Filed Pursuant
to Rule 424(b)(5)
Registration No.
333-25643
PROSPECTUS SUPPLEMENT
(TO PROSPECTUS DATED MARCH 12, 2001)
500,000 SHARES
[REDWOOD LOGO]
REDWOOD TRUST, INC.
COMMON STOCK
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Redwood Trust, Inc. is offering 500,000 shares of its common stock. Our
common stock is traded on the New York Stock Exchange under the symbol "RWT."
The last reported sale price of the common stock on the New York Stock Exchange
on April 23, 2002 was $27.01 per share.
------------------------------
INVESTING IN OUR COMMON STOCK INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE S-4.
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PER SHARE TOTAL
--------- --------------
Public offering price.................................. $27.01 $13,505,000.00
Underwriting discounts................................. $ 1.02 $ 510,000.00
Proceeds before expenses to Redwood Trust, Inc......... $25.99 $12,995,000.00
The underwriter named in this prospectus supplement may purchase up to an
additional 75,000 shares of common stock from us under selected circumstances.
The underwriter expects to deliver the shares to purchasers on or about April
29, 2002.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus supplement and the accompanying prospectus is truthful or complete.
Any representation to the contrary is a criminal offense.
------------------------------
FLAGSTONE SECURITIES
PROSPECTUS SUPPLEMENT DATED APRIL 23, 2002
PROSPECTUS SUPPLEMENT SUMMARY
This summary highlights information contained elsewhere or incorporated by
reference in this prospectus supplement and the accompanying prospectus. This
summary does not contain all of the information that you should consider before
investing in our common stock. You should carefully read the entire prospectus
supplement and the accompanying prospectus, including in each case the documents
incorporated by reference, and with particular attention to the section entitled
"Risk Factors" beginning on page S-4 and our consolidated financial statements
and the notes to the consolidated financial statements incorporated by
reference.
THE COMPANY
Redwood Trust is a real estate finance company. We distribute to our
stockholders as dividends the mortgage payments we receive from our real estate
loans and securities, less interest expenses and operating costs.
Our primary business is owning, financing, and credit enhancing
high-quality jumbo residential mortgage loans. Jumbo residential loans have
mortgage balances that exceed the financing limit imposed on Fannie Mae and
Freddie Mac, both of which are United States government-sponsored real estate
finance entities. Most of the loans that we finance have mortgage loan balances
between $300,000 and $600,000.
We acquire high-quality jumbo residential mortgage loans from large,
high-quality mortgage origination companies. We hold these loans on our balance
sheet to earn interest income. We typically fund these loans with a combination
of equity and long-term amortizing non-recourse debt. At December 31, 2001, our
residential mortgage loan portfolio totaled $1.5 billion.
We also acquire mortgage securities representing subordinated interests in
pools of high-quality residential mortgage loans. By acquiring the subordinated
securities of these loan pools, we provide credit-enhancement for the more
senior securities backed by the pool so the senior securities can be sold to
capital market investors. Our total investment in residential credit-enhancement
securities was $191 million at December 31, 2001. The residential mortgage loans
in the pools that we credit enhanced in this manner totaled $52 billion at
December 31, 2001. Our prospective returns from our investment in these credit-
enhancement securities will be driven primarily by the future credit performance
of these mortgages.
We also own and finance commercial mortgage loans and own a portfolio of
residential and commercial real estate securities. At December 31, 2001, our
commercial mortgage loan portfolio totaled $51 million and our securities
portfolio totaled $683 million. We may acquire or create other types of assets
in the future.
We have elected, and anticipate that Redwood Trust will continue to elect,
to be organized as a real estate investment trust, or REIT. As a REIT, we
distribute substantially all of our net taxable earnings (excluding earnings
generated in taxable subsidiaries) to our stockholders as dividends. As long as
we retain our REIT status, we will not pay most types of corporate income taxes
on taxable income earned in Redwood Trust, Inc.
Redwood Trust, Inc. was incorporated in the State of Maryland on April 11,
1994, and commenced operations on August 19, 1994. Our executive offices are
located at 591 Redwood Highway, Suite 3100, Mill Valley, California 94941.
At April 23, 2002, Redwood Trust had outstanding 14,835,249 shares of
common stock (New York Stock Exchange, Symbol "RWT") and 902,068 shares of Class
B Cumulative Convertible Preferred Stock (New York Stock Exchange, Symbol
"RWT-PB").
For more information about Redwood Trust, please visit
www.redwoodtrust.com. Information on our web site and on web sites linked to it
is not part of this prospectus supplement or the accompanying prospectus.
S-1
RECENT DEVELOPMENTS
In March 2002, our Board of Directors declared a regular dividend on our
common stock for the first quarter of 2002. The regular quarterly cash dividend
for the first quarter of $0.62 per share of common stock is payable on April 22,
2002 to common stockholders of record as of March 29, 2002. Our Board of
Directors also declared a first quarter preferred dividend of $0.755 per share,
which is payable on April 22, 2002 to preferred stockholders of record as of
March 29, 2002.
In February 2002, we completed a follow-on offering of 1,725,000 shares of
common stock for net proceeds of approximately $40 million. Net proceeds from
this offering were for the purpose of funding the continued expansion of our
residential and commercial real estate finance business. As of the date of this
prospectus supplement, we have invested or have commitments to invest the bulk
of the net proceeds from the February 2002 offering.
In April 2002, we priced approximately $510 million of long-term debt
through our Sequoia securitization program. This debt will be amortizing,
callable, primarily AAA-rated and will be matched to the prepayment and maturity
characteristics of the underlying residential mortgage loans. We expect to issue
this debt in late April 2002. The net proceeds from this debt issuance will be
used to reduce our short-term debt.
For the first quarter of 2002, we will report core earnings of $0.77 per
share, an increase of 5% over our first quarter of 2001 core earnings per share
of $0.73. Core earnings equal earnings calculated in accordance with generally
accepted accounting principles, or GAAP, excluding mark-to-market adjustments
and non-recurring items. GAAP earnings for the first quarter of 2002 were $0.80
per share. Credit results remained strong during the quarter and balance sheet
growth was encouraging. At March 31, 2002, residential mortgage loans totaled
$1.8 billion, residential credit-enhanced securities totaled $250 million,
commercial mortgages totaled $49 million and our securities portfolio totaled
$609 million.
THE OFFERING(1)
Common stock offered.......... 500,000 shares
Common stock outstanding after
this offering(2).............. 15,335,249 shares
Use of proceeds............... We intend to use the net proceeds, together
with borrowings, to purchase mortgage assets.
See "Use of Proceeds."
New York Stock Exchange
trading symbol................ RWT
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(1) Does not include up to 75,000 shares of our common stock that may be issued
in connection with the underwriter's over-allotment option.
(2) Based on shares outstanding as of April 23, 2002. Does not include an
aggregate of 2,522,176 shares of common stock reserved for issuance upon
exercise of outstanding options and convertible preferred stock.
S-2
SUMMARY OF SELECTED FINANCIAL DATA
Core earnings were $0.76 per share for the fourth quarter of 2001, an
increase of 23% over fourth quarter 2000 core earnings of $0.62 per share. Core
earnings were $0.76 per share in the third quarter 2001. Core earnings for the
year 2001 were $3.05 per share, an increase of 47% over core earnings for the
year 2000 of $2.08 per share and an increase of 78% over core earnings per share
of $1.71 for 1999. Core earnings equal GAAP earnings excluding mark-to-market
adjustments and non-recurring items.
Core earnings are not a measure of earnings in accordance with GAAP. Core
earnings are calculated as GAAP earnings from ongoing operations less
mark-to-market adjustments (on certain assets, hedges, and stock options) and
non-recurring items. Management believes that core earnings provide relevant and
useful information regarding our results of operations in addition to GAAP
measures of performance. This is, in part, because market valuation adjustments
on only a portion of our assets, hedges and stock options and none of our
liabilities are recognized through our income statement under GAAP, and these
valuation adjustments may not be fully indicative of changes in market values on
our balance sheet or a reliable guide to our current or future operating
performance. Furthermore, gains or losses realized upon sales of assets and
operating results of closed business units are generally non-recurring and any
non-recurring items may also be unrepresentative of our current or future
operating performance. Because all companies and analysts do not calculate
non-GAAP measures such as core earnings in the same fashion, core earnings as
calculated by us may not be comparable to similarly titled measures reported by
other companies. See page S-16 for reconciliation of GAAP earnings to core
earnings.
GAAP earnings were $0.69 per share for the fourth quarter of 2001 and $2.88
for the year 2001.
YEAR ENDED DECEMBER 31,
-------------------------------------
2001 2000 1999
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(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net interest income (net revenue)........................... $ 46,470 $30,658 $ 26,737
Operating expenses.......................................... (11,836) (7,850) (3,835)
Other income (expense)...................................... (911) (1,578) (21,458)
Net unrealized/realized market value gains (losses)......... 1,532 (2,296) 284
Dividends on Class B preferred stock........................ (2,724) (2,724) (2,741)
Cumulative effect of adopting EITF 99-20.................... (2,368) -- --
-------- ------- --------
GAAP net income (loss) available to common stockholders..... $ 30,163 $16,210 $ (1,013)
======== ======= ========
Diluted GAAP net income (loss) per share.................... $ 2.88 $ 1.82 $ (0.10)
Core earnings(1)............................................ $ 31,910 $18,585 $ 16,622
Core earnings per share(1).................................. $ 3.05 $ 2.08 $ 1.71
Regular dividends declared per common share................. $ 2.22 $ 1.61 $ 0.40
Special dividends declared per common stock................. $ 0.33 -- --
-------- ------- --------
Total common stock dividends per share...................... $ 2.55 $ 1.61 $ 0.40
Book value per common share................................. $ 22.21 $ 21.47 $ 20.88
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(1) Core earnings equal GAAP earnings excluding mark-to-market adjustments and
non-recurring items. Core earnings is not a measure of earnings in
accordance with GAAP and is not intended to be a substitute for GAAP
earnings.
S-3
RISK FACTORS
You should carefully consider the following factors and other information
contained or incorporated by reference in this prospectus supplement and the
accompanying prospectus before deciding to purchase shares of our common stock.
The following is a summary of the risk factors that we currently believe
are important and that could cause our results to differ from expectations. This
is not an exhaustive list; other factors not listed below could be material to
our results.
We can provide no assurances with respect to projections or forward-looking
statements made by us or by others with respect to our future results. Any one
of the risk factors listed below, or other factors not so listed, could cause
actual results to differ materially from expectations. It is not possible to
accurately project future trends with respect to these risk factors, to project
which risk factors will be most important in determining our results, or to
project what our future results will be.
Throughout this prospectus supplement and other documents we release or
statements we make, the words "believe," "expect," "anticipate," "intend,"
"aim," "will," and similar words identify "forward-looking" statements.
MORTGAGE LOAN DELINQUENCIES, DEFAULTS, AND CREDIT LOSSES COULD REDUCE OUR
EARNINGS. CREDIT LOSSES COULD REDUCE OUR CASH FLOW AND ACCESS TO LIQUIDITY.
As a core part of our business, we assume the credit risk of mortgage
loans. We do this in each of our portfolios. We may add other product lines over
time that may have different types of credit risk than are described herein. We
are generally not limited in the types of credit risk or other types of risk
that we can undertake.
We generally intend to increase our credit risk exposure over time through
net acquisitions of credit-sensitive loans and securities and through net
dispositions of more highly-rated securities.
Tax and GAAP accounting for credit losses differ. While we have established
a credit reserve for GAAP reporting purposes, we are not permitted for tax
purposes to reduce our taxable income to provide for a reserve for future credit
losses. Thus, if credit losses occur in the future, taxable income may be
reduced relative to GAAP income. When taxable income is reduced, our minimum
dividend distribution requirements under the REIT tax rules are reduced. We
could reduce our dividend rate in such a circumstance. Alternatively, credit
losses in some assets may be capital losses for tax. Unless we had offsetting
capital gains, our minimum dividend distribution requirement would not be
reduced by these credit losses, but eventually our cash flow would be. This
could reduce our free cash flow and liquidity.
If the recent slowdown in the U.S. economy should persist, or worsen, our
credit losses could be increased beyond levels that we have anticipated. If we
incur increased credit losses, our earnings might be reduced, and our cash
flows, asset market values, and access to borrowings might be adversely
affected. The amount of capital and cash reserves that we hold to help us manage
credit and other risks may prove to be insufficient to protect us from earnings
volatility, dividend cuts, liquidity, and solvency issues.
WE ASSUME DIRECT CREDIT RISK IN OUR RESIDENTIAL MORTGAGE LOANS, AND REALIZED
CREDIT LOSSES MAY REDUCE OUR EARNINGS AND FUTURE CASH FLOW.
In our residential mortgage loan portfolio, we assume the direct credit
risk of residential mortgages. Realized credit losses will reduce our earnings
and future cash flow. For GAAP reporting, we have a credit reserve for these
loans and we may continue to add to this reserve in the future. There can be no
assurance that our credit reserve will be sufficient to cover future losses. We
may need to reduce earnings by increasing our credit-provisioning expenses in
the future.
Credit losses on residential mortgage loans can occur for many reasons,
including: poor origination practices -- leading to losses from fraud, faulty
appraisals, documentation errors, poor underwriting, legal errors, etc.; poor
servicing practices; weak economic conditions; declines in the values of homes;
special
S-4
hazards; earthquakes and other natural events; over-leveraging of the borrower;
changes in legal protections for lenders; reduction in personal incomes; job
loss; and personal events such as divorce or health problems.
Despite our efforts to manage our credit risk, there are many aspects of
credit that we cannot control, and there can be no assurance that our quality
control and loss mitigation operations will be successful in limiting future
delinquencies, defaults, and losses. Our underwriting reviews may not be
effective. The representations and warranties that we receive from sellers may
not be enforceable. We may not receive funds that we believe are due to us from
mortgage insurance companies. We rely on our servicers; they may not cooperate
with our loss mitigation efforts, or such efforts may otherwise be ineffective.
Various service providers to securitizations, such as trustees, bond insurance
providers and custodians, may not perform in a manner that promotes our
interests. The value of the homes collateralizing our loans may decline. The
frequency of default, and the loss severity on our loans upon default, may be
greater than we anticipated. Interest-only loans, negative amortization loans,
loans with balances over $1 million, and loans that are partially collateralized
by non-real estate assets may have special risks. Our geographical
diversification may be ineffective in reducing losses. If loans become "real
estate owned," or REO, we, or our agents, will have to manage these properties
and may not be able to sell them. Changes in consumer behavior, bankruptcy laws
and the like may exacerbate our losses. In some states and circumstances, we
have recourse against the borrower's other assets and income; but, in most cases
we may only be able to look to the value of the underlying property for any
recoveries. Expanded loss mitigation efforts in the event that defaults increase
could be costly. We expect to continue to increase the size of our residential
loan portfolio at a rate faster than we increase our equity base, thus exposing
us to a greater degree to the potential risks of owning these loans.
At December 31, 2001, 22% of our residential mortgage loans were secured by
properties located in California. This concentration in one state may expose us
to special credit risks.
WE HAVE CREDIT RISKS IN OUR RESIDENTIAL CREDIT-ENHANCEMENT SECURITIES RELATED TO
THE UNDERLYING LOANS.
Of our total net investment in residential credit-enhancement securities at
December 31, 2001, $30 million, or 16%, was in a first loss position with
respect to the underlying loans. We generally expect that the entire amount of
these first loss investments will be subject to credit loss, potentially even in
healthy economic environments. Our ability to make an attractive return on these
investments depends on how quickly these expected losses occur. If the losses
occur more quickly than we anticipate, we may not recover our investment and/or
our rates of return may suffer.
Second loss credit-enhancement securities, which are subject to credit loss
when the entire first loss investment (whether owned by us or by others) has
been eliminated by credit losses, made up 31%, or $60 million, of our net
investment in credit-enhancement securities at December 31, 2001. Third loss
credit-enhancement securities, or other investments that themselves enjoy
various forms of material credit enhancement, made up 53%, or $101 million, of
our net investment in credit-enhancement interests at December 31, 2001. Given
our normal expectations for credit losses, we would anticipate some future
losses on many of our second loss interests but no losses on investments in the
third loss or similar position. If credit losses are greater than, or occur
sooner than, expected, our expected future cash flows will be reduced and our
earnings will be negatively affected. Credit losses and delinquencies could also
affect the cash flow dynamics of these securitizations and thus extend the
period over which we will receive a return of principal from these investments.
In most cases, adverse changes in anticipated cash flows would reduce our
economic and accounting returns and may also precipitate mark-to-market charges
to earnings. From time to time, we may pledge these interests as collateral for
borrowings; a deterioration of credit results in this portfolio may adversely
affect the terms or availability of these borrowings and, thus, our liquidity.
We generally expect to increase our net acquisitions of residential
credit-enhancement securities and to increase our net acquisitions of first loss
and second loss investments relative to third loss investments. This may result
in increased risk with respect to the credit results of the residential loans we
credit enhance.
In our credit-enhancement securities portfolio, we may benefit from credit
rating upgrades or restructuring opportunities through re-securitizations or
other means in the future. If credit results deteriorate,
S-5
these opportunities may not be available to us or may be delayed. It is likely,
in many instances, that we will not be able to anticipate increased credit
losses in a pool soon enough to allow us to sell such credit-enhancement
interests at a reasonable price.
In anticipation of future credit losses, we designate a portion of the
purchase discount associated with many of our credit-enhancement securities as a
form of credit reserve. The remaining discount is amortized into income over
time via the effective yield method. If the credit reserve we set aside at
acquisition proves to be insufficient, we may need to reduce our effective yield
income recognition in the future or we may adjust our basis in these interests,
thus reducing earnings.
We adopted EITF 99-20 in the first quarter of 2001. Generally, under EITF
99-20, if prospective cash flows from certain investments deteriorate even
slightly from original expectations -- due to changes in anticipated credit
losses, prepayment rates, and otherwise -- then the asset will be
marked-to-market if the market value is lower than our basis. Any mark-to-market
adjustments under EITF 99-20 reduce earnings in that period. Since we do not
expect every asset we own to always perform equal to or better than our
expectations, we expect to make negative EITF 99-20 adjustments to earnings from
time to time. Any positive adjustments to anticipated future cash flows are
generally reflected in a higher yield recognition for that asset for as long as
anticipated future cash flows remain favorable.
At December 31, 2001, 53% of the properties securing the residential loans
that we credit-enhanced were located in California. This concentration in one
state may expose us to special credit risks.
WE MAY HAVE CREDIT LOSSES IN OUR SECURITIES PORTFOLIO.
Most of our securities (excluding our residential credit-enhancement
securities) are currently rated AAA or AA (99% at December 31, 2001). Most of
these securities are backed by residential and commercial real estate assets.
These securities benefit from various forms of corporate guarantees from Fannie
Mae, Freddie Mac, and other companies, and/or from credit enhancement provided
by third parties, usually through their ownership of subordinated
credit-enhancement interests. Thus, the bulk of our existing securities have
reduced exposure to currently expected levels of credit losses. However, in the
event of greater than expected future delinquencies, defaults, or credit losses,
or a substantial deterioration in the financial strength of Fannie Mae, Freddie
Mac, or other corporate guarantors, our results would likely be adversely
affected. We may experience credit losses in our securities portfolio.
Deterioration of the credit results or guarantees of these assets may reduce the
market value of these assets, thus limiting our borrowing capabilities and
access to liquidity. Generally, we do not control or influence the underwriting,
servicing, management, or loss mitigation efforts with respect to these assets.
Results could be affected through credit rating downgrades, market value losses,
reduced liquidity, adverse financing terms, reduced cash flow, experienced
credit losses, or in other ways. For the non-investment grade assets in our
securities portfolio, representing 1% of our securities portfolio at December
31, 2001, our protection against credit loss is smaller and our credit risks and
liquidity risks are increased. If we acquire equity securities, results may be
volatile. We intend to increase the percentage of our securities portfolio that
is rated below AA and that is rated below investment grade, and we intend to
expand the range of types of securities that we acquire; these trends may
increase the potential credit risks in our securities portfolio.
WE ASSUME DIRECT CREDIT RISK IN OUR COMMERCIAL MORTGAGE LOANS.
The loans in our commercial mortgage loan portfolio may have higher degrees
of credit and other risks than do our residential mortgage loans, including
various environmental and legal risks. The net operating income and market
values of income-producing properties may vary with economic cycles and as a
result of other factors, so that debt service coverage is unstable. The value of
the property may not protect the value of the loan if there is a default. Our
commercial loans are not geographically diverse, so we are at risk for regional
factors: at December 31, 2001, $30 million, or 59%, of our commercial loan
balances were on commercial properties located in California. Many of our
commercial loans are not fully amortizing, so the timely recovery of our
principal is dependent on the borrower's ability to refinance at maturity. We
generally lend against income-properties that are in transition. Such lending
entails higher risks than traditional
S-6
commercial property lending against stabilized properties. Initial debt service
coverage ratios, loan-to-value ratios, and other indicators of credit quality
may not meet standard commercial mortgage market criteria for stabilized loans.
