<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
------------------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________ .
COMMISSION FILE NUMBER: 1-13759
REDWOOD TRUST, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
MARYLAND 68-0329422
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
591 REDWOOD HIGHWAY, SUITE 3100 94941
MILL VALLEY, CALIFORNIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
</TABLE>
(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.
<TABLE>
<S> <C>
Class B Preferred Stock ($.01 par value).... 902,068 as of November 10, 2000
Common Stock ($.01 par value)............... 8,809,501 as of November 10, 2000
</TABLE>
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<PAGE> 2
REDWOOD TRUST, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements -- Redwood Trust, Inc
Consolidated Balance Sheets at September 30, 2000 and
December 31, 1999......................................... 1
Consolidated Statements of Operations for the three and
nine months ended September 30, 2000 and September 30,
1999...................................................... 2
Consolidated Statements of Stockholders' Equity for the
three and nine months ended September 30, 2000............ 3
Consolidated Statements of Cash Flows for the three and
nine months ended September 30, 2000 and September 30,
1999...................................................... 4
Notes to Consolidated Financial Statements................ 5
Consolidated Financial Statements -- RWT Holdings, Inc.
Consolidated Balance Sheets at September 30, 2000 and
December 31, 1999......................................... 21
Consolidated Statements of Operations for the three and
nine months ended September 30, 2000 and September 30,
1999...................................................... 22
Consolidated Statements of Stockholders' Equity for the
three and nine months ended September 30, 2000............ 23
Consolidated Statements of Cash Flows for the three and
nine months ended September 30, 2000 and September 30,
1999...................................................... 24
Notes to Consolidated Financial Statements................ 25
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 48
Item 2. Changes in Securities....................................... 48
Item 3. Defaults Upon Senior Securities............................. 48
Item 4. Submission of Matters to a Vote of Security Holders......... 48
Item 5. Other Information........................................... 48
Item 6. Exhibits and Reports on Form 8-K............................ 48
SIGNATURES........................................................... 49
</TABLE>
i
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(UNAUDITED)
<S> <C> <C>
Mortgage loans
Residential: held-for-investment, net..................... $1,178,180 $ 968,709
Residential: held-for-sale................................ 7,619 415,880
Commercial: held-for-sale................................. 32,308 8,437
---------- ----------
1,218,107 1,393,026
Mortgage securities
Residential: trading...................................... 871,396 941,781
Residential: available-for-sale, net...................... 69,065 27,999
---------- ----------
940,461 969,780
Cash and cash equivalents................................... 7,056 19,881
Restricted cash............................................. 3,591 5,384
Interest rate agreements.................................... 274 2,037
Accrued interest receivable................................. 16,401 13,244
Principal receivable........................................ 5,845 4,599
Investment in RWT Holdings, Inc............................. 2,019 3,391
Loans to RWT Holdings, Inc.................................. -- 6,500
Receivable from RWT Holdings, Inc........................... -- 472
Other assets................................................ 1,655 1,614
---------- ----------
Total Assets....................................... $2,195,409 $2,419,928
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt............................................. $ 822,389 $1,253,565
Long-term debt, net......................................... 1,148,519 945,270
Accrued interest payable.................................... 5,355 5,462
Accrued expenses and other liabilities...................... 4,102 2,819
Dividends payable........................................... 4,381 2,877
---------- ----------
Total Liabilities.................................. 1,984,746 2,209,993
---------- ----------
Commitments and contingencies (See Note 13)
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.01 per share; Class B 9.74%
Cumulative Convertible 902,068 shares authorized, issued
and outstanding ($28,645 aggregate liquidation
preference)............................................... 26,517 26,517
Common stock, par value $0.01 per share; 49,097,932 shares
authorized; 8,809,356 and 8,783,341 issued and
outstanding............................................... 88 88
Additional paid-in capital.................................. 242,520 242,094
Accumulated other comprehensive income...................... (4,001) (3,348)
Cumulative earnings......................................... 21,430 8,140
Cumulative distributions to stockholders.................... (75,891) (63,556)
---------- ----------
Total Stockholders' Equity......................... 210,663 209,935
---------- ----------
Total Liabilities and Stockholders' Equity......... $2,195,409 $2,419,928
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
1
<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,
------------------------ ------------------------
2000 1999 2000 1999
---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
INTEREST INCOME
Mortgage loans
Residential: held-for-investment.... $ 22,131 $ 16,816 $ 62,262 $ 49,646
Residential: held-for-sale.......... 158 1,001 6,897 6,715
Commercial: held-for-sale........... 372 452 976 821
---------- ---------- ---------- -----------
22,661 18,269 70,135 57,182
Mortgage securities
Residential: trading................ 16,662 14,507 50,921 49,571
Residential: available-for-sale..... 2,328 1,061 6,079 2,723
---------- ---------- ---------- -----------
18,990 15,568 57,000 52,294
U.S. Treasury securities: trading... -- -- -- 913
Cash and cash equivalents........... 268 718 858 1,988
---------- ---------- ---------- -----------
Total interest income.......... 41,919 34,555 127,993 112,377
INTEREST EXPENSE
Short-term debt........................ (14,053) (11,887) (47,203) (38,517)
Long-term debt......................... (20,449) (15,503) (56,735) (50,901)
---------- ---------- ---------- -----------
Total interest expense................. (34,502) (27,390) (103,938) (89,418)
Net interest rate agreements expense... (192) (457) (819) (1,527)
---------- ---------- ---------- -----------
Net Interest Income.................... 7,225 6,708 23,236 21,432
Net unrealized and realized market
value gains (losses)
Loans and securities................ 2,343 (2,532) 411 (550)
Interest rate agreements............ (1,416) 464 (2,067) 2,063
---------- ---------- ---------- -----------
927 (2,068) (1,656) 1,513
Provision for credit losses............ (240) (416) (487) (1,132)
---------- ---------- ---------- -----------
Net Revenues........................... 7,912 4,224 21,093 21,813
Operating expenses..................... (2,066) (964) (6,450) (2,617)
Other income........................... 34 39 69 80
Equity in earnings (losses) of RWT
Holdings, Inc....................... (321) (6,350) (1,420) (12,591)
---------- ---------- ---------- -----------
Net income before preferred dividend... 5,559 (3,051) 13,292 6,685
Less cash dividends on Class B
preferred stock..................... (681) (687) (2,043) (2,060)
---------- ---------- ---------- -----------
Net Income Available to Common
Stockholders........................ $ 4,878 $ (3,738) $ 11,249 $ 4,625
========== ========== ========== ===========
EARNINGS PER SHARE:
Basic.................................. $ 0.55 $ (0.39) $ 1.28 $ 0.46
Diluted................................ $ 0.55 $ (0.39) $ 1.27 $ 0.45
WEIGHTED AVERAGE SHARES OF COMMON STOCK
AND COMMON STOCK EQUIVALENTS:
Basic............................... 8,789,966 9,481,418 8,788,127 10,090,305
Diluted............................. 8,908,399 9,570,931 8,878,379 10,189,625
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE> 5
REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
CLASS B ACCUMULATED
PREFERRED STOCK COMMON STOCK ADDITIONAL OTHER CUMULATIVE
----------------- ------------------ PAID-IN COMPREHENSIVE CUMULATIVE DISTRIBUTIONS TO
SHARES AMOUNT SHARES AMOUNT CAPITAL INCOME EARNINGS STOCKHOLDERS
------- ------- --------- ------ ---------- ------------- ---------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1999... 902,068 $26,517 8,783,341 $88 $242,094 $(3,348) $ 8,140 $(63,556)
------- ------- --------- --- -------- ------- ------- --------
Comprehensive income:
Net income before preferred
dividend................. -- -- -- -- -- -- 3,964 --
Net unrealized loss on
assets
available-for-sale....... -- -- -- -- -- (487) -- --
Total comprehensive
income............. -- -- -- -- -- -- -- --
Issuance of common stock..... -- -- 6,035 -- 45 -- -- --
Dividends declared:
Preferred.................. -- -- -- -- -- -- -- (681)
Common..................... -- -- -- -- -- -- -- (3,076)
------- ------- --------- --- -------- ------- ------- --------
BALANCE, MARCH 31, 2000...... 902,068 $26,517 8,789,376 $88 $242,139 $(3,835) $12,104 $(67,313)
------- ------- --------- --- -------- ------- ------- --------
Comprehensive income:
Net income before preferred
dividend................. -- -- -- -- -- -- 3,767 --
Net unrealized loss on
assets
available-for-sale....... -- -- -- -- -- (886) -- --
Total comprehensive
income............. -- -- -- -- -- -- -- --
Dividends declared:
Preferred.................. -- -- -- -- -- -- -- (681)
Common..................... -- -- -- -- -- -- -- (3,516)
------- ------- --------- --- -------- ------- ------- --------
BALANCE, JUNE 30, 2000....... 902,068 $26,517 8,789,376 $88 $242,139 $(4,721) $15,871 $(71,510)
------- ------- --------- --- -------- ------- ------- --------
Comprehensive income:
Net income before preferred
dividend................. -- -- -- -- -- -- 5,559 --
Net unrealized loss on
assets
available-for-sale....... -- -- -- -- -- 720 -- --
Total comprehensive
income............. -- -- -- -- -- -- -- --
Issuance of common stock..... 19,980 381
Dividends declared:
Preferred.................. -- -- -- -- -- -- -- (681)
Common..................... -- -- -- -- -- -- -- (3,700)
------- ------- --------- --- -------- ------- ------- --------
BALANCE, SEPTEMBER 30,
2000....................... 902,068 $26,517 8,809,356 $88 $242,520 $(4,001) $21,430 $(75,891)
======= ======= ========= === ======== ======= ======= ========
<CAPTION>
TOTAL
--------
<S> <C>
BALANCE, DECEMBER 31, 1999... $209,935
--------
Comprehensive income:
Net income before preferred
dividend................. 3,964
Net unrealized loss on
assets
available-for-sale....... (487)
--------
Total comprehensive
income............. 3,477
Issuance of common stock..... 45
Dividends declared:
Preferred.................. (681)
Common..................... (3,076)
--------
BALANCE, MARCH 31, 2000...... $209,700
--------
Comprehensive income:
Net income before preferred
dividend................. 3,767
Net unrealized loss on
assets
available-for-sale....... (886)
--------
Total comprehensive
income............. 2,881
Dividends declared:
Preferred.................. (681)
Common..................... (3,516)
--------
BALANCE, JUNE 30, 2000....... $208,384
--------
Comprehensive income:
Net income before preferred
dividend................. 5,559
Net unrealized loss on
assets
available-for-sale....... 720
--------
Total comprehensive
income............. 6,279
Issuance of common stock..... 381
Dividends declared:
Preferred.................. (681)
Common..................... (3,700)
--------
BALANCE, SEPTEMBER 30,
2000....................... $210,663
========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<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,
--------------------- ----------------------
2000 1999 2000 1999
-------- --------- --------- ---------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) before preferred dividend............... $ 5,559 $ (3,051) $ 13,292 $ 6,685
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization........................... 1,445 1,212 3,033 5,601
Provision for credit losses............................. 240 416 487 1,132
Equity in (earnings) losses of RWT Holdings, Inc........ 321 6,350 1,420 12,591
Net unrealized and realized market value (gains)
losses................................................ (927) 2,068 1,656 (1,513)
Purchases of mortgage loans: held-for-sale.............. (32,363) (27,194) (67,897) (98,949)
Proceeds from sales of mortgage loans: held-for-sale.... 9,800 71,481 432,714 121,619
Principal payments on mortgage loans: held-for-sale..... 542 3,089 19,735 58,327
Purchases of mortgage securities: trading............... (45,229) (72,867) (224,779) (76,592)
Proceeds from sales of mortgage securities: trading..... -- -- 77,309 7,668
Principal payments on mortgage securities: trading...... 58,575 90,909 217,093 398,310
Purchases of U.S. Treasury securities: trading.......... -- -- -- (45,844)
Proceeds from sales of U.S. Treasury securities:
trading............................................... -- -- -- 90,519
Net (purchases) sales of interest rate agreements....... (697) (29) (1,582) 459
(Increase) decrease in accrued interest receivable...... (362) 273 (3,157) 5,803
(Increase) decrease in principal receivable............. (509) (1,208) (1,246) 6,392
(Increase) decrease in other assets..................... (395) 155 (240) 74
Increase (decrease) in accrued interest payable......... (627) (319) (107) (5,853)
Increase (decrease) in accrued expenses and other
liabilities........................................... (452) 1,264 1,310 1,075
-------- --------- --------- ---------
Net cash (used in) provided by operating activities... (5,079) 72,549 469,041 487,504
-------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of mortgage loans: held-for-investment.......... -- -- (384,328) --
Principal payments on mortgage loans:
held-for-investment..................................... 79,461 69,638 172,164 261,487
Purchases of mortgage securities: available-for-sale...... (9,617) (6,997) (41,243) (7,931)
Principal payments on mortgage securities:
available-for-sale...................................... 522 83 1,171 213
Net (increase) decrease in restricted cash................ 30 3,620 1,793 7,930
Investment in RWT Holdings, Inc., net of dividends
received................................................ -- -- -- (9,900)
(Loans) to RWT Holdings, Inc., net of repayments.......... -- (17,375) 6,500 (12,875)
(Increase) decrease in receivable from RWT Holdings,
Inc..................................................... -- (121) 472 115
-------- --------- --------- ---------
Net cash provided by (used in) investing activities... 70,397 48,848 (243,470) 239,039
-------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) on short-term debt............ 15,746 (68,280) (431,176) (403,105)
Proceeds (costs) from issuance of long-term debt.......... -- -- 375,844 (337)
Repayments on long-term debt.............................. (79,101) (72,501) (172,658) (310,207)
Net proceeds from issuance of common stock................ 381 -- 426 1
Repurchases of common stock............................... -- (15,004) -- (35,036)
Dividends paid............................................ (4,197) (687) (10,831) (2,059)
-------- --------- --------- ---------
Net cash used in financing activities................. (67,171) (156,472) (238,395) (750,743)
-------- --------- --------- ---------
Net increase (decrease) in cash and cash equivalents........ (1,854) (35,075) (12,825) (24,200)
Cash and cash equivalents at beginning of period............ 8,910 66,502 19,881 55,627
-------- --------- --------- ---------
Cash and cash equivalents at end of period.................. $ 7,056 $ 31,427 $ 7,056 $ 31,427
======== ========= ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest.................................... $ 35,129 $ 27,709 $ 104,045 $ 95,271
======== ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE> 7
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(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 real estate finance company
specializing in the mortgage portfolio spread lending business. The Company's
primary activity is the acquisition, financing, structuring, and management of
high-quality residential mortgage loans with funds raised through long-term debt
issuance. The Company also acquires, finances, and manages residential mortgage
securities and originates, sells, finances and manages commercial mortgage
loans.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying interim consolidated financial statements are unaudited.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the quarter ended September 30, 2000 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2000. The accompanying consolidated financial statements should be read in
conjunction with the consolidated financial statements and related notes
included in the Company's Annual Report on Form 10-K for the year ended December
31, 1999.
