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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
| For the fiscal year ended: December 31, 2005 | ||
| OR | ||
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
| For the transition period from to | ||
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Maryland
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68-0329422 | |
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(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
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One Belvedere Place,
Suite 300 Mill Valley, California (Address of principal executive offices) |
94941 (Zip Code) |
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| Title of Each Class: | Name of Exchange on Which Registered: | |
| Common Stock, par value $0.01 per share | New York Stock Exchange |
2
Item 1.
BUSINESS
CAUTIONARY STATEMENT
This Annual Report on
Form 10-K and the
documents incorporated by reference herein contain
forward-looking statements within the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. Statements
that are not historical in nature, including the words
“anticipated,” “estimated,”
“should,” “expect,” “believe,”
“intend,” and similar expressions, are intended to
identify forward-looking statements. These forward-looking
statements are subject to risks and uncertainties, including,
among other things, those described in this Annual Report on
Form 10-K under
Item 1A “Risk Factors.” Other risks,
uncertainties, and factors that could cause actual results to
differ materially from those projected are detailed from time to
time in reports filed by us with the Securities and Exchange
Commission (SEC), including
Forms 10-Q
and 8-K. Important
factors that may impact our actual results include changes in
interest rates and market values; changes in prepayment rates;
general economic conditions, particularly as they affect the
price of earning assets and the credit status of borrowers; the
level of liquidity in the capital markets as it affects our
ability to finance our real estate asset portfolio and other
factors not presently identified. In light of these risks,
uncertainties, and assumptions, the forward-looking events
mentioned, discussed in, or incorporated by reference into this
Annual Report on
Form 10-K might
not occur. Accordingly, our actual results may differ from our
current expectations, estimates, and projections. We undertake
no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future
events, or otherwise.
REDWOOD TRUST, INC.
Redwood Trust, Inc., together with its subsidiaries (Redwood,
we, or us), is a specialty finance company that invests in,
credit-enhances, and securitizes residential and commercial real
estate loans and securities. In general, we invest in real
estate loans by acquiring and owning asset-backed securities
(ABS) backed by these loans. Our primary focus is investing in
first-loss and second-loss credit-enhancement securities (CES)
issued by real estate loan securitizations, thereby partially
guaranteeing (credit-enhancing) the credit performance of
residential or commercial real estate loans owned by the issuing
securitization entity.
Most of the real estate loans we credit-enhance are above
average in terms of loan quality as compared to other
securitized real estate loans. As a result, our delinquency and
loss rates have been significantly lower than average. When
market conditions are favorable, we intend to expand our
credit-enhancement activities for loans that have average or
below-average quality characteristics. Nevertheless, it is
likely that most of the real estate loans we credit-enhance will
continue to be high quality loans.
On an economic basis, most of our assets consist of residential
and commercial CES that we have acquired from securitizations
that have been sponsored by others. We also sponsor residential
loan securitizations. We acquire residential whole loans from
originators, accumulate loans over a period of a few weeks or
months, and then sell the loans to newly-created securitization
entities (Sequoia entities) that create and sell securities
backed by these loans. We may also acquire some of the
interest-only securities (prepayment rate sensitive securities)
from these securitizations.
We also acquire and aggregate pools of diverse types of
investment-grade and non-investment grade residential and
commercial real estate securities. We then sell these pools of
assets to newly-created securitization entities (Acacia
entities) that create and sell ABS. We earn on-going management
fees from outstanding Acacia transactions. We may also acquire
the equity from collateralized debt obligation (CDO)
transactions.
As a real estate investment trust (REIT), we are required to
distribute to stockholders as dividends at least 90% of our REIT
taxable income, which is our income as calculated for tax
3
purposes, exclusive of income earned in non-REIT subsidiaries.
In order to meet our dividend distribution requirements, we have
been paying both a regular quarterly dividend and a year-end
special dividend. We set our regular quarterly dividend at a
rate that we believe is more likely than not to be sustainable
over time. If we earn more taxable income than is required to
fund the regular dividend, we have generally paid a special
dividend in December. We expect our special dividend amount to
be highly variable, and we may not pay a special dividend in
every year. Our dividend policies and distribution practices are
determined by our Board of Directors and may change over time.
Redwood was incorporated in the State of Maryland on
April 11, 1994, and commenced operations on August 19,
1994. We have our executive offices at One Belvedere Place,
Suite 300, Mill Valley, California 94941.
BUSINESS MODEL AND STRATEGY
Our business model and strategy are based on our belief that an
efficiently structured specialty finance company can achieve an
attractive level of profitability through investing in,
credit-enhancing, and securitizing residential and commercial
real estate loans and securities in a disciplined manner. Our
primary financial goal is to generate steady regular dividends
for our stockholders.
Our primary source of revenue is interest income paid to us from
the securities and loans we own, which in turn consists of the
monthly loan payments made by homeowners (and to a lesser
degree, commercial property owners) on their real estate loans.
Our primary product focus is credit-enhancing residential and
commercial loans that are high quality. “High quality”
means real estate loans that typically have features such as low
loan-to-value ratios,
borrowers with strong credit histories, and other indications of
quality relative to the range of loans within U.S. real
estate markets as a whole.
We seek to maintain a structured balance sheet that we believe
should allow us to weather potential general economic downturns
and liquidity crises. We generally seek to put ourselves in a
position where changes in interest rates would not be likely to
materially harm our ability to meet our long-term goals or
maintain our regular dividend rate. We use debt to finance loans
and securities that we are accumulating as inventory for sale to
securitization entities sponsored by us.
We currently sponsor the securitization through our Sequoia
program of all the residential real estate loans we acquire. Our
residential loan securitization activities focus primarily on
jumbo residential loans products. We typically retain a
credit-enhancement security from these securitizations. We may
also acquire and retain an interest-only security that has
investment return characteristics primarily related to the rate
of prepayment of the loans owned by the Sequoia securitization
entity.
We also sponsor the re-securitization through our
Acacia CDO program of investment-grade (and, to a lesser
degree, non-investment grade) real estate securities. We
typically acquire and retain the CDO equity securities issued by
the Acacia securitization entities. CDO equity securities bear
the first-loss and second-loss credit risk with respect to the
securities owned by the Acacia entities.
We seek to invest in assets that have the potential to provide
high cash flow returns over a long period of time to help
support our goal of maintaining steady regular dividends over
time. We typically fund these assets entirely with equity
(i.e., no debt). We refer to the assets we own that meet
these criteria as “permanent assets”. Thus, our goal
is to build a permanent asset portfolio that consists primarily
of various ABS. The ABS in our permanent asset portfolio are
collateralized by residential and commercial loans and generally
represent the types of securities that have the most
concentrated credit risk with respect to the underlying loans.
In some instances, we may also invest in ABS that have the most
concentrated prepayment risk (and/or interest rate risk, if
any). Our permanent assets also include commercial real estate
loan
4
investments. By acquiring and managing these ABS, our permanent
asset portfolio is designed to generate long-term cash flows
that will fund dividend distributions to our stockholders.
By funding our permanent assets with equity, we have no
liquidity risk, debt roll-over risk, or margin call risk with
respect to these assets. We use a combination of debt and equity
to fund “inventory” assets that we acquire for re-sale
to a securitization entity. Our balance sheet is strong because
our maximum economic loss with respect to the credit risks
associated with our permanent assets is limited to our
investment in CES. In other words, our maximum loss on these
investments is less than our equity capital base.
As a result of the form of securitization we have chosen to
utilize for most of the securitizations we sponsor, we
consolidate and report under GAAP all of the assets of the
securitization entities we have sponsored as assets on our
Consolidated Balance Sheets, and we consolidate and report all
of the ABS issued by those entities and held by unrelated third
parties as liabilities on our Consolidated Balance Sheets. Thus,
the ABS we acquire for our permanent asset portfolio from
securitizations we sponsor are not shown as specific assets on
our Consolidated Balance Sheets, but rather are represented by
the excess of the recorded value of the securitized pool of
assets over the related liabilities, in each case consolidated
from the securitization entities we have sponsored. As a result
of this GAAP treatment, no gain on sale is recognized for GAAP
purposes from the securitizations we sponsor even if these
securitizations result in taxable gains on sales for us.
Although we currently invest in residential and commercial real
estate securities including interest only (IO) securities, home
equity lines of credit (HELOC), commercial real estate loan
participations, and CDO equity securities backed by diverse
types of residential and commercial real estate loans and
securities, we are open to investing in, credit-enhancing, and
securitizing other types of real estate assets that may
complement and benefit our core business activities. We also may
make non-real estate investments or enter non-real estate
businesses.
COMPETITION
We believe we are more efficient than banks and thrifts at
owning, credit-enhancing, securitizing, and financing
residential and commercial real estate loans. As a non-regulated
specialty finance company, we have greater freedom to operate in
the capital markets and securitization markets than do other
financial institutions such as banks and insurance companies.
Also our operating costs are lower. As a public company with
permanent capital, we have an advantage in making investments in
illiquid assets relative to investment companies and
partnerships that might suffer investor withdrawals and
liquidity issues. As a REIT, we have tax advantages relative to
non-REITs that have to pay corporate income taxes, typically one
of the largest costs of doing business. As a market leader, we
have size advantages that bring economies of scale as well as
marketing and operating advantages. As a company with a small
number of employees, we have a strong culture that is
entrepreneurial, focused, and disciplined.
We believe that the business of acquiring and owning residential
and commercial loan CES is highly fragmented. Companies
that credit-enhance residential and commercial loan
securitizations include banks and thrifts (generally
credit-enhancing their own loan originations), Fannie Mae and
Freddie Mac, Wall Street broker-dealers, hedge funds, private
investment firms, mortgage REITs, business development
companies, asset management firms, pension funds, and others. In
addition, our credit-enhancement business competes with banks
and similar financial institutions to the extent that they hold
real estate loans in portfolio rather than securitizing them.
The volume of high-quality CES has declined recently as a result
of lower overall origination levels as interest rates have risen
and a lower percentage of loans are being securitized,
particularly hybrid loans, as they are being held in portfolio
by banks and other financial institutions. Additionally, the
supply of high-quality loans is impacted by a general
deterioration in underwriting standards. This decline in volume
has led to excess capacity in the residential
5
mortgage industry, which in turn continues to put pressure on
prices for new residential loan CES.
We believe that the business of acquiring and owning residential
IO securities generated through the securitization of jumbo
residential loans is also fragmented. A deeper and more active
market for more complex IO securities has developed in the
last several years, in part due to interest from asset
management firms, mutual funds, hedge funds, Wall Street
broker-dealers, and other capital markets participants seeking
attractive fixed income yields.
Our sponsorship of Sequoia residential loan securitizations
competes with Wall Street broker-dealers, mortgage REITs, and
various mortgage conduits that acquire loans to create economic
gains through securitization. We also compete with banks, loan
origination companies, and REITs that securitize their own real
estate loan origination.
Our sponsorship of Acacia CDO securitizations and our investment
in CDO equity securities competes with a large variety of asset
management organizations, financial institutions, and
institutional investors worldwide.
A reduction in securitization volume or profitability, caused by
increased competition, reduced asset supply, market
fluctuations, ABS spread widening, poor hedging results, or
other factors, could have a material adverse impact on our
taxable income and also on our GAAP income. Competition in the
business of sponsoring securitizations of the type we focus on
is increasing as Wall Street broker-dealers, mortgage REITs,
investment management companies, and other financial
institutions expand their activities or enter this field. In
general, this has reduced our taxable gains on sales as we have
had to pay a higher price for securitizable assets relative to
the proceeds available from securitization.
We believe competitive pressures within the commercial loan
origination business are generally leading to a decline in
origination standards. Furthermore, the underlying commercial
properties are generally valued at high prices compared to their
cash flow (relative to commercial real estate prices in the last
ten years). In addition, competition to acquire commercial loan
CES has increased, thus raising effective current prices for the
commercial loan CES we buy. These market factors may make
expansion or prudent investing difficult.
INFORMATION AVAILABLE ON OUR WEBSITE
Our website can be found at www.redwoodtrust.com. We make
available, free of charge on or through our website, access to
our annual reports on
Form 10-K,
quarterly reports on
Form 10-Q, current
reports on
Form 8-K, and
amendments to those reports filed pursuant to Section 13(a)
or 15(d) of the Securities Exchange Act of 1934 as soon as
reasonably practicable after those materials are filed with, or
furnished to, the SEC. We also make available, free of charge,
access to our Code of Ethics, Corporate Governance Standards,
Audit Committee Charter, Compensation Committee Charter, and
Governance and Nominating Committee Charter.
CERTIFICATIONS
Our Chief Executive Officer and Chief Financial Officer have
executed certifications dated February 23, 2006, as
required by Sections 302 and 906 of the Sarbanes-Oxley Act
of 2002, and we have included those certifications as exhibits
to our Annual Report on
Form 10-K for the
year ended December 31, 2005. In addition, our Chief
Executive Officer certified to the New York Stock Exchange
(NYSE) on May 26, 2005 that he is unaware of any violations
by Redwood Trust, Inc. of the NYSE’s corporate governance
listing standards in effect as of that date.
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EMPLOYEES
As of December 31, 2005, Redwood employed 79 people.
Item 1A.
RISK FACTORS
The following is a summary of the risk factors that we believe
are most relevant to our business. These are factors that,
individually or in the aggregate, we think could cause our
actual results to differ significantly from anticipated or
historical results. You should understand that it is not
possible to predict or identify all such factors. Consequently,
you should not consider the following to be a complete
discussion of all potential risks or uncertainties. We undertake
no obligation to publicly update forward-looking statements,
whether as a result of new information, future events, or
otherwise. You are advised, however, to consult any further
disclosure we make on related subjects in our reports on
forms 10-Q
and 8-K filed with
the SEC.
Risks Related to our Business
The securities we own expose us to concentrated risks and
thus are likely to lead to variable returns.
Many of the securities we own employ a high degree of internal
structural leverage and concentrated credit, interest rate,
prepayment, or other risks. No amount of risk management or
mitigation can change the variable nature of the cash flows,
market values, and financial results generated by concentrated
risks in our investments backed by real estate loans and
securities, which, in turn, can result in variable returns to us
and our stockholders. We only acquire securities that we believe
can earn a high enough yield to enable us to provide our
stockholders with an attractive equity rate of return. In
general, we expect to earn an internal rate of return, or IRR,
of cash flows of at least 14% on a pre-tax and pre-overhead
basis from most of our assets in most circumstances. In order to
earn this rate of return on a financially un-leveraged basis, we
generally acquire the most risky securities from any
securitization. Most securitizations of residential and
commercial real estate loans concentrate almost all the credit
risk of all the securitized assets into one or more CES or CDO
equity securities. To the extent that there is significant
prepayment risk or interest rate risk internal to these
securitization structures, those risks are generally also
concentrated in one or more securities. Securities with these
types of concentrated risks are typically the securities we buy.
Residential real estate loan delinquencies, defaults, and
credit losses could reduce our earnings, dividends, cash flows,
and access to liquidity.
We assume credit risk with respect to residential real estate
loans primarily through the ownership of residential
loan CES and similarly structured securities acquired from
securitizations sponsored by others and from Sequoia
securitizations sponsored by us. These securities have below
investment-grade credit ratings due to their high degree of
credit risk with respect to the residential real estate loans
within the securitizations that issued these securities. Credit
losses from any of the loans in the securitized loan pools
reduce the principal value of and economic returns from
residential loan CES.
Credit losses on residential real estate loans can occur for
many reasons, including: poor origination practices; fraud;
faulty appraisals; documentation errors; poor underwriting;
legal errors; poor servicing practices; weak economic
conditions; decline in the value of homes; special hazards;
earthquakes and other natural events; over-leveraging of the
borrower; changes in legal protections for lenders; reduction in
personal incomes; job loss; and personal events such as divorce
or health problems. In addition, if the U.S. economy or the
housing market weakens, our credit losses could be increased
beyond levels that we have anticipated. The interest rate is
adjustable for most of the loans securitized by securitization
trusts sponsored by us and for a portion of the loans underlying
residential loan CES we have acquired from securitizations
sponsored by others. Accordingly, when short-term interest rates
rise, required monthly payments from homeowners will rise under
the terms of these adjustable-rate mortgages, and this may
increase borrowers’ delinquencies and defaults. If we incur
increased
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credit losses, our taxable income would be reduced, our GAAP
earnings might be reduced (if these increased credit losses are
greater than we have anticipated), and our cash flows, asset
market values, access to short-term borrowings (typically used
to acquire assets for sale to securitization entities), and our
ability to securitize assets might be harmed. The amount of
capital and cash reserves that we hold to help us manage credit
and other risks may prove to be insufficient to protect us from
earnings volatility, dividend cuts, liquidity issues, and
solvency issues.
Significant losses on residential credit-enhancement
securities could diminish our equity capital base, reduce our
earnings, and otherwise negatively affect our business.
The credit performance of residential loans underlying
residential loan CES directly affects our results for the
CES we own and also affects our returns from CDO equity
securities that we have acquired from Acacia CDO securitization
entities that own residential loan CES. The total amount of
residential real estate loans underlying residential
loan CES (acquired from securitizations sponsored by others
and Sequoia) was $184 billion at December 31, 2005.
Our total potential credit loss from the underlying residential
real estate loans is limited to our total investment in
residential loan CES and Acacia CDO equity securities. This
total potential loss is smaller than our equity capital base of
$935 million at December 31, 2005. Nevertheless,
significant realized losses from residential CES could harm our
results from operations and significantly diminish our capital
base.
If we incur increased credit losses, our taxable income would be
reduced, our GAAP earnings might be reduced (if these increased
credit losses are greater than we have anticipated), and our
cash flows, asset market values, our access to short-term
borrowings (typically used to acquire assets for sale to
securitization entities), and our ability to securitize assets
might be harmed. The amount of capital and cash reserves that we
hold to help us manage credit and other risks may prove to be
insufficient to protect us from earnings volatility, dividend
cuts, liquidity issues, and solvency issues.
Significant credit losses could also reduce our ability to
sponsor new securitizations of residential loans. We generally
expect to increase our portfolio of residential loan CES
and our credit exposure to the residential real estate loan
pools that underlie these securities.
The timing of credit losses can harm our economic
returns.
The timing of credit losses can be a material factor in our
economic returns from residential loan CES. If
unanticipated losses occur within the first few years after a
securitization is completed, they will have a larger negative
impact on CES investment returns. In addition, larger levels of
delinquencies and cumulative credit losses within a securitized
loan pool can delay our receipt of the principal and interest
that is due to us. This would also lower our economic returns.
Our efforts to manage credit risk may not be successful in
limiting delinquencies and defaults in underlying loans or
losses on our investments.
Despite our efforts to manage credit risk, there are many
aspects of credit that we cannot control. Our quality control
and loss mitigation operations may not be successful in limiting
future delinquencies, defaults, and losses. Our underwriting
reviews may not be effective. The securitizations in which we
have invested may not receive funds that we believe are due from
mortgage insurance companies and other counter-parties. Loan
servicing companies may not cooperate with our loss mitigation
efforts, or such efforts may be ineffective. Service providers
to securitizations, such as trustees, bond insurance providers,
and custodians, may not perform in a manner that promotes our
interests. The value of the homes collateralizing residential
loans may decline. The frequency of default, and the loss
severity on loans upon default, may be greater than we
anticipated. Interest-only loans, negative amortization loans,
adjustable-rate loans, loans with balances over $1 million,
reduced documentation loans, sub-prime loans, HELOCs, second
lien loans, loans in certain locations, and loans that are
partially collateralized by non-real estate assets may have
special risks. If loans become “real estate owned”
(REO),
8
servicing companies will have to manage these properties and may
not be able to sell them. Changes in consumer behavior,
bankruptcy laws, tax laws, and other laws may exacerbate loan
losses. In some states and circumstances, the securitizations in
which we invest have recourse as owner of the loan against the
borrower’s other assets and income in the event of loan
default; however, in most cases, the value of the underlying
property will be the sole source of funds for any recoveries.
Expanded loss mitigation efforts in the event that defaults
increase could increase our operating costs.
We have significant credit risk in California. We also
have credit risk in other states and our business may be
adversely affected by a slowdown in the economy or by natural
disasters in these states.
As of December 31, 2005, approximately 46% of the
residential real estate loans that underlie the residential
loan CES we owned were secured by property in California.
As of December 31, 2005, approximately 25% of our
commercial real estate loans, and 16% of loans underlying our
commercial loan CES were secured by properties located in
California. Factors specific to California could aversely affect
our results.
As of December 31, 2005, approximately 3% to 6% of our
residential real estate loans that underlie the residential
loan CES we owned were secured by properties in each of
Florida, Virginia, New York, New Jersey, Illinois, and Texas. We
have residential credit risk in all states, although we do not
have more than 1% of our loans in any one zip code. As of
December 31, 2005, our commercial loan CES had more
than 5% of real estate properties in each of New York, Texas,
and Florida. Factors specific to each of these states’
economies could adversely affect our results.
An overall decline in the economy or the real estate market
could decrease the value of residential and commercial
properties. This, in turn, would increase the risk of
delinquency, default, or foreclosure on real estate loans
underlying our CES portfolios. This could adversely affect our
credit loss experience and other aspects of our business,
including our ability to securitize real estate loans.
The occurrence of a natural disaster (such as an earthquake or a
flood) may cause a sudden decrease in the value of real estate
and would likely reduce the value of the properties
collateralizing the underlying mortgage loans in the securities
we own. Since certain natural disasters may not typically be
covered by the standard hazard insurance policies maintained by
borrowers, the borrowers may have to pay for repairs due to such
disasters. Borrowers may not repair their property or may stop
paying their mortgage loans under such circumstances, especially
if the property is damaged. This would likely cause foreclosures
to increase and lead to higher credit losses on the underlying
pool of mortgage loans on which we are providing
credit-enhancement.
We assume credit risk on a variety of residential and
commercial mortgage assets.
In addition to residential and commercial loan CES we own,
the Acacia entities we sponsor (sometimes collectively referred
as Acacia) own investment-grade and non-investment grade
securities (typically rated AAA through B, and in a second-loss
position or better, or otherwise effectively more senior in the
credit structure as compared to a first-loss residential
loan CES or equivalent) issued by residential and
commercial real estate loan securitization entities. The Acacia
securities are reported as part of our consolidated securities
portfolio on our Consolidated Balance Sheets. Generally, we do
not control or influence the underwriting, servicing,
management, or loss mitigation efforts with respect to the
underlying assets in these securities. Some of the securities
Acacia owns are backed by sub-prime loans that have
substantially higher risk characteristics than prime-quality
loans. These lower-quality loans can be expected to have higher
rates of delinquency and loss, and losses to Acacia (and thus
Redwood as owner of the Acacia CDO equity securities) could
occur. Some of the assets Acacia has acquired are
investment-grade and non-investment grade residential loan
securities from the Sequoia securitization entities we have
sponsored. Although we may have a limited degree of control or
influence over the selection and management of the loans
underlying Sequoia
9
securitizations, we believe the possibility of loss on these
assets remains approximately the same as it is for securities
issued from securitizations of equivalent-quality loans that we
did not sponsor. If the pools of residential loans underlying
any of these securitizations were to experience poor credit
results, Acacia’s securities could have their credit
ratings down-graded, could suffer losses in market value, or
could experience principal losses. If any of these events
occurs, it would likely reduce our long-term returns and
near-term cash flows from the Acacia CDO equity securities we
have acquired, and may also reduce our ability to sponsor Acacia
transactions in the future.
The risks of credit-enhancing commercial real estate loans
may exceed those of credit-enhancing residential loans.
The commercial real estate assets in which we have a direct or
indirect interest may have significant degrees of credit and
other risks, including various environmental and legal risks.
The net operating income and market values of commercial real
estate properties may vary with economic cycles and as a result
of other factors, so that debt service coverage is unstable. The
value of the property may not protect the value of the loan if
there is a default. Each commercial real estate loan is at risk
for local and regional factors. Many commercial real estate
loans are not fully amortizing and, therefore, the timely
recovery of principal is dependent on the borrower’s
ability to refinance or sell the property at maturity. For some
commercial real estate loans in which we have an economic
interest, the real estate is in transition. Such lending entails
higher risks than traditional commercial property lending
against stabilized properties. Initial debt service coverage
ratios, loan-to-value
ratios, and other indicators of credit quality may not meet
standard market criteria for stabilized commercial real estate
loans. The underlying properties may not transition or stabilize
as expected. The personal guarantees and forms of
cross-collateralization that we benefit from on some loans may
not be effective. We own some mezzanine loans that do not have a
direct lien on the underlying property. We generally do not
service commercial real estate loans; we rely on our servicers
to a great extent to manage commercial assets and workout loans
and properties if there are delinquencies or defaults. This may
not work to our advantage. As part of the workout process of a
troubled commercial real estate loan, we may assume ownership of
the property, and the ultimate value of this asset would depend
on our management of, and eventual sale of, the property that
secured the loan.
Our commercial loans are illiquid; if we choose to sell them, we
may not be able to do so in a timely manner or for a
satisfactory price. Financing these loans may be difficult, and
may become more difficult if credit quality deteriorates.
We have purchased distressed commercial loans at discount prices
where there is a reasonable chance we may not recover full
principal value. We have sold senior loan participations on some
of our loans, with the result that the asset we retain is
junior. Mezzanine loans, distressed assets, and loan
participations have concentrated credit, servicing, and other
risks. We have directly originated some of our commercial loans
and participated in the origination of others. This may expose
us to certain credit, legal, and other risks that may be greater
than is usually present with acquired loans. We have acquired
and intend to acquire commercial loans for sale to Acacia that
require a specific credit rating to be efficient as a
securitized asset, and we may not be able to get the rating on
the loan that we need.
Our first-loss and second-loss commercial loan CES have
concentrated risks with respect to commercial real estate loans.
In general, losses on an asset securing a commercial real estate
loan included in a securitization will be borne first by the
owner of the property (i.e., the owner will first lose the
equity invested in the property) and, thereafter, by a cash
reserve fund or letter of credit, if any, and then by the
first-loss commercial loan CES holder. In the event of
default and the exhaustion of any equity support, reserve fund,
letter of credit, and any classes of securities junior to those
in which we invest, we will not be able to recover all of our
principal investment in the securities we purchase. In addition,
if the underlying properties have been overvalued by the
originating appraiser or if the values subsequently decline and,
as a result, less collateral is available to satisfy interest
and principal payments due on the related ABS, the first-loss
securities may suffer a total loss of principal, and the
second-loss (or more highly rated)
10
securities in which we invest (or have an indirect interest) may
effectively become the first-loss position behind the more
senior securities, which may result in significant losses to us.
The prices of commercial loan CES are more sensitive to
adverse economic downturns or individual issuer developments
than more highly rated commercial real estate securities. A
projection of an economic downturn, for example, could cause a
decline in the price of commercial loan CES because of
increasing concerns regarding the ability of obligors of loans
underlying commercial ABS to continue to make principal and
interest payments.
We acquire and manage a portion of our commercial assets in
conjunction with partners. Our partners may have greater control
over the management of commercial securitizations than we do.
Working with partners in this manner may expose us to increased
risks.
Investments in diverse types of assets and businesses
could expose us to new, different, or increased risks.
We have invested in and intend to invest in a variety of real
estate and non-real estate related assets that may not be
closely related to our current core business. Additionally, we
may enter various securitization, service, and other operating
businesses that may not be closely related to our current
business. Any of these actions may expose us to new, different,
or increased investment, operational, financial, or management
risks. We have made investments in CDO debt and equity
securities issued by CDO securitizations other than Acacia that
own various types of assets, generally real estate related.
These CDOs (as well as the Acacia entities) have invested in
manufactured housing securities, sub-prime residential
securities, and other residential securities backed by
lower-quality borrowers. They also own a variety of commercial
real estate loans and securities, corporate debt issued by REITs
that own commercial real estate properties, and other assets
that have diverse credit risks. We may invest in CDO equity
securities issued by CDOs that own trust preferred securities
issued by banks or other types of non-real estate assets. We may
invest directly or indirectly in real property. We may invest in
non-real estate ABS or corporate debt or equity. We have
invested in diverse types of IO securities from residential and
commercial securitizations sponsored by us or by others. The
higher credit and/or prepayment risks associated with these
types of investments may increase our exposure to losses. We may
invest in
non-U.S. assets
that may expose us to currency risks (which we may choose not to
hedge) and different types of credit, prepayment, hedging,
interest rate, liquidity, and other risks.
We establish credit reserves for GAAP accounting purposes,
but there are no reserves established for tax accounting
purposes.
In determining our REIT taxable income (which drives our minimum
dividend distribution requirements as a REIT), no current tax
deduction is available for future credit losses that are
anticipated to occur. Credit losses can only be deducted for tax
purposes when they are actually realized. As a result, for tax
purposes, there is no credit reserve or reduction of yield
accruals based on anticipated losses, and an increase in our
credit losses in the future will reduce our taxable income (and
dividend distribution requirements). Since, for GAAP purposes,
we are able to incorporate an assumption about the amount and
timing of credit losses, the occurrence of these losses as
assumed will not directly impact our future GAAP income
(although they could lead to additional provisions or credit
reserve designations to provide for potential additional losses).
We have exposure under representations and warranties we
make in the contracts of sale of loans to securitization
entities.
With respect to loans that have been securitized by entities
sponsored by us, we have potential credit and liquidity exposure
for loans that default and are the subject of fraud,
irregularities in their loan files or process, or other issues
that potentially could expose us to liability as a result of
representations and warranties in the contract of sale of loans
to the securitization entity. In these cases, we may be
obligated to repurchase loans from the securitization entities
at principal value. However, we have obtained representations
and warranties from the counter-parties that
11
sold the loans to us that generally parallel the representations
and warranties we have provided to the entities. As a result, we
believe that we should, in most circumstances, be able to compel
the original seller of the loan to repurchase any loans that we
are obligated to repurchase from the securitization trusts.
However, if the representations and warranties are not parallel,
or if the original seller is not in a financial position to be
able to repurchase the loan, we may have to use some of our cash
resources to repurchase loans.
Our results could be harmed by counter-party credit
risk.
We have other credit risks that are generally related to the
counter-parties with which we do business. In the event a
counterparty to our short-term borrowings becomes insolvent, we
may fail to recover the full value of our pledged collateral,
thus reducing our earnings and liquidity. In the event a
counter-party to our interest rate agreements becomes insolvent
or interprets our agreements with it in a manner unfavorable to
us, our ability to realize benefits from hedging may be
diminished, and any cash or collateral that we pledged to such a
counter-party may be unrecoverable. We may be forced to unwind
these agreements at a loss. In the event that one of our
servicers becomes insolvent or fails to perform, loan
delinquencies and credit losses may increase. We may not receive
funds to which we are entitled. In other aspects of our
business, we depend on the performance of third parties that we
do not control. We attempt to diversify our counter-party
exposure and limit our counter-party exposure to strong
companies with investment-grade credit ratings; however, we are
not always able to do so. Our counter-party risk management
strategy may prove ineffective and, accordingly, our earnings
could be harmed.
We may be subject to the risks associated with inadequate
or untimely services from third-party service providers, which
may harm our results of operations.
Our loans and loans underlying securities are serviced by
third-party service providers. These arrangements allow us to
increase the volume of the loans we purchase and securitize
without incurring the expenses associated with servicing
operations. However, as with any external service provider, we
are subject to the risks associated with inadequate or untimely
services. Many borrowers require notices and reminders to keep
their loans current and to prevent delinquencies and
foreclosures. A substantial increase in our delinquency rate
that results from improper servicing or loan performance in
general could harm our ability to securitize our real estate
loans in the future and may have an adverse effect on our
earnings.
Interest rate fluctuations can have various negative
effects on us, and could lead to reduced earnings and/or
increased earnings volatility.
Our balance sheet and asset/liability operations are complex and
diverse with respect to interest rate movements. We do not seek
to eliminate all interest rate risk. Changes in interest rates,
the interrelationships between various interest rates, and
interest rate volatility could have negative effects on our
earnings, the market value of our assets and liabilities, loan
prepayment rates, and our access to liquidity. Changes in
interest rates can also harm the credit performance of our
assets. We seek to hedge some interest rate risks. Our hedging
may not work effectively, or we may change our hedging
strategies or the degree or type of interest rate risk we want
to assume.
We generally fund most of our permanent asset portfolio with
equity, so there is no asset/liability mismatch for these
assets. A portion our equity-funded assets have adjustable-rate
coupons. The cash flows we receive from these assets may vary as
a function of interest rates, as do the GAAP earnings generated
by these assets. We also own loans and securities as inventory
prior to sale to a securitization entity. We fund these assets
with equity and with one-month floating rate debt. To the extent
these assets have fixed or hybrid interest rates (or are
adjustable with an adjustment period longer than one month), an
interest rate mismatch exists and we would earn less (and incur
market value declines) if interest rates rise. We usually seek
to reduce asset/liability mismatches for these inventory assets
with a hedging program using interest rate swaps and futures.
Interest rate changes have diverse and sometimes unpredictable
effects on the prepayment rates of real estate loans. Change in
prepayment rates can lower the returns we earn from our
12
assets, diminish or delay our cash flows, reduce the market
value of our assets, and decrease our liquidity.
Higher interest rates generally reduce the market value of our
assets (except perhaps our adjustable rate assets). This may
affect our earnings results, reduce our ability to re-securitize
or sell our assets, or reduce our liquidity. Higher interest
rates could reduce the ability of borrowers to make interest
payments or to refinance. Higher interest rates could reduce
property values and increased credit losses could result. Higher
interest rates could reduce mortgage originations, thus reducing
our opportunities to acquire new assets, and possibly driving
asset acquisition prices higher.
When short-term interest rates are high relative to long-term
interest rates, an increase in adjustable-rate residential loan
prepayments may occur, which would likely reduce our returns
from owning IO securities backed by these ARM loans.
Changes in prepayment rates of residential real estate
loans could reduce our earnings, dividends, cash flows, and
access to liquidity.
The economic returns we expect to earn from most of the
residential real estate securities we (or Sequoia or Acacia) own
are affected by the rate of prepayment of the underlying
residential real estate loans. Adverse changes in the rate of
prepayment could reduce our earnings and dividends. They could
delay cash payments or reduce the total of cash payments we
would otherwise eventually receive. Adverse changes in cash
flows would likely reduce an affected asset’s market value,
which would likely reduce our access to liquidity if we borrowed
against that asset and may cause a market value write-down for
GAAP purposes, which would reduce our reported earnings. While
we estimate prepayment rates to determine the effective yield of
our assets and valuations, these estimates are not precise, and
prepayment rates do not necessarily change in a predictable
manner as a function of interest rate changes. Prepayment rates
can change rapidly. As a result, such changes can cause
volatility in our financial results, affect our ability to
securitize assets, affect our ability to fund acquisitions, and
have other negative impacts on our ability to grow and generate
earnings.
