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Redwood Belief (NYSE:RWT) has an over 20% return since I positioned a “Purchase” score on the REIT in Might. With different mortgage REITS struggling, let’s take a better have a look at the identify forward of its Q3 earnings.
Firm Profile
As a refresher, RWT is a specialty finance firm that’s categorised as a REIT (actual property funding belief). It operates in three segments.
The agency has an funding portfolio consisting of largely enterprise function lending (BPL) loans and prime jumbo residential mortgages. It additionally has investments in different RMBS, CRT, Freddie Mac Okay-Collection multifamily mortgage securitizations and reperforming mortgage securitizations, and residential fairness investments.
Its Enterprise Function Mortgage Banking section acquires or originates enterprise function lending (BPL) loans which are then bought, securitized, or transferred into its funding portfolio. BPL are loans given out to buyers in multifamily or single-family leases, and can both be time period loans or bridge loans.
RWT’s Residential Mortgage Banking section, in the meantime, purchases jumbo loans, which it then places in its funding portfolio, sells them to complete mortgage patrons, or securitizes them by its non-public label platform.
The corporate additionally has an funding automobile that invests in early-stage fintech, actual property expertise, and different corporations.
Q2 Earnings Outcomes
For Q2, RWT recorded EPS of 0 cents. That in comparison with EPS of -85 cents a yr in the past.
Adjusted earnings accessible for distribution was 14 cents per share. That in comparison with 11 cents in Q1 and
Its internet curiosity earnings was $26 million versus $40 million a yr in the past. NII was $26 million in Q1.
E-book worth fell to $9.26 from $9.40 in Q1, a -1.5% lower. The corporate paid out a 16-cent dividend, down from 23 cents final quarter.
Wanting forward, the RWT’s administration was very enthusiastic about regulatory modifications occurring within the banking business and the way it might positively influence the agency.
On its Q2 earnings name, CEO Christopher Abate mentioned:
“Quick forwarding to at the moment, we’re witnessing yet one more spherical of coverage modifications in Washington that may kick off this subsequent period of the mortgage market. The outgoing period, characterised by a 41% enhance in residence costs since 2020, was fueled by extraordinarily accommodative Fed financial and authorities fiscal coverage in response to the COVID-19 pandemic. With benchmark Fed charges diminished to successfully 0 throughout this era, banks had an virtually limitless provide of deposit capital to lend because the nation battled COVID. Many banks selected to opportunistically put that cash to work in 30-year jumbo mortgages. And these mortgages had been predominantly held in portfolio for funding reasonably than distributed into the capital markets. These mortgage portfolios proved to be sound credit score investments and posed a bit principal danger to the banks, however the rate of interest mismatch between the 30-year loans and the deposits funding them was undeniably vital, and in lots of instances, very dangerous. Whilst benchmark Treasury payments gapped from close to 0 in January 2021 to over 5% in March 2023, the perceived stickiness of deposits compelled many banks to proceed providing mortgages to most well-liked purchasers at charges properly beneath market. Actually, previous to the onset of the regional financial institution disaster this previous March, depositories originated 2/3 of all jumbo mortgages within the first quarter. As we take inventory of the scenario at the moment, the price of deposit capital is now rising quickly, and deposits proceed to steer the banking system with each shoppers and companies demanding a lot larger charges on their financial savings. However as well as, the regulatory capital costs for residential mortgages held at banks are about to rise as properly. The place does the non-agency market go from right here? Effectively, for a lot of of those banks, persevering with to supply aggressive mortgage merchandise to retain their purchasers will likely be crucial, and the options Redwood affords are a logical different to portfolio lending.”
As for the BPL market, the agency famous volumes had been down modestly sequentially, with fastened time period originations down. The corporate is anticipating the market to select up within the second half.
At current, BPL bridge loans symbolize the majority of RWT’s portfolio, with about an 68% financial curiosity. Abut 90% of the loans are due inside two years, with the opposite 10% due between 2-3 years. These loans are largely floating charge and thus should not carry a lot rate of interest danger.
Delinquencies, nevertheless, ticked up meaningfully quarter over quarter. Loans due previous 90 days had been 4.9% of the portfolio in Q2, up from solely 2.1% of its portfolio in Q1. Traditionally, these loans have a delinquency charge of between 1.9%-6.2%. The geographical mixture of the loans are fairly diversified, with Georgia and Texas the 2 largest states at 16% every.
How a lot ebook worth declines will probably be what drives the inventory when it reviews earnings. Nevertheless, buyers also needs to preserve a detailed eye on delinquency tendencies.
Valuation and Conclusion
When valuing mortgage REITs, I often have a look at a value to ebook as one of the best ways to worth them. On that entrance, RWT trades at about 0.73x ebook. That is a pleasant low cost. Nevertheless, ebook worth can change fairly shortly as evidenced by AGNC (AGNC) warning that its ebook worth had fallen about -25% for the reason that finish of Q1.
Now there are some main variations between the 2 mortgage REITs. One is that the majority of RWT’s portfolio is in BPL loans, which should not have the rate of interest sensitivity that AGNC’s portfolio has. Now RWT’s investments in jumbo mortgages and different interest-rate delicate funding will take a success in mark-to-market worth, however this makes up a smaller proportion of its portfolio.
RWT additionally carries a lot much less leverage than conventional company mortgage REITs. The agency has solely 2.2x recourse leverage on the finish of Q2, whereas AGNC had 7.2x. That further leverage goes to exacerbate the mark-to-market declines in a portfolio.
What buyers might want to watch with RWT that they do not must with conventional company REITs is delinquency charges. The agency noticed a reasonably large enhance final quarter. Total delinquency charges for multi-family properties stays low, however has began to tick up some. This is without doubt one of the huge dangers for RWT at the moment given the present macro backdrop.
Total, I might anticipate RWT’s ebook worth to say no when it reviews its outcomes subsequent week, however not almost to the extent of company mortgage REITs. Given its present giant low cost to ebook, I believe the inventory stays enticing, though I might wait till after earnings to be a brand new cash purchaser and in addition see how delinquencies are holding up. That mentioned, I see no purpose to alter my long term “Purchase” score at this level. The inventory at present yields over 9.5%.