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, 2017

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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
 
Accelerated filer
o
Non-accelerated filer
o
(Do not check if a smaller reporting company)
Smaller reporting company
o
 
 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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
 
77,091,797 shares outstanding as of May 1, 2017





REDWOOD TRUST, INC.
2017 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)
 
March 31, 2017
 
December 31, 2016
ASSETS (1)
 
 
 
 
Residential loans, held-for-sale, at fair value
 
$
376,607

 
$
835,399

Residential loans, held-for-investment, at fair value
 
3,095,634

 
3,052,652

Real estate securities, at fair value
 
1,165,940

 
1,018,439

Mortgage servicing rights, at fair value
 
111,013

 
118,526

Cash and cash equivalents
 
221,781

 
212,844

Total earning assets
 
4,970,975

 
5,237,860

Restricted cash
 
1,929

 
8,623

Accrued interest receivable
 
17,645

 
18,454

Derivative assets
 
26,660

 
36,595

Other assets
 
197,082

 
181,945

Total Assets
 
$
5,214,291

 
$
5,483,477

 
 
 
 
 
LIABILITIES AND EQUITY (1)
 
 
 
 
Liabilities
 
 
 
 
Short-term debt
 
$
563,773

 
$
791,539

Accrued interest payable
 
16,035

 
9,608

Derivative liabilities
 
66,867

 
66,329

Accrued expenses and other liabilities
 
51,960

 
72,428

Asset-backed securities issued at fair value, net
 
728,391

 
773,462

Long-term debt, net
 
2,621,494

 
2,620,683

Total liabilities
 
4,048,520

 
4,334,049

Equity
 
 
 
 
Common stock, par value $0.01 per share, 180,000,000 shares authorized; 77,038,725 and 76,834,663 issued and outstanding
 
770

 
768

Additional paid-in capital
 
1,677,198

 
1,676,486

Accumulated other comprehensive income
 
72,602

 
71,853

Cumulative earnings
 
1,186,904

 
1,149,935

Cumulative distributions to stockholders
 
(1,771,703
)
 
(1,749,614
)
Total equity
 
1,165,771

 
1,149,428

Total Liabilities and Equity
 
$
5,214,291

 
$
5,483,477

——————
(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, 2017 and December 31, 2016, assets of consolidated VIEs totaled $750,694 and $798,317, respectively. At March 31, 2017 and December 31, 2016, liabilities of consolidated VIEs totaled $728,923 and $773,980, respectively. See Note 4 for further discussion.


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

2


REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, except Share Data)
 
Three Months Ended March 31,
(Unaudited)
 
2017
 
2016
Interest Income
 
 
 
 
Residential loans
 
$
34,362

 
$
31,400

Commercial loans
 
82

 
9,460

Real estate securities
 
19,817

 
21,095

Other interest income
 
367

 
373

Total interest income
 
54,628

 
62,328

Interest Expense
 
 
 
 
Short-term debt
 
(4,453
)
 
(6,697
)
Asset-backed securities issued
 
(3,530
)
 
(4,282
)
Long-term debt
 
(13,048
)
 
(12,971
)
Total interest expense
 
(21,031
)
 
(23,950
)
Net Interest Income
 
33,597

 
38,378

Provision for loan losses
 

 
(289
)
Net Interest Income after Provision
 
33,597

 
38,089

Non-interest Income
 
 
 
 
Mortgage banking activities, net
 
17,604

 
7,218

Mortgage servicing rights income, net
 
1,713

 
6,281

Investment fair value changes, net
 
1,551

 
(19,538
)
Other income
 
1,184

 
955

Realized gains, net
 
5,703

 
9,538

Total non-interest income, net
 
27,755

 
4,454

Operating expenses
 
(18,226
)
 
(30,452
)
Net Income before Provision for Income Taxes
 
43,126

 
12,091

Provision for income taxes
 
(6,157
)
 
(28
)
Net Income
 
$
36,969

 
$
12,063

 
 
 
 
 
Basic earnings per common share
 
$
0.47

 
$
0.15

Diluted earnings per common share
 
$
0.43

 
$
0.15

Regular dividends declared per common share
 
$
0.28

 
$
0.28

Basic weighted average shares outstanding
 
76,738,202

 
77,137,682

Diluted weighted average shares outstanding
 
97,946,137

 
77,137,682


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 March 31,
(Unaudited)
 
2017
 
2016
Net Income
 
$
36,969

 
$
12,063

Other comprehensive income (loss):
 
 
 
