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UNITED STATES OF AMERICA

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended: September 30, 2020

OR

☐			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						111,928,020			shares outstanding as of November 2, 2020

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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 September 30, 2020 (Unaudited) and December 31, 2019						2
			Consolidated Statements of Income (Loss) for the Three and Nine Months Ended September 30, 2020 and 2019 (Unaudited)						3
			Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2020 and 2019 (Unaudited)						4
			Consolidated Statements of Changes in Stockholders' Equity for the Three and Nine Months Ended September 30, 2020 and 2019 (Unaudited)						5
			Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 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						24
			Note 6. Residential Loans						33
			Note 7. Business Purpose Residential Loans						35
			Note 8. Multifamily Loans						38
			Note 9. Real Estate Securities						39
			Note 10. Other Investments						43
			Note 11. Derivative Financial Instruments						46
			Note 12. Other Assets and Liabilities						48
			Note 13. Short-Term Debt						49
			Note 14. Asset-Backed Securities Issued						51
			Note 15. Long-Term Debt						52
			Note 16. Commitments and Contingencies						54
			Note 17. Equity						59
			Note 18. Equity Compensation Plans						62
			Note 19. Mortgage Banking Activities, Net						64
			Note 20. Other Income						65
			Note 21. General and Administrative Expenses, Loan Acquisition Costs, and Other Expenses						66
			Note 22. Taxes						67
			Note 23. Segment Information						68
Item 2.			Management’s Discussion and Analysis of Financial Condition and Results of Operations						73
Item 3.			Quantitative and Qualitative Disclosures About Market Risk						104
Item 4.			Controls and Procedures						104
PART II —			OTHER INFORMATION
Item 1.			Legal Proceedings						105
Item 1A.			Risk Factors						106
Item 2.			Unregistered Sales of Equity Securities and Use of Proceeds						107
Item 3.			Defaults Upon Senior Securities						107
Item 4.			Mine Safety Disclosures (Not Applicable)						107
Item 5.			Other Information						107
Item 6.			Exhibits						108
Signatures									110

i

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In Thousands, except Share Data) (Unaudited)						September 30, 2020						December 31, 2019
ASSETS (1)
Residential loans, held-for-sale, at fair value						$	105,128					$	536,385
Residential loans, held-for-investment, at fair value						4,389,808						7,178,465
Business purpose residential loans, held-for-sale, at fair value						285,549						331,565
Business purpose residential loans, held-for-investment, at fair value						3,670,552						3,175,178
Multifamily loans, held-for-investment, at fair value						491,415						4,408,524
Real estate securities, at fair value						351,335						1,099,874
Other investments						384,628						358,130
Cash and cash equivalents						450,684						196,966
Restricted cash						73,594						93,867
Goodwill and intangible assets						60,737						161,464
Derivative assets						14,709						35,701
Other assets						124,273						419,321
Total Assets						$	10,402,412					$	17,995,440
LIABILITIES AND EQUITY (1)
Liabilities
Short-term debt, net						$	482,761					$	2,329,145
Derivative liabilities						1,612						163,424
Accrued expenses and other liabilities						155,989						206,893
Asset-backed securities issued (includes $6,969,376 and $10,515,475 at fair value), net						7,172,398						10,515,475
Long-term debt, net						1,536,188						2,953,272
Total liabilities						9,348,948						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; 111,904,322 and 114,353,036 issued and outstanding						1,119						1,144
Additional paid-in capital						2,261,911						2,269,617
Accumulated other comprehensive (loss) income						(20,560)						41,513
Cumulative earnings						942,982						1,579,124
Cumulative distributions to stockholders						(2,131,988)						(2,064,167)
Total equity						1,053,464						1,827,231
Total Liabilities and Equity						$	10,402,412					$	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 September 30, 2020 and December 31, 2019, assets of consolidated VIEs totaled $8,197,095 and $11,931,869, respectively. At September 30, 2020 and December 31, 2019, liabilities of consolidated VIEs totaled $7,238,047 and $10,717,072, respectively. See Note 4 for further discussion.

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

2

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REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(In Thousands, except Share Data)						Three Months Ended September 30,												Nine Months Ended September 30,
(Unaudited)						2020						2019						2020						2019
Interest Income
Residential loans						$	44,921					$	77,070					$	179,331					$	230,308
Business purpose residential loans						55,637						5,446						161,710						12,231
Multifamily loans						4,918						36,829						49,960						94,134
Real estate securities						10,135						23,047						38,471						72,514
Other interest income						6,371						7,725						20,537						20,513
Total interest income						121,982						150,117						450,009						429,700
Interest Expense
Short-term debt						(5,145)						(24,239)						(45,119)						(70,732)
Asset-backed securities issued						(66,514)						(71,065)						(232,316)						(196,473)
Long-term debt						(28,752)						(21,300)						(72,313)						(64,895)
Total interest expense						(100,411)						(116,604)						(349,748)						(332,100)
Net Interest Income						21,571						33,513						100,261						97,600
Non-interest Income (Loss)
Mortgage banking activities, net						59,395						9,515						24,511						40,984
Investment fair value changes, net						107,047						11,444						(611,557)						34,741
Other income, net						(114)						4,356						3,979						13,840
Realized gains, net						602						4,714						30,419						18,227
Total non-interest income (loss), net						166,930						30,029						(552,648)						107,792
General and administrative expenses						(27,630)						(24,899)						(84,832)						(70,722)
Loan acquisition costs						(2,158)						(1,916)						(7,716)						(5,507)
Other expenses						(7,788)						(2,531)						(104,286)						(6,021)
Net Income (Loss) before (Provision for) Benefit from Income Taxes						150,925						34,196						(649,221)						123,142
(Provision for) benefit from income taxes						(9,113)						114						13,079						(3,102)
Net Income (Loss)						$	141,812					$	34,310					$	(636,142)					$	120,040
Basic earnings (loss) per common share						$	1.21					$	0.33					$	(5.60)					$	1.20
Diluted earnings (loss) per common share						$	1.02					$	0.31					$	(5.60)					$	1.09
Basic weighted average shares outstanding						113,403,102						101,872,126						113,952,308						97,214,064
Diluted weighted average shares outstanding						141,969,977						136,522,709						113,952,308						131,202,689

