Business Context and Reporting Period
Company: Redwood Trust, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2009
Business Overview: Redwood Trust is a real estate investment trust (REIT) that invests in, finances, and manages residential and commercial real estate loans and asset-backed securities. The company operates through its parent entity and consolidated securitization vehicles (Sequoia and Acacia) and a sponsored fund (Redwood Opportunity Fund LP). The company elected to be taxed as a REIT and anticipates a taxable loss for 2009, meaning dividends are likely characterized as a return of capital.
Key Financial Metrics
| Metric (in thousands, except per share) | Three Months Ended Sep 30, 2009 | Nine Months Ended Sep 30, 2009 | Three Months Ended Sep 30, 2008 | Nine Months Ended Sep 30, 2008 |
|---|---|---|---|---|
| Net Interest Income | $45,545 | $114,650 | $39,037 | $127,295 |
| Net Income (Loss) Attributable to Redwood | $27,128 | $(1,095) | $(111,304) | $(328,800) |
| Diluted EPS | $0.35 | $(0.02) | $(3.34) | $(9.99) |
| Total Assets | $5,284,988 | - | - | - |
| Total Liabilities | $4,358,514 | - | - | - |
| Stockholders' Equity | $907,106 | - | - | - |
| Cash and Cash Equivalents | $216,771 | - | - | - |
| Real Estate Loans | $3,830,821 | - | - | - |
| Asset-Backed Securities Issued | $4,015,955 | - | - | - |
| Long-Term Debt | $140,000 | - | - | - |
Liquidity: The company held $216.8 million in cash and cash equivalents as of September 30, 2009. There was no short-term debt outstanding. The company funds investments primarily with permanent capital (equity and long-term debt).
Material Changes vs. Prior Period
- Profitability Turnaround: The company reported a net income of $27.1 million ($0.35 EPS) for the third quarter of 2009, a significant improvement from a net loss of $111.3 million ($3.34 EPS) in the same period in 2008. This was driven by lower negative market valuation adjustments and reduced impairment charges.
- Portfolio Composition: Real estate loans decreased from $4.66 billion at year-end 2008 to $3.83 billion at September 30, 2009, primarily due to the deconsolidation of $439 million in loans and principal paydowns. Conversely, real estate securities increased significantly from $572 million to $1.06 billion, reflecting a strategic shift toward acquiring senior non-agency residential mortgage-backed securities (RMBS) at distressed prices.
- Equity Growth: Total stockholders' equity increased from $301.9 million at December 31, 2008, to $907.1 million at September 30, 2009. This increase was largely due to secondary offerings of common stock raising approximately $520 million and positive market valuation adjustments on securities.
- Debt Reduction: Asset-backed securities issued decreased from $4.86 billion to $4.02 billion due to principal paydowns and deconsolidation. Long-term debt decreased slightly from $150 million to $140 million following a repurchase of $10 million in subordinated debt.
Guidance, Outlook, and Risks
- Investment Strategy: Management noted that the opportunity to acquire senior RMBS at distressed prices has diminished due to rising prices and increased competition. Consequently, acquisition activity slowed in the third quarter. The company is now focusing on creating its own investments and exploring opportunities in the commercial mortgage sector.
- Dividends: The company declared a regular quarterly dividend of $0.25 per share. Due to an anticipated taxable loss for 2009, these dividends are expected to be characterized as a return of capital for tax purposes.
- Market Risks:
- Credit Risk: Serious delinquencies on consolidated Sequoia loans rose to 3.79% (from 2.36% in 2008). The company maintains an allowance for loan losses of $50 million.
- Interest Rate Risk: The company uses interest rate agreements to manage risk but does not fully hedge, accepting short-term volatility for long-term returns.
- Prepayment Risk: Faster prepayments can reduce yields on discount assets but benefit premium assets like Interest-Only (IO) securities. The company is currently biased toward faster prepayment speeds for long-term economic effect.
- Accounting Changes: The company adopted new accounting guidance (FAS 166 and FAS 167) regarding transfers of financial assets and consolidation of variable interest entities, effective in 2010, which could significantly impact future financial statements.
Key Facts for Investor Verification
- Source of Earnings: Verify the sustainability of the Q3 2009 profit, which was heavily influenced by a $17.6 million realized gain (including $6.6 million from debt extinguishment) and a reduction in market valuation adjustments compared to the prior year.
- Portfolio Shift: Confirm the transition from a loan-heavy portfolio to a securities-heavy portfolio and the associated yield characteristics of the newly acquired senior RMBS.
- Debt Repurchase: Review the details of the $10 million subordinated debt repurchase at 34% of face value, which generated a significant one-time gain.
- Delinquency Trends: Monitor the 3.79% serious delinquency rate on Sequoia loans and the adequacy of the $50 million allowance for loan losses against potential future credit losses.
- Capital Deployment: Assess the company's ability to deploy its $217 million cash balance into attractive investments given the reduced availability of distressed senior RMBS.