 
Net unrealized gain (loss) on available-for-sale securities (1)
 
2,930

 
(10,103
)
Reclassification of unrealized gain on available-for-sale securities to net income
 
(3,928
)
 
(10,953
)
Net unrealized gain (loss) on interest rate agreements
 
1,733

 
(14,243
)
Reclassification of unrealized loss on interest rate agreements to net income
 
14

 
18

Total other comprehensive income (loss)
 
749

 
(35,281
)
Total Comprehensive Income (Loss)
 
$
37,718

 
$
(23,218
)
——————
(1)
Amounts are presented net of tax (provision) benefit of $(0.1) million and $0.1 million for the three months ended March 31, 2017 and 2016, respectively.

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 Three Months Ended March 31, 2017
(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, 2016
 
76,834,663

 
$
768

 
$
1,676,486

 
$
71,853

 
$
1,149,935

 
$
(1,749,614
)
 
$
1,149,428

Net income
 

 

 

 

 
36,969

 

 
36,969

Other comprehensive income
 

 

 

 
749

 

 

 
749

Employee stock purchase and incentive plans
 
204,062

 
2

 
(1,530
)
 

 

 

 
(1,528
)
Non-cash equity award compensation
 

 

 
2,242

 

 

 

 
2,242

Common dividends declared
 

 

 

 

 

 
(22,089
)
 
(22,089
)
March 31, 2017
 
77,038,725

 
$
770

 
$
1,677,198

 
$
72,602

 
$
1,186,904

 
$
(1,771,703
)
 
$
1,165,771


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
 
 
 
 
 
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



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)
 
Three Months Ended March 31,
 
2017
 
2016
Cash Flows From Operating Activities:
 
 
 
 
Net income
 
$
36,969

 
$
12,063

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Amortization of premiums, discounts, and securities issuance costs, net
 
(5,023
)
 
(7,568
)
Depreciation and amortization of non-financial assets
 
306

 
277

Purchases of held-for-sale loans
 
(1,103,047
)
 
(1,245,068
)
Proceeds from sales of held-for-sale loans
 
1,347,575

 
1,336,617

Principal payments on held-for-sale loans
 
13,001

 
23,518

Net settlements of derivatives
 
10,238

 
(1,154
)
Provision for loan losses
 

 
289

Non-cash equity award compensation expense
 
2,242

 
5,782

Market valuation adjustments
 
(15,129
)
 
15,848

Realized gains, net
 
(5,703
)
 
(9,538
)
Net change in:
 
 
 
 
Accrued interest receivable and other assets
 
(10,490
)
 
(30,056
)
Accrued interest payable and accrued expenses and other liabilities
 
(17,301
)
 
4,966

Net cash provided by operating activities
 
253,638

 
105,976

Cash Flows From Investing Activities:
 
 
 
 
Proceeds from sales of loans held-for-investment
 

 
6,298

Principal payments on loans held-for-investment
 
147,127

 
125,631

Purchases of real estate securities
 
(144,948
)
 
(48,446
)
Proceeds from sales of real estate securities
 
26,887

 
340,798

Principal payments on real estate securities
 
17,529

 
22,401

Purchase of mortgage servicing rights
 
(100
)
 
(5,397
)
Proceeds from sales of mortgage servicing rights
 
9,136

 
28,268

Net change in restricted cash
 
6,694

 
3,430

Net cash provided by investing activities
 
62,325

 
472,983

Cash Flows From Financing Activities:
 
 
 
 
Proceeds from borrowings on short-term debt
 
877,495

 
1,027,320

Repayments on short-term debt
 
(1,105,261
)
 
(2,078,148
)
Repayments on asset-backed securities issued
 
(55,609
)
 
(50,868
)
Proceeds from issuance of long-term debt
 

 
771,287

Repayments on long-term debt
 

 
(118,146
)
Net settlements of derivatives
 
(34
)
 
(73
)
Net proceeds from issuance of common stock
 
73

 
77

Net payments on repurchase of common stock
 

 
(22,987
)
Taxes paid on equity award distributions
 
(1,601
)
 
(229
)
Dividends paid
 
(22,089
)
 
(22,306
)
Net cash used in financing activities
 
(307,026
)
 
(494,073
)
Net increase in cash and cash equivalents
 
8,937

 
84,886

Cash and cash equivalents at beginning of period
 
212,844

 
220,229

Cash and cash equivalents at end of period
 
$
221,781

 
$
305,115

Supplemental Cash Flow Information:
 
 
 
 
Cash paid during the period for:
 