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

3

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REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In Thousands)						Three Months Ended September 30,												Nine Months Ended September 30,
(Unaudited)						2020						2019						2020						2019
Net Income (Loss)						$	141,812					$	34,310					$	(636,142)					$	120,040
Other comprehensive income (loss):
Net unrealized gain (loss) on available-for-sale securities						8,236						4,484						(19,890)						19,764
Reclassification of unrealized gain on available-for-sale securities to net income						(445)						(3,492)						(11,525)						(15,807)
Net unrealized loss on interest rate agreements						—						(11,791)						(32,806)						(27,130)
Reclassification of unrealized loss on interest rate agreements to net income						1,040						—						2,148						—
Total other comprehensive income (loss)						8,831						(10,799)						(62,073)						(23,173)
Total Comprehensive Income (Loss)						$	150,643					$	23,511					$	(698,215)					$	96,867

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

4

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REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

For the Three Months Ended September 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
June 30, 2020						114,940,197						$	1,149					$	2,279,625					$	(29,391)					$	801,170					$	(2,115,977)					$	936,576
Net income						—						—						—						—						141,812						—						141,812
Other comprehensive income						—						—						—						8,831						—						—						8,831
Employee stock purchase and incentive plans						11,460						—						9						—						—						—						9
Non-cash equity award compensation						—						—						3,906						—						—						—						3,906
Share repurchases						(3,047,335)						(30)						(21,629)						—						—						—						(21,659)
Common dividends declared ($0.14 per share)						—						—						—						—						—						(16,011)						(16,011)
September 30, 2020						111,904,322						$	1,119					$	2,261,911					$	(20,560)					$	942,982					$	(2,131,988)					$	1,053,464

For the Nine Months Ended September 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						—						—						—						—						(636,142)						—						(636,142)
Other comprehensive loss						—						—						—						(62,073)						—						—						(62,073)
Issuance of common stock						350,088						3						5,544						—						—						—						5,547
Employee stock purchase and incentive plans						248,533						2						(2,767)						—						—						—						(2,765)
Non-cash equity award compensation						—						—						11,146						—						—						—						11,146
Share repurchases						(3,047,335)						(30)						(21,629)						—						—						—						(21,659)
Common dividends declared ($0.585 per share)						—						—						—						—						—						(67,821)						(67,821)
September 30, 2020						111,904,322						$	1,119					$	2,261,911					$	(20,560)					$	942,982					$	(2,131,988)					$	1,053,464

For the Three Months Ended September 30, 2019

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED)

For the Nine Months Ended September 30, 2019

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

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

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

(In Thousands) (Unaudited)						Nine Months Ended September 30,
						2020						2019
Cash Flows From Operating Activities:
Net (loss) income						$	(636,142)					$	120,040
Adjustments to reconcile net (loss) income to net cash used in operating activities:
Amortization of premiums, discounts, and securities issuance costs, net						6,213						(3,486)
Depreciation and amortization of non-financial assets						13,166						5,673
Originations of held-for-sale loans						(654,820)						(124,392)
Purchases of held-for-sale loans						(2,893,246)						(4,002,509)
Proceeds from sales of held-for-sale loans						3,224,526						2,971,811
Principal payments on held-for-sale loans						53,677						77,100
Net settlements of derivatives						(187,130)						(32,902)
Non-cash equity award compensation expense						11,146						10,552
Goodwill impairment expense						88,675						—
Market valuation adjustments						606,764						(62,720)
Realized gains, net						(30,419)						(18,227)
Net change in:
Accrued interest receivable and other assets						304,147						(141,197)
Accrued interest payable and accrued expenses and other liabilities						(82,489)						(1,049)
Net cash used in operating activities						(175,932)						(1,201,306)
Cash Flows From Investing Activities:
Originations of loan investments						(327,494)						(171,915)
Purchases of loan investment						—						(49,489)
Proceeds from sales of loan investments						1,574,160						9,422
Principal payments on loan investments						1,652,418						1,091,652
Purchases of real estate securities						(106,422)						(309,839)
Purchases of residential securities held in consolidated securitization trust						—						(193,212)
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						634,709						487,469
Principal payments on real estate securities						19,446						62,711
Purchases of servicer advance investments						(179,419)						(69,610)
Principal repayments from servicer advance investments						83,124						150,512
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						40,898						(33,090)
Other investing activities, net						(19,865)						(24,989)
Net cash provided by investing activities						3,514,545						915,516
Cash Flows From Financing Activities:
Proceeds from borrowings on short-term debt						3,981,572						4,009,083
Repayments on short-term debt						(5,828,972)						(4,435,823)
Proceeds from issuance of asset-backed securities						1,343,845						1,020,136
Repayments on asset-backed securities issued						(1,037,546)						(720,651)
Proceeds from issuance of long-term debt						1,251,850						387,053
Deferred long-term debt issuance costs paid						(9,526)						(7,023)
Repayments on long-term debt						(2,640,007)						—
Net settlements of derivatives						(84,336)						—
Net proceeds from issuance of common stock						5,791						426,970
Net payments on repurchase of common stock						(21,659)						—
Taxes paid on equity award distributions						(3,009)						—
Dividends paid						(67,821)						(94,286)
Other financing activities, net						4,650						1,400
Net cash (used in) provided by financing activities						(3,105,168)						586,859
Net increase in cash, cash equivalents and restricted cash						233,445						301,069
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)						$	524,278					$	506,146

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

(In Thousands) (Unaudited)						Nine Months Ended September 30,
						2020						2019
Supplemental Cash Flow Information:
Cash paid during the period for:
Interest						$	364,875					$	319,036
Taxes						218						6,977
Supplemental Noncash Information:
Real estate securities retained from loan securitizations						$	46,560					$	7,759
Retention of mortgage servicing rights from loan securitizations and sales						—						868
Consolidation of residential loans held in securitization trusts						—						1,190,995
Consolidation of residential ABS						—						997,783
(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						770,754						1,361,015
Transfers from residential loans to real estate owned						12,547						5,280
Right-of-use asset obtained in exchange for operating lease liability						5,362						13,016
Reduction in operating lease liability due to lease modification						1,466						—

