================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: JUNE 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____________ TO _____________ COMMISSION FILE NUMBER: 0-26436 REDWOOD TRUST, INC. (Exact name of Registrant as specified in its Charter) MARYLAND 68-0329422 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 591 REDWOOD HIGHWAY, SUITE 3100 MILL VALLEY, CALIFORNIA 94941 (Address of principal executive offices) (Zip Code) (415) 389-7373 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------ ------- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of stock, as of the last practicable date. Class B Preferred Stock ($.01 par value) 909,518 as of August 11, 1997 Common Stock ($.01 par value) 14,809,167 as of August 11, 1997
================================================================================ REDWOOD TRUST, INC. FORM 10-Q INDEX
Page ---- PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements Consolidated Balance Sheets at June 30, 1997 and December 31, 1996 ............................ 3 Consolidated Statements of Operations for the three and six months ended June 30, 1997 and June 30, 1996 ......................................................... 4 Consolidated Statements of Stockholders' Equity for the three and six months ended June 30, 1997 and June 30, 1996 ......................................................... 5 Consolidated Statements of Cash Flows for the three and six months ended June 30, 1997 and June 30, 1996 ......................................................... 6 Notes to Consolidated Financial Statements .................................................... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ...................................................... 18 PART II. OTHER INFORMATION Item 1. Legal Proceedings .................................................................................. 67 Item 2. Changes in Securities .............................................................................. 67 Item 3. Defaults Upon Senior Securities. ................................................................... 67 Item 4. Submission of Matters to a Vote of Security Holders................................................. 67 Item 5. Other Information .................................................................................. 68 Item 6. Exhibits and Reports on Form 8-K. .................................................................. 68 SIGNATURES .................................................................................................... 69
2 PART I. FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS REDWOOD TRUST, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (In thousands, except share data)
June 30, 1997 December 31, 1996 --------------- ----------------- ASSETS Mortgage assets: Mortgage securities $ 2,227,389 $ 1,627,953 Mortgage loans 1,135,765 525,475 --------------- ----------------- 3,363,154 2,153,428 Interest rate agreements 4,867 2,601 Cash and cash equivalents 29,425 11,068 Accrued interest receivable 25,818 15,537 Other assets 1,242 1,563 --------------- ----------------- $ 3,424,506 $ 2,184,197 =============== ================= LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Short-term borrowings $ 3,102,784 $ 1,953,103 Accrued interest payable 18,153 14,060 Accrued expenses and other liabilities 1,743 761 Dividends payable 8,638 5,268 --------------- ----------------- 3,131,318 1,973,192 --------------- ----------------- Commitments and contingencies (See Note 11) STOCKHOLDERS' EQUITY Preferred stock, par value $0.01 per share; Class B 9.74% Cumulative Convertible 909,518 and 1,006,250 shares authorized; 909,518 and 1,006,250 shares issued and outstanding ($28,882 aggregate liquidation preference) 26,733 29,579 Common stock, par value $0.01 per share; 49,090,482 and 48,993,750 shares authorized; 13,251,847 and 10,996,572 issued and outstanding 133 110 Additional paid-in capital 274,420 187,507 Net unrealized loss on assets available for sale (3,762) (3,460) Dividends in excess of net income (4,336) (2,731) --------------- ----------------- 293,188 211,005 --------------- ----------------- $ 3,424,506 $ 2,184,197 =============== =================
The accompanying notes are an integral part of these consolidated financial statements. 3 CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share data)
Three Months Ended Six Months Ended June 30, June 30, -------------------------- -------------------------- 1997 1996 1997 1996 ----------- ----------- ----------- ----------- INTEREST INCOME Mortgage assets $ 49,243 $ 12,699 $ 87,649 $ 21,613 Cash and investments 266 202 428 419 ----------- ----------- ----------- ----------- 49,509 12,901 88,077 22,032 INTEREST EXPENSE 38,958 9,075 67,858 15,277 INTEREST RATE AGREEMENTS Interest rate agreements expense 839 255 1,434 406 ----------- ----------- ----------- ----------- NET INTEREST INCOME 9,712 3,571 18,785 6,349 Provision for credit losses 776 477 1,471 808 ----------- ----------- ----------- ----------- Net interest income after provision for credit losses 8,936 3,094 17,314 5,541 Operating expenses 1,215 594 2,382 1,087 ----------- ----------- ----------- ----------- NET INCOME 7,721 2,500 14,932 4,454 ----------- ----------- ----------- ----------- Less cash dividends on Class B preferred stock 687 -- 1,442 -- ----------- ----------- ----------- ----------- NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 7,034 $ 2,500 $ 13,490 $ 4,454 =========== =========== =========== =========== NET INCOME PER SHARE Primary $ 0.52 $ 0.29 $ 1.05 $ 0.60 Fully diluted $ 0.52 $ 0.28 $ 1.05 $ 0.58 Weighted average shares of common stock and common stock equivalents: Primary 13,470,930 8,600,232 12,800,960 7,453,969 Fully diluted 13,470,930 8,789,968 12,805,892 7,643,586 Dividends declared per Class B preferred share $ 0.755 $ -- $ 1.510 $ -- Dividends declared per common share $ 0.600 $ 0.400 $ 1.200 $ 0.860
The accompanying notes are an integral part of these consolidated financial statements. 4 REDWOOD TRUST, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the six months ended June 30, 1997 (In thousands, except share data)
Class B Preferred Stock Common Stock Additional ------------------------------------------------------ Paid-in Shares Amount Shares Amount Capital ---------- ---------- ---------- ---------- ---------- Balance, December 31, 1996 1,006,250 $ 29,579 10,996,572 $ 110 $ 187,507 ---------- ---------- ---------- ---------- ---------- Net income -- -- -- -- -- Conversion of preferred stock (6,612) (196) 6,612 1 195 Issuance of common stock -- -- 902,773 8 31,759 Dividends declared: Class B Preferred -- -- -- -- -- Common -- -- -- -- -- Fair value adjustment on assets available for sale -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- Balance, March 31, 1997 999,638 $ 29,383 11,905,957 $ 119 $ 219,461 ---------- ---------- ---------- ---------- ---------- Net income -- -- -- -- -- Conversion of preferred stock (90,120) (2,650) 90,120 1 2,649 Issuance of common stock -- -- 1,255,770 13 52,310 Dividends declared: Class B Preferred -- -- -- -- -- Common -- -- -- -- -- Fair value adjustment on assets available for sale -- -- -- -- -- ---------- ---------- ---------- ---------- ---------- Balance, June 30, 1997 909,518 $ 26,733 13,251,847 $ 133 $ 274,420 ========== ========== ========== ========== ==========
Net Unrealized Gain (Loss) on Assets Dividends in Available Excess of for Sale Net Income Total ---------- ---------- ---------- Balance, December 31, 1996 $ (3,460) $ (2,731) $ 211,005 ---------- ---------- ---------- Net income -- 7,211 7,211 Conversion of preferred stock -- -- 0 Issuance of common stock -- -- 31,767 Dividends declared: Class B Preferred -- (755) (755) Common -- (7,144) (7,144) Fair value adjustment on assets available for sale 3,578 -- 3,578 ---------- ---------- ---------- Balance, March 31, 1997 $ 118 $ (3,419) $ 245,662 ---------- ---------- ---------- Net income -- 7,721 7,721 Conversion of preferred stock -- -- 0 Issuance of common stock -- -- 52,323 Dividends declared: Class B Preferred -- (687) (687) Common -- (7,951) (7,951) Fair value adjustment on assets available for sale (3,880) -- (3,880) ---------- ---------- ---------- Balance, June 30, 1997 $ (3,762) $ (4,336) $ 293,188 ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. 5 REDWOOD TRUST, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Three Months Ended Six Months Ended June 30, June 30, 1997 1996 1997 1996 ---------- ----------- ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 7,721 $ 2,500 $ 14,932 $ 4,454 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of mortgage asset premium and discount, net 5,109 1,023 8,927 1,554 Depreciation and amortization 29 18 55 35 Provision for credit losses on mortgage assets 776 477 1,471 808 Amortization of interest rate cap agreements 756 189 1,067 340 Increase in accrued interest receivable (6,567) (2,796) (10,281) (4,022) (Increase) decrease in other assets (930) (1,098) 266 (1,164) Increase in accrued interest payable 3,191 2,436 4,093 2,762 Increase in accrued expenses and other 481 71 982 134 ---------- ----------- ------------ ------------ Net cash provided by operating activities 10,566 2,820 21,512 4,901 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of mortgage securities (492,416) (447,175) (868,626) (614,027) Purchases of mortgage loans (470,474) (49,009) (721,339) (49,009) Principal payments on mortgage securities 135,662 48,909 263,778 80,143 Principal payments on mortgage loans 64,283 4,149 109,529 5,729 Purchases of interest rate cap agreements (5,110) (489) (7,101) (654) ---------- ----------- ------------ ------------ Net cash used in investing activities (768,055) (443,615) (1,223,759) (577,818) CASH FLOWS FROM FINANCING ACTIVITIES: Net short-term borrowings 729,505 387,493 1,149,681 525,898 Net proceeds from issuance of common stock 52,323 56,544 84,090 56,575 Dividends paid (7,899) (2,540) (13,167) (3,974) ---------- ----------- ------------ ------------ Net cash provided by financing activities 773,929 441,497 1,220,604 578,499 Net increase in cash and cash equivalents 16,440 702 18,357 5,582 Cash and cash equivalents at beginning of period 12,985 9,705 11,068 4,825 ---------- ----------- ------------ ------------ Cash and cash equivalents at end of period $29,425 $ 10,407 $ 29,425 $ 10,407 ========== =========== ============ ============ Supplemental disclosure of cash flow information: Cash paid for interest $35,923 $ 6,639 $ 63,991 $ 12,515 ========== =========== ============ ============
The accompanying notes are an integral part of these consolidated financial statements. 6 REDWOOD TRUST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1997 (AMOUNTS IN THOUSANDS EXCEPT SHARE DATA) NOTE 1. THE COMPANY Redwood Trust, Inc. ("Redwood Trust" or the "Company") was incorporated in Maryland on April 11, 1994 and commenced operations on August 19, 1994. The Company acquires and manages real estate mortgage assets ("Mortgage Assets") which may be acquired as whole loans ("Mortgage Loans") or as mortgage securities representing interests in or obligations backed by pools of mortgage loans ("Mortgage Securities"). The Company acquires Mortgage Assets that are secured by single-family real estate properties throughout the United States. NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The consolidated financial statements include the accounts of Redwood Trust, Inc. and its special-purpose finance subsidiary, Sequoia Mortgage Funding Corporation (collectively, the Company). All inter-company balances and transactions have been eliminated. Certain amounts for prior years have been reclassified to conform with the 1997 presentation. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. Actual results could differ from those estimates. INCOME TAXES The Company has elected to be taxed as a Real Estate Investment Trust ("REIT") under the Internal Revenue Code (the "Code") and the corresponding provisions of State law. As a result, the Company generally will not be subject to Federal or State income taxation at the corporate level to the extent that it distributes at least 95% of its taxable income to its shareholders and complies with certain other requirements. Accordingly, no provision has been made for income taxes in the accompanying consolidated financial statements, as the Company believes it has met the prescribed distribution requirements. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less. The carrying amount of cash equivalents approximates their fair value. MORTGAGE ASSETS The Company's Mortgage Assets may consist of Mortgage Securities and Mortgage Loans. 7 Mortgage Securities Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities ("SFAS 115"), requires the Company to classify its Mortgage Securities as either trading investments, available- for-sale investments or held-to-maturity investments. Although the Company generally intends to hold most of its Mortgage Securities until maturity, it may, from time to time, sell any of its Mortgage Securities as part of its overall management of its balance sheet. Accordingly, to maintain flexibility, the Company currently classifies all of its Mortgage Securities as available- for-sale. All assets classified as available-for-sale are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. Unrealized losses on Mortgage Securities that are considered other-than- temporary, as measured by the amount of decline in fair value attributable to factors other than temporary, are recognized in income and the cost basis of the Mortgage Security is adjusted. Other-than-temporary unrealized losses are based on management's assessment of various factors affecting the expected cash flow from the Mortgage Securities, including an other-than-temporary deterioration of the credit quality of the underlying mortgages and/or the credit protection available to the related mortgage pool. Mortgage Loans Mortgage Loans are carried at their unpaid principal balance, net of unamortized discount or premium. Interest income is accrued based on the outstanding principal amount of the Mortgage Assets and their contractual terms. Discounts and premiums relating to Mortgage Assets are amortized into interest income over the lives of the Mortgage Assets using methods that approximate the effective yield method. Gains or losses on the sale of Mortgage Assets are based on the specific identification method. DEFERRED BOND ISSUANCE COSTS Costs incurred in connection with the issuance of long-term debt in the form of collateralized mortgage bonds are deferred and amortized over the estimated lives of the collateralized mortgage bonds using the interest method adjusted for the effects of prepayments. Issuance costs are included in the carrying value of the collateral for collateralized mortgage bonds. At June 30, 1997, the costs incurred in establishing the Company's long-term debt shelf are reflected as a component of Other Assets until allocated to the issuance of specific collateralized mortgage bonds. INTEREST RATE AGREEMENTS The rate the Company pays on its short-term and variable borrowings will rise and fall without limit as short-term market interest rates fluctuate. The rate the Company earns on its adjustable rate assets, however, is limited by periodic and lifetime caps. Statement of Financial Accounting Standards No. 119, Disclosure about Derivative Financial Instruments, requires the Company to provide certain disclosures concerning its derivative instruments according to a set of prescribed guidelines. Under the Company's hedging policy a specific portfolio of assets and liabilities, with similar economic characteristics including a low life strike, variable interest rate based on a market-sensitive index, similar expected prepayment rate behavior and similar periodic caps, exposing the Company to interest rate risk is identified. The hedge instruments are chosen as the ones probable of substantially reducing the interest rate risk being hedged, and a high degree of correlation is maintained on an on-going basis. Currently, the Company enters into "Interest Rate Agreements" as hedges. Interest Rate Agreements, which include interest rate cap agreements (the "Cap Agreements"), interest rate swap agreements (the "Swap Agreements"), interest rate collar agreements (the "Collar Agreements") and interest rate futures agreements (the "Futures Agreements"), entered into by the Company are intended to provide income to offset potential reduced net interest income under certain rising interest rate scenarios. The Company periodically evaluates the effectiveness of these hedges under various interest rate scenarios. 8 The Company accounts for the Interest Rate Agreements as hedges. Interest Rate Agreements that are hedging Mortgage Assets carried at fair value are also carried at fair value, with unrealized gains and losses reported as a separate component of equity. Similarly, Interest Rate Agreements that are used to hedge Mortgage Assets carried at amortized cost are reflected at amortized cost. The cost of each Cap Agreement and the net cost or payment received on each Collar Agreement is amortized over the effective period of that Cap or Collar Agreement using the effective interest method. The income and expense related to each Swap Agreement is recognized on an accrual basis. Gains and losses on early termination of Interest Rate Agreements are amortized as a component of net interest income over the remaining term of the original Interest Rate Agreement, or, if shorter, over the remaining term of associated Mortgage Assets as adjusted for estimated future principal repayments. In the event that an underlying hedged item is sold or extinguished, any related hedging gains or losses would be recognized in income. Unrealized losses on Interest Rate Agreements that are considered other-than-temporary are recognized in income and the cost basis of the Interest Rate Agreement is adjusted. The other-than-temporary decline is measured as the amount of the decline in fair value attributable to factors that are other-than-temporary. Other-than-temporary unrealized losses are based on management's assessment of various factors affecting the Interest Rate Agreements, for example, a serious deterioration of the ability of the counter-party to perform under the terms of the Interest Rate Agreement. NET INCOME PER SHARE Net income per share is based on the weighted average shares of common stock outstanding plus common equivalent shares using the treasury stock method. The treasury stock method calculation assumes all dilutive common stock equivalents are exercised and the funds generated by the exercise are used to buy back outstanding common stock at the average market price during the reporting period, for primary earnings per share, or at the end of period market price if higher, for fully diluted earnings per share. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"). SFAS 128 is designed to improve the earnings per share ("EPS") information provided in the financial statements by simplifying the existing computational guidelines, revising the disclosure requirements, and increasing the comparability of EPS data on an international basis. SFAS 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods. The Company will implement SFAS 128 in its December 31, 1997 financial statements. The following table reflects the impact that SFAS 128 would have had on the current financial statements.
Three Months Ended Six Months Ended June 30, June 30, 1997 1996 1997 1996 ----- ----- ----- ----- As Reported: Primary Earnings Per Share $0.52 $0.29 $1.05 $0.60 Fully Diluted Earnings Per Share $0.52 $0.28 $1.05 $0.58 Under SFAS No. 128: Basic Earnings Per Share $0.54 $0.32 $1.10 $0.67 Fully Diluted Earnings Per Share $0.52 $0.29 $1.05 $0.60
CREDIT RISK The majority of the Company's Mortgage Securities have protection from some degree of credit loss either through subordination, insurance, third party guarantees, or other means, whereas, Mortgage Loans do not have such protection. Many of the Company's Mortgage Securities have received ratings from one or more of the four nationally recognized credit rating agencies. Based on these ratings, and on credit criteria similar to those used by 9 rating agencies, the Company assigns a "rating equivalent" to each Mortgage Security and pool of Mortgage Loans. For purposes of assigning a rating equivalent to unrated pools of Mortgage Loans or unrated Mortgage Securities, the Company assigns a series of ratings to different portions of the pool according to the Company's estimation of how the pool would currently be structured and rated if it were newly securitized. At June 30, 1997, the Mortgage Assets held by the Company had rating equivalents ranging from AAA to unrated, with a weighted average of AA+. At December 31, 1996, the Mortgage Assets held by the Company had rating equivalents ranging from AAA to unrated, with a weighted average of AA+. An allowance for credit losses is maintained at a level deemed appropriate by management to provide for known losses as well as unidentified potential losses in its Mortgage Asset portfolio. The allowance is based upon management's assessment of various factors affecting its Mortgage Assets, including current and projected economic conditions, delinquency status and credit protection. In determining the allowance for credit losses, the Company's credit exposure is considered based on its credit risk position in the mortgage pool. These estimates are reviewed periodically and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. The reserve is increased by provisions charged to income from operations. When a loan or portions of a loan are determined to be uncollectible, the portion deemed uncollectible is charged against the allowance and subsequent recoveries, if any, are credited to the allowance. During the three and six months ended June 30, 1997 the Company provided for $776 and $1,471 in credit losses and incurred $28 and $70 in charge-offs, respectively, resulting in a reserve balance of $3,580 at June 30, 1997. During the three and six months ended June 30, 1996 the Company provided for $477 and $808 in credit losses, respectively, and incurred no charge-offs, resulting in a reserve balance of $1,298 at June 30, 1996. The reserve balance at December 31, 1996 was $2,180. RECENT ACCOUNTING PRONOUNCEMENTS In February 1997, the FASB issued SFAS No. 129, Disclosure of Information about Capital Structure. This statement establishes standards for disclosing information about an entity's capital structure. The Company intends to comply with the disclosure requirements of this statement which is effective for periods ending after December 15, 1997. On June 30, 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. This statement requires companies to classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position, and is effective for financial statements issued for fiscal years beginning after December 15, 1997. The impact of adopting SFAS No. 130 has not been determined. NOTE 3. MORTGAGE ASSETS At June 30, 1997, Mortgage Assets consisted of the following:
AGENCY NON-AGENCY MORTGAGE MORTGAGE MORTGAGE SECURITIES SECURITIES LOANS TOTAL ------------ ------------ ------------ ------------ Mortgage Assets, Gross $ 1,178,533 $ 1,000,653 $ 1,111,375 $ 3,290,561 Unamortized Discount (194) (14,774) (123) (15,091) Unamortized Premium 40,249 21,970 25,442 87,661 ------------ ------------ ------------ ------------ Amortized Cost 1,218,588 1,007,849 1,136,694 3,363,131 Allowance for Credit Losses 0 (2,651) (929) (3,580) Gross Unrealized Gains 5,606 2,719 0 8,325 Gross Unrealized Losses (817) (3,905) 0 (4,722) ============ ============ ============ ============ Carrying Value $ 1,223,377 $ 1,004,012 $ 1,135,765 $ 3,363,154 ============ ============ ============ ============
10 At December 31, 1996, Mortgage Assets consisted of the following:
AGENCY NON-AGENCY MORTGAGE MORTGAGE MORTGAGE SECURITIES SECURITIES LOANS TOTAL ----------- ----------- ----------- ----------- Mortgage Assets, Gross $ 939,936 $ 662,276 $ 515,033 $ 2,117,245 Unamortized Discount (234) (15,717) (142) (16,093) Unamortized Premium 26,939 16,366 11,012 54,317 ----------- ----------- ----------- ----------- Amortized Cost 966,641 662,925 525,903 2,155,469 Allowance for Credit Losses 0 (1,752) (428) (2,180) Gross Unrealized Gains 3,173 2,791 0 5,964 Gross Unrealized Losses (873) (4,952) 0 (5,825) =========== =========== =========== =========== Carrying Value $ 968,941 $ 659,012 $ 525,475 $ 2,153,428 =========== =========== =========== ===========
At June 30, 1997 and December 31, 1996, all investments in Mortgage Assets consisted of interests in adjustable-rate mortgages on residential properties. A majority of the mortgages in pools in which the Company owns a security interest rated less than AA are on properties located in California. Agency Mortgage Securities ("Agency Securities") represent securitized interests in pools of adjustable-rate mortgages from the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. The Agency Securities are guaranteed as to principal and interest by those US government agencies. The original maturity of the majority of the Mortgage Assets is thirty years; the actual maturity is subject to change based on the prepayments of the underlying mortgage loans. At June 30, 1997, the average annualized effective yield on the Mortgage Assets was 6.89% based on the amortized cost of the assets. At December 31, 1996, the average annualized effective yield was 7.11% based on the amortized cost of the assets. The coupons most of the adjustable-rate mortgage securities and loans owned by the Company are limited by periodic caps (generally interest rate adjustments are limited to no more than 1% every six months or 2% every year) and lifetime caps. At June 30, 1997 and December 31, 1996, the weighted average lifetime cap was 12.01% and 11.73%, respectively. NOTE 4. INTEREST RATE AGREEMENTS The amortized cost and fair value of the Company's Interest Rate Agreements are summarized as follows:
JUNE 30, 1997 DECEMBER 31, 1996 ------------- ----------------- Amortized Cost $ 12,233 $ 6,200 Gross Unrealized Gains 6 156 Gross Unrealized Losses (7,372) (3,755) ---------- ---------- Carrying Value $ 4,867 $ 2,601 ========== ==========
The sum of the notional amounts of all of the Company's Interest Rate Agreements in effect was $2.5 billion at June 30, 1997 and $1.1 billion at December 31, 1996, respectively. The sum of the notional amounts of all of the Interest Rate Agreements owned by the Company was $5.5 billion at June 30, 1997 and $2.6 billion at December 31, 1996. 11 Cap Agreements The Company had one hundred-seven outstanding Cap Agreements at June 30, 1997 and fifty-seven outstanding Cap Agreements at December 31, 1996. Potential future earnings from each of these Cap Agreements are based on variations in the London Inter-Bank Offered Rate ("LIBOR"). The sum of the notional amounts of the Company's Cap Agreements in effect was $2.1 billion and $703 million at June 30, 1997 and December 31, 1996, respectively. The weighted average cap strike rate during the three and six months ended June 30, 1997 was 7.14% and 7.29%, respectively. The weighted average cap strike rate during the three and six months ended June 30, 1996 was 7.12% and 7.22%, respectively. Under these Cap Agreements the Company will receive cash payments should an agreed-upon reference rate, either one-month or three-month LIBOR, increase above the strike rates of the Cap Agreements. Information on the Cap Agreements outstanding at June 30, 1997 is summarized below.
