Redwood Trust, Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Redwood invests in mortgage and other real-estate-related assets and operates residential mortgage banking, residential investments, and commercial mortgage banking and investments businesses. It has elected REIT status.
Financial results and position
Amounts below are in millions, except per-share data and percentages.
| Metric | Q3 / Sep. 30, 2015 | Comparable period / prior date |
|---|---|---|
| Interest income | $63.5 | Q3 2014: $63.4 |
| Net interest income | $39.6 | Q3 2014: $40.0 |
| Net income | $19.2; diluted EPS $0.22 | Q3 2014: $45.1; diluted EPS $0.50 |
| Net income, nine months | $61.0; diluted EPS $0.69 | Nine months 2014: $73.4; diluted EPS $0.84 |
| Operating expenses | $24.5 | Q3 2014: $21.4 |
| Dividend declared per common share | $0.28 for Q3 | Q3 2014: $0.28 |
| Total assets / equity | $6,269 / $1,207 | Dec. 31, 2014: $5,919 / $1,256 |
| Cash and cash equivalents | $235 | Dec. 31, 2014: $270 |
| Short-term / long-term debt | $1,873 / $1,822 | Dec. 31, 2014: $1,794 / $1,195 |
| GAAP book value per share | $14.69 | June 30, 2015: $14.96 |
- Q3 comprehensive income was a loss of $1.8 million, including $21.0 million of other comprehensive loss, largely from unrealized changes in securities and interest-rate agreements.
- Nine-month cash flows: operating activities used $1,050 million, investing activities provided $670 million, and financing activities provided $346 million. Cash declined $34 million. Operating cash use chiefly reflected mortgage-loan purchases and sales; management says it was $43 million negative excluding cash flows from loans initially classified as held-for-sale.
- Available capital for long-term investments was approximately $85 million. Total liabilities were $5,062 million, including debt and liabilities of consolidated securitization entities; some consolidated VIE assets are restricted to settling those entities’ obligations and their creditors generally have no recourse to Redwood.
- The filing does not provide a clear consolidated profit-margin measure. It reports jumbo loan-sale margins of 47 basis points for the first nine months, within its 25–50 basis-point long-term target; conforming margins were 24 basis points for the same period.
Changes versus comparable periods
- Q3 net income fell $25.9 million year over year. Net interest income was nearly flat, but non-interest income shifted from $30.1 million of income in Q3 2014 to a $3.4 million loss in Q3 2015. Management attributed the decline principally to weaker residential and commercial mortgage-banking returns and hedging and valuation effects.
- For the first nine months, net interest income rose $6.5 million, but net income fell $12.4 million. Non-interest income declined $21.3 million, and operating expenses increased $11.1 million, principally reflecting higher compensation and staffing.
- Residential investments grew: residential loans held-for-investment increased to $1,360 million from $582 million at year-end, while real-estate securities declined to $1,085 million from $1,379 million. MSRs rose to $163 million from $139 million.
- Short-term debt increased $79 million and long-term debt increased $627 million from year-end. FHLB of Chicago advances funded growth in residential loans held-for-investment.
- Redwood early-adopted ASU 2014-13 on January 1, 2015, measuring assets and liabilities of consolidated Sequoia entities at fair value. Adoption increased opening equity by approximately $10 million and makes some comparisons with 2014 less directly comparable.
Outlook, management commentary, and risks
- Management said it was unlikely to achieve its previously projected 2015 residential acquisition volumes of $5.5–$7 billion in jumbo loans and $6–$7 billion in conforming loans. It also expected to fall short of its prior commercial origination outlook of $1.0–$1.25 billion at an average 1.5% margin.
- Management cited intense conforming-loan and MSR competition, reduced refinance activity, and difficult CMBS conditions, including wider spreads and more selective investors. It is adjusting pricing and costs, expanding jumbo whole-loan distribution for 2016, and pursuing operational efficiency and improved conforming margins. It remained optimistic about the commercial business improving in 2016.
- Management said investment-portfolio performance and underlying credit performance remained strong. It deployed $87 million into new investments in Q3 and reported a $1.53 billion residential loan-purchase pipeline at quarter-end, before fallout adjustments. No residential securitization was completed in Q3.
- The Q3 dividend of $0.28 per share exceeded Q3 GAAP EPS of $0.22. The board subsequently declared a $0.28 fourth-quarter dividend; the filing does not establish a longer-term dividend commitment.
- In August, the board authorized up to $100 million of share repurchases. Redwood bought approximately 2.45 million shares for $35 million at an average $14.43 per share in Q3; approximately $65 million remained authorized at quarter-end. Repurchases reduce available capital.
- Liquidity and funding risks include reliance on short-term secured borrowings and an uncommitted FHLB facility. Short-term facilities can be declined or not renewed, and collateral-value declines can trigger margin calls. Redwood reported covenant compliance at quarter-end, with more than $200 million of headroom on minimum-equity covenants.
- Q3 included a $7.4 million income-tax benefit; the nine-month benefit was $10.3 million, despite positive consolidated GAAP income, reflecting losses at taxable subsidiaries and REIT tax treatment. Estimated nine-month taxable income was $26.6 million versus GAAP net income of $61.0 million.
- Risk-sharing arrangements cover conforming-loan pools; maximum potential future payments were $19 million at quarter-end and fully collateralized. Redwood reported no losses under the arrangements and no additional loss allowance was required.
- Litigation-related reserves were $2 million. Redwood stated that indemnity exposure could result in losses beyond the reserve. Other risks include fair-value estimates using significant unobservable inputs, interest-rate and prepayment changes, credit losses, and possible regulatory changes affecting FHLB access.
Important facts for investors to verify
- Whether mortgage-banking volumes and margins, especially conforming and commercial, recover as management’s 2016 initiatives anticipate.
- How the $0.28 quarterly dividend compares with future GAAP and REIT taxable income, cash generation, and available capital.
- Funding capacity, collateral and margin-call requirements, renewals of uncommitted facilities, and the availability and terms of FHLB advances.
- Fair-value assumptions and hedging results for loans, securities, MSRs, derivatives, and consolidated Sequoia interests; Q3 market-valuation effects were significant.
- Developments in credit performance, residential repurchase claims, risk-sharing obligations, and the FHLB-Seattle-related indemnity and litigation matters.