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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: JUNE 30, 1999
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 ($.01 par value) 909,518 as of August 10, 1999
Common Stock ($.01 par value) 9,408,617 as of August 10, 1999
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REDWOOD TRUST, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
Page
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<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements - Redwood Trust, Inc
Consolidated Balance Sheets at June 30, 1999 and December 31, 1998 ............... 3
Consolidated Statements of Operations for the three and
six months ended June 30, 1999 and June 30, 1998 ................................. 4
Consolidated Statements of Stockholders' Equity for
the three and six months ended June 30, 1999 ..................................... 5
Consolidated Statements of Cash Flows for the three
and six months ended June 30, 1999 and June 30, 1998 ............................. 6
Notes to Consolidated Financial Statements ....................................... 7
Consolidated Financial Statements - RWT Holdings, Inc.
Consolidated Balance Sheets at June 30, 1999 and December 31, 1998................21
Consolidated Statements of Operations for the three
months ended June 30, 1999 and 1998 and for the six
months ended June 30, 1999 and for the period from
April 1, 1998 to June 30, 1998 ...................................................22
Consolidated Statements of Stockholders' Equity for
the three and six months ended June 30, 1999......................................23
Consolidated Statements of Cash Flows for the three
months ended June 30, 1999 and 1998 and for the six
months ended June 30, 1999 and for the period from
April 1, 1998 to June 30, 1998 ...................................................24
Notes to Consolidated Financial Statements........................................25
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.........................................30
PART II OTHER INFORMATION
Item 1. Legal Proceedings.....................................................................45
Item 2. Changes in Securities.................................................................45
Item 3. Defaults Upon Senior Securities.......................................................45
Item 4. Submission of Matters to a Vote of Security Holders...................................45
Item 5. Other Information.....................................................................46
Item 6. Exhibits and Reports on Form 8-K......................................................46
SIGNATURES ....................................................................................47
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
----------- -----------
ASSETS (Unaudited)
<S> <C> <C>
Mortgage loans: held-for-sale
Residential $ 67,452 $ 265,914
Commercial 19,614 8,287
----------- -----------
87,066 274,201
----------- -----------
Mortgage loans: held-for-investment, net
Residential 1,089,778 1,131,300
----------- -----------
1,089,778 1,131,300
----------- -----------
Mortgage securities: trading 941,618 1,257,655
Mortgage securities: available-for-sale, net 7,937 7,707
U.S. Treasury securities -- 48,009
Cash and cash equivalents 66,502 55,627
Restricted cash 8,547 12,857
Interest rate agreements 2,697 2,517
Accrued interest receivable 12,952 18,482
Investment in RWT Holdings, Inc. 18,782 15,124
Loan to RWT Holdings, Inc. 2,000 6,500
Receivable from RWT Holdings, Inc. 209 445
Other assets 2,013 2,024
----------- -----------
$ 2,240,101 $ 2,832,448
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt $ 922,745 $ 1,257,570
Long-term debt, net 1,066,976 1,305,560
Accrued interest payable 5,286 10,820
Accrued expenses and other liabilities 2,833 3,022
Dividends payable 687 686
----------- -----------
1,998,527 2,577,658
----------- -----------
Commitments and contingencies (See Note 13)
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01 per share;
Class B 9.74% Cumulative Convertible
909,518 shares authorized, issued and outstanding
($28,882 aggregate liquidation preference) 26,736 26,736
Common stock, par value $0.01 per share;
49,090,482 shares authorized;
9,929,717 and 11,251,556 issued and outstanding 99 113
Additional paid-in capital 259,184 279,201
Accumulated other comprehensive income (1,918) (370)
Cumulative earnings 16,149 6,412
Cumulative distributions to stockholders (58,676) (57,302)
----------- -----------
241,574 254,790
----------- -----------
$ 2,240,101 $ 2,832,448
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
3
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REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
INTEREST INCOME
Mortgage loans: held-for-sale
Residential $ 1,427 $ -- $ 5,714 $ --
Commercial 293 -- 369 --
1,720 -- 6,083 --
------------ ------------ ------------ ------------
Mortgage loans: held-for-investment
Residential 16,545 29,905 32,830 55,715
------------ ------------ ------------ ------------
16,545 29,905 32,830 55,715
Mortgage securities: trading 16,090 -- 35,064 --
Mortgage securities: available-for-sale 859 23,423 1,662 51,090
U.S. Treasury securities 380 -- 913 --
Cash and cash equivalents 497 455 1,270 839
------------ ------------ ------------ ------------
Total interest income 36,091 53,783 77,822 107,644
------------ ------------ ------------ ------------
INTEREST EXPENSE
Short-term debt (11,880) (33,282) (26,630) (61,285)
Long-term debt (16,657) (16,887) (35,398) (34,981)
------------ ------------ ------------ ------------
Total interest expense (28,537) (50,169) (62,028) (96,266)
------------ ------------ ------------ ------------
Net interest rate agreements expense (737) (1,624) (1,070) (3,002)
------------ ------------ ------------ ------------
NET INTEREST INCOME 6,817 1,990 14,724 8,376
Net unrealized and realized gains (losses) on assets 1,413 -- 3,582 (723)
Provision for credit losses (371) (763) (716) (1,364)
Equity in earnings (losses) of RWT Holdings, Inc. (3,757) (581) (6,241) (581)
Operating expenses (939) (589) (1,653) (2,514)
Other income 33 139 41 139
------------ ------------ ------------ ------------
NET INCOME (LOSS) 3,196 196 9,737 3,333
Cash dividends on Class B preferred stock (687) (687) (1,374) (1,374)
------------ ------------ ------------ ------------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $ 2,509 $ (491) $ 8,363 $ 1,959
============ ============ ============ ============
EARNINGS PER SHARE:
Basic $ 0.25 $ (0.03) $ 0.80 $ 0.14
Diluted $ 0.25 $ (0.03) $ 0.79 $ 0.14
Weighted average shares of common stock and
common stock equivalents:
Basic 10,051,565 14,106,828 10,412,855 14,115,342
Diluted 10,172,960 14,255,858 10,523,329 14,368,616
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
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REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
(Unaudited)
<TABLE>
<CAPTION>
Class B Accumulated
Preferred stock Common stock Additional other Cumulative
------------------------------------ paid-in comprehensive Cumulative distributions
Shares Amount Shares Amount capital income earnings to stockholders Total
Balance, December 31, 1998 909,518 $26,736 11,251,556 $ 113 $ 279,201 $ (370) $ 6,412 $(57,302) $ 254,790
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Comprehensive income:
Income before
preferred dividend -- -- -- -- -- -- 6,541 -- 6,541
Net unrealized loss on
assets available-for-sale -- -- -- -- -- (412) -- -- (412)
---------
Total comprehensive income -- -- -- -- -- -- -- -- 6,129
Issuance of common stock -- -- 12,361 -- 1 -- -- -- 1
Repurchase of common stock -- -- (1,077,600) (11) (16,024) -- -- -- (16,035)
Dividends declared:
Preferred -- -- -- -- -- -- -- (687) (687)
Common -- -- -- -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, March 31, 1999 909,518 26,736 10,186,317 102 263,178 (782) 12,953 (57,989) 244,198
- ------------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Income before
preferred dividend -- -- -- -- -- -- 3,196 -- 3,196
Net unrealized loss on
assets available-for-sale -- -- -- -- -- (1,136) -- -- (1,136)
---------
Total comprehensive income -- -- -- -- -- -- -- -- 2,060
Repurchase of common stock -- -- (256,600) (3) (3,994) -- -- -- (3,997)
Dividends declared:
Preferred -- -- -- -- -- -- -- (687) (687)
Common -- -- -- -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1999 909,518 $26,736 9,929,717 $ 99 $ 259,184 $(1,918) $16,149 $(58,676) $ 241,574
====================================================================================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
5
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REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) available to common stockholders $ 2,509 $ (491) $ 8,363 $ 1,959
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,868 12,715 4,389 22,425
Provision for credit losses 371 763 716 1,364
Equity in (earnings) losses of RWT Holdings, Inc. 3,757 581 6,241 581
Net unrealized and realized (gains) losses on assets (1,413) -- (3,582) 723
Purchases of mortgage loans: held-for-sale (65,343) -- (71,755) --
Proceeds from sales of mortgage loans: held-for-sale 7,509 -- 50,138 --
Principal payments on mortgage loans: held-for-sale 19,990 -- 55,239 --
Purchases of mortgage securities: trading (3,725) -- (3,725) --
Proceeds from sales of mortgage securities: trading 7,668 -- 7,668 --
Principal payments on mortgage securities: trading 146,019 -- 315,001 --
Purchases of U.S. Treasury securities -- -- (45,844) --
Proceeds from sales of U.S. Treasury securities 32,077 -- 90,519 --
Purchases of interest rate agreements (224) -- (633) --
Proceeds from sales of interest rate agreements 1,121 -- 1,121 --
Decrease in accrued interest receivable 2,460 2,332 5,530 1,565
(Increase) decrease in other assets 906 (2,235) (81) (3,006)
Increase (decrease) in accrued interest payable (409) 1,463 (5,534) (801)
Increase (decrease) in accrued expenses and other liabilities 1,222 395 (189) 20
--------- --------- --------- ---------
Net cash provided by operating activities 156,363 15,523 413,582 24,830
--------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of mortgage loans: held-for-investment -- (525,510) -- (967,472)
Principal payments on mortgage loans: held-for-investment 84,487 169,766 191,849 288,472
Purchases of mortgage securities: available-for-sale (934) (69,326) (934) (231,167)
Proceeds from sales of mortgage securities: available-for-sale -- -- -- 9,296
Principal payments on mortgage securities: available-for-sale 72 255,526 130 442,931
Purchases of interest rate agreements -- (1,127) -- (2,024)
Net decrease in restricted cash 2,944 4,174 4,310 3,097
Investment in RWT Holdings, Inc., net of dividends received (9,900) -- (9,900) (9,900)
Repayments from RWT Holdings, Inc. 11,700 -- 4,500 --
(Increase) decrease in receivable from RWT Holdings, Inc. (67) (831) 236 (831)
--------- --------- --------- ---------
Net cash provided by (used in) investing activities 88,302 (167,328) 190,191 (467,598)
--------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of (repayments on) short-term debt (110,897) (351,860) (334,825) 21,633
Proceeds (costs) from issuance of long-term debt (337) 635,193 (337) 635,193
Repayments on long-term debt (103,570) (123,238) (237,706) (214,918)
Net proceeds from issuance of common stock -- 1,588 1 1,588
Repurchases of common stock (3,997) (1,183) (20,032) (5,458)
Increase in dividends payable - preferred -- -- 1 --
Dividends paid on common stock -- (3,809) -- (8,808)
--------- --------- --------- ---------
Net cash provided by (used in) financing activities (218,801) 156,691 (592,898) 429,230
--------- --------- --------- ---------
Net increase (decrease) in cash and cash equivalents 25,864 4,886 10,875 (13,538)
Cash and cash equivalents at beginning of period 40,638 6,468 55,627 24,892
--------- --------- --------- ---------
Cash and cash equivalents at end of period $ 66,502 $ 11,354 $ 66,502 $ 11,354
========= ========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 28,946 $ 48,818 $ 67,562 $ 97,237
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
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REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
NOTE 1. THE COMPANY
Redwood Trust, Inc. ("Redwood Trust") was incorporated in Maryland on April 11,
1994 and commenced operations on August 19, 1994. During 1997, Redwood Trust
formed Sequoia Mortgage Funding Corporation ("Sequoia"), a special-purpose
finance subsidiary. Redwood Trust acquired an equity interest in RWT Holdings,
Inc. ("Holdings"), a taxable affiliate of Redwood Trust, during the first
quarter of 1998. For financial reporting purposes, references to the "Company"
mean Redwood Trust, Sequoia and Redwood Trust's equity interest in Holdings.
Redwood Trust, together with its affiliates, is a finance company specializing
in 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"). Its
primary activity is the financing of high quality residential mortgage loans
with funds raised through long-term debt issuance. The Company also finances
commercial mortgage loans and residential mortgage securities. Through its
affiliate operations, the Company is developing its ability to create mortgage
assets of significant value for its own portfolio and for sale to institutional
mortgage investors.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Redwood Trust and
Sequoia. Substantially all of the assets of Sequoia are pledged or subordinated
to support long-term debt in the form of collateralized mortgage bonds
("Long-Term Debt") and are not available for the satisfaction of general claims
of the Company. The Company's exposure to loss on the assets pledged as
collateral is limited to its net investment, as the Long-Term Debt is
non-recourse to the Company. All significant inter-company balances and
transactions with Sequoia have been eliminated in the consolidation of the
Company. Certain amounts for prior periods have been reclassified to conform to
the 1998 presentation.
During March 1998, the Company acquired an equity interest in Holdings, which
originates, acquires, accumulates, services and sells residential and commercial
Mortgage Loans. The Company owns all of the preferred stock and has a
non-voting, 99% economic interest in Holdings. As the Company does not own the
voting common stock of Holdings or control Holdings, its investment in Holdings
is accounted for under the equity method. Under this method, original equity
investments in Holdings are recorded at cost and adjusted by the Company's share
of earnings or losses and decreased by dividends received.
USE OF ESTIMATES
The preparation of financial statements in conformity with Generally Accepted
Accounting Principles requires management to make estimates and assumptions that
affect the reported amounts of certain assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of certain revenues and expenses during the reported
period. Actual results could differ from those estimates. The primary estimates
inherent in the accompanying consolidated financial statements are discussed
below.
Fair Value. Management estimates the fair value of its financial instruments
using available market information and other appropriate valuation
methodologies. The fair value of a financial instrument, as defined by Statement
of Financial Accounting Standards ("SFAS") No. 107, Disclosures about Fair Value
of Financial Instruments, is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation sale. Management's estimates are inherently subjective in
nature and involve matters of uncertainty and judgement to interpret relevant
market and other data. Accordingly, amounts realized in actual sales may differ
from the fair values presented in Notes 3, 7 and 10.
7
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Reserve for Credit Losses. A reserve for credit losses is maintained at a level
deemed appropriate by management to provide for known, future losses as well as
potential losses inherent in its Mortgage Asset portfolio. The reserve 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 reserve for credit losses, the Company's
credit exposure is considered based on its credit risk position in the mortgage
pool. These estimates are reviewed periodically and, as adjustments become
necessary, they are reported in earnings in the periods in which they become
known. The reserve is increased by provisions, which are charged to income from
operations. When a loan or portions of a loan are determined to be
uncollectible, the portion deemed uncollectible is charged against the reserve
and subsequent recoveries, if any, are credited to the reserve. The Company's
actual credit losses may differ from those estimates used to establish the
reserve. Summary information regarding the Reserve for Credit Losses is
presented in Note 4.
ADOPTION OF SFAS NO. 133
The Company adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, effective July 1, 1998. In accordance with the transition
provisions of SFAS No. 133, the Company recorded a net-of-tax
cumulative-effect-type transition adjustment of $10.1 million (loss) in earnings
to recognize at fair value the ineffective portion of all interest rate
agreements that were previously designated as part of a hedging relationship.
The Company, upon its adoption of SFAS No. 133, also reclassified $1.53 billion
of mortgage securities from available-for-sale to trading. This reclassification
resulted in an $11.9 million reclassification loss adjustment, which was
transferred from other comprehensive income to current earnings effective July
1, 1998. Under the provisions of SFAS No. 133, such a reclassification does not
call into question the Company's intent to hold current or future debt
securities to their maturity. Immediately after the adoption of SFAS No. 133 and
the reclassification, the Company elected to not seek hedge accounting for any
of the Company's interest rate agreements.
MORTGAGE ASSETS
The Company's Mortgage Assets consist of Mortgage Loans and Mortgage Securities.
Interest is recognized as revenue when earned according to the terms of the
loans and when, in the opinion of management, it is collectible. Discounts and
premiums relating to Mortgage Assets are amortized into interest income over the
lives of the Mortgage Assets using methods that approximate the effective yield
method. Gains or losses on the sale of Mortgage Assets are based on the specific
identification method.
Mortgage Loans: Held-for-Sale
Effective September 30, 1998, the Company elected to reclassify certain
short-funded Mortgage Loans from held-for-investment to held-for-sale. These
Mortgage Loans are carried at the lower of cost or aggregate market value
("LOCOM"). Realized and unrealized gains and losses on these loans are
recognized in "Net unrealized and realized gains (losses) on assets" on the
Consolidated Statements of Operations.
Some of the Mortgage Loans purchased by the Company for which securitization or
sale is contemplated are committed for sale by the Company to Holdings, or a
subsidiary of Holdings, under a Master Forward Commitment Agreement. As the
forward commitment is entered into on the same date that the Company commits to
purchase the loans, the price under the forward commitment is the same as the
price that the Company paid for the Mortgage Loans, as established by the
external market. Fair value is therefore equal to the commitment price, which is
the carrying value of the Mortgage Loans. Accordingly, no gain or loss is
recognized on the subsequent sales of these Mortgage Loans to Holdings or
subsidiaries of Holdings.
Mortgage Loans: Held-for-Investment
Mortgage Loans held-for-investment are carried at their unpaid principal balance
adjusted for net unamortized premiums or discounts, and net of the related
allowance for credit losses.
Mortgage Securities: Trading
Effective July 1, 1998, concurrent with the adoption of SFAS No. 133, the
Company elected to reclassify all of its short-funded Mortgage Securities from
available-for-sale to trading. Mortgage Securities classified as trading are
8
<PAGE> 9
accounted for in accordance with SFAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities. Accordingly, such securities are
recorded at their estimated fair market value. Unrealized and realized gains and
losses on these securities are recognized as a component of "Net unrealized and
realized gains (losses) on assets" on the Consolidated Statements of Operations.
Mortgage Securities: Available-for-Sale
Prior to the adoption of SFAS No. 133, the Company, in accordance with SFAS No.
115, classified all of its Mortgage Securities as available-for-sale investments
as the Company, from time to time, sold some of its Mortgage Securities as part
of its overall management of its balance sheet. Effective July 1, 1998, the
Company reclassified all of its short-funded Mortgage Securities as trading
investments, while all equity-funded Mortgage Securities remained in the
available-for-sale classification. All Mortgage Securities classified as
available-for-sale are carried at their estimated fair value. Current period
unrealized gains and losses are excluded from net income and reported as a
component of Other Comprehensive Income in Stockholders' Equity with cumulative
unrealized gains and losses classified as Accumulated Other Comprehensive Income
in Stockholders' Equity.
Unrealized losses on Mortgage Securities classified as available-for-sale that
are considered other-than-temporary, are recognized in income and the carrying
value of the Mortgage Security is adjusted. Other-than-temporary unrealized
losses are based on management's assessment of various factors affecting the
expected cash flow from the Mortgage Securities, including an
other-than-temporary deterioration of the credit quality of the underlying
mortgages and/or the credit protection available to the related mortgage pool
and a significant change in the prepayment characteristics of the underlying
collateral.
U.S. TREASURY SECURITIES
U.S. Treasury securities include notes issued by the U.S. Government. Interest
is recognized as revenue when earned according to the terms of the Treasury
securities. Discounts and premiums are amortized into interest income over the
life of the security using methods that approximate the effective yield method.
U.S. Treasury securities are classified as trading and, accordingly, are
recorded at their estimated fair market value with unrealized gains and losses
recognized as a component of "Net unrealized and realized gains (losses) on
assets" on the Consolidated Statements of Operations.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of three months or less. At June 30, 1999 and December
31, 1998, cash equivalents included $32 million and $25 million in repurchase
agreements, respectively.
RESTRICTED CASH
Restricted cash of the Company includes principal and interest payments on
mortgage loans held as collateral for the Company's Long-Term Debt, and cash
pledged as collateral on certain interest rate agreements.
INTEREST RATE AGREEMENTS
The Company maintains an overall interest-rate risk-management strategy that
incorporates the use of derivative interest rate agreements to minimize
significant unplanned fluctuations in earnings that are caused by interest-rate
volatility. Interest rate agreements that are used as part of the Company's
interest-rate risk management strategy include interest rate options, swaps,
options on swaps, futures contracts, and options on futures contracts
(collectively "Interest Rate Agreements"). On the date an Interest Rate
Agreement is entered into, the Company designates the interest rate agreement as
(1) a hedge of the fair value of a recognized asset or liability or of an
unrecognized firm commitment ("fair value" hedge), (2) a hedge of a forecasted
transaction or of the variability of cash flows to be received or paid related
to a recognized asset or liability ("cash flow" hedge), or (3) held for trading
("trading" instruments). Concurrent with the adoption of SFAS No. 133, the
Company has elected to designate all of its existing Interest Rate Agreements as
trading instruments.
Net premiums on interest rate options are amortized as a component of net
interest income over the effective period of the interest rate option using the
effective interest method. The income and/or expense related to interest rate
options and swaps are recognized on an accrual basis.
9
<PAGE> 10
Interest Rate Agreements Classified as Trading
Interest Rate Agreements that are designated as trading are not linked to
specific assets and liabilities or to a forecasted transaction, or otherwise are
not designated and, therefore do not qualify for hedge accounting. Accordingly,
interest rate agreements classified as trading are reported at their estimated
fair value with changes in their fair value reported in current-period earnings
in "Net unrealized and realized gains (losses) on assets" on the Consolidated
Statements of Operations.
Interest Rate Agreements Classified as Hedges
Interest Rate Agreements that are designated as hedges are linked to specific
assets and liabilities on the balance sheet or to a forecasted transaction, or
otherwise qualify for hedge accounting. The Company currently does not have any
Interest Rate Agreements classified as hedges.
Prior to the adoption of SFAS No. 133, Interest Rate Agreements that were
hedging Mortgage Securities available-for-sale were carried at fair value with
unrealized gains and losses reported as a component of Accumulated Other
Comprehensive Income in stockholders' equity, consistent with the reporting of
unrealized gains and losses on the related securities. Similarly, Interest Rate
Agreements that were used to hedge Mortgage Loans, Short-Term Debt or Long-Term
Debt were carried at amortized cost. Realized gains and losses from the
settlement or early termination of Interest Rate Agreements were deferred and
amortized into net interest income over the remaining term of the original
Interest Rate Agreement, or, if shorter, over the remaining term of the
associated hedged asset or liability, as adjusted for estimated future principal
repayments.
DEBT
Short-Term and Long-Term Debt are carried at their unpaid principal balances,
net of any unamortized discount or premium and any unamortized deferred bond
issuance costs. The amortization of any discount or premium is recognized as an
adjustment to interest expense using the effective interest method based on the
maturity schedule of the related borrowings. Bond issuance costs incurred in
connection with the issuance of Long-Term Debt are deferred and amortized over
the estimated lives of the Long-Term Debt using the interest method adjusted for
the effects of prepayments.
INCOME TAXES
The Company has elected to be taxed as a Real Estate Investment Trust ("REIT")
under the Internal Revenue Code (the "Code") and the corresponding provisions of
State law. In order to qualify as a REIT, the Company must annually distribute
at least 95% of its taxable income to stockholders and meet certain other
requirements. If these requirements are met, the Company generally will not be
subject to Federal or state income taxation at the corporate level with respect
to the taxable income it distributes to its stockholders. Because the Company
believes it meets the REIT requirements and also intends to distribute all of
its taxable income, no provision has been made for income taxes in the
accompanying consolidated financial statements.
Under the Code, a dividend declared by a REIT in October, November or December
of a calendar year and payable to shareholders of record as of a specified date
in such month, will be deemed to have been paid by the Company and received by
the shareholders on the last day of that calendar year, provided the dividend is
actually paid before February 1st of the following calendar year, and provided
that the REIT has any remaining undistributed taxable income on the record date.
The Company expects to pay a total of $3.4 million of preferred dividends in
1999 from 1999 taxable income. The Company will not declare a common stock
dividend until the 1999 taxable income exceeds the preferred dividend
requirements.
NET INCOME PER SHARE
Net income per share for the three and six months ended June 30, 1999 and 1998
is shown in accordance with SFAS No. 128, Earnings Per Share. Basic net income
per share is computed by dividing net income available to common stockholders by
the weighted average number of common shares outstanding during the period.
Diluted net income per share is computed by dividing the net income available to
common stockholders by the weighted average number of common shares and common
equivalent shares outstanding during the period. The common equivalent shares
are calculated using the treasury stock method, which assumes that all dilutive
common stock
10
<PAGE> 11
equivalents are exercised and the funds generated by the exercise are used to
buy back outstanding common stock at the average market price during the
reporting period.
The following tables provide reconciliations of the numerators and denominators
of the basic and diluted net income per share computations.
<TABLE>
<CAPTION>
(IN THOUSANDS, EXCEPT SHARE DATA) THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
NUMERATOR:
Numerator for basic and diluted earnings per share--
Net income $ 3,196 $ 196 $ 9,737 $ 3,333
Cash dividends on Class B preferred stock (687) (687) (1,374) (1,374)
============ ============ ============ ============
Basic and Diluted EPS - Income available
to common stockholders $ 2,509 $ (491) $ 8,363 $ 1,959
============ ============ ============ ============
DENOMINATOR:
Denominator for basic earnings per share--
Weighted average number of common shares
outstanding during the period 10,051,565 14,106,828 10,412,855 14,115,342
Net effect of dilutive stock options 121,395 149,030 110,474 253,274
------------ ------------ ------------ ------------
Denominator for diluted earnings per share-- 10,172,960 14,255,858 10,523,329 14,368,616
============ ============ ============ ============
Net earnings per share--basic $ 0.25 $ (0.03) $ 0.80 $ 0.14
============ ============ ============ ============
Net earnings per share--diluted $ 0.25 $ (0.03) $ 0.79 $ 0.14
============ ============ ============ ============
</TABLE>
COMPREHENSIVE INCOME
SFAS No. 130, Reporting Comprehensive Income, requires the Company to classify
items of "other comprehensive income" by their nature in a financial statement
and display the accumulated balance of other comprehensive income separately
from retained earnings and additional paid-in capital in the equity section of
the balance sheet. In accordance with SFAS No. 130, current period unrealized
gains and losses on assets available-for-sale are reported as a component of
Comprehensive Income on the Statement of Stockholders' Equity with cumulative
unrealized gains and losses classified as Accumulated Other Comprehensive Income
in Stockholders' Equity. At June 30, 1999 and December 31, 1998, the only
component of Accumulated Other Comprehensive Income was unrealized gains and
losses on assets available-for-sale.
NOTE 3. MORTGAGE ASSETS
At June 30, 1999 and December 31, 1998, investments in Mortgage Assets consisted
of interests in adjustable-rate, hybrid or fixed-rate mortgages on residential
and commercial properties. The hybrid mortgages have an initial fixed coupon
rate for three to ten years followed by annual adjustments. Agency Mortgage
Securities ("Agency Securities") represent securitized interests in pools of
adjustable-rate mortgages from the Federal Home Loan Mortgage Corporation and
the Federal National Mortgage Association. The Agency Securities are guaranteed
as to principal and interest by these United States government-sponsored
entities. The original maturity of the majority of the Mortgage Assets is thirty
years; the actual maturity is subject to change based on the prepayments of the
underlying mortgage loans.
At June 30, 1999 and December 31, 1998, the average annualized effective yield
after taking into account the amortization expense due to prepayments on the
Mortgage Assets was 6.51% and 6.95%, respectively, based on the reported cost of
the assets. Of the Mortgage Assets owned by the Company at June 30, 1999, 74%
were adjustable-rate mortgages, 22% were hybrid mortgages and 4% were fixed-rate
mortgages. The coupons on 69% of the adjustable-rate Mortgage Assets are limited
by periodic caps (generally interest rate adjustments are limited to no more
than 1% every six months or 2% every year) while another 31% are not limited by
such periodic caps. Most of the coupons on the adjustable-rate and hybrid
Mortgage Assets owned by the Company are limited by
11
<PAGE> 12
lifetime caps. At June 30, 1999 and December 31, 1998, the weighted average
lifetime cap on the adjustable-rate Mortgage Assets was 11.77% and 11.81%,
respectively.