 
 
 
 Interest
 
$
14,726

 
$
18,634

 Taxes
 
4

 
64

Supplemental Noncash Information:
 
 
 
 
Real estate securities retained from loan securitizations
 
$
25,858

 
$

Retention of mortgage servicing rights from loan securitizations and sales
 
7,386

 
3,463

Transfers from loans held-for-sale to loans held-for-investment
 
184,996

 
660,818

Transfers from loans held-for-investment to loans held-for-sale
 

 
54,747

Transfers from residential loans to real estate owned
 
968

 
2,042


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

6


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(Unaudited)




Note 1. Organization
Redwood Trust, Inc., together with its subsidiaries, focuses on investing in mortgages 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 two segments: Investment Portfolio and Residential Mortgage Banking. 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, 2017 and December 31, 2016, and for the three months ended March 31, 2017 and 2016. 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 the consolidated financial statements and notes thereto included in the company's Annual Report on Form 10-K for the year ended December 31, 2016. In the opinion of management, all normal and recurring adjustments to present fairly the financial condition of the company at March 31, 2017 and results of operations for all periods presented have been made. The results of operations for the three months ended March 31, 2017 should not be construed as indicative of the results to be expected for the full year.
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. 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 owned at the consolidated Sequoia entities are shown under Residential loans, held-for-investment, at fair value on our consolidated balance sheets. The asset-backed securities (“ABS”) issued to third parties by these entities are shown under ABS issued. In our consolidated statements of income, we recorded interest income on the loans owned at these entities and interest expense on the ABS issued by these entities as well as other income and expenses associated with these entities' activities. See Note 12 for further discussion on ABS issued.
See Note 4 for further discussion on principles of consolidation.

7


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(Unaudited)
Note 2. Basis of Presentation - (continued)

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 2016 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, 2017.
Recent Accounting Pronouncements
Newly Adopted Accounting Standards Updates ("ASUs")
In January 2017, the FASB issued ASU 2017-03, "Accounting Changes and Error Corrections (Topic 250) and Investments - Equity Method and Joint Ventures (Topic 323)." This new guidance requires that companies evaluate ASUs that have not been adopted to determine the appropriate financial statement disclosures about the potential material effects of those ASUs on the financial statements when adopted. This new guidance is effective immediately. We adopted this guidance, as required, in the first quarter of 2017, 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 provides simplifications of 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 November 2016, the FASB issued ASU 2016-18, "Statement of Cash Flows (Topic 230): Restricted Cash." This new guidance amends previous guidance on how to classify and present changes in restricted cash on the statement of cash flows. This new guidance is effective for fiscal years beginning after December 15, 2017. Early adoption is permitted. We plan to adopt this new guidance by the required date and we will modify the presentation of our cash flow statement as required.
In October 2016, the FASB issued ASU 2016-16, "Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory." This new guidance allows an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. It also eliminates the exceptions for an intra-entity transfer of assets other than inventory. This new guidance is effective for fiscal years beginning after December 15, 2017. 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 August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments." This new guidance provides guidance on how to present and classify certain cash receipts and cash payments in the statement of cash flows. This new guidance is effective for fiscal years beginning after December 15, 2017. Early adoption is permitted. We plan to adopt this new guidance by the required date and do not anticipate that this update will have a material impact on our consolidated financial statements.

8


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(Unaudited)

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

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses." This new guidance provides a new impairment model that is based on expected losses rather than incurred losses to determine the allowance for credit losses. This new guidance is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for fiscal years beginning December 15, 2018. Currently, a significant portion of our financial instruments are measured at fair value, for which we do not maintain any allowances for loan losses in accordance with fair value accounting. As such, based on our initial evaluation of this new guidance, we do not believe the provisions in this guidance will have a material impact to how we account for these instruments. Separately, we account for our available-for-sale securities under the other-than-temporary impairment ("OTTI") model for debt securities. This new guidance changes the accounting for available-for-sale securities, including AFS securities purchased with credit deterioration. We are currently evaluating the impact that this update will have on our consolidated financial statements in regard to our available-for-sale securities. We plan to adopt this new guidance by the required date.
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. Based on our initial evaluation of this new guidance, and taking into consideration our current in-place leases, we do not expect that its adoption will have a material impact on our consolidated financial statements. As discussed in Note 14, our only material leases are those related to our leased office space, for which future payments under these leases total $4 million. We will continue evaluating this new standard and caution that any changes in our business or additional leases we may enter into could change our initial assessment.
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 plan to adopt this new guidance by the required date and do not anticipate that this update will have a material impact on our consolidated financial statements.
In 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 ASU 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients," and in December 2016, the FASB issued ASU 2016-20, "Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers." These new ASUs provide more specific guidance on certain aspects of Topic 606. Based on our initial evaluation of these new accounting standards, we do not expect that their adoption will have a material impact on our consolidated financial statements, as financial instruments are explicitly scoped out of the standards and nearly all of our income is generated from financial instruments. We will continue evaluating these new standards and caution that any changes in our business or additional amendments to these standards could change our initial assessment.

