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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 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 ($.01 par value) 902,068 as of November 10, 1999 Common
Stock ($.01 par value) 8,780,417 as of November 10, 1999
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REDWOOD TRUST, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
Page
PART I. FINANCIAL INFORMATION ----
<S> <C> <C>
Item 1. Consolidated Financial Statements - Redwood Trust, Inc.
Consolidated Balance Sheets at September 30, 1999 and December 31, 1998............................. 3
Consolidated Statements of Operations for the three
and nine months ended September 30, 1999 and September 30, 1998..................................... 4
Consolidated Statements of Stockholders' Equity for the three and nine months ended
September 30, 1999................................................................................... 5
Consolidated Statements of Cash Flows for the three and nine months ended September 30, 1999 and
September 30, 1998................................................................................... 6
Notes to Consolidated Financial Statements........................................................... 7
Consolidated Financial Statements - RWT Holdings, Inc.
Consolidated Balance Sheets at September 30, 1999 and December 31, 1998..............................22
Consolidated Statements of Operations for the three months ended September 30, 1999 and 1998,
for the nine months ended September 30, 1999 and for the period from April 1, 1998 to
September 30, 1998...................................................................................23
Consolidated Statements of Stockholders' Equity for the three and nine months ended
September 30, 1999...................................................................................24
Consolidated Statements of Cash Flows for the three months ended September 30, 1999 and 1998,
for the nine months ended September 30, 1999 and for the period from
April 1, 1998 to September 30, 1998..................................................................25
Notes to Consolidated Financial Statements...........................................................26
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations................................................................32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................................49
Item 2. Changes in Securities........................................................................................49
Item 3. Defaults Upon Senior Securities..............................................................................49
Item 4. Submission of Matters to a Vote of Security Holders..........................................................49
Item 5. Other Information............................................................................................49
Item 6. Exhibits and Reports on Form 8-K.............................................................................49
SIGNATURES ............................................................................................................50
</TABLE>
2
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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>
September 30, 1999 December 31, 1998
------------------ -----------------
(Unaudited)
<S> <C> <C>
ASSETS
Mortgage loans: held-for-sale
Residential $ 21,588 $ 265,914
Commercial 17,877 8,287
----------- -----------
39,465 274,201
----------- -----------
Mortgage loans: held-for-investment, net
Residential 1,019,046 1,131,300
----------- -----------
1,019,046 1,131,300
----------- -----------
Mortgage securities: trading 918,057 1,257,655
Mortgage securities: available-for-sale, net 19,235 7,707
U.S. Treasury securities -- 48,009
Cash and cash equivalents 31,427 55,627
Restricted cash 4,927 12,857
Interest rate agreements 2,684 2,517
Accrued interest receivable 12,679 18,482
Investment in RWT Holdings, Inc. 12,432 15,124
Loans to RWT Holdings, Inc. 19,375 6,500
Receivable from RWT Holdings, Inc. 330 445
Other assets 1,812 2,024
----------- -----------
$ 2,081,469 $ 2,832,448
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt $ 854,465 $ 1,257,570
Long-term debt, net 994,355 1,305,560
Accrued interest payable 4,967 10,820
Accrued expenses and other liabilities 4,097 3,022
Dividends payable 687 686
----------- -----------
1,858,571 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;
8,955,317 and 11,251,556 issued and outstanding 89 113
Additional paid-in capital 244,190 279,201
Accumulated other comprehensive income (1,852) (370)
Cumulative earnings 13,098 6,412
Cumulative distributions to stockholders (59,363) (57,302)
----------- -----------
222,898 254,790
----------- -----------
$ 2,081,469 $ 2,832,448
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
3
<PAGE> 4
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
INTEREST INCOME
Mortgage loans: held-for-sale
Residential $ 1,001 $ -- $ 6,715 $ --
Commercial 452 -- 821 --
------------ ------------ ------------ ------------
1,453 -- 7,536 --
Mortgage loans: held-for-investment
Residential 16,816 37,594 49,646 93,308
------------ ------------ ------------ ------------
16,816 37,594 49,646 93,308
Mortgage securities: trading 14,507 22,728 49,571 22,864
Mortgage securities: available-for-sale 1,061 776 2,723 51,731
U.S. Treasury securities -- -- 913 --
Cash and cash equivalents 718 460 1,988 1,298
------------ ------------ ------------ ------------
Total interest income 34,555 61,558 112,377 169,201
INTEREST EXPENSE
Short-term debt (11,887) (31,528) (38,517) (92,812)
Long-term debt (15,503) (24,642) (50,901) (59,623)
------------ ------------ ------------ ------------
Total interest expense (27,390) (56,170) (89,418) (152,435)
Net interest rate agreements expense (457) (247) (1,527) (3,248)
------------ ------------ ------------ ------------
NET INTEREST INCOME 6,708 5,141 21,432 13,518
Provision for credit losses (416) 638 (1,132) (726)
Equity in earnings (losses) of RWT Holdings, Inc. (6,350) (1,575) (12,591) (2,156)
Operating expenses (964) (1,029) (2,617) (3,545)
Other income 39 -- 80 139
------------ ------------ ------------ ------------
NET INCOME (LOSS) BEFORE NET UNREALIZED AND REALIZED
GAINS (LOSSES) ON ASSETS (983) 3,175 5,172 7,230
Net unrealized and realized gains (losses) on assets (2,068) (40,293) 1,513 (41,016)
------------ ------------ ------------ ------------
Net income (loss) before preferred dividend and change in
accounting principle (3,051) (37,118) 6,685 (33,786)
Less cash dividends on Class B preferred stock (687) (687) (2,060) (2,060)
------------ ------------ ------------ ------------
Net income (loss) before change in accounting principle (3,738) (37,805) 4,625 (35,846)
Cumulative transition effect of adopting SFAS No. 133 (See Note 2) -- (10,061) -- (10,061)
------------ ------------ ------------ ------------
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS $ (3,738) $ (47,866) $ 4,625 $ (45,907)
============ ============ ============ ============
EARNINGS PER SHARE:
Basic Earnings Per Share:
Net income (loss) before change in accounting principle $ (0.39) $ (2.85) $ 0.46 $ (2.59)
Cumulative transition effect of adopting SFAS No. 133 $ -- $ (0.76) $ -- $ (0.73)
Net income (loss) $ (0.39) $ (3.61) $ 0.46 $ (3.32)
Diluted Earnings Per Share:
Net income (loss) before change in accounting principle $ (0.39) $ (2.85) $ 0.45 $ (2.59)
Cumulative transition effect of adopting SFAS No. 133 $ -- $ (0.76) $ -- $ (0.73)
Net income (loss) $ (0.39) $ (3.61) $ 0.45 $ (3.32)
Weighted average shares of common stock and common
stock equivalents:
Basic 9,481,418 13,247,908 10,090,305 13,823,020
Diluted 9,570,931 13,311,528 10,189,625 13,915,644
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
4
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REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
(Unaudited)
<TABLE>
<CAPTION>
Class B
Preferred stock Common stock Additional
--------------- -------------------- paid-in
Shares Amount Shares Amount capital
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------
Balance, December 31, 1998 909,518 $26,736 11,251,556 $113 $279,201
- ------------------------------------------------------------------------------------------
Comprehensive income:
Net income (loss) before
preferred dividend and change
in accounting principle -- -- -- -- --
Net unrealized loss on assets
available-for-sale -- -- -- -- --
Total comprehensive income -- -- -- -- --
Issuance of common stock -- -- 12,361 -- 1
Repurchase of common stock -- -- (1,077,600) (11) (16,024)
Dividends declared:
Preferred -- -- -- -- --
Common -- -- -- -- --
- ------------------------------------------------------------------------------------------
Balance, March 31, 1999 909,518 26,736 10,186,317 102 263,178
- ------------------------------------------------------------------------------------------
Comprehensive income:
Net income (loss) before
preferred dividend and change
in accounting principle -- -- -- -- --
Net unrealized loss on assets
available-for-sale -- -- -- -- --
Total comprehensive income -- -- -- -- --
Repurchase of common stock -- -- (256,600) (3) (3,994)
Dividends declared:
Preferred -- -- -- -- --
Common -- -- -- -- --
- ------------------------------------------------------------------------------------------
Balance, June 30, 1999 909,518 26,736 9,929,717 99 259,184
- ------------------------------------------------------------------------------------------
Comprehensive income:
Net income (loss) before
preferred dividend and change
in accounting principle -- -- -- -- --
Net unrealized income on assets
available-for-sale -- -- -- -- --
Total comprehensive loss -- -- -- -- --
Repurchase of common stock -- -- (974,400) (10) (14,994)
Dividends declared:
Preferred -- -- -- -- --
Common -- -- -- -- --
- ------------------------------------------------------------------------------------------
Balance, September 30, 1999 909,518 $26,736 8,955,317 $89 $244,190
- ------------------------------------------------------------------------------------------
</TABLE>
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
(Unaudited)
<TABLE>
<CAPTION>
Accumulated
other Cumulative
comprehensive Cumulative distributions to
income earnings stockholders Total
<S> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------
Balance, December 31, 1998 $(370) $6,412 $(57,302) $254,790
- ---------------------------------------------------------------------------------------------------
Comprehensive income:
Net income (loss) before
preferred dividend and change
in accounting principle -- 6,541 -- 6,541
Net unrealized loss on assets
available-for-sale (412) -- -- (412)
---------
Total comprehensive income -- -- -- 6,129
Issuance of common stock -- -- -- 1
Repurchase of common stock -- -- -- (16,035)
Dividends declared:
Preferred -- -- (687) (687)
Common -- -- -- --
- ---------------------------------------------------------------------------------------------------
Balance, March 31, 1999 (782) 12,953 (57,989) 244,198
- ---------------------------------------------------------------------------------------------------
Comprehensive income:
Net income (loss) before
preferred dividend and change
in accounting principle -- 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 -- -- -- (3,997)
Dividends declared:
Preferred -- -- (687) (687)
Common -- -- -- --
- ---------------------------------------------------------------------------------------------------
Balance, June 30, 1999 (1,918) 16,149 (58,676) 241,574
- ---------------------------------------------------------------------------------------------------
Comprehensive income:
Net income (loss) before
preferred dividend and change
in accounting principle -- (3,051) -- (3,051)
Net unrealized income on assets
available-for-sale 66 -- -- 66
---------
Total comprehensive loss -- -- -- (2,985)
Repurchase of common stock -- -- -- (15,004)
Dividends declared:
Preferred -- -- (687) (687)
Common -- -- -- --
- ---------------------------------------------------------------------------------------------------
Balance, September 30, 1999 $(1,852) $13,098 $(59,363) $222,898
- ---------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
5
<PAGE> 6
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) available to common stockholders $ (3,738) $ (47,866) $ 4,625 $ (45,907)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,212 7,305 5,601 29,730
Provision for credit losses 416 (638) 1,132 726
Equity in (earnings) losses of RWT Holdings, Inc. 6,350 1,575 12,591 2,156
Net unrealized and realized (gains) losses on assets 2,068 40,293 (1,513) 41,016
Cumulative transition effect of adopting SFAS No. 133 -- 10,061 -- 10,061
Purchases of mortgage loans: held-for-sale (27,194) -- (98,949) --
Proceeds from sales of mortgage loans: held-for-sale 71,481 -- 121,619 --
Principal payments on mortgage loans: held-for-sale 3,089 -- 58,327 --
Purchases of mortgage securities: trading (72,867) (135,717) (76,592) (366,884)
Proceeds from sales of mortgage securities: trading -- -- 7,668 --
Principal payments on mortgage securities: trading 89,701 227,233 404,702 227,233
Purchases of U.S. Treasury securities -- -- (45,844) --
Proceeds from sales of U.S. Treasury securities -- -- 90,519 --
Purchases of interest rate agreements (279) (11,898) (912) (13,923)
Proceeds from sales of interest rate agreements 250 2,769 1,371 2,769
(Increase) decrease in accrued interest receivable 273 (3,496) 5,803 (1,931)
Decrease in other assets 155 3,329 74 323
Decrease in accrued interest payable (319) (4,523) (5,853) (5,324)
Increase (decrease) in accrued expenses and other liabilities 1,264 (411) 1,075 (391)
----------- ----------- ----------- -----------
Net cash provided by (used in) operating activities 71,862 88,016 485,444 (120,346)
----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of mortgage loans: held-for-investment -- (629,201) -- (1,596,673)
Proceeds from sales of mortgage loans: held-for-investment -- 374,520 -- 374,520
Principal payments on mortgage loans: held-for-investment 69,638 187,432 261,487 475,905
Purchases of mortgage securities: available-for-sale (6,997) -- (7,931) --
Proceeds from sales of mortgage securities: available-for-sale -- -- -- 9,296
Principal payments on mortgage securities: available-for-sale 83 54 213 442,985
Net decrease in restricted cash 3,620 1,885 7,930 4,982
Investment in RWT Holdings, Inc., net of dividends received -- -- (9,900) (9,900)
Loans to RWT Holdings, Inc., net of repayments (17,375) -- (12,875) --
(Increase) decrease in receivable from RWT Holdings, Inc. (121) 55 115 (776)
----------- ----------- ----------- -----------
Net cash provided by (used in) investing activities 48,848 (65,255) 239,039 (299,661)
----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of (repayments on) short-term debt (68,280) 131,008 (403,105) 152,641
Proceeds (costs) from issuance of long-term debt -- -- (337) 635,192
Repayments on long-term debt (72,501) (127,511) (310,207) (342,428)
Net proceeds from issuance of common stock -- 3 1 1,591
Repurchases of common stock (15,004) (33,667) (35,036) (39,125)
Increase in dividends payable - preferred -- -- 1 --
Dividends paid on common stock -- (137) -- (8,945)
----------- ----------- ----------- -----------
Net cash provided by (used in) financing activities (155,785) (30,304) (748,683) 398,926
----------- ----------- ----------- -----------
Net decrease in cash and cash equivalents (35,075) (7,543) (24,200) (21,081)
Cash and cash equivalents at beginning of period 66,502 11,354 55,627 24,892
----------- ----------- ----------- -----------
Cash and cash equivalents at end of period $ 31,427 $ 3,811 $ 31,427 $ 3,811
=========== =========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 27,709 $ 60,693 $ 95,271 $ 157,759
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
6
<PAGE> 7
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 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 and is developing technology and processes designed
to streamline access to the residential mortgage market for a wide variety of
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 1999 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.
