Greg Weston

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

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.

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

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.

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

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.

Don’t Buy What Wall Street Is Selling

Excellent article, persuasive and well-written.

There will be some vultures who end up making a bundle buying financials when they are near the bottom, as happened to those who picked up the survivors of the 1990-92 recession. Problem is right now, the bottom for many financials is bankruptcy, and the rest have a long ways to fall.

GM and Ford: Still Easy Shorts

What you are missing is the strong chance that there will be big subsidies to F and GM from the US Gov to the form of hybrid factory startups and national health care.

Both companies can and do produce a variety of good small cars, just not so far for the US market. GM is bringing over more and more of its Opels, rebadged as Saturns, and Ford has a number of good small cars in Europe and Latin America it will be bringing to the US in the coming years.

Why Subprime Loss Estimates Are Still Too High

Tom, you have a truly horrible track record. You were pumping up First Marblehead here with multiple articles when it was around 40, now it is down more than 90% to below 4. Last you were also defending Countrywide, down more than 80%, and early this year you were defending the monolines, down 75%-90% since those articles appeared.

Regarding this specific article, your assumption that banks might eventually return to trading at several times equity ignores the fact that the ultra-loose regulatory environment that allowed them to enjoy such a multiple likely will never return. Barney Frank is setting bank policy these days, not Phil Gramm, former chairman of the Senate Banking Committee and lately an executive of tax fraud specialist UBS.

Moreover, event your own graphs don't support your position. The rate of increase in some subprime indexes may be down, but:
(1) M over M increases of 2-5% still shows extreme weakness (2) you only provide some of the data rather than showing all the ABX indexes. How do we know you are not cherry-picking the strongest ones to make your point? (3) percentage increases will always go down as the base of delinquencies goes up. An increase from $1 million to $2 million in one month is a bigger percentage increase than $10 million to $11.5 million.

Finally, you down play what the realized losses will and suggest they will mirror historic averages. But the decrease in median home prices has no precedent since the Great Depression. Therefore data on loss reserves from the past 20-40 years, when the nation never suffered a large decline in nominal nationwide housing prices, is of limited value in estimating future realized losses.