Redwood Trust Inc (RWT) 2016 Q1 法說會逐字稿

Good afternoon and welcome to the Redwood Trust 2016 First Quarter Earnings Conference Call. During management's presentation, your line will be in a listen-only mode. At the conclusion of management's remarks, there will be a question-and-answer session. I will provide you with instructions to enter the Q&A queue after management's comments. I would now like to turn the conference over to Kristin Brown, Vice President of Investor Relations. Please go ahead.

Thank you, Kim. Good afternoon and thank you for joining us to review Redwood Trust's first quarter 2016 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 may constitute 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 Annual Report on Form 10-K, 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, May 5, 2016. 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 Redwood Trust's CEO, Marty Hughes.

Good afternoon, everyone. Thank you for participating in Redwood's first quarter 2016 earnings call. Joining me on the call are Brett Nicholas, Redwood's President; and Chris Abate, Redwood's CFO. After my remarks, Brett will discuss our residential mortgage banking business, then Chris will discuss our investment activity and financial results for the first quarter.

We had a very productive first quarter during which we substantially completed the repositioning of our residential and commercial mortgage banking businesses. Deployed $146 million of capital into new investments, including $25 million to repurchase our common shares and convertible stock. We reduced our repo debt by $259 million from year-end and sold $150 million -- $151 million of residential securities freeing up $58 million of capital for reinvestment into higher yielding assets.

Margins on our jumbo mortgage banking activity were very strong at just below 150 basis points, which is well in excess of our normalized expectations. Additionally, our first quarter cash flows from our investment portfolio increased from the fourth quarter of 2015 and the underlying credit performance of our investments remains stellar. Despite the progress we made in many aspects of our business during the first quarter, some of this activity coupled with continued volatility in the fixed income market, did create some noise in our first quarter GAAP earnings, which came in at $0.15 per share as compared to $0.46 per share in the prior quarter and $0.16 per share in the first quarter of 2015. The decline in our fourth (sic - see page 6 of Redwood Review, "first") quarter earnings was largely due to a $0.14 per share in restructuring expenses and $0.19 per share of negative market valuation adjustments, primarily driven by credit spread widening during the quarter. If we repriced at today's credit spreads, these negative adjustments have largely recovered in value.

To offer additional transparency on one of the ways we analyze the performance of our businesses, we have introduced a new non-GAAP core earnings metric to supplement our quarterly GAAP earnings analysis going forward. Our non-GAAP core earnings for the first quarter of 2016 were $0.44 per share as compared with $0.45 per share in the fourth quarter of 2015.

This new metric was developed in response to feedback from shareholders and analysts, based on the need for a better way to comparatively analyze our quarterly earnings, which has been extremely volatile over the past few years. Some of this volatility has been driven by our mortgage banking operations, which we had taken steps to address in recent months. The majority though has been driven by the extreme volatility in the fixed income markets over the past couple of years and the shift towards fair value accounting, which requires us to reprice our long-term investments each quarter, causing significant volatility in GAAP earnings that we don't believe is reflective of our core results. Our hope is that this new metric becomes an effective tool to supplement, though not replace our quarterly GAAP operating results going forward. Chris will provide further details on both our GAAP and core earnings in a moment and we look forward to your feedback.

I also want to touch on our business strategy, which we believe bears repeating, following all the recent business repositioning. Our goal has been to create a growing stream of earnings through a combination of investment income from our portfolio and fee income from our residential mortgage banking activities. We are continuing to allocate over 90% of our capital to investment activities with the primary focus on residential mortgage credit. Our target investments include prime jumbo loans, new issue RMBS subordinate securities, credit risk transfer transactions and potentially legacy RMBS issued by third parties. To source of these investments, we will rely on our established network of external relationships, our proprietary mortgage banking platform and our Sequoia securitization program. We may also look to legacy or newly issued CMBS should risk adjusted returns be attractive and we will also continue to review our holdings of our commercial mezzanine portfolio and may look to opportunistically sell all or part of this portfolio.