The consolidated financial statements included herein are unaudited; however, in
the opinion of management, the interim financial information contains all
adjustments, including normal recurring adjustments, necessary to present fairly
the results for the interim period.
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
7
<PAGE> 8
of Financial Accounting Standards ("SFAS") No. 107, Disclosures about Fair Value
of Financial Instruments, is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation sale. Management's estimates are inherently subjective in
nature and involve matters of uncertainty and judgement to interpret relevant
market and other data. Accordingly, amounts realized in actual sales may differ
from the fair values presented in Notes 3, 7 and 10.
Reserve for Credit Losses. A reserve for credit losses 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 securities and when, in the opinion of management, it is collectible.
Discounts and premiums relating to Mortgage Assets are amortized into interest
income over the lives of the Mortgage Assets using 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.
8
<PAGE> 9
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
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 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 December 31, 1998, cash
equivalents included $25 million in repurchase agreements.
RESTRICTED CASH
Restricted cash of the Company includes principal and interest payments on
Mortgage Loans held as collateral for the Company's Long-Term Debt, and cash
pledged as collateral on certain interest rate agreements.
INTEREST RATE AGREEMENTS
The Company maintains an overall interest-rate risk-management strategy that
incorporates the use of derivative interest rate agreements to minimize
significant unplanned fluctuations in earnings that are caused by interest-rate
volatility. Interest rate agreements that are used as part of the Company's
interest-rate risk management strategy include interest rate options, swaps,
options on swaps, futures contracts, and options on futures contracts
(collectively "Interest Rate Agreements"). On the date an Interest Rate
Agreement is entered into, the Company designates the interest rate agreement as
(1) a hedge of the fair value of a recognized asset or liability or of an
unrecognized firm commitment ("fair value" hedge), (2) a hedge of a forecasted
transaction or of the variability of cash flows to be received or paid related
to a recognized asset or liability ("cash flow" hedge), or (3) held for
9
<PAGE> 10
trading ("trading" instruments). Since the adoption of SFAS No. 133, the Company
has elected to designate all of its 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.
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.
10
<PAGE> 11
NET INCOME (LOSS) PER SHARE
Net income (loss) per share for the three and nine months ended September 30,
1999 and 1998 is shown in accordance with SFAS No. 128, Earnings Per Share.
Basic net income (loss) per share is computed by dividing net income (loss)
available to common stockholders by the weighted average number of common shares
outstanding during the period. Diluted net income (loss) per share is computed
by dividing the net income (loss) available to common stockholders by the
weighted average number of common shares and common equivalent shares
outstanding during the period. The common equivalent shares are calculated using
the treasury stock method, which assumes that all dilutive common stock
equivalents are exercised and the funds generated by the exercise are used to
buy back outstanding common stock at the average market price during the
reporting period. Due to the net loss available to common stockholders for both
the three and nine months ended September 30, 1998, the addition of potential
dilutive shares is anti-dilutive and therefore, the basic and diluted loss per
share are the same.
The following tables provide reconciliations of the numerators and denominators
of the basic and diluted net income (loss) per share computations.
<TABLE>
<CAPTION>
(in thousands, except share data) Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
---------- ----------- ------------ -------------
<S> <C> <C> <C> <C>
Numerator:
Numerator for basic and diluted earnings per share--
Net income (loss) before preferred dividend and
change in accounting principle $ (3,051) $ (37,118) $ 6,685 $ (33,786)
Cash dividends on Class B preferred stock (687) (687) (2,060) (2,060)
---------- ----------- ------------ -------------
Net income (loss) before change in accounting
principle (3,738) (37,805) 4,625 (35,846)
Cumulative transition effect of adopting SFAS
No. 133 -- (10,061) -- (10,061)
---------- ----------- ------------ -------------
Basic and Diluted EPS - Net income (loss)
available to common stockholders $ (3,738) $ (47,866) $ 4,625 $ (45,907)
========== =========== ============ ============
Denominator:
Denominator for basic earnings per share--
Weighted average number of common shares
outstanding during the period 9,481,418 13,247,908 10,090,305 13,823,020
Net effect of dilutive stock options 89,513 63,620 99,320 92,624
---------- ----------- ------------ -------------
Denominator for diluted earnings per share-- 9,570,931 13,311,528 10,189,625 13,915,644
---------- ----------- ------------ -------------
Basic Earnings Per Share:
Net income (loss) before change in accounting principle $ (9.39) (2.85) $ 0.46 $ (2.59)
Cumulative transition effect of adopting SFAS No. 133 -- (0.76) -- (0.73)
---------- ----------- ------------ -------------
Net earnings per share $ (0.39) $ (3.61) $ 0.46 $ (3.32)
========== =========== ============ ============
Diluted Earnings Per Share:
Net income (loss) before change in accounting principle $ (0.39) $ (2.85) $ 0.45 $ (2.59)
Cumulative transition effect of adopting SFAS No. 133 -- (0.76) -- (0.73)
---------- ----------- ------------ -------------
Net earnings per share $ (0.39) $ (3.61) $ 0.45 $ (3.32)
========== =========== ============ ============
</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-
11
<PAGE> 12
for-sale are reported as a component of Comprehensive Income on the Consolidated
Statements of Stockholders' Equity with cumulative unrealized gains and losses
classified as Accumulated Other Comprehensive Income in Stockholders' Equity. At
September 30, 1999 and December 31, 1998, the only component of Accumulated
Other Comprehensive Income was net unrealized gains and losses on assets
available-for-sale.
NOTE 3. MORTGAGE ASSETS
At September 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 September 30, 1999 and December 31, 1998, the annualized effective yield
after taking into account the amortization expense due to prepayments on the
Mortgage Assets was 6.76% and 6.95%, respectively, based on the reported cost of
the assets. Of the Mortgage Assets owned by the Company at September 30, 1999,
77% were adjustable-rate mortgages, 21% were hybrid mortgages and 2% were
fixed-rate mortgages. The coupons on 66% 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 34% 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 lifetime caps. At
September 30, 1999 and December 31, 1998, the weighted average lifetime cap on
the adjustable-rate Mortgage Assets was 11.61% and 11.81%, respectively.
At September 30, 1999 and December 31, 1998, Mortgage Assets consisted of the
following:
Mortgage Loans: Held-for-Sale
<TABLE>
<CAPTION>
(in thousands) September 30, 1999 December 31, 1998
------------------ -----------------
<S> <C> <C>
Current Face $40,177 $274,630
Unamortized Discount (712) (1,099)
Unamortized Premium -- 670
------------ -----------------
Carrying Value $39,465 $274,201
============ =================
</TABLE>
Mortgage loans held-for-sale include Residential and Commercial Mortgage Loans
at September 30, 1999 and December 31, 1998. During the three and nine months
ended September 30, 1999, the Company recognized net losses of $281,014 and
$195,169 as a result of LOCOM adjustments on Mortgage Loans held-for-sale,
respectively. Also during the three and nine months ended September 30, 1999,
the Company sold Mortgage Loans held-for-sale for proceeds of $71.5 million and
$121.6 million, resulting in net gains of $0 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 during the second quarter of
1999 (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 nine months ended
September 30, 1998, as the Mortgage Loans were not reclassified to held-for-sale
until September 30, 1998.
12
<PAGE> 13
Mortgage Loans: Held-for-Investment
<TABLE>
<CAPTION>
(in thousands) September 30, 1999 December 31, 1998
------------------- -------------------
<S> <C> <C>
Current Face $1,010,334 $1,118,375
Unamortized Premium 13,623 16,709
------------------- -------------------
Amortized Cost 1,023,957 1,135,084
Allowance for Credit Losses (4,911) (3,784)
=================== ===================
Carrying Value $1,019,046 $1,131,300
=================== ===================
</TABLE>
There were no sales of Mortgage Loans held-for-investment for the three and nine
months ended September 30, 1999. During the three and nine months ended
September 30, 1998, and prior to the reclassification, the Company sold
held-for-investment Mortgage Loans with an amortized cost of $376 million. The
net realized loss of $1 million on the transaction is reflected as a component
of "Net Unrealized and Realized Gains (Losses) on Assets" on the Consolidated
Statements of Operations. 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>
September 30, 1999 December 31, 1998
(in thousands) Agency Non-Agency Total Agency Non-Agency Total
---------------------------------------- ----------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Current Face $512,844 $397,555 $910,399 $609,826 $640,923 $1,250,749
Unamortized Discount (9) (2,841) (2,850) (5) (3,084) (3,089)
Unamortized Premium 8,924 1,584 10,508 7,602 2,393 9,995
======================================== ========================================
Carrying Value $521,759 $396,298 $918,057 $617,423 $640,232 $1,257,655
======================================== ========================================
</TABLE>
For the three and nine months ended September 30, 1999, the Company recognized a
mark-to-market loss of $2.3 million and a mark-to-market gain of $2.9 million,
respectively, on Mortgage Securities classified as trading. The Company sold
Mortgage Securities classified as trading for proceeds of $0 and $7.7 million,
respectively, for the three and nine months ended September 30, 1999. The
Company reclassified all of its short-funded Mortgage Securities from
available-for-sale to trading on July 1, 1998 (see Note 2). For the three and
nine months ended September 30, 1998, the Company recognized a mark-to-market
loss of $14.6 million on Mortgage Securities classified as trading. 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>
September 30, 1999 December 31, 1998
(in thousands) Non-Agency Non-Agency
------------------ -----------------
<S> <C> <C>
Current Face $34,194 $17,281
Unamortized Discount (12,241) (8,015)
------------------ -----------------
Amortized Cost 21,953 9,266
Allowance for Credit Losses (867) (1,189)
Gross Unrealized Gains 43 313
Gross Unrealized Losses (1,894) (683)
================== =================
Carrying Value $19,235 $7,707
================== =================
</TABLE>
No sales or write-downs of Mortgage Securities available-for-sale occurred
during the three and nine months ended September 30, 1999 and the three months
ended September 30, 1998. During the nine months ended
13
<PAGE> 14
September 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 nine
months ended September 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 Nine Months Ended
September 30, September 30,
(in thousands) 1999 1998 1999 1998
------------------ -----------------
<S> <C> <C> <C> <C>
Balance at beginning of period $5,494 $5,784 $4,973 $4,931
Provision for credit losses 416 (638) 1,132 726
Charge-offs (132) (320) (327) (831)
------------------ -----------------
Balance at end of period $5,778 $4,826 $5,778 $4,826
================== =================
</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
The Company did not hold any U.S. Treasury securities at September 30, 1999. At
December 31, 1998 U.S. Treasury securities held by the Company consisted of the
following:
<TABLE>
<CAPTION>
(in thousands) December 31, 1998
-----------------
<S> <C>
Current Face $45,000
Unamortized Premium 3,009
-----------------
Carrying Value $48,009
=================
</TABLE>
For the three and nine months ended September 30, 1999, the Company recognized
mark-to-market losses of $0 and $3.3 million on U.S. Treasury securities and
sold U.S. Treasury securities for proceeds of $0 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.