AVERAGE CAP EXPECTED NOTIONAL FACE AVERAGE CAP LOW CAP HIGH CAP CAP EXPENSE YEAR AMOUNT STRIKE RATE STRIKE RATE STRIKE RATE AMORTIZATION ---- ------ ----------- ----------- ----------- ------------ 1997 (last 6 months) $2,511,586 7.12% 5.50% 12.00% $2,042 1998 1,840,339 7.71% 5.50% 12.00% 4,001 1999 1,360,356 9.05% 6.30% 12.00% 2,679 2000 864,720 9.78% 7.00% 12.00% 1,547 2001 632,932 9.99% 7.00% 11.00% 1,076 2002 112,425 8.59% 7.50% 11.00% 304 2003 32,634 8.31% 7.50% 9.00% 203 2004 31,834 8.30% 7.50% 9.00% 197 2005 13,901 7.75% 7.50% 9.00% 87 2006 10,000 7.50% 7.50% 7.50% 72 2007 (first 4 months) 9,833 7.50% 7.50% 7.50% 25 -------- Total $ 12,233 ========
Collar Agreement At June 30, 1997, the Company had entered into one outstanding collar agreement, consisting of the purchase of a cap agreement subsidized by the sale of a floor agreement. On the cap portion, the Company will receive net hedge income to the extent that three month LIBOR exceeds 7.50%. On the floor portion, the Company will incur a net hedge expense to the extent that three month LIBOR falls below 5.91%. Information on the Collar Agreement outstanding at June 30, 1997 is summarized below.
EXPECTED NOTIONAL FACE CAP STRIKE FLOOR COLLAR EXPENSE EFFECTIVE PERIOD: AMOUNT INDEX RATE STRIKE RATE AMORTIZATION ----------------- ------ ----- ---- ----------- ------------ July 1997 to July 1999 $20,000 3 mo LIBOR 7.50% 5.91% $0
Swap Agreements The Company has entered into three types of Interest Rate Swap Agreements summarized as follows: Fixed vs. Floating Rate Swap Agreements: The Company had four outstanding fixed vs. floating rate Swap Agreements ("Fixed Pay Rate Swaps") at June 30, 1997 and six outstanding Fixed Pay Rate Swaps at December 31, 1996. The sum of the notional amounts of the Company's Fixed Pay Rate Swaps in effect was $95 million at June 30, 1997 and $135 million at December 12 31, 1996. Under these Swap Agreements, the Company receives the 3 month LIBOR rate and pays the agreed upon fixed rate. Information on the Fixed Pay Rate Swaps outstanding at June 30, 1997 is summarized below.
AVERAGE SWAP NOTIONAL FACE AVERAGE LOW HIGH YEAR AMOUNT PAY RATE PAY RATE PAY RATE ---- ------ -------- -------- -------- 1997 (last 6 months) $88,723 6.31% 6.08% 7.18% 1998 (first 5 months) 25,828 6.59% 6.40% 7.18%
Periodic Swap Agreements: As of June 30, 1997, the Company had entered into three Periodic Swap Agreements designed to produce income to the Company in the event that the three month LIBOR rate rises sharply. In each of these swaps, the Company receives income on the notional face at a rate equal to three month LIBOR less 0.230% to 0.265% and pays income on the notional face on the lesser of (a) three month LIBOR or (b) the prior period's LIBOR plus 0.50%. The average notional face of these swaps is $110 million, with $90 million maturing in August 1999 and $20 million maturing in September 1999. Information on the Periodic Swap Agreements outstanding at June 30, 1997 is summarized below.
AVERAGE SWAP NOTIONAL FACE AVERAGE SPREAD LOW SPREAD HIGH SPREAD YEAR AMOUNT RECEIVED RECEIVED RECEIVED ---- ------ -------- -------- -------- 1997 (last 6 months) $110,000 -0.255% -0.265% -0.230% 1998 110,000 -0.255% -0.265% -0.230% 1999 (first 9 months) 98,242 -0.257% -0.265% -0.230%
Basis Swap Agreements: As of June 30, 1997, the Company had entered into five LIBOR/Treasury bill Basis Swap Agreements totaling $160 million in notional value. These Basis Swap Agreements, in conjunction with the Company's other Swap and Cap Agreements, are designed to reduce the potential risks in that portion of the Company's balance sheet wherein Treasury-based assets are funded with LIBOR-based liabilities. The Basis Swap Agreements will produce net hedge income for the Company to the extent that three month LIBOR exceeds the average three month Treasury bill rate by 0.440% to 0.465% and will produce a net hedge expense for the Company to the extent that the spread between these two indices is narrower than 0.440% to 0.465%. The maturities of these Basis Swap Agreements are as follows: $30 million in June 1998, $50 million in December 1998, $30 million in June 1999 and $50 million in December 1999. Information on Basis Swap Agreements outstanding June 30, 1997 is summarized below.
AVERAGE SWAP NOTIONAL FACE AVERAGE SPREAD LOW SPREAD HIGH SPREAD YEAR AMOUNT PAID PAID PAID ---- ------ ---- ---- ---- 1997 (last 6 months) $160,000 0.453% 0.440% 0.465% 1998 144,877 0.455% 0.440% 0.465% 1999 64,712 0.464% 0.460% 0.465%
The Company has incurred credit risk to the extent that the counter-parties to the Interest Rate Agreements do not perform their obligations under the Interest Rate Agreements. Potential credit write-offs are limited to the amortized cost of the Cap Agreements. In addition, for Cap, Swap and Collar Agreements, if one of the counter-parties does not perform, the Company would not receive the cash to which it would otherwise be entitled under 13 the Interest Rate Agreement. In order to mitigate this risk, the Company has entered into Interest Rate Agreements only with counter-parties rated A or better and has entered into Interest Rate Agreements with seventeen different counter-parties in order to reduce the risk of credit exposure to any one counter-party. NOTE 5. SHORT-TERM BORROWINGS The Company has entered into reverse repurchase agreements, notes payable and a revolving line of credit (together "Short-Term Borrowings") to finance acquisitions of a portion of its Mortgage Assets. These Short-Term Borrowings are collateralized by a portion of the Company's Mortgage Assets. At June 30, 1997, the Company had $3,102,784 of Short-Term Borrowings outstanding with a weighted average borrowing rate of 5.978% and a weighted average maturity of 52 days. These borrowings were collateralized with $3,227,734 of Mortgage Assets. At December 31, 1996, the Company had $1,953,103 of Short-Term Borrowings outstanding with a weighted average borrowing rate of 5.83% and a weighted average remaining maturity of 98 days. These borrowing were collateralized with $2,050,813 of Mortgage Assets. In September 1996, the Company entered into a $20 million, one-year revolving line of credit agreement with a financial institution. The agreement requires that the Company maintain certain financial ratios. The Company is in compliance with all requirements. Interest rates on borrowings under this facility are based on LIBOR. At June 30, 1997, borrowings under this facility totaled $18.2 million and were committed through July 16, 1997. At December 31, 1996, borrowings under this facility totaled $19.3 million. These borrowings are reflected in the $3,102,784 and $1,953,103 of Short-Term Borrowings outstanding at June 30, 1997 and December 31, 1996. At June 30, 1997 and December 31, 1996, the Short-Term Borrowings had the following remaining maturities:
JUNE 30, 1997 DECEMBER 31, 1996 ------------- ----------------- Within 30 days $ 1,485,307 $ 268,042 30 to 90 days 695,058 667,567 Over 90 days 922,419 1,017,494 ------------ ------------ Total Borrowings $ 3,102,784 $ 1,953,103 ============ ============
For the three and six months ended June 30, 1997, the average balance of Short-Term Borrowings was $2,659,914 and $2,359,650 with a weighted average interest cost of 5.86% and 5.75%, respectively. For the three and six months ended June 30, 1996, the average balance of Short-Term Borrowings was $651,643 and $543,811 with a weighted average interest cost of 5.57% and 5.62%, respectively. The maximum balance outstanding during the six months ended June 30, 1997 was $3,114,770. The maximum balance outstanding during the year ended December 31, 1996 was $1,953,103. NOTE 6. FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents the carrying amounts and estimated fair values of the Company's financial instruments at June 30, 1997 and December 31, 1996. Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced liquidation sale.
JUNE 30, 1997 DECEMBER 31, 1996 ------------------------------ ------------------------------ CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE ------------ ------------ ------------ ------------ Assets Mortgage Assets $ 3,363,154 $ 3,363,393 $ 2,153,428 $ 2,153,428 Interest Rate Agreements 4,867 4,206 2,601 2,601
14 Management bases its fair value estimates primarily on third party bid price indications, such as bid indications provided by dealers who make markets in these assets and asset valuations made by collateralized lenders, when such indications are available. However, the fair value reported reflects estimates and may not necessarily be indicative of the amounts the Company could realize in a current market exchange. Cash and cash equivalents, interest receivable, short-term borrowings, accrued interest payable, accrued expenses and other liabilities are reflected in the financial statements at their costs, which approximates their fair value because of the short-term nature of these instruments. NOTE 7. CLASS B 9.74% CUMULATIVE CONVERTIBLE PREFERRED STOCK On August 8, 1996, the Company issued 1,006,250 shares of Class B Preferred Stock. Each share of the Class B Preferred Stock is convertible at the option of the holder at any time into one share of Common Stock. After September 30, 1999, the Company can either redeem or cause a conversion of the Class B Preferred Stock. The Class B Preferred Stock pays a dividend equal to the greater of (i) $0.755 per quarter or (ii) an amount equal to the quarterly dividend declared on the number of shares of the Common Stock into which the Class B Preferred Stock is convertible. The Class B Preferred Stock ranks senior to the Company's Common Stock as to the payment of dividends and liquidation rights. The liquidation preference entitles the holders of the Class B Preferred Stock to receive $31 per share plus any accrued dividends before any distribution is made on the Common Stock. As of June 30, 1997, a total of 96,732 shares of the Class B Preferred Stock has been converted into 96,732 shares of the Company's Common Stock. At June 30, 1997 and December 31, 1996, there were 909,518 and 1,006,250 shares of the Class B Preferred Stock outstanding, respectively. NOTE 8. STOCK PURCHASE WARRANTS At June 30, 1997 and December 31, 1996, there were 236,297 and 412,894 Warrants outstanding, respectively. Each Warrant entitles the holder to purchase 1.000667 shares of the Company's Common Stock at an exercise price of $15.00 per share. The Warrants remain exercisable until December 31, 1997. NOTE 9. STOCK OPTION PLAN The Company has adopted a Stock Option Plan for executive officers, employees and non-employee directors (the "Stock Option Plan"). The Stock Option Plan authorizes the Board of Directors (or a committee appointed by the Board of Directors) to grant "incentive stock options" as defined under section 422 of the Code ("ISOs"), options not so qualified ("NQSOs"), deferred stock, restricted stock, performance shares, stock appreciation rights and limited stock appreciation rights ("Awards") and dividend equivalent rights ("DERs") to such eligible recipients other than non-employee directors. Non-employee directors are automatically provided annual grants of NQSOs with DERs pursuant to a formula under the Stock Option Plan. The number of shares of Common Stock available under the Stock Option Plan for options and Awards, subject to certain anti-dilution provisions, is 15% of the Company's total outstanding shares of Common Stock. At June 30, 1997 and December 31, 1996, 1,181,959 and 1,138,743 shares of Common Stock, respectively, were available for grant. Of the shares of Common Stock available for grant, no more than 500,000 shares of Common Stock shall be cumulatively available for grant as ISOs. At June 30, 1997 and December 31, 1996, 317,284 and 299,633 ISOs had been granted, respectively. The exercise price for ISOs granted under the Stock Option Plan may not be less than the fair market value of shares of Common Stock at the time the ISO is granted. All stock options granted under the Stock Option Plan vest no earlier than ratably over a four year period from the date of grant and expire within ten years after the date of grant. 15 The Company's Stock Option Plan permits stock options granted under the plan to accrue stock DERs. For the three and six months ended June 30, 1997, the stock DERs accrued on NQSOs that had a stock DER feature resulted in non-cash charges to operating expenses of $80 and $204, respectively. For the three and six months ended June 30, 1996, the stock DERs accrued on NQSOs that had a stock DER feature resulted in non-cash charges to operating expenses of $79 and $164, respectively. Stock DERs represent shares of stock which are issuable to holders of stock options when the holders exercise the underlying stock options. The number of stock DER shares accrued are based on the level of the Company's dividends and on the price of the stock on the related dividend payment date. Information with respect to stock option and DER activity is as follows:
SIX MONTHS ENDED YEAR ENDED JUNE 30, 1997 DECEMBER 31, 1996 ------------------------------------ ---------------------------------- WEIGHTED AVERAGE WEIGHTED AVERAGE SHARES EXERCISE PRICE SHARES EXERCISE PRICE ----------- ---------------- ----------- -------------- Outstanding options at beginning of period: 421,577 $ 19.05 310,857 $ 9.48 Options granted 289,630 39.03 141,300 36.01 Options exercised (4,120) 0.10 (42,083) 0.11 Dividend equivalent rights earned 5,451 0.00 11,503 0.00 ----------- ----------- Outstanding options at end of period 712,538 27.14 421,577 19.05 =========== ===========
NOTE 10. DIVIDENDS The Company declared and paid the following dividends for the three and six months ended June 30, 1997 and for the year ended December 31, 1996:
DIVIDENDS PER SHARE ------------------------------- DECLARATION RECORD PAYABLE TOTAL CLASS B COMMON DATE DATE DATE DIVIDENDS PREFERRED STOCK STOCK ----------- --------- ---------- --------- --------------- ----- 6/12/97 6/30/97 7/21/97 $8,638 $0.755 $0.600 3/5/97 3/31/97 4/21/97 $7,899 $0.755 $0.600 12/16/96 12/31/96 1/21/97 $5,268 $0.755 $0.410 9/16/96 9/30/96 10/21/96 $4,016 $0.386 $0.400 6/14/96 6/28/96 7/18/96 $3,408 -- $0.400 3/11/96 3/29/96 4/19/96 $2,540 -- $0.460
Under the Internal Revenue Code of 1986, a dividend declared by a REIT in December of a calendar year, payable to shareholders of record as of a specified date in December, will be deemed to have been paid by the Company and received by the shareholders on that record date if the dividend is actually paid before February 1st of the following calendar year. Therefore, the dividend declared in December 1996 which was paid in January 1997 is considered taxable income to shareholders in the year declared. The Company's dividends are not eligible for the dividends received deduction for corporations. NOTE 11. COMMITMENTS AND CONTINGENCIES As of June 30, 1997, the Company had entered into a conditional commitment to purchase approximately $150 million of Mortgage Assets for settlement by September 1997. At June 30, 1997, the Company had no other outstanding commitments to purchase or sell Mortgage Assets or to purchase, sell or terminate Interest Rate Agreements. The Company also had no commitments to enter into additional reverse repurchase agreements or other borrowings. 16 Future minimum rental commitments as of June 30, 1997 under non-cancelable operating leases with initial or remaining terms of more than one year, are as follows:
MINIMUM RENTAL YEAR ENDING COMMITMENT DECEMBER 31, AS OF JUNE 30, 1997 ------------- ------------------- 1997 $ 96 1998 191 1999 191 2000 191 2001 64 ---- ----- Total $733
NOTE 12. SUBSEQUENT EVENTS On July 25, 1997, the Company issued $534.3 million of long-term debt in the form of collateralized mortgage bonds which were issued by Sequoia Mortgage Trust 1, a business trust established by the Company's wholly-owned subsidiary, Sequoia Mortgage Funding Corporation ("Sequoia"). These bonds are collateralized by a pool of conventional, adjustable-rate, 30 year mortgage loans secured by first liens on one- to four- family residential properties which were transferred from Redwood Trust, Inc. to Sequoia. The initial principal balance of the bond collateral pool is approximately $543.1 million. The proceeds received from this issuance are expected to be used to pay down a portion of the Company's Short-Term Borrowings. On July 25, 1997, the Company completed a public offering of 1,500,000 shares of Common Stock at an offering price of $45.00 per share. The Company received proceeds of $66.8 million, net of an underwriting discount of $0.45 per share and other offering costs. The proceeds received from this issuance are expected to be used to pay down a portion of the Company's Short-Term Borrowings. 17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes. SAFE HARBOR STATEMENT "Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995: Statements in this discussion regarding Redwood Trust, Inc. (the "Company") and its business which are not historical facts are "forward-looking statements" that involve risks and uncertainties. For a discussion of such risks and uncertainties, which could cause actual results to differ from those contained in the forward-looking statements, see "Risk Factors" commencing on Page 26 of the Company's 1996 Form 10-K. OVERVIEW Redwood Trust, Inc. is a financial institution specializing in the single-family residential mortgage spread lending business. Through its operations of building and managing a balance sheet of high quality mortgage loans and mortgage securities, the Company acts as a supplier of funds to families and individuals seeking to borrow funds in order to own a home. The Company funds its operations with debt and equity. The Company earns net income to the extent that the interest income it earns from its mortgages exceeds the cost of borrowed funds, credit loss expenses and operating expenses. The Company focuses solely on seeking to earn net interest income from first-lien single-family residential mortgage loans underwritten to "A" or "prime" quality standards. The Company believes its primary competitors in the "A" quality mortgage spread lending business are banks, savings and loans, and the two government-sponsored mortgage entities (GSE's: Fannie Mae and Freddie Mac). The Company has chosen to pursue a wholesale strategy (such as is employed by the GSEs) rather than a retail strategy (such as is employed by most banks and savings and loans). Like the GSEs. the Company does not originate loans directly but rather acquires loans from mortgage origination companies and from the secondary mortgage market. The Company out-sources the servicing of its mortgage loans. The Company sources its borrowings on a wholesale basis in the capital markets rather than seeking retail deposits through a branch banking system. The Company believes that its wholesale strategy allows the Company to operate in a highly efficient manner while remaining focused on its core spread lending business. The Company has elected to be considered a Real Estate Investment Trust (REIT) with respect to Federal and State income taxes. This election generally allows the Company to avoid paying corporate income tax so long as it distributes at least 95% of its taxable income as dividends and meets the other REIT requirements. RESULTS OF OPERATIONS Mortgage Asset Acquisitions, Principal Repayments and Net Asset Growth In the second quarter of 1997, the Company acquired $963 million new mortgage loans and mortgage securities (together, "mortgage assets"). The Company received mortgage principal repayments of $200 million during the quarter. For the second quarter of 1997, total assets grew by $785 million, or 30%, to $3.4 billion. In the second quarter of 1996, the Company acquired $496 million new mortgage assets. The Company received mortgage principal repayments of $53 million during the quarter. Net growth of total assets was $447 million, or 76%, for that quarter. The Company has increasingly focused on the acquisition of mortgage loans as opposed to mortgage securities; mortgage loans represented 49% of acquisitions in the second quarter of 1997 and 10% of acquisitions in the second quarter of 1996. Through June 30, 1997, all mortgage loans acquired have been high quality, adjustable 18 rate, first lien mortgages on single-family residential properties. All mortgage securities acquired have represented securitized interests in pools of adjustable rate, single-family mortgage loans. Through June 30, 1997, mortgage principal repayment rates for the Company have remained within management's range of expectations and have been similar to industry averages for the types of adjustable-rate mortgages owned by the Company. The average annual rate of prepayment of principal (CPR) for the Company's mortgage loans and the mortgages contained in the pools underlying its mortgage securities was 23% in the second quarter of 1997 and 29% in the second quarter of 1996. The Company also receives scheduled mortgage principal payments (payments representing the normal principal amortization of a 30-year mortgage loan). In addition, some mortgage securities owned by the Company are subject to call and some receive accelerated payments, i.e., a greater than pro-rata share of principal repayments generated by the underlying mortgage pool. The average annual rate of mortgage principal repayment from all of these sources was 28% in the second quarter of 1997 and 29% in the second quarter of 1996. In the first six months of 1997 (the first half of 1997), the Company acquired $1.59 billion new mortgage assets. The Company received mortgage principal repayments of $373 million during this period. Net growth of total assets was $1.24 billion, or 57%, for the half year. In the first six months of 1996, the Company acquired $663 million new mortgage assets. The Company received mortgage principal repayments of $86 million during the quarter. Net growth of total assets was $586 million, or 131%, for the first half of 1996. Mortgage loans represented 45% of acquisitions in the first half of 1997 and 7% of acquisitions in the first half of 1996. All other asset acquisitions during these periods were mortgage securities rated AAA and AA. The Company's average mortgage asset prepayment rate (CPR) was 23% in the first half of 1997 and 28% in the first half of 1996. The total rate of principal repayment was 30% in the first half of 1997 and 28% in the first half of 1996. Interest Income From the second quarter of 1996 to the second quarter of 1997, interest income increased by 284%. This increase was driven primarily by a 286% increase in average earning assets (mortgage assets plus cash). In the second quarter of 1997, the Company's average earning assets of $2.89 billion generated interest income of $49.5 million. In the second quarter of 1996, the Company's average earning assets of $748 million generated interest income of $12.9 million. In the second quarter of 1997, the Company's earning asset yield (interest income annualized and divided by the average daily amortized cost of earning assets) was 6.86%. The average mortgage coupon rate (mortgage interest payments annualized and divided by the average daily principal value of mortgages) was 7.74%. Since the Company's average amortized cost was 102.1% of mortgage principal value during that quarter, the coupon yield on amortized cost book value for the Company's mortgages was 7.57%. Net mortgage premium and discount amortization expenses of $5.1 million reduced the coupon yield by 0.71% for a net mortgage yield of 6.86%. The yield earned on the Company's cash balances during the quarter was 5.52%; the blended earning asset yield was 6.86%. The Company's earning asset yield was 6.90% in the second quarter of 1996. The average mortgage coupon rate was 7.47%. Since the Company's average amortized cost for mortgage assets was 99.95% of mortgage principal value during that quarter, the coupon yield on amortized cost book value for the Company's mortgages was 7.48%. Net mortgage premium and discount amortization expenses of $1.0 million reduced the coupon yield by 0.56% for a net mortgage yield of 6.92%. The yield earned on the Company's cash balances during the quarter was 5.61%, bringing the overall second quarter of 1996 blended earning asset yield to 6.90%. 