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

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: September 30, 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
 
77,114,790 shares outstanding as of November 3, 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)
 
September 30, 2017
 
December 31, 2016
ASSETS (1)
 
 
 
 
Residential loans, held-for-sale, at fair value
 
$
925,681

 
$
835,399

Residential loans, held-for-investment, at fair value
 
3,259,239

 
3,052,652

Real estate securities, at fair value
 
1,356,272

 
1,018,439

Mortgage servicing rights, at fair value
 
62,928

 
118,526

Cash and cash equivalents
 
257,611

 
212,844

Total earning assets
 
5,861,731

 
5,237,860

Restricted cash
 
26,258

 
8,623

Accrued interest receivable
 
21,256

 
18,454

Derivative assets
 
11,948

 
36,595

Other assets
 
209,506

 
181,945

Total Assets
 
$
6,130,699

 
$
5,483,477

 
 
 
 
 
LIABILITIES AND EQUITY (1)
 
 
 
 
Liabilities
 
 
 
 
Short-term debt (2)
 
$
1,238,196

 
$
791,539

Accrued interest payable
 
18,836

 
9,608

Derivative liabilities
 
65,238

 
66,329

Accrued expenses and other liabilities
 
81,062

 
72,428

Asset-backed securities issued, at fair value
 
944,288

 
773,462

Long-term debt, net
 
2,574,439

 
2,620,683

Total liabilities
 
4,922,059

 
4,334,049

Equity
 
 
 
 
Common stock, par value $0.01 per share, 180,000,000 shares authorized; 77,122,687 and 76,834,663 issued and outstanding
 
771

 
768

Additional paid-in capital
 
1,681,968

 
1,676,486

Accumulated other comprehensive income
 
82,316

 
71,853

Cumulative earnings
 
1,259,408

 
1,149,935

Cumulative distributions to stockholders
 
(1,815,823
)
 
(1,749,614
)
Total equity
 
1,208,640

 
1,149,428

Total Liabilities and Equity
 
$
6,130,699

 
$
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 September 30, 2017 and December 31, 2016, assets of consolidated VIEs totaled $995,768 and $798,317, respectively. At September 30, 2017 and December 31, 2016, liabilities of consolidated VIEs totaled $945,873 and $773,980, respectively. See Note 4 for further discussion.
(2)
Includes $250 million of convertible notes, which were reclassified from Long-term debt, net to Short-term debt as the maturity of the notes was less than one year as of April 2017. See Note 11 for further discussion.

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

2

REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, except Share Data)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Unaudited)
 
2017
 
2016
 
2017
 
2016
Interest Income
 
 
 
 
 
 
 
 
Residential loans
 
$
38,541

 
$
35,595

 
$
109,538

 
$
102,149

Commercial loans
 
—

 
6,453

 
345

 
28,834

Real estate securities
 
23,425

 
18,600

 
65,068

 
58,112

Other interest income
 
771

 
258

 
1,638

 
926

Total interest income
 
62,737

 
60,906

 
176,589

 
190,021

Interest Expense
 
 
 
 
 
 
 
 
Short-term debt
 
(10,182
)
 
(5,405
)
 
(23,985
)
 
(17,439
)
Asset-backed securities issued
 
(3,956
)
 
(3,193
)
 
(11,191
)
 
(11,457
)
Long-term debt
 
(13,305
)
 
(12,999
)
 
(37,532
)
 
(39,095
)
Total interest expense
 
(27,443
)
 
(21,597
)
 
(72,708
)
 
(67,991
)
Net Interest Income
 
35,294

 
39,309

 
103,881

 
122,030

Reversal of provision for loan losses
 
—

 
859

 
—

 
7,102

Net Interest Income after Provision
 
35,294

 
40,168

 
103,881

 
129,132

Non-interest Income
 
 
 
 
 
 
 
 
Mortgage banking activities, net
 
21,200

 
9,766

 
50,850

 
24,712

Mortgage servicing rights income, net
 
1,615

 
3,770

 
6,106

 
12,834

Investment fair value changes, net
 
324

 
11,918

 
9,990

 
(18,686
)
Other income
 
1,197

 
1,643

 
3,367

 
4,157

Realized gains, net
 
1,734

 
6,615

 
8,809

 
26,037

Total non-interest income, net
 
26,070

 
33,712

 
79,122

 
49,054

Operating expenses
 
(19,922
)
 
(20,355
)
 
(56,789
)
 
(70,962
)
Net Income before Provision for Income Taxes
 
41,442

 
53,525

 
126,214

 
107,224

Provision for income taxes
 
(5,262
)
 