(1)    Cash, cash equivalents, and restricted cash at September 30, 2020 includes cash and cash equivalents of $451 million and restricted cash of $74 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.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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 September 30, 2020 and December 31, 2019, and for the three and nine months ended September 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 September 30, 2020 and results of operations for all periods presented have been made. The results of operations for the three and nine months ended September 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.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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 nine months ended September 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 September 30, 2020						Weighted Average Amortization Period (in years)
(Dollars in Thousands)
Borrower network						$	43,952					$	—					$	(4,854)					$	39,098					7
Broker network						15,083						—						(2,715)						12,368						5
Non-compete agreements						8,236						—						(2,375)						5,861						3
Tradenames						3,472						—						(1,000)						2,472						3
Developed technology						1,613						—						(675)						938						2
Loan administration fees on existing loan assets						433						—						(433)						—						1
Total						$	72,789					$	—					$	(12,052)					$	60,737					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)																		September 30, 2020
2020 (3 months)																		$	3,873
2021																		15,304
2022																		12,800
2023																		10,091
2024																		7,073
2025 and thereafter																		11,596
Total Future Intangible Asset Amortization																		$	60,737

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.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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 September 30, 2020, the carrying value of this deferred liability was $14 million and was recorded as a component of Accrued expenses and other liabilities on our consolidated balance sheets. During the three and nine months ended September 30, 2020, we recorded $0.1 million and $0.6 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 nine months ended September 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 September 30, 2019						Nine Months Ended September 30, 2019
(In Thousands)
Supplementary pro forma information:
Net interest income												$	45,702					$	133,446
Non-interest income												38,177						116,649
Net income												46,609						140,790

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 nine months ended September 30, 2020.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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.

13

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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 August 2020, the FASB issued ASU 2020-06, "Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity's Own Equity (Subtopic 815-40)." This new guidance simplifies the accounting for convertible debt by reducing the number of accounting models to separately present certain conversion features in equity. This new guidance is effective for fiscal years beginning after December 31, 2021. Early adoption is permitted. We plan to adopt this new guidance by the required date and do not anticipate that this update will have a material impact on our consolidated financial statements.

In 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. Through September 30, 2020, we have not elected to apply the optional expedients and exceptions to any of our existing contracts, hedging relationships, or other transactions.

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.

14

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

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

Balance Sheet Netting

Certain of our derivatives and short-term debt are subject to master netting arrangements or similar agreements. Under GAAP, in certain circumstances we may elect to present certain financial assets, liabilities and related collateral subject to master netting arrangements in a net position on our consolidated balance sheets. However, we do not report any of these financial assets or liabilities on a net basis, and instead present them on a gross basis on our consolidated balance sheets.

The table below presents financial assets and liabilities that are subject to master netting arrangements or similar agreements categorized by financial instrument, together with corresponding financial instruments and corresponding collateral received or pledged at September 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
September 30, 2020 (In Thousands)																								Financial Instruments						Cash Collateral (Received) Pledged
Assets (2)
Interest rate agreements						$	3,471					$	—					$	3,471					$	(15)					$	(1,240)					$	2,216
TBAs						402						—						402						—						(263)						139
Futures						63						—						63						—						—						63
Total Assets						$	3,936					$	—					$	3,936					$	(15)					$	(1,503)					$	2,418
Liabilities (2)
Interest rate agreements						$	(15)					$	—					$	(15)					$	15					$	—					$	—
TBAs						(263)						$	—					(263)						—						263						—
Loan warehouse debt						(81,898)						$	—					(81,898)						81,898						—						—
Security repurchase agreements						(75,054)						—						(75,054)						75,054						—						—
Total Liabilities						$	(157,230)					$	—					$	(157,230)					$	156,967					$	263					$	—

15

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

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

						Gross Amounts of Recognized Assets (Liabilities)						Gross Amounts Offset in Consolidated Balance Sheet						Net Amounts of Assets (Liabilities) Presented in Consolidated Balance Sheet						Gross Amounts Not Offset in Consolidated Balance Sheet (1)												Net Amount
December 31, 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.

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.

16

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 4. Principles of Consolidation - (continued)

Analysis of Consolidated VIEs

At September 30, 2020, we consolidated Legacy Sequoia, Sequoia Choice, 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 September 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 $5 million, $211 million, $418 million, $27 million, and $232 million, respectively.

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.

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 September 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 September 30, 2020, the estimated fair value of our investment in the Servicing Investment entities was $65 million.

17

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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 Accounted for as Collateralized Financing Entities

September 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						$	296,765					$	1,836,361					$	2,256,682					$	—					$	—					$	—					$	4,389,808
Business purpose residential loans, held-for-investment						—						—						—						—						2,969,692						—						2,969,692
Multifamily loans, held-for-investment						—						—						—						491,415						—						—						491,415
Other investments						—						—						—						—						—						278,487						278,487
Cash and cash equivalents						—						—						—						—						—						10,425						10,425
Restricted cash						146						—						—						—						—						20,649						20,795
Accrued interest receivable						402						7,292						6,928						1,342						12,071						2,609						30,644
Other assets						784						—						887						—						4,158						—						5,829
Total Assets						$	298,097					$	1,843,653					$	2,264,497					$	492,757					$	2,985,921					$	312,170					$	8,197,095
Short-term debt						$	—					$	—					$	—					$	—					$	—					$	228,998					$	228,998
Accrued interest payable						180						5,652						5,009						1,182						9,337						137						21,497
Accrued expenses and other liabilities						—						47						—						—						—						18,129						18,176
Asset-backed securities issued						292,484						1,626,564						1,841,313						464,865						2,744,150						—						6,969,376
Total Liabilities						$	292,664					$	1,632,263					$	1,846,322					$	466,047					$	2,753,487					$	247,264					$	7,238,047
Number of VIEs						20						10						2						1						13						3						49

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

18

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 4. Principles of Consolidation - (continued)

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

Table 4.2 – Income (Loss) from Consolidated VIEs Accounted for as Collateralized Financing Entities

