UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Form 10-Q
þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the quarterly period ended: September 30, 2002 | ||
or | ||
o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period from to |
Commission file number: 1-13759
Redwood Trust, Inc.
Maryland
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68-0329422 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
|
591 Redwood Highway, Suite 3100 Mill Valley, California |
94941 | |
(Address of principal executive offices) | (Zip Code) |
(415) 389-7373
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 þ No o
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuers classes of stock, as of the last practicable date.
Class B Preferred Stock ($.01 par value)
|
902,068 as of November 14, 2002 | |
Common Stock ($.01 par value)
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16,082,840 as of November 14, 2002 |
REDWOOD TRUST, INC.
FORM 10-Q
INDEX
Page | ||||||
PART I. FINANCIAL INFORMATION | ||||||
Item 1.
|
Consolidated Financial Statements Redwood Trust, Inc | |||||
Consolidated Balance Sheets at September 30, 2002 and December 31, 2001 | 2 | |||||
Consolidated Statements of Operations for the three and nine months ended September 30, 2002 and 2001 | 3 | |||||
Consolidated Statements of Stockholders Equity for the three and nine months ended September 30, 2002 | 4 | |||||
Consolidated Statements of Cash Flows for the three and nine months ended September 30, 2002 and 2001 | 5 | |||||
Notes to Consolidated Financial Statements | 6 | |||||
Item 2.
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Managements Discussion and Analysis of Financial Condition and Results of Operations | 25 | ||||
Item 3.
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Quantitative and Qualitative Disclosures About Market Risk | 56 | ||||
Item 4.
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Controls and Procedures | 57 | ||||
PART II. OTHER INFORMATION | ||||||
Item 1.
|
Legal Proceedings | 57 | ||||
Item 2.
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Changes in Securities | 57 | ||||
Item 3.
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Defaults Upon Senior Securities | 57 | ||||
Item 4.
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Submission of Matters to a Vote of Security Holders | 57 | ||||
Item 5.
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Other Information | 57 | ||||
Item 6.
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Exhibits and Reports on Form 8-K | 57 | ||||
SIGNATURES | 58 | |||||
CERTIFICATIONS | 59 |
1
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements
REDWOOD TRUST, INC. AND SUBSIDIARIES
September 30, | December 31, | ||||||||
2002 | 2001 | ||||||||
(Unaudited) | |||||||||
(In thousands, except | |||||||||
share data) | |||||||||
ASSETS | |||||||||
Residential mortgage loans
|
$ | 4,761,893 | $ | 1,474,862 | |||||
Residential credit-enhancement securities
|
324,130 | 190,813 | |||||||
Commercial mortgage loans
|
50,664 | 51,084 | |||||||
Securities portfolio
|
491,756 | 683,482 | |||||||
Cash and cash equivalents
|
20,606 | 9,030 | |||||||
Total Earning Assets
|
5,649,049 | 2,409,271 | |||||||
Restricted cash
|
326 | 3,399 | |||||||
Accrued interest receivable
|
17,109 | 13,729 | |||||||
Principal receivable
|
3,644 | 7,823 | |||||||
Other assets
|
4,174 | 1,422 | |||||||
Total Assets
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$ | 5,674,302 | $ | 2,435,644 | |||||
LIABILITIES AND STOCKHOLDERS EQUITY | |||||||||
LIABILITIES
|
|||||||||
Short-term debt
|
$ | 834,081 | $ | 796,811 | |||||
Long-term debt, net
|
4,365,281 | 1,313,715 | |||||||
Accrued interest payable
|
4,515 | 2,569 | |||||||
Accrued expenses and other liabilities
|
12,022 | 6,498 | |||||||
Dividends payable
|
12,675 | 8,278 | |||||||
Total Liabilities
|
5,228,574 | 2,127,871 | |||||||
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; 15,886,421 and 12,661,749 issued
and outstanding
|
159 | 127 | |||||||
Additional paid-in capital
|
408,675 | 328,668 | |||||||
Accumulated other comprehensive income
|
54,148 | 2,701 | |||||||
Cumulative earnings
|
101,331 | 59,961 | |||||||
Cumulative distributions to stockholders
|
(145,102 | ) | (110,201 | ) | |||||
Total Stockholders Equity
|
445,728 | 307,773 | |||||||
Total Liabilities and Stockholders
Equity
|
$ | 5,674,302 | $ | 2,435,644 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
2
REDWOOD TRUST, INC. AND SUBSIDIARIES
Three Months Ended | Nine Months Ended | ||||||||||||||||
September 30, | September 30, | ||||||||||||||||
2002 | 2001 | 2002 | 2001 | ||||||||||||||
(Unaudited) | |||||||||||||||||
(In thousands, except share data) | |||||||||||||||||
Interest Income
|
|||||||||||||||||
Residential mortgage loans
|
$ | 24,447 | $ | 15,252 | $ | 58,173 | $ | 51,217 | |||||||||
Residential credit-enhancement securities
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10,443 | 5,246 | 26,144 | 11,291 | |||||||||||||
Commercial mortgage loans
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1,280 | 1,695 | 3,787 | 5,589 | |||||||||||||
Securities portfolio
|
5,719 | 10,744 | 20,455 | 44,354 | |||||||||||||
Cash and cash equivalents
|
204 | 235 | 502 | 811 | |||||||||||||
Total interest income
|
42,093 | 33,172 | 109,061 | 113,262 | |||||||||||||
Interest Expense
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|||||||||||||||||
Short-term debt
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(5,398 | ) | (8,841 | ) | (15,934 | ) | (34,259 | ) | |||||||||
Long-term debt
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(18,893 | ) | (12,714 | ) | (42,448 | ) | (45,719 | ) | |||||||||
Total interest expense
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(24,291 | ) | (21,555 | ) | (58,382 | ) | (79,978 | ) | |||||||||
Net Interest Income
|
17,802 | 11,617 | 50,679 | 33,284 | |||||||||||||
Operating expenses
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(4,290 | ) | (2,748 | ) | (12,372 | ) | (9,106 | ) | |||||||||
Other income (expense)
|
745 | (227 | ) | (587 | ) | (891 | ) | ||||||||||
Net unrealized and realized market value gains
(losses)
|
730 | 104 | 3,650 | 2,332 | |||||||||||||
Net income before preferred dividend and change
in accounting principle
|
14,987 | 8,746 | 41,370 | 25,619 | |||||||||||||
Cumulative effect of adopting EITF 99-20 (See
Note 2)
|
| | | (2,368 | ) | ||||||||||||
Net income before preferred dividend
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14,987 | 8,746 | 41,370 | 23,251 | |||||||||||||
Dividends on Class B preferred stock
|
(681 | ) | (681 | ) | (2,043 | ) | (2,043 | ) | |||||||||
Net Income Available to Common
Stockholders
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$ | 14,306 | $ | 8,065 | $ | 39,327 | $ | 21,208 | |||||||||
Other comprehensive income:
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|||||||||||||||||
Net unrealized income on assets available for sale
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18,322 | 5,303 | 51,447 | 5,715 | |||||||||||||
Comprehensive Income
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$ | 32,628 | $ | 13,368 | $ | 90,774 | $ | 26,923 | |||||||||
Earnings per Share:
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|||||||||||||||||
Basic Earnings Per Share:
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|||||||||||||||||
Net income before change in accounting principle
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$ | 0.91 | $ | 0.78 | $ | 2.64 | $ | 2.51 | |||||||||
Cumulative effect of adopting EITF 99-20
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$ | | $ | | $ | | $ | (0.25 | ) | ||||||||
Net income
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$ | 0.91 | $ | 0.78 | $ | 2.64 | $ | 2.26 | |||||||||
Diluted Earnings Per Share:
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|||||||||||||||||
Net income before change in accounting principle
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$ | 0.88 | $ | 0.75 | $ | 2.56 | $ | 2.44 | |||||||||
Cumulative effect of adopting EITF 99-20
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$ | | $ | | $ | | $ | (0.25 | ) | ||||||||
Net income
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$ | 0.88 | $ | 0.75 | $ | 2.56 | $ | 2.19 | |||||||||
Weighted average shares of common stock and
common stock equivalents:
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|||||||||||||||||
Basic
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15,730,182 | 10,392,820 | 14,879,883 | 9,379,286 | |||||||||||||
Diluted
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16,240,194 | 10,752,062 | 15,365,352 | 9,666,136 | |||||||||||||
Common Dividends Per Share:
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|||||||||||||||||
Common Dividends Declared Per Share (Regular)
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$ | 0.630 | $ | 0.570 | $ | 1.880 | $ | 1.620 | |||||||||
Common Dividends Declared Per Share (Special)
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$ | 0.125 | $ | 0.180 | $ | 0.250 | $ | 0.180 | |||||||||
Total Common Dividends Declared Per Share
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$ | 0.755 | $ | 0.750 | $ | 2.130 | $ | 1.800 |
The accompanying notes are an integral part of these consolidated financial statements.
3
REDWOOD TRUST, INC. AND SUBSIDIARIES
Class B | Accumulated | ||||||||||||||||||||||||||||||||||||
Preferred Stock | Common Stock | Additional | Other | Cumulative | |||||||||||||||||||||||||||||||||
Paid-in | Comprehensive | Cumulative | Distributions to | ||||||||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | Capital | Income | Earnings | Stockholders | Total | |||||||||||||||||||||||||||||
(Unaudited) | |||||||||||||||||||||||||||||||||||||
(In thousands, except share data) | |||||||||||||||||||||||||||||||||||||
Balance, December 31, 2001
|
902,068 | $ | 26,517 | 12,661,749 | $ | 127 | $ | 328,668 | $ | 2,701 | $ | 59,961 | $ | (110,201 | ) | $ | 307,773 | ||||||||||||||||||||
Comprehensive income:
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|||||||||||||||||||||||||||||||||||||
Net income before preferred dividend
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| | | | | | 11,900 | | 11,900 | ||||||||||||||||||||||||||||
Net unrealized income on assets available-for-sale
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| | | | | 8,314 | | | 8,314 | ||||||||||||||||||||||||||||
Total comprehensive income
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| | | | | | | | 20,214 | ||||||||||||||||||||||||||||
Issuance of common stock
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| | 1,962,898 | 19 | 46,186 | | | | 46,205 | ||||||||||||||||||||||||||||
Dividends declared:
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|||||||||||||||||||||||||||||||||||||
Preferred
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| | | | | | | (681 | ) | (681 | ) | ||||||||||||||||||||||||||
Common
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| | | | | | | (9,067 | ) | (9,067 | ) | ||||||||||||||||||||||||||
Balance, March 31, 2002
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902,068 | $ | 26,517 | 14,624,647 | $ | 146 | $ | 374,854 | $ | 11,015 | $ | 71,861 | $ | (119,949 | ) | $ | 364,444 | ||||||||||||||||||||
Comprehensive income:
|
|||||||||||||||||||||||||||||||||||||
Net income before preferred dividend
|
| | | | | | 14,483 | | 14,483 | ||||||||||||||||||||||||||||
Net unrealized income on assets available-for-sale
|
| | | | | 24,811 | | | 24,811 | ||||||||||||||||||||||||||||
Total comprehensive income
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| | | | | | | | 39,294 | ||||||||||||||||||||||||||||
Issuance of common stock
|
| | 999,365 | 10 | 26,659 | | | | 26,669 | ||||||||||||||||||||||||||||
Dividends declared:
|
|||||||||||||||||||||||||||||||||||||
Preferred
|
| | | | | | | (681 | ) | (681 | ) | ||||||||||||||||||||||||||
Common
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| | | | | | | (11,796 | ) | (11,796 | ) | ||||||||||||||||||||||||||
Balance, June 30, 2002
|
902,068 | $ | 26,517 | 15,624,012 | $ | 156 | $ | 401,513 | $ | 35,826 | $ | 86,344 | $ | (132,426 | ) | $ | 417,930 | ||||||||||||||||||||
Comprehensive income:
|
|||||||||||||||||||||||||||||||||||||
Net income before preferred dividend
|
| | | | | | 14,987 | | 14,987 | ||||||||||||||||||||||||||||
Net unrealized income on assets available-for-sale
|
| | | | | 18,322 | | | 18,322 | ||||||||||||||||||||||||||||
Total comprehensive income
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| | | | | | | | 33,309 | ||||||||||||||||||||||||||||
Issuance of common stock
|
| | 262,409 | 3 | 7,162 | | | | 7,165 | ||||||||||||||||||||||||||||
Dividends declared:
|
|||||||||||||||||||||||||||||||||||||
Preferred
|
| | | | | | | (681 | ) | (681 | ) | ||||||||||||||||||||||||||
Common
|
| | | | | | | (11,995 | ) | (11,995 | ) | ||||||||||||||||||||||||||
Balance, September 30, 2002
|
902,068 | $ | 26,517 | 15,886,421 | $ | 159 | $ | 408,675 | $ | 54,148 | $ | 101,331 | $ | (145,102 | ) | $ | 445,728 | ||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
4
REDWOOD TRUST, INC. AND SUBSIDIARIES
Three Months Ended | Nine Months Ended | ||||||||||||||||||
September 30, | September 30, | ||||||||||||||||||
2002 | 2001 | 2002 | 2001 | ||||||||||||||||
(Unaudited) | |||||||||||||||||||
(In thousands) | |||||||||||||||||||
Cash Flows From Operating
Activities:
|
|||||||||||||||||||
Net income available to common stockholders
before preferred dividend
|
$ | 14,987 | $ | 8,746 | $ | 41,370 | $ | 23,251 | |||||||||||
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
|
|||||||||||||||||||
Depreciation and amortization
|
2,276 | 2,264 | 6,728 | 5,874 | |||||||||||||||
Provision for credit losses
|
894 | 151 | 1,648 | 499 | |||||||||||||||
Non-cash stock compensation
|
30 | 75 | 133 | 326 | |||||||||||||||
Net unrealized and realized market value gains
|
(730 | ) | (104 | ) | (3,649 | ) | (2,332 | ) | |||||||||||
Cumulative effect of adopting EITF 99-20
|
| | | 2,368 | |||||||||||||||
Net purchases (sales) of mortgage loans
held-for-sale
|
2,960 | (390,600 | ) | (1,558,104 | ) | (464,690 | ) | ||||||||||||
Principal payments on mortgage loans held-for-sale
|
1,235 | 5,062 | 14,821 | 7,251 | |||||||||||||||
Net sales (purchases) of mortgage securities
trading
|
| 101,079 | 19,355 | (25,112 | ) | ||||||||||||||
Principal payments on mortgage securities trading
|
20,860 | 71,280 | 127,082 | 250,047 | |||||||||||||||
Net (purchases) sales of interest rate
agreements
|
(1,901 | ) | 109 | (2,024 | ) | (664 | ) | ||||||||||||
Net change in:
|
|||||||||||||||||||
Accrued interest receivable
|
435 | (1,143 | ) | (3,380 | ) | 1,708 | |||||||||||||
Principal receivable
|
2,653 | (354 | ) | 4,179 | (1,725 | ) | |||||||||||||
Other assets
|
(2,231 | ) | (116 | ) | (3,339 | ) | 192 | ||||||||||||
Accrued interest payable
|
1,591 | 950 | 1,946 | (115 | ) | ||||||||||||||
Accrued expenses and other liabilities
|
628 | 578 | 2,820 | 3,099 | |||||||||||||||
Net cash provided by (used in) operating
activities
|
43,687 | (202,023 | ) | (1,350,414 | ) | (200,023 | ) | ||||||||||||
Cash Flows From Investing
Activities:
|
|||||||||||||||||||
Purchases of mortgage loans held-for-investment
|
(2,076,216 | ) | | (2,077,787 | ) | (100 | ) | ||||||||||||
Proceeds from sales of mortgage loans
held-for-investment
|
| 1,935 | 44,811 | 4,313 | |||||||||||||||
Principal payments on mortgage loans
held-for-investment
|
108,480 | 90,843 | 282,327 | 238,239 | |||||||||||||||
Purchases of mortgage securities
available-for-sale
|
(35,795 | ) | (74,496 | ) | (176,723 | ) | (185,556 | ) | |||||||||||
Proceeds from sales of mortgage securities
available-for-sale
|
| 5,219 | 88,971 | 10,025 | |||||||||||||||
Principal payments on mortgage securities
available-for-sale
|
20,408 | 2,305 | 59,913 | 5,405 | |||||||||||||||
Net change in restricted cash
|
(213 | ) | 451 | 3,073 | 628 | ||||||||||||||
Net cash (used in) provided by investing
activities
|
(1,983,336 | ) | 26,257 | (1,775,415 | ) | 72,954 | |||||||||||||
Cash Flows From Financing
Activities:
|
|||||||||||||||||||
Net (repayments) borrowings on short-term
debt
|
(170,922 | ) | 228,381 | 37,270 | 315,185 | ||||||||||||||
Proceeds from issuance of long-term debt
|
2,231,833 | | 3,381,754 | 17,033 | |||||||||||||||
Repayments on long-term debt
|
(108,469 | ) | (88,081 | ) | (330,976 | ) | (229,937 | ) | |||||||||||
Net proceeds from issuance of common stock
|
7,135 | 50,586 | 79,860 | 52,120 | |||||||||||||||
Dividends paid
|
(12,477 | ) | (7,396 | ) | (30,503 | ) | (17,082 | ) | |||||||||||
Net cash provided by financing activities
|
1,947,100 | 183,490 | 3,137,405 | 137,319 | |||||||||||||||
Net increase in cash and cash equivalents
|
7,451 | 7,724 | 11,576 | 10,250 | |||||||||||||||
Cash and cash equivalents at beginning of period
|
13,155 | 18,009 | 9,030 | 15,483 | |||||||||||||||
Cash and cash equivalents at end of period
|
$ | 20,606 | $ | 25,733 | $ | 20,606 | $ | 25,733 | |||||||||||
Supplemental disclosure of cash flow
information:
|
|||||||||||||||||||
Cash paid for interest
|
$ | 22,700 | $ | 20,605 | $ | 56,436 | $ | 79,744 | |||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
5
REDWOOD TRUST, INC. AND SUBSIDIARIES
Note 1. The Company
Redwood Trust, Inc. (Redwood Trust) together with its subsidiaries, is an investor in real estate loans. Redwood Trusts largest business is owning, financing, and credit enhancing high-quality jumbo residential mortgage loans nationwide. Redwood Trust also invests in diverse types of real estate loans through its real estate securities portfolio and its commercial loan portfolio. Redwood Trusts primary source of revenue is monthly loan payments made by homeowners and property owners on their mortgages, and its primary expense is the cost of borrowed funds. Redwood Trust is structured as a Real Estate Investment Trust (REIT) and therefore the majority of its taxable net earnings are distributed to shareholders as dividends.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation |
The accompanying consolidated financial statements as of September 30, 2002 and 2001 are unaudited. The unaudited interim consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for a fair statement of the Companys financial position, results of operations, and cash flows as of and for the period ended September 30, 2002 and 2001. These consolidated financial statements and notes thereto are unaudited and should be read in conjunction with the Companys audited consolidated financial statements included in the Companys Form 10-K for the year ended December 31, 2001. The results for the nine months ended September 30, 2002 are not necessarily indicative of the expected results for the year ended December 31, 2002.
