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Section 1: 8-K (8-K)

Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
  
 
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 OR 15(d) of The Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): May 8, 2019
  
 
REDWOOD TRUST, INC.
(Exact name of registrant as specified in its charter)
 
 
 
 
 
 
Maryland
 
001-13759
 
68-0329422
(State or other jurisdiction
of incorporation)
 
(Commission
File Number)
 
(I.R.S. Employer
Identification No.)
One Belvedere Place
Suite 300
Mill Valley, California 94941
(Address of principal executive offices and Zip Code)
(415) 389-7373
(Registrant’s telephone number, including area code)
Not Applicable
(Former name or former address, if changed since last report)
  
 
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (see General Instruction A.2. below):
o
Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)
o
Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)
o
Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))
o
Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))
Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 or Rule 12b-2 of the Securities Exchange Act of 1934.
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of each exchange on which registered
Common stock, par value $0.01 per share
RWT
New York Stock Exchange






Item 2.02.
Results of Operations and Financial Condition;
 
Item 7.01.
Regulation FD Disclosure.
On May 8, 2019, Redwood Trust, Inc. issued a press release announcing its financial results for the quarter ended March 31, 2019 and The Redwood Review - 1st Quarter 2019, copies of which are attached as Exhibit 99.1 and Exhibit 99.2, respectively, to this current report on Form 8-K.
The information contained in this Item 2.02 and Item 7.01 and the attached Exhibits 99.1 and 99.2 is furnished to and not filed with the Securities and Exchange Commission, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except as shall be expressly set forth by specific reference in such filing.
 
Item 9.01.
Financial Statements and Exhibits.
(d)
 
Exhibits
 
 
Exhibit 99.1
 
Press Release dated May 8, 2019
Exhibit 99.2
 
The Redwood Review – 1st Quarter 2019




SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
 
 
 
Date: May 8, 2019
 
 
REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
By:
 
 /s/ Collin L. Cochrane
 
 
 
 
 
 
 
 
 
 
 
Collin L. Cochrane
 
 
 
 
 
Chief Financial Officer






Exhibit Index
 
 
 
 
 
Exhibit No.
 
Exhibit Title
 
 
 
 
 
Exhibit 99.1
 
 
Exhibit 99.2
 
 
 
 
 
 


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Section 2: EX-99.1 (EXHIBIT 99.1)

Exhibit

Exhibit 99.1

397858350_q119prlogoa01.jpg
    

REDWOOD TRUST REPORTS FIRST QUARTER 2019 FINANCIAL RESULTS

MILL VALLEY, CA Wednesday, May 8, 2019 – Redwood Trust, Inc. (NYSE:RWT), a leading innovator in housing credit investing, today reported its financial results for the quarter ended March 31, 2019.
Key Financial Results
GAAP net income was $54 million, or $0.49 per diluted common share
Non-GAAP core earnings(1) were $38 million, or $0.36 per diluted common share
Book value per common share was $16.00 at March 31, 2019
Economic return on book value(2) of 2.6% for the first quarter of 2019
Recourse debt-to-equity leverage ratio(3) of 2.9x at March 31, 2019

Business Highlights
Deployed $163 million of capital into new investments, a majority of which were proprietary
Purchased $1.0 billion of jumbo loans
Closed two Sequoia securitizations totaling $0.7 billion
Raised $181 million of equity capital in January
Completed the acquisition of the remaining 80% interest in 5 Arches in March
“Our first quarter results reflected both strong operational performance and improved market conditions. We are efficiently deploying our capital into unique investment opportunities that are beginning to scale our platform and drive returns higher,” commented Chris Abate, Chief Executive Officer of Redwood Trust. “We are optimistic about 2019 and remain focused on creating durable, long-term cash flows and optimizing our balance sheet to support a sustainable dividend.”
First Quarter 2019 Redwood Review Available Online
A further discussion of Redwood's business, financial results, core earnings and taxable income, as well as a discussion of management's 2019 outlook, is included in the first quarter 2019 Redwood Review, which is available on the Company’s website at www.redwoodtrust.com.

_____________________
(1)
During the first quarter of 2019, we updated our definition of core earnings. A reconciliation of GAAP net income to non-GAAP core earnings and a reconciliation of GAAP earnings per diluted share to non-GAAP core earnings per diluted share, along with additional information about Redwood’s core earnings measure, is included in the tables that follow.
(2)
Economic return on book value is based on the periodic change in GAAP book value per common share plus dividends declared per common share during the period.
(3)
Recourse debt excludes $5.9 billion of consolidated securitization debt (ABS issued and servicer advance financing) that is non-recourse to Redwood.

1



REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial Performance
 
Three Months Ended
($ in millions, except per share data)
 
3/31/2019
 
12/31/2018
 
3/31/2018
 
 
 
 
 
 
 
GAAP net income (loss)
 
$
54

 
$
(1
)
 
$
47

GAAP net income (loss) per diluted common share
 
$
0.49

 
$
(0.02
)
 
$
0.50

 
 
 
 
 
 
 
Non-GAAP core earnings
 
$
38

 
$
40

 
$
58

Non-GAAP core earnings per diluted common share
 
$
0.36

 
$
0.41

 
$
0.60

 
 
 
 
 
 
 
REIT taxable income (estimated)
 
$
29

 
$
27

 
$
33

REIT taxable income per share (estimated)
 
$
0.30

 
$
0.32

 
$
0.44

 
 
 
 
 
 
 
GAAP book value per share
 
$
16.00

 
$
15.89

 
$
16.12

Dividends per common share
 
$
0.30

 
$
0.30

 
$
0.28

Economic return on book value
 
2.6
%
 
(1.4
)%
 
3.6
%
Recourse debt-to-equity leverage ratio (1)
 
2.9x

 
3.5x

 
3.4x

 
 
 
 
 
 
 
Capital deployment
 
$
163

 
$
235

 
$
108

Jumbo loans purchased
 
$
1,022

 
$
1,563

 
$
1,815

Jumbo loans securitized or sold
 
$
833

 
$
1,290

 
$
1,595

(1)
Recourse debt excludes $5.9 billion, $5.7 billion, and $1.5 billion of consolidated securitization debt (ABS issued and servicer advance financing) that is non-recourse to Redwood at March 31, 2019, December 31, 2018, and March 31, 2018, respectively.
Conference Call and Webcast
Redwood will host an earnings call today, May 8, 2019, at 2:00 p.m. Pacific Time / 5:00 p.m. Eastern Time to discuss its first quarter 2019 financial results. The number to dial in order to listen to the conference call is 1-866-548-4713 in the U.S. and Canada. International callers must dial 1-323-794-2093. Callers should reference call ID #3022803. A replay of the call will be available through midnight on May 22, 2019, and can be accessed by dialing 1-844-512-2921 in the U.S. and Canada or 1-412-317-6671 internationally and entering access code #3022803.
The live conference call will also be webcast in listen-only mode in the Newsroom section of Redwood’s website under "Events." To listen to the webcast, please go to Redwood's website at least 15 minutes prior to the call to register and download and install any needed audio software. An audio replay of the call will also be available on Redwood's website following the call. Redwood plans to file its Quarterly Report on Form 10-Q with the Securities and Exchange Commission by Friday, May 10, 2019, and also make it available on Redwood’s website.
About Redwood Trust
Redwood Trust, Inc. (NYSE: RWT) is a specialty finance company focused on making credit-sensitive investments in residential mortgages and related assets and engaging in mortgage banking activities. Our goal is to provide attractive returns to shareholders through a stable and growing stream of earnings and dividends, as well as through capital appreciation. Redwood Trust was established in 1994, is internally managed, and structured as a real estate investment trust (“REIT”) for tax purposes. For more information about Redwood, please visit our website at www.redwoodtrust.com.

