Business Context and Reporting Period
Company: Redwood Trust, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008
Business Overview: Redwood Trust is a Real Estate Investment Trust (REIT) that invests in, finances, and manages residential and commercial real estate loans and asset-backed securities. The company focuses on credit-enhancing securitized real estate loans, acquiring first-loss and credit-sensitive securities. It operates through sponsored securitization programs named Sequoia (residential loans) and Acacia (securities and loans), as well as the Opportunity Fund LP.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2008 | Nine Months Ended Sep 30, 2008 | Three Months Ended Sep 30, 2007 | Nine Months Ended Sep 30, 2007 |
|---|---|---|---|---|
| Net Interest Income | $39.4 million | $128.1 million | $55.1 million | $162.3 million |
| Provision for Loan Losses | $(18.3) million | $(36.5) million | $(1.5) million | $(7.8) million |
| Market Valuation Adjustments (Net) | $(127.2) million | $(381.7) million | $(102.8) million | $(142.5) million |
| Net (Loss) Income | $(111.3) million | $(328.8) million | $(60.9) million | $(31.2) million |
| Diluted EPS | $(3.34) | $(9.99) | $(2.18) | $(1.14) |
| Total Assets | $7.38 billion (Sep 30, 2008) vs. $9.94 billion (Dec 31, 2007) | |||
| Stockholders' Equity | $411.9 million (Sep 30, 2008) vs. $(718.3) million deficit (Dec 31, 2007) | |||
| Cash and Cash Equivalents | $177.0 million (Sep 30, 2008) | |||
| Total Debt (Short-term + Long-term + ABS) | $6.61 billion (ABS) + $156.9 million (Redwood Debt) |
Material Changes vs. Prior Period
- Net Loss Expansion: The net loss for the nine months ended September 30, 2008, increased significantly to $328.8 million compared to $31.2 million in the same period in 2007. The primary drivers were a $239 million increase in negative market valuation adjustments and a $28.6 million increase in the provision for loan losses.
- Market Valuation Adjustments: Negative adjustments totaled $381.7 million for the nine months of 2008, driven largely by impairment charges on real estate securities and fair value declines in trading securities. This compares to $142.5 million in the prior year period.
- Provision for Loan Losses: The provision increased to $36.5 million for the nine months of 2008 from $7.8 million in 2007, reflecting higher expected credit losses on residential real estate loans held by Sequoia entities. Serious delinquencies on Sequoia loans rose to 2.36% of current balances.
- Net Interest Income Decline: Net interest income decreased by $34.2 million for the nine-month period, primarily due to lower interest rates, higher credit costs, and slower prepayments.
- Balance Sheet Contraction: Total assets decreased by approximately $2.56 billion from year-end 2007, largely due to the adoption of FAS 159 (Fair Value Option) which resulted in a one-time $1.5 billion reduction in the carrying value of Acacia assets and liabilities, as well as principal paydowns on loans and securities.
Guidance, Outlook, and Risks
- Dividend Policy: The Board reaffirmed the intention to pay a fourth-quarter dividend of $0.75 per share. However, the company projects that REIT taxable income for 2008, combined with undistributed income from 2007, will fall short of covering full-year distributions at the regular rate. It is highly probable that taxable income for 2009 will be negative, and the Board plans to review the dividend policy for 2009 in November.
- Investment Activity: The company suspended purchasing assets at Redwood from mid-June to mid-October 2008 to analyze the impact of government loan modification programs (FHA/FDIC) and the Troubled Asset Relief Plan (TARP). Investment activity was selectively resumed in mid-October.
- Market Conditions: Management highlights extreme market volatility, unprecedented contraction in liquidity, and significant price declines (approx. 30%) in residential and commercial mortgage-backed securities. Delinquencies are trending upwards faster than base case expectations.
- Accounting Volatility: GAAP earnings are expected to remain volatile due to mark-to-market adjustments. The company notes that negative mark-to-market balance sheet write-downs not yet realized through the income statement totaled $63 million at September 30, 2008.
- Liquidity: The company maintains a strong liquidity position with $177 million in unrestricted cash and $163 million in excess capital. It does not anticipate a need to sell assets to meet obligations.
Key Facts for Investor Verification
- Dividend Sustainability: Verify the company's ability to maintain the $0.75 quarterly dividend given the projection of negative taxable income for 2009 and the shortfall in 2008 taxable income relative to distributions.
- Credit Loss Trajectory: Monitor the trend of serious delinquencies (currently 2.36% for Sequoia loans) and the adequacy of the allowance for loan losses ($46.9 million), which has increased significantly from $18.3 million at year-end 2007.
- Impact of Government Programs: Assess the financial impact of the new FHA/FDIC loan modification programs and TARP on the value of the company's non-prime and subprime securities portfolio.
- Mark-to-Market Volatility: Understand that GAAP net income is heavily influenced by non-cash fair value adjustments on trading securities and Acacia liabilities, which may not reflect the underlying cash flow performance of the assets.
- Capital Deployment: Track the resumption of investment activity and the company's strategy for raising non-dilutive capital to seize opportunities in the distressed market.