Kristin Brown - VP IR Marty Hughes - CEO Chris Abate - President Dash Robinson - EVP Collin Cochrane - CFO.

Bose George - Keefe Bruyette & Woods Steve DeLaney - JMP Securities.

Good afternoon, and welcome to the Redwood Trust Incorporated Third Quarter 2017 Earnings Conference call. During management's presentation, your line 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 Q&A 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, Jessica. Good afternoon, and thank you for joining us to review Redwood Trust's third quarter 2017 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 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 analysis Redwood's performance.

A reconciliation between GAAP and non-GAAP financial measures is provided in our second quarter earnings press release and Redwood review, available on our website, redwoodtrust.com. Also note that the content of this conference call contains time-sensitive information that is accurate only as of today, Monday, November 06, 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. I will now turn the call over to Marty Hughes, Redwood's Chief Executive Officer and for opening remarks and introductions..

Good afternoon, everyone. Thank you for participating in Redwood's third quarter 2017 earnings call.

Joining me on the call are Chris Abate, Redwood's President, Dash Robinson our new Executive Vice President who joined us in late September from Wells Fargo where he was the Head of Mortgage Finance with their Asset Back Finance Group and Collin Cochrane, our newly appointed CFO who joined Redwood as Controller in 2013.

For this quarter's call only, Chris and I intentionally deferred his prepared remarks to Collin and Dash as we thought it was important for you to hear from the newest members of our executive team. Chris's here and will be available to address any questions during Q&A.

So, following my remarks on our key accomplishments and financial metrics for the third quarter, Dash will discuss the quarter's residential mortgage banking and investment portfolio activities and Collin will close with our detailed financial results. During the quarter we made strong tactical and financial progress.

We completed our first-Choice securitization our fifth and sixth Sequoia securitization of the year and closed our seven in October. We put a $118 million of capital to work and we raised $245 million of convertible debt at attractive levels and most importantly, we welcome Dash to our Senior Executive Team and Collin in his new role as CFO.

In terms of our quarterly financial results our GAAP book value increased by $0.38 per share to $15.67 at September 30 from $15.29 at June 30. Our GAAP earnings per share were $0.41 versus $0.43 in the second quarter and our non-GAAP core earnings per share were $0.35 per share consistent with the second quarter.

While persistent spread tightening through the first three quarters of this year have bolstered our investment portfolio returns, we have maintained consistent levels of net interest income and refined our portfolio by selling some of our lower yielding securities when appropriate.

We've also been aggressive to add to the investment portfolio when we have experienced pockets of opportunity, both early in the year and again in September due to spread widening as a result of the hurricane activity. On the other hand, tighter credit spreads have benefited the execution for Sequoia securitization program.

Mortgage banking margins continue to be robust and we are encouraged by the relative mix of selecting choice loans in our pipeline. As we progress through the fourth quarter, our year-to-date operating metrics are validating the full year guidance we provided in Q4 2016 Redwood review.

We feel good about our progress so far, this year, particularly in terms of our success in deploying capital despite a tight spread environment, the underlying credit performance of our investment portfolio and the momentum of our choice program and our Sequoia activity.

However, we remain cognizant of forces outside our control; both financial and otherwise and the potential impact on our business. With this backdrop, a fully seated executive team is important milestone as we continue to think critically about our business assumptions and look ahead to next year and beyond.

As we've done in the past, we'll provide an outlook for next year with our yearend letter in February of 2018. As always, we thank you for your continued support. I will now turn the call over to Dash Robinson, our new Executive Vice President..

Whole loan sales also continued to be an important source of liquidity for our business. We sold $212 million of whole loans to portfolio buyers during the third quarter and bringing the year-to-date total as of September 30 to almost $900 million.

Favorable market conditions have allowed us to become more competitive with bank retail and correspondent channels and our loan purchase volumes have risen as a result.

Loan purchase commitments adjusted for fallout increased to $1.6 billion in the third quarter of 2017 up from $1.4 billion and $1.1 billion in the second and first quarters respectively. We had strong growth during the third quarter with our Choice program.

Adjusted for fallout Choice accounted for approximately 30% of our total third quarter loan purchase commitment, up from approximately 20% in the second quarter. Rate on Choice loans are currently about 75 to 100 basis points higher than on select loans.

We still expect overall purchase volume levels to be in the $5 billion to $6 billion range in 2017 and fourth quarter mortgage banking margins to be in line with our long-term expectations of 75 to 100 basis points. Additionally, we estimate the effective tax rate on our.

mortgage banking activities will be approximately 25% to 30% Turning to the investment portfolio, we were able to aggressively pursue new investments during the quarter, particularly in September when volatility due to hurricane activity drove spreads wider.

The bulk of the quarter's capital deployment occurred during this period and included $63 million in agency residential CRT securities, $39 million in Sequoia and third party RMBS and $17 million in agency multifamily securities.

