Redwood Trust - Q2 2023

Transcript

Operator (participant)

Good afternoon, and welcome to the Redwood Trust Inc. Second Quarter 2023 Financial Results Conference Call. Today's conference is being recorded. I will now turn the call over to Kaitlyn Mauritz, Redwood's Senior Vice President of Investor Relations. Please go ahead, ma'am.

Kaitlyn Mauritz (SVP of Investor Relations)

Thank you, operator. Hello, everyone, and thank you for joining us today for our Second Quarter 2023 Earnings Conference Call. With me on today's call are Chris Abate, Chief Executive Officer; Dash Robinson, President; and Brooke Carillo, Chief Financial Officer.

Before we begin, I want to remind you that certain statements made during management's presentation today with respect to future financial or business performance may constitute forward-looking statements. Forward-looking statements are based on current expectations, forecasts, and assumptions and involve risks and uncertainties that could cause actual results to differ materially.

We encourage you to read the company's annual report on Form 10-K, which provides a description of some of the factors that could have a material impact on the company's performance and cause actual results to differ from those that may be expressed in forward-looking statements.

On this call, we might also refer to both GAAP and non-GAAP financial measures. The non-GAAP financial measures provided should not be utilized in isolation or considered as a substitute for measures of financial performance prepared in accordance with GAAP. A reconciliation between GAAP and non-GAAP financial measures are provided in our second quarter Redwood Review, which is available on our website, redwoodtrust.com.

Also note that the content on today's conference call contains time-sensitive information that are only accurate as of today, and we do not intend and undertake no obligation to update this information to reflect subsequent events or circumstances. Finally, today's call is being recorded and will be available on our website later today. I'll now turn the call over to Chris for opening remarks.

Christopher Abate (CEO)

Thank you, Kate, and thank you all for joining us here today. Before I dive into our quarterly results, I'd like to take the opportunity to share how Redwood is positioned with respect to the impending regulatory rule changes concerning higher bank capital charges for holding residential mortgages.

We expect some version of this proposed rule to become final in the foreseeable future in response to the regional bank crisis. More importantly, we expect that through the benefit of hindsight, these regulatory changes will mark a major turning point in how most non-agency loans are owned and distributed in the United States.

Our confidence in this outcome stems from working behind the scenes with many bank executives who, like us, see where the proverbial puck is headed after watching portfolio mortgages play a central role in the demise of Silicon Valley Bank and First Republic Bank earlier this year.

In fact, over the past few months, we've completed onboarding and have already activated a number of regional and mid-sized banks with aggregate assets of over $2 trillion. We're in various stages of bringing many more online in the coming weeks and months. In some cases, a number of these banks represent longstanding flow relationships we've built over many years or even decades.

Others are new to Redwood and have previously held loans on balance sheet, but no longer find it economical to do so. As the tide turns, more and more depositories are looking to Redwood, given our longstanding track record of accumulating and distributing non-agency loans.

As such, our strategic focus will be to continue onboarding such depositories with the goal of becoming their primary capital partner as they look to serve their jumbo clients in a seamless manner, even before the final regulatory changes go into effect. To try and contextualize the transformational shift that we foresee for our market, I'll begin by reiterating to today's listeners that mortgage cycles are no longer determined by Wall Street.

Today, they are almost exclusively determined by Washington, D.C. Monetary policy and the path of mortgage rates is governed by the Fed. Regulatory rules and enforcement actions concerning banks and other lenders is overseen by the Treasury, the FDIC, OCC, CFPB, and others. Of course, housing policy, as dictated by the current administration, primarily through the FHFA and HUD.

Altogether, these government influencers play a much more prominent role in the booms and busts of the mortgage market than they ever have before. The effects that Washington has on banks and their propensity to lend has always had a profound effect on Redwood's business.

That's why we consider this impending regulatory change, in keeping with our historical experience, to be a very positive market-shifting event for our business. As many of you know, Redwood got its start on the back of another bank crisis, the S&L crisis.

As interest rates rose and credit worsened, many depositories that held long-duration residential mortgages started losing money and became insolvent as the loans declined in value. It was through this lens where Redwood's value proposition became clear. The company was built to serve banks and other originators who relied upon mismatched borrowings for liquidity.

Our ability to match fund long-term mortgages with long-term debt via securitization technology provided an outlet for lenders, just as Fannie Mae and Freddie Mac did for agency-conforming mortgages.

Since our founding almost three decades ago, the non-agency mortgage market has endured significant changes, yet Redwood has continued to provide valuable liquidity to the market by aggregating residential mortgages so that lenders can recycle their capital and continue making new loans.

In recent years, we've expanded our consumer business to also serve housing investors in response to secular shifts in how homes are owned in the United States. During the second quarter of 2023, we completed our 143rd residential securitization that packaged billions of dollars of bulk pools for distribution to all types of investors.

Fast-forwarding to today, we are witnessing yet another round of policy changes in Washington that will kick off this next era of the mortgage market. The outgoing era, characterized by a 41% increase in home prices since 2020, was fueled by extremely accommodative Fed monetary and government fiscal policy in response to the COVID-19 pandemic.

With benchmark Fed rates reduced to effectively zero during this period, banks had an almost limitless supply of deposit capital to lend as the country battled COVID. Many banks chose to opportunistically put that money to work in 30-year jumbo mortgages, and these mortgages were predominantly held in portfolio for investment rather than distributed into the capital markets.

These mortgage portfolios proved to be sound credit investments and posed little principal risk to the banks, but the interest rate mismatch between the 30-year loans and the deposits funding them was undeniably significant and in many cases, very risky.

Even as benchmark Treasury bills gapped from near zero in January 2021 to over 5% in March 2023, the perceived stickiness of deposits compelled many banks to continue offering mortgages to preferred clients at rates well below market.

