Redwood Trust, Inc. — FY2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010; fourth-quarter results are also summarized. Redwood invests in and manages residential and commercial real estate loans and mortgage-backed securities and is organized as a REIT.
Financial results and condition
| Metric | 2010 | 2009 |
|---|---|---|
| Interest income | $230.1 million | $287.9 million |
| Interest expense | $84.7 million | $132.0 million |
| Net interest income | $145.4 million | $155.9 million |
| Loan-loss provision | $24.1 million | $49.6 million |
| Net market valuation adjustments | $(19.6) million | $(87.6) million |
| Realized gains on sales and calls, net | $63.5 million | $63.2 million |
| Net income attributable to Redwood | $110.1 million | $39.2 million |
| Diluted earnings per share | $1.36 | $0.55 |
| Cash from operating activities | $29.9 million | $210.1 million |
Fourth-quarter net income was $14.7 million ($0.18 per diluted share), versus $40.3 million ($0.51) in Q4 2009. The filing does not provide a single comparable operating-margin measure.
- At year-end, total assets were $5.14 billion, total liabilities $4.07 billion, stockholders’ equity $1.06 billion, and GAAP book value $13.63 per share. Management’s non-GAAP estimated economic book value was $14.31 per share.
- Cash and cash equivalents were $46.9 million, down from $242.8 million a year earlier. Management estimated $224 million of capacity for long-term investment, assuming it could obtain secured borrowing; this is not the same as cash on hand.
- Redwood had $44.1 million of short-term debt and $139.5 million of long-term debt. Consolidated Sequoia and Acacia asset-backed securities were $3.76 billion; much of the related consolidated assets and liabilities sit in bankruptcy-remote entities and are not obligations of Redwood.
- Declared regular dividends totaled $1.00 per share for 2010 ($0.25 quarterly), unchanged from 2009. The 2010 dividend was expected to be characterized 62% as ordinary income and 38% as return of capital.
Changes and business developments
- Annual net income rose to $110.1 million from $39.2 million, mainly as loan-loss provisions and negative market valuation adjustments fell substantially. Net interest income declined by $10.5 million, reflecting lower interest income despite reduced interest expense.
- Interest income fell about 20% year over year, while operating expenses increased to $53.7 million from $47.0 million. The increase included approximately $4 million of non-recurring equity compensation related to the former CEO’s retirement, as well as higher costs associated with business expansion and legal expenses.
- Redwood completed a $238 million residential mortgage securitization in April 2010—the company’s first since 2007—and issued approximately $211 million of securities to third parties. It acquired $253 million of residential loans by year-end and had identified another $119 million for potential purchase.
- The company began expanding commercial lending, originating three commercial loans in Q4 with approximately $31 million outstanding at year-end. Commercial assets could reach 20% of invested capital over the next one to two years, according to management.
- Residential securities were $823 million at Redwood at year-end, 80% senior, 10% re-REMIC and 9% subordinate. Management cited improved market values but noted significant credit exposure and expected further losses on subordinate securities.
Outlook, risks and unusual items
- Management stated its intention to pay a regular dividend of $0.25 per share per quarter in 2011, subject to business conditions and board discretion. It did not expect to need to issue equity in the near term and planned to increase investment and borrowing activity.
- Management expected residential securities to provide most 2011 interest income, with commercial and residential loan businesses contributing more over time. It anticipated that commercial assets would receive a significant portion of 2011 investment capital. These are forward-looking expectations, not guaranteed results.
- Management expected private residential securitization opportunities to improve over time, but said housing-finance reform and the government’s role in mortgage markets could take years to affect results. The filing cites Dodd-Frank implementation, GSE policy, credit performance, prepayments, interest rates, funding access, liquidity, counterparties and fair-value estimates as material uncertainties.
- Serious delinquencies in consolidated Sequoia residential loans were 3.74% of outstanding balances at year-end, versus 3.98% in 2009. Redwood reported $151 million of realized credit losses in its residential subordinate securities during 2010 and said future losses could extinguish most of their remaining principal.
- Three investor lawsuits involving Sequoia RMBS were pending; Redwood said it considered the claims without merit and would defend them. The company also reported responding to an SEC information order concerning CDO trading and valuation practices and an NCUA subpoena concerning RMBS. The filing stated neither inquiry was an indication that a violation had occurred; outcomes were uncertain.
- Estimated total taxable loss for 2010 was $15.7 million, although estimated REIT taxable income was approximately $4.0 million; tax and GAAP results differ materially. Management anticipated that credit losses would remain a major factor in 2011 taxable results.
Important facts for investors to verify
- Whether the $0.25 quarterly dividend remains supported by taxable income, cash flows and liquidity, given that 2010 GAAP earnings and taxable income differed substantially.
- Progress and economics of the residential loan conduit and securitization program, including execution of the identified $119 million potential loan purchases.
- Commercial loan growth, underwriting, geographic concentration and realized performance relative to management’s stated capital-allocation outlook.
- Credit losses, delinquencies and reserve assumptions across residential and commercial exposures, particularly subordinate securities and concentrated loan vintages or regions.
- Available secured financing, short-term debt renewal and the effect of collateral or derivative margin requirements on usable liquidity.
- Developments in the RMBS lawsuits and regulatory inquiries, and any resulting loss estimates, reserves or other financial impact.
- Valuation sensitivity: the filing says much of its securities portfolio relies on Level 3 inputs and management assumptions; verify subsequent fair-value changes and cash realization.
The independent auditor issued unqualified opinions on the consolidated financial statements and internal control over financial reporting as of December 31, 2010.