At June 30, 1999 and December 31, 1998, Mortgage Assets consisted of the
following:
MORTGAGE LOANS: HELD-FOR-SALE
<TABLE>
<CAPTION>
(IN THOUSANDS) JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
<S> <C> <C>
Current Face $ 88,963 $ 274,630
Unamortized Discount (1,897) (1,099)
Unamortized Premium 0 670
======== =========
Carrying Value $ 87,066 $ 274,201
======== =========
</TABLE>
During the three and six months ended June 30, 1999, the Company recognized net
gains of $110,675 and $85,846 as a result of LOCOM adjustments on Mortgage Loans
held-for-sale, respectively. Also during the three and six months ended June 30,
1999, the Company sold Mortgage Loans held-for-sale for proceeds of $7.5 million
and $50.1 million, resulting in net gains of $9,777 and $27,718, respectively.
Additionally, as a result of the call and subsequent restructuring of a portion
of the Long-Term Debt, the Company reclassified $154 million of Mortgage Loans
held-for-sale to Mortgage Loans held-for-investment (see Note 9). The LOCOM
adjustments and net gains on sales are reflected as a component of "Net
unrealized and realized gains (losses) on assets" on the Consolidated Statements
of Operations. There were no LOCOM adjustments or sale transactions on
held-for-sale Mortgage Loans for the three and six months ended June 30, 1998,
as the Mortgage Loans were not reclassified to held-for-sale until September 30,
1998.
MORTGAGE LOANS: HELD-FOR-INVESTMENT
<TABLE>
<CAPTION>
(IN THOUSANDS) JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
<S> <C> <C>
Current Face $ 1,079,971 $ 1,118,375
Unamortized Premium 14,293 16,709
----------- -----------
Amortized Cost 1,094,264 1,135,084
Allowance for Credit Losses (4,487) (3,784)
=========== ===========
Carrying Value $ 1,089,777 $ 1,131,300
=========== ===========
</TABLE>
There were no sales of Mortgage Loans held-for-investment for the three and six
months ended June 30, 1999 and 1998. During the second quarter of 1999, as a
result of the call and subsequent restructuring of a portion of the Long-Term
Debt, the Company reclassified $154 million of Mortgage Loans held-for-sale to
Mortgage Loans held-for-investment (see Note 9).
MORTGAGE SECURITIES: TRADING
<TABLE>
<CAPTION>
JUNE 30, 1999 DECEMBER 31, 1998
(IN THOUSANDS) AGENCY NON-AGENCY TOTAL AGENCY NON-AGENCY TOTAL
----------------------------------- ---------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Current Face $484,554 $ 448,379 $ 932,933 $ 609,826 $ 640,923 $ 1,250,749
Unamortized Discount 0 (3,098) (3,098) (5) (3,084) (3,089)
Unamortized Premium 9,281 2,502 11,783 7,602 2,393 9,995
======== ========= ========= ========= ========= ===========
Carrying Value $493,835 $ 447,783 $ 941,618 $ 617,423 $ 640,232 $ 1,257,655
======== ========= ========= ========= ========= ===========
</TABLE>
For the three and six months ended June 30, 1999, the Company recognized a
mark-to-market gain of $0.3 million and $5.1 million on Mortgage Securities
classified as trading and sold Mortgage Securities classified as trading for
proceeds of $7.7 million, respectively. As the Company did not reclassify all of
its short-funded
12
<PAGE> 13
Mortgage Securities from available-for-sale to trading until July 1, 1998 (see
Note 2), there were no such mark-to-market adjustments for the three and six
months ended June 30, 1998. The mark to market adjustments are reflected as a
component of "Net unrealized and realized gains (losses) on assets" on the
Consolidated Statements of Operations.
MORTGAGE SECURITIES: AVAILABLE-FOR-SALE
<TABLE>
<CAPTION>
JUNE 30, 1999 DECEMBER 31, 1998
(IN THOUSANDS) NON-AGENCY NON-AGENCY
------------- -----------------
<S> <C> <C>
Current Face $ 18,156 $ 17,281
Unamortized Discount (7,294) (8,015)
-------- --------
Amortized Cost 10,862 9,266
Allowance for Credit Losses (1,007) (1,189)
Gross Unrealized Gains 3 313
Gross Unrealized Losses (1,921) (683)
======== ========
Carrying Value $ 7,937 $ 7,707
======== ========
</TABLE>
No sales or write-downs of Mortgage Securities available-for-sale occurred
during the three and six months ended June 30, 1999. During the six months ended
June 30, 1998, the Company sold Mortgage Securities available-for-sale with an
amortized cost of $9.3 million for proceeds of $9.3 million, resulting in a net
gain of $5,689. The Company also recognized a $0.7 million loss on the
write-down of certain Mortgage Securities available-for-sale during the six
months ended June 30, 1998. The gains and losses on the sales and write-downs of
Mortgage Securities available-for-sale are reflected as a component of "Net
unrealized and realized gains (losses) on assets" on the Consolidated Statements
of Operations.
NOTE 4. RESERVE FOR CREDIT LOSSES
The following table summarizes the Reserve for Credit Losses activity:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
(IN THOUSANDS) 1999 1998 1999 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
Balance at beginning of period $ 5,197 $ 5,484 $ 4,973 $ 4,931
Provision for credit losses 371 763 716 1,364
Charge-offs (74) (463) (195) (511)
------- ------- ------- -------
Balance at end of period $ 5,494 $ 5,784 $ 5,494 $ 5,784
======= ======= ======= =======
</TABLE>
The Reserve for Credit Losses is reflected as a component of Mortgage Assets on
the Consolidated Balance Sheets.
NOTE 5. U.S. TREASURY SECURITIES
At June 30, 1999 and December 31, 1998 U.S. Treasury securities consisted of the
following:
<TABLE>
<CAPTION>
(IN THOUSANDS) JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
<S> <C> <C>
Current Face -- $45,000
Unamortized Premium -- 3,009
---- -------
Carrying Value -- $48,009
==== =======
</TABLE>
13
<PAGE> 14
For the three and six months ended June 30, 1999, the Company recognized
mark-to-market losses of $1.4 million and $3.3 million on U.S. Treasury
securities and sold U.S. Treasury securities for proceeds of $32.1 million and
$90.5 million, respectively. The mark to market adjustments are reflected as a
component of "Net unrealized and realized gains (losses) on assets" on the
Consolidated Statements of Operations.
NOTE 6. COLLATERAL FOR LONG-TERM DEBT
The Company has pledged collateral in order to secure the Long-Term Debt issued
in the form of collateralized mortgage bonds ("Bond Collateral"). This Bond
Collateral consists primarily of adjustable-rate and hybrid, conventional,
30-year mortgage loans secured by first liens on one- to four-family residential
properties. All Bond Collateral is pledged to secure repayment of the related
Long-Term Debt obligation. All principal and interest (less servicing and
related fees) on the Bond Collateral is remitted to a trustee and is available
for payment on the Long-Term Debt obligation. The Company's exposure to loss on
the Bond Collateral is limited to its net investment, as the Long-Term Debt is
non-recourse to the Company.
During the second quarter of 1999, as a result of the call and subsequent
restructuring of a portion of the Long-Term Debt, the Company reclassified $154
million of Mortgage Loans held-for-sale to Mortgage Loans held-for-investment
(see Note 9).
The components of the Bond Collateral are summarized as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS) JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
<S> <C> <C>
Mortgage loans: held-for-sale $ 0 $ 197,646
Mortgage loans: held-for-investment, net 1,089,778 1,131,300
Restricted cash 8,035 12,857
Accrued interest receivable 6,073 7,707
---------- ----------
$1,103,886 $1,349,510
========== ==========
</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 7. INTEREST RATE AGREEMENTS
At June 30, 1999 and December 31, 1998, all of the Company's Interest Rate
Agreements were classified as trading, and therefore, reported at fair value.
During the three and six months ended June 30, 1999, the Company recognized net
gains of $2.4 million and $1.6 million, respectively, as a result of
mark-to-market adjustments on interest rate agreements classified as trading. As
the Company did not classify its interest rate agreements as trading instruments
until July 1, 1998 (see Note 2), there were no related mark-to-market
adjustments recognized during the three and six months ended June 30, 1998. The
mark-to-market gains are reflected as a component of "Net unrealized and
realized gains (losses) on assets" on the Consolidated Statements of Operations.
14
<PAGE> 15
The following table summarizes the aggregate notional amounts of all of the
Company's Interest Rate Agreements as well as the credit exposure related to
these instruments.
<TABLE>
<CAPTION>
NOTIONAL AMOUNTS CREDIT EXPOSURE(a)
(IN THOUSANDS) JUNE 30, 1999 DECEMBER 31, 1998 JUNE 30, 1999 DECEMBER 31, 1998
------------- ----------------- ------------- -----------------
<S> <C> <C>
Interest Rate Options
Purchased $3,261,900 $3,569,200 -- --
Interest Rate Swaps 410,000 440,000 $6,976 $8,673
Interest Rate Futures 325,000 -- 512 --
---------- ---------- ------ ------
Total $3,996,900 $4,009,200 $7,488 $8,673
========== ========== ====== ======
</TABLE>
(a) Reflects the fair market value of all cash and collateral of the Company
held by counterparties.
Interest Rate Options purchased (written), which may include caps, floors, call
and put corridors, options on futures and swaption collars (collectively,
"Options"), are agreements which transfer, modify or reduce interest rate risk
in exchange for the payment (receipt) of a premium when the contract is
initiated. Purchased interest rate cap agreements provide cash flows to the
Company to the extent that a specific interest rate index exceeds a fixed rate.
Conversely, purchased interest rate floor agreements produce cash flows to the
Company to the extent that the referenced interest rate index falls below the
agreed upon fixed rate. Purchased call (put) corridors will cause the Company to
incur a gain (loss) to the extent that the yield of the specified index is below
(above) the strike rate at the time of the option expiration. [The maximum gain
or loss on a call (put) corridor is established at the time of the transaction
by establishing a minimum (maximum) index rate]. The Company will receive cash
on the purchased options on futures if the futures price exceeds (is below) the
call (put) option strike price at the expiration of the option. For the written
options on futures, the Company receives an up-front premium for selling the
option, however, the Company will pay cash on the written option if the futures
price exceeds (is below) the call (put) option strike price at the expiration of
the option. Purchased receiver (payor) swaption collars will cause the Company
to incur a gain (loss) should the index rate be below (above) the strike rate as
of the expiration date. [The maximum gain or loss on a receiver (payor) swaption
is established at the time of the transaction by establishing a minimum
(maximum) index rate]. The Company's credit risk on the purchased Options is
limited to the carrying value of the Options agreements. The credit risk on
options on futures is limited due to the fact that the exchange and its members
are required to satisfy the obligations of any member that fails to perform.
Interest Rate Swaps ("Swaps") are agreements in which a series of interest rate
flows are exchanged over a prescribed period. The notional amount on which the
interest payments are based is not exchanged. Most of the Company's Swaps
involve the exchange of either fixed interest payments for floating interest
payments or the exchange of one floating interest payment for another floating
interest payment based on a different index. Most of the Swaps require that the
Company provide collateral, such as Mortgage Securities, to the counterparty.
Should the counterparty fail to return the collateral, the Company would be at
risk for the fair market value of that asset.
Interest Rate Futures ("Futures") are contracts for the delivery of securities
or cash in which the seller agrees to deliver on a specified future date, a
specified instrument (or the cash equivalent), at a specified price or yield.
Under these agreements, if the Company has sold (bought) the futures, the
Company will generally receive additional cash flows if interest rates rise
(fall). Conversely, the Company will generally pay additional cash flows if
interest rates fall (rise). Similar to options on futures, the credit risk on
futures is limited by the requirement that the exchange and its members make
good on obligations of any member that fails to perform.
In general, the Company has incurred credit risk to the extent that the
counterparties to the Interest Rate Agreements do not perform their obligations
under the Interest Rate Agreements. If one of the counterparties does not
perform, the Company would not receive the cash to which it would otherwise be
entitled under the Interest Rate Agreement. In order to mitigate this risk, the
Company has only entered into Interest Rate Agreements that
15
<PAGE> 16
are either a) transacted on a national exchange or b) transacted with
counterparties that are either i) designated by the U.S. Department of the
Treasury as a "primary government dealer", ii) affiliates of "primary government
dealers", or iii) rated BBB or higher. Furthermore, the Company has entered into
Interest Rate Agreements with several different counterparties in order to
diversify the credit risk exposure.
NOTE 8. SHORT-TERM DEBT
The Company has entered into reverse repurchase agreements and other forms of
collateralized short-term borrowings (collectively, "Short-Term Debt") to
finance acquisitions of a portion of its Mortgage Assets. This Short-Term Debt
is collateralized by a portion of the Company's Mortgage Assets and U.S.
Treasury securities.
At June 30, 1999, the Company had $923 million of Short-Term Debt outstanding
with a weighted-average borrowing rate of 5.30% and a weighted average remaining
maturity of 232 days. This debt was collateralized with $961 million of Mortgage
Assets. At December 31, 1998, the Company had $1.3 billion of Short-Term Debt
outstanding with a weighted average borrowing rate of 5.62% and a weighted
average remaining maturity of 48 days. This debt was collateralized with $1.3
billion of Mortgage Assets and U.S. Treasury securities.
At June 30, 1999 and December 31, 1998, the Short-Term Debt had the following
remaining maturities:
<TABLE>
<CAPTION>
(IN THOUSANDS) JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
<S> <C> <C> <C>
Within 30 days $ 98,642 $ 428,292
30 to 90 days 22,244 714,114
Over 90 days 801,859 115,164
-------- ----------
Total Short-Term Debt $922,745 $1,257,570
======== ==========
</TABLE>
For the three and six months ended June 30, 1999, the average balance of
Short-Term Debt was $0.9 billion and $1.0 billion with a weighted average
interest cost of 5.07% and 5.10%, respectively. For the three and six months
ended June 30, 1998, the average balance of Short-Term Debt was $2.3 billion and
$2.1 billion with a weighted average interest cost of 5.88% and 5.83%,
respectively. The maximum balance outstanding during the six months ended June
30, 1999 and 1998 was $1.3 billion and $1.0 billion, respectively.
NOTE 9. LONG-TERM DEBT
Long-Term Debt in the form of collateralized mortgage bonds is secured by a
pledge of Bond Collateral. As required by the indentures relating to the
Long-Term Debt, the Bond Collateral is held in the custody of trustees. The
trustees collect principal and interest payments on the Bond Collateral and make
corresponding principal and interest payments on the Long-Term Debt. The
obligations under the Long-Term Debt are payable solely from the Bond Collateral
and are otherwise non-recourse to the Company.
Each series of Long-Term Debt consists of various classes of bonds at variable
rates of interest. The maturity of each class is directly affected by the rate
of principal prepayments on the related Bond Collateral. Each series is also
subject to redemption according to the specific terms of the respective
indentures. As a result, the actual maturity of any class of a Long-Term Debt
series is likely to occur earlier than its stated maturity.
During the second quarter of 1999, the Company exercised its right to call the
Long-Term Debt of Sequoia Mortgage Trust 1 ("Sequoia 1"), a series of debt
issued by Sequoia. This Long-Term Debt was called on May 4, 1999. In conjunction
with this call, the Company restructured and contributed the Sequoia 1 debt to
Sequoia Mortgage Trust 1A ("Sequoia 1A"), a newly formed trust, and Sequoia 1A
issued Long-Term Debt collateralized by Sequoia 1 debt. Under the terms of this
new structure, the Sequoia 1A debt is not likely to be called within the next
twelve months. As a result, the $154 million of Bond Collateral in the form of
Mortgage Loans held-for-sale
16
<PAGE> 17
was reclassified to Mortgage Loans held-for-investment to reflect the shift in
the expected holding period of the Mortgage Assets.
The components of the Long-Term Debt at June 30, 1999 and December 31, 1998
along with selected other information are
summarized below:
<TABLE>
<CAPTION>
(IN THOUSANDS) JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
<S> <C> <C>
Long-Term Debt $ 1,065,700 $ 1,303,405
Unamortized premium on Long-Term Debt 4,580 5,783
Deferred bond issuance costs (3,304) (3,628)
----------- -----------
Total Long-Term Debt $ 1,066,976 $ 1,305,560
=========== ===========
Range of weighted-average interest rates, by series 5.36% to 6.47% 5.75% to 6.55%
Stated maturities 2017 - 2029 2017 - 2029
Number of series 3 3
</TABLE>
For the three and six months ended June 30, 1999, the average effective interest
cost for Long-Term Debt, as adjusted for the amortization of bond premium,
deferred bond issuance costs and other related expenses, was 5.96% and 6.00%,
respectively. For the three and six months ended June 30, 1998, the average
effective interest cost for Long-Term Debt, as adjusted for the amortization of
bond premium, deferred bond issuance costs and other related expenses, was 6.45%
and 6.44%, respectively. At June 30, 1999 and December 31, 1998, interest
payable on Long-Term Debt was $3.2 million and $4.2 million, respectively, and
is reflected as a component of Accrued Interest Payable on the Consolidated
Balance Sheets.
NOTE 10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values of
the Company's financial instruments at June 30, 1999 and December 31, 1998.
<TABLE>
<CAPTION>
(IN THOUSANDS) JUNE 30, 1999 DECEMBER 31, 1998
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
--------------------------- ---------------------------
<S> <C> <C> <C> <C>
Assets
Mortgage Loans: held-for-sale $ 87,066 $ 87,066 $ 274,201 $ 274,302
Mortgage Loans: held-for-investment $1,089,778 $1,081,407 $1,131,300 $1,120,376
Mortgage Securities: trading $ 941,611 $ 941,611 $1,257,655 $1,257,655
Mortgage Securities: available-for-sale $ 7,944 $ 7,944 $ 7,707 $ 7,707
U.S. Treasury Securities -- -- $ 48,009 $ 48,009
Interest Rate Agreements $ 2,697 $ 2,697 $ 2,517 $ 2,517
Investment in RWT Holdings, Inc. $ 18,782 $ 19,261 $ 15,124 $ 15,124
Liabilities
Long-Term Debt $1,066,976 $1,058,450 $1,305,560 $1,302,330
</TABLE>
The carrying values of all other balance sheet accounts as reflected in the
financial statements approximate fair value because of the short-term nature of
these accounts.
NOTE 11. STOCKHOLDERS' EQUITY
CLASS B 9.74% CUMULATIVE CONVERTIBLE PREFERRED STOCK
On August 8, 1996, the Company issued 1,006,250 shares of Class B Preferred
Stock ("Preferred Stock"). Each share of the Preferred Stock is convertible at
the option of the holder at any time into one share of Common Stock. After
September 30, 1999, the Company can either redeem or, under certain
circumstances, cause a
17
<PAGE> 18
conversion of the Preferred Stock. The Preferred Stock pays a dividend equal to
the greater of (i) $0.755 per quarter or (ii) an amount equal to the quarterly
dividend declared on the number of shares of the Common Stock into which the
Preferred Stock is convertible. The Preferred Stock ranks senior to the
Company's Common Stock as to the payment of dividends and liquidation rights.
The liquidation preference entitles the holders of the Preferred Stock to
receive $31.00 per share plus any accrued dividends before any distribution is
made on the Common Stock.
As of June 30, 1999 and December 31, 1998, 96,732 shares of the Preferred Stock
have been converted into 96,732 shares of the Company's Common Stock. At June
30, 1999 and December 31, 1998, there were 909,518 shares of the Preferred Stock
outstanding.
STOCK OPTION PLAN
The Company has adopted a Stock Option Plan for executive officers, employees
and non-employee directors (the "Plan"). The Plan authorizes the Board of
Directors (or a committee appointed by the Board of Directors) to grant
"incentive stock options" as defined under Section 422 of the Code ("ISOs"),
options not so qualified ("NQSOs"), deferred stock, restricted stock,
performance shares, stock appreciation rights and limited stock appreciation
rights ("Awards") and dividend equivalent rights ("DERs") to such eligible
recipients other than non-employee directors. Non-employee directors are
automatically provided annual grants of NQSOs with DERs pursuant to a formula
under the Plan.
The number of shares of Common Stock available under the Plan for options and
Awards, subject to certain anti-dilution provisions, is 15% of the Company's
total outstanding shares of Common Stock. The total outstanding shares are
determined as the highest number of shares outstanding prior to any stock
repurchases. At June 30, 1999 and December 31, 1998, 304,784 and 273,312 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 June 30, 1999 and December 31,
1998, 384,970 and 381,298 ISOs had been granted, respectively. The exercise
price for ISOs granted under the Plan may not be less than the fair market value
of shares of Common Stock at the time the ISO is granted. All stock options
granted under the Plan vest no earlier than ratably over a four-year period from
the date of grant and expire within ten years after the date of grant.
The Company's Plan permits certain stock options granted under the plan to
accrue stock DERs. There were no stock DERs accrued for the three and six months
ended June 30, 1999. For the three and six months ended June 30, 1998, the stock
DERs accrued on NQSOs that had a stock DER feature resulted in charges to
operating expenses of $1,994 and $55,222, respectively. Stock DERs represent
shares of stock which are issuable to holders of stock options when the holders
exercise the underlying stock options. The number of stock DER shares accrued is
based on the level of the Company's dividends and on the price of the stock on
the related dividend payment date.
A summary of the status of the Company's Plan as of June 30, 1999 and changes
during the periods ending on that date is presented below.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------------- ----------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
(IN THOUSANDS, EXCEPT SHARE DATA) SHARES EXERCISE PRICE SHARES EXERCISE PRICE
---------------------------- ----------------------------
<S> <C> <C> <C> <C>
Outstanding options at beginning of period 1,627,905 $ 23.16 1,739,787 $ 23.58
Options granted 91,300 $ 16.62 133,300 $ 15.95
Options exercised -- -- (12,361) $ 0.11
Options canceled (23,252) $ 20.03 (164,772) $ 27.70
--------- ---------
Outstanding options at end of period 1,695,953 $ 22.75 1,695,953 $ 22.75
========== =========
</TABLE>
18
<PAGE> 19
STOCK REPURCHASES
Since September 1997, the Company's Board of Directors has approved the
repurchase of 6,455,000 shares of the Company's Common Stock. Pursuant to this
repurchase program, the Company repurchased 256,600 and 1,334,200 shares of its
Common Stock for $4.0 million and $20.0 million during the three and six months
ended June 30, 1999, respectively. At June 30, 1999, there were 1,149,300 shares
available for repurchase. The repurchased shares have been returned to the
Company's authorized but unissued shares of Common Stock.
NOTE 12. RELATED PARTY TRANSACTIONS
SALE OF MORTGAGE LOANS
During the three and six months ended June 30, 1999, the Company sold $0 and $8
million, respectively, of commercial mortgage loans to Redwood Commercial
Funding ("RCF"), a subsidiary of Holdings. Pursuant to the Master Forward
Commitment Agreement, the Company sold the Mortgage Loans to RCF at the same
price for which the Company acquired the Mortgage Loans. Similarly, the Company
purchased or committed to purchase $21 million and $24 million of commercial
mortgage loans during the three and six months ended June 30, 1999,
respectively, and, under the terms of the Master Forward Commitment Agreement,
committed to sell the Mortgage Loans to RCF during the second half of 1999.
During June 1999, the Company purchased $49 million of residential mortgage
loans. Pursuant to the Master Forward Commitment Agreement with Redwood
Residential Funding ("RRF"), a subsidiary of Holdings, the Company committed to
sell the Mortgage Loans to RRF during the third quarter of 1999.
OTHER
Under a revolving credit facility arrangement, the Company may loan funds to
Holdings to finance certain Mortgage Loans owned by Holdings. These loans are
typically unsecured and are repaid within six months. Such loans bear interest
at a rate of 3.5% over the London Interbank Offered Rate ("LIBOR"). At June 30,
1999 and December 31, 1998, the Company had loaned $2.0 million and $6.5
million, respectively, to Holdings in accordance with the provisions of this
arrangement. During the three and six months ended June 30, 1999, the Company
earned $0.2 million and $0.4 million, respectively in interest on loans to
Holdings. During both the three and six months ended June 30, 1998, the Company
earned $15,243 in interest on loans to Holdings.
The Company shares many of the operating expenses of Holdings, including
personnel and related expenses, subject to full reimbursement by Holdings.
During the three and six months ended June 30, 1999, $0.8 million and $1.5
million, respectively, of Holdings' operating expenses were paid by the Company.
For both the three and six months ended June 30, 1998, the Company paid $0.7
million of Holdings' expenses.
The Company may provide credit support to Holdings to facilitate Holdings'
financings from third-party lenders and/or hedging arrangements with
counterparties. As part of this arrangement, Holdings is authorized as a
co-borrower under some of the Company's Short-Term Debt agreements subject to
the Company continuing to remain jointly and severally liable for repayment.
Accordingly, Holdings pays the Company credit support fees on borrowings subject
to this arrangement. At June 30, 1999, the Company was providing credit support
on $53.1 million of Holdings' Short-Term Debt. No such arrangements were
outstanding at December 31, 1998. During the three and six months ended June 30,
1999, the Company recognized $32,948 and $40,858 of credit support fees. Credit
support fees for both the three and six months ended June 30, 1998 were
$138,966. Credit support fees are reflected as a component of "Other Income" on
the Consolidated Statements of Operations.
NOTE 13. COMMITMENTS AND CONTINGENCIES
At June 30, 1999, the Company had entered into commitments to purchase $4
million of commercial Mortgage Loans and $3 million of residential Mortgage
Securities for settlement during July 1999. At June 30, 1999, the Company had
also entered into commitments to sell $24 million of commercial Mortgage Loans
to RCF and $49 million of residential Mortgage Loans to RRF for settlement
during the third quarter of 1999.
19
<PAGE> 20
At June 30, 1999, the Company is obligated under non-cancelable operating leases
with expiration dates through 2001. The future minimum lease payments under
these non-cancelable leases are as follows: 1999 - $140,662; 2000 - $281,324;
2001 - $117,219.
NOTE 14. SUBSEQUENT EVENTS
Through August 10, 1999, pursuant to its stock repurchase program (see Note 11),
the Company repurchased 521,100 shares of the Company's Common Stock for $8.7
million.
On August 10, 1999, Holdings announced that it intends to merge the operations
of its two residential mortgage production subsidiaries, Redwood Financial
Services and Redwood Residential Funding. As a result of this consolidation,
Holdings currently expects to take a one-time third quarter restructuring charge
of up to $2 million. This charge reflects costs to be incurred in connection
with anticipated staff reductions, planned dispositions of certain facilities,
premises and equipment, and other restructuring costs. As the Company accounts
for Holdings under the equity method, the Company's earnings for the third
quarter of 1999 will reflect 99% of Holdings' restructuring charge.