In fact, prior to the onset of the regional bank crisis this past March, depositories originated two-thirds of all jumbo mortgages in the first quarter. As we take stock of the situation today, the cost of deposit capital is now rising rapidly, and deposits continue to leave the banking system, with both consumers and businesses demanding much higher rates on their savings.

In addition, the regulatory capital charges for residential mortgages held at banks are about to rise as well. Where does the non-agency market go from here? Well, for many of these banks, continuing to offer competitive mortgage products to retain their clients will be imperative, and the solutions Redwood offers are a logical alternative to portfolio lending.

Our re-engagement with many banks over the past two months has validated this statement. In recent weeks, we have recast our correspondent network and renewed or established new partnerships with depositories, which in the aggregate, speak for approximately 45% of new jumbo originations.

A number that, by our estimates, represents upwards of $130 billion in annual volume. We view this as our target addressable market, when combined with the independent mortgage banks within our existing seller network. As Dash will cover, that business channel has also resumed growing.

Our June lock volume is more than the previous two quarters combined, with July flow volumes continuing to grow. As our bank partners will attest, going live with a capital partner in the non-agency sector requires much more than just flipping a switch.

For banks especially, investing in these relationships entails workflow changes, underwriting guide implementations, loan officer training, systems integration and onboarding, regulatory compliance protocols, cash and collateral management, and other infrastructure enhancements necessary to distribute whole loans with no noticeable impact to the consumer experience.

Partnering with Redwood allows this work to be applied across a variety of mortgage products that we offer lenders to meet their diverse needs, with speed to close and reliable execution, acting as part of our competitive moat.

Perhaps our biggest differentiator is that while we help our bank partners serve their customers, we don't seek to serve those customers directly in other ways, such as by running our own competing origination business.

Eliminating this inherent conflict of interest that often exists with our competition, is cited by many banks as foundational to our partnership. To sum things up, our enthusiasm has grown considerably in recent months, bolstered by our engagement with an increasing number of originators eager to work with Redwood.

With such significant changes afoot, the need for Redwood to play a centralized role going forward is rising rapidly in importance. There's a lot of work ahead. The leading indicators we use to assess our progress, including the strategic onboarding of new loan sellers and the depth of their origination channels, are a reliable roadmap for the growth of our residential business going forward.

I'll now turn the call over to Dash and Brooke, who will cover our operating and financial results for the second quarter.

Dashiell Robinson (President)

Thanks, Chris. The second quarter represented a turning point for our residential mortgage banking business. Our narrative the past several quarters in residential has been one of discipline and readiness. We prioritize moving existing risk and managing our pipeline to historically low levels, with the premise that a combination of rational loan pricing and a more accommodative securitization market would ultimately re-emerge.

That moment has arrived and looks familiar to us in several important ways. As the dust settled on a period of intense stress for the banking industry, it became clear how various stakeholders would likely fare amidst the fallout, including the likelihood that the country's largest banks will have to hold substantially more capital against residential mortgages.

As Chris articulated, meeting the moment will require the right mix of competencies that have long been our competitive advantage.

Since the end of Q1, we have increased capital allocated to our residential mortgage banking segment and began reengaging with bank partners who, since COVID, have predominantly used deposits to fund non-agency originations.

We are still early in this shift and would expect the transition to take form over the next few quarters. Early momentum has been positive. During the second quarter, we locked $567 million of loans, almost 5x the first quarter's volume and the highest since the second quarter of 2022.

A portion of second quarter volume was seasoned bulk pools purchased at an attractive discount to par, and we have seen an increase in bulk opportunities in recent weeks, as sellers have wrapped their heads around the economics and the critical trade-off of bolstering capital and liquidity.

As a driver of longer-term portfolio deployment opportunities going forward, we also expect this work to position us well to provide other types of solutions to banks. including credit risk transfer and other mutually accretive structures.

Combined with recently implemented expense measures, second quarter activity resulted in an annualized segment return for residential of 43%, the highest in over a year. Gross margins for the quarter were 178 basis points, well above the target range of 75 to 100 basis points, within which we have traditionally run the business.

We expect to continue increasing our capital allocation to residential through the second half of the year, including in supportive products that will help consumers access the substantial equity in their homes.

As Chris articulated, the essence of our residential business from the beginning, has been to provide flexible and reliable liquidity as a prudent long-term owner of credit and interest rate risk. With secular shifts in the market advancing quickly, the prospects are bright for a business ready to once again unlock its substantial operating leverage.

Turning to business purpose lending, demand for CoreVest's broad suite of products remains supported by key housing fundamentals, including elevated occupancy levels and ongoing demand for rental products, driven by continued pressure on housing affordability.

Sponsor demand, however, remains tempered by persistently higher financing costs, impacted most acutely by the rapid rise in SOFR and the resulting overall slowdown in transaction activity.

With benchmark rates once again higher, including the 10-year Treasury rate hovering just under 4%, we expect some project sponsors to remain on the sidelines, while others may seek both bridge and term products that lock in a fixed rate, but offer more prepayment flexibility.

Our BPL volumes were down modestly quarter-over-quarter, driven by a decline in originations of our fixed rate term product, with bridge fundings up slightly. Overall, fundings for the second quarter were $406 million, split between 68% bridge and 32% term.

Early July marked the one year anniversary of our acquisition of Riverbend Lending, and our single asset bridge channel turned in a strong showing in the second quarter, with a growing go-forward pipeline and continued investor demand for the product.

Reduced lending appetite at banks and disruption at certain private lenders are also shaping up as a meaningful tailwind for BPL volumes going forward. While many of our core BPL customers have never been efficiently served by the banks, a principal strength of the business, our current pipeline includes many opportunities in which a sponsor is seeking financing options away from their banking relationship.

With an estimated $200 billion of multi-family loans currently on bank balance sheets, we anticipate increased opportunities to capture customers seeking a reliable and flexible lending partner. Core drivers of rental demand remain entrenched and continue to influence consumer behavior.

