Good afternoon, and welcome to the Redwood Trust, Inc. 2014 Second Quarter Earnings Conference Call. [Operator Instructions] Management has requested that I remind you that certain information presented and certain statements made during management's presentation with respect to future financial or business performance, strategies or expectations 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. Management encourages you to read the company's most recent annual report on Form 10-K filed with the SEC, which provides a description of some of the factors that could have material impact on the company's performance and could cause actual results to differ from those that may be expressed in forward-looking statements. I've also been asked to note that the content of this conference call contains time-sensitive information that is accurate only as of today, Thursday, August 7, 2014. The company does not intend and undertakes no duty to update this information to reflect subsequent events or circumstances. Finally, today's call is being recorded, and access to recording of the call will be available on the company's website at www.redwoodtrust.com later today. For opening remarks and introductions, I will now turn the call over to Marty Hughes, Redwood's Chief Executive Officer. Please go ahead, Mr. Hughes.

Good afternoon, everyone. Thank you for participating in Redwood's Second Quarter 2014 Earnings Call. Joining me on the call are Brett Nicholas, Redwood's President; and Chris Abate, Redwood's CFO, and they will get into some of the details when they cover the residential and commercial business activities and the financials. We continue to manage, invest and position our residential and commercial businesses for long-term growth and to build sustainable franchise value. With these goals in mind, both businesses continue to make really solid measurable progress in the second quarter. Our residential and commercial loan platforms are the vehicles to drive earnings in new investment creation. There are 3 levers to grow and expand these platforms. We can do it by adding new products, adding new sellers and by adding more distribution capability. As Brett will discuss shortly, we made significant progress on these fronts during the quarter, especially with our new business relationship with the Federal Home Loan Bank of Chicago. Unfortunately, despite all the good news with the key growth metrics, our near-term quarterly earnings are lagging the progress we see in our operations. It is not a company-wide issue. Our earnings from our commercial mortgage banking business and our investment portfolio continue to be in line with or ahead of our expectations. The primary area of our earnings pressure is coming from our residential mortgage banking activities. This is due to 2 factors. First, our conforming loan product line is more commoditized when compared to the jumbo product line and therefore, more subjected to the overall industry-wide pressure on gain on sale margins resulting from lower refinancing activity. Our jumbo product line margins were in excess of our long-term target of 25 to 50 basis points before personnel and overhead costs. Additionally, we are incurring upfront costs that…

Thank you, Marty. We made significant operational progress in the second quarter specifically on the 3 levers Marty just mentioned. Let me run through some of the operating metrics. Our residential loan acquisition volume was $1.8 billion in second quarter, that's up 64% from the first quarter. We originated $149 million of senior commercial loans in the second quarter. We issued a $347 million residential loan securitization that closed in April, and we also issued a second securitization late in the second quarter for $306 million that closed in early July. Our residential securities portfolio increased by $102 million to $1.8 billion. I will comment briefly on each of these areas. In the second quarter, we acquired $923 million of jumbo loans. That's up 16% from the first quarter of 2014. We made very good progress growing our conforming product line in the second quarter, which was only the second full quarter in which we have been acquiring conforming loans. We acquired $868 million in the second quarter, up from $299 million in the first quarter. That's 190% increase for our conforming product line. Our seller network continues to grow every quarter. At the end of the second quarter, we had 140 sellers, up from 124 at the end of the prior quarter. Our team has done a very good job of identifying high-quality originators nationwide, engaging in getting them up and running, which is driving new business across all residential product lines. In the second quarter, we completed 6 jumbo whole loan sales transactions for a total of $357 million. As with the past few quarters, whole loan sales continue to offer better execution but securitization has become more competitive with whole loan execution as AAA spreads have tightened over the last quarter. Given the tightening of AAA spreads,…

Thank you, Brett, and good afternoon, everyone. Earnings per share were $0.18 for the second quarter of 2014, up from $0.14 in the first quarter. The increase in earnings is largely attributable to higher mortgage banking income, which increased by $6 million or $0.07 per share in the second quarter. Partially offsetting the improved mortgage banking results were an additional $2 million or $0.02 per share of operating expenses quarter-over-quarter that related to the build-out of our residential and commercial platforms. Our quarterly results continue to experience timing differences related to our jumbo mortgage pipeline and hedging for those loans, making it difficult to fully ascertain our quarterly operating performance from our high level GAAP results. In the second quarter, we incurred hedging expenses due to falling interest rates that were reflected in that period's earnings with the anticipated increase in value of the $1.6 billion of jumbo loans we plan to purchase at June 30, was not reflected in earnings. Instead, the valuation will be reflected in third quarter earnings, to the extent those loans are required throughout the quarter. Our best estimate of this amount would currently be positive $9 million or $0.10 per share of additional income that we would currently expect to come through our third quarter 2014 reported earnings. Obviously, as I've stated in the past, this is only an estimate and is subject to change based on a number of different factors. Additionally, I would note that this type of timing difference is specific to our jumbo products and is self-correcting over time as the loans processed through are conduit. However, to the extent we believe it is significant in this quarter or any given quarter, whether positive or negative, we may choose to discuss it on the quarterly call. Additional regularities that affected…

[Operator Instructions] And we take our next question from Steve Delaney with JMP Securities.

