rwt-20200630

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: June 30, 2020


☐			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						114,944,552			shares outstanding as of August 4, 2020

REDWOOD TRUST, INC.

2020 FORM 10-Q REPORT

TABLE OF CONTENTS


		Page
PART I —	FINANCIAL INFORMATION
Item 1.	Financial Statements	2
	Consolidated Balance Sheets at June 3 0 , 2020 (Unaudited) and December 31, 2019	2
	Consolidated Statements of Income (Loss) for the Three and Six Months Ended June 3 0 , 2020 and 2019 (Unaudited)	3
	Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 3 0 , 2020 and 2019 (Unaudited)	4
	Consolidated Statements of Changes in Stockholders' Equity for the Three and Six Months Ended J une 3 0 , 2020 and 2019 (Unaudited)	5
	Consolidated Statements of Cash Flows for the Six Months Ended June 3 0 , 2020 and 2019 (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	12
	Note 4. Principles of Consolidation	16
	Note 5. Fair Value of Financial Instruments	23
	Note 6. Residential Loans	32
	Note 7. Business Purpose Residential Loans	34
	Note 8. Multifamily Loans	37
	Note 9. Real Estate Securities	37
	Note 10. Other Investments	42
	Note 11. Derivative Financial Instruments	44
	Note 12. Other Assets and Liabilities	46
	Note 13. Short-Term Debt	47
	Note 14. Asset-Backed Securities Issued	49
	Note 15. Long-Term Debt	50
	Note 16. Commitments and Contingencies	52
	Note 17. Equity	56
	Note 18. Equity Compensation Plans	59
	Note 19. Mortgage Banking Activities, Net	61
	Note 20. Other Income	62
	Note 21. General and Administrative Expenses and Other Expenses	63
	Note 22. Taxes	64
	Note 23. Segment Information	64
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	69
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	98
Item 4.	Controls and Procedures	98

PART II —	OTHER INFORMATION
Item 1.	Legal Proceedings	99
Item 1A.	Risk Factors	101
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	101
Item 3.	Defaults Upon Senior Securities	101
Item 4.	Mine Safety Disclosures (Not Applicable)	101
Item 5.	Other Information	101
Item 6.	Exhibits	105
Signatures			107

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS


(In Thousands, except Share Data) (Unaudited)	June 30, 2020		December 31, 2019
ASSETS⁽¹⁾
Residential loans, held-for-sale, at fair value	$	20,199	$	536,385
Residential loans, held-for-investment, at fair value	4,514,131		7,178,465
Business purpose residential loans, held-for-sale, at fair value	379,795		331,565
Business purpose residential loans, held-for-investment, at fair value	3,402,405		3,175,178
Multifamily loans, held-for-investment, at fair value	489,075		4,408,524
Real estate securities, at fair value	316,436		1,099,874
Other investments	429,840		358,130
Cash and cash equivalents	528,612		196,966
Restricted cash	44,496		93,867
Goodwill and intangible assets	64,610		161,464


Derivative assets	357		35,701
Other assets	171,586		419,321
Total Assets	$	10,361,542	$	17,995,440

LIABILITIES AND EQUITY ⁽¹⁾
Liabilities
Short-term debt, net	$	662,807	$	2,329,145

Derivative liabilities	1,932		163,424
Accrued expenses and other liabilities	166,013		206,893

Asset-backed securities issued, at fair value	6,856,086		10,515,475
Long-term debt, net	1,738,128		2,953,272
Total liabilities	9,424,966		16,168,209
Commitments and Contingencies (see Note 16)
Equity
Common stock, par value $0.01 per share, 395,000,000 and 270,000,000 shares authorized; 114,940,197 and 114,353,036 issued and outstanding	1,149		1,144
Additional paid-in capital	2,279,625		2,269,617
Accumulated other comprehensive (loss) income	(29,391)		41,513
Cumulative earnings	801,170		1,579,124
Cumulative distributions to stockholders	(2,115,977)		(2,064,167)
Total equity	936,576		1,827,231
Total Liabilities and Equity	$	10,361,542	$	17,995,440

——————

(1)Our consolidated balance sheets include assets of consolidated variable interest entities (“VIEs”) that can only be used to settle obligations of these VIEs and liabilities of consolidated VIEs for which creditors do not have recourse to Redwood Trust, Inc. or its affiliates. At June 30, 2020 and December 31, 2019, assets of consolidated VIEs totaled $7,984,618 and $11,931,869, respectively. At June 30, 2020 and December 31, 2019, liabilities of consolidated VIEs totaled $7,140,221 and $10,717,072, respectively. See Note 4 for further discussion.

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

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (LOSS)


(In Thousands, except Share Data)	Three Months Ended June 30,						Six Months Ended June 30,
(Unaudited)	2020		2019		2020		2019
Interest Income
Residential loans	$	54,974	$	77,288	$	134,410	$	153,238
Business purpose residential loans	53,419		3,996		106,073		6,785
Multifamily loans	4,870		35,917		45,042		57,305
Real estate securities	10,027		25,017		28,336		49,467
Other interest income	6,656		6,324		14,166		12,788
Total interest income	129,946		148,542		328,027		279,583
Interest Expense
Short-term debt	(16,907)		(24,275)		(39,974)		(46,493)
Asset-backed securities issued	(65,304)		(70,113)		(165,802)		(125,408)
Long-term debt	(20,455)		(21,832)		(43,561)		(43,595)
Total interest expense	(102,666)		(116,220)		(249,337)		(215,496)
Net Interest Income	27,280		32,322		78,690		64,087
Non-interest Income (Loss)
Mortgage banking activities, net	(5,772)		19,160		(34,183)		31,469
Investment fair value changes, net	152,228		3,138		(718,604)		23,297
Other income, net	955		4,859		3,392		9,484
Realized gains, net	25,965		2,827		29,817		13,513
Total non-interest income (loss), net	173,376		29,984		(719,578)		77,763
General and administrative expenses	(30,092)		(26,255)		(62,760)		(49,414)
Other expenses	(5,083)		(2,452)		(96,498)		(3,490)
Net Income (Loss) before (Provision for) Benefit from Income Taxes	165,481		33,599		(800,146)		88,946
(Provision for) benefit from income taxes	(37)		(2,333)		22,192		(3,216)
Net Income (Loss)	$	165,444	$	31,266	$	(777,954)	$	85,730

Basic earnings (loss) per common share	$	1.41	$	0.31	$	(6.82)	$	0.88
Diluted earnings (loss) per common share	$	1.00	$	0.30	$	(6.82)	$	0.78
Basic weighted average shares outstanding	114,383,289		96,983,764		114,229,928		94,846,431
Diluted weighted average shares outstanding	147,099,079		130,696,954		114,229,928		128,499,431

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

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)


(In Thousands)	Three Months Ended June 30,						Six Months Ended June 30,
(Unaudited)	2020		2019		2020		2019
Net Income (Loss)	$	165,444	$	31,266	$	(777,954)	$	85,730
Other comprehensive income (loss):
Net unrealized gain (loss) on available-for-sale securities	52,393		8,562		(28,126)		15,280
Reclassification of unrealized loss (gain) on available-for-sale securities to net income	2,718		(2,822)		(11,080)		(12,315)
Net unrealized loss on interest rate agreements	—		(9,501)		(32,806)		(15,339)
Reclassification of unrealized loss on interest rate agreements to net income	1,029		—		1,108		—
Total other comprehensive income (loss)	56,140		(3,761)		(70,904)		(12,374)
Total Comprehensive Income (Loss)	$	221,584	$	27,505	$	(848,858)	$	73,356

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 June 30, 2020


(In Thousands, except Share Data)	Common Stock					Additional Paid-In Capital		Accumulated Other Comprehensive Income (Loss)		Cumulative Earnings		Cumulative Distributions to Stockholders		Total
(Unaudited)	Shares	Amount
March 31, 2020	114,837,533	$	1,148	$	2,275,808	$	(85,531)	$	635,726	$	(2,101,949)	$	725,202
Net income	—	—		—		—		165,444		—		165,444
Other comprehensive income	—	—		—		56,140		—		—		56,140


Employee stock purchase and incentive plans	102,664	1		(235)		—		—		—		(234)
Non-cash equity award compensation	—	—		4,052		—		—		—		4,052

Common dividends declared ($0.125 per share)	—	—		—		—		—		(14,028)		(14,028)
June 30, 2020	114,940,197	$	1,149	$	2,279,625	$	(29,391)	$	801,170	$	(2,115,977)	$	936,576

For the Six Months Ended June 30, 2020


(In Thousands, except Share Data)	Common Stock					Additional Paid-In Capital		Accumulated Other Comprehensive Income (Loss)		Cumulative Earnings		Cumulative Distributions to Stockholders		Total
(Unaudited)	Shares	Amount
December 31, 2019	114,353,036	$	1,144	$	2,269,617	$	41,513	$	1,579,124	$	(2,064,167)	$	1,827,231
Net loss	—	—		—		—		(777,954)		—		(777,954)
Other comprehensive loss	—	—		—		(70,904)		—		—		(70,904)
Issuance of common stock	350,088	3		5,544		—		—		—		5,547

Employee stock purchase and incentive plans	237,073	2		(2,776)		—		—		—		(2,774)
Non-cash equity award compensation	—	—		7,240		—		—		—		7,240

Common dividends declared ($0.445 per share)	—	—		—		—		—		(51,810)		(51,810)
June 30, 2020	114,940,197	$	1,149	$	2,279,625	$	(29,391)	$	801,170	$	(2,115,977)	$	936,576

For the Three Months Ended June 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
March 31, 2019	96,866,464	$	969	$	1,996,358	$	52,684	$	1,464,405	$	(1,964,489)	$	1,549,927
Net income	—	—		—		—		31,266		—		31,266
Other comprehensive loss	—	—		—		(3,761)		—		—		(3,761)
Issuance of common stock	791,191	8		12,503		—		—		—		12,511

Employee stock purchase and incentive plans	57,366	—		18		—		—		—		18
Non-cash equity award compensation	—	—		4,165		—		—		—		4,165

Common dividends declared ($0.30 per share)	—	—		—		—		—		(30,094)		(30,094)
June 30, 2019	97,715,021	$	977	$	2,013,044	$	48,923	$	1,495,671	$	(1,994,583)	$	1,564,032

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)

For the Six Months Ended June 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
December 31, 2018	84,884,344	$	849	$	1,811,422	$	61,297	$	1,409,941	$	(1,934,715)	$	1,348,794
Net income	—	—		—		—		85,730		—		85,730
Other comprehensive loss	—	—		—		(12,374)		—		—		(12,374)
Issuance of common stock	12,291,191	123		189,985		—		—		—		190,108
Direct stock purchase and dividend reinvestment plan	399,838	4		6,303		—		—		—		6,307
Employee stock purchase and incentive plans	139,648	1		(1,921)		—		—		—		(1,920)
Non-cash equity award compensation	—	—		7,255		—		—		—		7,255

Common dividends declared ($0.60 per share)	—	—		—		—		—		(59,868)		(59,868)
June 30, 2019	97,715,021	$	977	$	2,013,044	$	48,923	$	1,495,671	$	(1,994,583)	$	1,564,032

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)	Six Months Ended June 30,
			2020			2019
Cash Flows From Operating Activities:
Net (loss) income	$	(777,954)		$	85,730
Adjustments to reconcile net (loss) income to net cash used in operating activities:
Amortization of premiums, discounts, and securities issuance costs, net	4,083			144
Depreciation and amortization of non-financial assets	8,962			696
Originations of held-for-sale loans	(457,510)			(84,924)
Purchases of held-for-sale loans	(2,720,245)			(2,534,886)
Proceeds from sales of held-for-sale loans	3,126,860			2,123,794
Principal payments on held-for-sale loans	48,901			49,894
Net settlements of derivatives	(183,373)			(25,751)