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 for Long-Term Debt is limited to its net equity investment in
Sequoia, 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 2000 presentation.
During March 1998, the Company acquired an equity interest in Holdings,
which originates and sells commercial mortgage loans. The Company owns all of
the preferred stock and has a non-voting, 99% economic interest in Holdings. As
the Company does not own the voting common stock of Holdings or control
Holdings, its investment in Holdings is accounted for under the equity method.
Under this method, original equity investments in Holdings are recorded at cost
and adjusted by the Company's share of earnings or losses and decreased by
dividends received.
USE OF ESTIMATES
The preparation of financial statements in conformity with Generally
Accepted Accounting Principles requires management to make estimates and
assumptions that affect the reported amounts of certain assets and liabilities
and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of certain revenues and expenses during the
reported period. Actual results could differ from those estimates. The primary
estimates inherent in the accompanying consolidated financial statements are
discussed below.
Fair Value. Management estimates the fair value of its financial
instruments using available market information and other appropriate valuation
methodologies. The fair value of a financial instrument, as defined by Statement
of Financial Accounting Standards ("SFAS") No. 107, Disclosures about Fair Value
of
5
<PAGE> 8
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
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 losses, as well as
potential losses inherent in its mortgage loan portfolio. The reserve is based
upon management's assessment of various factors affecting its mortgage loans,
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.
MORTGAGE ASSETS
The Company's mortgage assets consist of mortgage loans and mortgage
securities ("Mortgage Assets"). 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-Investment
All of the assets of Sequoia that are pledged or subordinated to support
the Long-Term Debt are classified as held-for-investment. Mortgage loans
classified as 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 Loans: Held-for-Sale
The Company classifies certain short-funded mortgage loans as
held-for-sale. These mortgage loans are carried at the lower of original cost or
market value ("LOCOM"). Realized and unrealized gains and losses on these loans
are recognized in "Net unrealized and realized market value gains (losses)" 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 which Holdings will pay to
purchase the loans 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.
6
<PAGE> 9
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
Mortgage Securities: Trading
The Company classifies all of its mortgage securities with a rating of AA
or higher as 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 market
value gains (losses)" on the Consolidated Statements of Operations.
Mortgage Securities: Available-for-Sale
The Company classifies all mortgage securities rated A or lower as
available-for-sale. 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 market value gains (losses)" 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.
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, options on futures contracts, forward sales
of fixed-rate Agency mortgage securities ("MBS"), and options on forward
purchases or sales of MBS' (collectively "Interest Rate Agreements"). On the
date an Interest Rate
7
<PAGE> 10
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
Agreement is entered into, the Company designates the Interest Rate Agreement as
(1) a hedge of the fair value of a recognized asset or liability or of an
unrecognized firm commitment ("fair value" hedge), (2) a hedge of a forecasted
transaction or of the variability of cash flows to be received or paid related
to a recognized asset or liability ("cash flow" hedge), or (3) held for trading
("trading" instruments). Since the adoption of SFAS No. 133, the Company has
elected to designate all of its Interest Rate Agreements as trading instruments.
Accordingly, such instruments are recorded at their estimated fair market value
with changes in their fair value reported in current-period earnings in "Net
unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
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.
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. Therefore, the dividends declared in December 1999 which
were paid in January 2000 are considered taxable income to shareholders in 1999,
the year declared.
NET INCOME PER SHARE
Net income per share for the three and nine months ended September 30, 2000
and 1999 is shown in accordance with SFAS No. 128, Earnings Per Share. Basic net
income per share is computed by dividing net income available to common
stockholders by the weighted average number of common shares outstanding during
the period. Diluted net income per share is computed by dividing the net income
available to common stockholders by the weighted average number of common shares
and common equivalent shares outstanding during the period. The common
equivalent shares are calculated using the treasury stock method, which assumes
that all dilutive common stock 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.
8
<PAGE> 11
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
The following tables provide reconciliations of the numerators and
denominators of the basic and diluted net income per share computations.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- ------------------------
2000 1999 2000 1999
---------- ---------- ---------- -----------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C>
NUMERATOR:
Numerator for basic and diluted earnings per
share --
Net income (loss) before preferred
dividend............................... $ 5,559 $ (3,051) $ 13,292 $ 6,685
Cash dividends on Class B preferred
stock.................................. (681) (687) (2,043) (2,060)
---------- ---------- ---------- -----------
Basic and Diluted EPS -- Net income (loss)
available to common stockholders....... $ 4,878 $ (3,738) $ 11,249 $ 4,625
---------- ---------- ---------- -----------
DENOMINATOR:
Denominator for basic earnings per share --
Weighted average number of common shares
outstanding during the period.......... 8,789,996 9,481,418 8,788,127 10,090,305
Net effect of dilutive stock options...... 118,403 89,513 90,252 99,320
---------- ---------- ---------- -----------
Denominator for diluted earnings per
share --.................................. 8,908,399 9,570,931 8,878,379 10,189,625
========== ========== ========== ===========
Net income per share -- basic............... $ 0.55 $ (0.39) $ 1.28 $ 0.46
========== ========== ========== ===========
Net income per share -- diluted............. $ 0.55 $ (0.39) $ 1.27 $ 0.45
========== ========== ========== ===========
</TABLE>
COMPREHENSIVE INCOME
SFAS No. 130, Reporting Comprehensive Income, requires the Company to
classify items of "other comprehensive income" by their nature in a financial
statement and display the accumulated balance of other comprehensive income
separately from retained earnings and additional paid-in capital in the equity
section of the balance sheet. In accordance with SFAS No. 130, current period
unrealized gains and losses on assets available-for-sale are reported as a
component of Comprehensive Income on the Consolidated Statements of
Stockholders' Equity with cumulative unrealized gains and losses classified as
Accumulated Other Comprehensive Income in Stockholders' Equity. At September 30,
2000 and December 31, 1999, the only component of Accumulated Other
Comprehensive Income was net unrealized gains and losses on assets
available-for-sale.
RECENT ACCOUNTING PRONOUNCEMENT
During March 2000, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation -- an interpretation of APB Opinion No. 25 ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 by expanding upon a number of
issues not specifically addressed in the Opinion such as the definition of an
employee for purposes of applying APB Opinion No. 25 and the accounting for
modifications to a previously fixed stock option award. FIN 44 was effective
July 1, 2000. The impact on the Company of adopting FIN 44 does not have a
material effect on the operations of the Company.
NOTE 3. MORTGAGE ASSETS
At September 30, 2000 and December 31, 1999, investments in Mortgage Assets
consisted of interests in adjustable-rate, hybrid, or fixed-rate mortgage loans
on residential and commercial properties. The hybrid
9
<PAGE> 12
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
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, 2000 and December 31, 1999, the annualized effective yield
after taking into account the amortization expense due to prepayments on the
Mortgage Assets was 7.76% and 7.00%, respectively, based on the reported cost of
the assets. At September 30, 2000, 81% of the Mortgage Assets owned by the
Company were adjustable-rate mortgages, 15% were hybrid mortgages, and 4% were
fixed-rate mortgages. At December 31, 1999, 81% of the Mortgage Assets owned by
the Company were adjustable-rate mortgages, 17% were hybrid mortgages, and 2%
were fixed-rate mortgages. The coupons on 62% and 61% of the adjustable-rate
Mortgage Assets were limited by periodic caps (generally interest rate
adjustments are limited to no more than 1% every six months or 2% every year) at
September 30, 2000 and December 31, 1999, respectively. The majority of the
coupons on the adjustable-rate and hybrid Mortgage Assets owned by the Company
are limited by lifetime caps. At September 30, 2000 and December 31, 1999, the
weighted average lifetime cap on the adjustable-rate Mortgage Assets was 11.89%
and 11.64%, respectively.
At September 30, 2000 and December 31, 1999, Mortgage Assets consisted of
the following:
Mortgage Loans: Residential
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
----------------------------------- -----------------------------------
HELD-FOR- HELD-FOR- HELD-FOR- HELD-FOR-
INVESTMENT SALE TOTAL INVESTMENT SALE TOTAL
---------- --------- ---------- ---------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Current Face................. $1,169,363 $7,748 $1,177,111 $960,928 $412,456 $1,373,384
Unamortized Discount......... -- (129) (129) -- (305) (305)
Unamortized Premium.......... 14,390 -- 14,390 12,906 3,729 16,635
---------- ------ ---------- -------- -------- ----------
Amortized Cost............... 1,183,753 7,619 1,191,372 973,834 415,880 1,389,714
Reserve for Credit Losses.... (5,573) -- (5,573) (5,125) -- (5,125)
---------- ------ ---------- -------- -------- ----------
Carrying Value............... $1,178,180 $7,619 $1,185,799 $968,709 $415,880 $1,384,589
========== ====== ========== ======== ======== ==========
</TABLE>
The Company recognized gains of $0.1 million and $0.0 million during the
three and nine months ended September 30, 2000, respectively, as a result of
LOCOM adjustments on residential mortgage loans held-for-sale. During both the
three and nine months ended September 30, 1999, the Company recognized losses of
$0.3 million and $0.2 million, respectively as a result of LOCOM adjustments on
residential mortgage loans held-for-sale. The LOCOM adjustments are reflected as
a component of "Net unrealized and realized market value gains (losses)" on the
Consolidated Statements of Operations. During the nine months ended September
30, 2000, the Company sold to Holdings a $380.5 million participation agreement
on residential mortgage loans for proceeds of $380.5 million (see Note 12).
Additionally, during the nine months ended September 30, 2000, the Company sold
residential mortgage loans to Redwood Residential Funding ("RRF"), a subsidiary
of Holdings, for proceeds of $17.1 million. Pursuant to the terms of the Master
Forward Commitment Agreement, the mortgage loans were sold to RRF at the same
price for which the Company acquired the mortgage loans (see Note 12).
Accordingly, there were no LOCOM adjustments or gains on sales related to the
RRF sales transactions. During the three and nine months ended September 30,
1999, the Company sold residential mortgage loans held-for-sale for proceeds of
$71.5 million and $121.6 million, respectively.
10
<PAGE> 13
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
There were no sales of residential mortgage loans held-for-investment
during the three and nine months ended September 30, 2000 and 1999.
Mortgage Loans: Commercial
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
HELD-FOR-SALE HELD-FOR-SALE
------------------ -----------------
(IN THOUSANDS)
<S> <C> <C>
Current Face............................... $32,746 $8,450
Unamortized Discount....................... (438) (13)
------- ------
Carrying Value............................. $32,308 $8,437
======= ======
</TABLE>
During the three and nine months ended September 30, 2000, the Company sold
commercial mortgage loans to Redwood Commercial Funding ("RCF"), a subsidiary of
Holdings, for proceeds of $9.8 million and $35.1 million, respectively. To date,
pursuant to the Master Forward Commitment Agreement, all commercial mortgage
loans purchased or originated by the Company are sold to RCF at the same price
for which the Company acquires or originates the commercial mortgage loans (see
Note 12). Accordingly, there are no LOCOM adjustments or gains on sales related
to commercial mortgage loans.
During the three and nine months ended September 30, 2000, the Company
purchased commercial mortgage loans from RCF aggregating $9.6 million which were
not subject to the terms of the Master Forward Commitment Agreement. The Company
intends to hold these commercial loans through maturity. All such commercial
mortgage loans purchased by the Company from RCF are purchased at the market
price at the time of the sale. Any inter-company gains or losses recorded on the
sale of the commercial mortgage loans from RCF to the Company are eliminated
against the basis of the commercial mortgage loan purchased by the Company.
During both the three and nine months ended September 30, 2000, Redwood's 99%
interest of such gains recognized by Holdings was $0.1 million. The Company made
no such purchases from RCF during the three and nine months ended September 30,
1999.
Mortgage Securities: Residential
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
---------------------------------- ----------------------------------
AVAILABLE- AVAILABLE-
TRADING FOR-SALE TOTAL TRADING FOR-SALE TOTAL
-------- ---------- -------- -------- ---------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Current Face............. $861,438 $109,172 $970,610 $934,360 $48,620 $982,980
Unamortized Discount..... (1,498) (35,662) (37,160) (3,548) (16,444) (19,992)
Unamortized Premium...... 11,456 -- 11,456 10,969 -- 10,969
-------- -------- -------- -------- ------- --------
Amortized Cost........... 871,396 73,510 944,906 941,781 32,176 973,957
Reserve for Credit
Losses................. -- (444) (444) -- (829) (829)
Gross Unrealized Gains... -- 1,226 1,226 -- 166 166
Gross Unrealized
Losses................. -- (5,227) (5,227) -- (3,514) (3,514)
-------- -------- -------- -------- ------- --------
Carrying Value........... $871,396 $ 69,065 $940,461 $941,781 $27,999 $969,780
======== ======== ======== ======== ======= ========
Agency................... $630,274 -- $630,274 $576,480 -- $576,480
Non-Agency............... 241,122 $ 69,065 310,187 365,301 $27,999 393,300
-------- -------- -------- -------- ------- --------
Carrying Value........... $871,396 $ 69,065 $940,461 $941,781 $27,999 $969,780
======== ======== ======== ======== ======= ========
</TABLE>
For the three and nine months ended September 30, 2000, the Company
recognized market value gains $2.3 million and $0.4 million on mortgage
securities classified as trading, respectively. During the three and
11
<PAGE> 14
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
nine months ended September 30, 1999, the Company recognized a market value loss
of $2.3 million and a market value gain of $2.9 million on mortgage securities
classified as trading, respectively. The market value adjustments are reflected
as a component of "Net unrealized and realized market value gains (losses)" on
the Consolidated Statements of Operations. The Company did not sell any mortgage
securities classified as trading during the three months ended September 30,
2000 and 1999. The Company sold mortgage securities classified as trading for
proceeds of $77.3 million and $7.7 million during the nine months ended
September 30, 2000 and 1999, respectively.