Maybe I could start on the commercial real estate. Definitely sounds like some momentum there and the margins are holding up. I just wanted to ask, I guess, Chris, if you're the right person, just to make sure my math is -- I'm doing the right math here. So it looks like the commercial mortgage banking contribution net of the hedge costs was $5 million and I think based on prior conversations and calls, that the appropriate denominator for that to try to calculate a margin on that business is actually the loans originated in the quarter. I think everything is -- that's originated for sale is mark to fair value. So that would be 1 49 in the simple math, it gets us to somewhere between 3%, 3.5% margin. Is that the right way to think about the profit margin on that business?

That's one way to look at it. We certainly -- I think you've got it right in that we look at the loans originated and the point at which they're distributed and there's noise as there was last quarter, Steve, with loans that were held over from the prior quarter. I think the big picture though, 3%, is not a realistic trend or a number to draw a line through. I think in this business, there's a lot of competition and through the end of the year, I think margins have been healthy and will remain healthy but something well over 100 basis points but not $350 million is...

Okay. And when we look at $300-and-some million, $300 million, $350 million in the third quarter, I think you're just -- you're cautioning that don't carry that second quarter margin forward.

Yes. I mean, it's -- we had -- there are a few quarters last year where we were generating returns like that but I think that looking at the pipeline and thinking about the end of the year and the supply in the market, I would caution you to before booking that.

This is Marty. I would look closer to 2.

Okay. That's very helpful. And then appreciate the challenge you guys have with the timing differences and I know you're working to try to maybe get your -- some documents changed so that, that will be resolved in 2015 but, Chris, I just wanted to clarify, the $1.6 billion that was the pipeline -- or maybe the pipeline, I want to use the right term, those were the loans identified for acquisition at June 30 in jumbos, right?

That's correct. They weren't on the balance sheet.

Okay. And you're suggesting that those may have a -- since that wasn't recognized, that may have been a $9 million offset to hedge costs or $0.10 a share. Now if we think about -- I try to net these timing differences to basically start with sort of a core number and then adjust the timing difference. But I think I probably need to net against the June 30 timing difference, don't I have to look back at -- to where we were at March 31, and maybe I think that pipeline was like $670 million. So should I think about, as far as the net timing difference, the impact in 2Q, should I look at the dollar difference in the jumbo pipeline and then try to apply some kind of unrecognized margin?

Yes. That's right. So last quarter, we didn't spend as much time on this because the numbers weren't as significant. As you said, the pipeline was quite a bit less. I think where we ended the last quarter since our last call, we bought those loans and distributed them. There was probably less than $1 million of additional income on the loans. So I think if you're looking at netting, I think that you're looking at the $9 million and some number that's less than $1 million from the June 30 one.

Okay. That's helpful to know. Okay, well, that's enough on the nitty-gritty. Maybe, Marty, I'd just like to get a big picture thought and then I'll drop off. I know there are others that probably want to ask questions. So last year, think about Washington D.C., last year, we were all hoping while the market was there, we might get a cut in limits and GSE Reform was sort of going to be something that would benefit the business model for the private label model. That didn't happen but now it seems there's a new move there, some focus, I guess, treasury at the end of June when they were celebrating 5 years of making homes affordable. There was a white paper put out on reinvigorating the private label market and then just yesterday, SFIG put out of this Green Paper. I was just curious if you've got some thoughts, big picture thoughts you could share with us about what are these -- what really needs to be fixed in this market to improve the liquidity and the breadth of the market?

By the way, for everyone on the call, we submitted a White Paper yesterday as well. And my observations would be, one, for a Redwood-type deal probably doing something more safety when we've done 10,000 loans and there's only 2 loans that have issues and 1 of which is current. But I think 1 of the things that with all the talk on RMBS 3.0, again we took the position, why don't we lead, how can we build a standard that's even higher and really let -- getting built with an eye towards -- some time, the collateral will get worse, in which case, you will need more protections, not necessarily on our deals but other deals. And there's people out there that are actually boycotting at the moment, waiting until RMBS 3.0 comes in. And essentially, it's 2 things. It's essentially, one, much more prescriptive -- prescriptiveness to the documents, standardization, taking out ambiguity so there's less discretion on the behalf of servicers or trustees. And then the second thing is to have a traffic comp in the deals and these are our ideas. So overlook to 3 areas which were most impacted -- where investors are most impacted and that would be to oversee servicing, oversee reps and warrants and oversee cash flow mechanisms. It's a lot to go on in the call but really, our paper is out there and I encourage you to take a look at it.

Our next question comes from Vik Agrawal with Wells Fargo Securities.

I was just curious. When you talk about or mention that you're looking at increased activity for the second half of the year, is that sort of a sign that the market is starting to normalize in the jumbo side?

