UNITED
STATES OF AMERICA
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF
1934
|
For
the Quarterly Period Ended: June 30, 2007
OR
o |
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF
1934
|
For
the transition period from
to
Commission
file number 1-13759
REDWOOD
TRUST, INC.
(Exact
Name of Registrant as Specified in Its Charter)
|
Maryland
|
|
68-0329422
|
|
|
(State
or Other Jurisdiction of
Incorporation
or Organization)
|
|
(I.R.S.
Employer
Identification
No.)
|
|
One
Belvedere Place, Suite 300
Mill
Valley, California 94941
(Address
of Principal Executive Offices) (Zip Code)
(Registrant’s
Telephone Number, Including Area Code): (415)
389-7373
Securities
registered pursuant to Section 12(g) of the Act:
Title
of Each Class:
|
Name
of Exchange on Which Registered:
|
Common
Stock, par value $0.01 per share
|
New
York Stock Exchange
|
Securities
registered pursuant to Section 12(g) of the Act: None
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days.
Yes
x No
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
Accelerated Filer x
|
Accelerated
Filer o
|
Non-Accelerated
Filer o
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes
o No
x
Indicate
the number of shares outstanding of each of the issuer’s classes of stock, as of
the last practicable date.
Common
Stock, $0.01 par value per share
|
27,937,406
as of August 7, 2007
|
REDWOOD
TRUST, INC.
2007
FORM 10-Q REPORT
TABLE
OF CONTENTS
|
|
Page
|
|
|
|
PART
I
|
|
|
Item
1.
|
|
Financial
Statements
|
|
|
|
|
Consolidated
Balance Sheets at June 30, 2007 (unaudited) and December 31,
2006
|
|
1
|
|
|
Consolidated
Statements of Income for the three and six months ended June 30,
2007 and
2006 (unaudited)
|
|
2
|
|
|
Consolidated
Statements of Comprehensive Income (Loss) for the three and six months
ended June 30, 2007 and 2006 (unaudited)
|
|
3
|
|
|
Consolidated
Statements of Stockholders’ Equity for the six months ended June 30, 2007
and 2006 (unaudited)
|
|
4
|
|
|
Consolidated
Statements of Cash Flows for the six months ended June 30, 2007 and
2006
(unaudited)
|
|
5
|
|
|
Notes
to Consolidated Financial Statements
|
|
6
|
Item
2.
|
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
|
43
|
Item
3.
|
|
Quantitative
and Qualitative Disclosures about Market Risk
|
|
83
|
Item
4.
|
|
Controls
and Procedures
|
|
|
|
|
|
|
|
PART
II
|
|
|
Item
2.
|
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
|
|
Item
4.
|
|
Voting
Results
|
|
|
Item
6.
|
|
Exhibits
|
|
|
Signatures
|
|
|
PART
I. FINANCIAL INFORMATION
ITEM
1. FINANCIAL STATEMENTS
REDWOOD
TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
(In
thousands, except share data)
|
|
June
30,
2007
|
|
December 31,
2006
|
|
(Unaudited)
|
|
|
|
ASSETS
|
|
|
|
|
|
Real
estate loans
|
|
$
|
8,377,474
|
|
$
|
9,352,107
|
|
Real
estate securities
|
|
|
3,725,772
|
|
|
3,232,767
|
|
Other
real estate investments
|
|
|
34,168
|
|
|
—
|
|
Non-real
estate investments
|
|
|
80,000
|
|
|
—
|
|
Cash
and cash equivalents
|
|
|
82,626
|
|
|
168,016
|
|
Total
earning assets
|
|
|
12,300,040
|
|
|
12,752,890
|
|
Restricted
cash
|
|
|
206,664
|
|
|
112,167
|
|
Accrued
interest receivable
|
|
|
57,337
|
|
|
70,769
|
|
Derivative
assets
|
|
|
40,713
|
|
|
26,827
|
|
Deferred
tax asset
|
|
|
4,660
|
|
|
5,146
|
|
Deferred
asset-backed securities issuance costs
|
|
|
48,532
|
|
|
42,468
|
|
Other
assets
|
|
|
23,369
|
|
|
20,206
|
|
Total
Assets
|
|
$
|
12,681,315
|
|
$
|
13,030,473
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
LIABILITIES
|
|
|
|
|
|
|
|
Redwood
debt
|
|
$
|
848,662
|
|
$
|
1,856,208
|
|
Asset-backed
securities issued
|
|
|
10,675,469
|
|
|
9,979,224
|
|
Accrued
interest payable
|
|
|
48,473
|
|
|
50,590
|
|
Derivative
liabilities
|
|
|
6,250
|
|
|
6,214
|
|
Accrued
expenses and other liabilities
|
|
|
55,515
|
|
|
16,832
|
|
Dividends
payable
|
|
|
20,862
|
|
|
18,715
|
|
Subordinated
notes
|
|
|
150,000
|
|
|
100,000
|
|
Total
liabilities
|
|
|
11,805,231
|
|
|
12,027,783
|
|
Commitments
and contingencies (Note 17)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS’
EQUITY
|
|
|
|
|
|
|
|
Common
stock, par value $0.01 per share, 50,000,000 shares authorized; 27,816,200
and 26,733,460 issued and outstanding
|
|
|
279
|
|
|
267
|
|
Additional
paid-in capital
|
|
|
964,944
|
|
|
903,808
|
|
Accumulated
other comprehensive income (loss)
|
|
|
(80,913
|
)
|
|
93,158
|
|
Cumulative
earnings
|
|
|
838,736
|
|
|
809,011
|
|
Cumulative
distributions to stockholders
|
|
|
(846,962
|
)
|
|
(803,554
|
)
|
Total
stockholders’ equity
|
|
|
876,084
|
|
|
1,002,690
|
|
Total
Liabilities and Stockholders’ Equity
|
|
$
|
12,681,315
|
|
$
|
13,030,473
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF INCOME
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
(In
thousands, except share data)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
Interest
Income
|
|
|
|
|
|
|
|
|
|
Real
estate loans
|
|
$
|
119,576
|
|
$
|
154,972
|
|
$
|
246,427
|
|
$
|
321,875
|
|
Real
estate securities
|
|
|
95,193
|
|
|
60,395
|
|
|
178,651
|
|
|
116,897
|
|
Other
real estate investments
|
|
|
669
|
|
|
—
|
|
|
3,134
|
|
|
—
|
|
Non-real
estate investments
|
|
|
464
|
|
|
—
|
|
|
464
|
|
|
—
|
|
Cash
and cash equivalents
|
|
|
3,756
|
|
|
2,871
|
|
|
6,088
|
|
|
5,348
|
|
Total
interest income
|
|
|
219,658
|
|
|
218,238
|
|
|
434,764
|
|
|
444,120
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redwood
debt
|
|
|
(22,700
|
)
|
|
(1,822
|
)
|
|
(53,794
|
)
|
|
(3,894
|
)
|
Asset-backed
securities issued
|
|
|
(140,541
|
)
|
|
(171,697
|
)
|
|
(275,487
|
)
|
|
(350,280
|
)
|
Subordinated
notes
|
|
|
(2,516
|
)
|
|
—
|
|
|
(4,572
|
)
|
|
—
|
|
Total
interest expense
|
|
|
(165,757
|
)
|
|
(173,519
|
)
|
|
(333,853
|
)
|
|
(354,174
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Interest Income
|
|
|
53,901
|
|
|
44,719
|
|
|
100,911
|
|
|
89,946
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses
|
|
|
(12,772
|
)
|
|
(16,037
|
)
|
|
(30,554
|
)
|
|
(28,619
|
)
|
Realized
gains on sales and calls, net
|
|
|
2,738
|
|
|
8,988
|
|
|
3,884
|
|
|
10,050
|
|
Market
valuation adjustments, net
|
|
|
(29,430
|
)
|
|
(2,995
|
)
|
|
(39,694
|
)
|
|
(5,927
|
)
|
Net
income before provision for income taxes
|
|
|
14,437
|
|
|
34,675
|
|
|
34,547
|
|
|
65,450
|
|
Provision
for income taxes
|
|
|
(3,021
|
)
|
|
(3,265
|
)
|
|
(4,822
|
)
|
|
(6,025
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Income
|
|
$
|
11,416
|
|
$
|
31,410
|
|
$
|
29,725
|
|
$
|
59,425
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings per share:
|
|
$
|
0.42
|
|
$
|
1.23
|
|
$
|
1.10
|
|
$
|
2.34
|
|
Diluted
earnings per share:
|
|
$
|
0.41
|
|
$
|
1.20
|
|
$
|
1.06
|
|
$
|
2.29
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Regular
dividends declared per common share
|
|
$
|
0.75
|
|
$
|
0.70
|
|
$
|
1.50
|
|
$
|
1.40
|
|
Special
dividends declared per common share
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
Total
dividends declared per common share
|
|
$
|
0.75
|
|
$
|
0.70
|
|
$
|
1.50
|
|
$
|
1.40
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
weighted average shares outstanding
|
|
|
27,405,284
|
|
|
25,496,552
|
|
|
27,132,001
|
|
|
25,349,853
|
|
Diluted
weighted average shares outstanding
|
|
|
28,164,944
|
|
|
26,108,975
|
|
|
27,917,502
|
|
|
25,909,923
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
Net
Income
|
|
$
|
11,416
|
|
$
|
31,410
|
|
$
|
29,725
|
|
$
|
59,425
|
|
Other
Comprehensive (Loss) Income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
unrealized (losses) gains on available-for-sale securities
|
|
|
(101,745
|
)
|
|
6,679
|
|
|
(194,430
|
)
|
|
(1,380
|
)
|
Reclassification
adjustment for net (gains) losses included in net income
|
|
|
7,058
|
|
|
(1,342
|
)
|
|
6,945
|
|
|
656
|
|
Unrealized
(losses) gains on cash flow hedges, net
|
|
|
19,952
|
|
|
10,128
|
|
|
13,814
|
|
|
24,315
|
|
Reclassification
of net realized cash flow hedge losses (gains) to interest expense
on
asset-backed securities issued and realized gains on sales and
calls
|
|
|
5
|
|
|
(6,119
|
)
|
|
(400
|
)
|
|
(6,385
|
)
|
Total
Other Comprehensive (Loss) Income
|
|
|
(74,730
|
)
|
|
9,346
|
|
|
(174,071
|
)
|
|
17,206
|
|
Comprehensive
(Loss) Income
|
|
$
|
(63,314
|
)
|
$
|
40,756
|
|
$
|
(144,346
|
)
|
$
|
76,631
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
For
the Six Months Ended June 30, 2007
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
|
Cumulative
|
|
|
|
|
|
|
|
|
|
Additional
|
|
Comprehensive
|
|
|
|
Distributions
|
|
|
|
(In
thousands, except
|
|
Common
Stock
|
|
Paid-In
|
|
Income
|
|
Cumulative
|
|
to
|
|
|
|
share
data)
|
|
Shares
|
|
Amount
|
|
Capital
|
|
(Loss)
|
|
Earnings
|
|
Stockholders
|
|
Total
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2006
|
|
|
26,733,460
|
|
$
|
267
|
|
$
|
903,808
|
|
$
|
93,158
|
|
$
|
809,011
|
|
$
|
(803,554
|
)
|
$
|
1,002,690
|
|
Net
income
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
29,725
|
|
|
—
|
|
|
29,725
|
|
Net
unrealized gain/reclassification on assets AFS
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(187,485
|
)
|
|
—
|
|
|
—
|
|
|
(187,485
|
)
|
Net
unrealized gain/reclassification on interest rate
agreements
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
13,414
|
|
|
—
|
|
|
—
|
|
|
13,414
|
|
Issuance
of common stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividend
reinvestment & stock purchase plans
|
|
|
1,004,165
|
|
|
10
|
|
|
52,054
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
52,064
|
|
Employee
option & stock purchase plan
|
|
|
78,575
|
|
|
2
|
|
|
330
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
332
|
|
Non-cash
equity award compensation
|
|
|
—
|
|
|
—
|
|
|
8,752
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
8,752
|
|
Common
dividends declared
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(43,408
|
)
|
|
(43,408
|
)
|
June
30, 2007
|
|
|
27,816,200
|
|
$
|
279
|
|
$
|
964,944
|
|
$
|
(80,913
|
)
|
$
|
838,736
|
|
$
|
(846,962
|
)
|
$
|
876,084
|
|
For
the Six Months Ended June 30, 2006
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
|
Cumulative
|
|
|
|
|
|
|
|
|
|
Additional
|
|
Comprehensive
|
|
|
|
Distributions
|
|
|
|
(In
thousands, except |
|
Common
Stock
|
|
Paid-In
|
|
Income
|
|
Cumulative
|
|
to
|
|
|
|
share
data)
|
|
Shares
|
|
Amount
|
|
Capital
|
|
(Loss)
|
|
Earnings
|
|
Stockholders
|
|
Total
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2005
|
|
|
25,132,625
|
|
$
|
251
|
|
$
|
824,365
|
|
$
|
73,731
|
|
$
|
681,479
|
|
$
|
(644,866
|
)
|
$
|
934,960
|
|
Net
income
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
59,425
|
|
|
—
|
|
|
59,425
|
|
Net
unrealized loss/reclassification on assets AFS
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(724
|
)
|
|
—
|
|
|
—
|
|
|
(724
|
)
|
Net
unrealized gain/reclassification on interest rate
agreements
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
17,930
|
|
|
—
|
|
|
—
|
|
|
17,930
|
|
Issuance
of common stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividend
reinvestment & stock purchase plans
|
|
|
485,101
|
|
|
5
|
|
|
20,497
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
20,502
|
|
Employee
option & stock purchase plan
|
|
|
52,257
|
|
|
1
|
|
|
387
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
388
|
|
Non-cash
equity award compensation
|
|
|
(2,430
|
)
|
|
—
|
|
|
8,647
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
8,647
|
|
Common
dividends declared
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(36,862
|
)
|
|
(36,862
|
)
|
June
30, 2006
|
|
|
25,667,553
|
|
$
|
257
|
|
$
|
853,896
|
|
$
|
90,937
|
|
$
|
740,904
|
|
$
|
(681,728
|
)
|
$
|
1,004,266
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
|
Six
Months Ended
June
30,
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
(Unaudited)
|
|
|
|
|
|
Cash
Flows From Operating Activities:
|
|
|
|
|
|
Net
income
|
|
$
|
29,725
|
|
$
|
59,425
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
Amortization
of premiums, discounts, and debt issuance costs
|
|
|
(32,749
|
)
|
|
(31,080
|
)
|
Depreciation
and amortization of non-financial assets
|
|
|
830
|
|
|
545
|
|
Provision
for credit losses
|
|
|
6,329
|
|
|
(2,330
|
)
|
Non-cash
equity award compensation
|
|
|
8,752
|
|
|
8,647
|
|
Net
recognized losses (gains) and valuation adjustments
|
|
|
35,810
|
|
|
(4,123
|
)
|
Purchases
of other real estate investments - trading
|
|
|
(40,818
|
)
|
|
—
|
|
Purchases
of non-real estate investments - trading
|
|
|
(80,000
|
)
|
|
—
|
|
Principal
payments on other real estate investments - trading
|
|
|
7,431
|
|
|
—
|
|
Net
change in:
|
|
|
|
|
|
|
|
Accrued
interest receivable
|
|
|
13,432
|
|
|
9,671
|
|
Deferred
income taxes
|
|
|
568
|
|
|
281
|
|
Other
assets
|
|
|
4,111
|
|
|
(683
|
)
|
Accrued
interest payable
|
|
|
(2,117
|
)
|
|
5,900
|
|
Accrued
expenses and other liabilities
|
|
|
38,683
|
|
|
937
|
|
Net
cash (used in) provided by operating activities
|
|
|
(10,013
|
)
|
|
47,190
|
|
Cash
Flows From Investing Activities:
|
|
|
|
|
|
|
|
Purchases
of real estate loans held-for-investment
|
|
|
(1,091,496
|
)
|
|
(325,316
|
)
|
Proceeds
from sales of real estate loans held-for-investment
|
|
|
2,191
|
|
|
8,408
|
|
Principal
payments on real estate loans held-for-investment
|
|
|
2,025,662
|
|
|
3,733,573
|
|
Purchases
of real estate securities available-for-sale
|
|
|
(1,011,181
|
)
|
|
(496,822
|
)
|
Proceeds
from sales of real estate securities available-for-sale
|
|
|
175,559
|
|
|
176,432
|
|
Principal
payments on real estate securities available-for-sale
|
|
|
160,737
|
|
|
101,803
|
|
Proceeds
from sales of other real estate investments - trading
|
|
|
2,237
|
|
|
—
|
|
Net
increase in restricted cash
|
|
|
(94,497
|
)
|
|
(13,806
|
)
|
Net
cash provided by investing activities
|
|
|
169,212
|
|
|
3,184,272
|
|
Cash
Flows From Financing Activities:
|
|
|
|
|
|
|
|
Net
(repayments) borrowings on Redwood debt
|
|
|
(1,007,546
|
)
|
|
359,676
|
|
Proceeds
from issuance of asset-backed securities
|
|
|
3,332,925
|
|
|
288,709
|
|
Deferred
asset-backed security issuance costs
|
|
|
(19,147
|
)
|
|
(3,383
|
)
|
Repayments
on asset-backed securities
|
|
|
(2,609,157
|
)
|
|
(3,934,557
|
)
|
Proceeds
from issuance of subordinated notes
|
|
|
50,000
|
|
|
—
|
|
Net
(purchases) proceeds from interest rate agreements
|
|
|
(2,798
|
)
|
|
4,297
|
|
Net
proceeds from issuance of common stock
|
|
|
52,396
|
|
|
20,890
|
|
Dividends
paid
|
|
|
(41,262
|
)
|
|
(36,488
|
)
|
Net
cash used in financing activities
|
|
|
(244,589
|
)
|
|
(3,300,856
|
)
|
Net
decrease in cash and cash equivalents
|
|
|
(85,390
|
)
|
|
(69,394
|
)
|
Cash
and cash equivalents at beginning of period
|
|
|
168,016
|
|
|
175,885
|
|
Cash
and cash equivalents at end of period
|
|
$
|
82,626
|
|
$
|
106,491
|
|
Supplemental
Disclosure of Cash Flow Information:
|
|
|
|
|
|
|
|
Cash
paid for interest
|
|
$
|
335,970
|
|
$
|
348,274
|
|
Cash
paid for taxes
|
|
$
|
8,480
|
|
$
|
4,099
|
|
Non-Cash
Financing Activity:
|
|
|
|
|
|
|
|
Dividends
declared but not paid
|
|
$
|
20,862
|
|
$
|
17,967
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
1. Redwood Trust
Redwood
Trust, Inc., together with its subsidiaries (Redwood, we, or us), invests in,
finances, and manages real estate assets. We invest in residential and
commercial real estate loans and in asset-backed securities backed by real
estate loans. Our primary focus is credit-enhancing residential and commercial
real estate loans. We credit-enhance loans by acquiring and managing the
first-loss and other credit-sensitive securities that bear the bulk of the
credit risk of securitized loans.
We
seek
to invest in assets that have the potential to generate high long-term cash
flow
returns to help support our goal of distributing an attractive level of
dividends per share to shareholders over time. For tax purposes, we are
structured as a real estate investment trust (REIT).
Redwood
was incorporated in the State of Maryland on April 11, 1994, and commenced
operations on August 19, 1994. Our executive offices are located at One
Belvedere Place, Suite 300, Mill Valley, California 94941.
Note
2. Summary of Significant Accounting Policies
Basis
of Presentation
The
consolidated financial statements presented herein are at June 30, 2007 and
December 31, 2006 and for the three and six months ended June 30, 2007 and
2006. The accompanying consolidated financial statements are unaudited. The
unaudited interim consolidated financial statements have been prepared on the
same basis as the annual consolidated financial statements and, in our opinion,
reflect all adjustments necessary for a fair statement of our financial
position, results of operations, and cash flows. These consolidated financial
statements and notes thereto should be read in conjunction with our audited
consolidated financial statements included in our Annual Report on Form 10-K
for
the year ended December 31, 2006. The results for the six months ended June
30, 2007 are not necessarily indicative of the expected results for the year
ended December 31, 2007. Certain amounts for prior years have been
reclassified to conform to the June 30, 2007 presentation.
These
consolidated financial statements include the accounts of Redwood Trust, Inc.
(Redwood Trust) and its direct and indirect wholly-owned subsidiaries
(collectively, Redwood). All inter-company balances and transactions have been
eliminated in consolidation. A number of Redwood Trust’s subsidiaries are
qualifying REIT subsidiaries and the remainder are taxable subsidiaries.
References to the Redwood REIT mean Redwood Trust and its qualifying REIT
subsidiaries, excluding taxable subsidiaries.
We
currently operate two securitization programs. Our Sequoia program is used
for
the securitization of residential mortgage loans. References to Sequoia refer
collectively to all the Sequoia securitization entities. Our Acacia program
involves the resecuritization of mortgage-backed securities and other types
of
financial assets through the issuance of collateralized debt obligations (CDOs).
References to Acacia refer collectively to all of the Acacia CDO issuing
entities.
Under
the
provisions of Statement of Financial Accounting Standards No. 140, Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities
(FAS
140), we treat the securitizations we sponsor as financings, as under these
provisions we have retained effective control over these loans and securities.
Control is maintained through our active management of the assets in the
securitization entities, our retained asset transfer discretion, our ability
to
direct certain servicing decisions, or a combination of the foregoing.
Accordingly, the underlying loans and securities owned by these securitization
entities are shown on our consolidated balance sheets under real estate loans,
real estate securities, and the asset-back securities (ABS) issued to third
parties are shown on our consolidated balance sheets under ABS issued. In our
consolidated statements of income, we record interest income on the loans and
securities and interest expense on the ABS issued. Any Sequoia ABS acquired
by
Redwood or Acacia from Sequoia entities and any Acacia ABS acquired by Redwood
for its own portfolio are eliminated in consolidation and thus are not shown
separately on our consolidated balance sheets and the associated income and
expense are not shown separately on our consolidated statements of
income.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
2. Summary of Significant Accounting Policies -
(continued)
Use
of Estimates
The
preparation of financial statements in conformity with Generally Accepted
Accounting Principles in the United States of America (GAAP) requires us to
make
a significant number of estimates. These include fair market value of certain
assets, amount and timing of credit losses, prepayment assumptions, and other
items that affect the reported amounts of certain assets and liabilities as
of
the date of the consolidated financial statements and the reported amounts
of
certain revenues and expenses during the reported period. It is likely that
changes in these estimates (e.g., market values due to changes in supply and
demand, credit performance, prepayments, interest rates, or other reasons;
yields due to changes in credit outlook and loan prepayments) will occur in
the
near term. Our estimates are inherently subjective in nature and actual results
could differ from our estimates and the differences may be
material.
Real
Estate Loans
Residential
and Commercial Real Estate Loans: Held-for-Investment
Real
estate loans include residential and commercial real estate loans. Real estate
loans held-for-investment are carried at their unpaid principal balances
adjusted for net unamortized premiums or discounts and net of any allowance
for
credit losses.
Coupon
interest is recognized as revenue when earned and deemed collectible. We accrue
interest on loans until they are more than 90 days past due at which point
they
are placed on nonaccrual status. Purchase discounts and premiums related to
real
estate loans are amortized into interest income over their estimated lives
to
generate an effective yield, considering the actual and future estimated
prepayments of the loans pursuant to the provisions discussed below. Gains
or
losses on the sale of real estate loans are based on the specific identification
method.
Pursuant
to Statement of Financial Accounting Standards No. 91, Accounting
for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans
and Initial Direct Cost of Leases
(FAS
91), we use the interest method to determine an effective yield and amortize
the
premium or discount on loans. For loans acquired prior to July 1, 2004, we
use coupon interest rates as they change over time and anticipated principal
payments to determine an effective yield to amortize the premium or discount.
For loans acquired after July 1, 2004, we use the initial coupon interest
rate of the loans (without regard to future changes in the underlying indices)
and anticipated principal payments to calculate an effective yield to amortize
the premium or discount.
We
may
exercise our right to call ABS issued by entities sponsored by us and may
subsequently sell the underlying loans to third parties. For balance sheet
purposes, we reclassify held-for-investment loans to held-for-sale loans once
we
determine which loans will be sold to third parties. In our consolidated
statements of cash flows, sales of loans are reported as sales of loans
held-for-investment as the acquisition of loans were reported as purchases
of
loans held-for-investment.
Residential
and Commercial Real Estate Loans: Held-for-Sale
Residential
and commercial real estate loans that we are marketing for sale are classified
as real estate loans held-for-sale. These are carried at the lower of cost
or
fair market value on a loan-by-loan basis. Any market valuation adjustments
on
these loans are recognized in valuation adjustments net, in our consolidated
statements of income.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
2. Summary of Significant Accounting Policies -
(continued)
Real
Estate Loans - Reserve for Credit Losses
For
consolidated real estate loans held-for-investment, we establish and maintain
credit reserves based on estimates of credit losses inherent in these loan
portfolios as of the reporting date. To calculate the credit reserve, we assess
inherent losses by determining loss factors (defaults, the timing of defaults,
and loss severities upon defaults) that can be specifically applied to each
of
the consolidated loans, loan pools, or individual loans. See Note
8
for a
discussion of the reserves for credit losses.
We
follow
the guidelines of Staff Accounting Bulletin No. 102, Selected
Loan Loss Allowance Methodology and Documentation
(SAB
102), Statement of Financial Accounting Standards No. 5, Accounting
for Contingencies
(FAS 5),
and Statement of Financial Accounting Standards No. 114, Accounting
by Creditors for Impairment of a Loan
(FAS
114), and Statement of Financial Accounting Standards No. 118, Accounting
by Creditors for Impairment of a Loan-Income Recognition and
Disclosures
(FAS
118) in setting credit reserves for our real estate loans.
The
following factors are considered and applied in such
determinations:
|
·
|
Ongoing
analyses 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;
|
|
·
|
Information
supporting the borrowers’ ability to meet
obligations;
|
|
·
|
Ongoing
evaluations of fair market values of collateral using current appraisals
and other valuations; and
|
|
·
|
Discounted
cash flow analyses.
|
Once
we
determine applicable default amounts, the timing of the defaults, and severity
of losses upon the defaults, we estimate expected losses for each pool of loans
over its expected life. 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 impairment or charge-off of the loan).
The losses expected to occur within the estimated 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 we record provision,
charge-offs, and recoveries monthly.
We
do not
maintain a loan repurchase reserve, as any risk of loss due to loan repurchases
(i.e., due to breach of representations) would normally be covered by recourse
to the companies from whom we acquired the loans.
Real
Estate Securities
Real
estate securities include residential, commercial, and CDO securities. Real
estate securities are classified as available-for-sale (AFS) and are carried
at
their estimated fair market values. Cumulative unrealized gains and losses
are
reported as a component of accumulated other comprehensive income (loss) in
our
consolidated statements of stockholders’ equity. Upon sale this accumulated
other comprehensive income (loss) is reclassified into earnings on the specific
identification method.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
2. Summary of Significant Accounting Policies -
(continued)
Coupon
interest is recognized as revenue when earned and deemed collectible. Purchase
discounts and premiums related to the securities are amortized into interest
income over their estimated lives to generate an effective yield, considering
the actual and future estimated prepayments of the securities pursuant to the
provisions discussed below. Gains or losses on the sale of securities are based
on the specific identification method.
When
recognizing revenue on AFS securities, we employ the interest method to account
for purchase premiums, discounts, and fees associated with these securities.
For
securities rated AAA or AA, we use the interest method as prescribed under
FAS
91, while for securities rated A or lower we use the interest method as
prescribed under the Emerging Issues Task Force of the Financial Accounting
Standards Board 99-20, Recognition
of Interest Income and Impairment on Purchased and Retained Beneficial Interests
in Securitized Financial Assets
(EITF
99-20).
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, the timing and amount of credit losses, and other factors.
We
review and make adjustments to 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. Actual maturities
of AFS securities are generally shorter than stated contractual maturities.
All
of our stated maturities are greater than ten years. Actual maturities of the
AFS securities are affected by the contractual lives of the underlying
mortgages, periodic payments of principal, and prepayments of principal. There
can be no assurance that our assumptions used to estimate future cash flows
or
the current period’s yield for each asset would not change in the near term, and
the change could be material.
Yields
recognized for GAAP for each security vary as a function of credit results,
prepayment rates, and, for our securities with variable rate coupons, interest
rates. If estimated future credit losses are less than our prior estimate,
credit losses occur later than expected, or prepayment rates are faster than
expected (meaning the present value of projected cash flows is greater than
previously expected), the yield over the remaining life of the security may
be
adjusted upwards. If estimated future credit losses exceed our prior
expectations, credit losses occur more quickly than expected, or prepayments
occur more slowly than expected (meaning the present value of projected cash
flows is less than previously expected), the yield over the remaining life
of
the security may be adjusted downward or we may have an other-than-temporary
impairment.
For
determining other-than-temporary impairment on our real estate securities,
we
use the guidelines prescribed under EITF 99-20, Statement of Financial
Accounting Standards No. 115, Accounting
for Certain Investments in Debt and Equity Securities
(FAS
115), and Staff Accounting Bulletin No. 5(m), Other-Than-Temporary
Impairment for Certain Investments in Debt and Equity
Securities
(SAB
5(m)). Any other-than-temporary impairments are reported under market valuation
adjustments, net in our consolidated statements of income. For real estate
securities subject to Emerging Issues Task Force of the Financial Accounting
Standards Board 03-1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments
(EITF
03-1), we assess whether a drop in fair market value below the cost of the
real
estate security should be deemed as other-than-temporary impairment. If we
have
the ability and intent to hold a real estate security for a reasonable period
of
time sufficient for a forecasted recovery of fair market value up to (or beyond)
the cost of the investment, we do not deem that unrealized loss an
other-than-temporary impairment.
In
the
footnotes to the consolidated financial statements, we disclose information
on
our real estate securities portfolio based on the underlying residential,
commercial, and CDO assets. We also provide a further breakdown of these
securities by investment-grade securities (IGS, those rated BBB to AAA) and
credit-enhancement securities (CES, those rated non-rated to BB, also referred
to as first-loss, second-loss, and third-loss securities) based on their current
credit rating.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
2. Summary of Significant Accounting Policies -
(continued)
Other
Real Estate Investments
Other
real estate investments include interest-only certificates (IOs), net interest
margin securities (NIMs), and residual securities (residuals). At the conclusion
of the first quarter of 2007, we classified these investments as trading
securities. With the adoption of Statement
of Financial Accounting Standards
No. 155,
Accounting
for Certain Hybrid Financial Investments,
(FAS
155) IOs, NIMs and residuals may contain embedded derivatives which would
require bifurcation and separate valuation through the income statement. We
have
elected to treat these investments as trading securities under FAS 115 rather
than bifurcate the embedded derivative component. Trading securities are
reported on our consolidated balance sheet at their estimated fair market values
with changes in fair market values reported through our consolidated statements
of income through market valuation adjustments.
Total
income recognized in current period earnings on these investments equals coupon
interest earned plus the change in fair market value. Interest income is equal
to the instruments’ yield based on market expectations.
Non-Real
Estate Investments
Non-real
estate investments represents a guaranteed investment contract (GIC)
entered into by an Acacia securitization entity that we consolidate for
financial statements purposes. We have classified this investment as a trading
security that is recorded on our consolidated balance sheets at its estimated
fair market value. Management considers the GIC’s fair market value to
approximate contract value, as the interest rate is variable at LIBOR minus
a
spread and resets on a monthly basis. Changes in fair market value are reported
through our consolidated statements of income through market valuation
adjustments. See Note
6
for
further discussion of our non-real estate investments.
Cash
and Cash Equivalents
Cash
and
cash equivalents include cash on hand and highly liquid investments with
original maturities of three months or less.
Derivative
Financial Instruments
All
derivative financial instruments are reported at fair market value on our
consolidated balance sheets. Those with a positive value to us are reported
as
an asset and those with a negative value to us are reported as a liability.
Whether changes in the fair market value of these instruments are reported
through our income statement depends on the type of derivative and the
accounting treatment chosen.
We
currently enter into interest rate agreements to help manage some of our
interest rate risks. We report our interest rate agreements at fair market
value. We may elect hedge accounting treatment under Statement of Financial
Accounting Standards No. 133, Accounting
for Derivative Instruments and Hedging Activities
(FAS
133), or we may account for these as trading instruments. Net purchases and
proceeds from interest rate agreements are classified within cash flows from
financing activities within the consolidated statement of cash flows together
with the items the interest rate agreements hedge.
We
designate an interest rate agreement as (1) a hedge of the fair market 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).
In
a cash
flow hedge, the effective portion of the change in the fair market value of
the
hedging derivative is recorded in accumulated other comprehensive income (loss)
and is subsequently reclassified into earnings when the hedging
relationship is terminated. The ineffective portion of the cash flow hedge
is
recognized immediately in earnings. We use the dollar-offset method to determine
the amount of ineffectiveness, and we anticipate having some ineffectiveness
in
our hedging program, as not all terms of our hedges and not all terms of our
hedged items match perfectly.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
2. Summary of Significant Accounting Policies -
(continued)
We
will
discontinue hedge accounting when (1) we determine that the derivative is no
longer expected to be effective in offsetting changes in the fair market value
or cash flows of the designated hedged item; (2) the derivative expires or
is
sold, terminated, or exercised; (3) the derivative is de-designated as a fair
value or cash flow hedge; or (4) it is probable that the forecasted transaction
will not occur by the end of the originally specified time period.
As
of
each period end, we may also have outstanding commitments to purchase real
estate loans. These commitments are accounted for as derivatives under Statement
of Financial Accounting Standards No. 149, Amendment
of Statement 133 on Derivative Instruments and Hedging
Activities
(FAS
149), when applicable. These are classified as trading instruments and changes
in fair market value of the purchase commitments are recorded through valuation
adjustments in the consolidated statements of income.
Beginning
in the first quarter of 2007, we entered into credit default swap agreements.
A
credit default swap is an agreement to provide (receive) credit event protection
based on a financial index or specific security in exchange for receiving
(paying) a fixed rate fee or premium over the term of the contract. Under FAS
133, credit default swaps are accounted for as trading instruments.
