- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 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 ($.01 par value) 909,518 as of November 10, 1997 Common Stock ($.01 par value) 14,471,477 as of November 10, 1997 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- REDWOOD TRUST, INC. FORM 10-Q INDEX
Page ---- PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements Consolidated Balance Sheets at September 30, 1997 and December 31, 1996.............. 3 Consolidated Statements of Operations for the three and nine months ended September 30, 1997 and September 30, 1996...................................... 4 Consolidated Statements of Stockholders' Equity for the three and nine months ended September 30, 1997 and September 30, 1996...................................... 5 Consolidated Statements of Cash Flows for the three and nine months ended September 30, 1997 and September 30, 1996...................................... 6 Notes to Consolidated Financial Statements........................................... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......................................... 20 PART II. OTHER INFORMATION Item 1. Legal Proceedings..................................................................... 61 Item 2. Changes in Securities................................................................. 61 Item 3. Defaults Upon Senior Securities....................................................... 61 Item 4. Submission of Matters to a Vote of Security Holders................................... 61 Item 5. Other Information..................................................................... 61 Item 6. Exhibits and Reports on Form 8-K...................................................... 61 SIGNATURES .................................................................................. 62
2 PART I. FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS REDWOOD TRUST, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (In thousands, except share data)
September 30, 1997 December 31, 1996 ------------------ ----------------- ASSETS Mortgage assets: Mortgage securities $ 2,059,595 $ 1,627,953 Mortgage loans 1,378,328 525,475 ----------- ----------- 3,437,923 2,153,428 Interest rate agreements 2,926 2,601 Cash and cash equivalents 57,696 11,068 Accrued interest receivable 23,859 15,537 Other assets 2,848 1,563 ----------- ----------- $ 3,525,252 $ 2,184,197 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Short-term debt $ 2,639,773 $ 1,953,103 Long-term debt 497,367 -- Accrued interest payable 20,216 14,060 Accrued expenses and other liabilities 2,129 761 Dividends payable 9,433 5,268 ----------- ----------- 3,168,918 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; 14,576,477 and 10,996,572 issued and outstanding 146 110 Additional paid-in capital 333,841 187,507 Net unrealized gain (loss) on assets available for sale 1,837 (3,460) Dividends in excess of net income (6,223) (2,731) ----------- ----------- 356,334 211,005 ----------- ----------- $ 3,525,252 $ 2,184,197 =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 3 REDWOOD TRUST, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share data)
Three Months Ended Nine Months Ended September 30, September 30, 1997 1996 1997 1996 ------------ ------------ ------------ ------------ INTEREST INCOME Mortgage assets $ 56,044 $ 19,121 $ 143,693 $ 40,734 Cash and investments 499 250 927 669 ------------ ------------ ------------ ------------ 56,543 19,371 144,620 41,403 INTEREST EXPENSE Short-term debt 40,318 14,447 108,176 29,724 Long-term debt 5,570 -- 5,570 -- ------------ ------------ ------------ ------------ 45,888 14,447 113,746 29,724 NET INTEREST RATE AGREEMENTS EXPENSE 1,038 349 2,472 756 ------------ ------------ ------------ ------------ NET INTEREST INCOME 9,617 4,575 28,402 10,923 Provision for credit losses 943 516 2,414 1,324 Net (gain)/loss on sale transactions (20) -- (20) -- Operating expenses 1,148 672 3,530 1,758 ------------ ------------ ------------ ------------ NET INCOME 7,546 3,387 22,478 7,841 ------------ ------------ ------------ ------------ Less cash dividends on Class B preferred stock 687 388 2,129 388 ------------ ------------ ------------ ------------ NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 6,859 $ 2,999 $ 20,349 $ 7,453 ============ ============ ============ ============ NET INCOME PER SHARE Primary $ 0.47 $ 0.32 $ 1.52 $ 0.90 Fully diluted $ 0.47 $ 0.31 $ 1.52 $ 0.89 Weighted average shares of common stock and common stock equivalents: Primary 14,624,601 9,516,174 13,416,032 8,246,815 Fully diluted 14,624,601 9,657,395 13,416,032 8,402,542 Dividends declared per Class B preferred share $ 0.755 $ 0.386 $ 2.265 $ 0.386 Dividends declared per common share $ 0.600 $ 0.400 $ 1.800 $ 1.260
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 nine months ended September 30, 1997 (In thousands, except share data)
Net Unrealized Gain (Loss) Class B Preferred Stock Common Stock Additional on Assets Dividends in ------------------------ ------------------ Paid-in Available Excess of Shares Amount Shares Amount Capital for Sale Net Income Total ------------------------------------------------------------------------------------------------- Balance, December 31, 1996 1,006,250 $29,579 10,996,572 $110 $187,507 $(3,460) $(2,731) $211,005 ------------------------------------------------------------------------------------------------- Net income -- -- -- -- -- -- 7,211 7,211 Conversion of preferred stock (6,612) (196) 6,612 1 195 -- -- 0 Issuance of common stock -- -- 902,773 8 31,759 -- -- 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 999,638 $29,383 11,905,957 $119 $219,461 $ 118 $(3,419) $245,662 ------------------------------------------------------------------------------------------------ Net income -- -- -- -- -- -- 7,721 7,721 Conversion of preferred stock (90,120) (2,650) 90,120 1 2,649 -- -- 0 Issuance of common stock -- -- 1,255,770 13 52,310 -- -- 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 909,518 $26,733 13,251,847 $133 $274,420 $(3,762) $(4,336) $293,188 ------------------------------------------------------------------------------------------------ Net income -- -- -- -- -- -- 7,546 7,546 Issuance of common stock -- -- 1,697,630 17 70,446 -- -- 70,463 Repurchase of common stock -- -- (373,000) (4) (11,025) -- -- (11,029) Dividends declared: Class B Preferred -- -- -- -- -- -- (687) (687) Common -- -- -- -- -- -- (8,746) (8,746) Fair value adjustment on assets available for sale -- -- -- -- -- 5,599 -- 5,599 ------------------------------------------------------------------------------------------------ Balance, September 30, 1997 909,518 $26,733 14,576,477 $146 $333,841 $ 1,837 $(6,223) $356,334 ================================================================================================
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 Nine Months Ended September 30, September 30, 1997 1996 1997 1996 --------- --------- ----------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 7,546 $ 3,387 $ 22,478 $ 7,841 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of mortgage asset premium and discount, net 6,512 1,435 15,439 2,989 Amortization of deferred bond issuance costs 228 -- 228 -- Depreciation and amortization 32 25 87 60 Provision for credit losses on mortgage assets 943 516 2,414 1,324 Amortization of interest rate cap agreements 966 208 2,033 548 Net (gain)/loss on sale transactions (20) -- (20) -- (Increase) decrease in accrued interest receivable 1,959 (3,489) (8,322) (7,511) (Increase) decrease in other assets (1,606) 420 (1,340) (744) Increase in accrued interest payable 2,063 6,327 6,156 9,089 Increase in accrued expenses and other 386 111 1,368 245 --------- --------- ----------- --------- Net cash provided by operating activities 19,009 8,940 40,521 13,841 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of mortgage securities (43,163) (379,879) (911,789) (993,906) Proceeds from sales of mortgage securities 42,023 -- 42,023 -- Purchases of mortgage loans (326,300) (63,981) (1,047,639) (112,990) Principal payments on mortgage securities 170,942 71,145 434,720 151,288 Principal payments on mortgage loans 81,456 5,797 190,985 11,526 Purchases of interest rate cap agreements (596) (660) (7,697) (1,314) --------- --------- ----------- --------- Net cash used in investing activities (75,638) (367,578) (1,299,397) (945,396) CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from (repayments on) short-term borrowings (463,011) 328,880 686,670 854,778 Net proceeds from long-term borrowings 497,140 -- 497,140 -- Net proceeds from issuance of Class B preferred stock -- 29,712 -- 29,712 Net proceeds from issuance of common stock 70,438 7,646 154,528 64,221 Repurchases of common stock (11,029) -- (11,029) -- Dividends paid (8,638) (3,408) (21,805) (7,382) --------- --------- ----------- --------- Net cash provided by financing activities 84,900 362,830 1,305,504 941,329 Net increase in cash and cash equivalents 28,271 4,192 46,628 9,774 Cash and cash equivalents at beginning of period 29,425 10,407 11,068 4,825 --------- --------- ----------- --------- Cash and cash equivalents at end of period $ 57,696 $ 14,599 $ 57,696 $ 14,599 ========= ========= =========== ========= Supplemental disclosure of cash flow information: Cash paid for interest $ 43,594 $ 8,120 $ 107,585 $ 20,635 ========= ========= =========== =========
The accompanying notes are an integral part of these consolidated financial statements. 6 REDWOOD TRUST, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1997 NOTE 1. THE COMPANY Redwood Trust, Inc. 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.("Redwood Trust") and its special-purpose finance subsidiary, Sequoia Mortgage Funding Corporation (collectively, the "Company"). All inter-company balances and transactions have been eliminated. Substantially all of the assets of the special-purpose finance subsidiary are pledged to secure long-term debt in the form of collateralized mortgage bonds ("Long-Term Debt") and are not available for the satisfaction of general claims of the Company. The Company's exposure to loss on the assets pledged as collateral is limited to its net investment, as the Long-Term Debt is non-recourse to the Company. Certain amounts for prior years have been reclassified to conform with the 1997 presentation. 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. 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. 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. 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 Long-Term Debt using the interest method adjusted for the effects of prepayments. Deferred bond issuance costs are included in the carrying value of the Long-Term Debt. Unallocated 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 Long-Term Debt. 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. 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. 8 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. DEBT Short-term and long-term debt are carried at their unpaid principal balances, net of any unamortized discount or premium and any unamortized deferred bond issuance costs. Any discount or premium is recognized as an adjustment to interest expense using the interest method based on the maturity schedule of the related borrowings. 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 NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 1997 1996 1997 1996 ------------------------------------------------ As Reported: Primary Earnings Per Share $0.47 $0.32 $1.52 $0.90 Fully Diluted Earnings Per Share $0.47 $0.31 $1.52 $0.89 Under SFAS No. 128: Basic Earnings Per Share $0.48 $0.34 $1.57 $1.01 Fully Diluted Earnings Per Share $0.47 $0.32 $1.52 $0.90
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 9 revenue and expenses during the reported period. Actual results could differ from those estimates. The primary estimates inherent in the accompanying consolidated financial statements are discussed below. Fair Value. The Company uses estimates in establishing fair value for its investments available-for-sale. 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. Estimates of fair value for all remaining investments available-for-sale are based primarily on management's judgment. 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. The fair value of all on- and off- balance sheet financial instruments is presented in Notes 3, 6 and 9. Allowance for Credit Losses. As discussed in Note 5, the Company has assumed credit risk on certain Mortgage Assets. An allowance for credit losses has been estimated and established for the credit risk assumed based on management's judgment. The allowance for credit losses is evaluated and adjusted periodically by management based on the actual and projected timing and amount of potential credit losses, as well as industry loss experience. Provisions made to increase the allowance related to the credit risk assumed is presented as "Provision for Credit Losses" in the accompanying consolidated financial statements. The Company's actual credit losses may differ from those estimates used to establish the allowance. 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 September 30, 1997, Mortgage Assets consisted of the following:
MORTGAGE SECURITIES ------------------------- MORTGAGE (IN THOUSANDS) AGENCY NON-AGENCY LOANS TOTAL ----------------------------------------------------- Mortgage Assets, Gross $1,050,782 $959,592 $1,348,839 $3,359,213 Unamortized Discount (182) (14,205) 0 (14,387) Unamortized Premium 35,843 20,239 30,852 86,934 ---------- -------- ---------- ---------- Amortized Cost 1,086,443 965,626 1,379,691 3,431,760 Allowance for Credit Losses 0 (3,093) (1,363) (4,456) Gross Unrealized Gains 7,155 9,071 0 16,226 Gross Unrealized Losses (1,191) (4,416) 0 (5,607) ---------- -------- ---------- ---------- Carrying Value $1,092,407 $967,188 $1,378,328 $3,437,923 ========== ======== ========== ==========
10 At December 31, 1996, Mortgage Assets consisted of the following:
MORTGAGE SECURITIES ----------------------- MORTGAGE (IN THOUSANDS) AGENCY NON-AGENCY 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 September 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 September 30, 1997, the average annualized effective yield on the Mortgage Assets was 6.79% 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 on 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 September 30, 1997 and December 31, 1996, the weighted average lifetime cap was 12.01% and 11.73%, respectively. During the third quarter of 1997, the Company sold Mortgage Securities with a face value of approximately $40.0 million. Proceeds and realized gains and losses on the sales of Mortgage Securities are presented below:
NINE MONTHS ENDED (IN THOUSANDS) SEPTEMBER 30, 1997 ------------------ Proceeds from sales of available-for-sale securities $42,023 Available-for-sale securities gains $202 Available-for-sale securities losses (28) ---- Net gain on sales of available-for-sale securities $174 ====
As discussed in the Interest Rate Agreements policies in Note 1, in the event that an underlying hedged item is sold, any related hedging gains or losses are recognized in income. Accordingly, the sales of Mortgage Securities resulted in a charge to expense of $154,800, reflecting the write-down to fair value of the related interest rate hedges. The sales of Mortgage Securities therefore produced a net gain of $19,643. 11 NOTE 4. COLLATERAL FOR LONG-TERM DEBT The Company has pledged collateral in order to secure the Long-Term Debt issued in the form of collateralized mortgage bonds ("Bond Collateral"). This Bond Collateral consists primarily of adjustable-rate, conventional, 30-year mortgage loans secured by first liens on one- to four-family residential properties. All Bond Collateral is pledged to secure repayment of the related Long-Term Debt obligation. All principal and interest (less servicing related fees) on the Bond Collateral is remitted to a trustee and is available for payment on the Long-Term Debt obligation. The Company's exposure to loss on the Bond Collateral is limited to its net investment, as the Long-Term Debt is non-recourse to the Company. The Company may also be exposed to losses from prepayments of the underlying loans to the extent of unamortized net premium on the loans or deferred bond issuance costs related to the issuance of the Long-Term Debt. The components of the Bond Collateral at September 30, 1997 are summarized as follows:
(IN THOUSANDS) SEPTEMBER 30, 1997 ------------------ Mortgage loans $492,123 Cash and cash equivalents held by trustees 28,890 Accrued interest receivable 3,172 -------- $524,185 ========
For presentation purposes, the various components of the Bond Collateral summarized above are reflected in their corresponding line items on the Consolidated Balance Sheets. NOTE 5. ALLOWANCE FOR CREDIT LOSSES
NINE MONTHS ENDED YEAR ENDED (IN THOUSANDS) SEPTEMBER 30, 1997 DECEMBER 31, 1996 ------------------------------- -------------------------------- MORTGAGE MORTGAGE MORTGAGE MORTGAGE SECURITIES LOANS TOTAL SECURITIES LOANS TOTAL ------------------------------- -------------------------------- Balance at beginning of period $1,752 $ 428 $2,180 $ 411 $ 79 $ 490 Provision for credit losses 1,426 988 2,414 1,347 349 1,696 Charge-offs (85) (53) (138) (6) 0 (6) ------ ------ ------ ------ ---- ------ Balance at end of period $3,093 $1,363 $4,456 $1,752 $428 $2,180 ====== ====== ====== ====== ==== ======
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 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 September 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 12 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. NOTE 6. INTEREST RATE AGREEMENTS The amortized cost and fair value of the Company's Interest Rate Agreements are summarized as follows:
(IN THOUSANDS) SEPTEMBER 30, 1997 DECEMBER 31, 1996 ------------------ --------------- Amortized Cost $11,708 $ 6,200 Gross Unrealized Gains 468 156 Gross Unrealized Losses (9,250) (3,755) - ----------------------- ------- -------- Carrying Value $ 2,926 $ 2,601 ======= =======
The sum of the notional amounts of all of the Company's Interest Rate Agreements in effect was $3.1 billion at September 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 $5.6 billion at September 30, 1997 and $2.6 billion at December 31, 1996. Cap Agreements Potential future earnings from the Company's 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 $2.6 billion and $703 million at September 30, 1997 and December 31, 1996, respectively. The weighted average cap strike rate during the three and nine months ended September 30, 1997 was 7.09% and 7.20%, respectively. The weighted average cap strike rate during the three and nine months ended September 30, 1996 was 7.11% and 7.18%, 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 September 30, 1997 is summarized below.
