Earnings Call Transcript - RWT Q2 2023

Operator, Operator

Good afternoon, and welcome to the Redwood Trust, Inc. Second Quarter 2023 Financial Results Conference Call. Today's conference is being recorded. I will now turn the call over to Kait Mauritz, Redwood's Senior Vice President of Investor Relations. Please go ahead, ma'am.

Kait Mauritz, Senior Vice President of Investor Relations

Thank you, operator. Hello, everyone, and thank you for joining us today for our second quarter 2023 earnings conference call. With me on today's call are Chris Abate, Chief Executive Officer; Dash Robinson, President; and Brooke Carillo, Chief Financial Officer. Before we begin, I want to remind you that certain statements made during management's presentation today regarding future financial or business performance may constitute forward-looking statements. Forward-looking statements are based on current expectations, forecasts, and assumptions that involve risks and uncertainties that could cause actual results to differ materially. We encourage you to read the company's Annual Report on Form 10-K, which provides a description of some of the factors that could have a material impact on the company's performance and cause actual results to differ from those that may be expressed in forward-looking statements. On this call, we might 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. A reconciliation between GAAP and non-GAAP financial measures is provided in our second quarter Redwood Review, which is also available on our website redwoodtrust.com. Also, note that the content of today's conference call contains time-sensitive information that is only accurate 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 and will be available on our website later today. I'll now turn the call over to Chris for opening remarks.

Chris Abate, CEO

Thank you, Kait, and thank you all for joining us here today. Before we dive into our quarterly results, I'd like to take the opportunity to share how Redwood is positioned with respect to the impending regulatory rule changes concerning higher bank capital charges for holding residential mortgages. We expect some version of this proposed rule to become final in the foreseeable future in response to the regional bank crisis. More importantly, we expect that through the benefit of hindsight, these regulatory changes will mark a major turning point in how most non-agency loans are owned and distributed in the United States. Our confidence in this outcome stems from working behind the scenes with many bank executives. Just like us, were the proverbial puck headed after watching portfolio mortgages play a central role in the demise of Silicon Valley Bank and First Republic Bank earlier this year. In fact, over the past few months, we've completed onboarding and have already activated a number of regional and midsized banks with aggregate assets of over $2 trillion, and we're in various stages of bringing many more online in the coming weeks and months. In some cases, these banks represent long-standing flow relationships we've built over many years or even decades. Others are new to Redwood and have previously held loans on their balance sheets that they no longer find economical to maintain. As the tide turns, more and more depositories are looking to Redwood, given our long-standing track record of accumulating and distributing non-agency loans. As such, our strategic focus will be to continue onboarding such depositories with the goal of becoming their primary capital partner as they look to serve their jumbo clients in a seamless manner, even before the final regulatory changes go into effect. To try and contextualize the transformational shift that we foresee for our market, I'll begin by reiterating to today's listeners that mortgage cycles are no longer determined by Wall Street. Today, they are almost exclusively determined by Washington, DC. Monetary policy and the path of mortgage rates are governed by the Fed, and regulatory rules and enforcement actions concerning banks and other lenders are overseen by the Treasury, the FDIC, OCC, CFPB, and others. Of course, housing policy is dictated by the current administration primarily through the FHFA and HUD. Altogether, these government influencers play a much more prominent role in the boom-and-bust of the mortgage market than they ever had before. The effects that Washington has on banks and their propensity to lend have always had a profound effect on Redwood's business. That's why we consider this impending regulatory change, in keeping with our historical experience, to be a very positive market-shifting event for our business. As many of you know, Redwood got its start on the back of another bank crisis, the S&L crisis. As interest rates rose and credit worsened, many depositories that held long-duration residential mortgages started losing money and became insolvent as the loans declined in value. It was through this lens that Redwood's value proposition became clear. The company was built to serve banks and other originators that relied upon mismatch