See
Note
7
for a
further discussion of our derivative financial instruments.
Restricted
Cash
Restricted
cash includes principal and interest payments from real estate loans and
securities owned by consolidated securitization entities that are collateral
for, or payable to, owners of ABS issued by those entities and cash pledged
as
collateral on interest rate agreements. Restricted cash may also include cash
retained in Acacia or Sequoia securitization trusts prior to purchase of real
estate loans and securities or the redemption of outstanding ABS
issued.
Accrued
Interest Receivable
Accrued
interest receivable represents interest that is due and payable to us. This
is
generally received within the next month.
Deferred
Tax Assets
Income
recognition for GAAP and tax differ in material respects. As a result, we may
recognize taxable income in periods prior to recognizing the income for GAAP.
When this occurs, we pay the tax liability and establish a deferred tax asset
for GAAP. When the income is then realized under GAAP in future periods, the
deferred tax asset is recognized as an expense. Our deferred tax assets are
generated by differences in GAAP and tax income at our taxable
subsidiaries.
Deferred
Asset-Backed Securities Issuance Costs
ABS
issuance costs are costs associated with the issuance of ABS from securitization
entities we sponsor. These costs typically include underwriting, rating agency,
legal, accounting, and other fees. Deferred ABS issuance costs are reported
on
our consolidated balance sheets as deferred charges and are amortized as an
adjustment to consolidated interest expense using the interest method based
on
the actual and estimated repayment schedules of the
related ABS issued under the principles prescribed in Accounting Practice
Bulletin 21, Interest
on Receivables and Payables
(APB
21).
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
2. Summary of Significant Accounting Policies -
(continued)
Other
Assets
Other
assets on our consolidated balance sheets include real estate owned (REO),
fixed
assets, purchased interest, principal receivable, and other prepaid expenses.
REO is reported at the lower of cost or fair market value.
Redwood
Debt
Redwood
debt is currently all short-term debt collateralized by loans and securities.
We
report this debt at its unpaid principal balance.
Asset-Backed
Securities Issued
The
majority of the liabilities reported on our consolidated balance sheets
represent ABS issued by bankruptcy-remote securitization entities sponsored
by
Redwood. These ABS issued are carried at their unpaid principal balances net
of
any unamortized discount or premium. Our exposure to loss from consolidated
securitization entities (such as Sequoia and Acacia) is limited (except, in
some
circumstances, for limited loan repurchase obligations) to our net investment
in
securities we have acquired from these entities. Sequoia and Acacia assets
are
held in the custody of trustees. Trustees collect principal and interest
payments (less servicing and related fees) from the assets and make
corresponding principal and interest payments to the ABS investors. ABS
obligations are payable solely from the assets of these entities and are
non-recourse to Redwood.
Subordinated
Notes
Subordinated
notes includes subordinated notes (trust preferred securities) and subordinated
notes. Both are unsecured debt, requiring quarterly interest payments at a
floating rate equal to LIBOR plus a spread until they are redeemed in whole,
or
mature at a future date. These notes contain an earlier optional redemption
date
without penalty.
Earnings
per Share
Basic
earnings per share are computed by dividing net income by the weighted average
number of common shares outstanding during the period. Diluted earnings per
share are computed by dividing net income by the weighted average number of
common shares and potential common shares outstanding during the period.
Potential common shares outstanding are calculated using the treasury stock
method, which assumes that all dilutive common stock equivalents are exercised
and the funds generated by the exercises are used to buy back outstanding common
stock at the average market price of the common stock during the reporting
period.
The
following table provides reconciliation of denominators of the basic and diluted
earnings per share computations.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
2. Summary of Significant Accounting Policies -
(continued)
Basic
and Diluted Earnings per Share
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
(In
thousands, except share data)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Denominators:
|
|
|
|
|
|
|
|
|
|
Denominator
for basic earnings per share is equal to the weighted average number
of
common shares outstanding during the period
|
|
|
27,405,284 |
|
|
25,496,552
|
|
|
27,132,001
|
|
|
25,349,853
|
|
Adjustments
for diluted earnings per share are:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
effect of dilutive stock options
|
|
|
759,660 |
|
|
612,423
|
|
|
785,501
|
|
|
560,070
|
|
Denominator
for diluted earnings per share
|
|
|
28,164,944 |
|
|
26,108,975
|
|
|
27,917,502
|
|
|
25,909,923
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
Earnings Per Share:
|
|
$
|
0.42
|
|
$
|
1.23
|
|
$
|
1.10
|
|
$
|
2.34
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
Earnings Per Share:
|
|
$
|
0.41
|
|
$
|
1.20
|
|
$
|
1.06
|
|
$
|
2.29
|
|
Pursuant
to EITF 03-6, Participating
Securities and the Two — Class Method under FASB No. 128
(EITF
03-6), we determined that there was no allocation of income for our outstanding
stock options as they were antidilutive for the three and six months ended
June
30, 2007 and 2006. There were no other participating securities, as defined
by
EITF 03-6, during the three and six months ended June 30, 2007 and 2006. For
the
three months ended June 30, 2007 and 2006, the number of outstanding stock
options that were antidilutive totaled 449,105 and 465,980 respectively. For
the
six months ended June 30, 2007 and 2006, the number of outstanding stock options
that were antidilutive totaled 252,109, and 466,166 respectively.
Other
Comprehensive Income (Loss)
Current
period net unrealized gains and losses on real estate securities
available-for-sale, and interest rate agreements classified as cash flow hedges
are reported as components of other comprehensive income (loss) on our
consolidated statements of comprehensive income (loss). Net unrealized gains
and
losses on securities and interest rate agreements held by our taxable
subsidiaries that are reported in other comprehensive income (loss) are adjusted
for the effects of tax and may create deferred tax assets or
liabilities.
Stock-Based
Compensation
As
of
June 30, 2007 and December 31, 2006, we had one stock-based employee
compensation plan and one employee stock purchase plan. These plans, and
associated stock options and other equity awards, are described more fully
in
Note
16.
We
adopted Statement of Financial Accounting Standards No. 123R, Share-Based
Payment
(FAS
123R), on January 1, 2006. With the adoption of FAS 123R, the grant date
fair market value of all remaining unvested stock compensation awards (stock
options, deferred stock units, and restricted stock) are expensed on the
consolidated statements of income over the remaining vesting period.
The
Black-Scholes option-pricing model was used in determining fair market values
of
option grants accounted for under FAS 123R. The model requires the use of inputs
such as strike price, and assumptions such as expected life, risk free rate
of
return, and stock price volatility. Options are generally granted over the
course of the calendar year. The stock price volatility assumption is based
on
the historical volatility of our common stock. Certain options have dividend
equivalent rights (DERs) and, accordingly, the assumed dividend yield was zero
for these options. Other options granted have no DERs and the assumed dividend
yield was 10%.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
2. Summary of Significant Accounting Policies -
(continued)
The
following table describes the weighted average of assumptions used for
calculating the value of options granted for the three and six months ended
June
30, 2007 and 2006.
Weighted
Average Assumptions used for Valuation of Options under FAS 123R Granted during
period
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Stock
price volatility
|
|
|
27.2
|
%
|
|
—
|
|
|
25.5
|
%
|
|
25.7
|
%
|
Risk
free rate of return (5 yr Treasury Rate)
|
|
|
4.87
|
%
|
|
—
|
|
|
4.58
|
%
|
|
4.75
|
%
|
Average
life
|
|
|
5
years
|
|
|
—
|
|
|
6
years
|
|
|
5
years
|
|
Dividend
yield
|
|
|
10.00
|
%
|
|
—
|
|
|
10.00
|
%
|
|
10.00
|
%
|
Note
3. Real Estate Loans
We
acquire residential real estate loans from third party originators. A portion
of
these loans are sold to securitization entities sponsored by us under our
Sequoia program which, in turn, issue ABS. The remainder of the loans we invest
in are held and financed with Redwood debt and equity. At June 30, 2007, we
transferred $13 million (of outstanding principal) of residential delinquent
loans from held-for-investment to held-for-sale as we are actively marketing
these loans for sale.
The
following tables summarize the carrying value of the residential and commercial
real estate loans, as reported on our consolidated balance sheets at June 30,
2007 and December 31, 2006.
Real
Estate Loans Composition
(In
thousands)
|
|
June
30,
2007
|
|
December 31,
2006
|
|
|
|
|
|
|
|
Residential
real estate loans -
held-for-sale
|
|
$
|
9,410
|
|
$
|
—
|
|
Residential
real estate loans - held-for-investment
|
|
|
8,342,237
|
|
|
9,323,935
|
|
Total
residential real estate
loans
|
|
|
8,351,647
|
|
|
9,323,935
|
|
Commercial
real estate loans - held-for-investment
|
|
|
25,827
|
|
|
28,172
|
|
Total
real estate loans
|
|
$
|
8,377,474
|
|
$
|
9,352,107
|
|
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
3. Real Estate Loans - (continued)
Real
Estate Loans Carrying Value -Held-for-Investment
June
30, 2007
(In
thousands)
|
|
Residential
Real
Estate
Loans
|
|
Commercial
Real
Estate
Loans
|
|
Total
|
|
|
|
|
|
|
|
|
|
Current
face
|
|
$
|
8,256,759
|
|
$
|
38,311
|
|
$
|
8,295,070
|
|
Unamortized
premium (discount)
|
|
|
101,894
|
|
|
(1,995
|
)
|
|
99,899
|
|
Discount
designated as credit reserve
|
|
|
—
|
|
|
(8,141
|
)
|
|
(8,141
|
)
|
Amortized
cost
|
|
|
8,358,653
|
|
|
28,175
|
|
|
8,386,828
|
|
Reserve
for credit losses
|
|
|
(16,416
|
)
|
|
(2,348
|
)
|
|
(18,764
|
)
|
Carrying
value
|
|
$
|
8,342,237
|
|
$
|
25,827
|
|
$
|
8,368,064
|
|
December 31,
2006
(In
thousands)
|
|
Residential
Real
Estate
Loans
|
|
Commercial
Real
Estate
Loans
|
|
Total
|
|
|
|
|
|
|
|
|
|
Current
face
|
|
$
|
9,212,002
|
|
$
|
38,360
|
|
$
|
9,250,362
|
|
Unamortized
premium (discount)
|
|
|
132,052
|
|
|
(2,047
|
)
|
|
130,005
|
|
Discount
designated as credit reserve
|
|
|
—
|
|
|
(8,141
|
)
|
|
(8,141
|
)
|
Amortized
cost
|
|
|
9,344,054
|
|
|
28,172
|
|
|
9,372,226
|
|
Reserve
for credit losses
|
|
|
(20,119
|
)
|
|
—
|
|
|
(20,119
|
)
|
Carrying
value
|
|
$
|
9,323,935
|
|
$
|
28,172
|
|
$
|
9,352,107
|
|
Of
the
$8.3 billion of face and $102 million of unamortized premium on our
residential real estate loans at June 30, 2007, $3.5 billion of face and
$83 million of unamortized premium relates to residential loans acquired
prior to July 1, 2004. At December 31, 2006, the residential loans
acquired prior to July 1, 2004 had face and unamortized premium balances of
$5.2 billion and $104 million, respectively. For these residential
loans, we use coupon interest rates as they change over time and anticipated
principal payments to determine an effective yield to amortize the premium
or
discount. During the first half of 2007, 32% of these residential loans prepaid
and we amortized 20% of the premium. For residential loans acquired after
July 1, 2004, the face and unamortized premium was $4.8 billion and
$19 million at June 30, 2007 and $4.0 billion and $28 million at
December 31, 2006, respectively. For these residential loans, we use the
initial coupon interest rate of the loans (without regard to future changes
in
the underlying indices) and anticipated principal payments to calculate an
effective yield to amortize the premium or discount.
Residential
real estate loans are either sold to securitization entities sponsored by us
under our Sequoia program which, in turn, issue ABS or are held and financed
with Redwood debt. The table below presents information regarding real estate
loans pledged under our borrowing agreements.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
3. Real Estate Loans - (continued)
Real
Estate Loans Pledged and Unpledged
|
|
June
30,
2007
|
|
December 31,
2006
|
|
(In
thousands)
|
|
Face
Value
|
|
Carrying
Value
|
|
Face
Value
|
|
Carrying
Value
|
|
|
|
|
|
|
|
|
|
|
|
Unpledged
|
|
$
|
175,965
|
|
$
|
163,789
|
|
$
|
120,578
|
|
$
|
111,231
|
|
Pledged
for Redwood debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Repurchase
(repo) agreements
|
|
|
506,932
|
|
|
506,576
|
|
|
978,713
|
|
|
982,629
|
|
Commercial
paper
|
|
|
204,825
|
|
|
207,135
|
|
|
301,827
|
|
|
302,615
|
|
Owned
by securitization entities, financed through
the
issuance of ABS
|
|
|
7,419,895
|
|
|
7,499,974
|
|
|
7,849,244
|
|
|
7,955,632
|
|
Carrying
value
|
|
$
|
8,307,617
|
|
$
|
8,377,474
|
|
$
|
9,250,362
|
|
$
|
9,352,107
|
|
Note
4. Real Estate Securities
The
real
estate securities shown on our consolidated balance sheets include residential,
commercial, and CDO securities acquired from securitizations sponsored by
others. The table below presents the carrying value (which equals fair market
value as these are available-for-sale securities (AFS)) of our securities that
are included in our consolidated balance sheets as of June 30, 2007 and
December 31, 2006, by type of securities, and by credit rating of
investment-grade (IGS) and below investment-grade (CES).
Securities
(AFS) — Underlying Collateral Characteristics
June
30, 2007
(In
thousands)
|
|
CES
|
|
IGS
|
|
Total
AFS
Securities
|
|
|
|
|
|
|
|
|
|
Residential
securities:
|
|
|
|
|
|
|
|
Prime
|
|
$
|
569,789
|
|
$
|
869,884
|
|
$
|
1,439,673
|
|
Alt-a
|
|
|
172,356
|
|
|
855,555
|
|
|
1,027,911
|
|
Subprime
|
|
|
2,830
|
|
|
437,507
|
|
|
440,337
|
|
Total
residential securities
|
|
|
744,975
|
|
|
2,162,946
|
|
|
2,907,921
|
|
Commercial
securities
|
|
|
450,941
|
|
|
111,144
|
|
|
562,085
|
|
CDO
securities
|
|
|
21,133
|
|
|
234,633
|
|
|
255,766
|
|
Total
securities
|
|
$
|
1,217,049
|
|
$
|
2,508,723
|
|
$
|
3,725,772
|
|
December 31,
2006
(In
thousands)
|
|
CES
|
|
IGS
|
|
Total
AFS
Securities
|
|
|
|
|
|
|
|
|
|
Residential
securities:
|
|
|
|
|
|
|
|
Prime
|
|
$
|
555,369
|
|
$
|
723,247
|
|
$
|
1,278,616
|
|
Alt-a
|
|
|
156,859
|
|
|
455,550
|
|
|
612,409
|
|
Subprime
|
|
|
9,303
|
|
|
518,453
|
|
|
527,756
|
|
Total
residential securities
|
|
|
721,531
|
|
|
1,697,250
|
|
|
2,418,781
|
|
Commercial
securities
|
|
|
448,060
|
|
|
119,613
|
|
|
567,673
|
|
CDO
securities
|
|
|
21,964
|
|
|
224,349
|
|
|
246,313
|
|
Total
securities
|
|
$
|
1,191,555
|
|
$
|
2,041,212
|
|
$
|
3,232,767
|
|
The
table
below presents the components comprising the carrying value of
available-for-sale IGS reported on our consolidated balance sheets at June
30,
2007 and December 31, 2006.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
4. Real Estate Securities - (continued)
Investment-Grade
Securities (AFS)
June
30, 2007
(In
thousands)
|
|
Residential
|
|
Commercial
|
|
CDO
|
|
Total
IGS
|
|
|
|
|
|
|
|
|
|
|
|
Current
face
|
|
$
|
2,276,704
|
|
$
|
121,131
|
|
$
|
262,881
|
|
$
|
2,660,716
|
|
Unamortized
discount, net
|
|
|
(32,187
|
)
|
|
(3,103
|
)
|
|
(7,096
|
)
|
|
(42,386
|
)
|
Amortized
cost
|
|
|
2,244,517
|
|
|
118,028
|
|
|
255,785
|
|
|
2,618,330
|
|
Gross
unrealized gains
|
|
|
3,800
|
|
|
16
|
|
|
640
|
|
|
4,456
|
|
Gross
unrealized losses
|
|
|
(85,371
|
)
|
|
(6,900
|
)
|
|
(21,792
|
)
|
|
(114,063
|
)
|
Carrying
value
|
|
$
|
2,162,946
|
|
$
|
111,144
|
|
$
|
234,633
|
|
$
|
2,508,723
|
|
December 31,
2006
(In
thousands)
|
|
Residential
|
|
Commercial
|
|
CDO
|
|
Total
IGS
|
|
|
|
|
|
|
|
|
|
|
|
Current
face
|
|
$
|
1,708,607
|
|
$
|
122,869
|
|
$
|
222,413
|
|
$
|
2,053,889
|
|
Unamortized
discount, net
|
|
|
(16,382
|
)
|
|
(3,367
|
)
|
|
(238
|
)
|
|
(19,987
|
)
|
Amortized
cost
|
|
|
1,692,225
|
|
|
119,502
|
|
|
222,175
|
|
|
2,033,902
|
|
Gross
unrealized gains
|
|
|
14,622
|
|
|
980
|
|
|
2,638
|
|
|
18,240
|
|
Gross
unrealized losses
|
|
|
(9,597
|
)
|
|
(869
|
)
|
|
(464
|
)
|
|
(10,930
|
)
|
Carrying
value
|
|
$
|
1,697,250
|
|
$
|
119,613
|
|
$
|
224,349
|
|
$
|
2,041,212
|
|
The
table
below presents the components comprising the carrying value of
available-for-sale CES reported on our consolidated balance sheets at June
30,
2007 and December 31, 2006.
Credit-Enhancement
Securities (AFS)
June
30, 2007
(In
thousands)
|
|
Residential
|
|
Commercial
|
|
CDO
|
|
Total
CES
|
|
|
|
|
|
|
|
|
|
|
|
Current
face
|
|
$
|
1,291,193
|
|
$
|
880,987
|
|
$
|
31,381
|
|
$
|
2,203,561
|
|
Unamortized
discount, net
|
|
|
(125,948
|
)
|
|
(95,346
|
)
|
|
(9,955
|
)
|
|
(231,249
|
)
|
Discount
designated as credit reserve
|
|
|
(453,076
|
)
|
|
(310,745
|
)
|
|
—
|
|
|
(763,821
|
)
|
Amortized
cost
|
|
|
712,169
|
|
|
474,896
|
|
|
21,426
|
|
|
1,208,491
|
|
Gross
unrealized gains
|
|
|
66,177
|
|
|
11,637
|
|
|
1,776
|
|
|
79,590
|
|
Gross
unrealized losses
|
|
|
(33,371
|
)
|
|
(35,592
|
)
|
|
(2,069
|
)
|
|
(71,032
|
)
|
Carrying
value
|
|
$
|
744,975
|
|
$
|
450,941
|
|
$
|
21,133
|
|
$
|
1,217,049
|
|
December 31,
2006
(In
thousands)
|
|
Residential
|
|
Commercial
|
|
CDO
|
|
Total
CES
|
|
|
|
|
|
|
|
|
|
|
|
Current
face
|
|
$
|
1,180,605
|
|
$
|
793,743
|
|
$
|
28,731
|
|
$
|
2,003,079
|
|
Unamortized
discount, net
|
|
|
(144,842
|
)
|
|
(71,424
|
)
|
|
(6,889
|
)
|
|
(223,155
|
)
|
Discount
designated as credit reserve
|
|
|
(372,247
|
)
|
|
(295,340
|
)
|
|
—
|
|
|
(667,587
|
)
|
Amortized
cost
|
|
|
663,516
|
|
|
426,979
|
|
|
21,842
|
|
|
1,112,337
|
|
Gross
unrealized gains
|
|
|
71,134
|
|
|
23,235
|
|
|
516
|
|
|
94,885
|
|
Gross
unrealized losses
|
|
|
(13,119
|
)
|
|
(2,154
|
)
|
|
(394
|
)
|
|
(15,667
|
)
|
Carrying
value
|
|
$
|
721,531
|
|
$
|
448,060
|
|
$
|
21,964
|
|
$
|
1,191,555
|
|
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
4. Real Estate Securities - (continued)
At
June
30, 2007, our residential CES provided credit-enhancement on $220 billion
of residential real estate loans and our commercial CES provided
credit-enhancement on $70 billion of commercial real estate loans. At
December 31, 2006, our residential CES provided credit-enhancement on
$210 billion of residential real estate loans and our commercial CES
provided credit-enhancement on $58 billion of commercial real estate
loans.
The
amount of designated credit reserve equals the estimate of credit losses within
the underlying loan pool on the CES that we expect to incur over the life of
the
loans. This estimate is determined based upon various factors affecting these
assets, including economic conditions, characteristics of the underlying loans,
delinquency status, past performance of similar loans, and external credit
reserves. We use a variety of internal and external credit risk cash flow
modeling and portfolio analytical tools to assist in our assessments. We review
our assessments on each individual underlying loan pool and determine the
appropriate level of credit reserve required for each security we own at least
quarterly. The designated credit reserve is specific to each security.
The
following table presents the aggregate changes in our unamortized discount
and
the portion of the discount designated as credit reserve for the three and
six
months ended June 30, 2007 and 2006.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
4. Real Estate Securities - (continued)
Changes
In Unamortized Discount and Designated Credit Reserves on Residential,
Commercial, and CDO CES
Three
Months Ended June 30, 2007
(In
thousands)
|
|
Residential
|
|
Commercial
|
|
CDO
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Beginning
balance of unamortized discount, net
|
|
$
|
158,669
|
|
$
|
71,455
|
|
$
|
7,004
|
|
$
|
237,128
|
|
Amortization
of discount
|
|
|
(21,065 |
) |
|
(200 |
) |
|
— |
|
|
(21,265
|
)
|
Calls,
sales, and other
|
|
|
12,931 |
|
|
766 |
|
|
105 |
|
|
13,802
|
|
Re-designation
between credit reserve and discount
|
|
|
(21,803 |
) |
|
9,877 |
|
|
— |
|
|
(11,926
|
)
|
Upgrades
to investment-grade securities
|
|
|
— |
|
|
— |
|
|
— |
|
|
—
|
|
Purchased
discount (premium)
|
|
|
(2,784 |
) |
|
13,448 |
|
|
2,846 |
|
|
13,510
|
|
Ending
balance of unamortized discount, net
|
|
$
|
125,948
|
|
$
|
95,346
|
|
$
|
9,955
|
|
$
|
231,249
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning
balance of designated credit reserve
|
|
$
|
392,763
|
|
$
|
294,466
|
|
|
— |
|
$
|
687,229
|
|
Realized
credit losses
|
|
|
(5,648 |
) |
|
(42 |
) |
|
— |
|
|
(5,690
|
)
|
Calls,
sales, and other
|
|
|
(2,158 |
) |
|
— |
|
|
— |
|
|
(2,158
|
)
|
Re-designation
between credit reserve and discount
|
|
|
21,803 |
|
|
(9,877 |
) |
|
— |
|
|
11,926
|
|
Purchased
discount designated as credit reserve
|
|
|
46,316 |
|
|
26,198 |
|
|
— |
|
|
72,514
|
|
Ending
balance of designated credit reserve
|
|
$
|
453,076
|
|
$
|
310,745
|
|
|
— |
|
$
|
763,821
|
|
Three
Months Ended June 30, 2006
(In
thousands)
|
|
Residential
|
|
Commercial
|
|
CDO
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Beginning
balance of unamortized discount, net
|
|
$
|
108,371
|
|
$
|
20,473
|
|
$
|
8,048
|
|
$
|
136,892
|
|
Amortization
of discount
|
|
|
(11,684 |
) |
|
257 |
|
|
— |
|
|
(11,427
|
)
|
Calls,
sales, and other
|
|
|
(813 |
) |
|
1,835 |
|
|
(70 |
) |
|
952
|
|
Re-designation
between credit reserve and discount
|
|
|
20,828 |
|
|
(884 |
) |
|
— |
|
|
19,944
|
|
Upgrades
to investment-grade securities
|
|
|
— |
|
|
— |
|
|
— |
|
|
—
|
|
Purchased
discount
|
|
|
— |
|
|
6,503 |
|
|
— |
|
|
6,503
|
|
Ending
balance of unamortized discount, net
|
|
$
|
116,702
|
|
$
|
28,184
|
|
$
|
7,978
|
|
$
|
152,864
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning
balance of designated credit reserve
|
|
$
|
373,781
|
|
$
|
167,772
|
|
|
— |
|
$
|
541,553
|
|
Realized
credit losses
|
|
|
(1,041 |
) |
|
138 |
|
|
— |
|
|
(903
|
)
|
Calls,
sales, and other
|
|
|
(192 |
) |
|
— |
|
|
— |
|
|
(192
|
)
|
Re-designation
between credit reserve and discount
|
|
|
(20,828 |
) |
|
884 |
|
|
— |
|
|
(19,944
|
)
|
Purchased
discount designated as credit reserve
|
|
|
73,858 |
|
|
23,340 |
|
|
— |
|
|
97,198
|
|
Ending
balance of designated credit reserve
|
|
$
|
425,578
|
|
$
|
192,134
|
|
|
— |
|
$
|
617,712
|
|
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
4. Real Estate Securities - (continued)
Changes
In Unamortized Discount and Designated Credit Reserves on Residential,
Commercial, and CDO CES
Six
Months Ended June 30, 2007
(In
thousands)
|
|
Residential
|
|
Commercial
|
|
CDO
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Beginning
balance of unamortized discount, net
|
|
$
|
144,842
|
|
$
|
71,424
|
|
$
|
6,889
|
|
$
|
223,155
|
|
Amortization
of discount
|
|
|
(39,957
|
)
|
|
(191
|
)
|
|
—
|
|
|
(40,148
|
)
|
Calls,
sales, and other
|
|
|
15,301
|
|
|
766
|
|
|
105
|
|
|
16,172
|
|
Re-designation
between credit reserve and discount
|
|
|
509
|
|
|
9,480
|
|
|
—
|
|
|
9,989
|
|
Upgrades
to investment-grade securities
|
|
|
—
|
|
|
160
|
|
|
115
|
|
|
275
|
|
Purchased
discount
|
|
|
5,253
|
|
|
13,707
|
|
|
2,846
|
|
|
21,806
|
|
Ending
balance of unamortized discount, net
|
|
$
|
125,948
|
|
$
|
95,346
|
|
$
|
9,955
|
|
$
|
231,249
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning
balance of designated credit reserve
|
|
$
|
372,247
|
|
$
|
295,340
|
|
|
—
|
|
$
|
667,587
|
|
Realized
credit losses
|
|
|
(9,453
|
)
|
|
(1,313
|
)
|
|
—
|
|
|
(10,766
|
)
|
Calls,
sales, and other
|
|
|
(3,674
|
)
|
|
—
|
|
|
—
|
|
|
(3,674
|
)
|
Re-designation
between credit reserve and discount
|
|
|
(509
|
)
|
|
(9,480
|
)
|
|
—
|
|
|
(9,989
|
)
|
Purchased
discount designated as credit reserve
|
|
|
94,465
|
|
|
26,198
|
|
|
—
|
|
|
120,663
|
|
Ending
balance of designated credit reserve
|
|
$
|
453,076
|
|
$
|
310,745
|
|
|
—
|
|
$
|
763,821
|
|
Six
Months Ended June 30, 2006
(In
thousands)
|
|
Residential
|
|
Commercial
|
|
CDO
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Beginning
balance of unamortized discount, net
|
|
$
|
121,824
|
|
$
|
28,993
|
|
$
|
8,004
|
|
$
|
158,821
|
|
Amortization
of discount
|
|
|
(24,075
|
)
|
|
821
|
|
|
—
|
|
|
(23,254
|
)
|
Calls,
sales, and other
|
|
|
(57
|
)
|
|
1,209
|
|
|
(26
|
)
|
|
1,126
|
|
Re-designation
between credit reserve and discount
|
|
|
22,650
|
|
|
(5,313
|
)
|
|
—
|
|
|
17,337
|
|
Upgrades
to investment-grade securities
|
|
|
(6,249
|
)
|
|
—
|
|
|
—
|
|
|
(6,249
|
)
|
Purchased
discount
|
|
|
2,609
|
|
|
2,474
|
|
|
—
|
|
|
5,083
|
|
Ending
balance of unamortized discount, net
|
|
$
|
116,702
|
|
$
|
28,184
|
|
$
|
7,978
|
|
$
|
152,864
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning
balance of designated credit reserve
|
|
$
|
354,610
|
|
$
|
141,806
|
|
|
—
|
|
$
|
496,416
|
|
Realized
credit losses
|
|
|
(3,618
|
)
|
|
136
|
|
|
—
|
|
|
(3,482
|
)
|
Calls,
sales, and other
|
|
|
(4,903
|
)
|
|
—
|
|
|
—
|
|
|
(4,903
|
)
|
Re-designation
between credit reserve and discount
|
|
|
(22,650
|
)
|
|
5,313
|
|
|
—
|
|
|
(17,337
|
)
|
Purchased
discount designated as credit reserve
|
|
|
102,139
|
|
|
44,879
|
|
|
—
|
|
|
147,018
|
|
Ending
balance of designated credit reserve
|
|
$
|
425,578
|
|
$
|
192,134
|
|
|
—
|
|
$
|
617,712
|
|
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
4. Real Estate Securities - (continued)
For
the
three and six months ended June 30, 2007, we recognized other-than-temporary
impairments of $21.7 million and $24.1 million, respectively, through market
valuation adjustments in our consolidated statements of income. This includes
AFS securities that were in unrealized loss positions of $2.4 million at
the end of the period that we did not deem the cash flows impaired but we did
not intend to hold for a period long enough to recover the unrealized loss.
For
the three and six months ended June 30, 2006, we recognized other-than-temporary
impairments of $2.3 million and $5.5 million, respectively.
The
table
below presents the gross realized gains and losses on securities and the
realized gains on calls for the three and six months ended June 30, 2007 and
2006.
Gross
Realized Gains and Losses on Real Estate Securities
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Gross
realized gains on sales
|
|
$
|
2,746
|
|
$
|
3,389
|
|
$
|
3,415
|
|
$
|
4,451
|
|
Gross
realized losses on sales
|
|
|
(1,284 |
) |
|
(1,348
|
)
|
|
(2,737 |
) |
|
(1,348
|
)
|
Gains
on calls
|
|
|
1,310 |
|
|
747
|
|
|
2,153 |
|
|
747
|
|
Total
realized gains on sales and calls
|
|
$
|
2,772
|
|
$
|
2,788
|
|
$
|
2,831
|
|
$
|
3,850
|
|
Gross
unrealized gains and losses represent the difference between the net amortized
cost and the fair market value of individual securities. Gross unrealized losses
represent a decline in fair market value for securities not deemed impaired
for
GAAP.
The
following tables show the gross unrealized losses, fair market values, and
length of time that any real estate securities have been in a continuous
unrealized loss position as of June 30, 2007 and December 31, 2006. These
unrealized losses are not considered to be other-than-temporary impairments
because these losses are not due to adverse changes in cash flows and we have
the intent and ability to hold these securities for a period sufficient for
these securities to potentially recover their values.
Securities
with Unrealized Losses
|
|
Less
Than 12 Months
|
|
12
Months or More
|
|
Total
|
|
June
30, 2007
(In
thousands)
|
|
Fair
Market
Value
|
|
Unrealized
Losses
|
|
Fair
Market
Value
|
|
Unrealized
Losses
|
|
Fair
Market
Value
|
|
Unrealized
Losses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
$
|
1,792,503
|
|
$
|
(99,977
|
)
|
$
|
322,159
|
|
$
|
(18,765
|
)
|
$
|
2,114,662
|
|
$
|
(118,742
|
)
|
Commercial
|
|
|
363,950
|
|
|
(34,326
|
)
|
|
108,054
|
|
|
(8,166
|
)
|
|
472,004
|
|
|
(42,492
|
)
|
CDO
|
|
|
188,480
|
|
|
(20,475
|
)
|
|
16,794
|
|
|
(3,386
|
)
|
|
205,274
|
|
|
(23,861
|
)
|
Total
securities
|
|
$
|
2,344,933
|
|
$
|
(154,778
|
)
|
$
|
447,007
|
|
$
|
(30,317
|
)
|
$
|
2,791,940
|
|
$
|
(185,095
|
)
|
|
|
Less
Than 12 Months
|
|
12
Months or More
|
|
Total
|
|
December 31,
2006
(In
thousands)
|
|
Fair
Market
Value
|
|
Unrealized
Losses
|
|
Fair
Market
Value
|
|
Unrealized
Losses
|
|
Fair
Market
Value
|
|
Unrealized
Losses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
$
|
495,242
|
|
$
|
(9,938
|
)
|
$
|
385,170
|
|
$
|
(12,778
|
)
|
$
|
880,412
|
|
$
|
(22,716
|
)
|
Commercial
|
|
|
111,603
|
|
|
(1,055
|
)
|
|
85,010
|
|
|
(1,968
|
)
|
|
196,613
|
|
|
(3,023
|
)
|
CDO
|
|
|
29,378
|
|
|
(257
|
)
|
|
29,543
|
|
|
(601
|
)
|
|
58,921
|
|
|
(858
|
)
|
Total
securities
|
|
$
|
636,223
|
|
$
|
(11,250
|
)
|
$
|
499,723
|
|
$
|
(15,347
|
)
|
$
|
1,135,946
|
|
$
|
(26,597
|
)
|
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
4. Real Estate Securities - (continued)
We
fund
the credit-sensitive securities we acquire with equity. We fund some of the
securities we acquire on a temporary basis with short-term borrowings prior
to
the sale to the securitization entities we sponsor. We also acquire less
credit-risk sensitive assets and finance these investments with a combination
of
Redwood debt and equity. The table below presents information regarding our
securities pledged under borrowing agreements and owned by securitization
entities as of June 30, 2007 and December 31, 2006.
