercise of such Shareholder Rights; (v) the date on and after which such
Shareholder Rights and the related Securities will be transferable separately;
(vi) the date on which the right to exercise such Shareholder Rights shall
commence and the expiration date on which such right shall expire; (vii) certain
federal income tax consequences; and (viii) any other material terms of such
Shareholder Rights.
In addition to the terms of the Shareholder Rights and the Securities
issuable upon exercise thereof, the Prospectus Supplement will describe, for a
holder of such Shareholder Rights who validly exercises all Shareholder Rights
issued to such holder, how to subscribe for unsubscribed Securities (issuable
pursuant to unexercised Shareholder Rights issued to other holders) to the
extent such Shareholder Rights have not been exercised.
No Rights as Shareholders. Holders of Shareholder Rights will not be
entitled by virtue of being such holders, to vote, to consent, to receive
dividends, to receive notice as shareholders with respect to any meeting of
shareholders for the election of directors of the Company or any other matter,
or to exercise any rights whatsoever as shareholders of the Company.
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REPURCHASE OF SHARES AND RESTRICTIONS ON TRANSFER
In order that the Company may meet the requirements for qualification as a
REIT at all times, the Articles of Incorporation prohibit any person from
acquiring or holding, directly or constructively, ownership of a number of
shares of Common Stock and Preferred Stock (collectively, "Capital Stock") in
excess of 9.8% (the "Ownership Limit") of the outstanding shares. For this
purpose the term "ownership" generally means either direct ownership or
constructive ownership in accordance with the constructive ownership provisions
of Section 544 of the Code.
Under the constructive ownership provisions of Section 544 of the Code, a
holder of a Warrant will be treated as owning the number of shares of Capital
Stock into which such Warrant may be converted. In addition, the constructive
ownership rules generally attribute ownership of securities owned by a
corporation, partnership, estate or trust proportionately to its stockholders,
partners or beneficiaries, attribute ownership of securities owned by family
members to other members of the same family, and set forth rules as to when
securities constructively owned by a person are considered to be actually owned
for the application of such attribution provisions (i.e., "reattribution"). For
purposes of determining whether a person holds or would hold Capital Stock in
excess of the Ownership Limit, a person will thus be treated as owning not only
shares of Capital Stock actually owned, but also any shares of Capital Stock
attributed to such person under the attribution rules described above (including
any shares of Capital Stock attributed to such person by reason of such person's
ownership of Warrants). Accordingly, a person who individually owns less than
9.8% of the shares outstanding may nevertheless be in violation of the Ownership
Limit.
Any transfer of shares of Capital Stock or Warrants that would result in
disqualification of the Company as a REIT or that would (a) create a direct or
constructive ownership of shares of stock in excess of the Ownership Limit, (b)
result in the shares of stock being beneficially owned (within the meaning of
Section 856(a) of the Code) by fewer than 100 persons (determined without
reference to any rules of attribution), or (c) result in the Company being
"closely held" within the meaning of Section 856(h) of the Code, will be null
and void, and the intended transferee will acquire no rights to such shares or
warrants. The foregoing restrictions on transferability and ownership will not
apply if the Board of Directors determines that it is no longer in the best
interests of the Company to continue to qualify as a REIT. The Company's Board
of Directors, upon receipt of a ruling from the IRS, an opinion of counsel or
other evidence satisfactory to the Board of Directors, may also waive the
Ownership Limit with respect to a purported transferee. As a condition to such
waiver the intended transferee must give written notice to the Company of the
proposed transfer no later than the fifteenth day prior to any transfer which,
if consummated, would result in the intended transferee owning shares in excess
of the Ownership Limit. The Board of Directors may also take such other action
as it deems necessary or advisable to protect the Company's status as a REIT.
