Redwood Trust Inc (RWT) 2015 Q3 法說會逐字稿

Please standby. Good afternoon and welcome to the Redwood Trust Incorporated 2015 Third Quarter Earnings Conference Call. (Operator Instructions). I would now like to turn the conference over to Kristin Brown, Vice President of Investor Relations. Please, go ahead.

Thank you, Renee. Good afternoon and thank you for joining us to review Redwood Trust's Third Quarter 2015 Earnings Report. Before we begin, I wanted to remind you that certain statements made during management's presentation with respect to future financial, or business performance, or expectations may constitute a forward-looking statements.

Forward-looking statements are based on current expectations, forecasts, and assumptions that involve risks and uncertainties that could cause actual results to differ materially. We encourage 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 the 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.

Also note that the content of this conference call contains time-sensitive information that is accurate only as of today, Thursday, November 5th, 2015. The company does not intend and undertakes no duty to update this information to reflect subsequent events or circumstances. Finally, today's call is being recorded and access to this recording will be available on the Company's website at RedwoodTrust.com later today.

For opening remarks and introductions, I will now turn the call over to Marty Hughes, Redwood's Chief Executive Officer.

Good afternoon, everyone. Thank you for participating in Redwood's Third Quarter 2015 Earnings Call. Joining me on the call are Brett Nicholas, Redwood's President, and Chris Abate, Redwood's CFO.

After my remarks, Brett will go through our thoughts on the operating environment and all of the key metrics in our residential and commercial businesses. And Chris will discuss the quarterly financial results.

All things considered we would categorize our quarterly performance as mixed. We earned $0.22 per share in the third quarter compared to [$0.31] per share in the second quarter of 2015. Book value at quarter end was $14.69, down 1.8% from the prior quarter.

On the one hand, earnings and cash flow from our investment portfolio remains strong and the underlying credit performance of our investment, especially for those created through our residential and commercial loan conduits, has been stellar. The strength and consistency of our investment portfolio performance has enabled us to maintain a stable dividend during times when our mortgage banking conduits encounter periods of market dislocation.

Our residential and commercial loan platforms also continue to serve as an important and direct source of new portfolio investments for us despite a difficult operating environment. Over half the capital we deployed into new investments during the third quarter and three quarters of the capital we have deployed year to date, has been into investments created through our residential and commercial loan conduits.

We also made good operating progress during the third quarter on several key initiatives that we believe will enhance our growth going forward, including additional risk sharing arrangements with the GSEs and throughout MPF direct channel. Brett, will discuss these in further detail in a moment.

On the other hand, as has been the pattern for several quarters now, the fixed-income markets have been increasingly cautious and pessimistic in the face of uncertainty over interest rates and the real strength of the global economy. As a consequence, our residential and commercial mortgage banking businesses saw no reprieve from the challenges posed by high-interest rate volatility, widening credit spreads, and also by stiff price competition to acquire both residential and commercial loans.

As a result, both of these businesses under perform relative to our expectations and make it unlikely that we'll achieve the volume expectations we had projected for 2015.

Our business strategy has been to build scalable operating loan platforms capable of creating our own investments and fee generating opportunities with enough flexibility to add new products and points of distribution.

Our goal has been to create an attractive growing stream of earnings through a combination of investment income from our portfolio, and fee income from our conduits operating in loan distribution activity. We still believe this is the right strategy. We are however shifting some tactics to optimize these loan platforms we have built. Brett, will discuss this in further detail.

In terms of share repurchases, last quarter we announced a new authorization by our board of directors to repurchase up to $100 million of Redwood Common Stock. We believe repurchasing shares boils down to a decision on allocating capital in a manner that is in the best interest of our shareholders.

Our approach is consistent with many long-term investments who believe a company should preserve enough investment capital to meet the near term needs of the business and repurchase shares only when the market price is below intrinsic value.

Using this approach, we repurchased approximately 2.5 million shares of our common stock during the third quarter at an average price of $14.43 for a total investment of $35.4 million.

