Document

UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q



☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended: September 30, 2019



☐	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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

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	☒	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
		Emerging growth company	☐

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. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Securities registered pursuant to Section 12(b) of the Act:



Title of each class	Trading symbol(s)	Name of each exchange on which registered
Common stock, par value $0.01 per share	RWT	New York Stock Exchange

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	112,689,511	shares outstanding as of November 5, 2019

REDWOOD TRUST, INC.

2019 FORM 10-Q REPORT

TABLE OF CONTENTS



		Page
PART I —	FINANCIAL INFORMATION
Item 1.	Financial Statements	2
	Consolidated Balance Sheets at September 30, 2019 (Unaudited) and December 31, 2018	2
	Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2019 and 2018 (Unaudited)	3
	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2019 and 2018 (Unaudited)	4
	Consolidated Statements of Changes in Stockholders' Equity for the Three and Nine Months Ended September 30, 2019 and 2018 (Unaudited)	5
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2019 and 2018 (Unaudited)	7
	Notes to Consolidated Financial Statements (Unaudited)	9
	Note 1. Organization	9
	Note 2. Basis of Presentation	9
	Note 3. Summary of Significant Accounting Policies	13
	Note 4. Principles of Consolidation	17
	Note 5. Fair Value of Financial Instruments	23
	Note 6. Residential Loans	36
	Note 7. Business Purpose Residential Loans	39
	Note 8. Multifamily Loans	41
	Note 9. Real Estate Securities	41
	Note 10. Other Investments	46
	Note 11. Derivative Financial Instruments	49
	Note 12. Other Assets and Liabilities	51
	Note 13. Short-Term Debt	53
	Note 14. Asset-Backed Securities Issued	55
	Note 15. Long-Term Debt	57
	Note 16. Commitments and Contingencies	59
	Note 17. Equity	64
	Note 18. Equity Compensation Plans	67
	Note 19. Mortgage Banking Activities	69
	Note 20. Investment Fair Value Changes, Net	70
	Note 21. Other Income, Net	71
	Note 22. Operating Expenses	71
	Note 23. Taxes	72
	Note 24. Segment Information	72
	Note 25. Subsequent Events	76
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	77
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	119
Item 4.	Controls and Procedures	120

PART II —	OTHER INFORMATION
Item 1.	Legal Proceedings	121
Item 1A.	Risk Factors	122
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	123
Item 3.	Defaults Upon Senior Securities	124
Item 4.	Mine Safety Disclosures (Not Applicable)	124
Item 5.	Other Information	124
Item 6.	Exhibits	125
Signatures		127

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS



(In Thousands, except Share Data) (Unaudited)	September 30, 2019			December 31, 2018
ASSETS⁽¹⁾
Residential loans, held-for-sale, at fair value	$	925,887		$	1,048,801
Residential loans, held-for-investment, at fair value	7,755,916			6,205,941
Business purpose residential loans, at fair value	336,035			141,258
Multifamily loans, held-for-investment, at fair value	3,791,622			2,144,598
Real estate securities, at fair value	1,285,426			1,452,494
Other investments	347,707			438,518
Cash and cash equivalents	394,628			175,764
Restricted cash	111,518			29,313
Goodwill and intangible assets	49,121			—
Accrued interest receivable	57,464			47,105
Derivative assets	43,649			35,789
Other assets	377,310			217,825
Total Assets	$	15,476,283		$	11,937,406

LIABILITIES AND EQUITY ⁽¹⁾
Liabilities
Short-term debt, net ⁽²⁾	$	1,980,817		$	2,400,279
Accrued interest payable	46,881			42,528
Derivative liabilities	234,011			84,855
Accrued expenses and other liabilities	129,742			78,719
Asset-backed securities issued, at fair value	8,346,051			5,410,073
Long-term debt, net	2,953,722			2,572,158
Total liabilities	13,691,224			10,588,612
Commitments and Contingencies (see Note 16)
Equity
Common stock, par value $0.01 per share, 270,000,000 and 180,000,000 shares authorized; 112,101,731 and 84,884,344 issued and outstanding	1,121			849
Additional paid-in capital	2,244,834			1,811,422
Accumulated other comprehensive income	38,124			61,297
Cumulative earnings	1,529,981			1,409,941
Cumulative distributions to stockholders	(2,029,001		)	(1,934,715		)
Total equity	1,785,059			1,348,794
Total Liabilities and Equity	$	15,476,283		$	11,937,406

——————

(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, 2019 and December 31, 2018, assets of consolidated VIEs totaled $9,596,537 and $6,331,191, respectively. At September 30, 2019 and December 31, 2018, liabilities of consolidated VIEs totaled $8,582,595 and $5,709,807, respectively. See Note 4 for further discussion.


(2)	Includes $201 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 November 15, 2018. See Note 13 for further discussion.

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

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME



(In Thousands, except Share Data)	Three Months Ended September 30,						Nine Months Ended September 30,
(Unaudited)	2019			2018			2019			2018
Interest Income
Residential loans	$	77,070		$	63,265		$	230,308		$	169,010
Business purpose residential loans	5,446			1,445			12,231			1,445
Multifamily loans	36,829			5,578			94,134			5,578
Real estate securities	23,047			27,063			72,514			79,054
Other interest income	7,725			2,046			20,513			3,905
Total interest income	150,117			99,397			429,700			258,992
Interest Expense
Short-term debt	(24,239		)	(14,146		)	(70,732		)	(40,756		)
Asset-backed securities issued	(71,065		)	(27,421		)	(196,473		)	(55,171		)
Long-term debt	(21,300		)	(22,784		)	(64,895		)	(58,151		)
Total interest expense	(116,604		)	(64,351		)	(332,100		)	(154,078		)
Net Interest Income	33,513			35,046			97,600			104,914
Non-interest Income
Mortgage banking activities, net	9,515			11,224			40,984			48,396
Investment fair value changes, net	11,444			10,332			34,741			12,830
Other income, net	1,825			3,453			7,819			8,893
Realized gains, net	4,714			7,275			18,227			21,352
Total non-interest income, net	27,498			32,284			101,771			91,471
Operating expenses	(26,815		)	(21,490		)	(76,229		)	(63,529		)
Net Income before Provision for Income Taxes	34,196			45,840			123,142			132,856
Benefit from (provision for) income taxes	114			(4,919		)	(3,102		)	(12,343		)
Net Income	$	34,310		$	40,921		$	120,040		$	120,513

Basic earnings per common share	$	0.33		$	0.49		$	1.20		$	1.51
Diluted earnings per common share	$	0.31		$	0.42		$	1.09		$	1.30
Basic weighted average shares outstanding	101,872,126			80,796,856			97,214,064			77,211,188
Diluted weighted average shares outstanding	136,522,709			114,682,688			131,202,689			107,792,029

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

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



(In Thousands)	Three Months Ended September 30,						Nine Months Ended September 30,
(Unaudited)	2019			2018			2019			2018
Net Income	$	34,310		$	40,921		$	120,040		$	120,513
Other comprehensive loss:
Net unrealized gain (loss) on available-for-sale securities	4,484			(2,408		)	19,764			(9,749		)
Reclassification of unrealized gain on available-for-sale securities to net income	(3,492		)	(5,686		)	(15,807		)	(19,821		)
Net unrealized (loss) gain on interest rate agreements	(11,791		)	4,801			(27,130		)	16,649
Total other comprehensive loss	(10,799		)	(3,293		)	(23,173		)	(12,921		)
Total Comprehensive Income	$	23,511		$	37,628		$	96,867		$	107,592

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

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

For the Three Months Ended September 30, 2019



(In Thousands, except Share Data)	Common Stock			Additional Paid-In Capital		Accumulated Other Comprehensive Income			Cumulative Earnings		Cumulative Distributions to Stockholders			Total
(Unaudited)	Shares	Amount		Additional Paid-In Capital		Accumulated Other Comprehensive Income			Cumulative Earnings		Cumulative Distributions to Stockholders			Total
June 30, 2019	97,715,021	$	977	$	2,013,044	$	48,923		$	1,495,671	$	(1,994,583	)	$	1,564,032
Net income	—	—		—		—			34,310		—			34,310
Other comprehensive loss	—	—		—		(10,799		)	—		—			(10,799		)
Issuance of common stock	14,375,000	144		228,339		—			—		—			228,483
Employee stock purchase and incentive plans	11,710	—		154		—			—		—			154
Non-cash equity award compensation	—	—		3,297		—			—		—			3,297
Common dividends declared ($0.30 per share)	—	—		—		—			—		(34,418		)	(34,418		)
September 30, 2019	112,101,731	$	1,121	$	2,244,834	$	38,124		$	1,529,981	$	(2,029,001	)	$	1,785,059

For the Nine Months Ended September 30, 2019



(In Thousands, except Share Data)	Common Stock			Additional Paid-In Capital			Accumulated Other Comprehensive Income			Cumulative Earnings		Cumulative Distributions to Stockholders			Total
(Unaudited)	Shares	Amount		Additional Paid-In Capital			Accumulated Other Comprehensive Income			Cumulative Earnings		Cumulative Distributions to Stockholders			Total
December 31, 2018	84,884,344	$	849	$	1,811,422		$	61,297		$	1,409,941	$	(1,934,715	)	$	1,348,794
Net income	—	—		—			—			120,040		—			120,040
Other comprehensive loss	—	—		—			(23,173		)	—		—			(23,173		)
Issuance of common stock	26,666,191	267		418,324			—			—		—			418,591
Direct stock purchase and dividend reinvestment plan	399,838	4		6,303			—			—		—			6,307
Employee stock purchase and incentive plans	151,358	1		(1,767		)	—			—		—			(1,766		)
Non-cash equity award compensation	—	—		10,552			—			—		—			10,552
Common dividends declared ($0.90 per share)	—	—		—			—			—		(94,286		)	(94,286		)
September 30, 2019	112,101,731	$	1,121	$	2,244,834		$	38,124		$	1,529,981	$	(2,029,001	)	$	1,785,059

For the Three Months Ended September 30, 2018



(In Thousands, except Share Data)	Common Stock			Additional Paid-In Capital		Accumulated Other Comprehensive Income			Cumulative Earnings		Cumulative Distributions to Stockholders			Total
(Unaudited)	Shares	Amount		Additional Paid-In Capital		Accumulated Other Comprehensive Income			Cumulative Earnings		Cumulative Distributions to Stockholders			Total
June 30, 2018	75,742,719	$	757	$	1,665,749	$	75,620		$	1,369,933	$	(1,883,104	)	$	1,228,955
Net income	—	—		—		—			40,921		—			40,921
Other comprehensive loss	—	—		—		(3,293		)	—		—			(3,293		)
Issuance of common stock	7,187,500	72		116,964		—			—		—			117,036
Employee stock purchase and incentive plans	62	—		94		—			—		—			94
Non-cash equity award compensation	—	—		3,150		—			—		—			3,150
Common dividends declared ($0.30 per share)	—	—		—		—			—		(25,536		)	(25,536		)
September 30, 2018	82,930,281	$	829	$	1,785,957	$	72,327		$	1,410,854	$	(1,908,640	)	$	1,361,327

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

For the Nine Months Ended September 30, 2018



(In Thousands, except Share Data)	Common Stock					Additional Paid-In Capital			Accumulated Other Comprehensive Income			Cumulative Earnings		Cumulative Distributions to Stockholders			Total
(Unaudited)	Shares		Amount			Additional Paid-In Capital			Accumulated Other Comprehensive Income			Cumulative Earnings		Cumulative Distributions to Stockholders			Total
December 31, 2017	76,599,972		$	766		$	1,673,845		$	85,248		$	1,290,341	$	(1,837,913	)	$	1,212,287
Net income	—		—			—			—			120,513		—			120,513
Other comprehensive loss	—		—			—			(12,921		)	—		—			(12,921		)
Issuance of common stock	7,187,500		72			116,964			—			—		—			117,036
Employee stock purchase and incentive plans	183,638		1			(101		)	—			—		—			(100		)
Non-cash equity award compensation	—		—			10,783			—			—		—			10,783
Share repurchases	(1,040,829	)	(10		)	(15,534		)	—			—		—			(15,544		)
Common dividends declared ($0.88 per share)	—		—			—			—			—		(70,727		)	(70,727		)
September 30, 2018	82,930,281		$	829		$	1,785,957		$	72,327		$	1,410,854	$	(1,908,640	)	$	1,361,327

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

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



(In Thousands) (Unaudited)	Nine Months Ended September 30,
(In Thousands) (Unaudited)	2019			2018
Cash Flows From Operating Activities:
Net income	$	120,040		$	120,513
Adjustments to reconcile net income to net cash used in operating activities:
Amortization of premiums, discounts, and securities issuance costs, net	(3,486		)	(11,091		)
Depreciation and amortization of non-financial assets	5,673			922
Originations of held-for-sale loans	(124,392		)	—
Purchases of held-for-sale loans	(4,002,509		)	(5,596,326		)
Proceeds from sales of held-for-sale loans	2,971,811			4,097,211
Principal payments on held-for-sale loans	77,100			51,853
Net settlements of derivatives	(32,902		)	36,721
Non-cash equity award compensation expense	10,552			10,783
Market valuation adjustments	(62,720		)	(53,666		)
Realized gains, net	(18,227		)	(21,352		)
Net change in:
Accrued interest receivable and other assets	(141,197		)	(32,722		)
Accrued interest payable and accrued expenses and other liabilities	(1,049		)	34,137
Net cash used in operating activities	(1,201,306		)	(1,363,017		)
Cash Flows From Investing Activities:
Originations of loans held-for-investment	(171,915		)	—
Purchases of loans held-for-investment	(49,489		)	(111,231		)
Proceeds from sales of loans held-for-investment	9,422			—
Principal payments on loans held-for-investment	1,091,652			550,973
Purchases of real estate securities	(309,839		)	(482,150		)
Purchases of residential securities held in consolidated securitization trust	(193,212		)	—
Purchases of multifamily securities held in consolidated securitization trusts	(68,601		)	(54,957		)
Proceeds from sales of real estate securities	487,469			432,199
Principal payments on real estate securities	62,711			61,278
Purchases of servicer advance investments	(69,610		)	—
Principal repayments from servicer advance investments	150,512			—
Acquisition of 5 Arches, net of cash acquired	(3,714		)	—
Net investment in participation in loan warehouse facility	38,209			(37,814		)
Net investment in multifamily loan fund	(33,090		)	—
Other investing activities, net	(24,989		)	(3,731		)
Net cash provided by investing activities	915,516			354,567
Cash Flows From Financing Activities:
Proceeds from borrowings on short-term debt	4,009,083			4,760,083
Repayments on short-term debt	(4,435,823		)	(5,274,664		)
Proceeds from issuance of asset-backed securities	1,020,136			1,658,848
Repayments on asset-backed securities issued	(720,651		)	(305,528		)
Proceeds from issuance of long-term debt	387,053			199,000
Deferred long-term debt issuance costs paid	(7,023		)	(4,977		)
Net proceeds from issuance of common stock	426,970			117,311
Net payments on repurchase of common stock	—			(16,315		)
Dividends paid	(94,286		)	(70,727		)
Other financing activities, net	1,400			(619		)
Net cash provided by financing activities	586,859			1,062,412
Net increase in cash, cash equivalents and restricted cash	301,069			53,962
Cash, cash equivalents and restricted cash at beginning of period ⁽¹⁾	205,077			146,807
Cash, cash equivalents and restricted cash at end of period ⁽¹⁾	$	506,146		$	200,769

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



(In Thousands) (Unaudited)	Nine Months Ended September 30,
(In Thousands) (Unaudited)	2019		2018
Supplemental Cash Flow Information:
Cash paid during the period for:
Interest	$	319,036	$	139,003
Taxes	6,977		6,372
Supplemental Noncash Information:
Real estate securities retained from loan securitizations	$	7,759	$	46,872
Retention of mortgage servicing rights from loan securitizations and sales	868		—
Consolidation of residential loans held in securitization trusts	1,190,995		—
Consolidation of residential ABS	997,783		—
Consolidation of multifamily loans held in securitization trusts	1,481,554		946,650
Consolidation of multifamily ABS	1,408,002		880,602
Transfers from loans held-for-sale to loans held-for-investment	1,361,015		1,981,170
Transfers from loans held-for-investment to loans held-for-sale	22,808		15,717
Transfers from residential loans to real estate owned	5,280		2,139
Right-of-use asset obtained in exchange for operating lease liability	13,016		—


(1)	Cash, cash equivalents, and restricted cash at September 30, 2019 includes cash and cash equivalents of $395 million and restricted cash of $112 million, and at December 31, 2018 includes cash and cash equivalents of $176 million and restricted cash of $29 million.

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

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 1. Organization

Redwood Trust, Inc., together with its subsidiaries, is a specialty finance company focused on making credit-sensitive investments in single-family residential and multifamily mortgages and related assets and engaging in mortgage banking activities. Our goal is to provide attractive returns to shareholders through a stable and growing stream of earnings and dividends, as well as through capital appreciation. We operate our business in two segments: Investment Portfolio and Mortgage Banking.

Our primary sources of income are net interest income from our investment portfolio and non-interest income from our mortgage banking activities. Net interest income consists of the interest income we earn on investments less the interest expense we incur on borrowed funds and other liabilities. Income from mortgage banking activities is generated through the acquisition of residential loans and their subsequent sale or securitization, as well as through the origination of business purpose residential loans.

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.”

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.

Note 2. Basis of Presentation

The consolidated financial statements presented herein are at September 30, 2019 and December 31, 2018, and for the three and nine months ended September 30, 2019 and 2018. 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, 2018. In the opinion of management, all normal and recurring adjustments to present fairly the financial condition of the company at September 30, 2019 and results of operations for all periods presented have been made. The results of operations for the three and nine months ended September 30, 2019 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 entities formed in connection with the securitization of Redwood Choice expanded-prime loans beginning in the third quarter of 2017 ("Sequoia Choice"). In addition, we consolidated the assets and liabilities of certain Freddie Mac K-Series securitizations we invested in beginning in the third quarter of 2018, and the assets and liabilities of certain Freddie Mac SLST securitizations we invested in beginning in the fourth quarter of 2018. 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 purchased or retained, although for the consolidated Sequoia entities 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.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 2. Basis of Presentation - (continued)

For financial reporting purposes, the underlying loans owned at the consolidated Sequoia and Freddie Mac SLST entities are shown under Residential loans, held-for-investment, at fair value, and the underlying loans at the consolidated Freddie Mac K-Series are shown under Multifamily 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 14 for further discussion on ABS issued.

Beginning in the fourth quarter of 2018, we consolidated two partnerships ("Servicing Investment" entities) through which we have invested in servicing-related assets. We maintain an 80% ownership interest in each entity and have determined that we are the primary beneficiary of these partnerships.

Beginning in the first quarter of 2019, we consolidated 5 Arches, LLC ("5 Arches"), an originator of business purpose residential loans, pursuant to the exercise of our purchase option and the acquisition of the remaining equity in the company.

See Note 4 for further discussion on principles of consolidation.

Use of Estimates

The preparation of financial statements requires us to make a number of significant estimates. These include estimates of fair value of certain assets and liabilities, amounts and timing of credit losses, prepayment rates, and other estimates that affect the reported amounts of certain assets and liabilities as of the date of the consolidated financial statements and the reported amounts of certain revenues and expenses during the reported periods. It is likely that changes in these estimates (e.g., valuation changes due to supply and demand, credit performance, prepayments, interest rates, or other reasons) will occur in the near term. Our estimates are inherently subjective in nature and actual results could differ from our estimates and the differences could be material.

Acquisition of 5 Arches, LLC

On March 1, 2019, we completed the acquisition of the remaining 80% interest in 5 Arches, an originator of business purpose residential loans. In May 2018, Redwood acquired a 20% minority interest in 5 Arches for $10 million in cash, with a one-year option to purchase all remaining equity in the company. At closing, we paid approximately $13 million of cash, and the remainder of the consideration, which could total up to an additional $27 million, will be paid in a mix of cash and Redwood common stock and is contingent on the achievement of certain specified loan origination thresholds over the next two years.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 2. Basis of Presentation - (continued)

We accounted for the acquisition of 5 Arches under the acquisition method of accounting pursuant to ASC 805. We performed the preliminary purchase price allocation and recorded underlying assets acquired and liabilities assumed based on their estimated fair values using the information available as of the acquisition date, with the excess of the purchase price allocated to goodwill. Through September 30, 2019, there have been no significant changes to our preliminary purchase price allocation, which is summarized in the following table.

Table 2.1 – 5 Arches Purchase Price Allocation



(In Thousands)	March 1, 2019
Purchase price:
Cash	$	12,575
Contingent consideration, at fair value	24,621
Purchase option, at fair value	5,082
Equity method investment, at fair value	8,052
Total consideration	$	50,330

Allocated to:
Tangible net assets acquired ⁽¹⁾	$	985
Goodwill	28,747
Intangible assets	24,800
Deferred tax liability	(4,202		)
Total net assets acquired	$	50,330


(1)	5 Arches net assets acquired consisted of assets of $19 million and liabilities of $18 million as of March 1, 2019.

Because we owned a 20% noncontrolling interest in 5 Arches immediately before obtaining full control, we remeasured our initial minority investment and purchase option at their acquisition-date fair values using the income approach, which resulted in a gain of $2 million that was recorded in Other income, net on our consolidated statements of income during the three months ended March 31, 2019.