Forward-Looking Statements:  This press release and the related conference call contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including statements related to estimates of 2019 REIT taxable income and the expected timing for the filing of Redwood's Quarterly Report on Form 10-Q. Forward-looking statements involve numerous risks and uncertainties. Redwood's actual results may differ from Redwood's beliefs, expectations, estimates, and projections and, consequently, you should not rely on these forward-looking statements as predictions of future events. Forward-looking statements are not historical in nature and can be identified by words such as “anticipate,” “estimate,” “will,” “should,” “expect,” “believe,” “intend,” “seek,” “plan” and similar expressions or their negative forms, or by references to strategy, plans, or intentions. These forward-looking statements are subject to risks and uncertainties, including, among other things, those described in our Annual Report on Form 10-K under the caption “Risk Factors.” Other risks, uncertainties, and factors that could cause actual results to differ materially from those projected may be described from time to time in reports we file with the Securities and Exchange Commission, including reports on Forms 10-Q and 8-K. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

2



REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Income Statements (1)
 
Three Months Ended
($ in millions, except share and per share data)
 
3/31/19
 
12/31/18
 
9/30/18
 
6/30/18
 
3/31/18
 
 
 
 
 
 
 
 
 
 
 
Interest income
 
$
131

 
$
120

 
$
99

 
$
83

 
$
77

Interest expense
 
(99
)
 
(85
)
 
(64
)
 
(48
)
 
(42
)
Net interest income
 
32

 
35

 
35

 
35

 
35

Non-interest income
 
 
 
 
 
 
 
 
 
 
Mortgage banking activities, net
 
12

 
11

 
11

 
11

 
27

Investment fair value changes, net
 
20

 
(39
)
 
10

 
1

 
2

Other income, net
 
4

 
4

 
3

 
3

 
2

Realized gains, net
 
11

 
6

 
7

 
5

 
9

Total non-interest income (loss), net
 
47

 
(18
)
 
32

 
20

 
40

Operating expenses
 
(23
)
 
(19
)
 
(21
)
 
(19
)
 
(23
)
(Provision for) benefit from income taxes
 
(1
)
 
1

 
(5
)
 
(3
)
 
(5
)
Net income (loss)
 
$
54

 
$
(1
)
 
$
41

 
$
33

 
$
47

 
 
 
 
 
 
 
 
 
 
 
Weighted average diluted shares (thousands) (2)
 
126,278

 
83,217

 
114,683

 
100,432

 
108,195

Diluted earnings (loss) per common share
 
$
0.49

 
$
(0.02
)
 
$
0.42

 
$
0.38

 
$
0.50

Regular dividends declared per common share
 
$
0.30

 
$
0.30

 
$
0.30

 
$
0.30

 
$
0.28

 
 
 
 
 
 
 
 
 
 
 
(1)
Certain totals may not foot due to rounding.
(2)
In the periods presented above, excluding the fourth quarter of 2018, weighted average diluted shares included shares from the assumed conversion of our convertible and/or exchangeable debt in accordance with GAAP diluted EPS provisions. Actual shares outstanding at March 31, 2019, December 31, 2018, September 30, 2018, June 30, 2018, and March 31, 2018 were 96,866, 84,884, 82,930, 75,743, and 75,703, respectively.











3



REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reconciliation of GAAP Net Income to
Non-GAAP Core Earnings
 (1) (2)
Three Months Ended
($ in millions, except per share data)
3/31/19
 
12/31/18
 
3/31/18
 
 
 
 
 
 
GAAP net income (loss)
$
54

 
$
(1
)
 
$
47

Adjustments:
 
 
 
 
 
Eliminate mark-to-market changes on long-term investments and associated derivatives (3)
(16
)
 
40

 
(7
)
Include cumulative gain on long-term investments sold, net (4)
1

 
4

 
18

Eliminate purchase accounting adjustments (5)
(2
)
 

 

Income taxes associated with core earnings adjustments (6)
(1
)
 
(2
)
 

Total adjustments
(16
)
 
41

 
11

Non-GAAP core earnings
$
38

 
$
40

 
$
58

 
 
 
 
 
 
GAAP net income per diluted common share
$
0.49

 
$
(0.02
)
 
$
0.50

Non-GAAP core earnings per diluted common share (7)
$
0.36

 
$
0.41

 
$
0.60

 
 
 
 
 
 
(1)
Certain totals may not foot due to rounding.
(2)
Core earnings is a non-GAAP measure of Redwood’s earnings and results of operations. Specifically, management has defined core earnings as: GAAP net income adjusted to (i) eliminate the impact of quarterly mark-to-market changes on the fair value of long-term investments (and associated derivatives) related to changes in benchmark interest rates and credit spreads, (ii) include the cumulative net gains or losses on long-term investments accounted for as trading securities under GAAP that were sold during the period presented, net of any gains or losses from derivatives associated with the investments sold, (iii) exclude certain items related to Redwood's acquisition of 5 Arches (as described in footnote 5 below) and (iv) include the hypothetical income taxes associated with core earnings adjustments.
Management utilizes this core earnings measure internally as one way of analyzing Redwood’s performance over multiple periods, as it believes it provides useful comparative results absent the impact of certain quarterly mark-to-market changes and other items that management believes are not reflective of core results. Core earnings should not be utilized in isolation, nor should it be considered as an alternative to GAAP net income or other measurements of results of operations computed in accordance with GAAP. A further discussion of core earnings is included in the first quarter Redwood Review.
(3)
Adjustments eliminate the mark-to-market changes on the fair value of loans held-for-investment, trading securities, other investments, and associated derivatives that are primarily related to changes in benchmark interest rates and credit spreads. Beginning with the first quarter of 2019, management has updated its calculation of this adjustment for certain investments accounted for under the fair value option that have significant differences between expected cash interest and expected yield-to-maturity. For consistency of presentation, core earnings for the first and fourth quarters of 2018 has been updated to reflect the impact of this change during those quarters. Details regarding the change in calculation of this adjustment and the components of investment fair value changes, net, are included in the Appendix of the first quarter 2019 Redwood Review.
(4)
Adjustment includes the cumulative net gains or losses on long-term investments accounted for as trading securities under GAAP that were sold during the period presented, net of any realized gains or losses from derivatives associated with the investments sold. Cumulative gains and losses are calculated by multiplying the difference between the sales price and original purchase price by the face value of the securities sold.
(5)
Beginning with the first quarter of 2019, core earnings excludes several items related to the acquisition of 5 Arches. These items include the exclusion of a one-time gain associated with the re-measurement of our initial minority investment and purchase option in 5 Arches, as well as ongoing adjustments to exclude amortization of intangible assets and, in future quarters, changes in fair value of the contingent consideration liability related to the remaining purchase consideration for the platform. Additional information regarding this adjustment is included in the Appendix to the first quarter 2019 Redwood Review.
(6)
We apply estimated effective tax rates to core earnings adjustments occurring within Redwood's taxable REIT subsidiaries to estimate the hypothetical income tax expense or benefit associated with those adjustments.
(7)
Additional information on the calculation of non-GAAP core diluted EPS can be found in Table 2 in the Financial Tables section of the Redwood Reviews for the respective quarters presented.

4



REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Balance Sheets (1)
 
 
 
 
 
 
 
 
 
 
 
($ in millions, except share and per share data)
 
3/31/19
 
12/31/18
 
9/30/18
 
6/30/18
 
3/31/18
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential loans
 
$
7,274

 
$
7,255

 
$
5,922

 
$
5,491

 
$
5,146

 
Business purpose loans
 
161

 
141

 
116

 

 

 
Multifamily loans
 
2,176

 
2,145

 
942

 

 

 
Real estate securities
 
1,543

 
1,452

 
1,470

 
1,454

 
1,358

 
Other investments
 
414

 
439

 
114

 
117

 
66

 
Cash and cash equivalents
 
201

 
176

 
174

 
185

 
179

 
Other assets
 
424

 
330

 
402

 
266

 
251

 
Total assets
 
$
12,193

 
$
11,937

 
$
9,140

 
$
7,513

 
$
7,000

 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term debt
 
$
2,163

 
$
2,400

 
$
1,424

 
$
1,426

 
$
1,504

 
Other liabilities
 
270

 
206

 
176

 
157

 
157

 
Asset-backed securities issued
 
5,638

 
5,410

 
3,407

 
1,930

 
1,542

 
Long-term debt, net
 
2,573

 
2,572

 
2,771

 
2,770

 
2,576

 
Total liabilities
 
10,643

 
10,589

 
7,778

 
6,284

 
5,780

 
 
 
 
 
 
 
 
 
 
 
 
 
Stockholders' equity
 
1,550

 
1,349

 
1,361

 
1,229

 
1,220

 
 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and equity
 
$
12,193

 
$
11,937

 
$
9,140

 
$
7,513

 
$
7,000

 
 
 
 
 
 
 
 
 
 
 
 
 
Shares outstanding at period end (thousands)
 
96,866

 
84,884

 
82,930

 
75,743

 
75,703

 
GAAP book value per share
 
$
16.00

 
$
15.89

 
$
16.42

 
$
16.23

 
$
16.12

 
 
 
 
 
 
 
 
 
 
 
 
 
(1)
Certain totals may not foot due to rounding.




