Good afternoon and welcome to the Redwood Trust Incorporated Third Quarter 2019 Financial Results Conference Call. During management’s presentation, your line will be in listen-only mode. At the conclusion of management’s remarks, there will be a question-and-answer session. And I will provide you with the instructions to join into the question queue after management’s comments. Today’s conference is being recorded I will now turn the call over to Lisa Hartman, Redwood's Senior Vice President and Head of Investor Relations for opening remarks and introductions. Please go ahead, ma'am.

All right. Thank you, Jerry. Hello, everyone. Thank you for participating in Redwood's third quarter 2019 financial results call. Joining me on the call today are Chris Abate, Redwood's Chief Executive Officer; Dash Robinson, Redwood's President; and Collin Cochrane, Redwood's Chief Financial Officer. Before we begin, I want to remind you that certain statements made during management's presentation 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 could cause actual results to differ from those that may be expressed in forward-looking statements. On this call, we will 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. They are included to aid investors in further understanding the company's performance and to provide insight into one of the ways that management analyzes Redwood's performance. A reconciliation between GAAP and non-GAAP financial measures is provided in both our third quarter earnings press release and Redwood review available on our website. Also note that the content of this conference call contains time-sensitive information that is accurate only as of today, October 30th, 2019. The company does not intend and undertakes no obligation to update this information to reflect subsequent events or circumstances. Finally, today's call is being recorded and will be available on the company's website later today. I will now turn the call over to Chris, Redwood's Chief Executive Officer, for opening remarks and introductions.

Thanks Lisa and good afternoon everyone. Before I begin my remarks, I wanted to recognize the great efforts undertaken by our local officials, especially the firemen, evacuation coordinators, and others, who have bravely fought to contain Getty and various wildfires currently burning at this hour in California. These fires are very close to home for us, as a Northern California headquartered company, and we look forward to helping our communities recover and rebuild as these fires are contained. At Redwood, third quarter marked an historic time for us, were we made significant progress positioning the company for the future of housing finance. Looking back to a few years ago, we announced a comprehensive new strategy to leverage our housing credit competencies across a broad and evolving residential landscape. This entailed not only the expansion of our consumer mortgage business, but also a commitment to offering similar solutions for housing investors to purchase residential real estate for business income. Since that time, we've demonstrated the skills and operations necessary to grow in this market and have taken tangible steps toward building a best-in-class specialty finance platform, one that serves the liquidity needs of all homebuyers, homeowners, and investors alike. Our expansion into the business purpose lending space began organically, but quickly evolved into a partnership with our 5 Arches team in Irvine. The investment opportunities we have seen through 5 Arches have validated the thesis underpinning our new strategy. That is, the rate of new home building in the United States is not keeping up with the pace of new household formation. With our convictions strengthened, we further solidified business purpose lending as a core strategy at Redwood by recently announcing a second new partner in CoreVest. To recap our announcement from a few weeks ago, CoreVest is an industry-leading BPL…

Thank you, Chris and good afternoon everyone. Before I touch on results for the third quarter, I want to share more about our recent acquisition of CoreVest. As a refresher, our investment of $492 million completed earlier this month included CoreVest's origination platform, with an ascribed value of $130 million, and over $900 million of related financial assets, along with in-place financing. CoreVest's balance sheet is principally comprised of subordinate securities retained from the company's single-family rental securitizations, SFR loans held in pipeline slated for inclusion in upcoming securitizations, and short-term bridge loans made to investors seeking to stabilize or sell their portfolios. As Chris mentioned, life-to-date, the platform has funded over $4 billion of loans, including $1.1 billion year-to-date through September 30th. Almost 70% of CoreVest's 2019 originations are comprised of single-family rental loans, a volume that is fed by both organic borrower cultivation and natural lead generation through the bridge lending book. As Chris noted, the acquisition of CoreVest reflects our strong belief that this area of housing credit offers substantial opportunity for growth and accretive returns for our shareholders, which we estimate to be in the range of $0.15 to $0.20 annually on a per-share basis over the course of the next 12 to 15 months. Our forecasted earnings accretion is a function of projected returns on the acquired financial assets, forecasted operating income of the origination platform, and flow of additional portfolio investments created through go-forward originations. Importantly, this forecasted accretion does not fully encapsulate the acquisition's strategic rationale. An overlap in our competencies, most notably reliability and speed to close for clients and seasoned securitization platforms, is complemented by competitive advantages that we believe can bring unique to CoreVest's business. These include our extensive mortgage banking network, potentially fertile ground through which to expand product…