The underlying properties may not transition or stabilize as we expected. The
personal guarantees and forms of cross-collateralization that we receive on some
loans may not be effective. We generally do not service our loans; we rely on
our servicers to a great extent to manage our commercial assets and work-out
loans and properties if there are delinquencies or defaults. This may not work
to our advantage. As part of the work-out process of a troubled commercial loan,
we may assume ownership of the property, and the ultimate value of this asset
would depend on our management of, and eventual sale of, the property which
secured the loan. Our loans are illiquid; if we choose to sell them, we may not
be able to do so in a timely manner or for a satisfactory price. Financing these
loans may be difficult, and may become more difficult if credit quality
deteriorates. We have sold senior loan participations on some of our loans, so
that the asset we retain is junior and has concentrated credit, servicing, and
other risks. We have directly originated our commercial loans. This may expose
us to certain credit, legal, and other risks that may be greater than is usually
present with acquired loans. We have sold commercial mortgage loans. The
representations and warranties we made on these sales are limited, but could
cause losses and claims in some circumstances. On a net basis, we intend to
increase our investment in commercial real estate loans and in junior
participations of these loans.
WE MAY INVEST IN OTHER TYPES OF CREDIT RISKS THAT COULD ALSO CAUSE LOSSES.
We intend to invest in other types of commercial loan assets, such as
mezzanine loans, second liens, credit-enhancement interests of commercial loan
securitizations, junior participations, among others, that may entail other
types of risks. In addition, we intend to invest in other assets with material
credit risk, including sub-prime residential mortgage securities, the equity and
debt of collateralized bond obligations (CBOs), corporate debt and equity of
REITs and non-real estate companies, real estate and non-real estate asset-
backed securities, and other financial and real property assets.
OUR RESULTS COULD ALSO BE ADVERSELY AFFECTED BY COUNTER-PARTY CREDIT RISK.
We have other credit risks that are generally related to the
counter-parties with which we do business. In the event a counter-party to our
short-term borrowings becomes insolvent, we may fail to recover the full value
of our collateral, thus reducing our earnings and liquidity. In the event a
counter-party to our interest rate agreements becomes insolvent or interprets
our agreements with them in an unfavorable manner, our ability to realize
benefits from hedging may be diminished, and any cash or collateral that we
pledged to these counter-parties may be unrecoverable. We may be forced to
unwind these agreements at a loss. In the event that one of our servicers
becomes insolvent or fails to perform, loan delinquencies and credit losses may
increase. We may not receive funds to which we are entitled. In various other
aspects of our business, we depend on the performance of third parties that we
do not control. We attempt to diversify our counter-party exposure and to limit
our counter-party exposure to strong companies with investment-grade credit
ratings, but we are not always able to do so. Our counter-party risk management
strategy may prove ineffective.
FLUCTUATIONS IN OUR RESULTS MAY BE EXACERBATED BY THE LEVERAGE THAT WE EMPLOY
AND BY LIQUIDITY RISKS.
We employ substantial financial leverage on our balance sheet relative to
many non-financial companies, although we believe we employ less leverage than
most banks, thrifts, and other financial institutions. In addition, the bulk of
our financing is typically in the form of non-recourse debt issued through asset
securitization. We believe this is generally an effective and lower-risk form of
financing compared to many other forms of debt utilized by financial companies.
We believe the amount of leverage that we employ is appropriate, given the risks
in our balance sheet, the non-recourse nature of the long-term financing
structures that we typically employ, and our management policies. However, in
order to operate our business successfully, we require continued access to debt
on favorable terms with respect to financing costs, capital efficiency,
covenants, and other factors. We may not be able to obtain debt on such terms.
Due to our leverage, relatively small changes in asset quality, asset
yield, cost of borrowed funds, and other factors could have relatively large
effects on us and our stockholders, including fluctuations in earnings
S-7
and liquidity. Our use of leverage may not enhance our returns and could erode
our financial soundness. In general, we currently intend to increase our use of
leverage in the future through asset accumulation funded by securitized
non-recourse debt issuance.
Although we do not have a corporate debt rating, the nationally-recognized
credit rating agencies have a strong influence on the amount of capital that we
hold relative to the amount of credit risk we take. The rating agencies
determine the amount of net investment we must make to credit enhance the
long-term debt, mostly rated AAA, that we issue to fund our residential loan
portfolio. They also determine the amount of principal value required for the
credit-enhancement interests we acquire. The rating agencies, however, do not
have influence over how we fund our net credit investments nor do they determine
or influence many of our other capital and leverage policies. With respect to
our short-term debt, our lenders, typically large commercial banks and Wall
Street firms, limit the amount of funds that they will advance versus our
collateral. We typically use far less leverage than would be permitted by our
lenders. However, lenders can reduce the amount of leverage that they will
permit us to undertake, or the value of our collateral may decline, thus
reducing our liquidity.
Unlike banks, thrifts, and the government-sponsored mortgage finance
companies, we are not regulated by national regulatory bodies. Thus, the amount
of financial leverage that we employ is largely controlled by management, and by
the risk-adjusted capital policies approved by our Board of Directors.
In the period in which we are accumulating loans, securities, or other
assets in order to build a portfolio of efficient size to issue securitized
long-term debt, variations in the market for these assets or for long-term debt
issuance could affect our results. Ultimately we may not be able to issue long
term debt, the cost of such debt could be greater than we anticipated, the net
investment in our financing trust required by the rating agencies could be
greater than anticipated, certain of our assets could not be accepted into the
financing trust, the market value of our assets to be sold into the financing
trust may have changed, our hedging activities or agreements with
counter-parties may have been ineffective, or other negative effects could
occur.
We borrow on a short-term basis to fund a portion of our securities
portfolio, to fund residential loans or other assets prior to the issuance of
long-term debt, to use a certain amount of leverage with respect to our net
investments in credit-enhancement interests, to fund a portion of our commercial
loan portfolio, to fund working capital and general corporate needs, and for
other reasons. We borrow short-term by pledging our assets as collateral. We
usually borrow via uncommitted borrowing facilities for the substantial majority
of our short-term debt funded assets that are generally liquid, have active
trading markets, and have readily discernable market prices. The term of these
borrowings can range from one day to one year. To fund less liquid or more
specialized assets, we typically utilize committed credit lines from commercial
banks and finance companies with a one to two year term. Whether committed or
not, we need to roll over short-term debt on a frequent basis; our ability to
borrow is dependent on our ability to deliver sufficient market value of
collateral to meet lender requirements. Our payment of commitment fees and other
expenses to secure committed borrowing lines may not protect us from liquidity
issues or losses. Variations in lenders' ability to access funds, lender
confidence in us, lender collateral requirements, available borrowing rates, the
acceptability and market values of our collateral, and other factors could force
us to utilize our liquidity reserves or to sell assets, and, thus, affect our
liquidity, financial soundness, and earnings. In recent years, we believe that
the marketplace for our type of secured short-term borrowing has been more
stable than the commercial paper market (corporate unsecured short-term
borrowing typically utilized by larger corporations), but there is no assurance
that such stability will continue. Our current intention is to reduce our
short-term debt levels over time, with the exception of short-term debt used to
fund assets under accumulation for a securitization. There can be no assurance
that this planned short-term debt reduction will be achieved. In the future, we
may borrow on an unsecured basis through bank loans, issuance of corporate debt,
and other means.
Various of our borrowing arrangements subject us to debt covenants. While
these covenants have not meaningfully restricted our operations through December
31, 2001, they could be restrictive or harmful to us and our stockholder
interests in the future. Should we violate debt covenants, we may incur
expenses, losses, or reduced ability to access debt.
S-8
Preferred stock makes up a portion of our equity capital base, representing
9% at December 31, 2001. Our Class B Preferred Stock has a dividend rate of at
least $0.755 per share per quarter, and has certain rights to dividend
distributions and preferences in liquidation that are senior to common
stockholders. Having preferred stock in our capital structure is a form of
leverage, and such leverage may or may not work to the advantage of common
stockholders.
CHANGES IN THE MARKET VALUES OF OUR ASSETS AND LIABILITIES CAN ADVERSELY AFFECT
OUR EARNINGS, STOCKHOLDERS' EQUITY, AND LIQUIDITY.
The market values of our assets, liabilities, and hedges are affected by
interest rates, the shape of yield curves, volatility, credit quality trends,
mortgage prepayment rates, supply and demand, capital markets trends and
liquidity, general economic trends, expectations about the future, and other
factors. For the assets that we mark-to-market through our income statement or
balance sheet, such market value fluctuations will affect our earnings and book
value. To the extent that our basis in our assets is thus changed, future
reported income may be affected as well. If we sell an asset that has not been
marked-to-market through our income statement at a reduced market price relative
to our basis, our earnings will be reduced. Market value reductions of the
assets that we pledge for short-term borrowings may reduce our access to
liquidity.
Generally, reduced asset market values for the assets that we own may have
negative effects, but might improve our opportunities to acquire new assets at
attractive pricing levels. Conversely, increases in the market values of our
existing assets may have positive effects, but may mean that acquiring new
assets at attractive prices becomes more difficult.
CHANGES IN MORTGAGE PREPAYMENT RATES MAY AFFECT OUR EARNINGS, LIQUIDITY, AND THE
MARKET VALUES OF OUR ASSETS.
Residential and commercial mortgage prepayment rates are affected by
interest rates, borrower behavior and confidence, seasoning of loans, the value
of and amount of equity in the underlying properties, prepayment terms of the
mortgages, the ease and cost of refinancing, the property turnover rate, media
awareness of refinancing opportunities, and many other factors.
Changes in prepayment rates (including prepayments from liquidated
defaulted loans) may have multiple effects on our operations. Faster mortgage
prepayment rates may lead to increased premium amortization expenses for premium
and interest-only assets, increased working capital requirements, reduced market
values for certain types of assets, adverse reductions in the average life of
certain assets, adverse changes in hedge ratios, and an increase in the need to
reinvest cash to maintain operations. Premium assets may experience faster rates
of prepayments than discount assets. Slower prepayment rates may lead to reduced
discount amortization income for discount assets, reduced market values for
discount and other types of assets, extension of the average life of certain
investments at a time when this would be contrary to our interests, adverse
changes in hedge ratios, a reduction in cash flow available to support
operations and make new investments, and a reduction in new investment
opportunities, since the volume of new origination and securitizations would
likely decline. Slower prepayment rates may lead to increased credit losses.
The amount of premium and discount we have on our books, and thus our net
amortization expenses, can change over time as we mark-to-market assets or as
our asset composition changes through principal repayments and asset purchases
and sales.
INTEREST RATE FLUCTUATIONS CAN HAVE VARIOUS EFFECTS ON OUR COMPANY, AND COULD
LEAD TO REDUCED EARNINGS AND/OR INCREASED EARNINGS VOLATILITY.
Our balance sheet and asset/liability operations are complex and diverse
with respect to interest rate movements, so we cannot fully describe all the
possible effects of changing interest rates. We do not seek to eliminate all
interest rate risk. Changes in interest rates, the interrelationships between
various interest rates, and interest rate volatility could have negative effects
on our earnings, the market value of our assets and liabilities, mortgage
prepayment rates, and our access to liquidity. Changes in interest rates can
also affect our credit results.
S-9
Generally, rising interest rates could lead to reduced asset market values
and slower prepayment rates. Initially, our net interest income may be reduced
if short-term interest rates increase, as our cost of funds would likely respond
to this increase more quickly than would our asset yields. Within three to
twelve months of a rate change, however, asset yields for our adjustable rate
mortgages may increase commensurately with the rate increase. Higher short-term
interest rates may reduce earnings in the short-term, but could lead to higher
long-term earnings, as we earn more on the equity-funded portion of our balance
sheet. To the extent that we own fixed-rate assets that are funded with floating
rate debt, our net interest income from this portion of our balance sheet would
be unlikely to recover until interest rates dropped again or the assets matured.
Some of our adjustable-rate mortgages have periodic caps that limit the extent
to which the coupon we earn can rise or fall, usually 2% annual caps, and life
caps that set a maximum coupon. If short-term interest rates rise rapidly or
rise so that our mortgage coupons reach their periodic or life caps, the ability
of our asset yields to rise along with market rates would be limited, but there
may be no such limits on the increase in our liability costs.
Falling interest rates can also lead to reduced asset market values in some
circumstances, particularly for prepayment-sensitive, premium, and other assets
and for many types of interest rate agreement hedges. Decreases in short-term
interest rates can be positive for earnings in the near-term, as our cost of
funds may decline more quickly than our asset yields would. For longer time
horizons, falling short-term interest rates can reduce our earnings, as we may
earn lower yields from the assets that are equity-funded on our balance sheet.
Changes in the interrelationships between various interest rates can reduce
our net interest income even in the absence of a clearly defined interest rate
trend. For instance, if the short-term interest rate indices that drive our
asset yields were to decline relative to the short-term interest rate indices
that determine our cost of funds, our net interest income would be reduced.
HEDGING ACTIVITIES MAY REDUCE LONG-TERM EARNINGS AND MAY FAIL TO REDUCE EARNINGS
VOLATILITY OR TO PROTECT OUR CAPITAL IN DIFFICULT ECONOMIC ENVIRONMENTS; FAILURE
TO HEDGE MAY ALSO HAVE ADVERSE EFFECTS ON OUR RESULTS.
Hedging against interest rate movements using interest rate agreements
(including interest rate swap instruments and interest rate futures) and other
instruments usually has the effect over long periods of time of lowering
long-term earnings. To the extent that we hedge, it is usually to protect us
from some of the effects of a rapid or prolonged increase in short-term interest
rates, to lower short-term earnings volatility, to stabilize liability costs, or
to stabilize the future cost of anticipated liability issuance. Such hedging may
not be in the long-term interest of stockholders, and may not achieve its
desired goals. For instance, hedging costs may rise as interest rates increase,
without an offsetting increase in hedging income. In a rapidly rising interest
rate environment, the market values or cash flows of hedges may not increase as
predicted. Using interest rate agreements to hedge may increase short-term
earnings volatility, particularly since we employ mark-to-market accounting for
our hedges. Reductions in market values of interest rate agreements may not be
offset by increases in market values of the assets or liabilities being hedged.
Conversely, increases in market values of interest rate agreements may not fully
offset declines in market values of assets or liabilities being hedged. Changes
in market values of interest rate agreements may require us to pledge collateral
or cash.
We also may hedge by taking short or long positions in U.S. Treasuries,
mortgage securities, or other instruments. Such hedges may have special basis,
liquidity, and other risks.
At December 31, 2001, we had no hedges in place that would materially
affect our results and operations. We reduced our hedging operations as we
believe we have generally achieved our asset/liability goals with our existing
on-balance sheet assets and liabilities. The absence of hedging, however, may
not prove to be in the best interests of our stockholders. We generally intend
to increase our hedging activities in the future.
S-10
MAINTAINING REIT STATUS MAY REDUCE OUR FLEXIBILITY.
To maintain REIT status, we must follow rules and meet certain tests. In
doing so, our flexibility to manage our operations may be reduced. If we make
frequent asset sales, we could be viewed as a "dealer," and thus subject to
entity level taxes. Certain types of hedging may produce income that is limited
under the REIT rules. Our ability to own non-real estate related assets and earn
non-real estate related income is limited. Meeting minimum REIT dividend
distribution requirements may reduce our liquidity. Because we will generally
distribute all our taxable earnings as dividends, we may need to raise new
equity capital if we wish to grow operations at a rapid pace. Stock ownership
tests may limit our ability to raise significant amounts of equity capital from
one source. Failure to meet REIT requirements may subject us to taxation,
penalties, and/or loss of REIT status. REIT laws and taxation could change in a
manner adverse to our operations. To pursue our business plan as a REIT, we
generally need to avoid becoming a Registered Investment Company, or RIC. To
avoid RIC restrictions, we generally need to maintain at least 55% of our assets
in whole loan form or in other related forms of assets that qualify for this
test. Meeting this test may restrict our flexibility. Failure to meet this test
would limit our ability to leverage and would impose other restrictions on our
operations. Our ability to operate a taxable subsidiary is limited under the
REIT rules. Our REIT status affords us certain protections against take-over
attempts. These take-over restrictions may not always work to the advantage of
stockholders. Our stated goal is to not generate income that would be taxable as
unrelated business taxable income, or UBTI, to our tax-exempt shareholders.
Achieving this goal may limit our flexibility in pursuing certain transactions.
Despite our efforts to do so, we may not be able to avoid distributing UBTI to
our stockholders.
OUR CASH BALANCES AND CASH FLOWS MAY BECOME LIMITED RELATIVE TO OUR CASH NEEDS.
We need cash to meet our working capital, preferred stock dividends minimum
REIT dividend distribution requirements, and other needs. Cash could be required
to paydown our borrowings in the event that the market values of our assets that
collateralize our debt decline, the terms of short-term debt become less
attractive, or for other reasons. Cash flows from principal repayments could be
reduced should prepayments slow or should credit quality trends deteriorate (in
the latter case since, for certain of our assets, credit tests must be met for
us to receive cash flows). For some of our assets, cash flows are "locked-out"
and we receive less than our pro rata share of principal payment cash flows in
the early years of the investment. Operating cash flow generation could be
reduced if earnings are reduced, if discount amortization income significantly
exceeds premium amortization expense, or for other reasons. Our minimum dividend
distribution requirements could become large relative to our cash flow if our
income as calculated for tax purposes significantly exceeds our cash flow from
operations. Generally, our cash flow has materially exceeded our cash
requirements; this situation could be reversed, however, with corresponding
adverse consequences to us. We generally maintain what we believe are ample cash
balances and access to borrowings to meet projected cash needs. In the event,
however, that our liquidity needs exceed our access to liquidity, we may need to
sell assets at an inopportune time, thus reducing our earnings. In an adverse
cash flow situation, our REIT status or our solvency could be threatened.
INCREASED COMPETITION COULD REDUCE OUR ACQUISITION OPPORTUNITIES OR AFFECT OUR
OPERATIONS IN A NEGATIVE MANNER.
We believe that our principal competitors in our business of real estate
finance are depositories such as banks and thrifts, mortgage and bond insurance
companies, other mortgage REITs, hedge funds and private investment
partnerships, life insurance companies, government entities such as Fannie Mae,
Freddie Mac, Ginnie Mae, and the Federal Home Loan Banks, mutual funds, pension
funds, mortgage originators, overseas entities, and other financial
institutions. We anticipate that we will be able to compete effectively due to
our relatively low level of operating costs, relative freedom to securitize our
assets, our ability to utilize leverage, freedom from certain forms of
regulation, focus on our core business, and the tax advantages of our REIT
status. Nevertheless, many of our competitors have greater operating and
financial resources than we do. Competition from these entities, or new
entrants, could raise prices on mortgages and other assets, reduce our
S-11
acquisition opportunities, or otherwise materially affect our operations in a
negative manner. Relative to the years 2000 and 2001, we expect competition to
increase in 2002.
NEW ASSETS MAY NOT BE AVAILABLE AT ATTRACTIVE PRICES, THUS LIMITING OUR GROWTH
AND/OR EARNINGS.
In order to reinvest proceeds from mortgage principal repayments, or to
deploy new equity capital that we may raise in the future, we need to acquire
new assets. If pricing of new assets is unattractive, or if the availability of
new assets is much reduced, we may not be able to acquire new assets at
attractive prices. Our new assets may generate lower returns than the assets
that we have on our balance sheet. Generally, unattractive pricing and
availability of new assets is a function of reduced supply and/or increased
demand. Supply can be reduced if originations of a particular product are
reduced, or if there are few sales in the secondary market of seasoned product
from existing portfolios. The supply of new securitized assets appropriate for
our balance sheet could be reduced if the economics of securitization become
unattractive or if a form of securitization that is not favorable for our
balance sheet predominates. Also, assets with a favorable risk/reward ratio may
not be available if the risks of owning such assets increase substantially
relative to market pricing levels. Increased competition could raise prices to
unattractive levels.
ACCOUNTING CONVENTIONS AND ESTIMATES CAN CHANGE, AFFECTING OUR REPORTED RESULTS
AND OPERATIONS.
Accounting rules for the various aspects of our business change from time
to time. Changes in accounting rules can affect our reported income, earnings
and stockholders' equity. Our revenue recognition and other aspects of our
reported results are based on estimates of future events. These estimates can
change in a manner that adversely affects our results.
OUR POLICIES, PROCEDURES, PRACTICES, PRODUCT LINES, RISKS, AND INTERNAL
RISK-ADJUSTED CAPITAL GUIDELINES ARE SUBJECT TO CHANGE.
In general, we are free to alter our policies, procedures, practices,
product lines, leverage, risks, internal risk-adjusted capital guidelines, and
other aspects of our business. We can enter new businesses or pursue
acquisitions of other companies. In most cases, we do not need to seek
stockholder approval to make such changes. We will not necessarily notify
stockholders of such changes.
