Redwood Trust: From $30 to $4 by Year-End?

Introduction: Heavy Mortgage Backed Securities Exposure Will Lead To Big Declines

Redwood Trust (RWT) is a REIT-structured entity that makes leveraged investments in financial instruments that themselves are highly leveraged. It’s my candidate for the financial midcap stock most likely to lose 80% of its value in the next six months. Its portfolio is broadly similar to other mortgage REITs that have fallen more than 99% from their peaks to now, such as New Century Financial (NEWCQ) and Thornburg Mortgage (TMA). What has allowed RWT to not collapse 99% as several other mortgage finance REITs is (1) RWT wisely did not rely on short-term debt and debt subject to margin calls, and instead funded its most unwise investments with securitized debt; (2) its portfolio of MBS is of somewhat older vintage than TMA’s and NEWCQ; (3) its exposure is more to jumbo, ALT-A, and Neg-Am mortgages rather than subprime.

What follows is a detailed analysis of RWT’s assets, liabilities, and what I think the stock is worth. Those with a short attention span and/or little familiarity with modern real estate financial terms may want to skip to the bottom of this section for my conclusion. The short version: RWT, now trading for about $30, is worth perhaps $8 now and should decline to as little as $4 by the end of this year.

Balance Sheet Analysis: Big Writedows Will Be Reported For Q2 and Thereafter

• Questionable Accounting

To start, I am first going to note, and then temporally ignore, two major issues with RWT’s accounting practices. First, I would be cautious about accepting uncritically RWT’s repeated claims that most of its debt is “non-recourse,” “bankruptcy remote” and “legally not ours.” In fact, I suspect at least some of RWT’s counterparties, who have lost billions buying “investment grade” obligations issued by RWT’s arboreal “securitization entities” have a different view of this point. Nonetheless, it is still helpful to take RWT’s word on this issue and focus on what monsters lurk on the non-“securitization entities” part of its balance sheet.

Redwood’s second accounting issue is a very questionable attempt to understate its debt levels by marking-to-market certain liabilities. Showing good timing, right before its credit quality fell through the floor RWT issued $150 million in subordinated notes. Debt markets now think so little of RWT’s ability to pay its liabilities, however, that the company’s debt is trading for less than 50 cents on the dollar, even worse than GM’s. Redwood therefore carries this $150 million dollar debt as a $72 million debt, thus booking a $78 million dollar profit, not through good business practices, but because its MBS portfolio is so risky that debt markets rightfully predict the company has a very high chance of default and/or bankruptcy. The consumer equivalent would be if an individual with $30,000 in credit card debt, after defaulting on his mortgage, decides “Hey, now that my credit score is so low, my credit card debt just went down by more than half, since my creditors won’t be able to sell my debt to collection agencies for more than 50 cents on the dollar.”

Rather than as immediate risks, I view these questionable accounting practices as clouds hanging over the company’s head and greatly detracting from its credibility. While I think only companies in serious financial jeopardy would employ them to such a massive extent, I am going to ignore them for the sake of argument and look just at the company’s liabilities as it reports them, and then visit it again in my conclusion.

• Assets Facing Writedowns

RWT’s single largest asset class is “real estate securities.” Within this group are mostly “credit enhancement securities” (“CES”) which is an exotic financial term for the super-junior “first loss” tranches of a mortgage securitization. These are great investments as long as defaults on mortgages are at historic lows and the rate of mortgage pre-payments are at historic highs. That does not describe today, or the foreseeable future. Defaults are rapidly rising, and resales and refinances are at extremely low volumes.

RWT’s defenders like to point to the fact that much of these CES are based on prime mortgage securitizations. The problem is, what RWT considers “prime” are not the safe, conservative, conforming, 20%-down mortgages to people with verified incomes and good credit that most people think of when they hear the word “prime.” Instead RWT’s “prime” portfolio includes a risky hodgepodge of ARMs, hybrid ARMs, and worst of all Neg-Am ARMs.

This argument about the “prime” quality of the mortgages underlying RWT’s MBS portfolio also misses the mark since these “prime” CES have much more built-in leverage than subprime CES. In theory, a tranche of a prime and a tranche a subprime securitization with the same rating should have the same risk. Since prime mortgages are assumed when securitized to have much lower default rates, the degree of leverage can be much greater, so there is much less credit support on the prime CES that RWT owns. So what matters is not the obvious and unchanging fact that prime mortgages have much lower default rates than subprime. What matters is the ratio of actual defaults to those expected by the bond rating agencies, whose ratings criteria in practice determined the degree of leverage in MBS. It takes a much, much smaller spike in prime mortgage losses to completely wipe out RWT’s prime CES investments than it would a comparable investment in subprime CES.

RWT has $100 million in commercial CES and $88 million in residential CES. These investments are valued at “management’s estimates.” My rough estimate, based on the vintage and changes in Markit’s ABX and CMBX indices (specifically the oldest and most junior indexes for both, which most closely reflect what is in RWT’s portfolio) is that the $88 million in ABX will be written down to $43 million and its CMBX CES will be written down to $96 million, for a total Q2 write-down of CES investments of about $49 million.

