Redwood Trust, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; unaudited. Redwood is a specialty finance company focused on residential and multifamily mortgage investments and mortgage banking, operating through four segments. Results were sharply affected by COVID-19-related market dislocation, particularly in March.
Financial performance and position
- Net loss: $943.4 million, versus net income of $54.5 million in Q1 2019; diluted loss per share was $8.28, versus diluted earnings of $0.49.
- Net interest income: $51.4 million, up from $31.8 million. Interest income was $198.1 million and interest expense was $146.7 million. Management attributed the increase to higher average invested capital and lower debt yields.
- Non-interest results: Net non-interest loss was $893.0 million, including an $870.8 million net investment fair-value loss and a $28.4 million mortgage-banking loss. The fair-value loss included $274 million of realized losses and $597 million of unrealized losses on assets and liabilities still held at quarter-end.
- Other expenses and taxes: Other expenses were $91.4 million, including an $88.7 million non-cash goodwill impairment. General and administrative expense was $32.7 million, up from $23.2 million. Redwood recorded a $22.2 million tax benefit.
- Equity and book value: Total equity was $725.2 million, down from $1.83 billion at year-end 2019. Book value per share was $6.32, a $9.66 quarterly decline. Management said negative fair-value changes accounted for $8.73 per share and goodwill impairment for $0.78 per share.
- Assets and liquidity: Total assets were $12.30 billion, down from $18.00 billion, in part reflecting asset sales and deconsolidation of multifamily securitization entities. Cash and cash equivalents were $378.2 million and restricted cash was $25.8 million at quarter-end. Unrestricted cash was reported at $516 million as of May 13, 2020.
- Debt: Short-term debt was $2.34 billion; asset-backed securities issued were $6.46 billion; and long-term debt was $2.45 billion. Redwood repaid $633 million of FHLBC borrowings during the quarter. Consolidated securitization assets and related liabilities are generally ring-fenced, non-recourse obligations of the respective entities.
- Cash flows: Operating cash flow was negative $241.4 million, investing cash flow was positive $910.6 million, and financing cash flow was negative $556.0 million. Cash, cash equivalents and restricted cash increased by $113.2 million to $404.0 million.
- Dividend: The declared Q1 dividend was $0.32 per share. Payment was deferred from March 30 and made fully in cash on May 8, 2020.
Material changes versus Q1 2019
- Redwood moved from a $54.5 million profit to a $943.4 million loss, principally because of severe investment fair-value declines and weaker mortgage-banking results.
- Net interest income increased by $19.6 million, but mortgage-banking results fell by $40.7 million, from income of $12.3 million to a loss of $28.4 million.
- Investment fair-value results swung from a $20.2 million gain to an $870.8 million loss. The company attributed the declines primarily to pandemic-driven spread widening and market dislocation.
- Redwood sold substantial investments and reduced financing exposure. It deconsolidated $3.86 billion of multifamily loans and $3.72 billion of associated ABS after selling subordinate securities in four Freddie Mac K-Series trusts; the deconsolidation contributed a $72 million market-valuation loss.
- Q1 2020 included a $88.7 million goodwill impairment in Business Purpose Lending, following reduced long-term profitability forecasts. The company found no impairment of its acquired intangible assets.
Outlook, management commentary and risks
- Management expects lower net interest income in subsequent quarters following loan and securities sales and associated debt repayments. It also expects near-term declines in loan acquisition and origination volumes and potentially lower mortgage-banking profitability.
- After quarter-end, Redwood reported settling $1.8 billion of residential loan sales and repaying $1.5 billion of associated borrowings from April 1 through May 13. It also priced a business-purpose securitization backed by approximately $234 million of single-family rental loans, then expected to close around May 19, subject to customary conditions.
- Redwood said it had entered into two non-marginable borrowing facilities and was working to reduce remaining marginable debt. It expected to sell or refinance substantially all remaining FHLBC-financed assets and repay substantially all FHLBC borrowings. Non-marginable facilities reduce margin-call exposure but may carry higher borrowing costs.
- Management described its posture as defensive and said it was preparing for a potentially prolonged recession and possible resurgence of the pandemic. It expressed cautious optimism that housing-credit investments could recover if markets and the economy improve, while acknowledging the uncertainty of that outlook.
- Key risks include further fair-value declines, borrower delinquencies and forbearance, servicing-advance funding needs, reduced loan-sale or securitization liquidity, additional margin calls, covenant compliance and refinancing access. Redwood reported meeting margin calls due through May 13 and being in covenant compliance, but said covenant amendments and future compliance remained uncertain.
- At April 30, delinquent Sequoia securitized loans subject to Redwood servicing-advance funding obligations were approximately 3.2% of principal, up from approximately 0.9% for March payments. Redwood estimated that each additional 10 percentage points of such delinquency would increase average monthly P&I advance funding by about $6 million.
- In April, Redwood implemented a workforce reduction affecting approximately 35% of employees and estimated related non-recurring charges of less than $2 million, primarily in Q2.
- Residential loan sellers had asserted claims after Redwood became more selective in loan purchases. The company estimated reasonably possible losses on claims received at $0–$10 million, while warning actual losses could be higher. A separate lawsuit alleged more than $2 million of damages. The filing also reported $2 million of reserves for previously described litigation matters.
- Redwood had $223 million of commitments to fund advances on existing residential bridge loans. It also disclosed a multifamily partnership guarantee with maximum exposure of $135 million less specified collateral; management considered performance under that guarantee remote.
Important facts for investors to verify
- Whether the post-quarter loan sales, debt repayments, securitization and migration to non-marginable financing closed on the expected terms, and the resulting liquidity and leverage.
- Subsequent asset valuations, realized versus unrealized losses, and whether management’s expectation of potential portfolio value recovery is supported by market and credit performance.
- Borrower delinquency, forbearance and servicing-advance trends, especially in Sequoia and business-purpose portfolios.
- Compliance with amended borrowing covenants, availability and renewal terms of financing facilities, and any future margin calls.
- Future dividend decisions, litigation developments and any changes to the estimated $0–$10 million range for residential loan seller claims.