Redwood Trust, Inc. — Q2 2022 Form 10-Q
Reporting period: Three and six months ended June 30, 2022. Redwood is a specialty housing-credit finance company with Residential Mortgage Banking, Business Purpose Mortgage Banking, and Investment Portfolio segments. Financial amounts below are in U.S. dollars; rounded figures are in millions unless noted.
Financial performance and position
- Q2 results: Net loss was $100 million, or $0.85 per diluted share, versus net income of $90 million, or $0.66 per diluted share, in Q2 2021. Total interest income was $167 million and net interest income was $40 million, up from $139 million and $31 million, respectively.
- Six-month results: Net loss was $69 million, or $0.60 per diluted share, versus net income of $187 million, or $1.38 per diluted share, in the first half of 2021. Net interest income increased to $94 million from $56 million.
- Key drivers: Q2 mortgage banking activities recorded a $30 million loss and investment fair value changes recorded an $88 million loss. These compared with income of $54 million and $49 million, respectively, in Q2 2021. Management attributed much of the investment loss to mark-to-market effects from credit-spread widening; it reported generally stable underlying credit performance.
- Segment contribution: Q2 losses were $14 million in Residential Mortgage Banking, $21 million in Business Purpose Mortgage Banking, and $53 million in Investment Portfolio. Each segment reported positive contribution in Q2 2021.
- Book value and dividends: Book value was $10.78 per share at June 30, down approximately 10% during Q2. Economic return on book value was negative 8.3% for Q2 and negative 6.8% for the first half. The Q2 dividend was $0.23 per share; $0.46 per share was declared year to date.
- Balance sheet: Total assets were $13.88 billion and equity was $1.26 billion, compared with $14.71 billion and $1.39 billion at December 31, 2021. Unrestricted cash was $371 million; management estimated available capital of approximately $190 million, after accounting for the subsequent Riverbend acquisition payment.
- Debt and liquidity: Short-term debt was $1.87 billion, long-term debt was $1.97 billion, and asset-backed securities issued were $8.58 billion. Short-term debt declined from $2.18 billion at year-end, while long-term debt increased from $1.64 billion. Management reported approximately $500 million of pledgeable, unencumbered assets and compliance with debt covenants.
- Cash flow, first half: Operating activities used $491 million; investing activities provided $204 million; financing activities provided $199 million. Operating cash flow excluding specified held-for-sale loan and associated derivative flows was positive $68 million. Cash, cash equivalents, and restricted cash decreased by $88 million to $444 million.
Material changes versus the prior comparable period
- Rising mortgage rates, market volatility, and sharp credit-spread widening reversed prior-year positive mortgage banking and investment valuation results. Mortgage banking losses were $30 million in Q2 and $14 million in the first half, versus income of $54 million and $137 million, respectively, in 2021.
- Investment fair value changes swung to losses of $88 million in Q2 and $94 million in the first half, versus gains of $49 million and $95 million in 2021. Management said most losses were unrealized and that it saw little deterioration in expected future cash flows during Q2.
- Net interest income improved year over year, supported by higher average investment balances, including bridge loans and retained SFR securitization securities. Redwood cautioned that rising benchmark rates would likely increase borrowing costs.
- General and administrative expenses fell to $32 million in Q2 from $41 million, and to $67 million for the first half from $84 million, primarily reflecting lower variable compensation.
- Equity declined from year-end, reflecting net losses, other comprehensive losses, and dividends, partly offset by stock issuance. Redwood issued $215 million of 7.75% convertible notes due 2027 and repurchased 3.7 million shares for approximately $33 million during Q2.
Outlook, commentary, risks, and unusual items
- Management described Q2 as a period of volatility, inflation, and rising mortgage rates. It said it had adopted a more conservative risk posture, emphasizing pipeline turnover, liquidity, and lower near-term mortgage banking volumes than its longer-term growth ambitions. No specific earnings guidance was provided.
- Redwood expected business-purpose origination volume to likely slow in the second half of 2022, while noting continued demand for short-term bridge loans. It said its mortgage banking platforms would focus on returning to profitability and maintaining a stable market presence.
- Management cited approximately $391 million of net discount to par in its securities portfolio as potential value recovery over time, subject to credit performance, prepayments, and other market factors. It cautioned that further spread widening or credit deterioration could produce additional fair value losses.
- Management reported 90+ day delinquencies of 1.7% in jumbo, 2.4% in SFR, and 2.6% in bridge portfolios. It also noted that approximately 20% of investment portfolio capital was in SLST reperforming-loan investments.
- Liquidity and financing risks include uncommitted warehouse facilities, potential margin calls, facility renewals, rising interest expense, and the need to manage LIBOR transition. At June 30, Redwood had $835 million of bridge-loan funding commitments and $225 million of remaining HEI purchase commitments.
- Other disclosed exposures include up to $44 million of potential future payments under risk-sharing arrangements, a $6 million residential loan and MSR repurchase reserve, and $2 million of reserves for specified litigation matters. Redwood reported no significant litigation update.
- Subsequent events: Redwood closed its Riverbend Funding acquisition on July 1 for an initial cash purchase price of approximately $44 million, subject to adjustments and potential earnout consideration. In July, the board authorized up to $125 million of common-stock repurchases, replacing the prior authorization.
- Fair value measurement is a significant source of estimation uncertainty: most financial instruments carried at fair value use Level 3 inputs, and changes in assumptions or market conditions may materially affect reported results.
Most important facts for investors to verify
- Whether credit spreads, mortgage rates, and fair values stabilize, and whether unrealized portfolio losses are ultimately recoverable.
- Whether mortgage banking volumes and margins recover, particularly after Q2 residential gross margin was negative 240 basis points versus positive 71 basis points in Q1 2022.
- Available liquidity, warehouse facility renewals and terms, margin-call exposure, and the use of the estimated $190 million of available capital.
- Credit performance and funding needs across bridge loans, SFR loans, and HEIs, including the stated commitments to fund additional loans and purchase HEIs.
- The effects of the Riverbend acquisition, the new repurchase authorization, and the 7.75% convertible notes on capital, debt costs, and per-share book value.