<PAGE> 1
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER: 0-26436
REDWOOD TRUST, INC.
(Exact name of Registrant as specified in its Charter)
MARYLAND 68-0329422
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
591 REDWOOD HIGHWAY, SUITE 3100
MILL VALLEY, CALIFORNIA 94941
(Address of principal executive offices) (Zip Code)
(415) 389-7373
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all
documents and reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes X No
----- -----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of stock, as of the last practicable date.
Class B Preferred Stock ($.01 par value) 909,518 as of November 10, 1997
Common Stock ($.01 par value) 14,471,477 as of November 10, 1997
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<PAGE> 2
REDWOOD TRUST, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at September 30, 1997 and December 31, 1996.............. 3
Consolidated Statements of Operations for the three and nine months
ended September 30, 1997 and September 30, 1996...................................... 4
Consolidated Statements of Stockholders' Equity for the three and nine months
ended September 30, 1997 and September 30, 1996...................................... 5
Consolidated Statements of Cash Flows for the three and nine months
ended September 30, 1997 and September 30, 1996...................................... 6
Notes to Consolidated Financial Statements........................................... 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations......................................... 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................................... 61
Item 2. Changes in Securities................................................................. 61
Item 3. Defaults Upon Senior Securities....................................................... 61
Item 4. Submission of Matters to a Vote of Security Holders................................... 61
Item 5. Other Information..................................................................... 61
Item 6. Exhibits and Reports on Form 8-K...................................................... 61
SIGNATURES .................................................................................. 62
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
September 30, 1997 December 31, 1996
------------------ -----------------
<S> <C> <C>
ASSETS
Mortgage assets:
Mortgage securities $ 2,059,595 $ 1,627,953
Mortgage loans 1,378,328 525,475
----------- -----------
3,437,923 2,153,428
Interest rate agreements 2,926 2,601
Cash and cash equivalents 57,696 11,068
Accrued interest receivable 23,859 15,537
Other assets 2,848 1,563
----------- -----------
$ 3,525,252 $ 2,184,197
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt $ 2,639,773 $ 1,953,103
Long-term debt 497,367 --
Accrued interest payable 20,216 14,060
Accrued expenses and other liabilities 2,129 761
Dividends payable 9,433 5,268
----------- -----------
3,168,918 1,973,192
----------- -----------
Commitments and contingencies (See Note 11)
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01 per share;
Class B 9.74% Cumulative Convertible
909,518 and 1,006,250 shares authorized;
909,518 and 1,006,250 shares issued and
outstanding ($28,882 aggregate liquidation
preference) 26,733 29,579
Common stock, par value $0.01 per share;
49,090,482 and 48,993,750 shares authorized;
14,576,477 and 10,996,572 issued
and outstanding 146 110
Additional paid-in capital 333,841 187,507
Net unrealized gain (loss) on assets
available for sale 1,837 (3,460)
Dividends in excess of net income (6,223) (2,731)
----------- -----------
356,334 211,005
----------- -----------
$ 3,525,252 $ 2,184,197
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
3
<PAGE> 4
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
INTEREST INCOME
Mortgage assets $ 56,044 $ 19,121 $ 143,693 $ 40,734
Cash and investments 499 250 927 669
------------ ------------ ------------ ------------
56,543 19,371 144,620 41,403
INTEREST EXPENSE
Short-term debt 40,318 14,447 108,176 29,724
Long-term debt 5,570 -- 5,570 --
------------ ------------ ------------ ------------
45,888 14,447 113,746 29,724
NET INTEREST RATE AGREEMENTS EXPENSE 1,038 349 2,472 756
------------ ------------ ------------ ------------
NET INTEREST INCOME 9,617 4,575 28,402 10,923
Provision for credit losses 943 516 2,414 1,324
Net (gain)/loss on sale transactions (20) -- (20) --
Operating expenses 1,148 672 3,530 1,758
------------ ------------ ------------ ------------
NET INCOME 7,546 3,387 22,478 7,841
------------ ------------ ------------ ------------
Less cash dividends on Class B preferred stock 687 388 2,129 388
------------ ------------ ------------ ------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 6,859 $ 2,999 $ 20,349 $ 7,453
============ ============ ============ ============
NET INCOME PER SHARE
Primary $ 0.47 $ 0.32 $ 1.52 $ 0.90
Fully diluted $ 0.47 $ 0.31 $ 1.52 $ 0.89
Weighted average shares of common stock and
common stock equivalents:
Primary 14,624,601 9,516,174 13,416,032 8,246,815
Fully diluted 14,624,601 9,657,395 13,416,032 8,402,542
Dividends declared per Class B preferred share $ 0.755 $ 0.386 $ 2.265 $ 0.386
Dividends declared per common share $ 0.600 $ 0.400 $ 1.800 $ 1.260
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
4
<PAGE> 5
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the nine months ended September 30, 1997
(In thousands, except share data)
<TABLE>
<CAPTION>
Net
Unrealized
Gain (Loss)
Class B Preferred Stock Common Stock Additional on Assets Dividends in
------------------------ ------------------ Paid-in Available Excess of
Shares Amount Shares Amount Capital for Sale Net Income Total
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 1,006,250 $29,579 10,996,572 $110 $187,507 $(3,460) $(2,731) $211,005
-------------------------------------------------------------------------------------------------
Net income -- -- -- -- -- -- 7,211 7,211
Conversion of preferred stock (6,612) (196) 6,612 1 195 -- -- 0
Issuance of common stock -- -- 902,773 8 31,759 -- -- 31,767
Dividends declared:
Class B Preferred -- -- -- -- -- -- (755) (755)
Common -- -- -- -- -- -- (7,144) (7,144)
Fair value adjustment on
assets available for sale -- -- -- -- -- 3,578 -- 3,578
------------------------------------------------------------------------------------------------
Balance, March 31, 1997 999,638 $29,383 11,905,957 $119 $219,461 $ 118 $(3,419) $245,662
------------------------------------------------------------------------------------------------
Net income -- -- -- -- -- -- 7,721 7,721
Conversion of preferred stock (90,120) (2,650) 90,120 1 2,649 -- -- 0
Issuance of common stock -- -- 1,255,770 13 52,310 -- -- 52,323
Dividends declared:
Class B Preferred -- -- -- -- -- -- (687) (687)
Common -- -- -- -- -- -- (7,951) (7,951)
Fair value adjustment on
assets available for sale -- -- -- -- -- (3,880) -- (3,880)
------------------------------------------------------------------------------------------------
Balance, June 30, 1997 909,518 $26,733 13,251,847 $133 $274,420 $(3,762) $(4,336) $293,188
------------------------------------------------------------------------------------------------
Net income -- -- -- -- -- -- 7,546 7,546
Issuance of common stock -- -- 1,697,630 17 70,446 -- -- 70,463
Repurchase of common stock -- -- (373,000) (4) (11,025) -- -- (11,029)
Dividends declared:
Class B Preferred -- -- -- -- -- -- (687) (687)
Common -- -- -- -- -- -- (8,746) (8,746)
Fair value adjustment on
assets available for sale -- -- -- -- -- 5,599 -- 5,599
------------------------------------------------------------------------------------------------
Balance, September 30, 1997 909,518 $26,733 14,576,477 $146 $333,841 $ 1,837 $(6,223) $356,334
================================================================================================
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
5
<PAGE> 6
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
--------- --------- ----------- ---------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,546 $ 3,387 $ 22,478 $ 7,841
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of mortgage asset premium and discount, net 6,512 1,435 15,439 2,989
Amortization of deferred bond issuance costs 228 -- 228 --
Depreciation and amortization 32 25 87 60
Provision for credit losses on mortgage assets 943 516 2,414 1,324
Amortization of interest rate cap agreements 966 208 2,033 548
Net (gain)/loss on sale transactions (20) -- (20) --
(Increase) decrease in accrued interest receivable 1,959 (3,489) (8,322) (7,511)
(Increase) decrease in other assets (1,606) 420 (1,340) (744)
Increase in accrued interest payable 2,063 6,327 6,156 9,089
Increase in accrued expenses and other 386 111 1,368 245
--------- --------- ----------- ---------
Net cash provided by operating activities 19,009 8,940 40,521 13,841
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of mortgage securities (43,163) (379,879) (911,789) (993,906)
Proceeds from sales of mortgage securities 42,023 -- 42,023 --
Purchases of mortgage loans (326,300) (63,981) (1,047,639) (112,990)
Principal payments on mortgage securities 170,942 71,145 434,720 151,288
Principal payments on mortgage loans 81,456 5,797 190,985 11,526
Purchases of interest rate cap agreements (596) (660) (7,697) (1,314)
--------- --------- ----------- ---------
Net cash used in investing activities (75,638) (367,578) (1,299,397) (945,396)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from (repayments on) short-term borrowings (463,011) 328,880 686,670 854,778
Net proceeds from long-term borrowings 497,140 -- 497,140 --
Net proceeds from issuance of Class B preferred stock -- 29,712 -- 29,712
Net proceeds from issuance of common stock 70,438 7,646 154,528 64,221
Repurchases of common stock (11,029) -- (11,029) --
Dividends paid (8,638) (3,408) (21,805) (7,382)
--------- --------- ----------- ---------
Net cash provided by financing activities 84,900 362,830 1,305,504 941,329
Net increase in cash and cash equivalents 28,271 4,192 46,628 9,774
Cash and cash equivalents at beginning of period 29,425 10,407 11,068 4,825
--------- --------- ----------- ---------
Cash and cash equivalents at end of period $ 57,696 $ 14,599 $ 57,696 $ 14,599
========= ========= =========== =========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 43,594 $ 8,120 $ 107,585 $ 20,635
========= ========= =========== =========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
6
<PAGE> 7
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
NOTE 1. THE COMPANY
Redwood Trust, Inc. was incorporated in Maryland on April 11, 1994 and commenced
operations on August 19, 1994.
The Company acquires and manages real estate mortgage assets ("Mortgage Assets")
which may be acquired as whole loans ("Mortgage Loans") or as mortgage
securities representing interests in or obligations backed by pools of mortgage
loans ("Mortgage Securities"). The Company acquires Mortgage Assets that are
secured by single-family real estate properties throughout the United States.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Redwood Trust,
Inc.("Redwood Trust") and its special-purpose finance subsidiary, Sequoia
Mortgage Funding Corporation (collectively, the "Company"). All inter-company
balances and transactions have been eliminated. Substantially all of the assets
of the special-purpose finance subsidiary are pledged to secure long-term debt
in the form of collateralized mortgage bonds ("Long-Term Debt") and are not
available for the satisfaction of general claims of the Company. The Company's
exposure to loss on the assets pledged as collateral is limited to its net
investment, as the Long-Term Debt is non-recourse to the Company.
Certain amounts for prior years have been reclassified to conform with the 1997
presentation.
INCOME TAXES
The Company has elected to be taxed as a Real Estate Investment Trust ("REIT")
under the Internal Revenue Code (the "Code") and the corresponding provisions of
State law. As a result, the Company generally will not be subject to Federal or
State income taxation at the corporate level to the extent that it distributes
at least 95% of its taxable income to its shareholders and complies with certain
other requirements. Accordingly, no provision has been made for income taxes in
the accompanying consolidated financial statements, as the Company believes it
has met the prescribed distribution requirements.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of three months or less. The carrying amount of cash
equivalents approximates their fair value.
MORTGAGE ASSETS
The Company's Mortgage Assets may consist of Mortgage Securities and Mortgage
Loans. Interest income is accrued based on the outstanding principal amount of
the Mortgage Assets and their contractual terms. Discounts and premiums relating
to Mortgage Assets are amortized into interest income over the lives of the
Mortgage Assets using methods that approximate the effective yield method. Gains
or losses on the sale of Mortgage Assets are based on the specific
identification method.
7
<PAGE> 8
Mortgage Securities
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities ("SFAS 115"), requires the Company to
classify its Mortgage Securities as either trading investments,
available-for-sale investments or held-to-maturity investments. Although the
Company generally intends to hold most of its Mortgage Securities until
maturity, it may, from time to time, sell any of its Mortgage Securities as part
of its overall management of its balance sheet. Accordingly, to maintain
flexibility, the Company currently classifies all of its Mortgage Securities as
available-for-sale. All assets classified as available-for-sale are reported at
fair value, with unrealized gains and losses excluded from earnings and reported
as a separate component of stockholders' equity.
Unrealized losses on Mortgage Securities that are considered
other-than-temporary, as measured by the amount of decline in fair value
attributable to factors other than temporary, are recognized in income and the
cost basis of the Mortgage Security is adjusted. Other-than-temporary unrealized
losses are based on management's assessment of various factors affecting the
expected cash flow from the Mortgage Securities, including an
other-than-temporary deterioration of the credit quality of the underlying
mortgages and/or the credit protection available to the related mortgage pool.
Mortgage Loans
Mortgage Loans are carried at their unpaid principal balance, net of unamortized
discount or premium.
DEFERRED BOND ISSUANCE COSTS
Costs incurred in connection with the issuance of Long-Term Debt in the form of
collateralized mortgage bonds are deferred and amortized over the estimated
lives of the Long-Term Debt using the interest method adjusted for the effects
of prepayments. Deferred bond issuance costs are included in the carrying value
of the Long-Term Debt. Unallocated costs incurred in establishing the Company's
Long-Term Debt shelf are reflected as a component of Other Assets until
allocated to the issuance of specific Long-Term Debt.
INTEREST RATE AGREEMENTS
The rate the Company pays on its short-term and variable borrowings will rise
and fall without limit as short-term market interest rates fluctuate. The rate
the Company earns on its adjustable rate assets, however, is limited by periodic
and lifetime caps.
Statement of Financial Accounting Standards No. 119, Disclosure about Derivative
Financial Instruments, requires the Company to provide certain disclosures
concerning its derivative instruments according to a set of prescribed
guidelines. Under the Company's hedging policy a specific portfolio of assets
and liabilities, with similar economic characteristics including a low life
strike, variable interest rate based on a market-sensitive index, similar
expected prepayment rate behavior and similar periodic caps, exposing the
Company to interest rate risk is identified. The hedge instruments are chosen as
the ones probable of substantially reducing the interest rate risk being hedged,
and a high degree of correlation is maintained on an on-going basis. Currently,
the Company enters into "Interest Rate Agreements" as hedges. Interest Rate
Agreements, which include interest rate cap agreements (the "Cap Agreements"),
interest rate swap agreements (the "Swap Agreements"), interest rate collar
agreements (the "Collar Agreements") and interest rate futures agreements (the
"Futures Agreements"), entered into by the Company are intended to provide
income to offset potential reduced net interest income under certain rising
interest rate scenarios. The Company periodically evaluates the effectiveness of
these hedges under various interest rate scenarios.
The Company accounts for the Interest Rate Agreements as hedges. Interest Rate
Agreements that are hedging Mortgage Assets carried at fair value are also
carried at fair value, with unrealized gains and losses reported as a separate
component of equity. Similarly, Interest Rate Agreements that are used to hedge
Mortgage Assets carried at amortized cost are reflected at amortized cost.
8
<PAGE> 9
The cost of each Cap Agreement and the net cost or payment received on each
Collar Agreement is amortized over the effective period of that Cap or Collar
Agreement using the effective interest method. The income and expense related to
each Swap Agreement is recognized on an accrual basis. Gains and losses on early
termination of Interest Rate Agreements are amortized as a component of net
interest income over the remaining term of the original Interest Rate Agreement,
or, if shorter, over the remaining term of associated Mortgage Assets as
adjusted for estimated future principal repayments. In the event that an
underlying hedged item is sold or extinguished, any related hedging gains or
losses would be recognized in income.
Unrealized losses on Interest Rate Agreements that are considered
other-than-temporary are recognized in income and the cost basis of the Interest
Rate Agreement is adjusted. The other-than-temporary decline is measured as the
amount of the decline in fair value attributable to factors that are
other-than-temporary. Other-than-temporary unrealized losses are based on
management's assessment of various factors affecting the Interest Rate
Agreements, for example, a serious deterioration of the ability of the
counter-party to perform under the terms of the Interest Rate Agreement.
DEBT
Short-term and long-term debt are carried at their unpaid principal balances,
net of any unamortized discount or premium and any unamortized deferred bond
issuance costs. Any discount or premium is recognized as an adjustment to
interest expense using the interest method based on the maturity schedule of the
related borrowings.
NET INCOME PER SHARE
Net income per share is based on the weighted average shares of common stock
outstanding plus common equivalent shares using the treasury stock method. The
treasury stock method calculation assumes all dilutive common stock equivalents
are exercised and the funds generated by the exercise are used to buy back
outstanding common stock at the average market price during the reporting
period, for primary earnings per share, or at the end of period market price if
higher, for fully diluted earnings per share.
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"). SFAS
128 is designed to improve the earnings per share ("EPS") information provided
in the financial statements by simplifying the existing computational
guidelines, revising the disclosure requirements, and increasing the
comparability of EPS data on an international basis. SFAS 128 is effective for
financial statements issued for periods ending after December 15, 1997,
including interim periods. The Company will implement SFAS 128 in its December
31, 1997 financial statements. The following table reflects the impact that SFAS
128 would have had on the current financial statements.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
------------------------------------------------
<S> <C> <C> <C> <C>
As Reported:
Primary Earnings Per Share $0.47 $0.32 $1.52 $0.90
Fully Diluted Earnings Per Share $0.47 $0.31 $1.52 $0.89
Under SFAS No. 128:
Basic Earnings Per Share $0.48 $0.34 $1.57 $1.01
Fully Diluted Earnings Per Share $0.47 $0.32 $1.52 $0.90
</TABLE>
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of
9
<PAGE> 10
revenue and expenses during the reported period. Actual results could differ
from those estimates. The primary estimates inherent in the accompanying
consolidated financial statements are discussed below.
Fair Value. The Company uses estimates in establishing fair value for its
investments available-for-sale. Management bases its fair value estimates
primarily on third party bid price indications, such as bid indications provided
by dealers who make markets in these assets and asset valuations made by
collateralized lenders, when such indications are available. Estimates of fair
value for all remaining investments available-for-sale are based primarily on
management's judgment. However, the fair value reported reflects estimates and
may not necessarily be indicative of the amounts the Company could realize in a
current market exchange. The fair value of all on- and off- balance sheet
financial instruments is presented in Notes 3, 6 and 9.
Allowance for Credit Losses. As discussed in Note 5, the Company has assumed
credit risk on certain Mortgage Assets. An allowance for credit losses has been
estimated and established for the credit risk assumed based on management's
judgment. The allowance for credit losses is evaluated and adjusted periodically
by management based on the actual and projected timing and amount of potential
credit losses, as well as industry loss experience. Provisions made to increase
the allowance related to the credit risk assumed is presented as "Provision for
Credit Losses" in the accompanying consolidated financial statements. The
Company's actual credit losses may differ from those estimates used to establish
the allowance.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the FASB issued SFAS No. 129, Disclosure of Information about
Capital Structure. This statement establishes standards for disclosing
information about an entity's capital structure. The Company intends to comply
with the disclosure requirements of this statement which is effective for
periods ending after December 15, 1997.
On June 30, 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income.
This statement requires companies to classify items of other comprehensive
income by their nature in a financial statement and display the accumulated
balance of other comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of a statement of financial
position, and is effective for financial statements issued for fiscal years
beginning after December 15, 1997. The impact of adopting SFAS No. 130 has not
been determined.
NOTE 3. MORTGAGE ASSETS
At September 30, 1997, Mortgage Assets consisted of the following:
<TABLE>
<CAPTION>
MORTGAGE SECURITIES
------------------------- MORTGAGE
(IN THOUSANDS) AGENCY NON-AGENCY LOANS TOTAL
-----------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage Assets, Gross $1,050,782 $959,592 $1,348,839 $3,359,213
Unamortized Discount (182) (14,205) 0 (14,387)
Unamortized Premium 35,843 20,239 30,852 86,934
---------- -------- ---------- ----------
Amortized Cost 1,086,443 965,626 1,379,691 3,431,760
Allowance for Credit Losses 0 (3,093) (1,363) (4,456)
Gross Unrealized Gains 7,155 9,071 0 16,226
Gross Unrealized Losses (1,191) (4,416) 0 (5,607)
---------- -------- ---------- ----------
Carrying Value $1,092,407 $967,188 $1,378,328 $3,437,923
========== ======== ========== ==========
</TABLE>
10
<PAGE> 11
At December 31, 1996, Mortgage Assets consisted of the following:
<TABLE>
<CAPTION>
MORTGAGE SECURITIES
----------------------- MORTGAGE
(IN THOUSANDS) AGENCY NON-AGENCY LOANS TOTAL
---------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage Assets, Gross $939,936 $662,276 $515,033 $2,117,245
Unamortized Discount (234) (15,717) (142) (16,093)
Unamortized Premium 26,939 16,366 11,012 54,317
-------- -------- -------- ----------
Amortized Cost 966,641 662,925 525,903 2,155,469
Allowance for Credit Losses 0 (1,752) (428) (2,180)
Gross Unrealized Gains 3,173 2,791 0 5,964
Gross Unrealized Losses (873) (4,952) 0 (5,825)
-------- -------- -------- ----------
Carrying Value $968,941 $659,012 $525,475 $2,153,428
======== ======== ======== ==========
</TABLE>
At September 30, 1997 and December 31, 1996, all investments in Mortgage Assets
consisted of interests in adjustable-rate mortgages on residential properties. A
majority of the mortgages in pools in which the Company owns a security interest
rated less than AA are on properties located in California. Agency Mortgage
Securities ("Agency Securities") represent securitized interests in pools of
adjustable-rate mortgages from the Federal Home Loan Mortgage Corporation and
the Federal National Mortgage Association. The Agency Securities are guaranteed
as to principal and interest by those US government agencies. The original
maturity of the majority of the Mortgage Assets is thirty years; the actual
maturity is subject to change based on the prepayments of the underlying
mortgage loans.
At September 30, 1997, the average annualized effective yield on the Mortgage
Assets was 6.79% based on the amortized cost of the assets. At December 31,
1996, the average annualized effective yield was 7.11% based on the amortized
cost of the assets.
The coupons on most of the adjustable-rate mortgage securities and loans owned
by the Company are limited by periodic caps (generally interest rate adjustments
are limited to no more than 1% every six months or 2% every year) and lifetime
caps. At September 30, 1997 and December 31, 1996, the weighted average lifetime
cap was 12.01% and 11.73%, respectively.