WE DEPEND ON KEY PERSONNEL FOR SUCCESSFUL OPERATIONS.
We depend significantly on the contributions of our executive officers and
staff. Many of our officers and employees would be difficult to replace. The
loss of any key personnel could materially affect our results.
INVESTORS IN OUR COMMON STOCK MAY EXPERIENCE LOSSES, VOLATILITY, AND POOR
LIQUIDITY, AND WE MAY REDUCE OUR DIVIDENDS IN A VARIETY OF CIRCUMSTANCES.
Our earnings, cash flow, book value, and dividends can be volatile and
difficult to predict. Investors should not rely on predictions or management
beliefs. Although we seek to pay a regular common stock dividend rate that is
sustainable, we may cut our dividend rate in the future for a variety of
reasons. We may not provide public warnings of such dividend reductions prior to
their occurrence. Fluctuations in our current and prospective earnings, cash
flow, and dividends, as well as many other factors such as perceptions, economic
conditions, stock market conditions, and the like, can affect our stock price.
Investors may experience volatile returns and material losses. In addition,
liquidity in the trading of our stock may be insufficient to allow investors to
sell their stock in a timely manner or at a reasonable price.
S-12
USE OF PROCEEDS
The net proceeds that we will receive from the sale of 500,000 shares of
our common stock in this offering are estimated to be approximately
$12,920,000.00, after deducting underwriting discounts and commissions and
estimated expenses, assuming the over-allotment option is not exercised by the
underwriter, and $14,869,250.00 million assuming the over-allotment option is
exercised in full. We intend to use the net proceeds, together with borrowings,
to purchase new assets, substantially all of which we expect will be mortgage
assets. Pending use of the net proceeds to purchase such assets, the net
proceeds will be used to reduce short-term collateralized borrowings. These
borrowings generally bear interest at rates that adjust based on the one-month
London Inter-Bank Offered Rate, or LIBOR, and are secured by assets owned by us.
S-13
COMMON STOCK DIVIDEND POLICY AND DISTRIBUTIONS
We intend to distribute substantially all of the taxable income that
Redwood Trust, Inc. earns to our stockholders so as to comply with the REIT tax
rules. The taxable income of Redwood Trust, Inc. does not ordinarily equal net
income as calculated for GAAP. We do not ordinarily intend to distribute as
dividends the taxable income we earn in our non-REIT subsidiaries. We currently
declare regular quarterly dividends. Our goal is to pay dividends on our common
stock at a conservative rate that is steady and that is sustainable given the
levels of cash flow we expect to generate from our REIT operations over time. In
March 2002, our Board of Directors declared an increase in the regular quarterly
common stock dividend rate for the first quarter of 2002 to $0.62 per share.
This dividend is payable on April 22, 2002 to common stockholders of record on
March 29, 2002. Based upon our current outlook, we believe that our cash flows
will be sufficient to sustain dividend payments at the common stock dividend
rate of at least $0.62 per share per quarter for the reasonably foreseeable
future. Please see "Risk Factors" for a discussion of some of the factors that
could potentially lead to a lower dividend rate. We have been increasing our
dividend rate in the last few years as our profits and cash flows have
increased. Our Board of Directors will consider additional increases to our
regular dividend rate in the event that our current business initiatives
successfully increase our expected long-term rate of profitability and cash
flows.
In years such as 2001, our Board may declare one or more special dividends
in order to meet the annual minimum dividend distribution requirements necessary
to comply with the REIT tax rules. In 2001, our Board of Directors declared two
special cash dividends totaling $0.33 per share of our common stock. The total
common stock dividend declared, including regular and special dividends, was
$2.55 for the full year of 2001. Our total dividends declared on our preferred
and common stock for 2001 totaled $30 million.
The dividend policy with respect to our common stock is subject to revision
at the discretion of our Board of Directors. All distributions will be made by
us at the discretion of our Board of Directors and will depend on our taxable
and GAAP earnings, our cash flows and overall financial condition, maintenance
of REIT status, and such other factors as our Board of Directors deems relevant.
No dividends will be paid or set apart for payment on shares of our common stock
unless full cumulative dividends have been paid on our Class B 9.74% Cumulative
Convertible Preferred Stock. In March 2002, our Board of Directors also declared
a preferred dividend of $0.755 per share for the first quarter of 2002, which is
payable on April 22, 2002 to preferred stockholders of record on March 29, 2002.
The full cumulative dividends have been paid on the preferred stock through the
end of the first quarter of 2002.
Distributions to our stockholders will generally be subject to tax as
ordinary income, although a portion of such distributions may be designated by
us as capital gain or may constitute a tax-free return of capital. Our Board of
Directors may elect to maintain a steady dividend rate during periods of
fluctuating taxable income. In such event, our Board may choose to declare
dividends that include a return of capital. We will annually furnish to each
stockholder a statement setting forth distributions paid during the preceding
year and their characterization as ordinary income, capital gains or return of
capital. For a discussion of the Federal income tax treatment of our
distributions, see "Federal Income Tax Considerations -- Taxation of Holders of
Redwood Trust's Common Stock" in this prospectus supplement.
S-14
CAPITALIZATION
The following table sets forth our capitalization as of December 31, 2001
(i) on an actual basis, (ii) as adjusted for the issuance of 1,725,000 shares of
our common stock in February 2002, and (iii) as adjusted to give effect to the
issuance as described in clause (ii) above and the issuance of 500,000 shares of
our common stock offered hereby. See "Use of Proceeds." The capitalization
information set forth in the table below is qualified by the more detailed
Consolidated Financial Statements and Notes thereto included in our Annual
Report on Form 10-K for the fiscal year ended December 31, 2001.
DECEMBER 31, 2001
-------------------------------------------------
ACTUAL(1)(2) AS ADJUSTED(3) AS ADJUSTED(3)(4)
------------ -------------- -----------------
(IN THOUSANDS, UNAUDITED)
STOCKHOLDERS' EQUITY:
Preferred stock, par value $0.01 per share; Class B
9.74% Cumulative convertible 902,068 shares
authorized, issued and outstanding ($28,645,000
aggregate liquidation preference)................. $ 26,517 $ 26,517 $ 26,517
Common stock, par value $0.01 per share; 49,097,932
shares authorized; 12,661,749 issued and
outstanding, actual; 14,386,749 shares issued and
outstanding, as adjusted(3); 14,886,749 shares
issued and outstanding, as adjusted(3)(4)......... 127 144 149
Additional paid-in capital........................... 328,668 368,976 381,891
Accumulated other comprehensive income............... 2,701 2,701 2,701
Cumulative earnings.................................. 59,961 59,961 59,961
Cumulative distributions to stockholders............. (110,201) (110,201) (110,201)
--------- --------- ---------
Total stockholders' equity................... $ 307,773 $ 348,098 $ 361,018
========= ========= =========
------------
(1) Excludes as of December 31, 2001 (i) 1,618,501 shares of common stock
issuable upon exercise of outstanding options at a weighted average exercise
price of $22.33 per share and (ii) an aggregate of 299,064 shares available
for future issuance under our Stock Option Plan.
(2) At December 31, 2001, we also utilized borrowings of $796,811,000 of
short-term debt and $1,313,715,000 of long-term debt, net.
(3) Adjusted for the issuance of 1,725,000 shares in February 2002, with net
proceeds of $40,324,500 after underwriting discounts, commissions and other
estimated expenses.
(4) Adjusted for the issuance of 500,000 shares offered hereby, with net
proceeds of $12,920,000.00 after underwriting discounts, commissions and
other estimated expenses. Assumes no exercise of the underwriter's
over-allotment option.
S-15
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with "Selected Financial Data", "Management's Discussion and
Analysis of Financial Condition and Results of Operations", and our Consolidated
Financial Statements and the related Notes included in our Annual Report on Form
10-K for the fiscal year ended December 31, 2001.
YEAR ENDED DECEMBER 31,
---------------------------------------
2001 2000 1999
----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Information in Accordance with GAAP
Interest income after credit expenses from:
Residential mortgage loans................................ $ 65,012 $ 90,134 $ 71,804
Residential credit enhancement securities................. 16,683 8,524 4,202
Commercial mortgage loans................................. 7,480 2,002 1,081
Securities portfolio...................................... 54,257 67,206 66,219
Cash and cash equivalents................................. 1,107 1,395 2,658
--------- --------- ---------
Total interest income after credit expenses................. 144,539 169,261 145,964
Interest expense............................................ (98,069) (138,603) (119,227)
--------- --------- ---------
Net interest income (net revenue)........................... 46,470 30,658 26,737
Operating expenses.......................................... (11,836) (7,850) (3,835)
Other income (expense)(1)................................... (911) (1,578) (21,458)
Net unrealized/realized market value gains (losses)......... 1,532 (2,296) 284
Dividends on Class B preferred stock........................ (2,724) (2,724) (2,741)
Change in accounting principles(2).......................... (2,368) -- --
--------- --------- ---------
GAAP net income (loss) available to common stockholders..... $ 30,163 $ 16,210 $ (1,013)
========= ========= =========
Average common shares -- diluted............................ 10,475 8,902 9,768
Diluted GAAP net income (loss) per share.................... $ 2.88 $ 1.82 $ (0.10)
Non-GAAP Supplemental Information
Core earnings(3):
Net income (loss)......................................... $ 30,163 $ 16,210 $ (1,013)
(Gains) losses from market value changes.................. 1,747 2,329 (38)
(Gains) losses from closed business units................. -- 46 17,673
--------- --------- ---------
Core earnings(3).................................. $ 31,910 $ 18,585 $ 16,622
========= ========= =========
Core earnings per share(3).................................. $ 3.05 $ 2.08 $ 1.71
Dividend History
Dividends declared per Class B preferred share.............. $ 3.02 $ 3.02 $ 3.02
Regular dividends declared per common share................. $ 2.22 $ 1.61 $ 0.40
Special dividends declared per common share................. $ 0.33 -- --
--------- --------- ---------
Total dividends declared per common share................... $ 2.55 $ 1.61 $ 0.40
Total common dividends declared............................. $ 27,029 $ 14,168 $ 3,513
------------
(1) Effective January 1, 2001, we acquired 100% of the voting common stock of
RWT Holdings, Inc. ("Holdings"). Accordingly, Holdings has been consolidated
into our results of operations for the year ended December 31, 2001. Prior
periods do not reflect Holdings on a consolidated basis. Prior to the
acquisition of the voting common stock of Holdings, we accounted for
Holdings under the equity method. Other income/(expense) includes equity in
earnings (losses) of Holdings for periods prior to 2001.
(2) In the first quarter of 2001, we adopted EITF 99-20 Recognition of Interest
Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets, effective January 1, 2001. In accordance with
the transition provision of EITF 99-20, we recorded a net-of-tax
cumulative-effect-type transition adjustment of $2.4 million (loss).
(3) Core earnings are not a measure of earnings in accordance with generally
accepted accounting principles (GAAP). It is calculated as GAAP earnings
from ongoing operations less mark-to-market adjustments (on certain assets,
hedges, and variable stock options) and non-recurring items. Management
believes that core earnings provide relevant and useful information
regarding our results of operations in addition to GAAP measures of
performance. This is, in part, because market valuation adjustments on only
a portion of our assets and stock options and none of our liabilities are
recognized through our income statement under GAAP, and these
S-16
valuation adjustments may not be fully indicative of changes in market
values on our balance sheet or a reliable guide to our current or future
operating performance. Furthermore, gains or losses realized upon sales of
assets and operating results of closed business units are generally
non-recurring and any non-recurring items may also be unrepresentative of
our current or future operating performance. Because all companies and
analysts do not calculate non-GAAP measures such as core earnings in the
same fashion, core earnings as calculated by us may not be comparable to
similarly titled measures reported by other companies.
DECEMBER 31,
---------------------------------------
2001 2000 1999
----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
BALANCE SHEET DATA:
Residential mortgage loans............................ $1,474,862 $1,130,997 $1,385,589
Residential credit enhancement securities............. 190,813 80,764 26,999
Securities portfolio.................................. 683,482 764,775 941,781
Commercial mortgage loan.............................. 51,084 57,169 8,437
Cash and cash equivalents.................................. 9,030 15,483 19,881
---------- ---------- ----------
Total earning assets....................................... $2,409,271 $2,049,188 $2,382,687
Working capital and other assets........................... 26,373 32,927 37,241
---------- ---------- ----------
Total assets............................................... $2,435,644 $2,082,115 $2,419,928
Short-term debt............................................ 796,811 756,222 1,253,565
Long-term debt............................................. 1,313,715 1,095,835 945,270
Working capital and other liabilities...................... 17,345 14,394 11,158
Total liabilities.......................................... $2,127,871 $1,866,451 $2,209,993
Common equity.............................................. $ 281,256 $ 189,147 $ 183,418
Preferred equity........................................... $ 26,517 $ 26,517 $ 26,517
---------- ---------- ----------
Total stockholders' equity................................. $ 307,773 $ 215,664 $ 209,935
Number of Class B preferred shares outstanding............. 902 902 902
Number of common shares outstanding(1)..................... 12,661 8,810 8,783
Book value per common share................................ $ 22.21 $ 21.47 $ 20.88
------------
(1) Number of common shares outstanding may change monthly due to equity
offerings such as the one contemplated in this prospectus supplement,
activities in our dividend reinvestment and direct stock purchase plan, and
activity in our stock option plan which may include exercise of options or
surrender of shares for tax withholding purposes by our employees and
directors.
S-17
YEAR ENDED DECEMBER 31,
---------------------------------
2001 2000 1999
--------- --------- ---------
(IN THOUSANDS)
CASH FLOW DATA:
Information in Accordance with GAAP
Net income (loss) available to common stockholders.......... $ 30,163 $ 16,210 $ (1,013)
Preferred dividends......................................... 2,724 2,724 2,741
--------- --------- ---------
Net income (loss) available before preferred dividends...... 32,887 18,934 1,728
Adjustments to reconcile net income (loss) to net cash
provided by operating activities.......................... (404,853) 565,827 76,257
--------- --------- ---------
Net cash provided by operating activities................... 371,966 584,761 77,985
Net cash (used in) provided by investing activities......... 66,179 (227,442) 291,189
Net cash provided by (used) in financing activities......... 299,334 (361,717) (404,920)
--------- --------- ---------
Net (decrease) increase in cash and cash equivalents........ $ 6,453 $ (4,398) $ (35,746)
========= ========= =========
Non-GAAP Supplemental Information
Net income (loss) available to common stockholders.......... $ 30,163 $ 16,210 $ (1,013)
Adjustments for non-cash operating expenses................. 13,231 8,873 29,468
--------- --------- ---------
Cash flow before working capital, capital expenditures, and
portfolio activities...................................... 43,394 25,083 28,455
Working capital and capital expenditures.................... 4,347 2,368 5,254
--------- --------- ---------
Free cash flow(1)........................................... 47,741 27,451 33,709
Common dividends paid....................................... (23,307) (12,488) (1,323)
Sale/(purchase) of capital stock............................ 85,785 428 (37,334)
--------- --------- ---------
Funds retained for portfolio investing(1)................... $ 110,219 $ 15,391 $ (4,948)
========= ========= =========
------------
(1) Cash flow from operations equals earnings adjusted for non-cash items, such
as depreciation, amortization, provisions, and mark-to-market adjustments.
Free cash flow equals cash flow from operations less capital expenditures
and increases in working capital. Generally, free cash flow (together with
principal receipts from assets) is available to pay dividends, pay down
debt, repurchase stock, or acquire new portfolio assets. Funds retained to
support a net increase in portfolio investment generally equals free cash
flow less dividends plus any net issuance of stock. The presentation of free
cash flow and funds available for portfolio investing is intended to
supplement the presentation of cash provided by operating activities in
accordance with GAAP. Since all companies do not calculate these alternative
measures of cash flow in the same fashion, free cash flow and funds retained
for portfolio investing may not be comparable to similarly titled measures
reported by other companies.
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DECEMBER 31,
--------------------------------------
2001 2000 1999
----------- ----------- ----------
(DOLLARS IN THOUSANDS)
OTHER DATA:
Recourse assets(1)........................................ $ 1,120,061 $ 983,097 $1,471,570
Recourse debt(1).......................................... 812,288 767,433 1,261,635
Equity to recourse assets................................. 28% 22% 14%
Recourse debt-to-equity ratio............................. 2.6x 3.6x 6.0x
Loans underlying our residential credit enhancement
securities(2)........................................... $51,720,856 $22,633,860 $6,376,571
Residential mortgage loans owned.......................... 1,474,862 1,130,997 1,385,589
----------- ----------- ----------
Total residential mortgage loans.......................... $53,195,718 $23,764,857 $7,762,160
=========== =========== ==========
Our internal credit reserve............................... $ 145,610 $ 31,866 $ 15,366
External credit enhancement(3)............................ 90,224 86,840 26,111
----------- ----------- ----------
Total credit protection................................... $ 235,834 $ 118,706 $ 41,477
=========== =========== ==========
Total credit protection as % of total current residential
loans................................................... 0.44% 0.50% 0.53%
Delinquencies (90+ days, foreclosure, bankruptcy, REO).... $ 129,881 $ 57,376 $ 50,086
Delinquencies as % of total current residential loans..... 0.24% 0.24% 0.65%
Redwood's share of credit losses.......................... $ 1,148 $ 800 $ 1,151
Losses to external credit enhancement..................... 2,352 3,750 1,995
----------- ----------- ----------
Total credit losses....................................... $ 3,500 $ 4,550 $ 3,146
=========== =========== ==========
Total credit losses as % of total current residential
loans................................................... 0.01% 0.02% 0.04%
------------
* Annualized.
(1) The long-term debt we have issued is non-recourse to us; the long-term
debtholders can rely only on the assets pledged to support this debt for
repayment. Thus, we believe a useful measure of our balance sheet leverage
and liquidity posture is to compare our recourse assets (assets not pledged
to support non-recourse debt) to our recourse debt (all borrowings other
than non-recourse debt) and to our equity base. Working capital and other
liabilities are included in recourse debt.
(2) Represents the principal balance of residential mortgage loans in the pools
of mortgage loans that we fully or partially credit enhance through our
ownership of junior securitized interests in these pools.
(3) Represents the principal value of securitized interests in the loan pools we
credit enhance that are junior to our interests and thus provide us with
protection from credit losses in these pools (up to the principal amount).
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COMPANY BUSINESS AND STRATEGY
OUR INDUSTRY
There are approximately $5.8 trillion of residential mortgage loans
outstanding in the United States. The amount outstanding has grown at a rate of
between 4% and 10% per year for approximately 20 years as home ownership and
housing values have generally increased. New originations of residential
mortgage loans have ranged from $0.9 trillion to $2.1 trillion per year over the
last five years. Originations generally increase in years when refinancing
activity is stronger due to declines in long-term interest and mortgage rates.
Fannie Mae and Freddie Mac are prohibited from owning or guaranteeing
single-family mortgage loans with balances greater than $300,700 for loans in
the continental United States. These larger loans are commonly referred to as
jumbo mortgage loans. Originations of jumbo mortgage loans have remained at
between 22% and 24% of total new residential mortgage originations for the last
five years. We believe that jumbo mortgages currently outstanding total over
$1.2 trillion, which represents approximately 20% of the total residential
mortgages outstanding. We also believe that this outstanding balance of jumbo
mortgages has grown at a rate of between 4% and 10% per year along with the
residential mortgage market as a whole. New originations of jumbo residential
mortgage loans have ranged between approximately $198 billion and $437 billion
per year for the last five years.
Each year the amount of jumbo mortgages that require new financing consists
of both new originations and seasoned loans that are sold into the secondary
mortgage market by financial institutions from their portfolios. The size of the
financing market for jumbo mortgages each year depends on the economic
conditions and other factors that determine the level of new originations and
the attractiveness to financial institutions of selling loans.
Historically, jumbo residential mortgages have been financed by financial
institutions, such as banks and thrifts, that own loans in portfolio on their
balance sheets. These institutions fund their mortgage finance activities with
deposits and other borrowings. Increasingly since the mid-1980s, jumbo mortgages
have been funded through mortgage securitization. We estimate that the share of
jumbo mortgages outstanding that have been securitized has been increasing
steadily from approximately 10% in 1990 to approximately 50% in 2001. We believe
that mortgage securitization has become the financing method of choice in the
jumbo market, because securitization is generally a more efficient form of
funding than deposits or other borrowings.
Jumbo mortgage securitizations may consist of seasoned loans or newly
originated loans. Seasoned loan securitizations generally contain loans that are
being sold from the retained mortgage portfolios of the larger banks and
thrifts. Securitizations of new originations generally contain loans sold by the
larger originators of jumbo mortgage loans or by conduits. Conduits acquire
individual loans or small mortgage portfolios in order to aggregate mortgage
pools for securitization.
