Redwood Trust(RWT) - 2022 Q3 - Quarterly Report

PART I — FINANCIAL INFORMATION Financial Statements This section presents the unaudited consolidated financial statements for the three and nine months ended September 30, 2022, providing a detailed overview of the company's financial position and performance through various statements and 24 explanatory notes Consolidated Financial Highlights (Unaudited) | Financial Metric | Q3 2022 (in thousands) | Q3 2021 (in thousands) | Nine Months 2022 (in thousands) | Nine Months 2021 (in thousands) | |---|---|---|---|---| | Net Interest Income | $34,935 | $41,968 | $128,525 | $98,351 | | Total Non-interest (Loss) Income, Net | $(37,135) | $98,331 | $(129,359) | $346,993 | | Net (Loss) Income | $(50,411) | $88,286 | $(119,462) | $275,568 | | Diluted (Loss) Earnings per Share | $(0.44) | $0.65 | $(1.04) | $2.03 | Consolidated Balance Sheet Summary (Unaudited) | (In Thousands) | September 30, 2022 | December 31, 2021 | |---|---|---| | Total Assets | $13,145,947 | $14,706,944 | | Total Liabilities | $11,991,705 | $13,320,857 | | Total Equity | $1,154,242 | $1,386,087 | Consolidated Cash Flow Summary (Unaudited) | (In Thousands) | Nine Months Ended Sep 30, 2022 | Nine Months Ended Sep 30, 2021 | |---|---|---| | Net cash used in operating activities | $(129,432) | $(3,780,271) | | Net cash provided by investing activities | $168,959 | $1,363,013 | | Net cash (used in) provided by financing activities | $(201,923) | $2,518,514 | | Net (decrease) increase in cash | $(162,396) | $101,256 | Note 1. Organization Redwood Trust, Inc. operates as a specialty finance REIT, focusing on housing credit through Residential Mortgage Banking, Business Purpose Mortgage Banking, and Investment Portfolio segments, deriving income from net interest and mortgage banking activities - The company operates in three segments: Residential Mortgage Banking, Business Purpose Mortgage Banking, and Investment Portfolio[29] - Primary income is derived from net interest income on investments and non-interest income from mortgage banking activities, which involve originating, acquiring, and then selling or securitizing loans[30] Note 2. Basis of Presentation The unaudited interim financial statements adhere to SEC regulations and GAAP, incorporating significant estimates, particularly for fair value, and detail the consolidation principles for VIEs, including the acquisition of Riverbend Funding, LLC - On July 1, 2022, the company acquired Riverbend Funding LLC for an initial cash payment of approximately $44 million, plus potential earnout consideration[41] Riverbend Acquisition Purchase Price Allocation (July 1, 2022) | (In Thousands) | Amount | |---|---| | Total consideration | $44,603 | | Assets Acquired: | | | Business purpose loans, at fair value | $59,748 | | Goodwill | $23,373 | | Intangible assets | $13,300 | | Other assets | $19,239 | | Total assets acquired | $115,660 | | Liabilities Assumed: | | | Short-term debt, net | $67,423 | | Accrued expenses and other liabilities | $3,634 | | Total liabilities assumed | $71,057 | | Total net assets acquired | $44,603 | - The acquisition of Riverbend resulted in the recognition of $23.4 million in goodwill and $13.3 million in finite-lived intangible assets[43][49] Note 4. Principles of Consolidation This note details the company's GAAP application for consolidating Variable Interest Entities (VIEs), reporting $9.4 billion in total assets and $8.4 billion in liabilities for 64 consolidated VIEs as of September 30, 2022, while also discussing unconsolidated VIEs Assets and Liabilities of Consolidated VIEs (as of Sep 30, 2022) | (In Thousands) | Total Consolidated VIEs | |---|---| | Total Assets | $9,449,163 | | Residential loans, held-for-investment | $4,918,295 | | Business purpose loans, held-for-investment | $3,531,229 | | Consolidated Agency multifamily loans | $427,458 | | Total Liabilities | $8,448,479 | | Asset-backed securities issued | $8,139,293 | | Short-term debt | $233,104 | - The company's maximum loss exposure from its involvement with unconsolidated VIEs, primarily