Redwood Trust Inc

NYSE:RWT

Earnings Call Transcript 2023-Q2

[Operator]

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 Kait Mauritz, Redwood's Senior Vice President of Investor Relations. Please go ahead, ma'am.

[Kait Mauritz, Senior Vice President, 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 that 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 also available on our website redwoodtrust.com.

Also note that the content of today's conference call contain 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.

[Chris Abate, Chief Executive Officer]

Thank you, Kait, and thank you all for joining us here today. Before we 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 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 like us, we were 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 midsized banks with aggregate assets of over $2 trillion, and 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 long-standing flow relationships we've built over many years or even decades. Others are new to Redwood and have previously held loans on balance sheet that no longer find it economical to do so. As the tide turns, more and more depositories are looking to Redwood given our long-standing 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, DC. 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, and 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 boom-and-bust of the mortgage market than they ever had before. And 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, relied upon mismatch 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, at Redwood has continued to provide valuable liquidity to the market by aggregating residential mortgages 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 package 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 battle 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 pose a little principal risk to the banks, 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 year zero in January 2021, 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. Deposits continue to lead the banking system with both consumers and businesses demanding much higher rates on their savings. But 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? While for many of these banks, continuing to offer competitive mortgage products to retain their clients will be imperative and the solutions Redwood offers or a logical alternative to portfolio lending. Our reengagement 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 of 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.

In partnering with Redwood, allows this work to be applied across a variety of mortgage products that we offer lenders to meet their diverse needs, the 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, excited by many banks as foundational to our partnership.

Some 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 a foot, the need for Redwood to play a centralized role going forward is rising rapidly in importance. There's a lot of work ahead, with the leading indicators we use to assess our progress, including the strategic onboarding of new loan sellers and the depth of their origination channels, a reliable road map 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.

[Dash Robinson, President]

Thanks, Chris. The second quarter represented a turning point for our residential mortgage banking business. Our narrative of 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 reemerge. 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 at 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 the shift and would expect the transition to take form over the next few quarters. But early momentum has been positive.

During the second quarter, we locked $567 million of loans, almost five times 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 support of 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 is 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 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.

And with an estimated $200 billion of multifamily loans currently on bank balance sheets, we anticipate increased opportunities to capture customers seeking reliable and flexible lending partner. More 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 and 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 US are currently for sale the lowest ratio since at least the early 1980s. In planning for the second half of 2023, we placed 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 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 focused 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 and CoreVest 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 time lines.

Occupancy rates are tracking to plan as our 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 remained robust, driven by strong employment data, embedded equity protection from a seasoned book and borrowers incented to protect one of their most valuable assets, a low coupon first mortgage.

Our jumbo and re-performing loan securities saw continued strength in 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, Chief Financial Officer]

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 in the quarter.

Income from residential mortgage banking activities increased $4 million in the quarter due to a resurgence in lock volumes off of recent lows. In June alone, we locked three times the number of loans we lost 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 to 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 in the quarter as we freed up incremental capital through investment portfolio optimization and we allocated 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 the nominally positive quarterly economic return on common equity for the second quarter. The primary drivers of book value during the second quarter was five 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 30 were $357 million, which exceeded our marginable debt. Recourse leverage was down slightly to 2.2 times for the quarter. We continue 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 and effective rate, which exceeded our cost of funds on net 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 in 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, at June 30, 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 ATI 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 plus quarterly purchase volume given the lock 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 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 for the remainder of the year, we also anticipate a rebound in volumes in BPL due to several factors discussed earlier by Chris and Dash. These include new capital partnerships, the introduction of new products, disruptions were seen in the competitive landscape and the possibility of the federal reserve, including its hiking cycle.

And with that, operator, we will now open the call for questions

[Operator]

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Doug Harter with Credit Suisse. Please go ahead.

[Doug Harter, Credit Suisse]

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

[Chris Abate, Chief Executive Officer]

Hey, Doug, it's Chris. Well, first of all, I think that there's probably not any one 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 us to this point.

