10-Q

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: March 31, 2016



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		76,964,286 shares outstanding as of May 2, 2016

REDWOOD TRUST, INC.

2016 FORM 10-Q REPORT

TABLE OF CONTENTS



		Page
PART I —	FINANCIAL INFORMATION
Item 1.	Financial Statements	2
	Consolidated Balance Sheets at March 31, 2016 (Unaudited) and December 31, 2015	2
	Consolidated Statements of Income for the Three Months Ended March 31, 2016 and 2015 (Unaudited)	3
	Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2016 and 2015 (Unaudited)	4
	Consolidated Statements of Changes in Stockholders' Equity for the Three Months Ended March 31, 2016 and 2015 (Unaudited)	5
	Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2016 and 2015 (Unaudited)	6
	Notes to Consolidated Financial Statements (Unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	61
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	104
Item 4.	Controls and Procedures	105

PART II —	OTHER INFORMATION
Item 1.	Legal Proceedings	106
Item 1A.	Risk Factors	107
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	107
Item 3.	Defaults Upon Senior Securities	107
Item 4.	Mine Safety Disclosures (Not Applicable)	107
Item 5.	Other Information	108
Item 6.	Exhibits	109
Signatures		110

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS



(In Thousands, Except Share Data) (Unaudited)	March 31, 2016			December 31, 2015
ASSETS⁽¹⁾
Residential loans, held-for-sale, at fair value	$	441,076		$	1,115,738
Residential loans, held-for-investment, at fair value	3,273,980			2,813,065
Commercial loans, held-for-sale, at fair value	—			39,141
Commercial loans, held-for-investment (includes $69,674 and $67,657 at fair value)	363,893			363,506
Real estate securities, at fair value	919,927			1,233,256
Mortgage servicing rights, at fair value	126,620			191,976
Cash and cash equivalents	305,115			220,229
Total earning assets	5,430,611			5,976,911
Restricted cash	2,137			5,567
Accrued interest receivable	19,766			23,290
Derivative assets	31,975			16,393
Other assets	242,391			197,886
Total Assets	$	5,726,880		$	6,220,047

LIABILITIES AND EQUITY ⁽¹⁾
Liabilities
Short-term debt	$	804,175		$	1,855,003
Accrued interest payable	15,522			8,936
Derivative liabilities	97,468			62,794
Accrued expenses and other liabilities	82,169			69,897
Asset-backed securities issued (includes $907,023 and $996,820 at fair value), net ⁽²⁾	958,364			1,049,415
Long-term debt (includes $65,181 and $63,152 at fair value), net ⁽²⁾	2,683,432			2,027,737
Total liabilities	4,641,130			5,073,782
Equity
Common stock, par value $0.01 per share, 180,000,000 shares authorized; 76,627,231 and 78,162,765 issued and outstanding	766			782
Additional paid-in capital	1,680,981			1,695,956
Accumulated other comprehensive income	56,712			91,993
Cumulative earnings	1,030,746			1,018,683
Cumulative distributions to stockholders	(1,683,455		)	(1,661,149		)
Total equity	1,085,750			1,146,265
Total Liabilities and Equity	$	5,726,880		$	6,220,047

——————

(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 March 31, 2016 and December 31, 2015, assets of consolidated VIEs totaled $1,102,195 and $1,195,574, respectively. At March 31, 2016 and December 31, 2015, liabilities of consolidated VIEs totaled $959,464 and $1,050,861, respectively. See Note 4 for further discussion.


(2)	At March 31, 2016 and December 31, 2015, Asset-backed securities issued, net included $339 and $542, respectively, of deferred debt issuance costs, and long-term debt, net included $9,513 and $10,438, respectively, of deferred debt issuance costs.