(972
)
 
(16,741
)
 
(1,327
)
Net Income
 
$
36,180

 
$
52,553

 
$
109,473

 
$
105,897

 
 
 
 
 
 
 
 
 
Basic earnings per common share
 
$
0.46

 
$
0.67

 
$
1.39

 
$
1.34

Diluted earnings per common share
 
$
0.41

 
$
0.58

 
$
1.26

 
$
1.23

Regular dividends declared per common share
 
$
0.28

 
$
0.28

 
$
0.84

 
$
0.84

Basic weighted average shares outstanding
 
76,850,830

 
76,680,183

 
76,803,324

 
76,827,026

Diluted weighted average shares outstanding
 
102,703,108

 
97,831,617

 
99,397,866

 
97,991,678


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



3

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

(In Thousands)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Unaudited)
 
2017
 
2016
 
2017
 
2016
Net Income
 
$
36,180

 
$
52,553

 
$
109,473

 
$
105,897

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
Net unrealized gain on available-for-sale securities (1)
 
13,158

 
9,038

 
17,899

 
5,195

Reclassification of unrealized gain on available-for-sale securities to net income
 
(853
)
 
(1,319
)
 
(7,103
)
 
(19,983
)
Net unrealized gain (loss) on interest rate agreements
 
321

 
647

 
(375
)
 
(22,545
)
Reclassification of unrealized loss on interest rate agreements to net income
 
14

 
18

 
42

 
55

Total other comprehensive income (loss)
 
12,640

 
8,384

 
10,463

 
(37,278
)
Total Comprehensive Income
 
$
48,820

 
$
60,937

 
$
119,936

 
$
68,619

——————
(1)
Amounts are presented net of tax benefit (provision) of zero and $(0.1) million for the three and nine months ended September 30, 2017, respectively, and $0.2 million and $0.6 million for the three and nine months ended September 30, 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 Nine Months Ended September 30, 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
 
—

 
—

 
—

 
—

 
109,473

 
—

 
109,473

Other comprehensive income
 
—

 
—

 
—

 
10,463

 
—

 
—

 
10,463

Employee stock purchase and incentive plans
 
288,024

 
3

 
(2,315
)
 
—

 
—

 
—

 
(2,312
)
Non-cash equity award compensation
 
—

 
—

 
7,797

 
—

 
—

 
—

 
7,797

Common dividends declared
 
—

 
—

 
—

 
—

 
—

 
(66,209
)
 
(66,209
)
September 30, 2017
 
77,122,687

 
$
771

 
$
1,681,968

 
$
82,316

 
$
1,259,408

 
$
(1,815,823
)
 
$
1,208,640


For the Nine Months Ended September 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
 
—

 
—

 
—

 
—

 
105,897

 
—

 
105,897

Other comprehensive loss
 
—

 
—

 
—

 
(37,278
)
 
—

 
—

 
(37,278
)
Employee stock purchase and incentive plans
 
437,441

 
4

 
(4,183
)
 
—

 
—

 
—

 
(4,179
)
Non-cash equity award compensation
 
—

 
—

 
10,595

 
—

 
—

 
—

 
10,595

Share repurchases
 
(1,917,873
)
 
(19
)
 
(24,745
)
 
—

 
—

 
—

 
(24,764
)
Common dividends declared
 
—

 
—

 
—

 
—

 
—

 
(66,406
)
 
(66,406
)
September 30, 2016
 
76,682,333

 
$
767

 
$
1,677,623

 
$
54,715

 
$
1,124,580

 
$
(1,727,555
)
 
$
1,130,130



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


5

REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
 
Nine Months Ended September 30,
 
2017
 
2016
Cash Flows From Operating Activities:
 
 
 
 
Net income
 
$
109,473

 
$
105,897

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
Amortization of premiums, discounts, and securities issuance costs, net
 
(14,246
)
 
(20,251
)
Depreciation and amortization of non-financial assets
 
909

 
849

Purchases of held-for-sale loans
 
(3,760,110
)
 
(3,817,445
)
Proceeds from sales of held-for-sale loans
 
3,079,877

 
2,930,641

Principal payments on held-for-sale loans
 
38,500

 
55,694

Net settlements of derivatives
 
(10,570
)
 
(13,914
)
Provision for loan losses
 
—

 
(7,102
)
Non-cash equity award compensation expense
 
7,797

 
10,595

Market valuation adjustments
 
(50,352
)
 
