Redwood Trust Inc (RWT) Q3 2026 Earnings Call Transcript

Greetings, and welcome to the Redwood Trust Third Quarter 2026 Financial Results Conference Call. Today's conference is being recorded. I'll now turn the call over to Ann Wynn, Head of Investor Relations. Please go ahead, ma'am.

Thank you for joining us today for Redwood's Third Quarter 2026 Earnings Conference Call. With me, on today's call, are Chris Abate, Chief Executive Officer. Dash Robinson, president, and Brooke Carrillo, chief financial officer. Before we begin today, I want to remind you that certain statements made during management's presentation with respect to future financial and business performance may constitute forward-looking statements. Forward-looking statements are based on current expectations, forecasts, and assumptions, which includes risk and uncertainties that can cause actual results to differ materially. We encourage you to read the company's annual report on Form 10-K and quarterly report on Form 10-Q, which provides the description of some of the factors that could have a material impact on the company's performance and can cause actual results to differ from those that may be expressed in forward-looking statements. On this call, we may 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. Reconciliation between GAAP and non-GAAP financial measures are provided in our third quarter Redwood Review, which is available on our website, redwoodtrust.com. Also note that the contents of today's conference call may contain time-sensitive information that are accurate only as of today. We do not intend and undertake no obligation to update this information to reflect subsequent events or circumstances. Finally, today's call is being recorded. It will be available on our website later today. With that, I'll turn the call over to Chris for opening remarks.

Good afternoon, everyone. Today, we announced several important developments for Redwood. I'll cover the key points before Dash and Brooke share their prepared remarks, and then we'll take your questions. After 32 years as a real estate investment trust, Redwood plans to transition to a taxable C corporation beginning in 2027. We believe this structure better aligns with our operating business today and will strengthen our ability to build long-term shareholder value. We expect the transition to generate an initial GAAP book value benefit of approximately $0.73 to $0.77 per share in the fourth quarter of 2026, which translates to an increase of approximately 11% over our September 30 book value per share of $6.56. We realize that this transition has been anticipated for some time by many of our shareholders. Redwood has evolved considerably since its founding in 1994, with our transformation into an operating platform accelerating in recent years. Today, we serve as an embedded partner to hundreds of loan originators and real estate investors, including 70 of the top 100 U.S. banks. We support these institutions with deep underwriting and asset management expertise and leading securitization and whole loan distribution programs. Our recent market share gains in mortgage banking indicate that we have only begun to monetize the full potential of these relationships. However, the earnings strength of our franchise has not translated into sustained book value growth. One reason is that we've distributed substantial capital through dividends, limiting our ability to allocate capital and compete effectively with our mortgage banking peers. By de-REITing, beginning with the 2027 tax year, we want to share three near-term benefits. First, we expect to unlock significant, tangible value from our existing tax assets through previously unusable federal and state NOL carry forwards. In this regard, we are unique, as all REITs that come to mind would stand to lose their tax shelters by not complying with the REIT rules. Our shareholders will immediately realize the opposite. Second, we will have greater flexibility to retain earnings and allocate capital. As we disclosed earlier, we expect the board to reset the quarterly common dividend to $0.02 per share beginning in the fourth quarter. This would bring our payout ratio in line with banks, asset managers, and other C-corp mortgage businesses with comparable operating models. We recognize that the DREIT transition While in the long-term interest of the company, entails a lower common dividend to fully leverage the compounding effect of earnings and associated benefits. For our shareholders who value Redwood's historically high dividend yield, particularly our retail investors, Today, we announced plans for a preferred for common exchange offer that we expect to come at a significant premium. This new series of preferred stock will carry a high dividend yield aligned with income-oriented objectives. I would strongly encourage interested shareholders to fully explore it ahead of the upcoming launch. For our common shareholders, this exchange can be thought of akin to a share buyback and will further enhance the contribution from our newly minted tax assets. Based on our projected size for this exchange, we would expect any remaining potential dilution associated with our September convertible debt issuance to be neutralized, especially when factoring in our third quarter common share buybacks. Third, and finally, the C-Corp transition creates a path towards a structurally lower cost of capital. Our corporate debt costs reflect constraints associated with mortgage REITs, particularly the requirement to pay out substantially all earnings rather than allocate that capital for other uses. As a consequence, non-REIT mortgage peers enjoy broader access to the debt markets, including rated debt, with covenants better suited for operating businesses. With more than 80% of our unsecured debt callable by the end of 2028, the C-Corp transition will allow us to not only pursue more attractive debt, but also opportunistically replace higher-cost obligations with lower-cost financing. In step with Ed Unlock, today we announced the upsize of our corporate-secured financing facility with CPP Investments and extended its maturity to March of 2030, adding valuable funding flexibility. As we head towards year-end, we are working very hard to resolve as much of the legacy book as possible in the fourth quarter. While Dash & Brooke will cover legacy, I want to be sure our shareholders understand that the legacy book remains very much a melting ice cube. Charges went up this quarter because liquidations went up and the outstanding balance went down. I'd also note that our legacy book is marked dramatically lower than many who utilize CECL reserving for similar assets. This distinction is a big reason why we can pursue liquidations at this time rather than traditional loan modifications. In closing, through all of today's announcements, our mission remains the same, to make quality housing, whether rented or owned, accessible to all American households. As we discuss in this quarter's shareholder letter, that mission is taking on new significance as we transition towards becoming an agentic enterprise. With our expectation that markets begin to normalize after the midterm elections, we're excited to challenge the boundaries between agency and non-agency mortgage lending in the quarters ahead. With that, I'll turn the call over to Dash.

