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Redwood Trust, Inc. Message Board

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  • craigla11956 craigla11956 Dec 10, 2007 11:44 AM Flag

    Craig - Check my Math

    Your math is excellent! The issue isn't the math - it's the assumptions. Before I address your post, please respond to this (if you don't mind).

    The Redwood Report for 9/30 states the following (I believe on page 100):

    Residential R/E Loans: $7.546bn
    Internally Designated Credit Reserves: $15.195mm
    External Credit Enhancements: 0
    Total Credit Protection: $15.195mm, or .20% of Total Loans
    Seriously Delinquent Loans: $56.068mm, or .74%

    Please help me with your earlier contention that there are CES tied to this portfolio (Redwood's owned) that results in much higher effective reserves against the portfolio than the 20 basis points show above.

    Of course, as I've stated, the short play here is the complete inadequacy of their reserves, a well as coming write downs on their CMBS portfolio (where spreads have widened to 500 basis points).

    As for your contention about ROI on the cash, my first question is why they're raising equity at < $30/share? As a CFO of 4 companies, isn't this close to dilutive (given their claim their adjusted book value is over $28/share)? If this thing is so undervalued and oversold, why not do a follow-on offering in the $40s? And if they're going to be earning $8/share (or whatever you showed), do a convert with a 20% premium! CFO 101 ...

    20% premium would give them equity at well over $40 - not under $30!

    I think they NEED the liquidity NOW, as their constant prepayment rate is probably coming WAY DOWN given the fact consumers are having an extremely difficult time getting refinanced (high FICO scores notwithstanding).

    SO they notion of investing this liquidity and attaining a 20% ROI is a great goal, and quite a sanguine view of Redwood. My counter is something much uglier is at work:

    Much less liquidity due to less refinancing; credit defaults increasing (s they are nationally, across sub-prime AND prime portfolios).

    Thoughts? Thanks.

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    • Hello My Friend:

      The resi loan portfolio only has traditional credit reserves of $15mm against the $7.5 billion of loans for a ratio of 0.20%. There are no CES tied to this and if I implied so earlier, I did not mean to. The CPR on this portfolio in 3Q07 was 37%, down from 44% in 2Q07, but still very high. RWT's high quality borrowers can refinance.

      Only RWT's investment in CES have CES that are junior to RWTs. On page 98, the face value of the securities for which RWT holds a CES is $211.9 billion. RWT owns CES with a principal or face balance of $1.269577 billion of which $450.8 million has been allocated toward reserves, $127 million is unamortized discount, and $159 million are unrealized losses, which nets to an on-balance sheet value of $532.445 million. There are also $335.7 million of other CES owned by 3rd parties that are junior to RWT's CES. The correct way to look at the credit protectin for RWT's net investment of $532 million of CES is the company's own internally designated reserves of $451 million, plus all of the CES that are junior to RWTs ($336 million), which totals $786.5 million, or 0.37% of the $212 billion of total securities.

      They sold equity at the spot close, about $29 million, which was not dilutive to core book of about $28. They sold it to take advantage of the opportunties they see to acquire assets at bargin prices that are being dumped in the market. Note that the Super SIV is being downsized since banks are deciding to sell assets rather than delay the final resolution. This will or is helping RWT.

      I never understood how to price a convertible so I can't add anything there. I know RWT had converts in the past, and I was an investor then.

      Finally, I don't think they will earn $8, but there is the potential if you take the current core run rate in 3Q, annualize it, and add the incremental EPS from this capital raise, and ASSUMING they invest thier existing excess $300 million of capital. That is the potential. It could even be higher if losses are not as high as their reserves indicate. Continued high prepayment rates will cause RWT to take some of those reserves into income (don't laugh!).

      I enjoy the back and forth between us. Are you a CFO in the mortgage industry? Just curious.

      • 2 Replies to mightimercx
      • craig, the page 100 that you cite (actually page 99) in the Q3 Review -- see title on top of table on these pages. These $7.6B of real estate loans are NOT owned by RWT but instead are managed on behalf of other investors in the CDO securitizations called Acacia that RWT manages. The same table identifies RWT's portion of the loan losses. These vehicles are non-recourse, so your point on the adequacy of loss reserves is frankly pointless. I'm sure that given the current market environment and economy (despite the bungling efforts of our politicians notwithstanding), more losses will be forthcoming as you suggest, but they simply don't have the financial impact on RWT that you are harping about. The investors in RWT's securitization won't get as high a return as they bargained for because loan losses will be higher, but RWT doesn't bear that risk. It will get less mgmt fees but that doesn't blow RWT up as you are suggesting (IMO, erroneously, at least related to the RE loan portfolio that you cite). Rather then needing cash to meet these losses on a loan portfolio that it doesn't even own, I suspect that you'll find that RWT probably started investing its excess cash ($300 million on sep 30th) in new opportunities, and the purpose of the new capital raise gives them more firepower to pursue attractive investment opportunities.

        On the matter of converts, REITs dont issue converts because most convert buyers are hedged buyers and trade on the volatility of the stock -- in this case a convert holder who is short RWT will have to be paying out nearly 16% dividend yield on its short position. So not only does that explain why RWT doesn't issue converts (no one will buy it unless it's yield is north of the stock's underlying dividend) but also a convert grants the holder a "put" to get its principle back. The better solution for the REIT issuer is to issue outright stock so long it believes that it can out earn the dividend yield -- the incremental return is accretive to the exisitng shareholders. Evidently the market agrees, because the stock has gone up 20% in a week since the capital raise -- it seems that the market believes that this was highly accretive to RWT shareholders.

        Hope that helps you thnk about the issues.

      • OK, thanks my friend. You do bring lots of value to this message board!

        My biggest gripe here is (IMHO) the very, very low level of reserves on their portfolio of mortgage loans. Not the CES, but the $7.546bn in mortgages. 71% of which are ARMs.

        My intel (brokers on the ground whose buyers cannot get financing) tells me the mortgage market is seized. This - plus the fact it is impossible to find a lender with a prime portfolio with only 20 basis points of reserves - leads me to believe RWT hasn't come close to taking their medicine on the mortgage portfolio. They did it with the RMBS held by Acacia. Now I think they're facing a fiscal year-end battle with their auditors on the adequacy of a 20 basis point LLR.

        The CES mark? This is alchemy, at best. My judgment is that they will be very slow to recognize additional reserves, as it's in their interest to claim that these securities are worth as much as possible. Mind you they just got investors to put up > $100mm ....

        The bottom line for me with CES: they are 1st and 2nd loss securities, so they are most vulnerable, of course.

        I find companies throughout the entire mortgage sector NOT forthcoming about marks, valuation and certainly NOT conservative with regard to reserves. These guys are no CFC, of course. But look at UBS this morning. You'd think this bank would be forthcoming and conservative. The write-downs are mind boggling.

        Now .... IF we're going into recession, all bets are off! D you agree? Jobs & incomes will suffer, and the real estate market will have another big leg down (Paulson and Bernanke nothwithstanding).

        I was CFO of a tech firm in the S Valley, a luxury retailer in LA (with a national footprint), a new media company in LA, a well as 20 years as an investment & merchant banker.

        Thanks for the exchange of ideas.

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