(DOLLARS IN THOUSANDS) AVERAGE CAP EXPECTED NOTIONAL AVERAGE CAP LOW CAP HIGH CAP CAP EXPENSE FACE AMOUNT STRIKE RATE STRIKE RATE STRIKE RATE AMORTIZATION YEAR - ------------------------------------------------------------------------------------------- 1997 (last 3 months) $2,688,124 7.08% 5.50% 12.00% $1,137 1998 2,016,375 7.57% 5.50% 12.00% 4,407 1999 1,360,356 9.05% 6.30% 12.00% 2,653 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 $11,708 =======
13 Collar Agreement At September 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 September 30, 1997 is summarized below.
NOTIONAL FACE EXPECTED COLLAR AMOUNT CAP STRIKE FLOOR STRIKE EXPENSE EFFECTIVE PERIOD: (IN THOUSANDS) INDEX RATE RATE AMORTIZATION - ------------------------- ------------ -------------- ---------- --------- ----------------------- October 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 sum of the notional amounts of the Company's fixed vs. floating rate Swap Agreements ("Fixed Pay Rate Swaps") in effect was $168 million at September 30, 1997 and $135 million at December 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 September 30, 1997 is summarized below.
(DOLLARS IN THOUSANDS) AVERAGE SWAP NOTIONAL FACE AVERAGE LOW HIGH YEAR AMOUNT PAY RATE PAY RATE PAY RATE - ----------------------------------------------------------------------------- 1997 (last 3 months) $155,446 6.04% 5.59% 7.18% 1998 (first 6 months) 70,569 5.89% 6.40% 7.18%
Periodic Swap Agreements: The Company enters into Periodic Swap Agreements in order 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 September 30, 1997 is summarized below.
(DOLLARS IN THOUSANDS) AVERAGE SWAP NOTIONAL FACE AVERAGE SPREAD LOW SPREAD HIGH SPREAD YEAR AMOUNT RECEIVED RECEIVED RECEIVED - ------------------------------------------------------------------------------- 1997 (last 3 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 September 30, 1997, the Company had entered into 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 14 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 September 30, 1997 is summarized below.
(DOLLARS IN THOUSANDS) AVERAGE SWAP NOTIONAL FACE AVERAGE LOW SPREAD HIGH SPREAD YEAR AMOUNT SPREAD PAID PAID PAID - ------------------------------------------------------------------------------ 1997 (last 3 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 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 eighteen different counter-parties in order to reduce the risk of credit exposure to any one counter-party. NOTE 7. SHORT-TERM DEBT The Company has entered into reverse repurchase agreements, notes payable and a revolving line of credit (together "Short-Term Debt") to finance acquisitions of a portion of its Mortgage Assets. This Short-Term Debt is collateralized by a portion of the Company's Mortgage Assets. At September 30, 1997, the Company had $2.6 billion of Short-Term Debt outstanding with a weighted average borrowing rate of 5.95% and a weighted average remaining maturity of 67 days. This debt was collateralized with $2.75 billion of Mortgage Assets. At December 31, 1996, the Company had $2.0 billion of Short-Term Debt outstanding with a weighted average borrowing rate of 5.83% and a weighted average remaining maturity of 98 days. This debt was collateralized with $2.1 billion of Mortgage Assets. During September 1997, the Company entered into a $20 million, six-month 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 September 30, 1997, borrowings under this facility totaled $19.9 million and were committed through October 15, 1997. At December 31, 1996, borrowings under this facility totaled $19.3 million. These borrowings are reflected in the $2.6 billion and $2.0 billion of Short-Term Debt outstanding at September 30, 1997 and December 31, 1996, respectively. At September 30, 1997 and December 31, 1996, the Short-Term Debt had the following remaining maturities:
(IN THOUSANDS) SEPTEMBER 30, 1997 DECEMBER 31, 1996 ------------------ ---------------- Within 30 days $1,591,742 $ 268,042 30 to 90 days 183,453 667,567 Over 90 days 864,578 1,017,494 - ------------ ---------- ---------- Total Short-Term Debt $2,639,773 $1,953,103 ========== ==========
15 For the three and nine months ended September 30, 1997, the average balance of Short-Term Debt was $2.7 billion and $2.5 billion with a weighted average interest cost of 5.98% and 5.85%, respectively. For the three and nine months ended September 30, 1996, the average balance of Short-Term Debt was $1.0 billion and $0.7 billion with a weighted average interest cost of 5.78% and 5.69%, respectively. The maximum balance outstanding during the nine months ended September 30, 1997 was $3.1 billion. The maximum balance outstanding during the year ended December 31, 1996 was $2.0 billion. NOTE 8. LONG-TERM DEBT During the third quarter of 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"). This series of Long-Term Debt consists of two classes of bonds at variable rates of interest. Payments received on the Bond Collateral are used to make payments on the Long-Term Debt. The obligations under the Long-Term Debt are payable solely from the Bond Collateral and are otherwise non-recourse to the Company. The maturity of each class is directly affected by the rate of principal prepayments on the related Bond Collateral. The Long-Term Debt is also subject to redemptions according to specific terms of the respective indentures. As a result, the actual maturity of any class of this series of Long-Term Debt is likely to occur earlier than its stated maturity. The components of the Long-Term Debt along with selected other information are summarized as follows:
(IN THOUSANDS) SEPTEMBER 30, 1997 ------------------ Long-Term Debt $498,859 Deferred bond issuance costs (1,492) -------- Total Long-Term Debt $497,367 ======== Range of coupons on bonds 6.005% to 6.095% Stated maturities 2029
For the three months ended September 30, 1997, the average effective interest cost for Long-Term Debt, as adjusted for the amortization of deferred bond issuance costs and other related expenses, was 6.27%. Interest paid on Long-Term Debt for the three months ended September 30, 1997 totaled $3.1 million. NOTE 9. FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents the carrying amounts and estimated fair values of the Company's financial instruments at September 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.
(IN THOUSANDS) SEPTEMBER 30, 1997 DECEMBER 31, 1996 ------------------------ ------------------------ CARRYING CARRYING AMOUNT FAIR VALUE AMOUNT FAIR VALUE ------------------------ ------------------------ Assets Mortgage Assets $3,437,923 $3,438,760 $2,153,428 $2,153,428 Interest Rate Agreements 2,926 2,169 2,601 2,601
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. 16 NOTE 10. STOCKHOLDER'S EQUITY CLASS B 9.74% CUMULATIVE CONVERTIBLE PREFERRED STOCK On August 8, 1996, the Company issued 1,006,250 shares of Class B Preferred Stock. 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 September 30, 1997, 96,732 shares of the Class B Preferred Stock have been converted into 96,732 shares of the Company's Common Stock. At September 30, 1997 and December 31, 1996, there were 909,518 and 1,006,250 shares of the Class B Preferred Stock outstanding, respectively. 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 September 30, 1997 and December 31, 1996, 1,294,939 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 September 30, 1997 and December 31, 1996, 320,448 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. The Company's Stock Option Plan permits stock options granted under the plan to accrue stock DERs. For the three and nine months ended September 30, 1997, the stock DERs accrued on NQSOs that had a stock DER feature resulted in non-cash charges to operating expenses of $119,436 and $366,239, respectively. For the three and nine months ended September 30, 1996, the stock DERs accrued on NQSOs that had a stock DER feature resulted in non-cash charges to operating expenses of $80,592 and $244,916, 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. 17 Information with respect to stock option and DER activity is as follows:
NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, 1997 DECEMBER 31, 1996 -------------------------- -------------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE SHARES EXERCISE PRICE SHARES EXERCISE PRICE -------------------------- -------------------------- Outstanding options at beginning of period: 421,583 $19.05 310,857 $ 9.48 Options granted 371,102 40.34 141,300 36.01 Options exercised (54,485) 0.89 (42,083) 0.11 Dividend equivalent rights earned 9,682 0.00 11,509 0.00 ------- ------- Outstanding options at end of period 747,882 30.69 421,583 19.05 ======= =======
STOCK PURCHASE WARRANTS At September 30, 1997 and December 31, 1996, there were 149,466 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. STOCK REPURCHASES On September 11, 1997, the Company's Board of Directors approved the repurchase of up to 745,000 shares of the Company's Common Stock. Pursuant to this repurchase program, the Company repurchased 373,000 shares of its Common Stock for $11.0 million. The repurchased shares have been returned to the Company's authorized but unissued shares of Common Stock. DIVIDENDS The Company declared and paid the following dividends for the three and nine months ended September 30, 1997 and for the year ended December 31, 1996:
DIVIDENDS PER SHARE TOTAL ---------------------------- DECLARATION RECORD PAYABLE DIVIDENDS CLASS B COMMON DATE DATE DATE (IN THOUSANDS) PREFERRED STOCK STOCK ---- ---- ---- -------------- --------------- ----- 9/8/97 9/30/97 10/21/97 $9,433 $0.755 $0.600 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 At September 30, 1997, the Company had no 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. 18 At September 30, 1997, the Company is obligated under non-cancelable operating leases with expiration dates through 2001. The future minimum lease payments under these non-cancelable leases are as follows: 1997 - $47,816; 1998 through 2000 - $191,262; 2001 - $63,754. NOTE 12. SUBSEQUENT EVENTS On November 6, 1997, the Company issued at a premium, $749.2 million in face value of long-term debt in the form of collateralized mortgage bonds. The Company received net proceeds of $755.1 million from this issuance. This long-term debt was issued by Sequoia Mortgage Trust 2, a business trust established by the Company's wholly-owned subsidiary, Sequoia. This debt is 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 collateral for this long-term debt is approximately $756.7 million. The proceeds received from this issuance are expected to be used to pay down a portion of the Company's Short-Term Debt. On November 10, 1997, the Company repurchased 105,000 shares of the Company's Common Stock for $2.8 million. Also on November 10, 1997, the Company entered into a commitment to repurchase 200,000 shares of the Company's Common Stock for $5.3 million with a settlement date of November 14, 1997. Repurchased shares are returned to the Company's authorized but unissued shares of Common Stock. 19 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. The Company earns net income to the extent that the interest income it earns from its mortgage loans and securities exceeds the cost of borrowed funds, hedging, credit loss expenses and operating expenses. The Company seeks 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, the two government-sponsored mortgage entities ("GSEs": Fannie Mae and Freddie Mac) and other mortgage Real Estate Investment Trusts ("REITs"). 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. Like the GSEs, the Company out-sources the servicing of its mortgage loans and 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. Over the past year, the Company has moved a long way towards transforming itself from a spread lending company managing mortgage securities funded with short-term debt to a spread lending company managing high-quality single-family mortgage loans funded with long-term debt. The impact of this transition on the Company's results is discussed below. The Company has elected to be considered a 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 third quarter of 1997, the Company acquired $326 million in mortgage loans and $43 million in mortgage securities (together, "mortgage assets"). Thus, over 88% of acquisitions during the quarter were mortgage loans. The Company received mortgage principal repayments of $252 million and sold mortgage securities for $42 million during the quarter. In the third quarter of 1997, total assets grew by $101 million, or 3%, to $3.5 billion. In the third quarter of 1996, the Company acquired $444 million new mortgage assets. Of these acquisitions, 14% were mortgage loans and 86% were mortgage securities. The Company received mortgage principal repayments of $77 million during the quarter. Net growth of total assets was $375 million, or 36%, in that quarter. 20 Through September 30, 1997, all mortgage loans acquired have been high quality, adjustable 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 September 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 specific types of adjustable-rate mortgages owned by the Company. One commonly used measure of the average annual rate of prepayment of mortgage principal is the conditional prepayment rate ("CPR"). The CPR for the Company's mortgage loans and the mortgages contained in the pools underlying its mortgage securities increased from 24% in the third quarter of 1996 to 25% in the third quarter of 1997. The CPR rate of the Company's mortgage asset portfolio has ranged between 23% and 29% since the fourth quarter of 1995. 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 provisions, some receive accelerated payments, i.e., a greater than pro-rata share of principal repayments generated by the underlying mortgage pool, and some are locked-out of such prepayments for a period of time. The average annual rate of mortgage principal repayment from all of these sources increased from 28% in the third quarter of 1996 to 31% in the third quarter of 1997. This total rate of mortgage principal repayment on the Company's mortgage assets has ranged between 26% and 32% since the fourth quarter of 1995. In the first nine months of 1997, the Company acquired $1.96 billion of new mortgage assets. Of these acquisitions, 54% were mortgage loans and 46% were mortgage securities. The Company received mortgage principal repayments of $626 million during this period. Net growth of total assets was $1.34 billion, or 61%, in the first nine months of 1997. In the first nine months of 1996, the Company acquired $1.11 billion of new mortgage assets. Of these acquisitions, 10% were mortgage loans and 90% were mortgage securities. The Company received mortgage principal repayments of $163 million during this period. Net growth of total assets was $962 million, or 218%, in the first nine months of 1996. The average CPR on the Company's mortgage assets (CPR) decreased from 26% in the first nine months of 1996 to 24% in the first nine months of 1997. The total rate of principal repayment increased from 28% in the first nine months of 1996 to 30% in the first nine months of 1997. Interest Income From the third quarter of 1996 to the third quarter of 1997, interest income increased by 192%. This increase was driven primarily by a 196% increase in average earning assets (mortgage assets plus cash). In the third quarter of 1997, the Company's average earning assets of $3.33 billion generated interest income of $56.5 million. In the third quarter of 1996, average earning assets of $1.12 billion generated interest income of $19.4 million. In the third quarter of 1997, the Company's earning asset yield (interest income annualized and divided by the average daily amortized cost of earning assets) was 6.80%. The average mortgage coupon rate (mortgage interest payments annualized and divided by the average daily principal value of mortgages) was 7.77%. Since the Company's average amortized cost was 102.2% of mortgage principal value during that quarter, the coupon yield on amortized cost book value for the Company's mortgages was 7.60%. Net mortgage premium and discount amortization expenses of $6.51 million reduced the coupon yield by 0.79% for a net mortgage yield