related to retained securities and MSRs, was estimated at $118.5 million as of September 30, 2022[99] Note 5. Fair Value of Financial Instruments This note describes the methodology for determining the fair value of financial instruments using a three-level hierarchy, with many assets and liabilities, particularly Level 3, requiring significant unobservable inputs and management judgment, and provides detailed tables of fair value measurements and market valuation changes Level 3 Assets and Liabilities Measured at Fair Value (Recurring Basis, Sep 30, 2022) | (In Thousands) | Carrying Value | |---|---| | Assets | | | Residential loans | $5,752,524 | | Business purpose loans | $5,257,218 | | Consolidated Agency multifamily loans | $427,458 | | Real estate securities | $259,212 | | HEIs | $340,437 | | Liabilities | | | ABS issued | $7,564,312 | Market Valuation Gains and Losses, Net | (In Thousands) | Three Months Ended Sep 30, 2022 | Nine Months Ended Sep 30, 2022 | |---|---|---| | Mortgage banking activities, net | $6,420 | $(38,877) | | Investment fair value changes, net | $(57,697) | $(151,789) | | Other income | $384 | $7,179 | | Total Market Valuation Gains (Losses), Net | $(50,893) | $(183,487) | Note 14. Short-Term Debt The company utilizes $2.11 billion in short-term debt, including repurchase agreements and loan warehouse facilities, to finance operations, and was in compliance with all related covenants as of September 30, 2022 Short-Term Debt Summary (as of Sep 30, 2022) | Facility Type | Outstanding Balance (in thousands) | Limit (in thousands) | Weighted Avg. Interest Rate | |---|---|---|---| | Residential loan warehouse | $748,962 | $2,850,000 | 4.83% | | Business purpose loan warehouse | $775,491 | $1,750,000 | 5.67% | | Real estate securities repo | $124,435 | N/A | 3.50% | | Servicer advance financing | $233,104 | $290,000 | 4.94% | | Convertible notes, net | $197,585 | N/A | 4.75% | | Total Short-Term Debt | $2,110,279 | | | Note 16. Long-Term Debt This note details the company's $1.53 billion in long-term debt obligations as of September 30, 2022, comprising various recourse and non-recourse financing facilities, convertible senior notes, and trust preferred securities with maturities extending to 2037, including a $215 million issuance in June 2022 - In June 2022, the company issued $215 million principal amount of 7.75% convertible senior notes due 2027, receiving net proceeds of $208 million[295] Long-Term Debt Summary (as of Sep 30, 2022) | Debt Type | Net Carrying Value (in thousands) | Final Maturity | |---|---|---| | Long-Term Debt Facilities | $868,851 | 2024-2026 | | 5.625% convertible senior notes | $148,716 | 2024 | | 5.75% exchangeable senior notes | $169,323 | 2025 | | 7.75% convertible senior notes | $208,581 | 2027 | | Trust preferred securities and subordinated notes | $138,755 | 2037 | | Total Long-Term Debt | $1,534,226 | | Note 17. Commitments and Contingencies This note outlines the company's future financial commitments, including $22 million for operating leases, up to $990 million for bridge loans, and $149 million for HEI acquisitions, alongside contingencies such as a $44 million maximum potential payment under risk-sharing arrangements and reserves for litigation - As of September 30, 2022, the company had commitments to fund up to $990 million of additional advances on existing bridge loans[304] - The company has an aggregate commitment to purchase $350 million of HEIs, with $149 million remaining outstanding as of September 30, 2022[307] - A contingent consideration liability related to the Riverbend acquisition, with a maximum potential payout of $25.3 million, was valued at zero as of September 30, 2022[310] Note 24. Segment Information This note provides a financial breakdown of the company's three operating segments—Residential Mortgage Banking, Business Purpose Mortgage Banking, and Investment Portfolio—all of which reported negative contributions for the nine months ended September 30, 2022, primarily due to significant unrealized mark-to-market losses, with the Investment Portfolio holding