Thanks Dash and good afternoon everyone. To summarize our financial results for the third quarter, our GAAP earnings were $0.31 per share, compared with $0.30 in the second quarter, and core earnings whatever $0.37 per share, compared with $0.39 in the second quarter. The increase in GAAP earnings in the third quarter was primarily driven by an increased benefits investment fair value changes from spread tightening in our security portfolio during the quarter. Core earnings per share decreased in the third quarter, primarily due to lower mortgage banking results and economic net interest income, which are both negatively impacted by rate volatility. These decreases were partially offset by higher realized gains. While elevated portfolio optimization activity benefitted gains during the quarter, growth in economic net interest income was dampened due to a higher average balance of undeployed capital, as we positioned ourselves for the acquisition of CoreVest and continue to be selective in redeploying capital due to the overall credit spread environment. Further, economic net interest income continued to be impacted by rate volatility during the quarter, which resulted in increased hedging costs and higher prepayments. While faster repayments helped to improve fair values of our subordinate investments, it negatively impacted portfolio investments held at a premium. Our GAAP book value decreased during the third quarter to $15.92 per share which, along with our dividend, contributed to a 1.3% economic return for the quarter. While GAAP earnings exceeded our dividend during the quarter, book value decreased, primarily due to an $0.11 per share decline in the value of derivatives hedging our long-term debt, which were impacted by the decline in benchmark interest rates during the third quarter. Additionally, while GAAP earnings benefitted overall by spread tightening on our subordinate credit securities, this benefit was partially offset by the negative impact…

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] The first question is from the line of Douglas Harter, Credit Suisse. Please go ahead sir.

Thanks. Can you talk about the impact of higher prepayments on, you know, sort of your economic returns? So, if you were to net, you know, kind of book value changes and earnings changes, kind of how higher prepays kind of flow through and impact you.

Sure, Doug. There's a few different ways, and one thing we cited was we're pretty happy with the balance in our business. Obviously, on the mortgage banking side, volumes have been elevated, especially refi volume. That said, we saw some really fast prints starting in June and July, particularly the 2018 vintage loans, and that definitely impacted securitization execution in the third quarter. I think investors, as we moved into some of the lower-coupon products, have definitely regained a lot of comfort, and that execution has strengthened a lot later in the third quarter, into the fourth quarter. You also had the impact on our premium investments, which we noted. I think all told perhaps in the neighborhood of $0.03, give or take, was probably the net impact. But, again, if you're in the mortgage banking business, you've got to keep the loans moving, so we're pleased to have gotten off the three deals that we did. And as I mentioned, we have no plans to alter the pace of activity going forward.

Great. And then I think you mentioned kind of the level of execution profitability kind of improved going, you know, as the quarter was ending. Can you just talk about how October looked from kind of a mortgage banking profitability standpoint?

Yes. So, Doug, its Dash. We did complete one deal in October, and if you compare the execution of that transaction to what we did in the third quarter, the execution on the AAAs improved by about three-eighths of a point in price, which was a function of a couple things, of course, where rates have gone, but also, to Chris's point, the ability to securitize collateral whose coupon was closer to current production coupon certainly helped. The execution on that transaction was quite strong on the AAA securities, and actually, the tightest we'd seen in several years, so the market has certainly bounced back here in October. It's certainly somewhat driven by demand, but also the normalization of rates and what we're securitizing versus where mortgages are trading generally.

Great. Thank you.

The next question is from Stephen Laws, Raymond James. Please go ahead sir.

Thank you. Good afternoon. Collin, I guess kind of following up on your comments, and I appreciate the update, it sounded like pro forma capital at the end of October was roughly around $100 million. Can you talk about, maybe little more detail on any additional lower-yielding securities you guys have identified that you'll look to sell down as other investment opportunities present themselves, as well as optimization efforts you can make on financing business purpose loans in some capacity that might be more attractive than the current warehouse facilities you have in place?