During the third quarter of 1997, the Company sold Mortgage Securities with a
face value of approximately $40.0 million. Proceeds and realized gains and
losses on the sales of Mortgage Securities are presented below:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
(IN THOUSANDS) SEPTEMBER 30, 1997
------------------
<S> <C>
Proceeds from sales of available-for-sale securities $42,023
Available-for-sale securities gains $202
Available-for-sale securities losses (28)
----
Net gain on sales of available-for-sale securities $174
====
</TABLE>
As discussed in the Interest Rate Agreements policies in Note 1, in the event
that an underlying hedged item is sold, any related hedging gains or losses are
recognized in income. Accordingly, the sales of Mortgage Securities resulted in
a charge to expense of $154,800, reflecting the write-down to fair value of the
related interest rate hedges. The sales of Mortgage Securities therefore
produced a net gain of $19,643.
11
<PAGE> 12
NOTE 4. COLLATERAL FOR LONG-TERM DEBT
The Company has pledged collateral in order to secure the Long-Term Debt issued
in the form of collateralized mortgage bonds ("Bond Collateral"). This Bond
Collateral consists primarily of adjustable-rate, conventional, 30-year mortgage
loans secured by first liens on one- to four-family residential properties. All
Bond Collateral is pledged to secure repayment of the related Long-Term Debt
obligation. All principal and interest (less servicing related fees) on the Bond
Collateral is remitted to a trustee and is available for payment on the
Long-Term Debt obligation. The Company's exposure to loss on the Bond Collateral
is limited to its net investment, as the Long-Term Debt is non-recourse to the
Company. The Company may also be exposed to losses from prepayments of the
underlying loans to the extent of unamortized net premium on the loans or
deferred bond issuance costs related to the issuance of the Long-Term Debt.
The components of the Bond Collateral at September 30, 1997 are summarized as
follows:
<TABLE>
<CAPTION>
(IN THOUSANDS) SEPTEMBER 30, 1997
------------------
<S> <C>
Mortgage loans $492,123
Cash and cash equivalents held by trustees 28,890
Accrued interest receivable 3,172
--------
$524,185
========
</TABLE>
For presentation purposes, the various components of the Bond Collateral
summarized above are reflected in their corresponding line items on the
Consolidated Balance Sheets.
NOTE 5. ALLOWANCE FOR CREDIT LOSSES
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED
(IN THOUSANDS) SEPTEMBER 30, 1997 DECEMBER 31, 1996
------------------------------- --------------------------------
MORTGAGE MORTGAGE MORTGAGE MORTGAGE
SECURITIES LOANS TOTAL SECURITIES LOANS TOTAL
------------------------------- --------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at beginning of period $1,752 $ 428 $2,180 $ 411 $ 79 $ 490
Provision for credit losses 1,426 988 2,414 1,347 349 1,696
Charge-offs (85) (53) (138) (6) 0 (6)
------ ------ ------ ------ ---- ------
Balance at end of period $3,093 $1,363 $4,456 $1,752 $428 $2,180
====== ====== ====== ====== ==== ======
</TABLE>
The majority of the Company's Mortgage Securities have protection from some
degree of credit loss either through subordination, insurance, third party
guarantees, or other means, whereas, Mortgage Loans do not have such protection.
Many of the Company's Mortgage Securities have received ratings from one or more
of the four nationally recognized credit rating agencies. Based on these
ratings, and on credit criteria similar to those used by rating agencies, the
Company assigns a "rating equivalent" to each Mortgage Security and pool of
Mortgage Loans. For purposes of assigning a rating equivalent to unrated pools
of Mortgage Loans or unrated Mortgage Securities, the Company assigns a series
of ratings to different portions of the pool according to the Company's
estimation of how the pool would currently be structured and rated if it were
newly securitized. At September 30, 1997, the Mortgage Assets held by the
Company had rating equivalents ranging from AAA to unrated, with a weighted
average of AA+. At December 31, 1996, the Mortgage Assets held by the Company
had rating equivalents ranging from AAA to unrated, with a weighted average of
AA+. 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 Mortgage Assets, including current
and projected economic conditions, delinquency status and credit protection. In
determining the allowance for credit losses, the Company's credit exposure is
considered based on its credit risk position in the mortgage pool. These
estimates are reviewed periodically and, as adjustments become necessary, they
are reported in earnings in the periods in which they become known. The
12
<PAGE> 13
reserve is increased by provisions charged to income from operations. When a
loan or portions of a loan are determined to be uncollectible, the portion
deemed uncollectible is charged against the allowance and subsequent recoveries,
if any, are credited to the allowance.
NOTE 6. INTEREST RATE AGREEMENTS
The amortized cost and fair value of the Company's Interest Rate Agreements are
summarized as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS) SEPTEMBER 30, 1997 DECEMBER 31, 1996
------------------ ---------------
<S> <C> <C>
Amortized Cost $11,708 $ 6,200
Gross Unrealized Gains 468 156
Gross Unrealized Losses (9,250) (3,755)
- ----------------------- ------- --------
Carrying Value $ 2,926 $ 2,601
======= =======
</TABLE>
The sum of the notional amounts of all of the Company's Interest Rate Agreements
in effect was $3.1 billion at September 30, 1997 and $1.1 billion at December
31, 1996, respectively. The sum of the notional amounts of all of the Interest
Rate Agreements owned by the Company was $5.6 billion at September 30, 1997 and
$2.6 billion at December 31, 1996.
Cap Agreements
Potential future earnings from the Company's Cap Agreements are based on
variations in the London Inter-Bank Offered Rate ("LIBOR"). The sum of the
notional amounts of the Company's Cap Agreements in effect was $2.6 billion and
$703 million at September 30, 1997 and December 31, 1996, respectively. The
weighted average cap strike rate during the three and nine months ended
September 30, 1997 was 7.09% and 7.20%, respectively. The weighted average cap
strike rate during the three and nine months ended September 30, 1996 was 7.11%
and 7.18%, respectively. Under these Cap Agreements the Company will receive
cash payments should an agreed-upon reference rate, either one-month or
three-month LIBOR, increase above the strike rates of the Cap Agreements.
Information on the Cap Agreements outstanding at September 30, 1997 is
summarized below.
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) AVERAGE CAP EXPECTED
NOTIONAL AVERAGE CAP LOW CAP HIGH CAP CAP EXPENSE
FACE AMOUNT STRIKE RATE STRIKE RATE STRIKE RATE AMORTIZATION
YEAR
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1997 (last 3 months) $2,688,124 7.08% 5.50% 12.00% $1,137
1998 2,016,375 7.57% 5.50% 12.00% 4,407
1999 1,360,356 9.05% 6.30% 12.00% 2,653
2000 864,720 9.78% 7.00% 12.00% 1,547
2001 632,932 9.99% 7.00% 11.00% 1,076
2002 112,425 8.59% 7.50% 11.00% 304
2003 32,634 8.31% 7.50% 9.00% 203
2004 31,834 8.30% 7.50% 9.00% 197
2005 13,901 7.75% 7.50% 9.00% 87
2006 10,000 7.50% 7.50% 7.50% 72
2007 (first 4 months) 9,833 7.50% 7.50% 7.50% 25
-------
Total $11,708
=======
</TABLE>
13
<PAGE> 14
Collar Agreement
At September 30, 1997, the Company had entered into one outstanding collar
agreement, consisting of the purchase of a cap agreement subsidized by the sale
of a floor agreement. On the cap portion, the Company will receive net hedge
income to the extent that three month LIBOR exceeds 7.50%. On the floor portion,
the Company will incur a net hedge expense to the extent that three month LIBOR
falls below 5.91%
Information on the Collar Agreement outstanding at September 30, 1997 is
summarized below.
<TABLE>
<CAPTION>
NOTIONAL FACE EXPECTED COLLAR
AMOUNT CAP STRIKE FLOOR STRIKE EXPENSE
EFFECTIVE PERIOD: (IN THOUSANDS) INDEX RATE RATE AMORTIZATION
- ------------------------- ------------ -------------- ---------- --------- -----------------------
<S> <C> <C> <C> <C> <C>
October 1997 to July 1999 $20,000 3 mo LIBOR 7.50% 5.91% $0
</TABLE>
Swap Agreements
The Company has entered into three types of Interest Rate Swap Agreements
summarized as follows:
Fixed vs. Floating Rate Swap Agreements:
The sum of the notional amounts of the Company's fixed vs. floating rate Swap
Agreements ("Fixed Pay Rate Swaps") in effect was $168 million at September 30,
1997 and $135 million at December 31, 1996. Under these Swap Agreements, the
Company receives the 3 month LIBOR rate and pays the agreed upon fixed rate.
Information on the Fixed Pay Rate Swaps outstanding at September 30, 1997 is
summarized below.
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) AVERAGE SWAP
NOTIONAL FACE AVERAGE LOW HIGH
YEAR AMOUNT PAY RATE PAY RATE PAY RATE
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997 (last 3 months) $155,446 6.04% 5.59% 7.18%
1998 (first 6 months) 70,569 5.89% 6.40% 7.18%
</TABLE>
Periodic Swap Agreements:
The Company enters into Periodic Swap Agreements in order to produce income to
the Company in the event that the three month LIBOR rate rises sharply. In each
of these swaps, the Company receives income on the notional face at a rate equal
to three month LIBOR less 0.230% to 0.265% and pays income on the notional face
on the lesser of (a) three month LIBOR or (b) the prior period's LIBOR plus
0.50%. The average notional face of these swaps is $110 million, with $90
million maturing in August 1999 and $20 million maturing in September 1999.
Information on the Periodic Swap Agreements outstanding at September 30, 1997 is
summarized below.
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) AVERAGE SWAP
NOTIONAL FACE AVERAGE SPREAD LOW SPREAD HIGH SPREAD
YEAR AMOUNT RECEIVED RECEIVED RECEIVED
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997 (last 3 months) $110,000 -0.255% -0.265% -0.230%
1998 110,000 -0.255% -0.265% -0.230%
1999 (first 9 months) 98,242 -0.257% -0.265% -0.230%
</TABLE>
Basis Swap Agreements:
As of September 30, 1997, the Company had entered into LIBOR/Treasury bill Basis
Swap Agreements totaling $160 million in notional value. These Basis Swap
Agreements, in conjunction with the Company's other Swap and Cap Agreements, are
designed to reduce the potential risks in that portion of the Company's balance
sheet
14
<PAGE> 15
wherein Treasury-based assets are funded with LIBOR-based liabilities. The Basis
Swap Agreements will produce net hedge income for the Company to the extent that
three month LIBOR exceeds the average three month Treasury bill rate by 0.440%
to 0.465% and will produce a net hedge expense for the Company to the extent
that the spread between these two indices is narrower than 0.440% to 0.465%. The
maturities of these Basis Swap Agreements are as follows: $30 million in June
1998, $50 million in December 1998, $30 million in June 1999 and $50 million in
December 1999.
Information on Basis Swap Agreements outstanding September 30, 1997 is
summarized below.
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) AVERAGE SWAP
NOTIONAL FACE AVERAGE LOW SPREAD HIGH SPREAD
YEAR AMOUNT SPREAD PAID PAID PAID
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997 (last 3 months) $160,000 0.453% 0.440% 0.465%
1998 144,877 0.455% 0.440% 0.465%
1999 64,712 0.464% 0.460% 0.465%
</TABLE>
The Company has incurred credit risk to the extent that the counter-parties to
the Interest Rate Agreements do not perform their obligations under the Interest
Rate Agreements. Potential credit write-offs are limited to the amortized cost
of the Cap Agreements. In addition, for Cap, Swap and Collar Agreements, if one
of the counter-parties does not perform, the Company would not receive the cash
to which it would otherwise be entitled under the Interest Rate Agreement. In
order to mitigate this risk, the Company has entered into Interest Rate
Agreements only with counter-parties rated A or better and has entered into
Interest Rate Agreements with eighteen different counter-parties in order to
reduce the risk of credit exposure to any one counter-party.
NOTE 7. SHORT-TERM DEBT
The Company has entered into reverse repurchase agreements, notes payable and a
revolving line of credit (together "Short-Term Debt") to finance acquisitions of
a portion of its Mortgage Assets. This Short-Term Debt is collateralized by a
portion of the Company's Mortgage Assets.
At September 30, 1997, the Company had $2.6 billion of Short-Term Debt
outstanding with a weighted average borrowing rate of 5.95% and a weighted
average remaining maturity of 67 days. This debt was collateralized with $2.75
billion of Mortgage Assets. At December 31, 1996, the Company had $2.0 billion
of Short-Term Debt outstanding with a weighted average borrowing rate of 5.83%
and a weighted average remaining maturity of 98 days. This debt was
collateralized with $2.1 billion of Mortgage Assets.
During September 1997, the Company entered into a $20 million, six-month
revolving line of credit agreement with a financial institution. The agreement
requires that the Company maintain certain financial ratios. The Company is in
compliance with all requirements. Interest rates on borrowings under this
facility are based on LIBOR. At September 30, 1997, borrowings under this
facility totaled $19.9 million and were committed through October 15, 1997. At
December 31, 1996, borrowings under this facility totaled $19.3 million. These
borrowings are reflected in the $2.6 billion and $2.0 billion of Short-Term Debt
outstanding at September 30, 1997 and December 31, 1996, respectively.
At September 30, 1997 and December 31, 1996, the Short-Term Debt had the
following remaining maturities:
<TABLE>
<CAPTION>
(IN THOUSANDS) SEPTEMBER 30, 1997 DECEMBER 31, 1996
------------------ ----------------
<S> <C> <C>
Within 30 days $1,591,742 $ 268,042
30 to 90 days 183,453 667,567
Over 90 days 864,578 1,017,494
- ------------ ---------- ----------
Total Short-Term Debt $2,639,773 $1,953,103
========== ==========
</TABLE>
15
<PAGE> 16
For the three and nine months ended September 30, 1997, the average balance of
Short-Term Debt was $2.7 billion and $2.5 billion with a weighted average
interest cost of 5.98% and 5.85%, respectively. For the three and nine months
ended September 30, 1996, the average balance of Short-Term Debt was $1.0
billion and $0.7 billion with a weighted average interest cost of 5.78% and
5.69%, respectively. The maximum balance outstanding during the nine months
ended September 30, 1997 was $3.1 billion. The maximum balance outstanding
during the year ended December 31, 1996 was $2.0 billion.
NOTE 8. LONG-TERM DEBT
During the third quarter of 1997, the Company issued $534.3 million of Long-Term
Debt in the form of collateralized mortgage bonds which were issued by Sequoia
Mortgage Trust 1, a business trust established by the Company's wholly-owned
subsidiary, Sequoia Mortgage Funding Corporation ("Sequoia"). This series of
Long-Term Debt consists of two classes of bonds at variable rates of interest.
Payments received on the Bond Collateral are used to make payments on the
Long-Term Debt. The obligations under the Long-Term Debt are payable solely from
the Bond Collateral and are otherwise non-recourse to the Company. The maturity
of each class is directly affected by the rate of principal prepayments on the
related Bond Collateral. The Long-Term Debt is also subject to redemptions
according to specific terms of the respective indentures. As a result, the
actual maturity of any class of this series of Long-Term Debt is likely to occur
earlier than its stated maturity. The components of the Long-Term Debt along
with selected other information are summarized as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS) SEPTEMBER 30, 1997
------------------
<S> <C>
Long-Term Debt $498,859
Deferred bond issuance costs (1,492)
--------
Total Long-Term Debt $497,367
========
Range of coupons on bonds 6.005% to 6.095%
Stated maturities 2029
</TABLE>
For the three months ended September 30, 1997, the average effective interest
cost for Long-Term Debt, as adjusted for the amortization of deferred bond
issuance costs and other related expenses, was 6.27%. Interest paid on Long-Term
Debt for the three months ended September 30, 1997 totaled $3.1 million.
NOTE 9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair values of
the Company's financial instruments at September 30, 1997 and December 31, 1996.
Statement of Financial Accounting Standards No. 107, Disclosures about Fair
Value of Financial Instruments, defines the fair value of a financial instrument
as the amount at which the instrument could be exchanged in a current
transaction between willing parties, other than in a forced
liquidation sale.
<TABLE>
<CAPTION>
(IN THOUSANDS) SEPTEMBER 30, 1997 DECEMBER 31, 1996
------------------------ ------------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------------------------ ------------------------
<S> <C> <C> <C> <C>
Assets
Mortgage Assets $3,437,923 $3,438,760 $2,153,428 $2,153,428
Interest Rate Agreements 2,926 2,169 2,601 2,601
</TABLE>
Cash and cash equivalents, interest receivable, short-term borrowings, accrued
interest payable, accrued expenses and other liabilities are reflected in the
financial statements at their costs, which approximates their fair value because
of the short-term nature of these instruments.
16
<PAGE> 17
NOTE 10. STOCKHOLDER'S EQUITY
CLASS B 9.74% CUMULATIVE CONVERTIBLE PREFERRED STOCK
On August 8, 1996, the Company issued 1,006,250 shares of Class B Preferred
Stock. Each share of the Class B Preferred Stock is convertible at the option of
the holder at any time into one share of Common Stock. After September 30, 1999,
the Company can either redeem or cause a conversion of the Class B Preferred
Stock. The Class B Preferred Stock pays a dividend equal to the greater of (i)
$0.755 per quarter or (ii) an amount equal to the quarterly dividend declared on
the number of shares of the Common Stock into which the Class B Preferred Stock
is convertible. The Class B Preferred Stock ranks senior to the Company's Common
Stock as to the payment of dividends and liquidation rights. The liquidation
preference entitles the holders of the Class B Preferred Stock to receive $31
per share plus any accrued dividends before any distribution is made on the
Common Stock.
As of September 30, 1997, 96,732 shares of the Class B Preferred Stock have been
converted into 96,732 shares of the Company's Common Stock. At September 30,
1997 and December 31, 1996, there were 909,518 and 1,006,250 shares of the Class
B Preferred Stock outstanding, respectively.
STOCK OPTION PLAN
The Company has adopted a Stock Option Plan for executive officers, employees
and non-employee directors (the "Stock Option Plan"). The Stock Option Plan
authorizes the Board of Directors (or a committee appointed by the Board of
Directors) to grant "incentive stock options" as defined under section 422 of
the Code ("ISOs"), options not so qualified ("NQSOs"), deferred stock,
restricted stock, performance shares, stock appreciation rights and limited
stock appreciation rights ("Awards") and dividend equivalent rights ("DERs") to
such eligible recipients other than non-employee directors. Non-employee
directors are automatically provided annual grants of NQSOs with DERs pursuant
to a formula under the Stock Option Plan.
The number of shares of Common Stock available under the Stock Option Plan for
options and Awards, subject to certain anti-dilution provisions, is 15% of the
Company's total outstanding shares of Common Stock. At September 30, 1997 and
December 31, 1996, 1,294,939 and 1,138,743 shares of Common Stock, respectively,
were available for grant. Of the shares of Common Stock available for grant, no
more than 500,000 shares of Common Stock shall be cumulatively available for
grant as ISOs. At September 30, 1997 and December 31, 1996, 320,448 and 299,633
ISOs had been granted, respectively. The exercise price for ISOs granted under
the Stock Option Plan may not be less than the fair market value of shares of
Common Stock at the time the ISO is granted. All stock options granted under the
Stock Option Plan vest no earlier than ratably over a four year period from the
date of grant and expire within ten years after the date of grant.
The Company's Stock Option Plan permits stock options granted under the plan to
accrue stock DERs. For the three and nine months ended September 30, 1997, the
stock DERs accrued on NQSOs that had a stock DER feature resulted in non-cash
charges to operating expenses of $119,436 and $366,239, respectively. For the
three and nine months ended September 30, 1996, the stock DERs accrued on NQSOs
that had a stock DER feature resulted in non-cash charges to operating expenses
of $80,592 and $244,916, respectively. Stock DERs represent shares of stock
which are issuable to holders of stock options when the holders exercise the
underlying stock options. The number of stock DER shares accrued are based on
the level of the Company's dividends and on the price of the stock on the
related dividend payment date.
17
<PAGE> 18
Information with respect to stock option and DER activity is as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED
SEPTEMBER 30, 1997 DECEMBER 31, 1996
-------------------------- --------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
-------------------------- --------------------------
<S> <C> <C> <C> <C>
Outstanding options at beginning of period: 421,583 $19.05 310,857 $ 9.48
Options granted 371,102 40.34 141,300 36.01
Options exercised (54,485) 0.89 (42,083) 0.11
Dividend equivalent rights earned 9,682 0.00 11,509 0.00
------- -------
Outstanding options at end of period 747,882 30.69 421,583 19.05
======= =======
</TABLE>
STOCK PURCHASE WARRANTS
At September 30, 1997 and December 31, 1996, there were 149,466 and 412,894
Warrants outstanding, respectively. Each Warrant entitles the holder to purchase
1.000667 shares of the Company's Common Stock at an exercise price of $15.00 per
share. The Warrants remain exercisable until December 31, 1997.
STOCK REPURCHASES
On September 11, 1997, the Company's Board of Directors approved the repurchase
of up to 745,000 shares of the Company's Common Stock. Pursuant to this
repurchase program, the Company repurchased 373,000 shares of its Common Stock
for $11.0 million. The repurchased shares have been returned to the Company's
authorized but unissued shares of Common Stock.
DIVIDENDS
The Company declared and paid the following dividends for the three and nine
months ended September 30, 1997 and for the year ended December 31, 1996:
<TABLE>
<CAPTION>
DIVIDENDS PER SHARE
TOTAL ----------------------------
DECLARATION RECORD PAYABLE DIVIDENDS CLASS B COMMON
DATE DATE DATE (IN THOUSANDS) PREFERRED STOCK STOCK
---- ---- ---- -------------- --------------- -----
<S> <C> <C> <C> <C> <C>
9/8/97 9/30/97 10/21/97 $9,433 $0.755 $0.600
6/12/97 6/30/97 7/21/97 $8,638 $0.755 $0.600
3/5/97 3/31/97 4/21/97 $7,899 $0.755 $0.600
12/16/96 12/31/96 1/21/97 $5,268 $0.755 $0.410
9/16/96 9/30/96 10/21/96 $4,016 $0.386 $0.400
6/14/96 6/28/96 7/18/96 $3,408 -- $0.400
3/11/96 3/29/96 4/19/96 $2,540 -- $0.460
</TABLE>
Under the Internal Revenue Code of 1986, a dividend declared by a REIT in
December of a calendar year, payable to shareholders of record as of a specified
date in December, will be deemed to have been paid by the Company and received
by the shareholders on that record date if the dividend is actually paid before
February 1st of the following calendar year. Therefore, the dividend declared in
December 1996 which was paid in January 1997 is considered taxable income to
shareholders in the year declared. The Company's dividends are not eligible for
the dividends received deduction for corporations.
NOTE 11. COMMITMENTS AND CONTINGENCIES
At September 30, 1997, the Company had no outstanding commitments to purchase or
sell Mortgage Assets or to purchase, sell or terminate Interest Rate Agreements.