Thank you, Chris. Our third quarter operating results reflected proactive risk management and the depth of distribution and product offerings that make our platform resilient, even in times of market volatility. We substantially increased activity with our joint venture partners, increased loan purchase and sale activity with banks, and made important strides in the wind-down of our legacy portfolio. The result was our ninth consecutive quarter of mortgage banking returns north of 20%, despite sharply higher benchmark rates and spread widening that has persisted into the fourth quarter. Across our platforms, we produced $6.6 billion of loans, down from $8 billion in the second quarter, while distributing $8.8 billion through securitizations, whole loan sales, and joint ventures. We meaningfully reduced net inventory, freeing up liquidity for fresh working capital and accretive deployment into our corporate capital structure. At Sequoia, lock volume was down modestly on the quarter to $5.1 billion from $5.6 billion in Q2. Gain on sale margins rose to 113 basis points, up from 92 basis points in the second quarter. Resilience that reflected a proactive distribution posture, appropriate conservatism with our rate sheet, and continued accretive hedging activities, particularly as 10-year Treasury yields moved sharply higher in the quarter end and the mortgage basis widened. Sequoia distributed over $7.1 billion of loans during the quarter, including $5.8 billion across 10 securitizations and the first out of the Castle Lake joint venture. Full loan sales totaled $700 million, including transactions with two new bank partners. The majority of Sequoia's dispositions on the quarter occurred prior to the uptick in rates in September, helping to support gross margins. Just one quarter after coming online, the Castle Lake Partnership is reinforcing how joint ventures can expand our production capacity while more efficiently deploying our shareholders' capital and increasing mortgage banking returns. Through these partnerships, Redwood earns upfront economics on loan sales, recurring management fees, and a share of gain-on-sale profits, providing growing revenue streams without the added working capital requirements. Amidst a more cautious operating approach, Sequoia continued to expand its product development and bring a deeper suite of solutions to our seller base. Traditional 30-year fixed-rate production represented less than 70% of locks on the quarter, a nod to strategic progress with our medical professional loan offering, for which we issued our second securitization during the third quarter, as well as HELOCs, which we formally rolled out in May. When rates and spreads are volatile, these products support margins both through our unique sourcing capabilities and increased market demand for non-fixed-rate product when convexity becomes more challenging to manage. Transaction activity with our bank network also continued to trend higher, with over 30% of our Q3 locks coming from depositories. While rates have rallied close to 40 basis points off their recent highs, spreads remain at or near recent-wides, an opportunity for the business heading into year-end, a period of time during which many competitors have historically retrenched. Market conditions more acutely impacted Aspire's third-quarter performance. Spread widening across the capital structure and rate volatility, particularly at the short end of the yield curve, led to roughly flat gross margins, down from 101 basis points in the second quarter. Locked volume on the quarter totaled $1.1 billion of loans, down from $2.1 billion in the second quarter, and the result of deliberate calibration of activity as distribution timelines extended, with both originators and aggregators challenged to efficiently move inventory.

