Kristin Brown - VP, IR Marty Hughes - CEO Christopher Abate - CFO.

Bose George - Keefe, Bruyette & Woods, Inc. Vivek Agarwal - Well Fargo Brock Vandervliet - Nomura Securities.

Please standby, we are about to begin. Good afternoon, and welcome to the Redwood Trust Inc. 2016 Fourth Quarter Earnings Conference call. During management’s presentation, your lines will be in a listen-only mode. At the conclusion of management’s remarks, there will be a question-and-answer session.

I will provide you with instructions to enter the QA queue after management’s comments. I would now like to turn the conference over to Kristin Brown, Vice President of Investor Relations. Please go ahead..

Thank you, Dana. Good afternoon, and thank you for joining us to review Redwood Trust’s fourth quarter 2016 earnings report. Before we begin, I wanted 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 also included to aid investors in further understanding the company’s performance and to provide insight into one of the ways that management analysis Redwood’s performance.

A reconciliation between GAAP and non-GAAP financial measures is provided in both our third quarter earnings press release and the Redwood review available on our Web site redwoodtrust.com. Also note that the content of this conference call contains time-sensitive information that is accurate only as of today, Thursday, February 23, 2017.

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 will be available on the company’s website later today. For opening remarks and introductions, I will now turn the call over to Marty Hughes, Redwood’s Chief Executive Officer..

Good afternoon, everyone. Thank you for participating in Redwood’s fourth quarter 2016 earnings call. Joining me on the call is Chris Abate, Redwood’s President and CFO.

Following my remarks on our key financial metrics and accomplishments over the past fiscal year, and our thoughts on the year ahead, Chris will discuss the quarter’s investment and residential mortgage banking activities and our financial results for the quarter.

2016 was a very productive year for Redwood, our GAAP earnings were $1.54 per share versus $1.18 in 2015. Our GAAP book value per share increased to $14.96 at December 31 from $14.74 at the end of the third quarter and $14.67 at the end of 2015.

After incurring $10 million of restructuring charges, we generated 11.8% GAAP return on equity, grew GAAP book value, showed up our balance sheet by reducing short-term repurchase debt and freed up capital internally for reinvestment through profitable sale of our commercial mezzanine loan portfolio.

We also delivered attractive and consistent quarterly dividends to shareholders that contributed to a total shareholder return of 25% for the year. Most importantly, we finished the year in a strong financial position and after making some difficult but necessary modifications to our shareholder strategy.

We now have a more focused capable and efficient investment platform that is well-positioned for the current winds of change in the mortgage market. Looking to the year ahead, efficiently deploying our available capital at attractive returns is at the forefront of our priorities for 2017.

We feel confident about her ability to create investments ourselves through our Sequoia securitization program, as well as other vehicles we may use to finance our expand prime choice loans.

We also remain focused on new and innovative ways to take credit risk on residential loans and continue to pursue investment opportunities in GSE issued securities that transfer risk on both single-family residential and multifamily properties to the private sector.

In addition to risk transfer transactions for newly originated loans, we’re seeing a growing market for government and bank issued securitization backed by nontraditional loans.

The economics of private label RMBS continues to be attractive and we expect higher issuance volumes in 2017, as well as a greater amount of subordinate securities available for investment. As investment and investor demand for yield continues to drive these positive economics, our mortgage banking business is off to a solid start in 2017.

We completed three securitization transactions in 2016 and have already completed two transactions in the first two months of 2017 at favorable pricing relative to our fourth-quarter transaction. Of course the year ahead will unfold against an evolving backdrop provided by a new administration in Washington.

Like many of you, we have a strong interest in making sense of all the changes currently underway and how the new administration’s policies will impact the mortgage market going forward.

While no one really knows for sure how the policies will payout or out quickly, our view is that federal regulation will turn in the direction that favors private capital and away from government dominance in the mortgage markets.

In addition the new Treasury Secretary has expressed a strong desire to finally get GSE reform legislation enacted which will likely result in private capital, taking the leading role as the investor in mortgage credit risk.

We welcome these policy developments and we’ll continue to aggressively position Redwood to take advantage of the opportunities that open up as a result. In closing, I’d like to start off with the big picture. We are and remain patient long-term credit investors.

We think in terms of years, not quarters, and are bullish on our business model and our future growth prospects. We see private capital investors continuing to advance and becoming the leading holders of credit risk in the mortgage markets.

