Redwood Trust, Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013; unaudited. Redwood is a specialty finance company focused on residential and commercial mortgage banking and mortgage-related investments, and is structured as a REIT for tax purposes. Financial amounts below are in U.S. dollars; millions are rounded.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Interest income | $57.4 million | $59.7 million | $168.7 million | $178.0 million |
| Net interest income | $35.6 million | $31.4 million | $107.0 million | $90.2 million |
| Mortgage banking activities, net | $(5.9) million | $12.3 million | $98.6 million | $13.6 million |
| Operating expenses | $21.9 million | $17.1 million | $65.1 million | $46.9 million |
| Net income attributable to Redwood | $21.9 million | $39.7 million | $148.1 million | $89.7 million |
| Diluted earnings per share | $0.25 | $0.48 | $1.65 | $1.09 |
| Regular dividend declared per share | $0.28 | $0.25 | $0.84 | $0.75 |
The filing does not present a conventional revenue total or a single consolidated margin measure. Q3 mortgage banking results included approximately $15 million, or $0.17 per share, of negative valuation adjustments associated with loans identified in the prior quarter; the company said it distributed nearly all of those loans and realized a small economic profit after hedges.
- Balance sheet at September 30: Assets $4.66 billion; liabilities $3.45 billion; equity $1.21 billion. Cash and cash equivalents were $204.6 million.
- Debt: Short-term debt was $838.3 million; asset-backed securities issued were $2.06 billion; long-term debt was $471.6 million, including $287.5 million of convertible notes issued in March 2013.
- Liquidity and capital: Management estimated approximately $150 million of investment capacity and reported $1.3 billion of additional borrowing capacity under existing warehouse lines, which are largely uncommitted. It said available capital and liquidity were sufficient for business and investment objectives through year-end 2013.
- Cash flow, nine months: Operating activities used $494.1 million; investing activities provided $544.3 million; financing activities provided $73.3 million. Cash increased $123.6 million to $204.6 million.
- Book value: $14.65 per share at quarter-end, versus $14.69 at June 30, 2013. The quarter-end dividend was $0.28 per share.
Material changes versus comparable periods
- Q3 net income and diluted EPS declined year over year, despite higher net interest income. Mortgage banking activities shifted from income to a loss, while operating expenses increased.
- Nine-month net income rose to $148.1 million from $89.7 million, largely alongside a substantial increase in mortgage banking activities, net. That result included significant valuation gains and is not directly indicative of recurring earnings.
- Residential loan acquisitions were $1.3 billion in Q3, down from $2.6 billion in Q2. Redwood completed three residential securitizations totaling $1.2 billion and approximately $600 million of whole-loan sales.
- At September 30, short-term debt was up from $551.9 million at December 31, 2012, while asset-backed securities issued declined from $2.53 billion. Cash rose from $81.1 million. Mortgage servicing rights increased to $60.2 million from $5.3 million at year-end 2012.
- Accumulated other comprehensive income declined to $114.8 million from $138.3 million at year-end, reflecting net unrealized losses and reclassifications.
Outlook, management commentary, risks and contingencies
- Management cited rising mortgage rates, slower refinancing, aggressive bank competition for jumbo mortgages, and a subdued private-label securitization market as near-term headwinds. It expected subdued refinancing for an extended period, subject to possible volatility.
- For Q4 2013, Redwood expected to acquire $500 million to $1 billion of jumbo residential loans, complete at least one securitization, and earn average loan-sale margins of 25–50 basis points net of hedges on identified loans. These are forward-looking expectations, not guarantees.
- Management said it began acquiring conforming GSE loans in mid-October and saw potential longer-term growth opportunities from GSE reform. It was exploring non-Qualified Mortgage products but cautioned that no near-term transactions should be expected.
- Commercial senior loan originations were expected at approximately $200–$300 million in Q4; management anticipated falling short of its $1 billion full-year goal. It was considering dedicated capital for further commercial-platform growth.
- Uncommitted short-term facilities, collateral valuation declines, and margin calls expose Redwood to refinancing and liquidity risk. The company reported compliance with its debt covenants and margin calls through the filing date.
- Fair values for many loans, securities, and MSRs rely on Level 3 assumptions, including credit losses, prepayments, and discount rates; changes in these estimates may materially affect earnings and equity.
- Three RMBS-related lawsuits were disclosed. Redwood recorded no litigation reserve, stating a material loss was not both probable and estimable, but estimated a reasonably possible aggregate loss range of $0–$25 million. It warned actual losses could exceed that range. The company also disclosed indemnity exposure related to underwriters.
- Management expected an additional $69 million of tax credit losses on residential securities to be realized over an estimated three-to-five-year period. Q3 included a $4.9 million income tax benefit, primarily from releasing a valuation allowance on capital-loss carryforwards.
Important facts for investors to verify
- Whether residential loan acquisition, securitization volume, and the projected 25–50 basis-point net sale margin were achieved after quarter-end.
- Availability and renewal terms of uncommitted financing, collateral values, and any subsequent margin calls or covenant developments.
- Performance of residential and commercial portfolios, including delinquencies, realized credit losses, and changes in loan-loss allowances.
- Valuation assumptions and sensitivity for Level 3 assets, particularly MSRs, retained securities, and loans held for sale.
- Developments in the disclosed RMBS litigation, indemnity obligations, and whether the estimated possible-loss range or reserve assessment changes.
- Actual taxable income, dividend tax characterization, and timing of the projected tax credit losses.