UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form
10-Q
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þ
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QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For the quarterly period ended:
September 30, 2006
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OR
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o
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TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For the transition period
from to
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Commission file number: 1-13759
REDWOOD TRUST, INC.
(Exact name of Registrant as specified in its Charter)
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Maryland
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68-0329422
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(State or other jurisdiction
of
incorporation or organization)
|
|
(I.R.S. Employer
Identification No.)
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|
One Belvedere Place,
Suite 300
Mill Valley, California
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94941
|
(Address of principal executive
offices)
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|
(Zip Code)
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(415) 389-7373
(Registrants telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed
all documents and reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period
that the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past
90 days. Yes
þ
No
o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer or a non-accelerated
filer. See definition of accelerated filer and large
accelerated filer in
Rule
12b-2
of the
Exchange Act. (Check one):
Large accelerated
filer
þ
Accelerated
filer
o
Non-accelerated
filer
o
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule
12b-2
of the
Exchange
Act). Yes
o
No
þ
Indicate the number of shares outstanding of each of the
issuers classes of stock, as of the last practicable date.
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|
Common Stock ($0.01 par value per share)
|
26,155,375 as of November 1, 2006
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REDWOOD TRUST, INC.
FORM
10-Q
INDEX
2
PART I. FINANCIAL
INFORMATION
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|
ITEM 1.
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FINANCIAL STATEMENTS
|
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
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|
|
|
|
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September 30, 2006
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|
December 31, 2005
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ASSETS
|
|
|
|
|
|
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Real estate loans
|
|
$
|
9,874,964
|
|
|
$
|
13,934,484
|
|
Real estate securities
|
|
|
2,912,365
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|
|
|
2,418,917
|
|
Cash and cash equivalents
|
|
|
112,926
|
|
|
|
175,885
|
|
|
|
|
|
|
|
|
|
Total earning assets
|
|
|
12,900,255
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|
|
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16,529,286
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|
Restricted cash
|
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|
139,441
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|
72,421
|
|
Accrued interest receivable
|
|
|
67,304
|
|
|
|
76,469
|
|
Interest rate agreements
|
|
|
29,692
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|
|
|
31,220
|
|
Principal receivable
|
|
|
1,075
|
|
|
|
225
|
|
Deferred tax asset
|
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|
3,205
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|
|
|
5,384
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|
Deferred asset-backed security
issuance costs
|
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46,945
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54,125
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Other assets
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11,885
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|
|
7,830
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|
|
|
|
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Total Assets
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|
$
|
13,199,802
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|
$
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16,776,960
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|
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LIABILITIES AND
STOCKHOLDERS EQUITY
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|
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LIABILITIES
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Redwood debt
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$
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509,994
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$
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169,707
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Asset-backed securities issued
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|
11,554,259
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15,585,277
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Accrued interest payable
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51,304
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41,027
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Interest rate agreements
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6,080
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|
507
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|
Accrued expenses and other
liabilities
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|
17,267
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|
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|
27,889
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|
Dividends payable
|
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|
18,237
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|
|
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17,593
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|
|
|
|
|
|
|
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Total liabilities
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12,157,141
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15,842,000
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|
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|
|
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Commitments and contingencies
(Note 11)
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STOCKHOLDERS EQUITY
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Common stock, par value
$0.01 per share, 50,000,000 shares authorized;
26,053,016 and 25,132,625 issued and outstanding
|
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|
261
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|
251
|
|
Additional paid-in capital
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874,847
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824,365
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Accumulated other comprehensive
income
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94,780
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|
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|
73,731
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|
Cumulative earnings
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|
773,320
|
|
|
|
681,479
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Cumulative distributions to
stockholders
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|
(700,547
|
)
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|
(644,866
|
)
|
|
|
|
|
|
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Total stockholders equity
|
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|
1,042,661
|
|
|
|
934,960
|
|
|
|
|
|
|
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|
Total Liabilities and
Stockholders Equity
|
|
$
|
13,199,802
|
|
|
$
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16,776,960
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|
|
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|
|
|
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|
The accompanying notes are an integral part of these
consolidated financial statements.
3
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share data)
(Unaudited)
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|
|
|
|
|
|
|
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|
|
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|
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Three Months Ended
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Nine Months Ended
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September 30,
|
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|
September 30,
|
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|
|
|
|
|
|
|
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|
2006
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|
2005
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|
|
2006
|
|
|
2005
|
|
|
|
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|
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|
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|
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|
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|
Interest income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Real estate loans
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|
$
|
149,483
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|
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$
|
194,025
|
|
|
$
|
469,028
|
|
|
$
|
600,282
|
|
Real estate securities
|
|
|
72,759
|
|
|
|
48,811
|
|
|
|
189,656
|
|
|
|
127,095
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Cash and cash equivalents
|
|
|
1,872
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|
|
|
990
|
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|
|
7,220
|
|
|
|
2,374
|
|
|
|
|
|
|
|
|
|
|
|
|
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Interest income before provision
for credit reserve
|
|
|
224,114
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|
|
|
243,826
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|
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|
665,904
|
|
|
|
729,751
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|
(Provision for) reversal of credit
reserve
|
|
|
(465
|
)
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|
|
805
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|
|
|
1,865
|
|
|
|
1,307
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income
|
|
|
223,649
|
|
|
|
244,631
|
|
|
|
667,769
|
|
|
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731,058
|
|
Interest expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redwood debt
|
|
|
(9,422
|
)
|
|
|
(3,789
|
)
|
|
|
(13,316
|
)
|
|
|
(8,272
|
)
|
Asset-backed securities issued
|
|
|
(165,251
|
)
|
|
|
(192,802
|
)
|
|
|
(515,531
|
)
|
|
|
(559,341
|
)
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|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest expense
|
|
|
(174,673
|
)
|
|
|
(196,591
|
)
|
|
|
(528,847
|
)
|
|
|
(567,613
|
)
|
Net interest income
|
|
|
48,976
|
|
|
|
48,040
|
|
|
|
138,922
|
|
|
|
163,445
|
|
Operating expenses
|
|
|
(13,455
|
)
|
|
|
(12,364
|
)
|
|
|
(42,074
|
)
|
|
|
(35,618
|
)
|
Net recognized gains and valuation
adjustments
|
|
|
433
|
|
|
|
24,916
|
|
|
|
4,556
|
|
|
|
42,973
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income before provision for
income taxes
|
|
|
35,954
|
|
|
|
60,592
|
|
|
|
101,404
|
|
|
|
170,800
|
|
Provision for income taxes
|
|
|
(3,538
|
)
|
|
|
(4,693
|
)
|
|
|
(9,563
|
)
|
|
|
(13,424
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
32,416
|
|
|
$
|
55,899
|
|
|
$
|
91,841
|
|
|
$
|
157,376
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per share:
|
|
$
|
1.25
|
|
|
$
|
2.26
|
|
|
$
|
3.60
|
|
|
$
|
6.41
|
|
Diluted earnings per share:
|
|
$
|
1.22
|
|
|
$
|
2.21
|
|
|
$
|
3.51
|
|
|
$
|
6.26
|
|
Regular dividends declared per
common share
|
|
$
|
0.70
|
|
|
$
|
0.70
|
|
|
$
|
2.10
|
|
|
$
|
2.10
|
|
Special dividends declared per
common share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total dividends declared per common
share
|
|
$
|
0.70
|
|
|
$
|
0.70
|
|
|
$
|
2.10
|
|
|
$
|
2.10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic weighted average shares
outstanding
|
|
|
25,869,743
|
|
|
|
24,712,536
|
|
|
|
25,525,054
|
|
|
|
24,554,475
|
|
Diluted weighted average shares
outstanding
|
|
|
26,624,532
|
|
|
|
25,314,315
|
|
|
|
26,132,000
|
|
|
|
25,159,619
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
4
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
32,416
|
|
|
$
|
55,899
|
|
|
$
|
91,841
|
|
|
$
|
157,376
|
|
Other comprehensive
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized gains (losses) on
available-for-sale securities
|
|
|
31,342
|
|
|
|
(16,200
|
)
|
|
|
29,962
|
|
|
|
34,578
|
|
|
Reclassification adjustment for net
(gains) losses included in net income
|
|
|
30
|
|
|
|
(18,137
|
)
|
|
|
686
|
|
|
|
(31,100
|
)
|
|
Net unrealized gains (losses) on
cash flow hedges
|
|
|
(27,576
|
)
|
|
|
13,891
|
|
|
|
(3,261
|
)
|
|
|
7,901
|
|
|
Reclassification of net realized
cash flow hedge (gains) losses to interest expense on
asset-backed securities issued and net recognized gains and
valuation adjustments
|
|
|
47
|
|
|
|
109
|
|
|
|
(6,338
|
)
|
|
|
307
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other comprehensive
income
|
|
|
3,843
|
|
|
|
(20,337
|
)
|
|
|
21,049
|
|
|
|
11,686
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
$
|
36,259
|
|
|
$
|
35,562
|
|
|
$
|
112,890
|
|
|
$
|
169,062
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
5
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
For the Nine Months Ended
September 30, 2006:
(In thousands, except share data)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
|
Additional
|
|
|
Other
|
|
|
|
|
Cumulative
|
|
|
|
|
|
|
|
|
Paid-In
|
|
|
Comprehensive
|
|
|
Cumulative
|
|
|
Distributions to
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Income
|
|
|
Earnings
|
|
|
Stockholders
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2005
|
|
|
25,132,625
|
|
|
$
|
251
|
|
|
$
|
824,365
|
|
|
$
|
73,731
|
|
|
$
|
681,479
|
|
|
$
|
(644,866
|
)
|
|
$
|
934,960
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
91,841
|
|
|
|
|
|
|
|
91,841
|
|
|
|
Net unrealized (gain)
reclassification on assets AFS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
30,648
|
|
|
|
|
|
|
|
|
|
|
|
30,648
|
|
|
|
Net unrealized gain/
reclassification on interest rate agreements
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(9,599
|
)
|
|
|
|
|
|
|
|
|
|
|
(9,599
|
)
|
Issuance of common stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividend Reinvestment &
Stock Purchase Plans
|
|
|
862,733
|
|
|
|
9
|
|
|
|
38,563
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
38,572
|
|
|
|
Employee Option & Stock
Purchase Plans
|
|
|
60,524
|
|
|
|
1
|
|
|
|
663
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
664
|
|
|
|
Restricted Stock & Stock
DERs
|
|
|
(2,866
|
)
|
|
|
|
|
|
|
11,256
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11,256
|
|
Dividends declared:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(55,681
|
)
|
|
|
(55,681
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30,
2006
|
|
|
26,053,016
|
|
|
$
|
261
|
|
|
$
|
874,847
|
|
|
$
|
94,780
|
|
|
$
|
773,320
|
|
|
$
|
(700,547
|
)
|
|
$
|
1,042,661
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months Ended
September 30, 2005:
(In thousands, except share data)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
|
Additional
|
|
|
Other
|
|
|
|
|
Cumulative
|
|
|
|
|
|
|
|
|
Paid-In
|
|
|
Comprehensive
|
|
|
Cumulative
|
|
|
Distributions to
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Income
|
|
|
Earnings
|
|
|
Stockholders
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2004
|
|
|
24,153,576
|
|
|
$
|
242
|
|
|
$
|
773,222
|
|
|
$
|
105,357
|
|
|
$
|
481,607
|
|
|
$
|
(496,272
|
)
|
|
$
|
864,156
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
157,376
|
|
|
|
|
|
|
|
157,376
|
|
|
|
Net unrealized gain on assets AFS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,478
|
|
|
|
|
|
|
|
|
|
|
|
3,478
|
|
|
|
Net unrealized gain on interest
rate agreements
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,208
|
|
|
|
|
|
|
|
|
|
|
|
8,208
|
|
Issuance of common stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secondary Offerings
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividend Reinvestment &
Stock Purchase Plans
|
|
|
582,250
|
|
|
|
5
|
|
|
|
31,294
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
31,299
|
|
|
|
Employee Option & Stock
Plans
|
|
|
19,969
|
|
|
|
1
|
|
|
|
739
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
740
|
|
|
|
Restricted Stock & Stock
DERs
|
|
|
8,609
|
|
|
|
|
|
|
|
2,852
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,852
|
|
Dividends declared:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(52,044
|
)
|
|
|
(52,044
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30,
2005
|
|
|
24,764,404
|
|
|
$
|
248
|
|
|
$
|
808,107
|
|
|
$
|
117,043
|
|
|
$
|
638,983
|
|
|
$
|
(548,316
|
)
|
|
$
|
1,016,065
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
6
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
Cash Flows From Operating
Activities:
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
91,841
|
|
|
$
|
157,376
|
|
|
Adjustments to reconcile net income
to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
Net amortization of premiums,
discounts, and debt issuance costs
|
|
|
(48,611
|
)
|
|
|
(61,045
|
)
|
|
Depreciation and amortization of
non-financial assets
|
|
|
836
|
|
|
|
622
|
|
|
Reversal of credit loss provision
|
|
|
(1,865
|
)
|
|
|
(1,307
|
)
|
|
Non-cash stock compensation
|
|
|
11,256
|
|
|
|
2,852
|
|
|
Net recognized gains and valuation
adjustments
|
|
|
(4,556
|
)
|
|
|
(42,973
|
)
|
|
Principal payments on real estate
loans held-for-sale
|
|
|
|
|
|
|
885
|
|
|
Net sales of real estate loans
held-for-sale
|
|
|
|
|
|
|
95,841
|
|
|
Purchases of real estate loans
held-for-sale
|
|
|
|
|
|
|
(81,804
|
)
|
|
Net change in:
|
|
|
|
|
|
|
|
|
|
Accrued interest receivable
|
|
|
9,165
|
|
|
|
(7,499
|
)
|
|
Principal receivable
|
|
|
(850
|
)
|
|
|
1,124
|
|
|
Deferred income taxes
|
|
|
212
|
|
|
|
2,893
|
|
|
Other assets
|
|
|
770
|
|
|
|
161
|
|
|
Accrued interest payable
|
|
|
10,277
|
|
|
|
7,141
|
|
|
Accrued expenses and other
liabilities
|
|
|
(10,622
|
)
|
|
|
2,387
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating
activities
|
|
|
57,853
|
|
|
|
76,654
|
|
|
|
|
|
|
|
|
Cash Flows From Investing
Activities:
|
|
|
|
|
|
|
|
|
|
Purchases of real estate loans
held-for-investment
|
|
|
(1,291,989
|
)
|
|
|
(1,530,510
|
)
|
|
Proceeds from sales of real estate
loans held-for-investment
|
|
|
8,408
|
|
|
|
181,827
|
|
|
Principal payments on real estate
loans held-for-investment
|
|
|
5,303,962
|
|
|
|
7,247,574
|
|
|
Purchases of real estate securities
available-for-sale
|
|
|
(818,219
|
)
|
|
|
(757,870
|
)
|
|
Proceeds from sales of real estate
securities available-for-sale
|
|
|
241,624
|
|
|
|
141,442
|
|
|
Principal payments on real estate
securities available-for-sale
|
|
|
161,790
|
|
|
|
153,971
|
|
|
Net increase in restricted cash
|
|
|
(67,020
|
)
|
|
|
(22,758
|
)
|
|
|
|
|
|
|
|
|
Net cash provided by investing
activities
|
|
|
3,538,556
|
|
|
|
5,413,676
|
|
|
|
|
|
|
|
|
Cash Flows From Financing
Activities:
|
|
|
|
|
|
|
|
|
|
Net borrowings (repayments) on
Redwood debt
|
|
|
340,287
|
|
|
|
(41,542
|
)
|
|
Proceeds from issuance of
asset-backed securities
|
|
|
1,460,572
|
|
|
|
1,998,008
|
|
|
Deferred asset-backed security
issuance costs
|
|
|
(10,591
|
)
|
|
|
(11,259
|
)
|
|
Repayments on asset-backed
securities
|
|
|
(5,431,649
|
)
|
|
|
(7,307,909
|
)
|
|
Net (purchase) of interest
rate agreements
|
|
|
(2,186
|
)
|
|
|
(2,860
|
)
|
|
Net proceeds from issuance of
common stock
|
|
|
39,236
|
|
|
|
32,038
|
|
|
Dividends paid
|
|
|
(55,037
|
)
|
|
|
(50,892
|
)
|
|
|
|
|
|
|
|
|
Net cash used in financing
activities
|
|
|
(3,659,368
|
)
|
|
|
(5,384,416
|
)
|
|
|
|
|
|
|
|
Net (decrease) increase in cash and
cash equivalents
|
|
|
(62,959
|
)
|
|
|
105,914
|
|
Cash and cash equivalents at
beginning of period
|
|
|
175,885
|
|
|
|
57,246
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of
period
|
|
$
|
112,926
|
|
|
$
|
163,160
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash
flow information:
|
|
|
|
|
|
|
|
|
|
Cash paid for interest
|
|
$
|
518,570
|
|
|
$
|
560,692
|
|
|
Cash paid for taxes
|
|
$
|
7,999
|
|
|
$
|
8,765
|
|
Non-cash financing
activity:
|
|
|
|
|
|
|
|
|
|
Dividends declared but not paid
|
|
$
|
18,237
|
|
|
$
|
17,335
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
7
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Redwood Trust, Inc., together with its subsidiaries (Redwood,
we, or us), is a specialty finance company that invests in and
manages real estate assets. In general, we invest in real estate
assets by acquiring and owning asset-backed securities backed by
real estate loans. Our primary focus is credit-enhancing
residential and commercial real estate loans. We credit-enhance
loans by acquiring and managing the first-loss and other
credit-sensitive securities that bear the bulk of the credit
risk of securitized loans.
As a real estate investment trust (REIT), we are required to
distribute to stockholders as dividends at least 90% of our REIT
taxable income, which is our income as calculated for tax
purposes, exclusive of income earned in taxable subsidiaries. In
order to meet our dividend distribution requirements, we have
been paying both a regular quarterly dividend and a year-end
special dividend. We expect our special dividend amount to be
highly variable and we may not pay a special dividend in every
year. Our dividend policies and distribution practices are
determined by our Board of Directors and may change over time.
Redwood was incorporated in the State of Maryland on
April 11, 1994, and commenced operations on August 19,
1994. Our executive offices are at One Belvedere Place,
Suite 300, Mill Valley, California 94941.
|
|
NOTE 2.
|
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
|
Basis of Presentation
The consolidated financial statements presented herein are for
September 30, 2006 and December 31, 2005 and for the
three and nine month periods ended September 30, 2006 and
2005. The accompanying consolidated financial statements are
unaudited. The unaudited interim consolidated financial
statements have been prepared on the same basis as the annual
consolidated financial statements and, in our opinion, reflect
all adjustments necessary for a fair statement of our financial
position, results of operations, and cash flows. These
consolidated financial statements and notes thereto should be
read in conjunction with our audited consolidated financial
statements included in our Annual Report on
Form
10-K
for the
year ended December 31, 2005. The results for the three and
nine months ended September 30, 2006 are not necessarily
indicative of the expected results for the year ended
December 31, 2006. Certain amounts for prior periods have
been reclassified to conform to the September 30, 2006
presentation. The nine months ended September 30, 2005
comparable cash flow statement has been reclassified to conform
with the 2005
Form
10-K
cash
flow presentation.
These consolidated financial statements include the accounts of
Redwood and its wholly-owned subsidiaries, Sequoia Mortgage
Funding Corporation, Redwood Mortgage Funding, Inc. (RMF),
Redwood Asset Management, Inc. (RAM), Cypress Trust, Inc.,
Acacia CDO 1, Ltd. through Acacia CDO 10, Ltd., Acacia
CDO CRE1, Ltd., RWT Holdings, Inc. (Holdings), and
Holdings wholly-owned subsidiaries, including Sequoia
Residential Funding, Inc. and Madrona Residential Funding LLC.
References to Sequoia mean Sequoia Mortgage Funding Corporation
and Sequoia Residential Funding, Inc. References to Acacia mean
all the Acacia CDO entities. References to the Redwood REIT mean
Redwood exclusive of its taxable subsidiaries. The taxable
subsidiaries of Redwood are Holdings, Holdings wholly
owned subsidiaries, RMF and RAM, and the Acacia entities. All
inter-company balances and transactions have been eliminated in
consolidation.
Due diligence expenses are costs for services related to
re-underwriting and analyzing the loans we acquire or the loans
we credit-enhance through the purchase of certain securities. In
previous financial statements we recognized these expenses as a
reduction in interest income. After reviewing again the nature
of these costs it was determined that they did not directly
relate to the specific creation of a securitization and were
dependent on specific asset acquisition analysis (which may or
may not result in our acquiring assets). Therefore, beginning in
the second quarter of 2006, we are recognizing these due
diligence costs as an operating expense, and these amounts for
prior periods have been reclassified to conform to this
presentation.
8
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
Use of Estimates
The preparation of financial statements in conformity with
Generally Accepted Accounting Principles in the United States of
America (GAAP) requires us to make a significant number of
estimates in the preparation of financial statements. These
include fair value of certain assets, amount and timing of
credit losses, prepayment assumptions, and other items that
affect the reported amounts of certain assets and liabilities as
of the date of the consolidated financial statements and the
reported amounts of certain revenues and expenses during the
reported period. It is likely that changes in these estimates
(e.g., market values due to changes in supply and demand, credit
performance, prepayments, interest rates, or other reasons;
yields due to changes in credit outlook and loan prepayments)
will occur in the near term. Our estimates are inherently
subjective in nature and actual results could differ from our
estimates and the differences may be material.
Sequoia and Acacia Securitizations
We treat the securitizations we sponsor as financings under the
provisions of Statement of Financial Accounting Standards
No. 140,
Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities
(FAS 140), as under these provisions we have retained
effective control over these loans and securities. Control is
maintained through our active management of the assets in the
securitization entities, our retained asset transfer discretion,
our ability to direct certain servicing decisions, or a
combination of the foregoing. These securitization entities
issue asset-backed securities (ABS) to fund their acquisitions
of loans and securities. Accordingly, the underlying loans owned
by the Sequoia entities are shown on our Consolidated Balance
Sheets under real estate loans and the Sequoia ABS issued to
third parties are shown on our Consolidated Balance Sheets under
ABS issued. Assets owned by the Acacia entities are shown on our
Consolidated Balance Sheets in our real estate securities
portfolio. ABS issued by the Acacia entities are shown on our
Consolidated Balance Sheets as ABS issued. In our Consolidated
Statements of Income, we record interest income on the loans and
securities and interest expense on the ABS issued. Any Sequoia
ABS (CES, investment grade, or interest-only security (IO))
acquired by Redwood or Acacia from Sequoia entities and any
Acacia ABS acquired by Redwood for its own portfolio are
eliminated in consolidation and thus are not shown separately on
our Consolidated Balance Sheets.
Earning Assets
Earning assets (as consolidated for GAAP purposes) consist
primarily of real estate loans and securities. Coupon interest
is recognized as revenue when earned according to the terms of
the loans and securities and when, in our opinion, it is
collectible. Purchase discounts and premiums related to earning
assets are amortized into interest income over their estimated
lives to generate an effective yield, considering the actual and
future estimated prepayments of the assets. Gains or losses on
the sale of earning assets are based on the specific
identification method.
Real estate loans combine our consolidated residential and
commercial real estate loans. Real estate securities combine our
consolidated residential and commercial real estate securities
including those securities we define as credit-enhancement
securities (CES). CES includes below-investment grade
securities. Also included in our securities portfolio are
residential sub-prime, collateral debt obligation (CDO), home
equity lines of credit (HELOCs), and REIT corporate debt
securities.
Real Estate Loans: Held-for-Investment
Our consolidated real estate loans are classified as
held-for-investment because the consolidated securitization
entities that own these assets have the ability and intent to
hold these loans to maturity. Real estate loans
held-for-investment are carried at their unpaid principal
balances adjusted for net unamortized premiums or discounts and
net of any allowance for credit losses.
Pursuant to Statement of Financial Accounting Standards
No. 91,
Accounting for Nonrefundable Fees and Costs
Associated with Originating or Acquiring Loans and Initial
Direct Cost of Leases
(FAS 91), we
9
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
use the interest method to determine an effective yield and
amortize the premium or discount on loans. For loans acquired
prior to July 1, 2004, we use coupon interest rates as they
change over time and anticipated principal payments to determine
an effective yield to amortize the premium or discount. For
loans acquired after July 1, 2004, we use the initial
coupon interest rate of the loans (without regard to future
changes in the underlying indices) and anticipated principal
payments to calculate an effective yield to amortize the premium
or discount.
Real Estate Securities: Available-for-Sale
Real estate securities are classified as available-for-sale
(AFS) and are carried at their estimated fair values.
Cumulative unrealized gains and losses are reported as a
component of accumulated other comprehensive income in our
Consolidated Statements of Stockholders Equity.
When recognizing revenue on AFS securities, we employ the
interest method to account for purchase premiums, discounts, and
fees associated with these securities. For securities rated AAA
or AA, we use the interest method as prescribed under
FAS 91, while for securities rated A or lower we use the
interest method as prescribed under the Emerging Issues Task
Force of the Financial Accounting Standards Board
99-20,
Recognition
of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets
(EITF
99-20).
The use of these methods requires us to project cash flows over
the remaining life of each asset. These projections include
assumptions about interest rates, prepayment rates, the timing
and amount of credit losses, and other factors. We review and
make adjustments to our cash flow projections on an ongoing
basis and monitor these projections based on input and analyses
received from external sources, internal models, and our own
judgment and experience. There can be no assurance that our
assumptions used to estimate future cash flows or the current
periods yield for each asset would not change in the near
term.
For determining other-than-temporary impairment on our real
estate securities, we use the guidelines prescribed under
EITF 99-20, Statement of Financial Accounting Standards
No. 115,
Accounting for Certain Investments in Debt and
Equity Securities
(FAS 115), and Staff Accounting
Bulletin No. 5(m),
Other-Than-Temporary Impairment
for Certain Investments in Debt and Equity Securities
(SAB 5(m)). Any other-than-temporary impairments are
reported under net recognized gains (losses) and valuation
adjustments in our Consolidated Statements of Income.
Credit Reserves
For consolidated real estate loans held-for-investment, we
establish and maintain credit reserves based on estimates of
credit losses inherent in these loan portfolios as of the
reporting date. To calculate the credit reserve, we assess
inherent losses by determining loss factors (defaults, the
timing of defaults, and loss severities upon defaults) that can
be specifically applied to each of the consolidated loans, loan
pools, or individual loans. We follow the guidelines of Staff
Accounting Bulletin No. 102,
Selected Loan Loss
Allowance Methodology and Documentation
(SAB 102),
Statement of Financial Accounting Standards No. 5,
Accounting for Contingencies
(FAS 5), and Statement
of Financial Accounting Standards No. 114,
Accounting by
Creditors for Impairment of a Loan
(FAS 114), in
setting credit reserves for our real estate loans.
The following factors are considered and applied in such
determinations:
|
|
|
Ongoing analyses of the pool of loans including, but
not limited to, the age of loans, underwriting standards,
business climate, economic conditions, geographical
considerations, and other observable data;
|
|
|
Historical loss rates and past performance of similar loans;
|
|
|
Relevant environmental factors;
|
|
|
Relevant market research and publicly available third-party
reference loss rates;
|
|
|
Trends in delinquencies and charge-offs;
|
10
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
|
|
|
Effects and changes in credit concentrations;
|
|
|
Information supporting the borrowers ability to meet
obligations;
|
|
|
Ongoing evaluations of fair values of collateral using current
appraisals and other valuations; and
|
|
|
Discounted cash flow analyses.
|
Once we determine applicable default amounts, the timing of the
defaults, and severity of losses upon the defaults, we estimate
expected losses for each pool of loans over its expected life.
We then estimate the timing of these losses and the losses
probable to occur over an effective loss confirmation period.
This period is defined as the range of time between the probable
occurrence of a credit loss (such as the initial deterioration
of the borrowers financial condition) and the confirmation
of that loss (the actual impairment or charge-off of the loan).
The losses expected to occur within the estimated loss
confirmation period are the basis of our credit reserves because
we believe those losses exist as of the reported date of the
financial statements. We re-evaluate the level of our credit
reserves on at least a quarterly basis, and we record provision,
charge-offs, and recoveries monthly.
Additionally, if a loan becomes real estate owned (REO) or
is reclassified as held-for-sale, valuations specific to that
loan also include analyses of the underlying collateral.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and highly liquid
investments with original maturities of three months or less.
Other Assets
Restricted Cash
Restricted cash includes principal and interest payments from
real estate loans and securities owned by consolidated
securitization entities that are collateral for, or payable to,
owners of ABS issued by those entities and cash pledged as
collateral on interest rate agreements. Restricted cash may also
include cash retained in Acacia or Sequoia securitization trusts
prior to purchase of real estate loans and securities.
Deferred Tax Assets
Net deferred tax assets represent the net benefit of net
operating loss (NOL) carry forwards, real estate asset basis
differences, recognized tax gains on whole loan securitizations,
interest rate agreement basis differences, and other temporary
GAAP and tax timing differences. These temporary timing
differences will be recognized in different periods for GAAP and
tax purposes. Net unrealized gains and losses on securities and
interest rate agreements in our taxable subsidiaries that are
reported in other comprehensive income are adjusted for the
effects of tax, thus creating deferred tax assets (liabilities).
Deferred Asset-Backed Securities Issuance Costs
Deferred ABS issuance costs are costs associated with the
issuance of ABS from securitization entities we sponsor. These
costs typically include underwriting, rating agency, legal,
accounting, and other fees. Deferred ABS issuance costs are
reported on our Consolidated Balance Sheets as deferred charges
and are amortized as an adjustment to consolidated interest
expense using the interest method based on the actual and
estimated repayment schedules of the related ABS issued under
the principles prescribed in Accounting Practice
Bulletin 21,
Interest on Receivables and Payables
(APB 21).
Other Assets
Other assets on our Consolidated Balance Sheets include REO,
fixed assets, purchased interest, and other prepaid expenses.
REO is reported at the lower of cost or market value.
11
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
Accrued Interest Receivable and Principal Receivable
Accrued interest receivable and principal receivable represent
principal and interest that is due and payable to us. These are
generally received within the next month.
Interest Rate Agreements and Purchase Commitments
We enter into interest rate agreements to help manage some of
our interest rate risks. We report our interest rate agreements
at fair value. Those with a positive value to us are reported as
an asset and those with a negative value to us are reported as a
liability. We may elect hedge accounting treatment under
Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities
(FAS 133), or we may account for these as trading
instruments. See
Note 5
for a further discussion on
interest rate agreements.
We enter into commitments to purchase loans. These commitments
are accounted for as derivatives under Statement of Financial
Accounting Standards No. 149,
Amendment of
Statement 133 on Derivative Instruments and Hedging
Activities
(FAS 149), when applicable. These are
classified as trading instruments on our Consolidated Balance
Sheets until the date of settlement and changes in fair value of
the commitments are recorded through Net Recognized Gains and
Valuation Adjustments in the Consolidated Statements of Income.
Redwood Debt
Redwood debt is short-term debt collateralized by loans and
securities. We report this debt at its unpaid principal balance.
We may use Redwood debt to fund assets temporarily as we
accumulate them for future sale to securitization entities.
Increasingly, we will use Redwood debt to fund loans and
securities that do not have significant credit risk and that we
believe can generate an attractive return on the capital
employed.
Asset-Backed Securities Issued
The majority of the liabilities reported on our Consolidated
Balance Sheets represents ABS issued by bankruptcy-remote
securitization entities sponsored by Redwood. These ABS issued
are carried at their unpaid principal balances net of any
unamortized discount or premium. Our exposure to loss from
consolidated securitization entities (such as Sequoia and
Acacia) is limited (except, in some circumstances, for limited
loan repurchase obligations) to our net investment in securities
we have acquired from these entities. As required by the
governing documents related to each series of ABS, Sequoia and
Acacia assets are held in the custody of trustees. Trustees
collect principal and interest payments (less servicing and
related fees) from the assets and make corresponding principal
and interest payments to the issued ABS. ABS obligations are
payable solely from the assets of these entities and are
non-recourse to Redwood.
Other Liabilities
Accrued Interest Payable
Accrued interest payable represents interest due and payable on
Redwood debt and ABS issued. It is generally paid within the
next month with the exception of interest due on Acacia ABS
which is generally settled quarterly.
Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities on our Consolidated
Balance Sheets include cash held back from borrowers,
derivatives margin liability, accrued employee bonuses,
executive deferred compensation, dividend equivalent rights
(DERs) payable, excise and income taxes, and accrued legal,
accounting, consulting, and other miscellaneous expenses.
12
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
Dividends Payable
Dividends payable reflect any dividend declared by us but not
yet distributed to our stockholders as of the financial
statement date.
Income Taxes
We have elected to be taxed as a REIT under the Internal Revenue
Code and the corresponding provisions of state law. In order to
qualify as a REIT, we must distribute at least 90% of our annual
REIT taxable income (this does not include taxable income
retained in our taxable subsidiaries) to stockholders within the
time frame set forth in the tax rules and we must meet certain
other requirements. If these requirements are met, we generally
will not be subject to Federal or state income taxation at the
corporate level with respect to the REIT taxable income we
distribute to our stockholders. We may retain up to 10% of our
REIT taxable income and pay corporate income taxes on this
retained income while continuing to maintain our REIT status.
We have recorded a provision for income taxes in our
Consolidated Statements of Income based upon our estimated
liability for Federal and state income tax purposes. These tax
liabilities arise from estimated taxable earnings in taxable
subsidiaries and from the planned retention of a portion of our
estimated REIT taxable income. See
Note 8
for a
further discussion on income taxes.
Net Income per Share
Basic net income per share is computed by dividing net income by
the weighted average number of common shares outstanding during
the period. Diluted net income per share is computed by dividing
net income by the weighted average number of common shares and
potential common shares outstanding during the period. Potential
common shares outstanding are calculated using the treasury
stock method, which assumes that all dilutive common stock
equivalents are exercised and the funds generated by the
exercises are used to buy back outstanding common stock at the
average market price of the common stock during the reporting
period.
13
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
The following table provides reconciliation of denominators of
the basic and diluted net income per share computations.
Basic and Diluted Net
Income Per Share
(In thousands, except share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per
share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average number of common
shares outstanding during the period
|
|
|
25,869,743
|
|
|
|
24,712,536
|
|
|
|
25,525,054
|
|
|
|
24,554,475
|
|
Net effect of dilutive stock options
|
|
|
754,789
|
|
|
|
601,779
|
|
|
|
606,946
|
|
|
|
605,144
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings
per share
|
|
|
26,624,532
|
|
|
|
25,314,315
|
|
|
|
26,132,000
|
|
|
|
25,159,619
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic Earnings Per
Share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share
|
|
$
|
1.25
|
|
|
$
|
2.26
|
|
|
$
|
3.60
|
|
|
$
|
6.41
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted Earnings Per
Share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share
|
|
$
|
1.22
|
|
|
$
|
2.21
|
|
|
$
|
3.51
|
|
|
$
|
6.26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pursuant to
EITF
03-6,
Participating Securities and the Two
Class Method
under
FASB No. 128
(EITF
03-6),
we determined that there was no allocation of income for our
outstanding stock options as they were antidilutive during the
three and nine months ended September 30, 2006 and 2005.
There were no other participating securities, as defined by
EITF
03-6,
during
the three and nine months ended September 30, 2006 and
2005. For the three and nine months ended September 30,
2006, the number of outstanding stock options that were
antidilutive totaled 369,343 and 384,399, respectively. For the
three and nine months ended September 30, 2005, the number
of outstanding stock options that were antidilutive totaled
368,522 and 167,622, respectively.
Other Comprehensive Income
Current period net unrealized gains and losses on real estate
loan CES, real estate securities available-for-sale, and
interest rate agreements classified as cash flow hedges are
reported as components of other comprehensive income on our
Consolidated Statements of Comprehensive Income. Net unrealized
gains and losses on securities and interest rate agreements held
by our taxable REIT subsidiaries that are reported in other
comprehensive income are adjusted for the effects of tax, thus
creating deferred tax assets (liabilities).
Stock-Based Compensation
As of September 30, 2006 and December 31, 2005, we had
one stock-based employee compensation plan and one employee
stock purchase plan. These plans, and associated stock options
and other equity awards, are described more fully in
Note 10.
We adopted Statement of Financial Accounting Standards
No. 123R,
Share-Based Payment
(FAS 123R), on
January 1, 2006. With the adoption of FAS 123R, the
grant date fair value of all remaining unvested stock
compensation awards (stock options, deferred stock units, and
restricted stock) are expensed on the Consolidated Statements of
Income over the remaining vesting period. At January 1,
2006, upon adoption of FAS 123R, we had $19.3 million
of unamortized costs related to non-
14
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
vested equity awards (stock options, restricted stock, and
deferred stock units). At September 30, 2006, the
unamortized costs totaled $11.4 million and will be
expensed over the next four years, over half of which will be
recognized over the next twelve months.
Beginning in 2003, in accordance with the guidance of Statement
of Financial Accounting Standards No. 148,
Accounting
for Stock Based Compensation Transition and
Disclosure, an amendment for FASB Statement No. 123
(FAS 148), we elected to prospectively apply the fair
value method of accounting for stock-based awards issued after
December 31, 2002. We accounted for all stock-based
compensation awards issued prior to December 31, 2002 under
the recognition and measurement principles of APB Opinion
No. 25,
Accounting for Stock Issued to Employees
(APB 25), and related interpretations. Under
APB 25, when we granted option awards we did not include
any stock-based employee compensation cost in net income, as all
option awards granted had an exercise price equal to the fair
market value of the underlying common stock on the date of
grant. All other equity awards (deferred stock units and
restricted stock), were valued at the grant date and expensed
over the vesting period (regardless of when they were granted).
Had we also applied Statement of Financial Accounting Standards
No. 123,
Accounting for Stock-Based Compensation
(FAS 123), to option awards granted prior to 2003, net
income and net income per share would have been the pro-forma
amounts indicated in the table below for the three and nine
months ended September 30, 2005. Since we adopted
FAS 123R as of January 1, 2006, there is no pro-forma
presentation for the three and nine months ended
September 30, 2006.
Pro-Forma Net Income Under
FAS 123
(In thousands, except share data)
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30, 2005
|
|
|
September 30, 2005
|
|
|
|
|
|
|
|
|
Net income, as reported
|
|
$
|
55,899
|
|
|
$
|
157,376
|
|
Add: Dividend equivalent right
operating expenses under APB 25
|
|
|
2,029
|
|
|
|
5,587
|
|
Deduct: Stock option operating
(expense) income under APB 25
|
|
|
(16
|
)
|
|
|
(98
|
)
|
Deduct: Stock-based employee
compensation expense determined under fair value based method
for awards granted prior to January 1, 2003
|
|
|
(201
|
)
|
|
|
(671
|
)
|
|
|
|
|
|
|
|
Pro forma net income
|
|
$
|
57,711
|
|
|
$
|
162,194
|
|
|
|
|
|
|
|
|
Earnings per share:
|
|
|
|
|
|
|
|
|
|
Basic as reported
|
|
$
|
2.26
|
|
|
$
|
6.41
|
|
|
Basic pro forma
|
|
$
|
2.34
|
|
|
$
|
6.61
|
|
|
Diluted as reported
|
|
$
|
2.21
|
|
|
$
|
6.26
|
|
|
Diluted pro forma
|
|
$
|
2.28
|
|
|
$
|
6.45
|
|
The Black-Scholes option-pricing model was used in determining
fair values of option grants accounted for under FAS 123R
and FAS 123. The model requires the use of assumptions such
as strike price, expected life, risk free rate of return, and
stock price volatility. Options are generally granted over the
course of the calendar year. Certain options have dividend
equivalent rights (DERs) and, accordingly, the assumed dividend
yield was zero for these options. Other options granted have no
DERs and the assumed dividend yield was 10%. There were no
options granted during the three months ended September 30,
2006 and 2005. The following table describes the weighted
average of assumptions used for calculating the value of options
granted during the nine months ended September 30, 2006 and
15
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
2005. Similar assumptions were used to calculate the pro forma
information presented in the table above.
Weighted Average Assumptions used for Valuation of Options
Under FAS 123R and FAS 123 Granted during
period
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
Stock price volatility
|
|
|
25.7%
|
|
|
|
26.41%
|
|
Risk free rate of return (Treasury
Rate)
|
|
|
4.75%
|
|
|
|
4.07%
|
|
Average life
|
|
|
5 years
|
|
|
|
5 years
|
|
Dividend yield assumptions
|
|
|
10.00%
|
|
|
|
4.45%
|
|
Recent Accounting Pronouncements
In February 2006, the FASB issued Statement 155,
Accounting for Certain Hybrid Financial Instruments,
(FAS 155), to amend FAS 133 and FAS 140. This
Statement simplifies the accounting for certain financial
instruments by allowing an entity to make an irrevocable
election on a specific instrument basis for certain financial
assets and liabilities that contain embedded derivatives that
would otherwise require bifurcation and to recognize and
re-measure at fair value these instruments so elected. Thus,
under this election, an entity would measure the entire hybrid
financial instrument at fair value with changes in fair value
recognized in earnings. FAS 155 will become effective for
us as of January 1, 2007. We are currently assessing the
impact on our financial statements.
In March 2006, the FASB issued Statement 156,
Accounting
for Servicing of Financial Assets an amendment of
FASB Statement No. 140
(FAS 156). This Statement
amends FAS 140 with respect to the accounting for
separately recognized servicing assets and servicing
liabilities. FAS 156 requires an entity to either
(i) recognize servicing assets or servicing liabilities
initially at fair value and amortize this value over the period
of servicing, or (ii) measure servicing assets or
liabilities at fair value at each reporting date with changes in
fair value reported in earnings. FAS 156 will become
effective for us as of January 1, 2007. We believe
FAS 156 will not have a material impact on our financial
statements.
In July 2006, the FASB released
Accounting for Uncertainty In
Income Taxes
(FIN 48). FIN 48 addresses the
recognition and measurement of uncertain income tax positions
using a more-likely-than-not threshold and
introduces a number of new disclosure requirements. The
differences between current practice and the requirements of
FIN 48 are significant, and a substantial effort will be
required by most companies to properly assess all material
uncertain positions. Further, the impact of FIN 48 is not
just technical; the interpretation may cause companies to modify
their tax-related strategies. The new guidance will become
effective for us January 1, 2007. We are currently
assessing the impact on our financial statements.
In September 2006, the FASB issued Statement 157,
Fair
Value Measurements,
(FAS 157). This statement clarifies
the definition of fair value, the methods used to measure fair
value, and requires expanded financial statement disclosures
about fair value measurements for assets and liabilities.
FAS 157 is effective for financial statements issued for
fiscal years beginning after November 15, 2007. The new
guidance will be effective for us January 1, 2008 and we
are currently assessing the impact on our financial statements.
In September 2006, the SECs Office of the Chief Accountant
and Divisions of Corporation Finance and Investment Management
released Staff Accounting Bulletin No. 108
(SAB 108), which provides interpretive guidance on how
registrants should quantify financial-statement misstatements.
Currently, the two methods most commonly used by preparers and
auditors to quantify misstatements are the rollover
method (which focuses primarily on the income statement impact
of misstatements) and the iron curtain method (which
focuses primarily on the balance sheet impact of misstatements).
Under SAB 108, registrants will be required to consider
both the rollover and iron curtain methods (i.e., a dual
16
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
approach) when evaluating the materiality of financial statement
errors. Registrants will need to revisit their prior materiality
assessments and consider them using both the rollover and iron
curtain methods.
SAB 108 is effective for annual financial statements in the
first fiscal year ending after November 15, 2006, therefore
for us, the year ended December 31, 2006. The SAB provides
transition accounting and disclosure guidance for situations in
which a registrant concludes that a material error(s) existed in
prior-period financial statements under the dual approach.
Specifically, registrants will be permitted to restate prior
period financial statements or recognize the cumulative effect
of initially applying SAB 108 through an adjustment to
beginning retained earnings in the year of adoption. We believe
SAB 108 will not have a material impact on our annual
financial statements.
In the first quarter of 2006, we became aware of a potential
technical interpretation of GAAP that differs from our current
accounting presentations. This issue relates to the accounting
for transactions where assets are purchased from a counterparty
and simultaneously financed through a repurchase agreement with
that same counterparty and whether these transactions create
derivatives instead of the acquisition of assets with related
financing (which is how we currently present these
transactions). This potential technical interpretation of GAAP
does not affect the economics of the transactions but may affect
how the transactions would be reported in our financial
statements. Our cash flows, our liquidity, and our ability to
pay a dividend would be unchanged, and we do not believe our
taxable income would be affected. We have not changed our
accounting treatment for this potential issue. However, if we
were to change our current accounting presentations based on
this interpretation, we do not believe there would be a material
impact on our consolidated financial statements.
As of September 30, 2006 and December 31, 2005 our
reported earning assets (owned by us or by consolidated
securitization entities) consisted of investments in
adjustable-rate, hybrid, and fixed-rate real estate loans and
securities. Adjustable-rate loans have coupons that reset at
least annually. Hybrid loans have an initial fixed coupon rate
for three to ten years followed by periodic (usually annual or
semi-annual) adjustments. The original maturity of the majority
of our residential real estate loans and residential real estate
securities is usually twenty-five to thirty years. The original
maturity of our HELOCs is generally ten years. The original
maturity of our commercial real estate loans and commercial real
estate securities is generally ten years. The actual maturity is
subject to change based on the prepayments of the underlying
loans.
For the three months ended September 30, 2006 and 2005, the
average consolidated balance of earning assets was
$12.9 billion and $20.1 billion, respectively. For the
nine months ended September 30, 2006 and 2005, the average
consolidated balance of earning assets was $13.9 billion
and $22.2 billion, respectively.
Real Estate Loans
We acquire real estate loans from third party originators for
sale to securitization entities sponsored by us under our
Sequoia program which, in turn, issue ABS (that are shown as
liabilities on our Consolidated Balance Sheets). The following
tables summarize the carrying value of real estate loans, which
17
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
include residential real estate loans, HELOCs, and commercial
real estate loans as reported on our Consolidated Balance Sheets
at September 30, 2006 and December 31, 2005.
Real Estate Loans
Composition
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
|
Residential real estate loans
|
|
$
|
9,725,153
|
|
|
$
|
13,693,833
|
|
HELOCs
|
|
|
117,641
|
|
|
|
180,959
|
|
Commercial real estate loans
|
|
|
32,170
|
|
|
|
59,692
|
|
|
|
|
|
|
|
|
Carrying value
|
|
$
|
9,874,964
|
|
|
$
|
13,934,484
|
|
|
|
|
|
|
|
|
Real Estate Loans Carrying
Value
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
|
Held for
|
|
|
Held for
|
|
|
|
Investment
|
|
|
Investment
|
|
|
|
|
|
|
|
|
Current face
|
|
$
|
9,761,369
|
|
|
$
|
13,789,333
|
|
Unamortized premium
|
|
|
141,062
|
|
|
|
175,948
|
|
Discount designated as credit
protection
|
|
|
(8,141
|
)
|
|
|
(8,141
|
)
|
|
|
|
|
|
|
|
Amortized cost
|
|
|
9,894,290
|
|
|
|
13,957,140
|
|
Reserve for credit losses
|
|
|
(19,326
|
)
|
|
|
(22,656
|
)
|
|
|
|
|
|
|
|
Carrying value
|
|
$
|
9,874,964
|
|
|
$
|
13,934,484
|
|
|
|
|
|
|
|
|
Of the $9.8 billion of face and $141 million of
unamortized premium on our real estate loans at
September 30, 2006, $6.0 billion of face and
$114 million of unamortized premium relates to loans
acquired prior to July 1, 2004. The loans acquired prior to
July 1, 2004 had face and unamortized premium balances of
$9.7 billion and $138 million, respectively, at
December 31, 2005. During the first nine months of 2006,
39% of these loans prepaid and we amortized 17% of the premium
over the first nine months of 2006. For these loans acquired
prior to July 2004, we use coupon interest rates as they change
over time and anticipated principal payments to determine an
effective yield to amortize the premium or discount. For real
estate loans acquired after July 1, 2004, the face and
unamortized premium was $3.8 billion and $27 million
at September 30, 2006 and $4.1 billion and
$38 million at December 31, 2005, respectively. For
these loans acquired after July 1, 2004, we use the initial
coupon interest rate of the loans (without regard to future
changes in the underlying indices) and anticipated principal
payments to calculate an effective yield to amortize the premium
or discount.