Low purchases represented roughly 88%

of Aspire's volume, and our active seller network grew to over 165 sellers. Aspire distributed $1.3 billion of loans, including $904 million across two Spire securitizations and $386 million of whole loan sales. The non-QM market remains in growth mode, and Aspire's addressable market remains significant. With a net undistributed pipeline of below $400 million, the business is well-positioned to capitalize as demand from insurance capital ramps back up, and we prepare for initial fundings under Aspire's newly formed joint venture, which at scale has overall purchasing power of approximately $8 billion. Corvess funded $406 million of loans in the third quarter, roughly flat with the second quarter. Higher rates once again weighed on the term loan pipeline, but combined bridge and RTL fundings increased roughly 35% and accounted for nearly three-quarters of volume. Corvess distributed $427 million of loans through joint venture transfers, securitization, and whole loan sales, including $244 million to our joint venture with CPP investments. We also launched a new pricing engine and redesigned a website to support lead generation and began transitioning servicing of certain bridge loans to our new servicing partner, an effort we expect to reduce on-the-run servicing costs through time. As production activity has increased across our platforms, credit performance has remained stable and delinquencies remain low. 60-day-plus delinquencies in Sequoia and Aspire are each below 20 basis points, reflective of continued strong underwriting discipline as those businesses continue to expand. Importantly, credit performance in recent core best production advantages has also remained healthy, with combined serious delinquency and REO below 5% in our securitized bridge portfolios, affirmation of the significant changes in our approach beginning in late 2022 that have delivered several consecutive years of strong credit cohorts. Total payoffs across all bridge portfolios have totaled $475 million in unpaid principal balance since June 30th, a level of turnover in line with expectations. This included $160 million of payoffs and dispositions of legacy and other season bridge loans, with another $70 million in UPB expected to be resolved by mid-Q4 or already under contract. As credit from core production activities remains resilient, the legacy investment segment, which continues to shrink, remains the primary area or focus for loss mitigation and disposition. Since the third quarter of 2025, we have reduced exposure in that segment by close to 40%, prioritizing proactive measures including note sales, refinances, and REO sales. As such, modification activity in the legacy portfolio has decreased sharply in recent quarters as we prioritize expedient recovery, capital reallocation, and reduction in interest expense. As we evaluate offers on close to 70% of the remaining loans in this segment, we maintain our posture of expeditiously reducing this position. While we may encounter additional transaction costs in doing so, the dual economic benefits are powerful. Reallocation of capital to our profitable mortgage banking activities and reduction in carrying costs that have averaged 12 to 14 cents per share per quarter thus far in 2026. I'll now turn the call over to Brooke to discuss our financial results.

Thank you, Dash. We reported a gap net loss related to common stockholders of $47 million, or $0.39 per share, compared to $3 million, or $0.03 per share in the second quarter. Book value ended the quarter at $6.56, down 4.9% from $6.90 on June 30. The decline reflected losses associated with resolutions of legacy assets and our $0.18 per share dividend, partially offset by approximately $0.25 per share of accretion from common stock repurchases we completed during the quarter. Our economic return on book value was negative 2.3%. Excluding the $0.39 gap loss from legacy investments, which included a $0.07 per share charge to position certain legacy HEI assets for liquidation, book value per share would have been up modestly from the second quarter. Consolidated non-gap EAD was negative $0.02 per share compared to positive $0.15 per share in the second quarter. Four segments generated $23 million of EAD, or $0.18 per share, representing a 12.7% annualized return on equity, compared to $0.25 per share last quarter. Legacy investments reduced consolidated EAD by $0.20 per share, compared to $0.11 per share in the second quarter, reflecting carry and resolution costs. Importantly, the underlying non-performing loan population continues to shrink, with non-accrual loans declining to $205 million at September 30th, down from $291 million at year-end. Throughout the year, we have not accrued on the majority of our legacy loans, irrespective of payment status. We completed no complex modifications or rate concessions during the quarter, focusing instead on sales foreclosures and other dispositions. As this portfolio continues to wind down, we expect the associated earnings drag to decline. Our goal remains to resolve as many legacy loans as possible throughout the remainder of the year. Mortgage banking generated $27 million of gap net income compared to $40 million in the second quarter and a 26% annualized non-gap return on capital. Sequoia generated $32 million of gap net income, essentially unchanged from the second quarter, and a 41% annualized return on capital. Margins benefited from our interest-only and servicing hedges, as well as joint venture distributions, offsetting the impact of lower volume. Aspire reported a $5 million gap loss compared to $7 million of net income in the second quarter. Volume declined 45%, reducing operating leverage as we deliberately moderated acquisitions early in the quarter when loan spreads did not adequately compensate for emerging market risks, a decision which was reinforced by subsequent market volatility. Corvess was approximately break-even on a gap basis. Excluding acquisition-related expenses and the related tax effects, EAD was $1.6 million, representing a 20% annualized EAD return on capital, and compared to $2.8 million in the second quarter. Funding remained relatively stable with increased bridge activity offsetting weaker term loan demand. Redwood Investments generated a $4 million gap loss versus $1 million of income in Q2 as higher rates and wider spreads pressured retained investment valuations. This was partially offset by $4.9 million of positive RWT Horizons fair value changes. Net interest income rose to $19 million from $10 million, primarily reflecting seasoned Iowan servicing investments transferred from mortgage banking as their pipeline hedging benefit diminished. Segment EAD before allocated corporate costs increased to $13.6 million from $10 million. TNA was essentially unchanged at $38.5 million. Year-to-date total expenses represented 69 basis points of production versus 88 basis points for the full year 2025, a 22% improvement. Turning to liquidity and capital, we ended September with $201 million of unrestricted cash, up from $192 million in June. We raised $205 million through our 7% convertible offering, retired approximately $125 million of 2027 converts, repurchased $34 million of common stock, deployed $67 million into retained investments, and paid $23 million in dividends. Cash generated through loan distributions and ongoing balance sheet management allowed us to fund these capital actions while increasing our cash balance, a trend that has continued into the fourth quarter. Recourse debt declined approximately $310 million to $4.2 billion as distributions outpaced production. Recourse leverage rose to 5.2 times from 5.0 times, reflecting lower equity from repurchases than net loss in dividends. Turning to the financial implications of today's corporate actions, our Plan C Corp conversion will allow us to use approximately $304 million of federal and over $1 billion of state net operating loss carry forwards from our re-qualified businesses to offset future taxable income generated by our operating businesses, where our effective tax rate at the TRS increased to approximately 29% this quarter, up from 21% in the second quarter. We expect to recognize an initial deferred tax asset of $85 to $90 million in the fourth quarter of 2026, increasing GAAP book value by approximately $0.73 to $0.77 per share, based on September 30th shares outstanding, and subject to final tax and accounting determinations. Beyond this initial benefit, at an illustrative $30 million of quarterly taxable income, NOL utilization could reduce quarterly taxes by approximately $0.05 to $0.06 per share per quarter over the next several years, subject to applicable limitations. As Chris mentioned, the Board is realigning our quarterly common dividend policy to $0.02 per share, expected to take effect with the declaration of our fourth quarter dividend in December. Compared to the current $0.18 quarterly dividend, that would reduce our annual common dividend payments by approximately $75 million at the September 30th share count and before the effects of the planned exchange offer. Finally, the board approved a one-for-five reverse split planned for January 4, 2027 to improve share marketability. It proportionally reduces shares outstanding and increases per share amounts without changing total equity. All per share figures discussed today are pre-split, as the split will be reflected in our fourth quarter metrics. With that, I'll turn the call back over to the operator for questions.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question comes from the mind of Doug Harder with BTIG. Please proceed.

