Redwood Trust, Inc. — Q2 2023 Form 10-Q
Reporting period: Unaudited quarter and six months ended June 30, 2023. Redwood is a specialty finance company focused on residential, business-purpose and multifamily housing credit. Unless noted, financial amounts below are in millions of dollars.
Financial performance and position
- Q2 earnings: Net income was $2.9 million, versus a net loss of $100.0 million in Q2 2022. After $1.8 million of preferred dividends, income available to common stockholders was $1.1 million. Reported diluted EPS was shown as $— (rounded to less than one cent).
- First-half earnings: Net income was $7.5 million, compared with a net loss of $69.1 million in the first half of 2022. Income available to common stockholders was $4.3 million, or $0.02 per diluted share.
- Interest income and spread: Q2 interest income was $179.0 million, up from $167.5 million, but interest expense rose to $152.9 million from $127.0 million. Net interest income fell to $26.1 million from $40.5 million. For the first half, net interest income declined to $52.5 million from $93.6 million.
- Non-interest results: Q2 non-interest income was $17.2 million, versus a $111.0 million loss in Q2 2022; first-half non-interest income was $38.3 million, versus a $92.2 million loss. Mortgage banking results improved, while investment fair-value changes remained negative: $(4.6) million in Q2 and $(4.7) million in the first half.
- Cash flow: First-half operating cash flow was $23.6 million, investing cash flow was $386.3 million, and financing cash flow was $(292.3) million. Cash, cash equivalents and restricted cash increased by $117.5 million to $446.8 million, including $357.3 million of unrestricted cash.
- Balance sheet and leverage: Total assets were $12.80 billion and total equity was $1.12 billion at June 30. Total liabilities were $11.67 billion, including $1.46 billion short-term debt, $8.18 billion of asset-backed securities issued and $1.80 billion long-term debt. Management reported total capital of $1.92 billion and a secured recourse leverage ratio of 1.0x for the Investment Portfolio.
- Shareholder measures: Book value per share was $9.26. Annualized GAAP return on common equity was 0.4% for Q2 and 0.8% for the first half; economic return on book value was 0.2% and 1.0%, respectively. Common dividends declared were $0.16 per share for Q2 and $0.39 for the first half. Series A preferred shares carry a 10% annual dividend rate through January 2028.
Material changes versus prior periods
- Net income improved substantially from Q2 and first-half 2022 losses, largely as mortgage banking results recovered and fair-value losses were much smaller than in 2022.
- Higher funding costs more than offset higher interest income: first-half interest expense increased to $305.0 million from $263.3 million, reducing net interest income by $41.1 million year over year.
- Residential loans held for sale decreased to $196.7 million from $780.8 million at year-end 2022, while residential loans held for investment increased to $5.26 billion from $4.83 billion. Real estate securities fell to $166.8 million from $240.5 million.
- Short-term debt decreased to $1.46 billion from $2.03 billion at year-end; long-term debt increased to $1.80 billion from $1.73 billion. Redwood issued $70 million of Series A preferred stock in January, receiving approximately $67 million net.
- Q2 Residential Mortgage Banking segment contribution was $3.2 million, compared with a $14.2 million loss a year earlier. Business Purpose Mortgage Banking remained loss-making at $3.3 million, but improved from a $20.7 million loss. Investment Portfolio contribution was $32.2 million, versus a $52.6 million loss.
Outlook, management commentary and risks
- Management cited renewed bank engagement and new jumbo-loan seller relationships, and said Q2 residential loan locks of $567 million supported the segment’s strongest returns in over a year. It expects residential mortgage banking margins, which exceeded 150 basis points in Q2, to normalize to 75–100 basis points for the remainder of 2023. Management expects new seller relationships to support volumes in Q3 and beyond; these are forward-looking expectations, not guarantees.
- Redwood and Oaktree announced a bridge-loan joint venture expected to have up to $1 billion of purchasing capacity, including secured financing. Redwood expects origination and administration fees; it had not contributed capital or sold loans into the venture by quarter-end.
- Management described overall portfolio credit as stable and within modeled expectations, but reported 90-plus-day delinquencies across combined CAFL securities and bridge loans rising to 4.2% from 2.0% in the prior quarter. It cautioned that further serious delinquencies could increase credit losses and reduce fair values. BPL bridge loans over 60 days delinquent also may trigger financing advance-rate reductions or repurchase requirements.
- Management estimated approximately $390 million of investment-portfolio discount to par, or $3.43 per share, and a projected forward loss-adjusted yield of 16%. These are estimates dependent on market and credit assumptions; the filing does not present them as guaranteed returns.
- Liquidity risks include higher benchmark rates and borrowing spreads, refinancing needs, and reliance on short-term facilities that are often uncommitted. Approximately $113 million of convertible debt was due in August 2023; management expected to repay it at maturity with cash on hand. At June 30, Redwood reported $206 million of unencumbered assets and $2.6 billion of excess warehouse financing capacity.
- Other key exposures include Level 3 fair-value estimates, credit and property-value changes, interest-rate and prepayment risks, potential margin or collateral calls, and the ability to renew financing. The company reported compliance with debt covenants. It also reported $755 million of conditional commitments to fund BPL bridge-loan advances, $44 million maximum potential payments under legacy risk-sharing arrangements, and $2 million of reserves for specified litigation matters.
- No formal earnings guidance was provided. Redwood cautioned that interim results are not necessarily indicative of full-year results. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether residential loan-lock activity converts into completed purchases and sales, and whether margins settle within management’s stated range.
- Trends in BPL delinquencies, foreclosures, collateral values, loan modifications and resulting fair-value marks or credit losses.
- Repayment of the August 2023 convertible notes and the company’s remaining unrestricted cash and financing capacity afterward.
- Availability and renewal terms for warehouse and other borrowing facilities, including collateral requirements, advance-rate step-downs and interest-rate exposure.
- Whether the Oaktree joint venture becomes operational at the expected scale and generates the anticipated fee income and funding flexibility.
- Key assumptions behind the $390 million portfolio discount-to-par estimate and 16% projected forward loss-adjusted yield, as well as the sensitivity of Level 3 valuations to rates, credit and prepayments.
- Sustainability of common and preferred dividends relative to earnings, liquidity, REIT distribution requirements and the 10% preferred dividend obligation.