Toggle SGML Header (+)


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): October 30, 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 October 30, 2019, Redwood Trust, Inc. issued a press release announcing its financial results for the quarter ended September 30, 2019 and The Redwood Review - 3rd 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 October 30, 2019
Exhibit 99.2
 
The Redwood Review – 3rd 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: October 30, 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
 
 
 
 
 
 


(Back To Top)

Section 2: EX-99.1 (EXHIBIT 99.1)

Exhibit

Exhibit 99.1

400726526_q319prlogoa02.jpg
    

REDWOOD TRUST REPORTS THIRD QUARTER 2019 FINANCIAL RESULTS

MILL VALLEY, CA Wednesday, October 30, 2019 – Redwood Trust, Inc. (NYSE:RWT), a leading innovator in housing credit investing, today reported its financial results for the quarter ended September 30, 2019.
Key Financial Results
GAAP net income was $34 million, or $0.31 per diluted common share
Non-GAAP core earnings(1) were $43 million, or $0.37 per diluted common share
Book value per common share was $15.92 at September 30, 2019
Economic return on book value(2) of 1.3% for the third quarter of 2019
Recourse debt-to-equity leverage ratio(3) of 2.7x at September 30, 2019
Paid a regular quarterly cash dividend of $0.30 per common share
Business Highlights
Closed three Sequoia securitizations totaling $1.1 billion, including our 100th overall, and sold $0.5 billion of whole loans
Purchased $1.5 billion of jumbo loans as volumes remained stable from the second quarter
Originated $162 million of business purpose residential loans in the third quarter of 2019
Deployed $152 million of capital into new investments in the third quarter of 2019
Raised $228 million of equity capital from a follow-on offering of common stock and generated $248 million of capital through portfolio optimization activities
In September, we issued $201 million of 5.75% exchangeable debt due in 2025 to replace our $201 million of exchangeable debt maturing in November 2019
In October, we completed our acquisition of CoreVest for $492 million

“The third quarter marked a historic time for Redwood, a time where we made significant progress positioning the
company for the future of housing finance,” said Chris Abate, Chief Executive Officer of Redwood Trust. “While the rate environment offered a variety of opportunities and challenges, we were able to leverage the strength of our business model to navigate through continued market volatility and execute on our long-term strategic initiatives. We spent ample time in the third quarter focused on the acquisition of CoreVest, our long-term funding needs, and our portfolio optimization goals, which we believe will deliver strong and durable returns for our shareholders.”

Abate concluded, “As we look ahead, the strength and agility of our business model has positioned us to perform well
under varying market conditions, and we’ve established a proven competency to capitalize on strategic initiatives as
opportunities arise. Our 25-year track record speaks to our ability to develop nascent, emerging products into scalable funding solutions that are transformative in nature. And with an eye towards integrating our consumer mortgage and BPL businesses over time across our national correspondent network, our vision of becoming the preeminent specialty finance operator in the mortgage industry can be realized.”
_____________________
(1)
During the third quarter of 2019, Redwood updated its 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 $8.5 billion of consolidated securitization debt (ABS issued and servicer advance financing) that is non-recourse to Redwood.

1


Third 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 third quarter 2019 Redwood Review, which is available on the Company’s website at www.redwoodtrust.com.











































2



REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial Performance
 
Three Months Ended
($ in millions, except per share data)
 
9/30/2019
 
6/30/2019
 
9/30/2018
 
 
 
 
 
 
 
GAAP net income
 
$
34

 
$
31

 
$
41

GAAP net income per diluted common share
 
$
0.31

 
$
0.30

 
$
0.42

 
 
 
 
 
 
 
Non-GAAP core earnings
 
$
43

 
$
43

 
$
36

Non-GAAP core earnings per diluted common share
 
$
0.37

 
$
0.39

 
$
0.38

 
 
 
 
 
 
 
REIT taxable income (estimated)
 
$
39

 
$
25

 
$
23

REIT taxable income per share (estimated)
 
$
0.34

 
$
0.25

 
$
0.27

 
 
 
 
 
 
 
GAAP book value per share
 
$
15.92

 
$
16.01

 
$
16.42

Dividends per common share
 
$
0.30

 
$
0.30

 
$
0.30

Economic return on book value
 
1.3
%
 
1.9
%
 
3.0
%
Recourse debt-to-equity leverage ratio (1)
 
2.7x

 
3.1x

 
3.1x

 
 
 
 
 
 
 
Capital deployment
 
$
152

 
$
136

 
$
281

Jumbo loans purchased
 
$
1,483

 
$
1,562

 
$
1,804

Jumbo loans securitized or sold
 
$
1,574

 
$
1,252

 
$
1,929

(1)
Recourse debt excludes $8.5 billion, $7.2 billion, and $3.4 billion of consolidated securitization debt (ABS issued and servicer advance financing) that is non-recourse to Redwood at September 30, 2019, June 30, 2019, and September 30, 2018, respectively.
Conference Call and Webcast
Redwood will host an earnings call today, October 30, 2019, at 2:00 p.m. Pacific Time / 5:00 p.m. Eastern Time to discuss its third quarter 2019 financial results. The number to dial in order to listen to the conference call is 1-877-423-9813 in the U.S. and Canada. International callers must dial 1-201-689-8573. Callers should reference call ID #13695283. A replay of the call will be available through midnight on November 13, 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 #13695283.
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 Tuesday, November 12, 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.

3



REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Income Statements (1)
 
Three Months Ended
($ in millions, except share and per share data)
 
9/30/19
 
6/30/19
 
3/31/19
 
12/31/18
 
9/30/18
 
 
 
 
 
 
 
 
 
 
 
Interest income
 
$
150

 
$
149

 
$
131

 
$
120

 
$
99

Interest expense
 
(117
)
 
(116
)
 
(99
)
 
(85
)
 
(64
)
Net interest income
 
34

 
32

 
32

 
35

 
35

Non-interest income (loss)
 
 
 
 
 
 
 
 
 
 
Mortgage banking activities, net
 
10

 
19

 
12

 
11

 
11

Investment fair value changes, net
 
11

 
3

 
20

 
(39
)
 
10

Other income, net
 
2

 
2

 
4

 
4

 
3

Realized gains, net
 
5

 
3

 
11

 
6

 
7

Total non-interest income (loss), net
 
27

 
28

 
47

 
(18
)
 
32

Operating expenses
 
(27
)
 
(26
)
 
(23
)
 
(19
)
 
(21
)
(Provision for) benefit from income taxes
 

 
(2
)
 
(1
)
 
1

 
(5
)
Net income (loss)
 
$
34

 
$
31

 
$
54

 
$
(1
)
 
$
41

 
 
 
 
 
 
 
 
 
 
 
Weighted average diluted shares (thousands) (2)
 
136,523

 
130,697

 
126,278

 
83,217

 
114,683

Diluted earnings (loss) per common share
 
$
0.31

 
$
0.30

 
$
0.49

 
$
(0.02
)
 
$
0.42

Regular dividends declared per common share
 
$
0.30

 
$
0.30

 
$
0.30

 
$
0.30

 
$
0.30

 
 
 
 
 
 
 
 
 
 
 
(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 September 30, 2019, June 30, 2019, March 31, 2019, December 31, 2018, and September 30, 2018 were 112,102, 97,715, 96,866, 84,884, and 82,930, respectively.