						Three Months Ended September 30, 2020
						Legacy Sequoia						Sequoia Choice						Freddie Mac SLST						Freddie Mac K-Series						CAFL						Servicing Investment						Total Consolidated VIEs
(Dollars in Thousands)
Interest income						$	1,795					$	20,919					$	21,696					$	4,918					$	36,181					$	4,403					$	89,912
Interest expense						(1,058)						(17,828)						(15,473)						(4,426)						(27,499)						(1,587)						(67,871)
Net interest income						737						3,091						6,223						492						8,682						2,816						22,041
Non-interest income
Investment fair value changes, net						(81)						7,851						82,214						2,166						9,692						(422)						101,420
Total non-interest income, net						(81)						7,851						82,214						2,166						9,692						(422)						101,420
General and administrative expenses						—						—						—						—						—						(41)						(41)
Other expenses						—						—						—						—						—						(471)						(471)
Income from Consolidated VIEs						$	656					$	10,942					$	88,437					$	2,658					$	18,374					$	1,882					$	122,949

						Nine Months Ended September 30, 2020
						Legacy Sequoia						Sequoia Choice						Freddie Mac SLST						Freddie Mac K-Series						CAFL						Servicing Investment						Total Consolidated VIEs
(Dollars in Thousands)
Interest income						$	7,675					$	68,566					$	64,869					$	49,960					$	99,169					$	13,026					$	303,265
Interest expense						(5,098)						(58,455)						(47,495)						(47,154)						(75,600)						(4,961)						(238,763)
Net interest income						2,577						10,111						17,374						2,806						23,569						8,065						64,502
Non-interest income
Investment fair value changes, net						(702)						(22,065)						(33,081)						(82,744)						(41,841)						(9,015)						(189,448)
Total non-interest income, net						(702)						(22,065)						(33,081)						(82,744)						(41,841)						(9,015)						(189,448)
General and administrative expenses						—						—						—						—						—						(784)						(784)
Other expenses						—						—						—						—						—						346						346
Income (Loss) from Consolidated VIEs						$	1,875					$	(11,954)					$	(15,707)					$	(79,938)					$	(18,272)					$	(1,388)					$	(125,384)

						Three Months Ended September 30, 2019
						Legacy Sequoia						Sequoia Choice						Freddie Mac SLST						Freddie Mac K-Series						CAFL						Servicing Investment						Total Consolidated VIEs
(Dollars in Thousands)
Interest income						$	4,295					$	27,555					$	11,830					$	36,829					$	—					$	3,922					$	84,431
Interest expense						(3,452)						(23,576)						(8,709)						(35,328)						—						(2,891)						(73,956)
Net interest income						843						3,979						3,121						1,501						—						1,031						10,475
Non-interest income
Investment fair value changes, net						(407)						2,722						17,300						7,445						—						963						28,023
Total non-interest income, net						(407)						2,722						17,300						7,445						—						963						28,023
General and administrative expenses						—						—						—						—						—						(16)						(16)
Other expenses						—						—						—						—						—						(395)						(395)
Income from Consolidated VIEs						$	436					$	6,701					$	20,421					$	8,946					$	—					$	1,583					$	38,087

19

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 4. Principles of Consolidation - (continued)

						Nine Months Ended September 30, 2019
						Legacy Sequoia						Sequoia Choice						Freddie Mac SLST						Freddie Mac K-Series						CAFL						Servicing Investment						Total Consolidated VIEs
(Dollars in Thousands)
Interest income						$	13,924					$	80,045					$	35,221					$	94,134					$	—					$	10,847					$	234,171
Interest expense						(11,548)						(68,823)						(26,013)						(90,089)						—						(9,905)						(206,378)
Net interest income						2,376						11,222						9,208						4,045						—						942						27,793
Non-interest income
Investment fair value changes, net						(904)						8,866						31,702						13,810						—						3,462						56,936
Total non-interest income, net						(904)						8,866						31,702						13,810						—						3,462						56,936
General and administrative expenses						—						—						—						—						—						(87)						(87)
Other expenses						—						—						—						—						—						(864)						(864)
Income from Consolidated VIEs						$	1,472					$	20,088					$	40,910					$	17,855					$	—					$	3,453					$	83,778

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.

During the third quarter of 2020, we re-securitized subordinate securities we owned in our consolidated Freddie Mac SLST securitization trusts, through the transfer of these financial assets to a re-securitization trust that we sponsored. We retain a subordinate investment in the re-securitization trust and maintain certain discretionary rights associated with the ownership of this investment that we determined reflected a controlling financial interest in the entity, as we have both the power to direct the activities that most significantly impact the performance of the VIE and the right to receive benefits of and the obligation to absorb losses from the VIE that could potentially be significant to the VIE. At securitization, we issued $210 million of ABS and have elected to account for the ABS issued at amortized cost.

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 September 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.

20

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 4. Principles of Consolidation - (continued)

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

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

						Three Months Ended September 30,												Nine Months Ended September 30,
(In Thousands)						2020						2019						2020						2019
Principal balance of loans transferred						$	—					$	366,999					$	1,573,703					$	1,116,092
Trading securities retained, at fair value						—						1,228						43,362						4,736
AFS securities retained, at fair value						—						1,069						3,198						3,023

The following table summarizes the cash flows during the three and nine months ended September 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 September 30,												Nine Months Ended September 30,
(In Thousands)						2020						2019						2020						2019
Proceeds from new transfers						$	—					$	376,126					$	1,610,761					$	1,138,778
MSR fees received						2,280						2,919						7,445						9,084
Funding of compensating interest, net						4						(76)						(293)						(213)
Cash flows received on retained securities						5,873						6,603						19,242						20,892

The following table presents the key weighted-average assumptions used to measure MSRs and securities retained at the date of securitization for securitizations completed during the three and nine months ended September 30, 2020 and 2019.

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

												Three Months Ended September 30, 2020																		Three Months Ended September 30, 2019
At Date of Securitization												Senior IO Securities						Subordinate Securities												Senior IO Securities						Subordinate Securities
Prepayment rates												N/A						N/A												37		%				15		%
Discount rates												N/A						N/A												14		%				7		%
Credit loss assumptions												N/A						N/A												0.20		%				0.20		%

												Nine Months Ended September 30, 2020																		Nine Months Ended September 30, 2019
At Date of Securitization												Senior IO Securities						Subordinate Securities												Senior IO Securities						Subordinate Securities
Prepayment rates												41		%				13		%										25		%				15		%
Discount rates												16		%				6		%										14		%				7		%
Credit loss assumptions												0.21		%				0.22		%										0.20		%				0.20		%

21

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 4. Principles of Consolidation - (continued)

The following table presents additional information at September 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)						September 30, 2020						December 31, 2019
On-balance sheet assets, at fair value:
Interest-only, senior and subordinate securities, classified as trading						$	19,878					$	88,425
Subordinate securities, classified as AFS						124,132						140,649
Mortgage servicing rights						14,240						40,254
Maximum loss exposure (1)						$	158,250					$	269,328
Assets transferred:
Principal balance of loans outstanding						$	8,571,916					$	10,299,442
Principal balance of loans 30+ days delinquent						200,910						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 September 30, 2020 and December 31, 2019.