Virtually all of the demand for mortgage-backed securities comes from
investors that desire to hold the cash flows of a mortgage but that are not able
or willing to build the operations necessary to manage the credit risk of
mortgages. These investors demand that mortgage securities be rated investment
grade by the credit rating agencies. In order to create investment grade
mortgage-backed securities from a pool of residential mortgage loans, credit
enhancement for those mortgage loans must be provided.
In a securitization, a pool of mortgage loans can be credit enhanced
through a number of different methods. The senior/subordinated structure is the
most prevalent method for credit enhancement of jumbo mortgage loans. This
structure establishes a set of senior interests in the pool of mortgage loans
and a set of subordinated interests in the pool. The set of subordinated
interests is acquired by one or more entities that provide credit enhancement to
the underlying mortgage loans. Credit losses in the mortgage pool reduce the
principal of the subordinated interests first, thus allowing the senior
interests to be rated investment grade. Other forms of credit enhancement, such
as pool insurance provided by mortgage insurance companies, bond insurance
provided by bond insurance companies, and corporate guarantees are often less
efficient than the senior/subordinated structure due to regulation and rating
agency requirements, among other factors.
S-20
Credit enhancers of jumbo mortgage securitizations profit from cash flows
generated from the ownership of the subordinated credit-enhancement interests.
The amount and timing of credit losses in the underlying mortgage pools affect
the yields generated by these assets. These interests are generally purchased at
a discount to the principal value of the interest, and much of the potential
return is generated through the ultimate return of the remaining principal after
realized credit losses.
The business of enabling the securitization of jumbo residential mortgages
by assuming credit risk on the underlying mortgage loans is highly fragmented.
There are no industry statistics known to us that identify participants or
market shares. Credit enhancers of jumbo mortgage securitizations include banks
and thrifts (generally credit enhancing their own originations), insurance
companies, Wall Street broker-dealers, hedge funds, private investment firms,
mortgage REITs, and others.
The liquidity crisis in the financial markets in 1998 caused many of the
participants in this market to withdraw. With reduced demand stemming from
reduced competition, and increased supply as a result of increased originations
and mortgage portfolio sales, prices of residential credit-enhancement interests
declined and the acquisition of these interests became more attractive. Prices
further declined in 1999 as financial turmoil continued and financial
institutions reorganized themselves to focus on their core businesses.
In 2000, 2001, and thus far in 2002, the prices of assets and the margins
available in the jumbo residential credit-enhancement business have generally
remained attractive. In general, we believe that few new competitors have
entered the market, so demand for credit-enhancement interests has remained
subdued. At the same time, the supply of credit-enhancement opportunities has
increased as jumbo mortgage securitizations have increased. In addition, a
significant supply of seasoned jumbo mortgage loan portfolios has been
securitized by banks that have origination capacities that far exceed both their
balance sheet capacities and their desires to hold loans in portfolio.
OUR COMPANY
Over the past seven years, we have built a company that allows us to
compete effectively in the high-quality jumbo mortgage finance market in the
United States. The key aspects of our business model are as follows:
Focus. We target the ownership and credit enhancement of jumbo residential
mortgage loans as our primary business. We specialize in funding jumbo mortgage
loans through securitization. Securitization of mortgages is either undertaken
by us to fund our residential mortgage loan portfolio or by others with credit
enhancement provided by us via our investment in residential credit-enhancement
securities. At December 31, 2001, we enabled securitizations for a total of
approximately $53 billion of jumbo mortgage loans ($52 billion securitized by
others and $1 billion securitized by us) for an approximate market share of 5%
of all jumbo mortgage loans outstanding and 10% of all securitized jumbo
mortgage loans outstanding. We believe securitization has and will continue to
prove to be a more efficient form of financing jumbo mortgage loans than funding
through deposits on the balance sheets of depository institutions such as banks
and thrifts. By focusing on this form of mortgage financing, we believe our
long-term growth opportunities will continue to be attractive. We believe that
opportunities will be particularly attractive if an increasing share of jumbo
mortgage loans continues to be securitized and if the jumbo residential market
as a whole continues to grow at the historical rate of between 4% and 10% per
year.
Specialized expertise and scalable operations. We have developed all of the
specialized expertise necessary to efficiently and economically credit enhance
and own jumbo residential mortgage loans. Our accumulated market knowledge,
relationships with mortgage originators and others, sophisticated risk-adjusted
capital policies, strict underwriting procedures, and successful experience with
shifting financial market conditions allow us to acquire and securitize mortgage
assets and effectively mitigate the risks inherent with those businesses. We
build and maintain relationships with large mortgage originators, banks that are
likely to sell mortgage loan portfolios, and Wall Street firms that broker
mortgage assets. We continue to develop our staff, our analytics, our models,
and other capabilities that help us structure transactions and cash flows,
evaluate credit quality of individual loans and pools of loans, underwrite loans
effectively, and monitor trends in credit quality and expected losses in our
existing portfolios. We establish relationships with our servicing
S-21
companies to assist with monthly surveillance, loss mitigation efforts,
delinquent loan work-out strategies, and REO liquidation. Aside from
collaborating with our servicers on these issues, we insist that specific
foreclosure time-lines are followed and that representations and warranties made
to us by sellers are enforced. For balance sheet management, we work to project
cash flows and earnings, determine capital requirements, source borrowings
efficiently, preserve liquidity, and monitor and manage risks.
Even as we continue to enhance our capabilities, we believe that our
operations are highly scalable. We do not expect our operating costs to grow at
the same rate as our net interest income should we expand our capital base and
our portfolios. Thus, other factors being equal, growth in capital could be
materially accretive to earnings and dividends per share.
Emphasis on long-term asset portfolio. Through our operations, we seek to
structure and build a unique portfolio of valuable mortgage assets. For our
residential loan portfolios, we seek to structure long-term assets with expected
average lives of five to fifteen years. The long-term nature of these assets
reduces reinvestment risk and provides us with more stable, proprietary cash
flows that help support our goal of maintaining steady dividends over time.
Competitive advantage of our corporate structure. As a REIT, we pay only
limited income taxes, traditionally one of the largest costs of doing business.
In addition, we are not subject to the extensive regulations applicable to
banks, thrifts, insurance companies, and mortgage banking companies; nor are we
subject to the rules governing regulated investment companies. The absence of
regulations in our market sector is a competitive advantage. The regulations
applicable to competitive financial companies can cause capital inefficiencies
and higher operating costs for certain of our competitors. Our structure enables
us to finance loans of higher quality than our competitors typically do while
earning an attractive return for stockholders.
Flexibility in mortgage loan portfolio orientation. We are open to other
areas of opportunity within real estate finance and related fields that may
compliment and benefit our core business activity of jumbo residential mortgage
loan finance. In addition to our jumbo residential loan operations, we currently
finance U.S. real estate through our securities portfolio (mostly mortgage
securities) and our commercial mortgage loan portfolio. Depending on the
relative attractiveness of the opportunities in these or new product lines, we
may increase or decrease the asset size and capital allocation of these
portfolios over time.
We also generally look for product lines that fit our value orientation,
that take advantage of the structural advantages of our balance sheet, that do
not put us in competition with Fannie Mae and Freddie Mac, and that allow us to
develop an advantage over many of our competitors.
OUR STRATEGY
Our objective is to produce attractive growth in earnings per share and
dividends per share for shareholders primarily through the efficient financing
and management of high-quality jumbo residential mortgage loans and other real
estate assets.
The key aspects of our strategy are as follows:
Preserve portfolio quality. In our experience, the highest long-term
risk-adjusted returns in the lending business come from the highest quality
assets. For this reason, we have focused only on "A," or prime, quality jumbo
residential mortgage loans. Within the prime mortgage loan category, there are
degrees of quality: "A," "Alt-A" and "A-." As compared to the market as a whole,
we believe our portfolio is generally concentrated in the top quality end of the
"A" mortgage loan category. We generally review and acquire mortgage loans from
the large, high-quality, national origination companies, and we have the top
quality servicing companies processing our loan payments and assisting with loss
mitigation. While we may acquire or credit enhance loans that are less than "A"
quality, we currently intend to do so for seasoned loans of this type that may
have less risk than newly-originated loans. We do own, and intend to acquire
additional A-, Alt-A, and sub-prime residential mortgage securities that, for
the most part, are rated investment-grade because they are credit enhanced in
some form by others; with this credit-enhancement, the risk of credit-loss from
these securities is mitigated. We believe we have booked credit reserves for our
jumbo
S-22
mortgage loans that exceed the level of reserves, as a percentage of principal
balances, of most bank and thrift portfolio lenders. We do so because of the
cyclical nature of the U.S. economy and to mitigate the risk of potential
mortgage asset defaults.
Maintain geographic diversity. Our jumbo mortgage loan portfolio is
approximately as diverse with respect to geography as is the U.S. jumbo mortgage
market as a whole. We finance loans in all 50 states. With the exception of
California, no one state represented more than 5% of the portfolio at December
31, 2001. Our exposure to California mortgage loans was 52% of our residential
loan and credit-enhancement portfolios at December 31, 2001; approximately
one-half of the jumbo mortgage loans outstanding in the United States are in
California.
Match-fund effectively. In the course of our business, we do not generally
seek to put ourselves in a position where the anticipation of interest rates or
mortgage prepayment rates is material to meeting our long-term goals.
Accordingly, we generally match the interest rate, prepayment rate, and cash
flow characteristics of our on-balance sheet assets to our liabilities.
Adjustable rate assets are funded with floating rate debt. Fixed and hybrid
assets are funded with matching debt that amortizes at the same rate as the
assets. The amount of unhedged or unmatched hybrid and fixed-rate assets we own
generally does not materially exceed our equity base. In the past, we have used
interest rate agreements to help us achieve our desired asset/ liability mix. We
may use interest rate agreements or other hedging mechanisms in the future if
required to meet our asset, liability matching goals. Despite efforts to
match-fund, our earnings are still sensitive to interest rate factors to a
degree. Our current plan is to continue to reduce, over several years, the
relative importance of our short-term funded securities portfolio on our balance
sheet (although we may increase the size of the short-term funded securities
portfolio on a temporary basis and increase the size of our total securities
portfolio when it can be profitably funded with long-term debt). Reducing our
short-term funded securities portfolio should help further reduce our on-balance
sheet leverage and the sensitivity of our earnings to changes in interest rates,
prepayment rates, and market value changes. We intend to retain some short-term
interest rate mis-matches in our residential whole loan portfolio and other
parts of our balance sheet. Although these assets and liabilities are
effectively match-funded, some variation in earnings may still result from
changes in short-term interest rates.
Manage capital levels. We manage our capital levels, and thus our access to
borrowings and liquidity, through sophisticated risk-adjusted capital policies
supervised by our senior executives. We believe these conservative and
well-developed guidelines are an important tool that helps us achieve our goals
and mitigate the risks of our business, even when the market value of our assets
securing short-term borrowings decline. Through these policies, we assign a
capital adequacy guideline amount, expressed as an equity-to-assets ratio, to
each of our assets. For short-term funded assets, this ratio will fluctuate over
time, based on changes in that asset's credit quality, liquidity
characteristics, potential for market value fluctuation, interest rate risk,
prepayment risk and the over-collateralization requirements for that asset set
by our collateralized short-term lenders. Capital requirements for residential
mortgage securities rated below AA, residential credit-enhancement interests,
retained interests from our securitizations of our whole loans, commercial
mortgage whole loans, and most other types of assets we may acquire in the
future are generally higher than for higher-rated residential securities and
residential whole loans. Capital requirements for our less liquid assets depend
chiefly on our access to secure funding for these assets, the number of sources
of such funding, the funding terms, and on the amount of extra capital we decide
to hold on hand to protect against possible liquidity events with these assets.
The sum of the capital adequacy amounts for all of our assets is our aggregate
capital adequacy guideline amount. In most circumstances in which our actual
capital levels decreased below our capital adequacy guideline amount, we would
generally expect to cease the acquisition of new assets until the capital
balance was restored through mortgage prepayments, interest rate changes, or
other means.
Pursue growth. We intend to pursue a growth strategy over time, increasing
our market share of the high quality jumbo residential market and other real
estate markets and increasing our capital base and the size of our portfolios.
As we increase our market share, we believe we will be able to deepen our
relationships with our customers, thus potentially giving us certain pricing,
cost and other competitive advantages. As we increase the size of our capital
base, we believe that we may benefit from improved operating expense ratios,
lower borrowing expenses, improved capital efficiencies, and related factors
that may
S-23
improve earnings and dividends per share. We will also pursue growth in assets
other than high quality residential jumbo loans in order to provide
diversification of risk and opportunity.
OUR PRODUCT LINES
At December 31, 2001, we had four basic product lines: residential mortgage
loans; residential credit-enhancement securities; commercial mortgage loans; and
securities portfolio. Our current intention is to focus on the management and
growth of these four existing product lines as well as to expand our investment
in other, primarily real estate related, assets. We operate our four current
product lines as a single business segment, with common staff and management,
joint financing arrangements, and flexible capital allocations between product
lines.
RESIDENTIAL MORTGAGE LOANS
We acquire high-quality jumbo residential mortgage loans and hold them as a
long-term investment. We generally fund these acquisitions with our equity and
through the issuance of non-recourse, long-term securitized debt that closely
matches the interest-rate, prepayment, and maturity characteristics of the
loans. We show on our balance sheet both the underlying residential mortgage
loans that we have securitized and the non-recourse long-term debt that we issue
to fund the loans.
The net interest income we earn from these assets equals the interest
income we earn on our loans, less amortization expenses incurred as we write-off
the premium we pay to acquire these assets in excess of the principal amount of
the loan, less credit provision expenses incurred to build a credit reserve for
future expected credit losses, and less interest expense on borrowed funds.
The process of adding to our mortgage loan portfolio commences when we
underwrite and acquire mortgage loans from sellers. We generally seek to quickly
build a portfolio large enough, usually $200 million or more, to support an
efficient issuance of long-term debt. We source our loan acquisitions primarily
from large, well-established mortgage originators and the larger banks and
thrifts.
We are always seeking bulk purchases of residential whole loan portfolios
that meet our acquisition criteria and that are priced attractively relative to
our long-term debt issuance levels. In addition, we acquire new loans on a
continuous or "flow" basis from originators that have loan programs that meet
our desired quality standards and loan type.
We fund our mortgage loan acquisitions initially with short-term debt. When
we are ready to issue long-term debt, we contribute these loans to our
wholly-owned, special purpose financing subsidiary, Sequoia Mortgage Funding
Corporation, or Sequoia. Sequoia, through a trust, then issues mostly investment
grade rated long-term debt that generally matches the interest rate, prepayment,
and maturity characteristics of the loans and remits the proceeds of this
offering back to us. Our net investment equals our basis in the loans less the
proceeds that we received from the sale of long-term debt. The amount of equity
that we invest in these trusts to support our long-term debt issuance is
determined by the credit rating agencies, based on their review of the loans and
the structure of the transaction.
We plan to accumulate more high-quality jumbo residential loans when loans
are available on attractive terms relative to our anticipated costs of issuing
long-term debt.
RESIDENTIAL CREDIT-ENHANCEMENT SECURITIES
In addition to acquiring and owning residential mortgage loans, we also
credit enhance pools of high-quality jumbo residential mortgage loans that have
been securitized by others. We do this by acquiring subordinated securities in
third-party securitizations. The subordinated interests in a securitization
transaction bear the bulk of the potential credit risk for the securitized pool
of mortgages, thus allowing the more senior securitized interests to qualify for
investment grade ratings for efficient sale into the world's capital markets. In
effect, we commit our capital to form a "guarantee" or "insurance" of these
securitized pool of mortgages.
S-24
Generally, we credit enhance mortgage loans from the top 15 high-quality
national mortgage origination firms and certain other smaller firms that
specialize in high-quality jumbo residential mortgage loan originations. We also
work with large banks that are sellers of seasoned portfolios of high-quality
jumbo mortgage loans. We either work directly with these customers or we work in
conjunction with an investment bank on these transactions.
The principal value of the credit-enhancement securities in any rated
senior/subordinated securitization is determined by the credit rating agencies:
Moody's Investors Service, Standard & Poor's Rating Services, and Fitch Ratings.
These credit agencies examine each pool of mortgage loans in detail. Based on
their review of individual mortgage loan characteristics, they determine the
credit-enhancement levels necessary to award investment grade ratings to the
bulk of the securities formed from these mortgage loans.
Our actual investment, and our risk, is less than the principal value of
our credit-enhancement securities since we acquire these interests at a discount
to principal value. A portion of this discount we designate as our credit
reserve for future losses; the remainder we amortize into income over time.
Our first defense against credit loss is the quality of the mortgage loans
we acquire or otherwise credit enhance. Our mortgage loans are generally in the
high-quality range for loan factors such as loan-to-value ratios, debt to income
ratios, credit quality of the borrower, and completeness of documentation. Our
mortgage loans are secured by the borrowers' homes. Compared to most corporate
and consumer loans, the mortgage loans that we credit enhance have a much lower
loss frequency and a much lower loss severity (the percentage of the loan
principal and accrued interest that we lose upon default).
Our exposure to credit risks of the mortgage loans that we credit enhance
is further limited in a number of respects as follows:
Risk tranching. A typical mortgage securitization has three
credit-enhancement interests -- a "first loss" security and securities that are
second and third in line to absorb credit losses. Of our net investment in
credit-enhancement assets, approximately $30 million, or 16%, was directly
exposed to the risk of mortgage loan default at December 31, 2001. The remainder
of our net investment, approximately $161 million, was in the second or third
loss position and benefited from credit enhancement provided by others through
their ownership of credit-enhancement interests junior to our positions, which
totaled $90 million. Credit enhancement varies by specific asset.
Limited maximum loss. Our potential credit exposure to the mortgage loans
that we credit enhance is limited to our investment in the credit-enhancement
securities that we acquire.
Credit reserve established at acquisition. We acquire credit-enhancement
interests at a discount to their principal value. We set aside a portion of this
discount as a credit reserve to provide for future credit losses. In most
economic environments, we believe that this reserve should be large enough to
absorb future losses. Thus, typically, most of our credit reserves are
established at acquisition and are, in effect, paid for by the seller of the
credit-enhancement interest. If future credit results are satisfactory, we may
not need all of the amounts designated as reserves. In such event, we may then
redesignate some of these reserves into unamortized discount to be amortized
into income over time.
Acquisition discount. For many of our credit-enhancement interests, the
discount that we receive upon our acquisition exceeds our designated credit
reserve. Since we own these assets at a discount to our credit reserve adjusted
value, the income statement effect of any credit losses in excess of our reserve
would be mitigated.
Mortgage insurance. A portion of our credit-enhanced portfolio consists of
mortgage loans with initial loan-to-value, or LTV, ratios in excess of 80%. For
the vast majority of these higher LTV ratio loans, we benefit from primary
mortgage insurance provided on our behalf by the mortgage insurance companies or
from pledged asset accounts. Thus, for what would otherwise be our most risky
mortgage loans, we have passed much of the risk on to third parties and our
effective loan-to-value ratios are lower than 80%.
Representations and warranties. As the credit enhancer of a mortgage
securitization, we benefit from representations and warranties received from the
sellers of the mortgage loans. In limited circumstances, the
S-25
sellers are obligated to repurchase delinquent mortgage loans from our
credit-enhanced pools, thus reducing our potential exposure.
We believe that the outlook for our jumbo mortgage credit-enhancement
product line in 2002 is excellent. The supply of credit-enhancement
opportunities is expected to be substantial as mortgage originations and
mortgage securitizations remain at relatively high levels. We expect pricing to
remain favorable, as we currently expect demand from competitors will remain
subdued. We expect to achieve continued growth with attractive pricing in this
product line.
COMMERCIAL MORTGAGE LOANS
Our primary business focus is on residential mortgage loan finance. We also
pursue opportunities in the commercial mortgage loan market. For several years,
we have been originating commercial real estate mortgage loans. Currently, our
goal is to increase the size of our commercial loan portfolio through
acquisition rather than origination. We finance our commercial portfolio with
committed bank lines and through selling senior participations in our mortgage
loans. We intend to acquire commercial mortgage loans, loan participations, and
commercial mortgage-backed securities in the future. Total commercial loans were
$51 million at December 31, 2001.
To date, we have not experienced delinquencies or credit losses in our
commercial mortgage loan portfolio, nor do we anticipate any material credit
problems at this time. We have not established a credit reserve for commercial
loans, although we may do so in the future. A slowing economy, and factors
particular to each mortgage loan, could cause credit issues in the future. If
this occurs, we may need to provide for future losses and create a specific
credit reserve on an asset-by-asset basis for our commercial mortgage loans held
for investment or reduce the reported market value for our commercial loans held
for sale. The market value of our loans may vary due to the changes in a variety
of other factors.
SECURITIES PORTFOLIO
In our securities portfolio, we finance real estate through acquiring and
funding securities. Our securities portfolio contains all of the securities we
own except residential credit-enhancement securities (below-investment-grade
securities with residential prime quality collateral) which are described
separately. At December 31, 2001, we owned $683 million of securities in this
portfolio. The substantial majority of this portfolio is currently rated AAA or
AA, or effectively has a AAA rating through a corporate guarantee from Fannie
Mae or Freddie Mac.