14
<PAGE> 15
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) September 30, 1999 December 31, 1998
------------------- -------------------
<S> <C> <C>
Mortgage loans: held-for-sale $ 0 $ 197,646
Mortgage loans: held-for-investment, net 1,019,046 1,131,300
Restricted cash 4,425 12,857
Accrued interest receivable 5,740 7,707
=================== ===================
$1,029,211 $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 September 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 nine months ended September 30, 1999, the Company
recognized net gains of $0.5 million and $2.1 million, respectively, as a result
of mark-to-market adjustments on interest rate agreements classified as trading.
The Company classified its interest rate agreements as trading instruments on
July 1, 1998 (see Note 2), and recognized a net loss of $6.4 million as a result
of mark-to-market adjustments on interest rate agreements classified as trading
during the three and nine months ended September 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.
On July 1, 1998, as a result of adopting SFAS No. 133, the Company recorded a
net-of-tax cumulative-effect-type transition adjustment of $10.1 million loss in
earnings to recognize at fair value the ineffective portion of Interest Rate
Agreements that were previously designated as part of a hedging relationship
(see Note 2). This loss is reflected on the Consolidated Statements of
Operations as "Cumulative Transition Effect of Adopting SFAS No. 133."
Approximately $7.6 million of this transition adjustment was transferred from
other comprehensive income to current earnings.
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) September 30, 1999 December 31, 1998 September 30, 1999 December 31, 1998
-------------------------------------- --------------------------------------
<S> <C> <C> <C> <C>
Interest Rate Options
Purchased $2,258,400 $3,569,200 -- --
Interest Rate Options
Sold (15,000) -- -- --
Interest Rate Swaps 300,000 440,000 $6,590 $8,673
Eurodollar/LIBOR Futures 405,000 -- 484 --
Treasury Futures 15,000 -- 18 --
=================== =================== =================== ====================
Total $2,963,400 $4,009,200 $7,092 $8,673
=================== =================== =================== ====================
</TABLE>
(a) Reflects the fair market value of all cash and collateral of the Company
held by counterparties.
15
<PAGE> 16
Interest Rate Options purchased (sold), 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 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 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.
At September 30, 1999, the Company had $854 million of Short-Term Debt
outstanding with a weighted-average borrowing rate of 5.53% and a
weighted-average remaining maturity of 167 days. This debt was collateralized
with $899 million of Mortgage Assets. At December 31, 1998, the Company had $1.3
billion of Short-Term
16
<PAGE> 17
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 September 30, 1999 and December 31, 1998, the Short-Term Debt had the
following remaining maturities:
<TABLE>
<CAPTION>
(in thousands) September 30, 1999 December 31, 1998
------------------ -----------------
<S> <C> <C>
Within 30 days $28,096 $ 428,292
30 to 90 days 163,422 714,114
Over 90 days 662,947 115,164
=================== =================
Total Short-Term Debt $854,465 $1,257,570
=================== =================
</TABLE>
For the three and nine months ended September 30, 1999, the average balance of
Short-Term Debt was $0.9 billion and $1.0 billion with a weighted-average
interest cost of 5.50% and 5.22%, respectively. For the three and nine months
ended September 30, 1998, the average balance of Short-Term Debt was $2.1
billion with a weighted-average interest cost of 5.93% and 5.86%, respectively.
The maximum balance outstanding during the nine months ended September 30, 1999
and 1998 was $1.3 billion and $2.5 billion, respectively.
In July 1999, the Company entered into a one-year, $90 million revolving
mortgage warehousing credit facility with two banks. The facility is primarily
intended to finance newly originated residential mortgage loans. At September
30, 1999, the Company had outstanding borrowings of $950,000 under this
facility. Holdings may borrow under this facility as a co-borrower. At September
30, 1999, Holdings had no outstanding borrowings under this facility. Borrowings
under this facility bear interest based on a specified margin over the London
Interbank Offered Rate ("LIBOR"). For the three months ending September 30,
1999, the weighted-average borrowing rate under this facility was 6.44%. The
Company and Holdings were in compliance with all material representations,
warranties and covenants under this credit facility at September 30, 1999.
In July 1999, the Company entered into a one-year, $350 million master loan and
security agreement with a Wall Street firm. The facility is primarily intended
to finance newly originated commercial and residential mortgage loans. At
September 30, 1999, the Company had outstanding borrowings of $14.6 million
under this facility. Holdings may borrow under this facility as a co-borrower.
At September 30, 1999, Holdings had outstanding borrowings of $19.2 million
under this facility. Borrowings under this facility bear interest based on a
specified margin over LIBOR. For the three months ending September 30, 1999, the
weighted-average borrowing rate under this facility was 6.76%. The Company and
Holdings were in compliance with all material representations, warranties and
covenants under this credit facility at September 30, 1999.
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
17
<PAGE> 18
Mortgage Trust 1A ("Sequoia 1A"), a newly formed trust, and Sequoia 1A
issued Long-Term Debt collateralized by Sequoia 1 debt. As a result, the $154
million of Bond Collateral in the form of Mortgage Loans held-for-sale was
reclassified to Mortgage Loans held-for-investment.
The components of the Long-Term Debt at September 30, 1999 and December 31, 1998
along with selected other information are summarized below:
<TABLE>
<CAPTION>
(in thousands) September 30, 1999 December 31, 1998
------------------- --------------------
<S> <C> <C>
Long-Term Debt $993,198 $1,303,405
Unamortized premium on Long-Term Debt 4,216 5,783
Deferred bond issuance costs (3,059) (3,628)
------------------ --------------------
Total Long-Term Debt $994,355 $1,305,560
================== ===================
Range of weighted-average interest rates, by series 5.78% to 6.45% 5.75% to 6.55%
Stated maturities 2017 - 2029 2017 - 2029
Number of series 3 3
</TABLE>
For the three and nine months ended September 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 6.01% and
6.00%, respectively. For the three and nine months ended September 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 6.46% and 6.44%, respectively. At September 30, 1999 and December
31, 1998, accrued interest payable on Long-Term Debt was $3.1 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 September 30, 1999 and December 31, 1998.
<TABLE>
<CAPTION>
(in thousands) September 30, 1999 December 31, 1998
Carrying Value Fair Value Carrying Value Fair Value
--------------- --------------- --------------- --------------
<S> <C> <C> <C> <C>
Assets
Mortgage Loans: held-for-sale $ 39,465 $ 39,465 $ 274,201 $ 274,302
Mortgage Loans: held-for-investment $1,019,046 $1,003,734 $1,131,300 $1,120,376
Mortgage Securities: trading $ 918,057 $ 918,057 $1,257,655 $1,257,655
Mortgage Securities: available-for-sale $ 19,235 $ 19,235 $ 7,707 $ 7,707
U.S. Treasury Securities -- -- $ 48,009 $ 48,009
Interest Rate Agreements $ 2,684 $ 2,684 $ 2,517 $ 2,517
Investment in RWT Holdings, Inc. $ 12,432 $ 12,721 $ 15,124 $ 15,132
Liabilities
Short-Term Debt $ 854,465 $ 854,465 $1,257,570 $1,257,570
Long-Term Debt $ 994,355 $ 977,540 $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
18
<PAGE> 19
Stock. Effective October 1, 1999, the Company can either redeem or, under
certain circumstances, cause a conversion of the Preferred Stock. The Preferred
Stock pays a dividend equal to the greater of (i) $0.755 per share, per quarter
or (ii) an amount equal to the quarterly dividend declared on the number of
shares of the Common Stock into which the Preferred Stock is convertible. The
Preferred Stock ranks senior to the Company's Common Stock as to the payment of
dividends and liquidation rights. The liquidation preference entitles the
holders of the Preferred Stock to receive $31.00 per share plus any accrued
dividends before any distribution is made on the Common Stock.
As of September 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
both September 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 September 30, 1999 and December 31, 1998, 384,029 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 September 30, 1999 and
December 31, 1998, 383,220 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. For the three and nine months ended September 30, 1999, the
stock DERs accrued on NQSOs that had a stock DER feature resulted in charges to
operating expenses of $8,187. For the three and nine months ended September 30,
1998, the stock DERs accrued on NQSOs that had a stock DER feature resulted in
charges to operating expenses of $0 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 September 30, 1999 and
changes during the periods ending on that date is presented below.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 1999 September 30, 1999
---------------------------- ---------------------------
Weighted Weighted
Average Average
Exercise Exercise
(in thousands, except share data) Shares Price Shares Price
------------ --------------- ------------ --------------
<S> <C> <C> <C> <C>
Outstanding options at beginning of period 1,695,954 $22.75 1,739,787 $23.58
Options granted 18,500 $14.97 151,800 $16.11
Options exercised -- -- (12,361) $0.11
Options canceled (97,748) $16.97 (262,520) $23.71
------------ ------------
Outstanding options at end of period 1,616,706 $23.05 1,616,706 $23.05
============ ============
</TABLE>
19
<PAGE> 20
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 974,400 and 2,308,600 shares of its
Common Stock for $15 million and $35 million during the three and nine months
ended September 30, 1999, respectively. The Company repurchased 2,275,700 and
2,550,100 shares of its Common Stock for $34 million and $39 million during the
three and nine months ended September 30, 1998, respectively. At September 30,
1999, there were 174,900 shares available for repurchase. The repurchased shares
have been returned to the Company's authorized but unissued shares of Common
Stock.
In March 1999, the Company's Board of Directors approved the repurchase of
150,000 shares of the Company's Preferred Stock. The Company did not repurchase
any shares of its Preferred Stock during the three and nine months ended
September 30, 1999.
NOTE 12. RELATED PARTY TRANSACTIONS
SALE OF MORTGAGE LOANS
During the three and nine months ended September 30, 1999, the Company sold $24
million and $32 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 $22 million and $42 million of commercial mortgage loans
during the three and nine months ended September 30, 1999, respectively. Under
the terms of the Master Forward Commitment Agreement, the Company committed to
sell the Mortgage Loans to RCF during the fourth quarter of 1999. There was no
such activity for the three and nine months ended September 30, 1998.