the vast majority of assets at $11.3 billion Segment Contribution (Nine Months Ended Sep 30, 2022) | (In Thousands) | Segment Contribution | |---|---| | Residential Mortgage Banking | $(7,371) | | Business Purpose Mortgage Banking | $(27,054) | | Investment Portfolio | $(24,049) | | Corporate/Other | $(60,988) | | Net (Loss) | $(119,462) | Total Assets by Segment (as of Sep 30, 2022) | (In Thousands) | Total Assets | |---|---| | Residential Mortgage Banking | $738,301 | | Business Purpose Mortgage Banking | $473,748 | | Investment Portfolio | $11,301,836 | | Corporate/Other | $632,062 | | Total Assets | $13,145,947 | Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses the company's Q3 2022 GAAP loss driven by mark-to-market adjustments in a volatile interest rate environment, detailing strategic actions, segment performance challenges, liquidity, capital resources, and debt management Overview In Q3 2022, Redwood Trust reported a GAAP loss of $(0.44) per share, with book value declining 5.6% to $10.18 per share, primarily due to unrealized fair value changes, while maintaining strong liquidity and deploying capital through acquisitions and stock repurchases amidst market challenges - GAAP book value per share declined 5.6% quarter-over-quarter to $10.18 at September 30, 2022, driving a GAAP loss of $(0.44) per share for Q3 2022[387] - The company maintained a strong liquidity position with $297 million of unrestricted cash, $491 million of unencumbered assets, and added $900 million of new financing capacity in Q3[388][402] - Key capital deployment in Q3 included the acquisition of Riverbend Funding, LLC and the repurchase of 3.4 million common shares for $24 million[388][402] - Management expects continued challenges in the consumer residential sector due to rapidly increasing mortgage rates and low housing affordability[392] Consolidated Results of Operations For Q3 2022, Redwood reported a net loss of $50.4 million, a sharp reversal from Q3 2021's net income, primarily driven by a $83.8 million negative swing in investment fair value changes and decreased mortgage banking activities, partially offset by reduced general and administrative expenses Consolidated Net (Loss) Income Summary | (In Thousands) | Q3 2022 | Q3 2021 | Change | |---|---|---|---| | Net Interest Income | $34,935 | $41,968 | $(7,033) | | Non-interest (loss) income, net | $(37,135) | $98,331 | $(135,466) | | General and administrative expenses | $(40,107) | $(47,692) | $7,585 | | Net (Loss) Income | $(50,411) | $88,286 | $(138,697) | - The decrease in income from mortgage banking activities was driven by lower volumes and margins in Residential Mortgage Banking and market volatility impacting the Business Purpose Mortgage Banking operations[411][412][413] - Negative investment fair value changes in Q3 2022 reflected extreme credit spread widening on longer-duration, fixed-rate investments, partially offset by gains in IO securities and interest rate hedges[415] Results of Operations by Segment All three operating segments experienced significant year-over-year declines in contribution for Q3 2022, with Residential Mortgage Banking, Business Purpose Mortgage Banking, and the Investment Portfolio reporting losses primarily due to lower volumes, market volatility, and large unrealized mark-to-market losses Segment Contribution Summary (Q3 2022 vs Q3 2021) | (In Thousands) | Q3 2022 | Q3 2021 | Change | |---|---|---|---| | Residential Mortgage Banking | $(640) | $19,406 | $(20,046) | | Business Purpose Mortgage Banking | $(3,856) | $10,837 | $(14,693) | | Investment Portfolio | $(22,404) | $71,085 | $(93,489) | | Corporate/Other | $(23,511) | $(13,042) | $(10,469) | - Residential Mortgage Banking intentionally reduced volume, with jumbo loan locks at $461 million in Q3 2022, down from $3.3 billion in Q3 2021, focusing on risk management in a challenging market[441][445] - Business Purpose Mortgage Banking funded $570 million in loans in Q3 2022, with a notable shift towards bridge loans (83% of volume) over SFR loans (17%) as borrowers preferred shorter-duration