Redwood Trust, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; unaudited. Redwood is a specialty finance company investing in residential and multifamily mortgage-related assets and conducting mortgage banking through its Investment Portfolio and Mortgage Banking segments.
Financial results and position
| Metric | Q1 2019 | Comparable period / date |
|---|---|---|
| Interest income | $131.0 million | $76.6 million in Q1 2018 |
| Net interest income | $31.8 million | $35.1 million in Q1 2018 |
| Non-interest income | $46.7 million | $39.7 million in Q1 2018 |
| Net income | $54.5 million | $46.8 million in Q1 2018 |
| Basic / diluted EPS | $0.57 / $0.49 | $0.60 / $0.50 in Q1 2018 |
| Annualized GAAP return on equity | 15% | Company-reported for Q1 2019 |
| Regular dividend declared per share | $0.30 | $0.28 in Q1 2018 |
| Total assets / equity | $12.19 billion / $1.55 billion | At March 31, 2019 |
| Cash and cash equivalents | $200.8 million | At March 31, 2019; restricted cash was an additional $14.6 million |
| Short-term debt / long-term debt | $2.16 billion / $2.57 billion | At March 31, 2019 |
| Asset-backed securities issued | $5.64 billion | At March 31, 2019; primarily obligations of consolidated securitization entities |
Cash flow from operating activities was negative $206.5 million; investing activities provided $140.6 million and financing activities provided $76.3 million. Cash, cash equivalents and restricted cash ended the quarter at $215.5 million. Management estimated approximately $100 million of capital available for investment. No operating margin or consolidated net interest margin is clearly provided in the filing text.
Material changes versus Q1 2018
- Net income rose $7.6 million, while diluted EPS decreased from $0.50 to $0.49, reflecting a larger diluted share count.
- Net interest income fell $3.3 million. Management attributed the decline mainly to higher variable-rate financing costs and lower average residential loans held-for-sale; it said net interest income plus interest on portfolio hedges increased by $4 million.
- Mortgage banking income declined $14.3 million, mainly because of lower residential loan purchase volume and margins. Investment fair-value gains increased to $20.2 million from $1.6 million, reflecting tighter credit spreads and improved asset prices after Q4 2018 spread widening.
- Redwood completed its acquisition of the remaining 80% of 5 Arches on March 1, 2019, becoming its sole owner. The acquisition added $28.7 million of goodwill, $24.8 million of intangible assets and $24.6 million of contingent consideration at acquisition; reported Q1 net income included a roughly $2 million remeasurement gain.
- Redwood issued 11.5 million common shares in January, raising approximately $177 million net. Shares outstanding were about 96.9 million at March 31, versus 84.9 million at December 31, 2018.
- Book value increased to $16.00 per share from $15.89 at year-end. The $0.11 increase reflected earnings above the dividend and positive portfolio marks, partly offset by hedging losses and share issuance dilution.
Outlook, risks and contingencies
- Management expected Q2 2019 loan purchase activity to exceed Q1 and anticipated capital deployment to increase during 2019, partly through 5 Arches’ origination pipeline. It stated the goal of building durable cash flows and supporting a sustainable higher dividend; no quantified earnings or dividend guidance was provided.
- Management said Q1 credit performance remained strong and that the company exited the quarter more optimistic about 2019. It noted favorable bridge-loan financing conditions and expected financing structures to support margins, while 5 Arches integration and execution remained in progress.
- Key exposures include interest-rate and spread changes, prepayments, credit losses, Level 3 fair-value estimates, and liquidity or margin calls. Much of the short-term borrowing capacity is uncommitted and lenders may decline further advances. Redwood reported compliance with debt covenants at quarter-end.
- Approximately $201 million principal amount of exchangeable notes was classified as short-term debt and was due November 2019. The company also had $2.0 billion of FHLB borrowings, with a weighted-average rate of 2.65% and approximately six-year weighted-average maturity.
- 5 Arches earn-out payments could total up to $27 million, subject to origination thresholds. A separate multifamily partnership guarantee had a stated maximum loss exposure of $135 million; management considered performance under it remote. Redwood also had $19 million remaining to fund servicing-related partnerships and $56 million remaining to fund its multifamily loan partnership.
- Litigation loss reserves were $2 million, and the filing warns that indemnity-related losses could exceed reserves. The new 5 Arches risk factor cites integration, origination, regulatory, control and cost risks. Redwood also reported a $4 million residential loan and MSR repurchase reserve.
- Reported results are sensitive to fair-value estimates and may be volatile; management cautioned that Q1 results should not be taken as indicative of full-year results.
Important facts for investors to verify
- Whether Q2 loan purchases and 2019 capital deployment meet management’s stated expectations, and whether 5 Arches integration delivers the expected returns.
- How much of earnings came from recurring net interest and mortgage banking activity versus fair-value changes, realized gains and the 5 Arches remeasurement gain.
- Liquidity and refinancing plans for the $201 million exchangeable notes due in November 2019, and the continued availability and terms of secured financing.
- Changes in delinquency and credit performance, particularly in the Freddie Mac SLST pool, where loans over 90 days delinquent increased to $84 million from $51 million at year-end.
- Updates to contingent consideration, partnership commitments and guarantees, repurchase reserves, litigation exposure, and the estimated $100 million available capital balance.