Redwood Trust, Inc. (NYSE:RWT) today reported GAAPearnings of $56 million ($2.21 per share) for the third quarter of2005. In the third quarter of 2004, GAAP earnings were $72 million($3.18 per share).
The table below presents our per share results, including GAAP andnon-GAAP financial measures. A reconciliation of non-GAAP financialmeasures to GAAP is set forth in the appended financial tables.
Core GAAP earnings exclude gains and losses from asset sales,calls, and market value changes that are included in earnings reportedfor GAAP purposes, and also excludes the $5.2 million one-time taxbenefit recorded for GAAP purposes in the second quarter of 2004. Webelieve core earnings highlight that portion of our reported earningsthat is more likely to be ongoing in nature.
Estimated total taxable income is our estimated pre-tax income ascalculated for tax purposes. It includes income earned in taxable REITsubsidiaries. Estimated core taxable income is estimated total taxableincome before gains and losses from asset sales and calls and certainother expenses such as deductions for stock option exercises.Estimated total taxable income and estimated core taxable income arenot GAAP performance measures. Estimated total taxable income is animportant measure in determining our dividend distributions tostockholders. Estimated core taxable income is an important measure intrying to understand our ability to sustain dividend distributions tostockholders.
"It appears that we are near the end of the bullish phase of anextraordinary real estate credit cycle," said Hansen. "If this is so,over the next several years we may experience increased credit losses,but also we should be able to develop attractive opportunities toacquire new assets."
"Typically we intend to hold our credit-enhancement assets untilthey mature, are called, or until they have achieved most of theirmarket value appreciation potential through seasoning," said Hansen."We have now changed course and have actively been selling assets.Since mid-year, through today, we have sold or committed to sellapproximately 40% of our residential credit-enhancement permanentassets. We did this to reduce our overall credit risk levels. Inaddition, these sales increased our uninvested cash balances. Ifstress in the real estate and capital markets creates assetacquisition opportunities, we will have cash available to invest."
"As a result of these asset sales, we believe we are wellpositioned no matter which direction the real estate cycle goes fromhere -- up, down or flat," said Hansen. "In a stressful environment,we should have good opportunities to develop our businesses, as wehave high-quality assets that should perform well relative to otherreal estate assets, we have no Redwood debt (except the debt we use ona temporary basis to fund assets held for short periods of time priorto sale or securitization), and we have cash to invest. On the otherhand, if real estate continues to be strong, we still have significantupside economic potential available from our remaining assets --enough, we believe, to produce reasonably attractive earnings anddividends over the next several years while also maintaining largeuninvested cash balances."
"Our regular dividend rate is covered by our cash flow andearnings, and we expect that this will continue to be the case,"concluded Hansen. "Since our taxable income has been strong this year,we currently anticipate being able to retain on a permanent basis someof this year's income (at both at the REIT and taxable subsidiarylevel) in order to support future earnings growth while also deferringthe timing of the distribution of enough REIT taxable income topre-fund two to three quarters of 2006's regular dividend payments andpaying a special dividend in the fourth quarter of 2005."
The table below presents our per share results, including GAAP andnon-GAAP financial measures, on a quarterly basis in 2004 and throughthe third quarter of 2005.
On a GAAP basis, net income decreased by $16.4 million in thethird quarter of 2005 as compared to the third quarter of 2004. Netinterest income decreased by $18.4 million and operating expensesincreased by $2.9 million. These items were partially offset byincreases from gains from asset sales and calls of $4.4 million and adecrease in our income tax provision and other expenses totaling $0.5million.
Core GAAP earnings per share have been declining for severalconsecutive quarters. Relative to last year, we own a reduced amountof high-yielding assets because the loans backing interest-onlysecurities retained from our 2003 and early 2004 Sequoia residentialloan securitizations have paid down rapidly and because our mostseasoned residential credit-enhancement securities have been called.Meanwhile, new asset acquisitions have been made at higher prices andlower prospective yields.
GAAP earnings per share have also been declining because theinitial effective yields we are booking for GAAP purposes on new CESassets are well below our long-term discount cash flow hurdle rate of14%. This is a result of the amount and timing of our credit lossassumptions for GAAP purposes. These assumptions incorporate anestimate of credit losses over the entire life of the pool of loansunderlying our residential and commercial real estatecredit-enhancement securities. The magnitude and timing of these lossassumptions on new assets reflect our belief that we are entering amore difficult credit environment. Should total credit losses be lessthan expected or the timing of losses be later than expected, the GAAPyields we report for these assets would likely rise over time fromtheir initial low yield levels.
