UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: September 30, 2015

OR

o

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
 
68-0329422
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)

One Belvedere Place, Suite 300
Mill Valley, California
 
94941
(Address of Principal Executive Offices)
 
(Zip Code)

(415) 389-7373
(Registrant’s Telephone Number, Including Area Code)
Not Applicable
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
 
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 x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Common Stock, $0.01 par value per share
 
 82,124,371 shares outstanding as of November 5, 2015



REDWOOD TRUST, INC.
2015 FORM 10-Q REPORT
TABLE OF CONTENTS
 
 
 
 
Page
PART I —
FINANCIAL INFORMATION
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
 
 
PART II —
OTHER INFORMATION
 
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 3.
 
Item 4.
 
Item 5.
 
Item 6.
 
 




i


PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
(Unaudited)
 
September 30, 2015
 
December 31, 2014
ASSETS (1)
 
 
 
 
Residential loans, held-for-sale, at fair value
 
$
1,506,151

 
$
1,342,519

Residential loans, held-for-investment, at fair value (2)
 
2,530,523

 
2,056,054

Commercial loans, held-for-sale, at fair value
 
80,756

 
166,234

Commercial loans, held-for-investment (includes $70,096 and $71,262 at fair value)
 
387,401

 
400,693

Real estate securities, at fair value
 
1,085,224

 
1,379,230

Mortgage servicing rights, at fair value
 
162,726

 
139,293

Cash and cash equivalents
 
235,362

 
269,730

Total earning assets
 
5,988,143

 
5,753,753

Restricted cash
 
8,361

 
628

Accrued interest receivable
 
20,223

 
18,222

Derivative assets
 
38,623

 
16,417

Deferred securities issuance costs
 
12,080

 
16,050

Other assets
 
201,596

 
113,896

Total Assets
 
$
6,269,026

 
$
5,918,966

 
 
 
 
 
LIABILITIES AND EQUITY (1)
 
 
 
 
Liabilities
 
 
 
 
Short-term debt
 
$
1,872,793

 
$
1,793,825

Accrued interest payable
 
14,738

 
8,503

Derivative liabilities
 
88,044

 
58,331

Accrued expenses and other liabilities
 
75,968

 
52,244

Deferred tax liability
 
10,236

 
10,236

Asset-backed securities issued (includes $1,105,588 and $0 at fair value) (2)
 
1,178,795

 
1,545,119

Long-term debt (includes $65,578 and $66,707 at fair value)
 
1,821,877

 
1,194,567

Total liabilities
 
5,062,451

 
4,662,825

Equity
 
 
 
 
Common stock, par value $0.01 per share, 180,000,000 shares authorized; 82,124,927 and 83,443,141 issued and outstanding
 
821

 
834

Additional paid-in capital
 
1,746,775

 
1,774,030

Accumulated other comprehensive income
 
119,721

 
140,688

Cumulative earnings
 
977,624

 
906,867

Cumulative distributions to stockholders
 
(1,638,366
)
 
(1,566,278
)
Total equity
 
1,206,575

 
1,256,141

Total Liabilities and Equity
 
$
6,269,026

 
$
5,918,966

——————
(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 September 30, 2015 and December 31, 2014, assets of consolidated VIEs totaled $1,539,350 and $1,900,208, respectively. At September 30, 2015 and December 31, 2014, liabilities of consolidated VIEs totaled $1,179,884 and $1,546,490, respectively. See Note 4 for further discussion.
(2)
On January 1, 2015, we adopted ASU 2014-13 and began to account for residential loans held-for-investment and asset backed securities issued at consolidated Sequoia entities (which are VIEs) at fair value. At December 31, 2014, amounts presented in residential loans held-for-investment for these assets included $1,474,386 at historical cost. See Note 3 for further discussion.
The accompanying notes are an integral part of these consolidated financial statements.

2

REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Share Data)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Unaudited)
 
2015
 
2014
 
2015
 
2014
Interest Income
 
 
 
 
 
 
 
 
Residential loans
 
$
29,472

 
$
19,280

 
$
80,289

 
$
45,539

Commercial loans
 
11,191

 
12,603

 
34,784

 
34,204

Real estate securities
 
22,749

 
31,461

 
75,363

 
97,062

Other interest income
 
72

 
7

 
167

 
15

Total interest income
 
63,484

 
63,351

 
190,603

 
176,820

Interest Expense
 
 
 
 
 
 
 
 
Short-term debt
 
(7,627
)
 
(8,441
)
 
(21,378
)
 
(17,409
)
Asset-backed securities issued
 
(5,190
)
 
(7,838
)
 
(17,037
)
 
(24,462
)
Long-term debt
 
(11,058
)
 
(7,071
)
 
(32,429
)
 
(21,689
)
Total interest expense
 
(23,875
)
 
(23,350
)
 
(70,844
)
 
(63,560
)
Net Interest Income
 
39,609

 
40,001

 
119,759

 
113,260

Reversal of provision for loan losses
 
60

 
1,596

 
115

 
629

Net Interest Income After Provision
 
39,669

 
41,597

 
119,874

 
113,889

Non-interest Income
 
 
 
 
 
 
 
 
Mortgage banking and investment activities, net
 
(12,836
)
 
14,166

 
(6,399
)
 
9,984

Mortgage servicing rights income (loss), net
 
3,549

 
5,821

 
(6,545
)
 
4,650

Other income
 
327

 
1,600

 
2,435

 
1,600

Realized gains, net
 
5,548

 
8,532

 
16,170

 
10,687

Total non-interest income (loss)
 