The September 30, 2002 and December 31, 2001 consolidated financial statements include the accounts of Redwood Trust and its wholly-owned subsidiaries, Sequoia Mortgage Funding Corporation and RWT Holdings, Inc. (Holdings), and Holdings wholly-owned subsidiaries including Sequoia Residential Funding, Inc. For financial reporting purposes, references to Sequoia mean Sequoia Mortgage Funding Corporation and Sequoia Residential Funding, Inc. References to the Company mean Redwood Trust, Sequoia, and Holdings.
Substantially all of the assets of Sequoia, consisting primarily of residential whole loans shown as part of Residential Mortgage Loans, are subordinated to support long-term debt in the form of collateralized mortgage-backed securities (Long-Term Debt) and are not available for the satisfaction of general claims of the Company. The Companys exposure to loss on the assets which are 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.
On January 1, 2001, the Company acquired 100% of the voting common stock of Holdings for $300,000 in cash consideration from two officers of Holdings, and Holdings became a wholly-owned consolidated subsidiary of the Company. This transaction did not have a material effect on the consolidated financial statements of the Company.
All significant intercompany balances and transactions with Sequoia and Holdings have been eliminated in the consolidation of the Company at September 30, 2002. Certain amounts for prior periods have been reclassified to conform to the September 30, 2002 presentation.
Use of Estimates |
The preparation of financial statements in conformity with Generally Accepted Accounting Principles (GAAP) 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
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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. Managements estimates are inherently subjective in nature and involve matters of uncertainty and judgment to interpret relevant market and other data. Accordingly, amounts realized in actual sales may differ from the fair values presented in Notes 3, 5, and 9.
Reserve for Credit Losses. A reserve for credit losses is maintained at a level deemed appropriate by management to provide for known credit losses, as well as estimated losses in Redwoods earning assets. The reserve is based upon managements assessment of various factors affecting its assets, including economic conditions, delinquency status, and credit protection. These estimates are reviewed periodically and adjusted as deemed necessary. The credit reserve on mortgage loans is increased by provisions, which are charged to income from operations. Summary information regarding the Reserve for Credit Losses on mortgage loans is presented in Note 4. The credit reserve on certain securities is established at acquisition and adjustments are made as further discussed below under EITF 99-20 and in Note 3. The Companys actual credit losses may differ from those estimates used to establish the reserve.
Individual mortgage loans are considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. When a loan is impaired, impairment is measured based upon the present value of the expected future cash flows discounted at the loans effective interest rate, the loans observable market price, or the fair value of the underlying collateral. At September 30, 2002 and December 31, 2001, the Company had no impaired mortgage loans.
EITF 99-20. The Emerging Issues Task Force (EITF) issued EITF 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets, which established new income and impairment recognition standards for interests in certain securitized assets. Under the provisions of EITF 99-20, the holder of a beneficial interest should recognize the excess of all estimated cash flows attributable to the beneficial interest estimated at the acquisition date over the initial investment (the accretable yield) as interest income over the life of the beneficial interest using the effective yield method. If the estimated cash flows change, then the holder of the beneficial interest should recalculate the accretable yield and adjust the periodic accretion recognized as income prospectively. If the fair value of a beneficial interest has declined below its carrying amount, an other-than-temporary decline may be considered to exist if there has been a decline in estimated future cash flows. The difference between the carrying value and fair value of the beneficial interest is recorded as a mark-to-market loss through the income statement. These adjustments under the provisions of EITF 99-20 are recognized as mark-to-market adjustments under Net Unrealized and Realized Market Value Gains (Losses) on the Consolidated Statement of Operations.
The provisions of EITF 99-20 became effective January 1, 2001. At that date, the Company held certain beneficial interests where the current projections of cash flows were less than the cash flows anticipated at acquisition and the fair value had declined below the carrying value. Accordingly, the Company recorded a $2.4 million charge through the Statement of Operations at that time as a cumulative effect of a change in accounting principle. The mark-to-market adjustments on these beneficial interests had previously been recorded as unrealized losses through Accumulated Other Comprehensive Income as a component of Stockholders Equity. Since this was a reclassification of declines in market values that had already been recognized in the Companys balance sheet and stockholders equity accounts, there was no change in net carrying value of these interests upon adoption of EITF 99-20.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Risks and Uncertainties |
The Company takes certain risks inherent in financial institutions, including, but not limited to, credit risk, liquidity risk, interest rate risk, prepayment risk, market value risk, and capital risk. In addition, there are several risks and uncertainties specific to Redwood Trust. The Company seeks to actively manage such risks while also providing stockholders an appropriate rate of return for risks taken. There can be no assurances that such risks and uncertainties are adequately provided for in the Companys financial statements. Management has prepared these financial statements in accordance with GAAP and in an effort to properly present the risks taken.
Earning Assets |
The Companys earning assets consist primarily of residential and commercial real estate mortgage loans and securities (Earning Assets). Mortgage loans and securities pledged as collateral under borrowing arrangements in which the secured party has the right by contract or custom to sell or repledge the collateral have been classified as pledged as discussed in Note 3. Coupon 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. Purchase discounts and premiums relating to Earning Assets are amortized into interest income over the lives of the Earning Assets using the effective yield method based on projected cash flows over the life of the asset. Gains or losses on the sale of Earning Assets are based on the specific identification method. It is our intention to hold all of our loans and securities to maturity.
Mortgage Loans: Held-for-Investment |
Mortgage loans held-for-investment are carried at their unpaid principal balance adjusted for net unamortized premiums or discounts and net of any allowance for credit losses. All of the Sequoia loans that are pledged or subordinated to support the Long-Term Debt are classified as held-for-investment. Effective July 1, 2002, the Company classified all residential mortgage loans acquired for future securitization through Sequoia as held-for-investment. Commercial loans that the Company has secured financing through the term of the loan or otherwise has the intent and the ability to hold to maturity, are classified as held-for-investment.
Mortgage Loans: Held-for-Sale |
Mortgage loans held-for-sale (residential and commercial) are carried at the lower of original cost or aggregate market value. 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. Real estate owned assets of the Company are included in mortgage loans held-for-sale.
Securities: Trading |
Securities classified as trading 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.
Securities: Available-for-Sale |
Securities available-for-sale are carried at their estimated fair value. Current period unrealized gains and losses are 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 these securities as a result of EITF 99-20 adjustments are reported as a component of Net Unrealized and Realized Market Value Gains (Losses) in the Consolidated Statements of Operations.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Interest income on loans and securities is calculated using the effective yield method based on projected cash flows over the life of the asset. Yields on each asset vary as a function of credit results, prepayment rates, and interest rates. For Residential Credit-Enhancement Securities purchased at a discount, a portion of the discount for each security may be designated as a credit reserve, with the remaining portion of the discount designated to be amortized into income over the life of the security using the effective yield method. If future credit losses exceed the Companys original expectations, or credit losses occur more quickly than expected, or prepayment rates occur more slowly than expected, the yield over the remaining life of the security may be adjusted downwards or the Company may take a mark-to-market earnings charge to write down the basis in the security to current market value under the provisions of EITF 99-20. If future credit losses are less than the Companys original estimate, or credit losses occur later than expected, or prepayment rates are faster than expected, the yield over the remaining life of the security may be adjusted upwards over time.
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 may include principal and interest payments on mortgage loans or securities held as collateral for the Companys Long-Term Debt, cash pledged as collateral on certain interest rate agreements, and cash held from borrowers until certain loan agreement requirements have been met. Any corresponding liability for cash held from borrowers is included in Accrued Expenses and Other Liabilities on the Consolidated Balance Sheets.
Other Assets |
Other Assets on the Consolidated Balance Sheets include fixed assets, prepaid interest, and other prepaid expenses.
Interest Rate Agreements |
The Company maintains an overall interest-rate risk-management strategy that may incorporate the use of derivative interest rate agreements for a variety of reasons, including minimizing significant fluctuations in earnings or market values on certain assets that may be caused by interest-rate volatility. Interest rate agreements the Company may use as part of its interest-rate risk management strategy include interest rate options, swaps, options on swaps, futures contracts, options on futures contracts, and options on forward purchases (collectively Interest Rate Agreements). On the date an Interest Rate Agreement is entered into, the Company designates the Interest Rate Agreement as (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge), or (3) held for trading (trading instruments).
The Company has elected not to seek hedge accounting under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, for any of its Interest Rate Agreements through September 30, 2002. Accordingly, such instruments are designated as trading and 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. The Company may elect to seek hedge accounting based on the provisions of SFAS No. 133 on certain Interest Rate Agreements entered into in the future.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Net premiums on Interest Rate Agreements are amortized as a component of net interest income over the effective period of the Interest Rate Agreement using the effective interest method. The income or expense related to Interest Rate Agreements is recognized on an accrual basis and is included in interest expense on Short-Term Debt in the Consolidated Statements of Operations.
Debt |
Short-Term Debt and Long-Term Debt are carried at their unpaid principal balances net of any unamortized discount or premium and any unamortized 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 actual principal paydown rates.
Taxes |
The Company has elected to be taxed as a 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 distribute at least 90% of its annual taxable income to stockholders within the time frame set forth in the tax rules 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 currently intends to distribute all of its taxable income, no provision has been made for income taxes at the REIT 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 year, 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 the fourth quarter 2001, which were paid in January 2002, are considered taxable income to stockholders in 2001, the year declared. All 2001 dividends were ordinary income to the Companys preferred and common stockholders.
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. See Note 8 for further discussion on income taxes at Holdings.
To the extent a REITs distributions declared before calendar year-end and paid on or before January 31 of the following calendar year are less than 85% of the REITs taxable income in the calendar year plus 100% of the undistributed income from prior calendar years, a REIT incurs a 4% excise tax on the shortfall. The Company met this 85% distribution requirement in all prior years and has not been subject to excise taxes. The Company currently anticipates, however, that it is likely to incur a 4% excise tax on a portion of its REIT taxable income earned in 2002; if so, a provision for this tax will be made in the fourth quarter when the amount can be estimated.
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Net Income 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.
The following tables provide reconciliations of the numerators and denominators of the basic and diluted net income (loss) per share computations.
Three Months Ended | Nine Months Ended | ||||||||||||||||
September 30, | September 30, | ||||||||||||||||
2002 | 2001 | 2002 | 2001 | ||||||||||||||
(in thousands, except share data) | |||||||||||||||||
Numerator:
|
|||||||||||||||||
Numerator for basic and diluted earnings per
share
|
|||||||||||||||||
Net income before preferred dividend and change
in accounting principle
|
$ | 14,987 | $ | 8,746 | $ | 41,370 | $ | 25,619 | |||||||||
Cumulative effect of adopting EITF 99-20
|
| | | (2,368 | ) | ||||||||||||
Net income before preferred dividend
|
14,987 | 8,746 | 41,370 | 23,251 | |||||||||||||
Cash dividends on Class B preferred stock
|
(681 | ) | (681 | ) | (2,043 | ) | (2,043 | ) | |||||||||
Basic and Diluted EPS Net income
available to common stockholders
|
$ | 14,306 | $ | 8,065 | $ | 39,327 | $ | 21,208 | |||||||||
Denominator:
|
|||||||||||||||||
Denominator for basic earnings per share
|
|||||||||||||||||
Weighted average number of common shares
outstanding during the period
|
15,730,182 | 10,392,820 | 14,879,883 | 9,379,286 | |||||||||||||
Net effect of dilutive stock options
|
510,012 | 359,242 | 485,469 | 286,850 | |||||||||||||
Denominator for diluted earnings per share
|
16,240,194 | 10,752,062 | 15,365,352 | 9,666,136 | |||||||||||||
Basic Earnings Per Share:
|
|||||||||||||||||
Net income before change in accounting principle
|
$ | 0.91 | $ | 0.78 | $ | 2.64 | $ | 2.51 | |||||||||
Cumulative effect of adopting EITF 99-20
|
| | | (0.25 | ) | ||||||||||||
Net income per share
|
$ | 0.91 | $ | 0.78 | $ | 2.64 | $ | 2.26 | |||||||||
Diluted Earnings Per Share:
|
|||||||||||||||||
Net income before change in accounting principle
|
$ | 0.88 | $ | 0.75 | $ | 2.56 | $ | 2.44 | |||||||||
Cumulative effect of adopting EITF 99-20
|
| | | (0.25 | ) | ||||||||||||
Net income per share
|
$ | 0.88 | $ | 0.75 | $ | 2.56 | $ | 2.19 | |||||||||
The number of common equivalent shares issued by the Company that were anti-dilutive during the three and nine months ended September 30, 2002 totaled 410,364 and 402,521, respectively.
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Comprehensive Income |
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, 2002 and December 31, 2001, the only component of Accumulated Other Comprehensive Income was net unrealized gains and losses on assets available-for-sale.
Recent Accounting Pronouncements |
In May 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS 145 rescinds the automatic treatment of gains or losses from extinguishment of debt as extraordinary unless they meet the criteria for extraordinary items as outlined in APB Opinion No. 30, Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. In addition, SFAS 145 also requires sale-leaseback accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions and makes various technical corrections to existing pronouncements. The provisions of this statement related to the rescission of FASB Statement 4 shall be applied in fiscal years beginning after May 15, 2002. The provisions in paragraphs 8 and 9(c) of this Statement related to FASB Statement 13 shall be effective for transactions occurring after May 15, 2002, with early application encouraged. All other provisions of this Statement shall be effective for financial statements issued on or after May 15, 2002.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). This Statement requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions-an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9. SFAS No. 147 requires the acquisitions of financial institutions under the purchase method to be accounted for in accordance with FASB Statements No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. Any excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired as an unidentifiable intangible asset is to be reported as goodwill on the balance sheet if certain criteria are met. The provisions of this Statement are effective for financial institution acquisitions occurring on or after October 1, 2002.
The Company believes that the adoption of SFAS No. 145, SFAS No. 146, and SFAS No. 147 will not have a material effect on its financial position or results of operations.
Note 3. Earning Assets
At September 30, 2002 and December 31, 2001, investments in Earning Assets generally consisted of interests in adjustable-rate, hybrid, and fixed-rate residential and commercial real estate mortgage loans and securities. Hybrid mortgages have an initial fixed coupon rate for three to ten years followed by annual adjustments. The original maturity of the majority of our residential mortgage assets is twenty-five to thirty years. The actual amount of principal outstanding is subject to change based on the prepayments of the underlying mortgage loans. The original maturity of the majority of our commercial mortgage loans is three years.
12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For the three and nine months ended September 30, 2002 and 2001, the annualized effective yield after taking into account the amortization income or expense due to discounts and premiums and associated credit expenses on the Earning Assets was 4.07% and 4.48%, and 6.63% and 7.19%, respectively, based on the reported carrying value of the assets. For the three and nine months ended September 30, 2002, the average balance of Earning Assets was $4.1 billion and $3.2 billion, respectively. For the three and nine months ended September 30, 2001, the average balance of Earning Assets was $2.0 billion and $2.1 billion, respectively.
At September 30, 2002 and December 31, 2001, Earning Assets consisted of the following:
Residential Mortgage Loans
September 30, 2002 | December 31, 2001 | |||||||||||||||||||||||
Held-for- | Held-for- | Held-for- | Held-for- | |||||||||||||||||||||
Sale | Investment | Total | Sale | Investment | Total | |||||||||||||||||||
Current Face
|
$ | 921 | $ | 4,735,724 | $ | 4,736,645 | $ | 153,125 | $ | 1,317,343 | $ | 1,470,468 | ||||||||||||
Unamortized Discount
|
(227 | ) | | (227 | ) | (364 | ) | (132 | ) | (496 | ) | |||||||||||||
Unamortized Premium
|
1 | 32,085 | 32,086 | 34 | 10,055 | 10,089 | ||||||||||||||||||
Amortized Cost
|
695 | 4,767,809 | 4,768,504 | 152,795 | 1,327,266 | 1,480,061 | ||||||||||||||||||
Reserve for Credit Losses
|
| (6,611 | ) | (6,611 | ) | | (5,199 | ) | (5,199 | ) | ||||||||||||||
Carrying Value
|
$ | 695 | $ | 4,761,198 | $ | 4,761,893 | $ | 152,795 | $ | 1,322,067 | $ | 1,474,862 | ||||||||||||
At September 30, 2002 and December 31, 2001, residential mortgage loans with a net carrying value of $387 million and $148 million, respectively, were pledged as collateral under short-term borrowing arrangements to third parties.
Residential Credit-Enhancement Securities
September 30, 2002 | December 31, 2001 | |||||||
Mortgage Securities | Mortgage Securities | |||||||
Available-for-Sale | Available-for-Sale | |||||||
Current Face
|
$ | 542,669 | $ | 353,435 | ||||
Unamortized Discount
|
(49,360 | ) | (25,863 | ) | ||||
Portion Of Discount Designated As A Credit Reserve
|
(220,735 | ) | (140,411 | ) | ||||
Amortized Cost
|
272,574 | 187,161 | ||||||
Gross Unrealized Gains
|
53,961 | 7,174 | ||||||
Gross Unrealized Losses
|
(2,405 | ) | (3,522 | ) | ||||
Carrying Value
|
$ | 324,130 | $ | 190,813 | ||||
The Company credit enhances pools of high-quality jumbo residential mortgage loans by acquiring subordinated securities in third-party securitizations. The subordinated interests in a securitization transaction bear the majority of the credit risk for the securitized pool of mortgages, thus allowing the more senior securitized interests to qualify for investment-grade ratings and to be sold in the capital markets. The Company therefore commits capital that effectively forms a guarantee or insurance on the securitized pool of mortgages.
The Companys Residential Credit-Enhancement Securities are first-loss, second-loss, and third-loss securities. First-loss securities are generally allocated actual credit losses on the entire underlying pool of loans
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
up to a maximum of the principal amount of the first loss security. First-loss securities provide credit-enhancement principal protection from the initial losses in the underlying pool for the second loss, third loss, and more senior securities. Any first loss securities that are owned by others and that are junior to the Companys second and third loss securities provide the Companys securities with some protection from losses, as they serve as external credit enhancement. The Company provided some level of credit enhancement on $68 billion and $52 billion of loans securitized by third parties at September 30, 2002 and December 31, 2001, respectively.