For both the three and nine months ended September 30, 1999, the Company sold
$47 million of residential mortgage loans to Redwood Residential Funding
("RRF"), a subsidiary of Holdings. Pursuant to the Master Forward Commitment
Agreement, the Company sold the Mortgage Loans to RRF at the same price for
which the Company acquired the Mortgage Loans. Similarly, the Company purchased
or committed to purchase $4 million and $53 million of residential mortgage
loans during the three and nine months ended September 30, 1999, respectively.
Under the terms of the Master Forward Commitment Agreement, the Company
committed to sell the Mortgage Loans to RRF during the fourth quarter of 1999,
or the first quarter of 2000. There was no such activity for the three and nine
months ended September 30, 1998.
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 3.50% over the LIBOR. At September 30, 1999 and December 31, 1998,
the Company had loaned $19.4 million and $6.5 million, respectively, to Holdings
in accordance with the provisions of this arrangement. During the three and nine
months ended September 30, 1999, the Company earned $0.3 million and $0.7
million, respectively in interest on loans to Holdings. During both the three
and nine months ended September 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 nine months ended September 30, 1999, $1.2 million and $2.7
million, respectively, of Holdings' operating expenses were paid by the Company,
and were subject to reimbursement by Holdings. During the three and nine months
ended September 30, 1998, $0.7 million and $1.4 million, respectively, of
Holdings' operating expenses were paid by the Company, and were subject to
reimbursement by Holdings.
20
<PAGE> 21
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 September 30, 1999, the Company was providing credit
support on $19.2 million of Holdings' Short-Term Debt. No such borrowings were
outstanding at December 31, 1998. During the three and nine months ended
September 30, 1999, the Company recognized $31,065 and $71,923 in credit support
fees. Credit support fees for the three and nine months ended September 30, 1998
were $0 $138,966, respectively. Credit support fees are reflected as a component
of "Other Income" on the Consolidated Statements of Operations.
NOTE 13. COMMITMENTS AND CONTINGENCIES
At September 30, 1999, the Company had entered into commitments to purchase
$21.7 million of residential Mortgage Securities for settlement during October
1999. At September 30, 1999, the Company had also entered into commitments to
sell $22 million of commercial Mortgage Loans to RCF and $4 million of
residential Mortgage Loans to RRF for settlement during the fourth quarter of
1999 and the first quarter of 2000.
At September 30, 1999, the Company is obligated under non-cancelable operating
leases with expiration dates through 2003. The future minimum lease payments
under these non-cancelable leases are as follows: 1999 - $106,504; 2000 -
$399,515; 2001 - $186,764; 2002 - $52,321; 2003 - $43,601.
NOTE 14. SUBSEQUENT EVENTS
The Company repurchased 174,900 shares of Common Stock for $2.1 million during
October 1999, pursuant to its common stock repurchase program (see Note 11). As
of November 10, 1999, there are no remaining shares authorized for repurchase
under the Company's common stock repurchase program.
Through November 10, 1999, pursuant to the Company's preferred stock repurchase
program (see Note 11), the Company repurchased 7,450 shares of its Preferred
Stock for $0.2 million.
On October 28, 1999, the Company declared a $0.15 per share common stock
dividend for the third quarter ended September 30, 1999. The common stock
dividend is payable on November 22, 1999 to shareholders of record on November
8, 1999.
From October 1, 1999 through November 10, 1999, the Company committed to
purchase $476 million of mortgage loans and mortgage securities.
21
<PAGE> 22
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------ -----------------
(Unaudited)
ASSETS
<S> <C> <C>
Mortgage loans: held-for sale
Residential $ 20,244 $ 12,247
Commercial 28,721 -
---------------- ---------------
48,965 12,247
---------------- ---------------
Cash and cash equivalents 1,480 9,711
Accrued interest receivable 367 78
Property, equipment and leasehold improvements, net 3,008 622
Other assets 316 120
---------------- ---------------
$ 54,136 $ 22,778
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt $ 19,207 $ -
Loans from Redwood Trust, Inc. 19,375 6,500
Payable to Redwood Trust, Inc. 330 445
Accrued restructuring charges 1,362 -
Accrued expenses and other liabilities 1,304 557
---------------- ---------------
41,578 7,502
---------------- ---------------
Commitments and contingencies (See Note 10)
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 (17,442) (4,724)
---------------- ---------------
12,558 15,276
---------------- ---------------
$ 54,136 $ 22,778
================ ===============
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
22
<PAGE> 23
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 Nine Months Ended operations) to
September 30, 1999 September 30, 1998 September 30, 1999 September 30, 1998
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
REVENUES
Interest income
Mortgage loans: held-for-sale
Residential $ 350 $ - $ 657 $ 2,779
Commercial 451 - 774 -
-------- -------- -------- --------
801 - 1,431 2,779
Mortgage securities: trading 367 - 1,021 -
Cash and cash equivalents 79 131 295 188
-------- -------- -------- --------
Total interest income 1,247 131 2,747 2,967
-------- -------- -------- --------
Interest expense
Short-term debt (507) - (1,111) (2,503)
Credit support fees (31) - (72) (139)
Loans from Redwood Trust, Inc. (336) - (691) (15)
-------- -------- -------- --------
Total interest expense (874) - (1,874) (2,657)
-------- -------- -------- --------
Net interest income 373 131 873 310
Net unrealized and realized gains
(losses) on assets (531) - 84 22
Other income (expense) - - 48 -
-------- -------- -------- --------
Net revenues (expenses) (158) 131 1,005 332
-------- -------- -------- --------
EXPENSES
Compensation and benefits (2,534) (1,219) (7,346) (1,740)
General and administrative (1,512) (502) (4,167) (770)
Restructuring charge (2,210) - (2,210) -
-------- -------- -------- --------
Total expenses (6,256) (1,721) (13,723) (2,510)
-------- -------- -------- --------
NET LOSS $ (6,414) $ (1,590) $(12,718) $ (2,178)
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
23
<PAGE> 24
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
(Unaudited)
<TABLE>
<CAPTION>
Series A
Preferred stock Common stock Additional
------------------------------------------ paid-in Accumulate
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
- -------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net loss - - - - - (6,414) (6,414)
- -------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1999 5,940 $ 29,700 3,000 - $ 300 $(17,442) $ 12,558
=========================================================================================================================
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
24
<PAGE> 25
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
For the period
from April 1, 1998
(commencement
Three Months Ended Nine Months Ended of operations) to
September 30, September 30, September 30,
1999 1998 1999 1998
--------- -------- ------------------ -----------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (6,414) $ (1,590) $ (12,718) $ (2,178)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 267 2 464 29
Net unrealized and realized (gains) losses
on assets 531 - (84) (22)
Purchases of mortgage loans: held for sale (79,178) - (231,359) (531,038)
Proceeds from sales of mortgage loans: held for sale 49,993 - 94,009 525,418
Principal payments on mortgage loans: held for sale 472 - 1,280 5,615
Purchases of mortgage securities: trading (4,619) - (4,619) -
Proceeds from sales of mortgage securities: trading 44,969 - 99,488 -
Principal payments on mortgage securities: trading 1,206 - 3,549 -
(Increase) in accrued interest receivable (224) (5) (289) (21)
(Increase) decrease in other assets 1,239 (31) 821 (49)
Increase (decrease) in amounts due to Redwood Trust 121 (55) (115) 776
Increase in accrued restructuring charges 1,362 - 1,362 -
Increase in accrued expenses and other liabilities 17 203 747 245
------------ --------- ------------- ------------------
Net cash provided by (used in) operating
activities 9,742 (1,476) (47,464) (1,225)
------------ --------- ------------- ------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, equipment and leasehold
improvements (567) (373) (2,849) (408)
------------ --------- ------------- ------------------
Net cash used in investing activities (567) (373) (2,849) (408)
------------ --------- ------------- ------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of short-term debt 8,896 - 157,075 519,347
Repayments on short-term debt (42,792) - (137,868) (519,347)
Loans from Redwood Trust, Inc. 71,724 - 132,168 4,000
Repayment of loans from Redwood Trust, Inc. (54,349) - (119,293) (4,000)
Net proceeds from issuance of preferred stock - - 9,900 9,900
Net proceeds from issuance of common stock - - 100 100
------------ --------- ------------- ------------------
Net cash provided by (used in)
financing activities (16,521) - 42,082 10,000
------------ --------- ------------- ------------------
Net increase (decrease) in cash and cash equivalents (7,346) (1,849) (8,231) 8,367
Cash and cash equivalents at beginning of period 8,826 10,216 9,711 -
------------ --------- ------------- ------------------
Cash and cash equivalents at end of period $ 1,480 $ 8,367 $ 1,480 $ 8,367
============ ========= ============= ==================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest expense $ 822 $ - $ 1,769 $ 2,518
Non-cash transaction:
Securitization of mortgage loans into
mortgage securities $ - $ - $ 98,290 $ -
============ ========= ============= ==================
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
25
<PAGE> 26
RWT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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"). Holdings is also developing a mortgage technology business.
Redwood Trust, Inc. ("Redwood Trust") owns all of the preferred stock and has a
non-voting, 99% economic interest in Holdings. The consolidated financial
statements include the three subsidiaries of Holdings. Redwood Commercial
Funding, Inc. ("RCF") originates commercial mortgages for sale to institutional
investors. Redwood Residential Funding, Inc. ("RRF") is a start-up mortgage
technology services venture which is developing a business-to-business
Internet-based process for linking mortgage investors to mortgage originators.
Redwood Financial Services, Inc. ("RFS") was combined with Holdings' other
operations in the third quarter of 1999. 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.
The consolidated financial statements included herein are unaudited; however, in
the opinion of management, the interim financial information contains all
adjustments, including normal recurring adjustments, necessary to present fairly
the results for the interim period.
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.
26
<PAGE> 27
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.
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 and net loan origination fees. 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 (losses) 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 (losses) 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 September 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 (losses) on assets" on the
Consolidated Statements of Operations. During the three and nine months ended
September 30, 1999, Holdings recognized mark-to-market gains on derivative
financial instruments of $0.9 million and $1.0 million, respectively. There were
no derivative financial instruments outstanding during the three and nine months
ended September 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 September 30, 1999 there was no other comprehensive
income.
27
<PAGE> 28
NOTE 3. MORTGAGE ASSETS
At September 30, 1999 and December 31, 1998 Mortgage Assets consisted of the
following:
MORTGAGE LOANS: HELD-FOR-SALE
<TABLE>
<CAPTION>
(IN THOUSANDS) SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
<S> <C> <C>
Current Face $49,868 $12,072
Unamortized Premium (Discount) (903) 175
----------------- ----------------
Carrying Value $48,965 $12,247
================== ================
</TABLE>
Mortgage Loans held for sale include residential and commercial mortgage loans.
For the three and nine months ended September 30, 1999 Holdings recognized a
lower of cost or market loss adjustment of $0.9 million and $1.1 million on
Mortgage Loans held-for-sale, respectively. This loss is reflected as a
component of "Net unrealized and realized gains (losses) on assets" on the
Consolidated Statements of Operations. Also, during the three and nine months
ended September 30, 1999, Holdings sold Mortgage Loans held-for-sale for
proceeds of $50 million and $94 million, respectively. For the three and nine
months ended September 30, 1998, Holdings sold Mortgage Loans for proceeds of $0
and $525 million, respectively.
MORTGAGE SECURITIES: TRADING
For the three and nine months ended September 30, 1999, Holdings recognized a
mark-to-market loss of $0.6 million and a mark to market gain of $0.1 million,
respectively, on Mortgage Securities classified as trading. This gain is
reflected as a component of "Net unrealized and realized gains (losses) on
assets" on the Consolidated Statements of Operations. Also during the three and
nine months ended September 30, 1999, Holdings sold Mortgage Securities
classified as trading for proceeds of $45 million and $99 million, respectively.