So we've had a lot of back and forth, and we're working with a lot of new partners, but I think that's sort of a natural evolution of what we do. We've run this correspondent business now for decades. And I think reputationally, we're pretty well established throughout the banking system.

So there's been quite a few inbounds and we're very focused on that segment. It's early to say the regulatory announcement today specifically applies to banks with over $100 billion of assets. That's been our primary focus up to this point. But I think over time, we plan to continue to build out the depository facet of our network to complement the INDs that we've done business with for many years.

So 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 think that there's probably not many bank executives today that are looking to double down on portfolio mortgages for obvious reasons. So finding liquidity is a priority. And as you know, we're very focused on the non-agency space, the segment of the market that Fannie and Freddie don't serve. So we're pretty excited about the opportunity, and we look forward to keeping you up to date on it.

[Doug Harter, Credit Suisse]

And then I know you guys talked about seeing increased lock volume today. But if you could just give us a sense as to what are the time lines from turning a lot of these conversations that you're having today into kind of the size of volume that these banks are talking to in terms of the market share opportunity, the addressable market you're talking about. How long does it take to start turning those conversations into meaningfully higher volumes?

[Chris Abate, Chief Executive Officer]

Well, I think we're well underway at this point and some banks where we initiated discussions over the last, call it, month or two, we're now actively locking with effectively, they're live and online. I mentioned in my opening remarks, it's a big investment for a bank that's used to having tailored underwriting and processes to be able to sell into the capital markets. There's a lot of compliance. There's considerations with respect to loans that are securitizable.

So all of that work, there's quite a big infrastructure build for banks, who have not been active in the secondary markets. So the time line will be staggered somewhat. But I think we're in multiple stages of conversations with a number of banks today. And my sense is we expect volume to grow meaningfully from here. I think we mentioned that June volumes exceeded the prior two quarters combined and July is looking like another strong month.

So as we progress, certainly, by the time we report next quarter, we should have a pretty good update. And that also, I should add is flow volume. 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 with respect to some of the lower coupon mortgages and to try to provide solutions there.

So it's a pretty holistic effort at this point. We're meaningfully increasing our capital allocation to the residential business. I think we're up to $80 million at June 30, and we're probably looking at $100 million to $125 million today and that we expect to go higher from there. So again, we'll have more to say in the coming months, but the response so far has been pretty positive.

[Doug Harter, Credit Suisse]

Great. Thank you, Chris.

[Operator]

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

[Don Fandetti, Wells Fargo]

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

[Dash Robinson, President]

I think we'll -- Don, it's Dash. I think, as always, we'll read the market and do what we think is most accretive. The securities that we parted ways with in Q2, we don't for quite some time, they delevered and those yields were well inside where we saw opportunities away, and so where we see incremental opportunities to do that, we certainly will.

As Chris articulated, reallocating more working capital to the resi mortgage banking business from our perspective is definitely among highest and best use, and as part of that, I think you can expect to see in the coming quarters, an element of natural reallocation of capital. We talked a lot about the Oaktree JV, that will provide very accretive capital parity with ours to support our bridge business going forward.

And you could expect us to unlock incremental capital from the existing bridge portfolio as we see maturities and run off there. So, 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 as we need to.

[Don Fandetti, Wells Fargo]

Got it. And then in the BPL 90-plus day delinquencies were up, I was just curious, like 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?

[Dash Robinson, President]

Yes. Certainly, you can provide some more context there. Obviously, asset management for the BPL portfolio has been a big focus for us. The first thing I would say is the 4% or so delinquency rate certainly well within our model and expectations. It's well within the range we've seen over the past few years.

But to your point, the priority remains to really resolve these delinquencies as quickly as possible because the early stage is when 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 caused the uptick in Q2 to actually be resolved by the end of the quarter, either through cooperative sponsor conversations or bringing in some sort of outside equity to recapitalize the situation.