4



 
 
 
 
 
REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
Consolidated Income Statements (1)
 
Nine Months Ended September 30,
($ in millions, except share and per share data)
 
2019
 
2018
 
 
 
 
 
Interest income
 
$
430

 
$
259

Interest expense
 
(332
)
 
(154
)
Net interest income
 
98

 
105

Non-interest income
 
 
 
 
Mortgage banking activities, net
 
41

 
48

Investment fair value changes, net
 
35

 
13

Other income, net
 
8

 
9

Realized gains, net
 
18

 
21

Total non-interest income
 
102

 
91

Operating expenses
 
(76
)
 
(64
)
Provision for income taxes
 
(3
)
 
(12
)
Net income
 
$
120

 
$
121

 
 
 
 
 
Weighted average diluted shares (thousands)
 
131,203

 
107,792

Diluted earnings per common share
 
$
1.09

 
$
1.30

Regular dividends declared per common share
 
$
0.90

 
$
0.88

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


















5



REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reconciliation of GAAP Net Income to
Non-GAAP Core Earnings
 (1) (2)
Three Months Ended
($ in millions, except per share data)
9/30/19
 
6/30/19
 
9/30/18
 
 
 
 
 
 
GAAP net income
$
34

 
$
31

 
$
41

Adjustments:
 
 
 
 
 
Eliminate mark-to-market changes on long-term investments and associated derivatives (3)
(14
)
 
(2
)
 
(13
)
Include cumulative gain on long-term investments sold, net (4)
20

 
13

 
8

Eliminate purchase accounting adjustments (5)
2

 
2

 

Eliminate corporate acquisition and related expenses (5)
2

 

 

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

Total adjustments
9

 
12

 
(5
)
Non-GAAP core earnings
$
43

 
$
43

 
$
36

 
 
 
 
 
 
GAAP net income per diluted common share
$
0.31

 
$
0.30

 
$
0.42

Non-GAAP core earnings per diluted common share (7)
$
0.37

 
$
0.39

 
$
0.38

 
 
 
 
 
 
(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 acquisitions of 5 Arches and CoreVest 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 third quarter 2019 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. During the third quarter of 2019, management updated its calculation of this adjustment. Additional information regarding this adjustment is included in the Appendix to the third 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 acquisitions of 5 Arches and CoreVest. 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 and ongoing adjustments to exclude amortization of intangible assets; beginning in the second quarter, changes in fair value of the contingent consideration liability related to the remaining purchase consideration for the 5 Arches platform; and, for the third quarter of 2019, exclusion of certain transaction expenses associated with our acquisition of CoreVest. Additional information regarding this adjustment is included in the Appendix to the third 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.

6



REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Balance Sheets (1)
 
 
 
 
 
 
 
 
 
 
 
($ in millions, except share and per share data)
 
9/30/19
 
6/30/19
 
3/31/19
 
12/31/18
 
9/30/18
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential loans
 
$
8,682

 
$
7,283

 
$
7,274

 
$
7,255

 
$
5,922

 
Business purpose loans
 
336

 
251

 
161

 
141

 
116

 
Multifamily loans
 
3,792

 
3,750

 
2,176

 
2,145

 
942

 
Real estate securities
 
1,285

 
1,477

 
1,543

 
1,452

 
1,470

 
Other investments
 
348

 
372

 
414

 
439

 
114

 
Cash and cash equivalents
 
395

 
218

 
201

 
176

 
174

 
Other assets
 
639

 
501

 
424

 
330

 
402

 
Total assets
 
$
15,476

 
$
13,852

 
$
12,193

 
$
11,937

 
$
9,140

 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term debt
 
$
1,981

 
$
2,463

 
$
2,163

 
$
2,400

 
$
1,424

 
Other liabilities
 
411

 
338

 
270

 
206

 
176

 
Asset-backed securities issued
 
8,346

 
6,913

 
5,638

 
5,410

 
3,407

 
Long-term debt, net
 
2,954

 
2,573

 
2,573

 
2,572

 
2,771

 
Total liabilities
 
13,691

 
12,288

 
10,643

 
10,589

 
7,778

 
 
 
 
 
 
 
 
 
 
 
 
 
Stockholders' equity
 
1,785

 
1,564

 
1,550

 
1,349

 
1,361

 
 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and equity
 
$
15,476

 
$
13,852

 
$
12,193

 
$
11,937

 
$
9,140

 
 
 
 
 
 
 
 
 
 
 
 
 
Shares outstanding at period end (thousands)
 
112,102

 
97,715

 
96,866

 
84,884

 
82,930

 
GAAP book value per share
 
$
15.92

 
$
16.01

 
$
16.00

 
$
15.89

 
$
16.42

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




CONTACTS
Lisa M. Hartman
SVP, Head of Investor Relations
Phone: 866-269-4976

7
(Back To Top)

Section 3: EX-99.2 (EXHIBIT 99.2)

Exhibit


Exhibit 99.2

400726526_q32019redwoodreviewousidefro.jpg


 
  T A B L E O F C O N T E N T S


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


 
THE REDWOOD REVIEW I 3RD 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 3RD 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 “third quarter” refer to the quarter ended September 30, 2019, and references to the “second quarter” refer to the quarter ended June 30, 2019, 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
 
REIT Taxable
Income per
Share
(1)
 
Annualized
GAAP Return
on Equity
 
GAAP Book
Value per
Share
 
Dividends
per Share
 
Economic Return on Book Value (2)
 
Recourse Leverage (3)
 
Q319
 
$0.31
 
$0.34
 
9%
 
$15.92
 
$0.30
 
1.3%
 
2.7x
 
Q219
 
$0.30
 
$0.25
 
8%
 
$16.01
 
$0.30
 
1.9%
 
3.1x
 
Q119
 
$0.49
 
$0.30
 
15%
 
$16.00
 
$0.30
 
2.6%
 
2.9x
 
Q418
 
$(0.02)
 
