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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.
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.
I'm sorry, but page 99 of the Redwood Report shows Redwood's MANAGED portfolio is all of ..... $219 billion!
The $7.5bn is THEIR portfolio. That's why you see this amount on their 9/30 balance sheet.
And - again - 20 basis points for a total loan loss reserve is puny. Please correct me ... and please find ANY PRIME LENDER who has a reserve anywhere near this low. Just one!
Granted, your point about converts is actually correct. Good point.
As for the liquidity they have, and the ability to put it to use:
My contention is they'll need every dime of this, given what's happening to ALL prime portfolios across the country. Having a portfolio with a greater CA concentration only supports this contention.
They will have to compete with many, many others in trying to purchase distress assets. Many big investment banks are pursuing this strategy, as is ANH and others.
<< 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.>>
--When you talk like that it sends shivers down my spine!
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.
I don't disagree with lots of your points, the mark on the CES is art, I agree, and a recession will be both bad and good. We know the bad part, but the good part is that the FED will continue cutting rates, RWT's margin will increase, lower rates will potentially enable borrowers to refi, etc... The one big issue that could derail this is if borrowers can refi, which depends upon the securitization market etc... Time will tell.