Kristin Brown - Vice President of Investor Relations Martin Hughes - Chief Executive Officer Christopher Abate - President Dashiell Robinson - Executive Vice President Collin Cochrane - Chief Financial Officer.

Bose George - Keefe Bruyette & Woods Inc. Steven Delaney - JMP Securities LLC.

Good afternoon, and welcome to the Redwood Trust, Incorporated First Quarter 2018 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 with instructions to enter the Q&A queue after management’s comment.

I’d 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 first quarter 2018 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 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 first quarter earnings press release and the Redwood Review, which is 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, May, 07, 2018.

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 for opening remarks and introduction..

Good afternoon, everyone. Thank you for participating in Redwood’s first quarter 2018 earnings call. As you all know by now, I will be retiring on May 22, which makes this my last conference call as CEO of Redwood, though I'll be staying on with the Company for two years in an advisory capacity.

Joining me on the call today is a team that will be leading Redwood into the next chapter. Chris Abate, Redwood’s President; Dash Robinson, Executive Vice President; and Collin Cochrane, Redwood’s CFO. I will leave it to these gentlemen to go through what all of the numbers and the progress on our business and strategies.

As I wrote my letter in the Redwood Review, I feel 100% confident in putting my support behind the executive team. I will also feel great about where the company is strategically positioned today. It has multiple avenues for growth, stellar portfolio in two now operating businesses. One of which Dash will talk about.

To me it's a perfect transition point with a strong franchise, talented team, and I firmly believe Redwood's finest days lie ahead. And with that, I will turn it over to Chris Abate..

Thank you, Marty, and good afternoon, everyone. For Redwood, 2018 has already been a transformative year. This is not been standing in the management transition that would formally occur in a few weeks at our Annual Shareholder Meeting.

As we highlighted in this quarter's Redwood Review, we remain enormously grateful to Marty, to all his leadership and support along the way. As Marty mentioned, he'll remain on as a consultant, more importantly, a significant long-term shareholder.

From that perspective, the best way I can think of to express our gratitude is to execute on our strategy and to profitably grow the company going forward. Emphasizing strategy, we wasted little time in announcing our first M&A style transaction in many years through our investment and business purpose lender 5 Arches.

From a big-picture perspective, this transaction expands our current footprint into a growing segment of the housing market, one that carries significant unmet demand. The opportunity fits squarely within Redwood's housing credit DNA, where we will be serving a housing finance niche in a reliable way.

And like the platform we have established in the jumbo space, it represents another avenue for us to source and create our own portfolio investments and to generate mortgage banking fee income. Our investment portfolio has also undergone a transition of sorts in 2018.

We continue to optimize our mix of assets and harvest gains in fully priced securities, while redeploying the capital into higher-yielding and more strategic alternatives. In addition to Sequoia, Agency multifamily and other securities, these alternatives included Redwood common stock repurchases in the first quarter.

We repurchased $16 million of common shares during the quarter. And in February 2018, our Board increased the total authorization for repurchases to $100 million, all of which remained outstanding at quarter-end. Turning to our mortgage banking business, we completed what I would characterize as a stellar first quarter.

We executed four Sequoia securitizations in the first quarter alone, including our third Redwood Choice securitization to date. These deals were done at attractive margins that were above our long-term expectations. Thus far in the second quarter, we've completed two more transactions, with additional activity in the pipeline for later in the quarter.

We remain optimistic about the potential to grow our mortgage banking volumes despite the uptick in interest rates, and we remain on track to achieve our full-year objectives.

Turning briefly to our first quarter financial results, the strong quarter for mortgage banking and continued optimization of our investment portfolio helped us generate GAAP earnings of $0.50 per share and non-GAAP core earnings of $0.60 per share for the first quarter.

Perhaps more notably, our GAAP book value increased 1.8% to $16.12 per share at March 31, up from $15.83 at December 31. This marked our eighth consecutive quarterly increase in book value after paying our regular quarterly dividend.

This increase in book value also occurred commensurate with the rise in the 10-year treasury yield during the first quarter of 33 basis points as well as a flattening of the spread between the two-year and 10-year treasury to less than 50 basis points. This marked the highest benchmark and flattish yield curve, respectively, in a decade or so.

Our emphasis on investing in credit-sensitive assets as well as our hedging strategy and our lower average versus other mortgage REITs all contributed to the outperformance in our first quarter results.

While I'm on the subject, I would reemphasize for listeners that the success of our business strategy going forward is not built upon the assumption of low benchmark interest rates or a steep yield curve.

These may be the primary drivers behind many mortgage investment strategies, but our results continue to highlight key differences that make Redwood unique.