Holdings did not own any Mortgage Securities prior to 1999.
NOTE 4. SHORT-TERM DEBT
Holdings 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. The average balance of
Short-Term Debt outstanding during the three and nine months ended September 30,
1999 was $35 million and $27 million with a weighted average borrowing rate of
5.77% and 5.42%, respectively. The maximum balance outstanding during the nine
months ended September 30, 1999 was $88 million. The average balance of
Short-Term Debt outstanding during the three and nine months ended September 30,
1998 was $0 and $157 million with a weighted-average borrowing rate of 6.37%.
The maximum balance outstanding during the nine months ended September 30, 1998
was $367 million.
In July 1999, Redwood Trust entered into a one-year, $90 million revolving
mortgage warehousing credit facility with two banks. The facility is primarily
intended to finance newly originated residential mortgage loans. Holdings may
borrow under this facility as a co-borrower. At September 30, 1999, Holdings had
no outstanding borrowings under this facility. Borrowings under this facility
bear interest based on a specified margin over the London Interbank Offered Rate
("LIBOR"). Holdings was in compliance with all material representations,
warranties and covenants under this credit facility at September 30, 1999.
In July 1999, Redwood Trust entered into a one-year, $350 million master loan
and security agreement with a Wall Street firm. The facility is primarily
intended to finance newly originated commercial and residential mortgage loans.
Holdings may borrow under this facility as a co-borrower. At September 30, 1999,
Holdings
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had outstanding borrowings of $19.2 million under this facility. Borrowings
under this facility bear interest based on a specified margin over LIBOR. For
the three months ending September 30, 1999, the weighted-average borrowing rate
under this facility was 6.76%. Holdings was in compliance with all material
representations, warranties and covenants under this credit facility at
September 30, 1999.
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 September 30, 1999, Redwood Trust was providing
credit support on $19.2 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.
NOTE 5. RESTRUCTURING CHARGE
In the third quarter of 1999, Holdings recognized a $2.2 million charge as a
result of combining the operations of RFS with other Holdings' operations. The
$2.2 million reflects $1.1 million of severance and other termination-related
costs, $1.0 million related to the disposition of certain facilities, premises
and equipment, and $0.1 million related to other restructuring costs. At
September 30, 1999 the reserve balance associated with the above charge was $1.3
million, of which $0.7 million related to severance and other
termination-related costs, $0.5 million related to the disposition of certain
facilities, premises and equipment, and $0.1 million related to other
restructuring costs.
NOTE 6. INCOME TAXES
The provision for income taxes for the period from January 1, 1999 through
September 30, 1999 amounted to $3,200 and represents minimum California
franchise taxes. No tax provision has been recorded for the nine months ended
September 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 September 30, 1999 and December 31, 1998. At September 30, 1999
and December 31, 1998 the valuation allowance amounted to $7.0 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 7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values of
Holdings' financial instruments at September 30, 1999 and December 31, 1998.
<TABLE>
<CAPTION>
(IN THOUSANDS) September 30, 1999 December 31, 1998
Carrying Value Fair Value Carrying Value Fair Value
---------------------------- -----------------------------
<S> <C> <C> <C> <C>
Assets
Mortgage Loans: held-for-sale $48,965 $49,254 $12,247 $12,255
Short-term debt 19,207 19,207 - -
Loans from Redwood Trust, Inc. 19,375 19,375 6,500 6,500
</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.
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NOTE 8. 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 9. RELATED PARTY TRANSACTIONS
PURCHASE OF MORTGAGE LOANS
During the three and nine months ended September 30, 1999, RCF purchased $24
million and $32 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 $22 million and
$42 million of commercial mortgage loans during the three and nine months ended
September 30, 1999, respectively. Under the terms of the Master Forward
Commitment Agreement, Redwood Trust committed to sell the Mortgage Loans to RCF
during the fourth quarter of 1999. There was no such activity for the three and
nine months ended September 30, 1998.
For both the three and nine months ended September 30, 1999, RRF purchased $47
million of residential mortgage loans from Redwood Trust. Pursuant to the Master
Forward Commitment Agreement, RRF 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, $4 million and $53
million of residential mortgage loans during the three and nine months ended
September 30, 1999, respectively. Under the terms of the Master Forward
Commitment Agreement, Redwood Trust committed to sell the Mortgage Loans to RRF
during the fourth quarter of 1999, or the first quarter of 2000. There was no
such activity for the three and nine months ended September 30, 1998.
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 September
30, 1999 and December 31, 1998, Holdings had borrowed $19.4 million and $6.5
million, respectively, from Redwood Trust in accordance with the provisions of
this arrangement. During the three and nine months ended September 30, 1999,
Holdings incurred $0.3 million and $0.7 million, respectively, in interest on
loans from Redwood Trust. During both the three and nine months ended September
30, 1998, Holdings incurred $15,243 in interest on loans from Redwood Trust.
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 nine months ended September 30, 1999, $1.2 million and $2.7
million, respectively, of Holdings' operating expenses were paid by Redwood
Trust. For the three and nine months ended September 30, 1998, Redwood Trust
paid $0.7 million and $1.4 million, respectively, of Holdings' expenses which
were subject to reimbursement by Holdings.
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Holdings may borrow under several of Redwood Trust's Short-Term Debt agreements
as a co-borrower. As of September 30, 1999, Holdings had borrowings of $19.2
million subject to this arrangement. At December 31, 1998, Holdings had no
outstanding borrowings under these agreements (see Note 4).
NOTE 10. COMMITMENTS AND CONTINGENCIES
At September 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 - $142,347; 2000-
$578,526; 2001 - $545,360; 2002 - $377,848; 2003 - $355,950; 2004 through 2006 -
$83,388.
Rent expense was $145,191 and $530,903, respectively, for the three and nine
months ended September 30, 1999. For the three and nine months ended September
30, 1998, rent expense was $33,600 and $87,067, respectively.
At September 30, 1999, RCF had entered into commitments to purchase $22 million
of commercial Mortgage Loans from Redwood Trust for settlement during the fourth
quarter of 1999.
At September 30, 1999, RRF had entered into commitments to purchase $4 million
of residential Mortgage Loans from Redwood Trust for settlement during the
fourth quarter of 1999 and the first quarter of 2000.
At September 30, 1999, RFS had entered into commitments to sell $21 million of
residential Mortgage Loans for settlement during October 1999.
NOTE 11. SUBSEQUENT EVENTS
Through November 10, 1999, RRF has committed to purchase $9 million of Mortgage
Loans from Redwood Trust for settlement during the first quarter of 2000.
On November 9, 1999, RCF sold $5 million of commercial Mortgage Loans.
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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 mortgage assets. Our primary activity is the financing of high-quality
residential mortgage loans with funds raised through long-term debt issuance. 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 and we are developing technology and
processes designed to streamline access to the residential mortgage market for a
variety of institutional investors.
Our core business of mortgage finance is conducted through Redwood Trust, which
is a qualified real estate investment trust ("REIT"). In general, 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.
We also own a 99% economic interest in a taxable affiliate company, RWT
Holdings, Inc. ("Holdings"). Our investment in Holdings is accounted for under
the equity method. Holdings originates commercial mortgage loans for sale to
institutional investors through its Redwood Commercial Funding, Inc. ("RCF")
subsidiary. Holdings also has a start-up mortgage technology services venture
called Redwood Residential Funding, Inc. ("RRF"). RRF is developing a
business-to-business Internet-based process for linking mortgage investors to
mortgage originators.
Holdings had a third operating business, Redwood Financial Services, Inc.
("RFS"). In the third quarter of 1999, RFS' operations were combined with
Holdings' other operations. This combination resulted in a $2.2 million
restructuring charge in the third quarter of 1999, and a significant reduction
in the headcount and ongoing operating expenses at Holdings.
In the third quarter of 1999, the net loss after preferred dividends totaled
$3.7 million, or $(0.39) per common share. For the nine months ending September
30, 1999, net income to common shareholders totaled $4.6 million, or $0.45 per
common share. In the third quarter of 1998, we adopted SFAS No. 133, Accounting
for Derivative Instruments and Hedging Activities, and adopted mark-to-market
accounting for all securities funded with short-term debt. These changes in
accounting methodologies resulted in a large earnings charge in that quarter. As
a result of the adoptions of these accounting changes, we reported a loss of
$47.9 million, or $(3.61) per share in the third quarter of 1998 and a loss of
$45.9 million, or $(3.32) per share, for the nine months ending September 30,
1998.
The following is a summary of the significant components of our earnings for the
three months and nine months ending September 30, 1999 and 1998. For the
Holdings' operations, the nine months ending September 30, 1998 reflect the
period from April 1, 1998 (the commencement of operations) to September 39,
1998. The summary includes only our share of the earnings and losses at
Holdings.
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<TABLE>
<CAPTION>
RESULTS OF OPERATIONS THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
(IN THOUSANDS, EXCEPT SHARE DATE) SEPT. 30, 1999 SEPT. 30, 1998 SEPT. 30, 1999 SEPT. 30, 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
REIT Mortgage Finance Income $ 5,367 $ 4,751 $ 17,763 $ 9,387
RCF Operating Results (664) (103) (1,527) (103)
RRF Operating Results (2,530) (522) (5,934) (1,103)
Preferred Dividends (687) (687) (2,060) (2,060)
-------- -------- ------- -------
Income before RFS and
REIT Mark-to-Market 1,486 3,439 8,242 6,121
RFS Operating Results (968) (951) (2,942) (951)
RFS Restructuring Charge (2,188) 0 (2,188) 0
-------- -------- ------- -------
Income (Loss) before
REIT Mark-to-Market (1,670) 2,488 (3,112) 5,170
REIT Mark-to-Market (2,068) (40,293) 1,513 (41,016)
Cumulative Effect of Adopting
SFAS No. 133 0 (10,061) 0 (10,061)
-------- -------- ------- -------
Net Income (Loss) to
Common Shareholders $ (3,738) $(47,866) $ 4,625 $(45,907)
======== ======== ======= =======
Earnings Per Share, diluted $ (0.39) $ (3.61) $ 0.45 $ (3.32)
Common Dividends Per Share $ 0.15 $ 0.00 $ 0.15 $ 0.28
</TABLE>
For more information, please visit our Web site at: http://www.redwoodtrust.com.
FINANCIAL CONDITION
Our balance sheet presents our mortgage finance assets and liabilities. It also
includes, as one line item, our net investment in Holdings. Holdings' balance
sheet and financial condition are presented separately with discussion and
analysis beginning on Page 47.
At September 30, 1999, our reported balance sheet had $2.1 billion of assets
funded with $1.9 billion of liabilities and $0.2 billion of equity. The portion
of our balance sheet that is subject to recourse is $1.1 billion of assets, $0.9
billion of borrowings and $0.2 billion of equity. The ratio of
equity-to-recourse-assets was 20.3%. The ratio of recourse-debt-to-equity was
3.8 to 1.0.
Our $1.1 billion of non-recourse assets and liabilities are owned by trusts
created by our special-purpose finance subsidiary, Sequoia Mortgage Funding
Corporation ("Sequoia"). The 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 September 30, 1999, these equity investments had a reported value of $33
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 $0.3 billion. The ratio of
equity-to-recourse-assets was 16.7% and the ratio of recourse-debt-to-equity was
4.9 to 1.0.
MORTGAGE LOANS: HELD FOR SALE
RESIDENTIAL
We owned $22 million residential mortgage loans held for sale at September 30,
1999. 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
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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 September 30, 1999, we owned $18 million of commercial mortgage loans
originated by RCF 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
At September 30, 1999, we owned $1.0 billion of residential mortgage loans that
were financed with long-term debt through trusts owned by our financing
subsidiary, Sequoia Mortgage Funding Corporation ("Sequoia"). The amount of
outstanding Sequoia long-term debt 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 of outstanding long-term debt 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",
"Accrued Interest Receivable", and "Accrued Interest Payable".