borrowings for liquidity. Our ability to match fund long-term mortgages with long-term debt via securitization technology provided an outlet for lenders, just as Fannie Mae and Freddie Mac did for agency conforming mortgages. Since our founding almost three decades ago, the non-agency mortgage market has endured significant changes, and Redwood has continued to provide valuable liquidity to the market by aggregating residential mortgages that lenders can recycle their capital into new loans. In recent years, we've expanded our consumer business to also serve housing investors, responding to secular shifts in how homes are owned in the United States. During the second quarter of 2023, we completed our 143rd residential securitization, packaging billions of dollars in bulk pools for distribution to all types of investors. Fast-forwarding to today, we are witnessing yet another round of policy changes in Washington that will kick off this next era of the mortgage market. The outgoing era, characterized by a 41% increase in home prices since 2020, was fueled by extremely accommodative Fed monetary and government fiscal policy in response to the COVID-19 pandemic. With benchmark Fed rates reduced to effectively zero during this period, banks had an almost limitless supply of deposit capital to lend, as the country battled COVID. Many banks chose to opportunistically put that money to work in 30-year jumbo mortgages, and these mortgages were predominantly held in portfolio for investment rather than distributed into the capital markets. These mortgage portfolios proved to be sound credit investments and posed little principal risk to the banks, the interest rate mismatch between the 30-year loans and the deposits funding them was undeniably significant and, in many cases, very risky. Even as benchmark treasury bills gapped from zero in January 2021 to over 5% in March 2023, the perceived stickiness of deposits compelled many banks to continue offering mortgages to preferred clients at rates well below market. In fact, prior to the onset of the regional bank crisis this past March, depositories originated two-thirds of all jumbo mortgages in the first quarter. As we take stock of the situation today, the cost of deposit capital is now rising rapidly. Deposits continue to leave the banking system, with both consumers and businesses demanding much higher rates on their savings. In addition, the regulatory capital charges for residential mortgages held at banks are about to rise as well. Where does the non-agency market go from here? While for many of these banks, continuing to offer competitive mortgage products to retain their clients will be imperative, the solutions Redwood offers are a logical alternative to portfolio lending. Our reengagement with many banks over the past two months has validated this statement. In recent weeks, we have recast our correspondent network and renewed or established new partnerships with depositories which, in the aggregate, represent approximately 45% of new jumbo originations, by our estimates, which represents upwards of $130 billion in annual volume. We view this as our target addressable market when combined with the independent mortgage banks within our existing seller network. As Dash will cover, that business channel has also resumed growing. Our June lock volume is more than the previous two quarters combined, with July flow volumes continuing to grow. Our bank partners will attest that going live with a capital partner in the non-agency sector requires much more than just flipping a switch. For banks, investing in these relationships entails workflow changes, underwriting guide implementations, loan officer training, systems integration and onboarding, regulatory compliance protocols, cash and collateral management, and other infrastructure enhancements necessary to distribute whole loans with no noticeable impact on the consumer experience. Partnering with Redwood allows this work to be applied across a variety of mortgage products that we offer lenders to meet their diverse needs, with speed to close and reliable execution acting as part of our competitive moat. Perhaps our biggest differentiator is that while we help our bank partners serve their customers, we don't seek to serve those customers directly by running our own competing origination business, eliminating this inherent conflict of interest that often exists with our competition. Summing up, our enthusiasm has grown considerably in recent months, bolstered by our engagement with an increasing number of originators eager to work with Redwood. With significant changes afoot, the need for Redwood to play a centralized role going forward is rising rapidly. There's a lot of work ahead, with the leading indicators we use to assess our progress, including the strategic onboarding of new loan sellers and the depth of their origination channels, forming a reliable roadmap for the growth of our residential business going forward. I'll now turn the call over to Dash and Brooke, who will cover our operating and financial results for the second quarter.