20
<PAGE> 21
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
------------- -----------------
(Unaudited)
<S> <C> <C>
ASSETS
Mortgage loans: held-for sale
Residential $ 13,057 $ 12,247
Commercial 8,080 --
-------- --------
21,137 12,247
-------- --------
Mortgage securities: trading 42,128 --
Cash and cash equivalents 8,826 9,711
Accrued interest receivable 143 78
Property, equipment and leasehold improvements, net 2,708 622
Other assets 629 120
-------- --------
$ 75,571 $ 22,778
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt $ 53,103 $ --
Loan from Redwood Trust, Inc. 2,000 6,500
Payable to Redwood Trust, Inc. 209 445
Accrued expenses and other liabilities 1,287 557
-------- --------
56,599 7,502
-------- --------
Commitments and contingencies (See Note 9)
STOCKHOLDERS' EQUITY
Series A preferred stock, par value $0.01 per share;
10,000 shares authorized; 5,940 issued and outstanding
($5,940 aggregate liquidation preference) 29,700 19,800
Common stock, par value $0.01 per share;
10,000 shares authorized; 3,000 issued and outstanding -- --
Additional paid-in capital 300 200
Accumulated deficit (11,028) (4,724)
-------- --------
18,972 15,276
-------- --------
$ 75,571 $ 22,778
======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
21
<PAGE> 22
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
For the period
from April 1, 1998
commencement of
Three Months Ended Six Months Ended operations) to
June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES
Interest income
Mortgage loans: held-for-sale
Residential $ 253 $ 2,779 $ 307 $ 2,779
Commercial 197 -- 323 --
450 2,779 630 2,779
Mortgage securities: trading 447 -- 654 --
Cash and cash equivalents 107 57 216 57
------- ------- ------- -------
Total interest income 1,004 2,836 1,500 2,836
------- ------- ------- -------
Interest expense
Short-term debt (497) (2,503) (604) (2,503)
Credit support fees (33) (139) (41) (139)
Loans from Redwood Trust, Inc. (196) (15) (355) (15)
------- ------- ------- -------
Total interest expense (726) (2,657) (1,000) (2,657)
------- ------- ------- -------
Net interest income 278 179 500 179
Net unrealized and realized gains on assets 137 22 614 22
Other income (expense) (8) -- 48 --
------- ------- ------- -------
Net revenues 407 201 1,162 201
------- ------- ------- -------
EXPENSES
Compensation and benefits (2,553) (520) (4,812) (520)
General and administrative (1,649) (268) (2,655) (268)
------- ------- ------- -------
Total expenses (4,202) (788) (7,467) (788)
------- ------- ------- -------
NET LOSS $(3,795) $ (587) $(6,305) $ (587)
======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
22
<PAGE> 23
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
(Unaudited)
<TABLE>
<CAPTION>
Series A
Preferred stock Common stock Additional
--------------------------------------- paid-in Accumulated
Shares Amount Shares Amount capital deficit Total
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998 3,960 $19,800 2,000 $-- $200 $ (4,724) $ 15,276
- --------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net loss -- -- -- -- -- (2,509) (2,509)
- --------------------------------------------------------------------------------------------------------------
Balance, March 31, 1999 3,960 19,800 2,000 -- 200 (7,233) 12,767
- --------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net loss -- -- -- -- -- (3,795) (3,795)
Issuance of preferred stock 1,980 9,900 -- -- -- -- 9,900
Issuance of common stock -- -- 1,000 -- 100 -- 100
- --------------------------------------------------------------------------------------------------------------
Balance, June 30, 1999 5,940 $29,700 3,000 $-- $300 $(11,028) $ 18,972
==============================================================================================================
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
23
<PAGE> 24
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
For the period
from April 1, 1998
(commencement of
Three Months Ended Six Months Ended operations) to
June 30, 1999 June 30, 1998 June 30, 1999 June 30, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (3,795) $ (587) $ (6,305) $ (587)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 93 27 196 27
Net unrealized and realized gains on assets (137) (22) (615) (22)
Purchases of mortgage loans: held for sale (49,839) (531,038) (152,181) (531,038)
Proceeds from sales of mortgage loans: held for sale 26,176 525,418 44,017 525,418
Principal payments on mortgage loans: held for sale 778 5,615 808 5,615
Proceeds from sales of mortgage securities: trading 44,018 -- 54,520 --
Principal payments on mortgage securities: trading 1,825 -- 2,343 --
(Increase) decrease in accrued interest receivable 50 (16) (65) (16)
(Increase) decrease in other assets 817 (18) (418) (18)
Increase (decrease) in amounts due to Redwood Trust 67 831 (236) 831
Increase in accrued expenses and other liabilities 515 41 730 41
-------- --------- --------- ---------
Net cash provided by (used in) operating activities 20,568 251 (57,206) 251
-------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, equipment and leasehold improvements (1,452) (35) (2,282) (35)
-------- --------- --------- ---------
Net cash used in investing activities (1,452) (35) (2,282) (35)
-------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of short-term debt 58,874 519,347 148,179 519,347
Repayments on short-term debt (78,084) (519,347) (95,076) (519,347)
Loans from Redwood Trust, Inc. 46,744 4,000 60,444 4,000
Repayment of loans from Redwood Trust, Inc. (58,444) (4,000) (64,944) (4,000)
Net proceeds from issuance of preferred stock 9,900 9,900 9,900 9,900
Net proceeds from issuance of common stock 100 100 100 100
-------- --------- --------- ---------
Net cash provided by (used in) financing activities (20,910) 10,000 58,603 10,000
-------- --------- --------- ---------
Net increase (decrease) in cash and cash equivalents (1,794) 10,216 (885) 10,216
Cash and cash equivalents at beginning of period 10,620 -- 9,711 --
-------- --------- --------- ---------
Cash and cash equivalents at end of period $ 8,826 $ 10,216 $ 8,826 $ 10,216
======== ========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest expense $ 794 $ 2,518 $ 947 $ 2,518
Non-cash transaction:
Securitization of mortgage loans into mortgage securities $ 35,447 $ -- $ 98,290 $ --
======== ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
24
<PAGE> 25
RWT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
(UNAUDITED)
NOTE 1. THE COMPANY
RWT Holdings, Inc. ("Holdings") was incorporated in Delaware on February 13,
1998 and commenced operations on April 1, 1998. Holdings' first fiscal year-end
was December 31, 1998. Holdings originates, acquires, accumulates, services and
sells real estate mortgage assets ("Mortgage Assets") which may be acquired or
sold as whole loans ("Mortgage Loans") or as mortgage securities representing
interests in or obligations backed by pools of mortgage loans ("Mortgage
Securities"). Redwood Trust, Inc. ("Redwood Trust") owns all of the preferred
stock and has a non-voting, 99% economic interest in Holdings. Holdings has
three subsidiaries which are included in the consolidated financial statements.
Redwood Financial Services, Inc. ("RFS") acquires seasoned loan portfolios from
banks and thrifts and sells this product to institutional mortgage investors.
Redwood Residential Funding, Inc. ("RRF") acquires newly-closed residential
loans from mortgage bankers and sells mortgage securities, loans and servicing
to investors. Redwood Commercial Funding, Inc. ("RCF") originates small balance
commercial mortgages and sells them to depository institutions. Holdings and its
subsidiaries currently utilize both debt and equity to finance acquisitions.
References to Holdings in the following footnotes refer to Holdings and its
subsidiaries.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Holdings and its
subsidiaries. All significant intercompany balances and transactions with
Holdings' consolidated subsidiaries have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with Generally Accepted
Accounting Principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reported period. Actual
results could differ from those estimates. The primary estimates inherent in the
accompanying consolidated financial statements are discussed below.
Fair Value. Management estimates the fair value of its financial instruments
using available market information and other appropriate valuation
methodologies. The fair value of a financial instrument, as defined by Statement
of Financial Accounting Standards ("SFAS") No. 107, Disclosures about Fair Value
of Financial Instruments, is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation sale. Management's estimates are inherently subjective in
nature and involve matters of uncertainty and judgement to interpret relevant
market and other data. Accordingly, amounts realized in actual sales may differ
from the fair values presented in Note 6.
ADOPTION OF SFAS NO. 133
Holdings adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, effective July 1, 1998. Upon the adoption of SFAS No. 133, Holdings
did not record a transition adjustment, as there were no outstanding derivative
instruments. Immediately after the adoption of SFAS No. 133, Holdings elected to
not seek hedge accounting for any of its derivative financial instruments
employed for hedging activities.
MORTGAGE ASSETS
Holdings' Mortgage Assets consist of Mortgage Loans and Mortgage Securities.
Interest is recognized as revenue when earned according to the terms of the
loans and when, in the opinion of management, it is collectible.
25
<PAGE> 26
Mortgage Loans: Held-for-Sale
Mortgage Loans are recorded at the lower of cost or aggregate market value. Cost
generally consists of the loan principal balance net of any unamortized premium
or discount. Interest income is accrued based on the outstanding principal
amount of the Mortgage Loans and their contractual terms. Realized and
unrealized gains or losses on the loans are based on the specific identification
method and are recognized in "Net unrealized and realized gains on assets" on
the Consolidated Statements of Operations.
Some of the Mortgage Loans purchased by Redwood Trust for which securitization
or sale is contemplated are committed for sale by Redwood Trust to Holdings, or
a subsidiary of Holdings, under a Master Forward Commitment Agreement. As the
forward commitment is entered into on the same date that Redwood Trust commits
to purchase the loans, the price under the forward commitment is the same as the
price Redwood Trust paid for the Mortgage Loans, as established by the external
market.
Mortgage Securities: Trading
Mortgage Securities classified as trading are accounted for in accordance with
SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities.
Accordingly, such securities are recorded at their estimated fair market value.
Unrealized and realized gains and losses on these securities are recognized as a
component of "Net unrealized and realized gains on assets" on the Consolidated
Statements of Operations.
LOAN ORIGINATION FEES
Loan fees, discount points and certain direct origination costs are recorded as
an adjustment to the cost of the loan and are recorded in earnings when the loan
is sold.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of three months or less.
DERIVATIVE FINANCIAL INSTRUMENTS
Holdings utilizes various derivative financial instruments to mitigate the risks
that a change in interest rates will result in a change in the value of the
Mortgage Assets. As of June 30, 1999, Holdings has entered into forward
contracts for the sale of mortgage-backed securities. Holdings currently
designates all derivative financial instruments as trading instruments.
Accordingly, such instruments are recorded at their estimated fair market value
with unrealized and realized gains and losses on these instruments recognized as
a component of "Net unrealized and realized gains on assets" on the Consolidated
Statements of Operations. During both the three and six months ended June 30,
1999, Holdings recognized mark-to-market gains on derivative financial
instruments of $0.1 million. There were no derivative financial instruments
outstanding during the three and six months ended June 30, 1998.
INCOME TAXES
Taxable earnings of Holdings are subject to state and federal income taxes at
the applicable statutory rates. Holdings provides for deferred income taxes if
any, to reflect the estimated future tax effects under the provisions of SFAS
No. 109, Accounting for Income Taxes. Under this pronouncement, deferred income
taxes, if any, reflect the estimated future tax effects of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and such amounts as measured by tax laws and regulations.
COMPREHENSIVE INCOME
SFAS No. 130, Reporting Comprehensive Income, requires Holdings to classify
items of "other comprehensive income" by their nature in a financial statement
and display the accumulated balance of other comprehensive income separately
from retained earnings and additional paid-in capital in the equity section of
the balance sheet. As of June 30, 1999 there was no other comprehensive income.
26
<PAGE> 27
NOTE 3. MORTGAGE ASSETS
At June 30, 1999 and December 31, 1998 Mortgage Assets consisted of the
following:
MORTGAGE LOANS: HELD-FOR-SALE
<TABLE>
<CAPTION>
(IN THOUSANDS) JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
<S> <C> <C>
Current Face $21,601 $12,072
Unamortized Premium (Discount) (464) 175
------- -------
Carrying Value $21,137 $12,247
======= =======
</TABLE>
For the three and six months ended June 30, 1999 Holdings recognized a lower of
cost or market loss adjustment of $116,626 and $177,034 on Mortgage Loans
held-for-sale, respectively. This loss is reflected as a component of "Net
unrealized and realized gains on assets" on the Consolidated Statements of
Operations. Also, during the three and six months ended June 30, 1999, Holdings
sold Mortgage Loans held-for-sale for proceeds of $26 million and $44 million,
respectively. For both the three and six months ended June 30, 1998, Holdings
sold Mortgage Loans for proceeds of $525.4 million, resulting in a net gain of
$18,953.
MORTGAGE SECURITIES: TRADING
<TABLE>
<CAPTION>
(IN THOUSANDS) JUNE 30, 1999
-------------
AGENCY
-------------
<S> <C>
Current Face $41,819
Unamortized Premium 309
-------
Carrying Value $42,128
=======
</TABLE>
For the three and six months ended June 30, 1999, Holdings recognized a
mark-to-market gain of $153,790 and $700,780, respectively, on Mortgage
Securities classified as trading. This gain is reflected as a component of "Net
unrealized and realized gains on assets" on the Consolidated Statements of
Operations. Also during the three and six months ended June 30, 1999, Holdings
sold Mortgage Securities classified as trading for proceeds of $44 million and
$55 million, respectively. Holdings did not own any Mortgage Securities prior to
1999.
NOTE 4. SHORT-TERM DEBT
Holdings has entered into reverse repurchase agreements ("Short-Term Debt") in
order to finance acquisitions of a portion of its Mortgage Assets. The average
balance of Short-Term Debt outstanding during the three and six months ended
June 30, 1999 was $37.6 million and $23.4 million with a weighted average
borrowing rate of 5.29% and 5.17%, respectively. The maximum balance outstanding
during the six months ended June 30, 1999 was $87.6 million. The average balance
of Short-Term Debt outstanding during both the three and six months ended June
30, 1998 was $157.1 million with a weighted-average borrowing rate of 6.37%. The
maximum balance outstanding during the six months ended June 30, 1998 was $367.1
million.
Redwood Trust may provide credit support to Holdings to facilitate Holdings'
financings from third-party lenders and/or hedging arrangements with
counterparties. As part of this arrangement, Holdings is authorized as a
co-borrower under some of Redwood Trust's Short-Term Debt agreements subject to
Redwood Trust continuing to remain jointly and severally liable for repayment.
Accordingly, Holdings pays Redwood Trust credit support fees on borrowings
subject to this arrangement. At June 30, 1999, Redwood Trust was providing
credit support on $53.1 million of Holdings' Short-Term Debt. No such
arrangements were outstanding at December 31, 1998. These expenses are reflected
as "Credit support fees" on the Consolidated Statements of Operations.
27
<PAGE> 28
NOTE 5. INCOME TAXES
The provision for income taxes for the period from January 1, 1999 through June
30, 1999 amounted to $3,200 and represents minimum California franchise taxes.
No tax provision has been recorded for the six months ended June 30, 1999, as
Holdings reported a loss for the period. Due to the uncertainty of realization
of net operating losses, no tax benefit has been provided against the loss for
the period. In addition, a valuation allowance has been provided to eliminate
the deferred tax asset related to net operating loss carryforwards at June 30,
1999 and December 31, 1998. At June 30, 1999 and December 31, 1998 the valuation
allowance amounted to $4.3 million and $1.8 million, respectively. At December
31, 1998, Holdings had net operating loss carryforwards of approximately $4.6
million for both federal and state income tax purposes. The federal and state
carryforwards expire through 2013 and 2003, respectively.
NOTE 6. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values of
Holdings' financial instruments at June 30, 1999 and December 31, 1998.
<TABLE>
<CAPTION>
(IN THOUSANDS) JUNE 30, 1999 DECEMBER 31, 1998
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
---------------------------- ----------------------------
<S> <C> <C> <C> <C>
Assets
Mortgage Loans: held-for-sale $21,137 $21,621 $12,247 $12,255
Mortgage Securities: trading $42,128 $42,128 -- --
</TABLE>
The carrying amounts of all other balance sheet accounts as reflected in the
financial statements approximate fair value because of the short-term nature of
these accounts.
NOTE 7. STOCKHOLDERS' EQUITY
The authorized capital stock of Holdings consists of Series A Preferred Stock
("Preferred Stock") and Common Stock. Holdings is authorized to issue 10,000
shares of Common Stock, each having a par value of $0.01, and 10,000 shares of
Preferred Stock, each having a par value of $0.01. All voting power is vested in
the common stock.
Holdings has issued a total of 5,940 shares of Preferred Stock to Redwood Trust.
The Preferred Stock entitles Redwood Trust to receive 99% of the aggregate
amount of any such dividends or distributions made by Holdings. The holders of
the Common Stock are entitled to receive the remaining 1% of the aggregate
amount of such dividends or distributions. The Preferred Stock ranks senior to
the Common Stock as to the payment of dividends and liquidation rights. The
liquidation preference entitles the holders of the Preferred Stock to receive
$1,000 per share liquidation preference before any distribution is made on the
Common Stock. After the liquidation preference, the holders of Preferred Stock
are entitled to 99% of any remaining assets.
NOTE 8. RELATED PARTY TRANSACTIONS
PURCHASE OF MORTGAGE LOANS
During the three and six months ended June 30, 1999, RCF purchased $0 and $8
million, respectively, of commercial mortgage loans from Redwood Trust. Pursuant
to the Master Forward Commitment Agreement, RCF purchased the Mortgage Loans
from Redwood Trust at the same price for which Redwood Trust acquired the
Mortgage Loans. Similarly, Redwood Trust purchased, or committed to purchase,
$21 million and $24.0 million of commercial mortgage loans during the three and
six months ended June 30, 1999, respectively. Under
28
<PAGE> 29
the terms of the Master Forward Commitment Agreement, Redwood Trust committed to
sell the Mortgage Loans to RCF during the second half of 1999.
During June 1999, Redwood Trust purchased $49 million of residential mortgage
loans, and, pursuant to the terms of the Master Forward Commitment Agreement
with RRF, committed to sell the Mortgage Loans to RRF during the third quarter
of 1999.
OTHER
Under a revolving credit facility arrangement, Redwood Trust may loan funds to
Holdings to finance certain Mortgage Assets owned by Holdings. These loans are
typically unsecured and are repaid within six months. Such loans bear interest
at a rate of 3.5% over the London Interbank Offered Rate ("LIBOR"). At June 30,
1999 and December 31, 1998, Holdings had borrowed $2.0 million and $6.5 million,
respectively, from Redwood Trust in accordance with the provisions of this
arrangement. These expenses are reflected as "Loans from Redwood Trust, Inc" on
the Consolidated Statements of Operations.
Redwood Trust shares many of the operating expenses of Holdings, including
personnel and related expenses, subject to full reimbursement by Holdings.
During the three and six months ended June 30, 1999, $0.8 million and $1.5
million, respectively, of Holdings' operating expenses were paid by Redwood
Trust. For both the three and six months ended June 30, 1998, Redwood Trust paid
$0.7 million of Holdings' expenses.
Holdings may borrow under several of Redwood Trust's Short-Term Debt agreements
as a co-borrower. As of June 30, 1999, Holdings had borrowings of $53.1 million
subject to this arrangement. At December 31, 1998, Holdings had no outstanding
borrowings under these agreements (see Note 4).
NOTE 9. COMMITMENTS AND CONTINGENCIES
At June 30, 1999, Holdings is obligated under non-cancelable operating leases
with expiration dates through 2006. The future minimum lease payments under
these non-cancelable leases are as follows: 1999 - $286,532; 2000- $578,526;
2001 - $545,360; 2002 - $377,848; 2003 - $355,950; 2004 through 2006 - $83,388.
Rent expense was $180,283 and $385,712 for the three and six months ended June
30, 1999. For both the three and six months ended June 30, 1998, rent expense
was $53,467.
At June 30, 1999, RCF had entered into commitments to purchase $24 million of
commercial Mortgage Loans from Redwood Trust for settlement during the second
half of 1999. At June 30, 1999, RCF had also entered into a commitment to sell
$0.3 million of commercial Mortgage Loans for settlement in July 1999.
At June 30, 1999, RFS had entered into a commitment to purchase $8 million of
residential Mortgage Loans for settlement in July 1999.
At June 30, 1999, RRF had entered into a commitment to purchase $49 million of
residential Mortgage Loans from Redwood Trust for settlement during the third
quarter of 1999.
NOTE 10. SUBSEQUENT EVENT
On August 10, 1999, Holdings announced that it intends to merge the operations
of RFS into RRF. As a result of this consolidation, Holdings currently expects
to take a one-time third quarter restructuring charge of up to $2 million. This
charge reflects costs to be incurred in connection with anticipated staff
reductions, planned dispositions of certain facilities, premises and equipment,
and other restructuring costs.
29
<PAGE> 30
ITEM 2. REDWOOD TRUST, INC.
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., or "Redwood
Trust", and our 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, we refer you to "Risk Factors"
commencing on Page 16 of our 1998 Annual Report.
OVERVIEW
Redwood Trust, together with its affiliates, is a finance company specializing
in real estate lending. Our primary activity is the financing of high-quality
residential mortgage loans with funds raised through issuance of long-term debt.
We also finance commercial mortgage loans and residential mortgage securities.
Through our affiliate operations, we are developing the ability to create
mortgage assets of significant value for our own portfolio and for sale to
institutional mortgage investors.
Our mortgage finance activities are conducted through Redwood Trust, which is a
qualified real estate investment trust ("REIT"). Generally, our REIT status
allows us to avoid corporate income taxes by distributing to our shareholders an
amount equal to at least 95% of taxable income. Our mortgage production
activities are conducted through RWT Holdings, Inc. ("Holdings"), an affiliate
of Redwood Trust. Earnings at Holdings are subject to regular corporate
taxation. Redwood Trust owns a 99% economic interest in Holdings.
Holdings originates, acquires, aggregates and resells mortgage loans and
securities. Holdings is a start-up business, and for the most part its most
important operations are in their early stages of production or will start
production in the third quarter of 1999. Holdings has been conducting its
business through three wholly owned subsidiaries: Redwood Residential Funding,
Inc., Redwood Commercial Funding, Inc., and Redwood Financial Services, Inc. On
August 10, 1999, Holdings integrated the operations of its two residential
mortgage production subsidiaries, Redwood Residential Funding and Redwood
Financial Services. This integration will result in a reduction in overhead and
a third quarter restructuring charge of up to $2 million. Redwood Residential
Funding is the surviving enterprise. Holdings businesses will generally continue
as before, but under the revised corporate structure.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
RESULTS OF OPERATIONS ---------------------------- -----------------------------
(IN THOUSANDS, EXCEPT SHARE DATE) JUNE 30, 1999 JUNE 30, 1998 JUNE 30, 1999 JUNE 30, 1998
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Mortgage Finance Income $ 6,953 $ 777 $ 15,978 $ 3,914
Mortgage Production Income (3,757) (581) (6,241) (581)
------- ----- -------- -------
Net Income 3,196 196 9,737 3,333
Preferred Dividends (687) (687) (1,374) (1,374)
------- ----- -------- -------
Net Income to Common Shareholders $ 2,509 $(491) $ 8,363 $ 1,959
======= ===== ======== =======
Earning Per Share $ 0.25 $(0.03) $ 0.79 $ 0.14
Common Dividends Per Share $ 0.00 $0.01 $ 0.00 $ 0.28
</TABLE>
Income available to common shareholders totaled $2.5 million in the second
quarter of 1999, or $0.25 per common share, as compared to a $0.5 million loss
or $(0.03) per common share in the second quarter of 1998. Net income for the
first half of 1999 was $8.4 million, or $0.79 per share. In the same period one
year earlier, we earned $2.0 million, or $0.14 per share.
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For more information, please visit our Web site on the Internet at:
http://www.redwoodtrust.com.
FINANCIAL CONDITION
At June 30, 1999, our reported balance sheet had $2.2 billion of assets funded
with $2.0 billion of borrowings and $242 million of equity. The portion of our
balance sheet that is subject to recourse to Redwood Trust is $1.1 billion of
assets, $0.9 billion of borrowings and $242 million of equity. The ratio of
equity to recourse assets was 20.6%. The ratio of recourse liabilities to equity
was 3.8 to 1.0.
Our $1.1 billion of non-recourse assets and liabilities are owned by our three
Sequoia financing trusts. The Sequoia trusts are "bankruptcy-remote" with
respect to Redwood Trust. Although the net earnings of the trusts accrue to
Redwood Trust, Redwood Trust is not responsible for the repayment of Sequoia
debt and Sequoia has no call on the liquidity of Redwood Trust. Our recourse
exposure to Sequoia's mortgage assets is limited to our equity investments in
these trusts. At June 30, 1999, these equity investments had a reported value of
$35 million.
At December 31, 1998, we reported $2.8 billion in assets, of which $1.5 billion
were recourse, and $2.6 billion of liabilities, of which $1.3 billion were
recourse. Equity capital was $255 million. The ratio of equity to recourse
assets was 16.7% and the ratio of recourse liabilities to equity was 4.9 to 1.0.
MORTGAGE LOANS: HELD FOR SALE
RESIDENTIAL
We owned $67 million residential mortgage loans at June 30, 1999. All these
loans are carried on our balance sheet at the lower-of-cost-or-market. At
December 31, 1998, we reported $266 million of residential mortgage loans in
this category, of which $198 million were part of Sequoia Mortgage Trust 1 (see
below) and $68 million were funded with short-term debt and equity.
COMMERCIAL
At June 30, 1999, we owned $20 million of commercial mortgage loans originated
by Redwood Commercial Funding, Inc. and carried on our balance sheet as
"Mortgage Loans: Held for Sale: Commercial". At December 31, 1998, we owned $8
million of commercial mortgage loans.
MORTGAGE LOANS: HELD FOR INVESTMENT
We own $1.1 billion of residential mortgage loans that are financed long-term
through our financing subsidiary, Sequoia Mortgage Funding Corporation
("Sequoia"). The amount of Sequoia long-term debt outstanding amortizes as the
underlying mortgages pay down. As the equity owner of these trusts, we are
entitled to distributions of the net earnings of the trusts, which principally
consist of the interest income earned from mortgages in each trust less the
interest expense of the debt of each trust.
We currently have three series outstanding as discussed below. We consolidate
the assets and liabilities of Sequoia on our balance sheet. Sequoia balance
sheet components appear on our balance sheet as part of "Mortgage Loans: Held
for Investment", "Restricted Cash", "Long-Term Debt", and "Accrued Interest
Receivable".
SEQUOIA MORTGAGE TRUST 1
Sequoia Mortgage Trust 1, "Sequoia 1", owned $146 million in principal value of
adjustable residential mortgage loans and $8 million of cash at June 30, 1999
funded with $149 million of floating-rate collateralized mortgage bonds.
Our credit risk with respect to these loans is limited to our investment in the
equity of Sequoia 1. The reported basis of this investment was $7 million at
June 30, 1999.
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In May 1999, we effectively reduced the cost of our long-term financing
arrangement for Sequoia 1's mortgage loans by exercising our right to call
Sequoia 1's debt. We restructured Sequoia 1's debt and contributed the debt to
Sequoia Mortgage Trust 1A ("Sequoia 1A"), a newly formed trust. Sequoia 1A
issued lower-cost long-term debt collateralized by Sequoia 1 debt.
At December 31, 1998, the principal value of Sequoia 1's loans totaled $197
million. We also reported $13 million of cash owned by Sequoia 1 as "Restricted
Cash". Total Sequoia 1 debt was $202 million.
SEQUOIA MORTGAGE TRUST 2
Sequoia Mortgage Trust 2, "Sequoia 2", owned $494 million of principal value of
adjustable-rate residential mortgage loans at June 30, 1999 funded with $489
million of floating-rate collateralized mortgage bonds.
Our credit risk with respect to these loans is limited to our investment in the
equity of Sequoia 2. The reported basis of this equity interest was $18 million.
We will have the right to call Sequoia 2's debt and re-acquire Sequoia 2's loans
when the underlying mortgage loans collateral has been paid down to less than
25% of its initial balance. As of June 30, 1999, the balance was at 64% of its
initial level and it most likely will be several years before we gain the right
to call this debt.
At December 31, 1998, Sequoia 2's loans totaled $579 million and total Sequoia 2
debt was $571 million.
SEQUOIA MORTGAGE TRUST 3
Sequoia Mortgage Trust 3, "Sequoia 3", owned $439 million of principal value of
residential mortgage loans at June 30, 1999 funded with $429 million of
long-term debt. Both the mortgage loans and debt of Sequoia 3 are fixed rate
until December 2002 and then become floating rate.
Our credit risk with respect to these loans is limited to our investment in the
equity of Sequoia 3. This investment had a reported basis of $10 million.
We will have the right to call Sequoia 3's debt and re-acquire Sequoia 3's loans
beginning in December 2002.
At December 31, 1998, Sequoia 3's loans totaled $540 million and total Sequoia 3
debt was $530 million.
MORTGAGE SECURITIES: TRADING
At June 30, 1999 and December 31, 1998, all our mortgage securities represented
interests in pools of residential mortgage loans. Our mortgage securities
portfolio is marked-to-market for income statement purposes except for the 1% of
mortgage securities we own that is rated "A" or below. For the mark-to-market
securities, the estimated bid-side market value was $0.9 billion at June 30,
1999. These appear on our balance sheet as "Mortgage Securities: Trading." We
owned $1.3 billion in market value of these securities at December 31, 1998. For
a discussion of our investments in lower-rated mortgage securities we refer you
to the section titled "Mortgage Securities: Available for Sale" below.
At June 30, 1999, 51.6% of our mark-to-market residential mortgage securities
portfolio consisted of residential adjustable-rate mortgage securities issued
and credit-enhanced by Fannie Mae or Freddie Mac and effectively rated "AAA".
These securities totaled $0.5 billion at June 30, 1999 and $0.6 billion at
December 31, 1998.
At June 30, 1999, 38.5% of this residential mortgage securities portfolio
consisted of residential adjustable-rate mortgage securities issued by
private-label security issuers. These securities were credit-enhanced through
subordination or other means and were rated "AAA" or "AA". The value of these
securities was $0.4 billion at June 30, 1999 and $0.6 billion at December 31,
1998.