18
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
The following table provides detail of the activity of reported
real estate loans for the three and nine months ended
September 30, 2006 and 2005.
Real Estate Loans Activity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
$
|
10,491,014
|
|
|
$
|
19,672,359
|
|
|
$
|
13,934,484
|
|
|
$
|
22,559,244
|
|
Acquisitions
|
|
|
966,673
|
|
|
|
346,268
|
|
|
|
1,291,989
|
|
|
|
1,612,316
|
|
Settled commitment deducted from
loan basis
|
|
|
(133
|
)
|
|
|
|
|
|
|
(133
|
)
|
|
|
|
|
Sales (other than to consolidated
ABS trusts)
|
|
|
|
|
|
|
(263,096
|
)
|
|
|
(8,408
|
)
|
|
|
(277,666
|
)
|
Principal repayments
|
|
|
(1,570,389
|
)
|
|
|
(3,127,329
|
)
|
|
|
(5,303,962
|
)
|
|
|
(7,248,463
|
)
|
Transfers to REO
|
|
|
(1,093
|
)
|
|
|
(2,005
|
)
|
|
|
(7,026
|
)
|
|
|
(3,334
|
)
|
Net premium amortization
|
|
|
(11,232
|
)
|
|
|
(14,507
|
)
|
|
|
(35,261
|
)
|
|
|
(32,038
|
)
|
Reversal of credit loss provision,
net of charge-offs
|
|
|
124
|
|
|
|
930
|
|
|
|
3,295
|
|
|
|
1,552
|
|
Net recognized gains (losses) and
valuation adjustments
|
|
|
|
|
|
|
(201
|
)
|
|
|
(14
|
)
|
|
|
808
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
9,874,964
|
|
|
$
|
16,612,419
|
|
|
$
|
9,874,964
|
|
|
$
|
16,612,419
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Some of the real estate loans we acquire from third party
originators, we sell to securitization entities that finance
their purchases of loans from us through the issuance of ABS.
During the period that we accumulate loans for securitization,
we fund these loans with equity and with short-term debt sourced
through various whole loan-financing facilities available to us.
Our Consolidated Statements of Cash Flows record the proceeds
from any principal payments or sales in the same category as our
original acquisition was recorded. The table below presents
information regarding real estate loans pledged under our
borrowing agreements and owned by securitization entities.
Real Estate Loans Pledged and Unpledged
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
Face
|
|
|
Carrying
|
|
|
Face
|
|
|
Carrying
|
|
|
|
Value
|
|
|
Value
|
|
|
Value
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unpledged
|
|
$
|
155,599
|
|
|
$
|
147,548
|
|
|
$
|
60,259
|
|
|
$
|
51,924
|
|
Pledged for Redwood debt
|
|
|
373,318
|
|
|
|
375,192
|
|
|
|
|
|
|
|
|
|
Owned by securitization entities,
financed through the issuance of ABS
|
|
|
9,232,452
|
|
|
|
9,352,224
|
|
|
|
13,729,074
|
|
|
|
13,882,560
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Carrying value
|
|
$
|
9,761,369
|
|
|
$
|
9,874,964
|
|
|
$
|
13,789,333
|
|
|
$
|
13,934,484
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real Estate Securities
The real estate securities shown on our Consolidated Balance
Sheets include residential and commercial real estate securities
acquired from securitizations sponsored by others and certain
other securities.
Our real estate securities portfolio includes residential CES
(BB, B, and unrated residential real estate securities),
commercial first-loss CES (unrated commercial real estates
securities), and various other securities, as reported on our
Consolidated Balance Sheets at September 30, 2006 and
December 31, 2005.
19
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
The table below presents the carrying value on the types of
securities that are included in our Consolidated Balance Sheets
as of September 30, 2006 and December 31, 2005, and
their current credit ratings.
Real Estate Securities Underlying Collateral
Characteristics
At September 30, 2006
(In millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
AAA
|
|
|
AA
|
|
|
A
|
|
|
BBB
|
|
|
BB
|
|
|
B
|
|
|
Unrated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
513
|
|
|
$
|
5
|
|
|
$
|
2
|
|
|
$
|
18
|
|
|
$
|
105
|
|
|
$
|
195
|
|
|
$
|
71
|
|
|
$
|
117
|
|
Residential prime real estate
|
|
|
1,378
|
|
|
|
20
|
|
|
|
201
|
|
|
|
265
|
|
|
|
294
|
|
|
|
339
|
|
|
|
131
|
|
|
|
128
|
|
Residential Alt-A real estate
|
|
|
283
|
|
|
|
81
|
|
|
|
39
|
|
|
|
8
|
|
|
|
16
|
|
|
|
86
|
|
|
|
20
|
|
|
|
33
|
|
Residential HELOCs
|
|
|
101
|
|
|
|
3
|
|
|
|
50
|
|
|
|
37
|
|
|
|
7
|
|
|
|
4
|
|
|
|
|
|
|
|
|
|
Residential sub-prime real estate
|
|
|
429
|
|
|
|
5
|
|
|
|
90
|
|
|
|
227
|
|
|
|
102
|
|
|
|
2
|
|
|
|
|
|
|
|
3
|
|
REIT corporate debt
|
|
|
9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
|
|
8
|
|
|
|
|
|
|
|
|
|
Real estate CDOs
|
|
|
199
|
|
|
|
44
|
|
|
|
28
|
|
|
|
37
|
|
|
|
72
|
|
|
|
14
|
|
|
|
|
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities
|
|
$
|
2,912
|
|
|
$
|
158
|
|
|
$
|
410
|
|
|
$
|
592
|
|
|
$
|
597
|
|
|
$
|
648
|
|
|
$
|
222
|
|
|
$
|
285
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2005
(In millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
AAA
|
|
|
AA
|
|
|
A
|
|
|
BBB
|
|
|
BB
|
|
|
B
|
|
|
Unrated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
380
|
|
|
$
|
11
|
|
|
$
|
2
|
|
|
$
|
20
|
|
|
$
|
129
|
|
|
$
|
130
|
|
|
$
|
30
|
|
|
$
|
58
|
|
Residential prime real estate
|
|
|
1,185
|
|
|
|
29
|
|
|
|
197
|
|
|
|
195
|
|
|
|
232
|
|
|
|
281
|
|
|
|
113
|
|
|
|
138
|
|
Residential Alt-A real estate
|
|
|
117
|
|
|
|
|
|
|
|
46
|
|
|
|
1
|
|
|
|
|
|
|
|
50
|
|
|
|
3
|
|
|
|
17
|
|
Residential HELOCs
|
|
|
108
|
|
|
|
|
|
|
|
49
|
|
|
|
54
|
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential sub-prime real estate
|
|
|
442
|
|
|
|
5
|
|
|
|
86
|
|
|
|
292
|
|
|
|
59
|
|
|
|
|
|
|
|
|
|
|
|
|
|
REIT corporate debt
|
|
|
32
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24
|
|
|
|
8
|
|
|
|
|
|
|
|
|
|
Real estate CDOs
|
|
|
155
|
|
|
|
37
|
|
|
|
25
|
|
|
|
37
|
|
|
|
44
|
|
|
|
11
|
|
|
|
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities
|
|
$
|
2,419
|
|
|
$
|
82
|
|
|
$
|
405
|
|
|
$
|
599
|
|
|
$
|
493
|
|
|
$
|
480
|
|
|
$
|
146
|
|
|
$
|
214
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The table below presents the face value, unamortized discount,
the portion of the discount designated as credit protection, the
unrealized gains and losses, and the carrying value of real
estate securities reported on our Consolidated Balance Sheets.
20
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
Real Estate Securities September 30,
2006
(In millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential CES
|
|
|
|
|
|
Total Real Estate
|
|
|
and Commercial
|
|
|
|
|
|
Securities
|
|
|
First-Loss CES
|
|
|
Other Securities
|
|
|
|
Available-for-Sale
|
|
|
Available-for-Sale
|
|
|
Available-for-Sale
|
|
|
|
|
|
|
|
|
|
|
|
Current face
|
|
$
|
3,679,693
|
|
|
$
|
1,533,697
|
|
|
$
|
2,145,996
|
|
Unamortized premium
interest-only certificates
|
|
|
8,764
|
|
|
|
|
|
|
|
8,764
|
|
Unamortized discount, net
|
|
|
(222,256
|
)
|
|
|
(111,412
|
)
|
|
|
(110,844
|
)
|
Discount designated as credit
protection
|
|
|
(642,779
|
)
|
|
|
(642,779
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized cost
|
|
|
2,823,422
|
|
|
|
779,506
|
|
|
|
2,043,916
|
|
Gross unrealized gains
|
|
|
112,919
|
|
|
|
91,228
|
|
|
|
21,691
|
|
Gross unrealized losses
|
|
|
(23,976
|
)
|
|
|
(11,612
|
)
|
|
|
(12,364
|
)
|
|
|
|
|
|
|
|
|
|
|
Carrying value
|
|
$
|
2,912,365
|
|
|
$
|
859,122
|
|
|
$
|
2,053,243
|
|
|
|
|
|
|
|
|
|
|
|
Real Estate Securities December 31,
2005
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential CES
|
|
|
|
|
|
Total Real Estate
|
|
|
and Commercial
|
|
|
|
|
|
Securities
|
|
|
First-Loss CES
|
|
|
Other Securities
|
|
|
|
Available-for-Sale
|
|
|
Available-for-Sale
|
|
|
Available-for-Sale
|
|
|
|
|
|
|
|
|
|
|
|
Current face
|
|
$
|
3,021,363
|
|
|
$
|
1,211,217
|
|
|
$
|
1,810,146
|
|
Unamortized premium
interest-only certificates
|
|
|
14,866
|
|
|
|
|
|
|
|
14,866
|
|
Unamortized discount, net
|
|
|
(177,438
|
)
|
|
|
(107,337
|
)
|
|
|
(70,101
|
)
|
Discount designated as credit
protection
|
|
|
(496,416
|
)
|
|
|
(496,416
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized cost
|
|
|
2,362,375
|
|
|
|
607,464
|
|
|
$
|
1,754,911
|
|
Gross unrealized gains
|
|
|
93,322
|
|
|
|
80,122
|
|
|
|
13,200
|
|
Gross unrealized losses
|
|
|
(36,780
|
)
|
|
|
(17,250
|
)
|
|
|
(19,530
|
)
|
|
|
|
|
|
|
|
|
|
|
Carrying value
|
|
$
|
2,418,917
|
|
|
$
|
670,336
|
|
|
$
|
1,748,581
|
|
|
|
|
|
|
|
|
|
|
|
At September 30, 2006, our residential CES provided
credit-enhancement on $225 billion of residential real
estate loans, and our commercial first-loss CES provided
credit-enhancement on $36 billion of commercial real estate
loans. At December 31, 2005, our residential CES provided
credit-enhancement on $170 billion of residential real
estate loans, and our commercial first-loss CES provided
credit-enhancement on $26 billion of commercial real estate
loans.
The amount of designated credit protection equals the amount of
credit losses within the underlying loan pool that we expect to
incur over the life of the loans. This estimate is determined
based upon various factors affecting these assets, including
economic conditions, characteristics of the underlying loans,
delinquency status, past performance of similar loans, and
external credit protection. We use a variety of internal and
external credit risk cash flow modeling and portfolio analytical
tools to assist in our assessments. Quarterly, we complete our
assessments on each individual underlying loan pool and
determine the appropriate level of credit protection required
for each security we own. The designated credit protection is
specific to each security. The following table presents the
changes in our unamortized discount and the portion of the
discount designated as credit protection for the three and nine
months ended September 30, 2006 and 2005.
21
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
Changes In Unamortized Discount and Designated Credit
Protection on Residential CES and Commercial First-Loss
CES
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning balance of net
unamortized discount
|
|
$
|
90,925
|
|
|
$
|
71,641
|
|
|
$
|
107,337
|
|
|
$
|
97,841
|
|
Amortization
|
|
|
(14,946
|
)
|
|
|
(10,291
|
)
|
|
|
(38,144
|
)
|
|
|
(26,038
|
)
|
Calls, sales, and other
|
|
|
(3,177
|
)
|
|
|
(14,153
|
)
|
|
|
(2,759
|
)
|
|
|
(29,544
|
)
|
Re-designation of credit protection
to discount
|
|
|
33,277
|
|
|
|
19,242
|
|
|
|
50,481
|
|
|
|
41,432
|
|
Acquisitions
|
|
|
5,333
|
|
|
|
(18,137
|
)
|
|
|
(5,503
|
)
|
|
|
(35,389
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance of net unamortized
discount
|
|
$
|
111,412
|
|
|
$
|
48,302
|
|
|
$
|
111,412
|
|
|
$
|
48,302
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning balance of designated
credit protection
|
|
$
|
617,712
|
|
|
$
|
491,390
|
|
|
$
|
496,416
|
|
|
$
|
385,762
|
|
Realized credit losses
|
|
|
(2,476
|
)
|
|
|
(1,505
|
)
|
|
|
(5,958
|
)
|
|
|
(4,736
|
)
|
Calls, sales, and other
|
|
|
(35,883
|
)
|
|
|
(33,420
|
)
|
|
|
(40,922
|
)
|
|
|
(44,799
|
)
|
Re-designation of credit protection
to discount
|
|
|
(33,277
|
)
|
|
|
(19,242
|
)
|
|
|
(50,481
|
)
|
|
|
(41,432
|
)
|
Acquisitions
|
|
|
96,703
|
|
|
|
84,169
|
|
|
|
243,724
|
|
|
|
226,597
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance of designated credit
protection
|
|
$
|
642,779
|
|
|
$
|
521,392
|
|
|
$
|
642,779
|
|
|
$
|
521,392
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The net unamortized discount balance at September 30, 2006
of $111 million consists of $147 million of net
unamortized discount on the residential CES and an effective
premium of $36 million on the commercial first-loss CES.
Yields recognized for GAAP for each security vary as a function
of credit results, prepayment rates, and, for our securities
with variable rate coupons, interest rates. If estimated future
credit losses are less than our prior estimate, credit losses
occur later than expected, or prepayment rates are faster than
expected (meaning the present value of projected cash flows is
greater then previously expected), the yield over the remaining
life of the security may be adjusted upwards over time. If
estimated future credit losses exceed our prior expectations,
credit losses occur more quickly than expected, or prepayments
occur more slowly than expected (meaning the present value of
projected cash flows is less than previously expected), the
yield over the remaining life of the security may be adjusted
downward or we may have an other-than-temporary impairment. For
the three and nine months ended September 30, 2006, we
recognized other-than-temporary impairments of $0.5 million
and $6.0 million, respectively. For the three and nine
months ended September 30, 2005, we recognized
other-than-temporary impairments of $1.2 million and
$3.3 million, respectively. These impairments are included
in net recognized gains and valuation adjustments in our
Consolidated Statements of Income.
Gross unrealized gains and losses represent the difference
between the net amortized cost and the fair value of individual
securities. Gross unrealized losses represent a decline in
market value for securities not deemed impaired for GAAP. The
following table shows the gross unrealized losses, fair value,
and length of time that any real estate securities have been in
a continuous unrealized loss position as of September 30,
2006. These unrealized losses are not considered to be
other-than-temporary impairments because these losses are not
due to adverse changes in cash flows and we have the intent and
ability to hold these securities for a period sufficient for
these securities to potentially recover their values.
22
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
Real Estate Securities with Unrealized Losses as of
September 30, 2006
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less Than 12 Months
|
|
|
12 Months or More
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
|
Value
|
|
|
(Losses)
|
|
|
Value
|
|
|
(Losses)
|
|
|
Value
|
|
|
(Losses)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate securities
|
|
$
|
548,959
|
|
|
$
|
(13,112
|
)
|
|
$
|
341,343
|
|
|
$
|
(10,864
|
)
|
|
$
|
890,302
|
|
|
$
|
(23,976
|
)
|
The following table provides detail of the activity in our real
estate securities portfolio for the three and nine months ended
September 30, 2006 and 2005.
Real Estate Securities Activity
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
$
|
2,661,250
|
|
|
$
|
2,384,429
|
|
|
$
|
2,418,917
|
|
|
$
|
1,956,232
|
|
Acquisitions
|
|
|
321,397
|
|
|
|
264,823
|
|
|
|
818,219
|
|
|
|
757,870
|
|
Sales (other than to consolidated
ABS trusts)
|
|
|
(65,192
|
)
|
|
|
(98,775
|
)
|
|
|
(241,624
|
)
|
|
|
(141,442
|
)
|
Principal repayments (including
calls)
|
|
|
(59,987
|
)
|
|
|
(60,236
|
)
|
|
|
(161,790
|
)
|
|
|
(153,971
|
)
|
Discount amortization
|
|
|
17,400
|
|
|
|
10,857
|
|
|
|
42,719
|
|
|
|
26,870
|
|
Net unrealized gains (losses)
|
|
|
32,291
|
|
|
|
(34,338
|
)
|
|
|
32,402
|
|
|
|
3,478
|
|
Net recognized gains and valuation
adjustments
|
|
|
5,206
|
|
|
|
25,010
|
|
|
|
3,522
|
|
|
|
42,733
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
2,912,365
|
|
|
$
|
2,491,770
|
|
|
$
|
2,912,365
|
|
|
$
|
2,491,770
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Of the $60 million and $162 million of principal pay
downs in the three and nine months ended September 30,
2006, $6 million and $12 million, respectively,
represented calls of the securities in accordance with the
original issue provisions of individual securitization entities.
Of the $60 million and $154 million of principal pay
downs in the three and nine months ended September 30,
2005, $19 million and $46 million, respectively,
represented calls of the securities.
23
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
The following tables provide the activity for the components of
the securities portfolios; residential CES, commercial CES, and
other securities.
Residential Credit-Enhancement Securities Activity
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
$
|
715,360
|
|
|
$
|
706,195
|
|
|
$
|
612,649
|
|
|
$
|
561,658
|
|
Acquisitions
|
|
|
78,887
|
|
|
|
57,481
|
|
|
|
220,926
|
|
|
|
213,139
|
|
Sales (other than to consolidated
ABS trusts)
|
|
|
(47,585
|
)
|
|
|
(98,775
|
)
|
|
|
(67,552
|
)
|
|
|
(126,068
|
)
|
Principal repayments (including
calls)
|
|
|
(32,338
|
)
|
|
|
(18,403
|
)
|
|
|
(77,909
|
)
|
|
|
(62,735
|
)
|
Discount amortization
|
|
|
16,616
|
|
|
|
11,193
|
|
|
|
42,181
|
|
|
|
27,695
|
|
Net unrealized gains (losses)
|
|
|
6,404
|
|
|
|
(18,848
|
)
|
|
|
3,983
|
|
|
|
5,545
|
|
Net recognized gains and valuation
adjustments
|
|
|
5,037
|
|
|
|
25,958
|
|
|
|
8,103
|
|
|
|
45,567
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
742,381
|
|
|
$
|
664,801
|
|
|
$
|
742,381
|
|
|
$
|
664,801
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial First-Loss Credit-Enhancement Securities
Activity
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
$
|
75,889
|
|
|
$
|
29,397
|
|
|
$
|
57,687
|
|
|
$
|
14,498
|
|
Acquisitions
|
|
|
36,858
|
|
|
|
17,182
|
|
|
|
51,894
|
|
|
|
30,052
|
|
Sales (other than to consolidated
ABS trusts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal repayments (including
calls)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premium amortization
|
|
|
(1,670
|
)
|
|
|
(902
|
)
|
|
|
(4,037
|
)
|
|
|
(1,657
|
)
|
Net unrealized gains (losses)
|
|
|
5,939
|
|
|
|
(2,137
|
)
|
|
|
12,761
|
|
|
|
798
|
|
Net recognized losses and valuation
adjustments
|
|
|
(275
|
)
|
|
|
|
|
|
|
(1,564
|
)
|
|
|
(151
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
116,741
|
|
|
$
|
43,540
|
|
|
$
|
116,741
|
|
|
$
|
43,540
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
Other Securities Activity
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
$
|
1,870,001
|
|
|
$
|
1,648,837
|
|
|
$
|
1,748,581
|
|
|
$
|
1,380,077
|
|
Acquisitions
|
|
|
205,652
|
|
|
|
190,160
|
|
|
|
545,399
|
|
|
|
514,679
|
|
Sales (other than to consolidated
ABS trusts)
|
|
|
(17,607
|
)
|
|
|
|
|
|
|
(174,072
|
)
|
|
|
(15,374
|
)
|
Principal repayments (including
calls)
|
|
|
(27,649
|
)
|
|
|
(41,833
|
)
|
|
|
(83,881
|
)
|
|
|
(91,236
|
)
|
Discount amortization
|
|
|
2,454
|
|
|
|
566
|
|
|
|
4,575
|
|
|
|
832
|
|
Net unrealized gains (losses)
|
|
|
19,948
|
|
|
|
(13,353
|
)
|
|
|
15,658
|
|
|
|
(2,866
|
)
|
Net recognized gains (losses) and
valuation adjustments
|
|
|
444
|
|
|
|
(948
|
)
|
|
|
(3,017
|
)
|
|
|
(2,683
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
2,053,243
|
|
|
$
|
1,783,429
|
|
|
$
|
2,053,243
|
|
|
$
|
1,783,429
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We generally fund the first-loss and second-loss interests of
residential securities and first-loss commercial securities with
equity capital. We sell the other interests we acquire to
securitization entities (generally, Acacia) that re-securitize
these assets by issuing ABS. Prior to sale to these
securitization entities, we may fund some of the securities
acquired on a temporary basis with short-term borrowings through
various financing facilities available to us. The table below
presents information regarding our securities pledged under
borrowing agreements and owned by securitization entities as of
September 30, 2006 and December 31, 2005.
Real Estate Securities Pledged and Unpledged
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
|
Unpledged
|
|
$
|
413,107
|
|
|
$
|
371,225
|
|
Pledged for Redwood debt
|
|
|
150,584
|
|
|
|
164,426
|
|
Owned by securitization entities,
financed through issuance of ABS
|
|
|
2,348,674
|
|
|
|
1,883,266
|
|
|
|
|
|
|
|
|
Carrying value
|
|
$
|
2,912,365
|
|
|
$
|
2,418,917
|
|
|
|
|
|
|
|
|
Net Recognized Gains (Losses) and Valuation
Adjustments
Fluctuations in the market value of certain of our real estate
loan and security assets and interest rate agreements may also
affect our net income. The table below describes the various
components of our net recognized gains (losses) and valuation
adjustments reported in income for the three and nine months
ended September 30, 2006 and 2005.
25
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
Net Recognized Gains and Valuation Adjustments
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized gains on calls:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate securities
|
|
$
|
723
|
|
|
$
|
2,914
|
|
|
$
|
1,470
|
|
|
$
|
14,883
|
|
Realized gains (losses) on sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate loans
|
|
|
|
|
|
|
(201
|
)
|
|
|
(14
|
)
|
|
|
808
|
|
|
Real estate securities
|
|
|
4,967
|
|
|
|
23,254
|
|
|
|
8,067
|
|
|
|
31,108
|
|
Valuation adjustments
impairments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate securities
|
|
|
(484
|
)
|
|
|
(1,158
|
)
|
|
|
(6,015
|
)
|
|
|
(3,259
|
)
|
Gains (losses) on interest rate
agreements
|
|
|
(8,475
|
)
|
|
|
107
|
|
|
|
982
|
|
|
|
(567
|
)
|
Purchase commitments
|
|
|
3,702
|
|
|
|
|
|
|
|
66
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net recognized gains and valuation
adjustments
|
|
$
|
433
|
|
|
$
|
24,916
|
|
|
$
|
4,556
|
|
|
$
|
42,973
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During the course of preparing the financial statements for the
period ended June 30, 2006, we discovered two errors and
under the provisions of Statement of Financial Accounting
Standards No. 154, Accounting Changes and Error
Corrections, a replacement of APB Opinion No. 20 and FASB
Statement No. 3 (FAS 154), we analyzed the errors for
each period affected. The accrual rate for interest income on
certain securities and interest expense on certain ABS issued
had been incorrectly applied and not correctly adjusted. The
impact of this error was that on a cumulative basis we had
overstated interest income by $1.3 million and understated
interest expense by $0.2 million. Additionally, due
diligence expenses for certain securities purchased had been
incorrectly capitalized and amortized. The impact of this error
was that on a cumulative basis we had understated operating
expenses by $0.6 million and overstated mortgages
securities on the Consolidated Balance Sheets.
After carefully assessing the effect of these errors on
previously reported earnings and the effect of recording a total
cumulative correcting adjustment of $2.1 million in the
second quarter of 2006, we determined that the errors were not
material to the financial statements for the six months ended
June 30, 2006 and the year ended December 31, 2006.
Accordingly, cumulative correcting adjustments for these errors
were recorded in the second quarter of 2006.
|
|
NOTE 4.
|
RESERVES FOR CREDIT LOSSES
|
We establish and maintain credit reserves that we believe
represent probable credit losses in our consolidated real estate
loans held-for-investment as of the date of the financial
statements. The reserves for credit losses are reflected as a
component of real estate loans on our Consolidated Balance
Sheets.
Our loan servicers advance payment on delinquent loans to the
extent they deem them recoverable. We generally accrue interest
on delinquent loans to the extent cash is received; any
potential loss is included in our credit reserve. When a loan
becomes REO, we estimate the specific loss, based on estimated
net proceeds from the sale of the property (including accrued
but unpaid interest), and charge this specific estimated loss
against the reserve for credit losses. A majority of the
residential loans consolidated on our balance sheet have
interest-only payments for an initial term. Any increased credit
risk that these loans may contain is reflected in our analysis
and determination of the appropriate credit reserves.
26
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
The following table summarizes the activity in reserves for
credit losses for our consolidated real estate loans for the
three and nine months ended September 30, 2006
and 2005.
Real Estate Loans
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
$
|
19,450
|
|
|
$
|
22,959
|
|
|
$
|
22,656
|
|
|
$
|
23,896
|
|
Provision for (reversal of) credit
reserve
|
|
|
465
|
|
|
|
(805
|
)
|
|
|
(1,865
|
)
|
|
|
(1,307
|
)
|
Charge-offs
|
|
|
(589
|
)
|
|
|
(125
|
)
|
|
|
(1,465
|
)
|
|
|
(560
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
$
|
19,326
|
|
|
$
|
22,029
|
|
|
$
|
19,326
|
|
|
$
|
22,029
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Delinquencies in our consolidated residential real estate loans
were $61 million and $37 million as of
September 30, 2006 and December 31, 2005,
respectively. Delinquencies include loans delinquent more than
90 days, in bankruptcy, in foreclosure, and REO. As a
percentage of our residential real estate loans, delinquencies
stood at 0.63% and 0.27% of our current loan balances as of
September 30, 2006 and December 31, 2005,
respectively. We had no delinquent commercial real estate loans
as of September 30, 2006 and December 31, 2005.
Reserve for Deferred Interest
For first and second loss securities owned, backed by negatively
amortizing loans, we intend to recognize interest income when we
receive the cash either currently, or at a later
date, according to the terms of the loan.
To the extent we own any first- or second-loss securities with
underlying loans that do not make the fully indexed payment, we
do not recognize any unpaid interest as income. That is, we only
recognize the actual interest paid by establishing a reserve for
the amounts the loans negatively amortize. These reserves are
netted against our accrued interest receivable. During the three
and nine months ended September 30, 2006, we increased our
reserve for deferred interest by $1.1 million and
$2.9 million, respectively, against interest income on
these securities. During both the three and nine months ended
September 30, 2005, we increased our reserve for deferred
interest by $0.3 million. At September 30, 2006, the
outstanding reserve for deferred interest was $3.7 million.
One commercial loan that we own, in accordance with the
contractual arrangements, began deferring interest payments in
2006, though we may receive these amounts at a later date.
Consistent with our accounting practice on negatively amortizing
loans, we did not recognize the $0.1 million and
$0.5 million of interest accrued and not paid on this loan,
during the three and nine months ended September 30, 2006,
respectively.
|
|
NOTE 5.
|
INTEREST RATE AGREEMENTS AND PURCHASE COMMITMENTS
|
We maintain an overall interest rate risk management strategy
that incorporates the use of derivative interest rate agreements
for a variety of reasons, including reducing significant
fluctuations in earnings or market values on certain assets or
liabilities that may be caused by interest rate volatility.
Currently, the majority of our interest rate agreements are used
to match the duration of liabilities to assets. Interest rate
agreements we use as part of our interest rate risk management
strategy may include interest rate options, swaps, options on
swaps, futures contracts, options on futures contracts, and
options on forward purchase commitments.
We may designate the interest rate agreement as (1) a hedge
of the fair value of a recognized asset or liability or of an
unrecognized firm commitment (fair value hedge), (2) a
hedge of a forecasted transaction or of the variability of cash
flows to be received or paid related to a recognized asset or
liability
27
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
(cash flow hedge), or (3) held for trading (trading
instrument). We currently have elected cash flow hedging
treatment for certain interest rate agreements and treat other
interest rate agreements as trading instruments.
We discontinue hedge accounting when (1) we determine that
the derivative is no longer expected to be effective in
offsetting changes in the fair value or cash flows of the
designated hedged item; (2) the derivative expires or is
sold, terminated, or exercised; (3) the derivative is
de-designated as a fair value or cash flow hedge; or (4) it
is probable that the forecasted transaction will not occur by
the end of the originally specified time period.
We incur credit risk to the extent that the counterparties to
the interest rate agreements do not perform their obligations
under the interest rate agreements. If one of the counterparties
does not perform, we may not receive the cash to which we would
otherwise be entitled under the interest rate agreement. In
order to mitigate this risk, we only enter into interest rate
agreements that are either (a) transacted on a national
exchange or (b) transacted with counterparties that are
either (i) designated by the U.S. Department of
Treasury as a primary government dealer, (ii) affiliates of
primary government dealers, or (iii) rated AA or higher.
Furthermore, we generally enter into interest rate agreements
with several different counterparties in order to diversify our
credit risk exposure and maintain margin accounts with them.
We report our interest rate agreements at fair value as
determined using third-party models and confirmed by Wall Street
dealers. As of September 30, 2006 and December 31,
2005, the net fair value of interest rate agreements was
$23.6 million and $30.7 million, respectively, and are
summarized in the table below. See
Note 10
for the
impact of these fair value changes on Accumulated Other
Comprehensive Income.
Interest Rate Agreements
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
Fair
|
|
|
Notional
|
|
|
Credit
|
|
|
Fair
|
|
|
Notional
|
|
|
Credit
|
|
|
|
Value
|
|
|
Amount
|
|
|
Exposure
|
|
|
Value
|
|
|
Amount
|
|
|
Exposure
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trading Instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate caps purchased
|
|
$
|
1,535
|
|
|
$
|
91,400
|
|
|
$
|
|
|
|
$
|
1,913
|
|
|
$
|
116,400
|
|
|
$
|
|
|
Interest rate caps sold
|
|
|
(175
|
)
|
|
|
(25,000
|
)
|
|
|
|
|
|
|
(239
|
)
|
|
|
(65,000
|
)
|
|
|
|
|
Interest rate corridors purchased
|
|
|
|
|
|
|
876,815
|
|
|
|
|
|
|
|
|
|
|
|
1,059,851
|
|
|
|
|
|
Interest rate swaps
|
|
|
320
|
|
|
|
131,234
|
|
|
|
|
|
|
|
148
|
|
|
|
80,400
|
|
|
|
|
|
Purchase commitments
|
|
|
200
|
|
|
|
93,250
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flow Hedges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swaps
|
|
|
21,732
|
|
|
|
3,475,569
|
|
|
|
4,029
|
|
|
|
28,891
|
|
|
|
5,399,653
|
|
|
|
(2,672
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Interest Rate
Agreements
|
|
$
|
23,612
|
|
|
$
|
4,643,268
|
|
|
$
|
4,029
|
|
|
$
|
30,713
|
|
|
$
|
6,591,304
|
|
|
$
|
(2,672
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We have elected cash flow hedging treatment for many of our
existing interest rate agreements. For these interest rate
agreements, the ineffective portion of the hedging derivative is
recognized immediately in earnings. We anticipate having some
ineffectiveness in our hedging program, as not all terms of our
hedges and not all terms of our hedged items match perfectly. We
use the dollar-offset method to determine the amount of
ineffectiveness. For the three and nine months ended
September 30, 2006, the amount of ineffectiveness was
$0.3 million and $0.5 million of income, respectively.
For both the three and nine months ended September 30,
2005, the amount of ineffectiveness was $0.1 million of
expense.
28
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
During the course of preparing the financial statements for the
period ended September 30, 2006 we discovered an error in
the valuation of certain interest rate agreements for the
purpose of measuring the amount of hedge ineffectiveness under
FAS 133. Under the provisions of Statement of Financial
Accounting Standards No. 154, Accounting Changes and Error
Corrections, a replacement of APB Opinion No. 20 and FASB
Statement No. 3 (FAS 154), we analyzed the errors for
each period affected. The impact of this error was that on a
cumulative basis we had understated interest expense (negative
ineffectiveness) by $1.0 million and overstated other
comprehensive income by $1.0 million.
After carefully assessing the effect of this error on previously
reported earnings and the effect of recording a total cumulative
correcting adjustment in the third quarter of 2006, we
determined that the errors were not material to the financial
statements for the nine-months ended September 30, 2006 and
the year ended December 31, 2006. Accordingly, a cumulative
correcting adjustment for this error was recorded in the third
quarter of 2006.
Should we choose to terminate a cash flow hedge, the value of
that hedge is reclassified from accumulated other comprehensive
income into earnings over time. The timing of the
reclassification depends on the status of the hedged or
forecasted transaction. If the hedged transaction no longer
exists, or the forecasted transaction is no longer expected to
occur, then the reclassification occurs immediately. If the
hedged transaction still exists, or the forecasted transaction
is still expected to occur, then the reclassification occurs
over the original period of such transaction. We have terminated
cash flow hedges where the hedged transaction still existed or
is still expected to occur. For the three and nine months ended
September 30, 2006, the amount reclassified from other
comprehensive income to interest expense totaled negative
$0.1 million and positive $0.4 million, respectively.
For the three and nine months ended September 30, 2005, the
amount reclassified from other comprehensive income to interest
expense totaled negative $0.1 million and negative
$0.3 million, respectively.
Also included in our interest expense in our Consolidated
Statements of Income is the net cash receipts (payments) on
interest rate agreements designated as cash flow hedges. For the
three and nine months ended September 30, 2006, the net
cash receipts credited to interest expense totaled
$3.0 million and $9.1 million, respectively. For the
three and nine months ended September 30, 2005, the net
cash receipts credited to interest expense totaled
$0.8 million and $3.4 million, respectively.
We do not elect hedge accounting treatment for some of our
interest rate agreements and these are accounted for as
trading instruments. Thus, changes in the market
value of these interest rate agreements and associated income
and expenses are reported through our earnings and appear in net
recognized gains (losses) and valuation adjustments in our
Consolidated Statements of Income.
We also enter into commitments to purchase loans. These
commitments are accounted for as derivatives under Statement of
Financial Accounting Standards No. 149,
Amendment of
Statement 133 on Derivative Instruments and Hedging
Activities
(FAS 149), where applicable and are
accounted for as trading instruments. During the three months
ended September 30, 2006 we entered into commitments to
purchase $93 million of residential hybrid loans that will
settle in the fourth quarter of 2006.
For the three months ended September 30, 2006, the amount
of market value changes associated with interest rate agreements
accounted for as trading instruments totaled negative
$8.5 million and the fair value change on loan purchase
commitments was positive $3.7 million. For the nine months
ended September 30, 2006, the amount of market value
changes associated with interest rate agreements accounted for
as trading instruments was positive $1.0 million and the
fair value change related to loan purchase commitments was
positive $0.1 million. For the three and nine months ended
September 30, 2005, the amount of market value changes
associated with interest rate agreements accounted for as
trading instruments totaled positive $0.1 million and
negative $0.6 million, respectively.
29
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
The following table depicts the amounts included in interest
expense and net recognized gains (losses) and valuation
adjustments activity for the three and nine months ended
September 30, 2006 and 2005 for our interest rate
agreements.
Interest Rate Agreements and Purchase Commitments
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Amounts Credited to
(Included in) Interest Expense for Cash Flow
Hedges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized net gains (losses) due to
net ineffective portion of hedges
|
|
$
|
322
|
|
|
$
|
(49
|
)
|
|
$
|
455
|
|
|
$
|
(93
|
)
|
Realized net gains (losses)
reclassified from other comprehensive income
|
|
|
(47
|
)
|
|
|
(109
|
)
|
|
|
425
|
|
|
|
(307
|
)
|
Net cash payment on interest rate
swaps
|
|
|
3,042
|
|
|
|
782
|
|
|
|
9,096
|
|
|
|
3,369
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
3,317
|
|
|
$
|
624
|
|
|
$
|
9,976
|
|
|
$
|
2,969
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Recognized Gains (Losses)
and Valuation Adjustments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized net gains (losses) on
interest rate agreements accounted for as trading instruments
|
|
$
|
(8,475
|
)
|
|
$
|
107
|
|
|
$
|
982
|
|
|
$
|
(567
|
)
|
Realized net gains (losses) on
purchase commitments
|
|
|
3,702
|
|
|
|
|
|
|
|
66
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
(4,773
|
)
|
|
$
|
107
|
|
|
$
|
1,048
|
|
|
$
|
(567
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At September 30, 2006 the balance of outstanding Redwood
debt was $510 million and at December 31, 2005 the
outstanding balance was $170 million. We generally enter
into repurchase agreements, bank borrowings, and other forms of
collateralized short-term borrowings to finance assets under
accumulation for future sale to securitization entities. The
table below summarizes Redwood debt by collateral type as of
September 30, 2006 and December 31, 2005.
Redwood Debt
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
|
Average
|
|
|
Average
|
|
|
|
Amount
|
|
|
Interest
|
|
|
Days Until
|
|
|
Amount
|
|
|
Interest
|
|
|
Days Until
|
|
|
|
Borrowed
|
|
|
Rate
|
|
|
Maturity
|
|
|
Borrowed
|
|
|
Rate
|
|
|
Maturity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential real estate loan
collateral
|
|
$
|
357,893
|
|
|
|
5.67
|
%
|
|
|
92
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
Residential loan CES collateral
|
|
|
62,112
|
|
|
|
6.47
|
%
|
|
|
182
|
|
|
|
38,707
|
|
|
|
4.99
|
%
|
|
|
73
|
|
Real estate securities collateral
|
|
|
89,989
|
|
|
|
6.00
|
%
|
|
|
182
|
|
|
|
131,000
|
|
|
|
5.07
|
%
|
|
|
73
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Redwood debt
|
|
$
|
509,994
|
|
|
|
5.82
|
%
|
|
|
119
|
|
|
$
|
169,707
|
|
|
|
5.05
|
%
|
|
|
73
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three and nine months ended September 30, 2006, the
average balance of Redwood debt was $0.6 billion and
$0.3 billion, and the weighted-average interest cost was
5.82% and 6.08%, respectively. For both the three and nine
months ended September 30, 2005, the average balance of
Redwood debt
30
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
was $0.3 billion and the weighted-average interest cost was
5.09% and 4.18%, respectively. At September 30, 2006 and
December 31, 2005, accrued interest payable on Redwood debt
was $0.5 million and $1.0 million, respectively.
As of September 30, 2006 and December 31, 2005,
Redwood debt had the following remaining maturities.
Redwood Debt
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
Within 30 days
|
|
$
|
|
|
|
$
|
|
|
31 to 90 days
|
|
|
|
|
|
|
169,707
|
|
Over 90 days
|
|
|
509,994
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Redwood debt
|
|
$
|
509,994
|
|
|
$
|
169,707
|
|
|
|
|
|
|
|
|
In 2005, we formed Madrona Residential Funding, LLC
(Madrona), a special purpose entity and wholly owned
subsidiary of Holdings. Madrona gives us the flexibility to
access the capital markets and issue short-term debt instruments
to finance the accumulation of loans prior to sale to sponsored
securitization entities. Madrona is designed to fund residential
loans accumulated for eventual sale to our Sequoia
securitization program by issuing A1+/P1 rated commercial paper.
Madrona was established to accumulate up to $1.5 billion of
loans (although the current authorization is for
$490 million) and can warehouse each loan up to
270 days. There are specific eligibility requirements for
financing loans in this facility that are similar to our
existing financing facilities with several banks and large
investment banking firms. There is a credit reserve account for
approximately 70 basis points that will serve as
credit-enhancement to the commercial paper investors. In
addition, we issued $5.4 million of a BBB-rated Madrona ABS
to provide further credit support. This facility has a
three-year term. As of September 30, 2006 there was no
commercial paper outstanding.
We have facilities available with several banks and major
investment banking firms for financing real estate loans and
securities and an unsecured line of credit with a bank.
Additional collateral in the form of additional qualifying
assets or cash may be required to meet changes in market values
from time to time under these agreements. Many of these
facilities for securities have no expiration date. The table
below summarizes our available facilities as of
September 30, 2006 and December 31, 2005 by collateral
type.
Redwood Debt
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
|
|
|
|
|
Number of
|
|
|
|
|
|
Facilities
|
|
|
Outstanding
|
|
|
Limit
|
|
|
Maturity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Facilities by collateral:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate loans
|
|
|
4
|
|
|
$
|
357,893
|
|
|
$
|
1,800,000
|
|
|
|
10/06-8/07
|
|
Real estate securities (warehouse)
|
|
|
1
|
|
|
|
152,101
|
|
|
|
400,000
|
|
|
|
3/07
|
|
Real estate securities (repo)
|
|
|
4
|
|
|
|
|
|
|
|
1,700,000
|
|
|
|
n/a
|
|
Unsecured line of credit
|
|
|
1
|
|
|
|
|
|
|
|
10,000
|
|
|
|
10/06
|
|
Madrona commercial paper facility
|
|
|
1
|
|
|
|
|
|
|
|
490,000
|
|
|
|
7/09
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total facilities
|
|
|
11
|
|
|
$
|
509,994
|
|
|
$
|
4,400,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
31
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
Number of
|
|
|
|
|
|
Facilities
|
|
|
Outstanding
|
|
|
Limit
|
|
|
Maturity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Facilities by collateral:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate loans
|
|
|
4
|
|
|
$
|
|
|
|
$
|
1,800,000
|
|
|
|
1/06-9/06
|
|
Real estate securities (warehouse)
|
|
|
1
|
|
|
|
169,707
|
|
|
|
300,000
|
|
|
|
3/06
|
|
Unsecured line of credit
|
|
|
1
|
|
|
|
|
|
|
|
10,000
|
|
|
|
8/06
|
|
Madrona commercial paper facility
|
|
|
1
|
|
|
|
|
|
|
|
300,000
|
|
|
|
4/08
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total facilities
|
|
|
7
|
|
|
$
|
169,707
|
|
|
$
|
2,410,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Borrowings under these facilities generally bear interest based
on a specified margin over the one-month London Inter-Bank
Offered Rate (LIBOR). interest rate. We continue to be in
compliance with all of our debt covenants for all of our
borrowing arrangements and credit facilities. Covenants
associated with our debt generally relate to our tangible net
worth, liquidity reserves, and leverage requirements. We have
not had, nor do we currently anticipate having, any problems in
meeting these covenants. It is our intent to renew facilities
and pursue additional facilities and other types of financing as
needed.
|
|
NOTE 7.
|
ASSET-BACKED SECURITIES ISSUED
|
Securitization entities sponsored by us issue ABS to raise the
funds to acquire assets from us and others. Each series of ABS
consists of various classes that pay interest at variable and
fixed rates. Substantially all of the ABS is indexed to one-,
three-, or six-month LIBOR. A lesser amount of the ABS are fixed
for a term and then adjust to a LIBOR rate (hybrid ABS) or are
fixed for their entire term. Some of the ABS interest only (IOs)
issued have a fixed spread, while others earn a coupon based on
the spread between collateral owned and the ABS issued by the
securitized entity. The maturity of each class is directly
affected by the rate of principal prepayments on the assets of
the issuing entity. Each series is also subject to redemption
(call) according to the specific terms of the respective
governing documents. As a result, the actual maturity of any
class of ABS is likely to occur earlier than its stated maturity.
32
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
The components of ABS issued by consolidated securitization
entities as of September 30, 2006 and December 31,
2005, along with other selected information, are summarized in
the table below.
Asset-Backed Securities Issued
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
|
Sequoia ABS issued
certificates with principal value
|
|
$
|
8,884,726
|
|
|
$
|
13,246,343
|
|
Sequoia ABS issued
interest-only certificates
|
|
|
90,114
|
|
|
|
142,788
|
|
Acacia ABS issued
|
|
|
2,575,833
|
|
|
|
2,165,840
|
|
Commercial ABS issued
|
|
|
|
|
|
|
4,250
|
|
Madrona ABS issued
|
|
|
5,400
|
|
|
|
5,400
|
|
Unamortized premium
(discount) on ABS
|
|
|
(1,814
|
)
|
|
|
20,656
|
|
|
|
|
|
|
|
|
Total consolidated ABS issued
|
|
$
|
11,554,259
|
|
|
$
|
15,585,277
|
|
|
|
|
|
|
|
|
Range of weighted average interest
rates, by series Sequoia
|
|
|
4.67% to 6.16
|
%
|
|
|
4.23% to 5.65
|
%
|
Stated Sequoia maturities
|
|
|
2008-2046
|
|
|
|
2007-2035
|
|
Number of Sequoia series
|
|
|
42
|
|
|
|
42
|
|
Range of weighted average interest
rates, by series Acacia
|
|
|
5.90%-6.31
|
%
|
|
|
4.32%-5.40
|
%
|
Stated Acacia maturities
|
|
|
2038-2046
|
|
|
|
2023-2046
|
|
Number of Acacia series
|
|
|
9
|
|
|
|
8
|
|
Weighted average interest
rates Commercial
|
|
|
|
|
|
|
12.00
|
%
|
Stated commercial maturities
|
|
|
|
|
|
|
2009
|
|
Number of commercial series
|
|
|
|
|
|
|
1
|
|
The following table summarizes the accrued interest payable on
ABS issued as of September 30, 2006 and December 31,
2005.
Accrued Interest Payable on Asset-Backed Securities
Issued
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
|
Sequoia
|
|
$
|
23,152
|
|
|
$
|
26,225
|
|
Acacia
|
|
|
27,651
|
|
|
|
13,778
|
|
Commercial
|
|
|
|
|
|
|
44
|
|
|
|
|
|
|
|
|
Total accrued interest payable on
ABS issued
|
|
$
|
50,803
|
|
|
$
|
40,047
|
|
|
|
|
|
|
|
|
The ABS issued by securitization entities sponsored by us are
collateralized by real estate loans and securities. The ABS
collateralized by residential real estate loans (and some
residential securities) are typically securitized through
entities with the brand name Sequoia. Residential real estate
loan collateral consists primarily of conventional, 25- or
30-year,
adjustable-rate and hybrid residential real estate loans secured
by first liens on one- to four-family residential properties.
HELOC collateral consists of adjustable-rate first and second
lien residential loans with a ten-year revolving period and a
maturity from origination of ten years. The ABS issued that are
collateralized by real estate securities and commercial real
estate loans are typically issued through entities with the
brand name Acacia. Other ABS collateralized by commercial loans
are issued on an individual basis. For financial reporting
purposes the assets and liabilities of these entities appear on
our Consolidated Balance Sheets. The ABS issued by Madrona
Residential Funding LLC (Madrona ABS) represents a form of
additional credit support potentially available to the
purchasers of the commercial paper.
33
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
Sequoia entities issued $0.7 billion of Sequoia ABS during
the three and nine months ended September 30, 2006 to fund
Sequoias acquisitions of residential real estate loans
from us. During the three and nine months ended
September 30, 2005, Sequoia entities issued
$0.3 billion and $1.5 billion, respectively, of
Sequoia ABS.