Dash Robinson, President

Thanks, Chris. The second quarter represented a turning point for our residential mortgage banking business. Our narrative of the past several quarters in residential has been one of discipline and readiness. We prioritized moving existing risk and managing our pipeline to historically low levels, with the premise that a combination of rational loan pricing and a more accommodative securitization market would ultimately reemerge. That moment has arrived and looks familiar to us in several important ways. As the dust settled on a period of intense stress for the banking industry, it became clear how various stakeholders would likely fare amidst the fallout, including the likelihood that the country's largest banks will have to hold substantially more capital against residential mortgages. As Chris articulated, meeting this moment will require the right mix of competencies that have long been our competitive advantage. Since the end of Q1, we have increased capital allocated to our residential mortgage banking segment and began reengaging with bank partners, who since COVID have predominantly relied on deposits to fund non-agency originations. We are still early in the shift and would expect the transition to take form over the next few quarters, but early momentum has been positive. During the second quarter, we locked $567 million of loans, almost five times the first quarter's volume and the highest since the second quarter of 2022. A portion of second quarter volume was seasoned bulk pools purchased at an attractive discount to par. We have seen an increase in bulk opportunities in recent weeks, as sellers have assessed the economics and the critical trade-off of bolstering capital and liquidity. As a driver of longer-term portfolio deployment opportunities going forward, we also expect this work to position us well to provide other types of solutions to banks, including credit risk transfer and other mutually accretive structures. Combined with recently implemented expense measures, second quarter activity resulted in an annualized segment return for residential of 43%, the highest in over a year. Gross margins for the quarter were 178 basis points, well above the target range of 75 to 100 basis points within which we have traditionally run the business. We expect to continue increasing our capital allocation to residential through the second half of the year, including in support of products that will help consumers access the substantial equity in their homes. The essence of our residential business from the beginning has been to provide flexible and reliable liquidity as a prudent long-term owner of credit and interest rate risk, with secular shifts in the market advancing quickly. The prospects are bright for a business ready to once again unlock its substantial operating leverage. Turning to business purpose lending. Demand for CoreVest's broad suite of products remains supported by key housing fundamentals, including elevated occupancy levels and ongoing demand for rental products, driven by continued pressure on housing affordability. Sponsor demand, however, remains tempered by persistently higher financing costs impacted most acutely by the rapid rise in SOFR and the resulting overall slowdown in transaction activity. With benchmark rates once again higher, including the 10-year Treasury rate hovering just under 4%, we expect some project sponsors to remain on the sidelines while others may seek both bridge and term products that lock in a fixed rate but offer more prepayment flexibility. Our BPL volumes were down modestly quarter-over-quarter, driven by a decline in originations of our fixed-rate term product with bridge funding up slightly. Overall fundings for the second quarter were $406 million, split between 68% bridge and 32% term. Early July marked the one-year anniversary of our acquisition of Riverbend Lending, and our single-asset bridge channel turned in a strong showing in the second quarter, with a growing go-forward pipeline and continued investor demand for the product. Reduced lending appetite from banks and disruption at certain private lenders is also shaping up as a meaningful tailwind for BPL volumes going forward. While many of our core BPL customers have never been efficiently served by the banks, this remains a principal strength of the business. Our current pipeline includes many opportunities in which a sponsor is seeking financing options away from their banking relationship. With an estimated $200 billion of multifamily loans currently on bank balance sheets, we anticipate increased opportunities to capture customers seeking a reliable and flexible lending partner. More drivers of rental demand remain entrenched and continue to influence consumer behavior. Overall leasing trends are strong, and the average cost to own an entry-level home now sits over 60% above the cost to rent a single-family home or apartment, equivalent to $1,500 a month in payments. This is the highest delta in at least three decades and particularly relevant for a portfolio like ours, in which the average underlying rent is generally between $1,000 and $1,200 per month. In addition to persistently higher borrowing costs, limited supply of for-sale housing continues to support the rental market. Analysts estimate that barely over 1% of the 85 million-plus single-family homes in the US are currently for sale, the lowest ratio since at least the early 1980s. In planning for the second half of 2023, we placed a continued premium on reliable funding sources to feed operations. Fortunately, there are premier capital partners in the private credit markets who are eager to work with us in this regard. During the second quarter, we announced a strategic joint venture with Oaktree to support CoreVest's bridge lending platform. As previously announced in June, the vehicle is expected to unlock purchasing power of bridge loans in the amount of approximately $1 billion, inclusive of secured financing. Through the joint venture, Redwood earns upfront and recurring fee-based income streams for creating the assets and managing the joint venture. The overall structure focuses exclusively on investing alongside each other, 80% Oaktree, 20% Redwood, with Redwood maintaining the relationship with our customers. In Oaktree, we gain a highly respected investor who is both familiar with our platform and eager to support the expansion of our bridge lending business. Overall, we continue to see deepening demand from investors for our broader suite of BPL products. This has strengthened distribution channels that will serve as an important complement to the joint venture, including traditional whole loan sales and private securitizations placed with anchor investors. During the second quarter, we sold $200 million of bridge and term loans to a variety of buyers and expect this type of distribution to continue being a meaningful part of the business. In mapping out the next chapter of our BPL business, we remain mindful of the macro credit environment, particularly the impact of short-term interest rates that we expect to continue weighing on project sponsors, notwithstanding continued strength in overall leasing trends. Delinquencies in CoreVest's term and bridge loan portfolios ticked up during the second quarter to 4.2%, within overall modeled expectations and generally reflective of a small subset of sponsors working through a rapid rise in borrowing rates across their portfolios and, in some cases, extended project timelines. Occupancy rates are tracking to plan as our rents on newly turned units. While we incrementally increased loss expectations across these portfolios during the second quarter, we believe these fundamentals will be important mitigants to any ultimate severities. Our asset management team will continue prioritizing proactive surveillance to the extent conditions persist and increase work required with sponsors to assess project plans and take other necessary steps where appropriate. Fundamentals in our overall investment portfolio remain robust, driven by strong employment data, embedded equity protection from a seasoned book, and borrowers incentivized to protect one of their most valuable assets, a low coupon first mortgage. Our jumbo and re-performing loan securities saw continued strength in performance. Delinquencies were 90 basis points in Sequoia and 9% for our RPL book, the latter of which is at its lowest level since the end of 2019. Opportunities to execute capital relief arrangements with banks would allow us to add incremental exposure to high-quality seasoned mortgage pools and complementary cash-on-cash returns to our existing portfolio. I will now turn the call over to Brooke to cover our financial results.