Yes, in terms of optimization, I think we've made a significant amount of progress this year, but I think there still remains a little bit of work to do there. We still have some CRT investments that I think we're looking at as potential candidates for optimization, and potentially some multifamily mezz that we're looking at. So, I still think, heading into the fourth quarter, I mentioned that there is a little bit more optimization that we expect to do, but I do think we have made a significant amount of progress year to date. So, we do see that optimization sort of tapering down through the end of the year. And in terms of financing, we did, again, make some good progress this year putting -- or this quarter, rather, putting this new term loan in place. In terms of some of the financing on our business purpose loans, I think there's a little bit of work we expect to do there through the end of the year to tighten up some of the terms and expect to see some improvement. And then, Dash also mentioned some work we've been doing to get SFR loans probably financed over on the FHLB. So, we moved a small balance of loans over before the end of the third quarter and we're looking to get the substantial majority of the remaining SFR loans that we originated through 5 Arches over in finance this month for the end of the year. So, I think those are really some of the more immediate things that we're looking at over the course of the next couple months here, heading into year-end.

Hey Stephen, it's Dash. One thing I would add to that and we talked a bit about this on our call a couple weeks ago announcing the acquisition, we -- as you know, we inherited a fair amount of financing in acquiring CoreVest, and there are, from our perspective, some near-term things we can do to sort of normalize that structure into how we typically structure those sorts of warehouses, which we hope in the relative near to medium term can be more of an immediate impact to the returns on financing. Because the assets, I think Collin covered the waterfront really well, probably, but I just wanted to reinforce that point that we mentioned a couple of weeks ago, because that could potentially be very meaningful.

Yes, I appreciate the color from both of you and thanks for the reminder on that. And Dash I was writing down as quickly as I could, but I want to circle back. Did you say $0.15 to $0.20 accretive on CoreVest, or was that a 15% to 25% ROE versus low to mid-teen ROE? I didn't quite catch the $0.15 to $0.20 that you mentioned. I was writing something else down.

Sure, Stephen, no problem. Yes, there were a fair amount of numbers and percent hedges in the script. The accretion was $0.15 to $0.20 per share per annum, which is based upon assumptions about what we've purchased, of course, and then assumptions around the go-forward profitability, and then creation power of the platform versus alternative uses of capital. The return profiles that we've stated are in the 12% to 15% range, which are certainly a big part of driving that accretion calculation that we talked about.

Great. Thanks for clarifying that. Last question for me here. Chris, could you maybe talk higher level GSE reforms? Specifically, Collin mentioned, and Dash as well, FHLB financing, but I know one proposal might open that back up again, you know, allow you guys to have maybe more access there. And then, secondly, comments around possibly a new qualifying mortgage definition and maybe what the latest is you're hearing around those issues and anything else that you'd like to highlight on potential GSE reform?

Thank you, Stephen. I hope you're doing well. There's obviously a lot going on. The SEC actually just released something today requesting feedback from the market on Reg AB II, risk retention, and some of the issues, the gating issues that have prohibited or been an impasse for the private label sector to do more public transactions, so we've been pretty active on that front. We published some pretty meaningful content, I think in August, on ways to do that, lessons learned from the 144A market and so forth, so that's one thing that is very current. I think on the QM patch front, we've had some recent statements from the Director, sort of reaffirming the intent to allow that to expire. I think the private sector needs to step up and do its part. We certainly plan to do ours. We're working quite a bit internally with automation efforts and technology, to try as best as we can to make the transition as painless as possible for originators. That said, we feel very strongly about a level playing field. We feel like it's certainly in the interest of taxpayers. We do feel like being able to compete on the same front will definitely move a significant amount of these loans away from taxpayers into the private sector, so we're excited about that. We've also been somewhat vocal on risk retention and some of the issues there. From a practical perspective, one loan, one non-QM loan in a QM securitization triggers full risk retention, so we've advocated things such as asset-specific risk retention and some other alternatives that will start to blunt this binary trigger effect when a loan goes from QM to non-QM. We are -- we did provide some thoughts on the QM definition, and our perspective, we still believe that credit metrics matter. We don't want to move fully to market-based metrics or definitions for QM versus non-QM. I think what we've emphasized is, wherever that definition lies, whether it's 43 DTI or 50 DTI, a big challenge in the market is the drop-off, and wherever it occurs, whether it's 43 to 44, 50 to 51, or some other metric, we're looking for ways to make that drop-off less acute. So, there's a lot going on. There's going to be some more announcements here in the coming months, but we definitely are pressing forward and are certainly looking to step up and absorb as much of this volume as we can.