Again based on changes to the most similar ABX indexes, I estimate RWT is going to have to mark down its remaining $25 in “investment-grade” (hahaha) RMBS by about 20% or $5 million. Next, RWT reported $3 million in “Other Real Estate Investments” which from its own description likely faced a similar markdown as residential CES, which would round to loss of $2 million.  Finally the company has $15 million CDO “investment-grade” securities. The company does not disclose enough information about this mysterious investment for me to estimate the appropriate markdown (or markup), so I am going to assume a smaller 20% markdown of $3 million in line with the general deterioration in real estate credit markets in the 2nd quarter. This is only half of the $6 million markdown RWT suffered on these investments in the first quarter, so is by no means an aggressive estimate.

In summary, assuming no significant changes in real estate credit markets in the last few days of the second quarter, I estimate that RWT will mark down its portfolio of real estate securities by $59 million, from $212 million to $153 million.

RWT has on its books $214 of investments in its Sequoia and Acacia entities. It provides a “management’s estimate of the economic value” of these investments of $141 million. I think this is far too rosy an outlook, but assuming that management stays excessively rosy while still accounting to the deterioration of real estate credit in the second quarter, I expect the investment in Sequoia’s estimated valuation to decrease by about $19 million. RWT’s investment in Acacia is even more vulnerable to be overstated because it is entirely valued by model rather than by dealer bid, unlike Sequoia. Nonetheless, based on management’s expectation that all cash flow will end to some of its CES backed by several Acacia entities, I expect about $4 million in second quarter Acacia write-downs. In grand total, I am expecting write-downs of $82 million to be reported in Q2.

• Book Value

As of 3/31/08, book value was reported at $585 million ($17.89/share). The company also provides a “management’s estimate of economic value” that writes down the value of Sequoia and Acacia investments as well as marking to market subordinated note liability as discussed in the introduction. This total is the similar figure of $590 million ($18.04/share).

After the $82 million write-down I expect to be reported on RWT’s next earnings release, the “management’s estimate” should decrease to $15.46/share, excluding the effects of operating income and dividends. This means that RWT is trading at almost two times book value. This is an absurdly rich valuation for a company with a broken business model, no prospect of earnings after write-downs for the foreseeable future and expenses rapidly increasing as a percentage of assets. The table below shows the valuation of RWT and several other companies that made foolish real estate related investments at bubble prices.

click to enlarge image

Source for information is Yahoo! Finance unless otherwise noted

^** Source AOL Market Watch 

Since RWT no longer has access to credit markets, the company, just like TMA, NCT, and JRT, is essentially like a huge bond-focused mutual fund sitting on very low quality assets, with very high expenses, and the prospects of big losses later in the year. Why on earth would somebody pay an almost 100% premium over assets to own such a bond fund?

Conclusion: RWT stock is set up for a big fall

I am not sure what the catalyst will be that causes RWT to fall down to a level more in line with its peers, which would be at most 0.5 times Q2 book value, or about $8 per share, but I suspect it is loyalty of unsophisticated investors brought on by years of consistently paying a high normal dividend and sometimes even bigger special dividends. I do expect RWT to make its next dividend payment of 75 cents per share, but this may end up being the last one. Even if the dividend is maintained for a few more quarters, these will not be distributions of income generated from interest spreads and securitization profits, but simply returns of capital that will further reduce the company’s equity.

Also, there will likely be even more write-downs in the third and fourth quarters. In particular, I expect that RWT’s commercial CES investments, which I think will only face small (roughly 4%) writedown at the end of this quarter, may face 30%-60% write-downs in the second half of this year as commercial credit suffers from the growing weakness in the retail, office, and casino/resort sectors. Since RWT holds the “first loss” positions in commercial mortgage pools, the decline in CRE does not have to be too large to inflict serious losses on RWT’s commercial CES portfolio.

Now getting back to the accounting issues I discussed the start of this article, RWT’s Q2 book value if you count its $150 million in subordinated notes as a $150 million liability instead of a $72 million liability, drops to a tad more than $13 per share, giving a target price of about $6.65 at 0.5 times book value. With additional losses coming later this year in both residential and commercial real estate, RWT, fairly valued at the end of the year, should probably be a four dollar stock. In a market where companies with big mortgage debt portfolios frequently lose half or more of their value in a matter of days or weeks, I don’t think it will be long before RWT’s stock price crashes down to the levels of its peers. 

Disclosure: Author is short RWT common stock and long RWT puts.

Comments

[packer:]

Is this guy for real? Comparing RWT, a low-leverage REIT with a great track record of picking mortgages out of the pack that have lower default statistics than the averages (look at the Redwood Review for details) to New Century (a mortgage originator) and Thornburg a highly-levered REIT is like comparing apples to oranges. As for leverage, the RWT trust has $79 million in debt, $257 million of cash and $268 million of real estate securities. In addition, using indexes to compare a proven manage to is like comparing Warren Buffett to the S&P 500 and drawing a conclusion about Berkshire Hathaway stock. Not comparable.

2008 Jun 27 08:58 AM

[Patrick Harden:]

This article is an excellent example of how a little knowledge is a dangerous thing.

FACT: Redwood Trust marks its CDO assets and liabilities in accordance with FAS 159. This is not questionable accounting, simply the prescribed GAAP accounting for such securities. This is not to say that I agree with the GAAP treatment, but marking to market both the assets and the paired liabilities, RWT presents a more accurate picture of its economic financial state.