We continue to identify ourselves as a specialty finance company with a best-in-class mortgage banking platform and an inability to create rather than just acquire credit investments for our portfolio.

From that perspective, we continue to evaluate our mechanisms for transmitting value to shareholders, whether that be through continued book value appreciation, share repurchases or dividends.

Looking ahead, we feel very good about where we are, particularly in terms of our success in optimizing our portfolio, the momentum of our Choice program and our Sequoia activity as well as the strong underlying credit performance of our investments.

And with our new relationship with 5 Arches, we took a big step toward executing on a primary strategic initiative we outlined late last year, which will help us profitably scale the platform. With that, I'll turn the call over to Dash Robinson, Redwood's Executive Vice President..

Thank you, Chris, and good afternoon, everyone. I'd like to start off with our investment in 5 Arches, a business purpose real estate lender and asset manager. As Chris touched on, and as we announced last week, Redwood is taking a 20% minority stake in the platform for a consideration of $10 million in cash.

The investment gives Redwood exclusive rights to purchase all of 5 Arches' single-family rental loan production for a one-year period and provides us with an exclusive option to buy the remaining 80% of the Company at any time over the next 12 months for a mix of cash and Redwood stock. This is an exciting transaction for several reasons.

For a modest initial investment, it jump starts our efforts in the single-family rental lending space with a market-proven partner and allows us to participate in the origination and asset management economics of 5 Arches' book of business.

We continue to observe secular trends in the market, driving demand for non-owner-occupied housing, including constraints on housing supply and the calculus of renting versus owning a home.

As Chris noted, we believe financing needs in this sector are being inefficiently served, and our partnership with 5 Arches positions us well to be a solutions provider to the single-family rental space and potentially other areas within business purpose real estate lending.

Importantly, we believe the initial efforts with 5 Arches will just scratch the surface. In our view, the integration of these new loan types with our platform will drive additional scale and make us an even more valuable partner to our existing seller network.

In short, the 5 Arches partnership directly complements our current mortgage banking business, providing us exclusive access to another operating platform that will drive accretive investment creation for our portfolio. Turning to our jumbo mortgage banking activity.

We took full advantage of improved market conditions in the first quarter and completed four securitizations on loans totaling over $1.7 billion.

We were able to work through a significant portion of our lower coupon inventory and achieved better pricing relative to what we anticipated at year-end, which enhanced our overall execution and generated margins in the first quarter above our long-term expectations of 75 basis points to 100 basis points.

Additionally, as Chris noted, we successfully completed two additional transactions in April amid significant interest rate volatility. Overall, the non-agency securitization market continues to gain traction. New issuers have entered the space, including banks and insurance companies.

And in the first quarter, we saw strong investor interest and tighter credit spreads versus the fourth quarter despite volatility in other markets. A deeper bench of issuers was not unexpected and provides us with additional investment opportunities for our portfolio.

As noted, market receptivity for our transactions was strong in the first quarter and Choice deals continued to be particularly well received. Our third Choice deal, backed by $452 million of loans, was well subscribed, with a deep base of investors.

The issuance created $26 million of credit securities that we retained, utilizing approximately $13 million of capital, net of financing. We are currently in the market with our fourth Choice deal overall.

We continue to believe Choice would be a significant area of growth for our mortgage banking business in 2018, especially as rates rise and the market pivots to more purchase money lending; two thirds of our Choice lock volume in the first quarter was for repurchase money mortgages, and thus far in the second quarter, this proportion is trending even higher.

We believe this positions us well in a purchase market expected to grow 5% year-on-year. Overall, first quarter purchase volume for mortgage banking was approximately $1.8 billion, a slight decrease from the prior quarter due to seasonality, but up 64% from the first quarter a year ago.

I’ll conclude with some comments on our investment portfolio as we remained active in optimizing our capital allocations in the first quarter. We deployed $108 million of capital, including share repurchases, during the quarter, focusing on newly issued jumbo and multifamily securities.

Our capital allocation to these sectors continues to increase as we rotate out of lower-yielding assets, including agency credit risk transfer, mezzanine and third-party legacy securities.

Specifically, in the first quarter, we freed up approximately $141 million of capital for redeployment, in the process capturing $28 million of previously unrealized gains. 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 first quarter, our GAAP earnings were $0.50 per share compared with $0.35 in the fourth quarter, and core earnings were $0.60 per share compared with $0.35 in the fourth quarter.

Our first quarter results reflect higher mortgage banking income, which, as Dash mentioned, was driven by higher margins on similar volume relative to the fourth quarter as well as higher gains realized as we continue to optimize our investment portfolio.