9


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(Unaudited)

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

Balance Sheet Netting
Certain of our derivatives and short-term debt are subject to master netting arrangements or similar agreements. Under GAAP, in certain circumstances we may elect to present certain financial assets, liabilities and related collateral subject to master netting arrangements in a net position on our consolidated balance sheets. However, we do not report any of these financial assets or liabilities on a net basis, and instead present them on a gross basis on our consolidated balance sheets.
The table below presents financial assets and liabilities that are subject to master netting arrangements or similar agreements categorized by financial instrument, together with corresponding financial instruments and corresponding collateral received or pledged at March 31, 2017 and December 31, 2016.
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, 2017
(In Thousands)
 
 
 
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Assets (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
11,552

 
$

 
$
11,552

 
$
(5,342
)
 
$
(1,470
)
 
$
4,740

TBAs
 
9,535

 

 
9,535

 
(8,429
)
 
(931
)
 
175

Futures
 
13

 

 
13

 
(4
)
 

 
9

Total Assets
 
$
21,100

 
$

 
$
21,100

 
$
(13,775
)
 
$
(2,401
)
 
$
4,924

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
(56,296
)
 
$

 
$
(56,296
)
 
$
5,342

 
$
50,954

 
$

TBAs
 
(9,743
)
 

 
(9,743
)
 
8,428

 
625

 
(690
)
Futures
 
(55
)
 

 
(55
)
 
4

 
51

 

Loan warehouse debt
 
(240,961
)
 

 
(240,961
)
 
240,961

 

 

Security repurchase agreements
 
(322,812
)
 

 
(322,812
)
 
322,812

 

 

Total Liabilities
 
$
(629,867
)
 
$

 
$
(629,867
)
 
$
577,547

 
$
51,630

 
$
(690
)

10


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(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, 2016
(In Thousands)
 
 
 
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Assets (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
24,980

 
$

 
$
24,980

 
$
(7,736
)
 
$
(4,784
)
 
$
12,460

TBAs
 
8,300

 

 
8,300

 
(3,936
)
 
(4,364
)
 

Total Assets
 
$
33,280

 
$

 
$
33,280

 
$
(11,672
)
 
$
(9,148
)
 
$
12,460

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
(56,919
)
 
$

 
$
(56,919
)
 
$
7,736

 
$
49,183

 
$

TBAs
 
(4,681
)
 

 
(4,681
)
 
3,936

 

 
(745
)
Futures
 
(928
)
 

 
(928
)
 

 
928

 

Loan warehouse debt
 
(485,544
)
 

 
(485,544
)
 
485,544

 

 

Security repurchase agreements
 
(305,995
)
 

 
(305,995
)
 
305,995

 

 

Total Liabilities
 
$
(854,067
)
 
$

 
$
(854,067
)
 
$
803,211

 
$
50,111

 
$
(745
)
(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, credit default index swaps, and futures are components of derivatives instruments on our consolidated balance sheets. Loan warehouse debt, which is secured by residential mortgage loans, and security repurchase agreements are components of Short-term debt on our consolidated balance sheets.
For each category of financial instrument set forth in the table above, the assets and liabilities resulting from individual transactions within that category between us and a counterparty are subject to a master netting arrangement or similar agreement with that counterparty that provides for individual transactions to be aggregated and treated as a single transaction. For certain categories of these instruments, some of our transactions are cleared and settled through one or more clearinghouses that are substituted as our counterparty. References herein to master netting arrangements or similar agreements include the arrangements and agreements governing the clearing and settlement of these transactions through the clearinghouses. In the event of the termination and close-out of any of those transactions, the corresponding master netting agreement or similar agreement provides for settlement on a net basis. Any such settlement would include the proceeds of the liquidation of any corresponding collateral, subject to certain limitations on termination, settlement, and liquidation of collateral that may apply in the event of the bankruptcy or insolvency of a party. Such limitations should not inhibit the eventual practical realization of the principal benefits of those transactions or the corresponding master netting arrangement or similar agreement and any corresponding collateral.