Non-cash equity award compensation expense	7,240			7,255
Goodwill impairment expense	88,675			—
Market valuation adjustments	765,647			(48,172)
Realized gains, net	(29,817)			(13,513)
Net change in:
Accrued interest receivable and other assets	254,368			(108,985)
Accrued interest payable and accrued expenses and other liabilities	(80,219)			(9,744)
Net cash provided by (used in) operating activities	55,618			(558,462)
Cash Flows From Investing Activities:
Originations of loan investments	(263,544)			(84,638)
Purchases of loan investment	—			(49,489)
Proceeds from sales of loan investments	1,574,160			2,780
Principal payments on loan investments	1,136,000			619,085
Purchases of real estate securities	(52,260)			(242,970)

Purchases of multifamily securities held in consolidated securitization trusts	—			(68,601)
Sales of multifamily securities held in consolidated securitization trusts	142,990			—
Proceeds from sales of real estate securities	621,730			241,217
Principal payments on real estate securities	16,405			39,041
Purchases of servicer advance investments	(179,419)			(68,976)
Principal repayments from servicer advance investments	75,478			111,662


Acquisition of 5 Arches, net of cash acquired	—			(3,714)
Net investment in participation in loan warehouse facility	—			38,209
Net investment in multifamily loan fund	10,203			(28,673)
Other investing activities, net	(21,342)			(7,616)
Net cash provided by investing activities	3,060,401			497,317
Cash Flows From Financing Activities:
Proceeds from borrowings on short-term debt	3,655,530			2,731,731
Repayments on short-term debt	(5,322,519)			(2,675,308)
Proceeds from issuance of asset-backed securities	827,644			330,534
Repayments on asset-backed securities issued	(673,323)			(416,789)

Proceeds from issuance of long-term debt	944,282			—
Deferred long-term debt issuance costs paid	(7,830)			—
Repayments on long-term debt	(2,128,805)			—
Net settlements of derivatives	(84,336)			—
Net proceeds from issuance of common stock	5,707			198,333

Taxes paid on equity award distributions	(2,934)			—
Dividends paid	(51,810)			(59,868)
Other financing activities, net	4,650			(467)
Net cash (used in) provided by financing activities	(2,833,744)			108,166
Net increase in cash, cash equivalents and restricted cash	282,275			47,021
Cash, cash equivalents and restricted cash at beginning of period ⁽¹⁾	290,833			205,077
Cash, cash equivalents and restricted cash at end of period ⁽¹⁾	$	573,108		$	252,098

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


(In Thousands) (Unaudited)	Six Months Ended June 30,
			2020			2019
























































Supplemental Cash Flow Information:
Cash paid during the period for:
Interest	$	267,787		$	203,086
Taxes	209			4,158
Supplemental Noncash Information:
Real estate securities retained from loan securitizations	$	46,560		$	5,462
Retention of mortgage servicing rights from loan securitizations and sales	—			868


(Deconsolidation) consolidation of multifamily loans held in securitization trusts	(3,849,779)			1,481,554
(Deconsolidation) consolidation of multifamily ABS	(3,706,789)			1,408,002
Transfers from loans held-for-sale to loans held-for-investment	706,775			518,521

Transfers from residential loans to real estate owned	9,645			5,098

Right-of-use asset obtained in exchange for operating lease liability	5,362			13,016

(1) Cash, cash equivalents, and restricted cash at June 30, 2020 includes cash and cash equivalents of $529 million and restricted cash of $44 million, and at December 31, 2019 includes cash and cash equivalents of $197 million and restricted cash of $94 million.

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

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(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 three segments: Residential Lending, Business Purpose Lending, and Third-Party Investments.

Our primary sources of income are net interest income from our investments 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 origination and acquisition of loans, and their subsequent sale, securitization, or transfer to our investment portfolios.

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 “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 taxable REIT subsidiaries” or “TRS.”

Redwood was incorporated in the State of Maryland on April 11, 1994, and commenced operations on August 19, 1994. On March 1, 2019, Redwood completed the acquisition of 5 Arches, LLC ("5 Arches"), at which time 5 Arches became a wholly-owned subsidiary of Redwood. On October 15, 2019, Redwood acquired CoreVest American Finance Lender, LLC and certain affiliated entities ("CoreVest"), at which time CoreVest became wholly owned by Redwood. 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 June 30, 2020 and December 31, 2019, and for the three and six months ended June 30, 2020 and 2019. 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, 2019. In the opinion of management, all normal and recurring adjustments to present fairly the financial condition of the company at June 30, 2020 and results of operations for all periods presented have been made. The results of operations for the three and six months ended June 30, 2020 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 ("Sequoia Choice"). We also consolidate the assets and liabilities of certain Freddie Mac K-Series and Freddie Mac Seasoned Loans Structured Transaction ("SLST") securitizations we invested in. Finally, we consolidated the assets and liabilities of certain CoreVest American Finance Lender ("CAFL") securitizations beginning in the fourth quarter of 2019, in connection with our acquisition of CoreVest. 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 and CAFL 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

June 30, 2020

(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, the underlying loans at the consolidated Freddie Mac K-Series are shown under Multifamily loans held-for-investment at fair value, and the underlying single-family rental loans at the consolidated CAFL entities are shown under Business purpose residential loans held-for-investment at fair value on our consolidated balance sheets. The asset-backed securities (“ABS”) issued to third parties by these entities are shown under ABS issued. In our consolidated statements of income (loss), 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.

During the first quarter of 2020, we sold subordinate securities issued by four of these Freddie Mac K-Series securitization trusts and determined that we should derecognize the associated assets and liabilities of each of these entities for financial reporting purposes. We deconsolidated $3.86 billion of multifamily loans and other assets and $3.72 billion of multifamily ABS issued and other liabilities, for which we realized market valuation losses of $72 million, which were recorded through Investment fair value changes, net on our consolidated statements of income (loss) for the three months ended March 31, 2020.

We also consolidate 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. In the fourth quarter of 2019, we acquired and consolidated CoreVest, an originator and portfolio manager of business purpose residential loans.

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.

Acquisitions

In May 2018, Redwood acquired a 20% minority interest in 5 Arches, an originator of business purpose residential loans. On March 1, 2019, we completed the acquisition of the remaining 80% interest in 5 Arches. On October 15, 2019, we acquired CoreVest, an originator and portfolio manager of business purpose residential loans. Refer to our Annual Report on Form 10-K for the year ended December 31, 2019 for additional information regarding these acquisitions, including purchase price allocations.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 2. Basis of Presentation - (continued)

In connection with the acquisitions of 5 Arches and CoreVest, we identified and recorded finite-lived intangible assets totaling $25 million and $57 million, respectively. The amortization period for each of these assets and the activity for the six months ended June 30, 2020 is summarized in the table below.

Table 2.1 – Intangible Assets – Activity


	Carrying Value at December 31, 2019		Additions		Amortization Expense		Carrying Value at June 30, 2020		Weighted Average Amortization Period (in years)
(Dollars in Thousands)

Borrower network	$	43,952	$	—	$	(3,236)	$	40,716	7
Broker network	15,083		—		(1,810)		13,273		4
Non-compete agreements	8,236		—		(1,583)		6,653		3
Tradenames	3,472		—		(667)		2,805		3
Developed technology	1,613		—		(450)		1,163		2
Loan administration fees on existing loan assets	433		—		(433)		—		—
Total	$	72,789	$	—	$	(8,179)	$	64,610	6

All of our intangible assets are amortized on a straight-line basis. Estimated future amortization expense is summarized in the table below.

Table 2.2 – Intangible Asset Amortization Expense by Year



(In Thousands)	June 30, 2020
2020 (6 months)	$	7,746
2021	15,304
2022	12,800
2023	10,091
2024	7,073
2025 and thereafter	11,596
Total Future Intangible Asset Amortization	$	64,610

We recorded total goodwill of $89 million in 2019 as a result of the total consideration exceeding the fair value of the net assets acquired from 5 Arches and CoreVest. 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 workforces continuing to provide services to the business. We expect $75 million of this goodwill to be deductible for tax purposes. For reporting purposes, we included the intangible assets and goodwill from these acquisitions within the Business Purpose Lending segment.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 2. Basis of Presentation - (continued)

During the first quarter of 2020, as a result of the deterioration in economic conditions caused by the spread of the COVID-19 pandemic (the "pandemic"), and its impact on our business, including a significant decline in the market price of our common stock, we determined that it was more likely than not that the fair value of our Business Purpose Lending reporting unit was lower than its carrying amount, including goodwill. Based on this analysis, we determined that an interim goodwill impairment test should be performed as of March 31, 2020 and prepared updated cash flow projections for the reporting unit, resulting in a reduction in the long-term forecasts of profitability for our Business Purpose Lending reporting unit as compared to the prior year forecasts. Using these projections, we concluded that the fair value of our Business Purpose Lending reporting unit was less than its carrying value, including goodwill. As a result of this evaluation, we recorded a non-cash $89 million goodwill impairment expense through Other expenses on our consolidated statements of income (loss) during the three months ended March 31, 2020. In conjunction with our assessment of goodwill, we also assessed our intangible assets for impairment at March 31, 2020 and determined they were not impaired. On a quarterly basis, we evaluate our finite-lived intangible assets for impairment indicators and additionally evaluate the useful lives of our intangible assets to determine if revisions to the remaining periods of amortization are warranted.

The liability resulting from the contingent consideration arrangement with 5 Arches was recorded at its acquisition-date fair value of $25 million as part of total consideration for the acquisition of 5 Arches. These contingent earn-out payments were classified as a contingent consideration liability and carried at fair value prior to March 31, 2020. During the three months ended March 31, 2020, we made a cash payment of $11 million and granted $3 million of Redwood common stock in connection with the first anniversary of the purchase date. Additionally, as a result of an amendment to the agreement, we reclassified the contingent liability to a deferred liability, as the remaining payments became payable on a set timetable without any remaining contingencies. At June 30, 2020, the carrying value of this deferred liability was $15 million and was recorded as a component of Accrued expenses and other liabilities on our consolidated balance sheets. During the three and six months ended June 30, 2020, we recorded $0.1 million and $0.4 million of contingent consideration expense, respectively, through Other expenses on our consolidated statements of income (loss). 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, 5 Arches, and CoreVest combined, for the three and six months ended June 30, 2019, as if the acquisitions occurred as of January 1, 2018. These pro forma amounts have been adjusted to include the amortization of intangible assets and acquisition-related compensation expense 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 acquisitions had been completed as of January 1, 2018 and should not be taken as indicative of our future consolidated results of operations.

Table 2.3 – Unaudited Pro Forma Financial Information


	Three Months Ended June 30, 2019		Six Months Ended June 30, 2019
(In Thousands)
Supplementary pro forma information:
Net interest income	$	44,353	$	87,743
Non-interest income	35,495		78,471
Net income	44,218		100,246

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, 2019 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 six months ended June 30, 2020.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

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

Available-for-Sale Securities

Upon adoption of ASU 2016-13, "Financial Instruments - Credit Losses" in the first quarter of 2020, we modified our policy for recording impairments on available-for-sale 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. The allowance for credit losses is calculated using a discounted cash flow approach and is measured as the difference between the beneficial interest’s amortized cost and the estimate of cash flows expected to be collected, discounted at the effective interest rate used to accrete the beneficial interest. Any allowance for credit losses in excess of the unrealized losses on the beneficial interests are accounted for as a prospective reduction of the effective interest rate. No allowance is recorded for beneficial interests in an unrealized gain position. Favorable changes in the discounted cash flows will result in a reduction in the allowance for credit losses, if any. Any reduction in allowance for credit losses is recorded in earnings. If the allowance for credit losses has been reduced to zero, the remaining favorable changes are reflected as a prospective increase to the effective interest rate. If we intend to sell or it is more likely than not that we will be required to sell the security before it recovers in value, the entire impairment amount will be recognized in earnings with a corresponding adjustment to the security's amortized cost basis.

Goodwill

Pursuant to our adoption of ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment" in the first quarter of 2020, we modified our goodwill impairment testing policy. We first assess qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying value. If, based on that assessment, we believe it is more likely than not that the fair value of the reporting unit is less than its carrying value, we measure the fair value of reporting unit and record a goodwill impairment charge for the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of the goodwill. Any such impairment charges would be recorded through Other expenses on our consolidated statements of income (loss).