$0.32
 
—%
 
$15.89
 
$0.30
 
(1.4)%
 
3.5x
 
Q318
 
$0.42
 
$0.27
 
12%
 
$16.42
 
$0.30
 
3.0%
 
3.1x
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1)
REIT taxable income per share for 2019 is an estimate until we file our tax return.
(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 3RD QUARTER 2019
3

 
S H A R E H O L D E R L E T T E R

Dear Fellow Shareholders:
Two years ago, we announced a comprehensive new business strategy to leverage our housing credit competencies across a broader residential landscape. This entailed not only the expansion of our consumer mortgage business, but also a commitment to offering similar solutions for housing investors who purchase residential real estate for business income (i.e., rent or refurbishment). Over the course of the past 18 months, we've developed the skills and operations necessary to grow in this market, and have taken tangible steps towards building a best-in-class specialty finance platform that serves the liquidity needs of all homebuyers - homeowners and investors alike.
Our expansion into the business-purpose lending ("BPL") space began organically, but quickly evolved into a partnership with our 5 Arches team in Irvine. We were extremely fortunate to bring 5 Arches fully into the fold this year, and their business has fit squarely within Redwood's DNA. The investment opportunities we have seen through 5 Arches have validated the thesis underpinning our new strategy; that is, a significant imbalance exists between the rate of new household formation in the United States and the rate of new homebuilding. Earlier this month, we had the opportunity to further solidify business-purpose lending as a core strategy at Redwood, and we announced a second new partner - CoreVest.
CoreVest is an industry leading BPL originator with over $900 million of total assets, and brings an extremely talented team to Redwood that shares our values of working with integrity and fostering deep relationships with our customers and business partners. Since their inception in 2014, CoreVest has funded over $4 billion of loans while developing industry-leading technology that offers a seamless borrower experience. The platform has generated attractive returns to date, with its highly scalable mortgage banking business significantly contributing to the company's profitability. The firm also recently completed its ninth securitization of single-family rental loans since it began issuing in 2015, more such transactions than any other issuer. Pairing this channel with our own market-leading Sequoia program further expands our lead in the private-label securitization market. This transaction strengthens our position as a leading lender in a market whose size we estimate to be in excess of $100 billion.
While our BPL expansion has been a key area of focus, we continue to expand our core consumer residential business. We are committed to growing expanded credit and non-qualified residential mortgage (non-QM) loans by leveraging our approach to credit, speed to close, and reliable execution we deliver to our loan sellers. We see a tremendous opportunity for this business thanks to announcements made regarding impending changes to housing finance rules made by regulators over the course of this year. Most recently, the CFPB announced in late July that they intend to let the so called "QM Patch" expire. As we laid out in a presentation we published in May, the QM Patch is a regulatory-driven competitive advantage afforded to the public mortgage sector that resulted in an unlevel playing field for non-QM mortgage lending. We estimate the patch expiration will open the private sector to a market in upwards of $185 billion of non-QM loans produced annually by Fannie Mae and Freddie Mac. To contextualize this opportunity, we

 
THE REDWOOD REVIEW I 3RD QUARTER 2019
4

 
S H A R E H O L D E R L E T T E R

purchased about $7 billion of loans in 2018, a successful and profitable year for our consumer mortgage banking business.
The CFPB's announcement in July included a notice of proposed rulemaking seeking information relating to the expiration of the QM Patch. In late August, we published a presentation on our perspective for potential changes focused on redefining Qualified Mortgages; improving pricing transparency at the GSEs; and refining certain rules that in our view, unnecessarily inhibit access to the public securitization markets. Our presentations can be viewed on the Newsroom section of our website at: http://www.redwoodtrust.com/Presentations.
The success of our operating businesses has been directly complimented by the great work done within our investment portfolio. The portfolio team continues to deploy capital at a record pace, leveraging unique and durable relationships forged over several years. A key differentiator for Redwood has always been our ability to source and structure investments our competitors cannot easily replicate. Our collective suite of businesses makes that truer than ever before, with over $670 million of capital deployed year-to-date, through October 29th, including our acquisition of the CoreVest investment portfolio. As we grow our mortgage banking platforms, our portfolio activities and efficiency of our corporate functions will be key to profitably scaling our consolidated platform and maximizing the growth of earnings per share.
As we reflect on the current state of our industry, the present marks an exciting time for Redwood. After years of fundraising, markets are awash in capital and credit-oriented strategies are in demand as the yield curve flattens and investors seek alternative means to source real estate-related assets. The product sourcing capabilities and operating know-how required to succeed, however, remain in scarce supply. At Redwood, we have built a solutions-based platform that possesses a unique ability to bridge the gap between the customized needs of non-agency borrowers - whether BPL, non-QM, or traditional jumbo and the liquidity options available to them in the marketplace. We are already making necessary investments in technology and infrastructure to further automate our loan purchase process in anticipation of these opportunities. Our 25-year track record speaks to our ability to operate efficiently, while developing nascent, emerging products into scalable funding solutions that are transformative in nature. With an eye towards integrating our consumer mortgage and BPL businesses over time across our national correspondent network, our vision of becoming the preeminent, and most profitable, specialty finance operator in the mortgage industry can be realized.
We are grateful to have your continued support.
400726526_q319ceosignaturea01.jpg
 
400726526_q319presidentsignaturea01.jpg
Christopher J. Abate
 
Dashiell I. Robinson
Chief Executive Officer
 
President

 
THE REDWOOD REVIEW I 3RD QUARTER 2019
5

 
Q U A R T E R L Y O V E R V I E W

Third Quarter Highlights
Ñ
During the third quarter, we issued $228 million of common stock and generated $248 million of capital through portfolio optimization, ending the quarter with approximately $590 million of available capital and reducing our recourse leverage ratio to 2.7x, below our historical target range of 3.0x - 4.0x.
Ñ
Our portfolio optimization activities during the quarter included the sale of $262 million of lower yielding securities, which freed-up $118 million of capital, and the completion of a new $185 million, non-mark-to-market, 3-year term facility, collateralized by a portion of our retained Sequoia securities, which generated $130 million of capital, after repayment of existing financing.
Ñ
We deployed $152 million of capital toward new investments in the third quarter of 2019, including $55 million into proprietary investments and $98 million into third-party investments (which included $73 million into subordinate re-performing loan (RPL) securities issued by Freddie Mac). On page 12, we provide a supplemental overview of our RPL investment strategy.
Ñ
We purchased $1.5 billion of residential jumbo loans during the third quarter of 2019, including a record $0.7 billion of Choice loans, and sold $1.6 billion of loans, through a combination of whole loan sales and three Sequoia securitizations, including our 100th overall. At September 30, 2019, our pipeline of jumbo residential loans identified for purchase was $1.3 billion.
Ñ
We originated $162 million of business purpose residential loans (BPLs) during the third quarter and at September 30, 2019, our total portfolio of BPLs was $336 million, including both single-family rental and residential bridge loans. On page 21, we provide additional detail on BPL activity at our 5 Arches subsidiary.
Ñ
In September, we issued $201 million of 5.75% 6-year exchangeable debt, which is excluded from our available capital, and will replace our $201 million of exchangeable debt maturing in November 2019.
Ñ
Following the end of the third quarter, we completed our acquisition of CoreVest, a leading nationwide originator and portfolio manager of business purpose residential loans. The acquisition included CoreVest's operating platform and $900 million of related financial assets. Total transaction consideration was $492 million, net of in-place financing on certain of the financial assets.