11


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(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 March 31, 2017, we consolidated certain Sequoia securitization entities issued prior to 2012 that we determined were VIEs and for which we determined we were the primary beneficiary. Each of these entities is independent of Redwood and of each other and the assets and liabilities of these entities are not owned by and are not legal obligations of ours. Our exposure to these entities is primarily through the financial interests we have retained, although 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
(Dollars in Thousands)
 
March 31, 2017
 
December 31, 2016
Residential loans, held-for-investment
 
$
745,621

 
$
791,636

Restricted cash
 
148

 
148

Accrued interest receivable
 
972

 
1,000

Other assets
 
3,953

 
5,533

Total Assets
 
$
750,694

 
$
798,317

Accrued interest payable
 
$
532

 
$
518

Asset-backed securities issued
 
728,391

 
773,462

Total Liabilities
 
$
728,923

 
$
773,980

 
 
 
 
 
Number of VIEs
 
20

 
20

Analysis of Unconsolidated VIEs with Continuing Involvement
Since 2012, we have transferred residential loans to 32 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.

12


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(Unaudited)

Note 4. Principles of Consolidation - (continued)


The following table presents information related to securitization transactions that occurred during the three months ended March 31, 2017 and 2016.
Table 4.2 – Securitization Activity Related to Unconsolidated VIEs Sponsored by Redwood
 
 
Three Months Ended March 31,
(In Thousands)
 
2017
 
2016
Principal balance of loans transferred
 
$
1,035,524

 
$

Trading securities retained, at fair value
 
20,703

 

AFS securities retained, at fair value
 
5,155

 

MSRs recognized
 
7,123

 

The following table summarizes the cash flows during the three months ended March 31, 2017 and 2016 between us and the unconsolidated VIEs sponsored by us and accounted for as sales since 2012.
Table 4.3 – Cash Flows Related to Unconsolidated VIEs Sponsored by Redwood
 
 
Three Months Ended March 31,
(In Thousands)
 
2017
 
2016
Proceeds from new transfers
 
$
1,022,024

 
$

MSR fees received
 
3,475

 
3,523

Funding of compensating interest
 
(38
)
 
(79
)
Cash flows received on retained securities
 
6,373

 
11,191

The following table presents the key weighted-average assumptions used to measure MSRs and securities retained at the date of securitization for securitizations completed during the three months ended March 31, 2017 and 2016.
Table 4.4 – Assumptions Related to Assets Retained from Unconsolidated VIEs Sponsored by Redwood

 
 
Three Months Ended March 31, 2017
 
Three Months Ended March 31, 2016
At Date of Securitization
 
MSRs
 
Senior Securities
 
Subordinate Securities
 
MSRs
 
Senior Securities
 
Subordinate Securities
Prepayment rates
 
9
%
 
10
%
 
10
%
 
N/A
 
N/A
 
N/A
Discount rates
 
11
%
 
11
%
 
5
%
 
N/A
 
N/A
 
N/A
Credit loss assumptions
 
N/A

 
0.25
%
 
0.25
%
 
N/A
 
N/A
 
N/A



13


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(Unaudited)

Note 4. Principles of Consolidation - (continued)


The following table presents additional information at March 31, 2017 and December 31, 2016, 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, 2017
 
December 31, 2016
On-balance sheet assets, at fair value:
 
 
 
 
Interest-only, senior and subordinate securities, classified as trading
 
$
61,464

 
$
41,909

Subordinate securities, classified as AFS
 
230,809

 
234,025

Mortgage servicing rights
 
65,018

 
58,800

Maximum loss exposure (1)
 
$
357,291

 
$
334,734

Assets transferred:
 
 
 
 
Principal balance of loans outstanding
 
$
7,639,569

 
$
6,870,398

Principal balance of loans 30+ days delinquent
 
18,830

 
21,427

(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, 2017 and December 31, 2016.
Table 4.6 – Key Assumptions and Sensitivity Analysis for Assets Retained from Unconsolidated VIEs Sponsored by Redwood
March 31, 2017
 
MSRs
 
Senior
Securities (1)
 
Subordinate Securities
(Dollars in Thousands)
 
 
 
Fair value at March 31, 2017
 
$
65,018

 
$
28,799

 
$
263,474

Expected life (in years) (2)
 
7

 
6

 
13

Prepayment speed assumption (annual CPR) (2)
 
10
%
 
8
%
 
12
%
Decrease in fair value from:
 
 
 