Thanks, and good afternoon, evening. With the combination of the cash savings from the dividends, cash tax savings, can you talk about Uh, you know, kind of your, your priorities, uh, for, for capital deployment, you know, whether that be repurchasing, uh, debt, you know, at a discount in the, in the market, uh, you know, continuing to invest in mortgage banking or, or share repurchase, kind of how you're thinking about those options.

Sure. Hey, Doug, I'll start, um, with respect to, uh, the common We've announced an exchange offering that we think really addresses the portion of the shareholder base that prefers a high dividend going forward. I'll let the press release do the talking at this point. We expect to launch a tender next week. That exchange has the potential to be very accretive to the common. We expect to take shares out of the market, and that's going to be our next step with respect to common. I think with the new dividend policy, it allows us to be much more opportunistic with debt repurchases across the stack. We also noted that the type of debt that we're able to raise and the rates become more attractive. So we'll be focused on our entire capital structure. And of course, mortgage banking, we're running a mortgage operation here. It needs capital to grow, pushing $6 billion, $8 billion a quarter through the pipes, retaining investments, managing the pipelines, all of those things. You know, take capital, but the earnings that we're generating, you know, at our core operating subsidiaries remain substantial. So we're very excited about having the opportunity to allocate capital in a more optimized fashion. So we'll have a lot more to discuss in the weeks ahead, but I think for now, we've given the market a lot today to digest.

Great. Thank you, Chris.

Thank you. Our next question comes from the line of Crispin Love with Piper Sandler. Please proceed.

Thank you. Good afternoon. Just following up on that last question, I think it addresses it somewhat, but just with the transition to a C-Corp, how do you expect the shareholder base to change? What have you learned from other companies taking similar steps? Just what that could look like over the next few months. I assume that the exchange offering is meant to address that, but what if that offering isn't as successful as intended?

Well, we certainly hope it's successful. I think it's well thought out, and it's a great opportunity for those shareholders who value a high dividend to step into what we currently expect to be an 11% coupon. There's a tender, a modified Dutch auction component, so the actual yield to the investor could certainly be higher. But again, we'll have more to say about that at the launch next week. I think for us, we've studied our mortgage banking peers. We were thoughtful in how to reset the dividend, looking at our true competitors based on the business that we're running, not based on the tax. And we also have historically had a very high institutional ownership percentage within the common stock. So our retail ownership has not typically been nearly as high as we've seen in other more passive income-oriented REITs. So we're optimistic that... Hopefully, many or most of our long-term shareholders understand these changes or even anticipated these changes, and we're going to work hard to make sure that those investors who value a high dividend have a great option to exchange into a preferred.

Can I add one thing, too, Christian? And just, you know, I think for all the common shareholders, too, this is... An atypical C-Corp conversion in that we actually think it's very ROE accretive for us. It's actually really unlocking these tax assets that will provide a significant financial benefit for us. In addition to the retained capital that has a significant compounding effect to be able to reinvest that both in our businesses and potentially deliver, that $75 million alone could bring our leverage multiple down by a half a turn over the next year and provide. Significant working capital for our 20% plus mortgage banking entities, and the safe cash taxes is significant, too. Every $20 to $25 million is about a 20% ROE accretion for us. So taken together, we think that this is really exciting for a prospective shareholder base that we'll get to enjoy in book value growth and ROE accretion from this change, too.

