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: June 30, 2016

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
 
76,934,715 shares outstanding as of August 1, 2016





REDWOOD TRUST, INC.
2016 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)
 
June 30, 2016
 
December 31, 2015
ASSETS (1)
 
 
 
 
Residential loans, held-for-sale, at fair value
 
$
882,380

 
$
1,115,738

Residential loans, held-for-investment, at fair value
 
3,157,758

 
2,813,065

Commercial loans, held-for-sale (includes $69,720 and $39,141 at fair value)
 
302,778

 
39,141

Commercial loans, held-for-investment (includes $0 and $67,657 at fair value)
 
22,285

 
363,506

Real estate securities, at fair value
 
883,801

 
1,233,256

Mortgage servicing rights, at fair value
 
110,046

 
191,976

Cash and cash equivalents
 
216,923

 
220,229

Total earning assets
 
5,575,971

 
5,976,911

Restricted cash
 
8,293

 
5,567

Accrued interest receivable
 
20,594

 
23,290

Derivative assets
 
57,610

 
16,393

Other assets
 
235,124

 
197,886

Total Assets
 
$
5,897,592

 
$
6,220,047

 
 
 
 
 
LIABILITIES AND EQUITY (1)
 
 
 
 
Liabilities
 
 
 
 
Short-term debt
 
$
1,059,045

 
$
1,855,003

Accrued interest payable
 
9,515

 
8,936

Derivative liabilities
 
119,161

 
62,794

Accrued expenses and other liabilities
 
73,338

 
69,897

Asset-backed securities issued (includes $859,628 and $996,820 at fair value), net (2)
 
859,628

 
1,049,415

Long-term debt (includes $65,240 and $63,152 at fair value), net (2)
 
2,684,302

 
2,027,737

Total liabilities
 
4,804,989

 
5,073,782

Equity
 
 
 
 
Common stock, par value $0.01 per share, 180,000,000 shares authorized; 76,935,053 and 78,162,765 issued and outstanding
 
769

 
782

Additional paid-in capital
 
1,678,928

 
1,695,956

Accumulated other comprehensive income
 
46,331

 
91,993

Cumulative earnings
 
1,072,027

 
1,018,683

Cumulative distributions to stockholders
 
(1,705,452
)
 
(1,661,149
)
Total equity
 
1,092,603

 
1,146,265

Total Liabilities and Equity
 
$
5,897,592

 
$
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 June 30, 2016 and December 31, 2015, assets of consolidated VIEs totaled $888,026 and $1,195,574, respectively. At June 30, 2016 and December 31, 2015, liabilities of consolidated VIEs totaled $860,256 and $1,050,861, respectively. See Note 4 for further discussion.
(2)
At June 30, 2016 and December 31, 2015, Asset-backed securities issued, net included $0 and $542, respectively, of deferred debt issuance costs, and long-term debt, net included $8,702 and $10,438, respectively, of deferred debt issuance costs.

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 June 30,
 
Six Months Ended June 30,
(Unaudited)
 
2016
 
2015
 
2016
 
2015
Interest Income
 
 
 
 
 
 
 
 
Residential loans
 
$
35,154

 
$
25,808

 
$
66,554

 
$
50,817

Commercial loans
 
12,921

 
12,679

 
22,381

 
23,593

Real estate securities
 
18,417

 
24,839

 
39,512

 
52,614

Other interest income
 
295

 
47

 
668

 
95

Total interest income
 
66,787

 
63,373

 
129,115

 
127,119

Interest Expense
 
 
 
 
 
 
 
 
Short-term debt
 
(5,337
)
 
(6,527
)
 
(12,034
)
 
(13,751
)
Asset-backed securities issued
 
(3,982
)
 
(5,645
)
 
(8,264
)
 
(11,847
)
Long-term debt
 
(13,125
)
 
(10,836
)
 
(26,096
)
 
(21,371
)
Total interest expense
 
(22,444
)
 
(23,008
)
 
(46,394
)
 
(46,969
)
Net Interest Income
 
44,343

 
40,365

 
82,721

 
80,150

Reversal of provision for loan losses
 
6,532

 
261

 
6,243

 
55

Net Interest Income after Provision
 
50,875

 
40,626

 
88,964

 
80,205

Non-interest Income
 
 
 
 
 
 
 