Additionally, in a low yielding investment world having a loan conduit that serves to both create investment and generate fees is a key competitive advantage. Now, narrowing the focus to 2017, our number one priority as I said before is to efficiently and attractively invest our available capital.

We continue to expect to generate a GAAP earnings that exceeds our recent historical dividend payout of the $1.12 per share annually, as many of our shareholders are aware our business entails a lumpy base of deployment, of capital deployment that doesn’t always align perfectly with quarterly run rate metrics typically used for a publicly traded company.

Most of the assets we acquire or create have long-term high – long return horizons and are liquid in nature and may not be consistently available or attractively priced.

Therefore generating excess returns in 2017 will largely depend on our ability to deploy our excess capital in efficient but prudent manner while maintaining our long-term value-driven approach to investing.

Aside from our primary investment objectives, we expect our residential mortgage banking business to meaningfully contribute to earnings in 2017. Our team is already off to a solid starts to the year, having completed two profitable securitizations and we are buying additional securitization activity.

This is not something we would have anticipated as recently in December in the wake of interest rate volatility following the U.S. presidential election.

We continue to feel very positive that our ability to capitalize on opportunities that rise in the market, as well as those we can create ourselves in order to generate additional net interest income to translate into compelling long-term shareholder value. I would now like to turn the call over to Chris Abate, Redwood’s President and CFO..

Thank you Marty and good afternoon everyone. I like to begin with some comments on our recent investment activity. We deployed $91 million of capital into new investments during the fourth quarter with an emphasis on residential CRT securities and commercial multifamily securities.

For the full year 2016 we deployed $419 million of capital, including $142 million into residential CRT, $85 million into commercial securities, $56 million into new Sequoia PRT in order RMBS, as well as $25 million into MSRs.

We also deployed $82 million of capital into loans financed through FHLB subsidiary earlier in the year, allowing us to fully utilize our $2 billion of financing capacity at the Federal Home Loan Bank of Chicago over the past three quarters. Finally, our convertible debt and common shares repurchases in 2016 totaled $29 million.

In the first eight weeks of 2017 we have deployed $123 million of capital into new investments and are confident that we will be able to deploy our remaining excess capital on a disciplined and prudent basis across a broad spectrum of opportunities.

We also sold $14 million of residential securities and $24 million of MSRs during the fourth quarter, bringing our total sales from our investment portfolio to $365 million for the full year of 2016. These sales split up approximately $205 million of capital for reinvestment and generated $23 million of realized gains for the year.

Our portfolio sales in 2016 primarily focused on lower yielding legacy securities that are fully appreciated. While we continue to be opportunistic in terms of our sales activity, we currently expect fewer security sales in 2017 than we saw in 2016.

We also expect to sell a significant portion of our remaining conforming MSR portfolio in 2017 and redeploy the proceeds into higher-yielding and REIT-eligible investments.

Overall, we were pleased with the performance of our investment portfolio during the fourth quarter as net interest income was steady and the underlying credit performance of our residential investments remained excellent. Our investment portfolio represented $1.6 billion or about 90% of our $1.8 billion of total capital at December 31.

The remaining 10% was allocated residential mortgage banking has continued to perform well since we repositioned our platform in early 2016. We purchased $5 billion of loans during the year and generated gross margins above expectations due in part to improved execution on our securitization activities.

As Marty noted, 2017 has begun in a strong note for residential mortgage banking business, as we completed our second Sequoia securitization of the year earlier this month, securitizing approximately $350 million of loans at tighter spreads than our first transaction in January. This should benefit our mortgage banking results in the first quarter.

We also continue to believe that our expanded prime Redwood Choice loan program will represent the most significant area of growth for our conduit going forward. Currently over 70% of our sellers have rolled out the Choice program and over 90% of those sellers had begun locking Choice loans.

With expanded prime loans increasing as a percentage of our jumbo volume and securitization execution improving in recent quarters, our long-term expectation is that gross margins for our jumbo business will average 75 to 100 basis points versus our previous expectation of 50 to 75 basis points.

We expect overall purchase volume levels in the $5 billion to $6 billion range in 2017, factoring in anticipated declines in industry origination volumes as a result of rising interest rates and declining refinance activity.

Now turning to our financial results for the fourth quarter, our GAAP earnings were $0.31 per share versus $0.58 per share for the third quarter. Fourth quarter GAAP results reflected the adverse mark-to-market impact of sharp increases in interest rates on our investment portfolio loan valuations and hedges.