Since we have an efficient, unregulated tax-advantaged corporate structure,
we believe that we have some advantages in the real estate securities market
relative to other capital market investors.
The maintenance of a securities portfolio serves several functions for us:
- given our balance sheet characteristics, tax status, and the capabilities
of our staff, real estate securities investments can earn an attractive
return on equity;
- using a portion of our capital to fund additional types of real estate
assets acts as a diversification of risk and opportunity for our balance
sheet;
- the high level of current cash flow from these securities, including
principal receipts from mortgage prepayments, and the general ability to
sell these assets into active trading markets can have attractive
liquidity characteristics for asset/liability management purposes; and
- our securities portfolio can be an attractive place to employ capital,
and earn rates of return that are higher than cash, when our capital is
not immediately needed to support our credit-related product lines or
when we need flexibility to adjust our capital allocations.
The bulk of our securities portfolio currently consists of adjustable rate
and floating rate mortgage securities funded with floating rate short-term debt.
We do own some fixed-rate assets in this portfolio that are either hedged or
that we hold unhedged to counter-balance certain characteristics of our balance
sheet.
S-26
The substantial majority of our current securities portfolio is backed by
high-quality residential mortgage loans. We do have smaller positions in
residential securities backed by less than high-quality mortgage loans; most of
these securities are substantially credit enhanced relative to the risks of the
loans and thus qualify for investment grade debt ratings. We also intend to
acquire commercial mortgage securities, corporate debt issued by REITs and other
real estate companies, non-real estate asset-backed securities, corporate debt
of non-real estate companies, interests in collateralized bond obligations and
collateralized debt obligations, and other types of assets. Assets acquired for
our securities portfolio may or may not have investment-grade credit ratings.
Although we have the ability to hold these securities to maturity, and our
average holding period is quite long, we do sell securities from time to time.
We do this either as part of our management of this portfolio or in order to
free capital for other uses.
We use mark-to-market accounting for this portfolio, with a portion of such
adjustments flowing through our income statement and the other portion flowing
through our balance sheet. As a result of market value fluctuations, quarterly
reported earnings from our securities portfolio as well as our reported book
value per share can be variable.
Our current long-term plan is to reduce short-term debt utilized to fund
our securities portfolio. We may reduce the size of our securities portfolio or
we may issue long-term debt or asset-backed securities in the form of REMICs or
collateralized bond obligations in order to fund a portion of our securities
portfolio on a long-term basis. Despite our long-term plan, we may acquire
securities using short-term debt funding on a temporary basis when we raise new
equity capital, or when prospective returns from investing in short-term funded
securities are attractive relative to our other opportunities.
OUR OPERATIONS
Our portfolio management staff forms flexible interdisciplinary product
management teams that work to develop our four product lines, develop new
product lines, issue securitized long-term debt, and increase our profitability
over time. Our finance staff participates on these teams, and manages our
overall balance sheet, borrowings, cash position, accounting, finance, tax,
equity issuance, and investor relations.
We build and maintain relationships with mortgage originators, banks that
are likely to sell mortgage loan portfolios, Wall Street firms that broker
mortgage product, mortgage servicing companies that process payments for us and
assist with loss mitigation, technology and information providers that can help
us conduct our business more effectively, with the banks and Wall Street firms
that provide us credit and assist with the issuance of our long-term debt, and
with commercial property owners and other participants in the commercial
mortgage market.
We evaluate, underwrite, and execute asset acquisitions. We also evaluate
potential asset sales. Some of the factors that we take into consideration are:
asset yield characteristics; liquidity; anticipated credit losses; expected
prepayment rates; the cost and type of funding available for the particular
asset; the amount of capital necessary to carry the particular investment in a
prudent manner and to meet our internal risk-adjusted capital guidelines; the
cost of any hedging that might be employed; potential market value fluctuations;
contribution to our overall asset/liability objectives; potential earnings
volatility in adverse scenarios; and cash flow characteristics.
We monitor and actively manage our credit risks. We work closely with our
residential and commercial mortgage servicers, especially with respect to all
delinquent loans. While procedures for working out troubled credit situations
for residential loans are relatively standardized, we still find that an intense
focus on assisting and monitoring our servicers in this process yields good
results. We work to enforce the representations and warranties of our sellers,
forcing them to repurchase loans if there is a breach of the conditions
established at purchase. If a mortgage pool starts to under-perform our
expectations, or if a servicer is not fully cooperative with our monitoring
efforts, we will often seek to sell a credit-enhancement investment at the
earliest opportunity before its market value is diminished.
S-27
Prior to acquisition of a credit-enhancement interest, we typically review
origination processes, servicing standards, and individual loan data. In some
cases, we underwrite individual loan files and influence which loans are
included in a securitization. Prior to acquisition of whole loans for our
residential loan portfolio, we conduct a legal document review of the loans,
review individual loan characteristics, and underwrite loans that appear to have
higher risk characteristics.
We actively monitor and adjust the asset/liability characteristics of our
balance sheet. We follow our internal risk-adjusted capital guidelines, seeking
to make sure that we are sufficiently capitalized to hold our assets to maturity
through periods of market fluctuation. We monitor our cash levels, the liquidity
of our assets, the stability of our borrowings, and our projected cash flows and
market values to make sure that we maintain a strong liquidity position. We
generally seek to match the interest rate characteristics of our assets and
liabilities within a range. If we cannot achieve our matching objectives
on-balance sheet, we use interest rate hedge agreements to adjust our overall
asset/liability mix. We monitor potential earnings fluctuations and cash flow
changes from prepayments. We project credit losses and cash flows from our
credit sensitive assets, and reassess our credit provisions and reserves, based
on information from our loss mitigation efforts, borrower credit trends, and
housing price trends. We regularly monitor the market values of our assets and
liabilities by reviewing pricing from external and internal sources.
We initiate new short-term borrowings on a regular basis with a variety of
counter-parties. We structure long-term debt issuance. We model potential
securitizations, allowing us to price potential asset acquisitions intended to
be funded via long-term debt. We work with the credit rating agencies to
determine credit-enhancement levels required to issue new long-term debt. In
cases where we intend to acquire a credit-enhancement interest in a
securitization performed by others, we sometimes assist them with maximizing the
efficiency of the structuring of their securitization.
S-28
FEDERAL INCOME TAX CONSIDERATIONS
The following discussion, together with that set forth under the same
heading in the prospectus, summarizes the material federal income tax
consequences that may be relevant to a prospective purchaser of common stock. It
is not exhaustive of all possible tax considerations. It does not give a
detailed discussion of any state, local or foreign tax considerations, nor does
it discuss all of the aspects of federal income taxation that may be relevant to
a prospective investor in light of such investor's particular circumstances or
to certain types of investors subject to special treatment under federal income
tax laws, including insurance companies, certain tax-exempt entities, financial
institutions, broker/dealers, foreign corporations and persons who are not
citizens or residents of the United States.
EACH PROSPECTIVE PURCHASER OF SECURITIES IS ADVISED TO CONSULT WITH HIS OR
HER OWN TAX ADVISOR REGARDING THE SPECIFIC CONSEQUENCES TO HIM OR HER OF THE
PURCHASE, OWNERSHIP AND SALE OF SECURITIES, INCLUDING THE FEDERAL, STATE, LOCAL,
FOREIGN AND OTHER TAX CONSIDERATIONS OF SUCH PURCHASE, OWNERSHIP AND SALE AND
THE POTENTIAL CHANGES IN APPLICABLE TAX LAWS.
GENERAL
In the opinion of GnazzoThill, A Professional Corporation, special tax
counsel to Redwood Trust, Redwood Trust, exclusive of any taxable affiliates,
has been organized and operated in a manner which qualifies it as a REIT under
the Internal Revenue Code of 1986, as amended (the "Code") since the
commencement of its operations on August 19, 1994 through December 31, 2001, the
date of Redwood Trust's latest audited financial statements received by special
tax counsel. However, whether Redwood Trust does and continues to so qualify
will depend on actual operating results and compliance with the various tests
for qualification as a REIT relating to its income, assets, distributions,
ownership and certain administrative matters, the results of which are not
reviewed by special tax counsel on an ongoing basis. No assurance can be given
that the actual results of Redwood Trust's operations for any one taxable year
will satisfy those requirements. Moreover, certain aspects of Redwood Trust's
planned method of operations have not been considered by the courts or the
Internal Revenue Service in any published authorities that interpret the
requirements of REIT status. There can be no assurance that the courts or the
Internal Revenue Service will agree with this opinion. In addition,
qualification as a REIT depends on future transactions and events that cannot be
known at this time. Accordingly, special tax counsel will be unable to opine
whether Redwood Trust will in fact qualify as a REIT under the Code in all
events and for all periods.
The opinions of special tax counsel are based upon existing law including
the Internal Revenue Code of 1986, as amended, existing treasury regulations,
revenue rulings, revenue procedures, proposed regulations and case law, all of
which is subject to change both prospectively or retroactively. Moreover,
relevant laws or other legal authorities may change in a manner that could
adversely affect Redwood Trust or its stockholders.
In the event that Redwood Trust does not qualify as a REIT in any year, it
will be subject to federal income tax as a domestic corporation and its
stockholders will be taxed in the same manner as stockholders of ordinary
corporations. To the extent that Redwood Trust would, as a consequence, be
subject to potentially significant tax liabilities, the amount of earnings and
cash available for distribution to its stockholders would be reduced.
TAXATION OF HOLDERS OF REDWOOD TRUST'S COMMON STOCK
General
In addition to the information already set forth under the heading
"Taxation of Redwood Trust's Stockholders" in the prospectus, prospective
investors should consider the following:
If Redwood Trust were to hold residual interests in a REMIC, or if Redwood
Trust or a pool of its assets were to be classified as a taxable mortgage pool,
any "excess inclusion income" generated by such residual interests or taxable
mortgage pool that is allocated to a stockholder may not be allowed to be offset
by a net operating loss of such stockholder.
S-29
Redwood Trust is required under treasury regulations to demand annual
written statements from the record holders of designated percentages of its
capital stock disclosing the actual and constructive ownership of such stock and
to maintain permanent records showing the information it has received as to the
actual and constructive ownership of such stock and a list of those persons
failing or refusing to comply with such demand.
Tax-Exempt Entities
Subject to the discussion below regarding a "pension-held REIT," a
tax-exempt stockholder is generally not subject to tax on distributions from
Redwood Trust or gain realized on the sale of its securities, provided that such
stockholder has not incurred indebtedness to purchase or hold its securities,
that its securities are not otherwise used in an unrelated trade or business of
such stockholder, and that Redwood Trust, consistent with its present intent,
does not hold a residual interest in a real estate mortgage investment conduit
(a "REMIC") that gives rise to "excess inclusion" income as defined under
section 860E of the Code. However, if Redwood Trust were to hold residual
interests in a REMIC, or if Redwood Trust or a pool of its assets were to be
treated as a "taxable mortgage pool," a portion of the dividends paid to a
tax-exempt stockholder may be subject to tax as unrelated business taxable
income ("UBTI"). Although Redwood Trust does not believe that it, or any portion
of its assets, will be treated as a taxable mortgage pool, no assurance can be
given that the Internal Revenue Service might not successfully maintain that
such a taxable mortgage pool exists.
If a qualified pension trust, i.e., any pension or other retirement trust
that qualifies under Section 401(a) of the Code, holds more than 10% by value of
the interests in a "pension-held REIT" at any time during a taxable year, a
substantial portion of the dividends paid to the qualified pension trust by such
REIT may constitute UBTI. For these purposes, a "pension-held REIT" is a REIT
(i) that would not have qualified as a REIT but for the "look through" qualified
pension trust stockholders in determining ownership of stock of the REIT and
(ii) in which at least one qualified pension trust holds more than 25% by value
of the interest of such REIT or one or more qualified pension trusts, each
owning more than a 10% interest by value in the REIT, hold in the aggregate more
than 50% by value of the interests in such REIT. Assuming compliance with the
Ownership Limit provisions in Redwood Trust's Articles of Incorporation it is
unlikely that pension plans will accumulate sufficient stock to cause Redwood
Trust to be treated as a pension-held REIT.
Distributions to certain types of tax-exempt stockholders exempt from
Federal income taxation under Sections 501(c)(7), (c)(9), (c)(17), and (c)(20)
of the Code may also constitute UBTI, and such prospective investors should
consult their tax advisors concerning the applicable "set aside" and reserve
requirements.
Information Reporting and Backup Withholding
Redwood Trust will report to its U.S. stockholders and the Internal Revenue
Service the amount of distributions paid during each calendar year, and the
amount of tax withheld, if any. Under the backup withholding rules, a
stockholder may be subject to backup withholding with respect to distributions
paid (at the rate generally equal to the fourth lowest rate of federal income
tax then in effect) unless such holder (a) is a corporation or comes within
certain other exempt categories and, when required, demonstrates that fact; or
(b) provides a taxpayer identification number, certifies as to no loss of
exemption from backup withholding, and otherwise complies with applicable
requirements of the backup withholding rules. A stockholder that does not
provide Redwood Trust with its correct taxpayer identification number may also
be subject to penalties imposed by the Internal Revenue Service. Any amount paid
as backup withholding is not an additional tax but will be creditable against
the stockholder's income tax liability. In addition, Redwood Trust may be
required to withhold a portion of dividends and capital gain distributions to
any stockholders that do not certify under penalties of perjury their
non-foreign status to Redwood Trust.
S-30
TAXATION OF REDWOOD TRUST
In addition to the information already set forth under the heading
"Taxation of Redwood Trust" in the prospectus, prospective investors should
consider the following:
Qualified REIT Subsidiary
Redwood Trust currently holds some of its assets through Sequoia Mortgage
Funding Corporation, a wholly-owned subsidiary, which is treated as a "qualified
REIT subsidiary." As a "qualified REIT subsidiary," Sequoia is generally ignored
as a separate entity for federal income tax purposes and its assets, liabilities
and income are treated as assets, liabilities and income of Redwood Trust for
purposes of each of the REIT qualification tests.
Taxable Subsidiaries
As noted in the prospectus, Redwood Trust has also made elections to treat
several other wholly-owned subsidiaries as "taxable REIT subsidiaries." As of
the end of each calendar quarter, securities of one or more "taxable REIT
subsidiaries" must represent no more than 20% of the value of Redwood Trust's
assets. If Redwood Trust were to make investments in non-government securities
of other entities that did not qualify as either "qualified REIT subsidiaries"
or "taxable REIT subsidiaries" under the REIT asset tests, Redwood Trust
generally would be required to limit its ownership of such securities that do
not otherwise qualify as real estate assets as follows: (i) the securities of
any one issuer must represent no more than 5% of the value of Redwood Trust's
total assets as of the end of each calendar quarter; and (ii) Redwood Trust must
not hold securities possessing more than 10% of the total voting power or total
value of the outstanding securities of any one issuer as of the end of each
calendar quarter.
S-31
UNDERWRITING
The underwriter, Flagstone Securities, LLC, has agreed with us, subject to
the terms and conditions of the underwriting agreement, to purchase from us
500,000 shares of common stock. The underwriter is committed to purchase and pay
for all shares if any are purchased.
The underwriter has advised us that it proposes to offer the shares of
common stock to the public at the public offering price listed on the cover page
of this prospectus supplement and to selected dealers at that price less a
concession of not in excess of $0.50 per share. After this offering, the public
offering price, concession and reallowance to dealers may be reduced by the
underwriter. No such reduction shall change the amount of proceeds to be
received by us as listed on the cover page of this prospectus supplement. The
common stock is offered by the underwriter, subject to receipt and acceptance by
it and subject to its right to reject any order in whole or in part.
The underwriter has advised us that it does not expect sales to
discretionary accounts to exceed five percent of the total number of shares
offered.
Over-Allotment Option
We have granted to the underwriter an option, exercisable during the 30-day
period after the date of this prospectus supplement, to purchase up to 75,000
additional shares of common stock to cover over-allotments, if any, at the
public offering price less the underwriting discounts and commissions listed on
the cover page of this prospectus supplement. If the underwriter exercises its
over-allotment option to purchase any of the 75,000 additional shares of common
stock, these additional shares will be sold by the underwriter on the same terms
as those on which the 500,000 shares offered hereby are being sold. We will be
obligated, pursuant to the over-allotment option, to sell shares to the
underwriter to the extent the over-allotment option is exercised. The
underwriter may exercise the over-allotment option only to cover over-allotments
made in connection with the sale of the shares of common stock offered in this
offering.
The following table shows the per share and total underwriting discount we
will allow to the underwriter:
TOTAL
----------------------------
NO EXERCISE FULL EXERCISE
PER SHARE OF OPTION OF OPTION
--------- ----------- -------------
Public offering price.................................. $27.01 $13,505,000 $15,530,750
Underwriting discount and commissions to be paid by
us................................................... $ 1.02 $ 510,000 $ 586,500
------ ----------- -----------
Proceeds, before expenses, to us....................... $25.99 $12,995,000 $14,944,250
We estimate expenses payable by us in connection with this offering, other
than the underwriting discounts and commissions referred to above, will be
approximately $75,000.
Indemnity
We will indemnify the underwriter against specified civil liabilities,
including liabilities under the Securities Act, and liabilities arising from
breaches of representations and warranties contained in the underwriting
agreement.
Lock-Up Agreements
We, our directors and our executive officers, have agreed not to offer to
sell, contract to sell, or otherwise sell, dispose of, loan, pledge or grant any
rights with respect to any shares of common stock or any options or warrants to
purchase any shares of common stock, or any securities convertible into or
exchangeable for shares of common stock owned as of the date of this prospectus
supplement or thereafter acquired directly by those holders or with respect to
which they have the power of disposition, without the prior written consent of
Flagstone Securities, LLC. This restriction terminates at the close of trading
on the 60th day after (and including) the day the common stock issued in this
offering commences trading on the New York Stock Exchange. However, Flagstone
Securities, LLC, may, in its sole discretion and at any time or
S-32
from time to time before the termination of the 60-day period, without notice,
release all or any portion of the securities subject to lock-up agreements.
Flagstone Securities, LLC has agreed to allow each of our directors and officers
to sell up to a maximum aggregate total of 2,000 shares of our common stock
during the period beginning two days after the date of our public announcement
of our quarterly results for the first quarter of 2002 and ending on the last
day of May 2002, which period is referred to as the trading window. Flagstone
Securities, LLC has also agreed that it will not unreasonably withhold its
consent to permit our directors and officers to sell an additional reasonable
number of shares of our common stock during the trading window. Other than as
described in this paragraph, there are no existing agreements between Flagstone
Securities, LLC and any of our stockholders who have executed a lock-up
agreement providing consent to the sale of shares prior to the expiration of the
lock-up period.
In addition, we have agreed that during the lock-up period we will not,
without the prior written consent of Flagstone Securities, LLC, consent to the
disposition of any shares held by stockholders subject to market stand-off
agreements, nor will we consent to the removal of restrictive legends from
shares of our common stock, subject to certain limited exceptions, prior to the
expiration of such lock-up period, or issue, sell, contract to sell, or
otherwise dispose of, any shares of common stock, any options or warrants to
purchase any shares of common stock or any securities convertible into,
exercisable for or exchangeable for shares of common stock other than our sale
of shares in this offering; provided, however, that we may issue and sell our
common stock pursuant to our existing stock option, stock ownership and dividend
reinvestment and stock purchase plans that are in effect as of the date of this
prospectus supplement, and that we may issue our common stock upon the
conversion of securities or the exercise of warrants outstanding as of the date
of this prospectus supplement.
Listing
Our common stock is quoted on the New York Stock Exchange under "RWT."
Syndicate Short Sales
The underwriter has advised us that it may make short sales of our common
stock in connection with this offering, resulting in the sale by the underwriter
of a greater number of shares than it is required to purchase pursuant to the
underwriting agreement. The short position resulting from those short sales will
be deemed a "covered" short position to the extent that it does not exceed the
75,000 shares subject to the underwriter's over-allotment option and will be
deemed a "naked" short position to the extent that it exceeds that number.
A naked short position is more likely to be created if the underwriter is
concerned that there may be downward pressure on the trading price of the common
stock in the open market that could adversely affect investors who purchased
shares in the offering. The underwriter may reduce or close out their covered
short position either by exercising the over-allotment option or by purchasing
shares in the open market. In determining which of these alternatives to pursue,
the underwriter will consider the price at which shares are available for
purchase in the open market as compared to the price at which it may purchase
shares through the over-allotment option. Any "naked" short position will be
closed out by purchasing shares in the open market. Similar to the other
stabilizing transactions described below, open market purchases made by the
underwriter to cover all or a portion of its short position may have the effect
of preventing or retarding a decline in the market price of our common stock
following this offering. As a result, our common stock may trade at a price that
is higher than the price that otherwise might prevail in the open market.