Hedging activities may reduce long-term earnings and may
fail to reduce earnings volatility or to protect our capital in
difficult economic environments. Our failure to hedge may also
harm our results.
We attempt to hedge certain interest rate risks (and, to a much
lesser degree, prepayment risks) by balancing the
characteristics of our assets with respect to these risks and by
entering into various interest rate agreements. The amount and
level of interest rate agreements that we utilize may vary
significantly over time. We generally attempt to enter into
interest rate hedges that provide an appropriate and efficient
method for hedging the desired risk.
Hedging against interest rate risks using interest rate
agreements and other instruments usually has the effect over
long periods of time of lowering long-term earnings. To the
extent that we hedge, it is usually to protect us from some of
the effects of short-term interest rate volatility, to lower
short-term earnings volatility, to stabilize liability costs or
market values, to stabilize our economic returns from
securitization, or to stabilize the future cost of anticipated
ABS issuance by a securitization entity. Such hedging may not
achieve its desired goals. Using interest rate agreements to
hedge may increase short-term earnings volatility, especially if
we do not elect hedge accounting treatment for our hedges (i.e.,
our hedges are accounted for as trading instruments). Reductions
in market values of interest rate agreements may not be offset
by increases in market values of the assets or liabilities being
hedged. Conversely, increases in market values of interest rate
agreements may not fully offset declines in market values of
assets or liabilities being hedged. Changes in market values of
interest rate agreements may require us to pledge significant
amounts of collateral or cash. Hedging exposes us to
counter-party risks.
We also may hedge by taking short, forward, or long positions in
U.S. Treasuries, mortgage securities, or other cash
instruments. Such hedges may have special basis, liquidity, and
other risks to us.
13
Our quarterly earnings may reflect volatility in earnings as a
result of the accounting treatment for certain interest rate
agreements, as a result of accounting treatments for assets or
liabilities that do not necessarily match those used for
interest rate agreements, or our failure to meet the
requirements to obtain desired hedge accounting treatment for
certain interest rate agreements.
New assets we acquire may not generate yields as
attractive as yields on our current assets, resulting in a
decline in our earnings per share over time.
We believe the assets we are acquiring today are unlikely to
generate economic returns or GAAP yields at the same levels as
our historical assets generated. We receive monthly payments
from most of our assets, consisting of principal and interest.
In addition, occasionally some of our residential loan CES
are called (effectively sold). Principal payments and calls
reduce the size of our current portfolio and generate cash for
us. We also sell assets from time to time as part of our
portfolio management and capital recycling strategies. In order
to maintain our portfolio size and our earnings, we need to
reinvest a portion of the cash flows we receive from principal,
interest, calls, and sales into new earning assets.
If the assets we acquire today earn lower GAAP yields than the
assets we currently own, our reported earnings per share will
likely decline over time as the older assets pay down, are
called, or are sold. Under the effective yield method of
accounting that we use for GAAP accounting purposes for most of
our assets, we recognize yields on assets based on our
assumptions regarding future cash flows. A portion of the cash
flows we receive that exceeds the anticipated cash flows reduces
our basis in these assets. As a result of these various factors,
our basis for GAAP amortization purposes for many of our current
assets is lower than their current market values. Assets with a
lower GAAP basis generate higher GAAP yields, yields that are
not necessarily available on newly acquired assets. Business
conditions, including credit results, prepayment patterns, and
interest rate trends in the future are unlikely to be as
favorable as they have been for the last few years.
Our securitization operations expose us to liquidity,
market value, and execution risks.
In order to continue our securitization operations, we require
access to short-term debt to finance inventory accumulation
prior to sale to securitization entities. In times of market
dislocation, this type of short-term debt might become
unavailable from time to time. We pledge the inventory assets we
buy to secure our short-term debt. This debt is recourse to us,
and if the market value of the collateral declines we will need
to use our liquidity to increase the amount of collateral
pledged to secure the debt or to reduce the debt amount. Our
goal is to sell these assets to a securitization entity;
however, if our ability to sponsor a securitization is
disrupted, we may need to sell these assets (most likely at a
loss) into the secondary mortgage or securities markets, or we
would need to extend the term of the short-term debt used to
fund these assets.
When we acquire assets for a securitization, we make assumptions
about the cash flows that will be generated from the
securitization of these assets. Widening ABS spreads, rising ABS
yields, incorrect estimation of rating agency securitization
requirements, poor hedging results, and other factors could
result in a securitization execution that provides a lower
amount of proceeds than initially assumed. This could result in
a loss to us for tax purposes and reduced on-going earnings for
GAAP purposes.
Our short-term borrowing arrangements used to support our
securitization operations subject us to debt covenants. While
these covenants have not meaningfully restricted our operations
to date, as a practical matter, they could be restrictive or
harmful to our stockholders’ interests and us in the
future. In the event we violate debt covenants, we may incur
expenses, losses, or a reduced ability to access debt.
Our payment of commitment fees and other expenses to secure
borrowing lines may not protect us from liquidity issues or
losses. Variations in lenders’ ability to access funds,
lender confidence in us, lender collateral requirements,
available borrowing rates, the acceptability and market values
of our collateral, and other factors could force us to utilize
our liquidity reserves or to sell assets, and, thus, affect our
liquidity, financial soundness, and earnings.
14
We recently initiated a collateralized commercial paper program
to supplement the current short-term debt arrangements we use
for our securitization program, and this could expose us to new
risks and expenses.
Our cash balances and cash flows may become limited
relative to our cash needs.
We need cash to meet our interest expense payments, working
capital, minimum REIT dividend distribution requirements, and
other needs. Cash could be required to pay down our recourse
short-term borrowings in the event that the market values of our
assets that collateralize our debt decline, the terms of
short-term debt become less attractive, or for other reasons.
Cash flows from principal repayments could be reduced should
prepayments slow or credit quality trends deteriorate (in the
latter case since, for certain of our assets, credit tests must
be met for us to receive cash flows). For some of our assets,
cash flows are “locked-out” and we receive less than
our pro-rata share of principal payment cash flows in the early
years of the investment. Operating cash flows could be reduced
if earnings are reduced, if discount amortization income
significantly exceeds premium amortization expense, or for other
reasons. Our minimum dividend distribution requirements could
become large relative to our cash flows if our income as
calculated for tax purposes significantly exceeds our cash flows
from operations. In the event, that our liquidity needs exceed
our access to liquidity, we may need to sell assets at an
inopportune time, thus reducing our earnings. In an adverse cash
flow situation our REIT status or our solvency could be
threatened.
Our reported GAAP financial results differ from the
taxable income results that drive our dividend
distributions.
We manage our business based on long-term opportunities to earn
cash flows. Our dividend distributions are driven by our minimum
dividend distribution requirements under the REIT tax laws and
our taxable income as calculated for tax purposes pursuant to
Code. Our reported results for GAAP purposes differ materially,
however, from both the cash flows and our taxable income.
We own residential loan CES acquired from securitizations
sponsored by others and also from securitizations we have
sponsored. These securities do not differ materially in their
structure or cash flow generation characteristics, yet under
GAAP we consolidate all the assets and liabilities of entities
we have sponsored (and thus do not show the residential
loan CES we own as an asset) while we show only the net
investment as an asset for CES acquired from others. The same
issue arises with residential IO securities and other securities
investments that we make and with CDO securitizations that we
sponsor. As a result of this and other accounting treatments,
stockholders and analysts must undertake a complex analysis to
understand our economic cash flows, actual financial leverage,
and dividend distribution requirements. This complexity may
cause trading in our stock to be relatively illiquid or volatile.
Market values for our assets, liabilities, and hedges can be
volatile. A decrease in market value may not necessarily be the
result of deterioration in future cash flows. For GAAP purposes
we mark-to-market some,
but not all, of our consolidated assets and liabilities through
our Consolidated Balance Sheets. In addition, under various
circumstances, some market valuation adjustments on assets may
be realized in our Consolidated Statements of Income. As a
result, assets that are funded with certain liabilities and
interest-rate matched with certain liabilities and hedges may
have differing
mark-to-market
treatment than the liability or hedge. If we sell an asset that
has not been marked to market through our Consolidated
Statements of Income at a reduced market price relative to its
basis, our reported earnings will be reduced. Changes in our
Consolidated Statements of Income and Consolidated Balance
Sheets due to market value adjustments should be interpreted
with care.
15
Our reported income depends on accounting conventions and
assumptions about the future that may change.
Accounting rules for the various aspects of our business change
from time to time. Changes in GAAP, or the accepted
interpretation of these accounting principles, can affect our
reported income, earnings, and stockholders’ equity. Our
revenue recognition and other aspects of our reported results
are based on estimates of future events. These estimates can
change in a manner that harms our results or can demonstrate, in
retrospect, that revenue recognition in prior periods was too
high or too low.
The Financial Accounting Standards Board has issued exposure
drafts for a number of proposed amendments to FASB No. 140,
Accounting for Transfers of Financial Assets (FAS 140), and
has indicated that additional revisions to FAS 140 are
under consideration. While the proposals released to date would
not have a material impact on our operations or results, any
future amendments that required a change in the way we account
for our securitizations through our Sequoia or Acacia programs
could adversely after our business strategy and reported results.
We use the effective yield method of GAAP accounting for many of
our consolidated assets and ABS issued. We calculate projected
cash flows for each of these assets and ABS issued,
incorporating assumptions about the amount and timing of credit
losses, loan prepayment rates, and other factors. The yield we
recognize for GAAP purposes generally equals the discount rate
that produces a net present value for actual and projected cash
flows that equals our GAAP basis in that asset or ABS issued. We
change the yield we recognize on these assets and ABS issued
based on actual performance and as we change our estimates of
future cash flows. The assumptions that underlie our projected
cash flows and effective yield analysis may prove to be overly
optimistic. In these cases, we reduce the GAAP yield we
recognize for an asset and/or we write down the basis of the
asset to its current market value (if the market value is lower
than the basis). For a consolidated ABS-issued liability, a
change in assumptions could lead to a higher consolidated
interest expense. These types of actions reduce our reported
GAAP earnings.
Risks Related To Our Company Structure
Failure to qualify as a REIT would adversely affect our
dividend distributions and could adversely affect the value of
our securities.
We believe that we have met all requirements for qualification
as a REIT for federal income tax purposes for all tax years
since 1994 and we intend to continue to operate so as to qualify
as a REIT in the future. However, many of the requirements for
qualification as a REIT are highly technical and complex and
require an analysis of factual matters and an application of the
legal requirements to such factual matters in situations where
there is only limited judicial and administrative guidance.
Thus, no assurance can be given that the Internal Revenue
Service (IRS) or a court would agree with our conclusion that we
have qualified as a REIT or that future changes in our factual
situation or the law will allow us to remain qualified as a
REIT. If we failed to qualify as a REIT for federal income tax
purposes and did not meet the requirements for statutory relief,
we would be subject to federal income tax at regular corporate
rates on all of our income and we could possibly be disqualified
as a REIT for four years thereafter. Failure to qualify as a
REIT would adversely affect our dividend distributions and could
adversely affect the value of our common stock.
Maintaining REIT status may reduce our flexibility.
To maintain REIT status, we must follow certain rules and meet
certain tests. In doing so, our flexibility to manage our
operations may be reduced. For instance:
•
If we make frequent asset sales from our REIT entities to
persons deemed customers, we could be viewed as a
“dealer,” and thus subject to 100% prohibited
transaction taxes or other entity level taxes on income from
such transactions.
•
Compliance with the REIT income and asset rules may limit the
type or extent of hedging that we can undertake.
16
•
Our ability to own non-real estate related assets and earn
non-real estate related income is limited. Our ability to own
equity interests in other entities is limited. If we fail to
comply with these limits, we may be forced to liquidate
attractive assets on short notice on unfavorable terms in order
to maintain our REIT status.
•
Our ability to invest in taxable subsidiaries is limited under
the REIT rules. Maintaining compliance with this limit could
require us to constrain the growth of our taxable REIT
affiliates in the future.
•
Meeting minimum REIT dividend distribution requirements could
reduce our liquidity. Earning non-cash REIT taxable income could
necessitate our selling assets, incurring debt, or raising new
equity in order to fund dividend distributions.
•
Stock ownership tests may limit our ability to raise significant
amounts of equity capital from one source.
•
Historically, our stated goal has been to not generate excess
inclusion income that would be taxable as unrelated business
taxable income, or UBTI, to our tax-exempt stockholders.
Achieving this goal has limited our flexibility in pursuing
certain transactions. Despite our efforts to do so, we may not
be able to avoid creating or distributing UBTI to our
stockholders.
Changes in tax rules could adversely affect REITs.
The requirements for maintaining REIT status and/or the taxation
of REITs could change in a manner adverse to our operations.
Rules regarding the taxation of dividends are enacted from time
to time and future legislative or regulatory changes may limit
the tax benefits accorded to REITs, either of which may reduce
some of a REIT’s competitive edge relative to non-REIT
corporations.
Failure to qualify for the Investment Company Act
exclusion could harm us.
Under the Investment Company Act of 1940, as amended, an
investment company is required to register with the SEC and is
subject to extensive restrictive and potentially adverse
regulations relating to, among other things, operating methods,
management, capital structure, dividends, and transactions with
affiliates. However, companies primarily engaged in the business
of acquiring mortgages and other liens on and interests in real
estate (i.e., qualifying interests) are excluded from the
requirements of the Investment Company Act. To qualify for the
Investment Company Act exclusion, we, among other things, must
maintain at least 55% of our assets in certain qualifying real
estate assets (the 55% Requirement) and are also required to
maintain an additional 25% in qualifying assets or other real
estate-related assets (the 25% Requirement).
If we failed to meet the 55% Requirement and the 25%
Requirement, we could, among other things, be required either
(i) to change the manner in which we conduct our operations
to avoid being required to register as an investment company or
(ii) to register as an investment company, either of which
could harm us. Further, if we were deemed an unregistered
investment company, we could be subject to monetary penalties
and injunctive relief. We may be unable to enforce contracts
with third parties and third parties could seek to obtain
rescission of transactions undertaken during the period we were
deemed an unregistered investment company, unless the court
found that under the circumstances, enforcement (or denial of
rescission) would produce a more equitable result than no
enforcement (or grant of rescission) and would not be
inconsistent with the Investment Company Act.
Item 1B.
UNRESOLVED STAFF COMMENTS
None.
17
Item 2.
PROPERTIES
Redwood leases space for executive and administrative offices at
One Belvedere Place, Suite 300, Mill Valley, California
94941. The lease expires in 2013 and our 2006 rent
obligation is approximately $0.7 million.
Item 3.
LEGAL PROCEEDINGS
At December 31, 2005, there were no legal proceedings to
which Redwood was a party or to which any of its property was
subject.
Item 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of Redwood’s
stockholders during the fourth quarter of 2005.
Redwood’s Common Stock is listed and traded on the NYSE
under the symbol RWT. Redwood’s Common Stock was held by
over 2,000 holders of record on February 23, 2006 and the
total number of beneficial stockholders holding stock through
depository companies was over 33,000. As of February 23,
2006, there were 25,189,950 shares outstanding. The high
and low sales prices of shares of the Common Stock as reported
on the NYSE and the cash dividends declared on the Common Stock
for the periods indicated below were as follows:
| Common Dividends Declared | ||||||||||||||||||||||||
| Stock Prices | ||||||||||||||||||||||||
| Record | Payable | Per | Dividend | |||||||||||||||||||||
| High | Low | Date | Date | Share | Type | |||||||||||||||||||
|
Year Ended December 31,
2005
|
||||||||||||||||||||||||
|
Fourth Quarter
|
$ | 47.59 | $ | 41.26 | 12/30/05 | 1/23/06 | $ | 0.70 | Regular | |||||||||||||||
| 11/25/05 | 12/9/05 | $ | 3.00 | Special | ||||||||||||||||||||
|
Third Quarter
|
$ | 54.98 | $ | 48.61 | 9/30/05 | 10/21/05 | $ | 0.70 | Regular | |||||||||||||||
|
Second Quarter
|
$ | 54.08 | $ | 49.97 | 6/30/05 | 7/21/05 | $ | 0.70 | Regular | |||||||||||||||
|
First Quarter
|
$ | 62.45 | $ | 48.73 | 3/31/05 | 4/21/05 | $ | 0.70 | Regular | |||||||||||||||
|
Year Ended December 31,
2004
|
||||||||||||||||||||||||
|
Fourth Quarter
|
$ | 65.98 | $ | 57.54 | 12/31/04 | 1/21/05 | $ | 0.67 | Regular | |||||||||||||||
| 11/30/04 | 12/10/04 | $ | 5.50 | Special | ||||||||||||||||||||
|
Third Quarter
|
$ | 62.42 | $ | 54.60 | 9/30/04 | 10/21/04 | $ | 0.67 | Regular | |||||||||||||||
|
Second Quarter
|
$ | 62.10 | $ | 43.45 | 6/30/04 | 7/21/04 | $ | 0.67 | Regular | |||||||||||||||
|
First Quarter
|
$ | 62.69 | $ | 49.15 | 3/31/04 | 4/21/04 | $ | 0.67 | Regular | |||||||||||||||
| 3/31/04 | 4/21/04 | $ | 0.50 | Special | ||||||||||||||||||||
| Redwood intends to distribute to its stockholders substantially all of its REIT taxable income. All dividend distributions will be made by Redwood with the authorization of the Board of Directors at its discretion and will depend on the taxable earnings of Redwood, financial condition of Redwood, maintenance of REIT status, and such other factors as the Board of Directors may deem relevant from time to time. |
| Issuer Purchases of Equity Securities | ||||||||||||||||
| Total Number of | Maximum Number | |||||||||||||||
| Total | Shares Purchased as | Of Shares Available | ||||||||||||||
| Number of | Average | Part of Publicly | For Purchase Under | |||||||||||||
| Shares | Price Paid | Announced | Publicly Announced | |||||||||||||
| Period | Purchased | Per Share | Programs | Programs | ||||||||||||
|
October 1 - October 31,
2005
|
— | — | — | — | ||||||||||||
|
November 1 - November 30,
2005
|
1,025 | $ | 44.01 | — | — | |||||||||||
|
December 1 - December 31,
2005
|
— | — | — | — | ||||||||||||
|
Total
|
1,025 | $ | 44.01 | — | 1,000,000 | |||||||||||
| The Company announced stock repurchase plans on various dates from September 1997 through November 1999 for the total repurchase of a total of 7,455,000 shares. None of these plans have expiration dates. As of December 31, 2005, 1,000,000 shares remained available for repurchase under those plans. |
18
Item 6.
SELECTED FINANCIAL DATA
The following selected financial data is for the years ended
December 31, 2005, 2004, 2003, 2002, and 2001. It is
qualified in its entirety by, and should be read in conjunction
with the more detailed information contained in the Consolidated
Financial Statements and Notes thereto and,
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations” included elsewhere in
this Annual Report on
Form 10-K. Certain
amounts for prior periods have been reclassified to conform to
the 2005 presentation.
| (In thousands, except per share data) | 2005 | 2004 | 2003 | 2002 | 2001 | ||||||||||||||||
|
Statement of Operations
Data:
|
|||||||||||||||||||||
|
Interest income
|
$ | 959,951 | $ | 648,084 | $ | 330,976 | $ | 163,216 | $ | 144,539 | |||||||||||
|
Interest expense
|
(757,524 | ) | (431,918 | ) | (202,861 | ) | (91,705 | ) | (98,069 | ) | |||||||||||
|
Net interest income
|
202,427 | 216,166 | 128,115 | 71,511 | 46,470 | ||||||||||||||||
|
Operating expenses
|
(45,882 | ) | (34,661 | ) | (36,895 | ) | (20,005 | ) | (12,747 | ) | |||||||||||
|
Net recognized market value gains
|
60,848 | 59,127 | 46,676 | 5,111 | 1,532 | ||||||||||||||||
|
Provision for income taxes
|
(17,521 | ) | (7,997 | ) | (5,502 | ) | — | — | |||||||||||||
|
Dividends on Class B preferred
stock
|
— | — | (681 | ) | (2,724 | ) | (2,724 | ) | |||||||||||||
|
Undistributed earnings allocated to
Class B preferred stock
|
— | — | (15 | ) | (452 | ) | (150 | ) | |||||||||||||
|
Net income available to common
stockholders before change in accounting principle
|
199,872 | 232,635 | 131,698 | 53,441 | 32,381 | ||||||||||||||||
|
Cumulative effect of adopting
EITF 99-20
(1)
|
— | — | — | — | (2,368 | ) | |||||||||||||||
|
Net income available to common
stockholders
|
$ | 199,872 | $ | 232,635 | $ | 131,698 | $ | 53,441 | $ | 30,013 | |||||||||||
|
Average common shares —
basic
|
24,637,016 | 21,437,253 | 17,759,346 | 15,177,449 | 10,163,581 | ||||||||||||||||
|
Net income per share —
basic
|
$ | 8.11 | $ | 10.85 | $ | 7.42 | $ | 3.52 | $ | 2.95 | |||||||||||
|
Average common shares —
diluted
|
25,121,467 | 22,228,929 | 18,812,166 | 15,658,623 | 10,474,764 | ||||||||||||||||
|
Net income per share —
diluted
|
$ | 7.96 | $ | 10.47 | $ | 7.04 | $ | 3.41 | $ | 2.87 | |||||||||||
|
Dividends declared per Class B
preferred share
|
— | — | $ | 0.755 | $ | 3.020 | $ | 3.020 | |||||||||||||
|
Regular dividends declared per
common share
|
$ | 2.80 | $ | 2.68 | $ | 2.600 | $ | 2.510 | $ | 2.220 | |||||||||||
|
Special dividends declared per
common share
|
$ | 3.00 | $ | 6.00 | $ | 4.750 | $ | 0.375 | $ | 0.330 | |||||||||||
|
Total dividends declared per common
share
|
$ | 5.80 | $ | 8.68 | $ | 7.350 | $ | 2.885 | $ | 2.550 | |||||||||||
|
Balance Sheet Data: end of
period
|
|||||||||||||||||||||
|
Earning assets
|
$ | 16,529,286 | $ | 24,572,723 | $ | 17,543,487 | $ | 6,971,794 | $ | 2,409,271 | |||||||||||
|
Total assets
|
$ | 16,776,960 | $ | 24,778,065 | $ | 17,670,386 | $ | 7,028,939 | $ | 2,439,136 | |||||||||||
|
Redwood debt
|
$ | 169,707 | $ | 203,281 | $ | 236,437 | $ | 99,714 | $ | 796,811 | |||||||||||
|
Asset-backed securities issued
|
$ | 15,585,277 | $ | 23,630,162 | $ | 16,826,202 | $ | 6,418,187 | $ | 1,317,207 | |||||||||||
|
Total liabilities
|
$ | 15,842,000 | $ | 23,913,909 | $ | 17,117,058 | $ | 6,555,906 | $ | 2,131,363 | |||||||||||
|
Total stockholders’ equity
|
$ | 934,960 | $ | 864,156 | $ | 553,328 | $ | 473,033 | $ | 307,773 | |||||||||||
|
Number of Class B preferred
shares outstanding
|
— | — | — | 902,068 | 902,068 | ||||||||||||||||
|
Number of common shares outstanding
|
25,132,625 | 24,153,576 | 19,062,983 | 16,277,285 | 12,661,749 | ||||||||||||||||
|
Book value per common share
|
$ | 37.20 | $ | 35.78 | $ | 29.03 | $ | 27.43 | $ | 22.21 | |||||||||||
|
Other Data:
|
|||||||||||||||||||||
|
Average assets
|
$ | 21,797,922 | $ | 21,559,604 | $ | 11,058,272 | $ | 4,039,652 | $ | 2,223,280 | |||||||||||
|
Average borrowings
|
$ | 20,710,057 | $ | 20,748,658 | $ | 10,489,614 | $ | 3,616,506 | $ | 1,945,820 | |||||||||||
|
Average reported total equity
|
$ | 970,269 | $ | 730,499 | $ | 526,808 | $ | 402,986 | $ | 254,021 | |||||||||||
|
Net income/average common equity
|
20.6 | % | 31.8 | % | 25.3 | % | 14.2 | % | 13.2 | % | |||||||||||
| (1) | The provisions of Emerging Issues Task Force 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets (EITF 99-20) became effective January 1, 2001. At that date, our projections of cash flows in certain of Redwood’s residential CES were less than the cash flows anticipated at acquisition and the fair value had declined below the carrying value. Accordingly, Redwood recorded a $2.4 million charge ($0.23 per share using both basic and diluted shares outstanding in 2001) through the Consolidated Statements of Income at that time as a cumulative effect of a change in accounting principle. |
19
Item 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
SUMMARY AND OUTLOOK
Our primary source of revenue is interest income paid to us from
the securities and loans we own, which in turn consists of the
monthly loan payments made by homeowners (and to a lesser
degree, commercial property owners) on their real estate loans.
Our primary product focus is credit-enhancing residential and
commercial loans that are high quality. “High quality”
means real estate loans that typically have features such as low
loan-to-value ratios,
borrowers with strong credit histories, and other indications of
quality relative to the range of loans within U.S. real
estate markets as a whole. We currently sponsor the
securitization through our Sequoia program of all the
residential real estate loans we acquire. We also sponsor the
re-securitization through our Acacia CDO program, of
investment-grade (and, to a lesser degree, non-investment grade)
real estate securities. We seek to invest in assets that have
the potential to provide high cash flow returns over a long
period of time to help support our goal of maintaining steady
dividends over time.
Our reported GAAP net income was $200 million
($7.96 per share) for 2005. In 2004, GAAP net income was
$233 million ($10.47 per share) and was
$132 million ($7.04 per share) in 2003. Our results
for 2005 were not as strong as the extraordinary results we
achieved during 2004, but are still at a level that we consider
attractive. Our GAAP return on equity was 21% for 2005 compared
to 32% for 2004 and 25% in 2003. Better than expected credit
results on the loans we credit-enhance has been the primary
driver of our continued strong earnings results. For the
residential real estate loans we credit-enhance, delinquencies
remain at historically low levels and annual credit losses
continue to be less than one basis point (0.01%) of the current
balance of these loans. Credit results for the commercial real
estate loans we credit-enhance have also been excellent.
Table 1 Net Income
| (In thousands, except share data) | 2005 | 2004 | 2003 | |||||||||
|
Total interest income
|
$ | 959,951 | $ | 648,084 | $ | 330,976 | ||||||
|
Total interest expense
|
(757,524 | ) | (431,918 | ) | (202,861 | ) | ||||||
|
Net interest income
|
202,427 | 216,166 | 128,115 | |||||||||
|
Operating expenses
|
(45,882 | ) | (34,661 | ) | (36,895 | ) | ||||||
|
Net recognized gains and valuation
adjustments
|
60,848 | 59,127 | 46,676 | |||||||||
|
Provision for income taxes
|
(17,521 | ) | (7,997 | ) | (5,502 | ) | ||||||
|
Dividends and Income allocated to
Class B
|
— | — | (696 | ) | ||||||||
|
Net income
|
$ | 199,872 | $ | 232,635 | $ | 131,698 | ||||||
|
Diluted Common Shares
|
25,121,467 | 22,228,929 | 18,812,166 | |||||||||
|
Net income per share
|
$ | 7.96 | $ | 10.47 | $ | 7.04 | ||||||
| We declared four regular quarterly dividends of $0.70 per share in 2005 and, in the fourth quarter, declared and paid a special dividend of $3.00 per share. We permanently retained approximately 10% of the ordinary real estate investment trust (REIT) taxable income we earned during 2005 and we intend to declare and distribute the remainder of our 2005 REIT taxable income as dividends by September 2006. In addition, we also retained the after-tax profits earned in our non-REIT subsidiaries. We anticipate following a similar pattern of retention and distribution in 2006. | |
| In the second half of 2005 we sold single B-rated residential loan CES. This portfolio adjustment was made to reduce overall residential credit risk levels and to raise cash for future investment opportunities. We retained most of our first-loss (non-rated) CES while primarily selling second-loss CES. By changing our asset mix in this manner, we reduced our downside risk within our residential portfolio should credit losses increase, but retained most of the upside potential inherent in our portfolio that should be realized over time if residential credit losses continue to be low. |
20
21
Our net discount on all consolidated residential and commercial
real estate loans and securities (ARM, fixed, and hybrid) is
$623 million, or $24.79 per share outstanding at
December 31, 2005. The net discount at December 31,
2005 is $449 million or $17.87 per share on
residential real estate assets and is $174 million or
$6.92 per share on commercial real estate assets. We will
realize this $623 million net discount as income over the
next 10 years to the extent it is not diminished by credit
losses. If faster residential prepayments continue, we will
realize the residential portion of this income more quickly.
The health of the real estate industry is cyclical. The
tremendous growth in residential real estate prices appears to
be slowing. We believe it is probable that real estate
fundamentals may deteriorate over the next two years, causing
our credit losses to increase but also reducing acquisition
prices for the assets we seek to buy. As a result, our current
plan, which is subject to change, is to invest our excess
capital ($189 million at December 31, 2005) steadily
over the next two to three years so that we maintain reduced
risk levels while also capturing opportunities to acquire
cheaper assets. We will likely modify this plan as the market
environment changes. Nevertheless, as a result of this general
plan of action, it is likely that we will continue to have
relatively high cash balances for some time. Our strong balance
sheet and cash balances will be particularly helpful in the
event (unlikely, but possible, in our view) that real estate
credit fundamentals deteriorate significantly.
Our mortgage conduit’s residential loan securitization
business is in transition. In 2004 and prior years, we generated
attractive levels of economic gains (gain on sale through
securitization) by acquiring high-quality one- and six-month
LIBOR adjustable-rate residential loans from originators,
selling the loans to Sequoia securitization entities, and then
sponsoring Sequoia securitizations of these loans. In
today’s flat to inverted yield curve environment however,
LIBOR-indexed ARMs are not an attractive option for homeowners,
causing origination volume of this product to decrease
dramatically. In addition, several Wall Street firms have
recently entered the residential conduit business, increasing
competition and reducing securitization
gain-on-sale
opportunities.
We are responding to these changes by broadening our residential
conduit’s product line (both in terms of product type and
loan quality characteristics) and by expanding our mortgage
originator customer base. We are focusing on market areas and
relationships where we believe we have, or can develop, a
competitive advantage. We expect our residential conduit
business will break-even economically this year while also not
absorbing much capital. Even at break-even levels, our
residential conduit brings multiple benefits to our business as
a whole and is an excellent source of assets for us to invest
in. In the longer term, we expect our residential conduit to
develop in a manner that will once again generate attractive
returns for our shareholders.
We continue to be large and active investors in the market for
residential credit-enhancement securities created by others, and
we continue to allocate the greater part of our capital to these
assets. In the fourth quarter, we took advantage of some
excellent acquisition opportunities. Acquisition pricing for
some new assets improved, in part due to seasonal trends (as a
result of supply/demand trends, the fourth quarter is usually a
good time to buy assets) and also due to concerns about the
housing markets.
We are continuing to build our business of credit-enhancing
securitized commercial real estate loans. Commercial real estate
properties as a whole continue to improve their cash flows and
valuations. Due to the level of competition in commercial
credit-enhancement, and due to weakening commercial loan
origination standards, the prospective returns from commercial
credit-enhancement securities at the moment are acceptable, but
not overwhelming. We will continue to develop this business as
part of our long-term growth and diversification strategy, and
are pleased with our accomplishments to date in this area.
The market for sponsoring CDO securitizations continues to be
attractive, although it is has become more volatile. We expect
to continue sponsoring Acacia CDO transactions during 2006.
After we complete each securitization, we expect to acquire and
invest in all or a portion of the CDO equity securities created
in these transactions. We expect that these will be attractive
investments over time. We believe that the CDO business is a
fertile area for innovation. In 2005, we completed our first
predominately commercial real estate CDO. We may also
incorporated
22
synthetic assets in Acacia’s asset pools. Over the next few
years, we expect our CDO sponsorship business to grow and evolve
in interesting new ways and to continue to generate attractive
new investments and asset management fees.
We seek to maintain a structured balance sheet that we believe
should allow us to weather potential general economic downturns
and liquidity crises. We generally seek to put ourselves in a
position where changes in interest rates would not be likely to
materially harm our ability to meet our long-term goals or
maintain our regular dividend rate. We use debt to finance loans
and securities that we are accumulating as inventory for sale to
securitization entities sponsored by us.
In our view, the long-term outlook for our business is good.
Housing price increases over the past several years have reduced
our risk of credit loss in the future for our existing
residential assets. For most of our risk assets, the underlying
loans were originated in 2003 and 2004. Commercial property
values and cash flows are increasing in many areas. Our
portfolio of assets as a whole has the ability to generate
attractive earnings, cash flows, and dividends in the future,
assuming real estate credit losses do not increase materially.
In general, we expect per share earnings and the special
dividend in 2006 will be lower than 2005 as a result of much
higher cash balances, a newer portfolio on average (the
higher-yielding seasoned assets have largely been sold or
called), few gains from sales (as we are not planning
significant amount of sales at this time) and calls (as we have
few callable assets), continued high premium amortization
expenses on the residential loans consolidated from Sequoia
trusts as these loans continue to prepay rapidly, and for other
reasons. If we reduce our excess cash balances over the next few
years, invest wisely, and start to realize some of the upside
potential inherent in our existing assets, earnings and special
dividends in 2007 and 2008 could increase from 2006 levels.
Over the long-term we believe it is reasonably likely that we
will be able to continue to find attractive investment
opportunities, because we are an efficient competitor and
because our market segments are growing (as the amount of real
estate loans outstanding increases and the percentage of these
loans that are securitized increases).
RESULTS OF OPERATIONS
2005 AS COMPARED TO 2004
Acquisitions, Securitizations, Sales, and Calls
During 2005, we acquired $268 million residential
loan CES. This was similar to the $269 million we
acquired in 2004. The loans underlying the CES we acquired
during 2005 were generally of above-average quality as compared
to securitized residential loans as a whole.
In 2005, we had calls of our residential loan CES of
$36 million principal value for GAAP gains of
$19 million. This was a decrease from the calls realized in
2004 of $99 million principal value that generated GAAP
gains of $59 million. We had fewer of these assets become
callable during 2005. At the end of 2005, we had residential
loan CES securities with principal value totaling
$1 million that were callable.
