Business Context and Reporting Period
Company: Redwood Trust, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2009
Business Overview: Redwood Trust is a real estate investment trust (REIT) that invests in, finances, and manages residential and commercial real estate loans and securities. The company operates through sponsored securitization entities (Sequoia for residential loans, Acacia for CDOs/securities) and a private fund (Redwood Opportunity Fund). The company adopted new accounting standards (FSP 115-2) regarding other-than-temporary impairments (OTTI) in the second quarter of 2009.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2009 | Six Months Ended June 30, 2009 | Three Months Ended June 30, 2008 | Six Months Ended June 30, 2008 |
|---|---|---|---|---|
| Net Interest Income | $35.3 million | $69.1 million | $39.5 million | $88.3 million |
| Provision for Loan Losses | ($14.5 million) | ($30.6 million) | ($10.1 million) | ($18.1 million) |
| Market Valuation Adjustments, Net | ($29.1 million) | ($72.4 million) | ($60.5 million) | ($254.4 million) |
| Realized Gains, Net | $25.5 million | $26.0 million | $2.7 million | $2.8 million |
| Net Income (Loss) Attributable to Redwood | $6.7 million | ($28.2 million) | ($45.9 million) | ($217.5 million) |
| Diluted EPS | $0.10 | ($0.48) | ($1.40) | ($6.65) |
| Cash and Cash Equivalents | $337.1 million (Balance Sheet) | N/A | ||
| Total Assets | $5.29 billion (Balance Sheet) | N/A | ||
| Total Liabilities | $4.47 billion (Balance Sheet) | N/A | ||
| Stockholders' Equity | $801.8 million (Balance Sheet) | N/A |
Material Changes vs. Prior Period
- Profitability Turnaround: The company reported a net income of $6.7 million for the quarter ended June 30, 2009, compared to a net loss of $45.9 million in the same period in 2008. This improvement was driven by a significant reduction in negative market valuation adjustments and a $19 million gain from the deconsolidation of a Sequoia securitization entity.
- Market Valuation Adjustments: Negative market valuation adjustments decreased to $29.1 million in Q2 2009 from $60.5 million in Q2 2008. This reduction was primarily due to fewer impairment charges on securities and favorable fair value changes on Acacia liabilities.
- Loan Loss Provisions: The provision for loan losses increased to $14.5 million in Q2 2009 from $10.1 million in Q2 2008, reflecting higher expected losses on residential loans held by Sequoia entities. Serious delinquencies on consolidated Sequoia loans rose to 3.57% from 1.87% year-over-year.
- Capital Structure: The company raised approximately $520 million in net proceeds from the issuance of common stock during the first six months of 2009. Stockholders' equity increased significantly from $301.9 million at December 31, 2008, to $801.8 million at June 30, 2009.
- Asset Composition: Real estate loans decreased to $3.97 billion from $4.66 billion, while real estate securities increased to $804.6 million from $572.1 million, reflecting a strategic shift toward senior residential mortgage-backed securities (RMBS).
Guidance, Outlook, and Risks
- Outlook: Management expects to continue producing strong cash flows from existing investments and uninvested cash ($182 million as of July 2009). The company anticipates reporting a taxable loss for 2009, meaning dividends paid will likely be characterized as a return of capital.
- Investment Strategy: The company plans to invest remaining cash in select senior RMBS and structured credit-risk transfer transactions. Management noted that while prices for senior RMBS have risen, they remain disciplined in seeking assets that meet hurdle rates.
- Accounting Changes: The adoption of FSP 115-2 in April 2009 changed the recognition of OTTI, separating credit losses (recognized in earnings) from non-credit losses (recognized in OCI). This resulted in a $61 million cumulative-effect adjustment to reclassify non-credit impairments to OCI.
- Risks:
- Credit Risk: Continued deterioration in housing prices and rising delinquencies (particularly in non-prime pools) pose significant risks to cash flows and asset values.
- Regulatory Risk: The Obama Administration's Financial Reform Plan and potential changes to Fannie Mae/Freddie Mac could impact the securitization market and the company's business model.
- Accounting Volatility: GAAP earnings remain volatile due to mark-to-market adjustments, premium/discount amortization, and the timing of credit losses.
Key Facts for Investor Verification
- Deconsolidation Gain: Verify the $19 million realized gain from the deconsolidation of a Sequoia entity, which significantly impacted Q2 2009 net income.
- OTTI Adoption Impact: Confirm the $61 million reclassification of non-credit impairments to Other Comprehensive Income (OCI) due to the adoption of FSP 115-2 and its effect on reported equity.
- Delinquency Trends: Monitor the 3.57% serious delinquency rate on Sequoia residential loans and the 25.76% delinquency rate on non-prime subordinate securities.
- Cash Position: Note the strong liquidity position with $337 million in cash and cash equivalents and no short-term debt outstanding.
- Dividend Status: Verify that the $0.25 per share quarterly dividend is expected to be treated as a return of capital for tax purposes due to anticipated 2009 taxable losses.