At June 30, 1999, 6.0% of this residential mortgage securities portfolio
consisted of mortgage securities rated "AAA" or "AA" which were backed by home
equity loans, or "HEL". The value of these securities was $56 million at June
30, 1999; floating-rate HEL securities were $55 million and fixed-rate HEL
securities were $1
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million. The value of these securities was $71 million at December 31, 1998;
floating-rate HEL securities were $68 million and fixed-rate HEL securities were
$3 million.
At June 30, 1999, 1.8% of this residential mortgage securities portfolio
consisted of fixed-rate, private label collateralized mortgage obligations.
These are commonly referred to as CMO's. They are rated "AAA" or "AA" and have
average lives of 1 to 2 years. The value of these securities was $17 million at
June 30, 1999 and $19 million at December 31, 1998.
At June 30, 1999, 1.3% of this residential mortgage securities portfolio
consisted of fixed-rate, private label mortgage securities rated "AA" and backed
by residential mortgage loans with loan-to-value ratios in excess of 100%. The
value of these securities was $12 million at June 30, 1999 and $12 million at
December 31, 1998.
At June 30, 1999, 0.8% of this residential mortgage securities portfolio
consisted of floating-rate CMO's issued by Fannie Mae or Freddie Mac and
effectively rated "AAA". These securities totaled $8 million at June 30, 1999
and $17 million at December 31, 1998.
At June 30, 1999, 0.03% of this residential mortgage securities portfolio
consisted of interest-only mortgage securities rated "AAA" or "AA". The value of
these securities was $0.2 million at June 30, 1999 and $0.4 million at December
31, 1998.
MORTGAGES SECURITIES: AVAILABLE FOR SALE
In 1994 and 1995, we acquired a portfolio of subordinated mortgage securities.
These securities were interests in pools of residential mortgage loans that
served as the credit-enhancement for the "AAA" and other securities issued from
those pools. Through ownership of these securities, we assumed most of the
credit risk of the underlying mortgage loans. These securities were either not
rated or were rated "A" through "B". We sold these subordinated securities to a
trust, SMFC 97-A, in December 1997. SMFC 97-A issued mortgage securities to fund
its acquisition of this portfolio.
We acquired from SMFC 97-A certain subordinated interests. At June 30, 1999,
these securities effectively bore most of the credit risk related to $0.4
billion of underlying mortgages. Changes in market valuations of SMFC 97-A are
not included in our income statement as these assets are funded with equity. The
reported value of SMFC 97-A was $7 million at June 30, 1999 and $8 million at
December 31, 1998. Our credit risk from SMFC 97-A is limited to our investment.
In the second quarter of 1999, we resumed the acquisition of lower-rated
mortgage securities with the acquisition of one fixed-rate security, rated "B",
at a cost of $0.9 million. This security is reported at cost for income
statement purposes with mark-to-market adjustments included on the balance
sheet. We also began providing for potential credit losses from this security
and we will continue to add to its credit reserve over time. At December 31,
1998, we did not own any such securities. We generally intend to acquire
additional subordinated mortgage securities in the future, both from Holdings
and from other mortgage market participants.
U.S. TREASURY SECURITIES
At December 31, 1998, we owned $48 million of ten-year U.S. Treasury securities
as part of our asset/liability management and hedging program. We sold our
ten-year U.S. Treasury securities during the first half of 1999.
CASH
We had $67 million of unrestricted cash at June 30, 1999 and $56 million at
year-end 1998.
Sequoia owned cash totaling $8 million at June 30, 1999 and $13 million at
year-end 1998. In consolidating Sequoia assets on our balance sheet, we reflect
this cash as restricted cash since it will be used for the specific purpose of
making payments to Sequoia bondholders and is not available for general
corporate purposes.
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INTEREST RATE AGREEMENTS
Our interest rate agreements are carried on our balance sheet at estimated
market value, which was $2.7 million at June 30, 1999 and $2.5 million at
December 31, 1998. Please see "Note 2. Summary of Significant Accounting
Policies", "Note 7. Interest Rate Agreements" and "Note 10. Fair Value of
Financial Instruments" in the Notes to Consolidated Financial Statements for
more information.
INVESTMENT IN RWT HOLDINGS, INC.
We do not consolidate the assets and liabilities of Holdings on our balance
sheet. We reflect the net book value of our individual investment in one line
item on our balance sheet labeled "Investment in RWT Holdings, Inc."
Through June 30, 1999, we have invested $29.7 million in the preferred stock of
Holdings. Our share of the operating losses at Holdings has reduced the carrying
value of this investment. The carrying value was $18.8 million at June 30, 1999
and $15.1 million at December 31, 1998.
At June 30, 1999, our assets also included a loan to Holdings of $2.0 million
and a receivable from Holdings of $0.2 million. At December 31, 1998, loans to
Holdings totaled $6.5 million and receivables from Holdings were $0.4 million.
OTHER ASSETS
Our other assets include accrued interest receivables, other receivables, fixed
assets, leasehold improvements and prepaid expenses. These totaled $15 million
at June 30, 1999 and $21 million at December 31, 1998.
SHORT-TERM DEBT
Short-term borrowings totaled $923 million at June 30, 1999. We pledged a
portion of our mortgage securities portfolio, mortgage loan portfolio, and other
investments to secure this debt. Short-term debt totaled $1.3 billion at
December 31, 1998. Maturities on this debt typically range from one month to one
year. The interest rate on most of this debt typically adjusts monthly to a
spread over or under the one month LIBOR interest rate.
LONG-TERM DEBT
At June 30, 1999, we had a total of $1.1 billion in long-term mortgage-backed
debt outstanding, net of unamortized premiums on bonds and deferred bond
issuance costs. Sequoia 1 debt of $149 million and Sequoia 2 debt of $489
million is floating rate debt. Sequoia 3 debt of $429 million is fixed-rate
until December 2002 after which time it becomes floating rate debt.
At December 31, 1998, Sequoia 1 had $202 million, Sequoia 2 had $574 million,
and Sequoia 3 had $530 million of long-term mortgage-backed debt outstanding net
of unamortized premiums on bonds and deferred bond issuance costs, for a total
outstanding of $1.3 billion.
Sequoia debt is non-recourse to Redwood Trust. The debt is consolidated on our
balance sheet and is reflected as long-term debt, which is carried at historical
amortized cost. The original scheduled maturity of this debt was approximately
thirty years. Since these debt balances are retired over time as principal
payments are received on the underlying mortgages, the expected average life of
this debt is two to six years.
OTHER LIABILITIES
Our other liabilities include accrued interest payable, accrued expenses, and
dividends payable. The net balance of these accounts totaled $9 million at June
30, 1999 and $15 million at December 31, 1998. Most of the accrued interest
payable is related to the Sequoia trusts discussed above.
STOCKHOLDERS' EQUITY
Total equity capital was $242 million at June 30, 1999. Preferred stock equity
was $27 million. Reported common equity totaled $215 million, or $21.64 per
common share outstanding.
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In reporting equity at June 30, 1999, we marked-to-market all earning assets and
interest rate agreements except mortgage loans that were financed to maturity
(Sequoia). In accordance with Generally Accepted Accounting Principles, no
liabilities were marked-to-market.
If we had marked-to-market all of our assets and liabilities, equity capital
would have been reported as $241 million at June 30, 1999. After subtracting out
the preference value of the preferred stock, common equity on a full
mark-to-market basis was $214 million and the net mark-to-market value per
common share was $21.56.
Reported equity capital was $255 million at December 31, 1998. Reported common
equity was $228 million, or $20.27 per common share outstanding. Mark-to-market
common equity was $220 million, or $19.53 per common share.
Real shareholder wealth increased from $19.53 to $21.56 per share, an increase
of 10% or $2.03 per share, during the first half of 1999 due to net asset
appreciation, retained earnings, and the effects of our stock repurchase
program.
We acquired 1,334,200 shares of our common stock in the first half of 1999 at an
average price of $15.01 per share. In the third quarter of 1999 through August
10, 1999, we acquired an additional 521,100 shares at an average price of $16.62
per share.
RESULTS OF OPERATIONS
Our operating results include all of the reported income of our mortgage finance
operations plus, as one line item on our income statement, 99% of the after-tax
results of mortgage production operations at Holdings. Detailed results at
Holdings are discussed separately below.
INTEREST INCOME
In the second quarter of 1999, interest income generated by our mortgage finance
operations, including consolidated Sequoia assets, was $36 million. Our
portfolio had average earning assets of $2.2 billion and earned an average yield
of 6.54%. During this quarter, the average coupon rate, or the cash-earning rate
on mortgage principal, was 6.82%. The reported value of assets included a net
purchase premium of 0.80% of mortgage principal totaling $17 million. We write
off this premium balance as an expense over the life of the asset. Net premium
amortization expense for the quarter was $1.6 million, which reduced earning
asset yield by 0.23%. The prepayment rate on our mortgage assets, which drives
the rate at which we write off premium balances, was at a 30% Conditional
Prepayment Rate ("CPR") during the quarter. Other factors reduced the earning
asset yield by 0.05%.
In the first quarter of 1999, interest income was $42 million. Our portfolio had
average earning assets of $2.6 billion and earned an average yield of 6.55%. The
coupon rate was 6.99%. The reported value of assets included a 0.71% net
premium, or $18 million. Net premium amortization expense was $2.3 million,
which reduced earning asset yield by 0.37%. Prepayments during the quarter were
at a 33% CPR. Other factors reduced the earning asset yield by 0.07%.
Interest income declined from the first quarter of 1999 to the second quarter of
1999 as we continued reducing our earning asset balances in order to free
capital to fund the start-up operations at Holdings and to support our stock
repurchase program. Earning asset yields remained stable as lower coupon rates
were offset by the effect of slower prepayment rates.
In the second quarter of 1998, interest income was $54 million. The portfolio
had average earning assets of $3.5 billion and earned an average yield of 6.10%.
The coupon rate was 7.52%. The reported value of assets included 1.98% of net
premium, or $68 million. Net premium amortization expense was $11.0 million,
which reduced earning asset yield by 1.26%. Prepayments during the quarter were
at a 34% CPR. Other factors reduced the earning asset yield by 0.16%.
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From the second quarter of 1998 to the second quarter of 1999, we reduced our
earning asset balances in order to reduce our exposure to accelerating mortgage
prepayment rates, free capital to fund the start-up operations at Holdings and
fund our stock repurchases. In the third quarter of 1998, we began reporting
many of our assets at market value for income statement purposes. This served to
decrease our outstanding premium balance thereby reducing the effect prepayments
had on our earning asset yields.
In the first six months of 1999, interest income was $78 million. The portfolio
had average earning assets of $2.4 billion and earned an average yield of 6.54%.
The coupon rate was 6.92%. The reported value of assets included a 0.75% net
premium, or $17 million. Net premium amortization expense was $3.9 million,
which reduced earning asset yield by 0.30%. Prepayments during the period were
at a 31% CPR. Other factors reduced the earning asset yield by 0.08%.
In the first six months of 1998, interest income was $108 million. The portfolio
had average earning assets of $3.4 billion and earned an average yield of 6.29%.
The coupon rate was 7.58%. The reported value of assets included a 2.09% net
premium, or $69 million. Net premium amortization expense was $19.2 million,
which reduced earning asset yield by 1.13%. Prepayments during the period were
30% CPR. Other factors reduced the earning asset yield by 0.16%.
INTEREST EXPENSE
Interest expense in the second quarter of 1999 was $29 million. We funded our
mortgage finance portfolio and other assets with an average of $243 million of
equity and $2.1 billion of borrowings, including consolidated Sequoia debt. We
paid an average cost of funds of 5.55% for these borrowings. Short-term debt
averaged 46% of total debt and cost us 5.07%. Long-term debt averaged 54% of
total debt and cost us 5.96%.
In the first quarter of 1999, interest expense was $33 million. We funded our
mortgage finance portfolio with an average of $250 million of equity and $2.4
billion of borrowings. We paid an average cost of funds of 5.59% for these
borrowings. Short-term debt averaged 48% of total debt and cost us 5.12%.
Long-term debt averaged 52% of total debt and cost us 6.03%.
From the first quarter of 1999 to the second quarter of 1999, total interest
expense decreased as the size of our portfolio has decreased. Our cost of funds
fell slightly as the average short-term rates declined. We refinanced the
long-term debt of Sequoia 1; this also contributed to a lower overall cost of
funds.
In the second quarter of 1998, interest expense was $50 million. We funded our
mortgage finance portfolio with an average of $329 million of equity and $3.3
billion of borrowings. We paid an average cost of funds of 6.06% for these
borrowings. Short-term debt averaged 68% of total debt and cost us 5.88%.
Long-term debt averaged 32% of total debt and cost us 6.45%.
From the second quarter of 1998 to the second quarter of 1999, total interest
expense was lower due to a reduction in the size of the portfolio. The cost of
funds decreased as short-term interest rates fell. Our borrowing costs did not
fall by the full amount of the decrease in short-term interest rates during this
period, as we utilized an increasing percentage of more expensive long-term
debt.
In the first six months of 1999, interest expense was $62 million. We funded our
portfolio with an average of $247 million of equity and $2.2 billion of
borrowings. We paid an average cost of funds of 5.58% for these borrowings.
Short-term debt averaged 47% of total debt and cost us 5.10%. Long-term debt
averaged 53% of total debt and cost us 6.00%.
In the first six months of 1998, interest expense was $96 million. We funded our
mortgage finance portfolio with an average of $329 million of equity and $3.2
billion of borrowings. We paid an average cost of funds of 6.04% for these
borrowings. Short-term debt averaged 66% of total debt and cost us 5.83%.
Long-term debt averaged 34% of total debt and cost us 6.44%.
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INTEREST RATE AGREEMENTS EXPENSE
We hedge using interest rate agreements in order to strengthen our balance
sheet, increase liquidity, and dampen potential earnings volatility. Net
interest rate agreements expense was $0.7 million in the second quarter of 1999,
or 0.14% of average borrowings. In the first quarter of 1999, interest rate
agreement expense was $0.3 million or 0.06% of average borrowings. In the second
quarter of 1998, interest rate agreement expense was $1.6 million or 0.19% of
average borrowings.
In adopting mark-to-market accounting for our interest rate agreements in the
third quarter of 1998 through the early adoption of SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, we wrote down our basis in our
interest rate agreements. This market value adjustment had the effect of
reducing interest rate agreement amortization expense on an on-going basis.
Total interest rate agreement expense has also fallen as the size of our balance
sheet decreased. We refer you to "Note 7. Interest Rate Agreements" in the Notes
to Consolidated Financial Statements for additional details.
Net interest rate agreements expense was $1.1 million in the first six months of
1999, or 0.19% of average borrowings. In the first six months of 1998, interest
rate agreements expense was $3.0 million or 0.10% of average borrowings.
NET INTEREST INCOME
Net interest income, which equals interest income less interest expense less
interest rate agreements expense, was $6.8 million in the second quarter of
1999. Our interest rate spread, which equals the yield on earning assets less
the cost of funds and hedging, was 0.85%. Our net interest margin, which equals
net interest income divided by average assets, was 1.18% during this period.
In the first quarter of 1999, net interest income was $7.9 million, the interest
rate spread was 0.90%, and the net interest margin was 1.19%. Net interest
income was lower in the second quarter of 1999 than in the first quarter of 1999
due to a lower average portfolio balance during the later period.
In the second quarter of 1998, net interest income was $2.0 million, the
interest rate spread was negative 0.15%, and the net interest margin was 0.22%.
Our spread and margin increased in 1999 due to our efforts to reduce mortgage
prepayment risk.
In the first six months of 1999, net interest income was $14.7 million, the
interest rate spread was 0.87%, and the net interest margin was 1.19. In the
first six months of 1998, net interest income was $8.4 million, the interest
rate spread was 0.06%, and the net interest margin was 0.47%.
NET UNREALIZED AND REALIZED GAINS AND LOSSES ON ASSETS
In the second quarter of 1999, the net appreciation income on our portfolio
assets that were marked-to-market for income statement purposes was $1.4
million. This net gain consisted of a $0.4 million market value gain on mortgage
assets, a $1.4 million market value loss on U.S. Treasury securities, and a $2.4
million market value gain on interest rate agreements. Market values for our
assets changed as interest rates rose and anticipated future prepayments speeds
fell.
In the first quarter of 1999, total net asset appreciation income was $2.2
million. This included a $4.9 million gain on mortgage assets, a $1.9 million
loss on U.S. Treasury securities, and a $0.8 million market value loss on
interest rate agreements.
In the second quarter of 1998, we had not yet adopted mark-to-market accounting.
As a result, most of the unrealized market value gains and losses incurred
during that quarter were not recognized in earnings. Since we did not sell any
assets in this quarter, there were no realized gains or losses during the
period.
In the first six months of 1999, the net gain on asset market valuations was
$3.6 million. In the first six months of 1998, prior to adopting mark-to-market
accounting, asset value losses were $0.7 million.
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PROVISION FOR CREDIT LOSSES
In the second quarter of 1999, credit provisions were $0.4 million. In the first
quarter of 1999, credit provisions totaled $0.3 million. In the second quarter
of 1998, credit provisions were $0.8 million. Actual realized credit losses
totaled $0.1 million in the second quarter of 1999, $0.1 million in the first
quarter of 1999 and $0.3 million in the second quarter of 1998.
In the first six months of 1999, total credit provisions were $0.7 million. In
the first six months of 1998, total credit provisions were $1.4 million. Credit
provision expenses have declined over time as the portfolio of assets requiring
such reserve has decreased in size from mid-1998 to mid-1999.
We establish a credit reserve through credit provisions to cover estimated
future losses from mortgage loans and securities. We take these provisions for
residential mortgage loans held for investment and for mortgage securities rated
lower than "BBB".
OPERATING EXPENSES
In the second quarter of 1999, total operating expenses for our mortgage finance
operations were $0.9 million. Total operating expenses for the first quarter of
1999 were $0.7 million. Total operating expenses for the second quarter of 1998
were $0.6 million.
On-going operating expenses as a percentage of assets were 0.16% in the second
quarter of 1999, 0.11% in the first quarter of 1999, and 0.06% in the second
quarter of 1998. Operating expenses as a percentage of equity were 1.54% in the
second quarter of 1999, 1.14% in the first quarter of 1999, and 0.69% in the
second quarter of 1998. These ratios have increased over time as we have
decreased the size of our portfolio and reduced our equity through the
repurchase of stock. In addition, operating expenses have risen as we prepare
for future growth.
Total operating expenses for the mortgage finance operations for the first six
months of 1999 were $1.7 million. Total operating expenses for the first six
months of 1998 were $2.5 million.
Operating expenses as a percentage of assets were 0.13% in the first six months
of 1999 and 0.14% in the first six months of 1998. Operating expenses as a
percentage of equity were 1.47% in the first six months of 1999, and 1.34% in
the first six months of 1998.
NET EARNINGS FROM MORTGAGE FINANCE OPERATIONS
Net earnings from mortgage finance operations, which equals net operating
revenue less operating expenses, were $7.0 million in the second quarter of
1999. In the first quarter of 1999, net earnings were $9.0 million. In the
second quarter of 1998, net earnings were $0.8 million.
In the first six months of 1999, net earnings totaled $16.0 million. In the
first six months of 1998, net earnings were $3.9 million.
EQUITY IN EARNINGS (LOSSES) OF RWT HOLDINGS, INC.
Our share of the losses generated by start-up operations at Holdings, our
mortgage production affiliate, was $3.8 million in the second quarter of 1999.
We recognized losses from Holdings of $2.5 million in the first quarter of 1999
and a loss of $0.6 million in the second quarter of 1998.
In the first six months of 1999, our share of losses from Holdings was $6.3
million. During the first six months of 1998, our share of losses was $0.6
million.
We refer you to Holdings' "Consolidated Financial Statements and Notes" and
Holdings' "Management's Discussion and Analysis" below for more information on
Holdings.
38
<PAGE> 39
NET INCOME
Net income for all of our operations was $3.2 million in the second quarter of
1999. After preferred dividends of $0.7 million, net income available to common
stockholders was $2.5 million.
In the first quarter of 1999, net income from all of our operations was $6.6.
After preferred dividends of $0.7 million, net income available to common
shareholders was $5.9 million.
In the second quarter of 1998, our net income was $0.2 million. After preferred
dividends of $0.7 million, the net loss was $0.5 million.
In the first six months of 1999, net income for all of our operations was $9.7
million. After preferred dividends of $1.4 million, net income available to
common stockholders was $8.4 million.
In the first six months of 1998, net income for all of our operations was $3.3
million. After preferred dividends of $1.4 million, net income available to
common stockholders was $2.0 million.
EARNINGS PER SHARE
Average diluted common shares outstanding were 10.2 million in the second
quarter of 1999, 10.9 million in the first quarter of 1999, and 14.3 million in
the second quarter of 1998. Diluted earnings per share were $0.25 in the second
quarter of 1999, $0.54 in the first quarter of 1999, and negative $0.03 in the
second quarter of 1998.
Average diluted common shares outstanding were 10.5 million in the first six
months of 1999 compared to 14.4 million in the first six months of 1998. Diluted
earnings per share were $0.79 in the first six months of 1999 and $0.14 in the
first six months of 1998.
Shares outstanding declined as a result of our common stock repurchase program.
DIVIDENDS
We paid no common stock dividends for the first half of 1999. We paid common
stock dividends totaling $0.28 per share in the first six months of 1998.
Under the minimum REIT dividend distribution rules, we were not required to
declare a common stock dividend in the first or second quarter of 1999. While we
had more than ample liquidity and balance sheet strength to pay a dividend in
those quarters, we chose to retain our capital for use in our operations and our
common stock repurchase program.
RISK MANAGEMENT
MARKET VALUE RISK
The market value of our assets can fluctuate due to changes in interest rates,
prepayment rates, liquidity, financing, supply and demand, credit and other
factors. These fluctuations affect our earnings.
At June 30, 1999, we owned mortgage securities and loans totaling $1.0 billion
that we account for on a mark-to-market basis or, in the case of mortgage loans,
on a lower-of-cost-or-market basis. Of these assets, 92% had adjustable-rate
coupons and 8% had fixed-rate coupons.
Our interest rate agreements hedging program may offset some asset market value
fluctuations due to interest rate changes. All of our $4 billion in notional
amounts of interest rate agreements are marked-to-market for income statement
purposes.
Market value fluctuations of as assets and interest rate agreements, especially
to the extent assets are funded with short-term borrowings, can also affect our
access to liquidity.
39
<PAGE> 40
INTEREST RATE RISK
At June 30, 1999, we, including Sequoia, owned $2.2 billion of assets and had
$2.0 billion of liabilities. The majority of the assets are adjustable-rate, as
are a majority of the liabilities.
Fixed-rate assets and hybrid mortgage assets (with fixed-rate coupons for 3 to 7
years and adjustable-rate coupons thereafter) totaled $0.5 billion, or 25% of
total assets. We had debt that had interest rate reset characteristics matched
to these hybrid mortgages totaling $0.4 billion.
We owned interest rate agreements with a notional face of $4 billion.
On average, our cost of funds has the ability to rise or fall more quickly as a
result of changes in short-term interest rates than does our earning rate on the
assets. In the case of a large increase in short-term interest rates, periodic
and lifetime caps for a portion of our assets could limit increases in interest
income. The risk of reduced earnings in a rising interest rate environment is
mitigated to some extent by our interest rate agreements hedging program.
Our net income may vary somewhat as the yield curve between one-month interest
rates and six- and twelve-month interest rates varies. At June 30, 1999, we
effectively owned $0.8 billion of adjustable-rate mortgages assets with interest
rates that adjust every six or twelve months off of interest rates of the same
maturity funded with $0.8 billion of our debt that has an interest rate that
adjusts monthly off of one-month LIBOR interest rates.
Adjustable-rate assets with earnings rates dependent on U.S. Treasury rates
totaled $0.6 billion at June 30, 1999. Liabilities with a cost of funds
dependent on U.S. Treasury rates totaled $0.4 billion at that time. As part of
our hedging program, we also had $0.3 billion notional amount of basis swaps
that, in effect, increased our U.S. Treasury-based liabilities to $0.7 billion.
Thus, at June 30, 1999, we had little earnings risk with respect to the risk of
U.S. Treasury rates deviating from LIBOR market rates.
Changes in interest rates affect prepayment rates (see below) and influence
other factors that may affect our results.
LIQUIDITY RISK
Our primary liquidity risk arises from financing long-term mortgage assets with
short-term debt. Even if the interest rate adjustments of these assets and
liabilities are well matched, maturities may not be matched. In addition, trends
in the liquidity of the U.S. capital markets in general may affect our ability
to roll-over short-term debt.
The assets that we pledge to secure short-term borrowings are high-quality,
liquid assets. As a result, we have not had difficulty refinancing our
short-term debt as it matures, even during the financial market liquidity crisis
in late 1998. Still, changes in the market values of our assets, in our
perceived credit worthiness, and in the capital markets, can impact our access
to liquidity.
At June 30, 1999, we had $134 million of highly liquid assets which were
unpledged and available to meet margin calls on short-term debt that could be
caused by asset value declines or changes in lender over-collateralization
requirements. These assets consisted of unrestricted cash and unpledged "AAA"
rated mortgage securities. Total available liquidity equaled 15% of our
short-term debt balances.
We have entered into borrowings with maturities beyond December 31, 1999 which
fund the substantial majority of our assets in order to avoid the need to
roll-over debt in advance of the beginning of the Year 2000.
PREPAYMENT RISK
As we receive repayments of mortgage principal, we amortize into income our
mortgage premium balances as an expense and our mortgage discount balances as
income. Mortgage premium balances arise when we acquire mortgage assets at a
price in excess of the principal value of the mortgages. Premium balances are
also created when an asset appreciates and is marked-to-market at a price above
par. Mortgage discount balances arise when
40
<PAGE> 41
we acquire mortgage assets at a price below the principal value of the
mortgages, or when an asset depreciates in market value and is marked-to-market
at a price below par. At June 30, 1999, mortgage premium balances were $26
million and mortgage discount balances were $12 million. Net mortgage premium
was $14 million.
Sequoia's long-term debt has associated deferred bond issuance costs. These
capitalized costs are amortized as an expense as the bonds are paid off with
mortgage principal receipts. These deferred costs totaled $3 million at June 30,
1999. In addition, premium received from the issuance of bonds at prices over
principal value is amortized as income as the bond issues pay down. These
balances totaled $5 million at June 30, 1999. The combined effect of these two
items was to reduce our effective mortgage-related premium by $1 million.
Our net premium at June 30, 1999 for assets and liabilities affected by the rate
of mortgage principal receipts was $13 million. This net premium equaled 5.2% of
total common equity. Amortization expense and income will vary as prepayment
rates on mortgage assets vary. In addition, changes in prepayment rates will
effect the market value of our assets and our earnings. Changes in the value of
our assets, to the extent they are incorporated into the basis of our assets,
will also affect future amortization expense.
CREDIT RISK
Our principal credit risk comes from mortgage loans owned by Sequoia, mortgage
loans held in portfolio, and our lower-rated mortgage securities. We also have
credit risk with counter-parties with whom we do business.
Not including Sequoia, we owned $67 million in residential mortgage loans at
June 30, 1999. Of these, $0.4 million were seriously delinquent (delinquent over
90 days, in foreclosure, in bankruptcy, or real estate owned). We also owned $20
million in commercial mortgage loans. These commercial mortgage loans were all
current at June 30, 1999.
The three Sequoia trusts owned $1.1 billion in residential mortgage loans at
June 30, 1999. Our total credit risk from these trusts is limited to our equity
investment in these trusts. These equity investments had a reported value of $35
million at June 30, 1999. At that time, $6.3 million of the underlying loans, or
0.58%, were seriously delinquent.
At June 30, 1999, we had $4.5 million loan of credit reserves to provide for
potential future credit losses from our mortgage loans. Total seriously
delinquent loans had a loan balance of $6.7 million. To date, our realized
credit losses from defaulted residential mortgage loans have averaged 8% of the
loan balance of the defaulted loans. Loss severity may increase in the future,
however, particularly if real estate values decline.