Recent Accounting Pronouncements

Newly Adopted Accounting Standards Updates ("ASUs")

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. We adopted this new guidance, as required, in the first quarter of 2020, which did not have a material impact on our consolidated financial statements but impacted certain of our fair value footnote disclosures.

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. We adopted this new guidance, as required, in the first quarter of 2020, which did not have a material impact on our consolidated financial statements.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(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. 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. In November 2019, the FASB issued ASU 2019-11, "Codification Improvements to Topic 326, Financial Instruments - Credit Losses," which is intended to clarify Codification guidance. In February 2020, the FASB issued ASU 2020-02, "Financial Instruments - Credit Losses (Topic 326) and Leases (Topic 842) - Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842) (SEC Update)," and in March 2020, the FASB issued ASU 2020-03, "Codification Improvements to Financial Instruments." These updates amend certain sections of the guidance. 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 accounted for our available-for-sale securities under the other-than-temporary impairment ("OTTI") model for debt securities prior to the issuance of this new guidance. 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 adopted this guidance, as required, in the first quarter of 2020, which did not have a material impact on our consolidated financial statements.

Other Recent Accounting Pronouncements

In March 2020, the FASB issued ASU 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting." This new guidance provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. This new guidance is effective for all entities as of March 12, 2020 through December 31, 2022. We are currently evaluating the impact the adoption of this standard would have on our consolidated financial statements.

In January 2020, the FASB issued ASU 2020-01, "Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815)." This new guidance clarifies the interaction of the accounting for equity securities, equity method investments, and certain forward contracts and purchased options. This new guidance is effective for fiscal years beginning after December 15, 2020. Early adoption is permitted. We plan to adopt this new guidance by the required date and do not anticipate that this update will have a material impact on the consolidated financial statements.

In December 2019, the FASB issued ASU 2019-12, "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes." This new guidance simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740 and by clarifying and amending existing guidance. This new guidance is effective for fiscal years beginning after December 15, 2020. Early adoption is permitted. We plan to adopt this new guidance by the required date and do not anticipate that this update will have a material impact on our consolidated financial statements.

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.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

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

The table below presents financial assets and liabilities that are subject to master netting arrangements or similar agreements categorized by financial instrument, together with corresponding financial instruments and corresponding collateral received or pledged at June 30, 2020 and December 31, 2019.

Table 3.1 – Offsetting of Financial Assets, Liabilities, and Collateral


	Gross Amounts of Recognized Assets (Liabilities)		Gross Amounts Offset in Consolidated Balance Sheet		Net Amounts of Assets (Liabilities) Presented in Consolidated Balance Sheet		Gross Amounts Not Offset in Consolidated  Balance Sheet ⁽¹⁾								Net Amount
June 30, 2020 (In Thousands)											Financial Instruments			Cash Collateral (Received) Pledged







Liabilities⁽²⁾



Loan warehouse debt	$	(449,560)	$	—	$	(449,560)	$	449,560	$	—		$	—
Security repurchase agreements	(311,888)		—		(311,888)		311,888		—			—
Total Liabilities	$	(761,448)	$	—	$	(761,448)	$	761,448	$	—		$	—


	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, 2019 (In Thousands)											Financial Instruments			Cash Collateral (Received) Pledged
Assets ⁽²⁾
Interest rate agreements	$	19,020	$	—	$	19,020	$	(14,178)	$	(915)		$	3,927

TBAs	5,755		—		5,755		(5,755)		—			—
Futures	137		—		137		—		—			137
Total Assets	$	24,912	$	—	$	24,912	$	(19,933)	$	(915)		$	4,064

Liabilities⁽²⁾
Interest rate agreements	$	(148,765)	$	—	$	(148,765)	$	14,178	$	134,587		$	—
TBAs	(13,359)		—		(13,359)		5,755		6,673			(931)

Loan warehouse debt	(432,126)		—		(432,126)		432,126		—			—
Security repurchase agreements	(1,096,578)		—		(1,096,578)		1,096,578		—			—
Total Liabilities	$	(1,690,828)	$	—	$	(1,690,828)	$	1,548,637	$	141,260		$	(931)

(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 certain residential and business purpose residential loans, and security repurchase agreements are components of Short-term debt and Long-term debt on our consolidated balance sheets.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

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

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.

Analysis of Consolidated VIEs

At June 30, 2020, we consolidated Legacy Sequoia, Freddie Mac SLST, Freddie Mac K-Series and CAFL 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 and CAFL 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 June 30, 2020, the estimated fair value of our investments in the consolidated Legacy Sequoia, Sequoia Choice, Freddie Mac SLST, Freddie Mac K-Series and CAFL entities was $6 million, $204 million, $336 million, $25 million, and $206 million, respectively.

Beginning in 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 June 30, 2020, 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 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 June 30, 2020, the estimated fair value of our investment in the Servicing Investment entities was $68 million.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 4. Principles of Consolidation - (continued)

The following table presents a summary of the assets and liabilities of these VIEs.

Table 4.1 – Assets and Liabilities of Consolidated VIEs


June 30, 2020	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		CAFL		Servicing Investment		Total Consolidated VIEs
(Dollars in Thousands)
Residential loans, held-for-investment	$	304,632	$	2,064,388	$	2,145,111	$	—	$	—	$	—	$	4,514,131
Business purpose residential loans, held-for-investment	—		—		—		—		2,615,038		—		2,615,038
Multifamily loans, held-for-investment	—		—		—		489,075		—		—		489,075

Other investments	—		—		—		—		—		290,805		290,805
Cash and cash equivalents	—		—		—		—		—		2,773		2,773
Restricted cash	145		9		—		—		—		30,416		30,570
Accrued interest receivable	529		8,236		6,627		1,342		11,087		6,725		34,546
Other assets	916		—		940		—		5,824		—		7,680
Total Assets	$	306,222	$	2,072,633	$	2,152,678	$	490,417	$	2,631,949	$	330,719	$	7,984,618
Short-term debt	$	—	$	—	$	—	$	—	$	—	$	244,437	$	244,437
Accrued interest payable	230		6,474		5,149		1,182		8,458		134		21,627
Accrued expenses and other liabilities	—		9		—		—		—		18,062		18,071
Asset-backed securities issued	300,357		1,861,777		1,812,008		464,691		2,417,253		—		6,856,086
Total Liabilities	$	300,587	$	1,868,260	$	1,817,157	$	465,873	$	2,425,711	$	262,633	$	7,140,221

Number of VIEs	20		10		2		1		12		3		48


December 31, 2019	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		CAFL		Servicing Investment		Total Consolidated VIEs
(Dollars in Thousands)
Residential loans, held-for-investment	$	407,890	$	2,291,463	$	2,367,215	$	—	$	—	$	—	$	5,066,568
Business purpose residential loans, held-for-investment	—		—		—		—		2,192,552		—		2,192,552
Multifamily loans, held-for-investment	—		—		—		4,408,524		—		—		4,408,524

Other investments	—		—		—		—		—		184,802		184,802
Cash and cash equivalents	—		—		—		—		—		9,015		9,015
Restricted cash	143		27		—		—		—		21,766		21,936
Accrued interest receivable	655		9,824		7,313		13,539		9,572		4,869		45,772
Other assets	460		—		445		—		1,795		—		2,700
Total Assets	$	409,148	$	2,301,314	$	2,374,973	$	4,422,063	$	2,203,919	$	220,452	$	11,931,869
Short-term debt	$	—	$	—	$	—	$	—	$	—	$	152,554	$	152,554
Accrued interest payable	395		7,732		5,374		12,887		7,485		187		34,060
Accrued expenses and other liabilities	—		27		—		—		—		14,956		14,983
Asset-backed securities issued	402,465		2,037,198		1,918,322		4,156,239		2,001,251		—		10,515,475
Total Liabilities	$	402,860	$	2,044,957	$	1,923,696	$	4,169,126	$	2,008,736	$	167,697	$	10,717,072

Number of VIEs	20		9		2		5		10		3		49

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 4. Principles of Consolidation - (continued)

The following table presents income (loss) from these VIEs for the three and six months ended June 30, 2020 and 2019.

Table 4.2 – Income (Loss) from Consolidated VIEs


	Three Months Ended June 30, 2020
	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		CAFL		Servicing Investment		Total Consolidated VIEs
(Dollars in Thousands)
Interest income	$	2,686	$	22,565	$	21,187	$	4,870	$	32,978	$	4,540	$	88,826
Interest expense	(1,518)		(19,117)		(15,845)		(4,378)		(24,446)		(1,797)		(67,101)
Net interest income	1,168		3,448		5,342		492		8,532		2,743		21,725
Non-interest income

Investment fair value changes, net	(230)		39,753		26,867		1,599		16,313		3,292		87,594


Total non-interest income, net	(230)		39,753		26,867		1,599		16,313		3,292		87,594
General and administrative expenses	—		—		—		—		—		(712)		(712)
Other expenses	—		—		—		—		—		(1,065)		(1,065)

Income from Consolidated VIEs	$	938	$	43,201	$	32,209	$	2,091	$	24,845	$	4,258	$	107,542


	Six Months Ended June 30, 2020
	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		CAFL		Servicing Investment		Total Consolidated VIEs
(Dollars in Thousands)
Interest income	$	5,880	$	47,647	$	43,173	$	45,042	$	62,988	$	8,623	$	213,353
Interest expense	(4,040)		(40,627)		(32,022)		(42,728)		(48,101)		(3,374)		(170,892)
Net interest income	1,840		7,020		11,151		2,314		14,887		5,249		42,461
Non-interest income

Investment fair value changes, net	(621)		(29,916)		(115,295)		(84,910)		(51,533)		(8,593)		(290,868)


Total non-interest income, net	(621)		(29,916)		(115,295)		(84,910)		(51,533)		(8,593)		(290,868)
General and administrative expenses	—		—		—		—		—		(743)		(743)
Other expenses	—		—		—		—		—		817		817

Income (Loss) from Consolidated VIEs	$	1,219	$	(22,896)	$	(104,144)	$	(82,596)	$	(36,646)	$	(3,270)	$	(248,333)


	Three Months Ended June 30, 2019
	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		CAFL		Servicing Investment		Total Consolidated VIEs
(Dollars in Thousands)
Interest income	$	4,776	$	26,828	$	11,597	$	35,917	$	—	$	3,579	$	82,697
Interest expense	(3,981)		(23,134)		(8,557)		(34,441)		—		(3,401)		(73,514)
Net interest income	795		3,694		3,040		1,476		—		178		9,183
Non-interest income

Investment fair value changes, net	(123)		2,879		8,037		3,246		—		1,069		15,108


Total non-interest income, net	(123)		2,879		8,037		3,246		—		1,069		15,108
General and administrative expenses	—		—		—		—		—		(41)		(41)
Other expenses	—		—		—		—		—		(242)		(242)

Income from Consolidated VIEs	$	672	$	6,573	$	11,077	$	4,722	$	—	$	964	$	24,008

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 4. Principles of Consolidation - (continued)


	Six Months Ended June 30, 2019
	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		CAFL		Servicing Investment		Total Consolidated VIEs
(Dollars in Thousands)
Interest income	$	9,629	$	52,490	$	23,391	$	57,305	$	—	$	6,926	$	149,741
Interest expense	(8,096)		(45,247)		(17,304)		(54,760)		—		(7,014)		(132,421)
Net interest income	1,533		7,243		6,087		2,545		—		(88)		17,320
Non-interest income

Investment fair value changes, net	(497)		6,144		14,402		6,365		—		2,499		28,913


Total non-interest income, net	(497)		6,144		14,402		6,365		—		2,499		28,913
General and administrative expenses	—		—		—		—		—		(70)		(70)
Other expenses	—		—		—		—		—		(468)		(468)

Income from Consolidated VIEs	$	1,036	$	13,387	$	20,489	$	8,910	$	—	$	1,873	$	45,695

We consolidate the assets and liabilities of certain Sequoia and CAFL 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 and CAFL 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 and CAFL 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, and in the case of certain CAFL securitizations, resulting from securities acquired through our acquisition of CoreVest. 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 51 Sequoia securitization entities sponsored by us that are still outstanding as of June 30, 2020, 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.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 4. Principles of Consolidation - (continued)

The following table presents information related to securitization transactions that occurred during the three and six months ended June 30, 2020 and 2019.