NOTE 4. RESERVE FOR CREDIT LOSSES
The Reserve for Credit Losses is reflected as a component of Mortgage
Assets on the Consolidated Balance Sheets. The following table summarizes the
Reserve for Credit Losses activity:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2000 1999 2000 1999
------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Balance at beginning of period.......................... $5,931 $5,494 $5,954 $4,973
Provision for credit losses............................. 240 416 487 1,132
Charge-offs............................................. (154) (132) (424) (327)
------ ------ ------ ------
Balance at end of period................................ $6,017 $5,778 $6,017 $5,778
====== ====== ====== ======
</TABLE>
NOTE 5. U.S. TREASURY SECURITIES
The Company did not hold any U.S. Treasury securities at September 30, 2000
or December 31, 1999. During the nine months ended September 30, 1999, the
Company recognized market value losses of $3.3 million on U.S. Treasury
securities and sold U.S. Treasury securities for proceeds of $90.5 million. The
market value adjustments are reflected as a component of "Net unrealized and
realized market value gains (losses)" on the Consolidated Statements of
Operations.
NOTE 6. COLLATERAL FOR LONG-TERM DEBT
The Company has pledged collateral ("Bond Collateral") in order to secure
the Long-Term Debt issued in the form of collateralized mortgage bonds. This
Bond Collateral consists primarily of adjustable-rate and hybrid, conventional,
30-year mortgage loans secured by first liens on one- to four-family residential
properties. All Bond Collateral is pledged to secure repayment of the related
Long-Term Debt obligation. All principal and interest (less servicing and
related fees) on the Bond Collateral is remitted to a trustee and is available
for payment on the Long-Term Debt obligation. The Company's exposure to loss on
the Bond Collateral is limited to its net investment, as the Long-Term Debt is
non-recourse to the Company.
The components of the Bond Collateral are summarized as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Mortgage loans
Residential: held-for-investment, net............ $1,178,180 $968,709
Restricted cash.................................... 3,050 4,791
Accrued interest receivable........................ 7,339 5,633
---------- --------
$1,188,569 $979,133
========== ========
</TABLE>
12
<PAGE> 15
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
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, 2000 and December 31, 1999, all of the Company's Interest
Rate Agreements were classified as trading, and therefore, reported at fair
value.
For the three and nine months ended September 30, 2000, the Company
recognized market value losses of $1.4 million and $2.1 million on Interest Rate
Agreements classified as trading, respectively. During the three and nine months
ended September 30, 1999, the Company recognized market value gains of $0.5
million and $2.1 million on Interest Rate Agreements classified as trading,
respectively. The market value gains and losses are reflected as a component of
"Net unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
The following table summarizes the aggregate notional amounts of all of the
Company's Interest Rate Agreements as well as the credit exposure related to
these instruments.
<TABLE>
<CAPTION>
NOTIONAL AMOUNTS CREDIT EXPOSURE(A)
----------------------------- -----------------------------
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, DECEMBER 31,
2000 1999 2000 1999
------------- ------------ ------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest Rate Options
Purchased............................. $1,677,300 $2,960,900 -- --
Sold.................................. -- -- -- --
Interest Rate Swaps..................... 12,000 250,000 $2,194 $2,632
Interest Rate Futures and Forwards...... 646,600 630,000 541 593
---------- ---------- ------ ------
Total......................... $2,335,900 $3,840,900 $2,735 $3,225
========== ========== ====== ======
</TABLE>
---------------
(a) Reflects the fair market value of all cash and collateral of the Company
held by counterparties.
Interest Rate Options purchased (sold), which may include caps, floors,
call and put corridors, options on futures, options on MBS forwards, 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 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 purchased call (put) corridor is equal
to the up-front premium. Call (put) corridors that are sold will cause the
Company to incur a loss to the extent that the yield of the specified index is
below (above) the strike rate at the time of the option expiration. Such loss,
if any, will, in part, be offset by upfront premium received. The maximum gain
or loss on a call (put) corridor sold is determined at the time of the
transaction by establishing a minimum (maximum) index rate. The Company will
receive cash on the purchased options on futures/forwards if the futures/forward
price exceeds (is below) the call (put) option strike price at the expiration of
the option. For the written options on futures/forwards, the Company receives an
up-front premium for selling the option, however, the Company will incur a loss
on the written option if the futures/ forward 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
13
<PAGE> 16
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
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 and Forwards ("Futures and Forwards") are contracts
for the purchase or sale of securities or cash in which the seller (buyer)
agrees to deliver (purchase) 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/forwards, 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). The credit risk inherent in futures and forwards arises from
the potential inability of counterparties to meet the terms of their contracts,
however, 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 repurchase agreements, bank borrowings, 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, 2000, the Company had $0.8 billion of Short-Term Debt
outstanding with a weighted-average borrowing rate of 6.66% and a
weighted-average remaining maturity of 207 days. This debt was collateralized
with $0.9 billion of Mortgage Assets. At December 31, 1999, the Company had $1.3
billion of Short-Term Debt outstanding with a weighted-average borrowing rate of
6.22% and a weighted-average remaining maturity of 96 days. This debt was
collateralized with $1.3 billion of Mortgage Assets.
14
<PAGE> 17
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
At September 30, 2000 and December 31, 1999, the Short-Term Debt had the
following remaining maturities:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Within 30 days..................................... $ 3,005 $ 163,394
30 to 90 days...................................... -- 385,729
Over 90 days....................................... 819,384 704,442
-------- ----------
Total Short-Term Debt.............................. $822,389 $1,253,565
======== ==========
</TABLE>
For the three and nine months ended September 30, 2000, the average balance
of Short-Term Debt was $0.8 billion and $0.9 billion with a weighted-average
interest cost of 6.80% and 6.47%, respectively. 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. The maximum balance outstanding during both the nine months
ended September 30, 2000 and 1999 was $1.3 billion.
In March 2000, the Company entered into a $50 million revolving mortgage
warehousing credit facility. The facility is intended to finance newly
originated commercial mortgage loans. Holdings may borrow under this facility as
a co-borrower. In September 2000, this facility was extended through August 2001
and was increased to $70 million. In addition, a portion of this facility allows
for loans to be financed to the maturity of the loan, which may exceed the
expiration date of the facility. At September 30, 2000, the Company and Holdings
had outstanding borrowings of $4.3 million and $30.9 million, respectively,
under this facility. Borrowings under this facility bear interest based on a
specified margin over the London Interbank Offered Rate ("LIBOR"). At September
30, 2000, the weighted average borrowing rate under this facility was 8.50%. The
Company and Holdings were in compliance with all material representations,
warranties and covenants under this credit facility at September 30, 2000.
In July 2000, the Company renewed for one year, a $30 million master loan
and security agreement with a Wall Street Firm. The facility is intended to
finance newly originated commercial mortgage loans. In September 2000, this
facility was increased to $50 million. Holdings may borrow under this facility
as a co-borrower. At September 30, 2000, the Company had outstanding borrowings
of $7.3 million under this facility. Holdings had no outstanding borrowings
under this facility at September 30, 2000. Borrowings under this facility bear
interest based on a specified margin over LIBOR. At September 30, 2000, the
weighted average borrowing rate under this facility was 8.12%. The Company and
Holdings were in compliance with all material representations, warranties and
covenants under this credit facility at September 30, 2000.
In September 2000, the Company entered into two separate $30 million master
repurchase agreements with a bank and a Wall Street Firm. These facilities are
intended to finance residential mortgage-backed securities with lower than
investment grade ratings. At September 30, 2000, the Company had outstanding
borrowings of $27.2 million under these facilities. Borrowings under these
facilities bear interest based on a specified margin over LIBOR. At September
30, 2000, the weighted average borrowing rate under these facilities was 7.60%.
The Company was in compliance with all material representations, warranties and
covenants under these credit facilities at September 30, 2000. In October 2000,
the Company entered into a similar $20 million master repurchase agreement with
another Wall Street Firm.
NOTE 9. LONG-TERM DEBT
Long-Term Debt in the form of collateralized mortgage bonds is secured
primarily by a pledge of residential mortgage loans (see Note 6). As required by
the indentures relating to the Long-Term Debt, the
15
<PAGE> 18
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
mortgage loans are held in the custody of trustees. The trustees collect
principal and interest payments on the mortgage loans and make corresponding
principal and interest payments on the Long-Term Debt. The obligations under the
Long-Term Debt are payable solely from the mortgage loans 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 mortgage loans. 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.
The components of the Long-Term Debt at September 30, 2000 and December 31,
1999 along with selected other information are summarized below:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
-------------- --------------
(IN THOUSANDS)
<S> <C> <C>
Long-Term Debt................................ $1,148,685 $944,225
Unamortized premium on Long-Term Debt......... 3,191 3,881
Deferred bond issuance costs.................. (3,357) (2,836)
-------------- --------------
Total Long-Term Debt................ $1,148,519 $945,270
============== ==============
Range of weighted-average coupon rates, by
series...................................... 6.37% to 7.03% 6.21% to 6.88%
Stated maturities............................. 2017 - 2029 2017 - 2029
Number of series.............................. 4 3
</TABLE>
For the three and nine months ended September 30, 2000, the average balance
of Long-Term Debt was $1.2 billion and $1.1 billion, respectively. For the three
and nine months ended September 30, 1999, the average balance of Long-Term Debt
was $1.0 billion and $1.1 billion, respectively. For the three and nine months
ended September 30, 2000, 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 6.86% and 6.63%, respectively. The
average effective interest cost for the three and nine months ended September
30, 1999 was 6.01% and 6.00%, respectively. At September 30, 2000 and December
31, 1999, accrued interest payable on Long-Term Debt was $3.2 million and $3.0
million, respectively, and is reflected as a component of Accrued Interest
Payable on the Consolidated Balance Sheets.
16
<PAGE> 19
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
NOTE 10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying values and estimated fair values
of the Company's financial instruments.
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
---------------------------- ----------------------------
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
-------------- ---------- -------------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Assets
Mortgage Loans
Residential: held-for-investment,
net.............................. $1,178,180 $1,165,875 $968,709 $955,653
Residential: held-for-sale......... $ 7,619 $ 7,619 $415,880 $415,880
Commercial: held-for-sale.......... $ 32,308 $ 32,308 $ 8,437 $ 8,437
Mortgage Securities
Residential: trading............... $ 871,396 $ 871,396 $941,781 $941,781
Residential: available-for-sale,
net.............................. $ 69,065 $ 69,065 $ 27,999 $ 27,999
Interest Rate Agreements.............. $ 274 $ 274 $ 2,037 $ 2,037
Investment in RWT Holdings, Inc....... $ 2,019 $ 2,308 $ 3,391 $ 3,675
Liabilities
Long-Term Debt........................ $1,148,519 $1,137,602 $945,270 $928,449
</TABLE>
The carrying values of all other balance sheet accounts as reflected in the
financial statements approximate fair value because of the short-term nature of
these accounts.
NOTE 11. STOCKHOLDERS' EQUITY
Class B 9.74% Cumulative Convertible Preferred Stock
On August 8, 1996, the Company issued 1,006,250 shares of Class B Preferred
Stock ("Preferred Stock"). Each share of the Preferred Stock is convertible at
the option of the holder at any time into one share of Common Stock. 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. In the event of a liquidation or dissolution of the Company,
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, 2000 and December 31, 1999, 96,732
shares of the Preferred Stock have been converted into 96,732 shares of the
Company's Common Stock.
In March 1999, the Company's Board of Directors approved the repurchase of
up to 150,000 shares of the Company's Preferred Stock. There were no preferred
stock repurchases during the three and nine months ended September 30, 2000 and
1999. At September 30, 2000 and December 31, 1999, there were 142,550 shares
available for repurchase. At September 30, 2000 and December 31, 1999 there were
902,068 preferred shares 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
17
<PAGE> 20
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
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, 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, 2000 and December 31, 1999, 545,145 and 283,975
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, 2000 and
December 31, 1999, 322,303 and 389,942 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. 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.
For the three and nine months ended September 30, 2000, the stock DERs accrued
on NQSOs that had a stock DER feature resulted in charges to operating expenses
of approximately $0.1 million and $0.2 million, respectively. For both the three
and nine months ended September 30, 1999, the stock DERs accrued on NQSOs
resulted in a credit to operating expenses of $0.0 million and $0.1 million,
respectively.
A summary of the status of the Company's Plan as of September 30, 2000 and
changes during the periods ending on that date is presented below.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------- ---------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
--------- -------- --------- --------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C>
Outstanding options at beginning of period....... 1,485,573 $22.60 1,713,836 $21.97
Options granted................................ 1,500 $15.15 29,500 $13.63
Options exercised.............................. (19,980) $15.05 (26,014) $12.26
Options canceled............................... (44,783) $28.98 (302,944) $18.96
Stock dividend equivalent rights earned........ 4,340 -- 12,274 --
--------- ---------
Outstanding options at end of period............. 1,426,650 $22.43 1,426,652 $22.43
========= =========
</TABLE>
Common Stock Repurchases
Since September 1997, the Company's Board of Directors has approved the
repurchase of 7,455,000 shares of the Company's Common Stock. At September 30,
2000 and December 31, 1999, there were 1,000,000 shares authorized and remaining
for repurchase. The repurchased shares have been returned to the Company's
authorized but unissued shares of Common Stock.
