Redwood Trust Inc (RWT) 2017 Q3 法說會逐字稿

Good afternoon, and welcome to the Redwood Trust, Inc. Third Quarter 2017 Earnings Conference Call. (Operator Instructions)

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

Thank you, Jessica. Good afternoon, and thank you for joining us to review Redwood Trust third quarter 2017 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-Q, 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 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 our third quarter earnings press release and Redwood Review, which will be 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, Monday, November 6, 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.

I will now turn the call over to Marty Hughes, Redwood's Chief Financial -- Chief Executive Officer for opening remarks and introduction.

Good afternoon, everyone. Thank you for participating in Redwood's third quarter 2017 earnings call. Joining me on the call are Chris Abate, Redwood's President, Dash Robinson, our new Executive Vice President who joined us in late September from Wells Fargo, where he was the head of Mortgage Finance within their asset-backed finance group and Collin Cochrane, our newly appointed CFO, who joined Redwood as Controller in 2013.

For this call -- for this quarter's call only, Chris and I intentionally deferred his prepared remarks to Collin and Dash, as we thought it was important for you to hear from the newest members of our Executive team. Chris is here and will be available to address any questions during Q&A. So following my remarks, on our key accomplishments and financial metrics for the third quarter, Dash will discuss the quarter's residential mortgage banking and investment portfolio activities, and Collin will close with our detailed financial results.

During the quarter, we made strong tactical and financial progress. We completed our first Choice securitization, our fifth and sixth Sequoia securitization of the year and closed our seventh in October. We put $119 million of capital to work, and we raised $245 million of convertible debt at attractive levels. And most importantly, we welcome Dash to our senior executive team and Collin in his new role as CFO.

In terms of our quarterly financial results, our GAAP book value increased by $0.38 per share to $15.67 at September 30 from $15.29 at June 30.

Our GAAP earnings per share were $0.41 versus $0.43 in the second quarter and our non-GAAP quarter earnings per share were $0.35 per share consistent with the second quarter.

While persistent spread tightening through the first 3 quarters of this year have bolstered our investment portfolio returns, we have maintained consistent levels of net interest income and refined our portfolio by selling some of our lower yielding securities when appropriate.

We have also been aggressive to add to the investment portfolio when we have experienced pockets of opportunity, both early in the year and again in September due to spread widening as a result of the hurricane activity.

On the other hand, tighter credit spreads have benefited the execution for the Sequoia securitization program. Mortgage banking market -- margins continue to be robust, and we are encouraged by the relative mix of selecting Choice loans in our pipeline.

As we progress to the fourth quarter, our year-to-date operating metrics are validating the full year guidance we provided in Q4 2016 Redwood review. We feel good about our progress so far this year, particularly in terms of our success in deploying capital despite a tight spread environment, the underlying credit performance of our investment portfolio and the momentum of our Choice program and our Sequoia activity.

However, we remained cognizant of forces outside our control, both financial and otherwise and their potential impact on our business. With this backdrop, a fully seated executive team is an important milestone as we continue to think critically about our business assumptions and look ahead to next year and beyond.

As we have done in the past, we'll provide an outlook for next year with our year-end letter in February of 2018. As always, we thank you for your continued support.

I will now turn the call over to Dash Robinson, our new Executive Vice President.

Thank you, Marty, and good afternoon, everyone. I'd like to start off by touching on our mortgage banking activity which delivered very strong results in the third quarter. In particular, our expanded prime Choice program was a driver of performance, and it continues to represent a significant area of growth for our mortgage banking business overall. Our first Choice securitization, which closed near the end of the quarter was received favorably by the market and attracts a good number of both new and existing investors.

Importantly, the issuance created $31 million of investments to our portfolio, utilizing approximately $13 million of capital. On a percentage basis, this is more than double what is produced through a traditional Sequoia transaction. Going forward, we expect to issue Choice transactions on a regular basis.

In addition to our Choice activity, during the third quarter, we completed our fifth and sixth traditional Sequoia securitizations of the year, followed closely by our seventh in early October. This brings our year-to-date issuance volume through October to just shy of $3 billion.

Whole loan sales also continues to be an important source of liquidity for our business. We sold $212 million of whole loan's portfolio buyers during the third quarter and bringing the year-to-date total as of September 30 to almost $900 million. Favorable market conditions have allowed us to become more competitive with bank retail and correspondent channels, and our loan purchase volumes have risen as a result.

Loan purchase commitments, adjusted for fallout increased to $1.6 billion in the third quarter of 2017, up from $1.4 billion and $1.1 billion in the second and first quarters, respectively.

We had strong growth during the third quarter with our Choice program. Adjusted for fallout, Choice accounted for approximately 30% of our total third quarter loan purchase commitments, up from approximately 20% in the second quarter. Rates on Choice loans are currently about 75 to 100 basis point higher than on Select loans.

We still expect overall purchase volumes levels to be in the $5 billion to $6 billion range in 2017, and fourth quarter mortgage banking margins to be in line with our long-term expectations of 75 to 100 basis points. Additionally, we estimate the effective tax rate on our mortgage banking activities will be approximate 25% to 30%.