FACT: Redwood Trust consistently covers its dividend with ordinary taxable income. Combined with the spillover from 2007 and the taxable income earned in the first quarter of 2008, Redwood Trust has already covered substantially all of its 2008 dividends with ordinary taxable income.

FACT: Redwood Trust holds most of its portfolio to maturity. The Company is not dependent on asset sales to generate cash flows, but rather depends on collection of interest payments and release of overcollateralization from its older vintage securitizations to support operations.

Will Redwood Trust perform as well as it did from 2003-2006? No, of course not. However, the Company is well-positioned to ride out the storm and absorb increased credit losses through the remainder of 2008 and 2009. With the dividend of $3.00/share remaining intact throughout the period, a reasonable yield of 10% supports a $30 stock price.

Short Redwood at risk of your own peril.

2008 Jun 27 11:25 AM

[Greg Weston:]

Packer, you obviously have not read, or are not able to understand, the points I made in my article. I addressed several issues you raised.

1. "a low-leverage REIT"
RWT's leverage is in the financial instruments it buys, mainly CES. Can you not understand that a 20x leveraged position in an AA-tranche of MBS and a 2x leveraged position in a CES tranche can involve the same level of leverage?

2. "RWT trust has $79 million in debt"

No, its subordinated notes alone is $150 million in debt, but through the magic of "mark to market" liabilities, this $150 million debt became $72 million. The only justification for this is RWT's finances are so weak that its debt is not worth 50 cents on the dollar. Which begs the question, why is such a weak company trading for 2x book?

Patrick's points are a bit more informed, and confirms my point that RWT investors are obsessed with the company's dividend record. The business model that sustained it, however, was (1) profits from securitizations (2) investing in junior mortgage securities.

Both of these business models are dead. RWT will never do another securitization with its weak credit and horrible track record of losing billions of dollars for investors who purchased the mortgage securities it issued. The company even admits that it has not done a single securitization in 2008, and does not expect to.

The junior mortgage debt it owns is rapidly becoming worthless, with much of it already falling into default. RWT noted that multiple Acacia entities will stop making payments to the junior tranches this quarter.

2008 Jun 27 12:36 PM

[Yomgui:]

Your forecast of Q2 write-downs seems reasonable. But it DOESN’T MEAN that the stock will go down.

There is a big flaw in your argument: you ASSUME that RWT stock price is primarily derived by its book value.

Redwood is above all a Dividend Play. With a regular dividend of $3 per year it translates into a nice 11% rate at today’s price of 26.6 . And that’s without counting any “special” dividend (an extra $2 last year).

The stock price is driven by anticipations of the rise or fall of the dividend.

As a REIT, Redwood must distribute 90% of its REIT taxable income. Taxable income doesn’t take mark to market into account and thus makes the level of write downs irrelevant.
THAT’S WHY YOUR PREDICTION OF SEVERE PRICE DECLINE IS BASED ON AN IRRELEVANT MTM WRITE-DOWNS ANALYSIS.

Being funded by Long Term debt Redwood can wait patiently for the loans it holds to mature. It doesn’t have to sell now at heavily discounted prices in a panic market.

RWT also holds $ 250 Millions (that’s 1/3 of shareholders equity) of Excess Capital ready to be invested at today’s depressed price. These 2008 investments will produce juicy yields for years to come and potentially some big capital gains if and when the real estate market recovers.

While you wait for a potential recovery in real estate you pocket circa 11% per year of dividend. Not bad. That’s of course IF the regular dividend stays at 0,75 quarter.
To state Redwood Management “the board of directors has
indicated it intends to maintain the regular quarterly dividend rate of $0.75 per share during 2008 ”

The question now is: Will RWT be able to sustain such a dividend in 2009. The answer to this question will determine future share price MUCH MORE than volatile Quarterly Write Downs.

2008 Jun 27 01:30 PM

[Patrick Harden:]

Greg, thanks for your response to my comments. One additional point that I would like to make is that even if the junior tranches of the Acadia entities fail overcollateralization testing, Redwood will still record the interest income despite not receiving the related cash flow. Over time, this may create a more significant mismatch between taxable income and cash flows, but the release of overcollateralization from older, better performing securities should offset this cash flow mismatch.

2008 Jun 27 01:37 PM

[Kinabalu:]

This is the first guy i've seen who based his Short RWT case on more than mark-to-market and bogus leverage and credit issues. Of course he didn't do it in the article he did it in the Q&A when his arguments in the article were refuted. The comment on RWT's business model has some merit but i'd hate to take the short risk on that bet alone. It's a long term gamble with a high carry cost. I for one would not be surprised to see the securitization market return to normal after investors have had the chance to see where the losses really are.

Any way thanks for getting the stock price down with your well timed article so I could get some well priced shares.