Overall, leasing trends are strong, and the average cost to own an entry-level home now sits over 60% above the cost to rent a single-family home or apartment, equivalent to $1,500 a month in payments.

This is the highest delta in at least three decades, particularly relevant for a portfolio like ours, in which average underlying rent is generally between $1,000 and $1,200 per month. In addition to persistently higher borrowing costs, limited supply of for-sale housing continues to support the rental market.

Analysts estimate that barely over 1% of the 85 million-plus single-family homes in the U.S. are currently for sale, the lowest ratio since at least the early 1980s. In planning for the second half of 2023, we place a continued premium on reliable funding sources to feed operations.

Fortunately, there are premier capital partners in the private credit markets who are eager to work with us in this regard. During the second quarter, we announced a strategic joint venture with Oaktree to support CoreVest's bridge lending platform.

As previously announced in June, the vehicle is expected to unlock purchasing power of bridge loans in the amount of approximately $1 billion, inclusive of secured financing. Through the joint venture, Redwood earns upfront and recurring fee-based income streams for creating the assets and managing the joint venture.

The overall structure focuses exclusively on investing alongside each other, 80% Oaktree, 20% Redwood, with Redwood maintaining the relationship with our customers. In Oaktree, we gain a highly respected investor who is both familiar with our platform and eager to support the expansion of our bridge lending business.

Overall, we continue to see deepening demand from investors for our broader suite of BPL products. This has strengthened distribution channels that will serve as an important complement to the joint venture, including traditional whole loan sales and private securitizations placed with anchor investors.

During the second quarter, we sold $200 million of bridge and term loans to a variety of buyers and expect this type of distribution to continue being a meaningful part of the business.

In mapping out the next chapter of our BPL business, we remain mindful of the macro credit environment, particularly the impact of short-term interest rates, that we expect to continue weighing on project sponsors, notwithstanding continued strength in overall leasing trends.

Delinquencies in CoreVest's term and bridge loan portfolios ticked up during the second quarter to 4.2%, within overall modeled expectations and generally reflective of a small subset of sponsors working through a rapid rise in borrowing rates across their portfolios and in some cases, extended project timelines. Occupancy rates are tracking to plan, as are rents on newly turned units.

While we incrementally increased loss expectations across these portfolios during the second quarter and believe these fundamentals will be important mitigants to any ultimate severities, our asset management team will continue prioritizing proactive surveillance to the extent conditions persist and increased work is required with sponsors to assess project plans and take other required steps where appropriate.

Fundamentals in our overall investment portfolio remain robust, driven by strong employment data, embedded equity protection from a seasoned book, and borrowers incentive to protect one of their most valuable assets, a low-coupon first mortgage.

Our jumbo and reperforming loan securities saw continued strength and performance. Delinquencies were 90 basis points in Sequoia and 9% for our RPL book, the latter of which is at its lowest level since the end of 2019.

Opportunities to execute capital relief arrangements with banks would allow us to add incremental exposure to high-quality seasoned mortgage pools and complementary cash-on-cash returns to our existing portfolio. I will now turn the call over to Brooke to cover our financial results.

Brooke Carillo (CFO)

Thank you, Dash. We reported higher earnings available for distribution, or EAD, of $16 million, or $0.14 per basic common share, as compared to $14 million or $0.11 per share in the first quarter, resulting in an EAD return on common equity of 6.2%.

The increase in EAD was driven by recovery in residential mortgage banking income and by a reduction in G&A expense on the quarter. Income from residential mortgage banking activities increased $4 million on the quarter due to a resurgence in loss volumes off of recent lows.

In June alone, we locked 3x the number of loans we locked in the first two months of the quarter. As Dash noted, gain on sale margins were well in excess of our historical target range of 75-100 basis points.

Income from business purpose mortgage banking activities decreased as spreads remained relatively stable during the second quarter compared to the first quarter, where spread tightening benefited existing inventory and volume declined 7% from the first quarter.

G&A expenses decreased by $5 million from the first quarter on lower fixed compensation and equity compensation expense as a function of efficiencies created through firm-wide expense initiatives. On an annualized basis, G&A of $31 million represents the midpoint of the range we previously provided for the year, and the second quarter included approximately $1 million of related severance expense.

GAAP net income available to common shareholders of $1.1 million, or $0.00 per diluted share, compared to $3.2 million, or $0.02 per share in the first quarter.

GAAP earnings for the quarter were also impacted by net negative investment fair value changes from incremental impairments on our bridge loan portfolio and fair value declines on our reperforming loan, or RPL, investments from spread widening during the first quarter, despite fundamental credit performance of our RPL book continuing to improve.

Net interest income remained stable from the first quarter of 2023, as higher net interest income from mortgage banking and corporate cash were offset by a full quarter of MSR financing and increased borrowing costs.

Additionally, net interest income was impacted by sales on the quarter as we freed up incremental capital through investment portfolio optimization and reallocated the proceeds to the growing opportunity in residential mortgage banking.

We sold securities that were largely non-strategic third-party assets and were executed at accretive levels to Q1 book values, and we recognized gains of approximately $6 million.

While these sales reiterate market appetite for our collateral above our marks, we retain roughly $400 million of embedded net discount that we carry forward into future quarters, over 85% of which we control the call rights on.

Book value per share for the quarter was $9.26, as compared to $9.40 in the first quarter, reflecting a nominally positive quarterly economic return on common equity for the second quarter. The primary drivers of book value during the second quarter were flat basic earnings per share, as impacted by previously mentioned fair value changes and our $0.16 common dividend per share.

Our unrestricted cash and cash equivalents as of June 30th were $357 million, which exceeded our marginable debt. Recourse leverage was down slightly to 2.2x for the quarter.

We continued to manage our near-term corporate debt maturities accretively during the quarter, repurchasing an additional $31 million of our upcoming August 2023 maturity, bringing the outstanding balance for that maturity to $113 million.