Stabilization
The underwriter has advised us that, pursuant to Regulation M under the
Securities Act, the underwriter may engage in transactions, including
stabilization bids or the imposition of penalty bids, that may have the effect
of stabilizing or maintaining the market price of the shares of common stock at
a level above that which might otherwise prevail in the open market. A
"stabilization bid" is a bid for or the purchase of shares of common stock by
the underwriter for the purpose of fixing or maintaining the price of the common
S-33
stock. A "penalty bid" is an arrangement permitting the underwriter to claim the
selling concession otherwise accruing to a syndicate member in connection with
the offering if the common stock originally sold by that syndicate member is
purchased by the underwriter in the open market pursuant to a stabilizing bid or
to cover all or part of a syndicate short position. The underwriter has advised
us that stabilizing bids and open market purchases may be effected on the New
York Stock Exchange or otherwise and, if commenced, may be discontinued at any
time.
Information Regarding Flagstone Securities, LLC
Flagstone Securities, LLC, the underwriter, was organized and registered as
a broker-dealer in 2001. Prior to this offering, Flagstone Securities, LLC has
not acted as a lead managing underwriter in a public offering. Flagstone
Securities, LLC does not have any material relationship with us or any of our
officers, directors or controlling persons, except with respect to the
contractual arrangements in connection with this offering, as described above.
Other Agreements
The underwriter may in the future perform financial advisory services for
us.
EXPERTS
The financial statements incorporated in this prospectus supplement by
reference to the Annual Report on Form 10-K for the year ended December 31,
2001, have been so incorporated in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
LEGAL MATTERS
Selected legal matters relating to the common stock will be passed on for
us by Tobin & Tobin, a professional corporation, San Francisco, California.
Legal matters relating to our tax status as a REIT will be passed on for us by
GnazzoThill, A Professional Corporation, San Francisco, California. Certain
legal matters will be passed upon for the underwriter by O'Melveny & Myers LLP,
San Francisco, California.
INCORPORATION BY REFERENCE
The SEC allows us to "incorporate by reference" information into this
prospectus supplement, which means that we can disclose important information to
you by referring you to another document filed separately with the SEC. The
information incorporated by reference is deemed to be part of this prospectus
supplement, except for any information superseded by information in this
prospectus supplement.
We have filed the documents listed below with the SEC under the Securities
Exchange Act of 1934, or the Exchange Act, and these documents are incorporated
herein by reference:
- Our Annual Report on Form 10-K for the year ended December 31, 2001;
- Our Definitive Proxy Statement filed April 8, 2002.
Any statement contained in a document incorporated by reference shall be
deemed to be modified or superseded for all purposes to the extent that a
statement contained in this prospectus supplement modifies or supersedes that
statement.
You may obtain copies of all documents which are incorporated in this
prospectus supplement by reference (other than the exhibits to such documents
unless the exhibits are specifically incorporated herein by reference in the
documents that this prospectus supplement incorporates by reference) without
charge upon written or oral request to Redwood Trust, Inc., 591 Redwood Highway,
Suite 3100, Mill Valley, CA 94941, telephone (415) 389-7373.
S-34
FORWARD-LOOKING STATEMENTS AND NOTICE ABOUT INFORMATION PRESENTED
This prospectus supplement and the accompanying prospectus contain or
incorporate by reference certain forward-looking statements. When used,
statements which are not historical in nature, including the words "anticipate,"
"estimate," "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, changes in interest rates on our mortgage assets and borrowings, changes
in prepayment rates on our mortgage assets, general economic conditions,
particularly as they affect the price of mortgage assets and the credit status
of borrowers, and the level of liquidity in the capital markets, as it affects
our ability to finance our mortgage asset portfolio.
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, or SEC, including Forms
10-Q and 10-K.
We undertake no obligation to publicly 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 discussed in or incorporated by reference into this prospectus supplement
and the accompanying prospectus might not occur.
This prospectus supplement contains statistics and other data that in some
cases have been obtained from, or compiled from, information made available by
servicing entities and information service providers.
S-35
PROSPECTUS
MARCH 12, 2001
COMMON STOCK, PREFERRED STOCK, WARRANTS,
AND SHAREHOLDER RIGHTS TO PURCHASE
COMMON STOCK AND PREFERRED STOCK
$384,075,000
RWT
REDWOOD TRUST, INC.
------------------------------
By this prospectus, we may offer, from time to time, securities consisting
of:
- shares of our common stock
- shares of our preferred stock
- any warrants to purchase our common stock or preferred stock
- rights to purchase our common stock or preferred stock issued to our
shareholders
- any combination of the foregoing
We will provide specific terms of these securities in supplements to this
prospectus. You should read this prospectus and any supplement carefully before
you decide to invest.
This prospectus may not be used to consummate sales of these securities
unless it is accompanied by a prospectus supplement.
The New York Stock Exchange lists our common stock under the symbol "RWT."
We also currently have one class of outstanding preferred stock listed under the
symbol "RWTB."
To ensure we qualify as a real estate investment trust, no person may own
more than 9.8% of the outstanding shares of any class of our common stock or our
preferred stock, unless our Board of Directors waives this limitation.
------------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS ACCURATE OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
THE DATE OF THIS PROSPECTUS IS MARCH 12, 2001
TABLE OF CONTENTS
PAGE
----
About this Prospectus....................................... 2
Private Securities Litigation Reform Act of 1995............ 2
The Company................................................. 3
Use of Proceeds............................................. 3
Description of Securities................................... 3
Federal Income Tax Considerations........................... 9
Plan of Distribution........................................ 16
ERISA Investors............................................. 17
Legal Matters............................................... 18
Experts..................................................... 18
Where You Can Find More Information......................... 18
Incorporation by Reference.................................. 18
ABOUT THIS PROSPECTUS
This prospectus is part of a registration statement that we filed with the
Securities and Exchange Commission using a "shelf" registration process. Under
this process, we may offer and sell any combination of the securities covered by
this prospectus in one or more offerings up to a total dollar amount of
$384,075,000. This prospectus provides you with a general description of the
securities we may offer. Each time we offer to sell securities, we will provide
a supplement to this prospectus that will contain specific information about the
terms of that offering. The prospectus supplement may also add, update or change
information contained in this prospectus. You should read both this prospectus
and any prospectus supplement together with the additional information you may
need to make your investment decision.
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This prospectus and the documents incorporated by reference herein contain
forward-looking statements, as defined in the Private Securities Litigation
Reform Act of 1995, that are based on our current expectations, estimates and
projections. Statements that are not historical facts, including statements
about our beliefs and expectations, are forward-looking statements. These
statements are not guarantees of future performance, events or results and
involve potential risks and uncertainties. Accordingly, our actual results may
differ from our current expectations, estimates and projections. We undertake no
obligation to update publicly any forward-looking statements, whether as a
result of new information, future events or otherwise.
Important factors that may impact our actual results include changes in
interest rates, changes in the yield curve, changes in prepayment rates, the
supply of mortgage loans and mortgage securities, our ability to obtain
financing, the terms of any financing and other factors described in this
prospectus.
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THE COMPANY
Redwood Trust, Inc. is a real estate finance company specializing in
owning, financing and credit-enhancing high-quality jumbo residential mortgage
loans nationwide. We also finance U.S. real estate in a number of other ways,
including through our investment portfolio (investment-grade mortgage
securities) and our commercial loan portfolio. Our primary source of revenues is
monthly payments made by homeowners on their mortgages. Our primary expense is
the cost of borrowed funds. Since we are structured as a Real Estate Investment
Trust (REIT), we distribute the bulk of our net earnings to shareholders as
dividends. Our REIT status permits us to deduct dividend distributions to
stockholders from our taxable income, thereby eliminating the "double taxation"
that generally results when a corporation earns income and distributes that
income to stockholders in the form of dividends. We are self-advised and
self-managed. Our principal executive offices are located at 591 Redwood
Highway, Suite 3100, Mill Valley, CA 94941, telephone 415-389-7373.
USE OF PROCEEDS
Unless otherwise specified in the applicable prospectus supplement, we
intend to use the net proceeds from the securities for acquisition of mortgage
assets and general corporate purposes. Pending any such uses, we may invest the
net proceeds from the sale of any securities or may use them to reduce
short-term or adjustable-rate indebtedness. If we intend to use the net proceeds
from a sale of securities to finance a significant acquisition of a business, a
related prospectus supplement will describe the material terms of such
acquisition.
DESCRIPTION OF SECURITIES
GENERAL
The following is a brief description of the material terms of our
securities that may be offered under this prospectus. This description does not
purport to be complete and is subject in all respects to applicable Maryland law
and to the provisions of our Charter and Bylaws, including any applicable
amendments or supplements thereto, copies of which are on file with the
Commission as described under "Available Information" and are incorporated by
reference herein.
We may offer under this prospectus one or more of the following types of
securities: shares of common stock, par value $0.01 per share; shares of
preferred stock, in one or more classes or series; common stock warrants;
preferred stock warrants; shareholder rights; and any combination of the
foregoing, either individually or as units consisting of one or more of the
foregoing types of securities. The terms of any specific offering of securities,
including the terms of any units offered, will be set forth in a prospectus
supplement relating to such offering.
Our current authorized equity capitalization consists of 50 million shares
which may be comprised of common stock and preferred stock. The common stock and
the only currently issued, authorized and outstanding preferred stock, the Class
B 9.74% Cumulative Convertible Preferred Stock (the "Class B Preferred Stock"),
are listed on the New York Stock Exchange, and we intend to so list any
additional shares of our common stock which are issued and sold hereunder. We
may elect to list any future class or series of our securities issued hereunder
on an exchange, but we are not obligated to do so.
COMMON STOCK
Common stockholders are entitled to receive dividends when, as and if
declared by our board of directors, out of legally available funds. In the case
of the Class B Preferred Stock and in the event any future class or series of
preferred stock is issued, dividends on any outstanding shares of preferred
stock are required to be paid in full before payment of any dividends on the
common stock. If we have a liquidation, dissolution or winding up, common
stockholders are entitled to share ratably in all of our assets available for
distribution after payment of all our debts and other liabilities and the
payment of all liquidation and other
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preference amounts to preferred stockholders then outstanding. There are no
preemptive or other subscription rights, conversion rights, or redemption or
sinking fund provisions with respect to shares of common stock.
Each holder of common stock is entitled to one vote per share with respect
to all matters submitted to a vote of stockholders and do not have cumulative
voting rights. Accordingly, holders of a majority of the common stock entitled
to vote in any election of directors may elect all of the directors standing for
election, subject to the voting rights, if any, of any class or series of
preferred stock that may be outstanding from time to time. Our charter and
bylaws contain no restrictions on our repurchase of shares of the common stock.
All the outstanding shares of common stock are, and additional shares of common
stock will be, validly issued, fully paid and nonassessable.
PREFERRED STOCK
Subject to the terms of the outstanding Class B Preferred Stock, our board
of directors is authorized to designate with respect to each class or series of
preferred stock the number of shares in each such class or series, the dividend
rates and dates of payment, voluntary and involuntary liquidation preferences,
redemption prices, if any, whether or not dividends shall be cumulative, and, if
cumulative, the date or dates from which the same shall be cumulative, the
sinking fund provisions if any, the terms and conditions on which shares can be
converted into or exchanged for shares of another class or series, and the
voting rights, if any.
Any preferred stock issued may rank prior to the common stock as to
dividends and will rank prior to the common stock as to distributions in the
event of our liquidation, dissolution or winding up. The ability of our board of
directors to issue preferred stock, while providing flexibility in connection
with possible acquisitions and other corporate purposes, could, among other
things, adversely affect the voting powers of common stockholders. The shares of
Class B Preferred Stock are, and any future shares of preferred stock will be,
validly issued, fully paid and nonassessable.
SECURITIES WARRANTS
We may issue securities warrants for the purchase of common stock or
preferred stock, respectively referred to as common stock warrants and preferred
stock warrants. Securities warrants may be issued independently or together with
any other securities offered by this prospectus and any accompanying prospectus
supplement and may be attached to or separate from such other securities. Each
issuance of the securities warrants will be issued under a separate securities
warrant agreement to be entered into by us and a bank or trust company, as
securities warrant agent, all as set forth in the prospectus supplement relating
to the particular issue of offered securities warrants. Each issue of securities
warrants will be evidenced by securities warrant certificates. The securities
warrant agent will act solely as an agent of ours in connection with the
securities warrants certificates and will not assume any obligation or
relationship of agency or trust for or with any holder of securities warrant
certificates or beneficial owners of securities warrants.
If we offer securities warrants pursuant to this prospectus in the future,
the applicable prospectus supplement will describe the terms of such securities
warrants, including the following, where applicable:
- the offering price;
- the aggregate number of shares purchasable upon exercise of such
securities warrants, and in the case of securities warrants for preferred
stock, the designation, aggregate number and terms of the class or series
of preferred stock purchasable upon exercise of such securities warrants;
- the designation and terms of the securities with which such securities
warrants are being offered, if any, and the number of such securities
warrants being offered with each such security;
- the date on and after which such securities warrants and any related
securities will be transferable separately;
- the number of shares of preferred stock or shares of common stock
purchasable upon exercise of each of such securities warrant and the
price at which such number of shares of preferred stock or common stock
may be purchased upon such exercise;
4
- the date on which the right to exercise such securities warrants shall
commence and the expiration date on which such right shall expire;
- federal income tax considerations; and
- any other material terms of such securities warrants.
Holders of future securities warrants, if any, will not be entitled by
virtue of being such holders, to vote, to consent, to receive dividends, to
receive notice with respect to any meeting of stockholders for the election of
our directors or any other matter, or to exercise any rights whatsoever as
stockholders of Redwood Trust.
STOCKHOLDER RIGHTS
We may issue, as a dividend at no cost, stockholder rights to holders of
record of our securities or any class or series thereof on the applicable record
date. If stockholders rights are so issued to existing holders of securities,
each stockholder right will entitle the registered holder thereof to purchase
the securities pursuant to the terms set forth in the applicable prospectus
supplement.
If stockholder rights are issued, the applicable prospectus supplement will
describe the terms of such stockholder rights including the following where
applicable:
- record date;
- subscription price;
- subscription agent;
- aggregate number of shares of preferred stock or shares of common stock
purchasable upon exercise of such stockholder rights and in the case of
stockholder rights for preferred stock, the designation, aggregate number
and terms of the class or series of preferred stock purchasable upon
exercise of such stockholder rights;
- the date on which the right to exercise such stockholder rights shall
commence and the expiration date on which such right shall expire;
- federal income tax considerations; and
- and other material terms of such stockholder rights.
In addition to the terms of the stockholder rights and the securities
issuable upon exercise thereof, the prospectus supplement may describe, for a
holder of such stockholder rights who validly exercises all stockholder rights
issued to such holder, how to subscribe for unsubscribed securities, issuable
pursuant to unexercised stockholder rights issued to other holders, to the
extent such stockholder rights have not been exercised.
Holders of stockholder rights will not be entitled by virtue of being such
holders, to vote, to consent, to receive dividends, to receive notice with
respect to any meeting of stockholders for the election of our directors or any
other matter, or to exercise any rights whatsoever as stockholders of Redwood
Trust, except to the extent described in the related prospectus supplement.
RESTRICTIONS ON OWNERSHIP AND TRANSFER AND REPURCHASE OF SHARES
In order that we may meet the requirements for qualification as a REIT at
all times, our charter prohibits any person from acquiring or holding beneficial
ownership of a number of shares of common stock or preferred stock
(collectively, the "capital stock") in excess of 9.8% of the outstanding shares
of the related class of capital stock. For this purpose, the term "beneficial
ownership" means beneficial ownership, as determined under Rule 13d-3 under the
Securities Exchange Act of 1934, of capital stock by a person, either directly
or constructively under the constructive ownership provisions of Section 544 of
the Code and related provisions.
5
Under the constructive ownership rules of Section 544 of the Code, a holder
of a warrant will be treated as owning the number of shares of capital stock
into which such warrant may be converted. In addition, the constructive
ownership rules generally attribute ownership of securities owned by a
corporation, partnership, estate or trust proportionately to its stockholders,
partners or beneficiaries, respectively. The rules may also attribute ownership
of securities owned by family members to other members of the same family and
treat securities with respect to which a person has an option to purchase as
actually owned by that person. The rules further provide when securities
constructively owned by a person are considered to be actually owned for the
application of such attribution provisions. To determine whether a person holds
or would hold capital stock in excess of the 9.8% ownership limit, a person will
be treated as owing not only shares of capital stock actually owned, but also
any shares of capital stock attributed to that person under the attribution
rules described above. Accordingly, a person who individually owns less than
9.8% of the shares outstanding may nevertheless be in violation of the 9.8%
ownership limit.
Any transfer of shares of capital stock warrants that would cause us to be
disqualified as a REIT or that would create a direct or constructive ownership
of shares of capital stock in excess of the 9.8% ownership limit, or result in
the shares of capital stock being beneficially owned, within the meaning of
Section 856(a) of the Code, by fewer than 100 persons, determined without any
reference to any rules of attribution, or result in us being closely held within
the meaning of Section 856(h) of the Code, will be null and void, and the
intended transferee will acquire no rights to those shares or warrants. These
restrictions on transferability and ownership will not apply if our board
determines that it is no longer in our best interests to continue to qualify as
a REIT.
Any purported transfer of shares of capital stock or warrants that would
result in a purported transferee owning, directly or constructively, shares in
excess of the 9.8% ownership limit due to the unenforceability of the transfer
restrictions described above will constitute excess securities. Excess
securities will be transferred by operation of law to Redwood Trust as trustee
for the exclusive benefit of the person or persons to whom the excess securities
are ultimately transferred, until such time as the purported transferee
retransfers the excess securities. While the excess securities are held in
trust, a holder of such securities will not be entitled to vote or to share in
any dividends or other distributions with respect to such securities and will
not be entitled to exercise or convert such securities into shares of capital
stock. Subject to the 9.8% ownership limit, excess securities may be transferred
by the purported transferee to any person (if such transfer would not result in
excess securities) at a price not to exceed the price paid by the purported
transferee (or, if no consideration was paid by the purported transferee, the
fair market value of the excess securities on the date of the purported
transfer), at which point the excess securities will automatically be exchanged
for the stock or warrants, as the case may be, to which the excess securities
are attributable. If a purported transferee receives a higher price for
designating an ultimate transferee, such purported transferee shall pay, or
cause the ultimate transferee to pay, such excess to us. In addition, such
excess securities held in trust are subject to purchase by us at a purchase
price equal to the lesser of (a) the price per share or per warrant, as the case
may be, in the transaction that created such excess securities (or, in the case
of a devise or gift, the market price at the time of such devise or gift),
reduced by the amount of any distributions received in violation of the charter
that have not been repaid to us, and (b) the market price as reflected in the
last reported sales price of such shares of stock or warrants on the trading day
immediately preceding the date of the purchase by us as reported on any exchange
or quotation system over which such shares of stock or warrants may be traded,
or if not then traded over any exchange or quotation system, then the market
price of such shares of stock or warrants on the date of the purported transfer
as determined in good faith by our board of directors, reduced by the amount of
any distributions received in violation of the charter that have not been repaid
to us.
Upon a purported transfer of excess securities, the purported transferee
shall cease to be entitled to distributions, voting rights and other benefits
with respect to the shares of capital stock or warrants except the right to
payment of the purchase price for the shares of capital stock or warrants on the
retransfer of securities as provided above. Any dividend or distribution paid to
a purported transferee on excess securities prior to our discovery that shares
of capital stock have been transferred in violation of our articles of
incorporation shall be repaid to us upon demand. If these transfer restrictions
are determined to be void,
6
invalid or unenforceable by a court of competent jurisdiction, then the
purported transferee of any excess securities may be deemed, at our option, to
have acted as an agent on our behalf in acquiring the excess securities and to
hold the excess securities on our behalf.
All certificates representing shares of capital stock and warrants will
bear a legend referring to the restrictions described above.
Any person who acquires shares or warrants in violation of our Charter, or
any person who is a purported transferee such that excess securities result,
must immediately give written notice or, in the event of a proposed or attempted
transfer that would be void as set forth above, give at least 15 days prior
written notice to us of such event and shall provide us such other information
as we may request in order to determined the effect, if any, of the transfer on
our status as a REIT. In addition, every record owner of more than 5.0%, during
any period in which the number of record stockholders is 2,000 or more, or 1.0%,
during any period in which the number of record stockholders is greater than 200
but less than 2,000 or more, or 1/2%, during any period in which the number of
record stockholders is 200 or less, of the number or value of our outstanding
shares must send us an annual written notice by January 31 describing how the
shares are held. Further, each stockholder upon demand is required to disclose
to us in writing such information with respect to the direct and constructive
ownership of shares and warrants as our board deems reasonably necessary to
comply with the REIT provisions of the Code, to comply with the requirements of
any taxing authority or governmental agency or to determine any such compliance.