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

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME



(In Thousands, Except Share Data)	Three Months Ended March 31,
(Unaudited)	2016			2015
Interest Income
Residential loans	$	31,400		$	25,009
Commercial loans	9,460			10,914
Real estate securities	21,095			27,775
Other interest income	373			48
Total interest income	62,328			63,746
Interest Expense
Short-term debt	(6,697		)	(7,224		)
Asset-backed securities issued	(4,282		)	(6,202		)
Long-term debt	(12,971		)	(10,535		)
Total interest expense	(23,950		)	(23,961		)
Net Interest Income	38,378			39,785
Provision for loan losses	(289		)	(206		)
Net Interest Income After Provision	38,089			39,579
Non-interest Income
Mortgage banking activities, net	7,218			1,923
Mortgage servicing rights income (loss), net	6,281			(10,924		)
Investment fair value changes, net	(19,538		)	(1,145		)
Other income	955			809
Realized gains, net	9,538			4,306
Total non-interest income (loss), net	4,454			(5,031		)
Operating expenses	(30,452		)	(25,063		)
Net income before provision for income taxes	12,091			9,485
(Provision for) benefit from income taxes	(28		)	5,316
Net Income	$	12,063		$	14,801

Basic earnings per common share	$	0.15		$	0.17
Diluted earnings per common share	$	0.15		$	0.16
Regular dividends declared per common share	$	0.28		$	0.28
Basic weighted average shares outstanding	77,137,682			83,360,312
Diluted weighted average shares outstanding	77,137,682			85,622,216

——————

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

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



(In Thousands)	Three Months Ended March 31,
(Unaudited)	2016			2015
Net Income	$	12,063		$	14,801
Other comprehensive income (loss):
Net unrealized (loss) gain on available-for-sale securities	(10,103		)	5,053
Reclassification of unrealized gain on available-for-sale securities to net income	(10,953		)	(1,690		)
Net unrealized loss on interest rate agreements	(14,243		)	(8,442		)
Reclassification of unrealized loss on interest rate agreements to net income	18			31
Total other comprehensive income (loss)	(35,281		)	(5,048		)
Total Comprehensive Income (Loss)	$	(23,218	)	$	9,753

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

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

For the Three Months Ended March 31, 2016



(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			Additional Paid-In Capital			Accumulated Other Comprehensive Income			Cumulative Earnings		Cumulative Distributions to Stockholders			Total
December 31, 2015	78,162,765		$	782		$	1,695,956		$	91,993		$	1,018,683	$	(1,661,149	)	$	1,146,265
Net income	—		—			—			—			12,063		—			12,063
Other comprehensive loss	—		—			—			(35,281		)	—		—			(35,281		)
Employee stock purchase and incentive plans	73,651		—			(152		)	—			—		—			(152		)
Non-cash equity award compensation	—		—			5,782			—			—		—			5,782
Share repurchases	(1,609,185	)	(16		)	(20,605		)	—			—		—			(20,621		)
Common dividends declared	—		—			—			—			—		(22,306		)	(22,306		)
March 31, 2016	76,627,231		$	766		$	1,680,981		$	56,712		$	1,030,746	$	(1,683,455	)	$	1,085,750

For the Three Months Ended March 31, 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		Additional Paid-In Capital			Accumulated Other Comprehensive Income			Cumulative Earnings		Cumulative Distributions to Stockholders			Total
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	—	—		—			—			14,801		—			14,801
Other comprehensive loss	—	—		—			(5,048		)	—		—			(5,048		)
Dividend reinvestment & stock purchase plans	185,045	2		3,239			—			—		—			3,241
Employee stock purchase and incentive plans	120,435	1		(184		)	—			—		—			(183		)
Non-cash equity award compensation	—	—		2,692			—			—		—			2,692
Common dividends declared	—	—		—			—			—		(24,162		)	(24,162		)
March 31, 2015	83,748,621	$	837	$	1,779,777		$	135,640		$	931,396	$	(1,590,440	)	$	1,257,210


(1)	On January 1, 2015, we adopted ASU 2014-13, "Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity," and recorded this cumulative-effect adjustment, which represents the net effect of adjusting the assets and liabilities of the consolidated Sequoia collateralized financing entities ("CFEs") from amortized historical cost to fair value.

