Redwood Trust, Inc. — Q2 2021 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2021; unaudited. Redwood is a specialty finance company focused on residential, business-purpose and multifamily housing credit, operating through Residential Lending, Business Purpose Lending and Third-Party Investments.
Financial results and position
- Q2 earnings: Net income was $90.0 million, or $0.66 per diluted share, versus $165.4 million, or $1.00 per diluted share, in Q2 2020. First-half net income was $187.3 million, or $1.38 per diluted share, versus a $778.0 million loss in the first half of 2020.
- Income: Q2 net interest income was $30.6 million; non-interest income was $114.4 million, including $54.4 million of mortgage banking income and $49.5 million of investment fair-value gains. First-half net interest income was $56.4 million, down from $78.7 million; mortgage banking income was $137.0 million.
- Returns and book value: Annualized GAAP return on equity was 28.7% for Q2 and 31.2% for the first half. Book value per share rose 6.5% during Q2 to $11.46; first-half economic return on book value, including dividends, was 19.0%.
- Mortgage banking margin and volume: Residential mortgage banking gross margin was 98 basis points in Q2, down from 183 basis points in Q1 2021. The company locked close to $4 billion of jumbo residential loans and originated $527 million of business-purpose loans in Q2.
- Assets and equity: Total assets were $12.00 billion at June 30, up from $10.36 billion at year-end 2020. Total equity was $1.30 billion, compared with $1.11 billion.
- Debt and liquidity: Short-term debt was $1.48 billion; long-term debt was $1.48 billion; and asset-backed securities issued were $7.54 billion. Unrestricted cash was $421 million, with $55 million of restricted cash. Management estimated available capital of $175 million at quarter-end, plus approximately $100 million from a secured financing closed in early July. Residential warehouse facilities had $1.30 billion of available capacity; business-purpose facilities had $587 million.
- Cash flows, first half: Operating activities used $2.65 billion, investing activities provided $1.07 billion, and financing activities provided $1.51 billion. Cash, cash equivalents and restricted cash declined $68 million to $476 million. Operating cash use principally reflected loan purchases and originations for mortgage banking, which are substantially financed through borrowing.
- Dividend: Q2 dividend was $0.18 per share, a 13% increase announced in June; first-half dividends declared were $0.34 per share.
Changes versus comparable periods
- Q2 net income was lower than Q2 2020 despite stronger mortgage banking income. The prior-year quarter included a $25 million gain from repurchasing convertible debt and substantially larger investment fair-value gains.
- First-half 2021 results rebounded from the severe pandemic- and liquidity-related fair-value losses in early 2020. The 2020 first half also included an $89 million goodwill impairment. However, first-half 2021 net interest income declined year over year.
- Mortgage loan activity and financing expanded: residential loans held for sale were $1.16 billion at June 30, compared with $177 million at year-end 2020; short-term debt increased from $523 million to $1.48 billion.
Outlook, commentary and risks
- Management expressed optimism about Q3, citing lower interest rates, continued economic recovery and robust housing demand, but provided no specific numerical earnings or full-year guidance in the supplied filing text.
- Management expects revenue mix to continue shifting toward mortgage banking and taxable subsidiaries. It cited potential support from regulatory changes affecting GSE demand for second-home and investor-property loans, and growth opportunities in expanded-prime residential lending and business-purpose lending.
- Management highlighted competitive pressure, reduced refinancing demand, volatile rates and yield curves, inflation uncertainty, and increased hedging and execution costs. It also identified credit and prepayment risk, fair-value estimation uncertainty, leverage, uncommitted borrowing facilities, margin calls, counterparty risk, and COVID-19-related uncertainty.
- Many financial instruments are Level 3 fair-value measurements using significant unobservable assumptions; changes in credit losses, prepayments, interest rates or spreads could materially affect reported values and earnings. Management noted quarter-to-quarter GAAP earnings volatility.
- At June 30, the company had $374 million of commitments for additional advances on existing bridge loans. Maximum potential future payments under specified agency risk-sharing arrangements were $44 million; the residential loan and MSR repurchase reserve was $9 million. Litigation-related reserves and estimated seller-demand costs were each $2 million.
- The company reported compliance with debt covenants through the filing date. Most borrowing facilities are uncommitted, and certain debt remains subject to market-value or collateral-related margin calls. Redwood also reported it can no longer borrow from the Federal Home Loan Bank of Chicago.
Most important facts for investors to verify
- How much of earnings and book-value growth is repeatable operating income versus volatile fair-value changes, securitization activity and realized gains.
- Whether loan origination margins and volumes can hold up amid competition, lower refinancing demand and changing interest rates.
- Liquidity under stress: availability and terms of warehouse funding, collateral and margin-call exposure, and the timing of short-term debt maturities.
- Credit trends in bridge, residential and securitized loan portfolios, including delinquencies, foreclosures and potential loss exposure.
- Dividend sustainability, taxable income estimates and the effect of REIT and taxable-subsidiary tax positions.