The Company also had no commitments to enter into additional reverse repurchase
agreements or other borrowings.
18
<PAGE> 19
At September 30, 1997, the Company is obligated under non-cancelable operating
leases with expiration dates through 2001. The future minimum lease payments
under these non-cancelable leases are as follows: 1997 - $47,816; 1998 through
2000 - $191,262; 2001 - $63,754.
NOTE 12. SUBSEQUENT EVENTS
On November 6, 1997, the Company issued at a premium, $749.2 million in face
value of long-term debt in the form of collateralized mortgage bonds. The
Company received net proceeds of $755.1 million from this issuance. This
long-term debt was issued by Sequoia Mortgage Trust 2, a business trust
established by the Company's wholly-owned subsidiary, Sequoia. This debt is
collateralized by a pool of conventional, adjustable-rate, 30-year mortgage
loans secured by first liens on one- to four- family residential properties
which were transferred from Redwood Trust, Inc. to Sequoia. The initial
principal balance of the collateral for this long-term debt is approximately
$756.7 million. The proceeds received from this issuance are expected to be used
to pay down a portion of the Company's Short-Term Debt.
On November 10, 1997, the Company repurchased 105,000 shares of the Company's
Common Stock for $2.8 million. Also on November 10, 1997, the Company entered
into a commitment to repurchase 200,000 shares of the Company's Common Stock for
$5.3 million with a settlement date of November 14, 1997. Repurchased shares are
returned to the Company's authorized but unissued shares of Common Stock.
19
<PAGE> 20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes.
SAFE HARBOR STATEMENT
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995: Statements in this discussion regarding Redwood Trust, Inc. (the
"Company") and its business which are not historical facts are "forward-looking
statements" that involve risks and uncertainties. For a discussion of such risks
and uncertainties, which could cause actual results to differ from those
contained in the forward-looking statements, see "Risk Factors" commencing on
Page 26 of the Company's 1996 Form 10-K.
OVERVIEW
Redwood Trust, Inc. is a financial institution specializing in the single-family
residential mortgage spread lending business. The Company earns net income to
the extent that the interest income it earns from its mortgage loans and
securities exceeds the cost of borrowed funds, hedging, credit loss expenses and
operating expenses.
The Company seeks to earn net interest income from first-lien single-family
residential mortgage loans underwritten to "A" or "prime" quality standards. The
Company believes its primary competitors in the "A" quality mortgage spread
lending business are banks, savings and loans, the two government-sponsored
mortgage entities ("GSEs": Fannie Mae and Freddie Mac) and other mortgage Real
Estate Investment Trusts ("REITs").
The Company has chosen to pursue a wholesale strategy (such as is employed by
the GSEs) rather than a retail strategy (such as is employed by most banks and
savings and loans). Like the GSEs, the Company does not originate loans directly
but rather acquires loans from mortgage origination companies and from the
secondary mortgage market. Like the GSEs, the Company out-sources the servicing
of its mortgage loans and sources its borrowings on a wholesale basis in the
capital markets rather than seeking retail deposits through a branch banking
system. The Company believes that its wholesale strategy allows the Company to
operate in a highly efficient manner while remaining focused on its core spread
lending business.
Over the past year, the Company has moved a long way towards transforming itself
from a spread lending company managing mortgage securities funded with
short-term debt to a spread lending company managing high-quality single-family
mortgage loans funded with long-term debt. The impact of this transition on the
Company's results is discussed below.
The Company has elected to be considered a REIT with respect to Federal and
State income taxes. This election generally allows the Company to avoid paying
corporate income tax so long as it distributes at least 95% of its taxable
income as dividends and meets the other REIT requirements.
RESULTS OF OPERATIONS
Mortgage Asset Acquisitions, Principal Repayments and Net Asset Growth
In the third quarter of 1997, the Company acquired $326 million in mortgage
loans and $43 million in mortgage securities (together, "mortgage assets").
Thus, over 88% of acquisitions during the quarter were mortgage loans. The
Company received mortgage principal repayments of $252 million and sold mortgage
securities for $42 million during the quarter. In the third quarter of 1997,
total assets grew by $101 million, or 3%, to $3.5 billion.
In the third quarter of 1996, the Company acquired $444 million new mortgage
assets. Of these acquisitions, 14% were mortgage loans and 86% were mortgage
securities. The Company received mortgage principal repayments of $77 million
during the quarter. Net growth of total assets was $375 million, or 36%, in that
quarter.
20
<PAGE> 21
Through September 30, 1997, all mortgage loans acquired have been high quality,
adjustable rate, first lien mortgages on single-family residential properties.
All mortgage securities acquired have represented securitized interests in pools
of adjustable rate, single-family mortgage loans.
Through September 30, 1997, mortgage principal repayment rates for the Company
have remained within management's range of expectations and have been similar to
industry averages for the specific types of adjustable-rate mortgages owned by
the Company. One commonly used measure of the average annual rate of prepayment
of mortgage principal is the conditional prepayment rate ("CPR"). The CPR for
the Company's mortgage loans and the mortgages contained in the pools underlying
its mortgage securities increased from 24% in the third quarter of 1996 to 25%
in the third quarter of 1997. The CPR rate of the Company's mortgage asset
portfolio has ranged between 23% and 29% since the fourth quarter of 1995.
The Company also receives scheduled mortgage principal payments (payments
representing the normal principal amortization of a 30-year mortgage loan). In
addition, some mortgage securities owned by the Company are subject to call
provisions, some receive accelerated payments, i.e., a greater than pro-rata
share of principal repayments generated by the underlying mortgage pool, and
some are locked-out of such prepayments for a period of time. The average annual
rate of mortgage principal repayment from all of these sources increased from
28% in the third quarter of 1996 to 31% in the third quarter of 1997. This total
rate of mortgage principal repayment on the Company's mortgage assets has ranged
between 26% and 32% since the fourth quarter of 1995.
In the first nine months of 1997, the Company acquired $1.96 billion of new
mortgage assets. Of these acquisitions, 54% were mortgage loans and 46% were
mortgage securities. The Company received mortgage principal repayments of $626
million during this period. Net growth of total assets was $1.34 billion, or
61%, in the first nine months of 1997.
In the first nine months of 1996, the Company acquired $1.11 billion of new
mortgage assets. Of these acquisitions, 10% were mortgage loans and 90% were
mortgage securities. The Company received mortgage principal repayments of $163
million during this period. Net growth of total assets was $962 million, or
218%, in the first nine months of 1996.
The average CPR on the Company's mortgage assets (CPR) decreased from 26% in the
first nine months of 1996 to 24% in the first nine months of 1997. The total
rate of principal repayment increased from 28% in the first nine months of 1996
to 30% in the first nine months of 1997.
Interest Income
From the third quarter of 1996 to the third quarter of 1997, interest income
increased by 192%. This increase was driven primarily by a 196% increase in
average earning assets (mortgage assets plus cash). In the third quarter of
1997, the Company's average earning assets of $3.33 billion generated interest
income of $56.5 million. In the third quarter of 1996, average earning assets of
$1.12 billion generated interest income of $19.4 million.
In the third quarter of 1997, the Company's earning asset yield (interest income
annualized and divided by the average daily amortized cost of earning assets)
was 6.80%. The average mortgage coupon rate (mortgage interest payments
annualized and divided by the average daily principal value of mortgages) was
7.77%. Since the Company's average amortized cost was 102.2% of mortgage
principal value during that quarter, the coupon yield on amortized cost book
value for the Company's mortgages was 7.60%. Net mortgage premium and discount
amortization expenses of $6.51 million reduced the coupon yield by 0.79% for a
net mortgage yield of 6.81%. The yield earned on the Company's cash balances
during the quarter was 5.60%; the blended earning asset yield was 6.80%.
The Company's earning asset yield was 6.90% in the third quarter of 1996. The
average mortgage coupon rate was 7.52%. Because the Company's average amortized
cost for mortgage assets was 101.0% of mortgage principal value during that
quarter, the coupon yield on amortized cost book value for the Company's
mortgages was 7.44%. Net mortgage premium and discount amortization expenses of
$1.44 million reduced the coupon yield
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by 0.52% for a net mortgage yield of 6.92%. The yield earned on the Company's
cash balances during the quarter was 5.30%, bringing the overall third quarter
of 1996 blended earning asset yield to 6.90%.
The 6.80% earning asset yield for the third quarter of 1997 was slightly lower
than the 6.90% for the third quarter of 1996. The average coupon rate was lower
in the third quarter of 1996 due to the temporary effect of lower initial
coupons on newly acquired mortgages. At September 30, 1996 the average coupon
rate was 0.36% below the fully indexed rate. By September 30, 1997, the average
coupon rate on the Company's mortgage assets was 0.09% below the fully indexed
rate, as coupons rose and the relevant interest rate indices fell over this
period. The total rate of mortgage principal repayment was similar for these two
periods. However, because the Company's average amortized cost for mortgage
assets was higher in the third quarter of 1997 than in the third quarter of 1996
(102.2% versus 101.0%), the reduction in mortgage yield due to the net
amortization of premiums and discounts increased from 0.52% in the third quarter
of 1996 to 0.79% in the third quarter of 1996.
During 1996 and 1997, the Company generally acquired mortgage assets with lower
risk characteristics than those assets previously acquired. As a result, average
credit quality improved, with the percentage of the balance sheet consisting of
subordinated mortgage securities rated below AA falling from 3.9% at the end of
the third quarter of 1996 to 1.6% at the end of the third quarter of 1997.
Reflecting this change in asset mix to lower risk assets (as well as certain
other factors), the average equity-to-assets capital adequacy guideline
determined by the Company's Risk-Adjusted Capital Policy fell from 10.7% to 9.0%
over the same period. The lower risk assets acquired by the Company had higher
acquisition prices reflecting their lower risk and resulted in the Company's
earning asset yield being reduced somewhat as compared to short-term interest
rate index levels. To some degree, the slight decrease in the earning asset
yield in the third quarter of 1997 also reflects the high pricing levels for all
mortgages that have prevailed in the mortgage market for several quarters.
From the first nine months of 1996 to the first nine months of 1997, interest
income increased by 249%. This increase was driven primarily by a 257% increase
in average earning assets. In the first nine months of 1997, the Company's
average earning assets of $2.82 billion generated interest income of $144.6
million. In the first nine months of 1996, the Company's average earning assets
of $791 million generated interest income of $41.4 million.
In the first nine months of 1997, the Company's earning asset yield was 6.83%.
The average mortgage coupon was 7.73%. Since the Company's average amortized
cost was 102.1% of mortgage principal value during that quarter, the coupon
yield on amortized cost book value for the Company's mortgages was 7.57%. Net
mortgage premium and discount amortization expenses of $15.4 million reduced the
coupon yield by 0.73% for a net mortgage yield of 6.84%. The yield earned on the
Company's cash balances during the nine months was 5.51%; the blended earning
asset yield was 6.83%.
In the first nine months of 1996, the Company's earning asset yield was 6.98%.
The average mortgage coupon rate was 7.54%. Because the Company's average
amortized cost for mortgage assets was 100.2% of mortgage principal value during
that period, the coupon yield on amortized cost book value for the Company's
mortgages was 7.52%. Net mortgage premium and discount amortization expenses of
$3.0 million reduced the coupon yield by 0.51% for a net mortgage yield of
7.01%. The yield earned on the Company's cash balances during the nine months
was 5.58%, bringing the overall first nine months of 1996 earning asset yield to
6.98%.
Interest Expense
From the third quarter of 1996 to the third quarter of 1997, interest expense
increased by 218%, from $14.4 million to $45.9 million. This increase was driven
primarily by a 205% increase in average borrowings from $1.00 billion to $3.05
billion. Borrowings increased at a slightly faster rate over the last year than
did earning assets (205% versus 196%) as the Company utilized a greater
percentage of debt rather than equity to fund its growing mortgage operations.
The average equity-to-assets ratio for the Company was 10.1% in the third
quarter of 1997 and 12.8% in the third quarter of 1996.
An additional factor driving the increase in interest expense was a 0.24%
increase in the Company's cost of funds from 5.78% in the third quarter of 1996
to 6.02% in the third quarter of 1997. This increase reflects higher levels of
short-term interest rates; one, three and six month LIBOR rates over the
relevant time frame (one to six months
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prior to the end of the period) were higher for the third quarter of 1997 than
they were for the third quarter of 1996. The increase in cost of funds also
reflects the issuance of long-term debt during the third quarter of 1997 and a
change in the mix of assets towards mortgage loans rather than mortgage
securities.
The Company pays interest expense on its short-term debt based on the actual
number of days in a quarter. In a non-leap year, the first quarter has 90 days,
the second quarter has 91 days, and the third and fourth quarters each have 92
days. Thus, all other factors being equal, the Company's cost of short-term debt
will have a seasonal variation pattern; it will be highest in the third and
fourth quarters and will be lowest in the first quarter of the year. The
increase in the Company's cost of funds attributable to this seasonal day count
issue from the second to the third quarter of 1997 was approximately 0.06%
(thereby reducing earnings in the third quarter by $0.03 per share relative to
the second quarter, all other factors being equal). This impact of this seasonal
factor will be neutral for the fourth quarter of 1997 and positive for the first
quarter of 1998, in each case as compared to the third quarter of 1997. This
seasonal effect applies only to the Company's short-term borrowings and will be
reduced over time should the Company increase the percent of its total
borrowings which are long-term.
From the first nine months of 1996 to the first nine months of 1997, interest
expense increased by 283%, from $29.7 million to $113.7 million. This increase
was driven primarily by an increase in average borrowings of 272%, from $697
million to $2.59 billion. Borrowings increased at a faster rate than did earning
assets (272% versus 257%) as the Company utilized greater leverage. The average
equity-to-assets ratio was 13.9% in the first nine months of 1996 and was 10.1%
in the first nine months of 1997.
An additional factor driving the increase in interest expense was a 0.16%
increase in the Company's cost of funds from 5.69% in the first nine months of
1996 to 5.85% in the first nine months of 1997. This increase was largely due to
higher average short-term interest rates over the relevant periods.
Interest Rate Agreements Expense
Interest rate agreements are a form of interest rate insurance, or hedging,
which the Company utilizes to reduce the effects that a large increase in
interest rates could have on its balance sheet and earnings. The Company seeks
to hedge, in part, the market value and earnings risks arising from the life
caps, periodic caps and the fixed coupon period to the next adjustment date for
its adjustable-rate mortgage assets.
In the third quarter of 1997, on-going hedging expenses were $1.07 million and
hedging income was $.03 million for a net interest rate agreements expense of
$1.04 million. This net expense represented 0.12% of average assets, 0.14% of
average borrowings, and 9.7% of net interest income before hedge expenses.
In the third quarter of 1996, hedging expenses were $0.35 million and the
Company earned no hedge income. Net hedge expenses represented 0.12% of average
assets, 0.14% of average borrowings, and 7.1% of net interest income before
hedge expenses for that quarter.
In the first nine months of 1997, hedging expenses were $2.58 million and
hedging income was $0.11 million for a net interest rate agreement expense of
$2.47 million. This net expense represented 0.11% of average assets, 0.13% of
average borrowings, and 8.0% of net interest income before hedge expenses.
In the first nine months of 1996, hedging expenses were $0.76 million and the
Company earned no hedge income. This net expense represented 0.12% of average
assets, 0.14% of average borrowings, and 6.5% of net interest income before
hedge expenses.
Net Interest Income
Net interest income is interest income less interest expense and net interest
rate agreement hedging expenses. Net interest income increased by 111%, from
$4.6 million in the third quarter of 1996 to $9.6 million in the third quarter
of 1997. This increase was driven by asset growth, although growth in net
interest income was less than the growth in average total assets of 196% over
the same period. Net interest income as a percentage of average
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<PAGE> 24
assets (the net interest margin) decreased from 1.58% to 1.12% and net interest
income as a percentage of equity decreased from 12.40% to 11.13%.
Net interest income grew slower than the growth in net average assets primarily
due to a narrowed spread between the Company's yield on earning assets and the
cost of its borrowed funds and net hedging expenses (its interest rate spread).
The Company's interest rate spread was 0.98% in the third quarter of 1996 and
0.64% in the third quarter of 1997. The Company's yield on earning assets fell
by 0.10% over the last year while the cost of funds rose by 0.24% and the cost
of hedging remained the same. Please see "Interest Income" and "Interest
Expense" above for a discussion of the factors that resulted in a narrower
interest rate spread.
From the first nine months of 1996 to the first nine months of 1997, net
interest income increased by 160%, from $10.9 million to $28.4 million. This
increase was driven by asset growth, although growth in net interest income was
less than the growth in average total assets of 257% over the same period due.
As a result of the increased use of leverage and due to a narrowed spread
between the Company's yield on earning assets and the cost of its borrowed funds
and hedging, the net interest margin decreased from 1.79% to 1.30% while net
interest income as a percentage of equity increased slightly from 12.85% to
12.95%.
The Company's interest rate spread was 1.15% in the first nine months of 1996
and 0.85% in the first nine months of 1997. For reasons discussed above, the
Company's yield on earning assets fell by 0.15% while the cost of funds rose by
0.16% and the cost of hedging fell by 0.01%.
Gain or Loss on Sale Transactions
The Company sold $42.0 million of mortgage securities in the third quarter of
1997. The gain on the sale of the mortgage securities was $0.17 million. In
conjunction with the sale of the mortgage securities, the Company wrote down
$0.15 million of related interest rate agreements, thereby reducing the net gain
to $0.02 million.
Credit Provision Expense and Actual Credit Losses
The Company establishes credit provisions in order build a reserve for future
credit losses. Provisions were $0.94 million in the third quarter of 1997 and
$0.52 million in the third quarter of 1996.
The Company takes credit provisions for risk of credit loss from its portfolio
of below-BBB rated subordinated mortgage securities as a function of projections
of potential future losses. The Company reviews its loss projections based on
trends in serious delinquencies and loan loss severities (actual losses realized
as a percent of defaulted loan balances) in the underlying mortgage pools and
may make changes in its credit provisions accordingly. Credit provisions for
these assets were $0.47 million in the third quarter of 1997 and $0.34 million
in the third quarter of 1996.
The Company takes credit provisions for its mortgage loan portfolio to provide
for expected credit losses over the life of the portfolio. In the third quarters
of 1997 and 1996, the Company took mortgage loan provisions of $0.47 million and
$0.18 million, respectively. The Company's current policy is to set aside annual
credit provisions for mortgage loans on an on-going basis equaling 0.10% to
0.20% of its loan portfolio.
Total credit provisions equaled 0.18% of average total assets and 1.40% of
average equity in the third quarter of 1996 and declined to 0.11% of average
assets and 1.09% of average equity in the third quarter of 1997. The decline in
these ratios primarily reflects a change in asset mix towards assets with
reduced credit risk; subordinated securities rated lower than BBB declined over
this period as a percentage of total assets from 2.1% to 0.9%, although mortgage
loans increased from 9.3% to 40.2% over the same period. The Company has not
added to its portfolio of lower-rated subordinated mortgage securities since
1995.
The Company had no actual realized credit losses in the third quarter of 1996.
Actual credit losses were $68,000 in the third quarter of 1997. Of these losses,
$40,000 were from the Company's whole loans and $28,000 from the Company's
subordinated mortgage securities. Total cumulative actual credit losses from the
inception of the Company through September 30, 1997 have been $150,000; actual
losses from subordinated mortgage securities
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have totaled $97,000 while actual losses from mortgage loans have totaled
$53,000. Based on mortgage default and loss trends, the Company expects realized
credit losses over the next few quarters to increase to levels more consistent
with its provisioning rates and reserve levels, especially for its portfolio of
subordinated mortgage securities.
Credit provisions reduce net income and earnings per share but only actual
credit losses are deducted when calculating taxable income. Dividends from a
REIT are based on taxable income, so future dividends levels will be influenced
by the rate of actual realized credit loss rather than the rate of credit
provisioning. Net income and earnings per share will be reduced by actual losses
in a direct manner only if they exceed cumulative credit provisions.
Credit provisions were $2.41 million in the first nine months of 1997 and $1.32
million in the first nine months of 1996. Credit provisions for below-BBB rated
mortgage securities were $1.43 million and $1.01 million while mortgage loan
provisions were $0.99 million and $0.31 million, respectively. Total credit
provisions equaled 0.11% of average total assets and 1.10% of average equity in
the first nine months of 1997, a decline from 0.22% of average assets and 1.56%
of average equity in the first nine months of 1996.
Actual realized credit losses were $138,000 in the first nine months of 1997.
The Company had no actual credit losses in the first nine months of 1996.
Operating Expenses
Total operating expenses increased by 71%, from $0.67 million in the third
quarter of 1996 to $1.15 million in the third quarter of 1997. The Company
expanded its staff and increased compensation for employees to market levels. A
portion of the stock options granted to management, employees, and directors
have dividend equivalent rights ("DERs") attached; the DER expense increased as
the dividend rose and the number of stock options with DERs attached increased.
Other operating expenses increased as the scope of Company operations expanded.
Operating expense ratios have improved as the Company realized economies of
scale through growth. From the third quarter of 1996 to the third quarter of
1997, operating expenses as a percentage of assets improved from 0.23% to 0.13%,
operating expenses as a percentage of equity improved from 1.82% to 1.33%, the
efficiency ratio (operating expenses as a percentage of net interest income)
improved from 14.69% to 11.93%, and average assets per employee improved from
$115 million to $244 million.
From the first nine months of 1996 to the first nine months of 1997, total
operating expenses increased by 101%, from $1.76 million to $3.53 million.
Operating expenses as a percentage of assets improved from 0.29% to 0.16%,
operating expenses as a percentage of equity improved from 2.07% to 1.61%, the
efficiency ratio improved from 16.09% to 12.43%, and average assets per employee
improved from $92 million to $242 million.
Net Income Before Preferred Dividends
Total net income to common and preferred shareholders increased by 123%, from
$3.39 million in the third quarter of 1996 to $7.55 million in the third quarter
of 1997. The percentage of net interest income brought down to the net income
line increased from 74% to 78%. Return on assets dropped from 1.17% to 0.88%
while at the same time return on total equity (common plus preferred) decreased
from 9.18% to 8.73%. The positive effect of strong asset growth and improved
operational efficiencies, partially offset the interest spread narrowing caused
by the reasons discussed above.
Total net income to common and preferred shareholders increased by 187%, from
$7.84 million in the first nine months of 1996 to $22.48 million in the first
nine months of 1997. Return on assets dropped from 1.28% to 1.03% due interest
spread narrowing and the increased use of debt funding while at the same time
return on total equity (common plus preferred) increased from 9.23% to 10.25%.