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

REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS



(In Thousands) (Unaudited)	Three Months Ended March 31,
(In Thousands) (Unaudited)	2016			2015
Cash Flows From Operating Activities:
Net income	$	12,063		$	14,801
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Amortization of premiums, discounts, and securities issuance costs, net	(7,568		)	(9,176		)
Depreciation and amortization of non-financial assets	277			143
Purchases of held-for-sale loans	(1,245,068		)	(2,558,425		)
Proceeds from sales of held-for-sale loans	1,336,617			2,455,452
Principal payments on held-for-sale loans	23,518			14,394
Net settlements of derivatives	(1,154		)	(19,373		)
Provision for loan losses	289			206
Non-cash equity award compensation expense	5,782			2,692
Market valuation adjustments	15,848			19,435
Realized gains, net	(9,538		)	(4,306		)
Net change in:
Accrued interest receivable and other assets	(30,056		)	(38,394		)
Accrued interest payable, deferred tax liabilities, and accrued expenses and other liabilities	4,966			3,476
Net cash provided by (used in) operating activities	105,976			(119,075		)
Cash Flows From Investing Activities:
Purchases of loans held-for-investment	—			(7,600		)
Proceeds from sales of loans held-for-investment	6,298			—
Principal payments on loans held-for-investment	125,631			101,754
Purchases of real estate securities	(48,446		)	(15,613		)
Proceeds from sales of real estate securities	340,798			77,293
Principal payments on real estate securities	22,401			26,313
Purchase of mortgage servicing rights	(5,397		)	(5,173		)
Proceeds from sales of mortgage servicing rights	28,268			17,235
Net change in restricted cash	3,430			(97		)
Net cash provided by investing activities	472,983			194,112
Cash Flows From Financing Activities:
Proceeds from borrowings on short-term debt	1,027,320			1,641,380
Repayments on short-term debt	(2,078,148		)	(1,933,041		)
Proceeds from issuance of asset-backed securities	—			420
Repayments on asset-backed securities issued	(50,868		)	(80,918		)
Deferred securities issuance costs	—			(32		)
Proceeds from issuance of long-term debt	771,287			354,932
Repayments on long-term debt	(118,146		)	—
Net settlements of derivatives	(73		)	658
Net proceeds from issuance of common stock	77			134
Net payments on repurchase of common stock	(22,987		)	—
Taxes paid on equity award distributions	(229		)	(318		)
Dividends paid	(22,306		)	(24,162		)
Net cash used in financing activities	(494,073		)	(40,947		)
Net increase in cash and cash equivalents	84,886			34,090
Cash and cash equivalents at beginning of period	220,229			269,730
Cash and cash equivalents at end of period	$	305,115		$	303,820
Supplemental Cash Flow Information:
Cash paid during the period for:
Interest	$	18,634		$	15,032
Taxes	64			38
Supplemental Noncash Information:
Real estate securities retained from loan securitizations	$	—		$	6,282
Retention of mortgage servicing rights from loan securitizations and sales	3,463			15,675
Transfers from loans held-for-sale to loans held-for-investment	660,818			447,840
Transfers from loans held-for-investment to loans held-for-sale	54,747			—
Transfers from residential loans to real estate owned	2,042			3,166