of 6.81%. The yield earned on the Company's cash balances during the quarter was 5.60%; the blended earning asset yield was 6.80%. The Company's earning asset yield was 6.90% in the third quarter of 1996. The average mortgage coupon rate was 7.52%. Because the Company's average amortized cost for mortgage assets was 101.0% of mortgage principal value during that quarter, the coupon yield on amortized cost book value for the Company's mortgages was 7.44%. Net mortgage premium and discount amortization expenses of $1.44 million reduced the coupon yield 21 by 0.52% for a net mortgage yield of 6.92%. The yield earned on the Company's cash balances during the quarter was 5.30%, bringing the overall third quarter of 1996 blended earning asset yield to 6.90%. The 6.80% earning asset yield for the third quarter of 1997 was slightly lower than the 6.90% for the third quarter of 1996. The average coupon rate was lower in the third quarter of 1996 due to the temporary effect of lower initial coupons on newly acquired mortgages. At September 30, 1996 the average coupon rate was 0.36% below the fully indexed rate. By September 30, 1997, the average coupon rate on the Company's mortgage assets was 0.09% below the fully indexed rate, as coupons rose and the relevant interest rate indices fell over this period. The total rate of mortgage principal repayment was similar for these two periods. However, because the Company's average amortized cost for mortgage assets was higher in the third quarter of 1997 than in the third quarter of 1996 (102.2% versus 101.0%), the reduction in mortgage yield due to the net amortization of premiums and discounts increased from 0.52% in the third quarter of 1996 to 0.79% in the third quarter of 1996. During 1996 and 1997, the Company generally acquired mortgage assets with lower risk characteristics than those assets previously acquired. As a result, average credit quality improved, with the percentage of the balance sheet consisting of subordinated mortgage securities rated below AA falling from 3.9% at the end of the third quarter of 1996 to 1.6% at the end of the third 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 10.7% to 9.0% over the same period. The lower risk assets acquired by the Company had higher acquisition prices reflecting their lower risk and resulted in the Company's earning asset yield being reduced somewhat as compared to short-term interest rate index levels. To some degree, the slight decrease in the earning asset yield in the third quarter of 1997 also reflects the high pricing levels for all mortgages that have prevailed in the mortgage market for several quarters. From the first nine months of 1996 to the first nine months of 1997, interest income increased by 249%. This increase was driven primarily by a 257% increase in average earning assets. In the first nine months of 1997, the Company's average earning assets of $2.82 billion generated interest income of $144.6 million. In the first nine months of 1996, the Company's average earning assets of $791 million generated interest income of $41.4 million. In the first nine months of 1997, the Company's earning asset yield was 6.83%. The average mortgage coupon was 7.73%. 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 $15.4 million reduced the coupon yield by 0.73% for a net mortgage yield of 6.84%. The yield earned on the Company's cash balances during the nine months was 5.51%; the blended earning asset yield was 6.83%. In the first nine months of 1996, the Company's earning asset yield was 6.98%. The average mortgage coupon rate was 7.54%. Because the Company's average amortized cost for mortgage assets was 100.2% of mortgage principal value during that period, the coupon yield on amortized cost book value for the Company's mortgages was 7.52%. Net mortgage premium and discount amortization expenses of $3.0 million reduced the coupon yield by 0.51% for a net mortgage yield of 7.01%. The yield earned on the Company's cash balances during the nine months was 5.58%, bringing the overall first nine months of 1996 earning asset yield to 6.98%. Interest Expense From the third quarter of 1996 to the third quarter of 1997, interest expense increased by 218%, from $14.4 million to $45.9 million. This increase was driven primarily by a 205% increase in average borrowings from $1.00 billion to $3.05 billion. Borrowings increased at a slightly faster rate over the last year than did earning assets (205% versus 196%) 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 10.1% in the third quarter of 1997 and 12.8% in the third quarter of 1996. An additional factor driving the increase in interest expense was a 0.24% increase in the Company's cost of funds from 5.78% in the third quarter of 1996 to 6.02% in the third 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 22 prior to the end of the period) were higher for the third quarter of 1997 than they were for the third quarter of 1996. The increase in cost of funds also reflects the issuance of long-term debt during the third quarter of 1997 and a change in the mix of assets towards mortgage loans rather than mortgage securities. The Company pays interest expense on its short-term debt 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 short-term debt 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 second to the third quarter of 1997 was approximately 0.06% (thereby reducing earnings in the third quarter by $0.03 per share relative to the second quarter, all other factors being equal). This impact of this seasonal factor will be neutral for the fourth quarter of 1997 and positive for the first quarter of 1998, in each case as compared to the third quarter of 1997. This seasonal effect applies only to the Company's short-term borrowings and will be reduced over time should the Company increase the percent of its total borrowings which are long-term. From the first nine months of 1996 to the first nine months of 1997, interest expense increased by 283%, from $29.7 million to $113.7 million. This increase was driven primarily by an increase in average borrowings of 272%, from $697 million to $2.59 billion. Borrowings increased at a faster rate than did earning assets (272% versus 257%) as the Company utilized greater leverage. The average equity-to-assets ratio was 13.9% in the first nine months of 1996 and was 10.1% in the first nine months of 1997. An additional factor driving the increase in interest expense was a 0.16% increase in the Company's cost of funds from 5.69% in the first nine months of 1996 to 5.85% in the first nine months 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, which the Company utilizes to reduce the effects that a large increase in interest rates could have on its balance sheet and earnings. The Company seeks to hedge, in part, the market value and earnings risks arising from the life caps, periodic caps and the fixed coupon period to the next adjustment date for its adjustable-rate mortgage assets. In the third quarter of 1997, on-going hedging expenses were $1.07 million and hedging income was $.03 million for a net interest rate agreements expense of $1.04 million. This net expense represented 0.12% of average assets, 0.14% of average borrowings, and 9.7% of net interest income before hedge expenses. In the third quarter of 1996, hedging expenses were $0.35 million and the Company earned no hedge income. Net hedge expenses represented 0.12% of average assets, 0.14% of average borrowings, and 7.1% of net interest income before hedge expenses for that quarter. In the first nine months of 1997, hedging expenses were $2.58 million and hedging income was $0.11 million for a net interest rate agreement expense of $2.47 million. This net expense represented 0.11% of average assets, 0.13% of average borrowings, and 8.0% of net interest income before hedge expenses. In the first nine months of 1996, hedging expenses were $0.76 million and the Company earned no hedge income. This net expense represented 0.12% of average assets, 0.14% of average borrowings, and 6.5% of net interest income before hedge expenses. Net Interest Income Net interest income is interest income less interest expense and net interest rate agreement hedging expenses. Net interest income increased by 111%, from $4.6 million in the third quarter of 1996 to $9.6 million in the third 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 196% over the same period. Net interest income as a percentage of average 23 assets (the net interest margin) decreased from 1.58% to 1.12% and net interest income as a percentage of equity decreased from 12.40% to 11.13%. Net interest income grew slower than the growth in net average assets primarily due to a narrowed spread between the Company's yield on earning assets and the cost of its borrowed funds and net hedging expenses (its interest rate spread). The Company's interest rate spread was 0.98% in the third quarter of 1996 and 0.64% in the third quarter of 1997. The Company's yield on earning assets fell by 0.10% over the last year while the cost of funds rose by 0.24% and the cost of hedging remained the same. Please see "Interest Income" and "Interest Expense" above for a discussion of the factors that resulted in a narrower interest rate spread. From the first nine months of 1996 to the first nine months of 1997, net interest income increased by 160%, from $10.9 million to $28.4 million. This increase was driven by asset growth, although growth in net interest income was less than the growth in average total assets of 257% over the same period due. As a result of the increased use of leverage and due to a narrowed spread between the Company's yield on earning assets and the cost of its borrowed funds and hedging, the net interest margin decreased from 1.79% to 1.30% while net interest income as a percentage of equity increased slightly from 12.85% to 12.95%. The Company's interest rate spread was 1.15% in the first nine months of 1996 and 0.85% in the first nine months of 1997. For reasons discussed above, the Company's yield on earning assets fell by 0.15% while the cost of funds rose by 0.16% and the cost of hedging fell by 0.01%. Gain or Loss on Sale Transactions The Company sold $42.0 million of mortgage securities in the third quarter of 1997. The gain on the sale of the mortgage securities was $0.17 million. In conjunction with the sale of the mortgage securities, the Company wrote down $0.15 million of related interest rate agreements, thereby reducing the net gain to $0.02 million. Credit Provision Expense and Actual Credit Losses The Company establishes credit provisions in order build a reserve for future credit losses. Provisions were $0.94 million in the third quarter of 1997 and $0.52 million in the third 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. The Company reviews its loss projections based on trends in serious delinquencies and loan loss severities (actual losses realized as a percent of defaulted loan balances) in the underlying mortgage pools and may make changes in its credit provisions accordingly. Credit provisions for these assets were $0.47 million in the third quarter of 1997 and $0.34 million in the third 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 third quarters of 1997 and 1996, the Company took mortgage loan provisions of $0.47 million and $0.18 million, respectively. The Company's current policy is to set aside annual credit provisions for mortgage loans on an on-going basis equaling 0.10% to 0.20% of its loan portfolio. Total credit provisions equaled 0.18% of average total assets and 1.40% of average equity in the third quarter of 1996 and declined to 0.11% of average assets and 1.09% of average equity in the third 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 2.1% to 0.9%, although mortgage loans increased from 9.3% to 40.2% over the same period. The Company has not added to its portfolio of lower-rated subordinated mortgage securities since 1995. The Company had no actual realized credit losses in the third quarter of 1996. Actual credit losses were $68,000 in the third quarter of 1997. Of these losses, $40,000 were from the Company's whole loans and $28,000 from the Company's subordinated mortgage securities. Total cumulative actual credit losses from the inception of the Company through September 30, 1997 have been $150,000; actual losses from subordinated mortgage securities 24 have totaled $97,000 while actual losses from mortgage loans have totaled $53,000. 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 levels 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 $2.41 million in the first nine months of 1997 and $1.32 million in the first nine months of 1996. Credit provisions for below-BBB rated mortgage securities were $1.43 million and $1.01 million while mortgage loan provisions were $0.99 million and $0.31 million, respectively. Total credit provisions equaled 0.11% of average total assets and 1.10% of average equity in the first nine months of 1997, a decline from 0.22% of average assets and 1.56% of average equity in the first nine months of 1996. Actual realized credit losses were $138,000 in the first nine months of 1997. The Company had no actual credit losses in the first nine months of 1996. Operating Expenses Total operating expenses increased by 71%, from $0.67 million in the third quarter of 1996 to $1.15 million in the third quarter of 1997. The Company expanded its staff and increased compensation for employees to market levels. A portion of the stock options granted to management, employees, and directors have dividend equivalent rights ("DERs") attached; the DER 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 third quarter of 1996 to the third quarter of 1997, operating expenses as a percentage of assets improved from 0.23% to 0.13%, operating expenses as a percentage of equity improved from 1.82% to 1.33%, the efficiency ratio (operating expenses as a percentage of net interest income) improved from 14.69% to 11.93%, and average assets per employee improved from $115 million to $244 million. From the first nine months of 1996 to the first nine months of 1997, total operating expenses increased by 101%, from $1.76 million to $3.53 million. Operating expenses as a percentage of assets improved from 0.29% to 0.16%, operating expenses as a percentage of equity improved from 2.07% to 1.61%, the efficiency ratio improved from 16.09% to 12.43%, and average assets per employee improved from $92 million to $242 million. Net Income Before Preferred Dividends Total net income to common and preferred shareholders increased by 123%, from $3.39 million in the third quarter of 1996 to $7.55 million in the third quarter of 1997. The percentage of net interest income brought down to the net income line increased from 74% to 78%. Return on assets dropped from 1.17% to 0.88% while at the same time return on total equity (common plus preferred) decreased from 9.18% to 8.73%. The positive effect of strong asset growth and improved operational efficiencies, partially offset the interest spread narrowing caused by the reasons discussed above. Total net income to common and preferred shareholders increased by 187%, from $7.84 million in the first nine months of 1996 to $22.48 million in the first nine months of 1997. Return on assets dropped from 1.28% to 1.03% due interest spread narrowing and the increased use of debt funding while at the same time return on total equity (common plus preferred) increased from 9.23% to 10.25%. 25 Preferred Dividends The Company's Cumulative Convertible Class B Preferred Stock ("preferred stock") was issued in the third quarter of 1996. Total third quarter 1997 preferred dividends were $687,000 as compared to third quarter 1996 preferred dividends of $388,000. The preferred dividend was $0.755 per share for the third quarter of 1997 and $0.386 per share for the third quarter of 1996 due to the preferred stock being outstanding only 46 days in the 1996 quarter. The preferred dividend equals the greater of the common stock dividend or $0.755 per share. Each share of preferred stock is convertible at the option of the holder at any time into one share of common stock. There were 1,006,250 preferred shares outstanding at the end of the third quarter of 1996 and 909,518 shares outstanding at the end of the third quarter of 1997 as preferred shareholders converted 96,732 shares into common stock. 