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Preferred Dividends
The Company's Cumulative Convertible Class B Preferred Stock ("preferred stock")
was issued in the third quarter of 1996. Total third quarter 1997 preferred
dividends were $687,000 as compared to third quarter 1996 preferred dividends of
$388,000. The preferred dividend was $0.755 per share for the third quarter of
1997 and $0.386 per share for the third quarter of 1996 due to the preferred
stock being outstanding only 46 days in the 1996 quarter. The preferred dividend
equals the greater of the common stock dividend or $0.755 per share. Each share
of preferred stock is convertible at the option of the holder at any time into
one share of common stock. There were 1,006,250 preferred shares outstanding at
the end of the third quarter of 1996 and 909,518 shares outstanding at the end
of the third quarter of 1997 as preferred shareholders converted 96,732 shares
into common stock. After September 1999, the Company has the right to force the
conversion of each share of preferred stock into one share of common stock,
providing the price of the common stock exceeds $31.
Total preferred dividends in the first nine months of 1997 were $2.13 million,
or $2.265 per share. Total preferred dividends in the first nine months of 1996
were $0.39 million, or $0.386 per share.
Net Income to Common Shareholders
Net income available for common shareholders increased by 129% over the last
year, from $3.0 million in the third quarter of 1996 to $6.9 million in the
third quarter of 1997. Over the same period, average common equity increased by
141% to $319.0 million. Return on common equity decreased from 9.06% to 8.60%.
Net income available for common shareholders increased from $7.5 million in the
first nine months of 1996 to $20.3 million in the first nine months of 1997, an
increase of 173%. Over the same period, average common equity increased by 144%
to $264.0 million. Return on common equity increased from 9.18% to 10.28%.
Earnings Per Share
The average number of common shares outstanding on a primary basis (including
potential dilution from warrants and options) increased by 54%, from 9.52
million in the third quarter of 1996 to 14.62 million in the third quarter of
1997. Since net income to common shareholders increased by 129% over this
period, earnings per share rose by 47%, from $0.32 to $0.47.
The primary factor driving the 47% increase in earnings per share over this
period was a 47% increase in average book value (equity) per common share. Book
value per share increased as the Company issued new common stock at prices in
excess of book value. The Company issued common stock in accretive offerings in
November 1996, January 1997, April 1997 and July 1997. These offerings increased
book value per common share by 13%, 8%, 11% and 12%, respectively.
The average number of common shares outstanding on a primary basis (including
potential dilution from warrants and options) increased by 63%, from 8.25
million in the first nine months of 1996 to 13.42 million in the first nine
months of 1997. Since total net income increased by 173%, earnings per share
rose by 69%, from $0.90 to $1.52. This 69% increase in earnings per share was
made possible by a 12% increase in return on common equity, a 38% increase in
average book value (equity) per common share and a reduction in the dilutive
impact of warrants as there were less warrants outstanding in the first nine
months of 1997 than in the first nine months of 1996.
Taxable REIT Income
As a REIT, the Company is required to distribute as dividends over time at least
95% of its income as calculated for tax purposes ("taxable REIT income"). It is
the Company's intention to distribute as dividends 100% of taxable income over
time. During any given quarter or year, however, dividends declared may exceed
or be less than taxable REIT income.
Taxable REIT income (before preferred dividend) was $4.05 million in the third
quarter of 1996; this exceeded GAAP income of $3.39 million in that period due
to differences in credit expenses of $0.52 million (actual credit
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losses are deducted from taxable income rather than credit provisions), premium
and discount amortization of $0.06 million and operating expenses of $0.08
million.
Taxable REIT income (before preferred dividend) was $8.15 million in the third
quarter of 1997; this exceeded GAAP income of $7.55 million in that period due
to differences in credit expenses of $0.88 million, premium and discount
amortization of negative $0.10 million and operating expenses of negative $0.18
million.
On a taxable REIT income basis, return on total equity was 10.97% for the third
quarter of 1996 and 9.43% for the third quarter of 1997. Return on common equity
was 11.06% and 9.36% for the same periods, respectively.
Taxable REIT income (before preferred dividend) was $9.74 million in the first
nine months of 1996 and $24.38 million in the first nine months of 1997. On a
taxable REIT income basis, return on total equity was 11.46% for the first nine
months of 1996 and 11.11% for the first nine months of 1997. Taxable income
return on common equity was 11.52% and 11.24% for the same periods,
respectively.
Common Share Dividends
Dividends are based on taxable income. Dividends per common share have exceeded
primary earnings per common share because taxable income has exceeded net income
in each quarter.
In the third quarter of 1997, the Company declared a common dividend of $0.60
per share, resulting in the distribution of $8.75 million to 14.58 million
common shares outstanding at the end of the period. Together with the preferred
dividend of $0.69 million, the Company distributed 115.7% of the taxable income
it earned in that quarter. Through September 30, 1997, the Company had
cumulatively declared dividends equaling 102.7% of cumulative taxable REIT
income earned through that date.
In the third quarter of 1996, the Company declared a common dividend of $0.40
per share, resulting in the distribution of $3.63 million to 9.07 million common
shares outstanding at the end of the period. Together with the preferred
dividend of $0.39 million, the Company distributed 99.2% of the taxable income
it earned in that quarter. Through September 30, 1996, the Company had
cumulatively declared dividends equaling 98.3% of cumulative taxable REIT income
earned through that date.
In the first nine months of 1997, the Company declared common dividends totaling
$1.80 per share. The total common dividend paid was $23.84 million. Together
with the preferred dividend of $2.13 million, the Company distributed 106.5% of
the taxable income it earned in that nine months.
For the first nine months of 1996, the Company declared common dividends
totaling $1.26 per share, resulting in the distribution of $9.58 million.
Together with the preferred dividend of $0.39 million, the Company distributed
102.3% of the taxable income it earned in that nine months.
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FINANCIAL CONDITION
Mortgage Loans
From December 31, 1996 to September 30, 1997, the Company's mortgage loan
portfolio grew in size by 162% and increased as a percentage of the Company's
mortgage assets from 25% to 40%. In general over this period, the concentration
of properties located in California dropped, the average seasoning declined,
average loan size increased and effective loan-to-value ratios decreased. The
percentage of the loan portfolio on non-performing status remained steady at low
levels.
At September 30, 1997, the Company owned 4,651 adjustable-rate, first-lien
mortgage loans on single-family residential properties with a principal value of
$1.35 billion and an amortized cost of $1.38 billion. The Company estimates that
the bid-side market value of the Company's mortgage loan portfolio at September
30, 1997 was approximately $1.38 billion.
As verified by its re-underwriting process, the Company believes that all
mortgage loans owned as of September 30, 1997 were generally originated to "A"
quality, or "Prime" quality, underwriting standards. The average loan size was
$290,000. Loans with current balances less than $214,600 (the current Fannie
Mae/Freddie Mac limit for most loans) made up 19% of the Company's mortgage loan
portfolio, while loans with current balances in excess of $500,000 made up 33%.
Loans on owner-occupied houses made up 91% of the loan portfolio; second homes
represented 7% and investment properties 2%.
At September 30, 1997, 11.3% of loans had original loan-to-value ratios ("OLTV")
in excess of 80%. Of these, 86.6% had primary mortgage insurance ("PMI") serving
to bring the effective OLTV of those loans to 63%. Of the loans with OLTVs in
excess of 80%, 13.4% had no PMI; the average OLTV of these loans was 83%. The
Company also owns loans which may have OLTVs in excess of 80% with respect to
the collateral provided by the underlying real estate property but which is also
protected by additional non real estate collateral in the form of a separate
pledge account. These additional collateral loans make up 24.2% of the loan
portfolios as of September 30, 1997; the effective OLTV of these loans is 65%.
In total, after taking into account the available PMI and pledged accounts, the
average effective OLTV on the Company's mortgage loan portfolio was 66% as of
September 30, 1997. As of September 30, 1997, the average seasoning of the loan
portfolio was 19 months.
At September 30, 1997, 32% of the mortgage loans owned by the Company were on
properties located in California (13% in Northern California and 19% in Southern
California). Loans in Florida were 9% of the total; other states with a greater
than 3% representation in the loan portfolio included New York, Arizona,
Maryland, New Jersey, Connecticut, Texas, Illinois, Georgia and Colorado.
At September 30, 1997, 13 mortgage loans were non-performing assets (NPAs), as
they were over 90 days delinquent, in bankruptcy, in foreclosure, or had become
REO (Real Estate Owned). The loan balance of these NPAs totaled $2.79 million,
or 0.2% of the mortgage loan portfolio. Included in this NPA balance was REO of
$0.22 million resulting from the default of 2 loans.
The mortgage loan credit reserve as of September 30, 1997 was $1.36 million. If
all of the NPAs as of September 30, 1997 were to default rather than cure, and
the loss severity experienced on these loans was 10%, 20%, 30%, or 40%, the
Company estimates its realized credit losses from these assets would be
$283,000, $567,000, $850,000 or $1,133,000, respectively. At September 30, 1997,
management believed these defaults, to the extent they occur, would most likely
occur over a period of six to twelve months, during which time the Company
planned to take additional credit provisions to add to its mortgage loan credit
reserve. Cumulatively through September 30, 1997, the Company has achieved
resolution or liquidation on four defaulted mortgage loans: the average loss
severity on those loans was 6%. The analysis in this paragraph reviews the risk
of loss from NPAs as of September 30, 1997 only; it does not purport to analyze
or measure credit losses from additional NPAs that may arise after September 30,
1997.
At December 31, 1996, the Company owned 2,172 adjustable-rate, first-lien
mortgage loans on single-family residential properties with a principal value of
$0.52 billion and an amortized cost of $0.53 billion. The Company
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estimates that the bid-side market value of these mortgage loans at December 31,
1996 was approximately $0.53 billion.
The average loan size at December 31, 1996 was $237,000. Loans with current
balances less than $214,600 (the current FNMA/FHLMC limit for most loans) made
up 23% of the Company's mortgage loan portfolio, while loans with current
balances in excess of $500,000 made up 8%. Loans on owner-occupied houses made
up 94% of the loan portfolio; third homes represented 4% and investment
properties 2%.
At December 31, 1996, 25% of the loans had a loan-to-value ratio (LTV) at
origination in excess of 80%. Over 97% of these loans had primary mortgage
insurance (PMI). The average original LTV for the Company's mortgage loan
portfolio was 77% as of December 31, 1996; after giving effect to PMI, the
average effective original LTV was 73%. As of December 31, 1996, the average
seasoning of the loan portfolio was 37 months.
At December 31, 1996, 44% of the mortgage loans owned by the Company were on
properties located in California (18% in Northern California and 26% in Southern
California). Loans in Maryland were 8% of the total; other states with a greater
than 3% representation in the portfolio included Florida, Illinois, New York,
and Connecticut.
At December 31, 1996, 7 loans were non-performing assets. The loan balance of
these NPAs totaled $1.25 million, or 0.2% of the mortgage loan portfolio.
Included in this total was one REO of $0.2 million.
The mortgage loan credit reserve as of December 31, 1996 was $428,000. If all
the NPAs as of December 31, 1996 were to default rather than cure, and the loss
severity experienced on these loans was 10%, 20%, 30%, or 40%, the Company
estimated its realized credit losses from these assets would have been $127,000,
$253,000, $380,000 or $506,000, respectively.
Mortgage Securities
From December 31, 1996 to September 30, 1997, the Company's portfolio of
mortgage securities increased by 27%. Mortgage securities declined as a
percentage of total mortgage assets from 76% to 60%. All of the Company's
mortgage securities represent interests in pools of adjustable rate, first lien
mortgages on single-family residential properties.
At September 30, 1997, the principal value of the Company's mortgage securities
was $2.01 billion and the amortized cost was $2.05 billion. The Company
estimates that the bid-side market value of the Company's mortgage securities
portfolio at September 30, 1997 was approximately $2.06 billion.
At September 30, 1997, 97.4% of the Company's mortgage securities had a credit
rating equivalent of AAA or AA, 1.2% had a credit rating equivalent of A or BBB
and 1.4% had a credit rating equivalent less than BBB. Securities guaranteed by
Fannie Mae or Freddie Mac made up 53.0% of total mortgage securities. Non-agency
mortgage securities structured with large amounts of subordination or other
forms of third-party credit enhancement and rated AAA or AA made up 44.4% of the
mortgage securities portfolio. Based on information available as of September
30, 1997, the Company had no reason to suspect that it would be likely to incur
credit losses in the foreseeable future from its mortgage securities rated BBB
or better.
The Company has taken and expects to continue to take credit losses on its
mortgage securities rated below BBB. Although the loans in the mortgage pools
underlying these securities were, for the most part, originated to "A" quality
standards, these securities have received lower quality credit ratings as they
are subordinated to other securities issued from the same pools and therefore
are subject to leveraged credit risk with respect to the underlying mortgages.
At September 30, 1997, these below-BBB rated securities had a principal value of
$39.9 million, an amortized cost before credit reserve of $29.2 million and a
market value of $29.8 million. The Company's credit reserve for these assets at
September 30, 1997 was $3.1 million.
The Company estimates that if all the loans underlying the mortgage pools for
these below BBB mortgage securities which were over 90 days delinquent, in
foreclosure, in bankruptcy, or REO as of September 30, 1997
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were to default and have a loss severity of 10%, 20%, 30%, or 40%, realized
credit losses for the Company would be $0.72 million, $2.29 million, $3.79
million or $6.44 million, respectively. Cumulatively from the acquisition dates
of these assets in 1994 and 1995 through September 30, 1997, 182 defaulted
mortgage loans in these pools had been liquidated; the average loss severity on
these loans was 23%. At September 30, 1997, management believed prospective
defaults based on serious delinquencies, to the extent they occur, would most
likely occur over a period of six to twelve months, during which time the
Company planned to take additional credit provisions to add to its mortgage
securities credit reserve. The analysis in this paragraph reviews the risk of
loss from seriously delinquent loans underlying the Company's securities as of
September 30, 1997 only; it does not purport to analyze or measure credit losses
from additional serious delinquencies that may arise after September 30, 1997.
At December 31, 1996, the principal value of the Company's mortgage securities
was $1.60 billion and the amortized cost was $1.63 billion. The Company
estimates that the bid-side market value of the Company's mortgage securities
portfolio at December 31, 1996 was approximately $1.63 billion.
At December 31, 1996, 96.6% of the Company's mortgage securities had a credit
rating equivalent of AAA or AA, 1.6% had a credit rating equivalent of A or BBB
and 1.8% had a credit rating equivalent less than BBB. Securities guaranteed by
Fannie Mae or Freddie Mac made up 59.4% of total mortgage securities. Other AAA
and AA securities made up 37.2% of the mortgage securities portfolio.
At December 31, 1996, below-BBB rated securities had a principal value of $40.8
million, an amortized cost before credit reserve of $28.9 million and a market
value of $25.6 million. The Company's credit reserve for these assets at
December 31, 1996 was $1.75 million. The Company estimates that if all the loans
in the underlying mortgage pools which were over 90 days delinquent, in
foreclosure, in bankruptcy, or REO as of December 31, 1996 were to default and
have a loss severity of 10%, 20%, 30%, or 40%, realized credit losses for the
Company would be $0.06 million, $0.61 million, $2.04 million, or $3.65 million,
respectively.
Total Mortgage Asset Portfolio Characteristics
At September 30, 1997, the average credit rating equivalent of all of the
Company's mortgage assets (loans plus securities) was AA+, with mortgage loans
(the bulk of the value which would be rated AAA if securitized and rated)
representing 40.2% of the total mortgage asset portfolio, AAA and AA securities
representing 58.2%, A and BBB rated securities representing 0.7% and below-BBB
rated securities representing 0.9%.
At September 30, 1997, all mortgage assets consisted of adjustable-rate
mortgages. The average coupon rate accruing on these assets was 7.75%. The
average level of the short-term interest rate indices which determine coupon
adjustments was 5.65%. Since the average net margin was 2.19%, the highest
potential average mortgage coupon rate (the fully-indexed rate) at that time was
7.84%. The actual coupon rate was lower than the fully-indexed rate by 0.09% due
to the timing lag from when interest rate indices move and when the interest
rate on the related mortgage assets reset.
At September 30, 1997, 38.9% of the Company's mortgage assets had coupon rate
adjustments every six months based on the six month LIBOR or CD index and 12.4%
had monthly adjustments based on the one month LIBOR index. Mortgage assets with
annual coupon adjustments based on the six month or one year U.S. Treasury index
were 45.7% of the portfolio and one year Treasury mortgages with an initial
coupon rate set longer than one year represented 1.7%. Mortgage assets with
other indices made up 1.3% of the total. At September 30, 1997, the average term
to next coupon adjustment for all mortgage assets was 4 months. For most
mortgage assets, coupon rate adjustments are based on the index level 30 to 75
days prior to the start of a new coupon accrual period.
Potential coupon rate changes can be limited by periodic and life caps. At
September 30, 1997, the Company's average mortgage asset life time maximum cap
rate was 12.01%. At September 30, 1997, periodic caps limited coupon changes to
2% annually for 74.4% of the mortgage assets and there were no periodic caps on
25.6% of the mortgage assets.
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At December 31, 1996, the average mortgage asset credit rating equivalent was
AA+, with mortgage loans representing 24.5% of the total mortgage asset
portfolio, AAA and AA securities representing 73.0%, A and BBB rated securities
representing 1.2% and below-BBB rated securities representing 1.3%.
At December 31, 1996, all mortgage assets consisted of adjustable-rate
mortgages. The average coupon rate accruing on these assets was 7.75%. The
average level of the short-term interest rate indices which determine coupon
adjustments was 5.58%. Since the average net margin was 2.24%, the highest
potential average mortgage coupon rate (the fully-indexed rate) at that time was
7.82%. The actual coupon rate was lower than the fully-indexed rate by 0.07%.
At December 31, 1996, 38.7% of the Company's mortgage assets had coupon rate
adjustments every six months based on the six month LIBOR or CD index and 1.4%
had monthly adjustments based on the one month LIBOR index. Six month or one
year U.S. Treasury index mortgage assets made up 57.7% of the total. Mortgage
assets with other indices made up 2.2% of the total. At December 31, 1996, the
average term to next coupon adjustment for all mortgage assets was 5 months.
At December 31, 1996, the Company's average mortgage asset life time maximum cap
rate was 11.73%. At December 31, 1996, periodic caps limited coupon changes to
2% annually for 95.3% of the mortgage assets and there were no periodic caps on
4.7% of the mortgage assets.
Interest Rate Agreements
At September 30, 1997, the Company owned $5.6 billion notional face of interest
rate agreements, principally caps and swaps. These interest rate agreements had
various start dates, maturity dates, and interest rate protection features; they
are described in detail in "Note 6. Interest Rate Agreements" in the Notes to
Consolidated Financial Statements.
These agreements are designed to reduce the Company's interest rate and market
value fluctuation risk. They had a historical amortized cost basis of $11.71
million and an estimated bid-side market value of $2.17 million as of September
30, 1997. Market values were lower than amortized cost due to a drop in interest
rate volatility assumptions in the marketplace for interest rate agreements, a
drop in interest rates, the effect of taking bid-ask spread mark-downs on new
agreements and due to the mis-matched timing of GAAP amortization methods for
premiums paid for interest rate caps and the rate of actual economic decay in
their market values. Market value fluctuations for interest rate agreements
hedging mortgage securities are reflected in the Company's interest rate
agreement market valuation account of negative $8.78 million at September 30,
1997. Interest rate agreements hedging mortgage loans are carried on the balance
sheet at historical amortized cost, as a result changes in market values of
these interest rate agreements are not shown in the valuation account.
At December 31, 1996, the Company owned $2.6 billion notional face of interest
rate agreements with a historical amortized cost basis of $6.2 million and an
estimated bid-side market value of $2.6 million. The Company's interest rate
agreement market valuation account was negative $3.6 million at that time.
There is a risk that the counter-parties to the Company's interest rate
agreements will not be able to perform to the terms of these contracts. If this
were to happen, the Company's total accounting credit loss exposure would be
limited to its historical amortized cost basis in these assets, although the
true economic opportunity cost to the Company could be higher. Through September
30, 1997, each of the counter-parties to the Company's interest rate agreements
had a credit rating of at least A.
Net Non-Earning Assets
Increases in net working capital (receivables less payables) and fixed assets
reduce earnings as the Company must fund these non-earning assets with
additional borrowings.
At September 30, 1997, net working capital was negative, as accrued interest
payable, dividend payable, and accrued expenses exceeded interest receivable
from mortgage assets, fixed assets and prepaid expenses. This
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negative working capital provided funds at that time to reduce borrowings or
increase cash investments by $5.07 million. However, the Company had an average
investment in net positive working capital during the third quarter of 1997 of
$61.0 million. Total non-earning assets averaged $85.7 million during the third
quarter of 1997, representing 2.5% of total average assets and 24.8% of average
equity.
At December 31, 1996, net working capital was negative by $3.0 million,
providing a source of funds at that time. Total non-earning assets during the
fourth quarter of 1996 averaged $41.4 million, representing 2.7% of total
average assets and 22.4% of average equity during that quarter.
Borrowings, Cash Balances and Liquidity
At September 30, 1997, the Company's borrowings consisted primarily of
short-term collateralized borrowing arrangements such as reverse repurchase
agreements, notes payable, and revolving lines of credit ("short-term debt"). On
July 25, 1997, the Company also issued $534 million billion of amortizing
long-term floating rate debt in the form of collateralized mortgage bonds
("long-term debt") through its Sequoia program. The funds raised in this
long-term debt offering were used to reduce short-term debt.
Short-term borrowings totaled $2.640 billion with an average interest expense
rate of 5.95% at September 30, 1997 and $1.95 billion with an average interest
expense rate of 5.83% at December 31, 1996. Long-term borrowings totaled $0.497
billion at September 30, 1997 with an average interest expense rate of 6.27% in
the third quarter of 1997. The Company had no long term debt at December 31,
1996.
As the Company reduces risks on its balance sheet, it is able to use a greater
amount of leverage under its Risk-Adjusted Capital Policy. However, the
Company's debt-to-equity ratio declined from 9.1x at December 31, 1996 to 8.9x
at September 30, 1997 because the Company had a significant amount of excess
capital at of September 30, 1997. See "Stockholders' Equity, Capital Efficiency
and Capital Adequacy" below for a discussion on the reasons for this excess
capital which resulted in the decline in the Company's debt-to-equity ratio. The
average debt-to-equity ratio increased from and 7.3x during the fourth quarter
of 1996 to 8.8x during the third quarter of 1997.
At September 30, 1997, a portion of the mortgage assets served as collateral for
the Company's long term debt. The remaining mortgage assets, which had a market
value of $2.95 billion, were available to collateralize the Company's short-term
debt. The Company estimates it had additional borrowing capacity at that time of
$206 million. In addition, the Company had $58 million of cash. On average
during the third quarter of 1997, the Company estimates it had additional
borrowing capacity of $184 million and average cash balances of $36 million. The
monthly principal and interest payments received on the mortgages which serve as
collateral to the long-term debt are held in trust until the bond payment date
and are included in the Company's cash balances. The Company's unrestricted cash
balances at September 30, 1997 were $28.8 million.