Great. Well, between the two acquisitions this year and the upcoming reform proposals, certainly seems like next year will be quite an exciting year. Appreciate you taking my questions today.

Thank you.

The next question is from Steve Delaney, JMP Securities. Please go ahead sir.

Thanks. Hey folks. Look, first, before questions, just sending prayers to you, your families, and all your communities to get safely through these fires. It's just a terrible thing, and it seems to happen repeatedly, so we're thinking about you. On CoreVest, I mean, obviously it's going to take us -- after a quarter, so you guys will -- you won't have to listen to us ask CoreVest questions, but for now, we need to. Did you ever mention publicly what your headcount was at CoreVest? I recall 5 Arches was like 90 people or something, but do you have a figure you can share on CoreVest so we can get a sense for how large the platform is.

Sure, it's about 100 FTEs.

About 100, and was I correct on 5 Arches at 90, or was that too high? I don't know why I had that in my mind.

That was about the number when we completed the acquisition of the platform in March. It's a little over 100 now, just with additions across the platform -- facilitate more growth. So, the FTE count of each platform is actually pretty close.

Okay, great. That's helpful. Now, third quarter, you guys had consolidated operating expenses at $25 million. Collin, I think it was down $1 million from $26 million. Now, CoreVest obviously didn't close until fourth quarter. I'm going to come back to your -- thank you for the $0.15 to $0.20. But just as far as the overhead of the operation, ignoring all revenues, do you have a sense for either on a quarterly basis or an annual basis what CoreVest specifically would add to the G&A load on a quarterly basis?

Yes, I think on a quarterly basis, we're looking at about $5 million to $6 million of expenses as probably reasonable run rates.

Okay, great. That's very helpful. Thank you, Collin. And Dash in your remarks, what I took it to mean, you talked about the loans coming out of CoreVest on your balance sheet. You're looking for a 12% to 15% return on equity. But since you mentioned, you know, without fees and gain on sales. And I understand you guys are trying to run this as like a, it's part of Redwood, but it's a standalone business that needs to stand on its own two feet. And it sounds -- you're leaving fees, origination fees, and any gain on sale in CoreVest to help offset expenses. Is that what I heard you say?

Yes, I appreciate that question, Steve, because it brings up an important point about just making sure that we look at the value creation of these platforms holistically, you know, the actual operating metrics, revenue less expense, and the value of the loans and securities created. The -- some of this is a function of the just the geography of where the businesses sit. CoreVest, like 5 Arch, that operating platform is at our TRS because of the functions that it does day-to-day and the origination loans. And so those fees and the gain on sale associated with securitizing SFR loans and the borrower points associated with originations, similar to 5 Arches, those geographically will be at the TRS, and of course the long-term investments will go to the REIT on a more tax-advantaged basis. But similar to my remarks on 5 Arches, with CoreVest, we look at and measure performance holistically as it relates to the assets created and the operating metrics, those two go hand-in-hand. And so, some of it is just split geographically based on our tax structure, frankly. But when we assess performance and measure ourselves, it's holistic with assets and then the operating metrics together.

Okay, that's helpful. And when you -- you mentioned gain on sales tied to the securitizations, you know I think at one point, I can't remember if it was 5 Arches or CoreVest, somebody was selling off their bridge. But is -- the current situation, are you essentially retaining all production and then not selling anything off on a whole-on basis, but you retain it and then you choose to securitize it or put it with FHLB or whatever. Is that -- I mean, I guess what I'm saying is, is everything that they're producing coming to Redwood or are you actually trying to sell some of it away?