 
THE REDWOOD REVIEW I 3RD QUARTER 2019
6

 
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 third and second quarters of 2019.
 
GAAP Net Income
($ in millions, except per share data)
 
Three Months Ended
 
 
9/30/2019
 
6/30/2019
 
 
 
 
 
 
Net interest income
$
34

 
$
32

 
 
 
 
 
 
Non-interest income
 
 
 
 
Mortgage banking activities, net
10

 
19

 
Investment fair value changes, net
11

 
3

 
Other income, net
2

 
2

 
Realized gains, net
5

 
3

 
Total non-interest income, net
27

 
28

 
Operating expenses
(27
)
 
(26
)
 
Provision for income taxes

 
(2
)
 
 
 
 
 
 
GAAP net income
$
34

 
$
31

 
 
 
 
 
 
GAAP diluted earnings per common share
$
0.31

 
$
0.30

 
 
 
 
 
 
 
Non-GAAP Core Earnings (1)
($ in millions, except per share data)
 
Three Months Ended
 
 
9/30/2019
 
6/30/2019
 
 
 
 
 
 
GAAP net interest income
$
34

 
$
32

 
Change in basis and hedge interest
(3
)
 
1

 
Non-GAAP economic net interest income (1)
31

 
34

 
 
 
 
 
 
Non-interest income
 
 
 
 
Mortgage banking activities, net
10

 
19

 
Core investment fair value changes, net (1)

 

 
Core other income, net (1)
4

 
4

 
Core realized gains, net (1)
25

 
16

 
Total non-interest income, net
38

 
40

 
Core operating expenses
(25
)
 
(26
)
 
Core provision for income taxes (1)

 
(4
)
 
 
 
 
 
 
Core earnings (1)
$
43

 
$
43

 
 
 
 
 
 
Core diluted earnings per common share (2)
$
0.37

 
$
0.39

 
(1)
During the third quarter of 2019, we updated our definition of core earnings and economic net interest income. Prior period amounts presented above have been conformed. Additional information on Redwood's non-GAAP measures, including: economic net interest income; core investment 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 3RD QUARTER 2019
7

 
Q U A R T E R L Y O V E R V I E W

Overview
During the third quarter of 2019, we accelerated our pace of portfolio optimization and raised equity capital in early September, which together generated $476 million of available capital. These activities resulted in increased levels of core realized gains, but dampened economic net interest income, as our average undeployed capital increased. While lower rates generally persisted throughout the quarter, helping maintain residential loan purchase volume levels in our mortgage banking business, we experienced higher prepayments in our investment portfolio, which further impacted economic net interest income. Additionally, mortgage banking margins were negatively impacted by the rally in rates, which impacted execution on securitizations we completed during the quarter. Execution improved for our most recent securitization, completed in October. Despite the rate volatility, overall we continued to see strong demand for yield, resulting in positive investment fair value changes for the quarter.
Line Item Review
Ñ
Net interest income increased from the second quarter of 2019, as the benefit from continued capital deployment during the third quarter was partially offset by capital inflows that resulted from increased portfolio optimization activities, including an increase in opportunistic asset sales and the addition of incremental term financing within our investment portfolio.
Ñ
Non-GAAP economic net interest income declined from the second quarter of 2019, due to lower mortgage rates and strong prepayment activity. Faster prepayments helped to improve the fair value of our subordinate investments, but negatively impacted our portfolio investments held at a premium.
Ñ
Mortgage banking activities decreased primarily due to lower gross margins in our residential mortgage banking business, on similar loan purchase volume as the second quarter. Gross margins were driven lower primarily due to the impact of rate volatility on securitizations we executed during the third quarter.
Ñ
Investment fair value changes was positively impacted by tightening credit spreads in our securities portfolio during the third quarter, benefiting fair values to a greater extent than in the second quarter. Our non-GAAP core earnings excludes these market valuation adjustments.
Ñ
Realized gains in the third quarter resulted from the sale of $262 million of securities. After the repayment of associated debt, the security sales freed up $118 million of capital for reinvestment.
Ñ
GAAP operating expenses increased primarily due to $2 million of transaction costs incurred in relation to the acquisition of CoreVest. We exclude these expenses from our non-GAAP core operating expenses.
Ñ
The provision for income tax declined during the third quarter due to lower residential mortgage banking income at our taxable subsidiary during the third quarter, as compared with the second quarter. 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.

 
THE REDWOOD REVIEW I 3RD QUARTER 2019
8

 
Q U A R T E R L Y O V E R V I E W

Book Value
 
Changes in GAAP Book Value per Share
($ in per share)
 
Three Months Ended
 
 
9/30/2019
 
6/30/2019
 
 
 
 
 
 
Beginning book value per share
$
16.01

 
$
16.00

 
Earnings
0.31

 
0.30

 
Changes in unrealized gains on securities, net, from:
 
 
 
 
Realized gains recognized in earnings
(0.03
)
 
(0.02
)
 
Amortization income recognized in earnings
(0.01
)
 
(0.02
)
 
Mark-to-market adjustments, net
0.06

 
0.11

 
Total change in unrealized gains on securities, net
0.02

 
0.07

 
Dividends
(0.30
)
 
(0.30
)
 
Equity compensation, net
0.02

 
0.02

 
Changes in unrealized losses on derivatives hedging long-term debt
(0.11
)
 
(0.10
)
 
Other, net
(0.03
)
 
0.02

 
 
 
 
 
 
Ending book value per share
$
15.92

 
$
16.01

 

Ñ
Our GAAP book value declined $0.09 per share to $15.92 per share during the third quarter of 2019. While GAAP earnings exceeded our third quarter dividend, book value decreased primarily due to an $0.11 per share decline in the value of derivatives hedging our long-term debt, which were impacted by the decline in benchmark interest rates during the third quarter.
Ñ
Combining our third quarter dividend with our change in book value during the third quarter contributed to a positive economic return on book value(1) of 1.3% for the quarter.