2008 Jun 27 03:50 PM

[packer:]

Greg,

Thanks for your response. I am sorry about the sarcasm but having read about Redwood and their calling of the credit squeeze years before it happened hit a cord in me. I agree with you about the leverage in the tranches they have purchased (especially the CES (which are first to take the default securities), however, they have had a good track record in this space (it is my understanding they do a review of underlying loans on a loan by loan basis) and have focused on tranches (prior to 2005) where their assumptions have been more than exceeded by performance. Looking at the detailed financials (page 10 of Redwood Review), RWT has a credit reserve for prime securities CESs of 67% of face value, 96% for Alt-A CESs and 72% for commercial CESs. To use these reserves, the assumptions of default would have to be incredible. The current delinquencies are from 0.4% to 1.6% for the prime securities and 6% to 12% for the Alt-A securities.

I believe the 'management estimates' are very good and the best disclosure I have seen. RWT receives bids for 72% of its assets every quarter from dealers. The internal models it has developed (to value these securities) in the aggregate produces prices 29% below the bids received from the dealers. (see page 27 of latest Redwood Review) The assets and liabilities in Sequoia and Acacia are similarly valued. This provides me some comfort that the values are conservative and include distressed assumptions that are reflected in MBS prices.

As for high costs, if RWT was a mutual fund its cost would be close to 91bp ($68m costs/$8.546 billion under management). In addition, this structure is much more efficient than a bank (41% efficiency ratio). The other two aspects that RWT has is its cash ($260 million) for which it can play offense (buy more securities) and its management of the distressed opportunity fund (i.e. asset management fees).

The point about leverage was not stated correctly. The difference between New Century and Thornburg was they had recourse borrowing while RWT does not. I good analogy I think would be that New Century and Thornburg were REITs on margin while RWT has purchased some call options on MBS (i.e. CESs). The primary difference being that New Century had the obligation to pay back the debt while RWT has no obligation. I for one like the concept of buying call options on securities that may be undervalued (MBS) and are priced very conservatively. Good luck with your short and time will tell whether the voting machine is indicative of the weighing machine.

Packer

2008 Jun 27 09:21 PM

[Ames Tiedeman:]

RWT is not going to $4.00. Go re-do your research.

2008 Jun 28 09:24 PM

[Greg Weston:]

Patrick, it is nice to have someone commenting who works full time for the mortgage REIT industry, companies just like RWT. You have a vested personal interest in the prosperity of mortgage REITs, which I think can easily lead to bullish bias on the sector. On your blog, for example, you wrote on 2/28/08 that "If you ask me, Thornburg is a great buy on this dip." On that day TMA was at 9.76, now it is more than 97% lower. By contrast, I recognized that TMA was toast in August 2007, when I shorted the stock at 23.75.

Regarding the "release of overcollateralization" point you make, this does not result in a net increase in assets, while the failure to receive cash flows from busted junior MBS results in the loss of cash flows from the security and a decrease in the value of the security, to zero or nearly so.

2008 Jun 30 04:01 AM

[Greg Weston:]

Packer, here are some responses to the points you made in your 2nd article comment:

"it is my understanding they do a review of underlying loans on a loan by loan basis"

Well maybe there was some nominal review, but these were loans not originated by RWT for its own books, but by often-shady mortgage brokers, most of whom are now out of business, who did everything they could to qualify people for mortgages, in RWT's case often hybrid and Neg-Am loans, which RWT calls "prime" but a still non-traditional products with higher default rates than conforming 30-year fixed-rate loans.

Having read something like 100 quarterly and annual financial reports of mortgage REITs and mortgage banks in the past 2 years, I can tell you every one of them has plenty of almost identical BS about how wonderful the credit characteristics of their loan pool is, and how very, very, .... *very* careful the company is in its underwriting and purchase of mortgage loans.

RWT is no exception and layers on this boilerplate particularly thick. Feel free to believe it. I am not so trusting.

"if RWT was a mutual fund its cost would be close to 91bp"

I disagree with the method you use to calculate this number. I would do it by taking the company's expenses, subtracting management fees derived from Sequoia/Acacia, and then look at that number's ratio to equity.

"The difference between New Century and Thornburg was they had recourse borrowing while RWT does not."

On this point I agree completely. RWT was very smart not to rely on repo lines, so we won't see a sudden, margin-call induced collapse.

I don't agree with your analogy of RWT as a call option on MBS, but even if it were, I think buying MBS calls would be very foolish right now as the real estate crisis continues to worsen with no end in sight.

RWT is still trading at 1.5 times an inflated book value, a broken business model, and no access to credit markets. It is not worth the 26.70 it closed at Friday, or even half that number.

2008 Jun 30 04:21 AM

[Wez:]

When it comes to short calls in this sector, I'm onboard with Weston, he has made me a lot of money. I agree with his notion that many people underestimate how bad things are and will be. Companies can and do go out of business all the time. Most of my portfolio is long, but for short hedges, Weston is one of the guys I pay attention to.