SEQUOIA MORTGAGE TRUST 1
At September 30, 1999, Sequoia Mortgage Trust 1 ("Sequoia 1") owned $130 million
in principal value of adjustable-rate residential mortgage loans and $4 million
of restricted cash funded with $130 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 $6 million at
September 30, 1999.
We will have the right to call Sequoia 1's debt and re-acquire Sequoia 1's loans
when the underlying mortgage loan collateral has been paid down to less than 10%
of its initial securitization balance. As of September 30, 1999, the balance was
at 24% of its initial level.
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
At September 30, 1999, Sequoia Mortgage Trust 2 ("Sequoia 2") owned $472 million
in principal value of adjustable-rate residential mortgage loans funded with
$467 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 $17 million
at September 30, 1999.
We will have the right to call Sequoia 2's debt and re-acquire Sequoia 2's loans
when the underlying mortgage loan collateral has been paid down to less than 25%
of its initial balance. As of September 30, 1999, the balance was at 62% of its
initial level.
At December 31, 1998, the principal value of Sequoia 2's loans totaled $579
million and total Sequoia 2 debt was $571 million.
SEQUOIA MORTGAGE TRUST 3
At September 30, 1999, Sequoia Mortgage Trust 3 ("Sequoia 3") owned $408 million
in principal value of residential mortgage loans funded with $398 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.
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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 at
September 30, 1999.
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, the principal value of Sequoia 3's loans totaled $540
million and total Sequoia 3 debt was $530 million.
MORTGAGE SECURITIES: TRADING
At September 30, 1999 and December 31, 1998, all of 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 are rated below "AA". For the
mark-to-market securities, the estimated bid-side market value was $0.9 billion
at September 30, 1999. These assets 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 September 30, 1999, 56.8% 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 September 30,
1999 and $0.6 billion at December 31, 1998.
At September 30, 1999, 34.3% of our mark-to-market 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 $0.3 billion at September 30, 1999 and
$0.6 billion at December 31, 1998.
At September 30, 1999, 5.1% of our mark-to-market 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
$47 million at September 30, 1999 (99% of these were floating-rate HEL
securities). The value of HEL securities was $71 million at December 31, 1998;
floating-rate HEL securities were $68 million and fixed-rate HEL securities were
$3 million.
At September 30, 1999, 1.8% of our mark-to-market 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 $16 million at September 30, 1999 and $19 million at December 31,
1998.
At September 30, 1999, 1.3% of our mark-to-market 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 September 30,
1999 and $12 million at December 31, 1998.
At September 30, 1999, 0.7% of our mark-to-market residential mortgage
securities portfolio consisted of floating-rate CMO's issued by Fannie Mae or
Freddie Mac and effectively rated "AAA". These securities totaled $6 million at
September 30, 1999 and $17 million at December 31, 1998.
At September 30, 1999, 0.02% of our mark-to-market residential mortgage
securities portfolio consisted of interest-only mortgage securities rated "AAA"
or "AA". The value of these securities was $0.2 million at September 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
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<PAGE> 36
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 a re-REMIC transaction 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 September 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 September 30, 1999 and $8 million
at December 31, 1998. Our credit risk from SMFC 97-A is limited to our
investment.
In 1999, we resumed the acquisition of lower-rated mortgage securities, defined
as those with ratings of "A" or below. Mark-to-market adjustments on these
securities are not recorded through the income statement but are included in
"accumulated other comprehensive income" on the balance sheet. At September 30,
1999, these securities had a face value of $18 million and a reported value of
$12 million. At December 31, 1998, we did not own any such securities. We
generally intend to acquire additional subordinated mortgage securities in the
future.
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 in the first half of 1999.
CASH
We had $31 million of unrestricted cash at September 30, 1999 and $56 million at
year-end 1998.
Sequoia owned cash totaling $4 million at September 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.
INTEREST RATE AGREEMENTS
Our interest rate agreements are carried on our balance sheet at estimated
market value, which was $2.7 million at September 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 September 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 $12.4 million at
September 30, 1999 and $15.1 million at December 31, 1998.
At September 30, 1999, our assets also included loans to Holdings of $19.4
million and a receivable from Holdings of $0.3 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 $14.5 million
at September 30, 1999 and $20.5 million at December 31, 1998.
SHORT-TERM DEBT
Short-term borrowings totaled $854 million at September 30, 1999, and totaled
$1.3 billion at December 31, 1998. We pledge a portion of our mortgage
securities portfolio, mortgage loan portfolio, and other investments to
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secure this debt. Maturities on this debt typically range from one month to one
year. The interest rate on most of this debt adjusts monthly to a spread over or
under the one-month LIBOR interest rate.
LONG-TERM DEBT
At September 30, 1999, we had a total of $994 million in long-term
mortgage-backed debt outstanding, net of unamortized premiums on bonds and
deferred bond issuance costs. Sequoia 1 debt of $129 million and Sequoia 2 debt
of $467 million is floating-rate debt. Sequoia 3 debt of $398 million is
fixed-rate until December 2002; it then 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. The total
Sequoia debt outstanding was $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 $9.8 million at
September 30, 1999 and $14.5 million at December 31, 1998. Most of the accrued
interest payable is related to the Sequoia trusts discussed above.
STOCKHOLDERS' EQUITY
At September 30, 1999, total equity capital was $223 million, preferred stock
equity was $27 million, and reported common equity totaled $196 million, or
$21.90 per common share outstanding.
In reporting equity at September 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 $222 million at September 30, 1999. After
subtracting out the preference value of the preferred stock and the third
quarter common stock dividend, common equity on a full mark-to-market basis was
$194 million and the net mark-to-market value per common share was $21.68.
At December 31, 1998, reported equity capital was $255 million, preferred stock
equity was $27 million, and 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.
The mark-to-market common equity per share increased from $19.53 to $21.68 per
share, an increase of 11% or $2.15 per share, during the first nine months of
1999. This increase was due to net asset appreciation, retained earnings, cash
flow generated in excess of earnings, and the effects of our stock repurchase
program.
We acquired 2,308,600 shares of our common stock in the first nine months of
1999 at an average price of $15.18 per share. In the fourth quarter of 1999
through November 10, 1999, we acquired an additional 174,900 shares at an
average price of $12.12 per share.
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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, our share of the
after-tax results of operations at Holdings. Detailed results at Holdings are
discussed separately below.
INTEREST INCOME
In the third quarter of 1999, interest income generated by our mortgage finance
operations, including consolidated Sequoia assets, was $35 million. Our
portfolio had average earning assets of $2.0 billion and earned an average yield
of 6.66%. During this quarter, the average coupon rate, or the cash-earning rate
on mortgage principal, was 6.88%. The reported value of assets included a net
unamortized premium of 0.61% of mortgage principal totaling $12 million. We
write off this net premium balance as an expense over the life of the asset. Net
premium amortization expense for the quarter was $0.8 million, which reduced the
earning asset yield by 0.15%. The prepayment rate on our mortgage assets, which
drives the rate at which we write off premium balances, was 25% Conditional
Prepayment Rate ("CPR") during the quarter. Other factors reduced the earning
asset yield by 0.07%.
In the second quarter of 1999, interest income was $36 million. Our portfolio
had average earning assets of $2.2 billion and earned an average yield of 6.54%.
The coupon rate was 6.82%. The reported value of assets included a 0.80% net
premium, or $17 million. Net premium amortization expense was $1.6 million,
which reduced earning asset yield by 0.23%. Prepayments during the quarter were
30% CPR. Other factors reduced the earning asset yield by 0.05%.
Interest income declined slightly from the second quarter of 1999 to the third
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 increased as a result of rising
short-term interest rates and slowing prepayment speeds.
In the third quarter of 1998, interest income was $62 million. The portfolio had
average earning assets of $3.8 billion and earned an average yield of 6.42%. The
coupon rate was 7.22%. The reported value of assets included 1.13% of net
premium, or $43 million. Net premium amortization expense was $6.9 million,
which reduced earning asset yield by 0.72%. Prepayments during the quarter were
at a 29% CPR. Other factors reduced the earning asset yield by 0.08%.
From the third quarter of 1998 to the third quarter of 1999, we reduced our
earning asset balances in order to 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 that prepayments had on our earning asset yields.
In the first nine months of 1999, interest income was $112 million. The
portfolio had average earning assets of $2.4 billion and earned an average yield
of 6.58%. The coupon rate was 6.91%. The reported value of assets included a
0.71% net premium, or $16 million. Net premium amortization expense was $5
million, which reduced earning asset yield by 0.26%. Prepayments during the
period were at a 29% CPR. Other factors reduced the earning asset yield by
0.07%.
In the first nine months of 1998, interest income was $169 million. The
portfolio had average earning assets of $3.4 billion and earned an average yield
of 6.33%. The coupon rate was 7.45%. The reported value of assets included a
1.74% net premium, or $60 million. Net premium amortization expense was $26
million, which reduced earning asset yield by 0.98%. Prepayments during the
period were at a 30% CPR. Other factors reduced the earning asset yield by
0.14%.
INTEREST EXPENSE
Interest expense in the third quarter of 1999 was $27 million. We funded our
mortgage finance portfolio and other assets with an average of $233 million of
equity and $1.9 billion of borrowings, including consolidated
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Sequoia debt. We paid an average cost of funds of 5.80% for these borrowings.
Short-term debt averaged 46% of total debt and cost us 5.50%. Long-term debt
averaged 54% of total debt and cost us 6.01%.
In the second quarter of 1999, interest expense was $29 million. We funded our
mortgage finance portfolio with an average of $243 million of equity and $2.1
billion of borrowings. 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%.
From the second quarter of 1999 to the third quarter of 1999, total interest
expense decreased as the size of our portfolio has decreased. Our cost of funds
increased as short-term rates rose and we paid fees to secure committed sources
of short-term financing.
In the third quarter of 1998, interest expense was $56 million. We funded our
mortgage finance portfolio with an average of $293 million of equity and $3.7
billion of borrowings. We paid an average cost of funds of 6.15% for these
borrowings. Short-term debt averaged 58% of total debt and cost us 5.93%.
Long-term debt averaged 42% of total debt and cost us 6.43%.
From the third quarter of 1998 to the third 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 from year to year. 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 and we incurred costs in order to secure committed
short-term financing.
In the first nine months of 1999, interest expense was $89 million. We funded
our portfolio with an average of $242 million of equity and $2.1 billion of
borrowings. We paid an average cost of funds of 5.65% for these borrowings.
Short-term debt averaged 47% of total debt and cost us 5.22%. Long-term debt
averaged 53% of total debt and cost us 6.00%.
In the first nine months of 1998, interest expense was $152 million. We funded
our mortgage finance portfolio with an average of $317 million of equity and
$3.3 billion of borrowings. We paid an average cost of funds of 6.07% for these
borrowings. Short-term debt averaged 63% of total debt and cost us 5.86%.
Long-term debt averaged 37% of total debt and cost us 6.44%.
INTEREST RATE AGREEMENTS EXPENSE
We use interest rate agreements in order to strengthen our balance sheet,
increase liquidity, and dampen potential earnings volatility. Net interest rate
agreements expense was $0.5 million in the third quarter of 1999, $0.7 million
in the second quarter of 1999, and $0.2 million in the third quarter of 1998. As
a percent of average borrowings, net interest rate agreements expense was 0.10%
in the third quarter of 1999, 0.14% in the second quarter of 1999, and 0.03% in
the third quarter of 1999.