 
Mortgage banking activities, net
 
7,728

 
7,447

 
14,946

 
9,373

Mortgage servicing rights income (loss), net
 
2,783

 
830

 
9,064

 
(10,094
)
Investment fair value changes, net
 
(11,066
)
 
(1,788
)
 
(30,604
)
 
(2,936
)
Other income
 
1,559

 
1,299

 
2,514

 
2,108

Realized gains, net
 
9,884

 
6,316

 
19,422

 
10,622

Total non-interest income (loss), net
 
10,888

 
14,104

 
15,342

 
9,073

Operating expenses
 
(20,155
)
 
(25,218
)
 
(50,607
)
 
(50,281
)
Net income before provision for income taxes
 
41,608

 
29,512

 
53,699

 
38,997

(Provision for) benefit from income taxes
 
(327
)
 
(2,448
)
 
(355
)
 
2,868

Net Income
 
$
41,281

 
$
27,064

 
$
53,344

 
$
41,865

 
 
 
 
 
 
 
 
 
Basic earnings per common share
 
$
0.52

 
$
0.31

 
$
0.67

 
$
0.48

Diluted earnings per common share
 
$
0.48

 
$
0.31

 
$
0.67

 
$
0.47

Regular dividends declared per common share
 
$
0.28

 
$
0.28

 
$
0.56

 
$
0.56

Basic weighted average shares outstanding
 
76,664,829

 
83,936,844

 
76,901,255

 
83,650,170

Diluted weighted average shares outstanding
 
97,761,936

 
94,949,741

 
88,728,380

 
85,473,905

——————

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 June 30,
 
Six Months Ended June 30,
(Unaudited)
 
2016
 
2015
 
2016
 
2015
Net Income
 
$
41,281

 
$
27,064

 
$
53,344

 
$
41,865

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
Net unrealized gain (loss) on available-for-sale securities
 
6,260

 
(5,080
)
 
(3,843
)
 
(28
)
Reclassification of unrealized gain on available-for-sale securities to net income
 
(7,711
)
 
(5,360
)
 
(18,664
)
 
(7,050
)
Net unrealized gain (loss) on interest rate agreements
 
(8,949
)
 
15,468

 
(23,192
)
 
7,026

Reclassification of unrealized loss on interest rate agreements to net income
 
19

 
26

 
37

 
58

Total other comprehensive income (loss)
 
(10,381
)
 
5,054

 
(45,662
)
 
6

Total Comprehensive Income
 
$
30,900

 
$
32,118

 
$
7,682

 
$
41,871


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



4



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

For the Six Months Ended June 30, 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
 
 
 
 
 
December 31, 2015
 
78,162,765

 
$
782

 
$
1,695,956

 
$
91,993

 
$
1,018,683

 
$
(1,661,149
)
 
$
1,146,265

Net income
 

 

 

 

 
53,344

 

 
53,344

Other comprehensive loss
 

 

 

 
(45,662
)
 

 

 
(45,662
)
Employee stock purchase and incentive plans
 
431,156

 
4

 
(4,249
)
 

 

 

 
(4,245
)
Non-cash equity award compensation
 

 

 
8,488

 

 

 

 
8,488

Share repurchases
 
(1,658,868
)
 
(17
)
 
(21,267
)
 

 

 

 
(21,284
)
Common dividends declared
 

 

 

 

 

 
(44,303
)
 
(44,303
)
June 30, 2016
 
76,935,053

 
$
769

 
$
1,678,928

 
$
46,331

 
$
1,072,027

 
$
(1,705,452
)
 
$
1,092,603


For the Six Months Ended June 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
 

 

 

 

 
41,865

 

 
41,865

Other comprehensive income
 

 

 

 
6

 

 

 
6

Dividend reinvestment & stock purchase plans
 
418,508

 
4

 
6,830

 

 

 

 
6,834

Employee stock purchase and incentive plans
 
690,683

 
8

 
(7,723
)
 

 

 

 
(7,715
)
Non-cash equity award compensation
 

 

 
6,193

 

 

 

 
6,193

Common dividends declared
 

 

 

 

 

 
(48,268
)
 
(48,268
)
June 30, 2015
 
84,552,332

 
$
846

 
$
1,779,330

 
$
140,694

 
$
958,460

 
$
(1,614,546
)
 
$
1,264,784

(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.