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

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(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 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 mortgage banking activities. We operate our business in three segments: Residential Investments, Residential Mortgage Banking, and Commercial. 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. 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 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 March 31, 2016 and December 31, 2015, and for the three months ended March 31, 2016 and 2015. 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, 2015. In the opinion of management, all normal and recurring adjustments to present fairly the financial condition of the company at March 31, 2016 and results of operations for all periods presented have been made. The results of operations for the three months ended March 31, 2016 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 mortgage servicing right ("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, in the first quarter of 2016, we began to present the changes in fair value of certain investments and their associated derivatives in the new line item "Investment fair value changes, net" on our consolidated statements of income and began to present income from mortgage banking activities in "Mortgage banking activities, net" on our consolidated statements of income. We conformed the presentation of prior periods related to this change for consistency of comparison. See Notes 18 and 19 for additional detail on the components of these income statement line items.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(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 commercial securitization we engaged in during 2012 (“Commercial Securitization”). We also consolidated the assets and liabilities of an entity formed in connection with a resecuritization transaction we engaged in (“Residential Resecuritization”) from its creation in 2011 through the fourth quarter of 2015, when the debt of the entity was repaid, the assets of the entity were distributed to us, and the entity was dissolved. 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 2015 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 months ended March 31, 2016.

Recent Accounting Pronouncements

Newly Adopted Accounting Standards Updates ("ASUs")

In April 2015, the FASB issued ASU 2015-05, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud-Computing Arrangement.” This new guidance provides additional guidance on accounting for fees paid in a cloud-computing arrangement that contains a software license. This new guidance is effective for fiscal years beginning after December 15, 2015. We adopted this guidance, as required, in the first quarter of 2016, which did not have a material impact on our consolidated financial statements.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(Unaudited)

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

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, and is required to be applied on a retrospective basis. We adopted this guidance, as required, in the first quarter of 2016 and now present our deferred securities issuance costs as a reduction to the related liabilities on our consolidated balance sheets for all periods presented. At March 31, 2016 and December 31, 2015, we included $0.3 million and $0.5 million, respectively, of deferred securities issuance costs as a reduction to our ABS issued and presented it as ABS issued, net on our consolidated balance sheets and, for both periods, we included $10 million of deferred securities issuance costs as a reduction to our long-term debt and presented it as Long-term debt, net on our consolidated balance sheets.

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. We adopted this guidance, as required, in the first quarter of 2016, which did not have a material impact on our consolidated financial statements.

Other Recent Accounting Pronouncements

In March 2016, the FASB issued 2016 ASU 2016-09,"Compensation - Stock compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting." This new guidance is to simplify the accounting for share-based payment transactions, including related income tax accounting, classification of awards, and classification on the statement of cash flows. This new guidance is effective for fiscal years beginning after December 15, 2016. Early adoption is permitted. We plan to adopt this new guidance by the required date and do not believe it will have a material impact to 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. Early adoption is permitted. We plan to adopt this new guidance by the required date and we are currently evaluating the impact that this update will have on our consolidated financial statements.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(Unaudited)

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

In January 2016, the FASB issued ASU 2016-01,"Recognition and Measurement of Financial Assets and Financial Liabilities." This new guidance amends accounting related to the classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured at fair value. This new guidance also amends certain disclosure requirements associated with the fair value of financial instruments and it is effective for fiscal years beginning after December 15, 2017. We are currently evaluating the impact that this update will have on our consolidated financial statements.

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. In March 2016, the FASB issued ASU 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)." This new guidance provides additional implementation guidance on how an entity should identify the unit of accounting for the principal versus agent evaluations. We are currently evaluating the impact these updates will have on our consolidated financial statements.

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 March 31, 2016 and December 31, 2015.

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⁾						Net Amount
March 31, 2016 (In Thousands)	Gross Amounts of Recognized Assets (Liabilities)			Gross Amounts Offset in Consolidated Balance Sheet					Financial Instruments			Cash Collateral (Received) Pledged			Net Amount
Assets ⁽²⁾
Interest rate agreements	$	24,188		$	—	$	24,188		$	(18,926	)	$	(4,581	)	$	681
TBAs	2,843			—		2,843			(1,339		)	—			1,504
Total Assets	$	27,031		$	—	$	27,031		$	(20,265	)	$	(4,581	)	$	2,185