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. Total preferred dividends in the first nine months of 1997 were $2.13 million, or $2.265 per share. Total preferred dividends in the first nine months of 1996 were $0.39 million, or $0.386 per share. Net Income to Common Shareholders Net income available for common shareholders increased by 129% over the last year, from $3.0 million in the third quarter of 1996 to $6.9 million in the third quarter of 1997. Over the same period, average common equity increased by 141% to $319.0 million. Return on common equity decreased from 9.06% to 8.60%. Net income available for common shareholders increased from $7.5 million in the first nine months of 1996 to $20.3 million in the first nine months of 1997, an increase of 173%. Over the same period, average common equity increased by 144% to $264.0 million. Return on common equity increased from 9.18% to 10.28%. Earnings Per Share The average number of common shares outstanding on a primary basis (including potential dilution from warrants and options) increased by 54%, from 9.52 million in the third quarter of 1996 to 14.62 million in the third quarter of 1997. Since net income to common shareholders increased by 129% over this period, earnings per share rose by 47%, from $0.32 to $0.47. The primary factor driving the 47% increase in earnings per share over this period was a 47% increase in average book value (equity) per common share. 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, January 1997, April 1997 and July 1997. These offerings increased book value per common share by 13%, 8%, 11% and 12%, respectively. The average number of common shares outstanding on a primary basis (including potential dilution from warrants and options) increased by 63%, from 8.25 million in the first nine months of 1996 to 13.42 million in the first nine months of 1997. Since total net income increased by 173%, earnings per share rose by 69%, from $0.90 to $1.52. This 69% increase in earnings per share was made possible by a 12% increase in return on common equity, a 38% increase in average book value (equity) per common share and a reduction in the dilutive impact of warrants as there were less warrants outstanding in the first nine months of 1997 than in the first nine months of 1996. 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. During any given quarter or year, however, dividends declared may exceed or be less than taxable REIT income. Taxable REIT income (before preferred dividend) was $4.05 million in the third quarter of 1996; this exceeded GAAP income of $3.39 million in that period due to differences in credit expenses of $0.52 million (actual credit 26 losses are deducted from taxable income rather than credit provisions), premium and discount amortization of $0.06 million and operating expenses of $0.08 million. Taxable REIT income (before preferred dividend) was $8.15 million in the third quarter of 1997; this exceeded GAAP income of $7.55 million in that period due to differences in credit expenses of $0.88 million, premium and discount amortization of negative $0.10 million and operating expenses of negative $0.18 million. On a taxable REIT income basis, return on total equity was 10.97% for the third quarter of 1996 and 9.43% for the third quarter of 1997. Return on common equity was 11.06% and 9.36% for the same periods, respectively. Taxable REIT income (before preferred dividend) was $9.74 million in the first nine months of 1996 and $24.38 million in the first nine months of 1997. On a taxable REIT income basis, return on total equity was 11.46% for the first nine months of 1996 and 11.11% for the first nine months of 1997. Taxable income return on common equity was 11.52% and 11.24% for the same periods, respectively. Common Share Dividends Dividends are based on taxable income. Dividends per common share have exceeded primary earnings per common share because taxable income has exceeded net income in each quarter. In the third quarter of 1997, the Company declared a common dividend of $0.60 per share, resulting in the distribution of $8.75 million to 14.58 million common shares outstanding at the end of the period. Together with the preferred dividend of $0.69 million, the Company distributed 115.7% of the taxable income it earned in that quarter. Through September 30, 1997, the Company had cumulatively declared dividends equaling 102.7% of cumulative taxable REIT income earned through that date. In the third quarter of 1996, the Company declared a common dividend of $0.40 per share, resulting in the distribution of $3.63 million to 9.07 million common shares outstanding at the end of the period. Together with the preferred dividend of $0.39 million, the Company distributed 99.2% of the taxable income it earned in that quarter. Through September 30, 1996, the Company had cumulatively declared dividends equaling 98.3% of cumulative taxable REIT income earned through that date. In the first nine months of 1997, the Company declared common dividends totaling $1.80 per share. The total common dividend paid was $23.84 million. Together with the preferred dividend of $2.13 million, the Company distributed 106.5% of the taxable income it earned in that nine months. For the first nine months of 1996, the Company declared common dividends totaling $1.26 per share, resulting in the distribution of $9.58 million. Together with the preferred dividend of $0.39 million, the Company distributed 102.3% of the taxable income it earned in that nine months. 27 FINANCIAL CONDITION Mortgage Loans From December 31, 1996 to September 30, 1997, the Company's mortgage loan portfolio grew in size by 162% and increased as a percentage of the Company's mortgage assets from 25% to 40%. In general over this period, the concentration of properties located in California dropped, the average seasoning declined, average loan size increased and effective loan-to-value ratios decreased. The percentage of the loan portfolio on non-performing status remained steady at low levels. At September 30, 1997, the Company owned 4,651 adjustable-rate, first-lien mortgage loans on single-family residential properties with a principal value of $1.35 billion and an amortized cost of $1.38 billion. The Company estimates that the bid-side market value of the Company's mortgage loan portfolio at September 30, 1997 was approximately $1.38 billion. As verified by its re-underwriting process, the Company believes that all mortgage loans owned as of September 30, 1997 were generally originated to "A" quality, or "Prime" quality, underwriting standards. The average loan size was $290,000. Loans with current balances less than $214,600 (the current Fannie Mae/Freddie Mac limit for most loans) made up 19% of the Company's mortgage loan portfolio, while loans with current balances in excess of $500,000 made up 33%. Loans on owner-occupied houses made up 91% of the loan portfolio; second homes represented 7% and investment properties 2%. At September 30, 1997, 11.3% of loans had original loan-to-value ratios ("OLTV") in excess of 80%. Of these, 86.6% had primary mortgage insurance ("PMI") serving to bring the effective OLTV of those loans to 63%. Of the loans with OLTVs in excess of 80%, 13.4% had no PMI; the average OLTV of these loans was 83%. The Company also owns loans which may have OLTVs in excess of 80% with respect to the collateral provided by the underlying real estate property but which is also protected by additional non real estate collateral in the form of a separate pledge account. These additional collateral loans make up 24.2% of the loan portfolios as of September 30, 1997; the effective OLTV of these loans is 65%. In total, after taking into account the available PMI and pledged accounts, the average effective OLTV on the Company's mortgage loan portfolio was 66% as of September 30, 1997. As of September 30, 1997, the average seasoning of the loan portfolio was 19 months. At September 30, 1997, 32% of the mortgage loans owned by the Company were on properties located in California (13% in Northern California and 19% in Southern California). Loans in Florida were 9% of the total; other states with a greater than 3% representation in the loan portfolio included New York, Arizona, Maryland, New Jersey, Connecticut, Texas, Illinois, Georgia and Colorado. At September 30, 1997, 13 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 $2.79 million, or 0.2% of the mortgage loan portfolio. Included in this NPA balance was REO of $0.22 million resulting from the default of 2 loans. The mortgage loan credit reserve as of September 30, 1997 was $1.36 million. If all of the NPAs as of September 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 $283,000, $567,000, $850,000 or $1,133,000, respectively. At September 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 September 30, 1997, the Company has achieved resolution or liquidation on four defaulted mortgage loans: the average loss severity on those loans was 6%. The analysis in this paragraph reviews the risk of loss from NPAs as of September 30, 1997 only; it does not purport to analyze or measure credit losses from additional NPAs that may arise after September 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 $0.52 billion and an amortized cost of $0.53 billion. The Company 28 estimates that the bid-side market value of these mortgage loans at December 31, 1996 was approximately $0.53 billion. 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 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 loan portfolio; third homes represented 4% and investment properties 2%. At December 31, 1996, 25% of the loans 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 $1.25 million, or 0.2% of the mortgage loan portfolio. Included in this total was one REO of $0.2 million. The mortgage loan credit reserve as of December 31, 1996 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 estimated 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 September 30, 1997, the Company's portfolio of mortgage securities increased by 27%. Mortgage securities declined as a percentage of total mortgage assets from 76% to 60%. All of the Company's mortgage securities represent interests in pools of adjustable rate, first lien mortgages on single-family residential properties. At September 30, 1997, the principal value of the Company's mortgage securities was $2.01 billion and the amortized cost was $2.05 billion. The Company estimates that the bid-side market value of the Company's mortgage securities portfolio at September 30, 1997 was approximately $2.06 billion. At September 30, 1997, 97.4% of the Company's mortgage securities had a credit rating equivalent of AAA or AA, 1.2% had a credit rating equivalent of A or BBB and 1.4% had a credit rating equivalent less than BBB. Securities guaranteed by Fannie Mae or Freddie Mac made up 53.0% 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 44.4% of the mortgage securities portfolio. Based on information available as of September 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 September 30, 1997, these below-BBB rated securities had a principal value of $39.9 million, an amortized cost before credit reserve of $29.2 million and a market value of $29.8 million. The Company's credit reserve for these assets at September 30, 1997 was $3.1 million. The Company estimates that if all the loans underlying the mortgage pools for these below BBB mortgage securities which were over 90 days delinquent, in foreclosure, in bankruptcy, or REO as of September 30, 1997 29 were to default and have a loss severity of 10%, 20%, 30%, or 40%, realized credit losses for the Company would be $0.72 million, $2.29 million, $3.79 million or $6.44 million, respectively. Cumulatively from the acquisition dates of these assets in 1994 and 1995 through September 30, 1997, 182 defaulted mortgage loans in these pools had been liquidated; the average loss severity on these loans was 23%. At September 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 September 30, 1997 only; it does not purport to analyze or measure credit losses from additional serious delinquencies that may arise after September 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, an amortized cost before credit reserve of $28.9 million and a market value of $25.6 million. The Company's credit reserve for these assets at December 31, 1996 was $1.75 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. Total Mortgage Asset Portfolio Characteristics At September 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 40.2% of the total mortgage asset portfolio, AAA and AA securities representing 58.2%, A and BBB rated securities representing 0.7% and below-BBB rated securities representing 0.9%. At September 30, 1997, 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 5.65%. Since the average net margin was 2.19%, the highest potential average mortgage coupon rate (the fully-indexed rate) at that time was 7.84%. The actual coupon rate was lower than the fully-indexed rate by 0.09% due to the timing lag from when interest rate indices move and when the interest rate on the related mortgage assets reset. At September 30, 1997, 38.9% of the Company's mortgage assets had coupon rate adjustments every six months based on the six month LIBOR or CD index and 12.4% 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 45.7% of the portfolio and one year Treasury mortgages with an initial coupon rate set longer than one year represented 1.7%. Mortgage assets with other indices made up 1.3% of the total. At September 30, 1997, the average term to next coupon adjustment for all mortgage assets was 4 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. At September 30, 1997, the Company's average mortgage asset life time maximum cap rate was 12.01%. At September 30, 1997, periodic caps limited coupon changes to 2% annually for 74.4% of the mortgage assets and there were no periodic caps on 25.6% of the mortgage assets. 30 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, 38.7% 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 57.7% of the total. Mortgage assets with other indices made up 2.2% of the total. At December 31, 1996, the average term to next coupon adjustment for all mortgage assets was 5 months. At 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 95.3% of the mortgage assets and there were no periodic caps on 4.7% of the mortgage assets. Interest Rate Agreements At September 30, 1997, the Company owned $5.6 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 6. 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 $11.71 million and an estimated bid-side market value of $2.17 million as of September 30, 1997. Market values were lower than 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 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 economic 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 $8.78 million at September 30, 1997. Interest rate agreements hedging mortgage loans are carried on the balance sheet at historical amortized cost, as a result changes in market values of these interest rate agreements are not shown in the valuation account. 