5


REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
 
Six Months Ended June 30,
 
2016
 
2015
Cash Flows From Operating Activities:
 
 
 
 
Net income
 
$
53,344

 
$
41,865

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
 
Amortization of premiums, discounts, and securities issuance costs, net
 
(13,945
)
 
(18,310
)
Depreciation and amortization of non-financial assets
 
575

 
315

Purchases of held-for-sale loans
 
(2,578,592
)
 
(5,656,836
)
Proceeds from sales of held-for-sale loans
 
2,158,601

 
5,366,705

Principal payments on held-for-sale loans
 
35,649

 
29,282

Net settlements of derivatives
 
(9,427
)
 
(36,622
)
Provision for loan losses
 
(6,243
)
 
(55
)
Non-cash equity award compensation expense
 
8,488

 
6,193

Market valuation adjustments
 
25,584

 
21,478

Realized gains, net
 
(19,422
)
 
(10,622
)
Net change in:
 
 
 
 
Accrued interest receivable and other assets
 
(20,667
)
 
(28,265
)
Accrued interest payable, deferred tax liabilities, and accrued expenses and other liabilities
 
5,390

 
(1,390
)
Net cash used in operating activities
 
(360,665
)
 
(286,262
)
Cash Flows From Investing Activities:
 
 
 
 
Purchases of loans held-for-investment
 

 
(9,350
)
Proceeds from sales of loans held-for-investment
 
11,395

 

Principal payments on loans held-for-investment
 
354,188

 
243,179

Purchases of real estate securities
 
(138,527
)
 
(57,178
)
Proceeds from sales of real estate securities
 
451,262

 
271,963

Principal payments on real estate securities
 
41,466

 
62,090

Purchase of mortgage servicing rights
 
(13,766
)
 
(15,993
)
Proceeds from sales of mortgage servicing rights
 
28,268

 
17,235

Net change in restricted cash
 
(2,726
)
 
(1,761
)
Net cash provided by investing activities
 
731,560

 
510,185

Cash Flows From Financing Activities:
 
 
 
 
Proceeds from borrowings on short-term debt
 
2,184,069

 
3,605,887

Repayments on short-term debt
 
(2,980,027
)
 
(4,032,650
)
Repayments on asset-backed securities issued
 
(158,519
)
 
(174,949
)
Deferred securities issuance costs
 

 
(33
)
Proceeds from issuance of long-term debt
 
771,287

 
637,396

Repayments on long-term debt
 
(118,146
)
 
(251,134
)
Net settlements of derivatives
 
(82
)
 
999

Net proceeds from issuance of common stock
 
146

 
3,498

Net payments on repurchase of common stock
 
(24,235
)
 

Taxes paid on equity award distributions
 
(4,391
)
 
(7,973
)
Dividends paid
 
(44,303
)
 
(48,268
)
Net cash used in financing activities
 
(374,201
)
 
(267,227
)
Net decrease in cash and cash equivalents
 
(3,306
)
 
(43,304
)
Cash and cash equivalents at beginning of period
 
220,229

 
269,730

Cash and cash equivalents at end of period
 
$
216,923

 
$
226,426

Supplemental Cash Flow Information:
 
 
 
 
Cash paid during the period for:
 
 
 
 
 Interest
 
$
45,758

 
$
41,440

 Taxes
 
467

 
48

Supplemental Noncash Information:
 
 
 
 
Real estate securities retained from loan securitizations
 
$
1,834

 
$
39,698

Retention of mortgage servicing rights from loan securitizations and sales
 
5,688

 
36,834

Transfers from loans held-for-sale to loans held-for-investment
 
725,825

 
663,666

Transfers from loans held-for-investment to loans held-for-sale
 
359,005

 

Transfers from residential loans to real estate owned
 
5,867

 
4,780

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


6


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 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 June 30, 2016 and December 31, 2015, and for the three and six months ended June 30, 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 June 30, 2016 and results of operations for all periods presented have been made. The results of operations for the three and six months ended June 30, 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.


7


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 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”). During the second quarter of 2016, the debt of the Commercial Securitization was repaid. 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 recorded 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 and six months ended June 30, 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.