18
<PAGE> 21
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
NOTE 12. RELATED PARTY TRANSACTIONS
Purchases and Sales of Mortgage Loans
During the three and nine months ended September 30, 2000, the Company sold
$9.8 million and $35.1 million of commercial mortgage loans to RCF,
respectively. For the three and nine months ended September 30, 1999, the
Company sold $24 million and $32 million of commercial mortgage loans to RCF,
respectively. 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. At September 30, 2000, under the terms of the Master Forward
Commitment Agreement, the Company had committed to sell $22.7 million of
commercial mortgage loans to RCF for settlement during the fourth quarter of
2000.
During the three and nine months ended September 30, 2000, the Company
purchased commercial mortgage loans from RCF aggregating $9.6 million which were
not subject to the terms of the Master Forward Commitment Agreement. The Company
intends to hold these commercial loans through maturity. All such commercial
mortgage loans purchased by the Company from RCF are purchased at the market
price at the time of the sale. Accordingly, any inter-company gains or losses
recorded on the sale of the commercial mortgage loans from RCF to the Company
are eliminated against the basis of the commercial mortgage loan purchased by
the Company. During both the three and nine months ended September 30, 2000,
Redwood's 99% interest of such gains recognized by Holdings was $0.1. The
Company made no such purchases from RCF during the three and nine months ended
September 30, 1999.
During the nine months ended September 30, 2000, the Company sold $17.1
million of residential mortgage loans to Redwood Residential Funding ("RRF"), a
subsidiary of Holdings. The Company had no such sales during the three months
ended September 30, 2000. 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. During the three and nine months ended
September 30, 1999, the Company sold $47.0 million of residential mortgage loans
to RRF. As RRF ceased operations in 1999, there were no remaining outstanding
commitments at September 30, 2000.
During December 1999, Holdings purchased $390 million of residential
mortgage loans and subsequently sold a participation agreement on the mortgage
loans to the Company. Pursuant to the terms of the Mortgage Loan Participation
Purchase Agreement, the Company purchased a 99% interest in the mortgage loans,
and assumed all related risks of ownership. Holdings did not recognize any gain
or loss on this transaction. During March 2000, the Company sold the
participation agreement back to Holdings for proceeds of $380.5 million.
Holdings simultaneously sold $384 million of residential mortgage loans to
Sequoia for proceeds of $384 million. Sequoia pledged these loans as collateral
for a new issue of Long-Term Debt.
Other
Under a revolving credit facility arrangement, the Company may loan funds
to Holdings to finance Holdings' operations. These loans are unsecured,
subordinated, and are repaid within six months. Such loans bear interest at a
rate of 3.50% over the one-month LIBOR. There were no outstanding loans to
Holdings at September 30, 2000. At December 31, 1999, the Company had loaned
$6.5 million to Holdings in accordance with the provisions of this arrangement.
During both the nine months ended September 30, 2000, the Company earned $0.1
million in interest on loans to Holdings. The Company earned $0.3 million and
$0.7 million in interest on loans to Holdings during the three and nine months
ended September 30, 1999, respectively.
The Company shares many of the operating expenses of Holdings, including
personnel and related expenses, which are subject to reimbursement by Holdings.
During the three and nine months ended
19
<PAGE> 22
REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
September 30, 2000, $0.1 million and $0.2 million 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, 1999, the Company
paid $1.2 million and $2.7 million of Holdings' operating expenses,
respectively.
The Company may provide credit support to Holdings to facilitate Holdings'
financings from third-party lenders. 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, 2000 and December
31, 1999, the Company was providing credit support on $30.9 million and $22.4
million of Holdings' Short-Term Debt. During both the three and nine months
ended September 30, 2000 and 1999, the Company recognized approximately $0.1
million in credit support fee income. 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, 2000, the Company had entered into commitments to sell
$22.7 million of commercial mortgage loans to RCF for settlement during the
fourth quarter of 2000.
At September 30, 2000, the Company is obligated under non-cancelable
operating leases with expiration dates through 2003. The total future minimum
lease payments under these non-cancelable leases is $352,367 and is expected to
be recognized as follows: 2000 -- $83,364; 2001 -- $171,856; 2002 -- $53,546;
2003 -- $43,601.
20
<PAGE> 23
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(UNAUDITED)
<S> <C> <C>
Mortgage loans: held-for sale
Commercial................................................ $32,333 $29,605
Residential............................................... -- 4,399
------- -------
32,333 34,004
Cash and cash equivalents................................... 1,441 1,999
Restricted cash............................................. 1,387 50
Accrued interest receivable................................. 287 1,520
Property, equipment and leasehold improvements, net......... 86 299
Other assets................................................ 255 1,081
------- -------
Total Assets...................................... $35,789 $38,953
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Short-term debt............................................. $30,903 $22,427
Loans from Redwood Trust, Inc............................... -- 6,500
Payable to Redwood Trust, Inc............................... -- 472
Accrued interest payable.................................... 232 831
Accrued restructuring charges............................... 876 4,039
Accrued expenses and other liabilities...................... 1,739 1,259
------- -------
Total Liabilities................................. 33,750 35,528
------- -------
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 29,700
Common stock, par value $0.01 per share; 10,000 shares
authorized; 3,000 issued and outstanding.................. -- --
Additional paid-in capital.................................. 300 300
Accumulated deficit......................................... (27,961) (26,575)
------- -------
Total Stockholders' Equity........................ 2,039 3,425
------- -------
Total Liabilities and Stockholders' Equity........ $35,789 $38,953
======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
21
<PAGE> 24
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2000 1999 2000 1999
------- -------- ------- --------
<S> <C> <C> <C> <C>
REVENUES
Interest income
Mortgage loans: held-for-sale
Commercial..................................... $1,032 $ 451 $ 2,167 $ 774
Residential.................................... -- 350 69 657
------ ------- ------- --------
1,032 801 2,236 1,431
Mortgage securities: trading................... -- 367 -- 1,021
Cash and cash equivalents...................... 29 79 110 295
------ ------- ------- --------
Total interest income..................... 1,061 1,247 2,346 2,747
Interest expense
Short-term debt................................ (828) (507) (1,624) (1,111)
Credit support fees............................ (34) (31) (70) (72)
Loans from Redwood Trust, Inc.................. (3) (336) (108) (691)
------ ------- ------- --------
Total interest expense.................... (865) (874) (1,802) (1,874)
Net interest income............................ 196 373 544 873
Net unrealized and realized market value gains
(losses)..................................... 64 (531) 57 84
Other income (expense)......................... -- -- -- 48
------ ------- ------- --------
Net revenues................................... 260 (158) 601 1,005
EXPENSES
Compensation and benefits...................... (297) (2,534) (1,276) (7,346)
General and administrative..................... (239) (1,512) (711) (4,167)
Restructuring charge........................... -- (2,210) -- (2,210)
------ ------- ------- --------
Total expenses............................ (536) (6,256) (1,987) (13,723)
------ ------- ------- --------
Net Loss............................................ $ (276) $(6,414) $(1,386) $(12,718)
====== ======= ======= ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
22
<PAGE> 25
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 ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
------ ------- ------ ------ ---------- ----------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1999.... 5,940 $29,700 3,000 $-- $300 $(26,575) $3,425
----- ------- ----- --- ---- -------- ------
Comprehensive income:
Net loss.................... -- -- -- -- -- (574) (574)
----- ------- ----- --- ---- -------- ------
Balance, March 31, 2000....... 5,940 29,700 3,000 -- 300 (27,149) 2,851
----- ------- ----- --- ---- -------- ------
Comprehensive income:
Net loss.................... -- -- -- -- -- (536) (536)
----- ------- ----- --- ---- -------- ------
Balance, June 30, 2000........ 5,940 $29,700 3,000 $-- $300 $(27,685) $2,315
----- ------- ----- --- ---- -------- ------
Comprehensive income:
Net loss.................... -- -- -- -- -- (276) (276)
----- ------- ----- --- ---- -------- ------
Balance, September 30, 2000... 5,940 $29,700 3,000 $-- $300 $(27,961) $2,039
===== ======= ===== === ==== ======== ======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
23
<PAGE> 26
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ----------------------
2000 1999 2000 1999
-------- -------- --------- ---------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................. $ (276) $ (6,414) $ (1,386) $ (12,718)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization..................... 11 267 28 464
Net unrealized and realized market value (gains)
losses.......................................... (64) 531 (57) (84)
Purchases of mortgage loans: held for sale........ (22,705) (79,178) (460,543) (231,359)
Proceeds from sales of mortgage loans: held for
sale............................................ 32,881 49,993 462,026 94,009
Principal payments on mortgage loans: held for
sale............................................ 37 472 250 1,280
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) decrease in accrued interest
receivable...................................... (14) (224) 1,233 (289)
(Increase) decrease in other assets............... (143) 1,239 821 821
Increase (decrease) in amounts due to Redwood
Trust........................................... -- 121 (472) (115)
Increase (decrease) in accrued interest payable... (54) -- (599) --
Increase (decrease) in accrued restructuring
charges......................................... (250) 1,362 (3,163) 1,362
Increase (decrease) in accrued expenses and other
liabilities..................................... (328) 17 480 747
-------- -------- --------- ---------
Net cash provided by (used in) operating
activities................................. 9,095 9,742 (1,382) (47,464)
-------- -------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Purchases) sales of property and equipment, net..... (4) (567) 185 (2,849)
Net increase in restricted cash...................... 426 -- (1,337) --
-------- -------- --------- ---------
Net cash used in investing activities........ 422 (567) (1,152) (2,849)
-------- -------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of short-term debt (net of
repayments)....................................... (10,731) (33,896) 8,476 19,207
Loans from Redwood Trust, Inc. (net of repayments)... -- 17,375 (6,500) 12,875
Net proceeds from issuance of preferred stock........ -- -- -- 9,900
Net proceeds from issuance of common stock........... -- -- -- 100
-------- -------- --------- ---------
Net cash provided by (used in) financing
activities................................. (10,731) (16,521) 1,976 42,082
-------- -------- --------- ---------
Net increase (decrease) in cash and cash equivalents... (1,214) (7,346) (558) (8,231)
Cash and cash equivalents at beginning of period....... 2,655 8,826 1,999 9,711
-------- -------- --------- ---------
Cash and cash equivalents at end of period............. $ 1,441 $ 1,480 $ 1,441 $ 1,480
======== ======== ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest expense....................... $ 919 $ 822 $ 2,401 $ 1,769
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.
24
<PAGE> 27
RWT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(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 originates and
sells commercial mortgage loans. 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 wholly-owned
subsidiaries of Holdings. Redwood Commercial Funding, Inc. ("RCF") originates
commercial mortgage loans for sale to institutional investors. Redwood
Residential Funding, Inc. ("RRF") and Redwood Financial Services, Inc. ("RFS")
were start-up ventures that ceased operations in 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 accompanying interim consolidated financial statements are unaudited.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the quarter ended September 30, 2000 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2000. The accompanying consolidated financial statements should be read in
conjunction with the consolidated financial statements and related notes
included in the Annual Report on Form 10-K filed by Redwood Trust for the year
ended December 31, 1999.
The consolidated financial statements include the accounts of Holdings and
its subsidiaries. All significant intercompany balances and transactions with
Holdings' consolidated subsidiaries have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with Generally
Accepted Accounting Principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reported
period. Actual results could differ from those estimates. The primary estimates
inherent in the accompanying consolidated financial statements are discussed
below.
Fair Value. Management estimates the fair value of its financial
instruments using available market information and other appropriate valuation
methodologies. The fair value of a financial instrument, as defined by Statement
of Financial Accounting Standards ("SFAS") No. 107, Disclosures about Fair Value
of Financial Instruments, is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation sale. Management's estimates are inherently subjective in
nature and involve matters of uncertainty and judgement to interpret relevant
market and other data. Accordingly, amounts realized in actual sales may differ
from the fair values presented in Note 7.
MORTGAGE ASSETS
Holdings' mortgage assets consist of mortgage loans and mortgage securities
("Mortgage Assets"). Interest is recognized as revenue when earned according to
the terms of the loans and when, in the opinion of management, it is
collectible.
25
<PAGE> 28
RWT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
Mortgage Loans: Held-for-Sale
Mortgage loans are recorded at the lower of cost or market value ("LOCOM").
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 market value gains (losses)" 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 which Holdings will pay
to purchase the loans 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
Prior to 2000, Holdings invested in residential mortgage securities. These
mortgage securities were classified as trading and were accounted for in
accordance with SFAS No. 115, Accounting for Certain Investments in Debt and
Equity Securities. Accordingly, such securities were recorded at their estimated
fair market value. Unrealized and realized gains and losses on these securities
were recognized as a component of "Net unrealized and realized market value
gains (losses)" on the Consolidated Statements of Operations. Holdings did not
own any mortgage securities at September 30, 2000 or December 31, 1999.
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.
RESTRICTED CASH
Restricted cash includes cash held back from borrowers until certain loan
agreement requirements have been met. The corresponding liability for this cash
is reflected as a component of "Accrued expenses and other liabilities" on the
Consolidated Balance Sheets.
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.
26
<PAGE> 29
RWT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
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, 2000, there was no other comprehensive
income.
RECENT ACCOUNTING PRONOUNCEMENT
During March 2000, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation -- an interpretation of APB Opinion No. 25 ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 by expanding upon a number of
issues not specifically addressed in the Opinion such as the definition of an
employee for purposes of applying APB Opinion No. 25 and the accounting for
modifications to a previously fixed stock option award. FIN 44 was effective
July 1, 2000. The impact on Holdings of adopting FIN 44 does not have a material
impact on the operating results of Holdings.