Table 4.3 – Securitization Activity Related to Unconsolidated VIEs Sponsored by Redwood


	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2020		2019		2020		2019
Principal balance of loans transferred	$	—	$	400,836	$	1,573,703	$	749,093
Trading securities retained, at fair value	—		1,792		43,362		3,508
AFS securities retained, at fair value	—		1,069		3,198		1,954

The following table summarizes the cash flows during the three and six months ended June 30, 2020 and 2019 between us and the unconsolidated VIEs sponsored by us and accounted for as sales since 2012.

Table 4.4 – Cash Flows Related to Unconsolidated VIEs Sponsored by Redwood


	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2020		2019		2020		2019
Proceeds from new transfers	$	—	$	410,281	$	1,610,761	$	762,652
MSR fees received	2,475		3,105		5,165		6,165
Funding of compensating interest, net	(205)		(47)		(297)		(137)
Cash flows received on retained securities	6,788		6,743		13,369		14,289

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 six months ended June 30, 2020 and 2019.

Table 4.5 – Assumptions Related to Assets Retained from Unconsolidated VIEs Sponsored by Redwood


	Three Months Ended June 30, 2020				Three Months Ended June 30, 2019
At Date of Securitization	Senior IO Securities	Subordinate Securities	Senior IO Securities		Subordinate Securities
Prepayment rates	N/A	N/A	16	%	15	%
Discount rates	N/A	N/A	14	%	7	%
Credit loss assumptions	N/A	N/A	0.20	%	0.20	%


	Six Months Ended June 30, 2020						Six Months Ended June 30, 2019
At Date of Securitization	Senior IO Securities		Subordinate Securities		Senior IO Securities		Subordinate Securities
Prepayment rates	41	%	13	%	16	%	15	%
Discount rates	16	%	6	%	14	%	7	%
Credit loss assumptions	0.21	%	0.22	%	0.20	%	0.20	%

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 4. Principles of Consolidation - (continued)

The following table presents additional information at June 30, 2020 and December 31, 2019, related to unconsolidated VIEs sponsored by Redwood and accounted for as sales since 2012.

Table 4.6 – Unconsolidated VIEs Sponsored by Redwood


(In Thousands)	June 30, 2020		December 31, 2019
On-balance sheet assets, at fair value:
Interest-only, senior and subordinate securities, classified as trading	$	25,038	$	88,425
Subordinate securities, classified as AFS	117,675		140,649
Mortgage servicing rights	18,727		40,254
Maximum loss exposure ⁽¹⁾	$	161,440	$	269,328
Assets transferred:
Principal balance of loans outstanding	$	9,918,493	$	10,299,442
Principal balance of loans 30+ days delinquent	291,191		41,809

(1)Maximum loss exposure from our involvement with unconsolidated VIEs pertains to the carrying value of our securities and MSRs retained from these VIEs and represents estimated losses that would be incurred under severe, hypothetical circumstances, such as if the value of our interests and any associated collateral declines to zero. This does not include, for example, any potential exposure to representation and warranty claims associated with our initial transfer of loans into a securitization.

The following table presents key economic assumptions for assets retained from unconsolidated VIEs and the sensitivity of their fair values to immediate adverse changes in those assumptions at June 30, 2020 and December 31, 2019.

Table 4.7 – Key Assumptions and Sensitivity Analysis for Assets Retained from Unconsolidated VIEs Sponsored by Redwood


June 30, 2020	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
(Dollars in Thousands)
Fair value at June 30, 2020	$	18,727		$	21,524		$	121,189
Expected life (in years)⁽²⁾	4			3			12
Prepayment speed assumption (annual CPR)⁽²⁾	21		%	28		%	24		%
Decrease in fair value from:
10% adverse change	$	1,477		$	1,855		$	1,361
25% adverse change	3,435			4,489			4,246
Discount rate assumption⁽²⁾	12		%	14		%	6		%
Decrease in fair value from:
100 basis point increase	$	548		$	196		$	10,543
200 basis point increase	1,061			652			19,824
Credit loss assumption ⁽²⁾	N/A			0.22		%	0.22		%
Decrease in fair value from:
10% higher losses	N/A			$	—		$	1,888
25% higher losses	N/A			—			4,706

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 4. Principles of Consolidation - (continued)


December 31, 2019	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
(Dollars in Thousands)
Fair value at December 31, 2019	$	40,254		$	48,765		$	180,309
Expected life (in years)⁽²⁾	6			6			14
Prepayment speed assumption (annual CPR)⁽²⁾	11		%	14		%	16		%
Decrease in fair value from:
10% adverse change	$	1,643		$	1,908		$	205
25% adverse change	3,913			5,086			1,434
Discount rate assumption⁽²⁾	11		%	12		%	5		%
Decrease in fair value from:
100 basis point increase	$	1,447		$	1,079		$	18,127
200 basis point increase	2,795			2,482			33,630
Credit loss assumption ⁽²⁾	N/A			0.21		%	0.21		%
Decrease in fair value from:
10% higher losses	N/A			$	—		$	1,804
25% higher losses	N/A			—			4,520

(1)Senior securities included $22 million and $49 million of interest-only securities at June 30, 2020 and December 31, 2019, respectively.

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

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 June 30, 2020 and December 31, 2019, grouped by asset type.

Table 4.8 – Third-Party Sponsored VIE Summary


(In Thousands)	June 30, 2020		December 31, 2019
Mortgage-Backed Securities
Senior	$	11,336	$	127,094
Mezzanine	—		508,195
Subordinate	162,387		235,510
Total Mortgage-Backed Securities	173,723		870,799
Excess MSR	15,883		16,216
Total Investments in Third-Party Sponsored VIEs	$	189,606	$	887,015

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.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 5. Fair Value of Financial Instruments

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

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

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

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

The following table presents the carrying values and estimated fair values of assets and liabilities that are required to be recorded or disclosed at fair value at June 30, 2020 and December 31, 2019.

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


	June 30, 2020						December 31, 2019
	Carrying Value		Fair Value		Carrying Value		Fair Value
(In Thousands)
Assets
Residential loans, held-for-sale at fair value	$	20,098	$	20,098	$	536,385	$	536,509
Residential loans, held-for-investment	4,514,131		4,514,131		7,178,465		7,178,465
Business purpose residential loans, held-for-sale	379,795		379,795		331,565		331,565
Business purpose residential loans, held-for-investment	3,402,405		3,402,405		3,175,178		3,175,178
Multifamily loans	489,075		489,075		4,408,524		4,408,524

Trading securities	142,699		142,699		860,540		860,540
Available-for-sale securities	173,737		173,737		239,334		239,334
Servicer advance investments ⁽¹⁾	266,948		266,948		169,204		169,204
MSRs ⁽¹⁾	19,661		19,661		42,224		42,224

Excess MSRs ⁽¹⁾	36,197		36,197		31,814		31,814
Shared home appreciation options⁽¹⁾	40,851		40,851		45,085		45,085
Cash and cash equivalents	528,612		528,612		196,966		196,966
Restricted cash	44,496		44,496		93,867		93,867
Accrued interest receivable	44,134		44,134		71,058		71,058
Derivative assets	357		357		35,701		35,701
REO ⁽²⁾	9,780		10,014		9,462		10,389
Margin receivable⁽²⁾	2,746		2,746		209,776		209,776
FHLBC stock ⁽²⁾	5,000		5,000		43,393		43,393
Guarantee asset⁽²⁾	770		770		1,686		1,686

Pledged collateral⁽²⁾	33,105		33,105		32,945		32,945
Liabilities
Short-term debt facilities	$	418,370	$	418,370	$	2,176,591	$	2,176,591
Short-term debt - servicer advance financing	244,437		244,437		152,554		152,554
Accrued interest payable	37,024		37,024		60,655		60,655
Margin payable ⁽³⁾	—		—		1,700		1,700
Guarantee obligation ⁽³⁾	12,350		10,995		14,009		13,754
Contingent consideration ⁽³⁾	14,953		14,953		28,484		28,484
Derivative liabilities	1,932		1,932		163,424		163,424
ABS issued at fair value	6,856,086		6,856,086		10,515,475		10,515,475
FHLBC long-term borrowings	1,000		1,000		1,999,999		1,999,999
Other long-term debt, net	1,088,609		1,082,327		183,520		184,666
Convertible notes, net	509,868		469,360		631,125		661,985
Trust preferred securities and subordinated notes, net	138,651		55,800		138,628		99,045

(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

June 30, 2020

(Unaudited)

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

During the three and six months ended June 30, 2020, we elected the fair value option for $10 million and $78 million of securities, respectively, $58 million and $2.69 billion of residential loans (principal balance), respectively, $230 million and $696 million of business purpose residential loans (principal balance), respectively, $21 million and $179 million of servicer advance investments, respectively, $2 million and $11 million of excess MSRs, respectively, and zero and $4 million of shared home appreciation options, respectively. 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 June 30, 2020 and December 31, 2019, as well as the fair value hierarchy of the valuation inputs used to measure fair value.

Table 5.2 – Assets and Liabilities Measured at Fair Value on a Recurring Basis


June 30, 2020	Carrying Value		Fair Value Measurements Using
(In Thousands)					Level 1			Level 2			Level 3
Assets
Residential loans	$	4,534,229	$	—		$	—		$	4,534,229
Business purpose residential loans	3,782,200		—			—			3,782,200
Multifamily loans	489,075		—			—			489,075
Trading securities	142,699		—			—			142,699
Available-for-sale securities	173,737		—			—			173,737
Servicer advance investments	266,948		—			—			266,948
MSRs	19,661		—			—			19,661
Excess MSRs	36,197		—			—			36,197
Shared home appreciation options	40,851		—			—			40,851
Derivative assets	357		—			—			357
Pledged collateral	33,105		33,105			—			—
FHLBC stock	5,000		—			5,000			—
Guarantee asset	770		—			—			770

Liabilities

Derivative liabilities	$	1,932	$	—		$	—		$	1,932

ABS issued	6,856,086		—			—			6,856,086

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

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


December 31, 2019	Carrying Value		Fair Value Measurements Using
(In Thousands)					Level 1			Level 2			Level 3
Assets
Residential loans	$	7,714,745	$	—		$	—		$	7,714,745
Business purpose residential loans	3,506,743		—			—			3,506,743
Multifamily loans	4,408,524		—			—			4,408,524
Trading securities	860,540		—			—			860,540
Available-for-sale securities	239,334		—			—			239,334
Servicer advance investments	169,204		—			—			169,204
MSRs	42,224		—			—			42,224
Excess MSRs	31,814		—			—			31,814
Shared home appreciation options	45,085		—			—			45,085
Derivative assets	35,701		6,531			19,020			10,150
Pledged collateral	32,945		32,945			—			—
FHLBC stock	43,393		—			43,393			—
Guarantee asset	1,686		—			—			1,686

Liabilities
Contingent consideration	$	28,484	$	—		$	—		$	28,484
Derivative liabilities	163,424		13,368			148,766			1,290

ABS issued	10,515,475		—			—			10,515,475

The following table presents additional information about Level 3 assets and liabilities measured at fair value on a recurring basis for the six months ended June 30, 2020.