Liabilities⁽²⁾
Interest rate agreements	$	(92,100	)	$	—	$	(92,100	)	$	18,926		$	73,174		$	—
TBAs	(3,739		)	—		(3,739		)	1,339			1,680			(720		)
Futures	(1,324		)	—		(1,324		)	—			1,324			—
Loan warehouse debt	(368,679		)	—		(368,679		)	368,679			—			—
Security repurchase agreements	(435,496		)	—		(435,496		)	435,496			—			—
Total Liabilities	$	(901,338	)	$	—	$	(901,338	)	$	824,440		$	76,178		$	(720	)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(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, 2015 (In Thousands)	Gross Amounts of Recognized Assets (Liabilities)			Gross Amounts Offset in Consolidated Balance Sheet					Financial Instruments			Cash Collateral (Received) Pledged			Net Amount
Assets ⁽²⁾
Interest rate agreements	$	7,781		$	—	$	7,781		$	(5,651	)	$	(1,917	)	$	213
Credit default index swaps	1,207			—		1,207			—			(720		)	487
TBAs	2,734			—		2,734			(1,898		)	(293		)	543
Total Assets	$	11,722		$	—	$	11,722		$	(7,549	)	$	(2,930	)	$	1,243

Liabilities⁽²⁾
Interest rate agreements	$	(58,366	)	$	—	$	(58,366	)	$	5,651		$	52,715		$	—
TBAs	(2,519		)	—		(2,519		)	1,898			7			(614		)
Futures	(445		)	—		(445		)	—			445			—
Loan warehouse debt	(1,023,740		)	—		(1,023,740		)	1,023,740			—			—
Security repurchase agreements	(693,641		)	—		(693,641		)	693,641			—			—
Total Liabilities	$	(1,778,711	)	$	—	$	(1,778,711	)	$	1,724,930		$	53,167		$	(614	)

(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.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(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 March 31, 2016, the VIEs we are required to consolidate include certain Sequoia securitization entities and the Commercial Securitization entity. In addition, we consolidated the Residential Resecuritization from its creation in 2011 through the fourth quarter of 2015, when the VIE was dissolved. 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



March 31, 2016	Sequoia Entities		Commercial Securitization		Total
(Dollars in Thousands)	Sequoia Entities		Commercial Securitization		Total
Residential loans, held-for-investment	$	930,027	$	—	$	930,027
Commercial loans, held-for-investment	—		164,626		164,626
Restricted cash	147		136		283
Accrued interest receivable	1,038		1,290		2,328
Other assets	4,884		47		4,931
Total Assets	$	936,096	$	166,099	$	1,102,195
Accrued interest payable	$	519	$	242	$	761
Asset-backed securities issued	907,023		51,680		958,703
Total Liabilities	$	907,542	$	51,922	$	959,464

Number of VIEs	20		1		21

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(Unaudited)

Note 4. Principles of Consolidation - (continued)



December 31, 2015	Sequoia Entities		Commercial Securitization		Total
(Dollars in Thousands)	Sequoia Entities		Commercial Securitization		Total
Residential loans, held-for-investment	$	1,021,870	$	—	$	1,021,870
Commercial loans, held-for-investment	—		166,016		166,016
Real estate securities	—		—		—
Restricted cash	228		137		365
Accrued interest receivable	1,131		1,297		2,428
Other assets	4,895		—		4,895
Total Assets	$	1,028,124	$	167,450	$	1,195,574
Accrued interest payable	$	555	$	249	$	804
Accrued expenses and other liabilities	100		—		100
Asset-backed securities issued, net	996,820		53,137		1,049,957
Total Liabilities	$	997,475	$	53,386	$	1,050,861

Number of VIEs	21		1		22

Analysis of Unconsolidated VIEs with Continuing Involvement

Since 2012, we have transferred residential loans to 26 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.

The following table presents information related to securitization transactions that occurred during the three months ended March 31, 2016 and 2015.