_____________________
(1)
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 3RD QUARTER 2019
9

 
Q U A R T E R L Y O V E R V I E W

Capital Allocations
Ñ
We capitalize our business with a combination of equity and long-term unsecured corporate debt (which we collectively refer to as corporate “capital”). Our total capital of $2.6 billion at September 30, 2019 was comprised of $1.8 billion of equity capital and $0.8 billion of convertible notes and other long-term unsecured debt.
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
Collectively, over 73% of our total funding sources are corporate capital and other long-term secured debt.
Funding Sources
(as of September 30, 2019)
400726526_q3capitalalloc.jpg
Ñ
During the third quarter, capital raising combined with the completion of a new secured financing facility and portfolio optimization raised over $476 million of capital. This combined activity included $228 million of common equity raised in early September, a $185 million long-term, non-mark-to-market, 3-year-term secured debt facility collateralized by retained Sequoia residential securities (that generated $130 million of capital, after repayment of existing financing), and $118 million from security sales.
Ñ
In late September, we issued $201 million of 5.75% 6-year exchangeable debt. This issuance will replace our exchangeable notes maturing in November of this year, and we therefore do not consider it incremental capital.
_____________________
(1) Other long-term debt represents a non-mark-to-market secured-term facility.
(2) Other includes our exchangeable notes due in November 2019, which are classified as short-term.

 
THE REDWOOD REVIEW I 3RD QUARTER 2019
10

 
Q U A R T E R L Y O V E R V I E W

 
Capital Allocation Detail
By Investment Type
September 30, 2019
($ in millions)
 
GAAP Fair Value
 
Collateralized Short-Term Debt
 
Collateralized Long-Term Debt
 
Allocated Capital
 
% of Total Capital
 
 
 
 
 
 
 
 
 
 
 
 
Residential loans (1)
$
2,420

 
$

 
$
(1,945
)
 
$
475

 
19%
 
Business purpose residential loans
226

 
(139
)
 
(14
)
 
72

 
3%
 
 
 
 
 
 
 
 
 
 
 
 
Securities portfolio
 
 
 
 
 
 
 
 
 
 
Sequoia residential securities
505

 
(155
)
 
(185
)
 
166

 
6%
 
Agency CRT securities
141

 
(8
)
 

 
133

 
5%
 
Multifamily securities
683

 
(517
)
 

 
167

 
7%
 
Re-performing residential loan securities (2)
627

 
(315
)
 
(41
)
 
270

 
11%
 
Other third-party residential securities
254

 
(163
)
 

 
91

 
4%
 
Total securities portfolio (3)
2,211

 
(1,158
)
 
(226
)
 
827

 
32%
 
 
 
 
 
 
 
 
 
 
 
 
Other investments
201

 

 

 
201

 
8%
 
Other assets/(liabilities)
 
 
 
 
 
 
(74
)
 
(3)%
 
Cash and liquidity capital
 
 
 
 
 
 
868

 
N/A
 
 
 
 
 
 
 
 
 
 
 
 
Total Investments
$
5,057

 
$
(1,297
)
 
$
(2,185
)
 
$
2,370

 
93%
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage banking
 
 
 
 
 
 
130

 
5%
 
Business purpose mortgage banking
 
 
 
 
 
 
55

 
2%
 
 
 
 
 
 
 
 
 
 
 
 
Total Mortgage banking
 
 
 
 
 
 
$
185

 
7%
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
 
$
2,554

 
100%
 
(1)
Includes $43 million of FHLB stock, $34 million of cash and cash equivalents, and $77 million of restricted cash.
(2)
Re-performing residential loan securities represent third-party securities collateralized by seasoned re-performing residential loans.
(3)
In addition to our $1.3 billion of securities on our GAAP balance sheet, securities presented above also include $257 million, $454 million, and $214 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
During the third quarter, we deployed capital into re-performing residential loan securities and business purpose residential loans, and reduced our capital allocations to Agency CRT securities, other third-party residential securities, and multifamily mezzanine securities.
Ñ
Over the last several quarters, we have increased our allocation of capital to re-performing residential loan securities. The following section provides a summary of this investment opportunity.
Ñ
At September 30, 2019, our cash and liquidity capital included $590 million of available capital.
Ñ
In October 2019, we completed the acquisition of CoreVest for $492 million, net of in-place financing on financial assets acquired, with a mix of cash on hand and shares of Redwood stock.

 
THE REDWOOD REVIEW I 3RD QUARTER 2019
11

 
Q U A R T E R L Y O V E R V I E W

Overview of Re-Performing Loan Securities Investments
Since late 2016, we have deployed $270 million of capital into primarily Freddie Mac-issued securitizations backed by seasoned, re-performing and, to a lesser extent, non-performing single-family mortgage loans (RPLs). In most cases, these loans have experienced a credit event leading up to the securitization and have been modified in order to keep the borrower in their home and current in their payments under recast loan terms. Freddie Mac transfers credit risk by selling the subordinate securities and keeping or guaranteeing the senior tranches.
The majority of our deployed capital in this asset class is invested in a securitization structure in which we own 100% of the subordinate securities and that is consolidated on our balance sheet. The senior securities in the structure represent term financing for our investment in the underlying loans and carry a low interest rate for up to 10 years. Our estimated base case returns on our securities - which represent more than 20% of the transaction capital structure - range between 10-13% on a loss-adjusted basis, inclusive of the effects of leverage applied to the mezzanine tranches.
Central to the investment thesis in these securities is the view that a significant percentage of the underlying borrowers will improve upon their delinquency history and continue paying steadily under the modified or recast terms of the loan. This improvement in performance can sometimes be linked to the assumption of servicing duties by a more “high-touch” servicer that specializes in working with borrowers to keep them current in their payments. The performance of the first consolidated RPL transaction we invested in continues to trend favorably as delinquencies have declined from 50% to 33% in less than one year. The chart below details the trends in payment status for this transaction, which we invested in during December 2018. To date, the transaction has had 0.01% in realized losses, and 5% of the original principal balance has prepaid in full.

2018 Consolidated RPL Transaction
400726526_slstgraph2.jpg

 
THE REDWOOD REVIEW I 3RD QUARTER 2019
12

 
Q U A R T E R L Y O V E R V I E W

The following table details our RPL securities by asset type as of September 30, 2019.
 