This was partially offset by lower operating expenses and higher mortgage banking income in the fourth quarter. Core earnings for the fourth quarter were $0.31 per share as compared with $0.39 per share for the third quarter.

Our fourth quarter core earnings reflected steady net interest income from the residential investments, but also lower gain on sale and overall net interest income due to our commercial mezzanine loan sales in the third quarter. Fourth quarter operating expenses were $18 million, down from $20 million in the third quarter.

This decrease primarily reflected a decline in variable compensation expense in the fourth quarter. Our GAAP book value was $14.96 per share at December 31st, up from $14.74 per share at September 30th.

This increase was primarily driven by our quarterly earnings exceeding our dividend and an increase in the value of interest rate derivatives hedging and long-term debt. Turning to the balance sheet, our debt-to-equity leverage ratio was three times at December 31.

We exclude $774 million of legacy Sequoia consolidated ABS debt from our leverage calculation as it is non-recourse to Redwood. Leverage included $2 billion of borrowings by our FHLB member subsidiary with a weighted average maturity of approximately nine years and a weighted average cost of 64 basis points per annum.

We had short-term repurchase debt or repo debt of $306 million at December 31, funding mostly residential securities, down from $694 million at December 31, 2015. That concludes my prepared remarks.

Operator, why don’t we begin with the Q&A?.

[Operator Instructions] And we’ll go first to Bose George with KBW..

Hey guys good afternoon. Actually a couple of questions, first, just wanted to dig into your guidance from mortgage volume a little bit.

You know I guess $5 billion to $6 billion versus $4.9 billion last year, despite the pretty big decline that people are expecting for industry volume, so can you talk a little bit about the drivers of that, how much of that is Redwood Choice and what are the other kind of drivers of it?.

Sure, hey, Bose. It is – you know in keeping with the recent trends, we feel optimistic about our ability to maintain or potentially grow volume even in a declining origination market.

You mentioned Redwood Choice, Choice is still ramping, as I indicated in the comments, but based on the early growth rate that we see, you know we’re hoping to achieve a run rate in the 15% to 20% range of annual volume. And really what that is indicative of just our emphasis towards purchase products.

You know one positive factor for us is that you know even though the re-fi wave may have ended here last fall, we’ll see. We’ve got great purchase products to offer to our seller base, whether it’s Robert Choice or select products, that we’re confident that in primarily a purchase market we can still grow volume..

Okay, great.

And what – actually what percentage of your production is purchased right now or was it last quarter?.

I don’t have the specific number, but it’s been in the 60% to 65% range..

Okay..

It’s been as low as 50-50 and it’s been trending higher. So it’s – again, it’s a factor of interest rate spread and we expect to see more purchase activity..

Okay.

And then just in the – in terms of your gain on sale margin guidance, what – the 75 to 100 now, up from 50 to 75, what mix does that assume between Redwood Select and Redwood Choice and is that the biggest driver of the new guidance?.

Well, it’s a few things. I think over time we want to get to a run rate in that 15% to 20% range, so it certainly factors in a higher percentage of Choice loans.

I think we said in the past those with average about 125 basis points higher in rate, but it also reflects that our margins have been elevated for a few quarters here, I think for the year we ended just over 100 basis points for mortgage banking margins.

So I think we feel good reducing that guidance, but it is going to be a function of Choice volume and just the direction of the market..

And one other contributing factor has been, you know the results of securitization where securitization lagged our bulk whole-loan sales and right now our securitization execution is probably 25 basis points better than the bulk sales. So I think it’s a combination of those things..

Okay, great. That’s helpful, thanks.

And just one question on a different topic, just the Portfolio Risk Transfer transactions that we saw earlier last year, you know it’s been a little quite on that front I guest since then any updated thoughts on how that product could potentially develop?.

Well, on the PRT specifically, I think many people have red some articles about an OCC commentary ruling about the risk capital relief for banks, specifically JPMorgan. At this point, it appears as though there won’t be additional PRT transactions in the near future.

I think it’s important for us to note that we don’t expect any impact whatsoever to our positions. There was real risk transfer there, those are contracts. And you know the other side of it is, irrespective of whether or not there is additional PRT transactions, I think that the results of the U.S.

presidential election took many people by a surprise and I think with that there could be additional regulatory changes. There has been talks about Dodd-Frank rollbacks and some other things. So, it’s hard to say at this point given the regime change, where ultimately regulation will end up and what the opportunities might be.