In summary, our full attention is now on growing earnings by seizing on new attractive investment opportunities, managing our invested capital and maximizing the value of our jumbo loan franchise. We're upbeat about the remainder of 2016 and more importantly about the long-term growth prospects of Redwood.

As stated in our fourth quarter Redwood review, our expectation is to generate GAAP earnings between $1.20 and $1.50 per share for the full year of 2016. After incorporating our first quarter results into our current outlook, we continue to expect GAAP earnings for the full year 2016 to fall within this range.

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

Thank you, Marty. We were pleased with our residential mortgage banking results for first quarter of 2016. We purchased $1.0 billion of residential jumbo loans during the quarter and, by shifting tactics to take advantage of the favorable economics for whole loan sales, improved the gain-on-sale margins on jumbo loans sold during the quarter. Jumbo loans sourced through our residential platform and held for investment by our Federal Home Loan Bank member subsidiary also increased by 31% during the first quarter of 2016.

As we have transitioned away from transacting in conforming loan products, our team has been able to shift all of its focus towards new jumbo loan initiatives. This has enabled us to accelerate the planned rebranding of our prime platform by a number of months and to offer new products to our sellers in response to growing demand. Beginning in April 2016, our traditional jumbo program has been re-branded as Redwood Select and we've launched a new expanded credit prime loan program called Redwood Choice. The new Choice program is a prime program that is fully documented, but with credit parameters outside our more recent underwriting guidelines. The choice program includes fixed rate and hybrid QM and non-QM loans and expands the low-end of our FICO range to 661 from 700 while increasing the high-end of the eligible loan-to-value ratios from 85% to 90%.

Additionally, we can acquire interest-only non-QM loans under the Choice program and non-QM loans with debt-to-income ratios up to 49.9% under each of the Select and Choice programs.

We believe that capturing the entire prime universe, rather than just a subset of it, will enhance our competitive position in the market, allow us to create better-yielding investments, and most importantly, allow us to leverage both the Redwood brand name and our existing resources. While we believe there will be a ramp-up period as our sellers adopt, offer, and originate these new loan alternatives for borrowers, we are excited about our Choice program's potential and expect to develop a better sense of how it will impact overall purchase volumes in the coming quarters.

Since we did not complete any residential securitizations during the first quarter of 2016, let's address what's going on with the private-label securitization market. Over the past five years, the issuance market for securitization has fluctuated between feast or famine, and unfortunately currently is in the latter state. Nevertheless, we continue to believe that over time private-label securitization is a very efficient and necessary mortgage financing, especially for prime jumbo loans. Our Sequoia securitization program is a market leader and we continue to actively work with triple-A investors to introduce new enhancements.

In our opinion, the primary obstacle to increasing private-label issuance volume is a lack of market liquidity, as many traditional issuers and many major triple-A investors remain on the sidelines. This condition has kept credit spreads both wide and volatile, which pressures securitization economics. Despite these headwinds, we currently expect to complete a Sequoia transaction in the next few months and are looking forward to investing in the subordinate tranches.

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, everyone. Our first quarter earnings were $0.15 per share as compared to $0.46 for the fourth quarter. Our earnings included $0.14 per share in restructuring and severance charges and $0.19 per share of negative market valuation adjustments, primarily driven by credit spreads widening during the quarter.

As Marty mentioned, we are happy with the progress we made repositioning the business during the first quarter. We also introduced a new non-GAAP core earnings metric to supplement our quarterly GAAP earnings analysis. Our non-GAAP core earnings for the first quarter were $0.44 per share as compared to $0.45 per share for the fourth quarter. Our core earnings metric excludes the charges we incurred from the recent restructuring of our residential conforming and commercial businesses. It also excludes certain market valuation adjustments related to the value of long-term investments that are otherwise repriced to our GAAP earnings each quarter. Lastly, it eliminates the impact of GAAP tax provisions or tax benefits. Importantly, it does not adjust our mortgage banking results, MSR income or make adjustments to normal operating expenses whether cash or non-cash. It also does not impact how we as managers are compensated.

