SEC Company Response from REDWOOD TRUST INC (RWT, RWTN, RWTO, RWTP, RWTQ, RWT-PA) (CIK 0000930236) (RWT) — Sep 16, 2008
REDWOOD TRUST INC (RWT, RWTN, RWTO, RWTP, RWTQ, RWT-PA) (CIK 0000930236)
Date: Sept. 16, 2008 · CIK: 0000930236 · Accession: 0001144204-08-053021
AI Filing Summary & Sentiment
Reasoning
Letter
Securities and Exchange Commission Division of Corporation Finance Division of Corporate Finance Redwood Trust, Inc. Responses to Comments on Form 10-K and Schedule 14A Filed on March 5, 2008 and April 22, 2008, respectively File No. 1-13759
Dear Mr. Demarest,
On behalf of Redwood Trust, Inc. (“Redwood”), I hereby provide the following responses in reply to the Staff’s comment letter dated September, 3, 2008 (the “Comment Letter”) in connection with the above-referenced Annual Report on Form 10-K and Definitive Proxy Statement on Schedule 14A.
The responses to the Staff’s comments are numbered to relate to the corresponding comments in the Comment Letter. For your convenience, each of our responses is preceded with an italicized recitation of the corresponding comment set forth in the Comment Letter.
Form 10-K for the year ended December 31, 2007
Item 9A. Controls and Procedures
Management’s Report on Internal Control over Financial Reporting, page
1.
We note that you have concluded that your internal controls over financial reporting were ineffective as of December 31, 2007 because you were unable to obtain the necessary evidence to support your initial conclusion that unrealized losses are recoverable. Please clarify to us how all such unrealized losses have been accounted for in your audited financial statements.
As part of our financial reporting process, we are required to assess whether declines in the fair value of available-for-sale (AFS) securities below their amortized cost should be reflected as other-than-temporary (OTT) impairments. The diagram below highlights the three step process we follow.
Our internal controls, processes, and assessments for OTT impairments were appropriate under steps one and two shown above. It was during our evaluation under step three, which is highly subjective, that in certain circumstances we were unable to obtain the necessary evidence as prescribed under SAB 59 to support our initial conclusions that these securities were not other-than-temporarily impaired. As a consequence, we determined that our internal controls over financial reporting as applied to this specific process were ineffective. We have since made enhancements to our internal controls relating to this process to improve their effectiveness going forward.
In all circumstances where we were unable to obtain sufficient evidence under SAB 59, we treated all of those AFS securities as other-than-temporarily impaired. We recorded these impairments as negative market valuation adjustments, which were recognized in our income statement for the quarter and year ended December 31, 2007.
Note 6. Real Estate Securities, page F-26
2.
We note that you have recorded losses in the amount of $132 million for real estate securities that have been in a loss position for greater than twelve months. Please tell us what evidence exists to support the recoverability of the fair value of these securities and why the losses have not been recognized into earnings. Refer to SAB Topic 5:M.
The table below summarizes the results of our impairment analysis on AFS securities as of December 31, 2007. This summary includes the $132 million of unrealized losses for securities that have been in a loss position for greater than twelve months, and also illustrates the significant amounts of OTT impairment recognized in our income statement for the quarter ended December 31, 2007.
Impairment Summary - Q4 2007
Amount of Impairment
in millions
< 12 months
> 12 months
Total
Impairments on AFS Securities at 12/31/2007
$
(1,357
)
$
(273
)
$
(1,630
)
Other-Than-Temporary (OTT) Impairment Test:
Step 1: Adverse Cash Flows
(268
)
(28
)
(296
)
Step 2: Intent and Ability to Hold
-
-
-
Step 3: Recoverability
(660
)
(113
)
(773
)
Impairments Deemed OTT
$
(928
)
$
(141
)
$
(1,069
)
Remaining Unrealized Losses
$
(429
)
$
(132
)
$
(561
)
As noted above, we employ a systematic three step testing process to determine whether an impairment is other-than-temporary and we consider all available information, positive and negative. The third and final step in this process is to consider the recoverability of the realizable value of the security in a reasonable amount of time in light of market conditions.
For impaired securities (especially those that have been in a loss position for greater than twelve months), we considered the following evidence to support our conclusion that an OTT impairment had not occurred.
·
The length of time that fair value has been less than cost:
The AFS securities we own are real estate securities, most of which have below investment grade (rated BB, B, or nonrated) credit ratings. These securities are illiquid in nature with a limited secondary market. Although GAAP disclosures distinguish between securities that have had unrealized losses for periods of more than and less than twelve months, we share the SEC staff’s view that this one-year time period is not an automatic line of demarcation for inferring when unrealized losses become other-than-temporary impairments. As evidenced historically, we believe a reasonable period of time to observe a recovery in value for illiquid real estate securities is often a longer period than one year. We intend to hold these securities through their longer, yet reasonable, forecasted recovery periods.