Our board may increase or decrease the 9.8% ownership limit. In addition,
to the extent consistent with the REIT provisions of the Code, our board may,
pursuant to our Charter, waive the 9.8% ownership limit for a purchaser of our
stock. As a condition to such waiver the intended transferee must give written
notice to the board of the proposed transfer no later than the fifteenth day
prior to any transfer which, if consummated, would result in the intended
transferee owning shares in excess of the ownership limit. Our board may also
take such other action as it deems necessary or advisable to protect our status
as a REIT.
The provisions described above may inhibit market activity and the
resulting opportunity for the holders of our capital stock and warrants to
receive a premium for their shares or warrants that might otherwise exist in the
absence of such provisions. Such provisions also may make us an unsuitable
investment vehicle for any person seeking to obtain ownership of more than 9.8%
of the outstanding shares of our capital stock.
MARYLAND CONTROL SHARE ACQUISITION STATUTE
The Maryland General Corporation Law provides that "control shares" of a
Maryland corporation acquired in a "control share acquisition" have no voting
rights except to the extent approved by a vote of two-thirds of the votes
entitled to be cast on the matter, excluding shares of stock owned by the
acquiror or by officers or directors who are employees of the corporation.
"Control shares" are voting shares of stock which, if aggregated with all other
shares of stock owned by such a person, would entitle the acquiror to exercise
voting power in electing directors within one of the following ranges of voting
power: (i) one-tenth or more but less than one third, (ii) one-third or more but
less than a majority, or (iii) a majority or more of all voting power. "Control
shares" do not include shares of stock the acquiring person is then entitled to
vote as a result of having previously obtained stockholder approval. A "control
share acquisition" means, subject to certain exceptions, the acquisition of,
ownership of, or the power to direct the exercise of voting power with respect
to, control shares.
A person who has made or proposes to make a "control share acquisition,"
upon satisfaction of certain conditions, including an undertaking to pay
expenses, may compel the board of directors to call a special meeting of
stockholders to be held within 50 days of demand to consider the voting rights
of the shares. If no request for a meeting is made, the corporation may itself
present the question at any stockholders' meeting. If voting rights are not
approved at the meeting or if the acquiring person does not deliver an acquiring
person statement as permitted by the statute, then, subject to certain
conditions and limitations, the corporation may redeem any or all of the
"control shares," except those for which voting rights have previously been
approved, for fair value determined, without regard to absence of voting rights,
as of the date of the last control share acquisition or of any meeting of
stockholders at which the voting rights of such shares are
7
considered and not approved. If voting rights for "control shares" are approved
at a stockholders meeting and the acquiror becomes entitled to vote a majority
of the shares entitled to vote, all other stockholders may exercise appraisal
rights. The fair value of the stock, as determined for purposes of such
appraisal rights may not be less than the highest price per share paid in the
control share acquisition, and certain limitations and restrictions otherwise
applicable to the exercise of dissenters' rights do not apply in the context of
"control share acquisitions."
The "control share acquisition" statute does not apply to stock acquired in
a merger, consolidation or share exchange if the corporation is a party to the
transaction, or to acquisitions approved or exempted by a provision of the
charter or bylaws of the corporation adopted prior to the acquisition of the
shares. The control share acquisition statute could have the effect of
discouraging offers to acquire us and of increasing the difficulty of
consummating any such offers, even if the acquisition would be in our
stockholders' best interests.
TRANSFER AGENT AND REGISTRAR
Mellon Investor Services LLC is the transfer agent and registrar with
respect to our securities.
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FEDERAL INCOME TAX CONSIDERATIONS
The following discussion summarizes the material federal income tax
consequences that may be relevant to a prospective purchaser of securities. It
is not exhaustive of all possible tax considerations. It does not give a
detailed discussion of any state, local or foreign tax considerations, nor does
it discuss all of the aspects of federal income taxation that may be relevant to
a prospective investor in light of such investor's particular circumstances or
to certain types of investors subject to special treatment under federal income
tax laws, including insurance companies, certain tax-exempt entities, financial
institutions, broker/dealers, foreign corporations and persons who are not
citizens or residents of the United States.
EACH PROSPECTIVE PURCHASER OF SECURITIES IS ADVISED TO CONSULT WITH HIS OR
HER OWN TAX ADVISOR REGARDING THE SPECIFIC CONSEQUENCES TO HIM OR HER OF THE
PURCHASE, OWNERSHIP AND SALE OF SECURITIES, INCLUDING THE FEDERAL, STATE, LOCAL,
FOREIGN AND OTHER TAX CONSIDERATIONS OF SUCH PURCHASE, OWNERSHIP AND SALE AND
THE POTENTIAL CHANGES IN APPLICABLE TAX LAWS.
GENERAL
The Code provides special tax treatment for organizations that qualify and
elect to be taxed as REITs. The discussion of various aspects of federal
taxation contained in this prospectus is based on the Code, administrative
regulations, judicial decisions, administrative rulings and practice as in
effect today, all of which are subject to change. In brief, if certain detailed
conditions imposed by the Code are met, entities that invest primarily in real
estate assets, including mortgage loans, and that otherwise would be taxed as
corporations are, with certain limited exceptions, not taxed at the corporate
level on their taxable income that is currently distributed to their
stockholders. This treatment eliminates most of the "double taxation," at the
corporate level and then again at the stockholder level when the income is
distributed, that typically results from the use of corporate investment
vehicles. A qualifying REIT, however, may be subject to certain excise and other
taxes, as well as normal corporate tax, on taxable income that is not currently
distributed to its stockholders.
Redwood Trust made an election to be taxed as a REIT under the Code
commencing with its taxable year ending December 31, 1994.
In the opinion of GnazzoThill, A Professional Corporation, special tax
counsel to Redwood Trust, Redwood Trust, exclusive of any taxable affiliates,
has been organized and operated in a manner which qualifies it as a REIT under
the Code since the commencing of its operations on August 19, 1994 through
September 30, 2000, the date of Redwood Trust's latest unaudited financial
statements received by special tax counsel. However, whether Redwood Trust does
and continues to so qualify will depend on actual operating results and
compliance with the various tests for qualification as a REIT relating to its
income, assets, distributions, ownership and certain administrative matters, the
results of which are not reviewed by special tax counsel on an ongoing basis. No
assurance can be given that the actual results of Redwood Trust's operations for
any one taxable year will satisfy those requirements. Moreover, certain aspects
of Redwood Trust's planned method of operations have not been considered by the
courts or the Internal Revenue Service in any published authorities that
interpret the requirements of REIT status. There can be no assurance that the
courts or the Internal Revenue Service will agree with this opinion. In
addition, qualification as a REIT depends on future transactions and events that
cannot be known at this time. Accordingly, special tax counsel will be unable to
opine whether Redwood Trust will in fact qualify as a REIT under the Code in all
events and for all periods.
The opinions of special tax counsel are based upon existing law including
the Internal Revenue Code of 1986, as amended, existing treasury regulations,
revenue rulings, revenue procedures, proposed regulations and case law, all of
which is subject to change both prospectively or retroactively. Moreover,
relevant laws or other legal authorities may change in a manner that could
adversely affect Redwood Trust or its stockholders.
In the event that Redwood Trust does not qualify as a REIT in any year, it
will be subject to federal income tax as a domestic corporation and its
stockholders will be taxed in the same manner as stockholders of ordinary
corporations. To the extent that Redwood Trust would, as a consequence, be
subject to potentially
9
significant tax liabilities, the amount of earnings and cash available for
distribution to its stockholders would be reduced. See "Termination or
Revocation of REIT Status" below for more detail.
QUALIFICATION AS A REIT
To qualify for tax treatment as a REIT under the Code, Redwood Trust must
meet certain tests which are described immediately below.
Ownership of Stock. For all taxable years after the first taxable year for
which a REIT election is made, Redwood Trust's shares of stock must be
transferable and must be held by a minimum of 100 persons for at least 335 days
of a 12 month year, or a proportionate part of a short tax year. Redwood Trust
must also use the calendar year as its taxable year for income tax purposes. In
addition, at all times during the second half of each taxable year, no more than
50% in value of the stock of Redwood Trust may be owned directly or indirectly
by five or fewer individuals. In determining whether Redwood Trust's shares are
held by five or fewer individuals, the attribution rules of Section 544 of the
Code (as modified by Section 856(h)(1)(B)(i) of the Internal Revenue Code)
apply. Redwood Trust's Charter imposes certain repurchase provisions and
transfer restrictions that are intended to avoid having more than 50% of the
value of Redwood Trust's stock being held by five or fewer individuals, directly
or constructively, at any time during the last half of any taxable year. These
repurchase transfer restrictions should not cause the stock to be treated as
"non-transferable" for purposes of qualification as a REIT. Redwood Trust
intends to satisfy both the 100 stockholder and 50%/5 stockholder individual
ownership limitations described above for as long as it seeks qualification as a
REIT.
Nature of Assets. On the last day of each calendar quarter at least 75% of
the value of Redwood Trust's assets must consist of qualified REIT assets,
government securities, cash and cash items (the "75% Assets Test"). Redwood
Trust expects that substantially all of its assets will be "qualified REIT
assets." Qualified REIT assets generally include interests in real property,
interests in mortgage loans secured by real property, and interests in other
REITs, REMICs and regular interests in FASITs.
For tax years beginning before December 31, 2000, on the last day of each
calendar quarter, of the investments in securities not included in the 75%
Assets Test, the value of any one issuer's securities may not exceed 5% by value
of Redwood Trust's total assets and Redwood Trust may not own more than 10% of
any one issuer's outstanding voting securities. For tax years beginning after
December 31, 2000, of the investments in securities not included in the 75%
Assets Test, the securities of one or more taxable REIT subsidiary may not
exceed 20% by value of Redwood Trust's total assets and, other than with respect
to taxable REIT subsidiaries, the value of any one issuer's securities may not
exceed 5% by value of Redwood Trust's total assets and Redwood Trust may not own
more than 10% of the voting power or value of any one issuer's securities.
Pursuant to its compliance guidelines, Redwood Trust intends to monitor closely,
on not less than a quarterly basis, the purchase and holding of Redwood Trust's
assets in order to comply with the above assets tests. In particular, as of the
end of each calendar quarter Redwood Trust intends to limit and diversify its
ownership of securities of any other entity, hedging contracts and other
mortgage securities that do not constitute qualified REIT assets to less than
25%, in the aggregate, by value of its portfolio, to less than 20% by value in
any taxable REIT subsidiary and, other than with respect to any taxable REIT
subsidiary, to less than 5% by value as to any single issuer, including the
stock of any taxable affiliate of Redwood Trust, and to less than 10% of the
voting stock or value of any single issuer. If such limits are ever exceeded,
Redwood Trust intends to take appropriate remedial action to dispose of such
excess assets within the 30 day period after the end of the calendar quarter, as
permitted under the Code.
When purchasing mortgage-related securities, Redwood Trust may rely on
opinions of counsel for the issuer or sponsor of such securities given in
connection with the offering of such securities, or statements made in related
offering documents, for purposes of determining whether and to what extent those
securities (and the income therefrom) constitute qualified REIT assets and
income for purposes of the 75% Assets Test, and the source of income tests
discussed below. If Redwood Trust invests in a partnership, Redwood Trust will
be treated as receiving its share of the income and loss of the partnership and
owning a proportionate
10
share of the assets of the partnership and any income from the partnership will
retain the character that it had in the hands of the partnership.
Sources of Income. Redwood Trust must meet two separate income-based tests
for each year to qualify as a REIT.
1. THE 75% TEST. At least 75% of Redwood Trust's gross income for the
taxable year must be derived from the following sources among others: (1)
interest, other than interest based in whole or in part on the income or
profits of any person, on obligations secured by mortgages on real property
or on interests in real property; (2) gains from the sale or other
disposition of interests in real property and real estate mortgages, other
than gain from property held primarily for sale to customers in the
ordinary course of Redwood Trust's business, known as "dealer property";
(3) income from the operation, and gain from the sale, of property acquired
at or in lieu of a foreclosure of the mortgage secured by such property or
as a result of a default under a lease of such property, known as
"foreclosure property"; (4) income received as consideration for entering
into agreements to make loans secured by real property or to purchase or
lease real property, including interests in real property and interests in
mortgages on real property, for example, commitment fees; (5) rents from
real property; and (6) income attributable to stock or debt instruments
acquired with the proceeds from the sale of stock or certain debt
obligations, or new capital, of Redwood Trust received during the one-year
period beginning on the day such proceeds were received, or qualified
temporary investment income. The investments that Redwood Trust intends to
make will give rise primarily to mortgage interest qualifying under the 75%
income test.
2. THE 95% TEST. In addition to deriving 75% of its gross income from
the sources listed above, at least an additional 20% of Redwood Trust's
gross income for the taxable year must be derived from those sources, or
from dividends, interest or gains from the sale or disposition of stock or
other securities that are not dealer property. Income attributable to
assets other than qualified REIT assets, such as income from or gain on the
disposition of qualified liability hedges, that Redwood Trust holds,
dividends on stock including any dividends from a taxable affiliate,
interest on any other obligations not secured by real property, and gains
from the sale or disposition of stock or other securities that are not
qualified REIT assets will constitute qualified income for purposes of the
95% income test only, and will not be qualified income for purposes of the
75% income test. Income from mortgage servicing, loan guarantee fees or
other contracts under which Redwood Trust would earn fees for performing
services, and asset hedging will not qualify for either the 95% or 75%
income tests. Redwood Trust intends to maintain its REIT status by
carefully monitoring its income, including income from hedging
transactions, futures contracts and sales of Mortgage Assets to comply with
the 75% income test and the 95% income test. Redwood Trust intends to
severely limit its acquisition of any assets or investments the income from
which does not qualify for purposes of the 95% income test. Moreover, in
order to help ensure compliance with the 95% income test and the 75% income
test, Redwood Trust has adopted guidelines the effect of which will be to
limit substantially all of the assets that it acquires, other than the
shares of Holdings and qualified liability hedges, to qualified REIT
assets. The policy of Redwood Trust to maintain REIT status may limit the
type of assets, including hedging contracts, that Redwood Trust otherwise
might acquire.
For purposes of determining whether Redwood Trust complies with the 75%
income test and the 95% income test detailed above, gross income does not
include gross income from "prohibited transactions." A "prohibited transaction"
is one involving a sale of dealer property, other than foreclosure property. Net
income from "prohibited transactions" is subject to a 100% tax. See "-- Taxation
of Redwood Trust" in this prospectus for more detail.
If Redwood Trust fails to satisfy one or both of the 75% or 95% income
tests for any year, it may face either (a) assuming such failure was for
reasonable cause and not willful neglect, a 100% tax on the greater of the
amounts of income by which it failed to comply with the 75% test of income or
the 95% income test, reduced by estimated related expenses or (b) loss of REIT
status. There can be no assurance that Redwood Trust will always be able to
maintain compliance with the gross income tests for REIT qualification despite
Redwood Trust's periodic monitoring procedures. Moreover, there is no assurance
that the relief provisions
11
for a failure to satisfy either the 95% or the 75% income tests will be
available in any particular circumstance.
Distributions. Redwood Trust must distribute to its stockholders on a pro
rata basis each year an amount equal to (1) 95% of its taxable income before
deduction of dividends paid and excluding net capital gain, plus (2) 95% of the
excess of the net income from foreclosure property over the tax imposed on such
income by the Code, less (iii) any "excess noncash income." Beginning with the
2001 tax year, this distribution requirement has been reduced to 90%. Redwood
Trust intends to make distributions to its stockholders in amounts sufficient to
meet this distribution requirement. Such distributions must be made in the
taxable year to which they relate or, if declared before the timely filing of
Redwood Trust's tax return for such year and paid not later than the first
regular dividend payment after such declaration, in the following taxable year.
A nondeductible excise tax, equal to 4% of the excess of such required
distributions over the amounts actually distributed will be imposed on Redwood
Trust for each calendar year to the extent that dividends paid during the year,
or declared during the last quarter of the year and paid during January of the
succeeding year, are less than the sum of (1) 85% of Redwood Trust's "ordinary
income," (2) 95% of Redwood Trust's capital gain net income, and (3) income not
distributed in earlier years.
If Redwood Trust fails to meet the distribution test as a result of an
adjustment to Redwood Trust's tax returns by the Internal Revenue Service,
Redwood Trust, by following certain requirements set forth in the Code, may pay
a deficiency dividend within a specified period which will be permitted as a
deduction in the taxable year to which the adjustment is made. Redwood Trust
would be liable for interest based on the amount of the deficiency dividend. A
deficiency dividend is not permitted if the deficiency is due to fraud with
intent to evade tax or to a willful failure to file timely tax return.
TAXATION OF REDWOOD TRUST
In any year in which Redwood Trust qualifies as a REIT, it generally will
not be subject to federal income tax on that portion of its taxable income or
net capital gain which is distributed to its stockholders. Redwood Trust will,
however, be subject to tax at normal corporate rates upon any net income or net
capital gain not distributed. Redwood Trust intends to distribute substantially
all of its taxable income to its stockholders on a pro rata basis in each year.
In addition, Redwood Trust will also be subject to a tax of 100% of net
income from any prohibited transaction and will be subject to a 100% tax on the
greater of the amount by which it fails either the 75% or 95% income tests,
reduced by approximated expenses, if the failure to satisfy such tests is due to
reasonable cause and not willful neglect and if certain other requirements are
met. Redwood Trust may be subject to the alternative minimum tax on certain
items of tax preference.
If Redwood Trust acquires any real property as a result of foreclosure, or
by a deed in lieu of foreclosure, Redwood Trust may elect to treat such real
property as "foreclosure property." Net income from the sale of foreclosure
property is taxable at the maximum federal corporate rate, currently 35%. Income
from foreclosure property will not be subject to the 100% tax on prohibited
transactions. Redwood Trust will determine whether to treat such real property
as foreclosure property on the tax return for the fiscal year in which such
property is acquired.
For tax years beginning prior to 2001, REITs were generally limited to
holding non-voting stock in taxable affiliates. However, beginning with the 2001
tax year, REITs may own directly all of the stock, including voting stock, of a
taxable REIT subsidiary. Effective January 1, 2001, RWT Holdings, Inc.
("Holdings") and Redwood Trust elected to treat Holdings as a taxable REIT
subsidiary of Redwood Trust. Any other taxable subsidiaries of Redwood Trust
generally will also be converted to qualified taxable REIT subsidiaries. The
aggregate value of these taxable REIT subsidiaries must be limited to 20% of the
total value of Redwood Trust's assets. In addition, the taxable REIT
subsidiaries may not, directly or indirectly, operate or manage a lodging
facility or healthcare facility or provide to any person, under franchise,
license or otherwise, rights to any lodging facility or healthcare facility
brand name. In addition, Redwood Trust will be subject to a 100% penalty tax
equal to any rent or other charges that it imposed on any taxable REIT
subsidiary in excess of an arm's-length price for comparable services.
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Redwood Trust will derive income from its taxable REIT subsidiaries by way
of dividends. Such dividends are non-real estate source income for purposes of
the 75% income test. Therefore, when aggregated with Redwood Trust's other
non-real estate source income, such dividends must be limited to 25% of Redwood
Trust's gross income each year. Redwood Trust will monitor the value of its
investment in its taxable REIT subsidiaries to ensure compliance with all
applicable income and asset tests.
Redwood Trust's taxable REIT subsidiaries are generally subject to
corporate level tax on their net income and will generally be able to distribute
only net after-tax earnings to its stockholders, including Redwood Trust, as
dividend distributions.
Redwood Trust will also be subject to the nondeductible 4% excise tax
discussed above if it fails to make timely dividend distributions for each
calendar year. Redwood Trust intends to declare its fourth regular annual
dividend during the final quarter of the year and to make such dividend
distribution no later than thirty-one (31) days after the end of the year in
order to avoid imposition of the excise tax. Such a distribution would be taxed
to the stockholders in the year that the distribution was declared, not in the
year paid. Imposition of the excise tax on Redwood Trust would reduce the amount
of cash available for distribution to Redwood Trust's stockholders. Shareholders
may also be required to include on their own returns certain undistributed
long-term capital gains earned by Redwood Trust and on which it has paid tax.
Shareholders shall receive a credit for the tax so paid by the REIT and shall
increase the basis in their stock by the excess of such gains over such tax
paid.
TERMINATION OR REVOCATION OF REIT STATUS
Redwood Trust's election to be treated as a REIT will be terminated
automatically if Redwood Trust fails to meet the requirements described above.
In that event, Redwood Trust will not be eligible again to elect REIT status
until the fifth taxable year which begins after the year for which Redwood
Trust's election was terminated unless all of the following relief provisions
apply:
- Redwood Trust did not willfully fail to file a timely return with respect
to the termination taxable year;
- inclusion of incorrect information in such return was not due to fraud
with intent to evade tax; and
- Redwood Trust establishes that failure to meet requirements was due to
reasonable cause and not willful neglect.