Looking forward, we have a remaining authorization of $64.6 million. We plan to follow this same approach in considering additional stock repurchases. We have the willingness and investment capacity to make further investments in our own stock when it is attractive relative to other uses of capital.

I will close by touching on our dividend policy. Our Board has in recent years announced its intention with respect to the regular quarterly dividend for the upcoming calendar year towards the end of the fourth quarter. The Board's deliberation over dividend policy have generally considered numerous factors including management's projections for the Company's GAAP and retaxable earnings, and also projections of investment cash flows, capital, and available liquidity. In addition to consistency and sustainability of the dividend has always been an important consideration and a priority for the board.

Now I'd like to turn the call over to Brett Nicholas, Redwood's President.

Thank you, Marty. And good afternoon everyone.

Our residential and commercial investment portfolio has produced strong results for the quarter. Of the $121 million in capital we deployed in the new investments during the third quarter of 2015, over half was in the investments created through our residential and commercial conduits.

Residential loans held by our Federal Home Loan Bank member subsidiary increased 23% during the third quarter from $1.2 billion to $1.4 billion at September 30th 2015. Year to date, we have deployed $346 million of capital, over three-quarters of which has been into investments we have created through these conduits.

As Marty mentioned, both of our mortgage banking operating segments remain challenging in light of volatile rate, capital markets, and fierce price competition for both residential and commercial loans. In terms of volume metrics, our combined residential, jumbo, and conforming purchase volume was $3 billion for the quarter, an increase of 5% from the second quarter of 2015.

At September 30th 2015, our pipeline of residential loans identified for purchase was $1.5 billion and included $1.1 billion of jumbo loans, and $0.4 billion of conforming loans unadjusted for fall out expectations.

Our margins on our jumbo mortgage banking activity remained within our long term target range of 25 to 50 basis points. All of our jumbo loan sales this quarter were bulk home loan transactions where pricing has been superior to comparable sales through securitization.

Our MPF direct channel also progressed as we added 28 new sellers during the quarter bringing the total number of sellers in this channel to 58, and four federal home loan bank district banks previously approved for the MPF direct program have begun to ramp up marketing efforts to their members.

Moving to the conforming product line, price competition remains challenging especially as refinance activity has waned. Additionally, new entrance has aggressively bid up conforming servicing rights further pressuring pricing and markets.

Our efforts on the front end of risk transfers with the GSEs have made steady progress. We were new to our credit risk sharing arrangement with Fannie Mae for an additional three months through March of 2016. And extended our credit risk sharing agreement with Freddie Mac through June of 2016.

We believe we have built a best in class residential conduit with flexibility to add new loan products and multiple points of distribution including securitization, home loan distribution, and the ability to hold loans for investments. However, given the market environment we are adjusting some short term [tactics] going into 2016.

The first shift is to rationalize the size and scope of our residential conduit relative to near term market opportunities. While preserving all of the longer term upside embedded in the platform. On the conforming side, this entails optimization of our seller network towards more profitable sellers that may result in flat to lower volume in the near term. We are also focused on achieving operational efficiencies at current volume levels which are lower than originally planned.

We believe we can make significant improvements to net conforming margins in 2016 irrespective of current market conditions. We believe that our conforming product line positions us for attractive risk sharing opportunities with the GSEs and are finally beginning to see these opportunities emerge on a consistent basis.

On the jumbo side, we have shifted our near term focus towards an expansion of our home loan distribution capabilities for 2016. In short, a strong portfolio bid for whole loans from banks currently results in more favorable loan sale execution for us versus securitization.

While this execution is not our preferred choice, as we are not able to create significant investments for our own portfolio as we can for securitization. It offers the best near term profit potential. As a leader in private label securitization, we do remain committed to issuing transactions enhancing our Sequoia brand with investor driver features to the extent the economics makes sense.