Brooke Carillo, CFO

Thank you, Dash. We reported higher earnings available for distribution (EAD) of $16 million or $0.14 per basic common share as compared to $14 million or $0.11 per share in the first quarter, resulting in an EAD return on common equity of 6.2%. The increase in EAD was driven by a recovery in residential mortgage banking income and by a reduction in G&A expenses in the quarter. Income from residential mortgage banking activities increased $4 million in the quarter due to a resurgence in lock volumes off recent lows. In June alone, we locked three times the number of loans we lost in the first two months of the quarter. As Dash noted, gains on sale margins were well in excess of our historical target range of 75 to 100 basis points. Income from business-purpose mortgage banking activities decreased as spreads remained relatively stable during the second quarter compared to the first quarter, where spread tightening benefited existing inventory and volume declined by 7% from the first quarter. G&A expenses decreased by $5 million from the first quarter on lower fixed and equity compensation expenses as a function of efficiencies created through firm-wide expense initiatives. On an annualized basis, G&A of $31 million represents the midpoint of the range we previously provided for the year, and the second quarter included approximately $1 million of related severance expenses. GAAP net income available to common shareholders was $1.1 million or $0.00 per diluted share compared to $3.2 million or $0.02 per share in the first quarter. GAAP earnings for the quarter were also impacted by net negative investment fair value changes from incremental impairments on our bridge loan portfolio and fair value declines on our re-performing loan (RPL) investments from spread widening during the first quarter, despite fundamental credit performance of our RPL book continuing to improve. Net interest income remained stable from the first quarter of 2023 as higher net interest income from mortgage banking and corporate cash were offset by a full quarter of MSR financing and increased borrowing costs. Additionally, net interest income was impacted by sales in the quarter as we freed up incremental capital through investment portfolio optimization, allocating the proceeds to the growing opportunity in residential mortgage banking. We sold securities that were largely non-strategic, third-party assets executed at accretive levels to Q1 book values and recognized gains of approximately $6 million. While these sales reiterate market appetite for our collateral above our marks, we retain roughly $400 million of embedded net discount that we carry forward into future quarters, over 85% of which we control the call rights on. Book value per share for the quarter was $9.26 compared to $9.40 in the first quarter, reflecting the nominally positive quarterly economic return on common equity for the second quarter. The primary drivers of book value during the second quarter were five basic earnings per share impacted by previously mentioned fair value changes and our $0.16 common dividend per share. Our unrestricted cash and cash equivalents as of June 30 were $357 million, which exceeded our marginable debt. Recourse leverage was down slightly to 2.2 times for the quarter. We continue to manage our near-term corporate debt maturities accretively during the quarter, repurchasing an additional $31 million of our upcoming August 2023 maturity, bringing the outstanding balance for that maturity to $113 million. We will repay the remainder in mid-August with existing cash on hand that has been invested in short-term Treasury bills at an effective rate exceeding our cost of funds on net debt. As we've demonstrated over the last several quarters, we have the capacity to generate additional capital organically through the establishment of new financing for certain unencumbered assets, which can serve both to fuel growth of our mortgage banking businesses or continue to repurchase corporate debt across our term structure to optimize our capital structure. Furthermore, we're actively engaged in capital partnership conversations, like our recently announced bridge joint venture, given the significant uses of offensive capital we see in front of us. We continue to be successful in managing financing facility capacity for our operating businesses, renewing two BPL lines and one residential line, representing approximately $1 billion of capacity on very similar terms. Overall, at June 30, we had excess capacity of $2.6 billion to support the continued growth of our BPL and residential businesses. Looking ahead, we intend to add two financing lines in the third quarter related to our recently established Oaktree joint venture, procure additional financing for our non-performing BPL loans, and add one additional financing line for ATI and potentially other home equity lending products. As previously guided during our last earnings call, we reset our common dividend level in the second quarter to align with our anticipated near to medium-term earnings profile, ultimately enhancing our ability to capitalize on growth opportunities across our businesses. Going forward, we see significant opportunities to increase our allocated capital to the residential business. With the changes we have made to our cost structure, we can generate returns accretive to our dividend yield for the residential business on $500 million to $1 billion plus quarterly purchase volume given the lock volume trends we're seeing today. As Chris and Dash have covered, we anticipate volumes to continue to increase in the third quarter as we begin purchasing from our newly established and existing bank flow partnerships and source additional pools. We are already seeing these trends manifest thus far in July. While the direction of interest rates could impact our projected second-half volumes for the remainder of the year, we also anticipate a rebound in volumes in BPL due to several factors discussed earlier by Chris and Dash. These include new capital partnerships, the introduction of new products, disruptions we're seeing in the competitive landscape, and the possibility of the Federal Reserve's ongoing hiking cycle. And with that, Operator, we will now open the call for questions.

Operator, Operator

Thank you. We will now be conducting a question-and-answer session. Our first question comes from Doug Harter with Credit Suisse. Please go ahead.

Doug Harter, Analyst

Thanks. And thanks for the color on the residential opportunity. First, hoping you could talk about how you see the competitive environment developing? Are there other non-banks that are looking to kind of get into this market? And kind of how do you see that playing out?

Chris Abate, CEO

Hey, Doug, it's Chris. Well, first of all, I think there’s probably no one that's directly competing with us today. We expect more competition. But the engagement we've had with banks, particularly regional banks, has been more or less us to this point. So, we've had a lot of back-and-forth, and we're working with a lot of new partners. Still, I think that's sort of a natural evolution of what we do. We've run this correspondent business now for decades, and I think reputationally, we're pretty well established throughout the banking system. So there have been quite a few inbounds, and we're very focused on that segment. It's still early to say. The regulatory announcement today specifically applies to banks with over $100 billion of assets. That's been our primary focus up to this point. Over time, we plan to continue to build out the depository facet of our network to complement the independent mortgage banks (IMBs) that we've done business with for many years. It's very early innings, but I don't think banks are waiting for the rules to be finalized. Probably not many bank executives are looking to double down on portfolio mortgages for obvious reasons. So, finding liquidity is a priority, and as you know, we're very focused on the non-agency space, a segment of the market that Fannie and Freddie don't serve. We're excited about the opportunity and look forward to keeping you up to date on it.

