Redwood Trust Inc (RWT) 2016 Q4 法說會逐字稿

Good afternoon and welcome to the Redwood Trust, Inc., 2016 fourth quarter earnings conference call. During management's presentation, your line will be in a listen-only mode. (Operator Instructions.)

I would now like to turn the conference over to Kristin Brown, Vice President of Investor Relations. Please go ahead.

Thank you, Dana. Good afternoon and thank you for joining us to review Redwood Trust's fourth 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.

On this call we will also refer to both GAAP and non-GAAP financial measures. The non-GAAP financial measures provided should not be utilized in isolation or considered as a substitute for measures of financial performance prepared in accordance with GAAP. They are also included to aid investors in further understanding the Company's performance and to provide insight into one of the ways that management analyzes Redwood's performance.

A reconciliation between GAAP and non-GAAP financial measures is provided in both our fourth quarter earnings press release and the Redwood Review, which is available on our website, redwoodtrust.com. Also note that the content of this conference call contains time-sensitive information that is accurate only as of today, Thursday, February 23, 2017. 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 will be available on the Company's website 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 fourth quarter 2016 earnings call. Joining me on the call is Chris Abate, Redwood's President and CFO. Following my remarks on our key financial metrics and accomplishments over the past fiscal year and our thoughts on the year ahead, Chris will discuss the quarter's investment and residential mortgage banking activities and our financial results for the quarter.

2016 was a very productive year for Redwood. Our GAAP earnings were $1.54 per share versus $1.18 in 2015. Our GAAP book value per share increased to $14.96 at December 31 from $14.74 at the end of the third quarter and $14.67 at the end of 2015.

After incurring $10 million of restructuring charges, we generated an 11.8% GAAP return on equity, grew GAAP book value, shored up our balance sheet by reducing short-term repurchase debt, and freed up capital internally for reinvestment through profitable sale of our commercial mezzanine loan portfolio. We also delivered attractive and consistent quarterly dividends to shareholders that contributed to a total shareholder return of 25% for the year.

Most importantly, we finished the year in a strong financial position. And after making some difficult but necessary modifications to our strategy, we now have a more focused, capable, and efficient investment platform that is well positioned for the current winds of change in the mortgage market.

Looking to the year ahead, efficiently deploying our available capital at attractive returns is at the forefront of our priorities for 2017. We feel confident about our ability to create investments ourselves through our Sequoia securitization program, as well as other vehicles we may use to finance our expanded prime Choice loans.

We also remain focused on new and innovative ways to take credit risk on residential loans and continue to pursue investment opportunities in GSE-issued securities that transfer risk on both single-family residential and multifamily properties to the private sector. In addition to risk transfer transactions for newly originated loans, we have seen a growing market for government- and bank-issued securitization backed by nontraditional loans. The economics of private-label RMBS continue to be attractive, and we expect higher issuance volumes in 2017 as well as a greater amount of subordinate securities available for investment.

As investor demand for yield continues to drive these positive economics, our mortgage banking business is off to a solid start in 2017. We completed three securitization transactions in 2016 and have already completed two transactions in the first two months of 2017 at favorable pricing relative to our fourth quarter transaction.

Of course, the year ahead will unfold against an evolving backdrop provided by a new administration in Washington. Like many of you, we have a strong interest in making sense of all the changes currently underway and how the new administration's policies will impact the mortgage market going forward. While no one really knows for sure how the policies will play out or how quickly, our view is that federal regulation will tend in the direction that favors private capital and away from government dominance in the mortgage markets. In addition, the new Treasury Secretary has expressed a strong desire to finally get GSE reform legislation enacted, which will likely result in private capital taking the leading role as the investor in mortgage credit risk. We welcome these policy developments, and we'll continue to aggressively position Redwood to take advantage of the opportunities that open up as a result.

In closing, I'd like to start off with the big picture. We are and remain patient, long-term credit investors. We think in terms of years, not quarters, and are bullish on our business model and our future growth prospects. We see private capital investors continuing to advance and becoming the leading holders of credit risk in the mortgage markets. Additionally, in a low-yielding investment world, having a loan conduit that serves to both create investment and generate fees is a key competitive advantage.

