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Redwood Trust shifts away from Fannie, Freddie conforming loans

Ending purchases of GSE loans; also ceases commercial loan originations for CMBS

Seeking to rid itself of two business segments that are dragging on the real estate investment trust’s bottom line, Redwood Trust announced recently that it will be discontinuing the acquisition and aggregation of conforming loans for sale to Fannie Mae and Freddie Mac, and will also discontinue commercial loan originations for distribution in commercial mortgage-backed securities.

Late last month, Redwood Trust announced its plans relating to its Fannie and Freddie loan business.

At the time, Redwood Trust said that its conforming loan purchase and sale operations generated a pre-tax loss of $10 to $11 million in 2015 or a loss of $7 to $8 million on an after-tax basis based on the REIT’s preliminary full-year 2015 results.

According to Christopher Abate, Redwood Trust’s chief financial officer, that included interest and fees of approximately $12 million associated with $5.2 billion of loan purchases, and operating expenses of approximately $22 million.

Abate said as a result of the restructuring, the REIT will eliminate this “earnings drag” from its conforming operating activities going forward and free up $45 million of capital for re-investment during 2016.

Redwood Trust said that instead of acquiring loans for sale to Fannie and Freddie, it will focus on direct conforming-related investments in mortgage servicing rights and risk-sharing transactions.

Redwood Trust said that as a result of this decision, the REIT plans to implement a “workforce reduction,” which primarily impacts the employees engaged in and supporting the REIT’s residential mortgage loan business. 

Redwood Trust said that the cuts will result in a 25% reduction in its workforce.

"One of our goals over the past few months has been to closely evaluate both our residential and commercial business operations and our corporate expense structure to look for ways to increase efficiency and profitability in the face of significant competitive pressures and market dislocations," Marty Hughes, chief executive officer of Redwood Trust, said last month. "Today's announcement specifically addresses our actions related to our conforming loan activities, which we view as necessary as we do not see the competitive pressures easing for the foreseeable future.”

According to Redwood Trust, its conforming business activities use less than 5% of the company’s capital, while its investment portfolio, which utilizes 85% of the company's capital base, continues to display “strong credit performance” and “remains a steady and growing source of income.”

Brett Nicholas, Redwood Trust’s president, said that that the REIT will maintain seller/servicer approvals with both Fannie Mae and Freddie Mac and “keep its options open” to take advantage of “future opportunities” in the conforming loan market.

“The full range of our jumbo loan business, as well as our re-focused conforming loan business, will still be conducted in all of our current office locations," Nicholas said.

“We know the restructuring of our conforming operations will be difficult on the hardworking employees impacted by today's announcement and we sincerely appreciate their contributions to the company," Hughes added.

"Our goal is to enhance Redwood's competitive position in each of our businesses while boosting profitability through more efficient operating platforms,” Hughes said. “As market conditions for both our residential and commercial businesses develop over the year, we will continue to respond to them from a revenue, expense, and risk-management perspective to best position Redwood for success in the near- and long-term future."

And speaking of that commercial business, Redwood Trust also announced earlier this week that it plans to cease commercial loan originations for CMBS distribution.

Hughes said that the change is due to “challenging market conditions” that the REIT’s CMBS conduit has faced recently.

“We have concluded that the challenging market conditions our CMBS conduit has faced over the past few quarters are worsening and are not likely to improve for the foreseeable future,” Hughes said during the 2016 outlook for investors.

"The escalation in the risks to both source and distribute loans through CMBS, as well as the diminished economic opportunity for this activity, no longer make our commercial conduit activities an accretive use of capital," he added.

According to a release from Redwood Trust, the company has focused on both investing in commercial mezzanine loans and originating commercial senior loans for sale into CMBS transactions since 2010. 

During the last five-plus years, Redwood Trust said that it originated more than $2.5 billion of commercial loans, generated more than $50 million of revenues from the sale of loans into CMBS transactions, and created a portfolio of commercial mezzanine loans that totaled approximately $300 million as of the end of 2015.

According to Redwood Trust, that commercial loan portfolio generated approximately $30 million of net interest income during 2015, based on preliminary financial results. 

But going forward, Redwood will no longer originate either senior or mezzanine commercial loans.

"We have a strong track record as a long-term credit investor, focused on building net interest income for our investment portfolio, and we can continue to opportunistically invest in mezzanine and subordinate CMBS tranches that meet our risk/return profile," Nicholas said. "The market dislocations that negatively impacted our CMBS conduit may create opportunities to deploy capital into attractive investments in CMBS or other commercial transactions."

As with the cutbacks in the Fannie, Freddie conforming loan business, the changes in the commercial loan segment will also result in a workforce reduction, the company said.

According to Redwood Trust, the move will result in a workforce reduction that will impact 25 employees primarily engaged in commercial loan origination activities.

Redwood plans to retain a team of commercial professionals to support the company's portfolio of commercial mezzanine loans as well as focus on additional commercial portfolio investments, the REIT said.

But Abate said that the decision to reduce Redwood’s commercial operations will help the business moving forward.

"Our commercial loan origination activities resulted in a pre-tax loss of approximately $3 million in 2015, or a loss of approximately $2 million on an after-tax basis, based on our preliminary full-year 2015 results. This included operating expenses of approximately $8 million," Abate said. "As a result of discontinuing these loan origination activities, we expect to eliminate this earnings drag going forward and free up approximately $100 million of capital for future investments."

Analysts at Nomura said that both moves should be positive for the REIT’s future.

“The restructuring announcement is positive from our perspective – the economics weren’t there and management is moving its feet,” Nomura’s Brock Vandervliet and Vilas Abraham said of Redwood’s Fannie, Freddie loan pullback.

“Assuming continuation of the current rate of one jumbo securitization/quarter and no agency activity going forward, there should be much less volatility in the results as the mortgage banking line shrinks,” the analysts continued. “Longer term, this should benefit the valuation.”

In a separate note, Nomura said that the two moves, collectively, are “positive steps” for the REIT, because the company is acknowledging “hard market realities” but also freeing a “substantial” amount of capital ($150 million) that can be used for share repurchase or other strategic use.

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