UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended: December 31, 2019
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _______________ to _______________.
Commission File Number 1-13759
REDWOOD TRUST, INC.
(Exact Name of Registrant as Specified in Its Charter)
Maryland
(State or Other Jurisdiction of
Incorporation or Organization)
One Belvedere Place, Suite 300
Mill Valley, California
(Address of Principal Executive Offices)
68-0329422
(I.R.S. Employer
Identification No.)
94941
(Zip Code)
(415) 389-7373
(Registrant’s Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class
Common stock, par value $0.01 per share
Trading symbol(s)
RWT
Name of each exchange on which registered
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes
No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes
No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule
405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes
No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company,
or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth
company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with
any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
No
At June 28, 2019, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $1,600,621,984 based
on the closing sale price as reported on the New York Stock Exchange.
The number of shares of the registrant’s Common Stock outstanding on February 26, 2020 was 114,353,805.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement to be filed with the Securities and Exchange Commission under Regulation 14A within 120
days after the end of registrant’s fiscal year covered by this Annual Report are incorporated by reference into Part III.
REDWOOD TRUST, INC.
2019 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures (Not Applicable)
PART I
PART II
Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity
Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures about Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Directors, Executive Officers and Corporate Governance
Executive Compensation
PART III
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accounting Fees and Services
Item 15.
Item 16.
Exhibits, Financial Statement Schedules
Form 10-K Summary
Consolidated Financial Statements
PART IV
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F- 1
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ITEM 1. BUSINESS
Introduction
PART I
Redwood Trust, Inc., together with its subsidiaries, is a specialty finance company focused on making credit-sensitive investments
in single-family residential and multifamily mortgages and related assets and engaging in mortgage banking activities. Our goal is to
provide attractive returns to shareholders through a stable and growing stream of earnings and dividends, as well as through capital
appreciation. We operate our business in four segments: Residential Lending, Business Purpose Lending, Multifamily Investments, and
Third-Party Residential Investments.
Our primary sources of income are net interest income from our investments and non-interest income from our mortgage banking
activities. Net interest income consists of the interest income we earn on investments less the interest expense we incur on borrowed
funds and other liabilities. Income from mortgage banking activities is generated through the origination and acquisition of loans, and
their subsequent sale, securitization, or transfer to our investment portfolios.
Redwood Trust, Inc. has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as
amended (the “Internal Revenue Code”), beginning with its taxable year ended December 31, 1994. We generally refer, collectively, to
Redwood Trust, Inc. and those of its subsidiaries that are not subject to subsidiary-level corporate income tax as “the REIT” or “our
REIT.” We generally refer to subsidiaries of Redwood Trust, Inc. that are subject to subsidiary-level corporate income tax as “our taxable
REIT subsidiaries” or “TRS.” Our mortgage banking activities and investments in mortgage servicing rights ("MSRs") are generally
carried out through our taxable REIT subsidiaries, while our portfolio of mortgage- and other real estate-related investments is primarily
held at our REIT. We generally intend to retain profits generated and taxed at our taxable REIT subsidiaries, and to distribute as dividends
at least 90% of the taxable income we generate at our REIT.
Redwood Trust, Inc. was incorporated in the State of Maryland on April 11, 1994, and commenced operations on August 19, 1994.
On March 1, 2019, Redwood completed the acquisition of 5 Arches, LLC ("5 Arches"), at which time 5 Arches became a wholly-owned
subsidiary of Redwood. On October 15, 2019, Redwood acquired CoreVest American Finance Lender, LLC and certain affiliated entities
("CoreVest"), at which time CoreVest became wholly owned by Redwood. Our executive offices are located at One Belvedere Place,
Suite 300, Mill Valley, California 94941. References herein to “Redwood,” the “company,” “we,” “us,” and “our” include Redwood Trust,
Inc. and its consolidated subsidiaries, unless the context otherwise requires.
Financial information concerning our business, both on a consolidated basis and with respect to each of our segments, is set forth in
Financial Statements and Supplementary Data as well as in Management’s Discussion and Analysis of Financial Condition and Results
of Operations which are included in Part II, Items 8 and 7, respectively, of this Annual Report on Form 10-K.
Our Business Segments
Beginning in the fourth quarter of 2019, we reorganized our segments to align with changes in how we view our segments for making
operating decisions and assessing performance. As a result of acquisitions in the business purpose lending space and the continued growth
of multifamily investments in 2019, we created four new operating segments: Residential Lending, Business Purpose Lending, Multifamily
Investments, and Third-Party Residential Investments. We conformed the presentation of prior periods in accordance with these new
segments. Following is a full description of our current segments.
Residential Lending – consists of a mortgage loan conduit that acquires residential loans from third-party originators for subsequent
sale, securitization, or transfer into our investment portfolio, as well as the investments we retain from these activities. We typically
acquire prime, jumbo mortgages and the related mortgage servicing rights on a flow basis from our network of loan sellers and distribute
those loans through our Sequoia private-label securitization program or to institutions that acquire pools of whole loans. Our investments
in this segment primarily consist of residential mortgage-backed securities ("RMBS") retained from our Sequoia securitizations (some
of which we consolidate for GAAP purposes), jumbo whole loans we retained and finance through our Federal Home Loan Bank of
Chicago ("FHLBC") member subsidiary, as well as MSRs retained from jumbo whole loans we sold or securitized. This segment also
includes various derivative financial instruments that we utilize to manage certain risks associated with our inventory of residential loans
held-for-sale and long-term investments we hold within this segment. This segment’s main source of revenue is net interest income from
its long-term investments and its inventory of loans held-for-sale, as well as income from mortgage banking activities, which includes
valuation increases (or gains) on loans we acquire and subsequently sell, securitize, or transfer into our investment portfolio, and the
hedges used to manage risks associated with these activities. Additionally, this segment may realize gains and losses upon the sale of
securities. Funding expenses, direct operating expenses, and tax expenses associated with these activities are also included in this segment.
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Business Purpose Lending – consists of a platform that originates and acquires business purpose residential loans for subsequent
securitization or transfer into our investment portfolio, as well as the investments we retain from these activities. We typically originate
single-family rental and residential bridge loans and distribute certain single-family rental loans through our CoreVest American Finance
Lender ("CAFL") private-label securitization program and retain others for investment along with our residential bridge loans. Single-
family rental loans are business purpose residential mortgage loans to investors in single-family (1-4 unit) rental properties. Residential
bridge loans are business purpose residential mortgage loans to investors rehabilitating and subsequently reselling or renting residential
properties. Our investments in this segment primarily consist of securities retained from our CAFL securitizations (which we consolidate
for GAAP purposes), residential bridge loans, and single-family rental loans we finance through our FHLBC member subsidiary. This
segment also includes various derivative financial instruments that we utilize to manage certain risks associated with our inventory of
single-family rental loans held-for-sale and our investments. This segment’s main source of revenue is net interest income from its
investments and loans held-for-sale, as well as income from mortgage banking activities, which includes valuation increases (or gains)
on loans we originate or acquire and subsequently sell, securitize or transfer into our investment portfolio, and the hedges used to manage
risks associated with these activities. Additionally, this segment may realize gains and losses upon the sale of securities. Funding expenses,
direct operating expenses, and tax expenses associated with these activities are also included in this segment.
Multifamily Investments – consists of investments in securities collateralized by multifamily mortgage loans, as well as other
investments in multifamily mortgages and related assets. The securities in this segment are primarily comprised of investments in Freddie
Mac K-Series securitizations. This segment’s main sources of revenue are interest income from securities and loans held-for-investment.
Additionally, this segment may realize gains and losses upon the sale of securities or loans. Funding expenses, hedging expenses, direct
operating expenses, and tax provisions associated with these activities are also included in this segment.
Third-Party Residential Investments – consists of investments in RMBS issued by third parties, investments in Freddie Mac SLST
securitizations (which we consolidate for GAAP purposes), our servicer advance investments, and other residential credit investments
not generated through our Residential Lending segment. This segment’s main sources of revenue are interest income from securities and
loans held-for-investment. Additionally, this segment may realize gains and losses upon the sale of securities. Funding expenses, hedging
expenses, direct operating expenses, and tax provisions associated with these activities are also included in this segment.
Consolidated Securitization Entities
We sponsor our Sequoia securitization program, which we use for the securitization of residential mortgage loans. We are required
under Generally Accepted Accounting Principles in the United States (“GAAP”) to consolidate the assets and liabilities of certain
securitization entities we have sponsored for financial reporting purposes. We refer to certain of these securitization entities issued prior
to 2012 as “consolidated Legacy Sequoia entities,” and the securitization entities formed in connection with the securitization of Redwood
Choice expanded-prime loans as the "consolidated Sequoia Choice entities." We also consolidate certain third-party Freddie Mac K-
Series and SLST securitization entities that we determined were VIEs and for which we determined we were the primary beneficiary.
Additionally, beginning in the fourth quarter of 2019, we consolidated certain CAFL securitization entities that we determined were VIEs
and for which we determined we were the primary beneficiary. Where applicable, in analyzing our results of operations, we distinguish
results from current operations "at Redwood" and from consolidated entities. Each of these consolidated entities is independent of Redwood
and of each other, and the assets and liabilities of these entities are not owned by us or legal obligations of ours, respectively, although
we are exposed to certain financial risks associated with any role we carry out for these entities (e.g., as sponsor or depositor) and, to the
extent we hold securities issued by, or other investments in, these entities, we are exposed to the performance of these entities and the
assets they hold.
Information Available on Our Website
Our website can be found at www.redwoodtrust.com. We make available, free of charge through the investor information section of
our website, access to our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments
to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the U.S. Securities Exchange Act of 1934, as well as proxy
statements, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and
Exchange Commission (“SEC”). We also make available, free of charge, access to the charters for our Audit Committee, Compensation
Committee, and Governance and Nominating Committee, our Corporate Governance Standards, and our Code of Ethics governing our
directors, officers, and employees. Within the time period required by the SEC and the New York Stock Exchange, we will post on our
website any amendment to the Code of Ethics and any waiver applicable to any executive officer, director, or senior officer (as defined
in the Code). In addition, our website includes information concerning purchases and sales of our equity securities by our executive
officers and directors, as well as disclosure relating to certain non-GAAP financial measures (as defined in the SEC’s Regulation G) that
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we may make public orally, telephonically, by webcast, by broadcast, or by similar means from time to time. The information on our
website is not part of this Annual Report on Form 10-K.
Our Investor Relations Department can be contacted at One Belvedere Place, Suite 300, Mill Valley, CA 94941, Attn: Investor
Relations, telephone (866) 269-4976 or email investorrelations@redwoodtrust.com.
Cautionary Statement
This Annual Report on Form 10-K and the documents incorporated by reference herein contain forward-looking statements within
the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve
numerous risks and uncertainties. Our actual results may differ from our beliefs, expectations, estimates, and projections and, consequently,
you should not rely on these forward-looking statements as predictions of future events. Forward-looking statements are not historical
in nature and can be identified by words such as “anticipate,” “estimate,” “will,” “should,” “expect,” “believe,” “intend,” “seek,” “plan”
and similar expressions or their negative forms, or by references to strategy, plans, or intentions. These forward-looking statements are
subject to risks and uncertainties, including, among other things, those described in this Annual Report on Form 10-K under the caption
“Risk Factors.” Other risks, uncertainties, and factors that could cause actual results to differ materially from those projected are described
below and may be described from time to time in reports we file with the SEC, including reports on Forms 10-Q and 8-K. We undertake
no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
Statements regarding the following subjects, among others, are forward-looking by their nature: (i) statements we make regarding
Redwood’s business strategy and strategic focus, including statements relating to our overall market position, strategy and long-term
prospects (including trends driving the flow of capital in the housing finance market, our strategic initiatives designed to capitalize on
those trends, our ability to attract capital to finance those initiatives, our approach to raising capital, our ability to pay higher sustainable
dividends in the future, and the prospects for federal housing finance reform); (ii) statements related to our financial outlook and
expectations for 2020 and future years; (iii) statements related to our residential and business purpose lending platforms, including our
positioning in the market and the expansion of our bridge lending business to include more robust construction/redevelopment
opportunities; (iv) statements relating to the potential for regulatory reform and positioning Redwood to capitalize on resulting
opportunities, including through the application of technological innovations; (v) statements we make relating to our recourse leverage
ratio, including our statement that, as we continue to deploy our capital available for investment, we expect this leverage ratio to increase
toward the middle of our 3.0x to 4.0x target range; (vi) statements relating to acquiring residential mortgage loans in the future that we
have identified for purchase or plan to purchase, including the amount of such loans that we identified for purchase during the fourth
quarter of 2019 and at December 31, 2019, and expected fallout and the corresponding volume of residential mortgage loans expected
to be available for purchase; (vii) statements regarding business purpose loan originations, loans funded, and associated funding
commitments; (viii) statements relating to our estimate of our available capital (including that we estimate our available capital at December
31, 2019 was approximately $260 million), and expectations relating to our belief that our available capital is sufficient to fund our
operations and currently contemplated investment activities; (ix) statements we make regarding future dividends, including with respect
to our regular quarterly dividends in 2020; and (x) statements regarding our expectations and estimates relating to the characterization
for income tax purposes of our dividend distributions, our expectations and estimates relating to tax accounting, tax liabilities and tax
savings, and GAAP tax provisions, and our estimates of REIT taxable income and TRS taxable income.
Important factors, among others, that may affect our actual results include:
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the pace at which we redeploy our available capital into new investments;
interest rate volatility, changes in credit spreads, and changes in liquidity in the market for real estate securities and loans;
"Credit spreads" is used generally to refer to the market value yield on a loan or security less the relevant risk-free
benchmark interest rate;
changes in the demand from investors for residential mortgages and investments, and our ability to distribute residential mortgages
through our whole-loan distribution channel;
our ability to finance our investments in securities and our acquisition of residential mortgages with short-term debt;
changes in the values of assets we own;
general economic trends, the performance of the housing, real estate, mortgage, credit, and broader financial markets, and their
effects on the prices of earning assets and the credit status of borrowers;
the impact of changes to U.S. federal income tax laws on the U.S. housing market, mortgage finance markets, and our business;
changes to fiscal, tax, and other federal policies by Congress or President Trump’s administration;
developments related to the fixed income and mortgage finance markets and the Federal Reserve’s statements regarding its
future open market activity and monetary policy;
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federal and state legislative and regulatory developments, and the actions of governmental authorities, including the new U.S.
presidential administration, and in particular those affecting the mortgage industry or our business (including, but not limited
to, the Federal Housing Finance Agency’s rules relating to FHLB membership requirements and the implications for our captive
insurance subsidiary’s membership in the FHLB);
strategic business and capital deployment decisions we make;
our exposure to credit risk and the timing of credit losses within our portfolio;
the concentration of the credit risks we are exposed to, including due to the structure of assets we hold and the geographical
concentration of real estate underlying assets we own;
our exposure to adjustable-rate mortgage loans;
the efficacy and expense of our efforts to manage or hedge credit risk, interest rate risk, and other financial and operational risks;
changes in credit ratings on assets we own and changes in the rating agencies’ credit rating methodologies;
changes in interest rates;
changes in mortgage prepayment rates;
changes in liquidity in the market for real estate securities and loans;
our ability to finance the acquisition of real estate-related assets with short-term debt;
the ability of counterparties to satisfy their obligations to us;
our involvement in securitization transactions, the profitability of those transactions, and the risks we are exposed to in engaging
in securitization transactions;
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exposure to claims and litigation, including litigation arising from our involvement in securitization transactions;
ongoing litigation against various trustees of RMBS transactions;
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• whether we have sufficient liquid assets to meet short-term needs;
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our ability to successfully compete and retain or attract key personnel;
our ability to adapt our business model and strategies to changing circumstances;
changes in our investment, financing, and hedging strategies and new risks we may be exposed to if we expand our business
activities;
our exposure to a disruption or breach of the security of our technology infrastructure and systems;
exposure to environmental liabilities;
our failure to comply with applicable laws and regulations;
our failure to maintain appropriate internal controls over financial reporting and disclosure controls and procedures;
the impact on our reputation that could result from our actions or omissions or from those of others; changes in accounting
principles and tax rules;
our ability to maintain our status as a REIT for tax purposes;
limitations imposed on our business due to our REIT status and our status as exempt from registration under the Investment
Company Act of 1940;
decisions about raising, managing, and distributing capital; and
other factors not presently identified.
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This Annual Report on Form 10-K may contain statistics and other data that in some cases have been obtained from or compiled
from information made available by servicers and other third-party service providers.
Certifications
Our Chief Executive Officer and Chief Financial Officer have executed certifications dated March 2, 2020, as required by Sections
302 and 906 of the Sarbanes-Oxley Act of 2002, and we have included those certifications as exhibits to this Annual Report on Form 10-
K. In addition, our Chief Executive Officer certified to the New York Stock Exchange (NYSE) on June 4, 2019 that he was unaware of
any violations by Redwood Trust, Inc. of the NYSE’s corporate governance listing standards in effect as of that date.
Employees
As of December 31, 2019, Redwood employed 372 people.
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Item 1A. Risk Factors
Risks Related to Recent or Potential Economic, Strategic, and Legislative/Regulatory Developments Affecting our Industry
General economic developments and trends and the performance of the housing, real estate, mortgage finance, and broader financial
markets may adversely affect our business and the value of, and returns on, real estate-related and other assets we own or may acquire
and could also negatively impact our business and financial results.
Our level of business activity and the profitability of our business, as well as the values of, and the cash flows from, the assets we
own, are affected by developments in the U.S. economy and the broader global economy. As a result, negative economic developments
are likely to negatively impact our business and financial results. There are a number of factors that could contribute to negative economic
developments, including, but not limited to, U.S. fiscal and monetary policy changes, including Federal Reserve policy shifts and changes
in benchmark interest rates, changing U.S. consumer spending patterns, negative developments in the housing, single-family rental (SFR),
multifamily, and real estate markets, rising unemployment, rising government debt levels, and changing expectations for inflation and
deflation. For example, changes and uncertainty resulting from, and the impact of, various international trade negotiations and the
appropriation process for funding the operations of the U.S. federal government could negatively impact financial markets, as well as
domestic and global economic growth. Also, the U.K. exit from the European Union is another factor that could adversely impact financial
markets, as well as domestic and global economic growth. Personal income and unemployment levels affect borrowers’ ability to repay
residential mortgage loans underlying our investments in residential real estate-related assets (and renters’ ability to meet rental obligations
underlying our investments in multifamily and SFR securities and loans secured by non-owner occupied rental properties), and there is
risk that economic growth and activity could be weaker than anticipated or negative.
Government interventions into the financial markets and fiscal stimulus spending that occurred in the wake of the 2007-2008 financial
crisis have contributed to significantly increased U.S. budget deficits and overall debt levels, and the federal tax reform legislation signed
into law in December 2017 is forecast to further increase budget deficits over the next decade. These increases can put upward pressure
on interest rates and could be among the factors that could lead to higher interest rates over the long-term future. Higher long-term interest
rates could adversely affect our overall business, income, and our ability to pay dividends, as discussed further below under “Interest rate
fluctuations can have various negative effects on us and could lead to reduced earnings and increased volatility in our earnings.”
Furthermore, our business and financial results may be harmed by our inability to accurately anticipate developments associated with
changes in, or the outlook for, interest rates. In addition, near-term and long-term U.S. economic conditions could be impacted by changes
in fiscal and tax policy.
Real estate values, and the ability to generate returns by owning or taking credit risk on loans secured by real estate, are important
to our business. Following the financial crisis of 2007-2008, government intervention has been important in supporting real estate markets,
the overall U.S. economy, and capital markets. Mortgage markets have also received substantial U.S. government support. In particular,
the government’s support of mortgage markets through its support of Fannie Mae and Freddie Mac expanded in late 2008, as the U.S.
Treasury Department chose to backstop these government-sponsored enterprises. The governmental support for these entities has
contributed to Fannie Mae’s and Freddie Mac’s continued dominance of residential mortgage finance and securitization activity, inhibiting
the return of private sector mortgage securitization. This support may continue for some time and could have potentially negative
consequences to us, since we have traditionally taken an active role in assuming credit risk in the private sector mortgage market, including
through investments in Sequoia securitizations we sponsor. Both Congress and President Trump's administration have proposed various
plans for reform of Fannie Mae and Freddie Mac (and the broader role of the government in the U.S. mortgage markets); however, it's
unclear which reforms will ultimately be implemented, if any, what the timeframe for any such reform would be, and what the impact
on our business would be.
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Changes to the U.S. federal income tax laws could have an adverse impact on the U.S. housing market, mortgage finance markets,
and our business.
In December 2017, President Trump signed into law the Tax Cuts and Jobs Act (the “Tax Act”), which contained significant changes
to the Internal Revenue Code for taxable years beginning in 2018. Among other things, the Tax Act reduced for individuals the annual
residential mortgage-interest deduction for purchase money mortgage debt incurred after December 15, 2017, in taxable years beginning
after December 31, 2017, and beginning before January 1, 2026, from $1,000,000 (or $500,000 in the case of married taxpayers filing
separately) to $750,000 (or $375,000 in the case of married taxpayers filing separately), as well as eliminated for individuals the deduction
for interest with respect to home equity indebtedness, with certain exceptions for indebtedness from refinancing existing indebtedness.
The Tax Act also limits the state and local tax deduction for individuals to a combined $10,000 for income, sales, and property taxes (for
both single and married tax filers) in taxable years beginning after December 31, 2017, and beginning before January 1, 2026. The
reduction or limitation of these tax deductions is a factor that, all other things being equal, would generally adversely affect home prices
at the higher end of the housing market, particularly in states with high state and local taxes and property values. In addition, such changes
increase taxes payable by certain borrowers, thereby reducing their available cash and adversely impacting their ability to make payment
on the mortgage loans, which in turn, could cause a rise in delinquencies. The impact of these changes has yet to be fully determined,
but the limitations on these deductions could have an adverse impact on the U.S. residential housing market, the market value of residential
mortgage loans and residential mortgage-backed securities, and the volume of future originations of residential mortgage loans, particularly
jumbo mortgage loans, all of which could negatively impact our business or financial results.
Congress and President Trump’s administration have made and may continue to make substantial changes to fiscal, tax, and other
federal policies that may adversely affect our business.
President Trump has called for and, in some cases, already signed into law substantial changes to U.S. fiscal and tax policies, including
corporate and individual tax reform. In addition, President Trump has also called for, and, in some cases, already made, significant changes
to U.S. trade, housing finance, healthcare, immigration, foreign, and government regulatory policy. Some of the called-for changes would
require Congressional approval, while others have already been, and may in the future be, carried out unilaterally by the executive branch
of the U.S. government. To the extent Congress or President Trump implement changes to U.S. policy, those changes may impact, among
other things, the U.S. economy, housing and housing finance markets, international trade, unemployment, immigration, the regulatory
environment in the U.S. including banking regulations and the Dodd-Frank Act, international relations, inflation, healthcare, and other
areas. Although we cannot predict the impact, if any, of these changes to our business, they could adversely affect our business. Until we
know what policy changes are made and how those changes impact our business and the business of our competitors over the long-term,
we will not know if, overall, we will benefit from them or be negatively affected by them.
Changing benchmark interest rates, and the Federal Reserve’s actions and statements regarding monetary policy, can affect the fixed
income and mortgage finance markets in ways that could adversely affect our future business and financial results and the value of,
and returns on, real estate-related investments and other assets we own or may acquire.
Statements by the Federal Reserve regarding monetary policy and the actions it takes to set or adjust monetary policy may affect the
expectations and outlooks of market participants in ways that disrupt our business and adversely affect our financial results and the value
of, and returns on, our portfolio of real-estate related investments and the pipeline of mortgage loans we own or may originate or acquire.
For example, since December 2015, the Federal Reserve raised the target federal funds rate nine times, bringing it from near zero to a
high of 2.25% to 2.50%, before it began easing rates in 2019 to the current target level between 1.50% and 1.75%. The federal funds rate
could be increased again over the next several years. Increasing rates generally reduce mortgage loan origination volumes, particularly
the volume of residential mortgage refinancings. As another example, from 2013 through 2019, statements made by the Chair and other
members of the Board of Governors of the Federal Reserve System and by other Federal Reserve Bank officials regarding the U.S.
economy, future economic growth, the Federal Reserve’s future open market activity and monetary policy had a significant impact on,
among other things, benchmark interest rates, the value of residential mortgage loans, and, more generally, the fixed income markets.
These statements and the actions of the Federal Reserve, and other factors also significantly impacted many market participants’
expectations and outlooks regarding future levels of benchmark interest rates and the expected yields these market participants would
require to invest in fixed income instruments, including most residential and SFR mortgages and residential, SFR, and multifamily
mortgage-backed securities.
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To the extent benchmark interest rates rise, one of the immediate potential impacts on our business would be a reduction in the overall
value of the pool of mortgage loans that we own and the overall value of the pipeline of mortgage loans that we have identified for
origination or purchase. Rising benchmark interest rates also generally have a negative impact on the overall cost of short- and long-term
borrowings we use to finance our acquisitions and holdings of mortgage loans, including as a result of the requirement to post additional
margin (or collateral) to lenders to offset any associated decline in value of the mortgage loans we finance with short- and long-term
borrowings. The short- and long-term borrowings we use to finance our acquisitions and holdings of mortgage loans are generally
uncommitted and have a limited term, which could result in these types of borrowings not being available in the future to fund our
acquisitions and holdings and could result in our being required to sell holdings of mortgage loans and incur losses. Similar impacts
would also be expected with respect to the short-term borrowings we use to finance our acquisitions and holdings of residential, SFR,
and multifamily mortgage-backed securities. In addition, any inability to fund originations or acquisitions of mortgage loans could damage
our reputation as a reliable counterparty in the mortgage finance markets.
To the extent benchmark interest rates rise, it would also likely impact the volume of residential mortgage loans available for purchase
in the marketplace and our ability to compete to acquire residential mortgage loans as part of our residential mortgage banking activities.
These impacts could result from, among other things, a lower overall volume of mortgage refinance activity by mortgage borrowers and
an increased level of competition from large commercial banks that may operate with a lower cost of capital than we do, including as a
result of Federal Reserve monetary policies that impact banks more favorably than us and other non-bank institutions. These and other
impacts of developments of the type described above may have a negative impact on our business and results of operations and we cannot
accurately predict the full extent of these impacts or for how long they may persist.
Federal and state legislative and regulatory developments and the actions of governmental authorities and entities may adversely
affect our business and the value of, and the returns on, mortgages, mortgage-related securities, and other assets we own or may
acquire in the future.
As noted above, our business is affected by conditions in the housing, business-purpose, multifamily, and real estate markets and
the broader financial markets, as well as by the financial condition and resources of other participants in these markets. These markets
and many of the participants in these markets are subject to, or regulated under, various federal and state laws and regulations. In some
cases, the government or government-sponsored entities, such as Fannie Mae and Freddie Mac, directly participate in these markets. In
particular, because issues relating to residential real estate and housing finance can be areas of political focus, federal, state and local
governments may be more likely to take actions that affect residential real estate, the markets for financing residential real estate, and
the participants in residential real estate-related industries than they would with respect to other industries. As a result of the government’s
statutory and regulatory oversight of the markets we participate in and the government’s direct and indirect participation in these markets,
federal and state governmental actions, policies, and directives can have an adverse effect on these markets and on our business and the
value of, and the returns on, mortgages, mortgage-related securities, and other assets we own or may acquire in the future, which effects
may be material.
Furthermore, the financial crisis of 2007-2008 and subsequent financial turmoil prompted the federal government to put into place
new statutory and regulatory frameworks and policies for reforming the U.S. financial system. These financial reforms are aimed at,
among other things, promoting robust supervision and regulation of financial firms, establishing comprehensive supervision of financial
markets, protecting consumers and investors from financial abuse, providing the U.S. government with additional tools to manage financial
crises, and raising international regulatory standards and improving international cooperation, but their scope could be expanded beyond
what has been currently enacted, implemented, and proposed. Certain financial reforms focused specifically on the issuance of asset-
backed securities through securitization transactions include significantly enhanced disclosure requirements, risk retention requirements,
and rules restricting a broad range of conflicts of interests in regard to these transactions. Implementation of financial reforms, whether
through law, regulations, or policy, including changes to the manner in which financial institutions, financial products, and financial
markets operate and are regulated and any related changes in the accounting standards that govern them, could adversely affect our
business and financial results by subjecting us to regulatory oversight, making it more expensive to conduct our business, reducing or
eliminating any competitive advantage we may have, or limiting our ability to expand, or could have other adverse effects on us.
Alternatively, under President Trump’s administration the scope of financial reforms and the regulatory framework governing the
financial system has been, and could continue to be, reduced or refocused. Trump administration policies, federal legislation, or executive
or regulatory actions aimed at weakening or dismantling the Dodd-Frank Act or its regulatory apparatus, including by reducing capital
requirements on banking institutions or by weakening or redirecting the Consumer Financial Protection Bureau ("CFPB"), its leadership,
or its enforcement capabilities or priorities, could result in increased competition from commercial banks and other large financial
institutions that may have advantages due to their size and cost of capital.
7
During and since 2008, the federal government made available programs designed to provide homeowners with assistance in avoiding
residential mortgage loan foreclosures, including through loan modification and refinancing programs. In addition, certain mortgage
lenders and servicers voluntarily, or as part of settlements with law enforcement authorities, established loan modification programs
relating to the mortgages they hold or service and adopted new servicing standards intended to protect homeowners. Changes to servicing
standards, whether resulting from a settlement or a change in regulation, are likely to have the effect of lengthening the time it takes for
a servicer to foreclose on the property underlying a delinquent mortgage loan. Loan modification programs and changes to servicing
standards and regulations, as well as future law enforcement and legislative or regulatory actions, may adversely affect the value of, and
the returns on, the mortgage loans and mortgage securities we currently own or may acquire in the future.
Ultimately, we cannot assure you of the impact that governmental actions may have on our business or the financial markets and, in
fact, they may adversely affect us, possibly materially. We cannot predict whether or when such actions may occur or what unintended
or unanticipated impacts, if any, such actions could have on our business and financial results. Even after governmental actions have
been taken and we believe we understand the impacts of those actions, we may not be able to effectively respond to them so as to avoid
a negative impact on our business or financial results.
Federal regulations may limit, eliminate, or reduce the attractiveness of our subsidiary’s ability to use borrowings from the Federal
Home Loan Bank of Chicago to finance the mortgage loans and securities it holds and acquires, which could negatively impact our
business and operating results.
In June 2014, we announced that our wholly-owned captive insurance company subsidiary, RWT Financial, LLC, was approved as
a member of the Federal Home Loan Bank of Chicago (“FHLBC”). This membership has provided RWT Financial with access to attractive
long-term collateralized financing for mortgage loans and securities it holds and acquires. RWT Financial currently has approximately
$2.00 billion of long-term borrowings from the FHLBC to finance its portfolio of residential and business-purpose mortgage loans and
securities. In January 2016, federal regulations were adopted by the Federal Housing Finance Agency (“FHFA”), which is the regulator
of the Federal Home Loan Bank System, relating to captive insurance company membership in the Federal Home Loan Bank System.
Under these regulations, RWT Financial is eligible to remain as a member of the FHLBC until the expiration of a five-year transition
period and its existing $2.00 billion of FHLB debt is permitted to remain outstanding until stated maturity (even though the scheduled
maturity extends beyond the five-year transition period). As residential and business-purpose loans and securities pledged as collateral
for this debt pay down, RWT Financial is permitted to pledge additional loans, securities, or other eligible assets to collateralize this debt;
however, we do not expect RWT Financial to be able to increase its FHLB debt above the existing $2.00 billion outstanding.
The final regulations published by the FHFA could negatively impact us in a number of different ways, including, without limitation,
by: limiting our ability to acquire (or the attractiveness of acquiring) residential and business-purpose mortgage loans to hold as long-
term investments; limiting our ability to increase net interest income earned by RWT Financial; and, following the five-year transition
period and the scheduled maturity of our currently outstanding advances, requiring us to arrange for alternative (and, likely, less attractive)
financing sources for residential and business-purpose mortgage loans and securities currently financed with the FHLBC or, if such
alternative financing sources are not then available, requiring us to liquidate all or a portion of our portfolio of residential and business-
purpose loans and securities currently financed with the FHLBC, any of which could negatively impact our business and operating results.
In addition, our increased reliance on long-term financing from the FHLBC exposes us to risks of the type described below in Part II,
Item 7 of this Annual Report on Form 10-K under the heading, “Risks Relating to Debt Incurred under Short- and Long-Term Borrowing
Facilities.”
State and/or local rent control or rent stabilization regulations may reduce the value of single-family rental or multifamily properties
collateralizing mortgage loans we own, or those underlying the securities or other investments we own. As a result, the value of these
types of mortgage loans, securities, and other investments may be negatively impacted, which impacts could be material.
Numerous counties and municipalities, including those in which certain of the properties securing SFR and multifamily mortgage
loans we own, or those underlying the securities or other investments we own, are located, impose rent control or rent stabilization rules
on apartment buildings. These ordinances may limit rent increases to fixed percentages, to percentages of increases in the consumer price
index, to increases set or approved by a governmental agency, or to increases determined through mediation or binding arbitration. In
some jurisdictions, including, for example, New York City, many apartment buildings are subject to rent stabilization and some units are
subject to rent control. These regulations, among other things, may limit the ability of single-family rental and multifamily property
owners who have borrowed money (including in the form of mortgage debt) to finance their property or properties to raise rents above
specified percentages. Any limitations on a borrower’s ability to raise property rents may impair such borrower’s ability to repair or
renovate the mortgaged property or repay its mortgage loan.
8
Some states, counties and municipalities have imposed or may impose in the future stricter rent control regulations. For example,
on June 14, 2019, the New York State Senate passed the Housing Stability and Tenant Protection Act of 2019 (the “HSTP Act”), which,
among other things, limits the ability of landlords to increase rents in rent stabilized apartments in New York State at the time of lease
renewal and after a vacancy. The HSTP Act also limits potential rent increases for major capital improvements and for individual apartment
improvements in such rent stabilized apartments. In addition, the HSTP Act permits certain qualified localities in the State of New York
to implement the rent stabilization system. In addition, the California State Assembly passed Assembly Bill 1482 (“AB 1482”), which,
among other things, will prevent landlords in California from increasing the gross rental rate by more than 5% plus the percentage change
in the cost of living in any 12-month period and require landlords to have “just cause” when evicting a tenant that has continuously and
lawfully occupied a residential property for 12 months. Such “just cause” may include, among other things, the failure to pay rent, causing
damage or destruction to the property, and assigning or subletting the premises in violation of the tenant’s lease. In addition, the Oregon
State House passed Senate Bill 608 (“SB 608”), which, among other things, will limit rent increases to 7% each year, in addition to
inflation, and would, in most cases, require landlords to provide notice and give a reason for evicting tenants. The HSTP Act, AB 1482
or SB 608 may reduce the value of the SFR and multifamily properties collateralizing mortgage loans we own, or those underlying the
securities or other investments we own, that are located in the States of New York, California or Oregon, respectively, that are subject to
the applicable rent control regulations. The value of SFR and multifamily mortgage loans, securities, and other investments may be
negatively impacted by rent control or rent stabilization laws, regulations, or ordinances, which impacts may be material.
Decisions we make about our business strategy and investments, as well as decisions about raising capital or returning capital to
shareholders (through dividends or common stock repurchases), could fail to improve our business and results of operations.
Since December 2017, we have announced several new initiatives to expand our mortgage banking activities and grow our investment
portfolio, including by expanding our mortgage loan purchase activity to include, for example, loans secured by non-owner occupied
rental properties generally made up of one to four units and residential bridge loans (which we collectively refer to as “business-purpose
real estate loans”), and increasing the size and optimizing the target returns of our investment portfolio. As examples, during 2019, we
completed the acquisitions of two business-purpose real estate loan origination platforms, CoreVest and 5 Arches, through which we now
originate business-purpose loans. As another example, in 2019, we participated in a multifamily whole loan investment fund created to
acquire $1 billion of floating rate, light-renovation multifamily loans from Freddie Mac. Other new investment initiatives include investing
in residential securities collateralized by re-performing and non-performing mortgage loans, multifamily securities, shared equity
appreciation real estate option contracts, and investments in excess mortgage servicing rights ("MSRs") and servicer advance investments
related to pools of residential and small-balance multifamily mortgage loans. Additionally, during 2019, we sold certain lower-yielding
securities in our investment portfolio in order to redeploy capital into higher-yielding securities as part of our portfolio and capital
management strategies.
These new initiatives are intended to grow our mortgage banking business and investment portfolio, as well as to allocate capital to
profitable business and investment opportunities. These initiatives are premised on our outlook for economic and market conditions,
secular trends in consumer demand for housing, as well as competitive considerations. Over the long-term, the assumptions underlying
these trends and changes, or assumptions regarding the risk profile of these initiatives and investments, could turn out to be incorrect or
economic and market conditions could develop in a manner that is not consistent with our assumptions. Additionally, these initiatives
may have more risks, and different risks, than our traditional mortgage banking activities and investment portfolio. For example, our
portfolio and capital management strategies may include selling securities and reinvesting in securities with greater exposure to credit
risk due to their structural credit enhancement of senior securities, as well as more limited payment histories. As another example,
originating and investing in business-purpose mortgage loans exposes us to new and different risks than our traditional residential mortgage
banking activities, including higher rates of delinquency, default, foreclosure and litigation. As a result, these new initiatives could fail
to improve the long-term profitability of Redwood, could fail to result in capital being available for or deployed into more profitable
businesses and investments, could result in dilutive issuances of equity or debt securities convertible into equity to fund our business and
investment activities, or could otherwise damage our business, our reputation, our ability to access financing, and our ability to raise
capital, or could have other unforeseen consequences, any or all of which could result in a material adverse effect on our business and
results of operations in the future. Decisions we make in the future about our business strategy and investments, as well as decisions
about raising capital or returning capital to shareholders (through dividends or common stock repurchases), could also fail to improve
our business and results of operations.
9
In February 2016 and again in February 2018, our Board of Directors approved authorizations for the purchase of Redwood common
stock and also authorized the repurchase of other securities issued by Redwood, including convertible and exchangeable debt securities.
Subsequently, since 2016, we have repurchased approximately $50 million of our common stock at an average price per share of $13.87
and approximately $4 million of our outstanding debt securities. At December 31, 2019, approximately $100 million of this current
authorization remained available for the repurchase of shares of our common stock. If we repurchase shares of Redwood common stock
or other securities issued by Redwood, it is because at the time we believe the shares or securities are trading at attractive levels relative
to other uses of capital or investment opportunities then available to us; however, it is possible that other uses of this capital could have
been more accretive to our earnings or book value or that subsequent capital needs arise that were not contemplated at the time we made
these decisions. Our past and future decisions relating to the repurchases of Redwood common stock or other securities issued by Redwood
could fail to improve our results of operations or could negatively impact our ability to execute our business plans, meet financial
obligations, access financing, or raise additional capital, any or all of which could result in a material adverse effect on our business and
results of operations in the future.
In addition, in September 2019, one of our subsidiaries issued approximately $201 million of exchangeable senior notes (exchangeable
into common stock), and during 2019, we issued approximately 25.9 million shares of common stock for aggregate net proceeds of
approximately $405 million through underwritten public offerings, from time to time in at-the-market ("ATM") offerings, under our direct
stock purchase and dividend reinvestment plan, and as a portion of the purchase price for our acquisition of CoreVest. We may issue
additional shares of common stock (or debt securities convertible into common stock) in subsequent public offerings or private placements.
In addition, we may issue additional shares of common stock pursuant to our ATM offering program, upon conversion of our convertible
debt or upon exchange of our exchangeable debt, to participants in our direct stock purchase and dividend reinvestment plan, to our
directors, officers and employees under our employee stock purchase plan and our incentive plan, including upon the exercise of, or in
respect of, distributions on equity awards previously granted thereunder, and as a portion of the purchase price for our acquisition of 5
Arches. It may not be possible for existing stockholders to participate in future share issuances, which may dilute existing stockholders’
interests in us. To the extent we raise capital to fund our operations and investment activities, our approach to raising capital is based on
what we believe to be in the best interest of our shareholders. However, it is possible that our use of the proceeds of such capital raising
transactions may not yield a significant return or any return at all for our stockholders.
Our acquisitions of 5 Arches and CoreVest could fail to improve our business or result in diminished returns, could expose us to new
or increased risks, and could increase our cost of doing business.
During 2019, we completed the acquisitions of two business-purpose real estate loan origination platforms, 5 Arches and CoreVest,
through which we now originate business-purpose loans. Prior to the completion of these two acquisitions, we had not previously acquired
an operating company, and we had not been engaged in directly originating mortgage loans since 2016, when we ceased our commercial
origination and mortgage banking activities. If we experience challenges with the integration of the 5 Arches or CoreVest platforms that
we did not anticipate or cannot mitigate, the returns we expected with respect to these investments may not be generated. For example,
originating business-purpose mortgage loans could fail to improve our business or financial results if we do not have the opportunity to
originate quality investments or if our estimates or projections of overall rates of return on such investments are incorrect. If our assumptions
are wrong, or if market conditions change, we may, as a result, not have capital available for deployment into more profitable businesses
and investments.
Our business-purpose loan origination platforms are dependent upon conditions in the investor real estate market, and conditions
that negatively impact this market may reduce demand for our loans and adversely impact our business, results of operations and financial
condition. Our borrowers are primarily owners of residential rental and small multifamily properties, and residential properties for
rehabilitation and subsequent resale or rental. Accordingly, the success of our business is closely tied to the overall success of the investors
and small business owners in these markets. Various changes in real estate conditions may impact this market. Any negative trends in
such real estate conditions may reduce demand for our products and services and, as a result, adversely affect our results of operations.
Integrating the 5 Arches and CoreVest businesses and directly originating mortgage loans could also expose us to new or increased
risks, including increased regulation by federal and state authorities, challenges in effectively integrating operations, failure to maintain
effective internal controls, procedures and policies, and other unknown liabilities and unforeseen increased expenses or delays associated
with the acquisitions or the business of originating mortgage loans. Additionally, CoreVest engages in and sponsors securitization
transactions relating to SFR mortgage loans, and in connection with the acquisition of CoreVest, we acquired, and we expect to continue
to retain, mortgage-backed securities issued in CoreVest's securitization transactions. These securitization transactions and investments
expose us to potentially material risks, in the same manner as described below in the risk factor titled “Through certain of our wholly-
owned subsidiaries we have engaged in the past, and expect to continue to engage in, securitization transactions relating to real estate
mortgage loans. In addition, we have invested in and continue to invest in mortgage-backed securities and other ABS issued in securitization
transactions sponsored by other companies. These types of transactions and investments expose us to potentially material risks.”
10
Additionally, in connection with our acquisitions of CoreVest and 5 Arches, a portion of the purchase price of each acquisition was
allocated to goodwill and intangible assets. The amount of the purchase price which is allocated to goodwill and intangible assets is
determined by the excess of the purchase price over the net identifiable assets acquired. As of December 31, 2019, $89 million of goodwill
and $73 million of intangible assets were recorded on our consolidated balance sheet. Accounting standards require that we test goodwill
and intangible assets for impairment at least annually (or more frequently if impairment indicators arise). If we determine goodwill or
intangible assets are impaired, we will be required to write down the value of these assets, up to their entire balance. Any write-down
would have a negative effect on our consolidated financial statements.
Risks Related to our Investments and Investing Activity
The nature of the assets we hold and the investments we make expose us to credit risk that could negatively impact the value of those
assets and investments, our earnings, dividends, cash flows, and access to liquidity, or otherwise negatively affect our business.
Overview of credit risk
We assume credit risk primarily through the ownership of securities backed by residential, business-purpose, and multifamily real
estate loans and through direct investments in residential, business-purpose, and multifamily real estate loans. We may also assume similar
credit risks through other types of transactions with counterparties who are seeking to reduce their exposure to credit risk or who are
seeking financing for their own holdings of residential, business-purpose, and multifamily real estate loans or servicing rights relating
to residential, business-purpose, and multifamily real estate loans. Credit losses on residential real estate loans can occur for many reasons,
including: fraud; poor underwriting; poor servicing practices; weak economic conditions; increases in payments required to be made by
borrowers; declines in the value of real estate; declining rents on single- and multifamily residential rental properties; natural disasters,
the effects of climate change (including flooding, drought, wildfires, and severe weather) and other natural events; uninsured property
loss; over-leveraging of the borrower; costs of remediation of environmental conditions, such as indoor mold; changes in zoning or
building codes and the related costs of compliance; acts of war or terrorism; changes in legal protections for lenders and other changes
in law or regulation; and personal events affecting borrowers, such as reduction in income, job loss, divorce, or health problems. In
addition, the amount and timing of credit losses could be affected by loan modifications, delays in the liquidation process, documentation
errors, and other action by servicers. Weakness in the U.S. economy or the housing market could cause our credit losses to increase
beyond levels that we currently anticipate.
In addition, rising interest rates may increase the credit risks associated with certain residential real estate loans. For example, the
interest rate is adjustable for many of the loans held at securitization entities we have sponsored and for a portion of the loans underlying
residential securities we have acquired from securitizations sponsored by others. In addition, a portion of the loans we have pledged to
secure short-term warehouse borrowings and a portion of the business-purpose and multifamily real estate loans and loans underlying
multifamily securities we have acquired may have adjustable interest rates. Accordingly, when short-term interest rates rise, required
monthly payments from borrowers will rise under the terms of these adjustable-rate mortgages, and this may increase borrowers’
delinquencies and defaults.
Credit losses on business-purpose and multifamily real estate loans and real estate loans collateralizing business-purpose and
multifamily securities can occur for many of the reasons noted above for residential real estate loans. Moreover, these types of real estate
loans may not be fully amortizing and, therefore, the borrower’s ability to repay the principal when due may depend upon the ability of
the borrower to refinance or sell the property at maturity. Business-purpose and multifamily real estate loans and real estate loans
collateralizing business-purpose and multifamily securities are particularly sensitive to conditions in the rental housing market and to
demand for rental residential properties.
We may have heightened credit losses associated with certain securities and investments we own.
Within a securitization of residential, multifamily, or business-purpose real estate loans, various securities are created, each of which
has varying degrees of credit risk. We may own the securities in which there is more (or the most) concentrated credit risk associated
with the underlying real estate loans.
11
In general, losses on an asset securing a residential, multifamily, or business-purpose real estate loan included in a securitization will
be borne first by the owner of the property (i.e., the owner will first lose any equity invested in the property) and, thereafter, by the first-
loss security holder, and then by holders of more senior securities. In the event the losses incurred upon default on the loan exceed any
classes of securities junior to those in which we invest (if any), we may not be able to recover all of our investment in the securities we
hold. In addition, if the underlying properties have been overvalued by the originating appraiser or if the values subsequently decline
and, as a result, less collateral is available to satisfy interest and principal payments due on the related security, then the first-loss securities
may suffer a total loss of principal, followed by losses on the second-loss and then third-loss securities (or other residential, business-
purpose, and multifamily securities that we own). In addition, with respect to residential securities we own, we may be subject to risks
associated with the determination by a loan servicer to discontinue servicing advances (advances of mortgage interest payments not made
by a delinquent borrower) if they deem continued advances to be unrecoverable, which could reduce the value of these securities or
impair our ability to project and realize future cash flows from these securities.
For loans or other investments we own directly (not through a securitization structure), we will most likely be in a position to incur
credit losses - should they occur - only after losses are borne by the owner of the property (e.g., by a reduction in the owner’s equity stake
in the property). Similar to our exposure to credit losses on loans we own directly, we have committed to assume credit losses - but only
up to a specified amount - on certain conforming residential mortgage loans that we acquired and then sold to Fannie Mae and Freddie
Mac pursuant to risk-sharing arrangements we entered into with those entities, to the extent any such losses exceed the owner’s equity
investment in the property. We may take actions available to us in an attempt to protect our position and mitigate the amount of credit
losses, but these actions may not prove to be successful and could result in our increasing the amount of credit losses we ultimately incur
on a loan.
Additionally, loans to small, privately owned businesses such as the borrowers in our business-purpose loan origination platforms
involve a high degree of business and financial risk. Often, there is little or no publicly available information about these businesses.
Accordingly, we must rely on our own due diligence to obtain information in connection with our investment decisions. A borrower’s
ability to repay its loan may be adversely impacted by numerous factors, including a downturn in its industry or other negative local or
more general economic conditions. Deterioration in a borrower’s financial condition and prospects may be accompanied by deterioration
in the collateral for the loan. These factors may have an impact on loans involving such businesses, and can result in substantial losses,
which in turn could have a material and adverse effect on our business, results of operations and financial condition.
The nature of the assets underlying some of the securities and investments we hold could increase the credit risk of those securities.
For certain types of loans underlying securities we may own or acquire, the loan rate or borrower payment rate may increase over
time, increasing the potential for default. For example, securities may be backed by residential real estate loans that have negative
amortization features. The rate at which interest accrues on these loans may change more frequently or to a greater extent than payment
adjustments on an adjustable-rate loan, and adjustments of monthly payments may be subject to limitations or may be limited by the
borrower’s option to pay less than the full accrual rate. As a result, the amount of interest accruing on the remaining principal balance of
the loans at the applicable adjustable mortgage loan rate may exceed the amount of the monthly payment. To the extent we are exposed
to it, this is particularly a risk in a rising interest rate environment. Negative amortization occurs when the resulting excess (of interest
owed over interest paid) is added to the unpaid principal balance of the related adjustable mortgage loan. For certain loans that have a
negative amortization feature, the required monthly payment is increased after a specified number of months or after a maximum amount
of negative amortization has occurred in order to amortize fully the loan by the end of its original term. Other negative amortizing loans
limit the amount by which the monthly payment can be increased, which results in a larger final payment at maturity. As a result, negatively
amortizing loans have performance characteristics similar to those of balloon loans. Negative amortization may result in increases in
delinquencies, loan loss severity, and loan defaults, which may, in turn, result in payment delays and credit losses on our investments.
Other types of loans and investments to which we are exposed, such as hybrid loans and adjustable-rate loans, may also have greater
credit risk than more traditional amortizing fixed-rate mortgage loans.
12
Many of the real estate loans collateralizing multifamily securities and business-purpose and multifamily real estate loans we own
or may acquire are only partially amortizing or do not provide for any principal amortization prior to a balloon principal payment at
maturity. Real estate loans that only partially amortize or that have a balloon principal payment at maturity may have a higher risk of
default at maturity than fully amortizing loans. In addition, since most of the principal of these loans is repaid at maturity, the amount of
loss upon default is generally greater than on other loans that provide for more principal amortization.
We have concentrated credit risk in certain geographical regions and may be disproportionately affected by an economic or housing
downturn, natural disaster, terrorist event, climate change, or any other adverse event specific to those regions.
A decline in the economy or difficulties in certain real estate markets, such as a high level of foreclosures in a particular area, are
likely to cause a decline in the value of residential and multifamily properties. This, in turn, will increase the risk of delinquency, default,
and foreclosure on real estate underlying securities and loans we hold with properties in those regions, and it will increase the risk of loss
on other investments we own. This may then adversely affect our credit loss experience and other aspects of our business, including our
ability to securitize (or otherwise sell) real estate loans and securities.
The occurrence of a natural disaster (such as an earthquake, tornado, hurricane, flood, landslide, or wildfire), or the effects of climate
change (including flooding, drought, and severe weather), may cause decreases in the value of real estate (including sudden or abrupt
changes) and would likely reduce the value of the properties collateralizing real estate loans we own or those underlying the securities
or other investments we own. For example, in recent years, hurricanes have caused widespread flooding in Florida and Texas and wildfires
and mudslides in northern and southern California have destroyed or damaged thousands of homes. Since certain natural disasters may
not typically be covered by the standard hazard insurance policies maintained by borrowers, the borrowers may have to pay for repairs
due to the disasters. Borrowers may not repair their property or may stop paying their mortgage loans under those circumstances, especially
if the property is damaged. This would likely cause foreclosures to increase and lead to higher credit losses on our loans or investments
or on the pool of mortgage loans underlying securities we own.
A significant number of residential real estate loans that we own, or that underlie the securities we own, are secured by properties
in California and, thus, we have a higher concentration of credit risk within California than in other states. Additional states where we
have concentrations of residential loan credit risk are set forth in Note 6 to the Financial Statements within this Annual Report on Form
10-K. Balances on real estate loans collateralizing multifamily securities and business-purpose real estate loans we own and may originate
or acquire are larger than residential loans and in the past we have had, and may have in the future, a geographically concentrated portfolio
of such loans and securities. Real estate loans collateralizing multifamily securities and business-purpose real estate loans we currently
own are generally concentrated in California, Texas, Florida, New Jersey, Georgia, and Arizona.
The timing of credit losses can harm our economic returns.
The timing of credit losses can be a material factor in our economic returns from real estate loans, investments, and securities. If
unanticipated losses occur within the first few years after a loan is originated, an investment is made, or a securitization is completed,
those losses could have a greater negative impact on our investment returns than unanticipated losses on more seasoned loans, investments,
or securities. In addition, higher levels of delinquencies and cumulative credit losses within a securitized loan pool can delay our receipt
of principal and interest that is due to us under the terms of the securities backed by that pool. This would also lower our economic returns.
The timing of credit losses could be affected by the creditworthiness of the borrower, the borrower’s willingness and ability to continue
to make payments, and new legislation, legal actions, or programs that allow for the modification of loans or ability for borrowers to get
relief through bankruptcy or other avenues.
Our efforts to manage credit risks may fail.
We attempt to manage risks of credit losses by continually evaluating our investments for impairment indicators and establishing
reserves under GAAP for credit and other risks based upon our assessment of these risks. We cannot establish credit reserves for tax
accounting purposes. The amount of reserves that we establish may prove to be insufficient, which would negatively impact our financial
results and would result in decreased earnings. In addition, cash and other capital we hold to help us manage credit and other risks and
liquidity issues may prove to be insufficient. If these increased credit losses are greater than we anticipated and we need to increase our
credit reserves, our GAAP earnings might be reduced. Increased credit losses may also adversely affect our cash flows, ability to invest,
dividend distribution requirements and payments, asset fair values, access to short-term borrowings, and ability to securitize or finance
assets.
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Despite our efforts to manage credit risk, there are many aspects of credit risk that we cannot control. Our quality control and loss
mitigation policies and procedures may not be successful in limiting future delinquencies, defaults, and losses, or they may not be cost
effective. Our underwriting reviews may not be effective. The securitizations in which we have invested may not receive funds that we
believe are due from mortgage insurance companies and other counterparties. Loan servicing companies may not cooperate with our loss
mitigation efforts or those efforts may be ineffective. Service providers to securitizations, such as trustees, loan servicers, bond insurance
providers, and custodians, may not perform in a manner that promotes our interests. Delay of foreclosures could delay resolution and
increase ultimate loss severities, as a result.
The value of the homes or properties collateralizing or underlying real estate loans or investments may decline, and rents on single-
and multifamily rental properties may decline. The frequency of default and the loss severity on loans upon default may be greater than
we anticipate. Interest-only loans, negative amortization loans, adjustable-rate loans, larger balance loans, reduced documentation loans,
subprime loans, Alt-A quality loans, second lien loans, loans in certain locations, residential mortgage loans that are not “qualified
mortgages” under regulations promulgated by the CFPB, re-performing and non-performing loans, and loans or investments that are
partially collateralized by non-real estate assets may have increased risks and severity of loss. If property securing or underlying loans
becomes real estate owned as a result of foreclosure, we bear the risk of not being able to sell the property and recovering our investment
and of being exposed to the risks attendant to the ownership of real property.
Changes in consumer behavior, bankruptcy laws, tax laws, regulation of the mortgage industry, and other laws may exacerbate loan
or investment losses. Changes in rules that would cause loans owned by a securitization entity to be modified may not be beneficial to
our interests if the modifications reduce the interest we earn and increase the eventual severity of a loss. In some states and circumstances,
the securitizations in which we invest have recourse as owner of the loan against the borrower’s other assets and income in the event of
loan default. However, in most cases, the value of the underlying property will be the sole effective source of funds for any recoveries.
Other changes or actions by judges or legislators regarding mortgage loans and contracts, including the voiding of certain portions of
these agreements, may reduce our earnings, impair our ability to mitigate losses, or increase the probability and severity of losses. Any
expansion of our loss mitigation efforts could increase our operating costs and the expanded loss mitigation efforts may not reduce our
future credit losses.
Credit ratings assigned to debt securities by the credit rating agencies may not accurately reflect the risks associated with those securities.
Furthermore, downgrades in credit ratings could increase our credit risk, reduce our cash flows, or otherwise adversely affect our business
and operations.
We generally do not consider credit ratings in assessing our estimates of future cash flows and desirability of our investments (although
our assessment of the quality of an investment may prove to be inaccurate and we may incur credit losses in excess of our initial
expectations). The assignment of an “investment grade” rating to a security by a rating agency does not mean that there is not credit risk
associated with the security or that the risk of a credit loss with respect to such security is necessarily remote. Many of the securities we
own do have credit ratings and, to the extent we securitize loans and securities, we expect to retain credit rating agencies to provide ratings
on the securities created by these securitization entities (as we have in the past).
Rating agencies rate debt securities based upon their assessment of the safety of the receipt of principal and interest payments. Rating
agencies do not consider the risks of fluctuations in fair value or other factors that may influence the value of debt securities and, therefore,
any assigned credit rating may not fully reflect the true risks of an investment in securities. Also, rating agencies may fail to make timely
adjustments to credit ratings based on available data or changes in economic outlook or may otherwise fail to make changes in credit
ratings in response to subsequent events, so that our investments may be better or worse than the ratings indicate. Credit rating agencies
may change their methods of evaluating credit risk and determining ratings on securities backed by real estate loans and securities. These
changes may occur quickly and often. The market’s ability to understand and absorb these changes and the impact to the securitization
market in general are difficult to predict. Such changes may have an impact on the amount of investment-grade and non-investment-
grade securities that are created or placed on the market in the future. Downgrades to the ratings of securities could have an adverse effect
on the value of some of our investments and our cash flows from those investments.
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Changes in prepayment rates of mortgage loans could reduce our earnings, dividends, cash flows, and access to liquidity.
The economic returns we earn from most of the real estate securities and loans we own (directly or indirectly) are affected by the
rate of prepayment of the underlying mortgage loans. Prepayments are difficult to accurately predict and adverse changes in the rate of
prepayment could reduce our cash flows, earnings, and dividends. Adverse changes in cash flows would likely reduce the fair values of
many of our assets, which could reduce our ability to borrow against our assets and may cause market valuation adjustments for GAAP
purposes, which could reduce our reported earnings. While we estimate prepayment rates to determine the effective yield of our assets
and valuations, these estimates are not precise and prepayment rates do not necessarily change in a predictable manner as a function of
interest rate changes. Prepayment rates can change rapidly. As a result, changes can cause volatility in our financial results, affect our
ability to securitize assets, affect our ability to fund acquisitions, and have other negative impacts on our ability to generate earnings.
We may own securities backed by residential loans that are particularly sensitive to changes in prepayments rates. These securities
include interest-only securities (IOs) that we acquire from third parties and from our Sequoia entities. Faster prepayments than we
anticipated on the underlying loans backing these IOs will have an adverse effect on our returns on these investments and may result in
losses. Similarly, we own mortgage servicing rights, or MSRs, associated with residential mortgage loans, and excess MSR investments
associated with residential and multifamily mortgage loans, all of which are particularly sensitive to changes in prepayments rates. As
the owner of an MSR (or excess MSR investment), we are entitled to a portion of the interest payments made by the borrower in respect
of the associated loan and, in the case of MSRs, we are responsible for hiring and compensating a sub-servicer to directly service the
associated loan. Faster prepayments than we anticipate on loans associated with MSRs and excess MSR investments we own will have
an adverse effect on our returns from these MSRs and may result in losses.
Some of the business-purpose loans we originate or hold may allow the borrower to make prepayments without incurring a prepayment
penalty and some may include provisions allowing the borrower to extend the term of the loan beyond the originally scheduled maturity.
Because the decision to prepay or extend a business-purpose loan is controlled by the borrower, we may not accurately anticipate the
timing of these events, which could affect the earnings and cash flows we anticipate and could impact our ability to finance these assets.
Interest rate fluctuations can have various negative effects on us and could lead to reduced earnings and increased volatility in our
earnings.
Changes in interest rates, the interrelationships between various interest rates, and interest rate volatility could have negative effects
on our earnings, the fair value of our assets and liabilities, loan prepayment rates, and our access to liquidity. Changes in interest rates
can also harm the credit performance of our assets. We generally seek to hedge some but not all interest rate risks. Our hedging may not
work effectively and we may change our hedging strategies or the degree or type of interest rate risk we assume.
Some of the loans and securities we own or may acquire have adjustable-rate coupons (i.e., they may earn interest at a rate that
adjusts periodically based on an interest rate index). The cash flows we receive from these assets may vary as a function of interest rates,
as may the reported earnings generated by these assets. We also acquire loans and securities for future sale, as assets we are accumulating
for securitization, or as a longer-term investment. We expect to fund assets with a combination of equity, fixed rate debt and adjustable
rate debt. To the extent we use adjustable rate debt to fund assets that have a fixed interest rate (or use fixed rate debt to fund assets that
have an adjustable interest rate), an interest rate mismatch could exist and we could, for example, earn less (and fair values could decline)
if interest rates rise, at least for a time. We may or may not seek to mitigate interest rate mismatches for these assets with hedges such as
interest rate agreements and other derivatives and, to the extent we do use hedging techniques, they may not be successful.
Higher interest rates generally reduce the fair value of many of our assets, with the exception of our IOs, MSRs, excess MSR
investments, and adjustable-rate assets. This may affect our earnings results, reduce our ability to securitize, re-securitize, or sell our
assets, or reduce our liquidity. Higher interest rates could reduce the ability of borrowers to make interest payments or to refinance their
loans. Higher interest rates could reduce property values and increased credit losses could result. Higher interest rates could reduce
mortgage originations, thus reducing our opportunities to acquire new assets.
When short-term interest rates are high relative to long-term interest rates, an increase in adjustable-rate residential loan prepayments
may occur, which would likely reduce our returns from owning interest-only securities backed by adjustable-rate residential loans.
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It can be difficult to predict the impact on interest rates of unexpected and uncertain global political and economic events, such as
the outbreak of pandemic or epidemic disease, the economic and international trade conflict between the U.S. and China, the upcoming
U.S. presidential election, the U.K. exit from the European Union, or changes in the credit rating of the U.S. government, the United
Kingdom, or one or more Eurozone nations; however, increased uncertainty or changes in the economic outlook for, or rating of, the
creditworthiness of the U.S. government, the United Kingdom, or Eurozone nations may have adverse impacts on, among other things,
the U.S. economy, financial markets, the cost of borrowing, the financial strength of counterparties we transact business with, and the
value of assets we hold. Any such adverse impacts could negatively impact the availability to us of short-term debt financing, our cost
of short-term debt financing, our business, and our financial results.
We have significant investment and reinvestment risks.
New assets we acquire or originate may not generate yields as attractive as yields on our current assets, which could result in a decline
in our earnings per share over time.
Assets we acquire, originate, or invest in may not generate the economic returns and GAAP yields we expect. Realized cash flow
could be significantly lower than expected and returns from new investments, originations, and acquisitions could be negative. In order
to maintain our portfolio size and our earnings, we must reinvest in new assets a portion of the cash flows we receive from principal,
interest, and sales. We receive monthly payments from many of our assets, consisting of principal and interest. In addition, occasionally
some of our residential securities are called (effectively sold). We may also sell assets from time to time as part of our portfolio and capital
management strategies. Principal payments, calls, and sales reduce the size of our current portfolio and generate cash for us.
If the assets we invest in or acquire in the future earn lower GAAP yields than do the assets we currently own, our reported earnings
per share could decline over time as the older assets are paid down, are called, or are sold, assuming comparable expenses, credit costs,
and market valuation adjustments. Under the effective yield method of accounting that we use for GAAP purposes for some of our assets,
we recognize yields on assets based on our assumptions regarding future cash flows. A portion of the cash flows we receive may be used
to reduce our basis in these assets. As a result of these various factors, our basis for GAAP amortization purposes may be lower than the
current fair values of these assets. Assets with a lower GAAP basis than current fair values generate higher GAAP yields, and such yields
are not necessarily available on newly acquired assets. Future economic conditions, including credit results, prepayment patterns, and
interest rate trends, are difficult to project with accuracy over the life of the assets we acquire, so there will be volatility in the reported
returns over time.
Our growth may be limited if assets are not available or not available at attractive prices.
To reinvest the proceeds from principal repayments we receive on our existing investments and deploy capital we raise, we must
originate, invest in, or acquire new assets. If the availability of new assets is limited, we may not be able to originate, invest in, or acquire
assets that will generate attractive returns. Generally, asset supply can be reduced if originations of a particular product are reduced or if
there are fewer sales in the secondary market of seasoned product from existing portfolios. In particular, assets we believe have a favorable
risk/reward ratio may not be available for purchase (or origination by our business-purpose loan origination platforms).
We do not originate residential loans; rather, we rely on the origination market to supply the types of loans we seek to invest in. At
times, due to increases in interest rates, heightened credit concerns, strengthened underwriting standards, increased regulation, and/or
concerns about economic growth or housing values, the volume of originations may decrease significantly. For example, in recent years
residential mortgage interest rates were generally declining, with the result that a significant portion of industry-wide origination volumes
were related to residential borrowers refinancing existing mortgage loans. As interest rates increased in 2017 and 2018, the volume of
refinance loans declined. To the extent interest rates increase in the future, refinance loan volume is likely to decline again, and this
volume may not return to previous levels. A reduced volume of loan originations may make it difficult for us to acquire loans and securities.
Similar factors may contribute to reduced volumes of loan originations by our business-purpose loan origination platforms, which would
otherwise be available for transfer to our investment portfolio.
We originate business-purpose loans, but we may not be willing to provide the level of loan proceeds to the borrower or interest rate
that borrowers find acceptable or that matches our competitors.
The supply of new issue residential mortgage-backed securities (RMBS) collateralized by jumbo mortgage loans available for
purchase could be adversely affected if the economics of executing securitizations are not favorable or if the regulations governing the
execution of securitizations discourage or preclude certain potential market participants from engaging in these transactions. In addition,
if there is not a robust market for triple-A rated securities, the supply of real estate subordinate securities could be significantly diminished.
16
In 2014, we began entering into risk-sharing arrangements with Fannie Mae and Freddie Mac and more recently we have been
purchasing credit risk transfer (CRT) securities issued by Fannie Mae and Freddie Mac under which we are compensated for agreeing
to absorb credit losses on new conforming loans or for engaging in similar types of credit risk-sharing or -transfer structures. Since
December 2017, we have announced several other new initiatives to grow our investment portfolio, including investing in residential
securities collateralized by re-performing and non-performing mortgage loans, multifamily securities, shared equity appreciation real
estate option contracts, and investments in excess MSRs and servicer advance investments related to pools of residential and small-
balance multifamily mortgage loans. While these initiatives represent potential opportunities for future capital deployment, ultimately
these initiatives may not produce sizable investment opportunities due to competition from other investors, regulatory issues, or federal
housing finance reform initiatives that impact Fannie Mae and Freddie Mac.
Investments in diverse types of assets and businesses could expose us to new, different, or increased risks.
We have invested in and may in the future invest in a variety of real estate and non-real estate related assets that may not be closely
related to the types of investments we have traditionally made. Additionally, we may enter into or engage in various types of securitizations,
transactions, services, and other operating businesses that are different than the types we have traditionally entered into or engaged in.
For example, in 2014 our FHLBC-member subsidiary established a borrowing facility with the FHLBC that provides a source of long-
term financing for residential and business-purpose mortgage loans that our subsidiary buys and holds, as a result of which its holdings
of residential and business-purpose whole loans have increased. As another example, we recently began expanding our mortgage loan
purchase activity to include business-purpose loans secured by non-owner occupied rental properties and residential bridge loans, and
in 2019 we completed the acquisitions of two business-purpose real estate loan origination platforms, CoreVest and 5 Arches, through
which we now originate business-purpose loans. We also recently completed investments in subordinate securities backed by re-performing
and non-performing residential loans, multifamily securities, shared equity appreciation real estate option contracts, excess MSR
investments collateralized by residential and multifamily loans, servicer advance investments related to residential mortgage loans, and
a whole loan investment fund created to acquire light-renovation multifamily loans.
Any of these actions may expose us to new, different, or increased investment, operational, financial, or management risks. Several
of these investments were complex, highly structured, and involve partnerships and joint ventures with co-investors, any or all of which
may limit the liquidity of such investments. Additionally, when investing in transactions with complex or novel structures, the risks
associated with the transactions and structures may not be fully known to buyers and sellers. For example, we have limited control of
our investment in a whole loan investment fund created to acquire light-renovation multifamily loans from Freddie Mac, and there are
contingent liabilities associated with this investment that are not reflected on our balance sheet. Also, we recently began investing in
shared equity appreciation real estate option contracts, which expose us to risk of loss related to home price appreciation (or depreciation).
If our assumptions regarding the valuation and rate of appreciation in value of the property securing an option contract are wrong, our
returns will be reduced, and if the value of the property securing the contract decreases, we may suffer losses, up to the total loss of our
investment. Additionally, real estate option contracts may be subject to regulatory risk from federal, state, and local regulators. For
example, if a state mortgage regulator determines that entering into, or investing in, a real estate option contract is activity covered by
that state’s mortgage licensing statute, our investment may be at risk if we and our purchase and sale counterparty, who enters into the
option contract with the homeowner, do not possess the applicable license.
For another example, one of our excess MSR investments includes an associated investment in servicer advances financed with non-
recourse debt. Non-recourse financing generally limits our exposure to losses to the value of the collateral securing the financing (i.e.,
the servicer advances). However, a default on such non-recourse financing of servicer advances could result in a complete loss of our
servicer advance investments and the related excess MSRs. Additionally, this non-recourse financing is short-term. We may not be able
to renew this financing on favorable terms, or at all, which may have a negative impact on the value of our investment. A more detailed
discussion of the risks related to this servicer advance financing is described below in Part II, Item 7 of this Annual Report on Form 10-
K under the heading, “Risks Relating to Debt Incurred under Short- and Long-Term Borrowing Facilities.”
As another example, in connection with our acquisitions of CoreVest and 5 Arches, we made assumptions about the cash flows and
investments that will be generated from these acquisitions. There may be risks and challenges associated with the integration of the
CoreVest and 5 Arches platforms and workforces that we did not anticipate or may not be able to mitigate. Additionally, originating and
investing in business-purpose mortgage loans exposes us to new and different risks than our traditional residential mortgage banking
activities, including higher rates of delinquency, default, foreclosure and litigation. If our assumptions are wrong, or if market conditions
change, it could have a negative impact on our financial or operational results related to these acquisitions and to our business as a whole.
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We may invest in non-real estate asset-backed securities (ABS), corporate debt, or equity. We have invested in diverse types of IOs
from residential, business-purpose, and multifamily securitizations sponsored by us or by others. The higher credit and prepayment risks
associated with these types of investments may increase our exposure to losses. We may invest in non-U.S. assets that may expose us to
currency risks (which we may choose not to hedge) and different types of credit, prepayment, hedging, interest rate, liquidity, legal, and
other risks. These types of investments could expose us to new, different, or increased risks that we did not anticipate, which could have
a negative impact on the financial returns generated.
In addition, when investing in assets or businesses we are exposed to the risk that those assets, or interest income or revenue generated
by those assets or businesses, result in our not meeting the requirements to maintain our REIT status or our status as exempt from
registration under the Investment Company Act of 1940, as amended (Investment Company Act), as further described in the risk factors
titled “We have elected to be taxed as a REIT and, as such, are required to meet certain tests in order to maintain our REIT status. This
adds complexity and costs to running our business and exposes us to additional risks” and “Conducting our business in a manner so that
we are exempt from registration under, and in compliance with, the Investment Company Act may reduce our flexibility and could limit
our ability to pursue certain opportunities. At the same time, failure to continue to qualify for exemption from the Investment Company
Act could adversely affect us.”
We may change our investment strategy or financing plans, which may result in riskier investments and diminished returns.
We may change our investment strategy or financing plans at any time, which could result in our making investments that are different
from, and possibly riskier than, the investments we have previously made or described. A change in our investment strategy or financing
plans may increase our exposure to interest rate and default risk and real estate market fluctuations. Decisions to employ additional
leverage could increase the risk inherent in our investment strategy. Additionally, a portion of our recent investment activity has included
financing that is either short-term securitization debt or is incurred by entities that we do not control and thus is not reflected on our
balance sheet. Furthermore, a change in our investment strategy could result in our making investments in new asset categories or in
different proportions among asset categories than we previously have. For example, as noted above, since December 2017, we have
announced several new initiatives to expand our mortgage banking and investment activities, including by expanding our mortgage loan
purchase activity to include business-purpose loans secured by non-owner occupied rental properties and residential bridge loans,
completing the acquisitions of two business-purpose real estate loan origination platforms, CoreVest and 5 Arches, through which we
now originate business-purpose loans, and increasing the size and optimizing the target returns of our investment portfolio. We also
recently completed investments in subordinate securities backed by re-performing and non-performing residential loans, multifamily
securities, shared equity appreciation real estate option contracts, excess MSR and servicer advance investments collateralized by
residential and multifamily loans, and a whole loan investment fund created to acquire light-renovation multifamily loans. As another
example, in the future, we could determine to invest a greater proportion of our assets in securities backed by non-prime or subprime
residential mortgage loans. These changes could result in our making riskier investments, which could ultimately have an adverse effect
on our financial returns. Alternatively, we could determine to change our investment strategy or financing plans to be more risk averse,
resulting in potentially lower returns, which could also have an adverse effect on our financial returns.
The performance of the assets we own and the investments we make will vary and may not meet our earnings or cash flow expectations.
In addition, the cash flows and earnings from, and market values of, securities, loans, and other assets we own may be volatile.
We seek to manage certain of the risks associated with acquiring, originating, holding, selling, and managing real estate loans and
securities and other real estate-related investments. No amount of risk management or mitigation, however, can change the variable nature
of the cash flows of, fair values of, and financial results generated by these loans, securities, and other assets. Changes in the credit
performance of, or the prepayments on, these investments, including real estate loans and the loans underlying real estate securities, and
changes in interest rates impact the cash flows on these securities and investments, and the impact could be significant for our loans,
securities, and other assets with concentrated risks. Changes in cash flows lead to changes in our return on investment and also to potential
variability in and level of reported income. The revenue recognized on some of our assets is based on an estimate of the yield over the
remaining life of the asset. Thus, changes in our estimates of expected cash flow from an asset will result in changes in our reported
earnings on that asset in the current reporting period. We may be forced to recognize adverse changes in expected future cash flows as a
current expense, further adding to earnings volatility. Additionally, our non-GAAP measures of financial performance and our earnings
calculated in accordance with GAAP may be subject to volatility. Moreover, the Securities and Exchange Commission has increasingly
been focused on the use of non-GAAP financial metrics and may require us to change the presentation or method of calculation of our
non-GAAP metrics which may result in variability and volatility.
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Changes in the fair values of our assets, liabilities, and derivatives can have various negative effects on us, including reduced earnings,
increased earnings volatility, and volatility in our book value.
Fair values for our assets and liabilities, including derivatives, can be volatile and our revenue and income can be impacted by changes
in fair values. The fair values can change rapidly and significantly and changes can result from changes in interest rates, perceived risk,
supply, demand, and actual and projected cash flows, prepayments, and credit performance. A decrease in fair value may not necessarily
be the result of deterioration in future cash flows. Fair values for illiquid assets can be difficult to estimate, which may lead to volatility
and uncertainty of earnings and book value.
For example, real estate-related securities in our investment portfolio may be subject to changes in credit spreads. Credit spreads
measure the yield demanded on securities by the market based on their credit relative to a specific benchmark, and is a measure of the
perceived risk of the investment. Fixed rate securities are valued based on a market credit spread over the rate payable on fixed rate swaps
or fixed rate U.S. Treasuries of like maturity. Floating rate securities are typically valued based on a market credit spread over LIBOR
(or another floating rate index such as the Secured Overnight Financing Rate (“SOFR”)) and are affected similarly by changes in LIBOR
(or other index) spreads. Excessive supply of these securities or reduced demand may cause the market to require a higher yield on these
securities, resulting in the use of a higher, or “wider,” spread over the benchmark rate to value such securities. Under such conditions,
the value of our securities portfolios would tend to decline. Conversely, if the spread used to value such securities were to decrease, or
“tighten,” the value of our real estate and other securities portfolio would tend to increase. Such changes in the market value of our real
estate-related securities portfolio may affect our net equity, net income or cash flow directly through their impact on unrealized gains or
losses on available-for-sale securities, and therefore our ability to realize gains on such securities, or indirectly through their impact on
our ability to borrow and access capital. Widening credit spreads could cause the net unrealized gains on our securities and derivatives,
recorded in accumulated other comprehensive income or retained earnings, and therefore our book value per share, to decrease and result
in net losses.
For GAAP purposes, we mark to market most of the assets and some of the liabilities on our consolidated balance sheet. In addition,
valuation adjustments on certain consolidated assets and many of our derivatives are reflected in our consolidated statement of income.
Assets that are funded with certain liabilities and hedges may have differing mark-to-market treatment than the liability or hedge. If we
sell an asset that has not been marked to market through our consolidated statement of income at a reduced market price relative to its
cost basis, our reported earnings will be reduced.
Our loan sale profit margins are generally reflective of gains (or losses) over the period from when we identify a loan for purchase
until we subsequently sell or securitize the loan. These profit margins may encompass elements of positive or negative market valuation
adjustments on loans, hedging gains or losses associated with related risk management activities, and any other related transaction
expenses; however, under GAAP, the differing elements may be realized unevenly over the course of one or more quarters for financial
reporting purposes, with the result that our financial results may be more volatile and less reflective of the underlying economics of our
business activity.
Our calculations of the fair value of the securities, loans, MSRs, derivatives, and certain other assets we own or consolidate are based
upon assumptions that are inherently subjective and involve a high degree of management judgment.
We report the fair values of securities, loans, MSRs, derivatives, and certain other assets on our consolidated balance sheets. In
computing the fair values for these assets we may make a number of market-based assumptions, including assumptions regarding future
interest rates, prepayment rates, discount rates, credit loss rates, and the timing of credit losses. These assumptions are inherently subjective
and involve a high degree of management judgment, particularly for illiquid securities and other assets for which market prices are not
readily determinable. For further information regarding our assets recorded at fair value see Note 5 to the Financial Statements within
this Annual Report on Form 10-K. Use of different assumptions could materially affect our fair value calculations and our financial
results. Further discussion of the risk of our ownership and valuation of illiquid securities is set forth in the immediately following risk
factor.
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Changes in banks’ inter-bank lending rate reporting practices, the method pursuant to which LIBOR is determined, or the discontinuation
of LIBOR may adversely affect the value of the financial obligations to be held or issued by us that are linked to LIBOR.
LIBOR and other indices which are deemed “benchmarks” are the subject of recent national, international, and other regulatory
guidance and proposals for reform. Some of these reforms are already effective while others are still to be implemented. These reforms
may cause such benchmarks to perform differently than in the past, or have other consequences which cannot be predicted. It currently
appears that, over time, U.S. Dollar LIBOR will be replaced by the Secured Overnight Financing Rate (“SOFR”) published by the Federal
Reserve Bank of New York. However, the manner and timing of this shift is uncertain. U.S. Dollar LIBOR's formal retirement is currently
set for the end of 2021, but it is possible that rates based on LIBOR could continue to be published after that point. It is also possible that
LIBOR will effectively end before 2021 if the number of panel banks reporting to LIBOR continues to decrease. Market participants are
still considering how various types of financial instruments and securitization vehicles should react to a discontinuation of LIBOR. It is
possible that not all of our assets and liabilities will transition away from LIBOR at the same time, and it is possible that not all of our
assets and liabilities will transition to the same alternative reference rate, in each case increasing the difficulty of hedging. For example,
switching existing financial instruments and hedging transactions from LIBOR to SOFR requires calculations of a spread. Industry
organizations are attempting to structure the spread calculation in a manner that minimizes the possibility of value transfer between
counterparties, borrowers, and lenders by virtue of the transition, but there is no assurance that the calculated spread will be fair and
accurate or that all asset types and all types of securitization vehicles will use the same spread. We and other market participants have
less experience understanding and modeling SOFR-based assets and liabilities than LIBOR-based assets and liabilities, increasing the
difficulty of investing, hedging, and risk management. The process of transition involves operational risks. It is also possible that no
transition will occur for many financial instruments. At this time, it is not possible to predict the effect of any such changes, any
establishment of alternative reference rates or any other reforms to LIBOR that may be implemented. Uncertainty as to the nature of such
potential changes, alternative reference rates or other reforms may adversely affect the market for or value of any securities on which the
interest or dividend is determined by reference to LIBOR, loans, derivatives and other financial obligations or on our overall financial
condition or results of operations. More generally, any of the above changes or any other consequential changes to LIBOR or any other
“benchmark” as a result of international, national or other proposals for reform or other initiatives, or any further uncertainty in relation
to the timing and manner of implementation of such changes, could have a material adverse effect on the value of and return on any
securities based on or linked to a “benchmark.”
Investments we make, hedging transactions that we enter into, and the manner in which we finance our investments and operations
expose us to various risks, including liquidity risk, risks associated with the use of leverage, market risks, and counterparty risk.
Many of our investments have limited liquidity.
Many of the residential, business-purpose, multifamily, and other securities we own or may own are generally illiquid - that is, there
is not a significant pool of potential investors that are likely to invest in these, or similar, securities. This illiquidity can also exist for the
real estate loans we may hold and the business-purpose loans we originate. At times, the vast majority of the assets we own are illiquid.
In turbulent markets, it is likely that the securities, loans, and other assets we own may become even less liquid. As a result, we may not
be able to sell certain assets at opportune times or at attractive prices or we may incur significant losses upon sale of these assets, should
we want or need to sell them.
Our level of indebtedness and liabilities could limit cash flow available for our operations, expose us to risks that could adversely affect
our business, financial condition and results of operations and impair our ability to satisfy our obligations under our convertible notes
and other debt instruments.
At December 31, 2019, our total consolidated liabilities (excluding indebtedness associated with asset-backed securities issued and
other liabilities of consolidated entities, for which we are not liable) was $5.5 billion. We may also incur additional indebtedness to meet
future financing needs. Our indebtedness could have significant negative consequences for our business, results of operations and financial
condition, including:
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increasing our vulnerability to adverse economic and industry conditions;
limiting our ability to obtain additional financing;
requiring the dedication of a substantial portion of our cash flow from operations to service our indebtedness, thereby reducing
the amount of our cash flow available for other purposes;
requiring asset sales to fund the repayment of maturing debt;
limiting our flexibility in planning for, or reacting to, changes in our business;
dilution experienced by our existing stockholders as a result of the conversion of the convertible notes or exchangeable securities
into shares of common stock; and
placing us at a possible competitive disadvantage with less leveraged competitors and competitors that may have better access
to capital resources.
We cannot assure you that we will be able to continue to maintain sufficient cash reserves or continue to generate cash flow from
operations at levels sufficient to permit us to pay principal, premium, if any, and interest on our indebtedness, or that our cash needs will
not increase. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments, or if we
fail to comply with the various requirements of our indebtedness then outstanding, we would be in default, which would permit the holders
of the affected indebtedness to accelerate the maturity of such indebtedness and could cause defaults under our other indebtedness. Any
default under any indebtedness could have a material adverse effect on our business, results of operations and financial condition. For
an additional discussion of our outstanding indebtedness, see Part II, Item 7 of this Annual Report on Form 10-K under the heading “Risks
Relating to Debt Incurred under Short- and Long-Term Borrowing Facilities."
Our use of financial leverage could expose us to increased risks.
We fund the residential loans we acquire in anticipation of a future sale or securitization with a combination of equity and short-term
debt. In addition, we also make investments in securities and loans financed with short- and long-term debt. By incurring this debt (i.e.,
by applying financial leverage), we expect to generate more attractive returns on our invested equity capital. However, as a result of using
financial leverage (whether for the accumulation of loans or related to longer-term investments), we could also incur significant losses
if our borrowing costs increase relative to the earnings on our assets and costs of any related hedges. Financing facility creditors may
also force us to sell assets pledged as collateral under adverse market conditions to meet margin calls, for example, in the event of a
decrease in the fair values of the assets pledged as collateral. Liquidation of the collateral could create negative tax consequences and
raise REIT qualification issues. Further discussion of the risk associated with maintaining our REIT status is set forth in the risk factor
titled “We have elected to be taxed as a REIT and, as such, are required to meet certain tests in order to maintain our REIT status. This
adds complexity and costs to running our business and exposes us to additional risks.” In addition, we make financial covenants to
creditors in connection with incurring short- and long-term debt, such as covenants relating to our maintaining a minimum amount of
tangible net worth or stockholders’ equity and/or a minimum amount of liquid assets, and a maximum ratio of recourse debt to stockholders’
equity. If we fail to comply with these financial covenants we would be in default under our financing facilities, which could result in,
among other things, the liquidation of collateral we have pledged pursuant to these facilities under adverse market conditions and the
inability to incur additional borrowings to finance our business activities. A further discussion of financial covenants we are subject to
and related risks associated with our use of short-term debt is set forth in Part II, Item 7 of this Annual Report on Form 10-K under the
heading, “Risks Relating to Debt Incurred Under Short- and Long-Term Borrowing Facilities.” Additionally, our ability to increase our
borrowing limits under our debt financing facilities (and therefore increase our investment capacity) may be limited by our ability to raise
equity capital, which we may not be able to raise at attractive prices or at all.
The inability to access financial leverage through warehouse and repurchase facilities, credit facilities, our FHLB-member subsidiary’s
borrowing facility with the FHLBC, or other forms of debt financing may inhibit our ability to execute our business plan, which could
have a material adverse effect on our financial results, financial condition, and business.
Our ability to fund our business and our investment strategy depends on our securing warehouse, repurchase, or other forms of debt
financing (or leverage) on acceptable terms. For example, pending the sale or securitization of a pool of mortgage loans or other assets
we generally fund the acquisition of those mortgage loans or other assets through borrowings from warehouse, repurchase, and credit
facilities, and other forms of short-term financing.
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We cannot assure you that we will be successful in establishing sufficient sources of short-term debt when needed. In addition,
because of its short-term nature, lenders may decline to renew our short-term debt upon maturity or expiration, and it may be difficult
for us to obtain continued short-term financing. During certain periods, lenders may curtail their willingness to provide financing, as
liquidity in short-term debt markets, including repurchase facilities and commercial paper markets, can be withdrawn suddenly, making
it difficult or expensive to renew short-term borrowings as they mature. To the extent our business or investment strategy calls for us to
access financing and counterparties are unable or unwilling to lend to us, then our business and financial results will be adversely affected.
In addition, it is possible that lenders who provide us with financing could experience changes in their ability to advance funds to us,
independent of our performance or the performance of our investments, in which case funds we had planned to be able to access may
not be available to us. Additionally, federal regulations were adopted by the Federal Housing Finance Agency in January 2016 relating
to captive insurance company membership in the Federal Home Loan Bank System. Under these regulations, our captive insurance
company subsidiary, RWT Financial, LLC, which is currently a member of the Federal Home Loan Bank of Chicago (FHLBC), is only
eligible to remain as a member of the FHLBC for a five-year transition period and may not be able to obtain additional advances or
increases to its borrowing capacity from the FHLBC. Although FHLBC is permitted to allow advances that were outstanding to RWT
Financial prior to effectiveness of the regulations to remain outstanding until scheduled maturity (even if that scheduled maturity extends
beyond the five-year transition period), these regulations may limit RWT Financial’s ability to increase the size of its portfolio of residential
and business-purpose mortgage loans and securities and thereby may impact the ability to increase net interest income generated by RWT
Financial’s portfolio of held-for-investment loans and securities, and could otherwise have an adverse effect on our business and results
of operations, as further described under the risk factor titled “Federal regulations may limit, eliminate, or reduce the attractiveness of
our subsidiary’s ability to use borrowings from the Federal Home Loan Bank of Chicago to finance the mortgage loans and securities it
holds and acquires, which could negatively impact our business and operating results.” Additionally, our ability to increase borrowing
limits under our debt financing facilities (and therefore increase our investment capacity) may be limited by our ability to raise equity
capital, which we may not be able to raise at attractive prices or at all.
Hedging activities may reduce earnings, may fail to reduce earnings volatility, and may fail to protect our capital in difficult economic
environments.
We attempt to hedge certain interest rate risks (and, at times, prepayment risks and fair values) by balancing the characteristics of
our assets and associated (existing and anticipated) liabilities with respect to those risks and entering into various interest rate agreements.
The number and scope of the interest rate agreements we utilize may vary significantly over time. We generally seek to enter into interest
rate agreements that provide an appropriate and efficient method for hedging certain risks related to changes in interest rates.
The use of interest rate agreements and other instruments to hedge certain of our risks may have the effect over time of lowering
long-term earnings to the extent these risks do not materialize. To the extent that we hedge, it is usually to seek to protect us from some
of the effects of short-term interest rate volatility, to lower short-term earnings volatility, to stabilize liability costs or fair values, to
stabilize our economic returns from, or meet rating agency requirements with respect to, a securitization transaction, or to stabilize the
future cost of anticipated issuance of securities by a securitization entity. Hedging may not achieve our desired goals. Hedging with
respect to the pipeline of loans we plan to purchase may not be effective due to loan fallout or other reasons. Using interest rate agreements
as a hedge may increase short-term earnings volatility, especially if we do not elect certain accounting treatments for our hedges. Reductions
in fair values of interest rate agreements may not be offset by increases in fair values of the assets or liabilities being hedged. Conversely,
increases in fair values of interest rate agreements may not fully offset declines in fair values of assets or liabilities being hedged. Changes
in fair values of interest rate agreements may require us to pledge significant amounts of cash or other acceptable forms of collateral.
We also may hedge by taking short, forward, or long positions in U.S. Treasuries, mortgage securities, or other cash instruments.
We may take both long and short positions in credit derivative transactions linked to real estate assets. These derivatives may have
additional risks to us, such as: liquidity risk, due to the fact that there may not be a ready market into which we could sell these derivatives
if needed; basis risk, which could result in a decline in value or a requirement to make a cash payment as a result of changes in interest
rates; and the risk that a counterparty to a derivative is not willing or able to perform its obligations to us due to its financial condition
or otherwise.