Table 4.2 – Securitization Activity Related to Unconsolidated VIEs Sponsored by Redwood



	Three Months Ended March 31,
(In Thousands)	2016		2015
Principal balance of loans transferred	$	—	$	338,796
Trading securities retained, at fair value	—		3,423
AFS securities retained, at fair value	—		2,859
MSRs recognized	—		1,872

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(Unaudited)

Note 4. Principles of Consolidation - (continued)

The following table summarizes the cash flows during the three months ended March 31, 2016 and 2015 between us and the unconsolidated VIEs sponsored by us.

Table 4.3 – Cash Flows Related to Unconsolidated VIEs Sponsored by Redwood



	Three Months Ended March 31,
(In Thousands)	2016			2015
Proceeds from new transfers	$	—		$	341,716
MSR fees received	3,523			3,770
Funding of compensating interest	(79		)	(90		)
Cash flows received on retained securities	11,191			12,645

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




	Three Months Ended March 31, 2016			Three Months Ended March 31, 2015
At Date of Securitization	MSRs		Subordinate Securities	MSRs					Subordinate Securities
Prepayment rate		N/A	N/A	5	%	-	19	%	8	%
Discount rates		N/A	N/A				11	%	6	%
Credit loss assumptions		N/A	N/A				N/A		0.25	%

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(Unaudited)

Note 4. Principles of Consolidation - (continued)

The following table presents additional information at March 31, 2016 and December 31, 2015, related to unconsolidated VIEs sponsored by Redwood and accounted for as sales since 2012.

Table 4.5 – Unconsolidated VIEs Sponsored by Redwood



(In Thousands)	March 31, 2016		December 31, 2015
On-balance sheet assets, at fair value:
Interest-only, senior and subordinate securities, classified as trading	$	32,434	$	258,697
Senior and subordinate securities, classified as AFS	274,380		272,715
Mortgage servicing rights	39,220		56,984
Maximum loss exposure ⁽¹⁾	$	346,034	$	588,396
Assets transferred:
Principal balance of loans outstanding	$	7,055,574	$	7,318,167
Principal balance of delinquent loans 30+ days delinquent	15,235		18,300

(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 March 31, 2016 and December 31, 2015.

Table 4.6 – Key Assumptions and Sensitivity Analysis for Assets Retained from Unconsolidated VIEs Sponsored by Redwood



March 31, 2016	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
(Dollars in Thousands)	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
Fair value at March 31, 2016	$	39,220		$	22,177		$	284,637
Expected life (in years)⁽²⁾	4			4			11
Prepayment speed assumption (annual CPR)⁽²⁾	21		%	14		%	13		%
Decrease in fair value from:
10% adverse change	$	2,423		$	1,297		$	969
25% adverse change	5,800			3,039			2,459
Discount rate assumption⁽²⁾	11		%	11		%	6		%
Decrease in fair value from:
100 basis point increase	$	1,024		$	650		$	21,432
200 basis point increase	2,012			1,264			40,189
Credit loss assumption ⁽²⁾	N/A			0.25		%	0.25		%
Decrease in fair value from:
10% higher losses	N/A			$	15		$	1,213
25% higher losses	N/A			38			3,042

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(Unaudited)

Note 4. Principles of Consolidation - (continued)



December 31, 2015	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
(Dollars in Thousands)	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
Fair value at December 31, 2015	$	56,984		$	248,570		$	282,842
Expected life (in years)⁽²⁾	7			5			12
Prepayment speed assumption (annual CPR)⁽²⁾	11		%	10		%	12		%
Decrease in fair value from:
10% adverse change	$	2,868		$	2,042		$	901
25% adverse change	6,119			4,810			2,278
Discount rate assumption⁽²⁾	11		%	5		%	6		%
Decrease in fair value from:
100 basis point increase	$	2,711		$	10,029		$	21,981
200 basis point increase	4,745			19,365			41,156
Credit loss assumption ⁽²⁾	N/A			0.25		%	0.25		%
Decrease in fair value from:
10% higher losses	N/A			$	35		$	1,244
25% higher losses	N/A			86			3,129


(1)	Senior securities included $22 million and $31 million of interest only securities as of March 31, 2016 and December 31, 2015, 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 March 31, 2016, grouped by security type.