Securities
Pledged and Unpledged
(In
thousands)
|
|
June
30,
2007
|
|
December 31,
2006
|
|
|
|
|
|
|
|
Unpledged
|
|
$
|
539,963
|
|
$
|
463,891
|
|
Pledged
for Redwood debt
|
|
|
133,333
|
|
|
593,070
|
|
Owned
by securitization entities, financed through issuance of
ABS
|
|
|
3,052,476
|
|
|
2,175,806
|
|
Carrying
value
|
|
$
|
3,725,772
|
|
$
|
3,232,767
|
|
Note
5. Other Real Estate Investments
Other
real estate investments shown on our balance sheets include IOs, NIMs and
residuals. We have elected to classify these investments as “trading
investments” under GAAP. These assets are carried at fair market value on our
consolidated balance sheet and changes in fair market value flow through market
valuation adjustments, net on the consolidated statements of
income.
The
table
below presents the carrying value (which equals fair market value as these
are
classified as trading instruments) of these investments as of June 30, 2007.
We
did not have any assets classified as other real estate investments at
December 31, 2006.
Other
Real Estate Investments - Trading
June
30, 2007
(In
thousands)
|
|
Prime
|
|
Alt-a
|
|
Subprime
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
|
|
|
|
|
|
|
|
IOs
|
|
$
|
1,453
|
|
$
|
351
|
|
$
|
—
|
|
$
|
1,804
|
|
NIMs
|
|
|
— |
|
|
9,084
|
|
|
13,086
|
|
|
22,170
|
|
Residuals
|
|
|
— |
|
|
7,764
|
|
|
2,430
|
|
|
10,194
|
|
Total
other real estate investments
|
|
$
|
1,453
|
|
$
|
17,199
|
|
$
|
15,516
|
|
$
|
34,168
|
|
The
fair
market value of our other real estate investments declined $6.2 million and
$11.6 million for the three and six months ended June 30, 2007 respectively.
As
of June 30, 2007, $2.0 million of other real estate investments were owned
by securitization entities, financed through the issuance of ABS. The remaining
$32.2 million were funded with equity.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
6. Non-Real
Estate Investments
Non-real
estate investments represents an $80 million guaranteed investment contract
(GIC) entered into during the second quarter of 2007 by an Acacia securitization
entity that we consolidate for financial statements purposes. This GIC
represents a deposit certificate issued by a rated investment bank. This deposit
certificate earns LIBOR minus a spread. This GIC serves as the collateral to
cover potential losses on a credit default swap (CDS) also entered into by
this
same Acacia entity. The CDS references BBB and A rated residential
mortgage-backed securities issued in 2006. In the event that any of these
referenced securities incurs a credit loss, the GIC can then be drawn upon
by
the CDS counterparty to cover the amount of such loss. We have classified this
investment as a trading security that is recorded on our consolidated balance
sheets at its estimated fair market value. Management currently considers the
GIC’s fair market value to approximate contract value, as the interest rate is
variable at LIBOR less 5 basis points and resets on a monthly basis. Changes
in
fair market value are reported through our consolidated statements of income
through market valuation adjustments.
The
carrying and fair market value was $80 million of this investment as of June
30,
2007. We did not have any assets classified as non-real estate investments
in
prior periods.
Note
7. Derivative Financial Instruments
We
report
our derivative financial instruments at fair market value as determined using
third-party models and confirmed by Wall Street dealers. As of June 30, 2007
and
December 31, 2006, the net fair market value of derivative financial instruments
was $34.5 million and $20.6 million, respectively.
The
following table shows the aggregate fair market value and notional amount of
our
derivative financial instruments as of June 30, 2007 and December 31, 2006.
(In
thousands)
|
|
June
30,
2007
|
|
December
31,
2006
|
|
|
|
Fair
Market
Value
|
|
Notional
Amount
|
|
Fair
Market
Value
|
|
Notional
Amount
|
|
|
|
|
|
|
|
|
|
|
|
Trading
Instruments
|
|
|
|
|
|
|
|
|
|
Interest
rate caps
purchased
|
|
$
|
4,432
|
|
$
|
701,900
|
|
$
|
1,114
|
|
$
|
71,900
|
|
Interest
rate caps sold
|
|
|
(985
|
)
|
|
250,000
|
|
|
—
|
|
|
—
|
|
Interest
rate corridors purchased
|
|
|
—
|
|
|
755,616
|
|
|
—
|
|
|
844,805
|
|
Interest
rate swaps
|
|
|
(453
|
)
|
|
354,513
|
|
|
242
|
|
|
131,195
|
|
Credit
default swaps
|
|
|
(3,939
|
)
|
|
78,000
|
|
|
(6
|
)
|
|
1,000
|
|
Futures
|
|
|
—
|
|
|
—
|
|
|
90
|
|
|
204,000
|
|
Purchase
commitments
|
|
|
67
|
|
|
148,531
|
|
|
(168
|
)
|
|
80,964
|
|
Cash
Flow Hedges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Futures
|
|
|
—
|
|
|
—
|
|
|
(44
|
)
|
|
627,000
|
|
Interest
rate swaps
|
|
|
35,341
|
|
|
1,300,965
|
|
|
19,385
|
|
|
1,279,007
|
|
Total
Derivative Financial Instruments
|
|
$
|
34,463
|
|
$
|
3,589,525
|
|
$
|
20,613
|
|
$
|
3,239,871
|
|
Interest
Rate Agreements
We
maintain an overall interest rate risk management strategy that incorporates
the
use of interest rate agreements for a variety of reasons, including minimizing
significant fluctuations in earnings or market values on certain assets or
liabilities that may be caused by interest rate volatility. Currently, the
majority of our interest rate agreements are used to match the duration of
liabilities to assets. Interest rate agreements we use as part of our interest
rate risk management strategy may include interest rate options, swaps, options
on swaps, futures contracts, options on futures contracts, and options
on forward purchases. We currently account for our interest rate agreements
as
either cash flow hedges or trading instruments.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
7. Derivative
Financial Instruments - (continued)
In
a cash
flow hedge, the effective portion of the change in the fair market value of
the
hedging derivative is recorded in accumulated other comprehensive income and
is
subsequently reclassified into earnings when the hedging relationship is
terminated. The ineffective portion of the cash flow hedge is recognized
immediately in earnings. For the three and six months ended June 30, 2007,
the
amount of ineffectiveness was $0.7 million income and $0.6 million income,
respectively, and was $0.4 million of expense and $0.1 million of income for
the
three and six months ended June 30, 2006, respectively.
Interest
rate agreements accounted for as cash flow hedges may be terminated prior to
the
completion of the forecasted transactions. In these cases, and when the
forecasted transaction is still likely to occur, the net gain or loss on the
interest rate agreements remains in accumulated other comprehensive income
and
will be reclassified from accumulated other comprehensive income to our
consolidated statements of income during the period the forecasted transaction
occurs.
Our
total
unrealized gain on interest rate agreements included in accumulated other
comprehensive income was $20.3 million at June 30, 2007 and $7.0 million at
December 31, 2006.
We
reclassified a negligible and negative $6,000 from other comprehensive income
to
interest expense for the three and six months ended June 30, 2007, respectively,
and reclassified positive $0.2 million and positive $0.5 million for the three
and six months ended June 30, 2006, respectively. At June 30, 2007, the maximum
length of time over which we are hedging our exposure to the variability of
future cash flows for forecasted transactions with cash flow hedges is ten
years, and in all cases, the forecasted transactions are expected to occur
within the next year.
In
the
case when the hedge is terminated and the forecasted transaction is not expected
to occur, we immediately recognize the gain or loss through gains on sales,
net
in our consolidated statements of income. For the three months ended June 30,
2007, there were no such instances. For the six months ended June 30, 2007,
there was one such instance which resulted in a gain of $1 million. For the
three and six months ended June 30, 2006, there was one such instance which
resulted in a gain of $6 million.
Our
interest rate agreements had net receipts of $2.7 million and $5.1 million
for
the three and six months ended June 30, 2007, respectively, and net receipts
of
$3.8 million and $6.1 million for the three and six months ended June 30, 2006,
respectively.
The
following table presents the interest income and expense of our interest rate
agreements accounted for as cash flow hedges for the three and six months ended
June 30, 2007 and 2006.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
7. Derivative Financial Instruments - (continued)
Impact
on Interest Income (Expense) of Our Interest Rate Agreements Accounted for
as
Cash Flow Hedges
(In
thousands)
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income on cash flow interest rate agreements
|
|
$
|
2,693
|
|
$
|
3,823
|
|
$
|
5,092
|
|
$
|
6,054
|
|
Realized
net gains (losses) due to net ineffective portion of
hedges
|
|
|
671 |
|
|
(350
|
)
|
|
590
|
|
|
133
|
|
Realized
net (losses) gains reclassified from other comprehensive
income
|
|
|
(6 |
) |
|
206
|
|
|
(678
|
)
|
|
472
|
|
Total
|
|
$
|
3,358
|
|
$
|
3,679
|
|
$
|
5,004
|
|
$
|
6,659
|
|
When
the
interest rate agreement is accounted for as a trading instrument, changes in
the
fair market value of the interest rate agreement and all associated income
and
expenses are reported in earnings through net recognized valuation adjustments.
We had net valuation adjustments on interest rate agreements of negative $1.5
million and negative $3.0 million for three and six months ended June 30, 2007,
respectively, and positive $5.5 million and positive $5.8 million for the three
and six months ended June 30, 2006.
Purchase
Commitments
Our
loan
purchase commitments represent derivative instruments under FAS No. 149,
Amendment
of Statement 133 on Derivative Instruments and Hedging
Activities
(FAS
149.) At June 30, 2007, our commitments to purchase residential real estate
loans were $149 million, and had a fair market value of less than $0.1 million.
The change in fair market value from period to period is included in valuation
adjustments, in our consolidated statements of income.
Credit
Default Swaps
A
credit
default swap is an agreement to provide (receive) credit event protection based
on a financial index or specific security in exchange for receiving (paying)
a
fixed rate fee or premium over the term of the contract. In the first quarter
of
2007, we began entering into these agreements where we agreed to provide credit
event protection in exchange for a premium. In essence, these instruments
enables us to credit enhance a specific pool of loans. We included these credit
default swaps in our Acacia CDO Option Arm 1 which closed in the second quarter
of 2007.
Credit
default swaps are accounted for as trading instruments, reported at fair market
value with the changes in fair market value recognized through our income
statement. The value of these contracts decrease for a variety of reasons,
including when the probability of the occurrence of a specific credit event
increases, when the market’s perceptions of default risk in general change, or
there are changes in the supply and demand of these instruments. Since the
acquisition of these credit default swaps, the value has decreased $3.9 million,
primarily as the result of widening spreads in these types of instruments.
During
the second quarter of 2007, we also entered into a credit default swap where
we
agreed to pay a premium and will receive payment upon the event of losses on
the
referenced pool of loans. At June 30, 2007, this derivative instrument had
a
negative market value of $0.1 million.
In
the
future, we may use credit default swaps to help us manage certain of our credit
risks. We would do this by agreeing to pay a fixed rate or premium in exchange
for credit event protection.
Counterparty
Credit Risk
We
incur
credit risk to the extent that the counterparties to the derivative financial
instruments do not perform their obligations under the agreements. If one of
the
counterparties does not perform, we may not receive the cash to which we would
otherwise be entitled under the agreement. In order to mitigate this risk,
we
only enter into agreements
that are either a) transacted on a national exchange or b) transacted with
counterparties that are either i) designated by the U.S. Department of Treasury
as a primary government dealer, ii) affiliates of primary government dealers,
or
iii) rated BBB or higher. Furthermore, we generally enter into agreements with
several different counterparties in order to diversify our credit risk exposure.
At June 30, 2007, we had $1.0 million credit exposure in interest rate
agreements. At December 31, 2006, we had $1.0 million credit exposure on futures
and $5.1 million credit exposure on interest rate agreements.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
8. Reserves for Credit Losses
We
establish reserves for credit losses on our real estate loans based on our
estimate of losses inherent in our loan portfolio.
Delinquencies
in our consolidated residential real estate loan portfolio were $56 million
and $65 million as of June 30, 2007 and December 31, 2006,
respectively. Delinquencies include loans delinquent more than 90 days, in
bankruptcy, and in foreclosure. As a percentage of our current residential
real
estate loan balances, delinquencies stood at 0.67% and 0.71% at June 30, 2007
and December 31, 2006, respectively. As a percentage of the original
balances, delinquencies stood at 0.20% and 0.21% at June 30, 2007 and
December 31, 2006, respectively.
Our
residential loan servicers advance payment on delinquent loans to the extent
they deem them recoverable. We accrue interest on loans until they are more
than
90 days past due at which point they are placed on nonaccrual status. When
a
loan becomes REO, we estimate the specific loss, based on estimated net proceeds
from the sale of the property (including accrued but unpaid interest) and charge
this specific estimated loss against the reserve for credit losses.
For
the
three months ended June 30, 2007, we had a total provision of $2.5 million.
At
the end of the second quarter of 2007 we transferred $13 million (of principal
value) of delinquent residential loans from held for investment to held for
sale
at the lower of cost or fair market value (LOCOM) with a corresponding reduction
in the reserve for credit losses through charge-offs. The impact was a $4
million reduction of the balance sheet credit reserve.
The
following table summarizes the activity in reserves for credit losses for our
consolidated residential real estate loans for the three and six months ended
June 30, 2007 and 2006.
Residential
Real Estate Loan Reserves for Credit Losses
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at beginning of period
|
|
$
|
19,954
|
|
$
|
22,372
|
|
$
|
20,119
|
|
$
|
22,656
|
|
Provision
for credit losses
|
|
|
2,500 |
|
|
(2,541
|
)
|
|
3,981
|
|
|
(2,365
|
)
|
Charge-offs
|
|
|
(6,038 |
) |
|
(381
|
)
|
|
(7,684
|
)
|
|
(841
|
)
|
Balance
at end of period
|
|
$
|
16,416
|
|
$
|
19,450
|
|
$
|
16,416
|
|
$
|
19,450
|
|
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
8. Reserves for Credit Losses - (continued)
The
following table summarizes the activity in reserves for credit losses for our
commercial real estate loans for the three and six months ended June 30, 2007
and 2006.
Commercial
Real Estate Loan Reserves for Credit Losses
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at beginning of
period
|
|
$
|
2,348
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
Provision
for credit losses
|
|
|
— |
|
|
35 |
|
|
2,348
|
|
|
35
|
|
Charge-offs
|
|
|
— |
|
|
(35 |
) |
|
—
|
|
|
(35
|
)
|
Balance
at end of period
|
|
$
|
2,348
|
|
$
|
—
|
|
$
|
2,348
|
|
$
|
—
|
|
During
the first quarter of 2007, we fully reserved in the amount of $2.3 million
for
an anticipated loss on a junior mezzanine commercial loan financing a
condominium-conversion project. Principal and accrued interest on this loan
was
scheduled to be paid upon the completion of the project and sale of the units.
Accordingly, the loan was not delinquent. However, due to cost overruns and
changing market conditions, we believe it is unlikely we will collect any
outstanding principal upon completion of the project. The provision for credit
losses on commercial loans for the six months ended June 30, 2007 relates to
that loan.
Note
9. Other Assets
Other
assets as of June 30, 2007 and December 31, 2006 are summarized in the
following table.
Other
Assets
(In
thousands)
|
|
June
30,
2007
|
|
December 31,
2006
|
|
|
|
|
|
|
|
Real
estate owned
(REO)
|
|
$
|
9,686
|
|
$
|
7,963
|
|
Fixed
assets and leasehold improvements
|
|
|
7,217
|
|
|
4,439
|
|
Principal
receivable
|
|
|
3,889
|
|
|
4,417
|
|
Purchased
interest
|
|
|
754
|
|
|
1,045
|
|
Other
|
|
|
1,823
|
|
|
2,342
|
|
Total
other assets
|
|
$
|
23,369
|
|
$
|
20,206
|
|
Note
10. Redwood Debt
We
enter
into repurchase agreements, bank borrowings, and other forms of collateralized
(and generally uncommitted) borrowings with several banks and major investment
banking firms. We also issue commercial paper for financing residential and
commercial real estate loans and securities. We refer to these borrowings as
Redwood debt. We report Redwood debt at its unpaid principal balance. We also
have other types of recourse debt such as subordinated notes (See Note
12).
The
table below summarizes the outstanding balances of Redwood debt as of June
30,
2007 and December 31, 2006, by collateral type.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
10. Redwood Debt - (continued)
Redwood
Debt
|
|
June
30, 2007
|
|
(In
thousands)
|
|
Number
of
Facilities
|
|
Outstanding
|
|
Limit
|
|
Maturity
|
|
|
|
|
|
|
|
|
|
|
|
Facilities
by collateral
|
|
|
|
|
|
|
|
|
|
Real
estate
loans
|
|
|
4
|
|
$
|
496,794
|
|
$
|
2,350,000
|
|
|
8/07-1/08
|
|
Real
estate securities
|
|
|
11
|
|
|
161,148
|
|
|
4,287,000
|
|
|
—
|
|
Unsecured
line of credit
|
|
|
1
|
|
|
—
|
|
|
10,000
|
|
|
10/07
|
|
Madrona
commercial paper facility
|
|
|
1
|
|
|
190,720
|
|
|
490,000
|
|
|
7/09
|
|
Total
facilities
|
|
|
17
|
|
$
|
848,662
|
|
$
|
7,137,000
|
|
|
|
|
|
|
December 31,
2006
|
|
(In
thousands)
|
|
Number
of
Facilities
|
|
Outstanding
|
|
Limit
|
|
Maturity
|
|
|
|
|
|
|
|
|
|
|
|
Facilities
by collateral
|
|
|
|
|
|
|
|
|
|
Real
estate
loans
|
|
|
5
|
|
$
|
959,139
|
|
$
|
2,700,000
|
|
|
1/07-10/07
|
|
Real
estate securities
|
|
|
14
|
|
|
597,069
|
|
|
5,787,000
|
|
|
—
|
|
Unsecured
line of credit
|
|
|
1
|
|
|
—
|
|
|
10,000
|
|
|
10/07
|
|
Madrona
commercial paper facility
|
|
|
1
|
|
|
300,000
|
|
|
490,000
|
|
|
7/09
|
|
Total
facilities
|
|
|
21
|
|
$
|
1,856,208
|
|
$
|
8,987,000
|
|
|
|
|
At
June
30, 2007, we had $4.3 billion of uncommitted real estate securities facilities
and $2.4 billion of uncommitted real estate loan facilities included within
the
limits above.
At
June
30, 2007, Redwood debt was all short-term debt. Borrowings under these
facilities generally bear interest based on a specified margin over the
one-month LIBOR interest rate. For the three and six months ended June 30,
2007,
the average balance of Redwood debt was $1.5 billion and $1.9 billion,
respectively, with a weighted-average interest cost of 5.99% and 5.82%,
respectively. For the three and six months ended June 30, 2006, the average
balance of Redwood debt was $0.1 billion, with a weighted-average interest
cost
of 8.51% and 7.00%, respectively. At June 30, 2007 and December 31, 2006,
accrued interest payable on Redwood debt was $0.7 million and
$7.0 million, respectively.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
10. Redwood Debt - (continued)
As
of
June 30, 2007 and December 31, 2006, we had $191 million and
$300 million of commercial paper outstanding through our Madrona special
purpose entity, respectively. The table below summarizes Redwood debt by
weighted average interest rates and by collateral type in Redwood debt at June
30, 2007 and December 31, 2006.
Redwood
Debt
|
|
June
30, 2007
|
|
December 31,
2006
|
|
(In
thousands)
|
|
Amount
Borrowed
|
|
Weighted
Average
Interest
Rate
|
|
Weighted
Average
Days
Until
Maturity
|
|
Amount
Borrowed
|
|
Weighted
Average
Interest
Rate
|
|
Weighted
Average
Days
Until
Maturity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real
estate loan
collateral
|
|
$
|
687,514
|
|
|
5.64
|
%
|
|
13
|
|
$
|
1,259,139
|
|
|
5.54
|
%
|
|
21
|
|
Securities
collateral
|
|
|
161,148
|
|
|
5.36
|
%
|
|
26
|
|
|
597,069
|
|
|
6.06
|
%
|
|
110
|
|
Total
Redwood debt
|
|
$
|
848,662
|
|
|
5.59
|
%
|
|
16
|
|
$
|
1,856,208
|
|
|
5.71
|
%
|
|
49
|
|
The
following table presents the remaining maturities of Redwood debt as of June
30,
2007 and December 31, 2006.
Redwood
Debt
(In
thousands)
|
|
June
30,
2007
|
|
December 31,
2006
|
|
|
|
|
|
|
|
Within
30
days
|
|
$
|
848,662
|
|
$
|
1,259,138
|
|
31
to 90 days
|
|
|
—
|
|
|
392,566
|
|
Over
90 days
|
|
|
—
|
|
|
204,504
|
|
Total
Redwood debt
|
|
$
|
848,662
|
|
$
|
1,856,208
|
|
We
continue to be in compliance with all of our debt covenants for all of our
borrowing arrangements and credit facilities. Additional collateral in the
form
of additional qualifying assets or cash may be required to meet changes in
fair
market values from time to time under these agreements. Covenants associated
with our 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. It is our intention to renew
committed and uncommitted facilities as needed, as well as pursue additional
facilities and other types of financing.
Note
11. Asset-Backed Securities Issued
The
Sequoia and Acacia securitization entities sponsored by us issue ABS to raise
the funds to acquire assets from us and others. Each series of ABS consists
of
various classes that pay interest at variable and fixed rates. Substantially
all
of the variable-rate ABS are indexed to one-, three- or six-month LIBOR, with
interest paid monthly or quarterly. A lesser amount of the ABS is fixed for
a
term and then will adjust to a LIBOR rate (hybrid ABS) or is fixed for its
entire term. Some of the ABS securities issued are IOs and have coupons set
at a
fixed rate or a fixed spread, while others earn a coupon based on the spread
between collateral owned by and the ABS issued by a securitized
entity.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
11. Asset-Backed Securities Issued - (continued)
The
maturity of each class of ABS is directly affected by the rate of principal
prepayments on the assets of the issuing entity. Each series is also subject
to
redemption (call) according to the specific terms of the respective governing
documents. As a result, the actual maturity of an ABS is likely to occur earlier
than its stated maturity.
The
carrying value components of the collateral for ABS issued and outstanding
as of
June 30, 2007 and December 31, 2006 are summarized in the table
below.
Collateral
for Asset-Backed Securities Issued
(In
thousands)
|
|
June
30,
2007
|
|
December 31,
2006
|
|
|
|
|
|
|
|
Real
estate
loans
|
|
$
|
7,499,974
|
|
$
|
7,955,632
|
|
Real
estate securities
|
|
|
3,052,476
|
|
|
2,175,806
|
|
Other
real estate investments
|
|
|
1,964
|
|
|
—
|
|
Real
estate owned (REO)
|
|
|
6,946
|
|
|
7,963
|
|
Restricted
cash owned by consolidated securitization entities
|
|
|
206,664
|
|
|
111,124
|
|
Accrued
interest receivable
|
|
|
53,419
|
|
|
61,617
|
|
Total
collateral for ABS issued
|
|
$
|
10,821,443
|
|
$
|
10,312,142
|
|
The
components of ABS issued by consolidated securitization entities as of June
30,
2007 and December 31, 2006, along with other selected information, are
summarized in the table below.
Asset-Backed
Securities Issued
(In
thousands)
|
|
June
30,
2007
|
|
December 31,
2006
|
|
|
|
|
|
|
|
Sequoia
ABS issued — certificates with principal
value
|
|
$
|
7,170,982
|
|
$
|
7,575,062
|
|
Sequoia
ABS issued — interest-only certificates
|
|
|
51,187
|
|
|
74,548
|
|
Acacia
ABS issued
|
|
|
3,453,848
|
|
|
2,327,504
|
|
Madrona
ABS issued
|
|
|
5,400
|
|
|
5,400
|
|
Unamortized
discount on ABS
|
|
|
(5,948
|
)
|
|
(3,290
|
)
|
Total
consolidated ABS issued
|
|
$
|
10,675,469
|
|
$
|
9,979,224
|
|
|
|
|
|
|
|
|
|
Sequoia
ABS:
|
|
|
|
|
|
|
|
Range
of weighted average interest rates, by series
|
|
|
4.57%
to 6.32
|
%
|
|
4.64%
to 6.37
|
%
|
Stated
maturities
|
|
|
2007
- 2047
|
|
|
2007
- 2046
|
|
Number
of series
|
|
|
38
|
|
|
40
|
|
Acacia
ABS:
|
|
|
|
|
|
|
|
Range
of weighted average interest rates, by series
|
|
|
5.73%
to 6.77
|
%
|
|
5.84%
to 6.03
|
%
|
Stated
maturities
|
|
|
2039
- 2052
|
|
|
2038
- 2046
|
|
Number
of series
|
|
|
10
|
|
|
8
|
|
Amortization
of deferred asset-backed securities issuance costs were $12.7 million and
$12.0 million for the six months ended June 30, 2007 and 2006,
respectively.
The
following table summarizes the accrued interest payable on ABS issued as of
June
30, 2007 and December 31, 2006. Interest due on Sequoia ABS is settled
monthly and on Acacia ABS is settled quarterly.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
11. Asset-Backed Securities Issued - (continued)
Accrued
Interest Payable on Asset-Backed Securities Issued
(In
thousands)
|
|
June
30,
2007
|
|
December 31,
2006
|
|
|
|
|
|
|
|
Sequoia
|
|
$
|
20,744
|
|
$
|
20,060
|
|
Acacia
|
|
|
25,250
|
|
|
23,137
|
|
Total
accrued interest payable on ABS issued
|
|
$
|
45,994
|
|
$
|
43,197
|
|
Note
12. Subordinated Notes
In
December 2006, we issued $100 million of subordinated notes (trust
preferred securities) through Redwood Capital Trust I, a wholly-owned Delaware
statutory trust, in a private placement transaction. These trust preferred
securities require quarterly distributions at a floating rate equal to
three-month LIBOR plus 2.25% until the notes are redeemed in whole, which will
be no later than January 30, 2037. The earliest optional redemption date
without a penalty is January 30, 2012.
In
May
2007, we issued $50 million of subordinated notes which require quarterly
distributions at a floating rate equal to three-month LIBOR plus 2.25% until
the
notes are redeemed in whole, which will be no later than July 30, 2037. The
earliest optional redemption date without a penalty is July 30, 2012.
At
June
30, 2007 and December 31, 2006, the accrued interest payable balance on
subordinated notes was $1.7 million and $0.4 million, respectively.
Note
13. Taxes
We
have
elected to be taxed as a REIT under the Internal Revenue Code and the
corresponding provisions of state law. In order to qualify as a REIT, we must
distribute at least 90% of our annual REIT taxable income (this does not include
taxable income retained in our taxable subsidiaries) to stockholders within
the
time frame set forth in the tax rules and we must meet certain other
requirements. We may retain up to 10% of our REIT ordinary taxable income (and
currently intend to do so in 2007 as we did in 2006) and pay corporate income
taxes on this retained income while continuing to maintain our REIT status.
We
distribute all capital gains. We are also subject to income taxes on taxable
income earned at our taxable subsidiaries.
We
recognized a total tax provision of $3.0 million and $3.3 million for
the three months ended June 30, 2007 and 2006, respectively. We recognized
a
total tax provision of $4.8 million and $6.0 million for the six months ended
June 30, 2007 and 2006, respectively..
Our
tax
provision is determined by applying our expected annual effective tax rate
to
our GAAP pre-tax income. The effective tax rate is determined as the ratio
of
tax liability to annual GAAP pre-tax income, based on estimates of taxable
and
GAAP annual income for the remainder of the year. Differences in taxable income
from GAAP income reflect various accounting treatments for tax and GAAP, such
as
the accounting for discount and premium amortization, credit losses, stock
options, compensation, asset impairments, changes in market valuations on
certain assets, and hedges. Some of these differences create timing differences
as to when the taxable income is earned, and the tax is paid, and when the
GAAP
income is recognized and the GAAP tax provision is recorded. Some of the
differences are permanent as the income (or expense) may be recorded for tax
and
not for GAAP (or vice-versa). One such significant permanent difference is
that,
as a REIT, we are able to deduct for tax purposes the dividends paid to
shareholders.
Our
GAAP
and taxable income projections are adjusted to reflect actual results and may
be
revised based on updated information and these changes may lead to changes
in
our effective tax rate calculations over the course of the year. In the second
quarter, our projections of GAAP income were adjusted as the result of the
volatility in the pricing
of assets and the subsequent negative market valuation adjustment recorded
in
the second quarter of 2007. As these negative market valuation adjustments
do
not have a tax effect until realized by sale of the asset, the projected tax
liability was not affected but projected GAAP pre-tax income was significantly
lowered. As a result of these revisions, our effective tax rate increased from
our prior estimates.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
13. Taxes - (continued)
We
currently expect our 2007 taxable income before dividend distributions to be
higher than our GAAP income primarily due to the accounting of discounts on
CES
and the market valuations taken on our assets for GAAP but not for tax. However,
the dividend distribution of at least 90% of our REIT taxable income reduces
our
effective tax rate from the statutory levels. The following is a reconciliation
of the statutory federal and state rates to the effective rates for 2007, as
estimated as of June 30, 2007, and 2006.
Reconciliation
of Statutory Tax Rate to Effective Tax Rate
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Federal
statutory
rate
|
|
|
35.0
|
%
|
|
35.0
|
%
|
State
statutory rate, net of Federal tax effect
|
|
|
7.0
|
%
|
|
7.0
|
%
|
Differences
in taxable income from GAAP income
|
|
|
35.8
|
%
|
|
11.6
|
%
|
Dividend
paid deduction
|
|
|
(63.8
|
%)
|
|
(46.3
|
%)
|
Effective
tax rate
|
|
|
14.0
|
%
|
|
7.3
|
%
|
Our
policy for interest and penalties on material uncertain tax positions recognized
in the consolidated financial statements is to classify these as interest
expense and operating expense, respectively. However, in accordance with
Financial Accounting Standard Board Interpretation Number 48, Accounting
for Uncertainty in Income Taxes,
(FIN
48) we assessed our tax positions for all open tax years (Federal, years 2003
to
2006 and State, years 2002 to 2006) as of June 30, 2007 and concluded that
we
have no material FIN 48 liabilities to be recognized at this time.
Note
14. Fair Market Value of Financial Instruments
We
estimate the fair market value of our financial instruments using available
market information and other appropriate valuation methodologies. These fair
market value estimates generally incorporate discounted future cash flows at
current market discount rates for comparable investments. We validate our fair
market value estimates on a quarterly basis by obtaining fair market value
estimates from dealers for securities who make a market in these financial
instruments and look at recent post period end acquisitions and sales. We
believe the estimates we use reasonably reflect the values we may be able to
receive should we choose to sell them. Many factors must be considered in order
to estimate fair 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. Accordingly, our estimates are inherently
subjective in nature and involve uncertainty and judgment to interpret relevant
market and other data. Amounts realized in actual sales may differ from the
fair
market values presented.
The
following table presents the carrying values and estimated fair market values
of
our financial instruments as of June 30, 2007 and December 31,
2006.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
14. Fair Market Value of Financial Instruments -
(continued)
Fair
Market Value of Financial Instruments
|
|
June
30,
2007
|
|
December 31,
2006
|
|
(In
thousands)
|
|
Carrying
Value
|
|
Fair
Market
Value
|
|
Carrying
Value
|
|
Fair
Market
Value
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
Real
estate loans (held-for-investment)
|
|
$
|
8,368,064
|
|
$
|
8,284,989
|
|
$
|
9,352,107
|
|
$
|
9,268,914
|
|
Real
estate loans (held-for-sale)
|
|
|
9,410
|
|
|
9,410
|
|
|
—
|
|
|
—
|
|
Real
estate securities (available-for-sale)
|
|
|
3,725,772
|
|
|
3,725,772
|
|
|
3,232,767
|
|
|
3,232,767
|
|
Other
real estate investments (trading)
|
|
|
34,168
|
|
|
34,168
|
|
|
—
|
|
|
—
|
|
Non-real
estate investments
|
|
|
80,000
|
|
|
80,000
|
|
|
—
|
|
|
—
|
|
Cash
and cash equivalents
|
|
|
82,626
|
|
|
82,626
|
|
|
168,016
|
|
|
168,016
|
|
Derivative
assets
|
|
|
40,713
|
|
|
40,713
|
|
|
26,827
|
|
|
26,827
|
|
Restricted
cash
|
|
|
206,664
|
|
|
206,664
|
|
|
112,167
|
|
|
112,167
|
|
Accrued
interest receivable
|
|
|
57,337
|
|
|
57,337
|
|
|
70,769
|
|
|
70,769
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redwood
debt
|
|
|
848,662
|
|
|
848,662
|
|
|
1,856,208
|
|
|
1,856,208
|
|
ABS
issued
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sequoia
|
|
|
7,237,961
|
|
|
7,183,059
|
|
|
7,664,066
|
|
|
7,627,644
|
|
Acacia
|
|
|
3,432,049
|
|
|
3,331,228
|
|
|
2,309,673
|
|
|
2,302,427
|
|
Madrona
|
|
|
5,459
|
|
|
5,510
|
|
|
5,485
|
|
|
5,510
|
|
Total
ABS issued
|
|
|
10,675,469
|
|
|
10,519,797
|
|
|
9,979,224
|
|
|
9,935,581
|
|
Derivative
liabilities
|
|
|
6,250
|
|
|
6,250
|
|
|
6,214
|
|
|
6,214
|
|
Accrued
interest payable
|
|
|
48,473
|
|
|
48,473
|
|
|
50,590
|
|
|
50,590
|
|
Subordinated
notes
|
|
|
150,000
|
|
|
150,000
|
|
|
100,000
|
|
|
100,000
|
|
Methodologies
we use to estimate fair market values for various asset types are described
below.
|
· |
Residential
real estate loan fair market values are determined by available market
quotes and discounted cash flow
analyses.
|
|
· |
Commercial
real estate loan fair market values are determined by appraisals
on
underlying collateral and discounted cash flow
analyses.
|
|
· |
Real
estate securities fair market values are determined by discounted
cash
flow analyses and other valuation techniques using market pricing
assumptions confirmed by third party dealer/pricing
indications.
|
|
·
|
Other
real estate investments
|
|
· |
Other
real estate investments fair market values are determined by discounted
cash flow analyses and other valuation techniques using market pricing
assumptions confirmed by third party dealer/pricing
indications.
|
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
14. Fair Market Value of Financial Instruments -
(continued)
|
·
|
Non-real
estate investments
|
|
· |
Non-real
estate investments fair market values are determined by discounted
cash
flow analyses and other valuation techniques using market pricing
assumptions.
|
|
·
|
Derivative
assets and liabilities
|
|
· |
Fair market values on interest rate
agreements
are determined by third party vendor modeling software and from valuations
provided by dealers active in derivative
markets. |
|
·
|
Cash
and cash equivalents
|
|
· |
Includes cash on hand and highly liquid
investments with original maturities of three months or less. Fair
market
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 market values
approximate carrying values. |
|
·
|
Accrued
interest receivable and payable
|
|
· |
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 market
values
approximate carrying values. |
|
· |
All Redwood debt is adjustable and
matures
within one year; fair market values approximate carrying
values. |
|
· |
Fair market values are determined by
discounted cash flow analyses and other valuation techniques confirmed
by
third party/dealer pricing indications. |
|
·
|
Commitments
to purchase
|
|
· |
Fair market values are determined by
discounted cash flow analyses and other valuation techniques confirmed
by
third party/dealer pricing indications. |
|
· |
Subordinated notes are adjustable;
fair market
values approximate carrying values. |
Note
15. Stockholders’ Equity
Accumulated
Other Comprehensive Income (Loss)
Accumulated
other comprehensive income (loss) includes the difference between fair market
value and our amortized cost of interest rate agreements accounted for as cash
flow hedges and our real estate securities accounted for as AFS. At June 30,
2007 the unrealized loss on AFS was $101 million, a decline of
$187 million from the unrealized gain of $86 million at
December 31, 2006. Also included in this account are any net gains or
losses from interest rate agreements accounted for as cash flow hedges that
have
been terminated and where the hedge transactions are still likely to occur.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
15. Stockholders’ Equity - (continued)
At
June
30, 2007, there was $1.5 million of net gains from terminated hedges, of
which a minimal amount will be amortized into income over the next twelve
months. At December 31, 2006, there was $0.6 million of net losses
from terminated hedges.