During 2005, we sold $207 million residential loan CES
generating GAAP gains of $40 million. During 2004, sales of
residential loan CES totaled $22 million generated
GAAP gains of $6 million. Sales in 2005 where higher due to
our portfolio restructuring activities.
We acquired $25 million commercial real estate loans during
2005, a decrease from the $38 million acquired during 2004.
We sold $11 million commercial real estate loans during
2005 and $2 million during 2004. Our commercial real estate
loan activity provides additional collateral to the
“Acacia” CDO securitizations we sponsor.
23
During 2005, we acquired $43 million commercial
loan CES, a significant increase from the $13 million
acquired in 2004. This increase reflects our ongoing efforts to
increase our ability to analyze, source, and manage commercial
real estate loan CES. No commercial loan CES were sold
during these periods.
In 2005, our residential real estate loan acquisitions totaled
$1.9 billion. We sold $1.5 billion of these loans to
Sequoia entities and also sold $507 million loans as whole
loans to others, leaving us with an inventory of loans of
$45 million at December 31, 2005. Sequoia entities
issued $1.5 billion asset-backed securities
(ABS) during 2005. This level of residential loan
securitization activity was a significant decrease from 2004
when Sequoia entities acquired loans of $10.0 billion and
issued a like amount of ABS. Typically we acquire London
Inter-Bank Offer Rate (LIBOR) adjustable-rate mortgage
(ARM) residential loans for the Sequoia securitization
program we sponsor; the flatter yield curve reduced the amount
of LIBOR ARM residential loans originated in 2005.
We acquired $684 million of other residential and
commercial real estate securities during 2005 as inventory for
sale to our Acacia CDO securitization program. This was an
increase from the $598 million of these acquisitions we
made for Acacia during 2004. We sold securities to Acacia
entities totaling $665 million during 2005 and
$584 million during 2004. At December 31, 2005, we had
securities of $214 million for sale to future Acacias
entities. In both 2005 and 2004, Acacia entities issued
$900 million CDO ABS.
Net Income
Our reported GAAP net income was $200 million
($7.96 per share) for 2005, a decrease from the
$233 million ($10.47 per share) earned in 2004. Our
GAAP return on equity was 21% for 2005 compared to 32% for 2004.
The reduction in our net income of $33 million from 2004 to
2005 resulted from a decrease in net interest income of
$14 million, an increase in operating expenses of
$11 million, an increase in provisions for income taxes of
$10 million, partially offset by an increase in net gains
on sales and calls (net of market valuation adjustments) of
$2 million.
Net Interest Income
Net interest income decreased to $202 million in 2005
compared to $216 million in 2004. The reduction in net
interest income of $14 million resulted from increased ARM
prepayments rates on residential loans consolidated from Sequoia
securitization entities and lower yields on our portfolio of
residential CES as our older higher-yielding securities were
called or sold, and from higher levels of unvested cash. In
addition, net interest income was higher in 2004 due to the
effect of a cumulative correcting adjustment of an error on
previously reported earnings of $4.1 million (which is
further discussed below on page 36). Net interest income in
2005 benefited from a reduction in credit provision expenses of
$7 million as a result of excellent loan credit performance
and reduced loan balances (as prepayments for loans owned by
Sequoia accelerated while Sequoia securitization volume dropped).
Prepayment rates (CPR) for residential ARM loans owned by
Sequoia entities increased from an average of 17% in 2004 to 43%
in 2005. Faster prepayments on ARMs have been caused primarily
by the flatter yield curve (higher than average short-term
interest rates relative to long-term interest rates) and the
increase in popularity of negative amortization loans. Borrowers
are more inclined to refinance out of ARMs and into hybrid or
fixed rate loans when the effective interest rates on ARMs are
not significantly lower than the fixed rate alternatives.
Additionally, new forms of adjustable-rate mortgages (negative
amortization, “option ARMs”, and Moving Treasury
Average ARMs) represent an increased share of the ARM market and
have increased
ARM-to-ARM refinancing.
These faster prepayment rates for consolidated ARM loans had a
negative impact on our net interest income in 2005. However, in
the long term we believe we will likely benefit from faster
residential loan prepayments due to our significant investment
in discount-priced residential loan CES.
Interest Income
Total interest income consists of interest earned on
consolidated earning assets, plus income from amortization of
discount for assets acquired at prices below principal value,
less expenses for amortization of premium for assets acquired at
prices above principal value, less credit provision expenses on
loans.
Table 2 Interest Income and Yield
| (Dollars in thousands) | 2005 | 2004 | ||||||
|
Interest income
|
$ | 965,594 | $ | 651,661 | ||||
|
Discount amortization
|
42,361 | 36,071 | ||||||
|
Premium amortization
|
(48,434 | ) | (32,412 | ) | ||||
|
Reversal of (provision for) credit
losses
|
430 | (7,236 | ) | |||||
|
Total interest income
|
$ | 959,951 | $ | 648,084 | ||||
|
Average earning assets
|
$ | 21,048,582 | $ | 21,208,757 | ||||
|
Yield as a result of:
|
||||||||
|
Interest income
|
4.59 | % | 3.07 | % | ||||
|
Discount amortization
|
0.20 | % | 0.17 | % | ||||
|
Premium amortization
|
(0.23 | )% | (0.15 | )% | ||||
|
Reversal of (provision for) credit
losses
|
0.00 | % | (0.03 | )% | ||||
|
Yield on earning assets
|
4.56 | % | 3.06 | % | ||||
| Interest income increased to $960 million in 2005 from $648 million in 2004 primarily due to an overall increase in yield caused by an increase in short-term interest rates. Since a majority of the assets on our Consolidated Balance Sheets are adjustable-rate residential real estate loans, yields on these loans increase as short-term interest rates rise. As a result, total interest income was higher, even though the residential real estate loans consolidated balances decreased slightly from the prior year’s level. | |
| In addition to the impact of higher short-term interest rates, the contribution from the other portfolios increased in 2005, also leading to higher interest income. The table below presents the contribution to interest income and yield from each of our portfolios. |
| Table 3 Interest Income and Yield by Portfolio |
| (Dollars in thousands) | ||||||||||||||||
| December 31, 2005 | ||||||||||||||||
| Percent of | ||||||||||||||||
| Total | ||||||||||||||||
| Interest | Interest | Average | ||||||||||||||
| Income | Income | Balance | Yield | |||||||||||||
|
Residential real estate loans, net
of provision for credit losses
|
$ | 773,854 | 80.62 | % | $ | 18,642,020 | 4.15 | % | ||||||||
|
Residential loan credit-enhancement
securities
|
86,564 | 9.02 | % | 541,224 | 15.99 | % | ||||||||||
|
Commercial loans, net of provision
for credit losses
|
5,285 | 0.55 | % | 52,008 | 10.16 | % | ||||||||||
|
Commercial loan credit-enhancement
securities
|
2,613 | 0.27 | % | 30,234 | 8.64 | % | ||||||||||
|
Securities portfolio
|
86,431 | 9.00 | % | 1,601,837 | 5.40 | % | ||||||||||
|
Cash and cash equivalents
|
5,204 | 0.54 | % | 181,259 | 2.87 | % | ||||||||||
|
Totals
|
$ | 959,951 | 100.00 | % | $ | 21,048,582 | 4.56 | % | ||||||||
24
| (Dollars in thousands) | ||||||||||||||||
| December 31, 2004 | ||||||||||||||||
| Percent of | ||||||||||||||||
| Total | ||||||||||||||||
| Interest | Interest | Average | ||||||||||||||
| Income | Income | Balance | Yield | |||||||||||||
|
Residential real estate loans, net
of provision for credit losses
|
$ | 529,842 | 81.76 | % | $ | 19,665,096 | 2.69 | % | ||||||||
|
Residential loan credit-enhancement
securities
|
64,602 | 9.97 | % | 349,779 | 18.47 | % | ||||||||||
|
Commercial loans, net of provision
for credit losses
|
3,769 | 0.58 | % | 30,469 | 12.37 | % | ||||||||||
|
Commercial loan credit-enhancement
securities
|
675 | 0.10 | % | 5,261 | 12.83 | % | ||||||||||
|
Securities portfolio
|
48,274 | 7.45 | % | 1,062,901 | 4.54 | % | ||||||||||
|
Cash and cash equivalents
|
922 | 0.14 | % | 95,251 | 0.97 | % | ||||||||||
|
Totals
|
$ | 648,084 | 100.00 | % | $ | 21,208,757 | 3.06 | % | ||||||||
| The table below details our interest income by portfolio as a result of changes in consolidated asset balances (“volume”) and yield (“rate”) for 2005 as compared to 2004. |
| Table 4 Volume and Rate Changes for Interest Income |
| (In thousands) | ||||||||||||
| Change in Interest Income | ||||||||||||
| 2005 Versus 2004 | ||||||||||||
| Total | ||||||||||||
| Volume | Rate | Change | ||||||||||
|
Residential real estate loans, net
of provisions for credit losses
|
$ | (27,565 | ) | $ | 271,577 | $ | 244,012 | |||||
|
Residential loan credit-enhancement
securities
|
35,359 | (13,397 | ) | 21,962 | ||||||||
|
Commercial loans, net of provision
for credit losses
|
2,664 | (1,148 | ) | 1,516 | ||||||||
|
Commercial loan credit-enhancement
securities
|
3,204 | (1,266 | ) | 1,938 | ||||||||
|
Securities portfolio
|
24,477 | 13,680 | 38,157 | |||||||||
|
Cash and cash equivalents
|
833 | 3,449 | 4,282 | |||||||||
|
Total interest income
|
$ | 38,972 | $ | 272,895 | $ | 311,867 | ||||||
| Volume change is the change in average portfolio balance between periods multiplied by the rate earned in the earlier period. Rate change is the change in rate between periods multiplied by the average portfolio balance in the prior period. Interest income changes that result from changes in both rate and volume were allocated to the rate change amounts shown in the table. | |
| A discussion of the changes in total income, average balances, and yields for each of our portfolios is provided below. |
| Table 5 Consolidated Residential Real Estate Loans — Interest Income and Yield |
| (Dollars in thousands) | 2005 | 2004 | ||||||
|
Interest income
|
$ | 818,783 | $ | 568,765 | ||||
|
Net premium discount amortization
|
(45,174 | ) | (31,687 | ) | ||||
|
Reversal of (provision for) credit
losses
|
245 | (7,236 | ) | |||||
|
Total interest income
|
$ | 773,854 | $ | 529,842 | ||||
|
Average consolidated residential
real estate loans
|
$ | 18,642,020 | $ | 19,665,096 | ||||
|
Yields as a result of:
|
||||||||
|
Interest income
|
4.39 | % | 2.89 | % | ||||
|
Net (premium) discount
amortization
|
(0.24 | )% | (0.16 | )% | ||||
|
Reversal of (provision for) credit
losses
|
0.00 | % | (0.04 | )% | ||||
|
Yield
|
4.15 | % | 2.69 | % | ||||
| Interest income on residential real estate loans increased primarily as a result of higher short-term interest rates. Almost all these loans have coupon rates that adjust monthly or every six |
25
months based on the one or six-month LIBOR interest rate. Yields
on these residential real estate loans increased as short-term
interest rates rose. The average balance decreased as loan
prepayments exceeded new acquisitions.
Higher premium amortization expenses (as a percentage of current
loan balances) in 2005 were caused primarily by increasing
prepayment speeds on these loans.
Table 6 Residential Loan Credit-Enhancement
Securities — Interest Income and Yield
| (Dollars in thousands) | 2005 | 2004 | ||||||
|
Interest income
|
$ | 48,413 | $ | 30,492 | ||||
|
Net discount amortization
|
38,151 | 34,110 | ||||||
|
Total interest income
|
$ | 86,564 | $ | 64,602 | ||||
|
Average residential loan
credit-enhancement securities
|
$ | 541,224 | $ | 349,779 | ||||
|
Yield as a result of:
|
||||||||
|
Interest income
|
8.94 | % | 8.72 | % | ||||
|
Net discount amortization
|
7.05 | % | 9.75 | % | ||||
|
Yield
|
15.99 | % | 18.47 | % | ||||
| Interest income recognized from residential loan CES increased primarily due to growth in our portfolio over the past year, partially offset by lower yields. Portfolio growth reflected our ability to find new assets at a pace in excess of our sales, calls, and principal prepayments. Yields decreased as many of our more seasoned, higher-yielding assets (higher yielding as a result of several years of strong credit performance and favorable prepayments) were called or sold over the last few years. The more recently acquired residential loan CES generally are being carried at lower effective yields because we do not expect the same strong credit performance or favorable prepayment patterns as we have had in the past, and because on average we acquired these assets at higher prices than in the past. | |
| The yields we currently recognize on recently acquired residential loan CES may be less than the yields we will actually realize over the lives of these residential loan CES. To determine yields on residential loan CES, we make assumptions regarding loan losses and prepayments. Since the market generally has a wide range for these assumptions (and not a specific estimate), we apply assumptions within a range that generally results in yields on these assets in early periods of ownership that are lower than what we might realize over the life of the assets if future performance turns out to be better than the low range of our expectations. Specifically, the initial yield we book on certain residential loan CES may be lower than the market mid-range expectation of performance (and below our hurdle rate of 14% pre-tax and pre-overhead internal rate of return). We review the actual performance of each residential loan CES and the market’s and our renewed range of expectations every quarter. We adjust the yield of the assets as a result of supportable changes in market conditions and anticipated performance. In addition, to the extent we credit-enhance loans with special credit risk (e.g., negative amortization loans), we may not recognize interest income that is not paid. We make ongoing determinations of the likelihood that any deferred interest payments will be collectible in recognizing current period yields. |
26
Table 7 Commercial Real Estate Loans —
Interest Income and Yield
| (Dollars in thousands) | 2005 | 2004 | ||||||
|
Interest income
|
$ | 5,450 | $ | 4,253 | ||||
|
Net premium amortization
|
(350 | ) | (484 | ) | ||||
|
Reversal of credit losses
|
185 | — | ||||||
|
Total interest income
|
$ | 5,285 | $ | 3,769 | ||||
|
Average earning assets
|
$ | 52,008 | $ | 30,469 | ||||
|
Yield as a result of:
|
||||||||
|
Interest income
|
10.47 | % | 13.96 | % | ||||
|
Net premium amortization
|
(0.67 | )% | (1.59 | )% | ||||
|
Reversal of credit losses
|
0.36 | % | 0.00 | % | ||||
|
Yield
|
10.16 | % | 12.37 | % | ||||
| The interest income earned on our commercial real estate loan portfolio increased due to the growth in our commercial loan portfolio. This increase was partially offset by lower yields recognized for newer commercial loans. |
| Table 8 Commercial Loan Credit-Enhancement Securities — Interest Income and Yield |
| (Dollars in thousands) | 2005 | 2004 | ||||||
|
Interest income
|
$ | 5,174 | $ | 1,000 | ||||
|
Net premium amortization
|
(2,561 | ) | (325 | ) | ||||
|
Total interest income
|
$ | 2,613 | $ | 675 | ||||
|
Average commercial loan
credit-enhancement securities
|
$ | 30,234 | $ | 5,261 | ||||
|
Yield as a result of:
|
||||||||
|
Interest income
|
17.11 | % | 19.01 | % | ||||
|
Net premium amortization
|
(8.47 | )% | (6.18 | )% | ||||
|
Yield
|
8.64 | % | 12.83 | % | ||||
| Interest income recognized from commercial loan CES increased due to the growth in this portfolio. This increase was partially offset by lower yields on newer commercial loan CES. The yield on commercial loan CES is based on our projected cash flows over time. Although we acquire commercial loan CES at a discount, we designate the amount of credit protection based on the anticipated losses in the underlying pool of loans. Since these commercial loan CES are the first loss pieces, the amount of credit protection so designated results in a premium balance to be amortized over the remaining lives of the assets. Over time, if the loans underlying these commercial loan CES perform better than we expect, we would re-designate a portion of the credit protection to accretable discount, thereby reducing the unamortized premium balance and increasing the yield recognized on these assets. |
| Table 9 Consolidated Securities Portfolio — Interest Income and Yield |
| (Dollars in thousands) | 2005 | 2004 | ||||||
|
Interest income
|
$ | 82,571 | $ | 46,229 | ||||
|
Discount amortization
|
4,211 | 2,286 | ||||||
|
Premium amortization
|
(351 | ) | (241 | ) | ||||
|
Total interest income
|
$ | 86,431 | $ | 48,274 | ||||
|
Average securities portfolio balance
|
$ | 1,601,837 | $ | 1,062,901 | ||||
|
Yield as a result of:
|
||||||||
|
Interest income
|
5.16 | % | 4.34 | % | ||||
|
Discount amortization
|
0.26 | % | 0.22 | % | ||||
|
Premium amortization
|
(0.02 | )% | (0.02 | )% | ||||
|
Yield
|
5.40 | % | 4.54 | % | ||||
27
Total interest income increased for the securities portfolio as
the total size of the portfolio grew and as yields increased as
the coupon rates on adjustable-rate loan securities (which
comprise over half of the portfolio) adjusted upward with the
increase in short-term interest rates.
Interest Expense
Interest expense consists of interest payments on Redwood debt
and consolidated ABS issued from sponsored securitization
entities, plus amortization of deferred ABS issuance costs and
expenses related to certain interest rate agreements less the
amortization of ABS issuance premiums. ABS issuance premiums are
created when interest-only securities and other ABS are issued
at prices greater than principal value.
Total consolidated interest expense increased as a result of a
higher cost of funds due to an increase in short-term interest
rates as most of our debt and consolidated ABS issued is indexed
to one-, three-, or six-month LIBOR. The average balance of debt
and consolidated ABS issued outstanding was at similar levels
during these years.
Table 10 Total Interest Expense
| (Dollars in thousands) | 2005 | 2004 | ||||||
|
Interest expense on Redwood debt
|
$ | 11,929 | $ | 9,933 | ||||
|
Interest expense on ABS issued
|
745,595 | 421,985 | ||||||
|
Total interest expense
|
$ | 757,524 | $ | 431,918 | ||||
|
Average Redwood debt balance
|
$ | 261,322 | $ | 434,662 | ||||
|
Average ABS issued balance
|
20,448,735 | 20,313,996 | ||||||
|
Average total obligations
|
$ | 20,710,057 | $ | 20,748,658 | ||||
|
Cost of funds of Redwood debt
|
4.56% | 2.29% | ||||||
|
Cost of funds of ABS issued
|
3.65% | 2.08% | ||||||
|
Cost of funds of total obligations
|
3.66% | 2.08% | ||||||
| For purposes of calculating the weighted average borrowing costs of ABS issued, we include the amortization of the deferred ABS issuance costs with interest expense. We include the average deferred ABS issuance costs in the average balances below. |
| Table 11 Average Balances of Asset-Backed Securities Issued |
| (In thousands) | 2005 | 2004 | ||||||
|
Sequoia
|
$ | 18,492,465 | $ | 19,129,555 | ||||
|
Acacia
|
2,008,705 | 1,229,075 | ||||||
|
Commercial
|
6,367 | 5,654 | ||||||
|
Average balance of ABS issued
|
$ | 20,507,537 | $ | 20,364,284 | ||||
|
Average deferred ABS issuance costs
|
(58,802 | ) | (50,288 | ) | ||||
|
Average balance of ABS issued, net
|
$ | 20,448,735 | $ | 20,313,996 | ||||
28
The table below details interest expense on debt and
consolidated ABS issued as a result of changes in consolidated
balances (“volume”) and cost of funds
(“rate”) for 2005 as compared to 2004.
Table 12 Volume and Rate Changes for Interest
Expense
| (In thousands) | ||||||||||||
| Change in Interest Expense | ||||||||||||
| 2005 Versus 2004 | ||||||||||||
| Total | ||||||||||||
| Volume | Rate | Change | ||||||||||
|
Interest expense on Redwood debt
|
$ | (3,961 | ) | $ | 5,957 | $ | 1,996 | |||||
|
Interest expense on ABS issued
|
2,799 | 320,811 | 323,610 | |||||||||
|
Total interest expense
|
$ | (1,162 | ) | $ | 326,768 | $ | 325,606 | |||||
| Details of the change in cost of funds of debt and consolidated ABS issued are provided in the tables below. |
| Table 13 Cost of Funds of Redwood Debt |
| (Dollars in thousands) | 2005 | 2004 | ||||||
|
Interest expense on Redwood debt
|
$ | 11,929 | $ | 9,933 | ||||
|
Average Redwood debt balance
|
$ | 261,322 | $ | 434,662 | ||||
|
Cost of funds of Redwood debt
|
4.56% | 2.29% | ||||||
| The increase in the cost of funds of Redwood debt is the result of higher short-term interest rates. |
| Table 14 Cost of Funds of Asset-Backed Securities Issued |
| (Dollars in thousands) | 2005 | 2004 | ||||||
|
ABS issued interest expense
|
$ | 742,659 | $ | 399,193 | ||||
|
ABS issuance expense amortization
|
21,890 | 16,828 | ||||||
|
Net ABS interest rate agreement
(income) expense
|
(6,541 | ) | 13,235 | |||||
|
Net ABS issuance premium
amortization
|
(12,413 | ) | (7,271 | ) | ||||
|
Total ABS issued interest expense
|
$ | 745,595 | $ | 421,985 | ||||
|
Average balance of ABS
|
$ | 20,448,735 | $ | 20,313,996 | ||||
|
ABS interest expense
|
3.63 | % | 1.97 | % | ||||
|
ABS issuance expense amortization
|
0.11 | % | 0.08 | % | ||||
|
Net ABS interest rate agreement
(income) expense
|
(0.03 | )% | 0.07 | % | ||||
|
Net ABS issuance premium
amortization
|
(0.06 | )% | (0.04 | )% | ||||
|
Cost of funds of issued ABS
|
3.65 | % | 2.08 | % | ||||
| The coupon payments on the consolidated ABS issued are primarily indexed to one-, three-, and six-month LIBOR. Over the past year, short-term interest rates have risen and, thus, so has the cost of funds of the consolidated ABS issued by securitization entities consolidated on our reported balance sheet. |
| Operating Expenses |
| Total operating expenses increased by 32% from 2004 to 2005 due to investments in systems and infrastructure, increases in the scale of our operations, increased excise taxes, and increased accounting, consulting fees, and internal control costs. Generally, the scale of our business over the last few years has increased more rapidly than our operating expenses. Our operating costs continue to increase in part because of increased personnel needs resulting from both prior and anticipated growth. The reconciliation of GAAP operating expense to |
29
operating expense before excise tax and variable stock option
income (or expense) is provided in the table below.
Table 15 Operating Expenses
| (Dollars in thousands) | 2005 | 2004 | ||||||
|
Total operating expenses
|
$ | 45,882 | $ | 34,661 | ||||
|
Less: Excise tax
|
(1,180 | ) | (626 | ) | ||||
|
Less: Variable stock option
income/(expense) (VSOI/ VSOE)
|
123 | (1,018 | ) | |||||
|
Total operating expenses before
excise tax and VSOE/ VSOI
|
$ | 44,825 | $ | 33,017 | ||||
|
Components of total operating
expense before excise tax and
VSOE/ VSOI |
||||||||
|
Fixed compensation expense
|
$ | 11,082 | $ | 8,040 | ||||
|
Other operating expense
|
14,635 | 8,593 | ||||||
|
Incentive stock expense
|
1,077 | 1,289 | ||||||
|
Variable compensation expense
|
18,031 | 15,095 | ||||||
|
Total operating expenses before
excise tax and VSOE/ VSOI
|
$ | 44,825 | $ | 33,017 | ||||
|
Net interest income (NII)
|
$ | 202,427 | $ | 216,166 | ||||
|
Adjusted efficiency ratio
(Operating expense before excise tax and VSOE/ VSOI)/net
interest income
|
22% | 15% | ||||||
| Our operating efficiency ratio was higher in 2005 than in 2004 due to continued growth in systems and infrastructure at a time when we are selling assets. Management excludes excise tax and variable option expense or income (VSOE/ VSOI) in determining the efficiency ratio. By excluding these items, management believes that we are providing a performance measure comparable to measures commonly used by other companies in our industry because these two types of excluded expenses do not reflect ongoing costs of day-to-day operations of our company. Stock option grant expenses under FAS 123, however, are an on-going expense and are included in operating expense before excise tax and VSOE/ VSOI. | |
| Excise tax is a function of the timing of dividend distributions. In years when we delay distributing dividends on a portion of our REIT taxable income, under the REIT tax rules, we may pay excise taxes on a portion of this delayed distribution. Excise tax is included in operating expenses on our Consolidated Statements of Income. | |
| VSOE/VSOI is a non-cash expense or income item that varies as a function of Redwood’s stock price. If our stock price increases during a quarter and the stock price is above the exercise price of certain “variable” options, we record a GAAP expense in that period equal to the increase in the stock price times the number of in-the-money “variable” options that remain outstanding. If our stock price decreases during a quarter, we record income in that period equal to the decrease in the stock price times the number of in-the-money “variable” options that remain outstanding. With the adoption of Financial Accounting Statement No. 123R, Share-Based Payment (FAS 123R), effective January 1, 2006, we will not have VSOE/VSOI, in future periods. | |
| Fixed compensation expenses include employee salaries and related employee benefits. Other operating expenses include office costs, systems, legal and accounting fees, and other business expenses. We expect to continue to make significant investments in expanding our staff and developing our business processes and information technologies in order to meet the operating needs we will face as we grow in the long term. As a result, we expect these fixed and other operating expenses will continue to increase. | |
| Incentive stock (income) expense represents the cost of equity compensation as determined under FAS 123 for options and option equity awards granted to employees and directors after December 31, 2002. Beginning January 1, 2006, with the adoption of FAS 123R, all remaining unvested incentive awards and all future awards will be accounted for under this principle. Beginning January 1, 2006, there will no longer be dividend equivalent right (DER) expenses for GAAP purposes as all remaining stock awards will be accounted for under FAS 123R (and the value of additional DERs on an award is already included in the value at the time of grant and is expensed over the requisite service period of the award). |
30
31
Variable compensation includes employee bonuses (which are based
on individual employee performance and the adjusted return on
equity earned by Redwood) and DER expenses on certain options
still outstanding and granted prior to December 31, 2002.
The primary drivers of this expense are the profitability
(return on equity) of Redwood, taxable income at the REIT (which
determines total dividend distribution requirements), the number
of employees, and the number of incentive stock awards
outstanding that receive DER payments that are expensed (options
granted prior to January 1, 2003).
We currently anticipate that our fixed costs will increase in
2006 relative to 2005, as we continue to add additional staff
and systems for meeting our future growth. However, we also
expect that expenses for variable compensation will decline as
our performance is not anticipated to be as strong. Thus, we
anticipate total operating expenses will be at a similar level
in 2006 as in 2005. The adoption of FAS 123R will change
the nature of our expenses but is not anticipated to have a
significant impact on our overall costs.
Net Recognized Gains (Losses) and Valuation
Adjustments
For 2005, our net recognized gains and valuation adjustments
totaled $60.8 million as compared to $59.1 million for
2004. Realized gains due to calls were significantly less in
2005 at $19.1 million than in 2004 at $58.7 million as
we had fewer securities that had reached their call factor.
Gains in sales we initiated as part of our portfolio
restructuring were greater in 2005 at $43.6 million than in
2004 at $7.6 million.
Accounting rules (FAS 115, EITF 99-20, and
SAB 5(m)) require us to review the projected discounted
cash flows on certain of our assets (based on credit,
prepayment, and other assumptions), and to
mark-to-market through
our income statement those assets that have experienced any
deterioration in discounted projected cash flows (as compared to
the previous projection) that could indicate permanent
impairment as defined by GAAP. Assets with reduced discounted
projected cash flows are written down in value (through a
non-cash income statement charge) if the current market value
for that asset is below our current basis. If the market value
is above our basis, our basis remains unchanged and there is no
gain recognized in income. It is difficult to predict the timing
or magnitude of these adjustments; the quarterly adjustment
could be substantial. Under the accounting rules (FAS 115,
EITF 99-20, and SAB 5(m)), we recognized
other-than-temporary impairments of $4.4 million for 2005
and $6.4 million for 2004.
Some of our interest rate agreements are accounted for as
trading instruments and in 2005 we de-designated one agreement
(as part of our call of an Acacia securitization). As a result,
we recognized gains of $2.5 million in 2005 and losses of
$0.5 million in 2004 on these interest rate agreements.
Provisions for Income Taxes
As a REIT, we are required to distribute at least 90% of our
REIT taxable income each year. Therefore, we generally pass
through substantially all of our earnings to stockholders
without paying federal income tax at the corporate level. We pay
income tax on this income and the income we earn at our taxable
subsidiaries. Taxable income calculations differ from GAAP
income calculations. We provide for income taxes for GAAP
purposes based on our estimates of our taxable income, the
amount of taxable income we permanently retain, and the taxable
income we estimate was earned at our taxable subsidiaries.
Our income tax provision in 2005 was $17.5 million, an
increase from the $8.0 million income tax provision taken
in 2004. In 2005, our income tax provision under GAAP benefited
slightly from state net operating losses. In 2004, we were able
to use state and Federal net operating losses to reduce our tax
liability. In addition, in 2004, we recognized a reversal of
previously existing valuation allowances related to net
operating losses (NOLs), thus recognizing the future value of
remaining net operating losses at that time.
Furthermore, in 2004 we generated taxable
gains-on-sales from our
securitization activities at the taxable subsidiaries. Gains on
these activities were much lower in 2005 due to decreased
volumes and a significant decrease in the gains generated by
each securitization. Since these securitizations were treated as
financings under GAAP, deferred tax assets were created. The
deferred tax assets are amortized through the deferred tax
provision as the related GAAP income is recognized.
Taxable Income and Dividends
Total taxable income is not a measure calculated in accordance
with GAAP. It is the pre-tax income calculated for tax purposes.
Estimated total taxable income is an important measure as it is
the basis of our dividend distributions to shareholders. Taxable
income calculations differ significantly from GAAP income
calculations. REIT taxable income is that portion of our taxable
income that we earn in our parent company and REIT subsidiaries.
It does not include taxable income earned in taxable non-REIT
subsidiaries. We must distribute at least 90% of REIT taxable
income as dividends to shareholders over time. As a REIT we are
not subject to corporate income taxes on the REIT taxable income
we distribute. The remainder of our taxable income is income we
earn in taxable subsidiaries. We pay income tax on this income
as we generally retain the after-tax income at the subsidiary
level. We also pay income tax on the REIT taxable income we
retain (we can retain up to 10% of the total). The table below
reconciles GAAP net income to total taxable income and REIT
taxable income for 2005 and 2004.
Table 16 Differences Between GAAP Net Income and
Total Taxable and REIT Taxable Income
| (In thousands, except per share data) | Estimated | Actual | |||||||
| 2005 | 2004 | ||||||||
|
GAAP net income
|
$ | 199,872 | $ | 232,635 | |||||
|
GAAP/ Tax differences in accounting
for:
|
|||||||||
|
Interest income and interest expense
|
(24,001 | ) | (27,402 | ) | |||||
|
Credit losses
|
(2,134 | ) | 6,352 | ||||||
|
Operating expenses
|
5,549 | (14,701 | ) | ||||||
|
Gains (losses) and valuation
adjustments
|
(7,453 | ) | 38,223 | ||||||
|
Provisions for taxes
|
12,278 | 5,870 | |||||||
|
Total taxable income (pre-tax)
|
184,111 | 240,977 | |||||||
|
Earnings from taxable subsidiaries
|
(12,626 | ) | (39,104 | ) | |||||
|
REIT taxable income (pre-tax)
|
$ | 171,485 | $ | 201,873 | |||||
|
GAAP net income per share
|
$7.96 | $10.47 | |||||||
|
Total taxable income per share
|
$7.44 | $10.89 | |||||||
|
REIT taxable income per share
|
$6.93 | $9.12 | |||||||
| Total taxable income per share and REIT taxable income per share are measured as, respectively, the estimated pretax total taxable income and REIT taxable income earned in a calendar quarter divided by the number of shares outstanding at the end of that quarter. Annual total taxable income per share and annual REIT taxable income per share are, respectively, the sum of the four quarterly total taxable income per share and REIT taxable income per share calculations. | |
| Total taxable income and total taxable income per share decreased in 2005 from 2004. The primary reason for this was decreased levels of capital invested in assets (not only CES but also IO and other securities), and fewer gains on sales on securitizations (at the taxable subsidiaries) as a result of lower volume of securitizations and less gain per transaction. In addition, the current yield we report for tax purposes on our new assets is much higher than the yield we report for GAAP purposes. This is true for those assets that have concentrated credit risk as, for tax purposes, credit losses are not anticipated but rather are only expensed as incurred. It is also true for other assets as, due to fast prepayments, some premium amortization expense for tax purposes has been delayed because we cannot recognize a negative yield for tax purposes on interest-only securities; this delayed premium amortization expense will likely impact the taxable gain or loss on sale or call in a future period. |
32
33
Dividends to stockholders during 2005 totaled $144 million,
approximately $37 million of which represented the
distribution of the balance of REIT taxable income earned in
2004. Based on our estimates of 2005 REIT taxable income, we
will enter 2006 with $51 million of undistributed REIT
taxable income which we will pay as dividends to our
stockholders during 2006. We currently project that most of the
first three regular quarterly dividends we pay in 2006 will
consist of REIT taxable income earned in 2005. Our estimates of
total taxable income and REIT taxable income are subject to
change due to changes in interest rates and other market factors
as well as changes in applicable income tax laws and regulations.
During 2005, a portion of taxable income was in the form of net
capital gains resulting from the sales and calls of some of our
residential loan CES. Our income from this activity was
long-term capital gain income for tax purposes. Thus, during
2005, 23.291% of our dividends distributed was characterized as
a distribution of long-term capital gain income and the
remaining 76.709% was characterized as a distribution of
ordinary income. Our tax-paying stockholders may benefit to the
degree they can take advantage of the lower tax rate on capital
gains versus ordinary income.
As of December 31, 2005, we had met all of the dividend
distribution requirements of a REIT. We generally attempt to
avoid acquiring assets or structuring financings or sales at the
REIT level that would be likely to generate distributions of
Unrelated Business Taxable Income (UBTI) or excess inclusion
income to our stockholders, or that would cause prohibited
transaction taxes on the REIT; however, there can be no
assurance that we will be successful in doing so.
