Redwood Trust Inc (RWT) 2014 Q1 法說會逐字稿

Good day and welcome to the Redwood Trust first-quarter 2014 earnings conference call. Today's call is being recorded. I would now like to turn the call over to Marty Hughes. Please go ahead, sir.

Good afternoon, everyone. Thank you for participating in Redwood's first-quarter 2014 earnings call. Joining on the call are Brett Nicholas, Redwood's President, and Chris Abate, Redwood's CFO, and they will get into some of the details when they cover the residential and commercial business activities and the financials.

As we handicap the developing market opportunities that lie ahead for Redwood, we remain bullish on the competitive position, strategy, and long-term prospects for our residential and commercial mortgage banking and investment business. We have noted repeatedly in the past that our business strategies are focused on the opportunities we see over the next several years, not over the next several quarters.

For those that are new to the Redwood story, our strategy was developed in response to the aftermath of the crisis, which has left the investment world awash with liquidity and searching for attractive, risk (technical difficulty) yield through an increasingly cutthroat bidding competition process. To us, the answer was to build a new businesses capable of creating their own investments and fee-generating opportunities. In other words, by making our own breaks.

This meant building flexible and scalable loan platforms that allow us to pivot in response to the involving residential and commercial mortgage markets. Our platforms are about three years old and we are happy with the growing momentum. However, we understand that our near-term prospects matter to you as well, especially as we steer through industry-wide headwinds that will likely pressure our earnings for much of 2014.

Our first-quarter financial and operating results were impacted by margin pressure but also by interest rate volatility. Chris will go through the numbers in more detail in a few minutes, but there were timing differences between quarters and we had some market valuation adjustments, some of which are reflected in earnings and others are reflected in our balance sheet.

From a financial standpoint, we see an overall positive as the book value increased by $0.04 a share to $15.14 after paying a $0.28 dividends per share. While this is not a perfect measure of economic creation, we believe this increase in book value cuts through some of the noise in our results by encompassing the impact of all quarterly valuation adjustments, regardless of whether they were reflected in our income statement or our balance sheet.

From an operating standpoint, we made good progress in the quarter, despite a challenging operating environment. As managers, we look to our key operating metrics to indicate whether we are growing and enhancing Redwood franchise value. During the first quarter 2014, we grew our residential loan purchase volume by 66% to $1.1 billion in an environment in which industry volumes were down sharply. We increased the number of active loan sellers to 124 at March 31, 2014 and we made progress in some of the big picture initiatives we discussed last quarter, including ramping up our conforming loan purchases.

Our residential loan conduits is the industry's largest securitization sponsor, having sponsored almost half of all securitization in the post-crisis period and has created over $500 million of investments for our investment portfolio at the end of the first quarter. Our commercial loan platform has become a leading contributor to CMBS transactions and created over $200 million of investments for our portfolio. Together these portfolios -- platforms, sorry -- have generated substantial income and investment for Redwood, income that we would not have otherwise recognize had we remained just an investor in mortgage securities available in the secondary market.

On a final note, it is clear to us that the residential mortgage market is coming our way as private capital is called upon to help reduce the government's current outside role. We believe this ultimately will happen through an expansion of private label securitization, through [risk] sharing arraignments with the GSEs while they are in conservatorship and eventually after mortgage reform legislation has been enacted.

Before I hand it off to Brett, you may have seen our recent public disclosure explaining that the two of us collectively sold 24,900 shares at the beginning of May. These sales were made under 10b5-1 plan, which we established back in 2013 and were made solely to satisfy our full personal income tax liability arising from the delivery of common stock to us on May 1 under long-term equity work plans.

Under the applicable rules, Redwood cannot withhold more than its statutory minimum, which is about 48%. This percentage is lower than our overall effective tax rate, so back in 2013 we preprogrammed these sales to address the tax gap. All of the proceeds we received from these sales will go to the taxing authority.

Now I'd like to turn over to Brett Nicholas, Redwood's President, to discuss our residential and commercial businesses.

Think you, Marty. As Marty noted, we made significant progress on a number of our key operating areas in the first quarter. Our overall residential loan purchase volume was $1.1 billion, up 66% from fourth quarter 2013. We made significant progress growing our GSE business.