Our first quarter core earnings reflected higher portfolio net interest income, higher income from MSRs and improved results from our jumbo mortgage banking operations. The overall decrease in core earnings from the prior quarter was primarily due to lower realized gains, as the fourth quarter included higher than usual sale activity associated with the resecuritization entity that was extinguished in the fourth quarter.

Our GAAP book value was $14.17 per share at March 31, 2016, as compared to $14.67 per share at December 31, 2015. The decline was primarily the result of our first quarter dividend, exceeding our GAAP earnings due to restructuring charges, as well as a decline in the value of interest-rate derivatives hedging our long-term debt and lower fair values for securities as a result of volatile market conditions in the first quarter.

Turning to our recent investment activity, we deployed $146 million of capital during the first quarter toward new investments, including $52 million of investments in subordinate RMBS issued by third-parties, $9 million of investments in MSRs, and $2 million of investments in commercial mortgage-backed securities. The subordinate securities we purchased during the quarter included both RMBS and credit risk transfer investments. We continue to focus on innovative new credit risk transfer opportunities as a way to provide credit solutions to large bank portfolio aggregators of residential loans as well as to Fannie Mae and Freddie Mac.

We continue to make significant progress replacing lower-yielding portfolio assets with higher-yielding, longer-duration investments. During the first quarter, we sold $151 million of residential securities and $30 million of MSRs while redeploying a portion of the net proceeds into loans financed with the Federal Home Loan Bank of Chicago. This represented $82 million of capital we invested during the quarter.

Additionally, we deployed $21 million of capital to repurchase 1.6 million shares of Redwood common stock at an average price of $12.81 per share and $4 million to repurchase some of our convertible senior notes, which had a stated maturity of November 2019.

Turning to the income statement, net interest income was $38 million for the first quarter as compared to $44 million for the fourth quarter. Net interest income from our residential investment portfolio continued to improve in the first quarter to $35 million as compared to $34 million in the fourth quarter. The overall decline in total net interest income was attributable to a lower average balance of loans held for sale at our mortgage banking operations, largely due to the wind down of our conforming and commercial mortgage banking activities.

In addition, net interest income for the fourth quarter of 2015 benefited from $2 million of non-recurring yield maintenance fees, received from the prepayment of two commercial mezzanine loans.

Income from residential mortgage banking activities increased to $7 million for the first quarter from breakeven in the fourth quarter, primarily due to higher jumbo loan sale margins. Jumbo gross margins were 140 basis points for the first quarter, well above the 59 basis points we recorded for the full year of 2015 and well above our long-term expectations, reflecting favorable execution on whole loan sales versus securitization.

Of our $1.7 billion of total capital at March 31, 2016, $1.5 billion or 91% was allocated to our investments, while the remaining $150 million or 9% was allocated to our mortgage-banking activities. Included in our capital allocation is approximately $200 million of capital available for future investments. We believe that our available capital is sufficient to fund our business and capital needs for the foreseeable future.

At March 31, we had short-term repurchase or repo debt of $435 million funding mostly residential securities, down from $694 million at December 31. We currently expect to further reduce this financing to below $300 million in the next few months through the sale of securities and by using excess cash reserves rather than repo to fund investments.

Our debt-to-equity leverage ratio was 3.2 times at March 31, 2016. We exclude $907 million of legacy Sequoia consolidated ABS debt from our leverage calculation, as it is non-recourse to Redwood. Leverage included $2 billion of borrowings by our FHLB member subsidiary and loans held for investment by the subsidiary increased 31% to $2.3 billion at March 31, from $1.8 billion at year-end 2015. The weighted average maturity of these borrowings is approximately nine years, with the weighted average cost of 15 basis points per annum.

That concludes my prepared remarks. Operator, why don't we start with the Q&A.

Thank you. (Operator Instructions) Bose George, KBW.

Hey, guys. Actually the first question is just on the jumbo gain-on-sale margins. Can you just talk about some of the factors that are driving the strength in those margins and just the outlook if you can, for the next few quarters?