 
 
 
10% adverse change
 
$
2,399

 
$
1,190

 
$
970

25% adverse change
 
5,707

 
2,836

 
2,381

Discount rate assumption (2)
 
11
%
 
8
%
 
6
%
Decrease in fair value from:
 
 
 
 
 
 
100 basis point increase
 
$
2,346

 
$
1,200

 
$
21,360

200 basis point increase
 
4,524

 
2,311

 
39,818

Credit loss assumption (2)
 
N/A

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

 
$
19

 
$
1,312

25% higher losses
 
N/A

 
48

 
3,279


14


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(Unaudited)

Note 4. Principles of Consolidation - (continued)


December 31, 2016
 
MSRs
 
Senior
Securities (1)
 
Subordinate Securities
(Dollars in Thousands)
 
 
 
Fair value at December 31, 2016
 
$
58,800

 
$
26,618

 
$
249,317

Expected life (in years) (2)
 
7

 
6

 
12

Prepayment speed assumption (annual CPR) (2)
 
11
%
 
8
%
 
12
%
Decrease in fair value from:
 
 
 
 
 
 
10% adverse change
 
$
2,226

 
$
1,075

 
$
997

25% adverse change
 
5,284

 
2,569

 
2,494

Discount rate assumption (2)
 
11
%
 
8
%
 
6
%
Decrease in fair value from:
 
 
 
 
 
 
100 basis point increase
 
$
2,088

 
$
1,105

 
$
19,574

200 basis point increase
 
4,032

 
2,128

 
36,574

Credit loss assumption (2)
 
N/A

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

 
$
19

 
$
1,174

25% higher losses
 
N/A

 
49

 
2,933


(1)
Senior securities included $29 million and $27 million of interest only securities at March 31, 2017 and December 31, 2016, 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, 2017, grouped by security type.
Table 4.7 – Third-Party Sponsored VIE Summary
(Dollars in Thousands)
 
March 31, 2017
Mortgage-Backed Securities
 
 
Senior
 
$
147,300

Re-REMIC
 
73,730

Subordinate
 
652,637

Total Investments in Third-Party Sponsored VIEs
 
$
873,667

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.

15


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(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.


16


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(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, 2017 and December 31, 2016.

Table 5.1 – Carrying Values and Fair Values of Assets and Liabilities
 
 
March 31, 2017
 
December 31, 2016
 
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
(In Thousands)
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Residential loans, held-for-sale
 
 
 
 
 
 
 
 
At fair value
 
$
375,407

 
$
375,407

 
$
834,193

 
$
834,193

At lower of cost or fair value
 
1,200

 
1,354

 
1,206

 
1,365

Residential loans, held-for-investment
 
 
 
 
 
 
 
 
At fair value
 
3,095,634

 
3,095,634

 
3,052,652

 
3,052,652

Trading securities
 
591,152

 
591,152

 
445,687

 
445,687

Available-for-sale securities
 
574,788

 
574,788

 
572,752

 
572,752

MSRs
 
111,013

 
111,013

 
118,526

 
118,526

Cash and cash equivalents
 
221,781

 
221,781

 
212,844

 
212,844

Restricted cash
 
1,929

 
1,929

 
8,623

 
8,623

Accrued interest receivable
 
17,645

 
17,645

 
18,454

 
18,454

Derivative assets
 
26,660

 
26,660

 
36,595

 
36,595

REO (1)
 
3,953

 
4,183

 
5,533

 
5,560

Margin receivable (1)
 
83,229

 
83,229

 
68,038

 
68,038

FHLBC stock (1)
 
43,393

 
43,393

 
43,393

 
43,393

Guarantee asset (1)
 
3,846

 
3,846

 
4,092

 
4,092

Commercial loans (1)
 
2,700

 
2,700

 
2,700

 
2,700

Pledged collateral (1)
 
42,916

 
42,916

 
42,875

 
42,875

Liabilities
 
 
 
 
 
 
 
 
Short-term debt
 
$
563,773

 
$
563,773

 
$
791,539

 
$
791,539

Accrued interest payable
 
16,035

 
16,035

 
9,608

 
9,608

Margin payable
 
3,394

 
3,394

 
12,783

 
12,783

Guarantee obligation
 
21,082

 
21,764

 
21,668

 
22,181

Derivative liabilities
 
66,867

 
66,867

 
66,329

 
66,329

ABS issued at fair value, net
 
728,391

 
728,391

 
773,462

 
773,462

FHLBC long-term borrowings
 
1,999,999

 
1,999,999

 
1,999,999

 
1,999,999

Convertible notes, net
 
482,994

 
496,820

 
482,195

 
493,365

Trust preferred securities and subordinated notes, net
 
138,501

 
101,138

 
138,489

 
96,255

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

17


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(Unaudited)

