Competition among lenders for commercial mortgages has driven down interest rates, margins and underwriting standards, and now it's helped drive one lender out of the business.

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. The real estate investment trust, based in Mill City, Calif., is likely to find itself in good company.

The decision comes as the cost of securitizing these loans is set to rise later this year when rules requiring sponsors to keep "skin in the game" take effect. Beginning in December, sponsors of commercial mortgage-backed securities deals will face a choice: either hold an economic interest in their deals, or pay investors in the lowest-rated securities from 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 starting its commercial mortgage business in 2010, Redwood has focused on 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 as of Dec. 31. This portfolio generated about $30 million of net interest income during the full year 2015, based on preliminary financial results.

From now on, Redwood will no longer originate 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 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 Dec. 31. As a result, it expects to incur one-time charges totaling $5 million to $6 million, primarily in the first quarter.

Redwood plans to retain a team of commercial lending 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 pretax 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 said it would provide more information on a conference call following the release of fourth quarter 2015 results at the end of February.

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