As part of this acquisition, we identified and recorded finite-lived intangible assets totaling $25 million. The amortization period for each of these assets and the activity for the period from March 1, 2019 to September 30, 2019 is summarized in the table below.

Table 2.2 – Intangible Assets – Activity



(Dollars in Thousands)	Carrying Value at December 31, 2018		Additions		Amortization Expense			Carrying Value at September 30, 2019		Weighted Average Amortization Period (in years)
Finite-lived intangible assets:
Broker network	$	—	$	18,100	$	(2,112	)	$	15,988	5
Non-compete agreements	—		2,900		(564		)	2,336		3
Loan administration fees on existing loan assets	—		2,600		(1,517		)	1,083		1
Tradename	—		1,200		(233		)	967		3
Total	$	—	$	24,800	$	(4,426	)	$	20,374	4

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 2. Basis of Presentation - (continued)

All of our intangible assets are amortized on a straight-line basis. Estimated amortization expense for the remainder of 2019 and the following years is summarized in the table below.

Table 2.3 – Intangible Asset Amortization Expense by Year



(In Thousands)	September 30, 2019
2019 (3 months)	$	1,897
2020	5,420
2021	4,987
2022	3,848
2023 and thereafter	4,222
Total Future Intangible Asset Amortization	$	20,374

We recorded goodwill of $29 million as a result of the total consideration exceeding the fair value of the net assets acquired. The goodwill was attributed to the expected business synergies and expansion into business purpose loan markets, as well as access to the knowledgeable and experienced workforce continuing to provide services to the business. We expect $3 million of our goodwill balance to be deductible for tax purposes. The following table presents the goodwill activity for the nine months ended September 30, 2019.

Table 2.4 – Goodwill – Activity



(In Thousands)	Nine Months Ended September 30, 2019
Beginning balance	$	—
Goodwill recognized from 5 Arches acquisition	28,728
Measurement period adjustment	19
Impairment	—
Ending Balance	$	28,747

The liability resulting from the contingent consideration arrangement was recorded at its acquisition-date fair value of $25 million as part of total consideration for the acquisition of 5 Arches. At September 30, 2019, our estimated fair value of this contingent liability was $25 million and was recorded as a component of Accrued expenses and other liabilities on our consolidated balance sheets. See Note 16 for additional information on our contingent consideration liability.

The following unaudited pro forma financial information presents Net interest income, Non-interest income, and Net income of Redwood and 5 Arches combined, as if the acquisition occurred as of January 1, 2018. These pro forma amounts have been adjusted to include the amortization of intangible assets for both periods, and to exclude the income statement impacts related to our equity method investment in 5 Arches. The unaudited pro forma financial information is not intended to represent or be indicative of the consolidated financial results of operations that would have been reported if the acquisition had been completed as of January 1, 2018 and should not be taken as indicative of our future consolidated results of operations. During the period from March 1, 2019 to September 30, 2019, 5 Arches had mortgage banking income of $12 million and a net loss of $3 million. Included in the net loss for this period was intangible asset amortization expense of $4 million.

Table 2.5 – Unaudited Pro Forma Financial Information



	Three Months Ended September 30,				Nine Months Ended September 30,
(In Thousands)	2019		2018		2019		2018
Supplementary pro forma information:
Net interest income	$	33,513	$	35,231	$	98,101	$	105,660
Non-interest income	27,498		22,280		98,780		84,684
Net income	34,310		32,636		115,809		111,072

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 3. Summary of Significant Accounting Policies

Significant Accounting Policies

Included in Note 3 to the Consolidated Financial Statements of our Annual Report on Form 10-K for the year ended December 31, 2018 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 position and results of operations for the three and nine months ended September 30, 2019.

Business Combinations

We use the acquisition method of accounting for business combinations, under which the purchase price is allocated to the fair values of the assets acquired and liabilities assumed at the acquisition date. The excess of the purchase price over the amount allocated to the assets acquired and liabilities assumed is recorded as goodwill. Adjustments to the values of the assets acquired and liabilities assumed that could be made during the measurement period, which could be up to one year after the acquisition date, are recorded in the period in which the adjustment is identified, with a corresponding offset to goodwill. Any adjustments made after the measurement period are recorded in the consolidated statements of income. Acquisition-related costs are expensed as incurred.

Goodwill and Intangible Assets

Significant judgment is required to estimate the fair value of intangible assets and in assigning their estimated useful lives. Accordingly, we typically seek the assistance of independent third-party valuation specialists for significant intangible assets. The fair value estimates are based on available historical information and on future expectations and assumptions we deem reasonable. We generally use an income-based valuation method to estimate the fair value of intangible assets, which discounts expected future cash flows to present value using estimates and assumptions we deem reasonable.

Determining the estimated useful lives of intangible assets also requires judgment. Our assessment as to which intangible assets are deemed to have finite or indefinite lives is based on several factors including economic barriers of entry for the acquired business, retention trends, and our operating plans, among other factors.

Finite-lived intangible assets are amortized over their estimated useful lives on a straight-line basis and reviewed for impairment if indicators are present. Additionally, useful lives are evaluated each reporting period to determine if revisions to the remaining periods of amortization are warranted. Goodwill is tested for impairment annually or more frequently if indicators of impairment exist. We have elected to make the first day of our fiscal fourth quarter the annual impairment assessment date for goodwill. We first assess qualitative factors to determine whether it is more likely than not that the fair value is less than the carrying value. If, based on that assessment, we believe it is more likely than not that the fair value is less than the carrying value, then a two-step quantitative goodwill impairment test is performed.

Loan Originations

Our wholly-owned subsidiary, 5 Arches, originates business purpose residential loans, including single-family rental and residential bridge loans. Single-family rental loans are mortgage loans secured by 1-4 unit residential real estate with a mortgage loan borrower that owns the real estate as an investment property and rents the property to residential tenants. Residential bridge loans are mortgage loans generally secured by unoccupied residential real estate that the borrower owns as an investment and that is being renovated, rehabilitated or constructed. Generally, single-family rental loans are classified as held-for-sale at fair value, as we have originated these loans with the intent to sell to third parties or transfer to securitization entities. Certain single-family rental loans may be subsequently reclassified to held-for-investment when the loans are transferred to our Federal Home Loan Bank of Chicago ("FHLBC") member subsidiary and pledged as collateral for borrowings made from the FHLBC. Residential bridge loans are classified as held-for-investment at fair value, if we intend to hold these loans to maturity, or held-for-sale at fair value, if we intend to sell the loans to a third party.

Contingent Consideration

In relation to our acquisition of 5 Arches, we recorded contingent consideration liabilities that represent the estimated fair value (at the date of acquisition) of our obligation to make certain earn-out payments that are contingent on 5 Arches loan origination volumes exceeding certain specified thresholds. These liabilities are carried at fair value and periodic changes in their estimated fair value are recorded through Other income, net on our consolidated statements of income. The estimate of the fair value of contingent consideration requires significant judgment regarding assumptions about future operating results, discount rates, and probabilities of projected operating result scenarios.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

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

Leases

Upon adoption of ASU 2016-02, "Leases," in the first quarter of 2019, we recorded a lease liability and right-of-use asset on our consolidated balance sheets. The lease liability is equal to the present value of our remaining lease payments discounted at our incremental borrowing rate and the right-of-use asset is equal to the lease liability adjusted for our deferred rent liability at the adoption of this accounting standard. As lease payments are made, the lease liability is reduced to the present value of the remaining lease payments and the right-of-use asset is reduced by the difference between the lease expense (straight-lined over the lease term) and the theoretical interest expense amount (calculated using the incremental borrowing rate). See Note 16 for further discussion on leases.

Recent Accounting Pronouncements

Newly Adopted Accounting Standards Updates ("ASUs")

In July 2019, the FASB issued ASU 2019-07, "Codification Updates to SEC Sections - Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification, and Nos. 33-10231 and 33-10442, Investment Company Reporting Modernization, and Miscellaneous Updates (SEC Update)." This new guidance amends certain SEC paragraphs in the FASB Accounting Standards Codification pursuant to the issuance of various SEC Final Rule Releases, and is effective immediately. We adopted this guidance, as required, in the third quarter of 2019, which did not have a material impact on our consolidated financial statements.

In February 2018, the FASB issued ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." This new guidance allows a reclassification from accumulated other comprehensive income ("AOCI") to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 (the "Tax Act"). This new guidance is effective for fiscal years beginning after December 15, 2018. However, we did not elect to reclassify any income tax effects of the Tax Act from AOCI to retained earnings as we did not have any tax effects related to the Tax Act remaining in AOCI at December 31, 2018. Our policy is to release any stranded income tax effects from AOCI to income tax expense on an investment-by-investment basis.

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. Additionally, in October 2018, the FASB issued ASU 2018-16, "Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes," which permits the use of the OIS rate based on SOFR as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815. The amendments in this update are required to be adopted concurrently with the amendments in ASU 2017-12. We adopted this guidance, as required, in the first quarter of 2019, which did not have a material impact 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. We adopted this guidance, as required, in the first quarter of 2019, which did not have a material impact on our consolidated financial statements.

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. We adopted this guidance, as required, in the first quarter of 2019, which did not have a material impact on our consolidated financial statements.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

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

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. In July 2018, the FASB issued ASU 2018-10, "Codification Improvements to Topic 842, Leases," which provides more specific guidance on certain aspects of Topic 842. Additionally, in July 2018, the FASB issued ASU 2018-11, "Leases (Topic 842): Targeted Improvements." This new ASU introduces an additional transition method which allows entities to apply the new standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. In March 2019, the FASB issued ASU 2019-01, "Leases (Topic 842): Codification Improvements," which is intended to clarify Codification guidance. We adopted this guidance, as required, in the first quarter of 2019, which did not have a material impact on our consolidated financial statements. We elected the package of practical expedients under the transition guidance within this standard, which allowed us to carry forward the classifications of each of our existing leases as operating leases. In connection with the adoption of this guidance, at September 30, 2019, our lease liability was $13 million, which represented the present value of our remaining lease payments discounted at our incremental borrowing rate and was recorded in Accrued expenses and other liabilities on our consolidated balance sheets. At September 30, 2019, our right-of-use asset was $11 million, which was equal to the lease liability adjusted for our deferred rent liability at adoption and was recorded in Other assets on our consolidated balance sheets. We will continue to record lease expense on a straight-line basis and have included required lease disclosures within Note 16.

Other Recent Accounting Pronouncements

In August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement." This new guidance amends previous guidance by removing and modifying certain existing fair value disclosure requirements, while adding other new disclosure requirements. This new guidance is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted and entities may elect to early adopt the removal or modification of disclosures immediately and delay adoption of the new disclosure requirements until their effective date. 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 July 2018, the FASB issued ASU 2018-09, "Codification Improvements." This new guidance is intended to clarify, correct, and make minor improvements to the FASB Accounting Standards Codification. The transition and effective dates are based on the facts and circumstances of each amendment, with some amendments becoming effective upon issuance of this ASU and others becoming effective for annual periods beginning after December 15, 2018. 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 January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment." This new guidance simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. This new guidance is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for interim and annual goodwill impairment tests performed on testing dates after January 1, 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.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(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 after December 15, 2018. In November 2018, the FASB issued ASU 2018-19, "Codification Improvements to Topic 326, Financial Instruments - Credit Losses," which clarifies the scope of the amendments in ASU 2016-13. In April 2019, the FASB issued ASU 2019-04, "Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments," which is intended to clarify this guidance. Additionally, in May 2019, the FASB issued ASU 2019-05, "Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief," which provides an option to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost. We currently have only a small balance of loans receivable that are not carried at fair value and would be subject to this new guidance for allowance for credit losses. Separately, we account for our available-for-sale securities under the other-than-temporary impairment ("OTTI") model for debt securities. This new guidance requires that credit impairments on our available-for-sale securities be recorded in earnings using an allowance for credit losses, with the allowance limited to the amount by which the security's fair value is less than its amortized cost basis. Subsequent reversals in credit loss estimates are recognized in income. We plan to adopt this new guidance by the required date and do not anticipate that these updates will have a material impact on our consolidated financial statements as nearly all of our financial instruments are carried at fair value and changes in fair values of these instruments are recorded on our consolidated statements of income in the period in which the valuation change occurs. 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, 2019 and December 31, 2018.

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, 2019 (In Thousands)	Gross Amounts of Recognized Assets (Liabilities)			Gross Amounts Offset in Consolidated Balance Sheet					Financial Instruments			Cash Collateral (Received) Pledged			Net Amount
Assets ⁽²⁾
Interest rate agreements	$	33,642		$	—	$	33,642		$	(25,802	)	$	(4,379	)	$	3,461
TBAs	5,250			—		5,250			(3,448		)	(1,040		)	762
Total Assets	$	38,892		$	—	$	38,892		$	(29,250	)	$	(5,419	)	$	4,223

Liabilities⁽²⁾
Interest rate agreements	$	(228,150	)	$	—	$	(228,150	)	$	25,802		$	202,348		$	—
TBAs	(4,192		)	—		(4,192		)	3,448			483			(261		)
Loan warehouse debt	(233,224		)	—		(233,224		)	233,224			—			—
Security repurchase agreements	(1,157,646		)	—		(1,157,646		)	1,157,646			—			—
Total Liabilities	$	(1,623,212	)	$	—	$	(1,623,212	)	$	1,420,120		$	202,831		$	(261	)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(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, 2018 (In Thousands)	Gross Amounts of Recognized Assets (Liabilities)			Gross Amounts Offset in Consolidated Balance Sheet					Financial Instruments			Cash Collateral (Received) Pledged			Net Amount
Assets ⁽²⁾
Interest rate agreements	$	28,211		$	—	$	28,211		$	(28,211	)	$	—		$	—
TBAs	4,665			—		4,665			(3,391		)	(835		)	439
Total Assets	$	32,876		$	—	$	32,876		$	(31,602	)	$	(835	)	$	439

Liabilities⁽²⁾
Interest rate agreements	$	(70,908	)	$	—	$	(70,908	)	$	28,211		$	42,697		$	—
TBAs	(13,215		)	—		(13,215		)	3,391			5,620			(4,204		)
Loan warehouse debt	(860,650		)	—		(860,650		)	860,650			—			—
Security repurchase agreements	(988,890		)	—		(988,890		)	988,890			—			—
Total Liabilities	$	(1,933,663	)	$	—	$	(1,933,663	)	$	1,881,142		$	48,317		$	(4,204	)

(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 and TBAs 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.

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.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 4. Principles of Consolidation - (continued)

Analysis of Consolidated VIEs

At September 30, 2019, we consolidated our Legacy Sequoia and Sequoia Choice securitization entities that we determined were VIEs and for which we determined we were the primary beneficiary. Additionally, beginning in the second half of 2018, we consolidated certain Freddie Mac K-Series and SLST securitization entities 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 for the consolidated Sequoia entities 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, 2019, the estimated fair value of our investments in the consolidated Legacy Sequoia, Sequoia Choice, Freddie Mac SLST and Freddie Mac K-Series entities was $10 million, $259 million, $456 million, and $215 million, respectively.

Beginning in the fourth quarter of 2018, we consolidated two Servicing Investment entities formed to invest in servicing-related assets that we determined were VIEs and for which we determined we were the primary beneficiary. At September 30, 2019, we held an 80% ownership interest in, and were responsible for the management of, each entity. See Note 10 for a further description of these entities and the investments they hold and Note 12 for additional information on the minority partner’s interest. Additionally, beginning in the fourth quarter of 2018, we consolidated an entity that was formed to finance servicer advances that we determined was a VIE and for which we, through our control of one of the aforementioned partnerships, were the primary beneficiary. The servicer advance financing consists of non-recourse short-term securitization debt, secured by servicer advances. We consolidate the securitization entity, but the securitization entity is independent of Redwood and the assets and liabilities are not owned by and are not legal obligations of Redwood. See Note 13 for additional information on the servicer advance financing. At September 30, 2019, the estimated fair value of our investment in the Servicing Investment entities was $75 million.

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, 2019	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		Servicing Investment		Total Consolidated VIEs
(Dollars in Thousands)	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		Servicing Investment		Total Consolidated VIEs
Residential loans, held-for-investment	$	429,159	$	2,618,316	$	2,441,223	$	—	$	—	$	5,488,698
Multifamily loans, held-for-investment	—		—		—		3,791,622		—		3,791,622
Other investments	—		—		—		—		238,316		238,316
Cash and cash equivalents	—		—		—		—		21,240		21,240
Restricted cash	143		15		—		—		21,450		21,608
Accrued interest receivable	716		10,806		7,215		11,300		4,472		34,509
REO	460		—		84		—		—		544
Total Assets	$	430,478	$	2,629,137	$	2,448,522	$	3,802,922	$	285,478	$	9,596,537
Short-term debt	$	—	$	—	$	—	$	—	$	191,203	$	191,203
Accrued interest payable	456		8,949		5,498		10,805		247		25,955
Accrued expenses and other liabilities	—		15		—		—		19,371		19,386
Asset-backed securities issued	419,890		2,361,111		1,987,473		3,577,577		—		8,346,051
Total Liabilities	$	420,346	$	2,370,075	$	1,992,971	$	3,588,382	$	210,821	$	8,582,595

Number of VIEs	20		9		2		4		3		38

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 4. Principles of Consolidation - (continued)



December 31, 2018	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		Servicing Investment		Total Consolidated VIEs
(Dollars in Thousands)	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		Servicing Investment		Total Consolidated VIEs
Residential loans, held-for-investment	$	519,958	$	2,079,382	$	1,222,669	$	—	$	—	$	3,822,009
Multifamily loans, held-for-investment	—		—		—		2,144,598		—		2,144,598
Other investments	—		—		—		—		312,688		312,688
Restricted cash	146		1,022		—		—		25,363		26,531
Accrued interest receivable	822		8,988		3,926		6,595		1,091		21,422
REO	3,943		—		—		—		—		3,943
Total Assets	$	524,869	$	2,089,392	$	1,226,595	$	2,151,193	$	339,142	$	6,331,191
Short-term debt	$	—	$	—	$	—	$	—	$	262,740	$	262,740
Accrued interest payable	571		7,180		2,907		6,239		483		17,380
Accrued expenses and other liabilities	—		1,022		—		—		18,592		19,614
Asset-backed securities issued	512,240		1,885,010		993,748		2,019,075		—		5,410,073
Total Liabilities	$	512,811	$	1,893,212	$	996,655	$	2,025,314	$	281,815	$	5,709,807

Number of VIEs	20		6		1		3		3		33

We consolidate the assets and liabilities of certain Sequoia securitization entities, as we did not meet the GAAP sale criteria at the time we transferred financial assets to these entities. Our involvement in consolidated Sequoia entities continues in the following ways: (i) we continue to hold subordinate investments in each entity, and for certain entities, more senior investments; (ii) we maintain certain discretionary rights associated with our sponsorship of, or our subordinate investments in, each entity; and (iii) we continue to hold a right to call the assets of certain entities (once they have been paid down below a specified threshold) at a price equal to, or in excess of, the current outstanding principal amount of the entity’s asset-backed securities issued. These factors have resulted in our continuing to consolidate the assets and liabilities of these Sequoia entities in accordance with GAAP.

We consolidate the assets and liabilities of certain Freddie Mac K-Series and SLST securitization trusts resulting from our investment in subordinate securities issued by these trusts. Additionally, we consolidate the assets and liabilities of Servicing Investment entities from our investment in servicer advance investments and excess MSRs. In each case, we maintain certain discretionary rights associated with the ownership of these investments that we determined reflected a controlling financial interest, as we have both the power to direct the activities that most significantly impact the economic performance of the VIEs and the right to receive benefits of and the obligation to absorb losses from the VIEs that could potentially be significant to the VIEs.

Analysis of Unconsolidated VIEs with Continuing Involvement

Since 2012, we have transferred residential loans to 46 Sequoia securitization entities sponsored by us that are still outstanding as of September 30, 2019, 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 certain of these transfers to securitization entities, for the transferred loans where we held the servicing rights prior to the transfer and continued to hold the servicing rights following the transfer, we recorded mortgage servicing rights ("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 servicing rights (which we retain a third-party sub-servicer to perform) and the receipt of interest income associated with the securities we retained.

During the first quarter of 2019, the master servicer for one of our unconsolidated Sequoia entities exercised their right to call the securitization and paid off the underlying securities. We realized a $4 million gain related to the called securities, which was recognized through Realized gains, net on our consolidated statements of income. In connection with this called securitization, Redwood acquired $39 million of residential real estate loans that were subsequently sold or were held in our held-for-investment portfolio at Redwood at September 30, 2019.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 4. Principles of Consolidation - (continued)

The following table presents information related to securitization transactions that occurred during the three and nine months ended September 30, 2019 and 2018.