Hey, Bose. Well, first of all, we want to be clear that we don't expect to be generating 150 basis points of gross margins per quarter. I think a better expectation is in the 50 basis point to 75 basis point range. We were in the 25 basis point to 50 basis point range combined with jumbo and conforming. With our jumbo business, we expect those margins to be on the higher side. So I think, we're more comfortable with the 50 basis point to 75 basis point guidance.

I think in the first quarter, there were a number of factors. There's a very strong demand from whole loan buyers from banks, there was some spread tightening later in the quarter, but overall it was on a $1 billion or so of volume. So the goal is to continue to work towards $5 billion to $6 billion for the year at the best margins we can.

Okay, great. And actually just in terms of the margin trend so far in the second quarter, is it still as strong as you saw it in the first or is it already heading towards that 50 basis points to 75 basis points?

It's differentiated. So I think we continue to see really strong demand for our hybrid loans. For 30-year fixed, that market can move up and down pretty quickly. So for certain aspects of it, we're able to sell and there's a lot of liquidity and other parts of the quarter there is not. So we're going to continue to work through the 30-year fixed, but the hybrids are very strong.

Another factor Bose and this is Marty, we will probably do a securitization transaction in the second quarter to kind of keep the wheels turning on that to generate some investments and then the -- which we think is the right decision to do, but the overall income we're going to receive or gains on those will be lower than we could do through whole loan sales.

Okay, that makes sense. Thanks. And then actually the CRT investment that you guys did in the quarter, was that pretty opportunistic or could we see you being a little more active there?

I think we expect to be quite a bit more active there. There has been some liquidity issues in CRT, spreads moved around by 50 or more basis points in the first quarter. So from that aspect, it's opportunistic with respect to CAS or STACR. We also participated in a JPMorgan sponsored transaction in the first quarter, which we thought was a very attractive execution and we hope to do additional similar transactions if they're available going forward.

Okay, great. Actually, just one quick one on the accounting, what was the share count that you used to calculate the core income number?

It was about 97 million.

Brock Vandervliet, Nomura Securities.

Thanks for taking the question. Chris, if you could just talk more about that, the JPM transaction? What led you into that position as being able to buy the subs? What you see as kind of the forward book and potential for other deals or whether that was kind of a petri dish test if you will, and may not produce others, more color on that would be great?

Yes, and it's Marty, and I am going to respond, Brock. What we say is we found the -- how many more they're going to do, I don't really know. That's really up to -- JP Morgan's decision. What I would say about the transaction itself though, I think it's a very elegant structure. it was efficient, it resolves several points of friction and the next thing, it's a technology that could be widely adopted by other banks. It's capital efficient from their standpoint, where they end-up holding liquid, highly-rated securities at top of the stack and then people like Redwood would hold the credit.

By our estimates, they cut the credit enhancement costs almost in half versus guarantee fees, they no longer have to advance P&I, they get consolidation accounting for GAAP where they're going to put things on at cost and reduce the mark-to-market, plus the structure allows for [read] primary securities. So we don't know how many more they're going to do, but we would look forward to participating in whatever transactions that were by them or by others.

I was struck by the fact that this apparently existed for several years, why if this has been so compelling, was it the risk retention rule or what kind of got this over the line?

There was a couple of things. I mean, number one, there had still been plenty of liquidity at the banks. So this in addition to improving their economics does provide Basel capital relief. So some of this might be petri dish and might be planning for the future in a world where there isn't so much excess liquidity, but also it was a way to test the level of GPs in the market. The transaction is 75% conforming loans and to the extent it was accepted by the market, which it was, that gives a much better sense of what the true credit costs from a market perspective might be.

But the elements are pretty complex. So, I mean, no loan advance in P&I involves the rating agencies, working through the capital efficiency and then making it [read] eligible, there's a lot of complexity to it, so which is my guess is why took a long time to kind of get it done. But they accomplished it and it was successful.

That's great. Okay. I'll jump back in the queue.

(Operator Instructions) Vivek Agrawal, Wells Fargo Securities.