Now turning to commercial. In our commercial business CMBS market conditions have also been far less than optimal. Perhaps the most difficult environment for the conduit sector since the market reopened in 2010. During the third quarter, triple-A credit spreads for CMBS widened by another 20 basis points to their highest level in two years.

Spreads widened in response to a general nervousness and uncertainty in most fixed-income markets. But also due to ongoing pushback by triple-A investors, [various] buyers and the rating agencies in response to deteriorating credit standards for CMBS loans. During the third quarter, we originated $168 million of senior loans, and $13 million of mezzanine loans.

The fourth quarter in the past has been strong for commercial originations. And we would note that the overall condition of the CMBS market remains concerning. As a consequence, we expect to fall short of our commercial volume and margin expectations in this business for 2015.

Nevertheless, we are optimistic about the commercial business going forward despite a difficult year in 2015. Tactically, our primary shift will be to improve our loan sale executions through more dynamic pricing strategies that allow us to be more competitive through each phase of the underwriting process.

Additionally, we are working closely with CMBS transaction sponsor to ensure that our loan products carry optimal collateral and geographic characteristics to meet the demands of a more selective CMBS investor base. Our ability to offer accompanying mezzanine financing should benefit our execution as we expect a higher percentage of senior loans to require mezzanine financing as long as the credit remains in focus for CMBS investors.

These tactical shifts combined with the markets believe that volumes will increase significantly over the next few years. It should position our commercial business for a better 2016.

I will now turn the call over to Chris Abate, Redwood's CFO to discuss the quarter's financial results.

Thank you, Brett, and good afternoon everybody. Our third quarter earnings were $0.22 per share as compared to $0.31 per share in the second quarter. While our investment portfolio continues to deliver steady results, our earnings declined in the third quarter due to hedging expenses for residential securities. Some of which was offset through valuation gains recorded to our balance sheet, and lower free-tax returns for our residential and commercial mortgage banking businesses.

Our book value was $14.69 per share, as compared to $14.96 per share at June 30th, a decline of less than 2%. The decline was largely due to an increase in unrealized losses on derivatives that we're hedging our long-term debt. And a decrease in unrealized gains on securities. Additionally, our third quarter dividend of $0.28 per share exceeded GAAP earnings for the quarter. As a result of strong portfolio growth over the past few quarters however, our estimated third quarter retaxable income was $0.29 per share and did exceed our third quarter dividend.

Turning to our recent investment activity, we deployed $120 million of capital into new investments during the third quarter bringing total capital deployed in the new investments to $346 million for the year. We continue to make significant progress replacing lower yielding portfolio assets with higher yielding, longer duration investments.

During the third quarter we sold $37 million of mezzanine RMBS with those bonds rated AA through BBB while redeploying a portion of the net proceeds into loans financed with the FHLB representing $44 million of capital invested during the quarter.

Other notable investment activity during the quarter included $23 million of MSR investments, and $13 million of commercial mezzanine loans. Additionally, as Marty noted, we repurchased $35 million of our common stock at a weighted average price of $14.43 per share.

Turning to the income statement, net interest income was $40 million for the third quarter unchanged from the second quarter. Net interest income from loans held by our FHLB captive increased during the quarter. Offset by a decline from our securities portfolio due to sales of securities that I had previously mentioned as well as principle pay downs.

Additionally, we received normalized income on our commercial mezzanine loans during the third quarter after receiving $2 million of non-recurring yield maintenance fees on three loans that had prepaid during the second quarter.

Income from residential mortgage banking activities declined from the second quarter primarily due to modestly lower jumbo loan sale margins on similar quarterly loan volume. However, at 47 basis points year to date jumbo margins continue to remain within our long term target range of 25 to 50 basis points. As home loan sales have recently provided a better execution for us than securitization, we have been targeting a higher percentage of jumbo loan sales which we anticipate will improve jumbo margins in the near term.

On the conforming side, although price competition has remained challenging, our conforming margins were stable during the third quarter. And we believe that profitability initiatives we have underway will improve conforming margins in the coming months.

