Redwood Trust, Inc. — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; comparisons are to Q1 2010 unless stated otherwise. Redwood invests in, finances and manages residential and commercial real estate loans and mortgage-backed securities, and operates as a REIT.
Financial performance and position
| Metric | Q1 2011 / March 31, 2011 | Comparable period / change |
|---|---|---|
| Interest income | $54.3 million | $58.7 million in Q1 2010 |
| Interest expense | $22.0 million | $18.2 million in Q1 2010 |
| Net interest income | $32.4 million | $40.5 million in Q1 2010 |
| Provision for loan losses | $2.8 million | $9.5 million in Q1 2010 |
| Net market valuation adjustments | Loss of $5.7 million | Loss of $11.2 million in Q1 2010 |
| Realized gains on sales and calls, net | $3.9 million | $44.3 million in Q1 2010 |
| Net income attributable to Redwood | $18.2 million; diluted EPS $0.22 | $46.8 million; diluted EPS $0.58 |
| Dividend declared | $0.25 per common share | $0.25 in Q1 2010 |
| Operating cash flow | $17.2 million | $61.6 million in Q1 2010 |
| Cash and cash equivalents | $220.3 million | $46.9 million at Dec. 31, 2010 |
| Total assets / total equity | $5.28 billion / $1.08 billion | $5.14 billion / $1.08 billion at Dec. 31, 2010 |
| Debt | No short-term debt; $139.5 million long-term debt | $44.1 million short-term debt at year-end; long-term debt unchanged |
| GAAP book value per share | $13.76 | Up $0.13 during the quarter |
| Estimated economic book value per share | $14.45 | Up $0.14 during the quarter; non-GAAP estimate |
Redwood reported consolidated net income of $16.2 million, including a $2.0 million net loss attributable to noncontrolling interests; income attributable to Redwood was $18.2 million. The filing does not provide a clear conventional operating-margin measure.
- Net interest income after loan-loss provision and market valuation adjustments rose to $23.8 million from $19.8 million. Lower provisions and less-negative valuation adjustments were partly offset by lower net interest income.
- Year-over-year earnings fell substantially, primarily because Q1 2010 included much larger realized gains, including gains on securities sales and repurchases of Sequoia ABS. Operating expenses declined to $11.5 million from $17.3 million, partly because Q1 2010 included a $4 million non-recurring equity-compensation charge.
- Cash increased mainly from the Q1 residential securitization. Investing cash flow was $66.0 million provided; financing cash flow was $90.2 million provided, including $280.1 million of ABS issuance proceeds and repayment of $44.1 million in short-term debt.
- Reported liabilities include securitization obligations. At quarter-end, consolidated VIEs had $4.13 billion of assets and $4.03 billion of liabilities; these entities’ assets are restricted to their obligations and their creditors generally have no recourse to Redwood.
- Investment capacity, as estimated by management, was $249 million, up from $224 million at year-end. The estimate assumes secured borrowing capacity and is not simply cash on hand.
Material changes and business developments
- Redwood completed a $295 million prime residential-loan securitization in March, issuing $281 million of ABS to third parties. It purchased about $101 million of prime residential loans during the quarter.
- Commercial real estate loans held for investment increased to $42.5 million from $30.5 million at year-end; two loans totaling $12 million were originated or acquired during Q1.
- Residential securities at Redwood declined to $788 million from $823 million at year-end, reflecting sales and principal payments, partly offset by purchases and valuation gains. Total consolidated real estate securities were $1.10 billion.
- The residential loan-loss allowance was $62.9 million, versus $62.4 million at year-end. Residential loans 90 or more days past due totaled $136.1 million in pools collectively evaluated for impairment, compared with $133.7 million at year-end.
- Accumulated other comprehensive income increased to $122.1 million from $112.3 million, reflecting net unrealized gains on securities and interest-rate hedges.
Outlook, management commentary and risks
- Management expected the regular quarterly dividend to remain $0.25 per share during 2011. It anticipated a full-year taxable loss, citing expected future tax-basis credit losses of approximately $169 million; timing of actual losses is uncertain.
- Management targeted the next residential securitization for Q3 2011, subject to market conditions, and said it was likely to complete three securitizations during 2011, totaling an estimated $800 million to $1.0 billion of loans. The residential conduit’s main constraint was loan-sourcing volume; management said it was not then earnings-accretive and could take until 2012 to gain significant traction.
- Management estimated commercial loan originations of $25 million to $50 million per quarter over the next several quarters, subject to market conditions. It reported three loans closed through April 30 totaling $19 million, with yields of 10%–11%, and a six-loan mezzanine portfolio of $49 million at that date.
- Management planned to deploy much of its excess capital in 2011, particularly in commercial real estate, and did not anticipate a near-term equity issuance. It cited potential additional investment capacity of $200 million to $300 million from financing residential securities, subject to execution and market access.
- Risks include housing and commercial property weakness, borrower defaults and loss severity, prepayment and interest-rate changes, illiquid or model-valued assets, financing availability, counterparty exposure, and volatility in fair-value accounting. Many securities and liabilities rely on Level 3 valuation inputs and management judgment.
- Proposed Dodd-Frank securitization rules were unresolved. Management said the draft risk-retention requirements could make residential and commercial securitizations more difficult or uneconomic if adopted substantially as proposed.
- Three investor lawsuits relate to Sequoia RMBS, including claims by the Federal Home Loan Banks of Seattle and Chicago and Charles Schwab. Redwood said it considered the claims without merit and would defend them; it could not estimate potential losses. Redwood also disclosed an SEC information order and an NCUA subpoena relating to prior securitization activities; it had responded to both.
- Management expected $5 million of negative estimated net assets at ten legacy Sequoia entities to reverse into earnings in future periods when those entities are retired or deconsolidated. The timing is uncertain.
- The filing disclosed no material change in internal control over financial reporting and management concluded disclosure controls were effective at a reasonable assurance level.
Most important facts for investors to verify
- Whether planned securitizations and residential loan pipeline targets were completed, and whether loan sourcing made the conduit profitable.
- Actual commercial loan originations, portfolio yields, credit performance and funding needs versus management’s estimates.
- Subsequent credit losses, delinquency trends, reserve adequacy and the timing of expected tax-basis losses.
- Changes in liquidity and secured borrowing capacity, including the amount of capital available after operating needs and liquidity buffers.
- Developments in the RMBS lawsuits, indemnification exposure and regulatory inquiries, for which the filing provides no estimable loss range.
- How final securitization risk-retention rules affect transaction economics, and how market changes influence Level 3 asset and liability valuations.