2004 AS COMPARED TO 2003
Acquisitions, Securitizations, Sales, and Calls
For the year ended 2004, residential real estate loan
acquisitions totaled $10.1 billion, sales to Sequoia
entities totaled $10.0 billion, and Sequoia entities issued
$10.0 billion ABS. This activity was a slight decrease from
the volume of residential loan acquisitions
($11.4 billion), sales to Sequoia ($11.5 billion), and
ABS issued ($11.5 billion) in 2003.
During 2004, we acquired $269 million residential
loan CES. This was an increase from the $149 million
acquired in 2003. In 2004, we had calls of our residential
loan CES of $99 million principal value for GAAP gains
of $59 million. This was a decrease from the calls realized
in 2003 of $117 million principal value that generated GAAP
gains of $57 million. In 2004, we sold $22 million
market value residential real estate CES loans generating GAAP
gains of $6 million. During 2003, sales of residential real
estate CES totaled $1 million market value generated
minimal GAAP gains.
We acquired $38 million commercial real estate loans during
2004, an increase from the $6 million acquired during 2003.
We sold $2 million commercial real estate loans during 2004
and $1 million during 2003.
During 2004, we acquired $13 million commercial
loan CES; we did not acquire any such securities in 2003.
No commercial loan CES were sold during these periods.
We acquired $598 million of other residential and
commercial real estate securities during 2004 for our Acacia CDO
securitization program. This was similar to the level of such
acquisitions ($566 million) during 2003. During 2004, we
sold $584 million of securities to Acacia entities and
during 2003, we sold $415 million to Acacia entities. In
2004, Acacia entities issued $900 million of CDO ABS,
compared to $600 million in 2003.
Net Income
Our reported GAAP net income was $233 million
($10.47 per share) for 2004, an increase from the
$132 million ($7.04 per share) earned in 2003. Our
GAAP return on equity was 32% for 2004 compared to 25% for 2003.
Our 2004 results were driven by the quality of our existing real
estate loan backed investments, a favorable operating
environment, excellent credit results, favorable prepayment
patterns, increased book value per share (giving us a greater
amount of equity per share with which to generate earnings),
increased capital efficiencies, increased operating
efficiencies, and income generated from residential CES that we
owned at a discount to face value that were called during 2004
at full face value. A significant portion of our income in 2004
and 2003 has come from gains from calls and sales of residential
CES securities. Returns from these sources are highly variable
and not readily predictable.
Interest Income
Total interest income for 2004 was $648 million, an
increase from the $331 million of total interest income in
2003. Interest income for 2004 increased from 2003 as a result
of 95% growth in the average balance of consolidated earning
assets. Total consolidated earning assets grew primarily as a
result of increased sponsorship of securitizations of
residential real estate loans. The yield remained at similar
levels (from 3.06% to 3.05%) as a result of an increase in
interest rates offset by a change in the mix of assets as well
as changes in net discount and premium amortization and lower
credit provision expenses.
Table 17 Interest Income and Yield
| (Dollars in thousands) | 2004 | 2003 | ||||||
|
Interest income
|
$ | 651,661 | $ | 332,033 | ||||
|
Discount amortization
|
36,071 | 37,752 | ||||||
|
Premium amortization
|
(32,412 | ) | (30,163 | ) | ||||
|
Provision for credit losses
|
(7,236 | ) | (8,646 | ) | ||||
|
Total interest income
|
$ | 648,084 | $ | 330,976 | ||||
|
Average earning assets
|
$ | 21,208,757 | $ | 10,858,311 | ||||
|
Yield as a result of:
|
||||||||
|
Interest income
|
3.07 | % | 3.06 | % | ||||
|
Discount amortization
|
0.17 | % | 0.35 | % | ||||
|
Premium amortization
|
(0.15 | )% | (0.28 | )% | ||||
|
Provision for credit losses
|
(0.03 | )% | (0.08 | )% | ||||
|
Yield on earning assets
|
3.06 | % | 3.05 | % | ||||
| The table below presents the contribution to interest income and yield from each of our portfolios. Further discussions of changes in yields and balances are presented below by portfolio. |
| Table 18 Interest Income and Yield by Portfolio |
| (Dollars in thousands) | ||||||||||||||||
| December 31, 2004 | ||||||||||||||||
| Percent of | ||||||||||||||||
| Total | ||||||||||||||||
| Interest | Interest | Average | ||||||||||||||
| Income | Income | Balance | Yield | |||||||||||||
|
Residential real estate loans, net
of provision for credit losses
|
$ | 529,842 | 81.76 | % | $ | 19,665,096 | 2.69 | % | ||||||||
|
Residential loan credit-enhancement
securities
|
64,602 | 9.97 | % | 349,779 | 18.47 | % | ||||||||||
|
Commercial loans, net of provision
for credit losses
|
3,769 | 0.58 | % | 30,469 | 12.37 | % | ||||||||||
|
Commercial loan credit-enhancement
securities
|
675 | 0.10 | % | 5,261 | 12.83 | % | ||||||||||
|
Securities portfolio
|
48,274 | 7.45 | % | 1,062,901 | 4.54 | % | ||||||||||
|
Cash and cash equivalents
|
922 | 0.14 | % | 95,251 | 0.97 | % | ||||||||||
|
Totals
|
$ | 648,084 | 100.00 | % | $ | 21,208,757 | 3.06 | % | ||||||||
34
| (Dollars in thousands) | ||||||||||||||||
| December 31, 2003 | ||||||||||||||||
| Percent of | ||||||||||||||||
| Total | ||||||||||||||||
| Interest | Interest | Average | ||||||||||||||
| Income | Income | Balance | Yield | |||||||||||||
|
Residential real estate loans, net
of provision for credit losses
|
$ | 235,978 | 71.30 | % | $ | 9,932,961 | 2.38 | % | ||||||||
|
Residential loan credit-enhancement
securities
|
68,091 | 20.57 | % | 275,308 | 24.73 | % | ||||||||||
|
Commercial loans, net of provision
for credit losses
|
2,959 | 0.89 | % | 29,473 | 10.04 | % | ||||||||||
|
Commercial loan credit-enhancement
securities
|
— | 0.00 | % | — | 0.00 | % | ||||||||||
|
Securities portfolio
|
23,530 | 7.11 | % | 532,683 | 4.42 | % | ||||||||||
|
Cash and cash equivalents
|
418 | 0.13 | % | 87,886 | 0.48 | % | ||||||||||
|
Totals
|
$ | 330,976 | 100.00 | % | $ | 10,858,311 | 3.05 | % | ||||||||
| The table below details our interest income by portfolio as a result of changes in consolidated asset balances (“volume”) and yield (“rate”) for 2004 as compared to 2003. |
| Table 19 Volume and Rate Changes for Interest Income |
| (In thousands) | ||||||||||||
| Change in Interest Income | ||||||||||||
| 2004 Versus 2003 | ||||||||||||
| Total | ||||||||||||
| Volume | Rate | Change | ||||||||||
|
Residential real estate loans, net
of provisions for credit losses
|
$ | 231,207 | $ | 62,657 | $ | 293,864 | ||||||
|
Residential loan credit-enhancement
securities
|
18,409 | (21,898 | ) | (3,489 | ) | |||||||
|
Commercial loans, net of provision
for credit losses
|
100 | 710 | 810 | |||||||||
|
Commercial loan credit-enhancement
securities
|
— | 675 | 675 | |||||||||
|
Securities portfolio
|
23,450 | 1,294 | 24,744 | |||||||||
|
Cash and equivalents
|
35 | 469 | 504 | |||||||||
|
Total interest income
|
$ | 273,201 | $ | 43,907 | $ | 317,108 | ||||||
| Volume change is the change in average portfolio balance between periods multiplied by the rate earned in the earlier period. Rate change is the change in rate between periods multiplied by the average portfolio balance in the prior period. Interest income changes that result from changes in both rate and volume were allocated to the rate change amounts shown in the table. | |
| A discussion of the changes in total income, average balances, and yields for each of our portfolios is provided below. |
| Table 20 Consolidated Residential Real Estate Loans — Interest Income and Yield |
| (Dollars in thousands) | 2004 | 2003 | ||||||
|
Interest income
|
$ | 568,765 | $ | 273,739 | ||||
|
Net Premium amortization
|
(31,687 | ) | (29,615 | ) | ||||
|
Provision for credit losses
|
(7,236 | ) | (8,146 | ) | ||||
|
Total interest income
|
$ | 529,842 | $ | 235,978 | ||||
|
Average consolidated residential
real estate loans
|
$ | 19,665,096 | $ | 9,932,961 | ||||
|
Yields as a result of:
|
||||||||
|
Interest income
|
2.89 | % | 2.76 | % | ||||
|
Net Premium amortization
|
(0.16 | )% | (0.30 | )% | ||||
|
Provision for credit losses
|
(0.04 | )% | (0.08 | )% | ||||
|
Yield
|
2.69 | % | 2.38 | % | ||||
| During 2004, interest income on residential real estate loans increased as a result of higher average balances and higher yields as short-term interest rates rose. |
35
During the course of reviewing the application of SFAS 91
for the third quarter of 2004, we realized that there were
several provisions of that standard that we had been applying
inappropriately. The impact of this error was that, on a
cumulative basis, we had accelerated loan acquisition premium
amortization by $4.1 million. Under the provisions of
APB 20: “Reporting Accounting Changes” and
SAB 99: “Materiality”, we analyzed the
impact of the error on each period affected. After carefully
assessing the effect of this error on previously reported
earnings and the effect of recording a cumulative correcting
adjustment of $4.1 million in the third quarter 2004, we
determined that the error was not material to previously issued
financial statements or to the financial statements for the nine
months ended September 30, 2004 and the year ended
December 31, 2004. Accordingly, a cumulative correcting
adjustment of $4.1 million was recorded and resulted in a
decrease in loan acquisition premium amortization and an
increase in net income on our Consolidated Statements of Income
and an increase in the residential real estate loan balance on
our Consolidated Balance Sheets. The correction of this error
did not have an impact on reported cash flow from operations,
did not affect reported taxable income, and did not affect our
dividend distributions.
Table 21 Residential Loan Credit-Enhancement
Securities — Interest Income and Yield
| (Dollars in thousands) | 2004 | 2003 | ||||||
|
Interest income
|
$ | 30,492 | $ | 30,902 | ||||
|
Net discount amortization
|
34,110 | 37,189 | ||||||
|
Total interest income
|
$ | 64,602 | $ | 68,091 | ||||
|
Average residential loan
credit-enhancement securities
|
$ | 349,779 | $ | 275,308 | ||||
|
Yield as a result of:
|
||||||||
|
Interest income
|
8.72 | % | 11.22 | % | ||||
|
Net discount amortization
|
9.75 | % | 13.51 | % | ||||
|
Yield
|
18.47 | % | 24.73 | % | ||||
| Interest income recognized from residential loan CES decreased during 2004, as compared to 2003, primarily due to calls of our highest-yielding assets from this portfolio over the past year. |
| Table 22 Commercial Real Estate Loans — Interest Income and Yield |
| (Dollars in thousands) | 2004 | 2003 | ||||||
|
Interest income
|
$ | 4,253 | $ | 3,678 | ||||
|
Net premium amortization
|
(484 | ) | (219 | ) | ||||
|
Provision for credit losses
|
— | (500 | ) | |||||
|
Total interest income
|
$ | 3,769 | $ | 2,959 | ||||
|
Average earning assets
|
$ | 30,469 | $ | 29,473 | ||||
|
Yield as a result of:
|
||||||||
|
Interest income
|
13.96 | % | 12.48 | % | ||||
|
Net premium amortization
|
(1.59 | )% | (0.74 | )% | ||||
|
Provision for credit losses
|
— | (1.70 | )% | |||||
|
Yield
|
12.37 | % | 10.04 | % | ||||
| The yield on our commercial real estate loan portfolio was higher in 2004 as compared to 2003 due to investments in higher-yielding commercial loans and commercial loan participations during 2004 as well as the payoff of lower-yielding loans earlier in 2004. |
36
Table 23 Commercial Loan Credit-Enhancement
Securities — Interest Income and Yield
| 2004 | 2003 | |||||||
| (Dollars in thousands) | ||||||||
|
Interest income
|
$ | 1,000 | $ | — | ||||
|
Net premium amortization
|
(325 | ) | — | |||||
|
Total interest income
|
$ | 675 | $ | — | ||||
|
Average commercial loan
credit-enhancement securities
|
$ | 5,261 | $ | — | ||||
|
Yield as a result of:
|
||||||||
|
Interest income
|
19.01 | % | — | |||||
|
Net premium amortization
|
(6.18 | )% | — | |||||
|
Yield
|
12.83 | % | — | |||||
| We started acquiring commercial real estate loan CES in 2004 so we had no such assets in 2003. |
| Table 24 Consolidated Securities Portfolio — Interest Income and Yield |
| (Dollars in thousands) | 2004 | 2003 | ||||||
|
Interest income
|
$ | 46,229 | $ | 23,296 | ||||
|
Discount amortization
|
2,286 | 563 | ||||||
|
Premium amortization
|
(241 | ) | (329 | ) | ||||
|
Total interest income
|
$ | 48,274 | $ | 23,530 | ||||
|
Average securities portfolio balance
|
$ | 1,062,901 | $ | 532,683 | ||||
|
Yield as a result of:
|
||||||||
|
Interest income
|
4.34 | % | 4.37 | % | ||||
|
Discount amortization
|
0.22 | % | 0.11 | % | ||||
|
Premium amortization
|
(0.02 | )% | (0.06 | )% | ||||
|
Yield
|
4.54 | % | 4.42 | % | ||||
| Total interest income increased for the securities portfolio as the total size of the portfolio grew. Yields for the total securities portfolio increased during 2004 as the coupon rates on adjustable-rate loan securities adjusted upward with the increase in short-term interest rates during the period. |
| Interest Expense |
| Total interest expense rose from $203 million in 2003 to $432 million in 2004. Over the same period, average balances of Redwood debt increased 20% from $363 million to $435 million, and the average balance of consolidated ABS increased by 101% — from $10.1 billion in 2003 to $20.3 billion in 2004. ABS issued by ABS entities sponsored by us (which are consolidated on our reported balance sheet) increased rapidly as we continued to sponsor the securitization of residential real estate loans through our Sequoia securitization program and diverse real estate securities through our Acacia resecuritization program. The total cost of funds on Redwood debt plus the cost of funds on consolidated ABS increased from 1.93% in 2003 to 2.08% in 2004, reflecting an increase in short-term interest rates during 2004 that increased both the cost of Redwood debt as well as cash payments made on consolidated floating-rate ABS issued by securitization entities. We include the average balance of deferred ABS issuance costs in the average ABS balance and the amortization expenses of the deferred ABS issuance in interest expense on ABS. |
37
Table 25 Total Interest Expense
| (Dollars in thousands) | 2004 | 2003 | ||||||
|
Interest expense on Redwood debt
|
$ | 9,933 | $ | 7,038 | ||||
|
Interest expense on ABS
|
421,985 | 195,823 | ||||||
|
Total interest expense
|
$ | 431,918 | $ | 202,861 | ||||
|
Average Redwood debt balance
|
$ | 434,662 | $ | 363,311 | ||||
|
Average ABS issued balance
|
20,313,996 | 10,126,303 | ||||||
|
Average total obligations
|
$ | 20,748,658 | $ | 10,489,614 | ||||
|
Cost of funds of Redwood debt
|
2.29% | 1.94% | ||||||
|
Cost of funds of ABS issued
|
2.08% | 1.93% | ||||||
|
Cost of funds of total obligations
|
2.08% | 1.93% | ||||||
| Table 26 Average Balances of Asset-Backed Securities Issued |
| (In thousands) | 2004 | 2003 | ||||||
|
Sequoia
|
$ | 19,129,555 | $ | 9,635,924 | ||||
|
Acacia
|
1,229,075 | 510,115 | ||||||
|
Commercial
|
5,654 | 7,575 | ||||||
|
Average balance of ABS issued
|
$ | 20,364,284 | $ | 10,153,614 | ||||
|
Average deferred ABS issuance costs
|
(50,288 | ) | (27,311 | ) | ||||
|
Average balance of ABS issued, net
|
$ | 20,313,996 | $ | 10,126,303 | ||||
| The table below details interest expense on debt and consolidated ABS issued as a result of changes in consolidated balances (“volume”) and cost of funds (“rate”) for 2004 as compared to 2003. |
| Table 27 Volume and Rate Changes for Interest Expense |
| (In thousands) | ||||||||||||
| Change in Interest Expense | ||||||||||||
| 2004 Versus 2003 | ||||||||||||
| Volume | Rate | Total | ||||||||||
|
Interest expense on Redwood debt
|
$ | 1,382 | $ | 1,513 | $ | 2,895 | ||||||
|
Interest expense on ABS
|
197,010 | 29,152 | 226,162 | |||||||||
|
Total interest expense
|
$ | 198,392 | $ | 30,665 | $ | 229,057 | ||||||
| Details of the change in cost of funds of debt and cost of funds on ABS issued are provided below. |
| Table 28 Cost of Funds of Redwood Debt |
| (Dollars in thousands) | 2004 | 2003 | ||||||
|
Interest expense on Redwood debt
|
$ | 9,933 | $ | 7,038 | ||||
|
Average Redwood debt balance
|
$ | 434,662 | $ | 363,311 | ||||
|
Cost of funds of Redwood debt
|
2.29 | % | 1.94 | % | ||||
| The increase in the cost of funds of Redwood debt is the result of higher short-term interest rates. |
38
Table 29 Cost of Funds of Asset-Backed Securities
Issued
| (Dollars in thousands) | 2004 | 2003 | ||||||
|
ABS interest expense
|
$ | 399,193 | $ | 183,214 | ||||
|
ABS issuance expense amortization
|
16,828 | 12,805 | ||||||
|
Net ABS interest rate agreement
(income) expense
|
13,235 | 8,175 | ||||||
|
Net ABS issuance premium
amortization
|
(7,271 | ) | (8,371 | ) | ||||
|
Total ABS interest expense
|
$ | 421,985 | $ | 195,823 | ||||
|
Average balance of ABS
|
$ | 20,313,996 | $ | 10,126,303 | ||||
|
ABS interest expense
|
1.97 | % | 1.80 | % | ||||
|
ABS issuance expense amortization
|
0.08 | % | 0.13 | % | ||||
|
Net ABS interest rate agreement
(income) expense
|
0.07 | % | 0.08 | % | ||||
|
Net ABS issuance premium
amortization
|
(0.04 | )% | (0.08 | )% | ||||
|
Cost of funds of ABS
|
2.08 | % | 1.93 | % | ||||
| Operating Expenses |
| Operating expenses decreased in 2004 from 2003. This decrease was the result of lower variable stock option expense and lower excise taxes. Variable stock option expense decreased as most of the options that generate this expense were exercised in late 2003 and in 2004. The amount of excise tax was lower in 2004 as we deferred a lower amount of excise-taxable REIT taxable income in 2004 than we did in 2003. |
| Table 30 Operating Expenses |
| (Dollars in thousands) | 2004 | 2003 | ||||||
|
Total operating expenses
|
$ | 34,661 | $ | 36,895 | ||||
|
Less: Excise tax
|
(626 | ) | (1,203 | ) | ||||
|
Less: Variable stock option
income/(expense) (VSOI/VSOE)
|
(1,018 | ) | (5,652 | ) | ||||
|
Total operating expenses before
excise tax and VSOE/ VSOI
|
$ | 33,017 | $ | 30,040 | ||||
|
Components of total operating
expense before excise tax and VSOE/VSOI
|
||||||||
|
Fixed compensation expense
|
$ | 8,040 | $ | 5,948 | ||||
|
Other operating expense
|
8,593 | 7,018 | ||||||
|
Incentive stock (income) expense
|
1,289 | 388 | ||||||
|
Variable compensation expense
|
15,095 | 16,686 | ||||||
|
Total operating expenses before
excise tax and VSOE/ VSOI
|
$ | 33,017 | $ | 30,040 | ||||
|
Net interest income (NII)
|
$ | 216,166 | $ | 128,115 | ||||
|
Adjusted efficiency ratio
(Operating expense before excise tax and VSOE/VSOI)/net interest
income
|
15 | % | 23 | % | ||||
| Net Recognized Gains (Losses) and Valuation Adjustments |
| We recognized income of $59 million in 2004 as a result of net recognized gains and valuation adjustments (change in market values of certain assets and hedges, either unrecognized or recognized via sale or call income). | |
| In 2004, GAAP gains from calls on $99 million par (principal or face) value of residential loan CES were $59 million. We acquire these securities at a discount. They are called — effectively sold — at par. Gains from sales of assets were $8 million during 2004. We have sold, and intend to continue to sell, appreciated assets from time to time to recycle capital into newer assets that have higher potential returns. In 2003, gains from calls were $57 million while gains from sales totaled $1 million. Rapid prepayment rates over the last four years have accelerated the first potential call dates of the securitizations we credit-enhance. We expect gains from calls to continue, although at an unpredictable and slower rate for the next few years. |
39
Our net reported SFAS 115 and EITF 99-20 write-downs
were $6.4 million in 2004 due primarily to the timing of
cash flows as a result of slower prepayment assumptions related
to certain securities purchased at a discount. These write-downs
totaled $7.6 million in 2003.
We have not sought hedge accounting treatment for a portion of
our interest rate agreements (interest rate swaps, futures, and
related instruments). We recognize in income each quarter the
change in market value of these agreements. Total valuation
adjustments for interest rate agreements accounted for as
trading were negative $0.5 million in 2004, compared to
negative $0.4 million in 2003.
Provisions for Income Taxes
Our income tax provision in 2004 was $8.0 million, an
increase from the $5.5 million income tax provision taken
in 2003 as we utilized existing NOLs in prior years and for a
portion of 2004. We recognized net deferred tax benefits in 2004
as a result of the build up of deferred tax assets attributable
to GAAP/tax securitization gain temporary differences, the
utilization of prior period deferred tax assets, and a reversal
of previously existing valuation allowances related to NOLs. No
deferred tax provisions were recorded during 2003.
Dividends on Preferred Stock
Our distributions of preferred stock dividends were
$0.7 million per quarter through and including the first
quarter of 2003, reflecting a dividend of $0.755 per share
on 902,068 preferred shares outstanding. In May 2003, we
converted all of the outstanding shares of preferred stock into
shares of common stock.
Taxable Income and Dividends
Total taxable income and total taxable income per share were
higher in 2004 than in 2003. The primary reason for these higher
levels was due to an increase in the amount of capital invested
plus an increase in gains from calls and sales. The table below
reconciles GAAP net income to total taxable income and REIT
taxable income for 2004 and 2003.
Table 31 Differences Between GAAP Net Income and
Total Taxable and REIT Taxable Income
| (In thousands, except per share data) | 2004 | 2003 | |||||||
|
GAAP net income
|
$ | 232,635 | $ | 131,698 | |||||
|
GAAP/ Tax differences in accounting
for:
|
|||||||||
|
Interest income and interest expense
|
(27,402 | ) | 22,095 | ||||||
|
Credit losses
|
6,352 | 7,821 | |||||||
|
Operating expenses
|
(14,701 | ) | 6,441 | ||||||
|
Gains (losses) and valuation
adjustments
|
38,223 | 1,998 | |||||||
|
Provisions for taxes
|
5,870 | 5,502 | |||||||
|
Preferred stock
|
— | 696 | |||||||
|
Total taxable income (pre-tax)
|
240,977 | $ | 176,251 | ||||||
|
Earnings from taxable subsidiaries
|
(39,104 | ) | (7,861 | ) | |||||
|
REIT Taxable Income (pre-tax)
|
$ | 201,873 | $ | 168,390 | |||||
|
GAAP net income per share
|
$ | 10.47 | $ | 7.04 | |||||
|
Total taxable income per share
|
$ | 10.89 | $ | 9.64 | |||||
|
REIT taxable income per share
|
$ | 9.12 | $ | 9.21 | |||||
| Dividends to stockholders during 2004 totaled $203 million, approximately $53 million of which represented the distribution of the balance of REIT taxable income earned in 2003. |
40
41
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
Impact of Hurricanes in 2005
During the third quarter of 2005, hurricanes Katrina and Rita
hit the Gulf Coast States, including parts of Louisiana,
Mississippi, and Texas. We own both residential and commercial
securities that have first loss risk on loans in the affected
areas. Based on available information and our analysis, we
continue to believe our hurricane-related losses (as measured
for tax) will be between $6 million to $18 million on
the residential and commercial loans we credit-enhance. We do
not anticipate an impact to our future GAAP earnings as a result
of these hurricanes as these losses are included in our credit
reserves. We regularly update our estimates and will adjust our
credit reserves accordingly. There can be no assurance that
actual losses will fall within this range as there are many
factors yet to be determined such as insurance claims, the state
of the local economy, and the strength or weakness of the real
estate markets in the affected areas.
Assets
Each of our product lines and portfolios is a component of our
single business of investing in, credit-enhancing, and
securitizing residential and commercial real estate loans and
securities. Our consolidated earning assets, as presented for
GAAP purposes, consist of five portfolios: residential real
estate loans, residential loan CES, commercial real estate
loans, commercial loan CES, and securities portfolio. A
discussion of the activities in each of these portfolios appears
below.
Residential Real Estate Loans
Residential loans shown on our Consolidated Balance Sheets
include loans owned by securitization entities we have sponsored
plus loans we own (typically on a temporary basis prior to sale
to a securitization entity). Loans underlying residential
credit-enhancement securities we have acquired from
securitizations that were not sponsored from us do not appear on
our Consolidated Balance Sheets.
The consolidated balance of residential real estate loans at
December 31, 2005 of $13.9 billion was lower than the
$22.5 billion we reported at December 31, 2004.
Prepayments on loans consolidated for GAAP purposes were greater
than acquisitions of new loans. This was the result of both an
increase in prepayment speeds and a decrease in the volume of
acquisitions and sponsored securitizations. Prepayment speeds
increased in ARMs as a result of a flattening of the yield curve
(an increase in short-term interest rates relative to long-term
interest rates). This change in the yield curve also served to
reduce the new production of adjustable-rate loans indexed to
LIBOR in the marketplace, reducing our acquisition
opportunities. In addition, we face increased competition to
purchase these loans.
At December 31, 2005, Redwood owned $45 million
residential real estate loans accumulated for future
securitizations. None of these loans were pledged to support
Redwood debt. ABS securitization entities consolidated on
Redwood’s balance sheet owned $13.8 billion of
residential real estate loans on December 31, 2005.
Charge-offs (credit losses) recorded in this portfolio totaled
$0.5 million during 2005, $0.2 million in 2004, and
$0.1 million in 2003. Credit losses remained at an
annualized rate of less than 1 basis point (0.01%) during
these periods. Serious delinquencies increased from
$13 million at December 31, 2004 to $37 million
at December 31, 2005. Serious delinquencies include loans
delinquent more than 90 days, in bankruptcy, in
foreclosure, and real estate owned. As a percentage of this loan
portfolio, serious delinquencies remained at low levels relative
to the U.S. residential real estate loans as a whole, and
were 0.27% of our current loan balances in this portfolio at
December 31, 2005, an increase from 0.06% at
December 31, 2004.
The reserve for credit losses on residential real estate loans
is included as a component of residential real estate loans on
our Consolidated Balance Sheets. The residential real estate
loan credit reserve balance of $23 million was 0.16% of the
current balance of this portfolio at
December 31, 2005, compared to $23 million or 0.10% at
December 31, 2004. The total amount of credit reserves did
not decrease over the year even though the balance of loans
decreased; this decline in loan balance was offset by increased
delinquencies and a worsening credit outlook.
Residential Loan Credit-Enhancement Securities
For GAAP purposes, this portfolio includes residential real
estate loan CES acquired from securitizations sponsored by
others. It does not include CES we acquired from our Sequoia
entities.
We mark residential loan CES to their current estimated
market value on our Consolidated Balance Sheets (but not
generally through our consolidated statements of income unless
we determine there is other-than-temporary impairment). At
December 31, 2005, our reported ownership of these
residential loan CES totaled $613 million. This was an
increase from the $562 million market value we reported on
December 31, 2004. Our acquisitions plus net positive
market value adjustments exceeded calls, sales, and principal
pay downs for 2005.
As a result of the concentrated credit risk associated with
residential loan CES, we are generally able to acquire these
securities at a discount to their face (principal) value. The
difference between the principal value ($1.04 billion) and
adjusted cost basis ($554 million) of these residential
loan CES at December 31, 2005 was $481 million,
of which $355 million was designated as internal credit
protection (reflecting our estimate of likely credit losses
on the underlying loans over the life of these securities),
while the remaining $126 million represented a purchase
discount we will accrue into income over time. The table below
presents the principal value, amortized cost, and carrying
values of our consolidated residential loan CES by first-,
second-, or third loss position. The first- and second-loss
position residential loan CES are generally funded with equity.
The third-loss position residential loan CES are generally owned
by the Acacia entities and consolidated on our balance sheets.
Table 32 Residential Loan Credit-Enhancement
Securities
| (In thousands) | 2005 | 2004 | ||||||
|
First loss position, principal value
|
$ | 471,079 | $ | 352,752 | ||||
|
Second loss position, principal
value
|
170,928 | 276,720 | ||||||
|
Third loss position, principal value
|
393,867 | 304,300 | ||||||
|
Total principal value
|
$ | 1,035,874 | $ | 933,772 | ||||
|
First loss position, amortized cost
|
$ | 111,264 | $ | 68,675 | ||||
|
Second loss position, amortized cost
|
109,306 | 171,220 | ||||||
|
Third loss position, amortized cost
|
333,883 | 243,030 | ||||||
|
Total amortized cost
|
$ | 554,453 | $ | 482,925 | ||||
|
First loss position, carrying value
|
$ | 154,930 | $ | 110,933 | ||||
|
Second loss position, carrying value
|
120,690 | 195,536 | ||||||
|
Third loss position, carrying value
|
337,029 | 255,189 | ||||||
|
Total carrying value
|
$ | 612,649 | $ | 561,658 | ||||
| As a net result of our acquisition, sale, and call activity, the loans underlying these reported residential loan CES increased from $126 billion at December 31, 2004 to $170 billion at December 31, 2005. Total residential loans credit-enhanced, through these securities plus similar CES securities acquired from Sequoia securitization entities, were $149 billion at December 31, 2004 and $184 billion at December 31, 2005. | |
| External credit protection serves to protect us from credit losses on a specific asset basis and represents the principal value of interests owned by others that are junior to interests owned by us. At December 31, 2005, we had $141 million of external credit-enhancement and $355 million of internally designated credit protection for this portfolio. The combined balance of external and internally designated credit protection represented 29 basis points (0.29%) of the $170 billion of |
42
43
loans underlying our credit-enhancement portfolio. The amount of
credit protection and the related risks are specific to each
credit-enhancement interest.
There were $4.6 million credit losses for the underlying
loans during 2005, $3.1 million credit losses during 2004,
and $4.1 million in 2003. The annualized rate of credit
loss was less than 1 basis point (0.01%) of the current
balance of underlying loans. Losses borne by external
credit-enhancement for 2005 totaled $0.4 million,
$0.3 million for 2004 and $1.0 million in 2003. Losses
by us (which reduce that portion of the purchase discount that
we have designated as credit reserves) totaled $4.2 million
during 2005, $2.8 million during 2004, and
$3.1 million during 2003.
Delinquencies (over 90 days, foreclosure, bankruptcy, and
REO) in the underlying portfolio of residential loans that we
credit-enhance through owning these CES were $331 million
at December 31, 2005, an increase from $150 million at
December 31, 2004. Delinquencies as a percentage of the
residential loans we credit-enhance increased to 0.19% at
December 31, 2005 from 0.12% at December 31, 2004. A
portion of the increase in delinquencies was caused by damage
from hurricanes. The level of delinquencies on these loans is
below national levels.
In 2005, we recognized $0.5 million losses due to
other-than-temporary impairment on our residential
loan CES. We recognized $4.2 million of
other-than-temporary impairments for 2004 and $1.5 million
during 2003. These losses are included in net recognized gains
and valuation adjustments in our Consolidated Statements of
Income.
Commercial Real Estate Loans
We have been investing in commercial real estate loans since
1998. Our commercial real estate loan portfolio increased during
2005 to $60 million at December 31, 2005 from
$54 million at December 31, 2004 due to the
acquisition of $25 million loans, offset by sales,
principal pay-downs, and amortization. We plan to continue to
make additional investments in commercial real estate loans,
including mezzanine loans, subordinated (junior or second lien)
loans, and B-Notes
(B-Notes represent a structured commercial real estate loan that
retains a higher portion of the credit risk and generates a
higher yield than the initial loan).
Factors particular to each of our other commercial loans (e.g.,
lease activity, market rents, and local economic conditions)
could cause credit concerns for our commercial loans. If this
occurs, we may need to provide for future losses by establishing
a credit reserve. We continually monitor and determine the level
of appropriate reserves for our commercial loans. At
December 31, 2005, we had an $8.1 million reserve on a
loan, which is the same reserve we had established at
acquisition of this loan. We acquired this loan at a discount to
par and designated a credit reserve based on our expected cash
flows at that time. We have no other credit reserves for any of
our other commercial real estate loans.
Commercial Loan Credit-Enhancement Securities
We acquire unrated first-loss interests in CMBS and fund them
with equity. We define these non-rated CMBS as commercial
loan CES. At December 31, 2005, we owned
$175 million principal value of these securities with a
market value of $58 million. This was an increase from the
$46 million principal value and $14 million market
value we owned at December 31, 2004, as we increased
acquisitions of these securities. Some of the commercial
loan CES we own represent an interest in a commercial CMBS
re-REMIC consisting primarily of first-and-second-loss interests
in several other CMBS.
At December 31, 2005, we credit-enhanced $26 billion
commercial real estate loans through ownership of first-loss
CMBS (excluding the re-REMIC interests) an increase from the
$6 billion commercial real estate loans we credit-enhanced
at December 31, 2004. Serious delinquencies (i.e., 90 plus
days, in bankruptcy, in foreclosure, or REO) were
$17 million, or 0.07%, of the loan balances at
December 31, 2005; there were no delinquencies on these
loans at December 31, 2004. We incurred no credit losses on
these underlying loans in 2005 or 2004. We did not own
first-loss CMBS securities in 2003.