NOTE 3. MORTGAGE ASSETS
At September 30, 2000 and December 31, 1999 Mortgage Assets consisted of
the following:
Mortgage Loans: Held-for-Sale
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, 1999
2000 ------------------------------------
COMMERCIAL RESIDENTIAL COMMERCIAL TOTAL
------------- ----------- ---------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Current Face.......................... $33,303 $4,995 $30,324 $35,319
Unamortized Discount.................. (971) (596) (719) (1,315)
------- ------ ------- -------
Carrying Value........................ $32,333 $4,399 $29,605 $34,004
======= ====== ======= =======
</TABLE>
Holdings recognized losses of $0.2 million during the nine months ended
September 30, 2000, as a result of LOCOM adjustments on mortgage loans
held-for-sale. No such losses were recognized by Holdings during the three
months ended September 30, 2000. Additionally, during the three and nine months
ended September 30, 2000, Holdings sold residential and commercial mortgage
loans for proceeds of $32.9 million and $462.0 million, resulting in net gains
of $0.1 million and $0.3 million, respectively. During the three and nine months
ended September 30, 1999, Holdings recognized $0.9 million and $1.1 million in
LOCOM loss adjustments on mortgage loans held-for-sale and sold mortgage loans
held-for-sale for proceeds of $50 million and $94 million, respectively. The
LOCOM adjustments and gains on sale are reflected as a component of "Net
unrealized and realized market value gains (losses)" on the Consolidated
Statements of Operations.
Mortgage Securities: Trading
Holdings did not own any mortgage securities at September 30, 2000 or
December 31, 1999. 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
market value gains (losses)" 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.
27
<PAGE> 30
RWT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
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. This Short-Term Debt
is collateralized by a portion of Holdings' mortgage loans.
At September 30, 2000, and December 31, 1999, Holdings had $30.9 million
and $22.4 million of Short-Term Debt outstanding with a weighted-average
borrowing rate of 8.50% and 7.02%, respectively. The average balance of
Short-Term Debt outstanding during the three and nine months ended September 30,
2000 was $38 million and $26 million with a weighted-average interest cost of
8.50% and 8.21%, respectively. The maximum balance outstanding during both the
three and nine months ended September 30, 2000 was $44.1 million. During the
three and nine months ended September 30, 1999, the average balance of Short-
Term Debt outstanding was $35 million and $27 million with a weighted-average
interest cost of 5.77% and 5.42%, respectively. The maximum balance outstanding
during the three and nine months ended September 30, 1999 was $53 million and
$89 million, respectively.
In March 2000, the Redwood Trust entered into a $50 million revolving
mortgage warehousing credit facility. The facility is intended to finance newly
originated commercial mortgage loans. Holdings may borrow under this facility as
a co-borrower. In September 2000, this facility was extended through August 2001
and was increased to $70 million. In addition, a portion of this facility allows
for loans to be financed to the maturity of the loan, which may exceed the
expiration date of the facility. At September 30, 2000, the Redwood Trust and
Holdings had outstanding borrowings of $4.3 million and $30.9 million,
respectively, under this facility. Borrowings under this facility bear interest
based on a specified margin over the London Interbank Offered Rate ("LIBOR"). At
September 30, 2000, the weighted average borrowing rate under this facility was
8.50%. Redwood Trust and Holdings were in compliance with all material
representations, warranties and covenants under this credit facility at
September 30, 2000.
In July 2000, the Redwood Trust renewed for one year, a $30 million master
loan and security agreement with a Wall Street Firm. The facility is intended to
finance newly originated commercial mortgage loans. In September 2000, this
facility was increased to $50 million. Holdings may borrow under this facility
as a co-borrower. At September 30, 2000, the Company had outstanding borrowings
of $7.3 million under this facility. Holdings had no outstanding borrowings
under this facility at September 30, 2000. Borrowings under this facility bear
interest based on a specified margin over LIBOR. At September 30, 2000, the
weighted average borrowing rate under this facility was 8.12%. The Redwood Trust
and Holdings were in compliance with all material representations, warranties
and covenants under this credit facility at September 30, 2000.
NOTE 5. RESTRUCTURING CHARGE
During the year ended December 31, 1999, Holdings recognized $8.4 million
in restructuring charges as a result of the closure of two of its subsidiaries,
RRF and RFS. Restructuring charges were determined in accordance with the
provisions of Staff Accounting Bulletin No. 100 "Restructuring and Impairment
Charges", Emerging Issues Task Force No. 94-3 "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity", and other
relevant accounting guidance. The restructuring accrual includes costs
associated with existing contractual and lease arrangements at both subsidiaries
which have no future value. In addition, as a result of the closure of the two
subsidiaries, certain assets utilized in these businesses were determined to
have little or no realizable value, resulting in impairment losses. These
28
<PAGE> 31
RWT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
assets included software developed for use at RRF and certain fixed assets at
both subsidiaries. The following table provides a summary of the primary
components of the restructuring liability.
<TABLE>
<CAPTION>
TOTAL REMAINING LIABILITY
----------------------------
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Payroll, severance, and termination benefits......... $311 $2,431
Lease and other commitments.......................... 404 1,068
Other................................................ 161 540
---- ------
Total...................................... $876 $4,039
==== ======
</TABLE>
Holdings expects to pay the majority of the remaining restructuring costs
during the year 2000. The liability for restructuring costs is reflected as
"Accrued restructuring charges" on the Consolidated Balance Sheets.
NOTE 6. INCOME TAXES
The provision for income taxes for the three and nine months ended
September 30, 2000 and 1999 is $3,200 and represents minimum California
franchise taxes. No additional tax provision has been recorded for the three and
nine months ended September 30, 2000, as Holdings reported a loss in each of the
periods. Due to the uncertainty of realization of net operating losses, no
deferred tax benefit has been recorded. That is, a valuation allowance has been
provided to offset the deferred tax assets related to net operating loss
carryforwards and other future temporary deductions at September 30, 2000 and
December 31, 1999. At September 30, 2000 and December 31, 1999, the deferred tax
assets and associated valuation allowances were approximately $9.4 million and
$8.9 million, respectively. At December 31, 1999 Holdings had net operating loss
carryforwards of approximately $19.5 million for federal tax purposes, and $9
million for state tax purposes. The federal loss carryforwards and a portion of
the state loss carryforwards expire between 2018 and 2019, while the largest
portion of the state loss carryforwards expire between 2003 and 2004.
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, 2000 and December 31, 1999.
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
---------------------------- ----------------------------
CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE
-------------- ---------- -------------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Assets
Mortgage loans: held-for-sale
Commercial........................... $32,333 $32,623 $29,605 $29,876
Residential.......................... -- -- $ 4,399 $ 4,415
</TABLE>
The carrying amounts of all other balance sheet accounts as reflected in
the financial statements approximate fair value because of the short-term nature
of these accounts.
NOTE 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
29
<PAGE> 32
RWT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
$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
Purchases and Sales of Mortgage Loans
During the three and nine months ended September 30, 2000, RCF purchased
$9.8 million and $35.1 million of commercial mortgage loans from Redwood Trust,
respectively. For the three and nine months ended September 30, 1999, RCF
purchased $24 million and $32 million of commercial mortgage loans from Redwood
Trust, respectively. 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. At September 30, 2000, under the
terms of the Master Forward Commitment Agreement, Redwood Trust had committed to
sell $22.7 million of commercial mortgage loans to RCF for settlement during the
fourth quarter of 2000.
During the three and nine months ended September 30, 2000, RCF sold
commercial mortgage loans aggregating $9.6 million to Redwood Trust which were
not subject to the terms of the Master Forward Commitment Agreement. All such
commercial mortgage loans sold by RCF to Redwood Trust are sold at the market
price at the time of the sale. Accordingly, any inter-company gains or losses
recorded on the sale of the commercial mortgage loans by RCF to Redwood Trust
are recorded on the Holdings' Statements of Operations under "net unrealized and
realized market value gains (losses)." Such gains or losses are eliminated on
the Redwood Trust Statements of Operations against the basis of the asset held
by Redwood Trust. During both the three and nine months ended September 30,
2000, the gains recognized by Holdings on the sale of RCF assets were $0.1
million. No such sales were made by the RCF during the three and nine months
ended September 30, 1999.
During the nine months ended September 30, 2000, RRF purchased $17.1
million of residential mortgage loans from Redwood Trust, respectively. No such
purchases were made during the three months ended September 30, 2000. For both
the three and nine months ended September 30, 1999, RRF purchased $47.0 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. As RRF ceased
operations in 1999, there were no remaining outstanding commitments at September
30, 2000.
During December 1999, Holdings purchased $390 million of residential
mortgage loans and subsequently sold a participation agreement on the mortgage
loans to Redwood Trust. Pursuant to the terms of the Mortgage Loan Participation
Purchase Agreement, Redwood Trust purchased a 99% interest in the mortgage
loans, and assumed all related risks of ownership. Holdings did not recognize
any gain or loss on this transaction. During March 2000, Redwood Trust sold the
participation agreement back to Holdings for proceeds of $380.5 million.
Holdings simultaneously sold $384 million of residential mortgage loans to
Sequoia for proceeds of $384 million.
30
<PAGE> 33
RWT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2000
(UNAUDITED)
Other
Under a revolving credit facility arrangement, Redwood Trust may loan funds
to Holdings to finance Holdings' operations. These loans are unsecured,
subordinated, and are repaid within six months. Such loans bear interest at a
rate of 3.50% over the LIBOR interest rate. Holdings had no outstanding loans
from Redwood Trust at September 30, 2000. At December 31, 1999, Holdings had
borrowed $6.5 million from Redwood Trust in accordance with the provisions of
this arrangement. During the three and nine months ended September 30, 2000,
Holdings incurred $0.0 million and $0.1 million in interest expense on loans
from Redwood Trust, respectively. Holdings incurred $0.3 million and $0.7
million in interest expense on loans from Redwood Trust during the three and
nine months ended September 30, 1999.
Redwood Trust shares many of the operating expenses of Holdings, including
personnel and related expenses, subject to reimbursement by Holdings. During the
three and nine months ended September 30, 2000, $0.1 million and $0.2 million of
Holdings' operating expenses were paid by Redwood Trust, and were subject to
reimbursement by Holdings, respectively. 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.
Redwood Trust may provide credit support to Holdings to facilitate
Holdings' financings from third-party lenders. 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, 2000
and December 31, 1999, Redwood Trust was providing credit support on $30.9
million and $22.4 million of Holdings' Short-Term Debt, respectively. During the
three and nine months ended September 30, 2000 and 1999, Holdings recognized
approximately $0.0 million and $0.1 million in credit support fee expense,
respectively.
NOTE 10. COMMITMENTS AND CONTINGENCIES
At September 30, 2000, RCF is obligated under non-cancelable operating
leases with expiration dates through 2004. The total future minimum lease
payments under these non-cancelable leases is $327,338 and is expected to be
recognized as follows: 2000 -- $26,536; 2001 -- $91,470; 2002 -- $76,672;
2003 -- $78,972; 2004 -- $53,688.
At September 30, 2000, RCF had entered into commitments to purchase $22.7
million of commercial mortgage loans from Redwood Trust for settlement during
the fourth quarter of 2000.
31
<PAGE> 34
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes.
SAFE HARBOR STATEMENT
"Safe Harbor" Statement under the Private Securities Litigation Reform Act
of 1995: Statements in this discussion regarding Redwood Trust, Inc., 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
"Company Business and Strategy" beginning on Page 4 and "Risk Factors"
commencing on Page 13 of our 1999 Form 10-K included in our 1999 Annual Report.
COMPANY OVERVIEW
Redwood Trust is a real estate finance company. We acquire, originate,
finance, structure, and manage residential and commercial mortgages representing
interests in real estate property nationwide.
To build our residential loan portfolio, we acquire loans from large
high-quality origination companies. In addition, we also buy residential loan
portfolios from banks. The commercial mortgage loans that we own have been
originated by our commercial mortgage origination affiliate.
Our business strategy is to actively manage our portfolio by monitoring and
working out any credit issues, by managing the effective terms of our assets and
our liabilities, and by changing our portfolio mix as opportunities arise or
risks develop.
As a key part of our strategy, we focus on high-quality mortgages. We do
not plan to invest in loans (or below-investment grade securities backed by
loans) that are made to lower-quality borrowers or that otherwise have
significant credit risk characteristics. As a result of this emphasis on
high-quality assets, our credit losses to date have been minor.
Our revenues consist primarily of interest income generated from our real
estate mortgage assets. Our profit consists of these revenues less interest,
credit, and operating expenses. Since we are a Real Estate Investment Trust
(REIT), we generally do not pay corporate taxes on our profits. As a REIT, we
distribute each year a high percentage of the profits that we generate to
shareholders in the form of quarterly dividend payments.
Redwood's primary goal is to generate high-quality cash flows from
high-quality assets in order to provide a steady and growing stream of dividends
to our shareholders.
For more information, please visit Redwood's Web site at
www.redwoodtrust.com.
SIGNIFICANT ASPECTS OF THE THIRD QUARTER AND YEAR-TO-DATE 2000
In 2000, we paid a common stock dividend of $0.35 per share in the first
quarter, $0.40 per share in the second quarter, and $0.42 per share in the third
quarter.
In the third quarter of 2000, our net income was $4.9 million, or $0.55 per
share. In the second quarter of 2000, our net income was $3.1 million, or $0.35
per share. In the third quarter of 1999, our net income was negative $3.7
million, or negative $0.39 per share. For the first nine months of 2000, our net
income was $11.2 million, or $1.27 per share. For the first nine months of 1999,
our net income was $4.6 million, or $0.45 per share.
We believe that core earnings -- earnings from on-going operations before
mark-to-market -- reflects Redwood's on-going earnings, cash flow generation,
and dividend-paying ability. Core earnings for the third quarter were $4.0
million, or $0.45 per share. Core earnings per share increased by 32% from the
$0.34 per share we earned in the third quarter of 1999. Core earnings for the
first nine months of 2000 were
32
<PAGE> 35
$13.0 million, or $1.46 per share. Year-to-date 2000 core earnings increased by
20% from the $1.22 per share we earned in the first nine months of 1999.
Core earnings for the third quarter of 2000 were somewhat lower than the
$0.51 per share we earned in each of the first two quarters of 2000. An increase
in mortgage prepayment rates (typical for the summer months) and the temporary
effect of rapid increases in short-term interest rates reduced our net interest
income earnings from quarter to quarter.