When the Company purchases residential credit enhancement interests, a portion of the discount for each security may be designated as a credit reserve, with the remaining portion of the discount designated to be amortized into income over the life of the security using the effective yield method. If future credit losses exceed the Companys original expectations, and the fair value of the security is less than its carrying value, the Company may record a charge on the Statement of Operations to write down the basis in the security to fair value. If future credit losses exceed the Companys original expectations, and the fair value of the security is greater than its carrying value, the yield over the remaining life of the security may be adjusted downward. If future credit losses are less than the Companys original estimate, the yield over the remaining life of the security may be adjusted upward. At September 30, 2002 and December 31, 2001, the Company designated $221 million and $140 million, respectively, as a credit reserve on its residential credit-enhancement interests. The credit reserves are specific to each residential credit-enhancement interest.
Interest income on loans and securities is calculated using the effective yield method based on projected cash flows over the life of the asset. Yields on each asset vary as a function of credit results, prepayment rates, and interest rates. For Residential Credit-Enhancement Securities purchased at a discount, a portion of the discount for each security may be designated as a credit reserve, with the remaining portion of the discount designated to be amortized into income over the life of the security using the effective yield method. If future credit losses exceed the Companys original expectations, or credit losses occur more quickly than expected, or prepayment rates occur more slowly than expected, the yield over the remaining life of the security may be adjusted downwards or the Company may take a mark-to-market earnings charge to write down the basis in the security to current market value under the provisions of EITF 99-20. If future credit losses are less than the Companys original estimate, or credit losses occur later than expected, or prepayment rates are faster than expected, the yield over the remaining life of the security may be adjusted upwards over time.
At September 30, 2002 and December 31, 2001, Residential Credit-Enhancement Securities with a net carrying value of $70 million and $89 million, respectively, were pledged as collateral under borrowing arrangements to third parties.
Commercial Mortgage Loans
September 30, 2002 | December 31, 2001 | |||||||||||||||||||||||
Held-for- | Held-for- | Held-for- | Held-for- | |||||||||||||||||||||
Sale | Investment | Total | Sale | Investment | Total | |||||||||||||||||||
Current Face
|
$ | 19,190 | $ | 32,128 | $ | 51,318 | $ | 30,931 | $ | 20,860 | $ | 51,791 | ||||||||||||
Unamortized Discount
|
(547 | ) | (107 | ) | (654 | ) | (683 | ) | (24 | ) | (707 | ) | ||||||||||||
Carrying Value
|
$ | 18,643 | $ | 32,021 | $ | 50,664 | $ | 30,248 | $ | 20,836 | $ | 51,084 | ||||||||||||
At both September 30, 2002 and December 31, 2001, commercial mortgage loans with a net carrying value of $19 million were pledged as collateral under short-term borrowing arrangements to third parties. At September 30, 2002 and December 31, 2001, commercial mortgage loans held-for-investment with a net carrying value of $31 million and $21 million, respectively, were pledged as collateral under long-term borrowing arrangements to third parties.
14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Securities Portfolio
September 30, 2002 | December 31, 2001 | |||||||||||||||||||||||
Securities | Securities | |||||||||||||||||||||||
Securities | Portfolio | Securities | Portfolio | |||||||||||||||||||||
Portfolio | Available- | Portfolio | Available- | |||||||||||||||||||||
Trading | for-Sale | Total | Trading | for-Sale | Total | |||||||||||||||||||
Current Face
|
$ | 275,050 | $ | 202,900 | $ | 477,950 | $ | 501,078 | $ | 171,877 | $ | 672,955 | ||||||||||||
Unamortized Discount
|
(1,020 | ) | (1,581 | ) | (2,601 | ) | (139 | ) | (1,320 | ) | (1,459 | ) | ||||||||||||
Unamortized Premium
|
7,719 | 6,096 | 13,815 | 6,634 | 6,303 | 12,937 | ||||||||||||||||||
Amortized Cost
|
281,749 | 207,415 | 489,164 | 507,573 | 176,860 | 684,433 | ||||||||||||||||||
Gross Unrealized Gains
|
| 2,704 | 2,704 | | 516 | 516 | ||||||||||||||||||
Gross Unrealized Losses
|
| (112 | ) | (112 | ) | | (1,467 | ) | (1,467 | ) | ||||||||||||||
Carrying Value
|
$ | 281,749 | $ | 210,007 | $ | 491,756 | $ | 507,573 | $ | 175,909 | $ | 683,482 | ||||||||||||
Agency
|
$ | 224,325 | $ | 0 | $ | 224,325 | $ | 353,523 | $ | 20,223 | $ | 373,746 | ||||||||||||
Non-Agency
|
57,424 | 210,007 | 267,431 | 154,050 | 155,686 | 309,736 | ||||||||||||||||||
Carrying Value
|
$ | 281,749 | $ | 210,007 | $ | 491,756 | $ | 507,573 | $ | 175,909 | $ | 683,482 | ||||||||||||
For the three and nine months ended September 30, 2002, the Company recognized net market value gains through the Consolidated Statement of Operations of $4.4 million and $5.9 million on its securities portfolio, respectively. For the three and nine months ended September 30, 2001, the Company recognized net market value gains of $0.1 million and $2.8 million, respectively, through the Consolidated Statement of Operations on its securities portfolio.
At September 30, 2002 and December 31, 2001, securities portfolio assets with a net carrying value of $467 million and $592 million, respectively, were pledged as collateral under borrowing arrangements to third parties.
Note 4. Reserve for Credit Losses
The Reserve for Credit Losses is for Residential Mortgage Loans held-for-investment and is reflected as a component of Earning Assets on the Consolidated Balance Sheets. The following table summarizes the activity in the Reserve for Credit Losses:
(in thousands)
Three Months | Nine Months | |||||||||||||||
Ended | Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2002 | 2001 | 2002 | 2001 | |||||||||||||
Balance at beginning of period
|
$ | 5,953 | $ | 5,120 | $ | 5,199 | $ | 4,814 | ||||||||
Provision for credit losses
|
894 | 151 | 1,648 | 499 | ||||||||||||
Charge-offs
|
(236 | ) | (311 | ) | (236 | ) | (353 | ) | ||||||||
Balance at end of period
|
$ | 6,611 | $ | 4,960 | $ | 6,611 | $ | 4,960 | ||||||||
15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 5. Interest Rate Agreements
Through September 30, 2002, the Company reports its Interest Rate Agreements at fair value, and has not elected to obtain hedge accounting treatment under SFAS No. 133 on any of its Interest Rate Agreements. As of September 30, 2002 and December 31 2001, the fair value of the Companys Interest Rate Agreements was negative $2.7 million and $0, respectively. At September 30, 2002, the Companys Interest Rate Agreements are included in Accrued Expenses and Other Liabilities on the Consolidated Balance Sheets.
During the three and nine months ended September 30, 2002, the Company recognized net market value losses of $3.4 million and $4.8 million, respectively, on Interest Rate Agreements. During the nine months ended September 30, 2001, the Company recognized net market value losses of $0.4 million on Interest Rate Agreements. No such market value losses were recognized by the Company during the three months ended September 30, 2001. The market value gains and losses are included in Net Unrealized and Realized Market Value Gains (Losses) on the Consolidated Statements of Operations.
The Company generally attempts to structure its balance sheet to address many of the interest rate risks inherent in financial institutions and in the Companys specific assets and liabilities. The Company may enter into certain Interest Rate Agreements from time to time with the objective of matching the interest rate characteristics of its assets and liabilities. At September 30, 2002 and December 31, 2001, the Company had two interest rate caps with strike rates based on the one-month London Interbank Offered Rate (LIBOR) interest rate ranging from 6.25% to 7.00% expiring in 2002 and 2003. At both September 30, 2002 and December 31, 2001, the notional amounts of the two interest rate caps totaled $8 million. In addition, the Company had a pair of generally offsetting interest rate swaps between Redwood Trust, Sequoia, and a third party financial institution that had gross notional amounts of $393 million at September 30, 2002 and $445 million at December 31, 2001. At September 30, 2002, the Company also had five interest rate swap agreements with third party financial institutions; in these agreements Redwood pays a fixed interest rate and receives three-month LIBOR. These five interest rate swap agreements had notional amounts totaling $58 million at September 30, 2002. The Company had no such interest rate swap agreements at December 31, 2001.
In the future, the Company may enter into Interest Rate Agreements consisting of interest rate caps, interest rate floors, interest rate futures, options on interest rate futures, interest rate swaps, and other types of hedging instruments.
The following table summarizes the aggregate notional amounts of all of the Companys Interest Rate Agreements as well as the credit exposure related to these instruments as of September 30, 2002 and December 31, 2001. The credit exposure reflects the fair market value of any cash and collateral of the Company held by counterparties. At September 30, 2002 and December 31, 2001, the swaps between Redwood and various third party financial institutions required Redwood to provide collateral in the form of agency securities of $8.1 million and $6.6 million, respectively. Sequoia did not hold collateral of the third party financial institution for its swap at September 30, 2002 or December 31, 2001. The cash and collateral held by counterparties are included in Restricted Cash or the Securities Portfolio on the Consolidated Balance Sheets.
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands)
Notional Amounts | Credit Exposure | |||||||||||||||
September 30, | December 31, | September 30, | December 31, | |||||||||||||
2002 | 2001 | 2002 | 2001 | |||||||||||||
Interest Rate Caps Purchased
|
$ | 8,000 | $ | 313,000 | | | ||||||||||
Interest Rate Swaps
|
451,087 | 445,107 | $ | 8,070 | $ | 6,645 | ||||||||||
Total
|
$ | 459,087 | $ | 758,107 | $ | 8,070 | $ | 6,645 | ||||||||
In general, the Company incurs 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 may 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 generally enters into Interest Rate Agreements with several different counterparties in order to diversify its credit risk exposure.
Note 6. 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 a portion of its Earning Assets.
At September 30, 2002, the Company had $0.8 billion of Short-Term Debt outstanding with a weighted-average borrowing rate of 2.25% and a weighted-average remaining maturity of 96 days. This debt was collateralized with $0.9 billion of Earning Assets. At December 31, 2001, the Company had $0.8 billion of Short-Term Debt outstanding with a weighted-average borrowing rate of 2.19% and a weighted-average remaining maturity of 82 days. This debt was collateralized with $0.8 billion of Earning Assets.
At September 30, 2002 and December 31, 2001, the Short-Term Debt had the following remaining maturities:
(in thousands)
September 30, | December 31, | |||||||
2002 | 2001 | |||||||
Within 30 days
|
$ | 332,973 | $ | 270,855 | ||||
31 to 90 days
|
56,850 | 226,407 | ||||||
Over 90 days
|
444,258 | 299,549 | ||||||
Total Short-Term Debt
|
$ | 834,081 | $ | 796,811 | ||||
For both the three and nine months ended September 30, 2002, the average balance of Short-Term Debt was $0.9 billion, with a weighted-average interest cost of 2.43% and 2.31%, respectively. For both the three and nine months ended September 30, 2001, the average balance of Short-Term Debt was $0.9 billion, with a weighted-average interest cost of 4.15% and 5.03%, respectively. The maximum balance outstanding during both the three and nine months ended September 30, 2002 was $1.4 billion. The maximum balance outstanding during both the three and nine months ended September 30, 2001 was $1.1 billion. Through September 30, 2002, the Company was in compliance with all of its debt covenants for all its short-term borrowing arrangements and credit facilities.
17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
At September 30, 2002 and December 31, 2001, the Company had uncommitted facilities with credit lines in excess of $4 billion for financing AAA and AA-rated residential mortgage securities. It is the intention of the Companys management to renew committed and uncommitted facilities as needed, as well as pursue additional facilities and other types of financings.
At September 30, 2002, the Company had short-term facilities with three Wall Street Firms totaling $1.4 billion to fund Residential Mortgage Loans. At December 31, 2001, the Company had short-term facilities with two Wall Street Firms totaling $1.0 billion to fund Residential Mortgage Loans. At September 30, 2002 and December 31, 2001, the Company had borrowings under these facilities of $377 million and $146 million, respectively. Borrowings under these facilities bear interest based on a specified margin over the one-month LIBOR interest rate. At September 30, 2002 and December 31, 2001, the weighted average borrowing rate under these facilities was 2.33% and 2.56%, respectively. These facilities expire between March 2003 and June 2003.
At September 30, 2002, the Company had one committed revolving mortgage warehouse credit facility totaling $50 million to finance commercial mortgage loans. The Company had borrowings under this facility of $16 million. This facility allows for loans to be financed to the maturity of the loan (up to three years). Borrowings under this facility bear interest based on a specified margin over the one-month LIBOR interest rate. At September 30, 2002, the weighted average borrowing rate under this facility was 3.82%. This facility expires in November 2002, although the Company is in the process of renewing the facility. At December 31, 2001, the Company had two committed revolving mortgage warehousing credit facilities totaling $57 million to finance commercial mortgage loans. At December 31, 2001, the Company had borrowings under these facilities of $17 million.
In July 2002, the Company entered into a Warehouse Agreement and an Engagement Letter with a Wall Street firm designed to enable the Company to pursue the issuance of a collateralized bond obligation (CBO). The Company is pursuing a CBO as a means of securing long-term debt financing for some of its existing securities and to enable the Company to long-term fund additional types of assets in the future. At September 30, 2002, the Company had borrowings under this facility of $44 million with a weighted average borrowing rate of 3.51%.
At September 30, 2002, the Company had four master repurchase agreements with two banks and two Wall Street Firms totaling $170 million. At December 31, 2001, the Company had three master repurchase agreements with a bank and two Wall Street Firms totaling $140 million. These facilities are intended to finance securities with lower-than-investment-grade ratings. In addition to these committed facilities, the Company may also finance securities with lower-than-investment-grade ratings through non-committed borrowing arrangements. At September 30, 2002 and December 31, 2001, the Company had borrowings under these committed and non-committed facilities of $48 million and $66 million, respectively. Borrowings under these facilities bear interest based on a specified margin over the one-month LIBOR interest rate. At September 30, 2002 and December 31, 2001, the weighted average borrowing rate under these facilities was 2.84% and 2.92%, respectively. Three of the committed facilities expire in February, September, and October 2003. The fourth committed facility has a six-month term that is extended monthly. Unless notice is provided by either party the expiration on this fourth facility remains at six months.
Note 7. | Long-Term Debt |
Through securitizations, the Company issues Residential Long-Term Debt in the form of collateralized mortgage-backed securities secured by Residential Mortgage Loans (Residential Bond Collateral). The Residential Bond Collateral consists primarily of adjustable-rate and hybrid, conventional, 25 or 30-year residential mortgage loans secured by first liens on one to four-family residential properties. All Residential Bond Collateral is pledged to secure repayment of the related Residential Long-Term Debt obligation. As required by the governing documents relating to the Residential Long-Term Debt, the Residential Bond
18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Collateral is held in the custody of trustees. Trustees collect principal and interest payments (less servicing and related fees) on the Residential Bond Collateral and make corresponding principal and interest payments on the Residential Long-Term Debt. Obligations under the Residential Long-Term Debt are payable solely from the Residential Bond Collateral and are otherwise non-recourse to the Company.
Each series of Residential Long-Term Debt consists of various classes of securities at variable rates of interest. The maturity of each class is directly affected by the rate of principal prepayments on the related Residential Bond Collateral. Each series is also subject to redemption according to the specific terms of the respective governing documents. As a result, the actual maturity of any class of a Residential Long-Term Debt series is likely to occur earlier than its stated maturity. During the three and nine months ended September 30, 2002, the Company issued $2.2 billion and $3.3 billion, respectively, in Residential Long-Term Debt through Sequoia to fund residential mortgage loans.
During the second quarter of 2002, the Company issued $80 million of Long-Term Debt secured by Residential Mortgage Securities with stated maturities of 2029 and 2030. The maturity of this Long-Term Debt is directly affected by the rate of principal prepayments on the related Residential Mortgage Securities. As a result, the actual maturity of any class of this Long-Term Debt is likely to occur earlier than its stated maturity.
The Companys Commercial Long-Term Debt is secured by three adjustable-rate Commercial Mortgage Loans with maturity dates in 2002 and 2003, which are secured by first liens on the related commercial mortgage properties reported on the Companys balance sheet as Mortgage Loans Held-for-Investment.
The Companys exposure to loss on the Residential Bond Collateral and the Commercial Loan Collateral is limited to its net investment, as the Residential and Commercial Long-Term Debt are non-recourse to the Company.
The components of the collateral for the Companys Long-Term Debt are summarized as follows:
(in thousands)
September 30, | December 31, | ||||||||
2002 | 2001 | ||||||||
Residential Mortgage Loans:
|
|||||||||
Residential Mortgage Loans held-for-sale
|
$ | 174 | $ | 848 | |||||
Residential Mortgage Loans held-for-investment
|
4,374,801 | 1,322,067 | |||||||
Residential Mortgage Securities available-for-sale
|
72,597 | | |||||||
Restricted cash
|
122 | 2,534 | |||||||
Accrued interest receivable
|
10,285 | 5,340 | |||||||
Total Residential Collateral
|
$ | 4,457,979 | $ | 1,330,789 | |||||
Commercial Mortgage Loans held-for-investment
|
$ | 30,654 | $ | 20,836 | |||||
Total Long-Term Debt Collateral
|
$ | 4,488,633 | $ | 1,351,625 | |||||
19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The components of the Long-Term Debt at September 30, 2002 and December 31, 2001 along with selected other information are summarized below:
(in thousands)
September 30, | December 31, | ||||||||
2002 | 2001 | ||||||||
Residential Long-Term Debt
|
$ | 4,346,151 | $ | 1,297,958 | |||||
Commercial Long-Term Debt
|
25,626 | 17,211 | |||||||
Unamortized premium on Long-Term Debt
|
5,554 | 2,038 | |||||||
Deferred bond issuance costs
|
(12,050 | ) | (3,492 | ) | |||||
Total Long-Term Debt
|
$ | 4,365,281 | $ | 1,313,715 | |||||
Range of weighted-average interest rates, by
series residential
|
1.95% to 6.78% | 2.28% to 6.35% | |||||||
Stated residential maturities
|
2024 2032 | 2024 2029 | |||||||
Number of residential series
|
10 | 5 | |||||||
Weighted-average interest rates
commercial
|
4.84% to 8.63% | 5.09% | |||||||
Stated commercial maturities
|
2002 2003 | 2002 2003 | |||||||
Number of commercial series
|
3 | 2 |
For the three and nine months ended September 30, 2002, the average balance of Residential Long-Term Debt was $2.9 billion and $2.0 billion, respectively. For the three and nine months ended September 30, 2001, the average balance of Residential Long-Term Debt was $0.9 billion and $1.0 billion, respectively. For the three and nine months ended September 30, 2002, the average effective interest cost for Residential Long-Term Debt (as adjusted for the amortization of bond premium, deferred bond issuance costs, and other related expenses) was 2.59% and 2.81%, respectively. For the three and nine months ended September 30, 2001, the average effective interest cost for Residential Long-Term Debt (as adjusted for the amortization of bond premium, deferred bond issuance costs, and other related expenses) was 5.44% and 6.05%, respectively. At September 30, 2002 and December 31, 2001, accrued interest payable on Residential Long-Term Debt was $3.5 million and $1.9 million, respectively, and is reflected as a component of Accrued Interest Payable on the Consolidated Balance Sheets.