Our earnings may be subject to fluctuations from quarter to quarter as a result of the accounting treatment for certain derivatives or
for assets or liabilities whose terms do not necessarily match those used for derivatives, or as a result of our inability to meet the requirements
necessary to obtain specific hedge accounting treatment for certain derivatives.
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Additionally, the interest rate agreements and other instruments that we may use to hedge certain risks are also subject to risks related
to the transition away from the use of LIBOR as a floating rate index, as further described above under the risk factor titled “The
performance of the assets we own and the investments we make will vary and may not meet our earnings or cash flow expectations. In
addition, the cash flows and earnings from, and market values of, securities, loans, and other assets we own may be volatile - Changes
in banks’ inter-bank lending rate reporting practices, the method pursuant to which LIBOR is determined, or the discontinuation of LIBOR
may adversely affect the value of the financial obligations to be held or issued by us that are linked to LIBOR.”
We enter into derivative contracts that may expose us to contingent liabilities and those contingent liabilities may not appear on our
balance sheet. We may invest in synthetic securities, credit default swaps, and other credit derivatives, which expose us to additional
risks.
We enter into derivative contracts, including interest rate swaps, options, and futures, that could require us to make cash payments
in certain circumstances. Additionally, we may be required to make capital contributions to an investment fund in certain circumstances,
including if debt covenants relating to financing incurred by the investment fund are not maintained. Such potential payment or capital
call obligations would be contingent liabilities and may not appear on our balance sheet. Our ability to satisfy these contingent liabilities
depends on the liquidity of our assets and our access to capital and cash. The need to fund these contingent liabilities could adversely
impact our financial condition.
We may in the future invest in synthetic securities, credit default swaps, and other credit derivatives that reference other real estate
securities or indices. These investments may present risks in excess of those resulting from the referenced security or index. These
investments are typically contractual relationships with counterparties and not acquisitions of referenced securities or other assets. In
these types of investments, we have no right directly to enforce compliance with the terms of the referenced security or other assets and
we have no voting or other consensual rights of ownership with respect to the referenced security or other assets. In the event of insolvency
of a counterparty, we will be treated as a general creditor of the counterparty and will have no claim of title with respect to the referenced
security.
Hedging activities may subject us to increased regulation.
Under the Dodd-Frank Act, there is increased regulation of companies, such as Redwood and certain of our subsidiaries, that enter
into interest rate hedging agreements and other hedging instruments and derivatives. This increased regulation could result in Redwood
or certain of our subsidiaries being required to register and be regulated as a commodity pool operator or a commodity trading advisor.
If we are not able to maintain an exemption from these regulations, it could have a negative impact on our business or financial results.
Moreover, rules requiring central clearing of certain interest rate swap and other transactions, as well as rules relating to margin and
capital requirements for swap transactions and regulated participants in the swap markets, as well as other swap market regulatory reforms,
may increase the cost or decrease the availability to us of hedging transactions, and may also limit our ability to include swaps in our
securitization transactions.
Our results could be adversely affected by counterparty credit risk.
We have credit risks that are generally related to the counterparties with which we do business. There is a risk that counterparties
will fail to perform under their contractual arrangements with us and this risk is usually more pronounced during an economic downturn.
Counterparties may seek to eliminate credit exposure by entering into offsetting, or “back-to-back,” hedging transactions, and the ability
of a counterparty to settle a synthetic transaction may be dependent on whether the counterparties to the back-to-back transactions perform
their delivery obligations. Those risks of non-performance may differ materially from the risks entailed in exchange-traded transactions,
which generally are backed by clearing organization guarantees, daily mark-to-market and settlement of positions, and segregation and
minimum capital requirements applicable to intermediaries. Transactions entered into directly between parties generally do not benefit
from those protections, and expose the parties to the risk of counterparty default. Furthermore, there may be practical and timing problems
associated with enforcing our rights to assets in the case of an insolvency of a counterparty.
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In the event a counterparty to our short-term borrowings becomes insolvent, we may fail to recover the full value of our pledged
collateral, thus reducing our earnings and liquidity. In the event a counterparty to our interest rate agreements or other derivatives becomes
insolvent or interprets our agreements with it in a manner unfavorable to us, our ability to realize benefits from the hedge transaction
may be diminished, any cash or collateral we pledged to the counterparty may be unrecoverable, and we may be forced to unwind these
agreements at a loss. In the event a counterparty that sells us residential mortgage loans becomes insolvent or is acquired by a third party,
we may be unable to enforce our loan repurchase rights in connection with a breach of loan representations and warranties and we may
suffer losses if we must repurchase delinquent loans. In the event that one of our sub-servicers becomes insolvent or fails to perform,
loan delinquencies and credit losses may increase and we may not receive the funds to which we are entitled. We attempt to diversify
our counterparty exposure and (except with respect to loan representations and warranties) attempt to limit our counterparty exposure to
counterparties with investment-grade credit ratings, although we may not always be able to do so. Our counterparty risk management
strategy may prove ineffective and, accordingly, our earnings and cash flows could be adversely affected.
Business, Operational and Other Risks
Through certain of our wholly-owned subsidiaries we have engaged in the past, and plan to continue to engage, in acquiring residential
mortgage loans and originating business-purpose mortgage loans with the intent to sell these loans to third parties or hold them as
investments. Similarly, we have engaged in the past, and may continue to engage, in acquiring residential MSRs. These types of
transactions and investments expose us to potentially material risks.
Acquiring and originating mortgage loans with intent to sell these loans to third parties generally requires us to incur short-term debt,
either on a recourse or non-recourse basis, to finance the accumulation of loans or other assets prior to sale. This type of debt may not
be available to us, or may only be available to us on an uncommitted basis, including in circumstances where a line of credit had previously
been made available or committed to us. In addition, the terms of any available debt may be unfavorable to us or impose restrictive
covenants that could limit our business and operations or the violation of which could lead to losses and inhibit our ability to borrow in
the future. We expect to pledge assets we acquire to secure the short-term debt we incur. To the extent this debt is recourse to us, if the
fair value of the assets pledged as collateral declines, we would be required to increase the amount of collateral pledged to secure the
debt or to repay all or a portion of the debt. In addition, when we originate or acquire assets for a sale, we make assumptions about the
cash flows that will be generated from those assets and the market value of those assets. If these assumptions are wrong, or if market
values change or other conditions change, it could result in a sale that is less favorable to us than initially assumed, which would typically
have a negative impact on our financial results.
Furthermore, if we are unable to complete the sale of these types of assets, it could have a negative impact on our business and
financial results. We have a limited capacity to hold residential and business-purpose loans on our balance sheet as investments, and our
business is not structured to buy-and-hold the full volume of loans that we routinely acquire or originate with the intent to sell. If demand
for buying whole-loans weakens, we may be forced to incur additional debt on unfavorable terms or may be unable to borrow to finance
these assets, which may in turn impact our ability to continue acquiring or originating loans over the short or long term.
Prior to originating or acquiring loans or other assets for sale, we may undertake underwriting and due diligence efforts with respect
to various aspects of the loan or asset. When underwriting or conducting due diligence, we rely on resources and data available to us,
which may be limited, and we rely on investigations by third parties. We may also only conduct due diligence on a sample of a pool of
loans or assets we are acquiring and assume that the sample is representative of the entire pool. Our underwriting and due diligence efforts
may not reveal matters which could lead to losses. If our underwriting process is not robust enough or if we do not conduct adequate due
diligence, or the scope of our underwriting or due diligence is limited, we may incur losses. Losses could occur due to the fact that a
counterparty that sold us a loan or other asset (or that is the obligor or a party related to an obligor of a business-purpose loan we originate)
refuses or is unable (e.g., due to its financial condition) to repay or repurchase that loan or asset or pay damages to us if we determine
subsequent to purchase that one or more of the representations or warranties made to us in connection with the sale or origination was
inaccurate.
Our ability to operate our business in the manner described above depends on the availability and productivity of our personnel. To
the extent our management or personnel are impacted in significant numbers by the outbreak of pandemic or epidemic disease, such as
the coronavirus or COVID-19, our business and operating results may be negatively impacted.
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In addition, when selling mortgage loans or acquiring servicing rights associated with residential mortgage loans, we typically make
representations and warranties to the purchaser or to other third parties regarding, among other things, certain characteristics of those
assets, including characteristics we seek to verify through our underwriting and due diligence efforts. If our representations and warranties
are inaccurate with respect to any asset, we may be obligated to repurchase that asset or pay damages, which may result in a loss. We
generally only establish reserves for potential liabilities relating to representations and warranties we make if we believe that those
liabilities are both probable and estimable, as determined in accordance with GAAP. As a result, we may not have reserves relating to
these potential liabilities or any reserves we may establish could be inadequate. Even if we obtain representations and warranties from
the counterparties from whom we acquired the loans or other assets or the borrowers to whom we made the loans, or their related parties,
they may not parallel the representations and warranties we make or may otherwise not protect us from losses, including, for example,
due to the fact that the counterparty may be insolvent or otherwise unable to make a payment to us at the time we make a claim for
repayment or damages for a breach of representation or warranty. Furthermore, to the extent we claim that counterparties we have acquired
loans from or borrowers to whom we made the loan, or their related parties have breached their representations and warranties to us, it
may adversely impact our business relationship with those counterparties, including by reducing the volume of business we conduct with
those counterparties, which could negatively impact our ability to acquire loans and our business. To the extent we have significant
exposure to representations and warranties made to us by one or more counterparties we acquire loans from, we may determine, as a
matter of risk management, to reduce or discontinue loan acquisitions from those counterparties, which could reduce the volume of
residential loans we acquire and negatively impact our business and financial results.
RWT Financial, our FHLB-member subsidiary, maintains a portfolio of residential and business-purpose mortgage loans and securities
it holds for investment with long-term financing provided by the FHLBC. At December 31, 2019, RWT Financial had approximately
$2.00 billion of long-term borrowings outstanding from the FHLBC, which were collateralized by residential and business-purpose
mortgage loans and securities. RWT Financial has effectively reached its maximum borrowing capacity from the FHLBC of $2.00 billion,
and it does not expect to be able to obtain any increase in its borrowing capacity in the future. FHLBC financing has enabled RWT
Financial to earn attractive returns on loans held as long-term investments, contributing a significant amount to our 2019 earnings. RWT
Financial’s ability to increase the size of its portfolio of residential and business-purpose mortgage loans and securities may be limited
by the lack of availability of attractive financing and this may impact the ability to increase net interest income generated by RWT
Financial, as further described under the risk factor titled “Federal regulations may limit, eliminate, or reduce the attractiveness of our
subsidiary’s ability to use borrowings from the Federal Home Loan Bank of Chicago to finance the mortgage loans and securities it holds
and acquires, which could negatively impact our business and operating results.” Additionally, the portfolio of residential and business-
purpose mortgage loans held as long-term investments exposes us to the risk of loss on the full balance of those loans, which is typically
not the case with respect to securities we retain from securitization transactions we sponsor. The materialization of any of these risks
related to RWT Financial’s investment activity and FHLB financing could significantly impact our financial and operating results.
Our portfolio of business-purpose loans held for investment represents a growing portion of our overall investment portfolio, and such
loans expose us to new and different risks from our traditional investments in jumbo residential mortgage loans.
A growing portion of our portfolio of loans held for investment is made up of business-purpose mortgage loans. Business-purpose
mortgage loans are directly exposed to losses resulting from default and foreclosure. Therefore, the value of the underlying property, the
creditworthiness and financial position of the borrower and the priority and enforceability of the lien will significantly impact the value
of such mortgages. Whether or not we have participated in the negotiation of the terms of any such mortgages, there can be no assurance
as to the adequacy of the protection of the terms of the loan, including the validity or enforceability of the loan and the maintenance of
the anticipated priority and perfection of the applicable security interests. Furthermore, claims may be asserted that might interfere with
enforcement of our rights. In the event of a foreclosure, we may assume direct ownership of the underlying real estate. The liquidation
proceeds upon sale of such real estate may not be sufficient to recover our cost basis in the loan, resulting in a loss to us. Any costs or
delays involved in the completion of a foreclosure of the loan or a liquidation of the underlying property will further reduce the proceeds
and thus increase the loss.
A portion of our business-purpose loan portfolio currently is, and in the future may be, delinquent and subject to increased risks of
credit loss for a variety of reasons, including, without limitation, because the underlying property is too highly-leveraged or the borrower
falls upon financial distress. Delinquent loans may require a substantial amount of workout negotiations or restructuring, which may
entail, among other things, a reduction in the interest rate or capitalization of past due interest. However, even if restructurings are
successfully accomplished, risks still exist that borrowers will not be able or willing to maintain the restructured payments or refinance
the restructured mortgage upon maturity.
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If restructuring is not successful, we may find it necessary to foreclose on the underlying property, and the foreclosure process may
be lengthy and expensive, including out-of-pocket costs and increased use of our internal resources. Borrowers may resist mortgage
foreclosure actions by asserting numerous claims, counterclaims and defenses against us including, without limitation, numerous lender
liability claims and defenses, even when such assertions may have no basis in fact, in an effort to prolong the foreclosure action and force
us into a modification of the loan or a favorable buy-out of the borrower’s position. In some states, foreclosure actions can sometimes
take several years or more to litigate. Foreclosure may create a negative public perception of the related mortgaged property, resulting
in a decrease in its value. Even if we are successful in foreclosing on a loan, the liquidation proceeds upon sale of the underlying real
estate may not be sufficient to recover our cost basis in the loan, resulting in a loss to us. Furthermore, any costs or delays involved in
the completion of a foreclosure of the loan or a liquidation of the underlying property will further reduce the proceeds and thus increase
the loss. Any such reductions could materially and adversely affect the value of the loan and could, in aggregate, have a material and
adverse effect on our business, results of operations and financial condition.
Additionally, residential bridge loans on properties in transition may involve a greater risk of loss than traditional mortgage loans.
This product typically is used for acquiring and rehabilitating or improving the quality of single-family residential investment properties
and generally serves as an interim solution for borrowers and/or properties prior to the borrower selling the property or stabilizing the
property and obtaining long-term permanent financing. The typical borrower of these bridge loans has often identified an undervalued
asset that has been under-managed or is located in a recovering market. If the market in which the asset is located fails to improve
according to the borrower’s projections, or if the borrower fails to improve the quality of the asset’s management or the value of the asset,
the borrower may not receive a sufficient return on the asset to satisfy the transitional loan, and we bear the risk that we may not recover
some or all of our investment. In addition, borrowers often use the proceeds of a conventional mortgage to repay a residential bridge
loan. Residential bridge loans therefore are subject to risks of a borrower’s inability to obtain permanent financing to repay the loan.
Residential bridge loans are also subject to risks of borrower defaults, bankruptcies, fraud, and other losses. In the event of any default
under residential bridge loans that may be held by us, we bear the risk of loss of principal and non-payment of interest and fees to the
extent of any deficiency between the value of the mortgage collateral and the principal amount and unpaid interest of the transitional
loan. To the extent we suffer such losses with respect to these loans, our business, results of operations and financial condition may be
materially adversely affected.
Through certain of our wholly-owned subsidiaries we have engaged in the past, and expect to continue to engage in, securitization
transactions relating to real estate mortgage loans. In addition, we have invested in and continue to invest in mortgage-backed securities
and other ABS issued in securitization transactions sponsored by other companies. These types of transactions and investments expose
us to potentially material risks.
Engaging in securitization transactions and other similar transactions generally requires us to incur short-term debt on a recourse
basis to finance the accumulation of loans or other assets prior to securitization. If demand for investing in securitization transactions
weakens, we may be unable to complete the securitization of loans accumulated for that purpose, which may hurt our business or financial
results. In addition, in connection with engaging in securitization transactions, we engage in due diligence with respect to the loans or
other assets we are securitizing and make representations and warranties relating to those loans and assets. The risks associated with
incurring this type of debt in connection with securitization activity, the risks related to our ability to complete securitization transactions
after we have accumulated loans for that purpose, and the risks associated with the due diligence we conduct, and the representations
and warranties we make, in connection with securitization activity are similar to the risks associated with acquiring and originating loans
with the intent to sell them to third parties, as described in the immediately preceding risk factor titled “Through certain of our wholly-
owned subsidiaries we have engaged in the past, and plan to continue to engage, in acquiring residential mortgage loans and originating
business-purpose mortgage loans with the intent to sell these loans to third parties or hold them as investments. Similarly, we have
engaged in the past, and continue to engage, in acquiring residential MSRs. These types of transactions and investments expose us to
potentially material risks.”
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When engaging in securitization transactions, we also prepare marketing and disclosure documentation, including term sheets,
offering documents, and prospectuses, that include disclosures regarding the securitization transactions and the assets being securitized.
If our marketing and disclosure documentation are alleged or found to contain inaccuracies or omissions, we may be liable under federal
and state securities laws (or under other laws) for damages to third parties that invest in these securitization transactions, including in
circumstances where we relied on a third party in preparing accurate disclosures, or we may incur other expenses and costs in connection
with disputing these allegations or settling claims. We have also engaged in selling or contributing commercial and multifamily real estate
loans, to third parties who, in turn, have securitized those loans. In these circumstances, we have in the past and may in the future also
prepare marketing and disclosure documentation, including documentation that is included in term sheets, offering documents, and
prospectuses relating to those securitization transactions. We could be liable under federal and state securities laws (or under other laws)
for damages to third parties that invest in these securitization transactions, including liability for disclosures prepared by third parties or
with respect to loans that we did not sell or contribute to the securitization. Additionally, we typically retain various third-party service
providers when we engage in securitization transactions, including underwriters or initial purchasers, trustees, administrative and paying
agents, and custodians, among others. We frequently contractually agree to indemnify these service providers against various claims and
losses they may suffer in connection with the provision of services to us and/or the securitization trust. To the extent any of these service
providers are liable for damages to third parties that have invested in these securitization transactions, we may incur costs and expenses
as a result of these indemnities.
There may be defects in the legal process and legal documents governing transactions in which securitization trusts and other secondary
purchasers take legal ownership of residential mortgage loans and establish their rights as first priority lien holders on underlying mortgaged
property. To the extent there are problems with the manner in which title and lien priority rights were established or transferred,
securitization transactions that we sponsored and third-party sponsored securitizations that we hold investments in may experience losses,
which could expose us to losses and could damage our ability to engage in future securitization transactions.
In connection with our operating and investment activity, we rely on third parties to perform certain services, comply with applicable
laws and regulations, and carry out contractual covenants and terms, the failure of which by any of these third parties may adversely
impact our business and financial results.
In connection with our business of acquiring and originating loans, engaging in securitization transactions, and investing in third-
party issued securities and other assets, we rely on third party service providers to perform certain services, comply with applicable laws
and regulations, and carry out contractual covenants and terms. As a result, we are subject to the risks associated with a third party’s
failure to perform, including failure to perform due to reasons such as fraud, negligence, errors, miscalculations, or insolvency. For
example, if loan servicers experience higher volumes of delinquent loans than they have in the past, there is a risk that, as a result, their
operational infrastructures may not be able to properly process this increased volume. Many loan servicers have been accused of
improprieties in the handling of the loan modification or foreclosure process with respect to residential mortgage loans that have gone
into default. To the extent a third-party loan servicer fails to fully and properly perform its obligations, loans and securities that we hold
as investments may experience losses and securitizations that we have sponsored may experience poor performance, and our ability to
engage in future securitization transactions could be harmed. As another example, our residential lending and business-purpose lending
segments utilize third party appraisals during the loan underwriting process, obtained on the collateral underlying each prospective
mortgage. The quality of these appraisals may vary widely in accuracy and consistency. The appraiser may feel pressure from the broker
or lender to provide an appraisal in the amount necessary to enable the originator to make the loan, whether or not the value of the property
justifies such an appraised value. Inaccurate or inflated appraisals may result in an increase in the severity of losses on the mortgage
loans, which could have a material and adverse effect on our business, results of operations and financial condition. Additionally, our
business-purpose loan origination platforms may utilize third party inspectors in connection with funding advances on bridge loans for
rehabilitation or ground-up construction. These third parties may be required to certify a borrower’s eligibility for advances based on the
satisfaction of construction milestones. In the past we have experienced, and may in the future experience, fraudulent or negligent activity
among borrowers and certain of these third parties that has led to the disbursement of under-collateralized funds and could cause us to
incur financial losses on loans we have originated.
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For some of the loans that we hold and for some of the loans we sell or securitize, we hold the right to service those loans and we
retain a sub-servicer to service those loans. In these circumstances we are exposed to certain risks, including, without limitation, that we
may not be able to enter into subservicing agreements on favorable terms to us or at all, or that the sub-servicer may not properly service
the loan in compliance with applicable laws and regulations or the contractual provisions governing their sub-servicing role, and that we
would be held liable for the sub-servicer’s improper acts or omissions. Additionally, in its capacity as a servicer of residential mortgage
loans, a sub-servicer will have access to borrowers’ non-public personal information, and we could incur liability in connection with a
data breach relating to a sub-servicer, as discussed further below under the risk factor titled “Maintaining cybersecurity is important to
our business and a breach of our cybersecurity could have a material adverse impact. Our technology infrastructure and systems are
important and any significant disruption or breach of the security of this infrastructure or these systems could have an adverse effect on
our business. We also rely on technology infrastructure and systems of third parties who provide services to us and with whom we transact
business.” When we retain a sub-servicer we are generally also obligated to fund any obligation of the sub-servicer to make advances on
behalf of a delinquent loan obligor. To the extent any one sub-servicer counterparty services a significant percentage of the loans with
respect to which we own the servicing rights, the risks associated with our use of that sub-servicer are concentrated around this single
sub-servicer counterparty. To the extent that there are significant amounts of advances that need to be funded in respect of loans where
we own the servicing right, it could have a material adverse effect on our business and financial results.
In addition, we have participated in various investments structured as joint ventures or partnerships with unaffiliated third parties.
Some of these joint venture entities rely, in part, on their members or partners to make committed capital contributions in order to pay
the purchase price for investments, to fund shortfalls in capital under related financing agreements, or to fund indemnification or repurchase
obligations related to securitization. A failure by one of the members to make such capital contributions for amounts required could result
in events of default under the terms of the investment or the related financing and a loss of our investment in the joint venture entity and
its related investments. For example, in connection with our servicer advance investments, we consolidate an entity that was formed to
finance servicing advances and for which we, through our control of an affiliated partnership entity (the "SA Buyer") formed to invest
in servicer advance investments and excess MSRs, are the primary beneficiary. SA Buyer has agreed to purchase all future arising servicer
advances under certain residential mortgage servicing agreements. SA Buyer relies, in part, on its members to make committed capital
contributions in order to pay the purchase price for future servicer advances. A failure by any or all of the members to make such capital
contributions for amounts required to fund servicer advances could result in an event of default under our servicer advance financing and
a complete loss of our investment in SA Buyer and its servicer advance investments and excess MSRs. Additionally, to the extent that
the servicer of the underlying mortgage loans (who is unaffiliated with us except through their co-investment in SA Buyer and the related
financing entity) fails to recover the servicer advances in which we have invested, or takes longer than we expect to recover such advances,
the value of our investment could be adversely affected and we could fail to achieve our expected return and suffer losses.
We also rely on corporate trustees to act on behalf of us and other holders of ABS in enforcing our rights as security holders. Under
the terms of most ABS we hold, we do not have the right to directly enforce remedies against the issuer of the security, but instead must
rely on a trustee to act on behalf of us and other security holders. Should a trustee not be required to take action under the terms of the
securities, or fail to take action, we could experience losses.
Our ability to execute or participate in future securitization transactions, including, in particular, securitizations of residential and
business-purpose mortgage loans, could be delayed, limited, or precluded by legislative and regulatory reforms applicable to asset-
backed securities and the institutions that sponsor, service, rate, or otherwise participate in or contribute to the successful execution
of a securitization transaction. Other factors could also limit, delay, or preclude our ability to execute securitization transactions.
These legislative, regulatory, and other factors could also reduce the returns we would otherwise expect to earn in connection with
executing securitization transactions.
In July 2010, the Dodd-Frank Act was enacted. Provisions of the Dodd-Frank Act require, among other things, significant revisions
to the legal and regulatory framework under which ABS, including RMBS and securities backed by business-purpose mortgage loans,
are issued through the execution of securitization transactions. Some of the provisions of the Dodd-Frank Act have become effective or
been implemented. In addition, prior to the passage of the Dodd-Frank Act, the Securities and Exchange Commission (SEC) and the
Federal Deposit Insurance Corporation had already published proposed and final regulations under already existing legislative authority
relating to the issuance of ABS, including RMBS. Additional federal or state laws and regulations that could affect our ability to execute
future securitization transactions could be proposed, enacted, or implemented. In addition, various federal and state agencies and law
enforcement authorities, as well as private litigants, have initiated and may, in the future, initiate additional broad-based enforcement
actions or claims, the resolution of which may include industry-wide changes to the way residential mortgage loans are originated,
transferred, serviced, and securitized, and any of these changes could also affect our ability to execute future securitization transactions.
For an example, please refer to the risk factor titled “Federal and state legislative and regulatory developments and the actions of
governmental authorities and entities may adversely affect our business and the value of, and the returns on, mortgages, mortgage-related
securities, and other assets we own or may acquire in the future.”
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Rating agencies can affect our ability to execute or participate in a securitization transaction, or reduce the returns we would otherwise
expect to earn from executing securitization transactions, not only by deciding not to publish ratings for our securitization transactions
(or deciding not to consent to the inclusion of those ratings in the prospectuses or other documents we file with the SEC relating to
securitization transactions), but also by altering the criteria and process they follow in publishing ratings. Rating agencies could alter
their ratings processes or criteria after we have accumulated loans or other assets for securitization in a manner that effectively reduces
the value of those previously acquired or originated loans or requires that we incur additional costs to comply with those processes and
criteria. For example, to the extent investors in a securitization transaction would have significant exposure to representations and
warranties made by us or by one or more counterparties we acquire loans from, rating agencies may determine that this exposure increases
investment risks relating to the securitization transaction. Rating agencies could reach this conclusion either because of our financial
condition or the financial condition of one or more counterparties we acquire loans from, or because of the aggregate amount of loan-
related representations and warranties (or other contingent liabilities) we, or one or more counterparties we acquire loans from, have
made or have exposure to. In addition, our ability to continue to securitize residential mortgage loans in the future will depend, in part,
on the rating agencies’ assessment of the investment risks that result from the ability-to-repay regulations and the TILA-RESPA Integrated
Disclosure Rule (TRID). This includes, for example, how they assess investment risks associated with (a) non-material errors in loan-
related disclosures made to mortgage borrowers, (b) residential mortgage loans that have an interest-only payment feature, or (c) loans
under which the borrower has a debt-to-income ratio of more than 43%. These types of loans have historically accounted for a significant
amount of the loans we have securitized, but they are not considered “qualified mortgages” under the ability-to-repay regulations. Since
these provisions were implemented over the past several years, the rating agencies’ assessment of these risks has generally been consistent
with ours, but to the extent their assessments diverge from ours, this could negatively impact our ability to execute securitization
transactions. If, as a result of any of the foregoing issues, rating agencies place limitations on our ability to execute future securitization
transactions or impose unfavorable ratings levels or conditions on our securitization transactions, it could reduce the returns we would
otherwise expect to earn from executing these transactions and negatively impact our business and financial results.
Furthermore, other matters, such as (i) accounting standards applicable to securitization transactions and (ii) capital and leverage
requirements applicable to banks’ and other regulated financial institutions’ holdings of ABS, could result in less investor demand for
securities issued through securitization transactions we execute or increased competition from other institutions that originate, acquire,
and hold residential and business-purpose mortgage loans, multifamily real estate loans, and other types of assets and execute securitization
transactions.
Our ability to profitably execute or participate in future securitizations transactions, including, in particular, securitizations of
residential and business-purpose mortgage loans, is dependent on numerous factors and if we are not able to achieve our desired
level of profitability or if we incur losses in connection with executing or participating in future securitizations it could have a material
adverse impact on our business and financial results.
There are a number of factors that can have a significant impact on whether a securitization transaction that we execute or participate
in is profitable to us or results in a loss. One of these factors is the price we pay for (or cost of originating) the mortgage loans that we
securitize, which, in the case of residential mortgage loans, is impacted by the level of competition in the marketplace for acquiring
mortgage loans and the relative desirability to originators of retaining mortgage loans as investments or selling them to third parties such
as us. Another factor that impacts the profitability of a securitization transaction is the cost to us of the short-term debt that we use to
finance our holdings of mortgage loans prior to securitization, which cost is affected by a number of factors including the availability of
this type of financing to us, the interest rate on this type of financing, the duration of the financing we incur, and the percentage of our
mortgage loans for which third parties are willing to provide short-term financing.
After we acquire or originate mortgage loans that we intend to securitize, we can also suffer losses if the value of those loans declines
prior to securitization. Declines in the value of a mortgage loan, for example, can be due to, among other things, changes in interest rates,
changes in the credit quality of the loan, and changes in the projected yields required by investors to invest in securitization transactions.
To the extent we seek to hedge against a decline in loan value due to changes in interest rates, there is a cost of hedging that also affects
whether a securitization is profitable. Other factors that can significantly affect whether a securitization transaction is profitable to us
include the criteria and conditions that rating agencies apply and require when they assign ratings to the mortgage-backed securities
issued in our securitization transactions, including the percentage of mortgage-backed securities issued in a securitization transaction that
the rating agencies will assign a triple-A rating to, which is also referred to as a rating agency subordination level. Rating agency
subordination levels can be impacted by numerous factors, including, without limitation, the credit quality of the loans securitized, the
geographic distribution of the loans to be securitized, and the structure of the securitization transaction and other applicable rating agency
criteria. All other factors being equal, the greater the percentage of the mortgage-backed securities issued in a securitization transaction
that the rating agencies will assign a triple-A rating to, the more profitable the transaction will be to us.
29
The price that investors in mortgage-backed securities will pay for securities issued in our securitization transactions also has a
significant impact on the profitability of the transactions to us, and these prices are impacted by numerous market forces and factors. In
addition, the underwriter(s) or placement agent(s) we select for securitization transactions, and the terms of their engagement, can also
impact the profitability of our securitization transactions. Also, transaction costs incurred in executing transactions impact the profitability
of our securitization transactions and any liability that we may incur, or may be required to reserve for, in connection with executing a
transaction can cause a loss to us. To the extent that we are not able to profitably execute future securitizations of residential mortgage
loans or other assets, including for the reasons described above or for other reasons, it could have a material adverse impact on our
business and financial results.
Our past and future loan origination and securitization activities or other past and future business or operating activities or practices
could expose us to litigation, which may adversely affect our business and financial results.
Through certain of our wholly-owned subsidiaries we have in the past engaged in or participated in loan origination and securitization
transactions relating to residential mortgage loans, business-purpose mortgage loans, multifamily mortgage loans, commercial real estate
loans, and other types of assets. In the future we expect to continue to engage in or participate in loan origination and securitization
transactions, including, in particular, securitization transactions relating to residential and business-purpose mortgage loans, and may
also engage in other types of securitization transactions or similar transactions. Sequoia securitization entities we sponsored issued ABS
backed by residential mortgage loans held by these Sequoia entities. Similarly, CoreVest securitization entities (or “CAFL” entities) we
sponsor issued ABS backed by business-purpose mortgage loans held by these CAFL entities. In Acacia securitization transactions we
participated in, Acacia securitization entities issued ABS backed by securities and other assets held by these Acacia entities. As a result
of declining property values, increasing defaults, changes in interest rates, and other factors, the aggregate cash flows from the loans held
by the Sequoia and CAFL entities and the securities and other assets held by the Acacia entities may be insufficient to repay in full the
principal amount of ABS issued by these securitization entities. We are not directly liable for any of the ABS issued by these entities.
Nonetheless, third parties who hold the ABS issued by these entities may try to hold us liable for any losses they experience, including
through claims under federal and state securities laws or claims for breaches of representations and warranties we made in connection
with engaging in these securitization transactions. Additionally, holders of ABS issued by CAFL entities prior to our acquisition of
CoreVest may make claims against us for losses arising from activities that occurred prior to our acquisition.
For example, as discussed below in Part I, Item 3 of this Annual Report on Form 10-K, on December 23, 2009, the Federal Home
Loan Bank of Seattle filed a claim in the Superior Court for the State of Washington against us and our subsidiary, Sequoia Residential
Funding, Inc. The complaint related in part to residential mortgage-backed securities that were issued by a Sequoia securitization entity
and alleged that, at the time of issuance, we, Sequoia Residential Funding, Inc. and the underwriters made various misstatements and
omissions about these securities in violation of Washington state law. We have also been named in other similar lawsuits. A further
discussion of these lawsuits is set forth in Note 15 to the Financial Statements within this Annual Report on Form 10-K. For another
example, refer to the risk factor below, titled “Litigation of the type initiated against various trustees of residential mortgage-backed
securitization transactions issued prior to financial crisis of 2007-2008 (“RMBS trustee litigation”) negatively impacted, and could
further negatively impact, the value of securities we hold, could expose us to indemnification claims, and could impact the profitability
of our participation in future securitization transactions.”
Other aspects of our business operations or practices could also expose us to litigation. In the ordinary course of our business we
enter into agreements relating to, among other things, loans we originate and acquire and investments we make, assets and loans we sell,
financing transactions, third parties we retain to provide us with goods and services, and our leased office space. We also regularly enter
into confidentiality agreements with third parties under which we receive confidential information. If we breach any of these agreements,
we could be subject to claims for damages and related litigation. For example, when we sell whole loans in the secondary market, we
are required to make customary representations and warranties about such loans to the loan purchaser. Our mortgage loan sale agreements
may require us to repurchase or substitute loans or indemnify investors in the event we breach a representation or warranty made to the
loan purchaser. In addition, we may be required to repurchase loans as a result of borrower fraud or in the event of early payment default
on a mortgage loan. The remedies available to a purchaser of mortgage loans may be broader than those available to us against the
borrower or correspondent. Further, if a purchaser enforces its remedies against us, we may not be able to enforce the remedies we have
against the borrower or correspondent seller. Financing for repurchased loans may be limited or unavailable, and may incur a steep
discount to their repurchase price from financing counterparties. They are also typically sold at a significant discount to the UPB. Significant
repurchase activity could harm our business, cash flow, results of operations and financial condition.
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Through our 5 Arches and CoreVest loan origination platforms, we may be subject to lender liability claims, and if we are held liable
under such claims, we could be subject to losses. A number of judicial decisions have upheld the right of borrowers to sue lending
institutions on the basis of various evolving legal theories, collectively termed “lender liability.” Generally, lender liability is founded on
the premise that a lender has either violated a duty, whether implied or contractual, of good faith and fair dealing owed to the borrower
or has assumed a degree of control over the borrower resulting in the creation of a fiduciary duty owed to the borrower or its other creditors
or stockholders. We cannot assure investors that such claims will not arise through litigation or regulatory action or that we will not be
subject to significant liability if a claim of this type did arise. Additionally, we could be subject to such claims relating to activities that
occurred prior to our acquisitions of 5 Arches and CoreVest.
We are also subject to various other laws and regulations relating to our business and operations, including, without limitation, privacy
laws and regulations and labor and employment laws and regulations, and if we fail to comply with these laws and regulations we could
also be subjected to claims for damages and litigation. In particular, if we fail to maintain the confidentiality of consumers’ personal or
financial information we obtain in the course of our business (such as social security numbers), we could be exposed to losses. A further
discussion of some of these risks is set forth in the risk factor titled “Maintaining cybersecurity is important to our business and a breach
of our cybersecurity could have a material adverse impact. Our technology infrastructure and systems are important and any significant
disruption or breach of the security of this infrastructure or these systems could have an adverse effect on our business. We also rely on
technology infrastructure and systems of third parties who provide services to us and with whom we transact business.”
Defending a lawsuit can consume significant resources and may divert management’s attention from our operations. We may be
required to establish or increase reserves for potential losses from litigation, which could be material. To the extent we are unsuccessful
in our defense of any lawsuit, we could suffer losses which could be in excess of any reserves established relating to that lawsuit) and
these losses could be material.
Litigation of the type initiated against various trustees of residential mortgage-backed securitization transactions issued prior to
financial crisis of 2007-2008 (“RMBS trustee litigation”) during 2017 negatively impacted, and could further negatively impact, the
value of securities we hold, could expose us to indemnification claims, and could impact the profitability of our participation in future
securitization transactions.
Litigation against RMBS trustees has related to, among other things, claims by certain investors in the RMBS issued in those
transactions that the trustees of those transactions breached their obligations to investors by, among other things, not appropriately
investigating and pursuing remedies against the originators and servicers of the underlying mortgage loans. We are not a party to any
RMBS trustee litigation; however, RMBS trustee litigation has negatively impacted the value of certain residential mortgage-backed
securities issued prior to the crisis (“legacy RMBS”) that were held in our investment portfolio during the year ended December 31, 2019.
The value of other legacy RMBS we continue to hold or acquire could be impacted in the future. In particular, trustees of various legacy
RMBS transactions that are the subject of the ongoing RMBS trustee litigation have withheld funds from investors in the RMBS issued
in those transactions by asserting that, pursuant to their indemnification rights against the securitization trusts established under the
applicable transaction documents, they are entitled to apply those funds to offset litigation expenses. Further, certain trustees have asserted
that their indemnification rights entitle them to withhold large lump sum amounts to hold and apply to anticipated future litigation
expenses. During the year ended December 31, 2019, these holdbacks resulted in an aggregate loss to the value of our portfolio of securities
of approximately $0.5 million, and other or similar holdbacks by that trustee or other trustees of legacy RMBS transactions could result
in further losses to the value of our portfolio of securities in the future, which losses could be material.
Our cash balances and cash flows may be insufficient relative to our cash needs.
We need cash to make interest payments, to post as collateral to counterparties and lenders who provide us with short-term debt
financing and who engage in other transactions with us, for working capital, to fund REIT dividend distribution requirements, to comply
with financial covenants and regulatory requirements, to fund general and administrative expenses, and for other needs and purposes.
We may also need cash to repay short-term borrowings when due or in the event the fair values of assets that serve as collateral for that
debt decline, the terms of short-term debt become less attractive, or for other reasons. In addition, we may need to use cash to post in
response to margin calls relating to various derivative instruments we hold as the values of these derivatives change. Over the longer
term, we may need cash to fund the repayment of outstanding convertible notes and exchangeable securities that mature in 2023, 2024,
and 2025.
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Our sources of cash flow include the principal and interest payments on the loans and securities we own, asset sales, securitizations,
short-term borrowing, issuing long-term debt, and issuing stock. Our sources of cash may not be sufficient to satisfy our cash needs. Cash
flows from principal repayments could be reduced if prepayments slow or if credit quality deteriorates. For example, for some of our
assets, cash flows are “locked-out” and we receive less than our pro-rata share of principal payment cash flows in the early years of the
investment.
Our minimum dividend distribution requirements could exceed our cash flows if our income as calculated for tax purposes significantly
exceeds our net cash flows. This could occur when taxable income (including non-cash income such as discount amortization and interest
accrued on negative amortizing loans) exceeds cash flows received. The Internal Revenue Code provides a limited relief provision
concerning certain items of non-cash income; however, this provision may not sufficiently reduce our cash dividend distribution
requirement. In the event that our liquidity needs exceed our access to liquidity, we may need to sell assets at an inopportune time, thus
reducing our earnings. In an adverse cash flow situation, we may not be able to sell assets effectively and our REIT status or our solvency
could be threatened. Further discussion of the risk associated with maintaining our REIT status is set forth in the risk factor titled “We
have elected to be taxed as a REIT and, as such, are required to meet certain tests in order to maintain our REIT status. This adds
complexity and costs to running our business and exposes us to additional risks.”
We are subject to competition and we may not compete successfully.
We are subject to competition in seeking investments, acquiring, originating, and selling loans, engaging in securitization transactions,
and in other aspects of our business. Our competitors include commercial banks, other mortgage REITs, Fannie Mae, Freddie Mac,
regional and community banks, broker-dealers, insurance companies, and other specialty finance companies and financial institutions,
as well as investment funds and other investors in real estate-related assets. In addition, other companies may be formed that will compete
with us. Some of our competitors have greater resources than us and we may not be able to compete successfully with them. Furthermore,
competition for investments, making loans, acquiring and selling loans, and engaging in securitization transactions may lead to a decrease
in the opportunities and returns available to us.
In addition, there are significant competitive threats to our business from governmental actions and initiatives that have already been
undertaken or which may be undertaken in the future. Sustained competition from governmental actions and initiatives could have a
material adverse effect on us. For example, Fannie Mae and Freddie Mac are, among other things, engaged in the business of acquiring
loans and engaging in securitization transactions. Until 2008, competition from Fannie Mae and Freddie Mac was limited to some extent
due to the fact that they were statutorily prohibited from purchasing loans for single unit residences in the continental United States with
a principal amount in excess of $417,000, while much of our business had historically focused on acquiring residential loans with a
principal amount in excess of that amount. In February 2008, Congress passed an economic stimulus package that temporarily increased
the size of certain loans these entities could purchase to up to $729,750, if the loans were made to secure real estate purchases in certain
high-cost areas of the U.S. Since 2008, the loan size limits for Fannie Mae and Freddie Mac purchases have been adjusted up and down,
and as of December 31, 2019, the maximum loan size limit was $ $765,600, which is an amount that continues to be above the historical
loan size limit. In addition, in September 2008, Fannie Mae and Freddie Mac were placed into conservatorship and have become, in
effect, instruments of the U.S. federal government.
Furthermore, it is unclear whether the Trump administration’s policies, and any future federal legislation or executive or regulatory
actions, regarding Fannie Mae and Freddie Mac will continue to maintain, or increase, the role of those entities in the housing finance
market. As long as there is governmental support for these entities to continue to operate and provide financing to a significant portion
of the mortgage finance market, they will represent significant business competition due to, among other things, their large size and low
cost of funding. Additionally, Trump administration policies, federal legislation, or executive or regulatory actions aimed at weakening
or dismantling the Dodd-Frank Act and its regulatory apparatus, including by reducing capital requirements on banking institutions or
by weakening the CFPB, its leadership, or its enforcement capabilities or priorities, could result in increased competition from commercial
banks and other large financial institutions that may have similar advantages due to their size and cost of capital. Further discussion is
set forth in the risk factor titled “Congress and President Trump’s administration have made and may continue to make substantial changes
to fiscal, tax, and other federal policies that may adversely affect our business.”
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To the extent that laws, regulations, or policies governing the business activities of Fannie Mae and Freddie Mac are not changed to
limit their role in housing finance (such as a change in these loan size limits or in the guarantee fees they charge), or the competition
from these two governmental entities will remain significant or could increase. In addition, to the extent that property values decline
while these loan size limits remain the same, it may have the same effect as an increase in this limit, as a greater percentage of loans
would likely be within the size limit. Any increase in the loan size limit, or in the overall percentage of loans that are within the limit,
allows Fannie Mae and Freddie Mac to compete against us to a greater extent than they had been able to compete previously and our
business could be adversely affected. Additionally, the Federal Housing Administration (FHA) and the Department of Veterans Affairs
(VA) guarantee qualified residential mortgages, and FHA and VA loans accounted for approximately 22% of the aggregate dollar value
of residential loans originated in the U.S. in 2018. The federal government’s ability to provide financing to a significant portion of the
mortgage finance market through these entities represents significant business competition due to, among other things, their size and low
cost of funding.
Our business model and business strategies, and the actions we take (or fail to take) to implement them and adapt them to changing
circumstances involve risk and may not be successful.
U.S. real estate markets, the mortgage industry and the related capital markets have undergone significant changes since the U.S.
financial crisis, including due to the significant governmental interventions in these areas and changes to the laws and regulations that
govern the banking and mortgage finance industry. Additionally, it remains unclear how the Trump administration’s policies, and any
future federal legislation or executive or regulatory actions, regarding Fannie Mae and Freddie Mac and the housing finance market more
broadly will impact that market and our business. Additional factors, including a rising or steady interest rate environment, which may
cause the volume of refinance loans to decline, and secular trends in consumer demand for renting versus owning a residence, may also
contribute to evolving conditions in the mortgage industry and capital markets. Our methods of, and model for, doing business and
financing our investments are changing and if we fail to develop, enhance, and implement strategies to adapt to changing conditions in
the mortgage industry and capital markets, our business and financial results may be adversely affected. Furthermore, changes we make
to our business to respond to changing circumstances may expose us to new or different risks than we were previously exposed to and
we may not effectively identify or manage those risks. Further discussion is set forth in the risk factor titled “Decisions we make about
our business strategy and investments, as well as decisions about raising capital or returning capital to shareholders (through dividends
or common stock repurchases), could fail to improve our business and results of operations.”
Similarly, the competitive landscape in which we operate and the products and investments for which we compete are also affected
by changing conditions. There may be trends or sudden changes in our industry or regulatory environment, changes in the role of
government-sponsored entities, such as Fannie Mae and Freddie Mac, changes in the role of credit rating agencies or their rating criteria
or processes, or changes in the U.S. economy more generally. If we do not effectively respond to these changes or if our strategies to
respond to these changes are not successful, our ability to effectively compete in the marketplace may be negatively impacted, which
would likely result in our business and financial results being adversely affected.
We have historically depended upon the issuance of mortgage-backed securities by the securitization entities we sponsor as a funding
source for our residential real estate-related business. However, due to market conditions, we did not engage in residential mortgage
securitization transactions in 2008 or 2009 and we only engaged in one residential mortgage securitization transaction in 2010 and two
residential mortgage securitization transactions in 2011. While we engaged in numerous residential mortgage securitization transactions
from 2012 through 2019, we do not know if market conditions will allow us to continue to regularly engage in these types of securitization
transactions and any disruption of this market may adversely affect our earnings and growth. For example, in each of 2014 and 2015, we
completed four securitization transactions, and in 2016 we completed three securitization transactions, as compared to 12 securitizations
in 2013, nine securitizations in 2017, 12 securitizations in 2018, and nine securitizations in 2019 (including eight Sequoia transactions
and one CAFL transaction following our acquisition of CoreVest). Even if regular residential and business-purpose mortgage loan
securitization activity continues among market participants other than government-sponsored entities, we do not know if it will continue
to be on terms and conditions that will permit us to participate or be favorable to us. Even if conditions are favorable to us, we may not
be able to return to or sustain the volume of securitization activity we previously conducted. Additionally, securities collateralized by
business-purpose loans such as those issued by our CAFL entities make up a small portion of the total volume of mortgage-backed
securities issuance. The market for such securities is not as mature as the market for residential mortgage-backed securities and dislocations
in this market or a change in the risk tolerance of investors or the perception of risk related to business-purpose mortgage-backed securities
may negatively impact our ability to grow or sustain the volume of business-purpose mortgage-backed securities we issue, which may
result in our business and financial results being adversely affected.
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Initiating new business activities or significantly expanding existing business activities may expose us to new risks and will increase
our cost of doing business.
Initiating new business activities or significantly expanding existing business activities, including through acquisitions, are two ways
to grow our business and respond to changing circumstances in our industry; however, they may expose us to new risks and regulatory
compliance requirements. We cannot be certain that we will be able to manage these risks and compliance requirements effectively.
Furthermore, our efforts may not succeed and any revenues we earn from any new or expanded business initiative may not be sufficient
to offset the initial and ongoing costs of that initiative, which would result in a loss with respect to that initiative.
For example, since December 2017, we have announced several new initiatives to expand our mortgage banking and investment
activities, including by expanding our mortgage loan purchase activity to include business-purpose loans secured by non-owner occupied
rental properties and residential bridge loans, completing the acquisitions of two business-purpose real estate loan origination platforms,
CoreVest and 5 Arches, through which we now originate business-purpose loans, and increasing the size and optimizing the target returns
of our investment portfolio. We also recently completed investments in subordinate securities backed by re-performing and non-performing
residential loans, multifamily securities, shared equity appreciation real estate option contracts, excess MSR and servicer advance
investments collateralized by residential and multifamily loans, and a whole loan investment fund created to acquire light-renovation
multifamily loans. Further discussion of these business changes is set forth in the risk factor titled “Decisions we make about our business
strategy and investments, as well as decisions about raising capital or returning capital to shareholders (through dividends or common
stock repurchases), could fail to improve our business and results of operations.”
In connection with initiating new business activities or expanding existing business activities, or for other business reasons, we may
create new subsidiaries. Frequently, these subsidiaries would be wholly-owned, directly or indirectly, by Redwood, but we may also
create or participate in partnerships and joint ventures with third-party co-investors and in those cases, the entities may be partially-owned
by Redwood. The creation of those subsidiaries may increase our administrative costs and expose us to other legal and reporting obligations,
including, for example, because they may be incorporated in states other than Maryland or may be established in a foreign jurisdiction.
Any new subsidiary we create may elect, together with us, to be treated as our taxable REIT subsidiary. Taxable REIT subsidiaries are
wholly-owned or partially-owned subsidiaries of a REIT that pay corporate income tax on the income they generate. A taxable REIT
subsidiary is not able to deduct its dividends paid to its parent in determining its taxable income and any dividends paid to the parent are
generally recognized as income at the parent level.
Our future success depends on our ability to attract and retain key personnel.
Our future success depends on the continued service and availability of skilled personnel, including our executive officers and other
leaders that are part of our management team. To the extent personnel we attempt to hire, or have already hired, are concerned that
economic, regulatory, or other factors could impact our ability to maintain or expand our current level of business, it could negatively
impact our ability to hire or retain the personnel we need to operate our business. We cannot assure you that we will be able to attract
and retain key personnel. Additionally, to the extent our management or personnel are impacted in significant numbers by the outbreak
of pandemic or epidemic disease, such as the coronavirus or COVID-19, our business and operating results may be negatively impacted.
We may not be able to obtain or maintain the governmental licenses required to operate our business and we may fail to comply with
various state and federal laws and regulations applicable to our business of acquiring residential mortgage loans and servicing rights
and originating business-purpose real estate loans. We are approved to service residential mortgage loans sold to Freddie Mac and
Fannie Mae and failure to maintain our status as an approved servicer could harm our business.
While we are not required to obtain licenses to purchase mortgage-backed securities, the purchase of residential and business-purpose
mortgage loans in the secondary market, and the origination of business-purpose loans, may, in some circumstances, require us to maintain
various state licenses. Acquiring the right to service residential mortgage loans and certain business-purpose mortgage loans may also,
in some circumstances, require us to maintain various state licenses even though we currently do not expect to directly engage in loan
servicing ourselves. As a result, we could be delayed in conducting certain business if we were first required to obtain a state license. We
cannot assure you that we will be able to obtain all of the licenses we need or that we would not experience significant delays in obtaining
these licenses. Furthermore, once licenses are issued we are required to comply with various information reporting and other regulatory
requirements to maintain those licenses, and there is no assurance that we will be able to satisfy those requirements or other regulatory
requirements applicable to our business of acquiring mortgage loans on an ongoing basis. Our failure to obtain or maintain required
licenses or our failure to comply with regulatory requirements that are applicable to our business of acquiring or originating mortgage
loans may restrict our business and investment options and could harm our business and expose us to penalties or other claims.
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For example, under the Dodd-Frank Act, the CFPB also has regulatory authority over certain aspects of our business as a result of
our residential mortgage banking activities, including, without limitation, authority to bring an enforcement action against us for failure
to comply with regulations promulgated by the CFPB that are applicable to our business. One of the CFPB’s areas of focus has been on
whether companies like Redwood take appropriate steps to ensure that business arrangements with service providers do not present risks
to consumers. The sub-servicers we retain to directly service residential mortgage loans (when we own the associated MSRs) are among
our most significant service providers with respect to our residential mortgage banking activities and our failure to take steps to ensure
that these sub-servicers are servicing these residential mortgage loans in accordance with applicable law and regulation could result in
enforcement action by the CFPB against us that could restrict our business, expose us to penalties or other claims, negatively impact our
financial results, and damage our reputation.
As another example, rules under the Home Mortgage Disclosure Act (HMDA) that took effect in January 2018 impose expanded
data collection requirements and additional reporting obligations on mortgage lenders and purchasers of residential mortgage loans. The
expanded data collection requirements may result in a higher frequency of data errors, which in turn could be perceived by regulators as
an indication of inadequate controls and poor compliance processes, and could lead to monetary civil penalties. Additionally, the availability
of increased amounts of data may increase regulatory scrutiny of our mortgage loan purchasing patterns. In addition, the Equal Credit
Opportunity Act, and other Federal and state laws and regulations that apply to certain of our investment and business activities, include
consumer protections relating to discrimination, abusive and deceptive practices, and other consumer-related matters. To the extent these
laws and regulations apply to us, our failure to comply with them, even if not intentional, could give rise to liabilities, fines, and remediation
requirements, which could be material. Failure to comply with these laws and regulations could also result for incorrectly concluding
that certain aspects of our investment and business activities are not subject to certain laws or regulations.
In addition, we are a servicer approved to service residential mortgage loans sold to Freddie Mac and Fannie Mae. As an approved
servicer, we are required to conduct certain aspects of our operations in accordance with applicable policies and guidelines published by
Freddie Mac and Fannie Mae. Failure to maintain our status as an approved servicer would mean we would not be able to service mortgage
loans for these entities, or could otherwise restrict our business and investment options and could harm our business and expose us to
losses or other claims.
With respect to mortgage loans we own, or which we have purchased and subsequently sold, we may be subject to liability for potential
violations of the CFPB’s TILA-RESPA Integrated Disclosure rule (also referred to as “TRID”) or other similar consumer protection
laws and regulations, which could adversely impact our business and financial results.
Federal consumer protection laws and regulations have been enacted and promulgated that are designed to regulate residential
mortgage loan underwriting and originators’ lending processes, standards, and disclosures to borrowers. These laws and regulations
include the CFPB’s “TRID”, “ability-to-repay” and “qualified mortgage” regulations. In addition, there are various other federal, state,
and local laws and regulations that are intended to discourage predatory lending practices by residential mortgage loan originators. For
example, the federal Home Ownership and Equity Protection Act of 1994 (HOEPA) prohibits inclusion of certain provisions in residential
mortgage loans that have mortgage rates or origination costs in excess of prescribed levels and requires that borrowers be given certain
disclosures prior to origination. Some states have enacted, or may enact, similar laws or regulations, which in some cases may impose
restrictions and requirements greater than those in place under federal laws and regulations. In addition, under the anti-predatory lending
laws of some states, the origination of certain residential mortgage loans, including loans that are classified as “high cost” loans under
applicable law, must satisfy a net tangible benefits test with respect to the borrower. This test, as well as certain standards set forth in the
“ability-to-repay” and “qualified mortgage” regulations, may be highly subjective and open to interpretation. As a result, a court may
determine that a residential mortgage loan did not meet the standard or test even if the originator reasonably believed such standard or
test had been satisfied. Failure of residential mortgage loan originators or servicers to comply with these laws and regulations could
subject us, as an assignee or purchaser of these loans (or as an investor in securities backed by these loans), to monetary penalties and
defenses to foreclosure, including by recoupment or setoff of finance charges and fees collected, and could result in rescission of the
affected residential mortgage loans, which could adversely impact our business and financial results.
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Environmental protection laws that apply to properties that secure or underlie our loan and investment portfolio could result in losses
to us. We may also be exposed to environmental liabilities with respect to properties we become direct or indirect owners of or to which
we take title, which could adversely affect our business and financial results.
Under the laws of several states, contamination of a property may give rise to a lien on the property to secure recovery of the cleanup
costs. In certain of these states, such a lien has priority over the lien of an existing mortgage against the property, which could impair the
value of an investment in a security we own backed by such a property or could reduce the value of such a property that underlies loans
we have made or own. In addition, under the laws of some states and under the federal Comprehensive Environmental Response,
Compensation and Liability Act of 1980, we may be liable for costs of addressing releases or threatened releases of hazardous substances
that require remedy at a property securing or underlying a loan we hold if our agents or employees have become sufficiently involved in
the hazardous waste aspects of the operations of the borrower of that loan, regardless of whether or not the environmental damage or
threat was caused by us or the borrower.
In the course of our business, we may take title to real estate or may otherwise become direct or indirect owners of real estate. If we
do take title or become a direct or indirect owner, we could be subject to environmental liabilities with respect to the property, including
liability to a governmental entity or third parties for property damage, personal injury, investigation, and clean-up costs. In addition, we
may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with
investigation or remediation activities could be substantial. If we ever become subject to significant environmental liabilities, our business
and financial results could be materially and adversely affected.
Maintaining cybersecurity is important to our business and a breach of our cybersecurity could have a material adverse impact on
our business and financial results. Our technology infrastructure and systems are important and any significant disruption or breach
of the security of this infrastructure or these systems could have an adverse effect on our business. We also rely on technology
infrastructure and systems of third parties who provide services to us and with whom we transact business.
When we acquire or originate real estate mortgage loans, or the rights to service mortgage loans, we come into possession of borrower
non-public personal information that an identity thief could utilize in engaging in fraudulent activity or theft. We may share this information
with third parties, such as loan sub-servicers, outside vendors, third parties interested in acquiring such loans from us, or lenders extending
credit to us collateralized by such loans. We have acquired more than 100,000 residential mortgage loans and rights to service residential
mortgage loans since 2010 and have also acquired or originated thousands of these or other types of mortgage loans prior to and following
2010.
While we have security measures in place to protect this information and prevent security breaches, these security measures may be
compromised as a result of third-party action, including intentional misconduct by computer hackers, cyber-attacks, "phishing" attacks,
service provider or vendor error, or malfeasance or other intentional or unintentional acts by third parties and bad actors, including third-
party service providers. Furthermore, borrower data, including personally identifiable information, may be lost, exposed, or subject to
unauthorized access or use as a result of accidents, errors, or malfeasance by our employees, independent contractors, or others working
with us or on our behalf. Our servers and systems, and those of our service providers, may be vulnerable to computer malware, break-
ins, denial-of-service attacks, and similar disruptions from unauthorized tampering with our computer systems, which could result in
someone obtaining unauthorized access to borrowers’ data or our data, including other confidential business information. In the past, we
have experienced unauthorized access to certain data and information. Our response was to take immediate steps to investigate and address
the unauthorized access, and past unauthorized access has not had, and is not expected to have, a material adverse effect on our business
and financial results. We have further developed and enhanced our cybersecurity systems and processes that are intended to protect this
type of data and information; however, they may not be effective in preventing unauthorized access in the future. While past unauthorized
access has been immaterial to our business and financial results, there can be no assurance of a similar result in the future. Furthermore,
because the techniques used to obtain unauthorized access to, or to sabotage, systems change frequently and often are not recognized
until launched against a target, we may be unable to anticipate these techniques or implement adequate preventative measures. We may
also experience security breaches that may remain undetected for an extended period.
We may be liable for losses suffered by individuals whose identities are stolen as a result of a breach of the security of the systems
that we or third-parties and service providers of ours store this information on, and any such liability could be material. Even if we are
not liable for such losses, any breach of these systems could expose us to material costs in notifying affected individuals and providing
credit monitoring services to them, as well as regulatory fines or penalties. In addition, any breach of these systems could disrupt our
normal business operations and expose us to reputational damage and lost business, revenues, and profits. Any insurance we maintain
against the risk of this type of loss may not be sufficient to cover actual losses, or may not apply to the circumstances relating to any
particular breach.
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In addition, in order to analyze, acquire, and manage our investments, manage the operations and risks associated with our business,
assets, and liabilities, and prepare our financial statements we rely upon computer hardware and software systems. Some of these systems
are located at our offices and some are maintained by third party vendors or located at facilities maintained by third parties. We also rely
on technology infrastructure and systems of third parties who provide services to us and with whom we transact business. Any significant
interruption in the availability or functionality of these systems could impair our access to liquidity, damage our reputation, and have an
adverse effect on our operations and on our ability to timely and accurately report our financial results.
In addition, any breach of the security of these systems could have an adverse effect on our operations and the preparation of our
financial statements. Steps we have taken to provide for the security of our systems and data may not effectively prevent others from
obtaining improper access to our systems data. Improper access could expose us to risks of data loss, reputational damage, increased
regulatory scrutiny, litigation, and liabilities to third parties, and otherwise disrupt our operations.
Our business could be adversely affected by deficiencies in our disclosure controls and procedures or internal controls over financial
reporting.
The design and effectiveness of our disclosure controls and procedures and internal controls over financial reporting may not prevent
all errors, misstatements, or misrepresentations. While management continues to review the effectiveness of our disclosure controls and
procedures and internal controls over financial reporting, there can be no assurance that our disclosure controls and procedures or internal
controls over financial reporting will be effective in accomplishing all control objectives all of the time. Additionally, since our acquisitions
of 5 Arches and CoreVest in 2019, we have been integrating these platforms into our enterprise, including as it relates to disclosure
controls and procedures and internal controls over financial reporting. However, for the year-ended December 31, 2019, we have elected
to exclude CoreVest from management’s report on internal controls over financial reporting, pursuant to an exemption from compliance
with section 404 of the Sarbanes-Oxley Act for newly-acquired companies. Deficiencies, particularly material weaknesses or significant
deficiencies, in internal controls over financial reporting which have occurred or which may occur in the future could result in misstatements
of our financial results, restatements of our financial statements, a decline in our stock price, or an otherwise material and adverse effect
on our business, reputation, financial results, or liquidity and could cause investors and creditors to lose confidence in our reported
financial results.
Our risk management efforts may not be effective.
We could incur substantial losses and our business operations could be disrupted if we are unable to effectively identify, manage,
monitor, and mitigate financial risks, such as credit risk, interest rate risk, prepayment risk, liquidity risk, and other market-related risks,
as well as operational risks related to our business, assets, and liabilities, such as mortgage operations risk, legal and compliance risk,
human resources-related risk, cybersecurity and technology-related risk, and financial reporting risk. Our risk management policies,
procedures, and techniques may not be sufficient to identify all of the risks we are exposed to, mitigate the risks we have identified for
mitigation, or to identify additional risks to which we may become subject in the future. Expansion of our business activities, including
through acquisitions such as our acquisitions of 5 Arches and CoreVest, generally also results in our being exposed to risks that we have
not previously been exposed to or may increase our exposure to certain types of risks and we may not effectively identify, manage,
monitor, and mitigate these risks as our business activity changes or increases. Further discussion is set forth in the risk factor titled
“Initiating new business activities or significantly expanding existing business activities may expose us to new risks and will increase
our cost of doing business.”
We could be harmed by misconduct or fraud that is difficult to detect.
We are exposed to risks relating to misconduct by our employees, contractors we use, or other third parties with whom we have
relationships. For example, our employees could execute unauthorized transactions, use our assets improperly or without authorization,
perform improper activities, use confidential information for improper purposes, or mis-record or otherwise try to hide improper activities
from us. This type of misconduct could also relate to loan administration services that we provide for others. This type of misconduct
can be difficult to detect and if not prevented or detected could result in claims or enforcement actions against us or losses. Accordingly,
misconduct by employees, contractors, or others could subject us to losses or regulatory sanctions and seriously harm our reputation.
Our controls may not be effective in detecting this type of activity.
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Inadvertent errors, including, for example, errors in the implementation of information technology systems, could subject us to
financial loss, litigation, or regulatory action.
Our employees, contractors we use, or other third parties with whom we have relationships may make inadvertent errors that could
subject us to financial losses, claims, or enforcement actions. These types of errors could include, but are not limited to, mistakes in
executing, recording, or reporting transactions we enter into for ourselves or with respect to assets we manage for others. Errors in the
implementation of information technology systems, compliance systems and procedures, or other operational systems and procedures
could also interrupt our business or subject us to financial losses, claims, or enforcement actions. Errors could also result in the inadvertent
disclosure of mortgage-borrower non-public personal information. Inadvertent errors expose us to the risk of material losses until the
errors are detected and remedied prior to the incurrence of any loss. The risk of errors may be greater for business activities that are new
for us or have non-standardized terms, for areas of our business that we are expanding, or for areas of our business that rely on new
employees or on third parties that we have only recently established relationships with.
Our business may be adversely affected if our reputation is harmed.
Our business is subject to significant reputational risks. If we fail, or appear to fail, to address various issues that may affect our
reputation, our business could be harmed. Issues could include real or perceived legal or regulatory violations or be the result of a failure
in governance, risk-management, technology, or operations. Similarly, market rumors and actual or perceived association with
counterparties whose own reputation is under question could harm our business. Lawsuits brought against us (or the resolution of lawsuits
brought against us), claims of employee misconduct, claims of wrongful termination, adverse publicity, conflicts of interest, ethical issues,
or failure to maintain the security of our information technology systems or to protect non-public personal information could also cause
significant reputational damages. Such reputational damage could result not only in an immediate financial loss, but could also result in
a loss of business relationships, the ability to raise capital, and the ability to access liquidity through borrowing facilities.
Our financial results are determined and reported in accordance with generally accepted accounting principles (and related
conventions and interpretations), or GAAP, and are based on estimates and assumptions made in accordance with those principles,
conventions, and interpretations. Furthermore, the amount of dividends we are required to distribute as a REIT is driven by the
determination of our income in accordance with the Internal Revenue Code rather than GAAP.
Our reported GAAP financial results differ from the taxable income results that drive our dividend distribution requirements and, therefore,
our GAAP results may not be an accurate indicator of taxable income and dividend distributions.
Generally, the cumulative income we report relating to an investment asset will be the same for GAAP and tax purposes, although
the timing of this recognition over the life of the asset could be materially different. There are, however, certain permanent differences
in the recognition of certain expenses under the respective accounting principles applied for GAAP and tax purposes and these differences
could be material. Thus, the amount of GAAP earnings reported in any given period may not be indicative of future dividend distributions.
A further explanation of differences between our GAAP and taxable income is presented in “Management’s Discussion and Analysis of
Financial Condition and Results of Operations,” which is set forth in Part II, Item 7 of this Annual Report on Form 10-K.
Our minimum dividend distribution requirements are determined under the REIT tax laws and are based on our REIT taxable income
as calculated for tax purposes pursuant to the Internal Revenue Code. Our Board of Directors may also decide to distribute more dividends
than required based on these determinations. One should not expect that our retained GAAP earnings will equal cumulative distributions,
as the Board of Directors’ dividend distribution decisions, permanent differences in GAAP and tax accounting, and even temporary
differences may result in material differences in these balances.
Over time, accounting principles, conventions, rules, and interpretations may change, which could affect our reported GAAP and taxable
earnings and stockholders’ equity.
Accounting rules for the various aspects of our business change from time to time. Changes in GAAP, or the accepted interpretation
of these accounting principles, can affect our reported income, earnings, and stockholders’ equity. In addition, changes in tax accounting
rules or the interpretations thereof could affect our taxable income and our dividend distribution requirements. Predicting and planning
for these changes can be difficult.
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Risks Related to Redwood's Capital, REIT and Legal/Organizational Structure
We have elected to be taxed as a REIT and, as such, are required to meet certain tests in order to maintain our REIT status. This adds
complexity and costs to running our business and exposes us to additional risks.
Failure to qualify as a REIT could adversely affect our net income and dividend distributions and could adversely affect the value of our
common stock.
We have elected to be taxed as a REIT for federal income tax purposes for all tax years since 1994. However, many of the requirements
for qualification as a REIT are highly technical and complex and require an analysis of particular facts and an application of the legal
requirements to those facts in situations where there is only limited judicial and administrative guidance. Thus, we cannot assure you
that the Internal Revenue Service (the “IRS”) or a court would agree with our conclusion that we have qualified as a REIT historically,
or that changes to our investments or business or the law will not cause us to fail to qualify as a REIT in the future. Furthermore, in an
environment where assets may quickly change in value, previous planning for compliance with REIT qualification rules may be disrupted.
If we failed to qualify as a REIT for federal income tax purposes and did not meet the requirements for statutory relief, we would be
subject to federal corporate income tax on our taxable income, and we would not be allowed a deduction for distributions to shareholders
in computing our taxable income. In such a case, we may need to borrow money or sell assets in order to pay the taxes due, even if the
market conditions are not favorable for such sales or borrowings. In addition, unless we are entitled to relief under applicable statutory
provisions, we could not elect to be taxed as a REIT for four years thereafter. Failure to qualify as a REIT could adversely affect our
dividend distributions and could adversely affect the value of our common stock.
Maintaining REIT status and avoiding the generation of excess inclusion income at Redwood Trust, Inc. and certain of our subsidiaries
may reduce our flexibility and could limit our ability to pursue certain opportunities. Failure to appropriately structure our business and
transactions to comply with laws and regulations applicable to REITs could have adverse consequences.
To maintain REIT status, we must follow certain rules and meet certain tests. In doing so, our flexibility to manage our operations
may be reduced. For instance:
• Compliance with the REIT income and asset rules, or uncertainty about the application of those rules to certain investments,
may result in our holding investments in our taxable REIT subsidiaries (where any income they produce is subject to corporate-
level taxation) when we would prefer to hold those investments in an entity that is taxed as a REIT (where they would not be
subject to corporate-level taxation).
• Compliance with the REIT income and asset rules may limit the type or extent of financing or hedging that we can undertake.
• Our ability to own non-real estate assets and earn non-real estate related income is limited, and the rules for classifying assets
and income are complicated. Our ability to own equity interests in other entities is also limited. If we fail to comply with these
limits, we may be forced to liquidate attractive investments on short notice on unfavorable terms in order to maintain our REIT
status.
• We generally use taxable REIT subsidiaries to own non-real estate assets and engage in activities that may give rise to non-real
estate related income under the REIT rules. However, our ability to invest in taxable REIT subsidiaries is limited under the REIT
rules. No more than 20% of the value of our total assets can be represented by securities of one or more taxable REIT subsidiaries.
Maintaining compliance with this limit could require us to constrain the growth of our taxable REIT subsidiaries (and the business
and investing activities they conduct) in the future.
• Meeting minimum REIT dividend distribution requirements could reduce our liquidity. We may earn non-cash REIT taxable
income due to timing and/or character mismatches between the computation of our income for tax and accounting purposes.
Earning non-cash REIT taxable income could necessitate our selling assets, incurring debt, or raising new equity in order to
fund dividend distributions.
• We could be viewed as a “dealer” with respect to certain transactions and become subject to a 100% prohibited transaction tax
or other entity-level taxes on income from such transactions.
Furthermore, the rules we must follow and the tests we must satisfy to maintain our REIT status may change, or the interpretation
of these rules and tests by the IRS may change.
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In addition, our stated goal has been to not generate excess inclusion income at Redwood Trust, Inc. and certain of its subsidiaries
that would be taxable as unrelated business taxable income (“UBTI”) to our tax-exempt shareholders. Achieving this goal has limited,
and may continue to limit, our flexibility in pursuing certain transactions or has resulted in, and may continue to result in, our having to
pursue certain transactions through a taxable REIT subsidiary, which would reduce the net returns on these transactions by the associated
tax liabilities payable by such subsidiary. Despite our efforts to do so, we may not be able to avoid creating or distributing UBTI to our
shareholders.
To maintain our REIT status, we may be forced to borrow funds during unfavorable market conditions, and the unavailability of such
capital on favorable terms at the desired times, or at all, may cause us to curtail our investment activities and/or to dispose of assets at
inopportune times, which could adversely affect our financial condition, results of operations, cash flow and per share trading price of
our common stock.
To qualify as a REIT, we generally must distribute to our shareholders at least 90% of our REIT taxable income each year (excluding
any net capital gains), and we will be subject to regular corporate income taxes to the extent that we distribute less than 100% of our
REIT taxable income each year. In addition, we will be subject to a 4% nondeductible excise tax on the amount, if any, by which
distributions we pay in any calendar year are less than the sum of 85% of our ordinary income, 95% of our net capital gains, and 100%
of our undistributed income from prior years. To maintain our REIT status and avoid the payment of federal income and excise taxes,
we may need to borrow funds to meet the REIT distribution requirements, even if the then-prevailing market conditions are not favorable
for these borrowings. These borrowing needs could result from differences in timing between the actual receipt of income and inclusion
of income for federal income tax purposes. For example, we may be required to accrue interest and discount income on mortgage loans,
MBS, and other types of debt securities or interests in debt securities before we receive any payments of interest or principal on such
assets. Our access to third-party sources of capital depends on a number of factors, including the market’s perception of our growth
potential, our current debt levels, the market price of our common stock, and our current and potential future earnings. We cannot assure
you that we will have access to such capital on favorable terms at the desired times, or at all, which may cause us to curtail our investment
activities and/or to dispose of assets at inopportune times, and could adversely affect our financial condition, results of operations, cash
flow and per share trading price of our common stock.
Dividends payable by REITs, including us, generally do not qualify for the reduced tax rates available for some dividends.
The maximum U.S. federal income tax rate for qualified dividends paid by domestic non-REIT corporations to U.S. stockholders
that are individuals, trust or estates is generally 20%. Although dividends paid by REITs to such stockholders are generally not eligible
for that rate (subject to limited exceptions), under the Tax Act, such stockholders may deduct up to 20% of ordinary dividends from a
REIT for taxable years beginning after December 31, 2017 and before January 1, 2026. Although this deduction reduces the effective tax
rate applicable to certain dividends paid by REITs, such tax rate is still higher than the tax rate applicable to regular corporate qualified
dividends. This may cause investors to view REIT investments as less attractive than investments in non-REIT corporations, which in
turn may adversely affect the value of shares of REITs, including the shares of our common stock.
The failure of mortgage loans or MBS subject to a repurchase agreement or a mezzanine loan to qualify as a real estate asset would
adversely affect our ability to qualify as a REIT.
When we enter into short-term financing arrangements in the form of repurchase agreements, we will sell certain of our assets to a
counterparty and simultaneously enter into an agreement to repurchase the sold assets. We believe that we will be treated for U.S. federal
income tax purposes as the owner of the assets that are the subject of any such agreements notwithstanding that such agreements may
transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could
assert that we did not own the assets during the term of the repurchase agreement, in which case we could fail to qualify as a REIT.
In addition, we have and may continue to acquire multifamily mezzanine loans. Multifamily mezzanine loans are loans secured by
equity interests in a partnership or limited liability company that directly or indirectly owns real estate. In Revenue Procedure 2003-65,
the IRS provided a safe harbor pursuant to which a mezzanine loan, if it meets each of the requirements contained in the Revenue
Procedure, will be treated by the IRS as a real estate asset for purposes of the REIT asset tests, and interest derived from the mezzanine
loan will be treated as qualifying mortgage interest for purposes of the REIT 75% gross income test. Although the Revenue Procedure
provides a safe harbor on which taxpayers may rely, it does not prescribe rules of substantive tax law. We believe that the mezzanine
loans that we have treated as real estate assets generally met all of the requirements for reliance on this safe harbor. However, there can
be no assurance that the IRS will not challenge the tax treatment of these mezzanine loans, and if such a challenge were sustained, we
could in certain circumstances be required to pay a penalty tax or fail to qualify as a REIT.
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Changes in tax rules could adversely affect REITs and could adversely affect the value of our common stock.
The rules addressing federal income taxation are constantly under review by persons involved in the legislative process and by the
IRS and the U.S. Department of the Treasury. Any future changes in the regulations or tax laws applicable to REITs or to mortgage related
financial products could negatively impact our operations or reduce any competitive advantages we may have relative to non-REIT
entities, either of which could reduce the value of our common stock.
The Tax Act significantly changed the U.S. federal income taxation of U.S. businesses and their owners, including REITs and their
stockholders. The Tax Act remains unclear in some respects and could be subject to potential amendments and technical corrections, as
well as interpretations and implementing regulations by the Treasury and IRS, any of which could lessen or increase its impact. In addition,
it remains unclear how these U.S. federal income tax changes will affect state and local taxation, which often uses federal taxable income
as a starting point for computing state and local tax liabilities. Some of the changes made by the tax legislation may adversely affect us
in one or more reporting periods and prospectively. We continue to work with our tax advisors and auditors to determine the full impact
that the Tax Act as a whole will have on us.
The application of the tax laws to our business is complicated, and we may not interpret and apply some of the rules and regulations
correctly. In addition, we may not make all available elections, which could result in our not being able to fully benefit from available
deductions or benefits. Furthermore, the elections, interpretations and applications we do make could be deemed by the IRS to be incorrect
and could have adverse impacts on our GAAP earnings and potentially on our REIT status.
The Internal Revenue Code may change and/or the interpretation of the rules and regulations by the IRS may change. In circumstances
where the application of these rules and regulations affecting our business is not clear, we may have to interpret them and their application
to us. We seek the advice of outside tax advisors in arriving at these interpretations, but our interpretations may prove to be wrong, which
could have adverse consequences.
Our tax payments and dividend distributions, which are intended to meet the REIT distribution requirements, are based in large part
on our estimate of taxable income which includes the application and interpretation of a variety of tax rules and regulations. While there
are some relief provisions should we incorrectly interpret certain rules and regulations, we may not be able to fully take advantage of
these provisions, and this could have an adverse effect on our REIT status. In addition, our GAAP earnings include tax provisions and
benefits based on our estimates of taxable income and should our estimates prove to be wrong, we could have to make an adjustment to
our tax provisions and this adjustment could be material.
Our decisions about raising, managing, and distributing our capital may adversely affect our business and financial results.
Furthermore, our growth may be limited if we are not able to raise additional capital.
We are required to distribute at least 90% of our REIT taxable income as dividends to shareholders. Thus, we do not generally have
the ability to retain all of the earnings generated by our REIT and, to a large extent, we rely on our ability to raise capital to grow. We
may raise capital through the issuance of new shares of our common stock, either through our direct stock purchase and dividend
reinvestment plan or through public or private offerings. We may also raise capital by issuing other types of securities, such as preferred
stock, convertible or exchangeable debt, or other types of debt securities. As of February 26, 2020, we had approximately 156 million
unissued shares of stock authorized for issuance under our charter (although approximately 55 million of these shares are reserved for
issuance under our equity compensation plans, dividend reinvestment and stock purchase plan, ATM offering program, and outstanding
convertible notes and exchangeable notes). The number of our unissued shares of stock authorized for issuance establishes a limit on the
amount of capital we can raise through issuances of shares of stock or securities convertible into, or exchangeable for, shares of stock,
unless we seek and receive approval from our shareholders to increase the authorized number of our shares in our charter. Also, certain
stock change of ownership tests may limit our ability to raise significant amounts of equity capital or could limit our future use of tax
losses to offset income tax obligations if we raise significant amounts of equity capital.
In addition, we may not be able to raise capital at times when we need capital or see opportunities to invest capital. Many of the
same factors that could make the pricing for investments in real estate loans and securities attractive, such as the availability of assets
from distressed owners who need to liquidate them at reduced prices, and uncertainty about credit risk, housing, and the economy, may
limit investors’ and lenders’ willingness to provide us with additional capital on terms that are favorable to us, if at all. There may be
other reasons we are not able to raise capital and, as a result, may not be able to finance growth in our business and in our portfolio of
assets. If we are unable to raise capital and expand our business and our portfolio of investments, our growth may be limited, we may
have to forgo attractive business and investment opportunities, and our general and administrative expenses may increase significantly
relative to our capital base. Alternatively, we may need to raise capital on unfavorable terms, which may lead to greater dilution of existing
shareholders, higher interest costs, or higher transaction costs.
41
To the extent we have capital that is available for investment, we have broad discretion over how to invest that capital and our
shareholders and other investors will be relying on the judgment of our management regarding its use. To the extent we invest capital in
our business or in portfolio assets, we may not be successful in achieving favorable returns.
Conducting our business in a manner so that we are exempt from registration under, and in compliance with, the Investment Company
Act may reduce our flexibility and could limit our ability to pursue certain opportunities. At the same time, failure to continue to
qualify for exemption from the Investment Company Act could adversely affect us.
Under the Investment Company Act, an investment company is required to register with the SEC and is subject to extensive restrictive
and potentially adverse regulations relating to, among other things, operating methods, management, capital structure, dividends, and
transactions with affiliates. However, companies primarily engaged in the business of acquiring mortgages and other liens on and interests
in real estate are generally exempt from the requirements of the Investment Company Act. We believe that we have conducted our business
so that we are not subject to the registration requirements of the Investment Company Act. In order to continue to do so, however, Redwood
and each of our subsidiaries must either operate so as to fall outside the definition of an investment company under the Investment
Company Act or satisfy its own exclusion under the Investment Company Act. For example, to avoid being defined as an investment
company, an entity may limit its ownership or holdings of investment securities to less than 40% of its total assets. In order to satisfy an
exclusion from being defined as an investment company, other entities, among other things, maintain at least 55% of their assets in certain
qualifying real estate assets (the 55% Requirement) and also maintain an additional 25% of their assets in such qualifying real estate
assets or certain other types of real estate-related assets (the 25% Requirement). Rapid changes in the values of assets we own, however,
can disrupt prior efforts to conduct our business to meet these requirements.
If Redwood or one of our subsidiaries fell within the definition of an investment company under the Investment Company Act and
failed to qualify for an exclusion or exemption, including, for example, if it was required to and failed to meet the 55% Requirement or
the 25% Requirement, it could, among other things, be required either (i) to change the manner in which it conducts operations to avoid
being required to register as an investment company or (ii) to register as an investment company, either of which could adversely affect
us by, among other things, requiring us to dispose of certain assets or to change the structure of our business in ways that we may not
believe to be in our best interests. Legislative or regulatory changes relating to the Investment Company Act or which affect our efforts
to qualify for exclusions or exemptions, including our ability to comply with the 55% Requirement and the 25% Requirement, could also
result in these adverse effects on us.
If we were deemed an unregistered investment company, we could be subject to monetary penalties and injunctive relief and we
could be unable to enforce contracts with third parties and third parties could seek to obtain rescission of transactions undertaken during
the period we were deemed an unregistered investment company, unless the court found that under the circumstances, enforcement (or
denial of rescission) would produce a more equitable result than no enforcement (or grant of rescission) and would not be inconsistent
with the Investment Company Act.
Provisions in our charter and bylaws and provisions of Maryland law may limit a change in control or deter a takeover that might
otherwise result in a premium price being paid to our shareholders for their shares in Redwood.
In order to maintain our status as a REIT, not more than 50% in value of our outstanding capital stock may be owned, actually or
constructively, by five or fewer individuals (defined in the Internal Revenue Code to include certain entities). In order to protect us against
the risk of losing our status as a REIT due to concentration of ownership among our shareholders and for other reasons, our charter
generally prohibits any single shareholder, or any group of affiliated shareholders, from beneficially owning more than 9.8% of the
outstanding shares of any class of our stock, unless our Board of Directors waives or modifies this ownership limit. This limitation may
have the effect of precluding an acquisition of control of us by a third party without the consent of our Board of Directors. Our Board of
Directors has granted a limited number of waivers to institutional investors to own shares in excess of this 9.8% limit, which waivers are
subject to certain terms and conditions. Our Board of Directors may amend these existing waivers to permit additional share ownership
or may grant waivers to additional shareholders at any time.
42
Certain other provisions contained in our charter and bylaws and in the Maryland General Corporation Law (“MGCL”) may have
the effect of discouraging a third party from making an acquisition proposal for us and may therefore inhibit a change in control. For
example, our charter includes provisions granting our Board of Directors the authority to issue preferred stock from time to time and to
establish the terms, preferences, and rights of the preferred stock without the approval of our shareholders. Provisions in our charter and
the MGCL also restrict our shareholders’ ability to remove directors and fill vacancies on our Board of Directors and restrict unsolicited
share acquisitions. These provisions and others may deter offers to acquire our stock or large blocks of our stock upon terms attractive
to our shareholders, thereby limiting the opportunity for shareholders to receive a premium for their shares over then-prevailing market
prices.
The ability to take action against our directors and officers is limited by our charter and bylaws and provisions of Maryland law and
we may (or, in some cases, are obligated to) indemnify our current and former directors and officers against certain losses relating
to their service to us.
Our charter limits the liability of our directors and officers to us and to shareholders for pecuniary damages to the fullest extent
permitted by Maryland law. In addition, our charter and bylaws together require us to indemnify our officers and directors (and those of
our subsidiaries and affiliates) to the maximum extent permitted by Maryland law in the defense of any proceeding to which he or she
is made, or threatened to be made, a party because of his or her service to us. In addition, we have entered into, and may in the future
enter into, indemnification agreements with our directors and certain of our officers and the directors and certain of the officers of certain
of our subsidiaries and affiliates which obligate us to indemnify them against certain losses relating to their service to us and the related
costs of defense.
Other Risks Related to Ownership of Our Common Stock
Investing in our common stock may involve a high degree of risk. Investors in our common stock may experience losses, volatility,
and poor liquidity, and we may reduce our dividends in a variety of circumstances.
An investment in our common stock may involve a high degree of risk, particularly when compared to other types of investments.
Risks related to the economy, the financial markets, our industry, our investing activity, our other business activities, our financial results,
the amount of dividends we distribute, the manner in which we conduct our business, and the way we have structured our operations
could result in a reduction in, or the elimination of, the value of our common stock. The level of risk associated with an investment in
our common stock may not be suitable for the risk tolerance of many investors. Investors may experience volatile returns and material
losses. In addition, the trading volume of our common stock (i.e., its liquidity) may be insufficient to allow investors to sell their common
stock when they want to or at a price they consider reasonable.
43
Our earnings, cash flows, book value, and dividends can be volatile and difficult to predict. Investors in our common stock should
not rely on our estimates, projections, or predictions, or on management’s beliefs about future events. In particular, the sustainability of
our earnings and our cash flows will depend on numerous factors, including our level of business and investment activity, our access to
debt and equity financing, the returns we earn, the amount and timing of credit losses, prepayments, the expense of running our business,
and other factors, including the risk factors described herein. As a consequence, although we seek to pay a regular common stock dividend
that is sustainable, we may reduce our regular dividend rate, or stop paying dividends, in the future for a variety of reasons. We may not
provide public warnings of dividend reductions prior to their occurrence. Although we have paid special dividends in the past, we have
not paid a special dividend since 2007 and we may not do so in the future. Changes to the amount of dividends we distribute may result
in a reduction in the value of our common stock.
A limited number of institutional shareholders own a significant percentage of our common stock, which could have adverse
consequences to other holders of our common stock.
As of February 26, 2020, based on filings of Schedules 13D and 13G with the SEC, we believe that five institutional shareholders
each owned approximately 5% or more of our outstanding common stock (and we believe one of these shareholders owned approximately
18% of our outstanding common stock) and we believe based on data obtained from other public sources that, overall, institutional
shareholders owned, in the aggregate, more than 90% of our outstanding common stock. Furthermore, one or more of these investors or
other investors could significantly increase their ownership of our common stock, including through the conversion of outstanding
convertible or exchangeable notes into shares of common stock. Significant ownership stakes held by these individual institutions or
other investors could have adverse consequences for other shareholders because each of these shareholders will have a significant influence
over the outcome of matters submitted to a vote of our shareholders, including the election of our directors and transactions involving a
change in control. In addition, should any of these significant shareholders determine to liquidate all or a significant portion of their
holdings of our common stock, it could have an adverse effect on the market price of our common stock.
Although, under our charter, shareholders are generally precluded from beneficially owning more than 9.8% of our outstanding
common stock, our Board of Directors may amend existing ownership-limitation waivers or grant waivers to other shareholders in the
future, in each case in a manner which may allow for increases in the concentration of the ownership of our common stock held by one
or more shareholders.
Future sales of our common stock by us or by our officers and directors may have adverse consequences for investors.
We may issue additional shares of common stock, or securities convertible into, or exchangeable for, shares of common stock, in
public offerings or private placements, and holders of our outstanding convertible notes or exchangeable securities may convert those
securities into shares of common stock. In addition, we may issue additional shares of common stock to participants in our direct stock
purchase and dividend reinvestment plan and to our directors, officers, and employees under our employee stock purchase plan, our
incentive plan, or other similar plans, including upon the exercise of, or in respect of, distributions on equity awards previously granted
thereunder. We are not required to offer any such shares to existing shareholders on a preemptive basis. Therefore, it may not be possible
for existing shareholders to participate in future share issuances, which may dilute existing shareholders’ interests in us. In addition, if
market participants buy shares of common stock, or securities convertible into, or exchangeable for, shares of common stock, in issuances
by us in the future, it may reduce or eliminate any purchases of our common stock they might otherwise make in the open market, which
in turn could have the effect of reducing the volume of shares of our common stock traded in the marketplace, which could have the
effect of reducing the market price and liquidity of our common stock.
At February 26, 2020, our directors and executive officers beneficially owned, in the aggregate, approximately 2% of our common
stock. Sales of shares of our common stock by these individuals are generally required to be publicly reported and are tracked by many
market participants as a factor in making their own investment decisions. As a result, future sales by these individuals could negatively
affect the market price of our common stock.
There is a risk that you may not receive dividend distributions or that dividend distributions may decrease over time. Changes in the
amount of dividend distributions we pay, in the tax characterization of dividend distributions we pay, or in the rate at which holders
of our common stock are taxed on dividend distributions we pay, may adversely affect the market price of our common stock or may
result in holders of our common stock being taxed on dividend distributions at a higher rate than initially expected.
Our dividend distributions are driven by a variety of factors, including our minimum dividend distribution requirements under the
REIT tax laws and our REIT taxable income as calculated for tax purposes pursuant to the Internal Revenue Code. We generally intend
to distribute to our shareholders at least 90% of our REIT taxable income, although our reported financial results for GAAP purposes
may differ materially from our REIT taxable income.
44
For 2019, we paid four regular quarterly dividends at a rate of $0.30 per share. Our ability to continue to pay future dividends in
2020 may be adversely affected by a number of factors, including the risk factors described herein. In addition, to the extent we determine
that future dividends would represent a return of capital to investors, rather than the distribution of income, we may determine to discontinue
dividend payments until such time that dividends would again represent a distribution of income. Any reduction or elimination of our
payment of dividend distributions would not only reduce the amount of dividends you would receive as a holder of our common stock,
but could also have the effect of reducing the market price of our common stock.
The rate at which holders of our common stock are taxed on dividends we pay and the characterization of our dividends - as ordinary
income, capital gains, or a return of capital - could have an impact on the market price of our common stock. In addition, after we announce
the expected characterization of dividend distributions we have paid, the actual characterization (and, therefore, the rate at which holders
of our common stock are taxed on the dividend distributions they have received) could vary from our expectation, including due to errors,
changes made in the course of preparing our corporate tax returns, or changes made in response to an IRS audit), with the result that
holders of our common stock could incur greater income tax liabilities than expected.
The market price of our common stock could be negatively affected by various factors, including broad market fluctuations.
The market price of our common stock may be negatively affected by various factors, which change from time to time. Some of
these factors are:
• Our actual or anticipated financial condition, performance, and prospects and those of our competitors.
• The market for similar securities issued by other REITs and other competitors of ours.
• Changes in the manner that investors and securities analysts who provide research to the marketplace on us analyze the value
of our common stock.
• Changes in recommendations or in estimated financial results published by securities analysts who provide research to the
marketplace on us, our competitors, or our industry.