CONTACTS
Lisa M. Hartman
SVP, Head of Investor Relations
Phone: 866-269-4976
Email: investorrelations@redwoodtrust.com

5
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Section 3: EX-99.2 (EXHIBIT 99.2)

Exhibit


Exhibit 99.2

397858350_q12019outsidefrontcovera001.jpg


 
  T A B L E O F C O N T E N T S


Introduction
 
 
Shareholder Letter
 
 
Quarterly Overview
 
 
Ñ First Quarter Highlights
 
 
Ñ Quarterly Earnings and Analysis
 
 
Ñ 5 Arches Acquisition
 
 
Ñ Segment Results
 
 
Ñ Book Value
 
 
Ñ Capital Allocations
 
 
Ñ 2019 Updated Financial Outlook
 
 
Financial Insights
 
 
Ñ Balance Sheet Analysis
 
 
Financial Tables
 
 
Appendix
 
 
Ñ Dividends
 
 
Ñ Non-GAAP Measurements
 
 
Ñ Forward-Looking Statements


 
THE REDWOOD REVIEW I 1ST QUARTER 2019
1

 
F O R W A R D - L O O K I N G S T A T E M E N T S

This Redwood Review contains forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve numerous risks and uncertainties. Our actual results may differ from our expectations, estimates, and projections and, consequently, you should not rely on these forward-looking statements as predictions of future events. Forward-looking statements are not historical in nature and can be identified by words such as “anticipate,” “estimate,” “will,” “should,” “expect,” “believe,” “intend,” “seek,” “plan,” and similar expressions or their negative forms, or by references to strategy, plans, goals, or intentions. These forward-looking statements are subject to risks and uncertainties, including, among other things, those described in our Annual Report on Form 10-K under the caption “Risk Factors.” Other risks, uncertainties, and factors that could cause actual results to differ materially from those projected are described below and may be described from time to time in reports we file with the Securities and Exchange Commission, including reports on Forms 10-K, 10-Q, and 8-K. We undertake no obligation to update or revise forward-looking statements, whether as a result of new information, future events, or otherwise.
Statements regarding the following subjects, among others, are forward-looking by their nature: statements we make regarding Redwood’s business strategy and strategic focus, statements related to our financial outlook and expectations for 2019, statements regarding our available capital and sourcing additional capital both internally and from the capital markets, and other statements regarding pending business activities and expectations and estimates relating to our business and financial results. Additional detail regarding the forward-looking statements in this Redwood Review and the important factors that may affect our actual results in 2019 are described in the Appendix of this Redwood Review under the heading “Forward-Looking Statements.”



 
THE REDWOOD REVIEW I 1ST QUARTER 2019
2

 
I N T R O D U C T I O N

Note to Readers:

We file annual reports (on Form 10-K) and quarterly reports (on Form 10-Q) with the Securities and Exchange Commission. These filings and our earnings press releases provide information about Redwood and our financial results in accordance with generally accepted accounting principles (GAAP). These documents, as well as information about our business and a glossary of terms we use in this and other publications, are available through our website, www.redwoodtrust.com. We encourage you to review these documents.
References herein to “Redwood,” the “company,” “we,” “us,” and “our” include Redwood Trust, Inc. and its consolidated subsidiaries. Note that because we round numbers in the tables to millions, except per share amounts, some numbers may not foot due to rounding. References to the “first quarter” refer to the quarter ended March 31, 2019, and references to the “fourth quarter” refer to the quarter ended December 31, 2018, unless otherwise specified.
We hope you find this Review helpful to your understanding of our business. We thank you for your input and suggestions, which have resulted in our changing the form and content of The Redwood Review over time.
 
Selected Financial Highlights
 
 
Quarter:Year
 
GAAP Income
(Loss) per Share
 
Non-GAAP Core Earnings per Share (1)
 
REIT Taxable
Income per
Share
(2)
 
Annualized
GAAP Return
on Equity
 
GAAP Book
Value per
Share
 
Dividends
per Share
 
Economic Return on Book Value (3)
 
Q119
 
$0.49
 
$0.36
 
$0.30
 
15%
 
$16.00
 
$0.30
 
2.6%
 
Q418
 
$(0.02)
 
$0.41
 
$0.32
 
—%
 
$15.89
 
$0.30
 
(1.4)%
 
Q318
 
$0.42
 
$0.39
 
$0.27
 
12%
 
$16.42
 
$0.30
 
3.0%
 
Q218
 
$0.38
 
$0.42
 
$0.35
 
11%
 
$16.23
 
$0.30
 
2.5%
 
Q118
 
$0.50
 
$0.60
 
$0.44
 
15%
 
$16.12
 
$0.28
 
3.6%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1)
During the first quarter of 2019, we updated our definition of core earnings. Prior period amounts presented above have been conformed. Additional information on non-GAAP core earnings per share, including a definition and reconciliation to GAAP earnings per share, is included in the Non-GAAP Measurements section of the Appendix and Table 2 in the Financial Tables section.
(2)
REIT taxable income per share for 2018 and 2019 are estimates until we file our tax returns.
(3)
Economic return on book value is based on the periodic change in GAAP book value per common share plus dividends declared per common share during the period.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
3

 
S H A R E H O L D E R L E T T E R

Dear Fellow Shareholders:
Never count out the mortgage business. With interest rates hitting multi-year highs in 2018 and refinance activity all but gone from the market, the industry began 2019 largely focused on the next shoe to drop. But as quickly as the reckoning began, revised signaling from the Federal Reserve drove benchmarks - and mortgage rates - precipitously lower. At its low point during the first quarter, the 10-year yield dipped below the 3-month yield on Treasury bills and stood close to 90 basis points below its level in early November.
While the inverted yield curve fueled recession talk, we view current market sentiment as markedly improved versus the fourth quarter. The much-anticipated corporate earnings season yielded strong results, and the IPO market has seen its busiest calendar in recent memory. Closer to home, lower mortgage rates coinciding with the spring selling season have provided a much-needed boost to the housing market.
That said, all is not solved. The industry suffers from excess mortgage origination capacity, and substantial unmet demand from households seeking an affordable place to rent or own. This creates opportunity but also the need to continue thoughtfully calibrating our investment and operating approach.
Our first quarter 2019 results reflected both strong operational performance and improved market conditions, collectively driving a resurgence in our GAAP financial results. GAAP earnings were $0.49 per share for the first quarter, as compared with a loss of $0.02 per share in the fourth quarter of 2018. Non-GAAP core earnings were $0.36 per share for the first quarter, as compared with $0.41 per share in the fourth quarter. Our GAAP book value increased to $16.00 per share at March 31, 2019, as compared to $15.89 per share at December 31, 2018.
We raised $184 million of new equity capital in the first quarter and deployed $163 million, ending the quarter with approximately $100 million of capital available for investment. Investment activity in the first quarter - often a more uneven period for deployment coming off a heavy year-end calendar - was down slightly from our recent pace, but up over 50% from the first quarter of 2018. While we are still in the early stages of execution, this increase in capital deployment has begun to drive returns higher and scale our platform - both key strategic initiatives. Details on our first quarter investment activity can be found in the Segment Results section of this Redwood Review.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
4

