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Redwood Trust turns in “disappointing” first quarter

Net income falls from $27 million to $15 million

Redwood Trust (RWT) saw its net income fall again in the first quarter of 2015, falling from $27 million in the fourth quarter of 2014 to $15 million in the first quarter.

The fourth quarter net income totals were down as well, falling by $18 million from $45 million in the third quarter to $27 million.

Those declines were in sharp contrast with the real estate investment trust’s performance in the third quarter of 2014, when its net income nearly tripled, rising from $16 million in the second quarter to $45 million in the third quarter.

Redwood also reported estimated REIT taxable income of $15 million, or $0.18 per share, for the first quarter of 2015. This compares to estimated REIT taxable income of $16 million, or $0.19 per share, for the fourth quarter of 2014 and estimated REIT taxable income of $15 million, or $0.19 per share, for the first quarter of 2014, the company said.

In a letter to shareholders, Redwood’s CEO, Marty Hughes, and president, Brett Nicholas, said they were “disappointed” by the results of the first quarter.

“During the first quarter, we continued to face difficult market conditions, in particular from high interest rate volatility, which negatively impacted our GAAP earnings,” Hughes and Nicholas said. “While our first quarter results were disappointing, we did a good job navigating through the turbulence and at the same time further advancing our residential and commercial business franchises to capitalize on opportunities we see evolving in the mortgage markets.”

Hughes and Nicholas cite the declining interest rate environment as an impairment to Redwood’s success.

“Similar to the fourth quarter of 2014, our hedging strategies were effective in economically protecting our balance sheet against the overall decline in interest rates that occurred during the first quarter,” Hughes and Nicholas said.

“Unfortunately, for accounting purposes, the negative impact on our mortgage servicing rights investments was recorded to our income statement, reducing earnings, while the offsetting positive impact of declining interest rates on our securities investments was primarily unrealized for accounting purposes and recorded to our balance sheet.”

Hughes and Nicholas go on to discuss why Redwood’s business is impacted by interest rate fluctuations.

“Interest rate volatility poses a challenge to our businesses overall, but is particularly disadvantageous for our jumbo residential and commercial mortgage banking activities. Why? Through our mortgage banking activities, we generally commit upfront to acquire or originate loans, which we typically intend to securitize or sell,” Hughes and Nicholas said.

“High interest rate volatility creates pricing uncertainty that generally results in senior triple-A investors and whole loan buyers demanding higher liquidity premiums (lower prices) to compensate them for the heightened uncertainty,” they continued. “We assume this risk as part of our business model and seek to address it on a go-forward basis by adjusting our loan acquisition and origination pricing, which we did for both businesses during the first quarter.”

While Hughes and Nichoals said that Redwood’s jumbo securitizations were “adversely impacted” by the first quarter’s interest rates, the jumbo product line is “off to a good start” in the second quarter.

“Interest rate volatility has calmed and loan sale pricing has firmed. During the second quarter, we expect to clear the vast majority of our first quarter jumbo pipeline and inventory at or above our quarter-end marks,” Hughes and Nicholas said. “To date in the second quarter, we had new loan sales totaling $480 million through the bulk whole-loan market and a Sequoia securitization transaction that, taken together, were executed at pricing levels significantly above our March 31st quarter-end marks.”

Redwood listed several highlights in its letter to investors, including:

We earned $0.16 per share for the first quarter of 2015, as compared to $0.31 per share for the fourth quarter of 2014. Earnings declined from the prior quarter primarily as a result of lower margins on jumbo loan sales as well as negative market valuation adjustments on mortgage servicing rights (MSRs) due to declining benchmark interest rates

Our GAAP book value at March 31, 2015, was $15.01 per share, as compared to $15.05 per share at December 31, 2014. The decline in earnings and its impact on book value was largely offset by our cumulative hedging results – much of which was not reflected in earnings. Our March 31, 2015 book value also reflects the $0.28 per share dividend we paid to shareholders in the first quarter

We deployed $133 million of capital in the first quarter of 2015, as compared to $159 million in the fourth quarter of 2014. Over two-thirds of the new investments we recorded over these periods were created through our residential and commercial mortgage-banking operations

Residential loans identified for purchase increased 32% to $3.7 billion during the first quarter of 2015 compared with $2.8 billion during the fourth quarter of 2014. At March 31, 2015, our pipeline of residential loans identified for purchase was $1.8 billion and included $1.4 billion of jumbo loans and $0.4 billion of conforming loans, unadjusted for fallout expectations

We completed one Sequoia securitization of $339 million during the first quarter (SEMT 2015-1), and created $8 million of new investments for our portfolio. In addition, we sold $511 million of jumbo loans to third parties during the first quarter of 2015. Our FHLB member subsidiary pledged $447 million of jumbo loans to the FHLBC, investing approximately $82 million of capital

Total commercial loan originations were $100 million for the first quarter of 2015 and included $93 million of senior loans and $8 million of mezzanine loans, as compared to $326 million of senior loans and $22 million of mezzanine loans for the fourth quarter of 2014. At April 30, 2015, our pipeline of senior loans (loans closed or under application) was $275 million

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