• General economic and financial market conditions, including, among other things, actual and projected interest rates,
prepayments, and credit performance and the markets for the types of assets we hold or invest in.
•
Proposals to significantly change the manner in which financial markets, financial institutions, and related industries, or financial
products are regulated under applicable law, or the enactment of such proposals into law or regulation.
• Other events or circumstances which undermine confidence in the financial markets or otherwise have a broad impact on financial
markets, such as the sudden instability or collapse of large financial institutions or other significant corporations (whether due
to fraud or other factors), terrorist attacks, natural or man-made disasters, the outbreak of pandemic or epidemic disease, or
threatened or actual armed conflicts.
Furthermore, these fluctuations do not always relate directly to the financial performance of the companies whose stock prices may
be affected. As a result of these and other factors, investors who own our common stock could experience a decrease in the value of their
investment, including decreases unrelated to our financial results or prospects.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
45
ITEM 2. PROPERTIES
Our principal executive and administrative office is located in Mill Valley, California and we have additional offices, including at
the locations listed below. We do not own any properties and lease the space we utilize for our offices. Additional information on our
leases is included in Note 16 to the Financial Statements within this Annual Report on Form 10-K. The following table presents the
locations and remaining lease terms of our primary offices.
Executive and Administrative Office Locations and Lease Expirations
Location
One Belvedere Place, Suite 300
Mill Valley, CA 94941
8310 South Valley Highway, Suite 425
Englewood, CO 80112
184 Shuman Boulevard, Suite 520
Naperville, IL 60563
19800 MacArthur Boulevard, Suite 1150
Irvine, CA 92612
1920 Main Street, Suite 850
Irvine, CA 92614
650 Fifth Avenue, Suite 2140
New York, NY 10019
Lease
Expiration
2028
2021
2023
2021
2021
2022
46
ITEM 3. LEGAL PROCEEDINGS
On or about December 23, 2009, the Federal Home Loan Bank of Seattle (the “FHLB-Seattle”) filed a complaint in the Superior
Court for the State of Washington (case number 09-2-46348-4 SEA) against Redwood Trust, Inc., our subsidiary, Sequoia Residential
Funding, Inc. (“SRF”), Morgan Stanley & Co., and Morgan Stanley Capital I, Inc. (collectively, the “FHLB-Seattle Defendants”), which
alleged that the FHLB-Seattle Defendants made false or misleading statements in offering materials for a mortgage pass-through certificate
(the “Seattle Certificate”) issued in the Sequoia Mortgage Trust 2005-4 securitization transaction (the “2005-4 RMBS”) and purchased
by the FHLB-Seattle. 8% The Seattle Certificate was issued with an original principal amount of approximately $133 million, and, at
December 31, 2019, approximately $128 million of principal and $12 million of interest payments had been made in respect of the Seattle
Certificate. As of December 31, 2019, the Seattle Certificate had a remaining outstanding principal amount of approximately $6 million.
The matter was subsequently resolved and the claims were dismissed by the FHLB Seattle as to all the FHLB Seattle Defendants. At the
time the Seattle Certificate was issued, Redwood agreed to indemnify the underwriters of the 2005-4 RMBS, which underwriters were
named as defendants in the action, for certain losses and expenses they might incur as a result of claims made against them relating to
this RMBS, including, without limitation, certain legal expenses. Regardless of the resolution of this litigation, we could incur a loss as
a result of these indemnities.
On or about July 15, 2010, The Charles Schwab Corporation (“Schwab”) filed a complaint in the Superior Court for the State of
California in San Francisco (case number CGC-10-501610) against SRF and 26 other defendants (collectively, the “Schwab Defendants”),
which alleged that the Schwab Defendants made false or misleading statements in offering materials for various residential mortgage-
backed securities sold or issued by the Schwab Defendants. Schwab alleged only a claim for negligent misrepresentation under California
state law against SRF and sought unspecified damages and attorneys’ fees and costs from SRF. Schwab claimed that SRF made false or
misleading statements in offering materials for a mortgage pass-through certificate (the “Schwab Certificate”) issued in the 2005-4 RMBS
and purchased by Schwab. The Schwab Certificate was issued with an original principal amount of approximately $15 million, and, at
December 31, 2019, approximately $14 million of principal and $1 million of interest payments had been made in respect of the Schwab
Certificate. As of December 31, 2019, the Schwab Certificate had a remaining outstanding principal amount of approximately $1 million.
At the time the Schwab Certificate was issued, Redwood agreed to indemnify the underwriters of the 2005-4 RMBS, which underwriters
were also named as defendants in the action, for certain losses and expenses they might incur as a result of claims made against them
relating to this RMBS, including, without limitation, certain legal expenses. Regardless of the resolution of this litigation, Redwood could
incur a loss as a result of these indemnities.
Through certain of our wholly-owned subsidiaries, we have in the past engaged in, and expect to continue to engage in, activities
relating to the acquisition and securitization of residential mortgage loans. In addition, certain of our wholly-owned subsidiaries have in
the past engaged in activities relating to the acquisition and securitization of debt obligations and other assets through the issuance of
collateralized debt obligations (commonly referred to as CDO transactions). Because of this involvement in the securitization and CDO
businesses, we could become the subject of litigation relating to these businesses, including additional litigation of the type described
above, and we could also become the subject of governmental investigations, enforcement actions, or lawsuits, and governmental
authorities could allege that we violated applicable law or regulation in the conduct of our business. As an example, in July 2016 we
became aware of a complaint filed by the State of California on April 1, 2016 against Morgan Stanley & Co. and certain of its affiliates
alleging, among other things, that there were misleading statements contained in offering materials for 28 different mortgage pass-through
certificates purchased by various California investors, including various California public pension systems, from Morgan Stanley and
alleging that Morgan Stanley made false or fraudulent claims in connection with the sale of those certificates. Of the 28 mortgage pass-
through certificates that were the subject of the complaint, two were Sequoia mortgage pass-through certificates issued in 2004 and two
were Sequoia mortgage pass-through certificates issued in 2007. With respect to each of those certificates, our wholly-owned subsidiary,
RWT Holdings, Inc., was the sponsor and our wholly-owned subsidiary, Sequoia Residential Funding, Inc., was the depositor. The
plaintiffs subsequently withdrew from the litigation their claims based on eight of the 28 mortgage pass-through certificates, including
one of the Sequoia mortgage pass-through certificates issued in 2004. We believe this matter was subsequently resolved and the plaintiffs
withdrew their remaining claims. At the time these Sequoia mortgage pass-through certificates were issued, Sequoia Residential Funding,
Inc. and Redwood Trust agreed to indemnify the underwriters of these certificates for certain losses and expenses they might incur as a
result of claims made against them relating to these certificates, including, without limitation, certain legal expenses. Regardless of the
resolution of this litigation, we could incur a loss as a result of these indemnities.
47
In accordance with GAAP, we review the need for any loss contingency reserves and establish reserves when, in the opinion of
management, it is probable that a matter would result in a liability and the amount of loss, if any, can be reasonably estimated. Additionally,
we record receivables for insurance recoveries relating to litigation-related losses and expenses if and when such amounts are covered
by insurance and recovery of such losses or expenses are due. At December 31, 2019, the aggregate amount of loss contingency reserves
established in respect of the FHLB-Seattle and Schwab litigation matters described above was $2 million. We review our litigation matters
each quarter to assess these loss contingency reserves and make adjustments in these reserves, upwards or downwards, as appropriate,
in accordance with GAAP based on our review.
In the ordinary course of any litigation matter, including certain of the above-referenced matters, we have engaged and may continue
to engage in formal or informal settlement communications with the plaintiffs or co-defendants. Settlement communications we have
engaged in relating to certain of the above-referenced litigation matters are one of the factors that have resulted in our determination to
establish the loss contingency reserves described above. We cannot be certain that any of these matters will be resolved through a settlement
prior to trial and we cannot be certain that the resolution of these matters, whether through trial or settlement, will not have a material
adverse effect on our financial condition or results of operations in any future period.
Future developments (including resolution of substantive pre-trial motions relating to these matters, receipt of additional information
and documents relating to these matters (such as through pre-trial discovery), new or additional settlement communications with plaintiffs
relating to these matters, or resolutions of similar claims against other defendants in these matters) could result in our concluding in the
future to establish additional loss contingency reserves or to disclose an estimate of reasonably possible losses in excess of our established
reserves with respect to these matters. Our actual losses with respect to the above-referenced litigation matters may be materially higher
than the aggregate amount of loss contingency reserves we have established in respect of these litigation matters, including in the event
that any of these matters proceeds to trial and the plaintiff prevails. Other factors that could result in our concluding to establish additional
loss contingency reserves or estimate additional reasonably possible losses, or could result in our actual losses with respect to the above-
referenced litigation matters being materially higher than the aggregate amount of loss contingency reserves we have established in
respect of these litigation matters include that: there are significant factual and legal issues to be resolved; information obtained or rulings
made during the lawsuits could affect the methodology for calculation of the available remedies; and we may have additional obligations
pursuant to indemnity agreements, representations and warranties, and other contractual provisions with other parties relating to these
litigation matters that could increase our potential losses.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
48
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER
PURCHASES OF EQUITY SECURITIES
Our common stock is listed and traded on the NYSE under the symbol RWT. At February 18, 2020, our common stock was held by
approximately 613 holders of record and the total number of beneficial stockholders holding stock through depository companies was
approximately 22,457. At February 26, 2020, there were 114,353,805 shares of common stock outstanding.
The cash dividends declared on our common stock for each full quarterly period during 2019 and 2018 were as follows:
Year Ended December 31, 2019
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
Year Ended December 31, 2018
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
Common Dividends Declared
Record
Date
Payable
Date
Per
Share
Dividend
Type
12/16/2019
9/16/2019
6/14/2019
3/15/2019
12/30/2019
9/30/2019
6/28/2019
3/29/2019
12/14/2018
9/14/2018
6/15/2018
3/15/2018
12/28/2018
9/28/2018
6/29/2018
3/29/2018
$
$
$
$
$
$
$
$
0.30
0.30
0.30
0.30
0.30
0.30
0.30
0.28
Regular
Regular
Regular
Regular
Regular
Regular
Regular
Regular
All dividend distributions are made with the authorization of the board of directors at its discretion and will depend on such items
as our GAAP net income, REIT taxable income, financial condition, maintenance of REIT status, and other factors that the board of
directors may deem relevant from time to time. The holders of our common stock share proportionally on a per share basis in all declared
dividends on common stock. As reported on our Current Report on Form 8-K on January 28, 2020, for dividend distributions made in
2019, we expect our dividends paid in 2019 to be characterized as 73% ordinary dividend income and 27% long-term capital gain dividend
income. None of the dividend distributions made in 2019 are expected to be characterized for federal income tax purposes as return of
capital or qualified dividends.
During the year ended December 31, 2019, we did not sell any equity securities that were not registered under the Securities Act of
1933, as amended. In February 2018, our Board of Directors approved an authorization for the repurchase of our common stock, increasing
the total amount authorized for repurchases of common stock to $100 million, and also authorized the repurchase of outstanding debt
securities, including convertible and exchangeable debt. This authorization increased the previous share repurchase authorization approved
in February 2016 and has no expiration date. This repurchase authorization does not obligate us to acquire any specific number of shares
or securities. Under this authorization, shares or securities may be repurchased in privately negotiated and/or open market transactions,
including under plans complying with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. At December 31, 2019, $100
million of this current total authorization remained available for repurchases of shares of our common stock. Like other investments we
may make, any repurchases of our common stock or debt securities under this authorization would reduce our available capital described
above.
49
The following table contains information on the shares of our common stock that we purchased or otherwise acquired during the
three months ended December 31, 2019.
(In Thousands, except Per Share Data)
October 1, 2019 - October 31, 2019
November 1, 2019 - November 30, 2019
December 1, 2019 - December 31, 2019
Total
Total Number
of Shares
Purchased or
Acquired
Average
Price per
Share Paid
— (1) $
$
—
—
—
$
$
16.41
—
—
—
Total Number of
Shares Purchased
as Part of
Publicly
Announced Plans
or Programs
Maximum Number
(or approximate
dollar value) of
Shares that May Yet
be Purchased under
the Plans or
Programs
— $
— $
— $
—
—
—
100,000
(1) Represents fewer than 1,000 shares reacquired to satisfy tax withholding requirements related to the vesting of restricted shares.
Information with respect to compensation plans under which equity securities of the registrant are authorized for issuance is set forth
in Part II, Item 12 of this Annual Report on Form 10-K.
50
Performance Graph
The following graph presents a cumulative total return comparison of our common stock, over the last five years, to the S&P
Composite-500 Stock Index and the National Association of Real Estate Investment Trusts, Inc. (“NAREIT”) Mortgage REIT index. The
total returns reflect stock price appreciation and the reinvestment of dividends for our common stock and for each of the comparative
indices, assuming that $100 was invested in each on December 31, 2014. The information has been obtained from sources believed to
be reliable; but neither its accuracy nor its completeness is guaranteed. The total return performance shown on the graph is not necessarily
indicative of future performance of our common stock.
Redwood Trust, Inc.
FTSE NAREIT Mortgage REIT Index
S&P Composite-500 Index
2014
100
100
100
2015
72
91
101
2016
90
112
113
2017
94
134
138
2018
103
131
132
2019
122
158
174
51
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are qualified in their entirety by, and should be read in conjunction with, the more detailed
information contained in the Consolidated Financial Statements and Notes thereto and Management’s Discussion and Analysis of
Financial Condition and Results of Operations included elsewhere in this Annual Report on Form 10-K and in our Annual Reports
on Form 10-K as of and for each of the years ended December 31, 2018, 2017, 2016, and 2015. Certain amounts for prior periods
have been reclassified to conform to the 2019 presentation.
(In Thousands, except Share Data)
Selected Statement of Operations Data:
Interest income
Interest expense
Net Interest Income
Reversal of provision for loan losses
Net Interest Income after Provision
Non-interest Income
Mortgage banking activities, net
Investment fair value changes, net
Other income
Realized gains, net
Total non-interest income, net
General and administrative expenses
Other expenses
Net Income before Provision for Income Taxes
(Provision for) benefit from income taxes
Net Income
Average common shares – basic
Earnings per share – basic
Average common shares – diluted (1)
Earnings per share – diluted
Regular dividends declared per common share
Selected Balance Sheet Data:
Total assets
Short-term debt
Asset-backed securities issued
Long-term debt, net (2)
Total liabilities
Total stockholders’ equity
Number of common shares outstanding
Book value per common share
Other Selected Data:
Average assets
Average debt and ABS issued outstanding
Average stockholders’ equity
Net income/average stockholders’ equity
2019
2018
2017
2016
2015
$
622,281
(479,808)
142,473
—
142,473
$
378,717
(239,039)
139,678
—
139,678
$
248,057
(108,816)
139,241
—
139,241
$
246,355
(88,528)
157,827
7,102
164,929
$
259,432
(95,883)
163,549
355
163,904
87,266
35,500
19,257
23,821
165,844
(118,672)
(13,022)
176,623
(7,440)
$
169,183
101,120,744
$
1.63
136,780,594
1.46
$
1.20
$
$ 17,995,440
$ 2,329,145
$ 10,515,475
$ 2,953,272
$ 16,168,209
$ 1,827,231
114,353,036
15.98
$
59,566
(25,689)
13,070
27,041
73,988
(82,782)
(196)
130,688
(11,088)
119,600
78,724,912
$
1.47
110,027,770
1.34
$
1.18
$
$
$ 11,937,406
$ 2,400,279
$ 5,410,073
$ 2,572,158
$ 10,588,612
$ 1,348,794
84,884,344
15.89
$
53,908
10,374
12,436
13,355
90,073
(77,156)
—
152,158
(11,752)
140,406
76,792,957
$
1.78
101,975,008
1.60
$
1.12
$
$
$ 7,039,822
$ 1,938,682
$ 1,164,585
$ 2,575,023
$ 5,827,535
$ 1,212,287
76,599,972
15.83
$
38,691
(28,574)
20,691
28,009
58,817
(88,786)
—
134,960
(3,708)
$
131,252
76,747,047
$
1.66
97,909,090
1.54
$
1.12
$
$ 5,483,477
791,539
$
$
773,462
$ 2,620,683
$ 4,334,049
$ 1,149,428
76,834,663
14.96
$
10,972
(21,357)
(730)
36,369
25,254
(97,416)
—
91,742
10,346
$
102,088
82,945,103
$
1.20
84,518,395
1.18
$
1.12
$
$ 6,220,047
$ 1,855,003
$ 1,049,415
$ 2,027,737
$ 5,073,782
$ 1,146,265
78,162,765
14.67
$
$ 14,255,384
$ 12,364,710
$ 1,601,259
$ 8,190,681
$ 6,751,746
$ 1,280,287
$ 5,918,233
$ 4,544,694
$ 1,181,056
$ 5,893,998
$ 4,617,956
$ 1,112,313
$ 6,015,420
$ 4,505,079
$ 1,240,345
10.6%
9.3%
11.9%
11.8%
8.2%
(1) Diluted average common shares for 2019, 2018, 2017, and 2016 include certain convertible notes that were determined to be dilutive for those years.
(2) At December 31, 2019, 2018, 2017, 2016, and 2015, Asset-backed securities issued, net included $0, $0, $0, $0, and $542, respectively, of deferred debt
issuance costs, and long-term debt, net included $16,359, $11,411, $10,240, $7,081, and $10,438, respectively, of deferred debt issuance costs.
52
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
INTRODUCTION
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide a reader
of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations,
liquidity and certain other factors that may affect our future results. Our MD&A is presented in six main sections:
•
•
•
•
•
•
Overview
Results of Operations
•
•
•
•
•
Consolidated Results
Segment Results
Investments
Consolidated VIEs
Tax Provision and Taxable Income
Liquidity and Capital Resources
Off Balance Sheet Arrangements and Contractual Obligations
Critical Accounting Policies and Estimates
New Accounting Standards
Our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes included in Part II, Item 8,
Financial Statements and Supplementary Data of this Annual Report on Form 10-K. References herein to “Redwood,” the “company,”
“we,” “us,” and “our” include Redwood Trust, Inc. and its consolidated subsidiaries, unless the context otherwise requires. The discussion
in this MD&A contains forward-looking statements that involve substantial risks and uncertainties. Our actual results could differ
materially from those anticipated in these forward-looking statements as a result of various factors, such as those discussed in the Cautionary
Statement in Part 1, Item 1, Business and in Part 1, Item 1A, Risk Factors of this Annual Report on Form 10-K.
OVERVIEW
Our Business
Redwood Trust, Inc., together with its subsidiaries, is a specialty finance company focused on making credit-sensitive investments
in single-family residential and multifamily mortgages and related assets and engaging in mortgage banking activities. Our goal is to
provide attractive returns to shareholders through a stable and growing stream of earnings and dividends, as well as through capital
appreciation. We operate our business in four segments: Residential Lending, Business Purpose Lending, Multifamily Investments, and
Third-Party Residential Investments. Our segments are based on our organizational and management structure, which aligns with how
our results are monitored and performance is assessed.
Our primary sources of income are net interest income from our investments and non-interest income from our mortgage banking
activities. Net interest income consists of the interest income we earn on investments less the interest expense we incur on borrowed
funds and other liabilities. Income from mortgage banking activities is generated through the acquisition and origination of loans and
their subsequent sale, securitization, or transfer to our investment portfolios.
Redwood Trust, Inc. has elected to be taxed as a real estate investment trust (“REIT”). We generally refer, collectively, to Redwood
Trust, Inc. and those of its subsidiaries that are not subject to subsidiary-level corporate income tax as “the REIT” or “our REIT.” We
generally refer to subsidiaries of Redwood Trust, Inc. that are subject to subsidiary-level corporate income tax as “our operating
subsidiaries” or “our taxable REIT subsidiaries” or “TRS.”
For additional information on our business, refer to Part I, Item 1, Business of this Annual Report on Form 10-K.
53
Business Update
Redwood ended 2019 on a strong note, with solid earnings and sustained momentum across our business lines. Our earnings
were $0.38 per share for the fourth quarter and we ended the year with earnings of $1.46 per share. Our earnings for the full year were
comprised of a healthy balance of investment returns and income from mortgage banking operations, and we made $1.09 billion of
investments through a combination of organic and acquisition activity that we believe will help us deliver increased returns to our
shareholders in the coming quarters and years.
We recently announced a 6.7% increase to our regular quarterly dividend to shareholders to $0.32 per share for the first quarter
of 2020. Our ability to raise our dividend despite the market volatility we experienced over the past year is significant and we believe
that it demonstrates the stability of our business model and the diversity of our revenues.
During 2019, we made significant progress on our strategic priorities. Enabled in part by two acquisitions, it was a historic year
for our business that set a new foundation for our participation in several distinct areas of housing credit, and allowed our consolidated
portfolio of investments to evolve to incorporate a diverse mix of residential, business purpose, and multifamily investments. We now
operate out of four principal geographic locations across the United States, and our earnings power is supported by organically created
investments and the associated platforms that produce them. Our risk-minded culture and our values, which emphasize passion,
integrity, change, relationships, and results, underlie our methodical pursuit to become one of the nation’s most innovative investors
in housing credit. We continue to look ahead and our strategic priorities for 2020 are focused on capitalizing on regulatory changes
and technological innovations to continue to advance our overall relevance to the housing market.
We recently reorganized our business to create a more scalable infrastructure. We believe this will allow us to better manage the
evolving opportunities and risks facing our business and to create better visibility into the earnings power of our operating platforms
and the investments they create. We now manage our business through four segments. Our new structure provides for centralized
strategic decision-making that drives the activities of these segments. In turn, our businesses can operate end-to-end in their respective
sectors while benefiting from corporate risk oversight and traditional shared services. Each of our segments currently operates at a
slightly different stage of maturity, creating a mix of earnings generation and future prospects.
Reflecting on the macro environment in 2019, it was an unexpected, record year for residential mortgage refinance activity. The
Federal Reserve kept interest rates low after three interest rate cuts in 2019 amid global trade tensions and signs of economic weakness.
Inflation, meanwhile, remained low and the U.S. consumer balance sheet remained strong, in part driven by an increased propensity
to save that is, in turn, putting downward pressure on benchmark interest rates. As we proceed further into 2020, interest rates on 30-
year conforming mortgages have fallen once again. This continues to bolster refinance activity, which has increased loan origination
volumes year-to-date in 2020. Low rates have also contributed to increased borrower spending power, something that should in theory
increase home purchase demand among the cohort of the population that is now entering their prime home buying years.
However, buying power is less impactful when there is limited housing stock. While the interest rate environment has contributed
to consistent home price appreciation over the last decade, it also conceals trends that continue to garner our close attention. Most
notably, the supply of quality, affordable homes in the United States badly trails new household formation. While this imbalance has
greatly supported rising home prices, it has made access to desirable housing more challenging for many - especially low to moderate
income families, many of whom are would-be first-time home buyers. An expedient solution being discussed in Washington, D.C. is
to relax underwriting standards and make it easier to offer loans with lower down payments to borrowers with higher debt-to-income
ratios. While we support expanding homeownership opportunities for all Americans who desire to own their own homes, lowering
underwriting standards had significant consequences leading up to the 2008 financial crisis and beyond. Additionally, these solutions
ignore the fundamental problem - not enough homes.
At Redwood, our approach to residential mortgage loan underwriting remains unchanged. We emphasize safe, well-structured
loans that borrowers can reliably afford. But more importantly, we are advocating for solutions in our business lines that offer more
high quality and accessible housing for consumers. For instance, our business purpose lending initiatives focus not only on stabilized
rentals, but also bridge lending - where homes are renovated, upgraded, and brought up to current building codes before getting resold
or rented to consumers. We are actively expanding our bridge loan lending business to include more robust construction/redevelopment
opportunities, including market-leading financing programs for build-to-rent communities, urban infill development, and modular
home development, among others. These strategies all complement our residential lending business.
54
As we look ahead into 2020, we are closely watching the U.S. housing finance regulator (Federal Housing Finance Agency),
where its new director is focused on exiting Fannie Mae and Freddie Mac out of conservatorship, reducing their size and impact across
the housing sector, and creating a level playing field for private capital to participate in a larger part of the market. We see this regulatory
shift as a major opportunity for our residential lending business, and the catalyst for us to invest in our platform to support higher
levels of growth. We are now applying recent technological innovations to reimagine our non-agency loan production and distribution
workstream. We plan to transform our correspondent loan acquisition platform to be more component-based, allowing us to implement
new technologies as they become available rather than through comprehensive systems that remain the standard in the industry. We
are also working to automate the revalidation of underwriting data to significantly reduce the time it takes us to purchase non-agency
loans from originators, allowing them to recycle capital faster and make more loans. At the moment, technology to assist loan sellers
in originating conventional loans that can be seamlessly sold exists only in the Agency origination space. Our goal is to make it a
reality in the private sector.
We also see compelling opportunities in our business-purpose lending segment. The business purpose lending platforms we
acquired last year originated a total of $2.4 billion of loans in 2019. We also have an active SFR securitization platform which should
support our goal to grow profitably and organically generate assets with attractive risk adjusted returns. We have begun the process
of combining the 5 Arches and CoreVest platforms under a unified leadership structure, taking the best features from both businesses
to position this segment for profitable future growth. Once fully integrated, our platform will possess a wide breadth of financing
products and depth of expertise to deliver all-inclusive and customized solutions to residential real estate investors. A unified platform
will also allow us to apply our technology advantage to a full suite of products and in the process remove redundant external costs in
the day-to-day operation of the business. Importantly, we are still just beginning to understand how business-purpose lending can
leverage the broader Redwood platform. For example, we have begun the process of offering single-family rental loan products to
our residential loan sellers, secured the ability to pledge single-family rental loans on our FHLB borrowing facility, and lowered our
cost of funds through both warehouse financing and securitization.
Our multifamily initiative continues to grow and expand and is quickly emerging as a strategic and complementary aspect of our
housing finance strategy. We now designate multifamily investing as a core business at Redwood, with over $475 million of capital
invested since 2017. We originate small-balance multifamily loans (both term and bridge) in our business-purpose lending segment
- an area of desired growth - however, capital deployment in traditional multifamily has been almost exclusively in programs offered
by Freddie Mac. To date, we remain one of the only investors in newly issued Freddie Mac multifamily B-pieces (first loss credit
risk) that is not also a multifamily operator. Given recent changes implemented by the FHFA, we are now exploring ways to expand
how we provide liquidity to this rapidly growing market.
While we anticipate most of our investing activities to originate from within our residential, business-purpose, and multifamily
segments, we continue to dedicate meaningful resources to other third-party investment activities. For over a quarter century, our role
as an active investor and liquidity provider has been highly relevant to the mortgage capital markets. This effort will operate in
coordination with our other businesses and focus on third-party opportunities that we find attractive, including non-agency RMBS,
agency CRT bonds, securities backed by re-performing loans, and other investments. Importantly, this segment also allows us to
continue tracking the pertinent markets and manage our capital both opportunistically and for liquidity management purposes.
Over the past two years we believe we have made meaningful progress in diversifying revenues, integrating resources, and
positioning Redwood for growth in the years ahead. Our business segments now encompass production and earnings generation
potential across a breadth of sectors and collaborate toward a unifying vision of being one of the market’s most innovative mortgage
investors.
55
2019 Financial Overview
This section includes an overview of our 2019 financial results. A detailed discussion of our results of operations is presented in the
next section of this MD&A. The following table presents selected financial highlights from 2019 and 2018.
Table 1 – Key Earnings and Return Metrics
(In Thousands, except per Share Data)
Net income
Earnings per share (diluted EPS)
Return on equity (ROE)
Book value per share
Economic return on book value (1)
REIT taxable income per share
Dividends per share
Years Ended December 31,
2019
169,183
1.46
10.6%
15.98
8.1%
1.28
1.20
$
$
$
$
$
2018
119,600
1.34
9.3%
15.89
7.8%
1.38
1.18
$
$
$
$
$
(1) Economic return on book value is based on the periodic change in GAAP book value per common share plus dividends declared per common share
during the period.
Our 2019 results benefited from the continued expansion of our businesses across the broader housing market, including our
acquisitions of 5 Arches and CoreVest in the business purpose residential lending space, and further capital deployment into multifamily
investments. Through these acquisitions, we established our business purpose loan origination capabilities, which helped drive higher
mortgage banking income in 2019, and also deployed a significant amount of capital into attractive business purpose lending ("BPL")
investments, which helped drive higher investment returns. Our results also benefited from a recovery in asset prices in the first quarter
of 2019, after a significant decrease in value during the fourth quarter of 2018, which negatively impacted our 2018 results. Investment
fair values also benefited in 2019 from spread tightening across many investment types, which also created opportunities to sell lower-
yielding assets and realize gains. After rotating a significant amount of capital out of lower yielding assets (through sales) and redeploying
that capital into higher yielding investments in business purpose, multifamily and reperforming loan assets, we expect our net interest
income to grow and the pace and overall amount of securities sales and resulting gains to decrease in 2020, given current market conditions.
Although REIT taxable income per share decreased in 2019, we earned a growing amount of more stable net interest income from
investments at our REIT, which is an important contributor to supporting our dividend.
Table 2 – Key Operational Metrics
(In Thousands)
Capital Deployed
Residential Loans Purchased
Business Purpose Residential Loans Originated
Years Ended December 31,
2019
2018
$
$
$
1,085,994
5,901,802
1,015,157
$
$
$
810,203
7,133,558
—
During 2019, we raised $451 million of equity capital, and replaced $201 million of exchangeable debt that matured with new
exchangeable debt maturing in six years. We used the proceeds from these issuances along with proceeds from portfolio optimization to
increase our capital deployment to $1.09 billion in 2019, which included approximately $530 million deployed into our two acquisitions
(including associated financial assets) and the remainder into investment assets. As in the prior year, we continued to deploy a meaningful
amount of our capital into business purpose residential loans, multifamily investments, and re-performing loan investments, expanding
further into these areas of housing.
Our residential mortgage banking business saw loan purchases decrease in 2019, impacted primarily by increased competition.
However, we operated this business with lower capital in 2019, helping to improve its return on equity. Additionally, we saw acquisition
volumes begin to increase late in the year and we expect purchase volumes to increase in 2020 given the current interest rate environment.
In 2019, through our Sequoia platform, we completed five Select securitizations and three Choice securitizations, which were supplemented
by an increasing proportion of whole loans sales.
56
Our business purpose mortgage banking business, which began in earnest early in 2019 through our acquisition of 5 Arches, steadily
grew origination volume throughout the year and saw a significant boost in the fourth quarter when we acquired CoreVest. With the
origination capabilities of the combined platforms, we believe origination volume from this business can increase in 2020 as compared
to 2019.
Book Value per Share
The following table sets forth the changes in our book value per share for the year ended December 31, 2019.
Table 3 – Changes in Book Value per Share
(In Dollars, per share basis)
Beginning book value per share
Net income (diluted EPS)
Changes in unrealized gains on securities, net from:
Realized gains recognized in net income
Amortization income recognized in net income
Mark-to-market adjustments, net
Total change in unrealized gains on securities, net
Dividends
Issuance of common stock
CoreVest acquisition equity consideration
Changes in unrealized losses on derivatives hedging long-term debt
Other, net (1)
Ending Book Value per Share
Year Ended
December 31, 2019
$
$
15.89
1.46
(0.15)
(0.06)
0.25
0.04
(1.20)
(0.06)
(0.08)
(0.17)
0.10
15.98
(1) Primarily represents income earned on actual shares outstanding, as we include diluted earnings per common share as a line item within table.
Our GAAP book value per share increased $0.09 per share to $15.98 per share during 2019. This increase was driven primarily by
earnings exceeding our dividend payments.
Unrealized gains on our available-for-sale securities increased $0.04 per share during 2019. This decrease primarily resulted from
$0.15 per share of previously unrealized net gains that were realized as income from the sale of securities, as well as $0.06 per share of
discount accretion income recognized in earnings from the appreciation in the amortized cost basis of our available-for-sale securities.
These decreases were offset by positive mark-to-market adjustments on available-for-sale securities primarily resulting from overall
credit spread tightening on these investments during 2019.
Lower benchmark interest rates during 2019 resulted in a $0.17 per share decrease to book value from unrealized losses on the
derivatives hedging a portion of our long-term debt. At December 31, 2019, the cumulative unrealized loss on these derivatives, which
is included in our GAAP book value per share, was $0.45 per share. During 2019, we issued common stock for net proceeds that on a
per share basis were lower than our book value per share and were, therefore, slightly dilutive to book value. Additionally, included in
the change in book value per share for 2019 was an $0.08 per share decrease from the issuance of restricted common stock related to our
acquisition of CoreVest.
57
RESULTS OF OPERATIONS
Consolidated Results of Operations
Within this Results of Operations section, we provide commentary that compares results year-over-year for 2019, 2018, and 2017.
Most tables include "changes" columns that show the amounts by which the year's results are greater or less than the results from the
prior year. Unless otherwise specified, references in this section to increases or decreases in 2019 refer to the change in results from 2018
to 2019, and increases or decreases in 2018 refer to the change in results from 2017 to 2018.
The following table presents the components of our net income for the years ended December 31, 2019, 2018, and 2017.
Table 4 – Net Income
(In Thousands, except per Share Data)
Net Interest Income
Non-interest Income
Mortgage banking activities, net
Investment fair value changes, net
Other income
Realized gains, net
Total non-interest income, net
General and administrative expenses
Other expenses
Net income before income taxes
Provision for income taxes
Net Income
Net Interest Income
Years Ended December 31,
2018
2017
2019
Changes
'19/'18
'18/'17
$ 142,473
$ 139,678
$ 139,241
$
2,795
$
437
87,266
35,500
19,257
23,821
59,566
(25,689)
13,070
27,041
165,844
(118,672)
(13,022)
176,623
(7,440)
$ 169,183
73,988
(82,782)
(196)
130,688
(11,088)
$ 119,600
53,908
10,374
12,436
13,355
90,073
(77,156)
—
152,158
(11,752)
$ 140,406
27,700
61,189
6,187
(3,220)
91,856
(35,890)
(12,826)
45,935
3,648
5,658
(36,063)
634
13,686
(16,085)
(5,626)
(196)
(21,470)
664
$
49,583
$ (20,806)
Net interest income increased in 2019, as higher net capital deployment towards multifamily, third party, and business purpose lending
investments improved net interest income. This improvement was partially offset by a decrease in net interest income from residential
loans held-for-sale at our residential lending segment, as the average balance of loans in inventory awaiting sale or securitization declined
in 2019 as compared with 2018. Additionally, higher interest expense on long-term debt in 2019 from a higher average balance of
convertible debt further offset the increase from net capital deployment.
We utilize hedges to manage interest rate risk in our investment portfolio and the net interest expense from these instruments is a
component of our Investment fair value changes line item, which is discussed below. Net hedge interest expense associated with investment
hedges increased in 2019 and on a combined basis, net interest income plus net interest expense on hedges increased by $5 million in
2019, compared to 2018.
Net interest income in 2018 was consistent with 2017, as higher interest income from net capital deployment and higher average
yields in 2018 was offset by higher interest expense on short-term floating rate debt facilities and FHLB borrowings from rising benchmark
interest rates.
Additional detail on changes in net interest income is provided in the “Net Interest Income” section that follows.
Mortgage Banking Activities, Net
Income from mortgage banking activities, net includes results from both our residential and business purpose mortgage banking
operations. The $28 million increase in 2019 was due to a $40 million increase from business purpose mortgage banking, partially offset
by a $12 million decrease from residential mortgage banking. The increase from business purpose mortgage banking resulted from our
acquisitions of 5 Arches and CoreVest in 2019 and the income generated from those operations. The decrease from residential mortgage
banking was primarily due to lower gross margins on slightly higher loan purchase commitments in 2019, relative to 2018. The $6 million
increase in 2018 was primarily due to an increase in residential loan purchase volume in 2018, relative to 2017, on similar gross margins.
Additional analysis of the changes in this line item is included in the “Results of Operations by Segment” section that follows.
58
Investment Fair Value Changes, Net
Investment fair value changes, net, is primarily comprised of the change in fair values of our investments accounted for under the
fair value option and interest rate hedges associated with these investments.
During 2019, the positive investment fair value changes primarily resulted from tightening credit spreads in several investment
classes. During 2018, the negative investment fair value changes primarily resulted from widening credit spreads during the fourth quarter,
which impacted both our residential securities and our residential loans held-for-investment.
Additional analysis of the changes in this line item is included in the “Results of Operations by Segment” section that follows.
Other Income
The $6 million increase in Other income in 2019 primarily resulted from $4 million of business purpose loan administration fee
income earned at 5 Arches, as well as a $2 million gain associated with the re-measurement of our initial minority investment and purchase
option in 5 Arches upon its acquisition. This increase was partially offset by a decrease in income from our MSR investments as the
notional balance of these investments continued to pay down. Details on the composition of Other income is included in Note 21 in Part
II, Item 8 of this Annual Report on Form 10-K
Realized Gains, Net
For 2019, we realized gains of $24 million, primarily from the sale of $110 million of AFS securities and the call of a seasoned
Sequoia securitization in the first quarter. For 2018, we realized gains of $27 million, primarily from the sale of $144 million of AFS
securities. For 2017, we realized gains of $13 million, primarily from the sale of $90 million of AFS securities.
General and Administrative Expenses
The $36 million increase in general and administrative expenses in 2019 primarily resulted from $28 million of additional expenses
from the operations of 5 Arches and CoreVest, which were acquired in March and October of 2019, respectively. The remainder of the
increase was primarily due to $7 million in higher compensation expense at the Redwood parent entity (exclusive of 5 Arches and
CoreVest), as well as higher systems, consulting, accounting, and legal costs, driven mostly by the acquisition-related expenses associated
with 5 Arches and CoreVest. The higher compensation expense at the Redwood parent entity was primarily driven by higher variable
compensation, commensurate with improved results in 2019, as well as a higher average employee count in 2019.
The increase in general and administrative expenses in 2018 primarily resulted from higher loan acquisition costs due to higher loan
purchase volume in 2018, as well as higher expenses associated with implementing new investment initiatives, including higher personnel
costs and legal fees. These increases were partially offset by lower variable compensation expense commensurate with a decline in net
income in 2018.
Other Expenses
Other expenses in 2019 primarily consisted of amortization expense from intangible assets and contingent consideration we recorded
in connection with acquisition activity during 2019.
Provision for Income Taxes
Our provision for income taxes is almost entirely related to activity at our taxable REIT subsidiaries, which primarily includes our
mortgage banking activities, MSR investments, as well as certain other investment and hedging activities associated with these investments.
The decrease in the provision for income taxes for 2019 was driven primarily by lower GAAP income earned at our TRS. Additionally,
the provision for 2019 included a $2 million tax benefit resulting from the purchase of 5 Arches.
The decrease in the provision for income taxes for 2018 resulted primarily from a lower corporate tax rate, and lower investment
portfolio income at our TRS during the year. The increase in the provision for income taxes in 2017 resulted primarily from higher
mortgage banking income in 2017, compared to 2016. This increase was offset by a tax benefit of $8 million from the reduction of our
net federal deferred tax liabilities as a result of the Tax Cuts and Jobs Act of 2017 (the "Tax Act") that was enacted in December 2017.
For additional detail on income taxes, see the “Tax Provision and Taxable Income” section that follows.
59
Net Interest Income
The following tables present the components of net interest income for the years ended December 31, 2019, 2018, and 2017.
Table 5 – Net Interest Income
(Dollars in Thousands)
Interest Income
2019
Years Ended December 31,
2018
2017
Interest
Income/
(Expense)
Average
Balance (1)
Yield
Interest
Income/
(Expense)
Average
Balance (1)
Yield
Interest
Income/
(Expense)
Average
Balance (1)
Yield
Residential loans, held-for-sale
$ 39,355
$
888,690
4.4 % $ 51,330
$ 1,129,810
4.5 % $ 38,854
$
939,273
4.1 %
Residential loans - HFI at
Redwood (2)
Residential loans - HFI at
Legacy Sequoia (2)
Residential loans - HFI at
Sequoia Choice (2)
Residential loans - HFI at
Freddie Mac SLST (2)
Business purpose residential
loans
Single-family rental loans - HFI
at CAFL
Multifamily loans - HFI at
Freddie Mac K-Series
Trading securities
Available-for-sale securities
Other interest income
Total interest income
Interest Expense
92,340
2,321,288
4.0 %
94,361
2,345,219
4.0 %
90,970
2,316,375
3.9 %
17,640
453,563
3.9 %
20,029
577,175
3.5 %
19,405
700,746
2.8 %
108,778
2,273,514
4.8 %
69,645
1,452,784
4.8 %
5,133
109,463
4.7 %
57,840
1,531,361
3.8 %
4,453
109,231
4.1 %
30,733
446,077
6.9 %
4,333
50,962
8.5 %
23,072
439,165
5.3 %
—
—
— %
—
—
—
—
—
—
132,600
70,359
21,463
28,101
622,281
3,373,743
1,119,220
182,251
605,863
13,634,735
3.9 %
6.3 %
11.8 %
4.6 %
4.6 %
21,322
71,350
33,728
8,166
378,717
532,020
1,016,613
302,134
211,651
7,727,599
4.0 %
7.0 %
11.2 %
3.9 %
4.9 %
—
47,419
43,384
2,892
248,057
—
713,945
430,395
225,610
5,435,807
— %
— %
— %
— %
6.6 %
10.1 %
1.3 %
4.6 %
Short-term debt facilities
(73,558)
1,973,542
(3.7)%
(52,832)
1,513,497
(3.5)%
(28,015)
1,075,430
(2.6)%
Short-term debt - servicer
advance financing
Short-term debt - convertible
notes, net
ABS issued - Legacy Sequoia (2)
ABS issued - Sequoia Choice (2)
ABS issued - Freddie Mac
SLST (2)
ABS issued - Freddie Mac K-
Series
ABS issued - CAFL
Long-term debt - FHLBC
Long-term debt - other
Total interest expense
Net Interest Income
(11,952)
219,307
(5.4)%
(971)
17,271
(5.6)%
—
—
— %
(10,996)
(14,418)
(93,354)
174,433
445,342
2,052,697
(6.3)%
(3.2)%
(4.5)%
(5,114)
(16,519)
(59,769)
97,035
567,908
1,317,645
(5.3)%
(2.9)%
(4.5)%
(8,836)
(14,833)
(4,275)
182,551
684,733
97,158
(4.8)%
(2.2)%
(4.4)%
(42,574)
1,237,205
(3.4)%
(3,156)
89,172
(3.5)%
—
—
— %
(126,948)
(17,172)
(48,999)
(39,837)
(479,808)
$ 142,473
3,184,441
401,467
1,999,999
676,278
12,364,711
(4.0)%
(19,985)
(4.3)%
—
(2.4)%
(41,360)
(39,333)
(5.9)%
(3.9)% (239,039)
$ 139,678
497,524
—
1,999,999
651,696
6,751,747
(4.0)%
—
— %
—
(2.1)%
(21,769)
(31,088)
(6.0)%
(3.5)% (108,816)
$ 139,241
—
—
1,999,999
504,822
4,544,693
— %
— %
(1.1)%
(6.2)%
(2.4)%
(1) Average balances for residential loans held-for-sale, residential loans held-for-investment, business purpose residential loans, multifamily loans
held-for-investment, and trading securities are calculated based upon carrying values, which represent estimated fair values. Average balances for
available-for-sale securities and debt are calculated based upon amortized historical cost, except for ABS issued, which is based upon fair value.
(2)
Interest income from residential loans held-for-investment ("HFI") at Redwood exclude loans HFI at consolidated Sequoia or Freddie Mac SLST
entities. Interest income from residential loans - HFI at Legacy Sequoia and the interest expense from ABS issued - Legacy Sequoia represent
activity from our consolidated Legacy Sequoia entities. Interest income from residential loans - HFI at Sequoia Choice and the interest expense
from ABS issued - Sequoia Choice represent activity from our consolidated Sequoia Choice entities. Interest income from residential loans - HFI
at Freddie Mac SLST and the interest expense from ABS issued - Freddie Mac SLST represent activity from our consolidated Freddie Mac SLST
entities.
60
The following table details how net interest income changed on a consolidated basis as a result of changes in average investment
balances (“volume”) and changes in interest yields (“rate”).
Table 6 – Net Interest Income - Volume and Rate Changes
(In Thousands)
Net Interest Income for the Beginning of
the Year
Impact of Changes in Interest Income
Change in Net Interest Income
For the Years Ended December 31,
Volume
2019
Rate
Total
Volume
$
139,678
2018
Rate
Total
$
139,241
Residential loans - HFS
$
(10,955) $
Residential loans - HFI at Redwood
Residential loans - HFI at Legacy Sequoia
Residential loans - HFI at Sequoia Choice
Residential loans - HFI at Freddie Mac SLST
Business purpose residential loans
Single-family rental loans - HFI at CAFL
Multifamily loans - HFI at Freddie Mac K-
Series
Trading securities
Available-for-sale securities
Other Interest Income
Net changes in interest income
Impact of Changes in Interest Expense
Short-term debt facilities
Short-term debt - servicer advance financing
Short-term debt - convertible notes, net
ABS issued - Legacy Sequoia
ABS issued - Sequoia Choice
ABS issued - Freddie Mac SLST
ABS issued - Freddie Mac K-Series
ABS issued - CAFL
Long-term debt - FHLBC
Long-term debt - Other
Net changes in interest expense
Net changes in interest income and expense
Net Interest Income for the Year Ended
(963)
(4,290)
39,345
57,976
33,593
23,072
113,889
7,201
(13,383)
15,209
260,694
(16,060)
(11,359)
(4,079)
3,565
(33,342)
(40,632)
(107,934)
(17,172)
—
(1,484)
(228,497)
32,197
7,882
$
4,594 12,476
1,133
(3,422)
62,992
4,453
4,333
—
21,322
20,103
(12,929)
(491)
105,376
(11,412)
(971)
4,139
2,531
(53,702)
(3,156)
(19,985)
—
—
(9,045)
(91,601)
13,775
2,258
4,046
1,520
—
—
—
—
3,391
624
64,512
4,453
4,333
—
21,322
3,828 23,931
3,273
5,765
(9,656)
5,274
25,284
130,660
(13,405)
—
(417)
(4,217)
(1,792)
—
—
—
(19,591)
800
(38,622)
(13,338)
(24,817)
(971)
3,722
(1,686)
(55,494)
(3,156)
(19,985)
—
(19,591)
(8,245)
(130,223)
437
$
139,678
(2,021)
(2,389)
39,133
(1,020) (11,975) $
(1,058)
1,901
(212)
(4,589)
(7,193)
—
53,387
26,400
23,072
(2,611)
(8,192)
1,118
4,726
(17,130)
(4,666)
378
(1,803)
(1,464)
(243)
1,214
971
—
(7,639)
980
(12,272)
(29,402)
111,278
(991)
(12,265)
19,935
243,564
(20,726)
(10,981)
(5,882)
2,101
(33,585)
(39,418)
(106,963)
(17,172)
(7,639)
(504)
(240,769)
2,795
$
142,473
61
The following table presents the components of net interest income by segment for the years ended December 31, 2019, 2018, and
2017.
Table 7 – Net Interest Income by Segment
(In Thousands)
Net Interest Income by Segment
Residential Lending
Business Purpose Lending
Multifamily Investments
Third-Party Residential Investments
Corporate/Other
Net Interest Income
Years Ended December 31,
Changes
2019
2018
2017
'19/'18
'18/'17
$
76,200
$
86,626
$
92,455
$
18,709
9,712
34,621
3,231
2,336
5,726
41,473
3,517
—
3,063
39,149
4,574
$
142,473
$
139,678
$
139,241
$
(10,426) $
16,373
3,986
(6,852)
(286)
2,795
$
(5,829)
2,336
2,663
2,324
(1,057)
437
Additional details regarding the activities impacting net interest income at each segment are included in the “Results of Operations
by Segment” section that follows.
The Corporate/Other line item in the table above primarily includes net interest income from consolidated Legacy Sequoia entities.
The decreases in net interest income from Corporate/Other during 2019 and 2018 were primarily due to lower net interest income from
consolidated Legacy Sequoia entities, as loans in these securitizations continued to pay down. Details regarding consolidated Legacy
Sequoia entities are included in the "Results of Consolidated Legacy Sequoia Entities" section that follows.
62
Results of Operations by Segment
We report on our business using four segments: Residential Lending, Business Purpose Lending, Multifamily Investments, and Third-
Party Residential Investments. Our segments are based on our organizational and management structure, which aligns with how our
results are monitored and performance is assessed. For additional information on our segments, refer to Note 24 in Part II, Item 8 and
Part I, Item 1 of this Annual Report on Form 10-K. The following table presents the segment contribution from our four segments
reconciled to our consolidated net income for the years ended December 31, 2019, 2018, and 2017.
Table 8 – Segment Results Summary
(In Thousands)
Segment Contribution from:
Residential Lending
Business Purpose Lending
Multifamily Investments
Third-Party Residential Investments
Corporate/Other
Net Income
Years Ended December 31,
Changes
2019
2018
2017
'19/'18
'18/'17
$
101,977
$
(25,772) $
17,586
$
78,780
$
17,239
36,918
88,321
(52,075)
169,183
$
$
104,552
(347)
8,820
47,936
(41,361)
119,600
—
18,596
70,132
(50,299)
140,406
$
2,575
(347)
(9,776)
(22,196)
8,938
$
(20,806)
28,098
40,385
(10,714)
49,583
$
The following sections provide a detailed discussion of the results of operations at each of our four business segments for the years
ended December 31, 2019, 2018, and 2017.
The $11 million increase in net expense from Corporate/Other in 2019 primarily resulted from a $9 million increase in corporate
general and administrative expenses, as well as $3 million of contingent consideration expense associated with our acquisition of 5 Arches,
recorded in Other expenses. These increases were partially offset by a $2 million gain associated with the re-measurement of our initial
minority investment and purchase option in 5 Arches. The increase in corporate general and administrative expenses in 2019 was primarily
due to $7 million in higher compensation expense, driven mostly by higher variable compensation commensurate with improved results
in 2019, as well as higher systems, consulting, accounting, and legal costs, driven mostly by the acquisitions of 5 Arches and CoreVest.
The $9 million improvement from Corporate/Other in 2018 primarily resulted from lower variable compensation expense
commensurate with lower GAAP earnings, as well as higher earnings from our consolidated Legacy Sequoia entities in 2018. Details
regarding consolidated Legacy Sequoia entities are included in the "Results of Consolidated Legacy Sequoia Entities" section that follows.
63
Residential Lending Segment
Our Residential Lending segment primarily consists of a mortgage loan conduit that acquires residential loans from third-party
originators for subsequent sale, securitization, or transfer to our investment portfolio, as well as the investments we retain from these
activities. We typically acquire prime, jumbo mortgages and the related mortgage servicing rights on a flow basis from our network of
loan sellers and distribute those loans through our Sequoia private-label securitization program or to institutions that acquire pools of
whole loans. Our investments in this segment primarily consist of residential mortgage-backed securities ("RMBS") retained from our
Sequoia securitizations (some of which we consolidate for GAAP purposes), jumbo whole loans we retained and finance through our
Federal Home Loan Bank of Chicago ("FHLBC") member subsidiary, as well as MSRs retained from jumbo whole loans we sold.
The following table presents the components of segment contribution for the Residential Lending segment for the years ended
December 31, 2019, 2018, and 2017.
Table 9 – Residential Lending Segment Contribution
(In Thousands)
Net interest income
Investments
Loans held-for-sale
Total net interest income
Non-interest income
Mortgage banking activities, net
Investment fair value changes, net
Other income
Realized gains, net
Total non-interest income, net
General and administrative expenses
Segment contribution before income taxes
Provision for income taxes
Total Segment Contribution
Years Ended December 31,
2018
2017
2019
Changes
'19/'18
'18/'17
$
56,802
$
62,661
$
19,398
76,200
23,965
86,626
70,515
21,940
92,455
$
(5,859) $
(4,567)
(10,426)
47,743
(27,920)
9,210
8,292
37,325
(30,671)
82,854
(4,074)
78,780
$
59,623
(21,686)
12,452
7,709
58,098
(32,139)
112,585
(8,033)
104,552
$
53,908
(25,466)
12,436
3,907
44,785
(28,622)
108,618
(6,641)
101,977
$
(11,880)
(6,234)
(3,242)
583
(20,773)
1,468
(29,731)
3,959
(25,772) $
$
(7,854)
2,025
(5,829)
5,715
3,780
16
3,802
13,313
(3,517)
3,967
(1,392)
2,575
The following table provides the activity of residential loans held-for-sale at Redwood during the years ended December 31, 2019
and 2018.
Table 10 – Residential Loans Held-for-Sale — Activity
(In Thousands)
Select
Years Ended December 31,
2019
Choice
Total
Select
2018
Choice
Total
Balance at beginning of period
$
716,193
$
332,608
$ 1,048,801
$ 1,101,356
$
326,589
$ 1,427,945
Acquisitions
Sales
Transfers between portfolios (1)
Principal repayments
Changes in fair value, net
Balance at End of Period
3,657,513
(4,047,210)
(602)
(50,835)
5,626
2,205,020
(1,085,255)
(1,145,375)
(52,374)
1,076
5,862,533
(5,132,465)
(1,145,977)
(103,209)
6,702
4,833,326
(5,149,243)
(29,965)
(46,744)
7,463
2,300,232
(277,061)
(2,017,129)
(20,945)
20,922
7,133,558
(5,426,304)
(2,047,094)
(67,689)
28,385
$
280,685
$
255,700
$
536,385
$
716,193
$
332,608
$ 1,048,801
(1) Represents the net transfers of loans from held-for-sale to held-for-investment within our Residential Lending investment portfolio. Includes $1.08
billion and $1.78 billion of Choice loans securitized during the years ended December 31, 2019 and 2018, respectively, which were not treated as
sales for GAAP purposes and continue to be reported on our consolidated balance sheets within this segment's investment portfolio.
64
The following table presents details of our Residential Lending investment portfolio at December 31, 2019 and December 31, 2018.
Table 11 – Residential Lending Investments
(In Thousands)
Residential loans at Redwood (1)
Residential securities at Redwood
Residential securities at consolidated Sequoia Choice entities (2)
Other investments
Total Segment Investments
(1) Excludes Sequoia Choice loans that we consolidate for GAAP purposes.
December 31, 2019
December 31, 2018
$
$
2,111,897
$
229,074
254,265
42,224
2,637,460
$
2,383,932
364,308
194,372
99,984
3,042,596
(2) Represents our retained economic investment in the consolidated Sequoia Choice securitization entities. For GAAP purposes, we consolidated
$2.29 billion of loans and $2.04 billion of ABS issued associated with these investments at December 31, 2019.
See the Investments and Consolidated VIEs sections that follow for additional details on these investments.
Overview
Segment contribution from our Residential Lending segment decreased during 2019, driven both by lower mortgage banking income
and lower overall investment returns. Mortgage banking income decreased due to a lower average balance of loans carried during 2019,
resulting in lower net interest income, as well as lower mortgage banking activities income resulting from lower profit margins due to
increased competition. Although the overall income from these operations decreased, we ran these operations with less capital in 2019
than 2018, resulting in higher returns on allocated capital year-over-year. The decrease in income from investing activities was primarily
due to a lower average balance of investments in this segment in 2019, as we shifted capital from this segment into other segments. For
example, as jumbo residential loans that we had financed with FHLB debt paid off, we pledged single-family rental loans to collateralize
an increasing portion of our FHLB debt. In addition, as mortgage rates decreased throughout much of the year, we experienced increased
loan prepayment rates, which negatively impacted the fair value of our investments held at a premium (including our residential loans
at Redwood and our interest only securities), which resulted in higher negative investment fair value changes in 2019.
During the year ended December 31, 2019, our residential mortgage loan conduit purchased $5.86 billion of predominately prime
residential jumbo loans, securitized $1.92 billion of jumbo Select loans that were accounted for as sales, and sold $3.22 billion of jumbo
loans to third parties. Additionally, we transferred $1.08 billion of jumbo Choice loans that did not qualify for sales accounting treatment
under GAAP to Sequoia securitization entities and we had net transfers of $69 million of residential jumbo loans into our Residential
Lending investment portfolio that were financed with borrowings from the FHLBC. Our pipeline of loans identified for purchase at
December 31, 2019 included $1.83 billion of jumbo loans. At December 31, 2019, our residential mortgage loan conduit had 492 loan
sellers, including 184 jumbo sellers and 308 sellers from various FHLB districts participating in the FHLB's MPF Direct program.
We utilize a combination of capital and our residential loan warehouse facilities to manage our inventory of residential loans held-
for-sale. At December 31, 2019, we had $186 million of warehouse debt outstanding to fund our residential loans held-for-sale. Jumbo
loan warehouse capacity at December 31, 2019 totaled $1.43 billion across four separate counterparties, which should continue to provide
sufficient liquidity to fund our residential mortgage banking operations in the near-term.
Net Interest Income
Net interest income from our Residential Lending segment is primarily comprised of net interest income earned from our residential
loans held for investment and financed with FHLB debt, net interest income from securities retained from our Sequoia securitizations,
and net interest income from our inventory of residential loans held-for-sale prior to sale or securitization.
Net interest income from residential lending investments decreased in 2019, due primarily to higher interest costs on our variable-
rate long-term FHLB borrowings during 2019, from higher benchmark interest rates. Additionally, the average balance of our investment
portfolio at this segment declined, as capital freed-up from sales and paydowns within this segment were redeployed in our business
purpose lending and multifamily investments segments. Residential securities at Redwood decreased from the sale of lower-yielding
Sequoia mezzanine securities, and residential securities at consolidated Sequoia Choice entities increased due to the retention of securities
from Choice securitizations that were issued in 2019.
The $6 million decrease in 2018 in net interest income was primarily attributable to higher interest expense in 2018 related to our
variable-rate borrowings on our residential lending investments, including from FHLB borrowings.
65
We use a combination of swaps and other derivatives to hedge our exposure to interest rates on our fixed-rate loan and securities
investments and their associated variable-rate debt. The interest expense or benefit associated with these hedges is included in our
Investment fair value changes, net line item on our financial statements. Including the impact of this hedge interest, our combined net
interest income for residential lending investments was $60 million, $62 million, and $59 million in 2019, 2018, and 2017, respectively.
Mortgage Banking Activities, Net
Mortgage banking activities, net, includes the changes in market value of both the loans we hold for sale and commitments for loans
we intend to purchase (collectively, our loan pipeline), as well as the effect of derivative instruments we utilize to manage risks associated
with our loan pipeline. Our loan sale profit margins are measured over the period from when we commit to purchase a loan and subsequently
sell or securitize the loan. Accordingly, these profit margins may encompass positive or negative market valuation adjustments on loans,
hedging gains or losses associated with our loan pipeline, and any other related transaction expenses, and may be realized over the course
of one or more quarters for financial reporting purposes.
The following table presents the components of residential mortgage banking activities, net. Amounts presented include both the
changes in market values for loans that were sold and associated derivative positions that were settled during the periods presented, as
well as changes in market values of loans and derivatives outstanding at the end of each period.
Table 12 – Components of Residential Mortgage Banking Activities, Net
(In Thousands)
Residential Mortgage Banking Activities, Net
Changes in fair value of:
Residential loans, at fair value (1)
Risk management derivatives (2)
Other income (3)
Total residential mortgage banking activities, net
Years Ended December 31,
2018
2017
2019
Changes
'19/'18
'18/'17
$
$
63,527
(17,519)
1,735
$
21,808
$
35,248
2,567
$
69,373
(17,529)
2,064
47,743
$
59,623
$
53,908
$
$
41,719
(52,767)
(832)
(11,880) $
(47,565)
52,777
503
5,715
(1) Includes changes in fair value for loan purchase and forward sale commitments.
(2) Represents market valuation changes of derivatives that are used to manage risks associated with our accumulation of residential loans.
(3) Amounts in this line include other fee income from loan acquisitions and the provision for repurchase expense, presented net.
The decrease in residential mortgage banking activities, net in 2019 was primarily due to lower gross margins on somewhat higher
loan purchase commitments in 2019, compared to 2018. Gross margins were towards the higher end of our long-term expectations in
2019, though below our 2018 gross margins, which benefited from significant spread tightening on AAA securities experienced early in
2018. The spread tightening benefited both loan production and the high balance of loans in inventory at the end of 2017, which were
subsequently sold in early 2018. The increase in mortgage banking activities, net in 2018 was primarily due to higher loan purchase
commitments on similar gross margins in 2018 compared to 2017. We define gross margins as net interest income plus income from
mortgage banking activities, divided by loan purchase commitments ("LPCs"). LPCs, adjusted for fallout expectations, were $7.01 billion,
$6.44 billion, and $5.89 billion for the years ended December 31, 2019, 2018, and 2017, respectively.
At December 31, 2019, we had a repurchase reserve of $4 million outstanding related to residential loans sold through this segment.
For the years ended December 31, 2019 and 2018, we recorded $0.3 million of repurchase provisions and $0.3 million of reversals of
provision for repurchases, respectively, that were included in income from mortgage banking activities, net, in this segment. We review
our loan repurchase reserves each quarter and adjust them as necessary based on current information available at each reporting date.
66
Investment Fair Value Changes, Net
The following table presents the components of investment fair value changes for our Residential Lending segment by investment
type for the years ended December 31, 2019, 2018, and 2017.
Table 13 – Investment Fair Value Changes, Net from Residential Lending
(In Thousands)
Investment Fair Value Changes, Net
Changes in fair value of:
Residential loans held-for-investment, at Redwood
Trading securities
Net investments in Sequoia Choice entities (1)
Risk-sharing and other investments
Risk management derivatives, net
Investment Fair Value Changes, Net
Years Ended December 31,
2019
2018
2017
$
$
$
58,891
(14,675)
6,947
(166)
(78,917)
(27,920) $
(29,573) $
(3,281)
443
(434)
11,159
(21,686) $
(5,765)
(5,600)
(323)
(1,484)
(12,294)
(25,466)
(1) Includes changes in fair value of the loans held-for-investment and the ABS issued at the entities, which netted together represent the change in
value of our investments (senior and subordinate securities) at the consolidated VIEs.
For 2019, the negative investment fair value changes primarily resulted from interest rate volatility, which increased prepayment
rates on loans held-for-investments, IO securities, and other premium securities, adversely impacting valuations, net of associated hedges.
This decline was partially offset by spread tightening on certain of our net investments in Sequoia Choice entities.
For 2018, the negative investment fair value changes primarily resulted from credit spread widening that occurred in the fourth
quarter, impacting both our residential loans and residential trading securities.
Included in the risk management derivatives component of investment fair value changes, net is net interest expense from derivative
instruments used to hedge interest rate risk on our financed investments. Net hedge interest expense associated with investment hedges
was income of $3 million in 2019, an expense of $0.5 million in 2018, and an expense of $12 million in 2017.
Other Income
Other income was primarily comprised of MSR income and income from our residential loan risk-sharing arrangements with Fannie
Mae and Freddie Mac. The $3 million decrease in Other income in 2019 was primarily due to a decrease in income from our MSR
investments, as the notional balance of underlying loans continued to pay down.
Realized Gains, Net
Realized gains, net result from sales of available-for-sale securities within this segment. We generally sell securities when their yields
fall below our return thresholds and we see opportunities to redeploy the capital into other investments with more attractive risk-adjusted
returns. During the past three years, the majority of the securities we sold in this segment were mezzanine securities we retained from
Sequoia Select securitizations that experienced significant credit spread tightening as the securitizations have paid-down and experienced
minimal losses.
General and Administrative Expenses
General and administrative expenses for this segment primarily include costs associated with the underwriting, purchase and sale of
residential loans, as well as costs associated with managing the segment's investment portfolio. General and administrative expenses
decreased $1 million during 2019, primarily related to a decrease in loan acquisition costs associated with lower loan purchase volume
in 2019 relative to 2018, as well as lower variable compensation expense commensurate with lower returns for this segment in 2019
relative to 2018. General and administrative expenses increased $4 million during 2018, primarily related to an increase in loan acquisition
costs associated with the increase in loan purchase volume in 2018 relative to 2017, as well as higher compensation expense as we
increased headcount in 2018 and paid higher variable compensation tied to higher earnings in 2018.
67
Provision for Income Taxes
The provision for income taxes for this segment primarily result from its mortgage banking activities, which are performed at our
taxable REIT subsidiary, and is generally correlated to the amount of this segment's contribution before income taxes in relation to the
TRS's overall GAAP income and associated tax provision. For 2019, the decrease in the tax provision primarily resulted from decreased
TRS GAAP earnings at this segment and, in 2018, the increase primarily resulted from increased TRS GAAP earnings at this segment.
For additional detail on income taxes, see the "Tax Provision and Taxable Income" section that follows.
Business Purpose Lending Segment
Our Business Purpose Lending segment consists of a platform that originates and acquires business purpose residential loans for
subsequent securitization or transfer into our investment portfolio, as well as the investments we retain from these activities. We typically
originate single-family rental and residential bridge loans and distribute certain single-family loans through our CoreVest American
Finance Lender ("CAFL") private-label securitization program and retain others for investment along with our residential bridge loans.
Single-family rental loans are business purpose residential mortgage loans to investors in single-family (1-4 unit) rental properties.
Residential bridge loans are business purpose residential mortgage loans to investors rehabilitating and reselling or renting residential
properties. Our investments in this segment primarily consist of securities retained from CAFL securitizations (which we consolidate for
GAAP purposes), residential bridge loans, and single-family rental loans we finance through our FHLBC member subsidiary.
The following table presents the components of segment contribution for the Business Purpose Lending segment for the years ended
December 31, 2019, 2018, and 2017.
Table 14 – Business Purpose Lending Segment Contribution
(In Thousands)
Net interest income
Investments
Loans held-for-sale
Total net interest income
Non-interest income
Mortgage banking activities, net
Investment fair value changes, net
Other income
Total non-interest income, net
General and administrative expenses
Other expenses
Segment contribution before income taxes
Provision for income taxes
Total Segment Contribution
Years Ended December 31,
2018
2017
2019
Changes
'19/'18
'18/'17
$
15,469
$
2,181
$
— $
13,288
$
3,240
18,709
39,523
(6,722)
5,852
38,653
(30,655)
(8,521)
18,186
(947)
17,239
$
$
155
2,336
(57)
(29)
—
(86)
(2,597)
—
(347)
—
(347) $
—
—
—
—
—
—
—
—
—
—
— $
3,085
16,373
39,580
(6,693)
5,852
38,739
(28,058)
(8,521)
18,533
(947)
17,586
$
2,181
155
2,336
(57)
(29)
—
(86)
(2,597)
—
(347)
—
(347)
68
The following table provides the business purpose residential loans origination activity at Redwood during the year ended
December 31, 2019.
Table 15 – Business Purpose Residential Loans — Origination Activity
(In Thousands)
Fair value at beginning of period
Originations
Acquisitions
Sales
Transfers between portfolios (2)
Principal repayments
Changes in fair value, net
Fair Value at End of Period
Single-Family
Rental HFS
Year Ended December 31, 2019
Residential
Bridge(1)
Total
$
28,460
$
— $
513,802
426,654
(20,426)
(632,650)
(2,991)
18,716
501,355
—
(56,485)
(449,388)
—
4,518
$
331,565
$
— $
28,460
1,015,157
426,654
(76,911)
(1,082,038)
(2,991)
23,234
331,565
(1) Our residential bridge loans are generally originated at our TRS and the majority are transferred to our REIT and a smaller portion sold. Origination
fees and any mark-to-market changes on these loans prior to transfer are recognized as mortgage banking income. The loans held at our REIT are
classified as held-for-investment, with subsequent fair value changes recorded through Investment fair value changes, net on our consolidated
statements of income. For the carrying value and activity of our residential bridge loans held-for-investment, see the Investments section that follows.
(2) For single-family rental loans, amounts represent transfers of loans from held-for-sale to held-for-investment, including when loans are securitized
(and consolidated for GAAP purposes) or transferred from our TRS to our REIT with the intent to hold for long-term investment. For residential
bridge loans, represents the transfer of loans from our TRS to REIT as described in preceding footnote.
The following table presents details of our Business Purpose Lending Investments portfolio at December 31, 2019 and December
31, 2018.
Table 16 – Business Purpose Lending Investments
(In Thousands)
Single-family rental loans at Redwood (1)
Residential bridge loans at Redwood
Single-family rental securities at consolidated CAFL entities (2)
Other investments
Total Segment Investments
(1) Excludes loans that we consolidate for GAAP purposes.
December 31, 2019
December 31, 2018
$
$
237,620
745,006
191,301
21,002
1,194,929
$
$
—
112,798
—
10,754
123,552
(2) Represents our economic investment in securities issued by consolidated CAFL securitization entities. For GAAP purposes, we consolidated $2.19
billion of loans and $2.00 billion of ABS issued associated with these investments at December 31, 2019.
See the Investments and Consolidated VIEs sections that follow for additional details on these investments.
69
Overview
Prior to our acquisitions of CoreVest and 5 Arches in 2019, we did not have significant investments in business purpose residential
loans and had only acquired a limited amount of business purpose residential loans from 5 Arches in 2018, while we held a minority
investment in 5 Arches. Through our acquisition of 5 Arches in March of 2019, we began originating business purpose loans, of which
the SFR loans were generally initially held in inventory for future securitization and the bridge loans were generally transferred into our
BPL investment portfolio. Later in 2019, we transferred nearly all of the 5 Arches originated SFR loans into our BPL investment portfolio,
where they were financed through our FHLB member subsidiary. In October of 2019, we acquired CoreVest and obtained its inventory
of single-family rental loans held-for-sale, along with an investment portfolio comprised of bridge loans and retained securities from
CAFL securitizations it had previously issued. In November 2019, we issued our first securitization under the CAFL program and retained
certain subordinate securities (for GAAP purposes, CAFL securitizations are not treated as sales and we consolidate all CAFL securitization
entities onto our balance sheet). In the future, we expect to securitize a portion of our SFR loan originations and transfer a portion into
our BPL investment portfolio. In the near-term, we generally expect to transfer the majority of newly originated bridge loans into our
BPL investment portfolio.
Results from this segment in 2019 were driven by our BPL mortgage banking operations as well as from our BPL investment portfolio,
which both increased meaningfully relative to 2018, due to the acquisitions of 5 Arches and CoreVest. Mortgage banking results for this
segment also benefited from spread tightening in the fourth quarter of 2019, as we experienced strong execution on the first securitization
we issued under the CAFL program.
During the first two months of 2019, prior to our acquisition of 5 Arches on March 1, 2019, we purchased $19 million of single-
family rental loans from 5 Arches. During the period from March 1, 2019 to December 31, 2019, we funded $514 million of single-family
rental loans, of which $238 million were transferred to our investment portfolio and financed with FHLB borrowings, and the remaining
loans were held-for-sale. During the period from March 1, 2019 to December 31, 2019, we funded $501 million of residential bridge
loans, of which $56 million were sold to a third party and the remaining loans were transferred to our BPL investment portfolio.
We utilize a combination of capital and our business purpose loan warehouse facilities to manage our inventory of business purpose
residential loans held-for-sale and our business purpose loan investments. Our business purpose residential loan warehouse capacity
totaled $1.48 billion across six separate counterparties. In addition, at December 31, 2019, we finance a portion of the CAFL securities
we own through a securities repurchase facility.
Net Interest Income
Net interest income from our Business Purpose Lending segment is primarily comprised of net interest income earned from our BPL
investments, and to a lesser extent from our inventory of SFR loans held-for-sale from the time we originate or acquire the loans to when
securitize them or transfer them to our investment portfolio.
The $16 million increase in net interest income in 2019 was primarily due to a higher average balance of BPL investments during
2019 relative to 2018, as we retained SFR and residential bridge loans from 5 Arches and CoreVest production during 2019 and also
acquired the in-place portfolio of residential bridge loans and retained SFR securities from CoreVest during the fourth quarter of 2019.
The increase was also driven by a higher average balance of loans held-for-sale during 2019 relative to 2018.
Mortgage Banking Activities, Net
Mortgage banking activities, net, includes loan origination fees and the changes in market value of both the loans we hold for sale
and our interest rate lock commitments (collectively, our loan pipeline), as well as the derivative instruments we utilize to manage risks
associated with our loan pipeline, from the time we lock a loan with a borrower to when we subsequently securitize the loan or transfer
it to our BPL investment portfolio. Accordingly, these profit margins may encompass positive or negative market valuation adjustments
on loans, hedging gains or losses associated with our loan pipeline, and any other related transaction expenses, and may be realized over
the course of one or more quarters for financial reporting purposes.
70
The following table presents the components of business purpose mortgage banking activities, net. Amounts presented include both
the changes in market values for loans that were sold and associated derivative positions that were settled during the periods presented,
as well as changes in market values of loans and derivatives outstanding at the end of each period.
Table 17 – Components of Business Purpose Mortgage Banking Activities, Net
(In Thousands)
Business Purpose Mortgage Banking Activities, Net
Changes in fair value of:
Single-family rental loans, at fair value(1)
Risk management derivatives (2)
Residential bridge loans, at fair value(3)
Other income (4)
Years Ended December 31,
2018
2017
2019
Changes
'19/'18
'18/'17
$
17,004
$
1,796
4,518
16,205
453
(510)
—
—
(57) $
$
— $
16,551
$
—
—
—
2,306
4,518
16,205
— $
39,580
$
453
(510)
—
—
(57)
Total business purpose mortgage banking activities, net
$
39,523
$
(1) Includes changes in fair value for interest rate lock commitments.
(2) Represents market valuation changes of derivatives that are used to manage risks associated with our accumulation of loans.
(3) Represents the change in fair market value from origination at our TRS to when the loan is sold or transferred to our REIT.
(4) Amounts in this line primarily include loan origination fees.
Increasing origination volumes drove higher income from mortgage banking activities in both 2019 and 2018. Business purpose
mortgage banking activities for 2019 included $30 million earned in the fourth quarter, driven both by new origination activity from
CoreVest, increased origination activity from 5 Arches, as well as a benefit from spread-tightening on securitization execution for the
SFR loans we acquired from CoreVest. We generally would not expect the same spread-tightening in subsequent quarters, dependent on
market conditions.
Investment Fair Value Changes, Net
The following table presents the components of investment fair value changes for our Business Purpose Lending segment by
investment type for the years ended December 31, 2019, 2018, and 2017.
Table 18 – Investment Fair Value Changes, Net from Business Purpose Lending
(In Thousands)
Investment Fair Value Changes, Net
Single-family rental loans held-for-investment
Residential bridge loans held-for-investment
REO
Net investments in CAFL entities (1)
Other
Investment Fair Value Changes, Net
Years Ended December 31,
2019
2018
2017
$
$
$
272
(2,139)
(1,045)
(3,636)
(174)
(6,722) $
— $
(29)
—
—
(29) $
—
—
—
—
—
(1) Includes changes in fair value of the loans held-for-investment and the ABS issued at the entities, which netted together represent the change in
value of our economic investments (senior and subordinate securities) in securities at the consolidated VIEs.
Residential bridge loans are carried at fair value and generally transferred to our REIT at a premium, which diminishes as the loans
mature and ultimately repay, resulting in negative fair value changes over the life of the loans. The change in fair value for our net
investments in CAFL entities represents the change in fair value of the underlying securities we own in these consolidated entities and
was negative in 2019, primarily due to the receipt of expected cash flows on IO securities we own. During 2019, we recorded $1 million
of negative fair value changes related to residential business purpose loans we foreclosed on and carried as REO.
71
Other Income
Other income at this segment is primarily comprised of fee income earned from the administration of loans for a third-party legacy
fund, which is winding down.
General and Administrative Expenses
General and administrative expenses for this segment include costs associated with the origination, purchase and securitization of
business purpose residential loans, as well as the management of our BPL investment portfolio. General and administrative expenses
increased during 2019 due to the acquisitions of 5 Arches and CoreVest. We expect these expenses to increase in 2020 as we incur a full
year of expenses for these operations.
Other Expenses
Other expenses for this segment includes amortization expense from intangible assets we recorded in connection with the acquisitions
of 5 Arches and CoreVest for the periods we owned each company during 2019.
Provision for Income Taxes
The provision for income taxes for this segment primarily result from its mortgage banking activities, which are performed at our
taxable REIT subsidiary, and is generally correlated to the amount of this segment's contribution before income taxes in relation to the
TRS's overall GAAP income and associated tax provision. For 2019, the increase in the tax provision primarily resulted from increased
TRS GAAP earnings at this segment. For additional detail on income taxes, see the "Tax Provision and Taxable Income" section that
follows.
Multifamily Investments Segment
Our Multifamily Investments segment consists of investments in securities collateralized by multifamily mortgage loans, as well as
other investments in multifamily mortgages and related assets. The securities in this segment are primarily comprised of investments in
Freddie Mac K-Series securitizations.
The following table presents the components of segment contribution for the Multifamily Investments segment for the years ended
December 31, 2019, 2018, and 2017.
Table 19 – Multifamily Investments Segment Contribution
(In Thousands)
Net interest income
Non-interest income
Investment fair value changes, net
Other income
Realized gains, net
Total non-interest income, net
General and administrative expenses
Segment contribution before income taxes
Provision for income taxes
Total Segment Contribution
Years Ended December 31,
2018
2017
2019
Changes
'19/'18
'18/'17
$
9,712
$
5,726
$
3,063
$
3,986
$
2,663
27,097
1,484
134
28,715
(1,498)
36,929
(11)
36,918
$
$
3,979
16,196
—
—
3,979
(869)
8,836
(16)
8,820
$
—
—
16,196
(425)
18,834
(238)
18,596
23,118
1,484
134
24,736
(629)
28,093
5
(12,217)
—
—
(12,217)
(444)
(9,998)
222
$
28,098
$
(9,776)
72
The following table presents details of the investments in our Multifamily Investments segment at December 31, 2019 and December
31, 2018.
Table 20 – Multifamily Investments
(In Thousands)
Multifamily securities at Redwood
Multifamily securities at consolidated Freddie Mac K-Series entities (1)
Other investments
Total Segment Investments
$
$
December 31, 2019
December 31, 2018
404,128
252,285
61,018
717,431
$
$
429,079
125,523
15,092
569,694
(1) Represents our economic investment in securities issued by consolidated Freddie Mac K-Series securitization entities. For GAAP purposes, we
consolidated $4.41 billion of loans and $4.16 billion of ABS issued associated with these investments at December 31, 2019.
See the Investments and Consolidated VIEs sections that follow for additional details on these investments.
Overview
Segment contribution from Multifamily Investments increased in 2019, primarily as a result of positive market valuation changes
driven by tightening credit spreads, as well as higher net interest income from a higher average balance of investments.
Beginning in 2018, we began investing in subordinate securities issued from Freddie Mac sponsored K-Series multifamily
securitizations. Due to certain rights given to the subordinate securities, we consolidate these securitizations for GAAP purposes and we
consolidated three such securitizations in 2018 and two in 2019 as result of securities we purchased in those years. We also invest in
mezzanine securities issued by Freddie Mac and Fannie Mae, which represent securities subordinate to senior securities, but senior to
the most subordinate bonds in a securitization. While we continued to invest in new mezzanine multifamily securities during 2019, on a
net basis we reduced our investment in these assets, as we sold several seasoned securities that had appreciated in price (contributing to
higher investment fair value changes in 2019) and had lower current returns. We account for most of the securities in this segment under
the fair value option and gains are reflected in investment fair value changes rather than realized gains.
In addition to our multifamily securities investments, our other investments are primarily comprised of an investment in a limited
partnership created to acquire multifamily loans from Freddie Mac, and investments in multifamily excess MSRs.
Net Interest Income
The increases in 2019 and 2018 in net interest income from multifamily investments were primarily driven by a higher average
balance of investments in each sequential year, as we increased our investments in Freddie Mac K-Series subordinate securities in both
years.
73
Investment Fair Value Changes, Net
The following table presents the components of investment fair value changes for our Multifamily segment by investment type for
the years ended December 31, 2019, 2018, and 2017.
Table 21 – Investment Fair Value Changes, Net from Multifamily Investments
(In Thousands)
Investment Fair Value Changes, Net
Changes in fair value of:
Trading securities
Excess MSRs
Net investments in Freddie Mac K-Series entities (1)
Risk management derivatives, net
Valuation adjustments on commercial loans held-for-sale
Years Ended December 31,
2019
2018
2017
$
$
33,233
(3,570)
21,430
(23,996)
—
3,825
(313)
931
(464)
—
$
15,798
—
—
98
300
Investment Fair Value Changes, Net
$
27,097
$
3,979
$
16,196
(1) Includes changes in fair value of the loans held-for-investment and the ABS issued at the entities, which netted together represent the change in
value of our investments (subordinate securities) at the consolidated VIEs.
The net positive investment fair value changes for 2019 were primarily driven by tightening credit spreads in our mezzanine securities
as well as the subordinate securities we own in the consolidated Freddie Mac K-Series entities. The mezzanine trading securities saw
price appreciation from both tightening credit spreads and lower benchmark interest rates in 2019. Nearly all of our risk management
derivatives at this segment are used to manage interest rate risk on our mezzanine securities, and in 2019 they decreased in value as a
result of declining benchmark interest rates. Our excess MSRs saw negative fair value changes in 2019 primarily related to the receipt
of expected cash flows.
Other Income
Other income in this segment includes income from our investment in a multifamily loan fund, which we entered into in January
2019.
General and Administrative Expenses
General and administrative expenses increased over the last two years as we hired additional personnel to manage our growing
investment portfolio.
Provision for Income Taxes
The provision for income taxes is generally correlated to the amount of this segment's contribution before income taxes in relation
to the TRS's overall GAAP income and associated tax provision. For 2019, the TRS GAAP income earned at this segment was consistent
with the prior year.
Third-Party Residential Investments Segment
Our Third-Party Residential Investments segment consists of investments in RMBS issued by third parties, investments in Freddie
Mac SLST securitizations (which we consolidate for GAAP purposes), our servicer advance investments, and other residential credit
investments not generated through our Residential Lending segment.
74
The following table presents the components of segment contribution for the Third-Party Residential Investments segment for the
years ended December 31, 2019, 2018, and 2017.
Table 22 – Third-Party Residential Investments Segment Contribution
(In Thousands)
Net interest income
Non-interest income
Investment fair value changes, net
Realized gains, net
Total non-interest income, net
General and administrative expenses
Other expenses
Segment contribution before income taxes
Provision for income taxes
Total Segment Contribution
Years Ended December 31,
2018
2017
2019
Changes
'19/'18
'18/'17
$
34,621
$
41,473
$
39,149
$
(6,852) $
2,324
44,662
15,395
60,057
(2,843)
(1,106)
90,729
(2,408)
88,321
$
(6,957)
19,332
12,375
(2,855)
(18)
50,975
(3,039)
47,936
$
27,684
10,200
37,884
(2,028)
—
75,005
(4,873)
70,132
$
51,619
(3,937)
47,682
12
(1,088)
39,754
631
(34,641)
9,132
(25,509)
(827)
(18)
(24,030)
1,834
$
40,385
$
(22,196)
The following table presents details of the investments in our Third-Party Residential Investments segment at December 31, 2019
and December 31, 2018.
Table 23 – Third-Party Residential Investments
(In Thousands)
Residential securities at Redwood
Residential securities at consolidated Freddie Mac SLST entities (1)
Other investments
Total Segment Investments
December 31, 2019
December 31, 2018
$
$
466,672
448,893
233,886
1,149,451
$
$
659,107
228,921
312,688
1,200,716
(1) Represents our economic investment in securities issued by consolidated Freddie Mac SLST securitization entities. For GAAP purposes, we
consolidated $2.37 billion of loans and $1.92 billion of ABS issued associated with these investments at December 31, 2019.
See the Investments and Consolidated VIEs sections that follows for additional details on these investments.
Overview
Segment contribution from Third-Party Residential Investments increased during 2019, primarily due to positive investment fair
value changes on our investments resulting from tightening credit spreads across much of this portfolio. This increase was partially offset
by lower net interest income in 2019 resulting from lower discount accretion on available-for-sale securities, and lower realized gains as
we sold fewer AFS securities in 2019.
Net Interest Income
Net interest income from our third-party residential investments decreased $7 million in 2019, primarily due to lower discount
accretion from legacy available-for-sale securities, resulting from lower average balances of these investments during 2019. This decline
was partially offset by an increase in net interest income from additional investments made in Freddie Mac SLST securities during 2019.
Our net investments in these entities (i.e., the securities issued by these entities that we own) are accounted for under the fair value method
and a portion of their economic return (related to the discount we purchased these securities at that we expect to receive in the future) is
recognized through investment fair value changes.
75
Investment Fair Value Changes, Net
The following table presents the components of investment fair value changes for our Third-Party Residential Investments segment
by investment type for the years ended December 31, 2019, 2018, and 2017.
Table 24 – Investment Fair Value Changes, Net from Third-Party Residential Investments
(In Thousands)
Investment Fair Value Changes, Net
Changes in fair value of:
Trading securities
Servicer advance investments
Excess MSRs
Shared home appreciation options
Net investment in Freddie Mac SLST entities (1)
Risk management derivatives, net
Impairments on AFS securities
Investment Fair Value Changes, Net
Years Ended December 31,
2019
2018
2017
$
37,488
$
3,001
310
842
27,206
(24,185)
—
$
44,662
$
(8,599) $
(701)
2,136
—
1,271
(975)
(89)
(6,957) $
29,328
—
—
—
—
(633)
(1,011)
27,684
(1) Includes changes in fair value of the loans held-for-investment and the ABS issued at the entities, which netted together represent the change in
value of our investments (subordinate securities) at the consolidated VIEs.
The net positive investment fair value changes for 2019 were primarily driven by tightening credit spreads in our trading securities
as well as the subordinate securities we own in the consolidated Freddie Mac SLST entities. The trading securities saw price appreciation
from both tightening credit spreads and lower benchmark interest rates in 2019. Nearly all of our risk management derivatives at this
segment are used to manage interest rate risk on our trading securities, and in 2019 they decreased in value as a result of declining
benchmark interest rates.
The net negative investment fair value changes for 2018 were primarily driven by widening credit spreads in the fourth quarter of
2018.
Realized Gains, Net
Realized gains in this segment resulted from the sale of third-party AFS securities. Our portfolio of third-party AFS securities has
decreased due to these sales and most of the new securities we purchase are accounted for under the fair value option. As such, we expect
fewer realized gains from this portfolio in the future.
General and Administrative Expenses
General and administrative expenses in this segment are mostly comprised of personnel costs to manage this portfolio and have
remained relatively consistent over the past two years.
Other Expenses
Other expenses in 2019 consisted of $1 million of income allocable to co-investors in our servicing advance investments.
Provision for Income Taxes
The provision for income taxes is generally correlated to the amount of this segment's contribution before income taxes in relation
to the TRS's overall GAAP income and associated tax provision. For 2019, while the TRS GAAP income earned at this segment increased
from the prior year, the decrease in the tax provision primarily resulted from the decrease in our overall tax provision.
76
Investments
This section presents additional details on our investment assets and their activity during 2019 and 2018.
Residential Loans Held-for-Investment at Redwood Portfolio
The following table provides the activity of residential loans held-for-investment at Redwood during the years ended December 31,
2019 and 2018.
Table 25 – Residential Loans Held-for-Investment at Redwood - Activity
(In Thousands)
Fair value at beginning of period
Acquisitions
Sales
Transfers between portfolios (1)
Principal repayments
Changes in fair value, net
Fair Value at End of Period
Years Ended December 31,
2019
2018
$
2,383,932
$
2,434,386
39,269
(9,421)
69,431
(430,205)
58,891
—
—
269,883
(290,327)
(30,010)
$
2,111,897
$
2,383,932
(1) Represents the net transfers of loans into our Investment Portfolio segment from our Mortgage Banking segment and their reclassification from
held-for-sale to held-for-investment.
The following table presents the unpaid principal balances and weighted average coupons for residential real estate loans held-for-
investment at fair value by product type at December 31, 2019.
Table 26 – Characteristics of Residential Real Estate Loans Held-for-Investment at Redwood
December 31, 2019
(Dollars in Thousands)
Fixed - 30 year
Fixed - 15, 20, & 25 year
Hybrid
Total Outstanding Principal
Principal Balance
Weighted Average
Coupon
$
$
1,770,855
54,524
227,399
2,052,778
4.16%
3.71%
4.16%
The outstanding residential loans held-for-investment at Redwood at December 31, 2019 were prime-quality, first-lien loans, of
which 96% were originated between 2013 and 2019 and 4% were originated in 2012 and prior years. The weighted average FICO score
of borrowers backing these loans was 768 (at origination) and the weighted average loan-to-value ("LTV") ratio was 66% (at origination).
At December 31, 2019, two of these loans with an aggregate fair value of $1 million and an unpaid principal balance of $2 million were
greater than 90 days delinquent and none of these loans were in foreclosure.
At December 31, 2019, $2.10 billion of residential loans were held by our FHLB-member subsidiary and financed with $1.78 billion
of borrowings from the FHLBC. At December 31, 2019, the weighted average maturity of these FHLB borrowings was approximately
six years and they had a weighted average cost of 1.88% per annum. While the interest costs on these borrowings is variable and resets
every 13 weeks, we utilize various interest rate derivative instruments to hedge our interest rate risk in this portfolio.
Under a final rule published by the Federal Housing Finance Agency in January 2016, our FHLB-member subsidiary will remain
an FHLB-member through the five-year transition period for captive insurance companies. Our FHLB-member subsidiary's existing
$2.00 billion of FHLB debt, which matures beyond this transition period, is permitted to remain outstanding until its stated maturity. As
residential loans pledged as collateral for this debt pay down, we are permitted to pledge additional loans or other eligible assets to
collateralize this debt; however, we do not expect to be able to increase our subsidiary's FHLB debt above the existing $2.00 billion.
77
Business Purpose Residential Loans Portfolio
Single-Family Rental Loans Held-for-Investment at Redwood
The following table provides the activity of single-family rental loans held-for-investment at Redwood during the year ended
December 31, 2019.
Table 27 –Single-Family Rental Loans Held-for-Investment at Redwood - Activity
(In Thousands)
Fair value at beginning of period
Transfers between portfolios
Principal repayments
Changes in fair value, net
Fair Value at End of Period
Year Ended
December 31, 2019
$
$
—
238,144
(796)
272
237,620
The outstanding single-family rental loans held-for-investment at Redwood at December 31, 2019 were first-lien, fixed-rate loans
with original maturities of five, seven, or ten years. At December 31, 2019, the weighted average coupon of our single-family rental loans
was 4.89% and the weighted average remaining loan term was seven years. At origination, the weighted average LTV ratio of these loans
was 68% and the weighted average DSCR was 1.36 times. At December 31, 2019, none of these loans were greater than 90 days delinquent
or in foreclosure.