Income from commercial mortgage banking activities was $1 million for the third quarter as compared to $3 million for the second quarter. With the decrease primarily due to reduced origination volume.

Turning to our cash and available capital position, at September 30th our unrestricted cash was $235 million and our investment capacity which we define as the approximate amount of capital we have readily available to make long term investments was $85 million.

Additionally, we anticipate that the remaining debt associated with a resecuritization we issued in 2011 will repay in full during the fourth quarter. Which could potentially free up as much as $175 million of additional capital based on the current market value of the collateralized securities. Combined with our available capital at over $250 million, we believe this will provide us with sufficient capacity to fund our business and capital needs for the foreseeable future.

And that concludes my prepared remarks. Operator, we are ready for Q&A.

Thank you. (Operator Instructions). Our first question comes from Steve Delaney with JMP Securities.

Hi, good afternoon everyone, and thanks for taking the question. Chris, I guess this is for you. There was a sizable increase in retaxable income, $0.29 versus $0.21 sequentially. And in your comments I believe you made reference to gains on securities. I guess the key here is do you see this pretty much as a one-time event or should the RCI maybe be running at a higher level here going forward? Thanks.

Hi, Steve.

Hi, Chris.

It's running at an increasing level. So there's enough moving parts with retaxable income where I'm not certain that we're going to be at that elevated level in perpetuity here. But what we are doing is despite challenging markets we've been consistently investing from a portfolio standpoint.

As you know, we've been very active utilizing our home loan bank facility. And we've been consistently growing assets and investments. We've been selling lower yielding securities and replacing them with longer yielding or longer duration/higher yielding loans in many respects. And over time, we do expect that to increase both net interest income as well as retaxable income.

Okay, so really to boil it down into simple terms for me, you've been running about $0.20 in retaxable, but trying to build and manage these conduits where the revenue stream can be volatile. And I think what I'm hearing you say is that as you grow the portfolio, which is now $3 billion, net interest income becomes a larger percentage of total revenue. I think I'm hearing you say that we should see retaxable income trend higher. Is that an accurate summary?

Yes, I think that's right. As a reminder, all of our mortgage banking activities occur at the taxable [REIT] subsidiaries. So really what's driving the increase in retaxable income is the portfolio. So as we grow the portfolio I do expect retaxable income to increase.

Great. So you're now up to -- I mean the $1.4 billion is just under 50% of the total. Can you comment, guys with your relationship with Chicago. Do you have additional capacity there to -- obviously you have to have the capital for the haircut. But do you think that that whole loan portfolio could continue to expand over the next couple quarters?

Yes, we still have some capacity remaining. So we can borrow up to $1.4 billion today. We certainly would entertain the idea with the Home Loan Bank of Chicago of increasing that. It's too early to tell, and as you know we have the NPR issue still unresolved with the FSHA. We're optimistic that -- or we would like to do more frankly, Steve, but at this point we're focused on utilizing our existing capacity.

Got it. Well, hopefully Congress will do the right thing and get that question about captives resolved. Last question, and guys I know the rationalization process can be a difficult decision process to reach. I mean over the years, I don't think anyone (inaudible) ever questioned that Redwood management were astute credit investors and trying to build an operating business or a loan factory is a challenging business. I applaud your willingness to kind of say okay maybe we'll take a foot off the gas pedal here and rationalize to use your word.

Chris, you're running $24 million, $25 million of quarter GNA. Is it too early to give us any indication of whether there will be any kind of material reduction in the GNA rate as a result of the rationalization? Or is the rationalization more pricing as Redwood's risk management and pricing as Brett suggested?

Yes, it is too early, Steve. A lot of the initiatives that we have underway are just beginning. But it really is. It's both sides. It's on the revenue side. There's a lot of efforts underway on price optimization. So focusing on more profitable sellers, focusing on margin and increasing margin.