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

September 30, 2020						MSRs						Senior Securities (1)						Subordinate Securities
(Dollars in Thousands)
Fair value at September 30, 2020						$	14,240					$	16,226					$	127,783
Expected life (in years) (2)						3						3						10
Prepayment speed assumption (annual CPR) (2)						26		%				30		%				27		%
Decrease in fair value from:
10% adverse change						$	1,105					$	1,622					$	1,075
25% adverse change						2,678						3,675						3,735
Discount rate assumption (2)						12		%				17		%				6		%
Decrease in fair value from:
100 basis point increase						$	383					$	327					$	10,219
200 basis point increase						746						638						19,348
Credit loss assumption (2)						N/A						0.38		%				0.38		%
Decrease in fair value from:
10% higher losses						N/A						$	—					$	2,274
25% higher losses						N/A						—						5,500

22

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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 $16 million and $49 million of interest-only securities at September 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 September 30, 2020 and December 31, 2019, grouped by asset type.

Table 4.8 – Third-Party Sponsored VIE Summary

(In Thousands)						September 30, 2020						December 31, 2019
Mortgage-Backed Securities
Senior						$	11,865					$	127,094
Mezzanine						2,016						508,195
Subordinate						193,445						235,510
Total Mortgage-Backed Securities						207,326						870,799
Excess MSR						15,205						16,216
Total Investments in Third-Party Sponsored VIEs						$	222,531					$	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.

23

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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.

24

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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 September 30, 2020 and December 31, 2019.

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

						September 30, 2020												December 31, 2019
						Carrying Value						Fair Value						Carrying Value						Fair Value
(In Thousands)
Assets
Residential loans, held-for-sale at fair value						$	105,091					$	105,091					$	536,385					$	536,509
Residential loans, held-for-investment						4,389,808						4,389,808						7,178,465						7,178,465
Business purpose residential loans, held-for-sale						285,549						285,549						331,565						331,565
Business purpose residential loans, held-for-investment						3,670,552						3,670,552						3,175,178						3,175,178
Multifamily loans						491,415						491,415						4,408,524						4,408,524
Real estate securities						351,335						351,335						1,099,874						1,099,874
Servicer advance investments (1)						258,621						258,621						169,204						169,204
MSRs (1)						14,878						14,878						42,224						42,224
Excess MSRs (1)						35,070						35,070						31,814						31,814
Shared home appreciation options (1)						41,758						41,758						45,085						45,085
Cash and cash equivalents						450,684						450,684						196,966						196,966
Restricted cash						73,594						73,594						93,867						93,867
Derivative assets						14,709						14,709						35,701						35,701
REO (2)						8,535						9,654						9,462						10,389
Margin receivable (2)						3,809						3,809						209,776						209,776
FHLBC stock (2)						5,000						5,000						43,393						43,393
Guarantee asset (2)						579						579						1,686						1,686
Pledged collateral (2)						8,172						8,172						32,945						32,945
Liabilities
Short-term debt						$	482,761					$	482,761					$	2,329,145					$	2,329,145
Margin payable (3)						—						—						1,700						1,700
Guarantee obligation (3)						11,264						10,185						14,009						13,754
Contingent consideration (3)						—						—						28,484						28,484
Derivative liabilities						1,612						1,612						163,424						163,424
ABS issued, net
Fair value						6,969,376						6,969,376						10,515,475						10,515,475
Amortized cost						203,022						207,812						—						—
FHLBC long-term borrowings						1,000						1,000						1,999,999						1,999,999
Other long-term debt, net						886,054						885,172						183,520						184,666
Convertible notes, net						510,472						476,071						631,125						661,985
Trust preferred securities and subordinated notes, net						138,663						73,238						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.

During the three and nine months ended September 30, 2020, we elected the fair value option for $18 million and $96 million of securities, respectively, $172 million and $2.86 billion of residential loans (principal balance), respectively, $260 million and $956 million of business purpose residential loans (principal balance), respectively, zero and $179 million of servicer advance investments, respectively, zero 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.

25

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

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

The following table presents the assets and liabilities that are reported at fair value on our consolidated balance sheets on a recurring basis at September 30, 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

September 30, 2020						Carrying Value						Fair Value Measurements Using
(In Thousands)												Level 1						Level 2						Level 3
Assets
Residential loans						$	4,494,899					$	—					$	—					$	4,494,899
Business purpose residential loans						3,956,101						—						—						3,956,101
Multifamily loans						491,415						—						—						491,415
Real estate securities						351,335						—						—						351,335
Servicer advance investments						258,621						—						—						258,621
MSRs						14,878						—						—						14,878
Excess MSRs						35,070						—						—						35,070
Shared home appreciation options						41,758						—						—						41,758
Derivative assets						14,709						464						3,472						10,773
Pledged collateral						8,172						8,172						—						—
FHLBC stock						5,000						—						5,000						—
Guarantee asset						579						—						—						579
Liabilities
Derivative liabilities						$	1,612					$	263					$	15					$	1,334
ABS issued						6,969,376						—						—						6,969,376

26

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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
Real estate securities						1,099,874						—						—						1,099,874
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 nine months ended September 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						2,927,697						—						—						96,318						56,664						179,419						—						10,906						3,517
Originations						—						982,315						—						—						—						—						—						—						—
Sales						(4,783,682)						(53,434)						—						(579,466)						(55,193)						—						—						—						—
Principal paydowns						(1,210,117)						(489,243)						(5,830)						(8,502)						(10,345)						(83,124)						—						—						(2,558)
Deconsolidations						—						—						(3,849,779)						—						—						—						—						—						—
Gains (losses) in net income (loss), net						(152,145)						16,246						(61,500)						(224,728)						(23,287)						(6,878)						(27,346)						(7,650)						(4,286)
Other settlements, net (1)						(1,599)						(6,526)						—						—						—						—						—						—						—
Ending balance - September 30, 2020						$	4,494,899					$	3,956,101					$	491,415					$	144,162					$	207,173					$	258,621					$	14,878					$	35,070					$	41,758

27

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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																																																—						—						—						1,137,656
Principal paydowns																																																—						—						(13,353)						(1,035,359)
Deconsolidations																																																—						—						—						(3,706,789)
Gains (losses) in net income (loss), net																																																(1,107)						34,620						(446)						58,393
Other settlements, net (1)																																																—						(34,041)						(14,685)						—
Ending balance - September 30, 2020																																																$	579					$	9,439					$	—					$	6,969,376

(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.