The
following table provides a summary of the components of accumulated other
comprehensive income (loss) as of June 30, 2007 and December 31,
2006.
Accumulated
Other Comprehensive Income (Loss)
(In
thousands)
|
|
June
30,
2007
|
|
December 31,
2006
|
|
|
|
|
|
|
|
Net
unrealized gains (losses) on real estate securities
|
|
$
|
(101,049
|
)
|
$
|
86,434
|
|
Net
unrealized gains on interest rate agreements accounted for as cash
flow
hedges
|
|
|
20,136
|
|
|
6,724
|
|
Total
accumulated other comprehensive (loss) income
|
|
$
|
(80,913
|
)
|
$
|
93,158
|
|
Note
16. Equity Compensation Plans
Stock-Based
Compensation
At
January 1, 2006, upon adoption of FAS 123R, we had $19.3 million of
unamortized costs related to unvested equity awards (stock options, restricted
stock, and deferred stock units). At June 30, 2007, the unamortized costs
totaled $14.7 million and will be expensed over the next six years, over
half of which will be recognized over the next twelve months.
Incentive
Plan
In
March 2006, we amended the previously amended 2002 Redwood Trust, Inc.
Incentive Stock Plan (Incentive Plan) for executive officers, employees, and
non-employee directors. This amendment was approved by our stockholders in
May 2006. The Incentive Plan authorizes our board of directors (or a
committee appointed by our board of directors) to grant incentive stock options
as defined under Section 422 of the Code (ISOs), options not so qualified
(NQSOs), deferred stock units, restricted stock, performance shares, stock
appreciation rights, limited stock appreciation rights (awards), and DERs to
eligible recipients other than non-employee directors. ISOs and NQSOs awarded
to
employees and directors have a maximum term of ten years. Stock options,
deferred stock units, and restricted stock granted to employees generally vest
over a four-year period. Non-employee directors are automatically provided
annual awards under the Incentive Plan that generally vest immediately. The
Incentive Plan has been designed to permit the compensation committee of our
board of directors to grant and certify awards that qualify as performance-based
and otherwise satisfy the requirements of Section 162(m) of the Code. As of
June
30, 2007 and December 31, 2006, 496,883 and 514,217 shares of common stock,
respectively, were available for grant.
A
summary
of stock option activity during the three and six months ended June 30, 2007
and
2006 is presented in the table below. See Note
2
for a
discussion on the assumptions used to value stock options at grant
date.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
16. Equity Compensation Plans - (continued)
Stock
Options Activity
|
|
Three
Months Ended
June
30,
|
|
|
|
2007
|
|
2006
|
|
|
|
Shares
|
|
Weighted
Average
Exercise
Price
|
|
Shares
|
|
Weighted
Average
Exercise
Price
|
|
|
|
|
|
|
|
|
|
|
|
Stock
Options Outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
options at beginning of period
|
|
|
1,032,462
|
|
$
|
35.11
|
|
|
1,507,957
|
|
$
|
33.19
|
|
Options
granted
|
|
|
219
|
|
|
53.50
|
|
|
—
|
|
|
—
|
|
Options
exercised
|
|
|
(9,996
|
)
|
|
34.09
|
|
|
(350
|
)
|
|
24.50
|
|
Options
forfeited
|
|
|
(14,836
|
)
|
|
56.73
|
|
|
(381
|
)
|
|
43.13
|
|
Outstanding
options at end of period
|
|
|
1,007,849
|
|
$
|
34.81
|
|
|
1,507,226
|
|
$
|
33.19
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
exercisable at period-end
|
|
|
920,904
|
|
$
|
32.83
|
|
|
1,287,156
|
|
$
|
30.29
|
|
Weighted
average fair market value of options
granted
during the period
|
|
|
|
|
$
|
4.93
|
|
|
|
|
$
|
—
|
|
|
|
Six
Months Ended
June
30,
|
|
|
|
2007
|
|
2006
|
|
|
|
Shares
|
|
Weighted
Average
Exercise
Price
|
|
Shares
|
|
Weighted
Average
Exercise
Price
|
|
|
|
|
|
|
|
|
|
|
|
Stock
Options Outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
options at beginning of period
|
|
|
1,072,622
|
|
$
|
34.70
|
|
|
1,548,412
|
|
$
|
32.60
|
|
Options
granted
|
|
|
15,934
|
|
|
55.73
|
|
|
33,871
|
|
|
41.09
|
|
Options
exercised
|
|
|
(64,172
|
)
|
|
32.52
|
|
|
(73,641
|
)
|
|
24.13
|
|
Options
forfeited
|
|
|
(16,535
|
)
|
|
56.66
|
|
|
(1,416
|
)
|
|
41.16
|
|
Outstanding
options at end of period
|
|
|
1,007,849
|
|
$
|
34.81
|
|
|
1,507,226
|
|
$
|
33.19
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
exercisable at period-end
|
|
|
920,904
|
|
$
|
32.83
|
|
|
1,287,156
|
|
$
|
30.29
|
|
Weighted
average fair market value of options
granted
during the period
|
|
|
|
|
$
|
4.30
|
|
|
|
|
$
|
3.41
|
|
With
the
adoption of FAS 123R on January 1, 2006, the grant date fair market value
of all remaining unvested stock options (which includes the value of any future
dividend equivalent rights) is expensed to the consolidated statements of income
over the remaining vesting period of each option.
For
the
three and six months ended June 30, 2007, expenses related to stock options
were
$0.5 million and $1.0 million, respectively. For the three and six months
ended June 30, 2006, expenses related to stock options were $0.5 million and
$1.1 million, respectively. As of June 30, 2007, there was $1.1 million of
unrecognized compensation cost related to unvested stock options. These costs
will be expensed over a weighted-average period of one year.
The
total
intrinsic value or gain (fair market value less exercise price) for options
exercised was $0.2 million and $1.4 million for the three and six months
ended June 30, 2007, respectively. The net cash proceeds received from the
exercise of stock options was $0.2 million and $1.2 million for the
three and six months ended June 30, 2007, respectively.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
16. Equity Compensation Plans - (continued)
The
total
gain for options exercised was $7,000 and $1.3 million for the three and six
months ended June 30, 2006. The net cash proceeds received from the exercise
of
stock options was $9,000 and $0.4 million for the three and six months ended
June 30, 2006.
The
aggregate intrinsic value of the options outstanding and options currently
exercisable was $14 million and $25 million at June 30, 2007 and
December 31, 2006, respectively.
In
the
first half of 2007, officers exercised 23,487 options and surrendered 15,715
shares to pay exercise costs and taxes of $1 million on the gains on the
options exercised.
The
following table summarizes information about stock options outstanding at June
30, 2007.
Stock
Options Exercise Prices as of June 30, 2007
|
|
Options
Outstanding
|
|
Options
Exercisable
|
|
Range
of
Exercise
Prices
|
|
Number
Outstanding
|
|
Weighted-Average
Remaining
Contractual
Life
|
|
Weighted-Average
Exercise
Price
|
|
Number
Exercisable
|
|
Weighted-Average
Exercise
Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$10
to $20
|
|
|
314,783
|
|
|
2.15
|
|
$
|
12.90
|
|
|
314,783
|
|
$
|
12.90
|
|
$20
to $30
|
|
|
201,065
|
|
|
1.29
|
|
|
21.59
|
|
|
201,065
|
|
|
21.59
|
|
$30
to $40
|
|
|
2,500
|
|
|
5.86
|
|
|
36.19
|
|
|
2,500
|
|
|
36.19
|
|
$40
to $50
|
|
|
49,271
|
|
|
5.21
|
|
|
43.35
|
|
|
49,196
|
|
|
43.35
|
|
$50
to $60
|
|
|
440,230
|
|
|
6.36
|
|
|
55.55
|
|
|
353,360
|
|
|
55.50
|
|
$
0
to $60
|
|
|
1,007,849
|
|
|
3.98
|
|
|
|
|
|
920,904
|
|
|
|
|
Restricted
Stock
As
of
June 30, 2007 and December 31, 2006, 22,252 and 27,524 shares,
respectively, of restricted stock were outstanding. Restrictions on these shares
lapse through January 2011. Restricted stock activity for the three and six
months ended June 30, 2007 and 2006 is presented in the table below. There
were
no restricted stock awards granted during the first six months of
2007.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
16. Equity Compensation Plans - (continued)
Restricted
Stock Outstanding
|
|
Three
Months Ended
June
30, 2007
|
|
Three
Months Ended
June
30, 2006
|
|
|
|
Shares
|
|
Weighted
Average
Grant
Date
Fair
Market Value
|
|
Shares
|
|
Weighted
Average
Grant
Date
Fair
Market Value
|
|
|
|
|
|
|
|
|
|
|
|
Restricted
stock outstanding at the beginning
of
period
|
|
|
23,124
|
|
$
|
50.05
|
|
|
18,070
|
|
$
|
45.65
|
|
Restricted
stock granted
|
|
|
—
|
|
|
—
|
|
|
247
|
|
|
40.49
|
|
Stock
for which restrictions lapsed
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Restricted
stock forfeited
|
|
|
(872
|
)
|
|
50.77
|
|
|
(131
|
)
|
|
46.98
|
|
Restricted
stock outstanding at end of period
|
|
|
22,252
|
|
$
|
50.02
|
|
|
18,186
|
|
$
|
45.57
|
|
|
|
Six
Months Ended
June
30, 2007
|
|
Six
Months Ended
June
30, 2006
|
|
|
|
Shares
|
|
Weighted
Average
Grant
Date
Fair
Market Value
|
|
Shares
|
|
Weighted
Average
Grant
Date
Fair
Market Value
|
|
|
|
|
|
|
|
|
|
|
|
Restricted
stock outstanding at the beginning
of
period
|
|
|
27,524
|
|
$
|
49.57
|
|
|
21,038
|
|
$
|
45.96
|
|
Restricted
stock granted
|
|
|
—
|
|
|
—
|
|
|
247
|
|
|
40.49
|
|
Stock
for which restrictions lapsed
|
|
|
(4,308
|
)
|
|
46.88
|
|
|
(972
|
)
|
|
53.74
|
|
Restricted
stock forfeited
|
|
|
(964
|
)
|
|
51.28
|
|
|
(2,127
|
)
|
|
45.
15
|
|
Restricted
stock outstanding at end of period
|
|
|
22,252
|
|
$
|
50.02
|
|
|
18,186
|
|
$
|
45.57
|
|
The
cost
of these grants is amortized over the vesting term using an accelerated method
in accordance with FASB Interpretation No. 28 Accounting
for Stock Appreciation Rights and Other Variable Stock Options or Award
Plans
(FIN
28), and FAS 123R. For both the three months ended June 30, 2007 and 2006,
the
expenses related to restricted stock were $0.1 million. For both the six
months ended June 30, 2007 and 2006, the expenses related to restricted stock
were $0.2 million. As of June 30, 2007, there was $0.6 million of
unrecognized compensation cost related to unvested restricted stock. This cost
will be recognized over a weighted average period of one year.
Deferred
Stock Units
Deferred
stock units (DSUs) are granted or purchased by participants in the Executive
Deferred Compensation Plan. Some of the DSUs awarded may have a vesting period
associated with them. Restrictions on some of the outstanding DSUs lapse through
2013.
For
the
three and six months ended June 30, 2007, expenses related to DSUs were
$3.0 million and $7.0 million, respectively. For the three and six
months ended June 30, 2006, expenses related to DSUs were $2.4 million and
$4.5
million, respectively. As of June 30, 2007, there was $13.0 million of
unrecognized compensation cost related to nonvested DSUs. This cost will be
recognized over a weighted-average period of one year. As of December 31,
2006, there was $19.4 million of unrecognized compensation cost related to
nonvested DSUs. As of June 30, 2007 and December 31, 2006, the number of
outstanding DSUs that had vested was 252,244 and 153,073,
respectively.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
16. Equity Compensation Plans - (continued)
The
tables below provide summaries of the activities relating to the DSUs for the
three and six months ended June 30, 2007 and balances as of June 30, 2007 and
December 31, 2006.
Deferred
Stock Units
(In
thousands)
|
|
|
June
30,
2007
|
|
|
December
31,
2006
|
|
|
|
|
|
|
|
|
|
Value
of DSUs at
grant
|
|
$
|
37,885
|
|
$
|
36,542
|
|
Participant
forfeitures
|
|
|
(322
|
)
|
|
(110
|
)
|
Distribution
of DSUs
|
|
|
(2,554
|
)
|
|
(347
|
)
|
Change
in value at period end since grant
|
|
|
(614
|
)
|
|
6,763
|
|
Value
of DSUs at end of period
|
|
$
|
34,395
|
|
$
|
42,848
|
|
Deferred
Stock Units Activity
|
|
Three
Months Ended
June
30,
|
|
|
|
2007
|
|
2006
|
|
(In
thousands, except unit amounts)
|
|
|
Units
|
|
|
Fair
Market
Value
|
|
|
Weighted
Average
Grant
Date
Fair
Market
Value
|
|
|
Units
|
|
|
Fair
Market
Value
|
|
|
Weighted
Average
Grant
Date
Fair
Market
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at beginning of period
|
|
|
703,270
|
|
$
|
36,697
|
|
$
|
49.60
|
|
|
491,121
|
|
$
|
21,275
|
|
$
|
45.00
|
|
Grants
of DSUs
|
|
|
11,202
|
|
|
562
|
|
|
50.19
|
|
|
12,721
|
|
|
556
|
|
|
43.71
|
|
Distribution
of DSUs
|
|
|
(3,531
|
)
|
|
(107
|
)
|
|
30.27
|
|
|
(11,471
|
)
|
|
(347
|
)
|
|
30.27
|
|
Change
in valuation during period
|
|
|
—
|
|
|
(2,757
|
)
|
|
—
|
|
|
—
|
|
|
2,558
|
|
|
—
|
|
Participant
forfeitures
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Net
change in number/value of DSUs
|
|
|
7,671
|
|
|
(2,302
|
)
|
|
—
|
|
|
1,250
|
|
|
2,767
|
|
|
—
|
|
Balance
at end of period
|
|
|
710,941
|
|
$
|
34,395
|
|
$
|
49.24
|
|
|
492,371
|
|
$
|
24,042
|
|
$
|
45.31
|
|
|
|
Six
Months Ended
June
30,
|
|
|
|
2007
|
|
2006
|
|
(In
thousands, except unit amounts)
|
|
Units
|
|
Fair
Market
Value
|
|
Weighted
Average
Grant
Date
Fair
Market
Value
|
|
Units
|
|
Fair
Market
Value
|
|
Weighted
Average
Grant
Date
Fair
Market
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at beginning of period
|
|
|
737,740
|
|
$
|
42,848
|
|
$
|
48.91
|
|
|
418,126
|
|
$
|
17,252
|
|
$
|
45.65
|
|
Grants
of DSUs
|
|
|
24,633
|
|
|
1,343
|
|
|
54.54
|
|
|
85,716
|
|
|
3,568
|
|
|
41.26
|
|
Distribution
of DSUs
|
|
|
(47,282
|
)
|
|
(2,207
|
)
|
|
46.67
|
|
|
(11,471
|
)
|
|
(347
|
)
|
|
30.27
|
|
Change
in valuation during period
|
|
|
—
|
|
|
(7,377
|
)
|
|
—
|
|
|
—
|
|
|
3,569
|
|
|
—
|
|
Participant
forfeitures
|
|
|
(4,150
|
)
|
|
(212
|
)
|
|
51.20
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Net
change in number/value of DSUs
|
|
|
(26,799
|
)
|
|
(8,453
|
)
|
|
—
|
|
|
74,245
|
|
|
6,790
|
|
|
—
|
|
Balance
at end of period
|
|
|
710,941
|
|
$
|
34,395
|
|
$
|
49.24
|
|
|
492,371
|
|
$
|
24,042
|
|
$
|
45.31
|
|
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
16. Equity Compensation Plans - (continued)
Executive
Deferred Compensation Plan
In
May 2002, our board of directors approved the 2002 Executive Deferred
Compensation Plan (EDCP). The EDCP allows eligible employees and directors
to
defer portions of current salary and certain other forms of compensation.
Redwood matches some deferrals. Compensation deferred under the EDCP are assets
of Redwood and subject to the claims of the general creditors of Redwood. The
EDCP allows for the investment of deferrals in either an interest crediting
account or additional DSUs. The rate of accrual in the interest crediting
account is set forth in the EDCP. For deferrals prior to July 1, 2004, the
accrual rate is based on a calculation of the marginal rate of return on our
portfolio of earning assets. For deferrals after July 1, 2004 and through
December 31, 2006, the accrual rate is based on 120% of the long-term
applicable federal rate (AFR) or the equivalent rate of employee pre-selected
publicly traded mutual funds. For deferrals subsequent to December 31, 2006
- and beginning July 1, 2007, for all prior deferrals - the accrual rate is
based on 120% of AFR. Participants may also use their deferrals to acquire
additional DSUs.
For
the
three and six months ended June 30, 2007, deferrals of $0.3 million and
$1.3 million, respectively, were made under the EDCP. For the three and six
months ended June 30, 2006, deferrals of $0.6 million and $1.9 million,
respectively, were made under the EDCP.
The
following table provides detail on changes in participants’ EDCP accounts for
the three and six months ended June 30, 2007 and 2006.
EDCP
Activity
(In
thousands)
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Transfer
into participants’ EDCP accounts
|
|
$
|
260
|
|
$
|
558
|
|
$
|
1,348
|
|
$
|
1,924
|
|
Accrued
interest earned in EDCP
|
|
|
129
|
|
|
208
|
|
|
520
|
|
|
504
|
|
Participants’
withdrawals
|
|
|
(2,581
|
)
|
|
(1,879
|
)
|
|
(3,374
|
)
|
|
(2,120
|
)
|
Net
change in participants’ EDCP accounts
|
|
$
|
(2,192
|
)
|
$
|
(1,113
|
)
|
$
|
(1,506
|
)
|
$
|
308
|
|
Balance
at beginning of period
|
|
$
|
10,379
|
|
$
|
8,426
|
|
$
|
9,693
|
|
$
|
7,005
|
|
Balance
at end of period
|
|
$
|
8,187
|
|
$
|
7,313
|
|
$
|
8,187
|
|
$
|
7,313
|
|
The
following table provides detail on the financial position of the EDCP at June
30, 2007 and December 31, 2006.
Balance
of Participants’ EDCP Accounts
(In
thousands)
|
|
June
30,
2007
|
|
December 31,
2006
|
|
|
|
|
|
|
|
Participants’
deferrals
|
|
$
|
4,617
|
|
$
|
6,643
|
|
Accrued
interest credited
|
|
|
3,570
|
|
|
3,050
|
|
Balance
of participants’ EDCP accounts
|
|
$
|
8,187
|
|
$
|
9,693
|
|
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
16. Equity Compensation Plans - (continued)
Employee
Stock Purchase Plan
In
May 2002, our stockholders approved the 2002 Redwood Trust, Inc. Employee
Stock Purchase Plan (ESPP), effective July 1, 2002. The purpose of the ESPP
is to give our employees an opportunity to acquire an equity interest in Redwood
through the purchase of shares of common stock at a discount. The ESPP allows
eligible employees to purchase common stock at 85% of its fair market value,
subject to limits. Fair market value as defined under the ESPP is the lesser
of
the closing market price of the common stock on the first day of the calendar
year or the first day of the calendar quarter of that year.
The
ESPP
allows a maximum of 100,000 shares of common
stock to
be purchased in aggregate for all employees. As of June 30, 2007 and
December 31, 2006, 41,207 and 35,570 shares have been purchased. As of June
30, 2007 and December 31, 2006, there remained a negligible amount of
uninvested employee contributions in the ESPP.
The
table
below presents the activity in the ESPP for the three and six months ended
June
30, 2007 and 2006.
Employee
Stock Purchase Plan
(In
thousands)
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Balance
at beginning of period
|
|
$
|
9
|
|
$
|
5
|
|
$
|
3
|
|
$
|
13
|
|
Transfer
in of participants’ payroll deductions from the ESPP
|
|
|
124
|
|
|
97
|
|
|
248
|
|
|
184
|
|
Cost
of common stock issued to participants under the terms of the
ESPP
|
|
|
(123
|
)
|
|
(97
|
)
|
|
(241
|
)
|
|
(192
|
)
|
Net
change in participants’ equity
|
|
$
|
1
|
|
$
|
—
|
|
$
|
7
|
|
$
|
(8
|
)
|
Balance
at end of period
|
|
$
|
10
|
|
$
|
5
|
|
$
|
10
|
|
$
|
5
|
|
Note
17. Commitments and Contingencies
As
of
June 30, 2007, we were obligated under non-cancelable operating leases with
expiration dates through 2018 for $16.1 million. The majority of the future
lease payments relate to a ten-year operating lease for our executive offices,
which expires in 2013, and a lease for additional office space at our executive
offices beginning January 1, 2008 and expiring May 31, 2018. Prior to
the beginning of the lease of the additional office space, we are subleasing
this office space from another tenant through the end of 2007. The total lease
payments to be made under the lease expiring in 2013 and the sublease, including
certain free-rent periods, are being recognized as office rent expense on
straight-line basis over the lease term. Operating lease expense was
$0.3 million and $0.2 million for the quarters ended June 30, 2007 and
2006, respectively. Operating lease expense was $0.6 million and $0.3 million
for the six months ended June 30, 2007 and 2006, respectively. Leasehold
improvements for our executive offices are amortized into expense over the
ten-year lease term. The unamortized leasehold improvement balance at June
30,
2007 and December 31, 2006 was $3.4 million and $2.0 million,
respectively.
REDWOOD
TRUST, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS
June
30, 2007
(Unaudited)
Note
17. Commitments and Contingencies - (continued)
Future
Lease Commitments by Year
(In
thousands)
|
|
June
30,
2007
|
|
|
|
|
|
2007
(six
months)
|
|
$
|
690
|
|
2008
|
|
|
1,636
|
|
2009
|
|
|
1,680
|
|
2010
|
|
|
1,709
|
|
2011
|
|
|
1,831
|
|
2012
and thereafter
|
|
|
8,574
|
|
Total
|
|
$
|
16,120
|
|
At
June
30, 2007, to our knowledge there were no legal proceedings to which we were
a
party or to which any of our properties was subject.
The
table
below shows our commitments to purchase loans and securities as of June 30,
2007. The loan purchase commitments represent derivative instruments with an
estimated value of positive $0.1 million at June 30, 2007 under FAS No.
149, Amendment
of Statement 133 on Derivative Instruments and Hedging
Activities
(FAS
149). This is included in net recognized gains and valuation adjustments on
our
Statements of Income.
Commitments
to Purchase - Principal Amount
(In
thousands)
|
|
June
30,
2007
|
|
|
|
|
|
Real
estate
loans
|
|
$
|
148,531
|
|
Real
estate securities
|
|
|
—
|
|
Total
|
|
$
|
148,531
|
|
Stock
Repurchases
We
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. There were no repurchases
during the second quarter of 2007 and 1,000,000 shares remained available for
repurchase under those plans.
Note
18. Recent Developments
Management
believes that the valuation of our real estate securities continued to decline
in July from June 30, 2007. Management has not quantified the effect of this
decline.
In
July
2007 we securitized $740 million of residential real estate loans through our
Sequoia program.
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS
OF OPERATIONS
Cautionary
Statement
This
Form
10-Q contains 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
our
Annual Report on Form 10-K for the year ended December 31, 2006 under the
caption “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-K, 10-Q, and 8-K.
We
undertake no obligation to update or revise any forward-looking statements,
whether as a result of new information, future events, or otherwise. In light
of
these risks, uncertainties, and assumptions, the forward-looking events
mentioned or discussed in, or incorporated by reference into, this Form 10-Q
might not occur. Accordingly, our actual results may differ from our current
expectations, estimates, and projections.
Important
factors that may impact our actual results include changes in interest rates
and
fair 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. This Form 10-Q contains statistics and other data that
in
some cases have been obtained from or compiled from information made available
by servicers and other third-party service providers.
Summary
Redwood
Trust, Inc., together with its subsidiaries (Redwood, we, or us), is a financial
institution focused on investing in, financing, and managing residential and
commercial real estate loans and 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 distributing attractive levels of dividends per
share. For tax purposes, we are structured as a real estate investment trust
(REIT).
Our
primary source of income is net interest income, which equals the interest
income we earn from our investments in loans and securities less the interest
expenses we incur from our borrowed funds and other liabilities. We assume
a
range of risks in our investments and the level of assumed risk dictates the
manner in which we finance our purchase of and derive income from these
investments.
Our
investments in residential, commercial, and collateralized debt obligation
(CDO)
credit enhancement securities (CES, or below investment-grade securities) have
concentrated credit risk. We finance the acquisition of most of our first-loss
and equivalent CES that are directly exposed to credit losses with capital.
We
generally finance the acquisition of our second-loss, third-loss, and equivalent
securities through our Acacia securitization program. To date, our primary
credit enhancement investment focus has been in securities backed by
high-quality residential and commercial real estate loans. “High-quality” real
estate loans are loans that typically have 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. Our CES investment
returns depend on the amount and timing of most of the interest and principal
collected on the loans in the pools supporting the securities. In an ideal
environment for most of our residential CES, we would experience fast loan
prepayments and low credit losses which would, in turn, lead to attractive
CES
returns. Conversely, the return on most of our residential CES investments
would
be adversely affected by slow loan prepayments and high credit
losses.
Our
investments in real estate loans and investment-grade securities (IGS) have
less
concentrated credit risk. To produce an attractive investment return on these
lower credit risk assets, we use leverage (primarily structural leverage through
securitization rather than financial leverage through the use of Redwood debt).
We earn income based upon the spread between the yield on the acquired asset
and
the cost of funds we borrowed to acquire the asset. We have obtained most of
the
financing used to acquire these assets through the issuance of asset-backed
securities (ABS) under our Sequoia and Acacia securitization programs. These
financings are not obligations of Redwood. To further facilitate these
investments, we have established a wholly-owned qualified REIT subsidiary to
hold some of our investments in high-quality investment-grade residential and
commercial securities and high-quality prime residential loans. We have recently
renamed this entity from Cypress to Juniper Trust, Inc. (Juniper). These assets
will be funded initially with debt, although in the future, Juniper will likely
also utilize securitization as a form of financing. We believe spread lending
opportunities with these types of securities and loans are becoming increasingly
attractive.
Our
reported GAAP net income was $11 million ($0.41 per share) in the second
quarter of 2007, a decrease from $31 million ($1.20 per share) for the
second quarter of 2006. For the six months ended June 30, 2007 and 2006, GAAP
income was $30 million ($1.06 per share) and $59 million ($2.29 per share),
respectively. Our GAAP return on equity was 5% for the three months ended June
30, 2007 compared to 13% for the three months ended June 30, 2006. GAAP return
on equity was 6% for the six months ended June 30, 2007 and 12% for the six
months ended June 30, 2006. In the second quarter of 2007, we declared a regular
dividend of $0.75 per share.
Table
1 Net Income
(In
thousands, except share data)
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Total
interest income
|
|
$
|
219,658
|
|
$
|
218,238
|
|
$
|
434,764
|
|
$
|
444,120
|
|
Total
interest expense
|
|
|
(165,757
|
)
|
|
(173,519
|
)
|
|
(333,853
|
)
|
|
(354,174
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income
|
|
|
53,901
|
|
|
44,719
|
|
|
100,911
|
|
|
89,946
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses
|
|
|
(12,772
|
)
|
|
(16,037
|
)
|
|
(30,554
|
)
|
|
(28,619
|
)
|
Realized
gains on sales and calls, net
|
|
|
2,738
|
|
|
8,988
|
|
|
3,884
|
|
|
10,050
|
|
Market
valuation adjustments, net
|
|
|
(29,430
|
)
|
|
(2,995
|
)
|
|
(39,694
|
)
|
|
(5,927
|
)
|
Provision
for income taxes
|
|
|
(3,021
|
)
|
|
(3,265
|
)
|
|
(4,822
|
)
|
|
(6,025
|
)
|
Net
income
|
|
$
|
11,416
|
|
$
|
31,410
|
|
$
|
29,725
|
|
$
|
59,425
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
common shares
|
|
|
28,164,944
|
|
|
26,108,975
|
|
|
27,917,502
|
|
|
25,909,923
|
|
Net
income per share
|
|
$
|
0.41
|
|
$
|
1.20
|
|
$
|
1.06
|
|
$
|
2.29
|
|
The
largest factor in the decline of net income for the second quarter was a $26
million increase in negative market valuation adjustments. The reason for this
increase is discussed in detail below - see Capital Markets Pricing Volatility.
Another factor was a $6 million decline from gains generated from sales and
calls of assets.
On
the
positive side, our operating results for the second quarter of 2007 were strong.
Net interest income increased to $54 million during the quarter up from $45
million in the same period last year. Higher net interest income from our IGS
and CES portfolios more than offset the decline from a reduced balance of
adjustable-rate residential loans under our Sequoia program. Operating expenses
were $3 million lower than the comparable period in 2006 primarily due to
reduced due diligence expenses resulting from lower commercial CES acquisition
activity.
Our
estimated taxable income was $1.66 per share and $3.14 per share for the three
and six months ended June 30, 2007, respectively. Our estimated REIT taxable
income was $1.63 per share and $2.92 per share for the three and six months
ended June 30, 2007, respectively. Our REIT taxable income is the primary
determinant of the minimum amount of dividends we must distribute in order
to
maintain our tax status as a real estate investment trust. Taxable income
continues to run higher than GAAP income as we are not permitted to establish
credit reserves for tax. As a result, we amortize more of our CES discount
into
income for tax and have a higher tax basis in these securities. Consequently,
any future credit losses on our CES will have a more significant impact on
tax
earnings compared to GAAP earnings. See Potential Income Tax Volatility later
in
this document.
Capital
Markets Pricing Volatility
Market
Conditions
Beginning
in the first quarter of 2007, capital market yield spreads for residential
mortgage-backed securities (RMBS) began to widen (causing required market yields
for each security to rise, thus reducing market prices for securities),
especially for securities backed by 2006 subprime loans. After briefly
tightening early in the second quarter, spreads for RMBS, CDO securities, and
commercial mortgage-backed securities (CMBS) significantly widened. Prices
for
fixed income assets fell across the credit spectrum. The steepest price declines
occurred with respect to RMBS and CDO securities backed by 2006 and early 2007
subprime and low quality alt-a loans.
We
believe several converging factors led to the broad decline in capital markets
pricing for RMBS, CMBS, and CDO securities which, in turn, caused us to incur
negative mark-to-market valuation adjustments against our securities portfolio.
These include:
|
·
|
General
concern over the decline in home prices and the financial stability
of
mortgage borrowers. Recent delinquency and default data now show
that
mortgage loans originated in 2006 and early 2007, especially loans
extended to subprime and low-quality alt-a borrowers, are significantly
underperforming the rating agencies’ credit expectations. It now appears
likely that some investment-grade rated RMBS backed by these loans
will
incur credit losses.
|
|
·
|
The
overall contraction in market liquidity has forced many potential
buyers
out of the market. Banks and Wall Street firms have been aggressively
taking steps to tighten credit by contracting margin leverage and
reducing
or withdrawing credit lines. Additionally, the turbulence surrounding
CDOs
has led to a dramatic decrease in new CDO issuance. CDOs were previously
significant acquirers of RMBS and
CMBS.
|
|
· |
The
supply of securities potentially available for sale has increased
due to
margin calls and the planned liquidation of several hedge funds with
large
RMBS and CDO securities positions.
|
From
the
end of the second quarter through the beginning of August, market pricing has
continued to decline as the negative impact of the above factors has escalated.
Moreover, in July the credit rating agencies began downgrading underperforming
2006 and early 2007 RMBS and CDO securities, and going forward, we expect the
credit rating agencies to take further negative rating actions.