Our core GAAP earnings have also declined as a result of higheroperating expenses caused primarily by continued growth in personnel.We are now close to completing our hiring plans for our residential,commercial, CDO, and finance groups. Other increased expenses includea large information technology upgrade project that is expected to becompleted in 2006. For GAAP purposes, we are expensing rather thancapitalizing the vast majority of these expenses.
Harold Zagunis, Redwood's CFO, said, "Over the next few quarters,additional declines in core GAAP earnings per share are possible,especially as we have sold and are continuing to sell assets that havebeen generating attractive levels of interest income. Unless weexperience very poor real estate credit results, however, we believeit is likely that our core GAAP earnings will continue to exceed ourregular dividend rate of $0.70 per share per quarter."
In contrast to core GAAP earnings, core taxable income per sharehas been rising for several consecutive quarters. For tax purposes,credit losses are not anticipated but rather are only expensed asincurred. As a result, the current yield we report for tax on our newassets is much higher than the yield we report for GAAP purposes. Inaddition, faster prepayment rates on Sequoia loans have caused less ofa near-term impact on taxable income than on GAAP earnings. Somepremium amortization expense for tax purposes have been delayedbecause we cannot recognize a negative yield for tax purposes oninterest-only securities. The notional principal balances of theseinterest-only securities have declined to the point where the delayedpremium amortization expense for tax will now accelerate, thuslowering core taxable income per share in the fourth quarter of 2005(and perhaps to a lesser degree in the first half of 2006).
For dividends, the REIT portion of our total taxable income isrelevant. We earned $47 million ($1.91 per share) REIT taxable incomein the third quarter of 2005. Estimated undistributed 2005 REITtaxable income at September 30, 2005 was $107 million or $4.31 pershare outstanding at September 30, 2005. This amount (plus fourthquarter REIT taxable income) is available to be retained, to bedistributed as dividends (regular and special) in the fourth quarterof 2005, or to be deferred and distributed as dividends in 2006.
We currently estimate our total residential and commercial creditlosses from hurricanes Katrina and Rita could be between $6 millionand $17 million for tax purposes ($0.24 to $0.69 per share currentlyoutstanding). We anticipate that the realization of these losses willlower our REIT taxable income in 2006 and 2007. For GAAP purposes, thefinancial statement impact likely will be less, due to existingreserves. Our hurricane loss estimates may change, as they arepreliminary and are based primarily on assumptions rather than on thefacts (which will not be known for some time).
Earning assets as reported for GAAP purposes consist of assetsowned either by Redwood or by consolidated securitization entities.They include adjustable-rate, hybrid, and fixed-rate residential andcommercial real estate loans and securities and home equity lines ofcredit. At September 30, 2005, the balance of GAAP earning assets was$19.3 billion, a decrease from the $24.6 billion in earning assets wereported at December 31, 2004. The primary reason for the decrease isincrease in prepayments on the residential whole loans owned bySequoia entities. For the third quarter, principal repayments forthese loans of $3.1 billion exceeded loans acquired of $0.3 billion.Principal repayments from these loans are used by the Sequoia entitiesto pay down their ABS liabilities. As a result, ABS issued liabilitiesconsolidated for GAAP purposes onto Redwood's balance sheet fromsecuritization entities also declined during the third quarter from$23.6 billion to $18.2 billion.
Earning assets owned by Redwood consist of what we call "permanentassets" and "inventory assets." Management believes that thediscussion of Redwood's permanent assets and inventory assets (apresentation of our assets that differs from GAAP) is helpful forfurther understanding our business. Permanent assets are assets wehold in portfolio for the long term to generate interest income andcapital gains. Inventory assets are loans and securities we accumulateon a temporary basis as part of our residential loan conduit and CDOsecuritization activities. We generally hold inventory assets for ashort period of time (generally a few weeks or months) prior to salevia securitization or a whole loan sale. We continue to use onlyequity capital (and not debt) to fund our permanent assets. We utilizedebt only to fund inventory assets during the short period we ownthese assets.