Doug Harter, Analyst

And then I know you guys talked about seeing increased lock volume today. But if you could just give us a sense as to what the timelines are for turning a lot of these conversations that you're having today into kind of the size of volume that these banks are targeting in terms of market share opportunity, the addressable market you're talking about. How long does it take to start turning those conversations into meaningfully higher volumes?

Chris Abate, CEO

Well, I think we're well underway at this point. Some banks where we initiated discussions over, call it, the last month or two, we're now actively locking with them effectively. They're live and online. I mentioned in my opening remarks that it's a big investment for a bank that's used to having tailored underwriting and processes to be able to sell into the capital markets. There's a lot of compliance, considerations with respect to loans that are securitizable. So all of that work involves quite a big infrastructure build for banks that have not been active in the secondary markets. The timeline will be staggered somewhat, but I think we're in multiple stages of conversations with a number of banks today. I sense we expect volume to grow meaningfully from here. I think we mentioned that June volumes exceeded the prior two quarters combined, and July is looking like another strong month for us. As we progress, certainly, by the time we report next quarter, we should have a pretty good update. That also, I should add, is flow volume. We're also very active in the bulk space, and we think there's a pretty interesting opportunity as we turn more of these banks online to access some of the portfolio opportunities with respect to some of the lower coupon mortgages and to try and provide solutions there. It's a pretty holistic effort at this point. We're meaningfully increasing our capital allocation to the residential business. I think we're up to $80 million at June 30, and we're probably looking at $100 million to $125 million today, and we expect to go higher from there. We'll have more to say in the coming months, but the response so far has been pretty positive.

Doug Harter, Analyst

Great. Thank you, Chris.

Operator, Operator

Thank you. Our next question comes from the line of Don Fandetti with Wells Fargo. Please go ahead.

Don Fandetti, Analyst

Yes. You mentioned the increased capital allocation to residential mortgage origination. I'm trying to understand how you balance being cautious in an uncertain market. Are you considering taking on more risk, or will you focus on selling more investments like you did this quarter, or is it a mix of both?

Dash Robinson, President

I believe we'll assess the market and take actions we find most beneficial. The securities we sold in Q2 are not expected to return for some time, as they have been deleveraged, and their yields were not aligned with the opportunities we identified. We will certainly pursue incremental opportunities as they arise. As Chris mentioned, reallocating more working capital to the residential mortgage banking business is clearly one of the best uses of our capital. Accordingly, you can expect a natural reallocation of capital in the upcoming quarters. We discussed the Oaktree joint venture, which will offer valuable capital parity with ours to enhance our bridge business moving forward. We anticipate unlocking additional capital from the existing bridge portfolio as we see maturities and run-offs occur. Much of this will happen organically due to the measures we've implemented, but we are always prepared to analyze the market and respond as necessary.

Don Fandetti, Analyst

Got it. And then in the BPL 90-plus day delinquencies were up; I was just curious, do you think you have visibility on where and when those could peak? I assume it's due to borrowers under pressure even with higher rates?

Dash Robinson, President

Yes. Certainly, I can provide some more context there. Obviously, asset management for the BPL portfolio has been a big focus for us. The first thing I would say is the 4% or so delinquency rate is well within our model and expectations. It's well within the range we've seen over the past few years. But to your point, the priority remains to resolve these delinquencies as quickly as possible because the early stage is when we tend to see the most accretive outcomes and where the sponsors remain most engaged. To that end, we expect the majority of the loans that caused the uptick in Q2 to actually be resolved by the end of the quarter, either through cooperative sponsor conversations or bringing in some sort of outside equity to recapitalize the situation. The fundamentals on the ground we're seeing across the BPL book, I think, are really strong. We talked about it a little bit in the prepared remarks. In terms of leasing velocity, the rents that our sponsors can achieve are looking generally really good. To your point, a lot of this is technical in terms of where silver has gone, which has caused stress in certain parts of our sponsors' portfolios. So when you have situations like that, just being really on top of it quickly and obviously, including loans that are still performing. Frankly, we want to be ahead and trying to anticipate issues that are more technical in nature than fundamental. If these conditions persist, I think we do expect the asset management work to continue, but it's really all about getting on top of these issues early to achieve the most accretive outcomes that we've been able to get so far.

Don Fandetti, Analyst

Thank you.

Operator, Operator

Thank you. Our next question comes from the line of Rick Shane with JPMorgan. Please go ahead.

Rick Shane, Analyst

Hey, everyone. Thanks for taking my questions this afternoon. Doug asked the questions about sort of hooking up the pipes on the front end in terms of sourcing mortgages and what that looks like. Can you talk a little bit in this environment about execution on the back end in terms of resuming Sequoia issuance, et cetera? I know you've done one deal year-to-date, but I'm assuming that if this business builds the way that you expect, we'll see larger transactions and more frequent transactions?

