Redwood Trust, Inc. — 2016 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2016. The filing also reports fourth-quarter results; this is an annual report, not a standalone quarterly filing. Redwood is a mortgage REIT investing in residential and commercial real estate assets and conducting mortgage banking through three segments: Residential Investments, Residential Mortgage Banking, and Commercial.
Financial performance and position
| Metric | 2016 | 2015 |
|---|---|---|
| Interest income | $246.4 million | $259.4 million |
| Net interest income | $157.8 million | $163.5 million |
| Non-interest income, net | $58.8 million | $25.3 million |
| Net income | $131.3 million | $102.1 million |
| Diluted earnings per share | $1.54 | $1.18 |
| GAAP return on equity | 11.8% | 8.2% |
| Dividends declared per share | $1.12 | $1.12 |
| Book value per share at year-end | $14.96 | $14.67 |
- Net income increased 29% year over year. Higher jumbo mortgage banking income, improved MSR results, lower operating expenses, and a $7.1 million reversal of loan-loss provisions contributed. Net interest income fell $5.7 million.
- Mortgage banking activities, net, rose to $38.7 million from $11.0 million, primarily reflecting higher jumbo loan-sale margins. Realized gains were $28.0 million, including $23 million from AFS securities sales and $5 million from commercial mezzanine loan sales. Investment fair-value changes were a negative $28.6 million.
- Operating expenses were $88.8 million, including $10.4 million in restructuring charges; excluding those charges, expenses were $78.4 million. Income-tax provision was $3.7 million, compared with a $10.3 million tax benefit in 2015.
- Fourth-quarter net income was $25.4 million; diluted EPS was $0.31. The quarterly dividend remained $0.28 per share.
- Year-end total assets were $5.48 billion, stockholders’ equity $1.15 billion, and cash and cash equivalents $212.8 million. Earning assets totaled $5.24 billion.
- Year-end short-term debt was $791.5 million, down from $1.86 billion. Long-term debt was $2.62 billion, including $2.00 billion of FHLBC advances, $288 million of convertible notes due 2018, $201 million of exchangeable notes due 2019, and $140 million of trust-preferred and subordinated debt. Consolidated liabilities were $4.33 billion; this includes securitization-entity liabilities that are generally nonrecourse to Redwood.
- Net cash used in operating activities was $545.7 million, largely reflecting mortgage loan purchases and sales. Cash provided by investing activities was $1.33 billion; cash used in financing activities was $795.4 million. Cash declined $7.4 million during the year.
Material changes versus 2015
- Redwood discontinued acquiring and aggregating conforming loans for resale to Fannie Mae and Freddie Mac and wound down commercial mortgage banking. It also ceased commercial loan originations and sold nearly all commercial mezzanine loans during the second half of 2016.
- Residential loans held for investment at Redwood increased to $2.26 billion, primarily through transfers from mortgage banking, and were financed by the fully utilized $2.00 billion FHLBC facility. Residential securities declined to $926.7 million and MSRs to $118.5 million, partly reflecting asset sales.
- Residential Investments segment contribution increased to $146.9 million from $136.2 million; Residential Mortgage Banking contribution rose to $35.1 million from $4.3 million; Commercial contribution rose to $38.1 million from $26.3 million. Corporate/Other loss widened to $88.9 million from $64.8 million, including restructuring costs.
- Redwood repurchased 1.94 million shares for approximately $25 million in 2016. The company reported book value per share increased by $0.29, as earnings exceeded dividends, partly offset by reduced unrealized securities gains and equity compensation.
Outlook, risks, and contingencies
- Management’s 2017 priorities are prudent deployment of available capital and growth in jumbo mortgage banking. At December 31, 2016, management estimated approximately $270 million of capital available for investment; it said $123 million had been deployed through the first eight weeks of 2017.
- Management expected higher private-label RMBS issuance and continued opportunities in GSE credit-risk-transfer investments. Redwood had completed two securitizations in early 2017 and identified expanded-prime Redwood Choice loans as a potential growth area. Management’s long-term expectation was for jumbo gross margins to average above its prior 50–75 basis-point expectation; no specific 2017 earnings guidance was provided.
- The Board stated its intention to continue a regular dividend of $0.28 per share per quarter in 2017. Dividend payments remain subject to Board discretion, taxable income, liquidity, and business conditions.
- The $2.00 billion FHLBC borrowing capacity was effectively maxed out. Federal rules allow the existing advances to remain outstanding to stated maturity, but the captive-insurance subsidiary’s membership is subject to a five-year transition period, and Redwood does not expect to increase this facility.
- Key risks include interest-rate and spread movements, prepayments, credit losses, fair-value estimation, illiquid assets, margin calls, reliance on uncommitted short-term financing and counterparties, securitization economics, and regulatory or tax changes. Mortgage assets and derivatives are substantially valued using management estimates and unobservable inputs.
- Redwood reported $2 million of litigation reserves for the FHLB-Seattle and Schwab matters. Redwood and its subsidiary were dismissed from the FHLB-Seattle claims, and Schwab dismissed its claim against the subsidiary; underwriter claims and Redwood indemnity exposure remain. The filing warns actual losses could exceed reserves. Agency risk-sharing obligations had a maximum potential future payment of $44 million, fully collateralized; realized losses to date were less than $0.1 million.
- Management reported effective disclosure controls and internal control over financial reporting; the auditor gave unqualified opinions on the financial statements and internal controls.
Most important facts for investors to verify
- Whether higher 2016 earnings and jumbo mortgage banking margins are repeatable, given their contribution from fair-value movements and favorable hedge rebalancing.
- How Redwood will deploy the remaining investment capital, and the realized returns and risks of those investments.
- Whether the FHLBC-funded residential loan portfolio can sustain returns when its $2.00 billion facility cannot be expanded, and what financing alternatives may be available over time.
- The amount and timing of potential credit losses, repurchase claims, indemnity payments, and other litigation exposures relative to recorded reserves.
- Whether cash generation, debt maturities, margin requirements, and REIT distribution obligations support the stated 2017 dividend intention.
- The effect of convertible and exchangeable debt conversion or repayment on dilution, liquidity, and per-share results.