At September 30, 2002 and December 31, 2001, the weighted average interest rate for Commercial Long-Term Debt was 6.06% and 5.09% and the balance of Commercial Long-Term Debt was $25.6 million and $17.2 million, respectively.
Note 8. | Taxes |
As a REIT, Redwood Trust can deduct dividends paid from taxable income and thus, effectively, may not be subject to income taxes. Holdings, the Companys taxable subsidiary, is subject to income taxes.
The current provision for income taxes for Holdings for the three and nine months ended September 30, 2002 and 2001 was $3,200 and was a component of Operating Expenses on the Consolidated Statement of Operations. These amounts represent the minimum California franchise taxes. No additional tax provision for Holdings has been recorded for the three and nine months ended September 30, 2002 and 2001 as taxable income reported for these periods was offset by Federal and state net operating loss carryforwards from prior years. In addition, due to the uncertainty of realization of net operating losses, no deferred tax benefit has been recorded. 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, 2002 and December 31, 2001. At
20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
September 30, 2002 and December 31, 2001, the deferred tax assets and associated valuation allowances were approximately $9.5 million and $9.3 million, respectively. At September 30, 2002 and December 31, 2001, Holdings had net operating loss carryforwards of approximately $23.5 million and $24.4 million for Federal tax purposes, and $15.7 million and $10.4 million for state tax purposes, respectively. The Federal loss carryforwards and a portion of the state loss carryforwards expire between 2018 and 2021, while the largest portion of the state loss carryforwards expire between 2003 and 2006.
To the extent a REITs distributions declared before calendar year-end and paid on or before January 31 of the following calendar year are less than 85% of the REITs taxable income in the calendar year plus 100% of the undistributed income from prior calendar years, a REIT incurs a 4% excise tax on this shortfall. The Company met this 85% distribution requirement in prior years and in the past has not been subject to excise taxes. The Company may be subject to excise taxes in 2002; a provision for excise taxes, if necessary, will be made in the fourth quarter of 2002.
Note 9. | Fair Value of Financial Instruments |
The following table presents the carrying values and estimated fair values of the Companys financial instruments at September 30, 2002 and December 31, 2001.
(in thousands) | ||||||||||||||||||
September 30, 2002 | December 31, 2001 | |||||||||||||||||
Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||||||||
Assets
|
||||||||||||||||||
Mortgage Loans
|
||||||||||||||||||
Residential: held-for-sale
|
$ | 695 | $ | 695 | $ | 152,795 | $ | 152,795 | ||||||||||
Residential: held-for-investment
|
4,761,198 | 4,766,598 | 1,322,067 | 1,318,673 | ||||||||||||||
Commercial: held-for-sale
|
18,643 | 18,680 | 30,248 | 30,248 | ||||||||||||||
Commercial: held-for-investment
|
32,021 | 32,128 | 20,836 | 20,860 | ||||||||||||||
Mortgage Securities
|
||||||||||||||||||
Residential: trading
|
281,749 | 281,749 | 507,573 | 507,573 | ||||||||||||||
Residential: available-for-sale
|
534,137 | 534,137 | 366,722 | 366,722 | ||||||||||||||
Liabilities
|
||||||||||||||||||
Short-Term Debt
|
834,081 | 834,081 | 796,811 | 796,811 | ||||||||||||||
Long-Term Debt
|
4,365,281 | 4,361,640 | 1,313,715 | 1,295,323 |
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 10. | 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 the Preferred Stock or, under certain circumstances, cause a conversion of the Preferred Stock into Common 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 Companys Common Stock as to the payment of dividends and liquidation rights. The liquidation preference entitles the holders of the Preferred Stock to
21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
receive $31.00 per share plus any accrued dividends before any distribution is made on the Common Stock. At both September 30, 2002 and December 31, 2001, 96,732 shares of the Preferred Stock have been converted into 96,732 shares of the Companys Common Stock.
In March 1999, the Companys Board of Directors approved the repurchase of up to 150,000 shares of the Companys Preferred Stock. The Company did not repurchase any shares of Preferred Stock during the three and nine months ended September 30, 2002 and 2001. At September 30, 2002, there remained 142,550 shares available under the authorization for repurchase.
Stock Option Plan |
In March 2002, the Company adopted an Incentive Stock Plan for executive officers, employees, and non-employee directors (the Plan) that was approved by the Companys shareholders in May 2002. The Plan authorizes the Board of Directors (or a committee appointed by the Board of Directors) to grant incentive stock options as defined under Section 422 of the Code (ISOs), options not so qualified (NQSOs), deferred stock, restricted stock, performance shares, stock appreciation rights, 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 under the Plan. The Plan has been designed to permit the Companys compensation committee to grant and certify awards that qualify as performance-based and otherwise satisfy the requirements of Section 162(m) of the Code, however, not all awards may so qualify. This plan replaced the Companys prior stock option plan. At September 30, 2002 and December 31, 2001, 662,161 and 299,064 shares of Common Stock, respectively, were available for grant.
Of shares of Common Stock available for grant, no more than 963,637 shares of Common Stock are cumulatively available for grant as ISOs. At September 30, 2002 and December 31, 2001, 478,437 and 458,537 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.
As of December 31, 2001, 28,000 shares of restricted stock had been granted to two officers of the Company. At September 30, 2002, restrictions on 10,500 of these shares had lapsed. The restrictions on the remaining 17,500 shares lapse in equal increments on the first day of each calendar quarter from October 1, 2002 through January 1, 2005. As of September 30, 2002, no other restricted shares had been awarded.
The Company has granted certain stock options that accrue and pay stock and cash DERs. This feature results in current expenses being incurred that relate to long-term incentive grants made in the past. To the extent the Company increases its taxable income, and thus its REIT dividend distribution requirement, stock and cash DER expenses may increase. For the three and nine months ended September 30, 2002, the Company accrued cash and stock DER expenses of $1.3 million and $4.2 million, respectively. For the three and nine months ended September 30, 2001, the Company accrued cash and stock DER expenses of $0.9 million and $2.6 million, respectively. Stock and cash DERs are included in Operating Expenses in the Consolidated Statement of Operations.
Stock DERs represent shares of stock, which are issuable when the holders exercise the underlying stock options and are considered to be variable stock awards under the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. In addition to the stock DER expense on these options, for the three months ended September 30, 2002, the Company recognized variable stock option income of $0.7 million and, for the nine months ended September 30, 2002, the Company recognized variable stock option expense of $0.6 million. For the three and nine months ended September 30, 2001, the Company recognized variable stock option expense of $0.2 million and $0.9 million, respectively. Variable stock option expense is included in Other Income (Expense) on the Consolidated Statement of Operations.
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Stock DERs are accrued based on an estimate of the Companys common stock dividend requirements. At September 30, 2002 and December 31, 2001, there were 187,030 and 181,010 unexercised options with stock DERs under the Plan, respectively. Cash DERs are accrued based on an estimate of the Companys common stock dividend requirements. At September 30, 2002 and December 31, 2001, there were 1,303,602 and 1,284,222 unexercised options with cash DERs under the Plan, respectively. At September 30, 2002 and December 31, 2001, there were 153,176 and 153,269 unexercised options with no DERs under the Plan, respectively.
A summary of the status of the Plan and changes during the three and nine months ended September 30, 2002 is presented below.
(in thousands, except share data)
Three Months Ended | Nine Months Ended | ||||||||||||||||
September 30, 2002 | September 30, 2002 | ||||||||||||||||
Weighted | Weighted | ||||||||||||||||
Average | Average | ||||||||||||||||
Exercise | Exercise | ||||||||||||||||
Shares | Price | Shares | Price | ||||||||||||||
Outstanding options at beginning of period
|
1,632,920 | $ | 22.31 | 1,618,501 | $ | 22.33 | |||||||||||
Options granted
|
19,500 | $ | 27.93 | 37,400 | $ | 28.32 | |||||||||||
Options exercised
|
(3,780 | ) | $ | 13.11 | (15,859 | ) | $ | 16.25 | |||||||||
Options canceled
|
(4,832 | ) | $ | 34.92 | (5,861 | ) | $ | 31.31 | |||||||||
Dividend equivalent rights earned
|
| | 9,627 | | |||||||||||||
Outstanding options at end of period
|
1,643,808 | $ | 22.36 | 1,643,808 | $ | 22.36 | |||||||||||
Employee Stock Purchase Plan |
In May 2002, the Companys common shareholders approved the Employee Stock Purchase Plan (ESPP). Effective July 1, 2002, the ESPP allows eligible employees to purchase, through payroll deductions, shares of the Companys common stock on a quarterly basis at a discount rate from the fair market value of the shares as determined under the ESPP. At September 30, 2002, employees acquired an aggregate of 1,544 shares of common stock at a purchase price of $23.23 per share under this Plan.
Common Stock Repurchases |
The Companys Board of Directors approved the repurchase of a total of 7,455,000 shares of the Companys Common Stock. The Company did not repurchase any shares of Common Stock during the three and nine months ended September 30, 2002 and 2001. At September 30, 2002, there remained 1,000,000 shares available under the authorization for repurchase. Repurchased shares have been returned to the Companys authorized but unissued shares of Common Stock.
Common Stock Issuances |
In February and April 2002, the Company completed secondary offerings of 1,725,000 and 575,000 shares of common stock for net proceeds of $40.3 million and $14.9 million, respectively. The Company also issued 257,796 and 911,536 shares of common stock, through its Dividend Reinvestment and Stock Purchase Plan for net proceeds of $7.1 million and $24.5 million, respectively, during the three and nine months ended September 30, 2002.
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 11. | Commitments and Contingencies |
At September 30, 2002, the Company had entered into commitments to purchase $0.4 million of securities and $133 million of residential mortgage loans for settlement in October 2002. At September 30, 2002, the Company had entered into commitments to sell $199 million of securities.
At September 30, 2002, the Company is obligated under non-cancelable operating leases with expiration dates through 2006. The total future minimum lease payments under these non-cancelable leases are $2.2 million and are expected to be paid as follows: 2002 $0.2 million; 2003 $0.7 million; 2004 $0.6 million; 2005 $0.5 million; 2006 $0.2 million.
In July 2002, the Company entered into a Warehouse Agreement and an Engagement Letter with a Wall Street firm designed to enable the Company to pursue the issuance of a collateralized bond obligation (CBO). The Company is pursuing a CBO as a means of securing long-term debt financing for some of its existing securities and to enable the Company to long-term fund additional types of real estate assets that may be acquired in the future. Pursuant to these agreements, the Wall Street firm is providing short-term financing for some of the Companys assets (as discussed in Note 6) and is also acquiring assets for potential future sale to the Company. The fair value of the assets in the warehouse that the Company may acquire totaled $86.7 million at September 30, 2002.
Note 12. | Subsequent Events |
In October 2002, the Company issued $0.7 billion in face value of Long-Term Debt through Sequoia Mortgage Trust 11, a trust established by Sequoia. This debt is collateralized by a pool of adjustable-rate residential mortgage loans. The proceeds received from this issuance were used to pay down a portion of the Companys Short-Term Debt.
In November 2002, the Companys Board of Directors declared a regular and special cash dividend for common shareholders of $0.63 per share and $0.125 per share, respectively, for the fourth quarter of 2002. The Board of Directors also declared a preferred cash dividend of $0.755 per share for the fourth quarter of 2002. The common and preferred cash dividends are payable on January 21, 2003 to shareholders of record on December 31, 2002. These dividends are considered distributions of our 2002 taxable income. As discussed above in Notes 2 and 8, to the extent total dividend distributions in a year are less than REIT taxable income carried over from the previous year plus 85% of a REITs taxable income earned in that year, the REIT is subject to a 4% excise tax on a portion of its taxable income. The Company may be subject to excise taxes in 2002; a provision for excise taxes, if necessary, will be made in the fourth quarter of 2002.
24
Item 2. | Managements 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: Certain matters discussed in this Form 10-Q may constitute forward-looking statements within the meaning of the federal securities laws that inherently include certain risks and uncertainties. Throughout this Form 10-Q and other Company documents, the words believe, expect, anticipate, intend, aim, will, and similar words identify forward-looking statements. Actual results and the timing of certain events could differ materially from those projected in, or contemplated by, the forward-looking statements due to a number of factors, including, among other things, changes in interest rates and market values on our earning assets and borrowings, changes in prepayment rates on our mortgage assets, general economic conditions, particularly as they affect the price of earning assets and the credit status of borrowers, and the level of liquidity in the capital markets as it affects our ability to finance our mortgage asset portfolio, and other risk factors outlined in our Annual Report on Form 10-K for the year ended December 31, 2001 and our Prospectus Supplement dated April 23, 2002. Other factors not presently identified may also cause actual results to differ. Future results and changes in expectations of future results could lead to adverse changes in our dividend rate. We continuously update and revise our estimates based on actual conditions experienced. It is not practical to publish all such revisions and, as a result, no one should assume that results or trends projected in or contemplated by the forward-looking statements included herein will prove to be accurate in the future.
This Form 10-Q contains statistics and other data that in some cases have been obtained from, or compiled from, information made available by servicing entities and information service providers. In addition, some of the historical presentations contained herein have been restated to conform to current formats.
Results of Operations
Summary and Outlook |
Redwood Trust invests in real estate loans. In the first nine months of 2002, we invested $3.6 billion in high-quality residential mortgage loans, $2 million in commercial mortgage loans, $115 million in residential loan credit enhancement securities, and $107 million in other types of real estate loan securities. These new investments were funded with new equity (sourced through two equity offerings and our direct stock purchase and dividend reinvestment program) and with new issuance of non-recourse long-term debt. We continue to reduce our reliance on short-term debt to fund our assets. As a result, our short-term debt declined from 37% of our liabilities at the beginning of the year to 16% of our liabilities at the end of the third quarter of 2002. Our credit results remain excellent and our asset/ liability posture remains well balanced.
Our largest investment is in high-quality residential real estate loans and securities. In addition, we continue to invest in commercial real estate loans and diverse types of real estate loan securities. We significantly increased our staff and will continue to make material investments in building our operating capabilities and expertise. While our operating expenses are increasing, they increased at a slower rate than our business has grown. We believe our operations have become both more capable and more productive.
Our GAAP earnings were $0.88 per share for the third quarter 2002, $0.88 per share for the second quarter of 2002, and $0.75 per share in the third quarter of 2001. For the first nine months of 2002, our GAAP earnings were $2.56 per share, an increase from the $2.19 per share we reported in the first nine months of 2001.
Core earnings were $0.79 per share for the third quarter of 2002, a slight decrease from the $0.80 we reported in the second quarter of 2002 and an increase from the $0.76 per share we reported in the third quarter of 2001. Our core earnings totaled $2.36 per share in the first nine months of 2002, an increase of 3% over the $2.29 per share we earned in the first nine months of 2001. Core earnings equal GAAP earnings excluding mark-to-market adjustments and non-recurring items. We believe that core earnings is a useful
25
Net interest income as a percentage of equity is, in our opinion, the best measure of the profitability rate of our real estate mortgage portfolios. This measure has remained between 17% and 21% throughout the last few years, and was 18.5% in the third quarter of 2002. In 2001, we benefited on a temporary basis from a significant drop in short-term interest rates. In 2002, the benefits from the prior years interest rate changes have been diminishing. At the same time, in 2002, our portfolio profitability has been enhanced by increases in returns from our credit-related investments (due to excellent credit results and faster prepayment rates) and by continued favorable changes in asset mix (increased growth in our loan portfolios). As a result, our net interest income profitability in the first nine months of 2002 has improved from the first nine months of 2001 despite diminished short-term interest rate benefits.
Operating expenses as a percentage of equity is, in our opinion, the best measure of operating cost efficiency for our company. Although this measure varies from quarter to quarter due to factors such as equity offerings and variable compensation expense accruals tied to earnings and dividends the general trend has been towards greater productivity. Operating expenses as a percentage of equity improved from 5.3% in the first nine months of 2001 to 4.5% in the first nine months of 2002.
Our return on equity (annualized core earnings as a percentage of average common equity) has generally been stable, remaining in the 13% to 15% range throughout 2001 and 2002. It was 14.3% in third quarter of 2002.
We believe the key longer-term trends for our business are the strength of our credit results and the strength of our competitive market position. We believe the outlook for our business remains favorable.
Our credit losses remained under 0.01% of our residential real estate loan portfolios on an annualized basis. In addition, in many parts of the country, housing prices have continued to increase. This reduces our risk of future credit loss. As a result of these favorable credit trends (and faster prepayments), we are recognizing more income under the effective yield method from our residential credit-enhancement portfolio. (We calculate GAAP yields for our assets using long-term assumptions about prepayments, future credit losses over the life of the mortgage, and the timing of credit losses. For many of our more seasoned assets, we have increased the yield we are recognizing for GAAP purposes, as relative to initial assumptions current estimates of the likely long-term prepayment rate has increased, estimates of total life-of-the-mortgage credit losses has decreased, and/or estimates of the likely timing of credit losses has been extended to later years). We have also reduced our credit provision expense rates for the more seasoned portions of our residential loan portfolio. If favorable credit results, risk reduction through increasing housing prices, and faster prepayment rates continue, we will continue to increase our estimates of the long-term cash flows we will receive from these assets and will thus recognize increased yields on our credit-enhancement portfolio and reduced credit provision expense rates on our loan portfolios. However, the economy is still weak, deflationary forces are still evident, and some observers believe that housing prices are vulnerable. A reversal of our current favorable credit trends remains a real possibility. If this occurs, the asset yields we recognize into income would decline or we would incur a mark-to-market expense under EITF 99-20. We monitor relevant market trends continuously, and revise, as appropriate, the assumptions that go into our GAAP yield calculations and credit provisions.