At December 31, 2005, we credit-enhanced $17 billion
commercial real estate loans through our interests in a CMBS
re-REMIC, a decrease from the $20 billion credit-enhanced
at December 31, 2004. Delinquencies on these loans were
$228 million, or 1.34% of the loan balances at
December 31, 2005. Delinquencies on these loans were
$363 million, or 1.80% of the loan balances at
December 31, 2004. External credit protection on these
loans was $1.6 billion at both December 31, 2005 and
2004. Our internally designated credit reserves were
$14 million at December 31, 2005 and $19 million
at December 31, 2004. For 2005, total credit losses on
these underlying loans were $81 million, of which
$79 million were borne by credit-enhancement securities not
owned by us. Credit losses realized in 2004 were $6 million
and were all borne against credit-enhancement securities not
owned by us.
Securities Portfolio
We continue to acquire diverse residential real estate loan
securities, commercial real estate loan securities, debt
interests in real estate-oriented CDOs, in each case primarily
rated AA, A, and BBB. Also included in this portfolio are
non-investment grade interests in commercial real estate
securities (excluding commercial loan CES), manufactured
housing securities, corporate bonds issued by REITs, and equity
in CDOs sponsored by others. We have sold most of our securities
in this consolidated portfolio (as reported for GAAP purposes)
to Acacia bankruptcy-remote securitization entities. Acacia
issues CDO ABS to fund its acquisition of these assets. We
consolidate these Acacia’s assets as “securities
portfolio” assets (however, BB-rated residential
loan CES are consolidated within our “Residential
Loan CES”). We reflect Acacia’s issuance of CDO
ABS as ABS issued obligations on our Consolidated Balance Sheets.
The increase in the securities portfolio during 2005 was the
result of additional acquisitions of securities for sale to
Acacia. Our consolidated securities portfolio totaled
$1.7 billion carrying value on December 31, 2005, of
which $1.6 billion had been sold to Acacia ABS
securitization entities as of that date. At December 31,
2004, we had $1.4 billion carrying value of these
securities, of which $1.3 billion had been sold to Acacia
entities as of that date.
We continue to acquire non-investment grade CMBS that are rated
BB and B. We generally sell these assets to Acacia entities. The
balance of these CMBS assets increased to $160 million at
December 31, 2005 from $70 million at
December 31, 2004.
The table below presents the types of securities we own as
reported in this securities portfolio by their credit ratings as
of December 31, 2005 and December 31, 2004.
Table 33 Consolidated Securities
Portfolio — Underlying Collateral Characteristics at
December 31, 2005 and December 31, 2004
| (In millions) | Rating | |||||||||||||||||||||||||||||||
| At December 31, 2005 | Total | AAA | AA | A | BBB | BB | B | Unrated | ||||||||||||||||||||||||
|
Commercial real estate
|
$ | 322 | $ | 11 | $ | 2 | $ | 20 | $ | 129 | $ | 130 | $ | 30 | $ | — | ||||||||||||||||
|
Residential Prime real estate
|
690 | 29 | 240 | 194 | 227 | — | — | — | ||||||||||||||||||||||||
|
Residential Sub-prime real estate
|
442 | 5 | 86 | 292 | 59 | — | — | — | ||||||||||||||||||||||||
|
Residential Second Lien real estate
|
108 | — | 49 | 54 | 5 | — | — | — | ||||||||||||||||||||||||
|
Manufactured Housing
|
— | — | — | — | — | — | — | — | ||||||||||||||||||||||||
|
REIT Corporate Debt
|
32 | — | — | — | 24 | 8 | — | — | ||||||||||||||||||||||||
|
Real Estate CDOs
|
155 | 37 | 25 | 37 | 44 | 11 | — | 1 | ||||||||||||||||||||||||
|
Total Securities Portfolio
|
$ | 1,749 | $ | 82 | $ | 402 | $ | 597 | $ | 488 | $ | 149 | $ | 30 | $ | 1 | ||||||||||||||||
44
| (In millions) | Rating: | |||||||||||||||||||||||||||||||
| At December 31, 2004 | Total | AAA | AA | A | BBB | BB | B | Unrated | ||||||||||||||||||||||||
|
Commercial real estate
|
$ | 229 | $ | 16 | $ | 2 | $ | 35 | $ | 106 | $ | 62 | $ | 8 | $ | — | ||||||||||||||||
|
Residential Prime real estate
|
400 | 27 | 200 | 80 | 93 | — | — | — | ||||||||||||||||||||||||
|
Residential Sub-prime real estate
|
429 | — | 43 | 288 | 98 | — | — | — | ||||||||||||||||||||||||
|
Residential Second Lien real estate
|
131 | — | 55 | 67 | 9 | — | — | — | ||||||||||||||||||||||||
|
Manufactured Housing
|
14 | 3 | 5 | — | — | — | 6 | — | ||||||||||||||||||||||||
|
REIT Corporate Debt
|
65 | 0 | 0 | 8 | 49 | 8 | — | — | ||||||||||||||||||||||||
|
Real Estate CDOs
|
113 | 13 | 24 | 37 | 36 | 2 | — | 1 | ||||||||||||||||||||||||
|
Total Securities Portfolio
|
$ | 1,381 | $ | 59 | $ | 329 | $ | 515 | $ | 391 | $ | 72 | $ | 14 | $ | 1 | ||||||||||||||||
| We reported other-than-temporary impairments (EITF 99-20 and FAS115) in the consolidated securities portfolio of $3.5 million during the 2005, $2.2 million for 2004, and $6.2 million in 2003. |
| Liabilities and Stockholders’ Equity |
| Redwood Debt |
| We typically use debt to fund the accumulation of assets prior to sale to sponsored ABS securitization entities (Sequoia and Acacia entities). These accumulated assets are pledged to secure the associated debt. Additional collateral in the form of additional qualifying assets or cash may be required to meet changes in market values from time to time under these agreements. These borrowings have maturities of less than one year and interest rates that generally change monthly based upon a margin over the one-month LIBOR interest rate. Our debt levels vary based on the timing of our asset accumulation and securitization activities. During 2005, as measured daily, our maximum debt level was $552 million, our minimum debt level was $94 million, and our average debt level was $261 million. | |
| Redwood’s debt was secured by mostly investment grade securities accumulated as inventory for sale to Acacia securitization entities. We also have an unsecured line of credit available that was not drawn upon as of December 31, 2005. Covenants associated with a portion of our short-term debt generally relate to our tangible net worth, liquidity reserves, and leverage requirements. We have not had, nor do we currently anticipate having, any problems in meeting these covenants. However, many factors, including ones external to us, may affect our ability to meet these covenants and may affect our liquidity in the future. | |
| In March 2005, we formed Madrona Residential Funding, LLC (“Madrona”), a special purpose entity and wholly owned subsidiary of RWT Holdings. Madrona gives us the flexibility to access the capital markets and issue short-term debt instruments to finance the accumulation of loans prior to sale to sponsored securitization entities. Madrona is designed to fund residential loans accumulated for eventual sale to our Sequoia securitization program by issuing A1+/ P1 rated commercial paper. Madrona was established to accumulate up to $1.5 billion of loans (with a current authorization for $300 million) and can warehouse each loan up to 270 days. There are specific eligibility requirements for financing loans in this facility that are similar to our existing financing facilities with several banks and large investment banking firms. There is a credit reserve account for approximately 70 basis points that will serve as credit-enhancement to the commercial paper investors. In addition, we issued $5.4 million of a BBB-rated Madrona ABS to provide further credit support to the holders of commercial paper. This facility has a three-year term. As of December 31, 2005, there was no commercial paper issuance outstanding. |
| Asset-Backed Securities Issued |
| Redwood consolidates on its balance sheets the ABS that are obligations of those securitization entities that are sponsored by Redwood. These ABS issued are not obligations of Redwood. |
45
46
Sequoia had $13.4 billion ABS outstanding on
December 31, 2005 compared to $21.9 billion on
December 31, 2004. Pay downs of existing ABS issued by
Sequoia exceeded new issuance.
Acacia entities issued ABS of a type known as CDOs to fund their
acquisitions of real estate securities from Redwood. Acacia CDO
issuance outstanding was $2.2 billion on December 31,
2005 and $1.7 billion on December 31, 2004. We issued
$0.9 billion of Acacia ABS in 2005. For 2005, there were
$322 million of Acacia ABS pay downs, which includes
$216 million related to the redemption of Acacia CDO 1.
Stockholders’ Equity
Our reported stockholders’ equity increased by 8% during
2005, from $864 million at December 31, 2004 to
$935 million at December 31, 2005 as a result of
$200 million earnings, $148 million dividends
declared, $46 million stock issuance, $1 million
proceeds from stock option exercises, $4 million non-cash
equity adjustments, and a $32 million net decrease in the
unrealized gains of assets and interest rate agreements that are
marked-to-market
through our Consolidated Balance Sheets.
We may seek to issue additional shares even during a period when
we are maintaining uninvested cash balances. This would allow us
to accommodate additional portfolio growth while also using cash
balances to reduce overall risk (and insure funding for future
opportunities). As always, we issue equity only when we believe
such issuance would enhance long-term earnings and dividends per
share, compared to what they would have been otherwise.
Certain assets are
marked-to-market
through accumulated other comprehensive income; these
adjustments affect our book value but not our net income. As of
December 31, 2005, we reported a net accumulated other
comprehensive income of $74 million and at
December 31, 2004 we reported net accumulated other
comprehensive income of $105 million. Changes in this
account reflect increases in the fair value of our earning
assets (positive $6 million) and interest rate agreements
(positive $7 million), and also reflect changes due to
calls, sales, and other-than-temporary impairments of a portion
of our securities ($44 million). Our reported book value at
December 31, 2005 was $37 per share.
Cash Requirements, Sources of Cash, and Liquidity
We use cash to fund our operating and securitization activities,
invest in earning assets, service and repay Redwood debt, fund
working capital, and fund our dividend distributions.
One primary source of cash is principal and interest payments
received on a monthly basis from real estate loans and
securities. This includes payments received from ABS that we
acquired as investment assets from ABS securitizations we
sponsor. Other sources of cash include proceeds from sales of
assets to securitizations entities, proceeds from sales of other
assets, borrowings, and issuance of common stock.
We currently use borrowings solely to finance the accumulation
of assets for future sale to securitization entities. Sources of
borrowings include repurchase agreements, bank borrowings, and
forms of collateralized short-term borrowings, and non-secured
lines of credit. We may also issue commercial paper. Our
borrowings are typically repaid using proceeds received from the
sale of assets to securitization entities. For residential
loans, our typical inventory holding period is one to twelve
weeks. For securities held for sale to Acacia CDO securitization
entities, our typical holding period is one to six months.
Our Consolidated Statements of Cash Flows includes cash flows
generated and used by the ABS securitization entities that are
consolidated on our Consolidated Balance Sheets. Cash flows
generated within these entities are not available to Redwood,
except to the degree that a portion of these cash flows may be
due to Redwood as an owner of one or more of the ABS issued by
the entity. Cash flow obligations of and uses of cash by these
ABS entities are not part of Redwood’s operations and are
not obligations of Redwood, although a decrease in net cash flow
(or an increase in credit losses) generated by an ABS entity
could defer or reduce (or
47
potentially eliminate) interest and/or principal payments
otherwise due to Redwood as an owner of certain more risky ABS
issued by the entities.
In connection with our internal year-end preparation and review
of our Consolidated Financial Statements for the year ended
December 31, 2005, we determined that the Consolidated
Statement of Cash Flows for the quarter ended September 30,
2005 reflected an error as it included misclassified amounts.
Specifically, Redwood did not follow the guidance of Statement
of Financial Accounting Standards (FAS) No. 102
Statement of Cash Flows — Exemption of Certain
Enterprises and Classification of Cash Flows from Certain
Securities Acquired for Resale (an Amendment of FASB Statement
No. 95), that requires cash receipts resulting from
sales of loans that were not specifically acquired for resale to
be classified as cash flows from investing activities. In the
third quarter of 2005, Redwood sold $263 million in loans,
$182 million of which we had acquired in earlier periods.
When acquiring these earlier loans, our intention was to keep
these on our Consolidated Balance Sheets through the Sequoia
program, and, in prior periods, the Consolidated Statement of
Cash Flows had correctly reflected the purchase of these loans
within cash flows from investing activities. However, upon the
sale of these loans in the third quarter, we classified the
receipts as cash flows from operating activity. Management
believes this error is immaterial as it does not have any impact
on earnings, the balance sheet, total cash flow, taxable income,
or dividends.
As a result of this discovery, we have corrected the
classifications of these cash flows and have included in this
Annual Report on Form 10-K a correct Consolidated Statement
of Cash Flows for the year ended December 31, 2005 in
conformity with generally accepted accounting principles. We
have concluded that the misclassification of cash flows in the
third quarter of 2005 was the result of a significant deficiency
in the design or operation of our internal controls regarding
the application of generally accepted accounting principles and
the review process of the implementation of accounting guidance.
We have discussed the significant deficiency described above
with the Audit Committee. Our management is working to identify
and implement corrective actions where required to improve the
effectiveness of our internal controls, including the
enhancement of our systems and procedures.
At December 31, 2005, we had $176 million unrestricted
cash and unpledged liquid assets (104% of our short-term debt
balances) available to meet potential liquidity needs. Increases
or decreases in this ratio at different balance sheet dates
primarily are the result of the timing of sale of assets to
securitization entities. While we anticipate maintaining a
strong liquidity position, our ratio of liquid assets to
short-term debt will fluctuate as we continue to fund our real
estate loans and other securities with short-term borrowings
prior to securitization. At this time, we see no indications or
materially negative trends that we believe would be likely to
cause us a liquidity shortage.
Net liquidity at December 31, 2005 was $284 million.
Net liquidity is the amount of unrestricted cash we would have
had on hand if we had sold all the loans and securities we are
accumulating for future sale at their estimated market value
($278 million on December 31, 2005) and used the
proceeds to pay off Redwood’s debt ($170 million on
December 31, 2005). Net liquidity is available for cash
needs such as dividend distributions, acquiring new permanent
assets, and supporting our securitization efforts.
Under our internal risk-adjusted capital guidelines,
$189 million of this net liquidity at December 31,
2005 was excess liquidity available to support growth in our
business. The remainder of the net liquidity balance was
required under our risk-adjusted capital guidelines to support
our current assets and other operating needs and liquidity risks
(such as the risk of requiring cash to post as margin for
interest rate agreements if interest rates move adversely for
these agreements).
We are not going to be in a hurry to invest our excess capital.
While we remain optimistic about the performance of the housing
markets, we are starting to see numerous signs of weakness in
the housing markets today. We believe that a weakening of the
housing market, if it continues, likely bring excellent asset
acquisition opportunities over the next few years. In order to
take advantage of future opportunities, our goal is to maintain
cash balances that are available to
make new investments. Our current plan, which is subject to
change, is to invest our excess cash steadily over the next two
to three years.
Off-Balance Sheet Commitments
At December 31, 2005, in the ordinary course of business,
we had commitments to purchase $2 million of real estate
loans that settled in 2006. These purchase commitments represent
derivative instruments under FAS No. 149, Amendment
of Statement 133 on Derivative Instruments and Hedging
Activities. The value of these commitments was negligible as
of December 31, 2005.
Contractual Obligations and Commitments
The table below presents our contractual obligations and
commitments as of December 31, 2005, as well as the
consolidated obligations of the securitization entities that we
sponsored and are consolidated on our balance sheets. The
operating leases are commitments that are expensed based on the
terms of the related contracts.
Table 34 Contractual Obligations and Commitments as of
December 31, 2005
| (In thousands) | ||||||||||||||||
| Payments Due or Commitment Expiration by Period | ||||||||||||||||
| Less Than | 1 to | |||||||||||||||
| Total | 1 Year | 5 Years | After 5 Years | |||||||||||||
|
Redwood obligations:
|
||||||||||||||||
|
Redwood debt
|
$ | 169,707 | $ | 169,707 | $ | — | $ | — | ||||||||
|
Accrued interest payable
|
980 | 980 | — | — | ||||||||||||
|
Operating leases
|
5,825 | 1,046 | 2,829 | 1,950 | ||||||||||||
|
Purchase commitments —
securities
|
— | — | — | |||||||||||||
|
Purchase commitments —
whole loans
|
2,356 | 2,356 | — | — | ||||||||||||
|
Total Redwood obligations and
commitments
|
$ | 178,868 | $ | 174,089 | $ | 2,829 | $ | 1,950 | ||||||||
|
Obligations of securitization
entities:
|
||||||||||||||||
|
Consolidated asset-backed securities
|
$ | 15,585,277 | $ | — | $ | — | $ | 15,585,277 | ||||||||
|
Accrued interest payable
|
40,047 | 40,047 | — | — | ||||||||||||
|
Total obligations of securitization
entities
|
$ | 15,625,324 | $ | 40,047 | $ | — | $ | 15,585,277 | ||||||||
|
Total consolidated obligations and
commitments
|
$ | 15,804,192 | $ | 214,136 | $ | 2,829 | $ | 15,587,227 | ||||||||
| Note: All consolidated ABS issued are collateralized by associated assets and, although the stated maturity is as shown, the ABS obligations will pay down as the principal of the associated real estate loans or securities pay down. |
| MARKET RISKS |
| We seek to manage the risks inherent in our business — including but not limited to credit risk, interest rate risk, prepayment risk, and market value risk — in a prudent manner designed to insure Redwood’s longevity. At the same time, we endeavor, to the best of our ability, to provide our stockholders with both a steady regular dividend and an attractive long-term return. In general, we seek to assume risks that can be quantified from historical experience, to actively manage such risks, to earn sufficient compensation to justify the taking of such risks, and to maintain capital levels consistent with the risks we do take. |
| Credit Risk |
| Our core business is assuming the credit risk of real estate loans. | |
| We assume credit risk with respect to residential and commercial real estate loans primarily through the ownership of residential and commercial loan CES and similarly structured securities acquired from securitizations sponsored by others and from Sequoia securitizations sponsored |
48
49
by us. These securities have below investment-grade credit
ratings due to their high degree of credit risk with respect to
the residential real estate loans within the securitization
entities that issued these securities. Credit losses from any of
the loans in the securitized loan pools reduce the principal
value of and economic returns from residential loan CES. We
assume credit risk with respect to commercial real estate loan
through the ownership of commercial loan CES acquired from
securitizations sponsored by others.
We are highly leveraged in an economic sense due to the
structured leverage within the securities we own, as the amount
of residential and commercial real estate loans on which we take
“first-loss” risk is high relative to our equity
capital base. However, we do not use debt to fund these assets
and our maximum credit loss from these assets (excluding loans
and securities held temporarily as inventory for securitization)
is limited and is less than our equity capital base. The
majority of our credit risk comes from high-quality residential
real estate loans. This includes residential real estate loans
consolidated from ABS securitizations from which we have
acquired a credit-sensitive ABS security, and loans we
effectively “guarantee” or “insure” through
the acquisitions of residential loan CES from
securitizations sponsored by others. We are also exposed to
credit risks in our commercial real estate loan portfolio, the
“first-loss” commercial real estate securities we own,
our other residential and commercial real estate securities, and
with counter-parties with whom we do business.
Credit losses on residential real estate loans can occur for
many reasons, including: poor origination practices; fraud;
faulty appraisals; documentation errors; poor underwriting;
legal errors; poor servicing practices; weak economic
conditions; decline in the value of homes; special hazards;
earthquakes and other natural events; over-leveraging of the
borrower; changes in legal protections for lenders; reduction in
personal incomes; job loss; and personal events such as divorce
or health problems. In addition, if the U.S. economy or the
housing market weakens, our credit losses could be increased
beyond levels that we have anticipated. The interest rate is
adjustable for most of the loans securitized by securitization
trusts sponsored by us and for a portion of the loans underlying
residential loan CES we have acquired from securitizations
sponsored by others. Accordingly, when short-term interest rates
rise, required monthly payments from homeowners will rise under
the terms of these ARMs, and this may increase borrowers’
delinquencies and defaults. In addition, a portion of the loans
we credit-enhance are interest-only and negative amortization
loans, which may have special credit risks.
In the fourth quarter, we continued to acquire
credit-enhancement securities backed by negative amortization
adjustable-rate loans made to high-quality residential
borrowers. Even though most of these loans are made to
high-quality borrowers who make substantial down payments and do
not need a negative amortization feature in order to afford
their home, we still expect significantly higher delinquencies
and losses from these loans compared to regular amortization
loans. Nevertheless, we believe we have a good chance of
generating attractive risk-adjusted returns on these investments
as a result of the way the securitizations of these riskier loan
types are structured and because of attractive acquisition
pricing of these credit-enhancement securities. Although
seemingly attractive, there is substantial uncertainty about the
future performance of these assets. As a result, we will limit
our overall investment in these credit-enhancement securities.
Credit losses on commercial real estate loans can occur for many
reasons, including: poor origination practices; fraud; faulty
appraisals; documentation errors; poor underwriting; legal
errors; poor servicing practices; weak economic conditions;
decline in the value of the property; special hazards;
earthquakes and other natural events; over-leveraging of the
property; changes in legal protections for lenders; reduction in
market rents and occupancies and poor property management
practices. In addition, if the U.S. economy weakens, our
credit losses could be increased beyond levels that we have
anticipated. The large majority of the commercial loans we
credit-enhance are fixed-rate loans with required amortization.
A small number of loans are interest-only loans for the entire
term or a portion thereof, which may have special credit risks.
In addition to residential and commercial loan CES, the
Acacia entities we also sponsor own investment-grade and other
securities (typically rated AAA through B, and in a second-loss
position or better, or otherwise effectively more senior in the
credit structure as compared to a
50
residential loan CES or commercial loan CES or
equivalent held by us) issued by residential securitization
entities that are sponsored by others. Generally, we do not
control or influence the underwriting, servicing, management, or
loss mitigation efforts with respect to these assets. Some of
the securities Acacia owns are backed by sub-prime residential
loans that have substantially higher risk characteristics than
prime-quality loans. These lower-quality residential loans can
be expected to have higher rates of delinquency and loss, and
losses to Acacia (and thus Redwood interest in) could occur.
Most of Acacia’s securities are reported as part of our
consolidated securities portfolio on our Consolidated Balance
Sheets. Acacia has also acquired investment-grade BB-rated, and
B-rated residential loan securities from the Sequoia
securitization entities we have sponsored. The probability of
incurring a credit loss on these securities is less than the
probability of loss from first-loss residential loan CES
and commercial loan CES, as cumulative credit losses within
a pool of securitized loans would have to exceed the principal
value of the subordinated CES (and exhaust any other credit
protections) before losses would be allocated to the Acacia
securities. If the pools of residential and commercial loans
underlying these securities were to experience poor credit
results, however, these Acacia securities could have their
credit ratings down-graded, could suffer losses in market value,
or could experience principal losses. If any of these events
occurs, it would likely reduce our returns from the Acacia CDO
equity securities we have acquired and may reduce our ability to
sponsor Acacia transactions in the future.
Interest Rate Risk
Our strategy is to maintain an asset/liability posture on a
consolidated basis that is effectively match-funded so that the
achievement of our long-term goals is unlikely to be affected by
changes in interest rates. This includes assets owned and the
ABS issued by consolidated securitization entities, to the
extent that any mismatches within the entities could affect our
cash flows. We use interest-rate agreements so that the interest
rate characteristics of the ABS issued by consolidated
securitization entities, as adjusted for outstanding interest
rate agreements, closely matches the interest rate
characteristics of the assets owned by those entities. Overall,
we believe we maintain a close match between the interest rate
characteristics of Redwood debt and the pledged assets. For most
of our debt-funded assets (assets acquired for future sale to
sponsored securitization entities or to other financial
institutions as whole loans), the floating rate nature of our
debt closely matches the adjustable-rate interest income earning
characteristics of the accumulated assets. Not all of the
accumulated assets we acquire are adjustable-rate. We also
acquire fixed rate and hybrid rate securities for
re-securitization through our Acacia CDO program, and we may
acquire hybrid rate residential real estate loans in the future
for our Sequoia securitization program. We typically use
interest rate agreements to hedge associated interest rate
mismatches when the assets we accumulate for future
securitizations do not match the interest rate characteristics
of our debt.
At December 31, 2005, we consolidated $14.9 billion
adjustable-rate ABS collateralized by adjustable-rate assets and
$0.7 billion fixed/hybrid rate ABS collateralized by
consolidated fixed/hybrid rate assets. We owned the IO security,
CDO equity, or similar security that economically benefits from
the spread between the assets and the liabilities of the issuing
securitization entity on a portion ($11.5 billion) of these
consolidated entities. These assets and liabilities are closely
matched economically and to the degree there is a mismatch we
attempt to reduce this mismatch through the use of interest rate
agreements. For the remainder of the consolidated ABS entities
($4.1 billion), we do not own the security that benefits
from the asset/liability spread. Thus, spread changes between
the yield of these assets and the cost of these liabilities do
not affect our economic profits or cash flow. Thus, we do not
utilize interest rate agreements with respect to interest rate
mismatches that may exist between these assets and liabilities
on these other consolidated ABS entities.
The remainder of our consolidated assets at December 31,
2005 ($233 million six-month adjustable-rate assets,
$24 million short-term fixed rate assets, $517 million
hybrid and fixed-rate assets, and $161 million non-earning
assets) were funded, for interest rate matching purposes,
effectively with equity.
51
Prepayment Risk
We seek to maintain an asset/liability posture that benefits
from investments in prepayment-sensitive assets while limiting
the risk of adverse prepayment fluctuations to an amount that,
in most circumstances, can be absorbed by our capital base while
still allowing us to make regular dividend payments.
Prepayments affect GAAP earnings in the near-term primarily
through the timing of the amortization of purchase premium and
discount. Amortization income from discount assets may not
necessarily offset amortization expense from premium assets, and
vice-versa. Variations in current and projected prepayment rates
for individual assets and changes in short-term interest rates
(as they affect projected coupons on ARMs and thus change
effective yield calculations on certain loans) may cause net
premium amortization expense or net discount amortization income
to vary substantially from quarter to quarter. In addition, the
timing of premium amortization on assets may not always match
the timing of the premium amortization taken to income on
liabilities even when the underlying assets are the same (i.e.,
the prepayments are identical).
We believe there is a relatively low likelihood of prepayment
risk events occurring within our securitization inventory
assets, as we typically sell these loans within a few months of
acquiring them. However, changes in prepayment forecasts by
market participants could affect the market prices for ABS
(especially IO securities) sold by these securitization
entities, and thus could affect the gain on sale for economic
and tax purposes (not for GAAP purposes since these are
accounted for as financings) that we seek to earn from
sponsoring these securitizations.
There are prepayment risks in the assets and associated
liabilities consolidated on our balance sheets. In general,
discount securities (such as CES) benefit from faster prepayment
rates on the underlying real estate loans and premium securities
(such as IO securities) benefit from slower prepayments on the
underlying loans. Our largest current potential exposure to
increases in prepayment rates is from short-term residential ARM
loans. However, as of December 31, 2005, our premium
balances on IO securities backed by ARM loans were less than our
discount balances on residential loan CES backed by ARM
loans. As a result, we believe that as of December 31,
2005, we are biased in favor of faster prepayment speeds with
respect to the long-term economic effect of ARM prepayments.
However, in the short-term, for GAAP, changes in ARM prepayment
rates could cause GAAP earnings volatility.
ARM prepayment rates are driven by many factors, one of which is
the steepness of the yield curve. As the yield curve flattens
(short-term interest rates rise relative to longer-term interest
rates), ARM prepayments typically increase. Prepayment rates on
the ARMs underlying the Redwood-sponsored Sequoia
securitizations increased from near 25% to nearly 50% over the
last year as the yield curve flattened.
Through our ownership of discount residential loan CES
backed by fixed rate and hybrid residential loans, we generally
benefit from faster prepayments on fixed and hybrid loans.
Prepayment rates for these loans typically accelerate as
medium-and-long-term interest rates decline.
Prepayments can also affect our credit results and risks. Credit
risks for the CES we own are reduced each time a loan prepays.
All other factors being equal, faster prepayment rates should
reduce our credit risks on our existing portfolio.
Market Value Risk
At December 31, 2005, we reported on a consolidated basis
$2.4 billion assets that were
marked-to-market
through our balance sheet (i.e., available for sale securities)
but not through our income statement. Of these assets, 59% had
adjustable-rate coupons, 18% had hybrid coupon rates, and the
remaining 23% had fixed coupon rates. Many of these assets are
credit-sensitive. Market value fluctuations of these assets can
affect the balance of our stockholders’ equity base. Market
value fluctuations for our securities can affect not only our
earnings and
52
book value, but also our liquidity, especially to the extent
these assets may be funded with short-term debt prior to
securitization.
Most of our consolidated real estate assets are loans accounted
for as held-for-investment and reported at cost. Although these
loans have generally been sold to Sequoia entities at
securitization and, thus, changes in the market value of the
loans do not have an impact on our liquidity in the long-term,
changes in market value during the accumulation period (while
these loans are funded with debt) may have a short-term effect
on our liquidity.
We use interest rate agreements to manage certain interest rate
risks. Our interest rate agreements are reported at market
value, with any periodic changes reported through either our
income statement or in our balance sheet. Adverse changes in the
market values of our interest rate agreements (which would
generally be caused by falling interest rates) may require us to
devote additional amounts of cash to margin calls.
Inflation Risk
Virtually all of our consolidated assets and liabilities are
financial in nature. As a result, changes in interest rates and
other factors drive our performance far more than does
inflation. Changes in interest rates do not necessarily
correlate with inflation rates or changes in inflation rates.
Our financial statements are prepared in accordance with GAAP
and, as a REIT, our dividends must equal at least 90% of our net
REIT taxable income as calculated for tax purposes. In each
case, our activities and balance sheet are measured with
reference to historical cost or fair market value without
considering inflation.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with GAAP
requires us to make estimates and assumptions that affect the
reported amounts of certain assets and liabilities at the date
of the consolidated financial statements and the reported
amounts of certain revenues and expenses during the reported
period. Actual results could differ from those estimates. The
critical accounting policies and how changes in estimates might
affect our financial results and statements are discussed below.
Management discusses the ongoing development and selection of
these critical accounting policies with the Audit Committee of
the Board of Directors.
In recent weeks we have become aware of a potential technical
interpretation of GAAP that differs from our current accounting
presentations. We have not changed our accounting treatment for
this potential issue. However, if we were to change our current
accounting presentations based on this interpretation we do not
believe there would be a material impact on our net income or
balance sheets. This issue relates to the accounting for
transactions where assets are purchased from a counterparty and
simultaneously financed through a repurchase agreement with that
same counterparty and whether these transactions create
derivatives instead of the acquisition of assets with related
financing (which is how we currently present these
transactions). This potential technical interpretation of GAAP
does not affect the economics of the transactions but may affect
how the transactions would be reported in our financial
statements. Our cash flows, our liquidity, and our ability to
pay a dividend would be unchanged, and we do not believe our
taxable income would be affected.
Revenue Recognition
When recognizing revenue on consolidated earning assets, we
employ the interest method and determine an effective yield to
account for purchase premiums, discounts, and other net
capitalized fees or costs associated with purchasing and
financing real estate loans and securities. For consolidated
real estate loans, the interest method is applied as prescribed
under FAS 91. For loans acquired prior to July 1,
2004, the interest method or effective yield is determined using
interest rates as they change over time and future anticipated
principal prepayments. For loans acquired subsequent to that
date, the initial interest rate of the loans and future
anticipated principal prepayments are used in determining the
effective yield. For our
53
consolidated securities, the interest method to determine an
effective yield is applied as prescribed under FAS 91 or
EITF 99-20 using anticipated principal prepayments. The use
of these methods requires us to project cash flows over the
remaining life of each asset. These projections include
assumptions about interest rates, prepayment rates, timing and
amount of credit losses, when certain tests will be met that may
allow for changes in payments made under the structure of
securities, estimates regarding the likelihood and timing of
calls of securities at par, and other factors. We review our
cash flow projections on an ongoing basis and monitor these
projections based on input and analyses received from external
sources, internal models, and our own judgment and experience.
We constantly review our assumptions and make adjustments to the
cash flows as deemed necessary. There can be no assurance that
our assumptions used to generate future cash flows, or the
current period’s yield for each asset, will prove to be
accurate.
Under the interest method, decreases in our credit loss
assumptions embedded in our cash flow forecasts could result in
increasing yields being recognized from residential
loan CES. In addition, faster-than-anticipated prepayment
rates would also tend to increase realized yields over the
remaining life of an asset. In contrast, increases in our credit
loss assumptions and/or slower than anticipated prepayment rates
could result in lower yields being recognized under the interest
method and may represent an other-than-temporary impairment
under GAAP, in which case the asset may be written down to its
fair value through our Consolidated Statements of Income.
Redwood applies APB 21 and APB 12 in determining its
periodic amortization for the premium on its debt, including the
issuance of IO securities and deferred bond issuance cost
(DBIC). We arrive at a periodic interest cost that represents a
level effective rate on the sum of the face amount of the ABS
issued and (plus or minus) the unamortized premium or discount
at the beginning of each period. The difference between the
periodic interest cost so calculated and the nominal interest on
the outstanding amount of the ABS issued is the amount of
periodic amortization. Prepayment assumptions used in modeling
the underlying assets to determine accretion or amortization of
discount or premium are used in developing the liability cash
flows that are used to determine ABS issued premium amortization
and DBIC expenses.
Establishing Valuations and Accounting for Changes in
Valuations
Valuation adjustments to real estate loans held-for-sale are
reported as net recognized losses and valuation adjustments on
our Consolidated Statements of Income in the applicable period
of the adjustment. Adjustments to the fair value of securities
available-for-sale are reported through our Consolidated Balance
Sheets as a component of accumulated other comprehensive income
in stockholders’ equity within the cumulative unrealized
gains and losses classified as accumulated other comprehensive
income. The exception to this treatment of securities
available-for-sale is when a specific impairment is identified
or a decrease in fair value results from a decline in estimated
cash flows that is considered other-than-temporary. In such
cases, the resulting decrease in fair value is recorded in net
recognized gains (losses) and valuation adjustments on our
Consolidated Statements of Income in the applicable period of
the adjustment.
We estimate fair value of assets and interest rate agreements
using available market information and other appropriate
valuation methodologies. We believe estimates we use reflect
market values we may be able to receive should we choose to sell
assets. Our estimates are inherently subjective in nature and
involve matters of uncertainty and judgment in interpreting
relevant market and other data. Many factors are necessary to
estimate market values, including, but not limited to, interest
rates, prepayment rates, amount and timing of credit losses,
supply and demand, liquidity, and other market factors. We apply
these factors to each of our assets, as appropriate, in order to
determine market values. Residential real estate loans
held-for-sale are generally valued on a pool basis while
commercial real estate loans held-for-sale and securities
available-for-sale are valued on an asset-specific basis.