Impact
on Redwood
We
believe that in the long-term the widening of spreads will be advantageous
to us
as we will able to buy higher quality assets at more attractive prices. However,
it had a negative accounting impact on us in the first and second quarters,
as
mark-to-market (MTM) adjustments to our existing real estate securities
portfolio caused our GAAP book value and our GAAP earnings to decline. Unless
RMBS prices recover from August levels, which at this point seems unlikely,
we
will incur additional, potentially significant, negative mark-to-market
write-downs in subsequent quarters. That being said, the MTM adjustments had
little impact on the economics or cash flows of our business. The vast majority
of our credit-sensitive investments are backed by prime or near-prime alt-a
borrowers whose credit performance continues to exceed, or is within, our
modeling expectations. Additionally, we experienced no liquidity issues, as
all
of our credit-sensitive securities were financed through Acacia or with
capital.
The
process of establishing fair market values for our securities is inherently
subjective since it relies on modeling assumptions and indications of value
obtained from brokers and dealers. Our policy is to reflect fair market values
that we believe we could realize if we chose to sell the assets. However,
establishing fair market values for our securities has proven particularly
difficult during this quarter. Not only has there been a significant disruption
in the market, but securities trading volume has been, and continues to be,
very
light as a result of the failure of willing buyers and sellers to be able to
agree on price. Consequently, the visibility normally provided by market
activity has been constrained. In certain limited instances of establishing
fair
market value, we either received no independent bid indication or an extremely
distressed bid which we did not consider to be an appropriate indication of
fair
market value. In those instances, we relied on our internal model to value
the
securities. We expect the difficulty in ascertaining fair market value from
market sources to continue until trading levels increase and market price
clearing levels are re-established. We caution that these securities’ valuations
are subjective and will change over time, potentially in a material
way.
The
total
mark-to-market valuation impact on Redwood’s investments in real estate
securities and other investments resulted in a write-down of $104 million for
the three months ended June 30, 2007, after netting the impact of hedges. Of
this amount, $29 million flowed through our income statement and $75 million
was
recorded as a reduction of stockholders’ equity. Of the $29 million of income
statement write-downs taken in the second quarter, $19 million were impairments
under EITF 99-20.
A
summary
of the changes in fair market value during the second quarter of 2007 by type
and security is shown in the table below.
Table
2 Mark-To-Market Adjustments
|
|
Three
Months Ended June
30, 2007
|
|
(In
millions)
|
|
Residential
|
|
Commercial
|
|
CDO
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
IGS
|
|
$
|
(37
|
)
|
$
|
(5
|
)
|
$
|
(19
|
)
|
$
|
(61
|
)
|
CES
|
|
|
(22
|
)
|
|
(34
|
)
|
|
— |
|
|
(56 |
) |
NIMs,
residuals, IOs, and CDS
|
|
|
(7
|
)
|
|
—
|
|
|
— |
|
|
(7 |
) |
Total
mark-to-market adjustments
|
|
|
(66
|
)
|
|
(39
|
)
|
$
|
(19
|
)
|
$
|
(124
|
)
|
Interest
rate hedges
|
|
|
—
|
|
|
—
|
|
|
— |
|
|
20 |
|
Total
mark-to-market adjustments
|
|
$
|
(66
|
)
|
$
|
(39
|
)
|
$
|
(19
|
)
|
$
|
(104
|
)
|
The
total
mark-to-market valuation impact on Redwood’s investments in real estate
securities and other investments resulted in a write-down of $213 million for
the six months ended June 30, 2007, after netting the impact of hedges. Of
this
amount, $39 million flowed through our income statement and $174 million was
recorded as a reduction of stockholders’ equity. Of the $39 million of income
statement write-downs taken during the first six months of 2007, $22 million
were impairments under EITF 99-20.
A
summary
of the changes in fair market value during the first six months of 2007 by
type
and security is shown in the table below.
|
|
Six
Months Ended June
30,
2007
|
|
(In
millions)
|
|
Residential
|
|
Commercial
|
|
CDO
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
IGS
|
|
$
|
(89
|
)
|
$
|
(7
|
)
|
$
|
(30
|
)
|
$
|
(126
|
)
|
CES
|
|
|
(40
|
)
|
|
(46
|
)
|
|
— |
|
|
(86 |
) |
NIMs,
residuals, IOs, and CDS
|
|
|
(15
|
)
|
|
—
|
|
|
— |
|
|
(15 |
) |
Total
mark-to-market adjustments
|
|
|
(144
|
)
|
|
(53
|
)
|
$
|
(30
|
)
|
$
|
(227
|
)
|
Interest
rate hedges
|
|
|
—
|
|
|
—
|
|
|
— |
|
|
14 |
|
Total
mark-to-market adjustments
|
|
$
|
(144
|
)
|
$
|
(53
|
)
|
$
|
(30
|
)
|
$
|
(213
|
)
|
We
note
that the disruption in the capital markets not only affected real estate asset
spreads, but liability spreads as well. Liability spreads widened, reducing
the
fair market value of the ABS we have issued to levels below the carrying value
on our books. Under GAAP, we are required to carry our real estate securities
on
our balance sheet at their fair market value but we are not permitted to adjust
paired Acacia ABS issued liabilities to fair market value. Using the assumptions
described in Note
14
to our
financial statements, we estimate that if we had recorded our Acacia ABS issued
at fair market value and adjusted for Acacia unamortized deferred bond issuance
costs of $26 million, our liabilities at June 30, 2007 would have been lower
than reported by $75 million. We caution that these fair market value
figures have not been audited, rely on estimates, and are inherently subjective.
Exposure
to Subprime and CDO Securities
We
do not
originate, acquire, service, or securitize subprime mortgages. Accordingly
we
are not directly subject to subprime loan repurchase issues. We do own subprime
securities and CDO securities, both of which are backed by subprime
loans.
The
following table provides detail of the subprime and CDO securities on our
consolidated balance sheet by vintage and rating at June 30, 2007.
Table
3 Subprime and CDO Securities
|
|
Subprime
|
|
CDO
|
|
(In
millions)
|
|
2005
and Prior
|
|
|
|
Total
|
|
2005
and Prior
|
|
2006
and
2007
|
|
Total
|
|
AAA
|
|
$
|
5
|
|
$
|
9
|
|
$
|
14
|
|
$
|
38
|
|
$
|
43
|
|
$
|
81
|
|
AA
|
|
|
99
|
|
|
55
|
|
|
154
|
|
|
27
|
|
|
3
|
|
|
30
|
|
A
|
|
|
121
|
|
|
28
|
|
|
149
|
|
|
33
|
|
|
15
|
|
|
48
|
|
BBB
|
|
|
36
|
|
|
84
|
|
|
120
|
|
|
37
|
|
|
39
|
|
|
76
|
|
Total
investment-grade
|
|
|
261
|
|
|
176
|
|
|
437
|
|
|
135
|
|
|
100
|
|
|
235
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CES
and residuals
|
|
|
—
|
|
|
3
|
|
|
3
|
|
|
12
|
|
|
9
|
|
|
21
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
subprime and CDO securities
|
|
$
|
261
|
|
$
|
179
|
|
$
|
440
|
|
$
|
147
|
|
$
|
109
|
|
$
|
256
|
|
Our
economic exposure to subprime and CDO securities is significantly less than
the
assets shown above, as $648 million of these securities were financed on a
non-recourse basis through Acacia securitization entities and $48 million were
financed with capital. Our economic exposure is limited to our $116 million
equity investment in the Acacia securitization entities that financed those
securities plus the $48 million of securities financed with capital, for a
total
economic exposure of $164 million.
Over
time, our GAAP exposure and our economic exposure will be the same. If credit
losses on securities owned by Acacia entities are in excess of our investment
in
those entities, those credit losses would be passed through to Acacia debt
holders and our balance sheet liabilities would be reduced. Due to certain
timing differences under GAAP however, there could be interim periods of time
when our GAAP losses would be in excess of our economic investment. These timing
differences arise from the fact that we are not permitted to adjust the carrying
value of our Acacia liabilities until actual losses are passed through to debt
holders, but we are required to mark to market quarterly all of the Acacia
assets.
In
April,
the turbulence in the residential mortgage markets began to impact the CDO
market. Many CDOs completed in the beginning of 2006 and those marketed in
the
first quarter of 2007 had a high concentration of securities backed by BBB
and
BBB- rated subprime securities from the 2006 vintage. The volume of CDO activity
has slowed dramatically and CDO debt spreads, especially for securities rated
below AAA, have widened significantly. The level of our new CDO activity will
largely depend on market conditions and debt spreads. If today’s turbulent
environment persists, it is unlikely that we would complete another CDO
transaction this year. This will require us to look to other potential sources
of financing, such as Redwood debt or capital, to fund acquisitions, or else
slow the pace of our acquisitions.
During
the very difficult market conditions of the second quarter, we successfully
priced and closed two CDO ABS issuances, Acacia Option Arm 1 and Acacia 12,
with
equity returns that are expected to meet or exceed our internal hurdle rates.
Relative to other real estate CDO issuance in the second quarter, our Acacia
CDO
ABS were priced at tighter spreads.
In
the
longer term, we believe our CDO business will likely benefit from recent market
developments. We believe that our successful track record as a CDO manager
and
our willingness to invest in the equity of our CDO transactions gives us a
competitive advantage. Additionally, we believe non-recourse warehouse
facilities provided in the past by lenders during the two-to-six month ramp-up
phase will no longer be available. Going forward, we believe these warehouse
providers will require issuers, including Redwood, to assume more risk during
the aggregation period. Consequently, the advantage will go to CDO managers,
like Redwood, with strong balance sheets and the hedging expertise necessary
to
bear this risk. We believe the likely result for us will be decreased
competition and increased margins in our CDO business.
Capital
and Liquidity
At
June
30, 2007, we had $83 million unrestricted cash. We also had $878 million
principal value of unsecuritized prime residential loans and $168 million
principal value of AAA-rated prime residential securities. Total short-term
borrowings against these assets were $849 million. Since quarter end, we
completed a securitization of residential loans through our Sequoia program.
As
a result of this and other activity, as of August 7, 2007, we had $231 million
unrestricted cash. We also had $189 million principal value of unsecuritized
prime residential loans and $330 million principal value of AAA-rated
residential securities. We believe the current fair market values for these
portfolios equal 95% to 100% of their principal value. As of August 7, 2007,
total short-term borrowings against these assets were $472 million. On August
3,
2007, we sold for future settlement $39.5 million of the $330 million principal
value of AAA-rated securities for a price of 99.43% of principal value for
proceeds of $39.3 million. We also own other assets on an
unencumbered basis, including CES, OREI, and retained assets from our Sequoia
and Acacia securitizations.
At
June
30, 2007, we had $158 million of excess capital, a decrease from the $182
million excess capital we had at December 31, 2006. We derive our excess
capital figures by calculating the amount of cash we have available for
investment if we fully leveraged our loans and securities in accordance with
our
internal risk-adjusted capital policies and deducted from the resulting cash
balances an amount we believe is sufficient to fund operations, working capital,
and to provide for certain potential liquidity risks. We include subordinated
notes in our capital base calculations. In part as a result of a successful
Sequoia securitization of prime residential whole loans, our excess capital
as of August 7, 2007 increased to $200 million.
Uses
of
capital during the first half of 2007 included new asset acquisitions ($325
million) and dividends ($42 million). Sources of capital included asset sales
($61 million), principal payments ($109 million), subordinated debt issuance
($50 million), equity issuance ($61 million), earnings ($30 million), and other
factors, including recycling of capital ($32 million).
At
the
beginning of 2007, we anticipated net capital absorption of $200 million to
$400
million for the calendar year. At this point, the outlook for capital absorption
is uncertain due to market turmoil. The amount of capital we deploy will depend
on the level of and expected returns from possible acquisitions. Given our
current acquisition plans, it is possible that we will finish the year at or
below the lower end of that range. However, it is also possible that large
and
exceptional opportunities may develop during the remainder of the year. If
that
occurs, we may utilize our current excess capital and also elect to raise
additional capital, through the issuance of long-term debt or equity, to take
advantage of those opportunities. Alternatively, we may consider using our
excess capital to repurchase shares if we believe it is in our best interests
to
do so.
Outlook
We
believe the long-term outlook for our business has improved over the last few
weeks and months. Pricing for asset acquisitions is becoming more attractive,
loan quality is improving, property prices are becoming more realistic, and
a
number of our competitors are facing significant challenges or have gone out
of
business. Our competitive position has been further enhanced by our strong
balance sheet, permanent capital, scale of operations, and product line
diversity. We have been through several liquidity and credit cycles in the
past.
Each time we have emerged as a stronger company, and we believe we are well
positioned to do so again this time around. Our current liquidity position
and
our balance sheet are strong, and we believe we are in a good position to
acquire new higher quality assets at attractive prices as they become available
in the currently distressed environment.
Over
the
next two or three years, we will likely experience delinquencies and credit
losses that will increase materially on a percentage basis from the low levels
we have experienced over the last few years. We believe we have established
appropriate reserves for these increased losses. We expect most of our assets
to
produce healthy economic returns even with the increased losses that we now
anticipate. We don’t know how long or how severe this credit down cycle will be,
however, and our current expectations about the level of future losses could
be
overly optimistic. Furthermore, we have some assets that may experience greater
than expected losses even in a more mild credit down cycle. As a result, we
believe the most appropriate expectation over the next few years is that credit
losses will escalate and possibly reduce the amount and likelihood of our
special dividends.
In
a severe case, taxable income alone may be insufficient
to
cover the payment of our regular dividend.
Results
of Operations
Interest
Income
Total
interest income consists of interest earned on consolidated earning assets
adjusted for amortization of discounts and premiums and provisions for loan
credit losses. The table below summarizes interest income earned on real estate
loans, real estate securities, other real estate investments, non-real estate
investments, and cash.
Table
4 Interest Income and Yield
(Dollars
in thousands)
|
|
Three
Months Ended June
30,
|
|
|
|
2007
|
|
2006
|
|
|
|
Interest
Income
|
|
Percent
of
Total
Interest
Income
|
|
Average
Balance
|
|
Yield
|
|
Interest
Income
|
|
Percent
of
Total
Interest
Income
|
|
Average
Balance
|
|
Yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real
estate loans, net of provision for
credit
losses
|
|
$
|
119,576
|
|
|
54.44
|
%
|
$
|
8,258,322
|
|
|
5.79
|
%
|
$
|
154,972
|
|
|
71.01
|
%
|
$
|
10,832,187
|
|
|
5.72
|
%
|
Real
estate securities
|
|
|
95,193
|
|
|
43.34
|
%
|
|
3,669,629
|
|
|
10.38
|
%
|
|
60,395
|
|
|
27.67
|
%
|
|
2,502,926
|
|
|
9.65
|
%
|
Other
real estate investments
|
|
|
669
|
|
|
0.30
|
%
|
|
44,061
|
|
|
6.07
|
%
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Non-real
estate investments
|
|
|
464
|
|
|
0.21
|
%
|
|
38,681
|
|
|
4.80
|
%
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Cash
and cash equivalents
|
|
|
3,756
|
|
|
1.71
|
%
|
|
290,869
|
|
|
5.17
|
%
|
|
2,871
|
|
|
1.32
|
%
|
|
246,597
|
|
|
4.66
|
%
|
Total
interest income
|
|
$
|
219,658
|
|
|
100.00
|
%
|
$
|
12,301,562
|
|
|
7.14
|
%
|
$
|
218,238
|
|
|
100.00
|
%
|
$
|
13,581,710
|
|
|
6.43
|
%
|
(Dollars
in thousands)
|
|
Six
Months Ended June
30,
|
|
|
|
2007
|
|
2006
|
|
|
|
Interest
Income
|
|
Percent
of
Total
Interest
Income
|
|
Average
Balance
|
|
Yield
|
|
Interest
Income
|
|
Percent
of
Total
Interest
Income
|
|
Average
Balance
|
|
Yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real
estate loans, net of provision for
credit
losses
|
|
$
|
246,427
|
|
|
56.68
|
%
|
$
|
8,494,018
|
|
|
5.80
|
%
|
$
|
321,875
|
|
|
72.48
|
%
|
$
|
11,710,861
|
|
|
5.50
|
%
|
Real
estate securities
|
|
|
178,651
|
|
|
41.09
|
%
|
|
3,468,680
|
|
|
10.30
|
%
|
|
116,897
|
|
|
26.32
|
%
|
|
2,445,031
|
|
|
9.56
|
%
|
Other
real estate investments
|
|
|
3,134
|
|
|
0.72
|
%
|
|
40,634
|
|
|
15.43
|
%
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Non-real
estate investments
|
|
|
464
|
|
|
0.11
|
%
|
|
19,448
|
|
|
4.78
|
%
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Cash
and cash equivalents
|
|
|
6,088
|
|
|
1.40
|
%
|
|
268,779
|
|
|
4.53
|
%
|
|
5,348
|
|
|
1.20
|
%
|
|
245,306
|
|
|
4.36
|
%
|
Total
interest income
|
|
$
|
434,764
|
|
|
100.00
|
%
|
$
|
12,291,559
|
|
|
7.07
|
%
|
$
|
444,120
|
|
|
100.00
|
%
|
$
|
14,401,198
|
|
|
6.17
|
%
|
The
table
below details how our interest income changed by portfolio as a result of
changes in consolidated asset balances (“volume”) and yield (“rate”) for the
three and six months ended June 30, 2007 as compared to the three and six months
ended June 30, 2006.
Table
5 Volume and Rate Changes for Interest Income
|
|
Change
in Interest Income
Three
Months Ended
June
30, 2007 Versus June 30, 2006
|
|
(In
thousands)
|
|
Volume
|
|
Rate
|
|
Total
Change
|
|
|
|
|
|
|
|
|
|
Real
estate loans, net of provisions for credit
losses
|
|
$
|
(36,823
|
)
|
$
|
1,427
|
|
$
|
(35,396
|
)
|
Real
estate securities
|
|
|
28,152
|
|
|
6,646
|
|
|
34,798
|
|
Other
real estate investments
|
|
|
669
|
|
|
—
|
|
|
669
|
|
Non-real
estate investments
|
|
|
464
|
|
|
—
|
|
|
464
|
|
Cash
and cash equivalents
|
|
|
515
|
|
|
370
|
|
|
885
|
|
Total
interest income
|
|
$
|
(7,023
|
)
|
$
|
8,443
|
|
$
|
1,420
|
|
|
|
Change
in Interest Income
Six
Months Ended
June
30, 2007 Versus June 30, 2006
|
|
(In
thousands)
|
|
Volume
|
|
Rate
|
|
Total
Change
|
|
|
|
|
|
|
|
|
|
Real
estate loans, net of provisions for credit
losses
|
|
$
|
(88,415
|
)
|
$
|
12,967
|
|
$
|
(75,
448
|
)
|
Real
estate securities
|
|
|
48,941
|
|
|
12,813
|
|
|
61,754
|
|
Other
real estate investments
|
|
|
3,134
|
|
|
—
|
|
|
3,134
|
|
Non-real
estate investments
|
|
|
464
|
|
|
—
|
|
|
464
|
|
Cash
and cash equivalents
|
|
|
512
|
|
|
228
|
|
|
740
|
|
Total
interest income
|
|
$
|
(35,364
|
)
|
$
|
26,008
|
|
$
|
(9,356
|
)
|
Note:
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.
Below
is
a further breakdown and discussion of the year-over-year changes for real estate
loans, real estate securities, other real estate investments, non-real estate
securities and cash.
Interest
Income - Real Estate Loans
The
following tables provide detail on interest income earned on our residential
and
commercial real estate loan portfolios for the three and six months ended June
30, 2007 and 2006.
Table
6 Consolidated Real Estate Loans
(Dollars
in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended June 30, 2007
Yield
as a Result of
|
|
|
|
Interest
Income
|
|
Net
(Premium)
Discount
Amortization
|
|
Provision
For
Credit
Losses
|
|
Total
Interest
Income
|
|
Average
Balance
|
|
Interest
Income
|
|
(Premium)
Discount
Amortization
and
Credit
Provision
|
|
Total
Interest
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
loans
|
|
$
|
132,546
|
|
$
|
(10,889
|
)
|
$
|
(2,500
|
)
|
$
|
119,157
|
|
$
|
8,232,476
|
|
|
6.44
|
%
|
|
(0.65
|
)%
|
|
5.79
|
%
|
Commercial
loans
|
|
|
393
|
|
|
26
|
|
|
—
|
|
|
419
|
|
|
25,846
|
|
|
6.08
|
%
|
|
0.40
|
%
|
|
6.48
|
%
|
Total
loans
|
|
$
|
132,939
|
|
$
|
(10,863
|
)
|
$
|
(2,500
|
)
|
$
|
119,576
|
|
$
|
8,258,322
|
|
|
6.44
|
%
|
|
(0.65
|
)%
|
|
5.79
|
%
|
(Dollars
in thousands)
|
|
|
|
|
|
Reversal
|
|
|
|
|
|
Three
Months Ended June 30, 2006
Yield
as a Result of
|
|
|
|
Interest
Income
|
|
Net
(Premium)
Discount
Amortization
|
|
of
Provision
For
Credit
Losses
|
|
Total
Interest
Income
|
|
Average
Balance
|
|
Interest
Income
|
|
(Premium)
Discount
Amortization
and
Credit
Provision
|
|
Total
Interest
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
loans
|
|
$
|
163,726
|
|
$
|
(12,072
|
)
|
$
|
2,541
|
|
$
|
154,195
|
|
$
|
10,789,275
|
|
|
6.07
|
%
|
|
(0.35
|
)%
|
|
5.72
|
%
|
Commercial
loans
|
|
|
786
|
|
|
26
|
|
|
(35
|
)
|
|
777
|
|
|
42,912
|
|
|
7.33
|
%
|
|
(0.07
|
)%
|
|
7.24
|
%
|
Total
loans
|
|
$
|
164,512
|
|
$
|
(12,046
|
)
|
$
|
2,506
|
|
$
|
154,972
|
|
$
|
10,832,187
|
|
|
6.07
|
%
|
|
(0.35
|
)%
|
|
5.72
|
%
|
(Dollars
in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Six
Months Ended June 30, 2007
Yield
as a Result of
|
|
|
|
Interest
Income
|
|
Net
(Premium)
Discount
Amortization
|
|
Provision
For
Credit
Losses
|
|
Total
Interest
Income
|
|
Average
Balance
|
|
Interest
Income
|
|
(Premium)
Discount
Amortization
and
Credit
Provision
|
|
Total
Interest
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
loans
|
|
$
|
274,898
|
|
$
|
(22,615
|
)
|
$
|
(3,981
|
)
|
$
|
248,302
|
|
$
|
8,467,008
|
|
|
6.49
|
%
|
|
(0.63
|
)%
|
|
5.86
|
%
|
Commercial
loans
|
|
|
426
|
|
|
47
|
|
|
(2,348
|
)
|
|
(1,875
|
)
|
|
27,010
|
|
|
3.15
|
%
|
|
(17.04
|
)%
|
|
(13.89
|
)%
|
Total
loans
|
|
$
|
275,324
|
|
$
|
(22,568
|
)
|
$
|
(6,329
|
)
|
$
|
246,427
|
|
$
|
8,494,018
|
|
|
6.48
|
%
|
|
(0.68
|
)%
|
|
5.80
|
%
|
(Dollars
in thousands)
|
|
|
|
|
|
Reversal
|
|
|
|
|
|
Six
Months Ended June 30, 2006
Yield
as a Result of
|
|
|
|
Interest
Income
|
|
Net
(Premium)
Discount
Amortization
|
|
of
Provision
For
Credit
Losses
|
|
Total
Interest
Income
|
|
Average
Balance
|
|
Interest
Income
|
|
(Premium)
Discount
Amortization
and Credit
Provision
|
|
Total
Interest
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
loans
|
|
$
|
341,608
|
|
$
|
(24,148
|
)
|
$
|
2,365
|
|
$
|
319,825
|
|
$
|
11,661,054
|
|
|
5.86
|
%
|
|
(0.37
|
)%
|
|
5.49
|
%
|
Commercial
loans
|
|
|
1,966
|
|
|
119
|
|
|
(35
|
)
|
|
2,050
|
|
|
49,807
|
|
|
7.89
|
%
|
|
0.34
|
%
|
|
8.23
|
%
|
Total
loans
|
|
$
|
343,574
|
|
$
|
(24,029
|
)
|
$
|
2,330
|
|
$
|
321,875
|
|
$
|
11,710,861
|
|
|
5.87
|
%
|
|
(0.37
|
)%
|
|
5.50
|
%
|
Residential
Real Estate Loans
Interest
income on residential real estate loans decreased to $119 million and $248
million for the three and six months ended June 30, 2007, respectively, from
$154 million and $320 million for the three and six months ended June 30,
2006, respectively. This was primarily a result of lower average balances of
residential real estate loans. We continue to experience high prepayments (but
at a reduced rate compared to 2006) within our existing portfolio of
LIBOR-indexed ARMs and had a relatively low level of new loan acquisitions.
This
decline in balances was only partially offset by increased yields due to
increases in the short-term interest rates to which most of the residential
real
estate loans are indexed.
Our
residential real estate loan balance was $8.4 billion at June 30, 2007 and
$9.3 billion at December 31, 2006. Of the $8.4 billion
residential loan balance at June 30, 2007, 71% were one- and six-month LIBOR
adjustable-rate residential loans (LIBOR ARMs). The flat yield curve, which
has
been flattening since 2005, has led to fast prepayments on existing LIBOR ARMs
and caused origination volume of new LIBOR ARMs to significantly decline. The
average constant prepayment rate (CPR) for our LIBOR ARMs was 42% in the six
months ended June 30, 2007 and was 46% for all of 2006.
Loan
premium amortization expense was $11 million and $23 million for the three
and six months ended June 30, 2007, respectively, and $12 million and $24
million for the three months and six months ended June 30, 2006 respectively.
On
a percentage basis, loan premium amortization expense for our LIBOR ARMs
continues to lag the decrease in our LIBOR ARM residential loan balance. The
reason for this anomaly relates to the loan premium amortization method we
use
for loans acquired prior to July 2004, which represented 43% of the loan
balance at June 30, 2007. For these loans, the premium amortization rate is
somewhat influenced by prepayments, but is more significantly influenced by
short-term interest rates. As short-term rates increase, premium amortization
slows; as short-term rates decrease, premium amortization potentially
accelerates in a material way. See the Potential for GAAP Earnings Volatility
discussion later in this document. For the remainder of the loans (those
acquired after July 2004), we use a different accounting method for premium
amortization, and as a result, the percentage of amortization is more closely
correlated to prepayment rates regardless of changes in short-term interest
rates.
During
the second quarter of 2007, our provision for credit losses for residential
loans was $2.5 million. On a percentage basis, our credit reserve decreased
slightly to 0.20% of the residential loan balance at June 30, 2007 from 0.22%
at
December 31, 2006. This decrease in the reserve percentage correlates
to a decline in residential loan serious delinquencies which decreased from
0.71% of the current loan balance at December 31, 2006 to 0.67% at June 30,
2007. Delinquencies as a percentage of original balance decreased from
0.21% at December 31, 2006 to 0.20% at June 30, 2007. The percentages shown
above for June 30, 2007 exclude $13 million (of principal) delinquencies on
loans that were transferred during the quarter from the held for investment
to
held-for-sale. The transferred loans are carried at the lower of cost or fair
market value on a loan-by-loan basis. In connection with this transfer the
credit reserve was reduced by $4 million. There were no held-for-sale
residential loans at December 31, 2006.
Commercial
Real Estate Loans
Interest
income on commercial real estate loans decreased by $4 million for the six
months ended June 30, 2007 from the same period last year. The majority of
the
reduction related to fully reserving for an anticipated loss on a mezzanine
commercial loan financing a condominium-conversion project during the first
quarter of 2007. Cost over-runs and changing market conditions make it probable
that we will not collect any outstanding principal or accrued interest upon
completion of the project. The total charge for this loan was $3 million,
of which $2 million related to principal and $1 million to accrued
interest.
Interest
Income - Real Estate Securities
The
tables below present the income and yields of the components of our real estate
securities for the three and six months ended June 30, 2007 and
2006.
Table
7 Real Estate Securities — Interest Income and Yield
(Dollars
in thousands)
|
|
|
|
|
|
|
|
|
|
Yield
as a Result of
|
|
Three
Months Ended June 30, 2007
|
|
Interest
Income
|
|
Discount
Amortization
|
|
Total
Interest
Income
|
|
Average
Balance
|
|
Interest
Income
|
|
Discount
(Premium)
Amortization
|
|
Total
Interest
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment-grade
securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
$
|
33,612
|
|
$
|
2,449
|
|
$
|
36,061
|
|
$
|
2,119,280
|
|
|
6.34
|
%
|
|
0.46
|
%
|
|
6.80
|
%
|
Commercial
|
|
|
1,758
|
|
|
69
|
|
|
1,827
|
|
|
118,231
|
|
|
5.95
|
%
|
|
0.23
|
%
|
|
6.18
|
%
|
CDO
|
|
|
4,575
|
|
|
66
|
|
|
4,641
|
|
|
262,005
|
|
|
6.98
|
%
|
|
0.10
|
%
|
|
7.08
|
%
|
Total
investment-grade
securities
|
|
|
39,945
|
|
|
2,584
|
|
|
42,529
|
|
|
2,499,516
|
|
|
6.39
|
%
|
|
0.41
|
%
|
|
6.80
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit
enhancement securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
|
19,820
|
|
|
21,065
|
|
|
40,885
|
|
|
695,709
|
|
|
11.40
|
%
|
|
12.11
|
%
|
|
23.51
|
%
|
Commercial
|
|
|
10,919
|
|
|
200
|
|
|
11,119
|
|
|
456,039
|
|
|
9.58
|
%
|
|
0.17
|
%
|
|
9.75
|
%
|
CDO
|
|
|
660
|
|
|
—
|
|
|
660
|
|
|
18,365
|
|
|
14.38
|
%
|
|
—
|
|
|
14.38
|
%
|
Total
credit enhancement securities
|
|
|
31,399
|
|
|
21,265
|
|
|
52,664
|
|
|
1,170,113
|
|
|
10.73
|
%
|
|
7.27
|
%
|
|
18.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
real estate securities
|
|
$
|
71,344
|
|
$
|
23,849
|
|
$
|
95,193
|
|
$
|
3,669,629
|
|
|
7.78
|
%
|
|
2.60
|
%
|
|
10.38
|
%
|
|
|
|
|
|
|
|
|
|
|
Yield
as a Result of
|
|
Three
Months Ended June 30, 2006
|
|
Interest
Income
|
|
Discount
(Premium)
Amortization
|
|
Total
Interest
Income
|
|
Average
Balance
|
|
Interest
Income
|
|
Discount
(Premium)
Amortization
|
|
Total
Interest
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment-grade
securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
$
|
20,543
|
|
$
|
1,744
|
|
$
|
22,287
|
|
$
|
1,358,453
|
|
|
6.06
|
%
|
|
0.