At December 31, 2019, $211 million of single-family rental loans were held by our FHLB-member subsidiary and financed with
$185 million of borrowings from the FHLBC. At December 31, 2019, the weighted average maturity of these FHLB borrowings was
approximately six years and they had a weighted average cost of 1.88% per annum.
Residential Bridge Loans Held-for-Investment at Redwood
The following table provides the activity of residential bridge loans held-for-investment at Redwood during the year ended
December 31, 2019.
Table 28 – Residential Bridge Loans Held-for-Investment at Redwood - Activity
(In Thousands)
Fair value at beginning of period
Acquisitions
Originations (1)
Transfers to REO
Principal repayments
Changes in fair value, net
Fair Value at End of Period
Year Ended
December 31, 2019
$
$
112,798
384,986
449,388
(7,775)
(192,255)
(2,136)
745,006
(1) All of our residential bridge loans are originated at our TRS then transferred to our REIT. Origination fees and any mark-to-market changes on
these loans prior to transfer are recognized as mortgage banking income. Once the loans are transferred to our REIT, they are classified as held-
for-investment, with subsequent fair value changes recorded through Investment fair value changes, net on our consolidated statements of income.
Our $745 million of residential bridge loans held-for-investment at December 31, 2019 were comprised of first-lien, fixed-rate,
interest-only loans with a weighted average coupon of 8.11% and original maturities of six to 24 months. At origination, the weighted
average FICO score of borrowers backing these loans was 732 and the weighted average LTV ratio of these loans was 70%. At December 31,
2019, of the 2,653 loans in this portfolio, 31 loans with an aggregate fair value of $12 million and an unpaid principal balance of $14
million were in foreclosure, of which 15 of these loans with an aggregate fair value of $7 million and an unpaid principal balance of $9
million were greater than 90 days delinquent.
78
To finance our residential bridge loans, we had eight business purpose residential loan warehouse facilities with a total uncommitted
borrowing limit of $1.48 billion at December 31, 2019. The weighted average cost of the borrowings outstanding under these facilities
during 2019 was 5.09%.
Real Estate Securities Portfolio
The following table sets forth our real estate securities activity by collateral type for the years ended December 31, 2019 and 2018.
Table 29 – Real Estate Securities Activity by Collateral Type
Year Ended December 31, 2019
Residential
Multifamily
(In Thousands)
Beginning fair value
Transfers (1)
Acquisitions
Sequoia securities
Third-party securities
Sales
Sequoia securities
Third-party securities
Gains on sales and calls, net
Effect of principal payments (2)
Change in fair value, net
Ending Fair Value (3)
Senior
Mezzanine
Subordinate
Mezzanine
Total
$
246,285
$
218,147
$
558,983
$
—
8,882
45,063
—
(68,661)
9,453
(33,855)
(31,308)
—
—
70,169
(55,312)
(86,754)
3,059
(10,594)
13,082
—
4,848
81,559
(6,362)
(308,350)
11,175
(15,678)
41,915
429,079
(4,951)
$
1,452,494
(4,951)
—
148,611
13,730
345,402
—
(181,752)
134
(20,444)
33,451
(61,674)
(645,517)
23,821
(80,571)
57,140
$
175,859
$
151,797
$
368,090
$
404,128
$
1,099,874
79
Year Ended December 31, 2018
Residential
Multifamily
(In Thousands)
Beginning fair value
Transfers (1)
Acquisitions
Sequoia securities
Third-party securities
Sales
Sequoia securities
Third-party securities
Gains on sales and calls, net
Effect of principal payments (2)
Change in fair value, net
Ending Fair Value
Senior
Mezzanine
Subordinate
Mezzanine
Total
$
249,838
$
331,452
$
571,195
$
—
—
—
324,025
(17,181)
$
1,476,510
(17,181)
29,968
78,868
—
(67,333)
16,973
(35,410)
(26,619)
$
246,285
$
14,204
54,675
(54,743)
(114,222)
4,354
(8,896)
(8,677)
218,147
$
7,739
250,503
(16,953)
(248,957)
5,714
(9,545)
(713)
558,983
—
225,521
51,911
609,567
—
(79,741)
—
(28,051)
4,506
(71,696)
(510,253)
27,041
(81,902)
(31,503)
$
429,079
$
1,452,494
(1) Represents the derecognition of mezzanine securities we owned in Freddie Mac K-Series securitizations when we began to consolidate the
securitizations upon the acquisition of subordinate interests in these entities.
(2) The effect of principal payments reflects the change in fair value due to principal payments, which is calculated as the cash principal received on
a given security during the period multiplied by the prior quarter ending price or acquisition price for that security.
(3) At December 31, 2019, excludes $254 million and $191 million of securities retained from our consolidated Sequoia Choice and CAFL
securitizations, respectively, as well as $449 million and $252 million of securities we owned that were issued by consolidated Freddie Mac SLST
and Freddie Mac K-Series securitizations, respectively. For additional details on our Choice, CAFL, Freddie Mac SLST and multifamily loans, see
the subsections titled "Consolidated Sequoia Choice Entities," "Consolidated CAFL Entities," "Consolidated Freddie Mac SLST Entities," and
"Consolidated Freddie Mac K-Series Entities" that follow.
During the year ended December 31, 2019, we sold $707 million of mostly lower-yielding securities as part of our ongoing portfolio
optimization activities.
At December 31, 2019, our securities consisted of fixed-rate assets (86%), adjustable-rate assets (9%), hybrid assets that reset within
the next year (4%), and hybrid assets that reset between 12 and 36 months (1%). For the portions of our securities portfolio that are
sensitive to changes in interest rates, we seek to minimize this interest rate risk by using various derivative instruments.
80
We directly finance our holdings of real estate securities with a combination of capital and collateralized debt in the form of repurchase
(or “repo”) financing. The following table presents the fair value of our residential securities that were financed with repurchase debt at
December 31, 2019.
Table 30 – Real Estate Securities Financed with Repurchase Debt
December 31, 2019
(Dollars in Thousands, except Weighted Average Price)
Real Estate
Securities (1)
Repurchase
Debt
Allocated
Capital
Weighted
Average
Price (2)
Financing
Haircut (3)
Residential Securities
Senior
Mezzanine (4)
Re-performing (5)
Total Residential Securities
Multifamily Securities (6)
BPL Securities (7)
Total Securities
$
72,512
$
238,024
412,069
722,605
641,541
127,840
(66,474) $
(210,454)
(314,825)
(591,753)
(504,826)
(80,000)
6,038
$
27,570
97,244
130,852
136,715
47,840
$ 1,491,986
$ (1,176,579) $
315,407
101
103
90
95
89
76
8%
12%
24%
18%
21%
37%
(1) Amounts represent carrying value of securities, which are held at GAAP fair value.
(2) GAAP fair value per $100 of principal. Weighted average price excludes IO securities.
(3) Allocated capital divided by GAAP fair value.
(4) Includes $111 million of securities we owned that were issued by consolidated Sequoia Choice securitizations, which we consolidate in accordance
with GAAP.
(5) Includes $382 million of securities we owned that were issued by consolidated Freddie Mac SLST securitizations, which we consolidate in accordance
with GAAP.
(6) Includes $252 million of securities we owned that were issued by consolidated Freddie Mac K-Series securitizations, which we consolidate in
accordance with GAAP.
(7) Includes $128 million of securities we owned that were issued by consolidated CAFL securitizations, which we consolidate in accordance with
GAAP.
At December 31, 2019, we had short-term debt incurred through repurchase facilities of $1.18 billion, which was secured by $1.49
billion of real estate securities (including securities owned in consolidated securitization entities). Our repo borrowings were made under
facilities with 10 different counterparties, and the weighted average cost of funds for these facilities during 2019 was approximately
3.35%. Additionally, at December 31, 2019, real estate securities with a fair value of $39 million were financed with long-term FHLBC
debt, and real estate securities with a fair value of $250 million (including securities owned in consolidated Sequoia Choice securitization
entities), were financed with long-term, non-mark-to-market recourse repurchase debt through our subordinate securities financing facility.
The remaining $471 million of our securities, including certain securities we own that were issued by consolidated securitization entities,
were financed with capital.
At December 31, 2019, the credit performance on the securities we financed through repurchase facilities generally continued to
perform in line with, or better than our expectations. In addition to the allocated capital listed in the table above that directly supports
our repurchase facilities (the "financing haircut”), we continue to hold a designated amount of supplemental risk capital available for
potential margin calls or future obligations relating to these borrowings.
81
The following table presents our real estate securities at December 31, 2019 and December 31, 2018, categorized by portfolio vintage
(the years the securities were issued), and by priority of cash flows (senior, mezzanine, and subordinate). We have additionally separated
securities issued through our Sequoia platform or by third parties, including the Agencies.
Table 31 – Real Estate Securities by Vintage and Type
December 31, 2019
(In Thousands)
Senior (1)
Mezzanine (2)
Subordinate (1)
Total Securities (3)
December 31, 2018
(In Thousands)
Senior (1)
Mezzanine (2)
Subordinate (1)
Total Securities (3)
Sequoia
2012-2019
Third
Party
2013-2019
Agency
CRT
2018-2019
Third
Party
<=2008
Total
Residential
Securities
Multifamily
2016-2019
Total Real
Estate
Securities
$
48,765
$
101,297
$
— $
25,797
$
175,859
$
— $
175,859
43,980
136,329
107,817
124,809
—
96,016
—
10,936
151,797
368,090
404,128
—
555,925
368,090
$
229,074
$
333,923
$
96,016
$
36,733
$
695,746
$
404,128
$ 1,099,874
Sequoia
2012-2018
Third
Party
2013-2018
Agency
CRT
2013-2018
Third
Party
<=2008
Total
Residential
Securities
Multifamily
2015-2018
Total Real
Estate
Securities
$
$
61,179
99,977
130,271
96,069
118,170
135,826
$
— $
—
276,894
$
89,037
—
15,992
246,285
218,147
558,983
$
— $
429,079
—
246,285
647,226
558,983
$
291,427
$
350,065
$
276,894
$
105,029
$ 1,023,415
$
429,079
$ 1,452,494
(1) At December 31, 2019 and December 31, 2018, senior Sequoia and third-party securities included $64 million and $82 million of IO securities,
respectively. At December 31, 2019 and December 31, 2018, subordinate third-party securities included $6 million and $12 million of IO securities,
respectively. Our interest-only securities included $36 million and $43 million of A-IO-S securities at December 31, 2019 and December 31, 2018,
respectively, that we retained from certain of our Sequoia securitizations. These securities represent certificated servicing strips and therefore may
be negatively impacted by the operating and funding costs related to servicing the associated securitized mortgage loans.
(2) Mezzanine includes securities initially rated AA through BBB- and issued in 2012 or later.
(3) At December 31, 2019, excluded $254 million, $449 million, $252 million, and $191 million of securities we owned that were issued by consolidated
Sequoia Choice, Freddie Mac SLST, Freddie Mac K-Series, and CAFL securitizations, respectively. At December 31, 2018, excluded $194 million,
$229 million, and $126 million of securities we owned that were issued by consolidated Sequoia Choice, Freddie Mac SLST, and Freddie Mac K-
Series securitizations, respectively. For GAAP purposes we consolidated $11.26 billion of loans and $10.11 billion of non-recourse ABS debt
associated with these retained securities.
82
(Dollars in Thousands)
Residential
Senior
Mezzanine
Subordinate
Year Ended December 31, 2018
(Dollars in Thousands)
Residential
Senior
Mezzanine
Subordinate
Year Ended December 31, 2017
(Dollars in Thousands)
Residential
Senior
Mezzanine
Subordinate
The following tables present the components of the interest income we earned on AFS securities for the years ended December 31,
2019, 2018, and 2017.
Table 32 – Interest Income — AFS Securities
Year Ended December 31, 2019
Interest
Income
Discount
(Premium)
Amortization
Total
Interest
Income
Average
Amortized
Cost
Interest
Income
Yield as a Result of
Discount
(Premium)
Amortization
Total
Interest
Income
Total AFS Securities
$ 13,542
$
7,921
$ 21,463
$ 182,251
$ 2,082
$
3,214
$
5,296
$
29,555
692
10,768
249
4,458
941
15,226
17,143
135,553
7.04%
4.04%
7.94%
7.43%
10.87%
17.91%
1.45%
3.29%
4.35%
5.49%
11.23%
11.78%
Interest
Income
Discount
(Premium)
Amortization
Total
Interest
Income
Average
Amortized
Cost
Interest
Income
Yield as a Result of
Discount
(Premium)
Amortization
Total
Interest
Income
Total AFS Securities
$ 19,630
$
14,098
$ 33,728
$ 302,134
$ 6,290
$
8,174
$ 14,464
$ 106,304
1,999
11,341
838
5,086
2,837
16,427
47,414
148,416
5.92%
4.22%
7.64%
6.50%
7.69%
1.77%
3.43%
4.67%
13.61%
5.99%
11.07%
11.16%
Interest
Income
Discount
(Premium)
Amortization
Total
Interest
Income
Average
Amortized
Cost
Interest
Income
Yield as a Result of
Discount
(Premium)
Amortization
Total
Interest
Income
$ 8,361 $
11,176
$ 19,537
$ 153,619
4,860
11,368
2,215
5,404
7,075
16,772
123,571
153,205
5.44%
3.93%
7.42%
5.71%
7.28%
1.79%
3.53%
4.37%
12.71%
5.72%
10.95%
10.08%
Total AFS Securities
$ 24,589
$
18,795
$ 43,384
$ 430,395
Mortgage Servicing Rights Portfolio
Our MSRs are held and managed at our taxable REIT subsidiary and typically are acquired together with loans from originators and
then separately recognized under GAAP when the MSR is retained and the associated loan is sold to a third party or transferred to a
Sequoia residential securitization sponsored by us that meets the GAAP criteria for sale. Although we own the rights to service loans,
we contract with sub-servicers to perform these activities. Our receipt of MSR income is not subject to any covenants other than customary
performance obligations associated with servicing residential loans. If a sub-servicer we contract with was to fail to perform these
obligations, our servicing rights could be terminated and we would evaluate our MSR asset for impairment at that time.
83
The following table provides the activity for MSRs for the years ended December 31, 2019 and 2018.
Table 33 – MSR Activity
(In Thousands)
Balance at beginning of period
Additions
MSRs retained from third-party loan sales
Sold MSRs
Market valuation adjustments
Balance at End of Period
Years Ended December 31,
2019
2018
60,281
$
63,598
868
—
(18,925)
42,224
$
328
(1,077)
(2,568)
60,281
$
$
The following table presents characteristics of our MSR investments and their associated loans at December 31, 2019.
Table 34 – Characteristics of MSR Investments Portfolio
(Dollars in Thousands)
Unpaid principal balance
Fair value of MSRs
MSR values as percent of unpaid principal balance
Gross cash yield (1)
Number of loans
Average loan size
Average coupon
Average loan age (months)
Average original loan-to-value
Average original FICO score
60+ day delinquencies
$
$
$
December 31, 2019
4,346,545
42,224
0.97%
0.30%
6,836
636
3.97%
64
67%
771
0.22%
(1) Gross cash yield is calculated by dividing the gross servicing fees we received for the year ended December 31, 2019, by the weighted average
notional balance of loans associated with MSRs we owned during the year.
At December 31, 2019, nearly all of our MSRs were comprised of base MSRs and within this portfolio we did not own any portion
of a servicing right related to any loan where we did not own the entire servicing right. At December 31, 2019 and December 31, 2018,
we had $0.4 million and $1 million, respectively, of servicer advances outstanding related to our MSRs, which are presented in Other
assets on our consolidated balance sheets.
84
Servicing Investments
In 2018, we invested in servicer advances and excess MSRs associated with legacy RMBS (See Note 10 in Part II, Item 8 of this
Annual Report on Form 10-K). At December 31, 2019, our servicer advance investments and excess MSRs associated with this investment
had a carrying value of $169 million and $16 million, respectively. The following table presents characteristics of the residential mortgage
loans underlying these investments at December 31, 2019.
Table 35 – Characteristics of Servicing Investments
(Dollars in Thousands)
Unpaid principal balance
Number of loans
Average loan size
Average coupon
Average loan age (months)
Average original loan-to-value
Average original FICO score
60+ day delinquencies (1)
$
$
December 31, 2019
7,937,704
40,898
194
5.13%
172
74%
695
9.00%
(1) Includes unpaid principal balance of $467 million, or 6% of total portfolio, of loans in foreclosure or transferred to REO.
85
Consolidated VIEs
Consolidated Legacy Sequoia Entities
We sponsored Sequoia securitization entities prior to 2012 that are reported on our consolidated balance sheets for financial reporting
purposes in accordance with GAAP. Each of these entities is independent of Redwood and of each other and the assets and liabilities of
these entities are not, respectively, owned by us or legal obligations of ours. We record the assets and liabilities of the consolidated Legacy
Sequoia entities at fair value, based on the estimated fair value of the debt securities (ABS) issued from the securitizations in accordance
with GAAP provisions for collateralized financing entities. At December 31, 2019, the estimated fair value of our investments in the
consolidated Legacy Sequoia entities was $6 million.
The following tables present the statements of income (loss) for the years ended December 31, 2019, 2018, and 2017 and the balance
sheets of the consolidated Legacy Sequoia entities at December 31, 2019 and December 31, 2018. All amounts in the statements of income
and balance sheets presented below are included in our consolidated financial statements and within the corporate/other section of our
segment financial statements.
Table 36 – Consolidated Legacy Sequoia Entities Statements of Income (Loss)
(In Thousands)
Interest income
Interest expense
Net interest income
Investment fair value changes, net
Net Income (Loss) from Consolidated
Legacy Sequoia Entities
Years Ended December 31,
Changes
2019
2018
2017
'19/'18
'18/'17
$
17,649
(14,418)
3,231
(1,545)
$
20,036
(16,519)
3,517
(1,016)
$
19,407
(14,789)
4,618
(8,027)
(2,387) $
2,101
(286)
(529)
629
(1,730)
(1,101)
7,011
1,686
$
2,501
$
(3,409)
$
(815) $
5,910
$
$
Table 37 – Consolidated Legacy Sequoia Entities Balance Sheets
(In Thousands)
Residential loans held-for-investment, at fair value
Other assets
Total Assets
Other liabilities
Asset-backed securities issued, at fair value
Total liabilities
Equity (fair value of Redwood's retained investments in entities)
Total Liabilities and Equity
Net Interest Income at Consolidated Legacy Sequoia Entities
December 31, 2019 December 31, 2018
$
$
$
$
$
$
$
407,890
1,258
409,148
395
402,465
402,860
6,288
409,148
$
519,958
4,911
524,869
571
512,240
512,811
12,058
524,869
The decreases in net interest income in 2019 and 2018 were primarily attributable to the continued paydown of loans at the consolidated
entities.
Investment Fair Value Changes, net at Consolidated Legacy Sequoia Entities
Investment fair value changes, net at consolidated Legacy Sequoia entities includes the change in fair value of the residential loans
held-for-investment, REO, and the ABS issued at the entities, which netted together represent the change in value of our retained
investments in the consolidated Legacy Sequoia entities. The negative investment fair value changes in each of the years presented was
primarily related to a decline in fair value on retained IO securities, as the basis of these assets continues to diminish.
86
Residential Loans at Consolidated Legacy Sequoia Entities
The following table provides details of residential loan activity at consolidated Legacy Sequoia entities for the years ended
December 31, 2019 and 2018.
Table 38 – Residential Loans at Consolidated Legacy Sequoia Entities — Activity
(In Thousands)
Balance at beginning of period
Principal repayments
Transfers to REO
Changes in fair value, net
Balance at End of Period
Years Ended December 31,
2019
2018
$
$
$
519,958
(116,899)
(339)
5,170
407,890
$
632,817
(146,210)
(4,104)
37,455
519,958
First lien adjustable rate mortgage ("ARM") and hybrid loans comprise all of the loans in the consolidated Legacy Sequoia entities
and were primarily originated in 2006 or prior. For outstanding loans at consolidated Legacy Sequoia entities at December 31, 2019, the
weighted average FICO score of borrowers backing these loans was 727 (at origination) and the weighted average original LTV ratio
was 65% (at origination). At December 31, 2019 and December 31, 2018, the unpaid principal balance of loans at consolidated Legacy
Sequoia entities delinquent greater than 90 days was $10 million and $14 million, respectively, of which the unpaid principal balance of
loans in foreclosure was $4 million and $5 million, respectively.
Consolidated Sequoia Choice Entities
As of December 31, 2019, we had issued nine securitizations primarily comprised of expanded-prime Choice loans that we consolidate
for financial reporting purposes in accordance with GAAP. These entities are independent of Redwood and the assets and liabilities of
these entities are not, respectively, owned by us or legal obligations of ours. We record the assets and liabilities of the consolidated Sequoia
Choice entities at fair value, based on the estimated fair value of the debt securities (ABS) issued from the securitizations, in accordance
with GAAP provisions for collateralized financing entities. At December 31, 2019, our economic investment in the consolidated Sequoia
Choice entities had an estimated fair value of $256 million. The securities retained from our consolidated Sequoia Choice entities included
senior and subordinate securities of $13 million and $241 million, respectively, at December 31, 2019.
The following tables present the statements of income for the years ended December 31, 2019, 2018, and 2017 and the balance sheets
of the consolidated Sequoia Choice entities at December 31, 2019 and December 31, 2018. All amounts in the statements of income and
balance sheets presented below are included in our consolidated financial statements and are included in our Residential Lending segment.
Table 39 – Consolidated Sequoia Choice Entities Statements of Income
(In Thousands)
Interest income
Interest expense
Net interest income
Investment fair value changes, net
Net Income from Consolidated Sequoia
Choice Entities
Years Ended December 31,
2018
2017
2019
Changes
'19/'18
'18/'17
$
$
108,798
(93,354)
15,444
6,947
$
69,645
(59,769)
9,876
444
$
5,133
(4,275)
858
(323)
39,153
(33,585)
5,568
6,503
$
64,512
(55,494)
9,018
767
$
22,391
$
10,320
$
535
$
12,071
$
9,785
87
Table 40 – Consolidated Sequoia Choice Entities Balance Sheets
(In Thousands)
Residential loans, held-for-investment, at fair value
Other assets
Total Assets
Other liabilities
Asset-backed securities issued, at fair value
Total liabilities
Equity (fair value of Redwood's retained investments in entities)
Total Liabilities and Equity
December 31, 2019
December 31, 2018
$
$
$
$
$
$
$
2,291,463
9,851
2,301,314
7,759
2,037,198
2,044,957
256,357
2,301,314
$
2,079,382
10,010
2,089,392
8,202
1,885,010
1,893,212
196,180
2,089,392
The following table presents residential loan activity at the consolidated Sequoia Choice entities for the years ended December 31,
2019 and 2018.
Table 41 – Residential Loans Held-for-Investment at Consolidated Sequoia Choice Entities - Activity
(In Thousands)
Balance at beginning of period
New securitization issuance
Principal repayments
Changes in fair value, net
Balance at End of Period
$
$
Years Ended December 31,
2018
2019
2,079,382
$
1,076,671
(849,357)
(15,233)
2,291,463
620,062
1,777,229
(305,252)
(12,657)
$
2,079,382
The outstanding loans held-for-investment at our Sequoia Choice entities at December 31, 2019 were primarily comprised of prime-
quality, first-lien, 30-year, fixed-rate loans originated in 2017 or 2018. The gross weighted average coupon of these loans was 4.73%,
the weighted average FICO score of borrowers backing these loans was 744 (at origination) and the weighted average original LTV ratio
was 75% (at origination). At December 31, 2019, nine of these loans with an aggregate unpaid principal balance of $7 million were
greater than 90 days delinquent and three of these loans with an aggregate unpaid principal balance of $2 million was in foreclosure. At
December 31, 2018, three of these loans with an aggregate unpaid principal balance of $2 million were greater than 90 days delinquent
and none of these loans were in foreclosure.
Consolidated Freddie Mac SLST Entities
Beginning in 2018, we invested in certain subordinate securities backed by pools of seasoned re-performing and, to a lesser extent,
non-performing residential mortgage loans that were issued by certain Freddie Mac SLST securitization entities and we were required
to consolidate these entities for financial reporting purposes in accordance with GAAP. These entities are independent of Redwood and
the assets and liabilities of these entities are not, respectively, owned by us or legal obligations of ours. We record the assets and liabilities
of the consolidated Freddie Mac SLST entities at fair value, based on the estimated fair value of the debt securities (ABS) issued from
the securitizations, in accordance with GAAP provisions for collateralized financing entities. At December 31, 2019, our economic
investment in the consolidated Freddie Mac SLST entities had an estimated fair value of $451 million, and was comprised of subordinate
securities.
88
The following tables present the statements of income for the years ended December 31, 2019, 2018, and 2017 and the balance sheets
of the consolidated Freddie Mac SLST entities at December 31, 2019 and December 31, 2018. All amounts in the statements of income
and balance sheets presented below are included in our consolidated financial statements and are included in our Third-Party Residential
Investments segment.
Table 42 – Consolidated Freddie Mac SLST Entities Statements of Income
(In Thousands)
Interest income
Interest expense
Net interest income
Investment fair value changes, net
Net Income from Consolidated Freddie Mac
SLST Entities
Years Ended December 31,
Changes
2019
2018
2017
'19/'18
'18/'17
$
$
57,840
(42,574)
15,266
27,206
4,453
(3,156)
1,297
1,271
$
— $
—
—
—
$
53,387
(39,418)
13,969
25,935
4,453
(3,156)
1,297
1,271
$
42,472
$
2,568
$
— $
39,904
$
2,568
Table 43 – Consolidated Freddie Mac SLST Entities Balance Sheets
(In Thousands)
Residential loans, held-for-investment, at fair value
Other assets
Total Assets
Other liabilities
Asset-backed securities issued, at fair value
Total liabilities
Equity (fair value of Redwood's investments in entities)
Total Liabilities and Equity
December 31, 2019
December 31, 2018
$
$
$
$
2,367,215 $
$
$
7,758
2,374,973
5,374
1,918,322
1,923,696
451,277
1,222,669
3,926
1,226,595
2,907
993,748
996,655
229,940
2,374,973
$
1,226,595
The following table presents residential loan activity at the consolidated Freddie Mac SLST entity for the years ended December 31,
2019 and 2018.
Table 44 – Residential Loans Held-for-Investment at Consolidated Freddie Mac SLST Entities - Activity
(In Thousands)
Balance at beginning of period
Consolidation of residential loans held in securitization trusts
Principal repayments
Transfers to REO
Changes in fair value, net
Balance at End of Period
Years Ended December 31,
2018
2019
1,222,669
$
1,190,995
(109,537)
(495)
63,583
—
1,206,645
(5,272)
—
21,296
2,367,215
$
1,222,669
$
$
89
The outstanding re-performing and non-performing residential loans held-for-investment at the Freddie Mac SLST entities at
December 31, 2019 were first-lien, fixed- or step-rate loans that have been modified. At securitization, the weighted average FICO score
of borrowers backing these loans was 600 and the weighted average LTV ratio of these loans was 73%. At December 31, 2019, 587 of
these loans with an aggregate unpaid principal balance of $135 million were greater than 90 days delinquent and 208 of these loans with
an aggregate unpaid principal balance of $33 million were in foreclosure. At December 31, 2018, 306 of these loans with an aggregate
unpaid principal balance of $51 million were greater than 90 days delinquent and none of these loans were in foreclosure. Due to the
credit profile of re-performing and non-performing loans, our investment in the subordinate securities issued by the Freddie Mac SLST
entities was made based on an expectation of defaults and credit losses that will occur on the underlying pool of residential mortgage
loans, which was reflected in our purchase price yield. At December 31, 2019, delinquencies and credit losses in the portfolio remained
in line with our expectations.
Consolidated Freddie Mac K-Series Entities
Beginning in 2018, we invested in certain subordinate securities issued by Freddie Mac K-Series securitization entities and were
required to consolidate these entities for financial reporting purposes in accordance with GAAP. Each of these entities is independent of
Redwood and of each other and the assets and liabilities of these entities are not, respectively, owned by us or legal obligations of ours.
We record the assets and liabilities of the consolidated Freddie Mac K-Series entities at fair value, based on the estimated fair value of
the debt securities (ABS) issued from the securitizations, in accordance with GAAP provisions for collateralized financing entities. At
December 31, 2019, our economic investment in the consolidated Freddie Mac K-Series entities had an estimated fair value of $253
million, and was comprised of subordinate securities.
The following tables present the statements of income for the years ended December 31, 2019, 2018, and 2017 and the balance sheets
of the consolidated Freddie Mac K-Series entities at December 31, 2019 and December 31, 2018. All amounts in the statements of income
and balance sheets presented below are included in our consolidated financial statements and are included in our Multifamily Investments
segment.
Table 45 – Consolidated Freddie Mac K-Series Entities Statements of Income
(In Thousands)
Interest income
Interest expense
Net interest income
Investment fair value changes, net
Net Income from Consolidated Freddie Mac
K-Series Entities
Years Ended December 31,
Changes
2019
2018
2017
'19/'18
'18/'17
$
$
132,600
(126,948)
5,652
21,430
21,322
(19,985)
1,337
931
$
— $
—
—
—
111,278
(106,963)
4,315
20,499
$
21,322
(19,985)
1,337
931
$
27,082
$
2,268
$
— $
24,814
$
2,268
Table 46 – Consolidated Freddie Mac K-Series Entities Balance Sheets
(In Thousands)
Multifamily loans, held-for-investment, at fair value
Other assets
Total Assets
Other liabilities
Asset-backed securities issued, at fair value
Total liabilities
Equity (fair value of Redwood's investments in entities)
Total Liabilities and Equity
December 31, 2019
December 31, 2018
$
$
$
$
4,408,524 $
$
$
13,539
4,422,063
12,887
4,156,239
4,169,126
252,937
4,422,063
$
2,144,598
6,595
2,151,193
6,239
2,019,075
2,025,314
125,879
2,151,193
90
The following table presents multifamily loan activity at the consolidated Freddie Mac K-Series entities for the years ended
December 31, 2019 and 2018.
Table 47 – Multifamily Loans Held-for-Investment at Consolidated Freddie Mac K-Series Entities - Activity
(In Thousands)
Balance at beginning of period
Consolidation of multifamily loans held in securitization trusts
Principal repayments
Changes in fair value, net
Balance at End of Period
Years Ended December 31,
2018
2019
2,144,598
$
2,162,385
(28,543)
130,084
—
2,099,916
(1,873)
46,555
4,408,524
$
2,144,598
$
$
The outstanding multifamily loans held-for-investment at the Freddie Mac K-Series entities at December 31, 2019 were first lien,
fixed-rate loans that were primarily originated between 2015 and 2017 and had original loan terms of seven to ten years and an original
weighted average LTV ratio of 69%. At December 31, 2019, the weighted average coupon of these loans was 4.13% and the weighted
average loan term was six years. At both December 31, 2019 and December 31, 2018, none of these loans were greater than 90 days
delinquent or in foreclosure.
Consolidated CAFL Entities
As a result of our acquisition of CoreVest in the fourth quarter of 2019, which included the acquisition of certain subordinate and
IO securities in CAFL securitizations, we were required to consolidate certain CAFL entities for financial reporting purposes in accordance
with GAAP. Each of these entities is independent of Redwood and of each other and the assets and liabilities of these entities are not,
respectively, owned by us or legal obligations of ours. We record the assets and liabilities of the consolidated CAFL entities at fair value,
based on the estimated fair value of the debt securities (ABS) issued from the securitizations, in accordance with GAAP provisions for
collateralized financing entities. At December 31, 2019, our economic investment in the consolidated CAFL entities had an estimated
fair value of $195 million, and was comprised of subordinate and interest-only securities.
The following tables present the statements of income for the years ended December 31, 2019, 2018, and 2017 and the balance sheets
of the consolidated CAFL entities at December 31, 2019 and December 31, 2018. All amounts in the statements of income and balance
sheets presented below are included in our consolidated financial statements and are included in our Business Purpose Lending segment.
Table 48 – Consolidated CAFL Entities Statements of Income
(In Thousands)
Interest income
Interest expense
Net interest income
Investment fair value changes, net
Net Income from Consolidated CAFL
Entities
Years Ended December 31,
Changes
2019
2018
2017
'19/'18
'18/'17
$
$
$
23,072
(17,173)
5,899
(3,636)
— $
—
—
—
— $
—
—
—
$
23,072
(17,173)
5,899
(3,636)
2,263
$
— $
— $
2,263
$
—
—
—
—
—
91
Table 49 – Consolidated CAFL Entities Balance Sheets
(In Thousands)
December 31, 2019
December 31, 2018
Single-family rental loans, held-for-investment, at fair value
Other assets
Total Assets
Other liabilities
Asset-backed securities issued, at fair value
Total liabilities
Equity (fair value of Redwood's investments in entities)
Total Liabilities and Equity
$
$
$
$
2,192,552 $
$
$
11,367
2,203,919
7,485
2,001,251
2,008,736
195,183
2,203,919
$
—
—
—
—
—
—
—
—
The following table presents single-family rental loan activity at the consolidated CAFL entities for the years ended December 31,
2019 and 2018.
Table 50 – Single-Family Rental Loans Held-for-Investment at Consolidated CAFL Entities - Activity
(In Thousands)
Balance at beginning of period
Consolidation of single-family rental loans held in securitization trusts
New securitization issuances
Principal repayments
Transfers to REO
Changes in fair value, net
Balance at End of Period
Years Ended December 31,
2018
2019
$
$
— $
1,829,281
394,506
(17,611)
1,057
(14,681)
2,192,552
$
—
—
—
—
—
—
The outstanding single-family rental loans held-for-investment at CAFL entities at December 31, 2019 were first lien, fixed-rate
loans with original maturities of five, seven, or ten years. At December 31, 2019, the weighted average coupon of our single-family rental
loans was 5.70% and the weighted average remaining loan term was seven years. At origination, the weighted average LTV ratio of these
loans was 68% and the weighted average debt service coverage ratio was 1.35 times. At December 31, 2019, 18 of these loans with an
aggregate unpaid principal balance of $29 million were greater than 90 days delinquent and five of these loans with an aggregate unpaid
principal balance of $9 million were in foreclosure.
Tax Provision and Taxable Income
Tax Provision under GAAP
For the years ended December 31, 2019, 2018, and 2017, we recorded tax provisions of $7 million, $11 million, and $12 million,
respectively. Our tax provision is primarily derived from GAAP net income or loss at our TRS, as we do not book a material tax provision
associated with income generated at our REIT. Our TRS income is generally earned from our mortgage banking activities, MSRs, and
other non-REIT eligible security investments.
92
Taxable Income
The following table summarizes our taxable income and distributions to shareholders for the years ended December 31, 2019, 2018,
and 2017. For each of these periods, we had no undistributed REIT taxable income, after the application of net operating loss carryforwards.
Table 51 – Taxable Income
(In Thousands except per Share Data)
REIT taxable income
Taxable REIT subsidiary income
Total Taxable Income
REIT taxable income per share
Total taxable income per share
Distributions to shareholders
Distributions to shareholders per share
Years Ended December 31,
2019 est. (1)
2018
2017
$
$
$
$
$
$
136,255
56,650
192,905
1.28
1.82
126,139
1.20
$
$
$
$
$
$
110,161
58,551
168,712
1.38
2.13
94,134
1.18
$
$
$
$
$
$
90,122
31,675
121,797
1.17
1.59
86,271
1.12
(1) Our tax results for the year ended December 31, 2019 are estimates until we file tax returns for 2019.
Taxable Income Distribution Requirement
As a REIT, we are required to distribute at least 90% of our taxable income, after the application of available federal net operating
loss carryforwards (NOLs), to our shareholders. For 2019, our estimated REIT taxable income of $136 million exceeded our available
NOLs by $98 million, and therefore our minimum dividend distribution requirement was $88 million. The following table details our
federal NOLs and capital loss carryforwards available as of December 31, 2019.
Table 52 - Federal Net Operating and Capital Loss Carryforwards
(In Thousands)
REIT Loss Carryforwards
Net operating loss
Capital loss
Total REIT Loss Carryforwards
TRS Loss Carryforwards
Net operating loss
Capital loss
Total TRS Loss Carryforwards
Loss Carryforward Expiration by Period
1 to 3
Years
3 to 5
Years
5 to 15
Years
After 15
No
Years
Expiration
Total
$
— $
— $
—
— $
—
— $
$
(28,488) $
—
(28,488) $
— $
— $
(28,488)
—
— $
—
—
— $
(28,488)
$
— $
— $
— $
— $
—
— $
—
— $
—
— $
—
— $
$
(374) $
—
(374) $
(374)
—
(374)
At December 31, 2018, we maintained $39 million of NOLs at the REIT level. In order to utilize these carryforwards, taxable income
must exceed our dividend distributions. During 2019, we distributed $126 million to shareholders, which was less than our estimated
taxable income of $136 million. We therefore expect to report REIT taxable income on our 2019 federal income tax return after the
application of a dividends paid deduction. As a result, we expect $10 million of our federal NOLs at the REIT level to be utilized in 2019.
Federal NOLs at the REIT level do not expire until 2029.
The Tax Act created a limitation on the annual usage of REIT NOLs to 80% of REIT taxable income, effective with respect to NOLs
arising in taxable years beginning after December 31, 2017. We do not expect this to materially impact our REIT.
93
Our TRS NOL carryforwards were acquired in the 5 Arches acquisition. They were generated after December 31, 2017 and therefore
carry forward indefinitely. These NOLs are subject to the Separate Return Limitation Year ("SRLY") rules, which can limit the usage of
the NOLs. However, we do not expect this to prevent us from utilizing these NOLs over time.
Tax Characteristics of Distributions to Shareholders
For the year ended December 31, 2019, we declared and distributed four regular quarterly dividends totaling $126 million ($1.20
per share). Under the federal income tax rules applicable to REITs, the taxable portion of any distribution to shareholders is determined
by (i) taxable income of the REIT, exclusive of the dividends paid deduction and NOLs; and (ii) net capital gains recognized by the REIT,
exclusive of capital loss carryforwards. The income or loss generated at our TRS does not directly affect the tax characterization of our
dividends.
Our 2019 dividend distributions are expected to be characterized for federal income tax purposes as 73% ordinary dividend income
and 27% long-term capital gain dividend income. Under the federal income tax rules applicable to REITs, none of the 2019 dividend
distributions are expected to be characterized as a return of capital or qualified dividends.
Beginning in 2018, the Tax Act provides that individual taxpayers may generally deduct 20% of their ordinary REIT dividends from
taxable income. This results in a maximum federal effective tax rate of 29.6% on an individual taxpayer’s ordinary REIT dividends,
compared to the highest marginal rate of 37%. This deduction does not apply to REIT dividends classified as qualified dividends or long-
term capital gains dividends, as those dividends are taxed at a maximum rate of 20% for individuals.
Differences between Estimated Total Taxable Income and GAAP Income
Differences between estimated taxable income and GAAP income are largely due to the following: (i) we cannot establish loss
reserves for future anticipated events for tax but we can for GAAP, as realized credit losses are expensed when incurred for tax and these
losses can be anticipated through lower yields on assets or through loss provisions for GAAP; (ii) the timing, and possibly the amount,
of some expenses (e.g., certain compensation expenses) are different for tax than for GAAP; (iii) since amortization and impairments
differ for tax and GAAP, the tax and GAAP gains and losses on sales may differ, resulting in differences in realized gains on sale; (iv) at
the REIT and certain TRS entities, unrealized gains and losses on market valuation adjustments of loans, securities and derivatives are
not recognized for tax until the instrument is sold or extinguished; (v) for tax, basis may not be assigned to mortgage servicing rights
retained when whole loans are sold resulting in lower tax gain on sale; (vi) for tax, we do not consolidate securitization entities as we do
under GAAP; and, (vii) dividend distributions to our REIT from our TRS are included in REIT taxable income, but not GAAP income.
As a result of these differences in accounting, our estimated taxable income can vary significantly from our GAAP income during certain
reporting periods.
For tax years beginning after December 31, 2018, the Tax Act may require acceleration of discount accretion for federal income tax
purposes for debt instruments with original issue discount. We have evaluated the effects of this change, and it did not have a material
income tax effect for us.
The tax basis in assets and liabilities at the REIT was $6.35 billion and $4.68 billion, respectively, at December 31, 2019. The GAAP
basis in assets and liabilities at the REIT was $16.22 billion and $14.52 billion, respectively, at December 31, 2019. The primary difference
in both the tax and GAAP assets and liabilities is attributable to securitization entities that are consolidated for GAAP reporting purposes
but not for tax purposes.
94
The tables below reconcile our estimated total taxable income to our GAAP income for the years ended December 31, 2019, 2018,
and 2017.
Table 53 – Differences between Estimated Total Taxable Income and GAAP Net Income
Year Ended December 31, 2019
Total Tax
(Est.)
GAAP
TRS (Est.)
57,393
(53,224)
4,169
—
80,146
6,034
(62,956)
13,356
19,073
(2,684)
(488)
56,650
0.54
$
$
$
320,480
(183,550)
136,930
(534)
80,146
4,307
(109,737)
23,397
62,613
(3,351)
(866)
192,905
1.82
$
$
$
622,281
(479,808)
142,473
—
87,266
35,500
(118,672)
19,257
23,821
(13,022)
(7,440)
169,183
1.63
Differences
$
(301,801)
296,258
(5,543)
(534)
(7,120)
(31,193)
8,935
4,140
38,792
9,671
6,574
23,722
0.19
$
$
Year Ended December 31, 2018
TRS
Total Tax
GAAP
Differences
52,878
(43,021)
9,857
—
57,212
(586)
(36,957)
15,822
13,098
344
(239)
58,551
0.75
$
$
$
265,400
(139,147)
126,253
(1,738)
57,212
4,927
(78,022)
17,584
43,099
(65)
(538)
168,712
2.13
$
$
$
378,717
(239,039)
139,678
—
59,566
(25,689)
(82,782)
13,070
27,041
(196)
(11,088)
119,600
1.47
$
(113,317)
99,892
(13,425)
(1,738)
(2,354)
30,616
4,760
4,514
16,058
131
10,550
49,112
0.66
$
$
(In Thousands, except per Share Data)
REIT (Est.)
Interest income
Interest expense
Net interest income
Realized credit losses
Mortgage banking activities, net
Investment fair value changes, net
General and administrative expenses
Other income
Realized gains, net
Other expenses
Provision for income taxes
Net Income
Income per basic common share
(In Thousands, except per Share Data)
Interest income
Interest expense
Net interest income
Realized credit losses
Mortgage banking activities, net
Investment fair value changes, net
General and administrative expenses
Other income
Realized gains, net
Other expenses
Provision for income taxes
Net Income
Income per basic common share
$
$
$
$
$
$
263,087
(130,326)
132,761
(534)
—
(1,727)
(46,781)
10,041
43,540
(667)
(378)
136,255
1.28
REIT
212,522
(96,126)
116,396
(1,738)
—
5,513
(41,065)
1,762
30,001
(409)
(299)
110,161
1.38
$
$
$
$
$
$
95
Year Ended December 31, 2017
(In Thousands, except per Share Data)
REIT
TRS
Total Tax
GAAP
Differences
Interest income
Interest expense
Net interest income
Realized credit losses
Mortgage banking activities, net
Investment fair value changes, net
General and administrative expenses
Other income (1)
Realized gains, net
Provision for income taxes
Net Income
Income per basic common share
$
$
$
186,214
(59,875)
126,339
(3,442)
—
(16,483)
(41,589)
26,382
(735)
(350)
90,122
1.17
$
$
$
38,865
(29,787)
9,078
—
44,143
5,292
(31,614)
4,943
(1)
(166)
31,675
0.42
$
$
$
225,079 $
(89,662)
135,417
(3,442)
44,143
(11,191)
(73,203)
31,325
(736)
(516)
121,797
$
248,057
(108,816)
139,241
—
53,908
10,374
(77,156)
12,436
13,355
(11,752)
140,406
1.59
$
1.78
$
(22,978)
19,154
(3,824)
(3,442)
(9,765)
(21,565)
3,953
18,889
(14,091)
11,236
(18,609)
(0.19)
$
$
(1) For 2017, other income at the REIT is primarily comprised of dividend income from our TRS.
Potential Taxable Income Volatility
We expect period-to-period volatility in our estimated taxable income. A description of the factors that can cause this volatility is
provided below.
Recognition of Gains and Losses on Sale
Since the computation of amortization and impairments on assets may differ for tax and GAAP and many of our assets held for
investment purposes are marked-to-market for GAAP, but not for tax, the tax and GAAP basis on assets sold or called may differ, resulting
in differences in gains and losses on sale or call. In addition, capital losses in excess of capital gains are generally disallowed and carry
forward to future tax years. Subsequent capital gains realized for tax may be offset by prior capital losses and, thus, not affect taxable
income. At December 31, 2019, we had no capital loss carryforwards at the REIT or TRS level.
Prepayments on Securities
We have retained certain IO securities since the time they were issued from Sequoia securitizations we sponsored and purchased
additional third-party IO securities. Our tax basis in these securities was $159 million at December 31, 2019. The return on IOs is sensitive
to prepayments and, to the extent prepayments vary period to period, income from these IOs will vary. Typically, fast prepayments reduce
yields and slow prepayments increase yields. We are not permitted to recognize a negative yield under tax accounting rules, so during
periods of fast prepayments our periodic premium expense for tax purposes can be relatively low and the tax cost basis for these securities
may not be significantly reduced. Currently, our tax basis is above the fair values for these IOs in the aggregate. If a securitization is
called, the remaining tax basis in the IO is expensed, creating an ordinary loss at the call date.
Prepayments also affect the taxable income recognition on other securities we own. For tax purposes, we are required to use particular
prepayment assumptions for the remaining lives of each security. As actual prepayment speeds vary, the yield we recognize for tax
purposes will be adjusted accordingly. Thus, to the extent actual prepayments differ from our long-term assumptions or vary from period
to period, the yield recognized will also vary and this difference could be material.
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Credit Losses on Securities and Loans
To determine estimated taxable income, we are generally not permitted to anticipate, or reserve for, credit losses on investments
which are generally purchased at a discount. For tax purposes, we accrue the entire purchase discount on a security into taxable income
over the expected life of the security. Estimated taxable income is reduced when actual credit losses occur. As we have no credit reserves
or allowances for tax, any future credit losses on securities or loans will have a more significant impact on tax earnings than on GAAP
earnings and may create significant taxable income volatility to the extent the level of credit losses fluctuates during reporting periods.
Credit losses are based on our tax basis, which differs from our basis for GAAP purposes. We anticipate an additional $14 million of
credit losses for tax on securities, based on our projection of principal balance losses and assuming a similar tax basis as we have recently
experienced, although the timing of actual losses is difficult to accurately project.
Our estimated total taxable income for the years ended December 31, 2019, 2018, and 2017 included $1 million, $2 million, and $3
million, respectively, in realized credit losses on investments.
Compensation Expense
The total tax expense for equity award compensation is dependent upon varying factors such as the timing of payments of dividend
equivalent rights, the distribution of deferred stock units and performance stock units, and the cash deferrals to and withdrawals from
our Executive Deferred Compensation Plan. For GAAP purposes, the total expense associated with an equity award is determined at the
award date and is recognized over the vesting period. For tax, the total expense is recognized at the date of distribution or exercise, not
the award date. In addition, some compensation may not be deductible for tax if it exceeds certain levels. An exception may apply to
performance-based compensation that is paid pursuant to a written and binding contract in effect before November 2, 2017. Thus, the
total amount of compensation expense, as well as the timing, could be significantly different for tax than for GAAP.
As an example, for GAAP we expense the grant date fair value of performance stock units (PSUs) granted over the vesting term of
those PSUs (regardless of the degree to which the performance conditions for vesting are ultimately satisfied, if at all), whereas for tax
the value of the PSUs that actually vest in accordance with the performance conditions of those awards and are subsequently distributed
to the award recipient is recorded as an expense on the date of distribution. For example, if no PSUs under a particular grant ultimately
vest, due to the failure to satisfy the performance conditions, no tax expense will be recorded for those PSUs, even though we would
have already recorded expense for GAAP equal to the grant date fair value of the PSU awards. Conversely, for example, if performance
is such that a number of shares of common stock equal to 200% of the PSU award ultimately vest and are delivered to the award recipient,
expense for tax will equal the common stock value on the date of distribution of 200% of the number of PSUs originally granted. This
expense for tax could significantly exceed the recorded expense for GAAP.
In addition, since the timing of distributions of deferred stock units, performance stock units, or cash out of the Executive Deferred
Compensation Plan is based on employees' deferral elections, it can be difficult to project when the tax expense will occur.
Mortgage Servicing Rights
For GAAP purposes, we recognize MSRs through the direct acquisition of servicing rights from third parties or through the retention
of MSRs associated with residential loans that we have acquired and subsequently sold to non-consolidated securitization entities or to
third parties. For tax purposes, basis in our MSR assets is recognized through the direct acquisition of servicing rights from third parties,
or to the extent that a retained MSR entitles us to receive a servicing fee in excess of so-called normal servicing (or the right to receive
reasonable compensation for services to be performed under the mortgage serving contract). Tax basis in our normal MSR assets is not
recognized when MSRs are retained from sales of loans to non-consolidated securitization entities or to third parties, thereby creating a
favorable temporary GAAP to tax difference from sale of the loans. For the year ended December 31, 2019, we retained $1 million of
MSRs from jumbo loan sales for which no tax basis was recognized. No other material tax basis in our MSR assets was recognized in
2019.
For GAAP purposes, mortgage servicing fee income, net of servicing expense, as well as changes in the estimated fair value of our
MSRs, is recognized on our consolidated statements of income over the life of the MSR asset. For tax purposes, only mortgage servicing
fee income, net of servicing expense is recognized as taxable income. Any MSR where basis is recognized for tax purposes through
acquisition is amortized as a tax expense over a finite life.
Periodic changes in the market values of MSRs are recorded through the income statement for GAAP purposes, but not for tax
purposes. Only when MSRs are sold will a tax gain or loss be recognized. As tax basis is not recognized for retained MSRs and the rules
for writing-off tax basis of purchased MSRs are restrictive, the tax gain from the sale of MSRs can be substantial.
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LIQUIDITY AND CAPITAL RESOURCES
Summary
In addition to the proceeds from equity and debt capital-raising transactions, our principal sources of cash consist of borrowings
under mortgage loan warehouse facilities, securities repurchase agreements, payments of principal and interest we receive from our
investment portfolios, and cash generated from our operating activities. Our most significant uses of cash are to purchase and originate
mortgage loans for our mortgage banking operations, to fund investments in residential loans, to purchase investment securities and
make other investments, to repay principal and interest on our warehouse facilities, repurchase agreements, and long-term debt, to
make dividend payments on our capital stock, and to fund our operations.
At December 31, 2019, our total capital was $2.60 billion and included $1.83 billion of equity capital and $0.79 billion of
convertible notes and long-term debt on our consolidated balance sheet, including $245 million of convertible debt due in 2023, $200
million of convertible debt due in 2024, $201 million of exchangeable debt due in 2025, and $140 million of trust-preferred securities
due in 2037.
As of December 31, 2019, our cash and liquidity capital included $260 million of capital available for investment. While we
believe our available capital, together with additional liquidity we believe we can source through continued portfolio optimization
(including collateralized borrowings or assets sales), is sufficient to fund our operations and currently contemplated investment
activities and to repay existing debt, we may raise equity or debt capital from time to time to acquire assets and make long-term
investments to expand our investment portfolio, including funding large purchases of portfolios of residential, multifamily, or business
purpose residential loans or securities, or other portfolio investments, for acquisitions (which could include acquisitions to expand
our mortgage banking operating platforms), or for other purposes. To the extent we seek to raise additional capital, our approach will
continue to be based on what we believe to be in the best interests of our shareholders.
We are subject to risks relating to our liquidity and capital resources, including risks relating to incurring debt under residential
loan warehouse facilities, securities repurchase facilities, and other short- and long-term debt facilities and other risks relating to our
use of derivatives. A further discussion of these risks is set forth below under the heading “Risks Relating to Debt Incurred under
Short- and Long-Term Borrowing Facilities" and in Part I, Item 1A - Risk Factors of this Annual Report on Form 10-K.
Cash Flows and Liquidity for the Year Ended December 31, 2019
Cash flows from our mortgage banking activities and our investments can be volatile from quarter to quarter depending on many
factors, including the timing and amount of loan and securities acquisitions and sales and repayments, the profitability of mortgage
banking activities, as well as changes in interest rates, prepayments, and credit losses. Therefore, cash flows generated in the current
period are not necessarily reflective of the long-term cash flows we will receive from these investments or activities.
Cash Flows from Operating Activities
Cash flows from operating activities were negative $1.17 billion in 2019. This amount includes the net cash utilized during the
period from the purchase and sale of residential mortgage loans associated with our mortgage banking activities. Purchases of loans
are financed to a large extent with short-term debt, for which changes in cash are included as a component of financing activities.
Excluding cash flows from the purchase, sale, and principal payments of loans classified as held-for-sale, cash flows from operating
activities were negative $76 million in 2019, positive $100 million in 2018, and positive $37 million in 2017. The variance in these
amounts from 2019 to 2018 was largely attributable to cash outflows for the net settlements of derivatives and payment of margin on
derivatives agreements, which totaled $175 million in 2019, compared to net cash inflows of $35 million in 2018.
Cash Flows from Investing Activities
During 2019, our net cash provided by investing activities was $1.03 billion and primarily resulted from proceeds from principal
payments on loans held-for-investment and sales of real estate securities. Although we generally intend to hold our investment securities
as long-term investments, we may sell certain of these securities in order to manage our interest rate risk and liquidity needs, to meet
other operating objectives, and to adapt to market conditions. We cannot predict the timing and impact of future sales of investment
securities, if any.
Because many of our investment securities are financed through repurchase agreements, a significant portion of the proceeds
from any sales or principal payments of our investment securities could be used to repay balances under these financing sources.
Similarly, all or a significant portion of cash flows from principal payments of loans at consolidated securitization entities would
generally be used to repay ABS issued by those entities.
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During 2019, we deployed capital into several new investments, including the acquisitions of 5 Arches and CoreVest, multifamily
and re-performing residential loan securities, business purpose residential loans, shared home appreciation options, and a limited
partnership to acquire light-renovation multifamily loans.
As presented in the "Supplemental Noncash Information" subsection of our consolidated statements of cash flows, during 2019,
2018, and 2017, we transferred residential loans between held-for-sale and held-for-investment classification, retained securities from
Sequoia securitizations we sponsored, and consolidated certain multifamily and re-performing residential securitization trusts which
represent significant non-cash transactions that were not included in cash flows from investing activities.
Cash Flows from Financing Activities
During 2019, our net cash provided by financing activities was $225 million. This primarily resulted from proceeds of $1.40
billion from the issuance of asset-backed securities from our Sequoia Choice and CAFL securitizations, proceeds of $451 million
from the issuance of common stock, and proceeds of $387 million from the issuance of exchangeable notes and borrowings under
our subordinate securities financing facility. These cash inflows were partially offset by $1.12 billion of repayments of ABS issued,
$741 million of net repayments of short-term debt, and the distribution of $129 million of dividends.
In February 2020, the Board of Directors declared a regular dividend of $0.32 per share for the first quarter of 2020, which is
payable on March 30, 2020 to shareholders of record on March 16, 2020.
In accordance with the terms of our outstanding deferred stock units and restricted stock units, which are stock-based compensation
awards, each time we declare and pay a dividend on our common stock, we are required to make a dividend equivalent payment in
that same per share amount on each outstanding deferred stock unit and restricted stock unit.
Repurchase Authorization
In February 2018, our Board of Directors approved an authorization for the repurchase of our common stock, increasing the total
amount authorized for repurchases of common stock to $100 million, and also authorized the repurchase of outstanding debt securities,
including convertible and exchangeable debt. This authorization increased the previous share repurchase authorization approved in
February 2016 and has no expiration date. This repurchase authorization does not obligate us to acquire any specific number of shares
or securities. Under this authorization, shares or securities may be repurchased in privately negotiated and/or open market transactions,
including under plans complying with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. At December 31, 2019,
$100 million of the current authorization remained available for the repurchase of shares of our common stock. Like other investments
we may make, any repurchases of our common stock or debt securities under this authorization would reduce our available capital
described above.
Leverage
Our debt-to-equity leverage ratio increased during 2019, as we increased the amount of borrowings we utilized to finance our
investments, including through additional short-term and long-term borrowings. Additionally, our leverage ratio is impacted by the
amount of loans we hold for sale at our mortgage banking businesses and our amount of undeployed capital available for investment.
At December 31, 2019, we estimate we had approximately $260 million of capital available for investment. As this capital is deployed,
our leverage ratio is expected to increase, all other factors being equal, as we generally make investments in loans, securities, and
other assets with a combination of capital and borrowings secured by the assets we invest in. In general, higher leverage creates greater
liquidity risk as the amount of our equity relative to borrowings decreases, including liquidity risks of the types described in Part I,
Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors,” and in Part II, Item 7A of this Annual Report on Form
10-K under the heading “Market Risks.”
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Short-Term Debt
In the ordinary course of our business, we use recourse debt through several different types of borrowing facilities and use cash
borrowings under these facilities to, among other things, fund the acquisition and origination of residential and multifamily loans (including
those we acquire and originate in anticipation of securitization), finance investments in securities and other investments, and otherwise
fund our business and operations.
At December 31, 2019, we had four short-term residential loan warehouse facilities with a total outstanding debt balance of $186
million (secured by residential loans with an aggregate fair value of $202 million) and a total uncommitted borrowing limit of $1.43
billion. In addition, at December 31, 2019, we had an aggregate outstanding short-term debt balance of $1.18 billion under 10 securities
repurchase facilities, which were secured by securities with a fair market value of $619 million. In addition, at December 31, 2019, the
fair value of our real estate securities pledged as collateral included $111 million of securities retained from our consolidated Sequoia
Choice securitizations, as well as $382 million and $252 million of securities we owned that were issued by consolidated Freddie Mac
SLST and Freddie Mac K-series securitizations, respectively. We also had a secured line of credit with no outstanding debt balance and
a total borrowing limit of $10 million (secured by securities with a fair market value of $3 million) at December 31, 2019.
To finance our business purpose residential loan investments, at December 31, 2019, we had eight business purpose residential loan
warehouse facilities with a total outstanding debt balance of $814 million (secured by business purpose residential loans with an aggregate
fair value of $988 million) and a total uncommitted borrowing limit of $1.48 billion.
Servicer advance financing consists of non-recourse short-term securitization debt used to finance servicer advance investments we
made beginning in the fourth quarter of 2018. At December 31, 2019, the fair value of servicer advances, cash and restricted cash pledged
as collateral was $176 million. At December 31, 2019, the accrued interest payable balance on this debt was $0.2 million and the
unamortized capitalized commitment costs were $1 million.
During the fourth quarter of 2018, $201 million principal amount of 5.625% exchangeable senior notes and $1 million of unamortized
deferred issuance costs were reclassified from long-term debt to short-term debt as the maturity of the notes was less than one year as of
November 2018. In November 2019, we repaid these $201 million exchangeable notes and all related accrued interest in full. See Note
15 for additional information on our convertible notes.
During 2019, the highest balance of our short-term debt outstanding was $3.30 billion.
Long-Term Debt
FHLBC Borrowings
In July 2014, our FHLB-member subsidiary entered into a borrowing agreement with the Federal Home Loan Bank of Chicago. At
December 31, 2019, under this agreement, our subsidiary could incur borrowings up to $2.00 billion, also referred to as “advances,” from
the FHLBC secured by eligible collateral, including, but not limited to residential and business purpose mortgage loans. During the year
ended December 31, 2019, our FHLB-member subsidiary made no additional borrowings under this agreement. Under a final rule
published by the Federal Housing Finance Agency in January 2016, our FHLB-member subsidiary will remain an FHLB member through
a five-year transition period for captive insurance companies. Our FHLB-member subsidiary's existing $2.00 billion of FHLB debt, which
matures beyond this transition period, is permitted to remain outstanding until stated maturity. As mortgage loans pledged as collateral
for this debt pay down, we are permitted to pledge additional loans or other eligible assets to collateralize this debt; however, we do not
expect to be able to increase our subsidiary's FHLB debt above the existing $2.00 billion maximum.
At December 31, 2019, $2.00 billion of advances were outstanding under this agreement, which were classified as long-term debt,
with a weighted average interest rate of 1.88% per annum and a weighted average maturity of six years. At December 31, 2019, accrued
interest payable on these borrowings was $7 million. Advances under this agreement are charged interest based on a specified margin
over the FHLBC’s 13-week discount note rate, which resets every 13 weeks. At December 31, 2019, our total advances under this
agreement were secured by residential mortgage loans with a fair value of $2.10 billion, single-family rental loans with a fair value of
$211 million, securities with a fair value of $39 million, and $59 million of restricted cash. This agreement also requires our subsidiary
to purchase and hold stock in the FHLBC in an amount equal to a specified percentage of outstanding advances. At December 31, 2019,
our subsidiary held $43 million of FHLBC stock that is included in Other assets on our consolidated balance sheets.
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Subordinate Securities Financing Facility
In the third quarter of 2019, a subsidiary of Redwood entered into a repurchase agreement providing non-mark-to-market recourse
debt financing. The financing is fully and unconditionally guaranteed by Redwood, with an interest rate of approximately 4.21% through
September 2022. The financing facility may be terminated, at our option, in September 2022, and has a final maturity in September 2024,
provided that the interest rate on amounts outstanding under the facility increases between October 2022 and September 2024. At
December 31, 2019, we had borrowings under this facility totaling $185 million, net of $1 million of deferred issuance costs, for a carrying
value of $184 million. At December 31, 2019, the fair value of real estate securities pledged as collateral under this long-term debt facility
was $250 million, which included $125 million of securities retained from our consolidated Sequoia Choice securitizations. This facility
is included in Long-term debt, net on our consolidated balance sheets at December 31, 2019.
Convertible Notes
In September 2019, one of our taxable subsidiaries issued $201 million principal amount of 5.75% exchangeable senior notes due
2025. After deducting the underwriting discount and offering costs, we received approximately $195 million of net proceeds. Including
amortization of deferred debt issuance costs, the weighted average interest expense yield on these exchangeable notes is approximately
6.3% per annum. At December 31, 2019, the outstanding principal amount of these notes was $201 million and the accrued interest
payable balance on this debt was $3 million.
In June 2018, we issued $200 million principal amount of 5.625% convertible senior notes due 2024 at an issuance price of 99.5%.
After deducting the issuance discount, the underwriting discount and offering costs, we received approximately $194 million of net
proceeds. Including amortization of deferred debt issuance costs and the debt discount, the weighted average interest expense yield on
these convertible notes is approximately 6.2% per annum. At December 31, 2019, the outstanding principal amount of these notes was
$200 million and the accrued interest payable on this debt was $5 million.
In August 2017, we issued $245 million principal amount of 4.75% convertible senior notes due 2023. After deducting the underwriting
discount and issuance costs, we received approximately $238 million of net proceeds. Including amortization of deferred debt issuance
costs, the weighted average interest expense yield on these convertible notes is approximately 5.3% per annum. At December 31, 2019,
the outstanding principal amount of these notes was $245 million and the accrued interest payable balance on this debt was $4 million.
In November 2014, one of our taxable subsidiaries issued $205 million principal amount of 5.625% exchangeable senior notes due
2019. After deducting the underwriting discount and issuance costs, we received approximately $198 million of net proceeds. Including
amortization of deferred debt issuance costs, the weighted average interest expense yield on these exchangeable notes is approximately
6.3% per annum. During the year ended December 31, 2016, we repurchased $4 million par value of these notes at a discount and recorded
a gain on extinguishment of debt of $0.3 million in Realized gains, net on our consolidated statements of income. During the fourth
quarter of 2018, $201 million principal amount of 5.625% exchangeable senior notes and $1 million of unamortized deferred issuance
costs were reclassified from long-term debt to short-term debt as the maturity of the notes was less than one year as of November 2018.
In November 2019, we repaid these $201 million exchangeable notes and all related accrued interest in full. See Note 15 for additional
information on our convertible notes.
Trust Preferred Securities and Subordinated Notes
At December 31, 2019, we had trust preferred securities and subordinated notes outstanding of $100 million and $40 million,
respectively, issued by us in 2006 and 2007. This debt requires quarterly interest payments at a floating rate equal to three-month LIBOR
plus 2.25% and must be redeemed no later than 2037. Prior to 2014, we entered into interest rate swaps with aggregate notional values
totaling $140 million to hedge the variability in this long-term debt interest expense. Including hedging costs and amortization of deferred
debt issuance costs, the weighted average interest expense yield on our trust preferred securities and subordinated notes is approximately
6.9% per annum. These swaps are accounted for as cash flow hedges with all interest recorded as a component of net interest income
and other valuation changes recorded as a component of equity.
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Asset-Backed Securities
At December 31, 2019, there were $425 million (principal balance) of loans owned at consolidated Legacy Sequoia securitization
entities, which were funded with $420 million (principal balance) of ABS issued at these entities. At December 31, 2019, there were
$2.24 billion (principal balance) of loans owned at consolidated Sequoia Choice securitization entities, which were funded with $1.98
billion (principal balance) of ABS issued at these entities. At December 31, 2019, there were $2.43 billion (principal balance) of loans
owned at the consolidated Freddie Mac SLST securitization entity, which were funded with $1.84 billion (principal balance) of ABS
issued at this entity. At December 31, 2019, there were $4.20 billion (principal balance) of loans owned at the consolidated Freddie Mac
K-Series securitization entities, which were funded with $3.84 billion (principal balance) of ABS issued at these entities. At December 31,
2019, there were $2.08 billion (principal balance) of loans owned at the consolidated CAFL securitization entities, which were funded
with $1.88 billion (principal balance) of ABS issued at these entities. The loans and ABS issued from these entities are reported at estimated
fair value. See the subsections titled "Consolidated Legacy Sequoia Entities," "Consolidated Sequoia Choice Entities," "Consolidated
Freddie Mac SLST Entities," "Consolidated Freddie Mac K-Series Entities," and "Consolidated CAFL Entities" in the Results of
Operations section of this MD&A for additional details on these entities.
Risks Relating to Debt Incurred under Short- and Long-Term Borrowing Facilities
As described above under the heading “Results of Operations,” in the ordinary course of our business, we use debt financing obtained
through several different types of borrowing facilities to, among other things, finance the acquisition and origination of residential and
multifamily mortgage loans (including those we acquire and originate in anticipation of sale or securitization), and finance investments
in securities and other investments. We may also use short- and long-term borrowings to fund other aspects of our business and operations,
including the repurchase of shares of our common stock. Debt incurred under these facilities is generally either the direct obligation of
Redwood Trust, Inc., or the direct obligation of subsidiaries of Redwood Trust, Inc. and guaranteed by Redwood Trust, Inc.
Residential and Business Purpose Loan Warehouse Facilities. One source of our short-term debt financing is secured borrowings
under residential loan warehouse facilities that, as of December 31, 2019, were in place with four different financial institution
counterparties. In addition, as of December 31, 2019, we had eight business purpose loan warehouse facilities secured by single-family
rental loans and residential bridge loans, in place with six financial institution counterparties. Under the four residential loan warehouse
facilities, we had an aggregate borrowing limit of $1.43 billion at December 31, 2019, and under the eight business purpose loan warehouse
facilities we had an aggregate borrowing limit of $1.48 billion at December 31, 2019. However, these facilities (except one business
purpose loan warehouse facility secured by residential bridge loans) are uncommitted, which means that any request we make to borrow
funds under these facilities may be declined for any reason, even if at the time of the borrowing request we have then-outstanding
borrowings that are less than the borrowing limits under these facilities. Short-term financing for residential or business purpose mortgage
loans is obtained under these facilities by our transfer of mortgage loans to the counterparty in exchange for cash proceeds (in an amount
less than 100% of the principal amount of the transferred mortgage loans), and our covenant to reacquire those loans from the counterparty
for the same amount plus a financing charge.
In order to obtain financing for a residential or business purpose loan under these facilities, the loan must initially (and continuously
while the financing remains outstanding) meet certain eligibility criteria, including, without limitation, that the loan is not in a delinquent
status, except that certain business purpose loan facilities may allow a loan to continue to be financed if it becomes delinquent, if it meets
specified conditions. In addition, under these warehouse facilities, residential or business purpose loans can only be financed for a
maximum period, which period would not generally exceed 364 days. We generally intend to repay the short-term financing of a loan
under one of these facilities at or prior to the expiration of that financing with the proceeds of a securitization or other sale of that loan,
through the proceeds of other short-term borrowings, or with other equity or long-term debt capital. While a residential or business purpose
loan is financed under a warehouse facility, to the extent the market value of the loan declines (which market value is generally determined
by the counterparty under the facility), we are required to either immediately reacquire the loan or meet a margin requirement to pledge
additional collateral, such as cash or additional residential loans, in an amount at least equal to the decline in value. See further discussion
below under the heading “Margin Call Provisions Associated with Short-Term Debt and Other Debt Financing.”
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Because these warehouse facilities are uncommitted (except one business purpose loan warehouse facility secured by residential
bridge loans), at any given time we may not be able to obtain additional financing under them when we need it, exposing us to, among
other things, liquidity risks of the types described in Part I, Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors,”
and in Part II, Item 7A of this Annual Report on Form 10-K under the heading “Market Risks.” In addition, with respect to residential or
business purpose loans that at any given time are already being financed through these warehouse facilities, we are exposed to market,
credit, liquidity, and other risks of the types described in Part I, Item 1A of this Annual Report on Form 10-K under the heading “Risk
Factors,” and in Part II, Item 7A of this Annual Report on Form 10-K under the heading “Market Risks,” if and when those loans become
ineligible to be financed, decline in value, or have been financed for the maximum term permitted under the applicable facility.
Under our residential and business purpose loan warehouse facilities, we also make various representations and warranties and have
agreed to certain covenants, events of default, and other terms that if breached or triggered can result in our being required to immediately
repay all outstanding amounts borrowed under these facilities and these facilities being unavailable to use for future financing needs. In
particular, the terms of these facilities include financial covenants, cross-default provisions, judgment default provisions, and other events
of default (such as, for example, events of default triggered by one of the following: a change in control over Redwood, regulatory
investigation or enforcement action against Redwood, Redwood’s failure to continue to qualify as a REIT for tax purposes, or Redwood’s
failure to maintain the listing of its common stock on the New York Stock Exchange). Under a cross-default provision, an event of default
is triggered (and the warehouse facility becomes unavailable and outstanding amounts borrowed thereunder become due and payable) if
an event of default or similar event occurs under another borrowing or credit facility we maintain in excess of a specified amount. Under
a judgment default provision, an event of default is triggered (and the warehouse facility becomes unavailable and outstanding amounts
borrowed thereunder become due and payable) if a judgment for damages in excess of a specified amount is entered against us in any
litigation and we are unable to promptly satisfy the judgment. Financial covenants included in these warehouse facilities are further
described below under the heading “Financial Covenants Associated with Short-Term Debt and Other Debt Financing.”
These residential and business purpose loan warehouse facilities could also become unavailable and outstanding amounts borrowed
thereunder could become immediately due and payable if there is a material adverse change in our business. If we breach or trigger the
representations and warranties, covenants, events of default, or other terms of our warehouse facilities, we are exposed to liquidity and
other risks, including of the type described in Part I, Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors,” and
in Part II, Item 7A of this Annual Report on Form 10-K under the heading “Market Risks.”
In addition to the residential and business purpose loan warehouse facilities described above, in the ordinary course of business we
may seek to establish additional warehouse facilities that may be of a similar or greater size and may have similar or more restrictive
terms. In the event a counterparty to one or more of our warehouse facilities becomes insolvent or unable or unwilling to perform its
obligations under the facility, we may be unable to access short-term financing we need or fail to recover the full value of our mortgage
loans financed.
Securities Repurchase Facilities. Another source of short-term debt financing is through securities repurchase facilities we have
established with various different financial institution counterparties. Under these facilities we do not have an aggregate borrowing limit;
however, these facilities are uncommitted, which means that any request we make to borrow funds under these facilities may be declined
for any reason. Short-term financing for securities is obtained under these facilities by our transfer of securities to the counterparty in
exchange for cash proceeds (in an amount less than 100% of the fair value of the transferred securities), and our covenant to reacquire
those securities from the counterparty for the same amount plus a financing charge.
Under these securities repurchase facilities, securities are financed for a fixed period, which would not generally exceed 90 days.
We generally intend to repay the short-term financing of a security under one of these facilities through a renewal of that financing with
the same counterparty, through a sale of the security, or with other equity or long-term debt capital. While a security is financed under a
securities repurchase facility, to the extent the value of the security declines (which value is generally determined by the counterparty
under the facility), we are required to either immediately reacquire the security or meet a margin requirement to pledge additional collateral,
such as cash or U.S. Treasury securities, in an amount at least equal to the decline in value. See further discussion below under the heading
“Margin Call Provisions Associated with Short-Term Debt and Other Debt Financing.”
At the end of the fixed period applicable to the financing of a security under a securities repurchase facility, if we intend to continue
to obtain financing for that security we would typically request the same counterparty to renew the financing for an additional fixed
period. If the same counterparty does not renew the financing, it may be difficult for us to obtain financing for that security under one of
our other securities repurchase facilities, due to the fact that the financial institution counterparties to our securities repurchase facilities
generally only provide financing for securities that we purchased from them or one of their affiliates.
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Because our securities repurchase facilities are uncommitted, at any given time we may not be able to obtain additional financing
under them when we need it, exposing us to, among other things, liquidity risks of the types described in Part I, Item 1A of this Annual
Report on Form 10-K under the heading “Risk Factors,” and in Part II, Item 7A of this Annual Report on Form 10-K under the heading
“Market Risks.” In addition, with respect to securities that at any given time are already being financed through our securities repurchase
facilities, we are exposed to market, credit, liquidity, and other risks of the types described in Part I, Item 1A of this Annual Report on
Form 10-K under the heading “Risk Factors,” and in Part II, Item 7A of this Annual Report on Form 10-K under the heading “Market
Risks,” if and when those securities decline in value, or have been financed for the maximum term permitted under the applicable facility.
Under our securities repurchase facilities, we also make various representations and warranties and have agreed to certain covenants,
events of default, and other terms (including of the type described above under the heading “Residential and Business Purpose Loan
Warehouse Facilities”) that if breached or triggered can result in our being required to immediately repay all outstanding amounts borrowed
under these facilities and these facilities being unavailable to use for future financing needs. In particular, the terms of these facilities
include financial covenants, cross-default provisions, judgment default provisions, and other events of default (including of the type
described above under the heading “Residential and Business Purpose Loan Warehouse Facilities”). Financial covenants included in our
repurchase facilities are further described below under the heading “Financial Covenants Associated with Short-Term Debt and Other
Debt Financing.”
Our securities repurchase facilities could also become unavailable and outstanding amounts borrowed thereunder could become
immediately due and payable if there is a material adverse change in our business. If we breach or trigger the representations and warranties,
covenants, events of default, or other terms of our securities repurchase facilities, we are exposed to liquidity and other risks, including
of the type described in Part I, Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors,” and in Part II, Item 7A
of this Annual Report on Form 10-K under the heading “Market Risks.”
In the ordinary course of business we may seek to establish additional securities repurchase facilities that may have similar or more
restrictive terms. In the event a counterparty to one or more of our securities repurchase facilities becomes insolvent or unable or unwilling
to perform its obligations under the facility, we may be unable to access the short-term financing we need or fail to recover the full value
of our securities financed.
Other Short-Term Debt Facility. We also maintain a $10 million committed line of short-term credit from a bank, which is secured
by our pledge of certain mortgage-backed securities we own. This bank line of credit is an additional source of short-term financing for
us. Similar to the uncommitted warehouse and securities repurchase facilities described herein, under this committed line we make various
representations and warranties and have agreed to certain covenants, events of default, and other terms that if breached or triggered can
result in our being required to immediately repay all outstanding amounts borrowed under this facility and this facility being unavailable
to use for future financing needs. The margin call provisions and financial covenants included in this committed line are further described
below under the headings “Margin Call Provisions Associated with Short-Term Debt and Other Debt Financing” and “Financial Covenants
Associated with Short-Term Debt and Other Debt Financing.” When we use this committed line to incur short-term debt we are exposed
to the market, credit, liquidity, and other types of risks described above with respect to residential loan warehouse and securities repurchase
facilities.
Servicer Advance Financing. In connection with our servicer advance investments, we consolidate an entity that was formed to
finance servicing advances and for which we, through our control of an affiliated entity majority owned by Redwood (the "SA Buyer")
formed to invest in servicer advance investments and excess MSRs, are the primary beneficiary. The servicer advance financing consists
of non-recourse short-term securitization debt, secured by servicer advances. We consolidate the securitization entity that issued the debt,
but the securitization entity is independent of Redwood and the assets and liabilities are not owned by and are not legal obligations of
Redwood.
SA Buyer has agreed to purchase all future arising servicer advances under certain residential mortgage servicing agreements. SA
Buyer relies, in part, on its members to make committed capital contributions in order to pay the purchase price for future servicer
advances. A failure by any or all of the members to make such capital contributions for amounts required to fund servicer advances could
result in an event of default under our servicer advance financing and a complete loss of our investment in SA Buyer and its servicer
advance investments and excess MSRs. Additionally, to the extent that the servicer of the underlying mortgage loans (who is unaffiliated
with us except through its co-investment in SA Buyer and the securitization entity) fails to recover the servicer advances in which we
have invested, or takes longer than we expect to recover such advances, the value of our investment could be adversely affected and we
could fail to achieve our expected return and suffer losses.
104
The outstanding balance of servicer advances securing the financing is not likely to be repaid on or before the maturity date of such
financing arrangement. We expect to request the same counterparty or another one of our financing sources to renew or refinance the
financing for an additional fixed period; however, there can be no assurance that we will be able to extend the financing arrangement
upon the expiration of its stated term, which subjects us to a number of risks. A financing source that elects to extend or refinance may
charge higher interest rates and impose more onerous terms upon us, including without limitation, lowering the amount of financing that
can be extended against the servicer advances being financed. If we are unable to renew or refinance the servicer advance financing, the
securitization entity will be required to repay the outstanding balance of the financing on the related maturity date. Additionally, there
may be substantial increases in the interest rates under the financing arrangement if the debt is not repaid, extended or refinanced prior
to the expected repayment date, which may be before the related maturity date. If the securitization entity is unable to pay the outstanding
balance of the notes, the financing counterparty may foreclose on the servicer advances pledged as collateral.
Under this servicer advance financing, SA Buyer and the securitization entity, along with the servicer, make various representations
and warranties and have agreed to certain covenants, events of default, and other terms that if breached or triggered can result in acceleration
of all outstanding amounts borrowed under this facility and this facility being unavailable to use for future financing needs. We do not
have the direct ability to control the servicer’s compliance with such covenants and tests and the failure of SA Buyer, the securitization
entity, or the servicer to satisfy any such covenants or tests could result in a partial or total loss on our investment. The financial covenants
of SA Buyer included in this servicer advance financing are further described below under the heading “Financial Covenants Associated
with Short-Term Debt and Other Debt Financing.”
FHLB Borrowing Facility. Our wholly-owned subsidiary, RWT Financial, LLC, is a party to a secured borrowing facility with the
Federal Home Loan Bank of Chicago (FHLBC) that was put into place in July 2014. Borrowings under this facility, also referred to as
“advances,” are required to be secured by eligible collateral including, but not limited to, residential and business purpose mortgage loans
and residential mortgage-backed securities. Under a final rule published by the Federal Housing Finance Agency in January 2016, our
FHLB-member subsidiary will remain an FHLB member through the five-year transition period for captive insurance companies. Our
FHLB-member subsidiary's existing $2.00 billion of FHLB debt, which matures beyond this transition period, is permitted to remain
outstanding until stated maturity. As residential or business purpose loans pledged as collateral for this debt pay down, we are permitted
to pledge additional loans or other eligible assets to collateralize this debt; however, we do not expect to be able to increase our subsidiary's
FHLB debt above the existing $2.00 billion maximum. At December 31, 2019, $2.00 billion of advances were outstanding under this
facility.
Similar to the uncommitted warehouse and securities repurchase facilities described herein, under this facility we make various
representations and warranties and have agreed to certain covenants, events of default, and other terms that if breached or triggered can
result in our being required to immediately repay all outstanding amounts borrowed under this facility. In particular, the terms of this
facility permit the acceleration of the amortization of amounts borrowed through the facility if the FHLBC determines, in its sole discretion,
that our creditworthiness or the creditworthiness of our FHLB-member subsidiary does not meet the minimum requirements of the
FHLBC. Outstanding amounts borrowed under this facility could become immediately due and payable if the FHLBC determines there
has been a material adverse change in our financial condition, or that we have breached or otherwise not complied with the terms of the
FHLBC’s credit policy. Additionally, the FHLBC may increase the required amount of collateral at any time as a result of a change in its
credit policy or as a result of our credit deterioration, in which case we may be required to deliver additional collateral in the form of
cash or other eligible collateral. Factors that may affect the FHLB’s judgment of our or our FHLB member subsidiary’s creditworthiness,
financial condition, or compliance with its credit policy include, among other things, increases in levels of indebtedness, increases in
debt-to-capital ratios, or decreases in stockholders’ equity. The margin call provisions and financial covenants included in this facility
are further described below under the headings “Margin Call Provisions Associated with Short-Term Debt and Other Debt Financing”
and “Financial Covenants Associated with Short-Term Debt and Other Debt Financing.” When we use this facility to incur debt we are
exposed to the market, credit, liquidity, and other types of risks described above with respect to residential loan warehouse and securities
repurchase facilities.
Our access to financing under this facility is also subject to the risks described under the heading “Risk Factors - Federal regulations
may limit, eliminate, or reduce the attractiveness of our subsidiary’s ability to use borrowings from the Federal Home Loan Bank of
Chicago to finance the mortgage loans and securities it holds and acquires, which could negatively impact our business and operating
results” in Part I, Item 1A of this Annual Report on Form 10-K.
105
Subordinate Securities Financing Facility. Another source of long-term debt financing is through a subordinate securities financing
facility providing non-mark-to-market recourse debt financing on a portfolio of subordinate securities. Financing for the securities was
obtained under this facility by our transfer of securities to the counterparty in exchange for cash proceeds (in an amount less than 100%
of the fair value of the transferred securities), and our covenant to reacquire those securities from the counterparty for the same amount
plus a financing charge. The financing is fully and unconditionally guaranteed by Redwood. The financing facility may be terminated,
at our option, in September 2022, and has a final maturity in September 2024. At December 31, 2019, we had borrowings under this
facility totaling $185 million, net of $1 million of deferred issuance costs, for a carrying value of $184 million. At December 31, 2019,
the fair value of real estate securities pledged as collateral under this long-term debt facility was $250 million, which included $125
million of securities retained from our consolidated Sequoia Choice securitizations. In addition to the subordinate securities financing
facility described above, in the ordinary course of business we may seek to establish additional long-term securities repurchase facilities
that may be of a similar or greater size and may have similar or more restrictive terms.
Similar to the uncommitted warehouse and securities repurchase facilities described herein, under this facility we make various
representations and warranties and have agreed to certain covenants, events of default, and other terms that if breached or triggered can
result in our being required to immediately repay all outstanding amounts borrowed under this facility and this facility being unavailable
to use for future financing needs. In particular, outstanding amounts borrowed under this facility could become immediately due and
payable if there is a failure to pay any amounts due under the facility, the failure to repurchase the securities by the final maturity date,
or upon the insolvency of Redwood, as guarantor. If we breach or trigger the representations and warranties, covenants, events of default,
or other terms of this subordinate securities financing facility, we are exposed to liquidity and other risks, including of the type described
in Part I, Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors,” and in Part II, Item 7A of this Annual Report
on Form 10-K under the heading “Market Risks.”
106
Financial Covenants Associated With Short-Term Debt and Other Debt Financing
Set forth below is a summary of the financial covenants associated with our short-term debt and other debt financing facilities.
• Residential and Business Purpose Loan Warehouse Facilities. As noted above, one source of our short-term debt financing is
secured borrowings under residential and business purpose loan warehouse facilities we have established and, as of December 31,
2019, were in place with several different financial institution counterparties. Financial covenants included in these warehouse
facilities are as follows and at December 31, 2019, and through the date of this Annual Report on Form 10-K, we were in
compliance with each of these financial covenants:
• Maintenance of a minimum dollar amount of stockholders’ equity/tangible net worth at Redwood.
•
• Maintenance of a minimum dollar amount of cash and cash equivalents at Redwood or maintenance of an amount of cash
and cash equivalents in excess of a specified percentage of outstanding short-term recourse indebtedness.
• Maintenance of a maximum ratio of consolidated recourse indebtedness to stockholders’ equity and tangible net worth at
Redwood.
• With respect to residential loan warehouse facilities, maintenance of uncommitted residential loan warehouse facilities with
a specified level of unused borrowing capacity.
•
Securities Repurchase Facilities. As noted above, another source of our short-term debt financing is through secured borrowings
under securities repurchase facilities we have established with various financial institution counterparties. Financial covenants
included in these securities repurchase facilities are as follows and at December 31, 2019, and through the date of this Annual
Report on Form 10-K, we were in compliance with each of these financial covenants:
• Maintenance of a minimum dollar amount of stockholders’ equity/tangible net worth at Redwood.
• Maintenance of a minimum dollar amount of cash and cash equivalents at Redwood.
• Maintenance of a maximum ratio of consolidated recourse indebtedness to consolidated adjusted tangible net worth at
Redwood.
• Committed Line of Credit. As noted above, we also maintain a $10 million committed line of short-term credit from a bank,
which is secured by our pledge of certain mortgage-backed securities we own. The types of financial covenants included in this
bank line of credit are a subset of the covenants summarized above.
•
•
Servicer Advance Financing. As noted above, servicer advance financing consists of non-recourse short-term securitization debt,
secured by servicing advances. Financial covenants associated with this financing facility are as follows and at December 31,
2019, and through the date of this Annual Report on Form 10-K, we were in compliance with each of these financial covenants:
• Maintenance of a minimum dollar amount of stockholders’ equity/tangible net worth at SA Buyer.
• Maintenance of a minimum dollar amount of cash and cash equivalents at SA Buyer.
FHLB Borrowing Facility. As noted above, a wholly-owned subsidiary of ours, RWT Financial, also maintains a borrowing
facility with the FHLBC, borrowings under which are required to be secured by eligible collateral including, but not limited to,
residential and business purpose mortgage loans and residential mortgage-backed securities. Financial covenants included in
this facility are as follows and at December 31, 2019, and through the date of this Annual Report on Form 10-K, we were in
compliance with each of these financial covenants:
• Maintenance by RWT Financial of a maximum ratio of total liabilities (excluding debt subordinated to the FHLBC and
non-recourse debt) to stockholders’ equity and debt subordinated to the FHLBC.
• Maintenance by RWT Financial of a minimum level of unencumbered assets based on the level of indebtedness to the
FHLBC.
• Maintenance of a maximum ratio of total liabilities (excluding non-recourse debt) to stockholders’ equity at Redwood.
• Maintenance of a minimum dollar amount of cash and cash equivalents, excess qualifying collateral, or undrawn borrowing
capacity by RWT Financial (solely if certain servicing remittance-related conditions are not met).
107
As noted above, at December 31, 2019, and through the date of this Annual Report on Form 10-K, we were in compliance with the
financial covenants associated with our short-term debt and other debt financing facilities. In particular, with respect to: (i) financial
covenants that require us to maintain a minimum dollar amount of stockholders’ equity or tangible net worth at Redwood, at December 31,
2019 our level of stockholders’ equity and tangible net worth resulted in our being in compliance with these covenants by more than $200
million; and (ii) financial covenants that require us to maintain recourse indebtedness below a specified ratio at Redwood, at December 31,
2019 our level of recourse indebtedness resulted in our being in compliance with these covenants at a level such that we could incur at
least $600 million in additional recourse indebtedness.
Margin Call Provisions Associated With Short-Term Debt and Other Debt Financing
• Residential and Business Purpose Loan Warehouse Facilities. As noted above, one source of our short-term debt financing is
secured borrowings under residential and business purpose loan warehouse facilities we have established and, as of December 31,
2019, were in place with several different financial institution counterparties. These warehouse facilities include the margin call
provisions described below (except two business purpose loan warehouse facilities secured by residential bridge loans, which
have no margin call provisions) and during the twelve months ended December 31, 2019, and through the date of this Annual
Report on Form 10-K, we complied with any margin calls received from creditors under these warehouse facilities:
•
If at any time the market value (as determined by the creditor) of any residential mortgage loan financed under a facility
declines, then the creditor may demand that we transfer additional collateral to the creditor (in the form of cash, U.S. Treasury
obligations (in certain cases), or additional residential mortgage loans) with a value equal to the amount of the decline. If
we receive any such demand, (i) under two of our residential loan warehouse facilities, we would generally be required to
transfer the additional collateral on the same day (although demands received after a certain time would only require the
transfer of additional collateral on the following business day) and (ii) under two of our residential loan warehouse facilities
and our business purpose loan warehouse facilities (except two business purpose loan warehouse facilities secured by
residential bridge loans with no margin call provisions), we would generally be required to transfer the additional collateral
on the following business day. The value of additional residential and business purpose mortgage loans transferred as
additional collateral is determined by the creditor.
•
Securities Repurchase Facilities. Another source of our short-term debt financing is through secured borrowings under securities
repurchase facilities we have established with various financial institution counterparties. These repurchase facilities include
the margin call provisions described below and during the twelve months ended December 31, 2019, and through the date of
this Annual Report on Form 10-K, we complied with any margin calls received from creditors under these repurchase facilities:
•
If at any time the market value (as determined by the creditor) of any securities financed under a facility declines, then the
creditor may demand that we transfer additional collateral to the creditor (in the form of cash, U.S. Treasury obligations,
or additional securities) with a value equal to the amount of the decline. If we receive any such demand, we would generally
be required to transfer the additional collateral on the same day. The value of additional securities transferred as additional
collateral is determined by the creditor.