19 At 6.86% and 6.90% respectively, the Company's earning asset yield was similar for the second quarters of 1997 and 1996. The total rate of mortgage principal repayment was similar for these two periods. The mortgage yield in both periods was depressed by similar amounts due to the temporary effect of lower initial coupons on newly acquired mortgages. However, the relevant short-term interest rate index levels (over the six to twelve months prior to the start of the period) averaged approximately 0.10% higher for the second quarter of 1997 as compared to the second quarter of 1996. That the Company's earning asset yield did not increase in step with increases in short-term interest rates primarily reflects a change in asset mix and strategy. During 1996 and 1997, the Company generally acquired mortgage assets with lower risk characteristics than those assets acquired in 1994 and 1995. As a result, average credit quality improved, with the percentage of the balance sheet consisting of subordinated mortgage securities rated below AA falling from 5.4% in the second quarter of 1996 to 1.7% in the second quarter of 1997. Reflecting this change in asset mix to lower risk assets (as well as certain other factors), the average equity-to-assets capital adequacy guideline determined by the Company's Risk-Adjusted Capital Policy fell from 11.4% to 9.5% over the same period. The lower risk assets acquired by the Company had higher prices; the Company's earning asset yield was reduced somewhat as compared to short-term interest rate index levels. At the same time, the reduction in the Company's capital adequacy guidelines allowed the Company to acquire and manage more mortgages per dollar of equity. The net result of this strategy was reflected in a higher return on equity earned in the second quarter of 1997 as compared to the second quarter of 1996, despite lower earnings asset yields and spreads. To some degree, the lack of an increase in the earning asset yield in the second quarter of 1997 also reflects the high pricing levels for all mortgages that have prevailed in the mortgage market for several quarters. Despite higher mortgage market pricing, the Company was able to acquire a substantial amount of new mortgage assets in the second quarter of 1997 which the Company expects will meet its return on equity criteria. Operational and capital efficiencies have improved steadily at the Company over time. Due to these efficiencies, the Company believes that it can pay a higher price for a mortgage today than it could have in the past and still have the potential to generate acceptable returns on equity in most scenarios. Nevertheless, there is a risk that mortgage market pricing may increase further in the future or that the available supply of mortgages available for sale at acceptable pricing levels will diminish; asset growth for the Company may then slow. From the first half of 1996 to the first half of 1997, interest income increased by 300%. This increase was driven primarily by a 312% increase in average earning assets. In the first half of 1997, the Company's average earning assets of $2.57 billion generated interest income of $88.1 million. In the first half of 1996, the Company's average earning assets of $623 million generated interest income of $22.0 million. In the first half of 1997, the Company's earning asset yield was 6.86%. The average mortgage coupon was 7.72%. Since the Company's average amortized cost was 102.0% of mortgage principal value during that quarter, the coupon yield on amortized cost book value for the Company's mortgages was 7.56%. Net mortgage premium and discount amortization expenses of $8.9 million reduced the coupon yield by 0.70% for a net mortgage yield of 6.86%. The yield earned on the Company's cash balances during the half was 5.44%; the blended earning asset yield was 6.86%. In the first half of 1996, the Company's earning asset yield was 7.07%. The average mortgage coupon rate was 7.58%. Since the Company's average amortized cost for mortgage assets was 99.5% of mortgage principal value during that quarter, the coupon yield on amortized cost book value for the Company's mortgages was 7.61%. Net mortgage premium and discount amortization expenses of $1.6 million reduced the coupon yield by 0.51% for a net mortgage yield of 7.10%. The yield earned on the Company's cash balances during the quarter was 5.77%, bringing the overall first half of 1996 earning asset yield to 7.07%. Interest Expense From the second quarter of 1996 to the second quarter of 1997, interest expense increased by 329%, from $9.1 million to $39.0 million. This increase was driven primarily by a 308% increase in average borrowings from $652 million to $2.66 billion. Borrowings increased at a faster rate over the last year than did earning assets (308% versus 286%) as the Company utilized a greater percentage of debt rather than equity to fund its growing mortgage operations. The average equity-to-assets ratio for the Company was 9.9% in the second quarter of 1997 and 15.2% in the second quarter of 1996. An additional factor driving the increase in interest expense was a 0.29% increase in the Company's cost of funds from 5.57% in the second quarter of 1996 to 5.86% in the second quarter of 1997. This increase reflects higher levels of short-term interest rates; one, three and six month LIBOR rates over the relevant time frame (one to six months prior to the end of the period) were 0.20% to 0.30% higher for the second quarter of 1997 than they were for the second quarter of 1996. The Company pays interest expense on its borrowings based on the actual number of days in a quarter. In a non-leap year, the first quarter has 90 days, the second quarter has 91 days, and the third and fourth quarters each have 92 days. Thus, all other factors being equal, the Company's cost of funds will have a seasonal variation pattern; it will be highest in the third and fourth quarters and will be lowest in the first quarter of the year. The increase in the Company's cost of funds attributable to this seasonal day count issue from the first to the second quarter of 1997 was approximately 0.06% (thereby reducing earnings in the second quarter by $0.032 per share relative to the first quarter, all other factors being equal). From the first half of 1996 to the first half of 1997, interest expense increased by 344%, from $15.3 million to $67.9 million. This increase was driven primarily by an increase in average borrowings of 334%, from $544 million to $2.36 billion. Borrowings increased at a faster rate than did earning assets 20 (334% versus 312%) as the Company utilized greater leverage. The average equity-to-assets ratio was 15.0% in the first half of 1996 and was 10.0% in the first half of 1997. An additional factor driving the increase in interest expense was a 0.13% increase in the Company's cost of funds from 5.62% in the first half of 1996 to 5.75% in the first half of 1997. This increase was largely due to higher average short-term interest rates over the relevant periods. Interest Rate Agreements Expense Interest rate agreements are a form of interest rate insurance, or hedging, into which the Company enters in order to reduce the effects that a large increase in interest rates could have on its balance sheet and earnings. In the second quarter of 1997, hedging expenses were $912,000 and hedging income was $73,000 for a net interest rate agreements expense of $839,000. This net expense represented 0.11% of assets, 0.13% of borrowings, and 8.0% of net interest income before hedge expenses. In the second quarter of 1996, hedging expenses were $255,000 and the Company earned no hedge income. Net hedge expenses represented 0.13% of assets, 0.16% of borrowings, and 6.7% of net interest income before hedge expenses for that quarter. Hedging expense ratios were generally lower in the second quarter of 1997 as compared to the second quarter of 1996 as the cost of obtaining new contracts representing this type of interest rate insurance declined in accordance with declines in actual and projected rates of interest rate volatility. For similar reasons, the market value of the Company's existing interest rate agreements also fell. In the first half of 1997, hedging expenses were $1.51 million and hedging income was $0.08 million for a net interest rate agreement expense of $1.43 million. This net expense represented 0.11% of assets, 0.12% of borrowings, and 7.1% of net interest income before hedge expenses. In the first half of 1996, hedging expenses were $0.41 million and the Company earned no hedge income. This net expense represented 0.13% of assets, 0.15% of liabilities, and 6.0% of net interest income before hedge expenses. 21 Net Interest Income Net interest income is interest income less interest expense and net interest rate agreement hedging expenses. Net interest income increased by 172%, from $3.6 million in the second quarter of 1996 to $9.7 million in the second quarter of 1997. This increase was driven by asset growth, although growth in net interest income was less than the growth in average total assets of 285% over the same period. Primarily as a result of the increased use of leverage, net interest income as a percentage of assets (the net interest margin) decreased from 1.85% to 1.31% while, at the same time, net interest income as a percentage of equity increased from 12.14% to 13.25%. The net interest margin also declined (growth in net interest income was lower than asset growth), and growth in net interest income as a percentage of equity was not as much as it would otherwise have been, due to a narrowed spread between the Company's yield on earning assets and the cost of its borrowed funds and hedging (interest rate spread). The Company's interest rate spread was 1.17% in the second quarter of 1996 and 0.87% in the second quarter of 1997. The Company's yield on earning assets fell by 0.04% over the last year while the cost of funds rose by 0.29% and the cost of hedging fell by 0.03%. The reduced spread in the second quarter of 1997 was primarily a result of the increase in short-term interest rates in February, March and April of 1997; the Company's borrowing costs reacted more quickly to this change than did its mortgage yield. The increase in short-term rates during that period was not of sufficient magnitude, however, to produce significant hedge income from the Company's interest rate agreements. From the first half of 1996 to the first half of 1997, net interest income increased by 196%, from $6.3 million to $18.8 million. This increase was driven by asset growth, although growth in net interest income was less than the growth in average total assets of 312% over the same period due to the increased use of debt funding. Primarily reflecting the increased use of leverage, net interest income as a percentage of assets (the net interest margin) decreased from 1.98% to 1.42% while net interest income as a percentage of equity increased from 13.22% to 14.17%. The net interest margin also declined due to a narrowed spread between the Company's yield on earning assets and the cost of its borrowed funds and hedging. The Company's interest rate spread was 1.30% in the first half of 1996 and 0.99% in the first half of 1997. For reasons discussed above, the Company's yield on earning assets fell by 0.21% while the cost of funds rose by 0.13% and the cost of hedging fell by 0.03%. Credit Provision Expense and Actual Credit Losses The Company establishes credit provisions in order build a reserve for future credit losses. Provisions were $0.78 million in the second quarter of 1997 and $0.48 million in the second quarter of 1996. The Company takes credit provisions for risk of credit loss from its portfolio of below-BBB rated subordinated mortgage securities as a function of projections of potential future losses. Loss projections are based on trends in serious delinquencies and loan loss severities (average % of loan balance written off for liquidated defaulted loans) in the underlying mortgage pools. Credit provisions for these assets were $0.48 million in the second quarter of 1997 and $0.34 million in the second quarter of 1996. The Company takes credit provisions for its mortgage loan portfolio to provide for expected credit losses over the life of the portfolio. In the second quarters of 1997 and 1996, the Company took mortgage loan provisions of $0.30 million and $0.14 million, respectively. The Company's current policy is to set aside credit provisions for mortgage loans on an on-going basis equaling 0.10% to 0.20% of its loan portfolio. Total credit provisions equaled 0.25% of average total assets and 1.62% of average equity in the second quarter of 1996 and declined to 0.10% of average assets and 1.06% of average equity in the second quarter of 1997. The decline in these ratios primarily reflects a change in asset mix towards assets with reduced credit risk; subordinated securities rated lower than BBB declined over this period as a percentage of total assets from 2.9% to 0.9%. The Company has not added to its portfolio of lower-rated subordinated mortgage securities since 1995. 22 The Company had no actual realized credit losses in the second quarter of 1996. Actual credit losses were $28,000 in the second quarter of 1997. All of this loss came from the Company's subordinated mortgage security portfolio. Total cumulative actual credit losses from the inception of the Company through June 30, 1997 have been $80,000; actual losses from subordinated mortgage securities have totaled $69,000 while actual losses from mortgage loans have totaled $13,000. Based on mortgage default and loss trends, the Company expects realized credit losses over the next few quarters to increase to levels more consistent with its provisioning rates and reserve levels, especially for its portfolio of subordinated mortgage securities. Credit provisions reduce net income and earnings per share but only actual credit losses are deducted when calculating taxable income. Dividends from a REIT are based on taxable income, so future dividends declared by the Company will be influenced by the rate of actual realized credit loss rather than the rate of credit provisioning. Net income and earnings per share will be reduced by actual losses in a direct manner only if they exceed cumulative credit provisions. Credit provisions were $1.47 million in the first half of 1997 and $0.81 million in the first half of 1996. Credit provisions for below-BBB rated mortgage securities were $0.97 million and $0.67 million while mortgage loan provisions were $0.50 million and $0.14 million, respectively. Total credit provisions equaled 0.11% of average total assets and 1.11% of average equity in the first half of 1997, a decline from 0.25% of average assets and 1.68% of average equity in the first half of 1996. Actual realized credit losses were $71,000 in the first half of 1997. The Company had no actual credit losses in the first half of 1996. Operating Expenses Total operating expenses increased by 105%, from $594,000 in the second quarter of 1996 to $1,215,000 in the second quarter of 1997. The Company expanded its staff and increased salary and bonus compensation for employees to market levels. A portion of the stock options granted to management, employees, and directors have dividend equivalent rights, or DERs, attached (each subject to a dividend hurdle rate); the dividend equivalent right expense increased as the dividend rose and the number of stock options with DERs attached increased. Other operating expenses increased as the scope of Company operations expanded. Operating expense ratios have improved as the Company realized economies of scale through growth. From the second quarter of 1996 to the second quarter of 1997, operating expenses as a percentage of assets improved from 0.31% to 0.16%, operating expenses as a percentage of equity improved from 2.02% to 1.66%, the efficiency ratio (operating expenses as a percentage of net interest income) improved from 17% to 13%, and average assets per employee improved from $84 million to $257 million. From the first half of 1996 to the first half of 1997, total operating expenses increased by 119%, from $1.09 million to $2.38 million. Operating expenses as a percentage of assets improved from 0.34% to 0.18%, operating expenses as a percentage of equity improved from 2.26% to 1.80%, the efficiency ratio improved from 17% to 13%, and average assets per employee improved from $78 million to $240 million. Net Income Before Preferred Dividends Total net income to common and preferred shareholders increased by 209%, from $2.5 million in the second quarter of 1996 to $7.7 million in the second quarter of 1997. The percentage of net interest income brought down to the net income line increased from 70% to 79%. Return on assets dropped from 1.30% to 1.04% due the increased use of debt funding while at the same time return on total equity (common plus preferred) increased from 8.50% to 10.53%. The positive effect of strong asset growth, along with improved operational and capital efficiencies, more than offset the temporary spread narrowing caused by the first quarter 1997 increase in short-term interest rates and the lower net interest margin caused by the increased use of leverage. 