51
|
%
|
|
6.57
|
%
|
Commercial
|
|
|
2,077
|
|
|
56
|
|
|
2,133
|
|
|
132,154
|
|
|
6.29
|
%
|
|
0.17
|
%
|
|
6.46
|
%
|
CDO
|
|
|
2,092
|
|
|
7
|
|
|
2,099
|
|
|
171,687
|
|
|
4.87
|
%
|
|
0.02
|
%
|
|
4.89
|
%
|
Total
investment-grade
securities
|
|
|
24,712
|
|
|
1,807
|
|
|
26,519
|
|
|
1,662,294
|
|
|
5.95
|
%
|
|
0.43
|
%
|
|
6.38
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit
enhancement securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
|
16,375
|
|
|
11,684
|
|
|
28,059
|
|
|
573,253
|
|
|
11.43
|
%
|
|
8.15
|
%
|
|
19.58
|
%
|
Commercial
|
|
|
5,838
|
|
|
(257
|
)
|
|
5,581
|
|
|
253,429
|
|
|
9.21
|
%
|
|
(0.40
|
)%
|
|
8.81
|
%
|
CDO
|
|
|
236
|
|
|
—
|
|
|
236
|
|
|
13,950
|
|
|
6.77
|
%
|
|
—
|
|
|
6.77
|
%
|
Total
credit enhancement securities
|
|
|
22,449
|
|
|
11,427
|
|
|
33,876
|
|
|
840,632
|
|
|
10.68
|
%
|
|
5.44
|
%
|
|
16.12
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
real estate securities
|
|
$
|
47,
161
|
|
$
|
13,234
|
|
$
|
60,395
|
|
$
|
2,502,926
|
|
|
7.54
|
%
|
|
2.11
|
%
|
|
9.65
|
%
|
|
|
|
|
|
|
|
|
|
|
Yield
as a Result of
|
|
Six
Months Ended June 30, 2007
|
|
Interest
Income
|
|
Discount
Amortization
|
|
Total
Interest
Income
|
|
Average
Balance
|
|
Interest
Income
|
|
Discount
(Premium)
Amortization
|
|
Total
Interest
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment-grade
securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
$
|
61,711
|
|
$
|
3,770
|
|
$
|
65,481
|
|
$
|
1,958,101
|
|
|
6.30
|
%
|
|
0.39
|
%
|
|
6.69
|
%
|
Commercial
|
|
|
3,565
|
|
|
136
|
|
|
3,701
|
|
|
120,154
|
|
|
5.93
|
%
|
|
0.23
|
%
|
|
6.16
|
%
|
CDO
|
|
|
8,441
|
|
|
62
|
|
|
8,503
|
|
|
246,431
|
|
|
6.85
|
%
|
|
0.05
|
%
|
|
6.90
|
%
|
Total
investment-grade
securities
|
|
|
73,717
|
|
|
3,968
|
|
|
77,685
|
|
|
2,324,686
|
|
|
6.34
|
%
|
|
0.34
|
%
|
|
6.68
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit
enhancement securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
|
38,592
|
|
|
39,957
|
|
|
78,549
|
|
|
684,474
|
|
|
11.28
|
%
|
|
11.67
|
%
|
|
22.95
|
%
|
Commercial
|
|
|
21,068
|
|
|
191
|
|
|
21,259
|
|
|
441,163
|
|
|
9.55
|
%
|
|
0.09
|
%
|
|
9.64
|
%
|
CDO
|
|
|
1,158
|
|
|
—
|
|
|
1,158
|
|
|
18,357
|
|
|
12.62
|
%
|
|
—
|
|
|
12.62
|
%
|
Total
credit enhancement securities
|
|
|
60,818
|
|
|
40,148
|
|
|
100,966
|
|
|
1,143,994
|
|
|
10.63
|
%
|
|
7.02
|
%
|
|
17.65
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
real estate securities
|
|
$
|
134,535
|
|
$
|
44,116
|
|
$
|
178,651
|
|
$
|
3,468,680
|
|
|
7.76
|
%
|
|
2.54
|
%
|
|
10.30
|
%
|
|
|
|
|
|
|
|
|
|
|
Yield
as a Result of
|
|
Six
Months Ended June 30, 2006
|
|
Interest
Income
|
|
Discount
(Premium)
Amortization
|
|
Total
Interest
Income
|
|
Average
Balance
|
|
Interest
Income
|
|
Discount
(Premium)
Amortization
|
|
Total
Interest
Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment-grade
securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
$
|
39,317
|
|
$
|
3,150
|
|
$
|
42,467
|
|
$
|
1,329,514
|
|
|
5.92
|
%
|
|
0.47
|
%
|
|
6.39
|
%
|
Commercial
|
|
|
4,952
|
|
|
61
|
|
|
5,013
|
|
|
156,852
|
|
|
6.31
|
%
|
|
0.08
|
%
|
|
6.39
|
%
|
CDO
|
|
|
4,575
|
|
|
15
|
|
|
4,590
|
|
|
164,629
|
|
|
5.56
|
%
|
|
0.02
|
%
|
|
5.58
|
%
|
Total
investment-grade
securities
|
|
|
48,844
|
|
|
3,226
|
|
|
52,070
|
|
|
1,650,995
|
|
|
5.92
|
%
|
|
0.39
|
%
|
|
6.31
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit
enhancement securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
|
30,228
|
|
|
24,075
|
|
|
54,303
|
|
|
545,107
|
|
|
11.09
|
%
|
|
8.83
|
%
|
|
19.92
|
%
|
Commercial
|
|
|
10,670
|
|
|
(821
|
)
|
|
9,849
|
|
|
234,599
|
|
|
9.10
|
%
|
|
(0.70
|
)%
|
|
8.40
|
%
|
CDO
|
|
|
675
|
|
|
—
|
|
|
675
|
|
|
14,330
|
|
|
9.42
|
%
|
|
—
|
|
|
9.42
|
%
|
Total
credit enhancement securities
|
|
|
41,573
|
|
|
23,254
|
|
|
64,827
|
|
|
794,036
|
|
|
10.47
|
%
|
|
5.86
|
%
|
|
16.33
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
real estate securities
|
|
$
|
90,417
|
|
$
|
26,480
|
|
$
|
116,897
|
|
$
|
2,445,031
|
|
|
7.40
|
%
|
|
2.16
|
%
|
|
9.56
|
%
|
Investment-Grade
Securities
Interest
income from IGS increased to $43 million in the three months ended June 30,
2007 as compared to $27 million for the three months ended June 30, 2006, due
primarily to portfolio growth and an increase in yields. The year on year
changes for the six month periods follow the same trend. The majority of the
IGS
acquired over the past year were residential, in part because comparably rated
commercial securities traded at relatively higher prices and lower yields.
The
increase in yield is generally reflective of the strong credit and favorable
prepayment performance on our investment-grade securities.
Residential
Credit-Enhancement Securities
We
acquire many first-loss securities at 25% to 35% of their principal value and
other, more senior, credit-enhancement securities at 50% to 100% of their
principal value. Many of these securities are priced at a substantial discount
to their principal value since future credit losses could reduce or eliminate
the principal value of these securities. Our yields on these investments depend
on how much principal and interest we eventually collect and how quickly we
receive those payments. The faster we collect principal and the longer it takes
to realize credit losses, the better it is for our investment
returns.
Interest
income from our residential CES was $41 million for the three months ended
June 30, 2007, a $13 million increase over the same period in 2006. This
increase is the result of higher yields (24% for the second quarter of 2007
vs.
20% for the second quarter of 2006) and a 21% higher average balance. Higher
yields resulted from the strong credit performance and faster than anticipated
prepayment rates on adjustable rate mortgages (ARMs). ARMs represented 60%
of
our residential CES portfolio at June 30, 2007, and average actual prepayment
rates were in excess of 46% in the second quarter of 2007 compared to our
initial expectations (at the time of acquisition) of 20% to 25%. Portfolio
growth reflected our ability to find new assets at a pace in excess of our
sales, calls, and principal payments.
We
own
residential real estate securities that are backed by option ARMs, which give
the borrower the option of making a minimum payment that is less than the amount
of interest owed for that loan period. The unpaid interest is added to the
loan
balance creating negative amortization (neg am). The amount of neg am interest
we currently recognize or defer for GAAP purposes on option ARMs securities
depends on our expectation of collectibility. We currently expect that
accumulated neg am interest for securities rated BB and higher will be paid
in
full. In both the second quarter of 2007 and 2006, we recognized $1 million
of neg am interest on securities rated BB and higher. During these time periods,
we deferred recognition of neg am interest of $1.0 million and
$0.9 million, respectively, on our unrated and B-rated securities. For
these securities we do not currently expect to collect the neg am interest
and
will recognize this deferred interest if cash is received. Our cumulative
deferred neg am interest is $7.0 million at June 30, 2007. We will continue
to monitor and assess these assumptions.
Commercial
Credit-Enhancement Securities
Interest
income from our commercial CES was $11 million for the second quarter of
2007, a $6 million increase over the same period in 2006. This increase is
primarily the result of a higher average balances. Interest income for the
six
months ended June 30, 2007 was a $11 million increase over the same period
in
2006 for similar reasons.
The
average yield earned on our commercial CES portfolio for the second quarter
of
2007 was 9.75%. The yield was low relative to our other CES due to our credit
loss assumptions. Similar to residential, commercial CES are acquired at a
net
discount. Commercial CES generally have a ten year maturity and are not expected
to receive principal prepayments prior to maturity. As a result, it will take
several years to further observe credit performance and re-assess our loss
assumptions. A decrease in loss assumptions would result in higher yields (an
increase in discount amortization) while increased loss assumptions would lead
to lower yields or impairments.
Interest
Income - Other Real Estate Investments
The
table
below presents the interest income, average balances, and yield on our other
real estate investments for the three and six months ended June 30, 2007. We
did
not hold other real estate investments for the three and six months ended June
30, 2006.
Table
8 Other Real Estate Investments - Interest Income and
Yield
(In
thousands)
|
|
Interest
Income
|
|
Average
Balance
|
|
Yield
as a Result
of
Interest Income
|
|
|
|
|
|
|
|
|
|
Three
months ended June 30, 2007
|
|
$
|
669
|
|
$
|
44,061
|
|
|
6.07
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Six
months ended June 30, 2007
|
|
$
|
3,134
|
|
$
|
40,634
|
|
|
15.43
|
%
|
Other
real estate assets consist of residential IOs, NIMs, and residuals. In prior
periods, these assets were included in real estate securities. The majority
of
the interest income was from residuals we purchased in the first half of 2007.
Since we account for these assets as trading assets, the yield on other real
estate investments should be considered in conjunction with the market valuation
adjustments recognized through the income statement on these assets during
the
first half of 2007, as discussed further later in this document.
Interest
Income - Cash and Cash Equivalents
Interest
income from cash and cash equivalents was $4 million and $3 million for the
three months ended June 30, 2007 and 2006, respectively and $6 million and
$5
million for the six months ended June 30, 2007, respectively. Average cash
balances and yields were marginally higher for 2007 as compared to the periods
for 2006.
Interest
Expense
Interest
expense consists of interest payments on consolidated ABS issued from sponsored
securitization entities, Redwood debt, and subordinated notes.
The
table
below presents our interest expense and balances for these components for the
three and six months ended June 30, 2007 and 2006.
Table
9 Total Interest Expense
|
|
Three
Months Ended
June
30,
|
|
(Dollars
in thousands)
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
Interest
expense on consolidated ABS issued
|
|
$
|
140,541
|
|
$
|
171,697
|
|
Interest
expense on Redwood debt
|
|
|
22,700
|
|
|
1,822
|
|
Interest
expense on subordinated notes
|
|
|
2,516
|
|
|
—
|
|
Total
interest expense on total obligations
|
|
$
|
165,757
|
|
$
|
173,519
|
|
|
|
|
|
|
|
|
|
Average
balance of ABS issued
|
|
$
|
9,946,274
|
|
$
|
12,969,801
|
|
Average
balance of Redwood debt
|
|
|
1,515,988
|
|
|
85,616
|
|
Average
balance of subordinated notes
|
|
|
117,934
|
|
|
—
|
|
Average
total obligations
|
|
$
|
11,580,196
|
|
$
|
13,055,417
|
|
|
|
|
|
|
|
|
|
Cost
of funds of ABS issued
|
|
|
5.65
|
%
|
|
5.30
|
%
|
Cost
of funds of Redwood debt
|
|
|
5.99
|
%
|
|
8.51
|
%
|
Cost
of funds of subordinated notes
|
|
|
8.53
|
%
|
|
—
|
|
Total
cost of funds of obligations
|
|
|
5.73
|
%
|
|
5.32
|
%
|
|
|
Six
Months Ended
June
30,
|
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
Interest
expense on consolidated ABS issued
|
|
$
|
275,487
|
|
$
|
350,280
|
|
Interest
expense on Redwood debt
|
|
|
53,794
|
|
|
3,894
|
|
Interest
expense on subordinated notes
|
|
|
4,572
|
|
|
—
|
|
Total
interest expense on total obligations
|
|
$
|
333,853
|
|
$
|
354,174
|
|
|
|
|
|
|
|
|
|
Average
balance of ABS issued
|
|
$
|
9,646,104
|
|
$
|
13,811,790
|
|
Average
balance of Redwood debt
|
|
|
1,850,144
|
|
|
111,256
|
|
Average
balance of subordinated notes
|
|
|
107,531
|
|
|
—
|
|
Average
total obligations
|
|
$
|
11,603,779
|
|
$
|
13,923,046
|
|
|
|
|
|
|
|
|
|
Cost
of funds of ABS issued
|
|
|
5.71
|
%
|
|
5.07
|
%
|
Cost
of funds of Redwood debt
|
|
|
5.82
|
%
|
|
7.00
|
%
|
Cost
of funds of subordinated notes
|
|
|
8.50
|
%
|
|
—
|
|
Total
cost of funds of obligations
|
|
|
5.75
|
%
|
|
5.09
|
%
|
Total
consolidated interest expense decreased to $166 million in the second
quarter of 2007 from $174 million in the second quarter of 2006. The
primary reason relates to a decline in interest expense on ABS issued, which
was
partially offset by higher interest on Redwood debt and subordinated debt.
Interest
expense on consolidated ABS decreased by $31 million in the second quarter
of
2007 from $172 million in the second quarter of 2006. The reduction in
consolidated ABS interest expense was caused by a significant decline in the
average balance of outstanding consolidated ABS issued (23%) as a result of
rapid prepayments of the loans within these securitization entities. Offsetting
some of the decline in balances was the 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-months LIBOR. These factors are illustrated
in
the volume and rate change table below.
The
increase in Redwood debt interest expense of $21 million in the second quarter
of 2007 compared to the same period last year was the result of increased use
of
Redwood debt to fund loans and securities. The average balance of our
outstanding Redwood debt during the first half of 2007 increased by
$1.7 billion over the same period last year. Of this increase,
$1.1 billion represented financing for the acquisition of residential real
estate loans (in part, from calling our older Sequoia loan securitizations)
and
$0.6 billion related to the financing for the acquisition of real estate
securities.
Our
subordinated notes (issued December 2006 and May 2007) accrue interest
expense at three month LIBOR plus 225 basis points (2.25%). The cost of funds
on
these notes includes the amortization of deal costs.
Total
consolidated interest expense decreased to $334 million in the first six
months of 2007 from $354 million in the first six months of 2006 for the
same reasons as previously discussed for the second quarter of 2007. Interest
expense on consolidated ABS decreased by $75 million in the first six months
of
2007 as compared to the first six months of 2006. This decline was partially
offset by a $50 million increase in interest expense on Redwood debt. There
was
also a $5 million increase for interest expense on subordinated
notes.
The
table
below illustrates the factors for the reduction in consolidated ABS interest
expense.
Table
10 Volume and Rate Changes for Interest Expense
|
|
Change
in Interest Expense
Three
Months Ended
June
30, 2007 vs. June 30, 2006
|
|
(In
thousands)
|
|
|
Volume
|
|
|
Rate
|
|
|
Total
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense on
ABS
|
|
$
|
(40,026
|
)
|
$
|
8,870
|
|
$
|
(31,156
|
)
|
Interest
expense on Redwood debt
|
|
|
30,440
|
|
|
(9,562
|
)
|
|
20,878
|
|
Interest
expense on subordinated notes
|
|
|
2,516
|
|
|
—
|
|
|
2,516
|
|
Total
interest expense on total obligations
|
|
$
|
(7,070
|
)
|
$
|
(692
|
)
|
$
|
(7,762
|
)
|
|
|
Change
in Interest Expense
Six
Months Ended
June
30, 2007 vs. June 30, 2006
|
|
(In
thousands)
|
|
Volume
|
|
Rate
|
|
Total
Change
|
|
|
|
|
|
|
|
|
|
Interest
expense on
ABS
|
|
$
|
(105,646
|
)
|
$
|
30,853
|
|
$
|
(74,793
|
)
|
Interest
expense on Redwood debt
|
|
|
60,862
|
|
|
(10,962
|
)
|
|
49,900
|
|
Interest
expense on subordinated notes
|
|
|
4,572
|
|
|
—
|
|
|
4,572
|
|
Total
interest expense on total obligations
|
|
$
|
(40,212
|
)
|
$
|
19,891
|
|
$
|
(20,321
|
)
|
Note:
Volume change is the change in average balance of obligations between periods
multiplied by the rate paid in the earlier period. Rate change is the change
in
rate between periods multiplied by the average outstanding obligations in the
current period. Interest expense changes that resulted from changes in both
rate
and volume were allocated to the rate change amounts shown in the
table.
The
table
below presents the different components of our interest costs on ABS issued
for
the three and six months ended June 30, 2007 and 2006. ABS issuance premiums
are
created when ABS are issued at prices greater than principal value, such as
interest-only (IO) securities.
Table
11 Cost of Funds of Asset-Backed Securities Issued
|
|
Three
Months Ended
June
30,
|
|
(Dollars
in thousands)
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
ABS
issued interest
expense
|
|
$
|
140,512
|
|
$
|
171,659
|
|
ABS
issued issuance expense amortization
|
|
|
5,681
|
|
|
6,079
|
|
Net
ABS issued interest rate agreement income
|
|
|
(3,358
|
)
|
|
(3,678
|
)
|
Net
ABS issued issuance premium income amortization
|
|
|
(2,294
|
)
|
|
(2,363
|
)
|
Total
ABS issued interest expense
|
|
$
|
140,541
|
|
$
|
171,697
|
|
|
|
|
|
|
|
|
|
Average
balance of ABS issued
|
|
$
|
9,946,274
|
|
$
|
12,969,801
|
|
|
|
|
|
|
|
|
|
ABS
issued interest expense
|
|
|
5.65
|
%
|
|
5.29
|
%
|
ABS
issued issuance expense amortization
|
|
|
0.23
|
%
|
|
0.19
|
%
|
Net
ABS issued interest rate agreement income
|
|
|
(0.14
|
)%
|
|
(0.11
|
)%
|
Net
ABS issued issuance premium income amortization
|
|
|
(0.09
|
)%
|
|
(0.07
|
)%
|
Cost
of funds of ABS issued
|
|
|
5.65
|
%
|
|
5.30
|
%
|
|
|
Six
Months Ended
June
30,
|
|
(Dollars
in thousands)
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
ABS
issued interest
expense
|
|
$
|
271,905
|
|
$
|
349,841
|
|
ABS
issued issuance expense amortization
|
|
|
12,749
|
|
|
11,986
|
|
Net
ABS issued interest rate agreement income
|
|
|
(5,004
|
)
|
|
(6,658
|
)
|
Net
ABS issued issuance premium income amortization on ABS
issue
|
|
|
(4,163
|
)
|
|
(4,889
|
)
|
Total
ABS issued interest expense
|
|
$
|
275,487
|
|
$
|
350,280
|
|
|
|
|
|
|
|
|
|
Average
balance of ABS issued
|
|
$
|
9,646,104
|
|
$
|
13,811,790
|
|
|
|
|
|
|
|
|
|
ABS
issued interest expense
|
|
|
5.64
|
%
|
|
5.07
|
%
|
ABS
issued issuance expense amortization
|
|
|
0.26
|
%
|
|
0.17
|
%
|
Net
ABS issued interest rate agreement income
|
|
|
(0.10
|
)%
|
|
(0.10
|
)%
|
Net
ABS issued issuance premium income amortization
|
|
|
(0.09
|
)%
|
|
(0.07
|
)%
|
Cost
of funds of ABS issued
|
|
|
5.71
|
%
|
|
5.07
|
%
|
Operating
Expenses
Components
of our operating expenses for the three and six months ended June 30, 2007
and
2006 are presented in the table below.
Table
12 Operating Expenses
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
2007 |
|
2006 |
|
|
|
|
|
|
|
|
|
|
|
Fixed
compensation expense
|
|
$
|
4,286
|
|
$
|
3,311
|
|
$
|
8,902
|
|
$
|
6,746
|
|
Variable
compensation expense
|
|
|
198
|
|
|
1,900
|
|
|
2,449
|
|
|
3,414
|
|
Equity
compensation expense
|
|
|
3,540
|
|
|
2,991
|
|
|
6,888
|
|
|
5,686
|
|
Severance
expense
|
|
|
—
|
|
|
—
|
|
|
2,380
|
|
|
—
|
|
Total
compensation expense
|
|
|
8,024
|
|
|
8,202
|
|
|
20,619
|
|
|
15,846
|
|
Systems
|
|
|
2,163
|
|
|
2,130
|
|
|
3,819
|
|
|
3,556
|
|
Due
diligence
|
|
|
78
|
|
|
2,687
|
|
|
785
|
|
|
3,119
|
|
Office
costs
|
|
|
1,265
|
|
|
1,156
|
|
|
2,445
|
|
|
2,191
|
|
Accounting
and legal
|
|
|
284
|
|
|
944
|
|
|
1,139
|
|
|
2,277
|
|
Other
operating expenses
|
|
|
958
|
|
|
918
|
|
|
1,747
|
|
|
1,630
|
|
Total
operating expenses
|
|
$
|
12,772
|
|
$
|
16,037
|
|
$
|
30,554
|
|
$
|
28,619
|
|
Fixed
compensation expense includes employee salaries and related employee benefits.
Variable compensation expense includes employee bonuses which are based on
the
annual projected adjusted return on equity earned by Redwood and individual
performance. Equity compensation expense primarily includes the expense of
equity awards granted to employees and directors.
Due
diligence expenses are costs for services related to re-underwriting and
analyzing the loans we acquire or the loans we credit-enhance through the
purchase of securities. These costs fluctuate from period to period as a
function of the level and type of asset acquisitions.
Total
operating expenses of $12.8 million for the three months ended June 30, 2007
decreased by $3.3 million as compared to the same period in 2006. This was
primarily due to reduced due diligence expenses as a result of lower commercial
CES acquisition activity. Overall, compensation expense for comparable three
month periods was relatively flat as the increase in fixed compensation due
to
high staffing levels in 2007 (from 87 employees at June 30, 2006 to 104
employees at June 30, 2007) and higher equity compensation was offset by lower
variable compensation related to a decrease in projected bonuses for 2007
compared to 2006. Accounting and legal expenses for the three and six months
ended June 30, 2007, respectively, decreased due to a reduction in accrued
independent accountant fees.
Total
operating expenses of $30.6 million for the six months ended June 30, 2007
increased by $1.9 million as compared to the same periods in 2006. This
primarily represents an increase in compensation expense which was partially
offset by reduced due diligence expenses from lower commercial CES acquisition
activity. Compensation expense for the six months ended June 30, 2007 includes
severance charges recorded in the first quarter of 2007 as part of a
re-alignment of our commercial operations.
Realized
Gains on Sales and Calls
Total
realized gains on sales and calls were lower for the three and six months ended
June 30, 2007 compared to the same period for 2006. The primary reason for
the
decrease was lower gains on the sale of securities and interest rate agreements.
The number of calls of Acacia CDOs in the first six months of 2007 was
comparable to 2006. The gains on the sale of securities were higher due to
more
favorable market conditions in the 2006 periods. At the time of call and
resulting payoff of the Acacia ABS issued, the interest rate agreements hedging
the ABS were sold.
The
table
below provides detail of the net realized gains on sales and calls for the
three
and six months ended June 30, 2007 and 2006.
Table
13 Realized Gains on Sales and Calls, Net
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Realized
gains (losses) on sales of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real
estate loans
|
|
$
|
(34
|
) |
$
|
(14
|
)
|
$
|
(34
|
)
|
$
|
(14
|
)
|
Real
estate securities
|
|
|
1,462
|
|
|
2,041
|
|
|
678
|
|
|
3,103
|
|
Interest
rate agreements
|
|
|
—
|
|
|
6,214
|
|
|
1,087
|
|
|
6,214
|
|
Gains
on sales
|
|
|
1,428
|
|
|
8,241
|
|
|
1,731
|
|
|
9,303
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains
on calls of residential CES
|
|
|
1,310
|
|
|
747
|
|
|
2,153
|
|
|
747
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
realized gains on sales and calls
|
|
$
|
2,738
|
|
$
|
8,988
|
|
$
|
3,884
|
|
$
|
10,050
|
|
Market
Valuation Adjustments
Valuation
adjustments reflect those changes in fair market values of assets that we
recognize through our income statement. These include changes in the fair market
value of our trading instruments (other real estate investments, non-real estate
investments, credit default swaps, and certain interest rate agreements), the
write-downs of assets that are impaired under the provisions of EITF 99-20,
and
the change in the value of our commitments.
The
table
below provides the components of valuation adjustments for the three and six
months ended June 30, 2007 and 2006. Other than certain interest rate
agreements, we did not have any assets accounted for as trading securities
in
2006.
Table
14 Market Valuation Adjustments, Net
|
|
Three
Months Ended
June
30,
|
|
Six
Months Ended
June
30,
|
|
(In
thousands)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Changes
in fair market value of trading instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
real estate investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residuals
|
|
$
|
(5,296
|
)
|
$
|
—
|
|
$
|
(10,860
|
)
|
$
|
—
|
|
NIMs
|
|
|
(1,142
|
)
|
|
—
|
|
|
(1,297
|
)
|
|
—
|
|
IOs
|
|
|
192
|
|
|
—
|
|
|
571
|
|
|
—
|
|
Total
other real estate investments
|
|
|
(6,246
|
)
|
|
—
|
|
|
(11,586
|
)
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
financial instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit
default swaps
|
|
|
(1,379
|
)
|
|
—
|
|
|
(3,905
|
)
|
|
—
|
|
Interest
rate agreements
|
|
|
1,740
|
|
|
2,948
|
|
|
893
|
|
|
3,244
|
|
Total
derivative financial instruments
|
|
|
361
|
|
|
2,948
|
|
|
(3,012
|
)
|
|
3,244
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
change in fair market value of trading instruments
|
|
|
(5,885
|
)
|
|
2,948
|
|
|
(14,598
|
)
|
|
3,244
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Write-downs
to fair market value under EITF 99-20
|
|
|
(19,236
|
)
|
|
(2,307
|
)
|
|
(21,623
|
)
|
|
(5,535
|
)
|
Other
write-downs on AFS securities
|
|
|
(2,427
|
)
|
|
—
|
|
|
(2,427
|
)
|
|
—
|
|
Change
in value of purchase commitments
|
|
|
(1,882
|
)
|
|
(3,636
|
)
|
|
(1,046
|
)
|
|
(3,636
|
)
|
Total
market value adjustments
|
|
$
|
(29,430
|
)
|
$
|
(2,995
|
)
|
$
|
(39,694
|
)
|
$
|
(5,927
|
)
|
Our
portfolio of other real estate investments (OREI) accounted for as trading
securities was $34 million at June 30, 2007. We did not hold other real estate
investments accounted for as trading securities at December 31, 2006. Due to
the
implementation of a new accounting standard, Statement of Financial Accounting
Standards No. 155,
Accounting for Certain Hybrid Financial Investments
(FAS
155) in the first quarter of 2007, we elected at the end of the first quarter
to
classify certain securities (IOs, NIMs and residuals) that contain embedded
derivatives as trading instruments. Under previous GAAP guidance, we would
have
classified these securities as available for sale (AFS). The fair market value
of these OREI together with our investments in credit default swaps declined
during the second quarter as spreads widened considerably as a result of the
dislocation of the residential mortgage-backed securities market. We did not
own
any OREI or credit default swaps at December 31, 2006.
Impairments
for accounting purposes on our real estate securities are generally caused
by an
adverse change in projected cash flows in conjunction with a decrease in the
fair market value. We recorded $19.2 million of impairment on AFS securities
in
the second quarter of 2007 as we believed that, in addition to the fair market
value decrease due to the spread widening described above, the actual future
cash flows on those securities were impaired. We recorded an additional $2.4
million of write-downs for AFS securities in an unrealized loss position as
we
did not have the intent to hold the securities for a long enough future time
period to recover these losses.
The
fair
market value changes of those interest rate agreements accounted for as trading
increased by $0.4 million during the second quarter of 2007. All changes in
fair
market value, whether positive or negative, of these particular interest rate
agreements are recognized through the income statement. We use interest rate
agreements to manage our interest rate risks, and the changes in the fair market
value of the hedged asset or liability are not included in the valuation
adjustment. Consequently, our use of interest rate agreements accounted for
as
trading instruments, could lead to volatile reported earnings even when they
are
accomplishing the goal of hedging some of our interest rate risks.
Changes
in fair market values of our loan purchase commitments are also reflected
through our income statement (negative $1.9 million during the second quarter
of
2007). We commit to purchase certain loans and generally do not take possession
of the loans for up to a month. During that time, the value of the loan may
change from our commitment purchase price and the resulting change in value
is
recognized through our income statement.
Other
Comprehensive Income (Loss)
Most
of
our real estate securities are accounted for as AFS and are reported on our
consolidated balance sheets at fair market value. Many of our derivative
instruments are accounted for as cash flow hedges and are also reported on
our
consolidated balance sheets at fair market value. The differences between the
value of these assets and our amortized cost are shown as a component of
stockholders’ equity as accumulated other comprehensive income (loss). Periodic
changes in the fair market value of these assets relative to amortized cost
are
included in other comprehensive income (loss).
As
a
result of the spread widening on real estate securities that occurred during
the
first half of 2007, the fair market value adjustments on AFS assets decreased
by
$95 million and $188 million for the three and six months ended June 30, 2007,
respectively. This decrease was partially offset by an increase in value of
our
derivatives financial instruments of $19 million and $13 million for the three
and six months ended June 30, 2007.
The
table
below provides the change during the three months ended June 30, 2007 and
cumulative balances of unrealized gains and losses and carrying value by type
of
real estate securities and by IGS and CES at June 30, 207, March 31, 2007,
and
December 31, 2006.
Table
15 Other Comprehensive Income (Loss) - Real Estate
Securities
|
|
Cumulative
Unrealized Gain (Loss)
|
|
Change
in Unrealized
Gain
(Loss)
|
|
Carrying
Value
|
|
(Dollars
in thousands)
|
|
June
30,
2007
|
|
March
31, 2007
|
|
December
31, 2006
|
|
Three
Month Change June 30, 2007
|
|
Six
Month
Change
June
30, 2007
|
|
June
30, 2007
|
|
March
31,
2007
|
|
December
31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment-Grade
Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
$
|
(81,571
|
)
|
$
|
(49,027
|
)
|
$
|
5,025
|
|
$
|
(32,544
|
)
|
$
|
(86,596
|
)
|
$
|
2,162,946
|
|
$
|
2,025,850
|
|
$
|
1,697,250
|
|
Commercial
|
|
|
(6,884
|
)
|
|
(2,071
|
)
|
|
111
|
|
|
(4,813
|
)
|
|
(6,995
|
)
|
|
111,144
|
|
|
116,494
|
|
|
119,613
|
|
CDO
|
|
|
(21,152
|
)
|
|
(7,985
|
)
|
|
2,174
|
|
|
(13,167
|
)
|
|
(23,326
|
)
|
|
234,633
|
|
|
254,307
|
|
|
224,349
|
|
Total
IGS
|
|
|
(109,607
|
)
|
|
(59,083
|
)
|
|
7,310
|
|
|
(50,524
|
)
|
|
(116,917
|
)
|
|
2,508,723
|
|
|
2,396,651
|
|
|
2,041,212
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit-Enhancement
Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential
|
|
|
32,806
|
|
|
44,263
|
|
|
58,015
|
|
|
(11,457
|
)
|
|
(25,209
|
)
|
|
744,975
|
|
|
752,277
|
|
|
721,531
|
|
Commercial
|
|
|
(23,955
|
)
|
|
9,063
|
|
|
21,081
|
|
|
(33,018
|
)
|
|
(45,036
|
)
|
|
450,941
|
|
|
435,382
|
|
|
448,060
|
|
CDO
|
|
|
(293
|
)
|
|
(575
|
)
|
|
122
|
|
|
282
|
|
|
(415
|
)
|
|
21,133
|
|
|
16,152
|
|
|
21,964
|
|
Total
CES
|
|
|
8,558
|
|
|
52,751
|
|
|
79,218
|
|
|
(44,193
|
)
|
|
(70,660
|
)
|
|
1,217,049
|
|
|
1,203,811
|
|
|
1,191,555
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
real estate securities
|
|
|
(101,049
|
)
|
|
(6,332
|
)
|
$
|
86,528
|
|
$
|
(94,717
|
)
|
$
|
(187,577
|
)
|
$
|
3,725,772
|
|
$
|
3,600,462
|
|
$
|
3,232,767
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tax
effect of unrealized losses
|
|
|
|
|
|
|
|
|
|
|
|
30
|
|
|
92
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
other comprehensive income real estate securities
|
|
|
|
|
|
|
|
|
|
|
$
|
(94,687
|
)
|
$
|
(187,485
|
)
|
|
|
|
|
|
|
|
|
|
Taxes
Provisions
for Income Taxes
As
a
REIT, we are able to pass through substantially all of our earnings generated
at
our REIT to stockholders without paying income tax at the corporate level.
We
pay income tax on the REIT taxable income we choose to retain and on the income
we earn at our taxable subsidiaries.
Our
income tax provision in the first half of 2007 was $5 million, a decrease from
the $6 million income tax provision recorded for the same period in 2006,
primarily due to a decline in net income.
Taxable
Income and Dividends
In
the
first half of 2007, we earned an estimated $86 million of total taxable income,
or $3.14 per share outstanding. Of this amount, $80 million was earned at the
REIT and $6 million was earned at our taxable subsidiaries. Total taxable income
is not a measure calculated in accordance with GAAP; it is the pre-tax income
calculated for tax purposes. REIT taxable income is that portion of our taxable
income that we earn at Redwood Trust and its qualifying REIT subsidiaries and
does not include taxable income earned in taxable subsidiaries. Estimated REIT
taxable income is an important measure as it is the basis of our required
dividend distributions to shareholders.
Taxable
income calculations differ from GAAP income calculations in a variety of ways.
The most significant differences include the timing of amortization of premium
and discounts and the timing of the recognition of gains or losses on assets.
The rules for both GAAP and tax accounting for loans and securities are
technical and complicated, and the impact of changing interest rates, actual
and
projected prepayment rates, and actual and projected credit losses can have
a
very different impact on the amount of GAAP and tax income recognized in any
one
period. See the discussions under Potential GAAP Earnings Volatility and
Potential Tax Earnings Volatility below.
The
table
below reconciles GAAP income to total taxable income for the three and six
months ended June 30, 2007 and 2006.
Table
16 Differences Between GAAP Net Income and Total Taxable
Income
(In
thousands, except per share data)
|
|
Three
Months Ended
June
30, 2007
|
|
Three
Months Ended
June
30, 2006
|
|
|
|
|
|
|
|
GAAP
net
income
|
|
$
|
11,416
|
|
$
|
31,410
|
|
Difference
in taxable income calculations
|
|
|
|
|
|
|
|
Amortization
and credit losses
|
|
|
10,298
|
|
|
12,779
|
|
Operating
expense differences
|
|
|
(2,921
|
)
|
|
(288
|
)
|
Realized
gains on calls and sales
|
|
|
(4,735
|
)
|
|
(699
|
)
|
Unrealized
market valuation adjustments
|
|
|
30,576
|
|
|
2,305
|
|
Income
tax provisions
|
|
|
1,662
|
|
|
3,265
|
|
Total
differences in GAAP/tax income
|
|
|
34,880
|
|
|
17,362
|
|
Taxable
income
|
|
$
|
46,296
|
|
$
|
48,772
|
|
|
|
|
|
|
|
|
|
Shares
used for taxable EPS calculations
|
|
|
27,816
|
|
|
25,668
|
|
Total
taxable income per share
|
|
$
|
1.66
|
|
$
|
1.91
|
|
(In
thousands, except per share data)
|
|
Six
Months Ended
June
30, 2007
|
|
Six
Months Ended
June
30, 2006
|
|
|
|
|
|
|
|
GAAP
net
income
|
|
$
|
29,725
|
|
$
|
59,425
|
|
Difference
in taxable income calculations
|
|
|
|
|
|
|
|
Amortization
and credit losses (net interest income)
|
|
|
20,715
|
|
|
17,718
|
|
Operating
expense differences
|
|
|
(4,634
|
)
|
|
1,316
|
|
Realized
gains on calls and sales
|
|
|
(2,635
|
)
|
|
(1,312
|
)
|
Unrealized
market valuation adjustments
|
|
|
39,694
|
|
|
5,531
|
|
Income
tax provisions
|
|
|
3,462
|
|
|
2,562
|
|
Total
differences in GAAP/tax income
|
|
|
56,602
|
|
|
25,815
|
|
Taxable
income
|
|
$
|
86,327
|
|
$
|
85,240
|
|
|
|
|
|
|
|
|
|
Shares
used for taxable EPS calculations
|
|
|
27,816
|
|
|
25,668
|
|
Total
taxable income per share
|
|
$
|
3.14
|
|
$
|
3.35
|
|
Our
taxable income estimates are based on a number of assumptions regarding future
events. To the extent such events do not occur, or others occur which we have
not anticipated, our quarterly estimates could change and could be significantly
different quarter over quarter. See the discussion in Potential Tax Income
Volatility below.