28

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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 September 30, 2020 and 2019. Gains or losses incurred on assets or liabilities sold, matured, called, or fully written down during the three and nine months ended September 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 September 30, 2020 and 2019 Included in Net Income

						Included in Net Income
						Three Months Ended September 30,												Nine Months Ended September 30,
(In Thousands)						2020						2019						2020						2019
Assets
Residential loans at Redwood						$	(107)					$	17,771					$	(865)					$	82,408
Business purpose residential loans						21,155						584						17,901						4,069
Net investments in consolidated Sequoia entities (1)						7,700						1,860						(22,802)						7,051
Net investments in consolidated Freddie Mac SLST entities (1)						82,209						17,300						(33,087)						31,702
Net investments in consolidated Freddie Mac K-Series entities (1)						2,165						7,445						(11,014)						13,810
Net investments in consolidated CAFL entities (1)						9,673						—						(41,048)						—
Trading securities						(3,549)						11,206						(80,358)						33,196
Servicer advance investments						25						1,585						(6,172)						3,025
MSRs						(2,376)						(5,892)						(16,798)						(16,971)
Excess MSRs						(1,127)						(1,634)						(7,650)						(2,137)
Shared home appreciation options						2,384						29						(4,286)						29
Loan purchase and interest rate lock commitments						10,791						4,678						10,773						4,757
Other assets - Guarantee asset						(191)						(216)						(1,107)						(834)
Liabilities
Loan purchase commitments						$	420					$	(1,668)					$	(1,334)					$	(1,669)

(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 September 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 September 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 September 30, 2020.

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

																														Gain (Loss) for
September 30, 2020						Carrying Value						Fair Value Measurements Using																		Three Months Ended						Nine Months Ended
(In Thousands)												Level 1						Level 2						Level 3						September 30, 2020						September 30, 2020
Assets
REO						$	3,523					$	—					$	—					$	3,523					$	(805)					$	(840)

29

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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 nine months ended September 30, 2020 and 2019.

Table 5.6 – Market Valuation Gains and Losses, Net

						Three Months Ended September 30,												Nine Months Ended September 30,
(In Thousands)						2020						2019						2020						2019
Mortgage Banking Activities, Net
Residential loans held-for-sale, at fair value						$	(478)					$	(6,623)					$	(15,972)					$	289
Residential loan purchase and forward sale commitments						13,067						12,943						35,123						41,142
Single-family rental loans held-for-sale, at fair value						43,191						1,283						55,868						4,200
Single-family rental loan purchase and interest rate lock commitments						—						564						341						1,273
Residential bridge loans						938						1,010						(4,256)						2,108
Risk management derivatives, net						(99)						(2,972)						(52,931)						(15,387)
Total mortgage banking activities, net (1)						$	56,619					$	6,205					$	18,173					$	33,625
Investment Fair Value Changes, Net
Residential loans held-for-investment, at Redwood						$	218					$	7,667					$	(93,314)					$	71,323
Single-family rental loans held-for-investment						—						22						(20,806)						22
Residential bridge loans held-for-investment						6,812						(742)						(10,016)						(1,363)
Trading securities						(3,600)						15,275						(224,679)						55,577
Servicer advance investments						26						1,585						(6,172)						3,025
Excess MSRs						(1,127)						(1,635)						(7,650)						(2,137)
Net investments in Legacy Sequoia entities (2)						(81)						(407)						(702)						(904)
Net investments in Sequoia Choice entities (2)						7,851						2,722						(22,065)						8,866
Net investments in Freddie Mac SLST entities (2)						82,214						17,300						(33,081)						31,702
Net investments in Freddie Mac K-Series entities (2)						2,166						7,445						(82,744)						13,810
Net investments in CAFL entities (2)						9,673						—						(41,048)						—
Other investments						2,451						(355)						(9,111)						(632)
Risk management derivatives, net						—						(37,433)						(59,142)						(144,548)
Credit recoveries (losses) on AFS securities						444						—						(1,027)						—
Total investment fair value changes, net						$	107,047					$	11,444					$	(611,557)					$	34,741
Other Income
MSRs						$	(4,783)					$	(7,489)					$	(27,346)					$	(21,243)
Risk management derivatives, net						—						4,389						13,966						13,157
Gain on re-measurement of 5 Arches investment						—						—						—						2,440
Total other income (3)						$	(4,783)					$	(3,100)					$	(13,380)					$	(5,646)
Total Market Valuation Gains (Losses), Net						$	158,883					$	14,549					$	(606,764)					$	62,720

(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.