We believe our current level of reserve and credit provision policy is
reasonable and we will continue to increase our credit reserve over time in
anticipated of future potential losses.
At June 30, 1999, we also had $1.0 million credit reserves for our lower rated
mortgage securities. Our total potential credit exposure from these securities
(after this credit reserve) was $8 million. We believe this reserve is likely to
be sufficient to cover currently foreseen credit losses. As we acquire
additional subordinated securities, we will continue to build up this reserve in
anticipation of future potential losses.
CAPITAL RISK
Our capital levels, and thus our access to borrowings and liquidity, may be
tested, particularly if the market value of our assets securing short-term
borrowings declines.
Through our risk-adjusted capital policy, we assign a guideline capital adequacy
amount, expressed as a guideline equity-to-assets ratio, to each of our mortgage
assets. For short-term funded assets, this ratio will fluctuate over time, based
on changes in that asset's credit quality, liquidity characteristics, potential
for market value fluctuation, interest rate risk, prepayment risk, and the
over-collateralization requirements for that asset set by our collateralized
short-term lenders. Capital requirements for equity interests in Sequoia trusts
and for lower rated mortgage securities generally equal our net investment. The
sum of the capital adequacy amounts for all of our mortgage assets is our
aggregate guideline capital adequacy amount.
41
<PAGE> 42
The total guideline equity-to-assets ratio capital amount has declined over the
last few years as we have eliminated some of the risks of short-term debt
funding through issuing long-term debt. In the most recent quarters, however,
the total guideline ratio has increased as we have acquired new types of assets
such as commercial loans.
We do not expect that our actual capital levels will always exceed the guideline
amount. If interest rates were to rise in a significant manner, our capital
guideline amount would rise. As the potential interest rate risk of our
mortgages would increase, at least on a temporary basis, due to periodic and
life caps and slowing prepayment rates. We measure all of our mortgage assets
funded with short-term debt at estimated market value for the purpose of making
risk-adjusted capital calculations. Our actual capital levels, as determined for
the risk-adjusted capital policy, would likely fall as rates increase as the
market values of our mortgages, net of mark-to-market gains on hedges,
decreased. (Such market value declines may be temporary as well, as future
coupon adjustments on adjustable-rate mortgage loans may help to restore some of
the lost market value.)
In this circumstance, or any other circumstance in which our actual capital
levels decreased below our capital adequacy guideline amount, we would generally
cease the acquisition of new mortgage assets until capital balance was restored
through prepayments, interest rate changes, or other means. In certain cases
prior to a planned equity offering or other circumstances, the Board of
Directors has authorized management to acquire mortgage assets in a limited
amount beyond the usual constraints of our risk-adjusted capital policy.
Growth in assets and earnings may be limited when our access to new equity
capital is limited. Holdings can benefit over time from the re-investment of
retained earnings at Holdings. Our mortgage finance operations, however, are
generally required to distribute at least 95% of taxable income as dividends.
INFLATION RISK
Virtually all of our assets and liabilities are financial in nature. As a
result, interest rates, changes in interest rates and other factors drive our
performance far more than does inflation. Changes in interest rates do not
necessarily correlate with inflation rates or changes in inflation rates.
Our financial statements are prepared in accordance with Generally Accepted
Accounting Principles and our dividends are generally determined based on our
REIT net income as calculated for tax purposes. In each case, our activities and
balance sheet are measured with reference to historical cost or fair market
value without considering inflation.
YEAR 2000 READINESS DISCLOSURE
In 1998, we established a Year 2000 Project. The goal of this on-going project
is to ensure that our communications, data, and information systems are ready
for the Year 2000 and to employ prudent management to minimize any potential
negative impact of the Year 2000 on our business partners and our investors.
Senior management has taken an active role in the Year 2000 Project and provides
updates to the Board of Directors as necessary.
Our definition of "Readiness for the Year 2000" includes testing 100% of our
internal systems (hardware and software) to ensure that Year 2000 dates are
retained and correctly roll from December 31, 1999 to January 1, 2000 and from
February 28, to February 29, to March 1, 2000. It also includes having an
enterprise-wide contingency and disaster recovery plan for any known Year 2000
issues (and to the extent possible, other unforeseeable circumstances).
Our project management strategies include system risk assessment, system
upgrades or workarounds, and contingency planning. We believe we are devoting
the necessary resources to address all appropriate Year 2000 issues. We do not
currently anticipate incurring costs related to the Year 2000 issue that would
be material to our financial position, results of operations, or cash flows in
future periods.
42
<PAGE> 43
We commenced operations within the past five years and have built our internal
systems on a client-server model. Thus, we are not aware of any internal
"legacy" computer systems or software issues.
Existing internal computer systems have been successfully tested and any
additions to the existing systems and new systems are tested upon installation.
Hardware testing included forward date testing of the December 31, 1999 to
January 1, 2000 rollover and leap year 2000. Critical software applications used
to manage our businesses were also successfully tested.
As systems are modified or new hardware or software systems are implemented in
the normal course of business, our policy is to receive certification of Year
2000 compliance and to test for Year 2000 compliance upon installation.
We continue to gather and assess information regarding our business partners'
Year 2000 readiness. We solicited Year 2000 disclosures directly through our own
questionnaire and initiated direct discussions with certain key business
partners. A majority of questionnaire responses was received prior to July 1999.
No significant year 2000 issues have been identified through this process. We
will continue to monitor public disclosures by key business partners into the
Year 2000.
Business partners that provide information or services through externally
controlled or externally coordinated systems have been identified. Joint testing
of certain systems has been initiated. External joint testing is targeted for
completion by September 30, 1999.
We, together with our affiliates, are developing contingency plans and
workaround systems for critical systems. Workarounds may include substituting
compliant business partners for those who are non-compliant. The benefit of this
contingency plan is likely to be limited due to our lack of control on external
vendors and inability to replace certain business partners efficiently.
We believe we are devoting the necessary technical and management resources to
address the Year 2000 issues over which we have control. While it is inherently
difficult to assess the impact our vendors and their vendors may have on us in
the event they are unable to successfully manage their own year 2000 issues, we
believe we are on plan to reach our Year 2000 Project goals by October 1999.
43
<PAGE> 44
RWT HOLDINGS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RWT Holdings, Inc., or "Holdings" was incorporated in Delaware in February 1998
and commenced operations on April 1, 1998. Holdings' start-up operations have
been funded primarily by Redwood Trust, which has a significant investment in
Holdings through the ownership of all of Holdings' preferred stock. We refer you
to "Note 1. The Company" in the Notes to the Consolidated Financial Statements
of RWT Holdings, Inc. and Subsidiaries for additional information on Holdings'
initial capitalization.
At June 30, 1999, Holdings owned $13 million of residential mortgage loans, $8
million of commercial mortgage loans, and $42 million of residential mortgage
securities. Holdings also had $9 million in cash and $4 million in other assets,
for total assets of $76 million. Holdings had commitments to acquire $24 million
of commercial loans and $49 million of residential mortgage loans from Redwood
Trust.
The loans owned by Holdings were funded with short-term borrowings and equity.
Short-term debt was $53 million, loans from Redwood Trust were $2 million, and
other liabilities totaled $2 million. Total equity at June 30, 1999 was $19
million.
At December 31, 1998, Holdings owned $12 million of residential mortgage loans,
$10 million in cash, and $1 million in other assets, for total assets of $23
million. Loans from Redwood Trust totaled $7 million and other liabilities were
$1 million. Equity at this time totaled $15 million.
In the second quarter of 1999, net operating revenue totaled $0.4 million,
including interest income of $1.0 million, net asset appreciation income of $0.1
million, and interest expenses of $0.7 million. Operating expenses at Holdings
totaled $4.2 million in the second quarter of 1999. Holdings' net loss in the
second quarter of 1999 was $3.8 million.
In the first quarter of 1999, net operating revenue totaled $0.4 million,
including interest income of $1.0 million, net asset appreciation income of $0.1
million, and interest expenses of $0.7 million. In the first quarter of 1999,
operating expenses at Holdings totaled $3.3 million and Holdings' net loss was
$2.5 million.
In the second quarter of 1998, net operating revenue totaled $0.2 million,
including interest income of $2.9 million, minimal net asset appreciation
income, and interest expenses of $2.7 million. In the second quarter of 1998,
operating expenses at Holdings totaled $0.8 million and Holdings' net loss was
$0.6 million.
In the first six months of 1999, net operating revenue totaled $1.2 million,
including interest income of $1.5 million, net asset appreciation income of $0.6
million, and interest expenses of $1.0 million. Operating expenses at Holdings
totaled $7.5 million in the first six months of 1999. Holdings' net loss during
this six-month period was $6.3 million.
In the first six months of 1998, net operating revenue totaled $0.2 million,
including interest income of $2.9 million, minimal net asset appreciation
income, and interest expenses of $2.7 million. In the first six months of 1998,
operating expenses at Holdings totaled $0.8 million and Holdings' net loss was
$0.6 million.
Holdings pre-tax loss as reported for GAAP currently equals its after-tax loss.
Due to the start-up nature of its operations, Holdings is not able to accrue a
tax benefit relating to its operating losses for GAAP at this time. Each of the
Holdings' operations is still in start-up mode. Holdings currently expects these
operations to become profitable in the first half of year 2000.
On August 10, 1999, we announced our intention to consolidate the operations of
our two residential mortgage production subsidiaries, RFS and RRF. The sales,
marketing, trading, technology, and securitization operations of these two units
will be integrated together. Overall headcount will be reduced. In connection
with this consolidation, Holdings expects to take a restructuring charge of up
to $2 million in the third quarter of 1999.
44
<PAGE> 45
PART II OTHER INFORMATION
Item 1. Legal Proceedings
At June 30, 1999, there were no pending legal proceedings to which the
Company was a party or of which any of its property was subject.
Item 2. Changes in Securities
In May, 1999, the Bonds issued pursuant to the Indenture, dated as of
June 1, 1997, between Sequoia Mortgage Trust 1 and First Union National
Bank, as Trustee, were redeemed, restructured and contributed to
Sequoia Mortgage Trust 1A, interests in which were then privately
placed with investors.
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of Shareholders of the Company was held on May
6, 1999.
(b) The following matters were voted on at the Annual Meeting:
<TABLE>
<CAPTION>
Votes
-----------------------------
For Against Abstain
-----------------------------
<S> <C> <C> <C>
1. Election of Directors
Thomas F. Farb 9,746,601 1,000 --
Douglas B. Hansen 9,747,601 -- --
Charles J. Toeniskoetter 9,688,701 58,900 --
Thomas C. Brown 9,746,099 1,502 --
</TABLE>
The following Directors' terms of office continue after the meeting:
George E. Bull
Mariann Byerwalter
Dan A. Emmett
Nello Gonfiantini
<TABLE>
<CAPTION>
Votes
-------------------------------
For Against Abstain
-------------------------------
<S> <C> <C> <C>
2. Approval of amendment to the
Company's Stock Option Plan. 8,982,773 747,722 59,028
</TABLE>
<TABLE>
<CAPTION>
Votes
-----------------------------------
For Against Abstain
-----------------------------------
<S> <C> <C> <C>
3. Ratification of PricewaterhouseCoopers LLP
as the Company's independent
public accountants for the fiscal
year ending December 31, 1999. 9,765,618 12,131 11,774
</TABLE>
45
<PAGE> 46
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 4.4 - In May, 1999, the Bonds issued pursuant to the
Indenture, dated as of June 1, 1997, between Sequoia
Mortgage Trust 1 and First Union National Bank, as
Trustee, were redeemed, restructured and contributed
to Sequoia Mortgage Trust 1A, interests in which were
then privately placed with investors.
Exhibit 4.4.2 - Sequoia Mortgage Trust 1A Trust Agreement,
dated as of May 4, 1999 between Sequoia Mortgage
Trust 1 and First Union National Bank.
Exhibit 11.1 to Part I - Computation of Earnings Per Share
for the three and six months ended June 30, 1999 and
June 30, 1998.
Exhibit 27 - Financial Data Schedule
(b) Reports
None
46
<PAGE> 47
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
REDWOOD TRUST, INC.
Dated: August 10, 1999 By: /s/ Douglas B. Hansen
--------------------------------------
Douglas B. Hansen
President
(authorized officer of registrant)
Dated: August 10, 1999 By: /s/ Martin S. Hughes
--------------------------------------
Martin S. Hughes
Chief Financial Officer
(principal accounting officer)
47
<PAGE> 48
REDWOOD TRUST, INC.
INDEX TO EXHIBIT
<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Page
------- ------------
<S> <C> <C>
4.4.2 Sequoia Mortgage Trust 1A Trust Agreement, dated as of May 4, 1999
between Sequoia Mortgage Trust 1 and First Union National Bank............ 49
11.1 Computations of Earnings per Share........................................ 98
27 Financial Data Schedule.................................................. 100
</TABLE>
48
<PAGE> 1
EXHIBIT 4.4.2
EXECUTION
SEQUOIA MORTGAGE TRUST 1,
DEPOSITOR
AND
FIRST UNION NATIONAL BANK,
TRUSTEE
-----------------------------------------
TRUST AGREEMENT
Dated May 4, 1999
------------------------------------------
$157,266,300
Mortgage Bond-Backed Certificates
Series 1999-A
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
ARTICLE I
DEFINITIONS
Section 1.01. Definitions........................................................................1
Section 1.02. Calculations Respecting Accrued Interest...........................................6
ARTICLE II
CONVEYANCE OF THE UNDERLYING BONDS;
ORIGINAL ISSUANCE OF CERTIFICATES
Section 2.01. Conveyance of the Underlying Bonds.................................................6
Section 2.02. Issuance of Certificates...........................................................7
ARTICLE III
ADMINISTRATION OF THE UNDERLYING BONDS
Section 3.01. Collection of Payments on Underlying Bonds; Certificate Account....................7
Section 3.02. Distributions......................................................................8
Section 3.03. [Reserved].........................................................................8
Section 3.04. Statements to Certificateholders...................................................8
Section 3.05. No Segregation of Moneys...........................................................9
Section 3.06. Tax Status and Reporting...........................................................9
ARTICLE IV
THE CERTIFICATES
Section 4.01. The Certificates..................................................................10
Section 4.02. Registration of and Limitations on Transfer and Exchange of Certificates..........10
Section 4.03. Mutilated, Destroyed, Lost or Stolen Certificates.................................13
Section 4.04. Persons Deemed Owners.............................................................14
ARTICLE V
THE TRUSTEE
Section 5.01. Representation and Warranty.......................................................14
Section 5.02. Directions to Trustee.............................................................14
Section 5.03. Liability of the Trustee..........................................................14
Section 5.04. Merger or Consolidation of the Trustee............................................14
Section 5.05. Limitation on Liability of the Trustee and Others.................................15
Section 5.06. Trustee's Compensation............................................................16
Section 5.07. Resignation and Removal of the Trustee............................................16
Section 5.08. Successor Trustee.................................................................17
ARTICLE VI
TERMINATION
Section 6.01. Termination Upon Distribution to Certificateholders...............................17
Section 6.02. Failure of Certificateholders to Surrender Certificates...........................18
</TABLE>
i
<PAGE> 3
<TABLE>
<S> <C> <C>
ARTICLE VII
MISCELLANEOUS PROVISIONS
Section 7.01. Amendment.........................................................................18
Section 7.02. Limitation on Rights of Certificateholders........................................19
Section 7.03. Limitation on Liability of the Depositor and Others...............................20
Section 7.04. Governing Law.....................................................................20
Section 7.05. Notices...........................................................................20
Section 7.06. Severability of Provisions........................................................21
Section 7.07. Certificates Nonassessable and Fully Paid.........................................21
Section 7.08. Limitations of Liability..........................................................21
ARTICLE VIII
SECURITIES ACCOUNT
Section 8.01. The Securities Account............................................................22
Section 8.02. Definitions.......................................................................24
Section 8.03. Liability of the Securities Intermediary..........................................25
Exhibit A - Forms of Certificates
Exhibit B - Schedule of Underlying Bonds
Exhibit C - Form of Rule 144A Investment Letter
Exhibit D - Form of Non-Rule 144A Investment Letter
</TABLE>
ii
<PAGE> 4
This Trust Agreement (this "Agreement"), dated May 4, 1999, is between
SEQUOIA MORTGAGE TRUST 1, a Delaware business trust, as Depositor (the
"Depositor"), and FIRST UNION NATIONAL BANK, a national banking association, as
Trustee (the "Trustee").
WITNESSETH THAT:
In consideration of the mutual agreements herein contained, the
Depositor and the Trustee agree as follows:
ARTICLE I
DEFINITIONS
Section 1.01. Definitions. Whenever used in this Agreement, the
following words and phrases, unless the context otherwise requires, shall have
the following meanings:
Accrual Period: With respect to any Distribution Date, the one-month
period beginning on the immediately preceding Distribution Date and ending on
the day immediately preceding the related Distribution Date.
Administrator: Norwest Bank Minnesota, N.A., as administrator under the
Bond and Tax Administration Agreement, dated as of May 4, 1999, by and among the
Depositor, the Company, Redwood Trust, the Trustee and the Administrator.
Available Interest Amount: With respect to any Distribution Date, the
total amount paid in respect of interest on the Underlying Bonds on such
Distribution Date.
Available Principal Amount: With respect to any Distribution Date, the
total amount paid in respect of principal on the Underlying Bonds on such
Distribution Date.
Book-Entry Certificate: Any Certificate registered in the name of the
Depository or its nominee, ownership of which is reflected on the books of the
Depository or on the books of a Person maintaining an account with such
Depository (directly or as an indirect participant in accordance with the rules
of such Depository).
Business Day: Any day other than a Saturday, Sunday or a day on which
banking or savings institutions in the city and state in which the Trustee's
Corporate Trust Office (or, if different, the corporate trust office of the
Underlying Trustee) is located or in the State of Maryland or in New York, New
York are authorized or obligated by law or executive order to be closed.
Carryforward Interest: With respect to any Distribution Date and each
Class of Certificates, the sum of (a) the amount, if any, by which (i) the sum
of (x) Current Interest for such Class for the immediately preceding
Distribution Date and (y) any Unpaid Carryforward Interest for such Class for
such immediately preceding Distribution Date exceeds (ii) the amount distributed
in respect of interest on such Class on such immediately preceding Distribution
Date and (b) accrued interest thereon at the applicable Interest Rate.
<PAGE> 5
Certificate: Any one of the Certificates, each evidencing an undivided
percentage ownership interest in the Trust Fund and executed by the Trustee, in
substantially the form set forth in Exhibit A hereto.
Certificate Account: The trust account created and maintained with the
Trustee pursuant to Section 3.01 and referred to therein as the Certificate
Account. Funds deposited in the Certificate Account shall be held in trust for
the Certificateholders for the uses and purposes set forth in Article III
hereof.
Certificate Owner: With respect to any Book-Entry Certificate, the
Person that is the beneficial owner thereof.
Certificate Register: Shall have the meaning provided in Section 4.02.
Certificateholder or Holder: The person in whose name a Certificate is
registered in the Certificate Register, except that, solely for the purpose of
giving any consent pursuant to this Agreement (except for any consent pursuant
to Section 7.01), any Certificate registered in the name of the Depositor or the
Trustee or any affiliate of either shall be deemed not to be outstanding.
Class: Collectively, all of the Certificates bearing the same
designation.
Closing Date: May 4, 1999.
Code: The Internal Revenue Code of 1986, as amended, and the rules and
regulations promulgated thereunder.
Corporate Trust Office: The principal corporate trust office of the
Trustee located at 230 South Tryon Street, Charlotte, North Carolina 28288-1179,
or at such other address as the Trustee may designate from time to time by
notice to the Certificateholders, or the principal corporate trust office of any
successor Trustee.
Current Interest: With respect to each Class of Certificates and any
Distribution Date, the aggregate amount of interest accrued during the
immediately preceding Accrual Period at the applicable Interest Rate on the
Principal Amount or Notional Amount of such Class for such Distribution Date.
Definitive Certificate: Any Certificate, issued in definitive, fully
registered form.
Denomination: For each Certificate, the amount designated as the
original principal amount or notional amount of such Certificate on the face
thereof.
Depositor: Sequoia Mortgage Trust 1, a Delaware business trust, or its
successor in interest.
Depository: The initial Depository shall be The Depository Trust
Company, the nominee of which is Cede & Co. The Depository shall at all times be
a "clearing corporation" as defined
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<PAGE> 6
in Section 8-102(a)(5) of the Uniform Commercial Code of the State of New York,
as amended, or any successor provisions thereto.
Depository Participant: A broker, dealer, bank or other financial
institution or other Person for which, from time to time, the Depository effects
book-entry transfers and pledges of securities deposited with such Depository.
Distribution Date: The same meaning as "Payment Date" as defined in the
Underlying Indenture.
Eligible Account: Either (i) an account or accounts maintained with a
federal or state chartered depository institution or trust company (x) the
short-term unsecured debt obligations of which (or, in the case of a depository
institution or trust company that is the principal subsidiary of a holding
company, the short-term unsecured debt obligations of such holding company) are
rated "Aaa" by Moody's and "AAA" by S&P (or comparable ratings if Moody's and
S&P are not the Rating Agencies) at the time any amounts are held on deposit
therein, or (y) otherwise approved in writing by each Rating Agency, (ii) an
account or accounts the deposits in which are insured by the FDIC or the FSLIC
to the limits established by such corporations; provided that any amounts on
deposit therein do not exceed such insurable limits, or (iii) a trust account or
accounts (which shall be a "special deposit account") maintained with a federal
or state chartered depository institution or trust company, acting in its
fiduciary capacity, in a manner acceptable to each Rating Agency in respect of
mortgage pass-through certificates rated in one of the two highest rating
categories. If otherwise permitted by this definition, accounts maintained with
the Trustee (or an affiliate thereof) may constitute Eligible Accounts.
ERISA: The Employee Retirement Income Security Act of 1974, as amended,
and the rules and regulations promulgated thereunder.
Final Distribution Date: The Distribution Date set forth in the notice
delivered by the Trustee of the final distribution on the Certificates pursuant
to Section 6.01.
Independent: When used with respect to any specified Person means such
a Person who (i) is in fact independent of the Depositor, (ii) does not have any
direct financial interest or any material indirect financial interest in the
Depositor, and (iii) is not connected with the Depositor as an officer,
employee, promoter, underwriter, trustee, partner, director or person performing
similar functions.
Interest Rate: With respect to each Class of Certificates and each
Distribution Date, the per annum rate of interest applicable to Certificates of
such Class, as specified below:
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<PAGE> 7
<TABLE>
<CAPTION>
Class Interest Rate
----- -------------
<S> <C>
A The lesser of (i) LIBOR plus 0.40% and (ii) 10.38%.
X The amount, if any, by which (a) the interest rate
applicable to the Underlying Bonds exceeds (b) the
Interest Rate applicable to the Class A Certificates.
</TABLE>
LIBOR: As defined in the Underlying Master Servicing Agreement.
Moody's: Moody's Investors Service, or any successor thereto.
Mortgage Loan: Each mortgage loan included in the Underlying Trust
Estate at any time.
Notional Amount: With respect to any Distribution Date and the Class X
Certificates, an amount equal to the Principal Amount of the Class A
Certificates for such Distribution Date.
Opinion of Counsel: A written opinion of counsel, which may be counsel
for the Depositor or the Trustee, except that any opinion of counsel concerning
certain matters with respect to ERISA, or the taxation, or the federal income
tax status, of the Trust Fund, must be an opinion of Independent counsel.
Outstanding: With respect to the Certificates, as of any date of
determination, all Certificates theretofore executed, authenticated and
delivered under this Agreement except:
(i) Certificates theretofore cancelled by the Registrar or
delivered to the Trustee for cancellation; and
(ii) Certificates in exchange for or in lieu of which other
Certificates have been executed, authenticated and delivered pursuant
to this Agreement unless proof satisfactory to the Trustee is presented
that any such Certificates are held by a holder in due course.
Ownership Interest: As to any Certificate, any ownership or security
interest in such Certificate, including any interest in such Certificate as the
Holder thereof and any other interest therein, whether direct or indirect, legal
or beneficial, as owner or as pledgee.
Percentage Interest: As to any Certificate, the percentage interest
represented thereby, such percentage interest being equal to the percentage
obtained by dividing the Denomination of such Certificate by the original
aggregate Principal Amount or Notional Amount of such Class of Certificates.
Person: Any individual, corporation, partnership, joint venture,
association, joint-stock company, trust, unincorporated organization or
government or any agency or political subdivision thereof.
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<PAGE> 8
Principal Amount: With respect to any Distribution Date (without giving
effect to distributions on such date) and the Class A Certificates, the original
Principal Amount thereof less the sum of all previous distributions in reduction
of the Principal Amount of such Class.
Private Placement Memorandum: The private placement memorandum dated
April 30, 1999, relating to the Certificates.
Qualified Institutional Buyer: As defined in Rule 144A under the
Securities Act.
Rating Agency: Each of Moody's and S&P.
Record Date: With respect to any Distribution Date, the last Business
Day immediately preceding such Distribution Date, or in the case of the first
Distribution Date, the Closing Date.
Registrar: Initially the Trustee, in its capacity as Registrar, or any
successor to the Trustee in such capacity.
Responsible Officer: When used with respect to the Trustee, the
Chairman or Vice Chairman of the Board of Directors or Trustees, the President,
any senior vice president, any vice president, any assistant vice president, the
Secretary, any assistant secretary, the Treasurer, any assistant treasurer in
the Corporate Trust division, or any other officer of the Trustee customarily
performing functions similar to those performed by any of the above designated
officers and having direct responsibility for the administration of this
Agreement and, with respect to a particular matter, to whom such matter is
referred because of such officer's knowledge of and familiarity with the
particular subject.
S&P: Standard & Poor's Rating Services, a division of The McGraw-Hill
Companies, Inc., or any successor thereto.
Schedule of Underlying Bonds: The schedule attached as Exhibit B
hereto, such schedule setting forth as to each Underlying Bond (i) the original
principal amount and (ii) the principal amount after giving effect to any
reduction in principal on or prior to the Closing Date.
Securities Act: The Securities Act of 1933, as amended, and the rules
and regulations promulgated thereunder.
Trust: The trust created by this Agreement.
Trust Fund: The corpus of the Trust consisting of (i) the Underlying
Bonds described in the Schedule of Underlying Bonds, (ii) all payments on the
Underlying Bonds payable after May 4, 1999, (iii) all amounts held from time to
time by the Trustee in the Certificate Account, and (iv) the Certificate
Account.
Trustee: First Union National Bank, in its capacity as trustee, or its
successor in interest, or any successor trustee appointed as herein provided.
Underlying Bond: Each of the securities identified on Exhibit B hereto.
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<PAGE> 9
Underlying Distribution Date Statement: The report provided by the
Underlying Trustee to the holders of related Underlying Bonds and to the Trustee
in connection with each Distribution Date.
Underlying Indenture: The indenture dated as of June 1, 1997, between
Sequoia Mortgage Trust 1, as the issuer, and First Union National Bank, as the
trustee, pursuant to which the Underlying Bonds were issued.
Underlying Master Servicing Agreement: The master servicing agreement
dated as of June 1, 1997, among Sequoia Mortgage Trust 1, as the issuer, Redwood
Trust, Inc., Norwest Bank Minnesota, N.A., as the master servicer, and First
Union National Bank, as the trustee.
Underlying Trust Estate: The collateral pledged to secure the
Underlying Bonds pursuant to the Underlying Indenture.
Underlying Trustee: With respect to the Underlying Bonds, the trustee
under the Underlying Indenture.
Unpaid Carryforward Interest: With respect to any Distribution Date and
each Class of Certificates, the aggregate of all Carryforward Interest for such
Class of Certificates for all previous Distribution Dates, less all
distributions made with respect to such Class of Certificates in respect of
Carryforward Interest on such previous Distribution Dates.
Section 1.02. Calculations Respecting Accrued Interest. Accrued
interest, if any, on any Certificate shall be calculated based upon a 360 day
year consisting of twelve 30 day months.