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



	Three Months Ended September 30,				Nine Months Ended September 30,
(In Thousands)	2019		2018		2019		2018
Principal balance of loans transferred	$	366,999	$	327,511	$	1,116,092	$	2,735,644
Trading securities retained, at fair value	1,228		2,583		4,736		48,831
AFS securities retained, at fair value	1,069		776		3,023		6,728

The following table summarizes the cash flows during the three and nine months ended September 30, 2019 and 2018 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)	2019			2018			2019			2018
Proceeds from new transfers	$	376,126		$	329,231		$	1,138,778		$	2,723,012
MSR fees received	2,919			3,405			9,084			10,216
Funding of compensating interest, net	(76		)	(46		)	(213		)	(102		)
Cash flows received on retained securities	6,603			7,267			20,892			21,720

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 4. Principles of Consolidation - (continued)

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, 2019 and 2018.

Table 4.4 – Assumptions Related to Assets Retained from Unconsolidated VIEs Sponsored by Redwood



	Three Months Ended September 30, 2019				Three Months Ended September 30, 2018
At Date of Securitization	Senior IO Securities		Subordinate Securities		Senior IO Securities		Subordinate Securities
Prepayment rates	37	%	15	%	9	%	9	%
Discount rates	14	%	7	%	14	%	7	%
Credit loss assumptions	0.20	%	0.20	%	0.20	%	0.20	%



	Nine Months Ended September 30, 2019				Nine Months Ended September 30, 2018
At Date of Securitization	Senior IO Securities		Subordinate Securities		Senior IO Securities		Subordinate Securities
Prepayment rates	25	%	15	%	9	%	10	%
Discount rates	14	%	7	%	14	%	5	%
Credit loss assumptions	0.20	%	0.20	%	0.20	%	0.20	%

The following table presents additional information at September 30, 2019 and December 31, 2018, 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, 2019		December 31, 2018
On-balance sheet assets, at fair value:
Interest-only, senior and subordinate securities, classified as trading	$	106,691	$	129,111
Subordinate securities, classified as AFS	141,568		162,314
Mortgage servicing rights	37,904		58,572
Maximum loss exposure ⁽¹⁾	$	286,163	$	349,997
Assets transferred:
Principal balance of loans outstanding	$	10,360,700	$	10,580,216
Principal balance of loans 30+ days delinquent	28,782		21,805

(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.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 4. Principles of Consolidation - (continued)

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, 2019 and December 31, 2018.

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



September 30, 2019	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
(Dollars in Thousands)	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
Fair value at September 30, 2019	$	37,904		$	41,827		$	206,433
Expected life (in years)⁽²⁾	6			5			13
Prepayment speed assumption (annual CPR)⁽²⁾	14		%	16		%	16		%
Decrease in fair value from:
10% adverse change	$	1,893		$	1,977		$	454
25% adverse change	4,486			5,189			1,802
Discount rate assumption⁽²⁾	11		%	13		%	5		%
Decrease in fair value from:
100 basis point increase	$	1,259		$	848		$	19,313
200 basis point increase	2,436			1,977			35,950
Credit loss assumption ⁽²⁾	N/A			0.21		%	0.21		%
Decrease in fair value from:
10% higher losses	N/A			$	—		$	1,666
25% higher losses	N/A			—			4,153



December 31, 2018	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
(Dollars in Thousands)	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
Fair value at December 31, 2018	$	58,572		$	61,178		$	230,247
Expected life (in years)⁽²⁾	8			7			15
Prepayment speed assumption (annual CPR)⁽²⁾	7		%	10		%	9		%
Decrease in fair value from:
10% adverse change	$	1,668		$	2,151		$	201
25% adverse change	4,027			5,127			1,372
Discount rate assumption⁽²⁾	11		%	12		%	6		%
Decrease in fair value from:
100 basis point increase	$	2,323		$	2,190		$	21,982
200 basis point increase	4,493			4,226			40,641
Credit loss assumption ⁽²⁾	N/A			0.20		%	0.20		%
Decrease in fair value from:
10% higher losses	N/A			$	—		$	1,387
25% higher losses	N/A			—			3,471


(1)	Senior securities included $42 million and $61 million of interest-only securities at September 30, 2019 and December 31, 2018, respectively.


(2)	Expected life, prepayment speed assumption, discount rate assumption, and credit loss assumption presented in the tables above represent weighted averages.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 4. Principles of Consolidation - (continued)

Analysis of Unconsolidated 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 and other investments 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, 2019 and December 31, 2018, grouped by asset type.

Table 4.7 – Third-Party Sponsored VIE Summary



(In Thousands)	September 30, 2019		December 31, 2018
Mortgage-Backed Securities
Senior	$	141,264	$	185,107
Mezzanine	589,189		547,249
Subordinate	306,713		428,713
Total Mortgage-Backed Securities	1,037,166		1,161,069
Excess MSR	17,212		15,092
Total Investments in Third-Party Sponsored VIEs	$	1,054,378	$	1,176,161

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

Note 5. Fair Value of Financial Instruments

For financial reporting purposes, we follow a fair value hierarchy established under GAAP that is used to determine the fair value of financial instruments. This hierarchy prioritizes relevant market inputs in order to determine an “exit price” at the measurement date, or the price at which an asset could be sold or a liability could be transferred in an orderly process that is not a forced liquidation or distressed sale. Level 1 inputs are observable inputs that reflect quoted prices for identical assets or liabilities in active markets. Level 2 inputs are observable inputs other than quoted prices for an asset or liability that are obtained through corroboration with observable market data. Level 3 inputs are unobservable inputs (e.g., our own data or assumptions) that are used when there is little, if any, relevant market activity for the asset or liability required to be measured at fair value.

In certain cases, inputs used to measure fair value fall into different levels of the fair value hierarchy. In such cases, the level at which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. Our assessment of the significance of a particular input requires judgment and considers factors specific to the asset or liability being measured.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(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, 2019 and December 31, 2018.

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



	September 30, 2019				December 31, 2018
	Carrying Value		Fair Value		Carrying Value		Fair Value
(In Thousands)	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets
Residential loans, held-for-sale
At fair value	$	925,780	$	925,780	$	1,048,690	$	1,048,690
At lower of cost or fair value	107		126		111		131
Residential loans, held-for-investment	7,755,916		7,755,916		6,205,941		6,205,941
Business purpose residential loans	336,035		336,035		141,258		141,258
Multifamily loans	3,791,622		3,791,622		2,144,598		2,144,598
Trading securities	1,013,785		1,013,785		1,118,612		1,118,612
Available-for-sale securities	271,641		271,641		333,882		333,882
Servicer advance investments ⁽¹⁾	222,591		222,591		300,468		300,468
MSRs ⁽¹⁾	39,837		39,837		60,281		60,281
Participation in loan warehouse facility ⁽¹⁾	—		—		39,703		39,703
Excess MSRs ⁽¹⁾	32,937		32,937		27,312		27,312
Shared home appreciation options⁽¹⁾	11,372		11,372		—		—
Cash and cash equivalents	394,628		394,628		175,764		175,764
Restricted cash	111,518		111,518		29,313		29,313
Accrued interest receivable	57,464		57,464		47,105		47,105
Derivative assets	43,649		43,649		35,789		35,789
REO ⁽²⁾	5,069		5,124		3,943		4,396
Margin receivable⁽²⁾	226,727		226,727		100,773		100,773
FHLBC stock ⁽²⁾	43,393		43,393		43,393		43,393
Guarantee asset⁽²⁾	1,784		1,784		2,618		2,618
Pledged collateral⁽²⁾	57,832		57,832		42,433		42,433
Liabilities
Short-term debt facilities	$	1,589,062	$	1,589,062	$	1,937,920	$	1,937,920
Short-term debt - servicer advance financing	191,203		191,203		262,740		262,740
Accrued interest payable	46,881		46,881		42,528		42,528
Margin payable ⁽³⁾	6,658		6,658		835		835
Guarantee obligation ⁽³⁾	15,016		14,661		16,711		16,774
Contingent consideration ⁽³⁾	25,167		25,167		—		—
Derivative liabilities	234,011		234,011		84,855		84,855
ABS issued at fair value	8,346,051		8,346,051		5,410,073		5,410,073
FHLBC long-term borrowings	1,999,999		1,999,999		1,999,999		1,999,999
Subordinate securities financing facility	184,664		185,803		—		—
Convertible notes, net	830,995		853,471		633,196		618,271
Trust preferred securities and subordinated notes, net	138,616		92,070		138,582		102,533


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


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


(3)	These liabilities are included in Accrued expenses and other liabilities on our consolidated balance sheets.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

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

During the three and nine months ended September 30, 2019, we elected the fair value option for $16 million and $50 million of residential senior securities, respectively, $40 million and $247 million of subordinate securities, respectively, $2.67 billion and $5.20 billion of residential loans (principal balance), respectively, $124 million and $301 million of business purpose residential loans (principal balance), respectively, zero and $1.43 billion of multifamily loans (principal balance), respectively, $1 million and $70 million of servicer advance investments, respectively, and $1 million and $8 million of excess MSRs, respectively. Additionally, during the three months ended September 30, 2019, we elected the fair value option for $11 million of shared home appreciation options. We anticipate electing the fair value option for all future purchases of residential and business purpose residential loans that we intend to sell to third parties or transfer to securitizations, as well as 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, 2019 and December 31, 2018, 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, 2019	Carrying Value		Fair Value Measurements Using
(In Thousands)	Carrying Value		Level 1		Level 2		Level 3
Assets
Residential loans	$	8,681,696	$	—	$	—	$	8,681,696
Business purpose residential loans	336,035		—		—		336,035
Multifamily loans	3,791,622		—		—		3,791,622
Trading securities	1,013,785		—		—		1,013,785
Available-for-sale securities	271,641		—		—		271,641
Servicer advance investments	222,591		—		—		222,591
MSRs	39,837		—		—		39,837
Excess MSRs	32,937		—		—		32,937
Shared home appreciation options	11,372		—		—		11,372
Derivative assets	43,649		5,250		33,642		4,757
Pledged collateral	57,832		57,832		—		—
FHLBC stock	43,393		—		43,393		—
Guarantee asset	1,784		—		—		1,784

Liabilities
Contingent consideration	$	25,167	$	—	$	—	$	25,167
Derivative liabilities	234,011		4,192		228,150		1,669
ABS issued	8,346,051		—		—		8,346,051

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

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



December 31, 2018	Carrying Value		Fair Value Measurements Using
(In Thousands)	Carrying Value		Level 1		Level 2		Level 3
Assets
Residential loans	$	7,254,631	$	—	$	—	$	7,254,631
Business purpose residential loans	141,258		—		—		141,258
Multifamily loans	2,144,598		—		—		2,144,598
Trading securities	1,118,612		—		—		1,118,612
Available-for-sale securities	333,882		—		—		333,882
Servicer advance investments	300,468		—		—		300,468
MSRs	60,281		—		—		60,281
Excess MSRs	27,312		—		—		27,312
Derivative assets	35,789		4,665		28,211		2,913
Pledged collateral	42,433		42,433		—		—
FHLBC stock	43,393		—		43,393		—
Guarantee asset	2,618		—		—		2,618

Liabilities
Derivative liabilities	$	84,855	$	13,215	$	70,908	$	732
ABS issued	5,410,073		—		—		5,410,073

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, 2019.

Table 5.3 – Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis



	Assets
	Residential Loans			Business Purpose Residential Loans			Multifamily Loans			Trading Securities			AFS Securities			Servicer Advance Investments			MSRs			Excess MSRs			Shared Home Appreciation Options
(In Thousands)	Residential Loans			Business Purpose Residential Loans			Multifamily Loans			Trading Securities			AFS Securities			Servicer Advance Investments			MSRs			Excess MSRs			Shared Home Appreciation Options
Beginning balance - December 31, 2018	$	7,254,631		$	141,258		$	2,144,598		$	1,118,612		$	333,882		$	300,468		$	60,281		$	27,312		$	—
Acquisitions	5,257,800			29,093			1,481,554			296,484			21,115			69,610			868			7,762			11,343
Originations	—			296,955			—			—			—			—			—			—			—
Sales	(2,941,592		)	(46,855		)	—			(418,168		)	(82,384		)	—			—			—			—
Principal paydowns	(1,068,878		)	(84,410		)	(12,904		)	(33,730		)	(28,981		)	(150,512		)	—			—			—
Gains (losses) in net income, net	179,964			4,990			178,374			55,538			24,052			3,025			(21,312		)	(2,137		)	29
Unrealized losses in OCI, net	—			—			—			—			3,957			—			—			—			—
Other settlements, net ⁽¹⁾	(229		)	(4,996		)	—			(4,951		)	—			—			—			—			—
Ending Balance - September 30, 2019	$	8,681,696		$	336,035		$	3,791,622		$	1,013,785		$	271,641		$	222,591		$	39,837		$	32,937		$	11,372

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

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

Table 5.3 – Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis (continued)



	Assets						Liabilities
	Guarantee Asset			Derivatives ⁽²⁾			Contingent Consideration		ABS Issued
(In Thousands)	Guarantee Asset			Derivatives ⁽²⁾			Contingent Consideration		ABS Issued
Beginning balance - December 31, 2018	$	2,618		$	2,181		$	—	$	5,410,073
Acquisitions	—			—			24,621		3,423,561
Principal paydowns	—			—			—		(718,293		)
Gains (losses) in net income, net	(834		)	42,415			546		230,710
Other settlements, net ⁽¹⁾	—			(41,508		)	—		—
Ending Balance - September 30, 2019	$	1,784		$	3,088		$	25,167	$	8,346,051

(1)

Other settlements, net for residential and business purpose residential loans represents the transfer of loans to REO, and for derivatives, the settlement of forward sale commitments and the transfer of the fair value of loan purchase commitments at the time loans are acquired to the basis of residential loans. Other settlements, net for trading securities relates to the consolidation of a Freddie Mac K-Series entity during the second quarter of 2019.


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

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(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 September 30, 2019 and 2018. Gains or losses incurred on assets or liabilities sold, matured, called, or fully written down during the three and nine months ended September 30, 2019 and 2018 are not included in this presentation.

Table 5.4 – Portion of Net Gains (Losses) Attributable to Level 3 Assets and Liabilities Still Held at September 30, 2019 and 2018 Included in Net Income



	Included in Net Income
	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	2019			2018			2019			2018
Assets
Residential loans at Redwood	$	17,771		$	(18,100	)	$	82,408		$	(70,316	)
Residential loans at consolidated Sequoia entities	(11,132		)	(8,978		)	10,111			11,936
Residential loans at consolidated Freddie Mac SLST entities	39,783			—			94,788			—
Business purpose residential loans	584			(20		)	4,069			(20		)
Multifamily loans at consolidated Freddie Mac K-Series entities	47,353			(4,199		)	178,374			(4,199		)
Trading securities	11,206			3,821			33,196			(1,956		)
Available-for-sale securities	—			(33		)	—			(90		)
Servicer advance investments	1,585			—			3,025			—
MSRs	(5,892		)	337			(16,971		)	4,861
Excess MSRs	(1,634		)	—			(2,137		)	—
Shared home appreciation options	29			—			29			—
Loan purchase commitments	4,678			2,168			4,757			2,157
Other assets - Guarantee asset	(216		)	(51		)	(834		)	15

Liabilities
Loan purchase commitments	$	(1,668	)	$	(2,314	)	$	(1,669	)	$	(2,388	)
Contingent consideration	(235		)	—			(546		)	—
ABS issued	(49,399		)	12,536			(230,709		)	(8,478		)

The following table presents information on assets recorded at fair value on a non-recurring basis at September 30, 2019. 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 sheets at September 30, 2019.

Table 5.5 – Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis at September 30, 2019



									Gain (Loss) for
September 30, 2019	Carrying Value		Fair Value Measurements Using						Three Months Ended			Nine Months Ended
(In Thousands)	Carrying Value		Level 1		Level 2		Level 3		September 30, 2019			September 30, 2019
Assets
REO	$	4,525	$	—	$	—	$	4,525	$	(332	)	$	(470	)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(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 and nine months ended September 30, 2019 and 2018.

Table 5.6 – Market Valuation Gains and Losses, Net



	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	2019			2018			2019			2018
Mortgage Banking Activities, Net
Residential loans held-for-sale, at fair value	$	(6,623	)	$	5,626		$	289		$	16,522
Residential loan purchase and forward sale commitments	12,943			1,610			41,142			(8,116		)
Single-family rental loans held-for-sale, at fair value	1,283			(99		)	4,200			(99		)
Single-family rental loan purchase commitments	564			(22		)	1,273			(22		)
Residential bridge loans	1,010			—			2,108			—
Risk management derivatives, net	(2,972		)	3,796			(15,387		)	38,378
Total mortgage banking activities, net ⁽¹⁾	$	6,205		$	10,911		$	33,625		$	46,663
Investment Fair Value Changes, Net
Residential loans held-for-investment, at Redwood	$	7,667		$	(17,063	)	$	71,323		$	(71,058	)
Single-family rental loans held-for-investment	22			—			22			—
Residential bridge loans held-for-investment	(742		)	53			(1,363		)	53
Trading securities	15,275			6,314			55,577			2,429
Servicer advance investments	1,585			—			3,025			—
Excess MSRs	(1,635		)	—			(2,137		)	—
Shared home appreciation options	29			—			29			—
REO	(331		)	—			(470		)	—
Net investments in Legacy Sequoia entities ⁽²⁾	(407		)	(248		)	(904		)	(976		)
Net investments in Sequoia Choice entities ⁽²⁾	2,722			(943		)	8,866			43
Net investments in Freddie Mac SLST entities ⁽²⁾	17,300			—			31,702			—
Net investments in Freddie Mac K-Series entities ⁽²⁾	7,445			511			13,810			511
Risk-sharing investments	(53		)	(126		)	(191		)	(474		)
Risk management derivatives, net	(37,433		)	21,867			(144,548		)	82,391
Impairments on AFS securities	—			(33		)	—			(89		)
Total investment fair value changes, net	$	11,444		$	10,332		$	34,741		$	12,830
Other Income (Expense), Net
MSRs	$	(7,489	)	$	(823	)	$	(21,243	)	$	1,324
Risk management derivatives, net	4,389			(890		)	13,157			(7,151		)
Gain on re-measurement of 5 Arches investment	—			—			2,440			—
Total other expense, net ⁽³⁾	$	(3,100	)	$	(1,713	)	$	(5,646	)	$	(5,827	)
Total Market Valuation Gains, Net	$	14,549		$	19,530		$	62,720		$	53,666


(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)	Includes changes in fair value of the residential loans held-for-investment, REO and the ABS issued at the entities, which netted together represent the change in value of our investments at the consolidated VIEs.


(3)	Other income (expense), net presented above does not include net MSR fee income or provisions for repurchases for MSRs, as these amounts do not represent market valuation adjustments.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

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

At September 30, 2019, 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, 2018. 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



September 30, 2019	Fair Value			Input Values
(Dollars in Thousands, except Input Values)	Fair Value		Unobservable Input	Range						Weighted Average
Assets
Residential loans, at fair value:
Jumbo fixed-rate loans	$	2,452,300	Prepayment rate (annual CPR)	20		-	20		%	20		%
			Whole loan spread to TBA price	$	0.56	-	$	1.56		$	1.55
			Whole loan spread to swap rate	94		-	375		bps	184		bps

Jumbo hybrid loans	321,793		Prepayment rate (annual CPR)	15		-	15		%	15		%
			Whole loan spread to swap rate	90		-	345		bps	146		bps

Jumbo loans committed to sell	418,905		Whole loan committed sales price	$	101.88	-	$	102.91		$	102.27

Loans held by Legacy Sequoia ⁽¹⁾	429,159		Liability price				N/A			N/A

Loans held by Sequoia Choice ⁽¹⁾	2,618,316		Liability price				N/A			N/A

Loans held by Freddie Mac SLST ⁽¹⁾	2,441,223		Liability price				N/A			N/A

Business purpose residential loans:
Single-family rental loans	129,145		Senior credit spread	110		-	110		bps	110		bps
			Subordinate credit spread	143		-	1,250		bps	308		bps
			Senior credit support	35		-	36		%	36		%
			IO discount rate	5		-	8		%	8		%
			Prepayment rate (annual CPR)	1		-	10		%	5		%

Residential bridge loans	206,890		Discount rate	6		-	10		%	7		%

Multifamily loans held by Freddie Mac K-Series ⁽¹⁾	3,791,622		Liability price				N/A			N/A

Trading and AFS securities	1,285,426		Discount rate	2		-	15		%	5		%
			Prepayment rate (annual CPR)	—		-	60		%	13		%
			Default rate	—		-	20		%	1		%
			Loss severity	—		-	40		%	21		%

Servicer advance investments	222,591		Discount rate	5		-	5		%	5		%
			Prepayment rate (annual CPR)	8		-	15		%	14		%
			Expected remaining life ⁽²⁾	2		-	2		years	2		years
			Mortgage servicing income	8		-	14		bps	10		bps

MSRs	39,837		Discount rate	11		-	13		%	11		%
			Prepayment rate (annual CPR)	6		-	53		%	14		%
			Per loan annual cost to service	$	82	-	$	82		$	82

Excess MSRs	32,937		Discount rate	11		-	16		%	14		%
			Prepayment rate (annual CPR)	9		-	14		%	11		%
			Excess mortgage servicing income	8		-	17		bps	13		bps

Shared home appreciation options	11,372		Discount rate	11		-	11		%	11		%
			Prepayment rate (annual CPR)	10		-	30		%	23		%
			Home price appreciation	3		-	3		%	3		%

Guarantee asset	1,784		Discount rate	11		-	11		%	11		%
			Prepayment rate (annual CPR)	16		-	16		%	16		%

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

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

Table 5.7 – Fair Value Methodology for Level 3 Financial Instruments (continued)



September 30, 2019	Fair Value			Input Values
(Dollars in Thousands, except Input Values)	Fair Value		Unobservable Input	Range						Weighted Average
Assets (continued)
REO	$	4,525	Loss severity	16		-	16		%	16		%

Residential loan purchase commitments, net	3,042		MSR multiple	0.6		-	4.6		x	2.5		x
			Pull-through rate	9		-	100		%	71		%
			Whole loan spread to TBA price	$	0.56	-	$	1.56		$	1.55
			Whole loan spread to swap rate - fixed rate	115		-	375		bps	257		bps
			Prepayment rate (annual CPR)	15		-	20		%	20		%
			Whole loan spread to swap rate - hybrid	90		-	330		bps	128		bps

Liabilities
ABS issued ⁽¹⁾:
At consolidated Sequoia entities	2,781,001		Discount rate	3		-	15		%	4		%
			Prepayment rate (annual CPR)	8		-	40		%	20		%
			Default rate	—		-	7		%	2		%
			Loss severity	20		-	29		%	21		%

At consolidated Freddie Mac SLST entities	1,987,473		Discount rate	2		-	13		%	3		%
			Prepayment rate (annual CPR)	6		-	6		%	6		%
			Default rate	22		-	22		%	22		%
			Loss severity	30		-	30		%	30		%

At consolidated Freddie Mac K-Series entities	3,577,577		Discount rate	2		-	9		%	2		%
			Prepayment rate (annual CPR)	—		-	—		%	—		%
			Default rate	1		-	1		%	1		%
			Loss severity	20		-	20		%	20		%

Contingent consideration	25,167		Discount rate	23		-	23		%	23		%
			Probability of outcomes ⁽³⁾	—		-	100		%	90		%

(1)

The fair value of the loans held by consolidated entities was based on the fair value of the ABS issued by these entities, including securities we own, which we determined were more readily observable, in accordance with accounting guidance for collateralized financing entities. At September 30, 2019, the fair value of securities we owned at the consolidated Sequoia, Freddie Mac SLST and Freddie Mac K-Series entities was $266 million, $454 million, and $214 million, respectively.