2008 Jun 30 01:24 PM

[Steve M.:]

I have to completely disagree with this article. Most of the arguements are compleley illogical. And some of the proported facts are erroneous. First of all comparing Redwood to Thornburg misses the point. Thornburgs downfall had completley to do with their loss of financing. The performance of the underlying mortgages was fine. And we dont know who bought them but Redwood certainly is a candidate. They reported that they bought CES's in Q1 at 37% of face value.
Redwood's debt is not trading at 50% of face value. It is just not trading at all. If you do your homework you will see that Redwood was forced by todays accounting standard to estimate that if someone had to sell the debt what price would it fetch. 50% is probably a good estimate as every market of this sort is currently inactive. The exact same thing hold true of many of the mortgages that Redwood owns. Redwood also marks those down to the price it would get if it had to sell. Fortunaltey unlike Thornberg, Redwood has commited financing until 2037 and will never be forced to sell.
In terms of the quality of the loans they own well it doesnt get much better. Average equity is the loans is 31%. Average FICO score is 736. Well heeled borrowers with lots of skin in the game means they will not be walking away from their obligations. So yes you would be in trouble if you had to sell like Thornberg did but Redwood smartly is buying qualityu paper while others are selling. to be fair Redwood does have a small exposure to ALT-A. But there as well it is very high quality ALT-A, Average equity is 22% and average FICO is 705. ALT-A currently makes up about 15% of Redwood's residential portfolio. This was all about knocking the stock down at the end of the quarter. Long term investors should hold on as Redwood is nicely postioned unless of course the entire US economy collapses and then well you got bigger problems than Redwood.

2008 Jun 30 02:47 PM

[onzilla:]

the whole 50% of book value pricing mechanisum is pretty flawed. Financials are trading at 50% of book based on things to come, yet in this article, you let these things arrive - AND THEN TAKE A 50% HAIRCUT ON THAT NUMBER? Let's talk some basic math here, if financial statements are accurate (big if - but you go through such painstaking mean to make them so) - why would you take an additional 50% off of book vaule?

2008 Jun 30 03:56 PM

[JZ:]

Good and thorough analysis.
However, I think you have undervalued RWT because of three reasons:
1. As the poster above (Onzilla) pointed out, you took a double dip when you lower the book value and lower the p/b ratio.
2. I believe there is upside potential when you combine RWT's management, $257M in cash and the current "fire-sell" environment with a lot of distressed sellers.
3. I am not sure you can use ABX and CMBS as proxy to value RWT's CES holdings.

2008 Jul 01 03:41 PM

[mortgageman:]

Lots of non-fact figures and bad comparisons. In addition to the ABX and CMBX comments, the author seems to contradict himself when he points out that Redwoods income from marking debt is bogus but at the same time, marking Redwood's assets down is the right thing to do and will drive Redwood down. The truth of the matter, is that neither of these marks impact the cashflows Redwood must pay on its debt nor the cashflow it will earn on its assets.

2008 Jul 01 09:07 PM

[RWTLong:]

RWT is a very well run company with a solid portfolio and safe dividend. The author completely ignores the cash flow aspect of the equation. However, if he is so wrong and all of us are so right, why is the stock trading at $22? Where is the "smart money" and the deep value guys that should be buying this stock with both hands?

2008 Jul 02 02:55 PM

[Greg Weston:]

JZ/onzilla, thank your for your comments. Responding to each of JZ's numbered points in kind,

1. It is not double-dipping if I think mortgage REITs should be trading at half of book valued of current fair market values. This is because (1) the company is poorly managed (2) the business model is broken (3) the assets are highly illiquid (3) I expect the value of the underlying assets to get *much* worse than current market values.

2. Here is again the same point where we have a fundamental disagreement. I don't think mortgage securities are right now at "fire-sale" prices. In fact, I think they are still priced way to high, and have a lot more to fall, and in the case of the extremely junior tranches RWT mostly owns, all the way to 0. Generally when you hear a market is "illiquid" where there once was well over $1 billion in volume a day, the market is not illiquid, but sellers are unwilling to mark down their assets to market-clearing prices because it would be an admission their assets are worth so little they are insolvent.

3. Yes, you can. And a several publicly traded holders of MBS explicitly note in their financial statements they use these indexes to value their Level III assets. You can confirm by reviewing, for instance, the correlation between RWT's market valuation of its CMBS portfolio and CMBX-NA-BBB-1.

2008 Jul 02 03:46 PM

[Wez:]

People so often underestimate just how bad things are for banks, and anything real estate/mortgage related. Credit, in many areas has gone away, not just tightened up. When your business is doing deals with bank financing involved, and there is no bank financing, than there is no business. Everything is delayed reaction too, meaning what seems bad now is going to get way worse before things get better. Home prices have only begun what will be much huger price drops. You can see it just by watching your local markets. Prices have been dropping over the last couple years, but they are only now just picking up steam. When we get to the crescendo of ARM resets/price drops/defaults/foreclo... not just the weak companies will have gone out of business, this cycle ends when we see some of the major players taken out. Bear Stearns was just the sound of distant thunder.

The market is telling us where we are headed, don't ignore it completely.

2008 Jul 02 05:17 PM

[put buyer:]

what is up with the 10,000,000 shares being offered

www.redwoodtrust.com/p...

2008 Jul 02 08:24 PM

[Jarret:]

Greg...you are two for two with your posts. I and many others will be keeping our eyes open for the next post.

2008 Jul 03 03:03 PM

[Greg Weston:]

Thank you Jarret. I've already submitted my next article, you should probably see it before the market opens on Monday.