9,238

Realized gains, net
 
(8,809
)
 
(26,037
)
Net change in:
 
 
 
 
Accrued interest receivable and other assets
 
(19,868
)
 
7,983

Accrued interest payable and accrued expenses and other liabilities
 
(1,677
)
 
7,728

Net cash used in operating activities
 
(629,076
)
 
(756,124
)
Cash Flows From Investing Activities:
 
 
 
 
Purchases of loans held-for-investment
 
—

 
—

Proceeds from sales of loans held-for-investment
 
—

 
219,639

Principal payments on loans held-for-investment
 
370,595

 
574,037

Purchases of real estate securities
 
(396,721
)
 
(212,364
)
Proceeds from sales of real estate securities
 
142,931

 
482,716

Principal payments on real estate securities
 
55,544

 
60,978

Purchase of mortgage servicing rights
 
(574
)
 
(15,286
)
Proceeds from sales of mortgage servicing rights
 
51,279

 
35,717

Net change in restricted cash
 
(17,635
)
 
3,523

Net cash provided by investing activities
 
205,419

 
1,148,960

Cash Flows From Financing Activities:
 
 
 
 
Proceeds from borrowings on short-term debt
 
3,126,949

 
3,156,642

Repayments on short-term debt
 
(2,968,050
)
 
(3,894,240
)
Proceeds from issuance of asset-backed securities
 
286,898

 
—

Repayments on asset-backed securities issued
 
(146,357
)
 
(208,801
)
Proceeds from issuance of long-term debt
 
245,000

 
771,287

Deferred long-term debt issuance costs
 
(7,380
)
 
—

Repayments on long-term debt
 
—

 
(118,146
)
Net settlements of derivatives
 
(115
)
 
(119
)
Net proceeds from issuance of common stock
 
224

 
220

Net payments on repurchase of common stock
 
—

 
(27,731
)
Taxes paid on equity award distributions
 
(2,536
)
 
(4,399
)
Dividends paid
 
(66,209
)
 
(66,406
)
Net cash provided by (used in) financing activities
 
468,424

 
(391,693
)
Net increase in cash and cash equivalents
 
44,767

 
1,143

Cash and cash equivalents at beginning of period
 
212,844

 
220,229

Cash and cash equivalents at end of period
 
$
257,611

 
$
221,372

Supplemental Cash Flow Information:
 
 
 
 
Cash paid during the period for:
 
 
 
 
 Interest
 
$
67,339

 
$
62,053

 Taxes
 
1,476

 
826

Supplemental Noncash Information:
 
 
 
 
Real estate securities retained from loan securitizations
 
$
67,083

 
$
3,673

Retention of mortgage servicing rights from loan securitizations and sales
 
7,387

 
7,679

Transfers from loans held-for-sale to loans held-for-investment
 
643,876

 
877,744

Transfers from loans held-for-investment to loans held-for-sale
 
98,853

 
359,005

Transfers from residential loans to real estate owned
 
3,177

 
8,479



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

6

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 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 September 30, 2017 and December 31, 2016, and for the three and nine months ended September 30, 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 our annual 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 in these interim financial statements 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 September 30, 2017 and results of operations for all periods presented have been made. The results of operations for the three and nine months ended September 30, 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 issued prior to 2012 where we maintain an ongoing involvement ("Legacy Sequoia"), as well as an entity formed in connection with the securitization of Redwood Choice expanded-prime loans during the third quarter of 2017 ("Sequoia Choice"). 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, servicing administrator, 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
September 30, 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 and nine months ended September 30, 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 was 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 August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." This new guidance amends previous guidance to better align an entity's risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. This new guidance is effective for fiscal years beginning after December 15, 2018. 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 July 2017, the FASB issued ASU 2017-11, "Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception." This new guidance changes the classification analysis of certain equity-linked financial instruments (or embedded conversion options) with down round features. This new guidance is effective for fiscal years beginning after December 15, 2018. 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
September 30, 2017
(Unaudited)

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

In March 2017, the FASB issued ASU 2017-08, "Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20)." This new guidance shortens the amortization period for certain callable debt securities purchased at a premium by requiring the premium to be amortized to the earliest call date. This new guidance is effective for fiscal years beginning after December 15, 2018. Early adoption is permitted. We plan to adopt this new guidance by the required date and do not anticipate that this update will have a material impact on our consolidated financial statements.
In 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 do not anticipate that this update will have a material impact 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.
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. 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 $18 million at September 30, 2017. Upon adoption of this standard in the first quarter of 2019, we will record a right-of-use asset and lease liability equal to the present value of these future lease payments discounted at our incremental borrowing rate. 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. 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.