As a REIT established in 1994, we act as a long term investor with the intent and ability to hold investment securities through their recovery periods. We fund AFS securities with equity or through bankruptcy remote securitization entities and we have very little recourse debt. At December 31, 2007, we had $8 million of short-term recourse debt and $290 million in unrestricted cash.
·
The extent to which fair value has been less than cost:
We believe each security’s fair value reflected the market's most recent evaluation of the total mix of available information, despite historically low liquidity and pricing transparency for real estate securities. As part of our testing process, we considered the severity of the decline in fair value relative to the amortized cost basis of each security. As this severity increased, we weighted it higher in our overall assessment of recoverability.
In reviewing the severities of declines in fair values, we also considered the trending of bid/ask spreads required by market makers for these illiquid real estate securities. These spreads were at historical highs at the time we filed our Form 10-K, contributing to a significant portion of the decline in fair values we observed during the second half of 2007. A narrowing of this bid/ask spread due to an increase in the number of active market participants should help to recover much of these unrealized losses for temporarily impaired securities.
Our review generally resulted in OTT impairments on securities with significant declines in fair value, with final determination based upon facts and circumstances specific to each security. This included $113 million of OTT impairments on securities with unrealized losses for periods of more than twelve months. The remaining securities generally had less severe declines in fair value and strong cash flows, which allowed us to conclude that they should recover in value.
·
Characteristics specific to each security:
We considered the characteristics specific to each impaired security and the general health of the market for that security as part of our assessment of recoverability. We observed a general deterioration in underwriting quality for residential loans originated during 2006 and 2007, which collateralize some of our real estate securities. Specifically, loan-to-value ratios, debt-service ratios, and borrower representations had become very aggressive relative to prior vintages. Loans originated prior to 2006 generally exhibited less aggressive underwriting standards and benefited from lower leverage due in part to significant home price appreciation. The CDO securities we own are complex structured products that are primarily backed by residential real estate loans and securities.
As the following table shows, our assessment process resulted in OTT impairment on most residential securities originated during 2006 and 2007 and all CDO securities. We also recognized OTT impairment on a significant portion of non-prime residential securities originated in 2005 and prior years.
Summary of Impairments> 12 months at 12/31/2007
(in millions)
Type of Impairment
Other-Than-Temporary
Temporary
Total Impairments > 12 months
By Vintage
2000-2005
2006-2007
Total
2000-2005
2006-2007
Total
2000-2005
2006-2007
Total
Real Estate Securities:
Residential Prime
$
-
$
(10
)
$
(10
)
$
(54
)
$
(12
)
$
(66
)
$
(54
)
$
(22
)
$
(76
)
Residential Non-Prime
(28
)
(83
)
(111
)
(27
)
(2
)
(29
)
$
(55
)
$
(85
)
$
(140
)
CDO
(15
)
(4
)
(19
)
-
-
-
$
(15
)
$
(4
)
$
(19
)
Commercial
-
(1
)
(1
)
(27
)
(10
)
(37
)
$
(27
)
$
(11
)
$
(38
)
Total
$
(43
)
$
(98
)
$
(141
)
$
(108
)
$
(24
)
$
(132
)
$
(151
)
$
(122
)
$
(273
)
Of our securities with unrealized losses greater than 12 months at December 31, 2007, a significant portion consisted of residential mortgage-backed securities (RMBS) collateralized with prime and non-prime residential loans originated in 2005 and prior years. They were generally purchased at significant discounts and are sensitive to small changes in valuation assumptions (e.g., prepayment speeds) in the near-term. We determined that the performance of the underlying loans to date, the market’s outlook for future performance, and the projected receipt of principal and interest provided us with sufficient support to anticipate that fair values on these specific securities would recover within a reasonable period of time.
The other significant portion of our securities with unrealized losses greater than 12 months at December 31, 2007, consisted of commercial mortgage-backed securities (CMBS). These securities are the lower rated securities within a commercial mortgage securitization and most are backed by loans originated in 2005 and prior years. Over the prior six months, we saw an increase in yields required by the market for CMBS in line with other structured real estate securities. However, the CMBS market seemed to be healthy with new securitizations planned at that time and little evidence that the cash flows on underlying commercia
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CORRESP
1
filename1.htm
Unassociated Document
September
16, 2008
VIA
FACSIMILE TRANSMISSION - 202-772-9209
Securities
and Exchange Commission
Division
of Corporation Finance
450
Fifth
Street, N.W.