Any purported transfer of shares or warrants that would result in a person
owning (directly or constructively) shares in excess of the Ownership Limit
(except as otherwise waived by the Board of Directors as set forth above) due to
the unenforceability of the transfer restrictions set forth above will
constitute "Excess Securities," which will be transferred by operation of law to
the Company as trustee for the exclusive benefit of the person or persons to
whom the Excess Securities are ultimately transferred, until such time as the
purported transferee retransfers the Excess Securities. While the Excess
Securities are held in trust, a holder of such securities will not be entitled
to vote or to share in any dividends or other distributions with respect to such
securities and will not be entitled to exercise or convert such securities into
shares of Capital Stock. Subject to the Ownership Limit, Excess Securities may
be transferred by the purported transferee to any person (if such transfer would
not result in Excess Securities) at a price not to exceed the price paid by the
purported transferee (or, if no consideration was paid by the purported
transferee, the fair market value of the Excess Securities on the date of the
purported transfer), at which point the Excess Securities will automatically be
exchanged for the stock or warrants, as the case may be, to which the Excess
Securities are attributable. If a purported transferee receives a higher price
for designating an ultimate transferee, such purported transferee shall pay, or
cause the ultimate transferee to pay, such excess to the Company. In addition,
such Excess Securities held in trust are subject to purchase by the Company at a
purchase price equal to the lesser of (a) the price per share or per warrant, as
the case may be, in the transaction that created such Excess Securities (or, in
the case of a devise or gift, the market price at the time of such devise or
gift),
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reduced by the amount of any distributions received in violation of the Articles
of Incorporation that have not been repaid to the Company, and (b) the market
price as reflected in the last reported sales price of such shares of stock or
warrants on the trading day immediately preceding the date of the purchase by
the Company as reported on any exchange or quotation system over which such
shares of stock or warrants may be traded, or if not then traded over any
exchange or quotation system, then the market price of such shares of stock or
warrants on the date of the purported transfer as determined in good faith by
the Board of Directors of the Company, reduced by the amount of any
distributions received in violation of the Articles of Incorporation that have
not been repaid to the Company.
From and after a purported transfer to the transferee of the Excess
Securities, the purported transferee shall cease to be entitled to
distributions, voting rights and other benefits with respect to such shares of
the stock or warrants except the right to payment of the purchase price for the
shares of stock or warrants or the retransfer of securities as provided above.
Any dividend or distribution paid to a purported transferee on Excess Securities
prior to the discovery by the Company that such shares of stock or warrants have
been transferred in violation of the provisions of the Company's Articles of
Incorporation shall be repaid to the Company upon demand. If the foregoing
transfer restrictions are determined to be void, invalid or unenforceable by a
court of competent jurisdiction, then the purported transferee of any Excess
Securities may be deemed, at the option of the Company, to have acted as an
agent on behalf of the Company in acquiring such Excess Securities and to hold
such Excess Securities on behalf of the Company.
All certificates representing shares of stock and warrants will bear a
legend referring to the restrictions described above.
Any person who acquires shares or warrants in violation of the Articles of
Incorporation, or any person who is a purported transferee such that Excess
Securities results, must immediately give written notice or, in the event of a
proposed or attempted transfer that would be void as set forth above, give at
least 15 days prior written notice to the Company of such event and shall
provide to the Company such other information as the Company may request in
order to determine the effect, if any, of such transfer on the Company's status
as a REIT. In addition, every record owner of more than 5.0% (during any period
in which the number of stockholders of record is 2,000 or more) or 1.0% (during
any period in which the number of stockholders of record is greater than 200 but
less than 2,000) or 1/2% (during any period in which the number of stockholders
is 200 or less) of the number or value of the outstanding shares of Capital
Stock of the Company must give an annual written notice to the Company by
January 31, stating the name and address of the record owner, the number of
shares held and describing how such shares are held. Further, each stockholder
shall upon demand be required to disclose to the Company in writing such
information with respect to the direct and constructive ownership of shares of
Capital Stock as the Board of Directors deems reasonably necessary to comply
with the REIT Provisions of the Code, to comply with the requirements of any
taxing authority or governmental agency or to determine any such compliance.
Subject to certain limitations, the Board of Directors may increase or
decrease the Ownership Limit. In addition, to the extent consistent with the
REIT Provisions of the Code, the Board of Directors may waive the Ownership
Limit for and at the request of certain purchasers in this Offering.