But we do think as we indicated that the winds are blowing positively for private capital, so I think we’re kind of in a wait-and-see approach for future PRT..

Okay, great, thanks..

We’ll go next to Vik Agrawal with Wells Fargo Securities..

Good afternoon and thanks for taking my questions.

I think you said you were looking to get 15% to 20% of your volume in the Choice program, is that what you need to be able to get to the point where you hold the loans or securitize them or is there other factors?.

You know in 15% to 20% we like to get it even higher, that’s a goal we have for the year to achieve that type of run rate. But ultimately securitizing Choice loans is a function of aggregation.

I think once we get you a run rate in that range, the accumulation period for securitization will come down to a few months, which is something that we’re comfortable with. In the meantime there’s nothing keeping us from holding more of the loans.

That said, we went through a period here where we wanted to validate our pricing, so Choice loans, we’ve been selling most of them through whole-loan distribution, we’re going to maintain two distributions over time, so we certainly hope to get a securitization completed at some point and then whether we hold the loans in portfolio or securitize them, we definitely like to do that on the coming quarter..

And then on the $44 million on CRT securities and the $20 million in agency, commercial or multifamily, can you give us some more detail around what you bought there?.

In the fourth quarter?.

Yes..

In CRT there is around $30 million of the M2s and M3s, $3 million of the M1s, $8 million of Bs and $3 million of IO. In multifamily, we continue to participate right in that triple-B range, where we’ve got 7 plus points of credit support.

So we found an area there that we’re comfortable with and we’ve been adding to that position, obviously it’s very commentary to what we do on resi. So I think we’ve had some success in both of those and then in Q1 we’ve continued to acquire CRT securities as well as multifamily.

And as Marty said, we completed two Sequoia transactions and we’ve also been active in subordinate RBS..

Okay and then, I think in your comments you said that you bought down the repo, substantially down at $300 million, are you looking to continue to bring that down or is that sort of a level you feel comfortable with now presently?.

I think we’re comfortable Vik, you know right now I think it’s more reflective of the opportunities, you know I think we would add if we found opportunities where we wanted to use repo, maybe up the capital structure, but right now we’re very comfortable with our repo level..

Thanks for the comments..

[Operator Instructions] We’ll go next to Brock Vandervliet with Nomura..

Great, good afternoon and thanks for taking the questions. I guess first on the MSR, I noticed in the Redwood review, I guess you may had mentioned it also that you are planning to sell that MSR portfolio.

What was the kind of decisioning behind that?.

The real reason, Brock is, the MSR is really a business does. It’s not just an investment. I mean, we look at it opportunistically. But you’re not just owning IO with MSR. You need all of the infrastructure it entails to manage it and oversee, in our case, sub-servicers. So, from our perspective, you’re kind of need to be they’re all in or not.

And on the conforming side, roughly, we felt like we either needed to grow our exposure significantly to the range of excess of $25 billion, or else pare back and reinvest in capital. So we’ve obviously decided that we’d like to pare that back. We’re going to continue to own jumbo MSR as a function of running the conduit.

Most of that is created through Sequoia. So we’ll continue to do that and operate that. But I think on the conforming MSR side, we’re going to continue to pare that back and we’ve been doing that in the first quarter..

Okay. And you’re deploying, but also freeing up pretty significant amounts of capital. You had $270 million available as of year-end. I guess, you’ve deployed about $120 million, $118 million, you’re going to be selling the MSR portfolios, selling some of the commercial mezz loans.

What – what’s the total pro forma for some of those moves of available capital?.

Well, we had $270 million year-end and with the $120 million that purchase closer to the $150 million range. We said, the MSR sale is a strategic decision, and then we’re always going to have portfolio rebalancing. But right now, I even feel like, we’re ahead of schedule as far as our capital deployment for the year versus where we expected to be.

So I feel good about our ability to put that capital to work in 2017 at this point. It’s hard to say, though, we also mentioned in the letter, this business entails lumpy capital deployment. There’s times in the market, where we don’t see anything that we like and there’s other times where we wish we had more capital.

So it’s really going to be a function of market opportunities, as well as what’s going on in Washington and how that impacts the business going forward..

Okay. Thanks for taking my questions..

There are no further questions at this time. This concludes our conference. On behalf of management, we very much appreciate you taking time to participate in our earnings call..