30

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

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

At September 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

September 30, 2020						Fair Value												Input Values
(Dollars in Thousands, except Input Values)												Unobservable Input						Range															Weighted Average(1)
Assets
Residential loans, at fair value:
Jumbo fixed-rate loans						$	6,312					Prepayment rate (annual CPR)						20			-			20			%						20			%
												Whole loan spread to swap rate						350			-			350			bps						350			bps
Jumbo loans committed to sell						98,779						Whole loan committed sales price						$	101.61		-			$	103.40								$	103.23
Loans held by Legacy Sequoia (2)						296,765						Liability price												N/A									N/A
Loans held by Sequoia Choice (2)						1,836,361						Liability price												N/A									N/A
Loans held by Freddie Mac SLST (2)						2,256,682						Liability price												N/A									N/A
Business purpose residential loans:
Single-family rental loans						285,549						Senior credit spread						130			-			130			bps						130			bps
												Subordinate credit spread						200			-			1,600			bps						551			bps
												Senior credit support						30			-			32			%						31			%
												IO discount rate						8			-			9			%						9			%
												Prepayment rate (annual CPR)						—			-			3			%						3			%
												Non-securitizable loan dollar price						$	101		-			$	101								$	101
Single-family rental loans held by CAFL						2,969,692						Liability price												N/A									N/A
Residential bridge loans						700,860						Discount rate						6			-			12			%						8			%
												Non-performing loan dollar price						$	3		-			$	100								$	89
Multifamily loans held by Freddie Mac K-Series (2)						491,415						Liability price												N/A									N/A
Trading and AFS securities						351,335						Discount rate						3			-			34			%						9			%
												Prepayment rate (annual CPR)						7			-			65			%						24			%
												Default rate						—			-			26			%						1			%
												Loss severity						—			-			50			%						19			%
												CRT dollar price						$	49		-			$	103								$	84
Servicer advance investments						258,621						Discount rate						3			-			4			%						4			%
												Prepayment rate (annual CPR)						8			-			14			%						13			%
												Expected remaining life (3)						1			-			2			years						2			years
												Mortgage servicing income						6			-			16			bps						8			bps
MSRs						14,878						Discount rate						12			-			12			%						12			%
												Prepayment rate (annual CPR)						8			-			97			%						26			%
												Per loan annual cost to service						$	95		-			$	95								$	95
Excess MSRs						35,070						Discount rate						15			-			21			%						18			%
												Prepayment rate (annual CPR)						10			-			13			%						11			%
												Excess mortgage servicing income						9			-			17			bps						12			bps

31

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

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

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

September 30, 2020						Fair Value												Input Values
(Dollars in Thousands, except Input Values)												Unobservable Input						Range															Weighted Average (1)
Assets (continued)
Shared home appreciation options						$	41,758					Discount rate						16			-			16			%						16			%
												Prepayment rate (annual CPR)						8			-			26			%						19			%
												Home price appreciation						2			-			3			%						3			%
Guarantee asset						579						Discount rate						12			-			12			%						12			%
												Prepayment rate (annual CPR)						42			-			42			%						42			%
REO						3,523						Loss severity						3			-			63			%						23			%
Residential loan purchase commitments, net						10,282						Committed sales price						$	100.89		-			$	103.40								$	102.59
												Pull-through rate						13			-			100			%						58			%
												Whole loan spread to TBA price						$	2.00		-			$	2.00								$	2.00
												Whole loan spread to swap rate - fixed rate						350			-			350			bps						350			bps
												Prepayment rate (annual CPR)						15			-			15			%						15			%
												MSR multiple						0.8			-			4.1			x						3.4			x
Liabilities
ABS issued (2):
At consolidated Sequoia entities						1,919,048						Discount rate						2			-			30			%						3			%
												Prepayment rate (annual CPR)						5			-			53			%						27			%
												Default rate						—			-			40			%						2			%
												Loss severity						—			-			50			%						31			%
At consolidated Freddie Mac SLST entities						1,841,313						Dollar price						$	1		-			$	108								$	99
At consolidated Freddie Mac K-Series entities (4)						464,865						Discount rate						1			-			18			%						2			%
At consolidated CAFL entities (4)						2,744,150						Discount rate						0.2			-			40			%						3			%
												Prepayment rate (annual CPR)						—			-			3			%						—			%
												Default rate						—			-			18			%						11			%
												Loss severity						30			-			30			%						30			%

(1)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.

(2)The fair value of the loans held by consolidated entities was based on the fair value of the ABS issued by these entities, including securities we own, which we determined were more readily observable, in accordance with accounting guidance for collateralized financing entities. At September 30, 2020, the fair value of securities we owned at the consolidated Sequoia, Freddie Mac SLST, Freddie Mac K-Series, and CAFL entities was $215 million, $416 million, $27 million, and $229 million, respectively.

(3)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).

(4)As a market convention, certain securities are priced to a no-loss yield and therefore do not include default and loss severity assumptions.

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.

32

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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 September 30, 2020 and December 31, 2019.

Table 6.1 – Classifications and Carrying Values of Residential Loans

September 30, 2020												Legacy						Sequoia						Freddie Mac
(In Thousands)						Redwood						Sequoia						Choice						SLST						Total
Held-for-sale at fair value						$	105,128					$	—					$	—					$	—					$	105,128
Held-for-investment at fair value						—						296,765						1,836,361						2,256,682						4,389,808
Total Residential Loans						$	105,128					$	296,765					$	1,836,361					$	2,256,682					$	4,494,936

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 September 30, 2020, we owned mortgage servicing rights associated with $103 million (principal balance) of residential loans owned at Redwood that were 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

The following table summarizes the characteristics of residential loans held-for-sale at September 30, 2020 and December 31, 2019.

Table 6.2 – Characteristics of Residential Loans Held-for-Sale

(Dollars in Thousands)						September 30, 2020						December 31, 2019
Number of loans						118						669
Unpaid principal balance						$	102,921					$	524,928
Fair value of loans						$	105,128					$	536,280
Number of loans with 90+ day delinquencies						2						1
Unpaid principal balance of loans with 90+ day delinquencies						$	2,356					$	747
Fair value of loans with 90+ day delinquencies						$	1,767					$	616
Number of loans in foreclosure						—						—
Market value of loans pledged as collateral under short-term borrowing agreements						$	95,023					$	201,949

33

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 6. Residential Loans - (continued)

The following table provides the activity of residential loans held-for-sale during the three and nine months ended September 30, 2020 and 2019.

Table 6.3 – Quarterly Activity of Residential Loans Held-for-Sale

						Three Months Ended September 30,												Nine Months Ended September 30,
(In Thousands)						2020						2019						2020						2019
Principal balance of loans acquired						$	172,162					$	1,446,750					$	2,859,813					$	3,936,111
Principal balance of loans sold						87,868						1,534,315						5,024,663						3,921,280
Net market valuation gains (losses) recorded (1)						(478)						(6,623)						(15,972)						286

(1)Net market valuation gains (losses) on residential loans held-for-sale are recorded through Mortgage banking activities, net on our consolidated statements of income (loss).

Residential Loans Held-for-Investment at Fair Value

The following tables summarize the characteristics of the residential loans owned at Redwood and at consolidated Sequoia and Freddie Mac SLST entities at September 30, 2020 and December 31, 2019.