(2)	Represents the estimated average duration of outstanding servicer advances at a given point in time (not taking into account new advances made with respect to the pool).


(3)	Represents the probability of a full payout of contingent purchase consideration.

Determination of Fair Value

A description of the instruments measured at fair value as well as the general classification of such instruments pursuant to the Level 1, Level 2, and Level 3 valuation hierarchy is listed herein. We generally use both market comparable information and discounted cash flow modeling techniques to determine the fair value of our Level 3 assets and liabilities. Use of these techniques requires determination of relevant inputs and assumptions, some of which represent significant unobservable inputs as indicated in the preceding table. Accordingly, a significant increase or decrease in any of these inputs – such as anticipated credit losses, prepayment rates, interest rates, or other valuation assumptions – in isolation would likely result in a significantly lower or higher fair value measurement.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

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

Residential loans at Redwood

Estimated fair values for residential loans are determined using models that incorporate various observable inputs, including pricing information from whole loan sales and securitizations. Certain significant inputs in these models are considered unobservable and are therefore Level 3 in nature. Pricing inputs obtained from market whole loan transaction activity include indicative spreads to indexed to be announced ("TBA") prices and indexed swap rates for fixed-rate loans and indexed swap rates for hybrid loans (Level 3). Pricing inputs obtained from market securitization activity include indicative spreads to indexed TBA prices for senior residential mortgage-backed securities ("RMBS") and indexed swap rates for subordinate RMBS, and credit support levels (Level 3). Other unobservable inputs also include assumed future prepayment rates. Observable inputs include benchmark interest rates, swap rates, and TBA prices. These assets would generally decrease in value based upon an increase in the credit spread, prepayment speed, or credit support assumptions.

Residential and multifamily loans at consolidated entities

We have elected to account for our consolidated securitization entities as CFEs in accordance with GAAP. A CFE is a variable interest entity that holds financial assets and issues beneficial interests in those assets, and these beneficial interests have contractual recourse only to the related assets of the CFE. Accounting guidance for CFEs allow companies to elect to measure both the financial assets and financial liabilities of a CFE using the more observable of the fair value of the financial assets or fair value of the financial liabilities. Pursuant to this guidance, we use the fair value of the ABS issued by the CFEs (which we determined to be more observable) to determine the fair value of the loans held at these entities, whereby the net assets we consolidate in our financial statements related to these entities represent the estimated fair value of our retained interests in the CFEs.

Business purpose residential loans

Business purpose residential loans include single-family rental loans and residential bridge loans that are generally illiquid in nature and trade infrequently. Significant inputs in the valuation analysis are predominantly Level 3 in nature, due to the lack of readily available market quotes and related inputs.

Prices for our single-family rental loans are determined using market comparable information. Significant inputs obtained from market activity include indicative spreads to indexed swap rates for senior and subordinate mortgage-backed securities ("MBS"), IO MBS discount rates, senior credit support levels, and assumed future prepayment rates (Level 3). These assets would generally decrease in value based upon an increase in the credit spread or prepayment speed assumptions.

Prices for our residential bridge loans are determined using discounted cash flow modeling, which incorporates a primary significant unobservable input of discount rate. These assets would generally decrease in value based upon an increase in the discount rate.

Real estate securities

Real estate securities include residential, multifamily, and other mortgage-backed securities that are generally illiquid in nature and trade infrequently. Significant inputs in the valuation analysis are predominantly Level 3 in nature, due to the lack of readily available market quotes and related inputs. For real estate securities, we utilize both market comparable pricing and discounted cash flow analysis valuation techniques. Relevant market indicators that are factored into the analysis include bid/ask spreads, the amount and timing of credit losses, interest rates, and collateral prepayment rates. Estimated fair values are based on applying the market indicators to generate discounted cash flows (Level 3). These cash flow models use significant unobservable inputs such as a discount rate, prepayment rate, default rate and loss severity. The estimated fair value of our securities would generally decrease based upon an increase in discount rate, default rates, loss severities, or a decrease in prepayment rates.

As part of our securities valuation process, we request and consider indications of value from third-party securities dealers. For purposes of pricing our securities at September 30, 2019, we received dealer price indications on 83% of our securities, representing 95% of our carrying value. In the aggregate, our internal valuations of the securities for which we received dealer price indications were within 1% of the aggregate average dealer valuations. Once we receive the price indications from dealers, they are compared to other relevant market inputs, such as actual or comparable trades, and the results of our discounted cash flow analysis. In circumstances where relevant market inputs cannot be obtained, increased reliance on discounted cash flow analysis and management judgment are required to estimate fair value.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

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

Derivative assets and liabilities

Our derivative instruments include swaps, swaptions, TBAs, loan purchase commitments ("LPCs"), and forward sale commitments ("FSCs"). Fair values of derivative instruments are determined using quoted prices from active markets, when available, or from valuation models and are supported by valuations provided by dealers active in derivative markets. Fair values of TBAs and financial futures are generally obtained using quoted prices from active markets (Level 1). Our derivative valuation models for swaps and swaptions require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates, and correlations of certain inputs. Model inputs can generally be verified and model selection does not involve significant management judgment (Level 2).

LPC and FSC fair values for residential jumbo and single-family rental loans are estimated based on the estimated fair values of the underlying loans (as described in "Residential loans at Redwood" and "Business purpose residential loans" above). In addition, fair values for LPCs are estimated based on the probability that the mortgage loan will be purchased (the "Pull-through rate") (Level 3).

For other derivatives, valuations are based on various factors such as liquidity, bid/ask spreads, and credit considerations for which we rely on available market inputs. In the absence of such inputs, management’s best estimate is used (Level 3).

Servicer advance investments

Estimated fair values for servicer advance investments are determined through internal pricing models that estimate future cash flows and utilize certain significant inputs that are considered unobservable and are therefore Level 3 in nature. Our estimations of cash flows include the combined cash flows of all of the components that comprise the servicer advance investments: existing advances, the requirement to purchase future advances, the recovery of advances, and the right to a portion of the associated mortgage servicing fee ("mortgage servicing income"). The valuation technique is based on discounted cash flows. Significant inputs used in the valuations included prepayment rate (of the loans underlying the investments), mortgage servicing income, servicer advance WAL (the weighted-average expected remaining life of servicer advances), and discount rate. These assets would generally decrease in value based upon an increase in prepayment rates, an increase in servicer advance WAL, or an increase in discount rate, or a decrease in mortgage servicing income.

MSRs

MSRs include the rights to service jumbo residential mortgage loans. Significant inputs in the valuation analysis are predominantly Level 3, due to the nature of these instruments and the lack of readily available market quotes. Changes in the fair value of MSRs occur primarily due to the collection/realization of expected cash flows, as well as changes in valuation inputs and assumptions. Estimated fair values are based on applying the inputs to generate the net present value of estimated future MSR income (Level 3). These discounted cash flow models utilize certain significant unobservable inputs including market discount rates, assumed future prepayment rates of serviced loans, and the market cost of servicing. An increase in these unobservable inputs would generally reduce the estimated fair value of the MSRs.

As part of our MSR valuation process, we received a valuation estimate from a third-party valuations firm. In the aggregate, our internal valuation of the MSRs were within 5% of the third-party valuation.

Excess MSRs

Estimated fair values for excess MSRs are determined through internal pricing models that estimate future cash flows and utilize certain significant inputs that are considered unobservable and are therefore Level 3 in nature. The valuation technique is based on discounted cash flows. Significant inputs used in the valuations included prepayment rate (of the loans underlying the investments), the amount of excess servicing income expected to be received ("excess mortgage servicing income"), and discount rate. These assets would generally decrease in value based upon an increase in prepayment rates or discount rate, or a decrease in excess mortgage servicing income.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

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

Shared Home Appreciation Options

Estimated fair values for shared home appreciation options are determined through internal pricing models that estimate future cash flows and utilize certain significant inputs such as forecasted home price appreciation, prepayment rates, and discount rate. The valuation technique is based on discounted cash flows. An increase in discount rate, or a decrease in expected future home values combined with a decrease in prepayment rates, would generally reduce the estimated fair value of the shared home appreciation options (Level 3).

FHLBC stock

Our Federal Home Loan Bank ("FHLB") member subsidiary is required to purchase FHLBC stock under a borrowing agreement between our FHLB-member subsidiary and the FHLBC. Under this agreement, the stock is redeemable at face value, which represents the carrying value and fair value of the stock (Level 2).

Guarantee asset

The guarantee asset represents the estimated fair value of cash flows we are contractually entitled to receive related to a risk-sharing arrangement with Fannie Mae. Significant inputs in the valuation analysis are Level 3, due to the nature of this asset and the lack of market quotes. The fair value of the guarantee asset is determined using a discounted cash flow model, for which significant unobservable inputs include assumed future prepayment rates and market discount rate (Level 3). An increase in prepayment rates or discount rate would generally reduce the estimated fair value of the guarantee asset.

Pledged collateral

Pledged collateral consists of cash and U.S. Treasury securities held by a custodian in association with certain agreements we have entered into. Treasury securities are carried at their fair value, which is determined using quoted prices in active markets (Level 1).

Cash and cash equivalents

Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less. Fair values equal carrying values (Level 1).

Restricted cash

Restricted cash primarily includes interest-earning cash balances related to risk-sharing transactions with the Agencies, cash held in association with borrowings from the FHLBC, cash held at Servicing Investment entities, and cash held at consolidated Sequoia entities for the purpose of distribution to investors and reinvestment. Due to the short-term nature of the restrictions, fair values approximate carrying values (Level 1).

Accrued interest receivable and payable

Accrued interest receivable and payable includes interest due on our assets and payable on our liabilities. Due to the short-term nature of when these interest payments will be received or paid, fair values approximate carrying values (Level 1).

Real estate owned

Real estate owned ("REO") includes properties owned in satisfaction of foreclosed loans. Fair values are determined using available market quotes, appraisals, broker price opinions, comparable properties, or other indications of value (Level 3).

Margin receivable

Margin receivable reflects cash collateral we have posted with our various derivative and debt counterparties as required to satisfy margin requirements. Fair values approximate carrying values (Level 2).

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

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

Contingent consideration

Contingent consideration is related to our acquisition of 5 Arches and is estimated and recorded at fair value as part of purchase consideration. Each reporting period we estimate the change in fair value of the contingent consideration, and such change is recognized in our consolidated statements of income, unless it is determined to be a measurement period adjustment. The estimate of the fair value of contingent consideration requires significant judgment and assumptions to be made about future operating results, discount rates, and probabilities of projected operating result scenarios (Level 3).

Short-term debt

Short-term debt includes our credit facilities for residential and business purpose residential loans and real estate securities as well as non-recourse short-term borrowings used to finance servicer advance investments. As these borrowings are secured and subject to margin calls and as the rates on these borrowings reset frequently to market rates, we believe that carrying values approximate fair values (Level 2).

ABS issued

ABS issued includes asset-backed securities issued through the Legacy Sequoia and Sequoia Choice securitization entities, as well as securities issued by certain third-party Freddie Mac SLST and K-series securitization entities which we consolidate. These instruments are generally illiquid in nature and trade infrequently. Significant inputs in the valuation analysis are predominantly Level 3, due to the nature of these instruments and the lack of readily available market quotes. For ABS issued, we utilize both market comparable pricing and discounted cash flow analysis valuation techniques. Relevant market indicators factored into the analysis include bid/ask spreads, the amount and timing of collateral credit losses, interest rates, and collateral prepayment rates. Estimated fair values are based on applying the market indicators to generate discounted cash flows (Level 3). These cash flow models use significant unobservable inputs such as a discount rates, prepayment rate, default rate, loss severity and credit support. A decrease in credit losses or discount rate, or an increase in prepayment rates, would generally cause the fair value of the ABS issued to decrease (i.e., become a larger liability).

FHLBC borrowings

FHLBC borrowings include amounts borrowed from the FHLBC that are secured, generally by residential mortgage loans. As these borrowings are secured and subject to margin calls and as the rates on these borrowings reset frequently to market rates, we believe that carrying values approximate fair values (Level 2).

Financial Instruments Carried at Amortized Cost

Participation in loan warehouse facility

Our participation in a loan warehouse facility was carried at amortized cost (Level 2).

Guarantee obligations

In association with our risk-sharing transactions with the Agencies, we have made certain guarantees which are carried on our balance sheet at amortized cost (Level 3).

Subordinate securities financing facility

Borrowings under our subordinate securities financing facility are secured by real estate securities and carried at unpaid principal balance net of any unamortized deferred issuance costs (Level 3).

Convertible notes

Convertible notes include unsecured convertible and exchangeable senior notes that are carried at their unpaid principal balance net of any unamortized deferred issuance costs. The fair value of the convertible notes is determined using quoted prices in generally active markets (Level 2).

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

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

Trust preferred securities and subordinated notes

Trust preferred securities and subordinated notes are carried at their unpaid principal balance net of any unamortized deferred issuance costs (Level 3).

Note 6. Residential Loans

We acquire residential loans from third-party originators and may sell or securitize these loans or hold them for investment. The following table summarizes the classifications and carrying values of the residential loans owned at Redwood and at consolidated Sequoia entities at September 30, 2019 and December 31, 2018.

Table 6.1 – Classifications and Carrying Values of Residential Loans



September 30, 2019			Legacy		Sequoia		Freddie Mac
(In Thousands)	Redwood		Sequoia		Choice		SLST		Total
Held-for-sale
At fair value	$	925,780	$	—	$	—	$	—	$	925,780
At lower of cost or fair value	107		—		—		—		107
Total held-for-sale	925,887		—		—		—		925,887
Held-for-investment at fair value	2,267,218		429,159		2,618,316		2,441,223		7,755,916
Total Residential Loans	$	3,193,105	$	429,159	$	2,618,316	$	2,441,223	$	8,681,803



December 31, 2018			Legacy		Sequoia		Freddie Mac
(In Thousands)	Redwood		Sequoia		Choice		SLST		Total
Held-for-sale
At fair value	$	1,048,690	$	—	$	—	$	—	$	1,048,690
At lower of cost or fair value	111		—		—		—		111
Total held-for-sale	1,048,801		—		—		—		1,048,801
Held-for-investment at fair value	2,383,932		519,958		2,079,382		1,222,669		6,205,941
Total Residential Loans	$	3,432,733	$	519,958	$	2,079,382	$	1,222,669	$	7,254,742

At September 30, 2019, we owned mortgage servicing rights associated with $2.51 billion (principal balance) of consolidated residential loans purchased from third-party originators. The value of these MSRs is included in the carrying value of the associated loans on our consolidated balance sheets. We contract with licensed sub-servicers that perform servicing functions for these loans.

Residential Loans Held-for-Sale

At Fair Value

At September 30, 2019, we owned 1,206 loans held-for-sale at fair value with an aggregate unpaid principal balance of $904 million and a fair value of $926 million, compared to 1,484 loans with an aggregate unpaid principal balance of $1.03 billion and a fair value of $1.05 billion at December 31, 2018. At both September 30, 2019 and December 31, 2018, one of these loans with a fair value of $0.6 million and an unpaid principal balance of $0.7 million was greater than 90 days delinquent and none of these loans were in foreclosure.

During the three and nine months ended September 30, 2019, we purchased $1.45 billion and $3.94 billion (principal balance) of loans, respectively, for which we elected the fair value option, and we sold $1.53 billion and $3.92 billion (principal balance) of loans, respectively, for which we recorded a net market valuation loss of $7 million and a net market valuation gain of $0.3 million, respectively, through Mortgage banking activities, net on our consolidated statements of income. At September 30, 2019, loans held-for-sale with a market value of $253 million were pledged as collateral under short-term borrowing agreements.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 6. Residential Loans - (continued)

During the three and nine months ended September 30, 2018, we purchased $1.79 billion and $5.52 billion (principal balance) of loans, respectively, for which we elected the fair value option, and we sold $1.90 billion and $5.83 billion (principal balance) of loans, respectively, for which we recorded net market valuation gains of $6 million and $16 million, respectively, through Mortgage banking activities, net on our consolidated statements of income.

At Lower of Cost or Fair Value

At both September 30, 2019 and December 31, 2018, we held two residential loans at the lower of cost or fair value with $0.1 million in outstanding principal balance and carrying values of $0.1 million. At both September 30, 2019 and December 31, 2018, none of these loans were greater than 90 days delinquent or in foreclosure.

Residential Loans Held-for-Investment at Fair Value

At Redwood

At September 30, 2019, we owned 3,118 held-for-investment loans at Redwood with an aggregate unpaid principal balance of $2.20 billion and a fair value of $2.27 billion, compared to 3,296 loans with an aggregate unpaid principal balance of $2.39 billion and a fair value of $2.38 billion at December 31, 2018. At September 30, 2019, one of these loans with an aggregate fair value of $0.5 million and an unpaid principal balance of $0.6 million was greater than 90 days delinquent and in foreclosure. At December 31, 2018, two of these loans with an aggregate fair value and unpaid principal balance of $1 million were greater than 90 days delinquent and none of these loans were in foreclosure.

During the three and nine months ended September 30, 2019, we purchased zero and $39 million (principal balance) of loans, respectively, for which we elected the fair value option, and did not sell any loans. During the three and nine months ended September 30, 2019, we transferred loans with a fair value of zero and $69 million, respectively, from held-for-sale to held-for-investment. During the three and nine months ended September 30, 2019, we transferred loans with a fair value of zero and $23 million, respectively, from held-for-investment to held-for-sale. During the three and nine months ended September 30, 2019, we recorded net market valuation gains of $8 million and $71 million, respectively, on residential loans held-for-investment at fair value through Investment fair value changes, net on our consolidated statements of income. At September 30, 2019, loans with a fair value of $2.27 billion were pledged as collateral under a borrowing agreement with the FHLBC.

During the three and nine months ended September 30, 2018, we transferred loans with a fair value of $116 million and $204 million, respectively, from held-for-sale to held-for-investment. During both the three and nine months ended September 30, 2018, we transferred loans with a fair value of $16 million from held-for-investment to held-for-sale. During the three and nine months ended September 30, 2018, we recorded net market valuation losses of $17 million and $71 million, respectively, on residential loans held-for-investment at fair value through Investment fair value changes, net on our consolidated statements of income.

The outstanding loans held-for-investment at Redwood at September 30, 2019 were prime-quality, first lien loans, of which 96% were originated between 2013 and 2019, and 4% were originated in 2012 and prior years. The weighted average Fair Isaac Corporation ("FICO") score of borrowers backing these loans was 768 (at origination) and the weighted average loan-to-value ("LTV") ratio of these loans was 66% (at origination). At September 30, 2019, these loans were comprised of 88% fixed-rate loans with a weighted average coupon of 4.15%, and the remainder were hybrid or ARM loans with a weighted average coupon of 4.19%.