We will repay the remainder in mid-August with existing cash on hand that has been invested in short-term Treasury bills, an effective rate which exceeded our cost of funds on that debt.

As we've demonstrated over the last number of quarters, we have the capacity to generate additional capital organically through the establishment of new financing for certain of our unencumbered assets, which can serve both to fuel growth of our mortgage banking businesses or continue to repurchase corporate debt across our term structure to optimize our capital structure.

Furthermore, we're actively engaged in capital partnership conversations like our recently announced bridge joint venture, given the significant uses of offensive capital we see in front of us.

We continue to be successful managing financing facility capacity for our operating businesses, renewing two BPL lines and one residential line, representing approximately $1 billion of capacity on very similar terms.

Overall, as of June 30th, we had excess capacity of $2.6 billion to support the continued growth of our BPL and residential businesses.

Looking ahead, we intend to add two financing lines in the third quarter related to our recently established Oaktree joint venture, procure additional financing for our non-performing BPL loans, and add one additional financing line for HEI and potentially other home equity lending products.

As previously guided during our last earnings call, we reset our common dividend level in the second quarter to align with our anticipated near to medium-term earnings profile, ultimately enhancing our ability to capitalize on growth opportunities across our businesses.

Going forward, we see significant opportunities to increase our allocated capital to the residential business. With the changes we have made to our cost structure, we can generate returns accretive to our dividend yield for the residential business on $500 million to $1 billion+ of quarterly purchase volume, given the last volume trends we're seeing today.

As Chris and Dash have covered, we anticipate volumes to continue to increase in the third quarter as we begin purchasing from our newly established and existing bank flow partnerships and source additional bulk pools. We are already seeing these trends manifest thus far in July.

While the direction of interest rates could impact our projected second half volumes and for the remainder of the year, we also anticipate a rebound in volumes in BTL due to several factors discussed earlier by Chris and Dash.

These include new capital partnerships, the introduction of new products, disruptions we're seeing in the competitive landscape, and the possibility of the Federal Reserve concluding its hiking cycle. With that, operator, we will now open the call for questions.

Operator (participant)

Thank you. Ladies and gentlemen, we will now be conducting a question and answer session. If you would like to ask a question, please press star and one on your telephone keypad. A confirmation tone will indicate your line is in the question queue.

You may press star and two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Ladies and gentlemen, we will wait for a moment while we poll for questions. Our first question comes from the line of Doug Harter with Credit Suisse. Please go ahead.

Douglas Harter (Director)

Thanks. Thanks for the, the color on, on the residential opportunity. First, hoping you could talk how you see the competitive environment developing. Are there other, you know, non-banks that are looking to, to kind of get, get into this market? Kind of how do you see that playing out?

Christopher Abate (CEO)

Hey, Doug, it's Chris. Well, first of all, I, I think that there's probably not anyone that's directly competing with us today. We expect more competition, but the engagement we've had with banks, particularly regional banks, has been, it's been more or less, you know, us to this point.

We've had a lot of back and forth, and we're working with a lot of new partners. I think that's sort of a natural evolution of what we do. We've run this, this correspondent business now for decades. I think reputationally, we're pretty well established throughout the banking system. There's been quite a few inbounds, and we're very focused on that segment.

It's early to say, you know, the regulatory announcement today specifically applies to banks with over $100 billion of assets. That's, that's been our primary focus up to this point. I think over time, you know, we plan to continue to build out, you know, the depository facet of our network to complement the IMBs that we've done business with for many years.

I think the, it's very early innings, but I also don't think that the banks are waiting for the rules to be finalized. I, I think that there's probably not many bank executives today that are looking to double down on portfolio mortgages for obvious reasons. Finding liquidity is a priority.

As you know, we're very focused on the non-agency space, the segment of the market that Fannie and Freddie don't serve. We're pretty excited about the opportunity, and, and we look forward to keeping you up to date on it.

Douglas Harter (Director)

Then, you know, I know you guys talked about, you know, seeing increased lock volume today, but if you could just give us, a sense as to, you know, what are the timelines from turning a lot of these conversations that you're having today into, you know, kind of the, the size of volume that

you know, that, that these, you know, that these banks are talking to, you know, in terms of the market share opportunity, the addressable market you're talking about, you know, how, how long does it take to start turning those conversations into, into meaningfully higher volumes?

Christopher Abate (CEO)

Well, I think, you know, we're, we're, we're well underway at this point. Some, some banks where we initiated discussions over the last, call it month or two, we're now actively locking with, effectively. They're, they're live and online.

I mentioned in my opening remarks that, you know, it's a big investment for a bank that's used to, you know, having tailored underwriting and, and, and processes to be able to sell into the capital markets. There's a lot of compliance.

There's, you know, considerations with respect to loans that are securitizable. All of that work, there's quite a big infrastructure build for banks who have not been active in the secondary markets.

The timeline will be staggered somewhat, but, I think we're in multiple stages of conversations with a number of banks today, and my sense is, you know, we expect volume to grow meaningfully from here. I think we mentioned that, you know, June volumes exceeded the prior two quarters combined, and July is looking like another strong month.

As we progress, certainly, you know, by the time we report next quarter, you know, we should have a pretty good update. That also, I should add, is flow volume.

You know, we're also very active in the bulk space, and we think there's a pretty interesting opportunity as we turn more of these banks online to access some of the portfolio opportunities that, that, you know, with respect to some of the lower coupon mortgages, and to try to provide solutions there.

It's a pretty holistic effort at this point. You know, we're, we're meaningfully increasing our capital allocation to the residential business. I think we're up to $80 million at June 30th, and we're probably looking at $100 million to $125 million today. That we expect to go higher from there.

You know, again, we'll, we'll have more to say in the coming months, but the, the response so far, has been pretty positive.