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)
Beginning balance - December 31, 2019	$	7,714,745	$	3,506,743	$	4,408,524	$	860,540	$	239,334	$	169,204	$	42,224	$	31,814	$	45,085

Acquisitions	2,751,590		—		—		77,889		31,181		179,419		—		10,906		3,517
Originations	—		721,054		—		—		—		—		—		—		—
Sales	(4,695,048)		(44,172)		—		(566,537)		(55,193)		—		—		—		—
Principal paydowns	(907,360)		(272,052)		(5,830)		(8,114)		(8,293)		(75,477)		—		—		(1,080)
Deconsolidations	—		—		(3,849,779)		—		—		—		—		—		—
Gains (losses) in net income (loss), net	(328,313)		(121,961)		(63,840)		(221,079)		(33,292)		(6,198)		(22,563)		(6,523)		(6,671)

Other settlements, net ⁽¹⁾	(1,385)		(7,412)		—		—		—		—		—		—		—
Ending balance - June 30, 2020	$	4,534,229	$	3,782,200	$	489,075	$	142,699	$	173,737	$	266,948	$	19,661	$	36,197	$	40,851

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(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)
Beginning balance - December 31, 2019	$	1,686	$	8,860	$	28,484	$	10,515,475

Acquisitions	—		—		—		827,645

Principal paydowns	—		—		(13,353)		(673,324)
Deconsolidations	—		—		—		(3,706,789)
Gains (losses) in net income (loss), net	(916)		20,643		(446)		(106,921)

Other settlements, net ⁽¹⁾	—		(31,078)		(14,685)		—
Ending balance - June 30, 2020	$	770	$	(1,575)	$	—	$	6,856,086

(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 or interest rate lock commitments at the time loans are acquired to the basis of residential and single-family rental loans. Other settlements, net for contingent consideration reflects the reclassification from a contingent liability to a deferred liability during the period due to an amendment in the underlying agreement. See Note 16 for further discussion.

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

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(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 (loss) that were attributable to Level 3 assets and liabilities recorded at fair value on a recurring basis and held at June 30, 2020 and 2019. Gains or losses incurred on assets or liabilities sold, matured, called, or fully written down during the three and six months ended June 30, 2020 and 2019 are not included in this presentation.

Table 5.4 – Portion of Net Gains (Losses) Attributable to Level 3 Assets and Liabilities Still Held at June 30, 2020 and 2019 Included in Net Income


	Included in Net Income
	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2020		2019		2020		2019
Assets
Residential loans at Redwood	$	(359)	$	48,575	$	(746)	$	80,615
Business purpose residential loans	31,187		3,038		(21,026)		4,032
Net investments in consolidated Sequoia entities ⁽¹⁾	39,558		2,487		(30,502)		5,191
Net investments in consolidated Freddie Mac SLST entities ⁽¹⁾	26,867		8,037		(115,295)		14,402
Net investments in consolidated Freddie Mac K-Series entities ⁽¹⁾	1,599		3,246		(13,180)		6,365
Net investments in consolidated CAFL entities ⁽¹⁾	17,125		—		(50,721)		—
Trading securities	30,647		17,771		(79,633)		38,658

Servicer advance investments	(136)		432		(6,198)		1,440
MSRs	(1,591)		(7,334)		(16,507)		(11,518)
Excess MSRs	2,971		(66)		(6,523)		(502)
Shared home appreciation options	884		—		(6,670)		—
Loan purchase and interest rate lock commitments	357		5,534		357		5,567

Other assets - Guarantee asset	(135)		(277)		(916)		(196)

Liabilities
Loan purchase commitments	$	2,137	$	(756)	$	(1,634)	$	(772)

(1) Represents the portion of net gains or losses included in our consolidated statements of income (loss) related to loans and the associated ABS issued at our consolidated securitization entities held at June 30, 2020 and 2019, which netted together represent the change in value of our investments at the consolidated VIEs.

The following table presents information on assets recorded at fair value on a non-recurring basis at June 30, 2020. 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 June 30, 2020.

Table 5.5 – Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis at June 30, 2020


												Gain (Loss) for
June 30, 2020	Carrying Value		Fair Value Measurements Using															Three Months Ended	Six Months Ended
(In Thousands)					Level 1			Level 2			Level 3			June 30, 2020			June 30, 2020
Assets


REO	$	1,712	$	—		$	—		$	1,712		$	(36)		$	(31)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(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 six months ended June 30, 2020 and 2019.

Table 5.6 – Market Valuation Gains and Losses, Net


	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2020		2019		2020		2019
Mortgage Banking Activities, Net
Residential loans held-for-sale, at fair value	$	(2,014)	$	3,379	$	(15,494)	$	6,912
Residential loan purchase and forward sale commitments	621		16,888		22,056		28,199
Single-family rental loans held-for-sale, at fair value	1,210		1,313		12,677		2,917
Single-family rental loan purchase and interest rate lock commitments	—		569		341		709
Residential bridge loans	(1,260)		1,012		(5,194)		1,098
Risk management derivatives, net	—		(7,431)		(52,832)		(12,415)
Total mortgage banking activities, net ⁽¹⁾	$	(1,443)	$	15,730	$	(38,446)	$	27,420
Investment Fair Value Changes, Net
Residential loans held-for-investment, at Redwood	$	104	$	35,548	$	(93,532)	$	63,656
Single-family rental loans held-for-investment	2,222		—		(20,806)		—
Residential bridge loans held-for-investment	21,774		(318)		(16,828)		(621)
Trading securities	42,246		18,442		(221,079)		40,302
Servicer advance investments	(136)		432		(6,198)		1,440
Excess MSRs	2,971		(65)		(6,523)		(502)


Net investments in Legacy Sequoia entities ⁽²⁾	(230)		(123)		(621)		(497)
Net investments in Sequoia Choice entities ⁽²⁾	39,753		2,879		(29,916)		6,144
Net investments in Freddie Mac SLST entities ⁽²⁾	26,867		8,037		(115,295)		14,402
Net investments in Freddie Mac K-Series entities ⁽²⁾	1,599		3,246		(84,910)		6,365
Net investments in CAFL entities ⁽²⁾	17,125		—		(50,721)		—
Other investments	(2,121)		(200)		(11,562)		(277)
Risk management derivatives, net	—		(64,740)		(59,142)		(107,115)

Credit recoveries (losses) on AFS securities	54		—		(1,471)		—
Total investment fair value changes, net	$	152,228	$	3,138	$	(718,604)	$	23,297
Other Income
MSRs	$	(3,955)	$	(8,653)	$	(22,563)	$	(13,753)
Risk management derivatives, net	—		6,517		13,966		8,768
Gain on re-measurement of 5 Arches investment	—		—		—		2,440
Total other income ⁽³⁾	$	(3,955)	$	(2,136)	$	(8,597)	$	(2,545)
Total Market Valuation Gains (Losses), Net	$	146,830	$	16,732	$	(765,647)	$	48,172

(1)Mortgage banking activities, net presented above does not include fee income from loan originations or acquisitions, provisions for repurchases expense, and other expenses that are components of Mortgage banking activities, net presented on our consolidated statements of income (loss), 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 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

June 30, 2020

(Unaudited)

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

At June 30, 2020, 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, 2019. 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


June 30, 2020	Fair Value				Input Values
(Dollars in Thousands, except Input Values)				Unobservable Input			Range							Weighted Average⁽⁵⁾
Assets
Residential loans, at fair value:









Jumbo loans committed to sell	$	20,199	Whole loan committed sales price		$	101.00	-	$	101.00		$	101.00






Loans held by Legacy Sequoia ⁽¹⁾	304,632		Liability price					N/A			N/A

Loans held by Sequoia Choice ⁽¹⁾	2,064,388		Liability price					N/A			N/A

Loans held by Freddie Mac SLST ⁽¹⁾	2,145,111		Liability price					N/A			N/A

Business purpose residential loans:
Single-family rental loans	379,795		Senior credit spread		230		-	230		bps	230		bps
			Subordinate credit spread		300		-	2,450		bps	772		bps
			Senior credit support		31		-	36		%	34		%
			IO discount rate		10		-	10		%	10		%
			Prepayment rate (annual CPR)		3		-	3		%	3		%

Single-family rental loans held by CAFL	2,615,038		Liability price					N/A			N/A

Residential bridge loans	787,367		Discount rate		8		-	17		%	11		%

Multifamily loans held by Freddie Mac K-Series ⁽¹⁾	489,075		Liability price					N/A			N/A



Trading and AFS securities	316,436		Discount rate		4		-	21		%	10		%
			Prepayment rate (annual CPR)		6		-	65		%	17		%
			Default rate		—		-	15		%	1		%
			Loss severity		—		-	50		%	16		%

Servicer advance investments	266,948		Discount rate		5		-	5		%	5		%
			Prepayment rate (annual CPR)		8		-	14		%	14		%
			Expected remaining life ⁽²⁾		2		-	2		years	2		years
			Mortgage servicing income		8		-	13		bps	10		bps

MSRs	19,661		Discount rate		12		-	12		%	12		%
			Prepayment rate (annual CPR)		8		-	62		%	21		%
			Per loan annual cost to service		$	95	-	$	95		$	95

Excess MSRs	36,197		Discount rate		15		-	20		%	18		%
			Prepayment rate (annual CPR)		10		-	14		%	12		%
			Excess mortgage servicing income		9		-	17		bps	12		bps

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

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

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


June 30, 2020	Fair Value				Input Values
(Dollars in Thousands, except Input Values)				Unobservable Input			Range							Weighted Average ⁽⁴⁾
Assets (continued)
















































Shared home appreciation options	$	40,851	Discount rate		17		-	17		%	17		%
			Prepayment rate (annual CPR)		8		-	28		%	21		%
			Home price appreciation		1		-	3		%	3		%

Guarantee asset	781		Discount rate		13		-	13		%	13		%
			Prepayment rate (annual CPR)		37		-	37		%	37		%

REO	1,712		Loss severity		3		-	86		%	19		%








Liabilities
Residential loan purchase commitments, net	177		Committed sales price		$	96.10	-	$	101.28		$	100.11

			Pull-through rate		100		-	100		%	100		%





ABS issued ⁽¹⁾:
At consolidated Sequoia entities	2,162,134		Discount rate		2		-	25		%	4		%
			Prepayment rate (annual CPR)		10		-	50		%	24		%
			Default rate		—		-	40		%	1		%
			Loss severity		—		-	50		%	32		%

At consolidated Freddie Mac SLST entities	1,812,008		Discount rate		2		-	14		%	4		%
			Prepayment rate (annual CPR)		6		-	6		%	6		%
			Default rate		17		-	18		%	17		%
			Loss severity		30		-	30		%	30		%

At consolidated Freddie Mac K-Series entities ⁽³⁾	464,691		Discount rate		1		-	19		%	2		%
			Non-IO prepayment rate (annual CPR)		—		-	—		%	—		%
			IO prepayment rate (annual CPY/CPP)		100		-	100		%	100		%



At consolidated CAFL entities ⁽³⁾	2,417,253		Discount rate		1		-	74		%	4		%
			Prepayment rate (annual CPR)		—		-	3		%	—		%

(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 June 30, 2020, the fair value of securities we owned at the consolidated Sequoia, Freddie Mac SLST, Freddie Mac K-Series, and CAFL entities was $208 million, $334 million, $24 million, and $203 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)As a market convention, certain securities are priced to a no-loss yield and therefore do not include default and loss severity assumptions.

(4)The weighted average input values for all loan types are based on the unpaid principal balance. The weighted average input values for all other assets and liabilities are based on relative fair value.

Determination of Fair Value

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 input 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

June 30, 2020

(Unaudited)

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

Included in Note 5 to the Consolidated Financial Statements of our Annual Report on Form 10-K for the year ended December 31, 2019 is a more detailed description of our financial instruments measured at fair value and their significant inputs, as well as the general classification of such instruments pursuant to the Level 1, Level 2, and Level 3 valuation hierarchy.

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 and Freddie Mac SLST entities at June 30, 2020 and December 31, 2019.