Our residential securities portfolio grew at an 14% annualized rate, up to $1.74 billion. We issued a $347 million residential loan securitization that closed in April and we originated $119 million of senior commercial loans in the first quarter. I will comment on each of these areas.

In the first quarter, we acquired $794 million of jumbo loans. That's up from $642 million in the fourth quarter which, as Marty said, was counter to the industry trend of originations declining by about 25%.

We made good progress on our conforming product line in the first quarter. We were on what you would call a test stage during the fourth quarter 2013 and we really started opening up in the first quarter this year.

We acquired $299 million of conforming loans from a relatively small number of sellers in the first quarter, up from $17 million during the fourth quarter. We expect conforming loan volume to increase as we transact with more of our existing and new sellers to sell us conforming loans.

Our proof seller network continues to grow. As of the end of the first quarter, we had 124 active loan sellers. We expect the pace of new sellers to increase as we have focused our efforts on signing up counterparties we believe will be a great fit for both our conforming and jumbo product lines

The growth of our residential market operation, located in Denver, has been successful. We now have over 50% of our employees in Denver, which gives us access to a deep mortgage finance labor pool, allows us to scale and operate efficiently from a cost perspective.

In the first quarter, we completed 12 jumbo whole loan sale transactions for a total of $562 million. Our preferred distributions for jumbo loans remains securitization, since we can retain attractive investments for our portfolio. As the past few quarters, whole loan sales continue to offer better execution. Unless credit spreads continue to tighten -- or AAA spreads, we expect whole loan sales to make up the largest portion of Redwood's distribution of jumbo loan volume in 2014.

Turning to the current state of private label securitization, the market improved compared to the fourth quarter. Spreads narrowed a bit, but the market remains weak, particularly in comparison to other securitized markets such as those for commercial mortgages, credit cards and autos. Redwood priced a $340 million securitization during the first quarter, which closed in early April. We expect to complete our next securitization late in the second quarter.

In our commercial business, we originated $119 million of senior loans and we sold $65 million in the first quarter to CMBS transactions. These numbers were down from our record fourth quarter and reflect the seasonal nature of the commercial origination business.

Competition for commercial loans has increased, as there are more commercial loan originators today than there were at the peak in 2007. The increase in competition has led to lower loan sale margins but we think and believe the business is still attractive. We've recently added production personnel in New York and will continue to grow our production team in other regions.

Our investment activity was down in the first quarter; however, activity picked up in April. In the first quarter of 2014 and through April 30, 2014, we acquired $110 million of third-party securities, $24 million of Sequoia securities from Sequoia 2014-1, $8 million in mortgage servicing rights, $7 million of commercial loans, which ended up deploying $32 million of capital net of financing. I'd like to emphasize again that since 2010, our securitization platform has generated over $500 million of credit and other investments for our portfolio that would not have been available in the secondary markets.

Our overall residential securities portfolio grew at a 14% annualized rate, including valuation increases in the first quarter to $1.74 billion. Our investment portfolio provides Redwood a steady and growing source of interest income, which serves to mitigate the volatility in our mortgage banking segments and remains a very important part of our business model.

Finally, we have had very good momentum going into the second quarter in both our residential and commercial businesses. In our residential business, loans identified for purchase in April were up 27% over March and were at the highest levels since last May. Our commercial business has also seen a pick up in origination activity more consistent with our expectations for 2014.

With that, I will turn it over to Chris Abate, our CFO, to run through the numbers.

Thank you, Brett. Good afternoon, everyone. In the face of challenging mortgage market conditions in the first quarter, which included volatile interest rates, our GAAP book value per share was $15.14 at March 31, an increase from $15.10 of December 31, 2013. The first quarter increase in book value per share reflected net positive valuation adjustments in our investment portfolio. Net of our hedges, that we combined with our earnings, exceeded our first-quarter dividend of $0.28 per share paid to shareholders.

Our earnings per share was $0.14 for the first quarter of 2014, down from $0.29 in the fourth quarter of 2013. The decline in our EPS is primarily attributable to negative market valuation adjustments on hedges and other interest rate-sensitive investments, combined with lower loan sale profit margins generated through our residential and commercial mortgage banking activities, which combined, produced a loss of $1 million the first quarter of 2014 compared to a gain of $17 million in the fourth quarter of 2013. Income from residential mortgage banking activities with a loss of $2 million for the first quarter of 2014 as compared to income of $10 million for the fourth quarter of 2013.