At December 31, 1996, the Company had borrowings equaling 90.7% of the $2.15
billion market value of its mortgage assets. The Company estimates it had
additional borrowing capacity at that time of $124 million, as well as $11
million of cash. During the fourth quarter of 1996, the Company estimates it
had, on average, additional borrowing capacity of $85 million and cash balances
of $16 million.
The Company's liquidity status, borrowing capacity, and ability to roll over its
short-term borrowings as they mature depend on the market value, liquidity and
credit quality of its assets, the soundness and capitalization of the Company's
balance sheet, the state of the collateralized lending market and other factors.
If the Company's liquidity or borrowing capacity were to become seriously
diminished, the Company would most likely seek to sell its mortgage assets (the
sale of which, in such circumstances, might be difficult and most likely would
be at a loss). In order to avoid such an occurrence, the Company seeks to
maintain what it believes to be a prudent level of capital, i.e., the Company
restricts its asset growth according to its Risk-Adjusted Capital Policy and
thereby seeks to maintain adequate unused borrowing capacity.
At September 30, 1997 and December 31, 1996, the average term to maturity of the
Company's short-term borrowings was 67 days and 98 days and the average term to
next rate adjustment was 40 days and 52 days, respectively; the term to next
rate adjustment was shorter than the term to maturity as some of the Company's
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borrowings had a cost of funds that adjusted to market levels on a monthly or
daily basis during the term of the borrowing. At each of these dates, the cost
of these short-term borrowings could adjust to changes in short-term interest
rates, on average, several months faster than coupon rates on the Company's
mortgages could adjust to those same changes. Through its interest rate
agreement hedging program, the Company seeks to mitigate the short-term impact
that a large increase in interest rates could have on its cost of funds and
spread earnings.
At September 30, 1997, the stated maturity on the Company's long-term debt was
thirty two years. The debt is callable before its stated maturity date. The
interest rate on the long-term debt resets monthly; 37% was tied to the Fed
Funds rate plus a spread and 63% was tied to one month LIBOR plus a spread at
September 30, 1997. The debt is AAA rated, adjustable rate, amortizes at the
same rate as the collateral and has a 10% lifetime interest cap.
Stockholders' Equity, Capital Efficiency and Capital Adequacy
From December 31, 1996 to September 30, 1997, the Company's equity base
(exclusive of the market valuation account) grew from $214.5 million to $354.5
million. This equity growth was the result of the Company issuing $154.5 million
in common stock through stock offerings, through the exercise of warrants and
through the Company's Dividend Reinvestment and Stock Purchase Plan and reduced
by $11.0 million used in the Company's Stock Repurchase Program. Because taxable
earnings have exceeded GAAP net income, cumulative dividends have exceeded GAAP
earnings; dividends exceeded GAAP earnings by $3.5 million in the first nine
months of 1997, thus reducing stockholders' equity by that amount.
Book value, or equity, per share (including common and preferred, excluding the
market valuation account) increased by 28% from $17.87 on December 31, 1996 to
$22.89 on September 30, 1997. The primary driver of this book value growth was
accretive stock offerings at prices in excess of book value.
For balance sheet purposes, the Company carries its mortgage securities and
associated interest rate agreements at their estimated bid-side market value
(historical amortized cost less market valuation account). The total market
valuation account for the Company was positive $1.8 million on September 30,
1997 and negative $3.5 million on December 31, 1996. As a result of this
accounting treatment, the Company's reported equity base and book value per
share may fluctuate due to market conditions and other factors. Mortgage loans,
associated interest rate agreements and all other assets and liabilities were
carried on the Company's balance sheet at September 30, 1997 at historical
amortized cost.
The Company estimated that the bid-side market value (or realizable value) of
all its assets less the cost of paying off all of its obligations was
approximately $211.2 million as of December 31, 1996 and $356.8 million as of
September 30, 1997. As compared to the shareholders' equity of the Company
(excluding the market valuation account), the net total "mark-to-market" value
for the Company was $3.2 million lower and $2.3 million higher, respectively, on
those dates. Between December 31, 1996 and September 30, 1997, the liquidation
value of the Company's mortgage assets increased while the liquidation value of
its interest rate agreements dropped: The Company expects that the net total
"mark-to-market" value of the Company may fluctuate significantly over time.
Through its Risk-Adjusted Capital Policy, the Company assigns a guideline
capital adequacy amount (expressed in the form of a guideline equity-to-assets
ratio) to each of its mortgage assets. This ratio will fluctuate over time,
based on changes in that asset's credit quality, liquidity characteristics,
potential for market value fluctuation, interest rate risk, prepayment risk, the
manner in which the asset is funded, and the over-collateralization requirements
for that asset set by the Company's collateralized lenders. The sum of the
capital adequacy amounts for all of the Company's mortgage assets is the
Company's aggregate guideline capital adequacy amount.
Since management believes that the bulk of the capital currently necessary to
manage the Company prudently is needed due to the liquidity and market value
fluctuation risks that arise from the utilization of short-term debt, the
guideline capital amount should decline as the Company eliminates these risks
through its transition towards greater utilization of long-term debt.
The Company does not expect that its actual capital levels will always exceed
the guideline amount. The Company measures all of its mortgage assets funded
with short-term borrowings at estimated market value for the purpose of
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making Risk-Adjusted Capital calculations. For example, if interest rates were
to rise in a significant manner, the Company's capital guideline amount would
rise (as the potential interest rate risk of its mortgages would increase, at
least on a temporary basis, due to periodic and life caps) while its actual
capital levels as determined for the Risk-Adjusted Capital Policy would likely
fall as the market values of its mortgages, net of mark-to-market gains on
hedges, fell (market value declines may be temporary as well, as future coupon
adjustments may help to restore some of the lost market value). In this
circumstance, or any other circumstance in which the Company's actual capital
levels fell below the Company's capital adequacy guideline amount, the Company
would cease the acquisition of new mortgage assets until capital balance was
restored.
As expressed as an equity-to-assets ratio, the Company's average guideline
capital amount was 10.2% of assets in the fourth quarter of 1996 and 9.0% in the
third quarter of 1997. Since 1995, the Company has adjusted its asset mix in a
manner that it believes presents the Company with lower levels of anticipated
risk. The capital guideline has dropped accordingly.
The actual average equity-to-asset ratio for the Company was 11.9% in the fourth
quarter of 1996, 10.3% in the first quarter of 1997, 9.9% in the second quarter
of 1997 and 10.1% in the third quarter of 1997. Since actual equity-to-asset
ratios in all these quarters were higher than the capital guideline ratios, the
Company could have owned more mortgage assets during those quarters and still
met its capital guidelines. Balance sheet capacity utilization (equity capital
employed in the base business divided by total equity capital) actual assets
divided by potential assets) is a key measure of capital efficiency for the
Company; it was 86% in the fourth quarter of 1996, 98% in the first quarter of
1997, 96% in the second quarter of 1997 and 89% in the third quarter of 1997.
Due to the issuance of long-term debt in the third and forth quarters and the
current slow pace of assets acquisition, the balance sheet capacity utilization
rate for the fourth quarter of 1997 will most likely be lower than it has been
in the recent past.
In defined circumstances prior to a planned equity offering, management is
authorized by the Board of Directors to acquire mortgage assets in a limited
amount beyond the usual constraints of the Company's Risk-Adjusted Capital
Policy.
From June 12, 1997 through the common stock equity offering of July 25, 1997,
the Company was at its approximate maximum asset size as determined by its
Risk-Adjusted Capital Policy, even after taking into account the expanded
guidelines prior to any equity offering. Accordingly, the Company ceased making
firm commitments to new asset acquisitions during that period. Approximately
$29.4 million of the proceeds from the July offering was necessary to bring the
Company into compliance with its normal capital guidelines. As a result of this
constraint on acquisitions during the early part of the quarter, the level of
total asset acquisitions for the third quarter of 1997 may have been less than
otherwise would have been the case.
Beginning in the second half of the third quarter of 1997, strong demand in an
environment of reduced supply led to increasing prices for mortgage loans and
securities. These rising prices together with the potential for increased
mortgage prepayment rates led the Company to reduce the rate at which it sought
to acquire new mortgage assets. Although this decision resulted in the Company's
balance sheet having excess capital in the later part of the third quarter of
1997, management believes long-term shareholder value will be enhanced by not
committing capital to the acquisition of mortgage assets at September price
levels. In order to reduce the amount of excess capital and increase long-term
shareholder value, a stock repurchase program was announced on September 11,
1997. The Company repurchased 373,000 shares at the end of September using $11
million of excess capital at an average price of $29.50 per share. The Company
remains committed to buying back shares when management believes such purchases
are in the best interests of long-term shareholders.
Through its Sequoia subsidiary the Company issued $534 million of long-term debt
in July of 1997 and issued another $755 million of long-term debt in November of
1997. Both issuances are rated AAA, adjustable rate, amortize at the same rate
as the collateral and have 10% lifetime interest rate caps. With this November
transaction, approximately 40% of the Company's debt is long-term debt.
Liquidity and market value fluctuation risk for that 40% portion of the
Company's balance sheet has been substantially eliminated. Recognizing this risk
reduction, the Company significantly lowered its Risk-Adjusted Capital guideline
amounts for the mortgage loans
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collateralizing long-term debt. The Company's overall weighted average
Risk-Adjusted Capital guideline equity-to-assets ratio declined as a result in
July 1997 and again in November 1997.
Risk Management
The Company seeks to manage the potential credit, interest rate, liquidity and
other risks inherent in all financial institutions in a prudent manner designed
to insure the longevity of the corporation while, at the same time, seeking to
provide an opportunity for shareholders to realize attractive total rates of
return through long-term stock ownership in the Company. While the Company does
not seek to avoid risk, it does seek, to the best of its ability, to assume
risks that can be quantified from historical experience, to actively manage such
risk, to earn sufficient compensation to justify the taking of such risks and to
maintain capital levels consistent with the risks it does undertake.
The Company seeks to limit credit risk by maintaining what it believes to be
high quality mortgage loan underwriting standards. The Company is a nationwide
"A" (or "prime") quality lending company: it acquires and owns first mortgages
on single-family residential properties which have been underwritten to the
highest levels of underwriting standards generally in use for these types of
loans. Credit losses from such mortgages tend to be cyclical. Historically,
however, the magnitude of credit loss incurred from high quality single-family
mortgages during historical credit cycles has been contained relative to credit
losses arising from other forms of commercial, consumer and mortgage lending.
The Company seeks to manage liquidity risk and short-term borrowing roll-over
risk (which could be caused by market value fluctuations of assets pledged as
collateral or by changes in lending markets) through: (1) maintaining what it
believes to be a high quality and liquid portfolio of mortgage assets, (2)
maintaining a hedging program utilizing interest rate agreements designed to
partially mitigate net changes in the market values of its assets, (3)
maintaining what it believes to be a prudent level of capitalization (and
therefore a prudent level of unused borrowing capacity), and (4) replacing a
portion of its short-term borrowings with long-term borrowings. Liquidity risks
and short-term borrowing roll-over risks cannot be completely eliminated unless
the Company can replace all of its short-term borrowings with long-term
borrowings. At September 30, 1997, the Company remained exposed to such risk,
particularly in general market environments of rapidly rising interest rates,
market dislocation or illiquidity.
The Company seeks to manage interest rate risk through matching the interest
rate characteristics of its mortgages and its borrowings to the degree that
management believes is likely to be in the best interests of the shareholders in
the long term.
The Company does not seek to be perfectly matched or to entirely eliminate
interest rate risk. Through September 30, 1997, the Company has paired
adjustable-rate mortgages with variable-rate liabilities. The Company has
generally maintained borrowings which adjust to market conditions several months
faster than its assets. This short-term mis-match has increased on the Company's
balance sheet in 1997 relative to prior periods. For larger interest rate
increases, the potential short-term negative earnings impact resulting from this
short-term mis-match should be partially mitigated by the Company's interest
rate agreements. In addition, since the Company's adjustable-rate earning assets
have exceeded its liabilities to a material degree through September 30, 1997,
the longer term impact of an increase in short-term interest rates may be
positive after a lag period (once the coupon rate on the assets has fully
adjusted to the rate increase). Conversely, while the short-term earnings effect
of a decline in short-term interest rates may be positive, the longer-run effect
after a lag period may be a decline in earnings relative to what they otherwise
would have been after the coupon rates on the assets have adjusted downwards.
Through September 30, 1997, the Company generally has assumed some other types
of asset/liability mis-matches as well, including some yield curve flattening
risk (the risk of six and twelve month interest rates falling relative to one
and three month interest rates) and some "TED" spread risk (the risk of U.S.
Treasury rates, upon which coupon rate changes for a portion of the Company's
assets are based, falling relative to LIBOR rates, upon which changes in the
cost of funds of most of the Company's liabilities are generally correlated). In
addition, the Company has not fully hedged the periodic caps on the 74.4% of its
assets at September 30, 1997 which had such
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caps, or the life caps which are contained in all its mortgage assets. Certain
other types of interest rate risks remain partially unhedged as well. Management
believes that the assumption of these risks, to the extent undertaken by the
Company, is more likely than not to result in higher earnings for the Company in
the long-term but also, from time to time, may cause earnings volatility and
opportunity cost from foregone growth potential. Management believes that
retained interest rate risks (to the extent they are separate from liquidity and
market value fluctuation risk) are unlikely to cause a safety and soundness
issue for the Company except in relatively extreme and unexpected scenarios.
If the rate of mortgage principal repayment of the Company's mortgage assets is
faster than expected, the rate at which the Company amortizes as an expense its
net premium balances will increase and earnings will be reduced relative to what
they would have been otherwise. Changes in principal repayment rates may be a
source of earnings volatility for the Company. In addition, faster principal
repayments may reduce the Company's net asset growth rate; net asset growth is
generally an important component of future earnings growth. Prospects for the
Company may also be reduced by higher than expected mortgage principal
repayments if the potential return characteristics of assets then available for
acquisition are less attractive than those of the existing assets held in
portfolio. Prepayment rates for adjustable-rate mortgages increased during the
third quarter of 1997 and management expects that such prepayment rates may
increase in the fourth quarter of 1997. Slowing rates of mortgage principal
repayment could exacerbate certain liquidity, market value fluctuation, and
interest rate risks in a rising interest rate environment.
While adjustable rate-mortgage principal repayment rates are not highly
predictable, in the past management believes the strongest influencing factor
has been the absolute level of longer-term interest rates. As long-term rates
drop, adjustable-rate mortgage principal repayments have tended to increase,
particularly if longer-term rates drop relative to short-term interest rates. In
addition, management believes adjustable rate mortgage principal repayments have
been increasing on a secular trend basis due to structural and behavioral
changes in the mortgage origination market. Through September 30, 1997, the
Company has not sought to hedge mortgage principal repayment risk but rather has
sought to analyze, based on individual mortgage characteristics, the propensity
of each acquired mortgage or mortgage pool to experience accelerated principal
repayment rates and to adjust its acquisition price bid accordingly based on the
level of perceived downside (and upside) earnings risk.
Virtually all of the Company's assets and liabilities are financial in nature.
As a result, interest rates, changes in interest rates and other factors drive
the Company's performance far more than does inflation. Changes in interest
rates do not necessarily correlate with inflation rates or changes in inflation
rates. The Company's financial statements are prepared in accordance with
Generally Accepted Accounting Principles and the Company's dividends are
generally determined based the Company's net income as calculated for tax
purposes; in each case, the Company's activities and balance sheet are measured
with reference to historical cost or fair market value without considering
inflation.
36
<PAGE> 37
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 1
INCOME STATEMENT FOR THREE MONTHS ENDING
------------------------------------
(ALL DOLLARS IN THOUSANDS) SEP. 30, JUN. 30, MAR. 31,
1997 1997 1997
---- ---- ----
<S> <C> <C> <C>
Mortgage Loans:
Coupon Income $ 21,432 $ 14,474 $ 10,784
Amortization of Discount Balances 1 8 11
Amortization of Premium Balances (1,803) (1,462) (940)
-------------------------------- -------- -------- --------
Interest Income: Mortgage Loans 19,630 13,020 9,855
Mortgage Securities:
Coupon Income 41,124 39,879 31,440
Amortization of Discount Balances 375 409 261
Amortization of Premium Balances (5,085) (4,065) (3,150)