Table 6.1 – Classifications and Carrying Values of Residential Loans


June 30, 2020			Legacy		Sequoia		Freddie Mac
(In Thousands)	Redwood		Sequoia		Choice		SLST		Total
Held-for-sale at fair value	$	20,200	$	—	$	—	$	—	$	20,200
Held-for-investment at fair value	—		304,632		2,064,388		2,145,111		4,514,131
Total Residential Loans	$	20,200	$	304,632	$	2,064,388	$	2,145,111	$	4,534,331


December 31, 2019			Legacy		Sequoia		Freddie Mac
(In Thousands)	Redwood		Sequoia		Choice		SLST		Total
Held-for-sale at fair value	$	536,385	$	—	$	—	$	—	$	536,385
Held-for-investment at fair value	2,111,897		407,890		2,291,463		2,367,215		7,178,465
Total Residential Loans	$	2,648,282	$	407,890	$	2,291,463	$	2,367,215	$	7,714,850

At June 30, 2020, we owned mortgage servicing rights associated with $20 million (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 June 30, 2020, we owned 29 loans held-for-sale at fair value with an aggregate unpaid principal balance of $21 million and a fair value of $20 million, compared to 669 loans with an aggregate unpaid principal balance of $525 million and a fair value of $536 million at December 31, 2019. At June 30, 2020, three of these loans with an aggregate fair value of $2 million and unpaid principal balance of $3 million were greater than 90 days delinquent and one of these loans with a fair value of $0.4 million and an unpaid principal balance of $1 million was in foreclosure. At December 31, 2019, one of these loans with a fair value and unpaid principal balance of $1 million was greater than 90 days delinquent and none of these loans were in foreclosure.

During the three and six months ended June 30, 2020, we purchased $58 million and $2.69 billion (principal balance) of loans, respectively, for which we elected the fair value option, and we sold $2.28 billion and $4.94 billion (principal balance) of loans, respectively, for which we recorded net market valuation losses of $2 million and $15 million, respectively, through Mortgage banking activities, net on our consolidated statements of income (loss). At June 30, 2020, loans held-for-sale with a market value of $15 million were pledged as collateral under short-term borrowing agreements.

During the three and six months ended June 30, 2019, we purchased $1.53 billion and $2.49 billion (principal balance) of loans, respectively, for which we elected the fair value option, and we sold $1.23 billion and $2.39 billion (principal balance) of loans, respectively, for which we recorded net market valuation gains of $3 million and $7 million, respectively, through Mortgage banking activities, net on our consolidated statements of income (loss).

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 6. Residential Loans - (continued)

Residential Loans Held-for-Investment at Fair Value

At Redwood

At June 30, 2020, we did not own any held-for-investment loans at Redwood. At December 31, 2019, we owned 2,940 held-for-investment loans at Redwood with an aggregate unpaid principal balance of $2.05 billion and a fair value of $2.11 billion. At December 31, 2019, two of these loans with an aggregate fair value of $1 million and an unpaid principal balance of $2 million were greater than 90 days delinquent and none of these loans were in foreclosure.

During the three and six months ended June 30, 2020, we transferred loans with a fair value of zero and $13 million, respectively, from held-for-sale to held-for-investment. During the three and six months ended June 30, 2020, we transferred loans with a fair value of zero and $1.87 billion, respectively, from held-for-investment to held-for-sale. During the three and six months ended June 30, 2020, we recorded net market valuation losses of zero and $94 million, respectively, on residential loans held-for-investment at fair value through Investment fair value changes, net on our consolidated statements of income (loss).

During the three and six months ended June 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 six months ended June 30, 2019, we transferred loans with a fair value of $30 million and $69 million, respectively, from held-for-sale to held-for-investment. During the three and six months ended June 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 six months ended June 30, 2019, we recorded net market valuation gains of $36 million and $64 million, respectively, on residential loans held-for-investment at fair value through Investment fair value changes, net on our consolidated statements of income (loss).

At Consolidated Legacy Sequoia Entities

At June 30, 2020, we consolidated 2,063 held-for-investment loans at consolidated Legacy Sequoia entities, with an aggregate unpaid principal balance of $382 million and a fair value of $305 million, as compared to 2,198 loans at December 31, 2019, with an aggregate unpaid principal balance of $425 million and a fair value of $408 million. At origination, the weighted average FICO score of borrowers backing these loans was 727, the weighted average LTV ratio of these loans was 65%, and the loans were nearly all first lien and prime-quality.

At June 30, 2020 and December 31, 2019, the aggregate unpaid principal balance of loans at consolidated Legacy Sequoia entities delinquent greater than 90 days was $12 million and $10 million, respectively, of which the aggregate unpaid principal balance of loans in foreclosure was $3 million and $4 million, respectively. During the three and six months ended June 30, 2020, we recorded a net market valuation gain of $8 million and a net market valuation loss of $61 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of income (loss). During the three and six months ended June 30, 2019, we recorded net market valuation gains of $1 million and $5 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of income (loss). 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 June 30, 2020, we consolidated 2,861 held-for-investment loans at the consolidated Sequoia Choice entities, with an aggregate unpaid principal balance of $2.03 billion and a fair value of $2.06 billion, as compared to 3,156 loans at December 31, 2019 with an aggregate unpaid principal balance of $2.24 billion and a fair value of $2.29 billion. At origination, the weighted average FICO score of borrowers backing these loans was 743, the weighted average LTV ratio of these loans was 74%, and the loans were all first lien and prime-quality. At June 30, 2020, 22 of these loans with an aggregate unpaid principal balance of $16 million were greater than 90 days delinquent and five of these loans with an aggregate unpaid principal balance of $3 million was in foreclosure. At December 31, 2019, nine of these loans with an aggregate unpaid principal balance of $7 million were greater than 90 days delinquent and three of these loans with an aggregate unpaid principal balance of $2 million were in foreclosure.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 6. Residential Loans - (continued)

During both the three and six months ended June 30, 2020, we transferred $271 million of loans from held-for-sale to held-for-investment associated with Choice securitizations. During the three and six months ended June 30, 2019, we transferred loans with a fair value of zero and $350 million, respectively, from held-for-sale to held-for-investment associated with Choice securitizations. During the three and six months ended June 30, 2020, we recorded a net market valuation gain of $94 million and a net market valuation loss of $17 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of income (loss). 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 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 June 30, 2020, we consolidated 14,143 held-for-investment loans at the consolidated Freddie Mac SLST entities, with an aggregate unpaid principal balance of $2.35 billion and a fair value of $2.15 billion, as compared to 14,502 loans at December 31, 2019 with an aggregate unpaid principal balance of $2.43 billion and a fair value of $2.37 billion. At securitization, the weighted average FICO score of borrowers backing these loans was 600 and the weighted average LTV ratio of these loans was 73%. At June 30, 2020, 1,409 of these loans with an aggregate unpaid principal balance of $258 million were greater than 90 days delinquent, of which 236 of these loans with an aggregate unpaid principal balance of $38 million were in foreclosure. At December 31, 2019, 587 of these loans with an aggregate unpaid principal balance of $135 million were greater than 90 days delinquent and 208 of these loans with an aggregate unpaid principal balance of $33 million were in foreclosure.

During the three and six months ended June 30, 2020, we recorded a net market valuation gain of $49 million and a net market valuation loss of $144 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of income (loss). During the three and six months ended June 30, 2019, we recorded net market valuation gains of $31 million and $55 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of income (loss). 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.

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 acquisitions of 5 Arches and CoreVest in 2019.

Business Purpose Residential Loan Originations

During the three months ended June 30, 2020, we funded $234 million of business purpose residential loans, of which $2 million of residential bridge loans and no single-family rental loans were sold to third parties. 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) for future securitizations. Prior to the transfer of residential bridge loans to our investment portfolio, we recorded a net market valuation loss of $3 million on these loans through Mortgage banking activities, net on our consolidated statements of income (loss) for the three months ended June 30, 2020. Market valuation adjustments on our single-family rental loans are also recorded in Mortgage banking activities, net on our consolidated statements of income (loss) prior to their sale or transfer to our investment portfolio. Additionally, during the three and six months ended June 30, 2020, we recorded loan origination fee income associated with business purpose residential loans of $2 million and $11 million, respectively, through Mortgage banking activities, net on our consolidated statements of income (loss).

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 7. Business Purpose Residential Loans - (continued)

The following table summarizes the classifications and carrying values of the business purpose residential loans owned at Redwood at June 30, 2020 and December 31, 2019.

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


June 30, 2020	Single-Family Rental						Residential
(In Thousands)	Redwood		CAFL		Bridge		Total
Held-for-sale at fair value	$	379,795	—		$	—	$	379,795
Held-for-investment at fair value	—		2,615,038		787,367		3,402,405
Total Business Purpose Residential Loans	$	379,795	$	2,615,038	$	787,367	$	3,782,200


December 31, 2019	Single-Family Rental						Residential
(In Thousands)	Redwood		CAFL		Bridge		Total
Held-for-sale at fair value	$	331,565	$	—	$	—	$	331,565
Held-for-investment at fair value	237,620		2,192,552		745,006		3,175,178
Total Business Purpose Residential Loans	$	569,185	$	2,192,552	$	745,006	$	3,506,743

Single-Family Rental Loans

At June 30, 2020, we owned 199 single-family rental loans with an aggregate unpaid principal balance and fair value of $380 million, as compared to 308 loans at December 31, 2019 with an aggregate unpaid principal balance of $553 million and a fair value of $569 million. At June 30, 2020, three of these loans with an aggregate unpaid principal balance and fair value of $3 million were in foreclosure, of which two of these loans with an aggregate unpaid principal balance and fair value of $2 million were greater than 90 days delinquent. At December 31, 2019, two of these loans with an aggregate unpaid principal balance and fair value of $2 million were greater than 90 days delinquent, of which one of these loans with an unpaid principal balance of $0.1 million was in foreclosure.

During the three and six months ended June 30, 2020, we originated $176 million and $436 million of single-family rental loans, respectively. During the six months ended June 30, 2020, we transferred $599 million of single-family rental loans from held-for-sale to held-for-investment associated with two CAFL securitizations and sold $26 million to third parties. Additionally, at March 31, 2020, we transferred all held-for-investment single-family rental loans to held-for-sale. During the three and six months ended June 30, 2020, we recorded a net market valuation gain of $3 million and a net market valuation loss of $9 million, respectively, on single-family rental loans. Of the $3 million of net market valuation gains recorded during the three months ended June 30, 2020, $1 million of net market valuation gains were recorded through Mortgage banking activities, net and $2 million of net market valuation gains were recorded through Investment fair value changes, net on our consolidated statements of income (loss). Of the $9 million of net market valuation losses recorded during the six months ended June 30, 2020, $12 million of net market valuation gains were recorded through Mortgage banking activities, net and $21 million of net market valuation losses were recorded through Investment fair value changes, net on our consolidated statements of income (loss). During the three and six months ended June 30, 2019, we recorded net market valuation gains of $1 million and $2 million, respectively, on single-family rental loans through Mortgage banking activities, net on our consolidated statements of income (loss).

The outstanding single-family rental loans held-for-sale at June 30, 2020 were first lien, fixed-rate loans with original maturities of five, seven, or ten years. At June 30, 2020, the weighted average coupon of our single-family rental loans was 4.82% and the weighted average remaining loan term was eight years. At origination, the weighted average LTV ratio of these loans was 67% and the weighted average debt service coverage ratio ("DSCR") was 1.35 times.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 7. Business Purpose Residential Loans - (continued)

Single-Family Rental Loans Held-for-Investment at CAFL

In conjunction with our acquisition of CoreVest in the fourth quarter of 2019, we consolidated the single-family rental loans owned at certain CAFL securitization entities. At June 30, 2020, we consolidated 967 held-for-investment single-family rental loans at the consolidated CAFL entities, with an aggregate unpaid principal balance of $2.58 billion and a fair value of $2.62 billion, as compared to 783 loans at December 31, 2019 with an aggregate unpaid principal balance of $2.08 billion and a fair value of $2.19 billion. The outstanding single-family rental loans held-for-investment at CAFL at June 30, 2020 were first-lien, fixed-rate loans with original maturities of five, seven, or ten years. At June 30, 2020, the weighted average coupon of our single-family rental loans was 5.52% and the weighted average remaining loan term was six years. At origination, the weighted average LTV ratio of these loans was 69% and the weighted average DSCR was 1.37 times. At June 30, 2020, 19 of these loans with an aggregate unpaid principal balance of $29 million were greater than 90 days delinquent and eight of these loans with an aggregate unpaid principal balance of $14 million were in foreclosure. At December 31, 2019, 18 of these loans with an aggregate unpaid principal balance of $29 million were greater than 90 days delinquent and five of these loans with an aggregate unpaid principal balance of $9 million were in foreclosure.