In the mean time I wrote about a weak Maryland bank back in March:

gweston.wordpress.com/.../

2008 Jul 03 07:07 PM

[packer:]

Greg,

What indexes are you using for your analysis? The oldest index I could find on Markit's website for ABX and CMBX is 2006 vintage. They also have 2007. Are you using these indexes or earlier vintages not available on their site? This may make a material difference in your analysis as the default rate for the 06 and 07 tranches is 3 to 5x the rate for the 2005 and before 2004 tranches. (see page 32 of the Redwood Review for details). Only 36% of RWTs RMBS CES securities have vintage 2006 to 2008. In addition, based upon data complied by Whitney Tilson, the make-up of RMBS tranches significantly changed in 2005 - 2007 including many more of the toxic waste securities you describe.

Do you know what the spread in returns is around the average reflected in the index? How does the ABX (a RMBS index) correlate to and CMBS security?

Packer

2008 Jul 04 07:41 PM

[inaja:]

Greg:

The Fed just released the quarterly valuation on the BSC portfolio. The valuation was done by Blackrock. It shows a modest decline for the quarter in the estimated value of that portfolio by about 3% during the second quarter. They did say that the valuation assumed an "orderly market" and not a forced sale of those subprime securities. But, since RWT has no debt pressure, this orderly market assumption should be valid for RWT as well.

How is this valuation consistent with your prediction of a major writedown in RWT assets for the same quarter?

Isn't this BSC portfolio very similar to the Redwood assets and a better comparable than one index of credit swaps?

And, Blackrock is a respected and knowledgeable resource in valuing this portfolio of subprime securities. There seems to be a substantial difference between this valuation and your "collapse" analysis.

2008 Jul 05 12:34 PM

[Kinabalu:]

What balance sheet are your numbers coming from? When I look at RWT's first quarter 10Q I see the Subordinated Notes listed as a single line item at $150 million not at $72 million. I don't see any profit on the income statement coming from a revaluation of this liability.

2008 Jul 05 05:39 PM

[Smooth Jazz:]

<When it comes to short calls in this sector, I'm onboard with Weston, he has made me a lot of money. I agree with his notion that many people underestimate how bad things are and will be. Companies can and do go out of business all the time. Most of my portfolio is long, but for short hedges, Weston is one of the guys I pay attention to>

I have no dog in the RWT hunt, but it appears your hero has pissed a lot of CRZ stakeholders off with his "next" hit piece. I know of at least 7 commenters on the CRZ piece and perhaps another 10 on the CRZ Yahoo message board that is contacting either Seeking Alpha Mgmt, the SEC, CRZ Investor Relations and Brookfield Investor Relations. Rarely do I see this type of passion with so many people, even folks without a position, react so vehemently. At a mimimum, Mr Weston has put a bulleye on himself and people WILL be watching.

seekingalpha.com/artic...

Mr Weston wants everyone to think CRZ is going bankrupt in a few weeks, but failed to tell his readers that the company has as much of $200M in liquidity via unrestricted cash, unencumbered assets, unused credit lines, etc and only approx $20+ in short term repo debt as of May 2008. He also failed to tell his readers CRZ just declared a 30cents dividend 2 weeks ago, or satisfactorily explain how a company going bankrupt in July after writing down assets is paying out dividends to shareholders. I don't think anybody is claiming CRZ is not struggling or will not go insolvent eventually; People are mostly upset that Mr Weston blatantly kept critical liquidity information from his article while claiming the company is going bankrupt, ostensibly to make a fast buck on his puts.

Well you will get the opportunity to pay a LOT of attention to him in the pokie IF it is demonstrated that he is blatantly using these forums to perpetrate a fraud for financial gain.

Peace out.

2008 Jul 06 04:54 PM

[Wez:]

Lol, haters....just brush em off like lint Greg..... I missed the CRZ boat because Alpha pulled the article cause of the haters....last time I let them cost me money....

2008 Jul 07 01:05 PM

[Greg Weston:]

Thank you for the nice thoughts wez.

First time I've ever had someone try to censor me, though to their great credit the Seeking Alpha editors let me know about the complaint right away, and were quick to put the article back up after I e-mailed a response showing just how nonsensical the davidfoulger/smoothjaz... screeds were.

2008 Jul 07 01:35 PM

[Wez:]

Nice. The Yahoo boards are hilarious. Heaven forbid someone give an opinion on the down side. Do Alpha readers forget that their is a "short ideas" tab? At the moment, that really is the only place anyone is making any money. Keep up the good work and remember their is a comment section on your website....I think I'm the only one who is using it, lol.

2008 Jul 07 01:45 PM

[UncleLongHair:]

Hi Greg, I hope you don't think I'm stalking you, I noticed this other article of yours and I happen to have been watching RWT along with CRZ. Really I don't have any position in either.

I feel that RWT is in a much better position than CRZ because, with no short-term financing, they can wait for their assets to run out if need be, and they'll naturally de-lever as loans prepay. If there is any discrepancy between today's panic-driven market value and actual intrinsic value of these assets, as I strongly suspect there is, RWT should be fine in the long term.

However, as you point out, I've been wondering about the quality and valuation of some of their assets, including the credit enhancement securities. The big question mark is how bad the default experience will be on prime loans. So far it has gone "from a very small number to a small number" but still basically within historical norms. If it breaks for the worse, the valuation of RWT's assets may see another leg down. But if it doesn't, which would be consistent with long term trends, maybe nothing will happen. I think this is a really tough call, and very little to use as the basis for a short position IMHO.