9

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(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 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. In September 2017, the FASB issued ASU 2017-13, "Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to the Staff Announcement at the July 20, 2017 EITF Meeting and Rescission of Prior SEC Staff Announcements and Observer Comments (SEC Update). This new ASU allows certain public business entities to use the nonpublic business entity effective dates for adoption of the new revenue standard. 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.
Balance Sheet Netting
Certain of our derivatives and short-term debt are subject to master netting arrangements or similar agreements. Under GAAP, in certain circumstances we may elect to present certain financial assets, liabilities and related collateral subject to master netting arrangements in a net position on our consolidated balance sheets. However, we do not report any of these financial assets or liabilities on a net basis, and instead present them on a gross basis on our consolidated balance sheets.
The table below presents financial assets and liabilities that are subject to master netting arrangements or similar agreements categorized by financial instrument, together with corresponding financial instruments and corresponding collateral received or pledged at September 30, 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
September 30, 2017
(In Thousands)
 
 
 
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Assets (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
3,942

 
$
—

 
$
3,942

 
$
(3,644
)
 
$
(298
)
 
$
—

TBAs
 
2,875

 
—

 
2,875

 
(2,806
)
 
—

 
69

Futures
 
135

 
—

 
135

 
—

 
—

 
135

Total Assets
 
$
6,952

 
$
—

 
$
6,952

 
$
(6,450
)
 
$
(298
)
 
$
204

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
(57,994
)
 
$
—

 
$
(57,994
)
 
$
3,644

 
$
54,350

 
$
—

TBAs
 
(3,946
)
 
—

 
(3,946
)
 
2,807

 
976

 
(163
)
Futures
 
(423
)
 
—

 
(423
)
 
—

 
423

 
—

Loan warehouse debt
 
(438,243
)
 
—

 
(438,243
)
 
438,243

 
—

 
—

Security repurchase agreements
 
(549,811
)
 
—

 
(549,811
)
 
549,811

 
—

 
—

Total Liabilities
 
$
(1,050,417
)
 
$
—

 
$
(1,050,417
)
 
$
994,505

 
$
55,749

 
$
(163
)

10

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 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
September 30, 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 September 30, 2017, we consolidated certain Legacy Sequoia securitization entities that we determined were VIEs and for which we determined we were the primary beneficiary. In addition, we consolidated the Sequoia Choice securitization entity beginning in the third quarter of 2017. 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, servicing administrator, or depositor of these entities or as a result of our having sold assets directly or indirectly to these entities. At September 30, 2017, the estimated fair value of our investments in the consolidated Legacy Sequoia entities and the Sequoia Choice entity was $19 million and $31 million, respectively. The following table presents a summary of the assets and liabilities of these VIEs.
Table 4.1 – Assets and Liabilities of Consolidated VIEs
September 30, 2017
 
Legacy
Sequoia
 
Sequoia
Choice
 
Total
Consolidated
VIEs
(Dollars in Thousands)
 
 
 
Residential loans, held-for-investment
 
$
673,134

 
$
317,303

 
$
990,437

Restricted cash
 
147

 
—

 
147

Accrued interest receivable
 
898

 
1,266

 
2,164

REO
 
3,020

 
—

 
3,020

Total Assets
 
$
677,199

 
$
318,569

 
$
995,768

Accrued interest payable
 
$
540

 
$
1,045

 
$
1,585

Asset-backed securities issued
 
657,960

 
286,328

 
944,288

Total Liabilities
 
$
658,500

 
$
287,373

 
$
945,873

 
 
 
 
 
 
 
Number of VIEs
 
20

 
1

 
21

December 31, 2016
 
Legacy
Sequoia
 
Sequoia
Choice
 
Total
Consolidated
VIEs
(Dollars in Thousands)
 
 
 
Residential loans, held-for-investment
 
$
791,636

 
$
—

 
$
791,636

Restricted cash
 
148

 
—

 
148

Accrued interest receivable
 
1,000

 
—

 
1,000

REO
 
5,533

 
—

 
5,533

Total Assets
 
$
798,317

 
$
—

 
$
798,317

Accrued interest payable
 
$
518

 
$
—

 
$
518

Asset-backed securities issued
 
773,462

 
—

 
773,462

Total Liabilities
 
$
773,980

 
$
—

 
$
773,980

 
 
 
 
 
 
 
Number of VIEs
 
20

 
—

 
20


12

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)

