Redwood Trust, Inc. — Q3 2023 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2023. Unaudited consolidated results. Redwood is a specialty housing-credit finance company operating Residential Mortgage Banking, Business Purpose Mortgage Banking, and Investment Portfolio segments.
Key financial results
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Interest income | $177.1 million | $177.7 million | $534.6 million | $534.5 million |
| Net interest income | $20.4 million | $34.9 million | $72.9 million | $128.5 million |
| Mortgage banking activities, net | $19.4 million | $16.5 million | $52.7 million | $2.8 million |
| Investment fair value changes, net | $(31.4) million | $(57.7) million | $(36.2) million | $(151.8) million |
| Net loss | $(30.8) million | $(50.4) million | $(23.3) million | $(119.5) million |
| Net loss per common share | $(0.29) | $(0.44) | $(0.27) | $(1.04) |
Q3 GAAP return on common equity was (12.3)%; nine-month return was (3.5)%. Book value per share was $8.77 at September 30. Economic return on book value, including dividends, was (3.6)% for Q3 and (2.4)% for the first nine months. Q3 residential mortgage banking gross margin was 80 basis points, within management’s stated historical range of 75–100 basis points.
- Cash flow: Operating activities used $867.5 million in the first nine months, including $896 million of net outflows related to held-for-sale loan activity and associated derivatives. Excluding those flows, management reported operating cash flow of positive $28 million. Investing activities provided $639.2 million; financing activities provided $158.6 million. Cash, cash equivalents and restricted cash ended at $259.7 million, including $203.6 million of unrestricted cash and cash equivalents.
- Balance sheet and leverage: Total assets were $13.02 billion and total liabilities were $11.92 billion. Balance-sheet debt included $1.48 billion short-term debt, $8.39 billion of asset-backed securities, and $1.83 billion long-term debt. Management reported $2.45 billion of recourse debt outstanding. Total equity was $1.11 billion.
- Liquidity: Management reported $2.2 billion of excess financing capacity across warehouse facilities and approximately $340 million of unencumbered assets. Residential warehouse facilities had $502 million of available capacity; BPL facilities had $1.71 billion available capacity. The company said it was in compliance with debt covenants.
- Dividends and capital: Common dividends declared were $0.16 per share in Q3 and $0.55 per share year to date. Redwood issued $70 million gross of 10% Series A preferred stock in January, receiving approximately $67 million net. It also raised $33 million through its common-stock ATM program in Q3.
Material changes versus prior comparable periods
- Net interest income fell $14.6 million in Q3 and $55.6 million year to date versus 2022. Higher borrowing costs, lower yield-maintenance and AFS accretion income, and $10 million of Q3/$16 million year-to-date interest income reversed or not recognized on non-accrual BPL bridge loans weighed on results.
- Mortgage banking results improved substantially year to date: net mortgage banking income was $52.7 million versus $2.8 million. Management attributed the change primarily to improved margins and execution compared with negative 2022 production margins, although Q3 BPL mortgage banking income was lower year over year.
- Investment fair value losses narrowed year over year but remained significant. Q3 losses were driven mainly by reperforming-loan securities and BPL bridge loans; management also cited losses on certain delinquent term loans for the nine-month period. The 2022 comparison reflected unusually large spread-widening losses.
- General and administrative expense declined to $29.7 million in Q3 from $38.2 million and to $96.1 million year to date from $101.7 million. Management cited headcount and non-compensation cost reductions; headcount was down 28% over the prior twelve months.
- Residential loan purchases rose to $815 million in Q3 from $184 million in Q2; lock volume reached $1.6 billion, up 189% sequentially. Depository institutions represented 50% of Q3 residential purchase activity, compared with 10% in Q2.
- BPL loans funded were $411 million in Q3, slightly above Q2. The portfolio saw more workout activity: BPL bridge REO rose to $49 million from $3 million at year-end 2022, and certain borrowers received loan modifications, maturity extensions, or fresh equity.
Outlook, management commentary, and risks
- Management described housing and capital markets as challenging, citing mortgage rates at 20-year highs, subdued housing transaction activity, geopolitical uncertainty, and the possibility of an interest-rate-driven recession in 2024. It expects volatility to continue to affect near-term GAAP results and said it will prioritize liquidity and caution.
- Management sees opportunities as banks reassess funding and capital needs, reporting 185 active residential loan sellers, including more than 70 banks. It expects to continue building residential volume as conditions permit and increased capital allocated to that business to $150 million from $80 million at the prior quarter-end.
- Redwood launched its Aspire HEI origination platform in Q3 and began originating home equity investments. Management also highlighted its Oaktree BPL bridge-loan joint venture and discussions with other potential private-capital partners. It intends to reduce lower-yielding third-party investments and focus more on internally sourced investments and deployment alongside partners.
- Credit risk remains material. Q3 90-day-plus delinquencies across the combined CAFL securities and bridge-loan portfolio were 4.0%. Redwood reported $216 million of BPL bridge loans on non-accrual status at quarter-end; $174 million of UPB had been modified in Q3, with first modified payments due in November. Further delinquencies, extensions, or unsuccessful workouts could reduce fair values and cause credit losses.
- Redwood had $623 million of commitments for additional advances on existing BPL bridge loans, generally subject to borrower, project, and other conditions. Management expects most to fund over several quarters.
- Funding risks include variable-rate borrowing costs, uncommitted facilities, margin and collateral requirements, and maturities. A convertible-note series due in 2024 and a subordinate-securities financing facility due in September 2024 require refinancing or repayment planning. Management said it expected normal-course renewals but gave no assurance that facilities would be renewed.
- A significant portion of assets and liabilities is measured using Level 3 fair-value inputs; changes in interest rates, credit spreads, prepayments, home prices, or credit assumptions can produce material earnings volatility. Redwood also disclosed $44 million of maximum potential future payments under legacy agency risk-sharing arrangements, a $5 million residential-loan/MSR repurchase reserve, and $2 million of reserves for specified litigation matters.
- Redwood said it believed it continued to qualify as a REIT and expected full-year dividend distributions to exceed minimum distribution requirements. It currently expected a significant portion of 2023 common dividends to be ordinary income for tax purposes; final tax characterization was not provided.
Important facts for investors to verify
- Whether BPL bridge-loan delinquencies, non-accrual balances, REO, modifications, and maturity extensions stabilize, and what recoveries are achieved on troubled loans.
- Whether warehouse and other financing facilities are renewed or expanded on acceptable terms, and how near-term debt maturities and borrowing costs affect liquidity and net interest income.
- How much of the $623 million BPL advance commitment is ultimately funded, and whether available capacity and cash cover those funding needs alongside debt and dividend obligations.
- Whether fair-value assumptions and market movements cause further material Level 3 portfolio losses, particularly in reperforming-loan securities, bridge loans, and HEI.
- Execution and economics of the residential growth strategy, Aspire HEI, the Oaktree joint venture, and prospective private-capital partnerships.
- Future common and preferred dividend decisions, REIT qualification and dividend tax characterization, and developments in litigation and repurchase claims.