Similar to recent prior quarters, we continue to experience timing differences related to our jumbo mortgage pipeline, which we define as those loans we have identified for purchase at the end of the quarter and the hedging for those loans that make it difficult to fully ascertain our quarterly operating performance from our high-level GAAP results. In summary, our hedge results are reflected in earnings while a positive or negative evaluation adjustments to the loans and the jumbo pipeline are neither reflected in earnings nor equity until the loans are acquired in subsequent periods. In the review this quarter, we provide a more in depth discussion of these timing differences, which I encourage you to read.

After taking into account the effective of volatile interest rates and timing differences that affected our high-level GAAP results, we believe the loan sale profit margins generated by our operations during the first quarter were only modestly down from the prior quarter and remain within our long-term target of 25 to 50 basis points, net of hedges, that we have disclosed in the past.

Our commercial platform generated income from mortgage banking activities of $1 million in the first quarter of 2014 as compared to $7 million in the fourth quarter of 2013. As is often typical in the commercial mortgage business, our first-quarter origination volume is down from a strong fourth quarter and loan sale margins were lower. We provide more detail on our residential and commercial mortgage banking activities in the Redwood Review.

Turning to our portfolio activities, our total residential securities increased by 4%, or $60 million, to $1.74 billion at March 31, up from $1.68 billion at December 31. We invested a net $15 million of capital in the first quarter 2014, $10 million in residential investments, and $5 million in commercial mezzanine and b-note investments, as compared to $76 million of capital invested in the fourth quarter of 2013.

Net interest income for the Company was $36 million for the first quarter of 2014, down from $38 million for the fourth quarter of 2013. After taking into account a $2 million commercial loan prepayment penalty received during the fourth quarter, our net interest income remained a steady source of earnings over the past few quarters.

Included in net interest income for the first quarter was $24.7 million from our residential investment portfolio, a $1.4 million increase from the prior quarter. This increase was offset by lower net interest income from mortgage banking activities as we held lower balances of residential and commercial loans in inventory awaiting sale or securitization in comparison to the fourth quarter of 2013.

Turning to our cash position and our capital, at March 31, 2014, our unrestricted cash was $150 million and our current investment capacity, which we defined as the approximate amount of capital we have readily available for long-term investments, was $110 million. We currently expect that our available capital and liquidity is sufficient to fund our business and investment objectives for most or all of 2014, in part because we believe we can source capital internally by selling or financing existing investments with higher-yielding investment opportunities arise.

That concludes my prepared remarks in our fourth quarter financial results. Before we open it up for Q&A, I want to quickly turn the call over to our head of Investor Relations, Mike McMahon.

Thank you, Chris, and before we start with the Q&A, I remind you that certain information presented and certain statements made during Management's presentation with respect to the future of financial or business performance strategies or expectations may constitute forward-looking statements. Forward-looking statements are based on current expectations, forecasts and assumptions that involve risk and uncertainties that could cause actual results to differ materially. Management encourages you to read the Company's most recent annual report on form 10-K filed with the SEC, which provides a description of some of factors that could have a material impact on the Company's performance and could cause actual results to differ from those that may be expressed in forward-looking statements.

This conference call contains time-sensitive information that is accurate only as of today, Monday, May 5, 2014. The Company does not intend and undertakes no duty to update this information to reflect subsequent events or circumstances. And with that, Operator, we'll open it up for calls -- or questions.

Thank you.

(Operator Instructions)

Daniel Furtado, Jefferies.

Good afternoon, everybody. Thank you for taking the questions.

The first is regards to this securitization that you just recently did. You had mentioned that the economics on that had improved from the last one you did in 2013. Was that simply the 10-year coming in, or is there something structural within the deal or collateral that helped improve the economics there?

This is Brett. That's primarily just AAA spreads have tightened from the fourth quarter.

Understand. Okay. And then, you had made the mention that normalizing for some of the noise that you see in your hedging book, that you see the gain on the loan margins about the same as 4Q. Do you have an estimate for what that potential mark-to-market on those pipeline loans would have been at $331 million?

