Redwood Trust, Inc. — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019; filed March 2, 2020. Redwood is a mortgage-focused specialty finance company and REIT. It operates Residential Lending, Business Purpose Lending, Multifamily Investments, and Third-Party Residential Investments.
Financial performance and position
| Metric | 2019 | 2018 |
|---|---|---|
| Interest income | $622.3 million | $378.7 million |
| Interest expense | $479.8 million | $239.0 million |
| Net interest income | $142.5 million | $139.7 million |
| Non-interest income | $165.8 million | $74.0 million |
| Net income | $169.2 million | $119.6 million |
| Diluted EPS | $1.46 | $1.34 |
| Return on average equity | 10.6% | 9.3% |
| Book value per share | $15.98 | $15.89 |
| Regular dividends per share | $1.20 | $1.18 |
| Total assets | $18.0 billion | $11.9 billion |
| Total stockholders’ equity | $1.83 billion | $1.35 billion |
Interest income and expense rose sharply as the balance sheet and consolidated securitization activity expanded. Net interest income increased only modestly. The improvement in net income was also driven by mortgage banking income ($87.3 million, up from $59.6 million) and a swing to positive investment fair-value changes ($35.5 million versus a $25.7 million loss in 2018). G&A increased to $118.7 million from $82.8 million, largely reflecting acquired businesses and higher compensation and operating costs.
Cash and cash equivalents were $197.0 million, with restricted cash of $93.9 million. Management estimated $260 million of capital available for investment. Operating cash flow was negative $1.17 billion, largely reflecting mortgage-loan purchases and originations; investing cash flow was positive $1.03 billion and financing cash flow positive $225.5 million. These cash-flow categories are affected by the company’s mortgage-banking and securitization activity and should not be read as conventional operating cash generation alone.
Short-term debt was $2.33 billion and long-term debt, net, was $2.95 billion. Redwood also reported $10.52 billion of asset-backed securities issued by consolidated entities. Those securitization liabilities are generally non-recourse to Redwood, though the company retains economic interests and other exposures. Redwood’s $2.00 billion of FHLBC advances were at a weighted-average rate of 1.88% and had an approximately six-year weighted-average maturity. The company reported compliance with financing covenants at year-end.
Material changes versus 2018
- Assets increased about 51%, reflecting investment growth, securitization consolidation, and acquisitions.
- Redwood acquired 5 Arches in March and CoreVest in October, adding business-purpose loan origination and investment capabilities. The acquisitions contributed to $89 million of goodwill and $73 million of intangible assets at year-end.
- Business-purpose lending became a significant new activity: the platforms originated $1.02 billion of loans during 2019, and segment contribution was $17.2 million versus a $0.3 million loss in 2018.
- Multifamily and third-party residential segment contributions rose to $36.9 million and $88.3 million, respectively; Residential Lending contribution declined to $78.8 million from $104.6 million.
- Capital deployed was $1.09 billion versus $810 million. Residential loan purchases fell to $5.90 billion from $7.13 billion, which management attributed mainly to competition.
- Redwood issued approximately $451 million of equity capital and $201 million of exchangeable notes; common shares outstanding rose to about 114.4 million from 84.9 million.
Outlook, risks, and unusual items
- Management outlook: Management expected net interest income to grow as capital deployed into higher-yielding business-purpose, multifamily, and re-performing-loan investments earns returns. It expected fewer securities-sale gains in 2020, and anticipated higher residential loan purchases and business-purpose originations, subject to market conditions. No formal earnings guidance was provided.
- Dividend: After paying $0.30 per share each quarter in 2019, the board declared a first-quarter 2020 dividend of $0.32 per share, a 6.7% increase. Future dividends remain discretionary and depend on taxable income, liquidity, results, and REIT requirements.
- Funding and market risk: Many warehouse and repo facilities are uncommitted, short-term, and subject to collateral margin calls. The FHLBC facility is capped at $2.00 billion; regulation may limit future access or require alternative financing when existing advances mature.
- Credit and valuation risk: Business-purpose bridge loans, subordinate mortgage securities, and re-performing/non-performing loan investments can experience elevated credit losses. Fair values rely substantially on management assumptions and limited observable market data; fair-value measurement was a critical audit matter.
- Acquisition and integration: Integration, expenses, goodwill and intangible-asset impairment, and execution of the expanded business-purpose platform may affect future results. Redwood reported $28 million of estimated 5 Arches contingent consideration at year-end.
- Legal and other contingencies: Redwood recorded $2 million of reserves for legacy litigation and indemnity exposures; actual losses could exceed reserves. It also had a $173 million commitment for residential bridge-loan advances and a $37 million remaining commitment to a multifamily loan partnership. The partnership guarantee had maximum exposure of $135 million, although management viewed performance as remote.
- Controls and uncertainty: Management and the auditor concluded internal control over financial reporting was effective, but CoreVest was excluded from the year-end control assessment under the newly acquired business exemption. The filing also identified COVID-19 as a potential business disruption risk; the extent of any impact was uncertain at filing.
Important facts for investors to verify
- Whether post-acquisition growth in business-purpose lending produces sustainable earnings after integration costs and contingent payments.
- The quality and delinquency trends of bridge, single-family rental, and re-performing-loan exposures, including the bridge portfolio’s foreclosures and the $135 million delinquent balance in consolidated Freddie Mac SLST loans.
- Liquidity under uncommitted financing, margin-call requirements, and the refinancing plan for FHLBC advances as they mature.
- The sensitivity of reported earnings and book value to fair-value assumptions, credit spreads, prepayments, interest rates, and hedges.
- Whether available capital, leverage, taxable income, and cash flows support the higher dividend and planned investment deployment.
- Potential dilution from convertible and exchangeable notes, equity awards, and further share issuance, and any developments in litigation or indemnity claims.