ARTICLE II
CONVEYANCE OF THE UNDERLYING BONDS; ORIGINAL
ISSUANCE OF CERTIFICATES
Section 2.01. Conveyance of the Underlying Bonds. The Depositor,
concurrently with the execution and delivery hereof, does hereby transfer,
convey, sell and assign to the Trustee, on behalf of the Holders of the
Certificates, without recourse, all the right, title and interest of the
Depositor in and to the Underlying Bonds, including all payments thereon payable
after May 4, 1999. In connection with such assignment, the Depositor shall have
caused the Underlying Bonds to be registered in the name of, or endorsed to the
order of, First Union National Bank, as trustee, or in a nominee name of the
Trustee, and to be delivered or transferred to the Trustee. The assignment of
the Underlying Bonds accomplished hereby is absolute and is intended as a sale.
The Depositor represents and covenants that the Underlying Bonds as of the
Closing Date are free and clear of any right, charge, security interest or lien
or claim in favor of the Depositor or any person claiming through the Depositor
(or any such security interest, lien or claim has been released) and that the
Depositor has, as of the Closing Date, the right to assign the Underlying Bonds
to the Trustee. The Depositor shall cooperate with the Trustee in providing any
required transfer documentation with respect to such conveyance. Any payment
received by the Depositor which shall be due to the Trustee hereunder shall be
paid immediately to the Trustee on or prior to the Closing Date.
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<PAGE> 10
In the event that any Underlying Bond has not been delivered or
transferred to the Trustee, together, in the case of Underlying Bonds in
definitive form, with any documentation necessary to effect the assignment
thereof to the Trustee, the Depositor shall, within two Business Days after its
receipt of notice that such delivery or transfer has not occurred, immediately
repurchase such Underlying Bond for a price equal to the principal amount
thereof plus interest accrued thereon at the applicable interest rate.
It is the intention of the Depositor that the transfer and assignment
of the Underlying Bonds shall constitute a sale from the Depositor to the Trust
and that such Underlying Bonds not be a part of the Depositor's estate in the
event of the insolvency of the Depositor. In the event the transfer and
assignment of the Underlying Bonds contemplated by this Agreement is deemed to
be other than a sale notwithstanding the intent of the parties hereto, this
Agreement shall be deemed to be and in such event hereby is the grant of a
security interest from the Depositor to the Trustee, and the Trustee shall have
all the rights, powers and privileges of a secured party under the Uniform
Commercial Code in effect in the applicable jurisdiction. In such event, the
Depositor agrees to take such action and execute such documents as shall be
necessary in order to fully realize the benefits of such secured party status,
including, without limitation, powers of attorney, financing statements, notices
of lien or other instruments or documents.
Section 2.02. Issuance of Certificates. The Trustee acknowledges the
transfer and delivery to it of the Underlying Bonds in the manner described in
Section 2.01 hereof and declares that the Trustee holds and will hold such
Underlying Bonds in trust for the benefit of all present and future
Certificateholders and, concurrently with such transfer and delivery, has caused
to be duly executed, authenticated and delivered to or upon the order of the
Depositor the Certificates in authorized Denominations, registered in such names
as the Depositor has requested.
ARTICLE III
ADMINISTRATION OF THE UNDERLYING BONDS
Section 3.01. Collection of Payments on Underlying Bonds; Certificate
Account. (a) The Trustee shall establish and maintain an account (the
"Certificate Account") entitled "Sequoia Mortgage Trust 1A Mortgage Bond-Backed
Certificates, Series 1999-A, Certificate Account," in which the Trustee shall
deposit, as soon as practicable after receipt, each payment received by the
Trustee with respect to the Underlying Bonds. The Certificate Account shall be
an Eligible Account.
(b) If the bank, trust company or other fiduciary serving as Trustee
hereunder is at any time not also serving as Underlying Trustee under the
Underlying Indenture, the following provisions of this paragraph shall apply. If
the Trustee shall not have received a payment with respect to an Underlying Bond
by the Business Day after the date on which such payment was due and payable
pursuant to the terms of such Underlying Bond, the Trustee shall request the
Underlying Trustee to make such payment as promptly as possible and legally
permitted and may, and at the direction of the Certificateholders shall, subject
to the penultimate sentence of this paragraph, take any available legal action,
including the prosecution of any claims in
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<PAGE> 11
connection therewith. The reasonable legal fees and expenses incurred by the
Trustee in connection with the prosecution of any such legal action shall be
reimbursed by the Depositor.
Section 3.02. Distributions. (a) On each Distribution Date the Trustee
shall distribute to the Certificateholders of record on the immediately
preceding Record Date, by wire transfer to an account specified in writing by
such Certificateholders at least five Business Days prior to the preceding
Record Date, or otherwise by check or by such other means of payment as such
Person and the Trustee shall agree, all amounts on deposit in the Certificate
Account; provided, however, that the Trustee shall not distribute to such
Holders any amount required to be withheld from a payment to such Holder by the
Code.
(b) Any amounts distributed to a particular Certificateholder pursuant
to this Section shall equal the aggregate Percentage Interest evidenced by such
Holder's Certificate(s) in the related Class multiplied by the aggregate of such
amounts to be distributed to such Class.
(c) On each Distribution Date the Trustee shall withdraw from the
Certificate Account the Available Interest Amount for such date and shall
distribute such amount in the following order of priority:
(i) concurrently, to the Class A Certificates and Class X
Certificates, in proportion to the amount of Current Interest for each
such Class, Current Interest for each such Class and such Distribution
Date; and
(ii) concurrently, to the Class A Certificates and Class X
Certificates, in proportion to the amount of Carryforward Interest for
each such Class, Carryforward Interest for each such Class and such
Distribution Date.
(d) On each Distribution Date, the Trustee shall withdraw from the
Certificate Account the Available Principal Amount for such date and shall
distribute such amount to the Holders of the Class A Certificates in reduction
of the Principal Amount thereof until the Principal Amount of the Class A
Certificates has been reduced to zero.
(e) The final distribution on any Certificate shall be made by wire
transfer or otherwise as above specified, after due notice by the Trustee to
each Holder of the pendency of such distribution and only upon surrender of such
Certificate at the Corporate Trust Office.
Section 3.03. [Reserved]
Section 3.04. Statements to Certificateholders. (a) On each
Distribution Date, the Trustee shall prepare, based on the information provided
by the Administrator, and forward by mail a statement to each Certificateholder
and each Rating Agency stating:
(i) the amount of principal distributable on such Distribution
Date to the Holders of the Class A Certificates;
(ii) the amount of Current Interest distributable on such
Distribution Date to the Holders of the Certificates;
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<PAGE> 12
(iii) the amount of Carryforward Interest distributable on such
Distribution date to the Holders of the Certificates;
(iv) the Interest Rate applicable to each Class of Certificates
with respect to such Distribution Date;
(v) the amount of principal and interest, if any, paid in
respect of each of the Underlying Bonds on the related Distribution
Date;
(vi) the outstanding principal balance of each of the
Underlying Bonds and the Principal Amount or Notional Amount, as
applicable, of each Class of Certificates as of such Distribution Date
after giving effect to distributions of principal on such Distribution
Date;
(vii) the amounts in (vi) above, expressed as percentages of
the aggregate principal balance of the related Mortgage Loans; and
(viii) the aggregate principal balance of the related Mortgage
Loans with respect to such Distribution Date.
In the case of information furnished pursuant to subclauses (i) through
(iii) above, the amounts shall be expressed as a dollar amount per Certificate
with a $1,000 denomination. The information furnished pursuant to subclauses
(iv) through (vii) inclusive shall be as reported in the Underlying Distribution
Date Statements.
(b) The Trustee shall, upon the request of any Certificateholder,
include copies of the most current Underlying Distribution Date Statements
previously delivered to the Trustee with each statement delivered pursuant to
subsection (a) above.
(c) For so long as any of the Certificates are "restricted securities"
within the meaning of Rule 144(a)(3) under the Securities Act, each of the
Depositor and the Trustee agree to cooperate with each other to provide to any
Certificateholders and to any prospective purchaser of Certificates designated
by such Certificateholder, upon the request of such Certificateholder or
prospective purchaser, any information required to be provided to such holder or
prospective purchaser to satisfy the condition set forth in Rule 144A(d)(4)
under the Securities Act. Any reasonable, out-of-pocket expenses incurred by the
Trustee in providing such information shall be reimbursed by the Depositor.
Section 3.05. No Segregation of Moneys. Money received by the Trustee
hereunder need not be segregated in any manner except to the extent required by
law, and as provided herein, and may be deposited under such general conditions
as may be prescribed by law, and the Trustee shall not be liable for any
interest thereon.
Section 3.06. Tax Status and Reporting. The Depositor has structured
this Agreement, and the Certificates have been (or will be) issued with the
intention that such Certificates qualify under applicable tax laws as
indebtedness. The Depositor, its affiliates, the Trustee and each
Certificateholder (or Certificate Owner) by acceptance of its Certificate (or,
in the case of a Certificate Owner, by virtue of such Certificate Owner's
acquisition of a beneficial interest
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<PAGE> 13
therein) agree to treat the Certificates (or beneficial interest therein) for
purposes of federal, state and local income or franchise taxes and any other tax
imposed on or measured by income, as indebtedness. Each Certificateholder agrees
that it will cause any Certificate Owner acquiring an interest in a Certificate
through it to comply with this Agreement as to treatment of the Certificate as
indebtedness for certain tax purposes.
ARTICLE IV
THE CERTIFICATES
Section 4.01. The Certificates. The Certificates shall be issued
substantially in the forms set forth in Exhibit A. The aggregate of the
Denominations of the Class A Certificates issued as of the Closing Date is
$157,266,300.00. The aggregate of the Denominations of the Class X Certificates
issued as of the Closing Date is $157,266,300.00.
The Class A Certificates shall be issued in minimum Denominations in
principal amount of $250,000 and integral multiples of $1 in excess thereof, and
the Class X Certificates will be issued in minimum Denominations in notional
amount of $20,000,000 and integral multiples of $1 in excess thereof; provided
that one Certificate of each such Class may be issued in any amount in excess of
such minimum denomination. The Certificates shall, on original issue, be
executed by the Trustee, not in its individual capacity but solely as Trustee,
authenticated by the Registrar and delivered by the Trustee to or upon the order
of Depositor upon receipt by the Trustee of the Underlying Bonds pursuant to
Section 2.01 hereof. The Class A Certificates shall initially be issued as
Book-Entry Certificates. The Class X Certificates shall initially be issued and
shall be maintained as Definitive Certificates. The Certificates shall be
executed by manual or facsimile signature on behalf of the Trustee by a
Responsible Officer. Certificates bearing the manual or facsimile signatures of
individuals who were, at the time when such signatures were affixed, authorized
to sign on behalf of the Trustee shall bind the Trustee, notwithstanding that
such individuals or any of them have ceased to be so authorized prior to the
authentication and delivery of such Certificates. No Certificate shall be
entitled to any benefit under this Agreement, or be valid for any purpose,
unless such Certificate shall have been manually authenticated by the Registrar
substantially in the form set forth in Exhibit A, and such manual signature upon
any Certificate shall be conclusive evidence, and the only evidence, that such
Certificate has been duly authenticated and delivered hereunder. All
Certificates shall be dated the date of their authentication and delivery.
Section 4.02. Registration of and Limitations on Transfer and Exchange
of Certificates.
(a) The Registrar shall cause to be kept at its Corporate Trust Office
a Certificate Register (the "Certificate Register") in which, subject to such
reasonable regulations as it may prescribe, the Registrar shall provide for the
registration of Certificates and of transfers and exchanges of Certificates as
herein provided.
Subject to the restrictions and limitations set forth below, upon
surrender for registration of transfer of any Certificate at the Corporate Trust
Office, the Trustee shall execute and the Registrar shall authenticate and
deliver, in the name of the designated transferee or transferees,
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<PAGE> 14
one or more new Certificates in authorized Denominations evidencing the same
aggregate Percentage Interests.
At the option of the Certificateholders, Certificates may be exchanged
for other Certificates in authorized Denominations evidencing the same aggregate
Percentage Interests upon surrender of the Certificates to be exchanged at the
Corporate Trust Office of the Registrar. Whenever any Certificates are so
surrendered for exchange, the Trustee shall execute and the Registrar shall
authenticate and deliver the Certificates which the Certificateholder making the
exchange is entitled to receive. Each Certificate presented or surrendered for
registration of transfer or exchange shall (if so required by the Registrar) be
duly endorsed by, or be accompanied by a written instrument of transfer in form
satisfactory to the Registrar duly executed by, the Holder thereof or his
attorney duly authorized in writing. Certificates delivered upon any such
transfer or exchange will evidence the same obligations, and will be entitled to
the same rights and privileges, as the Certificates surrendered.
No service charge shall be made for any registration of transfer or
exchange of Certificates, but the Registrar shall require payment of a sum
sufficient to cover any tax or governmental charge that may be imposed in
connection with any registration of transfer or exchange of Certificates.
All Certificates surrendered for registration of transfer and exchange
shall be cancelled by the Registrar and delivered to the Trustee for subsequent
destruction without liability on the part of either.
(b) Except as to any Certificate of any Class of Book-Entry
Certificates that is transferred to an entity other than a Qualified
Institutional Buyer, the Book-Entry Certificates shall, except as provided
below, at all times remain registered in the name of the Depository or its
nominee and at all times: (i) registration thereof may not be transferred by the
Trustee except to another Depository; (ii) the Depository shall maintain
book-entry records with respect to the Certificate Owners and with respect to
ownership and transfers of such Certificates; (iii) ownership and transfers of
registration of the Certificates issued in book-entry form on the books of the
Depository shall be governed by applicable rules established by the Depository
and the rights of Certificate Owners with respect to Book-Entry Certificates
shall be governed by applicable law and agreements between such Certificate
Owners and the Depository, Depository Participants, and indirect participating
firms; (iv) the Depository may collect its usual and customary fees, charges and
expenses from its Depository Participants; (v) the Trustee shall deal with the
Depository, Depository Participants and indirect participating firms as
authorized representatives of the Certificate Owners of the Certificates issued
in book-entry form for all purposes including the making of payments due on the
Book-Entry Certificates and exercising the rights of Holders under this
Agreement, and requests and directions for and votes of such representatives
shall not be deemed to be inconsistent if they are made with respect to
different Certificate Owners; (vi) the Trustee may rely and shall be fully
protected in relying upon information furnished by the Depository with respect
to its Depository Participants and furnished by the Depository Participants with
respect to indirect participating firms and persons shown on the books of such
indirect participating firms as direct or indirect Certificate Owners; (vii)
Certificate Owners shall not be entitled to certificates for the Book-Entry
Certificates; and (viii)
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<PAGE> 15
the Trustee may establish a reasonable record date in connection with
solicitations of consents from or voting by Certificateholders and give notice
to the Depository of such record date.
Any Book-Entry Certificate or interest therein that is transferred to
an entity other than a Qualified Institutional Buyer may, in accordance with the
applicable rules established by the Depository, and subject to Section 4.02(e)
of this Agreement, be issued in the form of a Definitive Certificate.
All transfers by Certificate Owners of Book-Entry Certificates shall be
made in accordance with the procedures established by the Depository Participant
or brokerage firm representing such Certificate Owner. Each Depository
Participant shall only transfer Book-Entry Certificates of Certificate Owners it
represents or of brokerage firms for which it acts as agent in accordance with
the Depository's normal procedures. Except as provided herein, the Trustee shall
have no duty to monitor or restrict the transfer of Certificates or interests
therein, and shall have no liability for any transfer, including any transfer
made through the book-entry facilities of the Depository or between or among
Depository Participants or Certificate Owners, made in violation of applicable
restrictions set forth herein, except in the event of the failure of the Trustee
to perform its duties and fulfill its obligations under this Agreement with
respect to such transfers.
(c) If (x)(i) the Depositor or the Depository advises the Trustee in
writing that the Depository is no longer willing, qualified or able to properly
discharge its responsibilities as Depository, and (ii) the Trustee or the
Depositor is unable to locate a qualified successor or (y) the Depositor at its
option advises the Trustee in writing that it elects to terminate the book-entry
system through the Depository, the Trustee shall notify all Certificate Owners,
through the Depository, of the occurrence of any such event and of the
availability of Definitive Certificates to Certificate Owners requesting the
same. Upon surrender to the Trustee of such Certificates by the Depository,
accompanied by registration instructions from the Depository for registration,
the Trustee shall issue the Definitive Certificates and deliver them to or upon
the order of Certificate Owners. Neither the Depositor nor the Trustee shall be
liable for any delay in delivery of such instructions and may conclusively rely
on, and shall be protected in relying on, such instructions. Upon the issuance
of Definitive Certificates all references herein to obligations imposed upon or
to be performed by the Depository shall be deemed to be imposed upon and
performed by the Trustee, to the extent applicable with respect to such
Definitive Certificates and the Trustee shall recognize the Holders of the
Definitive Certificates as Certificateholders hereunder.
(d) On or prior to the Closing Date, there shall be delivered to the
Depository, or to the Trustee as custodian therefor, one certificate for each
Class of Book-Entry Certificates registered in the name of the Depository's
nominee, Cede & Co. The face amount of each such Certificate shall represent
100% of the initial Principal Amount or Notional Amount thereof, except for such
amount that does not constitute an acceptable denomination to the Depository. An
additional Certificate of each Class of Book-Entry Certificates may be issued
evidencing such remainder and, if so issued, will be held in physical
certificated form by the Holders thereof. Each Certificate issued in book-entry
form shall bear the following legend:
"Unless this Certificate is presented by an authorized representative
of The Depository Trust Company, a New York corporation ("DTC"), to the Trustee
or its agent for registration of
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transfer, exchange, or payment, and any certificate issued is registered in the
name of Cede & Co. or in such other name as requested by an authorized
representative of DTC (and any payment is made to Cede & Co. or to such other
entity as is requested by an authorized representative of DTC), any transfer,
pledge or other use hereof for value or otherwise by or to any person is
wrongful inasmuch as the registered owner hereof, Cede & Co., has an interest
herein."
(e) Each transferee of a Book-Entry Certificate or interest therein, by
its acceptance of such Certificate or interest, shall be deemed to have
represented to the Trustee, the Depositor and the other Holders that (i) it is a
"qualified institutional buyer," as such term is defined in Rule 144A under the
Securities Act, or, if such Certificate or interest is to be purchased for one
or more institutional accounts ("investor accounts") for which the Holder
thereof is acting as fiduciary or agent (except if the Holder thereof is a bank
as defined in Section 3(a)(2) of the Securities Act, or a savings and loan
association or other institution as described in Section 3(a)(5)(A) of the
Securities Act, whether acting in its individual or in a fiduciary capacity),
each such investor account is a "qualified institutional buyer," (ii) it will
not transfer such Certificate or interest except in accordance with this
Agreement, and (iii) it will indemnify the Trustee and the Depositor against any
liability that may result if any transfer of a Certificate is not exempt from
the registration requirements of federal, state and foreign securities laws. No
transfer of a Definitive Certificate shall be made unless the Trustee shall have
received a representation letter from the proposed transferee in the form of
Exhibit C or Exhibit D attached hereto.
(f) The Class X Certificates shall initially be registered in the name
of AUER &CO. Notwithstanding any other provision herein, the Class X Certificate
shall not be transferred to any Person other than the Depositor, Sequoia
Mortgage Funding Corporation or Redwood Trust, Inc., and the Trustee shall not
register any transfer thereof, unless the Depositor shall have first delivered
to the Trustee an Opinion of Counsel to the effect that such transfer of
ownership will not result in material adverse tax consequences to the holders of
Class A Certificates, the Trust or the Depositor. Upon any transfer of the Class
X Certificates, the Trustee shall give prompt notice of such transfer to the
Administrator.
Section 4.03. Mutilated, Destroyed, Lost or Stolen Certificates. If (i)
any mutilated Certificate is surrendered to the Registrar or the Trustee
receives evidence to its satisfaction of the destruction, loss or theft of any
Certificate and of the ownership thereof, and (ii) there is delivered to the
Trustee such security or indemnity as may be required by it to save it and the
Registrar harmless, then, in the absence of receipt by the Trustee of written
notice that such Certificate has been acquired by a bona fide purchaser, the
Trustee shall execute and the Registrar shall authenticate and deliver, in
exchange for or in lieu of any such mutilated, destroyed, lost or stolen
Certificate, a new Certificate of like tenor. Upon the issuance of any new
Certificate under this Section 4.03, the Registrar may require the payment of a
sum sufficient to cover any tax or other governmental charge that may be imposed
in relation thereto and any other expenses (including the fees and expenses of
the Trustee or the Registrar) connected therewith. Any duplicate Certificate
issued pursuant to this Section shall constitute complete and indefeasible
evidence of ownership of a like Percentage Interest as if originally issued,
whether or not the lost, stolen or destroyed Certificate shall be found at any
time. All Certificates surrendered to the Registrar under the terms of this
Section 4.03 shall be cancelled
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by the Registrar and delivered to the Trustee for subsequent destruction without
liability on the part of either.
Section 4.04. Persons Deemed Owners. Prior to due presentation of a
Certificate for registration of transfer, the Trustee and any agent of the
Trustee shall treat the Person in whose name any Certificate is registered as
the owner of such Certificate for the purpose of receiving distributions
pursuant to Section 3.02 and at any other time for all other purposes
whatsoever, and neither the Trustee or the Registrar nor any agent of the
Trustee or the Registrar shall be affected by notice to the contrary.
ARTICLE V
THE TRUSTEE
Section 5.01. Representation and Warranty. The Trustee represents and
warrants to the Depositor, for the benefit of the Certificateholders, that this
Agreement has been executed and delivered by its Responsible Officer who is duly
authorized to execute and deliver such document in such capacity on its behalf.
Section 5.02. Directions to Trustee. The Trustee is hereby directed:
(a) to accept assignment of the Underlying Bonds and hold the Trust
Fund in trust for the Certificateholders;
(b) to issue, execute and deliver the Certificates substantially in the
forms prescribed by Exhibit A in accordance with the terms of this Agreement;
and
(c) to take all other actions as shall be required to be taken by the
terms of this Agreement.
Section 5.03. Liability of the Trustee. The Trustee shall be liable in
accordance herewith only to the extent provided in Section 5.05 and only to the
extent of the obligations specifically imposed upon and undertaken by the
Trustee herein and no implied covenants or obligations shall be read into this
Agreement against the Trustee.
The Trustee, upon receipt of all certificates, opinions, documents or
other instruments furnished to the Trustee which are specifically required to be
furnished pursuant to any provision of this Agreement, shall determine whether
they are in the form required by this Agreement; provided, however, that the
Trustee shall not be responsible for the accuracy or content of any such
certificate, opinion, document or other instrument furnished to it pursuant to
this Agreement.
Section 5.04. Merger or Consolidation of the Trustee. Any Person into
which the Trustee may be merged or consolidated, or any Person resulting from
any merger, conversion or consolidation to which the Trustee shall be a party,
or any Person succeeding to the corporate trust business of the Trustee shall be
the successor of the Trustee hereunder, without the execution or filing of any
paper or any further act on the part of any of the parties hereto,
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anything herein to the contrary notwithstanding; provided that such Person shall
satisfy the requirements for a successor trustee specified in the first sentence
of Section 5.08.
Section 5.05. Limitation on Liability of the Trustee and Others. In
entering into this Agreement the Trustee acts solely as trustee hereunder and
not in its individual capacity; and all persons having any claim under this
Agreement or under the Certificates by reason of the transactions contemplated
hereby shall look only to the Trust Fund for payment or satisfaction thereof,
subject to this Section 5.05. The Trustee shall not be responsible for the
validity or sufficiency of any Underlying Bond, the Trust Fund, any assignment
or registration, or for any depreciation in the value of the Trust Fund, subject
to this Section 5.05. The recitals and statements contained herein and in the
Certificates (other than the signature of the Trustee, the authentication of the
Registrar on the Certificates and the representation and warranty of the Trustee
in Section 5.01) shall be taken as the statements of the Depositor, and the
Trustee assumes no responsibility for the correctness of such recitals and
statements.
Neither the Trustee nor any of the directors, officers, employees or
agents of the Trustee shall be under any liability to the Trust Fund or the
Certificateholders for any action taken, or for refraining from the taking of
any action, in good faith (and shall be protected in acting or refraining from
acting) pursuant to this Agreement, or for errors in judgment; provided,
however, that this provision shall not protect the Trustee or any such person
against liability for any breach of the warranty or representation made in
Section 5.01 hereof or against any liability which would otherwise be imposed by
reason of willful misfeasance, bad faith or negligence in the performance of
duties or by reason of reckless disregard of obligations and duties hereunder.
The Trustee and any director, officer, employee or agent of the Trustee may rely
in good faith and shall be protected in acting or refraining from acting on any
document of any kind prima facie properly executed and submitted by any Person
respecting any matter arising hereunder. The Trustee and any director, officer,
employee or agent of the Trustee shall be indemnified by the Depositor and held
harmless against any loss, liability, damage, tax, claim, action, suit or
expense (including, without limitation, any and all extraordinary expenses of
the Trust, including any taxes or tax-related payments (other than filing fees)
and any expenses involved in any tax examination, audit or proceeding, including
professional fees incurred by the Trustee in connection with any such
examination, audit or proceeding) incurred by, imposed on or asserted against
the Trustee in any way relating to or arising out of this Agreement, the
Underlying Bonds, the administration of the Trust Fund, the action or inaction
of the Trustee hereunder, or in connection with investigating, preparing or
defending any legal action, commenced or threatened, relating to this Agreement
or the Underlying Bonds, other than any loss, liability, damage, tax, claim,
action, suit or expense incurred by reason of willful misfeasance, bad faith or
negligence in the performance of duties hereunder or by reason of reckless
disregard of obligations and duties hereunder. All sums due the Trustee pursuant
to the foregoing indemnity shall be reimbursed by the Depositor. The Trustee may
consult counsel satisfactory to it and the opinion or advice of such counsel in
any instance shall be full and complete authorization and protection in respect
of any action taken, suffered or omitted by it hereunder in good faith and in
accordance with the opinion or advice of such counsel. The Trustee may execute
any of the powers of trust under this Agreement or perform any duties hereunder
either directly or by or through agents or attorneys and the Trustee shall not
be responsible for any misconduct or negligence on the part of any agent or
attorney appointed with due care by it. The Trustee shall not be deemed to have
notice of any matter, including without limitation any event of default,
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unless one of its Responsible Officers has actual knowledge thereof or unless
written notice thereof is received by the Trustee at the Corporate Trust Office
and such notice references the Certificates generally or this Agreement. The
Trustee shall not be under any obligation (i) to make any investigation into the
facts or matters stated in any document of any kind presented to it or (ii) to
appear in, prosecute or defend any legal action except with respect to the
Underlying Bonds under the circumstances described in Section 3.01; provided,
however, that the Trustee shall at the request of Holders of Certificates
evidencing Percentage Interests aggregating not less than 66-2/3% of each Class
of Certificates undertake any such legal action which the Certificateholders
making such request shall specify with respect to this Agreement and the rights
and duties of the parties hereto and the interests of the Certificateholders
hereunder. In the event the Trustee takes any action above, whether at the
request of Certificateholders or otherwise, the legal fees and expenses of such
action and any liability therefrom shall be borne by Certificateholders pursuant
to indemnity furnished by them as a precondition to the Trustee's obligation to
take any such action pursuant to any such request.
The right of the Trustee to perform any discretionary act enumerated in
this Agreement shall not be construed as a duty.
Section 5.06. Trustee's Compensation. As compensation for all services
rendered by it hereunder (which shall not be limited by any provision of law in
regard to the compensation of a trustee of an express trust) the Trustee shall
be entitled to receive on each Distribution Date the compensation set forth in
the letter dated as of May 4, 1999, between the Trustee and the Depositor.
No provision of this Agreement or of the Certificates shall require the
Trustee to expend or risk its own funds or otherwise incur any financial
liability in the performance of any of its duties hereunder or thereunder, or in
the exercise of any of its rights or powers, if it shall have reasonable grounds
for believing that repayment of such funds or adequate indemnity against such
risk or liability is not reasonably assured to it.
Section 5.07. Resignation and Removal of the Trustee. Subject to the
last paragraph of this Section 5.07, the Trustee may at any time resign and be
discharged from the trusts hereby created by giving written notice thereof to
the Depositor. Upon receiving such notice of resignation, the Depositor shall
promptly appoint a successor trustee by written instrument, in duplicate, one
copy of which instrument shall be delivered to the resigning Trustee and one
copy to the successor trustee. If no successor trustee shall have been so
appointed and have accepted appointment within 30 days after the giving of such
notice of resignation, the resigning Trustee may petition any court of competent
jurisdiction for the appointment of a successor trustee.