(3,412
)
 
30,119

 
5,661

 
26,921

Operating expenses
 
(24,497
)
 
(21,406
)
 
(74,778
)
 
(63,660
)
Net income before provision for income taxes
 
11,760

 
50,310

 
50,757

 
77,150

Benefit from (provision for) income taxes
 
7,404

 
(5,213
)
 
10,272

 
(3,703
)
Net Income
 
$
19,164

 
$
45,097

 
$
61,029

 
$
73,447

 
 
 
 
 
 
 
 
 
Basic earnings per common share
 
$
0.22

 
$
0.53

 
$
0.71

 
$
0.87

Diluted earnings per common share
 
$
0.22

 
$
0.50

 
$
0.69

 
$
0.84

Regular dividends declared per common share
 
$
0.28

 
$
0.28

 
$
0.84

 
$
0.84

Basic weighted average shares outstanding
 
83,787,533

 
83,017,534

 
83,696,461

 
82,722,079

Diluted weighted average shares outstanding
 
85,074,704

 
96,956,232

 
85,338,996

 
85,031,130

——————

The accompanying notes are an integral part of these consolidated financial statements.

3

REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In Thousands)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Unaudited)
 
2015
 
2014
 
2015
 
2014
Net Income
 
$
19,164

 
$
45,097

 
$
61,029

 
$
73,447

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
Net unrealized (loss) gain on available-for-sale securities
 
(5,673
)
 
1,849

 
(5,701
)
 
35,078

Reclassification of unrealized gain on available-for-sale securities to net income
 
(3,270
)
 
(6,409
)
 
(10,320
)
 
(6,750
)
Net unrealized loss on interest rate agreements
 
(12,049
)
 
(3,258
)
 
(5,023
)
 
(17,454
)
Reclassification of unrealized loss on interest rate agreements to net income
 
19

 
32

 
77

 
131

Total other comprehensive income (loss)
 
(20,973
)
 
(7,786
)
 
(20,967
)
 
11,005

Total Comprehensive Income (Loss)
 
$
(1,809
)
 
$
37,311

 
$
40,062

 
$
84,452


The accompanying notes are an integral part of these consolidated financial statements.


4


REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

For the Nine Months Ended September 30, 2015
(In Thousands, Except Share Data)
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive
Income
 
Cumulative
 Earnings
 
Cumulative
Distributions
to Stockholders
 
Total
(Unaudited)
 
Shares
 
Amount
 
 
 
 
 
December 31, 2014
 
83,443,141

 
$
834

 
$
1,774,030

 
$
140,688

 
$
906,867

 
$
(1,566,278
)
 
$
1,256,141

Cumulative effect adjustment - adoption of ASU 2014-13 (1)
 
—

 
—

 
—

 
—

 
9,728

 
—

 
9,728

January 1, 2015
 
83,443,141

 
834

 
1,774,030

 
140,688

 
916,595

 
(1,566,278
)
 
1,265,869

Net income
 
—

 
—

 
—

 
—

 
61,029

 
—

 
61,029

Other comprehensive loss
 
—

 
—

 
—

 
(20,967
)
 
—

 
—

 
(20,967
)
Dividend reinvestment & stock purchase plans
 
418,508

 
4

 
6,830

 
—

 
—

 
—

 
6,834

Employee stock purchase and incentive plans
 
714,801

 
7

 
(7,735
)
 
—

 
—

 
—

 
(7,728
)
Non-cash equity award compensation
 
—

 
—

 
9,002

 
—

 
—

 
—

 
9,002

Share repurchases
 
(2,451,523
)
 
(24
)
 
(35,352
)
 
—

 
—

 
—

 
(35,376
)
Common dividends declared
 
—

 
—

 
—

 
—

 
—

 
(72,088
)
 
(72,088
)
September 30, 2015
 
82,124,927

 
$
821

 
$
1,746,775

 
$
119,721

 
$
977,624

 
$
(1,638,366
)
 
$
1,206,575



For the Nine Months Ended September 30, 2014
(In Thousands, Except Share Data)
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive
Income
 
Cumulative
 Earnings
 
Cumulative
Distributions
to Stockholders
 
Total
(Unaudited)
 
Shares
 
Amount
 
 
 
 
 
December 31, 2013
 
82,504,801

 
$
825

 
$
1,760,899

 
$
148,766

 
$
806,298

 
$
(1,471,005
)
 
$
1,245,783

Net income
 
—

 
—

 
—

 
—

 
73,447

 
—

 
73,447

Other comprehensive income
 
—

 
—

 
—

 
11,005

 
—

 
—

 
11,005

Dividend reinvestment & stock purchase plans
 
336,810

 
4

 
6,051

 
—

 
—

 
—

 
6,055

Employee stock purchase and incentive plans
 
442,781

 
4

 
(7,272
)
 
—

 
—

 
—

 
(7,268
)
Non-cash equity award compensation
 
—

 
—

 
8,934

 
—

 
—

 
—

 
8,934

Common dividends declared
 
—

 
—

 
—

 
—

 
—

 
(71,278
)
 
(71,278
)
September 30, 2014
 
83,284,392

 
$
833

 
$
1,768,612

 
$
159,771

 
$
879,745

 
$
(1,542,283
)
 
$
1,266,678

(1) On January 1, 2015, we adopted ASU 2014-13. See Note 3 for further discussion.