We believe our competitive position remains strong. We believe we have an efficient balance sheet combined with good economies of scale, strong capabilities, and a strong market position. Over the last twelve months, we have noted an increase in competition in the form of increased demand for residential whole loans from banks, increased demand for residential credit-enhancement securities from specialized investors, and an increase in demand for investment-grade real estate securities from corporate bond buyers and investment managers accumulating collateral for Collateralized Bond Obligation (CBO) issuances. This increased demand for assets has increased prices for some of the assets we generally seek to acquire for investment. These price increases do not affect cash flows from our current assets. Given what we believe to be our strong
26
Our short-term earnings can vary from quarter to quarter due to fluctuations in interest rates, prepayment rates, asset market values, and other factors; however, we believe we are well balanced from an asset/ liability management perspective and we believe that it is unlikely that fluctuations in these short-term factors will alter the returns we can generate over the long-term.
Our first goal in managing Redwoods operations is to do our best to make sure that our regular dividend rate for common shareholders remains sustainable in the long run from the cash flows generated by our assets. We believe that our current regular quarterly dividend rate of $0.63 per common share is more likely than not to be sustainable, given our current expectations for cash flow generation and other factors.
Reconciliation of GAAP Income and Core Income
The table below reconciles GAAP earnings to core earnings.
Table 1
Variable | ||||||||||||||||||||||||||||
Stock | ||||||||||||||||||||||||||||
Asset | Option | |||||||||||||||||||||||||||
Mark-to- | Mark-to- | Average | GAAP | Core | ||||||||||||||||||||||||
GAAP | Market | Market | Core | Diluted | Earnings | Earnings | ||||||||||||||||||||||
Earnings | Adjustments | Adjustments | Earnings | Shares | Per Share | Per Share | ||||||||||||||||||||||
Q3: 2001
|
$ | 8,065 | $ | 104 | $ | (227 | ) | $ | 8,188 | 10,752,062 | $ | 0.75 | $ | 0.76 | ||||||||||||||
Q4: 2001
|
8,955 | (800 | ) | (20 | ) | 9,775 | 12,888,420 | 0.69 | 0.76 | |||||||||||||||||||
Q1: 2002
|
11,219 | 875 | (543 | ) | 10,887 | 14,077,405 | 0.80 | 0.77 | ||||||||||||||||||||
Q2: 2002
|
13,802 | 2,045 | (789 | ) | 12,546 | 15,747,048 | 0.88 | 0.80 | ||||||||||||||||||||
Q3: 2002
|
14,306 | 730 | 745 | 12,831 | 16,240,194 | 0.88 | 0.79 | |||||||||||||||||||||
Nine Months: 2001
|
$ | 21,208 | $ | (36 | ) | $ | (891 | ) | $ | 22,135 | 9,666,136 | $ | 2.19 | $ | 2.29 | |||||||||||||
Nine Months: 2002
|
39,327 | 3,650 | (587 | ) | 36,264 | 15,365,352 | 2.56 | 2.36 |
Core earnings is not a measure of earnings in accordance with generally accepted accounting principles (GAAP). It is calculated as GAAP earnings from ongoing operations less mark-to-market adjustments (on certain assets, hedges, and variable stock options) and non-recurring items. Management believes that core earnings provide relevant and useful information regarding our results of operations in addition to GAAP measures of performance. This is, in part, because market valuation adjustments on only a portion of our assets and stock options and none of our liabilities are recognized through our income statement under GAAP and these valuation adjustments may not be fully indicative of changes in market values on our balance sheet or a reliable guide to our current or future operating performance. Furthermore, gains or losses realized upon sales of assets and operating results of closed business units are generally non-recurring and any non-recurring items may also be unrepresentative of our current or future operating performance. Because all companies and analysts do not calculate non-GAAP measures such as core earnings in the same fashion, core earnings as calculated by us may not be comparable to similarly titled measures reported by other companies.
Net Interest Income |
Net interest income after credit expenses was $17.8 million in both the third and second quarters of 2002 and $11.6 million in the third quarter of 2001. Net interest income has generally tracked changes in our equity
27
Table 2
Net | Interest | Interest | ||||||||||||||||||||||||||||||
Interest | Interest | Rate | Rate | Net | ||||||||||||||||||||||||||||
Income | Income | Spread | Margin | Interest | ||||||||||||||||||||||||||||
After | After | Earning | Cost | After | After | Income/ | ||||||||||||||||||||||||||
Credit | Interest | Credit | Asset | Of | Credit | Credit | Average | |||||||||||||||||||||||||
Expenses | Expense | Expenses | Yield | Funds | Expenses | Expenses | Equity | |||||||||||||||||||||||||
Q3: 2001
|
$ | 33,172 | $ | (21,555 | ) | $ | 11,617 | 6.63 | % | 4.83 | % | 1.80 | % | 2.24 | % | 18.3 | % | |||||||||||||||
Q4: 2001
|
31,277 | (18,091 | ) | 13,186 | 5.41 | % | 3.56 | % | 1.85 | % | 2.22 | % | 17.4 | % | ||||||||||||||||||
Q1: 2002
|
30,716 | (15,602 | ) | 15,114 | 4.92 | % | 2.82 | % | 2.10 | % | 2.36 | % | 18.1 | % | ||||||||||||||||||
Q2: 2002
|
36,252 | (18,489 | ) | 17,763 | 4.71 | % | 2.69 | % | 2.02 | % | 2.25 | % | 19.1 | % | ||||||||||||||||||
Q3: 2002
|
42,093 | (24,291 | ) | 17,802 | 4.07 | % | 2.57 | % | 1.50 | % | 1.68 | % | 18.5 | % | ||||||||||||||||||
Nine Months: 2001
|
$ | 113,262 | $ | (79,978 | ) | $ | 33,284 | 7.19 | % | 5.57 | % | 1.62 | % | 2.04 | % | 19.2 | % | |||||||||||||||
Nine Months: 2002
|
109,061 | (58,382 | ) | 50,679 | 4.48 | % | 2.66 | % | 1.82 | % | 2.03 | % | 18.6 | % |
Interest rate spread (yield on assets less cost of borrowed funds) and interest rate margin (net interest income divided by assets) are profitability measures often tracked by analysts of financial institutions. When measuring our balance sheet and income statement on a recourse basis as in Table 3 (non-recourse securitizations are accounted for as sales), our interest rate spread and margin increased in the third quarter of 2002 relative to the second quarter of 2002. However, as shown in Table 2, when measuring our balance sheet and income statement as we have chosen to report them for GAAP (non-recourse securitizations are accounted for as financings), our interest rate spread and margin decreased in the third quarter of 2002 relative to the second quarter of 2002. In each case, trends in these ratios over the last two quarters have, we believe, been more a function of trends in our portfolio investment mix for assets that have different accounting methods (our loan portfolio is growing relative to our residential credit-enhancement securities portfolio) than a function of a true change in our economic profitability. As discussed above, net interest income as a percentage of equity the portfolio profitability measure that we believe is most useful for our business has been stable.
Our primary source of debt funding is the issuance of non-recourse long-term collateralized debt through securitization transactions. Assets are transferred to special-purpose bankruptcy-remote financing trusts and non-recourse debt securities are issued from these trusts. We account for these transactions as financings. Thus, the securitized assets (residential mortgage loans and various real estate securities) remain on our reported balance sheet and the debt securities the trusts issue remain on our balance sheet as liabilities (long-term debt).
If we had used a different form of securitization these transactions may have been accounted for as sales. With sales accounting, our reported balance sheet (both assets and liabilities) would be substantially smaller (although the economics of the transaction and our exposure to risks would be unchanged). However, under sale accounting, our reported asset or liability-based ratios be different. For instance, our interest rate spread would be wider and our debt-to-equity ratio lower. Ratios calculated on this basis (sales accounting) may be more comparable to those reported by some other financial institutions. The table below presents our interest income and interest expense on an at-risk basis for assets and on a recourse basis for liabilities; that is, how our statement of income would likely be reported if we had accounted for our securitizations as sales rather than financings. Please also see the discussion under Financial Condition, Liquidity and Capital Resources Balance Sheet Leverage below for further information.
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Table 3
Total | Net | Interest | Interest | |||||||||||||||||||||||||||||
Interest | Interest | Rate | Rate | Net | ||||||||||||||||||||||||||||
Income | Income | Spread | Margin | Interest | ||||||||||||||||||||||||||||
After | After | Earning | Cost | After | After | Income/ | ||||||||||||||||||||||||||
Credit | Interest | Credit | Asset | Of | Credit | Credit | Average | |||||||||||||||||||||||||
Expenses | Expenses | Expenses | Yield | Funds | Expenses | Expenses | Equity | |||||||||||||||||||||||||
Q3: 2001
|
$ | 20,458 | $ | (8,841 | ) | $ | 11,617 | 7.74 | % | 4.15 | % | 3.59 | % | 4.11 | % | 18.3 | % | |||||||||||||||
Q4: 2001
|
19,328 | (6,142 | ) | 13,186 | 6.98 | % | 2.93 | % | 4.05 | % | 4.49 | % | 17.4 | % | ||||||||||||||||||
Q1: 2002
|
20,055 | (4,941 | ) | 15,114 | 6.61 | % | 2.12 | % | 4.49 | % | 4.72 | % | 18.1 | % | ||||||||||||||||||
Q2: 2002
|
23,358 | (5,595 | ) | 17,763 | 7.39 | % | 2.37 | % | 5.02 | % | 5.29 | % | 19.1 | % | ||||||||||||||||||
Q3: 2002
|
23,200 | (5,398 | ) | 17,802 | 7.59 | % | 2.43 | % | 5.16 | % | 5.37 | % | 18.5 | % | ||||||||||||||||||
Nine Months: 2001
|
$ | 67,543 | $ | (34,259 | ) | $ | 33,284 | 8.76 | % | 5.03 | % | 3.74 | % | 4.03 | % | 19.2 | % | |||||||||||||||
Nine Months: 2002
|
66,613 | (15,934 | ) | 50,679 | 6.93 | % | 2.31 | % | 4.62 | % | 4.95 | % | 18.6 | % |
Interest Income After Credit Expenses |
Our interest income in the third quarter of 2002 was $42.1 million, an increase from the $36.3 million earned in the second quarter of 2002 and the $33.2 million generated in the third quarter of 2001. This increase was the result of a higher average balance of earning assets primarily reflecting our growth in our residential mortgage loan portfolio over the past several quarters. For the first nine months of 2002 compared to the first nine months of 2001, total interest income decreased from $113.3 million to $109.1 million. This was a function of lower interest rates that were not entirely offset by our increase in the size of our portfolio. Most of the assets in our portfolio are adjustable rate mortgages, thus, our yield on these assets generally adjusts, with a lag, to changes in short-term interest rates (which fell in 2001). In addition, a change in the mix of assets has contributed to the decline in yields as an increasing percentage of our reported assets were adjustable-rate residential mortgage loans rather than higher-yielding residential credit-enhancement securities.
Table 4
Net | ||||||||||||||||||||||||
Average | Premium | Credit | Total | Earning | ||||||||||||||||||||
Earning | Interest | Amortization | Provision | Interest | Asset | |||||||||||||||||||
Assets | Income | Expense | Expense | Income | Yield | |||||||||||||||||||
Q3: 2001
|
$ | 2,001,687 | $ | 35,300 | $ | (1,977 | ) | $ | (151 | ) | $ | 33,172 | 6.63 | % | ||||||||||
Q4: 2001
|
2,310,906 | 36,399 | (4,854 | ) | (268 | ) | 31,277 | 5.41 | % | |||||||||||||||
Q1: 2002
|
2,498,565 | 33,977 | (2,979 | ) | (282 | ) | 30,716 | 4.92 | % | |||||||||||||||
Q2: 2002
|
3,080,165 | 37,267 | (543 | ) | (472 | ) | 36,252 | 4.71 | % | |||||||||||||||
Q3: 2002
|
4,131,870 | 44,819 | (1,832 | ) | (894 | ) | 42,093 | 4.07 | % | |||||||||||||||
Nine Months: 2001
|
$ | 2,099,740 | $ | 118,492 | $ | (4,731 | ) | $ | (499 | ) | $ | 113,262 | 7.19 | % | ||||||||||
Nine Months: 2002
|
3,242,849 | 116,063 | (5,354 | ) | (1,648 | ) | 109,061 | 4.48 | % |
To provide a greater level of detail on our interest income trends, we review interest income by product line below. Each of our product lines is a component of our single business segment of real estate finance.
Residential Mortgage Loans |
Our residential mortgage loan portfolio grew considerably in the first nine months of 2002, increasing from $1.5 billion at the beginning of 2002 to $4.8 billion at September 30, 2002. We acquired $3.6 billion
29
Table 5
Sep. 2002 | Jun. 2002 | Mar. 2002 | Dec. 2001 | Sep. 2001 | ||||||||||||||||
Start of Period Balances
|
$ | 2,803,556 | $ | 1,794,260 | $ | 1,474,862 | $ | 1,354,606 | $ | 1,060,470 | ||||||||||
Acquisitions
|
2,075,296 | 1,146,621 | 417,276 | 207,170 | 391,328 | |||||||||||||||
Sales
|
(2,960 | ) | (46,683 | ) | 0 | 0 | 0 | |||||||||||||
Principal Payments
|
(109,896 | ) | (89,582 | ) | (95,924 | ) | (82,676 | ) | (96,172 | ) | ||||||||||
Amortization Premium
|
(3,502 | ) | (1,060 | ) | (1,672 | ) | (3,991 | ) | (1,180 | ) | ||||||||||
Credit Provisions
|
(894 | ) | (472 | ) | (282 | ) | (268 | ) | (151 | ) | ||||||||||
Net Charge-Offs
|
236 | 0 | 0 | 29 | 311 | |||||||||||||||
Mark-To-Market (Balance Sheet)
|
0 | 0 | 0 | 0 | 0 | |||||||||||||||
Mark-To-Market (Income Statement)
|
57 | 472 | 0 | (8 | ) | 0 | ||||||||||||||
End of Period Balances
|
$ | 4,761,893 | $ | 2,803,556 | $ | 1,794,260 | $ | 1,474,862 | $ | 1,354,606 |
Most of our residential loans have coupon rates that adjust each month or each six months as a function of the one or six month LIBOR interest rate. Even though short-term interest rates have stabilized in 2002, the coupon rates on our variable rate loans continue to reset downwards reflecting a lagged response to the decline in short-term interest rates in 2001.
Table 6
Average | Net | |||||||||||||||||||||||||||||||
Average | Net | Average | Premium | Credit | Total | |||||||||||||||||||||||||||
Principal | Premium | Credit | Interest | Amortization | Provision | Interest | ||||||||||||||||||||||||||
Balance | Balance | Reserve | Income | Expense | Expense | Income | Yield | |||||||||||||||||||||||||
Q3: 2001
|
$ | 1,087,593 | $ | 12,138 | $ | (4,950 | ) | $ | 16,583 | $ | (1,180 | ) | $ | (151 | ) | $ | 15,252 | 5.57 | % | |||||||||||||
Q4: 2001
|
1,372,552 | 12,023 | (5,065 | ) | 18,053 | (3,990 | ) | (268 | ) | 13,795 | 4.00 | % | ||||||||||||||||||||
Q1: 2002
|
1,541,136 | 9,130 | (5,342 | ) | 16,079 | (1,672 | ) | (282 | ) | 14,125 | 3.66 | % | ||||||||||||||||||||
Q2: 2002
|
2,195,570 | 11,489 | (5,675 | ) | 21,133 | (1,060 | ) | (472 | ) | 19,601 | 3.56 | % | ||||||||||||||||||||
Q3: 2002
|
3,253,528 | 15,097 | (6,163 | ) | 28,843 | (3,502 | ) | (894 | ) | 24,447 | 3.00 | % | ||||||||||||||||||||
Nine Months: 2001
|
$ | 1,059,601 | $ | 12,857 | $ | (4,966 | ) | $ | 54,446 | $ | (2,730 | ) | $ | (499 | ) | $ | 51,217 | 6.40 | % | |||||||||||||
Nine Months: 2002
|
2,336,350 | 11,927 | (5,730 | ) | 66,055 | (6,234 | ) | (1,648 | ) | 58,173 | 3.31 | % |
Credit results remained excellent for our residential mortgage loan portfolio. At September 30, 2002, our residential mortgage loan credit reserve was $6.6 million, equal to 0.14% of the current balance of this portfolio. Although we have reduced or eliminated on-going credit provision expenses associated with many of our seasoned loans, our total credit provision expense is increasing due to the significant acquisitions of new residential mortgage loans. For new loans, we take credit provisions over time in order to establish an appropriate level of credit reserves for our estimated future credit losses on these loans.
Our residential loan portfolio delinquencies have been declining, from $5.1 million at December 31, 2001 to $1.4 million at September 30, 2002. Delinquencies include loans delinquent more than 90 days, in
30
Table 7
Loss Severity | Realized | Annualized | Ending | |||||||||||||||||||||||||
Ending | Delinquent | Delinquent | On Liquidated | Credit | Credit Losses | Credit | ||||||||||||||||||||||
Balance | Loans | Loan % | Loans | Losses | As % of Loans | Reserve | ||||||||||||||||||||||
Q3: 2001
|
$ | 1,354,606 | $ | 4,823 | 0.36 | % | 60 | % | $ | (311 | ) | 0.09 | % | $ | 4,960 | |||||||||||||
Q4: 2001
|
1,474,862 | 5,069 | 0.34 | % | 39 | % | (29 | ) | 0.01 | % | 5,199 | |||||||||||||||||
Q1: 2002
|
1,794,260 | 4,926 | 0.27 | % | 0 | % | 0 | 0.00 | % | 5,481 | ||||||||||||||||||
Q2: 2002
|
2,803,556 | 3,257 | 0.12 | % | 0 | % | 0 | 0.00 | % | 5,953 | ||||||||||||||||||
Q3: 2002
|
4,761,893 | 1,387 | 0.03 | % | 22 | % | (236 | ) | 0.01 | % | 6,611 | |||||||||||||||||
Nine Months: 2001
|
$ | 1,354,606 | $ | 4,823 | 0.36 | % | 42 | % | $ | (353 | ) | 0.03 | % | $ | 4,960 | |||||||||||||
Nine Months: 2002
|
4,761,893 | 1,387 | 0.03 | % | 22 | % | (236 | ) | 0.01 | % | 6,611 |
The characteristics of our loans continue to show the high-quality nature of our residential mortgage loan portfolio. At September 30, 2002, we owned 12,580 residential loans with a total value of $4.8 billion. These were all A quality loans at origination. Substantially all these loans (98%) were adjustable rate loans and the rest (2%) were hybrid loans (fixed rate for 3 to 7 years, then adjustable). Our average loan size was $378,529. Northern California loans were 12% of the total and Southern California loans were 12% of the total. Loans originated in 2002 were 70% of the total, loans originated in 2001 were 18% of the total, and loans originated in 2000 or earlier were 12% of the total. On average, our residential mortgage loans had 9 months of seasoning. Loans where the original loan balance exceeded 80% loan-to-value (LTV) made up 17% of loan balances; we benefit from mortgage insurance or additional pledged collateral on all of these loans, serving to substantially lower the effective LTV on these loans. The average effective LTV at origination for our mortgage loans (including the effect of mortgage insurance, pledged collateral, and other credit enhancements) was 67%. Given housing appreciation and loan amortization, we believe the current effective LTV of our residential mortgage loans at September 30, 2002 was lower than 67%.