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

To your point, a lot of this is technical in terms of where silver has gone, which has caused stress in certain parts of our sponsors portfolios. And so when you have situations like that, just being really on top of it quickly and obviously, including loans that are still performing.

Frankly, are just being ahead and trying to anticipate issues that are more technical in nature than fundamental. If these conditions persist, I think we do expect 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.

[Don Fandetti, Wells Fargo]

Thank you.

[Operator]

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

[Rick Shane, JPMorgan]

Hey, everyone. Thanks for taking my questions 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 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?

[Chris Abate, Chief Executive Officer]

Yes. Great question, Rick. We've done a few deals to date, and I don't think it's a secret. We're in the market with one -- there's one in the market now -- so 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 in. And First quarter or second quarter margins in the resi business were well in excess of our 75 to 100 basis point long-term targets.

So we're not out of the woods. There was a Fed hike, and things are still volatile out there. But I do think, the investors are picking up the phone, and we certainly plan to be fairly active in the securitization space to accompany the volume increases we're seeing on the front-end.

[Rick Shane, JPMorgan]

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, what was it 99% predicted. Curious as you -- 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 buy box?

[Chris Abate, Chief Executive Officer]

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

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

That will continue to take time, but we also view those relationships as quite sticky because, it is a big investment working with a capital partner. And we also have the benefit of bank balance sheets, helping us with aggregation and warehouse and so forth.

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

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

[Rick Shane, JPMorgan]

That's great. Thank you very much.

[Operator]

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

[Stephen Laws, Raymond James]

Hi. Good afternoon. Chris, it seems like a real opportunity, I think you guys have talked kind of glowingly about what you think is ahead with the resi business, but also mentioned the discounted pools that may be available.

How do you think about capital allocation? It seems like resi mortgage banking is an increasing need for capital given the outlook there. So 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 support growth in the mortgage banking side?

[Chris Abate, Chief Executive Officer]

Hey Stephen, it's a balance. And we're constantly weighing the right allocations between the businesses and certainly the risk capital and liquidity capital we need to run safely. I think some of the portfolio opportunities are still emerging.

Certainly, we've been active in bidding bulk pools -- successfully bidding bulk pools, but there remains billions and billions dollars of underwater mortgages on bank balance sheets, and we're in a position to offer solutions there, whether it be credit linked notes, CDS, acquiring the loans outright that we think, hopefully, over time, we'll emerge those opportunities as we organically establish relationships with many of these banks.

Over time, this is a very good problem to have, because we now see fairly large growth opportunities in residential but we're also growing BPL. And as Dash mentioned, we've got a great partnership now with Oaktree to facilitate significant growth in our bridge business. We're actively working with other potential capital partners there. So I think it's a really holistic approach to growth that we're focused on today and certainly third-party opportunities with our investment portfolio will be part of that.

[Stephen Laws, Raymond James]

Great. Most of other things have been answered. So I appreciate the time this afternoon.

[Chris Abate, Chief Executive Officer]

Thank you.

[Operator]

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

[Steve Delaney, JMP Securities]

Thanks. Hey guys, really great news. Somehow, I'm thinking about that movie. It was called Back to the Future or something, and 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 is 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 -- maybe a range of what impact that could have on your balance sheet in terms of loan balances in that product?

[Dash Robinson, President]

Sure, Steve, it's Dash. I can take a dig at that. 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 are very, very well-connected with the IMBs. And historically, we've been very well connected with the regionals and we also have from time to time partner with the traditional money centers as well on certain partnerships.

And if you think about the jumbo origination market as historically a $300-plus 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 if you think about originals 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 happens today in terms of the rules that Chris was articulating earlier.

So it's a very, very big opportunity, and we've been hardened, as Chris said, by the speed with, which a lot of these partners have either reengaged or engaged from -- new with us, which is fantastic.

The other piece I would reemphasize that Chris articulated is just is wallet share. We -- as a percentage of the jumbo market overall, as you well know, we've historically run our business at a 2% to 3% overall market share and in terms of the folks that we engage with, our wallet share has been between 8% to 12%, 8% to 14% over the past few years with some dispersion around that average.