The accompanying notes are an integral part of these consolidated financial statements.


5

REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
 
Nine Months Ended September 30,
 
2015
 
2014
Cash Flows From Operating Activities:
 
 
 
 
Net income
 
$
61,029

 
$
73,447

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
Amortization of premiums, discounts, and securities issuance costs, net
 
(26,244
)
 
(26,248
)
Depreciation and amortization of non-financial assets
 
510

 
369

Purchases of held-for-sale loans
 
(8,794,939
)
 
(6,844,403
)
Proceeds from sales of held-for-sale loans
 
7,741,024

 
5,328,901

Principal payments on held-for-sale loans
 
46,952

 
19,648

Net settlements of derivatives
 
(47,002
)
 
(22,776
)
Provision for loan losses
 
(115
)
 
(629
)
Non-cash equity award compensation expense
 
9,002

 
8,934

Market valuation adjustments
 
40,546

 
(1,787
)
Realized gains, net
 
(16,170
)
 
(10,687
)
Net change in:
 
 
 
 
Accrued interest receivable and other assets
 
(90,605
)
 
(57,806
)
Accrued interest payable, deferred tax liabilities, and accrued expenses and other liabilities
 
26,094

 
(266
)
Net cash used in operating activities
 
(1,049,918
)
 
(1,533,303
)
Cash Flows From Investing Activities:
 
 
 
 
Purchases of loans held-for-investment
 
(22,219
)
 
(65,584
)
Principal payments on loans held-for-investment
 
359,714

 
267,425

Purchases of real estate securities
 
(66,601
)
 
(132,393
)
Proceeds from sales of real estate securities
 
309,101

 
457,131

Principal payments on real estate securities
 
103,664

 
144,598

Purchase of mortgage servicing rights
 
(23,315
)
 
(41,834
)
Proceeds from sales of mortgage servicing rights
 
17,235

 
—

Net change in restricted cash
 
(7,733
)
 
(57
)
Net cash provided by investing activities
 
669,846

 
629,286

Cash Flows From Financing Activities:
 
 
 
 
Proceeds from borrowings on short-term debt
 
6,213,505

 
5,615,317

Repayments on short-term debt
 
(6,160,226
)
 
(4,643,308
)
Repayments on asset-backed securities issued
 
(256,614
)
 
(286,248
)
Deferred securities issuance costs
 
(33
)
 
—

Proceeds from issuance of long-term debt
 
1,156,396

 
272,937

Repayments on long-term debt
 
(502,268
)
 
(685
)
Net settlements of derivatives
 
(32
)
 
(2,507
)
Net proceeds from issuance of common stock
 
7,198

 
3,840

Net payments on repurchase of common stock
 
(32,042
)
 
—

Taxes paid on equity award distributions
 
(8,092
)
 
(7,635
)
Dividends paid
 
(72,088
)
 
(71,278
)
Net cash provided by financing activities
 
345,704

 
880,433

Net decrease in cash and cash equivalents
 
(34,368
)
 
(23,584
)
Cash and cash equivalents at beginning of period
 
269,730

 
173,201

Cash and cash equivalents at end of period
 
$
235,362

 
$
149,617

Supplemental Cash Flow Information:
 
 
 
 
Cash paid during the period for:
 
 
 
 
 Interest
 
$
57,998

 
$
57,047

 Taxes
 
55

 
1,399

Supplemental Noncash Information:
 
 
 
 
Real estate securities retained from loan securitizations
 
$
39,698

 
$
126,009

Retention of mortgage servicing rights from loan securitizations and sales
 
52,297

 
30,962

Transfers from loans held-for-sale to loans held-for-investment
 
964,013

 
278,913

Transfers from loans held-for-investment to loans held-for-sale
 
66,918

 
—

Transfers from residential loans to real estate owned
 
5,740

 
4,753

The accompanying notes are an integral part of these consolidated financial statements.


6

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Unaudited)




Note 1. Organization
Redwood Trust, Inc., together with its subsidiaries, focuses on investing in mortgage- and other real estate-related assets and engaging in residential and commercial mortgage banking activities. We seek to invest in real estate-related assets that have the potential to generate attractive cash flow returns over time and to generate income through our residential and commercial mortgage banking activities. We operate our business in three segments: residential mortgage banking, residential investments, and commercial mortgage banking and investments. Redwood was incorporated in the State of Maryland on April 11, 1994, and commenced operations on August 19, 1994. References herein to “Redwood,” the “company,” “we,” “us,” and “our” include Redwood Trust, Inc. and its consolidated subsidiaries, unless the context otherwise requires.
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. To qualify as a REIT, Redwood Trust, Inc. must distribute at least 90% of its annual REIT taxable income to shareholders (not including taxable income retained in its 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 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.” We generally intend to distribute as dividends at least 90% of the taxable income we generate at our REIT.
We sponsor our Sequoia securitization program, which we use for the securitization of residential mortgage loans. References to Sequoia with respect to any time or period generally refer collectively to all the then consolidated Sequoia securitization entities for the periods presented. We have also engaged in securitization transactions in order to obtain financing for certain of our securities and commercial loans.
Note 2. Basis of Presentation
The consolidated financial statements presented herein are at September 30, 2015 and December 31, 2014, and for the three and nine months ended September 30, 2015 and 2014. These interim unaudited consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and note disclosures normally included in financial statements 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”) —  have been condensed or omitted according to these SEC rules and regulations. Management believes that the disclosures included in these interim financial statements should be read in conjunction with consolidated financial statements and notes thereto included in the company's Annual Report on Form 10-K for the year ended December 31, 2014. In the opinion of management, all normal and recurring adjustments to present fairly the financial condition of the company at September 30, 2015 and results of operations for all periods presented have been made. The results of operations for the three and nine months ended September 30, 2015 should not be construed as indicative of the results to be expected for the full year.
In the second quarter of 2015, we began to specifically identify derivatives that are used to hedge our exposure to market interest rate risk associated with our MSR investments. As a result, beginning in the second quarter of 2015, we changed our income statement presentation to include the change in market value of these derivatives in the line item “Mortgage servicing rights income (loss), net.” As we previously managed our market interest rate risk on a portfolio-wide basis and did not necessarily rely on derivatives to hedge our MSRs, we cannot conform prior periods to the current presentation. Therefore, in periods prior to the second quarter of 2015 presented in our consolidated statements of income, amounts in “Mortgage servicing rights income (loss), net” do not reflect the impact of hedging. These changes and year-over-year comparisons are discussed in further detail in Part I, Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations in this quarterly report on Form 10-Q.
Additionally, beginning in the second quarter of 2015, we combined our “Mortgage banking activities” and “Other market valuation adjustments” line items on our consolidated statements of income into a single line, now called “Mortgage banking and investment activities, net.” As we currently manage our market interest rate risk on the remainder of our assets (excluding MSRs) on a net basis, we believe that combining these two line items will better reflect the net effect of our hedging activities on the assets associated with derivatives that are marked-to-market each quarter. We have conformed the presentation of prior periods related to this change for consistency of comparison.