The market value of our permanent assets decreased from $621million to $588 million during the third quarter of 2005. We acquired$72 million new permanent assets, had pay downs of $21 million, andsold assets for $98 million. Residential interest-only securitiesdeclined in market value by $23 million and residentialcredit-enhancement and other securities increased in market value by$37 million.
At September 30, 2005, Redwood owned a total of $1.2 billionassets, including $588 million permanent assets, $278 millioninventory assets, $163 million unrestricted cash, $25 million interestrate agreements, $121 million net working capital, and $3 millionfixed assets. These assets were funded with Redwood debt of $162million and equity of $1.0 billion. Our debt-to-capital ratio was 14%and our debt-to-equity ratio was 0.2 times. Redwood debt decreased by$291 million during the third quarter of 2005 due to a decrease ininventory assets and an increase in cash from asset sales.
At quarter-end, after setting aside the capital we need to operateour current business under our risk-adjusted capital guidelines, wehad $250 million excess capital (cash) available to invest in newpermanent assets and to pay dividends.
We issued 112,694 shares of common stock through our Direct StockPurchase and Dividend Reinvestment Plan in the third quarter of 2005at an average net price of $50.85 per share, raising $5.7 million newequity capital.
GAAP book value per share at quarter-end was $41.03 per share, anincrease of 2% during the quarter. Adjusted core book value per shareat quarter-end was $31.99 per share, an increase of 2% during thequarter (largely as a result of earnings retention). Core book valueis reported GAAP book value less unrealized asset market valueappreciation. Adjusted core book value is core book value less REITtaxable income earned that must be distributed as dividends prior toSeptember 2006 to comply with REIT rules. We believe adjusted corebook value is a reasonably good measure of the amount of capital wehave available in the long term to run our business. A reconciliationof core book value and adjusted core book value to GAAP book valueappears in the appended financial tables below.
"We continue to believe that the most reasonable expectation forour earnings potential is that we can earn an 11% to 18% return onequity on average if measured over a long period of time, barring amajor real estate credit collapse," said Zagunis. "Using adjusted corebook value of $32 per share, this would imply a long-term average GAAPor tax earnings rate between $0.88 per share and $1.44 per share perquarter. Of course, earnings above or below this range could occurover a short- or medium-term period without materially changing thelong-term average. To the extent we retain earnings in our taxablesubsidiaries or at our REIT, adjusted core book value will increaseover time and our earnings potential would also likely increase."
Brett Nicholas, head of Redwood's Residential Group, said,"Excellent credit results and faster prepayment rates continue tobenefit our residential credit-enhancement investments. Home priceincreases over the last several years have reduced the risks withinour more seasoned assets. Faster prepayment rates have also reducedour credit risks within our assets, and should increase our investmentreturns if they persist. If a real estate downturn comes, we believethat many of our assets, and especially our seasoned assets, willcontinue to generate attractive cash flow returns."
"The return potential of new credit-enhancement securities islower than in previous years, and perhaps the risks are higher," saidNicholas. "In addition, the volume of origination and securitizationof true high-quality jumbo residential loans has declined.Nevertheless, we were able to acquire $31 million new permanent assetsin the third quarter that we believe will be attractive investmentsfor shareholders."
"While continuing to meet the needs of our business relationshippartners, we anticipate slowing our overall rate of new residentialpermanent asset acquisitions," continued Nicholas. "We are willing tomaintain higher uninvested cash balances for now. We believe that thequality and pricing of new asset acquisition opportunities are likelyto improve over the next couple of years. In addition, if there is areal estate credit downturn, we may have the opportunity to acquiredistressed assets on a favorable basis."
"During the third and fourth quarters of 2005, we sold bothseasoned assets that have appreciated as well as assets backed byrecently-originated loans that may have higher risks should housingappreciation come to an end," said Nicholas. "For the most part, wesold single-B rated credit-enhancement securities while retaining ournon-rated first-loss assets. By doing so, we reduced our overall risklevels while also retaining the bulk of the upside potential of thecredit-enhancement portfolio we have built over the years."
"We are cautious now, but over the longer term we are housingbulls," concluded Nicholas. "Housing has very strong supply and demandfundamentals, and we believe credit-enhancing residential loansecuritizations will be an attractive and growing business over time."