23 Total net income to common and preferred shareholders increased by 235%, from $4.5 million in the first half of 1996 to $14.9 million in the first half of 1997. Return on assets dropped from 1.39% to 1.13% due the increased use of debt funding while at the same time return on total equity (common plus preferred) increased from 9.28% to 11.26%. Preferred Dividends The Company's preferred stock had not yet been issued in the second quarter of 1996. In the second quarter of 1997, preferred dividends were $687,000. The preferred dividend for the quarter was $0.755 per share; 909,518 preferred shares were outstanding and received a dividend. The preferred dividend equals the greater of the common stock dividend or $0.755. After September 1999, the Company has the right to force the conversion of each share of preferred stock into one share of common stock, providing the price of the common stock exceeds $31. At June 30, 1997, the preferred stock represented $26.7 million, or 8.9%, of the Company's shareholder capitalization. Preferred dividends were $1.44 million in the first half of 1997, or $1.51 per share. There were 999,638 preferred shares outstanding at the end of the first quarter of 1997 and 909,518 shares outstanding at the end of the second quarter; both quarterly preferred dividends were $0.755 per share. Net Income to Common Shareholders Net income available for common shareholders increased by 181% over the last year, from $2.5 million in the second quarter of 1996 to $7.0 million in the second quarter of 1997. Over the same period, average common equity increased by 125% to $264.2 million. Return on common equity increased from 8.50% to 10.65%. Net income available for common shareholders increased from $4.5 million in the first half of 1996 to $13.5 million in the first half of 1997, an increase of 203%. Over the same period, average common equity increased by 146%. Return on common equity increased from 9.28% to 11.43%. Earnings Per Share The average number of common shares outstanding on a primary basis (including potential dilution from warrants and options) increased by 57%, from 8.6 million in the second quarter of 1996 to 13.5 million in the second quarter of 1997. Since net income to common shareholders increased by 181% over this period, earnings per share rose by 79%, from $0.29 to $0.52. The primary factors driving the 79% increase in earnings per share were a 25% increase in return on common equity and a 35% increase in average book value (equity) per common share. Return on equity increased for reasons discussed above. Book value per share increased as the Company issued new common stock at prices in excess of book value. The Company issued common stock in accretive offerings in November 1996 and January and April of 1997. These offerings increased book value per common share by 13%, 8% and 11%, respectively. The average number of common shares outstanding on a primary basis (including potential dilution from warrants and options) increased by 72%, from 7.45 million in the first half of 1996 to 12.80 million in the first half of 1997. Since total net income increased by 203%, earnings per share rose by 75%, from $0.60 to $1.05. This 75% increase in earnings per share was made possible by a 23% increase in return on common equity and a 33% increase in average book value (equity) per common share. Taxable REIT Income As a REIT, the Company is required to distribute as dividends over time at least 95% of its income as calculated for tax purposes (taxable REIT income). It is the Company's intention to distribute as dividends 100% of taxable income over time. 24 Taxable REIT income (before preferred dividend) was $3.1 million in the second quarter of 1996; this exceeded GAAP income of $2.5 million in that period due to differences in credit expenses of $0.48 million (actual credit losses are deducted from taxable income rather than credit provisions), premium and discount amortization of $0.08 million and operating expenses of $0.08 million. Taxable REIT income (before preferred dividend) was $8.3 million in the second quarter of 1997; this exceeded GAAP income of $7.7 million in that period due to differences in credit expenses of $0.75 million, premium and discount amortization of negative $0.10 million and operating expenses of negative $0.05 million. On a taxable REIT income basis, return on total equity was 10.69% for the second quarter of 1996 and 11.34% for the second quarter of 1997. Return on common equity was 10.69% and 11.55% for the same periods, respectively. Taxable REIT income (before preferred dividend) was $5.7 million in the first half of 1996 and $16.2 million in the first half of 1997. On a taxable REIT income basis, return on total equity was 11.85% for the first half of 1996 and 12.23% for the first half of 1997. Taxable income return on common equity was 11.85% and 12.53% for the same periods, respectively. Common Share Dividends Dividends per common share have exceeded primary earnings per common share as taxable REIT income has exceeded net income in each quarter. In addition, in most quarters, the number of common shares outstanding at the end of the quarter receiving a dividend has been lower than the average number of primary common shares (including potential dilution from warrants and options) used to calculated earnings per share. In the second quarter of 1997, the Company declared a common dividend of $0.60 per share, resulting in the distribution of $7.95 million to 13.25 million common shares outstanding at the end of the period. Together with the preferred dividend of $0.69 million, the Company distributed 103.9% of the taxable income it earned in that quarter. Through the end of the second quarter of 1997, the Company had cumulatively declared dividends equaling 99.8% of cumulative taxable REIT income earned through June 30, 1997. In the second quarter of 1996, the Company declared a common dividend of $0.40 per share, resulting in the distribution of $3.41 million to 8.52 million common shares outstanding at the end of the period. There were no preferred shares outstanding at June 30, 1996. The Company distributed 108.5% of the taxable income it earned in that quarter. At the end of the second quarter of 1996, the Company had cumulatively declared dividends equaling 98.1% of cumulative taxable REIT income earned through June 30, 1996. In the first half of 1997, the Company declared a common dividend of $1.20 per share. The total common dividend was $15.1 million. Together with the preferred dividend of $1.1 million, the Company distributed 101.9% of the taxable income it earned in that half. For the first half of 1996, the Company declared a common dividend of $0.86 per share, resulting in the distribution of $5.9 million. There were no preferred shares outstanding in the first half of 1996. The Company distributed 104.5% of the taxable income it earned in that half. 25 FINANCIAL CONDITION Mortgage Loans From December 31, 1996 to June 30, 1997, the Company's whole loan portfolio grew in size by 116% and increased as a percentage of the Company's mortgage assets from 24.5% to 33.8%. In general over this period, the California concentration dropped, the average seasoning declined, average loan size increased and original loan-to-value ratios decreased. The percentage of the loan portfolio on non-performing status remained steady at low levels. At June 30, 1997, the Company owned 3,983 adjustable-rate, first-lien mortgage loans on single-family residential properties with a principal value of $1.111 billion and an amortized cost of $1.137 billion. The Company estimates that the bid-side market value of the Company's mortgage loan portfolio at June 30, 1997 was approximately $1.136 billion. As verified by its re-underwriting process, the Company believes that all mortgage loans owned as of June 30, 1997 were generally originated to "A" quality, or "Prime" quality, underwriting standards. The average loan size was $279,000. Loans with current balances less than $214,600 (the current Fannie Mae/Freddie Mac limit for most loans) made up 20% of the dollar balance of the Company's mortgage loan portfolio, while loans with current balances in excess of $500,000 made up 27%. Loans on owner-occupied houses made up 92% of the dollar balance of the loan portfolio; second homes represented 6% and investment properties 2%. At June 30, 1997, 33% of the loans (by dollar balance) had a loan-to-value ratio (LTV) at origination in excess of 80%. Over 94% of these loans had primary mortgage insurance (PMI) or additional collateral in the form of a pledged account, typically serving to bring the effective original LTV for the Company to 75% or less on those loans. The average original LTV for the Company's mortgage loan portfolio was 76% as of June 30, 1997; after giving effect to PMI or additional pledged collateral, the average effective original LTV was 69%. As of June 30, 1997, the average seasoning of the loan portfolio was 22 months. At June 30, 1997, 34% of the mortgage loans owned by the Company were on properties located in California (13% in Northern California and 21% in Southern California). Loans in Florida were 8% of the total; other states with a greater than 3% representation in the loan portfolio included New York, Maryland, New Jersey, Connecticut, Texas, Illinois, and Georgia. At June 30, 1997, 12 mortgage loans were non-performing assets (NPAs), as they were over 90 days delinquent, in bankruptcy, in foreclosure, or had become REO (Real Estate Owned). The loan balance of these NPAs totaled $2,366,000, or 0.2% of the mortgage loan portfolio. Included in this NPA balance was REO of $346,000 resulting from the default of 3 loans. The mortgage loan credit reserve as of June 30, 1997 was $929,000. If all of the NPAs as of June 30, 1997 were to default rather than cure, and the loss severity experienced on these loans was 10%, 20%, 30%, or 40%, the Company estimates its realized credit losses from these assets would be $241,000, $481,000, $722,000 or $962,000, respectively. At June 30, 1997, management believed these defaults, to the extent they occur, would most likely occur over a period of six to twelve months, during which time the Company planned to take additional credit provisions to add to its mortgage loan credit reserve. Cumulatively through June 30, 1997, the Company has achieved resolution on one defaulted mortgage loan: the loss severity on that loan was 7%. The analysis in this paragraph reviews the risk of loss from NPAs as of June 30, 1997 only; it does not purport to analyze or measure credit losses from additional NPAs that may arise after June 30, 1997. At December 31, 1996, the Company owned 2,172 adjustable-rate, first-lien mortgage loans on single-family residential properties with a principal value of $0.515 billion and an amortized cost of $0.527 billion. The Company estimates that the bid-side market value of these mortgage loans at December 31, 1996 was approximately $0.525 billion. 26 The average loan size at December 31, 1996 was $237,000. Loans with current balances less than $214,600 (the current FNMA/FHLMC limit for most loans) made up 23% of the dollar balance of the Company's mortgage loan portfolio, while loans with current balances in excess of $500,000 made up 8%. Loans on owner-occupied houses made up 94% of the dollar balance of the loan portfolio; second homes represented 4% and investment properties 2%. At December 31, 1996, 25% of the loans (by dollar balance) had a loan-to-value ratio (LTV) at origination in excess of 80%. Over 97% of these loans had primary mortgage insurance (PMI). The average original LTV for the Company's mortgage loan portfolio was 77% as of December 31, 1996; after giving effect to PMI, the average effective original LTV was 73%. As of December 31, 1996, the average seasoning of the loan portfolio was 37 months. At December 31, 1996, 44% of the mortgage loans owned by the Company were on properties located in California (18% in Northern California and 26% in Southern California). Loans in Maryland were 8% of the total; other states with a greater than 3% representation in the portfolio included Florida, Illinois, New York, and Connecticut. At December 31, 1996, 7 loans were non-performing assets. The loan balance of these NPAs totaled $1,249,000, or 0.2% of the mortgage loan portfolio. Included in this total was one REO of $196,000. The mortgage loan credit reserve as of December 31, 1997 was $428,000. If all the NPAs as of December 31, 1996 were to default rather than cure, and the loss severity experienced on these loans was 10%, 20%, 30%, or 40%, the Company estimates its realized credit losses from these assets would have been $127,000, $253,000, $380,000 or $506,000, respectively. Mortgage Securities From December 31, 1996 to June 30, 1997, the Company's portfolio of mortgage securities increased by 37%. Mortgage securities declined as a percentage of total mortgage assets from 75.5% to 66.2%. All of the Company's mortgage securities represent interests in pools of adjustable rate, first lien mortgages on single-family residential properties. At June 30, 1997, the principal value of the Company's mortgage securities was $2.18 billion and the amortized cost was $2.23 billion. The Company estimates that the bid-side market value of the Company's mortgage securities portfolio at June 30, 1997 was approximately $2.23 billion. At June 30, 1997, 97.6% of the Company's mortgage securities had a credit rating equivalent of AAA or AA, 1.1% had a credit rating equivalent of A or BBB and 1.3% had a credit rating equivalent less than BBB. Securities guaranteed by Fannie Mae or Freddie Mac made up 54.7% of total mortgage securities. Non-agency mortgage securities structured with large amounts of subordination or other forms of third-party credit enhancement and rated AAA or AA made up 42.9% of the mortgage securities portfolio. Based on information available as of June 30, 1997, the Company had no reason to suspect that it would be likely to incur credit losses in the foreseeable future from its mortgage securities rated BBB or better. The Company has taken and expects to continue to take credit losses on its mortgage securities rated below BBB. Although the loans in the mortgage pools underlying these securities were, for the most part, originated to "A" quality standards, these securities have received lower quality credit ratings as they are subordinated to other securities issued from the same pools and therefore are subject to leveraged credit risk with respect to the underlying mortgages. At June 30, 1997, these below-BBB rated securities had a principal value of $40.3 million and an amortized cost before credit reserve of $29.1 million. The Company estimates that if all the loans in the underlying mortgage pools which were over 90 days delinquent, in foreclosure, in bankruptcy, or REO as of June 30, 1997 were to default and have a loss severity of 10%, 20%, 30%, or 40%, realized credit losses for the Company would be $0.1 million, $1.5 million, $3.7 million or $6.4 million, respectively. Cumulatively from the acquisition dates of these assets in 1994 and 1995 through June 30, 1997, 138 defaulted mortgage loans in these 27 pools had been liquidated; the average loss severity on these loans was 24%. The Company's credit reserve for these assets at June 30, 1997 was $2.65 million. At June 30, 1997, management believed prospective defaults based on serious delinquencies, to the extent they occur, would most likely occur over a period of six to twelve months, during which time the Company planned to take additional credit provisions to add to its mortgage securities credit reserve. The analysis in this paragraph reviews the risk of loss from seriously delinquent loans underlying the Company's securities as of June 30, 1997 only; it does not purport to analyze or measure credit losses from additional serious delinquencies that may arise after June 30, 1997. At December 31, 1996, the principal value of the Company's mortgage securities was $1.60 billion and the amortized cost was $1.63 billion. The Company estimates that the bid-side market value of the Company's mortgage securities portfolio at December 31, 1996 was approximately $1.63 billion. At December 31, 1996, 96.6% of the Company's mortgage securities had a credit rating equivalent of AAA or AA, 1.6% had a credit rating equivalent of A or BBB and 1.8% had a credit rating equivalent less than BBB. Securities guaranteed by Fannie Mae or Freddie Mac made up 59.4% of total mortgage securities. Other AAA and AA securities made up 37.2% of the mortgage securities portfolio. At December 31, 1996, below-BBB rated securities had a principal value of $40.8 million and an amortized cost before credit reserve of $28.9 million. The Company estimates that if all the loans in the underlying mortgage pools which were over 90 days delinquent, in foreclosure, in bankruptcy, or REO as of December 31, 1996 were to default and have a loss severity of 10%, 20%, 30%, or 40%, realized credit losses for the Company would be $0.06 million, $0.61 million, $2.04 million, or $3.65 million, respectively. The cumulative realized loss severity experience in the underlying mortgage pools for the period the Company owned these securities through December 31, 1996 was 27%. The Company's credit reserve for these assets at December 31, 1996 was $1.75 million. Total Mortgage Asset Portfolio Characteristics At June 30, 1997, the average credit rating equivalent of all of the Company's mortgage assets (loans plus securities) was AA+, with mortgage loans (the bulk of the value which would be rated AAA if securitized and rated) representing 33.8% of the total mortgage asset portfolio, AAA and AA securities representing 64.5%, A and BBB rated securities representing 0.8% and below-BBB rated securities representing 0.9%. At June 30, 1997, all mortgage assets consisted of adjustable rate mortgages. The average coupon rate accruing on these assets was 7.73%. The average level of the short-term interest rate indices which determine coupon adjustments was 5.77%. Since the average net margin was 2.23%, the highest potential average mortgage coupon rate (the fully-indexed rate) at that time was 8.00%. The actual coupon rate was lower than the fully-indexed rate by 0.27% due to acquisition of mortgage assets with initial coupons set at lower than fully-indexed rates and due to interest rate fluctuations and other factors in the year prior to June 30, 1997. At June 30, 1997, 36.0% of the Company's mortgage assets had coupon rate adjustments every six months based on the six month LIBOR or CD index and 8.8% had monthly adjustments based on the one month LIBOR index. Mortgage assets with annual coupon adjustments based on the six month or one year U.S. Treasury index were 52.1% of the portfolio and one year Treasury mortgages with an initial coupon rate set longer than one year represented 1.8%. Mortgage assets with other indices made up 1.3% of the total. At June 30, 1997, the average term to next coupon adjustment for all mortgage assets was 5 months. For most mortgage assets, coupon rate adjustments are based on the index level 30 to 75 days prior to the start of a new coupon accrual period. Potential coupon rate changes can be limited by periodic and life caps. As of June 30, 1997, the Company's average mortgage asset life time maximum cap rate was 12.01%. At June 30, 1997, periodic caps limited coupon changes to 2% annually for 81.9% of mortgage assets; mortgage assets representing 18.0% of the total had no periodic caps and 0.1% had other periodic cap arrangements. 28 At December 31, 1996, the average mortgage asset credit rating equivalent was AA+, with mortgage loans representing 24.5% of the total mortgage asset portfolio, AAA and AA securities representing 73.0%, A and BBB rated securities representing 1.2% and below-BBB rated securities representing 1.3%. At December 31, 1996, all mortgage assets consisted of adjustable rate mortgages. The average coupon rate accruing on these assets was 7.75%. The average level of the short-term interest rate indices which determine coupon adjustments was 5.58%. Since the average net margin was 2.24%, the highest potential average mortgage coupon rate (the fully-indexed rate) at that time was 7.82%. The actual coupon rate was lower than the fully-indexed rate by 0.07%. At December 31, 1996, 38.4% of the Company's mortgage assets had coupon rate adjustments every six months based on the six month LIBOR or CD index and 1.4% had monthly adjustments based on the one month LIBOR index. Six month or one year U.S. Treasury index mortgage assets made up 58.1% of the total. Mortgage assets with other indices made up 2.1% of the total. At December 31, 1996, the average term to next coupon adjustment for all mortgage assets was 5 months. As of December 31, 1996, the Company's average mortgage asset life time maximum cap rate was 11.73%. At December 31, 1996, periodic caps limited coupon changes to 2% annually for 95.7% of mortgage assets; mortgage assets representing 4.2% of the total had no periodic caps and 0.1% had other periodic cap arrangements. Interest Rate Agreements At June 30, 1997, the Company owned $5.5 billion notional face of interest rate agreements, principally caps and swaps. These interest rate agreements had various start dates, maturity dates, and interest rate protection features; they are described in detail in "Note 4. Interest Rate Agreements" in the Notes to Consolidated Financial Statements. These agreements are designed to reduce the Company's interest rate and market value fluctuation risk. They had a historical amortized cost basis of $12.2 million and an estimated bid-side market value of $4.2 million as of June 30, 1997. Market values dropped as compared to amortized cost due to a drop in interest rate volatility assumptions in the marketplace for interest rate agreements, a drop in interest rates, the effect of taking bid-ask spread mark-downs on a substantial amount of new agreements and due to the mis-matched timing of GAAP amortization methods for premiums paid for interest rate caps and the rate of actual decay in their market values. Market value fluctuations for interest rate agreements hedging mortgage securities are reflected in the Company's interest rate agreement market valuation account of negative $7.4 million at June 30, 1997. Interest rate agreements hedging mortgage loans are carried on the balance sheet at historical amortized cost. At December 31, 1996, the Company owned $2.6 billion notional face of interest rate agreements with a historical amortized cost basis of $6.2 million and an estimated bid-side market value of $2.6 million. The Company's interest rate agreement market valuation account was negative $3.6 million at that time. There is a risk that the counter-parties to the Company's interest rate agreements will not be able to perform to the terms of these contracts. If this were to happen, the Company's total accounting credit loss exposure would be limited to its historical amortized cost basis in these assets, although the true economic opportunity cost to the Company could be higher. Through June 30, 1997, each of the counter-parties to the Company's interest rate agreements had a credit rating of at least A. Net Non-Earning Assets Increases in net working capital (receivables less payables) and fixed assets reduce earnings as the Company must fund these non-earning assets with borrowings. 