7

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Unaudited)
Note 2. Basis of Presentation - (continued)

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 where we maintain an ongoing involvement, as well as an entity formed in connection with a resecuritization transaction we engaged in during 2011 (“Residential Resecuritization”), and an entity formed in connection with a commercial securitization we engaged in during 2012 (“Commercial Securitization”). 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 retained, although we are exposed to certain financial risks associated with our role as a sponsor, manager, or depositor of these entities or as a result of our having sold assets directly or indirectly to these entities.
For financial reporting purposes, the underlying loans and securities owned at the consolidated Sequoia entities, the Residential Resecuritization entity, and the Commercial Securitization entity are shown under residential and commercial loans and real estate securities 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 record interest income on the loans and securities 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 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.
Note 3. Summary of Significant Accounting Policies

Significant Accounting Policies
Included in Note 3 to the Consolidated Financial Statements of our 2014 Annual Report on Form 10-K is a summary of our significant accounting policies. Provided below is a summary of additional accounting policies that are significant to the company’s consolidated financial condition and results of operations for the three and nine months ended September 30, 2015.
Recent Accounting Pronouncements
Adoption of ASU 2014-13
In November 2014, the FASB issued ASU 2014-13, “Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity” ("ASU 2014-13"). This update provides a measurement alternative to companies that consolidate collateralized financing entities ("CFEs"). Under the new guidance, companies can 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. This guidance is effective in the first quarter 2016 with early adoption permitted at the beginning of an annual period. The guidance can be applied either retrospectively to all relevant prior periods or by a modified retrospective approach with a cumulative-effect adjustment to equity as of the beginning of the annual period of adoption.
On January 1, 2015, we elected to early adopt ASU 2014-13, as we determined this measurement alternative more accurately reflects our economic interests in, and financial results from, certain consolidated financing entities.  We adopted the measurement alternative under this standard only for our consolidated Sequoia entities, which qualify under the standard as CFEs.  We did not elect the measurement alternative for our Residential Resecuritization or our Commercial Resecuritization, and will continue to account for the assets and liabilities in these CFEs in accordance with existing accounting guidance. 

8

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Unaudited)

Note 3. Summary of Significant Accounting Policies - (continued)

Under the provisions of ASU 2014-13, we use the fair value of the liabilities issued by the Sequoia CFEs (which we determined to be more observable) to determine the fair value of the assets, whereby the net assets we consolidate in our financial statements related to these entities represents the estimated fair value of our retained interests in the Sequoia CFEs.  Similarly, the periodic net market valuation adjustments we record on our income statement from the consolidated assets and liabilities of the CFEs represents the change in fair value of our retained interests in the Sequoia CFEs.
Using the modified retrospective approach, we recorded a cumulative-effect adjustment to equity of $10 million through retained earnings as of January 1, 2015.  This cumulative-effect adjustment represents the net effect of adjusting the assets and liabilities of the Sequoia CFEs from amortized historical cost to fair value.
Subsequent to the adoption of ASU 2014-13, the consolidated assets and liabilities of the Sequoia CFEs are both carried at fair value, with the periodic net changes in fair value recorded on our income statement, in mortgage banking and investment activities, net.
The following table presents the assets and liabilities of the consolidated Sequoia entities at December 31, 2014 prior to the adoption of ASU 2014-13, the adjustments required to adopt the new standard, and the adjusted balances at January 1, 2015.
Table 3.1 – Impact of Adoption of ASU 2014-13 on Balance Sheet (1) 
(In Millions)
 
December 31, 2014
 
ASU 2014-13 Adjustment
 
January 1, 2015
Loan Principal
 
$
1,486

 
$
—

 
$
1,486

Loan unamortized premium
 
13

 
(13
)
 
—

Allowance for loan losses
 
(21
)
 
21

 
—

Loan market valuation adjustment
 
—

 
(113
)
 
(113
)
Residential loans held-for-investment
 
1,478

 
(105
)
 
1,373

Deferred bond issuance costs
 
1

 
(1
)
 
—

Other assets
 
5

 
—

 
5

Total assets
 
1,482

 
(105
)
 
1,377

 
 
 
 
 
 

ABS issued principal
 
1,428

 
—

 
1,428

ABS issued unamortized discount
 
(10
)
 
10

 
—

ABS market valuation adjustment
 
—

 
(125
)
 
(125
)
Total liabilities
 
1,418

 
(115
)
 
1,303

Redwood's investment in consolidated Sequoia entities
 
$
64

 
$
10

 
$
74

(1)
Certain totals may not foot due to rounding.