Note 4. Principles of Consolidation - (continued)


Analysis of Unconsolidated VIEs with Continuing Involvement
Since 2012, we have transferred residential loans to 35 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 nine months ended September 30, 2017 and 2016.
Table 4.2 – Securitization Activity Related to Unconsolidated VIEs Sponsored by Redwood
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(In Thousands)
 
2017
 
2016
 
2017
 
2016
Principal balance of loans transferred
 
$
839,264

 
$
348,537

 
$
2,223,387

 
$
693,427

Trading securities retained, at fair value
 
24,617

 
—

 
55,607

 
—

AFS securities retained, at fair value
 
4,416

 
1,839

 
11,476

 
3,673

MSRs recognized
 
—

 
1,971

 
7,123

 
4,102

The following table summarizes the cash flows during the three and nine months ended September 30, 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 September 30,
 
Nine Months Ended September 30,
(In Thousands)
 
2017
 
2016
 
2017
 
2016
Proceeds from new transfers
 
$
839,642

 
$
356,497

 
$
2,213,151

 
$
708,539

MSR fees received
 
3,631

 
3,473

 
10,804

 
10,397

Funding of compensating interest, net
 
(35
)
 
(98
)
 
(114
)
 
(254
)
Cash flows received on retained securities
 
6,882

 
6,384

 
19,843

 
24,314

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 and nine months ended September 30, 2017 and 2016.
Table 4.4 – Assumptions Related to Assets Retained from Unconsolidated VIEs Sponsored by Redwood

 
 
Three Months Ended September 30, 2017
 
Three Months Ended September 30, 2016
At Date of Securitization
 
MSRs
 
Senior IO Securities
 
Subordinate Securities
 
MSRs
 
Subordinate Securities
Prepayment rates
 
N/A
 
11
%
 
10
%
 
24
%
 
15
%
Discount rates
 
N/A
 
14
%
 
5
%
 
11
%
 
7
%
Credit loss assumptions
 
N/A
 
0.25
%
 
0.25
%
 
N/A

 
0.25
%

13

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2017
(Unaudited)

Note 4. Principles of Consolidation - (continued)


 
 
Nine Months Ended September 30, 2017
 
Nine Months Ended September 30, 2016
At Date of Securitization
 
MSRs
 
Senior IO Securities
 
Subordinate Securities
 
MSRs
 
Subordinate Securities
Prepayment rates
 
9
%
 
10
%
 
10
%
 
20
%
 
15
%
Discount rates
 
11
%
 
13
%
 
5
%
 
11
%
 
7
%
Credit loss assumptions
 
N/A

 
0.25
%
 
0.25
%
 
N/A

 
0.25
%
The following table presents additional information at September 30, 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)
 
September 30, 2017
 
December 31, 2016
On-balance sheet assets, at fair value:
 
 
 
 
Interest-only, senior and subordinate securities, classified as trading
 
$
94,491

 
$
41,909

Subordinate securities, classified as AFS
 
228,764

 
234,025

Mortgage servicing rights
 
60,377

 
58,800

Maximum loss exposure (1)
 
$
383,632

 
$
334,734

Assets transferred:
 
 
 
 
Principal balance of loans outstanding
 
$
8,329,635

 
$
6,870,398

Principal balance of loans 30+ days delinquent
 
12,651

 
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 September 30, 2017 and December 31, 2016.
Table 4.6 – Key Assumptions and Sensitivity Analysis for Assets Retained from Unconsolidated VIEs Sponsored by Redwood
September 30, 2017
 
MSRs
 
Senior
Securities (1)
 
Subordinate Securities
(Dollars in Thousands)
 
 
 
Fair value at September 30, 2017
 
$
60,377

 
$
34,276

 
$
288,979

Expected life (in years) (2)
 
7

 
5

 
13

Prepayment speed assumption (annual CPR) (2)
 
9
%
 
10
%
 
11
%
Decrease in fair value from:
 
 
 
 
 
 
10% adverse change
 
$
1,694

 
$
1,575

 
$
667

25% adverse change
 
4,278

 
3,734

 
1,683

Discount rate assumption (2)
 
11
%
 
9
%
 
5
%
Decrease in fair value from:
 
 
 
 
 
 
100 basis point increase
 
$
2,311

 
$
1,281

 
$
25,377

200 basis point increase
 
4,453

 
2,472

 
47,107

Credit loss assumption (2)
 
N/A

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

 
$
4

 
$
1,505

25% higher losses
 
N/A

 
9

 
3,764


14

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 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 $34 million and $27 million of interest only securities at September 30, 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 September 30, 2017, grouped by security type.
Table 4.7 – Third-Party Sponsored VIE Summary
(Dollars in Thousands)
 
September 30, 2017
Mortgage-Backed Securities
 
 
Senior
 
$
181,723

Re-REMIC
 
39,033

Subordinate
 
812,260

Total Investments in Third-Party Sponsored VIEs
 
$
1,033,016

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
September 30, 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
September 30, 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 September 30, 2017 and December 31, 2016.

