Redwood Trust said Tuesday it will stop originating commercial mortgages for securitization and focus solely on investing in bonds backed by commercial mortgages originated by others.

It’s likely to be in good company.

Competition from other lenders, including banks and insurance companies, is driving down interest rates on commercial mortgages, making lending less profitable, and forcing lenders to lower their underwriting standards.

At the same time, the cost of securitizing these loans is set to rise later this year when rules requiring sponsor to keep “skin in the game” take effect. Beginning in December, CMBS sponsors will face a choice of either holding an economic interest in their deals or paying investors in the lowest rated securities issued by these deals to hold them for longer periods of time.

"We have concluded that the challenging market conditions our CMBS conduit has faced over the past few quarters are worsening and are not likely to improve for the foreseeable future," Marty Hughes, chief executive officer of Redwood, said in a press release.

"The escalation in the risks to both source and distribute loans through CMBS, as well as the diminished economic opportunity for this activity, no longer make our commercial conduit activities an accretive use of capital," he said.

Since initiating its commercial loan business in 2010, Redwood has focused on both investing in commercial mezzanine loans and originating commercial senior loans for sale into CMBS transactions.  During that time, the company originated more than $2.5 billion of commercial loans, generated more than $50 million of revenues from the sale of loans into CMBS transactions, and created a portfolio of commercial mezzanine loans that totaled approximately $300 million at December 31, 2015. This portfolio generated approximately $30 million of net interest income during the full year 2015, based on preliminary financial results. 

Going forward, Redwood will no longer originate either senior or mezzanine commercial loans.

"We have a strong track record as a long-term credit investor, focused on building net interest income for our investment portfolio, and we can continue to opportunistically invest in mezzanine and subordinate CMBS tranches that meet our risk/return profile," the company’s president, Brett Nicholas, said in the same press release. "The market dislocations that negatively impacted our CMBS conduit may create opportunities to deploy capital into attractive investments in CMBS or other commercial transactions."

As a result of the move, Redwood will eliminate 25 positions in commercial loan origination, including executive vice president Fred Matera, representing approximately 15% of the company's fixed compensation expense at December 31, 2015.  As a result, it expects to incur non-recurring charges totaling approximately $5 million to $6 million, primarily in the first quarter of 2016. 

Redwood plans to retain a team of commercial professionals to support the company's portfolio of commercial mezzanine loans as well as focus on additional commercial portfolio investments.

"Our commercial loan origination activities resulted in a pre-tax loss of approximately $3 million in 2015, or a loss of approximately $2 million on an after-tax basis, based on our preliminary full-year 2015 results.  This included operating expenses of approximately $8 million," said chief financial officer Christopher Abate.  "As a result of discontinuing these loan origination activities, we expect to eliminate this earnings drag going forward and free up approximately $100 million of capital for future investments."

The company will provide more information on a conference call following the release of fourth quarter 2015 results at the end of February.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.