Our credit results remain excellent. In the third quarter of 2000, our loan
delinquency rates dropped and we had no loan losses. Loan losses to date for the
year 2000 total $37,000, and loan losses in the mortgage pools that back our
mortgage securities remain well below our original expectations. The annualized
credit loss rate on our loan portfolio in 2000 has been less than one basis
point (0.004%). Our credit reserve at the end of the third quarter of $6.0
million represented 0.49% of our loan portfolio.
FINANCIAL CONDITION
At September 30, 2000, we owned $1.2 billion mortgage loans and $0.9
billion mortgage securities. Our total assets were $2.2 billion. We financed
these assets with $0.8 billion of recourse short-term debt, $1.1 billion of
non-recourse long-term debt, and $211 million of preferred and common equity.
As reported on our third quarter 2000 balance sheet, our equity-to-assets
ratio was 9.6% and our debt-to-equity ratio was 9.4 to 1.0. Nearly $1.2 billion
of the assets and liabilities consolidated on our reported balance sheet,
however, are owned by our Sequoia subsidiary. Sequoia is a special purpose
entity designed to allow Redwood to issue long-term debt that is non-recourse to
Redwood itself. Redwood's net investment in Sequoia is $38 million. Since
Sequoia's debts are payable only by Sequoia, Redwood's total risk related to
Sequoia's assets and liabilities is limited to its $38 million investment.
Adjusting for the non-recourse nature of the Sequoia assets and debt that are
reported on Redwood's balance sheet, at September 30, 2000 Redwood owned total
assets-at-risk of $1.0 billion funded with $0.8 billion of recourse debt and
$0.2 billion of equity. The ratio of equity-to-risk-assets was 20.0%. The ratio
of recourse-debt-to-equity was 3.9 to 1.0.
At December 31, 1999, we owned $1.4 billion mortgage loans and $1.0 billion
mortgage securities. Our total assets were $2.4 billion. We financed these
assets with $1.3 billion of recourse short-term debt, $0.9 billion of
non-recourse long-term debt, and $210 million of preferred and common equity.
Our equity-to-assets ratio was 8.7% and our debt -to-equity ratio was 10.5 to
1.0. Adjusting for Sequoia, we owned total assets at risk of $1.5 billion funded
with $1.3 billion of recourse debt and $0.2 billion of equity. The ratio of
equity-to-risk-assets was 14.3%. The ratio of recourse-debt-to-equity was 6.0 to
1.0.
The increase in long-term debt and reduction in short-term debt from
December 31, 1999 to September 30, 2000 was the result of our issuance of
non-recourse long-term debt in the first quarter of 2000.
Mortgage Assets
Mortgage Loans
Aspects of our loan portfolio are detailed in the paragraphs below. To
summarize, at September 30, 2000 we owned $1.2 billion mortgage loans
representing 56% of our total mortgage asset portfolio. Residential mortgage
loans were 97% of our mortgage loan portfolio and commercial mortgage loans were
3%. Within our residential mortgage loan portfolio, 72% were adjustable-rate
mortgages with coupon rates that adjust to market conditions at least annually
and 28% were hybrid-coupon mortgages that are fixed rate on average for two
years and then become adjustable-rate.
At September 30, 2000, $852 million carrying value, or 39% of our total
mortgage asset portfolio, were high-quality residential mortgage loans with
adjustable-rate coupons with a principal value of $842 million. Our carrying
value of these loans, after $3.2 million of credit reserves, was 101.17% of the
face or principal value of the loans. At December 31, 1999, we owned $993
million carrying value of these loans, or 42% of our portfolio, at a carrying
value of 101.21% of the $981 million principal value (net of a $2.8 million
credit
33
<PAGE> 36
reserve). Seriously delinquent loans (over 90 days delinquent, in foreclosure,
or REO) in this portion of our portfolio were $3.5 million at September 30, 2000
and $3.4 million at December 31, 1999.
At September 30, 2000, $334 million carrying value and principal value, or
15% of our total mortgage asset portfolio, were high-quality residential
mortgage loans with hybrid coupons. Our hybrid mortgage loans have an initial
fixed coupon rate for three to ten years followed by annual coupon adjustments.
On average, these loans become floating-rate in December 2002. This portion of
our portfolio is matched to the $326 million of amortizing non-recourse
long-term debt we have issued that is fixed-rate debt until December 2002. Our
carrying value of these loans, after $2.4 million of credit reserves, was 99.76%
of the $335 million face value. At December 31, 1999 we owned $391 million
carrying value of these loans, or 17% of our total portfolio, at a carrying
value of 99.84% of the $392 million principal value (net of a $2.3 million
credit reserve). Seriously delinquent loans in this portion of our portfolio
were $0.8 million at September 30, 2000 and $1.3 million at December 31, 1999.
We generally seek to acquire residential mortgage loans that are
high-quality, that have loan balances significantly larger than national
averages, and that are geographically diverse. At September 30, 2000, our total
residential loan portfolio consisted of 3,804 loans, with an average loan size
of $309,400. The geographic distribution was California 25%, Florida 9%, New
York 8%, New Jersey 5%, Texas 5%, and Georgia 5%. The remaining 43% were in
other states located throughout the country, with no one of these states
representing greater than 5% of the total. At December 31, 1999, we owned 4,366
loans with an average loan size of $315,700. The geographic distribution was
California 26%, Florida 9%, New York 8%, New Jersey 5%, Texas 5%, and Georgia
5%. The remaining 42% were in other states located throughout the country, with
no one of these states representing greater than 5% of the total.
At September 30, 2000, $32.3 million carrying value, or 1.5% of our total
mortgage asset portfolio, were commercial mortgage loans originated by our
affiliated commercial mortgage origination unit. These loans had a principal
value $32.7 million and were carried on our books at 98.66% of principal value.
These loans had an average size of $4.1 million and all the underlying
properties were located in California, New Jersey or Texas. At December 31,
1999, we owned $8.4 million carrying value of commercial mortgage loans, or 0.4%
of our portfolio, at a carrying value of 99.85% of principal value. These loans
had an average size of $2.8 million and all the underlying properties were
located in California. Generally, these loans are shorter-term bridge or
transition loans to high-quality borrowers on a variety of types on
income-producing properties. We expect that most of these loans will pre-pay or
mature within three years. Most of these loans have floating-rate coupons.
In addition to the commercial loans reported on our balance sheet, our
99%-owned unconsolidated affiliate (Holdings) also owned similar commercial
mortgage loans originated by our commercial origination affiliate of $32.3
million at September 30, 2000 and $29.6 million at December 31, 1999.
We have sold some of our originated commercial mortgage loans to banks and
other finance companies; we may make further sales in the future.
Mortgage Securities
Aspects of our mortgage securities portfolio are detailed in the paragraphs
below. To summarize, at September 30, 2000 we owned $0.9 billion mortgage
securities representing 44% of our total mortgage asset portfolio. All of these
securities represented interests in pools of residential mortgage loans. Of
these securities, 93% were rated BBB or higher by credit rating agencies. A
substantial majority of these were rated AAA. Securities with coupon rates that
adjust to market conditions at least once per year represented 89% of the
securities portfolio. Securities that have fixed rate coupons for 1 to 5 years
(and then either adjust or mature) represented 3% of the securities portfolio.
The remainder, 8%, had fixed rate coupons for longer than 5 years.
At September 30, 2000, 29% of our total mortgage asset portfolio, or $624
million carrying value with a principal value of $615 million, consisted of
residential mortgage securities issued and credit-enhanced by Fannie Mae or
Freddie Mac and effectively rated "AAA". The majority of these securities, $613
million or 99%, were adjustable-rate securities with the remaining 1% fixed-rate
securities. The carrying value of these
34
<PAGE> 37
securities was 101.62% of principal value. At December 31, 1999, we owned $575
million carrying value of these securities, or 24% of our portfolio, at a
carrying value of 101.73% of the $565 million principal value.
At September 30, 2000, 9% of our total mortgage asset portfolio, or $197
million carrying and $196 principal value, consisted of adjustable-rate
residential 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 carrying value of these securities was 100.44% of face
value. At December 31, 1999, we owned $291 million carrying value and principal
value of these securities, or 12% of our portfolio, at a carrying value of
99.86%.
At September 30, 2000, 3% of our mortgage asset portfolio, or $69 million
carrying value with a principal value of $109 million, consisted of lower-rated,
residential mortgage securities issued by private-label security issuers. Due to
their subordinated status, these securities bore some degree of credit risk and
were rated "A" or below. The loans underlying these securities are, with minor
exceptions, high-quality loans. The carrying value of these securities, after
$0.4 million of credit reserves, was 65.28% of face value. At December 31, 1999,
we owned $28 million carrying value of these securities, or 1% of our portfolio,
at a carrying value, after credit reserves, of 57.85% of the $49 million face
value. We intend to continue to increase our investment in lower-rated,
subordinated residential mortgage securities backed by high-quality loans in the
future.
At September 30, 2000, 1% of our total mortgage asset portfolio, or $23
million carrying value and principal value, consisted of residential
floating-rate mortgage securities rated "AAA" or "AA" which were backed by home
equity loans, or "HELs". The carrying value of these securities was 99.94% of
face value. At December 31, 1999, we owned $47 million carrying value of these
securities, or 2% of our portfolio, at a carrying value of 98.79% of the $48
million principal value.
At September 30, 2000, 1% of our mortgage asset portfolio, or $14 million
carrying value and principal value, consisted of fixed-rate, private-label
mortgage securities. These are commonly called "CMOs". They were rated "AAA" or
"AA" and had average lives of 1 to 2 years. The carrying value of these
securities was 97.56% of principal value. At December 31, 1999, we owned $16
million carrying value and principal value of these securities, or 1% of our
portfolio, at a carrying value of 97.28% of principal value.
At September 30, 2000, 1% of our mortgage asset portfolio, or $12 million
carrying value with a principal value of $13 million, consisted of fixed-rate,
credit-enhanced private-label mortgage securities rated "AA" and backed by
residential mortgage loans with loan-to-value ratios in excess of 100%. The
carrying value of these securities was 94.66% of face value. At December 31,
1999, we owned $12 million carrying value of these securities, or 0.5% of our
portfolio, at a carrying value of 91.00% of the $13 million principal value. The
average life of these assets was 7.5 years at September 30, 2000 and 8.2 years
at December 31, 1999
At December 31, 1999, 0.3% of our total mortgage asset portfolio, or $6
million carrying and face value, consisted of floating-rate CMO mortgage
securities issued by Fannie Mae or Freddie Mac and effectively rated "AAA". The
carrying value of these securities was 99.88% of principal value. We owned none
of these assets at September 30, 2000.
At September 30, 2000, 0.01% of our mortgage asset portfolio, or $0.2
million carrying value with no principal value, consisted of interest-only
mortgage securities rated "AAA" or "AA". At December 31, 1999, we owned $0.1
million carrying value of these securities, or 0.005% of our portfolio.
Cash
We had $7 million of unrestricted cash at September 30, 2000 and $20
million at year-end 1999.
Sequoia held cash totaling $3 million at September 30, 2000 and $5 million
at December 31, 1999. In consolidating Sequoia assets on our balance sheet, we
reflect this cash as "Restricted Cash" since it will be used for the specific
purpose of making payments to Sequoia bondholders and is not available for
general corporate purposes.
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<PAGE> 38
The amount of liquidity we maintain on a daily basis may differ from the
amount of cash we show on our balance sheet at the end of each reporting period.
Please refer to the discussion regarding our liquidity beginning on page 42.
Interest Rate Agreements
We use interest rate agreements as part of our asset/liability management.
Our interest rate agreements are carried on our balance sheet at estimated
market value, which was $0.3 million at September 30, 2000 and $2.0 million at
December 31, 1999. 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 investment in one line item on our
balance sheet labeled "Investment in RWT Holdings, Inc." We refer you to
Holdings' "Consolidated Financial Statements and Notes" and Holdings'
"Management's Discussion and Analysis" below for more information on Holdings.
The carrying value of our equity investment in Holdings was $2.0 million at
September 30, 2000 and $3.4 million at December 31, 1999.
From time to time, we may provide additional liquidity to Holdings. At
September 30, 2000, no such additional liquidity was needed. At December 31,
1999, loans to Holdings totaled $6.5 million and receivables from Holdings were
$0.5 million.
Other Assets
Our other assets include principal receivable, accrued interest
receivables, other receivables, fixed assets, leasehold improvements and prepaid
expenses. These totaled $24 million at September 30, 2000 and $19 million at
December 31, 1999.
Short-Term Debt
Short-term borrowings totaled $0.8 billion at September 30, 2000, or 42% of
our total debt. At December 31, 1999, short-term borrowings were $1.3 billion,
or 57% of our total debt. The level of short-term borrowings was reduced in the
first half of 2000 as we issued long-term debt and used the proceeds to reduce
short-term debt. We pledge a portion of our mortgage securities portfolio,
mortgage loan portfolio, and other assets to secure our short-term 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, with some of it adjusting daily based on the Fed
Funds interest rate.
Long-Term Debt
At September 30, 2000, we owned $1.18 billion of residential mortgage loans
that were financed with long-term debt through trusts owned by our financing
subsidiary, 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. 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.
At September 30, 2000, 58% of our total debt, or $1.15 billion, was
long-term mortgage-backed debt. Of this long-term debt, $518 million had a
floating-rate based on one-month LIBOR and $304 million had a floating-rate
based on the twelve-month average of the one-year Treasury rate. An additional
$326 million was
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<PAGE> 39
fixed-rate until December 2002 with a floating-rate coupon thereafter; this debt
is matched to our portfolio of hybrid fixed/floating residential mortgage loans.
At December 31, 1999, 43% of our total debt, or $945 million, was long-term
mortgage-backed debt. Of this long-term debt, $212 million had a floating-rate
based on one-month LIBOR, $351 had a floating-rate based on the twelve-month
average of the one-year Treasury rate, and $382 million had a fixed-rate until
December 2002 with a floating-rate coupon thereafter.