Great. Thank you. And, Brooke, just on that point, when you think about – because you've had ROE targets out in the past, but when you think about the conversion or the transition, the ROE uplift, the earnings outlook, can you just discuss kind of what do you think normalized ROEs could be?

Yeah, I think it's very similar to what we've been, you know, generating on, you know, the mortgage banking side. We have nine plus quarters of 20% plus ROE. Really, this is, you know, we will recognize this upfront benefit through book value and over time see that through kind of the cash savings. And that, again, is, you know, really compounding from an ROE effect. So I think... I think we continue to have the same kind of target returns for our capital that's redeployed back into our core segments, which despite the market volatility on a consolidated margin basis, we really saw Aspire, Sequoia, and Corvus collectively over kind of a 1% margin. So really looking forward to continuing to really target those same returns in our on-the-run business.

Okay, great. Thank you, and I appreciate you taking my questions.

Thank you. Our next question comes to the line of Marissa Lobo with UBS. Please proceed.

Hi, thank you. I just wanted to talk about mortgage banking with 30-year rates stubbornly above 7%. How are you thinking about, you know, the strategy in banking across the different platforms and where you see the best risk-adjusted returns?

Yes, we, Marissa, we'll tag team this one. At a high level, we've been, I'd say, extremely conservative and cautious up to this point in the fourth quarter. While we have seen benchmarks start to stabilize, spreads have continued to widen, I'd say, across the board. And we want to make sure that when we Lean back into mortgage banking, that we can confidently generate the margins that we've consistently generated for a number of quarters now. So I think at a high level, you know, we're excited to get the midterms today behind us. You know, we have started to see things stabilize. And the really good news about the platform is, you know, just given our market penetration and our access to our seller base, we're able to lean in, I think we've demonstrated this through past cycles, and this one I think will be no exception. So we sort of have the luxury of... You know, thinking about timing, thinking about when the right reentry point is to really step on the gas. And for us, you know, I think we've been very conservative, I'd say, from early September through today, candidly. But we're definitely starting to see the market stabilize. We're starting to see mortgage rates. We're looking forward to leaning in.

One subtext I would add there, Marissa, is just how light our position is, which is the function of two things, the conservatism that Chris articulated in terms of just the locks we've taken, you know, in the latter part of Q3 and to date in Q4, but also we were We're reasonably ahead of the curve, particularly in Sequoia, about distributing a lot of the risk in the position prior to Labor Day, after which, as you know, there was a significant amount of upward pressure on rates, and there's been fairly consistent upward pressure on spreads since then through today. So we're currently sitting at about $800 million of undistributed pipeline across Sequoia and Aspire, which is... As light as we've been, you know, as we can remember, and one of the reasons that's important is, you know, when rates move a lot, you know, very quickly and spreads wide, and current coupon, you know, moves very significantly as well. So we saw situations, you know, earlier in October and September where, you know, a high six, low seven percent current coupon was quickly seven and a half and seven and three quarters, and for a variety of reasons, including convexity, those portfolios or those inventories become. More challenging to manage. We were largely ahead of that, which is helpful, and as Chris articulated, the overall size of our position that's undistributed right now is as light as we've been in some time and does position us well when we feel like we can lean back in.

The other thing it's done, too, is really helped us build a nice cash position, I would say, with all of the distribution activities. So, you know, we've seen, you know, $20 to $25 million of cash inflow here that we can also use. We've made some comments around opportunistic debt repurchases for certain of our debt that's, you know, higher yielding than and looks attractive to us today. So that's certainly on our radar as well.

Okay, great. I appreciate that detail. And just on legacy, you mentioned you're evaluating offers in about 70% of the remaining loans. How should we think about potential for additional markdowns or transaction costs required to exit those positions?

Yeah, we're obviously very focused on that. Maybe just to look at what we just, you know, have accomplished over the past, you know, three or four months. We talked about the majority of The fair value changes and legacy being linked to actual realized dispositions, that was about 22 cents. That was linked to about 230, 240 million in resolutions. We either realized or expected to be realized, you know, here in the coming couple of weeks. A lot of those loans are the loans we disclosed and talked about when we issued our convert a few months back, you know, as part of that sale process, and there were others. So we will certainly evaluate everything. You know, it will depend upon, you know, the specific assets, but we feel like that's a reasonable proxy, potentially. You know, the reality of these assets is oftentimes there is a bid ask. Depending on the particular situation with the sponsor. Obviously, we're evaluating everything also in the context of timing. You know, we talked about the 12 to 14 cent carry cost per quarter. You know, that is definitely to the extent we take additional fair value hits on On where we have the position marked, that earn-back period and that quarterly savings is very important in terms of the interest expense and the carrying costs, et cetera. The big thing, just to underscore the prepared remarks, is that the position continues to shrink. We reduced it by over 20 percent last quarter alone. We're very engaged to reduce it even more significantly than that in the fourth quarter. And our recent credit cohorts have been very, very strong. So, you know, to use Brooke and Chris's terms, this really is a melting ice cube, and we're optimistic that we will continue to move the majority of the rest of this year, the rest of the quarter, and end early next year.