As measured for GAAP purposes, our residential loan CES portfoliowas $665 million at September 30, 2005. Acquisitions during the thirdquarter were $57 million, sales were $98 million, calls were $5million, and principal pay downs were $13 million. Of the $665 millionshown on our GAAP balance sheet, $326 million was owned by Acaciaentities, $44 million was owned by Redwood temporarily prior to saleto Acacia, and $295 million was owned by Redwood as permanent assetinvestments.
Residential CES permanent assets (which include CES acquired byRedwood from Sequoia transactions) declined from $398 million to $364million during the quarter as a result of $29 million acquisitions,$98 million sales, $5 million calls, $3 million pay downs, and $43million market value appreciation. Ongoing earnings from ourresidential loan CES portfolio will be reduced as a result of thesesales.
Total managed residential real estate loans -- the loans wecredit-enhance through our ownership of residential credit-enhancementsecurities -- grew by 6% during the quarter, from $183 billion to $195billion. Sales of CES did not reduce this amount as we soldsecond-loss but not first-loss securities (with a few exceptions).Seriously delinquent loans (over 90 days, in foreclosure, inbankruptcy, or real estate owned) increased from $246 million to $283million during the quarter. As a percentage of the current balance ofloans credit-enhanced, serious delinquencies increased during thethird quarter from 0.13% to 0.14%. Credit losses for the third quarterfor these loans continued at an annualized rate of loss of less thanone basis point (0.01%) of current loan balances.
Our quality standards remain high for the $195 billion residentialloans we credit-enhance. Generally, all of these loans were consideredto be "prime" quality loans at origination. The weighted averageloan-to-value (LTV) ratio at origination for these loans was 68%. Forsubstantially all the loans (4% of the total loan balance) that havean LTV ratio over 80%, we benefit from insurance or credit-enhancementprovided by others. The overall weighted average FICO credit score forthe borrowers whose loans we credit-enhance was 732 at origination.Investor properties make up less than 3% of the loan balance of theoverall credit-enhancement loan portfolio.
Prepayment rates for the $195 billion loans we credit-enhance haveincreased in recent months, in part because of the flattening of theyield curve. Average conditional prepayment rates (CPR) for theadjustable-rate loans in this portfolio (40% of the total) increasedfrom 31% CPR in the second quarter to 39% CPR in the third quarter.For hybrid loans (49% of the total), prepayments increased from 24% to30% CPR. For fixed rate loans (11% of the total), prepaymentsincreased from 19% to 23% CPR.
Redwood has been credit-enhancing interest-only and negativeamortization loans made to strong borrowers since the founding of thecompany in 1994. Our credit results for the interest-only and negativeamortization loans that we have credit-enhanced over the last 11 yearshave been and continue to be excellent. As a percentage of the $195billion residential loans we credit-enhanced at September 30, 2005,interest-only loans were 31% and negative amortization loans were 17%.Our goal is to credit-enhance loans to strong borrowers that are notover-leveraged. As a result, we have generally sought to avoidcredit-enhancing the more speculative interest-only and negativeamortization loans. We intend to continue to acquire CES backed bynegative amortization loans when the loan quality is reasonable andthe pricing and structural features of the CES are highly attractive.
The prepayment rate for adjustable-rate (ARM) loans securitizedthrough the Sequoia transactions we sponsor was 51% CPR in the thirdquarter of 2005, an increase from 41% CPR in the second quarter of2005 as a result of a flat yield curve and ARM-to-ARM andARM-to-hybrid re-financings. This benefits the CES we have acquiredfrom Sequoia. However, the Sequoia interest-only securities we ownhave declined an additional $23 million in market value in the thirdquarter after declining by $72 million in the second quarter as aresult of these faster prepayments. The remaining value of residentialinterest-only securities owned by Redwood as permanent assets atSeptember 30, 2005 was $50 million.
For GAAP purposes, the faster Sequoia loan prepayment speedsincrease premium amortization expenses and thus reduce the yield werecognize from the whole loans consolidated on our balance sheet fromSequoia entities. The total balance of loans consolidated on ourbalance sheet has declined as a result of these prepayments, reducingour GAAP net income.