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 September 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 additional borrowings. At September 30, 1997, net working capital was negative, as accrued interest payable, dividend payable, and accrued expenses exceeded interest receivable from mortgage assets, fixed assets and prepaid expenses. This 31 negative working capital provided funds at that time to reduce borrowings or increase cash investments by $5.07 million. However, the Company had an average investment in net positive working capital during the third quarter of 1997 of $61.0 million. Total non-earning assets averaged $85.7 million during the third quarter of 1997, representing 2.5% of total average assets and 24.8% 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 non-earning assets during the fourth quarter of 1996 averaged $41.4 million, representing 2.7% of total average assets and 22.4% of average equity during that quarter. Borrowings, Cash Balances and Liquidity At September 30, 1997, the Company's borrowings consisted primarily of short-term collateralized borrowing arrangements such as reverse repurchase agreements, notes payable, and revolving lines of credit ("short-term debt"). On July 25, 1997, the Company also issued $534 million billion of amortizing long-term floating rate debt in the form of collateralized mortgage bonds ("long-term debt") through its Sequoia program. The funds raised in this long-term debt offering were used to reduce short-term debt. Short-term borrowings totaled $2.640 billion with an average interest expense rate of 5.95% at September 30, 1997 and $1.95 billion with an average interest expense rate of 5.83% at December 31, 1996. Long-term borrowings totaled $0.497 billion at September 30, 1997 with an average interest expense rate of 6.27% in the third quarter of 1997. The Company had no long term debt at December 31, 1996. As the Company reduces risks on its balance sheet, it is able to use a greater amount of leverage under its Risk-Adjusted Capital Policy. However, the Company's debt-to-equity ratio declined from 9.1x at December 31, 1996 to 8.9x at September 30, 1997 because the Company had a significant amount of excess capital at of September 30, 1997. See "Stockholders' Equity, Capital Efficiency and Capital Adequacy" below for a discussion on the reasons for this excess capital which resulted in the decline in the Company's debt-to-equity ratio. The average debt-to-equity ratio increased from and 7.3x during the fourth quarter of 1996 to 8.8x during the third quarter of 1997. At September 30, 1997, a portion of the mortgage assets served as collateral for the Company's long term debt. The remaining mortgage assets, which had a market value of $2.95 billion, were available to collateralize the Company's short-term debt. The Company estimates it had additional borrowing capacity at that time of $206 million. In addition, the Company had $58 million of cash. On average during the third quarter of 1997, the Company estimates it had additional borrowing capacity of $184 million and average cash balances of $36 million. The monthly principal and interest payments received on the mortgages which serve as collateral to the long-term debt are held in trust until the bond payment date and are included in the Company's cash balances. The Company's unrestricted cash balances at September 30, 1997 were $28.8 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. The Company's liquidity status, borrowing capacity, and ability to roll over its short-term 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 September 30, 1997 and December 31, 1996, the average term to maturity of the Company's short-term borrowings was 67 days and 98 days and the average term to next rate adjustment was 40 days and 52 days, respectively; the term to next rate adjustment was shorter than the term to maturity as some of the Company's 32 borrowings had a cost of 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 short-term 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. At September 30, 1997, the stated maturity on the Company's long-term debt was thirty two years. The debt is callable before its stated maturity date. The interest rate on the long-term debt resets monthly; 37% was tied to the Fed Funds rate plus a spread and 63% was tied to one month LIBOR plus a spread at September 30, 1997. The debt is AAA rated, adjustable rate, amortizes at the same rate as the collateral and has a 10% lifetime interest cap. Stockholders' Equity, Capital Efficiency and Capital Adequacy From December 31, 1996 to September 30, 1997, the Company's equity base (exclusive of the market valuation account) grew from $214.5 million to $354.5 million. This equity growth was the result of the Company issuing $154.5 million in common stock through stock offerings, through the exercise of warrants and through the Company's Dividend Reinvestment and Stock Purchase Plan and reduced by $11.0 million used in the Company's Stock Repurchase Program. Because taxable earnings have exceeded GAAP net income, cumulative dividends have exceeded GAAP earnings; dividends exceeded GAAP earnings by $3.5 million in the first nine months of 1997, thus reducing stockholders' equity by that amount. Book value, or equity, per share (including common and preferred, excluding the market valuation account) increased by 28% from $17.87 on December 31, 1996 to $22.89 on September 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 positive $1.8 million on September 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, associated interest rate agreements and all other assets and liabilities were carried on the Company's balance sheet at September 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 $356.8 million as of September 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 lower and $2.3 million higher, respectively, on those dates. Between December 31, 1996 and September 30, 1997, the liquidation value of the Company's mortgage assets increased while the liquidation value of its interest rate agreements dropped: The Company expects that the net total "mark-to-market" value of the Company may 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, 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. Since management believes that the bulk of the capital currently 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 debt, the guideline capital amount should decline as the Company eliminates these risks through its transition towards greater utilization of long-term debt. 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 33 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 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 and 9.0% in the third 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, 9.9% in the second quarter of 1997 and 10.1% in the third quarter of 1997. Since actual equity-to-asset ratios in all these quarters were higher than the capital guideline ratios, the Company could have owned more mortgage assets during those quarters and still met its capital guidelines. Balance sheet capacity utilization (equity capital employed in the base business divided by total equity capital) 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, 96% in the second quarter of 1997 and 89% in the third quarter of 1997. Due to the issuance of long-term debt in the third and forth quarters and the current slow pace of assets acquisition, the balance sheet capacity utilization rate for the fourth quarter of 1997 will most likely be lower than it has been in the recent past. In defined circumstances prior to a planned equity offering, management is authorized by the Board of Directors to acquire mortgage assets in a limited amount beyond the usual constraints of the Company's Risk-Adjusted Capital Policy. 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, even after taking into account the expanded guidelines prior to any equity offering. Accordingly, the Company ceased making firm commitments to new asset acquisitions during that period. Approximately $29.4 million of the proceeds from the July offering was necessary to bring the Company into compliance with its normal capital guidelines. As a result of this constraint on acquisitions during the early part of the quarter, the level of total asset acquisitions for the third quarter of 1997 may have been less than otherwise would have been the case. Beginning in the second half of the third quarter of 1997, strong demand in an environment of reduced supply led to increasing prices for mortgage loans and securities. These rising prices together with the potential for increased mortgage prepayment rates led the Company to reduce the rate at which it sought to acquire new mortgage assets. Although this decision resulted in the Company's balance sheet having excess capital in the later part of the third quarter of 1997, management believes long-term shareholder value will be enhanced by not committing capital to the acquisition of mortgage assets at September price levels. In order to reduce the amount of excess capital and increase long-term shareholder value, a stock repurchase program was announced on September 11, 1997. The Company repurchased 373,000 shares at the end of September using $11 million of excess capital at an average price of $29.50 per share. The Company remains committed to buying back shares when management believes such purchases are in the best interests of long-term shareholders. Through its Sequoia subsidiary the Company issued $534 million of long-term debt in July of 1997 and issued another $755 million of long-term debt in November of 1997. Both issuances are rated AAA, adjustable rate, amortize at the same rate as the collateral and have 10% lifetime interest rate caps. With this November transaction, approximately 40% of the Company's debt is long-term debt. Liquidity and market value fluctuation risk for that 40% portion of the Company's balance sheet has been substantially eliminated. Recognizing this risk reduction, the Company significantly lowered its Risk-Adjusted Capital guideline amounts for the mortgage loans 34 collateralizing long-term debt. The Company's overall weighted average Risk-Adjusted Capital guideline equity-to-assets ratio declined as a result in July 1997 and again in November 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 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 tend to be cyclical. Historically, however, the magnitude of credit loss incurred from high quality single-family mortgages during historical credit cycles 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 completely eliminated unless the Company can replace all of its short-term borrowings with long-term borrowings. At September 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 entirely eliminate interest rate risk. Through September 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 September 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 September 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 most of the Company's liabilities are generally correlated). In addition, the Company has not fully hedged the periodic caps on the 74.4% of its assets at September 30, 1997 which had such 35 caps, or the life caps which are contained in all its mortgage assets. Certain other types of interest rate risks remain partially unhedged 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 assets then available for acquisition are less attractive than those of the existing assets held in portfolio. Prepayment rates for adjustable-rate mortgages increased during the third quarter of 1997 and management expects that such prepayment rates may increase in the fourth quarter of 1997. Slowing rates of mortgage principal repayment could exacerbate certain liquidity, market value fluctuation, and interest rate risks in a rising interest rate environment. 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 September 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, 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 generally determined based 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. 36 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 1 INCOME STATEMENT FOR THREE MONTHS ENDING ------------------------------------ (ALL DOLLARS IN THOUSANDS) SEP. 30, JUN. 30, MAR. 31, 1997 1997 1997 ---- ---- ---- Mortgage Loans: Coupon Income $ 21,432 $ 14,474 $ 10,784 Amortization of Discount Balances 1 8 11 Amortization of Premium Balances (1,803) (1,462) (940) -------------------------------- -------- -------- -------- Interest Income: Mortgage Loans 19,630 13,020 9,855 Mortgage Securities: Coupon Income 41,124 39,879 31,440 Amortization of Discount Balances 375 409 261 Amortization of Premium Balances (5,085) (4,065) (3,150) -------------------------------- -------- -------- -------- Interest Income: Mortgage Securities 36,414 36,223 28,551 Total Interest Income From Mortgage Assets 56,044 49,243 38,406 Interest Income: Cash Balances 499 266 162 - ------------------------------ -------- -------- -------- Total Interest Income 56,543 49,509 38,568 Interest Expense (45,888) (38,958) (28,900) Interest Rate Agreement Expense (1,066) (912) (602) Interest Rate Agreement Income 28 73 7 - ------------------------------ -------- -------- -------- Net Interest Rate Agreement Expense (1,038) (839) (595) Net Interest Income 9,617 9,712 9,073 Gain (Loss) on Sale 20 0 0 Other Income 0 0 0 - ------------ -------- -------- -------- Total Income 9,637 9,712 9,073 Provision for Potential Credit Losses Mortgage Loans (473) (299) (215) Mortgage Securities (470) (477) (480) ------------------- -------- -------- -------- Total Credit Provision (943) (776) (695) Compensation and Benefits Expense (441) (516) (529) Dividend Equivalent Rights Expense (361) (358) (203) Other Operating Expenses (346) (341) (435) - ------------------------ -------- -------- -------- Total Operating Expenses (1,148) (1,215) (1,167) Corporate Income Tax Expense 0 0 0 Net Income Before Preferred Dividends $ 7,546 $ 7,721 $ 7,211 Preferred Dividends (687) (687) (755) - ------------------- -------- -------- -------- Net Income to Common Shareholders $ 6,859 $ 7,034 $ 6,456 ================================= ======== ======== ======== Calculation of Taxable REIT Income - ---------------------------------- GAAP Net Income Before Preferred Dividends $ 7,546 $ 7,721 $ 7,211 Mortgage Amortization Differences (95) (103) (87) Credit Provisions less Actual Losses 875 747 653 Operating Expense Differences (175) (50) 135 - ----------------------------- -------- -------- -------- Taxable Income Before Preferred Dividend $ 8,151 $ 8,315 $ 7,912 ======================================== ======== ======== ========
37 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 1 (CONTINUED) INCOME STATEMENT FOR THREE MONTHS ENDING -------------------------------------------------- (ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31, 1996 1996 1996 1996 ---- ---- ---- ---- Mortgage Loans: Coupon Income $ 2,582 $ 1,656 $ 749 $ 479 Amortization of Discount Balances 11 7 11 2 Amortization of Premium Balances (189) (62) (43) (19) -------------------------------- -------- -------- -------- -------- Interest Income: Mortgage Loans 2,404 1,601 717 462 Mortgage Securities: Coupon Income 25,292 18,901 12,973 8,965 Amortization of Discount Balances 206 264 234 175 Amortization of Premium Balances (2,236) (1,645) (1,225) (688) -------------------------------- -------- -------- -------- -------- Interest Income: Mortgage Securities 23,262 17,520 11,982 8,452 Total Interest Income From Mortgage Assets 25,666 19,121 12,699 8,914 Interest Income: Cash Balances 215 250 202 217 - ------------------------------ -------- -------- -------- -------- Total Interest Income 25,881 19,371 12,901 9,131 Interest Expense (19,467) (14,447) (9,075) (6,202) Interest Rate Agreement Expense (403) (350) (255) (151) Interest Rate Agreement Income 1 0 0 0 - ------------------------------ -------- -------- -------- -------- Net Interest Rate Agreement Expense (402) (350) (255) (151) Net Interest Income 6,012 4,574 3,571 2,778 Gain (Loss) on Sale 0 0 0 0 Other Income 0 0 0 0 - ------------ -------- -------- -------- -------- Total Income 6,012 4,574 3,571 2,778 Provision for Potential Credit Losses Mortgage Loans (35) (178) (140) 5 Mortgage Securities (337) (338) (337) (336) ------------------- -------- -------- -------- -------- Total Credit Provision (372) (516) (477) (331) Compensation and Benefits Expense (343) (309) (305) (234) Dividend Equivalent Rights Expense (137) (81) (79) (85) Other Operating Expenses (316) (281) (210) (174) - ------------------------ -------- -------- -------- -------- Total Operating Expenses (796) (671) (594) (493) Corporate Income Tax Expense 0 0 0 0 Net Income Before Preferred Dividends $ 4,844 $ 3,387 $ 2,500 $ 1,954 Preferred Dividends (760) (388) 0 0 - ------------------- -------- -------- -------- -------- Net Income to Common Shareholders $ 4,084 $ 2,999 $ 2,500 $ 1,954 ================================= ======== ======== ======== ======== Calculation of Taxable REIT Income GAAP Net Income Before Preferred Dividends $ 4,844 $ 3,387 $ 2,500 $ 1,954 Mortgage Amortization Differences 131 61 82 175 Credit Provisions less Actual Losses 365 516 477 331 Operating Expense Differences 89 84 83 89 - ----------------------------- -------- -------- -------- -------- Taxable Income Before Preferred Dividend $ 5,429 $ 4,048 $ 3,142 $ 2,549 ======================================== ======== ======== ======== ========