During the three and six months ended June 30, 2020, we recorded a net market valuation gain of $169 million and a net market valuation loss of $103 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of income (loss). 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 CAFL securitizations. The net impact to our income statement associated with our retained economic investment in the CAFL securitization entities is presented in Note 5.

Residential Bridge Loans Held-for-Investment

At June 30, 2020, we owned 2,847 residential bridge loans held-for-investment with an aggregate unpaid principal balance of $803 million and a fair value of $787 million, as compared to 2,653 loans at December 31, 2019 with an aggregate unpaid principal balance of $743 million and a fair value of $745 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 June 30, 2020, 13 loans with an aggregate fair value of $30 million and an unpaid principal balance of $35 million were greater than 90 days delinquent, of which nine of these loans with an aggregate fair value of $28 million and an unpaid principal balance of $32 million were in foreclosure. At December 31, 2019, 31 loans with an aggregate fair value of $12 million and an unpaid principal balance of $14 million were in foreclosure, of which 15 of these loans with an aggregate fair value of $7 million and an unpaid principal balance of $9 million were greater than 90 days delinquent. During the six months ended June 30, 2020, we transferred three loans with a fair value of $2 million to REO, which is included in Other assets on our consolidated balance sheets.

During the three and six months ended June 30, 2020, $54 million and $260 million of newly originated residential bridge loans, respectively, were transferred to our investment portfolio. During the three and six months ended June 30, 2020, we recorded a net market valuation gain of $22 million and a net market valuation loss of $17 million, respectively, on residential bridge loans held-for-investment at fair value through Investment fair value changes, net on our consolidated statements of income (loss). During the three and six months ended June 30, 2019, we recorded net market valuation losses of $0.3 million and $0.6 million, respectively, on residential bridge loans held-for-investment at fair value through Investment fair value changes, net on our consolidated statements of income (loss).

The outstanding residential bridge loans held-for-investment at June 30, 2020 were first lien, fixed-rate, interest-only loans with a weighted average coupon of 7.96% and original maturities of six to 24 months. At origination, the weighted average FICO score of borrowers backing these loans was 720 and the weighted average LTV ratio of these loans was 69%.

At June 30, 2020, we had a $167 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

June 30, 2020

(Unaudited)

Note 8. Multifamily Loans

Since 2018, we invested in multifamily subordinate securities issued by 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. During the first quarter of 2020, we sold subordinate securities issued by four such Freddie Mac K-Series securitization trusts and deconsolidated $3.85 billion of multifamily loans. See Note 2 for further discussion.

At June 30, 2020, we consolidated 28 held-for-investment multifamily loans, with an aggregate unpaid principal balance of $465 million and a fair value of $489 million, as compared to 279 loans at December 31, 2019 with an aggregate unpaid principal balance of $4.20 billion and a fair value of $4.41 billion. The outstanding multifamily loans held-for-investment at the Freddie Mac K-Series entities at June 30, 2020 were first-lien, fixed-rate loans that were originated in 2015 and had original loan terms of ten years and an original weighted average LTV ratio of 67%. At June 30, 2020, the weighted average coupon of these multifamily loans was 4.25% and the weighted average remaining loan term was five years. At both June 30, 2020 and December 31, 2019, none of these loans were greater than 90 days delinquent or in foreclosure.

During the three and six months ended June 30, 2020, we recorded a net market valuation gain of $19 million and a net market valuation loss of $64 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of income (loss). During the three and six months ended June 30, 2019, we recorded net market valuation gains of $97 million and $131 million, respectively, on these loans through Investment fair value changes, net on our consolidated statements of income (loss). 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 June 30, 2020 and December 31, 2019.

Table 9.1 – Fair Values of Real Estate Securities by Type


(In Thousands)	June 30, 2020		December 31, 2019
Trading	$	142,699	$	860,540
Available-for-sale	173,737		239,334
Total Real Estate Securities	$	316,436	$	1,099,874

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. Many of our mezzanine classified securities were initially rated AA through BBB- and issued in 2012 or later. Subordinate securities are all interests below mezzanine. Excluding our re-performing loan securities, nearly all of our residential securities are supported by collateral that was designated as prime at the time of issuance.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 9. Real Estate Securities - (continued)

Trading Securities

The following table presents the fair value of trading securities by position and collateral type at June 30, 2020 and December 31, 2019.

Table 9.2 – Trading Securities by Position


(In Thousands)	June 30, 2020		December 31, 2019
Senior	$	32,860	$	150,067
Mezzanine	3,514		538,489
Subordinate	106,325		171,984

Total Trading Securities	$	142,699	$	860,540

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, and our residential securities also include securities backed by re-performing loans ("RPL"). At June 30, 2020 and December 31, 2019, our senior trading securities included $33 million and $64 million of interest-only securities, respectively, for which there is no principal balance, and the unpaid principal balance of our remaining senior trading securities was zero and $84 million, respectively. Our interest-only securities included $14 million and $36 million of certificated mortgage servicing rights at June 30, 2020 and December 31, 2019, respectively, which are securities we retained from certain of our Sequoia securitizations that represent certificated servicing strips. At June 30, 2020 and December 31, 2019, our senior trading securities included $11 million and $55 million of RPL securities, respectively.

At June 30, 2020 and December 31, 2019, our mezzanine trading securities had an unpaid principal balance of $4 million and $537 million, respectively. At June 30, 2020 and December 31, 2019, the fair value of our mezzanine securities was $4 million and $538 million, respectively, and included $4 million and $39 million of Sequoia securities, respectively, zero and $395 million of multifamily securities, respectively, and zero and $104 million of other third-party residential securities, respectively, including zero and $30 million of RPL securities, respectively.

At June 30, 2020 and December 31, 2019, our subordinate trading securities had an unpaid principal balance of $272 million and $302 million, respectively. At June 30, 2020 and December 31, 2019, the fair value of our subordinate securities was $106 million and $172 million, respectively, and included $50 million and $90 million, respectively, of Agency residential mortgage credit risk transfer (or "CRT") securities, $52 million and $82 million, respectively, of other third-party residential securities, including $49 million and $76 million of RPL securities, respectively.

During the three and six months ended June 30, 2020, we acquired $10 million and $67 million (principal balance), respectively, of securities for which we elected the fair value option and classified as trading, and sold $86 million and $705 million, respectively, of such securities. During the three and six months ended June 30, 2019, we acquired $115 million and $269 million (principal balance), respectively, of securities for which we elected the fair value option and classified as trading, and sold $132 million and $161 million, respectively, of such securities.

During the three and six months ended June 30, 2020, we recorded a net market valuation gain of $42 million and a net market valuation loss of $221 million, respectively, on trading securities, included in Investment fair value changes, net on our consolidated statements of income (loss). During the three and six months ended June 30, 2019, we recorded net market valuation gains of $18 million and $40 million, respectively, on trading securities, included in Investment fair value changes, net on our consolidated statements of income (loss).

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 9. Real Estate Securities - (continued)

AFS Securities

The following table presents the fair value of our available-for-sale securities by position and collateral type at June 30, 2020 and December 31, 2019.

Table 9.3 – Available-for-Sale Securities by Position


(In Thousands)	June 30, 2020		December 31, 2019
Senior	$	—	$	25,792
Mezzanine	—		13,687
Subordinate	173,737		199,855

Total AFS Securities	$	173,737	$	239,334

At June 30, 2020 and December 31, 2019, our available-for-sale securities were comprised of $150 million and $230 million of residential mortgage-backed securities, respectively, and $23 million and $9 million of multifamily mortgage-backed securities, respectively. At June 30, 2020 and December 31, 2019, our residential available-for-sale securities were comprised of $118 million and $141 million of residential mortgage-backed securities we retained from our Sequoia securitizations, respectively, and $33 million and $90 million of other third-party residential securities, respectively.

During the three and six months ended June 30, 2020, we purchased zero and $31 million of AFS securities, respectively, and sold $9 million and $55 million of AFS securities, respectively, which resulted in net realized gains of $1 million and $5 million, respectively. During the three and six months ended June 30, 2019, we purchased $4 million and $9 million of AFS securities, respectively, and sold $25 million and $67 million of AFS securities, respectively, which resulted in net realized gains of $3 million and $9 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 June 30, 2020, we had $21 million of AFS securities with contractual maturities less than five years, $2 million with contractual maturities greater than five years but less than ten years, and the remainder of our AFS securities had contractual maturities greater than ten years.

The following table presents the components of carrying value (which equals fair value) of AFS securities at June 30, 2020 and December 31, 2019.

Table 9.4 – Carrying Value of AFS Securities


June 30, 2020
(In Thousands)	Senior		Mezzanine		Subordinate		Total
Principal balance	$	—	$	—	$	264,100	$	264,100
Credit reserve	—		—		(37,785)		(37,785)
Unamortized discount, net	—		—		(104,260)		(104,260)
Amortized cost	—		—		122,055		122,055
Gross unrealized gains	—		—		56,999		56,999
Gross unrealized losses	—		—		(3,846)		(3,846)
Allowance for credit losses	—		—		(1,471)		(1,471)
Carrying Value	$	—	$	—	$	173,737	$	173,737

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 9. Real Estate Securities - (continued)


December 31, 2019
(In Thousands)	Senior		Mezzanine		Subordinate		Total
Principal balance	$	26,331	$	13,512	$	264,234	$	304,077
Credit reserve	(533)		—		(32,407)		(32,940)
Unamortized discount, net	(10,427)		(527)		(113,301)		(124,255)
Amortized cost	15,371		12,985		118,526		146,882
Gross unrealized gains	10,450		702		81,329		92,481
Gross unrealized losses	(29)		—		—		(29)
Carrying Value	$	25,792	$	13,687	$	199,855	$	239,334

The following table presents the changes for the three and six months ended June 30, 2020, 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 June 30, 2020						Six Months Ended June 30, 2020
	Credit Reserve		Unamortized Discount, Net		Credit Reserve		Unamortized Discount, Net
(In Thousands)
Beginning balance	$	37,717	$	109,538	$	32,940	$	124,255
Amortization of net discount	—		(1,087)		—		(2,841)
Realized credit losses	(184)		—		(703)		—
Acquisitions	—		—		5,184		777
Sales, calls, other	(520)		(3,419)		(726)		(16,841)

(Release of) transfers to credit reserves, net	772		(772)		1,090		(1,090)
Ending Balance	$	37,785	$	104,260	$	37,785	$	104,260

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 June 30, 2020 and December 31, 2019.

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)
June 30, 2020	$	37,751	$	(3,846)	$	32,433	$	—	$	—	$	—
December 31, 2019	—		—		—		5,830		(29)		5,801

At June 30, 2020, after giving effect to purchases, sales, and extinguishment due to credit losses, our consolidated balance sheet included 94 AFS securities, of which 13 were in an unrealized loss position and zero were in a continuous unrealized loss position for 12 consecutive months or longer. At December 31, 2019, our consolidated balance sheet included 107 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.

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 9. Real Estate Securities - (continued)

Evaluating AFS Securities for Credit Losses

Gross unrealized losses on our AFS securities were $4 million at June 30, 2020. Pursuant to our adoption of ASU 2016-13, "Financial Instruments - Credit Losses" in the first quarter of 2020, we evaluate all securities in an unrealized loss position to determine if the impairment is credit-related (resulting in an allowance for credit losses recorded in earnings) or non-credit-related (resulting in an unrealized loss through other comprehensive income). At June 30, 2020, 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 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.