Hi, this is actually, Max Marin for Vic. Thanks for taking my call. I was hoping if you could just talk about I guess some color around the Redwood Choice program?

Yeah, Max, thanks for the question. Really as Marty said we have been very busy working through the conforming ramp-up the past couple of quarters and when we decided to wind that business down, it gave us an opportunity to speed up some of our jumbo initiatives, one of which was to offer some type of expanded prime product category. And as Marty said, we've rebranded into Select, which is more of our traditional product. Some people refer to it as Super Prime, I've heard in the market. We've got very low LTVs, very high credit scores, very, very strong borrowers.

The Choice program is still a prime product, it's still fully documented. There is QM and non-QM aspects, we will go up to just under 50 DTI, we will consider LTVs up to 90, FICOs in the high 600s. All of those, in some combination so the product types don't include the most aggressive of each band if you will, but they're all -- all of those aspects we've got certain products for. And it's too early to tell at this point, what the sustainable volume will be, but I can say, the products that we've rolled out have been in response to very strong demand, both from our loan sellers, as well as some potential whole loan buyers or investors. So we're excited about the new products. Hopefully in the next few quarters, we'll have a better sense of what the volumes might be.

All right. Thank you very much. That's helpful. And thank you for the additional disclosures.

Brock Vandervliet, Nomura Securities.

Thanks, I know the guidance $1.20 to $1.50 that's on a GAAP basis. Is the mid [40s] run rate on your core basis now, is that representative of the earnings power as you see it at the present time?

Hey, Brock it's Chris. The $35 million to $40 million ish range might be a more conservative estimate. At this point, we haven't published any formal guidance on core. One of the reasons is we want to get feedback from you folks and from shareholders on, how effective it is, how used it might be. And we think that what it does do is, is it really eliminates some of the noise. As you know, as we've transition towards more and more mark-to-market accounting, most of our investments today are going through the P&L. And when you think about this relatively benign credit environment, the biggest driver in the market values has been changes in interest rates. So almost by association, the biggest driver in our income statement has been changes in interest rates. So it's really not reflecting the core earnings drivers. And I think by backing out some of those mark-to-markets on long-term investments and then obviously anything like restructuring charges that we don't expect to continue to incur, will give us a much a better sense of the real, I guess core earnings of the Company. So those -- we'll give it a few quarters before giving any more clear guidance. But I think having the first quarter come in a penny off of the fourth quarter makes sense to me.

Got it, okay. And given the changes and kind of moving pieces that you had, should we base things off your current leverage ratio, where could that kind of move to?

Yeah, so the recourse leverage ratio was around 3.2 times in the first quarter. That's actually probably more in line with some of our competitors today. At this point, the only thing we've said on debt is that we wanted to continue to pare down repo. One aspect that we don't control though directly is the amount of whole loan warehouse debt that we incur, that fluctuates with demand. But overall, that 3.2 to 4 range and I think that's -- I think these earnings would be relatively consistent in that band.

Okay, great. Thank you.

John Helfst, Voya.

Hey, guys. Quick question, the Redwood Choice product, is that new to the marketplace or are other people doing something similar and no follow-up or the second question would be the charges in the quarter for -- will there be more in 2Q or 3Q or is this most of it in 1Q? Thanks a lot.

Hey John, the charges we think are substantially incurred at this point in the first quarter. There might be a few small items going forward, but for all intents and purposes, we currently expect that significantly all of that was expensed in the first quarter.

As far as the Choice product, there has been some expanded prime products that we've seen in the market. I think one thing unique here is, I think it's a fairly comprehensive product rollout. The important thing to note though is we did just roll it out. I believe it rolled out on April 18, so it's going to take a period of time for even our sellers to be educated on the products and input them in their systems and so forth.

So again hopefully, we'll have a better sense of traction next quarter.

And John, I would also add, this should allow us to be more competitive against the big banks where, their sweet spot is kind of write down with Super Prime. And obviously our thing is to sell and service here. And with the complexity of the product and by the way emphasize it's still prime, I think, gives us some competitive advantages.

Yes, sounds good. Thank you.

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