 
S H A R E H O L D E R L E T T E R

As we evaluate the return profiles on our investments, our focus remains on creating durable, long-term cash flows and optimizing our balance sheet to support a sustainable higher dividend. The biggest driver of returns in our portfolio is credit performance, which remained strong in the first quarter. Our recent investments are, by design, highly structured and differentiated; and thanks to the recent increased pace of deployment, many are relatively unseasoned with long projected lifespans. Collectively, our portfolio construction is driving towards a mix of strong near-term returns, complemented by deeper-discount securities with earnings upside if credit performance meets or exceeds modeled expectations.
The completion of the 5 Arches acquisition has kept us busy, as work is underway to fully integrate the new platform. We continue to build our pipeline of single-family rental loans, and are beginning to reap the benefits of a consistent market presence in the form of repeat borrowers and more bespoke investment opportunities. Additionally, we expect to begin deploying incremental capital into the short-term bridge products that the platform produces, while continuing to monitor overall market demand for these loans. The financing market for bridge loans remains favorable, and we are utilizing structures that we expect will positively impact net margins. First quarter origination volume for the platform was lower than in the fourth quarter, driven in part by a portion of the pipeline pulling forward into the second quarter. With the transaction now closed, we will report separately on 5 Arches’ operating performance beginning with this Review.
Turning to our residential mortgage banking operations, volumes remained under pressure in the first quarter - partly a function of seasonality - but gross margins were quite strong as securitization markets found their footing and demand from whole-loan buyers remained robust. We completed one Select and Choice transaction apiece during the quarter, along with significant whole loan sale activity, which represented 41% of our total distribution. Redwood Choice remains an important contributor to earnings and accounted for 44% of locked loans during the first quarter. Gross margins for Choice loans were materially higher than those of our traditional Select loans as we achieved particularly strong execution on our Choice securitization.
We continued making progress towards managing our residential mortgage banking operations more efficiently by increasing asset turnover, which allows us to free up capital for reinvestment. Our goal remains to continue managing our capital down from an average of approximately $200 million last year, and we remain on track to do so.
As we work to optimize our platforms and plan for the future, we are closely monitoring the potential for regulatory reform and how we should position Redwood to capitalize on any resulting opportunities. Recently, Mark Calabria was confirmed as the new Director of the Federal Housing Finance Agency, and the Trump Administration directed both Treasury and HUD to develop and submit housing finance reform plans as soon as practicable. We expect the plans will likely identify reform measures that can be implemented through both administrative and legislative means, but note that there continues to be little bi-partisan support for finding a permanent solution for the conservatorship of Fannie Mae and Freddie Mac.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
5

 
S H A R E H O L D E R L E T T E R

In the near term, it’s more likely that change will come from administrative actions that have emphasized a greater role for the private sector, such as building on the success of GSE risk-sharing transactions. We believe we are ideally positioned to take advantage of any reforms that promote a leveling of the playing field between the public and private sectors. From our vantage point as a seasoned private-label RMBS issuer, private market participants are willing and able to step up with capital. That said, affirmative signals must be sent by Washington that investment in the infrastructure and staff necessary to participate in private-label transactions will not be undermined by policies aimed at crowding out private capital. We note that for the first time in many years, the private markets are speaking for an increasing share of loans that are eligible for sale to the GSEs, and we believe they can speak for more without a meaningful impact on rates available to borrowers.
Overall, we exited the first quarter more optimistic about 2019 than we began it. Our second quarter loan purchase activity is on pace to meaningfully exceed the first quarter’s, and we expect the pace of capital deployment to increase over the course of 2019, driven in part by access to 5 Arches’ origination pipeline. In funding the growth of our asset base, our strong focus is on utilizing our available capital, while continuing to generate capital through security sales and financing structures that optimize our balance sheet.
Thank you for your support.



397858350_q119ceosignature.jpg
 
397858350_q119presidentsignature.jpg
Christopher J. Abate
 
Dashiell I. Robinson
Chief Executive Officer
 
President

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
6

 
Q U A R T E R L Y O V E R V I E W

First Quarter Highlights
 
Key Financial Results and Metrics
($ in millions, except per share data)
 
 
Three Months Ended
 
 
3/31/2019
 
12/31/2018
 
 
 
 
 
 
GAAP Earnings (Loss) per Share
$
0.49

 
$
(0.02
)
 
Non-GAAP Core Earnings per Share (1)
$
0.36

 
$
0.41

 
 
 
 
 
 
Book Value per Share
$
16.00

 
$
15.89

 
Economic Return on Book Value (2)
2.6
%
 
(1.4
)%
 
Recourse Leverage (3)
2.9x

 
3.5x

 
 
 
 
 
 
Portfolio Capital Deployment
$
163

 
$
235

 
Residential Loan Purchase Commitments
$
1,199

 
$
1,252

 
 
 
 
 
 
Ñ
GAAP earnings per share increased in the first quarter, as spreads tightened and asset prices improved, recovering a significant portion of the market valuation losses we incurred in the fourth quarter from spread widening.
Ñ
Core earnings per share declined quarter-over-quarter, primarily due to higher variable compensation expense, which normalized in the first quarter after GAAP losses caused a significant decline in the fourth quarter. Mortgage banking produced solid results in the first quarter as consistent lock volume was supported by strong gross margins. Portfolio economic net interest income increased overall, though on a per share basis declined due to partial deployment of the proceeds from our recent capital raise.
Ñ
On March 1, 2019, we completed our purchase of the remainder of 5 Arches. The impact in the first quarter from the acquisition and one month of operations was approximately $0.02 per share to GAAP earnings and approximately zero impact to core earnings.
Ñ
Book value per share increased 0.7% during the quarter, as the benefit from spread tightening and strong GAAP earnings was offset by a decrease in the value of long-term debt hedges, the impact of stock-based compensation distributions, and dilution from our January common stock issuance.
Ñ
Recourse leverage declined in the first quarter as a result of our issuance of $181 million of common stock in January and a lower balance of loans held-for-sale that were financed.
_____________________
(1) During the first quarter of 2019, we updated our definition of core earnings. Prior period amounts presented above have been conformed. For details on GAAP earnings and non-GAAP core earnings, see the Quarterly Earnings and Analysis section that follows on page 8 and the Non-GAAP Measurements section of the Appendix.
(2) Economic return on book value is based on the periodic change in GAAP book value per common share plus dividends declared per common share during the period.
(3)
See Table 7 in the Financial Tables section of this Redwood Review for details of how our recourse debt to equity leverage ratio is calculated.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
7

 
Q U A R T E R L Y O V E R V I E W

Quarterly Earnings and Analysis
Below we present GAAP net income and non-GAAP core earnings for the first quarter of 2019 and fourth quarter of 2018.
 
GAAP Net Income
($ in millions, except per share data)
 
Three Months Ended
 
 
3/31/2019
 
12/31/2018
 
 
 
 
 
 
Interest income
$
131

 
$
120

 
Interest expense
(99
)
 
(85
)
 
Net interest income
32

 
35

 
 
 
 
 
 
Non-interest income
 
 
 
 
Mortgage banking activities, net
12

 
11

 
Investment fair value changes, net
20

 
(39
)
 
Other income, net
4

 
4

 
Realized gains, net
11

 
6

 
Total non-interest income (loss), net
47

 
(18
)
 
Operating expenses
(23
)
 
(19
)
 
(Provision for) benefit from income taxes
(1
)
 
1

 
 
 
 
 
 
GAAP net income (loss)
$
54

 
$
(1
)
 
 
 
 
 
 
GAAP diluted earnings per common share
$
0.49

 
$
(0.02
)
 
 
 
 
 
 
 
Non-GAAP Core Earnings (1)
($ in millions, except per share data)
 
Three Months Ended
 
 
3/31/2019
 
12/31/2018
 
 
 
 
 
 
GAAP net interest income
$
32

 
$
35

 
Change in basis and hedge expense
4

 
1

 
Non-GAAP economic net interest income (1)
36

 
36

 
 
 
 
 
 
Non-interest income
 
 
 
 
Mortgage banking activities, net
12

 
11

 
Core other fair value changes, net (1)

 

 
Core other income, net (1)
2

 
4

 
Core realized gains, net (1)
12

 
9

 
Total non-interest income, net
26

 
25

 
Operating expenses
(23
)
 
(19
)
 
Core provision for income taxes (1)
(1
)
 
(1
)
 
 
 
 
 
 
Core earnings (1)
$
38

 
$
40

 
 
 
 
 
 