At June 30, 2020, our allowance for credit losses related to our AFS securities was $1 million. AFS securities for which an allowance 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 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 security credit losses.

The table below summarizes the weighted average of the significant credit quality indicators we used for the credit loss allowance on our AFS securities at June 30, 2020.

Table 9.7 – Significant Credit Quality Indicators

June 30, 2020

Subordinate Securities

Default rate

0.5%

Loss severity

20%

The following table details the activity related to the allowance for credit losses for AFS securities held at June 30, 2020.

Table 9.8 – Rollforward of Allowance for Credit Losses


	Three Months Ended		Six Months Ended
(In Thousands)	June 30, 2020		June 30, 2020
Beginning balance allowance for credit losses	$	1,525	$	—
Transition impact from adoption of new standard	—		—
Additions to allowance for credit losses on securities for which credit losses were not previously recorded	—		1,525
Allowance on purchased financial assets with credit deterioration	—		—
Reduction to allowance for securities sold during the period	—		—
Reduction to allowance for securities we intend to sell or more likely than not will be required to sell	—		—
Write-offs charged against allowance	—		—
Recoveries of amounts previously written off	(54)		(54)
Ending balance of allowance for credit losses	$	1,471	$	1,471

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 9. Real Estate Securities - (continued)

Gains and losses from the sale of AFS securities are recorded as Realized gains, net, in our consolidated statements of income (loss). The following table presents the gross realized gains and losses on sales and calls of AFS securities for the three and six months ended June 30, 2020 and 2019.

Table 9.9 – Gross Realized Gains and Losses on AFS Securities


	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2020		2019		2020		2019
Gross realized gains - sales	$	1,074	$	2,827	$	8,779	$	9,487
Gross realized gains - calls	—		—		—		4,026
Gross realized losses - sales	(291)		—		(4,144)		—

Total Realized Gains on Sales and Calls of AFS Securities, net	$	783	$	2,827	$	4,635	$	13,513

Note 10. Other Investments

Other investments at June 30, 2020 and December 31, 2019 are summarized in the following table.

Table 10.1 – Components of Other Investments


(In Thousands)	June 30, 2020		December 31, 2019
Servicer advance investments	$	266,948	$	169,204
Shared home appreciation options	40,851		45,085
Excess MSRs	36,197		31,814
Mortgage servicing rights	19,661		42,224
Investment in multifamily loan fund	30,370		39,802
Other	35,813		30,001


Total Other Investments	$	429,840	$	358,130

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 (Refer to our Annual Report on Form 10-K for the year ended December 31, 2019 for additional information regarding the transaction). During the six months ended June 30, 2020, we funded additional purchases of outstanding servicer advances and excess MSRs under the same partnership structure. At June 30, 2020, we had funded $94 million of total capital to the SA Buyers (see Note 16 for additional detail).

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 10. Other Investments - (continued)

At June 30, 2020, our servicer advance investments had a carrying value of $267 million and were associated with a portfolio of residential mortgage loans with an unpaid principal balance of $10.26 billion. The outstanding servicer advance receivables associated with this investment were $250 million at June 30, 2020, 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 June 30, 2020 and December 31, 2019.

Table 10.2 – Components of Servicer Advance Receivables


(In Thousands)	June 30, 2020		December 31, 2019
Principal and interest advances	$	82,719	$	15,081
Escrow advances (taxes and insurance advances)	118,260		96,732
Corporate advances	48,726		39,769
Total Servicer Advance Receivables	$	249,705	$	151,582

We account for our servicer advance investments at fair value and during the three and six months ended June 30, 2020, we recorded $3 million and $6 million, respectively, of interest income associated with these investments, and recorded net market valuation losses of $0.1 million and $6 million, respectively, through Investment fair value changes, net in our consolidated statements of income (loss). During the three and six months ended June 30, 2019, we recorded $3 million and $5 million, respectively, of interest income associated with these investments for each of these periods, and recorded net market valuation gains of $0.4 million and $1 million, respectively, through Investment fair value changes, net in our consolidated statements of income (loss).

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 subsidiaries.

At June 30, 2020 and December 31, 2019, our MSRs had a fair value of $20 million and $42 million, respectively, and were associated with loans with an aggregate principal balance of $3.63 billion and $4.35 billion, respectively. During the three and six months ended June 30, 2020, including net market valuation gains and losses on our MSRs and related risk management derivatives, we recorded net losses of $1 million and $3 million, respectively, through Other income on our consolidated statements of income (loss). During the three and six months ended June 30, 2019, we recognized $2 million of income, net for both periods through Other income on our consolidated statements of income (loss).

Excess MSRs

In association with our servicer advance investments described above, we (through our consolidated SA Buyers) invested in excess MSRs associated with the same portfolio of legacy residential mortgage-backed securitizations. Additionally, we own excess MSRs associated with specified pools of multifamily loans. We account for our excess MSRs at fair value and during the three and six months ended June 30, 2020, we recognized $3 million and $6 million of interest income, respectively, through Other interest income, and recorded a net market valuation gain of $3 million and a net market valuation loss of $7 million, respectively, through Investment fair value changes, net on our consolidated statements of income (loss). During the three and six months ended June 30, 2019, we recognized $2 million and $4 million of interest income, respectively, through Other interest income, and recorded net market valuation losses of $0.1 million and $0.5 million, respectively, through Investment fair value changes, net on our consolidated statements of income (loss).

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 10. Other Investments - (continued)

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 $70 million at June 30, 2020. During the three months ended March 31, 2020, we acquired $28 million of securities from the partnership's first securitization transaction. At June 30, 2020, the carrying amount of our investment in the partnership was $30 million. During the three and six months ended June 30, 2020, we recorded losses of $1 million and income of $0.3 million, respectively, associated with this investment in Other income on our consolidated statements of income (loss). During both the three and six months ended June 30, 2019, we recorded $0.1 million of losses associated with this investment in Other income on our consolidated statements of income (loss).

Shared Home Appreciation Options

In the third quarter of 2019, we entered into a flow purchase agreement to acquire shared home appreciation options. At June 30, 2020, we had acquired $47 million of shared home appreciation options under this flow purchase agreement and had an outstanding commitment to fund up to an additional $3 million under this agreement. We account for these investments under the fair value option and during the three and six months ended June 30, 2020, we recorded a net market valuation gain of $1 million and a net market valuation loss of $7 million, respectively, related to these assets through Investment fair value changes, net on our consolidated statements of income (loss).

Note 11. Derivative Financial Instruments

The following table presents the fair value and notional amount of our derivative financial instruments at June 30, 2020 and December 31, 2019.

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


	June 30, 2020						December 31, 2019
	Fair Value		Notional Amount		Fair Value		Notional Amount
(In Thousands)


Assets - Risk Management Derivatives
Interest rate swaps	$	—	$	—	$	17,095	$	1,399,000
TBAs	—		—		5,755		2,445,000
Interest rate futures	—		—		777		213,700
Swaptions	—		—		1,925		1,065,000

Assets - Other Derivatives
Loan purchase and interest rate lock commitments	357		24,871		10,149		1,537,162

Total Assets	$	357	$	24,871	$	35,701	$	6,659,862

Liabilities - Cash Flow Hedges
Interest rate swaps	$	—	$	—	$	(51,530)	$	139,500
Liabilities - Risk Management Derivatives
Interest rate swaps	—		—		(97,235)		2,314,300
TBAs	—		—		(13,359)		4,160,000
Interest rate futures	—		—		(10)		12,300
Liabilities - Other Derivatives
Loan purchase commitments	(1,932)		199,932		(1,290)		303,394

Total Liabilities	$	(1,932)	$	199,932	$	(163,424)	$	6,929,494
Total Derivative Financial Instruments, Net	$	(1,575)	$	224,803	$	(127,723)	$	13,589,356

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 11. Derivative Financial Instruments - (continued)

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 June 30, 2020, we were not party to any derivative contracts. At December 31, 2019, we were party to swaps and swaptions with an aggregate notional amount of $4.78 billion, TBA agreements sold with an aggregate notional amount of $6.61 billion, and interest rate futures contracts with an aggregate notional amount of $226 million.

During the three and six months ended June 30, 2020, risk management derivatives had net market valuation losses of zero and $98 million, respectively. During the three and six months ended June 30, 2019, risk management derivatives had net market valuation losses of $66 million and $111 million, respectively. These market valuation gains and losses are recorded in Mortgage banking activities, net, Investment fair value changes, net, and Other income on our consolidated statements of income (loss). During the three months ended March 31, 2020, we settled substantially all of our outstanding derivative contracts as we determined that they were no longer effectively managing the risks associated with certain assets and liabilities.

Loan Purchase and Interest Rate Lock Commitments

LPCs and IRLCs that qualify as derivatives are recorded at their estimated fair values. For the three and six months ended June 30, 2020, LPCs and IRLCs had net market valuation gains of $3 million and $21 million, respectively, that were recorded in Mortgage banking activities, net on our consolidated statements of income (loss). For the three and six months ended June 30, 2019, LPCs and IRLCs had net market valuation gains of $17 million and $29 million, respectively, that were recorded in Mortgage banking activities, net on our consolidated statements of income (loss).

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.

During the first quarter of 2020, we terminated and settled all of our outstanding derivatives that had been designated as cash flow hedges for our long-term debt, with a payment of $84 million. For interest rate agreements previously designated as cash flow hedges, our total unrealized loss reported in Accumulated other comprehensive income was $83 million and $51 million at June 30, 2020 and December 31, 2019, respectively. We will amortize this loss into interest expense over the remaining term of the trust preferred securities and subordinated notes. As of June 30, 2020, we expect to amortize $4 million of realized losses related to terminated cash flow hedges into interest expense over the next twelve months.

For the three and six months ended June 30, 2020, changes in the values of designated cash flow hedges were zero and negative $33 million, respectively, and were recorded in Accumulated other comprehensive income, a component of equity. For the three and six months ended June 30, 2019, changes in the values of designated cash flow hedges were negative $10 million and negative $15 million, respectively, and were recorded in Accumulated other comprehensive income, a component of equity.

The following table illustrates the impact on interest expense of our interest rate agreements accounted for as cash flow hedges for the three and six months ended June 30, 2020 and 2019.

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


	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2020		2019		2020		2019
Net interest expense on cash flows hedges	$	—	$	(640)	$	(860)	$	(1,277)

Realized net losses reclassified from other comprehensive income	(1,029)		—		(1,108)		—
Total Interest Expense	$	(1,029)	$	(640)	$	(1,968)	$	(1,277)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

Note 11. Derivative Financial Instruments - (continued)

Derivative Counterparty Credit Risk

As discussed in our Annual Report on Form 10-K for the year ended December 31, 2019, we consider counterparty risk as part of our fair value assessments of all derivative financial instruments at each quarter-end. At June 30, 2020, we assessed this risk as remote and did not record a specific valuation adjustment.

At June 30, 2020, we were in compliance with our derivative counterparty ISDA agreements.

Note 12. Other Assets and Liabilities

Other assets at June 30, 2020 and December 31, 2019 are summarized in the following table.

Table 12.1 – Components of Other Assets


(In Thousands)	June 30, 2020		December 31, 2019
Accrued interest receivable	$	44,134	$	71,058
Pledged collateral	33,105		32,945
Investment receivable	29,916		23,330
Income tax receivables	17,255		36
Right-of-use asset	15,561		11,866
REO	9,780		9,462
FHLBC stock	5,000		43,393
Fixed assets and leasehold improvements⁽¹⁾	4,590		4,901
Margin receivable	2,746		209,776



Other	9,499		12,554
Total Other Assets	$	171,586	$	419,321

(1)Fixed assets and leasehold improvements had a basis of $12 million and accumulated depreciation of $7 million at June 30, 2020.

Accrued expenses and other liabilities at June 30, 2020 and December 31, 2019 are summarized in the following table.

Table 12.2 – Components of Accrued Expenses and Other Liabilities


(In Thousands)	June 30, 2020		December 31, 2019
Accrued interest payable	$	37,024	$	60,655

Lease liability	17,348		13,443