The characteristics of the loans that we credit enhanced continued to illustrate the high-quality nature of the loans. The average FICO score of borrowers on these residential mortgage loans (for those loans where a FICO score was obtained) was 729. Borrowers with FICO scores over 720 comprised 60% of this portfolio, those with scores between 680 and 720 comprised 24%, those with scores between 620 and 680 comprised 13%, and those with scores below 620 comprised 3%. In general, loans with lower FICO scores have strong compensating factors that may serve to mitigate the apparent risk of the lower FICO score.
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Table 8
Sep. 2002 | Jun. 2002 | Mar. 2002 | Dec. 2001 | Sep. 2001 | ||||||||||||||||
Principal Value (Face Value)
|
$ | 4,736,646 | $ | 2,795,628 | $ | 1,790,239 | $ | 1,470,467 | $ | 1,346,346 | ||||||||||
Internal Credit Reserves
|
(6,611 | ) | (5,953 | ) | (5,481 | ) | (5,199 | ) | (4,960 | ) | ||||||||||
Premium (Discount) to be Amortized
|
31,858 | 13,881 | 9,502 | 9,594 | 13,220 | |||||||||||||||
Retained Residential Loans
|
$ | 4,761,893 | $ | 2,803,556 | $ | 1,794,260 | $ | 1,474,862 | $ | 1,354,606 | ||||||||||
Number of loans
|
12,580 | 7,394 | 4,914 | 4,177 | 3,909 | |||||||||||||||
Average loan size
|
$ | 379 | $ | 379 | $ | 364 | $ | 353 | $ | 347 | ||||||||||
Adjustable %
|
98 | % | 96 | % | 100 | % | 100 | % | 81 | % | ||||||||||
Hybrid %
|
2 | % | 4 | % | 0 | % | 0 | % | 19 | % | ||||||||||
Fixed %
|
0 | % | 0 | % | 0 | % | 0 | % | 0 | % | ||||||||||
Northern California
|
12 | % | 13 | % | 12 | % | 10 | % | 10 | % | ||||||||||
Southern California
|
12 | % | 12 | % | 11 | % | 12 | % | 12 | % | ||||||||||
Florida
|
11 | % | 13 | % | 12 | % | 11 | % | 11 | % | ||||||||||
Georgia
|
8 | % | 9 | % | 7 | % | 8 | % | 7 | % | ||||||||||
New York
|
6 | % | 6 | % | 7 | % | 8 | % | 8 | % | ||||||||||
New Jersey
|
5 | % | 5 | % | 5 | % | 5 | % | 5 | % | ||||||||||
Texas
|
3 | % | 3 | % | 4 | % | 4 | % | 5 | % | ||||||||||
Other states
|
43 | % | 39 | % | 42 | % | 42 | % | 42 | % | ||||||||||
Year 2002 origination
|
70 | % | 47 | % | 17 | % | 0 | % | 0 | % | ||||||||||
Year 2001 origination
|
18 | % | 31 | % | 42 | % | 45 | % | 34 | % | ||||||||||
Year 2000 origination
|
0 | % | 0 | % | 0 | % | 0 | % | 0 | % | ||||||||||
Year 1999 origination
|
3 | % | 5 | % | 9 | % | 11 | % | 12 | % | ||||||||||
Year 1998 origination or earlier
|
9 | % | 17 | % | 32 | % | 44 | % | 54 | % | ||||||||||
% balance in loans> $1mm per
loan
|
15 | % | 15 | % | 16 | % | 15 | % | 14 | % |
We intend to permanently fund all our mortgage loan investments through the issuance of long-term debt through our special purpose subsidiaries, Sequoia Mortgage Funding Corporation and Sequoia Residential Funding Inc. (Sequoia). This type of financing is non-recourse to Redwood Trust. Our exposure to our $4.4 billion of long-term financed loans is limited to our investment in Sequoia, which at September 30, 2002 was $82 million or 1.9% of the Sequoia loan balances. Short-term funded residential mortgage loans at September 30, 2002 were $0.4 billion. In the third quarter of 2002, we issued $2.3 billion in long-term debt, completing Sequoia 8, Sequoia 9, and Sequoia 10. In October 2002, we completed Sequoia 11 and issued an additional $0.7 billion of long-term debt. We plan to continue to issue long-term debt through our Sequoia program and other types of securitizations.
Residential Loan Credit-Enhancement Securities |
At September 30, 2002, we owned $324 million market value of residential loan credit-enhancement securities, a net increase of $133 million since the beginning of the year. These securities generally had below-investment-grade credit ratings and represented subordinated interests in pools of high-quality jumbo residential mortgage loans. We intend to continue to invest in these securities.
32
Table 9
Sep. 2002 | Jun. 2002 | Mar. 2002 | Dec. 2001 | Sep. 2001 | ||||||||||||||||
Start of Period Balances
|
$ | 284,759 | $ | 249,832 | $ | 190,813 | $ | 188,283 | $ | 158,704 | ||||||||||
Acquisitions
|
28,983 | 25,849 | 59,157 | 17,132 | 27,172 | |||||||||||||||
Sales
|
0 | (898 | ) | (5,037 | ) | (7,786 | ) | 0 | ||||||||||||
Principal Payments
|
(9,437 | ) | (15,801 | ) | (4,270 | ) | (3,857 | ) | (1,895 | ) | ||||||||||
Amortization of Discount
|
2,722 | 1,767 | 366 | (92 | ) | 86 | ||||||||||||||
Mark-To-Market (Balance Sheet)
|
17,351 | 21,795 | 8,758 | (3,258 | ) | 4,216 | ||||||||||||||
Mark-To-Market (Income Statement)
|
(248 | ) | 2,215 | 45 | 391 | 0 | ||||||||||||||
End of Period Balances
|
$ | 324,130 | $ | 284,759 | $ | 249,832 | $ | 190,813 | $ | 188,283 |
Our residential credit-enhancement securities are generally first-loss, second-loss, or third loss interests. First loss interests are generally allocated actual credit losses on the entire underlying pool of loans up to a maximum of the principal amount of the first loss interest. Our ownership of first loss interests provides credit-enhancement principal protection from the initial losses in the underlying pool for the second loss, third loss, and more senior interests. Similarly, any first loss interests that are owned by others and that are junior to our second and third loss interests provide our interests with some principal protection from losses (they serve as external credit-enhancement).
Our credit-enhancement interests can be called away from us under limited circumstances. This is usually beneficial for us, as we receive a payment for the full principal value of an asset that, in general, we have acquired at a discount to the principal value. Our mark-to-market income for GAAP for the first nine months of 2002 benefited by $3.2 million from this type of call activity.
At September 30, 2002, we owned $543 million principal (face) value of residential credit-enhancement securities at a cost basis of $273 million. After mark-to-market adjustments, our net investment in these assets as reported on our balance sheet was $324 million. Over the life of the underlying mortgage loans, we expect to receive $543 million in principal payments from these securities less credit losses. We receive interest payments each month on the outstanding principal amount. Of the $219 million difference between principal value and reported value, $221 million was designated as an internal credit reserve (reflecting our estimate of future credit losses over the life of the underlying mortgages), $49 million was designated as purchase discount to be accreted into income over time, and there was $51 million in cumulative positive balance sheet market valuation adjustments.
33
Table 10
Sep. 2002 | Jun. 2002 | Mar. 2002 | Dec. 2001 | Sep. 2001 | ||||||||||||||||
Total principal value (face value)
|
$ | 542,669 | $ | 492,642 | $ | 460,035 | $ | 353,435 | $ | 323,870 | ||||||||||
Internal credit reserves
|
(220,735 | ) | (206,343 | ) | (194,556 | ) | (140,411 | ) | (112,133 | ) | ||||||||||
Discount to be amortized
|
(49,360 | ) | (35,745 | ) | (28,058 | ) | (25,863 | ) | (30,365 | ) | ||||||||||
Net investment
|
$ | 272,574 | 250,554 | 237,421 | 187,161 | 181,372 | ||||||||||||||
Market valuation adjustments
|
51,556 | 34,205 | 12,411 | 3,652 | 6,911 | |||||||||||||||
Net reported value
|
$ | 324,130 | $ | 284,759 | $ | 249,832 | $ | 190,813 | $ | 188,283 | ||||||||||
First loss position, principal value
|
$ | 206,062 | $ | 181,179 | $ | 173,990 | $ | 129,019 | $ | 105,830 | ||||||||||
Second loss position, principal
value
|
152,433 | 139,290 | 127,930 | 96,567 | 84,876 | |||||||||||||||
Third loss position, principal value
|
184,174 | 172,173 | 158,115 | 127,849 | 133,164 | |||||||||||||||
Total principal value
|
$ | 542,669 | $ | 492,642 | $ | 460,035 | $ | 353,435 | $ | 323,870 | ||||||||||
First loss position, reported value
|
$ | 52,595 | $ | 46,979 | $ | 42,760 | $ | 29,648 | $ | 25,886 | ||||||||||
Second loss position, reported value
|
104,928 | 90,878 | 79,969 | 60,074 | 53,925 | |||||||||||||||
Third loss position, reported value
|
166,607 | 146,902 | 127,103 | 101,091 | 108,472 | |||||||||||||||
Total reported value
|
$ | 324,130 | $ | 284,759 | $ | 249,832 | $ | 190,813 | $ | 188,283 |
Total interest income from our residential credit-enhancement securities increased to $10.4 million in the third quarter from $9.0 million in the second quarter of 2002 and $5.2 million in the third quarter of 2001. An increase in our net investment in these securities was the principal reason for the increase in interest income from this portfolio. For the same reason, our income during the first nine months of 2002 of $26.1 million was more than double the $11.3 million we earned during the first nine months of 2001 from this portfolio.
The yield on our investment in residential credit-enhancement securities was 16.20% during the third quarter of 2002, an increase from the 15.12% yield earned in the second quarter of 2002, and an increase from the 12.44% yield earned in the third quarter of 2001. Over the past several quarters, we have increased the yields recognized for our assets that are performing well (due to lower delinquencies, lower credit losses, faster prepayments) and that are expected to continue to perform well relative to initial assumptions. For similar reasons, the average yield for this portfolio in the first nine months of 2002 was 14.98%, an increase from the 12.24% this portfolio yielded during the first nine months of 2001.
The yield we estimate and recognize under the effective yield method for each of our assets is subject to change as we constantly review our assumptions and we review performance data for each specific asset as the underlying loans season. Under the effective yield method, credit losses lower than (or later than) anticipated by our designated credit reserve and/or faster than anticipated prepayment rates could result in increasing yields being recognized from our current portfolio. Credit losses higher than (or earlier than) anticipated by our designated credit reserve and/or slower than anticipated prepayment rates could result in lower yields being recognized under the effective yield method and/or require us to take market value adjustments through our income statement under EITF 99-20. Yield and EITF 99-20 adjustments are applied on an asset-specific basis. Thus, even during a period when most of our assets perform better than anticipated, and our yield on this portfolio of securities increases (as occurred thus far in 2002), we may have some assets that have adverse changes in their outlook and market values below book prices, triggering an EITF 99-20 market value charge through our income statement. Our EITF 99-20 mark-to-market charges in the first nine months of 2002 were $1.4 million.
34
Table 11
Average | Net | |||||||||||||||||||||||||||||||
Average | Average | Net | Discount | Total | ||||||||||||||||||||||||||||
Principal | Credit | Discount | Average | Coupon | Amortization | Interest | ||||||||||||||||||||||||||
Value | Reserve | Balance | Basis | Income | Income | Income | Yield | |||||||||||||||||||||||||
Q3: 2001
|
$ | 296,417 | $ | (96,364 | ) | $ | (31,378 | ) | $ | 168,675 | $ | 5,160 | $ | 86 | $ | 5,246 | 12.44 | % | ||||||||||||||
Q4: 2001
|
328,652 | (121,183 | ) | (27,914 | ) | 179,555 | 5,484 | (92 | ) | 5,392 | 12.01 | % | ||||||||||||||||||||
Q1: 2002
|
389,798 | (164,995 | ) | (23,263 | ) | 201,540 | 6,329 | 366 | 6,695 | 13.29 | % | |||||||||||||||||||||
Q2: 2002
|
467,108 | (198,564 | ) | (30,262 | ) | 238,282 | 7,239 | 1,767 | 9,006 | 15.12 | % | |||||||||||||||||||||
Q3: 2002
|
510,712 | (211,094 | ) | (41,774 | ) | 257,844 | 7,721 | 2,722 | 10,443 | 16.20 | % | |||||||||||||||||||||
Nine Months: 2001
|
$ | 206,043 | $ | (59,112 | ) | $ | (23,901 | ) | $ | 123,030 | $ | 10,918 | $ | 373 | $ | 11,291 | 12.24 | % | ||||||||||||||
Nine Months: 2002
|
456,315 | (191,720 | ) | (31,833 | ) | 232,762 | 21,289 | 4,855 | 26,144 | 14.98 | % |
Credit losses for the residential loans that we credit enhanced through our ownership of residential credit-enhancement securities totaled $0.7 million in the first nine months of 2002. The annualized rate of credit loss was less than 1 basis point (0.01%) of the $68 billion of underlying loans we credit enhanced at September 30, 2002.
Delinquencies (over 90 days, foreclosure, bankruptcy, and REO) in our credit-enhancement loans remained steady at low levels. They were 0.22% of current balances at September 30, 2002 and 0.24% at the beginning of the year. We expect delinquencies and losses for our existing residential credit-enhancement securities to increase from their current modest levels, given a weaker economy and the natural seasoning pattern of these loans. However, in periods where we have significant increases in the size of our credit-enhanced loan amounts through the acquisition of credit-enhancement securities on performing loan pools (as occurred thus far in 2002), delinquencies as a percent of the underlying pool balances may decline due to the addition of performing loans to the denominator of this ratio.
Table 12
Redwoods | ||||||||||||||||||||||||||||
Share of | Losses To | Total Credit | ||||||||||||||||||||||||||
Underlying | Delinquencies | Credit | External | Total | Losses as | |||||||||||||||||||||||
Mortgage | (Losses) | Credit | Credit | % of Loans | ||||||||||||||||||||||||
Loans | $ | % | Recoveries | Enhancement | Losses | (annualized) | ||||||||||||||||||||||
Q3: 2001
|
$ | 49,977,641 | $ | 107,821 | 0.22 | % | $ | (192 | ) | $ | (407 | ) | $ | (599 | ) | 0.01 | % | |||||||||||
Q4: 2001
|
51,720,856 | 124,812 | 0.24 | % | (321 | ) | (571 | ) | (892 | ) | 0.01 | % | ||||||||||||||||
Q1: 2002
|
64,826,605 | 129,849 | 0.20 | % | 166 | (618 | ) | (452 | ) | 0.01 | % | |||||||||||||||||
Q2: 2002
|
66,061,159 | 149,960 | 0.23 | % | 74 | (189 | ) | (115 | ) | 0.01 | % | |||||||||||||||||
Q3: 2002
|
68,483,359 | 151,507 | 0.22 | % | (47 | ) | (103 | ) | (150 | ) | 0.01 | % | ||||||||||||||||
Nine Months: 2001
|
$ | 49,977,641 | $ | 107,821 | 0.22 | % | $ | (443 | ) | $ | (1,781 | ) | $ | (2,224 | ) | 0.01 | % | |||||||||||
Nine Months: 2002
|
68,483,359 | 151,507 | 0.22 | % | 193 | (910 | ) | (717 | ) | 0.01 | % |
At September 30, 2002, we had $64 million of external credit enhancement reserves and $221 million of internal credit reserves for this portfolio. External credit reserves serve to protect us from credit losses on a specific asset basis and represent the principal value of interests that are junior to us and are owned by others.
35
Table 13
Sep. 2002 | Jun. 2002 | Mar. 2002 | Dec. 2001 | Sep. 2001 | ||||||||||||||||
Internal Credit Reserves
|
$ | 220,735 | $ | 206,343 | $ | 194,556 | $ | 140,411 | $ | 112,133 | ||||||||||
External Credit Enhancement
|
64,147 | 65,102 | 79,924 | 90,224 | 94,745 | |||||||||||||||
Total Credit Protection
|
$ | 284,882 | $ | 271,445 | $ | 274,480 | $ | 230,635 | $ | 206,878 | ||||||||||
As % of Total Portfolio
|
0.42 | % | 0.41 | % | 0.42 | % | 0.45 | % | 0.41 | % |
Based on the most recent loan level detail available for each pool in which we own an interest, the following provides a summary of the characteristics of the loans in our credit-enhancement portfolio. At September 30, 2002, we credit enhanced 160,695 loans in this portfolio. Of the $68 billion loan balances, 52% were fixed-rate loans, 28% were hybrid loans (loans that become adjustable 3 to 10 years after origination), and 20% were adjustable-rate loans. The average size of the loans that we credit-enhanced was $426,170. Loans we credit-enhanced with principal balances in excess of $1 million had an average size of $1.3 million and a total loan balance of $4.4 billion. Loans over $1 million were 2% of the total number of loans and 6% of the total balance of loans that we credit-enhanced at September 30, 2002.
On average, our credit-enhancement portfolio loans had 24 months of seasoning at September 30, 2002. Generally, the credit risk for seasoned loans is reduced as property values appreciate and the loan balances amortize. The current LTV ratio for seasoned loans is often much reduced from the LTV ratio at origination.