Chris Abate, CEO

Yes, great question, Rick. We've completed a few deals so far, and it's no secret that we are currently active in the market. Securitization will definitely remain a key part of our distribution strategy. The market has strengthened considerably in recent weeks, with tighter spreads and clear insights into our execution opportunities. The margins in the residential sector during the first and second quarters surpassed our long-term targets of 75 to 100 basis points. While we still face challenges due to the recent Fed hike and ongoing volatility, I believe investors are starting to engage, and we plan to be quite active in the securitization market to support the increase in volume we’re observing on the front end.

Rick Shane, Analyst

Got it. I'm assuming that when you were purchasing loans, you factored in the anticipated rate hike that was predicted at 99%. I'm curious if there's a feedback loop where, as you observe market execution, it will influence how you approach your counterparties regarding your purchasing criteria.

Chris Abate, CEO

Certainly. Right now, I think our typical guidelines for Sequoia are pretty well known at this point. The investor base is quite seasoned regarding what to expect when we launch deals. We are educating banks on that process as well and certainly servicing into securitization guidelines and exceptions, geographic diversity, all of those facets that play a role. We're helping banks get up to speed, who haven't been actively selling loans in the past. That will continue to take time, but we also view those relationships as quite sticky because it's a big investment working with a capital partner. We also have the benefit of bank balance sheets helping us with aggregation and warehouse and so forth. The partnerships are off to a good start. Ultimately, we're confident that we'll be able to securitize the mortgages that we're acquiring profitably. We actively hedge and manage our pipelines, so this is all bread and butter for Redwood. We expect that in the coming months and quarters, especially if this rate hike cycle ends in the fall. Hard to say, but I believe more capital will flow back to the sector, and liquidity will continue to improve.

Rick Shane, Analyst

That's great. Thank you very much.

Operator, Operator

Thank you. Our next question comes from the line of Stephen Laws with Raymond James. Please go ahead.

Stephen Laws, Analyst

Hi. Good afternoon. Chris, it seems like a real opportunity. I think you guys have talked glowingly about what you think is ahead for the residential business, but also mentioned the discounted pools that may be available. How do you think about capital allocation? It seems like resi mortgage banking is an increasing need for capital given the outlook there. So what does it take when you see a pool that you're looking at to justify the capital going into that purchase as opposed to continuing to support growth in the mortgage banking side?

Chris Abate, CEO

Hey Stephen, it's a balance. We're constantly weighing the right allocations between the businesses and certainly the risk capital and liquidity capital we need to run safely. Some of the portfolio opportunities are still emerging. Certainly, we've been active in bidding on bulk pools successfully, but there remain billions of dollars of underwater mortgages on bank balance sheets. We're in a position to offer solutions there, whether it be credit-linked notes, CDS, and acquiring the loans outright that we think, hopefully, over time, will emerge as we organically establish relationships with many of these banks. Over time, this is a very good problem to have, because we now see fair growth opportunities in residential, but we're also growing BPL. As Dash mentioned, we've got a great partnership now with Oaktree to facilitate significant growth in our bridge business. We're actively working with other potential capital partners there. It's a holistic approach to growth that we're focused on today, and certainly third-party opportunities with our investment portfolio will be part of that.

Stephen Laws, Analyst

Great. Most of the other things have been answered. So I appreciate the time this afternoon.

Chris Abate, CEO

Thank you.

Operator, Operator

Thank you. Our next question comes from the line of Steve Delaney with JMP Securities. Please go ahead.

Steve Delaney, Analyst

Thanks. It's exciting to hear you discuss the prime jumbo product, which has been such a vital part of your legacy. I'm really pleased that this opportunity has emerged for you. Could you provide an estimate on the bulk purchases? I know we're discussing both bulk and flow, but it seems you've managed some bulk seasonal acquisitions. Is there any way to gauge the impact of this on your balance sheet in terms of loan balances for that product over the second half of the year?

Dash Robinson, President

Sure, Steve, it's Dash. I can take a stab at that. I think the way to answer that is to look at the traditional origination footprint for these products with banks and non-banks. We are very well-connected with the IMBs, and historically, we've been very well connected with the regionals. From time to time, we partner with traditional money centers as well on certain partnerships. If you think about the jumbo origination market as historically a $300-plus billion market, at the moment, and we talk a little bit about this in the review, we're connected with almost half of that market share if you think about records and non-banks. That doesn't even factor in the potential migration of originations away from some of the money center banks. There's a lot to learn in terms of what happens today in terms of the rules that Chris was articulating earlier. It's a very, very big opportunity, and we've been encouraged, as Chris said, by the speed with which many of these partners have either reengaged or new partners have engaged with us, which is fantastic. The other piece I would reemphasize that Chris articulated is just the wallet share. As a percentage of the jumbo market overall, we've historically run our business at a 2% to 3% overall market share, and in terms of the folks we engage with, our wallet share has been between 8% to 12%, 8% to 14% over the past few years with some dispersion around that average. The operational moat with these banks that have not sold loans before or for whom it's been a while is really pretty meaningful. Our view is that once we get operationally set up with them, as Chris said, it's not just flipping a switch. It takes a lot of work; it's a lot of vendor management and other considerations. Being the first mover here and, frankly, the first to lock loans with this cohort, from our perspective, allows us to have some real upside to what our historical wallet share has been, and that can really move the needle.