That is predominantly the case. With the 5 Arches, we're to the point where we're retaining essentially 100% of what that platform produces. There are a couple of exceptions, but there's no front-foot effort there to sell loans to third parties. With CoreVest, there's a small part of the production which is sort of a smaller balance SFR product, which to-date, the platform has been selling. That's partly what I was alluding to as a product that could potentially be very logical to marry up with our mortgage banking network, and so the options are sort of open to us at this point. We haven't concluded exactly yet the right outcome there. We could certainly keep them and securitize them, along with the more regular-way SFR loans. But for the most part, the intention is to retain, though it's always like we talked about before, similar to mortgage banking. It's important to keep the muscle memory open to be able to sell these loans to counterparties, depending on risk/return, where the market's pricing, risk, et cetera.

Sure. Well, thank you all for your comments, and I look forward to seeing you in a couple weeks.

You too. Thanks.

We have a question from Bose George, KBW. Please go ahead sir.

Hey good afternoon. Just going back to your 2019 guidance, did you narrow that down to a core ROE range, or was it really just on the line items? I can't remember.

Yes, I mean, we've typically expressed our guidance in terms of components where we allocate our capital between the businesses and so that's the format in which we've laid it out, and that's what we updated things relative to in the fourth quarter. So, we broke that down between our investment portfolio, our residential mortgage banking business, and then we gave an update on the business purpose component of mortgage banking, inclusive of CoreVest. And so, that's what we've laid out in the [Indiscernible] review.

Okay. And then, I was trying to think, the $0.15 to $0.20 accretion, should we think of that really on top of the core earnings number that you guys end up with in 2019, and it's $0.15 to $0.20 over that? Is that kind of the right way to think about it?

Yes, going forward we've offered EPS guidance as a firm in the past, and we have in the past few years, but we felt like since we just completed this acquisition, we felt like we needed to do something more holistic. And so, I think we'll think about how to incorporate that guidance into next quarter's review, where we refresh our annual guidance, but for now, that's sort of in addition to what we've currently been earning.

Okay. Thanks. And then in terms of the dividend, you guys had talked in the past about increasing the dividend closer to core earnings. I'm just curious, now you have obviously more earnings at the TRS through the acquisition. Just updated thoughts on how you view that.

Yes, I mean, what we're trying to do, and what we -- we spent a little bit more time this quarter talking about economic net interest income, because we've put a lot of the puzzle pieces together, we think, to drive that -- those durable, sustainable cash flows. We've been optimizing, and those are one-time realized gains, per se. But I think what we've done is we've really extended our runway and the line of sight and how we get to core and the consistency of core. We feel like we've put a portfolio together that will be a little bit more transparent in how we generate cash flows. Ultimately, of course, the goal is to have those consistent durable cash flows that will enable us to raise the dividends, so that's something we're focused on.

Okay, great. Thanks.

We have a question from Matthew Howlett, Instinet Nomura. Please go ahead sir.

Hi everyone. Thanks for taking my question. I apologize if I missed it, but did you give an origination guidance number for CoreVest, or just single-family rental combined, business purpose loan combined for 2020?

Hey Matt, it's Dash. No, we didn't. We'll have more to say on that when we get a quarter behind us here. I would sort of point you to the current run rate of production, which we've talked about. I can certainly see room for growth, but we haven't, at this point, put a number--

Okay. Just help me think about the securitization process. How big are the retained interests that you would take down in terms of the subordinate tranches? And then, remind me a little bit of what the collateral -- I mean, these are prepayment penalty loans, are they not, and the coupons are, what, maybe 6%-plus?

Yes, so taking those in reverse, yes, these loans typically have five- to 10-year terms, either or 30-year ad [ph] or some IO period. And yes, it's certainly one of the compelling things about them is, from a commercial real estate like perspective, they tend to have strong prepayment protections. The vast majority of what CoreVest securitizes has yield maintenance typically up through six months prior to the maturity of the loan, or there's a declining point structure, but yield maintenance is much more common. There are certainly some loans with rates at 6%, but with rates having declined as much as they have the average coupon is in the 5s. At this point, that will obviously move around with rates. From a securitization perspective, you know, in terms of retention, we estimate retaining, all in, 6% to 8% plus of the securitization. That would include the subordinate credit securities, as well as potentially some of the interest-only securities that are part of the structure. So, at a high level, not unlike Sequoia, although the thickness of what we're retaining, which is part of the attractiveness, obviously at those return targets is significantly higher than what we're typically retaining on a Select transaction and even, to an extent, Choice.