-------------------------------- -------- -------- --------
Interest Income: Mortgage Securities 36,414 36,223 28,551
Total Interest Income From Mortgage Assets 56,044 49,243 38,406
Interest Income: Cash Balances 499 266 162
- ------------------------------ -------- -------- --------
Total Interest Income 56,543 49,509 38,568
Interest Expense (45,888) (38,958) (28,900)
Interest Rate Agreement Expense (1,066) (912) (602)
Interest Rate Agreement Income 28 73 7
- ------------------------------ -------- -------- --------
Net Interest Rate Agreement Expense (1,038) (839) (595)
Net Interest Income 9,617 9,712 9,073
Gain (Loss) on Sale 20 0 0
Other Income 0 0 0
- ------------ -------- -------- --------
Total Income 9,637 9,712 9,073
Provision for Potential Credit Losses
Mortgage Loans (473) (299) (215)
Mortgage Securities (470) (477) (480)
------------------- -------- -------- --------
Total Credit Provision (943) (776) (695)
Compensation and Benefits Expense (441) (516) (529)
Dividend Equivalent Rights Expense (361) (358) (203)
Other Operating Expenses (346) (341) (435)
- ------------------------ -------- -------- --------
Total Operating Expenses (1,148) (1,215) (1,167)
Corporate Income Tax Expense 0 0 0
Net Income Before Preferred Dividends $ 7,546 $ 7,721 $ 7,211
Preferred Dividends (687) (687) (755)
- ------------------- -------- -------- --------
Net Income to Common Shareholders $ 6,859 $ 7,034 $ 6,456
================================= ======== ======== ========
Calculation of Taxable REIT Income
- ----------------------------------
GAAP Net Income Before Preferred Dividends $ 7,546 $ 7,721 $ 7,211
Mortgage Amortization Differences (95) (103) (87)
Credit Provisions less Actual Losses 875 747 653
Operating Expense Differences (175) (50) 135
- ----------------------------- -------- -------- --------
Taxable Income Before Preferred Dividend $ 8,151 $ 8,315 $ 7,912
======================================== ======== ======== ========
</TABLE>
37
<PAGE> 38
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 1 (CONTINUED)
INCOME STATEMENT FOR THREE MONTHS ENDING
--------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1996 1996 1996 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Mortgage Loans:
Coupon Income $ 2,582 $ 1,656 $ 749 $ 479
Amortization of Discount Balances 11 7 11 2
Amortization of Premium Balances (189) (62) (43) (19)
-------------------------------- -------- -------- -------- --------
Interest Income: Mortgage Loans 2,404 1,601 717 462
Mortgage Securities:
Coupon Income 25,292 18,901 12,973 8,965
Amortization of Discount Balances 206 264 234 175
Amortization of Premium Balances (2,236) (1,645) (1,225) (688)
-------------------------------- -------- -------- -------- --------
Interest Income: Mortgage Securities 23,262 17,520 11,982 8,452
Total Interest Income From Mortgage Assets 25,666 19,121 12,699 8,914
Interest Income: Cash Balances 215 250 202 217
- ------------------------------ -------- -------- -------- --------
Total Interest Income 25,881 19,371 12,901 9,131
Interest Expense (19,467) (14,447) (9,075) (6,202)
Interest Rate Agreement Expense (403) (350) (255) (151)
Interest Rate Agreement Income 1 0 0 0
- ------------------------------ -------- -------- -------- --------
Net Interest Rate Agreement Expense (402) (350) (255) (151)
Net Interest Income 6,012 4,574 3,571 2,778
Gain (Loss) on Sale 0 0 0 0
Other Income 0 0 0 0
- ------------ -------- -------- -------- --------
Total Income 6,012 4,574 3,571 2,778
Provision for Potential Credit Losses
Mortgage Loans (35) (178) (140) 5
Mortgage Securities (337) (338) (337) (336)
------------------- -------- -------- -------- --------
Total Credit Provision (372) (516) (477) (331)
Compensation and Benefits Expense (343) (309) (305) (234)
Dividend Equivalent Rights Expense (137) (81) (79) (85)
Other Operating Expenses (316) (281) (210) (174)
- ------------------------ -------- -------- -------- --------
Total Operating Expenses (796) (671) (594) (493)
Corporate Income Tax Expense 0 0 0 0
Net Income Before Preferred Dividends $ 4,844 $ 3,387 $ 2,500 $ 1,954
Preferred Dividends (760) (388) 0 0
- ------------------- -------- -------- -------- --------
Net Income to Common Shareholders $ 4,084 $ 2,999 $ 2,500 $ 1,954
================================= ======== ======== ======== ========
Calculation of Taxable REIT Income
GAAP Net Income Before Preferred Dividends $ 4,844 $ 3,387 $ 2,500 $ 1,954
Mortgage Amortization Differences 131 61 82 175
Credit Provisions less Actual Losses 365 516 477 331
Operating Expense Differences 89 84 83 89
- ----------------------------- -------- -------- -------- --------
Taxable Income Before Preferred Dividend $ 5,429 $ 4,048 $ 3,142 $ 2,549
======================================== ======== ======== ======== ========
</TABLE>
38
<PAGE> 39
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 1 (CONTINUED)
INCOME STATEMENT FOR YEAR ENDING
------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31, DEC. 31,
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Mortgage Loans:
Coupon Income $ 5,466 $ 379 $ 0
Amortization of Discount Balances 31 4 0
Amortization of Premium Balances (313) (4) 0
-------------------------------- -------- -------- --------
Interest Income: Mortgage Loans 5,184 379 0
Mortgage Securities:
Coupon Income 66,131 14,759 1,102
Amortization of Discount Balances 879 915 101
Amortization of Premium Balances (5,794) (559) (19)
-------------------------------- -------- -------- --------
Interest Income: Mortgage Securities 61,216 15,115 1,184
Total Interest Income From Mortgage Assets 66,400 15,494 1,184
Interest Income: Cash Balances 884 232 112
- ------------------------------ -------- -------- --------
Total Interest Income 67,284 15,726 1,296
Interest Expense (49,191) (10,608) (760)
Interest Rate Agreement Expense (1,159) (339) (8)
Interest Rate Agreement Income 1 0 0
- ------------------------------ -------- -------- --------
Net Interest Rate Agreement Expense (1,158) (339) (8)
Net Interest Income 16,935 4,779 528
Gain (Loss) on Sale 0 0 0
Other Income 0 0 0
- ------------ -------- -------- --------
Total Income 16,935 4,779 528
Provision for Potential Credit Losses
Mortgage Loans (348) (79) 0
Mortgage Securities (1,348) (414) 0
------------------- -------- -------- --------
Total Credit Provision (1,696) (493) 0
Compensation and Benefits Expense (1,191) (463) (63)
Dividend Equivalent Rights Expense (382) (54) 0
Other Operating Expenses (981) (614) (83)
- ------------------------ -------- -------- --------
Total Operating Expenses (2,554) (1,131) (146)
Corporate Income Tax Expense 0 0 0
Net Income Before Preferred Dividends $ 12,685 $ 3,155 $ 382
Preferred Dividends (1,148) 0 0
- ------------------- -------- -------- --------
Net Income to Common Shareholders $ 11,537 $ 3,155 $ 382
================================= ======== ======== ========
Calculation of Taxable REIT Income
- ----------------------------------
GAAP Net Income Before Preferred Dividends $ 12,685 $ 3,155 $ 382
Mortgage Amortization Differences 449 175 (28)
Credit Provisions less Actual Losses 1,689 490 0
Operating Expense Differences 345 12 0
- ----------------------------- -------- -------- --------
Taxable Income Before Preferred Dividend $ 15,168 $ 3,832 $ 354
======================================== ======== ======== ========
</TABLE>
39
<PAGE> 40
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 2 AT
---------------------------------------------
BALANCE SHEETS SEP. 30, JUN. 30, MAR. 31,
(ALL DOLLARS IN THOUSANDS) 1997 1997 1997
----------- ----------- -----------
<S> <C> <C> <C>
Cash and Cash Equivalents $ 57,696 $ 29,425 $ 12,985
Mortgage Loans:
Principal Value 1,348,619 1,111,029 716,009
Unamortized Premium 30,852 25,442 15,951
Unamortized Discount 0 (123) (131)
Real Estate Owned 220 346 128
Reserve For Credit Losses (1,363) (929) (630)
Market Valuation Account 0 0 (1,291)
------------------------ ----------- ----------- -----------
Total Mortgage Loans 1,378,328 1,135,765 730,035
Mortgage Securities:
Principal Value 2,010,374 2,179,186 1,839,720
Unamortized Premium 56,082 62,219 49,156
Unamortized Discount (14,387) (14,968) (15,510)
Reserve For Credit Losses (3,093) (2,651) (2,203)
Market Valuation Account 10,619 3,603 3,516
----------- ----------- -----------
Total Mortgage Securities 2,059,595 2,227,389 1,874,679
Total Mortgage Assets 3,437,923 3,363,154 2,604,714
Interest Rate Agreements 11,708 12,233 7,879
Market Valuation Account (8,782) (7,366) (2,106)
- ------------------------ ----------- ----------- -----------
Total Interest Rate Agreements 2,926 4,867 5,773
Accrued Interest Receivable 23,859 24,065 17,722
Fixed Assets, Leasehold, Org Costs 358 257 259
Prepaid Expenses and Other Receivables 2,490 2,738 1,611
- -------------------------------------- ----------- ----------- -----------
Other Assets 26,707 27,060 19,592
Total Assets $ 3,525,252 $ 3,424,506 $ 2,643,064
============ =========== =========== ===========
Short-Term Borrowings $ 2,639,773 $ 3,102,784 $ 2,373,279
Long--Term Borrowings 497,367 0 0
Accrued Interest Payable 20,216 18,153 14,962
Accrued Expenses and Other Payables 2,129 1,743 1,262
Dividends Payable 9,433 8,638 7,899
- ----------------- ----------- ----------- -----------
Total Liabilities $ 3,168,918 $ 3,131,318 $ 2,397,402
Preferred Stock $ 26,733 $ 26,733 $ 29,383
Common Stock 146 133 119
Additional Paid-in Capital 333,841 274,420 219,461
Net Market Valuation Account 1,837 (3,762) 118
Retained Earnings after Dividends (6,223) (4,336) (3,419)
- --------------------------------- ----------- ----------- -----------
Total Stockholders' Equity 356,334 293,188 245,662
Total Liabilities plus Stockholders' Equity $ 3,525,252 $ 3,424,506 $ 2,643,064
=========================================== =========== =========== ===========
</TABLE>
40
<PAGE> 41
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 2 (CONTINUED) AT
------------------------------------------------------
BALANCE SHEETS DEC. 31, SEP. 30, JUN. 30, MAR. 31,
(ALL DOLLARS IN THOUSANDS) 1996 1996 1996 1996
----------- ----------- ----------- ---------
<S> <C> <C> <C> <C>
Cash and Cash Equivalents $ 11,068 $ 14,599 $ 10,407 $ 9,705
Mortgage Loans:
Principal Value 514,837 126,426 69,154 24,831
Unamortized Premium 12,389 1,535 686 191
Unamortized Discount (142) (153) (160) (171)
Real Estate Owned 196 0 0 0
Reserve For Credit Losses (428) (393) (214) (74)
Market Valuation Account (1,377) 279 200 84
------------------------ ----------- ---------- ---------- ---------
Total Mortgage Loans 525,475 127,694 69,666 24,861
Mortgage Securities:
Principal Value 1,602,212 1,234,636 936,611 548,976
Unamortized Premium 41,928 31,072 22,004 12,599
Unamortized Discount (15,951) (16,185) (16,448) (16,683)
Reserve For Credit Losses (1,752) (1,421) (1,084) (747)
Market Valuation Account 1,516 74 (3,269) (3,847)
------------------------ ----------- ---------- ---------- ---------
Total Mortgage Securities 1,627,953 1,248,176 937,814 540,298
Total Mortgage Assets 2,153,428 1,375,870 1,007,480 565,159
Interest Rate Agreements 6,200 3,286 2,835 2,534
Market Valuation Account (3,599) (2,413) (1,484) (1,301)
- ------------------------ ----------- ---------- ---------- ---------
Total Interest Rate Agreements 2,601 873 1,351 1,233
Accrued Interest Receivable 14,134 10,781 7,292 4,496
Fixed Assets, Leasehold, Org Costs 257 265 233 198
Prepaid Expenses and Other Receivables 2,709 1,090 1,567 522
- -------------------------------------- ----------- ----------- ----------- ---------
Other Assets 17,100 12,136 9,092 5,216
Total Assets $ 2,184,197 $ 1,403,478 $ 1,028,330 $ 581,313
============ =========== =========== =========== =========
Short-Term Borrowings $ 1,953,103 $ 1,225,094 $ 896,214 $ 508,721
Long-Term Borrowings 0 0 0 0
Accrued Interest Payable 14,060 10,379 4,052 1,616
Accrued Expenses and Other Payables 761 472 361 290
Dividends Payable 5,268 4,016 3,408 2,540
- ----------------- ----------- ----------- ---------- ---------
Total Liabilities $ 1,973,192 $ 1,239,961 $ 904,035 $ 513,167
Preferred Stock $ 29,579 $ 29,712 $ 0 $ 0
Common Stock 110 91 85 55
Additional Paid-in Capital 187,507 138,081 130,441 73,926
Net Market Valuation Account (3,460) (2,060) (4,553) (5,065)
Retained Earnings after Dividends (2,731) (2,307) (1,678) (770)
- --------------------------------- ----------- ----------- ----------- ---------
Total Stockholders' Equity 211,005 163,517 124,295 68,146
Total Liabilities plus Stockholders' Equity $ 2,184,197 $ 1,403,478 $ 1,028,330 $ 581,313
=========================================== =========== =========== =========== =========
</TABLE>
41
<PAGE> 42
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 2 (CONTINUED) AT
-------------------------------------
BALANCE SHEETS DEC. 31, DEC. 31, DEC. 31,
(ALL DOLLARS IN THOUSANDS) 1996 1995 1994
----------- --------- ---------
<S> <C> <C> <C>
Cash and Cash Equivalents $ 11,068 $ 4,825 $ 1,027
Mortgage Loans:
Principal Value 514,837 26,411 0
Unamortized Premium 12,389 210 0
Unamortized Discount (142) (172) 0
Real Estate Owned 196 0 0
Reserve For Credit Losses (428) (79) 0
Market Valuation Account (1,377) 80 0
------------------------ ----------- --------- ---------
Total Mortgage Loans 525,475 26,450 0
Mortgage Securities:
Principal Value 1,602,212 417,214 120,627
Unamortized Premium 41,928 9,433 828
Unamortized Discount (15,951) (16,860) (1,320)
Reserve For Credit Losses (1,752) (411) 0
Market Valuation Account 1,516 (3,582) (2,658)
------------------------ ----------- --------- ---------
Total Mortgage Securities 1,627,953 405,794 117,477
Total Mortgage Assets 2,153,428 432,244 117,477
Interest Rate Agreements 6,200 2,521 1,791
Market Valuation Account (3,599) (1,974) 101
- ------------------------ ----------- --------- ---------
Total Interest Rate Agreements 2,601 547 1,892
Accrued Interest Receivable 14,134 3,270 743
Fixed Assets, Leasehold, Org Costs 257 206 201
Prepaid Expenses and Other Receivables 2,709 465 188
- -------------------------------------- ------------ --------- ---------
Other Assets 17,100 3,941 1,132
Total Assets $ 2,184,197 $ 441,557 $ 121,529
============ =========== ========= =========
Short-Term Borrowings $ 1,953,103 $ 370,316 $ 100,376
Long-Term Borrowings
Accrued Interest Payable 14,060 1,290 676
Accrued Expenses and Other Payables 761 227 29
Dividends Payable 5,268 1,434 167
- ----------------- ----------- --------- ---------
Total Liabilities $ 1,973,192 $ 373,267 $ 101,248
----------- --------- ---------
Preferred Stock $ 29,579 $ 0 $ 22,785
Common Stock 110 55 2
Additional Paid-in Capital 187,507 73,895 19
Net Market Valuation Account (3,460) (5,476) (2,557)
Retained Earnings after Dividends (2,731) (184) 31
- --------------------------------- ----------- --------- ---------
Total Stockholders' Equity 211,005 68,290 20,280
Total Liabilities plus Stockholders' Equity $ 2,184,197 $ 441,557 $ 121,528
=========================================== =========== ========= =========
</TABLE>
42
<PAGE> 43
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 3 AT OR
MORTGAGE ASSET CHARACTERISTICS FOR THREE MONTHS ENDING
--------------------------------------
(ALL DOLLARS IN THOUSANDS) SEP. 30, JUN. 30, MAR. 31,
1997 1997 1997
---------- ---------- ----------
<S> <C> <C> <C>
Average Characteristics of Mortgage Assets
Single-Family Properties 100% 100% 100%
Adjustable Rate 100% 100% 100%
First Lien 100% 100% 100%
Credit Rating Equivalent AA+ AA+ AA+
Amortized Cost as % of Principal Value 102.16% 102.21% 101.94%
Coupon Rate 7.75% 7.73% 7.70%
Months to Next Coupon Adjustment 4 5 5
Level of Index 5.65% 5.77% 5.98%
Net Margin 2.19% 2.23% 2.21%
Fully Indexed Coupon Rate 7.84% 8.00% 8.19%
Coupon Versus Fully-Indexed Rate -0.09% -0.27% -0.49%
Net Life Cap 12.01% 12.01% 11.91%
Percentage of Mortgage Assets by Credit Type (By Amortized Cost)
Mortgage Loans 40.2% 33.8% 28.1%
Mortgage Securities: AAA/AA 58.2% 64.5% 69.8%
Mortgage Securities: A/BBB 0.7% 0.8% 1.0%
Mortgage Securities: Below BBB 0.9% 0.9% 1.1%
- ------------------------------ ----- ----- -----
Total Mortgage Assets (%) 100.0% 100.0% 100.0%
Total Mortgage Assets (Amortized Cost) $3,431,760 $3,363,131 $2,605,323
Percentage of Mortgage Assets by Index, Adjustment Frequency, and Annualized Periodic Cap (By Principal Value)
1 Month LIBOR, adjusts monthly, no periodic 12.4% 8.9% 2.6%
6 Month LIBOR, adjusts each 6 months, 2% periodic 26.2% 27.5% 32.4%
6 Month LIBOR, adjusts each 6 months, no periodic 11.4% 7.4% 1.9%
6 Month CD, adjusts each 6 months, 2% periodic 1.3% 1.5% 1.9%
6 Month Treasury, adjusts each 6 months, 2% periodic 0.6% 0.6% 0.8%
6 Month Treasury, adjusts each 6 months, no periodic 0.5% 0.5% 0.7%
3/1 Hybrid: 12 Month Treasury with 3 year initial coupon 1.7% 1.8% 2.4%
12 Month Treasury, adjusts annually, 2% periodic 44.5% 50.3% 55.4%
12 Month Treasury, adjusts annually, no periodic 0.1% 0.1% 0.1%
Other 1.3% 1.4% 1.8%
- ----- ----- ----- -----
Total Mortgage Assets (%) 100.0% 100.0% 100.0%
Total Mortgage Assets (Principal Value) $3,359,213 $3,290,562 $2,555,857
Net Mortgage Asset Growth
Mortgage Acquisitions $ 369,463 $ 962,889 $ 627,075
---------- ---------- ----------
Mortgage Principal Repayments (252,397) (199,945) (173,362)
Amortization, Sales and Other (48,437) (5,136) (3,859)
- ------------------------------ ---------- ---------- ----------
Change in Mortgage Assets (Amortized Cost) 68,629 757,808 449,854
Net Mortgage Asset Growth versus Prior Quarter 2% 29% 21%
Net Mortgage Asset Growth Over 12 Months 149% 232% 357%
Prepayment Rate of Underlying Mortgages (CPR) 25% 23% 24%
Total Rate of Mortgage Principal Repayment 31% 28% 32%
</TABLE>
43
<PAGE> 44
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 3 (CONTINUED) AT OR
MORTGAGE ASSET CHARACTERISTICS FOR THREE MONTHS ENDING
--------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1996 1996 1996 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Average Characteristics of Mortgage Assets
Single-Family Properties 100% 100% 100% 100%
Adjustable Rate 100% 100% 100% 100%
First Lien 100% 100% 100% 100%
Credit Rating Equivalent AA+ AA+ AA+ AA+
Amortized Cost as % of Principal Value 101.81% 101.20% 100.60% 99.29%
Coupon Rate 7.75% 7.55% 7.42% 7.59%
Months to Next Coupon Adjustment 5 4 4 3
Level of Index 5.58% 5.70% 5.72% 5.47%
Net Margin 2.24% 2.21% 2.21% 2.11%
Fully Indexed Coupon Rate 7.82% 7.91% 7.93% 7.58%
Coupon Versus Fully-Indexed Rate -0.07% -0.36% -0.51% 0.01%
Net Life Cap 11.73% 11.69% 11.71% 11.53%
Percentage of Mortgage Assets by Credit Type (By Amortized Cost)
Mortgage Loans 24.5% 9.3% 6.9% 4.4%
Mortgage Securities: AAA/AA 73.0% 86.8% 87.7% 86.1%
Mortgage Securities: A/BBB 1.2% 1.8% 2.5% 4.6%
Mortgage Securities: Below BBB 1.3% 2.1% 2.9% 4.9%
- ------------------------------ ----- ----- ----- -----
Total Mortgage Assets (%) 100.0% 100.0% 100.0% 100.0%
Total Mortgage Assets (Amortized Cost) $2,155,469 $1,377,331 $1,011,847 $569,743
Percentage of Mortgage Assets by Index, Adjustment Frequency, and Annualized Periodic Cap (By Principal Value)
1 Month LIBOR, adjusts monthly, no periodic 1.4% 2.3% 3.3% 6.6%
6 Month LIBOR, adjusts each 6 months, 2% periodic 36.2% 45.9% 54.4% 63.2%
6 Month LIBOR, adjusts each 6 months, no periodic 0.0% 0.0% 0.0% 0.0%
6 Month CD, adjusts each 6 months, 2% periodic 2.5% 2.4% 3.3% 8.7%
6 Month Treasury, adjusts each 6 months, 2% periodic 1.1% 1.7% 2.4% 0.0%
6 Month Treasury, adjusts each 6 months, no periodic 0.9% 1.3% 1.9% 3.6%
3/1 Hybrid: 12 Month Treasury with 3 year initial coupon 0.0% 0.0% 0.0% 0.0%
12 Month Treasury, adjusts annually, 2% periodic 55.7% 45.0% 32.8% 14.6%
12 Month Treasury, adjusts annually, no periodic 0.0% 0.0% 0.0% 0.0%
Other 2.2% 1.4% 1.9% 3.3%
- ----- ----- ----- ----- -----
Total Mortgage Assets (%) 100.0% 100.0% 100.0% 100.0%
Total Mortgage Assets (Principal Value) $2,117,244 $1,361,062 $1,005,764 $573,807
Net Mortgage Asset Growth
Mortgage Acquisitions $ 875,968 $ 443,860 $ 496,184 $166,852
Mortgage Principal Repayments (95,610) (76,942) (53,058) (32,814)
Amortization, Sales and Other (2,220) (1,434) (1,022) (530)
- ------------------------------ ---------- ---------- ---------- --------
Change in Mortgage Assets (Amortized Cost) 778,138 365,484 442,104 133,508
Net Mortgage Asset Growth versus Prior Quarter 56% 36% 78% 31%
Net Mortgage Asset Growth Over 12 Months 394% 361% 480% 302%
Prepayment Rate of Underlying Mortgages (CPR) 23% 24% 29% 26%
Total Rate of Mortgage Principal Repayment 26% 28% 29% 27%
</TABLE>
44
<PAGE> 45