Core diluted earnings per common share (2)
$
0.36

 
$
0.41

 
(1)
During the first quarter of 2019, we updated our definition of core earnings. Prior period amounts presented above have been conformed. Additional information on Redwood's non-GAAP measures, including: economic net interest income; core other fair value changes, net; core other income, net; core realized gains, net; core provision for income taxes; and core earnings as well as reconciliations to associated GAAP measures, is included in the Non-GAAP Measurements section of the Appendix.
(2)
Additional information on the calculation of non-GAAP core diluted EPS can be found in Table 2 in the Financial Tables section of this Redwood Review.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
8

 
Q U A R T E R L Y O V E R V I E W

Ñ
GAAP net interest income decreased from the fourth quarter of 2018, primarily due to the reduction in income from available-for-sale securities due to sales and paydowns in the first quarter. The proceeds from these sales were reinvested into fair value securities, which benefited our GAAP income through a combination of net interest income and investment fair value changes, net.
Ñ
Non-GAAP economic net interest income remained flat quarter-over quarter, as an increase from our investment portfolio from recent capital deployment was partially offset by a slight decrease from mortgage banking operations.
Ñ
Mortgage banking activities, net, increased to $12 million for the first quarter of 2019, from $11 million for the fourth quarter of 2018. First quarter mortgage banking results included $1 million of income from business purpose loan originations by 5 Arches. Loan purchase commitments and gross margins from our residential mortgage banking operations remained fairly consistent quarter-over-quarter, with higher than average margins supported by improved securitization execution during the first quarter of 2019.
Ñ
Investment fair value changes in our securities portfolio were positively impacted by tightening credit spreads during the first quarter of 2019, helping us to recover a significant portion of the fair value decline these investments experienced in the fourth quarter from spread widening. Our non-GAAP core earnings excludes these market valuation adjustments and were not impacted by these changes.
Ñ
Other income, net for GAAP purposes includes a $2 million benefit related to a re-measurement gain associated with our purchase of 5 Arches and $0.6 million of amortization of purchased intangible assets. Non-GAAP core earnings excludes these amounts. The remaining amounts included in core earnings decreased primarily due to lower MSR income during the first quarter of 2019.
Ñ
Realized gains in the first quarter were $11 million on a GAAP basis and $12 million on a non-GAAP core basis, resulting from the sale of $74 million of securities and the call of a seasoned Sequoia securitization. After the repayment of associated debt, the security sales freed up $33 million of capital for reinvestment.
Ñ
Operating expenses increased to $23 million in the first quarter of 2019 from $19 million in the fourth quarter of 2018, primarily resulting from higher variable compensation expense commensurate with higher GAAP earnings in the first quarter. Our first quarter operating expenses also included $2 million of operating expenses related to the 5 Arches platform.
Ñ
Income taxes increased to a provision of $1 million during the first quarter of 2019, from a benefit of $1 million in the fourth quarter of 2018, primarily due to higher GAAP income during the first quarter driven by spread tightening on securities held at our taxable subsidiary. A reconciliation of GAAP and taxable income is set forth in Table 6 in the Financial Tables section of this Redwood Review.
Ñ
Additional details on our earnings are included in the Segment Results section that follows.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
9

 
Q U A R T E R L Y O V E R V I E W

5 Arches Acquisition
On March 1st, we purchased the remaining 80% of 5 Arches. At closing, we paid $13 million of cash and the remainder of the consideration, which could total up to an additional $27 million, will be paid in a mix of cash and stock and is contingent on the achievement of certain performance thresholds over the next two years. Below we present the impact to our consolidated GAAP net income from the acquisition of 5 Arches for the three months ended March 31, 2019:
 
5 Arches Impact to GAAP Net Income
($ in millions)
 
5 Arches
Other
Redwood
 
 
Redwood
Total
 
 
 
 
 
 
 
 
Net interest income
$

$
32

 
 
$
32

 
 
 
 
 
 
 
 
Non-interest income
 
 
 
 
 
 
Mortgage banking activities, net
1

12

 
 
12

 
Investment fair value changes, net

20

 
 
20

 
Other income, net
2

1

 
 
4

 
Realized gains, net

11

 
 
11

 
Total non-interest income, net
3

44

 
 
47

 
Operating expenses
(2
)
(21
)
 
 
(23
)
 
(Provision for) benefit from income taxes
2

(3
)
 
 
(1
)
 
 
 
 
 
 
 
 
GAAP net income
$
3

$
51

 
 
$
54

 
Ñ
Income and expenses associated with 5 Arches loan originations and asset management activities are included in our mortgage banking segment. This segment also includes the amortization of intangible assets related to the purchase of 5 Arches, which is included in Other income, net from 5 Arches above. The $0.6 million expense recognized in the first quarter represents one month of amortization, and we anticipate a similar amount per month for the remainder of the year.
Ñ
Other income, net from 5 Arches above also includes a $2 million gain associated with the re-measurement of our initial minority investment and purchase option in 5 Arches. This gain is included in "Corporate/Other" for segment reporting purposes.
Ñ
Income taxes from 5 Arches above includes $2 million of benefit resulting primarily from purchase accounting.
Ñ
On a non-GAAP core earnings basis, we excluded the amortization of intangible assets as well as the re-measurement gain associated with the purchase of 5 Arches (and associated income tax effects). Additionally, our contingent consideration is classified as a liability, and will be marked-to-market each quarter going forward through GAAP income, and will also be excluded from core earnings.
Ñ
In addition to our income statement, our balance sheet at March 31, 2019 reflects the impact of this acquisition and includes $29 million of goodwill, $24 million of intangible assets, $25 million of contingent consideration liabilities, and $4 million of deferred tax liabilities.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
10

 
Q U A R T E R L Y O V E R V I E W

Segment Results *
Investment Portfolio
The following table presents segment contribution from our investment portfolio for the first quarter of 2019 and fourth quarter of 2018.
 
Investment Portfolio Segment Contribution
($ in millions)
 
Three Months Ended
 
 
3/31/2019
 
12/31/2018
 
 
 
 
 
 
GAAP net interest income
$
38

 
$
40

 
Change in basis and hedge expense
4

 
1

 
Non-GAAP economic net interest income (1)
42

 
41

 
 
 
 
 
 
Non-GAAP other fair value changes, net (2)
16

 
(40
)
 
Other income, net
1

 
4

 
Realized gains, net
11

 
6

 
Operating expenses
(3
)
 
(4
)
 
Provision for income taxes

 
1

 
Segment contribution (3)
$
67

 
$
9

 
Core earnings adjustments (4)
 
 
 
 
Eliminate non-GAAP other fair value changes, net (2)
(16
)
 
40

 
Include cumulative gain on long-term investments sold, net
1

 
4

 
Income taxes associated with core earnings adjustments
1

 
(2
)
 
Non-GAAP core segment contribution
$
54

 
$
49

 
(1)
Consistent with management's definition of non-GAAP economic net interest income set forth in the Non-GAAP Measurements section of the Appendix, this measure, as presented above, is calculated in the same manner, inclusive only of amounts allocable to this segment.
(2)
Non-GAAP other fair value changes, net, represents GAAP investment fair value changes adjusted to exclude the change in basis and hedge expense that is presented in the table above and included in non-GAAP economic net interest income.
(3)
Segment contribution totals above are presented in accordance with GAAP. Within the table, "change in basis and hedge expense" has been reallocated between investment fair value changes and net interest income as described above.
(4)
Consistent with management's definition of core earnings set forth on page 39, non-GAAP core segment contribution reflects GAAP segment contribution adjusted to reflect the portion of core earnings adjustments allocable to this segment.
Ñ
Segment contribution from our investment portfolio improved during the first quarter, as the increase in non-GAAP economic net interest income from net capital deployment was supported by the positive impact from spread tightening on our investments.