8


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 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 June 30, 2016 and December 31, 2015, we included zero 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 we included $9 million and $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.
In March 2016, the FASB issued 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. In addition, this guidance permits the withholding of employee taxes related to the distribution of equity awards up to the maximum individual employee statutory tax rates. This new guidance is effective for fiscal years beginning after December 15, 2016 and early adoption is permitted. In the second quarter of 2016, we adopted this new guidance. Upon adoption, we elected to account for forfeitures on employee equity awards as they occur, rather than estimating expected forfeitures. The adoption of this guidance did not have a material impact on our consolidated financial statements.
Other Recent Accounting Pronouncements
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses." This new guidance provides a new impairment model that is based on expected losses rather than incurred losses to determine the allowance for credit losses. This new guidance is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for fiscal year beginning December 15, 2018. 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.
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.
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.

9


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2016
(Unaudited)

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

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. In May 2016, the FASB issued 2016 ASU 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients." This new ASU provides more specific guidance on certain aspects of Topic 606. 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 June 30, 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
June 30, 2016
(In Thousands)
 
 
 
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Assets (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
40,500

 
$

 
$
40,500

 
$
(33,619
)
 
$
(6,881
)
 
$

TBAs
 
5,584

 

 
5,584

 
(2,641
)
 
(2,200
)
 
743

Futures
 
4,078

 

 
4,078

 

 
(2,449
)
 
1,629

Total Assets
 
$
50,162

 
$

 
$
50,162

 
$
(36,260
)
 
$
(11,530
)
 
$
2,372

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
(108,497
)
 
$

 
$
(108,497
)
 
$
33,619

 
$
74,878

 
$

TBAs
 
(10,151
)
 

 
(10,151
)
 
2,640

 
7,204

 
(307
)
Loan warehouse debt
 
(706,055
)
 

 
(706,055
)
 
706,055

 

 

Security repurchase agreements
 
(352,990
)
 

 
(352,990
)
 
352,990

 

 

Total Liabilities
 
$
(1,177,693
)
 
$

 
$
(1,177,693
)
 
$
1,095,304

 
$
82,082

 
$
(307
)




10


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 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)
 
 
 
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
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.






11


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 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
At June 30, 2016, the VIEs we are required to consolidate include certain Sequoia securitization entities and the Commercial Securitization entity. During the second quarter of 2016, the debt of the Commercial Securitization was repaid. 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
June 30, 2016
 
Sequoia
Entities
 
Commercial Securitization
 
Total
(Dollars in Thousands)
 
 
 
Residential loans, held-for-investment
 
$
880,197

 
$

 
$
880,197

Restricted cash
 
147

 
131

 
278

Accrued interest receivable
 
1,058

 

 
1,058

Other assets
 
6,493

 

 
6,493

Total Assets
 
$
887,895

 
$
131

 
$
888,026

Accrued interest payable
 
$
528

 
$
100

 
$
628

Asset-backed securities issued
 
859,628

 

 
859,628

Total Liabilities
 
$
860,156

 
$
100

 
$
860,256

 
 
 
 
 
 
 
Number of VIEs
 
20

 
1

 
21


12


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2016
(Unaudited)

Note 4. Principles of Consolidation - (continued)


December 31, 2015
 
Sequoia
Entities
 
Commercial Securitization
 
Total
(Dollars in Thousands)
 
 
 
Residential loans, held-for-investment
 
$
1,021,870

 
$

 
$
1,021,870

Commercial loans, held-for-investment
 

 
166,016

 
166,016

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 27 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 and six months ended June 30, 2016 and 2015.
Table 4.2 – Securitization Activity Related to Unconsolidated VIEs Sponsored by Redwood
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In Thousands)
 
2016
 
2015
 
2016
 
2015
Principal balance of loans transferred
 
$
344,890

 
$
699,655

 
$
344,890

 
$
1,038,451

Trading securities retained, at fair value
 

 
29,966

 

 
33,389

AFS securities retained, at fair value
 
1,834

 
3,450

 
1,834

 
6,309

MSRs recognized
 
2,131

 
6,002

 
2,131

 
7,874


13


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2016
(Unaudited)

Note 4. Principles of Consolidation - (continued)


The following table summarizes the cash flows during the three and six months ended June 30, 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 June 30,
 
Six Months Ended June 30,
(In Thousands)
 
2016
 
2015
 
2016
 
2015
Proceeds from new transfers
 
$
352,042

 
$
676,596

 
$
352,042

 
$
1,018,312

MSR fees received
 
3,401

 
3,700

 
6,924

 
7,470

Funding of compensating interest
 
(77
)
 