Steve Delaney, Analyst

That's helpful context. I appreciate it, Dash. Where we are today on the flow business; where are these banks? I guess this ties into your SMT execution. But we're at 7% on agency 30 years, I guess, in that ballpark, maybe 6.80%. But where are the prime jumbos being priced in terms of coupon on new originations?

Chris Abate, CEO

Well, prime jumbos are close to conforming. So they're in that 7% range. Same ballpark, but we're now seeing a 6% coupon on AAAs, which allows those bonds to price much closer to par or even above par. From a liquidity standpoint, we're not dealing with the convexity issues that we dealt with during the better part of the past two years as rates rose, and you've had these large inventories of underwater mortgages. Much of that the market has passed through. The new issue market is much healthier. We've been discussing that in recent quarters. We're in a better spot from a liquidity standpoint, and that allows us to really lean in on pricing. Because these banks, in particular, have large inventories of mortgages, we can combine some combination of flow with bulk. We're looking at probably close to $1 billion of bulk pools right now. That really allows us to move more quickly. The quicker we can turn the capital and move the pipelines, it creates much more certainty on the execution side than we've had in quite a while. So, that's very positive. As mentioned earlier, we're in various stages of implementation with new partners. It will take time to gauge how much of this addressable market, this $130 million to $150 billion of originations, that these banks have spoken for on an annual basis, how much we might see in the capital markets. However, being a reliable partner matters more to depositories. Plugging in takes more work and requires a bigger investment. I don’t think you manage down to the last basis point of execution. You focus on reliability, understanding each other, handling exceptions and addressing the inner workings of selling loans. Over the course of the next few months, I think we'll have a much better idea of how big this market could be.

Steve Delaney, Analyst

Can you just estimate roughly how many bank partners that you're engaged with? I mean, obviously, you're not going to be specific; I guess when you do securitizations, that information. But are we talking about a dozen banks or several dozen banks that you're actively involved with?

Chris Abate, CEO

I'd couch it closer to 70% plus. We obviously have thousands of banks in this country, and to some degree, all of them will probably benefit from an outside capital partner to varying degrees. We're well underway. And as we turn more of these banks online with our platform, it's going to shift the balance, I think, of banks and non-banks back to something, to reference your back to the future comment, to something we’ve experienced in the past that is much more balanced between the independents and the depositories.

Steve Delaney, Analyst

Thank you very much for your time and your comments. Very helpful.

Operator, Operator

Thank you. Our next question comes from the line of Bose George with KBW. Please go ahead.

Bose George, Analyst

Yes. Good afternoon. I wanted to just ask about sort of the cadence between the current EAD and more normalized returns. Is there a way to think about how long that takes? And then does the bank opportunity here kind of accelerate that process?

Brooke Carillo, CFO

Yes. It's a great question. Our investments for value changes, which tends to be one of the deltas between GAAP and EAD weren't as meaningful this quarter as it has been in certain prior quarters. Net interest income has been stable for the last three quarters. So, I think generally, our EAD here represents a better run rate as we head forward to Chris and Dash point on the trends that we're seeing in July in terms of lock volume for residential. We had a meaningful pickup in our expectations for the second half of the year that could be somewhere between $3 billion and $5 billion in volume. But to Chris' point on bulk opportunities, that flexes up and down fairly quickly here, just given the pace unfolding out of the banks. That alone could add a couple of cents here to EAD as we move forward from our residential mortgage banking revenues. I think to tie the comments into capital earlier as well, Chris mentioned about $100 million to $125 million of allocated capital to resi. What you'll see from us is just the benefits of operating leverage and scale from here. Our cost per loan was meaningfully lower in the second quarter versus the first, but we could flex volumes probably at least twofold from here with a lot of that hitting the bottom line directly. The same thing with how we're thinking about these partnerships structured from a capital efficiency perspective.

Bose George, Analyst

Okay. Great. That's helpful. Thanks. And then just switching over to BPL. Just in terms of the securitization market there, can you just provide any color on trends? I don't think you've done a deal this year. Are there signs of that market becoming more open?

Dash Robinson, President

Yeah. Bose, this is Dash. There are trends on the fixed-rate side for our term product, which we've historically securitized a fair amount of. As you know, we're the only ones doing that specific product and securitization, but it tends to map closely to some of the single-borrower SFR transactions, and we've seen a little bit of momentum there recently, which is good. On the Bridge side, there are continuing deals that are unrated, although there is some potential for at least one rating agency to start to rate those transactions in the second half of the year, which would be very, very accretive for that market and bring a lot of new investors in, which is exciting. To that point, we've spent a lot of time over the past couple of years diversifying our distribution and BPL. Oaktree is a primary example of that. We sold about $200 million of BPL loans in the first quarter. We haven't done, as you probably know, a broadly syndicated securitization in over a year at this point, but we continue to support the business through other distribution channels. As that market continues to normalize, that's upside for us, and we're tracking that closely and will certainly utilize it if it makes sense.

Bose George, Analyst

Okay. Great. Thanks a lot.

Operator, Operator

Thank you. Our next question comes from the line of Derek Sommers with Jefferies. Please go ahead.