We think at December 31 we had a pipeline of loans that we yet to purchase on the jumbo side. We would estimate that somewhere between $4 million and $5 million of pipeline losses associated with those that we recognize in the first quarter.

Okay. My final question if I may, I recall last question you had -- last call you had mentioned the conforming business. You had kind of aspirational volumes of getting up to $1 billion per month by the end of 2014, if I recall correctly. Is that still valid, considering what's happened in the market? Or how should investors be thinking about that conforming side?

We have not changed that goal and feel like we can get there.

Great. Thank you for the time.

By the end of the year.

Understood. Thank you, guys.

Steve DeLaney, JMP Securities.

Thanks. Good afternoon, everyone.

I just wanted to make sure I understood the conventional numbers in the first quarter. Brett, did you mention in your remarks that the conventional purchase volume, did you say $249 million?

It was $299 million, just under $300 million.

Oh, $299 million. Okay. That would put you at about purchase or let's see -- I apologize, Brett. So $299 million, call $300 million and you sold $160 million, correct? So that would suggest to us that you have $140 million or something on the books at the end. And then I noticed you had $155 million in the total loans identified for purchase.

Just trying to see what you were carrying over, what you had already identified for purchase, and that looks about $300 million. So, gosh, it seems to me you're at least going to double your conforming business in the second quarter. Is there a chance it could be as much as three times what it was in the first quarter?

Were not prepared to forecast at this point. We can say we've been pleased with the ramp. Obviously, a big component of our Denver expansion has been to build the efficiencies we need to scale conforming and we are starting to see that. I would say the conforming volume was more back end, as far as the first quarter than front end. So we like the trojectory. We like where we're at heading into the last month of Q2.

That's helpful, Chris. Appreciate that. And then back to the 2014-1 deal, as far as the differences as Danny was talking about. One thing we noted was that the credit enhancement was down below 7%, or slightly -- 6.95%.

The deals later last year were 7.25%, 8%, 8.35%. Is that a function of who the rating agencies were? Do you think that is that sign of maybe CE is headed lower?

Yes. I think, Steve, it's really a function of the collateral and the collateral mix. To the extent that you have more 15 year in there, you going to have less credit enhancement. So it really depends deal by deal.

Got it.

I would say all levels are pretty much the same place they were toward the end of last year.

Right. You even had some10-year ARMs, I think, in there, as well. Okay. And lastly, Marty, you are carrying a lot of whole loans, both resy and commercial whole loans and you've got, when you do securitizations you got some retained investment great RMBS. And just curious if you plan to have any conversations with the Federal Home Loan Bank about possibly becoming a member and taking advantage of their advance program for any of that type of collateral.

Yes. We had indicated before that we're exploring the opportunity to join the Federal Home Loan Bank system. We believe that becoming a member of that system would be actually a win for the community banks as well as it would be for us.

To the loan platform we have, we could provide an outlet for loan sales by members of that system providing mortgage liquidity, which is really in step with the system's mission and purpose. And at the same time it can provide us with another source of long-term, low-cost funding. To this end, we have taken definitive steps towards membership, including establishing a captive insurance subsidiary and we'll plan to update everybody on next quarter's call as the process moves forward.

Very good. Well, appreciate the comments from everyone. Thank you.

Paul Miller, FBR Capital Markets

Thank you very much. Going back to the comments you made about the market being very tight and the capacity has to adjust to the current environment. The question is, does that mean the we should expect this type of earnings for the next couple quarters until the market straightens itself? I know you had long-term opportunities but in the short term, the next couple of quarters, how are we supposed to look at this?

Well, we don't to earnings projections, but I will say, to us, this looks like a pretty much a garden-style correction, where capacity in the industry has to come in line with existing [vibes]. It's moved little quicker than it has in the past. Yet my guess is, margins will stay under pressure probably for the next six to maybe even nine months until it gets right-sized.

I would add, Paul, that we've experienced a lot of earnings volatility as a result of movements in interest rates and in timing with our pipeline. That's something that's really tough to predict, so we tried to isolate that as much as we could in the review, but we do have significant P&L volatility coming from interest rates. And that something were going to have to manage going forward.