Thank you very much.

Thank you. Our next question comes to the line of Rick Shane with J.P. Morgan. Please proceed.

Hey, guys. Thanks for taking my questions this morning or this afternoon, I guess. A couple of things. Look, you know, tactically, the decision to pull back on volumes in hindsight looks like a very good decision. Uh, strategically, the conversion to the REIT, or to D-REIT, I should say, um, is interesting. I'm curious about a couple of different things. Um, one is, and I think this all sort of ties together because we've talked about the financing and the corporate structure, but if we look at the expense structure, it's about $250 million on a run rate basis over the last 12 months. That makes it fairly challenging in current volumes to generate profit. So I am curious when you guys look forward and get credit for sort of that 75% deferred tax asset, what are the underlying assumptions to actually realize that value? Is there going to be operational change along with sort of the corporate and financial structure change?

Yeah, thanks. Maybe Brooke and I can team up on this one, Rick. You know, at the highest level, you know, we should continue to underscore that a huge amount of our costs associated with mortgage banking are variable. You know, it's a unit issue, and if you're pushing through fewer units because, in our case, we've decided to be more conservative, the spreads have widened, And there's going to be a direct reduction in expenses associated with that throughput. Obviously, there's fixed costs associated with the operation. I think that's where the retention of capital comes into play to continue to leverage the platform. We also, you know, a few other things. I'll let Brooke talk about our joint venture partners and, you know, how we're scaling on that front. But we continue to point to, you know, an efficiency ratio based on operating expenses and revenue versus equity. This is a big reason why we've decided to move forward with the DREIT. You know, our business, you know, when we think about our business and our operating expenses divided by revenues, you know, we actually look better than most of the money center banks. The operation itself is efficient, and we can dig into those numbers with investors, but the corporate structure has not been, and so we're trying to strike that balance. But certainly, we definitely want to preserve margin, and margin requires, obviously, net revenues that make sense and are consistent. I personally think we're definitively seeing signs of the mortgage market stabilizing here. We're hoping that as we exit the midterms and some of the vol that we've experienced over the last six or eight weeks, You know, it's going to be a great opportunity to lean back in. But certainly, if the market remains challenging and we don't see the volume opportunities that we expect, we're going to remain efficient. We're going to make sure that our expenses and our efficiency is in line.

Yeah, Brooke, before you answer, do you mind helping me with what percentage of the offenses you see as fixed versus variable? I think that'll be really helpful as we sort of think through this.

Yeah, so about 56% of our costs are variable today, Rick. One thing that, you know, some of that noise was muted in a quarter like this where we had a pickup in predominantly legacy portfolio management costs while G&A was flat. You know, we did have a couple of, you know, we had some workout costs associated with loans that increased overall OPEX. I would also note that, you know, while our lock volume was down this quarter, our purchase volume is actually up. This is really just because purchase volume lags by 30 to 45 days, so you will actually see our loan acquisition costs, some of those variable costs decrease in the fourth quarter on our, you know, 18% lower lock volume. A couple of other comments there, you know, Chris mentioned... Our joint ventures, we had, you know, over a billion... And a half or so of volume that ran through our JVs. Capital really has been the biggest constraint to our model, not our addressable market. And so it is really both these joint ventures and the retained capital that we're freeing up through our both retained earnings and these cash savings that we're talking about via taxes. So this is why it's so meaningful to our ability to continue to grow volume. As Chris noted, we have intentionally slowed over the past month, but as we look out over a more stable market, then, you know, we really have an ability through our joint ventures and this retained capital to continue to meet the right operating leverage of our model. I would lastly note just consolidated EAD would have been a mid-teens return if not for kind of two main factors. One, Aspire's net margin was really the primary driver of the decrease. That was due to fairly extraordinary spread widening and rate volatility in the market, which... It's not something specific to us. And then secondly, I would say the mark-to-market on the HEI intended resolutions actually does run through EAD. So those are just a couple of notes on the quarter as it relates to forward profitability.

Got it. Very helpful, and I'm going to follow up with one thing. Can you walk through the Section 382 risk? And the reason I ask is obviously by reducing the dividend, there is risk that you're going to have pretty significant shareholder turnover. I know one of the strategies to mitigate that is to offer preps to equity holders. Do folks who tender and take PRESS count for or against the 382 test?

You know, the exchange offer, we don't expect... To meaningfully mitigate the 3D2 analysis, because our board has been very thoughtful together with tax advisors as to how to structure the preferred instrument so that it, you know, so that we are very mindful of any 3D2 impact, which we don't expect a significant one at the time of the exchange. The plan that was put in place that's detailed in one of our press releases that the board put out with respect to ownership thresholds is exactly to your point to be mindful of this very significant tax asset. And this preservation plan is really very similar that's been adopted by other companies with significant net operating losses. So a lot of time has been put into making sure that this structure is very cautious with respect to any forward implications in our 382 analysis.