Vik, it's Brett Nicholas. No, It's a combination of a few things. One, we continue to grow our seller network and origination network; and then secondly, rates are down and spreads have tightened. So borrowers are -- there's much more competitive rates out there for borrowers to buy homes or refinance. So that's really what is driving a lot of it. Some of it's on our behalf and the other is just absolute interest rates.

Okay. And then on -- shifting gears on your -- sort of you mentioned that there were higher residential expansion costs. Can you give me a sense of how much that was in the quarter and are you expecting more in the future?

No, we don't -- we have a lot of just general overhead that we don't allocate specifically to segments each quarter. But we did say that they went up $2 million quarter-over-quarter and just to give you an idea, we've got a headcount of 172 at June 30. Most of those hires have occurred on the residential mortgage banking side. So our goal is we're ramping up the conforming business, trying to achieve a level of volume that we're -- makes us efficient. And in order to accommodate that volume, we still have some hiring to do. We have some work on systems but we expect it to be substantially completed by the end of the year.

And our next question comes from Paul Miller with FBR.

This is actually Thomas LeTrent on behalf of Paul. Another question on the pipeline, if I can. The $9 million benefit is obviously based on some sort of rate assumption. If rates continue to move down like we saw today, I mean, the 10-year was weak again today, would it be fair to say that, that benefit could be higher or will they also cause some additional hedging costs that would flow through third quarter as well?

Yes, I mean, we're -- it's -- there are some assumptions built into that number and why we're always hesitant to say too much because obviously, one of them is fallout and how many of the loans in the pipeline, how much of the 1.6 of the jumbo pipeline actually pulls through. Rates is another one. And rates has a big influence on fallout. So at this point, that $9 million estimate is our current estimate. So it's our estimate as of today. You're correct, the rates have fallen. So at this point, we don't have a better guess or sense of where it's going to head but rates do impact ultimately the pull through.

Okay. And then one more question. On the confirming loan piece, which -- obviously, confirming loan acquisitions were very strong in the quarter. Would you say you're sort of on par with where you wanted to be at this point? Would you say you're ahead of schedule? I know you're targeting $1 billion per month by the end of the year. But just trying to get a sense of where you feel like you are right now.

We think we're on schedule or even slightly ahead of schedule. I think we're pretty impressed with our second quarter volumes. And as Chris mentioned, our focus is really around acquisition costs and efficiencies so that our expenses don't keep going up with volume. But they go flat and the volume goes up.

[Operator Instructions] We'll take our next question from Bose George with KBW.

Can you just comment on the gain on sale margin on the conforming side and then just your longer-term outlook given the 25 to 50 on the jumbo side. Just what do you think that will be on the conforming side?

Yes, we -- the 25 to 50 on the jumbo side, that has been our long-term assumption for those products and I think we mentioned earlier that we're doing even a little bit better than that or in the higher end of that through the first 6 months of the year. On the conforming side, it's a completely different situation. As Marty mentioned, it's a commoditized market and we're a new entrant in that space. Really, margins there are very close to breakeven at this point and that's before expenses. So through the end of the year, we expect things to improve somewhat and the reason why is, number one, as Brett mentioned, there's going to be more efficiencies in the business but also, we're still in the middle of ramping our sellers. We've got 140 active sellers in the jumbo side. There's a lot more that we need to add on the conforming side and as we do that from a pricing standpoint, we expect to see margins move. But I think at this point in the year, breakeven margins are where we're at.

And just in terms of the outlook for that. I mean, is there way to think about where that will be as you get to the scale that you want to be like in 2015?

Well, I mean, what we're most focused on is covering our costs. So -- and we need to achieve a level of efficiency and if that level is somewhere in the neighborhood of 30 to 45 basis points for the industry, then that's where we need to be. The way we look at that business is, not only are we operating and running mortgage banking activities but we're creating investments, both through adding mortgage servicing rights and at some point in the future, potentially adding investments through risk-sharing transactions with the GSEs. We see a lot of upside in the business but some of it is in 2015.

And in part -- this is Marty, Bose. In part, we're trying to build market share in the conforming side. Everybody knows this on the jumbo side. And to ultimately be a real counterparty to these different sellers, we need to have multiple products and have the same level of service, whether it's jumbo, conforming or non-QM. So there is some market share building that we're doing right now to get in the door, show them what we can do. And that, ultimately, over time, begin to bring back up price and build in a little bigger margin. And obviously the same is probably happening to the industry...

So let me just throw in one on the commercial side. Did you guys -- you're growing that in terms of originators, et cetera, or do you see your strength really reflect to the strength of the market as a whole?

It's been through adding originators and the market has also picked up as well. So it's a combination of both. And Bose, we've been in the business now for 3 years on that side. So our names and brand recognition on the commercial side is growing and that's really helping a lot.

And at this time, we have no further questions in the queue. I'd like to turn things over back to management for any additional remarks.

Thank you, everyone. Obviously, the Redwood review is out to take a look at with everything, as well as our White Paper. Thank you very much. Bye.

That does concludes today's presentation. We thank you for your participation.