Our residential conduit buys closed residential loans on a flow orbulk basis from mortgage originators and sells these loans (viasecuritization or whole loan sale) to generate an economicgain-on-sale. During the third quarter, we acquired $332 millionhigh-quality adjustable-rate and hybrid residential loans. We sold$327 million loans via a Sequoia securitization that we sponsored. Wealso completed whole loan sales of $263 million during the quarter.Consistent with the increased level of competition and the difficultand rapidly changing business environment in the conduit business,this securitization and these whole loan sales generated a smalleconomic loss.
At quarter-end, Redwood owned $17 million residential whole loansheld as inventory for future sale or securitization. These loans werefunded with equity.
"Our conduit generated significant economic gains in 2002, 2003,and 2004," said Nicholas. "For many reasons, it is an importantcomponent of our business plan going forward. We expect it willgenerate attractive profits in the long run. In the currentenvironment, our goal for our conduit activities is to do no worsethan break-even economically while expanding our product line tobetter serve our customers."
Loren Picard, head of Redwood's Commercial Group, said, "Buildinga commercial credit-enhancement business in this environment ischallenging. Commercial real estate fundamentals vary by region andproperty type, and are reasonably sound in many cases. Commercialproperty valuations, however, are high, and commercial real estateloan underwriting standards are loosening."
"As we have expanded our operations and commercial real estateinvestments over the last year, we believe we have picked our spotswisely," said Picard. "We expect that our assets will perform well inthe future relative to other securitized commercial real estate loans.Although we believe that the commercial real estate markets andrelated capital markets are less speculative at this point than areresidential real estate markets, we also believe that assetacquisition opportunities in commercial will improve in terms ofquality and pricing over the next couple of years. In addition,distressed assets for sale are likely to become more available overtime, creating potential acquisition opportunities."
Commercial real estate assets owned by Redwood and by consolidatedsecuritization entities as reported for GAAP purposes totaled $411million at September 30, 2005 and $298 million at December 31, 2004.These assets are reported as commercial loans, commercial CES, and aportion of the reported securities portfolio. Of the $411 millionassets reported at September 30, 2005, $263 million were owned byAcacia, $90 million were owned by Redwood as inventory for future saleto Acacia, and $58 million were owned by Redwood as permanent assets.
Total commercial permanent assets increased from $43 million to$58 million during the third quarter. We acquired $17 millioncommercial CES permanent assets; this increase was partially offset bya $2 million decrease in mark-to-market values (due to spreadwidening, interest rate increases, and marking new assets to bid-sidevalues). Our September 30, 2005 commercial permanent asset portfolioconsisted of $38 million first-loss commercial credit-enhancementsecurities, a $6 million CES investment in a re-securitization ofseasoned commercial CES, and $11 million commercial loans.
Total managed commercial real estate loans -- the loans wecredit-enhance through ownership of first loss commercialcredit-enhancement securities -- increased from $31 billion to $39billion during the third quarter. Seriously delinquent loans (over 90days, in foreclosure, in bankruptcy, or real estate owned) increasedfrom $255 million to $268 million while decreasing as a percentage ofthe current balance of loans credit-enhanced from 0.81% to 0.68%. Mostof these delinquencies are part of the seasoned CES re-securitization.Redwood incurred no commercial credit losses during the quarter,although the $39 billion loans underlying our securities incurredcredit losses of $1 million that were absorbed by junior interests.
Andy Sirkis, head of Redwood's CDO Group, said, "In July, wecompleted Acacia 8, a real estate CDO with underlying assets of $300million. The pool of assets that was securitized consisted of 82%residential real estate securities, 17% commercial real estatesecurities, and 1% real estate CDO securities."
"We have been successful so far at generating attractive returnsfor the investors in the Acacia CDO ABS securities we have created,"continued Sirkis. "In addition, we believe Redwood's $113 millioninvestment in the CDO equity of the eight Acacia transactions we havecompleted to date is likely to produce attractive returns, even in amore stressful environment."
Redwood has acquired as permanent assets all the CDO equity(preference shares and below-investment-grade rated bonds) from theeight Acacia CDO transactions we have sponsored. Redwood also hasacquired similar equity securities from CDO transactions sponsored byothers. The estimated market value of Redwood's total CDO permanentassets was $115 million at quarter-end.