Re-Performing Residential Loan Securities by Type
September 30, 2019
($ in millions)
 
GAAP Fair Value
 
Collateralized Short-Term Debt
 
Collateralized Long-Term Debt
 
Allocated Capital
 
 
 
 
 
 
 
 
 
 
Consolidated RPL securities
 
 
 
 
 
 
 
 
Subordinate
$
454

 
$
(289
)
 
$

 
$
165

 
 
 
 
 
 
 
 
 
 
Other RPL securities
 
 
 
 
 
 
 
 
Senior / IO
70

 

 
(41
)
 
29

 
Subordinate
103

 
(26
)
 

 
76

 
Total other RPL securities
173

 
(26
)
 
(41
)
 
105

 
 
 
 
 
 
 
 
 
 
Total Re-Performing Residential Loan Securities
$
627

 
$
(315
)
 
$
(41
)
 
$
270

 


 
THE REDWOOD REVIEW I 3RD QUARTER 2019
13

 
Q U A R T E R L Y O V E R V I E W

2019 Updated Financial Outlook(1) 
We currently anticipate our full year results will be towards the higher end, overall, of the original range we provided in our fourth quarter 2018 Redwood Review.
For the remainder of 2019, we will continue to focus on key strategic initiatives to increase sustainable earnings - namely integrating the CoreVest operating platform, improving 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.
While we do not anticipate the CoreVest acquisition to meaningfully impact our 2019 expected range of returns on equity, we do expect a slight impact to the capital allocation expectations we set at the beginning of the year. Additionally, as a result of the acquisition, we expect our leverage ratio to increase toward the higher end of our historical 3.0x - 4.0x target range.
The following are additional details on our expected activity in 2019:
For our investment portfolio
Ñ
Our investment portfolio returns through the first nine months of 2019, were near the high end of the 11-13% return on equity range previously provided, benefiting from higher gains associated with increased portfolio optimization activity. For the remainder of 2019, we expect economic net interest income to increase and core realized gains to moderate, keeping expected returns for this portfolio for the full year towards the higher end of our original range of 11-13%. With the acquisition of CoreVest, we expect to allocate approximately 85% of our capital to our investment portfolio for the remainder of 2019.
Ñ
Investment returns include an estimate of portfolio economic net interest income, interest expense on corporate debt capital, core realized gains, direct operating expenses, and taxes.






____________________
(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 3RD QUARTER 2019
14

 
Q U A R T E R L Y O V E R V I E W

For our residential mortgage banking platform
Ñ
Our residential mortgage banking platform had strong performance through the first nine months of 2019, generating a return on equity in excess of our originally projected range of mid to high teens. The outperformance was driven by gross margins above our long-term expectations of 75-100 basis points and strong volume growth. For the remainder of 2019, we expect gross margins to be within our long-term expected range and volume to remain stable, supporting full year results that we expect to be above our previously disclosed return range. We expect to maintain our current 5% allocation of capital to this platform for the remainder of 2019.
Ñ
Mortgage banking returns include an estimate of loan purchase volume, gross margins, direct operating expenses, and taxes.
For our business purpose mortgage banking platform
Ñ
In May, subsequent to the acquisition of 5 Arches, we estimated we would allocate 3-4% of our capital to our business purpose mortgage banking platform for the remainder of 2019 and generate a return on equity in the low double digits.
Ñ
Inclusive of both CoreVest's origination platform and 5 Arches, we expect to allocate approximately 10% of our capital to our business purpose mortgage banking platform for the remainder of 2019. This includes the platform premiums for both businesses and the working capital required to fund single-family rental loans in inventory. For the remainder of 2019, we expect to generate an overall return on equity from the platforms of 12-14%, bringing full-year results slightly below our previously disclosed return range.
Ñ
Additionally, we expect both of these businesses to provide new accretive business purpose loans and securities for our investment portfolio, the anticipated returns on which are included in our investment portfolio outlook.
Ñ
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 amortization of purchase-related intangibles and other items, consistent with what we exclude for core earnings.
For our corporate overhead
Ñ
We continue to expect our baseline corporate operating expenses to be between $48 million and $50 million, exclusive of any CoreVest acquisition-related expenses, with variable compensation commensurate with company performance.





 
THE REDWOOD REVIEW I 3RD QUARTER 2019
15

 
Q U A R T E R L Y O V E R V I E W

Analysis and Outlook for Economic Net Interest Income
Ñ
Over the past several quarters, as demand for residential mortgage credit has continued to strengthen and drive prices higher, we have taken advantage of the opportunity to rotate out of portfolio investments whose forward return profile fell below our long-term targets. Year-to-date through the third quarter of 2019, we have sold over $500 million of securities and freed-up approximately $230 million of capital through portfolio optimization, locking in $53 million in core realized gains. These activities have benefited our GAAP and core results, but have impacted economic net interest income (ENII) as we have been selective in redeploying capital due to the overall credit spread environment. ENII is also impacted by hedging costs and premium amortization, and as such has been affected by the sharp rally in rates and overall heightened interest rate volatility we have observed since early in the second quarter of 2019.
Ñ
With substantial portfolio optimization and the CoreVest acquisition complete, our investment portfolio has meaningfully increased sustainable earnings potential and we expect ENII to begin growing in the fourth quarter of 2019 and into 2020. We anticipate the key drivers towards this increase will be:
Ñ
the investments acquired as part of the CoreVest acquisition;
Ñ
a full quarter of income from our most recent investment in RPL securities issued by Freddie Mac;
Ñ
improved returns on SFR loans originated by 5 Arches that we expect to be financed with long-term FHLB debt; and
Ñ
incremental interest income from higher-returning BPL investments created by our newly expanded BPL origination platform



 
THE REDWOOD REVIEW I 3RD QUARTER 2019
16

 
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 third and second quarters of 2019.
 
Investment Portfolio Segment Contribution
($ in millions)
 
Three Months Ended
 
 
9/30/2019
 
6/30/2019
 
 
 
 
 
 
GAAP net interest income
$
38

 
$
38

 
Change in basis and hedge interest
(3
)
 
1

 
Non-GAAP economic net interest income (1)
36

 
39

 
 
 
 
 
 
Non-GAAP other fair value changes, net (2)
15

 
2

 
Other income, net
2

 
3

 
Realized gains, net
5

 
3

 
Operating expenses
(2
)
 
(2
)
 
Provision for income taxes

 
(1
)
 
Segment contribution (3)
$
55

 
$
44

 
Core earnings adjustments (4)
 
 
 
 
Eliminate non-GAAP other fair value changes, net (2)
(15
)
 
(2
)
 
Include cumulative gain on long-term investments sold, net
20

 
13

 
Income taxes associated with core earnings adjustments

 
(1
)
 
Non-GAAP core segment contribution
$
60

 
$
54

 
(1)
During the third quarter of 2019, we updated our definition of non-GAAP economic net interest income. 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 interest 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 interest" has been reallocated between investment fair value changes and net interest income as described above.
(4)
During the third quarter of 2019, we updated our definition of core earnings. Consistent with management's definition of core earnings set forth on page 41, 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 third quarter, as we experienced a benefit to investment fair value changes from spread tightening and higher realized gains from sales of available-for-sale securities, offset by increased hedging costs from interest rate volatility and higher levels of prepayments on loans and securities held at premiums.