And then expense management. I think rationalization is the right term right now. At this point it's too early to say if there's going to be significant reductions. But it's something that management is squarely focused on. And we anticipate as early as the fourth quarter to be exercising some of these initiatives.

Steve, I'll just add. It's Brett here.

Hi, Brett.

We really built out, and we do operate more of a flex model where we use a lot of third-party resources. That's the first area where we can scale back. Which would reduce operating costs in terms of our cost to produce per loan. And then it's really focusing on pricing profitability, who are our right partners out there where there's really a beneficial relationship for both sides?

Got it. Guys, thanks a lot for the comment.

Thank you. We move now to Bose George with KPW.

Hi, guys. Good afternoon. I just wanted to get a little color on the $13 million expense, the derivative and hedging allocation expense. And also you guys mentioned that there is a partial offset that flows through the balance sheet. Can you size that?

Yes, the offset was $2 million. What's going on there, Bose, is we continue to deal with an accounting issue where some of the gains are going through the balance sheet in this case that are offsetting some of the hedging declines. So this does relate primarily to our mezzanine RMBS portfolio. So a portion of the offset was in the balance sheet. Another portion was in realized gains because we've been selling mezzanine securities over the past few quarters.

But we're hoping as that portfolio is sold or pays down that this one-sided issue becomes less material. But the big swing was directly associated with rates. So rates were up last quarter which means the derivatives that go through the income statement were up. And the bonds were down through the balance sheet. This quarter it was the opposite. So it created a big swing in quarterly P&L

Okay, great. That makes sense. And then just a follow up to this question. In terms of the changes with the conforming business and where that could move from profitability, you guys year to date I guess you've noted that business has lost around $5 million. So with the changes you're making is it fair to think that that could be a profitable business next year?

Yes, another thing we noted was the quarterly loss has been declining. It was close to a $1 million in the third quarter. So the trend has been heading in the right direction, but we still haven't quite reached break even. We think with the initiatives that we're undertaking today and the analysis. We feel optimistic that we can get there certainly in 2016.

Okay, great. Thank you.

Thank you. Our next question comes from Matthew Howlett with UBS.

Hi, thanks, guys. Chris, did you say that the resecuritization debt was going to come due was going to be called and you could have had the residual come out that you could do something with capital. Is that how -- if you could just go into detail on that?

Hi, Matt. We completed a resecuritization a few years back of legacy, primarily '04 and '06 legacy seniors, RMBS. And over the years the [A piece] has continued to pay down. And I believe there was something, approximately $5 million outstanding of the debt. And so we anticipate that paying off based on current speeds, most likely in the fourth quarter.

So the $176 million or so of collateral -- these seniors will become available to us. From a market standpoint, they're very low yielding so our options would be to potentially relever them using repurchase facilities which isn't optimal. We think a better option would be to sell them and use that capital for more accretive investments.

Right. And then on a notion -- you said it was about $150? What was the size of it?

It was $175 million.

In terms if you look at, you repurchased 2.5 million shares at $14.00 something, if you look at that versus just buying your own stock back, I mean you continue to weight both options, what's more attractive, and so forth all that?

Matt, this is Marty. Yes, obviously we have about $65 million of capacity left. And to the extent that the -- after collapsing the [re-remic] it would give us a lot more capital. And one of the decisions would be the attractiveness of potentially selling some of these securities which are lower yielding versus buying back our stock.

Got you. Okay, got you. Well, we'll wait for that. And then you also have a pretty sizeable mezz portfolio that you said you expect to just run off or sell. It's a couple hundred million.

That was quite a bit larger a few quarters ago, Matt. And we've been selling that fairly consistently over the past few quarters. They're lower yielding bonds, and there's also been the accounting complexities associated with the portfolio. So to the extent we've got higher yielding opportunities, we're going to sell those as well.

Got you, okay.

I wanted to add that one of the reasons they're obviously lower yielding is that they have increased so much in price over time. And for many of these things they're approaching par. So there's not a lot of upside in price. And in terms of getting more -- enhancing yield out of these securities.