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 may change over time as the mix of our
assets and liabilities changes. 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 $1.5 million in the first nine months
of 1999, or 0.10% of average borrowings. In the first nine months of 1998,
interest rate agreements expense was $3.2 million or 0.13% of average
borrowings.
NET INTEREST INCOME
Net interest income, which equals interest income less interest expense less
interest rate agreements expense, was $6.7 million in the third quarter of 1999.
Our interest rate spread, which equals the yield on earning assets less
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the cost of funds and hedging, was 0.76%. Our net interest margin, which equals
net interest income divided by average assets, was 1.26% during this period.
In the second quarter of 1999, net interest income was $6.8 million, the
interest rate spread was 0.85%, and the net interest margin was 1.18%. Net
interest income fell from the second quarter of 1999 to the third quarter of
1999 due to a lower average portfolio balance during the later period.
In the third quarter of 1998, net interest income was $5.1 million, the interest
rate spread was 0.24%, and the net interest margin was 0.52%. Our spread and
margin increased in the third quarter of 1999 from the third quarter of 1998 due
to a decrease in short-term interest rates over the past year and a recent
slowdown in prepayment speeds. The decrease in short-term interest rates reduces
our cost of funds. The recent slowdown in prepayments has reduced the effect on
our yield of premium amortization expenses. Thus, despite a reduction in coupon
rates as short-term rates have fallen, our yield on assets was higher in the
third quarter of 1999 than in the third quarter of 1998.
In the first nine months of 1999, net interest income was $21.4 million, the
interest rate spread was 0.84%, and the net interest margin was 1.21%. In the
first nine months of 1998, net interest income was $13.5 million, the interest
rate spread was 0.13%, and the net interest margin was 0.49%.
PROVISION FOR CREDIT LOSSES
We take credit provision expenses on our mortgage loans held for investment,
which are those loans financed with long-term debt and accounted for on an
amortized cost basis. In the third quarter of 1999, credit provisions were $0.4
million. In the second quarter of 1999, credit provisions totaled $0.4 million.
In the third quarter of 1998, as part of the mark-to-market adoption, we
reversed net credit provisions of $0.6 million. Actual realized taxable credit
losses totaled $0.2 million in the third quarter of 1999, $0.1 million in the
second quarter of 1999, and $0.3 million in the third quarter of 1998.
In the first nine months of 1999, total credit provisions were $1.1 million. In
the first nine months of 1998, total credit provisions were $0.7 million. Actual
credit losses were $0.3 million in the first nine months of 1999 and $0.8
million in the first nine months of 1998.
OPERATING EXPENSES
In the third quarter of 1999, total operating expenses for our mortgage finance
operations were $1.0 million. Total operating expenses for the second quarter of
1999 were $0.9 million. Total operating expenses for the third quarter of 1998
were $1.0 million.
On-going operating expenses as a percentage of assets were 0.18% in the third
quarter of 1999, 0.16% in the second quarter of 1999, and 0.10% in the third
quarter of 1998. Operating expenses as a percentage of equity were 1.64% in the
third quarter of 1999, 1.54% in the second quarter of 1999, and 1.41% in the
third 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.
Total operating expenses for the mortgage finance operations for the first nine
months of 1999 were $2.6 million. For the first nine months of 1998, operating
expenses totaled $3.5 million.
Operating expenses as a percentage of assets were 0.15% in the first nine months
of 1999 and 0.13% in the first nine months of 1998. Operating expenses as a
percentage of equity were 1.44% in the first nine months of 1999, and 1.45% in
the first nine months of 1998.
We share many operating expenses of Holdings, including personnel and related
expenses. Holdings' share is subject to full reimbursement to Redwood Trust by
Holdings. We incurred reimbursable operating expenses for Holdings of $1.2
million in the third quarter of 1999 and $0.7 million in the third quarter of
1998. For the nine months ending September 30, 1999, reimbursable operating
expenses were $2.7 million. For the nine months ending September 30, 1998,
reimbursable operating expenses were $1.4 million.
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NET EARNINGS FROM MORTGAGE FINANCE OPERATIONS BEFORE MARK-TO-MARKET ADJUSTMENTS
AND OTHER EFFECTS
Net earnings from mortgage finance operations before mark-to-market adjustments
were $5.4 million in the third quarter of 1999. In the second quarter of 1999,
net earnings before mark-to-market adjustments were $5.5 million. In the third
quarter of 1998, net earnings before mark-to-market adjustments and the
cumulative effect of adopting SFAS No. 133 were $4.8 million.
In the first nine months of 1999, net earnings before mark-to-market adjustments
totaled $17.8 million. In the first nine months of 1998, net earnings before
mark-to-market adjustments and the cumulative effect of adopting SFAS No. 133
were $9.4 million.
NET UNREALIZED AND REALIZED GAINS AND LOSSES ON ASSETS
In the third quarter of 1999, our portfolio of assets that were marked-to-market
for income statement purposes had a decline in estimated market value of $2.1
million. This net loss consisted of a $2.6 million market value loss on mortgage
assets and a $0.5 million market value gain on interest rate agreements. Market
values for our assets fell as interest rates rose towards the end of the
quarter.
In the second quarter of 1999, total net asset appreciation income was $1.4
million. This included a $0.4 million gain on mortgage assets, a $1.4 million
loss on U.S. Treasury securities, and a $2.4 million gain on interest rate
agreements. Market values for our mortgage assets rose as anticipated prepayment
speeds fell. Changes in the U.S. Treasury securities and interest rate
agreements were a function of rising interest rates and rising volatility.
In the third quarter of 1998, we adopted mark-to-market accounting and SFAS No.
133. As a result, we recognized a $40.3 million market valuation loss through
the income statement, plus a cumulative negative effect of adopting SFAS No. 133
of $10.1 million.
In the first nine months of 1999, the net gain on asset market valuations was
$1.5 million. In the first nine months of 1998, asset value losses were $41.0
million and the cumulative negative effect of adopting SFAS No. 133 was $10.1
million.
NET EARNINGS FROM MORTGAGE FINANCE OPERATIONS
In the third quarter of 1999, net earnings from mortgage finance operations
before preferred dividends were $3.3 million. Net earnings before preferred
dividends were $7.0 million in the second quarter of 1999 and negative $45.6
million in the third quarter of 1998.
In the first nine months of 1999, net earnings from mortgage operations before
preferred dividends totaled $19.3 million. In the first nine months of 1998, net
losses before preferred dividends were $41.7 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 $6.4 million in the third quarter of 1999.
This included $2.2 million of restructuring charges at RFS. We recognized losses
from Holdings of $3.8 million in the second quarter of 1999 and $1.6 million in
the third quarter of 1998.
In the first nine months of 1999, our share of losses from Holdings was $12.6
million, (including $2.2 million of restructuring charges.) During the first
nine months of 1998, our share of losses was $2.2 million.
We refer you to Holdings' "Consolidated Financial Statements and Notes" and
Holdings' "Management's Discussion and Analysis" below for more information on
Holdings.
NET INCOME In the third quarter of 1999, net losses for all of our operations
were $3.0 million. After preferred dividends of $0.7 million, net income
available to common stockholders was negative $3.7 million.
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In the second quarter of 1999, net income from all of our operations was $3.2.
After preferred dividends of $0.7 million, net income available to common
shareholders was $2.5 million.
In the third quarter of 1998, net losses for all of our operations were $37.1
million. After preferred dividends of $0.7 million and the cumulative effect of
adopting SFAS No. 133 of $10.1 million, the net loss was $47.9 million.
In the first nine months of 1999, net income for all of our operations was $6.7
million. After preferred dividends of $2.1 million, net income available to
common stockholders was $4.6 million.
In the first nine months of 1998, net losses for all of our operations were
$33.7 million. After preferred dividends of $2.1 million and the cumulative
transition effect of adopting SFAS No. 133 of $10.1 million, the net loss to
common stockholders was $45.9 million.
EARNINGS PER SHARE
Average diluted common shares outstanding were 9.6 million in the third quarter
of 1999, 10.2 million in the second quarter of 1999, and 13.3 million in the
third quarter of 1998. Diluted earnings per share were negative $0.39 in the
third quarter of 1999, positive $0.25 in the second quarter of 1999, and
negative $3.61 in the third quarter of 1998.
Average diluted common shares outstanding were 10.2 million in the first nine
months of 1999 compared to 13.9 million in the first nine months of 1998.
Diluted earnings per share were $0.45 in the first nine months of 1999 and
negative $3.32 in the first nine months of 1998.
Shares outstanding declined as a result of our common stock repurchase program.
We repurchased 5.2 million shares from July 1, 1998 through September 30, 1999.
DIVIDENDS
We declared a common stock dividend of $0.15 per share for the third quarter of
1999. We have not paid a common stock dividend since the second quarter of 1998.
We paid common stock dividends of $0.15 per share during the first nine months
of 1999 and $0.28 per share during the first nine months of 1998.
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 September 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, 97% had
adjustable-rate coupons and 3% had fixed-rate coupons.
Our interest rate agreement hedging program may offset some asset market value
fluctuations due to interest rate changes. All of our $3 billion in notional
amounts of interest rate agreements are marked-to-market for income statement
purposes.
Market value fluctuations of assets and interest rate agreements, especially to
the extent assets are funded with short-term borrowings, can also affect our
access to liquidity.
INTEREST RATE RISK
At September 30, 1999, we, including Sequoia, owned $2.1 billion of assets and
had $1.9 billion of liabilities. The majority of the assets were
adjustable-rate, as were a majority of the liabilities.
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Fixed-rate mortgage assets and hybrid mortgage assets (with fixed-rate coupons
for 3 to 7 years and adjustable-rate coupons thereafter) totaled $0.4 billion,
or 23% of total assets. We had debt with interest rate reset characteristics
matched to these hybrid mortgages totaling $0.4 billion.
We owned interest rate agreements with a notional face of $3 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 the earning rate on our
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 agreement hedging program and by
any concurrent slowing of mortgage prepayment rates that may occur.
Our net income may vary somewhat as the yield curve between one-month interest
rates and six- and twelve-month interest rates vary. At September 30, 1999, we
effectively owned $0.6 billion of adjustable-rate mortgage assets with interest
rates that adjust every six or twelve months off of interest rates of the same
maturity funded with $0.6 billion of debt that has an interest rate that adjusts
monthly off of one-month LIBOR interest rates.
At September 30, 1999, we owned $0.4 billion of adjustable-rate mortgage assets
that adjust monthly off of one-month interest rates, funded with $0.4 million of
debt that also adjusts monthly off of one-month LIBOR interest rates. However,
the date on which the assets reset may differ from that date on which the
liabilities reset, so in times of rapid changes in one-month LIBOR interest
rates, our net spread may not be constant on these assets and liabilities.
Adjustable-rate assets with earnings rates dependent on U.S. Treasury rates
totaled $0.5 billion at September 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 September 30, 1999, we had an excess of U.S. Treasury-based liabilities
over U.S. Treasury-based assets.
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-maturity mortgage assets
with short-term debt. Even if the interest rate adjustments of these assets and
liabilities are well matched, maturities may not be matched. In addition, trends
in the liquidity of the U.S. capital markets in general may affect our ability
to rollover short-term debt.
The assets that we pledge to secure short-term borrowings are generally
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, in lender over-collateralization requirements, and
in the capital markets, can impact our access to liquidity.
At September 30, 1999, we had $78 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, including unrestricted
cash, equaled 9% of our short-term debt balances.
We paid fees in the third quarter of 1999 to secure two committed lines of
short-term financing for a one-year term. There are certain restrictions
regarding the collateral for which these lines can be used, but they generally
allow us to fund whole loan acquisitions for the term of the commitments. There
is no assurance that we will be able to renew such lines upon expiration.
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We have entered into borrowings with maturities beyond December 31, 1999 to fund
the substantial majority of our assets in order to avoid the need to rollover
debt in advance of the beginning of the Year 2000. Nevertheless, year-end market
fluctuations could negatively effect our liquidity position and our earnings.