The operational moat with these banks were -- that have not sold loans before or for whom it's been a while, is really pretty meaningful. Our view is that 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.

And so just being the first mover here and, frankly, the first to lock loans with this cohort 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, JMP Securities]

That's helpful context. I appreciate it, Dash. And so where we are today on -- like on the flow business, where are these banks I guess this ties into your SMT execution. But we're 7% on agency 30 years, I guess, in that ballpark, maybe 6.80%. But where are the -- where are the prime jumbos being priced in terms of coupon on new originations?

[Chris Abate, Chief Executive Officer]

Well, prime jumbos are close to conforming. So they're in that 7% range.

[Steve Delaney, JMP Securities]

Same ballpark.

[Chris Abate, Chief Executive Officer]

Same ballpark, but we're now at a 6% coupon on AAAs, which allows those bonds to price much closer to par or even above par. And so just from a liquidity standpoint, we're not dealing with the convexity issues that we had to deal with over the past -- the better part of the past two years as rates rose, and you've had these large inventories of underwater mortgages.

So, a lot of that, the market is through. And so the new issue market is much healthier as a result of that. And we had talked about that in recent quarters. So in many respects, we're in a better spot from a liquidity standpoint and that allows us to really lean in on pricing. And because these banks, in particular, have large inventories of mortgages, we can combine some combination of flow with bulk.

We're looking at probably close to $1 billion of bulk pools right now. And so that really allows us to move more quickly and the quicker we can turn the capital and move the pipelines, the much -- it just creates much more certainty on the execution side than we've had in quite a while. So, that's all very positive.

And like I mentioned earlier, we're in various stages of implementation with new partners. So, it's going to take some time to really see how much of this addressable market, this $130 million, $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. But I do think that being a reliable partner matters more to depositories.

The whole process of plugging in I think is -- takes more work, takes a bigger investment. And so I don't think you're managing down to the last basis point of execution. I think you're really focused on reliability in understanding each other and exceptions and just sort of all of the inner workings of selling loans.

So, that's ultimately -- 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, JMP Securities]

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 are we talking about a dozen banks or several dozen banks that you're actively involved with?

[Chris Abate, Chief Executive Officer]

I'd couch it closer to 70% plus. And that sort of live engagement we've got obviously thousands of banks in this country. And to some degree, all of them will probably benefit from an outside capital partner to varying degrees. So we're well underway, Steve. And as we turn more of these guys on live with our platform it's going to be shifting this balance, I think, of banks and nonbanks back to something to reference your back to the future comment to something that we've experienced in the past much more balanced between the independents and the depositories.

[Steve Delaney, JMP Securities]

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

[Chris Abate, Chief Executive Officer]

Thank you.

[Operator]

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

[Bose George, KBW]

Yes. Good afternoon. I wanted to just ask about sort of the cadence between the current EAD and more sort of normalized returns. Is there a way to kind of think about how long that takes? And then does the bank opportunity here kind of accelerate that process?

[Brooke Carillo, Chief Financial Officer]

Yes. So it's a great question. This our investments for 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. 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 to Chris and Dash point on the trends that we're seeing in July in terms of lock volume for resi. We had -- we have had a meaningful pickup in our expectations for the second half of the year that could really be somewhere between $3 billion to $5 billion in volume. But to Chris' point on bulk opportunities, that flexes up and down fairly quickly here just given the pace of what's unfolding out of the bank.

So that alone could add a couple of cents here to EAD as we move forward from our residential mortgage banking revenues. And I think to tie the comments into capital earlier as well, 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 operating leverage and scale from here. Our cost per loan was meaningfully lower in the second quarter versus the first, but we could flex volumes probably at least twofold from here with 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 capital efficiency perspective as well. So 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, KBW]

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

[Dash Robinson, President]

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

And then on the Bridge side, there continue to be deals that are unrated, although there is some potential for at least one rating agency to start to rate those transactions in the second half of the year, which would be very, very accretive for that market and bring a lot of new investors in, which is exciting. To that point, we've really spent a lot of time over the past couple of years diversifying our distribution and BPL.

