2023-05-02 14:20:53 ET
Summary
- RWT plans to cut its dividend by 20-30% next quarter.
- However, trading at a 0.64x book value that is showing signs of stabilization, the stock looks too cheap to ignore.
- The stock looks like a "Buy" for risk-tolerant investors.
Everything has a price, and with Redwood Trust ( RWT ) trading at a 0.64x book value that is starting to stabilize, it looks like an interesting option for more aggressive investors.
Company Profile
RWT is a specialty finance company. The firm operates in three segments and is classified as a real estate investment trust ((REIT)).
Its Residential Mortgage Banking segment acquires residential loans from third-party originators, with a focus on jumbo loans. It then sells the loans to whole loans buyers, securitizes them through its private label platform, or transfers them to its investment portfolio.
RWT’s Business Purpose Mortgage Banking segment, meanwhile, originates and acquires business purpose lending ((BPL)) loans, which are loans to investors in multifamily or single-family rentals. These can be either term loans that mature between 3-30 years, or bridge loans that mature in 12-36 months. These loans are sold, securitized, or transferred to RWT’s investment portfolio. The segment generates revenue from net interest earned on loans while they are held and fees.
The firm’s investment portfolio consists of residential mortgage loans (prime jumbo loans) and BPL loans, as well as other RMBS, CRT, investments in Freddie Mac K-Series multifamily loan securitizations and reperforming loan securitizations, and home equity investments.
RWT also has a small investment arm that invest in early-stage fintech, real estate technology, and other companies. It had 31 investments worth $27 million in 26 portfolio companies at the end of Q1.
Q1 Earnings Results
For Q1, RWT saw recorded EPS of 2 cents. That compared to EPS of 24 cents a year ago. It’s the first GAAP profit the firm has reported in the past four quarters.
Adjusted earnings available for distribution was 11 cents per share. That compared to a loss of -11 cents in Q4.
Its net interest income was $26 million versus $53 million a year ago. NII was $27 million in Q4.
Book value fell to $9.40 from $9.55 in Q4, a -1.6% decrease. The company paid out a 23-cent dividend, unchanged from a year ago.
Commenting on the quarter , CEO Christopher Abate said:
“Since March 31, we've continued to protect book value and estimate our current book value is flat from quarter end. The notable improvement in first quarter earnings was largely driven by healthier mortgage banking activities including almost $1 billion in whole loan distributions across our residential and business purpose lending platforms. These dispositions freed up meaningful capital left us with relatively light inventories, particularly in Residential Mortgage Banking, where we've chosen in recent quarters, to be very conservative with our capital and market positioning. This is in light of the rapidly rising rates and subsequent volatility the market has endured over the past year.
“In step with the reduced capital allocation, we took further steps in the first quarter to reduce costs, allowing our operating platforms to run more efficiently going forward. With continued low leverage, strong financing and robust liquidity, our balance sheet today remains strong and will allow us to be flexible and capitalize on market opportunities.”
Probably the most important thing to come out of the quarter was the stabilization of book value. The company has seen a big decline in book value over the past year, as have many companies that invest in fixed-income securities, so this was a good sign. However, the company is still paying out a dividend that it can’t cover and will have to reduce it, which it plans to do next quarter. That shouldn't be surprising.
Opportunities and Risks
Similar to traditional agency mortgage REITs, RWT is a spread business where it uses short-term financing to buy loans for its investment portfolio. Where it differs is that it has a pretty large origination business that focuses on BPL loans, while on the residential side it tends to focus on jumbo mortgages. These loans also carry credit risk, and as such, it uses a lot less leverage than the typical agency mortgage REIT.
As with other firms that invest in fixed-income securities, RWT’s portfolio has been hurt by rising interest rates. However, it has shifted much of its portfolio towards BPL bridge loans that should carry less interest rate risk and which given their short-term nature can easily be held to maturity.
At present, BPL bridge loans represent the bulk of RWT’s portfolio, with about a 65% economic interest. 82% of the loans are due within two years, with the other 18% due between 2-3 years. These loans are largely floating rate and thus don’t carry much if any interest rate risk. Delinquencies meanwhile have remained low, are loans due past 90 days were only 2.1% of the portfolio in Q1, towards the loan end of its historical 1.9%-6.2% range.
The rest of RWT’s investment portfolio is a mix of jumbo, single-family residential, home equity, RPL securities (re-performing single-family mortgage loans), multi-family, and CRT. These are generally seasoned loans, and its RPL and jumbo loan portfolios both have high adjusted LTVs (loan to values) of over 43%.
RWT says that the carrying value of its subordinated portfolio is only 63% of face value, giving it $4.10 of book value upside it the securities were to return to face value. Over half of that comes from RPL securities, which have 16.3 years of seasoning and a 43.6% adjusted LTV. These look like pretty good loans if the company wants to hang onto them and not worry too much about mark-to-market moves.
The firm has also done a decent job of lowering its recourse leverage, taking it from 2.8x at the end of Q4 to 2.3x at the end of Q1. It now has unrestricted cash of $404 million versus $259 million at the end of last year.
Conclusion
Most firms that have fixed-income portfolios have likely experienced some rocky times recently given the sharp jump in interest rates. For Q1, RWT's portfolio showed some stabilization, and it's moved much of its investments into bridge BPL loans, which shouldn’t face interest rate risk. Now the firm does face credit risk in a potential weakening economy, but its BPL loans have performed well and much of the rest of its portfolio is in seasoned loans with high LVTs, which should limit risk as well.
For mortgage REITs, I usually look at a price to book as the best way to value them. On that front, RWT trades at about 0.64x book. That’s a fairly significant discount following a quarter in which its book value showed signs of stabilization. Meanwhile, some of its assets certainly have the characteristics to recover some of their value as well.
RWT currently has a yield of about 15%, but the dividend isn’t covered, and the company said it would cut it probably by 20-30% in Q2 on the conference call. That would put the yield around 11%.
I think when you can buy assets at 64 cents on the dollar when the mark-to-market declines seem to be stabilizing that’s a pretty good deal. As such, I think RWT looks like a “Buy” for more aggressive investors.
For further details see:
Redwood Trust: The Dividend Will Be Cut, But The Valuation Is Appealing