(107
)
 
(156
)
 
(197
)
Cash flows received on retained securities
 
6,739

 
10,706

 
17,930

 
23,351

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 June 30, 2016
 
Three Months Ended June 30, 2015
At Date of Securitization
 
MSRs
 
Subordinate Securities
 
MSRs
 
Senior Securities
 
Subordinate Securities
Prepayment rate
 
20
%
 
15
%
 
13
%
 
8
%
 
8
%
Discount rates
 
11
%
 
7
%
 
11
%
 
3
%
 
6
%
Credit loss assumptions
 
N/A

 
0.25
%
 
N/A

 
0.25
%
 
0.25
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2016
 
Six Months Ended June 30, 2015
At Date of Securitization
 
MSRs
 
Subordinate Securities
 
MSRs
 
Senior Securities
 
Subordinate Securities
Prepayment rate
 
20
%
 
15
%
 
15
%
 
8
%
 
8
%
Discount rates
 
11
%
 
7
%
 
11
%
 
3
%
 
6
%
Credit loss assumptions
 
N/A

 
0.25
%
 
N/A

 
0.25
%
 
0.25
%



14


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2016
(Unaudited)

Note 4. Principles of Consolidation - (continued)


The following table presents additional information at June 30, 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)
 
June 30, 2016
 
December 31, 2015
On-balance sheet assets, at fair value:
 
 
 
 
Interest-only, senior and subordinate securities, classified as trading
 
$
29,679

 
$
258,697

Senior and subordinate securities, classified as AFS
 
255,618

 
272,715

Mortgage servicing rights
 
30,976

 
56,984

Maximum loss exposure (1)
 
$
316,273

 
$
588,396

Assets transferred:
 
 
 
 
Principal balance of loans outstanding
 
$
7,030,007

 
$
7,318,167

Principal balance of delinquent loans 30+ days delinquent
 
12,684

 
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 June 30, 2016 and December 31, 2015.
Table 4.6 – Key Assumptions and Sensitivity Analysis for Assets Retained from Unconsolidated VIEs Sponsored by Redwood
June 30, 2016
 
MSRs
 
Senior
Securities (1)
 
Subordinate Securities
(Dollars in Thousands)
 
 
 
Fair value at June 30, 2016
 
$
30,976

 
$
17,710

 
$
267,587

Expected life (in years) (2)
 
5

 
4

 
11

Prepayment speed assumption (annual CPR) (2)
 
28
%
 
12
%
 
13
%
Decrease in fair value from:
 
 
 
 
 
 
10% adverse change
 
$
2,390

 
$
688

 
$
885

25% adverse change
 
5,631

 
1,648

 
2,229

Discount rate assumption (2)
 
11
%
 
21
%
 
6
%
Decrease in fair value from:
 
 
 
 
 
 
100 basis point increase
 
$
706

 
$
442

 
$
20,724

200 basis point increase
 
1,373

 
862

 
38,779

Credit loss assumption (2)
 
N/A

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

 
$
8

 
$
1,225

25% higher losses
 
N/A

 
21

 
3,074


15


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2016
(Unaudited)

Note 4. Principles of Consolidation - (continued)


December 31, 2015
 
MSRs
 
Senior
Securities (1)
 
Subordinate Securities
(Dollars in Thousands)
 
 
 
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 $18 million and $31 million of interest only securities at June 30, 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 June 30, 2016, grouped by security type.
Table 4.7 – Third-Party Sponsored VIE Summary
(Dollars in Thousands)
 
June 30, 2016
Mortgage Backed Securities
 
 
Senior
 
$
78,747

Re-REMIC
 
165,707

Subordinate
 
354,050

Total Investments in Third-Party Sponsored VIEs
 
$
598,504

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
June 30, 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.


17


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 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 June 30, 2016 and December 31, 2015.