Table 4.7 – Third-Party Sponsored VIE Summary



(Dollars in Thousands)	March 31, 2016
Mortgage Backed Securities
Senior	$	146,030
Re-REMIC	162,970
Subordinate	304,113
Total Investments in Third-Party Sponsored VIEs	$	613,113

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.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(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.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(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 March 31, 2016 and December 31, 2015.

Table 5.1 – Carrying Values and Fair Values of Assets and Liabilities



	March 31, 2016				December 31, 2015
	Carrying Value		Fair Value		Carrying Value		Fair Value
(In Thousands)	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets
Residential loans, held-for-sale
At fair value	$	439,674	$	439,674	$	1,114,305	$	1,114,305
At lower of cost or fair value	1,402		1,594		1,433		1,635
Residential loans, held-for-investment ⁽¹⁾
At fair value	3,273,980		3,273,980		2,813,065		2,813,065
Commercial loans, held-for-sale	—		—		39,141		39,141
Commercial loans, held-for-investment
At fair value	69,674		69,674		67,657		67,657
At amortized cost	294,219		301,488		295,849		300,824
Trading securities	221,571		221,571		404,011		404,011
Available-for-sale securities	698,356		698,356		829,245		829,245
MSRs	126,620		126,620		191,976		191,976
Cash and cash equivalents	305,115		305,115		220,229		220,229
Restricted cash	2,137		2,137		5,567		5,567
Accrued interest receivable	19,766		19,766		23,290		23,290
Derivative assets	31,975		31,975		16,393		16,393
REO ⁽²⁾	4,884		5,475		4,896		5,282
Margin receivable⁽²⁾	107,941		107,941		83,191		83,191
FHLBC stock ⁽²⁾	44,071		44,071		34,437		34,437
Guarantee asset⁽²⁾	4,272		4,272		5,697		5,697
Pledged collateral⁽²⁾	59,664		59,664		53,600		53,600
Liabilities
Short-term debt	$	804,175	$	804,175	$	1,855,003	$	1,855,003
Accrued interest payable	15,522		15,522		8,936		8,936
Margin payable	14,247		14,247		6,415		6,415
Guarantee obligation	24,896		23,595		22,704		22,702
Derivative liabilities	97,468		97,468		62,794		62,794
ABS issued, net ^{(1) (2)}
Fair value	907,023		907,023		996,820		996,820
Amortized cost	51,341		51,680		52,595		53,137
FHLBC long-term borrowings	1,999,999		1,999,999		1,343,023		1,343,023
Commercial secured borrowings	65,181		65,181		63,152		63,152
Convertible notes, net ⁽²⁾	479,798		453,396		483,119		461,053
Trust preferred securities and subordinated notes, net ⁽²⁾	138,454		80,910		138,443		83,700


(1)	These assets are included in other assets on our consolidated balance sheets.


(2)	On January 1, 2016, we adopted ASU 2015-03 and began to present ABS issued, convertible notes, and other long-term debt net of deferred debt issuance costs. See Note 3 for further discussion.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(Unaudited)

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

During the three months ended March 31, 2016, we elected the fair value option for $48 million of residential subordinate securities, $1.19 billion of residential loans (principal balance), $38 million of commercial loans (principal balance), and $9 million of MSRs. We anticipate electing the fair value option for all future purchases of residential 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 March 31, 2016 and December 31, 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