During the three and nine months ended September 30, 2006,
Acacia entities issued $500 million and $800 million
of Acacia ABS, respectively. During the three and nine months
ended September 30, 2005, Acacia entities issued
$300 million and $600 million of Acacia ABS,
respectively.
No commercial ABS issuances occurred during the three and nine
months ended September 30, 2006 and during the three months
ended September 30, 2005. During the nine months ended
September 30, 2005, we issued $4.3 million of
commercial ABS. No commercial ABS were paid off during the three
months ended September 30, 2006 and 2005, respectively.
During the nine months ended September 30, 2006 and 2005,
we paid off commercial ABS in full of $4.3 million and
$9.5 million, respectively.
The carrying value components of the collateral for ABS issued
and outstanding as of September 30, 2006 and
December 31, 2005 are summarized in the table below:
Collateral for Asset-Backed Securities Issued
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
|
Real estate loans
|
|
$
|
9,352,224
|
|
|
$
|
13,882,560
|
|
Real estate securities
|
|
|
2,348,674
|
|
|
|
1,883,266
|
|
Real estate owned (REO)
|
|
|
5,997
|
|
|
|
2,589
|
|
Restricted cash owned by
consolidated securitization entities
|
|
|
139,441
|
|
|
|
70,276
|
|
Accrued interest receivable
|
|
|
62,107
|
|
|
|
71,850
|
|
|
|
|
|
|
|
|
Total collateral for ABS issued
|
|
$
|
11,908,443
|
|
|
$
|
15,910,541
|
|
|
|
|
|
|
|
|
For tax purposes, a REIT can deduct dividends paid from REIT
taxable income, and thus effectively reduce or eliminate
corporate-level income taxes on REIT income. A REIT can retain
up to 10% of its REIT taxable income, maintain its REIT status,
and be taxable at corporate rates on retained income. As of
September 30, 2006, we had met all of the dividend
distribution requirements of a REIT.
Under the Internal Revenue Code, a dividend declared by a REIT
in October, November, or December of a calendar year and payable
to stockholders of record as of a specified date in such year
will be deemed to have been paid by the REIT and received by the
stockholders on the last day of that calendar year, provided the
dividend is actually paid before February 1st of the
following calendar year, and provided that the REIT has any
remaining undistributed REIT taxable income on the record date.
Therefore, the regular dividends declared in the fourth quarter
of 2005 that were paid in January 2006 are considered taxable
income to stockholders in 2005 (the year declared).
Our 2005 dividend distributions declared before
December 31, 2005 and distributed on or before
January 31, 2006, were less than 85% of our estimated 2005
REIT taxable income. This resulted in a 4% excise tax provision
on the shortfall. We anticipate following a similar pattern in
2006. For the three and nine months ended September 30,
2006, we provided for excise tax of $0.3 million and
$0.9 million, respectively, which is reflected as a
component of operating expenses on our Consolidated Statements
of Income. For the three and nine months ended
September 30, 2005, we provided for excise tax of
$0.3 million and $0.9 million, respectively. As of
September 30, 2006 and December 31, 2005, accrued
excise tax payable was $0.9 million and $1.2 million,
respectively, and was reflected as a component of accrued
expenses and other liabilities on our Consolidated Balance
Sheets.
34
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
We currently plan to retain approximately 10% of our 2006 REIT
ordinary taxable income (as we have in the previous three years)
and will be subject to corporate level income taxes on any
retained income for the 2006 calendar tax year. We plan to
distribute any net capital gains (gains generated from calls and
sales offset by losses on IOs as a result of calls) that we
generate to allow our stockholders to potentially take advantage
of a lower tax rate on those distributions.
The following table summarizes the tax provisions for the three
and nine months ended September 30, 2006 and 2005.
Provision for Income Tax
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current Tax Provision:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
3,129
|
|
|
$
|
3,537
|
|
|
$
|
7,529
|
|
|
$
|
7,047
|
|
State
|
|
|
478
|
|
|
|
2,014
|
|
|
|
1,822
|
|
|
|
3,484
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current tax provision
|
|
$
|
3,607
|
|
|
$
|
5,551
|
|
|
$
|
9,351
|
|
|
$
|
10,531
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred Tax
Provision:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable REIT subsidiaries
|
|
|
(69
|
)
|
|
|
(858
|
)
|
|
|
212
|
|
|
|
2,893
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total provision for income tax
|
|
$
|
3,538
|
|
|
$
|
4,693
|
|
|
$
|
9,563
|
|
|
$
|
13,424
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Federal and State tax provision for corporate income tax is
estimated based on the amount of REIT ordinary income that we
permanently retained, or plan to retain and estimated taxable
income at our taxable REIT subsidiaries. Taxable REIT
subsidiaries deferred tax provisions are attributable to
temporary differences between GAAP and tax accounting treatments
on securitization gains and the utilization of prior period
deferred tax assets.
As of September 30, 2006 and December 31, 2005, our
taxable REIT subsidiaries had net deferred tax assets as
presented in the table below. Realization of the deferred tax
asset is dependent on many factors including generating
sufficient taxable income prior to the expirations of net
operating loss carry forwards. Although realization is not
assured, we believe it is more likely than not that most of the
deferred tax asset will be realized. The amount of the deferred
tax asset considered realizable, however, could be reduced if
revised estimates of future taxable income during the carry
forward periods are lower than expectations.
Deferred Tax Assets (Liabilities)
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
|
Net operating loss carry
forward State
|
|
$
|
611
|
|
|
$
|
725
|
|
Real estate assets
|
|
|
2,448
|
|
|
|
1,970
|
|
Gains from Sequoia securitizations
|
|
|
1,620
|
|
|
|
2,536
|
|
Interest rate agreements
|
|
|
996
|
|
|
|
224
|
|
Other
|
|
|
188
|
|
|
|
229
|
|
|
|
|
|
|
|
|
Total net deferred tax assets
|
|
|
5,863
|
|
|
|
5,684
|
|
Valuation allowance
|
|
|
(314
|
)
|
|
|
(300
|
)
|
|
|
|
|
|
|
|
Total benefited deferred tax assets
through tax provision
|
|
|
5,549
|
|
|
|
5,384
|
|
Tax effect of unrealized losses
|
|
|
(2,344
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total benefited deferred tax assets
|
|
$
|
3,205
|
|
|
$
|
5,384
|
|
|
|
|
|
|
|
|
35
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
In accordance with
FAS 109, Accounting for Income
Taxes,
deferred tax assets (liabilities) are
recognized for GAAP items relating to unrealized gains (losses)
recognized through other comprehensive income. Deferred tax
assets (liabilities) are recognized for these items in
order to take into account potential tax effects if these
unrecognized gains (losses) are realized in the future through
the Consolidated Statements of Income. Any deferred tax assets
(liabilities) recognized for these items are booked through
equity as opposed to the provision for income taxes in the
Consolidated Statements of Income.
Holdings state NOLs were $8.7 million and
$10.1 million at September 30, 2006 and
December 31, 2005, respectively. These state NOLs will
expire by 2012, unless utilized. At September 30, 2006 and
December 31, 2005, the valuation allowance relates
exclusively to Holdings state NOLs which may expire before
being utilized.
The statutory combined Federal and state corporate tax rate is
42%. This rate is applied to the amount of estimated REIT
taxable income retained and to taxable income earned at the
taxable subsidiaries. Thus, as a REIT, our effective tax rate is
significantly less than the statutory combined rate as we are
allowed to deduct dividend distributions. In addition, there are
some permanent and temporary differences (including accounting
for securitizations, stock options and other equity
compensation, and other employee compensation expenses) between
GAAP income and taxable income that result in changes in our
effective rate from the statutory rates.
|
|
NOTE 9.
|
FAIR VALUE OF FINANCIAL INSTRUMENTS
|
We estimate the fair value of our financial instruments using
available market information and other appropriate valuation
methodologies. These fair value estimates generally incorporate
discounted future cash flows at current market discount rates
for comparable investments. We validate our fair value estimates
on a quarterly basis by obtaining fair value estimates from
dealers who make a market in these financial instruments. We
believe the estimates we use reasonably reflect the values we
may be able to receive should we choose to sell them. Many
factors must be considered in order to estimate market values,
including, but not limited to interest rates, prepayment rates,
amount and timing of credit losses, supply and demand,
liquidity, and other market factors. Accordingly, our estimates
are inherently subjective in nature and involve uncertainty and
judgment to interpret relevant market and other data. Amounts
realized in actual sales may differ from the fair values
presented.
The following table presents the carrying values and estimated
fair values of our financial instruments as of
September 30, 2006 and December 31, 2005.
Fair Value of Financial Instruments
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
Carrying
|
|
|
Fair
|
|
|
Carrying
|
|
|
Fair
|
|
|
|
Value
|
|
|
Value
|
|
|
Value
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate loans
held-for-investment
|
|
$
|
9,874,964
|
|
|
$
|
9,802,467
|
|
|
$
|
13,934,484
|
|
|
$
|
13,855,709
|
|
Real estate securities
available-for-sale
|
|
$
|
2,912,365
|
|
|
$
|
2,912,365
|
|
|
$
|
2,418,917
|
|
|
$
|
2,418,917
|
|
Interest rate agreements
|
|
$
|
29,492
|
|
|
$
|
29,492
|
|
|
$
|
31,220
|
|
|
$
|
31,220
|
|
Commitments to purchase
|
|
$
|
200
|
|
|
$
|
200
|
|
|
$
|
|
|
|
$
|
|
|
Cash and cash equivalents
|
|
$
|
112,926
|
|
|
$
|
112,926
|
|
|
$
|
175,885
|
|
|
$
|
175,885
|
|
Restricted cash
|
|
$
|
139,441
|
|
|
$
|
139,441
|
|
|
$
|
72,421
|
|
|
$
|
72,421
|
|
Accrued interest receivable
|
|
$
|
67,304
|
|
|
$
|
67,304
|
|
|
$
|
76,469
|
|
|
$
|
76,469
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redwood debt
|
|
$
|
509,994
|
|
|
$
|
509,994
|
|
|
$
|
169,707
|
|
|
$
|
169,707
|
|
ABS issued
|
|
$
|
11,554,259
|
|
|
$
|
11,508,429
|
|
|
$
|
15,585,277
|
|
|
$
|
15,519,383
|
|
Interest rate agreements
|
|
$
|
6,080
|
|
|
$
|
6,080
|
|
|
$
|
507
|
|
|
$
|
507
|
|
Accrued interest payable
|
|
$
|
51,304
|
|
|
$
|
51,304
|
|
|
$
|
41,027
|
|
|
$
|
41,027
|
|
36
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
Methodologies we use to estimate fair market values for various
asset types are described below.
|
|
|
|
|
Residential loan and HELOC fair values are determined by
available market quotes and discounted cash flow analyses and
are confirmed by third party/dealer pricing indications.
|
|
|
|
Commercial loan fair values are determined by appraisals on
underlying collateral and discounted cash flow analyses.
|
|
|
|
|
|
Real estate securities fair values are determined by discounted
cash flow analyses and other valuation techniques using market
pricing assumptions confirmed by third party dealer/pricing
indications.
|
|
|
|
Interest rate agreements
|
|
|
|
|
|
Fair values on interest rate agreements are determined by third
party vendor modeling software and from valuations provided by
dealers active in derivative markets.
|
|
|
|
Cash and cash equivalents
|
|
|
|
|
|
Includes cash on hand and highly liquid investments with
original maturities of three months or less. Fair values equal
carrying values.
|
|
|
|
|
|
Includes interest-earning cash balances in ABS entities for the
purpose of distribution to bondholders and reinvestment. Due to
the short-term nature of the restrictions, fair values
approximate carrying values.
|
|
|
|
Accrued interest receivable and payable
|
|
|
|
|
|
Includes interest due and receivable on assets and due and
payable on our liabilities. Due to the short-term nature of when
these interest payments will be received or paid, fair values
approximate carrying values.
|
|
|
|
|
|
All Redwood debt is adjustable and matures within one year; fair
values approximate carrying values.
|
|
|
|
|
|
Fair values are determined by discounted cash flow analyses and
other valuation techniques confirmed by third party/dealer
pricing indications.
|
|
|
|
Commitments to purchase
|
|
|
|
|
|
Fair values are determined by discounted cash flow analyses and
other valuation techniques confirmed by third party/dealer
pricing indications.
|
|
|
NOTE 10.
|
STOCKHOLDERS EQUITY
|
Accumulated Other Comprehensive Income
Certain assets are marked to market through accumulated other
comprehensive income on our Consolidated Balance Sheets. These
adjustments affect our book value but not our net income. As of
September 30, 2006 and December 31, 2005, we reported
net accumulated other comprehensive income of $94.8 million
and $73.7 million, respectively.
37
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
This account include the fair value of our earning assets and
changes during a period include the impact of calls of our
securities, write downs to fair value of a portion of our
securities, premium or discount amortization of our securities
agreements.
Also included in accumulated other comprehensive income at
September 30, 2006, was a net gain balance of
$0.1 million related to terminated cash flow hedges to be
reclassified into earnings over the original period of the
transaction. This net gain consisted of $4.1 million of
hedges terminated at a gain and $4.0 million of hedges
terminated at a loss. Of this net amount, $0.2 million will
be recognized as interest expense on our Consolidated Statements
of Income over the next twelve months. At September 30,
2006, the maximum length of time over which we are hedging our
exposure to the variability of future cash flows for forecasted
transactions is ten years, and all forecasted transactions are
expected to occur within the next year.
The following table provides a summary of the components of
accumulated other comprehensive income as of September 30,
2006 and December 31, 2005.
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
|
Net unrealized gains on real estate
securities
|
|
$
|
87,190
|
|
|
$
|
56,542
|
|
Net unrealized gains on interest
rate agreements accounted for as cash flow hedges
|
|
|
7,590
|
|
|
|
17,189
|
|
|
|
|
|
|
|
|
Total accumulated other
comprehensive income
|
|
$
|
94,780
|
|
|
$
|
73,731
|
|
|
|
|
|
|
|
|
Stock Option Plan
In March 2006, we amended the previously amended 2002 Redwood
Trust, Inc. Incentive Stock Plan (Incentive Plan, or IP) for
executive officers, employees, and non-employee directors. This
amendment was approved by our stockholders in May 2006. The IP
authorizes our Board of Directors (or a committee appointed by
our Board of Directors) to grant incentive stock options as
defined under Section 422 of the Code (ISOs), options not
so qualified (NQSOs), deferred stock, restricted stock,
performance shares, stock appreciation rights, limited stock
appreciation rights (awards), and DERs to eligible recipients
other than non-employee directors. ISOs and NQSOs awarded to
employees have a maximum term of ten-years and generally vest
ratably over a four-year period. NQSOs awarded to non-employee
directors have a maximum term of ten years and generally vest
immediately or ratably over a three- or four-year period.
Non-employee directors are automatically provided annual awards
under the IP. The IP has been designed to permit the
Compensation Committee of our Board of Directors to grant and
certify awards that qualify as performance-based and otherwise
satisfy the requirements of Section 162(m) of the Code. In
addition, this latest amendment incorporated the addition of
performance units as a type of award under the Plan, which may
be awarded to officers, directors, and employees of Redwood or
any of its subsidiaries, and other persons expected to provide
significant services to Redwood or any of its subsidiaries.
Performance units are intended to be used for annual cash bonus
payments granted to Executive Committee members who are named
executive officers (the Chief Executive Officer and other four
most highly compensated officers) in an amount not to exceed
$5 million per grantee per year, so as to qualify as
performance-based compensation under the Code. As of
September 30, 2006 and December 31, 2005, 849,407 and
315,866 shares of common stock, respectively, were
available for grant.
ISOs
Of the total shares of common stock available for grant, no more
than 963,637 shares of common stock are cumulatively
available for grant as ISOs. As of both September 30, 2006
and December 31, 2005, 551,697 ISOs had been granted. The
exercise price for ISOs granted under the IP may not be less
than the fair market value of shares of common stock at the time
the ISO is granted.
38
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
DERs
Redwood has granted stock options that pay cash DERs. Cash DERs
per applicable option are cash payments made that are equal to
the per share dividends paid on common stock to our
shareholders. As of September 30, 2006 and
December 31, 2005, there were 1,366,462 and 1,491,403
unexercised options with cash DERs, respectively. With the
adoption of FAS 123R on January 1, 2006, the grant
date fair value of all remaining unvested stock options (which
includes the value of any future DERs, if any) is expensed on
the Consolidated Statements of Income over the remaining vesting
period of each option. As of September 30, 2006, there was
$2.0 million of unrecognized compensation cost related to
nonvested stock options. These costs will be expensed over a
weighted-average period of 1.0 years.
Redwood had granted stock options that accrue stock DERs, but no
longer grants those awards. Stock DERs represented shares of
stock that were issuable when the holders exercised the
underlying stock options, the amount of which was based on prior
dividends paid per share on common stock and the market value of
the stock on the various dividend payable dates. In November
2005, all options with stock DERs were converted to options with
cash DERs to comply with Internal Revenue Code Section 409A
deferred compensation rules.
Redwood has also granted stock options with no DERs or where the
DERs do not extend beyond the vesting period. As of
September 30, 2006 and December 31, 2005, there were
135,288 and 57,009 of unexercised options with no right to DERs,
respectively.
For the three and nine months ended September 30, 2006
expenses related to stock option compensation were
$0.5 million and $1.5 million. For the three and nine
months ended September 30, 2005, expenses related to stock
option compensation were and $2.0 million and
$6.2 million.
A summary of the stock option activity during the three and nine
months ended September 30, 2006 and 2005 is presented
below.
Note 2
provides a discussion on the
assumptions used to value stock options at grant date.
Stock Option Activity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
Weighted Average
|
|
|
Shares
|
|
Exercise Price
|
|
Shares
|
|
Exercise Price
|
|
|
|
|
|
|
|
|
|
Stock Options
Outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding options at beginning of
period
|
|
|
1,507,226
|
|
|
$
|
33.19
|
|
|
|
1,602,040
|
|
|
$
|
31.71
|
|
|
|
Options granted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercised
|
|
|
(5,375
|
)
|
|
$
|
32.25
|
|
|
|
(3,525
|
)
|
|
$
|
36.86
|
|
|
|
Options forfeited
|
|
|
(101
|
)
|
|
$
|
33.13
|
|
|
|
(494
|
)
|
|
$
|
31.84
|
|
|
Stock dividend equivalent rights
earned
|
|
|
|
|
|
|
|
|
|
|
5,103
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding options at end of period
|
|
|
1,501,750
|
|
|
$
|
33.20
|
|
|
|
1,603,124
|
|
|
$
|
31.59
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at period-end
|
|
|
1,317,160
|
|
|
$
|
30.65
|
|
|
|
1,197,548
|
|
|
$
|
27.40
|
|
Weighted average fair value of
options granted during the period
|
|
$
|
|
|
|
|
|
|
|
$
|
|
|
|
|
|
|
39
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
Weighted Average
|
|
|
Shares
|
|
Exercise Price
|
|
Shares
|
|
Exercise Price
|
|
|
|
|
|
|
|
|
|
Stock Options Activity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding options at beginning of
period
|
|
|
1,548,412
|
|
|
$
|
32.60
|
|
|
|
1,624,465
|
|
|
$
|
31.77
|
|
|
|
Options granted
|
|
|
33,871
|
|
|
$
|
41.09
|
|
|
|
3,601
|
|
|
$
|
51.70
|
|
|
|
Options exercised
|
|
|
(79,016
|
)
|
|
$
|
24.68
|
|
|
|
(26,070
|
)
|
|
$
|
21.33
|
|
|
|
Options forfeited
|
|
|
(1,517
|
)
|
|
$
|
40.63
|
|
|
|
(13,853
|
)
|
|
$
|
43.22
|
|
|
Stock dividend equivalent rights
earned
|
|
|
|
|
|
|
|
|
|
|
14,981
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding options at end of period
|
|
|
1,501,750
|
|
|
$
|
33.20
|
|
|
|
1,603,124
|
|
|
$
|
31.59
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at period-end
|
|
|
1,317,160
|
|
|
$
|
30.65
|
|
|
|
1,197,548
|
|
|
$
|
27.40
|
|
Weighted average fair value of
options granted during the period
|
|
$
|
3.41
|
|
|
|
|
|
|
$
|
10.84
|
|
|
|
|
|
The following table summarizes information about stock options
outstanding at September 30, 2006.
Stock Option Exercise Prices as of September 30,
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
Options Exercisable
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
Remaining
|
|
|
|
|
|
|
Number
|
|
Contractual Life
|
|
Weighted Average
|
|
Number
|
|
Weighted Average
|
Range of Exercise Prices
|
|
Outstanding
|
|
in Years
|
|
Exercise Price
|
|
Exercisable
|
|
Exercise Price
|
|
|
|
|
|
|
|
|
|
|
|
$10 to $20
|
|
|
351,783
|
|
|
|
2.93
|
|
|
$
|
12.75
|
|
|
|
351,783
|
|
|
$
|
12.75
|
|
$20 to $30
|
|
|
385,881
|
|
|
|
3.93
|
|
|
$
|
24.15
|
|
|
|
359,337
|
|
|
$
|
23.93
|
|
$30 to $40
|
|
|
264,000
|
|
|
|
0.65
|
|
|
$
|
37.49
|
|
|
|
264,000
|
|
|
$
|
37.49
|
|
$40 to $50
|
|
|
130,743
|
|
|
|
2.55
|
|
|
$
|
44.38
|
|
|
|
130,593
|
|
|
$
|
44.38
|
|
$50 to $60
|
|
|
368,542
|
|
|
|
7.39
|
|
|
$
|
55.08
|
|
|
|
210,646
|
|
|
$
|
54.82
|
|
$60 to $63
|
|
|
801
|
|
|
|
5.87
|
|
|
$
|
62.54
|
|
|
|
801
|
|
|
$
|
62.54
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$10 to $63
|
|
|
1,501,750
|
|
|
|
3.85
|
|
|
$
|
33.20
|
|
|
|
1,317,160
|
|
|
$
|
30.65
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted Stock
As of September 30, 2006 and December 31, 2005, 17,750
and 21,038 shares, respectively, of restricted stock were
outstanding. Restrictions on this shares lapse through
July 1, 2010. Restricted stock activity for the three and
nine months ended September 30, 2006 and 2005 is presented
in the table below. The cost of these grants is amortized over
the vesting term using an accelerated method in accordance with
FASB Interpretation No. 28
Accounting for Stock
Appreciation Rights and Other Variable Stock Options or Award
Plans
(FIN 28), and FAS 123R. As of
September 30, 2006, there was $0.4 million of
unrecognized compensation cost related to nonvested restricted
stock. This cost will be recognized over a weighted average
period of 1.2 years. For the three and nine months ended
September 30, 2006 and 2005, the expenses related to
restricted stock were negligible.
40
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
Restricted Stock Outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
|
Weighted Average
|
|
|
|
|
|
Grant Date
|
|
|
|
|
Grant Date
|
|
|
|
Units
|
|
|
Fair Value
|
|
|
Units
|
|
|
Fair Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock outstanding at the
beginning of period
|
|
|
18,186
|
|
|
$
|
45.57
|
|
|
|
3,616
|
|
|
$
|
56.75
|
|
Restricted stock granted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock for which restrictions lapsed
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock forfeited
|
|
|
(436
|
)
|
|
|
46.13
|
|
|
|
(317
|
)
|
|
|
52.23
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock outstanding at end
of period
|
|
|
17,750
|
|
|
$
|
45.55
|
|
|
|
3,299
|
|
|
$
|
56.80
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted Stock Outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
|
Weighted Average
|
|
|
|
|
|
Grant Date
|
|
|
|
|
Grant Date
|
|
|
|
Units
|
|
|
Fair Value
|
|
|
Units
|
|
|
Fair Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock outstanding at the
beginning of period
|
|
|
21,038
|
|
|
$
|
45.96
|
|
|
|
5,912
|
|
|
$
|
45.47
|
|
Restricted stock granted
|
|
|
247
|
|
|
|
40.49
|
|
|
|
|
|
|
|
|
|
Stock for which restrictions lapsed
|
|
|
(972
|
)
|
|
|
53.74
|
|
|
|
(1,750
|
)
|
|
|
18.62
|
|
Restricted stock forfeited
|
|
|
(2,563
|
)
|
|
|
45.32
|
|
|
|
(863
|
)
|
|
|
56.63
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted stock outstanding at end
of period
|
|
|
17,750
|
|
|
$
|
45.55
|
|
|
|
3,299
|
|
|
$
|
56.80
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred Stock Units
The IP allows for the granting of Deferred Stock Units (DSUs)
through the 2002 Redwood Trust, Inc., Executive Deferred
Compensation Plan (EDCP). These are discussed below.
Executive Deferred Compensation Plan
In May 2002, our Board of Directors approved the 2002 EDCP. The
EDCP allows eligible employees and directors to defer portions
of current salary and certain other forms of compensation.
Redwood may match some deferrals up to certain levels.
Compensation deferred under the EDCP are assets of Redwood and
subject to the claims of the general creditors of Redwood. For
the three and nine months ended September 30, 2006,
deferrals of $0.5 million and $2.4 million,
respectively, were made under the EDCP. For the three and nine
months ended September 30, 2005, deferrals of
$0.1 million and $0.8 million, respectively, were made
under the EDCP. The EDCP allows for the investment of deferrals
in either an interest crediting account or DSUs. The rate of
accrual in the interest crediting account is set forth in the
EDCP. For deferrals prior to July 1, 2004, the accrual rate
is based on a calculation of the marginal rate of return on our
portfolio of earning assets. This accrual rate will continue for
these deferred amounts through July 1, 2007 and then will
be based on references to publicly traded mutual funds or the
applicable federal rate (AFR). For deferrals after July 1,
2004, the accrual rate is based on
41
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
references to publicly traded mutual funds or the AFR. The
following table provides detail on changes in participants
accounts in the EDCP for the three and nine months ended
September 30, 2006 and 2005.
EDCP Activity
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
|
|
|
Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash accounts transfer in of
participants payroll deductions from the EDCP
|
|
$
|
494
|
|
|
$
|
83
|
|
|
$
|
2,418
|
|
|
$
|
786
|
|
Accrued interest earned in EDCP
|
|
|
269
|
|
|
|
265
|
|
|
|
773
|
|
|
|
959
|
|
Participant withdrawals
|
|
|
|
|
|
|
|
|
|
|
(2,120
|
)
|
|
|
(225
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in participants
equity
|
|
$
|
763
|
|
|
$
|
348
|
|
|
$
|
1,071
|
|
|
$
|
1,520
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
$
|
7,313
|
|
|
$
|
6,100
|
|
|
$
|
7,005
|
|
|
$
|
4,928
|
|
Balance at end of period
|
|
$
|
8,076
|
|
|
$
|
6,448
|
|
|
$
|
8,076
|
|
|
$
|
6,448
|
|
The following table provides detail on the financial position of
the EDCP at September 30, 2006 and December 31, 2005.
Net Assets Available for EDCP Participant Benefits
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
|
Cash Accounts
|
|
|
|
|
|
|
|
|
Participants deferrals
|
|
$
|
5,277
|
|
|
$
|
4,064
|
|
Accrued interest credited
|
|
|
2,799
|
|
|
|
2,941
|
|
|
|
|
|
|
|
|
Net assets available for
participants benefit
|
|
$
|
8,076
|
|
|
$
|
7,005
|
|
|
|
|
|
|
|
|
Deferred Stock Units
DSUs are granted or purchased by participants in the EDCP. Some
of the DSU awarded may have a vesting period associated with
them. As of September 30, 2006 and December 31, 2005,
493,396 and 418,126 of DSUs were outstanding, respectively. As
of September 30, 2006 and December 31, 2005, the
number of these DSUs in the EDCP that had vested was 135,628 and
44,981, respectively. Restrictions on the remaining shares of
outstanding DSUs lapse through July 1, 2010. For the three
and nine months ended September 30, 2006, expenses related
to DSUs were $2.0 million and $6.5 million. For the
three and nine months ended September 30, 2005, expenses
related to DSUs were $0.3 million and $1.1 million. As
of September 30, 2006, there was $9.0 million of
unrecognized compensation cost related to nonvested DSUs. This
cost will be recognized over a weighted-average period of
1.0 years. The tables below provide summaries of the
balance and activities of the DSUs in the EDCP.
Deferred Stock Units
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
December 31, 2005
|
|
|
|
|
|
|
|
|
Value of DSUs at grant
|
|
$
|
22,816
|
|
|
$
|
19,199
|
|
Participant forfeitures
|
|
|
(110
|
)
|
|
|
(110
|
)
|
Participant distributions
|
|
|
(347
|
)
|
|
|
|
|
Change in value at period end since
date of grant
|
|
|
2,493
|
|
|
|
(1,837
|
)
|
|
|
|
|
|
|
|
Value of DSUs at end of period
|
|
$
|
24,852
|
|
|
$
|
17,252
|
|
|
|
|
|
|
|
|
42
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
Deferred Stock Units Activity
(In thousands, except unit amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
Weighted
|
|
|
|
|
|
Average
|
|
|
|
|
Average
|
|
|
|
|
|
Fair
|
|
|
Grant Date
|
|
|
|
|
Fair
|
|
|
Grant Date
|
|
|
|
Units
|
|
|
Value
|
|
|
Fair Value
|
|
|
Units
|
|
|
Value
|
|
|
Fair Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
|
492,371
|
|
|
$
|
24,042
|
|
|
$
|
45.31
|
|
|
|
124,836
|
|
|
$
|
6,442
|
|
|
$
|
51.37
|
|
Transfer in of DSUs (value of
grants)
|
|
|
1,025
|
|
|
|
50
|
|
|
|
48.46
|
|
|
|
7,000
|
|
|
|
357
|
|
|
|
50.96
|
|
Distribution of DSUs
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in valuation during period
|
|
|
|
|
|
|
760
|
|
|
|
|
|
|
|
|
|
|
|
(220
|
)
|
|
|
|
|
Participant forfeitures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change during period
|
|
|
1,025
|
|
|
|
810
|
|
|
|
|
|
|
|
7,000
|
|
|
|
137
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
|
493,396
|
|
|
$
|
24,852
|
|
|
$
|
45.32
|
|
|
|
131,836
|
|
|
$
|
6,579
|
|
|
$
|
51.35
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred Stock Units Activity
(In thousands, except unit amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
Weighted
|
|
|
|
|
|
Average
|
|
|
|
|
Average
|
|
|
|
|
|
Fair
|
|
|
Grant Date
|
|
|
|
|
Fair
|
|
|
Grant Date
|
|
|
|
Units
|
|
|
Value
|
|
|
Fair Value
|
|
|
Units
|
|
|
Value
|
|
|
Fair Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
|
418,126
|
|
|
$
|
17,252
|
|
|
$
|
45.65
|
|
|
|
92,161
|
|
|
$
|
5,722
|
|
|
$
|
50.52
|
|
Transfer in of DSUs (value of
grants)
|
|
|
86,741
|
|
|
|
3,617
|
|
|
|
41.70
|
|
|
|
41,564
|
|
|
|
2,224
|
|
|
|
53.51
|
|
Distribution of DSUs
|
|
|
(11,471
|
)
|
|
|
(347
|
)
|
|
|
30.27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in valuation during period
|
|
|
|
|
|
|
4,330
|
|
|
|
|
|
|
|
|
|
|
|
(1,257
|
)
|
|
|
|
|
Participant forfeitures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,889
|
)
|
|
|
(110
|
)
|
|
|
58.23
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change during period
|
|
|
75,270
|
|
|
|
7,600
|
|
|
|
|
|
|
|
39,675
|
|
|
|
857
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of period
|
|
|
493,396
|
|
|
$
|
24,852
|
|
|
$
|
45.32
|
|
|
|
131,836
|
|
|
$
|
6,579
|
|
|
$
|
51.35
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee Stock Purchase Plan
In May 2002, our stockholders approved the 2002 Redwood Trust,
Inc. Employee Stock Purchase Plan (ESPP), effective July 1,
2002. The purpose of the ESPP is to give our employees an
opportunity to acquire an equity interest in Redwood through the
purchase of shares of common stock at a discount. The ESPP
allows eligible employees to have up to 15% of their annual
gross compensation (including base salary, bonus, and cash DERs,
and subject to certain other limitations) withheld to purchase
common stock at 85% of its market value. The maximum gross
compensation that any participant can contribute to the ESPP in
any calendar quarter is $6,250. Market value as defined under
the ESPP is the lesser of the closing market price of the common
stock as of the start of an offering period in the ESPP or the
closing market price on the quarterly purchase date. The
offering period starts on January 1st of each calendar
year and consists of four quarterly purchase periods.
The ESPP allows a maximum of 100,000 shares of common stock
to be purchased. As of September 30, 2006,
31,967 shares have been purchased. As of September 30,
2006 and December 31, 2005,
43
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
there remained a negligible amount of uninvested employee
contributions in the ESPP. The table below presents the activity
in the ESPP for the three and nine months ended
September 30, 2006 and 2005.
Employee Stock Purchase Plan Activity
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfer in of participants
payroll deductions from the ESPP
|
|
$
|
99
|
|
|
$
|
68
|
|
|
$
|
283
|
|
|
$
|
179
|
|
Cost of common stock issued to
participants under ESPP
|
|
|
(102
|
)
|
|
|
(64
|
)
|
|
|
(294
|
)
|
|
|
(172
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in participants
equity
|
|
$
|
(3
|
)
|
|
$
|
4
|
|
|
$
|
(11
|
)
|
|
$
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of period
|
|
$
|
5
|
|
|
$
|
6
|
|
|
$
|
13
|
|
|
$
|
3
|
|
Balance at end of period
|
|
$
|
2
|
|
|
$
|
10
|
|
|
$
|
2
|
|
|
$
|
10
|
|
Direct Stock Purchase and Dividend Reinvestment
Plan
For the three and nine months ended September 30, 2006, we
issued 377,632 and 862,733 shares of common stock,
respectively, through our Direct Stock Purchase and Dividend
Reinvestment Plan (DSPP) for net proceeds of $18.1 million
and $38.6 million, respectively. For the three and nine
months ended September 30, 2005 112,694 and
582,250 shares were issued through our DSPP for total
proceeds of $5.7 million and $31.3 million,
respectively. For the three and nine months ended
September 30, 2006 and 2005, we did not undertake any
equity offerings.
Stock Repurchases
Our Board of Directors has approved the repurchase of a total of
7,455,000 shares of our common stock. A total of
6,455,000 shares were repurchased in 1998 and 1999. As of
September 30, 2006 and December 31, 2005, there
remained 1,000,000 shares available under the authorization
for repurchase. Repurchased shares have been returned to the
status of authorized but unissued shares of common stock.
NOTE 11. COMMITMENTS AND CONTINGENCIES
As of September 30, 2006, we were obligated under
non-cancelable operating leases with expiration dates through
2018 for $17.2 million. The majority of the future lease
payments relate to a ten-year operating lease for our executive
offices, which expires in 2013, and a lease for additional
office space at our executive offices beginning January 1,
2008 and expiring May 31, 2018. Prior to the beginning of
the lease of the additional office space, we are subleasing this
office space from another tenant through December 31, 2007.
The total lease payments to be made under the lease expiring in
2013 and the sublease, including certain free-rent periods, are
being recognized as office rent expense on straight-line basis
over the lease term. Leasehold improvements for our executive
offices are amortized into expense over the ten-year lease term.
The unamortized leasehold improvement balance at
September 30, 2006 was $1.8 million. We will incur
additional leasehold improvements as we prepare the additional
office space.
44
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (Continued)
Future Lease Commitments by Year
(In thousands)
|
|
|
|
|
|
|
September 30, 2006
|
|
|
|
|
|
2006 (last three months)
|
|
$
|
371
|
|
2007
|
|
|
1,350
|
|
2008
|
|
|
1,636
|
|
2009
|
|
|
1,680
|
|
2010
|
|
|
1,709
|
|
2011 and thereafter
|
|
|
10,405
|
|
|
|
|
|
Total
|
|
$
|
17,151
|
|
|
|
|
|
As of September 30, 2006, there were no pending legal
proceedings to which we were a party or to which any of our
properties were subject.
The table below shows our commitments to purchase loans and
securities as of September 30, 2006. The loan purchase
commitments represent derivative instruments with an estimated
value of $0.2 million at September 30, 2006 under
FAS No. 149,
Amendment of Statement 133 on
Derivative Instruments and Hedging Activities
(FAS 149). This is included in net recognized gains and
valuation adjustments on our Statements of Income. See
Note 9
for the fair value of those commitments.
Commitments to Purchase
(In thousands)
|
|
|
|
|
|
|
September 30, 2006
|
|
|
|
|
|
Real estate loans
|
|
$
|
93,250
|
|
Real estate securities
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
93,250
|
|
|
|
|
|
In November 2005, we entered into an agreement to purchase
certain certificates in a commercial mortgage loan
securitization to be issued by a securitization entity to be
formed at a later date. We anticipate that this will require us
to purchase up to 50% of any BB+ and lower grade certificates
issued by this entity, on between $150 million to
$200 million of loan collateral, pursuant to the
underwriting criteria set forth in the agreement. As of
September 30, 2006, there were approximately
$150 million of commercial mortgage loans originated, but
not yet securitized under this agreement. Additionally, we may
be required to purchase at least 50% of a third partys
junior participation interest in this securitization, under
certain circumstances (primarily where underlying loan
collateral is required to be repurchased due to poor loan
performance). As of September 30, 2006, we have not been
required to purchase any junior participation interest; all
loans funded to date are performing as expected. At
September 30, 2006, we estimate the value of this
commitment to be negligible.
NOTE 12. RECENT DEVELOPMENTS
In October 2006, we purchased or committed to purchase
$62 million residential real estate loans, and
$102 million real estate securities.
In October 2006, we exercised our option to call Acacia
CDO 3, and commited to sell $124 million real estate
securities. The estimated GAAP gains on these sales was
$5 million.
In October 2006, we called Sequoia 7 and 8. The principal
balance of the residential whole loans at the time of call was
$235 million.
45
|
|
Item 2.
|
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
|
CAUTIONARY STATEMENT
This Form
10-Q
contains forward-looking statements within the safe harbor
provisions of the Private Securities Litigation Reform Act of
1995. Statements that are not historical in nature, including
the words anticipated, estimated,
should, expect, believe,
intend, and similar expressions, are intended to
identify forward-looking statements. These forward-looking
statements are subject to risks and uncertainties, including,
among other things, those described in our Annual Report on
Form
10-K
for the
year ended December 31, 2005 under the caption Risk
Factors. Other risks, uncertainties, and factors that
could cause actual results to differ materially from those
projected are detailed from time to time in reports filed by us
with the Securities and Exchange Commission (SEC), including
Forms
10-K,
10-Q,
and
8-K.
We undertake no obligation to 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 mentioned or discussed in, or incorporated by reference
into, this
Form
10-Q
might
not occur. Accordingly, our actual results may differ from our
current expectations, estimates, and projections.
Important factors that may impact our actual results include
changes in interest rates and market values; changes in
prepayment rates; general economic conditions, particularly as
they affect the price of earning assets and the credit status of
borrowers; the level of liquidity in the capital markets as it
affects our ability to finance our real estate asset portfolio;
and other factors not presently identified. This
Form
10-Q
contains
statistics and other data that in some cases have been obtained
from, or compiled from information made available by, servicers
and other third-party service providers.
SUMMARY AND OUTLOOK
Redwood Trust, Inc., together with its subsidiaries (Redwood,
we, or us), invests in and manages real estate assets. We invest
in residential and commercial real estate loans and in
asset-backed securities backed by real estate loans. Our primary
focus is credit-enhancing residential and commercial real estate
loans. We credit-enhance loans by acquiring and managing the
first-loss and other credit-sensitive securities that bear the
bulk of the credit risk of securitized loans.
We seek to invest in assets that have the potential to generate
high long-term cash flow returns to help support our goal of
distributing an attractive level of dividends per share to
shareholders over time. For tax purposes, we are structured as a
real estate investment trust (REIT).
Net Income
Net income for the third quarter was $32 million
($1.22 per share) a decline from the
$56 million ($2.21 per share) we earned in the third
quarter of 2005 but an increase from the $31 million
($1.20 per share) we earned in the second quarter of 2006.
For the first nine months of 2006, our net income was
$92 million ($3.51 per share), a decline from the
$157 million ($6.26 per share) we earned in the first
nine months of 2005.
The largest factor in the decline in net income has been a
significant drop in income from gains generated on the sale or
calls of assets. For the comparable nine month periods, income
from this source dropped by $38 million. In addition, for
these nine month periods, net interest income dropped by
$25 million, operating expenses rose by $6 million,
and tax provisions declined by $4 million.
46
Table 1 Net Income
(In thousands, except share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income
|
|
$
|
223,649
|
|
|
$
|
244,631
|
|
|
$
|
667,769
|
|
|
$
|
731,058
|
|
Total interest expense
|
|
|
(174,673
|
)
|
|
|
(196,591
|
)
|
|
|
(528,847
|
)
|
|
|
(567,613
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
48,976
|
|
|
|
48,040
|
|
|
|
138,922
|
|
|
|
163,445
|
|
Operating expenses
|
|
|
(13,455
|
)
|
|
|
(12,364
|
)
|
|
|
(42,074
|
)
|
|
|
(35,618
|
)
|
Net recognized gains and valuation
adjustments
|
|
|
433
|
|
|
|
24,916
|
|
|
|
4,556
|
|
|
|
42,973
|
|
Provision for income taxes
|
|
|
(3,538
|
)
|
|
|
(4,693
|
)
|
|
|
(9,563
|
)
|
|
|
(13,424
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
32,416
|
|
|
$
|
55,899
|
|
|
$
|
91,841
|
|
|
$
|
157,376
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted common shares
|
|
|
26,624,532
|
|
|
|
25,314,315
|
|
|
|
26,132,000
|
|
|
|
25,159,619
|
|
Net income per share
|
|
$
|
1.22
|
|
|
$
|
2.21
|
|
|
$
|
3.51
|
|
|
$
|
6.26
|
|
Financial Condition
Residential Real Estate Assets
Redwood invests in and manages residential real estate loans and
securities backed by residential real estate loans. At
September 30, 2006, Redwoods residential loans
totaled $9.8 billion and residential securities totaled
$2.2 billion.
An important part of Redwoods business is investing in
residential securities that have credit ratings that are below
investment grade. For securitizations of prime residential
loans, these are typically the three securities (the first-loss,
second-loss, and third-loss credit-enhancement securities) that
bear the bulk of the credit risk of the underlying loans, and
thus credit-enhance the other securities issued from the same
entity. Due to the large amount of underlying loans, these
credit-enhancement assets have concentrated credit risks, and
both the upside and downside that could come from taking on
concentrated risks. Redwoods residential
credit-enhancement securities have grown by 21% this year, and
totaled $742 million at September 30, 2006.
The underlying loans are primarily high-quality loans but also
include
Alt-A
(medium
quality) loans. The underlying loans, which total
$225 billion, are nationwide with a large concentration in
California. They continue to perform well from a credit
perspective. For the third quarter of 2006, realized residential
credit losses were $2.2 million of principal value, a rate
that is less than one basis point (0.01%) on an annualized basis
of the current balance of loans. Delinquencies (90+ days, in
foreclosure, in bankruptcy or REO) at September 30, 2006
were 0.21% of current balance and 0.14% of original balance. For
loans in prime pools, delinquencies were 0.16% of current
balance and 0.11% of original balance.
Alt-A
pools had
delinquencies of 0.60% of current balance and 0.40% of original
balance.
As a result of the concentrated credit risk associated with
residential loan CES, we are generally able to acquire
these securities at a discount to their face (principal) value.
The difference between the principal value ($1.2 billion)
and carrying (market) value ($742 million) of these
residential loan CES at September 30, 2006 was
$469 million. Of this difference, $384 million was
designated as internal credit protection (reflecting our
estimate of likely credit losses on the underlying loans over
the life of these securities), $147 million represented a
purchase discount we are accreting into income over time and
$62 million represented net unrealized
mark-to
-market gains.
Redwood also invests in higher-rated investment-grade
residential securities.
Year-to
-date growth for
our investment in these residential securities has been 13%,
with a total portfolio of $1.4 billion at
September 30, 2006. These investment-grade securities are
backed by prime, Alt-A, and sub-prime loans. They are not
directly exposed to first-loss credit risk as they benefit from
credit-enhancement provided by others. The credit performance of
these assets continues to be excellent.
Redwood buys residential real estate loans from originators.
These generally high-quality loans totaled $9.8 billion on
September 30, 2006. Most of these loans are adjustable-rate
loans using one- or six-
47
month London Inter-Bank Offered Rate (LIBOR) as the
adjustable-rate index. Redwoods loan balance for these
loans has declined by 29%
year-to
-date as
prepayments have exceeded new purchases. These loans have been
prepaying rapidly due to the flat yield curve (short-term
interest rates such as LIBOR are high relative to longer-term
interest rates). Rapid prepayments of these loans have resulted
in higher levels of premium amortization expense, one reason net
interest income in 2006 is lower than in 2005.
Commercial Real Estate Assets
Redwood invests in commercial real estate securities and, to a
lesser degree, directly in commercial real estate loans. At
September 30, 2006, commercial securities totaled
$513 million and commercial loans totaled $32 million.
Redwoods total below investment-grade commercial real
estate securities were $383 million at September 30,
2006. Of these, $117 million were first-loss commercial
securities. These credit-enhancement securities bear
concentrated credit risks with respect to $36 billion
underlying loans on office, retail, multifamily, industrial, and
other income-producing properties nationwide. Overall, the
underlying loans continue to perform well, with some isolated
credit losses due to loan specific issues.
As a result of the concentrated credit risk associated with
commercial real estate CES, we are generally able to acquire
these securities at a discount to their face (principal) value.
The difference between the principal value ($322 million)
and carrying value ($117 million) of our first-loss
commercial CES at September 30, 2006 was $205 million.
Of this difference, $222 million was designated as internal
credit protection (reflecting our estimate of likely credit
losses on the underlying loans over the life of these
securities), and $17 million represented net unrealized
mark-to
-market gains.
Redwoods investment in commercial real estate securities
rated investment-grade has declined by 20%
year-to
-date to a total
of $130 million on September 30, 2006. Our investment
in commercial loans has declined by 46%
year-to
-date to a total
of $32 million at quarter-end. These assets continue to
perform well from a credit perspective.
CDO Assets
Collateralized debt obligations (CDOs) are a form of
securitization in which a (usually) diverse portfolio of
assets is acquired by a securitization entity that creates and
sells securities (CDO securities) in order to fund its asset
purchases. Redwood uses CDOs as a method of funding its assets
(see below) but also acquires CDO securities created by others
as an asset portfolio investment. At September 30, 2006,
Redwoods portfolio of CDO securities acquired from others
included $181 million investment-grade CDO securities and
$18 million below-investment-grade (CDO equity) securities.
These CDO securities are generally backed by residential and
commercial real estate assets. Redwoods CDO securities
portfolio has grown by 28%
year-to
-date in 2006.
These assets are generally performing well from a credit
perspective.
Asset-Backed Securities Issued
Redwood has securitized the bulk of the assets shown on its
consolidated balance sheet. In a securitization, Redwood sells
assets to a securitization entity that creates and sells
asset-backed securities (ABS) in order to fund its asset
purchases. The residential whole loan securitization entities
Redwood uses are generally called Sequoia and the CDO
securitization entities Redwood uses are generally called
Acacia. These securitization entities are bankruptcy-remote from
Redwood, so that Redwoods liabilities cannot become
liabilities of the securitization entity and the ABS issued by
the securitization entity cannot become obligations of Redwood
Trust. Nevertheless, since according to accounting definitions
Redwood controls these securitization entities, Redwood shows
both the assets and liabilities of these entities on its
consolidated balance sheet. On Redwoods September 30,
2006 balance sheet, $11.9 billion (89%) of the assets shown
and $11.6 billion (95%) of the liabilities shown were the
assets and obligations of securitization entities.