Our GAAP book value increased 1.8% to $16.12 per share at March 31, which, with our $0.28 dividend, generated a total economic return of 3.6% for the quarter or 14.4% annualized.

While our strong earnings and an increase in the value of the derivatives hedging our long-term debt primarily contributed to this increase, our book value was minimally impacted by rising rates during the quarter.

As Chris discussed and as we presented in the supplemental materials we recently posted to our website, our investment in hedging strategy makes our portfolio less sensitive to changes in interest rates than many of the competitors in our space.

Aside from rates, spreads in our investment portfolio during the first quarter remained relatively flat overall, with the exception being multifamily, where we saw some tightening through quarter-end. Shifting to the taxable side for a moment.

Our total taxable income also increased in the first quarter up to $0.76 per share, with an increase to REIT taxable income driven mostly by gains from portfolio optimization and an increase to taxable income at our TRS, driven by higher mortgage banking income.

Because of certain security sales at the REIT in the first quarter of 2018, we anticipate a portion of our 2018 dividend distributions will be characterized as long-term capital gains, which are taxed at a maximum rate of 20% for individuals.

Additionally, given the higher REIT taxable income in the first quarter and the potential for additional gains later this year as we continue to optimize our portfolio, it is likely we will use a portion of our REIT NOL carryforward in 2018.

Turning to the balance sheet, our recourse debt-to-equity leverage ratio was 3.4 times at the end of the first quarter compared with 3.7 times at the end of the fourth quarter. As we mentioned on our previous call in February, we had a higher-than-usual balance of loans held for sale and financeable warehouse debt at year-end.

And we sold our securitized – a significant amount of these loans during the first quarter, which brought this ratio back down. Additionally, subsequent to quarter-end, we repaid our $250 million of convertible debt that matured in April.

This repayment didn't fundamentally impact our overall leverage as we have now brought the leverage at our mortgage banking business back to historical levels. As a reminder, we opportunistically issued a new convert in August of last year and had generally utilized the proceeds to temporarily paydown warehouse borrowings ahead of this maturity.

Since the cost of the warehouse borrowings is below that of the converts we repaid, we will see modest pickup from this going forward. I’ll close with our outlook for 2018.

Our priorities for the remainder of 2018 are to generate GAAP earnings that exceed our recent historical annual dividends of $1.12 per share, grow our residential loan purchase volume and maintain our strong capital deployment trends.

For our mortgage banking business, our full-year expected purchase volume remains on track to meet our targeted goal of $7 billion to $8 billion and we expect margins for the remainder of the year will be more in line with our long-term expected range of 75 basis points to 100 basis points.

As Dash discussed, we believe Choice loans will be a significant area of growth this year, and we are currently on track to meet our goal of doubling our Redwood Choice volume – purchase volume in 2018. For our investment portfolio, we expected overall returns between 9% and 11% for the remainder of year.

These returns are based on overall segment contribution relative to the capital allocated to the segment and do include some additional gains we expect from portfolio optimization as well as the benefit from higher yields as we deploy capital into new opportunities in the single family and multifamily housing sectors.

Finally, we continue to expect full year corporate operating expenses between $40 million and $45 million, with variable compensation commensurate with company performance. And with that, I'll conclude 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 KBW..

Hey guys. Good afternoon, and Marty, congratulations on your retirement and best wishes..

Thank you..

First question is when you give your guidance on the gain on sales going back to 75 to 100 basis point level.

Is that based on expectations that the securitization spreads could widen a little bit? Or is that pricing could get more competitive? Or what are the pieces kinds of moving you back to the range?.

Yes, hey Bose, it's Chris. It's a little bit of everything, as you mentioned. Over time, in our experience, if margins remain elevated for too long, more competitors enter the space. We've started to see that in securitization markets. On the flip side, when margins get too tight, people leave.

And so for us in the long run, if we're going to give guidance, we like to keep it in an area that we feel relatively good that the market can bear for our types of production. So I think the 75 to 100, we've been north of that recently, but the market shifts pretty meaningfully on a quarter-to-quarter basis.

So to the extent we exceed that, we'll talk about it. But I think, for now, we feel best keeping that guidance where it's at that..

Okay. That makes sense. Thanks.

And did you sell much in terms of whole loans this quarter? Or it was mostly – securitization was mostly execution?.

Hey Bose, it’s Dash. We did sell some whole loans in the first quarter, about $300 million or so of UPB, but the preponderance of our distribution was in securitization across the four transactions we spoke about..

Okay. Great. Thanks a lot..

And we’ll take our next question from Steve Delaney with JMP Securities..

Thank you. And Marty, I'll add my congratulations and what good planning on your part to go out with a bang with what looks like to be a record quarter. Congrats. All the best..