The credit performance of the assets underlying the Acacia CDOtransactions in which we have invested generally remains excellent.Credit rating upgrades of Acacia collateral assets have exceededdowngrades by a ratio of 19 to 1. The credit ratings of theasset-backed securities issued by Acacia 1 and 2 have been upgraded.
At September 30, 2005, our inventory of securities acquired on atemporary basis prior to sale to an Acacia CDO entity was $268million. These assets were funded with equity and debt, and appear onour GAAP balance sheet as part of the residential loan CES andsecurities portfolio.
In the fourth quarter through November 3, we committed to sell $77million market value residential CES permanent assets for anticipatedGAAP gains of $9 million and estimated taxable gains of $5 million.These were all second-loss securities, primarily rated single-B. Aswith all of our permanent asset sales this year, we were able toattract reasonably attractive bid prices for these assets.
During October 2005, residential CES permanent assets with aprincipal value of $7 million were called, generating estimated gainsof $3 million for GAAP purposes and $2 million for tax purposes.
In the fourth quarter through November 3, 2005, we committed toacquire $7 million residential CES and $4 million commercial CES aspermanent assets. We also committed to buy $29 million residentialreal estate securities, $16 million residential real estate loans, $21million commercial real estate securities, and $4 million commercialreal estate loans as inventory assets for future securitization.
To recycle and redeploy capital, during the fourth quarter weexercised our option to call the Acacia 1 CDO transaction that wesponsored in 2002. We plan to sell or re-securitize the Acacia 1collateral.
Please see our supplemental information package, released today onour web site (www.redwoodtrust.com) and included as an exhibit to ourCurrent Report on Form 8-K, for more information about the thirdquarter of 2005. Our Quarterly Report on Form 10-Q for the quarterended September 30, 2005 also contains important additionalinformation about the third quarter.
As is our current practice, we have simultaneously released ourthird quarter earnings release, Quarterly Report on Form 10-Q, andsupplemental information package. Our current plan is to release ourearnings and supplemental information package for the fourth quarterof 2005 and our Annual Report on Form 10-K for the year ended December31, 2005 no later than the SEC filing deadline, which is March 1, 2006according to a current SEC proposal.
This press release contains forward-looking statements within thesafe harbor provisions of the Private Securities Litigation Reform Actof 1995. Statements that are not historical in nature, including thewords "anticipated," "estimated," "should," "expect," "believe,""intend," and similar expressions, are intended to identifyforward-looking statements. These forward-looking statements aresubject to risks and uncertainties, including, among other things,those described in our Annual Report on Form 10-K under the caption"Risk Factors." Other risks, uncertainties, and factors that couldcause actual results to differ materially from those projected aredetailed from time to time in reports filed by us with the Securitiesand Exchange Commission, or SEC, including Forms 10-Q and 8-K.
We undertake no obligation to publicly update or revise anyforward-looking statements, whether as a result of new information,future events, or otherwise. In light of these risks, uncertainties,and assumptions, any forward-looking events mentioned, or discussedin, this press release might not occur. Accordingly, our actualresults may differ from our current expectations, estimates, andprojections.
Important factors that may impact our actual results includechanges in interest rates and market values; changes in prepaymentrates; general economic conditions, particularly as they affect theprice of earning assets and the credit status of borrowers; the levelof liquidity in the capital markets as it affects our ability tofinance our real estate asset portfolio; and other factors notpresently identified. This press release contains statistics and otherdata that in some cases have been obtained from, or compiled frominformation made available by servicers and other third-party serviceproviders.