Douglas Harter (Director)

Great. Thank you, Chris.

Operator (participant)

Thank you. Our next question comes from the line of Don Fandetti with Wells Fargo. Please go ahead.

Donald Fandetti (Managing Director)

Oh, yes. You guys kind of touched on this in terms of more capital being allocated to residential mortgage origination. You know, just trying to think how you balance playing defense, market's still uncertain. I mean, are you willing to kind of lean into things more, or are you going to sell more investments like you did this quarter? Or is it a combination of the two?

Dashiell Robinson (President)

I think we'll, hey, Don, it's Dash. I, I think as always, we'll, we'll read the market and do what we think is, is most accretive. You know, the securities that we parted ways with in Q2, you know, we owned for quite some time. You know, they, they delevered, and, and those yields were, were well inside where we saw opportunities away.

Where we see incremental opportunities to do that, you know, we certainly will. As, as Chris articulated, you know, reallocating more working capital, you know, to the resi mortgage banking business from our perspective is, is, is definitely among highest and best use.

As, you know, as part of that, I think you can expect to see, in the coming quarters, an element of natural, you know, reallocation of capital. You know, we talked a lot about the Oaktree JV.

You know, that will provide, you know, very accretive capital par with ours, you know, to support our bridge business going forward. You know, you could expect us to unlock incremental capital from the existing bridge portfolio as we see maturities and roll out there. I think a lot of it will happen naturally with some of the pieces we've put in place, but we always have the ability to sort of read the market and respond, you know, as we need to.

Donald Fandetti (Managing Director)

Got it. Then, you know, in the BPL, 90+ day delinquencies were up. I was just curious, like, you know, do you think that you have visibility on where and when those could peak? I assume it's due to borrowers under pressure, even with higher rates.

Dashiell Robinson (President)

Yeah, certainly can provide some more context there. You know, obviously, asset management for the BPL portfolio has been, you know, a big, a big focus for us. The first thing I would say is that, you know, the 4% or so delinquency rate, certainly well within our modeled expectations.

It's, it's well within the range that we've seen over the past few years. You know, to your point, the priority remains to really resolve these delinquencies as quickly as possible because, you know, the early stage is when, you know, we tend to see the most accretive outcomes and where the sponsors remain most engaged.

To that end, we expect the majority of the loans that, that caused the uptick in Q2 to actually be resolved by the end of the quarter, either through cooperative sponsor conversations or, or bringing in, you know, some sort of outside equity, you know, to recapitalize the situation.

You know, the fundamentals on the ground we're seeing across the BPL book, I think are really strong. We talked about it a little bit on the, in the prepared remarks. You know, in terms of leasing velocity, the rents that our sponsors are able to get, you know, that's, that's all looking, you know, generally really, really good.

You know, to your point, a lot of this is technical in terms of where SOFR has gone, which has caused, you know, stress in certain parts of our sponsors' portfolios.

So, you know, when you have situations like that, just being really on top of it quickly and, you know, obviously including loans that are still performing, frankly, or just being ahead and trying to anticipate issues that are more technical in nature than fundamental.

If, if these conditions persist, you know, I, I think we do expect, you know, the asset management work to continue, but it's really all about getting on top of these issues early, to get to those most accretive outcomes that we've been able to get so far.

Donald Fandetti (Managing Director)

Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Rick Shane with JPMorgan. Please go ahead.

Richard Shane (Managing Director and Senior Equity Research Analyst)

Hey, everyone. Thanks for taking my question this afternoon. Look, Doug asked the questions about sort of hooking up the pipes on the front end in terms of sourcing mortgages and what that looks like.

Can you talk a little bit in this environment about execution and on the back end in terms of resuming Sequoia issuance, et cetera? I know you've done one deal year to date, but I'm assuming that if this business builds the way that you expect, we'll see larger transactions and more frequent transactions.

Dashiell Robinson (President)

Yeah, great question, Rick. You know, we've done a few deals to date, and, and, you know, I don't think it's a secret. We're in the market with one, or there's one in the market now. Certainly, securitization is going to continue to be a major facet of our distribution strategy.

I will say that the market has firmed up quite a bit in recent weeks. Spreads are tighter, and so we've got good visibility into where we can execute. And, and, you know, first quarter or second quarter margins on the resi business were well in excess of our 75-100 basis point long-term targets. We're not out of the woods. You know, there was a Fed hike, and things are still volatile out there.

I do think there are investors picking up the phone, and we certainly plan to be fairly active in the securitization space to accompany, you know, the volume increases we're seeing on the front end.

Richard Shane (Managing Director and Senior Equity Research Analyst)

Got it. Yeah, I'm assuming that you guys, probably, when you were buying loans, were pricing in for the most predicted rate hike in, in, what was it? 99% predicted. Curious, as you, you know, is there a feedback loop here that as you see execution in the market, it will continue to refine how you approach your counterparties in terms of your buybacks?

Christopher Abate (CEO)

Certainly. You know, right now, I think, you know, our, our typical guides for Sequoia are pretty, pretty well known at this point. The investor base is quite seasoned with respect to, you know, what to expect, you know, when we launch deals.

We're, we're educating banks on that process as well, and, and certainly servicing into a securitization, you know, guidelines and exceptions, geographic diversity, all of those facets that, that play a role. You know, we're, we're helping banks get up to speed who haven't been actively selling loans in the past.

You know, that'll continue to take time, but we also view those relationships as quite sticky because, you know, it is a big investment working with a capital partner.

We also have the benefit of, of bank balance sheets, you know, helping us with aggregation and warehouse and so forth.

The partnerships, you know, are off to a good start, and ultimately, we're very confident that, you know, we'll be able to securitize the mortgages that we're, we're acquiring profitably. You know, we actively hedge and manage our pipelines.