Our
board
of directors declared regular dividends of $0.75 per share for the first and
second quarters of 2007. In 2007, as in the past few years, we intend to
permanently retain 10% of our taxable REIT income and defer the distribution
of
a portion of our taxable REIT income to shareholders in the subsequent year.
At
June 30, 2007, there was $80 million ($2.86 per share) of estimated 2006 and
2007 undistributed REIT taxable income that we plan to distribute to our
shareholders during the remainder of 2007 and the first three quarters of
2008.
We
continue to be in compliance with all REIT tests. We generally attempt to avoid
acquiring assets or structuring financings or sales at the REIT that could
generate unrelated business taxable income or excess inclusion income that
would
be distributed to our shareholders or that would cause prohibited transaction
taxes on the REIT. There can be no assurance that we will be successful in
doing
so.
Potential
GAAP Earnings Volatility
We
expect
quarter-to-quarter GAAP earnings volatility for a variety of reasons, including
the timing of sales and calls of assets, changes in interest rates, prepayments,
credit losses, fair market values of assets, and capital utilization. In
addition, volatility may occur because of technical accounting issues, some
of
which are described below.
Loan
Premium
Our
unamortized loan premium on our consolidated residential real estate loans
at
June 30, 2007 was $102 million. This will be expensed over the remaining life
of
these loans. Amortization for a significant portion of this premium balance
is
driven by effective yield calculations that depend on interest rates and
prepayments (see Critical Accounting Policies for further details). Loan premium
amortization was $23 million and $24 million in the first six months of 2007
and
2006, respectively. Declines in short-term interest rates could cause a
significant increase in required amortization in subsequent
periods.
In
addition, premium amortization expense acceleration could occur if we reclassify
a portion of the underlying loans from held-for-investment to held-for-sale,
as
the GAAP carrying value of these loans are currently in excess of their fair
market value. This reclassification could occur as the various underlying pools
of loans become callable and we decide to sell these loans, or it could occur
if
there is a change in accounting principles (for example, if we adopt
Statement
of
Financial Accounting Standards No. 159,
The
Fair Value Option for Financial assets of FASB Statement No. 115
and
elect
to account for our loans as fair value instruments.)
Real
Estate Securities
Currently,
all of our IGS and CES are classified as AFS and are carried on our balance
sheets at their estimated fair market value. Cumulative unrealized fair market
value gains and losses are reported as a component of accumulated other
comprehensive income (loss) in our consolidated statements of stockholders’
equity. However, adverse changes to projected cash flows related to poor credit
performance, adverse changes to prepayment speeds, or our decision to sell
assets could create an other-than-temporary impairment for accounting purposes
and could cause fair market value losses to be reported through our income
statement.
At
June
30, 2007, we owned $3.7 billion of securities. Of these, $440 million were
backed by subprime loans ($3 million of CES and $437 million of IGS) and
$1.3 billion were backed by option ARMs ($239 million of prime CES, $356
million of prime IGS, $163 million of alt-a CES, and $594 million alt-a IGS).
In
the event future credit performance of these securities is worse than our
current projections, we would be required to report losses through our income
statement. See the Financial Condition discussion later in this document for
further detail on these securities.
Other
Real Estate Investments
Due
to
the implementation of a new accounting standard (FAS 155) in the first quarter
of 2007, we elected at the end of the first quarter to classify certain
securities (IOs, NIMs and residuals) that contain embedded derivatives as
trading instruments within the portfolio other real estate investments. IOs,
NIMs, and residuals typically contain embedded derivatives that require
bifurcation and separate valuation through the income statement under FAS 155.
We have elected to treat these investments as trading securities rather than
bifurcate the embedded derivative component. Trading securities are required
to
be reported on our consolidated balance sheet at their estimated fair market
values with changes in fair market values reported through our consolidated
statements of income (through market valuation adjustments). Using FAS 155
in
this manner will increase GAAP earnings volatility going forward. Under previous
GAAP guidance, we would have classified these securities as available for sale
(AFS).
Derivative
Financial Investments
To
date,
we have elected two classifications for derivative instruments: trading
instruments and cash flow hedges. All derivative instruments, regardless of
classification, are reported on our consolidated balance sheets at fair market
value. Changes to the fair market value of the derivatives classified as trading
instruments are recognized through the consolidated statements of income. For
those derivatives accounted for as cash flow hedges, the changes in fair market
values are reported through our consolidated balance sheets with only the
ineffective portions (as determined according to the accounting provisions)
reported through our income statement.
We
could
experience significant earnings volatility from our use of derivatives. This
could occur, for example, when the recognition in changes in the fair market
value of the derivatives are reported through our income statement but changes
in the fair market value in the hedged asset or liability are not recognized
in
a similar manner. Earnings volatility could also occur as we expand our use
of
derivatives (including acquiring derivatives as investments and not just as
hedging instruments).
Potential
Tax Income Volatility
Taxable
income may vary from quarter to quarter based on many reasons, three of which
are discussed below.
CES
and Loans
To
determine taxable income we are not permitted to anticipate, or reserve for,
credit losses. Taxable income can only be reduced by actual losses. As a
consequence, we are required to accrete the entire purchase discount on CES
into
taxable income over their expected life. For GAAP purposes, we do anticipate
credit losses and thus only accrete a portion of the CES discount into income.
As a result, our income recognition on CES is faster for tax as compared to
GAAP, especially in the early years of owning the assets (when there are
generally few credit losses). At June 30, 2007, the cumulative difference
between the GAAP and tax amortized costs basis of our residential, commercial,
and CDO CES was $115 million. In addition, as of June 30, 2007, we had a credit
reserve of $19 million for GAAP on our residential and commercial loans, and
none for tax. As we have no credit reserves for tax and a higher CES basis,
any
future credit losses on our CES or loans would have a more significant impact
on
tax earnings as compared to GAAP and may create significant taxable income
volatility to the extent the level of credit losses varies during
periods.
Sequoia
Interest-Only Certificates (IOs)
As
a
result of rapid prepayments, we are experiencing negative economic returns
on
some IOs we acquired from prior Sequoia securitizations. For tax purposes,
however, we are not permitted to recognize a negative yield, so premium
amortization expenses for tax have not been as high as they otherwise would
have
been based on the economic returns. As a result, our current tax bases on these
IOs are higher than the fair market values by approximately $49 million. We
expect to call most Sequoia securitization entities over the next two years,
at
which time the remaining IO tax basis will be written off and a capital loss
for
tax created. Capital losses do not reduce ordinary income (or our requirement
to
distribute ordinary income as dividends). Capital losses do offset capital
gains
realized from sales or calls of assets, and thus will reduce future
distributions of these capital gains. Our taxable earnings will vary from period
to period based on the exact timing of these Sequoia calls.
Compensation
Compensation
expense for tax varies depending on the timing of dividend equivalent rights
payments, the exercise of stock options, the distribution of deferred stock
units, and deferrals to and withdrawals from our executive deferred compensation
plan.
FINANCIAL
CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
Summary
We
discuss our business of investing in, financing, and managing real estate loans
and securities in each of our earnings asset portfolios below.
Residential
Real Estate Loans
We
acquire high-quality residential real estate loans on a bulk or flow basis
from
originators. Prior to 2006, these loan purchases were predominately comprised
of
short reset LIBOR indexed ARMs (LIBOR ARMs). Since then, we have expanded our
residential conduit’s product offerings to include high-quality hybrid loans
(loans with a fixed rate coupon for a period of two to ten years before becoming
adjustable). All of the $675 million of acquisitions during the second quarter
of 2007 and the $1 billion for the six months ended June 30, 2007 were hybrid
loans.
The
following table provides details of the activity with respect to our residential
real estate loans for the three and six months ended June 30, 2007.
Table
17 Residential Real Estate Loans - Activity
(In
thousands)
|
|
|
Three
Months Ended
June
30, 2007
|
|
|
Six
Months Ended
June
30, 2007
|
|
|
|
|
|
|
|
|
|
Balance
at beginning of
period
|
|
$
|
8,680,487
|
|
$
|
9,323,935
|
|
Acquisitions
|
|
|
674,932
|
|
|
1,090,215
|
|
Sale
proceeds
|
|
|
(2,191
|
)
|
|
(2,191
|
)
|
Principal
repayments
|
|
|
(983,557
|
)
|
|
(2,025,618
|
)
|
Transfers
to REO
|
|
|
(4,635
|
)
|
|
(8,098
|
)
|
Premium
amortization
|
|
|
(10,889
|
)
|
|
(22,615
|
)
|
Provision
for credit losses
|
|
|
(2,500
|
)
|
|
(3,981
|
)
|
Balance
at end of period
|
|
$
|
8,351,647
|
|
$
|
8,351,647
|
|
Our
residential real estate loan balance declined to $8.4 billion at June 30,
2007 from $8.7 billion at March 31, 2007 and $9.3 billion at December 31,
2006. Of the balance at June 30, 2007, 71% of the loans were one- and six-month
LIBOR ARMs. The flattening of the yield curve since 2005 has continued to
result in fast prepayments on existing LIBOR ARMs and has caused origination
levels of new LIBOR ARMs to decline significantly. The average constant
prepayment rate (CPR) for our LIBOR ARMs continues to be at relatively high
levels of 43% and 42% for the three months and six months ended June 30, 2007,
respectively. In a flat yield curve environment, hybrid or fixed-rate loans
are
a more attractive loan alternative to a borrower.
Our
June
30, 2007 residential loan balance of $8.4 billion included $7.5 billion loans
funded via securitization and $0.9 billion loans financed with equity and
Redwood debt. We will either securitize loans through our Sequoia program,
sell
loans to third parties, or continue to hold loans funded with Redwood debt
to
earn an interest spread. Our funding decision depends on a number of factors,
including our level of excess cash, the cost and availability of securitization
financing, and the availability of attractive alternative investment
opportunities.
Residential
Credit-Enhancement Securities
The
largest part of our business in terms of capital employed is investing in
residential CES. These credit-enhancement securities have credit ratings that
are below investment-grade and have both the upside opportunities and downside
risks that come from taking on concentrated credit risks.
Our
residential CES portfolio had a fair market value of $745 million at June 30,
2007 and $722 million at December 31, 2006, reflecting an annualized growth
rate of 6% during the first half of 2007. 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. At June 30,
2007, the difference between the principal value ($1.3 billion) and carrying
value ($745 million) - which equals fair market value of these residential
loan
CES - was $546 million. Of this difference, $453 million was designated as
internal credit reserve (reflecting our estimate of credit losses on the
underlying loans over the life of these securities), $126 million represented
a
purchase discount we are accreting into income over time, and $33 million
represented net unrealized mark-to-market gains. Amortized cost (principal
value
less internal credit reserve less amortized discount) increased $48 million
from
$664 million at December 31, 2006 to $712 million at June 30, 2007. Net
unrealized mark-to-market gains fell by $25 million from $58 million at December
31, 2006 to $33 million at June 30, 2007.
The
following table provides detail of the activity with respect to our residential
CES for the three and six months ended June 30, 2007.
Table
18 Residential CES - Activity
(In
thousands)
|
|
|
Three
Months Ended
June
30, 2007
|
|
|
Six
Months Ended
June
30, 2007
|
|
|
|
|
|
|
|
|
|
Balance
at beginning of period
|
|
$
|
752,277
|
|
$
|
721,531
|
|
Acquisitions
|
|
|
39,381
|
|
|
113,106
|
|
Sale
proceeds
|
|
|
(3,292
|
)
|
|
(8,506
|
)
|
Gains
(losses) recognized on sales, net
|
|
|
(135
|
)
|
|
252
|
|
Principal
repayments (including calls)
|
|
|
(43,556
|
)
|
|
(79,228
|
)
|
Gains
recognized on calls, net
|
|
|
1,142
|
|
|
1,875
|
|
Discount
amortization
|
|
|
21,065
|
|
|
39,957
|
|
Transfer
to other portfolios
|
|
|
—
|
|
|
(4,480
|
)
|
Change
in fair market value adjustments, net
|
|
|
(21,907
|
)
|
|
(39,532
|
)
|
Balance
at end of period
|
|
$
|
744,975
|
|
$
|
744,975
|
|
The
$113
million residential CES acquired in the first half of 2007 were comprised of
$58
million prime securities, $51 million alt-a securities, and $4 million subprime
securities.
Prime
securities are residential mortgage-backed securities backed primarily by high
credit quality loans. Many of the loans are jumbos, with loan balances greater
than conforming loan limits. Prime securities typically have relatively high
weighted average FICO scores (700 or higher), low (75% or less), weighted
average loan-to-value ratios (LTV), and limited concentrations of investor
properties.
Alt-a
securities are residential mortgage-backed securities that have higher credit
quality than subprime and lower credit quality than prime. Alt-a originally
represented loans with alternative documentation, but has shifted over time
to
include loans with additional risk characteristics and a higher percentage of
investor loans. For example, borrowers’ income may not be verified, and in some
cases, may not be disclosed on the loan application. Expanded criteria also
allows for higher debt-to-income ratios with higher accompanying LTV than
otherwise would be permissible for prime loans.
Subprime
securities are residential mortgage-backed securities backed by loans to
borrowers who have impaired credit histories, but who appear to exhibit the
ability to repay the current loan. Typically, these borrowers have lower credit
scores or other credit deficiencies that prevent them from qualifying for prime
or alt-a mortgages. To compensate for the greater risks and higher costs to
service these loans, subprime borrowers pay higher interest rates, points,
and
origination fees. When evaluating the acquisition of CES backed by subprime
loans, we use loss assumptions that are significantly higher than those we
use
for prime loans.
The
following table details our residential CES portfolios by the underlying loan
type (prime, alt-a, subprime) and by current credit rating at June 30, 2007
and
December 31, 2006.
Table
19 Residential CES - Credit Rating and Collateral
Type
June
30, 2007
|
|
Rating
|
|
(In
millions)
|
|
BB
|
|
B
|
|
Unrated
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Prime
|
|
$
|
318
|
|
$
|
$
131
|
|
$
|
$
121
|
|
$
|
$
570
|
|
Alt-a
|
|
|
103 |
|
|
34
|
|
|
35
|
|
|
172
|
|
Subprime
|
|
|
3 |
|
|
—
|
|
|
—
|
|
|
3
|
|
Total
residential CES
|
|
$
|
424
|
|
$
|
165
|
|
$
|
156
|
|
$
|
745
|
|
December 31,
2006
|
|
Rating
|
|
|
|
BB
|
|
B
|
|
Unrated
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Prime
|
|
$
|
307
|
|
$
|
119
|
|
$
|
129
|
|
$
|
555
|
|
Alt-a
|
|
|
94 |
|
|
23
|
|
|
40
|
|
|
157
|
|
Subprime
|
|
|
7 |
|
|
—
|
|
|
3
|
|
|
10
|
|
Total
residential CES
|
|
$
|
408
|
|
$
|
142
|
|
$
|
172
|
|
$
|
722
|
|
The
following table details our residential CES portfolios by the product type
and
collateral vintage at June 30, 2007.
Table
20 Residential CES - Product and Vintage
June
30, 2007
|
|
Vintage
|
|
(In
millions)
|
|
2004
& Earlier
|
|
2005
|
|
2006
|
|
2007
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime
|
|
|
|
|
|
|
|
|
|
|
|
Option
ARM
|
|
$
|
64
|
|
$
|
109
|
|
$
|
48
|
|
$
|
18
|
|
$
|
239
|
|
ARM
|
|
|
39 |
|
|
5
|
|
|
—
|
|
|
—
|
|
|
44
|
|
Hybrid
|
|
|
91 |
|
|
36
|
|
|
73
|
|
|
20
|
|
|
220
|
|
Fixed
|
|
|
36 |
|
|
17
|
|
|
8
|
|
|
6
|
|
|
67
|
|
Total
prime
|
|
|
230 |
|
|
167
|
|
|
129
|
|
|
44
|
|
|
570
|
|
Alt-a
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option
ARM
|
|
|
33 |
|
|
22
|
|
|
64
|
|
|
43
|
|
|
162
|
|
ARM
|
|
|
1 |
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1
|
|
Hybrid
|
|
|
6 |
|
|
—
|
|
|
1
|
|
|
—
|
|
|
7
|
|
Fixed
|
|
|
1 |
|
|
—
|
|
|
—
|
|
|
1
|
|
|
2
|
|
Total
Alt-a
|
|
|
41 |
|
|
22
|
|
|
65
|
|
|
44
|
|
|
172
|
|
Subprime
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Hybrid
|
|
|
— |
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Fixed
|
|
|
— |
|
|
—
|
|
|
1
|
|
|
2
|
|
|
3
|
|
Total
subprime
|
|
|
— |
|
|
—
|
|
|
1
|
|
|
2
|
|
|
3
|
|
Total
residential CES
|
|
$
|
271
|
|
$
|
189
|
|
$
|
195
|
|
$
|
90
|
|
$
|
745
|
|
The
loans
underlying all of our residential CES totaled $220 billion at June 30, 2007,
and
consist of $196 billion prime, $21 billion alt-a, and $3 billion subprime.
These
loans are located nationwide with a large concentration in California (46%).
These loans continue to perform well from a credit perspective - during the
first half of 2007, realized residential credit losses were $9.4 million of
principal value, a rate that is less than one basis point (0.01%) on an
annualized basis of the balance of loans. Serious delinquencies (90+ days,
in
foreclosure, in bankruptcy or REO) at June 30, 2007 were 0.63% of current
balance and 0.36% of original balance. For loans in prime pools, delinquencies
were 0.3% of current balance and 0.17% of original balance. Alt-a pools had
delinquencies of 1.95% of current balance and 1.04% of original balance.
Subprime loans had delinquencies of 11.28% of current balance and 9.65% of
original balance.
Residential
Investment-Grade Securities
We
invest
in investment-grade residential securities (IGS) backed by prime, alt-a, and
subprime residential loans. Our residential investment-grade securities totaled
$2.2 billion at June 30, 2007 and $1.7 billion at December 31, 2006. These
IGS are not directly exposed to first-loss credit risk as they benefit from
credit-enhancement provided by others’ securities. The credit performance of
these assets continued to be relatively strong during the first half of 2007.
However, the fall in market values of $37 million for the months ended June
30,
2007 included $2 million of EITF 99-20 cash flow impairments recorded to the
consolidated statements of income. The majority of these securities are funded
through securitizations under our Acacia program.
The
following table provides detail of the activity for the three and six months
ended June 30, 2007.
Table
21 Residential IGS - Activity
(In
thousands)
|
|
Three
Months Ended
June
30, 2007
|
|
Six
Months Ended
June
30, 2007
|
|
|
|
|
|
|
|
Balance
at beginning of period
|
|
$
|
2,025,850
|
|
$
|
1,697,250
|
|
Acquisitions
|
|
|
267,695 |
|
|
803,041
|
|
Sale
proceeds
|
|
|
(52,217 |
) |
|
(160,589
|
)
|
Gains
(losses) recognized on sales, net
|
|
|
1,597 |
|
|
381
|
|
Principal
repayments (including calls)
|
|
|
(45,857 |
) |
|
(78,105
|
)
|
Gains
recognized on calls, net
|
|
|
169 |
|
|
245
|
|
Discount
amortization
|
|
|
2,449 |
|
|
3,770
|
|
Transfer
to other portfolios
|
|
|
— |
|
|
(13,816
|
)
|
Change
in fair market value adjustments, net
|
|
|
(36,740 |
) |
|
(89,231
|
)
|
Balance
at end of period
|
|
$
|
2,162,946
|
|
$
|
2,162,946
|
|
The
$803
million IGS acquired in the first half of 2007 consisted of $247 million prime,
$443 million alt-a, and $113 million subprime.
The
following table details the type of underlying loans (prime, alt-a, subprime)
and the current credit rating of our residential IGS as of June 30, 2007 and
December 31, 2006.
Table
22 Residential IGS - Credit Rating and Collateral
Type
June
30, 2007
|
|
Rating
|
|
(In
millions)
|
|
AAA
|
|
AA
|
|
A
|
|
BBB
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime
|
|
$
|
153
|
|
$
|
180
|
|
$
|
255
|
|
$$
|
282
|
|
$
|
870
|
|
Alt-a
|
|
|
235
|
|
|
101
|
|
|
271
|
|
|
249
|
|
|
856
|
|
Subprime
|
|
|
14
|
|
|
154
|
|
|
149
|
|
|
120
|
|
|
437
|
|
Total
residential IGS
|
|
$
|
402
|
|
$
|
435
|
|
$
|
675
|
|
$
|
651
|
|
$
|
2,163
|
|
December 31,
2006
|
|
Rating
|
|
|
|
AAA
|
|
AA
|
|
A
|
|
BBB
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime
|
|
$
|
14
|
|
$
|
181
|
|
$
|
243
|
|
$
|
285
|
|
$
|
723
|
|
Alt-a
|
|
|
136
|
|
|
84
|
|
|
106
|
|
|
130
|
|
|
456
|
|
Subprime
|
|
|
8
|
|
|
127
|
|
|
209
|
|
|
174
|
|
|
518
|
|
Total
residential IGS
|
|
$
|
158
|
|
$
|
392
|
|
$
|
558
|
|
$
|
589
|
|
$
|
1,697
|
|
The
following table details our residential CES portfolios by the product type
and
collateral vintage at June 30, 2007.
Table
23 Residential IGS - Product and Vintage
|
|
Vintage
|
|
June
30, 2007 (In
millions)
|
|
2004
& Earlier
|
|
2005
|
|
2006
|
|
2007
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime
|
|
|
|
|
|
|
|
|
|
|
|
Option
ARM
|
|
$
|
39
|
|
$
|
205
|
|
$
|
70
|
|
$
|
42
|
|
$
|
356
|
|
ARM
|
|
|
28 |
|
|
— |
|
|
— |
|
|
— |
|
|
28 |
|
Hybrid
|
|
|
78 |
|
|
119 |
|
|
114 |
|
|
74 |
|
|
385 |
|
Fixed
|
|
|
29 |
|
|
23 |
|
|
12 |
|
|
37 |
|
|
101 |
|
Total
prime
|
|
|
174 |
|
|
347 |
|
|
196 |
|
|
153 |
|
|
870 |
|
Alt-a
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option
ARM
|
|
|
29 |
|
|
50 |
|
|
288 |
|
|
227 |
|
|
594 |
|
ARM
|
|
|
4 |
|
|
— |
|
|
— |
|
|
3 |
|
|
7 |
|
Hybrid
|
|
|
12 |
|
|
8 |
|
|
35 |
|
|
27 |
|
|
82 |
|
Fixed
|
|
|
5 |
|
|
— |
|
|
109 |
|
|
59 |
|
|
173 |
|
Total
alt-a
|
|
|
50 |
|
|
58 |
|
|
432 |
|
|
316 |
|
|
856 |
|
Subprime
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Hybrid
|
|
|
131 |
|
|
61 |
|
|
63 |
|
|
38 |
|
|
293 |
|
Fixed
|
|
|
47 |
|
|
22 |
|
|
43 |
|
|
32 |
|
|
144 |
|
Total
subprime
|
|
|
178 |
|
|
83 |
|
|
106 |
|
|
70 |
|
|
437 |
|
Total
residential IGS
|
|
$
|
402
|
|
$
|
488
|
|
$
|
734
|
|
$
|
539
|
|
$
|
2,163
|
|
The
following
table
details the vintage of the underlying loan collateral behind our subprime IGS
at
June 30, 2007.
Table
24 Subprime IGS - Credit Rating and Collateral
Vintage
|
|
Vintage
|
|
(In
millions)
|
|
2004
& Earlier
|
|
2005
|
|
2006
|
|
2007
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
IGS
|
|
|
|
|
|
|
|
|
|
|
|
AAA
|
|
$
|
—
|
|
$
|
5
|
|
$
|
9
|
|
$
|
—
|
|
$
|
14
|
|
AA
|
|
|
48 |
|
|
51
|
|
|
26
|
|
|
29 |
|
|
154 |
|
A
|
|
|
94 |
|
|
27
|
|
|
13
|
|
|
15 |
|
|
149 |
|
BBB+
|
|
|
36 |
|
|
—
|
|
|
39
|
|
|
10 |
|
|
84 |
|
BBB
|
|
|
— |
|
|
—
|
|
|
9
|
|
|
6 |
|
|
14 |
|
BBB-
|
|
|
— |
|
|
—
|
|
|
10
|
|
|
10 |
|
|
20 |
|
Total
IGS
|
|
$
|
178
|
|
$
|
83
|
|
$
|
106
|
|
$
|
70
|
|
$
|
437
|
|
Commercial
Real Estate Loans
We
have
invested in commercial real estate loans since 1998. At June 30, 2007 and
December 31, 2006, commercial real estate loans totaled $26 million and $28
million, respectively. These include mezzanine loans, subordinated (junior
or
senior 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). Except for one loan (where we fully
reserved for an anticipated loss on a junior mezzanine loan financing a
condominium-conversion project), credit performance of our commercial loan
portfolio remains strong and in line with our expectations.
The
following table provides activity on our commercial real estate loans for the
three and six months ended June 30, 2007.
Table
25 Commercial Real Estate Loans - Activity
(In
thousands)
|
|
Three
Months Ended
June
30, 2007
|
|
Six
Months Ended
June
30, 2007
|
|
|
|
|
|
|
|
Commercial
real estate loans at beginning of
period
|
|
$
|
25,883
|
|
$
|
28,172
|
|
Recognized
gains on sales, net
|
|
|
—
|
|
|
—
|
|
Principal
repayments
|
|
|
(82
|
)
|
|
(44
|
)
|
Discount
amortization
|
|
|
26
|
|
|
47
|
|
Provision
for credit losses
|
|
|
—
|
|
|
(2,348
|
)
|
Commercial
real estate loans at end of period
|
|
$
|
25,827
|
|
$
|
25,827
|
|
Commercial
Credit-Enhancement Securities
Our
total
commercial CES was $451 million at June 30, 2007, a decrease from $448 million
at December 31, 2006. At June 30, 2007, these securities provided credit
enhancement on $70 billion underlying loans on office, retail, multifamily,
industrial, and other income-producing properties nationwide.
The
following table provides detail of the activity for the three and six months
ended June 30, 2007.
Table
26 Commercial CES - Activity
(In
thousands)
|
|
Three
Months Ended
June
30, 2007
|
|
Six
Months Ended
June
30, 2007
|
|
|
|
|
|
|
|
Balance
at beginning of
period
|
|
$
|
435,382
|
|
$
|
448,060
|
|
Acquisitions
|
|
|
49,177 |
|
|
51,920
|
|
Principal
repayments (including calls)
|
|
|
— |
|
|
—
|
|
Discount
amortization
|
|
|
200 |
|
|
191
|
|
Upgrades
to investment-grade securities
|
|
|
— |
|
|
(3,501
|
)
|
Change
in fair market value adjustments, net
|
|
|
(33,818 |
) |
|
(45,729
|
)
|
Balance
at end of period
|
|
$
|
450,941
|
|
$
|
450,941
|
|
The
following table presents the current credit ratings of our commercial CES at
June 30, 2007 and December 31, 2006.
Table
27 Commercial CES - Credit Rating
(In
millions)
|
|
Rating
|
|
|
|
BB
|
|
B
|
|
Unrated
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
June
30,
2007
|
|
$
|
215
|
|
$ |
99 |
|
$
|
137
|
|
$
|
451
|
|
December 31,
2006
|
|
$
|
224
|
|
$ |
90 |
|
$
|
134
|
|
$
|
448
|
|
As
a
result of the concentrated credit risk associated with commercial CES, we are
generally able to acquire these securities at a discount to their face
(principal) value. The difference between the principal value ($881 million)
and
carrying value ($451 million) of our commercial CES at June 30, 2007 was $430
million. Of this difference, $311 million was designated as internal credit
reserve (reflecting our estimate of likely credit losses on the underlying
loans
over the life of these securities), $95 million represented a purchase discount
we are accreting into income over time, and $24 million represented net
unrealized mark-to-market losses.
Commercial
Investment-Grade Securities
Our
commercial IGS totaled $111 million at June 30, 2007 and $120 million at
December 31, 2006.
The
following table provides detail of the activity for the three and six months
ended June 30, 2007.
Table
28 Commercial IGS - Activity
(In
thousands)
|
|
Three
Months Ended
June
30, 2007
|
|
Six
Months Ended
June
30, 2007
|
|
|
|
|
|
|
|
Balance
at beginning of period
|
|
$
|
116,494
|
|
$
|
119,613
|
|
Acquisitions
|
|
|
— |
|
|
2,964
|
|
Sale
proceeds
|
|
|
— |
|
|
(6,464
|
)
|
Recognized
gains on calls, net
|
|
|
— |
|
|
45
|
|
Principal
repayments (including calls)
|
|
|
(607 |
) |
|
(1,545
|
)
|
Discount
amortization
|
|
|
69 |
|
|
136
|
|
Upgrades
from commercial CES
|
|
|
— |
|
|
3,501
|
|
Change
in fair market value adjustments, net
|
|
|
(4,812 |
) |
|
(7,106
|
)
|
Balance
at end of period
|
|
$
|
111,144
|
|
$
|
111,144
|
|
Our
balance of commercial IGS has generally been declining over the last several
quarters, as we have slowed acquisitions of commercial IGS as pricing has become
extremely competitive.
The
following table presents the current credit ratings of our commercial
investment-grade securities at June 30, 2007 and December 31,
2006.
Table
29
Commercial IGS - Credit Rating
(In
millions)
|
|
Rating
|
|
|
|
AAA
|
|
AA
|
|
A
|
|
BBB
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June
30,
2007
|
|
$
|
8
|
|
$
|
4
|
|
$
|
23
|
|
$
|
76
|
|
$
|
111
|
|
December 31,
2006
|
|
$
|
9
|
|
$
|
2
|
|
$
|
16
|
|
$
|
93
|
|
$
|
120
|
|
CDO
Credit-Enhancement Securities
CDOs
are
a form of securitization in which a diverse portfolio of assets is acquired
by a
securitization entity that creates and sells securities (CDO securities) in
order to fund its asset purchases. We acquire CDO securities created by others
as an asset portfolio investment. These CDO securities are generally backed
by
residential and commercial real estate assets and are generally financed through
our CDOs.
At
June
30, 2007, our CDO CES totaled $21 million, a decrease from $22 million at
December 31, 2006. The change in balance consisted of $5 million in
acquisitions, $5 million in upgrades to CDO IGS and a negative $1 million change
of fair market value recognized through other comprehensive income (loss).
The
following tables present the credit ratings of our CDO CES at June 30, 2007
and
December 31, 2006.
Table
30 CDO CES - Credit Rating
(In
millions)
|
|
Rating
|
|
|
|
BB
|
|
B
|
|
Unrated
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
June
30, 2007
|
|
$
|
13
|
|
$
|
—
|
|
$
|
8
|
|
$
|
21
|
|
December 31,
2006
|
|
$
|
14
|
|
$
|
—
|
|
$
|
8
|
|
$
|
22
|
|
CDO
Investment-Grade Securities
At
June
30, 2007, our CDO IGS totaled $235 million, an increase of $11 million from
the
December 31, 2006 balance of $224 million. During the first half of 2007,
acquisitions of CDO investment-grade securities were $35 million, upgrades
from
CDO CES to CDO IGS were $5 million, and balance sheet mark-to-market adjustments
were negative $29 million.
The
following table presents the credit ratings of our CDO IGS at June 30, 2007
and
December 31, 2006.
Table
31 CDO IGS - Credit Rating
(In
millions)
|
|
Rating
|
|
|
|
AAA
|
|
AA
|
|
A
|
|
BBB
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June
30,
2007
|
|
$
|
81
|
|
$
|
30
|
|
$
|
48
|
|
$
|
76
|
|
$
|
235
|
|
December 31,
2006
|
|
$
|
66
|
|
$
|
30
|
|
$
|
52
|
|
$
|
76
|
|
$
|
224
|
|
Other
Real Estate Investments
Our
other
real estate investments totaled $34 million at June 30, 2007. There were no
assets classified as other real estate investments at December 31,
2006.
The
following table
represents the activity within other real estate investments during the first
three and six months ended June 30, 2007.
Table
32 Other Real Estate Investment - Activity
(In
thousands)
|
|
Three
Months Ended
June
30, 2007
|
|
Six
Months Ended
June
30, 2007
|
|
|
|
|
|
|
|
Balance
at beginning of
period
|
|
$
|
50,057
|
|
$
|
—
|
|
Acquisitions
|
|
|
— |
|
|
40,790
|
|
Sale
proceeds
|
|
|
(2,237 |
) |
|
(2,237
|
)
|
Principal
repayments (including calls)
|
|
|
(5,301 |
) |
|
(8,380
|
)
|
Discount
amortization
|
|
|
(2,104 |
) |
|
(2,636
|
)
|
Transfers
from other portfolios
|
|
|
— |
|
|
18,296
|
|
Change
in fair market value adjustments, net
|
|
|
(6,247 |
) |
|
(11,665
|
)
|
Balance
at end of period
|
|
$
|
34,168
|
|
$
|
34,168
|
|
Acquisitions
during the first half of 2007 were $41 million, which consisted of $21 million
of alt-a securities and $20 million of subprime securities. Of the $12 million
of negative value change in other real estate investments for the first half
of
2007, $4 million related to investments acquired prior to this year, which
were
reclassified into this portfolio in the first quarter of 2007.
The
following table presents the current credit ratings of our other real estate
investments at June 30, 2007.