Now narrowing the focus to 2017, our number-one priority, as I said before, is to efficiently and attractively invest our available capital. We continue to expect to generate GAAP earnings that exceed our recent historical dividend payout of $1.12 per share annually. As many of our shareholders are aware, our business entails a lumpy base of deployment -- of capital deployment that doesn't always align perfectly with quarterly run-rate metrics typically used for a publicly traded company. Most of the assets we acquire or create have long return horizons and are illiquid in nature and may not be consistently available or attractively priced. Therefore, generating excess returns in 2017 will largely depend on our ability to deploy our excess capital in an efficient but prudent manner while maintaining our long-term, value-driven approach to investing.

Aside from our primary investment objectives, we expect our residential mortgage banking business to meaningfully contribute to earnings in 2017. Our team is already off to a solid start to the year, having completed two profitable securitizations, and we are eyeing additional securitization activity. This is not something we would have anticipated as recently in December in the wake of interest rate volatility following the US presidential election. We continue to feel very positive about our ability to capitalize on opportunities that arise in the market, as well as those we can create ourselves in order to generate additional net interest income that translates into compelling long-term shareholder value.

I would now like to turn the call over to Chris Abate, Redwood's President and CFO.

Thank you, Marty, and good afternoon, everyone. I'd like to begin with some comments on our recent investment activity. We deployed $91 million of capital into new investments during the fourth quarter, with an emphasis on residential CRT securities and commercial multifamily securities. For the full year 2016, we deployed $419 million of capital, including $142 million into residential CRT, $85 million into commercial securities, $56 million into new Sequoia PRT and other RMBS, as well as $25 million into MSRs. We also deployed $82 million of capital into loans financed through our FHLB subsidiary earlier in the year, allowing us to fully utilize our $2 billion of financing capacity at the Federal Home Loan Bank of Chicago over the past three quarters. Finally, our convertible debt and common share repurchases in 2016 totaled $29 million.

Through the first eight weeks of 2017, we have deployed $123 million of capital into new investments and are confident that we will be able to deploy our remaining excess capital on a disciplined and prudent basis across a broad spectrum of opportunities.

We also sold $14 million of residential securities and $24 million of MSRs during the fourth quarter, bringing our total sales from our investment portfolio to $365 million for the full year of 2016. These sales freed up approximately $205 million of capital for reinvestment and generated $23 million of realized gains for the year. Our portfolio sales in 2016 primarily focused on lower-yielding legacy securities that have fully appreciated.

While we continue to be opportunistic in terms of our sales activity, we currently expect fewer security sales in 2017 than we saw in 2016. We also expect to sell a significant portion of our remaining conforming MSR portfolio in 2017 and redeploy the proceeds into higher-yielding, REIT-eligible investments.

Overall, we were pleased with the performance of our investment portfolio during the fourth quarter, as net interest income was steady and the underlying credit performance of our residential investments remained excellent. Our investment portfolio represented $1.6 billion, or about 90% of our $1.8 billion of total capital at December 31. The remaining 10% was allocated to residential mortgage banking, which has continued to perform well since we repositioned our platform in early 2016. We purchased $5 billion of loans during the year and generated gross margins above expectations, due in part to improved execution on our securitization activities.

As Marty noted, 2017 has begun on a strong note for our residential mortgage banking business, as we completed our second Sequoia securitization of the year earlier this month, securitizing approximately $350 million of loans at tighter spreads than our first transaction in January. This should benefit our mortgage banking results in the first quarter.

We also continue to believe that our expanded prime Redwood Choice loan program will represent the most significant area of growth for our conduit going forward. Currently, over 70% of our sellers have rolled out the Choice program, and over 90% of those sellers have begun locking Choice loans. With expanded prime loans increasing as a percentage of our jumbo volume and securitization execution improving in recent quarters, our long-term expectation is that gross margins for our jumbo business will average 75 to 100 basis points versus our previous expectation of 50 to 75 basis points. We expect overall purchase volume levels in the $5 billion to $6 billion range in 2017, factoring in anticipated declines in industry origination volumes as a result of rising interest rates and declining refinance activity.