9

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Unaudited)

Note 3. Summary of Significant Accounting Policies - (continued)

Other Recent Accounting Pronouncements
In April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs.” This new guidance requires debt issuance costs to be presented in the balance sheet as a direct deduction from the carrying value of the associated debt liability, consistent with the presentation of a debt discount. This new guidance is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted for financial statements that have not been previously issued. The new guidance is required to be applied on a retrospective basis. We plan to adopt this new guidance by the required date and will reclassify our deferred securities issuance costs that we currently present on the face of our consolidated balance sheets and present them as debt discounts.
In February 2015, the FASB issued ASU 2015-02, “Consolidation (Topic 810) - Amendments to the Consolidation Analysis.” This new guidance provides a new scope exception for certain money market funds, makes targeted amendments to the current consolidation guidance, and ends the deferral granted to investment companies from applying the VIE guidance. This new guidance is effective for annual periods beginning after December 15, 2015. Early adoption is allowed, including in any interim period. We are evaluating the impact of adopting this new standard.
In June 2014, the FASB issued ASU 2014-11, “Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.” This new guidance amends the accounting guidance for “repo-to-maturity” transactions and repurchase agreements executed as repurchase financings. In addition, the new standard requires a transferor to disclose more information about certain transactions, including those in which it retains substantially all of the exposure to the economic returns of the underlying transferred asset over the transaction’s term. This new guidance is effective in the first interim reporting period beginning after December 15, 2014. However, for repurchase and securities lending transactions reported as secured borrowings, the new standard’s enhanced disclosures are effective for annual periods beginning after December 15, 2014 and interim periods beginning after March 15, 2015. We adopted the new guidance, as required, in the first quarter of 2015 and adopted the disclosure requirements in the second quarter of 2015, as required, which are included in Note 12 of these notes to our consolidated financial statements. The adoption in the first quarter of 2015 did not have a material impact on our financial statements, as we did not have repo-to-maturity transactions outstanding.
In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers.” The update modifies the guidance companies use to recognize revenue from contracts with customers for transfers of goods or services and transfers of nonfinancial assets, unless those contracts are within the scope of other standards. The guidance also requires new qualitative and quantitative disclosures, including information about contract balances and performance obligations. In July 2015, the FASB approved a one year deferral of the effective date. Accordingly, the update is effective for us in the first quarter of 2018 with retrospective application to prior periods presented or as a cumulative effect adjustment in the period of adoption. Early adoption is permitted in the first quarter of 2017. We are evaluating the impact the update will have on our consolidated financial statements.
In January 2014, the FASB issued ASU 2014-04, “Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.” This update to the receivable guidance clarifies when a creditor is considered to have received physical possession of residential real estate resulting from an in substance repossession or foreclosure. In addition, the amendments require disclosure of both: (i) the amount of foreclosed residential real estate property held by the creditor; and (ii) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure. The update requires the guidance to be applied using either a modified retrospective transition method or a prospective transition method for interim and annual periods beginning after December 15, 2014, with early adoption permitted. We adopted this standard in the first quarter of 2015, as required, and it did not have a material impact on our financial statements.

10

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Unaudited)

Note 3. Summary of Significant Accounting Policies - (continued)

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.
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 September 30, 2015 and December 31, 2014.
Table 3.2 – 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)
 
Net Amount
September 30, 2015
(In Thousands)
 
 
 
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Assets (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
16,788

 
$
—

 
$
16,788

 
$
(9,932
)
 
$
(6,856
)
 
$
—

Credit default index swaps
 
2,792

 
—

 
2,792

 
—

 
—

 
2,792

TBAs
 
8,910

 
—

 
8,910

 
(8,659
)
 
—

 
251

Total Assets
 
$
28,490

 
$
—

 
$
28,490

 
$
(18,591
)
 
$
(6,856
)
 
$
3,043

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
(72,415
)
 
$
—

 
$
(72,415
)
 
$
9,932

 
$
59,933

 
$
(2,550
)
TBAs
 
(14,994
)
 
—

 
(14,994
)
 
8,659

 
3,868

 
(2,467
)
Futures
 
(188
)
 
—

 
(188
)
 
—

 
188

 
—

Loan warehouse debt
 
(1,271,610
)
 
—

 
(1,271,610
)
 
1,271,610

 
—

 
—

Security repurchase agreements
 
(475,494
)
 
—

 
(475,494
)
 
475,494

 
—

 
—

Total Liabilities
 
$
(1,834,701
)
 
$
—

 
$
(1,834,701
)
 
$
1,765,695

 
$
63,989

 
$
(5,017
)




11

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Unaudited)

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)
 
Net Amount
December 31, 2014
(In Thousands)
 
 
 
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Assets (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
7,006

 
$
—

 
$
7,006

 
$
(1,160
)
 