We review our fair value calculations on an ongoing basis. We
monitor the critical performance factors for each loan and
security. Our expectations of future performance are shaped by
input
54
and analyses received from external sources, internal models,
and our own judgment and experience. We review our existing
assumptions relative to our and the market’s expectations
of future events and make adjustments to the assumptions that
may change our market values. Changes in perceptions regarding
future events can have a material impact on the value of our
assets. Should such changes or other factors result in
significant changes in the market values, our net income and
book value could be adversely affected.
In addition to our valuation processes, we are active acquirers
and occasional sellers of assets on our Consolidated Balance
Sheets. Thus, we believe that we have the ability to understand
and determine changes in assumptions that are taking place in
the marketplace and make appropriate changes in our assumptions
for valuing assets. In addition, we use third party sources to
validate our valuation estimates.
There are certain other valuation estimates we make that have an
impact on current period income and expense. One such area is
the valuation of certain equity grants. For equity awards
granted prior to January 1, 2003, we use the principles
provided by APB 25, Interest on Receivables and
Payables. For all subsequent awards, FAS 123 applies.
Furthermore, FAS 123R will become the appropriate principle
January 1, 2006.
Credit Reserves
For consolidated residential and commercial real estate loans
held-for-investment, we establish and maintain credit reserves
that we believe represent probable credit losses that will
result from inherent losses existing in our consolidated
residential and commercial real estate loans held for investment
as of the date of the financial statements. The reserves for
credit losses are adjusted by taking provisions for credit
losses recorded as a reduction in interest income on residential
and commercial real estate loans on our Consolidated Statements
of Income. The reserves consist of estimates of specific loan
impairment and estimates of collective losses on pools of loans
with similar characteristics.
To calculate the credit reserve for credit losses for
residential real estate loans and HELOCs, we determine inherent
losses by applying loss factors (default, the timing of
defaults, and the loss severity upon default) that can be
specifically applied to each pool of loans. The following
factors are considered and applied in such determination:
•
On-going analysis of the pool of loans, including, but not
limited to, the age of the loans, underwriting standards,
business climate, economic conditions, geographic
considerations, and other observable data;
•
Historical loss rates and past performance of similar loans;
•
Relevant environmental factors;
•
Relevant market research and publicly available third-party
reference loss rates;
•
Trends in delinquencies and charge-offs;
•
Effects and changes in credit concentrations;
•
Prepayment assumptions.
Once we determine the applicable default rate, the timing of
defaults, and the severity of loss upon the default, we estimate
the expected losses of each pool of loans over their expected
lives. We then estimate the timing of these losses and the
losses probable to occur over an effective loss confirmation
period. This period is defined as the range of time between the
probable occurrence of a credit loss (such as the initial
deterioration of the borrower’s financial condition) and
the confirmation of that loss (the actual charge-off of the
loan). The losses expected to occur within the effective loss
confirmation period are the basis of our credit reserves because
we believe those losses exist as of the reported date of the
financial statements. We re-evaluate the level of our credit
reserves on at least a quarterly basis and record provision,
charge-offs, and recoveries monthly.
The credit reserve for credit losses for the commercial real
estate loans includes a detailed analysis of each loan and
underlying property. The following factors are considered and
applied in such determination.
55
•
On-going analysis of each individual loan, including, but not
limited to, the age of the loans, underwriting standards,
business climate, economic conditions, geographic
considerations, and other observable data;
•
On-going evaluation of fair values of collateral using current
appraisals and other valuations;
•
Discounted cash flow analysis;
•
Borrower’s ability to meet obligations.
If residential loan becomes REO or a commercial loan becomes
impaired, or loans are reclassified as held-for-sale, specific
valuations are primarily based on analyses of the underlying
collateral.
Residential and commercial loan CES are the securities
issued by an ABS securitization entity that bear most of the
initial credit risk of the underlying pool of loans that was
securitized. As a result of the relatively high credit risks of
these investments, we are able to purchase residential and
commercial loan CES at a discount to principal
(par) value. A portion of the purchase discount is
subsequently accreted as interest income under the interest
method while the remaining portion of the purchase discount is
considered as a form of credit protection. The amount of credit
protection is based upon our assessment of various factors
affecting our assets, including economic conditions,
characteristics of the underlying loans, delinquency status,
past performance of similar loans, and external credit
protection. We use a variety of internal and external credit
risk analyses, cash flow modeling, and portfolio analytical
tools to assist us in our assessments. If cumulative credit
losses in the underlying pool of loans exceed the principal
value of the first-loss piece, we may never receive a principal
payment from that security. The maximum loss for the owner of
these securities, however, is limited to the investment made in
purchasing the CES. In addition to the amount of losses, the
timing of future credit losses is also important. In general,
the longer credit losses are delayed, the better our economic
returns, as we continue to earn coupon interest on the face
value of our security.
Accounting for Derivative Instruments (Interest Rate
Agreements)
We use derivative instruments to manage certain risks such as
market value risk and interest rate risk. Currently, the
majority of our interest rate agreements are used to match the
duration of liabilities to assets. The derivative instruments we
employ include, but are not limited to, interest rate swaps,
interest rate options, options on swaps, futures contracts,
options on futures contracts, options on forward purchases, and
other similar derivatives. We collectively refer to these
derivative instruments as “interest rate agreements”.
On the date an interest rate agreement is entered into, we
designate each interest rate agreement under GAAP as (1) a
hedge of the fair value of a recognized asset or liability or of
an unrecognized firm commitment (fair value hedge), (2) a
hedge of a forecasted transaction or of the variability of cash
flows to be received or paid related to a recognized asset or
liability (cash flow hedge), or (3) held for trading
(trading instrument).
We currently elect to account for most of our interest rate
agreements as cash flow hedges; the remainder are accounted for
as trading instruments. We record these derivatives at their
estimated fair market values, and record changes in their fair
values in accumulated other comprehensive income on our
Consolidated Balance Sheets. These amounts are reclassified to
our Consolidated Statements of Income over the effective hedge
period as the hedged item affects earnings. Any ineffective
portions of these cash flow hedges are included in our
Consolidated Statements of Income, and any changes in the market
value on our hedges designated as trading instruments.
We may discontinue GAAP hedge accounting prospectively when we
determine that (1) the derivative is no longer effective in
offsetting changes in the fair value or cash flows of a hedged
item; (2) it is no longer probable that the forecasted
transaction will occur; (3) a hedged firm commitment no
longer meets the definition of a firm commitment; or
(4) designating the derivative as a hedging instrument is
no longer appropriate. A discontinued hedge may result in
recognition of certain gains or losses immediately through our
Consolidated Statements of Income, or such gains or losses may
be accreted from accumulated other comprehensive income into
earnings over the original hedging period.
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Item 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We provide a discussion about market risks in Item 7 of
this Annual Report on
Form 10-K. To
supplement these discussions, the table below incorporates
information that may be useful in analyzing certain market value
risks on our Consolidated Balance Sheets. This table presents
just one scenario regarding potential future principal
prepayments and interest rates of our assets and liabilities,
based on certain underlying assumptions. There can be no
assurance that assumed events will occur as anticipated. Future
sales, principal repayments, acquisitions, calls, and
restructuring could materially change our interest rate risk
profile.
For our interest-rate sensitive assets, the table presents
principal cash flows and related average interest rates by year
of repayment. The forward curve (future interest rates as
implied by the yield structure of debt markets) as of
December 31, 2005 was used to project the average coupon
rates for each year presented, based on the existing
characteristics of our portfolio. The timing of principal cash
flows includes assumptions on the prepayment speeds of these
assets based on their recent prepayment performance and future
prepayment performance consistent with this interest rate
scenario. Actual prepayment speeds will likely vary
significantly from these assumptions. Furthermore, this table
does not include anticipated credit losses and assumes all of
the principal we are entitled to receive will be received. The
actual amount and timing of credit losses will affect the
principal payments and effective rates during all periods.
However, in determining the fair market values of many of these
assets, potential credit losses are included.
As discussed throughout this Annual Report on
Form 10-K, our
future earnings are sensitive to a number of factors and changes
in these factors may have a variety of secondary effects that,
in turn, will also impact our earnings. In addition, one of the
key factors in projecting our income is the reinvestment rate on
new assets and there is no reinvestment assumed in this table.
The information provided in this table is based on our existing
portfolio at December 31, 2005 under one set of assumptions.
The composition of our balance sheet and the set of assumptions
used at December 31, 2005, differs slightly from those used
at December 31, 2004, and, as a result, the presentation of
the tabular information presented this year differs from a year
ago. The balance of residential loans is lower and we now also
consolidate hybrid loans and the balance of securities is
greater. The assumptions we use reflect the market conditions at
the date of the financial statements, so the future interest
rates assumed and corresponding prepayment speeds used to
project the cash flows differ from those used a year ago.
However, the overall results are similar in that our future
results still depend greatly on the credit performance of the
underlying loans (although the tabular information assumes no
credit losses), future interest rates (as many of our assets are
adjustable-rate), and prepayment behavior on residential
mortgages.
| At December 31, 2005 | ||||||||||||||||||||||||||||||||||||||
| (All dollars in thousands) | Principal Amounts Maturing and Effective Rates During Period | |||||||||||||||||||||||||||||||||||||
| Principal | Carrying | |||||||||||||||||||||||||||||||||||||
| Interest Rate Sensitive Assets | 2006 | 2007 | 2008 | 2009 | 2010 | Thereafter | Value | Value | Fair Value | |||||||||||||||||||||||||||||
|
Residential Real Estate
Loans
|
||||||||||||||||||||||||||||||||||||||
|
Adjustable Rate
|
Principal | 3,402,800 | 2,559,432 | 1,925,675 | 1,452,875 | 1,087,801 | 3,113,746 | 13,542,329 | 13,695,889 | 13,625,263 | ||||||||||||||||||||||||||||
| Interest Rate | 5.85% | 6.01% | 5.99% | 6.04% | 6.10% | 6.47% | 101.13% | 99.48% | ||||||||||||||||||||||||||||||
|
Hybrid
|
Principal | 41,401 | 30,849 | 23,045 | 17,338 | 12,918 | 51,362 | 176,913 | 178,903 | 169,250 | ||||||||||||||||||||||||||||
| Interest Rate | 4.10% | 4.10% | 4.46% | 5.87% | 6.84% | 7.41% | 101.13% | 94.60% | ||||||||||||||||||||||||||||||
|
Residential Loan-Credit
Enhancement Securities
|
||||||||||||||||||||||||||||||||||||||
|
Adjustable Rate
|
Principal | 50,246 | 77,472 | 97,230 | 101,287 | 77,431 | 248,372 | 652,038 | 381,283 | 381,283 | ||||||||||||||||||||||||||||
| Interest Rate | 5.91% | 6.06% | 6.18% | 6.39% | 7.45% | 8.46% | 58.48% | 58.48% | ||||||||||||||||||||||||||||||
|
Fixed
|
Principal | 3,216 | 2,946 | 3,108 | 3,561 | 4,828 | 29,512 | 47,171 | 30,035 | 30,035 | ||||||||||||||||||||||||||||
| Interest Rate | 6.00% | 5.97% | 5.96% | 5.95% | 5.96% | 5.86% | 63.67% | 63.67% | ||||||||||||||||||||||||||||||
|
Hybrid
|
Principal | 31,913 | 47,102 | 60,019 | 50,105 | 36,922 | 110,604 | 336,665 | 201,331 | 201,331 | ||||||||||||||||||||||||||||
| Interest Rate | 4.78% | 4.94% | 5.30% | 5.94% | 6.49% | 7.42% | 59.80% | 59.80% | ||||||||||||||||||||||||||||||
|
Commercial Real Estate
Loans
|
||||||||||||||||||||||||||||||||||||||
|
Adjustable Rate
|
Principal | 15,168 | 4,250 | — | 9,500 | N/A | N/A | 28,918 | 20,640 | 21,205 | ||||||||||||||||||||||||||||
| Interest Rate | 8.08% | 6.78% | 7.24% | 7.29% | N/A | N/A | 71.37% | 73.33% | ||||||||||||||||||||||||||||||
|
Fixed
|
Principal | 4,500 | — | — | 11,993 | 9,367 | 15,313 | 41,173 | 39,052 | 39,991 | ||||||||||||||||||||||||||||
| Interest Rate | 8.25% | 7.61% | 7.61% | 7.61% | 5.62% | 5.81% | 94.85% | 97.13% | ||||||||||||||||||||||||||||||
|
Commercial
Loan CES
|
||||||||||||||||||||||||||||||||||||||
|
Fixed
|
Principal | — | — | — | — | — | 175,343 | 175,343 | 57,687 | 57,687 | ||||||||||||||||||||||||||||
| Interest Rate | 4.95% | 4.95% | 4.95% | 4.95% | 4.95% | 4.86% | 32.90% | 32.90% | ||||||||||||||||||||||||||||||
|
Securities Portfolio
|
||||||||||||||||||||||||||||||||||||||
|
Adjustable Rate
|
Principal | 103,684 | 192,429 | 154,603 | 115,370 | 92,002 | 392,084 | 1,050,172 | 1,041,358 | 1,041,358 | ||||||||||||||||||||||||||||
| Interest Rate | 5.99% | 6.04% | 5.95% | 5.97% | 6.02% | 6.31% | 99.16% | 99.16% | ||||||||||||||||||||||||||||||
|
Fixed
|
Principal | 11,328 | 25,809 | 26,753 | 26,538 | 16,838 | 405,666 | 512,932 | 465,401 | 465,401 | ||||||||||||||||||||||||||||
| Interest Rate | 5.58% | 5.67% | 5.65% | 5.75% | 5.88% | 6.05% | 90.73% | 90.73% | ||||||||||||||||||||||||||||||
|
Hybrid
|
Principal | 20,939 | 30,537 | 50,550 | 39,784 | 28,461 | 76,771 | 247,042 | 241,822 | 241,822 | ||||||||||||||||||||||||||||
| Interest Rate | 5.39% | 5.40% | 5.75% | 6.08% | 6.58% | 7.23% | 97.89% | 97.89% | ||||||||||||||||||||||||||||||
57
| At December 31, 2005 | ||||||||||||||||||||||||||||||||||||||
| (All dollars in thousands) | Principal Amounts Maturing and Effective Rates During Period | |||||||||||||||||||||||||||||||||||||
| Principal | Carrying | |||||||||||||||||||||||||||||||||||||
| Interest Rate Sensitive Liabilities | 2006 | 2007 | 2008 | 2009 | 2010 | Thereafter | Value | Value | Fair Value | |||||||||||||||||||||||||||||
|
SHORT-TERM DEBT
|
||||||||||||||||||||||||||||||||||||||
|
Reverse Repurchase Agreements
|
Principal | 169,707 | N/A | N/A | N/A | N/A | N/A | 169,707 | 169,707 | 169,707 | ||||||||||||||||||||||||||||
|
and Bank Warehouse Facilities
|
Interest Rate | 5.05% | N/A | N/A | N/A | N/A | N/A | 100% | 100% | |||||||||||||||||||||||||||||
|
ASSET-BACKED SECURITIES
ISSUED
|
||||||||||||||||||||||||||||||||||||||
|
Fixed Rate ABS Securities Issued
|
Principal | 2,457 | 1,826 | 1,356 | 5,536 | 1,017 | 13,988 | 26,180 | 26,180 | 25,650 | ||||||||||||||||||||||||||||
| Interest Rate | 6.04% | 6.08% | 6.01% | 6.01% | 6.07% | 15.92% | 100% | 97.98% | ||||||||||||||||||||||||||||||
|
Variable Rate ABS Securities Issued
|
Principal | 3,387,179 | 2,530,939 | 1,928,906 | 1,490,578 | 1,183,581 | 4,874,469 | 15,395,652 | 15,559,097 | 15,493,733 | ||||||||||||||||||||||||||||
| Interest Rate | 5.01% | 5.09% | 5.10% | 5.17% | 5.29% | 5.94% | 101.06% | 100.64% | ||||||||||||||||||||||||||||||
|
INTEREST RATE
AGREEMENTS
|
||||||||||||||||||||||||||||||||||||||
|
Interest Rate
Cap/Corridors
|
Notional Amount | 212,046 | 514,025 | 315,779 | 2,600 | 4,400 | 62,400 | 1,111,250 | 1,674 | 1,674 | ||||||||||||||||||||||||||||
|
(Purchased/Sold)
|
Buy Strike Rate | 11.29% | 11.27% | 11.38% | 4.75% | 6.00% | 6.20% | |||||||||||||||||||||||||||||||
| Receive Strike Rate | 12.25% | 12.22% | 12.41% | N/A | N/A | N/A | ||||||||||||||||||||||||||||||||
|
Interest Rate Swaps
|
Notional Amount | 4,659,432 | 52,121 | 150,091 | 148,750 | 109,458 | 360,201 | 5,480,053 | 29,039 | 29,039 | ||||||||||||||||||||||||||||
|
(Purchased)
|
Receive Strike Rate | 4.51% | 4.54% | 4.67% | 4.61% | 4.72% | 4.96% | |||||||||||||||||||||||||||||||
| Pay Strike Rate | 4.18% | 4.51% | 4.50% | 4.83% | 4.88% | 4.63% | ||||||||||||||||||||||||||||||||
58
59
Item 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of Redwood Trust, Inc. and
Notes thereto, together with the Reports of Independent
Registered Public Accounting Firm thereon, are set forth on
pages F-1 through
F-46 of this Annual
Report on
Form 10-K and
incorporated herein by reference.
Item 9.
CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On June 24, 2005, we retained Grant Thornton LLP as the
Company’s independent registered public accounting firm
effective for 2005. Grant Thornton LLP replaced
PricewaterhouseCoopers LLP which we had retained to audit our
financial statements for years prior to 2005. On May 5,
2005 and June 24, 2005, we filed current reports on
Form 8-K to report
this change. There were no disagreements with
PricewaterhouseCoopers on any accounting, financial statement
disclosure, or auditing matters.
Item 9A.
CONTROLS AND PROCEDURES
We have carried out an evaluation, under the supervision and
with the participation of our management including our principal
executive officer and principal financial officer, of the
effectiveness of the design and operation of our disclosure
controls and procedures, as that term is defined in
Rules 13a-15(e) under the Securities Exchange Act of 1934,
as amended. Based on that evaluation, our principal executive
officer and principal financial officer concluded that as of
December 31, 2005, which is the end of the period covered
by this Annual Report on Form 10-K, our disclosure controls and
procedures are effective.
There have been no changes in our internal controls over
financial reporting in the fiscal quarter ended
December 31, 2005 that have materially affected, or are
reasonably likely to materially affect, our internal control
over financial reporting.
Management has issued its report on internal control over
financial reporting, concluding that our internal control over
financial reporting is effective, which appears on page F-3 of
this Annual Report on Form 10-K. The report of the
Independent Registered Public Accounting Firm on
Management’s Report on of Internal Control over Financial
Reporting appears on page F-4 referenced in Item 8 of this
Annual Report on Form 10-K.
Item 9B.
OTHER INFORMATION
There is no information required to be disclosed in a report on
Form 8-K during
the fourth quarter of the year covered by this Annual Report on
Form 10-K that has
not been so reported.
60
Item 10.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is incorporated herein
by reference to the definitive Proxy Statement to be filed with
the SEC pursuant to Regulation 14A within 120 days
after the end of the fiscal year covered by this Annual Report
on Form 10-K.
Item 11.
EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein
by reference to the definitive Proxy Statement to be filed with
the SEC pursuant to Regulation 14A within 120 days
after the end of the fiscal year covered by this Annual Report
on Form 10-K.
Item 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required by Item 12 is incorporated herein
by reference to the definitive Proxy Statement to be filed with
the SEC pursuant to Regulation 14A within 120 days
after the end of the fiscal year covered by this Annual Report
on Form 10-K.
Item 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein
by reference to the definitive Proxy Statement to be filed with
the SEC pursuant to Regulation 14A within 120 days
after the end of the fiscal year covered by this Annual Report
on Form 10-K.
Item 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by Item 14 is incorporated herein
by reference to the definitive Proxy Statement to be filed with
the SEC pursuant to Regulation 14A within 120 days
after the end of the fiscal year covered by this Annual Report
on Form 10-K.
Item 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Documents filed as part of this report:
(1)
Consolidated Financial Statements and Notes thereto
(2)
Schedules to Consolidated Financial Statements:
All Consolidated Financial Statements schedules not included
have been omitted because they are either inapplicable or the
information required is provided in the Company’s
Consolidated Financial Statements and Notes thereto, included in
Part II, Item 8, of this Annual Report on
Form 10-K.
| Exhibit | ||||
| Number | Exhibit | |||
| 3 | .1 | Articles of Amendment and Restatement of the Registrant, effective July 6, 1994 (Incorporated by reference to the Registrant’s Registration Statement on Form S-11 (No. 333-08363), Exhibit 3.1, filed on July 18, 1996) | ||
| 3 | .1.1 | Articles Supplementary of the Registrant, effective August 11, 1994 (Incorporated by reference to the Registrant’s Registration Statement on Form S-11 (No. 33-92272), Exhibit 3.2, filed on May 19, 1995) | ||
| 3 | .1.2 | Articles Supplementary of the Registrant, effective August 14, 1995 (Incorporated by reference to the Registrant’s Registration Statement on Form S-11 (No. 333-02962), Exhibit 3.4, filed on March 26, 1996) | ||
| 3 | .1.3 | Articles Supplementary of the Registrant, effective August 9, 1996 (Incorporated by reference to the Registrant’s Registration Statement on Form S-11 (No. 333-08363), Exhibit 3.5, filed on July 18, 1996) | ||
| 3 | .1.4 | Certificate of Amendment of the Registrant, effective June 30, 1998 (Incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 3.1.1, filed on July 20, 1998) | ||
| 3 | .1.5 | Articles Supplementary of the Registrant, effective April 10, 2003 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2003, Exhibit 3.4.2) | ||
| 3 | .2 | Amended and Restated Bylaws, as adopted on May 5, 2005 (Incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 3.1, filed on May 9, 2005) | ||
| 3 | .2.1 | Amendment to Amended and Restated Bylaws, as adopted on November 13, 2005 (Incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 3, filed on November 17, 2005) | ||
61
| Exhibit | ||||
| Number | Exhibit | |||
| 4 | .1 | Specimen Common Stock Certificate (Incorporated by reference to the Registrant’s Registration Statement on Form S-11 (No. 33-92272), Exhibit 4.2, filed on May 19, 1995) | ||
| 4 | .2 | Indenture dated as of October 1, 2001 between Sequoia Mortgage Trust 5 (a wholly-owned consolidated subsidiary of the Registrant) and Bankers Trust Company of California, N.A., as Trustee (Incorporated by reference to Sequoia Mortgage Funding Corporation’s Current Report on Form 8-K, Exhibit 99.1, filed on November 15, 2001) | ||
| 4 | .3 | Indenture dated as April 1, 2002 between Sequoia Mortgage Trust 6 (a wholly-owned consolidated subsidiary of the Registrant) and Deutsche Bank National Trust Company, as Trustee (Incorporated by reference to Sequoia Mortgage Funding Corporation’s Current Report on Form 8-K, Exhibit 99.1, filed on May 13, 2002) | ||
| 4 | .4 | Indenture dated as of April 1, 2002 between Sequoia Mortgage Funding Company 2002-A (a wholly-owned consolidated subsidiary of the Registrant) and The Bank of New York, as Trustee (Incorporated by reference to Sequoia Mortgage Funding Corporation’s Current Report on Form 8-K, Exhibit 99.1, filed on May 14, 2002) | ||
| 4 | .5 | Indenture dated as of May 1, 2002 between Sequoia Mortgage Trust 7 (a wholly-owned consolidated subsidiary of Registrant) and HSBC Bank, USA, as Trustee (Incorporated by reference to Sequoia Mortgage Funding Corporation’s Current Report on Form 8-K, Exhibit 99.1, filed on June 13, 2002) | ||
| 10 | .1 | Amended and Restated Employment Agreement, dated as of April 7, 2003, by and between George E. Bull III and the Registrant (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2003, Exhibit 10.10.1) | ||
| 10 | .2 | Amended and Restated Employment Agreement, dated as of April 7, 2003, by and between Douglas B. Hansen and the Registrant (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2003, Exhibit 10.11.1) | ||
| 10 | .3 | Amended and Restated Employment Agreement, dated as of February 22, 2005, by and between Brett D. Nicholas and the Registrant (Incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.13.4, filed on February 25, 2005) | ||
| 10 | .4 | Amended and Restated Employment Agreement, dated as of February 22, 2005, by and between Loren Picard and the Registrant (Incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.13.5, filed on February 25, 2005) | ||
| 10 | .5 | Amended and Restated Employment Agreement, dated as of February 22, 2005, by and between Andrew I. Sirkis and the Registrant (Incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.13.6, filed on February 25, 2005) | ||
62
| Exhibit | ||||
| Number | Exhibit | |||
| 10 | .6 | Amended and Restated Employment Agreement, dated as of February 22, 2005, by and between Harold F. Zagunis and the Registrant (Incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.13.7, filed on February 25, 2005) | ||
| 10 | .7 | Employment Agreement, dated as of June 1, 2005, by and between Martin S. Hughes and the Registrant (Incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.1, filed on June 6, 2005) | ||
| 10 | .8 | Form of Amendment to Employment Agreement between the Registrant and each of George E. Bull III, Douglas B. Hansen, Brett D. Nicholas, Loren Picard, Andrew I. Sirkis, Harold F. Zagunis and Martin S. Hughes (Incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.1, filed on November 17, 2005) | ||
| 10 | .9 | Amended and Restated 1994 Executive and Non-Employee Director Stock Option Plan, amended January 24, 2002 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2002, Exhibit 10.14.5) | ||
| 10 | .10 | 2002 Incentive Stock Plan, amended through May 6, 2004 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2004, Exhibit 10.15.2) | ||
| 10 | .10.1 | Form of Employee Incentive Stock Option Grant Agreement under 2002 Incentive Stock Plan (Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004, Exhibit 10.8.1) | ||
| 10 | .10.2 | Form of Employee Non-Qualified Stock Option Grant Agreement under 2002 Incentive Stock Plan (Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004, Exhibit 10.8.2) | ||
| 10 | .10.3 | Form of Amendment to Employee Non-Qualified Stock Option Grant Agreement under 2002 Incentive Stock Plan (Incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.2, filed on November 17, 2005) | ||
| 10 | .10.4 | Form of Restricted Stock Award Agreement under 2002 Incentive Stock Plan (Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004, Exhibit 10.8.3) | ||
| 10 | .11 | 2002 Employee Stock Purchase Plan (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2002, Exhibit 10.16) | ||
| 10 | .12 | Executive Deferred Compensation Plan, amended through May 8, 2003 (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2003, Exhibit 10.17.1) | ||
63
| Exhibit | ||||
| Number | Exhibit | |||
| 10 | .13 | Forms of Indemnification Agreement for Directors and Executive Officers (Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003, Exhibit 10.18) | ||
| 10 | .14 | Direct Stock Purchase and Dividend Reinvestment Plan (Incorporated by reference to the Plan text included in the Registrant’s Registration Statement on Form S-3 (No. 333-122427) filed on January 31, 2005) | ||
| 10 | .15 | Office Building Lease, dated [February, 27, 2003] (Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003, Exhibit 10.30.2) | ||
| 10 | .16 | Summary of Redwood Trust, Inc. Compensation Arrangements for Non-Employee Directors Effective January 1, 2005 (Incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.1, filed on January 6, 2005) | ||
| 14 | Code of Business Conduct and Ethics (Incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 14, filed on November 17, 2005) | |||
| 21 | List of Subsidiaries (filed herewith) | |||
| 23 | .1 | PricewaterhouseCoopers LLP Consent (filed herewith) | ||
| 23 | .2 | Grant Thornton LLP Consent (filed herewith) | ||
| 31 | .1 | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith) | ||
| 31 | .2 | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith) | ||
| 32 | .1 | Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith) | ||
| 32 | .2 | Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith) | ||
64
| REDWOOD TRUST, INC. | ||
|
Dated: February 27, 2006
|
By: /s/ George E. Bull | |
| George E. Bull | ||
| Chairman and Chief Executive Officer | ||
| Signature | Title | Date | ||
|
/s/ George E.
Bull |
George E. Bull Chairman of the Board and Chief Executive Officer (Principal Executive Officer) |
February 27, 2006 | ||
|
/s/ Douglas B.
Hansen |
Douglas B. Hansen Director, President |
February 27, 2006 | ||
|
/s/ Harold F.
Zagunis |
Harold F. Zagunis Vice President, Chief Financial Officer, Controller, Treasurer, and Secretary (Principal Financial and Accounting Officer) |
February 27, 2006 | ||
|
/s/ Richard D.
Baum |
Richard D. Baum Director |
February 27, 2006 | ||
|
/s/ Thomas C.
Brown |
Thomas C. Brown Director |
February 27, 2006 | ||
|
/s/ Mariann
Byerwalter |
Mariann Byerwalter Director |
February 27, 2006 | ||
|
/s/ Greg H.
Kubicek |
Greg H. Kubicek Director |
February 27, 2006 | ||
|
/s/ Charles J.
Toeniskoetter |
Charles J. Toeniskoetter Director |
February 27, 2006 | ||
|
/s/ David L.
Tyler |
David L. Tyler Director |
February 27, 2006 | ||
65
F-1
| Page | ||||
| F-3 | ||||
| F-4 | ||||
| F-6 | ||||
| F-7 | ||||
| F-8 | ||||
| F-9 | ||||
| F-10 | ||||
| F-11 | ||||
| F-13 | ||||
| F-14 | ||||
F-2
F-3
(i)
pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and
dispositions of the assets of Redwood;
(ii)
provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles and
that receipts and expenditures of Redwood are being made only in
accordance with authorization of management and directors of
Redwood; and
(iii)
provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition use, or disposition of our
assets that could have a material effect on the financial
statements
F-4
Board of Directors and Stockholders of
Redwood Trust, Inc.
We have audited management’s assessment, included in the
accompanying Management’s Report on Internal Control Over
Financial Reporting as of December 31, 2005, that the
Company maintained effective internal control over financial
reporting as of December 31, 2005, based on criteria
established in Internal Control—Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). The Company’s management is responsible
for maintaining effective internal control over financial
reporting, and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is
to express an opinion on management’s assessment, and an
opinion on the effectiveness of the Company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit of internal control included obtaining an
understanding of internal control over financial reporting,
evaluating management’s assessment, testing and evaluating
the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in
the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
A company’s internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Company
maintained effective internal control over financial reporting
as of December 31, 2005, is fairly stated, in all material
respects, based on Internal Control—Integrated Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Furthermore, in our opinion, the
Company maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2005,
based on Internal Control—Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheet of Redwood Trust, Inc. (a Maryland
corporation) and subsidiaries (the Company) as of
December 31, 2005, and the related consolidated statements
of income, comprehensive income, stockholders’ equity, and
cash flows
F-5
for the year then ended, and our report dated February 23,
2006 expressed an unqualified opinion on those financial
statements.
/s/ GRANT THORNTON LLP
San Francisco, CA
February 23, 2006
F-6
Board of Directors and Stockholders of
Redwood Trust, Inc.
We have audited the accompanying consolidated balance sheet of
Redwood Trust, Inc. (a Maryland corporation) and subsidiaries
(the Company) as of December 31, 2005, and the related
consolidated statements of income, comprehensive income,
stockholders’ equity, and cash flows for the year then
ended. These financial statements are the responsibility of the
Company’s management. Our responsibility is to express an
opinion on these financial statements, based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. Our audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, and evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of the Company as of
December 31, 2005 and the results of its operations and its
cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States of
America.
We have also audited in accordance with the standards of the
Public Company Accounting Oversight Board (United States) the
effectiveness of the Company’s internal control over
financial reporting as of December 31, 2005, based on
criteria established in Internal Control— Integrated
Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO) and our report dated
February 23, 2006 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
San Francisco, CA
February 23, 2006
F-7
To the Board of Directors and Stockholders of
Redwood Trust, Inc:
In our opinion, the accompanying consolidated balance sheet and
the related consolidated statements of income, comprehensive
income, stockholders’ equity, and cash flows present
fairly, in all material respects, the financial position of
Redwood Trust, Inc. and its subsidiaries at December 31,
2004, and the results of their operations and their cash flows
for each of the two years in the period ended December 31,
2004 in conformity with accounting principles generally accepted
in the United States of America. These financial statements are
the responsibility of the Company’s management; our
responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these
statements in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles
used and significant estimates made by management, and
evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our
opinion.