products[402][451] - The Investment Portfolio's economic investments grew to $3.6 billion, but its contribution was negative due to unrealized losses from credit spread widening, despite stable underlying credit performance[389][468][470] Liquidity and Capital Resources As of September 30, 2022, Redwood maintained a solid liquidity position with $297 million in unrestricted cash and $160 million of available capital, actively managing its $2.86 billion secured recourse debt, and repurchasing $24 million of common stock, with sufficient cash to meet operational and funding commitments - At September 30, 2022, the company had $297 million in unrestricted cash and an estimated $160 million of available capital[512] - The company had $2.86 billion of secured recourse debt, with only $480 million being marginable, reducing exposure to margin calls based on market value fluctuations[515] - In Q3 2022, the Board approved a new $125 million repurchase authorization for common stock and debt, and the company repurchased 3.4 million shares for $24 million during the quarter[517][518] - Material cash requirements include funding commitments of up to $990 million for bridge loans and $149 million for HEI purchases[529][530][531] Quantitative and Qualitative Disclosures About Market Risk This section incorporates by reference the market risk disclosures from the company's 2021 Annual Report on Form 10-K, indicating no material changes in market risk exposure since December 31, 2021, beyond what is discussed in the MD&A - There have been no material changes in the company's market risk exposure since December 31, 2021, beyond what is discussed in the MD&A section of this report[557] Controls and Procedures Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective at a reasonable assurance level as of Q3 2022, with no material changes to internal control over financial reporting during the quarter - The CEO and CFO concluded that the company's disclosure controls and procedures were effective as of September 30, 2022[559] - No material changes to internal control over financial reporting occurred during the third quarter of 2022[560] PART II — OTHER INFORMATION Legal Proceedings This section refers to Note 17 of the financial statements for information on legal proceedings, indicating no significant updates to litigation matters and an aggregate loss contingency reserve of $2 million as of September 30, 2022 - The aggregate loss contingency reserve for outstanding litigation matters was $2 million as of September 30, 2022[317] Risk Factors This section states that the company's risk factors are discussed in Part I, Item 1A of its Annual Report on Form 10-K for the year ended December 31, 2021, indicating no new or materially changed risk factors are being reported in this 10-Q Unregistered Sales of Equity Securities and Use of Proceeds The company did not sell any unregistered equity securities during Q3 2022, but repurchased 3.4 million common shares for $24 million under a new $125 million authorization approved in July 2022, with $101 million remaining available Common Stock Repurchases (Q3 2022) | Period | Total Shares Purchased (in thousands) | Average Price Paid per Share | Total Cost (in thousands) | |---|---|---|---| | July 2022 | — | $— | $— | | August 2022 | 1,126 | $8.07 | $9,087 | | September 2022 | 2,322 | $6.30 | $14,629 | | Total Q3 | 3,448 | $6.88 | $23,716 | - A new $125 million repurchase authorization for common stock and debt was approved in July 2022, replacing a previous program[565] Other Information Effective November 2, 2022, the Board of Directors adopted Amended and Restated Bylaws to update provisions related to annual stockholder meetings and director nominations, and on November 3, 2022, the company amended and restated employment agreements with five executive officers - The company adopted Amended and Restated Bylaws on November 2, 2022, updating rules for stockholder meetings and director nominations[570] - Amended and restated employment agreements were executed with five key executive officers on November 3, 2022[572]