38 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 1 (CONTINUED) INCOME STATEMENT FOR YEAR ENDING ------------------------------------ (ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31, DEC. 31, 1996 1995 1994 -------- -------- -------- Mortgage Loans: Coupon Income $ 5,466 $ 379 $ 0 Amortization of Discount Balances 31 4 0 Amortization of Premium Balances (313) (4) 0 -------------------------------- -------- -------- -------- Interest Income: Mortgage Loans 5,184 379 0 Mortgage Securities: Coupon Income 66,131 14,759 1,102 Amortization of Discount Balances 879 915 101 Amortization of Premium Balances (5,794) (559) (19) -------------------------------- -------- -------- -------- Interest Income: Mortgage Securities 61,216 15,115 1,184 Total Interest Income From Mortgage Assets 66,400 15,494 1,184 Interest Income: Cash Balances 884 232 112 - ------------------------------ -------- -------- -------- Total Interest Income 67,284 15,726 1,296 Interest Expense (49,191) (10,608) (760) Interest Rate Agreement Expense (1,159) (339) (8) Interest Rate Agreement Income 1 0 0 - ------------------------------ -------- -------- -------- Net Interest Rate Agreement Expense (1,158) (339) (8) Net Interest Income 16,935 4,779 528 Gain (Loss) on Sale 0 0 0 Other Income 0 0 0 - ------------ -------- -------- -------- Total Income 16,935 4,779 528 Provision for Potential Credit Losses Mortgage Loans (348) (79) 0 Mortgage Securities (1,348) (414) 0 ------------------- -------- -------- -------- Total Credit Provision (1,696) (493) 0 Compensation and Benefits Expense (1,191) (463) (63) Dividend Equivalent Rights Expense (382) (54) 0 Other Operating Expenses (981) (614) (83) - ------------------------ -------- -------- -------- Total Operating Expenses (2,554) (1,131) (146) Corporate Income Tax Expense 0 0 0 Net Income Before Preferred Dividends $ 12,685 $ 3,155 $ 382 Preferred Dividends (1,148) 0 0 - ------------------- -------- -------- -------- Net Income to Common Shareholders $ 11,537 $ 3,155 $ 382 ================================= ======== ======== ======== Calculation of Taxable REIT Income - ---------------------------------- GAAP Net Income Before Preferred Dividends $ 12,685 $ 3,155 $ 382 Mortgage Amortization Differences 449 175 (28) Credit Provisions less Actual Losses 1,689 490 0 Operating Expense Differences 345 12 0 - ----------------------------- -------- -------- -------- Taxable Income Before Preferred Dividend $ 15,168 $ 3,832 $ 354 ======================================== ======== ======== ========
39 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 2 AT --------------------------------------------- BALANCE SHEETS SEP. 30, JUN. 30, MAR. 31, (ALL DOLLARS IN THOUSANDS) 1997 1997 1997 ----------- ----------- ----------- Cash and Cash Equivalents $ 57,696 $ 29,425 $ 12,985 Mortgage Loans: Principal Value 1,348,619 1,111,029 716,009 Unamortized Premium 30,852 25,442 15,951 Unamortized Discount 0 (123) (131) Real Estate Owned 220 346 128 Reserve For Credit Losses (1,363) (929) (630) Market Valuation Account 0 0 (1,291) ------------------------ ----------- ----------- ----------- Total Mortgage Loans 1,378,328 1,135,765 730,035 Mortgage Securities: Principal Value 2,010,374 2,179,186 1,839,720 Unamortized Premium 56,082 62,219 49,156 Unamortized Discount (14,387) (14,968) (15,510) Reserve For Credit Losses (3,093) (2,651) (2,203) Market Valuation Account 10,619 3,603 3,516 ----------- ----------- ----------- Total Mortgage Securities 2,059,595 2,227,389 1,874,679 Total Mortgage Assets 3,437,923 3,363,154 2,604,714 Interest Rate Agreements 11,708 12,233 7,879 Market Valuation Account (8,782) (7,366) (2,106) - ------------------------ ----------- ----------- ----------- Total Interest Rate Agreements 2,926 4,867 5,773 Accrued Interest Receivable 23,859 24,065 17,722 Fixed Assets, Leasehold, Org Costs 358 257 259 Prepaid Expenses and Other Receivables 2,490 2,738 1,611 - -------------------------------------- ----------- ----------- ----------- Other Assets 26,707 27,060 19,592 Total Assets $ 3,525,252 $ 3,424,506 $ 2,643,064 ============ =========== =========== =========== Short-Term Borrowings $ 2,639,773 $ 3,102,784 $ 2,373,279 Long--Term Borrowings 497,367 0 0 Accrued Interest Payable 20,216 18,153 14,962 Accrued Expenses and Other Payables 2,129 1,743 1,262 Dividends Payable 9,433 8,638 7,899 - ----------------- ----------- ----------- ----------- Total Liabilities $ 3,168,918 $ 3,131,318 $ 2,397,402 Preferred Stock $ 26,733 $ 26,733 $ 29,383 Common Stock 146 133 119 Additional Paid-in Capital 333,841 274,420 219,461 Net Market Valuation Account 1,837 (3,762) 118 Retained Earnings after Dividends (6,223) (4,336) (3,419) - --------------------------------- ----------- ----------- ----------- Total Stockholders' Equity 356,334 293,188 245,662 Total Liabilities plus Stockholders' Equity $ 3,525,252 $ 3,424,506 $ 2,643,064 =========================================== =========== =========== ===========
40 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 2 (CONTINUED) AT ------------------------------------------------------ BALANCE SHEETS DEC. 31, SEP. 30, JUN. 30, MAR. 31, (ALL DOLLARS IN THOUSANDS) 1996 1996 1996 1996 ----------- ----------- ----------- --------- Cash and Cash Equivalents $ 11,068 $ 14,599 $ 10,407 $ 9,705 Mortgage Loans: Principal Value 514,837 126,426 69,154 24,831 Unamortized Premium 12,389 1,535 686 191 Unamortized Discount (142) (153) (160) (171) Real Estate Owned 196 0 0 0 Reserve For Credit Losses (428) (393) (214) (74) Market Valuation Account (1,377) 279 200 84 ------------------------ ----------- ---------- ---------- --------- Total Mortgage Loans 525,475 127,694 69,666 24,861 Mortgage Securities: Principal Value 1,602,212 1,234,636 936,611 548,976 Unamortized Premium 41,928 31,072 22,004 12,599 Unamortized Discount (15,951) (16,185) (16,448) (16,683) Reserve For Credit Losses (1,752) (1,421) (1,084) (747) Market Valuation Account 1,516 74 (3,269) (3,847) ------------------------ ----------- ---------- ---------- --------- Total Mortgage Securities 1,627,953 1,248,176 937,814 540,298 Total Mortgage Assets 2,153,428 1,375,870 1,007,480 565,159 Interest Rate Agreements 6,200 3,286 2,835 2,534 Market Valuation Account (3,599) (2,413) (1,484) (1,301) - ------------------------ ----------- ---------- ---------- --------- Total Interest Rate Agreements 2,601 873 1,351 1,233 Accrued Interest Receivable 14,134 10,781 7,292 4,496 Fixed Assets, Leasehold, Org Costs 257 265 233 198 Prepaid Expenses and Other Receivables 2,709 1,090 1,567 522 - -------------------------------------- ----------- ----------- ----------- --------- Other Assets 17,100 12,136 9,092 5,216 Total Assets $ 2,184,197 $ 1,403,478 $ 1,028,330 $ 581,313 ============ =========== =========== =========== ========= Short-Term Borrowings $ 1,953,103 $ 1,225,094 $ 896,214 $ 508,721 Long-Term Borrowings 0 0 0 0 Accrued Interest Payable 14,060 10,379 4,052 1,616 Accrued Expenses and Other Payables 761 472 361 290 Dividends Payable 5,268 4,016 3,408 2,540 - ----------------- ----------- ----------- ---------- --------- Total Liabilities $ 1,973,192 $ 1,239,961 $ 904,035 $ 513,167 Preferred Stock $ 29,579 $ 29,712 $ 0 $ 0 Common Stock 110 91 85 55 Additional Paid-in Capital 187,507 138,081 130,441 73,926 Net Market Valuation Account (3,460) (2,060) (4,553) (5,065) Retained Earnings after Dividends (2,731) (2,307) (1,678) (770) - --------------------------------- ----------- ----------- ----------- --------- Total Stockholders' Equity 211,005 163,517 124,295 68,146 Total Liabilities plus Stockholders' Equity $ 2,184,197 $ 1,403,478 $ 1,028,330 $ 581,313 =========================================== =========== =========== =========== =========
41 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 2 (CONTINUED) AT ------------------------------------- BALANCE SHEETS DEC. 31, DEC. 31, DEC. 31, (ALL DOLLARS IN THOUSANDS) 1996 1995 1994 ----------- --------- --------- Cash and Cash Equivalents $ 11,068 $ 4,825 $ 1,027 Mortgage Loans: Principal Value 514,837 26,411 0 Unamortized Premium 12,389 210 0 Unamortized Discount (142) (172) 0 Real Estate Owned 196 0 0 Reserve For Credit Losses (428) (79) 0 Market Valuation Account (1,377) 80 0 ------------------------ ----------- --------- --------- Total Mortgage Loans 525,475 26,450 0 Mortgage Securities: Principal Value 1,602,212 417,214 120,627 Unamortized Premium 41,928 9,433 828 Unamortized Discount (15,951) (16,860) (1,320) Reserve For Credit Losses (1,752) (411) 0 Market Valuation Account 1,516 (3,582) (2,658) ------------------------ ----------- --------- --------- Total Mortgage Securities 1,627,953 405,794 117,477 Total Mortgage Assets 2,153,428 432,244 117,477 Interest Rate Agreements 6,200 2,521 1,791 Market Valuation Account (3,599) (1,974) 101 - ------------------------ ----------- --------- --------- Total Interest Rate Agreements 2,601 547 1,892 Accrued Interest Receivable 14,134 3,270 743 Fixed Assets, Leasehold, Org Costs 257 206 201 Prepaid Expenses and Other Receivables 2,709 465 188 - -------------------------------------- ------------ --------- --------- Other Assets 17,100 3,941 1,132 Total Assets $ 2,184,197 $ 441,557 $ 121,529 ============ =========== ========= ========= Short-Term Borrowings $ 1,953,103 $ 370,316 $ 100,376 Long-Term Borrowings Accrued Interest Payable 14,060 1,290 676 Accrued Expenses and Other Payables 761 227 29 Dividends Payable 5,268 1,434 167 - ----------------- ----------- --------- --------- Total Liabilities $ 1,973,192 $ 373,267 $ 101,248 ----------- --------- --------- Preferred Stock $ 29,579 $ 0 $ 22,785 Common Stock 110 55 2 Additional Paid-in Capital 187,507 73,895 19 Net Market Valuation Account (3,460) (5,476) (2,557) Retained Earnings after Dividends (2,731) (184) 31 - --------------------------------- ----------- --------- --------- Total Stockholders' Equity 211,005 68,290 20,280 Total Liabilities plus Stockholders' Equity $ 2,184,197 $ 441,557 $ 121,528 =========================================== =========== ========= =========
42 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 3 AT OR MORTGAGE ASSET CHARACTERISTICS FOR THREE MONTHS ENDING -------------------------------------- (ALL DOLLARS IN THOUSANDS) SEP. 30, JUN. 30, MAR. 31, 1997 1997 1997 ---------- ---------- ---------- Average Characteristics of Mortgage Assets Single-Family Properties 100% 100% 100% Adjustable Rate 100% 100% 100% First Lien 100% 100% 100% Credit Rating Equivalent AA+ AA+ AA+ Amortized Cost as % of Principal Value 102.16% 102.21% 101.94% Coupon Rate 7.75% 7.73% 7.70% Months to Next Coupon Adjustment 4 5 5 Level of Index 5.65% 5.77% 5.98% Net Margin 2.19% 2.23% 2.21% Fully Indexed Coupon Rate 7.84% 8.00% 8.19% Coupon Versus Fully-Indexed Rate -0.09% -0.27% -0.49% Net Life Cap 12.01% 12.01% 11.91% Percentage of Mortgage Assets by Credit Type (By Amortized Cost) Mortgage Loans 40.2% 33.8% 28.1% Mortgage Securities: AAA/AA 58.2% 64.5% 69.8% Mortgage Securities: A/BBB 0.7% 0.8% 1.0% Mortgage Securities: Below BBB 0.9% 0.9% 1.1% - ------------------------------ ----- ----- ----- Total Mortgage Assets (%) 100.0% 100.0% 100.0% Total Mortgage Assets (Amortized Cost) $3,431,760 $3,363,131 $2,605,323 Percentage of Mortgage Assets by Index, Adjustment Frequency, and Annualized Periodic Cap (By Principal Value) 1 Month LIBOR, adjusts monthly, no periodic 12.4% 8.9% 2.6% 6 Month LIBOR, adjusts each 6 months, 2% periodic 26.2% 27.5% 32.4% 6 Month LIBOR, adjusts each 6 months, no periodic 11.4% 7.4% 1.9% 6 Month CD, adjusts each 6 months, 2% periodic 1.3% 1.5% 1.9% 6 Month Treasury, adjusts each 6 months, 2% periodic 0.6% 0.6% 0.8% 6 Month Treasury, adjusts each 6 months, no periodic 0.5% 0.5% 0.7% 3/1 Hybrid: 12 Month Treasury with 3 year initial coupon 1.7% 1.8% 2.4% 12 Month Treasury, adjusts annually, 2% periodic 44.5% 50.3% 55.4% 12 Month Treasury, adjusts annually, no periodic 0.1% 0.1% 0.1% Other 1.3% 1.4% 1.8% - ----- ----- ----- ----- Total Mortgage Assets (%) 100.0% 100.0% 100.0% Total Mortgage Assets (Principal Value) $3,359,213 $3,290,562 $2,555,857 Net Mortgage Asset Growth Mortgage Acquisitions $ 369,463 $ 962,889 $ 627,075 ---------- ---------- ---------- Mortgage Principal Repayments (252,397) (199,945) (173,362) Amortization, Sales and Other (48,437) (5,136) (3,859) - ------------------------------ ---------- ---------- ---------- Change in Mortgage Assets (Amortized Cost) 68,629 757,808 449,854 Net Mortgage Asset Growth versus Prior Quarter 2% 29% 21% Net Mortgage Asset Growth Over 12 Months 149% 232% 357% Prepayment Rate of Underlying Mortgages (CPR) 25% 23% 24% Total Rate of Mortgage Principal Repayment 31% 28% 32%
43 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 3 (CONTINUED) AT OR MORTGAGE ASSET CHARACTERISTICS FOR THREE MONTHS ENDING -------------------------------------------------- (ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 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 101.81% 101.20% 100.60% 99.29% Coupon Rate 7.75% 7.55% 7.42% 7.59% Months to Next Coupon Adjustment 5 4 4 3 Level of Index 5.58% 5.70% 5.72% 5.47% Net Margin 2.24% 2.21% 2.21% 2.11% Fully Indexed Coupon Rate 7.82% 7.91% 7.93% 7.58% Coupon Versus Fully-Indexed Rate -0.07% -0.36% -0.51% 0.01% Net Life Cap 11.73% 11.69% 11.71% 11.53% Percentage of Mortgage Assets by Credit Type (By Amortized Cost) Mortgage Loans 24.5% 9.3% 6.9% 4.4% Mortgage Securities: AAA/AA 73.0% 86.8% 87.7% 86.1% Mortgage Securities: A/BBB 1.2% 1.8% 2.5% 4.6% Mortgage Securities: Below BBB 1.3% 2.1% 2.9% 4.9% - ------------------------------ ----- ----- ----- ----- Total Mortgage Assets (%) 100.0% 100.0% 100.0% 100.0% Total Mortgage Assets (Amortized Cost) $2,155,469 $1,377,331 $1,011,847 $569,743 Percentage of Mortgage Assets by Index, Adjustment Frequency, and Annualized Periodic Cap (By Principal Value) 1 Month LIBOR, adjusts monthly, no periodic 1.4% 2.3% 3.3% 6.6% 6 Month LIBOR, adjusts each 6 months, 2% periodic 36.2% 45.9% 54.4% 63.2% 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 2.5% 2.4% 3.3% 8.7% 6 Month Treasury, adjusts each 6 months, 2% periodic 1.1% 1.7% 2.4% 0.0% 6 Month Treasury, adjusts each 6 months, no periodic 0.9% 1.3% 1.9% 3.6% 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 55.7% 45.0% 32.8% 14.6% 12 Month Treasury, adjusts annually, no periodic 0.0% 0.0% 0.0% 0.0% Other 2.2% 1.4% 1.9% 3.3% - ----- ----- ----- ----- ----- Total Mortgage Assets (%) 100.0% 100.0% 100.0% 100.0% Total Mortgage Assets (Principal Value) $2,117,244 $1,361,062 $1,005,764 $573,807 Net Mortgage Asset Growth Mortgage Acquisitions $ 875,968 $ 443,860 $ 496,184 $166,852 Mortgage Principal Repayments (95,610) (76,942) (53,058) (32,814) Amortization, Sales and Other (2,220) (1,434) (1,022) (530) - ------------------------------ ---------- ---------- ---------- -------- Change in Mortgage Assets (Amortized Cost) 778,138 365,484 442,104 133,508 Net Mortgage Asset Growth versus Prior Quarter 56% 36% 78% 31% Net Mortgage Asset Growth Over 12 Months 394% 361% 480% 302% Prepayment Rate of Underlying Mortgages (CPR) 23% 24% 29% 26% Total Rate of Mortgage Principal Repayment 26% 28% 29% 27%
