Recent investor pessimism regarding mortgage REIT stocks is mainly centered around fears of margin call issues and book value declines. We have said repeatedly that these were salient issues in 2020 but are not material issues at this point in time – mainly because of better focus on liquidity and less risky leverage.
This week, the market received a good piece of evidence that market participants’ fears related to non-agency mortgage REITs are overblown. Redwood (RWT) preannounced earnings on Thursday and reported the following facts –
Preliminary Third Quarter 2022 Financial Results
The Company estimates that at September 30, 2022, GAAP book value per share was in a range of $10.15 to $10.25, a 4.9% to 5.8% decrease from $10.78 at June 30, 2022
Maintained robust balance sheet with unrestricted cash of $297 million and unencumbered assets of approximately $500 million at September 30, 2022
Added $900 million of new financing capacity across multiple borrowing facilities (with both new and existing domestic depository institutions) in the third quarter to further support operating platforms; have over $3 billion of unused financing capacity across Residential and Business Purpose Mortgage Banking segments
Repurchased 3.4 million shares of Redwood’s common stock at a cost of $24 million, resulting in $0.12 per share of book value accretion in the third quarter
Total margin call activity in the third quarter resulted in a net return of cash to Redwood from financing and hedging counterparties
A third quarter common stock dividend of $0.23 per share, unchanged from the second quarter of 2022, was paid on September 30, 2022 to shareholders of record at September 23, 2022
RWT predominantly owns non-agency residential mortgage loans/bonds so it can be a good proxy for some of other mortgage related equities.
Given the relatively small drop in book value (relative to market expectations and Agency mortgage REITs), the common shares are trading at less than 60% of tangible book value with a 15% dividend yield. The corporate bonds, which are higher up in the capital structure, trade at a similar yield with limited duration.
So to recap – no real margin call issues, modest decline in book value, maintaining high dividend, and buying back shares.. On Friday, the RWT common shares were up 6% pre-market on this news but ended the day basically unchanged given broader market weakness.
In our mind, this all adds up to be a significant buying opportunity in similar securities where there is a disconnect between fundamental value and current market pricing.