Turning to the investment portfolio, we were able to aggressively pursue new investments during the quarter, particularly in September when volatility due to hurricane activity drove spreads wider. The bulk of the quarter's capital deployment occurred during this period and includes $63 million in Agency Residential CRT securities, $39 million in Sequoia and third-party RMBS and $17 million in Agency multifamily securities. In total we deployed $119 million of capital into new investments in the third quarter, bringing the year-to-date total to $393 million, a number that includes $37 million of debt repurchases.

We continue to evaluate the potential impact of hurricane activity in Houston and Florida on our investment portfolio, although, it is still very early in the process. The vast majority of our non-Agency loans and securities were not impacted by the storms and to date, we have not incurred any realized losses related to properties in the affected areas.

Although, we did see some impact of pricing, most of our investments had net positive changes in market valuation for the quarter as the benefit from overall spread tightening exceeded any negative impact from the hurricane.

Now to recap our financial results, I'm going to turn over to Collin Cohcrane, Redwood's Chief Financial Officer.

Thanks, Dash, and good afternoon everyone. To summarize our financial results for the third quarter, our GAAP book value increased to $15.67 per share at September 30 from $15.29 per share at June 30, with the increase primarily driven by our quarterly earnings exceeding our dividend and higher fair values on our available-for-sale securities as we saw continued spread tightening on this portfolio. Our GAAP earnings were $0.41 per share for the third quarter compared with $0.43 in the second quarter, and core earnings were $0.35 per share, consistent with the second quarter.

Our results reflect a strong quarter for mortgage banking, offset by less benefit from spread tightening on the fair value of our securities portfolio relative to the second quarter.

The first 3 quarters of this year, our earnings run rate has trended above our annualized 2017 expectation, as strong operating results were bolstered by asset price increases.

Heading into the fourth quarter, we expect that both our investment portfolio and mortgage banking result returns will fall more in line with the return ranges we originally provided with our fourth quarter 2016 results, as a potential for additional spread tightening diminishes.

Turning to the balance sheet, our debt-to-equity leverage ratio was 3.2x at September 30 versus 3.1x at June 30. The modest increase was primarily related to our issuance of new convertible debt in August.

We continue to evaluate our options with respect to our upcoming convertible and exchangeable debt maturities in 2018 and 2019, respectively. However, at current market prices the excess cost to retire our 2018 convertible debt prior to its maturity is unattractive relative to alternative short-term uses of cash.

We also continue to fully utilize our $2 billion of borrowing capacity at our FHLB member subsidiary, which has a weighted average maturity of approximately 8 years and a weighted average interest cost of 1.3%. We seek to fix the interest cost of this debt over its weighted average maturity by using a combination of swaps, TBAs and other derivatives.

One final note to the balance sheet, as Marty and Dash mentioned, we completed our first Choice securitization during the third quarter. For GAAP purposes, we consolidated $317 million of residential loans and $286 million of nonrecoursed ABS debt associated with the $31 million of securities that we retained from this transaction.

Although, we accounted for this Choice securitization differently than our traditional Sequoia Select securitizations, which are treated as sales per GAAP, it did not change the economics or gains that flow through our income statement as a result of the securitization.

And that concludes our prepared remarks. Operator, why don't we start the Q&A?

(Operator Instructions) Our first question will come from Bose George with Keefe, Bruyette, & Woods.

Actually, first just a couple on Redwood Choice. Just given how strong that program seems to be going, can you talk about the potential outlook there for volumes in 2018? I mean, I guess the run rate now is 15% to 20% of total, could we see that pick up next year? And also, just the ROEs on the pieces of the -- those securitizations you have retained?

Sure. Bose, this is Dash. So taking your questions sequentially, you're certainly right that we've seen an increase in the percentage of our portfolio and our locks and purchases of Choice over the past few quarters, and we certainly ascribe that to number of things. Most importantly, our continued efforts in penetration with our sellers. At the moment, 75% or a bit more of our sellers have rolled out the Choice product, and we've locked loans with 90% of that group. And so we're optimistic around the continued trend there. The challenges with predicting the relative mix of Select and Choice of course is, it is subject to the market, and then it's subject to where the overall demand at the borrower level is. But we remain, as Marty said, certainly hardened by the relative mix at this point, but it is difficult to forecast the relative percentage though, we certainly anticipate making continued strides in terms of our penetration with our sellers and continuing to source more Choice loans from them. From a return on equity perspective, using the first deal as a barometer, we were very, very pleased with that execution for a couple of core reasons. First of all, obviously, we did retain a robust amount of securities for our portfolio, meaningfully more than we were in a traditional Sequoia deal, which we mentioned in the prepared remarks. And secondly, and as importantly, we were pleased with the execution on the securities we sold. From an ROE perspective, you can think about that as a high single-digit to low double-digit return levered in terms of what we took back.

