Redwood Trust, Inc. — Q3 2020 Form 10-Q
Business context and reporting period. Redwood is a specialty finance company focused on residential and multifamily mortgage investments and mortgage banking. This unaudited filing covers the quarter and nine months ended September 30, 2020. Its three segments are Residential Lending, Business Purpose Lending, and Third-Party Investments. The balance sheet includes consolidated securitization entities; their assets generally are available only to satisfy those entities’ obligations, and their creditors generally have no recourse to Redwood.
Financial results and key metrics
- Q3 rebound: Net income was $141.8 million, or $1.02 per diluted share, versus $34.3 million, or $0.31 per diluted share, in Q3 2019. Net interest income was $21.6 million, down from $33.5 million; non-interest income was $166.9 million, including $107.0 million of investment fair-value gains and $59.4 million of mortgage-banking income.
- Nine-month loss: Net loss was $636.1 million, or $5.60 per diluted share, compared with net income of $120.0 million in the prior-year period. Investment fair-value changes were a loss of $611.6 million, reflecting severe first-quarter market dislocations despite the third-quarter recovery. Net interest income was $100.3 million, up from $97.6 million.
- Expenses and unusual charges: Nine-month other expenses were $104.3 million, including an $88.7 million non-cash goodwill impairment in Q1 related to Business Purpose Lending. General and administrative expenses were $84.8 million for the nine months, versus $70.7 million.
- Balance sheet at September 30: Total assets were $10.40 billion, down from $18.00 billion at year-end 2019; total equity was $1.05 billion, down from $1.83 billion. Book value was $9.41 per share, up $1.26 during Q3. Assets include $450.7 million of cash and cash equivalents and $73.6 million of restricted cash.
- Debt and liquidity: Short-term debt was $482.8 million and long-term debt was $1.54 billion. Asset-backed securities issued were $7.17 billion, largely tied to consolidated securitization entities. Redwood reported $451 million of unrestricted cash and $1.70 billion of total capital. Management said it was in compliance with debt covenants at quarter-end and through the filing date.
- Cash flow, nine months: Operating cash flow was negative $175.9 million; investing cash flow was positive $3.51 billion; and financing cash flow was negative $3.11 billion. Cash, cash equivalents, and restricted cash increased $233.4 million to $524.3 million. Asset sales and debt repayments were significant drivers.
- Dividends and repurchases: The Q3 dividend was $0.14 per share; declared dividends for the first nine months totaled $0.585 per share. Redwood repurchased about 3.05 million shares for $22 million in Q3.
Material changes versus comparable periods
- Q3 earnings improved substantially year over year, led by fair-value recovery and stronger mortgage banking results, while net interest income declined with lower average asset balances and higher borrowing costs on newer facilities.
- Nine-month results swung to a large loss, principally because of Q1 fair-value declines and the goodwill impairment. Management said asset values continued recovering as spreads tightened in Q3, but the recovery did not offset earlier losses.
- The balance sheet contracted after asset sales, debt paydowns, and portfolio repositioning in response to pandemic-related market stress. Redwood deconsolidated about $3.86 billion of multifamily loans and $3.72 billion of associated ABS in Q1 after selling subordinate securities.
- At Q3 end, recourse debt had fallen to $1.35 billion from $1.82 billion at June 30, and marginable debt to $120 million from $375 million. New non-marginable and non-recourse facilities reduced exposure to market-value margin calls but generally carry higher borrowing costs.
Outlook, management commentary, risks and contingencies
- Management said operating businesses were running at full speed and expressed optimism about ending 2020 strongly, while cautioning about market volatility, the election period, and rising COVID-19 infections. It expects Redwood Choice expanded-prime lending to contribute more meaningfully to 2021 acquisition volumes.
- Q3 residential jumbo loan purchase commitments were $1.20 billion; the identified purchase pipeline at September 30 was $1.79 billion. Business Purpose Lending originated $261 million of loans and completed a $293 million single-family rental securitization. Management cited strong demand and improved securitization execution.
- Management believes excess market liquidity may support mortgage-related asset prices and that portfolio values may have further recovery potential. These are expectations, not guarantees; the filing provides no formal earnings or revenue guidance.
- COVID-19-related borrower forbearance, borrower credit deterioration, market liquidity and asset valuations remain significant uncertainties. Redwood also identifies financing availability, margin calls, covenant compliance, interest rates, credit spreads, prepayments, and counterparty performance as key risks. Some facilities are uncommitted and could be unavailable when needed.
- Residential bridge loans included 24 loans more than 90 days delinquent, with $38 million unpaid principal balance; all 24 were in foreclosure. Redwood also had $225 million of commitments to fund additional advances on bridge loans.
- Residential loan seller demands generated $9 million of expense for the first nine months and a $6.5 million accrual at September 30. Management estimated additional reasonably possible losses of $0 to $1.5 million for remaining unaccrued demands, but warned actual losses could be materially higher. A related lawsuit was settled in October 2020. Separate FHLB-Seattle and Schwab litigation reserves totaled $2 million.
- Other notable items include settlement of substantially all outstanding derivatives early in 2020, including an $84 million payment to terminate cash-flow hedges, and a $14 million deferred 5 Arches acquisition payment due in March 2021.
Important facts for investors to verify
- Whether subsequent fair-value recovery persisted and how much Q3 profit depended on mark-to-market gains rather than recurring earnings.
- Current loan delinquency, forbearance, foreclosure, and credit-loss trends, especially in bridge lending and securitized portfolios.
- Available liquidity, facility capacity and renewal terms, covenant headroom, and the cost and recourse terms of replacement financing.
- Resolution and ultimate cost of residential loan seller demands and other litigation, including whether reserves require revision.
- Actual full-year REIT taxable income and dividend tax characterization; the filing’s 2020 tax figures are estimates and management expected only a small portion, if any, of distributions to be taxable dividend income.