Got it. Okay, thank you. I'm sitting here thinking I had a lot more hair the last time I wrote a DREAT note, but looking forward to dusting off that knowledge base. Thank you, guys.

I spend a lot of time on the follow. Yeah, no problem.

Thanks.

Thank you. Our next question comes from the line of Jason Weaver with Jones Trading. Please proceed.

Hey, guys. Lots of news today, obviously. Maybe to the point of the last exchange, just thinking about the preferred exchange offer, what were your assumptions around sizing that transaction? And do you have an idea, is there a hard limit on oversubscription or upside to preserve a given level of common that you want to retain?

Good question. We disclosed $50 million with the potential to upsize based on demand and subscription. We want to be thoughtful. Candidly, we are going to have all the details when this actually launches, which we expect next week. But I think what we wanted to be mindful of, things like the 382 issue, covenants, other things. However, we think this is an excellent option for investors, common investors, that value a high dividend. And we expect it to come at a premium to the share price at the time. And, you know, I think once we have all the details ready to go, we will. We will have more to say.

One other point just around sizing is we anticipate at a $50 million level that this really would, together with the repurchases that we've already commenced since our September offering of our convertible instrument, that that would really care for any potential dilution of that instrument as well, depending on the ultimate premium there.

Got it. That's helpful. Thank you. And then maybe more broadly, without the REIT asset test restrictions, what, if any, changes do you anticipate for the investment or retained portfolio strategy going forward? As Brooke spoke to in, I think, one of Rick's questions, would that incorporate possibly increasing the amount of retention going forward?

Hey, Jason, it's Dash. I can take that. Probably not. I think we have continued to lean into our originate to distribute model, either full distribution or having these joint ventures be a bigger part of the story in terms of how we grow our mortgage banking platforms. You know, certainly the ability to retain, you know, more capital does give us the ability to, you know, to continue to invest and add to that portfolio. But I would expect us to continue, you know, to do more of what we've been doing, which is bringing outside capital partners. Either through whole-owned sales or joint ventures or sort of similar structures to continue to scale, you know, in tandem with the ability to continue to grow our capital base.

We also, you know, while we have joint venture partners, we are a partner. We're an investment partner. And for our business to scale, and this gets back to the essence of the mortgage business that we're running, we need to retain investments and securitizations. We own MSR. To run more volume, we need more working capital to fund warehouse haircuts and for hedging. Really, to meet our business objectives, we need that form of growth capital. If we're successful, the capital piece needs to follow. As Brooke mentioned, the real constraint to unlocking the true value of the franchise has been capital. We're focused on the amount of capital, our cost of capital, and certainly open to more joint ventures and partners. Got it. Thanks for that color.

Thank you. Our next question comes from the line of Mikhail Goberman with Citizens JMP. Please proceed.

Hey, good afternoon. Excuse me. Lots to unpack here, obviously, and we've been over quite a lot of ground already, so maybe if I could ask you guys to maybe walk through the mechanics of the C-Corp conversion. The timing of it, the expected timeline of it. If you guys need a shareholder, vote on that. Stuff like that. Thanks.

Yeah, I'll start, Mikel, and, you know, the team can add comments. The first thing is, you know, by way of the announcement today, we've announced the NOL plan and the board's intention to transition to a C-Corp. Once that intention has been made... Those tax assets become realizable. That's why we announced, you know, we expect... Which is pretty substantial. A reminder, these are NOLs that are operating businesses should be able to use more or less immediately. We've been paying for some time mid to high 20s effective tax rates on substantially all of our earnings, which is very counterintuitive for REIT. We've had the NOLs. We've not been able to use them based on the structure. So for some extended period of time, we expect to not have to pay taxes out of capital or cash, I should say, and tax obligations will be absorbed by the NOL. So it will become very tangible to us. I think we, you know, we have an example in the review, you know, on, you know, what an average quarter could look like in the per share, you know, P&L increase from tax savings alone. So we think that the benefits will become immediate. We mentioned that it becomes effective in the 2027 tax year. So the technical requirements. From a federal income tax perspective, would presumably be met in the first quarter, and, you know, I think that we are, you know, our next step is to kind of get through the next few weeks. You know, we've got this exchange plan. We're quite excited about it, and, you know, I think what we're trying to do in the fourth quarter. Through all of the initiatives that we mentioned, it's really put the business in a position to be growing on a stable basis in 2027. Hopefully more simple, more straightforward, with a business structure that is consistent with our operating model. And, you know, these calls, I think, will be, you know, our results will become a lot more intuitive.

So there's no shareholder vote that's needed. And if I could just make a quick little hard pivot to an operational segment, just your thoughts on credit quality going forward. Some data has been popping up about delinquencies sort of rising in the non-QM space and a few other pockets of the mortgage industry. So maybe just... Talk a little bit about that and if there was any effect of that on your Aspire volumes in the third quarter. Thanks.