/s/ PricewaterhouseCoopers LLP
San Francisco, CA
March 14, 2005
| December 31, 2005 | December 31, 2004 | ||||||||
| (In thousands, except share data) | |||||||||
|
ASSETS
|
|||||||||
|
Residential real estate loans
|
$ | 13,874,792 | $ | 22,504,765 | |||||
|
Residential loan credit-enhancement
securities
|
612,649 | 561,658 | |||||||
|
Commercial real estate loans
|
59,692 | 54,479 | |||||||
|
Commercial loan credit-enhancement
securities
|
57,687 | 14,498 | |||||||
|
Securities portfolio
|
1,748,581 | 1,380,077 | |||||||
|
Cash and cash equivalents
|
175,885 | 57,246 | |||||||
|
Total Earning Assets
|
16,529,286 | 24,572,723 | |||||||
|
Restricted cash
|
72,421 | 36,038 | |||||||
|
Accrued interest receivable
|
76,469 | 72,459 | |||||||
|
Interest rate agreements
|
31,220 | 16,144 | |||||||
|
Principal receivable
|
225 | 2,653 | |||||||
|
Deferred tax asset
|
5,384 | 10,572 | |||||||
|
Deferred asset-backed security
issuance costs
|
54,125 | 60,993 | |||||||
|
Other assets
|
7,830 | 6,483 | |||||||
|
Total Assets
|
$ | 16,776,960 | $ | 24,778,065 | |||||
|
LIABILITIES AND
STOCKHOLDERS’ EQUITY
|
|||||||||
|
LIABILITIES
|
|||||||||
|
Redwood debt
|
$ | 169,707 | $ | 203,281 | |||||
|
Asset-backed securities issued
|
15,585,277 | 23,630,162 | |||||||
|
Accrued interest payable
|
41,027 | 35,064 | |||||||
|
Interest rate agreements
|
507 | 1,124 | |||||||
|
Accrued expenses and other
liabilities
|
27,889 | 28,095 | |||||||
|
Dividends payable
|
17,593 | 16,183 | |||||||
|
Total Liabilities
|
15,842,000 | 23,913,909 | |||||||
|
Commitments and contingencies
(Note 11)
|
|||||||||
|
STOCKHOLDERS’ EQUITY
|
|||||||||
|
Common stock, par value
$0.01 per share, 50,000,000 shares authorized;
25,132,625 and 24,153,576 issued and outstanding
|
251 | 242 | |||||||
|
Additional paid-in capital
|
824,365 | 773,222 | |||||||
|
Accumulated other comprehensive
income
|
73,731 | 105,357 | |||||||
|
Cumulative earnings
|
681,479 | 481,607 | |||||||
|
Cumulative distributions to
stockholders
|
(644,866 | ) | (496,272 | ) | |||||
|
Total Stockholders’ Equity
|
934,960 | 864,156 | |||||||
|
Total Liabilities and
Stockholders’ Equity
|
$ | 16,776,960 | $ | 24,778,065 | |||||
F-8
| (In thousands, except share data) | Year Ended December 31 | |||||||||||
| 2005 | 2004 | 2003 | ||||||||||
|
Interest Income
|
||||||||||||
|
Residential real estate loans
|
$ | 773,609 | $ | 537,078 | $ | 244,124 | ||||||
|
Residential loan credit-enhancement
securities
|
86,564 | 64,602 | 68,091 | |||||||||
|
Commercial real estate loans
|
5,100 | 3,769 | 3,459 | |||||||||
|
Commercial loan credit-enhancement
securities
|
2,613 | 675 | — | |||||||||
|
Securities portfolio
|
86,431 | 48,274 | 23,530 | |||||||||
|
Cash and cash equivalents
|
5,204 | 922 | 418 | |||||||||
|
Interest income before provision
for credit losses
|
959,521 | 655,320 | 339,622 | |||||||||
|
Reversal of (provision for) credit
losses
|
430 | (7,236 | ) | (8,646 | ) | |||||||
|
Total interest income
|
959,951 | 648,084 | 330,976 | |||||||||
|
Interest Expense
|
||||||||||||
|
Redwood debt
|
(11,929 | ) | (9,933 | ) | (7,038 | ) | ||||||
|
Asset-backed securities issued
|
(745,595 | ) | (421,985 | ) | (195,823 | ) | ||||||
|
Total interest expense
|
(757,524 | ) | (431,918 | ) | (202,861 | ) | ||||||
|
Net Interest Income
|
202,427 | 216,166 | 128,115 | |||||||||
|
Operating expenses
|
(45,882 | ) | (34,661 | ) | (36,895 | ) | ||||||
|
Net recognized gains and valuation
adjustments
|
60,848 | 59,127 | 46,676 | |||||||||
|
Net income before provision for
income taxes
|
217,393 | 240,632 | 137,896 | |||||||||
|
Provision for income taxes
|
(17,521 | ) | (7,997 | ) | (5,502 | ) | ||||||
|
Net Income available to common
stockholders before preferred dividends
|
$ | 199,872 | $ | 232,635 | $ | 132,394 | ||||||
|
Dividends on Class B preferred
stock
|
— | — | (681 | ) | ||||||||
|
Undistributed earnings allocated to
Class B preferred stock
|
— | — | (15 | ) | ||||||||
|
Net income available to common
stockholders
|
$ | 199,872 | $ | 232,635 | $ | 131,698 | ||||||
|
Basic Earnings Per Share:
|
$ | 8.11 | $ | 10.85 | $ | 7.42 | ||||||
|
Diluted Earnings Per Share:
|
$ | 7.96 | $ | 10.47 | $ | 7.04 | ||||||
|
Dividends declared per preferred
share
|
N/A | N/A | $ | 0.76 | ||||||||
|
Regular dividends declared per
common share
|
$ | 2.80 | $ | 2.68 | $ | 2.60 | ||||||
|
Special dividends declared per
common share
|
$ | 3.00 | $ | 6.00 | 4.75 | |||||||
|
Total dividends declared per common
share
|
$ | 5.80 | $ | 8.68 | $ | 7.35 | ||||||
|
Basic weighted average shares
outstanding
|
24,637,016 | 21,437,253 | 17,759,346 | |||||||||
|
Diluted weighted average shares
outstanding
|
25,121,467 | 22,228,929 | 18,812,166 | |||||||||
F-9
| (In thousands) | Year Ended December 31 | ||||||||||||
| 2005 | 2004 | 2003 | |||||||||||
|
Net income available to common
stockholders before preferred dividend
|
$ | 199,872 | $ | 232,635 | $ | 132,394 | |||||||
|
Other comprehensive
income:
|
|||||||||||||
|
Net unrealized gains on
available-for-sale securities (AFS)
|
5,593 | 56,708 | 43,203 | ||||||||||
|
Reclassification adjustment for net
(gains) included in net income
|
(44,446 | ) | (43,913 | ) | (32,832 | ) | |||||||
|
Net unrealized gains on cash flow
hedges
|
6,791 | 9,982 | 605 | ||||||||||
|
Reclassification of net realized
cash flow hedge losses to interest expense on asset-backed
securities issued
|
436 | 401 | 2,057 | ||||||||||
|
Total other comprehensive
income
|
(31,626 | ) | 23,178 | 13,033 | |||||||||
|
Dividends on Class B Preferred
Stock
|
— | — | (681 | ) | |||||||||
|
Undistributed earnings allocated to
Class B preferred stock
|
— | — | (15 | ) | |||||||||
|
Comprehensive Income
|
$ | 168,246 | $ | 255,813 | $ | 144,731 | |||||||
F-10
For the Year Ended December 31, 2005:
| (In thousands, except | Cumulative | ||||||||||||||||||||||||||||
| share data) | Common Stock | Additional | Other | Distributions | |||||||||||||||||||||||||
| Paid-In | Comprehensive | Cumulative | to | ||||||||||||||||||||||||||
| Shares | Amount | Capital | Income | Earnings | Stockholders | Total | |||||||||||||||||||||||
|
December 31,
2004
|
24,153,576 | $ | 242 | $ | 773,222 | $ | 105,357 | $ | 481,607 | $ | (496,272 | ) | $ | 864,156 | |||||||||||||||
|
Net income
|
— | — | — | — | 199,872 | — | 199,872 | ||||||||||||||||||||||
|
Net unrealized
gain/reclassification on assets AFS
|
— | — | — | (38,853 | ) | — | — | (38,853 | ) | ||||||||||||||||||||
|
Net unrealized
gain/reclassification on interest rate agreements
|
— | — | — | 7,227 | — | — | 7,227 | ||||||||||||||||||||||
|
Issuance of common stock:
|
|||||||||||||||||||||||||||||
|
Secondary Offerings
|
— | — | — | — | — | — | — | ||||||||||||||||||||||
|
Dividend Reinvestment &
Stock Purchase Plans
|
925,060 | 9 | 46,007 | — | — | — | 46,016 | ||||||||||||||||||||||
|
Employee Option & Stock
Purchase Plans
|
34,472 | — | 851 | — | — | — | 851 | ||||||||||||||||||||||
|
Restricted Stock & Stock
DERs
|
19,517 | — | 4,285 | — | — | — | 4,285 | ||||||||||||||||||||||
|
Dividends declared:
|
|||||||||||||||||||||||||||||
|
Common
|
— | — | — | — | — | (148,594 | ) | (148,594 | ) | ||||||||||||||||||||
|
December 31,
2005
|
25,132,625 | $ | 251 | $ | 824,365 | $ | 73,731 | $ | 681,479 | $ | (644,866 | ) | $ | 934,960 | |||||||||||||||
| For the Year Ended December 31, 2004: |
| Cumulative | |||||||||||||||||||||||||||||
| Common Stock | Additional | Other | Distributions | ||||||||||||||||||||||||||
| Paid-In | Comprehensive | Cumulative | to | ||||||||||||||||||||||||||
| Shares | Amount | Capital | Income | Earnings | Stockholders | Total | |||||||||||||||||||||||
|
December 31,
2003
|
19,062,983 | $ | 191 | $ | 517,826 | $ | 82,179 | $ | 248,972 | $ | (295,840 | ) | $ | 553,328 | |||||||||||||||
|
Net income
|
— | — | — | — | 232,635 | — | 232,635 | ||||||||||||||||||||||
|
Net unrealized
gain/reclassification on assets AFS
|
— | — | — | 12,795 | — | — | 12,795 | ||||||||||||||||||||||
|
Net unrealized
gain/reclassification on interest rate agreements
|
— | — | — | 10,383 | — | — | 10,383 | ||||||||||||||||||||||
|
Issuance of common stock:
|
|||||||||||||||||||||||||||||
|
Secondary Offerings
|
2,350,000 | 24 | 116,741 | — | — | — | 116,765 | ||||||||||||||||||||||
|
Dividend Reinvestment &
Stock Purchase Plans
|
2,307,256 | 23 | 126,621 | — | — | — | 126,644 | ||||||||||||||||||||||
|
Employee Option & Stock
Purchase Plans
|
433,337 | 4 | 4,475 | — | — | — | 4,479 | ||||||||||||||||||||||
|
Restricted Stock & Stock
DERs
|
— | — | 7,559 | — | — | — | 7,559 | ||||||||||||||||||||||
|
Dividends declared:
|
|||||||||||||||||||||||||||||
|
Common
|
— | — | — | — | — | (200,432 | ) | (200,432 | ) | ||||||||||||||||||||
|
December 31,
2004
|
24,153,576 | $ | 242 | $ | 773,222 | $ | 105,357 | $ | 481,607 | $ | (496,272 | ) | $ | 864,156 | |||||||||||||||
F-11
For the Year Ended December 31, 2003:
| (In thousands, | |||||||||||||||||||||||||||||||||||||
| except | Class B Preferred | Cumulative | |||||||||||||||||||||||||||||||||||
| share data) | Stock | Common Stock | Distributions to | ||||||||||||||||||||||||||||||||||
| Other | |||||||||||||||||||||||||||||||||||||
| Additional | Compre- | ||||||||||||||||||||||||||||||||||||
| Paid-In | hensive | Cumulative | Stock- | ||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Income | Earnings | holders | Total | |||||||||||||||||||||||||||||
|
December 31,
2002
|
902,068 | $ | 26,517 | 16,277,285 | $ | 163 | $ | 418,701 | $ | 69,146 | $ | 116,578 | $ | (158,072 | ) | $ | 473,033 | ||||||||||||||||||||
|
Net income
|
— | — | — | — | — | — | 132,394 | — | 132,394 | ||||||||||||||||||||||||||||
|
Net unrealized gain
/reclassification on assets AFS
|
— | — | — | — | — | 10,371 | — | — | 10,371 | ||||||||||||||||||||||||||||
|
Net unrealized /reclassification on
interest rate agreements
|
— | — | — | — | — | 2,662 | — | — | 2,662 | ||||||||||||||||||||||||||||
|
Issuance of common stock:
|
— | — | |||||||||||||||||||||||||||||||||||
|
Secondary Offerings
|
— | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||
|
Dividend Reinvestment &
Stock Purchase Plans
|
— | — | 1,685,451 | 17 | 63,926 | — | — | — | 63,943 | ||||||||||||||||||||||||||||
|
Employee Option & Stock
Purchase Plans
|
— | — | 198,179 | 2 | 2,855 | — | — | — | 2,857 | ||||||||||||||||||||||||||||
|
Restricted Stock & Stock
DERs
|
— | — | — | — | 5,836 | — | — | — | 5,836 | ||||||||||||||||||||||||||||
|
Conversion of preferred stock
|
(902,068 | ) | (26,517 | ) | 902,068 | 9 | 26,508 | — | — | — | — | ||||||||||||||||||||||||||
|
Dividends declared:
|
|||||||||||||||||||||||||||||||||||||
|
Common
|
— | — | — | — | — | — | — | (137,087 | ) | (137,087 | ) | ||||||||||||||||||||||||||
|
Preferred
|
— | — | — | — | — | — | — | (681 | ) | (681 | ) | ||||||||||||||||||||||||||
|
December 31,
2003
|
—- | $ | — | 19,062,983 | $ | 191 | $ | 517,826 | $ | 82,179 | $ | 248,972 | $ | (295,840 | ) | $ | 553,328 | ||||||||||||||||||||
F-12
| (In thousands) | Year Ended December 31 | ||||||||||||
| 2005 | 2004 | 2003 | |||||||||||
|
Cash Flows From Operating
Activities:
|
|||||||||||||
|
Net income
|
$ | 199,872 | $ | 232,635 | $ | 132,394 | |||||||
|
Adjustments to reconcile net income
to net cash provided by operating activities:
|
|||||||||||||
|
Net amortization of premiums,
discounts, and debt issuance costs
|
(75,475 | ) | (87,557 | ) | (12,582 | ) | |||||||
|
Depreciation and amortization of
non-financial assets
|
845 | 543 | 207 | ||||||||||
|
(Reversal of) provision for credit
losses
|
(430 | ) | 7,236 | 8,646 | |||||||||
|
Non-cash stock compensation
|
4,285 | 7,559 | 5,836 | ||||||||||
|
Equity compensation dividend expense
|
113 | — | — | ||||||||||
|
Net recognized gains and valuation
adjustments
|
(60,848 | ) | (59,127 | ) | (46,676 | ) | |||||||
|
Principal payments on real estate
loans purchased for sale
|
1,353 | 31 | 440 | ||||||||||
|
Net sales of real estate loans
purchased for sale
|
336,842 | 3,204 | 1,379 | ||||||||||
|
Real estate loans purchased for sale
|
(323,193 | ) | — | — | |||||||||
|
Net change in:
|
|||||||||||||
|
Accrued interest receivable
|
(4,010 | ) | (32,753 | ) | (20,619 | ) | |||||||
|
Principal receivable
|
2,428 | 11,090 | (12,529 | ) | |||||||||
|
Deferred income taxes
|
5,188 | (10,572 | ) | — | |||||||||
|
Other assets
|
2,676 | (1,536 | ) | (1,987 | ) | ||||||||
|
Accrued interest payable
|
5,963 | 18,508 | 11,289 | ||||||||||
|
Accrued expenses and other
liabilities
|
(206 | ) | 6,589 | 5,508 | |||||||||
|
Net cash provided by operating
activities
|
95,403 | 95,850 | 71,306 | ||||||||||
|
Cash Flows From Investing
Activities:
|
|||||||||||||
|
Purchases of real estate loans
purchased for investment
|
(1,565,246 | ) | (10,088,680 | ) | (11,407,808 | ) | |||||||
|
Proceeds from sales of real estate
loans purchased for investment
|
181,811 | 112,811 | 73,137 | ||||||||||
|
Principal payments on real estate
loans purchased for investment
|
9,944,183 | 3,635,754 | 1,277,615 | ||||||||||
|
Purchases of real estate securities
|
(995,298 | ) | (879,682 | ) | (714,633 | ) | |||||||
|
Proceeds from sales of real estate
securities
|
374,354 | 30,891 | 5,299 | ||||||||||
|
Principal payments on real estate
securities
|
214,229 | 220,913 | 269,997 | ||||||||||
|
Net (increase) decrease in
restricted cash
|
(36,383 | ) | (14,081 | ) | (10,202 | ) | |||||||
|
Net cash provided by (used in)
investing activities
|
8,117,650 | (6,982,074 | ) | (10,506,595 | ) | ||||||||
|
Cash Flows From Financing
Activities:
|
|||||||||||||
|
Net borrowings on Redwood debt
|
(33,574 | ) | (33,156 | ) | 136,723 | ||||||||
|
Proceeds from issuance of
asset-backed securities
|
2,278,804 | 10,741,738 | 11,881,869 | ||||||||||
|
Deferred asset-backed security
issuance costs
|
(15,062 | ) | (17,378 | ) | (22,449 | ) | |||||||
|
Repayments on asset-backed
securities
|
(10,217,882 | ) | (3,849,363 | ) | (1,467,929 | ) | |||||||
|
Net (purchases) proceeds of
interest rate agreements
|
(6,269 | ) | (8,087 | ) | (2,079 | ) | |||||||
|
Net proceeds from issuance of
common stock
|
46,867 | 247,888 | 66,800 | ||||||||||
|
Dividends paid
|
(147,298 | ) | (196,639 | ) | (138,348 | ) | |||||||
|
Net cash (used in) provided by
financing activities
|
(8,094,414 | ) | 6,885,003 | 10,454,587 | |||||||||
|
Net increase (decrease) in cash and
cash equivalents
|
118,639 | (1,221 | ) | 19,298 | |||||||||
|
Cash and cash equivalents at
beginning of period
|
57,246 | 58,467 | 39,169 | ||||||||||
|
Cash and cash equivalents at end of
period
|
$ | 175,885 | $ | 57,246 | $ | 58,467 | |||||||
|
Supplemental disclosure of cash
flow information:
|
|||||||||||||
|
Cash paid for interest
|
$ | 751,561 | $ | 413,410 | $ | 191,572 | |||||||
|
Cash paid for taxes
|
$ | 13,174 | $ | 19,175 | $ | 7,006 | |||||||
|
Non-cash financing
activity:
|
|||||||||||||
|
Dividends declared but not paid
|
$ | 17,593 | $ | 16,183 | $ | 12,391 | |||||||
F-13
F-14
F-15
Residential and Commercial Loan Credit-Enhancement
Securities and Securities Portfolio Available-for-Sale
F-16
•
On-going analyses of the pool of loans — including,
but not limited to, the age of loans, underwriting standards,
business climate, economic conditions, geographical
considerations, and other observable data;
•
Historical loss rates and past performance of similar loans;
•
Relevant environmental factors;
•
Relevant market research and publicly available third-party
reference loss rates;
•
Trends in delinquencies and charge-offs;
•
Effects and changes in credit concentrations;
•
Prepayment assumptions.
F-17
•
On-going analyses of each individual loan — including,
but not limited to, the age of loans, underwriting standards,
business climate, economic conditions, geographical
considerations, and other observable data;
•
On-going evaluations of fair values of collateral using current
appraisals and other valuations;
•
Discounted cash flow analyses;
•
Borrowers’ ability to meet obligations.
F-18
| (In thousands, except share data) | 2005 | 2004 | 2003 | |||||||||
|
Denominator:
|
||||||||||||
|
Denominator for basic earnings per
share:
|
||||||||||||
|
Weighted average number of common
shares outstanding during the period
|
24,637,016 | 21,437,253 | 17,759,346 | |||||||||
|
Net effect of dilutive stock options
|
484,451 | 791,676 | 827,803 | |||||||||
|
Net effect of preferred stock
|
— | — | 225,517 | |||||||||
|
Denominator for diluted earnings
per share
|
25,121,467 | 22,228,929 | 18,812,166 | |||||||||
|
Basic Earnings Per
Share:
|
||||||||||||
|
Net income per share
|
$ | 8.11 | $ | 10.85 | $ | 7.42 | ||||||
|
Diluted Earnings Per
Share:
|
||||||||||||
|
Net income per share
|
$ | 7.96 | $ | 10.47 | $ | 7.04 | ||||||
F-19
| (In thousands, except share data) | 2005 | 2004 | 2003 | ||||||||||
|
Net income, as reported
|
$ | 199,872 | $ | 232,635 | $ | 131,698 | |||||||
|
Add: Dividend equivalent right
operating expenses under APB 25
|
7,166 | 8,992 | 12,392 | ||||||||||
|
(Deduct)/ Add: Stock option
operating (income) expenses under APB 25
|
(123 | ) | 1,018 | 5,652 | |||||||||
|
Deduct: Stock-based employee
compensation expense determined under fair value based method
for awards granted prior to January 1, 2003
|
(858 | ) | (1,101 | ) | (1,390 | ) | |||||||
|
Pro forma net income
|
$ | 206,057 | $ | 241,544 | $ | 148,352 | |||||||
|
Earnings per share:
|
|||||||||||||
|
Basic — as reported
|
$ | 8.11 | $ | 10.85 | $ | 7.42 | |||||||
|
Basic — pro forma
|
$ | 8.36 | $ | 11.27 | $ | 8.35 | |||||||
|
Diluted — as reported
|
$ | 7.96 | $ | 10.47 | $ | 7.04 | |||||||
|
Diluted — pro forma
|
$ | 8.20 | $ | 10.87 | $ | 7.89 | |||||||
| 2005 | 2004 | 2003 | ||||||||||
|
Stock Price Volatility
|
26.41 | % | 22.00 | % | 22.00 | % | ||||||
|
Risk free rate of return (5 yr
Treasury Rate)
|
4.07 | % | 3.61 | % | 3.24 | % | ||||||
|
Average Life
|
5 years | 5 years | 5 years | |||||||||
|
Dividend Yield Assumptions
|
4.45 | % | 1.49 | % | 0.00 | % | ||||||
F-20
| (In thousands) | ||||||||
| Carrying Value | ||||||||
| 2005 | 2004 | |||||||
|
Loans
|
$ | 13,693,833 | $ | 22,208,417 | ||||
|
HELOCs
|
180,959 | 296,348 | ||||||
|
Total residential loans
|
$ | 13,874,792 | $ | 22,504,765 | ||||
| (In thousands) | ||||||||||||||||||||||||
| December 31, 2005 | December 31, 2004 | |||||||||||||||||||||||
| Held for | Held for | Held for | Held for | |||||||||||||||||||||
| Sale | Investment | Total | Sale | Investment | Total | |||||||||||||||||||
|
Current face
|
$ | — | $ | 13,719,242 | $ | 13,719,242 | $ | 2,365 | $ | 22,310,477 | $ | 22,312,842 | ||||||||||||
|
Unamortized Premium
|
— | 178,206 | 178,206 | 32 | 215,662 | 215,694 | ||||||||||||||||||
|
Amortized Cost
|
— | 13,897,448 | 13,897,448 | 2,397 | 22,526,139 | 22,528,536 | ||||||||||||||||||
|
Lower of cost-or- market adjustments
|
— | — | — | (375 | ) | — | (375 | ) | ||||||||||||||||
|
Reserve for Credit Losses
|
— | (22,656 | ) | (22,656 | ) | — | (23,396 | ) | (23,396 | ) | ||||||||||||||
|
Carrying Value
|
$ | — | $ | 13,874,792 | $ | 13,874,792 | $ | 2,022 | $ | 22,502,743 | $ | 22,504,765 | ||||||||||||
F-21
| (In thousands) | 2005 | 2004 | 2003 | |||||||||
|
Residential Real Estate Loans at
beginning of period
|
$ | 22,504,765 | $ | 16,239,160 | $ | 6,215,179 | ||||||
|
Acquisitions
|
1,863,240 | 10,050,309 | 11,401,367 | |||||||||
|
Sales (other than to consolidated
ABS trusts)
|
(507,444 | ) | (113,676 | ) | (73,742 | ) | ||||||
|
Principal repayments
|
(9,936,152 | ) | (3,632,395 | ) | (1,266,702 | ) | ||||||
|
Transfers to REO
|
(5,267 | ) | — | — | ||||||||
|
Net discount
(premium) amortization
|
(45,174 | ) | (31,687 | ) | (29,615 | ) | ||||||
|
Reversal of (provision for) credit
losses, net of charge offs
|
740 | (7,060 | ) | (8,065 | ) | |||||||
|
Net recognized gains (losses) and
valuation adjustments
|
84 | 114 | 738 | |||||||||
|
Residential Real Estate Loans at
end of period
|
$ | 13,874,792 | $ | 22,504,765 | $ | 16,239,160 | ||||||
| (In thousands) | ||||||||||||||||
| December 31, 2005 | December 31, 2004 | |||||||||||||||
| Face | Carrying | Face | Carrying | |||||||||||||
| Value | Value | Value | Value | |||||||||||||
|
Unpledged
|
$ | 45,098 | $ | 45,299 | $ | 3,618 | $ | 3,288 | ||||||||
|
Pledged for Redwood debt
|
— | — | 188,707 | 190,207 | ||||||||||||
|
Owned by securitization entities,
financed through the issuance of ABS
|
13,674,144 | 13,829,493 | 22,120,517 | 22,311,270 | ||||||||||||
|
Total Value
|
$ | 13,719,242 | $ | 13,874,792 | $ | 22,312,842 | $ | 22,504,765 | ||||||||
F-22
| (dollars in thousands) | ||||||||||||||||||||||||
| December 31, 2005 | ||||||||||||||||||||||||
| 90+ days | ||||||||||||||||||||||||
| Interest | Interest | Carrying | Delinquent | |||||||||||||||||||||
| Loan Description/Type | Rate Index | Rate | Maturity Date | Current Face | Value | Face | ||||||||||||||||||
| 1st Lien Adjustable Rate Residential Real Estate Loans | 1 Month LIBOR | 4.00% - 7.355% | 2018 - 2035 | $ | 3,627,378 | $ | 3,668,282 | $ | 9,702 | |||||||||||||||
| 1st Lien Adjustable Rate Residential Real Estate Loans | 6 Month LIBOR | 3.125% - 6.655% | 2016 - 2035 | 9,737,112 | 9,846,648 | 26,046 | ||||||||||||||||||
| 1st Lien Adjustable Rate Residential Real Estate Loans | Hybrid/ 1 Year CMT | 3.25% - 7.375% | 2032 - 2035 | 176,913 | 178,903 | — | ||||||||||||||||||
| 1st Lien Adjustable Rate HELOC Loans | Prime | 6.50% - 8.25% | 2012 - 2014 | 46,809 | 47,630 | 418 | ||||||||||||||||||
| 2nd Lien Adjustable Rate HELOC Loans | Prime | 5.34% - 11.25% | 2012 - 2030 | 131,030 | 133,329 | 1,169 | ||||||||||||||||||
| $ | 13,719,242 | $ | 13,874,792 | $ | 37,335 | |||||||||||||||||||
| (dollars in thousands) | ||||||||||||||||||||||||
| December 31, 2004 | ||||||||||||||||||||||||
| 90+ days | ||||||||||||||||||||||||
| Interest | Interest | Carrying | Delinquent | |||||||||||||||||||||
| Loan Description/Type | Rate Index | Rate | Maturity Date | Current Face | Value | Face | ||||||||||||||||||
| 1st Lien Adjustable Rate Residential Real Estate Loans | 1 Month LIBOR | 2.50% - 5.86% | 2021 - 2034 | $ | 5,199,840 | $ | 5,243,407 | $ | 1,435 | |||||||||||||||
| 1st Lien Adjustable Rate Residential Real Estate Loans | 6 Month LIBOR | 1.99% - 6.00% | 2016 - 2037 | 16,808,632 | 16,949,464 | 11,614 | ||||||||||||||||||
| 1st Lien Adjustable Rate Residential Real Estate Loans | 3 Year Hybrid/6 Month LIBOR | 4.25% - 6.38% | 2031 - 2032 | 15,416 | 15,546 | — | ||||||||||||||||||
| 1st Lien Adjustable Rate HELOC Loans | Prime | 4.00% - 6.25% | 2012 - 2014 | 82,485 | 84,595 | 83 | ||||||||||||||||||
| 2nd Lien Adjustable Rate HELOC Loans | Prime | 4.00% - 8.75% | 2012 - 2014 | 206,469 | 211,753 | 206 | ||||||||||||||||||
| $ | 22,312,842 | $ | 22,504,765 | $ | 13,338 | |||||||||||||||||||
| Geographic Concentration | December 31, 2005 | December 31, 2004 | |||||||
|
Northern California
|
10% | 13% | |||||||
|
Southern California
|
11% | 13% | |||||||
|
Florida
|
12% | 11% | |||||||
|
New York
|
5% | 5% | |||||||
|
Georgia
|
5% | 5% | |||||||
|
New Jersey
|
4% | 4% | |||||||
|
Texas
|
5% | 4% | |||||||
|
Arizona
|
4% | 4% | |||||||
|
Colorado
|
4% | 4% | |||||||
|
North Carolina
|
3% | 3% | |||||||
|
Ohio
|
4% | 3% | |||||||
|
Virginia
|
3% | 3% | |||||||
|
Other States (none greater than 3%)
|
30% | 28% | |||||||
|
Total
|
100% | 100% | |||||||
F-23
Residential Loan CES Carrying Value
| (In thousands) | December 31, 2005 | December 31, 2004 | ||||||
| Securities | Securities | |||||||
| Available-for-Sale | Available-for-Sale | |||||||
|
Current face
|
$ | 1,035,874 | $ | 933,772 | ||||
|
Unamortized discount, net
|
(126,811 | ) | (110,724 | ) | ||||
|
Discount designated as credit
protection
|
(354,610 | ) | (340,123 | ) | ||||
|
Amortized cost
|
554,453 | 482,925 | ||||||
|
Gross unrealized gains
|
74,416 | 84,390 | ||||||
|
Gross unrealized losses
|
(16,220 | ) | (5,657 | ) | ||||
|
Carrying value
|
$ | 612,649 | $ | 561,658 | ||||
| Residential Loan CES Unamortized Discount and Designated Credit Protection |
| (In thousands) | 2005 | 2004 | 2003 | |||||||||
|
Beginning balance of unamortized
discount, net
|
$ | 110,724 | $ | 123,329 | $ | 58,578 | ||||||
|
Amortization of discount
|
(38,151 | ) | (34,110 | ) | (37,189 | ) | ||||||
|
Calls, sales, and other
|
(36,897 | ) | (47,497 | ) | (38,418 | ) | ||||||
|
Re-designation of credit protection
to discount
|
88,767 | 56,615 | 140,323 | |||||||||
|
Acquisitions
|
2,368 | 12,387 | 35 | |||||||||
|
Ending balance of unamortized
discount, net
|
$ | 126,811 | $ | 110,724 | $ | 123,329 | ||||||
|
Beginning balance of designated
credit protection
|
$ | 340,123 | $ | 200,970 | $ | 224,891 | ||||||
|
Realized credit losses
|
(4,227 | ) | (2,856 | ) | (3,102 | ) | ||||||
|
Calls, sales, and other
|
(79,732 | ) | (13,031 | ) | (17,138 | ) | ||||||
|
Re-designation of credit protection
to discount
|
(88,767 | ) | (56,615 | ) | (140,323 | ) | ||||||
|
Acquisitions
|
187,213 | 211,655 | 136,642 | |||||||||
|
Ending balance of designated credit
protection
|
$ | 354,610 | $ | 340,123 | $ | 200,970 | ||||||
F-24
| (In thousands) | ||||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | (Losses) | Value | (Losses) | Value | (Losses) | |||||||||||||||||||
|
Residential loan credit-
enhancement securities
|
$ | 177,809 | $ | (15,243 | ) | $ | 10,754 | $ | (977 | ) | $ | 188,563 | $ | (16,220 | ) | |||||||||
| (In thousands) | ||||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | (Losses) | Value | (Losses) | Value | (Losses) | |||||||||||||||||||
|
Residential loan credit-
enhancement securities
|
$ | 87,327 | $ | (4,557 | ) | $ | 7,924 | $ | (1,100 | ) | $ | 95,251 | $ | (5,657 | ) | |||||||||
| (In thousands) | 2005 | 2004 | 2003 | |||||||||
|
Residential loan CES at beginning
of period
|
$ | 561,658 | $ | 378,727 | $ | 352,479 | ||||||
|
Acquisitions
|
267,803 | 268,527 | 148,873 | |||||||||
|
Sales (other than to consolidated
ABS trusts)
|
(207,360 | ) | (22,416 | ) | (1,248 | ) | ||||||
|
Principal repayments (including
calls)
|
(85,203 | ) | (157,359 | ) | (216,207 | ) | ||||||
|
Discount amortization
|
38,151 | 34,110 | 37,189 | |||||||||
|
Net unrealized gains (losses)
|
(20,538 | ) | (601 | ) | 2,573 | |||||||
|
Net recognized gains and valuation
adjustments
|
58,138 | 60,670 | 55,068 | |||||||||
|
Residential Loan CES at end of
period
|
$ | 612,649 | $ | 561,658 | $ | 378,727 | ||||||
F-25
| (In thousands) | December 31, 2005 | December 31, 2004 | ||||||
|
Unpledged
|
$ | 276,045 | $ | 350,756 | ||||
|
Pledged for Redwood debt
|
35,020 | — | ||||||
|
Owned by securitization entities,
financed through issuance of ABS
|
301,584 | 210,902 | ||||||
|
Total Carrying Value
|
$ | 612,649 | $ | 561,658 | ||||
| (In thousands) | December 31, 2005 | December 31, 2004 | ||||||
| Held-for- | Held-for- | |||||||
| Investment | Investment | |||||||
|
Current face
|
$ | 70,091 | $ | 65,598 | ||||
|
Unamortized discount
|
(2,258 | ) | (2,478 | ) | ||||
|
Discount designated as credit
protection
|
(8,141 | ) | (8,141 | ) | ||||
|
Reserve for credit losses
|
— | (500 | ) | |||||
|
Carrying Value
|
$ | 59,692 | $ | 54,479 | ||||
| (All dollars in thousands) | ||||||||||||||||||||||||
| December 31, 2005 | ||||||||||||||||||||||||
| Interest Rate | Interest | Maturity | Current | Carrying | Delinquent | |||||||||||||||||||
| Loan Description/Type | Index | Rate | Date | Face | Value | Face | ||||||||||||||||||
| 1st Lien Adjustable Rate Commercial Real Estate Loans | 1 Month LIBOR | 5.82% - 10.52% | 2006 - 2007 | $ | 28,918 | $ | 20,640 | — | ||||||||||||||||