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 3 (CONTINUED) AT OR
MORTGAGE ASSET CHARACTERISTICS FOR YEAR ENDING
--------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31, DEC. 31,
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Average Characteristics of Mortgage Assets
Single-Family Properties 100% 100% 100%
Adjustable Rate 100% 100% 100%
First Lien 100% 100% 100%
Credit Rating Equivalent AA+ AA+ AA+
Amortized Cost as % of Principal Value 101.81% 98.33% 99.59%
Coupon Rate 7.75% 7.50% 6.00%
Months to Next Coupon Adjustment 5 3 3
Level of Index 5.58% 5.44% 6.94%
Net Margin 2.24% 2.08% 2.25%
Fully Indexed Coupon Rate 7.82% 7.52% 9.19%
Coupon Versus Fully-Indexed Rate -0.07% -0.02% -3.19%
Net Life Cap 11.73% 11.54% 11.48%
Percentage of Mortgage Assets by Credit Type (By Amortized Cost)
Mortgage Loans 24.5% 6.1% 0.0%
Mortgage Securities: AAA/AA 73.0% 81.5% 92.9%
Mortgage Securities: A/BBB 1.2% 5.8% 4.3%
Mortgage Securities: Below BBB 1.3% 6.6% 2.8%
- ------------------------------ ----- ----- -----
Total Mortgage Assets (%) 100.0% 100.0% 100.0%
Total Mortgage Assets (Amortized Cost) $2,155,469 $ 436,236 $ 120,135
Percentage of Mortgage Assets by Index, Adjustment Frequency, and Annualized Periodic Cap (By Principal Value)
1 Month LIBOR, adjusts monthly, no periodic 1.4% 7.6% 3.9%
6 Month LIBOR, adjusts each 6 months, 2% periodic 36.2% 60.3% 78.3%
6 Month LIBOR, adjusts each 6 months, no periodic 0.0% 0.0% 0.0%
6 Month CD, adjusts each 6 months, 2% periodic 2.5% 12.2% 17.8%
6 Month Treasury, adjusts each 6 months, 2% periodic 1.1% 0.0% 0.0%
6 Month Treasury, adjusts each 6 months, no periodic 0.9% 4.9% 0.0%
3/1 Hybrid: 12 Month Treasury with 3 year initial coupon 0.0% 0.0% 0.0%
12 Month Treasury, adjusts annually, 2% periodic 55.7% 12.3% 0.0%
12 Month Treasury, adjusts annually, no periodic 0.0% 0.0% 0.0%
Other 2.2% 2.7% 0.0%
- ----- ----- ----- -----
Total Mortgage Assets (%) 100.0% 100.0% 100.0%
Total Mortgage Assets (Principal Value) $2,117,244 $ 443,625 $ 120,627
Net Mortgage Asset Growth
Mortgage Acquisitions $1,982,864 $ 354,572 $ 121,297
Mortgage Principal Repayments (258,424) (38,824) (1,244)
Amortization, Sales and Other (5,206) 353 82
- ------------------------------ ---------- ---------- ----------
Change in Mortgage Assets (Amortized Cost) 1,719,234 316,101 120,135
Net Mortgage Asset Growth versus Prior Quarter n/a n/a n/a
Net Mortgage Asset Growth Over 12 Months 394% 263% n/a
Prepayment Rate of Underlying Mortgages (CPR) 25% 19% 9%
Total Rate of Mortgage Principal Repayment 27% 18% 7%
</TABLE>
45
<PAGE> 46
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 4 AT
---------------------------------
MORTGAGE LOAN SUMMARY SEP. 30, JUN. 30, MAR. 31,
(ALL DOLLARS IN THOUSANDS) 1997 1997 1997
---------- ---------- ---------
<S> <C> <C> <C>
Number of Loans 4,651 3,983 2,795
Principal Value $1,348,839 $1,111,376 $ 716,137
Amortized Cost 1,379,691 1,136,694 731,957
Reported Value 1,378,328 1,135,765 730,035
Estimated Bid-Side Market Value 1,379,166 1,136,004 730,035
Adjustable-Rate 100% 100% 100%
Single-Family 100% 100% 100%
"A" Quality Underwriting 100% 100% 100%
First Lien 100% 100% 100%
Primary Residence (Owner-Occupied) 91% 92% 94%
Second Home 7% 6% 4%
Investor Property 2% 2% 2%
Average Loan Size $ 290 $ 279 $ 256
Loan Balance Less Than $214,600 19% 20% 20%
Loan Balance Greater Than $500,000 33% 27% 14%
Original Loan-To-Value Ratio (LTV) 77% 78% 74%
Original LTV > 80% 35% 33% 24%
% of Original LTV > 80% with Primary Mortgage 96% 94% 94%
Insurance or Pledged Account Collateral
Effective Average Original LTV Including Primary 66% 69% 68%
Mortgage Insurance or Pledged Account Collateral
1990 and Prior Years' Origination 4% 6% 9%
1991 Origination 0% 1% 1%
1992 1% 2% 3%
1993 4% 6% 9%
1994 17% 23% 41%
1995 2% 2% 4%
1996 14% 18% 30%
1997 58% 42% 2%
Average Seasoning in Months 19 22 33
Northern California 13% 13% 17%
Southern California 19% 21% 24%
Florida 9% 8% 5%
New York 6% 5% 4%
New Jersey 4% 4% 3%
Connecticut 4% 4% 3%
Texas 4% 4% 3%
Georgia 4% 3% 2%
Maryland 3% 4% 6%
Illinois 3% 3% 4%
Colorado 3% 3% 2%
Arizona 3% 3% 1%
Other States 25% 25% 26%
*: less than 0.5%
</TABLE>
46
<PAGE> 47
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 4 (CONTINUED) AT
-----------------------------------------
MORTGAGE LOAN SUMMARY DEC. 31, SEP. 30, JUN. 30, MAR. 31,
(ALL DOLLARS IN THOUSANDS) 1996 1996 1996 1996
--------- --------- --------- --------
<S> <C> <C> <C> <C>
Number of Loans 2,172 478 257 101
Principal Value $ 515,033 $ 126,426 $ 69,154 $ 24,831
Amortized Cost 527,280 127,808 69,680 24,851
Reported Value 525,475 127,694 69,666 24,861
Estimated Bid-Side Market Value 525,475 127,694 69,666 24,861
Adjustable-Rate 100% 100% 100% 100%
Single-Family 100% 100% 100% 100%
"A" Quality Underwriting 100% 100% 100% 100%
First Lien 100% 100% 100% 100%
Primary Residence (Owner-Occupied) 94% 99% 99% 100%
Second Home 4% 1% 1% 0%
Investor Property 2% 0% 0% 0%
Average Loan Size $ 237 $ 264 $ 269 $ 246
Loan Balance Less Than $214,600 23% 18% 14% 30%
Loan Balance Greater Than $500,000 8% 12% 13% 25%
Original Loan-To-Value Ratio (LTV) 77% 78% 76% 77%
Original LTV > 80% 25% 32% 23% 27%
% of Original LTV > 80% with Primary Mortgage 97% 100% 100% 100%
Insurance or Pledged Account Collateral
Effective Average Original LTV Including Primary 73% 73% 73% 73%
Mortgage Insurance or Pledged Account Collateral
1990 and Prior Years' Origination 13% 0% 0% 0%
1991 Origination 2% 0% 0% 0%
1992 4% 0% 0% 0%
1993 14% 7% 1% 0%
1994 52% 43% 2% 2%
1995 7% 32% 63% 98%
1996 8% 18% 34% 0%
1997 0% 0% 0% 0%
Average Seasoning in Months 37 9 4 7
Northern California 18% 34% 30% 30%
Southern California 26% 51% 43% 46%
Florida 4% * 1% 1%
New York 3% * * 0%
New Jersey 3% * * 1%
Connecticut 3% 1% 1% 1%
Texas 2% 1% 1% 4%
Georgia 2% * 1% 1%
Maryland 8% * 1% 2%
Illinois 4% * 1% 0%
Colorado 1% 2% 3% 3%
Arizona 2% 0% 0% 0%
Other States 24% 11% 18% 11%
*: less than 0.5%
</TABLE>
47
<PAGE> 48
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 4 (CONTINUED) AT
-------------------------------
MORTGAGE LOAN SUMMARY DEC. 31, DEC. 31, DEC. 31,
(ALL DOLLARS IN THOUSANDS) 1996 1995 1994
---------- --------- --------
<S> <C> <C> <C>
Number of Loans 2,172 109 0
Principal Value $ 515,033 $ 26,411 $ 0
Amortized Cost 527,280 26,449 0
Reported Value 525,475 26,450 0
Estimated Bid-Side Market Value 525,475 26,450 0
Adjustable-Rate 100% 100% n/a
Single-Family 100% 100% n/a
"A" Quality Underwriting 100% 100% n/a
First Lien 100% 100% n/a
Primary Residence (Owner-Occupied) 94% 100% n/a
Second Home 4% 0% n/a
Investor Property 2% 0% n/a
Average Loan Size $ 237 $ 242 n/a
Loan Balance Less Than $214,600 23% 11% n/a
Loan Balance Greater Than $500,000 8% 13% n/a
Original Loan-To-Value Ratio (LTV) 77% 76% n/a
Original LTV > 80% 25% 26% n/a
% of Original LTV > 80% with Primary Mortgage 97% 100% n/a
Insurance or Pledged Account Collateral
Effective Average Original LTV Including Primary 73% 72% n/a
Mortgage Insurance or Pledged Account Collateral
1990 and Prior Years' Origination 13% 0% n/a
1991 Origination 2% 0% n/a
1992 4% 0% n/a
1993 14% 0% n/a
1994 52% 2% n/a
1995 7% 98% n/a
1996 8% 0% n/a
1997 0% 0% n/a
Average Seasoning in Months 37 4 n/a
Northern California 18% 30% n/a
Southern California 26% 44% n/a
Florida 4% 1% n/a
New York 3% 0% n/a
New Jersey 3% 1% n/a
Connecticut 3% 1% n/a
Texas 2% 4% n/a
Georgia 2% 1% n/a
Maryland 8% 2% n/a
Illinois 4% 0% n/a
Colorado 1% 3% n/a
Arizona 2% 2% n/a
Other States 24% 11% n/a
*: less than 0.5%
</TABLE>
48
<PAGE> 49
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 5
EARNING ASSET YIELD, INTEREST RATE SPREAD FOR THREE MONTHS ENDING
-----------------------------
AND INTEREST RATE MARGIN SEP. 30, JUN. 30, MAR. 31,
1997 1997 1997
---- ---- ----
<S> <C> <C> <C>
Average Initial Coupon Rate on Mortgage Acquisitions 7.32% 7.45% 7.45%
New Acquisitions Last 6 Months/Total Mortgages 39% 47% 58%
Mortgage Coupon Rate (All Mortgage Assets) 7.77% 7.74% 7.70%
Amortized Cost/ Principal Value 102.22% 102.15% 101.84%
Coupon Yield on Amortized Cost 7.60% 7.57% 7.56%
Effect of Premium/Discount Amortization -0.79% -0.71% -0.68%
Mortgage Yield 6.81% 6.86% 6.88%
Cash Yield 5.60% 5.52% 5.33%
Earning Asset Yield (Mortgages plus Cash) 6.80% 6.86% 6.87%
Cost of Funds 6.02% 5.86% 5.62%
Cost of Hedging (as % of Borrowings) 0.14% 0.13% 0.12%
Interest Rate Spread 0.64% 0.87% 1.13%
Net Interest Margin (Net Interest Income/Assets) 1.12% 1.31% 1.57%
Net Interest Income/Average Equity 11.13% 13.25% 15.30%
SELECTED OPERATING RATIOS AND RETURN ON EQUITY
Credit Provisions as a % of Assets 0.11% 0.10% 0.12%
Credit Provisions as a % of Equity 1.09% 1.06% 1.17%
Operating Expenses to Average Assets 0.13% 0.16% 0.20%
Operating Expenses to Average Equity 1.33% 1.66% 1.97%
Efficiency Ratio (Op Exp/Net Int Income) 11.93% 12.51% 12.86%
Average Assets Per Employee ($MM) $ 244 $ 257 $ 221
GAAP Return on Total Equity 8.73% 10.53% 12.16%
GAAP Return on Common Equity 8.60% 10.65% 12.44%
Taxable Income Return on Total Equity 9.43% 11.34% 13.34%
Taxable Income Return on Common Equity 9.36% 11.55% 13.79%
</TABLE>
49
<PAGE> 50
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 5 (CONTINUED)
EARNING ASSET YIELD, INTEREST RATE SPREAD FOR THREE MONTHS ENDING
-----------------------------------------
AND INTEREST RATE MARGIN DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1996 1996 1996 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Average Initial Coupon Rate on Mortgage Acquisitions 7.81% 7.53% 7.30% 7.60%
New Acquisitions Last 6 Months/Total Mortgages 61% 68% 66% 58%
Mortgage Coupon Rate (All Mortgage Assets) 7.58% 7.52% 7.47% 7.73%
Amortized Cost/ Principal Value 101.41% 100.98% 99.95% 98.85%
Coupon Yield on Amortized Cost 7.48% 7.44% 7.48% 7.82%
Effect of Premium/Discount Amortization -0.59% -0.52% -0.56% -0.44%
Mortgage Yield 6.89% 6.92% 6.92% 7.38%
Cash Yield 5.31% 5.30% 5.61% 5.93%
Earning Asset Yield (Mortgages plus Cash) 6.87% 6.90% 6.90% 7.34%
Cost of Funds 5.76% 5.78% 5.57% 5.69%
Cost of Hedging (as % of Borrowings) 0.12% 0.14% 0.16% 0.14%
Interest Rate Spread 0.99% 0.98% 1.17% 1.51%
Net Interest Margin (Net Interest Income/Assets) 1.55% 1.58% 1.85% 2.17%
Net Interest Income/Average Equity 13.01% 12.40% 12.14% 14.92%
SELECTED OPERATING RATIOS AND RETURN ON EQUITY
Credit Provisions as a % of Assets 0.10% 0.18% 0.25% 0.26%
Credit Provisions as a % of Equity 0.81% 1.40% 1.62% 1.78%
Operating Expenses to Average Assets 0.21% 0.23% 0.31% 0.38%
Operating Expenses to Average Equity 1.72% 1.82% 2.02% 2.64%
Efficiency Ratio (Op Exp/Net Int Income) 13.23% 14.69% 16.63% 17.71%
Average Assets Per Employee ($MM) $ 155 $ 115 $ 84 $ 70
GAAP Return on Total Equity 10.48% 9.18% 8.50% 10.50%
GAAP Return on Common Equity 10.53% 9.06% 8.50% 10.50%
Taxable Income Return on Total Equity 11.75% 10.97% 10.69% 13.69%
Taxable Income Return on Common Equity 12.03% 11.06% 10.69% 13.69%
</TABLE>
50
<PAGE> 51
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 5 (CONTINUED)
EARNING ASSET YIELD, INTEREST RATE SPREAD FOR YEAR ENDING
------------------------------
AND INTEREST RATE MARGIN DEC. 31, DEC. 31, DEC. 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Average Initial Coupon Rate on Mortgage Acquisitions 7.60% 7.25% 5.87%
New Acquisitions Last 6 Months/Total Mortgages 61% 68% 101%
Mortgage Coupon Rate (All Mortgage Assets) 7.55% 7.16% 6.09%
Amortized Cost/ Principal Value 100.68% 99.02% 100.02%
Coupon Yield on Amortized Cost 7.50% 7.23% 6.09%
Effect of Premium/Discount Amortization -0.55% 0.17% 0.45%
Mortgage Yield 6.95% 7.40% 6.54%
Cash Yield 5.51% 5.43% 4.73%
Earning Asset Yield (Mortgages plus Cash) 6.93% 7.36% 6.33%
Cost of Funds 5.71% 6.06% 5.55%
Cost of Hedging (as % of Borrowings) 0.13% 0.19% 0.06%
Interest Rate Spread 1.09% 1.11% 0.72%
Net Interest Margin (Net Interest Income/Assets) 1.69% 2.17% 2.50%
Net Interest Income/Average Equity 12.90% 11.03% 7.27%
SELECTED OPERATING RATIOS AND RETURN ON EQUITY
Credit Provisions as a % of Assets 0.17% 0.22% 0.00%
Credit Provisions as a % of Equity 1.29% 1.14% 0.00%
Operating Expenses to Average Assets 0.26% 0.51% 0.69%
Operating Expenses to Average Equity 1.94% 2.61% 2.01%
Efficiency Ratio (Op Exp/Net Int Income) 15.08% 23.66% 27.73%
Average Assets Per Employee ($MM) $ 109 $ 39 $ 12
GAAP Return on Total Equity 9.66% 7.28% 5.25%
GAAP Return on Common Equity 9.61% 7.28% 5.25%
Taxable Income Return on Total Equity 11.55% 8.84% 4.86%
Taxable Income Return on Common Equity 11.68% 8.84% 4.86%
</TABLE>
51
<PAGE> 52
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 6 AT OR
AVERAGE DAILY BALANCE SHEET FOR THREE MONTHS ENDING
----------------------------------------------
(ALL DOLLARS IN THOUSANDS) SEP. 30, JUN. 30, MAR. 31,
1997 1997 1997
---- ---- ----
<S> <C> <C> <C>
Cash $ 35,647 $ 19,307 $ 12,147
Mortgage Loans 1,155,099 758,445 574,781
Mortgage Securities 2,136,442 2,111,832 1,658,629
Credit Reserve (3,873) (3,083) (2,394)
Interest Rate Agreements 11,943 11,185 6,899
Other Assets 85,689 75,928 58,856
- ------------ ---------- ---------- ----------
Total Assets 3,420,947 2,973,614 2,308,918
- ------------ ---------- ---------- ----------
Short-Term Borrowings 2,695,438 2,659,914 2,056,051
Long-Term Borrowings 355,028 0 0
Other Liabilties 24,714 20,530 15,691
- ---------------- ---------- ---------- ----------
Total Liabilities 3,075,180 2,680,444 2,071,742
- ----------------- ---------- ---------- ----------
Preferred Stock 26,733 28,946 29,545
Common Stock 321,492 265,561 208,426
Retained Earnings, after Dividend (2,458) (1,337) (795)
- --------------------------------- ---------- ---------- ----------
Stockholders' Equity 345,767 293,170 237,176
- -------------------- ---------- ---------- ----------
Market Valuation Account, Mortgage Assets $ 6,072 $ 1,914 $ 1,022
Market Valuation Account, Interest Rate Agreements (8,640) (4,576) (4,004)
- -------------------------------------------------- ---------- ---------- ----------
Market Valuation Account, Total $ (2,568) $ (2,662) $ (2,982)
ESTIMATED PERIOD-END BID-SIDE MARKET VALUE/REALIZABLE VALUE
Cash $ 57,696 $ 29,425 $ 12,985
Mortgage Loans 1,379,166 1,136,004 730,035
Mortgage Securities 2,059,595 2,227,389 1,874,679
Interest Rate Agreements 2,169 4,206 5,773
Other Assets 26,048 25,857 19,291
Short-Term Borrowings 2,639,773 3,102,784 2,373,279
Long-Term Borrowings 497,465 0 0
Other Liabilities 30,628 27,515 23,411
- ----------------- ---------- ---------- ----------
"Mark-To-Market" of Equity $ 356,808 $ 292,582 $ 246,073
BALANCE SHEET UTILIZATION DURING PERIOD VS RISK-ADJUSTED CAPITAL GUIDELINES
Actual Average Equity/Assets 10.1% 9.9% 10.3%
Average Risk-Adjusted Capital Guideline 9.0% 9.5% 10.1%
Balance Sheet Capacity Utilization 89% 96% 98%
Excess Capital and Asset Growth Potential At Period End
Ending Actual Equity/Assets 10.12% 8.55% 9.28%
Ending Risk-Adjusted Capital Guideline 8.59% 9.41% 10.09%
Excess Capital $ 54,038 $ (29,417) $ (21,504)
Asset Growth Potential (Same Asset Mix) $ 629,081 $ (312,637) $ (213,079)
Expanded Risk-Adjusted Capital Guideline 7.97% 8.55% 9.17%
Excess Capital vs. Expanded Guideline $ 85,518 $ (140) $ 3,015
Asset Growth Potential (Expanded Guideline) $ 954,032 $ (1,915) $ 29,398
</TABLE>
52
<PAGE> 53
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 6 (CONTINUED) AT OR
AVERAGE DAILY BALANCE SHEET FOR THREE MONTHS ENDING
-------------------------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1996 1996 1996 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Cash $ 16,137 $ 18,854 $ 14,402 $ 14,639
Mortgage Loans 143,368 93,991 45,313 25,279
Mortgage Securities 1,347,617 1,010,853 688,697 457,841
Credit Reserve (1,952) (1,491) (1,002) (594)
Interest Rate Agreements 4,681 3,185 2,737 2,503
Other Assets 41,430 30,129 21,566 13,094
- ------------ ----------- ----------- --------- ---------
Total Assets 1,551,281 1,155,521 771,713 512,762
- ------------ ----------- ----------- --------- ---------
Short-Term Borrowings 1,351,510 999,229 651,643 435,979
Long-Term Borrowings 0 0 0 0
Other Liabilities 14,898 8,728 2,472 2,324
- ---------------- ----------- ----------- --------- ---------
Total Liabilities 1,366,408 1,007,957 654,115 438,303
- ----------------- ----------- ----------- --------- ---------
Preferred Stock 29,671 15,179 0 0
Common Stock 156,594 132,924 117,695 73,998
Retained Earnings, after Dividend (1,392) (539) (97) 461
- --------------------------------- ----------- ----------- --------- ---------
Stockholders' Equity 184,873 147,564 117,598 74,459
- -------------------- ----------- ----------- --------- ---------
Market Valuation Account, Mortgage Assets $ 603 $ (2,279) $ (3,865) $ (3,880)
Market Valuation Account, Interest Rate
Agreements (3,513) (1,352) (1,080) (1,836)
- ----------------------------------------- ----------- ----------- --------- ---------
Market Valuation Account, Total $ (2,910) $ (3,631) $ (4,945) $ (5,716)
ESTIMATED PERIOD-END BID-SIDE MARKET VALUE/REALIZABLE VALUE
Cash $ 11,068 $ 14,599 $ 10,407 $ 9,705
Mortgage Loans 525,475 127,694 69,666 24,861
Mortgage Securities 1,627,953 1,248,176 937,814 540,298
Interest Rate Agreements 2,601 873 1,351 1,233
Other Assets 16,778 11,766 8,864 4,987
Short-Term Borrowings 1,953,103 1,225,094 896,214 508,721
Long-Term Borrowings 0 0 0 0
Other Liabilities 19,531 14,457 7,522 4,240
- ----------------- ----------- ----------- --------- ---------
"Mark-To-Market" of Equity $ 211,241 $ 163,557 $ 124,366 $ 68,123
BALANCE SHEET UTILIZATION DURING PERIOD VS. RISK-ADJUSTED CAPITAL GUIDELINES
Actual Average Equity/Assets 11.9% 12.8% 15.2% 14.5%
Average Risk-Adjusted Capital Guideline 10.2% 10.7% 11.4% 12.8%
Balance Sheet Capacity Utilization 86% 84% 75% 88%
Excess Capital and Asset Growth Potential
At Period End
Ending Actual Equity/Assets 9.66% 11.65% 12.09% 11.72%
Ending Risk-Adjusted Capital Guideline 9.97% 10.32% 10.77% 11.72%
Excess Capital $ (6,798) $ 18,664 $ 13,566 $ 26
Asset Growth Potential (Same Asset Mix) $ (68,169) $ 180,836 $ 125,972 $ 227
Expanded Risk-Adjusted Capital Guideline 9.07% n/a n/a n/a
Excess Capital vs. Expanded Guideline $ 14,302 n/a n/a n/a
Asset Growth Potential (Expanded Guideline) $ 143,434 n/a n/a n/a
</TABLE>
53
<PAGE> 54
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 6 (CONTINUED) AT OR
AVERAGE DAILY BALANCE SHEET FOR YEAR ENDING
-------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31, DEC. 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Cash $ 16,016 $ 4,272 $ 6,627
Mortgage Loans 77,215 5,006 0
Mortgage Securities 877,907 204,284 50,080
Credit Reserve (1,262) (92) 0
Interest Rate Agreements 3,280 2,039 759
Other Assets 26,606 5,107 948
- ------------ ----------- --------- ---------
Total Assets 999,762 220,616 58,414
- ------------ ----------- --------- ---------
Short-Term Borrowings 861,316 174,926 37,910
Long-Term Borrowings 0 0 0
Other Liabilities 7,131 2,343 367
- ---------------- ----------- --------- ---------
Total Liabilities 868,447 177,269 38,277
- ----------------- ----------- --------- ---------
Preferred Stock 11,274 0 0
Common Stock 120,436 43,391 20,941
Retained Earnings, after Dividend (395) (42) (804)
- --------------------------------- ----------- --------- ---------
Stockholders' Equity 131,315 43,349 20,137
- -------------------- ----------- --------- ---------
Market Valuation Account, Mortgage Assets $ (2,347) $ (78) $ (583)
Market Valuation Account, Interest Rate Agreements (1,948) (1,046) 31
- -------------------------------------------------- ----------- --------- ---------
Market Valuation Account, Total $ (4,295) $ (1,124) $ (552)
ESTIMATED PERIOD-END BID-SIDE MARKET VALUE/REALIZABLE VALUE
Cash $ 11,068 $ 4,825 $ 1,027
Mortgage Loans 525,475 26,450 0
Mortgage Securities 1,627,953 405,794 117,477
Interest Rate Agreements 2,601 547 1,892
Other Assets 16,778 3,671 888
Short-Term Borrowings 1,953,103 370,316 100,376
Long-Term Borrowings 0 0 0
Other Liabilities 19,531 2,829 872
- ----------------- ----------- --------- ---------
"Mark-To-Market" of Equity $ 211,241 $ 68,142 $ 20,036
BALANCE SHEET UTILIZATION DURING PERIOD VS RISK-ADJUSTED CAPITAL GUIDELINES
Actual Average Equity/Assets 13.1% 19.6% 34.5%
Average Risk-Adjusted Capital Guideline 10.9% 13.4% 10.6%
Balance Sheet Capacity Utilization 83% 68% 31%
Excess Capital and Asset Growth Potential At Period End
Ending Actual Equity/Assets 9.66% 15.47% 16.69%
Ending Risk-Adjusted Capital Guideline 9.97% 12.59% 10.84%
Excess Capital $ (6,798) $ 12,028 $ 6,716
Asset Growth Potential (Same Asset Mix) $ (68,176) $ 100,874 $ 65,519
Expanded Risk-Adjusted Capital Guideline 9.07% n/a n/a