This is all, you know, bread and butter for Redwood Trust, and, and, you know, we expect that, you know, in the coming, you know, months and quarters, especially if, if this rate hike cycle ends in the fall. Hard to say, but, but I do think, you know, more capital will flow back to the sector and, and liquidity will continue to improve.

Richard Shane (Managing Director and Senior Equity Research Analyst)

That's great. Thank you very much.

Operator (participant)

Thank you. Our next question comes from the line of Stephen Laws with Raymond James. Please go ahead.

Stephen Laws (Head of Real Estate Finance)

Hi, good afternoon. Chris, it seems like, you know, real opportunity, I think you guys have talked kind of glowingly about what you think's ahead with the resi business, but also mentioned the discounted pool that may be available.

Yeah, how do you think about capital allocation? It seems like resi mortgage banking is an increasing need for capital, given the outlook there. You know, what does it take when you see a pool that you're looking at to justify the capital going into that purchase as opposed to continuing to you know, support growth on the mortgage banking side?

Christopher Abate (CEO)

Hey, Stephen. You know, it's, it's a balance. You know, and we're, we're, we're constantly, you know, weighing, you know, the right, the right allocations between the businesses and certainly the risk capital and liquidity capital we need to, to run safely.

I think some of the portfolio opportunities are still emerging. You know, certainly we've, we've been active in, in bidding bulk pools, successfully bidding bulk pools. There, there remains, you know, billions and billions of dollars of underwater mortgages on bank balance sheets.

And, you know, we're in a position to offer solutions there, whether it be credit-linked notes, CDS, acquiring the loans outright, that, you know, we think hopefully over time, you know, will emerge those opportunities as we organically re-establish flow relationships with many of these banks.

Over time, you know, this is a very good problem to have because we, we, we now see, you know, fairly large growth opportunities in residential, but we're also growing BPL. And as Dash mentioned, you know, we've got a great partnership now with Oaktree to facilitate significant growth in our bridge business.

We're actively, you know, working with other potential capital partners there. I think it's a really holistic approach to growth that we're focused on today.Certainly, third-party opportunities, you know, with our investment portfolio will be part of that.

Stephen Laws (Head of Real Estate Finance)

Great. Most of my other things have been answered, so appreciate the time this afternoon.

Christopher Abate (CEO)

Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Steve DeLaney with JMP Securities. Please go ahead.

Steve DeLaney (Managing Director)

Thanks. Hey, guys, really great news. Somehow or another, I'm thinking about that movie, what's it called? Back to the Future or something, it's just, kind of really exciting to hear you guys talk about the prime jumbo product because it's been such a part of your legacy. So glad, very glad that opportunity's developed for you.

Could you estimate, I know we're talking bulk and flow. It sounds like you have been able to do some bulk season purchases. Is there any way to estimate the magnitude of that, say, over the second half of the year, in terms of what impact that, maybe a range of what impact that could have on your balance sheet in terms of loan balances in that product?

Dashiell Robinson (President)

Sure, Steve. Hey, it's Dash. I can, I can take a crack at that.

Steve DeLaney (Managing Director)

Hey, Dash.

Dashiell Robinson (President)

I think the way to answer that is sort of a look at the traditional origination footprint for these products, with banks and non-banks. Obviously, we're we are very, very well connected with the IMBs.

Historically, we've been very well connected with the regionals, we also have from time to time partnered with the traditional money centers as well on certain partnerships. If you think about the jumbo origination market as historically a $300+ billion market. I mean, at the moment, and we talk a little bit about this in the review, we're connected with almost half of that market share.

You know, if you, if you think about regionals and non-banks and, that doesn't even price in the potential migration of origination footprint away from some of the money centers. Obviously, there's a lot to learn in terms of what, what happens today, you know, in, in terms of the roles that, that Chris was articulating earlier.

It's, it's a very, very big opportunity, and we've been, we've been hardened, as Chris said, by the speed with which a lot of these partners have either re-engaged or, or engaged from the be, you know, anew with us, which is, which is fantastic. The other piece I would sort of re-emphasize that Chris articulated is just is wallet share.

You know, we as a percentage of the jumbo market overall, as you well know, we've historically run our business at a 2% to 3% sort of overall market share. In terms of the folks that we engage with, our wallet share has kind of been between, you know, 8% to 12%, 8% to 14% over the past few years, with some, you know, some dispersion around that average.

You know, the operational moat with these banks that have not sold loans before or for whom it's been a while, is really, you know, pretty meaningful. You know, our view is that, you know, once we get operationally set up with someone, as Chris said, it's not just flipping a switch, it takes a lot of work.

It's a lot of vendor management and other considerations. Just being the first mover here and frankly, the first to lock loans, you know, with this cohort, you know, from our perspective, there's some real upside to what our historical wallet share has been, which can also really move the needle.

Steve DeLaney (Managing Director)

That's helpful context. I appreciate it, Dash. Where we are today on, on the flow business, where are these banks? I guess this ties into your, your SEMT execution, but we're 7% on, on, on agency, 30 years, I guess, in that ballpark, maybe 680. Where are the prime jumbos being priced in terms of, in terms of coupon on, on new originations?

Christopher Abate (CEO)

Well, prime jumbos are close to conforming, so they're in that seven range.

Steve DeLaney (Managing Director)

The same ballpark, yeah.

Christopher Abate (CEO)

Same ballpark, but, you know, we're now at a six coupon on AAAs, which allows those bonds to price much closer to par or even above par. Just from a liquidity standpoint, you know, we're not dealing with the convexity issues that we had to deal with over the better part of the past two years, as rates rose. You've had these large inventories of underwater mortgages. A lot of that, the market is true.

Steve DeLaney (Managing Director)

Right.

Christopher Abate (CEO)

So the, the, the new issue market is, is much healthier as a result of that. We, we had talked about that in recent quarters. In many respects, we're, we're in a better spot from a, from a liquidity standpoint, and that, that allows us to really lean in on pricing.

