Mill Valley, California-based Redwood Trust is struggling to find a steady revenue stream in the new financial landscape that has emerged following the Great Recession of 2008.
Since the beginning of the year, Redwood managers have announced that the company is bailing out of the business of purchasing conforming residential mortgages and commercial loans to use as collateral to issue new securities. The retrenchment has resulted in the laying off of about 75 to 80 of the company’s 221 employees.
Redwood’s stock, which closed at $10 per share on Friday, down 13 cents, has been trading at historic lows in recent days — lower than during the darkest days of the Great Recession.
“It’s really remarkable thinking about the fact that the company’s valuation is less than in 2008,” said Brock Vandervliet, a senior analyst covering the mortgage finance and housing sectors for Nomura Securities. “The company’s core business is under pressure, and there doesn’t seem to be a near term environmental change that would relieve that pressure.”
Kristin Brown, Redwood’s vice president of investor relations, said company management could not comment since Redwood is about to release its fourth quarter earnings report. The company reported net income of $19 million in the third quarter of 2015, down from a net income of $27 million in the second quarter of 2015, and $45 million in the third quarter of 2014.
Colorado Layoffs
The company has said that a majority of the layoffs occurred at its Colorado office. Redwood opened that office in 2013 when it announced it was expanding its business to include mortgages that conform with the government limit.
Prior to that, the company had specialized in using “jumbo” mortgages for its securitizations. Jumbo loans exceed the home price limit of $625,550 placed on the government-supported Fannie Mae and Freddie Mac.
At the time, since the market for conforming loans is much larger than the jumbo market, Redwood said it expected to boost its workforce from 95 to 552 employees. The state of Colorado pledged to reward the company with $3.39 million in tax credits over the next five years if it produced the jobs it promised.
One reason Redwood may have felt compelled to re-invent itself is the change in demand for private-label residential mortgage-backed securities following the financial meltdown of 2008, analysts said. An excess of poorly collateralized mortgages in some mortgage-backed securities were the root cause of the credit crisis.
“The private-label securitization market, which includes the market for prime jumbo loans, is barely functioning; it is on life support. It has never fully recovered since 2008,” said Steven DeLaney, a senior analyst with JMP Securities.
Market Conditions
When Redwood announced earlier this year that it would no longer securitize conforming residential mortgages or commercial loans, Redwood’s chief financial officer, Christopher Abate, estimated the company would suffer a combined after-tax loss of $9 million to $10 million in those businesses during 2015.
“It was a good move to close the businesses now with them losing money,” Vandervliet said.
DeLaney said, “Redwood did not execute poorly. These two strategies were essentially victims of extremely adverse market conditions.”
DeLaney said when interest rates are volatile, as they are now, the conforming residential mortgage business is “extremely difficult and unprofitable.”
He said Redwood also faced stiff competition in this area from large banks, such as Wells Fargo & Co. and JP Morgan Chase & Co., as well as online mortgage companies, such as Quicken Loans Inc. and loanDepot, which are gaining market share rapidly.
Vandervliet said Redwood is also facing increasing competition in the jumbo loan securitization business from large banks such as Citibank, N.A., Chase and Credit Suisse.
“The problem for Redwood is the bigger banks have a lower cost base,” Vandervliet said. “Until that changes, it’s just a tough environment for Redwood.”
Loan Strategy
DeLaney said Redwood will rely on interest earnings from its portfolio of jumbo loan investments and mortgage-backed securities backed by jumbo loans.
“They are going back to being more of an investment company than a mortgage company, which is where they started,” DeLaney said.
But Vandervliet said even Redwood’s strategy of leaving more loans on its balance sheet is under pressure.
The company had been funding the loans by borrowing $2 billion from the Federal Home Loan Bank. But federal regulators recently ruled that real estate investment trusts such as Redwood can no longer borrow from the Federal Home Loan Bank.
In a statement issued in January, Redwood said that it “may not be able to obtain additional advances or increases to its borrowing capacity from the Federal Home Loan Bank of Chicago” and that this may limit the company’s ability to increase the size of its portfolio of residential mortgage loans and ability to increase net interest income.
On the bright side, however, DeLaney said Redwood is one of five companies fortunate enough to be eligible for a five-year sunset provision. That means Redwood won’t have to pay back the $2 billion for several years.