44 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 3 (CONTINUED) AT OR MORTGAGE ASSET CHARACTERISTICS FOR YEAR ENDING -------------------------------------- (ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31, DEC. 31, 1996 1995 1994 ---------- ---------- ---------- Average Characteristics of Mortgage Assets Single-Family Properties 100% 100% 100% Adjustable Rate 100% 100% 100% First Lien 100% 100% 100% Credit Rating Equivalent AA+ AA+ AA+ Amortized Cost as % of Principal Value 101.81% 98.33% 99.59% Coupon Rate 7.75% 7.50% 6.00% Months to Next Coupon Adjustment 5 3 3 Level of Index 5.58% 5.44% 6.94% Net Margin 2.24% 2.08% 2.25% Fully Indexed Coupon Rate 7.82% 7.52% 9.19% Coupon Versus Fully-Indexed Rate -0.07% -0.02% -3.19% Net Life Cap 11.73% 11.54% 11.48% Percentage of Mortgage Assets by Credit Type (By Amortized Cost) Mortgage Loans 24.5% 6.1% 0.0% Mortgage Securities: AAA/AA 73.0% 81.5% 92.9% Mortgage Securities: A/BBB 1.2% 5.8% 4.3% Mortgage Securities: Below BBB 1.3% 6.6% 2.8% - ------------------------------ ----- ----- ----- Total Mortgage Assets (%) 100.0% 100.0% 100.0% Total Mortgage Assets (Amortized Cost) $2,155,469 $ 436,236 $ 120,135 Percentage of Mortgage Assets by Index, Adjustment Frequency, and Annualized Periodic Cap (By Principal Value) 1 Month LIBOR, adjusts monthly, no periodic 1.4% 7.6% 3.9% 6 Month LIBOR, adjusts each 6 months, 2% periodic 36.2% 60.3% 78.3% 6 Month LIBOR, adjusts each 6 months, no periodic 0.0% 0.0% 0.0% 6 Month CD, adjusts each 6 months, 2% periodic 2.5% 12.2% 17.8% 6 Month Treasury, adjusts each 6 months, 2% periodic 1.1% 0.0% 0.0% 6 Month Treasury, adjusts each 6 months, no periodic 0.9% 4.9% 0.0% 3/1 Hybrid: 12 Month Treasury with 3 year initial coupon 0.0% 0.0% 0.0% 12 Month Treasury, adjusts annually, 2% periodic 55.7% 12.3% 0.0% 12 Month Treasury, adjusts annually, no periodic 0.0% 0.0% 0.0% Other 2.2% 2.7% 0.0% - ----- ----- ----- ----- Total Mortgage Assets (%) 100.0% 100.0% 100.0% Total Mortgage Assets (Principal Value) $2,117,244 $ 443,625 $ 120,627 Net Mortgage Asset Growth Mortgage Acquisitions $1,982,864 $ 354,572 $ 121,297 Mortgage Principal Repayments (258,424) (38,824) (1,244) Amortization, Sales and Other (5,206) 353 82 - ------------------------------ ---------- ---------- ---------- Change in Mortgage Assets (Amortized Cost) 1,719,234 316,101 120,135 Net Mortgage Asset Growth versus Prior Quarter n/a n/a n/a Net Mortgage Asset Growth Over 12 Months 394% 263% n/a Prepayment Rate of Underlying Mortgages (CPR) 25% 19% 9% Total Rate of Mortgage Principal Repayment 27% 18% 7%
45 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 4 AT --------------------------------- MORTGAGE LOAN SUMMARY SEP. 30, JUN. 30, MAR. 31, (ALL DOLLARS IN THOUSANDS) 1997 1997 1997 ---------- ---------- --------- Number of Loans 4,651 3,983 2,795 Principal Value $1,348,839 $1,111,376 $ 716,137 Amortized Cost 1,379,691 1,136,694 731,957 Reported Value 1,378,328 1,135,765 730,035 Estimated Bid-Side Market Value 1,379,166 1,136,004 730,035 Adjustable-Rate 100% 100% 100% Single-Family 100% 100% 100% "A" Quality Underwriting 100% 100% 100% First Lien 100% 100% 100% Primary Residence (Owner-Occupied) 91% 92% 94% Second Home 7% 6% 4% Investor Property 2% 2% 2% Average Loan Size $ 290 $ 279 $ 256 Loan Balance Less Than $214,600 19% 20% 20% Loan Balance Greater Than $500,000 33% 27% 14% Original Loan-To-Value Ratio (LTV) 77% 78% 74% Original LTV > 80% 35% 33% 24% % of Original LTV > 80% with Primary Mortgage 96% 94% 94% Insurance or Pledged Account Collateral Effective Average Original LTV Including Primary 66% 69% 68% Mortgage Insurance or Pledged Account Collateral 1990 and Prior Years' Origination 4% 6% 9% 1991 Origination 0% 1% 1% 1992 1% 2% 3% 1993 4% 6% 9% 1994 17% 23% 41% 1995 2% 2% 4% 1996 14% 18% 30% 1997 58% 42% 2% Average Seasoning in Months 19 22 33 Northern California 13% 13% 17% Southern California 19% 21% 24% Florida 9% 8% 5% New York 6% 5% 4% New Jersey 4% 4% 3% Connecticut 4% 4% 3% Texas 4% 4% 3% Georgia 4% 3% 2% Maryland 3% 4% 6% Illinois 3% 3% 4% Colorado 3% 3% 2% Arizona 3% 3% 1% Other States 25% 25% 26% *: less than 0.5%
46 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 4 (CONTINUED) AT ----------------------------------------- MORTGAGE LOAN SUMMARY DEC. 31, SEP. 30, JUN. 30, MAR. 31, (ALL DOLLARS IN THOUSANDS) 1996 1996 1996 1996 --------- --------- --------- -------- Number of Loans 2,172 478 257 101 Principal Value $ 515,033 $ 126,426 $ 69,154 $ 24,831 Amortized Cost 527,280 127,808 69,680 24,851 Reported Value 525,475 127,694 69,666 24,861 Estimated Bid-Side Market Value 525,475 127,694 69,666 24,861 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) 94% 99% 99% 100% Second Home 4% 1% 1% 0% Investor Property 2% 0% 0% 0% Average Loan Size $ 237 $ 264 $ 269 $ 246 Loan Balance Less Than $214,600 23% 18% 14% 30% Loan Balance Greater Than $500,000 8% 12% 13% 25% Original Loan-To-Value Ratio (LTV) 77% 78% 76% 77% Original LTV > 80% 25% 32% 23% 27% % of Original LTV > 80% with Primary Mortgage 97% 100% 100% 100% 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 13% 0% 0% 0% 1991 Origination 2% 0% 0% 0% 1992 4% 0% 0% 0% 1993 14% 7% 1% 0% 1994 52% 43% 2% 2% 1995 7% 32% 63% 98% 1996 8% 18% 34% 0% 1997 0% 0% 0% 0% Average Seasoning in Months 37 9 4 7 Northern California 18% 34% 30% 30% Southern California 26% 51% 43% 46% Florida 4% * 1% 1% New York 3% * * 0% New Jersey 3% * * 1% Connecticut 3% 1% 1% 1% Texas 2% 1% 1% 4% Georgia 2% * 1% 1% Maryland 8% * 1% 2% Illinois 4% * 1% 0% Colorado 1% 2% 3% 3% Arizona 2% 0% 0% 0% Other States 24% 11% 18% 11% *: less than 0.5%
47 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 4 (CONTINUED) AT ------------------------------- MORTGAGE LOAN SUMMARY DEC. 31, DEC. 31, DEC. 31, (ALL DOLLARS IN THOUSANDS) 1996 1995 1994 ---------- --------- -------- Number of Loans 2,172 109 0 Principal Value $ 515,033 $ 26,411 $ 0 Amortized Cost 527,280 26,449 0 Reported Value 525,475 26,450 0 Estimated Bid-Side Market Value 525,475 26,450 0 Adjustable-Rate 100% 100% n/a Single-Family 100% 100% n/a "A" Quality Underwriting 100% 100% n/a First Lien 100% 100% n/a Primary Residence (Owner-Occupied) 94% 100% n/a Second Home 4% 0% n/a Investor Property 2% 0% n/a Average Loan Size $ 237 $ 242 n/a Loan Balance Less Than $214,600 23% 11% n/a Loan Balance Greater Than $500,000 8% 13% n/a Original Loan-To-Value Ratio (LTV) 77% 76% n/a Original LTV > 80% 25% 26% n/a % of Original LTV > 80% with Primary Mortgage 97% 100% n/a Insurance or Pledged Account Collateral Effective Average Original LTV Including Primary 73% 72% n/a Mortgage Insurance or Pledged Account Collateral 1990 and Prior Years' Origination 13% 0% n/a 1991 Origination 2% 0% n/a 1992 4% 0% n/a 1993 14% 0% n/a 1994 52% 2% n/a 1995 7% 98% n/a 1996 8% 0% n/a 1997 0% 0% n/a Average Seasoning in Months 37 4 n/a Northern California 18% 30% n/a Southern California 26% 44% n/a Florida 4% 1% n/a New York 3% 0% n/a New Jersey 3% 1% n/a Connecticut 3% 1% n/a Texas 2% 4% n/a Georgia 2% 1% n/a Maryland 8% 2% n/a Illinois 4% 0% n/a Colorado 1% 3% n/a Arizona 2% 2% n/a Other States 24% 11% n/a *: less than 0.5%
48 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 5 EARNING ASSET YIELD, INTEREST RATE SPREAD FOR THREE MONTHS ENDING ----------------------------- AND INTEREST RATE MARGIN SEP. 30, JUN. 30, MAR. 31, 1997 1997 1997 ---- ---- ---- Average Initial Coupon Rate on Mortgage Acquisitions 7.32% 7.45% 7.45% New Acquisitions Last 6 Months/Total Mortgages 39% 47% 58% Mortgage Coupon Rate (All Mortgage Assets) 7.77% 7.74% 7.70% Amortized Cost/ Principal Value 102.22% 102.15% 101.84% Coupon Yield on Amortized Cost 7.60% 7.57% 7.56% Effect of Premium/Discount Amortization -0.79% -0.71% -0.68% Mortgage Yield 6.81% 6.86% 6.88% Cash Yield 5.60% 5.52% 5.33% Earning Asset Yield (Mortgages plus Cash) 6.80% 6.86% 6.87% Cost of Funds 6.02% 5.86% 5.62% Cost of Hedging (as % of Borrowings) 0.14% 0.13% 0.12% Interest Rate Spread 0.64% 0.87% 1.13% Net Interest Margin (Net Interest Income/Assets) 1.12% 1.31% 1.57% Net Interest Income/Average Equity 11.13% 13.25% 15.30% SELECTED OPERATING RATIOS AND RETURN ON EQUITY Credit Provisions as a % of Assets 0.11% 0.10% 0.12% Credit Provisions as a % of Equity 1.09% 1.06% 1.17% Operating Expenses to Average Assets 0.13% 0.16% 0.20% Operating Expenses to Average Equity 1.33% 1.66% 1.97% Efficiency Ratio (Op Exp/Net Int Income) 11.93% 12.51% 12.86% Average Assets Per Employee ($MM) $ 244 $ 257 $ 221 GAAP Return on Total Equity 8.73% 10.53% 12.16% GAAP Return on Common Equity 8.60% 10.65% 12.44% Taxable Income Return on Total Equity 9.43% 11.34% 13.34% Taxable Income Return on Common Equity 9.36% 11.55% 13.79%
49 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 5 (CONTINUED) EARNING ASSET YIELD, INTEREST RATE SPREAD FOR THREE MONTHS ENDING ----------------------------------------- AND INTEREST RATE MARGIN DEC. 31, SEP. 30, JUN. 30, MAR. 31, 1996 1996 1996 1996 ---- ---- ---- ---- Average Initial Coupon Rate on Mortgage Acquisitions 7.81% 7.53% 7.30% 7.60% New Acquisitions Last 6 Months/Total Mortgages 61% 68% 66% 58% Mortgage Coupon Rate (All Mortgage Assets) 7.58% 7.52% 7.47% 7.73% Amortized Cost/ Principal Value 101.41% 100.98% 99.95% 98.85% Coupon Yield on Amortized Cost 7.48% 7.44% 7.48% 7.82% Effect of Premium/Discount Amortization -0.59% -0.52% -0.56% -0.44% Mortgage Yield 6.89% 6.92% 6.92% 7.38% Cash Yield 5.31% 5.30% 5.61% 5.93% Earning Asset Yield (Mortgages plus Cash) 6.87% 6.90% 6.90% 7.34% Cost of Funds 5.76% 5.78% 5.57% 5.69% Cost of Hedging (as % of Borrowings) 0.12% 0.14% 0.16% 0.14% Interest Rate Spread 0.99% 0.98% 1.17% 1.51% Net Interest Margin (Net Interest Income/Assets) 1.55% 1.58% 1.85% 2.17% Net Interest Income/Average Equity 13.01% 12.40% 12.14% 14.92% SELECTED OPERATING RATIOS AND RETURN ON EQUITY Credit Provisions as a % of Assets 0.10% 0.18% 0.25% 0.26% Credit Provisions as a % of Equity 0.81% 1.40% 1.62% 1.78% Operating Expenses to Average Assets 0.21% 0.23% 0.31% 0.38% Operating Expenses to Average Equity 1.72% 1.82% 2.02% 2.64% Efficiency Ratio (Op Exp/Net Int Income) 13.23% 14.69% 16.63% 17.71% Average Assets Per Employee ($MM) $ 155 $ 115 $ 84 $ 70 GAAP Return on Total Equity 10.48% 9.18% 8.50% 10.50% GAAP Return on Common Equity 10.53% 9.06% 8.50% 10.50% Taxable Income Return on Total Equity 11.75% 10.97% 10.69% 13.69% Taxable Income Return on Common Equity 12.03% 11.06% 10.69% 13.69%
50 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 5 (CONTINUED) EARNING ASSET YIELD, INTEREST RATE SPREAD FOR YEAR ENDING ------------------------------ AND INTEREST RATE MARGIN DEC. 31, DEC. 31, DEC. 31, 1996 1995 1994 ---- ---- ---- Average Initial Coupon Rate on Mortgage Acquisitions 7.60% 7.25% 5.87% New Acquisitions Last 6 Months/Total Mortgages 61% 68% 101% Mortgage Coupon Rate (All Mortgage Assets) 7.55% 7.16% 6.09% Amortized Cost/ Principal Value 100.68% 99.02% 100.02% Coupon Yield on Amortized Cost 7.50% 7.23% 6.09% Effect of Premium/Discount Amortization -0.55% 0.17% 0.45% Mortgage Yield 6.95% 7.40% 6.54% Cash Yield 5.51% 5.43% 4.73% Earning Asset Yield (Mortgages plus Cash) 6.93% 7.36% 6.33% Cost of Funds 5.71% 6.06% 5.55% Cost of Hedging (as % of Borrowings) 0.13% 0.19% 0.06% Interest Rate Spread 1.09% 1.11% 0.72% Net Interest Margin (Net Interest Income/Assets) 1.69% 2.17% 2.50% Net Interest Income/Average Equity 12.90% 11.03% 7.27% SELECTED OPERATING RATIOS AND RETURN ON EQUITY Credit Provisions as a % of Assets 0.17% 0.22% 0.00% Credit Provisions as a % of Equity 1.29% 1.14% 0.00% Operating Expenses to Average Assets 0.26% 0.51% 0.69% Operating Expenses to Average Equity 1.94% 2.61% 2.01% Efficiency Ratio (Op Exp/Net Int Income) 15.08% 23.66% 27.73% Average Assets Per Employee ($MM) $ 109 $ 39 $ 12 GAAP Return on Total Equity 9.66% 7.28% 5.25% GAAP Return on Common Equity 9.61% 7.28% 5.25% Taxable Income Return on Total Equity 11.55% 8.84% 4.86% Taxable Income Return on Common Equity 11.68% 8.84% 4.86%
51 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 6 AT OR AVERAGE DAILY BALANCE SHEET FOR THREE MONTHS ENDING ---------------------------------------------- (ALL DOLLARS IN THOUSANDS) SEP. 30, JUN. 30, MAR. 31, 1997 1997 1997 ---- ---- ---- Cash $ 35,647 $ 19,307 $ 12,147 Mortgage Loans 1,155,099 758,445 574,781 Mortgage Securities 2,136,442 2,111,832 1,658,629 Credit Reserve (3,873) (3,083) (2,394) Interest Rate Agreements 11,943 11,185 6,899 Other Assets 85,689 75,928 58,856 - ------------ ---------- ---------- ---------- Total Assets 3,420,947 2,973,614 2,308,918 - ------------ ---------- ---------- ---------- Short-Term Borrowings 2,695,438 2,659,914 2,056,051 Long-Term Borrowings 355,028 0 0 Other Liabilties 24,714 20,530 15,691 - ---------------- ---------- ---------- ---------- Total Liabilities 3,075,180 2,680,444 2,071,742 - ----------------- ---------- ---------- ---------- Preferred Stock 26,733 28,946 29,545 Common Stock 321,492 265,561 208,426 Retained Earnings, after Dividend (2,458) (1,337) (795) - --------------------------------- ---------- ---------- ---------- Stockholders' Equity 345,767 293,170 237,176 - -------------------- ---------- ---------- ---------- Market Valuation Account, Mortgage Assets $ 6,072 $ 1,914 $ 1,022 Market Valuation Account, Interest Rate Agreements (8,640) (4,576) (4,004) - -------------------------------------------------- ---------- ---------- ---------- Market Valuation Account, Total $ (2,568) $ (2,662) $ (2,982) ESTIMATED PERIOD-END BID-SIDE MARKET VALUE/REALIZABLE VALUE Cash $ 57,696 $ 29,425 $ 12,985 Mortgage Loans 1,379,166 1,136,004 730,035 Mortgage Securities 2,059,595 2,227,389 1,874,679 Interest Rate Agreements 2,169 4,206 5,773 Other Assets 26,048 25,857 19,291 Short-Term Borrowings 2,639,773 3,102,784 2,373,279 Long-Term Borrowings 497,465 0 0 Other Liabilities 30,628 27,515 23,411 - ----------------- ---------- ---------- ---------- "Mark-To-Market" of Equity $ 356,808 $ 292,582 $ 246,073 BALANCE SHEET UTILIZATION DURING PERIOD VS RISK-ADJUSTED CAPITAL GUIDELINES Actual Average Equity/Assets 10.1% 9.9% 10.3% Average Risk-Adjusted Capital Guideline 9.0% 9.5% 10.1% Balance Sheet Capacity Utilization 89% 96% 98% Excess Capital and Asset Growth Potential At Period End Ending Actual Equity/Assets 10.12% 8.55% 9.28% Ending Risk-Adjusted Capital Guideline 8.59% 9.41% 10.09% Excess Capital $ 54,038 $ (29,417) $ (21,504) Asset Growth Potential (Same Asset Mix) $ 629,081 $ (312,637) $ (213,079) Expanded Risk-Adjusted Capital Guideline 7.97% 8.55% 9.17% Excess Capital vs. Expanded Guideline $ 85,518 $ (140) $ 3,015 Asset Growth Potential (Expanded Guideline) $ 954,032 $ (1,915) $ 29,398
52 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 6 (CONTINUED) AT OR AVERAGE DAILY BALANCE SHEET FOR THREE MONTHS ENDING ------------------------------------------------------------- (ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31, 1996 1996 1996 1996 ---- ---- ---- ---- Cash $ 16,137 $ 18,854 $ 14,402 $ 14,639 Mortgage Loans 143,368 93,991 45,313 25,279 Mortgage Securities 1,347,617 1,010,853 688,697 457,841 Credit Reserve (1,952) (1,491) (1,002) (594) Interest Rate Agreements 4,681 3,185 2,737 2,503 Other Assets 41,430 30,129 21,566 13,094 - ------------ ----------- ----------- --------- --------- Total Assets 1,551,281 1,155,521 771,713 512,762 - ------------ ----------- ----------- --------- --------- Short-Term Borrowings 1,351,510 999,229 651,643 435,979 Long-Term Borrowings 0 0 0 0 Other Liabilities 14,898 8,728 2,472 2,324 - ---------------- ----------- ----------- --------- --------- Total Liabilities 1,366,408 1,007,957 654,115 438,303 - ----------------- ----------- ----------- --------- --------- Preferred Stock 29,671 15,179 0 0 Common Stock 156,594 132,924 117,695 73,998 Retained Earnings, after Dividend (1,392) (539) (97) 461 - --------------------------------- ----------- ----------- --------- --------- Stockholders' Equity 184,873 147,564 117,598 74,459 - -------------------- ----------- ----------- --------- --------- Market Valuation Account, Mortgage Assets $ 603 $ (2,279) $ (3,865) $ (3,880) Market Valuation Account, Interest Rate Agreements (3,513) (1,352) (1,080) (1,836) - ----------------------------------------- ----------- ----------- --------- --------- Market Valuation Account, Total $ (2,910) $ (3,631) $ (4,945) $ (5,716) ESTIMATED PERIOD-END BID-SIDE MARKET VALUE/REALIZABLE VALUE Cash $ 11,068 $ 14,599 $ 10,407 $ 9,705 Mortgage Loans 525,475 127,694 69,666 24,861 Mortgage Securities 1,627,953 1,248,176 937,814 540,298 Interest Rate Agreements 2,601 873 1,351 1,233 Other Assets 16,778 11,766 8,864 4,987 Short-Term Borrowings 1,953,103 1,225,094 896,214 508,721 Long-Term Borrowings 0 0 0 0 Other Liabilities 19,531 14,457 7,522 4,240 - ----------------- ----------- ----------- --------- --------- "Mark-To-Market" of Equity $ 211,241 $ 163,557 $ 124,366 $ 68,123 BALANCE SHEET UTILIZATION DURING PERIOD VS. RISK-ADJUSTED CAPITAL GUIDELINES Actual Average Equity/Assets 11.9% 12.8% 15.2% 14.5% Average Risk-Adjusted Capital Guideline 10.2% 10.7% 11.4% 12.8% Balance Sheet Capacity Utilization 86% 84% 75% 88% Excess Capital and Asset Growth Potential At Period End Ending Actual Equity/Assets 9.66% 11.65% 12.09% 11.72% Ending Risk-Adjusted Capital Guideline 9.97% 10.32% 10.77% 11.72% Excess Capital $ (6,798) $ 18,664 $ 13,566 $ 26 Asset Growth Potential (Same Asset Mix) $ (68,169) $ 180,836 $ 125,972 $ 227 Expanded Risk-Adjusted Capital Guideline 9.07% n/a n/a n/a Excess Capital vs. Expanded Guideline $ 14,302 n/a n/a n/a Asset Growth Potential (Expanded Guideline) $ 143,434 n/a n/a n/a