You know, and, and because these banks, in particular, you know, have large inventories of, of mortgages, you know, we can combine, you know, some combination of flow with bulk. You know, we're, we're looking at, probably close to $1 billion of bulk pools right now. So, you know, that really allows us to, to move more quickly. The quicker we can turn the capital and move the pipelines, the much.

It just, it just creates much more certainty on, on the execution side, than we've had in quite a while. That's, that's all very positive. Like I mentioned earlier, we're in various stages of implementation with, with new partners.

It's gonna take some time to really see, you know, how much of this addressable market, this $130 billion to $150 billion of originations that these banks, we think have spoken for on an annual basis, how much of that, we might see in the capital markets.

I do think that being a reliable partner, matters more to depositories. You know, the whole process of, of plugging in, I think is, takes, takes more work, takes a bigger investment.

So I don't think you're, you're managing down to the last basis point of execution. I think, I think you're really focused on reliability, and understanding, you know, each other, and exceptions and just sort of all of the, the inner workings of, of selling loans.

Steve DeLaney (Managing Director)

Yeah.

Christopher Abate (CEO)

That's ultimately, you know, it over the course of the next few months, I think we'll have a much better sense for how big this market could be.

Steve DeLaney (Managing Director)

Can you just estimate roughly how many bank partners that you're engaged with? I mean, obviously, you're not going to be specific, I guess when you do securitizations, that information, but, you know, are we talking about a dozen banks or several dozen banks that you're actively involved with?

Christopher Abate (CEO)

I'd couch it closer to 70+. That's, you know, and that's, that, that sort of live engagement. You know, we've got obviously, thousands of banks in this country, and, and, you know, to some degree, all of them will probably benefit from, from an outside capital partner to varying degrees.

You know, we're, we're well underway, Steve, and, you know, as we, as we turn more of these guys on, live, you know, with our platform, it's, it's, it's gonna be shifting, you know, this balance, I think, of banks and non-banks back to something.

You know, to reference your Back to the Future comment, just to something that, you know, we've experienced in the past, you know, much more balanced between the independents and, and the depositories.

Steve DeLaney (Managing Director)

Thank you very much for your time and your comments. Very helpful.

Christopher Abate (CEO)

Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Bose George with KBW. Please go ahead.

Bose George (Managing Director)

Yes, good afternoon. I wanted to just ask about sort of the cadence between the current, you know, EAD and more sort of normalized returns. You know, is there a way to kind of think about, you know, how long that takes? Then does the bank opportunity here kind of accelerate that process?

Brooke Carillo (CFO)

Yeah, so that's a, it's a great question. This, you know, our investment fair value changes, which tends to be one of the deltas between GAAP and EAD, weren't as meaningful this quarter as it has been in certain prior quarters.

You know, net interest income has been stable for the last three quarters, so I do think generally our EAD here represents a better run rate as we head forward.

As you know, to Chris and Dash's point on the trends that we're seeing in July in terms of, of lock volume for resi, you know, we had, you know, we have had a meaningful pickup in our expectations for the second half of the year that could really be somewhere between, you know, $3 billion to $5 billion in volume.

To, to Chris's point on bulk opportunities, that flexes up and down, you know, fairly quickly here, just given the pace of what's unfolding out of the bank. You know, that alone, could add a couple of cents here to EAD as we, as we move forward from our residential mortgage banking, revenues.

I think, you know, to, to tie the comments into capital earlier as well, you know, Chris mentioned like $100 million to $125 million of allocated capital to resi. What you'll see from us is just the benefits of our, our operating leverage and scale from here. You know, our cost per loan was meaningfully lower in the second quarter versus the first.

You know, we could flex volumes probably at least twofold from here, with a, you know, a lot of that hitting the bottom line directly. The same thing with how we're thinking about these partnerships as they are structured, from a, a capital efficiency perspective as well. We're able to address a lot of that volume through our existing capital allocation that we've set aside for the business.

Bose George (Managing Director)

Okay, great. That's helpful. Thanks. Then just switching over to BPL, just in terms of the securitization market there, can you just any, you know, color on trends there? I don't think you've done a deal this year. Is there, is it sort of sign to that market becoming more open?

Dashiell Robinson (President)

Yeah, Bose, this is Dash. There, there are, on the, on the, on the fixed rate side, you know, for our term product, which we've historically securitized a fair amount of, you know, as you know, we're the only ones really doing that specific product and securitization, but it, it tends to map closely to some of the single borrower SFR transactions, and we've seen, you know, a little bit of momentum there recently, which is good.

Then on the, you know, on the bridge side, you know, there continue to be deals that are, are unrated, although there is some, you know, potential for at least one rating agency to start to rate those transactions in the second half of the year, which would be, you know, which would be very, very accretive, you know, for that market and, and bring a lot of new investors in, you know, which is, which is exciting.

You know, to that point, like, we've really spent a lot of time, you know, over the past couple of years diversifying, you know, our distribution and BPL. Obviously, Oaktree is a primary example of that. You know, we sold about $200 million of BPL loans in the first quarter.

We haven't done, as you probably know, a broadly syndicated securitization, you know, in over a year at this point, but we continue to support the business, you know, through other distribution channels. As that market continues to normalize, that's upside for us. You know, we're obviously tracking that closely, and we'll certainly utilize it if it makes sense.

Bose George (Managing Director)

Okay, great. Thanks a lot.

Operator (participant)

Thank you. Our next question comes from the line of Derek Sommers with Jefferies. Please go ahead.

Derek Sommers (Equity Research Senior Associate)

Hi, good afternoon. Another follow-up on BPL. We kind of saw the pivot of BPL volumes towards the bridge product this time last year. As we lap that time period and see some rate stability, are you seeing the prior years vintage of bridge loans show any interest in moving towards a term product, or is the mix still favoring the bridge?

