Redwood Trust, Inc. — Second-Quarter 2011 Form 10-Q
Reporting period: Quarter ended June 30, 2011; financial statements are unaudited. Redwood is a REIT investing in, financing, and managing residential and commercial real estate loans and related securities. Unless noted otherwise, dollar amounts below are in millions.
Financial results and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Interest income | $53.0 | $56.6 | $107.3 | $115.3 |
| Net interest income | $29.3 | $35.4 | $61.7 | $75.9 |
| Loan-loss provision | $1.6 | $4.3 | $4.4 | $13.8 |
| Market valuation adjustments, net | $(11.1) | $(7.1) | $(16.9) | $(18.4) |
| Realized gains on sales and calls, net | $5.8 | $16.1 | $9.7 | $60.4 |
| Net income attributable to Redwood | $9.4 | $28.6 | $27.6 | $75.4 |
| Diluted earnings per share | $0.11 | $0.35 | $0.34 | $0.94 |
- Q2 net interest income after loan-loss provision and market valuation adjustments was $16.6 million, down from $24.0 million a year earlier. The filing does not provide a single consolidated net interest margin figure.
- Operating expenses were $12.1 million in Q2, versus $11.2 million; for the first half they were $23.6 million, versus $28.5 million.
- Six-month operating cash flow was $33.0 million, compared with cash used of $23.6 million in 2010. Cash and cash equivalents ended June at $80.0 million, up from $46.9 million at year-end; first-half dividends paid were $40.3 million.
- At June 30, total assets were $5.165 billion, total liabilities $4.138 billion, and total equity $1.027 billion. Stockholders’ equity was $1.025 billion; GAAP book value was $13.04 per share, down from $13.76 at March 31.
- Debt included $40.9 million of short-term debt, repaid in July, and $139.5 million of long-term debt. Consolidated Sequoia and Acacia asset-backed securities (ABS) were $3.839 billion. Most securitization assets and liabilities are held in bankruptcy-remote entities and are not direct obligations of Redwood.
- Management estimated investment capacity at $210 million at June 30. A July re-securitization generated $243 million net cash proceeds; management said this could lift investment capacity above $400 million once warehouse funding is established.
- The quarterly dividend declared was $0.25 per share, unchanged from 2010. Management stated its intention to pay $0.25 quarterly during 2011.
Material changes versus comparable periods
- Q2 net income attributable to Redwood fell to $9.4 million from $28.6 million, and diluted EPS declined to $0.11 from $0.35. The six-month comparison also declined substantially, reflecting much lower realized gains on sales and calls, lower net interest income, and ongoing valuation losses.
- Q2 realized gains were $5.8 million versus $16.1 million; Redwood sold $25 million of securities for a net gain of $5 million, compared with $116 million of sales and $16 million of gains in Q2 2010.
- The residential securities market weakened during Q2 after earlier price gains: risk appetite fell, bid-ask spreads widened, and prices declined, particularly for riskier securities. Accumulated other comprehensive income fell to $80.6 million from $112.3 million at year-end, chiefly reflecting unrealized securities losses.
- Residential loans on the balance sheet increased to $3.860 billion from $3.797 billion at year-end; commercial loans rose to $83.9 million from $50.4 million. Real estate securities declined to $1.038 billion from $1.155 billion.
- The residential loan-loss allowance was $62.3 million at June 30, roughly level with year-end; first-half provision was $4.4 million versus $13.8 million in 2010. Legacy Sequoia serious delinquencies were $131 million, or 3.57% of loan balances, down from $144 million, or 3.80%, a year earlier.
Outlook, risks, and unusual items
- Management is rebuilding its residential loan-conduit and commercial lending businesses, but said the timing and scale of residential private-market recovery remain uncertain. It targeted two additional securitizations in 2011, while acknowledging the goal had become more challenging and meaningful traction might not occur before 2012.
- Management expected commercial loan originations of $25–$50 million per quarter. Its commercial loan portfolio had an average unlevered yield of approximately 10.5% and weighted-average maturity above five years.
- Management expected a full-year 2011 taxable loss, citing an anticipated additional $138 million of tax credit losses on securities; the timing of those losses was uncertain. Taxable income and GAAP income differ materially.
- Q2 market valuation losses included negative derivative adjustments. Management said hedge losses might be recovered over time through higher interest income on retained securities, but cautioned that full recovery was not assured. Fair values for many assets and liabilities rely on Level 3 models and management assumptions.
- At June 30, residential loans held for investment had a $62.3 million allowance. Redwood’s securities included $301 million of designated credit reserves; management expected future losses to extinguish much of the principal of its residential subordinate securities.
- Three investor lawsuits concern prior Sequoia RMBS offerings: FHLB-Seattle, Charles Schwab, and FHLB-Chicago. Redwood disputed the claims and intended to defend them. Redwood was dismissed for lack of personal jurisdiction in the Seattle case in July, but claims against underwriters remained; other proceedings were pending. The filing says possible losses could not be reasonably estimated and indemnity obligations could still create costs.
- The company had responded to an SEC information order concerning past CDO activities and an NCUA subpoena concerning RMBS transactions. Neither, as described in the filing, asserted that a legal violation had occurred, but further action remained possible.
- Redwood transferred $365 million of residential securities into a Credit Suisse re-securitization trust in July for subordinated securities and $243 million net cash. Consolidation was still under review and could add approximately $245 million of ABS to reported liabilities.
- Management reported disclosure controls and procedures were effective at a reasonable assurance level and no material second-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether the planned residential securitizations and warehouse financing were completed, and whether the July re-securitization was consolidated as anticipated.
- Progress in deploying capital, loan acquisition volumes, commercial originations, and the effect of these activities on recurring net interest income and operating costs.
- Subsequent credit performance, realized losses, allowance adequacy, and the assumptions underlying Level 3 valuations and securities credit reserves.
- Developments in the three RMBS lawsuits, indemnity exposure, and any SEC or NCUA follow-up; loss amounts were not estimable in this filing.
- Actual taxable income and credit-loss timing, the characterization and sustainability of the $0.25 quarterly dividend, and the effect of market and interest-rate changes on liquidity and book value.