Okay, great, that's helpful. And then actually a couple just on the income statement. So just to get to your GAAP EPS, is the interest expense that you're pulling out on the convert, do you just have that number handy?

Yes, let me see if I could find that for you here real quick. I think it's the balance of the (inaudible). Yes, I'm sorry what was that Bose?

Actually I have just another question while you're finding that, but go ahead if you have that number, I'll take that now.

Yes, I think it's about $1 million. I'll double check that, but I think it's about $1 million there.

It's 4.75% there on booked ones.

Sorry, what was the number again?

4.75% over the course of a few months. It was in -- it was a mid-August issuance.

Yes, I think it's about $1.4 million, that's the number.

Okay, great. And then actually, you noted the spread tightening has benefited earnings and you're expecting it to normalize a little next quarter. Do you have just a number for the benefit to EPS from spread tightening this quarter?

Yes, it's about $0.20.

Year-to-date.

Year-to-date, it's about $0.20, Bose.

Our next question will come from Steve Delaney with JMP Securities.

Curious last week was a big week, big moment in mortgage land with the House proposal to limit mortgage interest deductibility. I don't know how that will play out. But curious, any initial reaction there in Mill Valley from seeing that, just your high level thoughts if you're willing to share those, it would be great.

Yes, well, overall for tax reform, we're obviously in the early stages of the process. So it remains to be seen what if anything will ultimately be passed. The base on the current House plan, there are a few provisions that we're focused on, namely the lowered corporate tax rate, the corporate interest expense deduction and then, the changes to the mortgage interest deduction. So obviously, on the corporate tax rate, that's the biggest one. If the rate were to be reduced to 20% that will benefit us in a couple ways. First, in the year of enactment, it would reduce our deferred tax liabilities, and we'd have a pickup from that. And then we'd obviously have a go-forward pick up as our effective tax rate would be reduced from about 34% down to 20%. The second piece that we are focused on here is the corporate interest expense deduction. The framework calls for a certain limits to the net interest expense. And since Redwood is a net creditor, our interest income exceeds the interest expense. And as it's currently drafted, we don't anticipate any limits on our interest expense deduction. And finally, as we focused on the mortgage interest deduction, it seems like there is already been a lot of analysis provided on this in the press. And overall, the consensus seems to be that this will be a modest negative for the housing market and for jumbo loans. However, looks like this is already experiencing a lot of pushback. So we're going to see how things progress and continue to evaluate the impact to the company and to the industry.

Okay, that's helpful, Collin. I guess, when you think about that impact, we'll wait to see the final bill. But my initial reaction was well, your IOs and your MSRs, if people mobility declines because people want to stick with their existing mortgage that might slow your prepays and on those assets, I think that would prove to be a benefit. And I guess, on the other hand, if property values broadly diminishes the result of that, it's good to have 67% LTV. So it didn't strike me that other than maybe some constraints on origination volume in the jumbos, it certainly didn't strike me as being something that would be overly problematic for Redwood. So we'll see how it plays out. We saw last week that Wells announced the launching of your second Choice deal, I think that was last Wednesday. I know you can't comment on deals in the marketplace, generally, but I guess we've seen in both of those deals, I think there was 15% credit enhancement, double which you would have on a Select deal I believe. And just curious looking down the road, the way the market reacted to this first deal, do you think it's possible that, that's going to improve -- first-time issue is always tough as you know. But just curious your thoughts on the [CEE] and where that might go over time?

Steve, it's Chris. It's going to take a period of time for the rating agencies to see enough performance data to really in my opinion move levels. You know that said, we certainly feel like we see levels in the Choice deals more than encompass what the expected losses are from our perspective. I think it was 10%, not 15% by the way. You know as being required to retain risk through some non -- through some non-QM loans in the deals, we're happy to hold larger investments as you know, it's a core tenet of our business. And irrespective of where [CEE] goes, we're happy to retain the investments. And I do think over time, with more performance history on this collateral, you'll see the levels move.

Okay. And for now Chris and -- or Dash, should we be thinking when you give us your long-term, sort of, stated objective of 75 to 100 basis points, should we be -- just -- whether it's Select volume or Choice volume, should we be just consistent that Choice for now but the Choice will be in the same ballpark? I mean, I know the absolute returns are higher about 75 to 100 basis points, but how should we think about the mortgage banking margin?

I think you said it right. We are typically -- when we work on our pricing and things of that nature, we are fairly consistent of trying to be in that range of 75 to 100 basis points for both. Obviously, the last few quarters, we've been in excess of that. But you can think about that as the right range for both products.

Okay, that's great. And could you share the -- your -- this is my final question, your correspondent network. Obviously, that has been built up dramatically over the last 3 years. Love to know the sort of the number -- the number count for your correspondence. And roughly, what percentage of those correspondence are -- have added the Choice product?

Sure. So we have a 187 sellers right now, plus 259 sellers through the MPF program. And as I mentioned, we have been successful in pushing the Choice program out to 3 quarters or a bit more of that group and have been successful in actually locking Choice loans with 90% plus of that about substance.

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.