Washington,
D.C. 20549
Attn:
William
H. Demarest IV
Staff
Accountant
Division
of Corporate Finance
Re:
Redwood
Trust, Inc.
Responses
to Comments on Form 10-K and Schedule 14A
Filed
on March 5, 2008 and April 22, 2008, respectively
File
No. 1-13759
Dear
Mr.
Demarest,
On
behalf
of Redwood Trust, Inc. (“Redwood”), I hereby provide the following responses in
reply to the Staff’s comment letter dated September, 3, 2008 (the “Comment
Letter”) in connection with the above-referenced Annual Report on Form 10-K and
Definitive Proxy Statement on Schedule 14A.
The
responses to the Staff’s comments are numbered to relate to the corresponding
comments in the Comment Letter. For your convenience, each of our responses
is
preceded with an italicized recitation of the corresponding comment set forth
in
the Comment Letter.
Form
10-K for the year ended December 31, 2007
Item
9A. Controls and Procedures
Management’s
Report on Internal Control over Financial Reporting, page
90
1.
We
note that you have concluded that your internal controls over financial
reporting were ineffective as of December 31, 2007 because you were
unable
to obtain the necessary evidence to support your initial conclusion
that
unrealized losses are recoverable. Please clarify to us how all such
unrealized losses have been accounted for in your audited financial
statements.
As
part
of our financial reporting process, we are required to assess whether declines
in the fair value of available-for-sale (AFS) securities below their amortized
cost should be reflected as other-than-temporary (OTT) impairments. The diagram
below highlights the three step process we follow.
Our
internal controls, processes, and assessments for OTT impairments were
appropriate under steps one and two shown above. It was during our evaluation
under step three, which is highly subjective, that in certain circumstances
we
were unable to obtain the necessary evidence as prescribed under SAB 59 to
support our initial conclusions that these securities were not
other-than-temporarily impaired. As a consequence, we determined that our
internal controls over financial reporting as applied to this specific process
were ineffective. We have since made enhancements to our internal controls
relating to this process to improve their effectiveness going forward.
In
all
circumstances where we were unable to obtain sufficient evidence under SAB
59,
we treated all of those AFS securities as other-than-temporarily impaired.
We
recorded these impairments as negative market valuation adjustments, which
were
recognized in our income statement for the quarter and year ended December
31,
2007.
Note
6. Real Estate Securities, page F-26
2.
We
note that you have recorded losses in the amount of $132 million
for real
estate securities that have been in a loss position for greater than
twelve months. Please tell us what evidence exists to support the
recoverability of the fair value of these securities and why the
losses
have not been recognized into earnings. Refer to SAB Topic
5:M.
The
table
below summarizes the results of our impairment analysis on AFS securities as
of
December 31, 2007. This summary includes the $132 million of unrealized losses
for securities that have been in a loss position for greater than twelve months,
and also illustrates the significant amounts of OTT impairment recognized in
our
income statement for the quarter ended December 31, 2007.
Impairment
Summary - Q4 2007
Amount
of Impairment
in
millions
<
12 months
>
12 months
Total
Impairments
on AFS Securities at 12/31/2007
$
(1,357
)
$
(273
)
$
(1,630
)
Other-Than-Temporary
(OTT) Impairment Test:
Step
1: Adverse Cash Flows
(268
)
(28
)
(296
)
Step
2: Intent and Ability to Hold
-
-
-
Step
3: Recoverability
(660
)
(113
)
(773
)
Impairments
Deemed OTT
$
(928
)
$
(141
)
$
(1,069
)
Remaining
Unrealized Losses
$
(429
)
$
(132
)
$
(561
)
As
noted
above, we employ a systematic three step testing process to determine whether
an
impairment is other-than-temporary and we consider all available information,
positive and negative. The third and final step in this process is to consider
the recoverability of the realizable value of the security in a reasonable
amount of time in light of market conditions.
For
impaired securities (especially those that have been in a loss position for
greater than twelve months), we considered the following evidence to support
our
conclusion that an OTT impairment had not occurred.
·
The
length of time that fair value has been less than
cost:
The
AFS
securities we own are real estate securities, most of which
have
below investment grade (rated BB, B, or nonrated) credit ratings. These
securities are illiquid in nature with a limited secondary market. Although
GAAP disclosures distinguish between securities that have had unrealized losses
for periods of more than and less than twelve months, we share the SEC staff’s
view that this one-year time period is not an automatic line of demarcation
for
inferring when unrealized losses become other-than-temporary impairments.