Table
33 Other Real Estate Investments - Credit Rating
(In
millions)
|
|
Rating
|
|
|
|
AAA
|
|
AA
|
|
A
|
|
BBB
|
|
BB
|
|
B
|
|
Unrated
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June
30,
2007
|
|
$
|
2
|
|
$
|
—
|
|
$
|
14
|
|
$
|
4
|
|
$
|
4
|
|
$
|
—
|
|
$
|
10
|
|
$
|
34
|
|
Liabilities
and Stockholders’ Equity
Redwood
Debt
We
use
repurchase (repo) agreements and our Madrona commercial paper facility to
finance certain of our residential real estate loans. We may securitize those
loans in the future or continue to fund them with debt. We also use warehouses
and repo agreements to finance securities. To date, the warehouses have limited
recourse to Redwood, whereas other Redwood debt facilities have full recourse
to
us. Redwood debt is secured by pledges of our loans and securities. The table
below shows the amount of debt outstanding by facility at June 30, 2007 and
December 31, 2006.
Table
34 Redwood Debt by Facility
(In
thousands)
|
|
June
30, 2007
|
|
December 31,
2006
|
|
|
|
|
|
|
|
Loans
|
|
|
|
|
|
Repo
agreements
|
|
$
|
496,794
|
|
$
|
959,139
|
|
Madrona
commercial paper facility
|
|
|
190,720
|
|
|
300,000
|
|
Securities
|
|
|
|
|
|
|
|
Repo
agreements
|
|
|
161,148
|
|
|
—
|
|
Acacia
warehouses
|
|
|
—
|
|
|
597,069
|
|
Total
Redwood debt
|
|
$
|
848,662
|
|
$
|
1,856,208
|
|
In
the
last few years, we generally used Redwood debt to fund the acquisition of loans
and securities on a temporary basis prior to their sale to a securitization
entity. We are more frequently acquiring these assets as a longer-term
investment that we intend to fund on an ongoing basis with Redwood
debt.
Asset-Backed
Securities Issued
Redwood
has securitized the majority of the assets shown on its consolidated balance
sheets. In a securitization, Redwood sells assets to a securitization entity
that creates and sells asset-backed securities (ABS) in order to fund its asset
purchases. The residential whole loan securitization entities Redwood sponsors
are called Sequoia and the CDO securitization entities Redwood sponsors are
called Acacia. These securitization entities are bankruptcy-remote from Redwood,
so that Redwood’s liabilities cannot become liabilities of the securitization
entity and the ABS issued by the securitization entity cannot become obligations
of Redwood. Nevertheless, since, according to accounting definitions, we control
these securitization entities, we show both the assets and liabilities of these
entities on our consolidated balance sheets. At June 30, 2007, our consolidated
balance sheets included $10.8 billion of assets owned by the securitization
entities (85% of total consolidated assets) and included $10.7 billion of
liabilities of the securitization entities (90% of total consolidated
liabilities).
The
following table provides detail of the activity for asset-backed securities
(ABS) for the three and six months ended June 30, 2007.
Table
35 ABS Issued - Activity
|
|
Three
Months Ended June
30, 2007
|
|
(In
thousands)
|
|
March 31,
2007
|
|
New
Issuance
|
|
Paydowns
|
|
Amortization
|
|
June
30,
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sequoia
ABS issued with principal value, net
|
|
$
|
7,146,901
|
|
$
|
1,020,495
|
|
$
|
(972,231
|
)
|
$
|
(2,910
|
)
|
$
|
7,192,255
|
|
Sequoia
ABS interest only issued
|
|
|
61,751
|
|
|
—
|
|
|
—
|
|
|
(10,564
|
)
|
|
51,187
|
|
Acacia
issued ABS with principal value, net
|
|
|
2,715,660
|
|
|
952,597
|
|
|
(259,043
|
)
|
|
83
|
|
|
3,409,297
|
|
Acacia
ABS CES issued
|
|
|
22,196
|
|
|
—
|
|
|
—
|
|
|
534
|
|
|
22,730
|
|
Total
ABS issued
|
|
$
|
9,946,508
|
|
$
|
1,973,092
|
|
$
|
(1,231,274
|
)
|
$
|
(12,857
|
)
|
$
|
10,675,469
|
|
|
|
Six
Months Ended June
30, 2007
|
|
(In
thousands)
|
|
December 31,
2006
|
|
New
Issuance
|
|
Paydowns
|
|
Amortization
|
|
June
30,
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sequoia
ABS issued with principal value, net
|
|
$
|
7,595,003
|
|
$
|
1,908,858
|
|
$
|
(2,306,041
|
)
|
$
|
(5,565
|
)
|
$
|
7,192,255
|
|
Sequoia
ABS interest only issued
|
|
|
74,548
|
|
|
—
|
|
|
—
|
|
|
(23,361
|
)
|
|
51,187
|
|
Acacia
issued ABS with principal value, net
|
|
|
2,294,629
|
|
|
1,417,597
|
|
|
(303,116
|
)
|
|
187
|
|
|
3,409,297
|
|
Acacia
ABS CES issued
|
|
|
15,044
|
|
|
6,470
|
|
|
—
|
|
|
1,216
|
|
|
22,730
|
|
Total
ABS issued
|
|
$
|
9,979,224
|
|
$
|
3,332,925
|
|
$
|
(2,609,157
|
)
|
$
|
(27,523
|
)
|
$
|
10,675,469
|
|
Generally,
when we securitize assets, as opposed to owning them directly and funding them
with Redwood debt and equity, our reported cost of funds is higher (the cost
of
ABS securities issued is generally higher than that of our debt) but we utilize
less equity capital. As a result, our return on equity may increase after
securitization. In addition, liquidity risks are generally reduced or
eliminated, as the Redwood debt associated with the accumulation of these assets
during their accumulation is paid off following securitization.
Subordinated
Notes
In
December 2006, we issued $100 million of subordinated notes (trust
preferred securities) through Redwood Capital Trust I, a wholly-owned Delaware
statutory trust, in a private placement transaction. These trust preferred
securities require quarterly distributions at a floating rate equal to
three-month LIBOR plus 2.25% until the notes are redeemed in whole, which will
be no later than January 30, 2037. The earliest optional redemption date
without a penalty is January 30, 2012.
In
May
2007, we issued $50 million of subordinated notes which require quarterly
distributions at a floating rate equal to three-month LIBOR plus 2.25% until
the
notes are redeemed in whole, which will be no later than July 30, 2037. The
earliest optional redemption date without a penalty is July 30, 2012.
In
our
internal risk-adjusted capital calculations, we include these subordinated
notes
in our capital base.
Derivative
Financial Investments
We
currently have three kinds of derivative instruments; interest rate agreements,
commitments to purchase, and credit default swaps. All derivatives are reported
on our balance sheet at fair market value. Changes in the fair market values
of
derivatives are either recorded through our consolidated statements of income
or
through accumulated other comprehensive income (loss) on our consolidated
balance sheets.
We
enter
into interest rate agreements to help manage some of our interest rate risks.
We
enter into these agreements with highly rated counterparties and maintain
certain risk management policies limiting our exposure concentrations to any
counterparty. At June 30, 2007, we were party to interest rate agreements with
an aggregate notional value of $4 billion and a net positive fair market value
of $34 million. At December 31, 2006, we were party to interest rate
agreements with an aggregate notional value of $3 billion and a net positive
fair market value of $21 million.
At
June
30, 2007, we had outstanding commitments to purchase $149 million residential
real estate loans. We estimate the value of these commitments at positive $0.07
million. At December 31, 2006, we had commitments to purchase $81 million
residential real estate loans with an estimated value of negative $0.2 million.
Purchase commitments have zero value at the date of the commitment so any
changes in value during the quarter are recognized through our income
statements. Once the loans are purchased, the value of the purchase commitment
adjusts our cost basis in the loans.
We
entered into our first credit default swaps in the first quarter of 2007. At
June 30, 2007 we had a $78 million notional balance worth negative $3.9
million. The swaps have zero value at purchase, so the entire change in value
was recognized through our income statement during the first half of
2007.
Stockholders’
Equity
Our
reported book value at June 30, 2007 was $31.50 per share, a decrease from
$37.51 per share at the beginning of the year. Our book value per share
decreased over this period primarily as a result of declines in the net fair
market value of our assets.
Cash
Requirements, Sources of Cash, and Liquidity
We
use
cash to fund our operations 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.
Other sources of cash include proceeds from sales of assets to securitizations
entities, proceeds from sales of other assets, proceeds from calls of
securities, borrowings, and issuance of equity and debt.
At
June
30, 2007, we had $83 million unrestricted cash. We also had $878 million
principal value of unsecuritized prime residential loans and $168 million
principal value of AAA-rated prime residential securities. Total short-term
borrowings against these assets were $849 million. Since quarter end, we
completed a securitization of residential loans through our Sequoia program.
As
a result of this and other activity, as of August 7, 2007, we had $231 million
unrestricted cash. We also had $189 million principal value of unsecuritized
prime residential loans and $330 million principal value of AAA-rated
residential securities. We believe the current fair market values for these
portfolios equal 95% to 100% of their principal value. As of August 7, 2007,
total short-term borrowings against these assets were $472 million. On August
3,
2007, we sold for future settlement $39.5 million of the $330 million principal
value of AAA-rated securities for a price of 99.43% of principal value for
proceeds of $39.3 million. We also own other assets on an
unencumbered basis, including CES, OREI, and retained assets from our Sequoia
and Acacia securitizations.
In
addition to the unrestricted cash, we had a restricted cash balance of $207
million at June 30, 2007. Restricted cash is the cash generated and used within
consolidated ABS securitization entities and is not directly available to
Redwood, although it is shown on our consolidated balance sheet and the cash
flow is included in our consolidated statement of cash flows. We own the call
rights for many of these securitization entities, generally allowing us, when
certain targets or dates have been met, to pay off the ABS liabilities of these
entities and acquire their assets at par.
We
generally use capital, rather than securitization proceeds or Redwood debt,
to
fund investments in assets that have highly concentrated credit risks, including
residential CES, commercial CES, CDO CES other real estate investments and
similar illiquid assets. For the acquisition of assets with less credit
sensitivity, we employ leverage under which the capital component is much lower,
generally from 8% to 30%. At times where there is some turbulence in the market
and financing may be more difficult to obtain, we may increase our capital
component to 100%, even on less credit risk sensitive assets.
At
June
30, 2007, we had $158 million of excess capital, a decrease from the $182
million excess capital we had at December 31, 2006. We derive our excess
capital figures by calculating the amount of cash we have available for
investment if we fully leveraged our loans and securities in accordance with
our
internal risk-adjusted capital policies and deducted from the resulting cash
balances an amount we believe is sufficient to fund operations, working capital,
and to provide for certain potential liquidity risks. We include subordinated
notes in our capital base calculations. Our excess capital as of August
7,
2007 was $200 million.
Uses
of
capital during the first half of 2007 included new asset acquisitions ($325
million) and dividends ($42 million). Sources of capital included asset sales
($61 million), principal payments ($109 million), subordinated debt issuance
($50 million), equity issuance ($61 million), earnings ($30 million), and other
factors, including recycling of capital ($32 million).
At
the
beginning of 2007, we anticipated net capital absorption of $200 million to
$400
million for the calendar year. At this point, the outlook for capital absorption
is uncertain due to market turmoil. The amount of capital we deploy will depend
on the level of and expected returns from possible acquisitions. Given our
current acquisition plans, it is possible that we will finish the year at or
below the lower end of that range. However, it is also possible that large
and
exceptional opportunities may develop during the remainder of the year. If
that
occurs, we may utilize our current excess capital and also elect to raise
additional capital, through the issuance of long-term debt or equity, to take
advantage of those opportunities. Alternatively, if our stock price were to
decline to a level materially below our reported book value per share, we would
consider using some of our excess capital to repurchase shares.
CONTRACTUAL
OBLIGATIONS AND COMMITMENTS
The
table
below presents our contractual obligations and commitments as of June 30, 2007,
as well as the 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
36 Contractual Obligations and Commitments as of June 30,
2007
(In
thousands)
|
|
Payments
Due or Commitment Expiration by Period
|
|
|
|
Total
|
|
Less
Than
1
Year
|
|
1
to 3
Years
|
|
3
to 5
Years
|
|
After
5
Years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redwood
Obligations:
|
|
|
|
|
|
|
|
|
|
|
|
Redwood
debt
|
|
$
|
848,662
|
|
$
|
848,662
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
Subordinated
notes
|
|
|
150,000
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
150,000
|
|
Accrued
interest payable
|
|
|
2,479
|
|
|
2,479
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Operating
leases
|
|
|
16,120
|
|
|
1,469
|
|
|
5,153
|
|
|
3,697
|
|
|
5,801
|
|
Purchase
commitments
|
|
|
148,531
|
|
|
148,531
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total
Redwood obligations and commitments
|
|
$
|
1,165,792
|
|
$
|
1,001,141
|
|
$
|
5,153
|
|
$
|
3,697
|
|
$
|
155,801
|
|
Obligations
of Securitization Entities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
asset-backed securities*
|
|
$
|
10,675,469
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
10,675,469
|
|
Accrued
interest payable
|
|
|
45,994
|
|
|
45,994
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total
obligations of securitization entities
|
|
$
|
10,721,463
|
|
$
|
45,994
|
|
$
|
—
|
|
$
|
—
|
|
$
|
10,675,469
|
|
Total
consolidated obligations and commitments
|
|
$
|
11,887,255
|
|
$
|
1,047,135
|
|
$
|
5,153
|
|
$
|
3,697
|
|
$
|
10,831,270
|
|
*
|
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, liquidity risk, and fair
market value risk - in a prudent manner designed to enhance our earnings and
dividends and preserve our capital. In general, we seek to assume risks that
can
be quantified from historical experience, to actively manage such risks, and
to
maintain capital levels consistent with these risks.
Credit
Risk
Integral
to our core business is assuming the credit risk of real estate loans primarily
through the ownership of residential and commercial real estate loans and
securities. Much of our capital base is employed in owning credit-enhancement
securities that have below investment-grade credit ratings due to their
concentrated credit risks with respect to underlying real estate loans. We
believe that many of the loans underlying these securities are above-average
in
credit quality as compared to U.S. real estate loans in general, but the balance
and percentage of loans with special risk factors (higher risk commercial loans,
interest-only and negative amortization residential loan types, and alt-a and
subprime residential loans) has increased and will likely continue to increase.
We also own a wide variety of residential and commercial real estate loans
of
various quality grades that are not securitized.
Credit
losses from any of the loans in securitized loan pools reduce the principal
value of and economic returns on the lower-rated securities in these pools.
Credit losses on 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, businesses, or commercial properties; special
hazards; earthquakes and other natural events; over-leveraging of the borrower
or on the property; reduction in market rents and occupancies and poor property
management practices; 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 increase beyond levels that we have anticipated. Credit
losses on real estate loans can vary for reasons not related to the general
economy.
With
respect to most of the loans securitized by securitization entities sponsored
by
us and for a portion of the loans underlying residential loan CES we have
acquired from securitizations sponsored by others, the interest rate is
adjustable. 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.
We
also
acquire credit-enhancement securities backed by negative amortization
adjustable-rate loans made to residential borrowers, some of which are
prime-quality loans while many are alt-a quality loans (and a few are subprime
loans). We invest in these riskier loan types with the expectation of
significantly higher delinquencies and losses as compared to regular
amortization loans, but believe these securities offer us the opportunity to
generate attractive risk-adjusted returns as a result of attractive pricing
and
the manner in which these securitizations are structured. Nevertheless, there
remains substantial uncertainty about the future performance of these
assets.
The
large
majority of the commercial loans we credit-enhance are fixed-rate loans, some
of
which are interest-only loans. In general, these loans are not fully amortizing
and therefore require balloon payments at maturity. Consequently, we could
be
exposed to credit losses at the maturity of these loans if the borrower is
unable to repay or refinance the borrowing with another third party
lender.
We
will
experience credit losses on residential and commercial loans and CES, and to
the
extent the losses are consistent with the amount and timing of our assumptions,
we expect to earn attractive returns on our investments. We manage our credit
risks by understanding the extent of the risk we are taking and insuring the
appropriate underwriting criteria are met, and we utilize systems and staff
to
continually monitor the ongoing credit performance of each loan and security.
To
the extent we find the credit risks on specific assets are changing adversely,
we will take actions (including selling the assets) to mitigate potential
losses. However, we may not always be successful in foreseeing adverse changes
in credit performance or in effectively mitigating future credit
losses.
In
addition to residential and commercial CES, the Acacia entities we sponsor
own
investment-grade and other securities issued by securitization entities that
are
sponsored by others. These investment-grade securities are typically rated
AAA
through B, and are in a second-loss or better position or are otherwise
effectively more senior in the credit structure in comparison to first-loss
CES
or their equivalent. A risk we face with respect to these securities is that
we
do not generally control or influence the underwriting, servicing, management,
or loss mitigation with respect to these underlying loans.
The
Acacia entities also own securities backed by subprime and alt-a residential
loans that have substantially higher credit risk characteristics than
prime-quality loans. Consequently, we can expect these lower-quality loans
to
have higher rates of delinquency and loss, and if such losses differ from our
assumptions, Acacia (and thus Redwood) could suffer losses.
In
addition to the foregoing, the Acacia entities own certain investment-grade,
BB-rated, and B-rated residential loan securities purchased from the Sequoia
securitization entities we sponsor. These securities are less likely to suffer
credit losses than other securities since credit losses ordinarily would not
occur until cumulative credit losses within the pool of securitized loans exceed
the principal value of the subordinated CES underneath and other credit
protections have been exhausted. However, if the pools of residential and
commercial loans underlying these securities were to experience poor credit
results, these Acacia securities could have their credit ratings downgraded,
could suffer losses in fair 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
Interest
rates and the shape of the yield curve can affect the cash flows and fair market
values of our assets, liabilities, and interest rate agreements, and
consequently, affect our earnings and reported equity. Our general strategy
with
respect to interest rates is to maintain an asset/liability posture (including
hedges) on a consolidated basis that assumes some interest rate risks but not
to
such a degree that the achievement of our long-term goals would likely be
affected by changes in interest rates. Accordingly, we are willing to accept
short-term volatility of earnings and changes in our reported equity in order
to
accomplish our goal of achieving attractive long-term returns.
To
implement our interest rate risk strategy, we may use interest rate agreements
in an effort to maintain a close match between pledged assets and Redwood debt,
as well as between the interest rate characteristics of the assets in the
securitization entities and the corresponding ABS issued. However, we do not
attempt to completely hedge changes in interest rates, and at times, we may
be
subject to more interest rate risk than we generally desire in the long term.
Changes in interest rates will have an impact on the values and cash flows
of
our assets and corresponding liabilities.
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 and through triggering fair market
value write-downs. For example, amortization income from discount assets may
not
necessarily offset amortization expense from premium assets, and vice-versa.
In
addition, variations in current and projected prepayment rates for individual
assets and changes in interest rates (as they affect projected coupons on ARMs
and other assets and thus change effective yield calculations) may cause net
premium amortization expense or net discount amortization income to vary
substantially from quarter to quarter. Moreover, the timing of premium
amortization on assets may not always match the timing of the premium
amortization on liabilities even when the underlying assets and liabilities
are
in the same securitization and pay down at the same rate.
With
respect to securities backed by residential mortgage loans (and in particular,
IO securities), changes in prepayment forecasts by market participants could
affect the market prices of those securities sold by securitization entities,
and thus could affect the profits we earn from securitized assets.
Prepayment
risks also exist 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 while premium
securities (such as IO securities) benefit from slower prepayments on the
underlying loans. Our largest current potential exposure to changes in
prepayment rates is on short-term residential ARM loans. We are currently biased
in favor of faster prepayment speeds with respect to the long-term economic
effect of ARM prepayments. However, for GAAP in the short-term, increases in
ARM
prepayment rates could result in negative GAAP earnings volatility.
Through
our ownership of discount residential loan CES backed by fixed rate and hybrid
residential loans, we generally benefit from faster prepayments on those
underlying loans. Prepayment rates for those loans typically accelerate as
medium-and-long-term interest rates decline.
Our
credit results and risks can also be affected by prepayments. For example,
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.
We
caution that prepayment rates are difficult to predict or anticipate, and
variations in prepayment rates can materially affect our earnings and dividends.
ARM prepayment rates, for example, 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.
We
do not
believe it is possible or desirable to control the effects of prepayments in
the
short-term. Consequently, our general approach is to seek to balance overall
characteristics of our balance sheet so that the net present values of cash
flows generated over the life of the assets and liabilities in our consolidated
portfolios do not materially change as prepayment rates change.
Fair
Market Value and Liquidity Risks
Most
of
our consolidated real estate loans are accounted for as held-for-investment
and
reported at amortized cost. Most of these loans have been sold to Sequoia
entities and, thus, changes in the fair market value of the loans do not have
an
impact on our liquidity. However, changes in fair market values during the
accumulation period (while these loans are funded with Redwood debt before
they
are sold to a Sequoia entity) may have a short-term effect on our liquidity.
We
may own some real estate loans accounted for as held-for-sale and adverse
changes in their value would be recognized through our income statement and
may
have an impact on our ability to obtain financing for them.
The
consolidated securities are accounted for as available-for-sale and are
generally marked-to-market through our balance sheets and not through our income
statement. Some of these assets are credit-sensitive, and all are interest-rate
sensitive. Fair market value fluctuations of these assets can affect reported
stockholders’ equity. Most of these securities are owned by securitization
entities we sponsor and fair market value fluctuations on these securities
do
not have an impact on our liquidity. Fair market value fluctuations on
securities we own and fund with short-term debt (generally prior to
securitization) could have an impact on our liquidity. Our earnings could be
affected by adverse changes in fair market values on all securities we own
or
consolidate to the extent there is an accompanying adverse change in projected
cash flows. In these cases, the negative changes in fair market values are
reported through our income statement.
Beginning
in the first quarter of 2007, we classified other real estate investments as
trading instruments. Changes in the fair market values of these investments
are
recognized through our income statement. Thus, changes in fair market values
may
add to the quarterly volatility of our earnings. This could occur whether these
instruments are hedged or are financed with non-recourse debt.
Our
consolidated obligations consist primarily of ABS issued. These are reported
at
amortized cost. Generally, changes in fair market value of ABS issued have
no
impact on our liquidity. However, because many of our consolidated assets funded
with ABS issued are reported at fair market value, the resulting reported net
equity may not necessarily reflect the true net fair market value of assets
and
liabilities in these securitization entities. Specifically, we mark-to-market
most of the assets and derivatives owned by the Acacia entities, but none of
Acacia’s liabilities. If fair market values for Acacia’s assets declined
sufficiently, we could be required to record balance sheet charges in excess
of
the total maximum economic amount that Redwood actually has invested.
Conversely, we would not be able to reflect an offsetting improvement in Acacia
liability fair market value changes in our consolidated financial statements.
These fair market value changes may not affect the cash flows we expect to
earn
from our Acacia investments, however.
We
hold
some assets funded with short-term debt that is recourse to Redwood. At some
point, this may increase our fair market value and liquidity risks. We manage
these risks by maintaining what we believe to be conservative capital levels
under our internal risk-adjusted capital and risk management policies and by
ensuring we have a variety of financing facilities available to fund each of
our
assets.
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. Our activities and
balance sheets 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 assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reported period. Actual
results could differ from those estimates. The critical accounting policies
and
the possible effect of changes in estimates on 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.
Revenue
Recognition
When
recognizing revenue on consolidated earning assets, we employ the effective
yield method and use assumptions about the future to determine an effective
yield that drives amortization of premiums, discounts, and other net capitalized
fees and costs associated with purchasing and financing real estate loans and
securities.
Loan
Premium Amortization
For
consolidated real estate loans, the effective yield method is applied as
prescribed under FAS 91. For loans acquired prior to July 2004, we apply
the existing interest rate at the reporting date rate to determine the effective
yield for each pool of loans. During a period of rising short-term rates, the
coupon is projected to increase, resulting in a higher effective yield. Under
those circumstances, prior to the coupon rate resetting (generally one to six
months for these loans), the amount of amortization is lower than it will be
once the coupon rate resets. Consequently, for the past two years, as short-term
rates increased, the amount of purchase premium we amortized was less than
it
would have been in a flat interest rate environment. With lower premium
amortization expenses as a result of rising interest rates combined with rapid
prepayments, our cost bases have increased on our remaining loans. The cost
bases in these loans continues to exceed their estimated fair market
values.
For
loans
acquired after July 1, 2004, we use the initial coupon interest rate of the
loans (without regard to future changes in the underlying indices) and
anticipated principal payments on a pool basis to calculate an effective yield
and to amortize the premium or discount. Any volatility in amortization expense
is dependent primarily on prepayments. The cost bases of these loans are
approximately equal to their fair market values.
Securities
Discount Amortization
For
discount amortization on our consolidated securities, an effective yield is
applied by projecting cash flows that incorporate assumptions of credit losses,
prepayment speeds, and interest rates over the remaining life of each asset.
If
our assumptions prove to be accurate, then the yield that we recognize in the
current period will remain the same over the life of the security. We constantly
review - and update as necessary - our assumptions and resulting cash flow
projections based on historical performance, input and analyses received from
external sources, internal models, and our own judgment and experience. There
can be no assurance that our assumptions used to generate future cash flows
will
prove to be accurate or that these estimates will not change
materially.
The
majority of our discount amortization is generated from residential and
commercial CES purchased at a significant discount to par value. Discount
balances equal to the credit losses that we expect to incur are set aside as
a
form of credit reserve and are not amortized into income. The level of this
reserve is based upon our assessment of various factors including economic
conditions, characteristics and delinquency status of the underlying loans,
past
performance of similar loans, and other factors. Thus, when credit losses do
occur, they are recorded against this reserve and there is no income statement
impact at that time. The difference between the amount of our total discount
and
the credit reserve is the accretable discount. The accretable discount
represents the amount of discount amortization that we expect to recognize
into
income over the remaining life of the assets. As we update our estimate of
future credit losses, increases in projected losses will increase the discount
set aside as reserve resulting in less accretable discount for amortization
into
income and lower portfolio yields. In contrast, lower credit loss projections
will decrease the reserve and increase the accretable discount balance,
increasing our CES discount amortization and resulting in higher portfolio
yields.
The
timing of projected receipt of cash flows from our CES is also an important
driver in the effective yield. Slower actual or projected prepayment speeds
will
cause projected receipt of cash flows to be delayed and will reduce the rate
of
CES discount accretion resulting in a lower yield for the portfolio. An increase
in actual or projected prepayment speeds will generally result in a higher
portfolio yield as a result of increased CES discount amortization.
Amortization
of ABS Issued Premium
We
apply
the effective yield method in determining amortization for the sales premium
and
deferred asset-backed securities issuance cost for ABS issued. ABS sales premium
is eventually recognized through our income statement as a reduction in interest
expense and the issuance cost amortized as additional interest expense. Similar
to our securities discount amortization, the use of this method requires us
to
project cash flows over the remaining life of each liability. These projections
are primarily impacted by forecasted prepayment rates of the related assets.
If
prepayment speeds are faster than modeled, the average life of the liability
will shorten, and we will recognize the ABS sales premium as expense at a faster
rate, and increasing net income. If prepayment speeds are slower than expected,
the average life of the liability will lengthen, and it will take us longer
to
recognize the ABS sales premium. For the deferred asset-backed securities
issuance costs, faster prepayments will result in faster amortization and an
increase in interest expense while slower prepayments will result in slower
amortization and a decrease in interest expense.
Establishing
Valuations and Accounting for Changes in Valuations
We
report
our securities at fair market value on our consolidated balance sheets. We
believe that the estimates of fair market value we use reflect fair market
values that we may be able to obtain should we choose to sell assets. Our
estimates, however, are inherently subjective in nature and involve matters
of
uncertainty and judgment in interpreting relevant market and other data. Because
we are also active acquirers, an issuer of debt securities, and an occasional
seller of assets, 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. However, changes
in perceptions regarding future events in spreads used to price assets can
have
a material impact on the fair market values of our assets. Should such changes
occur, there could be significant decreases in the fair market values of these
assets.
We
estimate the fair market values using available market information and other
appropriate valuation methodologies. Many assumptions are necessary to estimate
fair 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 fair market values. Our expectations of
future performance are shaped by historical performance and input and analyses
received from external sources, internal models, and our own judgment and
experience. In addition to our valuation processes, we use third party sources
to validate our valuation estimates. We mark our assets to
fair market value at the lower of our internal valuation process and
external values received from third party sources on our specific assets. This
gives us a fair market value at the conservative end of the possible
range.
Generally,
changes in the fair market value of real estate securities are reported through
equity. However, it is possible that decreases in fair market values of real
estate securities could be reported through the income statement. See the
discussion on other-than-temporary impairments below. Changes in the fair market
value of other real estate investments are reported through current period
earnings as these are treated as trading securities. Total income recognized
in
current period earnings on these investments equals coupon interest earned
plus
or minus change in fair market value. Interest income is equal to the
instruments’ yields based on market expectations.
Other-than-Temporary
Impairments
Increases
in our credit loss assumptions or changes in projected prepayment rates could
result in an adverse change in the net present value of expected cash flows.
If
we have an adverse change in projected cash flows and also the fair market
value
of that asset is less than our amortized cost, we have an other-than-temporary
impairment. The basis of the asset is written down to fair market value through
our consolidated statements of income. Fair market value write-downs of this
type could be substantial, reducing GAAP income and causing a loss. However,
for
securitized assets, reductions in fair market values may not affect our cash
flows or investment returns at all, or may not affect them to the degree implied
by the accounting write-down.
Credit
Reserves on Loans Held-for-Investment
For
consolidated real estate loans held-for-investment, we establish and maintain
credit reserves that we believe represent probable credit losses that will
result from intrinsic losses existing in our pool of consolidated 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 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 reserve for credit losses for real estate loans, we determine
intrinsic 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 and estimate expected losses of each pool over their expected lives.
Once
we determine the loss factors, 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 estimated 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
do not
maintain a loan repurchase reserve, as any risk of loss due to loan repurchases
(i.e., due to breach of representations) would normally be covered by recourse
to the companies from whom we acquired the loans.
Accounting
for Derivative Instruments
We
use
derivative instruments to manage certain risks such as interest rate risk and
fair market value risks. We may also acquire derivative financial instruments
as
investments. Derivative instruments are reported on our consolidated balance
sheets at their fair market value. If a derivative instrument has a positive
fair market value, it is reported as an asset. If the fair market value is
negative, the instrument is reported as a liability.
Changes
in fair market values of derivative instruments are reported either through
the
income statement or through our equity. For derivatives accounted for as trading
instruments, all changes in the fair market values are recognized through the
income statement. For interest rate agreements (a type of derivative) accounted
for as a cash flow hedge, most of the changes in fair market values are recorded
in our balance sheet through equity. Only the ineffective portions (as
determined according to the accounting principle) of the derivatives accounted
for as cash flow hedges are included in our income.
Using
derivatives may increase our earnings volatility, as the accounting results
for
derivatives may not match the accounting results for the hedged asset or
liability due to our inability to, or decision not to, meet the requirements
for
certain accounting treatments, or if the derivatives do not perform as
intended.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Discussions
about our quantitative and qualitive disclosures about market risk are included
in our Management’s Discussion and Analysis included herein.
ITEM
4. 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
June 30, 2007, which is the end of the period covered by this Report on Form
10-Q, our disclosure controls and procedures are effective.
There
have been no changes in our internal controls over financial reporting in the
fiscal quarter ended June 30, 2007 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
PART
II
ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
|
|
Issuer
Purchases of Equity Securities
|
|
Period
|
|
Total
Number
of
Shares
Purchased
|
|
Average
Price
Paid
Per
Share
|
|
Total
Number
of
Shares
Purchased
As
Part of
Publicly
Announced
Programs
|
|
Maximum
Number
of
Shares
Available
for
Purchase
Under
Publicly
Announced
Programs
|
|
|
|
|
|
|
|
|
|
|
|
April 1
- April 30,
2007
|
|
|
—
|
|
$
|
—
|
|
|
—
|
|
|
—
|
|
May 1
- May 31, 2007
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
June
1 - June 30, 2007
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total
|
|
|
—
|
|
$
|
—
|
|
|
—
|
|
|
1,000,000
|
|
No
shares
were purchased for the three months ended June 30, 2007 to satisfy tax
withholding requirements on the vesting of restricted shares. We announced
stock
repurchase plans on various dates from September 1997 through
November 1999 for the total repurchase of 7,455,000 shares. None of these
plans have expiration dates on repurchases. Shares totaling 1,000,000 are
currently available for repurchase under those plans.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The
2007
annual meeting of stockholders of Redwood Trust, Inc. was held on May 18,
2007.
The
following matters were voted on at the annual meeting of
stockholders:
The
election of the following nominees as Class I directors to serve until the
annual meeting of stockholders in 2010 and until their successors are duly
elected and qualify.
|
|
Votes
|
|
Nominee
|
|
For
|
|
Withheld
|
|
Richard
D. Baum
|
|
|
25,343,675
|
|
|
175,252
|
|
Mariann
Byerwalter
|
|
|
25,339,871
|
|
|
179,056
|
|
David
L. Tyler
|
|
|
25,317,502
|
|
|
201,425
|
|
The
following Directors’ terms of office continue after the annual
meeting:
Thomas
C.
Brown
George
E.
Bull, III
Greg
H.
Kubicek
Georganne
C. Proctor
Charles
J. Toeniskoetter
Douglas
B. Hansen
ITEM
6. EXHIBITS
Exhibit
Number
|
|
Exhibit
|
|
|
|
31.1
|
|
Certification
of the Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
31.2
|
|
Certification
of the Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
|
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
|
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
REDWOOD
TRUST, INC.
|
|
|
|
Dated:
August 8, 2007
|
By:
|
/s/
Douglas B. Hansen
|
|
|
Douglas
B. Hansen
President
(authorized
officer of registrant)
|
Dated:
August 8, 2007
|
By:
|
/s/
Martin S. Hughes
|
|
|
Martin
S. Hughes
Vice
President, Chief Financial Officer,
and
Secretary
(principal
financial officer)
|
Dated:
August 8, 2007
|
By:
|
/s/
Raymond S. Jackson
|
|
|
Raymond
S. Jackson
Vice
President and Controller
(principal
accounting officer)
|