29 At June 30, 1997, net working capital was negative, as accrued interest payable, dividend payable, and accrued expenses exceeded interest receivable from mortgage assets and prepaid expenses. This negative working capital provided funds at that time to reduce borrowings or increase cash investments by $1.5 million. However, the Company had an average investment in net positive working capital during the second quarter of 1997 of $55.4 million, requiring additional borrowings. Total non-earning assets (including total fixed assets of $257,000) averaged $75.9 million during the second quarter of 1997, representing 2.6% of total average assets and 25.9% of average equity. At December 31, 1996, net working capital was negative by $3.0 million, providing a source of funds at that time. Total fixed assets were $257,000. Total non-earning assets during the fourth quarter of 1996 averaged $41.4 million, however, representing 2.7% of total average assets and 22.4% of average equity during that quarter. Borrowings, Cash Balances and Liquidity Through June 30, 1997, the Company's borrowings consisted of short-term collateralized borrowing arrangements such as reverse repurchase agreements, notes payable, and revolving lines of credit. Borrowings totaled $3.10 billion with an average interest expense rate of 5.91% at June 30, 1997 and $1.95 billion with an average interest expense rate of 5.83% at December 31, 1996. In each case, the principal value, historical amortized cost, carrying value, and estimated bid-side market value of these borrowings were approximately the same. As the Company has reduced risks on its balance sheet, it has utilized a greater amount of leverage: the Company's debt-to-equity ratio was 10.4x at June 30, 1997 and 9.1x at December 31, 1996. The Company has been, on average, more leveraged at quarter end than it typically has been during the quarter, as the Company has historically planned common stock equity offerings in the first month of each quarter and has acquired assets in anticipation of these offerings. The average debt-to-equity ratio was 7.3x during the fourth quarter of 1996, 8.7x during the first quarter of 1997 and 9.1x during the second quarter of 1997. At June 30, 1997, the Company had borrowings equaling 92.3% of the $3.36 billion market value of its mortgage assets. The Company estimates it had additional borrowing capacity at that time of $149 million. In addition, the Company had $29 million of cash. On average during the second quarter of 1997, the Company estimates it had additional borrowing capacity of $113 million and cash on hand of $19 million. At December 31, 1996, the Company had borrowings equaling 90.7% of the $2.15 billion market value of its mortgage assets. The Company estimates it had additional borrowing capacity at that time of $124 million, as well as $11 million of cash. During the fourth quarter of 1996, the Company estimates it had, on average, additional borrowing capacity of $85 million and cash balances of $16 million. During the first quarter of 1997, the Company estimates it had $99 million in average unused borrowing capacity and an average cash balance of $12 million. The Company's liquidity status, borrowing capacity, and ability to roll over its borrowings as they mature depend on the market value, liquidity and credit quality of its assets, the soundness and capitalization of the Company's balance sheet, the state of the collateralized lending market and other factors. If the Company's liquidity or borrowing capacity were to become seriously diminished, the Company would most likely seek to sell its mortgage assets (the sale of which, in such circumstances, might be difficult and most likely would be at a loss). In order to avoid such an occurrence, the Company seeks to maintain what it believes to be a prudent level of capital, i.e., the Company restricts its asset growth according to its Risk-Adjusted Capital Policy and thereby seeks to maintain adequate unused borrowing capacity. At June 30, 1997 and December 31, 1996, the average term to maturity of the Company's borrowings was 75 days and 98 days and the average term to next rate adjustment was 36 days and 52 days, respectively; the term to next rate adjustment was shorter than the term to maturity as some of the Company's borrowings had a cost of 30 funds that adjusted to market levels on a monthly or daily basis during the term of the borrowing. At each of these dates, the cost of these borrowings could adjust to changes in short-term interest rates, on average, several months faster than coupon rates on the Company's mortgages could adjust to those same changes. Through its interest rate agreement hedging program, the Company seeks to mitigate the short-term impact that a large increase in interest rates could have on its cost of funds and spread earnings Stockholders' Equity, Capital Efficiency and Capital Adequacy From December 31, 1996 to June 30, 1997, the Company's equity base (exclusive of the market valuation account) grew from $214.4 million to $296.9 million. This equity growth was the result of the Company's January stock offering ($29.2 million), April common stock offering ($46.0 million), proceeds from the issuance of common stock through the exercise of warrants ($2.7 million), through the Company's Dividend Reinvestment Plan ($1.3 million) and through the Company's Optional Cash Investment Plan ($4.9 million). Since taxable REIT earnings have exceeded GAAP net income, cumulative dividends paid have exceeded retained GAAP earnings; dividends exceeded GAAP earnings by $1.6 million in the first half of 1997, thus reducing stockholders' equity as measured on a GAAP basis by that amount. Book value, or equity, per share (including common and preferred, excluding the market valuation account) increased by 17% from $17.87 on December 31, 1996 to $20.97 on June 30,1997. The primary driver of this book value growth was accretive stock offerings at prices in excess of book value. For balance sheet purposes, the Company carries its mortgage securities and associated interest rate agreements at their estimated bid-side market value (historical amortized cost less market valuation account). The total market valuation account for the Company was negative $3.8 million on June 30, 1997 and negative $3.5 million on December 31, 1996. As a result of this accounting treatment, the Company's reported equity base and book value per share may fluctuate due to market conditions and other factors. Mortgage loans and all other assets and liabilities were carried on the Company's balance sheet at June 30, 1997 at historical amortized cost. The Company estimated that the bid-side market value (or realizable value) of all its assets less the cost of paying off all of its obligations was approximately $211.2 million as of December 31, 1996 and $292.6 million as of June 30, 1997. As compared to the shareholders' equity of the Company (excluding the market valuation account), the net total "mark-to-market" value for the Company was $3.2 million and $4.4 million lower, respectively, on those dates. Between December 31, 1996 and June 30, 1997, the liquidation value of the Company's interest rate agreements dropped significantly: See "Interest Rate Agreements" above. The Company expects that the net total "mark-to-market" value of the Company will fluctuate significantly over time. Through its Risk-Adjusted Capital Policy, the Company assigns a guideline capital adequacy amount (expressed in the form of a guideline equity-to-assets ratio) to each of its mortgage assets. This ratio will fluctuate over time, according to a formula, based on changes in that asset's credit quality, liquidity characteristics, potential for market value fluctuation, interest rate risk, prepayment risk, the manner in which the asset is funded, and the over-collateralization requirements for that asset set by the Company's collateralized lenders. The sum of the capital adequacy amounts for all of the Company's mortgage assets is the Company's aggregate guideline capital adequacy amount. Management believes that the bulk of the capital necessary to manage the Company prudently is needed due to the liquidity and market value fluctuation risks that arise from the utilization of short-term collateralized borrowings. The Company does not expect that its actual capital levels will always exceed the guideline amount. The Company measures all of its mortgage assets funded with short-term borrowings at estimated market value for the purpose of making Risk-Adjusted Capital calculations. For example, if interest rates were to rise in a significant manner, the Company's capital guideline amount would rise (as the potential interest rate risk of its mortgages would increase, at least on a temporary basis, due to periodic and life caps) while its actual capital levels as determined for the Risk-Adjusted Capital Policy would likely fall as the market values of its mortgages, net of mark-to-market gains on hedges, fell (market value declines may be temporary as well, as future coupon 31 adjustments may help to restore some of the lost market value). In this circumstance, or any other circumstance in which the Company's actual capital levels fell below the Company's capital adequacy guideline amount, the Company would cease the acquisition of new mortgage assets until capital balance was restored. As expressed as an equity-to-assets ratio, the Company's average guideline capital amount was 10.2% of assets in the fourth quarter of 1996, 10.1% in first quarter of 1997 and 9.5% in the second quarter of 1997. Since 1995, the Company has adjusted its asset mix in a manner that it believes presents the Company with lower levels of anticipated risk. The capital guideline has dropped accordingly. The actual average equity-to-asset ratio for the Company was 11.9% in the fourth quarter of 1996, 10.3% in the first quarter of 1997, and 9.9% in the second quarter of 1997. Since actual equity-to-asset ratios in these quarters were higher than the capital guideline ratios, the Company could have owned more mortgage assets during these quarters and still met its capital guidelines. Balance sheet capacity utilization (actual assets divided by potential assets) is a key measure of capital efficiency for the Company; it was 86% in the fourth quarter of 1996, 98% in the first quarter of 1997, and 96% in the second quarter of 1997. Capacity utilization will remain high to the extent that the Company is able to match the timing of the acquisition of mortgages with its receipt of new capital. In October of 1996, the Board of Directors approved an expanded mortgage asset acquisition authority for the Company. In defined circumstances prior to a planned equity offering, management is authorized to acquire mortgage assets in a limited amount beyond the usual constraints of the Company's Risk-Adjusted Capital Policy. Thus at March 31, 1997, prior to the equity offering of April 1997, the Company's actual equity-to-assets ratio of 9.3% was less than the normal capital guideline of 10.1% but exceeded the expanded guideline in effect at that time of 9.2%. With the exception of June 30, 1997, the Company's actual capital level has always exceeded its capital guideline through such date (either the normal guideline or the expanded guideline, as appropriate for the circumstance). At June 30, 1997 and for a short period of time thereafter, the Company's actual "mark-to-market" capital level was $140,000 (0.05%) less than the Company's expanded capital guideline level due to market value fluctuations of its interest rate agreements. From June 12, 1997 through the common stock equity offering of July 25, 1997, the Company was at its approximate maximum asset size as determined by its Risk-Adjusted Capital Policy. Accordingly, the Company ceased making firm commitments to new asset acquisitions during that period. As a result, the level of total asset acquisitions for the third quarter of 1997 may be less than otherwise would have been the case. In July 1997, the Company completed the placement of $534 million amortizing long-term bonds. In doing so, liquidity and market value fluctuation risk for that portion of the Company's balance sheet was substantially eliminated. Recognizing this risk reduction, the Company significantly lowered its Risk-Adjusted Capital guideline amounts for the mortgage loans collateralizing this long-term debt. The Company's overall weighted average Risk-Adjusted Capital guideline equity-to-assets ratio declined as a result in July 1997. Risk Management The Company seeks to manage the potential credit, interest rate, liquidity and other risks inherent in all financial institutions in a prudent manner designed to insure the longevity of the corporation while, at the same time, seeking to provide an opportunity for shareholders to realize attractive total rates of return through long-term stock ownership in the Company. While the Company does not seek to avoid risk, it does seek, to the best of its ability, to assume risks that can be quantified from historical experience, to actively manage such risk, to earn sufficient compensation to justify the taking of such risks and to maintain capital levels consistent with the risks it does undertake. The Company seeks to limit credit risk by maintaining what it believes to be high quality mortgage loan underwriting standards. The Company is a nationwide "A" (or "prime") quality lending company: it acquires and owns first mortgages on single-family family residential properties which have been underwritten to the highest levels of underwriting standards generally in use for these types of loans. Credit losses from such mortgages are cyclical. Historically, however, the magnitude of loss from high quality single-family mortgages 32 has been contained relative to credit losses arising from other forms of commercial, consumer and mortgage lending. The Company seeks to manage liquidity risk and short-term borrowing roll-over risk (which could be caused by market value fluctuations of assets pledged as collateral or by changes in lending markets) through: (1) maintaining what it believes to be a high quality and liquid portfolio of mortgage assets, (2) maintaining a hedging program utilizing interest rate agreements designed to partially mitigate net changes in the market values of its assets, (3) maintaining what it believes to be a prudent level of capitalization (and therefore a prudent level of unused borrowing capacity), and (4) replacing a portion of its short-term borrowings with long-term borrowings. Liquidity risks and short-term borrowing roll-over risks cannot be substantially eliminated unless the Company can replace all of its short-term borrowings with long-term borrowings. At June 30, 1997, the Company remained exposed to such risk, particularly in general market environments of rapidly rising interest rates, market dislocation or illiquidity. The Company seeks to manage interest rate risk through matching the interest rate characteristics of its mortgages and its borrowings to the degree that management believes is likely to be in the best interests of the shareholders in the long term. The Company does not seek to be perfectly matched or to eliminate interest rate risk. Through June 30, 1997, the Company has paired adjustable-rate mortgages with variable rate liabilities. The Company has generally maintained borrowings which adjust to market conditions several months faster than its assets. This short-term mis-match has increased on the Company's balance sheet in 1997 relative to prior periods. For larger interest rate increases, the potential short-term negative earnings impact resulting from this short-term mis-match should be partially mitigated by the Company's interest rate agreements. In addition, since the Company's adjustable-rate earning assets have exceeded its liabilities to a material degree through June 30, 1997, the longer term impact of an increase in short-term interest rates may be positive after a lag period (once the coupon rate on the assets has fully adjusted to the rate increase). Conversely, while the short-term earnings effect of a decline in short-term interest rates may be positive, the longer-run effect after a lag period may be a decline in earnings relative to what they otherwise would have been after the coupon rates on the assets have adjusted downwards. Through June 30, 1997, the Company generally has assumed some other types of asset/liability mis-matches as well, including some yield curve flattening risk (the risk of six and twelve month interest rates falling relative to one and three month interest rates) and some "TED" spread risk (the risk of U.S. Treasury rates, upon which coupon rate changes for a portion of the Company's assets are based, falling relative to LIBOR rates, upon which changes in the cost of funds of all the Company's liabilities are generally correlated). In addition, the Company has not fully hedged the periodic caps (averaging 2% per year) and life caps (averaging 12.01% at June 30, 1997) imbedded in its assets. Certain other sources of interest rate type risks remain partially hedged as well. Management believes that the assumption of these risks to the extent undertaken by the Company is more likely than not to result in higher earnings for the Company in the long-term but also, from time to time, may cause earnings volatility and opportunity cost from foregone growth potential. Management believes that retained interest rate risks (to the extent they are separate from liquidity and market value fluctuation risk) are unlikely to cause a safety and soundness issue for the Company except in relatively extreme and unexpected scenarios. If the rate of mortgage principal repayment of the Company's mortgage assets is faster than expected, the rate at which the Company amortizes as an expense its net premium balances will increase and earnings will be reduced relative to what they would have been otherwise. Changes in principal repayment rates may be a source of earnings volatility for the Company. In addition, faster principal repayments may reduce the Company's net asset growth rate; net asset growth is generally an important component of future earnings growth. Prospects for the Company may also be reduced by higher than expected mortgage principal repayments if the potential return characteristics of new assets are less attractive than those of the existing assets held in portfolio. Conversely, certain liquidity, market value fluctuation, and interest rate risks may be exacerbated in a rising interest rate environment due to slowing rates of mortgage principal repayment. 33 While adjustable rate-mortgage principal repayment rates are not highly predictable, in the past management believes the strongest influencing factor has been the absolute level of longer-term interest rates. As long-term rates drop, adjustable-rate mortgage principal repayments have tended to increase, particularly if longer-term rates drop relative to short-term interest rates. In addition, management believes adjustable rate mortgage principal repayments have been increasing on a secular trend basis due to structural and behavioral changes in the mortgage origination market. Through June 30, 1997, the Company has not sought to hedge mortgage principal repayment risk but rather has sought to analyze, based on individual mortgage characteristics, the propensity of each acquired mortgage or mortgage pool to experience accelerated principal repayment rates and to adjust its acquisition price bid accordingly based on the level of perceived downside (and upside) earnings risk. Virtually all of the Company's assets and liabilities are financial in nature. As a result, interest rates and other factors drive the Company's performance far more than does inflation. Changes in interest rates and other factors drive the Company's performance far more than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. The Company's financial statements are prepared in accordance with Generally Accepted Accounting Principles and the Company's dividends are determined by the Company's net income as calculated for tax purposes; in each case, the Company's activities and balance sheet are measured with reference to historical cost or fair market value without considering inflation. 34 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 1 INCOME STATEMENT FOR THREE MONTHS ENDING ------------------------------ (ALL DOLLARS IN THOUSANDS) MAR. 31, JUN. 30, 1997 1997 ---------- ---------- Mortgage Loans: Coupon Income $ 10,784 $ 14,474 Amortization of Discount Balances 11 8 Amortization of Premium Balances (940) (1,462) ---------- ---------- Interest Income: Mortgage Loans 9,855 13,020 Mortgage Securities: Coupon Income 31,440 39,879 Amortization of Discount Balances 261 409 Amortization of Premium Balances (3,150) (4,065) ---------- ---------- Interest Income: Mortgage Securities 28,551 36,223 Total Interest Income From Mortgage Assets 38,406 49,243 Interest Income: Cash Balances 162 266 ---------- ---------- Total Interest Income 38,568 49,509 Interest Expense (28,900) (38,958) Interest Rate Agreement Expense (602) (912) Interest Rate Agreement Income 7 73 ---------- ---------- Net Interest Rate Agreement Expense (595) (839) Net Interest Income 9,073 9,712 Gain (Loss) on Sale 0 0 Other Income 0 0 ---------- ---------- Total Income 9,073 9,712 Provision for Potential Credit Losses Mortgage Loans (202) (299) Mortgage Securities (493) (477) ---------- ---------- Total Credit Provision (695) (776) Compensation and Benefits Expense (529) (516) Dividend Equivalent Rights Expense (203) (358) Other Operating Expenses (435) (341) ---------- ---------- Total Operating Expenses (1,167) (1,215) Corporate Income Tax Expense 0 0 Net Income Before Preferred Dividends $ 7,211 $ 7,721 Preferred Dividends (755) (687) ---------- ---------- Net Income to Common Shareholders $ 6,456 $ 7,034 ========== ========== Calculation of Taxable REIT Income GAAP Net Income Before Preferred Dividends $ 7,211 $ 7,721 Mortgage Amortization Differences (87) (103) Credit Provisions less Actual Losses 653 747 Operating Expense Differences 135 (50) ---------- ---------- Taxable Income Before Preferred Dividend $ 7,912 $ 8,315 ========== ==========
35 SUPPLEMENTAL HISTORICAL INFORMATION TABLE 1 (CONTINUED)