• Committed Line of Credit. As noted above, we also maintain a $10 million committed line of short-term credit from a bank,
which is secured by our pledge of certain mortgage-backed securities we own. Margin call provisions included in this bank line
of credit are as follows and during the twelve months ended December 31, 2019, and through the date of this Annual Report on
Form 10-K, we complied with any margin calls received from this creditor under this line of credit:
•
If at any time the total market value (as determined by two broker-dealers) of the securities that are pledged as collateral
under this facility declines to a value less than the outstanding amount of borrowings under this facility, then the creditor
may demand that we transfer additional collateral to the creditor (in the form of cash, U.S. Treasury obligations, or additional
securities) with a value equal to the amount of the difference. If we receive any such demand, we would generally be required
to transfer the additional collateral within two business days. The value of additional collateral pledged is determined by
the creditor.
108
•
FHLB Borrowing Facility. As noted above, a wholly-owned subsidiary of ours, RWT Financial, also maintains a borrowing
facility with the FHLBC, borrowings under which are required to be secured by eligible collateral including, but not limited to,
residential mortgage loans and residential mortgage-backed securities. This facility includes the margin call provisions described
below during the twelve months ended December 31, 2019, and through the date of this Annual Report on Form 10-K, we
complied with any margin calls received from the creditor under this facility.
•
If at any time the aggregate market value (as determined by the FHLBC) of the residential mortgage loans and residential
mortgage-backed securities pledged as collateral under this facility declines to a value less than the required collateral level,
or if any collateral ceases to be qualifying collateral under the terms of this facility, we would be required to promptly deliver
additional collateral sufficient to maintain the required collateral level. The value of additional loans or securities transferred
as additional collateral is determined by the FHLBC.
109
OFF BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
In the normal course of business, we engage in financial transactions that may not be recorded on the balance sheet. For additional
information on our commitments and contingencies, refer to Note 16 in Part II, Item 8 of this Annual Report.
The following table presents our contractual obligations and commitments at December 31, 2019, as well as the obligations of the
securitization entities that we consolidate for financial reporting purposes.
Table 54 – Contractual Obligations and Commitments
December 31, 2019
(In Millions)
Obligations of Redwood
Short-term debt
Convertible notes
Anticipated interest payments on convertible notes
FHLBC borrowings
Anticipated interest payments on FHLBC borrowings
Other long-term debt
Anticipated interest payments on other long-term debt (1)
Accrued interest payable
Operating leases
Commitment to fund partnerships
Total Redwood Obligations and Commitments
Obligations of Consolidated Securitization Entities for
Financial Reporting Purposes
Consolidated ABS (2)
Anticipated interest payments on ABS (3)
Non-recourse short-term debt
$
$
Accrued interest payable
Total Obligations of Securitization Entities Consolidated
for Financial Reporting Purposes
Total Consolidated Obligations and Commitments
(1) Includes anticipated interest payments related to hedges.
Payments Due or Commitment Expiration by Period
3 to 5
Years
After 5
Years
1 to 3
Years
Less Than
1 Year
Total
$
2,177 $
— $
— $
— $
2,177
—
34
—
58
—
17
20
3
37
—
69
—
106
185
33
—
4
—
445
57
470
106
—
19
—
3
—
201
12
1,530
38
140
114
—
6
—
646
172
2,000
308
325
183
20
16
37
2,346
$
397
$
1,100
$
2,041
$
5,884
— $
— $
— $
9,962
$
403
153
34
590
770
—
—
770
694
—
—
694
1,697
—
—
11,659
$
2,936
$
1,167
$
1,794
$
13,700
$
9,962
3,564
153
34
13,713
19,597
(2) All consolidated ABS issued are collateralized by real estate loans. Although the stated maturity is as shown, the ABS obligations will pay down
as the principal balances of these real estate loans or securities pay down. The amount shown is the principal balance of the ABS issued and not
necessarily the value reported in our consolidated financial statements.
(3) The anticipated interest payments on consolidated ABS issued is calculated based on the contractual maturity of the ABS and therefore assumes
no prepayments of the principal outstanding at December 31, 2019.
110
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and
expenses during the reported periods. Actual results could differ from those estimates. A discussion of critical accounting policies and
the possible effects of changes in estimates on our consolidated financial statements is included in Note 2 — Basis of Presentation and
Note 3 — Summary of Significant Accounting Policies included in Part II, Item 8 of this Annual Report on Form 10-K. Management
discusses the ongoing development and selection of these critical accounting policies with the audit committee of the board of directors.
We expect quarter-to-quarter GAAP earnings volatility from our business activities. This volatility can occur for a variety of reasons,
including the timing and amount of purchases, sales, calls, and repayment of consolidated assets, changes in the fair values of consolidated
assets and liabilities, increases or decreases in earnings from mortgage banking activities, and certain non-recurring events. In addition,
the amount or timing of our reported earnings may be impacted by technical accounting issues and estimates, some of which are described
below.
Changes in the Fair Value of Loans Held at Fair Value
We have elected the fair value option for our residential loans held-for-sale, residential loans held-for-investment, and business
purpose residential loans. As such, these loans are carried on our consolidated balance sheets at their estimated fair value and changes in
the fair values of these loans are recorded in Mortgage banking activities, net or Investment fair value changes, net on our consolidated
statements of income in the period in which the valuation change occurs. Periodic fluctuations in the values of these investments are
inherently volatile and thus can lead to significant period-to-period GAAP earnings volatility.
The fair value of loans is affected by, among other things, changes in interest rates, credit performance, prepayments, and market
liquidity. To the extent interest rates change or market liquidity and or credit conditions materially change, the value of these loans could
decline, which could have a material effect on reported earnings.
Changes in Fair Values of Securities
Our securities are classified as either trading or AFS securities, and in both cases are carried on our consolidated balance sheets at
their estimated fair values. In addition, we invest in securities of certain securitization entities that we are required to consolidate for
GAAP reporting purposes. We have elected to account for these entities as collateralized financing entities and use the fair value of the
ABS issued by these entities (which we determined to be more observable) to determine the fair value of the loans held at these entities.
For trading securities and collateralized financing entities, changes in fair values are recorded in Investment fair value changes, net on
our consolidated statements of income in the period in which the valuation change occurs. Periodic fluctuations in the values of these
investments are inherently volatile and thus can lead to significant period-to-period GAAP earnings volatility.
For AFS securities, cumulative unrealized gains and losses are recorded as a component of Accumulated other comprehensive income
in our consolidated balance sheets. Unrealized gains are not credited to current earnings and unrealized losses are not charged against
current earnings to the extent they are temporary in nature. Certain factors may require us, however, to recognize declines in the values
of AFS securities as other-than-temporary impairments and record them through our current earnings. Factors that determine other-than-
temporary-impairment include a change in our ability or intent to hold AFS securities, adverse changes to projected cash flows of assets,
or the likelihood that declines in the fair values of assets would not return to their previous levels within a reasonable time. Impairments
on AFS securities can lead to significant period-to-period GAAP earnings volatility. In addition, sales of securities in large unrealized
gain or loss positions that are not impaired can lead to significant period-to-period GAAP earnings volatility.
Changes in Fair Values of Mortgage Servicing Rights
Mortgage servicing rights are carried on our consolidated balance sheets at their estimated fair values, with changes in fair values
recorded in the consolidated statements of income as a component of Other income. Periodic fluctuations in the values of our mortgage
servicing rights can be caused by actual prepayments on the underlying loans, changes in assumptions regarding future projected
prepayments on the underlying loans, and changes in the discount rate assumptions used to value mortgage servicing rights, among other
factors. Periodic fluctuations in the values of these investments are inherently volatile and can lead to significant period-to-period GAAP
earnings volatility.
111
Changes in Fair Values of Servicer Advance Investments
Servicer advance investments are carried on our consolidated balance sheets at their estimated fair values, with changes in fair values
recorded in our consolidated statements of income in Investment fair value changes, net. Periodic fluctuations in the values of our servicer
advance investments can be caused by changes in the actual and anticipated balance of servicing advances outstanding, actual and
anticipated prepayments on the underlying loans, and changes in the discount rate assumptions used to value servicer advance investments.
Periodic fluctuations in the values of these investments are inherently volatile and can lead to significant period-to-period GAAP earnings
volatility.
Changes in Fair Values of Excess MSRs
Excess MSRs are carried on our consolidated balance sheets at their estimated fair values, with changes in fair values recorded in
our consolidated statements of income in Investment fair value changes, net. Periodic fluctuations in the values of our excess MSRs can
be caused by actual prepayments on the underlying loans, changes in assumptions regarding future projected prepayments on the underlying
loans, actual or anticipated changes in delinquencies, and changes in the discount rate assumptions used to value excess MSRs. Periodic
fluctuations in the values of these investments are inherently volatile and can lead to significant period-to-period GAAP earnings volatility.
Changes in Fair Values of Shared Home Appreciation Options
Shared home appreciation options are carried on our consolidated balance sheets at their estimated fair values, with changes in fair
values recorded in our consolidated statements of income in Investment fair value changes, net. Periodic fluctuations in the values of our
shared home appreciation options can be caused by changes in the discount rate assumptions used to value shared home appreciation
options, changes in assumptions regarding future projected home values, and changes in assumptions regarding future projected
prepayment rates. Periodic fluctuations in the values of these investments are inherently volatile and can lead to significant period-to-
period GAAP earnings volatility.
Changes in Fair Values of Derivative Financial Instruments
We generally use derivatives as part of our mortgage banking activities (e.g., to manage risks associated with loans we plan to acquire
and subsequently sell or securitize), in relation to our residential investments (to manage risks associated with our securities, MSRs, and
held-for-investment loans), and to manage variability in debt interest expense indexed to adjustable rates, and cash flows on assets and
liabilities that have different coupon rates (fixed rates versus floating rates, or floating rates based on different indices). The nature of the
instruments we use and the accounting treatment for the specific assets, liabilities, and derivatives may therefore lead to volatility in our
periodic earnings, even when we are meeting our hedging objectives.
Some of our derivatives are accounted for as trading instruments with all associated changes in value recorded through our consolidated
statements of income. Changes in value of the assets and liabilities we manage by using derivatives may not be accounted for similarly.
This could lead to reported income and book values in specific periods that do not necessarily reflect the economics of our risk management
strategy. Even when the assets and liabilities are similarly accounted for as trading instruments, periodic changes in their values may not
coincide as other market factors (e.g., supply and demand) may affect certain instruments and not others at any given time.
Changes in Fair Values of Goodwill and Intangible Assets
In connection with our acquisitions of CoreVest and 5 Arches, a portion of the purchase price of each acquisition was allocated to
goodwill and intangible assets. Accounting standards require that we test goodwill and intangible assets for impairment at least annually
(or more frequently if impairment indicators arise). The assessments to determine if goodwill or intangible assets are impaired requires
significant judgement to develop assumptions and estimates. If we determine goodwill or intangible assets are impaired, we will be
required to write down the value of these assets, up to their entire balance. Any write-down would have a negative effect on our consolidated
financial statements.
112
Changes in Mortgage Banking Income
The amount of income that can be earned from mortgage banking activities is primarily dependent on the volume of loans we are
able to acquire and any potential profit we earn upon the sale or securitization of these loans. Our ability to acquire loans and the volume
of loans we acquire is dependent on many factors that are beyond our control, including general economic conditions and changes in
interest rates, loan origination volumes industry-wide and at the sellers we purchase our loans from, increased regulation, and competition
from other financial institutions. Our profitability from mortgage banking activities is also dependent on many factors, including our
ability to effectively hedge certain risks related to changes in interest rates and other factors that are beyond our control, including changes
in market credit risk pricing. Additionally, our income from mortgage banking activities is generally generated over the period from when
we identify a loan for purchase until we subsequently sell or securitize the loan. This income may encompass positive or negative market
valuation adjustments on loans, hedging gains or losses associated with related risk management activities, and any other related transaction
expenses, and may be realized unevenly over the course of one or more quarters for financial reporting purposes. Additional factors that
could impact our profitability are discussed in Part I, Item 1A - Risk Factors of this Annual Report on Form 10-K and above, under the
headings “Changes in the Fair Value of Loans Held at Fair Value” and “Changes in Fair Values of Derivative Financial Instruments.”
Changes in the volumes of loans acquired or originated in connection with our mortgage banking activities and our profitability on these
activities can lead to significant period-to-period GAAP earnings volatility.
Changes in Yields for Securities
The yields we project on available-for-sale real estate securities can have a significant effect on the periodic interest income we
recognize for financial reporting purposes. Yields can vary as a function of credit results, prepayment rates, and interest rates. If estimated
future credit losses are less than our prior estimate, credit losses occur later than expected, or prepayment rates are faster than expected
(meaning the present value of projected cash flows is greater than previously expected for assets acquired at a discount to principal
balance), the yield over the remaining life of the security may be adjusted upwards. If estimated future credit losses exceed our prior
expectations, credit losses occur more quickly than expected, or prepayments occur more slowly than expected (meaning the present
value of projected cash flows is less than previously expected for assets acquired at a discount to principal balance), the yield over the
remaining life of the security may be adjusted downward.
Changes in the actual maturities of real estate securities may also affect their yields to maturity. Actual maturities are affected by the
contractual lives of the associated mortgage collateral, periodic payments of principal, and prepayments of principal. Therefore, actual
maturities of AFS securities are generally shorter than stated contractual maturities. Stated contractual maturities are generally greater
than 10 years. There is no assurance that our assumptions used to estimate future cash flows or the current period’s yield for each asset
will not change in the near term, and any change could be material.
Changes in Loss Contingency Reserves
We may be exposed to various loss contingencies, including, without limitation, those described in Note 16 to the consolidated
financial statements included in Part II, Item 8 of this Annual Report on Form 10-K. In accordance with FASB guidance on accounting
for contingencies, we review the need for any loss contingency reserves and establish them when, in the opinion of management, it is
probable that a matter would result in a liability, and the amount of loss, if any, can be reasonably estimated. The establishment of a loss
contingency reserve, the subsequent increase in a reserve or release of reserves previously established, or the recognition of a loss in
excess of previously established reserves, can occur as a result of various factors and events that affect management’s opinion of whether
the standard for establishing, increasing, or continuing to maintain, a reserve has been met. Changes in the loss contingency reserves can
lead to significant period-to-period GAAP earnings volatility.
Changes in Provision for Taxes
Our provision for income taxes is primarily the result of GAAP income or losses generated at our TRS. Deferred tax assets/liabilities
are generated by temporary differences in GAAP income and taxable income at our taxable subsidiaries and are a significant component
of our GAAP provision for income taxes. In assessing the realizability of deferred tax assets, we consider whether it is more likely than
not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent
upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider
historical and projected future taxable income and capital gains as well as tax planning strategies in making this assessment. We determine
the extent to which realization of this deferred asset is not assured and establish a valuation allowance accordingly. The estimate of net
deferred tax assets and associated valuation allowances could change in future periods to the extent that actual or revised estimates of
future taxable income during the carry-forward periods change from current expectations, causing significant period-to-period GAAP
earnings volatility.
113
Market Risks
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2018
REDWOOD TRUST, INC. AND SUBSIDIARIES
We seek to manage risks inherent in our business — including but not limited to credit risk, interest rate risk, prepayment risk,
liquidity risk, and fair value risk — in a prudent manner designed to enhance our earnings and dividends and preserve our capital. In
general, we seek to assume risks that can be quantified from historical experience, to actively manage such risks, and to maintain capital
levels consistent with these risks. Information concerning the risks we are managing, how these risks are changing over time, and potential
GAAP earnings and taxable income volatility we may experience as a result of these risks is discussed under the caption “Risk Factors”
of this Annual Report on Form 10-K, under the caption "Risks Relating to Debt Incurred under Short- and Long-Term Borrowing Facilities"
within this MD&A, and under the caption "Quantitative and Qualitative Disclosures About Market Risk" of this Annual Report on Form
10-K.
Other Risks
In addition to the market and other risks described above, our business and results of operations are subject to a variety of types of
risks and uncertainties, including, among other things, those described under the caption “Risk Factors” of this Annual Report on Form
10-K.
NEW ACCOUNTING STANDARDS
A discussion of new accounting standards and the possible effects of these standards on our consolidated financial statements is
included in Note 3 — Summary of Significant Accounting Policies included in Part II, Item 8 of this Annual Report on Form 10-K.
114
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risks
We seek to manage risks inherent in our business - including but not limited to credit risk, interest rate risk, prepayment risk, inflation
risk, and fair value and liquidity risk - in a prudent manner designed to enhance our earnings and dividends and preserve our capital. In
general, we seek to assume risks that can be quantified from historical experience, to actively manage such risks, and to maintain capital
levels consistent with these risks. This section presents a general overview of these risks. Additional information concerning the risks we
are managing, how these risks are changing over time, and potential GAAP earnings and taxable income volatility we may experience
as a result of these risks is further discussed in Part I, Item 1A and Part II, Item 7 of this Annual Report on Form 10-K.
Credit Risk
Integral to our business is assuming credit risk through our ownership of real estate loans, securities and other investments as well
as through our reliance on the creditworthiness of business counterparties. We believe the securities and loans we purchase are priced to
generate an expected return that compensates us for the underlying credit risk associated with these investments. Nevertheless, there may
be significant credit losses associated with these investments should they perform worse than we expect on a credit basis. For additional
details, refer to Part I, Item 1A of this Annual Report on Form 10-K and see the risk factor titled “The nature of the assets we hold and
the investments we make expose us to credit risk that could negatively impact the value of those assets and investments, our earnings,
dividends, cash flows, and access to liquidity, or otherwise negatively affect our business.”
We manage our credit risks by analyzing the extent of the risk we are taking and reviewing whether we believe the appropriate
underwriting criteria are met, and we utilize systems and staff to monitor the ongoing credit performance of our loans and securities. To
the extent we find the credit risks on specific assets are changing adversely, we may be able to take actions, such as selling the affected
investments, to mitigate potential losses. However, we may not always be successful in analyzing risks, reviewing underwriting criteria,
foreseeing adverse changes in credit performance or in effectively mitigating future credit losses and the ability to sell an asset may be
limited due to the structure of the asset or the absence of a liquid market for the asset.
Residential Loans and Securities
Our residential loans (including business purpose residential loans) and securities backed by residential loans are generally secured
by real property. Credit losses on real estate loans and securities can occur for many reasons, including: poor origination practices; fraud;
poor underwriting; poor servicing practices; weak economic conditions; increases in payments required to be made by borrowers; declines
in the value of real estate; natural disasters, the effects of climate change (including flooding, drought, and severe weather) and other
natural events; uninsured property loss; over-leveraging of the borrower; costs of remediation of environmental conditions, such as indoor
mold; acts of war or terrorism; changes in legal protections for lenders and other changes in law or regulation; and personal events
affecting borrowers, such as reduction in income, job loss, divorce, or health problems. In addition, if the U.S. economy or the housing
market were to weaken (and that weakening was in excess of what we anticipated), credit losses could increase beyond levels that we
have anticipated.
Credit losses on business purpose real estate loans can occur for many of the reasons noted above for residential real estate loans.
Moreover, these types of real estate loans may not be fully amortizing and, therefore, the borrower’s ability to repay the principal when
due may depend upon the ability of the borrower to refinance or sell the property at maturity. Business purpose real estate loans are
particularly sensitive to conditions in the rental housing market and to demand for rental residential properties.
With respect to most of the legacy Sequoia securitization entities sponsored by us that we consolidate and for a portion of the loans
underlying residential loan securities we have acquired from securitizations sponsored by others, the interest rate is adjustable. Accordingly,
when short-term interest rates rise, required monthly payments from homeowners may rise under the terms of these loans, and this may
increase borrowers’ delinquencies and defaults that can lead to additional credit losses.
We may also own some securities backed by loans that are not prime quality such as re-performing and non-performing loans, Alt-
A quality loans, and subprime loans, that have substantially higher credit risk characteristics than prime-quality loans. Consequently, we
can expect these lower credit-quality loans to have higher rates of delinquency and loss, and if such losses differ from our assumptions,
we could incur credit losses. In addition, we may invest in riskier loan types with the potential for higher delinquencies and losses as
compared to regular amortization loans, but believe these securities offer us the opportunity to generate attractive risk-adjusted returns
as a result of attractive pricing and the manner in which these securitizations are structured. Nevertheless, there remains substantial
uncertainty about the future performance of these assets.
115
Additionally, we own residential mortgage credit risk transfer (or "CRT") securities issued by Fannie Mae and Freddie Mac ("the
Agencies"), for which we assume credit risk both on the residential loans that the securities reference, as well as corporate credit risk
from the Agencies, as our investments in the securities are not secured by the reference loans.
Multifamily Loans and Securities
Multifamily loans we may acquire, invest in, or originate are generally secured by real property. The multifamily securities we invest
in are primarily subordinate positions in securitizations sponsored by Freddie Mac that are comprised of loans collateralized by multifamily
properties. We also own and may continue to invest in other third-party sponsored multifamily mortgage-backed securities, including
securities sponsored by Fannie Mae. Credit losses on these real estate loans and securities can occur for many of the reasons noted above
for residential and business-purpose real estate loans, including: poor origination practices; fraud; faulty appraisals; documentation errors;
poor underwriting; legal errors; poor servicing practices; weak economic conditions; decline in the value of properties; declining rents
on single and multifamily residential rental properties; special hazards; earthquakes and other natural events; over-leveraging of the
borrower or on the property; reduction in market rents and occupancies and poor property management practices; and changes in legal
protections for lenders. In addition, if the U.S. economy or were to weaken (and that weakening was in excess of what we anticipated),
credit losses could increase beyond levels that we have anticipated. Moreover, the principal balance of multifamily loans may be
significantly larger than the residential and business-purpose real estate loans we own.
Counterparties
We are also exposed to credit risk with respect to our business and lender counterparties. For example, counterparties we acquire
loans from, lend to, or invest in, make representations and warranties and covenants to us, and may also indemnify us against certain
losses. To the extent we have suffered a loss and are entitled to enforce those agreements to recover damages, if our counterparties are
insolvent or unable or unwilling to comply with these agreements we would suffer a loss due to the credit risk associated with our
counterparties. As an example, under short-term borrowing facilities and certain swap and other derivative agreements, we sometimes
transfer assets as collateral to our counterparties. To the extent a counterparty is not able to return this collateral to us if and when we are
entitled to its return, we could suffer a loss due to the credit risk associated with that counterparty.
In addition, because we rely on the availability of credit under committed and uncommitted borrowing facilities to fund our business
and investments, our counterparties’ willingness and ability to extend credit to us under these facilities is a significant counterparty risk
(and is discussed further below under the heading “Fair Value and Liquidity Risks”).
In connection with our servicer advance investments, the partnership entity (the "SA Buyer") formed to invest in servicer advance
investments and excess MSRs, has agreed to purchase all future arising servicer advances under certain residential mortgage servicing
agreements. SA Buyer relies, in part, on its members to make committed capital contributions in order to pay the purchase price for future
servicer advances. A failure by any or all of the members to make such capital contributions for amounts required to fund servicer advances
could result in an event of default under our servicer advance financing and a complete loss of our investment in SA Buyer and its servicer
advance investments and excess MSRs.
The outstanding balance of servicer advances securing the financing is not likely to be repaid on or before the maturity date of such
financing arrangement. We expect to request the same counterparty or another one of our financing sources to renew or refinance the
financing for an additional fixed period, however, there can be no assurance that we will be able to extend the financing arrangement
upon the expiration of its stated term, which subjects us to a number of risks. A financing source that elects to extend or refinance may
charge higher interest rates and impose more onerous terms upon us, including without limitation, lowering the amount of financing that
can be extended against the servicer advances being financed. If we are unable to renew or refinance the servicer advance financing, the
securitization entity will be required to repay the outstanding balance of the financing on the related maturity date. Additionally, there
may be substantial increases in the interest rates under the financing arrangement if the notes are not repaid, extended or refinanced prior
to the expected repayment date, which may be before the related maturity date. If the securitization entity is unable to pay the outstanding
balance of the notes, the financing counterparty may foreclose on the servicer advances pledged as collateral.
Under our servicer advance financing, the consolidated partnership (SA Buyer) and the securitization entity, along with the servicer
(who is unaffiliated with us except through their co-investment in SA Buyer and the securitization entity), make various representations
and warranties and have agreed to certain covenants, events of default, and other terms that if breached or triggered can result in acceleration
of all outstanding amounts borrowed under this facility and this facility being unavailable to use for future financing needs. We do not
have the direct ability to control the servicer’s compliance with such covenants and tests and the failure of SA Buyer, the securitization
entity, or the servicer to satisfy any such covenants or tests could result in a partial or total loss on our investment.
116
Interest Rate Risk
Changes in interest rates and the shape of the yield curve can affect the cash flows and fair values of our assets, liabilities, and
derivative financial instruments and, consequently, affect our earnings and reported equity. Our general strategy with respect to interest
rates is to maintain an asset/liability posture (including hedges) that assumes some interest rate risks but not to such a degree that the
achievement of our long-term goals would likely be adversely affected by changes in interest rates. Accordingly, we are willing to accept
short-term volatility of earnings and changes in our reported equity in order to accomplish our goal of achieving attractive long-term
returns. For additional details, refer to Part I, Item 1A of this Annual Report on Form 10-K and see the risk factor titled “Interest rate
fluctuations can have various negative effects on us and could lead to reduced earnings and increased volatility in our earnings.”
We invest in securities, residential loans, and other mortgage-related assets, which all expose us to interest rate risk. Additionally,
we acquire and originate residential loans, then sell or securitize these assets. We are exposed to interest rate risk during the “accumulation”
period - the period from when we enter into agreements to purchase the loans with the intention of selling or securitizing them at a future
date.
To mitigate this interest rate risk, we use derivative financial instruments for risk management purposes. We may also use derivative
financial instruments in an effort to maintain a close match between pledged assets and debt. However, we generally do not attempt to
completely hedge changes in interest rates, and at times, we may be subject to more interest rate risk than we generally desire in the long
term. Changes in interest rates will have an impact on the values and cash flows of our assets and corresponding liabilities.
Prepayment Risk
Prepayment risks exist in many of the assets on our consolidated balance sheets. In general, discount securities benefit from faster
prepayment rates on the underlying real estate loans while premium securities (such as certain IOs we own), and mortgage servicing
assets benefit from slower prepayments on the underlying loans. In addition, loans held for investment at premiums also benefit from
slower prepayments whereas loans held at discounts benefit from faster prepayments. For additional details, refer to Part I, Item 1A of
this Annual Report on Form 10-K and see the risk factor titled “Changes in prepayment rates of mortgage loans could reduce our earnings,
dividends, cash flows, and access to liquidity.”
When we make investments that are subject to prepayment risk, we apply a reasonable baseline prepayment range in determining
expected returns. If actual prepayment rates deviate from our baseline expectations, it could have an adverse change to our expected
returns. In order to mitigate this risk, we may use derivative financial instruments. We caution that prepayment rates are difficult to predict
or anticipate, and adverse changes in the rate of prepayment could reduce our cash flows, earnings, and dividends.
Inflation Risk
Virtually all of our consolidated assets and liabilities are financial in nature. As a result, changes in interest rates and other factors
drive our performance more directly than does inflation. That said, changes in interest rates generally correlate with inflation rates or
changes in inflation rates, and therefore adverse changes in inflation or changes in inflation expectations can lead to lower returns on our
investments than originally anticipated.
Our consolidated financial statements are prepared in accordance with GAAP. Our activities and balance sheets are measured with
reference to historical cost or fair value without considering inflation.
Fair Value and Liquidity Risks
To fund our assets we may use a variety of debt alternatives in addition to equity capital that present us with fair value and liquidity
risks. We seek to manage these risks, including by maintaining what we believe to be adequate cash and capital levels.
117
We acquire and originate residential loans and then sell or securitize them as part of our mortgage banking operations. Changes in
the fair value of the loans, once sold or securitized, do not have an impact on our liquidity. However, changes in fair values during the
accumulation period (while these loans are typically funded with short-term debt before they are sold or securitized) may impact our
liquidity. We also own residential loans that are held-for-investment and may be financed with borrowings from the FHLBC or funded
with short-term debt. We would be exposed to liquidity risk to the extent the values of these loans decline and/or the counterparties we
use to finance these investments adversely change our borrowing requirements. We attempt to mitigate our liquidity risk from FHLBC
borrowings and short-term financing facilities by setting aside adequate capital, in addition to amounts required by our financing
counterparties.
Many of the securities we acquire are funded with a combination of our capital and short-term debt facilities. For the securities we
acquire with a combination of capital and short-term debt, we would be exposed to liquidity risk to the extent the values of these investments
decline and/or the counterparties we use to finance these investments adversely change our borrowing requirements. We attempt to
mitigate our liquidity risk from short-term financing facilities by setting aside adequate capital.
Under our borrowing facilities, interest rate swaps and other derivatives agreements, we pledge assets as security for our payment
obligations and make various representations and warranties and agree to certain covenants, events of default, and other terms. In addition,
our borrowing facilities are generally uncommitted, meaning that each time we request a new borrowing under a facility the lender has
the option to decline to extend credit to us. The terms of these facilities and agreements typically include financial covenants (such as
covenants to maintain a minimum amount of tangible net worth or stockholders’ equity and/or a minimum amount of liquid assets and/
or a maximum amount of recourse debt to equity), margin requirements (which typically require us to pledge additional collateral if and
when the value of previously pledged collateral declines), operating covenants (such as covenants to conduct our business in accordance
with applicable laws and regulations and covenants to provide notice of certain events to creditors), representations and warranties (such
as representations and warranties relating to characteristics of pledged collateral, our exposure to litigation and/or regulatory enforcement
actions and the absence of material adverse changes to our financial condition, our operations, or our business prospects), and events of
default (such as a breach of covenant or representation/warranty and cross-defaults, under which an event of default is triggered under a
credit facility if an event of default or similar event occurs under another credit facility). For additional details, refer to Part II, Item 7 of
this Annual Report on Form 10-K and see the discussion titled “Risks Relating to Debt Incurred under Short- and Long-Term Borrowing
Facilities.”
Quantitative Information on Market Risk
Our future earnings are sensitive to a number of market risk factors and changes in these factors may have a variety of secondary
effects that, in turn, will also impact our earnings and equity. To supplement the discussion above of the market risks we face, the following
table incorporates information that may be useful in analyzing certain market risks that may affect our consolidated balance sheet at
December 31, 2019. The table presents principal cash flows and related average interest rates for material interest rate sensitive assets
and liabilities by year of repayment. The forward curve (future interest rates as implied by the yield structure of debt markets) at
December 31, 2019, was used to project the average coupon rates for each year presented. The timing of principal cash flows includes
assumptions on the prepayment speeds of assets based on their recent prepayment performance and future prepayment performance
consistent with the forward curve. Our future results depend greatly on the credit performance of the underlying loans (this table assumes
no credit losses), future interest rates, prepayments, and our ability to invest our existing cash and future cash flow.
118
Quantitative Information on Market Risk
(Dollars in Thousands)
Interest rate sensitive assets (1)
Residential Loans - HFS (2)
Adjustable Rate
Principal
$
Interest Rate
Fixed Rate
Principal
Hybrid
Interest Rate
Principal
Interest Rate
Residential Loans - HFI at
Redwood
Fixed Rate
Principal
Hybrid
Interest Rate
Principal
Interest Rate
Residential Loans - HFI at Sequoia
Adjustable Rate
Principal
Fixed Rate
Interest Rate
Principal
Interest Rate
Residential Loans - HFI at Freddie
Mac SLST
Fixed Rate
Principal
Interest Rate
Business Purpose Residential
Loans - HFS
Principal Amounts Maturing and Effective Rates During Period
2020
2021
2022
2023
2024
Thereafter
December 31, 2019
Fair
Value
Principal
Balance
$
141
3.80%
— $
N/A
— $
N/A
— $
N/A
— $
N/A
— $
N/A
141
$
105
433,045
4.25%
91,883
3.88%
—
N/A
—
N/A
—
N/A
—
N/A
—
N/A
—
N/A
—
N/A
—
N/A
—
N/A
—
N/A
433,045
442,525
91,883
93,755
368,311
313,962
267,633
228,140
194,475
452,858
1,825,379
1,879,316
4.14%
4.14%
4.14%
4.14%
4.14%
4.14%
36,102
32,377
29,037
26,041
23,354
80,488
227,399
232,581
4.16%
4.16%
4.16%
4.16%
4.16%
4.16%
123,220
96,536
74,975
58,097
44,870
27,132
424,830
407,890
3.24%
3.05%
3.10%
3.15%
3.23%
3.23%
633,849
454,606
326,162
234,043
167,948
424,072
2,240,680
2,291,463
5.05%
5.04%
5.03%
5.03%
5.03%
5.03%
170,826
168,829
158,007
147,930
138,477
1,643,965
2,428,034
2,367,215
4.08%
4.29%
4.30%
4.30%
4.29%
4.29%
Fixed Rate
Principal
Interest Rate
321,636
4.96%
—
N/A
—
N/A
—
N/A
—
N/A
—
N/A
321,636
331,565
Business Purpose Residential
Loans - HFI at Redwood
Fixed Rate
Principal
Interest Rate
Single-Family Rental Loans - HFI
at CAFL
Fixed Rate
Principal
523,837
218,691
—
2,406
39,105
189,700
973,739
982,626
7.35%
6.37%
4.89%
4.89%
4.89%
4.83%
26,990
28,569
30,240
32,008
33,881
1,926,526
2,078,214
2,192,552
Interest Rate
5.70%
5.70%
5.70%
5.70%
5.70%
5.70%
Multifamily Loans - HFI at Freddie
Mac K-Series
Fixed Rate
Principal
26,651
46,189
57,042
115,528
162,911
3,786,679
4,195,000
4,408,524
Interest Rate
4.07%
4.06%
4.06%
4.06%
4.07%
4.07%
119
Quantitative Information on Market Risk
Principal Amounts Maturing and Effective Rates During Period
2020
2021
2022
2023
2024
Thereafter
December 31, 2019
Fair
Value
Principal
Balance
(Dollars in Thousands)
Interest rate sensitive assets
(continued)
Residential Senior Securities
Adjustable Rate
Principal
$
2,042
$ 1,609
$ 1,261
$
985
$
766
$
2,231
$
8,894
$
8,868
Interest Rate
3.11%
2.96%
3.01%
3.05%
3.12%
3.21%
Fixed Rate (3)
Principal
11,330
9,636
8,208
13,802
11,726
28,889
83,591
150,062
Interest Rate
3.82%
3.82%
3.83%
3.87%
3.88%
Hybrid
Principal
3,893
3,100
2,458
1,942
1,528
Interest Rate
3.67%
3.55%
3.53%
3.53%
3.53%
3.73%
4,517
3.42%
3,790
3.55%
17,438
16,929
3,898
3,076
35
26
20
15
12
3.51%
3.51%
3.51%
3.52%
3.53%
8,322
8,906
10,117
13,682
17,738
573,041
631,806
459,837
4.53%
4.56%
4.53%
4.45%
4.39%
4.11%
3,577
2,885
1,948
1,488
1,139
55,735
66,772
56,974
3.46%
3.45%
3.51%
3.53%
3.55%
3.44%
18,754
16,517
10,790
6,714
7,814
28,759
89,348
89,721
Residential Subordinate
Securities
Adjustable Rate
Fixed Rate
Hybrid
Principal
Interest Rate
Principal
Interest Rate
Principal
Interest Rate
Multifamily Securities
Adjustable Rate
Principal
Interest Rate
4.27%
4.14%
4.19%
4.23%
4.16%
3.80%
Fixed Rate
Principal
—
—
—
—
—
316,723
316,723
314,407
Interest Rate
4.25%
4.25%
4.25%
4.25%
4.25%
4.25%
Interest rate sensitive liabilities
Asset-Backed Securities Issued
Sequoia Entities
Adjustable Rate
Principal
103,064
80,704
62,834
48,501
37,215
87,738
420,056
402,465
Interest Rate
2.44%
2.20%
2.27%
2.34%
2.37%
2.37%
Fixed Rate
Principal
608,613
434,727
309,701
211,626
138,184
276,868
1,979,719
2,037,198
Interest Rate
4.32%
4.33%
4.35%
4.39%
4.46%
4.46%
Freddie Mac SLST Entities
Fixed Rate
Principal
187,139
147,030
137,884
106,397
98,603
1,165,629
1,842,682
1,918,322
Interest Rate
3.16%
3.16%
3.16%
3.15%
3.16%
3.16%
Freddie Mac K-Series Entities
Adjustable Rate
Principal
9,830
16,083
16,905
17,657
18,340
Interest Rate
2.57%
2.60%
2.62%
2.67%
2.83%
5,418
2.83%
84,233
85,411
Fixed Rate
Principal
16,821
30,106
40,137
97,871
144,571
3,431,050
3,760,556
4,070,828
Interest Rate
2.75%
2.75%
2.75%
2.76%
2.79%
2.79%
CAFL Entities
Fixed Rate
Principal
86,295
178,527
264,627
269,450
427,801
648,307
1,875,007
2,001,251
Interest Rate
3.49%
3.40%
3.22%
2.84%
2.69%
2.69%
Short-term Debt
Principal
Interest Rate
2,329,145
3.41%
—
N/A
—
N/A
—
N/A
—
N/A
2,329,145
2,329,145
—
N/A
120
Quantitative Information on Market Risk
(Dollars in Thousands)
Interest rate sensitive liabilities
(continued)
Long-Term Debt
FHLBC
Borrowings
Principal
Interest Rate
Principal Amounts Maturing and Effective Rates During Period
2020
2021
2022
2023
2024
Thereafter
December 31, 2019
Fair
Value
Principal
Balance
$
— $
— $
— $
— $ 470,171
$ 1,529,828
$ 1,999,999
$ 1,999,999
1.90%
1.83%
1.87%
1.95%
2.04%
2.14%
Convertible Notes Principal
—
—
—
245,000
200,000
201,250
646,250
661,985
Interest Rate
5.89%
5.89%
5.89%
5.89%
6.25%
6.30%
Subordinate Securities Financing
Facility
Other Long-
Term Debt
Principal
Interest Rate
Principal
Interest Rate
Interest Rate Agreements
Interest Rate Swaps
(Purchased)
(Sold)
Notional
Amount
Receive Strike
Rate
Pay Strike Rate
Notional
Amount
Receive Strike
Rate
Pay Strike Rate
—
—
—
—
—
—
184,666
—
—
—
N/A
—
—
N/A
—
184,666
184,666
—
N/A
139,500
139,500
99,045
6.86%
6.86%
6.86%
6.86%
6.86%
6.86%
25,000
75,000
420,000
535,000
508,000
1,316,300
2,879,300
(138,843)
1.70%
2.35%
1.63%
2.35%
1.67%
2.35%
1.75%
2.42%
1.84%
2.62%
2.19%
2.81%
—
—
75,000
30,000
317,000
551,500
973,500
7,173
1.93%
1.70%
1.93%
1.63%
1.94%
1.67%
1.95%
1.75%
1.84%
1.84%
1.82%
2.08%
(1) For the key assumptions and sensitivity analysis for assets retained from securitizations, refer to Note 4 in Part II, Item 8 of this Annual Report.
(2) As we generally expect our residential loans held-for-sale to be sold within one year, we have only presented principal amounts and effective rates through 2020.
(3) The fair value of fixed-rate senior securities includes $64 million of interest-only securities, for which there is no principal at December 31, 2019.
121
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of Redwood Trust, Inc. and Notes thereto, together with the Reports of Independent Registered
Public Accounting Firm thereon, are set forth on pages F-1 through F-111 of this Annual Report on Form 10-K and incorporated herein
by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
We have adopted and maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed
on our reports under the Securities Exchange Act of 1934, as amended (the Exchange Act), is recorded, processed, summarized, and
reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms and that the information
is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate,
to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures,
management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable
assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
As required by Rule 13a-15(b) of the Exchange Act, we have carried out an evaluation, under the supervision and with the participation
of management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our
disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, our chief executive officer
and chief financial officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level.
Management of Redwood Trust, Inc., together with its consolidated subsidiaries (the Company, or Redwood), is responsible for
establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process
designed under the supervision of our chief executive officer and chief financial officer to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of our consolidated financial statements for external reporting purposes in accordance
with U.S. generally accepted accounting principles (GAAP).
As of the end of our 2019 fiscal year, management conducted an assessment of the effectiveness of our internal control over financial
reporting based on the framework established in Internal Control - Integrated Framework released by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in 2013. Based on this assessment, management has determined that the Company’s
internal control over financial reporting as of December 31, 2019, was effective. Management's evaluation of the effectiveness of our
internal control over financial reporting as of December 31, 2019 did not include internal controls over financial reporting that had not
yet been integrated for CoreVest, which we acquired in October 2019. Assessment of a recently acquired business may be omitted from
management's reporting on internal control over financial reporting in the year of acquisition under SEC guidelines. CoreVest comprised
approximately 17% of our total assets as of December 31, 2019 and approximately 12% of net income for the year ended December 31,
2019.
Except as described in the preceding paragraph, there have been no changes in our internal control over financial reporting during
the fourth quarter of 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial
reporting.
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are
recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are
being made only in accordance with authorizations of management and the board of directors of Redwood; and provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material
effect on our consolidated financial statements.
The Company’s internal control over financial reporting as of December 31, 2019, has been audited by Grant Thornton LLP, an
independent registered public accounting firm, as stated in their report appearing on page F-4, which expresses an unqualified opinion
on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019.
122
ITEM 9B. OTHER INFORMATION
On November 8, 2019, Redwood disclosed the departure of its Principal Accounting Officer, and following that departure named
Collin Cochrane to also serve as its Principal Accounting Officer. In connection with this additional role and the related responsibilities,
Redwood has entered into a letter agreement with Mr. Cochrane relating to his compensation terms. In particular, on February 28, 2020,
Redwood agreed to provide Mr. Cochrane a $500,000 cash award, payment of which is subject to continued employment through March
1, 2022 (subject to accelerated payment, in addition to his discretionary full-year or pro-rated annual bonus, in the event of a termination
without cause prior to March 1, 2022). Redwood also agreed to maintain Mr. Cochrane’s target bonus for 2020 at the same level that
was applicable in 2019 and to provide Mr. Cochrane accelerated vesting of DSU and PSU equity awards that are outstanding but unvested
as of February 28, 2020 in the event of termination without cause prior to the otherwise scheduled vesting date for such equity awards.
123
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Item 10 is incorporated herein by reference to the definitive Proxy Statement to be filed with the SEC
pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference to the definitive Proxy Statement to be filed with the SEC
pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
The information required by Item 12 is incorporated herein by reference to the definitive Proxy Statement to be filed with the SEC
pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by Item 13 is incorporated herein by reference to the definitive Proxy Statement to be filed with the SEC
pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by Item 14 is incorporated herein by reference to the definitive Proxy Statement to be filed with the SEC
pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
124
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Documents filed as part of this report:
(1) Consolidated Financial Statements and Notes thereto
PART IV
(2) Schedules to Consolidated Financial Statements: Schedule IV - Mortgage Loans on Real Estate
All other Consolidated Financial Statements schedules not included have been omitted because they are either inapplicable or the
information required is provided in the Company’s Consolidated Financial Statements and Notes thereto, included in Part II, Item 8, of
this Annual Report on Form 10-K.
(3) Exhibits:
Exhibit
Number
3.1
3.1.1
3.1.2
3.1.3
3.1.4
3.1.5
3.1.6
3.1.7
3.1.8
3.1.9
3.1.10
3.1.11
3.2.1
3.2.2
3.2.3
4.1
4.2
Exhibit
Articles of Amendment and Restatement of the Registrant, effective July 6, 1994 (incorporated by reference to the
Registrant’s Quarterly Report on Form 10-Q, Exhibit 3.1, filed on August 6, 2008)
Articles Supplementary of the Registrant, effective August 10, 1994 (incorporated by reference to the Registrant’s
Quarterly Report on Form 10-Q, Exhibit 3.1.1, filed on August 6, 2008)
Articles Supplementary of the Registrant, effective August 11, 1995 (incorporated by reference to the Registrant’s
Quarterly Report on Form 10-Q, Exhibit 3.1.2, filed on August 6, 2008)
Articles Supplementary of the Registrant, effective August 9, 1996 (incorporated by reference to the Registrant’s
Quarterly Report on Form 10-Q, Exhibit 3.1.3, filed on August 6, 2008)
Certificate of Amendment of the Registrant, effective June 30, 1998 (incorporated by reference to the Registrant’s
Quarterly Report on Form 10-Q, Exhibit 3.1.4, filed on August 6, 2008)
Articles Supplementary of the Registrant, effective April 7, 2003 (incorporated by reference to the Registrant’s
Quarterly Report on Form 10-Q, Exhibit 3.1.5, filed on August 6, 2008)
Articles of Amendment of the Registrant, effective June 12, 2008 (incorporated by reference to the Registrant’s
Quarterly Report on Form 10-Q, Exhibit 3.1.6, filed on August 6, 2008)
Articles of Amendment of the Registrant, effective May 19, 2009 (incorporated by reference to the Registrant’s
Current Report on Form 8-K, Exhibit 3.1, filed on May 21, 2009)
Articles of Amendment of the Registrant, effective May 24, 2011 (incorporated by reference to the Registrant’s
Current Report on Form 8-K, Exhibit 3.1, filed on May 20, 2011)
Articles of Amendment of the Registrant, effective May 18, 2012 (incorporated by reference to the Registrant’s
Current Report on Form 8-K, Exhibit 3.1, filed on May 21, 2012)
Articles of Amendment of the Registrant, effective May 16, 2013 (incorporated by reference to the Registrant’s
Current Report on Form 8-K, Exhibit 3.1, filed on May 21, 2013)
Articles of Amendment of the Registrant, effective May 15, 2019 (incorporated by reference to the Registrant’s
Current Report on Form 8-K, Exhibit 3.1, filed on May 17, 2019)
Amended and Restated Bylaws of the Registrant, as adopted on March 5, 2008 (incorporated by reference to the
Registrant’s Current Report on Form 8-K, Exhibit 3.1, filed on March 11, 2008)
First Amendment to Amended and Restated Bylaws of the Registrant, as adopted on May 17, 2012 (incorporated by
reference to the Registrant’s Current Report on Form 8-K, Exhibit 3.2, filed on May 21, 2012)
Second Amendment to Amended and Restated Bylaws of the Registrant, as adopted on May 22, 2018 (incorporated
by reference to the Registrant's Current Report on Form 8-K, Exhibit 3.1, filed on May 23, 2018)
Description of Redwood Trust, Inc. Common Stock (filed herewith)
Form of Common Stock Certificate (incorporated by reference to the Registrant’s Registration Statement on
Form S-11 (No. 333-08363), Exhibit 4.3, filed on August 6, 1996)
125
Exhibit
Number
4.3
4.4
4.5
4.6
4.7
4.8
4.9
4.10
4.11
4.12
4.13
4.14
9.1
9.2
10.1*
10.2*
10.3*
10.4*
Exhibit
Indenture dated as of October 1, 2001 between Sequoia Mortgage Trust 5 and Bankers Trust Company of California,
N.A., as Trustee (incorporated by reference to Sequoia Mortgage Funding Corporation’s Current Report on Form 8-
K, Exhibit 99.1, filed on November 15, 2001)
Indenture dated as April 1, 2002 between Sequoia Mortgage Trust 6 and Deutsche Bank National Trust Company, as
Trustee (incorporated by reference to Sequoia Mortgage Funding Corporation’s Current Report on Form 8-K,
Exhibit 99.1, filed on May 13, 2002)
Junior Subordinated Indenture dated as of December 12, 2006 between the Registrant and The Bank of New York
Trust Company, National Association, as Trustee (incorporated by reference to the Registrant’s Current Report on
Form 8-K, Exhibit 1.4, filed on December 12, 2006)
Amended and Restated Trust Agreement dated December 12, 2006 among the Registrant, The Bank of New York
Trust Company, National Association, The Bank of New York (Delaware), the Administrative Trustees (as named
therein) and the several holders of the Preferred Securities from time to time (incorporated by reference to the
Registrant’s Current Report on Form 8-K, Exhibit 1.3, filed on December 12, 2006)
Purchase Agreement dated December 12, 2006 among the Registrant, Redwood Capital Trust I and Merrill Lynch
International (incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 1.1, filed on
December 12, 2006)
Purchase Agreement dated December 12, 2006 among the Registrant, Redwood Capital Trust I and Bear, Stearns &
Co. Inc. (incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 1.2, filed on
December 12, 2006)
Subordinated Indenture dated as of May 23, 2007 between the Registrant and Wilmington Trust Company
(incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 1.2, filed on May 23, 2007)
Purchase Agreement dated May 23, 2007 between the Registrant and Obsidian CDO Warehouse, LLC (incorporated
by reference to the Registrant’s Current Report on Form 8-K, Exhibit 1.1, filed on May 23, 2007)
Indenture, dated March 6, 2013, between Redwood Trust, Inc. and Wilmington Trust, National Association, as
Trustee (incorporated by reference to the Registrant’s Current Report on Form 8-K/A, Exhibit 4.1, filed on March 6,
2013)
Second Supplemental Indenture, dated August 18, 2017, between Redwood Trust, Inc. and Wilmington Trust,
National Association, as Trustee (including the form of 4.75% Convertible Senior Note due 2023) (incorporated by
reference to the Registrant’s Current Report on Form 8-K, Exhibit 4.2, filed on August 18, 2017)
Third Supplemental Indenture, dated June 25, 2018, between Redwood Trust, Inc. and Wilmington Trust, National
Association, as Trustee (including the form of 5.625% Convertible Senior Note due 2024) (incorporated by reference
to the Registrant's Current Report on Form 8-K, Exhibit 4.2, filed on June 25, 2018)
Indenture, by and among Redwood Trust, Inc., RWT Holdings, Inc., and Wilmington Trust, National Association, as
Trustee, dated as of September 24, 2019 (incorporated by reference to the Registrant's Current Report on Form 8-K,
Exhibit 99.1, filed on September 25, 2019)
Waiver Agreement dated as of November 15, 2007 between the Registrant and Davis Selected Advisors, L.P.
(incorporated by reference to the Registrant’s Annual Report on Form 10-K, Exhibit 9.1, filed on March 5, 2008)
Amendment of Waiver Agreement dated as of January 16, 2008 between Registrant and Davis Selected Advisors,
L.P. (incorporated by reference to the Registrant’s Annual Report on Form 10-K, Exhibit 9.2, filed on March 5, 2008)
2014 Incentive Award Plan (incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.1,
filed on May 23, 2014)
Amended and Restated 2014 Incentive Award Plan (incorporated by reference to the Registrant's Current Report on
Form 8-K, Exhibit 10.2, filed on May 22, 2018)
Form of Redwood Trust, Inc. Deferred Stock Unit Award Agreement under 2014 Incentive Award Plan (2014)
(incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q, Exhibit 10.2, filed on August 8, 2014)
Form of Redwood Trust, Inc. Performance Stock Unit Award Agreement under 2014 Incentive Award Plan (2014)
(incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.1, filed on December 19,
2016)
126
Exhibit
Number
10.5*
10.6*
10.7*
10.8*
10.9*
10.10*
10.11*
10.12*
10.13*
10.14*
10.15*
10.16*
10.17*
10.18*
10.19*
10.20*
10.21*
10.22*
10.23*
10.24*
10.25*
Exhibit
Form of Redwood Trust, Inc. Restricted Stock Award Agreement under 2014 Incentive Award Plan (2014)
(incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q, Exhibit 10.4, filed on August 8, 2014)
Amended and Restated 1994 Executive and Non-Employee Director Stock Option Plan, as last amended January 24,
2002 (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q, Exhibit 10.14.5, filed on
May 15, 2002)
2002 Incentive Plan, as amended through May 16, 2013 (incorporated by reference to the Registrant’s Current
Report on Form 8-K, Exhibit 10.1, filed on May 21, 2013)
Form of Restricted Stock Award Agreement under 2002 Incentive Plan – Pre-December 2011 (incorporated by
reference to the Registrant’s Annual Report on Form 10-K, Exhibit 10.8.3, filed on March 16, 2005)
Form of Deferred Stock Unit Award Agreement under 2002 Incentive Plan – Pre-December 2011 (incorporated by
reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.1, filed on December 2, 2010)
Form of Performance Stock Unit Award Agreement under 2002 Incentive Plan – Pre-December 2011 (incorporated
by reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.2, filed on December 2, 2010)
Form of Restricted Stock Award Agreement under 2002 Incentive Plan (incorporated by reference to the Registrant’s
Current Report on Form 8-K, Exhibit 10.3, filed on December 8, 2011)
Form of Deferred Stock Unit Award Agreement under 2002 Incentive Plan (incorporated by reference to the
Registrant’s Current Report on Form 8-K, Exhibit 10.1, filed on December 8, 2011)
Form of Performance Stock Unit Award Agreement under 2002 Incentive Plan – December 2011 (incorporated by
reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.2, filed on December 8, 2011)
Form of Performance Stock Unit Award Agreement under 2002 Incentive Plan – December 2012 (incorporated by
reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.1, filed on December 11, 2012)
Form of Performance Stock Unit Award Agreement under 2014 Incentive Plan (2016 Form) (incorporated by
reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.1, filed on December 14, 2016)
Form of Performance Stock Unit Award Agreement under 2014 Incentive Plan (2017 Form) (incorporated by
reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.1, filed on December 14, 2017)
Form of Deferred Stock Unit Award Agreement under 2014 Incentive Plan (2018 Form of Award Agreement)
(incorporated by reference to the Registrant's Current Report on Form 8-K, Exhibit 10.1, filed on December 17,
2018)
Form of Performance Stock Unit Award Agreement under 2014 Incentive Plan (2018 Form of Award Agreement)
(incorporated by reference to the Registrant's Current Report on Form 8-K, Exhibit 10.2, filed on December 17,
2018)
Form of Letter Agreement Amendment to Equity Awards Under 2014 Incentive Plan (incorporated by reference to
the Registrant's Current Report on Form 8-K, Exhibit 10.3, filed on December 17, 2018)
Form of Restricted Stock Unit Award Agreement (2018 Form of Award Agreement) (incorporated by reference to the
Registrant's Annual Report on Annual 10-K, Exhibit 10.23, filed on March 1, 2019)
Form of Performance Stock Unit Award Agreement under 2014 Incentive Plan (2019 Form of Award Agreement)
(incorporated by reference to the Registrant's Current Report on Form 8-K, Exhibit 10.1, filed on December 13,
2019)
2002 Redwood Trust, Inc. Employee Stock Purchase Plan, as amended through May 15, 2019 (incorporated by
reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.1, filed on May 17, 2019)
Executive Deferred Compensation Plan, as amended and restated on December 10, 2008 (incorporated by reference
to the Registrant’s Current Report on Form 8-K, Exhibit 10.1, filed on January 14, 2009)
First Amendment to Amended and Restated Executive Deferred Compensation Plan, effective as of November 23,
2013 (incorporated by reference to the Registrant’s Annual Report on Form 10-K, Exhibit 10.15, filed on February
26, 2014)
Second Amendment to Amended and Restated Executive Deferred Compensation Plan (incorporated by reference to
the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.1, filed on November 8, 2018)
127
Exhibit
Number
10.26*
10.27*
10.28*
10.29
10.30
10.31
10.32
10.33
10.34
10.35
10.36
10.37
10.38
10.39
10.40
10.41
10.42
10.43
10.44
Exhibit
Direct Stock Purchase and Dividend Reinvestment Plan (incorporated by reference to the Plan text included in the
Registrant’s Prospectus Supplement filed on September 5, 2012)
Summary of the Registrant’s Compensation Arrangements for Non-Employee Directors (incorporated by reference to
the “Director Compensation” section of the Registrant’s Definitive Proxy Statement filed on March 28, 2018)
Revised Form of Indemnification Agreement for Directors and Executive Officers (incorporated by reference to the
Registrant’s Current Report on Form 8-K, Exhibit 99.3, filed on November 16, 2009)
Office Building Lease, dated February 27, 2003 (incorporated by reference to the Registrant’s Annual Report on
Form 10-K, Exhibit 10.30.2, filed on March 12, 2004)
Office Building Lease (second floor), dated July 31, 2006 (incorporated by reference to the Registrant’s Quarterly
Report on Form 10-Q, Exhibit 10.1, filed November 2, 2006)
Second Amendment to Lease, dated July 31, 2006 (incorporated by reference to the Registrant’s Quarterly Report on
Form 10-Q, Exhibit 10.3, filed November 2, 2006)
Office Building Lease, effective as of and dated as of June 1, 2012 (incorporated by reference to the Registrant’s
Quarterly Report on Form 10-Q, Exhibit 10.1, filed November 3, 2011)
First Amendment to Lease, effective as of May 25, 2017, between AG-SKB Belvedere Owner, L.P. and the
Registrant (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q, Exhibit 10.1, filed on
August 4, 2017)
Second Amendment to Lease, effective as of December 27, 2017, between AG-SKB Belvedere Owner, L.P. and the
Registrant (incorporated by reference to the Registrant's Annual Report on Form 10-K, Exhibit 10.30, filed on
February 28, 2018)
Lease Agreement, dated as of January 11, 2013, between MG-Point, LLC, as Landlord, and the Registrant, as Tenant
(incorporated by reference to the Registrant’s Annual Report on Form 10-K, Exhibit 10.22, filed on February 26,
2013)
First Amendment to Lease, effective as of June 27, 2013, between MG-Point, LLC, as Landlord, and the Registrant,
as Tenant (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q, Exhibit 10.4, filed August
8, 2013)
Second Amendment to Lease, effective as of June 23, 2014, between MG-Point, LLC, as Landlord, and the
Registrant, as Tenant (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q, Exhibit 10.7,
filed August 8, 2014)
Third Amendment to Lease, effective as of January 22, 2020, between ARTIS HRA Inverness Point, LP (successor-
in-interest to MG-Point, LLC), as Landlord, and the Registrant, as Tenant (filed herewith)
Lease, between SRI Nine Main Plaza LLC and CoreVest American Finance Lender LLC (formerly known as Colony
American Finance Lender, LLC), dated as of October 7, 2015 (incorporated by reference to the Registrant's
Quarterly Report on Form 10-Q, Exhibit 10.3, filed on November 8, 2019)
First Amendment to Lease, between Broadway Michelson LLC (as successor to SRI Nine Main Plaza LLC) and
CoreVest American Finance Lender LLC, dated as of May 21, 2018 (incorporated by reference to the Registrant's
Quarterly Report on Form 10-Q, Exhibit 10.4, filed on November 8, 2019)
Lease, between the Irvine Company LLC and 5 Arches, LLC, dated as of January 27, 2015 (incorporated by
reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.5, filed on November 8, 2019)
First Amendment to Lease, between the Irvine Company LLC and 5 Arches, LLC, dated as of September 9, 2016
(incorporated by reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.6, filed on November 8,
2019)
Second Amendment to Lease, between the Irvine Company LLC and 5 Arches, LLC, dated as of September 30, 2016
(incorporated by reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.7, filed on November 8,
2019)
Assignment and Assumption of Lease, between 5 Arches, LLC and 5 Arch Group, LLC, dated as of October 10,
2016 (incorporated by reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.8, filed on November
8, 2019)
128
Exhibit
Number
10.45
10.46
10.47
10.48*
10.49*
10.50*
10.51*
10.52*
10.53*
10.54*
10.55*
10.56*
10.57*
10.58*
10.59*
10.58*
10.59*
Exhibit
Third Amendment to Lease, between the Irvine Company LLC and 5 Arch Group, LLC, dated as of November 17,
2016 (incorporated by reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.9, filed on November
8, 2019)
Fourth Amendment to Lease, between Newport Gateway Office LLC (as successor in interest to the Irvine Company
LLC) and 5 Arch Group, LLC, dated as of May 11, 2018 (incorporated by reference to the Registrant's Quarterly
Report on Form 10-Q, Exhibit 10.10, filed on November 8, 2019)
Fifth Amendment to Lease and Consent to Assignment, between Newport Gateway Office LLC (as successor in
interest to the Irvine Company LLC) and 5 Arch Group, LLC, dated as of February 28, 2019 (incorporated by
reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.11, filed on November 8, 2019)
Amended and Restated Employment Agreement, dated as of February 22, 2017, by and between Martin S. Hughes
and the Registrant (incorporated by reference to the Registrant's Annual Report on Form 10-K, Exhibit 10.31, filed
February 24, 2017)
Amended and Restated Employment Agreement, dated as of May 22, 2018, by and between Martin S. Hughes and
the Registrant (incorporated by reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.2, filed
August 8, 2018)
Amended and Restated Employment Agreement, dated as of March 31, 2009, by and between Brett D. Nicholas and
the Registrant (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q, Exhibit 10.3, filed on
May 5, 2009)
First Amendment to Amended and Restated Employment Agreement, by and between Brett D. Nicholas and the
Registrant, dated as of March 17, 2010 (incorporated by reference to the Registrant’s Current Report on Form 8-K,
Exhibit 10.2, filed on March 18, 2010)
Second Amendment to Amended and Restated Employment Agreement, by and between Brett D. Nicholas and the
Registrant, dated as of February 24, 2011 (incorporated by reference to the Registrant’s Annual Report on Form 10-
K, Exhibit 10.24, filed on February 24, 2011)
Third Amendment to Amended and Restated Employment Agreement, by and between Brett D. Nicholas and the
Registrant, dated as of May 17, 2012 (incorporated by reference to the Registrant’s Current Report on Form 8-K,
Exhibit 10.4, filed on May 21, 2012)
Fourth Amendment to Amended and Restated Employment Agreement, by and between Brett D. Nicholas and the
Registrant, dated as of December 14, 2012 (incorporated by reference to the Registrant’s Annual Report on Form 10-
K, Exhibit 10.36, filed on February 26, 2013)
Fifth Amendment to Amended and Restated Employment Agreement, by and between Brett D. Nicholas and the
Registrant, dated as of August 6, 2014 (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q,
Exhibit 10.6, filed on August 8, 2014)
Sixth Amendment to Amended and Restated Employment Agreement, by and between Brett D. Nicholas and the
Registrant, dated as of August 5, 2015 (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q,
Exhibit 10.1, filed on November 6, 2015)
Amended and Restated Employment Agreement, by and between Christopher J. Abate and the Registrant, dated as of
February 22, 2017 (incorporated by reference to the Registrant's Annual Report on Form 10-K, Exhibit 10.49, filed
on February 24, 2017)
Second Amended and Restated Employment Agreement, dated as of May 22, 2018, by and between Christopher J.
Abate and the Registrant (incorporated by reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.3,
filed August 8, 2018)
Third Amended and Restated Employment Agreement, dated as of May 7, 2019, by and between Christopher J.
Abate and the Registrant (incorporated by reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.1,
filed on May 9, 2019)
Fourth Amended and Restated Employment Agreement, dated as of August 6, 2019, by and between Christopher J.
Abate and the Registrant (incorporated by reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.1,
filed on August 8, 2019)
Employment Agreement, by and between Fred J. Matera and the Registrant, dated as of January 1, 2016
(incorporated by reference to the Registrant’s Current Report on Form 8-K, Exhibit 10.2, filed on January 4, 2016)
129
Exhibit
Number
10.60*
10.61*
10.62*
10.63*
10.64*
10.65*
10.66*
10.67*
10.68*
10.69
10.70
10.71
10.72
10.73
10.74
10.75
Exhibit
Amended and Restated Employment Agreement, by and between Andrew P. Stone and the Registrant, dated as of
February 22, 2017 (incorporated by reference to the Registrant's Annual Report on Form 10-K, Exhibit 10.51, filed
on February 24, 2017)
Second Amended and Restated Employment Agreement, dated as of May 22, 2018, by and between Andrew P. Stone
and the Registrant (incorporated by reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.5, filed
August 8, 2018)
Third Amended and Restated Employment Agreement, dated as of May 7, 2019, by and between Andrew P. Stone
and the Registrant (incorporated by reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.2, filed
on May 9, 2019)
Fourth Amended and Restated Employment Agreement, dated as of August 6, 2019, by and between Andrew P.
Stone and the Registrant (incorporated by reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.3,
filed on August 8, 2019)
Employment Agreement, by and between Dashiell I. Robinson and the Registrant, dated as of August 8, 2017
(incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q, Exhibit 10.1, filed on November 7,
2017)
Side Letter Agreement, by and between Dashiell I. Robinson and the Registrant, dated as of August 8, 2017
(incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q, Exhibit 10.2, filed on November 7,
2017)
First Amendment to Employment Agreement, by and between Dashiell I. Robinson and the Registrant, dated as of
May 22, 2018 (incorporated by reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.4, filed
August 8, 2018)
First Amended and Restated Employment Agreement, dated as of May 7, 2019, by and between Dashiell I. Robinson
and the Registrant (incorporated by reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit 10.3, filed
on May 9, 2019)
Second Amended and Restated Employment Agreement, dated as of August 6, 2019, by and between Dashiell I.
Robinson and the Registrant (incorporated by reference to the Registrant's Quarterly Report on Form 10-Q, Exhibit
10.2, filed on August 8, 2019)
Advances, Collateral Pledge, and Security Agreement between the Federal Home Loan Bank of Chicago and RWT
Financial, LLC, dated as of July 16, 2014 (incorporated by reference to the Registrant’s Quarterly Report on Form
10-Q, Exhibit 10.8, filed on August 8, 2014)
Financial Covenant Supplement to Advances, Collateral Pledge, and Security Agreement between the Federal Home
Loan Bank of Chicago and RWT Financial, LLC, dated as of July 16, 2014 (incorporated by reference to the
Registrant’s Quarterly Report on Form 10-Q, Exhibit 10.9, filed on August 8, 2014)
Guaranty, dated July 16, 2014, given by Redwood Trust, Inc. in favor of the Federal Home Loan Bank of Chicago
(incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q, Exhibit 10.10, filed on August 8,
2014)
Second Supplement to Advances, Collateral Pledge and Security Agreement between the Federal Home Loan Bank
of Chicago and RWT Financial, LLC, dated as of February 19, 2015 (incorporated by reference to the Registrant’s
Annual Report on Form 10-K, Exhibit 10.53, filed on February 25, 2015)
Amendment to Advances, Collateral Pledge, and Security Agreement between the Federal Home Loan Bank of
Chicago and RWT Financial, LLC, dated as of October 31, 2017 (incorporated by reference to the Registrant’s
Quarterly Report on Form 10-Q, Exhibit 10.3, filed on November 7, 2017)
Amendment No. 1 to the Distribution Agreement by and among Wells Fargo Securities, LLC, J.P. Morgan Securities
LLC, Credit Suisse Securities (USA) LLC, Goldman Sachs & Co. LLC and JMP Securities LLC, dated May 9, 2019
(incorporated by reference to the Registrant's Current Report on Form 8-K, Exhibit 1.1, filed on May 10, 2019)
Distribution Agreement by and among Redwood Trust, Inc., Wells Fargo Securities, LLC, J.P. Morgan Securities
LLC, Credit Suisse Securities (USA) LLC, Goldman Sachs & Co. LLC, and JMP Securities LLC, dated November
14, 2018 (incorporated by reference to the Registrant's Current Report on Form 8-K, Exhibit 1.1, filed on November
15, 2018)
130
Exhibit
Number
10.76
Equity Interests Purchase Agreement by and among Redwood Trust, Inc., RWT Holdings, Inc., CF CoreVest Parent I
LLC, CF CoreVest Parent II LLC, CoreVest Management Partners LLC, and the Management Holders dated October
14, 2019 (incorporated by reference to the Registrant's Current Report on Form 8-K, Exhibit 99.1, filed on October
15, 2019)
Exhibit
10.77*
Letter Agreement, between Collin L. Cochrane and the Registrant, dated as of February 28, 2020 (filed herewith)
21
23
31.1
31.2
32.1
32.2
101
List of Subsidiaries (filed herewith)
Consent of Grant Thornton LLP (filed herewith)
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed
herewith)
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed
herewith)
Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed
herewith)
Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed
herewith)
Pursuant to Rule 405 of Regulation S-T, the following financial information from the Registrant’s Annual Report on
Form 10-K for the period ended December 31, 2019, is filed in XBRL-formatted interactive data files:
(i) Consolidated Balance Sheets at December 31, 2019 and 2018;
(ii) Consolidated Statements of Income for the years ended December 31, 2019, 2018, and 2017;
(iii) Statements of Consolidated Comprehensive (Loss) Income for the years ended December 31, 2019, 2018, and
2017;
(iv) Consolidated Statements of Changes in Equity for the years ended December 31, 2019, 2018, and 2017;
(v) Consolidated Statements of Cash Flows for the years ended December 31, 2019, 2018, and 2017; and
(vi) Notes to Consolidated Financial Statements.
104
Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)
* Indicates exhibits that include management contracts or compensatory plan or arrangements.
ITEM 16. FORM 10-K SUMMARY
Not applicable.
131
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report
to be signed on its behalf by the undersigned, hereunto duly authorized.
SIGNATURES
Date: March 2, 2020
REDWOOD TRUST, INC.
By:
/s/ CHRISTOPHER J. ABATE
Christopher J. Abate
Chief Executive Officer
Pursuant to the requirements the Securities Exchange Act of 1934, this report has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ CHRISTOPHER J. ABATE
Christopher J. Abate
/s/ COLLIN L. COCHRANE
Collin L. Cochrane
/s/ RICHARD D. BAUM
Richard D. Baum
/s/ DOUGLAS B. HANSEN
Douglas B. Hansen
/s/ MARIANN BYERWALTER
Mariann Byerwalter
/s/ DEBORA D. HORVATH
Debora D. Horvath
/s/ GREG H. KUBICEK
Greg H. Kubicek
/s/ FRED J. MATERA
Fred J. Matera
/s/ JEFFREY T. PERO
Jeffrey T. Pero
/s/ GEORGANNE C. PROCTOR
Georganne C. Proctor
Director and Chief Executive Officer
March 2, 2020
(Principal Executive Officer)
Chief Financial Officer
March 2, 2020
(Principal Financial and Accounting Officer)
Director, Chairman of the Board
March 2, 2020
March 2, 2020
March 2, 2020
March 2, 2020
March 2, 2020
March 2, 2020
March 2, 2020
March 2, 2020
Director
Director
Director
Director
Director
Director
Director
132
REDWOOD TRUST, INC.
CONSOLIDATED FINANCIAL STATEMENTS,
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
For Inclusion in Annual Report on Form 10-K Filed With
Securities and Exchange Commission
December 31, 2019
F- 1
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
REDWOOD TRUST, INC.
Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2019 and 2018
Consolidated Statements of Income for the Years Ended December 31, 2019, 2018, and 2017
Statements of Consolidated Comprehensive Income for the Years Ended December 31, 2019, 2018, and 2017
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2019, 2018, and 2017
Consolidated Statements of Cash Flows for the Years Ended December 31, 2019, 2018, and 2017
Notes to Consolidated Financial Statements
Note 1. Organization
Note 2. Basis of Presentation
Note 3. Summary of Significant Accounting Policies
Note 4. Principles of Consolidation
Note 5. Fair Value of Financial Instruments
Note 6. Residential Loans
Note 7. Business Purpose Residential Loans
Note 8. Multifamily Loans
Note 9. Real Estate Securities
Note 10. Other Investments
Note 11. Derivative Financial Instruments
Note 12. Other Assets and Liabilities
Note 13. Short-Term Debt
Note 14. Asset-Backed Securities Issued
Note 15. Long-Term Debt
Note 16. Commitments and Contingencies
Note 17. Equity
Note 18. Equity Compensation Plans
Note 19. Mortgage Banking Activities
Note 20. Investment Fair Value Changes
Note 21. Other Income
Note 22. General and Administrative Expenses and Other Expenses
Note 23. Taxes
Note 24. Segment Information
Note 25. Quarterly Financial Data
Schedule IV - Mortgage Loans on Real Estate
F- 2
Page
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F- 6
F- 7
F- 8
F- 9
F- 10
F- 11
F- 13
F- 13
F- 13
F- 17
F- 34
F- 40
F- 55
F- 63
F- 68
F- 70
F- 75
F- 78
F- 80
F- 82
F- 85
F- 87
F- 90
F- 95
F- 97
F- 102
F- 103
F- 104
F- 105
F- 106
F- 108
F- 111
F- 112
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Redwood Trust, Inc.
Opinion on the financial statements
We have audited the accompanying consolidated balance sheets of Redwood Trust, Inc. (a Maryland corporation) and subsidiaries
(the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, changes in
stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2019 and the related notes and financial
statement schedule included under Item 15(a) (collectively referred to as the "financial statements"). In our opinion, the financial statements
present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018 and the results of its
operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles
generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)
("PCAOB"), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013
Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"),
and our report dated March 2, 2020 expressed an unqualified opinion.
Basis for opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the
Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be
independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of
the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or
fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due
to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used
and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that
our audits provide a reasonable basis for our opinion.
Critical audit matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were
communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to
the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical
audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the
critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Fair value measurements of certain real estate securities, and beneficial interests in consolidated Sequoia Choice and Freddie Mac
Seasoned Loans Structured Transaction (“SLST”) securitization entities holding residential loans, consolidated CoreVest American
Finance Lender (“CAFL”) securitization entities holding business purpose residential loans, and consolidated Freddie Mac K-Series
securitization entities holding multifamily loans
As described further in Note 5 to the consolidated financial statements, the Company owns real estate securities, which are recorded
at fair value on a recurring basis. Some of these real estate securities result in the consolidation of the underlying securitization entities
as required by ASC 810, Consolidation. The Company has elected to account for consolidated securitization entities as Collateralized
Finance Entities (“CFEs”) and has elected to measure the financial assets of its CFEs using the fair value of the financial liabilities issued
by those entities, which management has determined to be more observable. The real estate securities and beneficial interests in
consolidated securitization entities, are priced individually by the Company utilizing market comparable pricing and discounted cash
flow analysis valuation techniques.
F- 3
We identified the fair value measurements of certain investment securities, specifically certain subordinate securities, as well the
beneficial interests in consolidated Sequoia Choice and Freddie Mac SLST securitization entities holding residential loans, consolidated
CAFL securitization entities holding business purpose residential loans, and consolidated Freddie Mac K-Series securitization entities
holding multifamily loans (together, “Investments”) as a critical audit matter.
The principal considerations for our determination that the fair value measurement of these Investments was a critical audit matter
are as follows. There is limited observable market data available for these Investments as they trade infrequently and, as such, the fair
value measurement requires management to make complex judgments in order to identify and select the significant assumptions, which
include the discount rate, prepayment rate, default rate and loss severity. In addition, the fair value measurements of the Investments are
highly sensitive to changes in the significant assumptions and underlying market conditions and are material to the consolidated financial
statements. As a result, obtaining sufficient appropriate audit evidence related to the fair value measurements required significant auditor
subjectivity.
Our audit procedures related to the fair value measurements of these Investments included the following, among others. We tested
the design and operating effectiveness of relevant controls including, among others, management’s validation of the inputs to the valuations,
and management’s review of the significant assumptions against available market data. Further, we involved firm valuation specialists
to independently determine the fair value measurement for a sample of the Investments and compared them to management’s fair value
measurement for reasonableness.
Fair value measurements of unsecuritized single-family rental loans
As described further in Note 7 to the consolidated financial statements, the Company purchases and originates Single-Family Rental
Loans (“SFR Loans”), which are both held for sale and held for investment, and in each case recorded at fair value on a recurring basis.
The unsecuritized SFR loans are priced by the Company using market comparable information that estimates the proceeds the Company
would receive in a hypothetical securitization of the loans. We identified the fair value measurement of these SFR Loans as a critical
audit matter.
The principal considerations for our determination that the fair value measurements of these SFR Loans was a critical audit matter
are as follows. In determining the fair value measurement, there is limited observable market data available for the SFR Loans, and the
secondary market for such SFR Loans is limited. As such, the fair value measurements require management to make complex judgements
in order to determine the significant valuation assumptions, which include the assumed senior credit spread and assumed subordinate
credit spread. In addition, the fair value measurements of the SFR Loans are highly sensitive to changes in these significant assumptions
and underlying market conditions and are material to the consolidated financial statements. As a result, obtaining sufficient appropriate
audit evidence related to the fair value measurements required significant auditor subjectivity.
Our audit procedures related to the fair value measurements of these SFR Loans included the following, among others. We tested
the design and operating effectiveness of controls relating to the fair value measurements of these SFR Loans, including controls over
the determination of the valuation of these SFR Loans. Such controls include management’s validation of the inputs to the valuations,
management’s review of the significant assumptions to the valuation against recent market transactions of similar products, and
management’s recalculation of the valuation on the basis of such inputs and assumptions. Further, for the portfolio of SFR Loans, we
reviewed and tested management’s process in determining the fair value measurements. This included agreeing the inputs used in the
valuation to loan agreements and other source documents for a sample of SFR Loans. We also involved firm valuation specialists to
assess the appropriateness of the significant assumptions used by management in their valuations by comparing to relevant observable
market data, benchmark yields for similar asset classes, or both.
Valuation of intangible asset related to the Company’s acquisition of CoreVest
As described further in Note 2 to the consolidated financial statements, the Company entered into an equity interests purchase
agreement, pursuant to which it acquired a 100% equity interest in CoreVest American Finance Lender LLC and several of its affiliates
(“CoreVest”). In accounting for this transaction, the Company performed a purchase price allocation and recorded underlying assets
acquired and liabilities assumed based on their estimated fair values using the information available as of the acquisition date, with the
excess of the purchase price allocated to goodwill. In performing the purchase price allocation, the Company identified and recorded a
borrower network asset. We identified the valuation of this intangible asset as a critical audit matter.
The principal consideration for our determination that the valuation of the borrower network was a critical audit matter is due to the
significant measurement uncertainty in determining the fair value of this asset. The fair value determination was sensitive to significant
assumptions including the discount rate and the prospective financial information, which are unobservable. As such, there is inherent
subjectivity and high estimation uncertainty in management’s judgment in identifying and determining the significant valuation
assumptions and to conclude upon the appropriate valuation. As a result, obtaining sufficient appropriate audit evidence related to the
assumptions required significant auditor subjectivity.
F- 4
Our audit procedures related to the valuation of the borrower network included the following, among others. We evaluated the
methodologies and tested the significant assumptions and underlying data used by the Company. Such testing included assessing the
reasonableness of the prospective financial information that was the basis of the valuation. In addition, we involved a firm valuation
specialist to assist in evaluating the methodology as well as evaluating the significant assumptions in the fair value estimate by comparing
the discount rate to relevant observable market data.
/s/ GRANT THORNTON LLP
We have served as the Company's auditor since 2005.
Newport Beach, California
March 2, 2020
F- 5
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Redwood Trust, Inc.
Opinion on internal control over financial reporting
We have audited the internal control over financial reporting of Redwood Trust, Inc. (a Maryland corporation) and subsidiaries (the
“Company”) as of December 31, 2019, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013 Internal
Control—Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)
("PCAOB"), the consolidated financial statements of the Company as of and for the year ended December 31, 2019, and our report dated
March 2, 2020 expressed an unqualified opinion on those financial statements.
Basis for opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment
of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control
over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based
on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company
in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission
and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness
exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such
other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Our audit of, and opinion on, the Company’s internal control over financial reporting does not include the internal control over
financial reporting for CoreVest American Finance Lender, LLC and certain affiliated entities (collectively “CoreVest”), wholly-owned
subsidiaries, whose financial statements reflect total assets and net income constituting approximately 17% and 12%, respectively, of the
related consolidated financial statement amounts as of and for the year ended December 31, 2019. As indicated in in the accompanying
Management’s Report, CoreVest was acquired during the fourth quarter of 2019. Management’s assertion on the effectiveness of the
Company’s internal control over financial reporting excluded internal control over financial reporting of CoreVest.
Definition and limitations of internal control over financial reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections
of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ GRANT THORNTON LLP
Newport Beach, California
March 2, 2020
F- 6
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands, except Share Data)
December 31, 2019 December 31, 2018
Residential loans, held-for-sale, at fair value
Residential loans, held-for-investment, at fair value
ASSETS (1)
Business purpose residential loans, held-for-sale, at fair value
Business purpose residential loans, held-for-investment, at fair value
Multifamily loans, held-for-investment, at fair value
Real estate securities, at fair value
Other investments
Cash and cash equivalents
Restricted cash
Goodwill
Intangible assets
Accrued interest receivable
Derivative assets
Other assets
Total Assets
LIABILITIES AND EQUITY (1)
Liabilities
Short-term debt (2)
Accrued interest payable
Derivative liabilities
Accrued expenses and other liabilities
Asset-backed securities issued, at fair value
Long-term debt, net
Total liabilities
Commitments and Contingencies (see Note 16)
Equity
Common stock, par value $0.01 per share, 270,000,000 and 180,000,000 shares
authorized; 114,353,036 and 84,884,344 issued and outstanding
Additional paid-in capital
Accumulated other comprehensive income
Cumulative earnings
Cumulative distributions to stockholders
Total equity
Total Liabilities and Equity
$
536,385
$
7,178,465
331,565
3,175,178
4,408,524
1,099,874
358,130
196,966
93,867
88,675
72,789
71,058
35,701
348,263
1,048,801
6,205,941
28,460
112,798
2,144,598
1,452,494
438,518
175,764
29,313
—
—
47,105
35,789
217,825
$
$
17,995,440
$
11,937,406
2,329,145
$
2,400,279
60,655
163,424
146,238
10,515,475
2,953,272
16,168,209
1,144
2,269,617
41,513
1,579,124
(2,064,167)
1,827,231
$
17,995,440
$
42,528
84,855
78,719
5,410,073
2,572,158
10,588,612
849
1,811,422
61,297
1,409,941
(1,934,715)
1,348,794
11,937,406
——————
(1) Our consolidated balance sheets include assets of consolidated variable interest entities (“VIEs”) that can only be used to settle obligations of these
VIEs and liabilities of consolidated VIEs for which creditors do not have recourse to Redwood Trust, Inc. or its affiliates. At December 31, 2019
and December 31, 2018, assets of consolidated VIEs totaled $11,931,869 and $6,331,191, respectively. At December 31, 2019 and December 31,
2018, liabilities of consolidated VIEs totaled $10,717,072 and $5,709,807, respectively. See Note 4 for further discussion.
(2) Includes $201 million of convertible notes at December 31, 2018, which were reclassified from Long-term debt, net to Short-term debt as the
maturity of the notes was less than one year as of the date presented. See Note 13 for further discussion.
The accompanying notes are an integral part of these consolidated financial statements.
F- 7
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, except Share Data)
2019
2018
2017
Years Ended December 31,
$
315,953
$
239,818
$
154,362
Interest Income
Residential loans
Business purpose residential loans
Multifamily loans
Real estate securities
Other interest income
Total interest income
Interest Expense
Short-term debt
Asset-backed securities issued
Long-term debt
Total interest expense
Net Interest Income
Non-interest Income
Mortgage banking activities, net
Investment fair value changes, net
Other income
Realized gains, net
Total non-interest income, net
General and administrative expenses
Other expenses
Net Income before Provision for Income Taxes
Provision for income taxes
Net Income
Basic earnings per common share
Diluted earnings per common share
Basic weighted average shares outstanding
Diluted weighted average shares outstanding
$
$
$
53,805
132,600
91,822
28,101
622,281
(96,506)
(294,466)
(88,836)
(479,808)
142,473
87,266
35,500
19,257
23,821
165,844
(118,672)
(13,022)
176,623
(7,440)
169,183
1.63
1.46
101,120,744
136,780,594
$
$
$
4,333
21,322
105,078
8,166
378,717
(58,917)
(99,429)
(80,693)
(239,039)
139,678
59,566
(25,689)
13,070
27,041
73,988
(82,782)
(196)
130,688
(11,088)
119,600
1.47
1.34
78,724,912
110,027,770
$
$
$
—
—
90,803
2,892
248,057
(36,851)
(19,108)
(52,857)
(108,816)
139,241
53,908
10,374
12,436
13,355
90,073
(77,156)
—
152,158
(11,752)
140,406
1.78
1.60
76,792,957
101,975,008
The accompanying notes are an integral part of these consolidated financial statements.
F- 8
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands)
Net Income
Years Ended December 31,
2018
2017
2019
$
169,183
$
119,600
$
140,406
Other comprehensive (loss) income:
Net unrealized gain (loss) on available-for-sale securities
Reclassification of unrealized gain on available-for-sale securities to
net income
Net unrealized (loss) gain on interest rate agreements
Reclassification of unrealized loss on interest rate agreements to net
income
Total other comprehensive (loss) income
Total Comprehensive Income
$
17,077
(7,298)
22,864
(19,967)
(16,894)
—
(19,784)
149,399
$
(25,561)
8,908
—
(23,951)
95,649
$
(10,536)
1,022
45
13,395
153,801
The accompanying notes are an integral part of these consolidated financial statements.
F- 9
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the Year Ended December 31, 2019
Issuance of common stock
28,724,645
(In Thousands, except
Share Data)
December 31, 2018
Net income
Other comprehensive loss
Direct stock purchase and
dividend reinvestment plan
Employee stock purchase and
incentive plans
Non-cash equity award
compensation
Common dividends declared
($1.20 per share)
December 31, 2019
(In Thousands, except
Share Data)
December 31, 2017
Net income
Other comprehensive loss
Direct stock purchase and
dividend reinvestment plan
Employee stock purchase and
incentive plans
Non-cash equity award
compensation
Share repurchases
Common dividends declared
($1.18 per share)
December 31, 2018
For the Year Ended December 31, 2018
Issuance of common stock
8,738,319
Common Stock
Shares
Amount
Additional
Paid-In
Capital
Accumulated
Other
Comprehensive
Income
Cumulative
Earnings
Cumulative
Distributions
to Stockholders
Total
84,884,344
$
849
$
1,811,422
$
61,297
$
1,409,941
$
(1,934,715) $
1,348,794
—
—
399,838
344,209
—
—
—
—
288
4
3
—
—
—
—
441,884
6,303
(4,949)
14,957
—
—
169,183
(19,784)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
169,183
(19,784)
442,172
6,307
(4,946)
14,957
(129,452)
(129,452)
114,353,036
$
1,144
$
2,269,617
$
41,513
$
1,579,124
$
(2,064,167) $
1,827,231
Common Stock
Shares
Amount
Additional
Paid-In
Capital
Accumulated
Other
Comprehensive
Income
Cumulative
Earnings
Cumulative
Distributions
to Stockholders
Total
76,599,972
$
766
$
1,673,845
$
85,248
$
1,290,341
$
(1,837,913) $
1,212,287
—
—
113,004
473,878
—
(1,040,829)
—
—
—
88
1
4
—
(10)
—
—
—
142,140
1,705
(4,470)
13,736
(15,534)
—
—
119,600
(23,951)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
119,600
(23,951)
142,228
1,706
(4,466)
13,736
(15,544)
(96,802)
(96,802)
84,884,344
$
849
$
1,811,422
$
61,297
$
1,409,941
$
(1,934,715) $
1,348,794
For the Year Ended December 31, 2017
(In Thousands, except
Share Data)
December 31, 2016
Net income
Other comprehensive income
Employee stock purchase and
incentive plans
Non-cash equity award
compensation
Share repurchases
Common dividends declared
($1.12 per share)
December 31, 2017
Common Stock
Shares
Amount
Additional
Paid-In
Capital
Accumulated
Other
Comprehensive
Income
Cumulative
Earnings
Cumulative
Distributions
to Stockholders
Total
76,834,663
$
768
$
1,676,486
$
71,853
$
1,149,935
$
(1,749,614) $
1,149,428
—
—
375,651
—
(610,342)
—
—
—
4
—
(6)
—
—
—
(3,838)
10,378
(9,181)
—
—
13,395
—
—
—
—
140,406
—
—
—
—
—
—
—
—
—
—
140,406
13,395
(3,834)
10,378
(9,187)
(88,299)
(88,299)
76,599,972
$
766
$
1,673,845
$
85,248
$
1,290,341
$
(1,837,913) $
1,212,287
The accompanying notes are an integral part of these consolidated financial statements.
F- 10
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
2018
2017
2019
$
169,183
$
119,600
$
140,406
(5,066)
10,133
(569,915)
(5,823,547)
5,198,089
106,183
(66,059)
14,957
(97,006)
(23,821)
(13,687)
1,308
—
(7,162,131)
5,383,313
66,892
51,115
13,736
(24,069)
(27,041)
(18,250)
1,213
—
(5,705,842)
3,903,147
52,956
(9,950)
10,378
(51,484)
(13,355)
(83,210)
(41,849)
(17,562)
4,502
(1,165,577)
21,080
(1,611,733)
(4,820)
(1,713,163)
(448,189)
(49,489)
9,422
1,751,303
(345,403)
(193,212)
(99,221)
707,357
84,303
(69,610)
203,876
(3,714)
(451,626)
38,209
(40,467)
(67,677)
1,025,862
—
(147,523)
—
781,063
(609,568)
(227,649)
(107,411)
582,331
84,495
(395,813)
94,644
(9,999)
—
(38,209)
—
(19,113)
(12,752)
—
—
—
523,561
(600,875)
—
—
228,420
77,778
—
—
—
—
—
—
51,494
280,378
(In Thousands)
Cash Flows From Operating Activities:
Net income
Adjustments to reconcile net income to net cash used in operating activities:
Amortization of premiums, discounts, and debt issuance costs, net
Depreciation and amortization of non-financial assets
Originations of held-for-sale loans
Purchases of held-for-sale loans
Proceeds from sales of held-for-sale loans
Principal payments on held-for-sale loans
Net settlements of derivatives
Non-cash equity award compensation expense
Market valuation adjustments
Realized gains, net
Net change in:
Accrued interest receivable and other assets
Accrued interest payable, deferred tax liabilities, and accrued expenses and other
liabilities
Net cash used in operating activities
Cash Flows From Investing Activities:
Originations of loans held-for-investment
Purchases of loans held-for-investment
Proceeds from sales of loans held-for-investment
Principal payments on loans held-for-investment
Purchases of real estate securities
Purchases of residential securities held in consolidated securitization trust
Purchases of multifamily securities held in consolidated securitization trusts
Proceeds from sales of real estate securities
Principal payments on real estate securities
Purchases of servicer advance investments
Principal repayments from servicer advance investments
Acquisition of 5 Arches, net of cash acquired
Acquisition of CoreVest, net of cash acquired
Net investment in participation in loan warehouse facility
Net investment in multifamily loan fund
Other investing activities, net
Net cash provided by (used in) investing activities
F- 11
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(In Thousands)
Cash Flows From Financing Activities:
Proceeds from borrowings on short-term debt
Repayments on short-term debt
Proceeds from issuance of asset-backed securities
Repayments on asset-backed securities issued
Proceeds from issuance of long-term debt
Deferred debt issuance costs
Repayments on long-term debt
Net proceeds from issuance of common stock
Net payments on repurchase of common stock
Taxes paid on equity award distributions
Dividends paid
Other financing activities, net
Net cash provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash, cash equivalents and restricted cash at beginning of period (1)
Cash, cash equivalents and restricted cash at end of period (1)
Supplemental Cash Flow Information:
Cash paid during the period for:
Interest
Taxes
Supplemental Noncash Information:
Real estate securities retained from loan securitizations
Retention of mortgage servicing rights from loan securitizations and sales
Consolidation of residential loans held in securitization trust
Consolidation of residential ABS issued
Consolidation of multifamily loans held in securitization trusts
Consolidation of multifamily ABS issued
Consolidation of single-family rental loans held in securitization trusts
Consolidation of single-family rental ABS issued
Transfers from loans held-for-sale to loans held-for-investment
Transfers from loans held-for-investment to loans held-for-sale
Transfers from residential loans to real estate owned
Right-of-use asset obtained in exchange for operating lease liability
Years Ended December 31,
2018
2017
2019
6,452,566
(7,193,677)
1,397,126
(1,123,119)
387,053
(7,023)
(1,137)
450,710
—
(5,471)
(129,452)
(2,105)
225,471
85,756
205,077
290,833
452,216
7,963
13,729
868
1,190,995
997,783
2,162,385
2,058,214
1,829,281
1,656,023
1,801,560
22,808
8,609
13,094
$
$
$
6,975,965
(6,711,264)
1,658,848
(459,171)
199,000
(4,977)
—
142,601
(16,315)
(4,839)
(96,802)
(291)
1,682,755
58,270
146,807
205,077
207,014
10,594
51,911
328
1,206,645
978,996
2,099,916
1,975,324
—
—
2,062,809
15,717
4,104
—
$
$
$
4,895,889
(4,036,634)
567,100
(205,163)
245,000
(7,380)
—
302
(8,417)
(4,136)
(88,299)
(137)
1,358,125
(74,660)
221,467
146,807
103,279
2,746
79,662
7,387
—
—
—
—
—
—
1,245,430
98,854
4,220
—
$
$
$
(1) Cash, cash equivalents, and restricted cash at December 31, 2019 included cash and cash equivalents of $197 million and restricted cash of $94 million; at December 31,
2018 included cash and cash equivalents of $176 million and restricted cash of $29 million; and at December 31, 2017 included cash and cash equivalents of $145
million and restricted cash of $2 million.