Regarding your concern over accounting treatments, I don't agree that non-recourse borrowings could end up being recourse. Even in the most catastrophic meltdown scenario (and there have been many over the past 12-18 months), in no situation did any mortgage bond holder have recourse to the originator's equity. That is a legal and financial firewall that has never been breached, nor should it be. The securitization markets might be dead for now, but a done deal is still a done deal.

Secondly, regarding FAS 159, I too had some questions about the prompt adoption of this by certain companies (RWT and CRZ to name two). On one hand, as you point out, one could envision some abusive scenario where a company quickly issues debt and then doesn't have to account for its full liability because paradoxically they made themself a poor credit.

But on the other hand, it doesn't seem right to me that a company's assets could be marked down severely due to temporary market fluctuations while their liabilities would not. Their liabilities, after all, are someone else's assets, and the other party is probably writing down the assets due to market fluctuations, whereas the liabilities are unaffected. So you've got one party marking down something on the left side of their balance sheet, but some other party, who has the very same financial instrument on the right side of their balance sheet, not making any changes. From this perspective, I think it makes perfect sense to mark both assets and liabilities to market in some situations where the two are directly related and well matched.

There is clearly some severe volatility going on in market valuations of financial assets of every kind. There are things to be worried about, but I also think that the valuations are overblown. Prime mortgages would have to default at many times the worst level in history in order for many of these valuations to make sense. The financial press thinks the sky is falling, but that doesn't mean that it is.

2008 Jul 07 05:26 PM

[Smooth Jazz:]

<Lol, haters....just brush em off like lint Greg..... I missed the CRZ boat because Alpha pulled the article cause of the haters....last time I let them cost me money....>

Hey Wez, You are just a flunky for Fast Money "Hitman" Westman, so let me make this plain for you in the case of CRZ: IT'S ABOUT FULL DISCLOSURE. If you are going to scream bankrutcy in an headline grabbing article, at least tell your reader about the company's liquidity backstop, like CRZ Mgmt did today, and let readers make up their own minds.

Keep chasing that Shill around, but a lot of people are watching him now, and people are gathering information about his omissions and deceptions in anticipation of a suit against him. CRZ started recovering after they came out with a statement today, so it may well turn out that his CRZ hit piece was deliberate manipulation. Rest assured, you may very well get an opportunity to cheer him on in the pokie.

2008 Jul 07 09:53 PM

[Wez:]

Jazz, you're old news bro....

www.tv.com/uservideos/...

2008 Jul 08 11:48 AM

[floorboard:]

On a technical analysis basis this stock has obvious resistance at 25. On the short side if it closes below 20 on high volume or closes below 20 for 2 days in a row. Pile on for a short!

2008 Jul 12 06:34 PM

[Kinabalu:]

"Redwood therefore carries this $150 million dollar debt as a $72 million debt, thus booking a $78 million dollar profit"


I questioned this statement more than 10 days ago and have received no response from Mr. Weston. In fact I know this statement to be false. It is the only negative statement of fact in the entire article. All of Mr. Weston's other negative statements regarding RWT are value statements consisting of his opinion with a tenuous strain of supporting logic.

In 10 seconds you can see that this statement is false by following the 2 links below. The first link shows where Mr. Weston got the numbers shown in the article. The source is a clearly labeled table on page 8 in the Redwood Review. RWT never wrote down the $150 million in Subordinated Notes as claimed by Mr. Weston or took the alleged $78 million into profit. Redwood management commented on what the fair value was because that would be of interest to a prudent investor, but clearly describes the "As Reported" amount as $150 million. The second link is to RWT's 10Q for the 1st quarter and shows the $150 million carried on the RWT balance Sheet, not a written down amount of $72 million as alleged by Mr. Weston.

media.corporate-ir.net...

www.sec.gov/Archives/e...

Anyone that takes an investment position based on Mr. Weston's "analysis" is, IMHO, foolish. I, in fact have taken the exact opposite position and am long RWT, partly because of this article. I am a long term investor and will enjoy the high dividends from this company for many years to come.

2008 Jul 16 07:00 PM

[tquill:]

Greg, are you still confident in your put positions with RWT?

2008 Jul 23 10:11 AM

[Craigla1:]

Greg, you owe us all a comment on their earnings. Not thet I disagree with your view, yet it would be helpful for you to put something out about their release yesterday.

2008 Aug 07 10:43 AM

[Greg Weston:]

Craigla1, My estimate for Q2 writedowns was $82 million, and the actual write-down was $60 million. I think I did pretty well with this, especially considering I wrote the article before Q2 was even over, and because management has a huge amount of discretion in valuing its assets.

The stock dropped quite a bit after earnings came out, so the market, after it got RWT's report, seemed to agree with me that this company is doing very poorly.

Tquill: I still own puts and have no short-term intention to sell. My August puts will expire soon for a good profit, and I own some longer puts as well. I previously was short the stock, but was forced to cover when my broker was no longer able to find shares to short. Clearly demand is huge for betting against this company.

I have never seen a case where a company was very difficult to short because of a huge demand for shares to short, and the company actually did well. Go read Herb Greenburg's old columns and then check out the current quotes of those companies.