INCOME STATEMENT FOR THREE MONTHS ENDING FOR YEAR ----------------------------------------------- ENDING (ALL DOLLARS IN THOUSANDS) MAR. 31, JUN. 30, SEP. 30, DEC. 31, DEC. 31, 1996 1996 1996 1996 1996 -------- -------- -------- -------- -------- Mortgage Loans: Coupon Income $ 479 $ 749 $ 1,656 $ 2,582 $ 5,466 Amortization of Discount Balances 2 11 7 11 31 Amortization of Premium Balances (19) (43) (62) (189) (313) -------- -------- -------- -------- -------- Interest Income: Mortgage Loans 462 717 1,601 2,404 5,184 Mortgage Securities: Coupon Income 8,965 12,973 18,901 25,292 66,131 Amortization of Discount Balances 175 234 264 206 879 Amortization of Premium Balances (688) (1,225) (1,645) (2,236) (5,794) -------- -------- -------- -------- -------- Interest Income: Mortgage Securities 8,452 11,982 17,520 23,262 61,216 Total Interest Income From Mortgage Assets 8,914 12,699 19,121 25,666 66,400 Interest Income: Cash Balances 217 202 250 215 884 -------- -------- -------- -------- -------- Total Interest Income 9,131 12,901 19,371 25,881 67,284 Interest Expense (6,202) (9,075) (14,447) (19,467) (49,191) Interest Rate Agreement Expense (151) (255) (350) (403) (1,159) Interest Rate Agreement Income 0 0 0 1 1 -------- -------- -------- -------- -------- Net Interest Rate Agreement Expense (151) (255) (350) (402) (1,158) Net Interest Income 2,778 3,571 4,574 6,012 16,935 Gain (Loss) on Sale 0 0 0 0 0 Other Income 0 0 0 0 0 -------- -------- -------- -------- -------- Total Income 2,778 3,571 4,574 6,012 16,935 Provision for Potential Credit Losses Mortgage Loans 5 (140) (178) (35) (348) Mortgage Securities (336) (337) (338) (337) (1,348) -------- -------- -------- -------- -------- Total Credit Provision (331) (477) (516) (372) (1,696) Compensation and Benefits Expense (234) (305) (309) (343) (1,191) Dividend Equivalent Rights Expense (85) (79) (81) (137) (382) Other Operating Expenses (174) (210) (281) (316) (981) -------- -------- -------- -------- -------- Total Operating Expenses (493) (594) (671) (796) (2,554) Corporate Income Tax Expense 0 0 0 0 0 Net Income Before Preferred Dividends $ 1,954 $ 2,500 $ 3,387 $ 4,844 $ 12,685 Preferred Dividends 0 0 (388) (760) (1,148) -------- -------- -------- -------- -------- Net Income to Common Shareholders $ 1,954 $ 2,500 $ 2,999 $ 4,084 $ 11,537 ======== ======== ======== ======== ======== Calculation of Taxable REIT Income GAAP Net Income Before Preferred Dividends $ 1,954 $ 2,500 $ 3,387 $ 4,844 $ 12,685 Mortgage Amortization Differences 175 82 61 131 449 Credit Provisions less Actual Losses 331 477 516 365 1,689 Operating Expense Differences 89 83 84 89 345 -------- -------- -------- -------- -------- Taxable Income Before Preferred Dividend $ 2,549 $ 3,142 $ 4,048 $ 5,429 $ 15,168 ======== ======== ======== ======== ========
36 SUPPLEMENTAL HISTORICAL INFORMATION TABLE 1 (CONTINUED)
INCOME STATEMENT FOR THREE MONTHS ENDING FOR YEAR ----------------------------------------------- ENDING (ALL DOLLARS IN THOUSANDS) MAR. 31, JUN. 30, SEP. 30, DEC. 31, DEC. 31, 1995 1995 1995 1995 1995 -------- -------- -------- -------- -------- Mortgage Loans: Coupon Income $ 0 $ 0 $ 0 $ 379 $ 379 Amortization of Discount Balances 0 0 0 4 4 Amortization of Premium Balances 0 0 0 (4) (4) -------- -------- -------- -------- -------- Interest Income: Mortgage Loans 0 0 0 379 379 Mortgage Securities: Coupon Income 1,940 2,737 3,779 6,303 14,759 Amortization of Discount Balances 234 237 280 164 915 Amortization of Premium Balances (19) (34) (123) (383) (559) -------- -------- -------- -------- -------- Interest Income: Mortgage Securities 2,155 2,940 3,936 6,084 15,115 Total Interest Income From Mortgage Assets 2,155 2,940 3,936 6,463 15,494 Interest Income: Cash Balances 15 20 50 147 232 -------- -------- -------- -------- -------- Total Interest Income 2,170 2,960 3,986 6,610 15,726 Interest Expense (1,533) (2,190) (2,432) (4,453) (10,608) Interest Rate Agreement Expense (16) (82) (112) (129) (339) Interest Rate Agreement Income 0 0 0 0 0 -------- -------- -------- -------- -------- Net Interest Rate Agreement Expense (16) (82) (112) (129) (339) Net Interest Income 621 688 1,442 2,028 4,779 Gain (Loss) on Sale 0 0 0 0 0 Other Income 0 0 0 0 0 -------- -------- -------- -------- -------- Total Income 621 688 1,442 2,028 4,779 Provision for Potential Credit Losses Mortgage Loans 0 0 0 (79) (79) Mortgage Securities (19) (40) (84) (271) (414) -------- -------- -------- -------- -------- Total Credit Provision (19) (40) (84) (350) (493) Compensation and Benefits Expense (81) (81) (197) (104) (463) Dividend Equivalent Rights Expense 0 0 (7) (47) (54) Other Operating Expenses (120) (117) (160) (217) (614) -------- -------- -------- -------- -------- Total Operating Expenses (201) (198) (364) (368) (1,131) Corporate Income Tax Expense 0 0 0 0 0 Net Income Before Preferred Dividends $ 401 $ 450 $ 994 $ 1,310 $ 3,155 Preferred Dividends 0 0 0 0 0 -------- -------- -------- -------- -------- Net Income to Common Shareholders $ 401 $ 450 $ 994 $ 1,310 $ 3,155 ======== ======== ======== ======== ======== Calculation of Taxable REIT Income GAAP Net Income Before Preferred Dividends $ 401 $ 450 $ 994 $ 1,310 $ 3,155 Mortgage Amortization Differences (15) 35 49 106 175 Credit Provisions less Actual Losses 19 40 84 347 490 Operating Expense Differences 3 3 (44) 50 12 -------- -------- -------- -------- -------- Taxable Income Before Preferred Dividend $ 408 $ 528 $ 1,083 $ 1,813 $ 3,832 ======== ======== ======== ======== ========
37 SUPPLEMENTAL HISTORICAL INFORMATION
INCOME STATEMENT FOR THREE MONTHS ENDING FOR YEAR ----------------------- ENDING (ALL DOLLARS IN THOUSANDS) SEP. 30, DEC. 31, DEC. 31, 1994 1994 1994 ------- ------- ------- Mortgage Loans: Coupon Income $ 0 $ 0 $ 0 Amortization of Discount Balances 0 0 0 Amortization of Premium Balances 0 0 0 ------- ------- ------- Interest Income: Mortgage Loans 0 0 0 Mortgage Securities: Coupon Income 18 1,084 1,102 Amortization of Discount Balances 0 101 101 Amortization of Premium Balances 0 (19) (19) ------- ------- ------- Interest Income: Mortgage Securities 18 1,166 1,184 Total Interest Income From Mortgage Assets 18 1,166 1,184 Interest Income: Cash Balances 80 32 112 ------- ------- ------- Total Interest Income 98 1,198 1,296 Interest Expense (10) (750) (760) Interest Rate Agreement Expense 0 (8) (8) Interest Rate Agreement Income 0 0 0 ------- ------- ------- Net Interest Rate Agreement Expense 0 (8) (8) Net Interest Income 88 440 528 Gain (Loss) on Sale 0 0 0 Other Income 0 0 0 ------- ------- ------- Total Income 88 440 528 Provision for Potential Credit Losses Mortgage Loans 0 0 0 Mortgage Securities 0 0 0 ------- ------- ------- Total Credit Provision 0 0 0 Compensation and Benefits Expense (15) (48) (63) Dividend Equivalent Rights Expense 0 0 0 Other Operating Expenses (25) (58) (83) ------- ------- ------- Total Operating Expenses (40) (106) (146) Corporate Income Tax Expense 0 0 0 Net Income Before Preferred Dividends $ 48 $ 334 $ 382 Preferred Dividends 0 0 0 ------- ------- ------- Net Income to Common Shareholders $ 48 $ 334 $ 382 ======= ======= ======= Calculation of Taxable REIT Income GAAP Net Income Before Preferred Dividends $ 48 $ 334 $ 382 Mortgage Amortization Differences 0 (28) (28) Credit Provisions less Actual Losses 0 0 0 Operating Expense Differences 0 0 0 ------- ------- ------- Taxable Income Before Preferred Dividend $ 48 $ 306 $ 354 ======= ======= =======
38 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 2 AT ------------------------------ BALANCE SHEETS MAR. 31, JUN. 30, (ALL DOLLARS IN THOUSANDS) 1997 1997 ------------ ------------ Cash and Cash Equivalents $ 12,985 $ 29,425 Mortgage Loans: Principal Value 716,009 1,111,029 Unamortized Premium 15,951 25,442 Unamortized Discount (131) (123) Real Estate Owned 128 346 Reserve For Credit Losses (630) (929) Market Valuation Account (1,291) 0 ------------ ------------ Total Mortgage Loans 730,035 1,135,765 Mortgage Securities: Principal Value 1,839,720 2,179,186 Unamortized Premium 49,156 62,219 Unamortized Discount (15,510) (14,968) Reserve For Credit Losses (2,203) (2,651) Market Valuation Account 3,516 3,603 ------------ ------------ Total Mortgage Securities 1,874,679 2,227,389 Total Mortgage Assets 2,604,714 3,363,154 Interest Rate Agreements 7,879 12,233 Market Valuation Account (2,106) (7,366) ------------ ------------ Total Interest Rate Agreements 5,773 4,867 Accrued Interest Receivable 17,722 24,065 Fixed Assets, Leasehold, Org Costs 259 257 Prepaid Expenses and Other Receivables 1,611 2,738 ------------ ------------ Other Assets 19,592 27,060 Total Assets $ 2,643,064 $ 3,424,506 ============ ============ Short-Term Borrowings $ 2,373,279 $ 3,102,784 Accrued Interest Payable 14,962 18,153 Accrued Expenses and Other Payables 1,262 1,743 Dividends Payable 7,899 8,638 ------------ ------------ Total Liabilities $ 2,397,402 $ 3,131,318 Preferred Stock $ 29,383 $ 26,733 Common Stock 119 133 Additional Paid-in Capital 219,461 274,420 Net Market Valuation Account 118 (3,762) Retained Earnings after Dividends (3,419) (4,336) ------------ ------------ Total Stockholders' Equity 245,662 293,188 Total Liabilities plus Stockholders' Equity $ 2,643,064 $ 3,424,506 ============ ============
39 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 2 (CONTINUED) AT --------------------------------------------------------------- BALANCE SHEETS MAR. 31, JUN. 30, SEP. 30, DEC. 31, (ALL DOLLARS IN THOUSANDS) 1996 1996 1996 1996 ------------ ------------ ------------ ------------ Cash and Cash Equivalents $ 9,705 $ 10,407 $ 14,599 $ 11,068 Mortgage Loans: Principal Value 24,831 69,154 126,426 514,837 Unamortized Premium 191 686 1,535 12,389 Unamortized Discount (171) (160) (153) (142) Real Estate Owned 0 0 0 196 Reserve For Credit Losses (74) (214) (393) (428) Market Valuation Account 84 200 279 (1,377) ------------ ------------ ------------ ------------ Total Mortgage Loans 24,861 69,666 127,694 525,475 Mortgage Securities: Principal Value 548,976 936,611 1,234,636 1,602,212 Unamortized Premium 12,599 22,004 31,072 41,928 Unamortized Discount (16,683) (16,448) (16,185) (15,951) Reserve For Credit Losses (747) (1,084) (1,421) (1,752) Market Valuation Account (3,847) (3,269) 74 1,516 ------------ ------------ ------------ ------------ Total Mortgage Securities 540,298 937,814 1,248,176 1,627,953 Total Mortgage Assets 565,159 1,007,480 1,375,870 2,153,428 Interest Rate Agreements 2,534 2,835 3,286 6,200 Market Valuation Account (1,301) (1,484) (2,413) (3,599) ------------ ------------ ------------ ------------ Total Interest Rate Agreements 1,233 1,351 873 2,601 Accrued Interest Receivable 4,496 7,292 10,781 14,134 Fixed Assets, Leasehold, Org Costs 201 238 270 257 Prepaid Expenses and Other Receivables 519 1,562 1,085 2,709 ------------ ------------ ------------ ------------ Other Assets 5,216 9,092 12,136 17,100 Total Assets $ 581,313 $ 1,028,330 $ 1,403,478 $ 2,184,197 ============ ============ ============ ============ Short-Term Borrowings $ 508,721 $ 896,214 $ 1,225,094 $ 1,953,103 Accrued Interest Payable 1,616 4,052 10,379 14,060 Accrued Expenses and Other Payables 290 361 472 761 Dividends Payable 2,540 3,408 4,016 5,268 ------------ ------------ ------------ ------------ Total Liabilities $ 513,167 $ 904,035 $ 1,239,961 $ 1,973,192 Preferred Stock $ 0 $ 0 $ 29,712 $ 29,579 Common Stock 55 85 91 110 Additional Paid-in Capital 73,926 130,441 138,081 187,507 Net Market Valuation Account (5,065) (4,553) (2,060) (3,460) Retained Earnings after Dividends (770) (1,678) (2,307) (2,731) ------------ ------------ ------------ ------------ Total Stockholders' Equity 68,146 124,295 163,517 211,005 Total Liabilities plus Stockholders' Equity $ 581,313 $ 1,028,330 $ 1,403,478 $ 2,184,197 ============ ============ ============ ============
40 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 2 (CONTINUED) AT ----------------------------------------------------------- BALANCE SHEETS MAR. 31, JUN. 30, SEP. 30, DEC. 31, (ALL DOLLARS IN THOUSANDS) 1995 1995 1995 1995 ----------- ----------- ----------- ----------- Cash and Cash Equivalents $ 953 $ 1,620 $ 1,150 $ 4,825 Mortgage Loans: Principal Value 0 0 0 26,411 Unamortized Premium 0 0 0 210 Unamortized Discount 0 0 0 (172) Real Estate Owned 0 0 0 0 Reserve For Credit Losses 0 0 0 (79) Market Valuation Account 0 0 0 80 ----------- ----------- ----------- ----------- Total Mortgage Loans 0 0 0 26,450 Mortgage Securities: Principal Value 143,393 178,429 298,718 417,214 Unamortized Premium 914 1,410 7,498 9,433 Unamortized Discount (2,515) (5,423) (7,322) (16,860) Reserve For Credit Losses (19) (59) (143) (411) Market Valuation Account 87 885 34 (3,582) ----------- ----------- ----------- ----------- Total Mortgage Securities 141,860 175,242 298,785 405,794 Total Mortgage Assets 141,860 175,242 298,785 432,244 Interest Rate Agreements 2,069 2,025 2,394 2,521 Market Valuation Account (635) (1,200) (1,585) (1,974) ----------- ----------- ----------- ----------- Total Interest Rate Agreements 1,434 825 809 547 Accrued Interest Receivable 855 1,256 2,008 3,270 Fixed Assets, Leasehold, Org Costs 210 212 225 209 Prepaid Expenses and Other Receivables 128 166 417 462 ----------- ----------- ----------- ----------- Other Assets 1,193 1,634 2,650 3,941 Total Assets $ 145,440 $ 179,320 $ 303,394 $ 441,557 =========== =========== =========== =========== Short-Term Borrowings $ 121,998 $ 155,881 $ 228,826 $ 370,316 Accrued Interest Payable 665 318 811 1,290 Accrued Expenses and Other Payables 92 89 181 227 Dividends Payable 333 500 1,103 1,434 ----------- ----------- ----------- ----------- Total Liabilities $ 123,088 $ 156,788 $ 230,921 $ 373,267 Preferred Stock $ 22,781 $ 22,776 $ 0 $ 0 Common Stock 2 2 55 55 Additional Paid-in Capital 19 19 74,028 73,895 Net Market Valuation Account (549) (314) (1,551) (5,476) Retained Earnings after Dividends 99 50 (60) (184) ----------- ----------- ----------- ----------- Total Stockholders' Equity 22,352 22,533 72,473 68,290 Total Liabilities plus Stockholders' Equity $ 145,440 $ 179,321 $ 303,394 $ 441,557 =========== =========== =========== ===========
41 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 2 (CONTINUED) AT ----------------------------- BALANCE SHEETS SEP. 30, DEC. 31, (ALL DOLLARS IN THOUSANDS) 1994 1994 ----------- ----------- Cash and Cash Equivalents $ 4,038 $ 1,027 Mortgage Loans: Principal Value 0 0 Unamortized Premium 0 0 Unamortized Discount 0 0 Real Estate Owned 0 0 Reserve For Credit Losses 0 0 Market Valuation Account 0 0 ----------- ----------- Total Mortgage Loans 0 0 Mortgage Securities: Principal Value 41,099 120,627 Unamortized Premium 487 828 Unamortized Discount (108) (1,320) Reserve For Credit Losses 0 0 Market Valuation Account (138) (2,658) ----------- ----------- Total Mortgage Securities 41,340 117,477 Total Mortgage Assets 41,340 117,477 Interest Rate Agreements 0 1,791 Market Valuation Account 0 101 ----------- ----------- Total Interest Rate Agreements 0 1,892 Accrued Interest Receivable 252 743 Fixed Assets, Leasehold, Org Costs 67 201 Prepaid Expenses and Other Receivables 63 188 ----------- ----------- Other Assets 382 1,132 Total Assets $ 45,760 $ 121,529 =========== =========== Short-Term Borrowings $ 28,978 $ 100,376 Accrued Interest Payable 10 676 Accrued Expenses and Other Payables 26 29 Dividends Payable 0 167 ----------- ----------- Total Liabilities $ 29,014 $ 101,248 Preferred Stock $ 16,816 $ 22,785 Common Stock 2 2 Additional Paid-in Capital 19 19 Net Market Valuation Account (138) (2,557) Retained Earnings after Dividends 48 31 ----------- ----------- Total Stockholders' Equity 16,746 20,280 Total Liabilities plus Stockholders' Equity $ 45,760 $ 121,528 =========== ===========
42 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 3 AT OR MORTGAGE ASSET CHARACTERISTICS FOR THREE MONTHS ENDING ---------------------------------- (ALL DOLLARS IN THOUSANDS) MAR. 31, JUN. 30, 1997 1997 ------------- ------------- Average Characteristics of Mortgage Assets Single-Family Properties 100% 100% Adjustable Rate 100% 100% First Lien 100% 100% Credit Rating Equivalent AA+ AA+ Amortized Cost as % of Principal Value 101.94% 102.21% Coupon Rate 7.70% 7.73% Months to Next Coupon Adjustment 5 5 Level of Index 5.98% 5.77% Net Margin 2.21% 2.23% Fully Indexed Coupon Rate 8.19% 8.00% Coupon Versus Fully-Indexed Rate -0.49% -0.27% Net Life Cap 11.91% 12.01% Percentage of Mortgage Assets by Credit Type Mortgage Loans 28.1% 33.8% Mortgage Securities: AAA/AA 69.8% 64.5% Mortgage Securities: A/BBB 1.0% 0.8% Mortgage Securities: Below BBB 1.1% 0.9% ------------- ------------- Total Mortgage Assets (%) 100.0% 100.0% Total Mortgage Assets ($) $ 2,605,323 $ 3,363,131 Percentage of Mortgage Assets by Index, Adjustment Frequency, and Annualized Periodic Cap 1 Month LIBOR, adjusts monthly, no periodic 2.6% 8.8% 6 Month LIBOR, adjusts each 6 months, 2% periodic 32.1% 27.2% 6 Month LIBOR, adjusts each 6 months, no periodic 1.9% 7.4% 6 Month CD, adjusts each 6 months, 2% periodic 1.9% 1.4% 6 Month Treasury, adjusts each 6 months, 2% periodic 0.8% 0.7% 6 Month Treasury, adjusts each 6 months, no periodic 0.7% 0.5% 3/1 Hybrid: 12 Month Treasury with 3 year initial coupon 2.4% 1.8% 12 Month Treasury, adjusts annually, 2% periodic 55.8% 50.8% 12 Month Treasury, adjusts annually, no periodic 0.1% 0.1% Other 1.7% 1.3% ------------- ------------- Total Mortgage Assets 100.0% 100.0% Total Mortgage Assets $ 2,605,323 $ 3,363,131 Net Mortgage Asset Growth Mortgage Acquisitions $ 627,075 $ 962,889 Mortgage Principal Repayments (173,362) (199,945) Amortization and Other (3,859) (5,136) ------------- ------------- Change in Mortgage Assets (Amort Cost) 449,854 757,808 Net Mortgage Asset Growth versus Prior Quarter 21% 29% Net Mortgage Asset Growth Over 12 Months 357% 232% Prepayment Rate of Underlying Mortgages (CPR) 24% 23% Total Rate of Mortgage Principal Repayment 32% 28%
43 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 3 (CONTINUED) AT OR MORTGAGE ASSET CHARACTERISTICS FOR THREE MONTHS ENDING ------------------------------------------------------------------ (ALL DOLLARS IN THOUSANDS) MAR. 31, JUN. 30, SEP. 30, DEC. 31, 1996 1996 1996 1996 ------------ ------------- ------------- ------------- Average Characteristics of Mortgage Assets Single-Family Properties 100% 100% 100% 100% Adjustable Rate 100% 100% 100% 100% First Lien 100% 100% 100% 100% Credit Rating Equivalent AA+ AA+ AA+ AA+ Amortized Cost as % of Principal Value 99.29% 100.60% 101.20% 101.81% Coupon Rate 7.59% 7.42% 7.55% 7.75% Months to Next Coupon Adjustment 3 4 4 5 Level of Index 5.47% 5.72% 5.70% 5.58% Net Margin 2.11% 2.21% 2.21% 2.24% Fully Indexed Coupon Rate 7.58% 7.93% 7.91% 7.82% Coupon Versus Fully-Indexed Rate 0.01% -0.51% -0.36% -0.07% Net Life Cap 11.53% 11.71% 11.69% 11.73% Percentage of Mortgage Assets by Credit Type Mortgage Loans 4.4% 6.9% 9.3% 24.5% Mortgage Securities: AAA/AA 86.1% 87.7% 86.8% 73.0% Mortgage Securities: A/BBB 4.6% 2.5% 1.8% 1.2% Mortgage Securities: Below BBB 4.9% 2.9% 2.1% 1.3% ------------ ------------- ------------- ------------- Total Mortgage Assets (%) 100.0% 100.0% 100.0% 100.0% Total Mortgage Assets ($) $ 569,743 $ 1,011,847 $ 1,377,331 $ 2,155,469 Percentage of Mortgage Assets by Index, Adjustment Frequency, and Annualized Periodic Cap 1 Month LIBOR, adjusts monthly, no periodic 6.5% 3.2% 2.2% 1.4% 6 Month LIBOR, adjusts each 6 months, 2% periodic 63.1% 54.2% 45.6% 35.9% 6 Month LIBOR, adjusts each 6 months, no periodic 0.0% 0.0% 0.0% 0.0% 6 Month CD, adjusts each 6 months, 2% periodic 8.8% 3.3% 2.4% 2.5% 6 Month Treasury, adjusts each 6 months, 2% periodic 0.0% 2.5% 1.7% 1.1% 6 Month Treasury, adjusts each 6 months, no periodic 3.6% 1.9% 1.3% 0.9% 3/1 Hybrid: 12 Month Treasury with 3 year initial coupon 0.0% 0.0% 0.0% 0.0% 12 Month Treasury, adjusts annually, 2% periodic 14.8% 33.2% 45.6% 56.1% 12 Month Treasury, adjusts annually, no periodic 0.0% 0.0% 0.0% 0.0% Other 3.2% 1.7% 1.2% 2.1% ------------ ------------- ------------- ------------- Total Mortgage Assets 100.0% 100.0% 100.0% 100.0% Total Mortgage Assets $ 569,743 $ 1,011,847 $ 1,377,331 $ 2,155,469 Net Mortgage Asset Growth Mortgage Acquisitions $ 166,852 $ 496,184 $ 443,860 $ 875,968 Mortgage Principal Repayments (32,814) (53,058) (76,942) (95,610) Amortization and Other (530) (1,022) (1,434) (2,220) ------------ ------------- ------------- ------------- Change in Mortgage Assets (Amort Cost) 133,508 442,104 365,484 778,138 Net Mortgage Asset Growth versus Prior Quarter 31% 78% 36% 56% Net Mortgage Asset Growth Over 12 Months 302% 480% 361% 394% Prepayment Rate of Underlying Mortgages (CPR) 26% 29% 24% 23% Total Rate of Mortgage Principal Repayment 27% 29% 28% 26%
44 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 3 (CONTINUED) AT OR MORTGAGE ASSET CHARACTERISTICS FOR THREE MONTHS ENDING --------------------------------------------------------------- (ALL DOLLARS IN THOUSANDS) MAR. 31, JUN. 30, SEP. 30, DEC. 31, 1995 1995 1995 1995 ------------ ------------ ------------ ------------ Average Characteristics of Mortgage Assets Single-Family Properties 100% 100% 100% 100% Adjustable Rate 100% 100% 100% 100% First Lien 100% 100% 100% 100% Credit Rating Equivalent AA+ AA+ AA+ AA+ Amortized Cost as % of Principal Value 98.88% 97.75% 100.06% 98.33% Coupon Rate 6.53% 6.94% 7.35% 7.50% Months to Next Coupon Adjustment 3 3 4 3 Level of Index 6.47% 5.99% 5.86% 5.44% Net Margin 2.24% 2.21% 2.20% 2.08% Fully Indexed Coupon Rate 8.71% 8.20% 8.06% 7.52% Coupon Versus Fully-Indexed Rate -2.18% -1.26% -0.71% -0.02% Net Life Cap 11.57% 11.54% 11.56% 11.54% Percentage of Mortgage Assets by Credit Type Mortgage Loans 0.0% 0.0% 0.0% 6.1% Mortgage Securities: AAA/AA 87.9% 85.8% 87.8% 81.5% Mortgage Securities: A/BBB 8.0% 6.5% 5.5% 5.8% Mortgage Securities: Below BBB 4.1% 7.7% 6.7% 6.6% ------------ ------------ ------------ ------------ Total Mortgage Assets (%) 100.0% 100.0% 100.0% 100.0% Total Mortgage Assets ($) $ 141,792 $ 174,416 $ 298,894 $ 436,236 Percentage of Mortgage Assets by Index, Adjustment Frequency, and Annualized Periodic Cap 1 Month LIBOR, adjusts monthly, no periodic 3.1% 2.5% 1.4% 7.5% 6 Month LIBOR, adjusts each 6 months, 2% periodic 78.7% 83.1% 66.9% 60.0% 6 Month LIBOR, adjusts each 6 months, no periodic 0.0% 0.0% 0.0% 0.0% 6 Month CD, adjusts each 6 months, 2% periodic 17.3% 13.7% 11.5% 12.5% 6 Month Treasury, adjusts each 6 months, 2% periodic 0.0% 0.0% 0.0% 0.0% 6 Month Treasury, adjusts each 6 months, no periodic 0.0% 0.0% 7.5% 5.0% 3/1 Hybrid: 12 Month Treasury with 3 year initial coupon 0.0% 0.0% 0.0% 0.0% 12 Month Treasury, adjusts annually, 2% periodic 0.9% 0.7% 11.5% 12.5% 12 Month Treasury, adjusts annually, no periodic 0.0% 0.0% 0.0% 0.0% Other 0.0% 0.0% 1.2% 2.5% ------------ ------------ ------------ ------------ Total Mortgage Assets 100.0% 100.0% 100.0% 100.0% Total Mortgage Assets $ 141,792 $ 174,416 $ 298,894 $ 436,236 Net Mortgage Asset Growth Mortgage Acquisitions $ 24,116 $ 35,355 $ 132,640 $ 162,461 Mortgage Principal Repayments (2,673) (2,934) (8,319) (24,898) Amortization and Other 214 203 157 (221) ------------ ------------ ------------ ------------ Change in Mortgage Assets (Amort Cost) 21,657 32,624 124,478 137,342 Net Mortgage Asset Growth versus Prior Quarter 18% 23% 71% 46% Net Mortgage Asset Growth Over 12 Months n/a n/a 621% 263% Prepayment Rate of Underlying Mortgages (CPR) 8% 11% 21% 25% Total Rate of Mortgage Principal Repayment 9% 7% 16% 28%