Loans with LTVs at origination in excess of 80% made up 5% of loan balances. We benefit from mortgage insurance or additional pledged collateral on 99% of these loans, serving to substantially reduce the effective LTV on these loans. The average effective LTV at origination for all the loans we credit enhance (including the effect of mortgage insurance, pledged collateral, and other credit enhancements) was 69%. Given housing appreciation and loan amortization, we believe the average current effective LTV for these loans at September 30, 2002 was lower than 69%.
36
Table 14
Sep. 2002 | Jun. 2002 | Mar. 2002 | Dec. 2001 | Sep. 2001 | ||||||||||||||||
Credit-enhancement securities
|
$ | 68,483,359 | $ | 66,061,159 | $ | 64,826,605 | $ | 51,720,856 | $ | 49,977,641 | ||||||||||
Number of credit-enhanced loans
|
160,695 | 165,515 | 162,502 | 133,634 | 132,555 | |||||||||||||||
Average loan size
|
$ | 426 | $ | 399 | $ | 398 | $ | 387 | $ | 377 | ||||||||||
Adjustable %
|
20 | % | 19 | % | 19 | % | 15 | % | 11 | % | ||||||||||
Hybrid %
|
28 | % | 20 | % | 14 | % | 17 | % | 19 | % | ||||||||||
Fixed %
|
52 | % | 61 | % | 67 | % | 68 | % | 70 | % | ||||||||||
Northern California
|
27 | % | 25 | % | 25 | % | 27 | % | 25 | % | ||||||||||
Southern California
|
24 | % | 24 | % | 25 | % | 26 | % | 26 | % | ||||||||||
New York
|
4 | % | 5 | % | 5 | % | 5 | % | 5 | % | ||||||||||
Texas
|
3 | % | 4 | % | 4 | % | 4 | % | 4 | % | ||||||||||
Virginia
|
3 | % | 3 | % | 3 | % | 3 | % | 3 | % | ||||||||||
New Jersey
|
3 | % | 3 | % | 3 | % | 3 | % | 3 | % | ||||||||||
Other states
|
36 | % | 36 | % | 35 | % | 32 | % | 34 | % | ||||||||||
Year 2002 origination
|
25 | % | 11 | % | 1 | % | 0 | % | 0 | % | ||||||||||
Year 2001 origination
|
43 | % | 49 | % | 55 | % | 43 | % | 32 | % | ||||||||||
Year 2000 origination
|
5 | % | 6 | % | 8 | % | 10 | % | 14 | % | ||||||||||
Year 1999 origination
|
11 | % | 16 | % | 17 | % | 22 | % | 31 | % | ||||||||||
Year 1998 or earlier origination
|
16 | % | 18 | % | 19 | % | 25 | % | 23 | % | ||||||||||
% balance in loans> $1mm per
loan
|
6 | % | 5 | % | 4 | % | 4 | % | 3 | % |
The geographic dispersion of our credit-enhancement portfolio generally mirrors that of the jumbo residential market as a whole, with approximately half of our loans concentrated in California.
For the loans that we credit enhanced where the home was located in Northern California (27% of the total portfolio), at September 30, 2002 the average loan balance was $451,956, the average FICO score was 732, and the average LTV at origination was 66%. On average, these Northern California loans had 21 months of seasoning, with 33% originated in year 2002, 39% in year 2001, 4% in year 2000, and 24% in years 1999 or earlier. At quarter end, loans with principal balances in excess of $1 million had an average size of $1.3 million and a total loan balance of $1.4 billion. They represented 3% of the total number of Northern California loans and 8% of the total balance of Northern California loans. Delinquencies in our Northern California residential credit-enhancement portfolio at September 30, 2002 were 0.10% of current loan balances.
For the loans that we credit enhanced where the home was located in Southern California (24% of the total portfolio), at September 30, 2002 the average loan balance was $438,638, the average FICO score was 727, and the average LTV at origination was 69%. On average, these Southern California loans had 30 months of seasoning, with 24% originated in year 2002, 36% in year 2001, 3% in year 2000, and 37% in years 1999 or earlier. At quarter end, loans with principal balances in excess of $1 million had an average size of $1.4 million and a total loan balance of $1.3 billion. They represented 3% of the total number of Southern California loans and 8% of the total balance of Southern California loans. Delinquencies in our Southern California residential credit-enhancement portfolio at September 30, 2002 were 0.22% of current loan balances.
37
Combined Residential Loan Portfolios |
The tables below summarize our residential mortgage loan portfolio and our residential credit-enhancement loan portfolio on a combined basis.
Table 15
Total | ||||||||||||||||||||
Redwoods | Credit | |||||||||||||||||||
Total | Residential | External | Total | Protection | ||||||||||||||||
Residential | Credit | Credit | Credit | As % of | ||||||||||||||||
Loans | Reserve | Enhancement | Protection | Loans | ||||||||||||||||
September 2001
|
$ | 51,332,247 | $ | 117,093 | $ | 94,745 | $ | 211,838 | 0.41 | % | ||||||||||
December 2001
|
53,195,718 | 145,610 | 90,224 | 235,834 | 0.44 | % | ||||||||||||||
March 2002
|
66,620,865 | 200,037 | 79,924 | 279,961 | 0.42 | % | ||||||||||||||
June 2002
|
68,864,715 | 212,296 | 65,102 | 277,398 | 0.40 | % | ||||||||||||||
September 2002
|
73,245,252 | 227,346 | 64,147 | 291,493 | 0.40 | % |
Table 16
Delinquencies | Redwoods | Losses | Total | |||||||||||||||||||||
As % of | Share of | To | Credit | |||||||||||||||||||||
Total | Net Credit | External | Total | Losses as | ||||||||||||||||||||
Residential | (Losses) | Credit | Credit | % of Loans | ||||||||||||||||||||
Delinquencies | Loans | Recoveries | Enhancement | Losses | (Annualized) | |||||||||||||||||||
Q3: 2001
|
$ | 112,644 | 0.22 | % | $ | (503 | ) | $ | (407 | ) | $ | (910 | ) | 0.01 | % | |||||||||
Q4: 2001
|
129,881 | 0.24 | % | (352 | ) | (571 | ) | (923 | ) | 0.01 | % | |||||||||||||
Q1: 2002
|
134,775 | 0.20 | % | 166 | (618 | ) | (452 | ) | 0.01 | % | ||||||||||||||
Q2: 2002
|
153,217 | 0.22 | % | 74 | (189 | ) | (115 | ) | 0.01 | % | ||||||||||||||
Q3: 2002
|
152,894 | 0.21 | % | (283 | ) | (103 | ) | (386 | ) | 0.01 | % | |||||||||||||
Nine Months: 2001
|
$ | 112,644 | 0.22 | % | $ | (796 | ) | $ | (1,781 | ) | $ | (2,577 | ) | 0.01 | % | |||||||||
Nine Months: 2002
|
152,894 | 0.21 | % | (43 | ) | (910 | ) | (953 | ) | 0.01 | % |
38
Commercial Mortgage Loans |
Our commercial real estate loan portfolio remained in the $49 million to $51 million range this year with minor levels of activity. We plan to continue to invest in more commercial loans and commercial loan participations in the future.
Table 17
Sep. 2002 | Jun. 2002 | Mar. 2002 | Dec. 2001 | Sep. 2001 | ||||||||||||||||
Start of Period Balances
|
$ | 49,798 | $ | 49,380 | $ | 51,084 | $ | 64,362 | $ | 67,043 | ||||||||||
Acquisitions
|
919 | 470 | 140 | 210 | 0 | |||||||||||||||
Sales
|
0 | 0 | 0 | 0 | (2,645 | ) | ||||||||||||||
Principal Payments
|
(54 | ) | (53 | ) | (1,873 | ) | (13,403 | ) | (44 | ) | ||||||||||
Amortization
|
0 | 0 | 28 | 29 | 15 | |||||||||||||||
Mark-To-Market (Balance Sheet)
|
0 | 0 | 0 | 0 | 0 | |||||||||||||||
Mark-To-Market (Income Statement)
|
1 | 1 | 1 | (114 | ) | (7 | ) | |||||||||||||
End of Period Balances
|
$ | 50,664 | $ | 49,798 | $ | 49,380 | $ | 51,084 | $ | 64,362 |
All our commercial mortgage loans in our portfolio had interest rate floors, so the decline in short-term interest rates during 2001 did not have a material impact on the yields on these loans. Thus, the yield on our commercial mortgage loan portfolio has remained in a relatively stable range over the past several quarters. Our yield during the first nine months of 2002 was lower than the yield during the first nine months of 2001 due to a reduction in fees recognized at the time of a loan payoff in the later period. Early payoffs generally result in the acceleration of the recognition of deferred origination fees, prepayment penalty, and exit fees.
Table 18
Average | ||||||||||||||||||||||||||||
Average | Net | Discount | Credit | Total | ||||||||||||||||||||||||
Principal | Discount | Coupon | Amortization | Provision | Interest | |||||||||||||||||||||||
Value | Balance | Income | Income | Expense | Income | Yield | ||||||||||||||||||||||
Q3: 2001
|
$ | 66,024 | $ | (724 | ) | $ | 1,680 | $ | 15 | $ | 0 | $ | 1,695 | 10.38 | % | |||||||||||||
Q4: 2001
|
64,851 | (601 | ) | 1,862 | 29 | 0 | 1,891 | 11.77 | % | |||||||||||||||||||
Q1: 2002
|
50,872 | (702 | ) | 1,247 | 27 | 0 | 1,274 | 10.15 | % | |||||||||||||||||||
Q2: 2002
|
50,036 | (667 | ) | 1,233 | 0 | 0 | 1,233 | 9.99 | % | |||||||||||||||||||
Q3: 2002
|
50,754 | (652 | ) | 1,280 | 0 | 0 | 1,280 | 10.22 | % | |||||||||||||||||||
Nine Months: 2001
|
$ | 70,018 | $ | (935 | ) | $ | 5,395 | $ | 194 | $ | 0 | $ | 5,589 | 10.79 | % | |||||||||||||
Nine Months: 2002
|
50,554 | (673 | ) | 3,760 | 27 | 0 | 3,787 | 10.12 | % |
Through September 30, 2002, we have not experienced delinquencies or credit losses in our commercial mortgage loans nor have we established a credit reserve for our commercial loans. A slowing economy, and factors particular to each loan, could cause credit concerns and issues in the future. If this occurs, we may need to provide for future losses or reduce the reported market value for commercial mortgage loans held for sale. Other factors may also affect the market value of these loans.
39
Table 19
Sep. 2002 | Jun. 2002 | Mar. 2002 | Dec. 2001 | Sep. 2001 | ||||||||||||||||
Commercial Mortgage Loans
|
$ | 50,664 | $ | 49,978 | $ | 49,380 | $ | 51,084 | $ | 64,362 | ||||||||||
Number of Loans
|
9 | 8 | 7 | 8 | 14 | |||||||||||||||
Average Loan Size
|
$ | 5,629 | $ | 6,247 | $ | 7,054 | $ | 6,386 | $ | 4,597 | ||||||||||
Serious Delinquency $
|
$ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||||
Realized Credit losses
|
$ | 0 | $ | 0 | $ | 0 | $ | 0 | $ | 0 | ||||||||||
California %
|
62 | % | 61 | % | 61 | % | 59 | % | 67 | % |
Our goal is to secure long-term non-recourse debt for our commercial mortgage loans. In the first nine months of 2002, we issued $8 million of long-term debt collateralized debt for our commercial real estate mortgage loans. At September 30, 2002, three of our commercial loans, totaling over $30 million of principal, were financed through long-term debt in the form of commercial loan participations. In the first nine months of 2002, we acquired subordinate participations in two commercial mortgage loans originated by others. Our loan participations and our remaining commercial mortgage loans were financed with either equity or a combination of equity and medium-term credit facilities.
Securities Portfolio |
Our securities portfolio consists of all the securities that we own with the exception of residential credit-enhancement securities (discussed above) and cash-equivalent securities.
Our current strategy for our securities portfolio is to sell many of our securities that are financed with short-term borrowings. These securities are generally rated AAA or AA. We plan to continue to invest in real estate loan securities that can be financed with securitized long-term debt in the form of re-REMICs or collateralized bond obligations (CBOs). To a greater degree than in the past, we anticipate that our new real estate securities investments will be rated A or BBB.
At September 30, 2002, our securities portfolio consisted of $492 million investment-grade real estate loan securities, including prime residential, sub-prime residential, manufactured housing, second-lien residential, diverse commercial real estate, and real estate CBO securities. As investors in these investment-grade securities, we are exposed to the credit risk of the underlying mortgage loans but we also benefit from a significant degree of credit-enhancement that the rating agencies require in order to give these securities an investment-grade rating. We also own equity in real estate-oriented CBOs.
In the fourth quarter of 2002, we have committed to sell most of our AAA and AA rated securities that we believe are not efficient to fund with long-term debt. We continue to invest in diverse real estate loan securities that are suitable for long-term funding. In the fourth quarter of 2002, we have made initial investments in below-investment grade commercial real estate securities and corporate debt issued by REITs that own commercial real estate properties.
A portion of our securities portfolio is currently financed with long-term debt and we are planning additional long-term debt issuances. Securities in this portfolio that were not funded with long-term debt totaled $683 million at December 31, 2001 and $419 million at September 30, 2002.
40
Table 20
Sep. 2002 | Jun. 2002 | Mar. 2002 | Dec. 2001 | Sep. 2001 | ||||||||||||||||
Start of Period Balances
|
$ | 512,490 | $ | 609,432 | $ | 683,482 | $ | 608,793 | $ | 739,187 | ||||||||||
Acquisitions
|
6,811 | 23,026 | 76,701 | 147,251 | 47,323 | |||||||||||||||
Sales
|
0 | (56,802 | ) | (89,395 | ) | (15,260 | ) | (106,297 | ) | |||||||||||
Principal Payments
|
(31,830 | ) | (65,617 | ) | (60,040 | ) | (53,400 | ) | (71,692 | ) | ||||||||||
Premium Amortization
|
(1,052 | ) | (1,249 | ) | (1,701 | ) | (799 | ) | (898 | ) | ||||||||||
Mark-To-Market (Balance Sheet)
|
970 | 3,017 | (444 | ) | (2,034 | ) | 1,087 | |||||||||||||
Mark-To-Market (Income Statement)
|
4,367 | 683 | 829 | (1,069 | ) | 83 | ||||||||||||||
End of Period Balances
|
$ | 491,756 | $ | 512,490 | $ | 609,432 | $ | 683,482 | $ | 608,793 |
Total interest income from our securities portfolio was $5.7 million in the third quarter of 2002, a decrease from $6.2 million in the second quarter of 2002 and a decrease from $10.7 million in the third quarter of 2001. This decrease was the result of lower average balances and lower yields. For similar reasons, total interest income during the first nine months of 2002 was $20.5 million, a decrease from the $44.4 million during the first nine months of 2001.
Yields for our securities portfolio continued to fall as most of these assets were variable rate assets and the coupons reset downwards as a result of falling short-term interest rates. The yield in the third quarter of 2002 was 4.63%, a decrease from 4.70% in the second quarter of 2002 and 6.73% in the third quarter of 2001. During the first nine months of 2002, the yield was 4.82%, a decrease from 7.26% in the first nine months of 2001.
Table 21
Average | Net | |||||||||||||||||||||||
Average | Net | Premium | Total | |||||||||||||||||||||
Principal | Premium | Interest | Amortization | Interest | ||||||||||||||||||||
Value | Balance | Income | Expense | Income | Yield | |||||||||||||||||||
Q3: 2001
|
$ | 626,246 | $ | 12,332 | $ | 11,642 | $ | (898 | ) | $ | 10,744 | 6.73 | % | |||||||||||
Q4: 2001
|
628,193 | 11,838 | 10,702 | (799 | ) | 9,903 | 6.19 | % | ||||||||||||||||
Q1: 2002
|
666,570 | 10,122 | 10,215 | (1,701 | ) | 8,514 | 5.03 | % | ||||||||||||||||
Q2: 2002
|
520,844 | 8,999 | 7,471 | (1,249 | ) | 6,222 | 4.70 | % | ||||||||||||||||
Q3: 2002
|
486,095 | 7,902 | 6,770 | (1,051 | ) | 5,719 | 4.63 | % | ||||||||||||||||
Nine Months: 2001
|
$ | 802,873 | $ | 12,178 | $ | 46,924 | $ | (2,570 | ) | $ | 44,354 | 7.26 | % | |||||||||||
Nine Months: 2002
|
557,175 | 9,000 | 24,456 | (4,001 | ) | 20,455 | 4.82 | % |
41
The table below presents our securities portfolio by asset type.
Table 22
Credit | |||||||||||||||||||||||||
Rating | Sep. 2002 | Jun. 2002 | Mar. 2002 | Dec. 2001 | Sep. 2001 | ||||||||||||||||||||
FNMA & FHLMC Residential
|
AAA | $ | 224,325 | $ | 236,084 | $ | 285,174 | $ | 373,743 | $ | 389,400 | ||||||||||||||
Prime Residential
|
AAA to BBB | 218,072 | 231,613 | 295,696 | 287,770 | 197,821 | |||||||||||||||||||
Subprime & Home Equity
|
|||||||||||||||||||||||||
Residential
|
AAA to BBB | 25,935 | 25,935 | 20,935 | 15,200 | 15,650 | |||||||||||||||||||
Commercial Real Estate
|
AAA to BBB | 11,054 | 11,502 | 4,768 | 4,874 | 5,008 | |||||||||||||||||||
Real Estate CBOs
|
AAA to NR | 12,370 | 7,356 | 2,859 | 1,892 | 914 | |||||||||||||||||||
Total Securities Portfolio
|
$ | 491,756 | $ | 512,490 | $ | 609,432 | $ | 683,482 | $ | 608,793 |
We own unhedged fixed rate and hybrid securities in our securities portfolio and residential credit-enhancement securities portfolio; however, our equity base at September 30, 2002 exceeds the total amount of unhedged fixed rate and hybrid assets we own (see Table 30). We have generally avoided funding unhedged fixed rate assets with floating rate liabilities.
Interest Expense |
Short-term interest rates stabilized in the first nine months of 2002 after falling for most of 2001. However, our reported cost of borrowed funds continued to fall in 2002 as the interest rates on our borrowings adjusted to market conditions with a lag. Our total reported cost of funds was 2.57% during the third quarter of 2002, a decrease from 2.69% in the second quarter of 2002 and from 4.83% in the third quarter of 2001. Our reported cost of borrowed funds during the first nine months of 2002 was 2.66%, a decrease from 5.57% in the first nine months of 2001. Our long-term debt is generally more expensive than short-term debt and our lower-rated securities are generally more expensive to finance than higher-rated securities. Our trend towards greater utilization of long-term debt and an increase in our investment in lower-rated securities that are more costly to finance could have increased our reported cost of funds; however, the decrease in short-term interest rates more than offset these factors.