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


During the three months ended March 31, 2017, we elected the fair value option for $3 million of residential senior securities, $142 million of subordinate securities, $1.09 billion of residential loans (principal balance), and $7 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, for MSRs purchased or retained from sales of residential loans, and for certain securities we purchase, including IO securities and fixed-rate securities rated investment grade or higher.
The following table presents the assets and liabilities that are reported at fair value on our consolidated balance sheets on a recurring basis at March 31, 2017 and December 31, 2016, 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, 2017
 
Carrying
Value
 
Fair Value Measurements Using
(In Thousands)
 
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
 
Residential loans
 
$
3,471,041

 
$

 
$

 
$
3,471,041

Trading securities
 
591,152

 

 

 
591,152

Available-for-sale securities
 
574,788

 

 

 
574,788

Derivative assets
 
26,660

 
9,548

 
11,552

 
5,560

MSRs
 
111,013

 

 

 
111,013

Pledged collateral
 
42,916

 
42,916

 

 

FHLBC stock
 
43,393

 

 
43,393

 

Guarantee asset
 
3,846

 

 

 
3,846

 
 
 
 
 
 
 
 
 
Liabilities
 


 
 
 
 
 
 
Derivative liabilities
 
$
66,867

 
$
9,798

 
$
56,296

 
$
773

ABS issued
 
728,391

 

 

 
728,391


December 31, 2016
 
Carrying
Value
 
Fair Value Measurements Using
(In Thousands)
 
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
 
Residential loans
 
$
3,886,845

 
$

 
$

 
$
3,886,845

Trading securities
 
445,687

 

 

 
445,687

Available-for-sale securities
 
572,752

 

 

 
572,752

Derivative assets
 
36,595

 
8,300

 
24,980

 
3,315

MSRs
 
118,526

 

 

 
118,526

Pledged collateral
 
42,875

 
42,875

 

 

FHLBC stock
 
43,393

 

 
43,393

 

Guarantee asset
 
4,092

 

 

 
4,092

 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Derivative liabilities
 
$
66,329

 
$
5,609

 
$
56,919

 
$
3,801

ABS issued
 
773,462

 

 

 
773,462


18


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(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, 2017.
Table 5.3 – Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis
 
 
Assets
 
 
 
Liabilities
 
 
Residential Loans
 
Trading Securities
 
AFS
Securities
 
MSRs
 
Guarantee Asset
 
Derivatives(1)
 
ABS
Issued
(In Thousands)
 
 
 
 
 
 
 
Beginning balance -
   December 31, 2016
 
$
3,886,845

 
$
445,687

 
$
572,752

 
$
118,526

 
$
4,092

 
$
(486
)
 
$
773,462

Acquisitions
 
1,108,332

 
145,396

 
25,333

 
7,485

 

 

 

Sales
 
(1,377,574
)
 
(8,279
)
 
(18,456
)
 
(11,928
)
 

 

 

Principal paydowns
 
(160,102
)
 
(2,836
)
 
(14,693
)
 

 

 

 
(55,609
)
Gains (losses) in net income, net
 
14,504

 
11,184

 
10,848

 
(3,070
)
 
(246
)
 
10,265

 
10,538

Unrealized losses in OCI, net
 

 

 
(996
)
 

 

 

 

Other settlements, net(2)
 
(964
)
 

 

 

 

 
(4,992
)
 

Ending Balance -
  March 31, 2017
 
$
3,471,041

 
$
591,152

 
$
574,788

 
$
111,013

 
$
3,846

 
$
4,787

 
$
728,391

(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.


19


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(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, 2017 and 2016. Gains or losses incurred on assets or liabilities sold, matured, called, or fully written down during the three months ended March 31, 2017 and 2016 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, 2017 and 2016 Included in Net Income
 
 
Included in Net Income
 
 
Three Months Ended March 31,
(In Thousands)
 
2017
 
2016
Assets
 
 
 
 
Residential loans at Redwood
 
$
3,723

 
$
27,285

Residential loans at consolidated Sequoia entities
 
8,414

 
(35,656
)
Commercial loans
 

 
2,171

Trading securities
 
10,051

 
(6,135
)
Available-for-sale securities
 
(117
)
 

MSRs
 
(916
)
 