$
(4,360
)
 
$
1,486

Credit default index swaps
 
1,598

 
—

 
1,598

 
—

 
(375
)
 
1,223

TBAs
 
6,653

 
—

 
6,653

 
(5,815
)
 
—

 
838

Total Assets
 
$
15,257

 
$
—

 
$
15,257

 
$
(6,975
)
 
$
(4,735
)
 
$
3,547

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
(48,173
)
 
$
—

 
$
(48,173
)
 
$
1,160

 
$
47,013

 
$
—

TBAs
 
(9,506
)
 
—

 
(9,506
)
 
5,815

 
2,715

 
(976
)
Futures
 
(372
)
 
—

 
(372
)
 
—

 
372

 
—

Loan warehouse debt
 
(1,185,316
)
 
—

 
(1,185,316
)
 
1,185,316

 
—

 
—

Security repurchase agreements
 
(608,509
)
 
—

 
(608,509
)
 
608,509

 
—

 
—

Total Liabilities
 
$
(1,851,876
)
 
$
—

 
$
(1,851,876
)
 
$
1,800,800

 
$
50,100

 
$
(976
)
(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, TBAs, and futures are components of derivatives instruments on our consolidated balances sheets. Loan warehouse debt, which is secured by residential and commercial 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.








12

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Unaudited)



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.
Analysis of Consolidated VIEs
As of September 30, 2015, the VIEs we are required to consolidate include certain Sequoia securitization entities, the Residential Resecuritization entity, and the Commercial Securitization entity. 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 we are exposed to certain financial risks associated with our role as a sponsor, manager, or depositor of these entities or as a result of our having sold assets directly or indirectly to these entities. The following table presents a summary of the assets and liabilities of these VIEs. Intercompany balances have been eliminated for purposes of this presentation.
Table 4.1 – Assets and Liabilities of Consolidated VIEs
September 30, 2015
 
Sequoia
Entities
 
Residential Resecuritization
 
Commercial Securitization
 
Total
(Dollars in Thousands)
 
 
 
 
Residential loans, held-for-investment
 
$
1,170,246

 
$
—

 
$
—

 
$
1,170,246

Commercial loans, held-for-investment
 
—

 
—

 
180,394

 
180,394

Real estate securities
 
—

 
181,253

 
—

 
181,253

Restricted cash
 
191

 
—

 
138

 
329

Accrued interest receivable
 
1,505

 
364

 
1,357

 
3,226

Other assets
 
3,902

 
—

 
—

 
3,902

Total Assets
 
$
1,175,844

 
$
181,617

 
$
181,889

 
$
1,539,350

Accrued interest payable
 
$
770

 
$
1

 
$
318

 
$
1,089

Asset-backed securities issued
 
1,105,588

 
5,261

 
67,946

 
1,178,795

Total Liabilities
 
$
1,106,358

 
$
5,262

 
$
68,264

 
$
1,179,884

 
 
 
 
 
 
 
 
 
Number of VIEs
 
24

 
1

 
1

 
26

Since 2012, we have transferred residential loans to 25 Sequoia securitization entities sponsored by us 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 the transferred loans where we held the servicing rights prior to the transfer and continue to hold the servicing rights, 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 residential MSRs (which we retain a third-party sub-servicer to perform) and the receipt of interest income associated with the securities we retained.

13

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Unaudited)

Note 4. Principles of Consolidation - (continued)


The following table presents information related to securitization transactions that occurred during the three and nine months ended September 30, 2015 and 2014.
Table 4.2 – Securitization Activity Related to Unconsolidated VIEs Sponsored by Redwood
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In Thousands)
 
2015
 
2014
 
2015
 
2014
Principal balance of loans transferred
 
$
—

 
$
635,608

 
$
1,038,451

 
$
982,913

Trading securities retained, at fair value
 
—

 
1,680

 
33,389

 
71,243

AFS securities retained, at fair value
 
—

 
39,330

 
6,309

 
59,757

MSRs recognized
 
—

 
4,356

 
7,874

 
6,542

The following table summarizes the cash flows during the three and nine months ended September 30, 2015 and 2014 between us and the unconsolidated VIEs sponsored by us.
Table 4.3 – Cash Flows Related to Unconsolidated VIEs Sponsored by Redwood
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In Thousands)
 
2015
 
2014
 
2015
 
2014
Proceeds from new transfers
 
$
—

 
$
610,167

 
$
1,018,312

 
$
877,943

MSR fees received
 
3,817

 
3,571

 
11,287

 
10,618

Funding of compensating interest
 
(86
)
 
(68
)
 
(283
)
 
(144
)
Cash flows received on retained securities
 
8,190

 
16,190

 
31,541

 
44,417

The following table presents the key weighted-average assumptions used to measure MSRs and securities retained at the date of securitization.
Table 4.4 – Assumptions Related to Assets Retained from Unconsolidated VIEs Sponsored by Redwood
 
 
Issued During The
 
 
Three Months Ended September 30, 2015
 
Nine Months Ended September 30, 2015
At Date of Securitization
 
MSRs
 
Senior Securities
 
Subordinate Securities
 
MSRs
 
Senior Securities
 
Subordinate Securities
Prepayment rate
 
N/A
 
N/A
 
N/A
 
5 - 15%

 
8
%
 
8
%
Discount rates
 
N/A
 
N/A
 
N/A
 
11
%
 
3
%
 
6
%
Credit loss assumptions
 
N/A
 
N/A
 
N/A
 
N/A

 
0.25
%
 
0.25
%

 
 