(1) Core GAAP earnings are not a measure of earnings in accordancewith GAAP. We attempt to strip some of the elements out of GAAPearnings that are temporary, one-time, or non-economic in nature orthat relate to the past rather than the future, so that the underlyingon-going "core" trend of earnings is more clear, at least in certainrespects. We also exclude realized gains (and losses) from asset salesand calls. We sell assets from time to time as part of our on-goingportfolio management activities. These occasional sales can producematerial gains and losses that could obscure the underlying trend ofour long-term portfolio earnings, so we exclude them from core GAAPearnings. Similarly, we exclude gains from calls of residentialcredit-enhancement securities, as these are essentially sales ofassets that produce a highly variable stream of income that mayobscure some underlying income generation trends. GAAP earningsinclude mark-to-market income and expenses for certain of our assetsand interest rate agreements. These are unrealized market valuefluctuations and we exclude them from core GAAP earnings. Similarly,we have issued certain stock options that are "variable" and thus aremarked-to-market for GAAP purposes. When our stock price goes up, itis a GAAP expense. When our stock price goes down, GAAP income iscreated. We exclude all this from core GAAP earnings. Managementbelieves that core GAAP earnings provide relevant and usefulinformation regarding results from operations in addition to GAAPmeasures of performance. This is, in part, because market valuationadjustments on only a portion of our assets and stock options and noneof its liabilities are recognized through the income statement underGAAP and thus GAAP valuation adjustments may not be fully indicativeof changes in market values on the balance sheet as a whole or areliable guide to current operating performance. Furthermore, gains orlosses realized upon sales of assets vary based on portfoliomanagement decisions; a sale of an asset for a gain or a loss may ormay not affect on-going earnings from operations. Because allcompanies and analysts do not calculate non-GAAP measures such as coreGAAP earnings in the same fashion, core earnings as calculated by usmay not be comparable to similarly titled measures reported by othercompanies.
(2) Core equity is not a measure calculated in accordance withGAAP. A reconciliation of core equity to GAAP equity appears in thetable presenting balance sheet data. GAAP equity includesmark-to-market adjustments for certain of our assets and interest rateagreements. This can be useful as a measure that approximatesliquidation value (at least for those assets), but for other purposeswe believe that GAAP equity is less useful. For instance, return onequity calculated using GAAP equity does not make much sense to us.When our assets that are marked-to-market through our balance sheetequity account appreciate (which is a good thing), our GAAP return onequity goes down because our equity base is larger but theseparticular mark-to-market gains are not recognized in GAAP income.Core equity is GAAP equity with mark-to-market gains and losses("accumulated other comprehensive income") excluded. It is, webelieve, a good measure of the amount of capital we have to run ourbusiness.
(1) Core GAAP earnings are not a measure of earnings in accordancewith GAAP. We attempt to strip some of the elements out of GAAPearnings that are temporary, one-time, or non-economic in nature orthat relate to the past rather than the future, so that the underlyingon-going "core" trend of earnings is more clear, at least in certainrespects. We also exclude realized gains (and losses) from asset salesand calls. We sell assets from time to time as part of our on-goingportfolio management activities. These occasional sales can producematerial gains and losses that could obscure the underlying trend ofour long-term portfolio earnings, so we exclude them from core GAAPearnings. Similarly, we exclude gains from calls of residentialcredit-enhancement securities, as these are essentially sales ofassets that produce a highly variable stream of income that mayobscure some underlying income generation trends. GAAP earningsinclude mark-to-market income and expenses for certain of our assetsand interest rate agreements. These are unrealized market valuefluctuations and we exclude them from core GAAP earnings. Similarly,we have issued certain stock options that are "variable" and thus aremarked-to-market for GAAP purposes. When our stock price goes up, itis a GAAP expense. When our stock price goes down, GAAP income iscreated. We exclude all this from core GAAP earnings. Managementbelieves that core GAAP earnings provide relevant and usefulinformation regarding results from operations in addition to GAAPmeasures of performance. This is, in part, because market valuationadjustments on only a portion of our assets and stock options and noneof its liabilities are recognized through the income statement underGAAP and thus GAAP valuation adjustments may not be fully indicativeof changes in market values on the balance sheet as a whole or areliable guide to current operating performance. Furthermore, gains orlosses realized upon sales of assets vary based on portfoliomanagement decisions; a sale of an asset for a gain or a loss may ormay not affect on-going earnings from operations. Because allcompanies and analysts do not calculate non-GAAP measures such as coreGAAP earnings in the same fashion, core earnings as calculated by usmay not be comparable to similarly titled measures reported by othercompanies.
(2) Core equity is not a measure calculated in accordance withGAAP. A reconciliation of core equity to GAAP equity appears in thetable presenting balance sheet data. GAAP equity includesmark-to-market adjustments for certain of our assets and interest rateagreements. This can be useful as a measure that approximatesliquidation value (at least for those assets), but for other purposeswe believe that GAAP equity is less useful. For instance, return onequity calculated using GAAP equity does not make much sense to us.When our assets that are marked-to-market through our balance sheetequity account appreciate (which is a good thing), our GAAP return onequity goes down because our equity base is larger but theseparticular mark-to-market gains are not recognized in GAAP income.Core equity is GAAP equity with mark-to-market gains and losses("accumulated other comprehensive income") excluded. It is, webelieve, a good measure of the amount of capital we have to run ourbusiness.