Thanks..

Yes, good timing. Timing is everything. Right? So, Collin, I guess anybody's comment would be helpful, but I guess I would ask you to jump in REIT taxable income. I'm looking at 1Q 2018 $0.44 versus $0.50 GAAP. And back in 1Q 2017, a year ago, just $0.22 versus $0.43.

It just seems like the last couple quarters, you moved to a $0.40 range from – or, a low-$0.30s range early this year and a $0.20-some range last year.

So help me understand is there something going with legacy stuff, reserves or whatever running off that – should we expect that [RBI] will be closer to core facts?.

Sure. Yes, thanks for the question Steve. There’s a couple of things going on, I think, in the last two quarters that are a little bit unusual. Last quarter I think we mentioned, we had a TRS dividend up to the REIT, and I think that was about $50 million, and that increased amount of REIT taxable income last quarter.

And then this quarter with the optimization, mostly sales of these securities, many of them are at the REIT. And so we had about $60 million of REIT taxable income that was generated from the sales this quarter. So as I mentioned, we think we could have a few more sales that could impact REIT taxable incomes through the quarter.

So we could see those coming through, but in general, we'd expect that to probably tick back down next quarter closer to the historical levels. But I would say up as we have been seeing some increased net interest income at the REIT as we've been redeploying capital through the optimization strategy..

Okay. That’s helpful. And again, I guess it was securities that you may have marked over the years, you were making – you were writing them up unrealized, but it's not until you sell them that you have to pay Uncle Sam. So, that makes a lot of sense. Thanks for clarifying. Second one, I guess, is to you, Dash.

Can you give us a bit of color about the loan products that you plan to offer for the SFR property type in terms of is it all going to be 30-year fixed? Can you use some ARMs? What should we think about there on products?.

Sure, Steve. Thanks for the question. I would profess the answer by saying it we likely evolve as we get into the market and continue to better understand from a product-type perspective what the investor universe is looking for.

We intend to start, however, with predominantly fixed-rate products, usually – probably five, seven and 10-year in tenure with 30-year-end periods, so a balloon-type product.

These will likely have some form of prepay protection as well, so another difference between these products and the traditional jumbo products that we are currently purchasing and securitizing. But I would emphasize again, we will see what the market bears and as always try and stay in sync with demand.

But those sorts of tenures and coupon types are what we're additionally planning to offer..

Okay, that’s helpful. And any sense for sort of what coupons on a single-family rental loan would look at compared to owner-occupied 30-year rates of 4.75% and [indiscernible] ones at 4%.

I mean, are we talking about something like 50 basis points to 100 basis points or could it be higher than that?.

It could be higher than that. Again, it's going to be a range in – and as always, we're going to refine our rate sheets going forward based upon what the market will bear and, obviously, dependent upon where the absolute level of benchmark rates is.

However, thinking about a high 5s and up, certainly well into the 6s gross WAC is initially what we're looking at..

Okay. All right, so significant. And I think this kind of ties it into the same, should we expect as your – as Choice grows, which I know we shouldn't call that an NQM product, but let's just call it an expanded product and a SFR, more specialized.

Are you going into these products vis-à-vis to your prime – core prime-prime product, is it your expectation that securitization execution – you could have higher coupons, but do you think securitization execution on the newer products has the potential to consistently be more profitable than the prime-prime product?.

It's Chris. Over the long-term, certainly and it's no surprise that we really gear the business towards leveraging our expertise in credit and housing credit specifically. And Choice and soon single-family rental really leverages that to us. And so I think part of that is the securitization execution.

And I think in addition to just having more demand from higher WAC and yield, we're actually creating significantly larger credit investments, which to us is what we're in this for. We're trying to grow the portfolio. We like the fact that we're able to create assets that basically can't be replicated or not replicated easily.

And I would definitely expect us to focus on additional Choice securitization. And once we, hopefully, scale the single-family opportunity, we'd love to securitize that as well..

Okay. Appreciate everybody’s color, and Marty it [indiscernible] here. I’m glad that [Yankees] gave you an early retirement presents as well or at least so far..

Thank you..

Thank you, guys. End of Q&A.

And there are no further questions at this time. I'd like to now turn the call back to Marty Hughes for closing remarks.

Well, we very much appreciate all of you taking the time to participate in the call. And again, I would just like to leave with I would personally like to thank you all for your support over the years as my tenure as CEO.

And all-in-all, to me, it's just a fantastic handoff point, whether it's team, strategy, market position, earnings, momentum, everything is going the right way. So it's a good time to sign off. Thank you very much..

This concludes today's call. Thank you for participation. You may now disconnect..