Issued During The
 
 
Three Months Ended September 30, 2014
 
Nine Months Ended September 30, 2014
At Date of Securitization
 
MSRs
 
Senior Securities
 
Subordinate Securities
 
MSRs
 
Senior Securities
 
Subordinate Securities
Prepayment rate
 
 5 - 16%

 
8
%
 
8
%
 
 5 - 16%

 
8 - 10%

 
8 - 10%

Discount rates
 
11
%
 
21
%
 
5
%
 
11
%
 
3
%
 
5
%
Credit loss assumptions
 
N/A

 
0.25
%
 
0.25
%
 
N/A

 
0.25
%
 
0.25
%



14

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Unaudited)

Note 4. Principles of Consolidation - (continued)


The following table presents additional information at September 30, 2015 and December 31, 2014, related to unconsolidated securitizations accounted for as sales since 2012.
Table 4.5 – Unconsolidated VIEs Sponsored by Redwood
(In Thousands)
 
September 30, 2015
 
December 31, 2014
On-balance sheet assets, at fair value:
 
 
 
 
Interest-only, senior and subordinate securities, classified as trading
 
$
61,602

 
$
93,802

Senior and subordinate securities, classified as AFS
 
292,948

 
460,990

Mortgage servicing rights
 
52,940

 
56,801

Maximum loss exposure (1)
 
$
407,490

 
$
611,593

Assets transferred:
 
 
 
 
Principal balance of loans outstanding
 
$
7,289,025

 
$
7,276,825

Principal balance of delinquent loans 30+ days delinquent
 
14,204

 
17,022

(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 September 30, 2015 and December 31, 2014.
Table 4.6 – Key Assumptions and Sensitivity Analysis for Assets Retained from Unconsolidated VIEs Sponsored by Redwood
September 30, 2015
 
MSRs
 
Senior
Securities (1)
 
Subordinate Securities
(Dollars in Thousands)
 
 
 
Fair value at September 30, 2015
 
$
52,940

 
$
51,308

 
$
303,242

Expected life (in years) (2)
 
6

 
6

 
11

Prepayment speed assumption (annual CPR) (2)
 
14
%
 
11
%
 
12
%
Decrease in fair value from:
 
 
 
 
 
 
10% adverse change
 
$
1,542

 
$
1,308

 
$
953

25% adverse change
 
5,003

 
3,103

 
2,252

Discount rate assumption (2)
 
11
%
 
11
%
 
5
%
Decrease in fair value from:
 
 
 
 
 
 
100 basis point increase
 
$
933

 
$
1,984

 
$
22,816

200 basis point increase
 
2,773

 
3,826

 
42,885

Credit loss assumption (2)
 
N/A

 
0.25
%
 
0.25
%
Decrease in fair value from:
 
 
 
 
 
 
10% higher losses
 
N/A

 
$
31

 
$
3,050

25% higher losses
 
N/A

 
76

 
7,567


15

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Unaudited)

Note 4. Principles of Consolidation - (continued)


December 31, 2014
 
MSRs
 
Senior
Securities (1)
 
Subordinate Securities
(Dollars in Thousands)
 
 
 
Fair value at December 31, 2014
 
$
56,801

 
$
93,802

 
$
460,990

Expected life (in years) (2)
 
7

 
6

 
10

Prepayment speed assumption (annual CPR) (2)
 
14
%
 
9
%
 
10
%
Decrease in fair value from:
 
 
 
 
 
 
10% adverse change
 
$
2,419

 
$
3,999

 
$
684

25% adverse change
 
5,639

 
9,475

 
2,355

Discount rate assumption (2)
 
11
%
 
8
%
 
5
%
Decrease in fair value from:
 
 
 
 
 
 
100 basis point increase
 
$
2,104

 
$
4,214

 
$
34,149

200 basis point increase
 
4,102

 
8,091

 
64,474

Credit loss assumption (2)
 
N/A

 
0.25
%
 
0.25
%
Decrease in fair value from:
 
 
 
 
 
 
10% higher losses
 
N/A

 
$
126

 
$
3,169

25% higher losses
 
N/A

 
299

 
7,841


(1)
Senior securities include $29 million and $88 million of interest only securities as of September 30, 2015 and December 31, 2014, respectively.
(2)
Expected life, prepayment speed assumption, discount rate assumption, and credit loss assumption presented in the tables above represent weighted averages.
Analysis of 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 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 September 30, 2015, grouped by security type.
Table 4.7 – Third-Party Sponsored VIE Summary
(Dollars in Thousands)
 
September 30, 2015
Residential Mortgage Backed Securities
 
 
Senior
 
$
415,827

Re-REMIC
 
167,639

Subordinate
 
147,208

Total Investments in Third-Party Sponsored VIEs
 
$
730,674

We determined that we are not the primary beneficiary of any 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.

16

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Unaudited)



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.


17

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Unaudited)

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 September 30, 2015 and December 31, 2014.