The provisions described above may inhibit market activity and the
resulting opportunity for the holders of the Company's Capital Stock and
Warrants to receive a premium for their shares or warrants that might otherwise
exist in the absence of such provisions. Such provisions also may make the
Company an unsuitable investment vehicle for any person seeking to obtain
ownership of more than 9.8% of the outstanding shares of Capital Stock.
CONTROL SHARE ACQUISITIONS
The Maryland General Corporation Law (the "Maryland GCL") provides that
"control shares" of a Maryland corporation acquired in a "control share
acquisition" have no voting rights except to the extent approved by a vote of
two-thirds of the votes entitled to be cast on the matter, excluding shares of
stock owned by the acquiror or by officers or directors who are employees of the
corporation. "Control shares" are voting shares of stock which, if aggregated
with all other shares of stock previously acquired by such a person, would
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entitle the acquiror to exercise voting power in electing directors within one
of the following ranges of voting power: (i) one-fifth or more but less than
one-third, (ii) onethird or more but less than a majority, or (iii) a majority
or more of all voting power. "Control shares" do not include shares of stock the
acquiring person is then entitled to vote as a result of having previously
obtained stockholder approval. A "control share acquisition" means, subject to
certain exceptions, the acquisition of, ownership of, or the power to direct the
exercise of voting power with respect to, control shares.
A person who has made or proposes to make a "control share acquisition,"
upon satisfaction of certain conditions (including an undertaking to pay
expenses), may compel the Board of Directors to call a special meeting of
stockholders to be held within 50 days of demand to consider the voting rights
of the shares. If no request for a meeting is made, the corporation may itself
present the question at any stockholders' meeting. If voting rights are not
approved at the meeting or if the acquiring person does not deliver an acquiring
person statement as permitted by the statute, then, subject to certain
conditions and limitations, the corporation may redeem any or all of the
"control shares" (except those for which voting rights have previously been
approved) for fair value determined, without regard to the absence of voting
rights, as of the date of the last control share acquisition or of any meeting
of stockholders at which the voting rights of such shares are considered and not
approved. If voting rights for "control shares" are approved at a stockholders
meeting and the acquiror becomes entitled to vote a majority of the shares
entitled to vote, all other stockholders may exercise appraisal rights. The fair
value of the stock as determined for purposes of such appraisal rights may not
be less than the highest price per share paid in the control share acquisition,
and certain limitations and restrictions otherwise applicable to the exercise of
dissenters' rights do not apply in the context of "control share acquisitions."
The "control share acquisition" statute does not apply to stock acquired in
a merger, consolidation or share exchange if the corporation is a party to the
transaction, or to acquisitions approved or exempted by a provision of the
Articles of Incorporation or Bylaws of the corporation adopted prior to the
acquisition of the shares.
TRANSFER AGENT AND REGISTRAR
ChaseMellon Shareholder Services, LLC is the transfer agent and registrar
with respect to the Common Stock, the Class B Preferred Stock and the Warrants.
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CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The following discussion is a general summary of certain Federal income tax
considerations to the Company and to holders of the Securities. It is based on
existing Federal income tax law, which is subject to change, possibly
retroactively. PROSPECTIVE INVESTORS ARE ADVISED TO REVIEW THE MORE SPECIFIC
DISCLOSURE IN THE APPLICABLE SUPPLEMENT AND TO CONSULT THEIR TAX ADVISORS AS TO
THE SPECIFIC TAX CONSEQUENCES TO THEM OF THE SECURITIES, 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.
The Board of Directors of the Company currently expects that the Company will
continue to operate in a manner that will permit the Company to maintain its
qualifications as a REIT for the taxable year ending December 31, 1996, and in
each taxable year thereafter. 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.