Packer:the CMBX-1 series is largely based on 2005 securitizations, and therefore likely mostly a mix of 2004 and early 2005 loans. Click on the constituents tab on the quote screen for the first CMBX to see this.

UncleLongHair: I am not saying that I completely disagree with marking down liabilities. I start to have a problem mainly when a company marks down its general obligations.

I did not rest my case against RWT based on supposedly non-recourse debt becoming recourse, but I do think that investors should be always be cautious with claims about debt being non-recourse. When a going concern defaults on a debt, the creditors will look at all of their options. As a lawyer I have seen this first hand. But this is a somewhat tangential point. Even if the debt is non-recourse, RWT is still a sell.

Sorry, do not know have time to respond to other comments at the moment, (and abusive ones will be ignored.)

2008 Aug 08 03:39 PM

[Greg Weston:]

To expand a bit on my response to unclelonghair:

When financial institutions try to stick investors with gigantic losses on investments that were marketed as "investment grade", they are often sorely disappointed. Look at the recent auction rate settlements for a timely example. And to think this can happen without any fight is even harder to believe.

If you invest in RWT, remember that it sold lots "AAA" and "AA" securities that are now worth much less than at the time of sale. You can bet some lawyers are reading the sales documents right now looking for material misrepresentations.

Again, this is a peripheral point, but given the scale of the billions of securities that RWT sold, could blow up in the company's face. Nevermind the poor state of the company if this doesn't happen.

2008 Aug 08 03:48 PM

[E Nuff Sed:]

Most of the losses are mark to market - not realized losses. So what if the GAAP book value continues to be marked down as long as the cash keeps coming in and dividends keep getting paid out. Once the market comes back and the realized losses do not materialize the write-ups will begin.

However when the current bear raid on RWT by Weston, et. al, abates it may be worth going long. I will watch this battle from the sidelines for a couple of months before going long.

2008 Aug 15 12:05 AM

[stopkidding...:]

Greg, you are spot on. Although a pioneer for the psuedo-REIT but really a hedge fund structure, that business model is now dead. If they can't reinvent themselves quickly, they are toast. They have too many high paid senior staff that have run out of ideas. They would be better served by outsourcing their excellent loss mitigation staff, as they have always impressed me with their extensive knowledge. Unfortunately they weren't invovled enough when the assets were being aquired, and are now left holding the bag.

2008 Sep 05 05:29 PM

[JCNP7:]

Greg you are spot on with your calls. Very impressive. Trying to hold back laughing at how wrong that guy Patrick has been with all his calls, boy am I glad I listened to you and not him!

2008 Sep 17 08:13 PM

[Greg Weston:]

JCNP7: While Patrick's bullish calls on mortgage finance turned out to be quite wrong, to his great credit he has written many informative articles here and elsewhere online about the industry, and I appreciated his comments here on my RWT article.

When we one day purge the corruption that has long afflicted the mortgage finance sector, I think he will have a good record in identifying the best companies. Until then I will continue my profitable hobby of looking for the worst.

Jan 10 03:34 AM

[tj987:]

GREG- since i believe that many of these companies will just disappear. Because as dire as it looks it is going to get worse. Do they need to refinance anything in 09.. you got any other shorts

Feb 03 02:16 PM

[sr9web:]

How's the RWT short doing for you these days, Greg?

Mar 03 11:26 PM

[Greg Weston:]

SR9: I recently increased my position when my broker let me know that more shares were available to short.

Mar 10 01:19 AM

[sr9web:]

So, doubling down on RWT eh? Why not just buy some ultra-short ETFs after the market bounces, like it did last week?

Also, you'll be happy to know that one of the other names you shorted (CRZ, new ticker CYRV) has been berry, berry good to me.

I own a significant number of shares all under 60 cents per share. I've got a 2x gain right now and am collecting sweet dividends to boot. So of course, this makes me ask: Did you change directions on Crystal River (CYRV) yet?

All in all, you were right to go short when you did, but if you haven't since gone long on Crystal River, you are missing the boat there.

Re-check the numbers and you'll see what I mean.

Q: Any new short ideas these days?


On Mar 10 01:19 AM Greg Weston wrote:

> SR9: I recently increased my position when my broker let me know
> that more shares were available to short.

Mar 31 04:34 PM

[Greg Weston:]

SR9: I was never able to get shares of CRZ to borrow for very long, so I shorted via options, all of which expired last year.

The one time I have ever been long an mREIT was snapping up some NCT when it fell below 30 cents. I sold it a couple days later for a nice profit.

I made a profit on RWT, though not as much as I would have liked, nor as much as if I had just went short SPY the same period.

In the end they were able to find secure financing with their $12 equity offering, and around that point I gave up and covered my position. The company is still somewhat overvalued, but they are in no danger of falling to $4, as they were before the offering.

I lack the time right now to do the DD needed to short individual names, and right now am only short CS and one smaller financial that I investigated may write about soon, but will not mention publicly.

May 22 10:26 PM

[E Nuff Sed:]

I am long RWT. It now seems to have stabilized and is seeking to take advantage of low values in the prime non-agency mortgage market. I see it more of asset manager rather than a mortgage reit.

May 23 09:21 PM