Redwood Trust, Inc. — 2013 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2013. Redwood is an internally managed mortgage finance company and REIT with residential mortgage banking, residential investments, and commercial mortgage banking and investments segments. This is an annual filing; quarterly figures below identify the fourth quarter where relevant.
Financial performance and position
| Metric | 2013 | 2012 |
|---|---|---|
| Interest income | $226.2 million | $231.4 million |
| Interest expense | $81.0 million | $120.7 million |
| Net interest income | $145.2 million | $110.7 million |
| Provision for loan losses | $4.7 million | $3.6 million |
| Mortgage banking income, net | $100.7 million | $36.3 million |
| MSR income (loss), net | $20.3 million | $(1.4) million |
| Realized gains, net | $25.3 million | $54.9 million |
| Operating expenses | $84.8 million | $65.4 million |
| Net income attributable to Redwood | $173.2 million | $131.8 million |
| Diluted EPS | $1.94 | $1.59 |
| Book value per share at year-end | $15.10 | $13.95 |
| Regular dividends per share | $1.12 | $1.00 |
- Fourth-quarter 2013 net income was $25.1 million, or $0.29 diluted EPS; quarterly dividends declared were $0.28 per share.
- Return on equity was 14.43%, versus 13.35% in 2012. The filing does not provide a single consolidated profit-margin measure.
- Cash and cash equivalents were $173.2 million at year-end, versus $81.1 million. Operating cash flow was negative $221.8 million, driven in part by loan purchases and sales; excluding those mortgage-banking loan flows, management reported operating cash flow of $138 million.
- Total assets were $4.61 billion, stockholders’ equity $1.25 billion, short-term debt $862.8 million, and long-term debt $476.5 million. Short-term debt included $678.0 million against securities and $184.8 million against residential loans. Consolidated ABS issued totaled $1.94 billion, principally obligations of securitization entities whose creditors generally have no recourse to Redwood.
- Management estimated investment capacity at approximately $130 million at year-end and said available capital and liquidity should fund objectives for most or all of 2014. It reported compliance with debt covenants and margin calls. Existing borrowing capacity was largely uncommitted and therefore not assured.
- At December 31, specific financing spreads were reported as 2.38% for residential loans and 4.62% for residential securities. These are not consolidated net interest margins.
Material changes versus 2012
- Net income rose 31% and diluted EPS rose 22%, primarily reflecting increased residential and commercial mortgage banking activity and positive MSR income. Lower interest expense also lifted net interest income, despite higher short-term and long-term borrowing.
- Residential loan purchases increased to about $7.1 billion from about $2.3 billion. Redwood completed 12 jumbo securitizations totaling $5.58 billion, versus six totaling $1.97 billion in 2012, and sold more loans through whole-loan channels as securitization conditions weakened in the second half.
- Senior commercial loan originations rose to $805 million from approximately $60 million. Commercial mortgage banking and investments segment contribution increased to $37.4 million from $11.5 million.
- The residential securities portfolio grew to about $1.57 billion from $1.10 billion; MSRs increased to $64.8 million from $5.3 million. A larger share of securities was subordinate: 34% at year-end versus 18% in 2012.
- Operating expenses rose about 30% to $84.8 million as the company expanded its platforms; headcount increased to 141 from 86. The company recorded a $12 million litigation reserve.
- The $287.5 million of 4.625% convertible senior notes issued in March 2013 increased long-term debt. Their conversion terms resulted in approximately 9.75 million incremental weighted-average shares in diluted EPS calculations.
Outlook, risks, contingencies, and unusual items
- Management expected lower 2014 jumbo loan acquisition volume than in 2013, but a smaller decline than the projected 32% industry decline. It targeted a conforming-loan acquisition run rate of $1 billion per month by year-end 2014, while cautioning that the ramp-up could be uneven.
- Management expected another residential securitization in late Q1 or early Q2 2014 and anticipated continued whole-loan sales in the near term. It cited a long-term loan-sale margin target of 25–50 basis points; 2013 margins exceeded that range.
- For commercial lending, management planned to add originators, increase senior and mezzanine activity, and sought to exceed $1 billion in annual senior originations. It expected allocated capital to be adequate for continued growth, while noting the outlook depended on market conditions.
- The board announced its intention to maintain regular dividends at $0.28 per share per quarter in 2014. This is not a guarantee; distributions depend on taxable income, financial condition, REIT requirements, and board discretion. Estimated 2013 taxable income was $93.3 million, materially below GAAP net income of $173.2 million.
- Major risks include interest-rate and prepayment volatility, credit losses, illiquid assets, collateral margin calls, reliance on short-term and often uncommitted financing, securitization-market access, competition, and changes in mortgage regulation or GSE policy. Management noted the second-half 2013 decline in securitization activity and rising rates.
- Three legacy Sequoia-related investor lawsuits remained disclosed. Redwood denied allegations in the Schwab and FHLB-Chicago matters; its claims in the FHLB-Seattle case had been dismissed for lack of personal jurisdiction, but claims against underwriters continued. Redwood had indemnity exposure and recorded a $12 million reserve; actual losses could exceed it, and timing or outcome was uncertain.
- Other notable exposures include a $1.8 million residential repurchase reserve and two commercial loans, totaling $42 million carrying value, moved to watch-list status. Those loans were current; the filing reported no commercial loans individually impaired and no 2013 commercial charge-offs.
Important facts for investors to verify
- Whether 2014 conforming and jumbo purchase volumes, securitization timing, and the stated loan-sale margin objectives were achieved.
- How much of reported earnings and book value depends on fair-value estimates, mortgage-banking activity, MSR valuations, and retained subordinate securities.
- Liquidity under stress: maturities and renewal of uncommitted facilities, collateral haircuts and margin calls, and the availability of the stated borrowing capacity.
- Developments in the three legacy RMBS lawsuits, indemnification obligations, and whether the $12 million reserve remains adequate.
- Actual REIT taxable income, dividend tax characterization, and the sustainability of the announced $0.28 quarterly dividend.
- Performance and loss trends in the legacy residential loan portfolio, the commercial watch-list loans, and geographic concentrations in both portfolios.