Our average reported debt levels continued to rise as we acquired residential loans, issued non-recourse long-term debt to fund these acquisitions, and accounted for these securitizations as financings. Our average reported borrowings were $3.8 billion during the third quarter of 2002, an increase from $2.8 billion in the second quarter and $1.8 billion in the third quarter of 2001. Our average reported debt balance in the first nine months of $2.9 billion was an increase from the $1.9 billion we averaged in the first nine months of 2001.
In the third quarter of 2002, our increased amount of borrowed funds on a reported basis resulted in an increase in total interest expense from the previous quarters. Total reported interest expense was $24.3 million in the third quarter of 2002, as compared to $18.5 million in the second quarter of 2002 and $21.6 million for the third quarter of 2001.
Our total reported interest expense decreased to $58.3 million in the first nine months of 2002 from $80.0 million in the first nine months 2001 due to the effect of lower short-term interest rates.
42
Table 23
Long | Long | Short | Short | |||||||||||||||||||||||||||||
Term | Term | Average | Term | Term | Total | |||||||||||||||||||||||||||
Average | Debt | Debt | Short | Debt | Debt | Total | Cost | |||||||||||||||||||||||||
Long Term | Interest | Cost of | Term | Interest | Cost of | Interest | of | |||||||||||||||||||||||||
Debt | Expense | Funds | Debt | Expense | Funds | Expense | Funds | |||||||||||||||||||||||||
Q3: 2001
|
$ | 933,340 | $ | 12,714 | 5.45 | % | $ | 852,341 | $ | 8,841 | 4.15 | % | $ | 21,555 | 4.83 | % | ||||||||||||||||
Q4: 2001
|
1,193,050 | 11,949 | 4.01 | % | 839,879 | 6,142 | 2.93 | % | 18,091 | 3.56 | % | |||||||||||||||||||||
Q1: 2002
|
1,280,503 | 10,661 | 3.33 | % | 931,424 | 4,941 | 2.12 | % | 15,602 | 2.82 | % | |||||||||||||||||||||
Q2: 2002
|
1,806,884 | 12,894 | 2.85 | % | 945,331 | 5,595 | 2.37 | % | 18,489 | 2.69 | % | |||||||||||||||||||||
Q3: 2002
|
2,893,682 | 18,893 | 2.61 | % | 888,035 | 5,398 | 2.43 | % | 24,291 | 2.57 | % | |||||||||||||||||||||
Nine Months: 2001
|
$ | 1,007,321 | $ | 45,719 | 6.05 | % | 908,563 | $ | 34,259 | 5.03 | % | $ | 79,978 | 5.57 | % | |||||||||||||||||
Nine Months: 2002
|
1,999,599 | 42,448 | 2.83 | % | 921,438 | 15,934 | 2.31 | % | 58,382 | 2.66 | % |
As shown in Tables 3 and 28, on a recourse basis (assuming we had accounted for our non-recourse securitizations as sales rather than financings) our cost of borrowed funds rose slightly (from 2.37% to 2.43%) in the third quarter of 2002 relative to the prior quarter. However, our recourse debt declined during the quarter from $1.0 billion to $0.8 billion as we reduced balance sheet leverage on a recourse basis. As a result, our interest expense on a recourse basis declined from $5.6 million in the second quarter of 2002 to $5.4 million in the third quarter of 2002.
We continue to issue long-term debt to finance our residential loans, commercial loans, and securities. The table below lists our long-term debt issuances through September 30, 2002. The principal balance of each of these long-term debt issuances pays down as a function of the principal payouts received on the underlying mortgage loans.
43
Table 24
Principal | Interest | |||||||||||||||||||||||||||||||
Original | Estimated | Outstanding | Rate At | |||||||||||||||||||||||||||||
Debt | Issue | Issue | Stated | Callable | At Sep. 30, | Sep. 30, | ||||||||||||||||||||||||||
Long Term Debt Issue | Rating | Date | Amount | Index | Maturity | Date | 2002 | 2002 | ||||||||||||||||||||||||
Sequoia 1 A1
|
AAA | 7/29/97 | $ | 334,347 | 1m LIBOR | 2/15/28 | Called | $ | 0 | NM | ||||||||||||||||||||||
Sequoia 1 A2
|
AAA | 7/29/97 | 200,000 | Fed Funds | 2/15/28 | Called | 0 | NM | ||||||||||||||||||||||||
Sequoia 2 A1
|
AAA | 11/6/97 | 592,560 | 1y Treasury | 3/30/29 | 2003 | 196,543 | 3.37 | % | |||||||||||||||||||||||
Sequoia 2 A2
|
AAA | 11/6/97 | 156,600 | 1m LIBOR | 3/30/29 | 2003 | 51,942 | 2.15 | % | |||||||||||||||||||||||
Sequoia 3 A1
|
AAA | 6/26/98 | 225,459 | Fixed to 12/02 | 5/31/28 | Retired | 0 | NM | ||||||||||||||||||||||||
Sequoia 3 A2
|
AAA | 6/26/98 | 95,000 | Fixed to 12/02 | 5/31/28 | Retired | 0 | NM | ||||||||||||||||||||||||
Sequoia 3 A3
|
AAA | 6/26/98 | 164,200 | Fixed to 12/02 | 5/31/28 | 2002 | 0 | NM | ||||||||||||||||||||||||
Sequoia 3 A4
|
AAA | 6/26/98 | 121,923 | Fixed to 12/02 | 5/31/28 | 2002 | 73,940 | 6.25 | % | |||||||||||||||||||||||
Sequoia 3 M1
|
AA/AAA | 6/26/98 | 16,127 | Fixed to 12/02 | 5/31/28 | 2002 | 16,127 | 6.78 | % | |||||||||||||||||||||||
Sequoia 3 M2
|
A/AA | 6/26/98 | 7,741 | Fixed to 12/02 | 5/31/28 | 2002 | 7,741 | 6.78 | % | |||||||||||||||||||||||
Sequoia 3 M3
|
BBB/A | 6/26/98 | 4,838 | Fixed to 12/02 | 5/31/28 | 2002 | 4,838 | 6.78 | % | |||||||||||||||||||||||
Sequoia 1A A1
|
AAA | 5/4/99 | 157,266 | 1m LIBOR | 2/15/28 | Called | 0 | NM | ||||||||||||||||||||||||
Sequoia 4 A
|
AAA | 3/21/00 | 377,119 | 1m LIBOR | 8/31/24 | 2006 | 212,255 | 2.18 | % | |||||||||||||||||||||||
Commercial 1
|
NR | 3/30/01 | 9,010 | 1m LIBOR | 11/1/02 | NC | 9,010 | 4.84 | % | |||||||||||||||||||||||
Commercial 2
|
NR | 3/30/01 | 8,320 | 1m LIBOR | 10/1/03 | NC | 8,320 | 4.84 | % | |||||||||||||||||||||||
Sequoia 5 A
|
AAA | 10/29/01 | 496,667 | 1m LIBOR | 10/29/26 | 2008 | 455,625 | 2.17 | % | |||||||||||||||||||||||
Sequoia 5 B1
|
AA | 10/29/01 | 5,918 | 1m LIBOR | 10/29/26 | 2008 | 5,918 | 2.62 | % | |||||||||||||||||||||||
Sequoia 5 B2
|
A | 10/29/01 | 5,146 | 1m LIBOR | 10/29/26 | 2008 | 5,146 | 2.62 | % | |||||||||||||||||||||||
Sequoia 5 B3
|
BBB | 10/29/01 | 2,316 | 1m LIBOR | 10/29/26 | 2008 | 2,316 | 2.62 | % | |||||||||||||||||||||||
Commercial 3
|
NR | 3/1/02 | 8,318 | 1m LIBOR | 7/1/03 | NC | 8,296 | 8.63 | % | |||||||||||||||||||||||
Sequoia 6A
|
AAA | 4/26/02 | 496,378 | 1m LIBOR | 4/26/27 | 2008 | 474,590 | 2.14 | % | |||||||||||||||||||||||
Sequoia 6B1
|
AA | 4/26/02 | 5,915 | 1m LIBOR | 4/26/27 | 2008 | 5,915 | 2.52 | % | |||||||||||||||||||||||
SMFC 2002-A A1
|
AAA | 4/30/02 | 64,761 | 1m LIBOR | 4/30/30 | 2008 | 57,379 | 2.41 | % | |||||||||||||||||||||||
SMFC 2002-A A2
|
AAA | 4/30/02 | 15,861 | 1m LIBOR | 8/30/29 | 2008 | 14,451 | 2.56 | % | |||||||||||||||||||||||
Sequoia 7A
|
AAA | 5/29/02 | 554,686 | 1m LIBOR | 5/29/32 | 2008 | 534,570 | 2.16 | % | |||||||||||||||||||||||
Sequoia 7B1
|
AA | 5/29/02 | 8,080 | 1m LIBOR | 5/29/32 | 2008 | 8,080 | 2.57 | % | |||||||||||||||||||||||
Sequoia 8 1A-1
|
AAA | 7/30/02 | 50,000 | 1m LIBOR | 8/20/32 | 2008 | 42,496 | 1.95 | % | |||||||||||||||||||||||
Sequoia 8 1A-2
|
AAA | 7/30/02 | 61,468 | Fixed to 12/04 | 8/20/32 | 2008 | 61,468 | 3.46 | % | |||||||||||||||||||||||
Sequoia 8 2A
|
AAA | 7/30/02 | 463,097 | 1m LIBOR | 8/20/32 | 2008 | 459,900 | 2.12 | % | |||||||||||||||||||||||
Sequoia 8 3A
|
AAA | 7/30/02 | 49,973 | 6m LIBOR | 8/20/32 | 2008 | 49,882 | 3.91 | % | |||||||||||||||||||||||
Sequoia 8 B1
|
AA | 7/30/02 | 9,069 | 1m LIBOR | 8/20/32 | 2008 | 9,069 | 2.50 | % | |||||||||||||||||||||||
Sequoia 9 1A
|
AAA | 8/28/02 | 381,689 | 1m LIBOR | 9/20/32 | 2010 | 380,615 | 2.17 | % | |||||||||||||||||||||||
Sequoia 9 2A
|
AAA | 8/28/02 | 168,875 | 1m LIBOR | 9/20/32 | 2010 | 166,043 | 3.58 | % | |||||||||||||||||||||||
Sequoia 9 B1
|
AA | 8/28/02 | 7,702 | 1m LIBOR | 9/20/32 | 2010 | 7,702 | 2.57 | % | |||||||||||||||||||||||
Sequoia 10 1A
|
AAA | 9/26/02 | 822,375 | 1m LIBOR | 10/20/27 | 2010 | 822,375 | 2.21 | % | |||||||||||||||||||||||
Sequoia 10 2A-1
|
AAA | 9/26/02 | 190,000 | 1m LIBOR | 10/20/27 | 2010 | 190,000 | 2.19 | % | |||||||||||||||||||||||
Sequoia 10 2A-2
|
AAA | 9/26/02 | 3,500 | 1m LIBOR | 10/20/27 | 2010 | 3,500 | 2.49 | % | |||||||||||||||||||||||
Sequoia 10 B1
|
AA | 9/26/02 | 12,600 | 1m LIBOR | 10/20/27 | 2010 | 12,600 | 2.61 | % | |||||||||||||||||||||||
Sequoia 10 B2
|
A | 9/26/02 | 8,400 | 1m LIBOR | 10/20/27 | 2010 | 8,400 | 2.61 | % | |||||||||||||||||||||||
Sequoia 10 B3
|
BBB | 9/26/02 | 4,725 | 1m LIBOR | 10/20/27 | 2010 | 4,725 | 3.21 | % | |||||||||||||||||||||||
Total Long-Term Debt
|
$ | 6,368,029 | $ | 4,371,777 | 2.45 | % | ||||||||||||||||||||||||||
Operating Expenses |
Operating expenses as a percentage of equity is, in our opinion, the best measure of operating cost efficiency for our company. Although this measure varies from quarter to quarter due to factors such as equity offerings and variable compensation expense accruals tied to earnings and dividends the general trend has been towards greater productivity.
44
Operating expenses as a percentage of equity improved from 5.3% in the first nine months of 2001 to 4.5% in the first nine months of 2002. Total operating expenses include performance-based operating expenses, which were higher in the 2002 periods as a result of increased performance to date. If we continue to increase the scale of our business, we would generally expect to continue to benefit from our operating leverage as we would expect growth in our operating expenses to be restrained relative to growth in equity and net interest income.
Table 25
Efficiency | ||||||||||||||||||||
Variable | Ratio: | |||||||||||||||||||
(Performance | Operating | Operating | ||||||||||||||||||
Fixed | Based) | Expenses/ | Expenses/ | |||||||||||||||||
Operating | Operating | Operating | Average | Net Interest | ||||||||||||||||
Expenses | Expenses | Expenses | Equity | Income | ||||||||||||||||
Q3: 2001
|
$ | 2,748 | $ | 1,293 | $ | 1,455 | 4.3 | % | 24 | % | ||||||||||
Q4: 2001
|
2,730 | 1,560 | 1,170 | 3.6 | % | 21 | % | |||||||||||||
Q1: 2002
|
3,546 | 1,758 | 1,788 | 4.3 | % | 23 | % | |||||||||||||
Q2: 2002
|
4,536 | 2,081 | 2,455 | 4.9 | % | 26 | % | |||||||||||||
Q3: 2002
|
4,290 | 2,101 | 2,189 | 4.5 | % | 24 | % | |||||||||||||
Nine Months: 2001
|
$ | 9,106 | $ | 4,722 | $ | 4,384 | 5.3 | % | 27 | % | ||||||||||
Nine Months: 2002
|
12,372 | 5,940 | 6,432 | 4.5 | % | 24 | % |
Stock Option Costs |
We currently recognize the cost of stock option issuance in our GAAP financial statements in two ways. First, in accordance with GAAP, we recognize in our per-share calculations the potential dilutive effect of all of our outstanding options that are in the money (those that have an option strike price less than the current Redwood share price). Our GAAP earnings per share, which is calculated on a diluted share basis, was $0.88 in the third quarter of 2002. Without this calculation of potential dilution, reported GAAP earnings (per basic share) was $0.91 per share. For the three-month period ending September 30, 2002, the difference between our average shares outstanding and average diluted shares outstanding (incorporating the potential dilutive effect of options) was 510,012 shares, or 3.2% of our average shares outstanding.
Second, we include in GAAP income stock option expenses associated with a portion of our stock options that require variable accounting treatment under GAAP. This GAAP income (expense) represents the change in the in-the-money amount (stock price less strike price, times number of options outstanding) of a portion of our outstanding stock options. This is not cash income or expense. In periods of stock price appreciation, like the first nine months of 2002, this expense totaled $0.6 million, or $0.04 per diluted share for this period. During periods of stock price decline, this accounting treatment may provide a net gain in income (like the third quarter of 2002) where it added $0.7 million ($0.05 per share) to our reported income for the quarter. This income (expense) is included in our Other Income (Expense) on our Income Statement. Since it is based on the market price of our common stock per share, we consider it a type of mark-to-market expense and exclude it from our core earnings calculations.
We have not adopted the fair value method under FAS 123 as a method of accounting for stock options and related items. As disclosed in our Annual Report on Form 10-K for the year ended December 31, 2001, the effect to year 2001 earnings of adoption of this method of accounting would have been less than 2% of our GAAP net income.
45
Mark-to-Market Adjustments |
Changes in the market value of certain of our mortgage assets and interest rate agreements affect our GAAP earnings each quarter. For the first nine months of 2002, income statement mark-to-market adjustments totaled a positive $3.7 million, or $0.22 per share. We also mark-to-market certain assets through our balance sheet; these adjustments affect our reported book value but not our earnings. Net balance sheet adjustments were positive $51.4 million in the first nine months of 2002. These increases in market values, totaling $55.1 million, were due to falling interest rates, increased competition and demand for mortgage assets in the market, favorable prepayment and credit performance, and other factors.
Shareholder Wealth |
In the 8 years since the commencement of Redwoods operations, cumulative shareholder wealth has grown at a compound rate of 20% per year. We define shareholder wealth as growth in tangible book value per share, plus dividends paid, plus reinvestment of dividends. In calculating shareholder wealth, we assume that dividends were reinvested through the purchase of additional shares at the prevailing book value per share. With this assumption, the shareholder wealth we created can be compared to book value per share growth at a non-REIT company that has retained its earnings and compounded book value within the company. This is a measure of management value-added, not a measure of actual shareholder returns.
Book value per share was $11.67 in September 1994 when we commenced operations. We increased book value to $26.39 per share at September 30, 2002 through the retention of cash by keeping dividends lower than cash flow, net positive changes in market values of assets, issuance of stock at prices above book value, and repurchases of stock at prices below book value. Since we mark-to-market many of our assets through our balance sheet, reported book value is a good approximation of tangible value in the company. Cumulative dividends paid during this period were $12.00 per share, and reinvestment earnings on those dividends were $10.87 per share. Thus, cumulatively, shareholder wealth has increased from $11.67 per share to $49.26 per share during this 8-year period. A company that earned a 20% after-tax return on equity and retained all its earnings would have shown a similar amount of shareholder wealth growth during this period.
Table 26
Dividends | Cumulative | |||||||||||||||||||
Declared | Reinvestment | Cumulative | ||||||||||||||||||
Book Value | During | Cumulative | Earnings on | Shareholder | ||||||||||||||||
Per Share | Period | Dividends | Dividends | Wealth | ||||||||||||||||
Sep. 1994
|
$ | 11.67 | $ | 0.00 | $ | 0.00 | $ | 0.00 | $ | 11.67 | ||||||||||
Dec. 1994
|
10.82 | 0.25 | 0.25 | 0.00 | 11.07 | |||||||||||||||
Dec. 1995
|
12.38 | 0.96 | 1.21 | 0.09 | 13.68 | |||||||||||||||
Dec. 1996
|
16.50 | 1.67 | 2.88 | 1.07 | 20.45 | |||||||||||||||
Dec. 1997
|
21.55 | 2.15 | 5.03 | 3.07 | 29.65 | |||||||||||||||
Dec. 1998
|
20.27 | 0.28 | 5.31 | 2.67 | 28.25 | |||||||||||||||
Dec. 1999
|
20.88 | 0.40 | 5.71 | 3.07 | 29.66 | |||||||||||||||
Dec. 2000
|
21.47 | 1.61 | 7.32 |