(30,834
)
Loan purchase commitments
 
4,823

 
4,644

Other assets - Guarantee asset
 
(246
)
 
(1,425
)
 
 
 
 
 
Liabilities
 
 
 
 
Commercial secured borrowing
 

 
2,171

ABS issued
 
(10,538
)
 
33,515

The following table presents information on assets recorded at fair value on a non-recurring basis at March 31, 2017. This table does not include the carrying value and gains or losses associated with the asset types below that were not recorded at fair value on our consolidated balance sheet at March 31, 2017.
Table 5.5 – Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis at March 31, 2017
 
 
 
 
 
 
 
 
 
 
Gain (Loss) for
March 31, 2017
 
Carrying
Value
 
Fair Value Measurements Using
 
Three Months Ended
(In Thousands)
 
 
Level 1
 
Level 2
 
Level 3
 
March 31, 2017
Assets
 
 
 
 
 
 
 
 
 
 
Residential loans, at lower of cost or fair value
 
$
862

 
$

 
$

 
$
862

 
$
2

Commercial loans, at lower of cost or fair value
 
2,700

 

 

 
2,700

 

REO
 
3,255

 

 

 
3,255

 
(674
)

20


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(Unaudited)

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


The following table presents the net market valuation gains and losses recorded in each line item of our consolidated statements of income for the three months ended March 31, 2017 and 2016.
Table 5.6 – Market Valuation Gains and Losses, Net
 
 
Three Months Ended March 31,
(In Thousands)
 
2017
 
2016
Mortgage Banking Activities, Net
 
 
 
 
Residential loans held-for-sale, at fair value
 
$
8,532

 
$
5,439

Residential loan purchase commitments
 
10,265

 
12,635

Commercial loans, at fair value
 

 
433

Sequoia securities
 

 
1,484

Risk management derivatives, net
 
(1,400
)
 
(12,754
)
Total mortgage banking activities, net (1)
 
$
17,397

 
$
7,237

Investment Fair Value Changes, Net
 
 
 
 
Residential loans held-for-investment at Redwood
 
$
(2,333
)
 
$
23,463

Trading securities
 
11,143

 
(5,601
)
Net investments in consolidated Sequoia entities
 
(1,810
)
 
(1,580
)
Risk sharing investments
 
(205
)
 
(10
)
Risk management derivatives, net
 
(5,127
)
 
(35,810
)
Impairments on AFS securities
 
(117
)
 

Total investment fair value changes, net
 
$
1,551

 
$
(19,538
)
MSR Income (Loss), Net
 
 
 
 
MSRs
 
$
(3,070
)
 
$
(44,604
)
Risk management derivatives, net
 
(749
)
 
41,057

Total MSR loss, net (2)
 
$
(3,819
)
 
$
(3,547
)
Total Market Valuation Gains (Losses), Net
 
$
15,129

 
$
(15,848
)

(1)
Mortgage banking activities, net presented above does not include fee income or provisions for repurchases that are components of Mortgage banking activities, net presented on our consolidated statements of income, as these amounts do not represent market valuation changes.
(2)
MSR income (loss), net presented above does not include net fee income or provisions for repurchases that are components of MSR income, net on our consolidated statements of income, as these amounts do not represent market valuation adjustments.

21


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2017
(Unaudited)

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


At March 31, 2017, our valuation policy and processes had not changed from those described in our Annual Report on Form 10-K for the year ended December 31, 2016. The following table provides quantitative information about the significant unobservable inputs used in the valuation of our Level 3 assets and liabilities measured at fair value.
Table 5.7 – Fair Value Methodology for Level 3 Financial Instruments
March 31, 2017
 
Fair
Value
 
 
 
Input Values
(Dollars in Thousands, except Input Values)
 
 
Unobservable Input
 
Range
 
 
Weighted
Average
Assets
 
 
 
 
 
 
 
 
 
 
 
 
Residential loans, at fair value:
 
 
 
 
 
 
 
 
 
 
 
 
Jumbo fixed-rate loans
 
$
2,438,357

 
Whole loan spread to TBA price
 
$
3.00

-
$
4.13

 
 
$
3.76

 
 
 
 
 
Whole loan spread to swap rate
 
190

-
285

bps
 
271

bps
 
 
 
 
 
 
 
 
 
 
 
 
 
Jumbo hybrid loans
 
66,842

 
Prepayment rate (annual CPR)
 
15

-
15

%
 
15

%
 
 
 
 
Whole loan spread to swap rate
 
115

-
230

bps
 
171

bps