Table 5.1 – Carrying Values and Fair Values of Assets and Liabilities
 
 
June 30, 2016
 
December 31, 2015
 
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
(In Thousands)
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Residential loans, held-for-sale
 
 
 
 
 
 
 
 
At fair value
 
$
881,100

 
$
881,100

 
$
1,114,305

 
$
1,114,305

At lower of cost or fair value
 
1,280

 
1,472

 
1,433

 
1,635

Residential loans, held-for-investment
 
 
 
 
 
 
 
 
At fair value
 
3,157,758

 
3,157,758

 
2,813,065

 
2,813,065

Commercial loans, held-for-sale
 
 
 
 
 
 
 
 
At fair value
 
69,720

 
69,720

 
39,141

 
39,141

At lower of cost or fair value
 
233,058

 
236,824

 

 

Commercial loans, held-for-investment
 
 
 
 
 
 
 
 
At fair value
 

 

 
67,657

 
67,657

At amortized cost
 
22,285

 
22,421

 
295,849

 
300,824

Trading securities
 
273,531

 
273,531

 
404,011

 
404,011

Available-for-sale securities
 
610,270

 
610,270

 
829,245

 
829,245

MSRs
 
110,046

 
110,046

 
191,976

 
191,976

Cash and cash equivalents
 
216,923

 
216,923

 
220,229

 
220,229

Restricted cash
 
8,293

 
8,293

 
5,567

 
5,567

Accrued interest receivable
 
20,594

 
20,594

 
23,290

 
23,290

Derivative assets
 
57,610

 
57,610

 
16,393

 
16,393

REO (1)
 
6,493

 
7,951

 
4,896

 
5,282

Margin receivable (1)
 
104,108

 
104,108

 
83,191

 
83,191

FHLBC stock (1)
 
43,393

 
43,393

 
34,437

 
34,437

Guarantee asset (1)
 
3,320

 
3,320

 
5,697

 
5,697

Pledged collateral (1)
 
44,095

 
44,095

 
53,600

 
53,600

Liabilities
 
 
 
 
 
 
 
 
Short-term debt
 
$
1,059,045

 
$
1,059,045

 
$
1,855,003

 
$
1,855,003

Accrued interest payable
 
9,515

 
9,515

 
8,936

 
8,936

Margin payable
 
19,592

 
19,592

 
6,415

 
6,415

Guarantee obligation
 
24,022

 
22,203

 
22,704

 
22,702

Derivative liabilities
 
119,161

 
119,161

 
62,794

 
62,794

ABS issued, net (2)
 
 
 
 
 
 
 
 
Fair value
 
859,628

 
859,628

 
996,820

 
996,820

Amortized cost
 

 

 
52,595

 
53,137

FHLBC long-term borrowings
 
1,999,999

 
1,999,999

 
1,343,023

 
1,343,023

Commercial secured borrowings
 
65,240

 
65,240

 
63,152

 
63,152

Convertible notes, net (2)
 
480,597

 
482,812

 
483,119

 
461,053

Trust preferred securities and subordinated notes, net (2)
 
138,466

 
79,515

 
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 trust preferred securities and subordinated notes, each net of deferred debt issuance costs. See Note 3 for further discussion.

18


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2016
(Unaudited)

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


During the three and six months ended June 30, 2016, we elected the fair value option for $75 million and $123 million of subordinate securities, $1.32 billion and $2.51 billion of residential loans (principal balance), zero and $38 million of commercial loans (principal balance), and $11 million and $19 million of MSRs, respectively. 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 June 30, 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
June 30, 2016
 
Carrying
Value
 
Fair Value Measurements Using
(In Thousands)
 
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
 
Residential loans
 
$
4,038,858

 
$

 
$

 
$
4,038,858

Commercial loans
 
69,720

 

 

 
69,720

Trading securities
 
273,531

 

 

 
273,531

Available-for-sale securities
 
610,270

 

 

 
610,270

Derivative assets
 
57,610

 
9,662

 
40,500

 
7,448

MSRs
 
110,046

 

 

 
110,046

Pledged collateral
 
44,095

 
44,095

 

 

FHLBC stock
 
43,393

 

 
43,393

 

Guarantee asset
 
3,320

 

 

 
3,320

 
 
 
 
 
 
 
 
 
Liabilities
 


 
 
 
 
 
 
Derivative liabilities
 
$
119,161

 
$
10,151

 
$
108,497

 
$
513

Commercial secured borrowings
 
65,240

 

 

 
65,240

ABS issued
 
859,628

 

 

 
859,628



19


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2016
(Unaudited)

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


December 31, 2015
 
Carrying
Value
 
Fair Value Measurements Using
(In Thousands)
 
 
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