Derek Sommers, Analyst

Hi. Good afternoon. Another follow-up on BPL. We kind of saw the pivot of BPL volumes towards the Bridge product this time last year. As we lap that time period and see some rate stability, are you seeing the prior year's vintage of bridge loans showing interest in moving towards the term product or is the mix still favoring the bridge?

Chris Abate, CEO

100%. The mix was about 2/3 bridge, 1/3 term in the second quarter. As we've talked about before, when the business is humming, that mix is probably closer to 50-50 in terms of rates being normalized, etc. A lot of sponsors are coming to us asking for some sort of term product, maybe shorter term with more prepayment flexibility. We would expect that mix to continue to evolve more toward some equilibrium between term and bridge. That said, the term business is closely linked to benchmarks because those loans are tied to value the homes, and they also consider debt service coverage. We have to be mindful of that. But yes, we're actively managing the book as I mentioned earlier, and we are seeing an increase in sponsors looking to term out. The key to that, obviously, is the execution of their business plans and getting to the required stabilization in order to achieve that. Most of the bridge business we do is for lighter rehab. This is very constructive for occupancy in terms of how quickly these sponsors can achieve stabilization. We're optimistic that the mix evolves in the second half of the year for many of the reasons you articulated. Rates will have something to do with that, but that's the plan.

Derek Sommers, Analyst

Great. Thank you. And then one quick follow-up just on G&A expenses given the kind of near-term opportunity on originations volume and the increased cadence. Will we see any increased upward pressure on G&A or do prior guides still hold there?

Brooke Carillo, CFO

No. As we mentioned in the prepared remarks, our prior guidance should still hold. We do view Q2 to be a good proxy for next quarter as we head forward, although, we did have about $1 million of severance and other transition-related expenses in that number this quarter as well. We just referenced on the operating expense (OpEx) side for resi that we still have a lot of operating leverage. That business is about a third lower in terms of overall costs than last year. We still see opportunities from here to increase our operating leverage before we add more costs.

Derek Sommers, Analyst

Great. Thank you. That's all for me.

Operator, Operator

Thank you. Our next question comes from the line of Eric Hagen with BTIG. Please go ahead.

Eric Hagen, Analyst

Hey, how are you doing? A couple of questions here. I think on Slide 30; the average borrowing cost for the recourse debt is about 7%. What's the yield for the retained assets that are secured in that portfolio?

Brooke Carillo, CFO

Yes. Most of that debt is against our investment portfolio. I would say that carried a 16% forward yield at the end of June 30.

Eric Hagen, Analyst

Okay. Looking at just what kinds of considerations you guys make around repurchasing the debt retiring it early, the 2024s and the 2025s, kind of similar to what you just did with the 2023s?

Brooke Carillo, CFO

Yes. We mentioned in some of our prepared commentary that we're provisioning some of our capital to continue to address our unsecured part of our capital structure. The 2024s look appealing to us, but so do a number of our series as well. We have several ways of strategically repositioning part of our third-party investment portfolio, also with $250 million of unencumbered assets on balance sheet, and some additional liquidity that we mentioned through financing activities that we're actively pursuing for the third quarter. All of this raises excess capital beyond what we have earmarked for the 2024s to continue to address our capital structure. You'll see a continued shift from us from unsecured to secured financing just given relative value there.

Eric Hagen, Analyst

That’s helpful. Thank you, guys very much.

Brooke Carillo, CFO

Thanks, Eric.

Operator, Operator

Thank you. Our next question comes from the line of Kevin Barker with Piper Sandler. Please go ahead.

Brad Capuzzi, Analyst

Hi, guys. This is Brad Capuzzi on for Kevin Barker. Dash, I know you touched on the loss expectations already in the BPL segment and the steps you are taking to mitigate it. To the extent you see any further pressure there, how would this impact your decision to allocate capital towards the BPL segment going forward?

Dash Robinson, President

Well, I think the market conditions always impact all of our capital allocation decisions. So I don't think anything has necessarily changed. I think where the puck is going is probably evolving the nature of the BPL footprint and the types of products that we're most focused on originating. If you look at Q2, for instance, it was much more indexed to the long-term loans, built for rent, things like this, and things that are probably more directly responsive to some of the supply elements within single-family. Overall activity in multifamily is just lower based on what's going on in the market. Multi-family made up less than 10% of our Q2 activity in BPL. That may tick up a little bit in the second half of the year. We're running the business responsive to where we see the biggest needs, which will, from our perspective, lead to outperformance in the underlying book. As I said a few minutes ago, based on the Oaktree joint venture and where we see alternative uses for capital, our expectation is that some of that capital will probably naturally reallocate to support our mortgage banking businesses holistically. But in general, we are always focused on sponsored business plans, etc., and I think we're going to run the business responsive to where the market needs liquidity and, frankly, where we see the strongest fundamentals.

Brad Capuzzi, Analyst

Awesome. Thank you.

Operator, Operator

Thank you. As there are no further questions, the conference of Redwood Trust, Inc. has now concluded. Thank you for your participation. You may now disconnect your lines.