_____________________
*
We report on our business using two distinct segments: Investment Portfolio and Mortgage Banking. Table 3 in the Financial Tables section of this Redwood Review includes a comprehensive presentation of our segment results reconciled to net income.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
11

 
Q U A R T E R L Y O V E R V I E W

Ñ
Non-GAAP other fair value changes, net benefited from spread tightening on our securities portfolio during the first quarter of 2019. Inclusive of changes in fair value of our AFS securities, which are marked-to-market through comprehensive income on our balance sheet, our securities portfolio recovered the majority of the market value decline experienced in the fourth quarter. Credit spreads on our residential loan portfolio remained largely unchanged from the fourth quarter.
Ñ
Realized gains in the first quarter were $11 million and included $7 million of gains resulting from the sale of $74 million of securities, and $4 million of gains as a result of the call of one of our 2012 Sequoia securitizations.
Ñ
Credit fundamentals in our investment portfolio remain strong, benefiting from continued stability in the general economy and in housing.

Investment Portfolio Capital Deployment
397858350_q1captypes.jpg

Ñ
We deployed $129 million of capital into proprietary investments in the first quarter, including a $78 million funding commitment to a limited partnership to acquire light-renovation multifamily loans from Freddie Mac, $40 million to complete our purchase of the remaining 80% ownership interest in 5 Arches, and $11 million into Sequoia RMBS.
_____________________
* Proprietary investments include investments sourced either internally or through strategic relationships.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
12

 
Q U A R T E R L Y O V E R V I E W

Ñ
We deployed $34 million into third-party investments in the first quarter, including $7 million of residential securities, $13 million of Agency CRT securities, and $14 million of Agency multifamily securities.
Ñ
As of March 31, 2019, we had funded approximately $22 million of the $78 million commitment to the light-renovation multifamily loan fund, and we expect the remainder of the commitment to be funded over the next few quarters.
Ñ
The $40 million consideration for 5 Arches is incremental to the $10 million we paid in May 2018 to purchase a 20% minority interest in the platform. Subsequently, $13 million of this $40 million was paid in cash upon completion of the acquisition on March 1, 2019 and the remaining consideration is payable in a mix of cash and stock and is contingent on 5 Arches reaching certain performance thresholds over the next two years.



 
THE REDWOOD REVIEW I 1ST QUARTER 2019
13

 
Q U A R T E R L Y O V E R V I E W

Mortgage Banking
 
Mortgage Banking Segment Contribution
($ in millions)
 
Three Months Ended
 
 
3/31/2019
 
12/31/2018
 
 
Residential
 
Business Purpose
 
Total Mortgage Banking
 
Total Mortgage Banking
 
 
 
 
 
 
 
 
 
 
Net interest income
$
5

 
$

 
$
5

 
$
5

 
Mortgage banking activities, net
11

 
1

 
12

 
11

 
Mortgage banking income
16

 
2

 
17

 
16

 
 
 
 
 
 
 
 
 
 
Other income, net

 

 

 

 
Operating expenses
(6
)
 
(2
)
 
(8
)
 
(7
)
 
Provision for income taxes
(1
)
 

 
(1
)
 

 
Segment contribution
$
9

 
$
(1
)
 
$
8

 
$
9

 
 
 
 
 
 
 
 
 
 
Jumbo loan purchase commitments
$
1,199

 
N/A

 
$
1,199

 
$
1,252

 
Residential Mortgage Banking
Ñ
Segment contribution from our residential mortgage banking operations was consistent quarter-over-quarter, as slightly lower loan purchase commitments were offset by strong gross margins supported by improved securitization execution during the first quarter. We define gross margins for this segment as mortgage banking income divided by loan purchase commitments.
Quarterly Jumbo Loan Purchase Volume
($ in billions)
397858350_q1loanpurch.jpg
Ñ
Choice production remained fairly consistent and Select purchase volumes declined in the first quarter of 2019, driven by a continued decline in overall industry originations as well as increased competition. At March 31, 2019, our pipeline of jumbo residential loans identified for purchase was $0.8 billion.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
14

 
Q U A R T E R L Y O V E R V I E W

Ñ
During the first quarter of 2019, we completed $1.2 billion of jumbo residential loan sales, including one Select securitization of $0.4 billion and one Choice securitization of $0.3 billion. Additionally, we sold $0.5 billion of whole loans to third parties.

Business Purpose Mortgage Banking
Ñ
Segment contribution from our business purpose mortgage banking operations included a full quarter of revenue and expenses from our single-family rental loan purchases as well as one month of operating revenue and expense from the 5 Arches platform, including $0.6 million of amortization expense related to acquired intangible assets.
Ñ
During the first quarter of 2019, we acquired $19 million of single-family rental loans from 5 Arches prior to their acquisition. In March, 5 Arches originated $38 million of residential bridge loans and $8 million of single-family rental loans, and sold $21 million of residential bridge loans to a third party. We expect volume from both single-family rental and residential bridge loans to increase in the second quarter, as seasonal factors and integration of the 5 Arches loan platform with Redwood impacted first quarter purchase volume.



 
THE REDWOOD REVIEW I 1ST QUARTER 2019
15

 
Q U A R T E R L Y O V E R V I E W

Book Value
Quarter-End Book Value Per Share (1) 
397858350_q1bvps.jpg

Ñ
Our GAAP book value increased $0.11 per share to $16.00 per share during the first quarter of 2019. This increase was primarily driven by positive market valuation adjustments on our portfolio investments, which both helped earnings exceed the dividend, and also increased comprehensive income (a component of equity) for our available-for-sale securities. These increases were partially offset by a decrease in the value of derivatives hedging our long-term debt, distributions of stock-based compensation, and dilution from our January common stock issuance.
Ñ
The increase in book value per share in the first quarter of 2019 contributed to an economic return on book value(2) of 2.6% for the quarter.






_____________________
(1) A detailed rollforward of book value per share is included in Table 5 in the Financial Tables section of this Redwood Review.
(2)
Economic return on book value is based on the periodic change in GAAP book value per common share plus dividends declared per common share during the period.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
16

 
Q U A R T E R L Y O V E R V I E W

Capital Allocations
We use a combination of equity and unsecured corporate debt (which we collectively refer to as “capital”) to fund our business.
Capital Allocation: By Source and By Business Use
(as of March 31, 2019)
397858350_q1capalloc2.jpg
Ñ
Our total capital of $2.3 billion at March 31, 2019 was comprised of $1.5 billion of equity capital and $0.8 billion of convertible notes and other long-term debt, including $201 million of exchangeable debt due in 2019, $245 million of convertible debt due in 2023, $200 million of convertible debt due in 2024, and $140 million of trust-preferred securities due in 2037, and has a weighted average cost of approximately 6.1%.
Ñ
We also utilize various forms of collateralized debt to finance certain investments and to warehouse our inventory of certain loans held-for-sale. We do not consider this collateralized debt as "capital" and, therefore, exclude it from our capital allocation analysis.
Ñ
The Balance Sheet Analysis portion of the Financial Insights section that follows describes our long-term and short-term borrowings in further detail.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
17

 
Q U A R T E R L Y O V E R V I E W

 
Capital Allocation Detail
By Investment Type
March 31, 2019
($ in millions)
 
GAAP Fair Value
 
Collateralized Debt
 
Allocated Capital
 
% of Total Capital
 
 
 
 
 
 
 
 
 
 
Residential loans (1)
$
2,448

 
$
(2,000
)
 
$
448

 
19%
 
 
 
 
 
 
 
 
 
 
Securities portfolio
 
 
 
 
 
 
 
 
Sequoia residential securities
495

 
(206
)
 
289

 
12%
 
Agency CRT securities
259

 
(35
)
 
224

 
10%
 
Multifamily securities
641

 
(418
)
 
223

 
10%
 
Re-performing residential loan securities (2)
356

 
(172
)
 
184

 
8%
 
Other third-party residential securities
373

 
(251
)
 
122

 
5%
 
Total securities portfolio (3)
2,123

 
(1,081
)
 
1,042

 
45%
 
 
 
 
 
 
 
 
 
 
Business purpose residential loans
104

 
(62
)
 
42

 
2%
 
Other investments
442

 
(271
)
 
172

 
7%
 
Other assets/(liabilities)
170

 
(106
)
 
64

 
3%
 
Cash and liquidity capital
 
 
 
 
360

 
N/A
 
 
 
 
 
 
 
 
 
 
Total Investments
$
5,287

 
$
(3,519
)
 
$
2,127

 
92%
 
 
 
 
 
 
 
 
 
 
Residential mortgage banking
 
 
 
 
130

 
6%
 
Business purpose mortgage banking
 
 
 
 
65

 
3%
 
 
 
 
 
 
 
 
 
 
Total Mortgage banking
 
 
 
 
$
195

 
8%
 
 
 
 
 
 
 
 
 
 
Total
 
 
 
 
$
2,323

 
100%
 
(1)
Includes $43 million of FHLB stock.
(2)
Re-performing residential loan securities represent third-party securities collateralized by seasoned re-performing residential loans.
(3)
In addition to our $1.5 billion of securities on our GAAP balance sheet, securities presented above also include $216 million, $235 million, and $129 million of securities retained from Sequoia Choice, Freddie Mac SLST, and Freddie Mac K-Series securitizations, respectively. For GAAP purposes, we consolidate these securitizations.