Dashiell Robinson (President)

100%. You know, we, you know, the, the mix was about 2/3 bridge, 1/3 term in the second quarter. As I think we've talked about, you know, before, you know, when the business is humming, that mix is probably closer to 50/50 in terms of, you know, rates, rates being normalized, et cetera.

Yeah, we, you know, particularly given where SOFR is, a lot of sponsors, you know, have come to us asking for, you know, some sort of term product, maybe shorter term, with more prepayment flexibility. We would expect, you know, that mix to continue to evolve more towards some equilibrium between term and bridge.

You know, that said, the term business, you know, is very much linked to benchmarks because as, as you know, those loans are, are sized not only to value the homes but also debt service coverage. So, you know, we have to be mindful of that.

Yeah, we obviously very proactively manage the book, as, as I mentioned earlier, and we are definitely seeing an increase in sponsors, you know, looking to term out. You know, the key to that, obviously, is execution of their business plans and getting to the required stabilization in order to get there.

You know, most of the bridge business that we do is, is sort of lighter rehab, so it's, that's very constructive for occupancy in terms of how quickly these sponsors can get to the right stabilization.

You know, we're certainly optimistic that the mix evolves in the second half of the year for the reasons you articulated. Rates will have something to do with that, but that's certainly this is the plan.

Derek Sommers (Equity Research Senior Associate)

Great. Thank you. Then one quick follow-up, just on G&A expenses, given the kind of near-term opportunity on originations volume and the increased cadence, will we see any increased, you know, upward pressure on G&A? Or do prior guides still hold there?

Brooke Carillo (CFO)

No, as, as we mentioned in the prepared remarks, our, our prior guidance should still hold. You know, we do view Q2 to be a good proxy for next quarter as we head forward, although we did have about $1 million of severance and other transition-related expenses in that number this quarter as well.

You know, we just, you know, we just referenced on the OpEx side for resi that we still have a lot of operating leverage. That, that business is about a third lower in terms of overall costs than we were last year. We still see opportunities from here to increase our operating leverage before we add more costs.

Derek Sommers (Equity Research Senior Associate)

Great. Thank you. That's all from me.

Operator (participant)

Thank you. Our next question comes from the line of Eric Hagen with BTIG. Please go ahead.

Eric Hagen (Managing Director)

Hey, how we doing? Couple questions here. I think on slide 30, the average borrowing cost for the recourse debt is about 7%. What's the yield for the retained assets that are secure in that portfolio? Then with the separate question here.

With the unsecured debt coming due in 2024 and some of the issues thereafter, what kinds of considerations do you feel like you make around repurchasing that debt, retiring it early, kind of similar to what you just did with the 2023?

Brooke Carillo (CFO)

Yeah, most of that debt is against our investment portfolio. I would say that carried a 16% forward yield at the end of June 30th.

Eric Hagen (Managing Director)

Okay.

Brooke Carillo (CFO)

I'm sorry, Eric, your second question?

Eric Hagen (Managing Director)

Yeah, we're looking at just what, what kinds of considerations you guys make around repurchasing the, the debt or retiring it early, you know, the 2024 and the 2025, kind of similar to what you just did with the 2023.

Brooke Carillo (CFO)

Yeah, that, you know, we mentioned in some of our prepared commentary that we're definitely provisioning some of our capital to continue to address our, our unsecured part of our capital structure. The 2024 look appealing to us, but so do, you know, a number of our series as well.

So we have several ways between our, you know, strategically, we're positioning part of our third-party investment portfolio. Also, you know, with $250 million of, of unencumbered assets on balance sheet and some additional liquidity that we mentioned through, through financing activities that we're actively pursuing for the third quarter.

All of that raises, you know, excess capital beyond what we have that we have earmarked for the 2024 to continue to address our capital structure. You'll see a shift, a continued shift from us, from unsecured to secured financing, just given relative value there.

Eric Hagen (Managing Director)

Yep, that's helpful. Thank you guys very much.

Brooke Carillo (CFO)

Thanks, Eric.

Operator (participant)

Thank you. Our next question comes from the line of Kevin Barker with Piper Sandler. Please go ahead.

Brad Capuzzi (VP of Equity Research)

Hi, guys. This is Brad Capuzzi on for Kevin Barker. Dash, I know you touched on the loss expectations already in the BPL segment, the steps you guys are taking to mitigate it. To the extent you see any further pressure there, how would this impact your decision to allocate capital towards the BPL segment going forward?

Dashiell Robinson (President)

Well, I think, I think the market conditions always impact all of our capital allocation decisions. I don't, I don't think that anything's necessarily changed. I think where, where the puck is going is, is probably evolving the, the nature of the BPL footprint and the types of products that, you know, we're most focused on originating.

You know, if you look at Q2, for instance, it was much more indexed to, you know, to the, to the long-term loans, you know, build-to-rent, things like this, things that are probably more directly responsive to, you know, some of the supply elements, you know, within single-family. Overall activity in multi-family is just, is just lower, based on what's going on in the market.

Multi was less than 10% of our Q2 activity in BPL, and that may, that may tick up a little bit in the second half of the year, but I think the way we try and run the business is, is responsive to where we see obviously the biggest needs, which will, which from our perspective, will, will lead to, to outperformance in the, in the underlying book.

As I said a few minutes ago, you know, based on the Oaktree joint venture and, and where we see alternative uses for capital, our expectation is that some of that capital will probably naturally reallocate away to, to support mortgage banking businesses holistically.

In general, you know, always focused on sponsored business plans, et cetera, and I just think we're going to run the business responsive to, to where the market needs liquidity and frankly, where we see the strongest fundamentals.

Brad Capuzzi (VP of Equity Research)

Awesome. Thank you.

Operator (participant)

Thank you. As there are no further questions, the conference of Redwood Trust Inc. has now concluded. Thank you for your participation. You may now disconnect your lines.