Obviously, Oaktree is a primary example of that. We sold about $200 million of BPL loans in the first quarter. And we haven't done as you probably know, a broadly syndicated securitization in over a year at this point, but we continue to support the business through other distribution channels. So as that market continues to normalize, that's upside for us, and we're obviously tracking that closely, and we'll certainly utilize it if it makes sense.

[Bose George, KBW]

Okay. Great. Thanks a lot.

[Operator]

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

[Derek Sommers, Jefferies]

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 year's vintage of bridge loans showing interest in moving towards the term product, or is the mix still favoring the bridge?

[Chris Abate, Chief Executive Officer]

100%. We -- the mix was about 2/3 bridge, 1/3 term in the second quarter. As I think we've talked about before when the business is humming, that mix is probably closer to 50-50 in terms of rates being normalized, et cetera. So yeah, we -- particularly given where SOFR is a lot of sponsors have come to us asking for some sort of term product, maybe shorter term with more prepayment flexibility. So we would expect that mix to continue to evolve more towards some equilibrium between term and bridge.

That said, the term business is very much linked to benchmarks because as you know, those loans are our size, not only to value the homes, but also debt service coverage. And so we have to be mindful of that. But yes, we obviously very proactively manage the book, as I mentioned earlier, and we are definitely seeing an increase in sponsors looking to term out. The key to that, obviously, is execution of their business plans and getting to the required stabilization in order to get there.

Most of the bridge business that we do 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. But 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 the plan.

[Derek Sommers, Jefferies]

Great. Thank you. And 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 upward pressure on G&A, were do prior guides still hold there?

[Brooke Carillo, Chief Financial Officer]

No. As we mentioned in the prepared remarks, our prior guidance should still hold. 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.

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

[Derek Sommers, Jefferies]

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

[Operator]

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

[Eric Hagen, BTIG]

Hey, how you are doing? A couple of 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?

And 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 at early kind of similar to what you just did with the 2023?

[Brooke Carillo, Chief Financial Officer]

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

[Eric Hagen, BTIG]

Okay.

[Brooke Carillo, Chief Financial Officer]

And I'm sorry, Eric, your second question.

[Eric Hagen, BTIG]

Yes. Looking at just what kinds of considerations you guys make around repurchasing the debt retiring it early, the 2024s and the 2025 kind of similar to what you just did with the 2023s?

[Brooke Carillo, Chief Financial Officer]

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

And so we have several ways between our strategically repositioning part of our third-party investment portfolio also with $250 million of unencumbered assets on balance sheet and some additional liquidity that we mentioned through financing activities that we're actively pursuing for the third quarter. All of that raises 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, BTIG]

That’s helpful. Thank you, guys very much.

[Brooke Carillo, Chief Financial Officer]

Thanks, Eric.

[Operator]

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

[Brad Capuzzi, Piper Sandler]

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 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?

[Dash Robinson, President]

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

If you look at Q2, for instance, it was much more indexed to – to the long-term loans, build for rent, things like this, things that are probably more directly responsive to some of the supply elements within single-family. Overall activity in multifamily is just lower based on what's going on in the market and multi with less than 10% of our Q2 activity in BPL. And that may tick up a little bit in the second half of the year, but I think we're the way we try and run the business is responsive to where we see, obviously, the biggest needs, which will -- which, from our perspective, will lead to outperformance in the underlying book.

So as I said a few minutes ago, based on the Oaktree joint venture and where we see alternative uses for capital, our expectation is that some of that capital will probably naturally reallocate a way to support mortgage banking businesses holistically. But in general, always focused on sponsored business plans, et cetera, and I just think we're going to run the business responsive to where the market needs liquidity and frankly, where we see the strongest fundamentals.

[Brad Capuzzi, Piper Sandler]

Awesome. Thank you.

[Operator]

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.