The accompanying notes are an integral part of these consolidated financial statements.
F- 12
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 1. Organization
Redwood Trust, Inc., together with its subsidiaries, is a specialty finance company focused on making credit-sensitive investments
in single-family residential and multifamily mortgages and related assets and engaging in mortgage banking activities. Our goal is to
provide attractive returns to shareholders through a stable and growing stream of earnings and dividends, as well as through capital
appreciation. We operate our business in four segments: Residential Lending, Business Purpose Lending, Multifamily Investments, and
Third-Party Residential Investments.
Our primary sources of income are net interest income from our investments and non-interest income from our mortgage banking
activities. Net interest income consists of the interest income we earn on investments less the interest expense we incur on borrowed
funds and other liabilities. Income from mortgage banking activities is generated through the origination and acquisition of loans, and
their subsequent sale, securitization, or transfer to our investment portfolios.
Redwood Trust, Inc. has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as
amended (the “Internal Revenue Code”), beginning with its taxable year ended December 31, 1994. We generally refer, collectively, to
Redwood Trust, Inc. and those of its subsidiaries that are not subject to subsidiary-level corporate income tax as “the REIT” or “our
REIT.” We generally refer to subsidiaries of Redwood Trust, Inc. that are subject to subsidiary-level corporate income tax as “our taxable
REIT subsidiaries” or “TRS.”
Redwood was incorporated in the State of Maryland on April 11, 1994, and commenced operations on August 19, 1994. On March
1, 2019, Redwood completed the acquisition of 5 Arches, LLC ("5 Arches"), at which time 5 Arches became a wholly-owned subsidiary
of Redwood. On October 15, 2019, Redwood acquired CoreVest American Finance Lender, LLC and certain affiliated entities ("CoreVest"),
at which time CoreVest became wholly owned by Redwood. References herein to “Redwood,” the “company,” “we,” “us,” and “our”
include Redwood Trust, Inc. and its consolidated subsidiaries, unless the context otherwise requires. Refer to Item 1 - Business in this
Annual Report on Form 10-K for additional information on our business.
Note 2. Basis of Presentation
The consolidated financial statements presented herein are at December 31, 2019 and December 31, 2018, and for the years ended
December 31, 2019, 2018, and 2017. These consolidated financial statements have been prepared in accordance with U.S. generally
accepted accounting principles ("GAAP") — as prescribed by the Financial Accounting Standards Board’s (“FASB”) Accounting
Standards Codification (“ASC”) — and the rules and regulations of the Securities and Exchange Commission ("SEC"). In the opinion
of management, all normal and recurring adjustments to present fairly the financial condition of the Company at December 31, 2019 and
2018, and results of operations for all periods presented have been made.
Principles of Consolidation
In accordance with GAAP, we determine whether we must consolidate transferred financial assets and variable interest entities
(“VIEs”) for financial reporting purposes. We currently consolidate the assets and liabilities of certain Sequoia securitization entities
issued prior to 2012 where we maintain an ongoing involvement ("Legacy Sequoia"), as well as entities formed in connection with the
securitization of Redwood Choice expanded-prime loans ("Sequoia Choice"). We also consolidate the assets and liabilities of certain
Freddie Mac K-Series and Freddie Mac Seasoned Loans Structured Transaction ("SLST") securitizations we invested in beginning in
2018. Finally, we consolidated the assets and liabilities of certain CoreVest American Finance Lender ("CAFL") securitizations beginning
in the fourth quarter of 2019, in connection with our acquisition of CoreVest. Each securitization entity is independent of Redwood and
of each other and the assets and liabilities are not owned by and are not legal obligations of Redwood Trust, Inc. Our exposure to these
entities is primarily through the financial interests we have purchased or retained, although for the consolidated Sequoia and CAFL
entities we are exposed to certain financial risks associated with our role as a sponsor, servicing administrator, or depositor of these entities
or as a result of our having sold assets directly or indirectly to these entities.
F- 13
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 2. Basis of Presentation - (continued)
For financial reporting purposes, the underlying loans owned at the consolidated Sequoia and Freddie Mac SLST entities are shown
under Residential loans held-for-investment at fair value, the underlying loans at the consolidated Freddie Mac K-Series are shown under
Multifamily loans held-for-investment, at fair value, and the underlying single-family rental loans at the consolidated CAFL entities are
shown under Business purpose loans held-for-investment, at fair value, on our consolidated balance sheets. The asset-backed securities
(“ABS”) issued to third parties by these entities are shown under ABS issued. In our consolidated statements of income, we recorded
interest income on the loans owned at these entities and interest expense on the ABS issued by these entities as well as other income and
expenses associated with these entities' activities. See Note 14 for further discussion on ABS issued.
Beginning in 2018, we consolidated two partnerships ("Servicing Investment" entities) through which we have invested in servicing-
related assets. We maintain an 80% ownership interest in each entity and have determined that we are the primary beneficiary of these
partnerships.
Beginning in the first quarter of 2019, we consolidated 5 Arches, an originator of business purpose residential loans, pursuant to the
exercise of our purchase option and the acquisition of the remaining equity in the company. In the fourth quarter of 2019, we acquired
and consolidated CoreVest, an originator and portfolio manager of business purpose residential loans.
See Note 4 for further discussion on principles of consolidation.
Use of Estimates
The preparation of financial statements requires us to make a number of significant estimates. These include estimates of fair value
of certain assets and liabilities, amounts and timing of credit losses, prepayment rates, and other estimates that affect the reported amounts
of certain assets and liabilities as of the date of the consolidated financial statements and the reported amounts of certain revenues and
expenses during the reported periods. It is likely that changes in these estimates (e.g., valuation changes due to supply and demand, credit
performance, prepayments, interest rates, or other reasons) will occur in the near term. Our estimates are inherently subjective in nature
and actual results could differ from our estimates and the differences could be material.
Acquisition of 5 Arches, LLC
In May 2018, Redwood acquired a 20% minority interest in 5 Arches for $10 million in cash, with a one-year option to purchase all
remaining equity in the company. On March 1, 2019, we completed the acquisition of the remaining 80% interest in 5 Arches, an originator
of business purpose residential loans. At closing, we paid approximately $13 million of cash and the remaining $27 million in consideration
will be paid in a mix of cash and Redwood common stock over the next two years.
Acquisition of CoreVest
On October 15, 2019, we acquired CoreVest, an originator and portfolio manager of business purpose residential loans. Aggregate
consideration for this acquisition totaled approximately $492 million, net of in-place financing on existing assets. The consideration
consisted of $482 million of cash and $10 million of restricted stock awards issued to the CoreVest management team. Based on the terms
of the equity interest purchase agreement, we determined that the $10 million of shares should be accounted for as compensation expense
for post-combination services, and therefore, it is not included in the GAAP purchase price allocated to the assets and liabilities acquired.
F- 14
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 2. Basis of Presentation - (continued)
During 2019, we accounted for the acquisitions of 5 Arches and CoreVest under the acquisition method of accounting pursuant to
ASC 805. We performed the purchase price allocations and recorded underlying assets acquired and liabilities assumed based on their
estimated fair values using the information available as of each acquisition date, with the excess of the purchase price allocated to goodwill.
Through December 31, 2019, there were no significant changes to our purchase price allocations, which are summarized in the following
table.
Table 2.1 – Purchase Price Allocations
(In Thousands)
Acquisition Date
Purchase price:
Cash
Contingent consideration, at fair value
Purchase option, at fair value
Equity method investment, at fair value
Total consideration
Allocated to:
Business purpose residential loans, at fair value
Cash and cash equivalents
Restricted cash
Other assets
Goodwill
Intangible assets
Deferred tax asset
Total assets acquired
Asset-backed securities issued, at fair value
Short-term debt, net
Accrued expenses and other liabilities
Deferred tax liability
Total liabilities assumed
Total net assets acquired
5 Arches
March 1, 2019
CoreVest
October 15, 2019
$
$
$
12,575
$
482,311
24,621
5,082
8,052
—
—
—
50,330
$
482,311
2,022
$
2,610,490
2,128
9,082
5,473
28,747
24,800
—
72,252
—
3,800
13,920
4,202
21,922
$
50,330
$
30,685
—
67,420
59,928
56,500
2,577
2,827,600
1,656,023
663,275
25,991
—
2,345,289
482,311
Because we owned a 20% noncontrolling interest in 5 Arches immediately before obtaining full control, we remeasured our initial
minority investment and purchase option at their acquisition-date fair values using the income approach, which resulted in a gain of $2
million that was recorded in Other income on our consolidated statements of income during the three months ended March 31, 2019.
We recognized $2 million of acquisition costs related our acquisitions of 5 Arches and CoreVest during the year ended December
31, 2019. These costs primarily related to accounting, consulting, and legal expenses and are included in our General and administrative
expenses on our consolidated statements of income.
F- 15
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 2. Basis of Presentation - (continued)
In connection with the acquisitions of 5 Arches and CoreVest, we identified and recorded finite-lived intangible assets totaling $25
million and $57 million, respectively. The amortization period for each of these assets and the activity for the year ended December 31,
2019 is summarized in the table below.
Table 2.2 – Intangible Assets – Activity
(Dollars in Thousands)
5 Arches
Broker network
Non-compete agreements
Loan administration fees on
existing loan assets
Tradename
Total 5 Arches
CoreVest
Borrower network
Non-compete agreements
Tradename
Developed technology
Total CoreVest
Total
Carrying Value at
December 31, 2018
Additions
Amortization
Expense
Carrying Value at
December 31, 2019
Weighted
Average
Amortization
Period (in years)
$
— $
18,100
$
(3,017) $
—
—
—
—
—
—
—
—
—
2,900
2,600
1,200
24,800
45,300
6,600
2,800
1,800
56,500
(806)
(2,167)
(333)
(6,323)
(1,348)
(458)
(194)
(188)
(2,188)
$
— $
81,300
$
(8,511) $
15,083
2,094
433
867
18,477
43,952
6,142
2,606
1,612
54,312
72,789
5
3
1
3
5
7
3
3
2
6
6
All of our intangible assets are amortized on a straight-line basis. Estimated future amortization expense is summarized in the table
below.
Table 2.3 – Intangible Asset Amortization Expense by Year
December 31, 2019
(In Thousands)
2020
2021
2022
2023
2024
2025 and thereafter
Total Future Intangible Asset Amortization
5 Arches
CoreVest
Total
5,420
$
10,505
$
4,987
3,848
3,620
602
—
10,317
8,952
6,471
6,471
11,596
18,477
$
54,312
$
15,925
15,304
12,800
10,091
7,073
11,596
72,789
$
$
We recorded total goodwill of $89 million in 2019 as a result of the total consideration exceeding the fair value of the net assets
acquired from 5 Arches and CoreVest. The goodwill was attributed to the expected business synergies and expansion into business purpose
loan markets, as well as access to the knowledgeable and experienced workforces continuing to provide services to the business. We
expect $75 million of this goodwill to be deductible for tax purposes. For reporting purposes, we included the intangible assets and
goodwill from these acquisitions within the Business Purpose Lending segment.
F- 16
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 2. Basis of Presentation - (continued)
The following table presents the goodwill activity for the year ended December 31, 2019.
Table 2.4 – Goodwill – Activity
(In Thousands)
Beginning balance
Goodwill recognized from acquisition
Impairment
Ending Balance
Year Ended December 31, 2019
5 Arches
CoreVest
Total
$
$
— $
— $
28,747
—
59,928
—
28,747
$
59,928
$
—
88,675
—
88,675
The liability resulting from the contingent consideration arrangement with 5 Arches was recorded at its acquisition-date fair value
of $25 million as part of total consideration for the acquisition of 5 Arches. At December 31, 2019, the estimated fair value of this
contingent liability was $28 million and was recorded as a component of Accrued expenses and other liabilities on our consolidated
balance sheets. During the year ended December 31, 2019, we recorded $3 million of contingent consideration expense through Other
expenses on our consolidated statements of income. See Note 16 for additional information on our contingent consideration liability.
The following unaudited pro forma financial information presents Net interest income, Non-interest income, and Net income of
Redwood, 5 Arches, and CoreVest combined, as if the acquisitions occurred as of January 1, 2018. These pro forma amounts have been
adjusted to include the amortization of intangible assets and acquisition-related compensation expense for both periods, and to exclude
the income statement impacts related to our equity method investment in 5 Arches. The unaudited pro forma financial information is not
intended to represent or be indicative of the consolidated financial results of operations that would have been reported if the acquisition
had been completed as of January 1, 2018 and should not be taken as indicative of our future consolidated results of operations.
During the period from March 1, 2019 to December 31, 2019, 5 Arches had net interest income of less than $0.1 million, non-interest
income of $19 million, and net income of $3 million. In addition, 5 Arches had intangible asset amortization expense of $6 million for
this period. During the period from October 15, 2019 to December 31, 2019, CoreVest had net interest income of $11 million, non-interest
income of $19 million, and net income of $22 million. In addition, CoreVest had intangible asset amortization expense of $2 million for
this period.
Table 2.5 – Unaudited Pro Forma Financial Information
(In Thousands)
Supplementary pro forma information:
Net interest income
Non-interest income
Net income
Note 3. Summary of Significant Accounting Policies
Significant Accounting Policies
Business Combinations
Years Ended December 31,
2019
2018
$
167,680
$
193,519
185,896
165,849
103,179
118,125
We use the acquisition method of accounting for business combinations, under which the purchase price is allocated to the fair values
of the assets acquired and liabilities assumed at the acquisition date. The excess of the purchase price over the amount allocated to the
assets acquired and liabilities assumed is recorded as goodwill. Acquisition-related costs are expensed as incurred.
F- 17
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
Fair Value Measurements
Our consolidated financial statements include assets and liabilities that are measured at their estimated fair values in accordance with
GAAP. A fair value measurement represents the price at which an orderly transaction would occur between willing market participants
at the measurement date.
We develop fair values for financial assets or liabilities based on available inputs and pricing that is observed in the marketplace.
After considering all available indications of the appropriate rate of return that market participants would require, we consider the
reasonableness of the range indicated by the results to determine an estimate that is most representative of fair value.
The markets for many of the assets that we invest in and issue are generally illiquid. Establishing fair values for illiquid assets and
liabilities is inherently subjective and is often dependent upon our estimates and modeling assumptions. If we determine that either the
volume and/or level of trading activity for an asset or liability has significantly decreased from normal market conditions, or price
quotations or observable inputs are not associated with orderly transactions, the market inputs that we obtain might not be relevant. For
example, broker or pricing service quotes might not be relevant if an active market does not exist for the financial asset or liability. The
nature of the quote (for example, whether the quote is an indicative price or a binding offer) is also evaluated.
In circumstances where relevant market inputs cannot be obtained, increased analysis and management judgment are required to
estimate fair value. This generally requires us to establish internal assumptions about future cash flows and appropriate risk-adjusted
discount rates. Regardless of the valuation inputs we apply, the objective of fair value measurement for assets is unchanged from what
it would be if markets were operating at normal activity levels and/or transactions were orderly; that is, to determine the current exit
price.
See Note 5 for further discussion on fair value measurements.
Fair Value Option
We have the option to measure eligible financial assets, financial liabilities, and commitments at fair value on an instrument-by-
instrument basis. This option is available when we first recognize a financial asset or financial liability or enter into a firm commitment.
Subsequent changes in the fair value of assets, liabilities, and commitments where we have elected the fair value option are recorded in
our consolidated statements of income.
We elect the fair value option for certain residential loans, business purpose residential loans, interest-only (“IO”) and certain
subordinate securities, MSRs, servicer advance investments, excess MSRs, and certain of our other investments. We generally elect the
fair value option for residential loans that are held-for-sale, due to our intent to sell or securitize the loans in the near-term. We elect the
fair value option for our IO and certain subordinate securities, and MSRs, for which we generally hedge market interest rate risk. As
such, we seek to offset interest rate related changes in the values of these investments with changes in the values of their associated hedges
through our consolidated statements of income. In addition, we elect the fair value option for the assets and liabilities of our consolidated
Sequoia, Freddie Mac SLST, Freddie Mac K-Series, and CAFL entities in accordance with GAAP accounting for collateralized financing
entities ("CFEs").
See Note 5 for further discussion on the fair value option.
Real Estate Loans
Residential Loans - Held-for-Sale at Fair Value
Residential loans held-for-sale include loans that we are marketing for sale to third parties, including transfers to securitization entities
that we plan to sponsor. We generally elect the fair value option for residential loans that we purchase with the intent to sell to third parties
or transfer to Sequoia securitizations. Coupon interest is recognized as revenue when earned and deemed collectible or until a loan
becomes more than 90 days past due, at which point the loan is placed on nonaccrual status and any accrued interest is reversed against
interest income. When a seriously delinquent loan previously placed on nonaccrual status has cured, meaning all delinquent principal
and interest have been remitted by the borrower, the loan is placed back on accrual status. Changes in fair value for these loans are
recurring and are reported through our consolidated statements of income in Mortgage banking activities, net.
F- 18
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
Residential Loans - Held-for-Investment At Fair Value
Certain loans that were originally purchased with the intent to sell as part of our residential mortgage banking operations, and for
which we elected the fair value option at acquisition, were subsequently reclassified to held-for-investment ("HFI") when the loans were
transferred to our Federal Home Loan Bank of Chicago ("FHLBC") member subsidiary and pledged as collateral for borrowings made
from the FHLBC. As of December 31, 2019, our current intent is to hold these loans for longer-term investment while they are financed
by the FHLBC.
Coupon interest for these loans is recognized as revenue when earned and deemed collectible or until a loan becomes more than 90
days past due, at which point the loan is placed on nonaccrual status and any accrued interest is reversed against interest income. When
a seriously delinquent loan previously placed on nonaccrual status has cured, meaning all delinquent principal and interest have been
remitted by the borrower, the loan is placed back on accrual status.
In addition, we record residential loans held at consolidated Sequoia and Freddie Mac SLST entities at fair value. In accordance with
accounting guidance for CFEs, we use the fair value of the ABS issued by these entities (which we determined to be more observable)
to determine the fair value of the loans held at these entities. Coupon interest for these loans is recognized as revenue based on amounts
expected to be paid to the securities issued by these entities.
Changes in fair value for these loans are recurring and are reported through our consolidated statements of income in Investment
fair value changes, net.
Business Purpose Residential Loans - Held-for-Sale at Fair Value
We originate business purpose residential loans, including single-family rental loans through our business purpose lending platform.
Single-family rental loans are mortgage loans secured by 1-4 unit residential real estate that the borrower owns as an investment property
and rents to residential tenants. We classify single-family rental loans as held-for-sale at fair value when we originate these loans with
the intent to transfer to securitization entities.
Coupon interest for these loans is recognized as revenue when earned and deemed collectible or until a loan becomes more than 90
days past due, at which point the loan is placed on nonaccrual status and any accrued interest is reversed against interest income. When
a seriously delinquent loan previously placed on nonaccrual status has cured, meaning all delinquent principal and interest have been
remitted by the borrower, the loan is placed back on accrual status. Changes in fair value are recurring and reported through our consolidated
statements of income in Mortgage banking activities, net.
Business Purpose Residential Loans - Held-for-Investment at Fair Value
We also originate residential bridge loans through our business purpose lending platform. Residential bridge loans are mortgage
loans generally secured by unoccupied residential real estate that the borrower owns as an investment and that is being renovated,
rehabilitated or constructed. Residential bridge loans are classified as held-for-investment at fair value if we intend to hold these loans
to maturity.
Certain single-family rental loans that were originated with the intent to sell as part of our business purpose mortgage banking
operations, and for which we elected the fair value option at acquisition, were subsequently reclassified to held-for-investment ("HFI")
when the loans were transferred to our Federal Home Loan Bank of Chicago ("FHLBC") member subsidiary and pledged as collateral
for borrowings made from the FHLBC. As of December 31, 2019, our current intent is to hold these loans for longer-term investment
while they are financed by the FHLBC.
Coupon interest for these loans is recognized as revenue when earned and deemed collectible or until a loan becomes more than 90
days past due, at which point the loan is placed on nonaccrual status and any accrued interest is reversed against interest income. When
a seriously delinquent loan previously placed on nonaccrual status has cured, meaning all delinquent principal and interest have been
remitted by the borrower, the loan is placed back on accrual status.
In addition, we record residential loans held at consolidated CAFL entities at fair value. In accordance with accounting guidance for
CFEs, we use the fair value of the ABS issued by these entities (which we determined to be more observable) to determine the fair value
of the loans held at these entities. Coupon interest for these loans is recognized as revenue based on amounts expected to be paid to the
securities issued by these entities.
F- 19
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
Changes in fair value for these loans are recurring and reported through our consolidated statements of income in Investment fair
value changes, net.
Multifamily Loans, Held-for-Investment at Fair Value
Multifamily loans are mortgage loans secured by multifamily properties, held in Freddie Mac-sponsored K-series securitization trusts
that we consolidate. In accordance with accounting guidance for CFEs, we use the fair value of the ABS issued by the Freddie Mac K-
Series entities (which we determined to be more observable) to determine the fair value of the loans held at these entities. Coupon interest
for these loans is recognized as revenue based on amounts expected to be paid to the securities issued by these entities. Changes in fair
value for the assets and liabilities of these trusts are recurring and are reported through our consolidated statements of income in Investment
fair value changes, net.
Repurchase Reserves
We sell and have sold residential and business purpose residential mortgage loans to various parties, including (1) securitization
trusts, (2) Fannie Mae and Freddie Mac (“the Agencies”), and (3) banks and other financial institutions that purchase mortgage loans for
investment or private label securitization. We may be required to repurchase mortgage loans we have sold, or loans associated with MSRs
we have purchased, in the event of a breach of specified contractual representations and warranties made in connection with these sales
and purchases. With respect to MSRs we purchased, if the associated residential loan was sold to one of the Agencies (which was typically
the case), that Agency can require us, as the owner of the MSR, to repurchase the residential loan in the event of such a breach of
representations and warranties even though we were not the party that sold the associated loan to that Agency. In January 2016, we
discontinued the acquisition and aggregation of conforming loans for resale to the Agencies.
We do not originate residential mortgage loans and believe the initial risk of loss due to loan repurchases (i.e., due to a breach of
representations and warranties) would generally be a contingency to the companies from whom we acquired the loans or MSRs. However,
in some cases, such as where loans or MSRs were acquired from companies that have since become insolvent, we may have to bear the
loss associated with a loan repurchase. Furthermore, even if we do not have to ultimately bear such a loss because we can recover from
the company that sold us the loan or the MSR, there could be a delay in making that recovery.
We establish reserves for mortgage repurchase liabilities related to various representations and warranties that reflect management’s
estimate of losses for loans for which we could have a repurchase obligation, based on a combination of factors. Such factors can include
estimated future defaults and loan repurchase rates, the potential severity of loss in the event of defaults, and the probability of our being
liable for a repurchase obligation. We establish a reserve at the time loans are sold and MSRs are purchased and continually update our
reserve estimate during its life. The reserve for mortgage loan repurchase losses is included in other liabilities on our consolidated balance
sheets and the related expense is included as a component of Mortgage banking activities, net on our consolidated statements of income.
See Note 16 for further discussion on the residential repurchase reserves.
Real Estate Securities, at Fair Value
Our securities primarily consist of mortgage-backed securities (“MBS”) collateralized by residential and multifamily mortgage
loans. We classify our real estate securities as trading or available-for-sale securities.
Trading Securities
We primarily denote trading securities as those securities where we have adopted the fair value option. Trading securities are carried
at their estimated fair values. Coupon interest is recognized as interest income when earned and deemed collectible. Changes in the fair
value of securities designated as trading securities are reported in Investment fair value changes, net on our consolidated statements of
income.
F- 20
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
Available-for-Sale Securities
AFS securities are carried at their estimated fair value with unrealized gains and losses excluded from earnings (except when an
other-than-temporary impairment (“OTTI”) is recognized, as discussed below) and reported in Accumulated other comprehensive income
(“AOCI”), a component of stockholders’ equity.
Interest income on AFS securities is accrued based on their outstanding principal balance and contractual terms and interest income
is recognized based on the security’s effective interest rate. In order to calculate the effective interest rate, we must project cash flows
over the remaining life of each security and make assumptions with regards to interest rates, prepayment rates, the timing and amount
of credit losses, and other factors. On at least a quarterly basis, we review and, if appropriate, make adjustments to our cash flow projections
based on input and analysis received from external sources, internal models, and our own judgments about interest rates, prepayment
rates, the timing and amount of credit losses, and other factors. Changes in cash flows from those originally projected, or from those
estimated at the last evaluation, may result in a prospective change in the yield and interest income recognized on these securities or in
the recognition of OTTI as discussed below.
For AFS securities purchased and held at a discount, a portion of the discount may be designated as non-accretable purchase discount
(“credit reserve”), based on the cash flows we have projected for the security. The amount designated as credit reserve may be adjusted
over time, based on our periodic evaluation of projected cash flows. If the performance of a security with a credit reserve is more favorable
than previously forecasted, a portion of the credit reserve may be reallocated to accretable discount and recognized into interest income
over time. Conversely, if the performance of a security with a credit reserve is less favorable than forecasted, the amount designated as
credit reserve may be increased, or impairment charges and write-downs of such securities to a new cost basis could result.
When the fair value of an AFS security is less than its amortized cost at the reporting date, the security is considered impaired. We
assess our impaired securities at least quarterly to determine if the impairment is temporary or other-than-temporary (resulting in an
OTTI). If we either - (i) intend to sell the impaired security; (ii) will more likely than not be required to sell the impaired security before
it recovers in value; or (iii) if there has been an adverse change in cash flows - the impairment is deemed an OTTI. In the case of criteria
(i) and (ii), we record the entire difference between the security’s estimated fair value and its amortized cost at the reporting date as an
impairment through market valuation adjustments on our consolidated statements of income. If there has been an adverse change in cash
flows, only the portion of the OTTI related to “credit” losses is recognized through other market valuation adjustments on our consolidated
statements of income, with the remaining “non-credit” portion recognized through AOCI on our consolidated balance sheets. If the first
two criteria are not met and there has not been an adverse change in cash flows, the impairment is considered temporary and the entire
unrealized loss is recognized through AOCI on our consolidated balance sheets.
For impaired AFS securities, to determine if there has been an adverse change in cash flows and if any portion of a resulting OTTI
is related to credit losses, we compare the present value of the cash flows expected to be collected as of the current financial reporting
date to the amortized cost basis of the security. The discount rate used to calculate the present value of expected future cash flows is the
current yield used for income recognition purposes. If the present value of the current expected cash flows is less than the amortized cost
basis, there has been an adverse change and the security is considered OTTI with the difference between these two amounts representing
the credit loss. The determination as to whether an OTTI exists and, if so, the amount of credit impairment recognized in earnings is
subjective, and based on information available at the time of the assessment as well as our estimates of future performance and cash
flows. As a result, the timing and amount of OTTI constitute a material estimate that is susceptible to significant change.
See Note 9 for further discussion on real estate securities.
F- 21
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
Other Investments
Servicer Advance Investments
Our servicer advance investments are comprised of outstanding servicer advances receivable, the requirement to purchase all future
servicer advances made with respect to a specified pool of residential mortgage loans and a fee component of the related MSR. We have
elected to record these investments at fair value. We recognize income from our servicer advance investments when earned and deemed
collectible and record the income as a component of Other interest income in our consolidated statements of income. Our servicer advance
investments are marked-to-market on a recurring basis with changes in the fair value reported in Investment fair value changes, net on
our consolidated statements of income.
See Note 10 for further discussion on our servicer advance investments.
MSRs
We recognize MSRs through the retention of servicing rights associated with residential mortgage loans that we acquired and
subsequently transferred to third parties when the transfer meets the GAAP criteria for sale accounting, or through the direct acquisition
of MSRs sold by third parties.
We contract with licensed sub-servicers to perform servicing functions for loans associated with our MSRs. We have elected the
fair value option for all of our MSRs, and they are initially recognized and subsequently carried at their estimated fair values. Servicing
fee income from MSRs is recorded on a cash basis when received. Net servicing income and changes in the estimated fair value of MSRs
are reported in Other income on our consolidated statements of income.
See Note 10 for further discussion on MSRs.
Participation in Loan Warehouse Facility
During 2018, we invested in a subordinated participation in a revolving mortgage loan warehouse facility of one of our loan sellers.
We accounted for this subordinated participation interest as a loan receivable at amortized cost, and all associated interest income was
recorded as a component of Other interest income in our consolidated statements of income. During the first quarter of 2019, our agreement
associated with this investment was terminated and the balance outstanding under this agreement was repaid.
Excess MSRs
Our excess MSR investments represent the right to receive a portion of mortgage servicing cash flows in excess of amounts paid for
the underlying mortgage loans to be serviced. As owners of excess MSRs, we are not required to be a licensed servicer, and we are not
required to assume any servicing duties, advance obligations or liabilities associated with the loan pool underlying the MSR. We have
elected to record these investments at fair value. We recognize income from Excess MSRs when it is earned and deemed collectible and
record the income as a component of Other interest income in our consolidated statements of income. Changes in fair value are recurring
and are reported through our consolidated statements of income in Investment fair value changes, net.
See Note 10 for further discussion on excess MSRs.
Investment in Multifamily Loan Fund
In January 2019, we invested in a limited partnership created to acquire floating rate, light-renovation multifamily loans from Freddie
Mac. We account for our ownership interest in this partnership using the equity method of accounting as we are able to exert significant
influence over but do not control the activities of the investee. We assess our investment for impairment whenever events or changes in
circumstances indicate that the carrying amount of our investment might not be recoverable. We have elected to record our share of
earnings or losses from this investment on a one-quarter lag, as a component of Other income on our consolidated statements of income.
F- 22
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
Shared Home Appreciation Options
During 2019, we invested in shared home appreciation options that allow us to share in both home price appreciation and depreciation.
We have elected to record these investments at fair value and report changes in fair value through Investment fair value changes, net on
our consolidated statements of income.
See Note 10 for further discussion on shared home appreciation options.
Investment in 5 Arches
During 2018, we acquired a 20% minority interest in 5 Arches, LLC ("5 Arches"), an originator and asset manager of business
purpose residential mortgage loans. We accounted for our ownership interest in 5 Arches using the equity method of accounting as we
were able to exert significant influence over but not control the activities of the investee. On March 1, 2019, we completed the acquisition
of the remaining 80% interest in 5 Arches and consolidated their assets and liabilities onto our balance sheet.
Cash and Cash Equivalents
Cash and cash equivalents include non-restricted cash and highly liquid investments with original maturities of three months or less.
The Company maintains its cash and cash equivalents with major financial institutions. Accounts at these institutions are guaranteed by
the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000 for each bank. The Company is exposed to credit risk for amounts
held in excess of the FDIC limit. The Company does not anticipate nonperformance by these institutions.
Restricted Cash
Restricted cash primarily includes cash held in association with borrowings from the Federal Home Loan Bank of Chicago, cash
held at our consolidated Servicing Investment entities, and cash associated with our risk-sharing transactions with the Agencies, as well
as cash collateral for certain consolidated securitization entities.
Goodwill and Intangible Assets
Significant judgment is required to estimate the fair value of intangible assets and in assigning their estimated useful lives. Accordingly,
we typically seek the assistance of independent third-party valuation specialists for significant intangible assets. The fair value estimates
are based on available historical information and on future expectations and assumptions we deem reasonable. We generally use an
income-based valuation method to estimate the fair value of intangible assets, which discounts expected future cash flows to present
value using estimates and assumptions we deem reasonable.
Determining the estimated useful lives of intangible assets also requires judgment. Our assessment as to which intangible assets are
deemed to have finite or indefinite lives is based on several factors including economic barriers of entry for the acquired business, retention
trends, and our operating plans, among other factors. Finite-lived intangible assets are amortized over their estimated useful lives on a
straight-line basis and reviewed for impairment if indicators are present. Additionally, useful lives are evaluated each reporting period to
determine if revisions to the remaining periods of amortization are warranted.
Goodwill is tested for impairment annually or more frequently if indicators of impairment exist. We have elected to make the first
day of our fiscal fourth quarter the annual impairment assessment date for goodwill. We first assess qualitative factors to determine
whether it is more likely than not that the fair value is less than the carrying value. If, based on that assessment, we believe it is more
likely than not that the fair value is less than the carrying value, then a two-step quantitative goodwill impairment test is performed. At
December 31, 2019, no impairment of goodwill was identified.
F- 23
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
Accrued Interest Receivable
Accrued interest receivable includes interest that is due and payable to us and deemed collectible. Cash interest is generally received
within thirty days of recording the receivable. For financial assets where we have elected the fair value option, the associated accrued
interest receivable on these assets is measured at fair value. For financial assets where we have not elected the fair value option, the
associated accrued interest carrying values approximate fair values.
Derivative Financial Instruments
Derivative financial instruments we typically utilize include swaps, swaptions, financial futures contracts, and “To Be
Announced” (“TBA”) contracts. These derivatives are primarily used to manage interest rate risk associated with our operations. In
addition, we enter into certain residential loan purchase commitments (“LPCs”), interest rate lock commitments ("IRLCs"), and residential
loan forward sale commitments (“FSCs”) that are treated as derivatives for financial reporting purposes. All derivative financial instruments
are recorded at their estimated fair value on our consolidated balance sheets. Derivatives with positive fair values to us are reported as
assets and derivatives with negative fair values to us are reported as liabilities. We classify each derivative as either (i) a trading instrument
(no specific hedging designation for financial reporting purposes) or (ii) a hedge of a forecasted transaction or of the variability of cash
flows to be received or paid related to a recognized asset or liability (cash flow hedge).
Changes in the fair values of derivatives accounted for as trading instruments, including any associated interest income or expense,
are recorded in our consolidated statements of income through Other income if they are used to manage risks associated with our MSR
investments, through Mortgage banking activities, net if they are used to manage risks associated with our mortgage banking activities,
or through Investment fair value changes, net if they are used to manage risks associated with our investments. Valuation changes related
to residential LPCs, IRLCs, and FSCs are included in Mortgage banking activities, net on our consolidated statements of income.
Changes in the fair values of derivatives accounted for as cash flow hedges, to the extent they are effective, are recorded in Accumulated
other comprehensive income, a component of equity on our consolidated balance sheets. Interest income or expense, and any
ineffectiveness associated with these derivatives, are recorded as a component of net interest income in our consolidated statements of
income. We measure the effective portion of cash flow hedges by comparing the change in fair value of the expected future variable cash
flows of the derivative hedging instruments with the change in fair value of the expected future variable cash flows of the hedged item.
We will discontinue a designated cash flow hedge relationship if (i) we determine that the hedging derivative is no longer expected
to be effective in offsetting changes in the cash flows of the designated hedged item; (ii) the derivative expires or is sold, terminated, or
exercised; (iii) the derivative is de-designated as a cash flow hedge; or (iv) it is probable that a forecasted transaction associated with the
hedged item will not occur by the end of the originally specified time period. To the extent we de-designate or terminate a cash flow
hedging relationship and the associated hedged item continues to exist, any unrealized gain or loss of the cash flow hedge at the time of
de-designation remains in accumulated other comprehensive income and is amortized using the straight-line method through interest
expense over the remaining life of the hedged item.
Swaps and Swaptions
Interest rate swaps are agreements in which (i) one counterparty exchanges a stream of fixed interest payments for another
counterparty’s stream of variable interest cash flows; or (ii) each counterparty exchanges variable interest cash flows that are referenced
to different indices. Interest rate swaptions are agreements that provide the owner the right but not the obligation to enter into an underlying
interest rate swap with a counterparty in the future. We enter into swap and swaptions primarily to reduce significant changes in our
income or equity caused by interest rate volatility. Certain of these interest rate agreements may be designated as cash flow hedges.
Interest Rate Futures
Interest rate futures are futures contracts based on U.S. Treasury notes, U.S. dollar-denominated interest rate swaps, or U.S. dollar-
denominated interest rate indices.
F- 24
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
TBA Agreements
TBA agreements are forward contracts to purchase mortgage-backed securities that will be issued by a U.S. government sponsored
enterprise in the future. We purchase or sell these derivatives to offset - to varying degrees - changes in the values of mortgage products
for which we have exposure to interest rate volatility.
Loan Purchase and Forward Sale Commitments
We use the term LPCs to refer to agreements with third-party residential loan originators to purchase residential loans at a future
date that qualify as a derivative under GAAP and we use the term FSCs to refer to agreements with third-parties to sell residential loans
at a future date that also qualify as derivatives under GAAP. LPCs and FSCs are recorded at their estimated fair values on our consolidated
balance sheets and changes in fair value are recurring and are reported through our consolidated statements of income in Mortgage banking
activities, net.
Interest Rate Lock Commitments
IRLCs are agreements we have made with third-party borrowers for single-family rental loans that will be originated and held for
sale. IRLCs qualify as derivatives under GAAP and are recorded at their estimated fair values on our consolidated balance sheets. Changes
in fair value are recurring and are reported through our consolidated statements of income in Mortgage banking activities, net.
See Note 11 for further discussion on derivative financial instruments.
Deferred Tax Assets and Liabilities
Our deferred tax assets/liabilities are generated by temporary differences in GAAP and taxable income at our taxable subsidiaries.
These differences generally reflect differing accounting treatments for GAAP and tax, such as accounting for mortgage servicing rights,
security discount and premium amortization, credit losses, asset impairments, and certain valuation estimates. As a result of these
differences, we may recognize taxable income in periods prior to when we recognize income for GAAP. When this occurs, we pay the
tax liability as required and establish a deferred tax asset. As the income is subsequently realized in future periods under GAAP, the
deferred tax asset is reduced. We may also recognize GAAP income in periods prior to when we recognize income for tax. When this
occurs, we establish a deferred tax liability for GAAP. As the income is subsequently realized in future periods for tax, the deferred tax
liability is reduced.
We may also record deferred tax assets/liabilities resulting from GAAP and tax basis differences of assets and liabilities acquired in
a business combination at our taxable subsidiaries. These deferred tax assets/liabilities generally do not affect our GAAP income at the
time of establishment as the offsetting accounting entry is recorded in GAAP goodwill. They also do not generally affect GAAP income
when they are subsequently realized as the deferred tax provision or benefit resulting from the realization is offset by a corresponding
current tax benefit or provision.
In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences become deductible. We consider historical and projected future taxable
income and capital gains as well as tax planning strategies in making this assessment. We determine the extent to which realization of
this deferred asset is not assured and establish a valuation allowance accordingly. The estimate of net deferred tax assets could change
in future periods to the extent that actual or revised estimates of future taxable income during the carryforward periods change from
current expectations.
Other Assets and Other Liabilities
Other assets primarily consists of margin receivable, FHLBC stock, pledged collateral, investment receivable, right-of-use asset,
fixed assets and leasehold improvements, and REO. Other liabilities primarily consists of accrued compensation, payable to minority
partner, guarantee obligations, lease liability, deferred tax liabilities, margin payable, and residential loan and MSR repurchase reserves.
See Note 12 for further discussion.
F- 25
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
FHLBC Stock
In accordance with its borrowing agreement with the FHLBC, our FHLB-member subsidiary is required to purchase and hold stock
in the FHLBC in an amount equal to a specified percentage of outstanding advances. FHLBC stock is considered a non-marketable, long-
term investment, and is carried at cost. Because this stock can only be redeemed or sold at its par value, and only to the FHLBC, carrying
value, or cost, approximates fair value. Dividends received from FHLBC stock are recorded in Other income in our consolidated statements
of income.
Margin Receivable and Payable
Margin receivable and payable result from margin calls between us and our derivatives, master repurchase agreements, and warehouse
facilities counterparties, whereby we or the counterparty were required to post collateral.
Agency Risk-Sharing - Other Assets and Liabilities
During 2014 and 2015, we entered into various risk-sharing arrangements with Fannie Mae and Freddie Mac. Under these
arrangements, we committed to assume the first 1.00% or 2.25% (depending on the arrangement) of losses realized on reference pools
of conforming residential mortgage loans that we acquired and then sold to the Agencies. As part of these risk-sharing arrangements,
during the 10-year term of our first Fannie Mae arrangement, we receive monthly cash payments from Fannie Mae based on the monthly
outstanding unpaid principal balance of the reference pool of loans, and for our Freddie Mac and our subsequent Fannie Mae arrangements,
the Agencies charged us a reduced guarantee fee for the reference loans we delivered to them in exchange for mortgage-backed securities,
which we then sold.
Under these arrangements we are required to pledge assets to the Agencies to collateralize our risk-sharing commitments to them
throughout the terms of the arrangements. These pledged assets are held by a third-party custodian for the benefit of the Agencies. To
the extent approved losses are incurred, the custodian will transfer collateral to the Agencies. As a result of these transactions, we recorded
“pledged collateral” in the other assets line item, and “guarantee obligations” in the other liabilities line item, on our consolidated balance
sheets. In addition, for the first Fannie Mae transaction, we recorded a “guarantee asset” in the other assets line item on our consolidated
balance sheets.
The guarantee obligations represent our commitments to assume losses under these arrangements. We amortize the guarantee
obligations over the 10-year terms of the arrangements based primarily on changes in the outstanding unpaid principal balance of loans
in the reference pools, with a portion of the liabilities treated as a credit reserve that is not amortized into income. In addition, each period
we assess the need for a separate loss allowance related to these arrangements, based on our estimate of credit losses inherent in the
reference pools of loans.
Income from cash payments received under the first Fannie Mae risk-sharing arrangement and income related to the amortization
of the guarantee obligations of all three arrangements are recorded in Other income, and market valuation changes of the guarantee asset
are recorded in Investment fair value changes, net on our consolidated statements of income.
Our consolidated balance sheets include assets of the special purpose entities ("SPEs") associated with these risk-sharing arrangements
(i.e., the "pledged collateral" referred to above) that can only be used to settle obligations of these SPEs and liabilities of these SPEs for
which the creditors of these SPEs (the Agencies) do not have recourse to Redwood Trust, Inc. or its affiliates. At December 31, 2019 and
December 31, 2018, assets of such SPEs totaled $48 million and $47 million, respectively, and liabilities of such SPEs totaled $14 million
and $17 million, respectively.
See Note 16 for further discussion on loss contingencies — risk-sharing.
F- 26
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
REO
REO property acquired through, or in lieu of, foreclosure is initially recorded at fair value, and subsequently reported at the lower
of its carrying amount or fair value (less estimated cost to sell). Changes in the fair value of an REO property that has a fair value at or
below its carrying amount are recorded in Investment fair value changes, net on our consolidated statements of income.
See Note 12 for further discussion on other assets.
Contingent Consideration
In relation to our acquisition of 5 Arches, we recorded contingent consideration liabilities that represent the estimated fair value (at
the date of acquisition) of our obligation to make certain earn-out payments that are contingent on 5 Arches loan origination volumes
exceeding certain specified thresholds. These liabilities are carried at fair value and periodic changes in their estimated fair value are
recorded through Other expenses on our consolidated statements of income. The estimate of the fair value of contingent consideration
requires significant judgment regarding assumptions about future operating results, discount rates, and probabilities of projected operating
result scenarios.
Leases
Upon adoption of ASU 2016-02, "Leases," in the first quarter of 2019, we recorded a lease liability and right-of-use asset on our
consolidated balance sheets. The lease liability is equal to the present value of our remaining lease payments discounted at our incremental
borrowing rate and the right-of-use asset is equal to the lease liability adjusted for our deferred rent liability at the adoption of this
accounting standard. As lease payments are made, the lease liability is reduced to the present value of the remaining lease payments and
the right-of-use asset is reduced by the difference between the lease expense (straight-lined over the lease term) and the theoretical interest
expense amount (calculated using the incremental borrowing rate). See Note 16 for further discussion on leases.
Short-Term Debt
Short-term debt includes borrowings under master repurchase agreements, loan warehouse facilities, and other forms of borrowings
that expire within one year with various counterparties. These borrowings are typically collateralized by cash, loans, or securities, and
in some cases may be unsecured. If the value (as determined by the applicable counterparty) of the collateral securing those borrowings
decreases, we may be subject to margin calls during the period the borrowings are outstanding. In instances where we do not satisfy the
margin calls within the required time frame, the counterparty may retain the collateral and pursue any outstanding debt amount from us.
Short-term debt also includes non-recourse short-term borrowings used to finance servicer advance investments.
See Note 13 for further discussion on short-term debt.
Accrued Interest Payable
Accrued interest payable includes interest that is due and payable to third parties. Interest is generally paid within one to three months
of recording the payable, based upon our remittance requirements, and is paid semi-annually for our convertible and exchangeable debt.
Interest on our FHLB borrowings is paid every 13 weeks. For borrowings where we have elected the fair value option, the associated
accrued interest on these liabilities is measured at fair value. For financial liabilities where we have not elected the fair value option, the
associated accrued interest carrying values approximate fair values.
Asset-Backed Securities Issued
ABS issued represents asset-backed securities issued through the Legacy Sequoia, Sequoia Choice, Freddie Mac K-Series, Freddie
Mac SLST, and CAFL securitization entities. Assets at these entities are held in the custody of securitization trustees and are not owned
by Redwood. These trustees collect principal and interest payments (less servicing and related fees) from the assets and make corresponding
principal and interest payments to the ABS investors. In accordance with accounting guidance for CFEs, we account for the ABS issued
under our consolidated entities at fair value, with periodic changes in fair value recorded in Investment fair value changes, net on our
consolidated statements of income.
F- 27
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
See Note 14 for further discussion on ABS issued.
Long-Term Debt
FHLBC Borrowings
FHLBC borrowings include amounts borrowed by our FHLB-member subsidiary, also referred to as “advances,” from the Federal
Home Loan Bank of Chicago that are secured by eligible collateral, including, but not limited to, residential mortgage loans, single-
family rental loans, and residential mortgage-backed securities. FHLBC borrowings are carried at their unpaid principal balance and
interest on advances is paid every 13 weeks from when each respective advance is made. If the value (as determined by the FHLBC) of
the collateral securing those borrowings decreases, we may be subject to margin calls during the period the borrowings are outstanding.
In instances where we do not satisfy the margin calls within the required time frame, the FHLBC may foreclose upon the collateral and
pursue any outstanding debt amount from us.
Subordinate securities financing facility
Borrowings under our subordinate securities financing facility are secured by real estate securities and carried at unpaid principal
balance net of any unamortized deferred issuance costs. Interest on this facility is paid monthly.
See Note 15 for further discussion on our subordinate securities financing facility.
Convertible Notes
Convertible notes include unsecured convertible and exchangeable debt that are carried at their unpaid principal balance net of any
unamortized deferred issuance costs. Interest on the notes is payable semiannually until such time the notes mature or are converted or
exchanged into shares. If converted or exchanged by a holder, the holder of the notes would receive shares of our common stock.
Trust Preferred Securities and Subordinated Notes
Trust preferred securities and subordinated notes are carried at their unpaid principal balance net of any unamortized deferred issuance
costs. This long-term debt is unsecured and interest is paid quarterly until it is redeemed in whole or matures at a future date.
Deferred Debt Issuance Costs
Deferred debt issuance costs are expenses associated with the issuance of long-term debt. These expenses typically include
underwriting, rating agency, legal, accounting, and other fees. Deferred debt issuance costs are included in the carrying value of the
related long-term debt issued and are amortized as an adjustment to interest expense using the interest method, based upon the actual and
estimated repayment schedules of the related long-term debt issued.
See Note 15 for further discussion on long-term debt.
Equity
Accumulated Other Comprehensive Income (Loss)
Net unrealized gains and losses on real estate securities available-for-sale and interest rate agreements designated as cash flow hedges
are reported as components of Accumulated other comprehensive income on our consolidated statements of changes in stockholders'
equity and our consolidated balance sheets. Net unrealized gains and losses on securities and interest rate agreements held by our taxable
subsidiaries that are reported in other comprehensive income are adjusted for the effects of taxation and may create deferred tax assets
or liabilities.
F- 28
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
Earnings per Common Share
Basic earnings per common share (“EPS”) is computed by dividing net income allocated to common shareholders by the weighted
average common shares outstanding. Net income allocated to common shareholders represents net income less income allocated to
participating securities (as described herein). Diluted EPS is computed by dividing income allocated to common shareholders by the
weighted average common shares outstanding plus amounts representing the dilutive effect of share-based payment awards. In addition,
if the assumed conversion or exchange of convertible or exchangeable debt into common shares is dilutive, diluted EPS is adjusted by
adding back the periodic interest expense (net of any tax effects) associated with dilutive convertible or exchangeable debt to net income
and adding the shares issued in an assumed conversion or exchange to the diluted weighted average share count.
The two-class method is an earnings allocation formula under which EPS is calculated for common stock and participating securities
according to dividends declared and participating rights in undistributed earnings. Under this method, all earnings (distributed and
undistributed) are allocated between participating securities and common shares based on their respective rights to receive dividends or
dividend equivalents. GAAP defines vested and unvested share-based payment awards containing nonforfeitable rights to dividends or
dividend equivalents as participating securities that are included in computing EPS under the two-class method.
See Note 17 for further discussion on equity.
Incentive Plans
In May 2018, our shareholders approved an amendment to the 2014 Redwood Trust, Inc. Incentive Plan (“Incentive Plan”) for
executive officers, employees, and non-employee directors, which increased the number of shares available under the Incentive Plan.
The Incentive Plan provides for the grant of restricted stock, deferred stock, deferred stock units, performance-based awards (including
performance stock units), dividend equivalents, stock payments, restricted stock units, and other types of awards to eligible participants.
Long-term incentive awards granted under the Incentive Plan generally vest over a three- or four-year period. Awards made under the
Incentive Plan to officers and other employees in lieu of the payment in cash of a portion of annual bonuses earned generally vest
immediately, but are subject to a three-year mandatory holding period. Deferred stock units, restricted stock units, and restricted stock
awards have attached dividend equivalent rights, resulting in the payment of dividend equivalents each time we pay a common stock
dividend. Non-employee directors are also provided annual awards under the Incentive Plan that generally vest immediately. The cost
of the awards is generally amortized over the vesting period on a straight-line basis. Upon adoption of ASU 2016-09 in 2016, we elected
to begin accounting for forfeitures on employee equity awards as they occur.
Employee Stock Purchase Plan
In 2013, our shareholders approved an amendment to our previously amended 2002 Redwood Trust, Inc. Employee Stock Purchase
Plan (“ESPP”) to increase the number of shares available under the ESPP. The purpose of the ESPP is to give our employees an opportunity
to acquire an equity interest in the Company through the purchase of shares of common stock at a discount. The ESPP allows eligible
employees to purchase common stock at 85% of its fair value, subject to certain limits. Fair value as defined under the ESPP is the lesser
of the closing market price of the common stock on the first day of the calendar year or the last day of the calendar quarter.
Executive Deferred Compensation Plan
In 2018, our Board of Directors approved an amendment to our 2002 Executive Deferred Compensation Plan (“EDCP”) to increase
the number of shares available to non-employee directors to defer certain cash payments and dividends into DSUs. The EDCP allows
eligible employees and directors to defer portions of current salary and certain other forms of compensation. The Company matches some
deferrals. Compensation deferred under the EDCP is recorded as a liability on our consolidated balance sheets. The EDCP allows for the
investment of deferrals in either an interest crediting account or DSUs.
F- 29
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
401(k) Plan
We offer a tax-qualified 401(k) Plan to all employees for retirement savings. Under this Plan, employees are allowed to defer and
invest up to 100% of their cash earnings, subject to the maximum 401(k) Plan contribution limit set forth by the Internal Revenue Service.
We match some employee contributions to encourage participation and to provide a retirement planning benefit to employees. Plan
matching contributions made by the Company for the years ended December 31, 2019, 2018, and 2017 were $0.7 million, $0.6 million,
and $0.5 million, respectively. Vesting of the 401(k) Plan matching contributions is based on the employee’s tenure at the Company, and
over time an employee becomes increasingly vested in matching contributions.
See Note 18 for further discussion on equity compensation plans.
Taxes
We have elected to be taxed as a REIT under the Internal Revenue Code and the corresponding provisions of state law. To qualify
as a REIT we must distribute at least 90% of our annual REIT taxable income to shareholders (not including taxable income retained in
our taxable subsidiaries) within the time frame set forth in the Internal Revenue Code and also meet certain other requirements related
to assets, income, and stock ownership. We assess our tax positions for all open tax years and record tax benefits only if tax positions
meet a more-likely-than-not threshold in accordance with GAAP guidance on accounting for uncertain tax positions. We classify interest
and penalties on material uncertain tax positions as interest expense and general and administrative expenses, respectively, in our
consolidated statements of income.
See Note 23 for further discussion on taxes.
Recent Accounting Pronouncements
Newly Adopted Accounting Standards Updates ("ASUs")
In July 2019, the FASB issued ASU 2019-07, "Codification Updates to SEC Sections - Amendments to SEC Paragraphs Pursuant
to SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company
Reporting Modernization, and Miscellaneous Updates (SEC Update)." This new guidance amends certain SEC paragraphs in the FASB
Accounting Standards Codification pursuant to the issuance of various SEC Final Rule Releases, and is effective immediately. We adopted
this guidance, as required, in the third quarter of 2019, which did not have a material impact on our consolidated financial statements.
In July 2018, the FASB issued ASU 2018-09, "Codification Improvements." This new guidance is intended to clarify, correct, and
make minor improvements to the FASB Accounting Standards Codification. The transition and effective dates are based on the facts and
circumstances of each amendment, with some amendments becoming effective upon issuance of this ASU and others becoming effective
for annual periods beginning after December 15, 2018. We adopted this guidance, as required, which did not have a material impact on
our consolidated financial statements.
In February 2018, the FASB issued ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220):
Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." This new guidance allows a reclassification
from accumulated other comprehensive income ("AOCI") to retained earnings for stranded tax effects resulting from the Tax Cuts and
Jobs Act of 2017 (the "Tax Act"). This new guidance is effective for fiscal years beginning after December 15, 2018. However, we did
not elect to reclassify any income tax effects of the Tax Act from AOCI to retained earnings as we did not have any tax effects related to
the Tax Act remaining in AOCI at December 31, 2018. Our policy is to release any stranded income tax effects from AOCI to income
tax expense on an investment-by-investment basis.
F- 30
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for
Hedging Activities." This new guidance amends previous guidance to better align an entity's risk management activities and financial
reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships
and the presentation of hedge results. This new guidance is effective for fiscal years beginning after December 15, 2018. Additionally,
in October 2018, the FASB issued ASU 2018-16, "Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing
Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes," which permits the use
of the OIS rate based on SOFR as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815. The amendments in
this update are required to be adopted concurrently with the amendments in ASU 2017-12. We adopted this guidance, as required, in the
first quarter of 2019, which did not have a material impact on our consolidated financial statements.
In July 2017, the FASB issued ASU 2017-11, "Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480);
Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II)
Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain
Mandatorily Redeemable Noncontrolling Interests with a Scope Exception." This new guidance changes the classification analysis of
certain equity-linked financial instruments (or embedded conversion options) with down round features. This new guidance is effective
for fiscal years beginning after December 15, 2018. We adopted this guidance, as required, in the first quarter of 2019, which did not
have a material impact on our consolidated financial statements.
In March 2017, the FASB issued ASU 2017-08, "Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20)." This new
guidance shortens the amortization period for certain callable debt securities purchased at a premium by requiring the premium to be
amortized to the earliest call date. This new guidance is effective for fiscal years beginning after December 15, 2018. We adopted this
guidance, as required, in the first quarter of 2019, which did not have a material impact on our consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, "Leases." This new guidance requires lessees to recognize most leases on their
balance sheet as a right-of-use asset and a lease liability. This new guidance retains a dual lease accounting model, which requires leases
to be classified as either operating or capital leases for lessees, for purposes of income statement recognition. This new guidance is
effective for fiscal years beginning after December 15, 2018. In July 2018, the FASB issued ASU 2018-10, "Codification Improvements
to Topic 842, Leases," which provides more specific guidance on certain aspects of Topic 842. Additionally, in July 2018, the FASB
issued ASU 2018-11, "Leases (Topic 842): Targeted Improvements." This new ASU introduces an additional transition method which
allows entities to apply the new standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of
retained earnings in the period of adoption. In March 2019, the FASB issued ASU 2019-01, "Leases (Topic 842): Codification
Improvements," which is intended to clarify Codification guidance. We adopted this guidance, as required, in the first quarter of 2019,
which did not have a material impact on our consolidated financial statements. We elected the package of practical expedients under the
transition guidance within this standard, which allowed us to carry forward the classifications of each of our existing leases as operating
leases. In connection with the adoption of this guidance, at December 31, 2019, our lease liability was $13 million, which represented
the present value of our remaining lease payments discounted at our incremental borrowing rate and was recorded in Accrued expenses
and other liabilities on our consolidated balance sheets. At December 31, 2019, our right-of-use asset was $12 million, which was equal
to the lease liability adjusted for our deferred rent liability at adoption and was recorded in Other assets on our consolidated balance
sheets. We will continue to record lease expense on a straight-line basis and have included required lease disclosures within Note 16.
Other Recent Accounting Pronouncements
In January 2020, the FASB issued ASU 2020-01, "Investments - Equity Securities (Topic 321), Investments - Equity Method and
Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815)." This new guidance clarifies the interaction of the accounting for
equity securities, equity method investments, and certain forward contracts and purchased options. This new guidance is effective for
fiscal years beginning after December 15, 2020. Early adoption is permitted. We plan to adopt this new guidance by the required date
and do not anticipate that this update will have a material impact on the consolidated financial statements.
F- 31
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
In December 2019, the FASB issued ASU 2019-12, "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes."
This new guidance simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740 and
by clarifying and amending existing guidance. This new guidance is effective for fiscal years beginning after December 15, 2020. Early
adoption is permitted. We plan to adopt this new guidance by the required date and do not anticipate that this update will have a material
impact on our consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the
Disclosure Requirements for Fair Value Measurement." This new guidance amends previous guidance by removing and modifying certain
existing fair value disclosure requirements, while adding other new disclosure requirements. This new guidance is effective for fiscal
years beginning after December 15, 2019. Early adoption is permitted and entities may elect to early adopt the removal or modification
of disclosures immediately and delay adoption of the new disclosure requirements until their effective date. We plan to adopt this new
guidance by the required date and do not anticipate that this update will have a material impact on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill
Impairment." This new guidance simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment
test. This new guidance is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for interim and annual
goodwill impairment tests performed on testing dates after January 1, 2017. We plan to adopt this new guidance by the required date and
do not anticipate that this update will have a material impact on our consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses." This new guidance provides a new impairment
model that is based on expected losses rather than incurred losses to determine the allowance for credit losses. This new guidance is
effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for fiscal years beginning after December 15,
2018. In November 2018, the FASB issued ASU 2018-19, "Codification Improvements to Topic 326, Financial Instruments - Credit
Losses," which clarifies the scope of the amendments in ASU 2016-13. In April 2019, the FASB issued ASU 2019-04, "Codification
Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial
Instruments," which is intended to clarify this guidance. In May 2019, the FASB issued ASU 2019-05, "Financial Instruments - Credit
Losses (Topic 326): Targeted Transition Relief," which provides an option to irrevocably elect the fair value option for certain financial
assets previously measured at amortized cost. In November 2019, the FASB issued ASU 2019-11, "Codification Improvements to Topic
326, Financial Instruments - Credit Losses," which is intended to clarify Codification guidance. In February 2020, the FASB issued ASU
2020-02, "Financial Instruments - Credit Losses (Topic 326) and Leases (Topic 842) - Amendments to SEC Paragraphs Pursuant to SEC
Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02,
Leases (Topic 842) (SEC Update)," which amends certain sections of the guidance. We currently have only a small balance of loans
receivable that are not carried at fair value and would be subject to this new guidance for allowance for credit losses. Separately, we
account for our available-for-sale securities under the other-than-temporary impairment ("OTTI") model for debt securities. This new
guidance requires that credit impairments on our available-for-sale securities be recorded in earnings using an allowance for credit losses,
with the allowance limited to the amount by which the security's fair value is less than its amortized cost basis. Subsequent reversals in
credit loss estimates are recognized in income. We plan to adopt this new guidance by the required date and do not anticipate that these
updates will have a material impact on our consolidated financial statements as nearly all of our financial instruments are carried at fair
value and changes in fair values of these instruments are recorded on our consolidated statements of income in the period in which the
valuation change occurs. We will continue evaluating these new standards and caution that any changes in our business or additional
amendments to these standards could change our initial assessment.
Balance Sheet Netting
Certain of our derivatives and short-term debt are subject to master netting arrangements or similar agreements. Under GAAP, in
certain circumstances we may elect to present certain financial assets, liabilities and related collateral subject to master netting arrangements
in a net position on our consolidated balance sheets. However, we do not report any of these financial assets or liabilities on a net basis,
and instead present them on a gross basis on our consolidated balance sheets.
F- 32
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
The table below presents financial assets and liabilities that are subject to master netting arrangements or similar agreements
categorized by financial instrument, together with corresponding financial instruments and corresponding collateral received or pledged
at December 31, 2019 and December 31, 2018.
Table 3.1 – Offsetting of Financial Assets, Liabilities, and Collateral
Gross
Amounts of
Recognized
Assets
(Liabilities)
Gross
Amounts
Offset in
Consolidated
Balance Sheet
Net Amounts
of Assets
(Liabilities)
Presented in
Consolidated
Balance Sheet
Gross Amounts Not Offset in
Consolidated
Balance Sheet (1)
Financial
Instruments
Cash
Collateral
(Received)
Pledged
Net Amount
$
$
19,020
5,755
137
24,912
$
$
— $
—
—
— $
19,020
5,755
137
24,912
$
$
(14,178) $
(5,755)
—
(19,933) $
(915) $
—
—
(915) $
December 31, 2019
(In Thousands)
Assets (2)
Interest rate agreements
TBAs
Interest rate futures
Total Assets
Liabilities (2)
Interest rate agreements
TBAs
Loan warehouse debt
Security repurchase agreements
Total Liabilities
$
(148,765) $
(13,359)
(432,126)
(1,096,578)
$ (1,690,828) $
(148,765) $
(13,359)
(432,126)
(1,096,578)
14,178
— $
5,755
—
432,126
—
—
1,096,578
— $ (1,690,828) $ 1,548,637
$
$
134,587
6,673
—
—
141,260
$
$
F- 33
3,927
—
137
4,064
—
(931)
—
—
(931)
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 3. Summary of Significant Accounting Policies - (continued)
Gross
Amounts of
Recognized
Assets
(Liabilities)
Gross
Amounts
Offset in
Consolidated
Balance Sheet
Net Amounts
of Assets
(Liabilities)
Presented in
Consolidated
Balance Sheet
Gross Amounts Not Offset in
Consolidated
Balance Sheet (1)
Financial
Instruments
Cash
Collateral
(Received)
Pledged
Net Amount
$
$
28,211
4,665
32,876
$
$
— $
—
— $
28,211
4,665
32,876
$
$
(28,211) $
(3,391)
(31,602) $
— $
(835)
(835) $
—
439
439
December 31, 2018
(In Thousands)
Assets (2)
Interest rate agreements
TBAs
Total Assets
Liabilities (2)
Interest rate agreements
TBAs
Loan warehouse debt
Security repurchase agreements
Total Liabilities
$
(70,908) $
(13,215)
(860,650)
(988,890)
$ (1,933,663) $
(70,908) $
(13,215)
(860,650)
(988,890)
28,211
— $
3,391
—
860,650
—
988,890
—
— $ (1,933,663) $ 1,881,142
$
$
42,697
5,620
—
—
48,317
$
$
—
(4,204)
—
—
(4,204)
(1) Amounts presented in these columns are limited in total to the net amount of assets or liabilities presented in the prior column by instrument. In
certain cases, there is excess cash collateral or financial assets we have pledged to a counterparty (which may, in certain circumstances, be a
clearinghouse) that exceed the financial liabilities subject to a master netting arrangement or similar agreement. Additionally, in certain cases,
counterparties may have pledged excess cash collateral to us that exceeds our corresponding financial assets. In each case, any of these excess
amounts are excluded from the table although they are separately reported in our consolidated balance sheets as assets or liabilities, respectively.
(2) Interest rate agreements and TBAs are components of derivatives instruments on our consolidated balance sheets. Loan warehouse debt, which is
secured by residential mortgage loans, and security repurchase agreements are components of Short-term debt on our consolidated balance sheets.
For each category of financial instrument set forth in the table above, the assets and liabilities resulting from individual transactions
within that category between us and a counterparty are subject to a master netting arrangement or similar agreement with that counterparty
that provides for individual transactions to be aggregated and treated as a single transaction. For certain categories of these instruments,
some of our transactions are cleared and settled through one or more clearinghouses that are substituted as our counterparty. References
herein to master netting arrangements or similar agreements include the arrangements and agreements governing the clearing and settlement
of these transactions through the clearinghouses. In the event of the termination and close-out of any of those transactions, the corresponding
master netting agreement or similar agreement provides for settlement on a net basis. Any such settlement would include the proceeds
of the liquidation of any corresponding collateral, subject to certain limitations on termination, settlement, and liquidation of collateral
that may apply in the event of the bankruptcy or insolvency of a party. Such limitations should not inhibit the eventual practical realization
of the principal benefits of those transactions or the corresponding master netting arrangement or similar agreement and any corresponding
collateral.
Note 4. Principles of Consolidation
GAAP requires us to consider whether securitizations we sponsor and other transfers of financial assets should be treated as sales
or financings, as well as whether any VIEs that we hold variable interests in – for example, certain legal entities often used in securitization
and other structured finance transactions – should be included in our consolidated financial statements. The GAAP principles we apply
require us to reassess our requirement to consolidate VIEs each quarter and therefore our determination may change based upon new
facts and circumstances pertaining to each VIE. This could result in a material impact to our consolidated financial statements during
subsequent reporting periods.
F- 34
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 4. Principles of Consolidation - (continued)
Analysis of Consolidated VIEs
At December 31, 2019, we consolidated Legacy Sequoia, Sequoia Choice, Freddie Mac K-Series and Freddie Mac SLST securitization
entities that we determined were VIEs and for which we determined we were the primary beneficiary. Additionally, beginning in the
fourth quarter of 2019, we consolidated certain CAFL securitization entities that we determined were VIEs and for which we determined
we were the primary beneficiary. Each of these entities is independent of Redwood and of each other and the assets and liabilities of these
entities are not owned by and are not legal obligations of ours. Our exposure to these entities is primarily through the financial interests
we have retained, although for the consolidated Sequoia and CAFL entities we are exposed to certain financial risks associated with our
role as a sponsor, servicing administrator, or depositor of these entities or as a result of our having sold assets directly or indirectly to
these entities. At December 31, 2019, the estimated fair value of our investments in the consolidated Legacy Sequoia, Sequoia Choice,
Freddie Mac SLST, Freddie Mac K-Series, and CAFL entities was $6 million, $256 million, $451 million, $253 million, and $195 million,
respectively.
Beginning in 2018, we consolidated two Servicing Investment entities formed to invest in servicing-related assets that we determined
were VIEs and for which we determined we were the primary beneficiary. At December 31, 2019, we held an 80% ownership interest
in, and were responsible for the management of, each entity. See Note 10 for a further description of these entities and the investments
they hold and Note 12 for additional information on the minority partner’s interest. Additionally, beginning in 2018, we consolidated an
entity that was formed to finance servicer advances, that we determined was a VIE and for which we, through our control of one of the
aforementioned partnerships, were the primary beneficiary. The servicer advance financing consists of non-recourse short-term
securitization debt, secured by servicing advances. We consolidate the securitization entity, but the securitization entity is independent
of Redwood and the assets and liabilities are not owned by and are not legal obligations of Redwood. See Note 13 for additional information
on the servicer advance financing. At December 31, 2019, the estimated fair value of our investment in the Servicing Investment entities
was $53 million.
The following table presents a summary of the assets and liabilities of these VIEs.
Table 4.1 – Assets and Liabilities of Consolidated VIEs
December 31, 2019
(Dollars in Thousands)
Residential loans, held-for-
investment
Business purpose residential loans,
held-for-investment
Multifamily loans, held-for-
investment
Other investments
Cash and cash equivalents
Restricted cash
Accrued interest receivable
Other assets
Total Assets
Short-term debt
Accrued interest payable
Accrued expenses and other
liabilities
Legacy
Sequoia
Sequoia
Choice
Freddie Mac
SLST
Freddie Mac
K-Series
CAFL
Servicing
Investment
Total
Consolidated
VIEs
$
407,890
$
2,291,463
$
2,367,215
$
— $
— $
— $
5,066,568
—
—
—
—
143
655
460
—
—
—
—
27
9,824
—
—
—
—
—
—
7,313
445
—
2,192,552
4,408,524
—
—
—
13,539
—
—
—
—
—
9,572
1,795
—
—
184,802
9,015
21,766
4,869
—
2,192,552
4,408,524
184,802
9,015
21,936
45,772
2,700
$
$
409,148
$
2,301,314
$
2,374,973
$
4,422,063
$
2,203,919
$
220,452
$ 11,931,869
— $
— $
— $
— $
— $
152,554
$
152,554
395
—
7,732
5,374
12,887
7,485
187
34,060
27
—
—
—
14,956
14,983
Asset-backed securities issued
402,465
2,037,198
1,918,322
4,156,239
2,001,251
—
10,515,475
Total Liabilities
$
402,860
$
2,044,957
$
1,923,696
$
4,169,126
$
2,008,736
$
167,697
$ 10,717,072
Number of VIEs
20
9
2
5
10
3
49
F- 35
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 4. Principles of Consolidation - (continued)
December 31, 2018
(Dollars in Thousands)
Residential loans, held-for-
investment
Multifamily loans, held-for-
investment
Other investments
Restricted cash
Accrued interest receivable
Other assets
Total Assets
Short-term debt
Accrued interest payable
Accrued expenses and other
liabilities
Legacy
Sequoia
Sequoia
Choice
Freddie Mac
SLST
Freddie Mac
K-Series
CAFL
Servicing
Investment
Total
Consolidated
VIEs
$
519,958
$
2,079,382
$
1,222,669
$
— $
— $
— $
3,822,009
—
—
146
822
3,943
—
—
1,022
8,988
—
—
—
—
3,926
—
2,144,598
—
—
6,595
—
—
—
—
—
—
$
$
524,869
$
2,089,392
$
1,226,595
$
2,151,193
$
— $
— $
— $
— $
— $
— $
339,142
262,740
$
$
571
—
7,180
1,022
2,907
6,239
—
—
—
2,144,598
312,688
25,363
1,091
—
483
312,688
26,531
21,422
3,943
6,331,191
262,740
17,380
18,592
19,614
—
5,410,073
—
—
—
Asset-backed securities issued
512,240
1,885,010
993,748
2,019,075
Total Liabilities
$
512,811
$
1,893,212
$
996,655
$
2,025,314
$
— $
281,815
$
5,709,807
Number of VIEs
20
6
1
3
—
3
33
We consolidate the assets and liabilities of certain Sequoia and CAFL securitization entities, as we did not meet the GAAP sale
criteria at the time we transferred financial assets to these entities. Our involvement in consolidated Sequoia and CAFL entities continues
in the following ways: (i) we continue to hold subordinate investments in each entity, and for certain entities, more senior investments;
(ii) we maintain certain discretionary rights associated with our sponsorship of, or our subordinate investments in, each entity; and (iii) we
continue to hold a right to call the assets of certain entities (once they have been paid down below a specified threshold) at a price equal
to, or in excess of, the current outstanding principal amount of the entity’s asset-backed securities issued. These factors have resulted in
our continuing to consolidate the assets and liabilities of these Sequoia and CAFL entities in accordance with GAAP.
We consolidate the assets and liabilities of certain Freddie Mac K-Series and SLST securitization trusts resulting from our investment
in subordinate securities issued by these trusts and in the case of certain CAFL securitizations, resulting from securities acquired through
our acquisition of CoreVest. Additionally, we consolidate the assets and liabilities of Servicing Investment entities from our investment
in servicer advance investments and excess MSRs. In each case, we maintain certain discretionary rights associated with the ownership
of these investments that we determined reflected a controlling financial interest, as we have both the power to direct the activities that
most significantly impact the economic performance of the VIEs and the right to receive benefits of and the obligation to absorb losses
from the VIEs that could potentially be significant to the VIEs.
Analysis of Unconsolidated VIEs with Continuing Involvement
Since 2012, we have transferred residential loans to 48 Sequoia securitization entities sponsored by us that are still outstanding as
of December 31, 2019 and accounted for these transfers as sales for financial reporting purposes, in accordance with ASC 860. We also
determined we were not the primary beneficiary of these VIEs as we lacked the power to direct the activities that will have the most
significant economic impact on the entities. For certain of these transfers to securitization entities, for the transferred loans where we
held the servicing rights prior to the transfer and continued to hold the servicing rights following the transfer, we recorded MSRs on our
consolidated balance sheets, and classified those MSRs as Level 3 assets. We also retained senior and subordinate securities in these
securitizations that we classified as Level 3 assets. Our continuing involvement in these securitizations is limited to customary servicing
obligations associated with retaining servicing rights (which we retain a third-party sub-servicer to perform) and the receipt of interest
income associated with the securities we retained.
F- 36
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 4. Principles of Consolidation - (continued)
During the first quarter of 2019, the master servicer for one of our unconsolidated Sequoia entities exercised their right to call the
securitization and paid off the underlying securities. We realized a $4 million gain related to the called securities, which was recognized
through Realized gains, net on our consolidated statements of income. In connection with this called securitization, Redwood acquired
$39 million of residential real estate loans that were subsequently sold or were held in our held-for-investment portfolio at Redwood at
December 31, 2019.
During the years ended December 31, 2019 and 2018, we transferred residential loans to five and eight Sequoia securitization entities
sponsored by us, respectively, and accounted for these transfers as sales for financial reporting purposes. The following table presents
information related to securitization transactions that occurred during the years ended December 31, 2019 and 2018.
Table 4.2 – Securitization Activity Related to Unconsolidated VIEs Sponsored by Redwood
(In Thousands)
Principal balance of loans transferred
Trading securities retained, at fair value
AFS securities retained, at fair value
Years Ended December 31,
2019
2018
$
1,872,910
$
3,188,358
8,882
4,847
52,859
7,739
The following table summarizes the cash flows during the years ended December 31, 2019 and 2018 between us and the unconsolidated
VIEs sponsored by us and accounted for as sales since 2012.
Table 4.3 – Cash Flows Related to Unconsolidated VIEs Sponsored by Redwood
(In Thousands)
Proceeds from new transfers
MSR fees received
Funding of compensating interest, net
Cash flows received on retained securities
Years Ended December 31,
2019
2018
$
1,912,334
$
3,175,900
11,857
(368)
27,045
13,417
(122)
28,614
The following table presents the key weighted average assumptions used to measure MSRs and securities retained at the date of
securitization for securitizations completed during 2019 and 2018.
Table 4.4 – Assumptions Related to Assets Retained from Unconsolidated VIEs Sponsored by Redwood
At Date of Securitization
Prepayment rates
Discount rates
Credit loss assumptions
Year Ended December 31, 2019
Subordinate
Securities
Senior IO
Securities
Year Ended December 31, 2018
Subordinate
Securities
Senior IO
Securities
25%
14%
0.20%
15%
7%
0.20%
9%
14%
0.20%
10%
5%
0.20%
F- 37
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 4. Principles of Consolidation - (continued)
The following table presents additional information at December 31, 2019 and December 31, 2018, related to unconsolidated VIEs
sponsored by Redwood and accounted for as sales since 2012.
Table 4.5 – Unconsolidated VIEs Sponsored by Redwood
(In Thousands)
On-balance sheet assets, at fair value:
Interest-only, senior and subordinate securities, classified as trading
Subordinate securities, classified as AFS
Mortgage servicing rights
Maximum loss exposure (1)
Assets transferred:
Principal balance of loans outstanding
Principal balance of loans 30+ days delinquent
December 31, 2019 December 31, 2018
$
$
$
88,425
$
140,649
40,254
269,328
10,299,442
41,809
$
$
129,111
162,314
58,572
349,997
10,580,216
21,805
(1) Maximum loss exposure from our involvement with unconsolidated VIEs pertains to the carrying value of our securities and MSRs retained from
these VIEs and represents estimated losses that would be incurred under severe, hypothetical circumstances, such as if the value of our interests
and any associated collateral declines to zero. This does not include, for example, any potential exposure to representation and warranty claims
associated with our initial transfer of loans into a securitization.
The following table presents key economic assumptions for assets retained from unconsolidated VIEs and the sensitivity of their fair
values to immediate adverse changes in those assumptions at December 31, 2019 and December 31, 2018.
Table 4.6 – Key Assumptions and Sensitivity Analysis for Assets Retained from Unconsolidated VIEs Sponsored by Redwood
December 31, 2019
(Dollars in Thousands)
Fair value at December 31, 2019
Expected life (in years) (2)
Prepayment speed assumption (annual CPR) (2)
Decrease in fair value from:
10% adverse change
25% adverse change
Discount rate assumption (2)
Decrease in fair value from:
100 basis point increase
200 basis point increase
Credit loss assumption (2)
Decrease in fair value from:
10% higher losses
25% higher losses
MSRs
$
40,254
Senior
Securities (1)
48,765
$
Subordinate
Securities
$
180,309
6
11%
6
14%
$
$
$
$
1,643
3,913
11%
1,447
2,795
N/A
$
$
1,908
5,086
12%
1,079
2,482
0.21%
14
16%
205
1,434
5%
18,127
33,630
0.21%
N/A $
N/A
— $
—
1,804
4,520
F- 38
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 4. Principles of Consolidation - (continued)
December 31, 2018
(Dollars in Thousands)
Fair value at December 31, 2018
Expected life (in years) (2)
Prepayment speed assumption (annual CPR) (2)
Decrease in fair value from:
10% adverse change
25% adverse change
Discount rate assumption (2)
Decrease in fair value from:
100 basis point increase
200 basis point increase
Credit loss assumption (2)
Decrease in fair value from:
10% higher losses
25% higher losses
MSRs
$
58,572
Senior
Securities (1)
61,178
$
Subordinate
Securities
$
230,247
8
7%
7
10%
$
$
$
$
1,668
4,027
11%
2,323
4,493
N/A
$
$
2,151
5,127
12%
2,190
4,226
0.20%
15
9%
201
1,372
6%
21,982
40,641
0.20%
N/A $
N/A
— $
—
1,387
3,471
(1) Senior securities included $49 million and $61 million of interest-only securities at December 31, 2019 and December 31, 2018, respectively.
(2) Expected life, prepayment speed assumption, discount rate assumption, and credit loss assumption presented in the tables above represent weighted
averages.
Analysis of Unconsolidated Third-Party VIEs
Third-party VIEs are securitization entities in which we maintain an economic interest, but do not sponsor. Our economic interest
may include several securities and other investments from the same third-party VIE, and in those cases, the analysis is performed in
consideration of all of our interests. The following table presents a summary of our interests in third-party VIEs at December 31, 2019,
grouped by asset type.
Table 4.7 – Third-Party Sponsored VIE Summary
(In Thousands)
Mortgage-Backed Securities
Senior
Mezzanine
Subordinate
Total Mortgage-Backed Securities
Excess MSR
Total Investments in Third-Party Sponsored VIEs
December 31, 2019
$
$
127,094
508,195
235,510
870,799
16,216
887,015
We determined that we are not the primary beneficiary of these third-party VIEs, as we do not have the required power to direct the
activities that most significantly impact the economic performance of these entities. Specifically, we do not service or manage these
entities or otherwise solely hold decision making powers that are significant. As a result of this assessment, we do not consolidate any
of the underlying assets and liabilities of these third-party VIEs – we only account for our specific interests in them.
Our assessments of whether we are required to consolidate a VIE may change in subsequent reporting periods based upon changing
facts and circumstances pertaining to each VIE. Any related accounting changes could result in a material impact to our financial statements.
F- 39
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments
For financial reporting purposes, we follow a fair value hierarchy established under GAAP that is used to determine the fair value
of financial instruments. This hierarchy prioritizes relevant market inputs in order to determine an “exit price” at the measurement date,
or the price at which an asset could be sold or a liability could be transferred in an orderly process that is not a forced liquidation or
distressed sale. Level 1 inputs are observable inputs that reflect quoted prices for identical assets or liabilities in active markets. Level 2
inputs are observable inputs other than quoted prices for an asset or liability that are obtained through corroboration with observable
market data. Level 3 inputs are unobservable inputs (e.g., our own data or assumptions) that are used when there is little, if any, relevant
market activity for the asset or liability required to be measured at fair value.
In certain cases, inputs used to measure fair value fall into different levels of the fair value hierarchy. In such cases, the level at which
the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. Our
assessment of the significance of a particular input requires judgment and considers factors specific to the asset or liability being measured.
F- 40
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
The following table presents the carrying values and estimated fair values of assets and liabilities that are required to be recorded or
disclosed at fair value at December 31, 2019 and December 31, 2018.
Table 5.1 – Carrying Values and Fair Values of Assets and Liabilities
(In Thousands)
Assets
Residential loans, held-for-sale at fair value
Residential loans, held-for-investment
Business purpose residential loans, held-for-sale
Business purpose residential loans, held-for-investment
Multifamily loans
Trading securities
Available-for-sale securities
Servicer advance investments (1)
MSRs (1)
Participation in loan warehouse facility (1)
Excess MSRs (1)
Shared home appreciation options (1)
Cash and cash equivalents
Restricted cash
Accrued interest receivable
Derivative assets
REO (2)
Margin receivable (2)
FHLBC stock (2)
Guarantee asset (2)
Pledged collateral (2)
Liabilities
Short-term debt facilities
Short-term debt - servicer advance financing
Accrued interest payable
Margin payable (3)
Guarantee obligation (3)
Contingent consideration (3)
Derivative liabilities
ABS issued at fair value
FHLBC long-term borrowings
Subordinate securities financing facility
Convertible notes, net
Trust preferred securities and subordinated notes, net
December 31, 2019
December 31, 2018
Carrying
Value
Fair
Value
Carrying
Value
Fair
Value
$
$
$
$
$
$
536,385
7,178,465
331,565
3,175,178
4,408,524
860,540
239,334
169,204
42,224
—
31,814
45,085
196,966
93,867
71,058
35,701
9,462
209,776
43,393
1,686
32,945
2,176,591
152,554
60,655
1,700
14,009
28,484
163,424
10,515,475
1,999,999
183,520
631,125
138,628
$
$
536,509
7,178,465
331,565
3,175,178
4,408,524
860,540
239,334
169,204
42,224
—
31,814
45,085
196,966
93,867
71,058
35,701
10,389
209,776
43,393
1,686
32,945
2,176,591
152,554
60,655
1,700
13,754
28,484
163,424
10,515,475
1,999,999
184,666
661,985
99,045
1,048,801
6,205,941
28,460
112,798
2,144,598
1,118,612
333,882
300,468
60,281
39,703
27,312
—
175,764
29,313
47,105
35,789
3,943
100,773
43,393
2,618
42,433
1,937,920
262,740
42,528
835
16,711
—
84,855
5,410,073
1,999,999
—
633,196
138,582
1,048,821
6,205,941
28,460
112,798
2,144,598
1,118,612
333,882
300,468
60,281
39,703
27,312
—
175,764
29,313
47,105
35,789
4,396
100,773
43,393
2,618
42,433
1,937,920
262,740
42,528
835
16,774
—
84,855
5,410,073
1,999,999
—
618,271
102,533
(1) These investments are included in Other investments on our consolidated balance sheets.
(2) These assets are included in Other assets on our consolidated balance sheets.
(3) These liabilities are included in Accrued expenses and other liabilities on our consolidated balance sheets.
F- 41
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
During the years ended December 31, 2019 and 2018, we elected the fair value option for $333 million and $654 million of securities,
respectively, $6.99 billion and $8.38 billion of residential loans (principal balance), respectively, $4.02 billion and $168 million of business
purpose residential loans (principal balance), respectively, $1.43 billion and $2.13 billion of multifamily loans (principal balance),
respectively, $70 million and $396 million of servicer advance investments, respectively, and $8 million and $25 million of excess MSRs,
respectively. Additionally, during the year ended December 31, 2019, we elected the fair value option for $43 million of shared home
appreciation options. We anticipate electing the fair value option for all future purchases of residential and business purpose residential
loans that we intend to sell to third parties or transfer to securitizations, as well as for certain securities we purchase, including IO securities
and fixed-rate securities rated investment grade or higher.
The following table presents the assets and liabilities that are reported at fair value on our consolidated balance sheets on a recurring
basis at December 31, 2019 and December 31, 2018, as well as the fair value hierarchy of the valuation inputs used to measure fair value.
Table 5.2 – Assets and Liabilities Measured at Fair Value on a Recurring Basis
December 31, 2019
(In Thousands)
Assets
Residential loans
Business purpose residential loans
Multifamily loans
Trading securities
Available-for-sale securities
Servicer advance investments
MSRs
Excess MSRs
Shared home appreciation options
Derivative assets
Pledged collateral
FHLBC stock
Guarantee asset
Liabilities
Contingent consideration
Derivative liabilities
ABS issued
Carrying
Value
Fair Value Measurements Using
Level 1
Level 2
Level 3
$
7,714,745
$
— $
— $
7,714,745
3,506,743
4,408,524
860,540
239,334
169,204
42,224
31,814
45,085
35,701
32,945
43,393
1,686
—
—
—
—
—
—
—
—
6,531
32,945
—
—
—
—
—
—
—
—
—
—
19,020
—
43,393
—
$
28,484
$
— $
— $
3,506,743
4,408,524
860,540
239,334
169,204
42,224
31,814
45,085
10,150
—
—
1,686
28,484
1,290
148,766
—
10,515,475
163,424
10,515,475
13,368
—
F- 42
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
December 31, 2018
(In Thousands)
Assets
Residential loans
Business purpose residential loans
Multifamily loans
Trading securities
Available-for-sale securities
Servicer advance investments
MSRs
Excess MSRs
Derivative assets
Pledged collateral
FHLBC stock
Guarantee asset
Liabilities
Derivative liabilities
ABS issued
Carrying
Value
Fair Value Measurements Using
Level 1
Level 2
Level 3
$
7,254,631
$
— $
— $
7,254,631
141,258
2,144,598
1,118,612
333,882
300,468
60,281
27,312
35,789
42,433
43,393
2,618
—
—
—
—
—
—
—
4,665
42,433
—
—
—
—
—
—
—
—
—
28,211
—
43,393
—
141,258
2,144,598
1,118,612
333,882
300,468
60,281
27,312
2,913
—
—
2,618
$
84,855
$
13,215
$
70,908
$
732
5,410,073
—
—
5,410,073
The following table presents additional information about Level 3 assets and liabilities measured at fair value on a recurring basis
for the years ended December 31, 2019 and December 31, 2018.
