If You Believe Housing Is For Real, This 6% Yield Play May Make Sense

| About: Redwood Trust (RWT)
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It was only a few short years ago securitized mortgages helped inflate and ultimately deflate the U.S. construction market. In fact, some felt mortgage backed securities wouldn't recover.

However, in risk comes opportunity and with it potential growth for firms willing to step in and double down on the MBS and CMBS market, including Redwood Trust (NYSE:RWT).

Investing in securitized mortgages has been a much better business in 2012 than in 2011.

Redwood is expected to earn $1.38 this year, versus $0.31 last year. Yet, those earnings remain well below the heady profits from the middle of the last decade when the company earned $7.96 per share.

However, improving construction spending and new and existing home sales suggest further earnings power, which has led analysts to increase FY13 expectations to $1.27 from $1.11 60 days ago.

The company has exceeded the Street's best guess in each of the past 3 quarters, beating by 76%, 33.3% and 100%, respectively. This suggests analysts are playing "catch-up" and in the process providing institutional support for shares.

The company's activity level has been climbing right alongside the rebounding construction markets.

In Q3, Redwood's interest income increased to $60 million, up from $53 million the prior year. And, the company's commercial loan portfolio increased to $298 million from $111 million.

Given agency fees have been increased, private mortgage markets have become more competitive. Adding support for private players like Redwood is QE3, which is absorbing the agency securitized market and driving investor interest in private securitizations.

As a result, the company had completed 5 residential securitizations this year through last quarter, up from 2 in all of 2011.

It's likely we'll see even more in 2013. The company expects to have 55 active loan sellers by year end, up from 37 in June. The increase is behind the company's goal is to securitize $300 monthly over the next 12-18 months.

In residential, the company's re-application as a seller and servicer to Fannie and Freddie may offer additional 2013 growth.

As for commercial, the company's decision to position itself as a source for mezzanine funding is paying off too. At the end of November, Redwood reported it had closed on a securitization of $291 million worth of such debt.

As investors continue to search for yield growth, REITs (NYSEARCA:RWR) remain an attractive alternative to low yielding treasuries. And, while the homebuilders, such as Pulte Homes (NYSE:PHM) may be right for some aggressive buyers, Redwood provides an option for income oriented investors to benefit from recovering construction markets.

This suggests you may wish to keep Redwood in mind, particularly given there's 10 days to cover still held short. If demand for private funding continues higher, Redwood's 6% yield should remain competitive.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in RWT over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.