If at any time the Trustee shall become incapable of acting, or shall
be adjudged a bankrupt or insolvent, or a receiver of the Trustee or of its
property shall be appointed, or any public officer shall take charge or control
of the Trustee or of its property or affairs for the purpose of rehabilitation,
conservation or liquidation, then the Depositor may remove the Trustee and
appoint a successor trustee by written instrument, in duplicate, one copy of
which instrument shall be delivered to the Trustee so removed and one copy to
the successor trustee.
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The Holders of Certificates evidencing Percentage Interests aggregating
not less than 66-2/3% of each Class of Certificates may, at any time, remove the
Trustee with cause and appoint a successor trustee by written instrument or
instruments, in triplicate, signed by such Holders or their attorneys-in-fact
duly authorized, one complete set of which instruments shall be delivered to the
Depositor, one complete set to the Trustee so removed and one complete set to
the successor so appointed.
Any resignation or removal of the Trustee and appointment of a
successor trustee pursuant to any of the provisions of this Section shall become
effective only upon acceptance of appointment by the successor trustee as
provided in Section 5.08 hereof.
Section 5.08. Successor Trustee. Any successor trustee appointed as
provided in Section 5.07 hereof shall be a bank, trust company or other
fiduciary authorized to administer trusts, subject to regulation or supervision
by federal or state authority and having a combined capital and surplus of at
least $50,000,000. Any such successor trustee shall execute, acknowledge and
deliver to the Depositor and to its predecessor Trustee an instrument accepting
such appointment hereunder, and thereupon the resignation or removal of the
predecessor Trustee shall become effective and such successor trustee, without
any further act, deed or conveyance, shall become fully vested with all the
rights, powers, duties and obligations of its predecessor hereunder, with like
effect as if originally named as Trustee herein. The predecessor Trustee shall
transfer to the successor trustee the Underlying Bonds and shall turn over all
related documents and statements held hereunder. In addition, the predecessor
Trustee and, upon request of the successor trustee, the Depositor shall execute
and deliver such instruments and do such other things as may reasonably be
required for more fully and certainly vesting and confirming in the successor
trustee all such rights, powers, duties and obligations, subject, however, to
the payment of all amounts due the predecessor Trustee under this Agreement.
Upon acceptance of appointment by a successor trustee as provided in
this Section, the Depositor shall mail notice of the succession of such Trustee
hereunder to each Rating Agency and to all Holders of Certificates at their
addresses as shown in the Certificate Register. The predecessor Trustee shall
cooperate with the Depositor to prepare and mail such notice. If the Depositor
fails to mail such notice within 10 days after acceptance of appointment by the
successor trustee, the successor trustee shall cause such notice to be mailed at
the expense of the Depositor.
No Trustee hereunder shall be personally liable hereunder by reason of
any act or failure to act of any predecessor or successor trustee hereunder.
Upon any termination or resignation of the Trustee, the Trustee shall
be entitled to and shall receive any and all accrued and unpaid fees and
expenses due to the Trustee hereunder.
ARTICLE VI
TERMINATION
Section 6.01. Termination Upon Distribution to Certificateholders. This
Agreement and the respective obligations and responsibilities of the Depositor
and the Trustee created hereby
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shall terminate upon the earlier of (i) the distribution to Certificateholders
and the Trustee of all amounts required to be distributed pursuant to Article
III; (ii) the receipt by the Trustee of a written instruction executed by or on
behalf of 100% of Certificateholders ordering such termination; and (iii) the
expiration of 21 years from the death of the survivor of the descendants of
Joseph P. Kennedy, the late ambassador of the United States to the Court of St.
James, living on the date hereof.
Holders of 100% of the Percentage Interests of each Class of
Certificates may, at any time, deliver a written instruction to the Trustee,
signed by or on behalf of each Holder, directing the Trustee to distribute all
assets of the Trust Fund to such Holders in the manner specified in such
instruction. The Trustee shall promptly comply with such instruction upon
receipt thereof, and upon such compliance this Agreement and the Trust created
hereby shall be terminated. Any expenses incurred by the Trustee in complying
with such instruction shall be reimbursed by the Depositor.
The Trustee shall notify the Certificateholders of the Distribution
Date upon which the Certificateholders may surrender their Certificates to the
Trustee for payment of the final distribution and cancellation. Such notice
shall be given promptly by the Trustee by letter to Certificateholders and each
Rating Agency mailed not later than three Business Days following the earlier of
(a) the receipt of notice by the Trustee of the final Distribution Date for the
Underlying Bonds and (b) receipt by the Trustee of the final distribution on the
Underlying Bonds, specifying (i) the Distribution Date as of which the final
distribution on the Certificates will be made upon presentation and surrender of
Certificates at the office of the Trustee therein designated, (ii) the amount of
any such final distribution, and (iii) that the Record Date otherwise applicable
to such Distribution Date is not applicable, distributions being made only upon
presentation and surrender of the Certificates at the office of the Trustee
therein specified. Upon presentation and surrender of a Certificate, the Trustee
shall cause to be distributed to the Holder thereof an amount equal to all
interest and principal distributable on such Certificate on the Final
Distribution Date.
Section 6.02. Failure of Certificateholders to Surrender Certificates.
In the event that any of the Certificateholders shall not surrender their
Certificates for cancellation within six months after the Final Distribution
Date, the Trustee shall give a written notice to the remaining
Certificateholders to surrender their Certificates for cancellation and receive
the final distribution with respect thereto. If within one year after such
notice all the Certificates shall not have been surrendered for cancellation,
the Trustee may take appropriate steps, or may appoint an agent to take
appropriate steps, to contact the remaining Certificateholders concerning
surrender of their Certificates, and the cost thereof shall be paid out of the
funds and other assets that remain subject to the Trust Fund.
ARTICLE VII
MISCELLANEOUS PROVISIONS
Section 7.01. Amendment. This Agreement may be amended from time to
time by the Trustee and the Depositor, without the consent of any of the
Certificateholders, (i) to cure any
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ambiguity, (ii) to cause the provisions herein to conform to or be consistent
with or in furtherance of the statements made with respect to the Certificates,
the Trust Fund or this Agreement in the Private Placement Memorandum, to correct
an error, or to correct or supplement any provisions herein which may be
inconsistent with any other provision herein, (iii) to add such other provisions
with respect to matters or questions arising under this Agreement that shall not
be inconsistent with other provisions of this Agreement, or (iv) to add, delete,
or amend any provisions to the extent necessary or desirable to comply with any
requirements imposed by the Code; provided that such action pursuant to clause
(iii) above shall not adversely affect in any material respect the interests of
any Certificateholder and that no such amendment shall, as evidenced by an
Opinion of Counsel (which Opinion of Counsel shall not be an expense of the
Trustee or the Trust Fund), adversely affect the tax status of the Trust
pursuant to this Agreement. This Agreement may also be amended from time to time
by the Trustee and the Depositor with the consent of the Holders of Certificates
evidencing Percentage Interests aggregating not less than 66-2/3% of each Class
of Certificates for the purpose of adding any provisions to or modifying this
Agreement or of modifying in any manner the rights of the Holders of
Certificates; provided, however, that no such amendment shall (i) reduce in any
manner the amount of, or delay the timing of, amounts required to be distributed
on any Certificate without the consent of the Holder of such Certificate, (ii)
reduce the aforesaid percentage of the Certificates the Holders of which are
required to consent to any such amendment without the consent of the Holders of
all Certificates then Outstanding, or (iii) permit the removal of the Trustee
without cause. In addition, this Agreement and the Certificates may be amended
at any time with the consent of the Holders of Certificates evidencing 100% of
the Percentage Interests of each Class for the purpose of increasing or
decreasing the Interest Rate applicable to any Class of Certificates.
Prior to the execution of any amendment to this Agreement, the Trustee
shall be entitled to receive and rely upon an Opinion of Counsel stating that
the execution of such amendment is authorized or permitted by this Agreement.
The Trustee may, but shall not be obligated to, enter into any such amendment
which affects the Trustee's own rights, duties or immunities under this
Agreement.
Promptly after the execution of any amendment to this Agreement
requiring the consent of Certificateholders, the Trustee shall furnish written
notification of the substance of such amendment to each Certificateholder and to
each Rating Agency.
It shall not be necessary for the consent of Certificateholders under
this Section to approve the particular form of any proposed amendment, but it
shall be sufficient if such consent shall approve the substance thereof. The
manner of obtaining such consents and of evidencing the authorization of the
execution thereof by Certificateholders shall be subject to such reasonable
regulations as the Trustee may prescribe.
Section 7.02. Limitation on Rights of Certificateholders. The
dissolution, bankruptcy, termination, death or incapacity of any
Certificateholder shall not operate to terminate this Agreement or the Trust
Fund, nor entitle such Certificateholder's legal representatives or heirs to
claim an accounting or to take any action or proceeding in any court for a
partition or winding up of the Trust Fund, nor otherwise affect the rights,
obligations and liabilities of any of the parties hereto.
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Except as expressly provided in this Agreement, no Certificateholder
shall have any right to vote or in any manner otherwise control the operation
and management of the Trust Fund, or the obligations of the parties hereto, nor
shall anything herein set forth, or contained in the terms of the Certificates,
be construed so as to constitute the Certificateholders from time to time as
partners or members of an association; nor shall any Certificateholder be under
any liability to any third person by reason of any action taken by the parties
to this Agreement pursuant to any provision hereof.
Except in the case of an action, suit or proceeding against the Trustee
in respect to a breach or alleged breach of its duties and responsibilities
hereunder, no Certificateholder shall have any right by virtue of any provisions
of this Agreement to institute any action, suit or proceeding in equity or at
law upon or under or with respect to this Agreement unless such Holder
previously shall have given to the Trustee a written notice of the basis of such
action, suit or proceeding, and unless also the Holders of Certificates
evidencing Percentage Interests aggregating not less than 51% of each Class of
Certificates shall have made written request upon the Trustee to institute such
action, suit or proceeding in its own name as Trustee hereunder and shall have
offered to the Trustee such reasonable indemnity as it may require against the
costs, expenses and liabilities to be incurred therein or thereby, and the
Trustee, for 60 days after its receipt of such notice, request and offer of
indemnity, shall have neglected or refused to institute any such action, suit or
proceeding; it being understood and intended, and being expressly covenanted by
each Certificateholder with every other Holder of a Certificate and the Trustee,
that no one or more Holders of Certificates shall have any right in any manner
whatever by virtue of any provision of this Agreement to affect, disturb or
prejudice the rights of the Holders of any other of such Certificates, or to
obtain or seek to obtain priority over or preference to any other such Holder of
Certificates, or to enforce any right under this Agreement, except in the manner
herein provided and for the equal, ratable and common benefit of all Holders of
Certificates. For the protection and enforcement of the provisions of this
Section, each and every Certificateholder and the Trustee shall be entitled to
such relief as can be given either at law or in equity.
Section 7.03. Limitation on Liability of the Depositor and Others.
Neither the Depositor nor any of the directors, officers, employees or agents of
the Depositor shall be under any liability to the Trust Fund or
Certificateholders for any action taken, or for refraining from the taking of
any action in good faith pursuant to this Agreement, or for errors in judgment;
provided, however, that this provision shall not protect the Depositor or any
such Person against any liability which would otherwise be imposed by reason of
willful misfeasance, bad faith or negligence in the performance of duties or by
reason of reckless disregard of obligations and duties hereunder.
Section 7.04. Governing Law. This Agreement shall be construed in
accordance with the laws of the State of New York applicable to agreements made
and to be performed in the State of New York, and the obligations, rights and
remedies of the parties hereto and the Certificateholders shall be determined in
accordance with such laws without regard to conflict of laws principles applied
in New York.
Section 7.05. Notices. All demands, notices and communications
hereunder shall be in writing and shall be deemed to have been duly given if
personally delivered at or mailed by
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registered mail, postage prepaid, to (a) in the case of the Depositor, Sequoia
Mortgage Trust 1, c/o Redwood Trust, Inc., 591 Redwood Highway, Suite 3100, Mill
Valley, California 94941, Attention: Vickie Rath or to such other address as may
hereafter be furnished to the Trustee in writing by the Depositor; (b) in the
case of the Trustee, First Union National Bank, 230 South Tryon Street,
Charlotte, North Carolina 28288-1179, Attention: Corporate Trust Department, or
to such other address as may hereafter be furnished to the Depositor in writing
by the Trustee; (c) in the case of the Administrator, Norwest Bank Minnesota,
National Association, 11000 Broken Land Parkway, Columbia, Maryland 21044-3562,
Attention: Sequoia Mortgage Trust 1A, 99-A; (d) in the case of Moody's, Moody's
Investors Service, 99 Church Street, New York, New York 10007, Attention: Rod
Dubitsky; and (e) in the case of S&P, Standard & Poor's Investors Services, 26
Broadway, 10th Floor, New York, New York 10004, Attention: Residential Mortgage
Surveillance Group. Any notice required or permitted to be mailed to a
Certificateholder shall be given by first class mail, postage prepaid, to the
address of such Holder as shown in the Certificate Register. Any notice so
mailed within the time prescribed in this Agreement shall be conclusively
presumed to have been duly given when mailed whether or not the
Certificateholder receives such notice.
Section 7.06. Severability of Provisions. If any one or more of the
covenants, agreements, provisions or terms of this Agreement shall be for any
reason whatsoever held invalid, then such covenants, agreements, provisions or
terms shall be deemed severable from the remaining covenants, agreements,
provisions or terms of this Agreement and shall in no way affect the validity or
enforceability of the other provisions of this Agreement or of the Certificates
or the rights of the Holders thereof.
Section 7.07. Certificates Nonassessable and Fully Paid. It is the
intention of this Agreement that Certificateholders shall not be personally
liable for obligations of the Trust Fund, that the beneficial ownership
interests represented by the Certificates shall be nonassessable for any losses
or expenses of the Trust Fund or for any reason whatsoever, and that
Certificates upon execution, authentication and delivery thereof by the Trustee
pursuant to Section 2.02 are and shall be deemed fully paid.
Section 7.08. Limitations of Liability. Notwithstanding any other
provision herein or elsewhere (i) this Agreement has been executed and delivered
by Wilmington Trust Company, not in its individual capacity, but solely in its
capacity as Owner Trustee (the "Owner Trustee") of the Depositor under the
Amended and Restated Deposit Trust Agreement of the Depositor, dated as of July
17, 1997 (the "Deposit Trust Agreement"), and solely pursuant to the instruction
of Sequoia Mortgage Funding Corporation as the sole Certificateholder (as
defined in the Deposit Trust Agreement) of the Depositor under the Deposit Trust
Agreement, (ii) in no event shall Wilmington Trust Company or the Owner Trustee
have any liability in respect of the representations, warranties, or obligations
of the Depositor hereunder or under any other document, as to all of which
recourse shall be had solely to the assets of the Depositor, and (iii) for all
purposes of this Agreement and every other document, the Owner Trustee and
Wilmington Trust Company shall be entitled to the benefits of the Deposit Trust
Agreement.
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ARTICLE VIII
SECURITIES ACCOUNT
Section 8.01. The Securities Account. The Depositor shall establish a
"Securities Account" in the name of the Securities Intermediary which shall be
pledged to the Trustee, as collateral agent, for the benefit of the
Certificateholders. The Securities Account shall be a segregated,
non-interest-bearing trust account maintained with the Trustee and established
for the purpose of holding the Underlying Bonds. The Depositor and the Trustee
hereby appoint First Union National Bank as Securities Intermediary with respect
to the Securities Account, and the Depositor hereby grants to the Trustee, as
collateral agent for the benefit of the Certificateholders, a security interest
to secure all amounts due Certificateholders hereunder in and to the Securities
Account and the Security Entitlements to all Financial Assets credited to the
Securities Account, including without limitation all amounts, securities,
investments, Financial Assets, investment property and other property from time
to time deposited in or credited to the Securities Account and all proceeds
thereof. Amounts held from time to time in the Securities Account will continue
to be held by the Securities Intermediary for the benefit of the Trustee, as
collateral agent, for the benefit of the Certificateholders. Upon the
termination of the Trust, the Trustee shall inform the Securities Intermediary
of such termination. By acceptance of their Certificates or interests therein,
the Certificateholders shall be deemed to have appointed First Union National
Bank as Securities Intermediary. First Union National Bank hereby accepts such
appointment as Securities Intermediary.
(i) With respect to the Account Property credited to the
Securities Account, the Securities Intermediary agrees that:
(A) any Account Property that is held in deposit
accounts shall be held solely in a bank rated no less than
"Aaa" by Moody's and "AAA" by S&P, or a bank otherwise approved
in writing by each Rating Agency; and each such deposit account
shall be subject to the exclusive custody and control of the
Securities Intermediary, and the Securities Intermediary shall
have sole signature authority with respect thereto;
(B) the sole assets permitted in the Securities Account
shall be those as the Securities Intermediary agrees to treat
as Financial Assets; and
(C) any such Account Property that is, or is treated
as, a Financial Asset shall be physically delivered
(accompanied by any required endorsements) to, or credited to
an account in the name of, the Securities Intermediary or other
eligible institution maintaining the Securities Account in
accordance with the Securities Intermediary's customary
procedures such that the Securities Intermediary or such other
institution establishes a Security Entitlement in favor of the
Trustee with respect thereto over which the Securities
Intermediary or such other institution has Control.
(ii) The Securities Intermediary hereby confirms that (A) the
Securities Account is an account to which Financial Assets are or may
be credited, and the
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Securities Intermediary shall, subject to the terms of this Agreement,
treat the Trustee, as collateral agent, as entitled to exercise the
rights that comprise any Financial Asset credited to the Securities
Account, (B) all Account Property in respect of the Securities Account
will be promptly credited by the Securities Intermediary to the
Securities Account, and (C) all securities or other property underlying
any Financial Assets credited to the Securities Account shall be
registered in the name of the Securities Intermediary, endorsed to the
Securities Intermediary or in blank or credited to another securities
account maintained in the name of the Securities Intermediary and in no
case will any Financial Asset credited to the Securities Account be
registered in the name of the Depositor, payable to the order of the
Depositor or specially endorsed to the Depositor except to the extent
the foregoing have been specially endorsed to the Securities
Intermediary or in blank.
(iii) The Securities Intermediary hereby agrees that each item
of property (whether investment property, Financial Asset, security,
instrument or cash) credited to the Securities Account shall be treated
as a Financial Asset.
(iv) If at any time the Securities Intermediary shall receive
any order from the Trustee directing transfer or redemption of any
Financial Asset relating to the Securities Account, the Securities
Intermediary shall comply with such entitlement order without further
consent by the Depositor or any other Person. If at any time the
Trustee notifies the Securities Intermediary in writing that the Trust
has been terminated in accordance herewith and the security interest
granted above has been released, then thereafter if the Securities
Intermediary shall receive any order from the Depositor directing
transfer or redemption of any Financial Asset relating to the
Securities Account, the Securities Intermediary shall comply with such
entitlement order without further consent by the Trustee or any other
Person.
(v) In the event that the Securities Intermediary has or
subsequently obtains by agreement, operation of law or otherwise a
security interest in the Securities Account or any Financial Asset
credited thereto, the Securities Intermediary hereby agrees that such
security interest shall be subordinate to the security interest of the
Trustee. The Financial Assets credited to the Securities Account will
not be subject to deduction, set-off, banker's lien, or any other right
in favor of any Person other than the Trustee (except that the
Securities Intermediary may set off the face amount of any checks which
have been credited to the Securities Account but are subsequently
returned unpaid because of uncollected or insufficient funds).
(vi) There are no other agreements entered into between the
Securities Intermediary in such capacity and the Depositor with respect
to the Securities Account. In the event of any conflict between this
Agreement (or any provision of this Agreement) and any other agreement
now existing or hereafter entered into, the terms of this Agreement
shall prevail.
(vii) The rights and powers granted herein to the Trustee have
been granted in order to perfect its security interest in the
Securities Account and the Security Entitlements to the Financial
Assets credited thereto and are powers coupled with an
23
<PAGE> 27
interest and will neither be affected by the bankruptcy of the
Depositor nor by the lapse of time. The obligations of the Securities
Intermediary hereunder shall continue in effect until the security
interest of the Trustee in the Securities Account and such Security
Entitlements has been terminated pursuant to the terms of this
Agreement and the Trustee has notified the Securities Intermediary of
such termination in writing.
(viii) Notwithstanding anything else contained herein, the
Depositor agrees that the Securities Account will be established only
with the Securities Intermediary or another institution meeting the
requirements of this Section, which agrees substantially as follows:
(1) it will comply with Entitlement Orders related to such account
issued by the Trustee, as collateral agent, without further consent by
the Depositor; (2) until termination of the Agreement, it will not
enter into any other agreement related to such account pursuant to
which it agrees to comply with Entitlement Orders of any Person other
than the Trustee, as collateral agent; and (3) all assets delivered or
credited to it in connection with such account and all investments
thereof will be promptly credited to such account.
(ix) The Depositor agrees to take or cause to be taken such
further actions, to execute, deliver and file or cause to be executed,
delivered and filed such further documents and instruments (including,
without limitation, any financing statements under the Relevant UCC or
this Agreement) as may be determined to be necessary, in order to
perfect the interests created by this Section and otherwise effectuate
the purposes, terms and conditions.
Section 8.02. Definitions. Capitalized terms set forth below and used
in Section 8.01 shall have the following meanings:
"Account Property" means all amounts and investments held from time to
time in the Securities Account (whether in the form of deposit accounts,
physical property, book-entry securities, uncertificated securities, securities
entitlements, investment property or otherwise), and all proceeds of the
foregoing.
"Control" shall have the meaning specified in Section 8-106 of the UCC.
"Entitlement Holder" shall have the meaning specified in Section
8-102(a)(7) of the UCC.
"Entitlement Order" shall have the meaning specified in Section
8-102(a)(8) of the UCC (i.e., generally, orders directing the transfer or
redemption of any Financial Asset).
"Financial Asset" shall have the meaning specified in Section
8-102(a)(9) of the UCC.
"Relevant UCC" means the Uniform Commercial Code as in effect in the
applicable jurisdiction.
"Securities Intermediary" means the Person acting as Securities
Intermediary under this Agreement (which is First Union National Bank), its
successor in interest, and any successor Securities Intermediary appointed
pursuant to Section 8.01.
24
<PAGE> 28
"Security Entitlement" shall have the meaning specified in Section
8-102(a)(17) of the UCC.
"UCC" shall mean the Uniform Commercial Code as adopted in the State of
New York.
Section 8.03. Liability of the Securities Intermediary. The Securities
Intermediary shall be liable in accordance herewith only to the same extent as
the Trustee shall be liable hereunder as provided in Sections 5.03 and 5.05
hereof.
25
<PAGE> 29
IN WITNESS WHEREOF, the Depositor and the Trustee have caused their
names to be signed hereto by their respective officers thereunto duly
authorized, all as of the day and year first above written.
SEQUOIA MORTGAGE TRUST 1
By: WILMINGTON TRUST COMPANY, not in its
individual capacity, but solely as
Owner Trustee of Sequoia Mortgage
Trust 1 under the Amended and
Restated Deposit Trust Agreement
dated as of July 17, 1997
By:__________________________________
Name:
Title:
FIRST UNION NATIONAL BANK,
as Trustee
By: _____________________________________
Name:
Title:
<PAGE> 30
EXHIBIT A
FORMS OF CERTIFICATES
<PAGE> 31
[Form of Class A Certificates]
THIS CERTIFICATE DOES NOT REPRESENT AN INTEREST IN OR OBLIGATION OF SEQUOIA
MORTGAGE TRUST 1, THE TRUSTEE (AS HEREINAFTER DEFINED) OR ANY OF THEIR
RESPECTIVE AFFILIATES, AND IS NOT INSURED OR GUARANTEED BY ANY GOVERNMENTAL
AGENCY OR INSTRUMENTALITY NOR ANY OTHER PERSON OR ENTITY.
THIS CERTIFICATE HAS NOT BEEN AND WILL NOT BE REGISTERED UNDER THE SECURITIES
ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY STATE OR FOREIGN
SECURITIES LAWS, AND MAY NOT, DIRECTLY OR INDIRECTLY, BE SOLD OR OTHERWISE
TRANSFERRED, OR OFFERED FOR SALE, UNLESS THE PROPOSED TRANSFEREE IS (I) A
"QUALIFIED INSTITUTIONAL BUYER" PURCHASING FOR ITS OWN ACCOUNT OR FOR THE
ACCOUNT OF A "QUALIFIED INSTITUTIONAL BUYER" TO WHOM NOTICE HAS BEEN GIVEN THAT
THE RESALE, PLEDGE OR TRANSFER IS BEING MADE IN RELIANCE ON RULE 144A UNDER THE
SECURITIES ACT OR (II) A SOPHISTICATED INSTITUTIONAL INVESTOR THAT IS AN
"ACCREDITED INVESTOR" OR ALL OF WHOSE EQUITY OWNERS ARE "ACCREDITED INVESTORS"
AS SUCH TERM IS DEFINED IN RULE 501(a)(1), (2), (3) OR (7) UNDER THE SECURITIES
ACT, OR, IF THIS CERTIFICATE IS TO BE PURCHASED FOR ONE OR MORE INSTITUTIONAL
ACCOUNTS ("INVESTOR ACCOUNTS") FOR WHICH SUCH PROPOSED TRANSFEREE IS ACTING AS
FIDUCIARY OR AGENT (EXCEPT IF SUCH PROPOSED TRANSFEREE IS A BANK DEFINED IN
SECTION 3(a)(2) OF THE SECURITIES ACT, OR A SAVINGS AND LOAN ASSOCIATION OR
OTHER INSTITUTION AS DESCRIBED IN SECTION 3(a)(5)(A) OF THE SECURITIES ACT,
WHETHER ACTING IN ITS INDIVIDUAL OR IN A FIDUCIARY CAPACITY), EACH SUCH INVESTOR
ACCOUNT IS AN INSTITUTIONAL INVESTOR AND AN "ACCREDITED INVESTOR" ON A LIKE
BASIS, AND SUCH TRANSFER IS IN ACCORDANCE WITH THE PROVISIONS OF SECTION 4.02 OF
THE TRUST AGREEMENT REFERRED TO HEREIN. ANY SUCH TRANSFER MUST ALSO COMPLY WITH
THE OTHER PROVISIONS OF SECTION 4.02 OF THE TRUST AGREEMENT.
UNLESS THIS CERTIFICATE IS PRESENTED BY AN AUTHORIZED REPRESENTATIVE OF THE
DEPOSITORY TRUST COMPANY, A NEW YORK CORPORATION ("DTC"), TO THE TRUSTEE OR ITS
AGENT FOR REGISTRATION OF TRANSFER, EXCHANGE, OR PAYMENT, AND ANY CERTIFICATE
ISSUED IS REGISTERED IN THE NAME OF CEDE & CO. OR IN SUCH OTHER NAME AS
REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC (AND ANY PAYMENT IS MADE TO
CEDE & CO. OR TO SUCH OTHER ENTITY AS IS REQUESTED BY AN AUTHORIZED
REPRESENTATIVE OF DTC), ANY TRANSFER, PLEDGE OR OTHER USE HEREOF FOR VALUE OR
OTHERWISE BY OR TO ANY PERSON IS WRONGFUL INASMUCH AS THE REGISTERED OWNER
HEREOF, CEDE & CO., HAS AN INTEREST HEREIN.