Ñ Over the last several quarters, we have increased our allocation of capital to multifamily and re-performing securities, and expect to continue allocating capital into these investment types going forward.
Ñ
During the first quarter of 2019, we reallocated capital from our residential mortgage banking business to our investment portfolio, leveraging operational changes that allow us to manage our mortgage banking business with less capital.
Ñ
As of March 31, 2019, our cash and liquidity capital included $100 million of capital available for investment.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
18

 
Q U A R T E R L Y O V E R V I E W

2019 Updated Financial Outlook(1)  
Our 2019 results to date are consistent with the expectations we laid out in our fourth quarter 2018 Redwood Review and overall, we have not changed our outlook for 2019. We remain focused on key strategic initiatives to increase sustainable earnings - namely increasing investment returns through portfolio optimization, implementing operational efficiencies to maintain strong returns on equity for our residential mortgage banking platform, and disciplined cost management to unlock operating leverage as we scale our business. The following are additional details on our expected activity in 2019:
For our investment portfolio
Ñ
We continue to expect to allocate over 90% of our capital towards portfolio investments and generate returns on equity of 11-13%. Investment returns include an estimate of portfolio economic net interest income, interest expense on corporate debt capital, realized gains, direct operating expenses, and taxes.
Ñ
Our return range incorporates the potential variability in timing of our capital deployment/optimization and the associated returns, as well as the gains we may realize from portfolio sales.
For our residential mortgage banking platform
Ñ
We continue to expect to allocate 5-6% of our capital to support this platform, and to generate a return on equity in the mid to high teens. Expected returns include an estimate of mortgage banking income, direct operating expenses, and taxes.
For our business purpose mortgage banking platform
Ñ
We expect to allocate 3-4% of our capital to support this platform, and to generate a return on equity in the low-double digits. Expected returns include an estimate of mortgage banking income (including origination points and fees), other income, direct operating expenses, and taxes. Return expectations exclude the same amounts excluded for core earnings related to the 5 Arches acquisition.
Ñ
Operating results of 5 Arches are included in this platform and will increase the run rate of both our revenue line items and our operating expenses. Additionally, we expect the platform to provide new accretive investments for our investment portfolio, the impact of which is reflected in our investment portfolio outlook.
For our corporate overhead
Ñ
We continue to expect our baseline corporate operating expenses to be between $48 million and $50 million, with variable compensation commensurate with company performance.
_____________________
(1)
As with all forward-looking statements, our forward-looking statements relating to our 2019 financial outlook are subject to risks and uncertainties, including, among other things, those described in our Annual Report on Form 10-K under the caption “Risk Factors” and other risks, uncertainties, and factors that could cause actual results to differ materially from those described above and under the heading "Forward-Looking Statements" in the Appendix to this Redwood Review, including those described in the “Forward-Looking Statements” at the beginning of this Redwood Review. Although we may update our 2019 financial outlook subsequently in 2019, as a general matter we undertake no obligation to update or revise forward-looking statements, whether as a result of new information, future events, or otherwise.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
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F I N A N C I A L I N S I G H T S

Balance Sheet Analysis
The following table presents our consolidated balance sheets at March 31, 2019 and December 31, 2018.
 
Consolidated Balance Sheets (1)
($ in millions)
 
3/31/2019
 
12/31/2018
 
 
 
 
 
 
Residential loans
$
7,274

 
$
7,255

 
Business purpose residential loans
161

 
141

 
Multifamily loans
2,176

 
2,145

 
Real estate securities
1,543

 
1,452

 
Other investments
414

 
439

 
Cash and cash equivalents
201

 
176

 
Other assets
424

 
330

 
 
 
 
 
 
Total assets
$
12,193

 
$
11,937

 
 
 
 
 
 
Short-term debt
 
 
 
 
Mortgage loan warehouse facilities
$
526

 
$
861

 
Business purpose mortgage loan warehouse facilities
106

 
88

 
Security repurchase facilities
1,081

 
989

 
Servicer advance financing
250

 
263

 
Convertible notes, net
200

 
200

 
Other liabilities
270

 
206

 
Asset-backed securities issued
 
 
 
 
Residential
3,590

 
3,391

 
Multifamily
2,047

 
2,019

 
Long-term debt, net
2,573

 
2,572

 
Total liabilities
10,643

 
10,589

 
 
 
 
 
 
Stockholders’ equity
1,550

 
1,349

 
 
 
 
 
 
Total liabilities and equity
$
12,193

 
$
11,937

 
(1)
Our consolidated balance sheets include assets of consolidated variable interest entities (“VIEs”) that can only be used to settle obligations of these VIEs and liabilities of consolidated VIEs for which creditors do not have recourse to the primary beneficiary (Redwood Trust, Inc.). At March 31, 2019 and December 31, 2018, assets of consolidated VIEs totaled $6.6 billion and $6.3 billion, respectively, and liabilities of consolidated VIEs totaled $5.9 billion and $5.7 billion, respectively. See Table 10 in the Financial Tables section of this Redwood Review for additional detail on consolidated VIEs.
Ñ
Over the past several quarters, we have invested in the subordinate securities of Agency multifamily securitizations and a re-performing loan securitization that we were required to consolidate under GAAP. Additionally, we invested in excess servicing assets that required us to consolidate servicing-related assets and liabilities, including $250 million of non-recourse securitization debt. See Table 9 in the Financial Tables section of this Redwood Review for additional information on these securitizations.

 
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F I N A N C I A L I N S I G H T S

Recourse Financing
We finance our business with a diversified mix of long-term and short-term recourse debt. The following charts present the composition of our recourse debt and its characteristics at the end of the first quarter:
397858350_q1recfin.jpg
 
Borrowing Type
Average Cost of Funds
Average Remaining Term (yrs.)
 
 
 
FHLBC Borrowings
2.6%
6
Unsecured Corporate Debt
6.1%
6
Mortgage Warehouse
4.2%
<1
Securities Repurchase
3.6%
<1
 
 
 
Weighted Average Cost of Funds
3.7%
 
 
 
 


Ñ
Our unsecured corporate debt is comprised of $200 million of 5.625% convertible notes due in 2024, $245 million of 4.75% convertible notes due in 2023, $201 million of 5.625% exchangeable notes due in 2019, and $140 million of trust-preferred securities due in 2037 (that we hedge to yield approximately 6.8%).
Ñ
Our FHLBC borrowings and securities repurchase debt are used to finance our whole loan and securities investments, respectively, and we utilize mortgage warehouse facilities to finance our mortgage banking activities and investments in business purpose residential loans. These are discussed in further detail in the following sections.
Ñ
Our recourse debt to equity leverage ratio decreased to 2.9x at the end of the first quarter of 2019 from 3.5x at the end of the fourth quarter primarily resulting from our issuance of common stock in January and a lower balance of financed loans held-for-sale at the end of the first quarter. (1) 
Ñ
In addition to our recourse financing, we have non-recourse ABS debt issued by securitization entities and other non-recourse short-term securitization debt that we consolidate.
_____________________
(1)
See Table 7 in the Financial Tables section of this Redwood Review for details of how our recourse debt to equity leverage ratio is calculated.