And then the MSRs. Do you hold the MSRs in the REIT? Are you planning to hold the MSRs in the REIT? And you mentioned in the release today that you're looking to buy some MSRs on the open market.

Yes, we currently don't hold them at the REIT. But a driving factor there is we don't believe we've achieved scale to want to bifurcate them, per say. We're just continue to hold them at the taxable subsidiaries.

You have no plans at all to put them in the REIT at all, just because of scale?

No current plans.

Thank you very much.

From a tax perspective there is a difference between creating MSR or purchasing MSR. So to the extent that we're purchasing a significant amount of MSR through on the open market, our view in that might change, but currently we're happy with where we hold them.

Okay.

Bose George, KBW.

Hello. Good afternoon. Just to follow up on that MSR question, have you seen returns, in terms of purchased MSRs that are reasonable levels or is it creating -- is a lot more compelling to just create them at the moment?

Well, we -- I think both are compelling. We have seen reasonable returns. We still think that MSRs where multiples are at are attractive.

Not as attractive as three or four quarters ago, but to the extent we see opportunities, we will continue to show interest. And to the extent that we're acquiring loans through the platform and we can create MSR, that's obviously very attractive, as well.

Bose, everything being equal, we'd much prefer to acquire MSRs just through our ongoing corresponded operation. But we will look at bulk and bifurcated programs. Absolutely.

Okay. Great. Thanks. And then, if you're switching to the -- on the last call you guys had talked a little bit about the GSE risk-sharing transactions. I was curious, are they developing at the pace you guys expected in 2014? And you also noted that you though you could see them happening on a flow basis this year. Do you still think that's the case?

Well, we believe they will continue to -- both Fannie and Freddie issued capital markets transactions and then there are numerous other efforts going on that are really, there just in concept phase right now. So what we feel is, we're doing business with both companies and that's as long as we're focused there and there can be an opportunity to establish different types of transactions related to risk transfer.

Okay. Then actually just one last one. The improvements in residential volume declines you saw in April, do you think that's just the market, or do you feel like there was a shift in shares while you continued to take share in April?

If a little bit of rates but a lot of it is our pull through with existing and new customers. We did not do business -- conforming business with many counterparties in the fourth quarter last year. We've increased that significantly and that's where a lot of this is coming through. And also pull through with existing jumbo sellers.

Okay. Great. Thanks a lot.

Matthew Howlett, UBS

Hello. Just to get back to the timing difference. Is there a more way to quantify the timing difference in terms of the loans you identify for purchase that you marked hedges down but it didn't mark the gain on and you'll sell in the subsequent quarter? Is there more of a way to qualify it?

Yes, we've really tried to do the best we can with the review disclosures. The issue is that if we try to quantify it, we're not sure which loans we're going to end up buying from a -- on a pull-through standpoint. We're not sure when they'll be sold and what levels.

We do have a little bit more clarity with loans that were in the pipeline in December 31, where we actually executed. That was the $45 million I had talked about earlier. Looking out at March 31, it is really difficult to venture a guess, just given the uncertainty around when the loans might actually be purchased and sold.

Got you. But overall the loan sells were in the 25 to 50 basis point range for the quarter? Is that the best way to look at it on a normalized mortgage banking quarter?

Yes. We make that statement to try and cut through the noise. There's just so many moving parts, much of which has to do with the accounting that we are required to apply around derivatives and commitments or lack thereof. So what we try and do is normalize it, not look at so much on a quarter-by-quarter cut off, but over time and we feel pretty confident that in Q1, ultimately with what we pull through from Q4 and what we eventually sell will be in that 25 to 50-basis point range.

Will that include the securitization that's going to close in April?

Yes. That's to us is a just another form of distribution. Another form of securitizing and we will look at the margins.

Got you. On investment proposal, I noticed that the decline in yields on the senior RMBS. I know that went up $150 million or so. And the repurchases on those yields, those yields have come down, so obviously it as you guys at the portfolio is going to drive down yield.

What can we expect on that part of the book? Do you still view that as non-core to Redwood, that over time you'll basically make room for the self-created securities in terms of the subordinate B pieces?

