REDWOOD TRUST INC quarterly report, Q3 FY2022

Redwood Trust, Inc. — Q3 2022 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2022; unaudited. Redwood is a specialty finance company focused on residential, business-purpose and multifamily housing credit, operating through Residential Mortgage Banking, Business Purpose Mortgage Banking and Investment Portfolio segments.

Financial results and position

Metric	Q3 2022	Prior-year comparison
Interest income	$177.7 million	$145.7 million
Interest expense	$142.7 million	$103.8 million
Net interest income	$34.9 million	$42.0 million
Mortgage banking activities, net	$16.5 million	$63.2 million
Investment fair value changes, net	$(57.7) million	$26.1 million
Net income (loss)	$(50.4) million; $(0.44) per diluted share	$88.3 million; $0.65 per diluted share

For the nine months, Redwood reported a net loss of $119.5 million, or $1.04 per diluted share, versus net income of $275.6 million, or $2.03 per diluted share, in 2021. Net interest income rose to $128.5 million from $98.4 million, but mortgage banking income fell to $2.8 million from $200.2 million and investment fair value changes swung to a $151.8 million loss from a $120.6 million gain. No conventional net interest margin percentage is clearly provided in the filing text.

Balance sheet: Total assets were $13.15 billion at September 30, down from $14.71 billion at December 31, 2021. Stockholders’ equity was $1.15 billion, down from $1.39 billion.
Book value: GAAP book value was $10.18 per share, down 5.6% from $10.78 at June 30. Economic return on book value, including dividends, was negative 3.4% for Q3 and negative 9.9% for the first nine months.
Debt: Short-term debt was $2.11 billion and long-term debt $1.53 billion. Asset-backed securities issued were $8.14 billion, largely obligations of consolidated securitization entities that are non-recourse to Redwood. Total liabilities were $11.99 billion.
Liquidity: Unrestricted cash was $297 million; restricted cash was $72 million. Management cited $491 million of unencumbered assets, approximately $3.8 billion of unused warehouse capacity in the mortgage banking segments and approximately $160 million of available capital. Recourse leverage was 2.6x; secured recourse leverage in the Investment Portfolio was 0.8x.
Cash flow, nine months: Operating activities used $129 million, investing activities provided $169 million and financing activities used $202 million. Cash, cash equivalents and restricted cash declined by $162 million to $369 million.
Dividends and capital: Q3 dividend declared was $0.23 per share; $0.69 per share was declared year to date. Redwood repurchased 3.4 million shares for $24 million in Q3 and 7.1 million shares for $56 million year to date.

Material changes and business developments

Rising interest rates and sharply wider credit spreads drove substantial unrealized valuation losses. Management attributed the Q3 loss primarily to mark-to-market changes, estimated at negative $0.50 per share. Fair value losses were partially offset by gains on interest-rate hedges and certain servicing-related assets.
Mortgage banking results weakened year over year as higher rates, market volatility and wider spreads reduced volumes and profitability. Management said Q3 distribution execution and margins improved sequentially, and the two mortgage banking platforms distributed almost $1 billion of loans during the quarter.
Residential loan locks were $461 million in Q3, down from $1.0 billion in Q2. Redwood sold $612 million of residential loans during Q3 and reported $712 million of net jumbo loan exposure at quarter-end.
Business-purpose loan fundings were $570 million in Q3, comprising 83% bridge and 17% single-family rental loans. Redwood completed a $274 million private SFR securitization and sold $85 million of loans.
On July 1, Redwood acquired Riverbend Funding for approximately $44 million in initial cash consideration, with up to $25.3 million of potential earnout consideration. The acquisition added bridge lending capacity; management expected key integration work to be largely completed by year-end.
Investment Portfolio economic interests totaled $3.59 billion, up from $2.69 billion at year-end 2021. Management estimated $458 million, or $4.05 per share, of net discount to par as potential value recoverable over time; realization is not assured.

Outlook, risks and contingencies

Management provided no specific numerical earnings or revenue guidance. It expected consumer residential mortgage conditions to remain challenging for several quarters amid higher mortgage rates, reduced investor demand and low housing affordability. It anticipated business-purpose lending activity could moderate as borrowers respond to higher rates and uncertainty.
Management said it intended to preserve liquidity and balance-sheet flexibility, while remaining open to opportunistic investment and share repurchases. It stated that further spread widening, deterioration in credit or declining home prices could cause additional investment losses.
Key exposures include interest-rate and credit-spread volatility, fair-value uncertainty, prepayments, housing prices and borrower performance, leverage, uncommitted or short-term financing, margin calls, facility renewals and refinancing costs. Most assets measured at fair value use Level 3 inputs, making estimates sensitive to assumptions.
At quarter-end, Redwood had commitments for up to $990 million of additional bridge-loan advances and $149 million of remaining HEI purchases. Funding bridge commitments is subject to contractual conditions. Risk-sharing arrangements had a maximum potential future payment of $44 million; the related guarantee carrying value was $7 million. The residential loan and MSR repurchase reserve was $6 million, and litigation reserves for identified matters were $2 million.
Redwood reported compliance with debt covenants and stated disclosure controls were effective at a reasonable-assurance level. It continued its LIBOR transition; remaining exposures included warehouse debt, bridge loans and certain legacy debt instruments.
After quarter-end, Redwood entered a one-year HEI repurchase facility with a $150 million limit and no borrowings reported as of the filing date. Through November 4, it had also repurchased $3 million of convertible notes due in 2023.

Important facts for investors to verify

Whether fair-value losses remain primarily market-driven or are followed by deterioration in loan credit performance, delinquencies or collateral values.
Actual liquidity and available financing, including renewal of short-term and uncommitted facilities, collateral requirements and upcoming debt maturities.
Funding pace and performance of the $990 million bridge-loan commitments and remaining HEI purchase commitments.
Whether the estimated $458 million discount to par is recoverable, and how Level 3 valuation assumptions change with rates, spreads, prepayments and home prices.
Riverbend integration, operating costs and any earnout obligations; also the sustainability of dividends, share repurchases and capital deployment amid reported losses.