Other Liabilities
Our other liabilities include accrued interest payable, accrued expenses,
and dividends payable. The net balance of these accounts totaled $14 million at
September 30, 2000 and $11 million at December 31, 1999.
Stockholders' Equity
At September 30, 2000, total equity capital was $211 million. Preferred
stock equity was $27 million. Reported common equity totaled $184 million, or
$20.90 per common share outstanding.
In reporting equity, we mark-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 ("GAAP"), no
liabilities were marked-to-market.
If we had marked-to-market all of our assets and liabilities, total equity
capital would have been reported as $209 million at September 30, 2000. After
subtracting out the preference value of the preferred stock, common equity on a
full mark-to-market basis was $181 million and the net asset value, or "NAV",
per common share was $20.59.
At December 31, 1999, reported equity capital was $210 million, preferred
stock equity was $27 million, and reported common equity was $183 million, or
$20.88 per common share outstanding. Mark-to-market common equity was $185
million, or a NAV of $21.07 per common share.
During the first nine months of 2000, our total equity, book value per
share, and NAV per share declined slightly after accruing for our $1.17 per
share common dividends. These dividends were below our core earnings during this
period of $1.46 per share and below our reported GAAP earnings of $1.27 per
share. The deduction in our book value was due to the negative net market value
adjustments on the assets and liabilities whose adjustments do not flow through
our income statement. However, given the rising interest rate environment, which
saw short-term rates rise by nearly 1.00% during the past nine months, we had a
relatively small net market valuation adjustment on all our assets and
liabilities, with the average net decline being 0.22% of average principal value
of all our assets.
RESULTS OF OPERATIONS
Our reported GAAP earnings of $0.55 per share in the third quarter of 2000
exceeded our GAAP earnings of $0.35 per share in the second quarter of 2000 and
exceeded our GAAP earnings of negative $0.39 per share in the third quarter of
1999. For the first nine months of 2000, our GAAP earnings of $1.27 per share
exceeded our GAAP earnings of $.045 per share for the first nine months of 1999.
Core earnings equal GAAP earnings less the earnings effect of the market
value changes of our assets less the effect of closed business units'
operations. While reported GAAP earnings are important, we believe core earnings
provide an alternative measure of our on-going cash flow generation and
dividend-paying ability.
Core earnings of $0.45 per share in the third quarter of 2000 exceeded by
32% the $0.34 per share of core earnings we generated in the third quarter of
1999. Third quarter 2000 core earnings were, however, somewhat lower than the
$0.51 per share of core earnings we generated in the second quarter of 2000.
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<PAGE> 40
The table below reconciles core earnings to reported GAAP earnings.
<TABLE>
<CAPTION>
THIRD SECOND THIRD FIRST NINE FIRST NINE
QUARTER QUARTER QUARTER MONTHS MONTHS
2000 2000 1999 2000 1999
------- ------- ------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Core Earnings............................ $3,951 $ 4,495 $ 3,181 $12,984 $12,368
Market Value Changes..................... 927 (1,452) (2,074) (1,689) 1,507
Closed Business Units.................... 0 43 (4,845) (46) (9,250)
------ ------- ------- ------- -------
Reported GAAP Earnings................... $4,878 $ 3,086 $(3,738) $11,249 $ 4,625
PER SHARE
Core Earnings............................ $ 0.45 $ 0.51 $ 0.34 $ 1.46 $ 1.22
Market Value Changes..................... $ 0.10 $ (0.16) $ (0.22) $ (0.19) $ 0.14
Closed Business Units.................... $ 0.00 $ 0.00 $ (0.51) $ (0.00) $ (0.91)
------ ------- ------- ------- -------
Reported GAAP Earnings................... $ 0.55 $ 0.35 $ (0.39) $ 1.27 $ 0.45
</TABLE>
Net Interest Income
The net interest income we generated from our real estate assets was $7.2
million in the third quarter of 2000. For the same quarter in 1999, we earned
$6.7 million. In second quarter of 2000, we earned $8.0 million. Net interest
income is interest income less interest expense and interest rate agreement
hedging expenses.
A key ratio we monitor is annualized net interest income as a percentage of
total equity. This was 13.9% in the third quarter of 2000, 11.5% in the third
quarter of 1999, and 15.4% in each of the first two quarters of 2000.
Net interest income earnings improved from the third quarter of 1999
compared to the third quarter of 2000 due to an increase in capital utilization
and an increase in interest rates. With our capital more fully utilized, we were
able to carry a greater amount of assets. Average earning assets increased from
$2.0 billion to $2.2 billion during this period. Due to rising short-term
interest rates, both the yield on our assets and our cost of borrowed funds
increased by approximately 1% over the last year. This was positive for our net
interest income earnings during the third quarter as the amount of our assets
exceeds our liabilities by $0.2 billion.
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<PAGE> 41
Net interest income earnings decreased somewhat from the second to the
third quarter of 2000 largely due to an increase in premium amortization expense
associated with an increase in mortgage prepayment rates. Our average annual
prepayment rate was 17% in the second quarter and 21% in the third quarter.
Prepayment rates typically increase in the summer months. Additional factors
effecting net interest income from quarter to quarter were an increase in our
cost of borrowed funds due to increases in short-term interest rates and a
slight decrease in average earning assets.
<TABLE>
<CAPTION>
THIRD SECOND THIRD FIRST NINE FIRST NINE
QUARTER QUARTER QUARTER MONTHS MONTHS
2000 2000 1999 2000 1999
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Mortgage Coupon Interest..... $ 42,967 $ 43,048 $ 35,337 $ 129,445 $ 117,064
Premium Amortization......... $ (1,048) $ 88 $ (782) $ (1,452) $ (4,687)
---------- ---------- ---------- ---------- ----------
Interest Income.............. $ 41,919 $ 43,136 $ 34,555 $ 127,993 $ 112,377
Interest Expense............. $ (34,502) $ (34,914) $ (27,390) $ (103,938) $ (84,418)
Interest Rate Agree Exp...... (192) (219) (457) (819) (1,527)
---------- ---------- ---------- ---------- ----------
Net Interest Income.......... $ 7,225 $ 8,003 $ 6,708 $ 23,236 $ 21,432
Ave. Earning Assets.......... $2,182,990 $2,278,670 $2,049,750 $2,273,825 $2,241,853
Ave. Coupon Rate............. 7.83% 7.53% 6.88% 7.57% 6.91%
Prepayment Rate.............. 21% 17% 25% 18% 29%
Ave. Asset Yield............. 7.65% 7.54% 6.66% 7.47% 6.58%
Ave. Borrowings.............. $2,018,844 $2,123,927 $2,197,900 $2,113,212 $2,111,279
Cost of Funds and Hedging.... 6.88% 6.62% 5.90% 6.61% 5.74%
Interest Rate Spread......... 0.78% 0.93% 0.76% 0.86% 0.84%
Net Interest Margin.......... 1.29% 1.36% 1.26% 1.33% 1.21%
Ave. Total Equity............ $ 213,341 $ 213,147 $ 234,579 $ 213,426 $ 243,068
Net Int. Inc. to Equity...... 13.9% 15.4% 11.5% 14.8% 11.8%
</TABLE>
Provision for Credit Losses
Our provision for credit loss expense was $0.2 million in the third quarter
of 2000. This was a lower expense than the $0.5 million provision we took in the
third quarter of 1999 and slightly higher than the $0.1 million provision we
took in the second quarter of 2000. Credit provision expenses were $0.5 million
for the first nine months of 2000 and $1.1 million for the first nine months of
1999.
We have reduced our credit provision expenses because our actual losses
have been quite low and delinquencies are declining. We had no actual loan
losses in the third quarter of 2000. Actual loan losses were $37,000 in the
second quarter of 2000 and $71,000 in the third quarter of 1999. Actual loan
losses were $37,000 for the first nine months of 2000 and $56,000 for the first
nine months of 1999. Our credit reserve at September 30, 2000 was $6.0 million.
We would expect our credit provision expenses to increase if we acquire or
originate a significant volume of new mortgage loans or if our delinquencies and
actual credit losses increased.
Net Unrealized and Realized Market Value Gains and Losses
We recognize in our reported earnings the quarterly changes in the
estimated market value of some of our assets. For the most part, these are
unrealized gains and losses. Earnings from market value changes were $0.9
million in the third quarter of 2000 and negative $2.1 million in the third
quarter of 1999. For the first nine months of 2000, earnings from market value
changes were negative $1.7 million and for the first nine months of 1999,
earnings from market value changes were $1.5 million.
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<PAGE> 42
Operating Expenses
Total operating expenses recognized at Redwood were $2.1 million in the
third quarter of 2000, $2.2 million in the second quarter of 2000, and $1.0
million in the third quarter of 1999. Due to changes in amounts of expense
allocated and recognized between Redwood and Holdings, we believe a more useful
number for understanding trends in operating expenses is the total operating
expenses of Redwood and Holdings combined. Combined operating expenses were $2.6
million in the third quarter of 2000, $2.8 million in the second quarter of
2000, and $5.0 million in the third quarter of 1999.
<TABLE>
<CAPTION>
THIRD SECOND THIRD FIRST NINE FIRST NINE
QUARTER QUARTER QUARTER MONTHS MONTHS
2000 2000 1999 2000 1999
------- ------- ------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Redwood Operating Expenses.............. $(2,066) $(2,239) $ (964) $(6,450) $ (2,617)
Holdings Operating Expenses............. (531) (584) (4,005) (1,967) (11,397)
------- ------- ------- ------- --------
Combined Operating Expenses............. $(2,597) $(2,823) $(4,969) $(8,417) $(14,014)
On-going Operating Expenses............. $(2,597) $(2,838) $(2,727) $(8,244) $ (6,570)
Closed Business Units Operating
Expenses.............................. (0) 15 (2,242) (173) (7,444)
------- ------- ------- ------- --------
Combined Operating Expenses............. $(2,597) $(2,823) $(4,969) $(8,417) $(14,014)
</TABLE>
Some of these expenses were associated with business units that have been
closed. Combined operating expenses for on-going operations were $2.6 million in
the third quarter of 2000, $2.8 million in the second quarter of 2000, and $2.7
million in the third quarter of 1999. Expenses are slightly lower in the third
quarter of 2000 as we have fewer employees. These savings were partially offset
by increased dividend equivalent rights payments to employees as a result of our
increasing dividend. Due to the increase in dividend rates and an increase in
the bonuses accrued (which are performance-based), our operating expenses from
on-going operations increased to $8.2 million in the first nine months of 2000
from the $6.6 million of expenses in the first nine months of 1999.
Equity in Earnings (Losses) of RWT Holdings, Inc.
In the third quarter of 2000, our share of the losses generated by Holdings
was $0.3 million. This accounting loss at Holdings' subsidiary RCF is not
representative of the profitability of our overall commercial operations because
it does not include related income recorded at Redwood.
In the second quarter of 2000, our share of the losses generated by
Holdings was $0.5 million. In the third quarter of 1999, we recognized losses
from Holdings of $6.4 million, which included losses and restructuring charges
from the operations of two subsidiaries that were shut down.
In the first nine months of 2000, our share of the losses generated by
Holdings was $1.4 million. In the first nine months of 1999, our share of losses
from Holdings was $12.6 million.
We refer you to Holdings' "Consolidated Financial Statements and Notes" and
Holdings' "Management's Discussion and Analysis" below for more information on
Holdings.
Net Income
For the quarter ended September 30, 2000, net income from all of our
operations was $5.6 million. After preferred dividends of $0.7 million, net
income available to common shareholders was $4.9 million. For the quarter ended
June 30, 2000, net income from all of our operations was $3.8 million. After
preferred dividends of $0.7 million, net income available to common stockholders
was $3.1 million. For the quarter ended September 30, 1999, net income from all
of our operations was negative $3.0 million. After preferred dividends of $0.7
million, net income available to common stockholders was negative $3.7 million.
For the first nine months of 2000, net income from all of our operations
was $13.2 million. After preferred dividends of $2.0 million, net income
available to common stockholders was $11.2 million. For the first nine months of
1999, net income from all our operations was $6.7 million. After preferred
dividends of $2.1 million, net income available to common shareholders was $4.6
million.
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<PAGE> 43
Earnings per Share
Average diluted common shares outstanding were 8.9 million for the quarter
ended September 30, 2000, 8.9 million for the quarter ended June 30, 2000, and
9.6 million for the third quarter of 1999. Shares outstanding declined as a
result of our common stock repurchase program. We repurchased 2.5 million shares
during 1999. We did not acquire any of our own shares in the first nine months
of 2000.
Reported earnings per share were $0.55 for the third quarter of 2000, $0.35
for second quarter of 2000, and negative $0.39 for third quarter of 1999.
Reported earnings per share for the first nine months of 2000 were $1.27,
as compared to reported earnings per share of $0.45 per share for the first nine
months of 1999. Average diluted common shares outstanding were 8.9 million in
the first nine months of 2000 as compared to 10.2 million in the first nine
months of 1999.
Core earnings equal reported earnings less the earnings effect of the
market value changes of our assets less the effect of closed business units'
operations. Core earnings per share were $0.45 in the third quarter of 2000,
$0.51 in the second quarter of 2000, and $1.46 for the first nine months of
2000.
Core earnings per share were $0.34 in the third quarter of 1999 and $1.22
for the first nine months of 1999.
Dividends
We declared common stock dividends of $0.42 per share for the quarter ended
September 30, 2000 and $0.40 per share for the quarter ended March 31, 2000. For
the first nine months of 2000, common dividends declared totaled $1.17 per
share. Common dividends of $0.15 per share were declared in the third quarter of
1999, and this represented the first dividend declared in 1999.
We continue to pay a quarterly dividend on our preferred stock of $0.755
per share.
RISK MANAGEMENT
We seek to manage the interest rate, market value, liquidity, prepayment,
and credit risks inherent in all financial institutions in a prudent manner
designed to insure our longevity. At the same time, we endeavor to provide our
shareholders an opportunity to realize an attractive total rate of return
through stock ownership in our company. We seek, to the best of our ability, to
only assume risk that can be quantified from historical experience, to actively
manage such risk, to earn sufficient compensation to justify the taking of such
risks, and to maintain capital levels consistent with the risks we do undertake.