 
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F I N A N C I A L I N S I G H T S

Residential Loan Investments
Ñ
At March 31, 2019, we had $2.4 billion of residential loans held-for-investment. These loans are prime-quality, first lien jumbo loans, most of which were originated between 2013 and 2019. At March 31, 2019, 88% of these loans were fixed rate and the remainder were hybrid, and in aggregate, had a weighted average coupon of 4.15%.
Ñ
At March 31, 2019, the weighted average FICO score of borrowers backing these loans was 768 (at origination) and the weighted average loan-to-value ("LTV") ratio of these loans was 66% (at origination). At March 31, 2019, 0.03% of these loans (by unpaid principal balance) were more than 90 days delinquent.
Ñ
We finance our residential loan investments with $2.0 billion of variable-rate FHLB debt through our FHLB-member subsidiary. In connection with these borrowings, our FHLB-member subsidiary is required to hold $43 million of FHLB stock.
Ñ
We seek to minimize the interest rate risk in this portfolio by using a combination of swaps, TBAs, and other derivative instruments.

 
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F I N A N C I A L I N S I G H T S

Securities Portfolio
The following table presents the fair value of our real estate securities at March 31, 2019.
 
Securities Portfolio - By Source and Security Type
March 31, 2019
($ in millions)
 
Interest-Only Securities
 
Senior
 
Mezzanine
 
Subordinate
 
Total
 
% of Total Securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sequoia (1)
$
73

 
$

 
$
250

 
$
172

 
$
495

 
23
%
 
Re-performing (2)
30

 
28

 
208

 
90

 
356

 
17
%
 
Agency CRT

 

 

 
234

 
234

 
11
%
 
Other third-party

 
127

 
141

 
129

 
397

 
19
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total residential securities
$
103

 
$
155

 
$
599

 
$
625

 
$
1,482

 
70
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Multifamily securities (3)

 

 
530

 
111

 
641

 
30
%
 
Total securities portfolio
$
103

 
$
155

 
$
1,129

 
$
736

 
$
2,123

 
100
%
 
(1)
Presents securities retained from our Sequoia securitizations that were issued from 2012 through 2018. These securities included $15 million of interest-only securities, $153 million of mezzanine securities, and $48 million of subordinate securities retained from our Sequoia Choice securitizations, which were consolidated for GAAP purposes.
(2)
Re-performing securities included $235 million of mezzanine and subordinate securities issued from an Agency residential securitization that is consolidated for GAAP purposes.
(3)
Multifamily securities included $18 million of mezzanine securities and $111 million of subordinate securities issued from Agency multifamily securitizations that are consolidated for GAAP purposes.
At March 31, 2019, our securities consisted of fixed-rate assets (84%), adjustable-rate assets (12%), hybrid assets that reset within the next year (3%), and hybrid assets that reset between 12 and 36 months (1%). For the portions of our securities portfolio that are sensitive to changes in interest rates, we seek to minimize this interest rate risk by using various derivative instruments.
We finance our holdings of real estate securities with a combination of capital and collateralized debt in the form of repurchase (or “repo”) financing. At March 31, 2019, we had short-term debt incurred through repurchase facilities totaling $1.1 billion with nine separate counterparties, which was secured by $1.3 billion of real estate securities. The remaining $797 million of securities were financed with capital.

 
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F I N A N C I A L I N S I G H T S

The following table presents the fair value of our real estate securities that are financed with repurchase debt, at March 31, 2019.
 
Real Estate Securities Financed with Repurchase Debt
March 31, 2019
($ in millions, except weighted average price)
 
Real Estate Securities (3)
 
Repurchase Debt
 
Allocated Capital
 
Weighted Average Price (1)
 
Financing Haircut (2)
 
 
 
 
 
 
 
 
 
 
 
 
Residential securities
 
 
 
 
 
 
 
 
 
 
Senior
$
150

 
$
(134
)
 
$
15

 
$
100

 
11
%
 
Mezzanine
581

 
(472
)
 
109

 
95

 
19
%
 
Subordinate
70

 
(57
)
 
13

 
97

 
18
%
 
Total residential securities
800

 
(663
)
 
137

 
 
 
 
 
Multifamily securities
526

 
(418
)
 
108

 
97

 
21
%
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
1,326

 
$
(1,081
)
 
$
245

 
$
93

 
18
%
 
(1)
GAAP fair value per $100 of principal.
(2)
Allocated capital divided by GAAP fair value.
(3)
Includes $146 million, $196 million, and $18 million of securities we owned that were issued by consolidated Sequoia Choice, Freddie Mac SLST, and Freddie Mac K-Series securitizations, respectively.     
Ñ
In addition to the allocated capital listed in the table above that directly supports our repurchase facilities (i.e., “the haircut”), we continue to hold a designated amount of supplemental risk capital available for potential margin calls or future obligations relating to these facilities.
Ñ
At March 31, 2019, we had securities repurchase facilities with nine different counterparties.
Ñ
Additional information on the residential securities we own is set forth in Table 9 in the Financial Tables section of this Redwood Review.
Business Purpose Residential Loan Investments
Ñ
At March 31, 2019, our $104 million of business purpose residential loans held-for-investment were comprised of short-term, residential bridge loans, most of which were originated in 2018. At March 31, 2019, the portfolio contained 158 loans with a weighted average coupon of 9.13%, and a weighted average LTV ratio of 75% (at origination). At March 31, 2019, seven of these loans with a cumulative unpaid principal balance of $9 million were more than 90 days delinquent. These delinquent loans had a weighted average LTV ratio of 86% (at origination), and we currently expect to recover the full carrying amount of these loans.
Ñ
We finance our business purpose residential loan investments with warehouse debt that had a balance of $62 million at March 31, 2019.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
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F I N A N C I A L I N S I G H T S

Ñ
At March 31, 2019, our business purpose residential warehouse capacity for financing residential bridge loans totaled $80 million across two separate counterparties.
Other Investments
Ñ
At March 31, 2019, we had $414 million of other investments, primarily comprised of $304 million of servicing advance investments ($54 million of capital invested, net of non-recourse securitization debt collateralized by servicing-related assets), $55 million of MSRs retained from our Sequoia securitizations, $29 million of excess servicing investments, and a $22 million investment in a light-renovation multifamily loan fund.
Residential Loans Held-for-Sale
Ñ
At March 31, 2019, we had $797 million of residential mortgages held-for-sale financed with $526 million of warehouse debt. These loans included $462 million of Select loans, and $335 million of expanded-prime Choice loans.
Ñ
Our residential warehouse capacity at March 31, 2019 totaled $1.4 billion across four separate counterparties.
Ñ
At March 31, 2019, our pipeline of jumbo residential loans identified for purchase was $0.8 billion.
Ñ
We seek to minimize the exposure we have to interest rates on our loan pipeline (for loans both on balance sheet and identified for purchase) by using a combination of TBAs, interest rate swaps, and other derivative instruments.
Ñ
At March 31, 2019, we had 478 loan sellers, which included 188 jumbo sellers and 290 MPF Direct sellers from various FHLB districts.
Business Purpose Residential Loans Held-for-Sale
Ñ
At March 31, 2019, we had $57 million of business purpose residential loans held-for-sale, collateralized by single-family rental properties, financed with $37 million of short-term warehouse debt.
Ñ
At March 31, 2019, the weighted average coupon on these loans was 5.72% and the LTV ratio was 65% (at origination).
Ñ
At March 31, 2019, our business purpose residential warehouse capacity for financing single-family rental loans totaled $400 million across two separate counterparties.
Ñ
We seek to minimize the exposure we have to interest rates on our business purpose loan pipeline by using interest rate swaps and other derivative instruments.

 
THE REDWOOD REVIEW I 1ST QUARTER 2019
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  G L O S S A R Y

397858350_a2019financialtablesdivi001.jpg

 
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26



397858350_rwtq12019appendixlogoa01.jpg
Table 1: GAAP Earnings (in thousands, except per share data)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2019
Q1
 
2018
Q4
 
2018
Q3
 
2018
Q2
 
2018
Q1
 
2017
Q4
 
2017
Q3
 
2017
Q2
 
2017
Q1
 
 
Twelve Months 2018
 
Twelve Months 2017
 
Interest income
$
129,111

 
$
116,858

 
$
96,074

 
$
79,128

 
$
72,559

 
$
67,370

 
$
58,106


$
54,419


$
49,367