45 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 3 (CONTINUED) AT OR MORTGAGE ASSET CHARACTERISTICS FOR THREE MONTHS ENDING ------------------------------- (ALL DOLLARS IN THOUSANDS) SEP. 30, DEC. 31, 1994 1994 ------------ ------------ Average Characteristics of Mortgage Assets Single-Family Properties 100% 100% Adjustable Rate 100% 100% First Lien 100% 100% Credit Rating Equivalent AA+ AA+ Amortized Cost as % of Principal Value 100.98% 99.59% Coupon Rate 5.64% 6.00% Months to Next Coupon Adjustment 3 3 Level of Index 5.74% 6.94% Net Margin 2.19% 2.25% Fully Indexed Coupon Rate 7.93% 9.19% Coupon Versus Fully-Indexed Rate -2.29% -3.19% Net Life Cap 11.39% 11.48% Percentage of Mortgage Assets by Credit Type Mortgage Loans 0.0% 0.0% Mortgage Securities: AAA/AA 100.0% 92.9% Mortgage Securities: A/BBB 0.0% 4.3% Mortgage Securities: Below BBB 0.0% 2.8% ------------ ------------ Total Mortgage Assets (%) 100.0% 100.0% Total Mortgage Assets ($) $ 41,478 $ 120,135 Percentage of Mortgage Assets by Index, Adjustment Frequency, and Annualized Periodic Cap 1 Month LIBOR, adjusts monthly, no periodic 0.0% 3.8% 6 Month LIBOR, adjusts each 6 months, 2% periodic 82.7% 78.3% 6 Month LIBOR, adjusts each 6 months, no periodic 0.0% 0.0% 6 Month CD, adjusts each 6 months, 2% periodic 17.3% 17.9% 6 Month Treasury, adjusts each 6 months, 2% periodic 0.0% 0.0% 6 Month Treasury, adjusts each 6 months, no periodic 0.0% 0.0% 3/1 Hybrid: 12 Month Treasury with 3 year initial coupon 0.0% 0.0% 12 Month Treasury, adjusts annually, 2% periodic 0.0% 0.0% 12 Month Treasury, adjusts annually, no periodic 0.0% 0.0% Other 0.0% 0.0% ------------ ------------ Total Mortgage Assets 100.0% 100.0% Total Mortgage Assets $ 41,478 $ 120,135 Net Mortgage Asset Growth Mortgage Acquisitions $ 41,478 $ 79,819 Mortgage Principal Repayments 0 (1,244) Amortization and Other 0 82 ------------ ------------ Change in Mortgage Assets (Amort Cost) 41,478 78,657 Net Mortgage Asset Growth versus Prior Quarter n/a 190% Net Mortgage Asset Growth Over 12 Months n/a n/a Prepayment Rate of Underlying Mortgages (CPR) 0% 11% Total Rate of Mortgage Principal Repayment 0% 7%
46 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 4 AT ----------------------------- MORTGAGE LOAN SUMMARY MAR. 31, JUN. 30, (ALL DOLLARS IN THOUSANDS) 1997 1997 ------------ ------------ Number of Loans 2,795 3,983 Principal Value $ 716,137 $ 1,111,375 Amortized Cost 731,957 1,136,694 Estimated Bid-Side Market Value 729,561 1,136,004 Adjustable-Rate 100% 100% Single-Family 100% 100% "A" Quality Underwriting 100% 100% First Lien 100% 100% Primary Residence (Owner-Occupied) 94% 92% Second Home 4% 6% Investor Property 2% 2% Average Loan Size $ 256 $ 279 Loan Balance Less Than $214,000 20% 20% Loan Balance Greater Than $500,000 14% 27% Original Loan-To-Value Ratio (LTV) 74% 76% Original LTV ** 80% 24% 33% % of Original LTV ** 80% with Primary Mortgage 94% 94% Insurance or Pledged Account Collateral Effective Average Original LTV Including Primary 68% 69% Mortgage Insurance or Pledged Account Collateral 1990 and Prior Years' Origination 9% 6% 1991 Origination 1% 1% 1992 3% 2% 1993 9% 6% 1994 41% 23% 1995 4% 2% 1996 30% 18% 1997 2% 42% Average Seasoning in Months 33 22 Northern California 17% 13% Southern California 24% 21% Florida 5% 8% New York 4% 5% Maryland 6% 4% New Jersey 3% 4% Connecticut 3% 4% Texas 3% 4% Illinois 4% 3% Georgia 2% 3% Colorado 2% 3% Arizona 1% 3% Other States 26% 25%
*: less than 0.5% ** Non-EDGAR Symbol for Greater Than 47 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 4 (CONTINUED) AT ---------------------------------------------------------- MORTGAGE LOAN SUMMARY MAR. 31, JUN. 30, SEP. 30, DEC. 31, (ALL DOLLARS IN THOUSANDS) 1996 1996 1996 1996 ---------- ---------- ---------- ---------- Number of Loans 101 257 478 2,172 Principal Value $ 24,831 $ 69,154 $ 126,426 $ 515,033 Amortized Cost 24,851 69,680 127,808 527,280 Estimated Bid-Side Market Value 24,861 69,666 127,694 525,475 Adjustable-Rate 100% 100% 100% 100% Single-Family 100% 100% 100% 100% "A" Quality Underwriting 100% 100% 100% 100% First Lien 100% 100% 100% 100% Primary Residence (Owner-Occupied) 100% 99% 99% 94% Second Home 0% 1% 1% 4% Investor Property 0% 0% 0% 2% Average Loan Size $ 246 $ 269 $ 264 $ 237 Loan Balance Less Than $214,000 30% 14% 18% 23% Loan Balance Greater Than $500,000 25% 13% 12% 8% Original Loan-To-Value Ratio (LTV) 77% 76% 78% 77% Original LTV ** 80% 27% 23% 32% 25% % of Original LTV ** 80% with Primary Mortgage 100% 100% 100% 97% Insurance or Pledged Account Collateral Effective Average Original LTV Including Primary 73% 73% 73% 73% Mortgage Insurance or Pledged Account Collateral 1990 and Prior Years' Origination 0% 0% 0% 13% 1991 Origination 0% 0% 0% 2% 1992 0% 0% 0% 4% 1993 0% 1% 7% 14% 1994 2% 2% 43% 52% 1995 98% 63% 32% 7% 1996 0% 34% 18% 8% 1997 0% 0% 0% 0% Average Seasoning in Months 7 4 9 37 Northern California 30% 30% 34% 18% Southern California 46% 43% 51% 26% Florida 1% 1% * 4% New York 0% * * 3% Maryland 2% 1% * 8% New Jersey 1% * * 3% Connecticut 1% 1% 1% 3% Texas 4% 1% 1% 2% Illinois 0% 1% * 4% Georgia 1% 1% * 2% Colorado 3% 3% 2% 1% Arizona 0% 0% 0% 2% Other States 11% 18% 11% 24%
*: less than 0.5% ** Non-EDGAR Symbol for Greater Than 48 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 4 (CONTINUED) AT ---------------------------------------------------- MORTGAGE LOAN SUMMARY MAR. 31, JUN. 30, SEP. 30, DEC. 31, (ALL DOLLARS IN THOUSANDS) 1995 1995 1995 1995 --------- --------- --------- ---------- Number of Loans 0 0 0 109 Principal Value $ 0 $ 0 $ 0 $ 26,411 Amortized Cost 0 0 0 26,449 Estimated Bid-Side Market Value 0 0 0 26,450 Adjustable-Rate n/a n/a n/a 100% Single-Family n/a n/a n/a 100% "A" Quality Underwriting n/a n/a n/a 100% First Lien n/a n/a n/a 100% Primary Residence (Owner-Occupied) n/a n/a n/a 100% Second Home n/a n/a n/a 0% Investor Property n/a n/a n/a 0% Average Loan Size n/a n/a n/a $ 242 Loan Balance Less Than $214,000 n/a n/a n/a 11% Loan Balance Greater Than $500,000 n/a n/a n/a 23% Original Loan-To-Value Ratio (LTV) n/a n/a n/a 76% Original LTV ** 80% n/a n/a n/a 26% % of Original LTV ** 80% with Primary Mortgage n/a n/a n/a 100% Insurance or Pledged Account Collateral Effective Average Original LTV Including Primary n/a n/a n/a 72% Mortgage Insurance or Pledged Account Collateral 1990 and Prior Years' Origination n/a n/a n/a 0% 1991 Origination n/a n/a n/a 0% 1992 n/a n/a n/a 0% 1993 n/a n/a n/a 0% 1994 n/a n/a n/a 2% 1995 n/a n/a n/a 98% 1996 n/a n/a n/a 0% 1997 n/a n/a n/a 0% Average Seasoning in Months n/a n/a n/a 4 Northern California n/a n/a n/a 30% Southern California n/a n/a n/a 44% Florida n/a n/a n/a 1% New York n/a n/a n/a 0% Maryland n/a n/a n/a 2% New Jersey n/a n/a n/a 1% Connecticut n/a n/a n/a 1% Texas n/a n/a n/a 4% Illinois n/a n/a n/a 0% Georgia n/a n/a n/a 1% Colorado n/a n/a n/a 3% Arizona n/a n/a n/a 2% Other States n/a n/a n/a 11%
*: less than 0.5% ** Non-EDGAR Symbol for Greater Than 49 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 4 (CONTINUED) AT -------------------- MORTGAGE LOAN SUMMARY SEP. 30, DEC. 31, (ALL DOLLARS IN THOUSANDS 1994 1994 -------- -------- Number of Loans 0 0 Principal Value $ 0 $ 0 Amortized Cost 0 0 Estimated Bid-Side Market Value 0 0 Adjustable-Rate n/a n/a Single-Family n/a n/a "A" Quality Underwriting n/a n/a First Lien n/a n/a Primary Residence (Owner-Occupied) n/a n/a Second Home n/a n/a Investor Property n/a n/a Average Loan Size n/a n/a Loan Balance Less Than $214,000 n/a n/a Loan Balance Greater Than $500,000 n/a n/a Original Loan-To-Value Ratio (LTV) n/a n/a Original LTV ** 80% n/a n/a % of Original LTV ** 80% with Primary Mortgage n/a n/a Insurance or Pledged Account Collateral Effective Average Original LTV Including Primary n/a n/a Mortgage Insurance or Pledged Account Collateral 1990 and Prior Years' Origination n/a n/a 1991 Origination n/a n/a 1992 n/a n/a 1993 n/a n/a 1994 n/a n/a 1995 n/a n/a 1996 n/a n/a 1997 n/a n/a Average Seasoning in Months n/a n/a Northern California n/a n/a Southern California n/a n/a Florida n/a n/a New York n/a n/a Maryland n/a n/a New Jersey n/a n/a Connecticut n/a n/a Texas n/a n/a Illinois n/a n/a Georgia n/a n/a Colorado n/a n/a Arizona n/a n/a Other States n/a n/a
*: less than 0.5% ** Non-EDGAR Symbol for Greater Than 50 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 5 AT OR EARNING ASSET YIELD, INTEREST RATE SPREAD FOR THREE MONTHS ENDING AND INTEREST RATE MARGIN ----------------------------- MAR. 31, JUN. 30, 1997 1997 ---------- ---------- Average Initial Coupon Rate on Mortgage Acquisitions 7.45% 7.45% New Acquisitions Last 6 Months/Total Mortgages 58% 47% Mortgage Coupon Rate (All Mortgage Assets) 7.70% 7.74% Amortized Cost/ Principal Value 101.84% 102.15% Coupon Yield on Amortized Cost 7.56% 7.57% Effect of Premium/Discount Amortization -0.68% -0.71% Mortgage Yield 6.88% 6.86% Cash Yield 5.33% 5.52% Earning Asset Yield (Mortgages plus Cash) 6.87% 6.86% Cost of Funds 5.62% 5.86% Cost of Hedging (as % of Borrowings) 0.12% 0.13% Interest Rate Spread 1.13% 0.87% Net Interest Margin (Net Interest Income/Assets) 1.57% 1.31% Net Interest Income/Average Equity 15.30% 13.25% SELECTED OPERATING RATIOS AND RETURN ON EQUITY Credit Provisions as a % of Assets 0.12% 0.10% Credit Provisions as a % of Equity 1.17% 1.06% Operating Expenses to Average Assets 0.20% 0.16% Operating Expenses to Average Equity 1.97% 1.66% Efficiency Ratio (Op Exp/Net Int Income) 12.86% 12.51% Average Assets Per Employee ($MM) $ 221 $ 257 GAAP Return on Total Equity 12.16% 10.53% GAAP Return on Common Equity 12.44% 10.65% Taxable Income Return on Total Equity 13.34% 11.34% Taxable Income Return on Common Equity 13.79% 11.55%
51 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 5 (CONTINUED) AT OR EARNING ASSET YIELD, INTEREST RATE SPREAD FOR THREE MONTHS ENDING ------------------------------------------------------------- AND INTEREST RATE MARGIN MAR. 31, JUN. 30, SEP. 30, DEC. 31, 1996 1996 1996 1996 ---------- ---------- ---------- ---------- Average Initial Coupon Rate on Mortgage Acquisitions 7.60% 7.30% 7.53% 7.81% New Acquisitions Last 6 Months/Total Mortgages 58% 66% 68% 61% Mortgage Coupon Rate (All Mortgage Assets) 7.73% 7.47% 7.52% 7.58% Amortized Cost/ Principal Value 98.85% 99.95% 100.98% 101.41% Coupon Yield on Amortized Cost 7.82% 7.48% 7.44% 7.48% Effect of Premium/Discount Amortization -0.44% -0.56% -0.52% -0.59% Mortgage Yield 7.38% 6.92% 6.92% 6.89% Cash Yield 5.93% 5.61% 5.30% 5.31% Earning Asset Yield (Mortgages plus Cash) 7.34% 6.90% 6.90% 6.87% Cost of Funds 5.69% 5.57% 5.78% 5.76% Cost of Hedging (as % of Borrowings) 0.14% 0.16% 0.14% 0.12% Interest Rate Spread 1.51% 1.17% 0.98% 0.99% Net Interest Margin (Net Interest Income/Assets) 2.17% 1.85% 1.58% 1.55% Net Interest Income/Average Equity 14.92% 12.14% 12.40% 13.01% SELECTED OPERATING RATIOS AND RETURN ON EQUITY Credit Provisions as a % of Assets 0.26% 0.25% 0.18% 0.10% Credit Provisions as a % of Equity 1.78% 1.62% 1.40% 0.81% Operating Expenses to Average Assets 0.38% 0.31% 0.23% 0.21% Operating Expenses to Average Equity 2.64% 2.02% 1.82% 1.72% Efficiency Ratio (Op Exp/Net Int Income) 17.71% 16.63% 14.69% 13.23% Average Assets Per Employee ($MM) $ 70 $ 84 $ 115 $ 155 GAAP Return on Total Equity 10.50% 8.50% 9.18% 10.48% GAAP Return on Common Equity 10.50% 8.50% 9.06% 10.53% Taxable Income Return on Total Equity 13.69% 10.69% 10.97% 11.75% Taxable Income Return on Common Equity 13.69% 10.69% 11.06% 12.03%
52 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 5 (CONTINUED) AT OR EARNING ASSET YIELD, INTEREST RATE SPREAD FOR THREE MONTHS ENDING ------------------------------------------------------------- AND INTEREST RATE MARGIN MAR. 31, JUN. 30, SEP. 30, DEC. 31, 1995 1995 1995 1995 ---------- ---------- ---------- ---------- Average Initial Coupon Rate on Mortgage Acquisitions 6.78% 6.42% 7.40% 7.39% New Acquisitions Last 6 Months/Total Mortgages 73% 34% 56% 68% Mortgage Coupon Rate (All Mortgage Assets) 6.32% 6.82% 7.29% 7.59% Amortized Cost/ Principal Value 99.47% 98.53% 98.71% 99.27% Coupon Yield on Amortized Cost 6.35% 6.92% 7.39% 7.64% Effect of Premium/Discount Amortization 0.70% 0.51% 0.30% -0.25% Mortgage Yield 7.05% 7.43% 7.69% 7.39% Cash Yield 4.96% 5.57% 5.53% 5.48% Earning Asset Yield (Mortgages plus Cash) 7.03% 7.41% 7.66% 7.34% Cost of Funds 5.96% 6.26% 6.09% 6.04% Cost of Hedging (as % of Borrowings) 0.06% 0.23% 0.28% 0.18% Interest Rate Spread 1.01% 0.92% 1.29% 1.12% Net Interest Margin (Net Interest Income/Assets) 1.96% 1.68% 2.68% 2.17% Net Interest Income/Average Equity 10.73% 11.96% 10.94% 10.99% SELECTED OPERATING RATIOS AND RETURN ON EQUITY Credit Provisions as a % of Assets 0.06% 0.10% 0.16% 0.38% Credit Provisions as a % of Equity 0.32% 0.70% 0.64% 1.90% Operating Expenses to Average Assets 0.63% 0.48% 0.68% 0.39% Operating Expenses to Average Equity 3.48% 3.44% 2.76% 1.99% Efficiency Ratio (Op Exp/Net Int Income) 32.39% 28.77% 25.25% 18.13% Average Assets Per Employee ($MM) $ 25 $ 33 $ 39 $ 53 GAAP Return on Total Equity 6.94% 7.82% 7.54% 7.10% GAAP Return on Common Equity 6.94% 7.82% 7.54% 7.10% Taxable Income Return on Total Equity 7.05% 9.19% 8.21% 9.83% Taxable Income Return on Common Equity 7.05% 9.19% 8.21% 9.83%
53 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 5 (CONTINUED) AT OR EARNING ASSET YIELD, INTEREST RATE SPREAD FOR THREE MONTHS ENDING -------------------------- AND INTEREST RATE MARGIN SEP. 30, DEC. 31, 1994 1994 -------- -------- Average Initial Coupon Rate on Mortgage Acquisitions 5.71% 5.95% New Acquisitions Last 6 Months/Total Mortgages 100% 101% Mortgage Coupon Rate (All Mortgage Assets) 6.32% 6.08% Amortized Cost/ Principal Value 101.12% 100.00% Coupon Yield on Amortized Cost 6.25% 6.08% Effect of Premium/Discount Amortization 0.00% 0.46% Mortgage Yield 6.25% 6.54% Cash Yield 4.45% 5.63% Earning Asset Yield (Mortgages plus Cash) 4.69% 6.51% Cost of Funds 5.48% 5.55% Cost of Hedging (as % of Borrowings) 0.00% 0.06% Interest Rate Spread -0.79% 0.90% Net Interest Margin (Net Interest Income/Assets) 4.14% 2.32% Net Interest Income/Average Equity 4.68% 8.15% SELECTED OPERATING RATIOS AND RETURN ON EQUITY Credit Provisions as a % of Assets 0.00% 0.00% Credit Provisions as a % of Equity 0.00% 0.00% Operating Expenses to Average Assets 1.86% 0.56% Operating Expenses to Average Equity 2.11% 1.97% Efficiency Ratio (Op Exp/Net Int Income) 45.38% 24.21% Average Assets Per Employee ($MM) $ 4 $ 15 GAAP Return on Total Equity 2.57% 6.17% GAAP Return on Common Equity 2.57% 6.17% Taxable Income Return on Total Equity 2.57% 5.65% Taxable Income Return on Common Equity 2.57% 5.65%
54 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 6 AT OR AVERAGE DAILY BALANCE SHEET FOR THREE MONTHS ENDING --------------------------------- (ALL DOLLARS IN THOUSANDS) MAR. 31, JUN. 30, 1997 1997 ----------- ----------- Cash $ 12,147 $ 19,307 Mortgage Loans 574,781 758,445 Mortgage Securities 1,658,629 2,111,832 Credit Reserve (2,394) (3,083) Interest Rate Agreements 6,899 11,185 Other Assets 58,856 75,928 ----------- ----------- Total Assets 2,308,918 2,973,614 ----------- ----------- Short-Term Borrowings 2,056,051 2,659,914 Other Liabilties 15,691 20,530 ----------- ----------- Total Liabilities 2,071,742 2,680,444 ----------- ----------- Preferred Stock 29,545 28,946 Common Stock 208,426 265,561 Retained Earnings, after Dividend (795) (1,337) ----------- ----------- Stockholders' Equity 237,176 293,170 ----------- ----------- Market Valuation Account, Mortgage Assets $ 1,022 $ 1,914 Market Valuation Account, Interest Rate Agreements (4,004) (4,576) ----------- ----------- Market Valuation Account, Total $ (2,982) $ (2,662) ESTIMATED PERIOD-END BID-SIDE MARKET VALUE / REALIZABLE VALUE Cash $ 12,985 $ 29,425 Mortgage Loans 729,561 1,136,004 Mortgage Securities 1,874,679 2,227,389 Interest Rate Agreements 5,773 4,206 Other Assets 19,290 25,857 Short-Term Borrowings 2,373,279 3,102,784 Other Liabilities 23,411 27,515 ----------- ----------- "Mark-To-Market" of Equity $ 245,598 $ 292,582 AVERAGE BALANCE SHEET UTILIZATION DURING PERIOD VERSUS RISK-ADJUSTED CAPITAL GUIDELINES Actual Average Equity/Assets 10.3% 9.9% Average Risk-Adjusted Capital Guideline 10.1% 9.5% Balance Sheet Capacity Utilization 98% 96% Excess Capital and Asset Growth Potential At Period End Ending Actual Equity/Assets 9.28% 8.55% Ending Risk-Adjusted Capital Guideline 10.09% 9.41% Excess Capital $ (21,504) $ (29,417) Asset Growth Potential (Same Asset Mix) $ (213,079) $ (312,637) Expanded Risk-Adjusted Capital Guideline 9.17% 8.55% Excess Capital vs. Expanded Guideline $ 3,015 $ (140) Asset Growth Potential (Expanded Guideline) $ 29,398 $ (1,915)
55 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 6 (CONTINUED) AT OR AVERAGE DAILY BALANCE SHEET FOR THREE MONTHS ENDING --------------------------------------------------------------- (ALL DOLLARS IN THOUSANDS) MAR. 31, JUN. 30, SEP. 30, DEC. 31, 1996 1996 1996 1996 ---------- ---------- ----------- ----------- Cash $ 14,639 $ 14,402 $ 18,854 $ 16,137 Mortgage Loans 25,279 45,313 93,991 143,368 Mortgage Securities 457,841 688,697 1,010,853 1,347,617 Credit Reserve (594) (1,002) (1,491) (1,952) Interest Rate Agreements 2,503 2,737 3,185 4,681 Other Assets 13,094 21,566 30,129 41,430 ---------- ---------- ----------- ----------- Total Assets 512,762 771,713 1,155,521 1,551,281 ---------- ---------- ----------- ----------- Short-Term Borrowings 435,979 651,643 999,229 1,351,510 Other Liabilties 2,324 2,472 8,728 14,898 ---------- ---------- ----------- ----------- Total Liabilities 438,303 654,115 1,007,957 1,366,408 ---------- ---------- ----------- ----------- Preferred Stock - - 15,179 29,671 Common Stock 73,998 117,695 132,924 156,594 Retained Earnings, after Dividend 461 (97) (539) (1,392) ---------- ---------- ----------- ----------- Stockholders' Equity 74,459 117,598 147,564 184,873 ---------- ---------- ----------- ----------- Market Valuation Account, Mortgage Assets $ (3,880) $ (3,865) $ (2,279) $ 603 Market Valuation Account, Interest Rate Agreements (1,836) (1,080) (1,352) (3,513) ---------- ---------- ----------- ----------- Market Valuation Account, Total $ (5,716) $ (4,945) $ (3,631) $ (2,910) ESTIMATED PERIOD-END BID-SIDE MARKET VALUE / REALIZABLE VALUE Cash $ 9,705 $ 10,407 $ 14,599 $ 11,068 Mortgage Loans 24,861 69,666 127,695 525,475 Mortgage Securities 540,298 937,814 1,248,176 1,627,953 Interest Rate Agreements 1,233 1,351 873 2,601 Other Assets 4,983 8,858 11,760 16,778 Short-Term Borrowings 508,721 896,214 1,225,094 1,953,103 Other Liabilities 4,240 7,522 14,457 19,531 ---------- ---------- ----------- ----------- "Mark-To-Market" of Equity $ 68,119 $ 124,360 $ 163,552 $ 211,241 AVERAGE BALANCE SHEET UTILIZATION DURING PERIOD VERSUS RISK-ADJUSTED CAPITAL GUIDELINES Actual Average Equity/Assets 14.5% 15.2% 12.8% 11.9% Average Risk-Adjusted Capital Guideline 12.8% 11.4% 10.7% 10.2% Balance Sheet Capacity Utilization 88% 75% 84% 86% Excess Capital and Asset Growth Potential At Period End Ending Actual Equity/Assets 11.72% 12.09% 11.65% 9.66% Ending Risk-Adjusted Capital Guideline 11.72% 10.77% 10.32% 9.97% Excess Capital $ 26 $ 13,566 $ 18,664 $ (6,798) Asset Growth Potential (Same Asset Mix) $ 227 $ 125,972 $ 180,836 $ (68,169) Expanded Risk-Adjusted Capital Guideline n/a n/a n/a 9.07% Excess Capital vs. Expanded Guideline n/a n/a n/a $ 14,302 Asset Growth Potential (Expanded Guideline) n/a n/a n/a $ 143,434
56 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 6 (CONTINUED) AT OR AVERAGE DAILY BALANCE SHEET FOR THREE MONTHS ENDING ------------------------------------------------------------- (ALL DOLLARS IN THOUSANDS) MAR. 31, JUN. 30, SEP. 30, DEC. 31, 1995 1995 1995 1995 ---------- ---------- ---------- ---------- Cash $ 1,217 $ 1,466 $ 3,597 $ 10,709 Mortgage Loans 0 0 0 19,861 Mortgage Securities 122,181 158,183 204,672 329,815 Credit Reserve (6) (31) (82) (249) Interest Rate Agreements 1,684 1,916 2,120 2,428 Other Assets 1,958 2,559 4,819 11,000 ---------- ---------- ---------- ---------- Total Assets 127,034 164,093 215,126 373,564 ---------- ---------- ---------- ---------- Short-Term Borrowings 102,894 139,979 159,794 295,089 Other Liabilties 978 1,111 2,585 4,654 ---------- ---------- ---------- ---------- Total Liabilities 103,872 141,090 162,380 299,743 ---------- ---------- ---------- ---------- Preferred Stock 0 0 0 0 Common Stock 23,455 22,795 52,481 74,175 Retained Earnings, after Dividend (293) 208 266 (354) ---------- ---------- ---------- ---------- Stockholders' Equity 23,162 23,003 52,747 73,821 ---------- ---------- ---------- ---------- Market Valuation Account, Mortgage Assets $ (1,058) $ 454 $ 410 $ (132) Market Valuation Account, Interest Rate Agreements (285) (896) (1,289) (1,698) ---------- ---------- ---------- ---------- Market Valuation Account, Total $ (1,343) $ (442) $ (879) $ (1,830) ESTIMATED PERIOD-END BID-SIDE MARKET VALUE / REALIZABLE VALUE Cash $ 953 $ 1,620 $ 1,150 $ 4,825 Mortgage Loans 0 0 0 26,450 Mortgage Securities 141,860 175,242 298,785 405,794 Interest Rate Agreements 1,434 825 809 547 Other Assets 953 1,417 2,329 3,668 Short-Term Borrowings 121,998 155,881 228,826 370,316 Other Liabilities 1,060 847 1,951 2,829 ---------- ---------- ---------- ---------- "Mark-To-Market" of Equity $ 22,142 $ 22,376 $ 72,296 $ 68,139 AVERAGE BALANCE SHEET UTILIZATION DURING PERIOD VERSUS RISK-ADJUSTED CAPITAL GUIDELINES Actual Average Equity/Assets 18.2% 14.0% 24.5% 19.8% Average Risk-Adjusted Capital Guideline 12.9% 13.2% 13.6% 13.6% Balance Sheet Capacity Utilization 71% 94% 55% 69% Excess Capital and Asset Growth Potential At Period End Ending Actual Equity/Assets 15.37% 12.57% 23.89% 15.47% Ending Risk-Adjusted Capital Guideline 12.41% 12.95% 13.08% 12.59% Excess Capital $ 3,970 $ (1,069) $ 32,155 $ 12,028 Asset Growth Potential (Same Asset Mix) $ 34,733 $ (5,332) $ 250,789 $ 100,874 Expanded Risk-Adjusted Capital Guideline n/a n/a n/a n/a Excess Capital vs. Expanded Guideline n/a n/a n/a n/a Asset Growth Potential (Expanded Guideline) n/a n/a n/a n/a
