Redwood Trust, Inc. — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. Unaudited. Redwood is a specialty finance company focused on residential, business-purpose and multifamily housing credit; it operates as a REIT.
Financial results and key metrics
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Net income (loss) | $88.3 million | $141.8 million | $275.6 million | ($636.1 million) |
| Diluted EPS | $0.65 | $1.02 | $2.03 | ($5.60) |
| Net interest income | $42.0 million | $21.6 million | $98.4 million | $100.3 million |
| Mortgage banking income | $63.2 million | $59.4 million | $200.2 million | $24.5 million |
| Investment fair value changes | $26.1 million | $107.0 million | $120.6 million | ($611.6 million) |
- Q3 annualized GAAP return on equity was 26.7%; economic return on book value was 6.5% for the quarter and 26.6% year to date. Book value per share ended at $12.00, up 4.7% in Q3 and 21% year to date.
- The company declared a Q3 dividend of $0.21 per share, a 17% increase from the prior quarterly dividend. Year-to-date declared dividends were $0.55 per share.
- At September 30, total assets were $13.07 billion, liabilities $11.70 billion and equity $1.38 billion. Cash and cash equivalents were $557 million, plus $89 million of restricted cash. Management estimated available capital at $350 million.
- Debt included $1.75 billion of short-term debt, $8.18 billion of asset-backed securities and $1.50 billion of long-term debt. Much of the ABS is issued by consolidated, non-recourse securitization entities; related assets are not generally available to settle Redwood’s other obligations.
- Operating cash flow was negative $3.78 billion for the nine months, largely reflecting loan purchases and originations held for sale. Excluding cash flows from held-for-sale loan purchases, originations, sales and principal payments, operating cash flow was positive $84 million. Investing cash flow was positive $1.36 billion and financing cash flow positive $2.52 billion.
Changes versus comparable periods
- Q3 net income declined year over year, despite higher net interest income and mortgage banking income; Q3 2020 included substantially larger investment fair value gains.
- Nine-month results improved sharply from 2020’s pandemic-related market valuation losses and an $89 million goodwill impairment. 2021 benefited from stronger mortgage banking activity and investment valuation recovery.
- Nine-month net interest income was slightly lower year over year. Total interest income declined, while lower interest expense partly offset the decline.
- Residential loans held for sale rose to $1.50 billion from $177 million at year-end 2020; business-purpose loans held for sale increased to $466 million from $245 million. Short-term debt increased to $1.75 billion from $523 million.
Management commentary, outlook and risks
- Management attributed Q3 performance to higher operating-platform volumes, strong margins, improved investment returns and a tax benefit. Residential mortgage banking gross margin was 122 basis points, versus 98 basis points in Q2 2021.
- CoreVest funded $639 million of business-purpose loans in Q3. Redwood locked $4.74 billion of residential loans, purchased $3.18 billion and distributed $2.43 billion through whole-loan sales; it also completed loan and home-equity-investment securitizations.
- The company completed its first CoreVest bridge-loan securitization and co-sponsored a Point HEI securitization. Management cited continuing acquisition and securitization opportunities, but provided no specific earnings or financial guidance.
- Management said it was proceeding cautiously amid COVID-19 variants, inflation, Federal Reserve tapering, debt-ceiling uncertainty and an uneven economic recovery. It noted that cash levels were high as part of its risk-management posture.
- Material risks include leverage and liquidity needs; availability and renewal of largely uncommitted funding facilities; margin calls and collateral values; credit, interest-rate, spread and prepayment risk; fair-value estimation; and economic, housing-market, regulatory and pandemic-related uncertainty. A substantial portion of financial assets and liabilities is valued using Level 3 inputs and significant judgment.
- Commitments included up to $426 million to fund bridge-loan advances and up to $125 million to acquire HEIs. Maximum potential future payments under Agency risk-sharing arrangements were $44 million; the recorded guarantee obligation was $8 million. The filing reported $2 million of reserves for specified litigation matters and $2 million accrued for residential loan-seller demands.
- A discrete release of federal and state deferred-tax valuation allowances contributed $20 million of tax benefit in Q3; management continued to maintain a valuation allowance against most state deferred tax assets.
Important facts for investors to verify
- How much reported earnings and book-value growth depends on fair-value marks, valuation assumptions and the timing of securitization calls.
- Funding availability, facility maturities, collateral and margin-call exposure, and the distinction between consolidated non-recourse VIE debt and Redwood’s recourse obligations.
- Whether loan origination, purchase and securitization volumes and margins are sustainable, and how much liquidity is required to support them.
- Credit and delinquency trends in residential, bridge and single-family-rental portfolios, including foreclosure and REO developments.
- Realization of deferred tax assets, future dividend capacity and characterization, and potential exposure from commitments, repurchase claims, risk-sharing arrangements and litigation.