As
evidenced historically, we believe a reasonable period of time to observe a
recovery in value for illiquid real estate securities is often a longer period
than one year. We intend to hold these securities through their longer, yet
reasonable, forecasted recovery periods.
As
a REIT
established in 1994, we act as a long term investor with the intent and ability
to hold investment securities through their recovery periods. We fund AFS
securities with equity or through bankruptcy remote securitization entities
and
we have very little recourse debt. At December 31, 2007, we had $8 million
of
short-term recourse debt and $290 million in unrestricted cash.
·
The
extent to which fair value has been less than
cost:
We
believe each security’s fair value reflected the market's most recent evaluation
of the total mix of available information, despite historically low liquidity
and pricing transparency for real estate securities. As part of our testing
process, we considered the severity of the decline in fair value relative to
the
amortized cost basis of each security. As this severity increased, we weighted
it higher in our overall assessment of recoverability.
In
reviewing the severities of declines in fair values, we also considered the
trending of bid/ask spreads required by market makers for these illiquid real
estate securities. These spreads were at historical highs at the time we filed
our Form 10-K, contributing to a significant portion of the decline in fair
values we observed during the second half of 2007. A narrowing of this bid/ask
spread due to an increase in the number of active market participants should
help to recover much of these unrealized losses for temporarily impaired
securities.
Our
review generally resulted in OTT impairments on securities with significant
declines in fair value, with final determination based upon facts and
circumstances specific to each security. This included $113 million of OTT
impairments on securities with
unrealized losses for periods of more than twelve months.
The
remaining securities generally had less severe declines in fair value and strong
cash flows, which allowed us to conclude that they should recover in
value.
·
Characteristics
specific to each security:
We
considered the characteristics specific to each impaired security and the
general health of the market for that security as part of our assessment of
recoverability. We observed a general deterioration in underwriting quality
for
residential loans originated during 2006 and 2007, which collateralize some
of
our real estate securities. Specifically, loan-to-value ratios, debt-service
ratios, and borrower representations had become very aggressive relative to
prior vintages. Loans originated prior to 2006 generally exhibited less
aggressive underwriting standards and benefited from lower leverage due in
part
to significant home price appreciation. The CDO securities we own are complex
structured products that are primarily backed by residential real estate loans
and securities.
As
the
following table shows, our assessment process resulted in OTT impairment on
most
residential securities originated during 2006 and 2007 and all CDO securities.
We also recognized OTT impairment on a significant portion of non-prime
residential securities originated in 2005 and prior years.
Summary
of Impairments>
12 months at 12/31/2007
(in
millions)
Type
of Impairment
Other-Than-Temporary
Temporary
Total
Impairments > 12 months
By
Vintage
2000-2005
2006-2007
Total
2000-2005
2006-2007
Total
2000-2005
2006-2007
Total
Real
Estate Securities:
Residential
Prime
$
-
$
(10
)
$
(10
)
$
(54
)
$
(12
)
$
(66
)
$
(54
)
$
(22
)
$
(76
)
Residential
Non-Prime
(28
)
(83
)
(111
)
(27
)
(2
)
(29
)
$
(55
)
$
(85
)
$
(140
)
CDO
(15
)
(4
)
(19
)
-
-
-
$
(15
)
$
(4
)
$
(19
)
Commercial
-
(1
)
(1
)
(27
)
(10
)
(37
)
$
(27
)
$
(11
)
$
(38
)
Total
$
(43
)
$
(98
)
$
(141
)
$
(108
)
$
(24
)
$
(132
)
$
(151
)
$
(122
)
$
(273
)
Of
our
securities with unrealized losses greater than 12 months at December 31, 2007,
a
significant portion consisted of residential mortgage-backed securities (RMBS)
collateralized with prime and non-prime residential loans originated in 2005
and
prior years. They were generally purchased at significant discounts and are
sensitive to small changes in valuation assumptions (e.g., prepayment speeds)
in
the near-term. We determined that the performance of the underlying loans to
date, the market’s outlook for future performance, and the projected receipt of
principal and interest provided us with sufficient support to anticipate that
fair values on these specific securities would recover within a reasonable
period of time.
The
other
significant portion of our securities with unrealized losses greater than 12
months at December 31, 2007, consisted of commercial mortgage-backed securities
(CMBS). These securities are the lower rated securities within a commercial
mortgage securitization and most are backed by loans originated in 2005 and
prior years. Over the prior six months, we saw an increase in yields required
by
the market for CMBS in line with other structured real estate securities.
However, the CMBS market seemed to be healthy with new securitizations planned
at that time and little evidence that the cash flows on underlying commercia