When we securitize assets, as opposed to owning them directly
and funding them with Redwood debt and equity, our reported cost
of funds is higher (the cost of ABS securities issued is
generally higher than that of our debt) but we utilize less
equity capital (the ABS that we acquire from the securitization
48
require less of an equity investment than using our own debt to
fund the securitized assets). As a result, our return on equity
may increase after securitization. In addition, liquidity risks
are generally reduced or eliminated, as the Redwood debt
associated with the accumulation of these assets during their
accumulation is paid off following securitization.
Redwood Debt
Our recourse debt obligations are shown on our balance sheet as
Redwood debt. These obligations totaled $510 million at
September 30, 2006, an increase from $170 million at
the beginning of the year. All of this debt is secured by a
pledge of our loans and securities. We have used Redwood debt
primarily to fund the acquisition of loans and securities on a
temporary basis prior to their sale to a securitization entity.
In a departure from our practice in the last few years, we are
starting to acquire assets as a longer-term investment that we
intend to fund on an ongoing basis with Redwood debt. This
accounts for a portion of the increase in Redwood debt during
the third quarter. The amount of debt we would be willing to use
to fund assets is determined on an asset-by-asset basis by our
internal policies on average we expect to use
approximately 8% equity and 92% debt to fund high-quality liquid
assets in this manner.
Interest Rate Agreements
We use interest rate agreements such as interest rate swaps to
reduce the potential volatility of our earnings and book value
as interest rates change. At September 30, 2006, we owned
interest rate agreements with a notional value of
$5 billion and a net market value of $24 million.
Equity Funding
We generally use equity (no debt or securitization) to fund
investments in assets that have highly concentrated credit
risks, including first-loss residential and commercial
credit-enhancement securities, CDO equity securities, and
similar illiquid assets. We also use equity to fund our working
capital and other operating requirements.
As our Acacia CDO securitization program has evolved over the
last few years, we have been able to securitize lower-rated
assets such as second- and third-loss residential and commercial
credit-enhancement securities. This reduces our equity capital
requirements and frees cash, allowing us to acquire additional
assets using the same capital base.
Excess Capital
We are not currently utilizing leverage to the extent possible
under our internal policies. At September 30, 2006, if we
had pledged assets and borrowed to the extent possible under our
internal policies, we would have had $219 million capital
in excess of that needed to fund our operations and assets. We
derive our excess capital figures by calculating the amount of
cash we would have available for investment if we conservatively
leveraged our securitization inventory and other assets. Excess
capital increased by $28 million in the third quarter, in
part because we sold $47 million equity-funded first- and
second-loss 2005 and 2006 vintage residential credit-enhancement
securities due to concerns about the housing credit cycle. In
addition, we recycled capital and freed cash by, for the first
time, securitizing in Acacia $32 million of second-loss
residential credit-enhancement securities In addition, we are
retaining (but not investing) cash for an expected special
dividend likely to be paid in December.
Stockholders Equity
Our reported book value at September 30, 2006 was
$40.02 per share, an increase from $39.13 per share at
the beginning of the quarter and $37.20 per share at the
beginning of the year. Our book value per share increased this
year as a result of retained earnings and increases in the net
market value of our assets and interest rate agreements. Book
value per share is reduced by dividends, and thus will likely
decline in the fourth quarter as a result of our special
dividend.
We issue equity only when we believe equity growth will enhance
long-term earnings and dividends per share, compared to what
they would have been otherwise. Given the amount and quality of
the asset
49
acquisition opportunities we anticipate seeing, we currently
expect to seek additional equity (and long-term debt) capital
during 2007.
Outlook
The near-term outlook for earnings, dividends, and growth
depends, in part, on the how fast we employ our
$219 million of excess capital. While we carry excess
capital, our earnings and dividends will be lower than they
would be if this capital were employed in attractive earning
assets.
We believe the outlook for employing this capital is good,
although the exact timing is uncertain. In commercial real
estate, we have increased our capabilities and expanded our
relationships, and we expect to continue to acquire commercial
credit-enhancement securities. We may also resume purchases of
commercial loans. We expect to increase our acquisitions of
investment-grade residential, commercial, and CDO securities. As
the housing market corrects and we increase our capabilities to
evaluate lower-quality residential loans, an increasing
percentage of these investment-grade securities will likely be
backed by
Alt-A
and
sub-prime residential loans. We are increasing our residential
whole loan purchases as a result of broadening the product types
we are willing to buy (currently focusing on prime-quality
hybrid loans) and expanding our relationships with originators.
We have the call rights to the Sequoia residential whole loan
transactions we have sponsored. As these transactions become
callable (starting in the fourth quarter of 2006), we will
likely call these transactions and acquire the underlying
seasoned high-quality adjustable-rate whole loans as an
investment for Redwood. For our acquisitions of investment-grade
securities and residential whole loans, we will continue to use
securitization as a funding method, but we also intend to fund a
growing proportion of these assets on an ongoing basis with
Redwood debt. This will utilize excess capital at an approximate
rate of 8% of the assets held in this manner. As a result,
Redwood debt outstanding will increase.
We currently expect to make a modest level of new investments in
residential credit-enhancement securities over the next few
quarters. Most likely, the bulk of these investments will be in
second- and third-loss securities that will be re-securitized
via Acacia CDO transactions. We expect that the risk/ reward
relationship for first-loss prime residential credit enhancement
securities will improve over the next year or two, at which time
we expect to increase our acquisition rate of these assets. As
the housing market corrects, housing prices will become less
vulnerable. We expect that fewer speculators and investors will
be active in the housing markets, and that loan origination
standards may improve somewhat. Additionally, if there is broad
stress in the housing capital markets, the prices for these
assets may decline, making their acquisition more attractive. As
a result of our increased capabilities, we have recently been
active participants in the markets for first-loss Alt-A and
sub-prime credit-enhancement securities and residuals. We expect
to make a small amount of investments in this area, although our
acquisitions may increase if the risk/reward relationship for
these improves in our opinion (perhaps as a result of housing
market stress).
In our view, in the absence of a deep housing recession, the
outlook for our earnings and dividends over the next few years
is reasonably good. (However, we continue to expect
quarter-to
-quarter GAAP
and tax earnings volatility for a variety of reasons, including
some technical accounting and tax issues more fully described
below). Housing price increases over the past several years have
reduced our risk of credit loss in the future for our existing
residential assets, since, for most of our residential credit
risk assets, the underlying loans were originated in 2003 and
2004. Commercial property values and cash flows are increasing
in many areas. Our existing portfolio of assets as a whole has
the ability to generate attractive earnings, cash flows, and
dividends in the future, assuming real estate credit losses do
not increase materially.
Over the long term, we believe it is reasonably likely that we
will be able to continue to find attractive investment
opportunities, as we believe that we are an efficient competitor
and because our market segments are growing (the amount of real
estate loans outstanding continues to increase and the
percentage of these loans that are securitized, also continues
to increase).
We declared regular quarterly dividends of $0.70 per share
in each of the first, second, and third quarters of 2006. Total
regular dividends to date totaled $56 million, of which
$52 million represented the distribution of the remainder
of our 2005 REIT taxable income. Consistent with our practice in
previous years, we expect to permanently retain approximately
10% of the ordinary REIT taxable income we earn during 2006, to
retain the after-tax profits earned in our taxable subsidiaries,
and defer
50
the distribution of a portion of our 2006 income so that it will
be distributed by September 2007 through regular dividends. With
these actions, and in order to meet our distribution
requirements, we expect to declare a special dividend in the
fourth quarter of 2006. Redwoods Board of Directors will
set the size of any special dividend, based on evolving
projections of fourth quarter REIT taxable income and other
factors. If the Board authorizes the dividend based on past
practice, it currently appears that the special dividend this
year will likely exceed $2.50 per share and could be close
to the $3.00 per share special dividend we paid in December
2005.
RESULTS OF OPERATIONS
THIRD QUARTER AND FIRST NINE MONTHS 2006 AS
COMPARED TO 2005
Net Income
Net income for the third quarter was $32 million
($1.22 per share) a decline from the
$56 million ($2.21 per share) we earned in the third
quarter of 2005. For the first nine months of 2006, our net
income was $92 million ($3.51 per share), a decline
from the $157 million ($6.26 per share) we earned in
the first nine months of 2005.
Interest Income
Total interest income consists of interest earned on
consolidated earning assets, adjusted for amortization of
discounts and premium and provisions for loan credit losses.
Table 2 Interest Income and Yield
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2006
|
|
|
Three Months Ended September 30, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent of
|
|
|
|
|
|
|
Percent of
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
Interest
|
|
|
Interest
|
|
|
Average
|
|
|
|
|
Interest
|
|
|
Interest
|
|
|
Average
|
|
|
|
|
|
Income
|
|
|
Income
|
|
|
Balance
|
|
|
Yield
|
|
|
Income
|
|
|
Income
|
|
|
Balance
|
|
|
Yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate loans, net of provision
for credit losses
|
|
$
|
149,018
|
|
|
|
66.63
|
%
|
|
$
|
9,979,261
|
|
|
|
5.97
|
%
|
|
$
|
194,830
|
|
|
|
79.65
|
%
|
|
$
|
17,645,610
|
|
|
|
4.42
|
%
|
Real estate securities
|
|
|
72,759
|
|
|
|
32.53
|
%
|
|
|
2,697,903
|
|
|
|
10.79
|
%
|
|
|
48,811
|
|
|
|
19.95
|
%
|
|
|
2,305,361
|
|
|
|
8.47
|
%
|
Cash and cash equivalents
|
|
|
1,872
|
|
|
|
0.84
|
%
|
|
|
183,323
|
|
|
|
4.08
|
%
|
|
|
990
|
|
|
|
0.40
|
%
|
|
|
134,422
|
|
|
|
2.95
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income
|
|
$
|
223,649
|
|
|
|
100.00
|
%
|
|
$
|
12,860,487
|
|
|
|
6.96
|
%
|
|
$
|
244,631
|
|
|
|
100.00
|
%
|
|
$
|
20,085,393
|
|
|
|
4.87
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2006
|
|
|
Nine Months Ended September 30, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent of
|
|
|
|
|
|
|
Percent of
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
Interest
|
|
|
Interest
|
|
|
Average
|
|
|
|
|
Interest
|
|
|
Interest
|
|
|
Average
|
|
|
|
|
|
Income
|
|
|
Income
|
|
|
Balance
|
|
|
Yield
|
|
|
Income
|
|
|
Income
|
|
|
Balance
|
|
|
Yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate loans, net of provision
for credit losses
|
|
$
|
470,893
|
|
|
|
70.52
|
%
|
|
$
|
11,127,318
|
|
|
|
5.64
|
%
|
|
$
|
601,589
|
|
|
|
82.29
|
%
|
|
$
|
19,979,127
|
|
|
|
4.01
|
%
|
Real estate securities
|
|
|
189,656
|
|
|
|
28.40
|
%
|
|
|
2,530,248
|
|
|
|
9.99
|
%
|
|
|
127,095
|
|
|
|
17.39
|
%
|
|
|
2,123,067
|
|
|
|
7.98
|
%
|
Cash and cash equivalents
|
|
|
7,220
|
|
|
|
1.08
|
%
|
|
|
224,418
|
|
|
|
4.29
|
%
|
|
|
2,374
|
|
|
|
0.32
|
%
|
|
|
127,974
|
|
|
|
2.47
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income
|
|
$
|
667,769
|
|
|
|
100.00
|
%
|
|
$
|
13,881,984
|
|
|
|
6.41
|
%
|
|
$
|
731,058
|
|
|
|
100.00
|
%
|
|
$
|
22,230,168
|
|
|
|
4.38
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
51
The table below details how our interest income changed by
portfolio as a result of changes in consolidated asset balances
(volume) and yield (rate) for the three
and nine months ended September 30, 2006 as compared to the
three and nine months ended September 30, 2005. The
reduction in total interest income due to declining balances was
partially offset by increased yields.
Table 3 Volume and Rate Changes for Interest Income
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Interest Income
|
|
|
Change in Interest Income
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30, 2006 Versus September 30, 2005
|
|
|
September 30, 2006 Versus September 30, 2005
|
|
|
|
|
|
|
|
|
|
|
Volume
|
|
|
Rate
|
|
|
Total Change
|
|
|
Volume
|
|
|
Rate
|
|
|
Total Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate loans, net of
provisions for credit losses
|
|
$
|
(84,646
|
)
|
|
$
|
38,834
|
|
|
$
|
(45,812
|
)
|
|
$
|
(266,536
|
)
|
|
$
|
135,840
|
|
|
$
|
(130,696
|
)
|
Real estate securities
|
|
|
8,311
|
|
|
|
15,637
|
|
|
|
23,948
|
|
|
|
24,375
|
|
|
|
38,186
|
|
|
|
62,561
|
|
Cash and cash equivalents
|
|
|
360
|
|
|
|
522
|
|
|
|
882
|
|
|
|
1,789
|
|
|
|
3,057
|
|
|
|
4,846
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income
|
|
$
|
(75,975
|
)
|
|
$
|
54,993
|
|
|
$
|
(20,982
|
)
|
|
$
|
(240,372
|
)
|
|
$
|
177,083
|
|
|
$
|
(63,289
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Volume change is the change in average portfolio balance
between periods multiplied by the rate earned in the earlier
period. Rate change is the change in rate between periods
multiplied by the average portfolio balance in the prior period.
Interest income changes that result from changes in both rate
and volume were allocated to the rate change amounts shown in
the table.
A discussion by portfolio of changes in total income, average
balances, and yields for our loans and securities is provided
below.
Table 4 Consolidated Real Estate Loans
Interest Income and Yield
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
$
|
160,715
|
|
|
$
|
208,532
|
|
|
$
|
504,282
|
|
|
$
|
632,320
|
|
Net premium amortization expense
|
|
|
(11,232
|
)
|
|
|
(14,507
|
)
|
|
|
(35,254
|
)
|
|
|
(32,038
|
)
|
(Provision for) reversal of credit
reserve
|
|
|
(465
|
)
|
|
|
805
|
|
|
|
1,865
|
|
|
|
1,307
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income
|
|
$
|
149,018
|
|
|
$
|
194,830
|
|
|
$
|
470,893
|
|
|
$
|
601,589
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average consolidated real estate
loans
|
|
$
|
9,979,261
|
|
|
$
|
17,645,610
|
|
|
$
|
11,127,318
|
|
|
$
|
19,979,127
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Yields as a result of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
6.44
|
%
|
|
|
4.73
|
%
|
|
|
6.04
|
%
|
|
|
4.22
|
%
|
Net premium amortization expense
|
|
|
(0.45
|
)%
|
|
|
(0.33
|
)%
|
|
|
(0.42
|
)%
|
|
|
(0.21
|
)%
|
Credit provision expense
|
|
|
(0.02
|
)%
|
|
|
0.02
|
%
|
|
|
0.02
|
%
|
|
|
0.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Yield
|
|
|
5.97
|
%
|
|
|
4.42
|
%
|
|
|
5.64
|
%
|
|
|
4.01
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income on real estate loans decreased in the 2006
periods from the 2005 periods primarily as a result of lower
average balances of real estate loans. This decline was
partially offset by increased yields. Yields increased primarily
due to increases in the short-term interest rates to which most
of these loans are indexed.
In 2005 and prior years, our residential conduit acquired
significant amounts of high-quality one- and six-month LIBOR
adjustable-rate residential loans from originators, selling the
loans to Sequoia securitization entities, and then sponsoring
Sequoia securitizations of these loans. In todays flat to
inverted yield curve environment, however, ARMs indexed to LIBOR
are not an attractive option for homeowners, causing origination
volume of this product to decrease dramatically. Additionally,
new forms of
52
adjustable-rate mortgages (negative amortization, option
ARMs, and Moving Treasury Average (MTA) ARMs)
represent an increased share of the ARM market.
The flatter yield curve has also lead to faster prepayment rates
on existing ARM loans. Borrowers are more inclined to refinance
out of ARMs and into hybrid or fixed rate loans when the
effective interest rates on ARMs are not significantly lower
than the alternatives. Prepayment rates for residential ARM
loans owned by Sequoia entities increased from an average CPR of
39% in the third quarter of 2005 to an average CPR of 45% in the
third quarter of 2006.
Loan premium amortization expenses for residential loans
acquired prior to July 2004 are influenced by prepayment rates
but also are driven in a significant manner directly by trends
in short-term interest rates. As short-term rates increase,
premium amortization slows; as short-term rates decrease,
premium amortization expenses could accelerate in a material
way. For the (smaller amount of) loans acquired after July 2004,
interest rate trends are less of a factor except as they may
influence prepayment rates. Comparing the two third-quarter
periods, premium amortization decreased by $3.3 million.
Comparing the two nine-month periods, premium amortization
expenses increased by $3.2 million. See Critical Accounting
Policies later in this document for further explanation of loan
premium amortization.
Although the overall real estate loan balance declined during
the quarter, the provision for credit losses increased due to a
rise in delinquencies as a percentage of the current loan
balance from 0.46% as of June 30, 2006 to 0.63% as of
September 30, 2006. This increase in delinquencies is in
line with expectations as our loan portfolio seasons and the
current balance decreases.
Table 5 Real Estate Securities Interest Income
and Yield
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
$
|
54,920
|
|
|
$
|
37,291
|
|
|
$
|
145,338
|
|
|
$
|
98,619
|
|
Net discount amortization income
|
|
|
17,839
|
|
|
|
11,520
|
|
|
|
44,318
|
|
|
|
28,476
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income
|
|
$
|
72,759
|
|
|
$
|
48,811
|
|
|
$
|
189,656
|
|
|
$
|
127,095
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average earning assets
|
|
$
|
2,697,903
|
|
|
$
|
2,305,361
|
|
|
$
|
2,530,248
|
|
|
$
|
2,123,067
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Yield as a result of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
8.15
|
%
|
|
|
6.47
|
%
|
|
|
7.65
|
%
|
|
|
6.19
|
%
|
Net discount amortization income
|
|
|
2.64
|
%
|
|
|
2.00
|
%
|
|
|
2.34
|
%
|
|
|
1.79
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
10.79
|
%
|
|
|
8.47
|
%
|
|
|
9.99
|
%
|
|
|
7.98
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income recognized from our real estate securities
increased in the third quarter and first nine months of 2006 as
compared to the third quarter and first nine months of 2005 due
to growth in our portfolio over the past year and increased
yields. Portfolio growth reflected our ability to find new
assets at a pace in excess of our sales, calls, and principal
prepayments. Yields increased for a variety of reasons,
including continued rising short-term interest rates, strong
credit performance and fast prepayments.
During the course of preparing the financial statements for the
period ended June 30, 2006, we discovered two errors and
under the provisions of Statement of Financial Accounting
Standards No. 154, Accounting Changes and Error
Corrections, a replacement of APB Opinion No. 20 and FASB
Statement No. 3 (FAS 154), we analyzed the errors for
each period affected. The accrual rate for interest income on
certain securities and interest expense on certain ABS issued
had been incorrectly applied and not correctly adjusted. The
impact of this error was that on a cumulative basis we had
overstated interest income by $1.3 million and understated
interest expense by $0.2 million. Additionally, due
diligence expenses for certain securities purchased had been
incorrectly capitalized and amortized. The impact of this error
was that on a cumulative basis we had understated operating
expenses by $0.6 million and overstated mortgages
securities on the Consolidated Balance Sheets.
53
After assessing the effect of these errors on previously
reported earnings and the effect of recording a total cumulative
correcting adjustment of $2.1 million in the second quarter
of 2006, we determined that the errors were not material to the
financial statements for the six months ended June 30, 2006
and the year ended December 31, 2006. Accordingly,
cumulative correcting adjustments for these errors were recorded
in the second quarter of 2006.
The tables below present the income and yields of the components
of our securities portfolio: residential CES, commercial
first-loss CES, and other securities.
Table 5a Residential Credit-Enhancement
Securities Interest Income and Yield
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
$
|
19,259
|
|
|
$
|
13,175
|
|
|
$
|
50,891
|
|
|
$
|
35,736
|
|
Net discount amortization income
|
|
|
16,616
|
|
|
|
11,193
|
|
|
|
42,181
|
|
|
|
27,695
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income
|
|
$
|
35,875
|
|
|
$
|
24,368
|
|
|
$
|
93,072
|
|
|
$
|
63,431
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average earning assets
|
|
$
|
669,181
|
|
|
$
|
585,663
|
|
|
$
|
613,538
|
|
|
$
|
543,516
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Yield as a result of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
11.52
|
%
|
|
|
9.00
|
%
|
|
|
11.06
|
%
|
|
|
8.77
|
%
|
Net discount amortization income
|
|
|
9.93
|
%
|
|
|
7.64
|
%
|
|
|
9.17
|
%
|
|
|
6.79
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
21.45
|
%
|
|
|
16.64
|
%
|
|
|
20.23
|
%
|
|
|
15.56
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income recognized from residential CES increased due to
growth in our portfolio over the past year and increased yields.
Portfolio growth reflected our ability to find new assets at a
pace in excess of our sales, calls, and principal prepayments.
Yields increased as the securities within our portfolio are
beginning to season and benefit from continued strong credit
performance and fast prepayment rates.
Table 5b Commercial First-Loss Credit-Enhancement
Securities Interest Income and Yield
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
$
|
3,807
|
|
|
$
|
1,355
|
|
|
$
|
8,810
|
|
|
$
|
3,347
|
|
Net premium amortization expense
|
|
|
(1,670
|
)
|
|
|
(902
|
)
|
|
|
(4,037
|
)
|
|
|
(1,657
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income
|
|
$
|
2,137
|
|
|
$
|
453
|
|
|
$
|
4,773
|
|
|
$
|
1,690
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average earning assets
|
|
$
|
88,681
|
|
|
$
|
32,192
|
|
|
$
|
70,340
|
|
|
$
|
25,558
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Yield as a result of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
17.17
|
%
|
|
|
16.84
|
%
|
|
|
16.70
|
%
|
|
|
17.46
|
%
|
Net premium amortization expense
|
|
|
(7.53
|
)%
|
|
|
(11.21
|
)%
|
|
|
(7.65
|
)%
|
|
|
(8.64
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
9.64
|
%
|
|
|
5.63
|
%
|
|
|
9.05
|
%
|
|
|
8.82
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income recognized from commercial first-loss CES
increased due to the growth in this portfolio and higher yields
on these securities. Our commercial portfolio is performing
well; the fundamentals of the commercial real estate business
are strong.
54
Table 5c Other Securities Interest Income and
Yield
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
$
|
31,854
|
|
|
$
|
22,761
|
|
|
$
|
85,637
|
|
|
$
|
59,536
|
|
Net discount amortization income
|
|
|
2,893
|
|
|
|
1,229
|
|
|
|
6,174
|
|
|
|
2,438
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income
|
|
$
|
34,747
|
|
|
$
|
23,990
|
|
|
$
|
91,811
|
|
|
$
|
61,974
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average earning assets
|
|
$
|
1,940,041
|
|
|
$
|
1,687,506
|
|
|
$
|
1,846,370
|
|
|
$
|
1,553,993
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Yield as a result of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
6.56
|
%
|
|
|
5.40
|
%
|
|
|
6.18
|
%
|
|
|
5.11
|
%
|
Net discount amortization expense
|
|
|
0.60
|
%
|
|
|
0.29
|
%
|
|
|
0.45
|
%
|
|
|
0.21
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
7.16
|
%
|
|
|
5.69
|
%
|
|
|
6.63
|
%
|
|
|
5.32
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest income increased for the securities portfolio as
the total size of the portfolio grew and as yields increased.
Yields increased primarily as the coupon rates on
adjustable-rate loan securities (which comprise over half of the
portfolio) adjusted upward with the increase in short-term
interest rates.
Interest Expense
Interest expense consists of interest payments on Redwood debt
and consolidated ABS issued from sponsored securitization
entities, plus amortization of deferred ABS issuance costs and
expenses related to certain interest rate agreements less the
amortization of ABS issuance premiums. ABS issuance premiums are
created when interest-only (IO) securities and other ABS
are issued at prices greater than principal value.
Table 6 Total Interest Expense
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense on Redwood debt
|
|
$
|
9,422
|
|
|
$
|
3,789
|
|
|
$
|
13,316
|
|
|
$
|
8,272
|
|
Interest expense on ABS
|
|
|
165,251
|
|
|
|
192,802
|
|
|
|
515,531
|
|
|
|
559,341
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest expense
|
|
$
|
174,673
|
|
|
$
|
196,591
|
|
|
$
|
528,847
|
|
|
$
|
567,613
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Redwood debt balance
|
|
$
|
647,978
|
|
|
$
|
297,788
|
|
|
$
|
292,129
|
|
|
$
|
264,024
|
|
Average ABS issued balance
|
|
|
11,684,412
|
|
|
|
19,542,413
|
|
|
|
13,094,871
|
|
|
|
21,630,747
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average total obligations
|
|
$
|
12,332,390
|
|
|
$
|
19,840,201
|
|
|
$
|
13,387,000
|
|
|
$
|
21,894,771
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of funds of Redwood debt
|
|
|
5.82
|
%
|
|
|
5.09
|
%
|
|
|
6.08
|
%
|
|
|
4.18
|
%
|
Cost of funds of ABS issued
|
|
|
5.66
|
%
|
|
|
3.95
|
%
|
|
|
5.25
|
%
|
|
|
3.45
|
%
|
Cost of funds of total obligations
|
|
|
5.67
|
%
|
|
|
3.96
|
%
|
|
|
5.27
|
%
|
|
|
3.46
|
%
|
Total consolidated interest expense decreased in the 2006
periods from the 2005 periods as a result of a significant
decline in consolidated ABS issued as a result of rapid
prepayments of securitized loans. Offsetting a portion of the
decline in balances was the higher cost of funds due to an
increase in short-term interest rates as most of our debt and
consolidated ABS issued is indexed to one-, three-, or six-month
LIBOR. These factors are illustrated in the table below.
55
During the course of preparing the financial statements for the
period ended September 30, 2006 we discovered an error in
the valuation of certain interest rate agreements for the
purpose of measuring the amount of hedge ineffectiveness under
FAS 133. Under the provisions of Statement of Financial
Accounting Standards No. 154, Accounting Changes and Error
Corrections, a replacement of APB
Opinion No. 20 and FASB Statement No. 3
(FAS 154), we analyzed the errors for each period affected.
The impact of this error was that on a cumulative basis we had
understated interest expense (negative ineffectiveness) by
$1.0 million and overstated other comprehensive income by
$1.0 million.
After carefully assessing the effect of this error on previously
reported earnings and the effect of recording a total cumulative
correcting adjustment in the third quarter of 2006, we
determined that the errors were not material to the financial
statements for the nine-months ended September 30, 2006 and
the year ended December 31, 2006. Accordingly, a cumulative
correcting adjustment for this error was recorded in the third
quarter of 2006.
Table 7 Volume and Rate Changes for Interest
Expense
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in Interest Expense
|
|
|
Change in Interest Expense
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30, 2006 vs. September 30, 2005
|
|
|
September 30, 2006 vs. September 30, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
Total
|
|
|
|
Volume
|
|
|
Rate
|
|
|
Change
|
|
|
Volume
|
|
|
Rate
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense on Redwood debt
|
|
$
|
4,456
|
|
|
$
|
1,177
|
|
|
$
|
5,633
|
|
|
$
|
881
|
|
|
$
|
4,163
|
|
|
$
|
5,044
|
|
Interest expense on ABS
|
|
|
(77,526
|
)
|
|
|
49,975
|
|
|
|
(27,551
|
)
|
|
|
(220,726
|
)
|
|
|
176,916
|
|
|
|
(43,810
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest expense
|
|
$
|
(73,070
|
)
|
|
$
|
51,152
|
|
|
$
|
(21,918
|
)
|
|
$
|
(219,845
|
)
|
|
$
|
181,079
|
|
|
$
|
(38,766
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Volume change is the change in average balance of obligations
between periods multiplied by the rate paid in the earlier
period. Rate change is the change in rate between periods
multiplied by the average outstanding obligations in the current
period. Interest expense changes that resulted from changes in
both rate and volume were allocated to the rate change amounts
shown in the table.
56
The table below presents the different components of our
interest costs on ABS issued for the three and nine months ended
September 30, 2006 and 2005.
Table 8 Cost of Funds of Asset-Backed Securities
Issued
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ABS interest expense
|
|
$
|
165,177
|
|
|
$
|
190,996
|
|
|
$
|
515,018
|
|
|
$
|
556,108
|
|
ABS issuance expense amortization
|
|
|
5,786
|
|
|
|
5,162
|
|
|
|
17,772
|
|
|
|
15,821
|
|
Net ABS interest rate agreement
expense (income)
|
|
|
(3,317
|
)
|
|
|
(623
|
)
|
|
|
(9,975
|
)
|
|
|
(2,968
|
)
|
Net ABS issuance premium
amortization (income) on ABS issue
|
|
|
(2,395
|
)
|
|
|
(2,733
|
)
|
|
|
(7,284
|
)
|
|
|
(9,620
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total ABS interest expense
|
|
$
|
165,251
|
|
|
$
|
192,802
|
|
|
$
|
515,531
|
|
|
$
|
559,341
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average balance of ABS
|
|
$
|
11,684,412
|
|
|
$
|
19,542,413
|
|
|
$
|
13,094,871
|
|
|
$
|
21,630,747
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ABS interest expense
|
|
|
5.65
|
%
|
|
|
3.91
|
%
|
|
|
5.24
|
%
|
|
|
3.43
|
%
|
ABS issuance expense amortization
|
|
|
0.20
|
%
|
|
|
0.11
|
%
|
|
|
0.18
|
%
|
|
|
0.10
|
%
|
Net ABS interest rate agreement
expense (income)
|
|
|
(0.11
|
)%
|
|
|
(0.01
|
)%
|
|
|
(0.10
|
)%
|
|
|
(0.02
|
)%
|
Net ABS issuance premium
amortization (income) on ABS issued
|
|
|
(0.08
|
)%
|
|
|
(0.06
|
)%
|
|
|
(0.07
|
)%
|
|
|
(0.06
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of funds of ABS
|
|
|
5.66
|
%
|
|
|
3.95
|
%
|
|
|
5.25
|
%
|
|
|
3.45
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Expenses
Total operating expenses increased by 9% in the third quarter of
2006 as compared to the third quarter of 2005 and by 18% from
the first nine months of 2005 to the first nine months of 2006.
Table 9 Operating Expenses
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Components of total operating
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed compensation expense
|
|
$
|
3,437
|
|
|
$
|
2,802
|
|
|
$
|
10,183
|
|
|
$
|
8,203
|
|
Variable compensation expense
|
|
|
5,209
|
|
|
|
4,241
|
|
|
|
14,308
|
|
|
|
13,980
|
|
Systems
|
|
|
1,954
|
|
|
|
1,612
|
|
|
|
5,498
|
|
|
|
4,037
|
|
Due diligence
|
|
|
384
|
|
|
|
1,075
|
|
|
|
3,503
|
|
|
|
1,949
|
|
Office costs
|
|
|
1,021
|
|
|
|
900
|
|
|
|
3,223
|
|
|
|
2,693
|
|
Accounting and legal
|
|
|
626
|
|
|
|
929
|
|
|
|
2,903
|
|
|
|
2,739
|
|
Other
|
|
|
824
|
|
|
|
805
|
|
|
|
2,456
|
|
|
|
2,017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
$
|
13,455
|
|
|
$
|
12,364
|
|
|
$
|
42,074
|
|
|
$
|
35,618
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Generally, operating expenses increased as we added personnel,
systems and additional internal controls to lay the foundation
for future growth. We have expanded our product lines and made
significant investments in further developing our business
processes and information technologies. Our efforts to build for
future growth are ongoing and we expect that our operating
expenses will continue to increase.
Fixed compensation expense includes employee salaries and
related employee benefits. Fixed compensation expense has
increased in 2006 as compared to 2005 due to increased staffing
levels. Our headcount increased from 76 at September 30,
2005 to 89 at September 30, 2006. Variable compensa-
57
tion expense includes employee bonuses (which are generally
based on the adjusted return on equity earned by Redwood and, to
a lesser degree, on individual performance) and the expense of
equity awards granted to employees and directors.
Due diligence expenses are costs for services related to
re-underwriting and analyzing the loans we acquire or the loans
we credit-enhance through the purchase of securities. These
costs fluctuate from period to period, depending on the level of
asset acquisitions and other factors. Our office costs, fees,
and other costs have increased as a result of increases in the
scale of our operations.
Net Recognized Gains (Losses) and Valuation
Adjustments
The reduction in net recognized gains and valuation adjustments
for 2006 compared to 2005 is primarily due to lower gains on
sales and calls of residential securities. In addition, market
values of interest rate agreements have fluctuated, and we are
not always able to
mark-to
-market all of
the associated assets or liabilities. We expect increasing
volatility in
mark-to
-market income
and expenses in the future for a variety of reasons, including
expected increases in residential whole loans purchase
commitments, interest rate agreements not accounted for as cash
flow hedges, securities accounted for as trading,
calls of Sequoia transactions that may accelerate market value
losses relative to our basis in the underlying loans, and
EITF 99-20 write-downs as assets come under stress due to
the housing market recession. As a result of the timing of call
dates, we are not expecting to realize significant amounts of
call income from our residential credit-enhancement securities
during 2007.
The table below provides a detail of the net recognized gains
(losses) and valuation adjustments for the three and nine months
ended September 30, 2006 and 2005.
Table 10 Net Recognized Gains and Valuation
Adjustments
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized gains on calls:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate securities
|
|
$
|
723
|
|
|
$
|
2,914
|
|
|
$
|
1,470
|
|
|
$
|
14,883
|
|
Realized gains (losses) on sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate loans
|
|
|
|
|
|
|
(201
|
)
|
|
|
(14
|
)
|
|
|
808
|
|
|
Real estate securities
|
|
|
4,967
|
|
|
|
23,254
|
|
|
|
8,067
|
|
|
|
31,108
|
|
Valuation adjustments
impairment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate securities
|
|
|
(484
|
)
|
|
|
(1,158
|
)
|
|
|
(6,015
|
)
|
|
|
(3,259
|
)
|
Gains (losses) on interest rate
agreements
|
|
|
(8,475
|
)
|
|
|
107
|
|
|
|
982
|
|
|
|
(567
|
)
|
Purchase commitments
|
|
|
3,702
|
|
|
|
|
|
|
|
66
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net recognized gains and valuation
adjustments
|
|
$
|
433
|
|
|
$
|
24,916
|
|
|
$
|
4,556
|
|
|
$
|
42,973
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The decrease in net recognized gains and valuations adjustments
in the 2006 periods as compared to the 2005 periods is primarily
due to lower gains on sales and calls of residential securities.
Furthermore, during 2006, a portion of the recognized gains
recognized were offset by the losses in derivative instruments
we had entered into to manage some of the risks associated with
our purchase commitments and certain securities.
Other Comprehensive Income
Our real estate securities are accounted for as AFS and are
reported on our Consolidated Balance Sheets at fair market
value. Many of our derivative instruments are accounted for as
cash flow hedges and are reported on our Consolidated Balance
Sheets at fair market value. The differences between the value
of these assets and our amortized cost bases are shown as a
component of Stockholders Equity as Accumulated Other
Comprehensive Income. Periodic changes in the value of these
assets are included in Other Comprehensive Income.
58
There are a number of factors that affect the fair value of our
assets. For certain securities and derivative instruments,
changes in interest rates can have an impact on the current
value. As a result of changes in market conditions (including a
decrease in longer term rates) during the third quarter of 2006,
the change in the value of our assets on AFS securities reported
as Other Comprehensive Income increased by $31 million and
the change in value of derivative instruments reported through
Other Comprehensive Income decreased by $28 million.
Taxes
Provisions for Income Taxes
As a REIT, we are able to pass through substantially all of our
earnings at the REIT level to stockholders without paying
federal income tax at the corporate level. We pay income tax on
the REIT taxable income we retain and the income we earn at our
taxable subsidiaries. We provide for income taxes for GAAP
purposes based on our estimates of our taxable income, the
amount of taxable income we plan to permanently retain, and the
taxable income we estimate was earned at our taxable
subsidiaries. A portion of our income tax provision is based on
current tax provisions and another portion may include changes
in our deferred taxes arising from timing differences between
our GAAP and taxable income recognition.
Our income tax provision in the third quarter of 2006 was
$3.5 million, a decrease from the $4.7 million income
tax provision taken in the third quarter of 2005. For the first
nine months of 2006, our income tax provision was
$9.6 million, a decrease from the $13.4 million income
tax provision taken in the first nine months of 2005. Our
provision for income taxes decreased for the three and nine
months ending September 30, 2006 as compared to similar
periods of 2005 generally due to an overall decline in earnings
we are retaining at the REIT and a decline in earnings at our
taxable REIT subsidiaries.
Taxable Income and Dividends
Total taxable income is not a measure calculated in accordance
with GAAP. It is the pre-tax income calculated for tax purposes.
Estimated REIT taxable income is an important measure as it is
the basis of our dividend distributions to shareholders. REIT
taxable income is that portion of our taxable income that we
earn in our parent (REIT) company and its REIT
subsidiaries. It does not include taxable income earned in
taxable subsidiaries.
Taxable income calculations differ from GAAP income calculations
in a variety of ways. For us, the most significant differences
include the timing of amortization of premium and discounts and
the timing of the recognition of gains or losses on assets. The
rules for both GAAP and tax accounting for loans and securities
are technical and complicated, and the impact of changing
interest rates, actual and projected prepayment rates, and
actual and projected credit losses can have a very different
impact on the amount of GAAP and tax income recognized in any
one period. See further discussion under Potential Tax Earnings
Volatility.
59
The table below reconciles GAAP income to total taxable income
and REIT taxable income for the three and nine month periods
ended September 30, 2006 and 2005.
Table 11 Differences between GAAP Net Income and Total
Taxable Income
and REIT Taxable Income
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
|
|
2006
|
|
|
2005
|
|
|
2006
|
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP net income
|
|
$
|
32,416
|
|
|
$
|
55,899
|
|
|
$
|
91,841
|
|
|
$
|
157,376
|
|
GAAP/tax differences in accounting
for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income and interest expense
|
|
|
10,589
|
|
|
|
1,353
|
|
|
|
32,326
|
|
|
|
(23,606
|
)
|
|
Credit losses
|
|
|
(635
|
)
|
|
|
(1,367
|
)
|
|
|
(4,653
|
)
|
|
|
(3,044
|
)
|
|
Operating expenses
|
|
|
2,545
|
|
|
|
576
|
|
|
|
3,861
|
|
|
|
5,033
|
|
|
Gains (losses) and valuation
adjustments
|
|
|
1,947
|
|
|
|
(6,318
|
)
|
|
|
6,165
|
|
|
|
(1,502
|
)
|
|
Provisions for taxes
|
|
|
4,123
|
|
|
|
5,013
|
|
|
|
6,685
|
|
|
|
8,182
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total taxable income (pre-tax)
|
|
|
50,985
|
|
|
|
55,156
|
|
|
|
136,225
|
|
|
|
142,439
|
|
Earnings from taxable subsidiaries
|
|
|
(5,234
|
)
|
|
|
(8,038
|
)
|
|
|
(10,052
|
)
|
|
|
(10,923
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
REIT taxable income (pre-tax)
|
|
$
|
45,751
|
|
|
$
|
47,118
|
|
|
$
|
126,173
|
|
|
$
|
131,516
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP net income per share
|
|
$
|
1.22
|
|
|
$
|
2.21
|
|
|
$
|
3.51
|
|
|
$
|
6.26
|
|
Total taxable income per share
|
|
$
|
1.95
|
|
|
$
|
2.23
|
|
|
$
|
5.29
|
|
|
$
|
5.78
|
|
REIT taxable income per share
|
|
$
|
1.76
|
|
|
$
|
1.90
|
|
|
$
|
4.90
|
|
|
$
|
5.33
|
|
Total taxable income per share and REIT taxable income per share
are measured as the estimated pretax total taxable income and
REIT taxable income, respectively, earned in a calendar quarter
divided by the number of shares outstanding at the end of each
quarter. Total taxable income per share and REIT taxable income
per share for the first nine months are the sum of the first
three quarters total taxable income per share and REIT
taxable income per share, respectively.
Based on our 2005 REIT taxable income and the first nine months
of 2006 estimated REIT taxable income, we estimate we had
$111 million of undistributed REIT taxable income at
September 30, 2006. We plan to distribute the bulk of this
income as dividends to our stockholders during the remainder of
2006 and through September 2007 as we continue to meet our REIT
dividend distribution requirements.
Potential GAAP Earnings Volatility
Going forward, we expect
quarter-to
-quarter GAAP
earnings volatility for a variety of reasons, including the
timing of sales and calls of assets, changes in interest rates,
prepayments, credit losses, and capital utilization. In
addition, volatility may occur because of technical accounting
issues described below.
Loan Premium
Our unamortized loan premium on our consolidated residential
loans at September 30, 2006 was $141 million and will
be expensed over the remaining life of these loans. This
represents a cost basis of 101.45 on the $9.8 billion of
principal of these loans. For a variety of technical accounting
reasons, the premium balance for these loans has not been
amortized as quickly as these loans have prepaid, so our
reported earnings have been higher than they would have been if,
for example, the proportion of total premium amortized equaled
the proportion of total principal prepaid on loans, and our
accounting cost basis per loan has been increasing over time.
Amortization for a significant portion of this premium balance
is driven by effective yield calculations that depend on
interest rates and prepayments (see Critical Accounting Policies
for further details). Loan premium amortization was
$11.2 million and $35.3 million in the third quarter
and first nine months of 2006, respectively. Declines in
short-term interest rates could cause a significant increase in
required amortization in subsequent quarters.
In addition, a premium amortization adjustment could occur if we
reclassify a portion of the underlying loans from
held-for-investment to held-for-sale, as the GAAP carrying value
of these loans are currently in excess of their fair value and
the carrying value may continue to increase. This
reclassification could
60
occur over time as the various underlying pools of loans become
callable and we decide to sell the loans, or it could occur if
there is a change in accounting principles.
Real Estate Securities
Currently, all of our real estate securities are classified as
available-for-sale (AFS) and are carried on our balance
sheet at their estimated fair value. Cumulative unrealized gains
and losses are reported as a component of accumulated other
comprehensive income in our Consolidated Statements of
Stockholders Equity.
We could experience significant earnings volatility from our
real estate securities. Adverse changes to projected cash flows
related to poor credit performance or adverse changes to
prepayment speeds could create an other-than-temporary
impairment and cause any market value losses that have not been
reported in income to be expensed through the income statement.
Earnings volatility related to real estate securities may also
occur if we changed the GAAP classification for existing
securities from AFS to trading or if we use
trading accounting for new securities acquired.
Generally, changes in the fair value of trading
securities are required to flow through our income statement. In
the fourth quarter and going forward, we anticipate that certain
real estate securities we acquire (those we intend to hold as an
investment funded with Redwood debt) will be classified as
trading securities.
Derivative Instruments
We could experience significant earnings volatility from our
derivative instruments. Currently we have two classifications
for derivative instruments; trading and cash flow
hedges. All derivative instruments, regardless of
classification, are reported on the Balance Sheet at fair market
value. Changes to the fair value of trading
derivative instruments are recognized through the Income
Statement. To the extent we elect to hedge trading
securities, we might increase our usage of trading
derivative instruments. If we elect to classify our derivative
instruments as cash flow hedges, we defer the effective portion
of the change in fair value of our derivative instruments for
Income Statement purposes. If the hedged item and the derivative
instrument are not perfectly correlated, we will recognize the
difference through the Income Statement.
Potential Tax Earnings Volatility
Total taxable and REIT taxable income may vary from quarter to
quarter based on the timing for tax purposes of certain
transactions and events or based on the application of technical
regulations. This could occur for many reasons, three of which
are discussed below.
CES and Loans
We are not permitted for tax purposes to anticipate, or reserve
for, credit losses. Taxable income can only be reduced by actual
losses. As a consequence, we are required to accrete the entire
purchase discount on CES into taxable income over their expected
life and cannot take credit loss provisions on loans. For GAAP
purposes, we do anticipate credit losses and only accrete a
portion of the CES discount into income and we do provide for
loan losses. As a result, our income recognition on CES is
faster for tax as compared to GAAP, especially in the early
years of owning the assets. At September 30, 2006, the
cumulative difference between the GAAP and tax bases on our CES
was $87 million. In addition, as of September 30,
2006, we have a credit reserve of $27 million for GAAP on
our residential and commercial loans, and none for tax. As we
have no credit reserves for tax and a higher CES basis, any
future credit losses on our CES or loans would have a more
significant impact on tax earnings as compared to GAAP.
Sequoia Interest-Only certificates (IOs)
For technical tax reasons, at fast prepayment rates we are not
permitted to amortize a portion of the cost basis on IOs we have
acquired from Sequoia transactions until the underlying
securitization is called. For this reason, our taxable income
has been higher than it would have been otherwise, and our
current tax basis in these IOs is higher than it would have been
otherwise. We expect to call a number of
61
Sequoia securitization entities over the next two years, at
which time the remaining IO basis for tax would be recognized as
a capital loss for tax. Capital losses generated will not reduce
our ordinary income (or our requirement to distribute ordinary
income as dividends). Capital losses would offset current or
future capital gains realized from sales or calls of assets, and
thus would reduce distributions of capital gains. Our taxable
earnings will vary from quarter to quarter based on the exact
timing of these Sequoia calls.
Compensation
Compensation expense for tax will vary depending on the timing
of DER payments, the exercise of stock options, the distribution
of DSUs, and withdrawals of deferred compensation.
Cash Requirements, Sources of Cash, and Liquidity
We use cash to fund our operating and securitization activities,
invest in earning assets, service and repay Redwood debt, fund
working capital, and fund our dividend distributions.
One primary source of cash is principal and interest payments
received on a monthly basis from real estate loans and
securities. Other sources of cash include proceeds from sales of
assets to securitizations entities, proceeds from sales of other
assets, proceeds from calls, borrowings, and issuance of common
stock.
At September 30, 2006, Redwood had $0.5 billion of
debt. Redwood debt includes repurchase agreements, bank
borrowings, collateralized short-term borrowings, and a
non-secured line of credit. We may also issue secured commercial
paper or unsecured debt. We currently use Redwood debt to
finance the accumulation of assets for future sale to
securitization entities. We also intend to use Redwood debt to
finance the purchase of high-quality, relatively liquid
securities and loans that we intend to hold on an ongoing basis
to earn net interest income. For this reason, we expect Redwood
debt to increase materially.
At September 30, 2006, we had $1.0 billion of equity
capital. We expect to seek to raise additional capital in 2007.
At September 30, 2006, we consolidated as liabilities on
our balance sheet $12 billion of ABS issued by
securitization entities. It is unclear whether this balance will
grow we expect to acquire loans and securities and
fund them through securitization but we also expect to call
Sequoia and Acacia transactions at an increasing pace.
Cash flows generated and used within consolidated ABS
securitization entities are not directly available to Redwood,
although they are shown on our Consolidated Statement of Cash
Flows. Assets consolidated from these entities are not
Redwoods assets and the ABS issued by these entities are
not obligations of Redwood Trust.
We have acquired credit-enhancement securities, IOs, and CDO
equity securities from these securitization entities. Our
investment returns on these assets depends on their contractual
rights to receive distributions of principal and interest from
these securitization entities, which in turn depends on the
credit performance of securitization entitys assets and
other factors. In addition, we own the call rights for many of
these entities, generally allowing us (when certain time,
prepayment, and/or performance targets have been met) if we
choose to do so to pay off the ABS liabilities of these entities
and to acquire their assets.
62
Contractual Obligations and Commitments
The table below presents our contractual obligations and
commitments as of September 30, 2006, as well as the
consolidated obligations of the securitization entities that we
sponsored and are consolidated on our balance sheets. The
operating leases are commitments that are expensed based on the
terms of the related contracts.