 
THE REDWOOD REVIEW I 3RD QUARTER 2019
17

 
Q U A R T E R L Y O V E R V I E W

Ñ
Core segment contribution improved during the third quarter, driven by an increase in gain on sale of long-term investments from portfolio optimization activities.
Ñ
We deployed $152 million of capital in the third quarter, including $55 million into proprietary investments and $98 million into third-party investments. Proprietary investments included $21 million of business purpose loans originated by 5 Arches, $21 million into Sequoia RMBS, and $12 million into a home equity shared appreciation investment. Third-party investments included $73 million of Freddie Mac subordinate re-performing loan securities, $16 million of Agency CRT securities, a $5 million multifamily mezzanine loan, $3 million of Agency multifamily securities, and $1 million of third-party securities.
Ñ
During the third quarter, we sold $262 million of lower yielding securities, which freed up approximately $118 million of capital for redeployment. Additionally, we completed a 3-year secured, non-mark-to-market term securities repurchase facility that generated approximately $130 million of capital for redeployment (after repayment of existing financing), while effectively enhancing the yield on the portfolio.
Ñ
Credit fundamentals in our investment portfolio remain strong, benefiting from continued stability in the general economy and in housing.




 
THE REDWOOD REVIEW I 3RD QUARTER 2019
18

 
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
 
 
9/30/2019
 
6/30/2019
 
 
 
 
 
 
Residential Mortgage Banking
 
 
 
 
Net interest income
$
5

 
$
4

 
Mortgage banking activities, net
5

 
15

 
Mortgage banking income
10

 
20

 
 
 
 
 
 
Other income, net

 

 
Operating expenses
(6
)
 
(6
)
 
Provision for income taxes

 
(1
)
 
Residential mortgage banking segment contribution
$
5

 
$
13

 
 
 
 
 
 
Business Purpose Mortgage Banking
 
 
 
 
Net interest income
$
1

 
$

 
Mortgage banking activities, net
4

 
4

 
Mortgage banking income
5

 
4

 
 
 
 
 
 
Other income, net
 
 
 
 
Loan administration fees and other
2

 
2

 
Amortization of intangible asset expense
(2
)
 
(2
)
 
Operating expenses
(6
)
 
(6
)
 
Provision for income taxes

 

 
Business purpose mortgage banking segment contribution
$
(1
)
 
$
(2
)
 
 
 
 
 
 
Mortgage banking segment contribution
$
3

 
$
11

 
 
 
 
 
 
Core earnings adjustments (1)
2

 
2

 
Non-GAAP core segment contribution (2)
$
5

 
$
12

 
Jumbo loan purchase commitments
$
1,700

 
$
1,695

 
(1)
Includes amounts to eliminate purchase accounting adjustments and income tax adjustments of $0.4 million for both the third and second quarters of 2019, related to our business purpose mortgage banking operations.
(2)
Consistent with management's definition of core earnings set forth on page 41, non-GAAP core segment contribution reflects GAAP segment contribution adjusted to reflect the portion of core earnings adjustments allocable to this segment.

 
THE REDWOOD REVIEW I 3RD QUARTER 2019
19

 
Q U A R T E R L Y O V E R V I E W

Residential Mortgage Banking
Ñ
Segment contribution from our residential mortgage banking operations decreased to $5 million in the third quarter from $13 million in the second quarter, due to lower gross margins on stable volume of purchase commitments. We define gross margins for this segment as mortgage banking income divided by loan purchase commitments.
Ñ
Rate volatility during the quarter negatively impacted margins as the sharp decline in rates impacted execution on our mortgage loan pipeline. Toward the end of the quarter, volatility decreased and we saw pricing and margins improve.
Quarterly Jumbo Loan Purchase Volume
($ in billions)
400726526_q3purchases3a01.jpg
Ñ
The continued lower interest rate environment helped keep mortgage purchase volumes elevated, and we saw a 37% increase in Choice purchase volume, representing record quarterly volume for this loan type. At September 30, 2019, our pipeline of jumbo residential loans identified for purchase was $1.3 billion.
Ñ
During the third quarter, we completed one Select securitization of $376 million and two Choice securitizations totaling $727 million. Additionally, we sold $470 million of whole loans to third parties.

Business Purpose Mortgage Banking
Ñ
Non-GAAP core segment contribution from our business purpose mortgage banking operations was $0.2 million for the third quarter.
Ñ
During the third quarter of 2019, we originated $162 million of loans and associated funding commitments, including $126 million of residential bridge loans and $36 million of single-family rental loans. Loan fundings during this period totaled $127 million, including $91 million of residential bridge loans and $36 million of single-family rental loans.



 
THE REDWOOD REVIEW I 3RD QUARTER 2019
20

 
Q U A R T E R L Y O V E R V I E W

Update on Contribution from 5 Arches
Ñ
The third quarter of 2019 represented our second full quarter of ownership of the 5 Arches platform, following our initial 20% investment in the platform in May 2018 and our full acquisition of the company in March 2019. We currently retain the majority of the single-family rental and bridge loans originated by 5 Arches, and at September 30, 2019, our portfolio of these assets totaled $336 million. Since the end of the third quarter, 5 Arches has originated an additional $140 million of business purpose loans (through October 28th), all of which we have retained on our balance-sheet.

Cumulative Business Purpose Loans on Balance Sheet
($ in millions)
400726526_bplgraph2.jpg
Ñ
Since our initial minority investment in 5 Arches and through September 30, 2019, we have deployed $68 million of capital into $207 million of bridge loans created by 5 Arches, which have generated core returns on capital of approximately 11% for our investment portfolio. Optimizing this capital for our currently available financing terms, we estimate levered returns to increase to 12-15%.
Ñ
Additionally, during the third quarter we began financing 5 Arches originated SFR loans using our FHLB financing facility and as of September 30, 2019, we had $17 million of these loans financed with FHLB borrowings. Going forward, we anticipate transferring the majority of our remaining 5 Arches-originated SFR loans to our investment portfolio and financing them at the FHLB with an estimated core return on capital of 11-12%.
Ñ
Total operating revenue in the third quarter of 2019 from 5 Arches origination and asset management activities rose 16% from the prior quarter, versus a 6% increase in operating expenses.