57 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 6 (CONTINUED) AT OR AVERAGE DAILY BALANCE SHEET FOR THREE MONTHS ENDING -------------------------------- (ALL DOLLARS IN THOUSANDS) SEP. 30, DEC. 31, 1994 1994 ----------- ----------- Cash $ 16,325 $ 2,305 Mortgage Loans 0 0 Mortgage Securities 2,526 71,273 Credit Reserve 0 0 Interest Rate Agreements 0 1,097 Other Assets 270 1,250 ----------- ----------- Total Assets 19,121 75,925 ----------- ----------- Short-Term Borrowings 1,699 54,048 Other Liabilties 626 252 ----------- ----------- Total Liabilities 2,325 54,300 ----------- ----------- Preferred Stock 0 0 Common Stock 16,782 22,794 Retained Earnings, after Dividend 14 (1,169) ----------- ----------- Stockholders' Equity 16,796 21,625 ----------- ----------- Market Valuation Account, Mortgage Assets $ 3 $ (844) Market Valuation Account, Interest Rate Agreements 0 45 ----------- ----------- Market Valuation Account, Total $ 3 $ (799) ESTIMATED PERIOD-END BID-SIDE MARKET VALUE / REALIZABLE VALUE Cash $ 4,038 $ 1,027 Mortgage Loans 0 0 Mortgage Securities 41,340 117,477 Interest Rate Agreements 0 1,892 Other Assets 252 888 Short-Term Borrowings 28,978 100,376 Other Liabilities 36 872 ----------- ----------- "Mark-To-Market" of Equity $ 16,616 $ 20,036 AVERAGE BALANCE SHEET UTILIZATION DURING PERIOD VERSUS RISK-ADJUSTED CAPITAL GUIDELINES Actual Average Equity/Assets 87.8% 28.5% Average Risk-Adjusted Capital Guideline 8.7% 11.5% Balance Sheet Capacity Utilization 10% 40% Excess Capital and Asset Growth Potential At Period End Ending Actual Equity/Assets 36.60% 16.69% Ending Risk-Adjusted Capital Guideline 8.67% 10.84% Excess Capital $ 12,650 $ 6,716 Asset Growth Potential (Same Asset Mix) $ 147,479 $ 65,519 Expanded Risk-Adjusted Capital Guideline n/a n/a Excess Capital vs. Expanded Guideline n/a n/a Asset Growth Potential (Expanded Guideline) n/a n/a
58 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 7 AT OR CREDIT PROVISIONS AND CREDIT RESERVES FOR THREE MONTHS ENDING ----------------------------- (ALL DOLLARS IN THOUSANDS) MAR. 31, JUN. 30, 1997 1997 ---------- ---------- MORTGAGE LOANS Credit Provision During Period $ 202 $ 299 Actual Losses During Period 13 0 Cumulative Actual Losses 13 13 Mortgage Loan Reserve End of Period 630 929 Annualized Credit Provision/ Ave. Mortgage Loans 0.14% 0.16% Mortgage Loan Reserve/Ending Mortgage Loans 0.09% 0.08% Non-Performing Assets: 90+ Days Delinquent, Foreclosures, Bankruptcies, and REO Number of Loan 6 12 NPA Loan Balance $ 1,220 $ 2,366 Non-Performing Assets as % of Mortgage Loans 0.2% 0.2% Non-Performing Assets as % of Total Assets 0.05% 0.09% Mortgage Loan Reserve as % of NPAs 52% 39% Credit Experience of Mortgage Loans Liquidated Defaulted Loans (Cumulative) 1 1 Average Loss Severity Experience (Cumulative) 7% 7% Scenario Analysis of Potential Credit Losses Over Next 12 Months If All Current (But No Future) Non-Performing Mortgage Loans Default: At 10% Loss Severity $ 124 $ 241 At 20% Loss Severity 248 481 At 30% Loss Severity 372 722 At 40% Loss Severity 496 962 MORTGAGE SECURITIES Credit Provision During Period $ 493 $ 477 Actual Losses During Period 29 29 Cumulative Actual Losses 40 69 Mortgage Securities Reserve End of Period 2,203 2,651 Annualized Credit Provision/Mtg. Sec. Rated *** BBB 6.8% 6.6% Mortgage Loan Reserve/Ending Mtg. Sec. Rated *** BBB 7.6% 9.1% Credit Experience of Loans in Pools Underlying Mtg. Sec. Rated ***BBB (Since Acquisition) Resolved Defaulted Loans (Cumulative) 90 138 Average Loss Severity Experience (Cumulative) 25% 24% Scenario Analysis of Potential Credit Losses Over Next 12 Months If All Current (But No Future) Seriously Delinquent Loans in Mortgage Pools Underlying *** BBB Rated Securities Default: At 10% Loss Severity $ 80 $ 109 At 20% Loss Severity 792 1,488 At 30% Loss Severity 2,845 3,702 At 40% Loss Severity 5,103 6,410 Average Monthly Mortgage Securities Credit Provision $ 164 $ 159 Reserve in 12 Months at Provisioning Rate If No Losses 4,177 4,558
*** Non-EDGAR Symbol for Less Than 59 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 7 (CONTINUED) AT OR CREDIT PROVISIONS AND CREDIT RESERVES FOR THREE MONTHS ENDING ---------------------------------------------------- (ALL DOLLARS IN THOUSANDS) MAR. 31, JUN. 30, SEP. 30, DEC. 31, 1996 1996 1996 1996 --------- --------- --------- --------- MORTGAGE LOANS Credit Provision During Period $ (5) $ 140 $ 178 $ 35 Actual Losses During Period 0 0 0 0 Cumulative Actual Losses 0 0 0 0 Mortgage Loan Reserve End of Period 74 214 393 428 Annualized Credit Provision/ Ave. Mortgage Loans -0.08% 1.23% 0.76% 0.10% Mortgage Loan Reserve/Ending Mortgage Loans 0.30% 0.31% 0.31% 0.08% Non-Performing Assets: 90+ Days Delinquent, Foreclosures, Bankruptcies, and REO Number of Loan 1 2 3 7 NPA Loan Balance $ 190 $ 279 $ 404 $ 1,249 Non-Performing Assets as % of Mortgage Loans 0.8% 0.4% 0.3% 0.2% Non-Performing Assets as % of Total Assets 0.03% 0.03% 0.03% 0.06% Mortgage Loan Reserve as % of NPAs Credit Experience of Mortgage Loans Liquidated Defaulted Loans (Cumulative) 0 0 0 0 Average Loss Severity Experience (Cumulative) 0% 0% 0% 0% Scenario Analysis of Potential Credit Losses Over Next 12 Months If All Current (But No Future) Non-Performing Mortgage Loans Default: At 10% Loss Severity $ 19 $ 28 $ 41 $ 127 At 20% Loss Severity 39 56 82 253 At 30% Loss Severity 58 85 123 380 At 40% Loss Severity 77 113 164 506 MORTGAGE SECURITIES Credit Provision During Period $ 336 $ 337 $ 338 $ 337 Actual Losses During Period 0 0 0 7 Cumulative Actual Losses 4 4 4 11 Mortgage Securities Reserve End of Period 747 1,084 1,421 1,752 Annualized Credit Provision/Mtg. Sec. Rated *** BBB 4.7% 4.7% 4.7% 4.7% Mortgage Loan Reserve/Ending Mtg. Sec. Rated *** BBB 2.7% 3.8% 4.9% 6.1% Credit Experience of Loans in Pools Underlying Mtg. Sec. Rated ***BBB (Since Acquisition) Resolved Defaulted Loans (Cumulative) 4 15 28 59 Average Loss Severity Experience (Cumulative) 10% 16% 22% 27% Scenario Analysis of Potential Credit Losses Over Next 12 Months If All Current (But No Future) Seriously Delinquent Loans in Mortgage Pools Underlying *** BBB Rated Securities Default: At 10% Loss Severity $ 20 $ 40 $ 61 $ 63 At 20% Loss Severity 39 91 123 608 At 30% Loss Severity 597 1,364 1,131 2,040 At 40% Loss Severity 2,162 3,148 3,041 3,647 Average Monthly Mortgage Securities Credit Provision $ 112 $ 112 $ 113 $ 112 Reserve in 12 Months at Provisioning Rate If No Losses 2,091 2,431 2,771 3,100
*** Non-EDGAR Symbol for Less Than 60 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 7 (CONTINUED) AT OR CREDIT PROVISIONS AND CREDIT RESERVES FOR THREE MONTHS ENDING ------------------------------------------------------ (ALL DOLLARS IN THOUSANDS) MAR. 31, JUN. 30, SEP. 30, DEC. 31, 1995 1995 1995 1995 --------- --------- --------- --------- MORTGAGE LOANS Credit Provision During Period $ 0 $ 0 $ 0 $ 79 Actual Losses During Period 0 0 0 0 Cumulative Actual Losses 0 0 0 0 Mortgage Loan Reserve End of Period 0 0 0 79 Annualized Credit Provision/ Ave. Mortgage Loans n/a n/a n/a 1.60% Mortgage Loan Reserve/Ending Mortgage Loans n/a n/a n/a 0.30% Non-Performing Assets: 90+ Days Delinquent, Foreclosures, Bankruptcies, and REO Number of Loan 0 0 0 0 NPA Loan Balance $ 0 $ 0 $ 0 $ 0 Non-Performing Assets as % of Mortgage Loans 0.0% 0.0% 0.0% 0.0% Non-Performing Assets as % of Total Assets 0.00% 0.00% 0.00% 0.00% Mortgage Loan Reserve as % of NPAs Credit Experience of Mortgage Loans Liquidated Defaulted Loans (Cumulative) 0 0 0 0 Average Loss Severity Experience (Cumulative) 0% 0% 0% 0% Scenario Analysis of Potential Credit Losses Over Next 12 Months If All Current (But No Future) Non-Performing Mortgage Loans Default: At 10% Loss Severity $ 0 $ 0 $ 0 $ 0 At 20% Loss Severity 0 0 0 0 At 30% Loss Severity 0 0 0 0 At 40% Loss Severity 0 0 0 0 MORTGAGE SECURITIES Credit Provision During Period $ 19 $ 40 $ 84 $ 271 Actual Losses During Period 0 0 0 4 Cumulative Actual Losses 0 0 0 4 Mortgage Securities Reserve End of Period 19 59 143 411 Annualized Credit Provision/Mtg. Sec. Rated *** BBB 1.6% 1.7% 2.0% 4.4% Mortgage Loan Reserve/Ending Mtg. Sec. Rated *** BBB 0.3% 0.4% 0.7% 1.4% Credit Experience of Loans in Pools Underlying Mtg. Sec Rated *** BBB (Since Acquisition) Resolved Defaulted Loans (Cumulative) 0 0 0 2 Average Loss Severity Experience (Cumulative) 0% 0% 0% 9% Scenario Analysis of Potential Credit Losses Over Next 12 Months If All Current (But No Future) Seriously Delinquent Loans in Mortgage Pools Underlying *** BBB Rated Securities Default: At 10% Loss Severity $ 0 $ 0 $ 0 $ 15 At 20% Loss Severity 0 0 0 29 At 30% Loss Severity 0 0 0 103 At 40% Loss Severity 0 0 0 768 Average Monthly Mortgage Securities Credit Provision $ 6 $ 13 $ 28 $ 90 Reserve in 12 Months at Provisioning Rate If No Losses 93 221 479 1,495
*** Non-EDGAR Symbol for Less Than 61 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 7 (CONTINUED) AT OR CREDIT PROVISIONS AND CREDIT RESERVES FOR THREE MONTHS ENDING --------------------------- (ALL DOLLARS IN THOUSANDS) SEP. 30, DEC. 31, 1994 1994 --------- --------- MORTGAGE LOANS Credit Provision During Period $ 0 $ 0 Actual Losses During Period 0 0 Cumulative Actual Losses 0 0 Mortgage Loan Reserve End of Period 0 0 Annualized Credit Provision/ Ave. Mortgage Loans n/a n/a Mortgage Loan Reserve/Ending Mortgage Loans n/a n/a Non-Performing Assets: 90+ Days Delinquent, Foreclosures, Bankruptcies, and REO Number of Loan 0 0 NPA Loan Balance $ 0 $ 0 Non-Performing Assets as % of Mortgage Loans 0.0% 0.0% Non-Performing Assets as % of Total Assets 0.00% 0.00% Mortgage Loan Reserve as % of NPAs Credit Experience of Mortgage Loans Liquidated Defaulted Loans (Cumulative) 0 0 Average Loss Severity Experience (Cumulative) 0% 0% Scenario Analysis of Potential Credit Losses Over Next 12 Months If All Current (But No Future) Non-Performing Mortgage Loans Default: At 10% Loss Severity $ 0 $ 0 At 20% Loss Severity 0 0 At 30% Loss Severity 0 0 At 40% Loss Severity 0 0 MORTGAGE SECURITIES Credit Provision During Period $ 0 $ 0 Actual Losses During Period 0 0 Cumulative Actual Losses 0 0 Mortgage Securities Reserve End of Period 0 0 Annualized Credit Provision/Mtg. Sec. Rated *** BBB n/a 0.0% Mortgage Loan Reserve/Ending Mtg. Sec. Rated *** BBB n/a 0.0% Credit Experience of Loans in Pools Underlying Mtg. Sec Rated ***BBB (Since Acquisition) Resolved Defaulted Loans (Cumulative) 0 0 Average Loss Severity Experience (Cumulative) 0% 0% Scenario Analysis of Potential Credit Losses Over Next 12 Months If All Current (But No Future) Seriously Delinquent Loans in Mortgage Pools Underlying *** BBB Rated Securities Default: At 10% Loss Severity $ 0 $ 0 At 20% Loss Severity 0 0 At 30% Loss Severity 0 0 At 40% Loss Severity 0 0 Average Monthly Mortgage Securities Credit Provision $ 0 $ 0 Reserve in 12 Months at Provisioning Rate If No Losses 0 0
*** Non-EDGAR Symbol for Less Than 62 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 8 AT OR SHARES OUTSTANDING AND PER SHARE DATA FOR THREE MONTHS ENDING ----------------------------- (ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) MAR. 31, JUN. 30, 1997 1997 ----------- ----------- Shares Outstanding and Receiving Dividends at Period End Common (RWTI) 11,905,957 13,251,847 Class A Preferred (converted 9/95) 0 0 Class B Preferred (RWTIP) 999,638 909,518 ----------- ----------- Total 12,905,595 14,161,365 Common Dividend Declared $ 0.60 $ 0.60 Class A Preferred Dividend Declared $ - $ - Class B Preferred Dividends Declared $ 0.755 $ 0.755 Common Dividend Total $ 7,144 $ 7,951 Class A Preferred Dividend Total 0 0 Class B Preferred Dividends Total 755 687 ----------- ----------- Total Dividend $ 7,899 $ 8,638 Taxable Income Earned $ 7,912 $ 8,315 Dividend Pay-Out Ratio for Period 99.8% 103.9% Cumulative Dividend Pay-Out Ratio 98.5% 99.7% Warrants Outstanding at Period End (RWTIW) 272,304 236,297 Average Shares Outstanding During Period Common 11,605,171 12,997,566 Class A Preferred 0 0 Class B Preferred 1,005,515 990,725 ----------- ----------- Total 12,610,686 13,988,291 Calculation of "Primary" Common Shares Average Common Shares 11,605,171 12,997,566 Potential Dilution Due to Warrants 258,422 182,137 Potential Dilution Due to Options 253,274 291,227 ----------- ----------- Total Average Primary Common Shares 12,116,867 13,470,930 Net Income to Common Shareholders $ 6,456 $ 7,034 Total Average Primary Common Shares 12,116,867 13,470,930 ----------- ----------- Earnings Per Share (EPS) $ 0.53 $ 0.52 EPS (Outstanding Common Shares Only) $ 0.56 $ 0.54 Per Share Ratios (Average Outstanding Common and Preferred Shares) Average Total Assets $ 183.09 $ 212.58 Average Total Equity $ 18.81 $ 20.96 Net Interest Income $ 0.72 $ 0.70 Credit Expenses $ 0.06 $ 0.06 Operating Expenses $ 0.09 $ 0.09 Net Income $ 0.57 $ 0.55
63 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 8 (CONTINUED) AT OR SHARES OUTSTANDING AND PER SHARE DATA FOR THREE MONTHS ENDING ----------------------------------------------------------------- (ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) MAR. 31, JUN. 30, SEP. 30, DEC. 31, 1996 1996 1996 1996 ----------- ----------- ----------- ----------- Shares Outstanding and Receiving Dividends at Period End Common (RWTI) 5,521,376 8,520,116 9,069,653 10,996,572 Class A Preferred (converted 9/95) 0 0 0 0 Class B Preferred (RWTIP) 0 0 1,006,250 1,006,250 ----------- ----------- ----------- ----------- Total 5,521,376 8,520,116 10,075,903 12,002,822 Common Dividend Declared $ 0.46 $ 0.40 $ 0.40 $ 0.41 Class A Preferred Dividend Declared $ - $ - $ 0.00 $ 0.00 Class B Preferred Dividends Declared $ - $ - $ 0.386 $ 0.755 Common Dividend Total $ 2,540 $ 3,408 $ 3,628 $ 4,508 Class A Preferred Dividend Total 0 0 0 0 Class B Preferred Dividends Total 0 0 388 760 ----------- ----------- ----------- ----------- Total Dividend $ 2,540 $ 3,408 $ 4,016 $ 5,268 Taxable Income Earned $ 2,549 $ 3,142 $ 4,048 $ 5,429 Dividend Pay-Out Ratio for Period 99.7% 108.5% 99.2% 97.0% Cumulative Dividend Pay-Out Ratio 93.0% 97.9% 98.3% 97.9% Warrants Outstanding at Period End (RWTIW) 1,665,063 1,563,957 1,076,431 412,894 Average Shares Outstanding During Period Common 5,521,376 7,813,974 8,732,326 9,705,138 Class A Preferred 0 0 0 0 Class B Preferred 0 0 514,063 1,006,250 ----------- ----------- ----------- ----------- Total 5,521,376 7,813,974 9,246,389 10,711,388 Calculation of "Primary" Common Shares Average Common Shares 5,521,376 7,813,974 8,732,326 9,705,138 Potential Dilution Due to Warrants 443,984 603,426 621,455 570,415 Potential Dilution Due to Options 164,227 182,832 162,393 176,919 ----------- ----------- ----------- ----------- Total Average Primary Common Shares 6,129,587 8,600,232 9,516,174 10,452,472 Net Income to Common Shareholders $ 1,954 $ 2,500 $ 2,999 $ 4,084 Total Average Primary Common Shares 6,129,587 8,600,232 9,516,174 10,452,472 ----------- ----------- ----------- ----------- Earnings Per Share (EPS) $ 0.32 $ 0.29 $ 0.32 $ 0.39 EPS (Outstanding Common Shares Only) $ 0.35 $ 0.32 $ 0.34 $ 0.42 Per Share Ratios (Average Outstanding Common and Preferred Shares) Average Total Assets $ 92.87 $ 98.76 $ 124.97 $ 144.83 Average Total Equity $ 13.49 $ 15.05 $ 15.96 $ 17.26 Net Interest Income $ 0.50 $ 0.45 $ 0.50 $ 0.55 Credit Expenses $ 0.06 $ 0.06 $ 0.06 $ 0.03 Operating Expenses $ 0.09 $ 0.07 $ 0.07 $ 0.07 Net Income $ 0.35 $ 0.32 $ 0.37 $ 0.45
64 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 8 (CONTINUED) AT OR SHARES OUTSTANDING AND PER SHARE DATA FOR THREE MONTHS ENDING ------------------------------------------------------- (ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) MAR. 31, JUN. 30, SEP. 30, DEC. 31, 1995 1995 1995 1995 ---------- ---------- ---------- ---------- Shares Outstanding and Receiving Dividends at Period End Common (RWTI) 208,332 208,332 5,516,313 5,517,299 Class A Preferred (converted 9/95) 1,666,063 1,666,063 0 0 Class B Preferred (RWTIP) 0 0 0 0 ---------- ---------- ---------- ---------- Total 1,874,395 1,874,395 5,516,313 5,517,299 Common Dividend Declared $ - $ - $ 0.20 $ 0.26 Class A Preferred Dividend Declared $ 0.20 $ 0.30 $ - $ - Class B Preferred Dividends Declared $ - $ - $ - $ - Common Dividend Total $ 0 $ 0 $ 1,103 $ 1,434 Class A Preferred Dividend Total 333 500 0 0 Class B Preferred Dividends Total 0 0 0 0 ---------- ---------- ---------- ---------- Total Dividend $ 333 $ 500 $ 1,103 $ 1,434 Taxable Income Earned $ 408 $ 528 $ 1,083 $ 1,813 Dividend Pay-Out Ratio for Period 81.6% 94.6% 101.9% 79.1% Cumulative Dividend Pay-Out Ratio 89.8% 91.8% 96.4% 88.9% Warrants Outstanding at Period End (RWTIW) 1,666,063 1,666,063 1,666,063 1,665,063 Average Shares Outstanding During Period Common 208,332 208,332 3,944,129 5,516,310 Class A Preferred 1,666,063 1,666,063 0 0 Class B Preferred 0 0 0 0 ---------- ---------- ---------- ---------- Total 1,874,395 1,874,395 3,944,129 5,516,310 Calculation of "Primary" Common Shares Average Common Shares 1,874,395 1,874,395 3,944,129 5,516,310 Potential Dilution Due to Warrants 0 0 84,123 413,004 Potential Dilution Due to Options 240,766 188,699 154,886 150,193 ---------- ---------- ---------- ---------- Total Average Primary Common Shares 2,115,161 2,063,094 4,183,138 6,079,507 Net Income to Common Shareholders $ 401 $ 450 $ 994 $ 1,310 Total Average Primary Common Shares 2,115,161 2,063,094 4,183,138 6,079,507 ---------- ---------- ---------- ---------- Earnings Per Share (EPS) $ 0.19 $ 0.22 $ 0.24 $ 0.22 EPS (Outstanding Common Shares Only) $ 0.21 $ 0.24 $ 0.25 $ 0.24 Per Share Ratios (Average Outstanding Common and Preferred Shares) Average Total Assets $ 67.77 $ 87.54 $ 54.54 $ 67.72 Average Total Equity $ 12.36 $ 12.27 $ 13.37 $ 13.38 Net Interest Income $ 0.33 $ 0.37 $ 0.37 $ 0.37 Credit Expenses $ 0.01 $ 0.02 $ 0.02 $ 0.06 Operating Expenses $ 0.11 $ 0.11 $ 0.09 $ 0.07 Net Income $ 0.21 $ 0.24 $ 0.26 $ 0.24
65 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 8 (CONTINUED) AT OR SHARES OUTSTANDING AND PER SHARE DATA FOR THREE MONTHS ENDING ----------------------------- (ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) SEP. 30, DEC. 31, 1994 1994 ----------- ----------- Shares Outstanding and Receiving Dividends at Period End Common (RWTI) 208,332 208,332 Class A Preferred (converted 9/95) 1,226,465 1,666,063 Class B Preferred (RWTIP) 0 0 ----------- ----------- Total 1,434,797 1,874,395 Common Dividend Declared $ - $ - Class A Preferred Dividend Declared $ - $ 0.25 Class B Preferred Dividends Declared $ - $ - Common Dividend Total $ 0 $ 0 Class A Preferred Dividend Total 0 350 Class B Preferred Dividends Total 0 0 ----------- ----------- Total Dividend $ 0 $ 350 Taxable Income Earned $ 48 $ 306 Dividend Pay-Out Ratio for Period 0.0% 114.7% Cumulative Dividend Pay-Out Ratio 0.0% 99.2% Warrants Outstanding at Period End (RWTIW) 1,666,063 1,666,063 Average Shares Outstanding During Period Common 208,332 208,332 Class A Preferred 1,226,465 1,575,276 Class B Preferred 0 0 ----------- ----------- Total 1,434,797 1,783,608 Calculation of "Primary" Common Shares Average Common Shares 1,434,797 1,783,608 Potential Dilution Due to Warrants 0 0 Potential Dilution Due to Options 0 0 ----------- ----------- Total Average Primary Common Shares 1,434,797 1,783,608 Net Income to Common Shareholders $ 48 $ 334 Total Average Primary Common Shares 1,434,797 1,783,608 ----------- ----------- Earnings Per Share (EPS) $ 0.03 $ 0.19 EPS (Outstanding Common Shares Only) $ 0.03 $ 0.19 Per Share Ratios (Average Outstanding Common and Preferred Shares) Average Total Assets $ 13.33 $ 42.57 Average Total Equity $ 11.71 $ 12.12 Net Interest Income $ 0.06 $ 0.25 Credit Expenses $ 0.00 $ 0.00 Operating Expenses $ 0.03 $ 0.06 Net Income $ 0.03 $ 0.19
66 PART II OTHER INFORMATION Item 1. Legal Proceedings At June 30, 1997, there were no pending legal proceedings to which the Company as a party or of which any of its property was subject. Item 2. Changes in Securities Not applicable Item 3. Defaults Upon Senior Securities Not applicable Item 4. Submission of Matters to a Vote of Security Holders (a) The Annual Meeting of Shareholders of the Company was held on June 12, 1997. (b) The following matters were voted on at the Annual Meeting:
Votes ------------------------------------- For Against Abstain ------------ ----------- ---------- 1. Election of Directors George E. Bull 9,981,581 39,822 0 Dan A. Emmett 9,414,840 606,563 0
The following Directors' terms of office continue after the meeting: Frederick H. Borden Thomas F. Farb Nello Gonfiantini Douglas B. Hansen Charles J. Toeniskoetter
Votes ------------------------------------- For Against Abstain ------------- ---------- ---------- 2. Ratification of Coopers & Lybrand L.L.P. as the Company's independent public accountants for the fiscal year ending December 31, 1997. 10,005,687 12,345 3,371
67 Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 11.1 to Part I - Computation of Earnings Per Share for the three and six months ended June 30, 1997. Exhibit 27 - Financial Data Schedule (b) Reports None 68 SIGNATURES Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. REDWOOD TRUST, INC. Dated: August 11, 1997 By:/s/ Douglas B. Hansen -------------------------------- Douglas B. Hansen President and Chief Financial Officer (authorized officer of registrant) Dated: August 11, 1997 By: /s/ Vickie L. Rath ------------------------------ Vickie L. Rath Vice President, Treasurer and Controller (principal accounting officer) 69 REDWOOD TRUST, INC. INDEX TO EXHIBIT
Sequentially Exhibit Numbered Number Page ------- ------------ 11.1 Computation of Earnings per Share ............... 71 27 Financial Data Schedule ......................... 73
70