<PAGE> 32
SEQUOIA MORTGAGE TRUST 1A
MORTGAGE BOND-BACKED CERTIFICATES,
SERIES 1999-A
Class A
Certificate No. 1
Original Principal Amount of this Certificate: $157,266,300.00
Percentage Interest: 100%
Certificate Interest Rate: Variable
Closing Date: May 4, 1999
CUSIP No.: 817435 AC4
This certifies that CEDE & CO. is the registered owner of the undivided
Percentage Interest evidenced by this Certificate in the aggregate amount
distributable on the Class of Certificates specified above evidencing undivided
ownership interests in a trust fund (the "Trust Fund") consisting primarily of
two classes of collateralized mortgage bonds with an aggregate outstanding
principal amount as of the Closing Date of $157,266,300.30 (the "Underlying
Bonds"), collateralized by a pool of adjustable rate, one- to-four-family first
lien mortgage loans and the Bond Insurance Policy. The Trust Fund was created
pursuant to a trust agreement dated May 4, 1999 (the "Trust Agreement") between
Sequoia Mortgage Trust 1 (the "Depositor") and First Union National Bank, as
trustee (the "Trustee"), which terms include any successor entity under the
Trust Agreement, a summary of certain of the pertinent provisions of which is
set forth hereinafter. This Certificate is issued under and is subject to the
terms, provisions and conditions of the Trust Agreement, to which Trust
Agreement the Holder of this Certificate by virtue of the acceptance hereof
assents and by which such Holder is bound.
This Certificate is one of a duly authorized issue of Sequoia Mortgage
Trust 1A Mortgage Bond-Backed Certificates, Series 1999-A (herein called the
"Certificates") issued under the Trust Agreement to which reference is hereby
made for a statement of the respective rights thereunder of the Depositor, the
Trustee and the Holders of the Certificates and the terms upon which the
Certificates are executed and delivered. All terms used in this Certificate
which are defined in the Trust Agreement shall have the meanings assigned to
them in the Trust Agreement.
2
<PAGE> 33
The Trust Agreement requires the distribution on each Distribution
Date, commencing in June 1999, to the person in whose name this Certificate is
registered at the close of business on the immediately preceding Record Date, of
an amount equal to the product of the Percentage Interest evidenced by this
Certificate and the amount distributable pursuant to the Trust Agreement on the
Class of Certificates specified above for such Distribution Date. Pursuant to
the Trust Agreement, this Class of Certificates is entitled on each Distribution
Date to distributions of interest and of principal to the extent provided for in
the Trust Agreement. Notwithstanding the foregoing, the obligation of the
Trustee to make any such distribution on any Distribution Date is limited to the
extent that distributions of interest and principal in respect of the Underlying
Bonds shall have been received by it not later than such Distribution Date.
Distributions on this Certificate will be made by the Trustee by wire
transfer to an account specified in writing by such Certificateholder at least
five Business Days prior to the preceding Record Date or in such other manner as
may be agreed to by the Trustee and such Certificateholder. Except as otherwise
provided in the Trust Agreement, the final distribution on this Certificate will
be made only upon presentation and surrender of this Certificate to the Trustee
at the office thereof specified in the notice to Certificateholders of such
final distribution.
The Certificates are limited in right of distribution to the Percentage
Interests represented thereby in distributions in respect of the Underlying
Bonds received by the Trustee, subject to the provisions of and all as more
specifically set forth in the Trust Agreement. The Certificateholder, by its
acceptance of this Certificate, agrees that it will look solely to the funds on
deposit in the Certificate Account for distributions hereunder and that neither
the Trustee in its individual capacity nor the Depositor is personally liable to
the Certificateholders for any amount distributable under this Certificate or
the Trust Agreement or, except as expressly provided in the Trust Agreement,
subject to any liability under the Trust Agreement.
This Certificate does not purport to summarize the Trust Agreement and
reference is made to the Trust Agreement for the interests, rights and
limitations of rights, benefits, obligations and duties evidenced hereby, and
the rights, duties and immunities of the Trustee.
This Class of Certificates is issuable in registered form in minimum
denominations of $250,000 initial Principal Amount and integral multiples of $1
in excess thereof. Transfer of this Class of Certificates is subject to certain
restrictions and limitations in the manner more fully set forth above and in,
and as limited by, the Trust Agreement.
The Holder hereof or of any interest herein, by its acceptance of this
Certificate or such interest, agrees with the Trustee, the Depositor and the
other Holders that (i) it is a "qualified institutional buyer", as such term is
defined in Rule 144A under the Securities Act or a sophisticated institutional
investor that is, or in which each equity owner is, an "accredited investor" as
such term is defined in Rule 501(a)(1), (2), (3) or (7) under the Securities
Act, or, if this Certificate or such interest is to be purchased for one or more
institutional accounts ("investor accounts") for which the Holder hereof or
thereof is acting as fiduciary or agent (except if the Holder hereof or thereof
is a bank as defined in Section 3(a)(2) of the Securities Act, or a savings and
loan association or other institution as described in Section 3(a)(5)(A) of the
Securities Act, whether acting in its individual or in a fiduciary capacity),
each such investor account is an institutional investor and an "accredited
investor" on a like basis, (ii) it will not
3
<PAGE> 34
transfer this Certificate or such interest except in accordance with the Trust
Agreement, (iii) it will indemnify the Trustee and the Depositor against any
liability that may result if any transfer of this Certificate or such interest
is not exempt from the registration requirements of federal, state and foreign
securities laws, and (iv) it will treat this Certificate as debt for all tax
purposes. The foregoing agreements are in addition to the other obligations of
the Holders under the Trust Agreement.
The Trustee and the Registrar shall treat the person in whose name a
Certificate is registered as provided in the Trust Agreement as the absolute
owner thereof for all purposes, whether or not such Certificate shall be overdue
and notwithstanding any notation of ownership or other writing thereon, and
neither the Trustee nor the Registrar shall be affected by any notice to the
contrary.
The Trust Agreement permits, with certain exceptions as therein
provided, the amendment thereof and the modification of the rights of the
Holders of the Certificates under the Trust Agreement at any time by the
Depositor and Trustee with the consent of the Holders of Certificates evidencing
Percentage Interests aggregating not less than 66-2/3% of each Class of
Certificates. Any such consent by the Holder of this Certificate shall be
conclusive and binding upon such Holder and upon all future Holders of this
Certificate and of any Certificate issued upon the registration of transfer
hereof or in exchange therefor or in lieu hereof whether or not notation of such
consent or waiver is made upon this Certificate. The Trust Agreement also
permits the Trustee to amend or waive certain terms and conditions set forth in
the Trust Agreement without the consent of Holders of the Certificates issued
thereunder.
4
<PAGE> 35
IN WITNESS WHEREOF, the Trustee has caused this certificate to be duly
executed.
Dated:____________________ FIRST UNION NATIONAL BANK, not in its
individual capacity but solely as
Trustee of the within mentioned Trust
Fund
By:____________________________________
Authorized Officer
Certificate of Authentication
This is one of the Certificates referred to in the within mentioned
Trust Agreement.
Dated:___________________
FIRST UNION NATIONAL BANK,
as Registrar
By:_____________________________________
5
<PAGE> 36
ASSIGNMENT
FOR VALUE RECEIVED the undersigned hereby sell(s), assign(s) and transfer(s)
unto ___________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
(Please print or typewrite name and address, including postal zip code, of
assignee)
the within Certificate and hereby authorize(s) the transfer of registration of
such Certificate on the books of the Registrar.
I (we) further direct the Registrar to issue a new Certificate of
authorized denomination or notional amount, as the case may be, evidencing the
same aggregate Percentage Interest as the within Certificate, to the above named
assignee and to deliver such Certificate to the following
address: _______________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
Dated: _______________________
Tax Identification _________________________________________
No. of Assignee: Signature by or on behalf of assignor
(signature must be signed as registered)
______________________________ _________________________________________
Signature Guaranteed
6
<PAGE> 37
DISTRIBUTION INSTRUCTIONS
The assignee should include the following for the information of the
Trustee:
Distribution shall be made by wire transfer in immediately available funds to
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
for the account of account number _____, or, if mailed by check, to ____________
Applicable statements should be mailed to _____________________________
________________________________________________________________________________
_________________________________________
Signature of assignee or agent
(for authorization of wire transfer only)
7
<PAGE> 38
[Form of Class X Certificates]
THIS CERTIFICATE DOES NOT REPRESENT AN INTEREST IN OR OBLIGATION OF SEQUOIA
MORTGAGE TRUST 1, THE TRUSTEE (AS HEREINAFTER DEFINED) OR ANY OF THEIR
RESPECTIVE AFFILIATES, AND IS NOT INSURED OR GUARANTEED BY ANY GOVERNMENTAL
AGENCY OR INSTRUMENTALITY NOR ANY OTHER PERSON OR ENTITY.
THIS CERTIFICATE HAS NOT BEEN AND WILL NOT BE REGISTERED UNDER THE SECURITIES
ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY STATE OR FOREIGN
SECURITIES LAWS, AND MAY NOT, DIRECTLY OR INDIRECTLY, BE SOLD OR OTHERWISE
TRANSFERRED, OR OFFERED FOR SALE, UNLESS THE PROPOSED TRANSFEREE IS (I) A
"QUALIFIED INSTITUTIONAL BUYER" PURCHASING FOR ITS OWN ACCOUNT OR FOR THE
ACCOUNT OF A "QUALIFIED INSTITUTIONAL BUYER" TO WHOM NOTICE HAS BEEN GIVEN THAT
THE RESALE, PLEDGE OR TRANSFER IS BEING MADE IN RELIANCE ON RULE 144A UNDER THE
SECURITIES ACT OR (II) A SOPHISTICATED INSTITUTIONAL INVESTOR THAT IS AN
"ACCREDITED INVESTOR" OR ALL OF WHOSE EQUITY OWNERS ARE "ACCREDITED INVESTORS"
AS SUCH TERM IS DEFINED IN RULE 501(a)(1), (2), (3) OR (7) UNDER THE SECURITIES
ACT, OR, IF THIS CERTIFICATE IS TO BE PURCHASED FOR ONE OR MORE INSTITUTIONAL
ACCOUNTS ("INVESTOR ACCOUNTS") FOR WHICH SUCH PROPOSED TRANSFEREE IS ACTING AS
FIDUCIARY OR AGENT (EXCEPT IF SUCH PROPOSED TRANSFEREE IS A BANK DEFINED IN
SECTION 3(a)(2) OF THE SECURITIES ACT, OR A SAVINGS AND LOAN ASSOCIATION OR
OTHER INSTITUTION AS DESCRIBED IN SECTION 3(a)(5)(A) OF THE SECURITIES ACT,
WHETHER ACTING IN ITS INDIVIDUAL OR IN A FIDUCIARY CAPACITY), EACH SUCH INVESTOR
ACCOUNT IS AN INSTITUTIONAL INVESTOR AND AN "ACCREDITED INVESTOR" ON A LIKE
BASIS, AND SUCH TRANSFER IS IN ACCORDANCE WITH THE PROVISIONS OF SECTION 4.02 OF
THE TRUST AGREEMENT REFERRED TO HEREIN. ANY SUCH TRANSFER MUST ALSO COMPLY WITH
THE OTHER PROVISIONS OF SECTION 4.02 OF THE TRUST AGREEMENT.
EXCEPT AS PROVIDED IN SECTION 4.02 OF THE TRUST AGREEMENT REFERRED TO HEREIN,
THIS CERTIFICATE MAY NOT BE PURCHASED BY OR TRANSFERRED TO ANY PERSON UNLESS THE
TRUSTEE SHALL HAVE RECEIVED AN OPINION OF COUNSEL TO THE EFFECT THAT SUCH
TRANSFER WILL NOT RESULT IN MATERIAL ADVERSE TAX CONSEQUENCES TO THE HOLDERS OF
CLASS A CERTIFICATES, THE TRUST FUND OR THE DEPOSITOR.
PRINCIPAL WILL NOT BE DISTRIBUTABLE IN RESPECT OF THIS CERTIFICATE. INTEREST IS
CALCULATED ON THIS CERTIFICATE BASED ON A NOTIONAL AMOUNT, WHICH, AS OF ANY
DISTRIBUTION DATE, IS EQUAL TO THE AGGREGATE PRINCIPAL AMOUNT OF THE CLASS A
CERTIFICATES ON SUCH DISTRIBUTION DATE. CONSEQUENTLY, THE NOTIONAL AMOUNT OF
THIS CERTIFICATE AT ANY TIME MAY BE LESS THAN THE INITIAL NOTIONAL AMOUNT OF
THIS CERTIFICATE AS SET FORTH HEREIN.
8
<PAGE> 39
SEQUOIA MORTGAGE TRUST 1A
MORTGAGE BOND-BACKED CERTIFICATES,
SERIES 1999-A
Class X
Certificate No. 1
Original Notional Amount of this Certificate: $157,266,300.00
Percentage Interest: 100%
Certificate Interest Rate: Variable
Closing Date: May 4, 1999
CUSIP No.: 817435 AD2
This certifies that AUER & CO. is the registered owner of the undivided
Percentage Interest evidenced by this Certificate in the aggregate amount
distributable on the Class of Certificates specified above evidencing undivided
ownership interests in a trust fund (the "Trust Fund") consisting primarily of
two classes of collateralized mortgage bonds with an aggregate outstanding
principal amount as of the Closing Date of $157,266,300.30 (the "Underlying
Bonds") collateralized by a pool of adjustable rate, one- to-four-family first
lien mortgage loans and the Bond Insurance Policy. The Trust Fund was created
pursuant to a trust agreement dated May 4, 1999 (the "Trust Agreement") between
Sequoia Mortgage Trust 1 (the "Depositor") and First Union National Bank, as
trustee (the "Trustee"), which terms include any successor entity under the
Trust Agreement, a summary of certain of the pertinent provisions of which is
set forth hereinafter. This Certificate is issued under and is subject to the
terms, provisions and conditions of the Trust Agreement, to which Trust
Agreement the Holder of this Certificate by virtue of the acceptance hereof
assents and by which such Holder is bound.
This Certificate is one of a duly authorized issue of Sequoia Mortgage
Trust 1A Mortgage Bond-Backed Certificates, Series 1999-A (herein called the
"Certificates") issued under the Trust Agreement to which reference is hereby
made for a statement of the respective rights thereunder of the Depositor, the
Trustee and the Holders of the Certificates and the terms upon which the
Certificates are executed and delivered. All terms used in this Certificate
which are defined in the Trust Agreement shall have the meanings assigned to
them in the Trust Agreement.
9
<PAGE> 40
The Trust Agreement requires the distribution on each Distribution
Date, commencing June 1999, to the person in whose name this Certificate is
registered at the close of business on the immediately preceding Record Date, of
an amount equal to the product of the Percentage Interest evidenced by this
Certificate and the amount distributable pursuant to the Trust Agreement on the
Class of Certificates specified above for such Distribution Date. Pursuant to
the Trust Agreement, this Class of Certificates is entitled on each Distribution
Date to distributions of interest to the extent provided for in the Trust
Agreement. Notwithstanding the foregoing, the obligation of the Trustee to make
any such distribution on any Distribution Date is limited to the extent that
distributions of interest in respect of the Underlying Bonds shall have been
received by it not later than such Distribution Date.
Distributions on this Certificate will be made by the Trustee by wire
transfer to an account specified in writing by such Certificateholder at least
five Business Days prior to the preceding Record Date or in such other manner as
may be agreed to by the Trustee and such Certificateholder. Except as otherwise
provided in the Trust Agreement, the final distribution on this Certificate will
be made only upon presentation and surrender of this Certificate to the Trustee
at the office thereof specified in the notice to Certificateholders of such
final distribution.
The Certificates are limited in right of distribution to the Percentage
Interests represented thereby in distributions in respect of the Underlying
Bonds received by the Trustee, subject to the provisions of and all as more
specifically set forth in the Trust Agreement. The Certificateholder, by its
acceptance of this Certificate, agrees that it will look solely to the funds on
deposit in the Certificate Account for distributions hereunder and that neither
the Trustee in its individual capacity nor the Depositor is personally liable to
the Certificateholders for any amount distributable under this Certificate or
the Trust Agreement or, except as expressly provided in the Trust Agreement,
subject to any liability under the Trust Agreement.
This Certificate does not purport to summarize the Trust Agreement and
reference is made to the Trust Agreement for the interests, rights and
limitations of rights, benefits, obligations and duties evidenced hereby, and
the rights, duties and immunities of the Trustee.
This Class of Certificates is issuable in registered form in minimum
denominations of $20,000,000 initial Notional Amount and integral multiples of
$1 in excess thereof. Transfer of this Class of Certificates is subject to
certain restrictions and limitations in the manner more fully set forth above
and in, and as limited by, the Trust Agreement.
The Holder hereof or of any interest herein, by its acceptance of this
Certificate or such interest, agrees with the Trustee, the Depositor and the
other Holders that (i) it is a "qualified institutional buyer", as such term is
defined in Rule 144A under the Securities Act or a sophisticated institutional
investor that is, or in which each equity owner is, an "accredited investor" as
such term is defined in Rule 501(a)(1), (2), (3) or (7) under the Securities
Act, or, if this Certificate or such interest is to be purchased for one or more
institutional accounts ("investor accounts") for which the Holder hereof or
thereof is acting as fiduciary or agent (except if the Holder hereof or thereof
is a bank as defined in Section 3(a)(2) of the Securities Act, or a savings and
loan association or other institution as described in Section 3(a)(5)(A) of the
Securities Act, whether acting in its individual or in a fiduciary capacity),
each such investor account is an institutional investor and an "accredited
investor" on a like basis, (ii) it will not
10
<PAGE> 41
transfer this Certificate or such interest except in accordance with the Trust
Agreement, (iii) it will indemnify the Trustee and the Depositor against any
liability that may result if any transfer of this Certificate or such interest
is not exempt from the registration requirements of federal, state and foreign
securities laws, and (iv) it will treat this Certificate as debt for all tax
purposes. The foregoing agreements are in addition to the other obligations of
the Holders under the Trust Agreement.
The Trustee and the Registrar shall treat the person in whose name a
Certificate is registered as provided in the Trust Agreement as the absolute
owner thereof for all purposes, whether or not such Certificate shall be overdue
and notwithstanding any notation of ownership or other writing thereon, and
neither the Trustee nor the Registrar shall be affected by any notice to the
contrary.
The Trust Agreement permits, with certain exceptions as therein
provided, the amendment thereof and the modification of the rights of the
Holders of the Certificates under the Trust Agreement at any time by the
Depositor and Trustee with the consent of the Holders of Certificates evidencing
Percentage Interests aggregating not less than 66-2/3% of each Class of
Certificates. Any such consent by the Holder of this Certificate shall be
conclusive and binding upon such Holder and upon all future Holders of this
Certificate and of any Certificate issued upon the registration of transfer
hereof or in exchange therefor or in lieu hereof whether or not notation of such
consent or waiver is made upon this Certificate. The Trust Agreement also
permits the Trustee to amend or waive certain terms and conditions set forth in
the Trust Agreement without the consent of Holders of the Certificates issued
thereunder.
11
<PAGE> 42
IN WITNESS WHEREOF, the Trustee has caused this certificate to be duly
executed.
Dated:____________________ FIRST UNION NATIONAL BANK,
not in its individual capacity but
solely as Trustee of the within
mentioned Trust Fund
By:___________________________________
Authorized Officer
Certificate of Authentication
This is one of the Certificates referred to in the within
mentioned Trust Agreement.
Dated:___________________
FIRST UNION NATIONAL BANK,
as Registrar
By:___________________________________
12
<PAGE> 43
ASSIGNMENT
FOR VALUE RECEIVED the undersigned hereby sell(s), assign(s) and transfer(s)
unto
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
(Please print or typewrite name and address, including postal zip code, of
assignee)
the within Certificate and hereby authorize(s) the transfer of registration of
such Certificate on the books of the Registrar.
I (we) further direct the Registrar to issue a new Certificate of
authorized denomination or notional amount, as the case may be, evidencing the
same aggregate Percentage Interest as the within Certificate, to the above named
assignee and to deliver such Certificate to the following
address: _______________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
Dated:____________________________
Tax Identification ________________________________________
No. of Assignee: Signature by or on behalf of assignor
(signature must be signed as registered)
__________________________________ ________________________________________
Signature Guaranteed
13
<PAGE> 44
DISTRIBUTION INSTRUCTIONS
The assignee should include the following for the information of the
Trustee:
Distribution shall be made by wire transfer in immediately available funds to
________________________________________________________________________________
________________________________________________________________________________
for the account of account number _____, or, if mailed by check, to ____________
Applicable statements should be mailed to _____________________________
________________________________________________________________________________
_________________________________________
Signature of assignee or agent
(for authorization of wire transfer only)
14
<PAGE> 45
EXHIBIT B
SCHEDULE OF UNDERLYING BONDS
<TABLE>
<CAPTION>
Original Principal Outstanding Principal
Certificate Designation Amount Amount
- ----------------------- ------ ------
<S> <C> <C>
Sequoia Mortgage Trust 1
Collateralized Mortgage Bonds
Class A-1 $334,347,000.00 $98,403,314.15
Class A-2 200,000,000.00 58,862,986.15
</TABLE>
<PAGE> 46
EXHIBIT C
FORM OF RULE 144A INVESTMENT LETTER
[FORM OF "QUALIFIED INSTITUTIONAL BUYER" TRANSFEREE'S CERTIFICATE]
____________________
Date
Sequoia Mortgage Trust 1
c/o Redwood Trust, Inc.
591 Redwood Highway
Suite 3100
Mill Valley, California 94941
Attention: Vickie Rath
First Union National Bank
230 South Tryon Street
Charlotte, North Carolina 28288
Attention: Structured Finance Trust Services - NC1179
Re: Sequoia Mortgage Trust 1A Mortgage
Bond-Backed Certificates, Series 1999-A
Ladies and Gentlemen:
In connection with our acquisition of the above-referenced Mortgage
Bond-Backed Certificates (the "Certificates") we certify that (a) we understand
that the Certificates have not been registered under the Securities Act of 1933,
as amended (the "Act"), or any state securities laws and are being transferred
to us in a transaction that is exempt from the registration requirements of the
Act and any such laws, (b) we have such knowledge and experience in financial
and business matters that we are capable of evaluating the merits and risks of
investments in the Certificates, (c) we have had the opportunity to ask
questions of and receive answers from the transferor concerning the purchase of
the Certificates and all matters relating thereto or any additional information
deemed necessary to our decision to purchase the Certificates, (d) we have not,
nor has anyone acting on our behalf, offered, transferred, pledged, sold or
otherwise disposed of the Certificates or any interest in the Certificates, or
solicited any offer to buy, transfer, pledge or otherwise dispose of the
Certificates or any interest in the Certificates from any person in any manner,
or made any general solicitation by means of general advertising or in any other
manner, or taken any other action that would constitute a distribution of the
Certificates under the Act or that would render the disposition of the
Certificates a violation of Section 5 of the Act or any state securities laws or
require registration pursuant thereto, and we will not act, or authorize any
person to act, in such manner with respect to the Certificates, and (e) we are a
"qualified institutional buyer" as that term is defined in Rule 144A under the
Act. We are aware that the sale to us is being made in reliance on Rule 144A
under the Act. We are acquiring the Certificates for our own account or for
resale pursuant to Rule 144A under the Act and understand that such Certificates
may be resold, pledged or
<PAGE> 47
transferred only (i) to a person reasonably believed to be a qualified
institutional buyer that purchases for its own account or for the account of a
qualified institutional buyer to whom notice is given that the resale, pledge or
transfer is being made in reliance on Rule 144A under the Act or (ii) pursuant
to another exemption from registration under the Act.
Very truly yours,
________________________________________
Print Name of Purchaser
By: ____________________________________
Name:
Title:
C-2
<PAGE> 48
EXHIBIT D
FORM OF NON-RULE 144A INVESTMENT LETTER
____________________
Date
Sequoia Mortgage Trust 1
c/o Redwood Trust, Inc.
591 Redwood Highway
Suite 3100
Mill Valley, California 94941
Attention: Vickie Rath
First Union National Bank
230 South Tryon Street
Charlotte, North Carolina 28288
Attention: Structured Finance Trust Services - NC1179
Re: Sequoia Mortgage Trust 1A Mortgage
Bond-Backed Certificates, Series 1999-A
Ladies and Gentlemen:
In connection with our acquisition of the above-referenced Mortgage
Bond-Backed Certificates (the "Certificates") we certify that (a) we understand
that the Certificates have not been registered under the Securities Act of 1933,
as amended (the "Act"), or any state securities laws and are being transferred
to us in a transaction that is exempt from the registration requirements of the
Act and any such laws, (b) we are an "accredited investor," as defined in Rule
501(a)(1), (2), (3) or (7) under the Act, and have such knowledge and experience
in financial and business matters that we are capable of evaluating the merits
and risks of investments in the Certificates, (c) we have had the opportunity to
ask questions of and receive answers from the transferor concerning the purchase
of the Certificates and all matters relating thereto or any additional
information deemed necessary to our decision to purchase the Certificates, (d)
we are acquiring the Certificates for investment for our own account and not
with a view to any distribution of such Certificates (but without prejudice to
our right at all times to sell or otherwise dispose of the Certificates in
accordance with clause (f) below), (e) we have not offered or sold any
Certificates to, or solicited offers to buy any Certificates from, any person,
or otherwise approached or negotiated with any person with respect thereto, or
taken any other action that would result in a violation of Section 5 of the Act
or any state securities laws, and (f) we will not sell, transfer or otherwise
dispose of any Certificates unless (1) such sale, transfer or other disposition
is made pursuant to an effective registration statement under the Act and in
compliance with any relevant state securities laws or is exempt from such
registration requirements and, if requested, we will at our expense provide an
opinion of counsel satisfactory to the addressees of this certificate that such
sale, transfer or other disposition may be made pursuant to an exemption from
the Act, (2) the purchaser or transferee of such Certificate has
<PAGE> 49
executed and delivered to you a certificate to substantially the same effect as
this certificate, and (3) the purchaser or transferee has otherwise complied
with any conditions for transfer set forth in the Trust Agreement dated May 4,
1999, between Sequoia Mortgage Trust 1, as depositor, and First Union National
Bank, as trustee.
Very truly yours,
________________________________________
Print Name of Purchaser
By:_____________________________________
Name:
Title:
D-2
<PAGE> 1
EXHIBIT 11.1
REDWOOD TRUST, INC.
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
Three Months Six Months
Ended Ended
June 30, 1999 June 30, 1999
----------- -----------
<S> <C> <C>
Basic:
Average common shares outstanding ............................. 10,051,565 10,412,855
----------- -----------
Total 10,051,565 10,412,855
=========== ===========
Net Income $ 2,508,411 $ 8,363,228
=========== ===========
Per Share Amount $ 0.25 $ 0.80
=========== ===========
DILUTED:
Average common shares outstanding ............................. 10,051,565 10,412,855
Net effect of dilutive stock options outstanding
during the period -- based on the treasury stock method ..... 121,395 110,474
----------- -----------
Total 10,172,960 10,523,329
=========== ===========
Net Income $ 2,508,411 $ 8,363,228
=========== ===========
Per Share Amount $ 0.25 $ 0.79
=========== ===========
</TABLE>
<PAGE> 2
REDWOOD TRUST, INC.
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
Three Months Six Months
Ended Ended
June 30, 1998 June 30, 1998
------------ -----------
<S> <C> <C>
Basic:
Average common shares outstanding ............................. 14,106,828 14,115,342
------------ -----------
Total 14,106,828 14,115,342
============ ===========
Net Income ($ 491,212) $ 1,959,171
============ ===========
Per Share Amount ($ 0.03) $ 0.14
============ ===========
DILUTED:
Average common shares outstanding ............................. 14,106,828 14,115,342
Net effect of dilutive stock options outstanding
during the period -- based on the treasury stock method ..... 149,030 253,274
------------ -----------
Total 14,255,858 14,368,616
============ ===========
Net Income ($ 491,212) $ 1,959,171
============ ===========
Per Share Amount ($ 0.03) $ 0.14
============ ===========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM JUNE 30,
1999 QUARTERLY REPORT ON FORM 10-Q.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 75,049
<SECURITIES> 2,129,096
<RECEIVABLES> 12,952
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,240,101
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 2,240,101
<CURRENT-LIABILITIES> 931,551
<BONDS> 1,066,976
0
26,736
<COMMON> 259,283
<OTHER-SE> (44,445)
<TOTAL-LIABILITY-AND-EQUITY> 2,240,101
<SALES> 0
<TOTAL-REVENUES> 36,091
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 5,067
<LOSS-PROVISION> 371
<INTEREST-EXPENSE> 28,537
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,509
<EPS-BASIC> .25
<EPS-DILUTED> .25
</TABLE>