Yes. We're still opportunistic in the secondary market looking at senior securities, legacy senior securities. Yields have definitely tightened over time, but there's still attractive financing for those bonds. I think were really pleased with the senior portfolio and the cash flows we've generated. Like the portfolio and we do expect it to run off over time and we're hopeful that we can over time, replace it with securities that we've created or bought.

Great. And last question, the subordinate securities, I know you broke out the yields from those versus the mezzanine. That's very helpful. That does not include the 2014 transaction?

No. Not at the end of Q1.

Okay. Great. Thanks.

Ryan Zacharia, JAM.

Hello. Thanks for taking the question. Can you just give us a sense as to the gain on sale differential between the conforming business and the jumbo business?

You know, again, it's tough right now and I think our hesitation comes from, we're still ramping and conforming. So, when we look at our margins and we look at expenses in the buildout, we're still in the process of implementing a number of sellers, but today, we still, on both sides of the business, we still think we're operating probably closer to that 25 basis point number. But I think with conforming as we sort of finish the buildout and increase efficiencies, we think we will be pretty competitive.

And are the guys that you're buying from on the conforming side, do they have other conforming correspondent relationships already? I mean, what's the volume gain attributable to? I view this business as largely about price, so can you give me a sense as to why they're selling to you if they have pre-existing relationships?

Well, we got this question before and I would say on the jumbo side we got it a year ago. I think a lot of it has to do with service. Obviously, we need to be competitive on price. On the conforming side, our goal is efficiency.

Jumbo is much more high-touch on a loan-by-loan basis and the conforming side we need, as you said, we need to be able to compete on price and service. I think that what we're seeing with the existing sellers is, they like our service and at this point were happy with the growth.

And just to add to it, any prudent secondary marketing manager for a mortgage company wants multiple outlets. We can provide that one stop. Were a big jumbo player and we can add conforming product and it's that same seamless service.

And there's no kind of push back on the fact that you, I think, at this point time can't do government loans?

No. They're two completely different businesses.

And then just, can you refresh my memory from the accounting side, some of your brethren who are in the correspondent business try and reduce the timing mismatch of revenues and hedging losses by booking revenues on the basis of adjusted locks. Can you give me a sense as to why you're accounting doesn't allow for that?

Well it really comes down to the specific contracts with our sellers. I would say on the conforming side, we don't anticipate having these timing differences because the nature of the agreements is such that they're pretty plain vanilla as the conforming market is very established.

The jumbo correspondent margin is not as liquid. There's not as many participants and the collateral can look very different. So for those reasons, factoring in the specific agreements we have with our sellers, we have accounting that we need to apply that we work on with our auditors and I think at this point, we would all like to change it and perhaps over time will be able to. But I don't think that we have many options at this point.

Steve Delaney, JMP Securities

Yes. Forgive me, but just a quick follow-up. You reported one, not one, but you reported commercial real estate loan sales of $65 million in the first quarter and we've been tracking this data that Commercial Mortgage Alert puts out for the sellers into the various CMBS conduits. And they've reported that you sold into a JPMorgan deal and a Goldman Sachs deal and the total, it looked like, contributed loans was $169 million. Is there some timing issues going on here between when you treat loans as sold and when they're being reported by Commercial Mortgage Alert and the CMBS transactions?

Hey, Steve. It's not so much timing as just to clarify. There is some accounting issues going on, as well. So we stated that we sold $65 million. We transferred $100 million, $65 million of which was accounted for sales. We ran into a consolidation issue with certain senior loans where we retain B notes. So we try to talk a little bit about that later in the review. I think that number you looking at may also include some sales that happened post-quarter end in April.

There was one transaction dated March 28 that probably did roll over, yes.

Yes, so I think when you factor in that rolling over and then the $65 million was more like $100 million, as far as what left Redwood.

Oh, I see. So $65 million, you did an A/B structure and sold the A note?

$65 million was sold out right and then $35 million relates to the A/B structure that we ended up consolidating.

Excellent. Thank you for that, Chris.

And that does conclude a question-and-answer session for today. I'll turn the call back over to Mr. Mike McMahon. Please go ahead.

Thank you, everyone, for participating in our first-quarter conference call. This concludes the call. If anyone has any questions, you can reach out to me after this call for further follow-up. Thank you very much.

Thank you for your participation. This does conclude today's call.