53 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 6 (CONTINUED) AT OR AVERAGE DAILY BALANCE SHEET FOR YEAR ENDING ------------------------------------------- (ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31, DEC. 31, 1996 1995 1994 ---- ---- ---- Cash $ 16,016 $ 4,272 $ 6,627 Mortgage Loans 77,215 5,006 0 Mortgage Securities 877,907 204,284 50,080 Credit Reserve (1,262) (92) 0 Interest Rate Agreements 3,280 2,039 759 Other Assets 26,606 5,107 948 - ------------ ----------- --------- --------- Total Assets 999,762 220,616 58,414 - ------------ ----------- --------- --------- Short-Term Borrowings 861,316 174,926 37,910 Long-Term Borrowings 0 0 0 Other Liabilities 7,131 2,343 367 - ---------------- ----------- --------- --------- Total Liabilities 868,447 177,269 38,277 - ----------------- ----------- --------- --------- Preferred Stock 11,274 0 0 Common Stock 120,436 43,391 20,941 Retained Earnings, after Dividend (395) (42) (804) - --------------------------------- ----------- --------- --------- Stockholders' Equity 131,315 43,349 20,137 - -------------------- ----------- --------- --------- Market Valuation Account, Mortgage Assets $ (2,347) $ (78) $ (583) Market Valuation Account, Interest Rate Agreements (1,948) (1,046) 31 - -------------------------------------------------- ----------- --------- --------- Market Valuation Account, Total $ (4,295) $ (1,124) $ (552) ESTIMATED PERIOD-END BID-SIDE MARKET VALUE/REALIZABLE VALUE Cash $ 11,068 $ 4,825 $ 1,027 Mortgage Loans 525,475 26,450 0 Mortgage Securities 1,627,953 405,794 117,477 Interest Rate Agreements 2,601 547 1,892 Other Assets 16,778 3,671 888 Short-Term Borrowings 1,953,103 370,316 100,376 Long-Term Borrowings 0 0 0 Other Liabilities 19,531 2,829 872 - ----------------- ----------- --------- --------- "Mark-To-Market" of Equity $ 211,241 $ 68,142 $ 20,036 BALANCE SHEET UTILIZATION DURING PERIOD VS RISK-ADJUSTED CAPITAL GUIDELINES Actual Average Equity/Assets 13.1% 19.6% 34.5% Average Risk-Adjusted Capital Guideline 10.9% 13.4% 10.6% Balance Sheet Capacity Utilization 83% 68% 31% Excess Capital and Asset Growth Potential At Period End Ending Actual Equity/Assets 9.66% 15.47% 16.69% Ending Risk-Adjusted Capital Guideline 9.97% 12.59% 10.84% Excess Capital $ (6,798) $ 12,028 $ 6,716 Asset Growth Potential (Same Asset Mix) $ (68,176) $ 100,874 $ 65,519 Expanded Risk-Adjusted Capital Guideline 9.07% n/a n/a Excess Capital vs. Expanded Guideline $ 14,302 n/a n/a Asset Growth Potential (Expanded Guideline) $ 143,434 n/a n/a
54 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 7 AT OR CREDIT PROVISIONS AND CREDIT RESERVES FOR THREE MONTHS ENDING ------------------------------- (ALL DOLLARS IN THOUSANDS) SEP. 30, JUN. 30, MAR. 31, 1997 1997 1997 ---- ---- ---- MORTGAGE LOANS Credit Provision During Period $ 473 $ 299 $ 215 Actual Losses During Period 40 0 13 Cumulative Actual Losses 53 13 13 Mortgage Loan Reserve End of Period 1,363 929 630 Annualized Credit Provision/ Ave. Mortgage Loans 0.16% 0.16% 0.15% Mortgage Loan Reserve/Ending Mortgage Loans 0.10% 0.08% 0.09% Non-Performing Assets: 90+ Days Delinquent, Foreclosures, Bankruptcies, and REO Number of Loan 13 12 6 NPA Loan Balance $2,792 $2,366 $1,220 Non-Performing Assets as % of Mortgage Loans 0.2% 0.2% 0.2% Non-Performing Assets as % of Total Assets 0.08% 0.07% 0.05% Mortgage Loan Reserve as % of NPAs 49% 39% 52% Credit Experience of Mortgage Loans Liquidated Defaulted Loans (Cumulative) 4 1 1 Average Loss Severity Experience (Cumulative) 6% 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 $ 283 $ 241 $ 124 At 20% Loss Severity 567 481 248 At 30% Loss Severity 850 722 372 At 40% Loss Severity 1,133 962 496 MORTGAGE SECURITIES Credit Provision During Period $ 470 $ 477 $ 480 Actual Losses During Period 28 29 29 Cumulative Actual Losses 97 69 40 Mortgage Securities Reserve End of Period 3,093 2,651 2,203 Annualized Credit Provision/Mtg. Sec. Rated < BBB 6.4% 6.6% 6.6% Mortgage Loan Reserve/Ending Mtg. Sec. Rated < BBB 10.6% 9.1% 7.6% Credit Experience of Loans in Pools Underlying Mtg Sec. Rated 55 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 7 (CONTINUED) AT OR CREDIT PROVISIONS AND CREDIT RESERVES FOR THREE MONTHS ENDING --------------------------------------------- (ALL DOLLARS IN THOUSANDS) DEC. 31, SEP. 30, JUN. 30, MAR. 31, 1996 1996 1996 1996 ---- ---- ---- ---- MORTGAGE LOANS Credit Provision During Period $ 35 $ 178 $ 140 $ (5) Actual Losses During Period 0 0 0 0 Cumulative Actual Losses 0 0 0 0 Mortgage Loan Reserve End of Period 428 393 214 74 Annualized Credit Provision/ Ave. Mortgage Loans 0.10% 0.76% 1.23% -0.08% Mortgage Loan Reserve/Ending Mortgage Loans 0.08% 0.31% 0.31% 0.30% Non-Performing Assets: 90+ Days Delinquent, Foreclosures, Bankruptcies, and REO Number of Loan 7 3 2 1 NPA Loan Balance $1,249 $ 404 $ 279 $ 190 Non-Performing Assets as % of Mortgage Loans 0.2% 0.3% 0.4% 0.8% Non-Performing Assets as % of Total Assets 0.06% 0.03% 0.03% 0.03% Mortgage Loan Reserve as % of NPAs 34% 97% 77% 39% 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 $ 127 $ 41 $ 28 $ 19 At 20% Loss Severity 253 82 56 39 At 30% Loss Severity 380 123 85 58 At 40% Loss Severity 506 164 113 77 MORTGAGE SECURITIES Credit Provision During Period $ 337 $ 338 $ 337 $ 336 Actual Losses During Period 7 0 0 0 Cumulative Actual Losses 11 4 4 4 Mortgage Securities Reserve End of Period 1,752 1,422 1,084 747 Annualized Credit Provision/Mtg. Sec. Rated < BBB 4.7% 4.7% 4.7% 4.7% Mortgage Loan Reserve/Ending Mtg. Sec. Rated < BBB 6.1% 4.9% 3.8% 2.7% Credit Experience of Loans in Pools Underlying Mtg. Sec. Rated 56 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 7 (CONTINUED) AT OR CREDIT PROVISIONS AND CREDIT RESERVES FOR YEAR ENDING ------------------------------- (ALL DOLLARS IN THOUSANDS) DEC. 31, DEC. 31, DEC. 31, 1996 1995 1994 ------ ------ -- MORTGAGE LOANS Credit Provision During Period $ 349 $ 79 $0 Actual Losses During Period 0 0 0 Cumulative Actual Losses 0 0 0 Mortgage Loan Reserve End of Period 428 79 0 Annualized Credit Provision/ Ave. Mortgage Loans 0.45% 1.58% n/a Mortgage Loan Reserve/Ending Mortgage Loans 0.08% 0.30% n/a Non-Performing Assets: 90+ Days Delinquent, Foreclosures, Bankruptcies, and REO Number of Loan 7 0 0 NPA Loan Balance $1,249 $ 0 $0 Non-Performing Assets as % of Mortgage Loans 0.2% 0.0% 0.0% Non-Performing Assets as % of Total Assets 0.06% 0.00% 0.00% Mortgage Loan Reserve as % of NPAs 34% n/a n/a Credit Experience of Mortgage Loans Liquidated Defaulted Loans (Cumulative) 0 0 0 Average Loss Severity Experience (Cumulative) 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 $ 127 $ 0 $0 At 20% Loss Severity 253 0 0 At 30% Loss Severity 380 0 0 At 40% Loss Severity 506 0 0 MORTGAGE SECURITIES Credit Provision During Period $1,348 $ 414 $0 Actual Losses During Period 7 4 0 Cumulative Actual Losses 11 4 0 Mortgage Securities Reserve End of Period 1,752 411 0 Annualized Credit Provision/Mtg. Sec. Rated < BBB 4.7% 2.6% 0.0% Mortgage Loan Reserve/Ending Mtg. Sec. Rated < BBB 6.1% 1.4% 0.0% Credit Experience of Loans in Pools Underlying Mtg. Sec. Rated 57 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) SEP. 30, JUN. 30, MAR. 31, 1997 1997 1997 ---- ---- ---- Shares Outstanding and Receiving Dividends at Period End - -------------------------------------------------------- Common (RWTI) 14,576,477 13,251,847 11,905,957 Class A Preferred (converted 9/95) 0 0 0 Class B Preferred (RWTIP) 909,518 909,518 999,638 - ------------------------- ----------- ----------- ----------- Total 15,485,995 14,161,365 12,905,595 Common Dividend Declared $ 0.60 $ 0.60 $ 0.60 Class A Preferred Dividend Declared $ 0.00 $ 0.00 $ 0.00 Class B Preferred Dividends Declared $ 0.755 $ 0.755 $ 0.755 Common Dividend Total $ 8,746 $ 7,951 $ 7,144 Class A Preferred Dividend Total 0 0 0 Class B Preferred Dividends Total 687 687 755 - --------------------------------- ----------- ----------- ----------- Total Dividend $ 9,433 $ 8,638 $ 7,899 Taxable Income Earned $ 8,151 $ 8,315 $ 7,912 Dividend Pay-Out Ratio for Period 115.7% 103.9% 99.8% Cumulative Dividend Pay-Out Ratio 102.7% 99.7% 98.5% Warrants Outstanding at Period End (RWTIW) 149,466 236,297 272,304 Average Shares Outstanding During Period - ---------------------------------------- Common 14,316,678 12,997,566 11,605,171 Class A Preferred 0 0 0 Class B Preferred 909,518 990,725 1,005,515 - ----------------- ----------- ----------- ----------- Total 15,226,196 13,988,291 12,610,686 Calculation of "Primary" Common Shares - -------------------------------------- Average Common Shares 14,316,678 12,997,566 11,605,171 Potential Dilution Due to Warrants 130,489 182,137 258,422 Potential Dilution Due to Options 177,434 291,227 253,274 - --------------------------------- ----------- ----------- ----------- Total Average Primary Common Shares 14,624,601 13,470,930 12,116,867 Net Income to Common Shareholders $ 6,859 $ 7,034 $ 6,456 Total Average Primary Common Shares 14,624,601 13,470,930 12,116,867 - ----------------------------------- ----------- ----------- ----------- Earnings Per Share (EPS) $ 0.47 $ 0.52 $ 0.53 EPS (Outstanding Common Shares Only) $ 0.48 $ 0.54 $ 0.56 Per Share Ratios (Average Outstanding Common and Preferred Shares) - ------------------------------------------------------------------ Average Total Assets $ 224.68 $ 212.58 $ 183.09 Average Total Equity $ 22.71 $ 20.96 $ 18.81 Net Interest Income $ 0.63 $ 0.70 $ 0.72 Credit Expenses $ 0.06 $ 0.06 $ 0.06 Operating Expenses $ 0.07 $ 0.09 $ 0.09 Gain/(Loss) on Sale $ 0.00 $ 0.00 $ 0.00 Net Income $ 0.50 $ 0.55 $ 0.57
58 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 AMOUMTS) DEC. 31, SEP. 30, JUN. 30, MAR. 31, 1996 1996 1996 1996 ---- ---- ---- ---- Shares Outstanding and Receiving Dividends at Period End - -------------------------------------------------------- Common (RWTI) 10,996,572 9,069,653 8,520,116 5,521,376 Class A Preferred (converted 9/95) 0 0 0 0 Class B Preferred (RWTIP) 1,006,250 1,006,250 0 0 - ------------------------- ----------- ----------- ---------- ---------- Total 12,002,822 10,075,903 8,520,116 5,521,376 Common Dividend Declared $ 0.41 $ 0.40 $ 0.40 $ 0.46 Class A Preferred Dividend Declared $ 0.00 $ 0.00 $ 0.00 $ 0.00 Class B Preferred Dividends Declared $ 0.755 $ 0.386 $ 0.00 $ 0.00 Common Dividend Total $ 4,508 $ 3,628 $ 3,408 $ 2,540 Class A Preferred Dividend Total 0 0 0 0 Class B Preferred Dividends Total 760 388 0 0 - --------------------------------- ----------- ----------- ---------- ---------- Total Dividend $ 5,268 $ 4,016 $ 3,408 $ 2,540 Taxable Income Earned $ 5,429 $ 4,048 $ 3,142 $ 2,549 Dividend Pay-Out Ratio for Period 97.0% 99.2% 108.5% 99.7% Cumulative Dividend Pay-Out Ratio 97.9% 98.3% 97.9% 93.0% Warrants Outstanding at Period End (RWTIW) 412,894 1,076,431 1,563,957 1,665,063 Average Shares Outstanding During Period - ---------------------------------------- Common 9,705,138 8,732,326 7,813,974 5,521,376 Class A Preferred 0 0 0 0 Class B Preferred 1,006,250 514,063 0 0 - ----------------- ----------- ----------- ---------- ---------- Total 10,711,388 9,246,389 7,813,974 5,521,376 Calculation of "Primary" Common Shares - -------------------------------------- Average Common Shares 9,705,138 8,732,326 7,813,974 5,521,376 Potential Dilution Due to Warrants 570,415 621,455 603,426 443,984 Potential Dilution Due to Options 176,919 162,393 182,832 164,227 - --------------------------------- ----------- ----------- ---------- ---------- Total Average Primary Common Shares 10,452,472 9,516,174 8,600,232 6,129,587 Net Income to Common Shareholders $ 4,084 $ 2,999 $ 2,500 $ 1,954 Total Average Primary Common Shares 10,452,472 9,516,174 8,600,232 6,129,587 - ----------------------------------- ----------- ----------- ---------- ---------- Earnings Per Share (EPS) $ 0.39 $ 0.32 $ 0.29 $ 0.32 EPS (Outstanding Common Shares Only) $ 0.42 $ 0.34 $ 0.32 $ 0.35 Per Share Ratios (Average Outstanding Common and Preferred Shares) - ------------------------------------------------------------------ Average Total Assets $ 144.83 $ 124.97 $ 98.76 $ 92.87 Average Total Equity $ 17.26 $ 15.96 $ 15.05 $ 13.49 Net Interest Income $ 0.55 $ 0.50 $ 0.45 $ 0.50 Credit Expenses $ 0.03 $ 0.06 $ 0.06 $ 0.06 Operating Expenses $ 0.07 $ 0.07 $ 0.07 $ 0.09 Gain/(Loss) on Sale $ 0.00 $ 0.00 $ 0.00 $ 0.00 Net Income $ 0.45 $ 0.37 $ 0.32 $ 0.35
59 SUPPLEMENTAL HISTORICAL INFORMATION
TABLE 8 (CONTINUED) AT OR SHARES OUTSTANDING AND PER SHARE DATA FOR YEAR ENDING --------------------------------------------- (ALL DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) DEC. 31, DEC. 31, DEC. 31, 1996 1995 1994 ---- ---- ---- Shares Outstanding and Receiving Dividends at Period End - -------------------------------------------------------- Common (RWTI) 10,996,572 5,517,299 208,332 Class A Preferred (converted 9/95) 0 0 1,666,063 Class B Preferred (RWTIP) 1,006,250 0 0 - ------------------------- ----------- ---------- ---------- Total 12,002,822 5,517,299 1,874,395 Common Dividend Declared $ 1.67 $ 0.46 $ 0.00 Class A Preferred Dividend Declared $ 0.00 $ 0.50 $ 0.25 Class B Preferred Dividends Declared $ 1.141 $ 0.000 $ 0.000 Common Dividend Total $ 14,084 $ 2,537 $ 0 Class A Preferred Dividend Total 0 833 350 Class B Preferred Dividends Total 1,148 0 0 - --------------------------------- ----------- ---------- ---------- Total Dividend $ 15,232 $ 3,370 $ 350 Taxable Income Earned $ 15,168 $ 3,832 $ 353 Dividend Pay-Out Ratio for Period 100.4% 88.0% 99.2% Cumulative Dividend Pay-Out Ratio 97.9% 88.9% 99.2% Warrants Outstanding at Period End (RWTIW) 412,894 1,665,063 1,666,063 Average Shares Outstanding During Period - ---------------------------------------- Common 7,950,175 2,487,857 208,332 Class A Preferred 0 826,185 1,467,748 Class B Preferred 382,155 0 0 - ----------------- ----------- ---------- ---------- Total 8,332,330 3,314,042 1,676,080 Calculation of "Primary" Common Shares - -------------------------------------- Average Common Shares 7,950,175 3,314,042 1,676,080 Potential Dilution Due to Warrants 618,618 221,112 240,766 Potential Dilution Due to Options 175,391 168,649 0 - --------------------------------- ----------- ---------- ---------- Total Average Primary Common Shares 8,744,184 3,703,803 1,916,846 Net Income to Common Shareholders $ 11,537 $ 3,155 $ 382 Total Average Primary Common Shares 8,744,184 3,703,803 1,916,846 - ----------------------------------- ----------- ---------- ---------- Earnings Per Share (EPS) $ 1.32 $ 0.85 $ 0.20 EPS (Outstanding Common Shares Only) $ 1.45 $ 0.95 $ 0.23 Per Share Ratios (Average Outstanding Common and Preferred Shares) - ------------------------------------------------------------------ Average Total Assets $ 119.99 $ 66.57 $ 34.85 Average Total Equity $ 15.76 $ 13.08 $ 12.01 Net Interest Income $ 2.03 $ 1.44 $ 0.32 Credit Expenses $ 0.20 $ 0.15 $ 0.00 Operating Expenses $ 0.31 $ 0.34 $ 0.09 Gain/(Loss) on Sale $ 0.00 $ 0.00 $ 0.00 Net Income $ 1.52 $ 0.95 $ 0.23
60 PART II OTHER INFORMATION Item 1. Legal Proceedings At September 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 Not applicable Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 4.4 - Indenture dated as of June 1, 1997 between Sequoia Mortgage Trust 1 (a wholly-owned, consolidated subsidiary of the Company) and First Union National Bank, as Trustee. (Incorporated by reference to the Form 8-K filed by Sequoia Mortgage Funding Corporation on August 12, 1997). Exhibit 11.1 to Part I - Computation of Earnings Per Share for the three and nine months ended September 30, 1997 and September 30, 1996. Exhibit 27 - Financial Data Schedule. (b) Reports No filings on Form 8-K were made. 61 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: November 10, 1997 By: /s/ Douglas B. Hansen ---------------------------------------- Douglas B. Hansen President and Chief Financial Officer (authorized officer of registrant) Dated: November 10, 1997 By: /s/ Vickie L. Rath ---------------------------------------- Vickie L. Rath Vice President, Treasurer and Controller (principal accounting officer) 62 REDWOOD TRUST, INC. INDEX TO EXHIBIT
Sequentially Exhibit Numbered Number Page ------- ------------ 11.1 Computation of Earnings per Share................. 64 27 Financial Data Schedule........................... 66
63