Table 5.3 – Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis
Residential
Loans
Business
Purpose
Residential
Loans
Multifamily
Loans
Trading
Securities
AFS
Securities
Servicer
Advance
Investments
MSRs
Excess
MSRs
Shared
Home
Appreciation
Options
Assets
$7,254,631
$ 141,258
$ 2,144,598
$1,118,612
$ 333,882
$
300,468
$ 60,281
$
27,312
$
7,092,866
2,639,615
2,162,386
332,593
26,539
69,610
— 1,015,436
—
—
—
(5,141,886)
(76,909)
— (597,122)
(110,069)
—
—
Principal paydowns
(1,609,220)
(213,655)
(28,543)
(44,600)
(39,704)
(203,876)
868
—
—
—
7,762
—
—
—
119,132
7,423
130,083
56,008
24,580
3,002
(18,925)
(3,260)
—
(778)
—
(6,425)
—
—
—
(4,951)
4,106
—
—
—
—
—
—
—
$7,714,745
$3,506,743
$ 4,408,524
$ 860,540
$ 239,334
$
169,204
$ 42,224
$
31,814
$
45,085
F- 43
(In Thousands)
Beginning balance -
December 31, 2018
Acquisitions
Originations
Sales
Gains (losses) in net
income, net
Unrealized losses in
OCI, net
Other settlements, net (1)
Ending balance -
December 31, 2019
—
44,243
—
—
—
842
—
—
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
Table 5.3 – Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis (continued)
(In Thousands)
Beginning balance - December 31, 2018
Acquisitions
Principal paydowns
Gains (losses) in net income, net
Other settlements, net (1)
Ending balance - December 31, 2019
Assets
Liabilities
Guarantee Asset
Derivatives (2)
Contingent
Consideration
ABS
Issued
$
$
2,618
$
2,181
$
— $
5,410,073
—
—
(932)
—
—
—
62,220
(55,541)
25,267
—
3,217
—
6,098,462
(1,112,437)
119,377
—
1,686
$
8,860
$
28,484
$
10,515,475
Residential
Loans
Business
Purpose
Residential
Loans
Multifamily
Loans
Trading
Securities
AFS
Securities
Servicer
Advance
Investments
MSRs
Excess
MSRs
Guarantee
Asset
Assets
$5,114,317
$
— $
— $ 968,844
$ 507,666
$
— $ 63,598
$
— $
2,869
8,338,724
167,777
2,099,916
653,739
7,739
395,813
328
25,489
(5,425,168)
—
— (438,304)
(143,644)
—
(1,077)
(814,122)
(27,382)
(1,873)
(40,050)
(44,446)
(94,644)
—
—
—
—
—
—
44,627
863
46,555
(8,436)
41,051
(701)
(2,568)
1,823
(251)
—
(3,747)
—
—
—
—
—
(34,484)
(17,181)
—
—
—
—
—
—
—
—
—
$7,254,631
$ 141,258
$ 2,144,598
$1,118,612
$ 333,882
$
300,468
$ 60,281
$
27,312
$
2,618
(In Thousands)
Beginning balance -
December 31, 2017
Acquisitions
Sales
Principal paydowns
Gains (losses) in net
income, net
Unrealized gains in
OCI, net
Other settlements, net (1)
Ending balance -
December 31, 2018
(In Thousands)
Beginning balance - December 31, 2017
Acquisitions
Principal paydowns
Gains (losses) in net income, net
Other settlements, net (1)
Ending balance - December 31, 2018
Liabilities
ABS
Issued
Derivatives (2)
$
1,714
$
1,164,585
—
—
(1,214)
1,681
4,613,168
(459,173)
91,493
—
$
2,181
$
5,410,073
(1) Other settlements, net for residential and business purpose residential loans represents the transfer of loans to REO, and for derivatives, the settlement
of forward sale commitments and the transfer of the fair value of loan purchase or interest rate lock commitments at the time loans are acquired to
the basis of residential and single-family rental loans. Other settlements, net for trading securities relates to the consolidation of Freddie Mac K-
Series securitization entities.
(2) For the purpose of this presentation, derivative assets and liabilities, which consist of loan purchase commitments, forward sale commitments, and
interest rate lock commitments, are presented on a net basis.
F- 44
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
The following table presents the portion of gains or losses included in our consolidated statements of income that were attributable
to Level 3 assets and liabilities recorded at fair value on a recurring basis and held at December 31, 2019, 2018, and 2017. Gains or losses
incurred on assets or liabilities sold, matured, called, or fully written down during the years ended December 31, 2019, 2018, and 2017
are not included in this presentation.
Table 5.4 – Portion of Net Gains (Losses) Attributable to Level 3 Assets and Liabilities Still Held at December 31, 2019, 2018, and
2017 Included in Net Income
(In Thousands)
Assets
Residential loans at Redwood
Residential loans at consolidated Sequoia entities
Residential loans at consolidated Freddie Mac SLST entities
Business purpose residential loans
Single-family rental loans at consolidated CAFL entities
Multifamily loans at consolidated Freddie Mac K-Series entities
Trading securities
Available-for-sale securities
Servicer advance investments
MSRs
Excess MSRs
Shared home appreciation options
Loan purchase and interest rate lock commitments
Loan forward sale commitments
Other assets - Guarantee asset
Liabilities
Loan purchase commitments
Contingent consideration
ABS issued
Included in Net Income
Years Ended December 31,
2019
2018
2017
67,470
(10,062)
63,583
14,603
(14,681)
130,083
18,865
—
3,001
(11,957)
(3,260)
842
10,190
—
(932)
$
(17,757) $
24,799
21,295
445
—
46,555
(12,256)
(89)
(702)
1,942
1,824
—
2,913
—
(251)
523
17,727
—
—
—
—
28,612
(1,011)
—
1,277
—
—
3,243
2,177
(1,223)
(1,290) $
(3,217)
(130,421)
(732) $
—
(71,468)
(3,706)
—
(29,187)
$
$
F- 45
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
The following table presents information on assets recorded at fair value on a non-recurring basis at December 31, 2019 and
December 31, 2018. This table does not include the carrying value and gains or losses associated with the asset types below that were
not recorded at fair value on our consolidated balance sheets at December 31, 2019 and December 31, 2018.
Table 5.5 – Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis
December 31, 2019
(In Thousands)
Assets
REO
December 31, 2018
(In Thousands)
Assets
REO
Carrying
Value
Fair Value Measurements Using
Gain (Loss) for
Year Ended
Level 1
Level 2
Level 3
December 31, 2019
$
4,051
$
— $
— $
4,051
$
(1,363)
Carrying
Value
Fair Value Measurements Using
Gain (Loss) for
Year Ended
Level 1
Level 2
Level 3
December 31, 2018
$
2,225
$
— $
— $
2,225
$
(131)
The following table presents the net market valuation gains and losses recorded in each line item of our consolidated statements of
income for the years ended December 31, 2019, 2018, and 2017.
F- 46
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
Table 5.6 – Market Valuation Gains and Losses, Net
(In Thousands)
Mortgage Banking Activities, Net
Residential loans held-for-sale, at fair value
Residential loan purchase and forward sale commitments
Single-family rental loans held-for-sale, at fair value
Single-family rental loan purchase and interest rate lock commitments
Residential bridge loans
Risk management derivatives, net
Total mortgage banking activities, net (1)
Investment Fair Value Changes, Net
Residential loans held-for-investment at Redwood
Single-family rental loans held-for-investment
Residential bridge loans held-for-investment
Trading securities
Commercial loans held-for-sale
Servicer advance investments
Excess MSRs
Shared home appreciation options
REO
Net investments in Legacy Sequoia entities (2)
Net investments in Sequoia Choice entities (2)
Net investments in Freddie Mac SLST entities (2)
Net investments in Freddie Mac K-Series entities (2)
Net investments in CAFL entities (2)
Other investments
Risk management derivatives, net
Impairments on AFS securities
Total investment fair value changes, net
Other Income
MSRs
Risk management derivatives, net
Gain on re-measurement of 5 Arches investment
Total other income (3)
Total Market Valuation Gains, Net
Years Ended December 31,
2018
2017
2019
$
3,267
$
23,144
$
60,260
15,043
1,961
4,518
(1,336)
375
78
—
31,493
37,880
—
—
—
(15,723)
34,739
69,326
$
57,000
$
(17,529)
51,844
58,891
$
(29,573) $
(5,765)
272
(2,139)
56,046
—
3,001
(3,260)
842
(1,045)
(1,545)
6,947
27,206
21,430
(3,636)
(341)
(127,169)
—
—
(29)
(8,055)
—
(701)
1,823
—
—
(1,016)
443
1,271
931
—
(434)
9,740
(89)
35,500
$
(25,689) $
—
—
39,526
300
—
—
—
—
(8,027)
(323)
—
—
—
(1,484)
(12,842)
(1,011)
10,374
(18,856) $
(2,508) $
(10,166)
8,595
2,441
(4,734)
—
(568)
—
(7,820) $
97,006
$
(7,242) $
(10,734)
24,069
$
51,484
$
$
$
$
$
$
(1) Mortgage banking activities, net presented above does not include fee income or provisions for repurchases that are components of Mortgage banking activities, net
presented on our consolidated statements of income, as these amounts do not represent market valuation changes.
(2)
Includes changes in fair value of the residential loans held-for-investment, REO and the ABS issued at the entities, which netted together represent the change in
value of our investments at the consolidated VIEs.
(3) Other income presented above does not include net MSR fee income or provisions for repurchases for MSRs, as these amounts do not represent market valuation
adjustments.
F- 47
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
Valuation Policy
We maintain policies that specify the methodologies we use to value different types of financial instruments. Significant changes to
the valuation methodologies are reviewed by members of senior management to confirm the changes are appropriate and reasonable.
Valuations based on information from external sources are performed on an instrument-by-instrument basis with the resulting amounts
analyzed individually against internal calculations as well as in the aggregate by product type classification. Initial valuations are performed
by our portfolio management groups using the valuation processes described below. Our finance department then independently reviews
all fair value estimates using available market, portfolio, and industry information to ensure they are reasonable. Finally, members of
senior management review all fair value estimates, including an analysis of the methodology and valuation changes from prior reporting
periods.
Valuation Process
We estimate fair values for financial assets or liabilities based on available inputs observed in the marketplace as well as unobservable
inputs. We primarily use two pricing valuation techniques: market comparable pricing and discounted cash flow analysis. Market
comparable pricing is used to determine the estimated fair value of certain instruments by incorporating known inputs and performance
metrics, such as observed prepayment rates, delinquencies, severities, credit support, recent transaction prices, pending transactions, or
prices of other similar instruments. Discounted cash flow analysis techniques generally consist of developing an estimate of future cash
flows that are expected to occur over the life of an instrument and then discounting those cash flows at a rate of return that results in an
estimate of fair value. After considering all available indications of the appropriate rate of return that market participants would require,
we consider the reasonableness of the range indicated by the results to determine an estimate that is most representative of fair value. We
also consider counterparty credit quality and risk as part of our fair value assessments.
F- 48
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
The following table provides quantitative information about the significant unobservable inputs used in the valuation of our Level
3 assets and liabilities measured at fair value.
Table 5.7 – Fair Value Methodology for Level 3 Financial Instruments
December 31, 2019
(Dollars in Thousands, except
Input Values)
Assets
Residential loans, at fair value:
Fair
Value
Unobservable Input
Range
Input Values
Weighted
Average
Jumbo fixed-rate loans
$ 2,113,977
Prepayment rate (annual CPR)
Whole loan spread to TBA price
Whole loan spread to swap rate
Jumbo hybrid loans
326,336
Prepayment rate (annual CPR)
Whole loan spread to swap rate
$
20 -
0.53 - $
95 -
15 -
80 -
20 %
1.63
375 bps
15 %
345 bps
$
20 %
1.62
170 bps
15 %
134 bps
Jumbo loans committed to sell
207,864 Whole loan committed sales price
$ 101.85 - $ 102.96
$ 102.41
Loans held by Legacy Sequoia (1)
407,890 Liability price
Loans held by Sequoia Choice (1)
2,291,463 Liability price
Loans held by Freddie Mac
SLST (1)
2,367,215 Liability price
N/A
N/A
N/A
Business purpose residential loans:
Single-family rental loans
569,185
Senior credit spread
Subordinate credit spread
Senior credit support
IO discount rate
Prepayment rate (annual CPR)
100 -
135 -
33 -
6 -
5 -
105 bps
1,400 bps
40 %
9 %
5 %
N/A
N/A
N/A
103 bps
299 bps
34 %
8 %
5 %
Single-family rental loans held by
CAFL
2,192,552 Liability price
Residential bridge loans
745,006 Discount rate
Multifamily loans held by Freddie
Mac K-Series (1)
4,408,524 Liability price
Trading and AFS securities
1,099,874 Discount rate
Prepayment rate (annual CPR)
Default rate
Loss severity
Servicer advance investments
169,204 Discount rate
Prepayment rate (annual CPR)
Expected remaining life (2)
Mortgage servicing income
MSRs
42,224 Discount rate
Prepayment rate (annual CPR)
Per loan annual cost to service
$
Excess MSRs
31,814 Discount rate
Prepayment rate (annual CPR)
Excess mortgage servicing amount
N/A
N/A
6
10 %
N/A
7 %
N/A
3 -
5 -
— -
— -
5 -
8 -
2 -
8 -
11 -
5 -
82 - $
11 -
9 -
8 -
40 %
50 %
7 %
30 %
5 %
15 %
2 year
13 bps
12 %
44 %
82
16 %
14 %
18 bps
$
5 %
16 %
1 %
5 %
5 %
14 %
2 year
10 bps
11 %
11 %
82
14 %
11 %
13 bps
F- 49
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
Table 5.7 – Fair Value Methodology for Level 3 Financial Instruments (continued)
Fair
Value
Unobservable Input
Range
Input Values
Weighted
Average
December 31, 2019
(Dollars in Thousands, except
Input Values)
Assets (continued)
Shared home appreciation options
$
45,085 Discount rate
Prepayment rate (annual CPR)
Home price appreciation
Guarantee asset
1,686 Discount rate
REO
Residential loan purchase
commitments, net
Prepayment rate (annual CPR)
4,051 Loss severity
8,419 MSR multiple
11 -
10 -
3 -
11 -
15 -
17 -
11 %
30 %
3 %
11 %
15 %
55 %
0.7 -
4.3 x
Pull-through rate
Whole loan spread to TBA price
Whole loan spread to swap rate - fixed rate
Prepayment rate (annual CPR)
Whole loan spread to swap rate - hybrid
$
8 -
0.53 - $
115 -
15 -
115 -
Single-family rental interest rate
lock commitments
440
Senior credit spread
Subordinate credit spread
Senior credit support
IO discount rate
Prepayment rate (annual CPR)
Pull-through rate
Liabilities
ABS issued (1)
At consolidated Sequoia entities
2,439,663 Discount rate
Prepayment rate (annual CPR)
Default rate
Loss severity
At consolidated Freddie Mac
SLST entities
1,918,322 Discount rate
Prepayment rate (annual CPR)
Default rate
Loss severity
At consolidated Freddie Mac K-
Series entities (4)
4,156,239 Discount rate
Non-IO prepayment rate (annual CPR)
IO prepayment rate (annual CPY/CPP)
At consolidated CAFL entities (4)
2,001,251 Discount rate
Prepayment rate (annual CPR)
Contingent consideration
28,484 Discount rate
Probability of outcomes (3)
105 -
140 -
33 -
6 -
5 -
100 -
3 -
17 -
— -
— -
3 -
6 -
17 -
30 -
1 -
— -
— -
2 -
— -
23 -
100 -
$
100 %
1.63
375 bps
20 %
155 bps
105 bps
1,400 bps
33 %
7 %
5 %
100 %
30 %
43 %
7 %
65 %
13 %
6 %
18 %
30 %
9 %
— %
100 %
30 %
5 %
23 %
100 %
F- 50
11 %
23 %
3 %
11 %
15 %
26 %
2.8 x
75 %
1.62
253 bps
20 %
131 bps
105 bps
299 bps
33 %
7 %
5 %
100 %
4 %
26 %
— %
1 %
3 %
6 %
17 %
30 %
3 %
— %
94 %
4 %
— %
23 %
100 %
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
Footnotes to Table 5.7
(1) The fair value of the loans held by consolidated entities was based on the fair value of the ABS issued by these entities, including securities we
own, which we determined were more readily observable in accordance with accounting guidance for collateralized financing entities. At
December 31, 2019, the fair value of securities we owned at the consolidated Sequoia, Freddie Mac SLST, Freddie Mac K-Series and CAFL entities
was $264 million, $449 million, $252 million, and $191 million, respectively.
(2) Represents the estimated average duration of outstanding servicer advances at a given point in time (not taking into account new advances made
with respect to the pool).
(3) Represents the probability of a full payout of contingent purchase consideration.
(4) As a market convention, certain securities are priced to a no-loss yield and therefore do not include default and loss severity assumptions.
Determination of Fair Value
A description of the instruments measured at fair value as well as the general classification of such instruments pursuant to the Level
1, Level 2, and Level 3 valuation hierarchy is listed herein. We generally use both market comparable information and discounted cash
flow modeling techniques to determine the fair value of our Level 3 assets and liabilities. Use of these techniques requires determination
of relevant inputs and assumptions, some of which represent significant unobservable inputs as indicated in the preceding table.
Accordingly, a significant increase or decrease in any of these inputs – such as anticipated credit losses, prepayment rates, interest rates,
or other valuation assumptions – in isolation would likely result in a significantly lower or higher fair value measurement.
Residential loans at Redwood
Estimated fair values for residential loans are determined using models that incorporate various observable inputs, including pricing
information from whole loan sales and securitizations. Certain significant inputs in these models are considered unobservable and are
therefore Level 3 in nature. Significant pricing inputs obtained from market whole loan transaction activity include indicative spreads to
indexed TBA prices and indexed swap rates for fixed-rate loans and indexed swap rates for hybrid loans (Level 3). Significant pricing
inputs obtained from market securitization activity include indicative spreads to indexed TBA prices for senior MBS and indexed swap
rates for subordinate MBS, senior credit support levels, and assumed future prepayment rates (Level 3). These assets would generally
decrease in value based upon an increase in the credit spread, prepayment speed, or credit support assumptions.
Residential loans, business purpose residential loans, and multifamily loans at consolidated entities
We have elected to account for our consolidated securitization entities as collateralized financing entities in accordance with GAAP.
A CFE is a variable interest entity that holds financial assets and issues beneficial interests in those assets, and these beneficial interests
have contractual recourse only to the related assets of the CFE. Accounting guidance for CFEs allows companies to elect to measure both
the financial assets and financial liabilities of a CFE using the more observable of the fair value of the financial assets or fair value of
the financial liabilities. Pursuant to this guidance, we use the fair value of the ABS issued by the CFEs (which we determined to be more
observable) to determine the fair value of the loans held at these entities, whereby the net assets we consolidate in our financial statements
related to these entities represent the estimated fair value of our retained interests in the CFEs.
Business purpose residential loans
Business purpose residential loans include single-family rental loans and residential bridge loans that are generally illiquid in nature
and trade infrequently. Significant inputs in the valuation analysis are predominantly Level 3 in nature, due to the lack of readily available
market quotes and related inputs.
Estimated fair values for our single-family rental loans are determined using models that incorporate various inputs, including pricing
information from market comparable securitizations. Certain significant inputs in these models are considered unobservable and are
therefore Level 3 in nature. Significant pricing inputs obtained from market activity include indicative spreads to indexed swap rates for
senior and subordinate MBS, IO MBS discount rates, senior credit support levels, and assumed future prepayment rates (Level 3). These
assets would generally decrease in value based upon an increase in the credit spread, prepayment speed, or credit support assumptions.
Prices for our residential bridge loans are determined using discounted cash flow modeling, which incorporates a primary significant
unobservable input of discount rate. These assets would generally decrease in value based upon an increase in the discount rate.
F- 51
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
Real estate securities
Real estate securities include residential, multifamily, and other mortgage-backed securities that are generally illiquid in nature and
trade infrequently. Significant inputs in the valuation analysis are predominantly Level 3 in nature, due to the lack of readily available
market quotes and related inputs. For real estate securities, we utilize both market comparable pricing and discounted cash flow analysis
valuation techniques. Relevant market indicators that are factored into the analysis include bid/ask spreads, the amount and timing of
credit losses, interest rates, and collateral prepayment rates. Estimated fair values are based on applying the market indicators to generate
discounted cash flows (Level 3). These cash flow models use significant unobservable inputs such as a discount rate, prepayment rate,
default rate and loss severity. The estimated fair value of our securities would generally decrease based upon an increase in discount rate,
default rates, loss severities, or a decrease in prepayment rates.
As part of our securities valuation process, we request and consider indications of value from third-party securities dealers. For
purposes of pricing our securities at December 31, 2019, we received dealer price indications on 83% of our securities, representing 94%
of our carrying value. In the aggregate, our internal valuations of the securities for which we received dealer price indications were within
1% of the aggregate average dealer valuations. Once we receive the price indications from dealers, they are compared to other relevant
market inputs, such as actual or comparable trades, and the results of our discounted cash flow analysis. In circumstances where relevant
market inputs cannot be obtained, increased reliance on discounted cash flow analysis and management judgment are required to estimate
fair value.
Derivative assets and liabilities
Our derivative instruments include swaps, swaptions, TBAs, interest rate futures, loan purchase commitments, and forward sale
commitments. Fair values of derivative instruments are determined using quoted prices from active markets, when available, or from
valuation models and are supported by valuations provided by dealers active in derivative markets. Fair values of TBAs and interest rate
futures are generally obtained using quoted prices from active markets (Level 1). Our derivative valuation models for swaps and swaptions
require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment
rates, and correlations of certain inputs. Model inputs can generally be verified and model selection does not involve significant
management judgment (Level 2).
LPC, IRLC and FSC fair values for residential jumbo and single-family rental loans are estimated based on the estimated fair values
of the underlying loans (as described in "Residential loans at Redwood" and "Business purpose residential loans" above). In addition,
fair values for LPCs and IRLCs are estimated based on the probability that the mortgage loan will be purchased or originated (the "Pull-
through rate") (Level 3).
For other derivatives, valuations are based on various factors such as liquidity, bid/ask spreads, and credit considerations for which
we rely on available market inputs. In the absence of such inputs, management’s best estimate is used (Level 3).
Servicer advance investments
Estimated fair values for servicer advance investments are determined through internal pricing models that estimate future cash flows
and utilize certain significant inputs that are considered unobservable and are therefore Level 3 in nature. Our estimations of cash flows
include the combined cash flows of all of the components that comprise the servicer advance investments: existing advances, the
requirement to purchase future advances, the recovery of advances, and the right to a portion of the associated mortgage servicing fee
("mortgage servicing income"). The valuation technique is based on discounted cash flows. Significant inputs used in the valuations
included prepayment rate (of the loans underlying the investments), mortgage servicing income, servicer advance WAL (the weighted-
average expected remaining life of servicer advances), and discount rate. These assets would generally decrease in value based upon an
increase in prepayment rates, an increase in servicer advance WAL, or an increase in discount rate, or a decrease in mortgage servicing
income.
F- 52
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
MSRs
MSRs include the rights to service jumbo residential mortgage loans. Significant inputs in the valuation analysis are predominantly
Level 3, due to the nature of these instruments and the lack of readily available market quotes. Changes in the fair value of MSRs occur
primarily due to the collection/realization of expected cash flows, as well as changes in valuation inputs and assumptions. Estimated fair
values are based on applying the inputs to generate the net present value of estimated future MSR income (Level 3). These discounted
cash flow models utilize certain significant unobservable inputs including market discount rates, assumed future prepayment rates of
serviced loans, and the market cost of servicing. An increase in these unobservable inputs would generally reduce the estimated fair value
of the MSRs.
As part of our MSR valuation process, we received a valuation estimate from a third-party valuations firm. In the aggregate, our
internal valuation of the MSRs were within 2% of the third-party valuation.
Excess MSRs
Estimated fair values for excess MSRs are determined through internal pricing models that estimate future cash flows and utilize
certain significant inputs that are considered unobservable and are therefore Level 3 in nature. The valuation technique is based on
discounted cash flows. Significant unobservable inputs used in the valuations included prepayment rate (of the loans underlying the
investments), the amount of excess servicing income expected to be received ("excess mortgage servicing income"), and discount rate.
These assets would generally decrease in value based upon an increase in prepayment rates or discount rate, or a decrease in excess
mortgage servicing income.
Shared Home Appreciation Options
Estimated fair values for shared home appreciation options are determined through internal pricing models that estimate future cash
flows and utilize certain significant unobservable inputs such as forecasted home price appreciation, prepayment rates, and discount rate,
and are therefore Level 3 in nature. The valuation technique is based on discounted cash flows. An increase in discount rate, or a decrease
in expected future home values combined with a decrease in prepayment rates, would generally reduce the estimated fair value of the
shared home appreciation options.
FHLBC stock
Our Federal Home Loan Bank ("FHLB") member subsidiary is required to purchase Federal Home Loan Bank of Chicago ("FHLBC")
stock under a borrowing agreement between our FHLB-member subsidiary and the FHLBC. Under this agreement, the stock is redeemable
at face value, which represents the carrying value and fair value of the stock (Level 2).
Guarantee asset
The guarantee asset represents the estimated fair value of cash flows we are contractually entitled to receive related to a risk-sharing
arrangement with Fannie Mae. Significant inputs in the valuation analysis are Level 3, due to the nature of this asset and the lack of
market quotes. The fair value of the guarantee asset is determined using a discounted cash flow model, for which significant unobservable
inputs include assumed future prepayment rates and market discount rate (Level 3). An increase in prepayment rates or discount rate
would generally reduce the estimated fair value of the guarantee asset.
Pledged collateral
Pledged collateral consists of cash and U.S. Treasury securities held by a custodian in association with certain agreements we have
entered into. Treasury securities are carried at their fair value, which is determined using quoted prices in active markets (Level 1).
Cash and cash equivalents
Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less. Fair
values equal carrying values (Level 1).
F- 53
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
Restricted cash
Restricted cash primarily includes interest-earning cash balances related to risk-sharing transactions with the Agencies, cash held in
association with borrowings from the FHLBC, cash held at Servicing Investment entities, and cash held at consolidated Sequoia entities
for the purpose of distribution to investors and reinvestment. Due to the short-term nature of the restrictions, fair values approximate
carrying values (Level 1).
Accrued interest receivable and payable
Accrued interest receivable and payable includes interest due on our assets and payable on our liabilities. Due to the short-term nature
of when these interest payments will be received or paid, fair values approximate carrying values (Level 1).
Real estate owned
Real estate owned ("REO") includes properties owned in satisfaction of foreclosed loans. Fair values are determined using available
market quotes, appraisals, broker price opinions, comparable properties, or other indications of value (Level 3).
Margin receivable
Margin receivable reflects cash collateral we have posted with our various derivative and debt counterparties as required to satisfy
margin requirements. Fair values approximate carrying values (Level 2).
Contingent consideration
Contingent consideration is related to our acquisition of 5 Arches and is estimated and recorded at fair value as part of purchase
consideration. Each reporting period we estimate the change in fair value of the contingent consideration, and such change is recognized
in our consolidated statements of income, unless it is determined to be a measurement period adjustment. The estimate of the fair value
of contingent consideration requires significant judgment and assumptions to be made about future operating results, discount rates, and
probabilities of projected operating result scenarios (Level 3).
Short-term debt
Short-term debt includes our credit facilities for residential and business purpose residential loans and real estate securities as well
as non-recourse short-term borrowings used to finance servicer advance investments. As these borrowings are secured and subject to
margin calls and as the rates on these borrowings reset frequently to market rates, we believe that carrying values approximate fair values
(Level 2).
ABS issued
ABS issued includes asset-backed securities issued through the Legacy Sequoia, Sequoia Choice, and CAFL securitization entities,
as well as securities issued by certain third-party Freddie Mac K-Series and SLST securitization entities that we consolidate. These
instruments are generally illiquid in nature and trade infrequently. Significant inputs in the valuation analysis are predominantly Level
3, due to the nature of these instruments and the lack of readily available market quotes. For ABS issued, we utilize both market comparable
pricing and discounted cash flow analysis valuation techniques. Relevant market indicators factored into the analysis include bid/ask
spreads, the amount and timing of collateral credit losses, interest rates, and collateral prepayment rates. Estimated fair values incorporate
market indicators as well as other significant unobservable inputs to generate discounted cash flows (Level 3). These cash flow models
use significant unobservable inputs such as discount rate, prepayment rate, default rate, loss severity and credit support. A decrease in
credit losses or discount rates, or an increase in prepayment rates, would generally cause the fair value of the ABS issued to decrease
(i.e., become a larger liability).
F- 54
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 5. Fair Value of Financial Instruments - (continued)
FHLBC borrowings
FHLBC borrowings include amounts borrowed from the FHLBC that are secured, generally by residential mortgage loans. As these
borrowings are secured and subject to margin calls and as the rates on these borrowings reset frequently to market rates, we believe that
carrying values approximate fair values (Level 2).
Financial Instruments Carried at Amortized Cost
Participation in loan warehouse facility
Our participation in a loan warehouse facility was carried at amortized cost (Level 2).
Guarantee obligations
In association with our risk-sharing transactions with the Agencies, we have made certain guarantees which are carried on our
balance sheet at amortized cost (Level 3).
Subordinate securities financing facility
Borrowings under our subordinate securities financing facility are secured by real estate securities and carried at unpaid principal
balance net of any unamortized deferred issuance costs (Level 3).
Convertible notes
Convertible notes include unsecured convertible and exchangeable senior notes that are carried at their unpaid principal balance net
of any unamortized deferred issuance costs. The fair value of the convertible notes is determined using quoted prices in generally active
markets (Level 2).
Trust preferred securities and subordinated notes
Trust preferred securities and subordinated notes are carried at their unpaid principal balance net of any unamortized deferred issuance
costs (Level 3).
Note 6. Residential Loans
We acquire residential loans from third-party originators and may sell or securitize these loans or hold them for investment. The
following table summarizes the classifications and carrying values of the residential loans owned at Redwood and at consolidated Sequoia
and Freddie Mac SLST entities at December 31, 2019 and December 31, 2018.
Table 6.1 – Classifications and Carrying Values of Residential Loans
December 31, 2019
(In Thousands)
Held-for-sale at fair value
Held-for-investment at fair value
Total Residential Loans
December 31, 2018
(In Thousands)
Held-for-sale at fair value
Held-for-investment at fair value
Total Residential Loans
Redwood
536,385
2,111,897
2,648,282
Redwood
1,048,801
2,383,932
3,432,733
$
$
$
$
$
$
$
$
Legacy
Sequoia
Sequoia
Choice
Freddie Mac
SLST
Total
— $
— $
— $
536,385
407,890
2,291,463
2,367,215
7,178,465
407,890
$
2,291,463
$
2,367,215
$
7,714,850
Legacy
Sequoia
Sequoia
Choice
Freddie Mac
SLST
Total
— $
— $
— $
1,048,801
519,958
2,079,382
1,222,669
6,205,941
519,958
$
2,079,382
$
1,222,669
$
7,254,742
F- 55
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 6. Residential Loans - (continued)
At December 31, 2019, we owned mortgage servicing rights associated with $2.03 billion (principal balance) of consolidated
residential loans purchased from third-party originators. The value of these MSRs is included in the carrying value of the associated loans
on our consolidated balance sheets. We contract with licensed sub-servicers that perform servicing functions for these loans.
Residential Loans Held-for-Sale
At Fair Value
At December 31, 2019, we owned 669 loans held-for-sale at fair value with an aggregate unpaid principal balance of $525 million
and a fair value of $536 million, compared to 1,484 loans with an aggregate unpaid principal balance of $1.03 billion and a fair value of
$1.05 billion at December 31, 2018. At December 31, 2019, one of these loans with a fair value of $0.6 million and an unpaid principal
balance of $0.7 million was greater than 90 days delinquent and none of these loans were in foreclosure. At December 31, 2018, one of
these loans with a fair value of $0.6 million and an unpaid principal balance of $0.7 million was greater than 90 days delinquent and none
of these loans were in foreclosure.
During the years ended December 31, 2019 and 2018, we purchased $5.73 billion and $7.07 billion (principal balance) of loans,
respectively, for which we elected the fair value option, and we sold $6.07 billion and $7.11 billion (principal balance) of loans, respectively,
for which we recorded net market valuation gains of $3 million and $23 million, respectively, through Mortgage banking activities, net
on our consolidated statements of income.
Residential Loans Held-for-Investment at Fair Value
At Redwood
At December 31, 2019, we owned 2,940 held-for-investment loans at Redwood with an aggregate unpaid principal balance of $2.05
billion and a fair value of $2.11 billion, compared to 3,296 loans with an aggregate unpaid principal balance of $2.39 billion and a fair
value of $2.38 billion at December 31, 2018. At December 31, 2019, two of these loans with a total fair value of $1 million and an unpaid
principal balance of $2 million were greater than 90 days delinquent and none of these loans were in foreclosure. At December 31, 2018,
two of these loans with an aggregate fair value and unpaid principal balance of $1 million were greater than 90 days delinquent and none
of these loans were in foreclosure.
During the years ended December 31, 2019 and 2018, we transferred loans with a fair value of $69 million and $286 million,
respectively, from held-for-sale to held-for-investment. During the years ended December 31, 2019 and 2018, we transferred loans with
a fair value of $23 million and $16 million, respectively, from held-for-investment to held-for-sale.
During the years ended December 31, 2019 and 2018, we recorded a net market valuation gain of $59 million and a net market
valuation loss of $30 million, respectively, on residential loans held-for-investment at fair value through Investment fair value changes,
net on our consolidated statements of income.
The outstanding loans held-for-investment at Redwood at December 31, 2019 were prime-quality, first-lien loans, of which 96%
were originated between 2013 and 2019, and 4% were originated in 2012 and prior years. The weighted average Fair Isaac Corporation
("FICO") score of borrowers backing these loans was 768 (at origination) and the weighted average loan-to-value ("LTV") ratio of these
loans was 66% (at origination). At December 31, 2019, these loans were comprised of 89% fixed-rate loans with a weighted average
coupon of 4.14%, and the remainder were hybrid or ARM loans with a weighted average coupon of 4.16%.
At Consolidated Legacy Sequoia Entities
At December 31, 2019, we consolidated 2,198 held-for-investment loans at consolidated Legacy Sequoia entities, with an aggregate
unpaid principal balance of $425 million and a fair value of $408 million, as compared to 2,641 loans at December 31, 2018, with an
aggregate unpaid principal balance of $545 million and a fair value of $520 million. At origination, the weighted average FICO score of
borrowers backing these loans was 727, the weighted average LTV ratio of these loans was 65%, and the loans were nearly all first lien
and prime-quality.
F- 56
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 6. Residential Loans - (continued)
At December 31, 2019 and December 31, 2018, the unpaid principal balance of loans at consolidated Sequoia entities delinquent
greater than 90 days was $10 million and $14 million, respectively, of which the unpaid principal balance of loans in foreclosure was $4
million and $5 million, respectively. During the years ended December 31, 2019 and 2018, we recorded net market valuation gains of
$5 million and $37 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of
income. Pursuant to the collateralized financing entity guidelines, the market valuation changes of these loans are based on the estimated
fair value of the associated ABS issued. The net impact to our income statement associated with our retained economic investment in the
Legacy Sequoia securitization entities is presented in Note 5.
At Consolidated Sequoia Choice Entities
At December 31, 2019, we consolidated 3,156 held-for-investment loans at consolidated Sequoia Choice entities, with an aggregate
unpaid balance of $2.24 billion and a fair value of $2.29 billion, as compared to 2,800 loans at December 31, 2018, with an aggregate
unpaid principal balance of $2.04 billion and a fair value of $2.08 billion. At origination, the weighted average FICO score of borrowers
backing these loans was 744, the weighted average LTV ratio of these loans was 75%, and the loans were all first lien and prime-quality.
At December 31, 2019, nine of these loans with an aggregate unpaid principal balance of $7 million were greater than 90 days delinquent
and three of these loans with an aggregate unpaid principal balance of $2 million were in foreclosure. At December 31, 2018, three of
these loans with an aggregate unpaid principal balance of $2 million were greater than 90 days delinquent and none of these loans were
in foreclosure.
During the years ended December 31, 2019 and 2018, we transferred loans with a fair value of $1.08 billion and $1.78 billion,
respectively, from held-for-sale to held-for-investment associated with Choice securitizations. During the years ended December 31, 2019
and 2018, we recorded net market valuation losses of $15 million and $13 million, respectively, on these loans through Investment fair
value changes, net on our consolidated statements of income. Pursuant to the collateralized financing entity guidelines, the market valuation
changes of these loans are based on the estimated fair value of the ABS issued associated with Choice securitizations. The net impact to
our income statement associated with our retained economic investment in the Sequoia Choice securitization entities is presented in Note
5.
At Consolidated Freddie Mac SLST Entities
Beginning in the fourth quarter of 2018, we invested in subordinate securities issued by certain Freddie Mac SLST securitization
trusts and were required to consolidate the underlying seasoned re-performing and non-performing residential loans owned at these
entities for financial reporting purposes in accordance with GAAP. At securitization, each of these mortgage loans was a fully amortizing,
fixed- or step-rate, first-lien loan that had been modified. At December 31, 2019, we consolidated 14,502 held-for-investment loans at
the consolidated Freddie Mac SLST entities, with an aggregate unpaid principal balance of $2.43 billion and a fair value of $2.37 billion,
as compared to 7,900 loans at December 31, 2018, with an aggregate unpaid principal balance of $1.31 billion and a fair value of $1.22
billion. At securitization, the weighted average FICO score of borrowers backing these loans was 600 and the weighted average LTV
ratio of these loans was 73%. At December 31, 2019, 587 of these loans with an aggregate unpaid principal balance of $135 million were
greater than 90 days delinquent and 208 of these loans with an aggregate unpaid principal balance of $33 million were in foreclosure. At
December 31, 2018, 306 of these loans with aggregate unpaid principal balance of $51 million were greater than 90 days delinquent and
none of these loans were in foreclosure.
F- 57
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 6. Residential Loans - (continued)
During the years ended December 31, 2019 and 2018, we recorded net market valuation gains of $64 million and $21 million,
respectively, on these loans through Investment fair value changes, net on our consolidated statements of income. Pursuant to the
collateralized financing entity guidelines, the market valuation changes of these loans are based on the estimated fair value of the ABS
issued associated with the Freddie Mac SLST securitizations. The net impact to our income statement associated with our economic
investment in the Freddie Mac SLST securitization entities is presented in Note 5.
Residential Loan Characteristics
The following table presents the geographic concentration of residential loans recorded on our consolidated balance sheets at
December 31, 2019 and December 31, 2018.
Table 6.2 – Geographic Concentration of Residential Loans
Geographic Concentration
(by Principal)
California
Washington
Texas
Colorado
Florida
New Jersey
New York
Other states (none greater than 5%)
Total
December 31, 2019
Held-for-Sale
Held-for-
Investment at
Legacy Sequoia
Held-for-
Investment at
Sequoia Choice
Held-for-
Investment at
Freddie Mac
SLST
Held-for-
Investment at
FVO
36%
7%
6%
6%
4%
2%
1%
38%
100%
18%
1%
6%
3%
14%
4%
10%
44%
100%
35%
7%
9%
4%
5%
2%
4%
34%
100%
14%
2%
3%
—%
10%
7%
10%
54%
100%
45%
5%
8%
4%
5%
2%
4%
27%
100%
Geographic Concentration
(by Principal)
California
Washington
Texas
Florida
New Jersey
New York
Other states (none greater than 5%)
Total
December 31, 2018
Held-for-Sale
Held-for-
Investment at
Legacy Sequoia
Held-for-
Investment at
Sequoia Choice
Held-for-
Investment at
Freddie Mac
SLST
Held-for-
Investment at
FVO
39%
7%
8%
4%
1%
5%
36%
100%
12%
2%
3%
10%
7%
10%
56%
100%
47%
5%
8%
5%
1%
3%
31%
100%
40%
10%
6%
4%
2%
3%
35%
100%
19%
1%
6%
13%
4%
10%
47%
100%
F- 58
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 6. Residential Loans - (continued)
The following table displays the loan product type and accompanying loan characteristics of residential loans recorded on our
consolidated balance sheets at December 31, 2019 and December 31, 2018.
Table 6.3 – Product Types and Characteristics of Residential Loans
Number
of
Loans
Interest
Rate(1)
Maturity
Date
Total
Principal
30-89
Days
DQ
90+
Days
DQ
December 31, 2019
(In Thousands)
Loan Balance
Held-for-Investment at Redwood:
Hybrid ARM loans
$250
$ — to
$500
to
$ 251
$750
to
$ 501
$1,000
to
$ 751
over $1,000
Fixed loans
$250
$ — to
$500
to
$ 251
$750
to
$ 501
to
$1,000
$ 751
over $1,000
Total HFI at Redwood:
3.50% to 4.50%
3.25% to 5.63%
2.88% to 5.13%
2.88% to 6.00%
3.00% to 5.50%
2043-09 - 2046-01
2041-01 - 2048-08
2041-09 - 2048-08
2043-12 - 2048-08
2040-10 - 2048-09
2.90% to 4.80%
2.75% to 6.00%
2.80% to 6.75%
2.75% to 6.63%
3.00% to 5.88%
2026-02 - 2047-12
2026-01 - 2049-04
2026-04 - 2049-05
2026-01 - 2049-04
2031-04 - 2049-05
12
51
97
90
49
299
38
676
1,091
519
317
2,641
2,940
Held-for-Investment at Legacy Sequoia:
ARM loans:
$ — to
$250
to
$ 251
$500
to
$ 501
$750
$1,000
to
$ 751
over $1,000
Hybrid ARM loans:
$ — to
to
$ 251
to
$ 501
over $1,000
$250
$500
$750
Total HFI at Legacy Sequoia:
1,685
345
87
45
24
2,186
2
7
2
1
12
2,198
Held-for-Investment at Sequoia Choice:
Fixed loans:
$250
$ — to
$500
to
$ 251
$750
to
$ 501
$1,000
to
$ 751
over $1,000
Total HFI at Sequoia Choice:
56
420
1,528
835
317
3,156
1.38% to 6.00%
1.25% to 5.63%
1.63% to 4.38%
1.63% to 4.38%
1.63% to 4.00%
2020-01 - 2035-11
2022-01 - 2036-05
2027-04 - 2035-02
2027-11 - 2036-03
2027-12 - 2035-04
4.25% to 4.50%
3.63% to 5.13%
4.50% to 4.50%
4.50% to 4.50%
2033-09 - 2033-10
2033-07 - 2034-06
2033-08 - 2033-08
2033-09 - 2033-09
2.75% to 5.50%
3.13% to 6.13%
3.13% to 6.75%
3.25% to 6.50%
3.50% to 5.88%
2038-02 - 2049-07
2037-12 - 2049-09
2037-02 - 2049-09
2035-04 - 2049-09
2038-01 - 2049-09
F- 59
$
$
$
$
$
$
2,423
20,781
61,708
77,550
64,937
227,399
6,549
287,984
669,159
447,499
414,188
1,825,379
2,052,778
169,230
120,261
53,811
37,756
38,341
419,399
465
2,494
1,181
1,291
5,431
424,830
10,743
184,455
940,914
719,609
384,959
2,240,680
$
$
$
$
$
$
— $
—
1,364
1,784
1,428
4,576
223
—
2,325
1,895
3,202
7,645
12,221
5,135
6,149
3,628
827
—
15,739
—
—
—
—
—
15,739
$
$
$
— $
2,282
13,020
7,856
1,108
24,266
$
—
—
—
971
—
971
—
—
614
—
—
614
1,585
3,109
3,835
1,211
1,648
—
9,803
—
—
—
—
—
9,803
—
—
2,366
3,297
1,093
6,756
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 6. Residential Loans - (continued)
Table 6.3 – Product Types and Characteristics of Residential Loans (continued)
December 31, 2019
(In Thousands)
Number
of
Loan Balance
Loans
Held-for-Investment at Freddie Mac SLST:
Fixed loans:
$250
$500
$750
$ — to
to
$ 251
to
$ 501
over $1,000
Total HFI at Freddie Mac SLST:
11,639
2,805
57
1
14,502
Interest
Rate(1)
Maturity
Date
Total
Principal
30-89
Days
DQ
90+
Days
DQ
2.00% to 11.00%
2.00% to 7.75%
2.00% to 6.75%
4.00% to 4.00%
2019-11 - 2059-10
2033-08 - 2058-11
2043-08 - 2058-07
2056-03 - 2056-03
$
$
$
$
1,501,538
894,125
31,350
1,021
2,428,034
1,254
432
33,611
28,573
28,013
91,883
481
6,234
186,251
139,786
100,293
433,045
524,928
$
$
$
$
477,592
297,732
8,787
1,021
785,132
$
$
79,632
52,920
2,623
—
135,175
— $
—
—
—
—
—
—
—
—
—
1,650
1,650
1,650
$
—
—
—
—
—
—
—
—
747
—
—
747
747
Held-for-Sale:
Hybrid ARM loans
$250
$ — to
$500
to
$ 251
$750
to
$ 501
to
$1,000
$ 751
over $1,000
Fixed loans
$250
$ — to
$500
to
$ 251
$750
to
$ 501
$1,000
to
$ 751
over $1,000
Total Held-for-Sale
5.20% to 7.00%
4.25% to 4.25%
3.00% to 5.50%
3.25% to 4.88%
3.25% to 5.25%
2047-08
2048-12
2049-08 - 2049-08
2047-04 - 2049-12
2047-04 - 2049-11
2048-06 - 2049-11
3.88% to 7.13%
3.63% to 6.50%
3.20% to 5.88%
3.50% to 6.50%
3.20% to 5.00%
2034-08 - 2049-07
2048-01 - 2050-01
2034-05 - 2050-01
2034-07 - 2050-01
2034-08 - 2050-01
7
1
52
33
22
115
2
13
301
161
77
554
669
F- 60
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 6. Residential Loans - (continued)
Table 6.3 – Product Types and Characteristics of Residential Loans (continued)
December 31, 2018
(In Thousands)
Loan Balance
Held-for-Investment at Redwood:
Hybrid ARM loans
$250
$ — to
$500
to
$ 251
$750
to
$ 501
to
$1,000
$ 751
over $1,000
Fixed loans
$250
$ — to
$500
to
$ 251
$750
to
$ 501
to
$1,000
$ 751
over $1,000
Total HFI at Redwood:
Held-for-Investment at Legacy Sequoia:
ARM loans:
$250
$ — to
$500
to
$ 251
$750
to
$ 501
to
$1,000
$ 751
over $1,000
Hybrid ARM loans:
$ — to
to
$ 251
to
$ 501
over $1,000
$250
$500
$750
Total HFI at Legacy Sequoia:
Held-for-Investment at Sequoia Choice:
Fixed loans:
$250
$ — to
$500
to
$ 251
$750
to
$ 501
to
$1,000
$ 751
over $1,000
Total HFI at Sequoia Choice:
Number
of
Loans
Interest
Rate(1)
Maturity
Date
Total
Principal
30-89
Days
DQ
90+
Days
DQ
12
59
116
129
69
385
36
679
1,213
599
384
2,911
3,296
1,988
424
110
61
37
2,620
4
10
6
1
21
2,641
29
336
1,363
761
311
2,800
2.88% to 4.88%
2.63% to 5.75%
2.88% to 5.75%
2.88% to 6.38%
3.00% to 5.50%
2043-09 - 2046-01
2043-08 - 2048-08
2043-03 - 2048-08
2043-09 - 2048-09
2040-10 - 2048-10
3.30% to 5.08%
2.75% to 5.75%
2.75% to 6.75%
2.75% to 6.13%
2.80% to 5.88%
2028-11 - 2047-12
2027-09 - 2048-11
2027-10 - 2048-11
2027-07 - 2048-11
2031-04 - 2048-11
1.25% to 5.50%
1.25% to 5.63%
1.63% to 4.50%
1.63% to 4.38%
1.63% to 4.38%
2019-02 - 2035-11
2023-05 - 2036-05
2022-01 - 2035-02
2027-11 - 2036-03
2027-12 - 2036-05
4.63% to 5.00%
2.63% to 4.88%
4.38% to 5.00%
4.88% to 4.88%
2033-08 - 2034-06
2033-07 - 2034-06
2033-08 - 2034-11
2033-09 - 2033-09
2.75% to
3.13% to
3.13% to
3.25% to
3.13% to
5.63% 2038-03 -
6.13% 2037-12 -
6.38% 2037-02 -
6.50% 2035-04 -
5.88% 2038-01 -
2048-09
2048-09
2048-09
2048-09
2048-09
$
$
$
$
$
$
2,190
23,986
73,360
111,879
92,151
303,566
6,737
292,730
746,503
517,075
518,719
2,081,764
2,385,330
206,490
148,154
67,471
51,918
61,710
535,743
769
3,675
3,667
1,355
9,466
545,209
5,484
149,917
841,692
659,845
384,072
2,041,010
$
$
$
$
$
$
59
—
692
—
1,112
1,863
—
—
1,320
903
2,000
4,223
6,086
7,179
5,989
1,309
791
1,023
16,291
—
—
—
—
—
16,291
$
$
$
$
— $
1,419
3,633
3,549
2,188
10,789
$
—
—
—
—
—
—
—
—
1,224
—
—
1,224
1,224
3,952
4,368
1,880
2,561
1,194
13,955
—
—
—
—
—
13,955
—
925
—
980
—
1,905
F- 61
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 6. Residential Loans - (continued)
Table 6.3 – Product Types and Characteristics of Residential Loans (continued)
December 31, 2018
(In Thousands)
Number
of
Loans
Loan Balance
Held-for-Investment at Freddie Mac SLST:
Fixed loans:
Interest
Rate(1)
Maturity
Date
Total
Principal
30-89
Days
DQ
90+
Days
DQ
$ — to
to
$ 251
to
$ 501
$250
$500
$750
Held-for-Sale:
Hybrid ARM loans
$ 251
$ 501
$ 751
$500
to
$750
to
$1,000
to
over $1,000
Fixed loans
$250
$ — to
$500
to
$ 251
$750
to
$ 501
to
$1,000
$ 751
over $1,000
Total Held-for-Sale
6,404
1,469
27
7,900
8
50
27
23
108
6
188
788
295
99
1,376
1,484
2.00% to 10.50%
2.00% to 7.38%
2.00% to 5.88%
2018-12 - 2058-10
2033-08 - 2058-11
2050-02 - 2057-12
3.88% to 5.38%
3.63% to 7.38%
3.88% to 5.25%
3.50% to 5.50%
2048-05 - 2048-12
2048-01 - 2049-01
2048-02 - 2049-01
2047-04 - 2048-12
4.38% to 5.75%
3.13% to 6.38%
3.75% to 7.00%
3.25% to 6.63%
3.75% to 6.13%
2048-08 - 2048-11
2029-04 - 2049-01
2033-11 - 2049-01
2033-12 - 2049-01
2032-10 - 2049-01
$
$
$
830,118
466,222
14,634
1,310,974
3,795
31,759
23,478
28,112
87,144
1,180
88,204
475,935
255,429
126,392
947,140
1,034,284
$
$
$
$
130,608
66,706
1,631
198,945
30,686
19,319
523
50,528
— $
—
—
—
—
—
—
559
—
—
559
559
$
—
—
—
—
—
—
—
747
—
—
747
747
(1) Rate is net of servicing fee for consolidated loans for which we do not own the MSR.
F- 62
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 7. Business Purpose Residential Loans
We originate business purpose residential loans, including single-family rental loans and residential bridge loans. This origination
activity commenced in connection with our acquisition of 5 Arches in March 2019.
Business Purpose Residential Loan Originations
During the period from March 1, 2019 to December 31, 2019, we funded $1.02 billion of business purpose residential loans, of which
$56 million of residential bridge loans and $20 million of single-family rental loans were sold to third parties. The remaining business
purpose residential loans were transferred to our investment portfolio (residential bridge loans and certain single-family rental loans), or
retained in our mortgage banking business (single-family rental loans) for future securitizations. Prior to the transfer of residential bridge
loans to our investment portfolio, we recorded a net market valuation gain of $5 million on these loans through Mortgage banking
activities, net on our consolidated statements of income for the period from March 1, 2019 to December 31, 2019, respectively. Market
valuation adjustments on our single-family rental loans are also recorded in Mortgage banking activities, net on our consolidated statements
of income prior to their sale or transfer to our investment portfolio. Additionally, during the period from March 1, 2019 to December 31,
2019, we recorded loan origination fee income associated with business purpose loans of $16 million through Mortgage banking activities,
net on our consolidated statements of income.
The following table summarizes the classifications and carrying values of the business purpose residential loans owned at Redwood
at December 31, 2019 and December 31, 2018.
Table 7.1 – Classifications and Carrying Values of Business Purpose Residential Loans
December 31, 2019
(In Thousands)
Held-for-sale at fair value
Held-for-investment at fair value
Total Business Purpose Residential Loans
December 31, 2018
(In Thousands)
Held-for-sale at fair value
Held-for-investment at fair value
Total Business Purpose Residential Loans
Single-Family Rental
Redwood
CAFL
Residential
Bridge
331,565
237,620
— $
2,192,552
569,185
$
2,192,552
$
— $
745,006
745,006
$
Single-Family Rental
Redwood
CAFL
Residential
Bridge
28,460
—
28,460
$
$
— $
—
— $
— $
112,798
112,798
$
$
$
$
$
Total
331,565
3,175,178
3,506,743
Total
28,460
112,798
141,258
Business Purpose Residential Loans Held-for-Sale at Fair Value
Single-Family Rental Loans
At December 31, 2019, we owned 201 single-family rental loans with an aggregate unpaid principal balance of $322 million and a
fair value of $332 million, as compared to 11 loans at December 31, 2018 with an aggregate unpaid principal balance of $28 million and
a fair value of $28 million. At December 31, 2019, two of these loans with an aggregate unpaid principal balance and fair value of $2
million were greater than 90 days delinquent, of which one of these loans with an unpaid principal balance of $0.1 million was in
foreclosure. At December 31, 2018, none of these loans were greater than 90 days delinquent or in foreclosure.
F- 63
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 7. Business Purpose Residential Loans - (continued)
During the period from March 1, 2019 to December 31, 2019, we originated $514 million of single-family rental loans. Additionally,
we acquired $407 million of single-family rental loans as part of our acquisition of CoreVest in the fourth quarter of 2019. During the
period from March 1, 2019 to December 31, 2019, $238 million of single-family rental loans were transferred to our investment portfolio
and financed with FHLB borrowings, and the remaining loans were retained in our mortgage banking business. During this same period,
we transferred $394 million of single-family rental loans from held-for-sale to held-for-investment associated with a CAFL securitization
and sold $20 million to third parties. During the first two months of 2019, prior to our acquisition of 5 Arches on March 1, 2019, we
purchased $19 million of single-family rental loans from 5 Arches. During the year ended December 31, 2019, we recorded a net market
valuation gain of $13 million on single-family rental loans held-for-sale at fair value through Mortgage banking activities, net on our
consolidated statements of income.
The outstanding single-family rental loans held-for-sale at December 31, 2019 were first-lien, fixed-rate loans with original maturities
of five, seven, or ten years. At December 31, 2019, the weighted average coupon of our single-family rental loans was 4.96% and the
weighted average remaining loan term was nine years. At origination, the weighted average LTV ratio of these loans was 69% and the
weighted average debt service coverage ratio ("DSCR") was 1.43 times.
Business Purpose Residential Loans Held-for-Investment at Fair Value
Single-Family Rental Loans at Redwood
At December 31, 2019, we owned 107 single-family rental loans held-for-investment with an aggregate unpaid principal balance
of $231 million and a fair value of $238 million. At December 31, 2019, none of these loans were greater than 90 days delinquent or in
foreclosure. During the year ended December 31, 2019, we transferred loans with a fair value of $238 million from held-for-sale to held-
for-investment. During the year ended December 31, 2019, we recorded a net market valuation gain of $0.3 million on single-family
rental loans held-for-investment at fair value through Investment fair value changes, net on our consolidated statements of income.
The outstanding single-family rental loans held-for-investment at Redwood at December 31, 2019 were first-lien, fixed-rate loans
with original maturities of five, seven, or ten years. At December 31, 2019, the weighted average coupon of our single-family rental loans
was 4.89% and the weighted average remaining loan term was seven years. At origination, the weighted average LTV ratio of these loans
was 68% and the weighted average DSCR was 1.36 times.
Single-Family Rental Loans at CAFL
In conjunction with our acquisition of CoreVest in the fourth quarter of 2019, we consolidated the single-family rental loans owned
at certain CAFL securitization entities. At December 31, 2019, we consolidated 783 held-for-investment single-family rental loans at the
consolidated CAFL entities, with an aggregate unpaid principal balance of $2.08 billion and a fair value of $2.19 billion. The outstanding
single-family rental loans held-for-investment at CAFL at December 31, 2019 were first-lien, fixed-rate loans with original maturities
of five, seven, or ten years. At December 31, 2019, the weighted average coupon of our single-family rental loans was 5.70% and the
weighted average remaining loan term was seven years. At origination, the weighted average LTV ratio of these loans was 68% and the
weighted average DSCR was 1.35 times. At December 31, 2019, 18 of these loans with an aggregate unpaid principal balance of $29
million were greater than 90 days delinquent and five of these loans with an aggregate unpaid principal balance of $9 million were in
foreclosure.
During the year ended December 31, 2019, we recorded a net market valuation loss of $15 million on these loans through Investment
fair value changes, net on our consolidated statements of income. Pursuant to the collateralized financing entity guidelines, the market
valuation changes of these loans are based on the estimated fair value of the ABS issued associated with CAFL securitizations. The net
impact to our income statement associated with our retained economic investment in the CAFL securitization entities is presented in Note
5. Additionally, as part of our acquisition of CoreVest during the year ended December 31, 2019, we acquired REO with a fair value of
$2 million related to loans at CAFL entities, which is included in Other assets on our consolidated balance sheets.
F- 64
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 7. Business Purpose Residential Loans - (continued)
Residential Bridge Loans
At December 31, 2019, we owned 2,653 residential bridge loans held-for-investment with an aggregate unpaid principal balance of
$741 million and a fair value of $745 million as compared to 157 loans at December 31, 2018 with an aggregate unpaid principal balance
of $112 million and a fair value of $113 million.
As part of our credit risk management practices, our residential bridge loans are subject to individual risk assessment using an internal
borrower and collateral quality evaluation framework. At December 31, 2019, 31 loans with an aggregate fair value of $12 million and
an unpaid principal balance of $14 million were in foreclosure, of which 15 of these loans with an aggregate fair value of $7 million and
an unpaid principal balance of $9 million were greater than 90 days delinquent. At December 31, 2018, seven loans with an aggregate
fair value of $12 million were greater than 90 days delinquent and four of these loans with an aggregate fair value of $11 million were
in foreclosure. During the year ended December 31, 2019, we transferred three loans with a fair value of $8 million to REO, which is
included in Other assets on our consolidated balance sheets.
During the period from March 1, 2019 to December 31, 2019, $448 million of newly originated residential bridge loans were
transferred to our investment portfolio. Additionally, we acquired $375 million of residential bridge loans as part of our acquisition of
CoreVest during the fourth quarter of 2019. During the first two months of 2019, prior to our acquisition of 5 Arches on March 1, 2019,
we purchased $10 million of residential bridge loans from 5 Arches. During the year ended December 31, 2019, we recorded a net market
valuation loss of $2 million on residential bridge loans held-for-investment at fair value through Investment fair value changes, net on
our consolidated statements of income.
The outstanding residential bridge loans held-for-investment at December 31, 2019 were first lien, fixed-rate, interest-only loans
with a weighted average coupon of 8.11% and original maturities of six to 24 months. At origination, the weighted average FICO score
of borrowers backing these loans was 732 and the weighted average LTV ratio of these loans was 70%.
At December 31, 2019, we had a $173 million commitment to fund residential bridge loans. See Note 16 for additional information
on this commitment.
F- 65
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 7. Business Purpose Residential Loans - (continued)
Business Purpose Residential Loan Characteristics
The following table presents the geographic concentration of business purpose residential loans recorded on our consolidated balance
sheets at December 31, 2019.
Table 7.2 – Geographic Concentration of Business Purpose Residential Loans
Geographic Concentration
(by Principal)
Florida
Texas
New Jersey
New York
California
Utah
Georgia
Alabama
Arkansas
Maryland
Illinois
Other states (none greater than 5%)
Total
Geographic Concentration
(by Principal)
Florida
Texas
California
Utah
Other states (none greater than 5%)
Total
December 31, 2019
Single-Family Rental
Held-for-Sale
Single-Family Rental
Held-for-Investment
at Redwood
Single-Family Rental
Held-for-Investment
at CAFL
Residential Bridge
5%
19%
12%
5%
2%
—%
8%
5%
6%
6%
1%
31%
100%
—%
12%
5%
1%
1%
—%
—%
—%
—%
—%
—%
81%
100%
8%
15%
11%
1%
7%
—%
5%
4%
2%
2%
5%
40%
100%
9%
3%
8%
6%
21%
5%
7%
4%
—%
—%
3%
34%
100%
December 31, 2018
Single-Family Rental
Held-for-Sale
Single-Family Rental
Held-for-Investment
at Redwood
Single-Family Rental
Held-for-Investment
at CAFL
Residential Bridge
69%
14%
—%
—%
17%
100%
—%
—%
—%
—%
—%
—%
—%
—%
—%
—%
—%
—%
7%
—%
79%
5%
9%
100%
F- 66
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 7. Business Purpose Residential Loans - (continued)
The following table displays the loan product type and accompanying loan characteristics of business purpose residential loans
recorded on our consolidated balance sheets at December 31, 2019.
Table 7.3 – Product Types and Characteristics of Business Purpose Residential Loans
December 31, 2019
(In Thousands)
Number
of
Loans
Interest
Rate
Maturity
Date
Total
Principal
30-89
Days
DQ
90+
Days
DQ
Loan Balance
Single-Family Rental Held-for-Investment at Redwood:
Fixed loans:
$ 251
$ 501
$ 751
to
$500
to
$750
$1,000
to
over $1,000
Total SFR HFI at Redwood:
20
26
16
45
107
4.88% to 7.47%
4.45% to 7.25%
4.91% to 6.58%
3.93% to 6.94%
2024-02 - 2030-01
2023-09 - 2030-01
2023-11 - 2029-09
2023-10 - 2030-01
Single-Family Rental Held-for-Investment at CAFL:
Fixed loans:
$250
$ — to
$500
to
$ 251
$750
to
$ 501
$1,000
to
$ 751
over $1,000
Total SFR HFI at CAFL:
Single-Family Rental Held-for-Sale:
Fixed loans:
$250
$ — to
$500
to
$ 251
$750
to
$ 501
to
$1,000
$ 751
over $1,000
Total Single-Family Rental HFS:
Residential Bridge:
Fixed loans:
$250
$ — to
$500
to
$ 251
$750
to
$ 501
to
$1,000
$ 751
over $1,000
Total Residential Bridge:
2
56
148
98
479
783
85
9
21
13
73
201
2,207
198
71
40
137
2,653
5.46% to 5.80%
4.92% to 7.05%
4.75% to 7.31%
4.62% to 7.23%
4.31% to 7.57%
2019-11 - 2021-09
2020-03 - 2029-10
2020-03 - 2029-10
2020-03 - 2029-10
2019-12 - 2029-11
5.50% to 7.63%
4.94% to 6.00%
4.55% to 5.96%
5.00% to 5.93%
4.35% to 6.28%
2027-03 - 2050-01
2024-11 - 2050-01
2024-01 - 2030-01
2024-01 - 2030-01
2024-01 - 2030-01
6.53% to 12.00%
6.99% to 13.00%
6.99% to 9.99%
7.28% to 10.00%
5.79% to 10.25%
2019-07 - 2022-01
2019-10 - 2022-01
2019-11 - 2021-10
2018-10 - 2022-01
2019-11 - 2022-01
F- 67
$
$
$
$
$
$
$
$
$
7,925
15,620
13,616
194,050
231,211
398
25,643
91,414
85,472
1,875,287
2,078,214
10,506
3,708
13,335
11,676
282,411
321,636
197,449
71,361
42,862
34,646
394,914
741,232
$
$
$
$
$
$
$
$
$
— $
—
—
—
— $
— $
$
1,306
1,259
1,639
18,567
22,771
$
— $
—
—
—
—
— $
1,447
2,811
2,072
1,771
31,452
39,553
$
$
—
—
—
—
—
—
—
1,990
879
26,170
29,039
130
—
—
—
1,688
1,818
369
675
508
2,443
4,994
8,989
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 7. Business Purpose Residential Loans - (continued)
December 31, 2018
(In Thousands)
Loan Balance
Single-Family Rental Held-for-Sale:
Fixed loans:
$ 251
$ 501
$ 751
$500
to
$750
to
to
$1,000
over $1,000
Total Single-Family Rental HFS:
Residential Bridge:
Fixed loans:
$250
$ — to
$500
to
$ 251
$750
to
$ 501
to
$1,000
$ 751
over $1,000
Total Residential Bridge:
Note 8. Multifamily Loans
Number
of
Loans
Interest
Rate
Maturity
Date
Total
Principal
30-89
Days
DQ
90+
Days
DQ
2
2
3
4
11
50
38
21
19
29
157
6.79% to 7.47%
6.12% to 7.25%
5.91% to 6.58%
5.62% to 6.94%
2028-08 - 2028-12
2023-09 - 2028-11
2023-11 - 2028-12
2023-10 - 2025-12
8.00% to 12.00%
8.00% to 10.00%
7.50% to 10.00%
7.50% to 10.00%
8.00% to 10.00%
2018-07 - 2020-05
2018-09 - 2019-12
2019-01 - 2019-12
2019-04 - 2019-12
2018-09 - 2019-12
$
$
$
$
787
1,252
2,488
23,039
27,566
7,941
13,297
12,410
16,937
61,775
112,360
$
$
$
$
— $
—
—
—
— $
—
—
—
—
—
262
636
1,769
840
1,484
4,991
$
$
695
469
—
—
10,970
12,134
Since 2018, we have invested in multifamily subordinate securities issued by three Freddie Mac K-Series securitization trusts and
were required to consolidate the underlying multifamily loans owned at these entities for financial reporting purposes in accordance with
GAAP. At December 31, 2019, we consolidated 279 held-for-investment multifamily loans, with an aggregate unpaid principal balance
of $4.20 billion and a fair value of $4.41 billion, as compared to 162 loans at December 31, 2018 with an aggregate unpaid principal
balance of $2.13 billion and a fair value of $2.14 billion. The outstanding multifamily loans held-for-investment at the Freddie Mac K-
Series entities at December 31, 2019 were first-lien, fixed-rate loans that were originated between 2015 and 2017 and had original loan
terms of seven to ten years and an original weighted average LTV ratio of 69%. At December 31, 2019, the weighted average coupon of
these multifamily loans was 4.13% and the weighted average remaining loan term was six years. At December 31, 2019 and December 31,
2018, none of these loans were greater than 90 days delinquent or in foreclosure.
During the years ended December 31, 2019 and 2018, we recorded net market valuation gains of $130 million and $47 million,
respectively, on these loans through Investment fair value changes, net on our consolidated statements of income. Pursuant to the
collateralized financing entity guidelines, the market valuation changes of these loans are based on the estimated fair value of the ABS
issued associated with the securitizations. The net impact to our income statement associated with our economic investment in the securities
of the Freddie Mac K-Series securitization entities is presented in Note 5.
F- 68
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 8. Multifamily Loans - (continued)
Multifamily Loan Characteristics
The following table presents the geographic concentration of multifamily loans recorded on our consolidated balance sheets at
December 31, 2019.
Table 8.1 – Geographic Concentration of Multifamily Loans
Geographic Concentration
(by Principal)
Texas
California
Florida
Arizona
Georgia
Washington
Colorado
Other states (none greater than 5%)
Total
December 31, 2019
December 31, 2018
13%
11%
10%
6%
6%
5%
5%
44%
100%
9%
11%
—%
8%
6%
—%
—%
66%
100%
The following table displays the loan product type and accompanying loan characteristics of multifamily loans recorded on our
consolidated balance sheets at December 31, 2019.
Table 8.2 – Product Types and Characteristics of Multifamily Loans
December 31, 2019
(In Thousands)
Loan Balance
Fixed loans:
$ 1,000
$ 10,001
$ 20,001
$ 30,001
$10,000
to
$20,000
to
$30,000
to
to
$40,000
over $40,000
Total:
December 31, 2018
(In Thousands)
Loan Balance
Fixed loans:
$ 1,000
$ 10,001
$ 20,001
$ 30,001
$10,000
to
$20,000
to
$30,000
to
$40,000
to
over $40,000
Total:
Number
of
Loans
114
102
32
19
12
279
Number
of
Loans
70
66
16
7
3
162
Interest
Rate
Maturity
Date
Total
Principal
30-89
Days
DQ
90+
Days
DQ
3.29% to 4.73%
3.54% to 4.94%
3.54% to 4.69%
3.52% to 4.79%
3.55% to 4.65%
2023-02 - 2029-10
2023-09 - 2029-08
2024-01 - 2026-12
2025-05 - 2029-10
2024-10 - 2026-09
Interest
Rate
Maturity
Date
3.29% to 4.73%
3.54% to 4.61%
3.65% to 4.72%
3.62% to 4.71%
3.74% to 4.18%
2023-02 - 2027-01
2023-09 - 2027-01
2024-01 - 2026-12
2025-11 - 2026-06
2024-10 - 2026-06
$
$
$
$
674,666
1,489,118
750,712
654,729
625,775
4,195,000
Total
Principal
394,373
960,992
373,036
244,074
154,223
2,126,698
$
$
$
$
— $
—
—
—
—
— $
30-89
Days
DQ
90+
Days
DQ
— $
—
—
—
—
— $
—
—
—
—
—
—
—
—
—
—
—
—
F- 69
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 9. Real Estate Securities
We invest in real estate securities that we acquire from third parties or create and retain from our Sequoia securitizations. The following
table presents the fair values of our real estate securities by type at December 31, 2019 and December 31, 2018.
Table 9.1 – Fair Values of Real Estate Securities by Type
(In Thousands)
Trading
Available-for-sale
Total Real Estate Securities
December 31, 2019
December 31, 2018
$
$
860,540
239,334
1,099,874
$
$
1,118,612
333,882
1,452,494
Our real estate securities include mortgage-backed securities, which are presented in accordance with their general position within
a securitization structure based on their rights to cash flows. Senior securities are those interests in a securitization that generally have
the first right to cash flows and are last in line to absorb losses. Mezzanine securities are interests that are generally subordinate to senior
securities in their rights to receive cash flows, and have subordinate securities below them that are first to absorb losses. Many of our
mezzanine classified securities were initially rated AA through BBB- and issued in 2012 or later. Subordinate securities are all interests
below mezzanine. Excluding our re-performing loan securities, nearly all of our residential securities are supported by collateral that was
designated as prime at the time of issuance.
Trading Securities
The following table presents the fair value of trading securities by position and collateral type at December 31, 2019 and December 31,
2018.
Table 9.2 – Trading Securities by Position
(In Thousands)
Senior
Mezzanine
Subordinate
Total Trading Securities
December 31, 2019
December 31, 2018
$
$
150,067
$
538,489
171,984
158,670
610,819
349,123
860,540
$
1,118,612
We elected the fair value option for certain securities and classify them as trading securities. Our trading securities include both
residential and multifamily mortgage-backed securities, and our residential securities also include securities backed by re-performing
loans ("RPL"). At December 31, 2019 and 2018, our senior trading securities included $64 million and $82 million of interest-only
securities, respectively, for which there is no principal balance, and the unpaid principal balance of our remaining senior trading securities
was $84 million and $78 million, respectively. Our interest-only securities included $36 million and $43 million of A-IO-S securities at
December 31, 2019 and 2018, respectively, which are securities we retained from certain of our Sequoia securitizations that represent
certificated servicing strips. At December 31, 2019 and 2018, our senior trading securities included $55 million and $48 million of RPL
securities, respectively.
At December 31, 2019 and 2018, our mezzanine trading securities had an unpaid principal balance of $537 million and $646 million,
respectively. At December 31, 2019 and 2018, the fair value of our mezzanine securities was $538 million and $611 million, respectively,
and included $39 million and $68 million of Sequoia securities, respectively, $395 million and $429 million of multifamily securities,
respectively, and $104 million and $114 million of other third party residential securities, respectively, including $30 million and $11
million of RPL securities, respectively.
F- 70
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 9. Real Estate Securities - (continued)
At December 31, 2019 and 2018, our subordinate trading securities had an unpaid principal balance of $302 million and $476 million,
respectively. At December 31, 2019 and 2018, the fair value of our subordinate securities was $172 million and $349 million, respectively,
and included $90 million and $277 million of Agency residential mortgage CRT securities, respectively, and $82 million and $72 million
of other third party residential securities, respectively, including $76 million and $63 million of RPL securities, respectively.
During the years ended December 31, 2019 and 2018, we acquired $367 million and $688 million (principal balance), respectively,
of securities for which we elected the fair value option and classified as trading, and sold $593 million and $415 million, respectively,
of such securities. During the years ended December 31, 2019 and 2018, we recorded a net market valuation gain of $56 million and a
net market valuation loss of $8 million, respectively, on trading securities, included in Investment fair value changes, net on our consolidated
statements of income.
AFS Securities
The following table presents the fair value of our available-for-sale securities by position and collateral type at December 31, 2019
and December 31, 2018.
Table 9.3 – Available-for-Sale Securities by Position
(In Thousands)
Senior
Mezzanine
Subordinate
Total AFS Securities
December 31, 2019
December 31, 2018
$
$
25,792
$
13,687
199,855
239,334
$
87,615
36,407
209,860
333,882
At December 31, 2019, our available-for-sale securities were comprised of $230 million of residential mortgage-backed securities
and $9 million of multifamily mortgage-backed securities. At December 31, 2018, our available-for-sale securities were comprised entirely
of residential mortgage-backed securities. During the years ended December 31, 2019 and 2018, we purchased $27 million and $8 million
of AFS securities, respectively, and sold $110 million and $144 million of AFS securities, respectively, which resulted in net realized
gains of $18 million and $27 million, respectively.
We often purchase AFS securities at a discount to their outstanding principal balances. To the extent we purchase an AFS security
that has a likelihood of incurring a loss, we do not amortize into income the portion of the purchase discount that we do not expect to
collect due to the inherent credit risk of the security. We may also expense a portion of our investment in the security to the extent we
believe that principal losses will exceed the purchase discount. We designate any amount of unpaid principal balance that we do not
expect to receive, and thus do not expect to earn or recover, as a credit reserve on the security. Any remaining net unamortized discounts
or premiums on the security are amortized into income over time using the effective yield method.
At December 31, 2019, there were no AFS securities with contractual maturities less than five years, $8 million with contractual
maturities greater than five years but less than 10 years, and the remainder of our AFS securities had contractual maturities greater than
10 years.
F- 71
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 9. Real Estate Securities - (continued)
The following table presents the components of carrying value (which equals fair value) of AFS securities at December 31, 2019
and December 31, 2018.
Table 9.4 – Carrying Value of AFS Securities
December 31, 2019
(In Thousands)
Principal balance
Credit reserve
Unamortized discount, net
Amortized cost
Gross unrealized gains
Gross unrealized losses
Carrying Value
December 31, 2018
(In Thousands)
Principal balance
Credit reserve
Unamortized discount, net
Amortized cost
Gross unrealized gains
Gross unrealized losses
Carrying Value
Senior
Mezzanine
Subordinate
Total
$
13,512
$
$
$
$
$
26,331
(533)
(10,427)
15,371
10,450
(29)
25,792
Senior
91,736
(7,790)
(18,460)
65,486
22,178
(49)
87,615
$
$
—
(527)
12,985
702
—
13,687
$
36,852
$
—
(3,697)
33,155
3,252
—
264,234
(32,407)
(113,301)
118,526
81,329
—
199,855
302,524
(33,580)
(129,043)
139,901
70,458
(499)
209,860
$
$
$
304,077
(32,940)
(124,255)
146,882
92,481
(29)
239,334
Total
431,112
(41,370)
(151,200)
238,542
95,888
(548)
$
333,882
Mezzanine
Subordinate
$
36,407
$
The following table presents the changes for the years ended December 31, 2019 and 2018, in unamortized discount and designated
credit reserves on residential AFS securities.
Table 9.5 – Changes in Unamortized Discount and Designated Credit Reserves on AFS Securities
(In Thousands)
Beginning balance
Amortization of net discount
Realized credit losses
Acquisitions
Sales, calls, other
Impairments
Year Ended December 31, 2019
Year Ended December 31, 2018
Credit
Reserve
Unamortized
Discount, Net
Credit
Reserve
Unamortized
Discount, Net
$
41,370
$
$
46,549
$
151,200
(7,921)
—
1,910
(21,017)
—
83
—
(2,165)
6,315
(1,850)
89
(7,568)
41,370
$
183,753
(14,098)
—
2,716
(28,739)
—
7,568
151,200
Transfers to (release of) credit reserves, net
Ending Balance
$
$
124,255
$
—
(2,606)
3,712
(9,453)
—
(83)
32,940
F- 72
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 9. Real Estate Securities - (continued)
AFS Securities with Unrealized Losses
The following table presents the components comprising the total carrying value of residential AFS securities that were in a gross
unrealized loss position at December 31, 2019 and December 31, 2018.
Table 9.6 – Components of Fair Value of AFS Securities by Holding Periods
(In Thousands)
December 31, 2019
December 31, 2018
Less Than 12 Consecutive Months
12 Consecutive Months or Longer
Amortized
Cost
Unrealized
Losses
Fair
Value
Amortized
Cost
Unrealized
Losses
Fair
Value
$
— $
— $
— $
12,923
(499)
12,424
$
5,830
7,464
(29) $
(49)
5,801
7,415
At December 31, 2019, after giving effect to purchases, sales, and extinguishment due to credit losses, our consolidated balance
sheet included 107 AFS securities, of which one was in an unrealized loss position and one was in a continuous unrealized loss position
for 12 consecutive months or longer. At December 31, 2018, our consolidated balance sheet included 128 AFS securities, of which seven
were in an unrealized loss position and three were in a continuous unrealized loss position for 12 consecutive months or longer.
Evaluating AFS Securities for Other-than-Temporary Impairments
Gross unrealized losses on our AFS securities were less than $0.1 million at December 31, 2019. We evaluate all securities in an
unrealized loss position to determine if the impairment is temporary or other-than-temporary (resulting in an OTTI). At December 31,
2019, we did not intend to sell any of our AFS securities that were in an unrealized loss position, and it is more likely than not that we
will not be required to sell these securities before recovery of their amortized cost basis, which may be at their maturity. We review our
AFS securities that are in an unrealized loss position to identify those securities with losses that are other-than-temporary based on an
assessment of changes in expected cash flows for such securities, which considers recent security performance and expected future
performance of the underlying collateral.
For the year ended December 31, 2019, there were no other-than-temporary impairments related to our AFS securities. AFS securities
for which OTTI is recognized have experienced, or are expected to experience, credit-related adverse cash flow changes. In determining
our estimate of cash flows for AFS securities we may consider factors such as structural credit enhancement, past and expected future
performance of underlying mortgage loans, including timing of expected future cash flows, which are informed by prepayment rates,
default rates, loss severities, delinquency rates, percentage of non-performing loans, FICO scores at loan origination, year of origination,
loan-to-value ratios, and geographic concentrations, as well as general market assessments. Changes in our evaluation of these factors
impacted the cash flows expected to be collected at the OTTI assessment date and were used to determine if there were credit-related
adverse cash flows and if so, the amount of credit related losses. Significant judgment is used in both our analysis of the expected cash
flows for our AFS securities and any determination of the credit loss component of OTTI.
The table below summarizes the significant valuation assumptions we used for our AFS securities in unrealized loss positions at
December 31, 2019.
Table 9.7 – Significant Valuation Assumptions
December 31, 2019
Prepayment rates
Projected losses
Range for Securities
15% - 15%
1% - 1%
F- 73
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 9. Real Estate Securities - (continued)
The following table details the activity related to the credit loss component of OTTI (i.e., OTTI recognized through earnings) for
AFS securities held at December 31, 2019, 2018, and 2017 for which a portion of an OTTI was recognized in other comprehensive
income.
Table 9.8 – Activity of the Credit Component of Other-than-Temporary Impairments
(In Thousands)
Balance at beginning of period
Additions
Initial credit impairments
Subsequent credit impairments
Reductions
Securities sold, or expected to sell
Securities with no outstanding principal at period end
Balance at End of Period
Years Ended December 31,
2018
2017
2019
$
18,652
$
21,037
$
28,261
—
—
76
—
(77)
(4,417)
14,158
$
(1,218)
(1,243)
18,652
$
178
47
(4,898)
(2,551)
$
21,037
Gains and losses from the sale of AFS securities are recorded as Realized gains, net, in our consolidated statements of income. The
following table presents the gross realized gains and losses on sales and calls of AFS securities for the years ended December 31, 2019,
2018, and 2017.
Table 9.9 – Gross Realized Gains and Losses on AFS Securities
(In Thousands)
Gross realized gains - sales
Gross realized gains - calls
Gross realized losses - sales
Gross realized losses - calls
Total Realized Gains on Sales and Calls of AFS Securities, net
Years Ended December 31,
2019
2018
2017
$
17,582
$
27,127
$
13,927
6,239
—
—
43
(129)
—
677
—
(497)
$
23,821
$
27,041
$
14,107
F- 74
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 10. Other Investments
Other investments at December 31, 2019 and December 31, 2018 are summarized in the following table.
Table 10.1 – Components of Other Investments
(In Thousands)
Servicer advance investments
Shared home appreciation options
Mortgage servicing rights
Investment in multifamily loan fund
Excess MSRs
Participation in loan warehouse facility
Investment in 5 Arches
Other
Total Other Investments
Servicer advance investments
December 31, 2019
December 31, 2018
$
169,204
$
45,085
42,224
39,802
31,814
—
—
$
30,001
358,130
$
300,468
—
60,281
—
27,312
39,703
10,754
—
438,518
In 2018, we and a third-party co-investor, through two partnerships (“SA Buyers”) consolidated by us, purchased the outstanding
servicer advances and excess MSRs related to a portfolio of legacy residential mortgage-backed securitizations serviced by the co-investor
(See Note 4 for additional information regarding the transaction). At December 31, 2019, we had funded $71 million of total capital to
the SA Buyers (see Note 16 for additional detail).
Our servicer advance investments (owned by the consolidated SA Buyers) are comprised of outstanding servicer advance receivables,
the requirement to purchase all future servicer advances made with respect to a specified pool of residential mortgage loans, and a portion
of the mortgage servicing fees from the underlying loan pool. A portion of the remaining mortgage servicing fees from the underlying
loan pool are paid directly to the third-party servicer for the performance of servicing duties and a portion is paid to excess MSRs that
we own as a separate investment. We hold our servicer advance investments at our taxable REIT subsidiaries.
Servicer advances are non-interest bearing and are a customary feature of residential mortgage securitization transactions. Servicer
advances are generally reimbursable cash payments made by a servicer when the borrower fails to make scheduled payments due on a
residential mortgage loan or to support the value of the collateral property. Servicer advances typically fall into three categories:
•
Principal and Interest Advances: cash payments made by the servicer to cover scheduled principal and interest payments on a
residential mortgage loan that have not been paid on a timely basis by the borrower.
• Escrow Advances (Taxes and Insurance Advances): Cash payments made by the servicer to third parties on behalf of the borrower
for real estate taxes and insurance premiums on the property that have not been paid on a timely basis by the borrower.
• Corporate Advances: Cash payments made by the servicer to third parties for the reimbursable costs and expenses incurred in
connection with the foreclosure, preservation and sale of the mortgaged property, including attorneys’ and other professional
fees.
Servicer advances are generally permitted to be repaid from amounts received with respect to the related residential mortgage loan,
including payments from the borrower or amounts received from the liquidation of the property securing the loan. Residential mortgage
servicing agreements generally require a servicer to make advances in respect of serviced residential mortgage loans unless the servicer
determines in good faith that the advance would not be ultimately recoverable from the proceeds of the related residential mortgage loan
or the mortgaged property.
F- 75
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 10. Other Investments - (continued)
At December 31, 2019, our servicer advance investments had a carrying value of $169 million and were associated with a portfolio
of residential mortgage loans with an unpaid principal balance of $7.94 billion. The outstanding servicer advance receivables associated
with this investment were $152 million at December 31, 2019, which were financed with short-term non-recourse securitization debt
(see Note 13 for additional detail on this debt). The servicer advance receivables were comprised of the following types of advances at
December 31, 2019 and December 31, 2018:
Table 10.2 – Components of Servicer Advance Receivables
(In Thousands)
Principal and interest advances
Escrow advances (taxes and insurance advances)
Corporate advances
Total Servicer Advance Receivables
December 31, 2019
December 31, 2018
$
$
15,081
$
96,732
39,769
151,582
$
144,336
94,828
47,614
286,778
We account for our servicer advance investments at fair value and during the years ended December 31, 2019 and 2018, we recorded
$11 million and $1 million of interest income associated with these investments, respectively, and recorded a net market valuation gain
of $3 million and a net market valuation loss of $1 million, respectively, through Investment fair value changes, net in our consolidated
statements of income.
Mortgage Servicing Rights
We invest in mortgage servicing rights associated with residential mortgage loans and contract with licensed sub-servicers to perform
all servicing functions for these loans. The majority of our investments in MSRs were made through the retention of servicing rights
associated with the residential jumbo mortgage loans that we acquired and subsequently transferred to third parties. We hold our MSR
investments at our taxable REIT subsidiaries.
At December 31, 2019 and December 31, 2018, our MSRs had a fair value of $42 million and $60 million, respectively, and were
associated with loans with an aggregate principal balance of $4.35 billion and $4.93 billion, respectively.
The following table presents activity for MSRs for the years ended December 31, 2019, 2018, and 2017.
Table 10.3 – Activity for MSRs
(In Thousands)
Balance at beginning of period
Additions
Sales
Changes in fair value due to:
Changes in assumptions (1)
Other changes (2)
Balance at End of Period
Years Ended December 31,
2018
2017
2019
$
60,281
$
63,598
$
118,526
868
—
328
(1,077)
8,026
(52,788)
(10,659)
(8,266)
42,224
$
4,434
(7,002)
60,281
$
(1,088)
(9,078)
63,598
$
(1) Primarily reflects changes in prepayment assumptions due to changes in market interest rates.
(2) Represents changes due to the realization of expected cash flows.
F- 76
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 10. Other Investments - (continued)
The following table presents the components of our MSR income for the years ended December 31, 2019, 2018, and 2017.
Table 10.4 – Components of MSR Income, net
(In Thousands)
Servicing income
Cost of sub-servicer
Net servicing fee income
Market valuation changes of MSRs
Market valuation changes of associated derivatives (1)
MSR reversal of provision for repurchases
MSR Income, Net
Years Ended December 31,
2018
2019
2017
$
$
$
15,038
(1,465)
13,573
(18,856)
8,596
208
3,521
$
15,372
(1,444)
13,928
(2,508)
(4,734)
390
7,076
$
$
21,120
(2,828)
18,292
(10,166)
(568)
302
7,860
(1) MSR income, net is included in Other income on our consolidated statements of income.
Excess MSRs
In association with our servicer advance investments described above, in the fourth quarter of 2018, we (through our consolidated
SA Buyers) also invested in excess MSRs associated with the same portfolio of legacy residential mortgage-backed securitizations.
Additionally, beginning in 2018, we invested in excess MSRs associated with specified pools of multifamily loans. We account for our
excess MSRs at fair value and during the years ended December 31, 2019 and 2018, we recognized $8 million and $1 million of interest
income, respectively, through Other interest income, and recorded a net market valuation loss of $3 million and a net market valuation
gain of $2 million, respectively, through Investment fair value changes, net on our consolidated statements of income.
Investment in Multifamily Loan Fund
In January 2019, we invested in a limited partnership created to acquire floating rate, light-renovation multifamily loans from Freddie
Mac. We committed to fund an aggregate of $78 million to the partnership, and have funded approximately $41 million at December 31,
2019. Freddie Mac is providing a debt facility to finance loans purchased by the partnership. After the partnership's acquisitions have
reached a specific threshold, the partnership and Freddie Mac may agree to include the related loans in a Freddie Mac-sponsored
securitization and the limited partners may acquire the subordinate securities issued in any such securitization.
We account for our ownership interest in this partnership using the equity method of accounting as we are able to exert significant
influence over but do not control the activities of the investee. At December 31, 2019, the carrying amount of our investment in the
partnership was $40 million. We have elected to record our share of earnings or losses from this investment on a one-quarter lag. During
the year ended December 31, 2019, we recorded $1 million of income associated with this investment in Other income on our consolidated
statements of income.
Shared Home Appreciation Options
In the third quarter of 2019, we entered into a flow purchase agreement to acquire shared home appreciation options. Under this
arrangement, our counterparty purchases an option to buy a fractional interest in a homeowner's ownership interest in residential property,
and subsequently the counterparty sells the option contract to us. Pursuant to the terms of the option contract, we share in both home
price appreciation and depreciation. At December 31, 2019, we had acquired $43 million of shared home appreciation options under this
flow purchase agreement and had an outstanding commitment to fund up to an additional $7 million under this agreement. We account
for these investments under the fair value option and during the year ended December 31, 2019, we recorded a net market valuation gain
of $1 million related to these assets through Investment fair value changes, net on our consolidated statements of income.
F- 77
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 10. Other Investments - (continued)
Participation in Loan Warehouse Facility
In the second quarter of 2018, we invested in a subordinated participation in a revolving mortgage loan warehouse credit facility of
one of our loan sellers. We accounted for this subordinated participation interest as a loan receivable at amortized cost, and all associated
interest income was recorded as a component of Other interest income in our consolidated statements of income. During the first quarter
of 2019, our agreement associated with this investment was terminated and the balance outstanding under this agreement was repaid.
Investment in 5 Arches
In May 2018, we acquired a 20% minority interest in 5 Arches for $10 million, which included a one-year option to purchase all
remaining equity in the company for a combination of cash and stock totaling $40 million. In March 2019, we closed on our option to
acquire the remaining 80% interest in 5 Arches. See Note 2 for discussion of this acquisition.
During 2018 and through February 28, 2019, we accounted for our minority ownership interest in 5 Arches using the equity method
of accounting as we were able to exert significant influence over but did not control the activities of the investee. During the period from
January 1, 2019 to February 28, 2019 and for the year ended December 31, 2018, we recorded $0.3 million and $0.6 million of gross
income, respectively, and, including amortization of certain intangible assets, recorded $0.1 million and $0.4 million of net earnings,
respectively, in Other income on our consolidated statements of income.
Note 11. Derivative Financial Instruments
The following table presents the fair value and notional amount of our derivative financial instruments at December 31, 2019 and
December 31, 2018.
Table 11.1 – Fair Value and Notional Amount of Derivative Financial Instruments
(In Thousands)
Assets - Risk Management Derivatives
Interest rate swaps
TBAs
Interest rate futures
Swaptions
Assets - Other Derivatives
December 31, 2019
December 31, 2018
Fair
Value
Notional
Amount
Fair
Value
Notional
Amount
$
17,095
$
1,399,000
$
28,211
$
2,106,500
5,755
777
1,925
2,445,000
213,700
1,065,000
4,665
520,000
—
—
—
—
Loan purchase and interest rate lock commitments
10,149
1,537,162
2,913
331,161
Total Assets
Liabilities - Cash Flow Hedges
Interest rate swaps
Liabilities - Risk Management Derivatives
Interest rate swaps
TBAs
Interest rate futures
Liabilities - Other Derivatives
Loan purchase commitments
Total Liabilities
Total Derivative Financial Instruments, Net
35,701
$
6,659,862
$
35,789
$
2,957,661
(51,530) $
139,500
$
(34,492) $
139,500
(97,235)
(13,359)
(10)
2,314,300
4,160,000
12,300
(36,416)
(13,215)
—
1,742,000
935,000
—
303,394
(1,290)
(163,424) $
6,929,494
(127,723) $ 13,589,356
$
$
(732)
(84,855) $
(49,066) $
137,224
2,953,724
5,911,385
$
$
$
$
F- 78
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 11. Derivative Financial Instruments - (continued)
Risk Management Derivatives
To manage, to varying degrees, risks associated with certain assets and liabilities on our consolidated balance sheets, we may enter
into derivative contracts. At December 31, 2019, we were party to swaps and swaptions with an aggregate notional amount of $4.78
billion, TBA agreements sold with an aggregate notional amount of $6.61 billion, and interest rate futures contracts with an aggregate
notional amount of $226 million. At December 31, 2018, we were party to swaps with an aggregate notional amount of $3.85 billion and
TBA agreements sold with an aggregate notional amount of $1.46 billion.