Table 12 Contractual Obligations and Commitments as of
September 30, 2006
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due or Commitment Expiration by
|
|
|
|
Period
|
|
|
|
|
|
|
|
|
|
Less Than
|
|
|
1 to
|
|
|
After
|
|
|
|
Total
|
|
|
1 Year
|
|
|
5 Years
|
|
|
5 Years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redwood Obligations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Redwood debt
|
|
$
|
509,994
|
|
|
$
|
509,994
|
|
|
$
|
|
|
|
$
|
|
|
Accrued interest payable
|
|
|
501
|
|
|
|
501
|
|
|
|
|
|
|
|
|
|
Operating leases
|
|
|
17,151
|
|
|
|
1,382
|
|
|
|
6,733
|
|
|
|
9,036
|
|
Purchase commitments
|
|
|
93,250
|
|
|
|
93,250
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Redwood obligations and
commitments
|
|
$
|
620,896
|
|
|
$
|
605,127
|
|
|
$
|
6,733
|
|
|
$
|
9,036
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of Securitization
Entities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated asset-backed securities
|
|
$
|
11,554,259
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
11,554,259
|
|
Accrued interest payable
|
|
|
50,803
|
|
|
|
50,803
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total obligations of securitization
entities
|
|
$
|
11,605,062
|
|
|
$
|
50,803
|
|
|
$
|
|
|
|
$
|
11,554,259
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total consolidated obligations and
commitments
|
|
$
|
12,225,958
|
|
|
$
|
655,930
|
|
|
$
|
6,733
|
|
|
$
|
11,563,295
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Note: All consolidated ABS issued are collateralized by
associated assets and, although the stated maturity is as shown,
the ABS obligations will pay down as the principal of the
associated real estate loans or securities pay down.
MARKET RISKS
We seek to manage the risks inherent in our business
including but not limited to credit risk, interest rate risk,
prepayment risk, and market value risk in a prudent
manner designed to ensure Redwoods longevity. At the same
time, we endeavor, to the best of our ability, to provide our
stockholders with both a steady regular dividend and an
attractive long-term return. In general, we seek to assume risks
that can be quantified from historical experience, to actively
manage such risks, to earn sufficient compensation to justify
the taking of such risks, and to maintain capital levels
consistent with the risks we do take.
Credit Risk
Integral to our core business is assuming the credit risk of
real estate loans.
We assume credit risk with respect to real estate loans
primarily through the ownership of residential and commercial
real estate loans and securities. Much of our capital base is
employed in owning credit-enhancement securities that have below
investment-grade credit ratings due to their concentrated credit
risks with respect to underlying real estate loans. Many of the
loans underlying these securities are above-average in credit
quality as compared to U.S. real estate loans in general,
but the balance and percentage of loans with special risk
factors (higher risk commercial loans, interest-only and
negative amortization residential loan types, Alt-A and
sub-prime residential loan quality) has been and will continue
to increase. Credit losses from any of the loans in the
securitized loan pools reduce the principal value of and
economic returns from these lower-rated securities. We also own
a wide variety of residential and commercial unsecuritized real
estate loans of various quality grades credit risks
are not as concentrated in loans as they are in
credit-enhancement securities, but the risks are real
nevertheless. Credit losses on real estate loans can occur for
many reasons. Losses rates on real
63
estate loans are cyclical, and can also vary for reasons not
related to the general economy. Historical experience is not
always a good guide to future loan losses.
We also own investment-grade real estate securities backed by
loans of various quality grades. These securities benefit from
some credit protections, but if losses to the underlying loans
are high enough, they could suffer credit rating downgrades,
market value declines, or principal value losses.
Interest Rate Risk
Interest rates can affect the cash flows and market values of
our assets, liabilities, and interest rate agreements, and thus
affect our earnings and reported book value. Our general
strategy with respect to interest rates is to maintain an
asset/liability posture (including hedges) on a consolidated
basis that assumes some interest rate risks but not to the
degree that the achievement of our long-term goals would likely
be affected by changes in interest rates. We are willing to
accept short-term volatility of earnings and book value while
seeking to achieve more attractive long-term returns.
Prepayment Risk
We seek to maintain an asset/liability posture that benefits
from investments in prepayment-sensitive assets while limiting
the risk of adverse prepayment fluctuations to an amount that,
in most circumstances, can be absorbed by our capital base while
still allowing us to make regular dividend payments. Prepayment
rates are difficult to predict or anticipate, and variations in
prepayment rates can materially affect our earnings and
dividends in many ways. We do not believe it is possible or
desirable to control these effects in the short-term. Thus our
general approach is to seek to balance overall characteristics
of our balance sheet so that the net present value of cash flows
generated over long periods of time does not have unattractive
volatility with respect to prepayment rate changes.
Market Value Risk
Most of our consolidated real estate assets are loans accounted
for as held-for-investment and reported at cost. Most of these
loans have been sold to Sequoia entities and, thus, changes in
the market value of the loans do not have an impact on our
liquidity in the long term. However, changes in market value
during the accumulation period (while these loans are funded
with debt) may have a short-term effect on our liquidity.
At September 30, 2006, we reported on a consolidated basis
$2.9 billion of assets that were
marked-to
-market
through our balance sheet (i.e., available-for-sale securities)
but not through our income statement. Some of these assets are
credit-sensitive, and all are interest-rate sensitive. Market
value fluctuations of these assets can affect the balance of our
stockholders equity base. Market value fluctuations for
our securities can affect not only our earnings and book value,
but also our liquidity, especially to the extent these assets
are funded with short-term debt (generally prior to
securitization).
Our consolidated obligations consist primarily of ABS issued.
These are reported at cost, and changes in market value in these
ABS have no impact on our liquidity. However, because many of
our consolidated assets are funded with these ABS issued are
reported at market value, the resulting reported net equity
value may not necessarily reflect the true market value of our
equity investments in these securitization entities.
Inflation Risk
Virtually all of our consolidated assets and liabilities are
financial in nature. As a result, changes in interest rates and
other factors drive our performance far more than does
inflation. Changes in interest rates do not necessarily
correlate with inflation rates or changes in inflation rates.
Our financial statements are prepared in accordance with GAAP.
Our activities and balance sheet are measured with reference to
historical cost or fair market value without considering
inflation.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with GAAP
requires us to make estimates and assumptions that affect the
reported amounts of certain assets and liabilities at the date
of the
64
consolidated financial statements and the reported amounts of
certain revenues and expenses during the reported period. Actual
results could differ from those estimates. The critical
accounting policies and the possible effect of changes in
estimates on our financial results and statements are discussed
below. Management discusses the ongoing development and
selection of these critical accounting policies with the Audit
Committee of the Board of Directors.
Revenue Recognition
When recognizing revenue on consolidated earning assets, we
employ the interest method and determine an effective yield to
account for purchase premiums, discounts, and other net
capitalized fees and costs associated with purchasing and
financing real estate loans and securities.
Loan Premium Amortization
For consolidated real estate loans, the interest method is
applied as prescribed under FAS 91. For loans acquired
prior to July 2004, we assume future prepayments on a pool basis
and apply the current interest rate to determine the effective
yield for each pool of loans. During a period of rising
short-term
rates, the
coupon is projected to increase and results in a higher
effective yield. Prior to the coupon rate resetting, (generally
one to six months for these loans), the amount of amortization
is lower than it will be once the coupon rate resets. Thus, for
the past two years, as
short-term
rates
increased every quarter, the amount of purchase premium we
amortized was less than it would have been in a flat interest
rate environment and as a result, our cost basis increased on
our remaining loans. The cost basis in these loans continues to
exceed the estimated fair market value.
For loans acquired after July 1, 2004, we use the initial
coupon interest rate of the loans (without regard to future
changes in the underlying indices) and anticipated principal
payments on a pool basis to calculate an effective yield and to
amortize the premium or discount. Any volatility in amortization
expense is dependent only on prepayments. The cost basis of
these loans is approximately equal to market value.
For our consolidated securities, the interest method to
determine an effective yield is applied as prescribed under
FAS 91 or
EITF
99-20,
using
anticipated principal prepayments. The use of these methods
requires us to project cash flows over the remaining life of
each asset. These projections include assumptions about interest
rates, prepayment rates, timing and amount of credit losses,
when certain tests will be met that may allow for changes in
payments made under the structure of securities, estimates
regarding the likelihood and timing of calls of securities at
par, and other factors. We review our cash flow projections on
an ongoing basis and monitor these projections based on input
and analyses received from external sources, internal models,
and our own judgment and experience. We constantly review our
assumptions and make adjustments to the cash flows as deemed
necessary. There can be no assurance that our assumptions used
to generate future cash flows, or the current periods
yield for each asset, will prove to be accurate.
Under the interest method, decreases in our projected credit
loss assumptions could result in increasing yields being
recognized from residential and commercial real estate
securities in the current period. In addition,
faster-than-anticipated
prepayment rates on residential loans would also tend to
increase realized yields. In contrast, increases in our credit
loss assumptions and/ or slower than anticipated prepayment
rates could result in lower yields being recognized and an
adverse change in cash flows may represent an
other-than-temporary
impairment under GAAP, in which case the asset may be written
down to its fair value through our Consolidated Statements of
Income.
Redwood applies APB 21 and APB 12 in determining its
periodic amortization for the premium on its debt, including the
issuance of IO securities and deferred bond issuance cost
(DBIC). We arrive at a periodic interest cost that represents a
level effective rate based on projected repayment rates.
Establishing Valuations and Accounting for Changes in
Valuations
Changes to the fair value of securities
available-for-sale
are
reported through our Consolidated Balance Sheets as cumulative
unrealized gains and losses classified as accumulated other
comprehensive income in stockholders equity. The exception
to this treatment is when a specific impairment is
65
identified and the resulting decrease in fair value is recorded
in net recognized gains (losses) and valuation adjustments on
our Consolidated Statements of Income.
We estimate the fair value of assets and interest rate
agreements using available market information and other
appropriate valuation methodologies. We believe that the
estimates we use reflect market values that we may be able to
receive should we choose to sell assets. Our estimates are
inherently subjective in nature and involve matters of
uncertainty and judgment in interpreting relevant market and
other data. Many assumptions are necessary to estimate market
values, including, but not limited to, interest rates,
prepayment rates, amount and timing of credit losses, supply and
demand, liquidity, and other market factors. We apply these
factors to each of our assets, as appropriate, in order to
determine market values.
We review our fair value calculations on an ongoing basis. We
monitor the critical performance factors for each of our assets.
Our expectations of future performance are shaped by input and
analyses received from external sources, internal models, and
our own judgment and experience. We review our existing
assumptions relative to our and the markets expectations
of future events and make adjustments to the assumptions that
may change our market values. Changes in perceptions regarding
future events can have a material impact on the value of our
assets. Should such changes or other factors result in
significant decreases in the market values, our net income and
book value could be adversely affected.
In addition to our valuation processes, we are active acquirers,
issuer of debt securities, and occasional sellers of assets.
Thus, we believe that we have the ability to understand and
determine changes in assumptions that are taking place in the
marketplace and make appropriate changes in our assumptions for
valuing assets. In addition, we use third party sources to
validate our valuation estimates.
There are certain other valuation estimates we make that have an
impact on current period income. One such area is the valuation
of certain equity grants. Under FAS 123R, we estimate the
value of options, which is based on a number of assumptions,
including forfeitures. Currently, most of our equity awards are
restricted stock and deferred stock units and the fair values at
grant equal the market value of Redwoods common stock at
the date of grant.
Credit Reserves
For consolidated real estate loans
held-for-investment,
we
establish and maintain credit reserves that we believe represent
probable credit losses that will result from inherent losses
existing in our consolidated real estate loans
held-for-investment
as
of the date of the financial statements. The reserves for credit
losses are adjusted by taking provisions for credit losses
recorded as a reduction in interest income on real estate loans
on our Consolidated Statements of Income. The reserves consist
of estimates of specific loan impairment and estimates of
collective losses on pools of loans with similar characteristics.
To calculate the credit reserve for credit losses for real
estate loans, we determine inherent losses by applying loss
factors (default, the timing of defaults, and the loss severity
upon default) that can be specifically applied to each pool of
loans. The following factors are considered and applied in such
determination:
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Ongoing analysis of the pool of loans, including, but not
limited to, the age of the loans, underwriting standards,
business climate, economic conditions, geographic
considerations, and other observable data;
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Historical loss rates and past performance of similar loans;
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Relevant environmental factors;
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Relevant market research and publicly available third-party
reference loss rates;
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Trends in delinquencies and charge-offs;
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Effects and changes in credit concentrations;
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Information supporting borrowers ability to meet
obligations;
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66
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Ongoing analyses of each individual loan including,
but not limited to, the age of loans, underwriting standards,
business climate, economic conditions, geographical
considerations and other observable data;
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Ongoing evaluation of fair values of collateral using current
appraisals and other valuations; and,
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Discounted cash flow analyses.
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Once we determine the applicable default rate, the timing of
defaults, and the severity of loss upon the default, we estimate
the expected losses of each pool of loans over their expected
lives. We then estimate the timing of these losses and the
losses probable to occur over an effective loss confirmation
period. This period is defined as the range of time between the
probable occurrence of a credit loss (such as the initial
deterioration of the borrowers financial condition) and
the confirmation of that loss (the actual charge-off of the
loan). After further review, we revised and shortened our
estimate of this confirmation in the second quarter of 2006. The
losses expected to occur within the estimated loss confirmation
period are the basis of our credit reserves because we believe
those losses exist as of the reported date of the financial
statements. We re-evaluate the level of our credit reserves on
at least a quarterly basis and record provision, charge-offs,
and recoveries monthly.
If a loan becomes REO or becomes impaired, or loans are
reclassified as held-for-sale, specific valuations are primarily
based on analyses of the underlying collateral.
Certain securities issued by an ABS securitization entity bear
most of the initial credit risk of the underlying pool of loans
that was securitized. As a result of the relatively high credit
risks of these investments, we are able to purchase these
securities at a discount to principal (par) value. A
portion of the purchase discount is subsequently accreted as
interest income under the interest method while the remaining
portion of the purchase discount is considered as a form of
credit protection. The amount of credit protection is based upon
our assessment of various factors affecting our assets,
including economic conditions, characteristics of the underlying
loans, delinquency status, past performance of similar loans,
and external credit protection. We use a variety of internal and
external credit risk analyses, cash flow modeling, and portfolio
analytical tools to assist us in our assessments. If cumulative
credit losses in the underlying pool of loans exceed the
principal value of the first-loss piece, we may never receive a
principal payment from that security. The maximum loss for the
owner of these securities, however, is limited to the investment
made in purchasing these securities. In addition to the amount
of losses, the timing of future credit losses is also important.
In general, the longer credit losses are delayed, the better our
economic returns, as we continue to earn coupon interest on the
face value of our security.
Accounting for Derivative Instruments
We use derivative instruments to manage certain risks such as
market value risk and interest rate risk. The derivative
instruments we employ include, but are not limited to, interest
rate swaps, interest rate options, options on swaps, futures
contracts, options on futures contracts, options on forward
purchases, and other similar derivatives. We collectively refer
to these derivative instruments as interest rate
agreements.
On the date an interest rate agreement is entered into, we
designate each interest rate agreement under GAAP as (1) a
hedge of the fair value of a recognized asset or liability or of
an unrecognized firm commitment (fair value hedge), (2) a
hedge of a forecasted transaction or of the variability of cash
flows to be received or paid related to a recognized asset or
liability (cash flow hedge), or (3) held for trading
(trading instrument).
We currently elect to account for most of our interest rate
agreements as cash flow hedges. We record these derivatives at
their estimated fair market values, and record changes in their
fair values in accumulated other comprehensive income on our
Consolidated Balance Sheets. These amounts are reclassified to
our Consolidated Statements of Income over the effective hedge
period as the hedged item affects earnings. Any ineffective
portions of these cash flow hedges and are included in our
Consolidated Statements of Income.
The remainder of our interest rate agreements are currently
accounted for as trading investments. We record these
derivatives at their estimated fair values with any changes in
the fair values recorded in our Consolidated Statements of
Income.
67
Item 3.
Quantitative and
Qualitative Disclosures about Market Risk
Discussions about our quantitative and qualitative disclosures
about market risk are included in our Managements
Discussion and Analysis included herein.
Item 4.
Controls and
Procedures
We have carried out an evaluation, under the supervision and
with the participation of our management, including our
principal executive officer and principal financial officer, of
the effectiveness of the design and operation of our disclosure
controls and procedures, as that term is defined in
Rule
13a-15(e)
under the Securities Exchange Act of 1934, as amended. Based on
that evaluation, our principal executive officer and principal
financial officer concluded that as of September 30, 2006,
which is the end of the period covered by this
Form
10-Q,
our
disclosure controls and procedures are effective.
There has been no change in Redwoods internal control over
financial reporting identified in connection with the evaluation
required by paragraph (d) of Exchange Act
Rule
13a-15
that
occurred during the quarter ended September 30, 2006 that
has materially affected, or is reasonably likely to materially
affect, Redwoods internal control over financial reporting.
68
PART II. OTHER INFORMATION
Item 2.
Unregistered
Sales of Equity Securities and Use of Proceeds
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Issuer Purchases of Equity Securities
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Total Number of
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Maximum Number
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Total
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Shares Purchased as
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of Shares Available
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Number of
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Average
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Part of Publicly
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for Purchase Under
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Shares
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Price Paid
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Announced
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Publicly Announced
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Period
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Purchased
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per Share
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Programs
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Programs
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July 1 - July 31, 2006
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August 1 - August 31, 2006
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September 1 - September 30,
2006
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Total
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1,000,000
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No shares were purchased for the three months ended
September 30, 2006. The Company announced stock repurchase
plans on various dates from September 1997 through November 1999
for the total repurchase of 7,455,000 shares. None of these
plans have expiration dates on repurchases. Shares totaling
1,000,000 are currently available for repurchase under those
plans.
Item 6.
Exhibits
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Exhibit 10
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.1
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Office building lease, second
floor, dated July 31, 2006
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Exhibit 10
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.2
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Office building sublease, second
floor, dated July 31, 2006
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Exhibit 10
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.3
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Second amendment to office building
lease, third floor, dated July 31, 2006
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Exhibit 31
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.1
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Certificate of Chief Executive
Officer pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 (filed herewith).
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Exhibit 31
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.2
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Certificate of Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 (filed herewith).
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Exhibit 32
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.1
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Certificate of Chief Executive
Officer pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (furnished herewith).
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Exhibit 32
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.2
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Certificate of Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002 (furnished herewith).
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69
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
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REDWOOD TRUST, INC.
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Dated: November 1, 2006
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By: /s/ Douglas B. Hansen
Douglas
B. Hansen
President
(authorized officer of registrant)
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Dated: November 1, 2006
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By: /s/ Martin S. Hughes
Martin
S. Hughes
Vice President, Chief Financial Officer,
Treasurer, and Secretary
(principal financial officer)
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Dated: November 1, 2006
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By: /s/ Raymond S. Jackson
Raymond
S. Jackson
Vice President and Controller
(principal accounting officer)
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70
Exhibit 10.1
BELVEDERE PLACE
DATED AS OF JULY 31
st
, 2006
BETWEEN
BENTLY HOLDINGS CALIFORNIA LP,
AS LANDLORD,
AND
REDWOOD TRUST, INC.
AS TENANT
BELVEDERE PLACE
BASIC LEASE INFORMATION
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1.
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Date:
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July 31
st
,2006
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2.
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Landlord:
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Bently Holdings California LP
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3.
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Tenant:
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Redwood Trust, Inc., a Maryland corporation
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4.
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Property:
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The real property legally described on
Exhibit A
attached
hereto
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5.
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Project:
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The Property, together with the buildings known as One and
Two Belvedere Place and all other improvements located thereon,
commonly known as the Belvedere Place Office Center containing
approximately 103,598 rentable square feet
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6.
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Building:
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That certain office building located within the Project
located at One Belvedere Place, Mill Valley, California
containing approximately 43,258 rentable square feet
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7.
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Premises:
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Subject to
Section l(b)
of the Lease, approximately 21,887
rentable square feet located on the second floor of the Building,
as outlined on the floor plan attached hereto as
Exhibit B
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8.
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Load Factor:
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1.23 (23%)
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9.
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Initial Term:
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Ten (10) years and five (5) months
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10.
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Estimated Delivery Date:
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N/A
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11 .
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Outside Delivery Date:
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N/A
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12 .
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Commencement Date :
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January 1, 2008
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13.
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Expiration Date:
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May 31, 2018, as the same may be extended pursuant to the
provisions of
Section 40
of the Lease.
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14.
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Initial Basic Rental Rate:
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$79,012.00/month
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15.
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Fair Market Rental Value:
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The rental rate per rentable square foot per month (taking
into account additional rent and all other monetary payments and
considering any base year or expense stop applicable thereto),
including all escalations, for all leases for comparable,
unencumbered
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-1-
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space for approximately the
same lease term,
executed at the
Project and/or any
other comparable
Class A building in
terms of size,
quality, level of
services, amenities,age and appearance
located within the Southern Marin County
area from the northern border of
Corte Madera and Larkspur south to the
Golden Gate Bridge (collectively,
Comparable Buildings
), during
the twelve (12) month period immediately
preceding the date upon which the
determination of Fair Market Rental Value
is made, and having a commencement date
within six (6) months of the date that the
Fair Market Rental Value will commence
under this Lease, and taking into account
any free rent, tenant improvements, tenant
improvement allowances, moving
allowances and other concessions granted
to tenants under leases of such
comparable space in Comparable Buildings
and the value, if any, of the existing
tenant improvements (with such value
being judged with respect to the
utility of such existing tenant
improvements to the general business
office user and not this particular
Tenant), provided that the Fair Market
Rental Value shall
not include
consideration of the
value of any Tenant
Improvements made to
the Premises by
Tenant under
Section
30
below costing in
excess of the Tenant
Improvement Allowance
or the value of any
Alterations to the
Premises made at the
expense of Tenant.
The Fair Market
Rental Value shall be
determined in
accordance with the
terms and provisions
of this Lease
below.
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16.
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Security Deposit:
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$79,012.00
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17.
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Base Year:
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2008
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18.
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Tenants Proportionate Share:
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The ratio
which the rentable
area of the Premises
bears to the rentable
area of the entire
Project, which,
subject to
Section
l(b)
of the Lease, is
agreed to be
21%.
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19.
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Tenant Improvement Allowance:
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Subiect to
Section 1(b)
of the
Lease, $35.00 per
rentable square foot
multiplied by 21,887
rentable square feet
= $766,045.00.
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20.
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Space Plan Deadline:
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N/A
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21 .
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Working Drawing Deadline:
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N/A
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22.
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Landlords Broker:
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None
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23.
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Tenants Broker:
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None
|
-2-
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24.
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Extension Term:
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Two five (5) year
options, in accordance
with
Section 40
below
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25.
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Guarantor:
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None
|
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
-3-
EXHIBITS
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Exhibit A
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Legal Description of Property
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Exhibit B
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Description of Premises
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Exhibit C
|
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Notice of Lease Term Dates
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Exhibit D
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Form of Tenant Estoppel Certificate
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Exhibit E
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Rules and Regulations
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Exhibit F
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Base Building Standard Shell Construction Specifications
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-4-
BELVEDERE PLACE OFFICE LEASE
THIS LEASE is entered into by and between Landlord and Tenant, as specified in the
Basic Lease Information, which is incorporated herein by reference, as of the date shown in
Paragraph 1 of the Basic Lease Information.
1.
PREMISES.
(a)
Initial Premises.
Landlord hereby leases to Tenant and Tenant hereby leases
from Landlord the Premises (as defined in
Paragraph 7
of the Basic Lease Information) upon
and subject to the terms, covenants and conditions herein set forth. Tenant covenants, as a
material part of the consideration for this Lease, to keep and perform each and all of said terms,
covenants and conditions for which Tenant is responsible and that this Lease is entered into upon
the condition of such performance.
(b)
Verification of Usable Square Feet of Premises, Building and Project.
For
the purposes of this Lease,
usable square feet
for the Premises shall be calculated pursuant to
the Standard Method for Measuring Floor Area in Office Buildings,
[ANSI Z65.1 1996], and
rentable
square feet
shall equal (i) the usable square feet
contained within the Premises
multiplied
by (ii) the sum of (x) one (1) plus (y) the Load
Factor (as defined in
Paragraph 8
of the
Basic Lease Information). The usable square feet and rentable square
feet of the Premises, Building
and the Project are subject to verification by Tenants
architect within ninety (90) days following
the Commencement Date. The usable square feet and rentable square
feet of the Premises are subject
to verification from time to time by Landlords planner/designer
only in the event of a change in
the boundaries of the Premises and the parties hereby agree that the
usable square footage and
rentable square footage of the Premises shall be as specified in the
Basic Lease Information unless
and until (i) there is such a change in the boundaries of the
Premises from as shown on
Exhibit B
attached hereto and/or (ii) Tenant exercises its right to
remeasure as provided above.
Notwithstanding the foregoing, Landlord shall have the right to
verify the usable and rentable
square feet in the Premises after completion of the Tenant
Improvements. In the event either
Landlord or Tenant elects to remeasure as provided herein,
Tenants architect may consult with
Landlords planner/designer regarding any such verification (if
applicable) as it pertains to the
Premises and such verification shall be subject to the approval of
Tenants architect (which
approval shall not be unreasonably withheld, conditioned or delayed),
and Landlords architect may
consult with Tenants architect regarding any such verification
as it pertains to the Premises and
such verification shall be subject to the approval of Landlords architect. In the event
Landlords architect and Tenants architect cannot agree on
the square footage of the Premises,
Landlord and Tenant shall select a mutually acceptable independent architect to measure the Premises
in accordance with this
Section 1(b)
and the decision of such architect shall be binding on
Landlord and Tenant. Landlord and Tenant shall equally share the cost of such independent
architect. In the event of such a change in the usable and rentable square footage in the Premises
as provided herein, all amounts, percentages and figures appearing or referred to in this Lease
based upon such incorrect amount (including, without limitation, the amount of rent) shall be
modified in accordance with such determination. If such determination is made, it will be confirmed
in writing by Landlord to Tenant.
-1-
2.
TERM.
(a)
Initial Term.
Except as otherwise provided herein, the term of this Lease
shall be the Initial Term as set forth in
Paragraph 9
of the Basic Lease Information,
commencing on the Commencement Date, and ending as of the Expiration Date, as set forth in
Paragraph 12
and
Paragraph 13,
respectively, of the Basic Lease Information. The
Initial Term, together with any extension term as to which a right has been properly exercised,
shall be referred to as the
Term.
Notwithstanding anything to the contrary set forth in this
Lease, in the event that Landlord has not delivered the Premises to Tenant in the Delivery Condition
by the Outside Delivery Date, as set forth in
Paragraph 11
of the Basic Lease Information,
Tenant shall have the right, at Tenants sole option, to elect to terminate this Lease by delivery
to Landlord of a notice (the
Termination Notice),
which termination shall be effective thirty (30)
days after Tenants delivery of the Termination Notice to Landlord, unless within such thirty (30)
day period
Landlord shall deliver the Premises to Tenant in the Delivery Condition. In the event
Tenant
shall elect to terminate this Lease, Tenant must deliver to Landlord the Termination Notice
prior to the date the Premises are delivered to Tenant in the Delivery Condition.
(b)
Confirmation of Lease Term.
When the Commencement Date and the Expiration
Date have
been ascertained, the parties shall promptly complete and execute a Notice of Lease
Term Dates in
the form of
Exhibit C
attached hereto; provided, however, that the failure of the
parties to
confirm same shall not affect the Commencement Date or otherwise invalidate this
Lease.
(c)
Lease Years.
The term
Lease Year
when used herein shall mean the twelve months
commencing on the Commencement Date and each subsequent period of
twelve months; provided, however,
that if the Commencement Date does not occur on the first day of the
calendar month, the first Lease
Year shall mean the twelve months commencing on the first day
of the calendar month following
the Commencement Date. As provided above, if the
Commencement Date does not occur on the
first day of the calendar month, the first Lease Year
shall include the period, if any, from the
Commencement Date to the end of the month in which
the Commencement Date occurs.
3.
BASIC RENT.
(a)
Basic Rent Payments.
Tenant agrees to pay Landlord each calendar month, as
base monthly rent, the Basic Rent as set forth in
Paragraph 14
of the Basic Lease
Information, subject to adjustment pursuant to subsection (b) below. Each monthly installment of
Basic Rent shall be payable in advance on the first day of each calendar month during the Term. If
the Term commences or ends on a day other than the first day of a calendar month, then the rent for
the months in which this Lease commences or ends shall be prorated (and paid at the beginning of
each such month) in the proportion that the number of days this Lease is in effect during such
month bears to the total number of days in such month, and such partial months installment shall
be paid no later than the commencement of the subject month except for the first months rent which
shall be paid no later than the Commencement Date. In addition to the Basic Rent, Tenant agrees to
pay as additional rent the amount of additional rent and rent adjustments and other charges
required by this Lease. All rent shall be paid to Landlord, without prior demand and without any
deduction or offset (except as otherwise provided in this Lease), in lawful
-2-
money of the United States of America, at the address of Landlord designated in
Section 31
below or to such other person or at such other place as Landlord may from time to time
designate in writing. Except as otherwise provided in this Lease, in the event of a remeasurement
or adjustment of the area of the Premises, the Basic Rent shall be recalculated using the Basic
Rental Rate referenced in
Paragraph 14
of the Basic Lease Information.
(b)
Adjustment in Basic Rent.
The Basic Rent payable by Tenant shall be increased at
the end of each twelve (12) month period by an amount to equal one hundred three percent (103%) of
the Basic Rent in effect immediately prior to the applicable adjustment date in accordance with the
following schedule (subject to modification based on a remeasurement as provided in
Section 1(b))
:
|
|
|
|
|
Months
|
|
Monthly Basic Rent
|
1-12
|
|
$
|
79,012.00
|
|
13-24
|
|
$
|
81,382.36
|
|
25-36
|
|
$
|
83,823.83
|
|
37-48
|
|
$
|
86,338.55
|
|
49-60
|
|
$
|
88,928.70
|
|
61-72
|
|
$
|
91,596.56
|
|
73-84
|
|
$
|
94,344.46
|
|
85-96
|
|
$
|
97,174.79
|
|
97-108
|
|
$
|
100,090.04
|
|
109-120
|
|
$
|
103,092.74
|
|
(c)
Late Charge.
If Tenant fails to pay any installment of Basic Rent,
additional rent or other changes or otherwise fails to make any other payment for which Tenant is
obligated under this Lease within five (5) days after Tenants receipt of notice that Tenant failed
to pay same when due, then Tenant shall pay to Landlord a late charge equal to five percent (5%) of
the amount so payable; provided, however, that if Tenant fails to pay any installment of Basic Rent
or additional rent when due more than three (3) times in any twelve (12) month period, Landlord
shall no longer be required to give Tenant notice before imposing the late charge and Tenant shall
pay to Landlord a late charge equal to five percent (5%) of the amount due for any amount not paid
within five (5) days after the date due. Tenant acknowledges that late payments will cause Landlord
to incur costs not contemplated by this Lease, the exact amount of which costs are extremely
difficult and impracticable to calculate. The parties agree that the late charge described above
represents a fair and reasonable estimate of the extra costs incurred by Landlord as a result of
such late payment. Such late charge shall not be deemed a consent by Landlord to any late payment,
nor a waiver of Landlords right to insist upon timely payments at any time, nor a waiver of any
remedies to which Landlord is entitled hereunder. In addition, all amounts payable by Tenant to
Landlord hereunder, exclusive of the late change described above, if not paid within five (5) days
after such amounts are due, shall bear interest from the due date until paid at the lesser of (i)
the rate of ten percent (10%) per annum or (ii) the maximum rate of interest permitted to be
collected by the Landlord by law
(Interest Rate).
-3-
4.
ADDITIONAL RENT
. In addition to the Basic Rent provided in
Section 3
of this
Lease, Tenant shall pay Tenants Proportionate Share as specified in
Paragraph 18
of the
Basic Lease Information, of the increase in (Actual Operating Expenses for each Operating Year over
the Base Amount (as such terms are defined below). Tenants Proportionate Share of the Building
may change based on remeasurement or adjustment of the area of the Project or the Premises as
described in
Section 1(b).
In addition, whenever additional space is added to the Premises,
Tenants Proportionate Share of the Project shall increase accordingly.
(a)
Estimated Operating Expenses
. Within ninety (90) days after the close of
each Operating Year during the Term following the Base Year, Landlord
shall furnish Tenant a written
statement of the
Estimated Operating Expenses
for
the then current Operating Year, and a
corresponding calculation of additional rent, which shall be one-twelfth (1/12) of
Tenants Proportionate Share of the amount, if any, by which the Estimated Operating Expenses
exceed the Base Amount. Such additional amount shall be added to the monthly installment of
Basic Rent payable by Tenant under this Lease for each month during such Operating Year.
(b)
Actual Operating Expenses.
Within ninety (90) days after the close of
each Operating Year (including the Base Year) during the Term, Landlord shall deliver to Tenant
a written statement setting forth the Actual Operating Expenses
during the preceding Operating Year
and the amount by which such Actual Operating Expenses exceed the Base Amount (theOperating
Expense Increase). If Tenants Proportionate Share of the Operating Expense
Increase for any
Operating Year exceeds the Estimated Operating Expenses paid by
Tenant to Landlord pursuant to
Section 4(a)
Tenant shall pay the amount of such excess
to Landlord as additional rent
within thirty (30) days after receipt by Tenant of such
statement. If such statement shows
Tenants Proportionate Share of the Operating Expense Increase
to be less than the amount paid by
Tenant to Landlord pursuant to
Section 4(a),
then the
amount of such overpayment shall be
paid by Landlord to Tenant within thirty (30) days following the
date of such statement or, at
Landlords option, credited by Landlord to the payment of rent
next due. Additionally, promptly
following the reassessment of the value of the Project by any such governmental authority subsequent
to the leasing and occupancy of a substantial portion of the Project, Landlord shall provide Tenant
with a written statement reflecting the adjusted Actual Operating Expenses for the Base Year. If,
as a result of Landlords recalculation of the Actual Operating Expenses for the Base Year Landlord
determines that the amount paid by Tenant pursuant to this
Section 4
for any Operating Year
was less than the amount owed by Tenant for such Operating Year, Tenant shall pay to Landlord the
amount of such shortfall within thirty (30) days after the date of Tenants receipt of such
statement, and if, as a result of Landlords recalculation of the Actual Operating Expenses for the
Base Year Landlord determines that amounts paid by Tenant pursuant to this
Section 4
for any
Operating Year exceeded the amount owed by Tenant for such Operating Year, then the amount of such
overpayment shall be paid by Landlord to Tenant within thirty (30) days following the date of such
statement or, at Landlords option, credited by Landlord to the payment of rent next due. Prior to
the date that is one (1)year after Tenants receipt of Landlords statement of Actual Operating
Expenses for any Operating Year, Landlord shall provide Tenant with reasonable access, upon
reasonable prior notice and during normal business hours, to inspect and photocopy Landlords books
and records with respect to the Actual Operating Expenses for such Operating Year
(Tenants
Audit)
, provided: (i) Tenant is not in default under any of the material provisions of the
Lease (remaining uncured following the expiration of any applicable period for cure under this
Lease),
-4-
(ii) Tenant shall pay any amounts owing hereunder when due, (iii) Tenants Audit is performed by an
employee of Tenant or certified, public accountant who is not paid on a contingency fee basis, (iv)
Tenant and any Tenant Party (as defined in
Section 6(c)
hereof) performing Tenants Audit
execute a confidentiality agreement in a form reasonably acceptable to Landlord and Tenant, (v)
Tenants Audit shall be performed at Tenants sole cost and expense unless otherwise provided
herein and (vi) Tenants Audit shall be completed within such sixty (60) days after Landlord gives
Tenant access to its books and records. If, within such sixty (60) day period, Tenant delivers to
Landlord the written results of Tenants Audit which states that Actual Operating Expenses are less
than Landlords determination of Actual Operating Expenses (the
Discrepancy
), Landlord shall,
promptly after its receipt of the written results of Tenants Audit either (A) reimburse Tenant for
the amount of any overpayment made by Tenant to Landlord pursuant to this
Section 4(b)
and
for Tenants reasonable out-of-pocket costs and expenses incurred in performing the Tenants Audit
in the event the Discrepancy is greater than five percent (5%) or (B) notify Tenant in writing that
Landlord disagrees with the result of Tenants Audit, in which event the Landlord and Tenant shall
submit their respective calculations of the Actual Operating Expenses to a neutral certified public
accountant appointed with the consent of both Landlord and Tenant, who shall review the respective
determinations of Actual Operating Expenses, and shall make a final determination of the Actual
Operating Expenses for the year in question which shall be binding on both Landlord and Tenant, and
if such accountant determines that there is a Discrepancy, Landlord, promptly after its receipt of
such final determination, shall reimburse Tenant for the amount of any overpayment made by Tenant
to Landlord pursuant to this
Section 4(b)
and for Tenants reasonable out-of-pocket costs
and expenses incurred in performing the Tenants Audit in the event the Discrepancy is greater than
five percent (5%).
(c)
Determinations
. The determination of Actual Operating Expenses and
Estimated Operating Expenses shall be made by Landlord reasonably and in good faith. Any
payments pursuant to this
Section 4
shall be additional rent payable by Tenant hereunder,
and in the event of nonpayment thereof, Landlord shall have the same rights with respect to such
nonpayment as it has with respect to any other nonpayment of rent hereunder.
(d)
End of Term
. If this Lease shall terminate on a day other than the last day of
an Operating Year, the amount of any adjustment between Estimated
Operating Expenses and Actual
Operating Expenses with respect to the Operating Year in which such
termination occurs shall be
prorated on the basis which the number of days from the commencement
of such Operating Year, to and
including such termination date, bears to three hundred sixty-five (365);and any amount payable by
Landlord to Tenant or Tenant to Landlord with respect to such adjustment shall be payable within
thirty (30) days after delivery of the statement of Actual Operating Expenses with respect to such
Operating Year.
(e)
Definitions
. The following terms shall have the respective meanings
hereinafter specified:
(1)
Base Amount
shall mean an amount equal to the Actual Operating Expenses for the Base
Year (as defined in
Paragraph 17
of the Basic Lease Information);
provided that,
if the Project is not ninety-five percent (95%) occupied (with all tenants paying full rent, as
contrasted with free rent, half rent and the like) during the entire Base Year, then the
-5-
Actual Operating Expenses actually incurred for the Base Year shall be annualized to reflect the
Actual Operating Expenses that would have been incurred had the Project been ninety-five percent
(95%) occupied (with all tenants paying full rent, as contrasted with free rent, half rent and the
like).
(2)
Operating
Year
shall mean a calendar year commencing January 1 and ending December 31.
(3)
Operating
Expenses
shall mean all expenses paid or incurred by Landlord for maintaining,
owning, operating and repairing the Project (as defined in
Paragraph 5
of the Basic Lease
Information), including, without limitation, the Building, and the
personal property used in
conjunction therewith, including, but not limited to expenses
incurred or paid for: (i) Property
Taxes (as hereinafter defined); (ii) utilities for the Project,
including but not limited to
electricity, power, gas, steam, oil or other fuel, water, sewer,
lighting, heating, air conditioning
and ventilating; (iii) permits, licenses and certificates
necessary to operate, manage and lease the
Project; (iv) insurance Landlord reasonably deems appropriate to
carry or is required to carry by
any mortgagee under any mortgage encumbering the Project or any
portion thereof or interest therein
or encumbering any of Landlords or the property managers
personal property used in the operation
of the Project; (v) supplies, tools, equipment and materials
used in the operation, repair and
maintenance of the Project; (vi) accounting, legal, inspection, consulting, concierge and
other services; (vii) equipment rental (or installment equipment purchase or equipment financing
agreements); (viii) management agreements (including the cost of any management fee actually paid
thereunder and the fair rental value of any office space provided thereunder, up to customary and
reasonable amounts); (ix) wages, salaries and other compensation and benefits (including the fair
value of any parking privileges provided) for all persons (not higher than Project manager) engaged
in the operation, maintenance or security of the Project, and employers Social Security taxes,
unemployment taxes or insurance, and any other taxes which may be levied on such wages, salaries,
compensation and benefits (provided that if an employee spends a portion of his or her time on
projects other than the Project, then the wages, salaries, compensation and benefits of such
employee and taxes thereon pursuant hereto shall be reasonably and equitably prorated); (x) payments
under any easement, operating agreement, declaration, restrictive covenant, or instrument pertaining
to the sharing of costs in any planned development or similar arrangement; (xi) operation, repair,
and maintenance of all systems and equipment and components thereof (including replacement of
components); (xii) janitorial service, alarm and security service, window cleaning, trash
removal, elevator maintenance, and cleaning of walks, parking facilities and building walls
(provided that janitorial service to the premises of other Project occupants shall not be included
in Operating Expenses if Tenant separately provides janitorial service to the Premises at Tenants
cost); (xiii) replacement of wall and floor coverings, ceiling tiles and fixtures in lobbies,
corridors, rest rooms and other common or public areas or facilities; (xiv) maintenance and
replacement of shrubs, trees, grass, sod and other landscape items, irrigation systems, drainage
facilities, fences, curbs, and walkways; (xv) maintenance of parking facilities; (xvi) roof
repairs and (xvii) capital expenditures, which capital expenditures shall be amortized for
purposes of this Lease over their respective useful lives (together with interest thereon at the
rate of 10% per annum), made (A) primarily to reduce Operating Expenses, or (B) to comply with any
laws or other governmental requirements (except that Operating Expenses shall specifically exclude
work required to correct any non-compliance of the Project with applicable laws or requirements
existing as of the
-6-
Commencement Date where correction of such noncompliance was then legally required as of the
Commencement Date). Notwithstanding the foregoing, Operating Expenses shall not include (a)
depreciation, interest and amortization on mortgages or other debt costs or ground lease payments,
if any; (b) legal fees in connection with leasing, tenant disputes or enforcement of leases; (c)
real estate brokers leasing commissions; (d) improvements or alterations to tenant spaces or
allowances, inducements or other concessions for any tenant; (e) the cost of providing any service
directly to and paid directly by, any tenant; (f) costs of any items to the extent Landlord
receives reimbursement from insurance proceeds or from a third party (such proceeds to be deducted
from Operating Expenses in the year in which received); (g) costs incurred by Landlord in
connection with the correction of structural and/or latent defects in the original construction
materials or installations for the Building; (h) costs incurred by Landlord to lease space to new
tenants or to retain existing tenants including all marketing, advertising and promotional
expenditures; (i) costs arising from the presence of Hazardous Materials on or about the Building,
the Project or the land not placed on or about the Premises, Project, land or the Building by the
Tenant or any Tenant Panty; (j) any amount billed separately to another tenant, whether or not the
tenant actually pays such amount; (k) the cost of charitable or political contributions; (1) the
cost of sculpture, paintings or other objects of art; (m) expenses incurred by Landlord in respect
of a development or buildings other than the Project; (n) salaries and benefits of executives and
management personnel above the level of the Project manager; (o) increased costs of performance to
the extent resulting from the negligence or willful misconduct of Landlord or its agents, employees
or contractors; (p) capital expenditures except those capital expenditures made primarily to reduce
Operating Expenses (as to which the amortized cost to be included in Operating Expenses in any
Operating Year shall be limited to the amount of the actual reduction in Operating Expenses during
such Operating Year as a result thereof), or to comply with any laws or other governmental
requirements (provided that Operating Expenses shall specifically exclude costs of work required to
correct any non-compliance of the Project with applicable laws or requirements existing as of the
Commencement Date where correction of such noncompliance was then legally required as of the
Commencement Date), which capital expenditures (together with interest thereon at the rate of 10%
per annum) shall be amortized for purposes of this Lease over their respective useful lives; (q)
rentals for items (except when needed in connection with normal repairs and maintenance of
permanent systems) which if purchased, rather than rented, would constitute a capital expenditure
which is specifically excluded in (p) above (excluding, however, equipment not affixed to the
Building or Project which is used in providing janitorial or similar services); (r) costs incurred
by Landlord for the repair of damage to the Building or Project, to the extent that Landlord is or
should be reimbursed by insurance proceeds, and costs of all capital repairs, replacements or
restorations resulting from a casualty, regardless of whether such repairs are covered by insurance
and costs due to repairs resulting from an earthquake or flood to the extent such costs exceed
$25,000; (s) expenses in connection with services or other benefits which are not offered to Tenant
or for which Tenant is charged for directly; (t) overhead and profit increment paid to Landlord or
to subsidiaries or affiliates of Landlord for goods and/or services in or to the Building and
Project to the extent the same exceeds
the costs of such goods and/or services rendered by
unaffiliated third parties on a competitive basis; (u) Landlords general corporate overhead and
general and administrative expenses; (v) advertising and promotional expenditures, and costs of
signs in or on the Project or the Building identifying the owner of the Project or Building or
other tenants signs; (w) costs incurred in connection with upgrading the Building or Project to
comply with
-7-
life, fire and safety codes, ordinances, statutes or other laws in effect prior to the
Commencement Date, including, without limitation, the ADA, including penalties or damages incurred
due to such non compliance; (x) tax penalties incurred as a result of Landlords failure to make
payments and/or to file any tax or informational returns when due; (y) costs for which Landlord
has been compensated by a management fee, and any management fees in excess of those management
fees which are normally and customarily charged by landlords of Comparable Buildings; (z) costs
associated with the operation of the business of the partnership or entity which constitutes
Landlord as the same are distinguished from the costs of operation of the Building and Project,
including partnership accounting and legal matters, costs of defending any lawsuits with or claims
by any mortgagee (except as the actions of Tenant may be in issue), costs of selling, syndicating,
financing, mortgaging or hypothecating any of Landlords interest in the Building or Project,
costs of any disputes between Landlord and its employees (if any) not engaged in Building or
Project operation, disputes of Landlord with Building or Project management, or outside fees paid
in connection with disputes with other tenants; (aa) any increase of, or reassessment in, real
property taxes and assessments in excess of two percent (2%) of the taxes for the previous year,
resulting from either (1) any sale, transfer, or other change in ownership of the Building or the
Project during the Term or from major alterations, improvements, modifications or renovations to
the Building or the Project; (bb) the cost of any item included in Operating Expenses to the
extent that such cost is attributable solely to the use, management, repair, service, insurance,
condition, operation or maintenance of other office buildings in the Project; or (cc) reserves for
bad debts or for future improvements, repairs, additions, etc.
(4)
Estimated Operating Expenses
shall mean Landlords estimate of Operating Expenses for the
following Operating Year, adjusted as if ninety-five percent (95%) of the total rentable area of the
Property will be occupied for the entire Operating Year, Base Year or Operating Year, as applicable,
with all tenants paying full rent, as contrasted with free rent, half rent and the like.
(5)
Actual
Operating Expenses
shall mean the actual Operating Expenses for the Base Year or
any Operating Year, as applicable, adjusted, (a) if less than
ninety-five percent (95%) of the total
rentable area of the Project had been occupied for the entire Base
Year or Operating Year, as
applicable, as if ninety-five percent (95%) of the total rentable
area of the Project had been
occupied for the entire Base Year or Operating Year, with all tenants
paying full rent, as
contrasted with free rent, half rent and the like, and (b) if
the Property Taxes component of the
Base Year or Operating Year, as applicable, are based on an
assessment of the value of the Project
made by a governmental authority prior to completion of the Project
and/or prior to leasing and
occupancy of a substantial portion of the Project, then the Property
Taxes component of the Actual
Operating Expenses for such Operating Year or Base Year, as applicable, shall be adjusted by
Landlord, in Landlords reasonable discretion, as if the Project had been fully assessed in such
Base Year or Operating Year with all improvements completed therein.
(6)
Property Taxes
shall mean all real and personal property taxes and assessments imposed by
any governmental authority or agency on the Project; any assessments levied in lieu of such taxes;
any non-progressive tax on or measured by gross rents received from the rental of space in the
Project; and any other costs levied or assessed by, or at the direction of,
-8-
any federal, state, or local government authority in connection with the use or occupancy of the
Project or the Premises or the parking facilities serving the Project; any tax on any document to
which Tenant is a party creating or transferring an interest in the Premises, and any expenses,
including the reasonable cost of attorneys or experts, incurred by Landlord in seeking reduction
by the taxing authority of the above-referenced taxes, less any tax refunds obtained as a result
of an application for review thereof; but shall not include any net income, franchise, estate,
excess profits, documentary transfer or inheritance taxes.
5.
SECURITY DEPOSIT.