Got you. Well, good. That sounds like a pretty good opportunity. A lot of capital is going to be freed up here at the company. Just getting back to the mortgage banking, and I get the challenges with the environment. I just want to make sure I've got this right. You put the sort of the [gain on] some margins sort of 47 basis points on the jumbo side for the first nine months. And you include the net interest income on that for the [care] that you get with some warehouse. But it looked like segment contribution was break even.

So if it's in your range, but the high end of your range, but the segment is still sort of break even. What are we missing in terms of what level do margins have to go to, to make the segment profitable or return some respectable ROE?

Well the margins in the third quarter were lower than 47 basis points.

Okay, got it.

So the jumbo mortgage banking side has been profitable through the first nine months of the year. So if we're earning on the higher end of that range we're making money in mortgage banking. Now the breakeven is a net of a loss in conforming, and a gain in jumbo.

Got you. Okay.

So that's really what's going on.

Got you, and then can you comment on the securitization that was announced today? The jumbo securitization and why the market conditions changed in the sense that you think you [get extra] triple-As at a tighter price, what you saw in the third quarter?

We can't comment on that.

We're active in market. We cannot comment.

Okay, and I mean can we assume that you wouldn't have taken that avenue if you didn't think that whole -- if whole loan [has the] better execution, then we can assume that maybe conditions are changed or are you just keeping that market open to you? Are you taking a strategy where you may not sell all the triple-As. I mean just something. Is there any reason why the change in strategies from what's been announced this morning to what went on in the third quarter?

We're being more tactical. But we've also said that we're going to be consistent players in securitization. So obviously we're focused on profitability, and that's a driver of the distribution we choose. So I do think that's right. That we're focused on what the economic returns would be if and when we securitize.

But I don't think this is a shift in strategy. I think we're going to continue to be active in securitization as we more likely [complete] more whole loan sales.

Matt, this is Brett. What I want to focus you on is the bulk of our production in jumbo is 30-year fixed.

Okay.

My comments earlier are that sales to banks and life companies are significantly through what we can execute in the securitization market. I can't comment on the deal we currently have, but it's not 30-year fixed rate loans.

Got you. That helps. Thanks, Brett. Thanks guys.

Thank you. Our next question comes from Brock Vandervliet with Nomura.

Thanks. Most of my more detailed questions have already been asked and answered. But just stepping back just so I understand this, I mean it sounds like not that it may be a bad decision given the environment, but there's a shift to use the balance sheet more aggressively and perhaps less of the capital markets capability. Is that fair enough?

Hi, Brock. We're still sourcing investments through the conduits. So they're going to remain active. I think as far as the volumes, those are going to be influenced by how profitable we can get both conduits. The market conditions have been very challenging this year. But we're also trying to focus on some of the good things that we've done through the portfolio which as you know is really the driver of the dividends.

So the portfolio is doing exceptionally well today. To the extent that we can create more investments through securitization, risk sharing opportunities with the GSCs and of course the home loan bank. Those have been bright spots despite some of the challenges we've faced on the mortgage banking side.

And, Brock, it's Marty. I would add, what we like to do is going to keep all our distribution options open. What we'll try to do within that is optimize profitability, but it's going to be the home loan bank, it's going to be bulk whole loan sales as well as securitization. And what we'll do is just pivot between them based on what the best execution is.

Okay, thank you.

Thank you. And we move to Vic Agrawal with Wells Fargo Securities.

Hi, good afternoon guys. Chris, can you help me understand what type of returns you're expecting or you think are possible with the sharing transactions?

Yes, hi Vic. What we're really targeting there is low double digit returns. So these are proprietary transactions and we've been limited in the disclosing the uber specific details. But in general when we create credit investments we're looking for returns in the low double digits.

Okay, thank you, Chris.

Yes.

Thank you. There are no further questions at this time. This concludes our conference. On behalf of management, we very much appreciate you taking the time to participate in our earnings call.

Thank you.