In the opinion of Giancarlo & Gnazzo, A Professional Corporation, special
tax counsel to the Company ("Special Tax Counsel"), the Company has been
organized and operated in a manner which qualifies it as a REIT under the Code
since the commencing of its operations on August 19, 1994 through June 30, 1996,
the date of the Company's last unaudited financials received by Special Tax
Counsel, and the Company's current and contemplated methods of operation, as
represented by the Company, will enable it to continue to so qualify. This
opinion is based on various assumptions relating to the organization and
operation of the Company to date and in the future and is conditioned upon
certain representations made by the Company as to certain factual matters. The
continued qualification and taxation of the Company as a REIT will depend upon
the Company's ability to meet, on a continuing basis, distribution levels and
diversity of stock ownership, and various other qualification tests imposed by
the Code. This opinion is based on the law existing and in effect on the date
hereof which is subject to change, possibly retroactively.
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 were not 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 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.
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 which 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 and may
also be subject to tax in certain other circumstances.
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 during which it became
disqualified.
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TAXATION OF SECURITIES HOLDERS
COMMON STOCK AND PREFERRED STOCK GENERALLY
Distributions (including constructive distributions) made to holders of
Common Stock or Preferred Stock, other than tax-exempt entities, 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 its shares, 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 still will be
treated as having received such dividend in the taxable year in which the
distribution is made.
Upon a sale or other disposition of either Common Stock or Preferred 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 will be long-term if the stock has been
held for more than one year. Any loss on the sale or exchange of shares held by
a stockholder for six months or less will generally be treated as a long-term
capital loss to the extent of any long-term capital gain dividends received by
such stockholder. If either Common Stock or Preferred Stock is sold after a
record date but before a payment date for declared dividends on such stock, a
stockholder will nonetheless be required to include such dividend in income in
accordance with the rules above for distributions, whether or not such dividend
is required to be paid over to the purchaser.
The Company also maintains a Dividend Reinvestment Plan (the "DRP" or
"Plan"). DRP Participants will generally be treated as having received a
dividend distribution equal to the fair value of the Plan Shares that are
purchased with the Participant's reinvested dividends generally on the date that
the Company credits such shares to the Participant's account, plus the brokerage
commissions, if any, allocable to the purchase of such shares, and participants
will have a tax basis in the shares equal to such value. DRP Participants may
not, however, receive any cash with which to pay the resulting tax liability.
Shares received pursuant to the DRP will have a holding period beginning on the
day after their purchase by the Plan Administrator.
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.
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TAXATION OF TAX-EXEMPT ENTITIES
The Company does not expect to incur inclusion income and therefore does
not prohibit tax-exempt entities or "disqualified organizations" from investing
in its Securities. In general, a tax-exempt entity that is a holder of the
Company's Securities will not be subject to tax on distribution.
The Company does not intend to issue debt obligations with different
maturities secured by a single pool of Mortgage Assets and does not expect to
create or acquire taxable mortgage pools that can generate excess inclusion
income. In addition, the Company does not intend to create or acquire REMIC
residual interests that can generate excess inclusion income.
EXERCISE OF SECURITIES WARRANTS
Upon a holder's exercise of a Securities Warrant, the holder will, in
general, (i) not recognize any income, gain or loss for federal income tax
purposes, (ii) receive an initial tax basis in the Security received equal to
the sum of the holder's tax basis in the exercised Securities Warrant and the
exercise price paid for such Security and (iii) have a holding period for the
Security received beginning on the date of exercise.
SALE OR EXPIRATION OF SECURITIES WARRANTS
If a holder of a Securities Warrant sells or otherwise disposes of such
Securities Warrant (other than by its exercise), the holder generally will
recognize capital gain or loss (long-term capital gain or loss if the holder's
holding period for the Securities Warrant exceeds twelve months on the date of
disposition; otherwise, short-term capital gain or loss) equal to the difference
between (i) the cash and fair market value of other property received and (ii)
the holder's tax basis (on the date of disposition) in the Securities Warrant
sold. Such a holder generally will recognize a capital loss upon the expiration
of an unexercised Securities Warrant equal to the holder's tax basis in the
Securities Warrant on the expiration date.