Thanks, Mikael. It's Dash. I can take that. No, in terms of the credit philosophy within Aspire, you know, non-QM, you know, can be a broad term. I think since we launched Aspire close to two years ago, we've had the thesis of sticking to our knitting and... You know, being on sort of the middle lanes of the highway in terms of credit, you know, I think we have market standard guidelines, but, you know, the judgmental underwriting that our underwriters do, how we price our rate sheet, et cetera, I think has generally guided us to, you know, on balance probably, you know, a higher credit quality, you know, net book than maybe the industry, you know, in total, which I think shines through with our delinquencies being at 20 basis points. Which is probably in the upper quartile of the market or the best quartile of the market. I should say. So we've taken a very conservative approach to higher LTVs, to aggressive debt service coverage ratios, you know, extremely mindful, you know, for some of the, you know, some of the issues in valuation that the sector overall has had over the past few years. And I think that's shining through, frankly, in delinquencies and performance. Obviously, that's a, that's a day-to-day discipline. But, you know, so far we feel. Like, we're performing that effectively. The volume pullback for Aspire was really largely market-driven. You know, as we saw spreads widen and rates move higher, you know, non-QM in particular did widen pretty significantly in the second half of the third quarter, and it actually has continued to widen in the fourth quarter. If you go back to the summer, maybe in August, AAAs were probably at 120, 125. Now prints are probably at 165 or so. So there's definitely significant widening in both whole loan and AAA spreads. One thing I would reinforce, which we didn't mention on this call but have on prior calls, is that with Aspire, we move all of our risk. We sell the subordinate securities. We sell the risk retention securities to third parties. And while that execution did impact our margins in the third quarter, that risk is sold. And, you know, we're not sitting on bonds that, you know, maybe have had some negative price action thus far this quarter. Spreads have to continue to widen. So I think sticking to our knitting on credit and continuing to focus on running that business capital efficiently, we have our JV we expect to set up here shortly in the fourth quarter. That will continue to be the story in Aspire.

All right. Thank you all. Looking forward to the updates going forward over the next couple weeks and beyond. Thanks.

Thank you. Our last question comes to the line of Bose George with KBW. Please proceed.

Hey, everyone. So first, just one follow-up on the legacy. You know, your capital there is 116 million, so it's less than a dollar a share. You know, on each position, can you walk away if the potential loss exceeds that equity allocation? And just confirming your loss is now ring-fenced at this It's a pretty small number.

Well, some of the debt allocated against that a position is non-recourse and some is recourse-bosed, so that is a consideration. We have some detail on that. So, that is... That is part of the capital allocation. There is some modicum of recourse debt. But again, we're going to do everything we can to move the position expeditiously, but obviously protect value. We recognize that it is an overall challenging environment. Each of these assets is bespoke and takes its own considerations. But, you know, we feel very good with the progress we made, again, you know, close to a quarter billion of resolutions since June 30th, and the opportunities we have in front of us to continue to de-risk between now and the end of the year and into early Q1. We're optimistic that the bulk of this can get behind us pretty quickly.

Okay, great. And then, actually, you noted that $0.12 to $0.14 a quarter of, you know, the carrying costs on this. Has that declined as the legacy has declined? I mean, was that number for 3Q as well, or was that a lower number?

It's been fairly consistent. And some of that is just the ongoing cost, but also in some cases just the cost to resolve and get to the real estate and move it. So those have been reasonably consistent. We should continue to see where we should start, I should say, to see those trend down in the fourth quarter and in the Q1 as some of the associated secured debt is paid down and obviously the ongoing property management and just overall protective costs come down as the position continues.

Okay, great. And then actually one on the deferred tax assets, just given the size of your NOL, is there going to be like, is there sort of incremental deferred tax assets that are going to have like a valuation allowance initially and can be reversed? Or is the, you know, the amount you noted kind of the max on the DTA?

No, we actually are putting, you know, a part of our DTA will have a valuation allowance up. We see some of our NOLs expiring before they're fully utilized, but, you know, there's a potential based on our profitability for that to be recognized over time, so we're not taking 100% of the value today.

Okay. And is that something you can quantify now? Is that – could that be a pretty meaningful number, just given the size of your NOL? It seemed like there should be more DTA eventually.

Yeah. Our VA that we're putting up is only on our – we have a billion one of NOLs at the California state level, and so we have – we're expecting to use roughly kind of half of that. State NOL today, to the extent, again, our projections change around our ability to utilize that, we would de-recognize that VA over time.

We can follow up with the amount, but I think the big takeaway is the amount, the big jump in book value is It's been heavily vetted with our tax accountants and tax attorneys, and that is what we expect to be realizable, but certainly, you know, there's more upside if more of that allowance can be released, and some of these DTAs date back to the financial crisis. It's been just a very long time coming, so we're excited to have that on lock.

Okay, great.

Thanks a lot.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.