Tenant has deposited with Landlord the Security Deposit specified in
Section 16
of the Basic Lease Information. Said sum shall
be held by Landlord as security
for the faithful performance by Tenant of all of Tenants
obligations under this Lease. If Tenant
defaults with respect to any provision hereof, including but not
limited to the provisions relating
to payment of rent, Landlord may (but shall not be required to) use,
apply or retain all or part of
the Security Deposit for the payment of any rent or any other sum in
default, or for the payment of
any other amount which Landlord may incur by reason of Tenants
default or to compensate Landlord
for any other loss or damage which Landlord may suffer by reason of Tenants default. If any portion
of the deposit is so use or applied, Tenant shall, upon demand, immediately deposit cash with
Landlord in an amount sufficient to restore the Security Deposit to its original amount. Tenants
failure to do so shall be a material breach of this Lease. Landlord shall not be obligated to keep
the Security Deposit separate from its general funds, and Tenant shall not be entitled to interest
on such deposit. If Tenant fully and faithfully performs all of its obligations under this Lease,
the Security Deposit or any balance thereof shall be returned to Tenant (or, at Landlords option,
to the last assignee of Tenants interests hereunder) after the expiration of the Term, provided
that Landlord may retain all or a portion of the Security Deposit in an amount reasonably determined
by Landlord to be necessary to cover any amounts owed by Tenant for the clean-up and repair of the
Premises if Tenant has filed to satisfy its obligations under Section 7(b) of this Lease, and Actual
Operating Expenses during the Term.
6.
USES; HAZARDOUS MATERIAL.
(a)
Use.
Landlord agrees that the Premises may be used for (i) the sale and
trading of securities (including, without limitation) stocks and bonds, (ii) providing private
banking services, investment banking services, trust services and other diversified financial
services, (iii) the sale of insurance, (iv) office use, including conference and computer
facilities, employee and visitor cafeteria and dining areas (including related kitchen facilities)
and/or (vi) and other legally permitted use consistent with the character of the Project and
Comparable Buildings. Tenant, at its sole cost and expense, shall promptly comply with all local,
state and federal laws, statutes, ordinances and governmental rules, regulations or requirements
now in force or which may hereinafter be in force relating to the use of the Premises, including,
without limitation, the Americans with Disabilities Act, 42 U. S .C. § 12101 et seq. and any
governmental regulations relating thereto (collectively, the
ADA
), including any required
alterations within the Premises for purposes of public accommodations under such statute.
However, notwithstanding anything to the contrary contained in this Lease, Landlord (and not
Tenant), at Landlords cost but as an item of Operating Expenses (subject to the provisions of
Section 4(e)
above establishing certain exclusions from Operating Expenses), shall be
required to make any alterations or improvements to the Premises constituting capital expenditures
(including, without limitation, alterations or improvements to the Premises in order to comply
with the ADA
-9-
constituting capital expenditures) and to the Building Structure and Building Systems (as those
terms are defined in
Section 7(a)
below) to the extent such alterations or improvements are
required to cause the Premises to comply with applicable laws, except that Tenant (and not
Landlord), at Tenants sole cost, shall be responsible for performing such alterations or
improvements work to the extent such compliance work is necessitated by the particular use of the
Premises by Tenant, any subtenant of Tenant or any of their respective employees, agents,
contractors, licensees or invitees (collectively,
Tenant
Parties
) (as opposed to mere occupancy
for general office use) or by any Alterations to the Premises under
Section 8
below to the
extent such Alterations are not normal and customary business office improvements. Tenant shall not
use or permit the Premises to be used in any manner nor do any act which would increase the
existing rate of insurance on the Project (unless Tenant agrees to pay such increased cost) or
cause the cancellation of any insurance policy covering the Project, nor shall Tenant permit to be
kept, used or sold, in or about the Premises, any article which may be prohibited by the standard
form of fire insurance policy, unless Tenant obtains an endorsement to the policy allowing such
activity. Tenant shall not during the Term (i) commit or allow to be committed any waste upon the
Premises, or any public or private nuisance in or around the Project, (ii) allow any sale by
auction upon the Premises, (iii) place any loads upon the floor, walls, or ceiling of the Premises
which endanger the Building, (iv) use any apparatus, machinery or device in or about the Premises
which will cause any substantial noise or vibration or in any manner damage the Building, (v) place
any harmful liquids in the drainage system or in the soils surrounding the Project, or (vi) disturb
or unreasonably interfere with other tenants of the Project. If any of Tenants office machines or
equipment unreasonably disturbs the quiet enjoyment of any other tenant in the Building, then
Tenant shall provide adequate insulation, or take such other action as may be reasonably necessary
to eliminate the disturbance, all at Tenants sole cost and expense.
(b)
Hazardous Material.
As used herein, the term Hazardous Material means any
hazardous or toxic substance, material or waste which is or becomes regulated by, or is dealt with
in, any local governmental authority, the State of California or the United States Government.
Accordingly, the term Hazardous Material includes, without limitation, any material or substance
which is (i) defined as a hazardous waste, extremely hazardous waste or restricted hazardous
waste under Sections 25115, 25117 or 25122.7, or listed pursuant to Section 25140 of the
California Health and Safety Code, Division 20, Chapter 6.5 (Hazardous Waste Control Law), (ii)
defined as a hazardous substance under Section 25316 of the California Health and Safety Code,
Division 20, Chapter 6.95 (Hazardous Materials Release Response Plans and Inventory), (iii)
defined as a hazardous substance under Section 25281 of the California Health and Safety Code,
Division 20, Chapter 6.7 (Underground Storage of Hazardous Substances), (iv) petroleum, (v)
asbestos, (vi) listed under Article 9 or defined as hazardous or extremely hazardous pursuant to
Article 11 of Title 22 of the California Administrative Code, Division 4, Chapter 20, (vii)
designated as a hazardous substance pursuant to Section 311 of the Federal Water Pollution
Control Act (33 U.S.C. § 1317), (viii) defined as a hazardous waste pursuant to Section 1004 of
the Federal Resource Conservation and Recovery Act, 42 U.S.C. § 6902 et seq., or (ix) defined as a
hazardous substance pursuant to Section 101 of the Compensation and Liability Act, 42 U.S.C. §
9601 et seq. Tenant shall not (either with or without negligence) cause or permit the escape,
disposal or release of any Hazardous Materials in or on the Premises or the Project by any Tenant
Parties. Tenant shall not allow the storage or use of Hazardous Materials in any manner not
sanctioned by law or by the highest standards prevailing in the industry for the storage or use of
such substances or materials,
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nor allow to be brought onto the Building or Project any such materials or substances, except
that Tenant may maintain products in the Premises which are incidental to the operation of its
offices, such as photocopy supplies, secretarial supplies and limited janitorial supplies which
products contain chemicals which are categorized as Hazardous Materials, provided that the use of
such products in the Premises by Tenant shall be in compliance with applicable laws and shall be in
the manner in which such products are designed to be used. In addition, Tenant shall execute
affidavits, representations and the like from time to time at Landlords request concerning
Tenants best knowledge and belief with no independent investigation regarding the presence of
Hazardous Materials on the Premises. The covenants of this
Section 6(b)
shall survive the
expiration or earlier termination of the Lease. To the best of Landlords actual knowledge, there
are no Hazardous Materials in the Building, the Project or the Premises as of the date hereof.
(c)
Environmental Obligations.
Landlord and Tenant shall notify each other in writing
of (i) any enforcement, clean-up, removal or other governmental action instituted with regard to
Hazardous Materials involving the Project, (ii) any claim made by any person against either of the
parties related to Hazardous Materials in the Premises or the Project, (iii) any reports made to
any governmental agency arising out of or in connection with Hazardous Materials in the Premises
or the Project including, without limitation, any complaints, notices or warnings, and (iv) any
spill, release, discharge or disposal of Hazardous Materials in the Premises or the Project that
is required to be reported to any governmental agency or authority under any applicable
governmental law, rule or regulation. Tenant shall indemnify and hold Landlord and its affiliates
harmless with respect to any environmental claims or liabilities which occur as a result of the
breach by Tenant of any of Tenants covenants set forth in
Section 6(b)
above or this
Section 6(c)
and from any escape, seepage, leakage, spillage, discharge, emission, release
from, onto or into the Premises, the Building or the Project of any Hazardous Materials to the
extent caused by Tenant or any of Tenant Parties. Landlord shall indemnify and hold Tenant and the
Tenant Parties harmless with respect to any environmental claims or liabilities which occur as a
result of the breach by Landlord of any of Landlords covenants, representations or warranties set
forth in
Section 6(b)
above or this
Section 6(c)
and from any escape, seepage,
leakage, spillage, discharge, emission, release from, onto or into the Premises, the Building or
the Project of any Hazardous Materials to the extent caused by Landlord or its employees, agents,
contractors, licensees or invitees.
7.
MAINTENANCE AND REPAIRS.
(a)
Landlords Obligations.
Landlord shall maintain and keep in first-class condition
and state of repair (comparable to other Comparable Buildings) and, subject to Section 6 above, in
compliance with applicable laws, the foundations, exterior walls, structural portions of the roof
and other structural portions of the Building (including the floor/ceiling slabs, curtain wall,
exterior glass and mullions, columns, beams, shafts (including elevator shafts), stairs, parking
facilities, stairwells, escalators, elevator cabs, plazas, pavement, sidewalks, curbs, entrances,
landscaping, art work, sculptures, restrooms, mechanical, electrical and telephone closets, and
all common and public areas) (collectively, the
Building Structure),
and shall maintain the
electrical, plumbing, heating, ventilating, sprinkler and life-safety equipment in the Building
(collectively, the
Building Systems
); and except that all damage or injury to the Premises, the
Building or the equipment and improvements therein caused by any act, neglect, misuse or omission
of any duty by any Tenant Parties shall be paid by Tenant except to the extent the cost
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of same is covered by insurance carried by Landlord hereunder (or would have been covered
had Landlord carried the insurance required hereunder). Subject to the provisions of
Section
42(i)
below, Landlord shall commence performance of any such required repairs promptly (but in
any event within ten (10) days or sooner if required by reason of an emergency situation, unsafe
condition or threat to person or property) following receipt of written notice from Tenant of the
need for such repairs and shall thereafter diligently prosecute the work of such repairs to
completion. Subject to the following provisions of this
Section 7(a),
Tenant hereby waives
and releases its right to make repairs at Landlords expense under Sections 1941 and 1942 of the
California Civil Code or under any similar law, statute or ordinance now or hereafter in effect.
Landlord makes no warranty as to the quality, continuity or availability of the telecommunications
services in the Building, and Tenant hereby waives any claim against Landlord for any actual or
consequential damages (including damages for loss of business) if Tenants telecommunications
services in any way are interrupted, damaged or rendered less effective, except to the extent
caused by the negligence or willful misconduct of Landlord, its agents, contractors or employees.
However, if Landlord fails to perform any of Landlords obligations under this
Section 7(a)
promptly after receipt of written notice of the need therefore from Tenant, and (1) such failure
results in a situation which materially and adversely affects the operation of Tenants business
from the Premises or an material risk of injury to persons or material property damage, (2) such
failure is susceptible of cure by Tenant without work upon or otherwise affecting the exterior
appearance of the Building, or adversely affecting the structural elements of the Building or the
integrated Building mechanical or utility systems, and (3) within three (3) business days (or such
shorter period as is reasonable under the circumstances if relating to an emergency situation,
unsafe condition or threat to person or property) following Landlords receipt of a second written
notice from Tenant of the existence of such situation stating Tenants intent to exercise its
rights under this Section if such situation is not cured, Landlord fails to commence and thereafter
diligently prosecute to completion the cure thereof, then Tenant shall have the right, but not the
obligation, to promptly take such measures as are necessary to cure such situation (using
qualified, licensed contractors reasonably experienced in performance of comparable work in
Comparable Buildings), and Landlord shall reimburse Tenant for the reasonable costs of completing
such cure, plus interest at the ten percent (10%) per annum (or such lesser rate as is the then
maximum lawful rate of interest) from the date such costs were incurred by Tenant until such
reimbursement by Landlord, within thirty (30) days following Tenants submission to Landlord of
reasonable evidence of the amount of such costs. If within thirty (30) days following Tenants
completion of such cure and submission of such evidence of the costs thereof, Landlord does not
either pay to Tenant the amount requested or deliver written notice
(an
Objection Notice
) to
Tenant objecting to Tenants claim that Landlord was required to perform such work under this Lease
and/or the amount requested for reimbursement (provided that if Landlord so objects to a portion of
the amount requested for reimbursement, Landlord shall pay to Tenant the undisputed amount), then,
notwithstanding anything to the contrary contained in this Lease, Tenant may offset the amount so
requested, including interest, for reimbursement from Tenants rental obligations next coming due
under this Lease; provided that if Landlord so delivers an Objection Notice, Tenant shall not be
entitled to any such offset (other than as to undisputed amounts if the Objection Notice objects
only to a portion of the amount requested for reimbursement) and as Tenants sole remedy for
amounts not so reimbursed or offset, Tenant may proceed to claim a default by Landlord. Any dispute
as to
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which Landlord delivers an Objection Notice pursuant hereto shall be resolved by arbitration in
accordance with the provisions of
Section 37
below.
(b)
Tenants Obligations.
Tenant shall at its expense maintain, repair and replace all
portions of the Premises and the equipment or fixtures therein, except to the extent specified in
Section 7(a),
above, at all times in first-class condition and state of repair, all in
accordance with the laws of the State of California and all health, fire, police and other
ordinances, regulations and directives of governmental agencies having jurisdiction over such
matters. However, notwithstanding anything to the contrary contained in this Lease, Landlord (and
not Tenant), at Landlords cost as an item of Operating Expenses (subject to the provisions of
Section 4(e)
above establishing certain exclusions from Operating Expenses), shall be
required to make any alterations, additions or improvements to the Premises constituting capital
expenditures (including, without limitation, alterations, additions or improvements to the Premises
constituting capital expenditures required in order to comply with the ADA) and to the Building
Structure and Building Systems to the extent such alterations, additions or improvements are
required to cause the Premises to comply with applicable laws, except that Tenant (and not
Landlord), at Tenants sole cost, shall be responsible for performing such alterations, additions
or improvements work to the extent such compliance work is necessitated by the particular use of
the Premises by Tenant or any of the Tenant Parties (as opposed to mere occupancy for general
office use) or by any Alterations to the Premises under
Section 8
below to the extent such
Alterations are not normal and customary business office improvements. Tenant shall replace at
Tenants sole expense any glass that may be broken in the Premises with glass of the same size,
specifications and quality, with signs thereon, if required. At the expiration of the Term, Tenant
shall surrender the Premises in good and reasonably clean condition, normal wear and tear and
damage by fire, other casualty or condemnation excepted; provided, however, that Tenant shall have
no obligation to repaint, install new floor coverings or patch wall and floor penetrations.
8.
ALTERATIONS.
(a)
Landlords Consent.
Tenant shall not make any alterations, additions
or improvements (collectively,
Alterations
) in or to the
Premises or make changes to locks on doors
or add, disturb or in any way change any plumbing or wiring without
obtaining the prior written
consent of Landlord, which consent shall not be withheld provided
that the Alterations would (i) not
adversely affect the Building Structure or Building Systems,
(ii) not affect the exterior appearance
of the Building or (iii) comply with applicable laws
(individually and collectively, a
Design
Problem
). Notwithstanding anything to the contrary set forth herein,Tenant shall not be required
to obtain Landlords prior consent with respect to any strictly cosmetic work performed within the
Premises by Tenant (i.e., paint, carpet and other similar alterations that do not affect the
Building Systems and Building Standard items).
(b)
Performance of Work.
All Alterations shall be made at Tenants sole expense and by
contractors or mechanics selected by Tenant, subject to
Landlords reasonable approval, except that
Landlord shall have the right to require use of Building standard
contractors or mechanics for work
affecting the Building Systems or items under warranty (including,
but not limited to, the Building
roof). All Alterations shall be made at such times and in such manner
as Landlord may from time to
time reasonably designate, and shall become the property of Landlord without its obligation to pay
therefore at the expiration or earlier termination of this
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Lease. All work with respect to any Alterations shall be performed in a good and workmanlike
manner, shall be of a quality equal to or exceeding the then existing construction standards for
the Project and must be of a type, and the floors and ceilings must be finished in a manner,
customary for general office use. Alterations shall be diligently prosecuted to completion to the
end that the Premises shall be at all times a complete unit except during the period necessarily
required for such work. All Alterations shall be made strictly in accordance with all laws,
regulations and ordinances relating thereto and if interior improvements installed in the Premises
shall be removed, Tenant shall either replace same with interior improvements of the same or better
quality or repair the damage caused by the removal so the Premises is in good condition. Landlord
hereby reserves the right to require any contractor or mechanic working in the Premises to provide
lien waivers and liability insurance covering the Alterations to the Premises. In addition to the
foregoing, Tenant shall provide Landlord with evidence that Tenant or its contractor carries
Builders All Risk insurance in an amount reasonably approved by the Landlord covering the
construction of such Alterations, and such other insurance as the Landlord may reasonably require,
it being understood and agreed that all of such Alterations shall be insured by Tenant pursuant to
Section 14(a)
of this Lease immediately upon completion thereof. Prior to the performance
of any Alterations, Tenant shall allow Landlord to enter the Premises and post appropriate notices
to avoid liability to contractors or material suppliers for payment for any Alterations. All
Alterations shall remain in and be surrendered with the Premises as a part thereof at the
expiration or earlier termination of this Lease, without disturbance, molestation or injury;
provided, however, that all of Tenants personal property, including furniture, trade fixtures, and
equipment, may be removed by Tenant at any time during the Term. Landlord may not require Tenant to
remove any Alterations (including cabling) or the Tenant Improvements from the Premises upon the
expiration or earlier termination of this Lease.
(c)
Landlords Expenses; Administrative Fee.
Tenant shall pay to Landlord, as
additional rent, any out-of-pocket costs incurred by Landlord in connection with the review and
approval of the Alterations and for any additional Building services provided to Tenant or to the
Premises in connection with any such alterations, additions or improvements which are beyond the
normal services provided to occupants of the Building as part of Operating Expenses. Under no
circumstances shall Landlord be liable to Tenant for any damage, loss, cost or expense incurred by
Tenant on account of Tenants plans and specifications, Tenants contractors or subcontractors, or
Tenants design of any work, construction of any work or delay in completion of any work.
9.
TENANTS PROPERTY.
(a)
Removal Upon Expiration of Lease.
All articles of personal property and all
business and trade fixtures, machinery and equipment, furniture and movable partitions owned by
Tenant or installed by Tenant at its expense in the Premises shall be and remain the property of
Tenant and may be removed by Tenant at any time during the Term, subject to the other requirements
of this Lease. If Tenant shall fail to remove all of such property from the Premises at the
expiration of the Term or within ten (10) days after any earlier termination of this Lease for any
cause whatsoever, Landlord may, at its option, on five (5) days notice to Tenant, remove the same
in any manner that Landlord shall choose, and store such property without liability to Tenant for
loss thereof. In such event, Tenant agrees to pay Landlord upon demand any and all reasonable
expenses incurred in such removal, including reasonable court costs and attorneys
-14-
fees and storage charges on such property for any length of time that the same shall be in
Landlords possession. Landlord may, at its option, without notice, sell said property or any of
the same, at private sale and without legal process, for such price as Landlord may obtain and
apply the proceeds of such sale to any amounts due under this Lease from Tenant to Landlord and to
the expense incident to the removal and sale of said property.
(b)
Personal Property Taxes.
Tenant shall be liable for and shall pay, at least five
(5) days before delinquency, all taxes levied against any personal property or trade fixtures
placed by Tenant in or about the Premises. If any such taxes on Tenants personal property or
trade fixtures are levied against Landlord or Landlords property or if the assessed value of the
Premises or Landlords obligations are increased by a value placed upon such personal property or
trade fixtures of Tenant and if Landlord, after written notice to Tenant, pays the taxes or
obligations based upon Tenants personal property or trade fixtures, which Landlord shall have the
right to do regardless of the validity thereof, but only under proper protest if requested by
Tenant, Tenant shall, within thirty (30) days of Landlords demand, repay to Landlord the taxes or
obligations so levied against Landlord, or the portion of such taxes or obligations resulting from
such increase in the assessment.
10.
ENTRY BY LANDLORD.
After not less than twenty four (24) hours prior notice (which may
be oral or written notice, notwithstanding anything to the contrary in this Lease governing the
manner of delivery of notices, and except that in the event of an emergency, Landlord may provide
shorter notice as may be required under the circumstances, which may be no prior notice, if
applicable under the circumstances of the applicable emergency situation), Landlord, its
authorized agents, contractors, and representatives shall at any and all times have the right to
enter the Premises to inspect the same, to supply janitorial service and any other service to be
provided by Landlord to Tenant hereunder, to show the Premises to prospective purchasers or (only
during the final six (6) months of the Term) tenants, to post notices, to alter, improve or repair
the Premises or any other portion of the Building, all without being deemed guilty of any eviction
of Tenant and without abatement of rent (except as otherwise provided in this Lease). Except in
the event of an emergency, Landlord shall endeavor to coordinate any such entry with Tenant, so as
to minimize the extent of any unreasonable interference with Tenants business operations to the
extent practicable under the circumstances. Landlord may, in order to carry out such purposes,
erect scaffolding and other necessary structures where reasonably required by the character of the
work to be performed, provided that the business of Tenant shall be interfered with as little as
is reasonably practicable. Landlord shall at all times have and retain a key with which to unlock
all doors in the Premises, excluding Tenants vaults and safes, Landlord shall have the right to
use any and all means which Landlord may deem proper to open said doors in an emergency in order
to obtain entry to the Premises. Any entry to the Premises obtained by Landlord pursuant to the
terms hereof shall not be deemed to be a forcible or unlawful entry into the Premises, or an
eviction of Tenant from the Premises or any portion thereof, and Tenant hereby waives any claim
for damages for any injury or inconvenience to or interference with Tenants business, any loss of
occupancy or quiet enjoyment of the Premises, and any other loss in, upon and about the Premises
except to the extent caused by the gross negligence or willful misconduct of Landlord.
Notwithstanding anything to the contrary set forth above, Tenant may designate certain areas of
the Premises as
Secured Areas
should Tenant require such areas for the purpose of securing
certain valuable property or confidential information. Landlord may not enter such Secured Areas
except in the
-15-
case of emergency or in the event of a Landlord inspection, in which case Landlord shall provide
Tenant with five (5) days prior written notice of the specific date and time of such Landlord
inspection.
11.
LIENS.
Tenant shall keep the Premises, the Building and the Project free from any
liens or encumbrances of any kind or nature arising out of any work performed, materials ordered
or obligations incurred by or on behalf of Tenant.
12.
INDEMNIFICATION.
(a)
Indemnity by Tenant.
Except to the extent caused by the negligence or
willful misconduct of Landlord or its members, partners, managers, shareholders, officers,
directors,trustees, employees, agents or contractors (collectively, the
Landlord Parties)
and
not covered by the insurance maintained by Tenant (and which would not have been so covered
had Tenant maintained the insurance required to be maintained by Tenant under this Lease),
Tenant shall indemnify, defend, and hold harmless Landlord, Landlords members,
shareholders, partners, trustees and the Landlords Parties from and against all losses,
liabilities, damages, costs, expenses and claims arising from or relating to (a) Tenants use of the
Premises or the conduct of its business or any activity, work, or thing done, permitted or suffered
by Tenant in or about the Premises, (b) any act, neglect, fault or omission of any of the Tenant
Parties, and (c) all reasonable costs, attorneys fees, expenses and liabilities incurred in or
about such claims or any action or proceeding brought thereon. In case any action or proceeding
shall be brought against any of the Landlord Parties by reason of any such claim, Tenant upon
written notice from Landlord shall defend the same at Tenants expense by counsel reasonably
approved in writing by Landlord. Tenant, as a material part of the consideration to Landlord, hereby
assumes all risk of and waives all claims against the Landlord Parties with respect to damage to
property or injury to persons in, upon or about the Premises from any cause whatsoever except that
which is caused by the negligence or willful misconduct of Landlord or the Landlord Parties or by
the failure of Landlord to observe any of the terms and conditions of this Lease where such failure
has persisted for an unreasonable period of time after written notice to Landlord of such failure.
(b)
Indemnity by Landlord.
Except to the extent caused by the negligence or
willful misconduct of Tenant or any of the Tenant Parties or any of Tenants members,
partners, managers, shareholders, officers, directors, trustees or agents (all of the foregoing
including Tenant and Tenant Parties are collectively referred to herein as the
Tenant Indemnitees)
and not covered by the insurance maintained by Landlord (and which
would not have been so covered had
Landlord maintained the insurance required to be maintained by
Landlord under this Lease), Landlord
shall indemnify, defend, and hold harmless Tenant and the Tenant
Indemnitees from and against all
losses, liabilities, damages, costs, expenses and claims arising from
or relating to (a) any
occurrence on the common areas of the Project, or (b) any claim
arising from the negligence or
willful misconduct of Landlord or any of the Landlord Parties and not
covered by the insurance
maintained by Tenant (and which would not have been so covered had
Tenant maintained the insurance
required to be maintained by Tenant under this Lease), and
(c) all reasonable costs, attorneys
fees, expenses and liabilities incurred in or about such claims or
any action or proceeding brought
thereon. In case any action or proceeding shall be brought against any of the Tenant Indemnitees by
reason of any such claim, Landlord upon written notice from
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Tenant shall defend the same at Landlords expense by counsel reasonably approved in writing by
Tenant.
13.
DAMAGE TO TENANTS PROPERTY.
Notwithstanding anything to the contrary in this Lease,
the Landlord Parties shall not be liable for (a) any damage to
any property entrusted to employees
of the Project or its property managers, (b) loss or damage to
any property by theft or otherwise,
(c) any injury or damage to persons or property resulting from
fire, explosion, falling plaster,
steam, gas, electricity, water or rain which may leak from any part
of the Building or from the
pipes, appliances or plumbing work therein or from the roof, street
or sub-surface or from any other
place or resulting from dampness or any other cause whatsoever, or
(d) any damage or loss to the
business or occupation of Tenant arising from the acts or neglect of
other tenants or occupants of,
or invitees to, the Project, except to the extent that such damage is due tothe negligence or
willful misconduct of Landlord or any of the Landlord Parties or the
breach of this Lease by
Landlord. Tenant shall give prompt written notice to Landlord in case
of fire or accident in the
Premises or in the Building or of defects therein or in the fixtures or equipment.
14.
INSURANCE.
(a)
Tenants Insurance.
Tenant shall, during the entire Term of this Lease and any
other period of occupancy, at its sole cost and expense, keep in full force and affect the
following insurance:
(1)
Standard form property insurance insuring against the perils of fire, vandalism, malicious
mischief, cause of loss-special form (
All-Risk
),
sprinkler leakage and earthquake sprinkler
leakage. This insurance policy shall be upon all trade fixtures and
other property owned by
Tenant, for which Tenant is legally liable and/or that was installed
by or on behalf of Tenant, and
which is located in the Building, including, without limitation,
Alterations, furniture, fittings,
installations, fixtures, Tenant Improvements and any other personal
property, in an amount not less
than the full replacement cost thereof. If there shall be a dispute
as to the amount which
comprises full replacement cost, the decision of Landlord or any
mortgagees of Landlord shall be
presumptive.
(2) Commercial
General Liability Insurance insuring Tenant against any liability arising out of
the lease, use, occupancy, or maintenance of the Premises and all
areas appurtenant thereto. Such
insurance shall be in the amount of Two Million Dollars ($2,000,000)Combined Single Limit for
injury to or death of one or more persons in an occurrence and Three Million Dollars ($3,000,000)
aggregate, and for damage to tangible property (including loss of use) in an occurrence, with an
Additional Insured Landlord Endorsement. The policy shall insure the hazards of premises and
operations, independent contractors, contractual liability (covering the indemnity contained in
Section 12
hereof) and shall (i) name Landlord as an additional insured, (ii) contain a
cross-liability provision, (iii) contain a provision that
the insurance provided the landlord
hereunder shall be primary and noncontributing with any other insurance available to the landlord,
and (iv) include fire legal liability coverage in the amount of One Million Dollars ($1,000,000).
(3)
Workers Compensation and Employers Liability Insurance (as required by state law).
-17-
(4)
If Tenant installs with prior approval of the landlord, any boiler, pressure object,
machinery, fire suppression system, supplemental air conditioning or
other mechanical equipment
within the Premises, Tenant shall also obtain and maintain at
Tenants expense, boiler and machinery
insurance covering loss arising from the use of such equipment.
(5)
Any other form or forms of insurance as Tenant or Landlord or any mortgagees of Landlord
may reasonably require from time to time in form, amounts and for insurance risks against which a
prudent tenant would protect itself and then being required by other reasonable and prudent
landlords of Comparable Buildings of tenants comparable to Tenant.
(6)
Notwithstanding the foregoing or any other provision of this Lease, Tenant shall have the
right to self insure. Tenant shall have the option, either alone or
in conjunction with any
subsidiaries or affiliates of Tenant, to maintain self insurance
and/or provide or maintain any
insurance required by this Lease under blanket insurance policies maintained by Tenant or
provide or maintain insurance through such alternative risk management programs as Tenant
may provide or participate in from time to time.
All such policies shall be written in a form reasonably satisfactory to Landlord and shall be taken
out with insurance companies qualified to issue insurance in the State of California and holding an
A.M. Bests Rating of A- and a Financial Size Rating of VII or better, as set forth in the most
current issue of Bests Key Rating Guide. Such insurance shall provide that it is primary
insurance, and not contributory with any other insurance in force for or on behalf of Landlord.
Prior to the commencement of the Term, Tenant shall deliver to Landlord certificates of insurance
evidencing the existence of the amounts and forms of coverage required above and, except for the
All-Risk insurance, naming Landlord and any other person specified by Landlord, as an additional
insured. No such policy shall be cancelable, terminable or reducible in coverage except after
thirty (30) days prior written notice to Landlord. Tenant shall, within ten (10) days prior to the
expiration of such policies, furnish Landlord with renewals or binders thereof, or Landlord may,
on five (5) days notice to Tenant, order such insurance and charge the cost thereof to Tenant as
additional rent, if Tenant fails to so notify Landlord. If Landlord obtains any insurance that is
the responsibility of Tenant under this
Section 14,
Landlord shall deliver to Tenant a
written statement setting forth the cost of any such insurance and showing in reasonable detail the
manner in which it has been computed.
(b)
Landlords Insurance.
Landlord shall, during the entire term of this Lease,
as an item of Operating Expenses, keep in full force and affect the following insurance:
(1) All Risk insurance (including a vandalism and malicious mischief endorsement and
sprinkler leakage coverage, and also covering such other risks as Landlord or Landlords lender
may require) upon the Project (excluding any property which Tenant is obligated to insure under
Section 14(a)
above) in an amount not less than the full replacement cost thereof
(excluding footings, foundations and excavation), and including commercially reasonable rental
loss coverage for losses covered by such insurance policy. Such insurance policy or policies shall
name Landlord as a named insured. The deductible under the All Risk policy shall not exceed such
commercially reasonable amount as Landlord reasonably
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determines to be appropriate given prudent risk management practices and the practices of
comparable landlords of Comparable Buildings.
(2) Commercial general liability insurance coverage, including personal injury, bodily
injury, broad form property damage, automobile, Premises operations hazard, contractual liability,
and products and completed operations liability, in the amount of One Million Dollars ($1,000,000)
Combined Single Limit for injury to or death of one or more persons in an occurrence and Five
Million Dollars ($5,000,000) aggregate.
Landlord may satisfy its insurance obligations under this Lease by blanket, umbrella and/or, as to
liability coverage in excess of One Million Dollars ($1,000,000), excess liability coverage. All
such policies shall be taken out with insurance companies qualified to issue insurance in the
State of California and holding an A.M. Bests Rating of A and a Financial Size Rating of VIII
or better, as set forth in the most current issue of Bests Key Rating Guide. Upon request,
Landlord shall deliver to Tenant certificates evidencing Landlords maintenance of insurance in
compliance with Landlords insurance requirements set forth in this Lease.
15.
WAIVER OF SUBROGATION.
Whether any loss or damage to or within the Project, the
Building and/or the Premises is due to the negligence of either of
the parties hereto, their agents
or employees, Landlord and Tenant do each herewith and hereby release
and relieve the other from
responsibility for, and waive their entire claim of recovery, for any
loss or damage to the real or
personal property of the other located anywhere in the Project and
including the Project itself,
arising out of or incident to the occurrence of any of the perils
which are covered by any fire
insurance policy covering the Project (or would have been covered by
any fire insurance policy
covering the Project had the applicable party carried the insurance
required to be carried
hereunder). To the extent that such risks above are, in fact, covered
by insurance, each party
shall cause its insurance carriers to consent to such waiver and to
waive all rights of subrogation
against the other party. Notwithstanding the foregoing, no such
release shall be effective unless
the aforesaid insurance policy or policies shall expressly permit
such a release or contain a waiver
of the carriers right to be subrogated.
16.
CASUALTY.
If the Building and/or the Premises are damaged by fire or other
perils covered by insurance carried by Landlord, Landlord and Tenant shall have the following
rights and obligations:
(a)
Repair and Restoration.
(1) If the Building and/or the Premises are damaged or destroyed by any such peril to the
extent that the Building and/or the Premises cannot reasonably be repaired, reconstructed and
restored within one hundred eighty (180) days from the date of such damage or destruction,
Landlord shall, at its sole option, as soon as reasonably possible thereafter, either (i) commence
or cause the commencement of the repair, reconstruction and restoration of the Building and/or the
Premises to substantially their condition existing immediately prior to such casualty, and
prosecute or cause the same to be prosecuted diligently to completion, in which event this Lease
shall remain in full force and effect; or (ii) within thirty (30) days after such damage or
destruction, elect not to so repair, reconstruct or restore the Building and/or the Premises, in
which event this Lease shall terminate. In either event, Landlord shall give Tenant
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written notice of its intention within said thirty (30) day period. If Landlord elects not to
restore the Building and/or the Premises, this Lease shall be deemed to have terminated as of the
date of such damage or destruction.
(2) If the Building and/or the Premises are partially damaged or destroyed by any such peril
to the extent that the Building and/or the Premises reasonably may be repaired, reconstructed or
restored within a period of one hundred eighty (180) days from the date of such damage or
destruction, then Landlord shall commence or cause the commencement of and diligently complete or
cause the completion of the work of repair, reconstruction and restoration of the Building and/or
the Premises to substantially their condition existing immediately prior to such casualty and this
Lease shall continue in full force and effect.
(b)
Uninsured Casualties.
If damage or destruction of the Building and/or
the Premises is due to any cause not covered by collectible insurance carried by Landlord at the
time of such damage or destruction and the costs of such repair
exceed Five Hundred Thousand Dollars
($500,000.00), Landlord may elect to terminate this Lease, provided
that Landlord may only elect to
terminate this Lease if Landlord also terminates the leases of all of
Building tenants. If the
repairing or restoring of the damage is delayed or prevented for
longer than two hundred forty (240)
days after the occurrence of such damage or destruction by reason of
weather, acts of God, war,
governmental restrictions, inability to procure the necessary labor
or materials, or any cause that
is beyond the reasonable control of Landlord, Landlord may elect to
be relieved of its obligation to
make such repairs or restoration and terminate this Lease, in which
case Landlord shall provide
Tenant with thirty (30) days written notice of its intent to
terminate this Lease. Further, Landlord
shall not have any obligation to repair, reconstruct or restore the
Premises and may terminate this
Lease when the damage resulting from any casualty covered under this
Section 16
occurs
during the last twelve (12) months of the Term and the Premises
cannot be repaired, reconstructed or
restored within thirty (30) days after the date of the casualty.
(c)
Tenants Termination Right.
Notwithstanding anything to the contrary contained in
this Lease, in the event of material casualty damage to the Premises
not resulting in termination of
this Lease by Landlord, Landlord shall deliver written notice to
Tenant within thirty (30) days
following such casualty damage or occurrence setting forth
Landlords good faith estimate of the
time required for completion of repair and/or restoration of the
Premises, and if such estimated
time exceeds one hundred eighty (180) days from the occurrence
of the casualty, Tenant may elect to
terminate this Lease by written notice to Landlord delivered within twenty (20) days following
Tenants receipt of such estimate notice. In addition, in the
event such repair and/or restoration
of the Premises is not actually completed within two hundred forty (240) days from the occurrence of
the casualty (or such longer time period as may have been estimated in such notice to Tenant),
Tenant may elect to terminate this Lease upon thirty (30) days prior written notice to Landlord,
provided that if such repair and/or restoration is completed within such thirty (30) day period,
such election to terminate shall be nullified and this Lease shall continue in full force and
effect. In addition, and notwithstanding anything to the contrary contained in this Lease, if the
Premises or the Building is wholly or partially damaged or destroyed within the final twelve (12)
months of the Term of this Lease so that Tenant shall be prevented from using the Premises for
thirty (30) consecutive days due to such damage or destruction, then Tenant may, at its option, by
notice to Landlord within sixty (60) days after the occurrence of such damage or destruction, elect
to terminate this Lease.
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(d)
Termination of Lease
. Upon any termination of this Lease under any of the
provisions of this
Section 16
, Landlord and Tenant shall each be released without further
obligation to the other from the date possession of the Premises is surrendered to Landlord or such
other date as is mutually agreed upon by Landlord and Tenant except for payments or other
obligations which have theretofore accrued and are then unpaid or unperformed.
(e)
Rent Abatement
. In the event of repair, reconstruction and restoration by or
through Landlord as herein provided, the rent payable under this Lease (including Basic Rent and
Tenants Proportionate Share of Operating Expenses) shall be abated in the proportion that the
rentable area of the portion of the Premises that Tenant is prevented from using, and does not use,
bears to the total rentable area of the Premises. However, in the event that Tenant is prevented
from conducting, and does not conduct, its business in any portion of the Premises and the
remaining portion of the Premises is not sufficient to allow Tenant to effectively conduct its
business therein, and if Tenant does not conduct its business from such remaining portion, then the
rent for the entire Premises shall be abated. Tenants abatement period shall continue until
Tenant has been given sufficient time, and sufficient access to the Premises, the parking
facilities and/or the Building, to rebuild such portion it is required to rebuild, to install its
property, furniture, fixtures, and equipment to the extent the same shall have been removed and/or
damaged as a result of such damage or destruction. Tenant shall not be entitled to any
compensation or damages for loss of the use of the whole or any part of the Premises and/or any
inconvenience or annoyance occasioned by such damage, repair, reconstruction or restoration, nor
shall Tenant be entitled to any insurance proceeds, including those in excess of the amount
required by Landlord for such repair, reconstruction or restoration. Tenant shall not be released
from any of its obligations under this Lease due to damage or destruction of the Building and/or
the Premises except to the extent and upon the conditions expressly stated in this
Section
16
.
(f)
Extent of Repair Obligation
. If Landlord is obligated to or elects to repair or
restore as herein provided, Landlord shall be obligated to make repair or restoration only of those
portions of the Building and the Premises which were originally provided at Landlords expense, and
the repair and restoration of items not provided at Landlords expense shall be the obligation of
Tenant, except that Tenant shall be responsible for the repair of all Tenant Improvements performed
by Tenant under
Section 30
below. Tenant shall be entitled to all insurance proceeds
payable to or received by Tenant in connection with the Tenant Improvements or any other
improvements insured by the Tenant pursuant to
Section 14
hereof.
(g)
Waiver
. The provisions of California Civil Code § 1932(2) and § 1933(4), which
permit termination of a lease upon destruction of the Premises, are hereby waived by Tenant; and
the provisions of this
Section 16
shall govern in case of such destruction.
17.
CONDEMNATION
.
(a)
Complete Taking
. If the whole of the Project, the Building or the Premises or so
much thereof shall be taken by condemnation or in any other manner for any public or quasi-public
use or purpose so that the Premises will no longer be reasonably suitable for Tenants continued
occupancy (as reasonably determined by Tenant), this Lease and the term and estate hereby granted
shall terminate as of the date that possession of the Project, the Building or the
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Premises is so taken (herein called
Date of the Taking
), and the Basic Rent and other sums
payable hereunder shall be prorated and adjusted as of such termination date.
(b)
Partial Taking
. If only a part of the Building, the Project or the Premises shall
be so taken and the remaining part thereof after reconstruction is reasonably suited for Tenants
continued occupancy (as reasonably determined by Tenant), this Lease shall be unaffected by such
taking, except that Landlord may, at its option, terminate this Lease by giving Tenant written
notice to that effect within sixty (60) days after the Date of the Taking provided that in such
event, Landlord also terminates the leases of all other Building tenants. In such event, this
Lease shall terminate on the date that such notice from the Landlord to Tenant shall be given, and
the Basic Rent and other sums payable hereunder shall be prorated and adjusted as of such
termination date. Upon a partial taking after which this Lease continues in force as to any part of
the Premises, the Basic Rent and other sums payable hereunder shall be adjusted according to the
rentable area remaining.
(c)
Award
. Landlord shall be entitled to receive the entire award or payment in
connection with any taking without deduction therefrom for any estate vested in Tenant by this
Lease, and Tenant shall receive no part of such award, including any award for the leasehold bonus
value of this Lease, provided that Tenant shall be entitled to make a separate claim for its
relocation expenses, the value of its personal property and fixtures belonging to Tenant actually
taken, the value of the Tenant Improvements and other improvements to the extent paid for by Tenant
and for the interruption of or damage to Tenants business (not attributable to the leasehold
bonus value of this Lease). Tenant hereby expressly assigns to Landlord all of its right, title
and interest in and to any award or payment attributable to the leasehold bonus value of this
Lease.
(d)
Waiver
. Except as may be otherwise provided herein, Tenant hereby waives and
releases any right to terminate this Lease under Sections 1265.120 and 1265.130 of the California
Code of Civil Procedure or under any similar law, statute or ordinance now or hereafter in effect
relative to eminent domain, condemnation or takings.
18.
ASSIGNMENT OR SUBLETTING
.
(a)
Landlords Consent
. Without the express prior written consent of Landlord,
which consent shall not be unreasonably withheld, conditioned or delayed, Tenant shall not directly
or indirectly, voluntarily or by operation of law, sell, assign, encumber, pledge, or otherwise
transfer or hypothecate all of its interest in or rights with respect to the Premises
(collectively,
Assignment
), or permit all or any portion of the Premises to be occupied by anyone
other than Tenant or sublet all or any portion of the Premises or transfer a portion of its
interest in or rights with respect to the Premises (collectively,
Sublease
).
(b)
Notice to Landlord
. If Tenant desires to enter into an Assignment or a Sublease,
Tenant shall give written notice to Landlord of its intention to do so (the
Transfer Notice
),
containing (i) the name of the proposed assignee or subtenant (collectively,
Transferee
), (ii)
the nature of the proposed Transferees business to be carried on in the Premises, (iii) the
material terms of the proposed Assignment or Sublease, including, without limitation, the
commencement and expiration dates thereof and the rent payable thereunder, (iv) the portion of
-22-
the
Premises proposed to be assigned or subleased (the
Transfer
Space
), (v) and the most recent
financial statement or other equivalent financial information reasonably available to Tenant
concerning the proposed Transferee. Within fifteen (15) days after Landlords receipt of the
Transfer Notice, Landlord shall, by written notice to Tenant, elect to (1) consent to the Sublease
or Assignment, or (2) disapprove the Sublease or Assignment; provided, however, that Landlord
agrees not to unreasonably withhold its consent to the Sublease or Assignment. Landlords consent
shall not be deemed to have been unreasonably withheld if the Transferee is a new concern with no
previous business history or if the Transferee intends to use the Premises (x) for executive suites
or any other use inconsistent with
Section 6
or the operation of a first- class office
building or (y) in a manner which would increase the use of, or the possibility of disturbance of,
Hazardous Substances on the Property. Landlords failure to make such election within fifteen (15)
days after Landlords receipt of the Transfer Notice shall be deemed to be Landlords approval of
the proposed Sublease or Assignment.
(c)
Permitted Transfers
. If Landlord consents to any Sublease or Assignment as
set forth in Section 18(b):
(1) Tenant may thereafter, within one hundred eighty (180) days after Landlords consent,
enter into such Assignment or Sublease, but only with the party and upon substantially the same
terms as set forth in the Transfer Notice, provided, however, that the financial terms contained in
the Assignment or Sublease shall be no less favorable to Tenant than those set forth in the
Transfer Notice.
(2) In the case of a Sublease, Tenant shall pay to Landlord fifty percent (50%) of the
difference between (x) any and all sums actually received by Tenant in connection with such
Sublease (including key money, bonus money and any payment in excess of fair market value for (A)
services rendered by Tenant in connection with such Sublease or (B) assets, fixtures, inventory,
equipment or furniture transferred by Tenant in connection with such Sublease, but expressly
excluding any payment up to the fair market value for the items referenced in the foregoing clauses
(A) and/or (B)), minus (y) the sum of the proportionate amount (on a rentable square footage basis)
of rent (including Basic Rent and Tenants Proportionate Share of Operating Expenses) payable by
Tenant under this Lease for the Transfer Space plus any actual and reasonable out-of-pocket costs
incurred by the Tenant in connection with such Sublease (including brokerage commissions, legal
fees, improvement costs for work for the benefit of the subtenant, improvement allowances or other
monetary concessions or inducements provided to the subtenant, the gross revenue as to the Transfer
Space paid to Landlord by Tenant for all days the Transfer Space was vacated from the date that
Tenant first vacated the Transfer Space until the date the subtenant was to pay rent, costs of
advertising the space for sublease and unamortized cost of initial and subsequent improvements to
the Premises by Tenant [collectively, the
Transfer Costs
]), which amounts shall not be paid by
Tenant to Landlord until Tenant has recovered its Transfer Costs. Once Tenant has recouped its
Transfer Costs, Tenant shall pay Landlord its share of the amounts due hereunder on a monthly
basis.
(3) In the case of an Assignment, Tenant shall pay to Landlord fifty percent (50%) of any
transfer or assignment fee, purchase price or other consideration received by Tenant in connection
with the Assignment attributable to the value of this Lease (but Landlord shall not be entitled to
any proceeds paid for the sale of Tenants business which are not related
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to the value of this Lease or for the fair market value of any assets, fixtures, inventory,
equipment or furniture transferred by Tenant in connection with such Assignment) less the Transfer
Costs, which amounts shall be paid by Tenant to Landlord as provided in
Section 18(c)(2)
above.
(4) Any Sublease or Assignment shall be subject to all of the provisions of this Lease, and
Landlords consent to any Sublease or Assignment shall not be construed as a consent to any terms
thereof which conflict with any of the provisions of this Lease except to the extent that Landlord
specifically agrees in writing to be bound by such conflicting terms.
(d)
Continuing Liability
. Tenant shall not be relieved of any obligation to be
performed by Tenant under this Lease, including the obligation to obtain Landlords consent to any
other Assignment or Sublease, regardless of whether Landlord consented to any Assignment or
Sublease. Any Assignment or Sublease that fails to comply with this
Section 18
shall be
void. The acceptance of Basic Rent or other sums by Landlord from a proposed Transferee shall not
constitute Landlords consent to such Assignment or Sublease.
(e)
Assumption by Transferee
. Each Transferee under an Assignment shall assume all
obligations of Tenant under this Lease and shall be and remain liable jointly and severally with
Tenant for the payment of Basic Rent, additional rent and other charges, and for the performance of
all other provisions of this Lease. Each Transferee under a Sublease shall be subject to this
Lease. No Assignment shall be binding on Landlord unless Landlord shall receive a counterpart of
the Assignment and an instrument that contains a covenant of assumption by the Transferee
reasonably satisfactory in substance and form to Landlord and consistent with the requirements of
this
Section 18
but the failure of the Transferee to execute such instrument shall not
release the Transferee from its liability as set forth above. Tenant shall reimburse Landlord,
within thirty (30) days after Tenants receipt of an invoice therefore, for any reasonable costs
(not to exceed $1,000) that Landlord may incur in connection with any proposed Assignment or
Sublease, including Landlords reasonable attorneys fees and the costs of investigating the
acceptability of any proposed Transferee.