Table 5.1 – Carrying Values and Fair Values of Assets and Liabilities
 
 
September 30, 2015
 
December 31, 2014
 
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
(In Thousands)
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Residential loans, held-for-sale
 
 
 
 
 
 
 
 
At fair value
 
$
1,504,705

 
$
1,504,705

 
$
1,341,032

 
$
1,341,032

At lower of cost or fair value
 
1,446

 
1,645

 
1,488

 
1,669

Residential loans, held-for-investment (1)
 
 
 
 
 
 
 
 
At fair value
 
2,530,523

 
2,530,523

 
581,668

 
581,668

At amortized cost
 
—

 
—

 
1,474,386

 
1,381,918

Commercial loans, held-for-sale
 
80,756

 
80,756

 
166,234

 
166,234

Commercial loans, held-for-investment
 
 
 
 
 
 
 
 
At fair value
 
70,096

 
70,096

 
71,262

 
71,262

At amortized cost
 
317,305

 
322,535

 
329,431

 
334,876

Trading securities
 
114,211

 
114,211

 
111,606

 
111,606

Available-for-sale securities
 
971,013

 
971,013

 
1,267,624

 
1,267,624

MSRs
 
162,726

 
162,726

 
139,293

 
139,293

Cash and cash equivalents
 
235,362

 
235,362

 
269,730

 
269,730

Restricted cash
 
8,361

 
8,361

 
628

 
628

Accrued interest receivable
 
20,223

 
20,223

 
18,222

 
18,222

Derivative assets
 
38,623

 
38,623

 
16,417

 
16,417

REO (2)
 
3,902

 
4,620

 
4,391

 
4,703

Margin receivable (2)
 
97,685

 
97,685

 
65,374

 
65,374

FHLBC stock (2)
 
30,001

 
30,001

 
10,688

 
10,688

Guarantee asset (2)
 
5,120

 
5,120

 
7,201

 
7,201

Pledged collateral (2)
 
28,482

 
28,482

 
9,927

 
9,927

Liabilities
 
 
 
 
 
 
 
 
Short-term debt
 
$
1,872,793

 
$
1,872,793

 
$
1,793,825

 
$
1,793,825

Accrued interest payable
 
14,738

 
14,738

 
8,502

 
8,502

Guarantee obligation
 
13,394

 
12,123

 
7,201

 
7,201

Derivative liabilities
 
88,044

 
88,044

 
58,331

 
58,331

ABS issued (1)
 
 
 
 
 
 
 
 
Fair value
 
1,105,588

 
1,105,588

 
—

 
—

Amortized cost
 
73,207

 
73,207

 
1,545,119

 
1,446,605

FHLBC long-term borrowings
 
1,124,299

 
1,124,299

 
495,860

 
495,860

Commercial secured borrowings
 
65,578

 
65,578

 
66,707

 
66,707

Convertible notes
 
492,500

 
464,164

 
492,500

 
492,188

Other long-term debt
 
139,500

 
90,675

 
139,500

 
101,835

(1)
Upon adoption of ASU 2014-13 on January 1, 2015, we began to record loans held-for-investment in, and ABS issued by, consolidated Sequoia entities at fair value. See Note 3 for further discussion.
(2)
These assets are included in other assets on our consolidated balance sheets.

18

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Unaudited)

Note 5. Fair Value of Financial Instruments - (continued)


During the three and nine months ended September 30, 2015, we elected the fair value option for $9 million and $68 million of residential subordinate securities, zero and $33 million of residential senior securities, $2.91 billion and $8.09 billion of residential loans (principal balance), $168 million and $518 million of commercial loans (principal balance), and $23 million and $74 million of MSRs, respectively. We anticipate electing the fair value option for all future purchases of residential loans and commercial senior loans that we intend to sell to third parties or transfer to securitizations as well as for MSRs purchased or retained from sales of residential loans.
The following table presents the assets and liabilities that are reported at fair value on our consolidated balance sheets on a recurring basis at September 30, 2015, 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 at September 30, 2015
September 30, 2015
 
Carrying
Value
 
Fair Value Measurements Using
(In Thousands)
 
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
 
Residential loans
 
$
4,035,228

 
$
—

 
$
236,314

 
$
3,798,914

Commercial loans
 
150,852

 
—

 
—

 
150,852

Trading securities
 
114,211

 
—

 
—

 
114,211

Available-for-sale securities
 
971,013

 
—

 
—

 
971,013

Derivative assets
 
38,623

 
8,910

 
19,580

 
10,133

MSRs
 
162,726

 
—

 
—

 
162,726

Pledged collateral
 
28,482

 
28,482

 
—

 
—

FHLBC stock
 
30,001

 
30,001

 
—

 
—

Guarantee asset
 
5,120

 
—

 
—

 
5,120

 
 


 
 
 
 
 
 
Liabilities
 


 
 
 
 
 
 
Derivative liabilities
 
$
88,044

 
$
15,182

 
$
72,415

 
$
447

Commercial secured borrowings
 
65,578

 
—

 
—

 
65,578

ABS issued
 
1,105,588

 
—

 
—

 
1,105,588


19

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2015
(Unaudited)

Note 5. Fair Value of Financial Instruments - (continued)


The following table presents additional information about Level 3 assets and liabilities measured at fair value on a recurring basis for the nine months ended September 30, 2015.
Table 5.3 – Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis
 
Assets
 
Liabilities
 
Residential Loans
 
Commercial
Loans
 
Trading Securities
 
AFS
Securities
 
MSRs
 
Guarantee Asset
 
Derivatives(1)
 
Commercial Secured Borrowings
 
ABS
Issued
(In Thousands)
 
 
 
 
 
 
 
Beginning balance -
   December 31, 2014
$
1,677,984

 
$
237,496

 
$
111,606

 
$
1,267,624

 
$
139,293

 
$
7,201

 
$
1,119

 
$
66,707

 
$
—

Transfer to FVO (2)
1,370,699

 
—

 
—

 
—