Now turning to our financial results for the fourth quarter, our GAAP earnings were $0.31 per share versus $0.58 per share for the third quarter. Fourth quarter GAAP results reflected the adverse mark-to-market impact of sharp increases in interest rates on our investment portfolio, loan valuations, and hedges. This was partially offset by lower operating expenses and higher mortgage banking income in the fourth quarter.

Core earnings for the fourth quarter were $0.31 per share as compared with $0.39 per share for the third quarter. Our fourth quarter core earnings reflected steady net interest income from our residential investments, but also lower gain on sales and overall managed income due to our commercial mezzanine loan sales in the third quarter.

Fourth quarter operating expenses were $18 million, down from $20 million in the third quarter. This decrease primarily reflected a decline in variable compensation expense in the fourth quarter. Our GAAP book value was $14.96 per share at December 31, up from $14.74 per share at September 30. This increase was primarily driven by our quarterly earnings exceeding our dividends and an increase in the value of interest rate derivatives hedging our long-term debt.

Turning to the balance sheet, our debt-to-equity leverage ratio was 3 times at December 31. We exclude $774 million of legacy Sequoia consolidated ABS debt from our leverage calculation, as it is non-recourse to Redwood. Leverage included $2 billion in borrowings by our FHLB member subsidiary, with a weighted average maturity of approximately nine years and a weighted average cost of 64 basis points per annum.

We had short-term repurchase debt, or repo debt, of $306 million at December 31, funding mostly residential securities, down from $694 million at December 31, 2015.

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

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

Actually, a couple of questions. First, just wanted to dig into your guidance for mortgage volume a little bit. I guess $5 billion to $6 billion versus $4.9 billion last year, despite the pretty big decline that people are expecting for industry volume. So can you talk a little bit about the drivers of that? How much of that is Redwood Choice, and what are the other drivers of it?

Sure. It is, in keeping with the recent trends, we feel optimistic about our ability to maintain or potentially grow volume, even in a declining origination market. You mentioned Redwood Choice. Choice is still ramping, as I indicated in the comments. But based on the early growth rate that we see, we're hoping to achieve a run rate in the 15% to 20% range of annual volume. And really, what that is indicative of, just our emphasis towards purchase products. One positive factor for us is that even though the refi wave may have ended here last fall -- we'll see -- we've got great purchase products to offer to our seller base, whether it's Redwood Choice or our Select products. So we're confident that in primarily a purchase market, we can still grow volume.

Okay. Actually, what percent of your production is purchase right now, or was it last quarter?

I don't have the specific number, but it's been in the 60% to 65% range. It's been as low as 50/50, and it's been trending higher. So again, it's a factor of interest rates, but we expect to see more purchase activity.

Okay. And then just in terms of your gain on sale margin guidance, the 75 to 100 basis points now, up from 50 to 75 basis points, what mix does that assume between Redwood Select and Redwood Choice? And is that the biggest driver of the new guidance?

Well, it's a few things. I think over time, we want to get to a run rate in that 15% to 20% range, so it certainly factors in a higher percentage of Choice loans. I think we said in the past those have averaged about 125 basis points higher in rate. But it also reflects that our margins have been elevated for a few quarters here. I think for the year, we ended at just over 100 basis points for mortgage banking margins. So I think we feel good raising that guidance. But it is going to be a function of Choice volume and just the direction of the market.

And one other contributing factor has been the results of securitization, where securitization lagged our bulk whole loan sales. And right now, our securitization execution is probably 25 basis points better than the bulk sales. So I think it's a combination of those things.

Okay, great. That's helpful, thanks. And actually one question on a different topic. Just the portfolio risk transfer transactions that we saw earlier last year, it's been a little quiet on that front, I guess, since then. Any updated thoughts on how that product could potentially develop?

Well, in the PRT specifically, I think many people have read some articles about no CC commentary or ruling about the risk capital relief for banks, or specifically JPMorgan. At this point, it appears as though there won't be additional PRT transactions in the near future. I think it's important for us to note that we don't expect any impact whatsoever to our positions. There was real risk transfer there. Those are contracts.