(f)
Default; Waiver
. Any Assignment or Sublease in violation of this Section 18
shall be void. The acceptance of rent or additional charges by Landlord from a purported assignee
or sublessee shall not constitute a waiver by Landlord of the provisions of this
Section
18
.
(g)
Intentionally Omitted
.
(h)
Use by Affiliates
. Tenant shall have the right, without consent of Landlord, to
assign this Lease or to sublease all or any portion of the Premises, to (i) any person or entity
which, directly or indirectly, controls Tenant or is controlled by Tenant or is under common
control with Tenant, (ii) any successor to Tenant by merger, consolidation or other operation of
law, (iii) any person or entity to whom all or substantially all of the assets of Tenant are
conveyed or (iv) any person or entity purchasing the business which the Tenant conducts at the
Premises so long as the Premises are used in a manner consistent with the requirements of this
Lease. The term
control
shall mean ownership, directly or indirectly, of more than fifty percent
(50%) of the equity and voting interests of Tenant or such entity, as the case may be.
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(i)
Recognition Agreement
. To the extent that Tenant enters into a Sublease for all of
the Premises, Landlord, if it grants its consent to such Sublease, shall also simultaneously
execute and deliver a recognition agreement pursuant to which Landlord shall agree that in the
event Tenant defaults under this Lease and this Lease is terminated, the Sublease shall be
recognized as a direct lease between Landlord and the subtenant on the terms and conditions of the
sublease to the extent same are not inconsistent with, or contrary to, the provisions of this Lease
and at a rental rate which is the higher of the rental rate under this Lease or the rental rate
under the sublease.
(j)
Occupancy By Others
. Tenant may allow any person or company which is a client or
customer of Tenant or which is providing service to Tenant or one of Tenants clients to occupy
certain portions of the Premises without such occupancy being deemed an assignment or subleasing
as long as no new demising walls are constructed to accomplish such occupancy and as long as such
relationship was not created as a subterfuge to avoid the obligations set forth in this
Section 18
.
19.
SUBORDINATION AND NON-DISTURBANCE
.
Subject to the last sentence of this Section 19,
Tenant agrees that this Lease is and shall be subordinate to any mortgage, deed of trust, ground
lease, underlying lease or other prior lien (hereinafter
Prior Lien)
that may heretofore or
hereafter be placed upon the Project or the Building, and all renewals, replacements and extensions
thereof. If any Prior Lien holder wishes to have this Lease prior to its Prior Lien, then and in
such event, upon such Prior Lien holders notifying Tenant to that effect, this Lease shall be
deemed prior to the Prior Lien. If any ground lease or underlying lease terminates for any reason
or any mortgage or deed of trust is foreclosed or a conveyance in lieu of foreclosure is made for
any reason, Tenant shall, notwithstanding any subordination, attorn to and become the tenant of the
successor in interest to Landlord, provided that such successor in interest recognizes the interest
of Tenant under this Lease if no default under this Lease then exists beyond all applicable notice
and cure periods. Within fifteen (15) days of presentation, Tenant shall execute any documents
which any such Prior Lien holder may require to effectuate the provisions of this
Section
19
. Notwithstanding anything to the contrary contained herein, Tenants obligation to
subordinate this Lease to the holder of any Prior Lien hereafter placed upon the Project or the
Building shall be conditioned upon such Prior Lien holders executing and delivering to Tenant an
agreement of subordination, non-disturbance and adornment with Tenant in commercially reasonable
form reasonably designated by such Prior Lien holder and reasonably acceptable to Tenant in which
the Prior Lien holder agrees not to disturb Tenant in its possession of the Premises. Landlord
represents and warrants to Tenant that as of the date hereof, the Building and Project are not
subject to any ground lease, mortgage or lien.
20.
ESTOPPEL
CERTIFICATE
.
Tenant will, upon ten (10) business days prior request by
Landlord, execute, acknowledge and deliver to Landlord a statement in writing executed by Tenant,
substantially in the form of
Exhibit D
attached hereto, certifying, among other things, the date of
this Lease, that this Lease is unmodified and in full force and effect (or, if there have been
modifications, that this Lease is in full force and effect as modified, and setting forth such
modifications) and the date to which the Basic Rent and additional rent and other sums payable
hereunder have been paid, and either stating that to the knowledge of Tenant no default exists
hereunder on the part of Landlord or Tenant or specifying each such default of which Tenant may
have knowledge and such other matters as may be reasonably requested by Landlord. The
-25-
parties agree and intend that any such statement by Tenant may be relied upon by any prospective
purchaser or mortgagee of the Building or the Project. Tenants failure to timely deliver such a
statement shall be deemed to be an acknowledgment by Tenant that this Lease is in full force and
effect without modification (except as set forth by Landlord), there are no uncured defaults under
this Lease by Landlord and no more than one monthly installment of Basic Rent and additional rent
and other sums payable hereunder have been paid in advance. Landlord will, upon ten (10) business
days prior request by Tenant, execute, acknowledge and deliver to Tenant a statement in writing
executed by Landlord substantially in the form of
Exhibit D
attached hereto with such
changes as may be required when Tenant is the requesting party.
21.
SERVICES
.
(a)
Standard Services
. Landlord shall maintain the public and common areas of
the Project and the Building, such as lobbies, stairs, corridors and restrooms, in first-class
condition and state of repair consistent with Comparable Buildings, except for damage occasioned
by the acts or omissions of the Tenant Parties, which shall be repaired at Tenants sole cost and
expense except to the extent the cost of such repair is covered by insurance carried by Landlord
(or would have been covered had Landlord carried the insurance required to be carried hereunder).
Landlord shall be solely responsible for providing janitorial services to the Premises comparable
to janitorial services provided in Comparable Buildings. Notwithstanding the foregoing, Tenant may
elect, from time to time with respect to any calendar month(s), by delivery of written notice to
Landlord not less than forty-five (45) calendar days prior to the commencement of such month(s),
to be responsible for providing janitorial services to the Premises, or to a portion thereof as
specified in such notice, which janitorial services shall be consistent with those janitorial
services provided by Landlord to other tenants in the Building, in which event Tenant shall be
responsible to perform such janitorial services in such month(s) and Tenant shall receive a
monthly credit to the Basic Rent due hereunder for such respective month(s), on a month-by- month
basis, in an amount equal to $.07 per rentable square foot of space for that portion of the
Premises as specified in such notice for which Tenant so elects to provide such janitorial
services. Tenant shall have access to the Premises and Project parking garage at all times.
Landlord shall furnish the Premises with a minimum of seven (7) watts consumed load per rentable
square foot within the Premises of electric power (in addition to the electrical power required
for lighting and base Building HVAC) for operation of typical general office machines, hot and
cold running water to restrooms, hot and cold water to the kitchen facility within the Premises
(through piping to be installed as a part of the Tenant Improvements) and elevator service
(including the use of one elevator as a freight elevator for deliveries and construction purposes,
but subject to availability based upon common use of such elevator with other Building occupants)
at all times during the Term. Landlord shall furnish the Premises with heating or normal office
air conditioning comparable to the amounts being provided by comparable landlords of Comparable
Buildings between the hours of 6:00 a.m. and 6:00 p.m., Monday through Friday, except for New York
Stock Exchange-recognized holidays, and between the hours of 9:00 a.m. and 12:00 p.m. on Saturday.
Supplemental air conditioning units and electricity therefore or special air conditioning
requirements, such as for any computer centers, and after-hours heating and air conditioning shall
be at Tenants expense at an hourly rate established by the Landlord as its Actual Cost (as
hereinafter defined). For purposes hereof,
Actual Cost
shall mean the actual out-of-pocket
incremental extra cost to Landlord to provide
-26-
additional services without markup for profit, overhead, depreciation or administration (to the
extent Landlords administration costs are duplicative of amounts being paid by Tenant as part of
Operating Expenses). After hours heating and air conditioning shall be charged by the Landlord to
the Tenant at the rate of $37.00/hour and shall be payable by the Tenant as Additional Rent within
thirty (30) days after receipt of an invoice therefore. Tenant shall be solely responsible for the
repair and maintenance of any separate heating, ventilating, air conditioning or other equipment
installed in the Premises by the Tenant (with the Landlords consent). Landlord shall also provide
lighting replacement for Landlord-furnished lighting, toilet room supplies, window washing with
reasonable frequency as is provided in other Comparable Buildings and janitorial service to all
common areas and garages of the Property comparable to that provided in Comparable Buildings.
Landlord shall not be liable to Tenant for any loss or damage caused by or resulting from any
variation, interruption or failure of said services due to any cause whatsoever; and no temporary
interruption or failure of such services incident to the making of repairs, Alterations or
improvements due to accident or strike or conditions or events not under Landlords control shall
be deemed an eviction of Tenant or relieve Tenant from any of Tenants obligations hereunder unless
otherwise provided in this Lease.
(b)
Overstandard Use
. Tenant shall not, without the Landlords prior written consent,
use heat-generating machines, machines other than normal office machines, or equipment or lighting
located in the Premises, which may materially affect the temperature otherwise maintained by the
air conditioning system or increase the water normally furnished for the Premises by Landlord.
If such consent is given, Landlord shall have the right to install supplementary air conditioning
units or other facilities in the Premises, including supplementary or additional metering devices,
and the Actual Cost thereof, including the Actual Cost of installation, operation and maintenance
shall be paid by Tenant to Landlord within thirty (30) days of billing by Landlord. If Tenant
uses water or electricity in excess of that supplied by Landlord pursuant to subsection (a) above,
Tenant shall pay to Landlord, within thirty (30) days of billing, the Actual Cost of such excess
consumption, the cost of the installation, operation and maintenance of equipment which is
installed in order to supply such excess consumption; and Landlord may install devices to
separately meter any increased use and in such event Tenant shall pay the increased cost directly
to Landlord, within thirty (30) days of demand, including the Actual Cost of such additional
metering devices (including installment costs).
(c)
Abatement of Rent
. Notwithstanding the foregoing or anything in this Lease to the
contrary, in the event that Tenant is prevented from using, and does not use, the Premises or any
portion thereof, for three (3) consecutive business days or ten (10) business days in any twelve
(12) month period (the
Eligibility Period
) as a result of (i) any repair, maintenance or
alteration performed by Landlord after the Commencement Date that substantially interferes with
Tenants use of the Premises, the parking facility and/or the Building, or (ii) any failure by
Landlord to provide Tenant with services or access to the Premises, the Parking Facility and/or the
Building, then Tenants Rent shall be abated or reduced, as the case may be, after expiration of
the Eligibility Period for such time that Tenant continues to be so prevented from using, and does
not use, the Premises or a portion thereof, in the proportion that the rentable area of the portion
of the Premises that Tenant is prevented from using, and does not use, bears to the total rentable
area of the Premises. However, in the event that Tenant is prevented from conducting, and does not
conduct, its business in any portion of the Premises for a period of time in excess of the
Eligibility Period, and the remaining portion of the Premises is not sufficient to allow Tenant
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to effectively conduct its business therein, and if Tenant does not conduct its business from such
remaining portion, then for such time after expiration of the Eligibility Period during which
Tenant is so prevented from effectively conducting its business therein, the Rent for the entire
Premises shall be abated; provided, however, if Tenant reoccupies and conducts its business from
any portion of the Premises during such period, the Rent allocable to such reoccupied portion,
based on the proportion that the rentable area of such reoccupied portion of the Premises bears to
the total rentable area of the Premises, shall be payable by Tenant from the date such business
operations commence.
22.
SIGNS AND ADVERTISING
.
Landlord shall provide Tenant, at Landlords sole cost and
expense, with Building standard signage (as such standard is established from time to time by
Landlord) on the Building directory in the lobby of the Building and at the entry to the Premises
for Tenant. In addition, Tenant shall have the right to install, at Tenants sole cost and expense,
signage on or adjacent to the entry to the Premises, in the lobby and corridor of any floor in
which any part of the Premises are located and on the exterior monument sign for the Building in
the top tenant location
(Additional Tenant Signage)
; provided, however, that Tenant must present
the desired signage to Landlord for its review and approval, which shall not be unreasonably
withheld. Any Additional Tenant Signage shall comply with Landlords signage program for the
Building; provided, however, that Tenant shall be permitted to use its standard font and logo in
connection with the Additional Tenant Signage. Tenant shall not erect or install or otherwise
utilize signs, lights, symbols, canopies, awnings, window coverings or other advertising or
decorative matter (collectively,
Signs
) on the windows, walls or exterior doors or otherwise
visible from the exterior of the Premises without first (a) submitting its plans to Landlord and
obtaining Landlords written approval thereof, which approval shall not be unreasonably withheld,
conditioned or delayed, and (b) obtaining any required approval of any applicable governmental
authority with jurisdiction at Tenants sole cost and expense. All Signs approved by Landlord
shall be professionally designed and constructed in a first-class workmanlike manner.
Subject to Tenants right to use its standard font and logo, Landlord shall have the right to
promulgate from time to time additional reasonable and non-discriminatory rules, regulations and
policies relating to the style and type of said advertising and decorative matter which may be used
by any occupant, including Tenant, in the Building, and may change or amend such rules and
regulations from time to time as in its discretion it deems advisable. Tenant agrees to abide by
such rules, regulations and policies. At the expiration or earlier termination of this Lease, all
such signs, lights, symbols, canopies, awnings or other advertising or decorative matter attached
to or painted by Tenant upon the Premises, whether on the exterior or interior thereof, shall be
removed by Tenant at its own expense, and Tenant shall repair any damage or injury to the Premises
or the Building, and correct any unsightly condition, caused by the maintenance and removal
thereof.
23.
PARKING
.
Subject to the rules and regulations of the Town of Mill Valley and the
County of Marin, Tenant shall have the right to use, without payment of additional rent for such
parking (provided that nothing contained in this
Section 23
shall be deemed to limit
Landlords right to include costs relating to the Project parking areas in Operating Expenses to
the extent permitted under the provisions of
Section 4
above), four (4) parking spaces for
every 1,000 rentable square feet in the Premises in the parking facilities for the Project in
common with other tenants, guests and invitees of the Project during the Term of this Lease and
otherwise subject to the reasonable rules and regulations applicable to the parking facilities,
including, without
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limitation, hours of operation. The Project shall contain approximately four (4) parking spaces for
each 1,000 square feet of usable office space. Access to and from the parking facilities shall be
available twenty-four (24) hours per day, seven (7) days per week in accordance with the Landlords
reasonable and nondiscriminatory rules and regulations established therefore from time to time.
24.
RULES AND REGULATIONS
.
Tenant agrees to observe and be bound by the Rules and
Regulations applicable to the Project, a copy of which is attached hereto as
Exhibit E.
Landlord reserves the right to amend said Rules and Regulations in a reasonable and
nondiscriminatory manner, as Landlord in its reasonable judgment may from time to time deem to be
necessary or desirable for the safety, care and cleanliness of the Project and the preservation of
good order therein, and Tenant agrees to comply therewith provided that no amendments to the Rules
and Regulations shall interfere with Tenants use of the Premises. Landlord may make concessions
requested by a tenant without granting the same concessions to any other tenant. To the extent
the Rules and Regulations conflict with this Lease, this Lease shall control.
25.
TIME
.
Time is of the essence of this Lease.
26.
QUIET ENJOYMENT
.
Landlord covenants to control its activities and personnel such that
if and so long as no Event of Default by Tenant is in existence under this Lease, Tenant shall hold
and enjoy the Premises peaceably and quietly, subject to the provisions of this Lease.
27.
DEFAULTS AND REMEDIES
.
(a)
Defaults
. The occurrence of any one or more of the following events
shall constitute a default hereunder by Tenant (each an
Event of Default):
(1) The failure by Tenant to make any payment of Basic Rent, additional rent, other charges or
any other payment required to be made by Tenant hereunder, as and when due, where such failure
shall continue for a period of ten (10) days after written notice thereof from Landlord to Tenant;
provided, however, that any such notice shall be in lieu of, and not in addition to, any notice
required under California Code of Civil Procedure § 1161 regarding unlawful detainer actions.
(2) The failure by Tenant to observe or perform any of the express or implied covenants or
provisions of this Lease to be observed or performed by Tenant, other than as specified in
Section 27(a)
above, where such failure shall continue for a period of thirty (30) days
after written notice thereof from Landlord to Tenant. Any such notice shall be in lieu of, and not
in addition to, any notice required under California Code of Civil Procedure § 1161 regarding
unlawful detainer actions. If the nature of Tenants default (other than a default specified in
Section 27(a)(l)
above) is such that more than thirty (30) days are reasonably required for
its cure, then Tenant shall not be deemed to be in default if Tenant shall promptly commence such
cure within said thirty (30) day period and thereafter diligently prosecute such cure to
completion.
(b)
Remedies
. If an Event of Default exists, in addition to any other remedies
available to Landlord at law or in equity, Landlord shall have the following rights and remedies:
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(1) The right to terminate the Lease and pursue its rights and remedies provided by California
Civil Code Section 1951 .2, in which event Landlord may recover
(A) The worth at the time of award of any unpaid rent which had been earned at
the time of such termination; plus
(B) The worth at the time of award of the amount by which the unpaid rent which
would have been earned after termination until the time of award exceeds the amount
of such rental loss that Tenant proves could have been reasonably avoided; plus
(C) The worth at the time of award of the amount by which the unpaid rent for
the balance of the Term after the time of award exceeds the amount of such rental
loss that Tenant proves could have been reasonably avoided; plus
(D) Any other amount necessary to compensate Landlord for all the detriment
proximately caused by Tenants failure to perform its obligations under this Lease
or which in the ordinary course of things would be likely to result therefrom,
specifically including, but not limited to, brokerage commissions and advertising
expenses incurred, expenses of remodeling the Premises or any portion thereof for a
new tenant, whether for the same or a different use, and any special
concessions made to obtain a new tenant; plus
(E) At Landlords election, such other amounts in addition to or in lieu of the
foregoing as may be permitted from time to time by applicable law so long as not
duplicative of other amounts paid or payable by Tenant.
The term rent as used hereinabove shall be deemed to be and to mean all sums of every
nature required to be paid by Tenant pursuant to the terms of this Lease, whether to Landlord or
to others. As used herein, the worth at the time of award for (A) and (B) above shall be
computed by allowing interest at the Interest Rate. As used herein, the worth at the time of
award for (C) above shall be computed by discounting such amount at the discount rate of the
Federal Reserve Bank of San Francisco at the time of award plus one percent (1%).
(2) The rights and remedies provided by California Civil Code Section 1951.4, that allow
Landlord to continue this Lease in effect and to enforce all of its rights and remedies under this
Lease, including the right to recover Basic Rent, additional rent and other charges as they become
due, for so long as Landlord does not terminate Tenants right to possession. Acts of
maintenance or preservation, efforts to re-let the Premises or the appointment of a receiver upon
Landlords initiative to protect its interest under this Lease shall not constitute a termination
of Tenants right to possession;
(3) The right to enter the Premises and remove therefrom all persons and property, store such
property in a public warehouse or elsewhere at the cost of and for the
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account of Tenant, and sell such property and apply the proceeds therefrom pursuant to applicable
California law; and
(4) The right to take steps necessary or appropriate to have a receiver appointed for Tenant
in order to take possession of the Premises and apply any rental collected and exercise all other
rights and remedies granted to Landlord.
(c)
Re-entry
. If an Event of Default exists, Landlord shall also have the right, with
or without terminating this Lease, to re-enter the Premises and remove all persons and property
from the Premises; such property may be removed and stored in a public warehouse or elsewhere at
the cost of and for the account of Tenant. No re-entry or taking possession of the Premises by
Landlord pursuant to this
Section 27(c)
shall be construed as an election to terminate this
Lease unless a written notice of such intention is given to Tenant or unless the termination
thereof is decreed by a court of competent jurisdiction.
(d)
Remedies Cumulative; Waiver
. All rights, options and remedies of Landlord
contained in this Lease or provided by law or in equity shall be construed and held to be
cumulative, and no one of them shall be exclusive of the other. No waiver of any default
hereunder shall be implied from any acceptance by Landlord of any Basic Rent, additional rent or
other charges due hereunder or any omission by Landlord to take any action on account of such
default, and no express waiver shall affect any default other than as specified in said waiver. The
consent or approval of Landlord to or of any act by Tenant requiring Landlords consent or approval
shall not be deemed to waive or render unnecessary Landlords consent or approval to or of any
subsequent similar acts by Tenant.
28.
TRANSFER OF LANDLORDS INTEREST
.
In the event of any transfer or transfers of
Landlords interest in the Project or the Building, other than a transfer for security purposes
only, and the assumption in writing by the transferee of the obligations of Landlord under this
Lease accruing with respect to the period from and after the date of such transfer, Tenant agrees
that Landlord shall be automatically relieved of any and all obligations and liabilities on the
part of Landlord accruing with respect to the period from and after the date of such transfer and
Tenant agrees to attorn to the transferee.
29.
RIGHT TO PERFORM
.
If Tenant shall fail to pay any sum of money, other than Basic Rent
required to be paid by it hereunder, or shall fail to perform any other act on its part to be
performed hereunder, and such failure shall continue for thirty (30) days after written notice
thereof by Landlord (or such shorter period as may be reasonably appropriate in an emergency
situation of imminent risk of injury to persons or property damage), Landlord may, but shall not be
obligated so to do, and without waiving or releasing Tenant from any obligations of Tenant, make
any such payment or perform any such other act on Tenants part to be made or performed as provided
in this Lease. Tenant shall reimburse Landlord for all costs incurred in connection with such
payment or performance within thirty (30) days of demand.
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30.
TENANT IMPROVEMENTS
.
(a)
Certain Definitions
.
(1)
Tenant Improvements
.
Tenant Improvements
shall mean all
improvements, alterations and additions desired by Tenant to be made initially in and to the
Premises in excess of and addition to the Base Building Work.
(2)
Tenant Improvement Allowance
.
Tenant Improvement Allowance
shall have the meaning set forth in
Paragraph 19
of the Basic Lease Provisions and shall
be credited toward the cost of the Tenant Improvements and Construction Costs in accordance with
the provisions of this
Section 30
.
(3)
Substantial Completion; Punch List Items
.
Substantial Completion
shall mean, and
the Tenant Improvements shall be deemed to be
Substantially
Complete
, when all of the following
have occurred: (i) Tenant has completed the Tenant Improvements in accordance with the Final Plans
and all applicable Laws so that Tenant may occupy the Premises for their intended business purpose
and conduct Tenants normal business operations from the Premises, subject only to minor and
customary punch list items which so not materially interfere with Tenants occupancy thereof and
conduct of its normal business operations therein (Collectively
Punch List Items)
; (ii) the
County of Marin has issued a certificate of occupancy (or is equivalent) for the Premises; and
(iii) Tenant is able to receive at the Premises all utilities and other building services to be
provided to Tenant by Landlord pursuant to the Lease.
(4)
Construction
Costs
.
Construction Costs
shall mean all costs incurred by Tenant
in the design and construction of its Tenant Improvements including costs for signage,
communication systems and cabling.
(5)
Building Plans
.
Building Plans
shall mean the Building plans and specifications
sufficient to allow Tenants Architect to complete a Space Plan and Working Drawings. Landlord
shall submit to Tenant the Building Plans prior to the execution of this Lease.
(6)
Base Building Work
.
Base Building Work
shall mean the work to be performed by
Landlord at its sole cost and expense (without deduction from the Tenant Improvement Allowance)
shown on
Exhibit F
.
(7)
Delivery Condition
.
Delivery Condition
shall mean (i) the Base Building
Work is substantially complete such that Tenant may construct its Tenant
Improvements without interference from Landlord and its contractors and (ii) the Building,
Premises, Building Structure and Building Systems are in first class condition and operating order,
free of hazardous materials and asbestos and in compliance with all laws applicable to new
construction, disregarding variances and grandfathered rights.
(8)
Force Majeure Delay
.
Force Majeure Delay
shall mean any delay incurred by Tenant
in the design and construction of its Tenant Improvements or its move into the Premises
attributable to any: (i) actual delay or failure to perform attributable to any strike,
-32-
lockout or other labor or industrial disturbance (whether or not on the part of the employee of
either party hereto), civil disturbance, further order claiming jurisdiction, act of public enemy,
war, riot, sabotage, blockade, embargo; (ii) delay due to changes in any applicable laws
(including, without limitation, the ADA) or Building Plans, or the interpretation thereof; or (iii)
delay attributable to lightning, earthquake, fire, storm, hurricane, tornado, flood, washout,
explosion, or any other similar industry-wide or Building-wide cause beyond the reasonable control
of the party from whom performance is required, or any of its contractors or other representatives.
(9)
Landlord Delay
.
Landlord Delay
shall mean any delay incurred by Tenant in the
design and construction of its Tenant Improvements or its move into the Premises caused by (i)
Landlords failure to approve the Space Plan or Working Drawings or any revisions to either the
Space Plan or Working Drawings within the time periods specified in
Section 30(c)
below;
(ii) deficiencies in the Base Building Work or failure of the Base Building Work to substantially
comply with the Building Plans; (iii) any material breach by Landlord or any of the Landlord
Parties of any provision of this Lease; (iv) any other delay to the extent requested or caused by
Landlord or the Landlord Parties; delay in the giving of authorizations or approvals by Landlord;
(v) delay attributable to the acts or failures to act, whether willful, negligent or otherwise, of
Landlord, its agents or contractors; (vi) delay attributable to the interference of Landlord, its
agents or contractors with the design of the Tenant Improvements or the failure or refusal of any
such party to permit Tenant, its agents or contractors, access to and priority use of the Building
or any Building facilities or services, including freight elevators, passenger elevators, and
loading docks, which access and use are required for the orderly and continuous performance of the
work necessary for Tenant to complete its move in into the Premises during the Construction Period;
(vii) delay by Landlord in the substantial completion of the Base Building Work prior to the
commencement of the move into the Premises; (viii) delay attributable to Landlords failure to
allow Tenant sufficient access to the Building and/or the Premises to move into the Premises over
one (1) weekend; and (ix) delay caused by the failure of the base Building to comply with the ADA;
provided, however, that no such Landlord Delay shall be deemed to have occurred unless and until
the matter giving rise to such claimed Landlord Delay is not cured within one (1) business day
following Landlords receipt of written notice thereof (provided, however, that notwithstanding
anything to the contrary in this Lease as to the manner of giving notices, such notice shall be
given by facsimile to (415) 288-0203).
(10)
Tenants Contractor
.
Tenants Contractor
shall mean
.
Tenants Contractor may also be another general contractor selected and retained by Tenant and
approved by Landlord to construct and install the Tenant Improvements within the Premises.
(11)
Material Change Order
.
Material Change Order
shall mean any change order or
modification which increases the Construction Costs by more than
.
(12)
Tenants Architect
.
Tenants Architect
shall be
.
(b)
Plans and Drawings
. Tenant shall submit to Landlord Tenants proposed space plan
for the Premises (the
Space Plan)
. Landlord shall approve or disapprove the Space Plan within
five (5) business days after delivery of the Space Plan to Landlord, which approval shall
-33-
not be withheld unless a Design Problem (as defined in
Section 8(a)
) exists or
conditioned. If Landlord reasonably disapproves the Space Plan because of a Design Problem,
Landlord shall return the Space Plan to Tenant with Landlords specific requested changes noted
thereon. Tenant shall revise and resubmit the Space Plan to Landlord and Landlord shall approve or
disapprove such revised Space Plan if a Design Problem exists within five (5) business days of
receipt. After Landlords approval of the Space Plan, Tenant shall deliver to Landlord for
Landlords approval working drawings consisting of a floor plan, reflected ceiling plan, interior
elevations and electrical plan (the
Working Drawings)
, which Working Drawings shall be consistent
with the Space Plan. Landlord shall approve or disapprove the Working Drawings within five (5)
business days after delivery of the Working Drawings to Landlord, which approval shall not be
withheld unless a Design Problem exists or conditioned. If Landlord disapproves the Working
Drawings, Landlord shall return the Working Drawings to Tenant with Landlords specific requested
changes noted thereon. Tenant shall revise and resubmit the Working Drawings to Landlord and
Landlord shall approve or disapprove such revised Working Drawings if a Design Problem exists
within five (5) business days after receipt. The Working Drawings as finally approved by Landlord
are referred to as the
Final Plans.
The Space Plan and Working Drawings may be submitted by
Tenant in one or more stages and at one or more times, and the time periods for Landlords approval
shall apply with respect to each such portion submitted. Tenant shall obtain all permits and
approvals necessary for all of the Tenant Improvements and construct and install all Tenant
Improvements within the Premises using Tenants Contractor in accordance with all applicable Laws
and the Final Plans, in a first-class and workmanlike manner. In the event Tenant needs to make
changes to the Final Plans, Tenant shall submit all Material Change Orders to Landlord for
Landlords approval, which approval shall be given or denied (and if denied, only if a Design
Problem exists and specifying the reasons for denial) within three (3) to five (5) business days
following Landlords receipt of any Material Change Order; provided, however, that Landlord agrees
to use commercially reasonable efforts to respond to a request for a Material Change Order within
three (3) business days. Any Construction Costs which are paid or incurred by Tenant by reason of
deficiencies in the Base Building Work shall be paid solely by Landlord and shall not be charged
against the Tenant Improvement Allowance or otherwise be paid by Tenant.
(c)
Payment of Tenant Improvement Allowance
. The Tenant Improvement Allowance shall
be disbursed to Tenant by Landlord within twenty (20) days of receipt of Tenants request
accompanied by paid invoices and lien free endorsements executed by the appropriate payee.
Landlords sole obligation to reimburse for Tenant Improvements shall not exceed that amount set
forth in the
Paragraph 19
of the Basic Lease Information. If any installment is not paid
when due, the same shall bear interest at the Interest Rate from the due date until the payment
date, and Tenant shall have the right to setoff the amount of such installments and such interest
against the rent due under the Lease. Landlord acknowledges that Tenant will be occupying the
Premises prior to the Commencement Date pursuant to a Sublease Agreement with MarketTools, Inc.
(the Sublease), which Sublease has been approved by Landlord. Notwithstanding any provision of
this Lease to the contrary, but subject to the terms and conditions of this Section 30, Tenant
shall be permitted to construct some or all of the Tenant Improvements to the Premises during the
term of the Sublease, and Landlord agrees to make the Tenant Improvement Allowance available
during such time period for such purposes. Landlord further agrees that (i) Tenant may use a
portion of the Tenant Improvement Allowance to construct an interior staircase connecting the
Premises with the premises leased by Tenant on
-34-
the third floor of the Building, and (ii) subject to Landlords approval as to the location,
capacity and means of installing the same, Tenant may install, at its cost, an emergency back-up
generator at a location mutually acceptable to Landlord and Tenant in compliance with all
applicable governmental regulations. The generator shall support all Building Systems, including
electrical, plumbing, heating, ventilating, sprinkler and life-safety equipment, serving the
Building, including the Premises and any common areas of the Building. Landlord will cooperate
with Tenant in obtaining any permits or other governmental approvals required by the City of Mill
Valley to install and operate the emergency
back-up generator.
(d)
Miscellaneous Charges
. Neither Tenant nor Tenants Contractor shall be charged
for, and Landlord shall provide, parking (to the extent parking is available) for Tenants
Architect, designers, contractors and subcontractors (including those people working on the Tenant
Improvements), electricity, water, toilet facilities, HVAC, security and elevators during the
design and construction of the Tenant Improvements and the move into the Premises. All such
equipment, areas, elevators and utilities shall be made reasonably available to Tenant during the
design and construction of the Tenant Improvements and the move into the Premises. The HVAC systems
for the Premises shall be run continuously twenty-four (24) hours per day, seven (7) days per week
during the move into the Premises to flush out and purge new finish odors.
(e)
Use of Conduits, Risers and Raceways
. Landlord shall make available to Tenant for
the initial Tenant Improvements and any later Alterations non-exclusive use of all existing
conduit, risers and vertical and horizontal raceways in the Building for
Tenants telecommunications and cabling requirements between the Premises and the roof of the
Building,
(f)
Codes/Hazardous Materials
. If Tenant cannot obtain or is delayed in obtaining
any permit required for construction of its Tenant Improvements or occupancy of the Premises
because the Building and/or the Premises (x) are not in full compliance with all applicable laws
and/or (y) contains Hazardous Materials and/or asbestos, then Landlord shall pay for or reimburse
Tenant for all increased costs paid or incurred by Tenant on account thereof in addition to the
Tenant Improvement Allowance and any delay in the completion of Tenants improvements shall be
deemed a Landlord Delay. Further, Landlord shall, at its sole cost and expense, immediately
correct any deficiencies as to legal compliance and the presence of Hazardous Materials and
asbestos.
(g)
Fee to Landlord
. Landlords management fee is three percent (3%).
31.
NOTICES
.
All notices under this Lease shall be in writing and sent to the parties at
the following addresses or at such other address as any party hereto may designate to the other by
notice delivered as provided herein:
|
|
|
To Landlord:
|
|
Bently Holdings CA LP
|
|
|
240 Stockton Street, 3rd Floor
|
|
|
San Francisco, California 94108
|
|
|
Telephone No.: (415) 288-0202
|
|
|
Facsimile No.: (415) 288-0203
|
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|
|
|
To Tenant:
|
|
Redwood Trust, Inc.
|
|
|
One Belvedere Place, Suite 300
|
|
|
Mill Valley, CA 94941
|
Any such notices shall be sent by (i) U.S. certified mail, postage prepaid, return receipt
requested, in which case notice shall be deemed delivered three business days after timely deposit
in the mail, (ii) a nationally recognized overnight courier, in which case notice shall be deemed
delivered one business day after timely deposit with such courier; (iii) personally delivered, in
which case notice shall be deemed delivered upon receipt or refusal of receipt, or (iv) electronic
communication, whether by telex, telegram or telecopying, in which case notice shall be deemed
delivered on the date of confirmed dispatch provided such electronic communication is followed up
with a notice sent by mail.
32.
ATTORNEYS FEES
. If either party places the enforcement of this Lease or any part
hereof, or the collection of any Basic Rent, additional rent or other charges due or to become due
hereunder, or recovery of the possession of the Premises, in the hands of an attorney, or files
suit or brings an arbitration upon the same, the non-prevailing (or defaulting) party shall pay the
other partys reasonable legal and attorneys fees, costs and expenses, including legal and
attorneys fees, costs and expenses incurred in connection with any appeals and any bankruptcy or
insolvency proceedings involving Tenant or this Lease. If Landlord is named as a defendant in any
suit brought against Tenant in connection with or arising out of Tenants occupancy hereunder,
Tenant shall pay to Landlord its reasonable costs and expenses in such suit, including its
reasonable attorneys fees. Any such attorneys fees and other expenses incurred by either party
in enforcing a judgment in its favor under this Lease shall be recoverable separately from and in
addition to any other amount included in such judgment, and such attorneys fees obligation is
intended to be severable from the other provisions of this Lease and to survive and not be merged
into any such judgment. The terms attorneys fees and attorneys fees, costs and expenses
shall mean the fees, costs and expenses of counsel to the parties hereto, which may include
printing, photostating, duplicating and other expenses, air freight charges, and fees billed for
law clerks, paralegals and other persons not admitted to the bar but performing services under the
supervision of an attorney, and the costs and fees incurred in connection with the enforcement or
collection of any judgment obtained in any such proceeding, and shall include, specifically, all
fees, costs and expenses of-expert witnesses. For purposes of this
Section 32
, the term
prevailing party shall include a prevailing party as defined in California Code of Civil
Procedure Section 998.
33.
HOLDING OVER
.
If Tenant holds over after the expiration or earlier termination of the
Term without the express prior written consent of Landlord, Tenant shall become a tenant from month
to month only, at a rental rate equal to one hundred twenty-five percent (125%) of the Basic Rent,
additional rent and other charges in effect upon the date of such expiration (subject to adjustment
as provided in
Section 4
hereof and prorated on a daily basis), and otherwise subject to
the terms, covenants and conditions herein specified, so far as applicable; provided, however, that
such percentage shall increase from one hundred twenty-five percent (125%) to one hundred fifty
percent (150%) following the first ninety (90) days of any such holding over. Acceptance by
Landlord of rent after such expiration or earlier termination shall not result in a renewal of this
Lease and shall not waive Landlords right to bring an unlawful detainer action against Tenant or
otherwise remove Tenant from the Premises. If Tenant fails to
-36-
surrender the Premises upon the expiration of this Lease despite demand to do so by Landlord,
Tenant shall indemnify, defend and hold Landlord harmless from all loss or liability, including
without limitation, any claim made by any succeeding tenant founded on or resulting from such
failure to surrender.
34.
SURRENDER OF PREMISES
. Subject to
Section 18(i)
, the voluntary or other
surrender of this Lease by Tenant, or a mutual cancellation hereof, shall not work a merger, and
shall, at the option of Landlord, operate as an assignment to it of any subleases or subtenancies.
35.
NON-WAIVER
. Neither the acceptance of rent nor any other act or omission of Landlord
or Tenant at any time or times after the happening of any event authorizing the cancellation or
forfeiture of this Lease shall operate as a waiver of any past or future violation, breach or
failure to keep or perform any covenant, agreement, term or condition hereof, or deprive the other
party of its rights and remedies under this Lease, or be construed so as to at any future time stop
Landlord or Tenant from promptly exercising any other option, right or remedy that it may have
under any term or provision of this Lease.
36.
MORTGAGE PROTECTION
. In the event of any default on the part of Landlord, Tenant will
give written notice by registered or certified mail to any beneficiary of a deed of trust or
mortgagee under a mortgage covering the Project or the Building whose address shall have been
furnished to Tenant, and shall offer such beneficiary or mortgagee a reasonable opportunity to cure
the default (if such beneficiary or mortgagee is acting in good faith to cure the Landlords
default (if curable)), including time to obtain possession of the Project or the Building by power
of sale or a judicial foreclosure, if such should prove necessary to effect a cure. For purposes
hereof, a reasonable opportunity shall mean thirty (30) days after receipt of Tenants notice or
such longer period as may be necessary so long as the cure is commenced within said thirty (30) day
period and is being diligently pursued to completion.
37.
EXPEDITED DISPUTE RESOLUTION
. With the exception of the arbitration provisions
which shall specifically apply to the determination of the Fair Market Rental Value and Landlords
exercise of unlawful detainer remedies, the provisions of this
Section 37
contain the sole
and exclusive method, means and procedure to resolve any and all disputes or disagreements,
including whether any particular matter constitutes, or with the passage of time would constitute,
an Event of Default. The parties hereby irrevocably waive any and all rights to the contrary and
shall at all times conduct themselves in strict, full, complete and timely accordance with the
provisions of this
Section 37
. Any and all attempts to circumvent the provisions of this
Section 37
shall be absolutely null and void and of no force or effect whatsoever. As to
any matter submitted to arbitration to determine whether it would, with the passage of time,
constitute an Event of Default, such passage of time shall not commence to run until any such
affirmative determination, so long as it is simultaneously determined that the challenge of such
matter as a potential Event of Default was made in good faith, except with respect to the payment
of money. With respect to the payment of money, such passage of time shall not commence to run
only if the party which is obligated to make the payment does in fact make the payment to the other
party. Such payment can be made under protest, which shall occur when such payment is
accompanied by a good faith notice stating why the party has elected to make a payment under
protest. Such protest will be deemed waived unless the subject matter identified in the protest is
submitted to arbitration as set forth in the following:
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(a)
Arbitration Panel
. Within ten (10) days after delivery of written notice
(Notice
of Dispute)
of the existence and nature of any dispute given by any party to the other party, and
unless otherwise provided herein in any specific instance, the parties shall each: (i) appoint one
(1) lawyer actively engaged in the licensed and full time practice of law, specializing in real
estate, in the County of Marin for a continuous period immediately preceding the date of delivery
(Dispute Date)
of the Notice of Dispute of not less than ten (10) years, but who has at no time
ever represented or acted on behalf of any of the parties, and (ii) deliver written notice of the
identity of such lawyer and a copy of his or her written acceptance of such appointment and
acknowledgment of and agreement to be bound by the time constraints and other provisions of this
Section 37
(Acceptance)
to the other parties hereto. The party who selects the lawyer
may not consult with such lawyer, directly or indirectly, to determine the lawyers position on the
issue which is the subject of the dispute. In the event that any party fails to so act, such
arbitrator shall be appointed pursuant to the same procedure that is followed when agreement cannot
be reached as to the third arbitrator. Within ten (10) days after such appointment and notice,
such lawyers shall appoint a third lawyer (together with the first two (2) lawyers,
Arbitration
Panel)
of the same qualification and background and shall deliver written notice of the identity
of such lawyer and a copy of his or her written Acceptance of such appointment to each of the
parties. In the event that agreement cannot be reached on the appointment of a third lawyer within
such period, such appointment and notification shall be made as quickly as possible by any court
of competent jurisdiction, by any licensing authority, agency or organization having
jurisdiction over such lawyers, by any professional association of lawyers in existence for not
less than ten (10) years at the time of such dispute or disagreement and the geographical
membership boundaries of which extend to the County of Marin or by any arbitration association or
organization in existence for not less than ten (10) years at the time of such dispute or
disagreement and the geographical boundaries of which extend to the County of Marin, as determined
by the party giving such Notice of Dispute and simultaneously confirmed in writing delivered by
such party to the other party. Any such court, authority, agency, association or organization
shall be entitled either to directly select such third lawyer or to designate in writing, delivered
to each of the parties, an individual who shall do so. In the event of any subsequent vacancies or
inabilities to perform among the Arbitration Panel, the lawyer or lawyers involved shall be
replaced in accordance with the provisions of this
Section 37
as if such replacement was an
initial appointment to be made under this
Section 37
within the time constraints set forth
in this
Section 37
, measured from the date of notice of such vacancy or inability, to the
person or persons required to make such appointment, with all the attendant consequences of failure
to act timely if such appointed person is a party hereto.
(b)
Duty
. Consistent with the provisions of this
Section 37
, the members of
the Arbitration Panel shall utilize their utmost skill and shall apply themselves diligently so as
to hear and decide, by majority vote, the outcome and resolution of any dispute or disagreement
submitted to the Arbitration Panel as promptly as possible, but in any event on or before the
expiration of thirty (30) days after the appointment of the members of the Arbitration Panel. None
of the members of the Arbitration Panel shall have any liability whatsoever for any acts or
omissions performed or omitted in good faith pursuant to the provisions of this
Section 37
.
(c)
Authority
. The Arbitration Panel shall (i) enforce and interpret the rights and
obligations set forth in the Lease to the extent not prohibited by law, (ii) fix and establish any
and all rules as it shall consider appropriate in its sole and absolute discretion to govern the
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proceedings before it, including any and all rules of discovery, procedure and/or evidence, and
(iii) make and issue any and all orders, final or otherwise, and any and all awards, as a court of
competent jurisdiction sitting at law or in equity could make and issue, and as it shall consider
appropriate in its sole and absolute discretion, including the awarding of monetary damages (but
shall not award consequential damages to either party and shall not award punitive damages except
in situations involving knowing fraud or egregious conduct condoned by, or performed by, the person
who, in essence, occupies the position which is the equivalent of the chief executive officer of
the party against whom damages are to be awarded), the awarding of reasonable attorneys fees and
costs to the prevailing party as determined by the Arbitration Panel and the issuance of injunctive
relief. If the party against whom the award is issued complies with the award, within the time
period established by the Arbitration Panel, then no Event of Default will be deemed to have
occurred, unless the Event of Default pertained to the non payment of money by Tenant or Landlord,
and Tenant or Landlord failed to make such payment under protest.
(d)
Appeal
. The decision of the Arbitration Panel shall be final and binding, may be
confirmed and entered by any court of competent jurisdiction at the request of any party and may
not be appealed to any court of competent jurisdiction or otherwise except upon a claim of fraud
on the part of the Arbitration Panel, or on the basis of a mistake as to the applicable law. The
Arbitration Panel shall retain jurisdiction over any dispute until its award has been implemented,
and judgment on any such award may be entered in any court having appropriate jurisdiction.
38.
CHANGES TO THE PROJECT
. Landlord reserves the right at any time to make changes,
alterations, reductions and additions to the Project, including the construction of other buildings
or improvements in the Project, the leasing of space to restaurant uses, the building of additional
stories on any building, without any liability or responsibility to Tenant. Landlord will not
block ingress and egress to the Premises. No rights to any view or to light or air over any
property, whether belonging to Landlord or any other person, are granted to Tenant by this Lease.
If at any time any windows of the Premises are temporarily darkened or the light or view therefrom
is obstructed by reason of any repairs, improvements, maintenance or cleaning in or about the
Project, the same shall be without liability to the Landlord and without any reduction or
diminution of Tenants obligations under this Lease. Notwithstanding the foregoing, Landlord agrees
that it shall not make or permit any permanent modification to the Building (as built substantially
in accordance with the Building Plans), on any changes, alterations, reductions and additions to
the Project, which change the nature of the Building to something other than a first class office
building, materially obstructs the natural light to the Premises or which materially adversely
affects (a) use or occupancy of the Premises, (b) parking serving the Building, or (c) ingress,
egress or access to or from the Building and the Premises.
39.
WAIVER OF JURY TRIAL
. EACH PARTY HEREBY WAIVES ANY RIGHT TO A TRIAL BY JURY IN ANY
ACTION TO ENFORCE THE SPECIFIC PERFORMANCE OF THIS LEASE, FOR DAMAGES FOR THE BREACH HEREOF, OR
OTHERWISE FOR ENFORCEMENT OF ANY REMEDY HEREUNDER. If either party commences litigation against
the other for the specific performance of this Lease, for damages for the breach hereof or
otherwise for enforcement of any remedy hereunder, the prevailing party shall be entitled to
recover from the other party such costs and reasonable attorneys fees as may have been
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incurred, including any and all costs incurred in enforcing, perfecting and executing such
judgment.
40.
OPTIONS TO EXTEND THE TERM
.
(a)
Extension Terms
.
(1)
First Extension Term
. Landlord grants to Tenant an option to extend the Initial
Term (the
First Extension Option)
with respect to all (but not less than all) of the rentable
area of the Premises leased by Tenant as of the Expiration Date of the Initial Term for five (5)
years (the
First Extension Term)
. The First Extension Term shall commence immediately
following the Expiration Date of the Initial Term. The First Extension Option shall be exercised,
if at all, by written notice to Landlord at any time during the Initial Term on or before the date
that is one hundred eighty (180) days prior to the Expiration Date, which notice shall be
irrevocable by Tenant. Notwithstanding the foregoing, if an Event of Default (following the
expiration of all applicable cure period without cure) exists under this Lease either at the time
Tenant exercises the First Extension Option or at any time thereafter prior to on upon the
commencement of the First Extension Term, Landlord shall have, in addition to all of Landlords
other rights and remedies under this Lease, the right to terminate the First Extension Option and
to cancel unilaterally Tenants exercise of the First Extension Option, in which event the
Expiration Date of this Lease shall be and remain the then scheduled Expiration Date, and Tenant
shall have no further rights under this Lease to renew or extend the Term.
(2)
Second Extension Term
. Landlord grants to Tenant an option to extend Term of
this Lease (the
Second Extension Option)
with respect to all (but not less than all) of the
rentable area of the Premises leased by Tenant as of the Expiration Date of the First Extension
Term for five (5) years (the
Second Extension Term)
. The Second Extension Term shall commence
immediately following the Expiration Date of the First Extension Term. The Second Extension Option
shall be exercised, if at all, by written notice to Landlord at any time during the First Extension
Term on or before the date that is one hundred eighty (180) days prior to the Expiration Date of
the First Extension Term, which notice shall be irrevocable by Tenant. Notwithstanding the
foregoing, if an Event of Default (following the expiration of all applicable cure period without
cure) exists under this Lease either at the time Tenant exercises the Second Extension Option or at
any time thereafter prior to or upon the commencement of the Second Extension Term, Landlord shall
have, in addition to all of Landlords other rights and remedies under this Lease, the right to
terminate the Second Extension Option and to cancel unilaterally Tenants exercise of the Second
Extension Option, in which event the Expiration Date of this Lease shall be and remain the then
scheduled Expiration Date of the First Extension Term, and Tenant shall have no further rights
under this Lease to renew or extend the Term.
(b)
Extension Term Rent
.