At Consolidated Legacy Sequoia Entities

At September 30, 2019, we consolidated 2,277 held-for-investment loans at consolidated Legacy Sequoia entities, with an aggregate unpaid principal balance of $446 million and a fair value of $429 million, as compared to 2,641 loans at December 31, 2018, with an aggregate unpaid principal balance of $545 million and a fair value of $520 million. At origination, the weighted average FICO score of borrowers backing these loans was 727, the weighted average LTV ratio of these loans was 66%, and the loans were nearly all first lien and prime-quality.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 6. Residential Loans - (continued)

At September 30, 2019 and December 31, 2018, the aggregate unpaid principal balance of loans at consolidated Legacy Sequoia entities delinquent greater than 90 days was $13 million and $14 million, respectively, of which the aggregate unpaid principal balance of loans in foreclosure was $3 million and $5 million, respectively. During the three and nine months ended September 30, 2019, we recorded a net market valuation loss of $0.1 million and a net market valuation gain of $5 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of income. During the three and nine months ended September 30, 2018, we recorded net market valuation gains of $4 million and $37 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of income. Pursuant to the collateralized financing entity guidelines, the market valuation changes of these loans are based on the estimated fair value of the associated ABS issued. The net impact to our income statement associated with our retained economic investment in the Legacy Sequoia securitization entities is presented in Note 5.

At Consolidated Sequoia Choice Entities

At September 30, 2019, we consolidated 3,543 held-for-investment loans at the consolidated Sequoia Choice entities, with an aggregate unpaid principal balance of $2.55 billion and a fair value of $2.62 billion, as compared to 2,800 loans at December 31, 2018 with an aggregate unpaid principal balance of $2.04 billion and a fair value of $2.08 billion. At origination, the weighted average FICO score of borrowers backing these loans was 745, the weighted average LTV ratio of these loans was 75%, and the loans were all first lien and prime-quality. At September 30, 2019, six of these loans with an aggregate unpaid principal balance of $4 million were greater than 90 days delinquent and one of these loans with an unpaid principal balance of $1 million was in foreclosure. At December 31, 2018, three of these loans with an aggregate unpaid principal balance of $2 million were greater than 90 days delinquent and none of these loans were in foreclosure.

During the three and nine months ended September 30, 2019, we transferred loans with a fair value of $727 million and $1.08 billion, respectively, from held-for-sale to held-for-investment associated with Choice securitizations. During the three and nine months ended September 30, 2019, we recorded a net market valuation loss of $11 million and a net market valuation gain of $5 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of income. During the three and nine months ended September 30, 2018, we recorded net market valuation losses of $13 million and $25 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of income. Pursuant to the collateralized financing entity guidelines, the market valuation changes of these loans are based on the estimated fair value of the ABS issued associated with Choice securitizations. The net impact to our income statement associated with our retained economic investment in the Sequoia Choice securitization entities is presented in Note 5.

At Consolidated Freddie Mac SLST Entities

Beginning in the fourth quarter of 2018, we invested in subordinate securities issued by certain Freddie Mac SLST securitization trusts and were required to consolidate the underlying seasoned re-performing and non-performing residential loans owned at these entities for financial reporting purposes in accordance with GAAP. At securitization, each of these mortgage loans was a fully amortizing, fixed- or step-rate, first-lien loan that had been modified. At September 30, 2019, we consolidated 14,706 held-for-investment loans at the consolidated Freddie Mac SLST entities, with an aggregate unpaid principal balance of $2.47 billion and a fair value of $2.44 billion, compared to 7,900 loans at December 31, 2018 with an aggregate unpaid principal balance of $1.31 billion and a fair value of $1.22 billion. At securitization, the weighted average FICO score of borrowers backing these loans was 599 and the weighted average LTV ratio of these loans was 68%. At September 30, 2019, 288 of these loans with an aggregate unpaid principal balance of $75 million were greater than 90 days delinquent, and 150 of these loans with an aggregate unpaid principal balance of $24 million were in foreclosure. At December 31, 2018, 306 of these loans with an aggregate unpaid principal balance of $51 million were greater than 90 days delinquent and none of these loans were in foreclosure.

During the three and nine months ended September 30, 2019, we recorded net market valuation gains of $40 million and $95 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of income. Pursuant to the collateralized financing entity guidelines, the market valuation changes of these loans are based on the estimated fair value of the ABS issued associated with the Freddie Mac SLST securitizations. The net impact to our income statement associated with our economic investment in the Freddie Mac SLST securitization entities is presented in Note 5.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 7. Business Purpose Residential Loans

We originate business purpose residential loans, including single-family rental loans and residential bridge loans. This origination activity commenced in connection with our acquisition of 5 Arches in March 2019.

Business Purpose Residential Loan Originations

During the three months ended September 30, 2019, we funded $127 million of business purpose residential loans, of which $3 million of residential bridge loans were sold to a third party. During the period from March 1, 2019 to September 30, 2019, we funded $297 million of business purpose residential loans, of which $47 million of residential bridge loans were sold to a third party. The remaining business purpose residential loans were transferred to our investment portfolio (residential bridge loans), or retained in our mortgage banking business (single-family rental loans). Prior to the transfer of residential bridge loans to our investment portfolio, we recorded net market valuation gains of $1 million and $2 million on these loans through Mortgage banking activities, net on our consolidated statements of income for the three months ended September 30, 2019 and for the period from March 1, 2019 to September 30, 2019, respectively. Market valuation adjustments on our single-family rental loans are also recorded in Mortgage banking activities, net on our consolidated statements of income. Additionally, during the three months ended September 30, 2019 and during the period from March 1, 2019 to September 30, 2019, we recorded loan origination fee income associated with business purpose loans of $3 million and $6 million, respectively, through Mortgage banking activities, net on our consolidated statements of income.

The following table summarizes the classifications and carrying values of the business purpose residential loans owned at Redwood at September 30, 2019 and December 31, 2018.

Table 7.1 – Classifications and Carrying Values of Business Purpose Residential Loans



September 30, 2019	Single-Family		Residential
(In Thousands)	Rental		Bridge		Total
Held-for-sale at fair value	$	110,434	$	—	$	110,434
Held-for-investment at fair value	18,711		206,890		225,601
Total Business Purpose Residential Loans	$	129,145	$	206,890	$	336,035



December 31, 2018	Single-Family		Residential
(In Thousands)	Rental		Bridge		Total
Held-for-sale at fair value	$	28,460	$	—	$	28,460
Held-for-investment at fair value	—		112,798		112,798
Total Business Purpose Residential Loans	$	28,460	$	112,798	$	141,258

Single-Family Rental Loans Held-for-Sale at Fair Value

At September 30, 2019, we owned 77 single-family rental loans held-for-sale with an aggregate unpaid principal balance of $106 million and a fair value of $110 million, compared to 11 loans at December 31, 2018 with an aggregate unpaid principal balance of $28 million and a fair value of $28 million. At both September 30, 2019 and December 31, 2018, none of these loans were greater than 90 days delinquent or in foreclosure.

During the three months ended September 30, 2019 and for the period from March 1, 2019 to September 30, 2019, we originated $36 million and $78 million of single-family rental loans, respectively. During both the three months ended September 30, 2019 and for the period from March 1, 2019 to September 30, 2019, $19 million of single-family rental loans were transferred to our investment portfolio and financed with FHLB borrowings, and the remaining loans were retained in our mortgage banking business. We did not sell any loans during either of these periods. During the first two months of 2019, prior to our acquisition of 5 Arches on March 1, 2019, we purchased $19 million of single-family rental loans from 5 Arches. During the three and nine months ended September 30, 2019, we recorded net market valuation gains of $1 million and $3 million, respectively, on single-family rental loans held-for-sale at fair value through Mortgage banking activities, net on our consolidated statements of income. At September 30, 2019, loans held-for-sale with a market value of $78 million were pledged as collateral under short-term borrowing agreements.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

The outstanding single-family rental loans held-for-sale at September 30, 2019 were first lien, fixed-rate loans with original maturities of five, seven, or ten years. At September 30, 2019, the weighted average coupon of our single-family rental loans was 5.35% and the weighted average remaining loan term was six years. At origination, the weighted average LTV ratio of these loans was 68% and the weighted average debt service coverage ratio ("DSCR") was 1.36 times.

Single-Family Rental Loans Held-for-Investment at Fair Value

At September 30, 2019, we owned one single-family rental loan held-for-investment with an aggregate unpaid principal balance of $17 million and a fair value of $19 million. At September 30, 2019, this loan was not greater than 90 days delinquent or in foreclosure. During the three months ended September 30, 2019, we transferred one loan with a fair value of $19 million from held-for-sale to held-for-investment. During both the three and nine months ended September 30, 2019, we recorded net market valuation gains of less than $0.1 million on single-family rental loans held-for-investment at fair value through Investment fair value changes, net on our consolidated statements of income.

Residential Bridge Loans Held-for-Investment at Fair Value

At September 30, 2019, we owned 392 residential bridge loans held-for-investment with an aggregate unpaid principal balance of $205 million and a fair value of $207 million, compared to 157 loans at December 31, 2018 with an aggregate unpaid principal balance of $112 million and a fair value of $113 million.

As part of our credit risk management practices, our residential bridge loans are subject to individual risk assessment using an internal borrower and collateral quality evaluation framework. At September 30, 2019, nine loans with an aggregate fair value and unpaid principal balance of $6 million were greater than 90 days delinquent, and eight of these loans with an aggregate fair value and unpaid principal balance of $5 million were in foreclosure. At December 31, 2018, seven loans with an aggregate fair value of $12 million were greater than 90 days delinquent and four of these loans with an aggregate fair value of $11 million were in foreclosure. During the nine months ended September 30, 2019, we transferred one loan with a fair value of $5 million to REO, which is included in Other assets on our consolidated balance sheets.

During the three months ended September 30, 2019 and for the period from March 1, 2019 to September 30, 2019, $88 million and $174 million of newly originated residential bridge loans, respectively, were transferred to our investment portfolio. During the first two months of 2019, prior to our acquisition of 5 Arches on March 1, 2019, we purchased $10 million of residential bridge loans from 5 Arches. During both the three and nine months ended September 30, 2019, we recorded net market valuation losses of $1 million on residential bridge loans held-for-investment at fair value through Investment fair value changes, net on our consolidated statements of income. At September 30, 2019, loans with a market value of $176 million were pledged as collateral under short-term borrowing agreements.

The outstanding residential bridge loans held-for-investment at September 30, 2019 were first lien, fixed-rate, interest-only loans with a weighted average coupon of 8.90% and original maturities of six to 24 months. At origination, the weighted average FICO score of borrowers backing these loans was 693 and the weighted average LTV ratio of these loans was 70%.

At September 30, 2019, we had a $67 million commitment to fund residential bridge loans. See Note 16 for additional information on this commitment.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 8. Multifamily Loans

Beginning in the second half of 2018, we invested in multifamily subordinate securities issued by certain Freddie Mac K-Series securitization trusts and were required to consolidate the underlying multifamily loans owned at these entities for financial reporting purposes in accordance with GAAP. At September 30, 2019, we consolidated 250 held-for-investment multifamily loans, with an aggregate unpaid principal balance of $3.54 billion and a fair value of $3.79 billion, compared to 162 loans at December 31, 2018 with an aggregate unpaid principal balance of $2.13 billion and a fair value of $2.14 billion. The outstanding multifamily loans held-for-investment at the Freddie Mac K-Series entities at September 30, 2019 were first lien, fixed-rate loans that were originated between 2015 and 2017 and had original loan terms of seven to ten years and an original weighted average LTV ratio of 69%. At September 30, 2019, the weighted average coupon of these multifamily loans was 4.19% and the weighted average remaining loan term was six years. At both September 30, 2019 and December 31, 2018, none of these loans were greater than 90 days delinquent or in foreclosure.

During the three and nine months ended September 30, 2019, we recorded net market valuation gains of $47 million and $178 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of income. Pursuant to the collateralized financing entity guidelines, the market valuation changes of these loans are based on the estimated fair value of the ABS issued associated with the securitizations. The net impact to our income statement associated with our economic investment in the securities of the Freddie Mac K-Series securitization entities is presented in Note 5.

Note 9. Real Estate Securities

We invest in real estate securities that we acquire from third parties or create and retain from our Sequoia securitizations. The following table presents the fair values of our real estate securities by type at September 30, 2019 and December 31, 2018.

Table 9.1 – Fair Values of Real Estate Securities by Type



(In Thousands)	September 30, 2019		December 31, 2018
Trading	$	1,013,785	$	1,118,612
Available-for-sale	271,641		333,882
Total Real Estate Securities	$	1,285,426	$	1,452,494

Our real estate securities include mortgage-backed securities, which are presented in accordance with their general position within a securitization structure based on their rights to cash flows. Senior securities are those interests in a securitization that generally have the first right to cash flows and are last in line to absorb losses. Mezzanine securities are interests that are generally subordinate to senior securities in their rights to receive cash flows, and have subordinate securities below them that are first to absorb losses. Most of our mezzanine classified securities were initially rated AA through BBB- and issued in 2012 or later. Subordinate securities are all interests below mezzanine. Nearly all of our residential securities are supported by collateral that was designated as prime at the time of issuance.

Trading Securities

The following table presents the fair value of trading securities by position and collateral type at September 30, 2019 and December 31, 2018.

Table 9.2 – Trading Securities by Position



(In Thousands)	September 30, 2019		December 31, 2018
Senior	$	149,634	$	158,670
Mezzanine	644,571		610,819
Subordinate	219,580		349,123
Total Trading Securities	$	1,013,785	$	1,118,612

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 9. Real Estate Securities - (continued)

We elected the fair value option for certain securities and classify them as trading securities. Our trading securities include both residential and multifamily mortgage-backed securities. At September 30, 2019, trading securities with a carrying value of $677 million as well as $113 million, $385 million, and $209 million of securities we owned that were issued by consolidated Sequoia Choice, Freddie Mac SLST, and Freddie Mac K-Series securitizations, respectively, were pledged as collateral under short-term borrowing agreements. See Note 13 for additional information on short-term debt. At September 30, 2019, trading securities with a carrying value of $4 million, as well as $126 million of securities we owned that were issued by consolidated Sequoia Choice securitizations, were pledged as collateral under our subordinate securities financing facility. In addition, at September 30, 2019, trading securities with a fair value of $41 million were pledged as collateral under a borrowing agreement with the FHLBC. See Note 15 for additional information on long-term debt.

At September 30, 2019 and December 31, 2018, our senior trading securities included $58 million and $82 million of interest-only securities, respectively, for which there is no principal balance, and the remaining unpaid principal balance of our senior trading securities was $88 million and $78 million, respectively. Our interest-only securities included $29 million and $43 million of A-IO-S securities at September 30, 2019 and December 31, 2018, respectively, which are securities we retained from certain of our Sequoia securitizations that represent certificated servicing strips.

At September 30, 2019 and December 31, 2018, our mezzanine and subordinate trading securities had an unpaid principal balance of $1.01 billion and $1.12 billion, respectively. At September 30, 2019 and December 31, 2018, the fair value of our mezzanine and subordinate securities was $864 million and $960 million, respectively, and included $128 million and $277 million, respectively, of Agency residential mortgage credit risk transfer (or "CRT") securities, $65 million and $68 million, respectively, of Sequoia securities, $207 million and $186 million, respectively, of other third-party residential securities, and $464 million and $429 million, respectively, of third-party commercial/multifamily securities.

During the three and nine months ended September 30, 2019, we acquired $66 million and $335 million (principal balance), respectively, of securities for which we elected the fair value option and classified as trading, and sold $236 million and $397 million, respectively, of such securities. During the three and nine months ended September 30, 2018, we acquired $189 million and $567 million (principal balance), respectively, of securities for which we elected the fair value option and classified as trading, and sold $79 million and $323 million, respectively, of such securities.

During the three and nine months ended September 30, 2019, we recorded net market valuation gains of $15 million and $56 million, respectively, on trading securities, included in Investment fair value changes, net on our consolidated statements of income. During the three and nine months ended September 30, 2018, we recorded net market valuation gains of $6 million and $2 million, respectively, on trading securities, included in Investment fair value changes, net on our consolidated statements of income.

AFS Securities

The following table presents the fair value of our available-for-sale securities by position and collateral type at September 30, 2019 and December 31, 2018.

Table 9.3 – Available-for-Sale Securities by Position



(In Thousands)	September 30, 2019		December 31, 2018
Senior	$	33,457	$	87,615
Mezzanine	13,967		36,407
Subordinate	224,217		209,860
Total AFS Securities	$	271,641	$	333,882

At September 30, 2019 and December 31, 2018, all of our available-for-sale securities were primarily comprised of residential mortgage-backed securities. At September 30, 2019, AFS securities with a carrying value of $59 million were pledged as collateral under short-term borrowing agreements. See Note 13 for additional information on short-term debt. At September 30, 2019, AFS securities with a carrying value of $123 million were pledged as collateral under our subordinate securities financing facility. See Note 15 for additional information on long-term debt.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 9. Real Estate Securities - (continued)

During the three and nine months ended September 30, 2019, we purchased $12 million and $21 million of AFS securities, respectively, and sold $15 million and $82 million of AFS securities, respectively, which resulted in net realized gains of $4 million and $13 million, respectively. During the three and nine months ended September 30, 2018, we purchased $1 million and $7 million of AFS securities, respectively, and sold $26 million and $118 million of AFS securities, respectively, which resulted in net realized gains of $7 million and $21 million, respectively.

We often purchase AFS securities at a discount to their outstanding principal balances. To the extent we purchase an AFS security that has a likelihood of incurring a loss, we do not amortize into income the portion of the purchase discount that we do not expect to collect due to the inherent credit risk of the security. We may also expense a portion of our investment in the security to the extent we believe that principal losses will exceed the purchase discount. We designate any amount of unpaid principal balance that we do not expect to receive and thus do not expect to earn or recover as a credit reserve on the security. Any remaining net unamortized discounts or premiums on the security are amortized into income over time using the effective yield method.

At September 30, 2019, there were no AFS securities with contractual maturities less than five years, $8 million with contractual maturities greater than five years but less than 10 years, and the remainder of our AFS securities had contractual maturities greater than 10 years.

The following table presents the components of carrying value (which equals fair value) of AFS securities at September 30, 2019 and December 31, 2018.

Table 9.4 – Carrying Value of AFS Securities



September 30, 2019
(In Thousands)	Senior			Mezzanine			Subordinate			Total
Principal balance	$	34,272		$	13,729		$	291,207		$	339,208
Credit reserve	(588		)	—			(33,623		)	(34,211		)
Unamortized discount, net	(12,346		)	(552		)	(119,756		)	(132,654		)
Amortized cost	21,338			13,177			137,828			172,343
Gross unrealized gains	12,131			790			86,389			99,310
Gross unrealized losses	(12		)	—			—			(12		)
Carrying Value	$	33,457		$	13,967		$	224,217		$	271,641



December 31, 2018
(In Thousands)	Senior			Mezzanine			Subordinate			Total
Principal balance	$	91,736		$	36,852		$	302,524		$	431,112
Credit reserve	(7,790		)	—			(33,580		)	(41,370		)
Unamortized discount, net	(18,460		)	(3,697		)	(129,043		)	(151,200		)
Amortized cost	65,486			33,155			139,901			238,542
Gross unrealized gains	22,178			3,252			70,458			95,888
Gross unrealized losses	(49		)	—			(499		)	(548		)
Carrying Value	$	87,615		$	36,407		$	209,860		$	333,882

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 9. Real Estate Securities - (continued)

The following table presents the changes for the three and nine months ended September 30, 2019, in unamortized discount and designated credit reserves on AFS securities.

Table 9.5 – Changes in Unamortized Discount and Designated Credit Reserves on AFS Securities



	Three Months Ended September 30, 2019						Nine Months Ended September 30, 2019
	Credit Reserve			Unamortized Discount, Net			Credit Reserve			Unamortized Discount, Net
(In Thousands)	Credit Reserve			Unamortized Discount, Net			Credit Reserve			Unamortized Discount, Net
Beginning balance	$	34,849		$	137,282		$	41,370		$	151,200
Amortization of net discount	—			(1,834		)	—			(5,823		)
Realized credit losses	(694		)	—			(1,874		)	—
Acquisitions	734			399			2,198			1,103
Sales, calls, other	(800		)	(3,071		)	(7,197		)	(14,112		)
(Release of) transfers to credit reserves, net	122			(122		)	(286		)	286
Ending Balance	$	34,211		$	132,654		$	34,211		$	132,654

AFS Securities with Unrealized Losses

The following table presents the components comprising the total carrying value of AFS securities that were in a gross unrealized loss position at September 30, 2019 and December 31, 2018.

Table 9.6 – Components of Fair Value of AFS Securities by Holding Periods



	Less Than 12 Consecutive Months							12 Consecutive Months or Longer
	Amortized Cost		Unrealized Losses			Fair Value		Amortized Cost		Unrealized Losses			Fair Value
(In Thousands)	Amortized Cost		Unrealized Losses			Fair Value		Amortized Cost		Unrealized Losses			Fair Value
September 30, 2019	$	—	$	—		$	—	$	6,254	$	(12	)	$	6,242
December 31, 2018	12,923		(499		)	12,424		7,464		(49		)	7,415

At September 30, 2019, after giving effect to purchases, sales, and extinguishment due to credit losses, our consolidated balance sheet included 113 AFS securities, of which one was in an unrealized loss position and one was in a continuous unrealized loss position for 12 consecutive months or longer. At December 31, 2018, our consolidated balance sheet included 128 AFS securities, of which seven were in an unrealized loss position and three were in a continuous unrealized loss position for 12 consecutive months or longer.