March 31, 2016	Carrying Value		Fair Value Measurements Using
(In Thousands)	Carrying Value		Level 1		Level 2		Level 3
Assets
Residential loans	$	3,713,654	$	—	$	1,387	$	3,712,267
Commercial loans	69,674		—		—		69,674
Trading securities	221,571		—		—		221,571
Available-for-sale securities	698,356		—		—		698,356
Derivative assets	31,975		2,843		24,188		4,944
MSRs	126,620		—		—		126,620
Pledged collateral	59,664		59,664		—		—
FHLBC stock	44,071		—		44,071		—
Guarantee asset	4,272		—		—		4,272

Liabilities
Derivative liabilities	$	97,468	$	5,063	$	92,100	$	305
Commercial secured borrowings	65,181		—		—		65,181
ABS issued	907,023		—		—		907,023



December 31, 2015	Carrying Value		Fair Value Measurements Using
(In Thousands)	Carrying Value		Level 1		Level 2		Level 3
Assets
Residential loans	$	3,927,370	$	—	$	129,819	$	3,797,551
Commercial loans	106,798		—		—		106,798
Trading securities	404,011		—		—		404,011
Available-for-sale securities	829,245		—		—		829,245
Derivative assets	16,393		2,734		8,988		4,671
MSRs	191,976		—		—		191,976
Pledged collateral	53,600		53,600		—		—
FHLBC stock	34,437		—		34,437		—
Guarantee asset	5,697		—		—		5,697

Liabilities
Derivative liabilities	$	62,794	$	2,963	$	58,368	$	1,463
Commercial secured borrowings	63,152		—		—		63,152
ABS issued	996,820		—		—		996,820

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(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 three months ended March 31, 2016.

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)	Residential Loans			Commercial Loans			Trading Securities			AFS Securities			MSRs			Guarantee Asset			Derivatives⁽¹⁾			Commercial Secured Borrowings			ABS Issued
Beginning balance - December 31, 2015	$	3,797,551		$	106,798		$	404,011		$	829,245		$	191,976		$	5,697		$	3,208		$	63,152		$	996,820
Acquisitions	1,020,846			37,626			47,760			15,585			8,807			—			—			—			—
Sales	(941,790		)	(77,183		)	(220,123		)	(125,911		)	(29,559		)	—			—			—			—
Principal paydowns	(161,241		)	(171		)	(5,718		)	(16,683		)	—			—			—			(155		)	(49,411		)
Gains (losses) in net income, net	(7,934		)	2,604			(4,359		)	17,314			(44,604		)	(1,425		)	15,606			2,171			(33,515		)
Unrealized losses in OCI, net	—			—			—			(21,194		)	—			—			—			—			—
Other settlements, net ⁽²⁾	4,835			—			—			—			—			—			(14,175		)	13			(6,871		)
Ending balance - March 31, 2016	$	3,712,267		$	69,674		$	221,571		$	698,356		$	126,620		$	4,272		$	4,639		$	65,181		$	907,023


(1)	For the purpose of this presentation, derivative assets and liabilities, which consist of loan purchase commitments, are presented on a net basis.


(2)	Other settlements, net for derivatives represents the transfer of the fair value of loan purchase commitments at the time loans are acquired to the basis of residential loans.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2016

(Unaudited)

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 March 31, 2016 and 2015. Gains or losses incurred on assets or liabilities sold, matured, called, or fully written down during the three months ended March 31, 2016 and 2015 are not included in this presentation.

Table 5.4 – Portion of Net Gains (Losses) Attributable to Level 3 Assets and Liabilities Still Held at March 31, 2016 and 2015 Included in Net Income



	Included in Net Income
	Three Months Ended March 31,
(In Thousands)	2016			2015
Assets
Residential loans at Redwood	$	27,285		$	5,464
Residential loans at consolidated Sequoia entities	(35,656		)	1,179
Commercial loans	2,171			2,959
Trading securities	(6,135		)	(13,790		)
MSRs	(30,834		)	(11,769		)
Loan purchase commitments	4,644			7,422		</