Redwood Trust may also voluntarily revoke its election, although it has no
intention of doing so, in which event Redwood Trust will be prohibited, without
exception, from electing REIT status for the year to which the revocation
relates and the following four taxable years.
If Redwood Trust fails to qualify for taxation as a REIT in any taxable
year, and the relief provisions do not apply, Redwood Trust would be subject to
tax, including any applicable alternative minimum tax, on its taxable income at
regular corporate rates. Distributions to stockholders of Redwood Trust with
respect to any year in which Redwood Trust fails to qualify as a REIT would not
be deductible by Redwood Trust nor would they be required to be made. Failure to
qualify as a REIT would result in Redwood Trust's reduction of its distributions
to stockholders in order to pay the resulting taxes. If, after forfeiting REIT
status, Redwood Trust later qualifies and elects to be taxed as a REIT again,
Redwood Trust could face significant adverse tax consequences.
TAXATION OF REDWOOD TRUST'S STOCKHOLDERS
General Taxation. For any taxable year in which Redwood Trust is treated as
a REIT for federal income purposes, amounts distributed by Redwood Trust to its
stockholders out of current or accumulated earnings and profits will be
includible by the stockholders as ordinary income for federal income tax
purposes unless properly designated by Redwood Trust as capital gain dividends.
In the latter case, the distributions will generally be taxable to the
stockholders as long-term capital gains.
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Distributions of Redwood Trust will not be eligible for the dividends
received deduction for corporations that are stockholders. Stockholders may not
deduct any net operating losses or capital losses of Redwood Trust.
Upon a sale or disposition of either common stock or preferred stock, a
stockholder will generally recognize a capital gain or loss in an amount equal
to the difference between the amount realized and the stockholder's adjusted
basis in such stock, which gain or loss will be long-term if the stock has been
held for more than one year. Any loss on the sale or exchange of shares of the
stock of Redwood Trust held by a stockholder for six months or less will be
treated as a long-term capital loss to the extent of any capital gain dividend
received on the stock held by such stockholders.
If Redwood Trust makes distributions to its stockholders in excess of its
current and accumulated earnings and profits, those distributions will be
considered first a tax-free return of capital, reducing the tax basis of a
stockholder's shares until the tax basis is zero. Such distributions in excess
of the tax basis will be taxable as gain realized from the sale of Redwood
Trust's shares.
Redwood Trust will notify stockholders after the close of Redwood Trust's
taxable year as to the portions of the distributions which constitute ordinary
income, return of capital and capital gain. Dividends and distributions declared
in the last quarter of any year payable to stockholders of record on a specified
date in such quarter will be deemed to have been received by the stockholders
and paid by Redwood Trust on December 31 of the record year, provided that such
dividends are paid before February 1 of the following year. If either common or
preferred stock is sold after a record date but before a payment date for
declared dividends on such stock, a stockholder will nonetheless be required to
include such dividend in income in accordance with the rules above for
distributions, whether or not such dividend is required to be paid over to the
purchaser.
Generally, a distribution of earnings from a REIT is considered for
estimated tax purposes only when the distribution is made. However, if Redwood
Trust is at any time deemed to be a "closely-held REIT" (a REIT in which at
least 50% of the vote or value is owned by 5 or fewer persons), any stockholder
owning 10% or more of the vote or value of Redwood's shares must accelerate
recognition of year end distributions such shareholder receives from Redwood
Trust in computing estimated tax payments. Redwood Trust is not currently, and
does not intend to be, a "closely-held REIT."
Redwood Trust maintains a Dividend Reinvestment and Stock Purchase Plan or
DRP Plan, Registration No. 333-18061, effective January 2, 1997. DRP
participants will generally be treated as having received a dividend
distribution equal to the fair market value on the investment date of the plan
shares that are purchased with the participants' reinvested dividends and/or
optional cash payments on such date, plus the brokerage commissions, if any,
allocable to the purchase of such shares, and participants will have a tax basis
in the shares equal to such value. DRP participants may not, however, receive
any cash with which to pay the resulting tax liability. Shares received pursuant
to the DRP will have a holding period beginning on the day after their purchase
by the plan administrator.
Preferred Stock. Distributions, including constructive distributions, made
to holders of preferred stock, other than tax-exempt entities, will generally be
subject to tax as described above. For federal income tax purposes, earnings and
profits will be allocated to distributions with respect to the preferred stock
before they are allocated to distributions with respect to common stock.
Conversion of preferred stock into common stock. In general, no gain or
loss will be recognized for federal income tax purposes upon conversion of the
preferred stock solely into shares of common stock. The basis that a holder will
have for tax purposes in the shares of common stock received upon conversion
will be equal to the adjusted basis of the holder in the shares of preferred
stock so converted, and, provided that the shares of preferred stock were held
as a capital asset, the holding period for the shares of common stock received
would include the holding period for the shares of preferred stock converted. A
holder, however, generally will recognize gain or loss on the receipt of cash in
lieu of fractional shares of common stock in an amount equal to the difference
between the amount of cash received and the holder's adjusted basis for tax
purposes in the fractional share of preferred stock for which cash was received.
Furthermore, under certain
14
circumstances, a holder of shares of preferred stock may recognize gain or
dividend income to the extent that there are dividends in arrears on the shares
at the time of conversion into common stock.
Adjustments to conversion price. Adjustments in the conversion price, or
the failure to make such adjustments, pursuant to the anti-dilution provisions
of the preferred stock or otherwise may result in constructive distributions to
the holder so preferred stock that could, under certain circumstances, be
taxable to them as dividends pursuant to Section 305 of the Code. If such a
constructive distribution were to occur, a holder of preferred stock could be
required to recognize ordinary income for tax purposes without receiving a
corresponding distribution of cash.
EXERCISE OF SECURITIES WARRANTS
Upon a holder's exercise of a securities warrant, the holder will, in
general, not recognize any income, gain or loss for federal income tax purposes,
will receive an initial tax basis in the security received equal to the sum of
the holder's tax basis in the exercised securities warrant and the exercise
price paid for such security and will have a holding period for the security
received beginning on the date of exercise.
SALE OR EXPIRATION OF SECURITIES WARRANTS
If a holder of a securities warrant sells or otherwise disposes of such
securities warrant, other than by exercise, the holder generally will recognize
capital gain or loss, long-term capital gain or loss if the holder's holding
period for the securities warrant exceeds twelve months on the date of
disposition. Otherwise, the holder will recognize short-term capital gain or
loss equal to the difference between the cash and fair market value of other
property received and the holder's tax basis, on the date of disposition, in the
securities warrant sold. Such a holder generally will recognize a capital loss
upon the expiration of an unexercised securities warrant equal to the holder's
tax basis in the securities warrant on the expiration date.
TAXATION OF STOCKHOLDER RIGHTS
If Redwood Trust makes a distribution of stockholder rights with respect to
its common stock, such distribution generally will be tax free and a
stockholder's basis in the rights received in such distribution will be zero. If
the fair market value of the rights on the date of issuance is 15% or more of
the value of the common stock or, if the stockholder so elects regardless of the
value of the rights, the stockholder will make an allocation between the
relative fair market values of the rights and the common stock on the date of
the issuance of the rights. On the exercise of the rights, the stockholder will
generally not recognize gain or loss. The stockholder's basis in the shares
received from the exercise of the rights will be the amount paid for the shares
plus the basis, if any, of the rights exercised. Distribution of stockholder
rights with respect to other classes of securities holders generally would be
taxable.
TAXATION OF TAX-EXEMPT ENTITIES
In general, a tax-exempt entity that is a stockholder of Redwood Trust is
not subject to tax on distributions. The Internal Revenue Service has ruled that
amounts distributed by a REIT to an exempt employees' pension trust do not
constitute unrelated trade or business income and thus should be nontaxable to
such a tax-exempt entity. Based on that ruling, but subject to the discussion of
excess inclusion income set forth under the heading "Taxation of Redwood Trust's
Stockholders," special tax counsel is of the opinion that indebtedness incurred
by Redwood Trust in connection with the acquisition of real estate assets such
as mortgage loans will not cause dividends of Redwood Trust paid to a
stockholder that is a tax-exempt entity to be unrelated trade or business
income, provided that the tax-exempt entity has not financed the acquisition of
its stock with "acquisition indebtedness" within the meaning of the Code. Under
certain conditions, however, if a tax-exempt employee pension or profit sharing
trust were to acquire more than 10% of Redwood Trust's stock, a portion of the
dividends on such stock could be treated as unrelated trade or business income.
Other tax-exempt entities should review the Code and should consult their
own tax advisors concerning application of the unrelated trade or business
income rules to them.
15
FOREIGN INVESTORS
The preceding discussion does not address the federal income tax
consequences to foreign investors, non-resident aliens and foreign corporations
as defined in the Code, of an investment in Redwood Trust. In general, foreign
investors will be subject to special withholding tax requirements on income and
capital gains distributions attributable to their ownership of Redwood Trust's
stock. Foreign investors in Redwood Trust should consult their own tax advisors
concerning the federal income tax consequences to them of a purchase of shares
of Redwood Trust's stock including the federal income tax treatment of
dispositions of interests in, and the receipt of distributions from, REITs by
foreign investors. In addition, federal income taxes must be withheld on certain
distributions by a REIT to foreign investors unless reduced or eliminated by an
income tax treaty between the United States and the foreign investor's country.
A foreign investor eligible for reduction or elimination of withholding must
file an appropriate form with Redwood Trust in order to claim such treatment.
PLAN OF DISTRIBUTION
We may sell securities to or through one or more underwriters or dealers
for public offering and sale, to one or more investors directly or through
agents, to existing holders of our securities directly through the issuance of
stockholders rights as a dividend, or through any combination of these methods
of sale. Any principal underwriter or agent involved in the offer and sale of
the securities will be named in the applicable prospectus supplement.
The distribution of the securities may be effected from time to time in one
or more transactions at a fixed price or prices, which may be changed, at market
prices prevailing at the time of sale, at prices related to such prevailing
market prices, or at negotiated prices (any of which may represent a discount
from the prevailing market prices). We may also sell our securities from time to
time through one or more agents in ordinary brokers' transactions. Such sales
may be effected during a series of one or more pricing periods at prices related
to the prevailing market prices reported on the New York Stock Exchange, as
shall be set forth in the applicable prospectus supplement.
In connection with the sale of securities, underwriters or agents may
receive compensation from us or from purchasers of securities, for whom they may
act as agents, in the form of discounts, concessions or commissions.
Underwriters may sell securities to or through dealers, and such dealers may
receive compensation in the form of discounts, concession or commissions from
the underwriters and/or commissions from the purchasers for whom they may act as
agents. Underwriters, dealers and agents that participate in the distribution of
securities may be deemed to be underwriters under the Securities Act, and any
discounts or commissions they receive from us and any profit on the resale of
securities they realize may be deemed to be underwriting discounts and
commissions under the Securities Act. Any principal underwriter or agent will be
identified, and any such compensation received from us will be described, in the
applicable prospectus supplement.
Unless otherwise specified in the related prospectus supplement, each class
or series of securities will be a new issue with no established trading market,
other than the common stock which is listed on the New York Stock Exchange. Any
shares of common stock sold pursuant to a prospectus supplement will also be
listed on the New York Stock Exchange, subject to official notice of issuance.
We may elect to list any future class or series of securities on an exchange,
but we are not obligated to do so. It is possible that one or more underwriters
may make a market in a future class or series of securities, but they will not
be obligated to do so and they may discontinue any market making at any time
without notice. Therefore, no assurance can be given as to the liquidity of, or
the trading market for, the securities.
In connection with the offering of securities hereby, underwriters and
selling group members and their respective affiliates may engage in transactions
that stabilize, maintain or otherwise affect the market price of the applicable
securities. These transactions may include stabilization transactions affected
in accordance with Rule 104 of Regulation M promulgated by the SEC pursuant to
which these persons may bid for or purchase securities for the purpose of
stabilizing their market price.
16
The underwriters in an offering of securities may also create a "short
position" for their account by selling more securities in connection with the
offering than they are committed to purchase from us. In that case, the
underwriters could cover all or a portion of the short position by either
purchasing securities in the open market following completion of the offering of
these securities or by exercising any over-allotment option granted to them by
us. In addition, the managing underwriter may impose penalty bids under
contractual arrangements with other underwriters, which means that they can
reclaim from an underwriter, or any selling group member participating in the
offering, for the account of the other underwriters, the selling concession for
the securities that are distributed in the offering but subsequently purchased
for the account of the underwriters in the open market. Any of the transactions
described in this paragraph or comparable transactions that are described in any
accompanying prospectus supplement may result in the maintenance of the price of
the securities at a level above that which might otherwise prevail in the open
market. None of the transactions described in this paragraph or in an
accompanying prospectus supplement are required to be taken by any underwriters
and, if they are undertaken, may be discontinued at any time.
The underwriters, dealers or agents used by us in any offering of
securities under this prospectus may be customers of, including borrowers from,
engage in transactions with, and perform services for, us or one or more of our
affiliates in the ordinary course of business.
Underwriters, dealers, agents and other persons may be entitled, under
agreements that they may enter into with us, to indemnification against civil
liabilities, including liabilities under the Securities Act.
If indicated in the applicable prospectus supplement, we will authorize
agents and underwriters to solicit offers by institutions to purchase securities
from us at the public offering price set forth in the prospectus supplement
pursuant to delayed delivery contracts providing for payment and delivery on the
date stated in the prospectus supplement. Each contract will be for an amount
not less than, and, unless we otherwise agree, the aggregate principal amount of
securities sold pursuant to contracts shall be not less nor more than, the
respective amounts stated in the prospectus supplement. Institutions with whom
contracts, when authorized, may be made include commercial and savings banks,
insurance companies, pension funds, investment companies, educational and
charitable institutions and other institutions, but shall in all cases be
subject to our approval. Contracts will not be subject to any conditions except
that the purchase by an institution of the securities covered by its contract
shall not at the time of delivery be prohibited under the laws of any
jurisdiction in the United States to which that institution is subject. A
commission indicated in the prospectus supplement will be paid to the
underwriters and agents soliciting purchases of debt securities pursuant to
contracts accepted by us.
Until the distribution of the securities is completed, rules of the SEC may
limit the ability of the underwriters and selling group members, if any, to bid
for and purchase the securities. As an exception to these rules, the
representatives of the underwriters, if any, are permitted to engage in
transactions that stabilize the price of the securities. Such transactions may
consist of bids or purchases for the purpose of pegging, fixing or maintaining
the price of securities.
ERISA INVESTORS
Because the common stock will qualify as a "publicly offered security,"
employee benefit plans and individual retirement accounts may purchase shares of
common stock and treat such shares, and not the underlying assets, as plan
assets. The status of securities offered hereby other than the common stock will
be discussed in the relevant prospectus supplement. Fiduciaries of ERISA plans
should consider (i) whether an investment in the common stock and other
securities offered hereby satisfies ERISA diversification requirements, (ii)
whether the investment is in accordance with the ERISA plans' governing
instruments and (iii) whether the investment is prudent.
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LEGAL MATTERS
The validity of the securities offered hereby and certain legal matters
will be passed on for us by Tobin & Tobin, a professional corporation, San
Francisco, California. Certain tax matters will be passed on by GnazzoThill, A
Professional Corporation, San Francisco, California.
EXPERTS
The financial statements incorporated in this Prospectus by reference to
the Annual Report on Form 10-K for the year ended December 31, 1999, have been
so incorporated in reliance on the report of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current reports, proxy statements and other
information with the Securities and Exchange Commission or the SEC. Our SEC
filings are available to the public over the Internet at the SEC's web site at
http://www.sec.gov. You may also read and copy any document we file at the SEC's
public reference facilities maintained by the Commission at Room 1204, Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C., New York, New York, and
Chicago, Illinois. Please call the SEC at 1-800-SEC-0300 for further information
on the public reference rooms.
We have filed a registration statement, of which this prospectus is a part,
covering the securities offered hereby. As allowed by SEC rules, this prospectus
does not contain all the information set forth in the registration statement and
the exhibits, financial statements and schedules thereto. We refer you to the
registration statement, the exhibits, financial statements and schedules thereto
for further information. This prospectus is qualified in its entirety by such
other information. You may request a free copy of any of the above filings by
writing or calling:
Redwood Trust, Inc.
591 Redwood Highway, Suite 3100
Mill Valley, CA 94941
(415) 389-7373
You should rely only on the information provided in this prospectus. We
have not authorized anyone else to provide you with different information. You
should not assume that the information in this prospectus is accurate as of any
date other than the date on the cover page of this prospectus.
INCORPORATION BY REFERENCE
The Commission allows us to "incorporate by reference" information into
this prospectus, which means that we can disclose important information to you
by referring you to another document filed separately with the Commission. The
information incorporated by reference is deemed to be part of this prospectus,
except for any information superseded by information in this prospectus.
We have filed the documents listed below with the Commission under the
Securities Exchange Act of 1934 (the "Exchange Act"), and these documents are
incorporated herein by reference:
- Our Annual Report on Form 10-K for the year ended December 31, 1999;
- Our Quarterly Report on Form 10-Q for the quarters ended March 31, 2000,
June 30, 2000 and September 30, 2000;
- Our Current Report on Form 8-K filed January 10, 2001; and
- The description of our common stock included in our registration
statement on Form 8-A, filed July 18, 1995 (Registration No. 0-26434) and
as amended by Form 8-A/A filed August 4, 1995, under the Exchange Act.
Any documents we file pursuant to Sections 13(a), 13(c), 14 or 15(d) of the
Exchange Act after the date of this prospectus and prior to the termination of
the offering of the securities to which this prospectus relates will
automatically be deemed to be incorporated by reference in this prospectus and
to be part hereof from
18
the date of filing those documents. Any documents we file pursuant to these
sections of the Exchange Act after the date of the initial registration
statement that contains this prospectus and prior to the effectiveness of the
registration statement will automatically be deemed to be incorporated by
reference in this prospectus and to be part hereof from the date of filing those
documents.
Any statement contained in this prospectus or in a document incorporated by
reference shall be deemed to be modified or superseded for all purposes to the
extent that a statement contained in this prospectus or in any other document
which is also incorporated by reference modifies or supersedes that statement.
You may obtain copies of all documents which are incorporated in this prospectus
by reference (other than the exhibits to such documents unless the exhibits are
specifically incorporated herein by reference in the documents that this
prospectus incorporates by reference) without charge upon written or oral
request to Redwood Trust, Inc., 591 Redwood Highway, Suite 3100, Mill Valley, CA
94941, telephone (415) 389-7373.
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YOU SHOULD RELY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS SUPPLEMENT
AND THE ACCOMPANYING PROSPECTUS. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU
WITH INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS PROSPECTUS SUPPLEMENT AND
THE ACCOMPANYING PROSPECTUS. NEITHER THE DELIVERY OF THIS PROSPECTUS SUPPLEMENT
AND THE ACCOMPANYING PROSPECTUS NOR SALE OF COMMON STOCK MEANS THAT INFORMATION
CONTAINED IN THIS PROSPECTUS SUPPLEMENT IS CORRECT AFTER THE DATE OF THIS
PROSPECTUS SUPPLEMENT. THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING
PROSPECTUS IS NOT AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY THESE
SHARES OF COMMON STOCK IN ANY CIRCUMSTANCES UNDER WHICH THE OFFER OR
SOLICITATION IS LAWFUL. IN THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING
PROSPECTUS, THE "COMPANY," "REDWOOD TRUST," "WE," "US," AND "OUR" REFER TO
REDWOOD TRUST, INC. AND ITS SUBSIDIARIES.
------------------------------
TABLE OF CONTENTS
PROSPECTUS SUPPLEMENT
PAGE
----
Prospectus Supplement Summary......... S-1
The Company......................... S-1
Recent Developments................. S-2
The Offering........................ S-2
Summary of Selected Financial
Data............................. S-3
Risk Factors.......................... S-4
Use of Proceeds....................... S-13
Common Stock Dividend Policy and
Distributions....................... S-14
Capitalization........................ S-15
Selected Consolidated Financial
Data................................ S-16
Company Business and Strategy......... S-20
Federal Income Tax Considerations..... S-29
Underwriting.......................... S-32
Experts............................... S-34
Legal Matters......................... S-34
Incorporation By Reference............ S-34
Forward-Looking Statements and Notice
about Information Presented......... S-35
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PROSPECTUS
PAGE
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About this Prospectus.................. 2
Private Securities Litigation Reform
Act of 1995.......................... 2
The Company............................ 3
Use of Proceeds........................ 3
Description of Securities.............. 3
Federal Income Tax Considerations...... 9
Plan of Distribution................... 16
ERISA Investors........................ 17
Legal Matters.......................... 18
Experts................................ 18
Where You Can Find More Information.... 18
Incorporation by Reference............. 18
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500,000 SHARES
[REDWOOD LOGO]
COMMON STOCK
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PROSPECTUS SUPPLEMENT
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FLAGSTONE SECURITIES
April 23, 2002
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