For the years ended December 31, 2019, 2018, and 2017, risk management derivatives had a net market valuation loss of $134
million, a net market valuation gain of $40 million, and a net market valuation loss of $31 million, respectively. These market valuation
gains and losses are recorded in Mortgage banking activities, net, Investment fair value changes, net and Other income on our consolidated
statements of income.
Loan Purchase, Interest Rate Lock, and Forward Sale Commitments
LPCs, IRLCs, and FSCs that qualify as derivatives are recorded at their estimated fair values. For the years ended December 31,
2019, 2018, and 2017, LPCs, IRLCs, and FSCs had a net market valuation gain of $62 million, a net market valuation loss of $1 million,
and a net market valuation gain of $38 million, respectively, that were recorded in Mortgage banking activities, net on our consolidated
statements of income.
Derivatives Designated as Cash Flow Hedges
To manage the variability in interest expense related to portions of our long-term debt and certain adjustable-rate securitization entity
liabilities that are included in our consolidated balance sheets for financial reporting purposes, we designated certain interest rate swaps
as cash flow hedges with an aggregate notional balance of $140 million.
For the years ended December 31, 2019, 2018, and 2017, changes in the values of designated cash flow hedges were negative $17
million, positive $9 million, and positive $1 million, respectively, and were recorded in Accumulated other comprehensive income, a
component of equity. For interest rate agreements currently or previously designated as cash flow hedges, our total unrealized loss reported
in Accumulated other comprehensive income was $51 million and $34 million at December 31, 2019 and December 31, 2018, respectively.
The following table illustrates the impact on interest expense of our interest rate agreements accounted for as cash flow hedges for
the years ended December 31, 2019, 2018, and 2017.
Table 11.2 – Impact on Interest Expense of Interest Rate Agreements Accounted for as Cash Flow Hedges
Years Ended December 31,
2018
2017
2019
$
$
(2,847) $
—
(2,847) $
(3,228) $
—
(3,228) $
(4,602)
(45)
(4,647)
(In Thousands)
Net interest expense on cash flows hedges
Realized net losses reclassified from other comprehensive income
Total Interest Expense
F- 79
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 11. Derivative Financial Instruments - (continued)
Derivative Counterparty Credit Risk
We incur credit risk to the extent that counterparties to our derivative financial instruments do not perform their obligations under
specified contractual agreements. If a derivative counterparty does not perform, we may not receive the proceeds to which we may be
entitled under these agreements. Each of our derivative counterparties that is not a clearinghouse must maintain compliance with
International Swaps and Derivatives Association (“ISDA”) agreements or other similar agreements (or receive a waiver of non-compliance
after a specific assessment) in order to conduct derivative transactions with us. Additionally, we review non-clearinghouse derivative
counterparty credit standings, and in the case of a deterioration of creditworthiness, appropriate remedial action is taken. To further
mitigate counterparty risk, we exit derivatives contracts with counterparties that (i) do not maintain compliance with (or obtain a waiver
from) the terms of their ISDA or other agreements with us; or (ii) do not meet internally established guidelines regarding creditworthiness.
Our ISDA and similar agreements currently require full bilateral collateralization of unrealized loss exposures with our derivative
counterparties. Through a margin posting process, our positions are revalued with counterparties each business day and cash margin is
generally transferred to either us or our derivative counterparties as collateral based upon the directional changes in fair value of the
positions. We also attempt to transact with several different counterparties in order to reduce our specific counterparty exposure. With
respect to certain of our derivatives, clearing and settlement is through one or more clearinghouses, which may be substituted as a
counterparty. Clearing and settlement of derivative transactions through a clearinghouse is also intended to reduce specific counterparty
exposure. We consider counterparty risk as part of our fair value assessments of all derivative financial instruments at each quarter-end.
At December 31, 2019, we assessed this risk as remote and did not record a specific valuation adjustment.
At December 31, 2019, we had outstanding derivative agreements with nine counterparties (other than clearinghouses) and were in
compliance with ISDA agreements governing our open derivative positions.
Note 12. Other Assets and Liabilities
Other assets at December 31, 2019 and December 31, 2018 are summarized in the following table.
Table 12.1 – Components of Other Assets
(In Thousands)
Margin receivable
FHLBC stock
Pledged collateral
Investment receivable
Right-of-use asset
REO
Fixed assets and leasehold improvements (1)
Other
Total Other Assets
December 31, 2019
December 31, 2018
$
209,776
$
100,773
43,393
32,945
23,330
11,866
9,462
4,901
12,590
$
348,263
$
43,393
42,433
6,959
—
3,943
5,106
15,218
217,825
(1) Fixed assets and leasehold improvements had a basis of $11 million and accumulated depreciation of $7 million at December 31, 2019.
F- 80
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 12. Other Assets and Liabilities - (continued)
Accrued expenses and other liabilities at December 31, 2019 and December 31, 2018 are summarized in the following table.
Table 12.2 – Components of Accrued Expenses and Other Liabilities
December 31, 2019
December 31, 2018
(In Thousands)
Accrued compensation
Contingent consideration
Guarantee obligations
Lease liability
Payable to minority partner
Residential bridge loan holdbacks
Accrued taxes payable
Deferred tax liabilities
Residential loan and MSR repurchase reserve
Legal reserve
Margin payable
$
33,888
$
28,484
14,009
13,443
13,189
10,682
5,268
5,152
4,268
2,000
1,700
19,769
—
16,711
—
14,331
—
423
9,022
4,189
2,000
835
11,439
78,719
Other
Total Accrued Expenses and Other Liabilities
$
14,155
146,238
$
Margin Receivable and Payable
Margin receivable and payable resulted from margin calls between us and our counterparties under derivatives, master repurchase
agreements, and warehouse facilities, whereby we or the counterparty posted collateral.
FHLBC Stock
In accordance with our FHLB-member subsidiary's borrowing agreement with the FHLBC, our subsidiary is required to purchase
and hold stock in the FHLBC. See Note 3 and Note 15 for additional information on this borrowing agreement.
Pledged Collateral and Guarantee Obligations
The pledged collateral and guarantee obligations presented in the tables above are related to our risk-sharing arrangements with
Fannie Mae and Freddie Mac, as well as collateral pledged for certain interest rate agreements. In accordance with these arrangements,
we are required to pledge collateral to secure our guarantee obligations and to meet margin requirements for our interest rate
agreements. See Note 3 and Note 16 for additional information on our risk-sharing arrangements.
Contingent Consideration
The contingent consideration presented in the table above is related to our acquisition of 5 Arches in 2019. See Note 16 for additional
information on our contingent consideration liabilities.
Lease Liability and Right-of-Use Asset
The lease liability and right-of-use asset presented in the tables above resulted from our adoption of ASU 2016-02, "Leases," in the
first quarter of 2019. The lease liability is equal to the present value of our remaining lease payments discounted at our incremental
borrowing rate and the right-of-use asset is equal to the lease liability adjusted for our deferred rent liability. These balances are reduced
as lease payments are made. See Note 16 for additional information on leases.
F- 81
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 12. Other Assets and Liabilities - (continued)
Residential Bridge Loan Holdbacks
Residential bridge loan holdbacks represent loan amounts payable to residential bridge loan borrowers subject to the completion
of various phases of property rehabilitation.
Investment Receivable
At December 31, 2019, investment receivable primarily consisted of unsettled trade receivables related to real estate securities sales.
In accordance with our policy to record purchases and sales of securities on the trade date, if the trade and settlement of a purchase or
sale crosses over a quarterly reporting period, we will record an investment receivable for sales and an unsettled trades liability for
purchases.
REO
The carrying value of REO at December 31, 2019, was $9 million, which included $0.5 million of REO from our Legacy Sequoia
entities, $7 million from our residential bridge loan portfolio, $0.4 million from our consolidated Freddie Mac SLST entities, and $2
million from CAFL entities. At December 31, 2019, there were four REO assets at our Legacy Sequoia entities, four residential bridge
loan REO assets, three REO assets at our Freddie Mac SLST entities, and two REO assets at our CAFL entities recorded on our consolidated
balance sheets. During the year ended December 31, 2019, transfers into REO included $0.3 million from Legacy Sequoia entities, a $8
million residential bridge loan, and $0.5 million from Freddie Mac SLST entities. In connection with our acquisition of CoreVest during
the fourth quarter of 2019, we acquired $3 million of REO associated with consolidated CAFL entities. During the year ended December 31,
2019, there were Legacy Sequoia REO liquidations of $5 million, resulting in $1 million of unrealized gains which were recorded in
Investment fair value changes, net, on our consolidated statements of income. At December 31, 2018, our REO included 13 properties,
all of which were owned at consolidated Legacy Sequoia entities.
Legal and Repurchase Reserves
See Note 16 for additional information on the legal and residential repurchase reserves.
Payable to Minority Partner
In 2018, Redwood and a third-party co-investor, through two partnership entities consolidated by Redwood, purchased servicer
advances and excess MSRs related to a portfolio of residential mortgage loans serviced by the co-investor (see Note 4 and Note 10 for
additional information on the partnership entities and associated investments). We account for the co-investor’s interests in the entities
as liabilities and at December 31, 2019, the carrying value of their interests was $13 million, representing their current economic interest
in the entities. Earnings from the partnership entities are allocated to the co-investors on a proportional basis and during the years ended
December 31, 2019 and 2018, we allocated $1 million of gains and less than $0.1 million of losses to the co-investors, respectively, which
were recorded in Other expenses on our consolidated statements of income.
Note 13. Short-Term Debt
We enter into repurchase agreements, bank warehouse agreements, and other forms of collateralized (and generally uncommitted)
short-term borrowings with several banks and major investment banking firms. At December 31, 2019, we had outstanding agreements
with several counterparties and we were in compliance with all of the related covenants.
F- 82
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 13. Short-Term Debt - (continued)
The table below summarizes our short-term debt, including the facilities that are available to us, the outstanding balances, the weighted
average interest rate, and the maturity information at December 31, 2019 and December 31, 2018.
Table 13.1 – Short-Term Debt
(Dollars in Thousands)
Facilities
Residential loan warehouse (1)
Business purpose residential loan warehouse (2)
Real estate securities repo (1)
Total Short-Term Debt Facilities
Servicer advance financing
Total Short-Term Debt
(Dollars in Thousands)
Facilities
Residential loan warehouse (1)
Business purpose residential loan warehouse (2)
Real estate securities repo (1)
Total Short-Term Debt Facilities
Servicer advance financing
Convertible notes, net
Total Short-Term Debt
December 31, 2019
Number of
Facilities
Outstanding
Balance
Limit
Weighted
Average
Interest
Rate
Maturity
Weighted
Average
Days Until
Maturity
4
8
10
22
1
$
185,894
$ 1,425,000
3.23% 1/2020-10/2020
814,118
1,475,000
4.11% 12/2020-5/2022
1,176,579
2,176,591
—
2.94%
1/2020-3/2020
69
489
23
152,554
400,000
3.56%
11/2020
335
$ 2,329,145
December 31, 2018
Number of
Facilities
Outstanding
Balance
Limit
Weighted
Average
Interest
Rate
Maturity
Weighted
Average
Days Until
Maturity
4
4
9
17
1
N/A
$
860,650
$ 1,425,000
4.10% 2/2019-12/2019
88,380
988,890
1,937,920
262,740
199,619
$ 2,400,279
480,000
4.99% 11/2019-6/2021
—
3.47%
1/2019-3/2019
350,000
4.32%
5.63%
11/2019
11/2019
178
594
26
333
319
(1) Borrowings under our facilities are generally charged interest based on a specified margin over the one-month LIBOR interest rate. At
December 31, 2019, all of these borrowings were under uncommitted facilities and were due within 364 days (or less) of the borrowing date.
(2) Due to the revolving nature of the borrowings under these facilities, we have classified these facilities as short-term debt at December 31, 2019.
Borrowings under these facilities will be repaid as the underlying loans mature or are sold to third parties or transferred to securitizations.
F- 83
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 13. Short-Term Debt - (continued)
The following table below presents the value of loans and securities pledged as collateral under our short-term debt facilities at
December 31, 2019 and December 31, 2018.
Table 13.2 – Collateral for Short-Term Debt
(In Thousands)
Collateral Type
Held-for-sale residential loans
Business purpose residential loans
Real estate securities
On balance sheet
Sequoia Choice securitizations (1)
Freddie Mac SLST securitizations (1)
Freddie Mac K-Series securitizations (1)
CAFL securitizations (1)
Total real estate securities owned
Total Collateral for Short-Term Debt
December 31, 2019
December 31, 2018
$
$
201,949 $
988,179
618,881
111,341
381,640
252,284
127,840
1,491,986
2,682,114
$
935,132
125,404
844,465
130,139
228,920
17,521
—
1,221,045
2,281,581
(1) Represents securities we have retained from consolidated securitization entities. For GAAP purposes, we consolidate the loans and non-recourse
ABS debt issued from these securitizations.
For the years ended December 31, 2019 and 2018, the average balances of our short-term debt facilities were $1.97 billion and $1.51
billion, respectively. At December 31, 2019 and December 31, 2018, accrued interest payable on our short-term debt facilities was $6
million and $4 million, respectively.
Servicer advance financing consists of non-recourse short-term securitization debt used to finance servicer advance investments. We
consolidate the securitization entity that issued the debt, but the entity is independent of Redwood and the assets and liabilities are not
owned by and are not legal obligations of Redwood. At December 31, 2019, the fair value of servicer advances, cash and restricted cash
collateralizing the securitization financing was $176 million. At December 31, 2019, the accrued interest payable balance on this financing
was $0.2 million and the unamortized capitalized commitment costs were $1 million.
During the fourth quarter of 2018, $201 million principal amount of 5.625% exchangeable senior notes and $1 million of unamortized
deferred issuance costs were reclassified from long-term debt to short-term debt as the maturity of the notes was less than one year as of
November 2018. In November 2019, we repaid these $201 million convertible notes and all related accrued interest in full.
We also maintain a $10 million committed line of credit with a financial institution that is secured by certain mortgage-backed
securities with a fair market value of $3 million at December 31, 2019. At both December 31, 2019 and December 31, 2018, we had no
outstanding borrowings on this facility.
F- 84
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 13. Short-Term Debt - (continued)
Remaining Maturities of Short-Term Debt
The following table presents the remaining maturities of our secured short-term debt by the type of collateral securing the debt as
well as our convertible notes at December 31, 2019.
Table 13.3 – Short-Term Debt by Collateral Type and Remaining Maturities
(In Thousands)
Collateral Type
Held-for-sale residential loans
Business purpose residential loans
Real estate securities
Total Secured Short-Term Debt
Servicer advance financing
Total Short-Term Debt
Note 14. Asset-Backed Securities Issued
December 31, 2019
Within 30 days
31 to 90 days
Over 90 days
Total
$
$
49,084 $
110,446
$
26,364
$
—
824,054
873,138
—
—
352,525
462,971
—
814,118
—
840,482
152,554
185,894
814,118
1,176,579
2,176,591
152,554
873,138
$
462,971
$
993,036
$
2,329,145
Through our Sequoia securitization program, we sponsor securitization transactions in which securities backed by residential mortgage
loans (ABS) are issued by Sequoia entities. We consolidated the Legacy Sequoia and Sequoia Choice securitization entities as well as
certain third-party Freddie Mac K-Series and SLST securitization entities that we determined were VIEs and for which we determined
we were the primary beneficiary. Additionally, beginning in the fourth quarter of 2019, we consolidated certain CAFL securitization
entities that we determined were VIEs and for which we determined we were the primary beneficiary. Each consolidated securitization
entity is independent of Redwood and of each other and the assets and liabilities of each entity are not owned by and are not legal
obligations of Redwood. Our exposure to these entities is primarily through the financial interests we have retained, although we are
exposed to certain financial risks associated with our role as a sponsor, servicing administrator, or depositor of these entities or as a result
of our having sold assets directly or indirectly to these entities.
We account for the ABS issued under our consolidated entities at fair value, with periodic changes in fair value recorded in Investment
fair value changes, net on our consolidated statements of income. Pursuant to the CFE guidelines, the market valuation changes on the
loans in these securitizations are based on the estimated fair value of the associated ABS issued we present on our balance sheet as well
as the securities retained or owned at the securitization entities. The net impact to our income statement associated with our economic
investment in each of these securitization entities is presented in Note 5.
The ABS issued by these entities consist of various classes of securities that pay interest on a monthly basis. All ABS issued by the
Sequoia Choice, Freddie Mac K-Series, and Freddie Mac SLST entities and substantially all the ABS issued by the CAFL entities pay
fixed rates of interest. Substantially all ABS issued by the Legacy Sequoia entities pay variable rates of interest, which are indexed to
one-, three-, or six-month LIBOR. ABS issued also includes some interest-only classes with coupons set at a fixed spread to a benchmark
rate, or set at a spread to the interest rates earned on the assets less the interest rates paid on the liabilities of a securitization entity.
F- 85
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 14. Asset-Backed Securities Issued - (continued)
The carrying values of ABS issued by our consolidated securitization entities at December 31, 2019 and December 31, 2018, along
with other selected information, are summarized in the following table.
Table 14.1 – Asset-Backed Securities Issued
December 31, 2019
(Dollars in Thousands)
Legacy
Sequoia
Sequoia
Choice
Freddie Mac
SLST
Freddie Mac
K-Series
CAFL
Total
Certificates with principal balance
$
420,056
$
1,979,719
$ 1,842,682
$
3,844,789
$
1,875,007
$
9,962,253
Interest-only certificates
Market valuation adjustments
ABS Issued, Net
Range of weighted average
interest rates, by series
Stated maturities
Number of series
1,282
(18,873)
16,514
40,965
30,291
45,349
217,891
93,559
90,134
36,110
356,112
197,110
$
402,465
$
2,037,198
$ 1,918,322
$
4,156,239
$
2,001,251
$ 10,515,475
1.94% to
3.26%
4.40% to
5.05%
3.50%
3.35% to
4.35%
3.25% to
5.36%
2024 - 2036
2047 - 2049
2028 - 2029
2025 - 2049
2022 - 2048
20
9
2
5
10
December 31, 2018
(Dollars in Thousands)
Legacy
Sequoia
Sequoia
Choice
Freddie Mac
SLST
Freddie Mac
K-Series
CAFL
Total
Certificates with principal balance
$
540,456
$
1,838,758
$
993,659
$
1,936,691
$
— $ 5,309,564
Interest-only certificates
Market valuation adjustments
ABS Issued, Net
Range of weighted average
interest rates, by series
Stated maturities
Number of series
1,537
(29,753)
25,662
20,590
—
89
$
512,240
$
1,885,010
$
993,748
$
1.36% to
3.60%
4.46% to
4.97%
3.51%
131,600
(49,216)
2,019,075
3.39% to
4.08%
2024 - 2036
2047 - 2048
2028
2025 - 2049
20
6
1
3
—
—
158,799
(58,290)
$
— $ 5,410,073
—%
—
—
The actual maturity of each class of ABS issued is primarily determined by the rate of principal prepayments on the assets of the
issuing entity. Each series is also subject to redemption prior to the stated maturity according to the terms of the respective governing
documents of each ABS issuing entity. As a result, the actual maturity of ABS issued may occur earlier than its stated maturity. At
December 31, 2019, the majority of the ABS issued and outstanding had contractual maturities beyond five years. The following table
summarizes the accrued interest payable on ABS issued at December 31, 2019 and December 31, 2018. Interest due on consolidated ABS
issued is payable monthly.
Table 14.2 – Accrued Interest Payable on Asset-Backed Securities Issued
(In Thousands)
Legacy Sequoia
Sequoia Choice
Freddie Mac SLST
Freddie Mac K-Series
CAFL
Total Accrued Interest Payable on ABS Issued
F- 86
December 31, 2019
December 31, 2018
$
$
395 $
7,732
5,374
12,887
7,298
33,686
$
571
7,180
2,907
6,239
—
16,897
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 14. Asset-Backed Securities Issued - (continued)
The following table summarizes the carrying value components of the collateral for ABS issued and outstanding at December 31,
2019 and December 31, 2018.
Table 14.3 – Collateral for Asset-Backed Securities Issued
December 31, 2019
(In Thousands)
Residential loans
Business purpose residential loans
Multifamily loans
Restricted cash
Accrued interest receivable
REO
Legacy
Sequoia
Sequoia
Choice
Freddie Mac
SLST
Freddie Mac
K-Series
CAFL
Total
$
407,890
$
2,291,463
$
2,367,215
$
— $
— $
5,066,568
—
—
143
655
460
—
—
27
9,824
—
—
—
—
7,313
445
—
2,192,552
4,408,524
—
13,539
—
—
—
9,572
1,795
2,192,552
4,408,524
170
40,903
2,700
Total Collateral for ABS Issued
$
409,148
$
2,301,314
$
2,374,973
$
4,422,063
$
2,203,919
$ 11,711,417
December 31, 2018
(In Thousands)
Residential loans
Multifamily loans
Restricted cash
Accrued interest receivable
REO
Legacy
Sequoia
Sequoia
Choice
Freddie Mac
SLST
Freddie Mac
K-Series
CAFL
Total
$
519,958
$
2,079,382
$
1,222,669
$
— $
— $
3,822,009
—
146
822
3,943
—
1,022
8,988
—
—
—
3,926
—
2,144,598
—
6,595
—
—
—
—
—
2,144,598
1,168
20,331
3,943
Total Collateral for ABS Issued
$
524,869
$
2,089,392
$
1,226,595
$
2,151,193
$
— $
5,992,049
Note 15. Long-Term Debt
FHLBC Borrowings
In July 2014, our FHLB-member subsidiary entered into a borrowing agreement with the Federal Home Loan Bank of Chicago. At
December 31, 2019, under this agreement, our subsidiary could incur borrowings up to $2.00 billion, also referred to as “advances,” from
the FHLBC secured by eligible collateral, including residential mortgage loans. During the year ended December 31, 2019, our FHLB-
member subsidiary made no additional borrowings under this agreement. Under a final rule published by the Federal Housing Finance
Agency in January 2016, our FHLB-member subsidiary will remain an FHLB member through the five-year transition period for captive
insurance companies. Our FHLB-member subsidiary's existing $2.00 billion of FHLB debt, which matures beyond this transition period,
is permitted to remain outstanding until its stated maturity. As residential loans pledged as collateral for this debt pay down, we are
permitted to pledge additional loans or other eligible assets to collateralize this debt; however, we do not expect to be able to increase
our subsidiary's FHLB debt above the existing $2.00 billion maximum.
F- 87
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 15. Long-Term Debt - (continued)
At December 31, 2019, $2.00 billion of advances were outstanding under this agreement, which were classified as long-term debt,
with a weighted average interest rate of 1.88% and a weighted average maturity of approximately six years. At December 31, 2018, $2.00
billion of advances were outstanding under this agreement, which were classified as long-term debt, with a weighted average interest
rate of 2.52% and a weighted average maturity of seven years. Advances under this agreement incur interest charges based on a specified
margin over the FHLBC’s 13-week discount note rate, which resets every 13 weeks. At December 31, 2019, total advances under this
agreement were secured by residential mortgage loans with a fair value of $2.10 billion, single-family rental loans with a fair value of
$211 million, real estate securities with a fair value of $39 million, and $59 million of restricted cash. This agreement also requires our
subsidiary to purchase and hold stock in the FHLBC in an amount equal to a specified percentage of outstanding advances. At December 31,
2019, our subsidiary held $43 million of FHLBC stock that is included in Other assets in our consolidated balance sheets.
The following table presents maturities of our FHLBC borrowings by year at December 31, 2019.
Table 15.1 – Maturities of FHLBC Borrowings by Year
(In Thousands)
2024
2025
2026
Total FHLBC Borrowings
Subordinate Securities Financing Facility
December 31, 2019
$
$
470,171
887,639
642,189
1,999,999
In the third quarter of 2019, a subsidiary of Redwood entered into a repurchase agreement providing non-mark-to-market recourse
debt financing. The financing is fully and unconditionally guaranteed by Redwood, with an interest rate of approximately 4.21% through
September 2022. The financing facility may be terminated, at our option, in September 2022, and has a final maturity in September 2024,
provided that the interest rate on amounts outstanding under the facility increases between October 2022 and September 2024. At
December 31, 2019, we had borrowings under this facility totaling $185 million, net of $1 million of deferred issuance costs, for a carrying
value of $184 million. At December 31, 2019, the fair value of real estate securities pledged as collateral under this long-term debt facility
was $250 million, which included $125 million of securities retained from our consolidated Sequoia Choice securitizations. This facility
is included in Long-term debt, net on our consolidated balance sheets at December 31, 2019.
Convertible Notes
In September 2019, RWT Holdings, Inc., a wholly-owned subsidiary of Redwood Trust, Inc., issued $201 million principal amount
of 5.75% exchangeable senior notes due 2025. These exchangeable notes require semi-annual interest payments at a fixed coupon rate
of 5.75% until maturity or exchange, which will be no later than October 1, 2025. After deducting the underwriting discount and offering
costs, we received $195 million of net proceeds. Including amortization of deferred debt issuance costs, the weighted average interest
expense yield on these exchangeable notes is approximately 6.3% per annum. At December 31, 2019, these notes were exchangeable at
the option of the holder at an exchange rate of 55.1967 common shares per $1,000 principal amount of exchangeable senior notes
(equivalent to an exchange price of $18.12 per common share). Upon exchange of these notes by a holder, the holder will receive shares
of our common stock. At December 31, 2019, the outstanding principal amount of these notes was $201 million. At December 31, 2019,
the accrued interest payable balance on this debt was $3 million and the unamortized deferred issuance costs were $6 million.
F- 88
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 15. Long-Term Debt - (continued)
In June 2018, we issued $200 million principal amount of 5.625% convertible senior notes due 2024 at an issuance price of 99.5%.
These convertible notes require semi-annual interest payments at a fixed coupon rate of 5.625% until maturity or conversion, which will
be no later than July 15, 2024. After deducting the issuance discount, the underwriting discount and offering costs, we received $194
million of net proceeds. Including amortization of deferred debt issuance costs and the debt discount, the weighted average interest
expense yield on these convertible notes is approximately 6.2% per annum. These notes are convertible at the option of the holder at a
conversion rate of 54.7645 common shares per $1,000 principal amount of convertible senior notes (equivalent to a conversion price of
$18.26 per common share). Upon conversion of these notes by a holder, the holder will receive shares of our common stock. At
December 31, 2019, the outstanding principal amount of these notes was $200 million and the accrued interest payable on this debt was
$5 million. At December 31, 2019, the unamortized deferred issuance costs and debt discount were $4 million and $1 million, respectively.
In August 2017, we issued $245 million principal amount of 4.75% convertible senior notes due 2023. These convertible notes require
semi-annual interest payments at a fixed coupon rate of 4.75% until maturity or conversion, which will be no later than August 15, 2023.
After deducting the underwriting discount and offering costs, we received $238 million of net proceeds. Including amortization of deferred
debt issuance costs, the weighted average interest expense yield on these convertible notes is approximately 5.3% per annum. At
December 31, 2019, these notes were convertible at the option of the holder at a conversion rate of 54.3346 common shares per $1,000
principal amount of convertible senior notes (equivalent to a conversion price of $18.40 per common share). Upon conversion of these
notes by a holder, the holder will receive shares of our common stock. At December 31, 2019, the outstanding principal amount of these
notes was $245 million. At December 31, 2019, the accrued interest payable balance on this debt was $4 million and the unamortized
deferred issuance costs were $5 million.
In November 2014, RWT Holdings, Inc., a wholly-owned subsidiary of Redwood Trust, Inc., issued $205 million principal amount
of 5.625% exchangeable senior notes due 2019. These exchangeable notes required semi-annual interest payments at a fixed coupon rate
of 5.625%. After deducting the underwriting discount and offering costs, we received $198 million of net proceeds. Including amortization
of deferred debt issuance costs, the weighted average interest expense yield on these exchangeable notes was approximately 6.3% per
annum. These notes were exchangeable at the option of the holder at an exchange rate of 46.5404 common shares per $1,000 principal
amount of exchangeable senior notes (equivalent to an exchange price of $21.49 per common share). Upon exchange of these notes by
a holder, the holder would have received shares of our common stock. During 2016, we repurchased $4 million par value of these notes
at a discount and recorded a gain on extinguishment of debt of $0.3 million in Realized gains, net on our consolidated statements of
income. Additionally, during the fourth quarter of 2018, $201 million principal amount of these notes and $1 million of unamortized
deferred issuance costs were reclassified from long-term debt to short-term debt as the maturity of the notes was less than one year as of
November 2018. In November 2019, we repaid these $201 million exchangeable notes and all related accrued interest in full.
Trust Preferred Securities and Subordinated Notes
At December 31, 2019, we had trust preferred securities and subordinated notes outstanding of $100 million and $40 million,
respectively. This debt requires quarterly interest payments at a floating rate equal to three-month LIBOR plus 2.25% until the notes are
redeemed. The $100 million trust preferred securities will be redeemed no later than January 30, 2037, and the $40 million subordinated
notes will be redeemed no later than July 30, 2037. Prior to 2014, we entered into interest rate swaps with aggregate notional values
totaling $140 million to hedge the variability in this long-term debt interest expense. Including hedging costs and amortization of deferred
debt issuance costs, the weighted average interest expense yield on our trust preferred securities and subordinated notes is approximately
6.9% per annum. At both December 31, 2019 and December 31, 2018, the accrued interest payable balance on our trust preferred securities
and subordinated notes was $1 million.
Under the terms of this debt, we covenant, among other things, to use our best efforts to continue to qualify as a REIT. If an event
of default were to occur in respect of this debt, we would generally be restricted under its terms (subject to certain exceptions) from
making dividend distributions to stockholders, from repurchasing common stock or repurchasing or redeeming any other then-outstanding
equity securities, and from making any other payments in respect of any equity interests in us or in respect of any then-outstanding debt
that is pari passu or subordinate to this debt.
F- 89
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 16. Commitments and Contingencies
Lease Commitments
At December 31, 2019, we were obligated under eight non-cancelable operating leases with expiration dates through 2028 for $16
million of cumulative lease payments. Our operating lease expense was $3 million, $2 million, and $2 million for the years ended
December 31, 2019, 2018 and 2017, respectively.
The following table presents our future lease commitments at December 31, 2019.
Table 16.1 – Future Lease Commitments by Year
(In Thousands)
2020
2021
2022
2023
2024
2025 and thereafter
Total Lease Commitments
Less: Imputed interest
Lease Liability
December 31, 2019
$
$
3,395
2,275
1,706
1,520
1,558
5,678
16,132
(2,689)
13,443
Leasehold improvements for our offices are amortized into expense over the lease term. There were $3 million of unamortized
leasehold improvements at December 31, 2019. For the years ended December 31, 2019, 2018, and 2017, we recognized $0.4 million,
$0.2 million, and $0.2 million of leasehold amortization expense, respectively.
During the first quarter of 2019, we adopted ASU 2016-02, "Leases," which required us to recognize a lease liability that was equal
to the present value of our remaining lease payments of $16 million discounted at various incremental borrowing rates, and a right-of-
use asset, which was equal to our lease liability adjusted for our deferred rent liability. We elected to apply the new guidance using the
optional transition method, which permits lessees to measure the lease liability and right-of-use asset at January 1, 2019, without adjusting
the comparative periods presented. We elected the package of practical expedients under the transition guidance within this standard,
which allowed us to carry forward the classifications of each of our four existing leases as operating leases and to continue to expense
lease payments on a straight-line basis. As one of our operating leases qualified for the short-term lease exception under this guidance,
we continued to account for this lease under legacy GAAP and did not include this lease in our calculation of the lease liability and right-
of-use asset.
We assumed five new leases during 2019 as a result of the acquisitions of 5 Arches and CoreVest. We determined that each of these
leases qualified as operating leases under the new guidance and accounted for them as such. At December 31, 2019, our lease liability
was $13 million, which was a component of Accrued expenses and other liabilities, and our right-of-use asset was $12 million, which
was a component of Other assets.
We determined that none of our leases contained an implicit interest rate and used a discount rate equal to our incremental borrowing
rate on a collateralized basis to determine the present value of our total lease payments. As such, we determined the applicable discount
rate for each of our leases using a swap rate plus an applicable spread for borrowing arrangements secured by our real estate loans and
securities for a length of time equal to the remaining lease term on the date of adoption. At December 31, 2019, the weighted-average
remaining lease term and weighted-average discount rate for our leases was 7 years and 5.3%, respectively.
F- 90
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 16. Commitments and Contingencies - (continued)
Commitment to Fund Residential Bridge Loans
As of December 31, 2019, we had commitments to fund up to $173 million of additional advances on existing residential bridge
loans. These commitments are generally subject to loan agreements with covenants regarding the financial performance of the customer
and other terms regarding advances that must be met before we fund the commitment. We may also advance funds related to loans sold
under a separate loan sale agreement that are generally repaid immediately by the loan purchaser and do not generally expose us to loss.
The outstanding commitments related to these loans that we may temporarily fund totaled approximately $56 million at December 31,
2019.
Commitment to Fund Partnerships
In the fourth quarter of 2018, we invested in two partnerships created to acquire and manage certain mortgage servicing related assets
(see Note 10 for additional detail). In connection with this investment, we are required to fund future net servicer advances related to the
underlying mortgage loans. The actual amount of net servicer advances we may fund in the future is subject to significant uncertainty
and will be based on the credit and prepayment performance of the underlying loans.
In the first quarter of 2019, we invested in a partnership created to acquire floating rate, light-renovation multifamily loans from
Freddie Mac (see Note 10 for additional detail). At December 31, 2019, we had an outstanding commitment to fund an additional $37
million to the partnership. Additionally, in connection with this transaction, we have made a guarantee to Freddie Mac in the event of
losses incurred on the loans that exceed the equity available in the partnership to absorb such losses. At December 31, 2019, the carrying
value of this guarantee was $0.1 million. We believe the likelihood of performance under the guarantee is remote. Our maximum loss
exposure from this guarantee arrangement is $135 million.
5 Arches Contingent Consideration
As part of the consideration for our acquisition of 5 Arches, we are committed to make earn-out payments up to $29 million, payable
in a mix of cash and Redwood common stock, which will be calculated following each of the first two anniversaries of the option closing
date based on loan origination volumes exceeding certain specified thresholds. These contingent earn-out payments are classified as a
contingent consideration liability and carried at fair value. At December 31, 2019, our estimated fair value of this contingent liability was
$28 million. For the year ended December 31, 2019, we recorded contingent consideration expense of $3 million related to our valuation
of this liability through Other expenses on our consolidated statements of income.
Commitment to Fund Shared Home Appreciation Options
In the third quarter of 2019, we entered into a flow purchase agreement to acquire shared home appreciation options. The counterparty
purchases an option to buy a fractional interest in a homeowner's ownership interest in residential property, and subsequently the
counterparty sells the option contract to us. Pursuant to the terms of the option contract, we share in both home price appreciation and
depreciation. At December 31, 2019, we had acquired $45 million of shared home appreciation options under this agreement, which are
included in Other Investments on our consolidated balance sheets. At December 31, 2019, we had an outstanding commitment to fund
up to an additional $7 million under this agreement.
Commitment to Participate in Loan Warehouse Facility
In the second quarter of 2018, we invested in a participation in the mortgage loan warehouse credit facility of one of our loan sellers.
This investment included a commitment to participate in (and an obligation to fund) a designated amount of the loan seller's borrowings
under this warehouse credit facility. Our commitment to participate in this facility was terminated in the first quarter of 2019. See Note
10 for additional detail on our participation in a loan warehouse facility.
F- 91
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 16. Commitments and Contingencies - (continued)
Loss Contingencies — Risk-Sharing
During 2015 and 2016, we sold conforming loans to the Agencies with an original unpaid principal balance of $3.19 billion, subject
to our risk-sharing arrangements with the Agencies. At December 31, 2019, the maximum potential amount of future payments we could
be required to make under these arrangements was $44 million and this amount was fully collateralized by assets we transferred to pledged
accounts and is presented as pledged collateral in Other assets on our consolidated balance sheets. We have no recourse to any third
parties that would allow us to recover any amounts related to our obligations under the arrangements. At December 31, 2019, we had not
incurred any losses under these arrangements. For the years ended December 31, 2019, 2018, and 2017, other income related to these
arrangements was $4 million, $4 million, and $3 million, respectively, and was included in Other income on our consolidated statements
of income. For the years ended December 31, 2019, 2018, and 2017, we recorded net market valuation losses related to these arrangements
of $0.2 million, $0.4 million, and $1 million, respectively, through Investment fair value changes, net, on our consolidated statements of
income.
All of the loans in the reference pools subject to these risk-sharing arrangements were originated in 2014 and 2015, and at December 31,
2019, the loans had an unpaid principal balance of $1.55 billion and a weighted average FICO score of 759 (at origination) and LTV ratio
of 76% (at origination). At December 31, 2019, $7 million of the loans were 90 days or more delinquent, of which $2 million were in
foreclosure. At December 31, 2019, the carrying value of our guarantee obligation was $14 million and included $5 million designated
as a non-amortizing credit reserve, which we believe is sufficient to cover current expected losses under these obligations.
Our consolidated balance sheets include assets of special purpose entities ("SPEs") associated with these risk-sharing arrangements
(i.e., the "pledged collateral" referred to above) that can only be used to settle obligations of these SPEs for which the creditors of these
SPEs (the Agencies) do not have recourse to Redwood Trust, Inc. or its affiliates. At December 31, 2019 and December 31, 2018, assets
of such SPEs totaled $48 million and $47 million, respectively, and liabilities of such SPEs totaled $14 million and $17 million, respectively.
Loss Contingencies — Residential Repurchase Reserve
We maintain a repurchase reserve for potential obligations arising from representation and warranty violations related to residential
loans we have sold to securitization trusts or third parties and for conforming residential loans associated with MSRs that we have
purchased from third parties. We do not originate residential loans and we believe the initial risk of loss due to loan repurchases (i.e., due
to a breach of representations and warranties) would generally be a contingency to the companies from whom we acquired the loans.
However, in some cases, for example, where loans were acquired from companies that have since become insolvent, repurchase claims
may result in our being liable for a repurchase obligation.
At both December 31, 2019 and December 31, 2018, our repurchase reserve associated with our residential loans and MSRs was $4
million and was recorded in Accrued expenses and other liabilities on our consolidated balance sheets. We received 15 repurchase requests
during the year ended December 31, 2019 and 11 during the year ended December 31, 2018. During the years ended December 31, 2019,
2018, and 2017, we repurchased zero loans, two loans, and one loan, respectively. During the years ended December 31, 2019, 2018, and
2017, we recorded $0.1 million, $0.7 million, and $0.3 million of reversals of repurchase provisions, respectively, that were recorded in
Mortgage banking activities, net and Other income on our consolidated statements of income and had charge-offs of zero, zero, and $0.2
million, respectively.
F- 92
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 16. Commitments and Contingencies - (continued)
Loss Contingencies — Litigation
On or about December 23, 2009, the Federal Home Loan Bank of Seattle (the “FHLB-Seattle”) filed a complaint in the Superior
Court for the State of Washington (case number 09-2-46348-4 SEA) against Redwood Trust, Inc., our subsidiary, Sequoia Residential
Funding, Inc. (“SRF”), Morgan Stanley & Co., and Morgan Stanley Capital I, Inc. (collectively, the “FHLB-Seattle Defendants”), which
alleged that the FHLB-Seattle Defendants made false or misleading statements in offering materials for a mortgage pass-through certificate
(the “Seattle Certificate”) issued in the Sequoia Mortgage Trust 2005-4 securitization transaction (the “2005-4 RMBS”) and purchased
by the FHLB-Seattle. 8% The Seattle Certificate was issued with an original principal amount of approximately $133 million, and, at
December 31, 2019, approximately $128 million of principal and $12 million of interest payments had been made in respect of the Seattle
Certificate. The matter was subsequently resolved and the claims were dismissed by the FHLB Seattle as to all the FHLB Seattle Defendants.
At the time the Seattle Certificate was issued, Redwood agreed to indemnify the underwriters of the 2005-4 RMBS, which underwriters
were named as defendants in the action, for certain losses and expenses they might incur as a result of claims made against them relating
to this RMBS, including, without limitation, certain legal expenses. Regardless of the resolution of this litigation, we could incur a loss
as a result of these indemnities.
On or about July 15, 2010, The Charles Schwab Corporation (“Schwab”) filed a complaint in the Superior Court for the State of
California in San Francisco (case number CGC-10-501610) against SRF and 26 other defendants (collectively, the “Schwab Defendants”),
which alleged that the Schwab Defendants made false or misleading statements in offering materials for various residential mortgage-
backed securities sold or issued by the Schwab Defendants. Schwab alleged only a claim for negligent misrepresentation under California
state law against SRF and sought unspecified damages and attorneys’ fees and costs from SRF. Schwab claimed that SRF made false or
misleading statements in offering materials for a mortgage pass-through certificate (the “Schwab Certificate”) issued in the 2005-4 RMBS
and purchased by Schwab. The Schwab Certificate was issued with an original principal amount of approximately $15 million, and, at
December 31, 2019, approximately $14 million of principal and $1 million of interest payments had been made in respect of the Schwab
Certificate. On November 14, 2014, Schwab voluntarily dismissed with prejudice its negligent misrepresentation claim, which resulted
in the dismissal with prejudice of SRF from the action. Subsequently, the matter was resolved and Schwab dismissed its claims against
the lead underwriter of the 2005-4 RMBS. At the time the Schwab Certificate was issued, Redwood agreed to indemnify the underwriters
of the 2005-4 RMBS, which underwriters were also named as defendants in the action, for certain losses and expenses they might incur
as a result of claims made against them relating to this RMBS, including, without limitation, certain legal expenses. Regardless of the
resolution of this litigation, Redwood could incur a loss as a result of these indemnities.
Through certain of our wholly-owned subsidiaries, we have in the past engaged in, and expect to continue to engage in, activities
relating to the acquisition and securitization of residential mortgage loans. In addition, certain of our wholly-owned subsidiaries have in
the past engaged in activities relating to the acquisition and securitization of debt obligations and other assets through the issuance of
collateralized debt obligations (commonly referred to as CDO transactions). Because of this involvement in the securitization and CDO
businesses, we could become the subject of litigation relating to these businesses, including additional litigation of the type described
above, and we could also become the subject of governmental investigations, enforcement actions, or lawsuits, and governmental
authorities could allege that we violated applicable law or regulation in the conduct of our business. As an example, in July 2016 we
became aware of a complaint filed by the State of California on April 1, 2016 against Morgan Stanley & Co. and certain of its affiliates
alleging, among other things, that there were misleading statements contained in offering materials for 28 different mortgage pass-through
certificates purchased by various California investors, including various California public pension systems, from Morgan Stanley and
alleging that Morgan Stanley made false or fraudulent claims in connection with the sale of those certificates. Of the 28 mortgage pass-
through certificates that were the subject of the complaint, two were Sequoia mortgage pass-through certificates issued in 2004 and two
were Sequoia mortgage pass-through certificates issued in 2007. With respect to each of those certificates, our wholly-owned subsidiary,
RWT Holdings, Inc., was the sponsor and our wholly-owned subsidiary, Sequoia Residential Funding, Inc., was the depositor. The
plaintiffs subsequently withdrew from the litigation their claims based on eight of the 28 mortgage pass-through certificates, including
one of the Sequoia mortgage pass-through certificates issued in 2004. We believe this matter was subsequently resolved and the plaintiffs
withdrew their remaining claims. At the time these Sequoia mortgage pass-through certificates were issued, Sequoia Residential Funding,
Inc. and Redwood Trust agreed to indemnify the underwriters of these certificates for certain losses and expenses they might incur as a
result of claims made against them relating to these certificates, including, without limitation, certain legal expenses. Regardless of the
resolution of this litigation, we could incur a loss as a result of these indemnities.
F- 93
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 16. Commitments and Contingencies - (continued)
In accordance with GAAP, we review the need for any loss contingency reserves and establish reserves when, in the opinion of
management, it is probable that a matter would result in a liability and the amount of loss, if any, can be reasonably estimated. Additionally,
we record receivables for insurance recoveries relating to litigation-related losses and expenses if and when such amounts are covered
by insurance and recovery of such losses or expenses are due. At December 31, 2019, the aggregate amount of loss contingency reserves
established in respect of the FHLB-Seattle and Schwab litigation matters described above was $2 million. We review our litigation matters
each quarter to assess these loss contingency reserves and make adjustments in these reserves, upwards or downwards, as appropriate,
in accordance with GAAP based on our review.
In the ordinary course of any litigation matter, including certain of the above-referenced matters, we have engaged and may continue
to engage in formal or informal settlement communications with the plaintiffs or co-defendants. Settlement communications we have
engaged in relating to certain of the above-referenced litigation matters are one of the factors that have resulted in our determination to
establish the loss contingency reserves described above. We cannot be certain that any of these matters will be resolved through a settlement
prior to trial and we cannot be certain that the resolution of these matters, whether through trial or settlement, will not have a material
adverse effect on our financial condition or results of operations in any future period.
Future developments (including resolution of substantive pre-trial motions relating to these matters, receipt of additional information
and documents relating to these matters (such as through pre-trial discovery), new or additional settlement communications with plaintiffs
relating to these matters, or resolutions of similar claims against other defendants in these matters) could result in our concluding in the
future to establish additional loss contingency reserves or to disclose an estimate of reasonably possible losses in excess of our established
reserves with respect to these matters. Our actual losses with respect to the above-referenced litigation matters may be materially higher
than the aggregate amount of loss contingency reserves we have established in respect of these litigation matters, including in the event
that any of these matters proceeds to trial and the plaintiff prevails. Other factors that could result in our concluding to establish additional
loss contingency reserves or estimate additional reasonably possible losses, or could result in our actual losses with respect to the above-
referenced litigation matters being materially higher than the aggregate amount of loss contingency reserves we have established in
respect of these litigation matters include that: there are significant factual and legal issues to be resolved; information obtained or rulings
made during the lawsuits could affect the methodology for calculation of the available remedies; and we may have additional obligations
pursuant to indemnity agreements, representations and warranties, and other contractual provisions with other parties relating to these
litigation matters that could increase our potential losses.
F- 94
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2018
Note 17. Equity
The following table provides a summary of changes to accumulated other comprehensive income by component for the years ended
December 31, 2019 and 2018.
Table 17.1 – Changes in Accumulated Other Comprehensive Income by Component
Years Ended December 31,
2019
2018
Net Unrealized
Gains on
Available-for-Sale
Securities
Net Unrealized
Losses on Interest
Rate Agreements
Accounted for as
Cash Flow Hedges
Net Unrealized
Gains on
Available-for-Sale
Securities
Net Unrealized
Losses on Interest
Rate Agreements
Accounted for as
Cash Flow Hedges
(In Thousands)
Balance at beginning of period
Other comprehensive income (loss)
before reclassifications
Amounts reclassified from other
accumulated comprehensive income (1)
Net current-period other comprehensive
income (loss)
Balance at End of Period
$
$
95,342
$
(34,045) $
128,201
$
(42,953)
17,077
(19,967)
(2,890)
92,452
$
(16,894)
—
(16,894)
(50,939) $
(7,298)
(25,561)
(32,859)
95,342
$
8,908
—
8,908
(34,045)
(1) Amount is presented net of tax provision of $2 million for the year ended December 31, 2018.
The following table provides a summary of reclassifications out of accumulated other comprehensive income for the years ended
December 31, 2019 and 2018.
Table 17.2 – Reclassifications Out of Accumulated Other Comprehensive Income
Amount Reclassified From
Accumulated Other Comprehensive Income
Affected Line Item in the
Years Ended December 31,
Income Statement
2019
2018
(In Thousands)
Net Realized (Gain) Loss on AFS Securities
Other than temporary impairment (1)
Gain on sale of AFS securities
Investment fair value
changes, net
Realized gains, net
Gain on sale of AFS securities
Provision for income taxes
$
$
— $
(19,967)
—
(19,967) $
89
(27,178)
1,528
(25,561)
(1) For the year ended December 31, 2019, there were no other-than-temporary impairments. For the year ended December 31, 2018, other-than-temporary
impairments were $1 million, of which $0.1 million were recognized through our consolidated statements of income, and $1 million were recognized in
Accumulated other comprehensive income, a component of our consolidated balance sheet.
F- 95
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 17. Equity - (continued)
Issuance of Common Stock
In 2018, we established a program to sell up to an aggregate of $150 million of common stock from time to time in at-the-market
("ATM") offerings. During the year ended December 31, 2019, we issued 2,259,758 common shares for net proceeds of approximately
$36 million through ATM offerings. During the year ended December 31, 2018, we issued 1,550,819 common shares for net proceeds
of approximately $25 million through ATM offerings. At December 31, 2019, approximately $88 million remained outstanding for future
offerings under this program.
On January 29, 2019, we sold 11,500,000 shares of common stock in an underwritten public offering, resulting in net proceeds of
approximately $177 million. On September 3, 2019, we sold 14,375,000 shares of common stock in an underwritten public offering,
resulting in net proceeds of approximately $228 million. During the year ended December 31, 2018, we sold 7,187,500 shares of common
stock in an underwritten public offering, resulting in net proceeds of approximately $117 million.
On October 15, 2019, we issued 588,260 shares of restricted common stock to members of CoreVest management at a grant date
fair market value of $16.48 per share, as a component of total consideration paid for the acquisition of CoreVest. The grant date fair value
of these restricted stock awards was $10 million, which will be recognized as compensation expense over the two-year vesting period in
accordance with GAAP.
Direct Stock Purchase and Dividend Reinvestment Plan
During the year ended December 31, 2019, we issued 399,838 shares of common stock through our Direct Stock Purchase and
Dividend Reinvestment Plan, resulting in net proceeds of approximately $6 million.
Earnings per Common Share
The following table provides the basic and diluted earnings per common share computations for the years ended December 31, 2019,
2018, and 2017.
Table 17.3 – Basic and Diluted Earnings per Common Share
(In Thousands, except Share Data)
Basic Earnings per Common Share:
Net income attributable to Redwood
Less: Dividends and undistributed earnings allocated to participating securities
Net income allocated to common shareholders
Basic weighted average common shares outstanding
Basic Earnings per Common Share
Diluted Earnings per Common Share:
Net income attributable to Redwood
Less: Dividends and undistributed earnings allocated to participating securities
Add back: Interest expense on convertible notes for the period, net of tax
Net income allocated to common shareholders
Weighted average common shares outstanding
Net effect of dilutive equity awards
Years Ended December 31,
2018
2017
2019
$
$
$
$
$
$
169,183
(4,797)
164,386
101,120,744
$
$
1.63
169,183
(5,273)
36,212
119,600
(3,754)
115,846
78,724,912
1.47
119,600
(4,283)
32,653
$
$
$
$
140,406
(3,632)
136,774
76,792,957
1.78
140,406
(3,836)
26,898
$
200,122
$
147,970
$
163,468
101,147,225
78,724,912
76,792,957
251,100
189,120
185,383
Net effect of assumed convertible notes conversion to common shares
35,382,269
31,113,738
24,996,668
Diluted weighted average common shares outstanding
Diluted Earnings per Common Share
136,780,594
110,027,770
101,975,008
$
1.46
$
1.34
$
1.60
F- 96
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 17. Equity - (continued)
We included participating securities, which are certain equity awards that have non-forfeitable dividend participation rights, in the
calculations of basic and diluted earnings per common share as we determined that the two-class method was more dilutive than the
alternative treasury stock method for these shares. Dividends and undistributed earnings allocated to participating securities under the
basic and diluted earnings per share calculations require specific shares to be included that may differ in certain circumstances.
During the year ended December 31, 2019, certain of our convertible notes were determined to be dilutive and were included in the
calculation of diluted EPS under the "if-converted" method. Under this method, the periodic interest expense (net of applicable taxes)
for dilutive notes is added back to the numerator and the weighted average number of shares that the notes are entitled to (if converted,
regardless of whether they are in or out of the money) are included in the denominator.
For the years ended December 31, 2019, 2018, and 2017, no common shares related to the assumed conversion of our convertible
notes were antidilutive and excluded from the calculation of diluted earnings per share.
For the years ended December 31, 2019, 2018, and 2017, the number of outstanding equity awards that were antidilutive totaled
10,051, 7,230, and 5,843, respectively.
Stock Repurchases
In February 2018, our Board of Directors approved an authorization for the repurchase of our common stock, increasing the total
amount authorized for repurchases of common stock to $100 million, and also authorized the repurchase of outstanding debt securities,
including convertible and exchangeable debt. This authorization increased the previous share repurchase authorization approved in
February 2016 and has no expiration date. This repurchase authorization does not obligate us to acquire any specific number of shares
or securities. Under this authorization, shares or securities may be repurchased in privately negotiated and/or open market transactions,
including under plans complying with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. At December 31, 2019, $100
million of the current authorization remained available for the repurchase of shares of our common stock.
Note 18. Equity Compensation Plans
At December 31, 2019 and December 31, 2018, 3,637,480 and 4,616,776 shares of common stock, respectively, were available for
grant under our Incentive Plan. The unamortized compensation cost of awards issued under the Incentive Plan and purchases under the
Employee Stock Purchase Plan totaled $32 million at December 31, 2019, as shown in the following table.
Table 18.1 – Activities of Equity Compensation Costs by Award Type
(In Thousands)
Unrecognized compensation cost at
beginning of period
Equity grants
Equity grant forfeitures
Equity compensation expense
Unrecognized Compensation Cost
at End of Period
Year Ended December 31, 2019
Restricted
Stock
Awards
Restricted
Stock Units
Deferred
Stock Units
Performance
Stock Units
Employee
Stock
Purchase
Plan
$
3,498
$
74
$
14,489
$
7,061
$
— $
—
—
(1,508)
4,233
—
(773)
11,230
(303)
(7,558)
5,275
—
(3,390)
173
—
(173)
Total
25,122
20,911
(303)
(13,402)
$
1,990
$
3,534
$
17,858
$
8,946
$
— $
32,328
At December 31, 2019, the weighted average amortization period remaining for all of our equity awards was two years.
F- 97
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 18. Equity Compensation Plans - (continued)
Restricted Stock Awards ("RSAs")
The following table summarizes the activities related to RSAs for the years ended December 31, 2019, 2018, and 2017.
Table 18.2 – Restricted Stock Awards Activities
Years Ended December 31,
2019
2018
2017
Weighted
Average
Grant Date
Fair Market
Value
$
$
14.92
—
15.05
—
14.85
Shares
334,606
—
(118,136)
—
216,470
Weighted
Average
Grant Date
Fair Market
Value
$
$
15.23
14.71
15.46
15.05
14.92
Weighted
Average
Grant Date
Fair Market
Value
$
$
14.27
16.52
14.97
14.78
15.23
Shares
204,515
134,364
(61,928)
(19,444)
257,507
Shares
257,507
168,537
(83,968)
(7,470)
334,606
Outstanding at beginning of period
Granted
Vested
Forfeited
Outstanding at End of Period
The expenses recorded for RSAs were $2 million, $2 million, and $1 million for the years ended December 31, 2019, 2018 and 2017,
respectively. As of December 31, 2019, there was $2 million of unrecognized compensation cost related to unvested RSAs. This cost will
be recognized over a weighted average period of less than two years. Restrictions on shares of RSAs outstanding lapse through 2022.
Restricted Stock Units ("RSUs")
The following table summarizes the activities related to RSUs for the years ended December 31, 2019, 2018, and 2017.
Table 18.3 – Restricted Stock Units Activities
Years Ended December 31,
2019
2018
2017
Weighted
Average
Grant Date
Fair Market
Value
$
$
15.38
15.66
—
—
15.65
Shares
4,876
270,297
—
—
275,173
Weighted
Average
Grant Date
Fair Market
Value
Shares
Weighted
Average
Grant Date
Fair Market
Value
Shares
— $
4,876
—
—
4,876
$
—
15.38
—
—
15.38
— $
—
—
—
— $
—
—
—
—
—
Outstanding at beginning of period
Granted
Vested
Forfeited
Outstanding at End of Period
The expenses recorded for RSUs were $1 million and less than $0.1 million for the years ended December 31, 2019 and 2018,
respectively. As of December 31, 2019, there was $4 million of unrecognized compensation cost related to unvested RSUs. This cost will
be recognized over a weighted average period of less than two years. Restrictions on shares of RSUs outstanding lapse through 2023.
F- 98
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 18. Equity Compensation Plans - (continued)
Deferred Stock Units (“DSUs”)
The following table summarizes the activities related to DSUs for the years ended December 31, 2019, 2018, and 2017.
Table 18.4 – Deferred Stock Units Activities
Years Ended December 31,
2019
2018
2017
Weighted
Average
Grant Date
Fair Market
Value
Units
Weighted
Average
Grant Date
Fair Market
Value
Units
Weighted
Average
Grant Date
Fair Market
Value
Units
Outstanding at beginning of period
2,336,720
$
Granted
Distributions
Forfeitures
733,096
(419,113)
(19,898)
Balance at End of Period
2,630,805
$
15.58
16.06
15.96
15.96
15.66
1,878,491
$
670,254
(212,025)
—
2,336,720
$
15.92
15.53
18.37
—
15.58
1,848,862
$
565,921
(504,417)
(31,875)
1,878,491
$
16.46
16.01
18.09
14.80
15.92
We generally grant DSUs annually, as part of our compensation process. In addition, DSUs are granted from time to time in connection
with hiring and promotions and in lieu of the payment in cash of a portion of annual bonus earned. At December 31, 2019 and 2018, the
number of outstanding DSUs that were unvested was 1,344,743 and 1,155,098, respectively. The weighted average grant-date fair value
of these unvested DSUs was $15.76 and $15.18 at December 31, 2019 and 2018, respectively. Unvested DSUs at December 31, 2019
will vest through 2023.
Expenses related to DSUs were $8 million, $8 million, and $6 million for the years ended December 31, 2019, 2018, and 2017,
respectively. At December 31, 2019, there was $18 million of unrecognized compensation cost related to unvested DSUs. This cost will
be recognized over a weighted average period of less than two years. At December 31, 2019 and 2018, the number of outstanding DSUs
that had vested was 1,286,063 and 1,181,623, respectively.
Performance Stock Units (“PSUs”)
At December 31, 2019 and December 31, 2018, the target number of PSUs that were unvested was 839,070 and 725,616, respectively.
During 2019, 2018, and 2017, 307,938, 258,078, and 273,054 target number of PSUs were granted, respectively, with per unit grant date
fair values of $17.13, $17.05, and $13.24, respectively. During the years ended December 31, 2019, 2018, and 2017, there were no PSUs
forfeited due to employee departures.
With respect to 307,938 and 235,053 target number of PSUs granted in December 2019 and December 2018, respectively, the number
of underlying shares of common stock that vest and that the recipient becomes entitled to receive at the time of vesting will generally
range from 0% to 250% of the target number of PSUs granted, with the target number of PSUs granted being adjusted to reflect the value
of any dividends declared on our common stock during the vesting period. Vesting of these PSUs will generally occur as of January 1,
2023 for the December 2019 awards and as of January 1, 2022 for the December 2018 awards. Vesting is based on a three-step process
as described below.
•
First, baseline vesting would range from 0% - 200% of the target number of PSUs granted based on the level of book value total
stockholder return (“bvTSR”) attained over the three-year vesting period, with 100% of the target number of PSUs vesting if
three-year bvTSR is 25%. Book Value TSR is defined as the percentage by which our book value "per share price" has increased
or decreased as of the last day of the three-year vesting period relative to the first day of such vesting period, adjusted to reflect
the reinvestment of all dividends declared and/or paid on our common stock, compared to the bvTSR goal for the performance
period.
F- 99
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 18. Equity Compensation Plans - (continued)
•
Second, the vesting level would then be adjusted to increase or decrease by up to an additional 50 percentage points based on
Redwood’s relative total stockholder return (“rTSR”) against a comparator group of companies measured over the three-year
vesting period, with median rTSR performance correlating to no adjustment from the baseline level of vesting.
• Third, if the vesting level after steps one and two is greater than 100% of the target number of PSUs, but absolute total shareholder
return (“TSR”) is negative over the three-year performance period, vesting would be capped at 100% of target number of PSUs.
TSR is defined as the percentage by which our common stock “per share price” has increased or decreased as of the last day of
the three-year vesting period relative to the first day of such vesting period, adjusted to reflect the reinvestment of all dividends
declared and/or paid on our common stock (“Three-Year TSR”).
The grant date fair value of the December 2019 PSUs of $17.13 was determined through Monte-Carlo simulations using the following
assumptions: the common stock closing price at the grant date for Redwood and each member of the comparator group, the average
closing price of the common stock price for the 60 trading days prior to the grant date for Redwood and each member of the comparator
group, and the range of performance-based vesting based on Absolute TSR over three years from the grant date. For the 2019 PSU grant,
an implied volatility assumption of 15% (based on historical volatility), a risk-free rate of 1.68% (the three-year Treasury rate on the
grant date), and a 0% dividend yield (the mathematical equivalent to reinvesting the dividends over the three-year performance period
as is consistent with the terms of the PSUs) were used.
The grant date fair value of the December 2018 PSUs of $17.23 was determined through Monte-Carlo simulations using the following
assumptions: the common stock closing price at the grant date for Redwood and each member of the comparator group, the average
closing price of the common stock price for the 60 trading days prior to the grant date for Redwood and each member of the comparator
group, and the range of performance-based vesting based on Absolute TSR over three years from the grant date. For the 2018 PSU grant,
an implied volatility assumption of 22% (based on historical volatility), a risk-free rate of 2.78% (the three-year Treasury rate on the
grant date), and a 0% dividend yield (the mathematical equivalent to reinvesting the dividends over the three-year performance period
as is consistent with the terms of the PSUs) were used.
In May 2018, 23,025 target number of PSUs with a per unit grant date fair value of $15.20 were granted to two executives in connection
with their promotions. The grant date fair values of these PSUs were determined through Monte-Carlo simulations using the following
assumptions: our common stock closing price at the grant date, the average closing price of our common stock price for the 60 trading
days prior to the grant date and the range of performance-based vesting based on Three-Year TSR and the performance-based vesting
formula described below with respect to PSUs granted in December 2017. For this PSU grant, an implied volatility assumption of 27%
(based on historical volatility), a risk-free rate of 2.71% (the three-year Treasury rate on the grant date), and a 0% dividend yield (the
mathematical equivalent to reinvesting the dividends over the three-year performance period as is consistent with the terms of the PSUs)
were used.
With respect to the PSUs granted in May 2018 and December 2017, vesting will generally occur at the end of three years from their
grant date, with the level of vesting at that time contingent on the Three-Year TSR. The number of underlying shares of our common
stock that will vest in future years will vary between 0% (if Three-Year TSR is zero or negative) and 200% (if Three-Year TSR is greater
than or equal to 125%) of the target number of PSUs originally granted, adjusted upward (if vesting is greater than 0%) to reflect the
value of dividends paid during the three-year vesting period.
The grant date fair values of 2017 PSUs were determined through Monte-Carlo simulations using the following assumptions: our
common stock closing price at the grant date, the average closing price of our common stock price for the 60 trading days prior to the
grant date and the range of performance-based vesting based on TSR over three years from the grant date. For the 2017 PSU grant, an
implied volatility assumption of 27% (based on historical volatility), a risk-free rate of 1.90% (the three-year Treasury rate on the grant
date), and a 0% dividend yield (the mathematical equivalent to reinvesting the dividends over the three-year performance period as is
consistent with the terms of the PSUs) were used.
F- 100
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 18. Equity Compensation Plans - (continued)
With respect to the PSUs granted in 2016, the three-year performance period ended during the fourth quarter of 2019, resulting in
the vesting of 222,769 shares of our common stock. With respect to the PSUs granted in 2015, the three-year performance period ended
during the fourth quarter of 2018, resulting in the vesting of 387,937 shares of our common stock. With respect to the PSUs granted in
2014, the three-year performance period ended during the fourth quarter of 2017, resulting in the vesting of zero shares of our underlying
common stock.
Expenses related to PSUs were $3 million for each of the years ended December 31, 2019, 2018, and 2017. As of December 31,
2019, there was $9 million of unrecognized compensation cost related to unvested PSUs.
Employee Stock Purchase Plan ("ESPP")
The ESPP allows a maximum of 600,000 shares of common stock to be purchased in aggregate for all employees. As of December 31,
2019, 430,772 shares had been purchased, respectively, and there remained a negligible amount of uninvested employee contributions
in the ESPP at December 31, 2019.
The following table summarizes the activities related to the ESPP for the years ended December 31, 2019, 2018, and 2017.
Table 18.5 – Employee Stock Purchase Plan Activities
(In Thousands)
Balance at beginning of period
Employee purchases
Cost of common stock issued
Balance at End of Period
Executive Deferred Compensation Plan
Years Ended December 31,
2019
2018
2017
$
$
6
$
524
(526)
4
$
4
$
375
(373)
6
$
3
305
(304)
4
The following table summarizes the cash account activities related to the EDCP for the years ended December 31, 2019, 2018, and
2017.
Table 18.6 – EDCP Cash Accounts Activities
(In Thousands)
Balance at beginning of period
New deferrals
Accrued interest
Withdrawals
Balance at End of Period
Years Ended December 31,
2019
2018
2017
$
$
2,484
$
2,171
$
789
68
(887)
2,454
$
759
82
(528)
2,484
$
2,088
750
58
(725)
2,171
In 2018, our Board of Directors approved an amendment to the EDCP to increase by 200,000 shares the shares available to allow
non-employee directors to defer certain cash payments and dividends into DSUs.
F- 101
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 19. Mortgage Banking Activities
The following table presents the components of Mortgage banking activities, net, recorded in our consolidated statements of income
for the years ended December 31, 2019, 2018, and 2017.
Table 19.1 – Mortgage Banking Activities
(In Thousands)
Residential Mortgage Banking Activities, Net
Changes in fair value of:
Residential loans, at fair value (1)
Risk management derivatives (2)
Other income (3)
Total residential mortgage banking activities, net
Business Purpose Mortgage Banking Activities, Net
Changes in fair value of:
Single-family rental loans, at fair value (1)
Risk management derivatives (2)
Residential bridge loans, at fair value
Other income (4)
Total business purpose mortgage banking activities, net
Years Ended December 31,
2018
2019
2017
$
21,808
$
$
63,527
(17,519)
1,735
47,743
17,004
1,796
4,518
16,205
39,523
69,373
(17,529)
2,064
53,908
—
—
—
—
—
35,248
2,567
59,623
453
(510)
—
—
(57)
59,566
Mortgage Banking Activities, Net
$
87,266
$
$
53,908
(1) For residential loans, includes changes in fair value for associated loan purchase and forward sale commitments. For single-family rental loans,
includes changes in fair value for associated interest rate lock commitments.
(2) Represents market valuation changes of derivatives that were used to manage risks associated with our accumulation of loans.
(3) Amounts in this line item include other fee income from loan acquisitions and the provision for repurchases expense, presented net.
(4) Amounts in this line item include other fee income from loan originations.
F- 102
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 20. Investment Fair Value Changes
The following table presents the components of Investment fair value changes, net, recorded in our consolidated statements of income
for the years ended December 31, 2019, 2018 and 2017.
Table 20.1 – Investment Fair Value Changes
(In Thousands)
Investment Fair Value Changes, Net
Changes in fair value of:
Years Ended December 31,
2019
2018
2017
Residential loans held-for-investment, at Redwood
$
58,891
$
Single-family rental loans held-for-investment
Residential bridge loans held-for-investment
Trading securities
Servicer advance investments
Excess MSRs
Shared home appreciation options
REO
Net investments in Legacy Sequoia entities (1)
Net investments in Sequoia Choice entities (1)
Net investment in Freddie Mac SLST entities (1)
Net investments in Freddie Mac K-Series entities (1)
Net investments in CAFL entities (1)
Risk-sharing and other investments
Risk management derivatives, net
Valuation adjustments on commercial loans held-for-sale
Impairments on AFS securities
Investment Fair Value Changes, Net
272
(2,139)
56,046
3,001
(3,260)
842
(1,045)
(1,545)
6,947
27,206
21,430
(3,636)
(341)
(127,169)
—
—
$
35,500
$
(29,573) $
—
(29)
(8,055)
(701)
1,823
—
—
(1,016)
443
1,271
931
—
(434)
9,740
—
(89)
(25,689) $
(5,765)
—
—
39,526
—
—
—
—
(8,027)
(323)
—
—
—
(1,484)
(12,842)
300
(1,011)
10,374
(1) Includes changes in fair value of the loans held-for-investment, REO and the ABS issued at the entities, which netted together represent the change
in value of our retained investments at the consolidated VIEs.
F- 103
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 21. Other Income
The following table presents the components of Other income recorded in our consolidated statements of income for the years ended
December 31, 2019, 2018 and 2017.
Table 21.1 – Other Income
(In Thousands)
MSR income, net
Risk share income
FHLBC capital stock dividend
Equity investment income
5 Arches loan administration fee income
Gain on re-measurement of investment in 5 Arches
Other
Other Income
Years Ended December 31,
2018
2017
2019
$
3,521
$
7,076
$
3,522
2,169
1,405
4,400
2,441
1,799
3,613
1,763
618
—
—
—
7,860
3,194
1,382
—
—
—
—
$
19,257
$
13,070
$
12,436
F- 104
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 22. General and Administrative Expenses and Other Expenses
Components of our general and administrative, and other expenses for the years ended December 31, 2019, 2018 and 2017 are
presented in the following table.
Table 22.1 – Components of General and Administrative Expenses and Other Expenses
(In Thousands)
General and Administrative Expenses
Fixed compensation expense
Variable compensation expense (1)
Equity compensation expense
Acquisition-related equity compensation expense (2)
Systems and consulting
Loan acquisition costs (3)
Office costs
Accounting and legal
Corporate costs
Other
Total General and Administrative Expenses
Other Expenses
Amortization of purchase-related intangible assets (4)
Contingent consideration expense (4)
Other
Total Other Expenses
Years Ended December 31,
2019
2018
2017
$
39,747
$
24,445
$
25,069
13,402
1,010
10,746
7,031
6,310
5,450
2,351
7,556
14,589
12,388
—
7,451
7,697
4,705
5,529
1,955
4,023
22,111
20,574
10,141
—
7,073
5,022
4,248
2,842
1,856
3,289
118,672
82,782
77,156
8,699
3,217
1,106
13,022
177
—
19
196
—
—
—
—
Total General and Administrative Expenses and Other Expenses
$
131,694
$
82,978
$
77,156
(1) Variable compensation expense in 2017 includes $2 million of costs associated with the hiring of a new executive officer.
(2) Acquisition-related equity compensation expense relates to 588,260 shares of restricted stock that were issued to members of CoreVest management
as a component of the consideration paid to them for our purchase of their interests in CoreVest. The grant date fair value of these restricted stock
awards was $10 million, which will be recognized as compensation expense over the two-year vesting period on a straight-line basis in accordance
with GAAP.
(3) Loan acquisition costs primarily includes underwriting and due diligence costs related to the acquisition of residential loans held-for-sale at fair
value.
(4)
Contingent consideration expense relates to the acquisition of 5 Arches during 2019. Refer to Note 2 for additional detail.
F- 105
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 23. Taxes
Components of our net deferred tax assets at December 31, 2019 and December 31, 2018 are presented in the following table.
Table 23.1 – Deferred Tax Assets (Liabilities)
(In Thousands)
Deferred Tax Assets
Net operating loss carryforward – state
Net operating loss carryforward – federal
Real estate assets
Interest rate agreements
Allowances and accruals
Goodwill and intangible assets
Other
Total Deferred Tax Assets
Deferred Tax Liabilities
Mortgage Servicing Rights
Interest rate agreements
Total Deferred Tax Liabilities
Valuation allowance
Total Deferred Tax Asset (Liability), net of Valuation Allowance
December 31, 2019 December 31, 2018
$
$
$
98,554
82
676
—
1,930
2,739
1,749
105,730
(13,783)
(42)
(13,825)
(97,057)
(5,152) $
103,858
—
2,400
2,320
1,830
—
1,586
111,994
(20,068)
—
(20,068)
(100,948)
(9,022)
The deferred tax assets and liabilities reported above, with the exception of the state net operating loss ("NOL") and capital loss
carryforwards, relate solely to our TRS. For state purposes, the REIT files a unitary combined return with its TRS. Because the REIT
may have state taxable income apportioned to it from the activity of its TRS, we report the entire combined unitary state NOL and capital
loss carryforwards as deferred tax assets, including the carryforwards allocated to the REIT.
Realization of our deferred tax assets ("DTAs") at December 31, 2019, is dependent on many factors, including generating sufficient
taxable income prior to the expiration of NOL carryforwards and generating sufficient capital gains in future periods prior to the expiration
of capital loss carryforwards. We determine the extent to which realization of the deferred assets is not assured and establish a valuation
allowance accordingly.
As a result of GAAP income generated at our TRS in 2019 and 2018, we are reporting net federal ordinary and capital deferred tax
liabilities ("DTLs") at December 31, 2019 and December 31, 2018 and consequently no valuation allowance was recorded against any
federal DTA in either of these periods. Consistent with prior periods, at December 31, 2019, we continued to maintain a valuation allowance
against our net state DTAs as we remain uncertain about our ability to generate sufficient income in future periods needed to utilize net
state DTAs beyond the reversal of our state DTLs.
Our estimate of net deferred tax assets could change in future periods to the extent that actual or revised estimates of future taxable
income during the carryforward periods change from current expectations. We assessed our tax positions for all open tax years (i.e.,
Federal, 2016 to 2019, and State, 2015 to 2019) and, at December 31, 2019 and December 31, 2018, concluded that we had no uncertain
tax positions that resulted in material unrecognized tax benefits.
F- 106
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 23. Taxes (continued)
At December 31, 2019, our federal NOL carryforward at the REIT was $28 million, which will expire in 2029. In order to utilize
NOLs at the REIT, taxable income must exceed dividend distributions. At December 31, 2019, our taxable REIT subsidiaries had $0.4
million of federal NOLs, which will carry forward indefinitely. Redwood and its taxable subsidiaries accumulated an estimated state
NOL of $1.15 billion at December 31, 2019. These NOLs expire beginning in 2029. If certain substantial changes in the Company’s
ownership occur, there could be an annual limitation on the amount of the carryforwards that can be utilized.
The following table summarizes the provision for income taxes for the years ended December 31, 2019, 2018, and 2017.
Table 23.2 – Provision for Income Taxes
(In Thousands)
Current Provision for Income Taxes
Federal
State
Total Current Provision for Income Taxes
Deferred (Benefit) Provision for Income Taxes
Federal
State
Total Deferred (Benefit) Provision for Income Taxes
Total Provision for Income Taxes
Years Ended December 31,
2019
2018
2017
$
12,036
$
11,387
$
897
12,933
820
12,207
(3,976)
(1,517)
(5,493)
7,440
$
(1,419)
300
(1,119)
11,088
$
$
512
361
873
10,991
(112)
10,879
11,752
The following is a reconciliation of the statutory federal and state tax rates to our effective tax rate at December 31, 2019, 2018, and
2017.
Table 23.3 – Reconciliation of Statutory Tax Rate to Effective Tax Rate
Federal statutory rate
State statutory rate, net of Federal tax effect
Differences in taxable (loss) income from GAAP income
Change in valuation allowance
Dividends paid deduction
Federal statutory rate change
Effective Tax Rate
December 31, 2019
December 31, 2018
December 31, 2017
21.0 %
8.6 %
(2.1)%
(2.2)%
(21.1)%
— %
4.2 %
21.0 %
8.6 %
(1.7)%
1.9 %
(21.3)%
— %
8.5 %
34.0 %
7.2 %
(3.9)%
(1.0)%
(23.4)%
(5.2)%
7.7 %
We believe that we have met all requirements for qualification as a REIT for federal income tax purposes. Many requirements for
qualification as a REIT are complex and require analysis of particular facts and circumstances. Often there is only limited judicial or
administrative interpretive guidance and as such there can be no assurance that the Internal Revenue Service or courts would agree with
our various tax positions. If we did not meet the requirements for statutory relief, we could be subject to a 100% prohibited transaction
tax for certain transactions, be required to distribute additional dividends, or be subject to federal corporate income tax on our taxable
income. We could also potentially lose our REIT status. Any of these outcomes could have a material adverse impact on our consolidated
financial statements.
F- 107
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 24. Segment Information
Redwood operates in four segments: Residential Lending, Business Purpose Lending, Multifamily Investments, and Third-Party
Residential Investments. Beginning in the fourth quarter of 2019, we reorganized our segments to align with changes in how we view
our business for making operating decisions and assessing performance, and conformed the presentation of prior periods. The accounting
policies of the reportable segments are the same as those described in Note 3 — Summary of Significant Accounting Policies. For a full
description of our segments, see Item 1—Business in this Annual Report on Form 10-K.
Segment contribution represents the measure of profit that management uses to assess the performance of our business segments
and make resource allocation and operating decisions. Certain corporate expenses not directly assigned or allocated to one of our four
segments, as well as activity from certain consolidated Sequoia entities, are included in the Corporate/Other column as reconciling items
to our consolidated financial statements. These unallocated corporate expenses primarily include indirect general and administrative
expenses and other expense.
The following tables present financial information by segment for the years ended December 31, 2019, 2018, and 2017.
Table 24.1 – Business Segment Financial Information
(In Thousands)
Interest income
Interest expense
Net interest income
Non-interest income
Mortgage banking activities, net
Investment fair value changes, net
Other income
Realized gains, net
Total non-interest income, net
General and administrative expenses
Other expenses
Provision for income taxes
Segment Contribution
Net Income
Non-cash amortization income
(expense), net
$
$
Residential
Lending
$
$
268,559
(192,359)
76,200
47,743
(27,920)
9,210
8,292
37,325
(30,671)
—
(4,074)
78,780
$
Year Ended December 31, 2019
Business
Purpose
Lending
54,372
(35,663)
18,709
39,523
(6,722)
5,852
—
38,653
(30,655)
(8,521)
(947)
17,239
Multifamily
Investments
161,692
$
(151,980)
9,712
Third-Party
Residential
Investments
120,009
$
(85,388)
34,621
Corporate/
Other
$
$
17,649
(14,418)
3,231
Total
622,281
(479,808)
142,473
—
27,097
1,484
134
28,715
(1,498)
—
(11)
36,918
$
—
44,662
—
15,395
60,057
(2,843)
(1,106)
(2,408)
88,321
$
—
(1,617)
2,711
—
1,094
(53,005)
(3,395)
—
(52,075)
$
87,266
35,500
19,257
23,821
165,844
(118,672)
(13,022)
(7,440)
$
169,183
3,669
$
(9,173) $
(1) $
6,957
$
(4,813) $
(3,361)
F- 108
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 24. Segment Information (continued)
Year Ended December 31, 2018
(In Thousands)
Interest income
Interest expense
Net interest income
Non-interest income
Mortgage banking activities, net
Investment fair value changes, net
Other income
Realized gains, net
Total non-interest income (loss),
net
General and administrative expenses
Other expenses
Provision for income taxes
Segment Contribution
Net Income
Non-cash amortization income
(expense), net
(In Thousands)
Interest income
Interest expense
Net interest income
Non-interest income
Mortgage banking activities, net
Investment fair value changes, net
Other income
Realized gains, net
Total non-interest income (loss),
net
General and administrative expenses
Provision for income taxes
Segment Contribution
Net Income
Non-cash amortization income
(expense), net
Residential
Lending
$
$
245,124
(158,498)
86,626
59,623
(21,686)
12,452
7,709
58,098
(32,139)
—
(8,033)
104,552
$
Business
Purpose
Lending
4,588
(2,252)
2,336
(57)
(29)
—
—
(86)
(2,597)
—
—
(347) $
$
$
Multifamily
Investments
40,050
$
(34,324)
5,726
Third-Party
Residential
Investments
68,919
$
(27,446)
41,473
Corporate/
Other
$
$
20,036
(16,519)
3,517
Total
378,717
(239,039)
139,678
—
3,979
—
—
3,979
(869)
—
(16)
8,820
$
—
(6,957)
—
19,332
12,375
(2,855)
(18)
(3,039)
47,936
$
—
(996)
618
—
(378)
(44,322)
(178)
—
(41,361)
59,566
(25,689)
13,070
27,041
73,988
(82,782)
(196)
(11,088)
$
119,600
4,486
$
(290) $
(1) $
12,295
$
(4,111) $
12,379
Year Ended December 31, 2017
Residential
Lending
$
$
158,819
(66,364)
92,455
Business
Purpose
Lending
Multifamily
Investments
9,170
(6,107)
3,063
— $
—
—
Third-Party
Residential
Investments
60,661
$
(21,512)
39,149
Corporate/
Other
$
$
19,407
(14,833)
4,574
Total
248,057
(108,816)
139,241
53,908
(25,466)
12,436
3,907
44,785
(28,622)
(6,641)
101,977
$
—
—
—
—
—
16,196
—
—
—
27,684
—
10,200
—
—
—
— $
16,196
(425)
(238)
18,596
$
37,884
(2,028)
(4,873)
70,132
$
—
(8,040)
—
(752)
(8,792)
(46,081)
—
(50,299)
53,908
10,374
12,436
13,355
90,073
(77,156)
(11,752)
$
140,406
4,946
$
— $
(1) $
15,927
$
(3,410) $
17,462
$
$
F- 109
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 24. Segment Information (continued)
The following table presents the components of Corporate/Other for the years ended December 31, 2019, 2018, and 2017.
Table 24.2 – Components of Corporate/Other
2019
Years Ended December 31,
2018
2017
(In Thousands)
Interest income
Interest expense
Net interest income
(loss)
Non-interest income
Investment fair value
changes, net
Other income
Realized gains, net
Total non-interest
(loss) income, net
General and
administrative expenses
Other expenses
Total
Legacy
Consolidated
VIEs (1)
Other
Total
Legacy
Consolidated
VIEs (1)
Other
Total
Legacy
Consolidated
VIEs (1)
Other
Total
$
17,649
$
— $
17,649
$
20,036
$
— $
20,036
$
19,407
$
— $
19,407
(14,418)
3,231
—
—
(14,418)
(16,519)
3,231
3,517
(1,545)
(72)
—
—
2,711
—
(1,617)
2,711
—
(1,016)
—
—
(1,545)
2,639
1,094
(1,016)
—
—
20
618
—
638
(16,519)
(14,789)
(44)
(14,833)
3,517
4,618
(44)
4,574
(996)
618
—
(378)
(8,027)
—
—
(13)
—
(752)
(8,040)
—
(752)
(8,027)
(765)
(8,792)
—
—
(53,005)
(53,005)
(3,395)
(3,395)
—
—
(44,322)
(44,322)
(178)
(178)
—
—
(46,081)
(46,081)
—
—
$
1,686
$
(53,761) $
(52,075) $
2,501
$
(43,862) $
(41,361) $
(3,409) $
(46,890) $
(50,299)
(1) Legacy consolidated VIEs represent Legacy Sequoia entities that are consolidated for GAAP financial reporting purposes. See Note 4 for further
discussion on VIEs.
The following table presents supplemental information by segment at December 31, 2019 and December 31, 2018.
Table 24.3 – Supplemental Segment Information
(In Thousands)
December 31, 2019
Residential loans
Business purpose residential loans
Multifamily loans
Real estate securities
Other investments
Goodwill and intangible assets
Total assets
December 31, 2018
Residential loans
Business purpose residential loans
Multifamily loans
Real estate securities
Other investments
Total assets
Residential
Lending
$ 4,939,745
—
—
229,074
42,224
—
5,410,540
$ 5,512,116
—
—
364,308
99,984
6,186,889
Business
Purpose
Lending
Multifamily
Investments
Third-Party
Residential
Investments
Corporate/
Other
Total
$
— $
3,506,743
—
—
21,002
161,464
3,786,641
— $ 2,367,215
—
—
—
4,408,524
466,672
404,128
233,886
61,018
—
—
3,139,616
4,889,330
$
— $
141,258
—
—
10,754
160,950
F- 110
— $ 1,222,668
—
—
—
2,144,598
659,107
429,079
312,688
15,092
2,232,276
2,600,150
$
$
407,890
—
—
—
—
—
769,313
$ 7,714,850
3,506,743
4,408,524
1,099,874
358,130
161,464
17,995,440
519,958
—
—
—
—
757,141
$ 7,254,742
141,258
2,144,598
1,452,494
438,518
11,937,406
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
Note 25. Quarterly Financial Data - Unaudited
(In Thousands, except Share Data)
2019
Operating results:
Interest income
Interest expense
Net interest income
Non-interest income
General and administrative, and other expenses
Net income
Per share data:
Net income – basic
Net income – diluted
Regular dividends declared per common share
2018
Operating results:
Interest income
Interest expense
Net interest income
Non-interest income
General, administrative, and other expenses
Net (loss) income
Per share data:
Net (loss) income – basic
Net (loss) income – diluted
Regular dividends declared per common share
$
$
$
$
December 31,
September 30,
June 30,
March 31,
Three Months Ended
$
$
$
192,581
(147,708)
44,873
58,052
(49,444)
49,143
0.42
0.38
0.30
119,725
(84,961)
34,764
(17,538)
(19,378)
(913)
(0.02) $
(0.02)
0.30
$
$
$
$
150,117
(116,604)
33,513
30,029
(29,346)
34,310
0.33
0.31
0.30
99,397
(64,351)
35,046
32,327
(21,561)
40,921
0.49
0.42
0.30
$
$
$
$
148,542
(116,220)
32,322
29,984
(28,707)
31,266
0.31
0.30
0.30
82,976
(48,213)
34,763
19,527
(19,009)
32,747
0.42
0.38
0.30
131,041
(99,276)
31,765
47,779
(24,197)
54,464
0.57
0.49
0.30
76,619
(41,514)
35,105
39,672
(23,030)
46,845
0.60
0.50
0.28
F- 111
Total Residential Loans Held-for-Investment
$
7,178,465
$
REDWOOD TRUST, INC. AND SUBSIDIARIES
SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE
December 31, 2019
Number of
Loans
Interest
Rate
Maturity
Date
Carrying
Amount
Principal Amount
Subject to
Delinquent
Principal or
Interest
299
2,641
2,186
12
2.875% to 6.00%
2041-01 - 2048-09
$
232,581
$
2.75% to 6.75%
2026-01 - 2049-05
1,879,316
1.25% to 6.00%
2020-01 - 2036-05
3.63% to 5.13%
2033-07 - 2034-06
402,837
5,053
3,156
2.75% to 6.75%
2035-04 - 2049-09
2,291,463
14,502
2.00% to 11.00%
2019-11 - 2059-10
2,367,215
3.38% to 3.50%
2032-11 - 2032-11
$
105
$
3.00% to 7.00%
2047-04 - 2049-12
3.20% to 7.13%
2034-05 - 2050-01
93,755
442,525
536,385
$
331,565
331,565
$
$
$
$
$
971
614
9,803
—
6,756
135,175
153,319
—
—
747
747
1,818
1,818
107
3.93% to 7.47%
2023-09 - 2030-01
$
237,620
$
—
783
4.31% to 7.57%
2019-11 - 2029-11
(In Thousands)
Description
Residential Loans Held-for-Investment
At Redwood (1):
Hybrid ARM loans
Fixed loans
At Legacy Sequoia (2):
ARM loans
Hybrid ARM loans
At Sequoia Choice (2):
Fixed loans
At Freddie Mac SLST (3):
Fixed loans
Residential Loans Held-for-Sale (4):
ARM loans
Hybrid ARM loans
Fixed loans
Total Residential Loans Held-for-Sale
Single-Family Rental Loans Held-for-Sale (4):
2
115
554
Total Single-Family Rental Loans Held-for-Sale
Single-Family Rental Loans Held-for-Investment:
At Redwood (1):
Fixed loans
At CAFL (2):
Fixed loans
Total Single-Family Rental Loans Held-for-Investment
Residential Bridge Loans Held-for-Investment (1):
2,192,552
2,430,172
$
745,006
745,006
4,408,524
4,408,524
$
$
$
$
$
$
$
$
$
29,039
29,039
8,989
8,989
—
—
Fixed loans
2,653
5.79% to 13.00%
2018-10 - 2022-01
Total Residential Bridge Loans Held-for-Investment
Multifamily Loans Held-for-Investment (3):
At Freddie Mac K-Series:
Fixed loans
Total Multifamily Loans Held-for-Investment
279
3.29% to 4.94%
2023-02 - 2029-10
(1) For our held-for-investment residential, single-family rental, and residential bridge loans at Redwood, the aggregate tax basis for Federal income
tax purposes at December 31, 2019 was $2.07 billion, $238 million, and $746 million, respectively.
(2) For our held-for-investment loans at consolidated Legacy Sequoia, Sequoia Choice, and CAFL entities, the aggregate tax basis for Federal income
tax purposes at December 31, 2019 was zero, as the transfers of these loans into securitizations were treated as sales for tax purposes.
(3) Our held-for-investment loans at Freddie Mac SLST and Freddie Mac K-Series entities were consolidated for GAAP purposes. For tax purposes,
we acquired real estate securities issued by these entities and therefore, the tax basis in these loans was zero at December 31, 2019.
(4) The aggregate tax basis for Federal income tax purposes of our mortgage loans held at Redwood approximates the carrying values, as disclosed in
the schedule.
F- 112
Fixed loans
201
4.35% to 7.63%
2024-01 - 2050-01
REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTE TO SCHEDULE IV - RECONCILIATION OF MORTGAGE LOANS ON REAL ESTATE
December 31, 2019
The following table summarizes the changes in the carrying amount of mortgage loans on real estate during the years ended
December 31, 2019, 2018, and 2017.
(In Thousands)
Balance at beginning of period
Additions during period:
Originations/acquisitions
Deductions during period:
Sales
Principal repayments
Transfers to REO
Changes in fair value, net
Balance at end of period
Years Ended December 31,
2019
2018
2017
$
9,540,598
$
5,115,210
$
3,890,751
12,911,261
10,607,896
5,741,427
(5,218,797)
(1,851,278)
(7,552)
255,885
(5,426,304)
(843,984)
(4,104)
91,884
(3,982,683)
(576,620)
(4,219)
46,554
$
15,630,117
$
9,540,598
$
5,115,210
F- 113