Excess Capital vs. Expanded Guideline $ 14,302 n/a n/a
Asset Growth Potential (Expanded Guideline) $ 143,434 n/a n/a
</TABLE>
54
<PAGE> 55
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 7 AT OR
CREDIT PROVISIONS AND CREDIT RESERVES FOR THREE MONTHS ENDING
-------------------------------
(ALL DOLLARS IN THOUSANDS) SEP. 30, JUN. 30, MAR. 31,
1997 1997 1997
---- ---- ----
<S> <C> <C> <C>
MORTGAGE LOANS
Credit Provision During Period $ 473 $ 299 $ 215
Actual Losses During Period 40 0 13
Cumulative Actual Losses 53 13 13
Mortgage Loan Reserve End of Period 1,363 929 630
Annualized Credit Provision/ Ave. Mortgage Loans 0.16% 0.16% 0.15%
Mortgage Loan Reserve/Ending Mortgage Loans 0.10% 0.08% 0.09%
Non-Performing Assets: 90+ Days Delinquent, Foreclosures, Bankruptcies, and REO
Number of Loan 13 12 6
NPA Loan Balance $2,792 $2,366 $1,220
Non-Performing Assets as % of Mortgage Loans 0.2% 0.2% 0.2%
Non-Performing Assets as % of Total Assets 0.08% 0.07% 0.05%
Mortgage Loan Reserve as % of NPAs 49% 39% 52%
Credit Experience of Mortgage Loans
Liquidated Defaulted Loans (Cumulative) 4 1 1
Average Loss Severity Experience (Cumulative) 6% 7% 7%
Scenario Analysis of Potential Credit Losses Over Next 12 Months
If All Current (But No Future) Non-Performing Mortgage Loans Default:
At 10% Loss Severity $ 283 $ 241 $ 124
At 20% Loss Severity 567 481 248
At 30% Loss Severity 850 722 372
At 40% Loss Severity 1,133 962 496
MORTGAGE SECURITIES
Credit Provision During Period $ 470 $ 477 $ 480
Actual Losses During Period 28 29 29
Cumulative Actual Losses 97 69 40
Mortgage Securities Reserve End of Period 3,093 2,651 2,203
Annualized Credit Provision/Mtg. Sec. Rated < BBB 6.4% 6.6% 6.6%
Mortgage Loan Reserve/Ending Mtg. Sec. Rated < BBB 10.6% 9.1% 7.6%
Credit Experience of Loans in Pools Underlying Mtg Sec. Rated <BBB (Since Acquisition)
Resolved Defaulted Loans (Cumulative) 182 138 90
Average Loss Severity Experience (Cumulative) 23% 24% 25%
Scenario Analysis of Potential Credit Losses Over Next 12 Months If All Current
(But No Future) Seriously Delinquent Loans in Mortgage Pools Underlying
< BBB Rated Securities Default:
At 10% Loss Severity $ 724 $ 109 $ 80
At 20% Loss Severity 2,286 1,488 792
At 30% Loss Severity 3,789 3,702 2,845
At 40% Loss Severity 6,437 6,410 5,103
Average Monthly Mortgage Securities Credit Provision $ 157 $ 159 $ 160
Reserve in 12 Months at Provisioning Rate If No Losses 4,972 4,557 4,124
</TABLE>
55
<PAGE> 56
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 7 (CONTINUED) AT OR
CREDIT PROVISIONS AND CREDIT RESERVES FOR THREE MONTHS ENDING
---------------------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1996 1996 1996 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
MORTGAGE LOANS
Credit Provision During Period $ 35 $ 178 $ 140 $ (5)
Actual Losses During Period 0 0 0 0
Cumulative Actual Losses 0 0 0 0
Mortgage Loan Reserve End of Period 428 393 214 74
Annualized Credit Provision/ Ave. Mortgage Loans 0.10% 0.76% 1.23% -0.08%
Mortgage Loan Reserve/Ending Mortgage Loans 0.08% 0.31% 0.31% 0.30%
Non-Performing Assets: 90+ Days Delinquent, Foreclosures, Bankruptcies, and REO
Number of Loan 7 3 2 1
NPA Loan Balance $1,249 $ 404 $ 279 $ 190
Non-Performing Assets as % of Mortgage Loans 0.2% 0.3% 0.4% 0.8%
Non-Performing Assets as % of Total Assets 0.06% 0.03% 0.03% 0.03%
Mortgage Loan Reserve as % of NPAs 34% 97% 77% 39%
Credit Experience of Mortgage Loans
Liquidated Defaulted Loans (Cumulative) 0 0 0 0
Average Loss Severity Experience (Cumulative) 0% 0% 0% 0%
Scenario Analysis of Potential Credit Losses Over Next 12 Months
If All Current (But No Future) Non-Performing Mortgage Loans Default:
At 10% Loss Severity $ 127 $ 41 $ 28 $ 19
At 20% Loss Severity 253 82 56 39
At 30% Loss Severity 380 123 85 58
At 40% Loss Severity 506 164 113 77
MORTGAGE SECURITIES
Credit Provision During Period $ 337 $ 338 $ 337 $ 336
Actual Losses During Period 7 0 0 0
Cumulative Actual Losses 11 4 4 4
Mortgage Securities Reserve End of Period 1,752 1,422 1,084 747
Annualized Credit Provision/Mtg. Sec. Rated < BBB 4.7% 4.7% 4.7% 4.7%
Mortgage Loan Reserve/Ending Mtg. Sec. Rated < BBB 6.1% 4.9% 3.8% 2.7%
Credit Experience of Loans in Pools Underlying Mtg. Sec. Rated <BBB (Since Acquisition)
Resolved Defaulted Loans (Cumulative) 59 28 15 4
Average Loss Severity Experience (Cumulative) 27% 22% 16% 10%
Scenario Analysis of Potential Credit Losses Over Next 12 Months If All Current (But No Future)
Seriously Delinquent Loans in Mortgage Pools Underlying < BBB Rated Securities Default:
At 10% Loss Severity $ 63 $ 61 $ 40 $ 20
At 20% Loss Severity 608 123 91 39
At 30% Loss Severity 2,040 1,131 1,364 597
At 40% Loss Severity 3,647 3,041 3,148 2,162
Average Monthly Mortgage Securities Credit Provision $ 112 $ 113 $ 112 $ 112
Reserve in 12 Months at Provisioning Rate If No Losses 3,100 2,772 2,431 2,091
</TABLE>
56
<PAGE> 57
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 7 (CONTINUED) AT OR
CREDIT PROVISIONS AND CREDIT RESERVES FOR YEAR ENDING
-------------------------------
(ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31, DEC. 31,
1996 1995 1994
------ ------ --
<S> <C> <C> <C>
MORTGAGE LOANS
Credit Provision During Period $ 349 $ 79 $0
Actual Losses During Period 0 0 0
Cumulative Actual Losses 0 0 0
Mortgage Loan Reserve End of Period 428 79 0
Annualized Credit Provision/ Ave. Mortgage Loans 0.45% 1.58% n/a
Mortgage Loan Reserve/Ending Mortgage Loans 0.08% 0.30% n/a
Non-Performing Assets: 90+ Days Delinquent, Foreclosures, Bankruptcies, and REO
Number of Loan 7 0 0
NPA Loan Balance $1,249 $ 0 $0
Non-Performing Assets as % of Mortgage Loans 0.2% 0.0% 0.0%
Non-Performing Assets as % of Total Assets 0.06% 0.00% 0.00%
Mortgage Loan Reserve as % of NPAs 34% n/a n/a
Credit Experience of Mortgage Loans
Liquidated Defaulted Loans (Cumulative) 0 0 0
Average Loss Severity Experience (Cumulative) 0% 0% 0%
Scenario Analysis of Potential Credit Losses Over Next 12 Months
If All Current (But No Future) Non-Performing Mortgage Loans Default:
At 10% Loss Severity $ 127 $ 0 $0
At 20% Loss Severity 253 0 0
At 30% Loss Severity 380 0 0
At 40% Loss Severity 506 0 0
MORTGAGE SECURITIES
Credit Provision During Period $1,348 $ 414 $0
Actual Losses During Period 7 4 0
Cumulative Actual Losses 11 4 0
Mortgage Securities Reserve End of Period 1,752 411 0
Annualized Credit Provision/Mtg. Sec. Rated < BBB 4.7% 2.6% 0.0%
Mortgage Loan Reserve/Ending Mtg. Sec. Rated < BBB 6.1% 1.4% 0.0%
Credit Experience of Loans in Pools Underlying Mtg. Sec. Rated <BBB (Since Acquisition)
Resolved Defaulted Loans (Cumulative) 59 2 0
Average Loss Severity Experience (Cumulative) 27% 9% 0%
Scenario Analysis of Potential Credit Losses Over Next 12 Months If All Current (But No Future)
Seriously Delinquent Loans in Mortgage Pools Underlying < BBB Rated Securities Default:
At 10% Loss Severity $ 63 $ 15 $0
At 20% Loss Severity 608 29 0
At 30% Loss Severity 2,040 103 0
At 40% Loss Severity 3,647 768 0
Average Monthly Mortgage Securities Credit Provision $ 112 $ 90 $0
Reserve in 12 Months at Provisioning Rate If No Losses 3,100 1,495 0
</TABLE>
57
<PAGE> 58
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 8 AT OR
SHARES OUTSTANDING AND PER SHARE DATA FOR THREE MONTHS ENDING
---------------------------------------------
(ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) SEP. 30, JUN. 30, MAR. 31,
1997 1997 1997
---- ---- ----
<S> <C> <C> <C>
Shares Outstanding and Receiving Dividends at Period End
- --------------------------------------------------------
Common (RWTI) 14,576,477 13,251,847 11,905,957
Class A Preferred (converted 9/95) 0 0 0
Class B Preferred (RWTIP) 909,518 909,518 999,638
- ------------------------- ----------- ----------- -----------
Total 15,485,995 14,161,365 12,905,595
Common Dividend Declared $ 0.60 $ 0.60 $ 0.60
Class A Preferred Dividend Declared $ 0.00 $ 0.00 $ 0.00
Class B Preferred Dividends Declared $ 0.755 $ 0.755 $ 0.755
Common Dividend Total $ 8,746 $ 7,951 $ 7,144
Class A Preferred Dividend Total 0 0 0
Class B Preferred Dividends Total 687 687 755
- --------------------------------- ----------- ----------- -----------
Total Dividend $ 9,433 $ 8,638 $ 7,899
Taxable Income Earned $ 8,151 $ 8,315 $ 7,912
Dividend Pay-Out Ratio for Period 115.7% 103.9% 99.8%
Cumulative Dividend Pay-Out Ratio 102.7% 99.7% 98.5%
Warrants Outstanding at Period End (RWTIW) 149,466 236,297 272,304
Average Shares Outstanding During Period
- ----------------------------------------
Common 14,316,678 12,997,566 11,605,171
Class A Preferred 0 0 0
Class B Preferred 909,518 990,725 1,005,515
- ----------------- ----------- ----------- -----------
Total 15,226,196 13,988,291 12,610,686
Calculation of "Primary" Common Shares
- --------------------------------------
Average Common Shares 14,316,678 12,997,566 11,605,171
Potential Dilution Due to Warrants 130,489 182,137 258,422
Potential Dilution Due to Options 177,434 291,227 253,274
- --------------------------------- ----------- ----------- -----------
Total Average Primary Common Shares 14,624,601 13,470,930 12,116,867
Net Income to Common Shareholders $ 6,859 $ 7,034 $ 6,456
Total Average Primary Common Shares 14,624,601 13,470,930 12,116,867
- ----------------------------------- ----------- ----------- -----------
Earnings Per Share (EPS) $ 0.47 $ 0.52 $ 0.53
EPS (Outstanding Common Shares Only) $ 0.48 $ 0.54 $ 0.56
Per Share Ratios (Average Outstanding Common and Preferred Shares)
- ------------------------------------------------------------------
Average Total Assets $ 224.68 $ 212.58 $ 183.09
Average Total Equity $ 22.71 $ 20.96 $ 18.81
Net Interest Income $ 0.63 $ 0.70 $ 0.72
Credit Expenses $ 0.06 $ 0.06 $ 0.06
Operating Expenses $ 0.07 $ 0.09 $ 0.09
Gain/(Loss) on Sale $ 0.00 $ 0.00 $ 0.00
Net Income $ 0.50 $ 0.55 $ 0.57
</TABLE>
58
<PAGE> 59
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 8 (CONTINUED) AT OR
SHARES OUTSTANDING AND PER SHARE DATA FOR THREE MONTHS ENDING
------------------------------------------------------------
(ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUMTS) DEC. 31, SEP. 30, JUN. 30, MAR. 31,
1996 1996 1996 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Shares Outstanding and Receiving Dividends at Period End
- --------------------------------------------------------
Common (RWTI) 10,996,572 9,069,653 8,520,116 5,521,376
Class A Preferred (converted 9/95) 0 0 0 0
Class B Preferred (RWTIP) 1,006,250 1,006,250 0 0
- ------------------------- ----------- ----------- ---------- ----------
Total 12,002,822 10,075,903 8,520,116 5,521,376
Common Dividend Declared $ 0.41 $ 0.40 $ 0.40 $ 0.46
Class A Preferred Dividend Declared $ 0.00 $ 0.00 $ 0.00 $ 0.00
Class B Preferred Dividends Declared $ 0.755 $ 0.386 $ 0.00 $ 0.00
Common Dividend Total $ 4,508 $ 3,628 $ 3,408 $ 2,540
Class A Preferred Dividend Total 0 0 0 0
Class B Preferred Dividends Total 760 388 0 0
- --------------------------------- ----------- ----------- ---------- ----------
Total Dividend $ 5,268 $ 4,016 $ 3,408 $ 2,540
Taxable Income Earned $ 5,429 $ 4,048 $ 3,142 $ 2,549
Dividend Pay-Out Ratio for Period 97.0% 99.2% 108.5% 99.7%
Cumulative Dividend Pay-Out Ratio 97.9% 98.3% 97.9% 93.0%
Warrants Outstanding at Period End (RWTIW) 412,894 1,076,431 1,563,957 1,665,063
Average Shares Outstanding During Period
- ----------------------------------------
Common 9,705,138 8,732,326 7,813,974 5,521,376
Class A Preferred 0 0 0 0
Class B Preferred 1,006,250 514,063 0 0
- ----------------- ----------- ----------- ---------- ----------
Total 10,711,388 9,246,389 7,813,974 5,521,376
Calculation of "Primary" Common Shares
- --------------------------------------
Average Common Shares 9,705,138 8,732,326 7,813,974 5,521,376
Potential Dilution Due to Warrants 570,415 621,455 603,426 443,984
Potential Dilution Due to Options 176,919 162,393 182,832 164,227
- --------------------------------- ----------- ----------- ---------- ----------
Total Average Primary Common Shares 10,452,472 9,516,174 8,600,232 6,129,587
Net Income to Common Shareholders $ 4,084 $ 2,999 $ 2,500 $ 1,954
Total Average Primary Common Shares 10,452,472 9,516,174 8,600,232 6,129,587
- ----------------------------------- ----------- ----------- ---------- ----------
Earnings Per Share (EPS) $ 0.39 $ 0.32 $ 0.29 $ 0.32
EPS (Outstanding Common Shares Only) $ 0.42 $ 0.34 $ 0.32 $ 0.35
Per Share Ratios (Average Outstanding Common and Preferred Shares)
- ------------------------------------------------------------------
Average Total Assets $ 144.83 $ 124.97 $ 98.76 $ 92.87
Average Total Equity $ 17.26 $ 15.96 $ 15.05 $ 13.49
Net Interest Income $ 0.55 $ 0.50 $ 0.45 $ 0.50
Credit Expenses $ 0.03 $ 0.06 $ 0.06 $ 0.06
Operating Expenses $ 0.07 $ 0.07 $ 0.07 $ 0.09
Gain/(Loss) on Sale $ 0.00 $ 0.00 $ 0.00 $ 0.00
Net Income $ 0.45 $ 0.37 $ 0.32 $ 0.35
</TABLE>
59
<PAGE> 60
SUPPLEMENTAL HISTORICAL INFORMATION
<TABLE>
<CAPTION>
TABLE 8 (CONTINUED) AT OR
SHARES OUTSTANDING AND PER SHARE DATA FOR YEAR ENDING
---------------------------------------------
(ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) DEC. 31, DEC. 31, DEC. 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Shares Outstanding and Receiving Dividends at Period End
- --------------------------------------------------------
Common (RWTI) 10,996,572 5,517,299 208,332
Class A Preferred (converted 9/95) 0 0 1,666,063
Class B Preferred (RWTIP) 1,006,250 0 0
- ------------------------- ----------- ---------- ----------
Total 12,002,822 5,517,299 1,874,395
Common Dividend Declared $ 1.67 $ 0.46 $ 0.00
Class A Preferred Dividend Declared $ 0.00 $ 0.50 $ 0.25
Class B Preferred Dividends Declared $ 1.141 $ 0.000 $ 0.000
Common Dividend Total $ 14,084 $ 2,537 $ 0
Class A Preferred Dividend Total 0 833 350
Class B Preferred Dividends Total 1,148 0 0
- --------------------------------- ----------- ---------- ----------
Total Dividend $ 15,232 $ 3,370 $ 350
Taxable Income Earned $ 15,168 $ 3,832 $ 353
Dividend Pay-Out Ratio for Period 100.4% 88.0% 99.2%
Cumulative Dividend Pay-Out Ratio 97.9% 88.9% 99.2%
Warrants Outstanding at Period End (RWTIW) 412,894 1,665,063 1,666,063
Average Shares Outstanding During Period
- ----------------------------------------
Common 7,950,175 2,487,857 208,332
Class A Preferred 0 826,185 1,467,748
Class B Preferred 382,155 0 0
- ----------------- ----------- ---------- ----------
Total 8,332,330 3,314,042 1,676,080
Calculation of "Primary" Common Shares
- --------------------------------------
Average Common Shares 7,950,175 3,314,042 1,676,080
Potential Dilution Due to Warrants 618,618 221,112 240,766
Potential Dilution Due to Options 175,391 168,649 0
- --------------------------------- ----------- ---------- ----------
Total Average Primary Common Shares 8,744,184 3,703,803 1,916,846
Net Income to Common Shareholders $ 11,537 $ 3,155 $ 382
Total Average Primary Common Shares 8,744,184 3,703,803 1,916,846
- ----------------------------------- ----------- ---------- ----------
Earnings Per Share (EPS) $ 1.32 $ 0.85 $ 0.20
EPS (Outstanding Common Shares Only) $ 1.45 $ 0.95 $ 0.23
Per Share Ratios (Average Outstanding Common and Preferred Shares)
- ------------------------------------------------------------------
Average Total Assets $ 119.99 $ 66.57 $ 34.85
Average Total Equity $ 15.76 $ 13.08 $ 12.01
Net Interest Income $ 2.03 $ 1.44 $ 0.32
Credit Expenses $ 0.20 $ 0.15 $ 0.00
Operating Expenses $ 0.31 $ 0.34 $ 0.09
Gain/(Loss) on Sale $ 0.00 $ 0.00 $ 0.00
Net Income $ 1.52 $ 0.95 $ 0.23
</TABLE>
60
<PAGE> 61
PART II OTHER INFORMATION
Item 1. Legal Proceedings
At September 30, 1997, there were no pending legal proceedings to which
the Company as a party or of which any of its property was subject.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 4.4 - Indenture dated as of June 1, 1997 between Sequoia
Mortgage Trust 1 (a wholly-owned, consolidated subsidiary of the
Company) and First Union National Bank, as Trustee. (Incorporated
by reference to the Form 8-K filed by Sequoia Mortgage Funding
Corporation on August 12, 1997).
Exhibit 11.1 to Part I - Computation of Earnings Per Share for
the three and nine months ended September 30, 1997 and September
30, 1996.
Exhibit 27 - Financial Data Schedule.
(b) Reports
No filings on Form 8-K were made.
61
<PAGE> 62
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
REDWOOD TRUST, INC.
Dated: November 10, 1997 By: /s/ Douglas B. Hansen
----------------------------------------
Douglas B. Hansen
President and Chief Financial Officer
(authorized officer of registrant)
Dated: November 10, 1997 By: /s/ Vickie L. Rath
----------------------------------------
Vickie L. Rath
Vice President, Treasurer and Controller
(principal accounting officer)
62
<PAGE> 63
REDWOOD TRUST, INC.
INDEX TO EXHIBIT
<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Page
------- ------------
<S> <C> <C>
11.1 Computation of Earnings per Share................. 64
27 Financial Data Schedule........................... 66
</TABLE>
63
<PAGE> 1
EXHIBIT 11.1
REDWOOD TRUST, INC.
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, 1997 September 30, 1997
------------------ ------------------
<S> <C> <C>
PRIMARY:
Average common shares outstanding .................. 14,316,678 12,983,071
Net effect of dilutive stock options outstanding
during the period -- based on the treasury
stock method ................................... 177,434 243,410
Net effect of dilutive stock warrants outstanding
during the period -- based on the treasury
stock method ................................... 130,489 189,551
----------- -----------
Total ........................................ 14,624,601 13,416,032
=========== ===========
Net Income ......................................... $ 6,859,361 $20,349,907
=========== ===========
Per Share Amount ................................... $0.47 $1.52
=========== ===========
FULLY DILUTED:
Average common shares outstanding .................. 14,316,678 12,983,071
Net effect of dilutive stock options outstanding
during the period -- based on the treasury
stock method ................................... 177,434 243,410
Net effect of dilutive stock warrants outstanding
during the period -- based on the treasury
stock method ................................... 130,489 189,551
----------- -----------
Total ........................................ 14,624,601 13,416,032
=========== ===========
Net Income ......................................... $ 6,859,361 $20,349,907
=========== ===========
Per Share Amount ................................... $0.47 $1.52
=========== ===========
</TABLE>
64
<PAGE> 2
EXHIBIT 11.1
REDWOOD TRUST, INC.
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, 1996 September 30, 1996
------------------ ------------------
<S> <C> <C>
PRIMARY:
Average common shares outstanding............................ 8,732,326 7,360,916
Net effect of dilutive stock options outstanding
during the period -- based on the treasury stock method.. 162,393 186,576
Net effect of dilutive stock warrants outstanding
during the period -- based on the treasury stock method.. 621,455 699,324
--------- ----------
Total 9,516,174 8,246,815
========= ==========
Net Income $2,999,205 $7,453,284
========== ==========
Per Share Amount $0.32 $0.90
========== ==========
FULLY DILUTED:
Average common shares outstanding............................ 8,732,326 7,360,916
Net effect of dilutive stock options outstanding
during the period -- based on the treasury stock method.. 180,891 204,202
Net effect of dilutive stock warrants outstanding
during the period -- based on the treasury stock method.. 744,178 837,425
---------- ----------
Total 9,657,395 8,402,542
========== ==========
Net Income $2,999,205 $7,453,284
========== ==========
Per Share Amount $0.31 $0.89
========== ==========
</TABLE>
65
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEPTEMBER
30, 1997 QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 57,696
<SECURITIES> 3,440,849
<RECEIVABLES> 23,859
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 3,525,252
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 3,525,252
<CURRENT-LIABILITIES> 2,639,773
<BONDS> 497,367
0
26,733
<COMMON> 333,987
<OTHER-SE> (4,386)
<TOTAL-LIABILITY-AND-EQUITY> 3,525,252
<SALES> 0
<TOTAL-REVENUES> 56,718
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 2,341
<LOSS-PROVISION> 943
<INTEREST-EXPENSE> 45,888
<INCOME-PRETAX> 7,546
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,546
<EPS-PRIMARY> 0.47
<EPS-DILUTED> 0.47
</TABLE>