In total, we deployed $119 million of capital into new investments in the third quarter bringing the year-to-date total to $393 million, a number that includes $37 million of debt repurchases.

We continue to evaluate the potential impact of hurricane activity in Houston and Florida on our investment portfolio although it is still very early in the process. The vast majority of our non-agency loans in securities were not impacted by the storms and to date we have not incurred any realized losses related to properties in the affected area.

Although we did see some impact of pricing, most of our investments had net positive changes in market valuation for the quarter as the benefit from overall spread tightening exceeded any negative impact from the hurricane. Now to recap our financial results, I'm going to turn it over to Collin Cochrane; Redwood's Chief Financial Officer..

Thanks Dash and good afternoon, everyone.

To summarize our financial results for the third quarter, our GAAP book value increased to $15.67 per share at September 30 from $15.29 per share at June 30, with the increase primarily driven by our quarterly earnings exceeding our dividend and higher fair values on our available-for-sale securities as we saw continued spread tightening on this portfolio.

Our GAAP earnings were $0.41 per share for the third quarter compared with $0.43 in the second quarter and core earnings were $0.35 per share consistent with the second quarter. Our results reflect a strong quarter for mortgage banking offset by less that spread tightening on the fair value of our securities portfolio, relative to the second quarter.

The first three quarters of this year, our earnings run rate has trended above our annualized 2017 expectation as strong operating results were bolstered by asset price increases.

Heading into the fourth quarter, we expect that both our investment portfolio and mortgage banking returns will form more in line with the return ranges we originally provided with our fourth quarter 2016 results as a potential for additional spread tightening diminishes.

Turning to the balance sheet, our debt-to-equity leverage ratio was 3.2 times at September 30 versus 3.1 times at June 30. The modest increase was primarily related to our issuance of new convertible debt in August.

We continue to evaluate our options with respect to our upcoming convertible and exchangeable debt maturities in 2018 and 2019 respectively. However, at current market prices the excess cost retired are 2018 convertible debt prior to its maturity is unattractive relative to alternative short-term leases of cash.

We also continue to fully utilize our $2 billion of borrowing capacity at the our FHLB member subsidiary, which has a weighted average maturity of approximately eight years and a weighted average interest cost of 1.3%.

We see the fixed interest cost of this debt over its weighted average maturity by using a combination of swaps, TDAs and other derivatives. One final note to the balance sheet as Marty and Dash mentioned, we completed our first-Choice securitization during the third quarter.

For GAAP purposes, we consolidated $317 million residential loans and $286 million of nonrecourse ADF debt associated with the $31 million of securities that we retained from this transaction.

Although we accounted for this choice securitization differently than our traditional sequoia select securitization, which are treated at sales for GAAP it did not change the economics or gains that flow through our income statement as a result of this securitization. And that concludes our prepared remarks. Operator, why don't we start the Q&A.

Thank you. [Operator instructions] Our first question will come from Bose George with Keefe Bruyette & Woods. Please go ahead..

Yes. Good afternoon.

Actually, first just a couple on Redwood Choice, just given how strong that program seems to be going, can you talk about the potential outlook there for volumes in 2018? And I guess the run rate now of 15% to 20% of total and that could be see that pick up next year and also just the ROEs on the pieces of the securitization you're seeing, thanks?.

Sure. Hey Bose, this is Dash. So, taking your questions sequentially, you're certainly right that we've seen an increase in the percentage of our portfolio and our [Lockton] purchases of choice over the past few quarters and we certainly ascribe that to a number of things, most importantly our continued efforts and penetration with our sellers.

At the moment, 75% or a bit more of our sellers have rolled out the Choice product and we've locked loans with 90% of that group and so we're optimistic around the continued trend there.

The challenges with predicting the relevant mix of selecting Choice of courses is it is open to the market and is subject to where the overall demand of the borrow level is but we remain as Marty said, certainly heartened by the relevant mix at this point but it is difficult to forecast the relative percentage though we certainly anticipate making continued strides in terms of our penetration with our sellers and continuing to source more Choice loans from them.

From a return on equity perspective, using the first deal as a barometer, we were very, very pleased with that execution for a couple of core reasons and first of all, obviously we did retain a robust amount of securities for our portfolio meaningfully more than we would in a traditional sequoia deal which we you mentioned in the prepared remarks.

And secondly and as importantly we were pleased with the execution on the securities we sold. From an ROE perspective, you can think about that as a high single-digit to low double-digit return lever in terms of what we took back..

Okay. Great. That's helpful thanks.

And then actually a couple just on the income statement, if you just to guess your guess, the interest expense that you're pulling out on the convert, you just have done comprehensive?.

Yeah, let me see if I could find that for you here quick.