Evaluating AFS Securities for Other-than-Temporary Impairments

Gross unrealized losses on our AFS securities were less than $0.1 million at September 30, 2019. We evaluate all securities in an unrealized loss position to determine if the impairment is temporary or other-than-temporary (resulting in an OTTI). At September 30, 2019, we did not intend to sell any of our AFS securities that were in an unrealized loss position, and it is more likely than not that we will not be required to sell these securities before recovery of their amortized cost basis, which may be at their maturity. We review our AFS securities that are in an unrealized loss position to identify those securities with losses that are other-than-temporary based on an assessment of changes in expected cash flows for such securities, which considers recent security performance and expected future performance of the underlying collateral.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 9. Real Estate Securities - (continued)

For both the three and nine months ended September 30, 2019, there were no other-than-temporary impairments related to our AFS securities. AFS securities for which OTTI is recognized have experienced, or are expected to experience, credit-related adverse cash flow changes. In determining our estimate of cash flows for AFS securities we may consider factors such as structural credit enhancement, past and expected future performance of underlying mortgage loans, including timing of expected future cash flows, which are informed by prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing loans, FICO scores at loan origination, year of origination, loan-to-value ratios, and geographic concentrations, as well as general market assessments. Changes in our evaluation of these factors impacted the cash flows expected to be collected at the OTTI assessment date and were used to determine if there were credit-related adverse cash flows and if so, the amount of credit related losses. Significant judgment is used in both our analysis of the expected cash flows for our AFS securities and any determination of the credit loss component of OTTI.

The table below summarizes the significant valuation assumptions we used for our AFS securities in unrealized loss positions at September 30, 2019.

Table 9.7 – Significant Valuation Assumptions



September 30, 2019	Range for Securities
Prepayment rates	15%	-	15%
Projected losses	1%	-	1%

The following table details the activity related to the credit loss component of OTTI (i.e., OTTI recognized through earnings) for AFS securities held at September 30, 2019 and 2018, for which a portion of an OTTI was recognized in other comprehensive income.

Table 9.8 – Activity of the Credit Component of Other-than-Temporary Impairments



	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	2019			2018			2019			2018
Balance at beginning of period	$	18,580		$	20,967		$	18,652		$	21,037
Additions
Initial credit impairments	—			33			—			76
Reductions
Securities sold, or expected to sell	(6		)	(927		)	(20		)	(1,026		)
Securities with no outstanding principal at period end	—			(1,229		)	(58		)	(1,243		)
Balance at End of Period	$	18,574		$	18,844		$	18,574		$	18,844

Gains and losses from the sale of AFS securities are recorded as Realized gains, net, in our consolidated statements of income. The following table presents the gross realized gains and losses on sales and calls of AFS securities for the three and nine months ended September 30, 2019 and 2018.

Table 9.9 – Gross Realized Gains and Losses on AFS Securities



	Three Months Ended September 30,				Nine Months Ended September 30,
(In Thousands)	2019		2018		2019		2018
Gross realized gains - sales	$	3,656	$	7,275	$	13,143	$	21,312
Gross realized gains - calls	1,058		—		5,084		43
Gross realized losses - sales	—		—		—		(3		)
Total Realized Gains on Sales and Calls of AFS Securities, net	$	4,714	$	7,275	$	18,227	$	21,352

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 10. Other Investments

Other investments at September 30, 2019 and December 31, 2018 are summarized in the following table.

Table 10.1 – Components of Other Investments



(In Thousands)	September 30, 2019		December 31, 2018
Servicer advance investments	$	222,591	$	300,468
Mortgage servicing rights	39,837		60,281
Excess MSRs	32,937		27,312
Investment in multifamily loan fund	32,158		—
Shared home appreciation options	11,372		—
Other	8,812		—
Participation in loan warehouse facility	—		39,703
Investment in 5 Arches	—		10,754
Total Other Investments	$	347,707	$	438,518

Servicer advance investments

In 2018, we and a third-party co-investor, through two partnerships (“SA Buyers”) consolidated by us, purchased the outstanding servicer advances and excess MSRs related to a portfolio of legacy residential mortgage-backed securitizations serviced by the co-investor (See Note 4 for additional information regarding the transaction). At September 30, 2019, we had funded $71 million of total capital to the SA Buyers (see Note 16 for additional detail).

Our servicer advance investments (owned by the consolidated SA Buyers) are comprised of outstanding servicer advance receivables, the requirement to purchase all future servicer advances made with respect to a specified pool of residential mortgage loans, and a portion of the mortgage servicing fees from the underlying loan pool. A portion of the remaining mortgage servicing fees from the underlying loan pool are paid directly to the third-party servicer for the performance of servicing duties and a portion is paid to excess MSRs that we own as a separate investment. We hold our servicer advance investments at our taxable REIT subsidiary.

Servicer advances are non-interest bearing and are a customary feature of residential mortgage securitization transactions. Servicer advances are generally reimbursable cash payments made by a servicer when the borrower fails to make scheduled payments due on a residential mortgage loan or to support the value of the collateral property. Servicer advances typically fall into three categories:


•	Principal and Interest Advances: cash payments made by the servicer to cover scheduled principal and interest payments on a residential mortgage loan that have not been paid on a timely basis by the borrower.


•	Escrow Advances (Taxes and Insurance Advances): Cash payments made by the servicer to third parties on behalf of the borrower for real estate taxes and insurance premiums on the property that have not been paid on a timely basis by the borrower.


•	Corporate Advances: Cash payments made by the servicer to third parties for the reimbursable costs and expenses incurred in connection with the foreclosure, preservation and sale of the mortgaged property, including attorneys’ and other professional fees.

Servicer advances are generally permitted to be repaid from amounts received with respect to the related residential mortgage loan, including payments from the borrower or amounts received from the liquidation of the property securing the loan. Residential mortgage servicing agreements generally require a servicer to make advances in respect of serviced residential mortgage loans unless the servicer determines in good faith that the advance would not be ultimately recoverable from the proceeds of the related residential mortgage loan or the mortgaged property.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

At September 30, 2019, our servicer advance investments had a carrying value of $223 million and were associated with a portfolio of residential mortgage loans with an unpaid principal balance of $8.38 billion. The outstanding servicer advance receivables associated with this investment were $205 million at September 30, 2019, which were financed with short-term non-recourse securitization debt (see Note 13 for additional detail on this debt). The servicer advance receivables were comprised of the following types of advances at September 30, 2019 and December 31, 2018:

Table 10.2 – Components of Servicer Advance Receivables



(In Thousands)	September 30, 2019		December 31, 2018
Principal and interest advances	$	54,670	$	144,336
Escrow advances (taxes and insurance advances)	99,227		94,828
Corporate advances	51,049		47,614
Total Servicer Advance Receivables	$	204,946	$	286,778

We account for our servicer advance investments at fair value and during the three and nine months ended September 30, 2019, we recorded $3 million and $9 million of interest income associated with these investments, respectively, and recorded net market valuation gains of $2 million and $3 million, respectively, through Investment fair value changes, net in our consolidated statements of income.

Mortgage Servicing Rights

We invest in mortgage servicing rights associated with residential mortgage loans and contract with licensed sub-servicers to perform all servicing functions for these loans. The majority of our investments in MSRs were made through the retention of servicing rights associated with the residential jumbo mortgage loans that we acquired and subsequently transferred to third parties. We hold our MSR investments at our taxable REIT subsidiary.

At September 30, 2019 and December 31, 2018, our MSRs had a fair value of $40 million and $60 million, respectively, and were associated with loans with an aggregate principal balance of $4.61 billion and $4.93 billion, respectively.

The following table presents activity for MSRs for the three and nine months ended September 30, 2019 and 2018.

Table 10.3 – Activity for MSRs



	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	2019			2018			2019			2018
Balance at beginning of period	$	47,396		$	64,674		$	60,281		$	63,598
Additions	—			—			868			—
Sales	—			—			—			(1,077		)
Changes in fair value due to:
Changes in assumptions ⁽¹⁾	(5,150		)	1,099			(15,291		)	6,388
Other changes ⁽²⁾	(2,409		)	(1,988		)	(6,021		)	(5,124		)
Balance at End of Period	$	39,837		$	63,785		$	39,837		$	63,785


(1)	Primarily reflects changes in prepayment assumptions due to changes in market interest rates.


(2)	Represents changes due to the realization of expected cash flows.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

The following table presents the components of our MSR income for the three and nine months ended September 30, 2019 and 2018.

Table 10.4 – Components of MSR Income, net



	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	2019			2018			2019			2018
Servicing income	$	3,850		$	4,004		$	11,310		$	11,601
Cost of sub-servicer	(319		)	(324		)	(1,090		)	(1,254		)
Net servicing fee income	3,531			3,680			10,220			10,347
Market valuation changes of MSRs	(7,489		)	(823		)	(21,243		)	1,324
Market valuation changes of associated derivatives	4,389			(890		)	13,157			(7,151		)
MSR reversal of provision for repurchases	—			—			208			277
MSR Income, Net ⁽¹⁾	$	431		$	1,967		$	2,342		$	4,797


(1)	MSR income, net is included in Other income, net on our consolidated statements of income.

Excess MSRs

In association with our servicer advance investments described above, in the fourth quarter of 2018, we (through our consolidated SA Buyers) also invested in excess MSRs associated with the same portfolio of legacy residential mortgage-backed securitizations. Additionally, beginning in 2018, we invested in excess MSRs associated with specified pools of multifamily loans. We account for our excess MSRs at fair value and during the three and nine months ended September 30, 2019, we recognized $2 million and $6 million of interest income, respectively, through Other interest income, and recorded net market valuation losses of $2 million and $2 million, respectively, through Investment fair value changes, net on our consolidated statements of income.

Investment in Multifamily Loan Fund

In January 2019, we invested in a limited partnership created to acquire floating rate, light-renovation multifamily loans from Freddie Mac. We committed to fund an aggregate of $78 million to the partnership, and have funded approximately $33 million at September 30, 2019. Freddie Mac is providing a debt facility to finance loans purchased by the partnership. After the partnership's acquisitions have reached a specific threshold, the partnership and Freddie Mac may agree to include the related loans in a Freddie Mac-sponsored securitization and the limited partners may acquire the subordinate securities issued in any such securitization.

We account for our ownership interest in this partnership using the equity method of accounting as we are able to exert significant influence over but do not control the activities of the investee. At September 30, 2019, the carrying amount of our investment in the partnership was $32 million. We have elected to record our share of earnings or losses from this investment on a one-quarter lag. During the three and nine months ended September 30, 2019, we recorded $1 million and $0.5 million of income, respectively, associated with this investment in Other income, net on our consolidated statements of income.

Shared Home Appreciation Options

In the third quarter of 2019, we entered into a flow purchase agreement to acquire shared home appreciation options. The counterparty purchases an option to buy a fractional interest in a homeowner's ownership interest in his or her real property, and subsequently the counterparty sells the option contract to us. Pursuant to the terms of the option contract, we are able to share in both home price appreciation and depreciation. At September 30, 2019, we had acquired $11 million of shared home appreciation options under this flow purchase agreement and had an outstanding commitment to fund up to an additional $39 million under this agreement.

Participation in Loan Warehouse Facility

In the second quarter of 2018, we invested in a subordinated participation in a revolving mortgage loan warehouse credit facility of one of our loan sellers. We accounted for this subordinated participation interest as a loan receivable at amortized cost, and all associated interest income was recorded as a component of Other interest income in our consolidated statements of income. During the first quarter of 2019, our agreement associated with this investment was terminated and the balance outstanding under this agreement was repaid.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Investment in 5 Arches

In May 2018, we acquired a 20% minority interest in 5 Arches for $10 million, which included a one-year option to purchase all remaining equity in the company for a combination of cash and stock totaling $40 million. In March 2019, we closed on our option to acquire the remaining 80% interest in 5 Arches. See Note 2 for discussion of this acquisition.

During 2018 and through February 28, 2019, we accounted for our minority ownership interest in 5 Arches using the equity method of accounting as we were able to exert significant influence over but did not control the activities of the investee. During the period from January 1, 2019 to February 28, 2019, we recorded $0.3 million of gross income associated with this investment and, including amortization of certain intangible assets, recorded $0.1 million of net earnings in Other income, net on our consolidated statements of income.

Note 11. Derivative Financial Instruments

The following table presents the fair value and notional amount of our derivative financial instruments at September 30, 2019 and December 31, 2018.

Table 11.1 – Fair Value and Notional Amount of Derivative Financial Instruments



	September 30, 2019					December 31, 2018
	Fair Value			Notional Amount		Fair Value			Notional Amount
(In Thousands)	Fair Value			Notional Amount		Fair Value			Notional Amount
Assets - Risk Management Derivatives
Interest rate swaps	$	28,987		$	1,190,500	$	28,211		$	2,106,500
TBAs	5,250			1,960,000		4,665			520,000
Swaptions	4,655			625,000		—			—
Assets - Other Derivatives
Loan purchase commitments	4,757			875,707		2,913			331,161
Total Assets	$	43,649		$	4,651,207	$	35,789		$	2,957,661

Liabilities - Cash Flow Hedges
Interest rate swaps	$	(61,685	)	$	139,500	$	(34,492	)	$	139,500
Liabilities - Risk Management Derivatives
Interest rate swaps	(166,465		)	3,896,300		(36,416		)	1,742,000
TBAs	(4,192		)	1,655,000		(13,215		)	935,000
Liabilities - Other Derivatives
Loan purchase commitments	(1,669		)	457,272		(732		)	137,224
Total Liabilities	$	(234,011	)	$	6,148,072	$	(84,855	)	$	2,953,724
Total Derivative Financial Instruments, Net	$	(190,362	)	$	10,799,279	$	(49,066	)	$	5,911,385

Risk Management Derivatives

To manage, to varying degrees, risks associated with certain assets and liabilities on our consolidated balance sheets, we may enter into derivative contracts. At September 30, 2019, we were party to swaps and swaptions with an aggregate notional amount of $5.71 billion and TBA agreements sold with an aggregate notional amount of $3.62 billion. At December 31, 2018, we were party to swaps with an aggregate notional amount of $3.85 billion and TBA agreements sold with an aggregate notional amount of $1.46 billion.

During the three and nine months ended September 30, 2019, risk management derivatives had net market valuation losses of $36 million and $147 million, respectively. During the three and nine months ended September 30, 2018, risk management derivatives had net market valuation gains of $25 million and $114 million, respectively. These market valuation gains and losses are recorded in Mortgage banking activities, net, Investment fair value changes, net, and Other income, net on our consolidated statements of income.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 11. Derivative Financial Instruments - (continued)

Loan Purchase and Forward Sale Commitments

LPCs and FSCs that qualify as derivatives are recorded at their estimated fair values. For the three and nine months ended September 30, 2019, LPCs and FSCs had net market valuation gains of $14 million and $42 million, respectively, that were recorded in Mortgage banking activities, net on our consolidated statements of income. For the three and nine months ended September 30, 2018, LPCs and FSCs had a net market valuation gain of $2 million and a net market valuation loss of $8 million, respectively, that were recorded in Mortgage banking activities, net on our consolidated statements of income.

Derivatives Designated as Cash Flow Hedges

To manage the variability in interest expense related to portions of our long-term debt and certain adjustable-rate securitization entity liabilities that are included in our consolidated balance sheets for financial reporting purposes, we designated certain interest rate swaps as cash flow hedges with an aggregate notional balance of $140 million.

For the three and nine months ended September 30, 2019, changes in the values of designated cash flow hedges were negative $12 million and negative $27 million, respectively, and were recorded in Accumulated other comprehensive income, a component of equity. For the three and nine months ended September 30, 2018, changes in the values of designated cash flow hedges were positive $5 million and positive $17 million, respectively, and were recorded in Accumulated other comprehensive income, a component of equity. For interest rate agreements currently or previously designated as cash flow hedges, our total unrealized loss reported in Accumulated other comprehensive income was $61 million and $34 million at September 30, 2019 and December 31, 2018, respectively.

The following table illustrates the impact on interest expense of our interest rate agreements accounted for as cash flow hedges for the three and nine months ended September 30, 2019 and 2018.

Table 11.2 – Impact on Interest Expense of Interest Rate Agreements Accounted for as Cash Flow Hedges



	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	2019			2018			2019			2018
Net interest expense on cash flows hedges	$	(727	)	$	(734	)	$	(2,004	)	$	(2,536	)
Total Interest Expense	$	(727	)	$	(734	)	$	(2,004	)	$	(2,536	)

Derivative Counterparty Credit Risk

As discussed in our Annual Report on Form 10-K for the year ended December 31, 2018, we consider counterparty risk as part of our fair value assessments of all derivative financial instruments at each quarter-end. At September 30, 2019, we assessed this risk as remote and did not record a specific valuation adjustment.

At September 30, 2019, we had outstanding derivative agreements with six counterparties (other than clearinghouses) and were in compliance with ISDA agreements governing our open derivative positions.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 12. Other Assets and Liabilities

Other assets at September 30, 2019 and December 31, 2018 are summarized in the following table.

Table 12.1 – Components of Other Assets



(In Thousands)	September 30, 2019		December 31, 2018
Margin receivable	$	226,727	$	100,773
Pledged collateral	57,832		42,433
FHLBC stock	43,393		43,393
Investment receivable	14,375		6,959
Right-of-use asset	11,076		—
REO	5,069		3,943
Fixed assets and leasehold improvements ⁽¹⁾	4,794		5,106
Other	14,044		15,218
Total Other Assets	$	377,310	$	217,825


(1)	Fixed assets and leasehold improvements had a basis of $11 million and accumulated depreciation of $6 million at September 30, 2019.

Accrued expenses and other liabilities at September 30, 2019 and December 31, 2018 are summarized in the following table.

Table 12.2 – Components of Accrued Expenses and Other Liabilities



(In Thousands)	September 30, 2019		December 31, 2018
Contingent consideration	$	25,167	$	—
Payable to minority partner	18,664		14,331
Accrued compensation	17,219		19,769
Guarantee obligations	15,016		16,711
Lease liability	12,570		—
Deferred tax liabilities	11,986		9,022
Margin payable	6,658		835
Accrued operating expenses	6,036		3,122
Residential bridge loan holdbacks	4,465		—
Residential loan and MSR repurchase reserve	3,947		4,189
Legal reserve	2,000		2,000
Other	6,014		8,740
Total Accrued Expenses and Other Liabilities	$	129,742	$	78,719

Margin Receivable and Payable

Margin receivable and payable resulted from margin calls between us and our counterparties under derivatives, master repurchase agreements, and warehouse facilities, whereby we or the counterparty posted collateral.

FHLBC Stock

In accordance with our FHLB-member subsidiary's borrowing agreement with the FHLBC, our subsidiary is required to purchase and hold stock in the FHLBC. See Note 3 and Note 15 for additional information on this borrowing agreement.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 12. Other Assets and Liabilities - (continued)

Pledged Collateral and Guarantee Obligations

The pledged collateral and guarantee obligations presented in the tables above are related to our risk-sharing arrangements with Fannie Mae and Freddie Mac, as well as collateral pledged to a clearinghouse related to our interest rate agreements. In accordance with these arrangements, we are required to pledge collateral to secure our guarantee obligations and to meet margin requirements for our interest rate agreements. See Note 3 and Note 16 for additional information on our risk-sharing arrangements.

Contingent Consideration

The contingent consideration presented in the table above is related to our acquisition of 5 Arches in the first quarter of 2019. See Note 16 for additional information on our contingent consideration liabilities.

Lease Liability and Right-of-Use Asset

The lease liability and right-of-use asset presented in the tables above resulted from our adoption of ASU 2016-02, "Leases," in the first quarter of 2019. The lease liability is equal to the present value of our remaining lease payments discounted at our incremental borrowing rate and the right-of-use asset is equal to the lease liability adjusted for our deferred rent liability. These balances are reduced as lease payments are made. See Note 16 for additional information on leases.

Residential Bridge Loan Holdbacks

Residential bridge loan holdbacks represent loan amounts payable to residential bridge loan borrowers subject to the completion of various phases of property rehabilitation.

Investment Receivable

At September 30, 2019, investment receivable primarily consisted of unsettled trade receivables related to real estate securities sales. In accordance with our policy to record purchases and sales of securities on the trade date, if the trade and settlement of a purchase or sale crosses over a quarterly reporting period, we will record an investment receivable for sales and an unsettled trades liability for purchases.

REO

The carrying value of REO at September 30, 2019 was $5 million, which included $0.5 million of REO from our Legacy Sequoia entities, $5 million from our residential bridge loan portfolio, and $0.1 million from our consolidated Freddie Mac SLST entities. During the nine months ended September 30, 2019, transfers into REO included $0.2 million from Legacy Sequoia entities, a $5 million residential bridge loan, and $0.1 million from Freddie Mac SLST entities. During the nine months ended September 30, 2019, there were Legacy Sequoia REO liquidations of $5 million, resulting in $1 million of unrealized gains which were recorded in Investment fair value changes, net, on our consolidated statements of income. At September 30, 2019, there were three REO properties at our Legacy Sequoia entities, one residential bridge loan REO property, and one REO property at our Freddie Mac SLST entities recorded on our consolidated balance sheets. At December 31, 2018, there were 13 REO properties recorded, all of which were owned at consolidated Legacy Sequoia entities.