TAXATION OF SHAREHOLDER RIGHTS
If the Company makes a distribution of Shareholder Rights with respect to
its Common Stock, such distribution generally will be tax-free and a
Shareholder's basis in the Rights received in such distribution will be zero. If
the fair market value of the Rights on the date of issuance is 15% or more of
the value of the Common Stock or, if the Shareholder so elects regardless of the
value of the Rights, the Shareholder will make an allocation between the
relative fair market values of the Rights and the Common Stock on the date of
issuance of the Rights. On exercise of the Rights, the Shareholder will
generally not recognize gain or loss. The Shareholder's basis in the Shares
received from the exercise of the Rights will be the amount paid for the Shares
plus the basis, if any, of the Rights exercised. Distribution of Shareholder's
Rights with respect to other classes of Securities holders generally would be
taxable.
FOREIGN INVESTORS
In general, foreign investors will be subject to special withholding tax
requirements on income and capital gains distributions attributable to their
ownership of the Company's Securities subject to reduction pursuant to an
applicable income tax treaty.
PLAN OF DISTRIBUTION
The Company may sell Securities to or through one or more underwriters or
dealers for public offering and sale, to one or more investors directly or
through agents, to existing holders of its Securities directly through the
issuance of Shareholders Rights as a dividend, or through any combination of
these methods of sale. Any such underwriter or agent involved in the offer and
sale of the Securities will be named in the applicable Prospectus Supplement.
The distribution of the Securities may be effected from time to time in one
or more transactions at a fixed price or prices, which may be changed, at market
prices prevailing at the time of sale, at prices related to such
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prevailing market prices, or at negotiated prices (any of which may represent a
discount from the prevailing market prices). The Company may also sell its
Securities from time to time through one or more agents in ordinary brokers'
transactions on Nasdaq. Such sales may be effected during a series of one or
more pricing periods at prices related to the prevailing market prices reported
on Nasdaq, as shall be set forth in the applicable Prospectus Supplement.
In connection with the sale of Securities, underwriters or agents may
receive compensation from the Company or from purchasers of Securities, for whom
they may act as agents, in the form of discounts, concessions or commissions.
Underwriters may sell Securities to or through dealers, and such dealers may
receive compensation in the form of discounts, concession or commissions from
the underwriters and/or commissions from the purchasers for whom they may act as
agents. Underwriters, dealers and agents that participate in the distribution of
Securities may be deemed to be underwriters under the Securities Act, and any
discounts or commissions they receive from the Company and any profit on the
resale of Securities they realize may be deemed to be underwriting discounts and
commissions under the Securities Act. Any such underwriter or agent will be
identified, and any such compensation received from the Company will be
described, in the applicable Prospectus Supplement.
Unless otherwise specified in the related Prospectus Supplement, each class
or series of Securities will be a new issue with no established trading market,
other than the Common Stock which is listed on Nasdaq. Any Securities sold
pursuant to a Prospectus Supplement will also be listed on the Nasdaq National
Market or a national securities exchange, subject to official notice of
issuance. The Company may elect to list any future class or series of Preferred
Stock on an exchange, but is not obligated to do so. It is possible that one or
more underwriters may make a market in a future class or series of Securities,
but will not be obligated to do so and may discontinue any market making at any
time without notice. Therefore, no assurance can be given as to the liquidity
of, or the trading market for, the Securities.
Under agreements into which the Company may enter, underwriters, dealers
and agents who participate in the distribution of Securities may be entitled to
indemnification by the Company against certain liabilities, including
liabilities under the Securities Act. Underwriters, dealers and agents may
engage in transactions with or perform services for the Company in the ordinary
course of business.
If so indicated in the applicable Prospectus Supplement, the Company may
authorize underwriters or other persons acting as the Company's agents to
solicit offers by certain institutions to purchase Securities from the Company
at regular intervals over a fixed period of time pursuant to negotiated
subscription commitments. Institutions with which such subscription commitments
may be made include commercial and savings banks, insurance companies, pension
funds, investment companies, educational and charitable institutions and others,
but in all cases such institutions must be approved by the Company. The
obligations of any purchaser under any such subscription commitments will be
subject to certain conditions, including that the purchase of the Securities
shall not be prohibited under the laws of the jurisdiction to which such
purchaser is subject, as well as to the specific terms and conditions negotiated
that will be set forth in the applicable Prospectus Supplement. The underwriters
and such other agents will not have any responsibility in respect of the
validity or performance of such subscription commitments.