| 1st Lien Fixed Rate Commercial Real Estate Loans | Fixed | 4.54% - 18% | 2006 - 2014 | 41,173 | 39,052 | — | ||||||||||||||||||
| $ | 70,091 | $ | 59,692 | — | ||||||||||||||||||||
| (all dollars in thousands) | ||||||||||||||||||||||||
| December 31, 2004 | ||||||||||||||||||||||||
| Interest Rate | Interest | Maturity | Current | Carrying | Delinquent | |||||||||||||||||||
| Loan Description/Type | Index | Rate | Date | Face | Value | Face | ||||||||||||||||||
| 1st Lien Adjustable Rate Commercial Real Estate Loans | 1 Month LIBOR | 4.7% - 8.8% | 2006 - 2009 | $ | 19,668 | $ | 11,959 | — | ||||||||||||||||
| 1st Lien Fixed Rate Commercial Real Estate Loans | 6 Month LIBOR, with interest rate floor | 9.5% - 11% | 2005 - 2009 | 15,300 | 14,283 | — | ||||||||||||||||||
| 1st Lien Adjustable Rate Commercial Real Estate Loans | Fixed | 14% - 18% | 2006 - 2014 | 30,630 | 28,237 | — | ||||||||||||||||||
| $ | 65,598 | $ | 54,479 | — | ||||||||||||||||||||
F-26
| Geographic Concentration | December 31, 2005 | December 31, 2004 | |||||||
|
California
|
26% | 44% | |||||||
|
Illinois
|
23% | 30% | |||||||
|
Arizona
|
15% | — | |||||||
|
Ohio
|
13% | — | |||||||
|
New York
|
8% | — | |||||||
|
Kansas
|
— | 10% | |||||||
|
Maryland
|
8% | 9% | |||||||
|
Connecticut
|
7% | 7% | |||||||
|
Total
|
100% | 100% | |||||||
| (In thousands) | 2005 | 2004 | 2003 | |||||||||
|
Commercial real estate loans at
beginning of period
|
$ | 54,479 | $ | 22,419 | $ | 29,270 | ||||||
|
Acquisitions
|
25,199 | 38,371 | 6,442 | |||||||||
|
Principal repayments
|
(9,384 | ) | (3,390 | ) | (11,353 | ) | ||||||
|
Net premium amortization
|
(350 | ) | (484 | ) | (298 | ) | ||||||
|
Reversal of (provision for) credit
losses
|
185 | — | (500 | ) | ||||||||
|
Sales (other than to consolidated
ABS trusts)
|
(11,209 | ) | (2,339 | ) | (774 | ) | ||||||
|
Net recognized gains (losses) and
valuation adjustments
|
772 | (98 | ) | (368 | ) | |||||||
|
Commercial real estate loans at end
of period
|
$ | 59,692 | $ | 54,479 | $ | 22,419 | ||||||
| (In thousands) | ||||||||||||||||
| December 31, 2005 | December 31, 2004 | |||||||||||||||
| Face | Carrying | Face | Carrying | |||||||||||||
| Value | Value | Value | Value | |||||||||||||
|
Unpledged
|
$ | 15,161 | $ | 6,625 | $ | 40,868 | $ | 32,119 | ||||||||
|
Pledged for Redwood debt
|
— | — | — | — | ||||||||||||
|
Owned by securitization entities,
financed through issuance of ABS
|
54,930 | 53,067 | 24,730 | 22,360 | ||||||||||||
|
Total carrying value
|
$ | 70,091 | $ | 59,692 | $ | 65,598 | $ | 54,479 | ||||||||
F-27
Commercial Loan CES Carrying Value
| (In thousands) | December 31, 2005 | December 31, 2004 | ||||||
| Securities | Securities | |||||||
| Available-for-Sale | Available-for-Sale | |||||||
|
Current face
|
$ | 175,343 | $ | 45,639 | ||||
|
Net discount
|
(122,332 | ) | (32,756 | ) | ||||
|
Amortized cost
|
53,011 | 12,883 | ||||||
|
Gross unrealized gains
|
5,706 | 1,615 | ||||||
|
Gross unrealized losses
|
(1,030 | ) | — | |||||
|
Carrying value
|
$ | 57,687 | $ | 14,498 | ||||
| Commercial Loan CES Net Discount |
| (In thousands) | 2005 | 2004 | ||||||
|
Beginning balance of net discount
|
$ | 32,756 | $ | — | ||||
|
Realized credit losses
|
(1,432 | ) | — | |||||
|
Amortization of cost basis
|
2,561 | 325 | ||||||
|
Calls, sales and other
|
357 | 12 | ||||||
|
Acquisitions
|
88,090 | 32,419 | ||||||
|
Ending balance of net discount
|
$ | 122,332 | $ | 32,756 | ||||
| (In thousands) | ||||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | (Losses) | Value | (Losses) | Value | (Losses) | |||||||||||||||||||
|
Commercial Loan CES
|
$ | 12,223 | $ | (1,030 | ) | $ | 0 | $ | 0 | $ | 12,223 | $ | (1,030 | ) | ||||||||||
F-28
| (In thousands) | 2005 | 2004 | ||||||
|
Commercial Loan CES at
beginning of period
|
$ | 14,498 | $ | — | ||||
|
Acquisitions
|
43,080 | 13,208 | ||||||
|
Sales (other than to consolidated
ABS trusts)
|
— | — | ||||||
|
Principal repayments (including
calls)
|
— | — | ||||||
|
Net discount
(premium) amortization
|
(2,561 | ) | (325 | ) | ||||
|
Net unrealized gains (losses)
|
3,061 | 1,615 | ||||||
|
Net recognized gains and valuation
adjustments
|
(391 | ) | — | |||||
|
Commercial Loan CES at end of
period
|
$ | 57,687 | $ | 14,498 | ||||
| Securities Portfolio Carrying Value |
| (In thousands) | December 31, 2005 | December 31, 2004 | ||||||
| Securities | Securities | |||||||
| Available-for-Sale | Available-for-Sale | |||||||
|
Current face
|
$ | 1,810,146 | $ | 1,378,924 | ||||
|
Unamortized discount
|
(73,548 | ) | (41,125 | ) | ||||
|
Unamortized premium
|
3,447 | 5,548 | ||||||
|
Unamortized premium —
interest-only certificates
|
14,866 | 21,682 | ||||||
|
Amortized cost
|
1,754,911 | 1,365,029 | ||||||
|
Gross unrealized gains
|
13,200 | 20,159 | ||||||
|
Gross unrealized losses
|
(19,530 | ) | (5,111 | ) | ||||
|
Carrying value
|
$ | 1,748,581 | $ | 1,380,077 | ||||
| (In thousands) | ||||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | (Losses) | Value | (Losses) | Value | (Losses) | |||||||||||||||||||
|
Securities portfolio
|
$ | 769,064 | $ | (15,022 | ) | $ | 129,318 | $ | (4,508 | ) | $ | 898,382 | $ | (19,530 | ) | |||||||||
F-29
| (In thousands) | ||||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | (Losses) | Value | (Losses) | Value | (Losses) | |||||||||||||||||||
|
Securities portfolio
|
$ | 204,136 | $ | (3,169 | ) | $ | 120,461 | $ | (1,942 | ) | $ | 324,597 | $ | (5,111 | ) | |||||||||
| (In thousands) | 2005 | 2004 | 2003 | |||||||||
|
Securities Portfolio at beginning
of period
|
$ | 1,380,077 | $ | 844,714 | $ | 335,697 | ||||||
|
Acquisitions
|
684,415 | 597,945 | 565,760 | |||||||||
|
Sales (other than to consolidated
ABS trusts)
|
(166,994 | ) | (8,475 | ) | (4,051 | ) | ||||||
|
Principal repayments
|
(129,026 | ) | (63,554 | ) | (53,790 | ) | ||||||
|
Net discount
(premium) amortization
|
1,739 | (1,254 | ) | (547 | ) | |||||||
|
Net unrealized gains (losses)
|
(21,376 | ) | 11,782 | 7,799 | ||||||||
|
Net recognized losses and valuation
adjustments
|
(254 | ) | (1,081 | ) | (6,154 | ) | ||||||
|
Securities Portfolio at end of
period
|
$ | 1,748,581 | $ | 1,380,077 | $ | 844,714 | ||||||
| (In thousands) | December 31, 2005 | December 31, 2004 | ||||||
|
Commercial real estate
|
$ | 322,366 | $ | 228,643 | ||||
|
Residential prime
|
690,329 | 400,047 | ||||||
|
Residential sub prime
|
442,114 | 428,610 | ||||||
|
Residential second lien
|
107,550 | 131,197 | ||||||
|
Manufactured housing
|
— | 14,016 | ||||||
|
REIT Corporate debt
|
31,569 | 64,479 | ||||||
|
Real estate CDOs
|
154,653 | 113,085 | ||||||
|
Total securities portfolio
|
$ | 1,748,581 | $ | 1,380,077 | ||||
| (in thousands) | December 31, 2005 | December 31, 2004 | ||||||
|
Unpledged
|
$ | 37,493 | $ | 93,472 | ||||
|
Pledged for Redwood debt
|
129,406 | 21,283 | ||||||
|
Owned by securitization entities,
financed through the issuance of ABS
|
1,581,682 | 1,265,322 | ||||||
|
Total Carrying Value
|
$ | 1,748,581 | $ | 1,380,077 | ||||
F-30
| (In thousands) | 2005 | 2004 | 2003 | ||||||||||
|
Realized gains on calls:
|
|||||||||||||
|
Residential loan CES
|
$ | 18,909 | $ | 58,630 | $ | 56,560 | |||||||
|
Securities portfolio
|
240 | 109 | — | ||||||||||
|
Realized gains (losses) on sales:
|
|||||||||||||
|
Residential real estate loans
|
84 | 489 | 738 | ||||||||||
|
Commercial real estate loans
|
772 | (98 | ) | 132 | |||||||||
|
Residential loan CES
|
39,736 | 6,246 | — | ||||||||||
|
Securities portfolio
|
2,978 | 1,002 | — | ||||||||||
|
Valuation adjustments —
impairment (EITF 99-20 and others):
|
|||||||||||||
|
Residential loan CES
|
(507 | ) | (4,206 | ) | (1,492 | ) | |||||||
|
Securities portfolio
|
(3,472 | ) | (2,192 | ) | (6,154 | ) | |||||||
|
Commercial loan CES
|
(391 | ) | — | — | |||||||||
|
Lower-of-cost-or-market
(LOCOM) valuation adjustments on real estate loans held for
sale:
|
|||||||||||||
|
Residential real estate loans
|
— | (375 | ) | — | |||||||||
|
Commercial real estate loans
|
— | — | (500 | ) | |||||||||
|
Loss on extinguishment of
asset-backed securities issued
|
— | — | (2,160 | ) | |||||||||
|
Gains (losses) on interest rate
agreements
|
2,499 | (478 | ) | (448 | ) | ||||||||
|
Net recognized gains and valuation
adjustments
|
$ | 60,848 | $ | 59,127 | $ | 46,676 | |||||||
| (In thousands) | 2005 | 2004 | 2003 | |||||||||
|
Balance at beginning of period
|
$ | 23,396 | $ | 16,336 | $ | 8,271 | ||||||
|
(Reversal of) provision for credit
losses
|
(245 | ) | 7,236 | 8,146 | ||||||||
|
Charge-offs
|
(495 | ) | (176 | ) | (81 | ) | ||||||
|
Balance at end of period
|
$ | 22,656 | $ | 23,396 | $ | 16,336 | ||||||
F-31
| (In thousands) | 2005 | 2004 | 2003 | |||||||||
|
Balance at beginning of period
|
$ | 500 | $ | 500 | $ | — | ||||||
|
(Reversal of) provision for credit
losses
|
(185 | ) | — | 500 | ||||||||
|
Charge-offs
|
(315 | ) | — | — | ||||||||
|
Balance at end of period
|
$ | 0 | $ | 500 | $ | 500 | ||||||
| (In thousands) | ||||||||||||||||||||||||
| December 31, 2005 | December 31, 2004 | |||||||||||||||||||||||
| Fair | Notional | Credit | Fair | Notional | Credit | |||||||||||||||||||
| Value | Amount | Exposure | Value | Amount | Exposure | |||||||||||||||||||
|
Trading Instruments
|
||||||||||||||||||||||||
|
Interest rate caps purchased
|
$ | 1,913 | $ | 116,400 | $ | — | $ | 1,861 | $ | 105,400 | $ | — | ||||||||||||
|
Interest rate caps sold
|
(239 | ) | (65,000 | ) | — | (440 | ) | (65,000 | ) | — | ||||||||||||||
|
Interest rate corridors purchased
|
— | 1,059,851 | — | 63 | 1,340,331 | — | ||||||||||||||||||
|
Interest rate swaps
|
148 | 80,400 | — | — | — | — | ||||||||||||||||||
|
Cash Flow Hedges
|
||||||||||||||||||||||||
|
Interest rate swaps
|
28,891 | 5,399,653 | (2,672 | ) | 13,536 | 11,081,719 | 280 | |||||||||||||||||
|
Total Interest Rate
Agreements
|
$ | 30,713 | $ | 6,591,304 | $ | (2,672 | ) | $ | 15,020 | $ | 12,462,450 | $ | 280 | |||||||||||
F-32
| (In thousands) | 2005 | 2004 | 2003 | |||||||||
|
Realized net losses reclassified
from other comprehensive income
|
$ | (436 | ) | $ | (401 | ) | $ | (2,057 | ) | |||
|
Realized net gains (losses) due to
net ineffective portion of hedges
|
190 | (790 | ) | (233 | ) | |||||||
|
Net cash receipts
(payments) on interest rate swaps
|
6,788 | (12,044 | ) | (5,885 | ) | |||||||
|
Total
|
$ | 6,542 | $ | (13,235 | ) | $ | (8,175 | ) | ||||
|
Net Recognized Gains (Losses)
and Valuation Adjustments
|
||||||||||||
|
Realized net gains (losses) on
trading instruments
|
$ | 2,499 | $ | (478 | ) | $ | (448 | ) | ||||
F-33
| (In thousands) | ||||||||||||||||||||||||
| December 31, 2005 | December 31, 2004 | |||||||||||||||||||||||
| Weighted | Weighted | Weighted | Weighted | |||||||||||||||||||||
| Average | Average | Average | Average | |||||||||||||||||||||
| Amount | Interest | Days Until | Amount | Interest | Days Until | |||||||||||||||||||
| Borrowed | Rate | Maturity | Borrowed | Rate | Maturity | |||||||||||||||||||
|
Residential real estate loan
collateral
|
$ | — | — | — | $ | 181,999 | 2.92 | % | 126 | |||||||||||||||
|
Residential loan CES collateral
|
38,707 | 4.99 | % | 73 | — | — | — | |||||||||||||||||
|
Commercial real estate loan
collateral
|
— | — | — | — | — | — | ||||||||||||||||||
|
Commercial loan CES collateral
|
— | — | — | — | — | — | ||||||||||||||||||
|
Securities portfolio collateral
|
131,000 | 5.07 | % | 73 | 21,282 | 4.05 | % | 69 | ||||||||||||||||
|
Total Redwood debt
|
$ | 169,707 | 5.05 | % | 73 | $ | 203,281 | 3.03 | % | 120 | ||||||||||||||
| (In thousands) | December 31, 2005 | December 31, 2004 | ||||||
|
Within 30 days
|
$ | — | $ | 868 | ||||
|
31 to 90 days
|
169,707 | 115,841 | ||||||
|
Over 90 days
|
— | 86,572 | ||||||
|
Total Redwood debt
|
$ | 169,707 | $ | 203,281 | ||||
| (In thousands) | ||||||||||||||||
| December 31, 2005 | ||||||||||||||||
| Number | ||||||||||||||||
| of | ||||||||||||||||
| Facilities | Outstanding | Limit | Maturity | |||||||||||||
|
Facilities by Collateral
|
||||||||||||||||
|
Real Estate Loans
|
4 | $ | — | $ | 1,800,000 | 1/06-9/06 | ||||||||||
|
Real Estate Securities
|
1 | 169,707 | 300,000 | 3/06 | ||||||||||||
|
Unsecured Line of Credit
|
1 | — | 10,000 | 8/06 | ||||||||||||
|
Madrona Commercial Paper Facility
|
1 | — | 300,000 | 4/08 | ||||||||||||
|
Total Facilities
|
7 | $ | 169,707 | $ | 2,410,000 | |||||||||||
F-34
| December 31, 2004 | ||||||||||||||||
| Number | ||||||||||||||||
| of | ||||||||||||||||
| Facilities | Outstanding | Limit | Maturity | |||||||||||||
|
Facilities by Collateral
|
||||||||||||||||
|
Real Estate Loans
|
4 | $ | 181,999 | $ | 1,600,000 | 3/05-10/05 | ||||||||||
|
Real Estate Securities
|
3 | 21,282 | 410,000 | 3/05-8/05 | ||||||||||||
|
Total Facilities
|
7 | $ | 203,281 | $ | 2,010,000 | |||||||||||
| (In thousands) | December 31, 2005 | December 31, 2004 | |||||||
|
Sequoia ABS issued —
certificates with principal value
|
$ | 13,246,343 | $ | 21,681,229 | |||||
|
Sequoia ABS issued —
interest-only certificates
|
142,788 | 210,385 | |||||||
|
Acacia ABS issued
|
2,165,840 | 1,691,592 | |||||||
|
Commercial ABS issued
|
4,250 | 9,523 | |||||||
|
Madrona ABS issued
|
5,400 | — | |||||||
|
Unamortized premium on ABS
|
20,656 | 37,433 | |||||||
|
Total consolidated ABS issued
|
$ | 15,585,277 | $ | 23,630,162 | |||||
|
Range of weighted average interest
rates, by series
— Sequoia |
4.23% to 5.65 | % | 2.22% to 5.54 | % | |||||
|
Stated Sequoia maturities
|
2007 - 2035 | 2007 - 2035 | |||||||
|
Number of Sequoia series
|
42 | 39 | |||||||
|
Range of weighted average interest
rates, by series
— Acacia |
4.32% - 5.40 | % | 2.69% - 3.35 | % | |||||
|
Stated Acacia maturities
|
2023 - 2046 | 2018 - 2040 | |||||||
|
Number of Acacia series
|
8 | 6 | |||||||
|
Weighted average interest
rates — Commercial
|
12.00 | % | 9.08 | % | |||||
|
Stated commercial maturities
|
2009 | 2005 and 2009 | |||||||
|
Number of commercial series
|
1 | 2 | |||||||
F-35
| (In thousands) | December 31, 2005 | December 31, 2004 | ||||||
|
Sequoia
|
$ | 26,225 | $ | 28,879 | ||||
|
Acacia
|
13,778 | 6,025 | ||||||
|
Commercial
|
44 | 65 | ||||||
|
Total accrued interest payable on
ABS issued
|
$ | 40,047 | $ | 34,969 | ||||
| (In thousands) | December 31, 2005 | December 31, 2004 | ||||||
|
Residential real estate loans
|
$ | 13,829,493 | $ | 22,311,270 | ||||
|
Residential loan CES
|
301,584 | 210,902 | ||||||
|
Commercial real estate loans
|
53,067 | 22,360 | ||||||
|
Securities portfolio securities
|
1,581,682 | 1,265,322 | ||||||
|
Real estate owned (REO)
|
2,589 | — | ||||||
|
Restricted cash owned by
consolidated securitization entities
|
70,276 | 35,740 | ||||||
|
Accrued interest receivable
|
71,850 | 65,951 | ||||||
|
Total collateral for ABS issued
|
$ | 15,910,541 | $ | 23,911,545 | ||||
| NOTE 8. | TAXES |
F-36
| (In thousands) | 2005 | 2004 | 2003 | ||||||||||
|
Current Tax Provision:
|
|||||||||||||
|
Redwood REIT — Federal
|
$ | 4,364 | $ | 5,977 | $ | 3,594 | |||||||
|
Holdings — Federal
|
3,944 | 7,913 | 0 | ||||||||||
|
State
|
4,025 | 4,679 | 1,908 | ||||||||||
|
Total current tax provision
|
12,333 | 18,569 | 5,502 | ||||||||||
|
Deferred tax provision/(benefit):
|
|||||||||||||
|
Redwood REIT
|
— | — | — | ||||||||||
|
Holdings
|
5,188 | (10,572 | ) | — | |||||||||
|
Total deferred tax (benefit)
provision
|
5,188 | (10,572 | ) | — | |||||||||
|
Total provision for income tax
|
$ | 17,521 | $ | 7,997 | $ | 5,502 | |||||||
F-37
| (In thousands) | December 31, 2005 | December 31, 2004 | ||||||
|
Net operating loss carry
forward — Federal
|
$ | — | $ | — | ||||
|
Net operating loss carry
forward — State
|
725 | 721 | ||||||
|
Real estate assets
|
1,970 | 315 | ||||||
|
Gains from Sequoia securitizations
|
2,536 | 9,536 | ||||||
|
State credit carry-forwards
|
229 | — | ||||||
|
Interest rate agreements
|
224 | — | ||||||
|
Total deferred tax assets
|
$ | 5,684 | 10,572 | |||||
|
Valuation allowance
|
(300 | ) | — | |||||
|
Total benefited deferred tax assets
|
$ | 5,384 | $ | 10,572 | ||||
|
Deferred tax liabilities
|
— | — | ||||||
|
Net deferred tax assets
|
$ | 5,384 | $ | 10,572 | ||||
| NOTE 9. | FAIR VALUE OF FINANCIAL INSTRUMENTS |
F-38
| (In thousands) | |||||||||||||||||
| December 31, 2005 | December 31, 2004 | ||||||||||||||||
| Carrying | Carrying | ||||||||||||||||
| Value | Fair Value | Value | Fair Value | ||||||||||||||
|
ASSETS
|
|||||||||||||||||
|
Real Estate Loans
|
|||||||||||||||||
|
Residential real estate loans:
held-for-investment
|
$ | 13,874,792 | $ | 13,794,513 | $ | 22,502,743 | $ | 22,690,897 | |||||||||
|
Residential real estate loans:
held-for-sale
|
$ | — | $ | — | $ | 2,022 | $ | 2,022 | |||||||||
|
Commercial real estate loans:
held-for-investment
|
$ | 59,692 | $ | 61,196 | $ | 54,479 | $ | 55,258 | |||||||||
|
Real Estate Loan Securities
|
|||||||||||||||||
|
Residential loan credit-enhancement
securities: available-for-sale
|
$ | 612,649 | $ | 612,649 | $ | 561,658 | $ | 561,658 | |||||||||
|
Commercial loan credit-enhancement
securities, available-for-sale
|
$ | 57,687 | $ | 57,687 | $ | 14,498 | $ | 14,498 | |||||||||
|
Securities portfolio:
available-for-sale
|
$ | 1,748,581 | $ | 1,748,581 | $ | 1,380,077 | $ | 1,380,077 | |||||||||
|
Interest Rate Agreements
|
$ | 31,220 | $ | 31,220 | $ | 16,144 | $ | 16,144 | |||||||||
|
Cash and Cash Equivalents
|
$ | 175,885 | $ | 175,885 | $ | 57,246 | $ | 57,246 | |||||||||
|
Restricted Cash
|
$ | 72,421 | $ | 72,421 | $ | 36,038 | $ | 36,038 | |||||||||
|
Accrued Interest Receivable
|
$ | 76,469 | $ | 76,469 | $ | 72,459 | $ | 72,459 | |||||||||
|
LIABILITIES
|
|||||||||||||||||
|
Redwood debt
|
$ | 169,707 | $ | 169,707 | $ | 203,281 | $ | 203,281 | |||||||||
|
ABS issued
|
$ | 15,585,277 | $ | 15,519,383 | $ | 23,630,162 | $ | 23,701,977 | |||||||||
|
Interest Rate Agreements
|
$ | 507 | $ | 507 | $ | 1,124 | $ | 1,124 | |||||||||
|
Accrued Interest Payable
|
$ | 41,027 | $ | 41,027 | $ | 35,064 | $ | 35,064 | |||||||||
| • | Residential and HELOC loans fair values are determined by available market quotes and discounted cash flow analyses and are confirmed by third party/dealer pricing indications. | |
| • | Commercial loans fair values are determined by appraisals on underlying collateral and discounted cash flow analyses. |
| • | Residential and commercial real estate securities fair values are determined by discounted cash flow analyses and other valuation techniques using market pricing assumptions confirmed by third party dealer pricing indications. |
| • | Fair values on interest rate agreements are determined by third party vendor modeling software and from valuations provided by dealers active in the derivatives markets. |
| • | Includes cash on hand and highly liquid investments with original maturities of three months or less. Fair values equal carrying values. |
| • | Includes interest earning cash balances in ABS entities for the purpose of distribution to bondholders and reinvestment. Due to the short-term nature of the restrictions, fair values approximate carrying values. |
F-39
F-40
•
Includes interest due and receivable on assets and due and
payable on our liabilities. Due to the short-term nature of when
these interest payments will be received or paid, fair values
approximate carrying values.
•
All Redwood debt is adjustable and matures within one year; fair
values approximate carrying values.
•
Fair values are determined by discounted cash flow analyses and
other valuations techniques confirmed by third party dealer
pricing indications.
•
The fair values of purchase commitments were negligible and are
thus not listed in this table. See Note 11 for a further
discussion of our commitments at December 31, 2005.
NOTE 10.
STOCKHOLDERS’ EQUITY
Stock Option Plan
| 2005 | 2004 | 2003 | |||||||||||||||||||||||
| Weighted | Weighted | Weighted | |||||||||||||||||||||||
| Average | Average | Average | |||||||||||||||||||||||
| Exercise | Exercise | Exercise | |||||||||||||||||||||||
| Shares | Price | Shares | Price | Shares | Price | ||||||||||||||||||||
|
Stock Options
Outstanding
|
|||||||||||||||||||||||||
|
Outstanding options at beginning of
period
|
1,624,464 | $ | 31.77 | 1,935,598 | $ | 26.48 | 1,869,782 | $ | 22.58 | ||||||||||||||||
|
Options granted
|
3,601 | 51.70 | 189,878 | 57.39 | 238,600 | 50.29 | |||||||||||||||||||
|
Options exercised
|
(32,990 | ) | 19.98 | (517,209 | ) | 18.69 | (189,883 | ) | 14.42 | ||||||||||||||||
|
Options forfeited
|
(67,680 | ) | 10.47 | (23,033 | ) | 37.54 | (9,220 | ) | 26.73 | ||||||||||||||||
|
Stock dividend equivalent rights
earned
|
21,017 | — | 39,230 | — | 26,319 | — | |||||||||||||||||||
|
Outstanding options at end of period
|
1,548,412 | $ | 32.60 | 1,624,464 | $ | 31.77 | 1,935,598 | $ | 26.48 | ||||||||||||||||
|
Options exercisable at period-end
|
1,231,341 | $ | 28.60 | 1,040,792 | $ | 25.69 | 1,286,750 | $ | 22.89 | ||||||||||||||||
|
Weighted average fair value of
options granted during the period
|
$ | 10.84 | $ | 13.71 | $ | 13.20 | |||||||||||||||||||
| Options Outstanding | Options Exercisable | |||||||||||||||||||
| Range of | Weighted-Average | |||||||||||||||||||
| Exercise | Number | Remaining | Weighted-Average | Number | Weighted-Average | |||||||||||||||
| Prices | Outstanding | Contractual Life | Exercise Price | Exercisable | Exercise Price | |||||||||||||||
|
$ 0 to $10
|
0 | 0.00 | $ | 0.00 | 0 | $ | 0.00 | |||||||||||||
|
$10 to $20
|
355,783 | 3.68 | 12.73 | 355,783 | 12.73 | |||||||||||||||
|
$20 to $30
|
458,275 | 4.91 | 24.27 | 382,449 | 23.77 | |||||||||||||||
|
$30 to $40
|
266,910 | 1.41 | 37.48 | 259,489 | 37.50 | |||||||||||||||
|
$40 to $50
|
97,772 | 2.69 | 45.50 | 97,022 | 45.53 | |||||||||||||||
|
$50 to $60
|
368,870 | 8.15 | 55.08 | 135,797 | 54.52 | |||||||||||||||
|
$60 to $63
|
802 | 6.62 | 62.54 | 802 | 62.54 | |||||||||||||||
|
$ 0 to $63
|
1,548,412 | 1,231,342 | ||||||||||||||||||
F-41
| 2005 | 2004 | 2003 | ||||||||||
|
Restricted stock outstanding at the
beginning of period
|
5,912 | 10,003 | 15,750 | |||||||||
|
Restricted stock granted
|
18,158 | 3,103 | 1,253 | |||||||||
|
Stock for which restrictions lapsed
|
(1,750 | ) | (7,000 | ) | (7,000 | ) | ||||||
|
Restricted stock forfeited
|
(1,282 | ) | (194 | ) | 0 | |||||||
|
Restricted stock outstanding at end
of period
|
21,038 | 5,912 | 10,003 | |||||||||
| (In thousands) | 2005 | 2004 | 2003 | |||||||||
|
Participants’ deferrals
|
$ | 973 | $ | 1,076 | $ | 1,731 | ||||||
|
Accrued interest earned in EDCP
|
1,329 | 1,231 | 393 | |||||||||
|
Participant withdrawals
|
(225 | ) | (13 | ) | — | |||||||
|
Net change in participants’
equity
|
$ | 2,077 | $ | 2,294 | $ | 2,124 | ||||||
|
Balance at beginning of period
|
$ | 4,928 | $ | 2,634 | $ | 510 | ||||||
|
Balance at end of period
|
$ | 7,005 | $ | 4,928 | $ | 2,634 | ||||||
| (In thousands) | December 31, 2005 | December 31, 2004 | ||||||
|
Cash Accounts
|
||||||||
|
Participants’ deferrals
|
$ | 4,064 | $ | 3,286 | ||||
|
Accrued interest credited
|
2,941 | 1,642 | ||||||
|
Net assets available for
participants’ benefit
|
$ | 7,005 | $ | 4,928 | ||||
F-42
| (In thousands) | December 31, 2005 | December 31, 2004 | ||||||
|
Value of DSUs at grant
|
$ | 19,199 | $ | 4,656 | ||||
|
Participant forfeitures
|
(110 | ) | — | |||||
|
Change in value at period end since
grant
|
(1,837 | ) | 1,066 | |||||
|
Value of DSUs at end of period
|
$ | 17,252 | $ | 5,722 | ||||
| (In thousands, except unit amounts) | ||||||||||||||||||||||||
| 2005 | 2004 | 2003 | ||||||||||||||||||||||
| Units | Value | Units | Value | Units | Value | |||||||||||||||||||
|
Balance at beginning of period
|
92,161 | $ | 5,722 | 25,417 | $ | 1,292 | — | $ | — | |||||||||||||||
|
Transfer in of DSUs (value of
grants)
|
327,854 | 14,543 | 66,744 | 3,887 | 25,417 | 769 | ||||||||||||||||||
|
Change in valuation during period
|
— | (2,903 | ) | — | 543 | — | 523 | |||||||||||||||||
|
Participant forfeitures
|
(1,889 | ) | (110 | ) | — | — | — | — | ||||||||||||||||
|
Net Change in number/value of DSUs
|
325,965 | 11,530 | 66,744 | 4,430 | 25,417 | 1,292 | ||||||||||||||||||
|
Balance at end of period
|
418,126 | $ | 17,252 | 92,161 | $ | 5,722 | 25,417 | $ | 1,292 | |||||||||||||||
| (In thousands) | 2005 | 2004 | 2003 | |||||||||
|
Balance at beginning of period
|
$ | 0 | $ | 0 | $ | 0 | ||||||
|
Transfer in of participants’
payroll deductions from the ESPP
|
239 | 225 | 236 | |||||||||
|
Cost of common stock issued to
participants under the terms of the ESPP
|
(226 | ) | (225 | ) | (236 | ) | ||||||
|
Net change in participants’
equity
|
$ | 13 | $ | 0 | $ | 0 | ||||||
|
Balance at end of period
|
$ | 13 | $ | 0 | $ | 0 | ||||||
F-43
| (In thousands) | December 31, | December 31, | |||||||
| 2005 | 2004 | ||||||||
|
Net unrealized gains on
available-for-sale securities:
|
|||||||||
|
Residential loan CES
|
$ | 58,196 | $ | 78,733 | |||||
|
Commercial loan CES
|
4,676 | 1,615 | |||||||
|
Securities portfolio
|
(6,330 | ) | 15,048 | ||||||
|
Total available-for-sale securities
|
$ | 56,542 | $ | 95,396 | |||||
|
Net unrealized gains (losses) on
interest rate agreements:
|
|||||||||
|
Interest rate agreements accounted
for as cash flow hedges
|
17,189 | 9,961 | |||||||
|
Total accumulated other
comprehensive income
|
$ | 73,731 | $ | 105,357 | |||||
| NOTE 11. | COMMITMENTS AND CONTINGENCIES |
F-44
| (In thousands) | December 31, 2005 | |||
|
2006
|
1,046 | |||
|
2007
|
735 | |||
|
2008
|
687 | |||
|
2009
|
703 | |||
|
2010 and thereafter
|
2,654 | |||
|
Total
|
$ | 5,825 | ||
| (In thousands) | December 31, 2005 | |||
|
Residential real estate loans
|
$ | 2,356 | ||
|
Residential loan CES
|
— | |||
|
Securities portfolio securities
|
— | |||
|
Total
|
$ | 2,356 | ||
| NOTE 12. | RECENT DEVELOPMENTS |
F-45
NOTE 13.
QUARTERLY FINANCIAL DATA — UNAUDITED
| (in thousands, except share data) | |||||||||||||||||
| For Three Months Ended | |||||||||||||||||
| December 31 | September 30 | June 30 | March 31 | ||||||||||||||
|
2005
|
|||||||||||||||||
|
Operating results:
|
|||||||||||||||||
|
Interest income
|
$ | 230,841 | $ | 243,556 | $ | 248,388 | $ | 237,166 | |||||||||
|
Interest expense
|
(189,691 | ) | (196,686 | ) | (195,180 | ) | (175,967 | ) | |||||||||
|
Net interest income
|
41,150 | 46,870 | 53,208 | 61,199 | |||||||||||||
|
Net income
|
42,496 | 55,899 | 40,915 | 60,562 | |||||||||||||
|
Per share data:
|
|||||||||||||||||
|
Net income — basic
|
$1.71 | $2.26 | $1.66 | $2.49 | |||||||||||||
|
Net income — diluted
|
$1.68 | $2.21 | $1.62 | $2.42 | |||||||||||||
|
Regular Dividends declared per
common share
|
$0.70 | $0.70 | $0.70 | $0.70 | |||||||||||||
|
Special dividends declared per
common share
|
$3.00 | — | — | — | |||||||||||||
|
2004
|
|||||||||||||||||
|
Operating results:
|
|||||||||||||||||
|
Interest income
|
$ | 205,178 | $ | 180,090 | $ | 137,979 | $ | 124,837 | |||||||||
|
Interest expense
|
(147,171 | ) | (114,811 | ) | (90,359 | ) | (79,577 | ) | |||||||||
|
Net interest income
|
58,007 | 65,279 | 47,620 | 45,260 | |||||||||||||
|
Net income
|
54,414 | 72,342 | 55,088 | 50,791 | |||||||||||||
|
Per share data:
|
|||||||||||||||||
|
Net income — basic
|
$2.29 | $3.30 | $2.67 | $2.61 | |||||||||||||
|
Net income — diluted
|
$2.22 | $3.18 | $2.58 | $2.49 | |||||||||||||
|
Regular dividends declared per
common share
|
$0.67 | $0.67 | $0.67 | $0.67 | |||||||||||||
|
Special dividends declared per
common share
|
$5.50 | — | — | $0.50 | |||||||||||||
F-46