Legal and Repurchase Reserves

See Note 16 for additional information on the legal and residential repurchase reserves.

Payable to Minority Partner

In 2018, Redwood and a third-party co-investor, through two partnership entities consolidated by Redwood, purchased servicer advances and excess MSRs related to a portfolio of residential mortgage loans serviced by the co-investor (see Note 4 and Note 10 for additional information on the partnership entities and associated investments). We account for the co-investor’s interests in the entities as liabilities and at September 30, 2019, the carrying value of their interests was $19 million, representing their current economic interest in the entities. Earnings from the partnership entities are allocated to the co-investors on a proportional basis and during the three and nine months ended September 30, 2019, we allocated $0.4 million and $0.9 million of gains to the co-investors, respectively, which were recorded in Other income, net on our consolidated statements of income.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 13. Short-Term Debt

We enter into repurchase agreements, bank warehouse agreements, and other forms of collateralized (and generally uncommitted) short-term borrowings with several banks and major investment banking firms. At September 30, 2019, we had outstanding agreements with several counterparties and we were in compliance with all of the related covenants. For additional information about these financial covenants and our short-term debt, see Part I, Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Quarterly Report on Form 10-Q and Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2018.

The table below summarizes our short-term debt, including the facilities that are available to us, the outstanding balances, the weighted average interest rate, and the maturity information at September 30, 2019 and December 31, 2018.

Table 13.1 – Short-Term Debt



	September 30, 2019
(Dollars in Thousands)	Number of Facilities	Outstanding Balance		Limit		Weighted Average Interest Rate		Maturity	Weighted Average Days Until Maturity
Facilities
Residential loan warehouse ⁽¹⁾	4	$	233,224	$	1,425,000	3.51	%	10/2019-3/2020	96
Real estate securities repo⁽¹⁾	9	1,157,646		—		3.11	%	10/2019-1/2020	28
Single-family rental loan warehouse ⁽²⁾	2	59,204		400,000		4.30	%	6/2020-6/2021	358
Residential bridge loan warehouse ⁽²⁾	4	138,988		330,000		4.54	%	10/2019-5/2022	707
Business purpose loan working capital ⁽²⁾	1	—		15,000		5.00	%	12/2020	N/A
Total Short-Term Debt Facilities	20	1,589,062
Servicer advance financing	1	191,203		350,000		3.89	%	11/2019	46
Convertible notes, net	N/A	200,552		—		5.63	%	11/2019	60
Total Short-Term Debt		$	1,980,817

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 13. Short-Term Debt - (continued)



	December 31, 2018
(Dollars in Thousands)	Number of Facilities	Outstanding Balance		Limit		Weighted Average Interest Rate		Maturity	Weighted Average Days Until Maturity
Facilities
Residential loan warehouse ⁽¹⁾	4	$	860,650	$	1,425,000	4.10	%	2/2019-12/2019	178
Real estate securities repo⁽¹⁾	9	988,890		—		3.47	%	1/2019-3/2019	26
Single-family rental loan warehouse ⁽²⁾	2	22,053		400,000		4.77	%	6/2020-6/2021	560
Residential bridge loan warehouse ⁽²⁾	2	66,327		80,000		5.20	%	11/2019-4/2021	629
Total Short-Term Debt Facilities	17	1,937,920
Servicer advance financing	1	262,740		350,000		4.32	%	11/2019	333
Convertible notes, net	N/A	199,619				5.63	%	11/2019	319
Total Short-Term Debt		$	2,400,279


(1)	Borrowings under our facilities are generally charged interest based on a specified margin over the one-month LIBOR interest rate. At September 30, 2019, all of these borrowings were under uncommitted facilities and were due within 364 days (or less) of the borrowing date.


(2)	Due to the revolving nature of the borrowings under these facilities, we have classified these facilities as short-term debt at September 30, 2019. Borrowings under these facilities will be repaid as the underlying loans mature or are sold to third parties or transferred to securitizations.

At September 30, 2019 and December 31, 2018, the fair value of held-for-sale residential loans pledged as collateral under our short-term debt facilities was $253 million and $935 million, respectively. At September 30, 2019, the fair value of real estate securities pledged as collateral under our short-term debt facilities was $736 million, and also included $113 million of securities retained from our consolidated Sequoia Choice securitizations as well as $385 million and $209 million of securities we owned that were issued by consolidated Freddie Mac SLST and Freddie Mac K-series securitizations, respectively. At December 31, 2018, the fair value of real estate securities pledged as collateral under our short-term debt facilities was $844 million, and also included $130 million of securities retained from our consolidated Sequoia Choice securitizations as well as $229 million and $18 million of securities we owned that were issued by consolidated Freddie Mac SLST and Freddie Mac K-series securitizations, respectively. The fair value of single-family rental and residential bridge loans pledged as collateral under our warehouse facilities was $78 million and $176 million, respectively, at September 30, 2019 and $28 million and $98 million, respectively, at December 31, 2018.

For the three and nine months ended September 30, 2019, the average balances of our short-term debt facilities were $1.97 billion and $1.81 billion, respectively. At September 30, 2019 and December 31, 2018, accrued interest payable on our short-term debt facilities was $3 million and $4 million, respectively.

Servicer advance financing consists of non-recourse short-term securitization debt used to finance servicer advance investments. We consolidate the securitization entity that issued the debt, but the entity is independent of Redwood and the assets and liabilities are not owned by and are not legal obligations of Redwood. At September 30, 2019, the fair value of servicer advances, cash and restricted cash collateralizing the securitization financing was $243 million. At September 30, 2019, the accrued interest payable balance on this financing was $0.2 million and the unamortized capitalized commitment costs were $0.4 million.

During the fourth quarter of 2018, $201 million principal amount of 5.625% exchangeable senior notes and $1 million of unamortized deferred issuance costs were reclassified from long-term debt to short-term debt as the maturity of the notes was less than one year as of November 2018. At September 30, 2019, the accrued interest payable balance on this debt was $4 million. See Note 15 for additional information on our convertible notes.

We also maintain a $10 million committed line of credit with a financial institution that is secured by certain mortgage-backed securities with a fair market value of $3 million at September 30, 2019. At both September 30, 2019 and December 31, 2018, we had no outstanding borrowings on this facility.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 13. Short-Term Debt - (continued)

Remaining Maturities of Short-Term Debt

The following table presents the remaining maturities of our secured short-term debt by the type of collateral securing the debt as well as our convertible notes at September 30, 2019.

Table 13.2 – Short-Term Debt by Collateral Type and Remaining Maturities



	September 30, 2019
(In Thousands)	Within 30 days		31 to 90 days		Over 90 days		Total
Collateral Type
Held-for-sale residential loans	$	31,031	$	108,316	$	93,877	$	233,224
Real estate securities	834,748		293,108		29,790		1,157,646
Single-family rental loans	—		—		59,204		59,204
Residential bridge loans	—		—		138,988		138,988
Total Secured Short-Term Debt	865,779		401,424		321,859		1,589,062
Servicer advance financing	—		191,203		—		191,203
Convertible notes, net	—		200,552		—		200,552
Total Short-Term Debt	$	865,779	$	793,179	$	321,859	$	1,980,817

Note 14. Asset-Backed Securities Issued

Through our Sequoia securitization program, we sponsor securitization transactions in which securities backed by residential mortgage loans (ABS) are issued by Sequoia entities. We consolidated the Legacy Sequoia and Sequoia Choice securitization entities, and beginning in 2018, certain third-party Freddie Mac K-Series and SLST securitization entities, that we determined were VIEs and for which we determined we were the primary beneficiary. Each consolidated 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. 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.

We account for the ABS issued under our consolidated entities at fair value, with periodic changes in fair value recorded in Investment fair value changes, net on our consolidated statements of income. Pursuant to the CFE guidelines, the market valuation changes on our loans are based on the estimated fair value of the associated ABS issued. The net impact to our income statement associated with our retained economic investment in each of these securitization entities is presented in Note 5.

The ABS issued by these entities consist of various classes of securities that pay interest on a monthly basis. All ABS issued by the Sequoia Choice and Freddie Mac K-Series, and Freddie Mac SLST entities pay fixed rates of interest and substantially all ABS issued by the Legacy Sequoia entities pay variable rates of interest, which are indexed to one-, three-, or six-month LIBOR. ABS issued also includes some interest-only classes with coupons set at a fixed spread to a benchmark rate, or set at a spread to the interest rates earned on the assets less the interest rates paid on the liabilities of a securitization entity.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 14. Asset-Backed Securities Issued - (continued)

The carrying values of ABS issued by Sequoia securitization entities we sponsored at September 30, 2019 and December 31, 2018, along with other selected information, are summarized in the following table.

Table 14.1 – Asset-Backed Securities Issued



September 30, 2019	Legacy Sequoia			Sequoia Choice		Freddie Mac SLST			Freddie Mac K-Series		Total
(Dollars in Thousands)	Legacy Sequoia			Sequoia Choice		Freddie Mac SLST			Freddie Mac K-Series		Total
Certificates with principal balance	$	437,793		$	2,285,479	$	1,885,106		$	3,239,009	$	7,847,387
Interest-only certificates	1,486			16,619		28,758			202,730		249,593
Market valuation adjustments	(19,389		)	59,013		73,609			135,838		249,071
ABS Issued, Net	$	419,890		$	2,361,111	$	1,987,473		$	3,577,577	$	8,346,051
Range of weighted average interest rates, by series	2.22% to 3.49%			4.41% to 5.06%		3.50		%	3.39% to 4.20%
Stated maturities	2024 - 2036			2047 - 2049		2028 - 2029			2025 - 2049
Number of series	20			9		2			4



December 31, 2018	Legacy Sequoia			Sequoia Choice		Freddie Mac SLST			Freddie Mac K-Series			Total
(Dollars in Thousands)	Legacy Sequoia			Sequoia Choice		Freddie Mac SLST			Freddie Mac K-Series			Total
Certificates with principal balance	$	540,456		$	1,838,758	$	993,659		$	1,936,691		$	5,309,564
Interest-only certificates	1,537			25,662		—			131,600			158,799
Market valuation adjustments	(29,753		)	20,590		89			(49,216		)	(58,290		)
ABS Issued, Net	$	512,240		$	1,885,010	$	993,748		$	2,019,075		$	5,410,073
Range of weighted average interest rates, by series	1.36% to 3.60%			4.46% to 4.97%		3.51		%	3.39% to 4.08%
Stated maturities	2024 - 2036			2047 - 2048		2028			2025 - 2049
Number of series	20			6		1			3

The actual maturity of each class of ABS issued is primarily determined by the rate of principal prepayments on the assets of the issuing entity. Each series is also subject to redemption prior to the stated maturity according to the terms of the respective governing documents of each ABS issuing entity. As a result, the actual maturity of ABS issued may occur earlier than its stated maturity. At September 30, 2019, all of the ABS issued and outstanding had contractual maturities beyond five years. The following table summarizes the accrued interest payable on ABS issued at September 30, 2019 and December 31, 2018. Interest due on consolidated ABS issued is payable monthly.

Table 14.2 – Accrued Interest Payable on Asset-Backed Securities Issued



(In Thousands)	September 30, 2019		December 31, 2018
Legacy Sequoia	$	456	$	571
Sequoia Choice	8,949		7,180
Freddie Mac SLST	5,498		2,907
Freddie Mac K-Series	10,805		6,239
Total Accrued Interest Payable on ABS Issued	$	25,708	$	16,897

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 14. Asset-Backed Securities Issued - (continued)

The following table summarizes the carrying value components of the collateral for ABS issued and outstanding at September 30, 2019 and December 31, 2018.

Table 14.3 – Collateral for Asset-Backed Securities Issued



September 30, 2019	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		Total
(In Thousands)	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		Total
Residential loans	$	429,159	$	2,618,316	$	2,441,223	$	—	$	5,488,698
Multifamily loans	—		—		—		3,791,622		3,791,622
Restricted cash	143		15		—		—		158
Accrued interest receivable	716		10,806		7,215		11,300		30,037
REO	460		—		84		—		544
Total Collateral for ABS Issued	$	430,478	$	2,629,137	$	2,448,522	$	3,802,922	$	9,311,059



December 31, 2018	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		Total
(In Thousands)	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		Total
Residential loans	$	519,958	$	2,079,382	$	1,222,669	$	—	$	3,822,009
Multifamily loans	—		—		—		2,144,598		2,144,598
Restricted cash	146		1,022		—		—		1,168
Accrued interest receivable	822		8,988		3,926		6,595		20,331
REO	3,943		—		—		—		3,943
Total Collateral for ABS Issued	$	524,869	$	2,089,392	$	1,226,595	$	2,151,193	$	5,992,049

Note 15. Long-Term Debt

FHLBC Borrowings

In July 2014, our FHLB-member subsidiary entered into a borrowing agreement with the Federal Home Loan Bank of Chicago. At September 30, 2019, under this agreement, our subsidiary could incur borrowings up to $2.00 billion, also referred to as “advances,” from the FHLBC secured by eligible collateral, including residential mortgage loans. During the three and nine months ended September 30, 2019, our FHLB-member subsidiary made no additional borrowings under this agreement. Under a final rule published by the Federal Housing Finance Agency in January 2016, our FHLB-member subsidiary will remain an FHLB member through the five-year transition period for captive insurance companies. Our FHLB-member subsidiary's existing $2.00 billion of FHLB debt, which matures beyond this transition period, is permitted to remain outstanding until its stated maturity. As residential loans pledged as collateral for this debt pay down, we are permitted to pledge additional loans or other eligible assets to collateralize this debt; however, we do not expect to be able to increase our subsidiary's FHLB debt above the existing $2.00 billion maximum.

At September 30, 2019, $2.00 billion of advances were outstanding under this agreement, which were classified as long-term debt, with a weighted average interest rate of 2.31% and a weighted average maturity of approximately six years. At December 31, 2018, $2.00 billion of advances were outstanding under this agreement, which were classified as long-term debt, with a weighted average interest rate of 2.52% and a weighted average maturity of seven years. Advances under this agreement incur interest charges based on a specified margin over the FHLBC’s 13-week discount note rate, which resets every 13 weeks. At September 30, 2019, total advances under this agreement were secured by residential mortgage loans with a fair value of $2.27 billion, securities with a fair value of $41 million, and $77 million of restricted cash. This agreement also requires our subsidiary to purchase and hold stock in the FHLBC in an amount equal to a specified percentage of outstanding advances. At September 30, 2019, our subsidiary held $43 million of FHLBC stock that is included in Other assets in our consolidated balance sheets.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 15. Long-Term Debt - (continued)

The following table presents maturities of our FHLBC borrowings by year at September 30, 2019.

Table 15.1 – Maturities of FHLBC Borrowings by Year



(In Thousands)	September 30, 2019
2024	$	470,171
2025	887,639
2026	642,189
Total FHLBC Borrowings	$	1,999,999

For additional information about our FHLBC borrowings, see Part I, Item 2 of Quarterly Report on Form 10-Q under the heading “Risks Relating to Debt Incurred under Short- and Long-Term Borrowing Facilities.”

Subordinate Securities Financing Facility

In September 2019, a subsidiary of Redwood entered into a repurchase agreement providing non-mark-to-market recourse debt financing. The financing is fully and unconditionally guaranteed by Redwood, with an interest rate of approximately 4.21% through September 2022. The financing facility may be terminated, at our option, in September 2022, and has a final maturity in September 2024, provided that the interest rate on amounts outstanding under the facility increases between October 2022 and September 2024. At September 30, 2019, we had borrowings under this facility totaling $186 million, net of $1 million of deferred issuance costs, for a carrying value of $185 million. At September 30, 2019, the fair value of real estate securities pledged as collateral under this long-term debt facility was $253 million, which included $126 million of securities retained from our consolidated Sequoia Choice securitizations. This facility is included in Long-term debt, net on our consolidated balance sheets at September 30, 2019.

Convertible Notes

In September 2019, RWT Holdings, Inc., a wholly-owned subsidiary of Redwood Trust, Inc., issued $201 million principal amount of 5.75% exchangeable senior notes due 2025. These exchangeable notes require semi-annual interest payments at a fixed coupon rate of 5.75% until maturity or exchange, which will be no later than October 1, 2025. After deducting the underwriting discount and offering costs, we received $195 million of net proceeds. Including amortization of deferred debt issuance costs, the weighted average interest expense yield on these exchangeable notes is approximately 6.3% per annum. At September 30, 2019, these notes were exchangeable at the option of the holder at an exchange rate of 55.1967 common shares per $1,000 principal amount of exchangeable senior notes (equivalent to an exchange price of $18.12 per common share). Upon exchange of these notes by a holder, the holder will receive shares of our common stock. At September 30, 2019, the outstanding principal amount of these notes was $201 million. At September 30, 2019, the accrued interest payable balance on this debt was $0.2 million and the unamortized deferred issuance costs were $6 million.

In June 2018, we issued $200 million principal amount of 5.625% convertible senior notes due 2024 at an issuance price of 99.5%. These convertible notes require semi-annual interest payments at a fixed coupon rate of 5.625% until maturity or conversion, which will be no later than July 15, 2024. After deducting the issuance discount, the underwriting discount and offering costs, we received $194 million of net proceeds. Including amortization of deferred debt issuance costs and the debt discount, the weighted average interest expense yield on these convertible notes is approximately 6.2% per annum. These notes are convertible at the option of the holder at a conversion rate of 54.7645 common shares per $1,000 principal amount of convertible senior notes (equivalent to a conversion price of $18.26 per common share). Upon conversion of these notes by a holder, the holder will receive shares of our common stock. At September 30, 2019, the outstanding principal amount of these notes was $200 million and the accrued interest payable on this debt was $2 million. At September 30, 2019, the unamortized deferred issuance costs and debt discount were $4 million and $1 million, respectively.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 15. Long-Term Debt - (continued)

In August 2017, we issued $245 million principal amount of 4.75% convertible senior notes due 2023. These convertible notes require semi-annual interest payments at a fixed coupon rate of 4.75% until maturity or conversion, which will be no later than August 15, 2023. After deducting the underwriting discount and offering costs, we received $238 million of net proceeds. Including amortization of deferred debt issuance costs, the weighted average interest expense yield on these convertible notes is approximately 5.3% per annum. At September 30, 2019, these notes were convertible at the option of the holder at a conversion rate of 53.9060 common shares per $1,000 principal amount of convertible senior notes (equivalent to a conversion price of $18.55 per common share). Upon conversion of these notes by a holder, the holder will receive shares of our common stock. At September 30, 2019, the outstanding principal amount of these notes was $245 million. At September 30, 2019, the accrued interest payable balance on this debt was $1 million and the unamortized deferred issuance costs were $5 million.

In November 2014, RWT Holdings, Inc., a wholly-owned subsidiary of Redwood Trust, Inc., issued $205 million principal amount of 5.625% exchangeable senior notes due 2019. These exchangeable notes require semi-annual interest payments at a fixed coupon rate of 5.625% until maturity or exchange, which will be no later than November 15, 2019. After deducting the underwriting discount and offering costs, we received $198 million of net proceeds. Including amortization of deferred debt issuance costs, the weighted average interest expense yield on these exchangeable notes is approximately 6.3% per annum. At September 30, 2019, these notes were exchangeable at the option of the holder at an exchange rate of 46.2370 common shares per $1,000 principal amount of exchangeable senior notes (equivalent to an exchange price of $21.63 per common share). Upon exchange of these notes by a holder, the holder will receive shares of our common stock. During 2016, we repurchased $4 million par value of these notes at a discount and recorded a gain on extinguishment of debt of $0.3 million in Realized gains, net on our consolidated statements of income. Additionally, during the fourth quarter of 2018, $201 million principal amount of these notes and $1 million of unamortized deferred issuance costs were reclassified from long-term debt to short-term debt as the maturity of the notes was less than one year as of November 2018. At September 30, 2019, the outstanding principal amount of these notes was $201 million. At September 30, 2019, the accrued interest payable balance on this debt was $4 million and the unamortized deferred issuance costs were $0.2 million.

Trust Preferred Securities and Subordinated Notes

At September 30, 2019, we had trust preferred securities and subordinated notes outstanding of $100 million and $40 million, respectively. This debt requires quarterly interest payments at a floating rate equal to three-month LIBOR plus 2.25% until the notes are redeemed. The $100 million trust preferred securities will be redeemed no later than January 30, 2037, and the $40 million subordinated notes will be redeemed no later than July 30, 2037. Prior to 2014, we entered into interest rate swaps with aggregate notional values totaling $140 million to hedge the variability in this long-term debt interest expense. Including hedging costs and amortization of deferred debt issuance costs, the weighted average interest expense yield on our trust preferred securities and subordinated notes is approximately 6.9% per annum. At both September 30, 2019 and December 31, 2018, the accrued interest payable balance on our trust preferred securities and subordinated notes was $1 million.

Under the terms of this debt, we covenant, among other things, to use our best efforts to continue to qualify as a REIT. If an event of default were to occur in respect of this debt, we would generally be restricted under its terms (subject to certain exceptions) from making dividend distributions to stockholders, from repurchasing common stock or repurchasing or redeeming any other then-outstanding equity securities, and from making any other payments in respect of any equity interests in us or in respect of any then-outstanding debt that is pari passu or subordinate to this debt.