 
THE REDWOOD REVIEW I 3RD QUARTER 2019
21

 
Q U A R T E R L Y O V E R V I E W

Balance Sheet Analysis
The following table presents our consolidated balance sheets at September 30, 2019 and June 30, 2019.
 
Consolidated Balance Sheets (1)
($ in millions)
 
9/30/2019
 
6/30/2019
 
 
 
 
 
 
Residential loans
$
8,682

 
$
7,283

 
Business purpose residential loans
336

 
251

 
Multifamily loans
3,792

 
3,750

 
Real estate securities
1,285

 
1,477

 
Other investments
348

 
372

 
Cash and cash equivalents
395

 
218

 
Other assets
639

 
500

 
 
 
 
 
 
Total assets
$
15,476

 
$
13,852

 
 
 
 
 
 
Short-term debt
 
 
 
 
Mortgage loan warehouse facilities
$
233

 
$
638

 
Business purpose mortgage loan warehouse facilities
198

 
174

 
Security repurchase facilities
1,158

 
1,214

 
Servicer advance financing
191

 
236

 
Convertible notes, net
201

 
200

 
Other liabilities
410

 
340

 
Asset-backed securities issued
 
 
 
 
Residential
4,768

 
3,370

 
Multifamily
3,578

 
3,543

 
Long-term debt, net
2,954

 
2,573

 
Total liabilities
13,691

 
12,288

 
 
 
 
 
 
Stockholders’ equity
1,785

 
1,564

 
 
 
 
 
 
Total liabilities and equity
$
15,476

 
$
13,852

 
(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 September 30, 2019 and June 30, 2019, assets of consolidated VIEs totaled $9.6 billion and $7.9 billion, respectively, and liabilities of consolidated VIEs totaled $8.6 billion and $7.2 billion, respectively. See Table 10 in the Financial Tables section of this Redwood Review for additional detail on consolidated VIEs.
Ñ
We have invested in several securitizations that we were required to consolidate under GAAP. See Table 9 in the Financial Tables section of this Redwood Review for additional information on these securitizations and other entities that we consolidate.

 
THE REDWOOD REVIEW I 3RD QUARTER 2019
22

 
Q U A R T E R L Y O V E R V I E W

Residential Loan Investments
Ñ
At September 30, 2019, we had $2.3 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 September 30, 2019, 88% of these loans were fixed rate and the remainder were hybrid, and in aggregate, had a weighted average coupon of 4.16%.
Ñ
At September 30, 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 September 30, 2019, 0.03% of these loans (by unpaid principal balance) were more than 90 days delinquent.
Ñ
We finance our residential loan investments with $1.9 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.
Business Purpose Residential Loan Investments
Ñ
At September 30, 2019, our $226 million of business purpose residential loans held-for-investment were comprised of $207 million of short-term, residential bridge loans, which were originated in 2018 and 2019, and $19 million of single-family rental loans, which were financed with variable-rate FHLB debt through our FHLB-member subsidiary.
Ñ
At September 30, 2019, the residential bridge portfolio contained 392 loans with a weighted average coupon of 8.90% and a weighted average LTV ratio of 70% (at origination). At September 30, 2019, nine of these loans with a cumulative unpaid principal balance and fair value of $6 million were more than 90 days delinquent or in foreclosure. These delinquent loans had a weighted average LTV ratio of 79% (at origination), and we currently expect to recover the full carrying amount of these loans. Since September 30, 2019, two of these loans with a cumulative unpaid principal balance and fair value of $1 million were resolved with full repayment of principal, regular interest and expenses.
Ñ
We finance our residential bridge loan investments with warehouse debt that had a balance of $139 million at September 30, 2019.
Ñ
At September 30, 2019, our business purpose residential warehouse capacity for financing residential bridge loans totaled $330 million across four separate counterparties.


 
THE REDWOOD REVIEW I 3RD QUARTER 2019
23

 
Q U A R T E R L Y O V E R V I E W

Securities Portfolio
The following table presents the fair value of our real estate securities at September 30, 2019.
 
Securities Portfolio - By Source and Security Type
September 30, 2019
($ in millions)
 
Interest-Only Securities
 
Senior
 
Mezzanine
 
Subordinate
 
Total
 
% of Total Securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sequoia (1)
$
55

 
$

 
$
251

 
$
200

 
$
505

 
23
%
 
Re-performing (2)
29

 
41

 
416

 
140

 
627

 
28
%
 
Agency CRT

 

 

 
141

 
141

 
6
%
 
Other third-party

 
84

 
89

 
81

 
254

 
12
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total residential securities
$
84

 
$
125

 
$
756

 
$
562

 
$
1,527

 
69
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Multifamily securities (3)

 

 
494

 
190

 
683

 
31
%
 
Total securities portfolio
$
84

 
$
125

 
$
1,249

 
$
752

 
$
2,211

 
100
%
 
(1)
Presents securities retained from our Sequoia securitizations that were issued from 2012 through 2019. These securities included $13 million of interest-only securities, $181 million of mezzanine securities, and $63 million of subordinate securities retained from our Sequoia Choice securitizations, which were consolidated for GAAP purposes.
(2)
Re-performing securities included $454 million of mezzanine and subordinate securities issued from Agency residential securitizations that are consolidated for GAAP purposes.
(3)
Multifamily securities included $24 million of mezzanine securities and $190 million of subordinate securities issued from Agency multifamily securitizations that are consolidated for GAAP purposes.
At September 30, 2019, our securities consisted of fixed-rate assets (90%), adjustable-rate assets (7%), hybrid assets that reset within the next year (2%), 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 and long-term debt. At September 30, 2019, we had short-term debt incurred through repurchase facilities totaling $1.2 billion with nine separate counterparties, which was secured by $1.4 billion of real estate securities. Additionally, we had long-term debt incurred through FHLB borrowings and secured term facilities totaling $226 million which was secured by $294 million of securities. The remaining $474 million of securities were financed with capital.

 
THE REDWOOD REVIEW I 3RD QUARTER 2019
24

 
Q U A R T E R L Y O V E R V I E W

The following table presents the fair value of our real estate securities that are financed with repurchase debt, at September 30, 2019.
 
Real Estate Securities Financed with Repurchase Debt
September 30, 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
$
84

 
$
(77
)
 
$
7

 
$
101

 
8
%
 
Mezzanine
289

 
(249
)
 
40

 
104

 
14