Table 5.1 – Carrying Values and Fair Values of Assets and Liabilities
 
 
September 30, 2017
 
December 31, 2016
 
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
(In Thousands)
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Residential loans, held-for-sale
 
 
 
 
 
 
 
 
At fair value
 
$
924,594

 
$
924,594

 
$
834,193

 
$
834,193

At lower of cost or fair value
 
1,087

 
1,227

 
1,206

 
1,365

Residential loans, held-for-investment
 
 
 
 
 
 
 
 
At fair value
 
3,259,239

 
3,259,239

 
3,052,652

 
3,052,652

Trading securities
 
820,134

 
820,134

 
445,687

 
445,687

Available-for-sale securities
 
536,138

 
536,138

 
572,752

 
572,752

MSRs
 
62,928

 
62,928

 
118,526

 
118,526

Cash and cash equivalents
 
257,611

 
257,611

 
212,844

 
212,844

Restricted cash
 
26,258

 
26,258

 
8,623

 
8,623

Accrued interest receivable
 
21,256

 
21,256

 
18,454

 
18,454

Derivative assets
 
11,948

 
11,948

 
36,595

 
36,595

REO (1)
 
3,020

 
3,441

 
5,533

 
5,560

Margin receivable (1)
 
93,679

 
93,679

 
68,038

 
68,038

FHLBC stock (1)
 
43,393

 
43,393

 
43,393

 
43,393

Guarantee asset (1)
 
3,049

 
3,049

 
4,092

 
4,092

Commercial loans (1)
 
—

 
—

 
2,700

 
2,700

Pledged collateral (1)
 
42,933

 
42,933

 
42,875

 
42,875

Liabilities
 
 
 
 
 
 
 
 
Short-term debt facilities
 
$
988,054

 
$
988,054

 
$
791,539

 
$
791,539

Accrued interest payable
 
18,836

 
18,836

 
9,608

 
9,608

Margin payable
 
841

 
841

 
12,783

 
12,783

Guarantee obligation
 
20,101

 
19,682

 
21,668

 
22,181

Derivative liabilities
 
65,238

 
65,238

 
66,329

 
66,329

ABS issued at fair value, net
 
944,288

 
944,288

 
773,462

 
773,462

FHLBC long-term borrowings
 
1,999,999

 
1,999,999

 
1,999,999

 
1,999,999

Convertible notes, net
 
686,058

 
705,703

 
482,195

 
493,365

Trust preferred securities and subordinated notes, net
 
138,524

 
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
September 30, 2017
(Unaudited)

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


During the three and nine months ended September 30, 2017, we elected the fair value option for $16 million and $32 million of residential senior securities, $167 million and $412 million of subordinate securities, $1.43 billion and $3.72 billion of residential loans (principal balance), and $0.3 million and $8 million of MSRs, respectively. We anticipate electing the fair value option for all future purchases of residential loans that we may 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 September 30, 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
September 30, 2017
 
Carrying
Value
 
Fair Value Measurements Using
(In Thousands)
 
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
 
Residential loans
 
$
4,183,833

 
$
—

 
$
—

 
$
4,183,833

Trading securities
 
820,134

 
—

 
—

 
820,134

Available-for-sale securities
 
536,138

 
—

 
—

 
536,138

Derivative assets
 
11,948

 
3,010

 
3,942

 
4,996

MSRs
 
62,928

 
—

 
—

 
62,928

Pledged collateral
 
42,933

 
42,933

 
—

 
—

FHLBC stock
 
43,393

 
—

 
43,393

 
—

Guarantee asset
 
3,049

 
—

 
—

 
3,049

 
 
 
 
 
 
 
 
 
Liabilities
 


 
 
 
 
 
 
Derivative liabilities
 
$
65,238

 
$
4,369

 
$
57,994

 
$
2,875

ABS issued
 
944,288

 
—

 
—

 
944,288


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
September 30, 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 nine months ended September 30, 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
 
3,791,471

 
444,073

 
31,654

 
7,957

 
—