Note 16. Commitments and Contingencies

Lease Commitments

At September 30, 2019, we were obligated under five non-cancelable operating leases with expiration dates through 2028 for $15 million of cumulative lease payments. Our principal executive and administrative office is located in Mill Valley, California and we have several additional offices, as disclosed in Part I, Item 2 of our Annual Report on Form 10-K for the year ended December 31, 2018. Additionally, with our acquisition of 5 Arches in the first quarter of 2019, we added an office located in Irvine, California. Our operating lease expense was $2 million for both nine-month periods ended September 30, 2019 and 2018.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 16. Commitments and Contingencies - (continued)

The following table presents our future lease commitments and a reconciliation to our lease liability at September 30, 2019.

Table 16.1 – Future Lease Commitments by Year



(In Thousands)	September 30, 2019
2019 (3 months)	$	688
2020	2,721
2021	1,864
2022	1,468
2023 and thereafter	8,749
Total Lease Commitments	15,490
Less: Imputed interest	(2,920		)
Lease Liability	$	12,570

During the first quarter of 2019, we adopted ASU 2016-02, "Leases," which required us to recognize a lease liability that was equal to the present value of our remaining lease payments of $15 million discounted at various incremental borrowing rates, and a right-of-use asset, which was equal to our lease liability adjusted for our deferred rent liability. We elected to apply the new guidance using the optional transition method, which permits lessees to measure the lease liability and right-of-use asset at January 1, 2019, without adjusting the comparative periods presented. We elected the package of practical expedients under the transition guidance within this standard, which allowed us to carry forward the classifications of each of our four existing leases as operating leases and to continue to expense lease payments on a straight-line basis. As one of our operating leases qualifies for the short-term lease exception under this guidance, we will continue to account for this lease under legacy GAAP and did not include this lease in our calculation of the lease liability and right-of-use asset. At September 30, 2019, our lease liability was $13 million, which was a component of Accrued expenses and other liabilities, and our right-of-use asset was $11 million, which was a component of Other assets.

We determined that the four remaining leases did not contain an implicit interest rate and used a discount rate equal to our incremental borrowing rate on a collateralized basis to determine the present value of our total lease payments. As such, we determined the applicable discount rate for each of our leases using a swap rate plus an applicable spread for borrowing arrangements secured by our real estate loans and securities for a length of time equal to the remaining lease term on the date of adoption. At September 30, 2019, the weighted-average remaining lease term and weighted-average discount rate for our leases was 8 years and 5.3%, respectively.

Commitment to Fund Residential Bridge Loans

As of September 30, 2019, we had commitments to fund $67 million of residential bridge loans. These commitments are generally subject to loan agreements with covenants regarding the financial performance of the customer and other terms regarding advances that must be met before we fund the commitment. We may also advance funds related to loans sold under a separate loan sale agreement that are generally repaid immediately by the loan purchaser and do not generally expose us to loss (outstanding commitments related to these loans that we may temporarily fund totaled approximately $65 million at September 30, 2019).

Commitment to Fund Partnerships

In the fourth quarter of 2018, we invested in two partnerships created to acquire and manage certain mortgage servicing related assets (see Note 10 for additional detail). In connection with this investment, we are required to fund future net servicer advances related to the underlying mortgage loans. The actual amount of net servicer advances we may fund in the future is subject to significant uncertainty and will be based on the credit and prepayment performance of the underlying loans.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 16. Commitments and Contingencies - (continued)

In the first quarter of 2019, we invested in a partnership created to acquire floating rate, light-renovation multifamily loans from Freddie Mac (see Note 10 for additional detail). At September 30, 2019, we had an outstanding commitment to fund an additional $49 million to the partnership. Additionally, in connection with this transaction, we have made a guarantee to Freddie Mac in the event of losses incurred on the loans that exceed the equity available in the partnership to absorb such losses. At September 30, 2019, the carrying value of this guarantee was $0.1 million. We believe the likelihood of performance under the guarantee is remote. Our maximum loss exposure from this guarantee arrangement is $135 million.

5 Arches Contingent Consideration

As part of the consideration for our acquisition of 5 Arches, we are committed to make earn-out payments up to $27 million, payable in a mix of cash and Redwood common stock, which will be calculated following each of the first two anniversaries of the option closing date based on loan origination volumes exceeding certain specified thresholds. These contingent earn-out payments are classified as a contingent consideration liability and carried at fair value. At September 30, 2019, our estimated fair value of this contingent liability was $25 million. For the three and nine months ended September 30, 2019, we recorded contingent consideration expense of $0.2 million and $0.5 million, respectively, related to our valuation of this liability through Other income, net, on our consolidated statements of income.

Commitment to Fund Shared Home Appreciation Options

In the third quarter of 2019, we entered into a flow purchase agreement to acquire shared home appreciation options. The counterparty purchases an option to buy a fractional interest in a homeowner's ownership interest in his or her real property, and subsequently the counterparty sells the option contract to us. Pursuant to the terms of the option contract, we are able to share in both home price appreciation and depreciation. At September 30, 2019, we had acquired $11 million of shared home appreciation options under this agreement, which are included in Other Investments on our consolidated balance sheets. At September 30, 2019, we had an outstanding commitment to fund up to an additional $39 million under this agreement.

Commitment to Participate in Loan Warehouse Facility

In the second quarter of 2018, we invested in a participation in the mortgage loan warehouse credit facility of one of our loan sellers. This investment included a commitment to participate in (and an obligation to fund) a designated amount of the loan seller's borrowings under this warehouse credit facility. Our commitment to participate in this facility was terminated in the first quarter of 2019. See Note 10 for additional detail on our participation in a loan warehouse facility.

Loss Contingencies — Risk-Sharing

During 2015 and 2016, we sold conforming loans to the Agencies with an original unpaid principal balance of $3.19 billion, subject to our risk-sharing arrangements with the Agencies. At September 30, 2019, the maximum potential amount of future payments we could be required to make under these arrangements was $44 million and this amount was fully collateralized by assets we transferred to pledged accounts and is presented as pledged collateral in Other assets on our consolidated balance sheets. We have no recourse to any third parties that would allow us to recover any amounts related to our obligations under the arrangements. At September 30, 2019, we had not incurred any losses under these arrangements. For the three and nine months ended September 30, 2019, other income related to these arrangements was $1 million and $2 million, respectively, and net market valuation losses related to these investments were $0.1 million and $0.2 million, respectively. For the three and nine months ended September 30, 2018, other income related to these arrangements was $1 million and $3 million, respectively, and net market valuation losses related to these investments were $0.1 million and $0.5 million, respectively.

All of the loans in the reference pools subject to these risk-sharing arrangements were originated in 2014 and 2015, and at September 30, 2019, the loans had an unpaid principal balance of $1.66 billion and a weighted average FICO score of 759 (at origination) and LTV ratio of 76% (at origination). At September 30, 2019, $7 million of the loans were 90 days or more delinquent, of which $2 million were in foreclosure. At September 30, 2019, the carrying value of our guarantee obligation was $15 million and included $5 million designated as a non-amortizing credit reserve, which we believe is sufficient to cover current expected losses under these obligations.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 16. Commitments and Contingencies - (continued)

Our consolidated balance sheets include assets of special purpose entities ("SPEs") associated with these risk-sharing arrangements (i.e., the "pledged collateral" referred to above) that can only be used to settle obligations of these SPEs for which the creditors of these SPEs (the Agencies) do not have recourse to Redwood Trust, Inc. or its affiliates. At September 30, 2019 and December 31, 2018, assets of such SPEs totaled $48 million and $47 million, respectively, and liabilities of such SPEs totaled $15 million and $17 million, respectively.

Loss Contingencies — Residential Repurchase Reserve

We maintain a repurchase reserve for potential obligations arising from representation and warranty violations related to residential loans we have sold to securitization trusts or third parties and for conforming residential loans associated with MSRs that we have purchased from third parties. We do not originate residential loans and we believe the initial risk of loss due to loan repurchases (i.e., due to a breach of representations and warranties) would generally be a contingency to the companies from whom we acquired the loans. However, in some cases, for example, where loans were acquired from companies that have since become insolvent, repurchase claims may result in our being liable for a repurchase obligation.

At both September 30, 2019 and December 31, 2018, our repurchase reserve associated with our residential loans and MSRs was $4 million and was recorded in Accrued expenses and other liabilities on our consolidated balance sheets. We received 10 repurchase requests during the nine months ended September 30, 2019, and did not repurchase any loans during this period. During both the nine months ended September 30, 2019 and 2018, we recorded reversals of repurchase provisions of $0.2 million that were recorded in Mortgage banking activities, net and Other income, net on our consolidated statements of income.

Loss Contingencies — Litigation

On or about December 23, 2009, the Federal Home Loan Bank of Seattle (the “FHLB-Seattle”) filed a complaint in the Superior Court for the State of Washington (case number 09-2-46348-4 SEA) against Redwood Trust, Inc., our subsidiary, Sequoia Residential Funding, Inc. (“SRF”), Morgan Stanley & Co., and Morgan Stanley Capital I, Inc. (collectively, the “FHLB-Seattle Defendants”), which alleged that the FHLB-Seattle Defendants made false or misleading statements in offering materials for a mortgage pass-through certificate (the “Seattle Certificate”) issued in the Sequoia Mortgage Trust 2005-4 securitization transaction (the “2005-4 RMBS”) and purchased by the FHLB-Seattle. The Seattle Certificate was issued with an original principal amount of approximately $133 million, and, at September 30, 2019, approximately $128 million of principal and $12 million of interest payments had been made in respect of the Seattle Certificate. The matter was subsequently resolved and the claims were dismissed by the FHLB Seattle as to all the FHLB Seattle Defendants. At the time the Seattle Certificate was issued, Redwood agreed to indemnify the underwriters of the 2005-4 RMBS, which underwriters were named as defendants in the action, for certain losses and expenses they might incur as a result of claims made against them relating to this RMBS, including, without limitation, certain legal expenses. Regardless of the resolution of this litigation, we could incur a loss as a result of these indemnities.

On or about July 15, 2010, The Charles Schwab Corporation (“Schwab”) filed a complaint in the Superior Court for the State of California in San Francisco (case number CGC-10-501610) against SRF and 26 other defendants (collectively, the “Schwab Defendants”), which alleged that the Schwab Defendants made false or misleading statements in offering materials for various residential mortgage-backed securities sold or issued by the Schwab Defendants. Schwab alleged only a claim for negligent misrepresentation under California state law against SRF and sought unspecified damages and attorneys’ fees and costs from SRF. Schwab claimed that SRF made false or misleading statements in offering materials for a mortgage pass-through certificate (the “Schwab Certificate”) issued in the 2005-4 RMBS and purchased by Schwab. The Schwab Certificate was issued with an original principal amount of approximately $15 million, and, at September 30, 2019, approximately $14 million of principal and $1 million of interest payments had been made in respect of the Schwab Certificate. On November 14, 2014, Schwab voluntarily dismissed with prejudice its negligent misrepresentation claim, which resulted in the dismissal with prejudice of SRF from the action. Subsequently, the matter was resolved and Schwab dismissed its claims against the lead underwriter of the 2005-4 RMBS. At the time the Schwab Certificate was issued, Redwood agreed to indemnify the underwriters of the 2005-4 RMBS, which underwriters were also named as defendants in the action, for certain losses and expenses they might incur as a result of claims made against them relating to this RMBS, including, without limitation, certain legal expenses. Regardless of the resolution of this litigation, Redwood could incur a loss as a result of these indemnities.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 16. Commitments and Contingencies - (continued)

Through certain of our wholly-owned subsidiaries, we have in the past engaged in, and expect to continue to engage in, activities relating to the acquisition and securitization of residential mortgage loans. In addition, certain of our wholly-owned subsidiaries have in the past engaged in activities relating to the acquisition and securitization of debt obligations and other assets through the issuance of collateralized debt obligations (commonly referred to as CDO transactions). Because of this involvement in the securitization and CDO businesses, we could become the subject of litigation relating to these businesses, including additional litigation of the type described above, and we could also become the subject of governmental investigations, enforcement actions, or lawsuits, and governmental authorities could allege that we violated applicable law or regulation in the conduct of our business. As an example, in July 2016 we became aware of a complaint filed by the State of California on April 1, 2016 against Morgan Stanley & Co. and certain of its affiliates alleging, among other things, that there were misleading statements contained in offering materials for 28 different mortgage pass-through certificates purchased by various California investors, including various California public pension systems, from Morgan Stanley and alleging that Morgan Stanley made false or fraudulent claims in connection with the sale of those certificates. Of the 28 mortgage pass-through certificates that were the subject of the complaint, two were Sequoia mortgage pass-through certificates issued in 2004 and two were Sequoia mortgage pass-through certificates issued in 2007. With respect to each of those certificates, our wholly-owned subsidiary, RWT Holdings, Inc., was the sponsor and our wholly-owned subsidiary, Sequoia Residential Funding, Inc., was the depositor. The plaintiffs subsequently withdrew from the litigation their claims based on eight of the 28 mortgage pass-through certificates, including one of the Sequoia mortgage pass-through certificates issued in 2004. We believe this matter was subsequently resolved and the plaintiffs withdrew their remaining claims. At the time these Sequoia mortgage pass-through certificates were issued, Sequoia Residential Funding, Inc. and Redwood Trust agreed to indemnify the underwriters of these certificates for certain losses and expenses they might incur as a result of claims made against them relating to these certificates, including, without limitation, certain legal expenses. Regardless of the resolution of this litigation, we could incur a loss as a result of these indemnities.

In accordance with GAAP, we review the need for any loss contingency reserves and establish reserves when, in the opinion of management, it is probable that a matter would result in a liability and the amount of loss, if any, can be reasonably estimated. Additionally, we record receivables for insurance recoveries relating to litigation-related losses and expenses if and when such amounts are covered by insurance and recovery of such losses or expenses are due. At September 30, 2019, the aggregate amount of loss contingency reserves established in respect of the FHLB-Seattle and Schwab litigation matters described above was $2 million. We review our litigation matters each quarter to assess these loss contingency reserves and make adjustments in these reserves, upwards or downwards, as appropriate, in accordance with GAAP based on our review.

In the ordinary course of any litigation matter, including certain of the above-referenced matters, we have engaged and may continue to engage in formal or informal settlement communications with the plaintiffs or co-defendants. Settlement communications we have engaged in relating to certain of the above-referenced litigation matters are one of the factors that have resulted in our determination to establish the loss contingency reserves described above. We cannot be certain that any of these matters will be resolved through a settlement prior to trial and we cannot be certain that the resolution of these matters, whether through trial or settlement, will not have a material adverse effect on our financial condition or results of operations in any future period.

Future developments (including resolution of substantive pre-trial motions relating to these matters, receipt of additional information and documents relating to these matters (such as through pre-trial discovery), new or additional settlement communications with plaintiffs relating to these matters, or resolutions of similar claims against other defendants in these matters) could result in our concluding in the future to establish additional loss contingency reserves or to disclose an estimate of reasonably possible losses in excess of our established reserves with respect to these matters. Our actual losses with respect to the above-referenced litigation matters may be materially higher than the aggregate amount of loss contingency reserves we have established in respect of these litigation matters, including in the event that any of these matters proceeds to trial and the plaintiff prevails. Other factors that could result in our concluding to establish additional loss contingency reserves or estimate additional reasonably possible losses, or could result in our actual losses with respect to the above-referenced litigation matters being materially higher than the aggregate amount of loss contingency reserves we have established in respect of these litigation matters include that: there are significant factual and legal issues to be resolved; information obtained or rulings made during the lawsuits could affect the methodology for calculation of the available remedies; and we may have additional obligations pursuant to indemnity agreements, representations and warranties, and other contractual provisions with other parties relating to these litigation matters that could increase our potential losses.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 17. Equity

The following table provides a summary of changes to accumulated other comprehensive income by component for the three and nine months ended September 30, 2019 and 2018.

Table 17.1 – Changes in Accumulated Other Comprehensive Income by Component



	Three Months Ended September 30, 2019						Three Months Ended September 30, 2018
(In Thousands)	Net Unrealized Gains on Available-for-Sale Securities			Net Unrealized Losses on Interest Rate Agreements Accounted for as Cash Flow Hedges			Net Unrealized Gains on Available-for-Sale Securities			Net Unrealized Losses on Interest Rate Agreements Accounted for as Cash Flow Hedges
Balance at beginning of period	$	98,307		$	(49,384	)	$	106,725		$	(31,105	)
Other comprehensive income (loss) before reclassifications ⁽¹⁾	4,484			(11,791		)	(2,408		)	4,801
Amounts reclassified from other accumulated comprehensive income	(3,492		)	—			(5,686		)	—
Net current-period other comprehensive income (loss)	992			(11,791		)	(8,094		)	4,801
Balance at End of Period	$	99,299		$	(61,175	)	$	98,631		$	(26,304	)



	Nine Months Ended September 30, 2019						Nine Months Ended September 30, 2018
(In Thousands)	Net Unrealized Gains on Available-for-Sale Securities			Net Unrealized Losses on Interest Rate Agreements Accounted for as Cash Flow Hedges			Net Unrealized Gains on Available-for-Sale Securities			Net Unrealized Losses on Interest Rate Agreements Accounted for as Cash Flow Hedges
Balance at beginning of period	$	95,342		$	(34,045	)	$	128,201		$	(42,953	)
Other comprehensive income (loss) before reclassifications ⁽¹⁾	19,764			(27,130		)	(9,749		)	16,649
Amounts reclassified from other accumulated comprehensive income	(15,807		)	—			(19,821		)	—
Net current-period other comprehensive income (loss)	3,957			(27,130		)	(29,570		)	16,649
Balance at End of Period	$	99,299		$	(61,175	)	$	98,631		$	(26,304	)


(1)	Amounts presented for net unrealized gains on available-for-sale securities are net of tax benefit (provision) of zero and $0.1 million for the three and nine months ended September 30, 2018, respectively.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 17. Equity - (continued)

The following table provides a summary of reclassifications out of accumulated other comprehensive income for the three and nine months ended September 30, 2019 and 2018.

Table 17.2 – Reclassifications Out of Accumulated Other Comprehensive Income




		Amount Reclassified From Accumulated Other Comprehensive Income
	Affected Line Item in the	Three Months Ended September 30,
(In Thousands)	Income Statement	2019			2018
Net Realized (Gain) Loss on AFS Securities
Other than temporary impairment ⁽¹⁾	Investment fair value changes, net	$	—		$	33
Gain on sale of AFS securities	Realized gains, net	(3,492		)	(7,247		)
Gain on sale of AFS securities	Provision for income taxes	—			1,528
		$	(3,492	)	$	(5,686	)



		Amount Reclassified From Accumulated Other Comprehensive Income
	Affected Line Item in the	Nine Months Ended September 30,
(In Thousands)	Income Statement	2019			2018
Net Realized (Gain) Loss on AFS Securities
Other than temporary impairment ⁽¹⁾	Investment fair value changes, net	$	—		$	89
Gain on sale of AFS securities	Realized gains, net	(15,807		)	(21,438		)
Gain on sale of AFS securities	Provision for income taxes	—			1,528
		$	(15,807	)	$	(19,821	)

(1)

For both the three and nine months ended September 30, 2019, there were no other-than-temporary impairments. For the three months ended September 30, 2018, other-than-temporary impairments were $0.4 million, of which less than $0.1 million were recognized through our consolidated statements of income and $0.3 million were recognized in Accumulated other comprehensive income, a component of our consolidated balance sheet. For the nine months ended September 30, 2018, other-than-temporary impairments were $0.6 million, of which $0.1 million were recognized through our consolidated statements of income and $0.5 million were recognized in Accumulated other comprehensive income, a component of our consolidated balance sheet.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

(Unaudited)

Note 17. Equity - (continued)

Issuance of Common Stock

In 2018, we established a program to sell up to an aggregate of $150 million of common stock from time to time in at-the-market ("ATM") offerings. During the nine months ended September 30, 2019, we issued 791,191 common shares for net proceeds of approximately $13 million through ATM offerings. At September 30, 2019, approximately $112 million remained outstanding for future offerings under this program.

On January 29, 2019, we sold 11,500,000 shares of common stock in an underwritten public offering, resulting in net proceeds of approximately $177 million. On September 3, 2019, we sold 14,375,000 shares of common stock in an underwritten public offering, resulting in net proceeds of approximately $228 million.

Direct Stock Purchase and Dividend Reinvestment Plan

During the nine months ended September 30, 2019, we issued 399,838 shares of common stock through our Direct Stock Purchase and Dividend Reinvestment Plan, resulting in net proceeds of approximately $6 million.

Earnings per Common Share

The following table provides the basic and diluted earnings per common share computations for the three and nine months ended September 30, 2019 and 2018.

Table 17.3 – Basic and Diluted Earnings per Common Share



	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands, except Share Data)	2019			2018			2019			2018
Basic Earnings per Common Share:
Net income attributable to Redwood	$	34,310		$	40,921		$	120,040		$	120,513
Less: Dividends and undistributed earnings allocated to participating securities	(856		)	(1,231		)	(3,260		)	(3,766		)
Net income allocated to common shareholders	$	33,454		$