(1) The First Extension Term and Second Extension Term (each an
Extension Term)
shall be
upon and subject to all of the terms, covenants and conditions of this Lease; provided, however,
that Basic Rent for each Extension Term shall be equal to ninety-five percent (95%) of the Fair
Market Rental Value and the Base Year for each Extension Term shall be the calendar year in which
such Extension Term commences unless the Extension Term
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commences on or after October 1 of such calendar year, in which event the Base Year shall be the
calendar year following the calendar year in which the Extension Term commences. Such Basic Rent
shall be determined by Landlord in good faith not later than four (4) months prior to the
commencement of the applicable Extension Term. Tenant shall send to Landlord a written notice,
within thirty (30) days after the date of Landlords notice setting forth the Fair Market Rental
Value for the Extension Term, which notice shall state that Tenant either (x) agrees with
Landlords determination of Fair Market Rental Value for the Extension Term or (y) disagrees with
Landlords determination of Fair Market Rental Value for the Extension Term and elects to resolve
the disagreement as provided in
Section 40(b)(2)
below. If Tenant does not send to Landlord
a notice as provided in the previous sentence within the said thirty (30) day period, Tenant will
be deemed to have elected (y) above and the Fair Market Rental Value shall be resolved in
accordance with
Section 40(b)(2)
below. Until the disagreement is resolved as provided in
Section 40(b)(2)
below, Tenants monthly payments of Basic Rent during the then applicable
Extended Term shall be in an amount not less than the greater of (x) Tenants determination of the
Fair Market Rental Value and (y) the Basic Rent payable for the twelve (12) month period
immediately preceding the commencement of the Extension Term. Within ten (10) business days
following the resolution of such dispute by the parties or the decision of the brokers, one party
shall make any necessary payment to the other party in order to adjust the amount previously paid
by Tenant during the Extension Term to the Fair Market Rental Value as determined. Tenant shall in
any event pay all applicable additional charges with respect to the Premises, in the manner and at
the times provided in this Lease, effective upon the commencement of the Extension Term, and
notwithstanding any dispute regarding the Basic Rent for the Extension Term.
(2) Any disagreement regarding the Fair Market Rental Value as defined in this
Section 40
shall be resolved as follows:
(i) Within twenty (20) days after Tenants response to Landlords notice of the Landlords
initial determination of the Fair Market Rental Value, Landlord and Tenant shall meet no less than
two (2) times, at a mutually agreeable time and place, to attempt to resolve any such
disagreement.
(ii) If, within the twenty (20) day consultation period described in subsection (i) above,
Landlord and Tenant cannot reach an agreement as to the Fair Market Rental Value, they shall each
make a separate determination of the Fair Market Rental Value within five (5) business days after
the expiration of the said twenty (20) day period, and such determinations shall be submitted to
arbitration in accordance with subsection (iii) below; provided that, if only one (1)
determination of Fair Market Rental Value is submitted to arbitration within the said five (5)
business day period, then such determination shall equal the Basic Rent for the Extension Term and
the parties shall not proceed with arbitration.
(iii) If the Basic Rent has not been determined pursuant to the procedures outlined above,
Landlord and Tenant shall each appoint one arbitrator who is unaffiliated with Landlord or Tenant
and who shall be a real estate broker and shall have been active over the five (5) year period
ending on the date of such appointment in the leasing of commercial mid-rise and/or high-rise
properties in the greater San Francisco metropolitan area. Each such arbitrator shall be appointed
within five (5) business days after the expiration of the
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twenty (20) day period described in subsection (ii) above. The two (2) arbitrators so appointed
shall within ten (10) days of the date of appointment of the last appointed arbitrator agree upon
and appoint a third arbitrator who shall be qualified under the same criteria set forth hereinabove
for qualification of the first two (2) arbitrators. The determination of the arbitrators shall be
limited solely to the issue of whether the Landlords or the Tenants submitted Fair Market Rental
Value (using the criteria for determining Fair Market Rental Value set forth in
Paragraph
15
of the Basic Lease Provisions) is the closest to the actual Fair Market Rental Value of the
Premises, as determined by the arbitrators. The three (3) arbitrators shall within thirty (30) days
of the appointment of the third arbitrator reach a decision as to whether the parties shall use the
Landlords or the Tenants submitted Fair Market Rental Value as the Basic Rent for the Extension
Term, and shall notify Landlord and Tenant thereof. The decision of the majority of the three (3)
arbitrators shall be binding upon Landlord and Tenant. If either Landlord or Tenant fails to
appoint an arbitrator within the five (5) business day period provided above, then the arbitrator
appointed by one of them shall reach a decision, notify Landlord and Tenant thereof, and such
arbitrators decision shall be binding upon Landlord and Tenant. If the two (2) arbitrators fail to
agree upon and appoint a third arbitrator within the ten (10) day period provided above, or both
parties fail to appoint an arbitrator within the five (5) business day period provided above, then
the Landlord shall prepare and submit to Tenant a list of three (3) proposed arbitrators that
possess the required qualifications as set forth above; provided that none of such proposed
arbitrators nor the firm for which any of them works shall be a current or past affiliate of either
the Landlord or the Tenant or currently retained or employed by the Landlord or the Tenant. Within
five (5) business days after receipt of such list, the Tenant shall select an arbitrator therefrom
and such person shall be the third or single, as the case may be, arbitrator hereunder. If Tenant
fails to make such selection with such five (5) business day period, then the Landlord shall select
the third or single, as the case may be, arbitrator from such list. Each party shall pay the cost
of the arbitrator which it first selects and the parties shall share equally the cost of the third
arbitrator.
41.
GENERAL PROVISIONS
.
(a)
Entire Agreement
. This Lease contains all of the agreements of the
parties, and there are no verbal or other agreements which modify or affect this Lease. This
Lease supersedes any and all prior agreements made or executed by or on behalf of the parties
hereto regarding the Premises.
(b)
Terms and Headings
. The words
Landlord
and
Tenant
include the plural as well
as the singular, and words used in any gender include all genders. The titles to sections of this
Lease are not a part of this Lease and shall have no effect upon the construction or interpretation
of any part hereof.
(c)
Successors and Assigns
. All of the covenants, agreements, terms and conditions
contained in this Lease shall inure to and be binding upon Landlord and Tenant and their respective
permitted successors in interest and assigns.
(d)
Brokers
. Each of Landlord and Tenant represents and warrants to the other party
that it has not engaged any broker, finder or other person who would be entitled to any commission
or fees in respect of the negotiation, execution or delivery of this Lease other than
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Landlords Broker and Tenants Broker (as defined in
Paragraphs 22 and 23
, respectively,
of the Basic Lease Information) (collectively, the
Brokers)
and shall indemnify, defend and hold
harmless the other party from and against any claim, demand, damage, loss, cost, liability or
expense incurred by such other party as a result of any claim asserted by any other broker, finder
or other person other than Brokers on the basis of any arrangements or agreements made or alleged
to have been made by or on behalf of such representing party, respectively.
(e)
Liability of Landlord
. Landlords obligations and liability to Tenant under this
Lease shall be limited solely to Landlords interest in the Project, all post-judgment rents,
issues and profits arising therefrom and the proceeds from the sale thereof, and any available
insurance proceeds and neither Landlord nor any of the members in Landlord, nor any officer,
director, shareholder or partner of or in Landlord or any members in Landlord shall have or incur
any personal liability whatsoever with respect to this Lease.
(f)
Independent Covenants
. Subject to the provisions of
Section 7(a)
above,
this Lease shall be construed as though the covenants herein between Landlord and Tenant are
independent and not dependent and Tenant agrees that if Landlord fails to perform its obligations
set forth herein, Tenant shall not be entitled to make any repairs or perform any acts hereunder at
Landlords expense or to any setoff of amounts owing hereunder against Landlord except as otherwise
provided in this Lease; provided, however, that the foregoing shall in no way impair the right of
Tenant to commence a separate action against Landlord for any violation by Landlord of the
provisions hereof so long as notice is first given to Landlord and any holder of a mortgage or deed
of trust covering the Building or the Project or any portion thereof, and an opportunity is granted
to Landlord and such mortgage holder to correct such violations as provided above.
(g)
Waiver of Redemption by Tenant
. Tenant hereby waives, for Tenant and for all
those claiming under Tenant, any and all rights now or hereafter existing to redeem by order or
judgment of any court or by any legal process or writ, Tenants right of occupancy of the Premises
after any termination of this Lease.
(h)
Severability
. Any provision of this Lease which shall prove to be invalid, void
or illegal shall in no way affect, impair or invalidate any other provision hereof, and the
remaining provisions hereof shall nevertheless remain in full force and effect.
(i)
Force Majeure
. Except as may be otherwise specifically provided herein, time
periods for Landlords or Tenants performance under any provisions of this Lease not involving
the payment of money shall be extended for periods of time during which the non-performing partys
performance is prevented due to circumstances beyond the partys control, including, without
limitation, strikes, embargoes, governmental regulations, acts of God, weather, war or other
strife. Tenant hereby waives and releases its right to terminate this Lease under Section 1932(1)
of the California Civil Code or under any similar law, statute or ordinance now or hereafter in
effect.
(j)
Intentionally Omitted
.
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(k)
Examination of Lease
. Submission of this instrument for examination or signature
by Tenant does not constitute a reservation of or option to lease, and it is not effective as a
lease or otherwise until execution by and delivery to both Landlord and Tenant.
(1)
No Warranty
. In executing and delivering this Lease, Tenant has not relied on any
representations, including, but not limited to, any representation as to the amount of any item
comprising additional rent or the amount of the additional rent in the aggregate or that Landlord
is furnishing the same services to other tenants, at all, on the same level or on the same basis,
or any warranty or any statement of Landlord which is not set forth herein or in one or more of
the exhibits attached hereto.
(m)
Right to Lease
. Landlord reserves the absolute right to effect such other
tenancies in the Project as Landlord in the exercise of its sole business judgment shall determine
to best promote the interests of the Building and the Belvedere Place office center so long as the
Building remains a first-class office building comparable to Comparable Buildings. Tenant does not
rely on the fact, nor does Landlord represent, that any specific tenant or type or number of
tenants shall, during the Term, occupy any space in the Building or the Belvedere Place office
center.
(n)
Transportation Management
. Tenant shall exercise commercially reasonable efforts
to comply with all present or future programs intended to manage parking, transportation or
traffic in and around the Project, and in connection therewith, Tenant shall take reasonable and
responsible action for the transportation planning and management of all employees located at the
Project by working directly with Landlord, any governmental transportation management organization
or any other transportation-related committees or entities. Such programs may include, without
limitation (i) restrictions on the number of peak-hour vehicle trips generated by Tenant; (ii)
increased vehicle occupancy; (iii) implementation of an in-house ridesharing program and an
employee transportation coordinator; (iv) working with employees and any Project, Building or
area-wide ridesharing program manager; and (v) utilizing flexible work shifts for employees.
(o)
Modification for Lender
. If, in connection with Landlords obtaining
construction, interim or permanent financing for the Building or Project, the lender shall request
reasonable modifications in this Lease as a condition to such financing, Tenant will not
unreasonably withhold, delay or defer its consent thereto, provided that such modifications do not
increase the obligations of Tenant hereunder, decrease Tenants rights or adversely affect the
leasehold interest hereby created or Tenants rights hereunder.
(p)
Requirements of Law
. Landlord shall comply with all laws, rules and regulations
(including, without limitation, the Americans with Disabilities Act) applicable to the common
areas of the Building, other than such laws, rules and regulations with which Tenant is obligated
to comply under the terms of this Lease.
(q)
Recording
. Neither Landlord nor Tenant shall record this Lease nor a short form
memorandum hereof without the consent of the other, which consent shall not be unreasonably
withheld.
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(r)
Applicable Laws
. This Lease shall be governed by and construed pursuant to the
laws of the State of California.
(s)
Relationship of Parties
. Nothing contained in this Lease shall be deemed or
construed by the parties hereto or by any third party to create the relationship of principal and
agent, partnership, joint venture or any association between Landlord and Tenant, it being
expressly understood and agreed that neither the method of computation of rent nor any act or
omission of the parties hereto shall be deemed to create any relationship between Landlord and
Tenant other than the relationship of landlord and tenant.
(t)
Landlords Title
. Landlords title is and always shall be paramount to the title
of Tenant. Nothing herein contained shall empower Tenant to do any act which can, shall or may
encumber the title of Landlord.
(u)
Project or Building Name and Storage
. Landlord shall have the right at any time
to change the name of the Building or Project and to install, affix and maintain any and all signs
on the exterior and on the interior of the Project or Building as Landlord may, in Landlords sole
discretion, desire. Tenant shall not use the name of the Project or the Building (including the
name Belvedere Place) or use pictures or illustrations of the Project or the Building in
advertising or other publicity, without the prior written consent of the Landlord (which consent
shall not be unreasonably withheld).
(v)
Survival of Obligations
. All provisions of this Lease which require the payment
of money or the delivery of property after the termination of this Lease or require either party
to indemnify, defend or hold the other harmless shall survive the termination of this Lease.
(w)
Authority
. Each individual executing this Lease represents that it has all
requisite power and authority to execute and deliver this Lease on behalf of the entity for which
it is signing, and by his or her signature, will bind such party to the terms of this Lease.
(x)
Execution in Counterparts
. This Agreement may be executed in any number of
counterparts and by different parties hereto in separate counterparts, each of which when so
executed shall be deemed to be an original and all of which taken together shall constitute one and
the same agreement.
(y)
Consent/Duty to Act Reasonably
. Any time the consent of Landlord or Tenant is
required, such consent shall not be unreasonably withheld, conditioned or delayed. Whenever this
Lease grants Landlord or Tenant the right to take action, exercise discretion, establish rules and
regulations or make allocations or other determinations (other than decisions to exercise
expansion, contraction, cancellation, termination or renewal options), Landlord and Tenant shall
act reasonably and in good faith and take no action which might result in the frustration of the
reasonable expectations of a sophisticated tenant or landlord concerning the benefits to be
enjoyed under this Lease.
(z)
Landlord Bankruptcy Proceeding
. In the event that the obligations of Landlord
under this Lease are not performed during the pendency of a bankruptcy or insolvency proceeding
involving the Landlord as the debtor, or following the rejection of this Lease in accordance with
Section 365 of the United States Bankruptcy Code, then notwithstanding any
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provision of this Lease to the contrary, and in addition to any and all other remedies permitted by
this Lease and/or by applicable laws Tenant shall have the right to set off against Rents next due
and owing under this Lease (a) any and all damages caused by such non-performance of Landlords
obligations under this Lease by Landlord, debtor-in-possession, or the bankruptcy trustee, and (b)
any and all damages caused by the non-performance of Landlords obligations under this Lease
following any rejection of this Lease in accordance with Section 365 of the United States
Bankruptcy Code.
(aa)
Access
. Tenant shall be granted access to the Building, the Premises and the
parking provided to the Building twenty-four (24) hours per day, seven (7) days per week, every
day of the year.
(bb)
Prohibited Persons and Transactions
. Tenant and Landlord (each, a
Representing
Party)
each represents and warrants to the other (i) that neither the Representing Party nor any
person or entity that directly owns a 10% or greater equity interest in it nor any of its
officers, directors or managing members is a person or entity (each, a
Prohibited Person)
with
whom U.S. persons or entities are restricted from doing business under regulations of the Office
of Foreign Asset Control
(OFAC)
of the Department of the Treasury (including those named on
OFACs Specially Designated and Blocked Persons List) or under any statute, executive order
(including Executive Order 13224 (the
Executive Order)
signed on September 24, 2001 and entitled
Blocking Property and Prohibiting Transactions with Persons Who Commit, Threaten to Commit, or
Support Terrorism, or other governmental action, (ii) that the Representing Partys activities do
not violate the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001
or the regulations or orders promulgated thereunder (as amended from time to time, the
Money
Laundering Act
), and (iii) that throughout the Term the Representing Party shall comply with the
Executive Order and with the Money Laundering Act.
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(cc)
When Payment Is Due
. Whenever in this Lease a payment is required to be made by
one party to the other, but a specific date for payment is not set forth or a specific number of
days within which payment is to be made is not set forth, or the words immediately, promptly
and/or on demand, or the equivalent, are used to specify when such payment is due, then such
payment shall be due thirty (30) days after the party which is entitled to such payment sends
written notice to the other party demanding payment.
IN WITNESS WHEREOF, the parties hereto have executed this Lease as of the date first above
written.
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LANDLORD:
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BENTLY HOLDINGS CALIFORNIA LP,
a California limited partnership
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By:
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/s/ Chris Bently
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Name: Chris Bently
Its: CEO
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By:
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/s/ Amber Marie Bently
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Name: Amber Marie Bently
Its: President
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TENANT:
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REDWOOD TRUST, INC., a Maryland corporation
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By:
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/s/ Harold F. Zagunis
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Name: Harold F. Zagunis
Its: CFO
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-47-
EXHIBIT A
LEGAL DESCRIPTION OF THE PROPERTY
All that certain real property situated in the County of Marin, State of California, described as
follows:
PARCEL ONE:
PARCEL 2, as shown upon that certain map entitled, Parcel Map, Bernard J. Schoenberg, 2514 O.R.
36 and 2721 O.R. 177, Marin County, California, filed for record August 22, 1974 in Volume 10 of
Parcel Maps, at Page 54, Marin County Records.
PARCEL TWO:
A NON-EXCLUSIVE EASEMENT for roadway and public utility purposes over the following described
property:
BEGINNING at a point called true point of beginning in the Memorandum of Lease recorded in Book
1965 of Official Records, at Page 240; thence along the Easterly line of Belvedere Drive on a curve
to the left, having a radius of 188.16 feet, whose center bears North 12
o
57
o
25
o
West through an
angle of 25
o
24
o
25
o
83.44 feet; thence leaving said Drive on a curve to the left having a radius
of 20 feet, whose center bears South 38
o
21
o
50
o
East through an angle of 48
o
12
o
10
o
16.83 feet;
thence South 03
o
26
o
West 155.95 feet to the Lands of Millard Development Company recorded February
4, 1966 in Book 2022 of Official Records, at Page 393; thence along said Lands, South 50
o
20
o
34
o
West 52.37 feet to an angle point in said Lands; thence leaving said Lands, North 03
o
20
o
17
o
West
13.69 feet to the corner of said Lands in the Memorandum of Lease; thence along said Lands, North
03
o
26
o
East 133.47 feet; thence on a curve to the left, having a radius of 20 feet, whose center
bears North 86
o
34
o
West through an angle of 106
o
23
o
25
o
a distance of 37.14 feet to the point of
beginning.
-1-
EXHIBIT B
DESCRIPTION OF THE PREMISES
-1-
EXHIBIT C
NOTICE OF LEASE TERM DATES
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Re:
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Office Lease dated _______ , 2006, between Bently Holdings California
LP, a California limited partnership (Landlord), and Redwood Trust, Inc., a
Maryland corporation (Tenant), concerning Suite 200 on the Second Floor of the
office building located within the Belvedere Place office center at Two Belvedere
Place, Mill Valley, California
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Ladies and Gentlemen:
In accordance with the referenced Office Lease (the Lease), we wish to advise you and/or
confirm as follows:
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1.
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The Substantial Completion of the Premises has occurred, and the Term shall
commence on or has commenced on
for a term of
months ending on
.
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2.
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Rent commenced to accrue on _______ , in the amount of
$
[INSERT BASIC RENT AND ADDITIONAL RENT].
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3.
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If the Commencement Date is other than the first day of the month, the first billing
will contain a pro rata adjustment. Each billing thereafter, with the exception of
the final billing, shall be for the full amount of the monthly installment as provided
for in the Lease.
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4.
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Your rent checks should be made payable to ___
____ at _______.
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Initially capitalized terms used herein without definition shall have the respective meanings
given such terms in the Lease.
LANDLORD:
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Bently Holdings California LP,
a California limited partnership
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By:
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/s/ Chris Bently
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Name: Chris Bently
Title: CEO
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-1-
EXHIBIT D
FORM OF TENANT ESTOPPEL CERTIFICATE
TENANT ESTOPPEL CERTIFICATE
Ladies and Gentlemen:
, a
(Tenant) hereby certifies as follows:
1. The undersigned is the Tenant under that certain Office Lease dated
(the Lease), executed by BENTLY HODLINGS CALIFORNIA LP, a California limited partnership
(Landlord), as Landlord, and the undersigned, as Tenant, covering a portion of the
building located at
Belvedere Place, Mill Valley, California designated as Suite 200 and
located on Second Floor (the Premises). Initially capitalized terms used herein without
definition shall have the respective meanings given such terms in the Lease.
2. The Premises consists of approximately
rentable square feet of
space. Tenant has paid to Landlord a security deposit of $
. The Term of the Lease
commenced on
and the expiration of the Lease is
. Tenant
has paid rent through
. The next rental payment in the amount of
$
is due on
. Tenant is required to pay
percent
(
%) of all annual operating expenses for the Project in excess of
.
3. The Lease provides for an option to extend the Term of the Lease for
years. The rental rate for such extension term is as follows:
.
Except as expressly provided in the Lease, and other documents attached hereto, Tenant does not
have any right or option to renew or extend the Term of the Lease, to lease other space at the
Project, nor any preferential right to purchase all or any part of the Premises, the Building or
the Project.
4. True, correct and complete copies of the Lease and all amendments, modifications and
supplements thereto are attached hereto and the Lease, as so amended, modified and supplemented is
in full force and effect, and represents the entire agreement between Tenant and Landlord with
respect to the Premises, the Building and the Project. There are no amendments, modifications or
supplements to the Lease, whether oral or written, except as follows (include the date of such
amendment, modification or supplement):
5. All space and improvements leased by the Tenant have been completed and furnished in
accordance with the provisions of the Lease, and the Tenant has accepted and taken possession of
the Premises.
-1-
6. To Tenants actual knowledge, Landlord is not in any respect in default in the
performance of the terms and provisions of the Lease. Tenant is not in any respect in default
under the Lease beyond all applicable notice and cure periods and has not assigned, transferred or
hypothecated the Lease or any interest therein or subleased all or any portion of the Premises.
7. There are no offsets or credits against rentals payable under the Lease and no free rent
periods or rental concessions have been granted to Tenant, except as
follows:
.
8. If Tenant is a corporation or partnership, each individual executing this Certificate on
behalf of Tenant hereby represents and warrants that Tenant is a duly formed and existing entity
qualified to do business in the State of California and that Tenant has full right and authority to
execute and deliver this Certificate and that each person signing on behalf of Tenant is authorized
to do so.
9. This Certificate is given to
with the understanding
that
will rely hereon in connection with the conveyance/financing
of the Building or Project of which the Premises is a part. Following any
such conveyance/financing, Tenant agrees that this Lease shall remain in full force and effect and
shall bind and inure to the benefit of
and its lenders, successors and assigns.
Tenant hereby expressly acknowledges and agrees that
is relying upon
this Certificate.
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Tenant
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,
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a
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By:
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Name:
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Title:
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-2-
EXHIBIT E
RULES AND REGULATIONS
1. Tenant shall have access to the Building and the Premises at all times during the Term,
except to the extent otherwise necessary for emergencies, maintenance or repairs, which maintenance
and repairs shall be accomplished with as little interference to Tenant as commercially
reasonable. On all hours other than normal business hours for the Project (as defined in
Paragraph 19(iii) of these Rules and Regulations below), or such other hours as Landlord shall
determine from time to time, access to the Project and/or to the passageways, entrances, exits,
shipping areas, halls, corridors, elevators or stairways and other areas in the Project may be
restricted and access gained by use of a key/card key to the outside doors of the Project, or
pursuant to such security procedures as Landlord may from time to time impose. All such areas, and
all roofs, are not for use of the general public, and Landlord shall in all cases retain the right
to control and prevent access thereto by all persons whose presence in the judgment of Landlord
shall be prejudicial to the safety, character, reputation and interests of the Project and its
tenants, provided, however, that nothing herein contained shall be construed to prevent such access
to persons with whom Tenant deals in the normal course of Tenants business unless such persons are
engaged in activities which are illegal or violate these Rules. No Tenant Parties shall enter into
areas reserved for the exclusive use of Landlord Parties. Tenant shall keep doors to corridors and
lobbies closed except when persons are entering or leaving.
2. Tenant shall not paint, display, inscribe, maintain or affix any sign, placard, picture,
advertisement, name, notice, lettering or direction on any part of the outside or inside of the
Project, or on any part of the inside of the Premises which can be seen from the outside of the
Premises, without the prior consent of Landlord, and then only such name or names or matter and in
such color, size, style, character and material as may be first approved by Landlord in writing.
Landlord shall prescribe the suite number and identification sign for the Premises (which shall be
prepared and installed by Landlord at Tenants expense). Landlord reserves the right to remove at
Tenants expense all matter not so installed or approved without notice to Tenant.
3. Tenant shall not in any manner use the name of the Project for any purpose other than that
of the business address of the Tenant, or use any picture or likeness of the Project, in any
letterheads, envelopes, circulars, notices, advertisements, containers or wrapping material without
Landlords express written consent.
4. Tenant shall not place anything or allow anything to be placed in the Premises near the
glass of any door, partition, wall or window which may be unsightly from outside the Premises, and
Tenant shall not place or permit to be placed any article of any kind on any window ledge or on the
exterior walls. Blinds, shades, awnings or other forms of inside or outside window ventilators or
similar devices, shall not be placed in or about the outside windows in the Premises except to the
extent, if any, that the character, shape, color, material and make thereof are first approved by
Landlord in writing.
5. Furniture, freight and other large or heavy articles, and all other deliveries may be
brought into the Project only at times and in the manner designated by Landlord, and always at
Tenants sole responsibility and risk. Landlord may impose reasonable charges for use of freight
-1-
elevators after or before normal business hours. All damage done to the Project by moving or
maintaining such furniture, freight or articles shall be repaired by Landlord at Tenants expense.
Landlord may inspect items brought into the Project or Premises with respect to weight or
dangerous nature. Landlord may require that all furniture, equipment, cartons and similar articles
removed from the Premises or the Project be listed and a removal permit therefor first be obtained
from Landlord. Tenant shall not take or permit to be taken in or out of other entrances or
elevators of the Project any item normally taken, or which Landlord otherwise reasonably requires
to be taken, in or out through service doors or on freight elevators. Tenant shall not allow
anything to remain in or obstruct in any way, any lobby, corridor, sidewalk, passageway, entrance,
exit, hall, stairway, shipping area, or other such area. Tenant shall move all supplies, furniture
and equipment as soon as received directly to the Premises, and shall move all such items and
waste (other than waste customarily removed by Project employees) that are at any time being taken
from the Premises directly to the areas designated for disposal. Any handcarts used at the Project
shall have rubber wheels.
6. Tenant shall not overload any floor or part thereof in the Premises, or Project, including
any public corridors or elevators therein bringing in or removing any large or heavy articles, and
Landlord may direct and control the location of safes and all other heavy articles and require
supplementary supports at Tenants expense of such material and dimensions as Landlord may deem
necessary to properly distribute the weight.
7. Tenant shall not attach or permit to be attached additional locks or similar devices to any
door or window, change existing locks or the mechanism thereof, or make or permit to be made any
keys for any door other than those provided by Landlord. If more than two keys for one lock are
desired, Landlord will provide them upon payment therefor by Tenant. Tenant, upon termination of
its tenancy, shall deliver to Landlord all keys of offices, rooms and toilet rooms which have been
furnished Tenant or which Tenant shall have had made, and in the event of loss of any keys so
furnished shall pay Landlord therefor.
8. If Tenant desires signal, communication, alarm or other utility or similar service
connections installed or changed, Tenant shall not install or change the same without the prior
approval of Landlord, and then only under Landlords direction at Tenants expense. Tenant shall
not install in the Premises any equipment which requires more electric current than Landlord is
required to provide under this Lease, without Landlords prior written approval, and Tenant shall
ascertain from Landlord the maximum amount of load or demand for or use of electrical current which
can safely be permitted in the Premises, taking into account the capacity of electric wiring in the
Building and the Premises and the needs of tenants of the Building, and shall not in any event
connect a greater load than such safe capacity.
9. Tenant shall not obtain for use upon the Premises ice, drinking water, towel, janitorial
and other similar services, except from Persons approved by Landlord in writing. Any Person engaged
by Tenant to provide janitor or other services shall be subject to direction by the manager or
security personnel of the Project.
10. The toilet rooms, urinals, washbowls and other such apparatus shall not be used for any
purpose other than that for which they were constructed, and no foreign substance of any kind
whatsoever shall be thrown therein, and the expense of any breakage, stoppage or damage resulting
from the violation of this Rule shall be borne by Tenant who, or whose employees or invitees, shall
have caused it. Tenant shall not cause any unnecessary labor by reason of
-2-
Tenants carelessness or indifference in the preservation of good order and cleanliness in and
around the Project.
11. The janitorial closets, utility closets, telephone closets, broom closets, electrical
closets, storage closets, and other such closets, rooms and areas shall be used only for the
purposes and in the manner designated by Landlord, and may not be used by tenants, or their
contractors, agents, employees, or other parties, without Landlords prior written consent.
12. Landlord reserves the right to exclude or expel from the Project any person who, in the
judgment of Landlord, is intoxicated or under the influence of liquor or drugs, or who shall in any
manner do any act in violation of any of these Rules. Tenant shall not at any time manufacture,
sell, use or give away, any spirituous, fermented, intoxicating or alcoholic liquors on the
Premises, nor permit any of the same to occur (except in connection with occasional social or
business events conducted in the Premises which do not violate any laws nor bother or annoy any
other tenants). Tenant shall not at any time sell, purchase or give away food in any form by or to
any of the other Tenant Parties or any other parties on the Premises, nor permit any of the same to
occur (other than in lunchrooms or kitchens for employees).
13. Tenant shall not make any room-to-room canvass to solicit business or
information or to distribute any article or material to or from other tenants or occupants of the
Project and shall not exhibit, sell or offer to sell, use, rent or exchange any products or
services in or from the Premises unless ordinarily embraced within the Tenants use of the Premises
specified in the Lease.
14. Tenant shall not waste electricity, water, heat or air conditioning or other utilities or
services, and agrees to cooperate fully with Landlord to ensure the most effective and energy-efficient operation of the Project and shall not allow the adjustment (except by Landlords
authorized Project personnel) of any controls. Tenant shall keep corridor doors closed and shall
not open any windows, except that if the air circulation shall not be in operation, windows which
are openable may be opened with Landlords consent. As a condition to claiming any deficiency in
the air-conditioning or ventilation services provided by Landlord, Tenant shall close any blinds or
drapes in the Premises to prevent or minimize direct sunlight.
15. Tenant shall conduct no auction, fire or going out of business sale or bankruptcy
sale in or from the Premises, and such prohibition shall apply to Tenants creditors.
16. Tenant shall cooperate and comply with any reasonable safety or security programs,
including fire drills and air raid drills, and the appointment of fire wardens developed by
Landlord for the Project, or required by law. Before leaving the Premises unattended, Tenant
shall close and securely lock all doors or other means of entry to the Premises and shut off all
lights and water faucets in the Premises (except heat to the extent necessary to prevent the
freezing or bursting of pipes).
17. Tenant will comply with all municipal, county, state, federal or other
governmental laws, statutes, codes, regulations and other requirements, including without
limitation, environmental health, safety and police requirements and regulations respecting the
Premises, now or hereinafter in force, at its sole cost, and will not use the Premises for any
immoral purposes.
-3-
18. Tenant shall not carry on any business, activity or service except those ordinarily
embraced within the permitted use of the Premises specified in the Lease and more particularly, but
without limiting the generality of the foregoing, shall not install or operate any internal
combustion engine, boiler, machinery, refrigerating, heating or air conditioning equipment in or
about the Premises except as permitted by the Lease, use the Premises for housing, lodging or
sleeping purposes or for the washing of clothes, place any radio or television antennae other
than inside of the Premises except as permitted by the Lease, operate or permit to be operated
any musical or sound producing instrument or device which may be heard outside the Premises, use
any source of power other than electricity, operate any electrical or other device from which may
emanate electrical or other waves which may interfere with or impair radio, television, microwave,
or other broadcasting or reception from or in the Project or elsewhere, bring or permit any
bicycle or other vehicle, or dog (except in the company of a blind person or except where
specifically permitted) or other animal or bird in the Project, make or permit objectionable
noise or odor to emanate from the Premises, do anything in or about the Premises tending to
create or maintain a nuisance or do any act tending to injure the reputation of the Project,
throw or permit to be thrown or dropped any article from any window or other opening in the
Building, use or permit upon the Premises anything that will invalidate or increase the rate of
insurance on any policies of insurance now or hereafter carried on the Project or violate the
certificates of occupancy issued for the Premises or the Project, use the Premises for any
purpose, or permit upon the Premises anything, that may be dangerous to persons or property
(including but not limited to flammable oils, fluids, paints, chemicals, firearms or any explosive
articles or materials), do or permit anything to be done upon the Premises in any way tending to
disturb any other tenant at the Project or the occupants of neighboring property, or at any
time go upon the roof of the Building without prior approval from Landlord.
19. The following Rules shall apply regarding the parking area:
(i) Parking shall be available in areas designated generally for tenant parking. Tenant shall
have card-key access to the parking facilities 24 hours a day, seven day a week. In all cases,
parking for Tenant and the other Tenant Parties shall be on a first come, first served,
unassigned basis, with Landlord and other tenants at the Project, and their employees and
visitors, and other Persons to whom Landlord shall grant the right or who shall otherwise have the
right to use the same, all subject to these Rules, as the same may be amended or supplemented, and
applied on a non-discriminatory basis. Notwithstanding the foregoing to the contrary, Landlord
reserves the right to assign specific spaces, and to reserve spaces for visitors, small cars,
handicapped individuals, and other tenants, visitors of tenants or other Persons, and Tenant
Parties shall not park in any such assigned or reserved spaces. Landlord may restrict or prohibit
full size vans and other large vehicles.
(ii)
In case of any violation of these provisions, Landlord may refuse to permit the violator
to park, and may remove the vehicle owned or driven by the violator from the Project without
liability whatsoever, at such violators risk and expense. Landlord reserves the right to
temporarily close all or a portion of the parking areas or facilities in order to make repairs or
perform maintenance services, or to alter, modify, re-stripe or renovate the same, or if required
by casualty, strike, condemnation, act of God, law or governmental requirement, or any other reason
beyond Landlords reasonable control. In the event access is denied for any reason, any monthly
parking charges shall be abated to the extent access is denied, as Tenants sole recourse. Tenant
acknowledges that such parking areas or facilities may be operated by an independent contractor not
affiliated with Landlord, and Tenant acknowledges that in such event,
-4-
Landlord shall have no liability for claims arising through acts or omissions of such independent
contractor.
(iii) Normal business hours for the Project shall be 7 A.M. to 6 P.M., Monday through Friday,
and 9:00 A.M. to 12:00 P.M. on Saturdays, or such other hours as may be reasonably established by
Landlord or its parking operator from time to time. During such normal business hours, cars must
be parked entirely within the stall lines, and only small cars may be parked in areas reserved for
small or compact cars; all directional signs and arrows must be observed; the speed limit shall be
5 miles per hour; spaces reserved for handicapped parking must be used only by vehicles properly
designated; every parker is required to park and lock his own car; washing, waxing, cleaning or
servicing of any vehicle is prohibited; parking spaces may be used only for parking automobiles;
parking is prohibited in areas: (a) not striped or designated for parking, (b) aisles, (c) where
no parking signs are posted, (d) on ramps, and (e) loading areas and other specially designated
areas. Delivery trucks and vehicles shall use only those areas designated therefor.
20. The directory of the Building will be provided for the display of the name and location of
tenants only, and Landlord reserves the right to exclude any other names therefrom. Any additional
name that Tenant shall desire to be placed upon the directory must first be approved by Landlord,
and if so approved, a charge will be made therefor.
21. Landlord may waive any one or more of these Rules for the benefit of a particular tenant,
but no such waiver by Landlord shall be construed as a waiver of these Rules in favor of any other
tenant nor prevent Landlord from thereafter enforcing any such Rules against any or all of the
tenants of the building.
22. Landlord reserves the right to make such other and reasonable rules as in its sole and
absolute discretion may from time to time be needed for the safety, care, efficiency, cleanliness,
management and operation of the building, and for the preservation of good order therein; provided,
however, that no such changes shall interfere with Tenants permitted use of the Premises. In the
event of a conflict between these Rules and Regulations and the Lease, the Lease shall control.
-5-
EXHIBIT F
BASE BUILDING STANDARD SHELL CONSTRUCTION SPECIFICATIONS
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Floor:
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Current floor covering is carpet.
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Exterior Bldg. Walls:
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Walls are insulated, finished with taped drywall and are
painted.
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Interior Demising Walls:
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Demising walls are finish taped drywall and ready to receive
tenants wall finish.
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Ceiling:
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Ceilings are left open to underside of slab above.
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Fire Sprinklers:
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Fire sprinklers are in upright pendant heads in general protective
pattern.
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Structural Elements:
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Columns and roof trusses are exposed and can be used as
architectural elements by the tenant or encased in drywall. (These elements
do not require fireproofing.)
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Mechanical:
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Each floor contains a central water loop with approximately one zone
per 2,000 square feet of space. The tenant is responsible for the
distribution and thermostatic controls in the tenant space. Tenants may add
additional zones (which require additional heat pumps) for private offices,
heat-generating equipment or special requirements.
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Electrical:
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A panel board at the designated building electrical room is
provided.
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The building has specified a 2 x 4-foot parawedge fluorescent
fixture to be used by the tenant improvement contractors. The building will
stipulate the layout of the lighting along the curtain wall for
consistency.
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Telecommunications:
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The building provides phone and cable connections to the designated
main electrical/communications room for each floor.
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Drapery:
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A building standard window covering is provided.
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Toilet rooms:
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Toilet rooms are fully improved.
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Multi-Tenant Floor:
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The Building provides exit corridors, elevator lobbies and an entry
door to each tenant space. Doors are wood birch, door frames are hollow
metal, lobbies have a stone floor with carpet inset, door hardware is
brushed
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aluminum and the storefront and
railings are aluminum and glass.
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Landscaping
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Paving and landscaping are existing on
exterior portions of the Project.
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-2-
TABLE OF CONTENTS
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Page
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1. PREMISES
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1
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(a) Initial Premises
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1
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(b) Verification of Usable Square Feet of Premises, Building and Project
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1
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2. TERM
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2
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(a) Initial Term
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2
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(b) Confirmation of Lease Term
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2
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(c) Lease Years
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2
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3. BASIC RENT
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2
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(a) Basic Rent Payments
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2
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(b) Adjustment in Basic Rent
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3
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(c) Late Charge
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3
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4. ADDITIONAL RENT
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4
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(a) Estimated Operating Expenses
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4
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(b) Actual Operating Expenses
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4
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(c) Determinations
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5
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(d) End of Term
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5
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(e) Definitions
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5
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5. INTENTIONALLY OMITTED
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6. USES; HAZARDOUS MATERIAL
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9
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(a) Use
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9
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(b) Hazardous Material
|
|
|
|
10
|
(c) Environmental Obligations
|
|
|
|
11
|
|
|
|
|
|
7. MAINTENANCE AND REPAIRS
|
|
|
|
11
|
|
|
|
|
|
|
(a) Landlords Obligations
|
|
|
|
11
|
(b) Tenants Obligations
|
|
|
|
13
|
|
|
|
|
|
8. ALTERATIONS
|
|
|
|
13
|
|
|
|
|
|
|
(a) Landlords Consent
|
|
|
|
13
|
(b) Performance of Work
|
|
|
|
13
|
(c) Landlords Expenses; Administrative Fee
|
|
|
|
14
|
|
|
|
|
|
9. TENANTS PROPERTY
|
|
|
|
14
|
|
|
|
|
|
|
(a) Removal Upon Expiration of Lease
|
|
|
|
14
|
(b) Personal Property Taxes
|
|
|
|
15
|
-i-
|
|
|
|
|
|
|
|
|
Page
|
10. ENTRY BY LANDLORD
|
|
|
|
15
|
|
|
|
|
11. LIENS
|
|
|
|
16
|
|
|
|
|
12. INDEMNIFICATION
|
|
|
|
16
|
|
|
|
|
(a) Indemnity by Tenant
|
|
|
|
16
|
(b) Indemnity by Landlord
|
|
|
|
16
|
|
|
|
13. DAMAGE TO TENANTS PROPERTY
|
|
|
|
17
|
|
|
|
|
14. INSURANCE
|
|
|
|
17
|
|
|
|
|
(a) Tenants Insurance
|
|
|
|
17
|
(b) Landlords Insurance
|
|
|
|
18
|
|
|
|
15. WAIVER OF SUBROGATION
|
|
|
|
19
|
|
|
|
|
16. CASUALTY
|
|
|
|
19
|
|
|
|
|
|
(a) Repair and Restoration
|
|
|
|
19
|
(b) Uninsured Casualties
|
|
|
|
20
|
(c) Tenants Termination Right
|
|
|
|
20
|
(d) Termination of Lease
|
|
|
|
21
|
(e) Rent Abatement
|
|
|
|
21
|
(f) Extent of Repair Obligation
|
|
|
|
21
|
(g) Waiver
|
|
|
|
21
|
|
|
|
|
17. CONDEMNATION
|
|
|
|
21
|
|
|
|
|
|
(a) Complete Taking
|
|
|
|
21
|
(b) Partial Taking
|
|
|
|
22
|
(c) Award
|
|
|
|
22
|
(d) Waiver
|
|
|
|
22
|
|
|
|
|
18. ASSIGNMENT OR SUBLETTING
|
|
|
|
22
|
|
|
|
|
|
(a) Landlords Consent
|
|
|
|
22
|
(b) Notice to Landlord
|
|
|
|
22
|
(c) Permitted Transfers
|
|
|
|
23
|
(d) Continuing Liability
|
|
|
|
24
|
(e) Assumption by Transferee
|
|
|
|
24
|
(f) Default; Waiver
|
|
|
|
24
|
(g) Intentionally Omitted
|
|
|
|
24
|
(h) Use by Affiliates
|
|
|
|
24
|
(i) Recognition Agreement
|
|
|
|
25
|
(j) Occupancy By Others
|
|
|
|
25
|
-ii-
|
|
|
|
|
|
|
|
|
Page
|
19. SUBORDINATION AND NON-DISTURBANCE
|
|
|
|
25
|
|
|
|
|
|
20. ESTOPPEL CERTIFICATE
|
|
|
|
25
|
|
|
|
|
|
21. SERVICES
|
|
|
|
26
|
|
|
|
|
|
(a) Standard Services
|
|
|
|
26
|
(b) Overstandard Use
|
|
|
|
27
|
(c) Abatement of Rent
|
|
|
|
27
|
|
|
|
|
22. SIGNS AND ADVERTISING
|
|
|
|
28
|
|
|
|
|
|
23. PARKING
|
|
|
|
28
|
|
|
|
|
|
24. RULES AND REGULATIONS
|
|
|
|
29
|
|
|
|
|
|
25. TIME
|
|
|
|
29
|
|
|
|
|
|
26. OUIET ENJOYMENT
|
|
|
|
29
|
|
|
|
|
|
27. DEFAULTS AND REMEDIES
|
|
|
|
29
|
|
|
|
|
|
(a) Defaults
|
|
|
|
29
|
(b) Remedies
|
|
|
|
29
|
(c) Re-entry
|
|
|
|
31
|
(d) Remedies Cumulative; Waiver
|
|
|
|
31
|
|
|
|
|
28. TRANSFER OF LANDLORDS INTEREST
|
|
|
|
31
|
|
|
|
|
|
29. RIGHT TO PERFORM
|
|
|
|
31
|
|
|
|
|
|
30. TENANT IMPROVEMENTS
|
|
|
|
32
|
|
|
|
|
|
(a) Certain Definitions
|
|
|
|
32
|
(1) Tenant Improvements
|
|
|
|
32
|
(2) Tenant Improvement Allowance
|
|
|
|
32
|
(3) Substantial Completion; Punch List Items
|
|
|
|
32
|
(4) Construction Costs
|
|
|
|
32
|
(5) Building Plans
|
|
|
|
32
|
(6) Base Building Work
|
|
|
|
32
|
(7) Delivery Condition
|
|
|
|
32
|
(8) Force Majeure Delay
|
|
|
|
32
|
(9) Landlord Delay
|
|
|
|
33
|
(10) Tenants Contractor
|
|
|
|
33
|
(11) Material Change Order
|
|
|
|
33
|
(12) Tenants Architect
|
|
|
|
33
|
(b) Plans and Drawings
|
|
|
|
33
|
(c) Payment of Tenant Improvement Allowance
|
|
|
|
34
|
-iii-
|
|
|
|
|
|
|
|
|
Page
|
(d) Miscellaneous Charges
|
|
|
|
35
|
(e) Use of Conduits, Risers and Raceways
|
|
|
|
35
|
(f) Codes/Hazardous Materials
|
|
|
|
35
|
(g) Fee to Landlord
|
|
|
|
35
|
|
|
|
|
31. NOTICES
|
|
|
|
35
|
|
|
|
|
|
32. ATTORNEYS FEES
|
|
|
|
36
|
|
|
|
|
|
33. HOLDING OVER
|
|
|
|
36
|
|
|
|
|
|
34. SURRENDER OF PREMISES
|
|
|
|
37
|
|
|
|
|
|
35. NON-WAIVER
|
|
|
|
37
|
|
|
|
|
|
36. MORTGAGE PROTECTION
|
|
|
|
37
|
|
|
|
|
|
37. EXPEDITED DISPUTE RESOLUTION
|
|
|
|
37
|
|
|
|
|
|
(a) Arbitration Panel
|
|
|
|
38
|
(b) Duty
|
|
|
|
38
|
(c) Authority
|
|
|
|
38
|
(d) Appeal
|
|
|
|
39
|
|
|
|
|
38. CHANGES TO THE PROJECT
|
|
|
|
39
|
|
|
|
|
|
39. WAIVER OF JURY TRIAL
|
|
|
|
39
|
|
|
|
|
|
40. OPTIONS TO EXTEND THE TERM
|
|
|
|
40
|
|
|
|
|
|
(a) Extension Terms
|
|
|
|
40
|
(1) First Extension Term
|
|
|
|
40
|
(2) Second Extension Term
|
|
|
|
40
|
(b) Extension Term Rent
|
|
|
|
40
|
|
|
|
|
41. GENERAL PROVISIONS
|
|
|
|
42
|
|
|
|
|
|
(a) Entire Agreement
|
|
|
|
42
|
(b) Terms and Headings
|
|
|
|
42
|
(c) Successors and Assigns
|
|
|
|
42
|
(d) Brokers
|
|
|
|
42
|
(e) Liability of Landlord
|
|
|
|
43
|
(f) Independent Covenants
|
|
|
|
43
|
(g) Waiver of Redemption by Tenant
|
|
|
|
43
|
(h) Severability
|
|
|
|
43
|
(i) Force Majeure
|
|
|
|
43
|
(j) Intentionally Omitted
|
|
|
|
43
|
(k) Examination of Lease
|
|
|
|
44
|
-iv-
|
|
|
|
|
|
|
|
|
Page
|
(1) No Warranty
|
|
|
|
44
|
(m) Right to Lease
|
|
|
|
44
|
(n) Transportation Management
|
|
|
|
44
|
(o) Modification for Lender
|
|
|
|
44
|
(p) Requirements of Law
|
|
|
|
44
|
(q) Recording
|
|
|
|
44
|
(r) Applicable Laws
|
|
|
|
45
|
(s) Relationship of Parties
|
|
|
|
45
|
(t) Landlords Title
|
|
|
|
45
|
(u) Project or Building Name and Storage
|
|
|
|
45
|
(v) Survival of Obligations
|
|
|
|
45
|
(w) Authority
|
|
|
|
45
|
(x) Execution in Counterparts
|
|
|
|
45
|
(y) Consent/Duty to Act Reasonably
|
|
|
|
45
|
(z) Landlord Bankruptcy Proceeding
|
|
|
|
45
|
(aa) Access
|
|
|
|
46
|
(bb) Prohibited Persons and Transactions
|
|
|
|
46
|
(cc) When Payment Is Due
|
|
|
|
47
|
-v-