And the other side of it is irrespective of whether or not there's additional PRT transactions, I think that the results of the US presidential election took many people by surprise, and I think with that, there could be additional regulatory changes. There's been talks about Dodd-Frank rollbacks and some other things. So it's hard to say at this point, given the regime change, where ultimately regulation will end up and what the opportunities might be. But we do think, as we indicated, that the winds are blowing positively for private capital, so I think we're in a wait-and-see approach for future PRT.

Okay, great. Thanks.

Vivek Agrawal, Wells Fargo Securities.

I think you said that you were looking to get 15% to 20% of your volume from the Choice program. Is that what you need to be able to get to the point where you pull the loans or securitize them? Or is there other factors?

No, and 15% to 20%, we'd like to get it even higher. That's a goal we have for the year, to achieve that type of run rate. But ultimately, securitizing Choice loans is a function of aggregation. I think once we get to a run rate in that range, the accumulation period for securitization will come down to a few months, which is something that we're comfortable with. In the meantime, there's nothing keeping us from holding more of the loans.

That said, we went through a period here where we wanted to validate our pricing, so Choice loans, we've been selling most of them through hold on distribution. We want to maintain two distributions over time, so we certainly hope to get a securitization completed at some point. And then whether we hold the loans in portfolio or securitize them, we'd definitely like to do that in the coming quarters.

And then on the $44 million on guaranteed securities and the $20.8 million in commercial multifamily, can you give us some more detail around what you bought there?

In the fourth quarter?

Yes.

In CRT, it was around $30 million of the M2s and M3s, $3 million of the M1s, $8 million of Bs, and $3 million of IO. In multifamily, we continue to participate right in that BBB range, where we're got seven-plus points of credit support. So we found an area there that we're comfortable with, and we've been adding to that position, obviously. It's very complementary to what we do in resi. So I think we've had some success in both of those.

And then in Q1, we've continued to acquire CRT securities as well as multifamily. And as Marty said, we completed two Sequoia transactions, and we've also been active in subordinate RMBS.

Great. Then I think in your comments, you said that you brought down the repo substantially, down to $300 million. Are you looking to continue to bring that down, or is that the sort of level that you feel comfortable with now, Chris?

I think we're comfortable, Vik. Right now, I think it's more reflective of the opportunities. I think we would add if we found opportunities where we wanted to use repo, maybe up the capital structure. But right now, we're very comfortable with our repo level.

Thanks for the comments.

(Operator Instructions.) Brock Vandervliet, Nomura.

I guess first on the MSR, I noticed in the Redwood Review, and I guess you may have mentioned it also, that you're planning to sell that MSR portfolio. What was the decisioning behind that?

The real reason, Brock, is the MSR, MSR is really a business to us. It's not just an investment. I mean, we look at it opportunistically, but you're not just owning IO with MSR. You need all of the infrastructure it entails to manage it and oversee -- in our case, sub-servicers. So from our perspective, you need to be either all in or not. And on the conforming side, roughly, we felt like we either needed to grow our exposure significantly, to the range of excess of $25 billion, or else pare it back and reinvest the capital. So we've obviously decided that we'd like to pare that back.

We're going to continue to own jumbo MSR as a function of running the conduit. Most of that is created through Sequoia. So we'll continue to do that and operate that. But I think on the conforming MSR side, we're going to continue to pare that back, and we've been doing that in the first quarter.

Okay. And you're deploying but also bringing up pretty significant amounts of capital. You had $270 million available as of year end. I guess you've deployed about $120 million or $118 million. You're going to be selling the MSR portfolio, selling some of the commercial mezz loans. What's the total pro forma for some of those moves of available capital?

Well, we had $270 million at year end, and with the $120 million figure, that puts us closer to the $150 million range. We said the MSR sale is a strategic decision, and then we're always going to have portfolio rebalancing. But right now, I even feel like we're ahead of schedule as far as our capital deployment for the year versus where we expected to be. So I feel good about our ability to put that capital to work in 2017 at this point.

It's hard to say, though. We also mentioned in the letter, this business entails lumpy capital deployment. There's times in the market where we don't see anything that we like, and then there's other times where we wish we had more capital. So it's really going to be a function of market opportunities as well as what's going on in Washington and how that impacts the business going forward.

Okay, thanks for taking my questions.

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 their earnings call.