Yes, that was my next question. Redwood practically amended the jumbo market. These structures that are coming out, is there anything relatively more attractive about investing in these securitizations versus what you've done traditionally in the jumbo space?

Yes, I mean, I think Dash hit the nail on the head in the sense that we can just put more capital to work at similar or better returns. I like to liken this market to where the jumbo space was 10 or 15 years ago. And so, when we think about our role in the markets as a specialty finance company, we're really meant to be involved here and take some of the lessons we've learned and experience we've gained from jumbo and apply them here.

Got it. My next question, I mean, you guys, you've grown the Choice program well, you're securitizing, and you have that bucket where you show sort of the third-party issuance that you take, and that's been sort of flat for a while. As we start to see these non-QM conduits come out, these banks that even do prime jumbo, I mean, how willing will Redwood be investing in third-party non-QM deals or anything that comes out from the banks, given expected GSE reform? I know in the past, Redwood's been pretty aggressive with some of the big banks. I was just curious how you're viewing third-party deals today, with some of the originations you're creating.

Yes, Matt. We've shied away, but really because we haven't liked the value proposition. So, as we've said, we've been doing a lot of optimization because asset prices have gotten so high. It's been great for gains, but not so great for putting capital to work. It's one of the reasons why we've progressively gotten more organic and are focused on sourcing the raw material to create the deals, rather than the deals themselves. That said, if there's a significant increase in supply that should have a countering effect on pricing. So, we're always open and looking at third-party opportunities we see in the market, and we can certainly see, with that supply going up, the opportunities becoming more attractive.

Great. Thanks. And the last question's on -- you've been watching, Chris, a lot. There was a comment on maybe letting the REITs active regain access to captive reinsurance. I know you're FHLB line doesn't expire until 2026, so just curious what you're hearing on that front.

Sure and I probably should have addressed this earlier with Steve and I apologize. But there's a lot going on, some of which is not ready for prime time, so to speak. But I can say that the new regime at the FHFA is very aware of it. I've made them personally aware that the QM patch expiration set for January of 2021 is right on top of the stated expiration of the grandfathered captives in January of 2021. So, we've been very clear that if they're moving that line of liquidity for the folks in the private sector, that they need to step up to assume some of this business from the GSEs is not going to be helpful. I think the real essence of the solution resides in safety and soundness for the system, first and foremost, and ensuring that the infrastructure is taking into account, whether it's captives or other forms of members. I think if there can be something that is compelling and ensures the safety and soundness of the system, hopefully, the regulator is receptive. But at this point, candidly, I think that the FHLB captive issue is a little bit behind the QM patch and some of the GSE privatization initiatives, or removing them from conservatorship. But those issues are, I think first and foremost, but this is quickly gaining some, I think, more greater notoriety within Washington, and we're certainly advocating for a solution.

Great. Thanks for that.

We have a follow-on question from Bose George, KBW. Please go ahead sir.

Great. Thanks. I just wanted to follow up on the question about the -- Matt's question just on the yield of the portfolio. Actually, how does it vary between the BPL and the SFR loans? And also, I thought the coupon at least on the existing bridge portfolio I thought was quite a bit higher, so I just wanted some color on that.

Sure. Bose, just to clarify, your first question is returns on the BPL versus Sequoia or --

No, just the SFR, the single-family, the investor stuff you're doing there as well.

Yes, so the -- in my response to Matt in terms of the coupons was specific to SFR loans. The average coupon for Bridge is about 8% and that doesn't include the borrower points at the platform or origination, but those loans are 200 to 300 basis points higher in coupon than SFR.

Okay, great. Yeah, I just wanted to confirm that. Thanks.

You're right.

There are no further questions at this time. This concludes today's teleconference. Thank you for joining and have a pleasant day.