In order to comply with the securities laws of certain states, if
applicable, the Securities offered hereby will be sold in such jurisdiction only
through registered or licensed brokers or dealers. In addition, in certain
states Securities may not be sold unless they have been registered or qualified
for sale in the applicable state or an exemption from the registration or
qualification requirement is available and is complied with.
Subject to the applicable rules and regulations under the Exchange Act, any
person engaged in the distribution of the Securities offered hereby may not be
able to simultaneously engage in market making activities with respect to the
Securities for a period of two business days prior to the commencement of such
distribution.
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ERISA INVESTORS
Because the Common Stock will qualify as a "publicly offered security,"
employee benefit plans and Individual Retirement Accounts may purchase shares of
Common Stock and treat such shares, and not the Company's assets, as plan assets
The status of Securities offered hereby other than the Common Stock will be
discussed in the relevant Prospectus Supplement. Fiduciaries of ERISA plans
should consider (i) whether an investment in the Common Stock and other
Securities offered hereby satisfies ERISA diversification requirements, (ii)
whether the investment is in accordance with the ERISA plans' governing
instruments and (iii) whether the investment is prudent.
LEGAL MATTERS
The validity of the Securities offered hereby and certain legal matters
will be passed on for the Company by Tobin & Tobin, a professional corporation,
San Francisco, California. Certain tax matters will be passed on by Giancarlo &
Gnazzo, A Professional Corporation, San Francisco, California. Tobin & Tobin and
Giancarlo & Gnazzo, A Professional Corporation, will rely as to all matters of
Maryland law upon Piper & Marbury L.L.P., Baltimore, Maryland.
EXPERTS
The Balance Sheet as of December 31, 1995 and 1994 and the Statements of
Operations, Stockholders' Equity and Cash Flows for the period from August 19,
1994 (Commencement of Operations) to December 31, 1995 incorporated by reference
in this Prospectus have been included therein in reliance on the report of
Coopers & Lybrand, L.L.P., independent accountants, given on the authority of
that firm as experts in accounting and auditing.
14
<PAGE> 36
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No person has been authorized to give any information or to make any
representations in connection with this offering other than those contained in
this Prospectus Supplement and the accompanying Prospectus, and, if given or
made, such other information and representations must not be relied upon as
having been authorized by the Company, the Underwriter or any other person.
Neither the delivery of this Prospectus Supplement or the accompanying
Prospectus nor any sale made hereunder shall, under any circumstances, create
any implication that there has been no change in the affairs of the Company
since the date hereof or that the information contained herein is correct as of
any time subsequent to its date. This Prospectus Supplement or the accompanying
Prospectus does not constitute an offer to sell or a solicitation of an offer to
buy any securities other than the registered securities to which it relates.
This Prospectus Supplement or the accompanying Prospectus does not constitute an
offer to sell or a solicitation of an offer to buy such securities, nor shall
any sales of the Common Stock be made pursuant to this Prospectus Supplement or
the accompanying Prospectus, in any circumstances in which such offer or
solicitation or sale is unlawful.
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TABLE OF CONTENTS
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PROSPECTUS SUPPLEMENT
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Supplement Summary......... S-3
Use of Proceeds....................... S-13
Risk Factors.......................... S-13
Market Prices and Dividend Data....... S-18
Capitalization........................ S-18
Selected Financial Data............... S-19
Federal Income Tax Considerations..... S-20
Underwriting.......................... S-21
Legal Matters......................... S-21
PROSPECTUS
Available Information................. 2
Incorporation of Certain Information
by Reference........................ 2
The Company........................... 4
Use of Proceeds....................... 4
Description of Securities............. 4
Certain Federal Income Tax
Considerations...................... 10
Plan of Distribution.................. 12
ERISA Investors....................... 14
Legal Matters......................... 14
Experts............................... 14
</TABLE>
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1,250,000 SHARES
RWT
REDWOOD TRUST, INC.
COMMON STOCK
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PROSPECTUS SUPPLEMENT
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MONTGOMERY SECURITIES
November 19, 1996
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