(1) Core equity is not a measure calculated in accordance withGAAP. A reconciliation of core equity to GAAP equity appears in thetable presenting balance sheet data. GAAP equity includesmark-to-market adjustments for certain of our assets and interest rateagreements. This can be useful as a measure that approximatesliquidation value (at least for those assets), but for other purposeswe believe that GAAP equity is less useful. For instance, return onequity calculated using GAAP equity does not make much sense to us.When our assets that are marked-to-market through our balance sheetequity account appreciate (which is a good thing), our GAAP return onequity goes down because our equity base is larger but theseparticular mark-to-market gains are not recognized in GAAP income.Core equity is GAAP equity with mark-to-market gains and losses("accumulated other comprehensive income") excluded. It is, webelieve, a good measure of the amount of capital we have to run ourbusiness.
(2) Adjusted core equity per share is not a measure calculated inaccordance with GAAP. Adjusted core equity is core equity lessundistributed REIT taxable income that is still undeclared but thatwill need to be paid out. We have minimum dividend distributionrequirements as a REIT and thus have future dividend paymentobligation. These dividend obligations are not recognized in GAAPaccounting until dividends are declared. Cash that we have earned butthat we must pay out as dividends is not cash that will be availableto us to acquire long-term assets and build our business. We use theadjusted core equity to evaluate how much equity per share we haveavailable to build our business and to generate dividends in thelong-term.
(1) The Asset-Backed Securities reported on our GAAP consolidatedbalance sheet as liabilities consist of asset-backed securities issuedby bankruptcy-remote securitization entities. The owners of thesesecurities have no recourse to Redwood and must look only to theassets of the securitization entities for repayment. Both the assetsand liabilities of these entities, however, are consolidated onRedwood's balance sheet for GAAP reporting purposes. Managementbelieves that an analyst could achieve insight into Redwood's businessand balance sheet by distinguishing between debt that must be repaidby Redwood and Asset-Backed Securities that are consolidated ontoRedwood's balance sheet from other entities. This table shows leverageratios calculated for Redwood using measures that incorporateRedwood's debt only.
(1) Includes loans securitized by securitization entitiessponsored by Redwood that are consolidated on Redwood's GAAP balancesheet as well as loans owned directly by Redwood on a temporary basisprior to sale to a securitization entity.
(1) Includes credit-enhancement securities acquired fromsecuritizations sponsored by third parties. Does not includeresidential CES acquired from securitizations sponsored by us.
(1) Includes loans securitized by Sequoia securitization entitiessponsored by Redwood from which Redwood has acquired the residentialCES plus loans securitized by third parties from which Redwood hasrequired the residential credit-enhanced securities, plus loans heldtemporarily by Redwood prior to securitization.
(2) The credit reserve on residential real estate loans owned isonly available to absorb losses on the residential real estate loanportfolio. The internally designated credit reserve on loanscredit-enhanced and the external credit enhancement on loanscredit-enhanced are only available to absorb losses on the pool ofloans related to each individual credit-enhancement security. Externalcredit protection absorbs losses before Redwood is exposed to lossesin such securities.
(1) Estimated total taxable income is the pre-tax income we earncalculated using calculation methods appropriate for tax purposes.Taxable income calculations differ significantly from GAAP. Estimatedtotal taxable income is not a GAAP financial measure, but it is animportant measure as it is the basis in determining our dividenddistributions to stockholders. REIT taxable income is estimated totaltaxable income less estimated taxable earnings from our taxablesubsidiaries. Estimated REIT taxable income is that portion of ourtaxable income that is subject to REIT tax rules. We must distributeat least 90% of this income as dividends to stockholders over time. Asa REIT we are not subject to corporate income taxes on the REITtaxable income we distribute. The remainder of our estimated totaltaxable income (the non-REIT taxable income) is income we earn intaxable subsidiaries. We pay income tax on this income and wegenerally retain the after-tax income at the subsidiary level.
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