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 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 September 30,
1999, mortgage premium balances were $24 million and mortgage discount balances
were $16 million. Net mortgage premium was $8 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
September 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 $4 million at September 30, 1999. The combined effect of
these two items was to reduce our effective mortgage-related premium by $1
million.
Our net premium at September 30, 1999 for assets and liabilities affected by the
rate of mortgage principal receipts was $7 million. This net premium equaled
3.6% 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 $21 million in residential mortgage loans at
September 30, 1999. Of these, $0.5 million were seriously delinquent (delinquent
over 90 days, in foreclosure, in bankruptcy, or real estate owned). We also
owned $18 million in commercial mortgage loans. These commercial mortgage loans
were all current at September 30, 1999.
The three Sequoia trusts owned $1.0 billion in residential mortgage loans at
September 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 $33 million at September 30, 1999. At that time, $3.4 million of the
underlying loans, or 0.33%, were seriously delinquent.
At September 30, 1999, we had $4.9 million of credit reserves to provide for
potential future credit losses from our mortgage loans. Total seriously
delinquent loans had a loan balance of $3.9 million. To date, our realized
credit losses from defaulted residential mortgage loans have averaged 9% 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. We will continue to increase our credit reserve over time in
anticipation of future potential losses.
At September 30, 1999, we also had $0.9 million credit reserves for our SMFC
97-A re-REMIC securities. Our total potential credit exposure from these
securities (after this credit reserve) was $7 million. We believe this reserve
is likely to be sufficient to cover currently foreseen credit losses from this
asset.
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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.
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 mortgage 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 operation, however, is
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.
45
<PAGE> 46
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.
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 substantially completed. No material Year 2000
issues were discovered during these tests.
We, together with our affiliates, are continuing to develop 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 and to plan for
contingencies where we lack control. At this time we believe we have
successfully achieved the goals of Year 2000 Readiness. However, 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. Thus, there can be no certainty that, in spite of our efforts, we will
not face any Year 2000 issues and that such issues will not materially affect
our operations.
46
<PAGE> 47
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.
Holdings originates commercial mortgage loans for sale to institutional
investors through its Redwood Commercial Funding, Inc. ("RCF") subsidiary. RCF
originated $22 million of commercial mortgage loans in the third quarter of 1999
and has originated $42 million of commercial loans in the first nine months of
1999. At September 30, 1999, commercial mortgage loans originated or acquired by
RCF totaled $47 million, of which $18 million were held by Redwood Trust and $29
million were held at Holdings. These loans which had not yet been sold are all
held for future sale.
RCF recorded net revenue in the third quarter of 1999 of $0.1 million. Loan
sales were minimal, and net interest income at RCF was low as most of the
commercial loans originated by RCF were held by Redwood Trust for most of the
period. Direct RCF operating expenses were $0.4 million and operating expenses
paid by Redwood Trust and reimbursable by Holdings were $0.4 million. The loss
recorded at RCF for the third quarter was $0.7 million. RCF will recognize sale
revenues upon the sale of the commercial loan portfolio.
Holdings also has a start-up mortgage technology services venture called Redwood
Residential Funding, Inc. ("RRF"). RRF is seeking to generate fee income by
matching the needs of residential mortgage investors with the needs of
residential mortgage originators using ELWOOD, a new business-to-business
Internet-based process and technology system. ELWOOD is designed to improve the
process and significantly reduce the operational costs of linking mortgage
investors to mortgage originators.
RRF commenced market operations in August of 1999 by opening its Internet site
on a beta-test basis to a small number of mortgage loan sellers. The initial
product is fixed-rate jumbo "A" quality mortgages.
Shareholders can view the public portion of RRF's Web site by visiting
http://www.SellLoans.com.
RRF's efforts during the third quarter of 1999 focused on testing and
implementation of the system, qualifying sellers, training sellers to use our
system and processes, designing system enhancements, and utilizing the system in
beta-test mode. In the fourth quarter, RRF efforts will focus on recruiting
investors for the system, adding sellers, expanding product lines, and
increasing system functionality.
In the third quarter of 1999, RRF had direct operating expenses of $1.8 million
and operating expenses paid by Redwood Trust and reimbursable by Holdings
totaling $0.5 million. Net revenue at RRF was negative $0.3 million as loans
acquired on a beta-test basis were sold at a small loss. The net loss at RRF for
the quarter was $2.5 million.
Holdings had a third operating business, Redwood Financial Services, Inc.
("RFS"). In the third quarter of 1999, RFS' operations were combined with
Holdings' other operations. This resulted in a $2.2 million restructuring charge
in the third quarter of 1999. This restructuring resulted in a significant
reduction in the headcount and ongoing operating expenses at Holdings.
In the fourth quarter of 1999, we will continue to develop Holdings' operations
and seek to increase their value as businesses. At the same time, we will
continue to evaluate ways to allow both the value of Redwood Trust's core
business and the value of Holdings' ventures to be reflected in Redwood Trust's
stock price.
47
<PAGE> 48
The following is a summary of the significant components of Holdings' earnings
for the three and nine months ending September 30, 1999, for the three months
ending September 30, 1998 and for the period from April 1, 1998 (commencement of
operations) to September 30, 1998.
<TABLE>
<CAPTION>
RESULTS OF OPERATIONS THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
(IN THOUSANDS, EXCEPT SHARE DATE) SEPT. 30, 1999 SEPT. 30, 1998 SEPT. 30, 1999 SEPT. 30, 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
RCF Operating Results $ (671) $ (104) $ (1,542) $ (104)
RRF Operating Results (2,555) (525) (5,994) (1,113)
RFS Operating Results (978) (961) (2,972) (961)
RFS Restructuring Charge (2,210) 0 (2,210) 0
-------- -------- -------- --------
Net Income (Loss) $ (6,414) $ (1,590) $(12,718) $ (2,178)
======== ======== ======== ========
</TABLE>
On a consolidated basis, at September 30, 1999, Holdings owned $20 million of
residential mortgage loans and $29 million of commercial mortgage loans.
Holdings also had $1 million in cash and $4 million in other assets, for total
assets of $54 million. Holdings had commitments to acquire $22 million of
commercial loans and $4 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 $19 million, loans from Redwood Trust were $20 million, and
other liabilities totaled $2 million. Total equity at September 30, 1999 was $13
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 third quarter of 1999, net interest income on a consolidated basis was
$0.3 million, including interest income of $1.2 million and interest expenses of
$0.9 million. Holdings also had net losses upon the sale of assets and
mark-to-market adjustments of $0.5 million in the third quarter of 1999,
resulting in net revenues of negative $0.2 million. Operating expenses at
Holdings totaled $4.0 million in the third quarter of 1999. Restructuring
charges related to the combining of RFS' operations with other Holding's
operations totaled $2.2 million. Holdings' net loss in the third quarter of 1999
was $6.4 million.
In the second quarter of 1999, net interest income totaled $0.3 million,
including interest income of $1.0 million and interest expenses of $0.7 million.
Gain on sale totaled $0.1 million, resulting in net revenues of $0.4 million. In
the second quarter of 1999, operating expenses at Holdings totaled $4.2 million
and Holdings' net loss was $3.8 million.
In the third quarter of 1998, revenues totaled $0.1 million, including interest
income of $0.1 million. In the third quarter of 1998, operating expenses at
Holdings totaled $1.7 million and Holdings' net loss was $1.6 million.
In the first nine months of 1999, net interest income totaled $0.9 million,
including interest income of $2.8 million, and interest expenses of $1.9
million. Gain on sale and other income totaled $0.1 million, resulting in net
revenues of $1.0 million. Operating expenses at Holdings totaled $11.5 million
in the first nine months of 1999. Including the restructuring charge of $2.2
million, Holdings' net loss during this nine-month period was $12.7 million.
For the period from April 1, 1998 (commencement of operations) through September
30, 1998, net operating revenue totaled $0.3 million, including interest income
of $3.0 million, interest expenses of $2.7 million, and minimal net asset
appreciation income. During this period operating expenses at Holdings totaled
$2.5 million and Holdings' net loss was $2.2 million.
Holdings pre-tax loss as reported for GAAP currently approximates 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.
48
<PAGE> 49
PART II OTHER INFORMATION
Item 1. Legal Proceedings
At September 30, 1999, there were no pending legal proceedings to which
the Company as a party or of which any of its property was subject.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 11.1 to Part I - Computation of Earnings Per Share for
the three and nine months ended September 30, 1999 and
September 30, 1998.
Exhibit 27 - Financial Data Schedule
(b) Reports
None
49
<PAGE> 50
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: November 10, 1999 By: /s/ Douglas B. Hansen
------------------------------
Douglas B. Hansen
President
(authorized officer of registrant)
Dated: November 10, 1999 By: /s/ Martin S. Hughes
--------------------------------
Martin S. Hughes
Chief Financial Officer
(principal accounting officer)
50
<PAGE> 51
REDWOOD TRUST, INC.
INDEX TO EXHIBIT
<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Page
- ------------------- -----------------
<S> <C> <C>
11.1 Computations of Earnings per Share...................................... 52
27 Financial Data Schedule................................................. 54
</TABLE>
51
<PAGE> 1
EXHIBIT 11.1
REDWOOD TRUST, INC.
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, 1999 September 30, 1999
------------------ -------------------
<S> <C> <C>
Average common shares outstanding.............................................. $ 9,481,418 $10,090,305
----------- -----------
Total ............................................................... 9,481,418 10,090,305
=========== ===========
Net Income .................................................................... $(3,738,178) $ 4,625,047
=========== ===========
Per Share Amount .............................................................. $ (0.39) $ 0.46
=========== ===========
Average common shares outstanding ............................................. 9,481,418 10,090,305
Net effect of dilutive stock options outstanding
during the period -- based on the treasury stock method ..................... 89,513 99,320
----------- -----------
Total ............................................................... 9,570,931 10,189,625
=========== ===========
Net Income .................................................................... $(3,738,178) $ 4,625,047
=========== ===========
Per Share Amount .............................................................. $ (0.39) $ 0.45
=========== ===========
</TABLE>
52
<PAGE> 2
EXHIBIT 11.1
REDWOOD TRUST, INC.
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, 1998 September 30, 1998
------------------ -------------------
<S> <C> <C>
BASIC:
Average common shares outstanding............................................ 13,247,908 13,823,020
------------ ------------
Total ............................................................... 13,247,908 13,823,020
============ ============
Net Income .................................................................. $(47,866,200) $(45,907,029)
============ ============
Per Share Amount ............................................................ $ (3.61) $ (3.32)
============ ============
DILUTED:
Average common shares outstanding ........................................... 13,247,908 13,823,020
Net effect of dilutive stock options outstanding
during the period -- based on the treasury stock method ................... 63,620 92,624
------------ ------------
Total ............................................................... 13,311,528 13,915,644
============ ============
Net Income .................................................................. $(47,866,200) $(45,907,029)
============ ============
Per Share Amount ............................................................ $ (3.60) $ (3.30)
============ ============
</TABLE>
53
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEPTEMBER
30, 1999 QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 36,354
<SECURITIES> 1,995,803
<RECEIVABLES> 12,679
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 2,081,469
<CURRENT-LIABILITIES> 864,216
<BONDS> 994,355
0
26,736
<COMMON> 244,279
<OTHER-SE> 48,117
<TOTAL-LIABILITY-AND-EQUITY> 2,081,469
<SALES> 0
<TOTAL-REVENUES> 34,555
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 7,732
<LOSS-PROVISION> 416
<INTEREST-EXPENSE> 27,390
<INCOME-PRETAX> (3,738)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,738)
<EPS-BASIC> (0.39)
<EPS-DILUTED> (0.39)
</TABLE>
