Redwood Trust, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; balance-sheet comparisons are with December 31, 2022. Redwood is a specialty housing-credit finance company operating residential mortgage banking, business purpose mortgage banking, and investment portfolio businesses. Amounts below are in U.S. dollars.
Financial results and position
| Metric | Q1 2023 / March 31, 2023 | Comparable period / prior year-end |
|---|---|---|
| Total interest income | $178.5 million | $189.4 million in Q1 2022 |
| Net interest income | $26.4 million | $53.1 million in Q1 2022 |
| Mortgage banking activities, net | $16.7 million | $16.3 million in Q1 2022 |
| Net income | $4.6 million; $3.2 million available to common stockholders | $30.9 million in Q1 2022 |
| Diluted earnings per common share | $0.02 | $0.24 in Q1 2022 |
| Common dividend per share | $0.23 | $0.23 in Q1 2022 |
| Total assets | $13.12 billion | $13.03 billion at December 31, 2022 |
| Total equity | $1.14 billion | $1.08 billion at December 31, 2022 |
| Cash and cash equivalents | $404 million; restricted cash was another $86 million | $259 million and $70 million, respectively, at December 31, 2022 |
Net interest income fell approximately 50% year over year. Management cited lower yield-maintenance and available-for-sale securities accretion income, higher funding costs, and smaller mortgage-banking loan inventories. Total operating expenses were $44.0 million, compared with $43.4 million in Q1 2022. Redwood reported a $1.1 million income-tax benefit. The filing does not provide a single consolidated net interest margin percentage.
Cash flow: Operating activities provided $102 million and investing activities provided $111 million; financing activities used $52 million. Cash, cash equivalents, and restricted cash increased by $161 million during the quarter. Cash flows are affected by loan purchases, sales, securitizations, principal repayments, and financing activity, and management cautions they may vary substantially between periods.
Debt and liquidity: At quarter-end, short-term debt was $1.62 billion, long-term debt was $1.73 billion, and asset-backed securities issued were $8.45 billion. Much of the ABS is non-recourse debt of consolidated securitization entities, not a direct obligation of Redwood. Management reported $2.43 billion of recourse debt, a 2.3x recourse leverage ratio, $227 million of unencumbered assets, and $3.5 billion of excess warehouse capacity. It said unrestricted cash was held in short-term Treasuries, money-market funds, or accounts at global money-center banks.
Redwood’s book value per share was $9.40. Management reported a 0.8% Q1 economic return on book value, including dividends, and a 1.2% annualized GAAP return on common stockholders’ equity. These are distinct measures.
Material changes and business performance
- Investment Portfolio segment contribution was $35.5 million, down from $50.9 million in Q1 2022, primarily due to lower net interest income, MSR-related other income, and realized gains. Residential Mortgage Banking contributed a loss of $1.3 million, versus $7.5 million of income a year earlier. Business Purpose Mortgage Banking contributed a loss of $1.0 million, an improvement from a $2.5 million loss.
- Management said it distributed almost $1 billion of whole loans through sales and securitizations in the quarter. Residential activity included two securitizations backed by $657 million of loans; quarter-end residential held-for-sale inventory was $27 million. Total net jumbo loan exposure was $70 million.
- Redwood funded $438 million of business purpose loans, approximately 60% bridge and 40% term, and sold approximately $230 million to third parties. Investment in home equity investments (HEIs) totaled $417 million at quarter-end, up from $403 million at year-end.
- Reported investment fair value changes were close to flat, compared with a $6.1 million loss in Q1 2022. Management said credit trends were generally stable, but a credit event affecting a single asset drove a $9 million decline in CAFL term securities. Other portfolio gains substantially offset that decline.
- Redwood issued 2.8 million shares of 10% Series A preferred stock in January, raising approximately $67 million net. It declared a $0.60417 per-share preferred dividend for the quarter. Common shares outstanding were approximately 113.9 million at quarter-end.
Outlook, risks and unusual items
Management said the March banking-sector disruption moderated the near-term outlook for operating businesses. It expects earnings to remain below current common-dividend levels over the next few quarters and, subject to board approval, expects to lower the Q2 2023 common dividend. It referenced dividend reductions of 20% to 30% elsewhere in the mortgage REIT sector, but did not specify Redwood’s expected new dividend amount.
Management sees potential opportunities as banks reassess balance sheets, including purchases of residential loans and growth in business-purpose lending. It also described HEIs as an area of expected consumer demand. These are forward-looking expectations, not assured results. Management cited an estimated $460 million net discount to par in the investment portfolio and a projected 17% forward loss-adjusted yield; both are management estimates based on assumptions and valuation inputs.
- Credit and property risk: Management reported stable overall credit measures, with 90-day-plus delinquencies across combined securities and bridge-loan portfolios of 2.7%, down 30 basis points from the prior quarter. It also noted rising construction timelines and increased 30- and 60-day delinquencies in some CAFL multifamily-backed loans, which could lead to further delinquencies, losses, or lower valuations. The bridge-loan portfolio included 94 loans at least 90 days delinquent and 92 loans in foreclosure; categories may overlap.
- Funding and interest-rate risk: Many warehouse facilities are short-term or uncommitted and require renewal; some debt is subject to margin calls. Higher benchmark rates, wider financing spreads, refinancing at higher costs, or reduced lender availability could pressure earnings and liquidity. Approximately $144 million principal of convertible debt was due in August 2023 at quarter-end. Management said it expected to repay the notes with cash on hand if new unsecured financing remained economically unattractive.
- Commitments and contingencies: Redwood had up to $811 million of conditional commitments for additional advances on existing BPL bridge loans and $8 million of HEI purchase commitments. Potential future risk-sharing payments were capped at $44 million, partially collateralized; the recorded guarantee obligation was $6 million. Litigation reserves for the FHLB-Seattle and Schwab matters totaled $2 million, with no significant update reported.
- Valuation and other risks: Most of the company’s significant investment assets use Level 3 fair-value inputs, so changes in credit-loss, prepayment, home-price, discount-rate, and other assumptions can materially affect reported results. Redwood also identified market, counterparty, liquidity, leverage, regulatory, cybersecurity, and REIT-qualification risks. Management stated disclosure controls were effective at a reasonable-assurance level and reported no material Q1 change in internal control over financial reporting.
Important facts for investors to verify
- Whether the board reduced the Q2 common dividend, and the resulting dividend and coverage relative to earnings.
- The timing and actual cash cost of repaying or refinancing the August 2023 convertible notes and other near-term maturities.
- Subsequent performance of BPL bridge loans and multifamily-backed CAFL assets, including delinquencies, foreclosures, construction progress, and realized losses.
- Availability and renewal terms of warehouse and other financing, margin-call exposure, and liquidity after funding loan commitments.
- Key assumptions behind Level 3 valuations, the estimated portfolio discount to par, and the projected forward loss-adjusted yield.
- Progress and economics of proposed private-capital partnerships and expected residential, BPL, and HEI opportunities; the filing provides no quantified earnings guidance.