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 reported earnings.
At September 30, 2000, we owned mortgage securities and loans totaling $1.0
billion that we account for on a mark-to-market basis (in the case of mortgage
loans, on a lower-of-cost-or-market basis) for purposes of determining reported
earnings. Of these assets, 98% had adjustable-rate coupons and 2% had fixed-rate
coupons.
Our interest rate agreements hedging program may offset some asset market
value fluctuations due to interest rate changes, or, in some cases, may
exacerbate such fluctuations. All of our $2.3 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.
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<PAGE> 44
Interest Rate Risk
At September 30, 2000, we owned $2.2 billion of assets and had $2.0 billion
of liabilities. The majority of the assets were adjustable-rate, as were a
majority of the liabilities.
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 addition, 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 may be mitigated to some extent by our interest rate
agreements hedging program and by any concurrent slowing of mortgage prepayment
rates that may occur.
Hybrid mortgage assets (with fixed-rate coupons for 3 to 7 years and
adjustable-rate coupons thereafter) totaled $0.3 billion. We had debt with
interest rate reset characteristics matched to the hybrid mortgages totaling
$0.3 billion.
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, 2000, we owned $0.6 billion of adjustable-rate mortgage
assets with interest rates that adjust every six months as a function of
six-month LIBOR interest rates funded with equity and with debt that had an
interest rate that adjusts monthly as a function of one-month LIBOR interest
rates.
At September 30, 2000, we owned $0.5 billion of adjustable-rate mortgage
assets that adjust monthly as a function of one-month LIBOR interest rates,
funded with equity and with debt that also adjusts monthly as a function of
one-month LIBOR interest rates.
Adjustable-rate assets with earnings rates dependent on one-year U.S.
Treasury rates with annual adjustments totaled $0.7 billion at September 30,
2000. These Treasury-based assets were effectively funded with equity and with
$0.3 billion of liabilities with a cost of funds dependent on one-year U.S.
Treasury rates with annual adjustments. The remainder of associated liabilities
had a cost of funds dependent on one-month LIBOR rates or the daily Fed Funds
rate. To the extent our Treasury-based assets are not funded with Treasury-based
liabilities, we incur basis risk. Such risk arises because changes in Treasury
rates may differ significantly from changes in the Fed Funds or LIBOR interest
rates.
Interest rates and related factors can affect our spread income and our
mark to market results. Changes in interest rates also 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, 2000, we had $65 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 8% of our short-term debt balances.
At September 30, 2000, we had four committed lines of short-term financing,
two for residential and two for commercial mortgage loans, with an additional
residential line to become committed in October 2000.
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<PAGE> 45
There are certain restrictions regarding the collateral for which these lines
can be used, but they generally allow us to fund either our commercial mortgage
originations or our lower-rated residential mortgage-backed securities. There is
no assurance that we will be able to renew such lines upon expiration. We
believe we have many alternative uncommitted financing sources available to us
for our residential loan acquisitions. We continue to pursue additional sources
of financing in order to enhance the liquidity of our portfolio.
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,
2000, mortgage premium balances were $25.8 million and mortgage discount
balances were $37.7 million. Net mortgage discount was $11.9 million. Since the
prepayment characteristics of our premium and discount mortgage assets may vary,
gross premium levels, net premium levels, and other factors may influence our
earnings.
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 $3.4 million at
September 30, 2000. 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 $3.2 million at September 30, 2000. The combined effect
of these two items was to increase our effective mortgage-related premium by
$0.2 million.
Our net discount at September 30, 2000 for assets and liabilities affected
by the rate of mortgage principal receipts was $11.7 million. This net discount
equaled 6.4% of common equity. Amortization expense and income will vary as
prepayment rates on mortgage assets vary. In addition, changes in prepayment
rates will affect the market value of our assets and our earnings.
Credit Risk
Our principal credit risk comes from residential mortgage loans owned by
Sequoia, residential and commercial mortgage loans held in portfolio, commercial
mortgage loans held prior to sale, and our lower-rated mortgage securities. We
also have credit risk with counter-parties with whom we do business.
Not including mortgage loans owned by Sequoia, we owned $7.3 million in
residential mortgage loans at September 30, 2000. Of these, $0.3 million were
seriously delinquent (delinquent over 90 days, in foreclosure, in bankruptcy, or
real estate owned). We also owned $32.3 million in commercial mortgage loans.
These commercial mortgage loans were all current at September 30, 2000.
The four Sequoia trusts owned $1.2 billion in residential mortgage loans at
September 30, 2000. Our total credit risk from these trusts is limited to our
equity investment in these trusts. These equity investments had a reported value
of $38 million, net of related credit reserves, at September 30, 2000. At that
time, $4.1 million of the underlying loans, or 0.34%, were seriously delinquent.
At September 30, 2000, we had $5.6 million of credit reserves to provide
for potential future credit losses from our mortgage loans held for investment
by the Sequoia trusts. The reserve is based upon our assessment of various
factors affecting our mortgage loans, including current and projected economic
conditions, delinquency status, and credit protection. To date, our realized
credit losses from defaulted residential mortgage loans have averaged 9% of the
loan balance of the defaulted loans. Delinquencies, defaults, and loss
severities may increase in the future, however, particularly if real estate
values decline or the general U.S. economy weakens. We believe our current level
of reserve and credit provision policy is reasonable.
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At September 30, 2000, we also held $0.4 million credit reserves against
our SMFC re-REMIC securities. Our total potential credit exposure from these
securities (after this credit reserve) is our net cost basis of $6.1 million.
We have purchased, and intend to continue purchasing, mortgage-backed
securities that have risk of credit loss. In acquiring such assets, we project
cash flows and resulting yields in a variety of potential loss scenarios as well
as other factors (e.g., interest rates, prepayment speeds.) We calculate and
book as income an effective yield on such assets after factoring in anticipated
losses. Once acquired, we continually monitor and review credit performance and
may revise our projected losses on each asset. Should projected credit losses
change, the effective yield earned over the remaining life of these assets will
change accordingly.
It should be noted that the establishment of a credit reserve for GAAP
purposes does not reduce our taxable income or our dividend payment obligations
as a REIT. For taxable income, credit expenses are recognized as incurred, and
may have the effect of reducing taxable income and our minimum dividend payment
obligation at that point.
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 residential
mortgage securities rated below AA and commercial mortgage whole loans are
generally higher than for higher-rated residential securities and residential
whole loans. Capital requirements for these less-liquid assets depend chiefly on
our access to secure funding for these assets, the number of sources of such
funding, the funding terms, and on the amount of extra capital we decide to hold
on hand to protect against possible liquidity events with these assets. Capital
requirements for equity interests in Sequoia 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.
Generally, our 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 guideline ratio has increased as we have acquired new
types of assets requiring more capital, such as commercial mortgage loans and
lower-rated mortgage securities.
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 may 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 real estate finance operation, however, is
generally required to distribute at least 95% of taxable income as dividends due
to its REIT status.
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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 GAAP and our
dividends must equal at least 95% of our 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.
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RWT HOLDINGS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
RWT Holdings, Inc. ("Holdings") was incorporated in Delaware in February
1998 and commenced operations on April 1, 1998. Holdings' start-up operations
have been funded by Redwood Trust, which has a significant investment in
Holdings through the ownership of all of Holdings' non-voting preferred stock,
and by Redwood Trust's senior management, who own Holding's voting common 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 (including Redwood Trust) through its Redwood Commercial Funding, Inc.
("RCF") subsidiary. Holdings had two other operating businesses, Redwood
Financial Services, Inc. ("RFS") and Redwood Residential Funding ("RRF"). Due to
a variety of start-up difficulties with these units, operations were closed at
RFS in the third quarter of 1999 and at RRF in the fourth quarter of 1999.
For reporting purposes, some of RCF's commercial operations take place at
Redwood Trust. Therefore, the reported earnings of Holdings' subsidiary RCF are
not representative of the profitability of our overall commercial operations
because it does not include related income recorded at Redwood Trust.
With a change in REIT tax rules, Redwood Trust intends to seek to acquire
the common stock of Holdings, representing a 1% economic interest, in January
2001. If accomplished, the preferred stock would be converted to common stock
and Redwood Trust would own 100% of Holdings. This would allow us to consolidate
our financial statements for GAAP. The two companies would continue to be
operated separately for tax purposes.
FINANCIAL CONDITION
At September 30, 2000, Holdings owned $32.3 million of commercial mortgage
loans. Holdings also had $1.4 million in unrestricted cash, $1.4 million in
restricted cash, $0.3 million of accrued interest receivable, and $0.3 million
in other assets, for total assets of $35.8 million. Holdings had commitments to
acquire $22.7 million of commercial mortgage loans from Redwood Trust for
settlement during the fourth quarter of 2000. Holdings intends to sell all $55.0
million of commercial loans within six months. Some of these loans may be sold
to Redwood Trust for its portfolio.
The loans owned by Holdings were funded with short-term borrowings and
equity. Short-term debt was $30.9 million, accrued restructuring charges were
$0.9 million, holdback accounts totaled $1.3 million, and other liabilities
totaled $0.7 million, for total liabilities of $33.7 million. Redwood Trust
expects to continue to provide liquidity to Holdings, when necessary, during the
year 2000. Holdings' total equity at September 30, 2000 was $2.0 million.
At December 31, 1999, Holdings owned $4.4 million of residential mortgage
loans, $29.6 million of commercial mortgage loans, $2.0 million in cash, and
$1.3 million in other assets, for total assets of $39.0 million. Short-term debt
totaled $22.4 million, loans from Redwood Trust totaled $6.5 million,
receivables due Redwood Trust were $0.5 million, accrued restructuring charges
totaled $4.0 million, other liabilities were $2.1 million, and total equity
totaled $3.4 million.
RESULTS OF OPERATIONS
For the quarter ended September 30, 2000, Holdings' operations consisted
almost entirely of RCF. Net interest income for Holdings was $0.3 million,
including interest income of $1.1 million and interest expense of $0.8 million.
Holdings had net gains on sales of $0.1 million during the third quarter of
2000, resulting in net
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revenues of $0.2 million. Operating expenses at Holdings totaled $0.5 million
for the three months ended September 30, 2000. Holdings' net loss for the
quarter ended September 30, 2000 was $0.3 million.
In the third quarter of 2000, RCF originated $16.8 million of commercial
mortgage loans and sold $13.1 million, of which $10.1 million was sold to
Redwood's portfolio. At September 30, 2000, commercial mortgage loans originated
or acquired by RCF that had not yet been sold totaled $55.0 million, of which
$22.7 million were held by Redwood Trust and $32.3 million were held at
Holdings. These loans are all held for future sale. RCF expects to recognize
sale revenues upon the sale of the commercial loan portfolio.
For the quarter ended June 30, 2000, Holdings' net interest income for
Holdings was $0.2 million, including interest income of $0.7 million and
interest expenses of $0.5 million. Holdings also had net losses as a result of
mortgage asset sales and market value adjustments of $0.1 million during the
second quarter of 2000, resulting in net revenues of $0.1 million. Operating
expenses at Holdings totaled $0.6 million for this quarter. Holdings' net loss
for the quarter ended June 30, 2000 was $0.5 million.
For the quarter ended September 30, 1999, net interest income for Holdings
was $0.4 million, including interest income of $1.2 million and interest expense
of $0.9 million. Holdings also had net losses as a result of commercial and
residential mortgage loan sales and market value adjustments of $0.5 million
during the third quarter of 1999, resulting in net revenues of negative $0.1
million. Operating expenses at Holdings totaled $4.0 million for the third
quarter of 1999 and there was a $2.2 million restructuring charge. Holdings' net
loss for the quarter ended September 30, 1999 was $6.4 million.
In the first nine months of 2000, Holdings generated net income of $0.5
million on $2.3 million of interest income and $1.8 million of interest
expenses. Holdings also had net gains as a result of mortgage asset sales and
market value adjustments of $0.1 million during the first nine months of 2000,
resulting in net revenues of $0.6 million. Operating expenses totaled $2.0
million, resulting in net losses of $1.4 million being recorded at Holdings
during the first nine months of 2000.
In the first nine months of 1999, Holdings generated net income of $0.9
million on $2.7 million of interest income and $1.8 million of interest
expenses. Holdings also had net gains as a result of mortgage asset sales and
market value adjustments of $0.1 million during the first nine months of 1999,
resulting in net revenues of $1.0 million. Operating expenses totaled $11.5 and
there was a $2.2 million restructuring charge, resulting in net losses of $12.7
million being recorded at Holdings during the first nine months of 1999.
Holdings' losses in the 1999 were mostly associated with operations that
were subsequently shut-down in the third and fourth quarter of 1999.
At December 31, 1999, Holdings had net operating loss carryforwards of
approximately $19.5 million for federal tax purposes and $9 million for state
income tax purposes. The federal carryforwards expire through 2019 and the state
carryforwards expire through 2004. We have established a reserve related to the
net operating loss carryforwards, as we do not believe this asset is realizable.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
At September 30, 2000, there were no pending legal proceedings to which the
Company was a party or of which any of its property was subject.
ITEM 2. CHANGES IN SECURITIES
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, 2000 and September 30, 1999.
Exhibit 27 -- Financial Data Schedule
(b) Reports
None
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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, 2000 By: /s/ DOUGLAS B. HANSEN
------------------------------------
Douglas B. Hansen
President
(authorized officer of registrant)
Dated: November 10, 2000 By: /s/ HAROLD F. ZAGUNIS
------------------------------------
Harold F. Zagunis
Vice President, Chief Financial
Officer
Secretary, Treasurer and Controller
(principal financial and accounting
officer)
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REDWOOD TRUST, INC.
INDEX TO EXHIBIT
<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Page
--------- ------------
<S> <C> <C>
11.1 Computations of Earnings per Share for the three and nine
months ended September 30, 2000 and September 30, 1999 ............ 50
27 Financial Data Schedule ........................................... 52
</TABLE>