Yeah, I am sorry, what was that Bose?.

Actually, I just had another question for you, but go ahead and get that number..

Yeah, I think it's about million, I'll double check that, but I think it's about a million there..

It's four and three quarters..

Sorry, what was the number again..

Four and three quarters over the course of a few months. So, it was a mid-August issuance..

Yeah, I think it was about $1.4 million..

That's okay. Great. Thanks. And then you know that the spread tightening has benefited earnings and you expect things to be normal little next quarter. Do you have just the number that benefit to EPS from spread tightening this quarter.

Yeah, it's about $0.20. Year-to-date, it's about $0.20 Bose..

Okay. Good. Thanks..

Our next question will come from Steve DeLaney with JMP Securities..

Hello everyone and we certainly love to thank everyone [stage] through those tragic fires you had, that was unbelievable, but thanks for the question. Curious las week was a big week, big moment in mortgage land with the house proposal to limit mortgage interest deductibility, don't know how that will play out.

But curious any initial reaction there in Mill Valley from seeing that just your high-level thoughts if you're willing to share those will be great thanks..

Yeah, well overall for [track] form we're obviously in the early stages of the process. So, it will remain to be seen what if anything will be passed.

But based on the current house plan, there are a few provisions that we're focused namely, the lowered corporate tax rate, the corporate interest expense deduction and then the changes to the mortgage interest deduction. So obviously in the corporate tax rate, that's the biggest one.

If the rate were to be reduced to 20%, that benefit us in a couple ways. First in the year of enactment, it would reduce our deferred tax liabilities and we have to pick up from that and then also we have a go forward pickup as our second tax rate would be reduced from about 34% down to 20%.

The second piece that we're focused on here is the corporate interest expense deduction. The framework calls for certain limits to the net interest expense and for instance Redwood is net creditor, our interest income exceeds interest expense and as it's currently drafted, we don't anticipate any limit on our interest expense deduction.

And finally, as you focused on, on the mortgage interest deduction, it seems like there is already been a lot of the analysis provided on this in the press and overall the teams will be there. So, it will be a modest negative for the housing market and for loans. However, we think this is already experiencing a lot so push back.

So, we're going to see how things progress and continue to evaluate the impact to the company and the industry..

That's helpful Collin. Thank you. I guess when you think about that impact, when you see the final bill, but my initial reaction was well your IOs and your MSRs if people mobility declines because people want to stick with their existing mortgage that might swallow your prepays and on those assets, I think that proves to be a debt benefit.

And I guess on the other hand, if property values broadly, diminishes the result of that, it's good to have 67% LTV. So, it didn't strike me that other than some maybe some constraints on origination volume and the jumbos it certainly didn't strike me as being something that would be a overly problematic for Redwood. So we'll see how it plays out.

We saw last week that Wells announced the launching of your second-Choice deal, I think that was last Wednesday. I know you can't comment on deals in the marketplace generally, but I guess we've seen in both of those deals I think that was 15% credit enhancement double which you would have on a select deal I believe.

And just curious looking down the road the way the market reacted to this first deal, do you think it is possible that your invest is going to improve, the first-time issue is always tough as you know, but just curious your thoughts on the CEE and where that might go over time?.

Steve, this is Chris. It's going to take a period of time for the rating agencies to see enough performance data to really in my opinion move levels. Now that said, we certainly feel like the sea levels in the Choice deals more than encompass what the expected losses are from our perspective.

And I think it was 10% not 15% by the way as being required to retain risk through some non-term loans and deals, we're happy to hold large investments as you know.

It's a core tenant of our business and irrespective of where she goes, we're happy to retain the investments and I do think over time with more performance history on this collateral do see the levels move..

Okay. Appreciate that.

And for now, Chris or Dash, should we be thinking when you give us your long term stated objective of 75 to 100 basis points, should we be just whether it's Select volume or Choice volume, should we be just consistent that Choice for now, but the Choice will be in the same ballpark? I know the absolute returns are higher by 75 to 100 basis points, but how should we think about the mortgage banking margin?.

I think you said it right. We are typically, when we work on our pricing and things of that nature, we're fairly consistent and try to be in that range of 75 to 100 basis points for both. Obviously the last few quarters we've been in excess of that, but you can think about that as the right range for both product..

Okay. That's great.

And could you share, this is final question, your correspondent network, obviously that has been built up dramatically over the three years, love to know there has been the number account for your correspondence and roughly what percentage of those correspondence have added the Choice product?.

Sure. So, we have 187 sellers right now plus 250 value sellers through the MPF program. And as I mentioned, we have been successful in pushing the Choice program out to three quarters or a bit more of that group and has been successful and actually locking choice loans with 90% plus of that substance..

Wow. Okay. Well congratulations on that progress and thanks for the comments tonight..

Thank you..

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