Table 6.4 – Characteristics of Residential Loans Held-for-Investment

September 30, 2020												Legacy						Sequoia						Freddie Mac
(Dollars in Thousands)						Redwood						Sequoia						Choice						SLST
Number of loans						—						1,976						2,546						13,893
Unpaid principal balance						$	—					$	352,392					$	1,811,967					$	2,304,047
Fair value of loans						$	—					$	296,765					$	1,836,361					$	2,256,683
Number of loans with 90+ day delinquencies (1)						—						49						132						1,772
Unpaid principal balance of loans with 90+ day delinquencies						$	—					$	16,076					$	102,693					$	339,537
Fair value of loans with 90+ day delinquencies (2)						$	—					N/A						N/A						N/A
Number of loans in foreclosure						—						21						3						175
Unpaid principal balance of loans in foreclosure						$	—					$	4,820					$	1,814					$	28,380

December 31, 2019												Legacy						Sequoia						Freddie Mac
(Dollars in Thousands)						Redwood						Sequoia						Choice						SLST
Number of loans						2,940						2,198						3,156						14,502
Unpaid principal balance						$	2,052,778					$	424,829					$	2,240,679					$	2,428,035
Fair value of loans						$	2,111,897					$	407,890					$	2,291,463					$	2,367,215
Number of loans with 90+ day delinquencies (1)						2						39						9						587
Unpaid principal balance of loans with 90+ day delinquencies						$	1,585					$	9,803					$	6,755					$	134,680
Fair value of loans with 90+ day delinquencies (2)						$	1,424					N/A						N/A						N/A
Number of loans in foreclosure						—						16						3						208
Unpaid principal balance of loans in foreclosure						$	—					$	3,673					$	2,290					$	33,042

(1)For loans held at consolidated entities, the number of loans greater than 90 days delinquent includes loans in foreclosure.

(2)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.

34

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 6. Residential Loans - (continued)

The following table provides the activity of residential loans held-for-investment at Redwood during the three and nine months ended September 30, 2020 and 2019.

Table 6.5 – Quarterly Activity of Residential Loans Held-for-Investment at Redwood

						Three Months Ended September 30,												Nine Months Ended September 30,
(In Thousands)						2020						2019						2020						2019
Principal balance of loans acquired						$	—					$	—					$	—					$	39,194
Principal balance of loans sold						—						—						—						—
Fair value of loans transferred from HFS to HFI						—						—						13,258						68,703
Fair value of loans transferred from HFI to HFS						—						—						1,870,986						22,814
Net market valuation gains (losses) recorded (1)						218						7,667						(93,314)						71,323

(1)Net market valuation gains (losses) on residential loans held-for-investment at Redwood are recorded through Investment fair value changes, net on our consolidated statements of income (loss).

The following table provides the activity of residential loans held-for-investment at consolidated entities during the three and nine months ended September 30, 2020 and 2019.

Table 6.6 – Quarterly Activity of Residential Loans Held-for-Investment at Consolidated Entities

						Three Months Ended September 30, 2020																		Nine Months Ended September 30, 2020
						Legacy						Sequoia						Freddie Mac						Legacy						Sequoia						Freddie Mac
(In Thousands)						Sequoia						Choice						SLST						Sequoia						Choice						SLST
Fair value of loans transferred from HFS to HFI (1)						N/A						$	—					N/A						N/A						$	270,506					N/A
Net market valuation gains (losses) recorded (2)						$	21,938					$	(5,175)					$	159,687					$	(38,996)					$	(21,727)					$	15,254

						Three Months Ended September 30, 2019																		Nine Months Ended September 30, 2019
						Legacy						Sequoia						Freddie Mac						Legacy						Sequoia						Freddie Mac
(In Thousands)						Sequoia						Choice						SLST						Sequoia						Choice						SLST
Fair value of loans transferred from HFS to HFI (1)						N/A						$	727,088					N/A						N/A						$	1,076,671					N/A
Net market valuation gains (losses) recorded (2)						$	(103)					$	(11,029)					$	39,783					$	5,271					$	4,841					$	94,788

(1)Represents the transfer of loans from held-for-sale to held-for-investment associated with Sequoia Choice securitizations.

(2)For loans held at our consolidated Legacy Sequoia, Sequoia Choice, and Freddie Mac SLST entities, market value changes are based on the estimated fair value of the associated ABS issued, pursuant to collateralized financing entity guidelines. The net impact to our income statement associated with our economic investments in these 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.

35

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 7. Business Purpose Residential Loans - (continued)

Business Purpose Residential Loan Originations

During the three months ended September 30, 2020, we funded $261 million of business purpose residential loans and sold $2 million of residential bridge loans and $2 million of single-family rental loans 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 gain of less than $0.1 million on these loans through Mortgage banking activities, net on our consolidated statements of income (loss) for the three months ended September 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 securitization. Additionally, during the three and nine months ended September 30, 2020, we recorded loan origination fee income associated with business purpose residential loans of $3 million and $13 million, respectively, through Mortgage banking activities, net on our consolidated statements of income (loss).

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

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

September 30, 2020						Single-Family Rental												Residential
(In Thousands)						Redwood						CAFL						Bridge						Total
Held-for-sale at fair value						$	285,549					—						$	—					$	285,549
Held-for-investment at fair value						—						2,969,692						700,860						3,670,552
Total Business Purpose Residential Loans						$	285,549					$	2,969,692					$	700,860					$	3,956,101

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

The following tables summarize the characteristics of the business purpose residential loans owned at Redwood at September 30, 2020 and December 31, 2019.

Table 7.2 – Characteristics of Business Purpose Residential Loans

September 30, 2020						Single-Family Rental at Redwood						Single-Family Rental at CAFL						Residential Bridge
(Dollars in Thousands)
Number of loans						140						1,027						2,262
Unpaid principal balance						$	272,492					$	2,815,045					$	708,555
Fair value of loans						$	285,549					$	2,969,692					$	700,860
Weighted average coupon						5.26		%				5.50		%				8.02		%
Weighted average remaining loan term (years)						7						6						1
Number of loans with 90+ day delinquencies (1)						6						26						24
Unpaid principal balance of loans with 90+ day delinquencies						$	3,018					$	70,949					$	38,437
Fair value of loans with 90+ day delinquencies (2)						$	2,954					N/A						$	33,464
Number of loans in foreclosure						—						9						24
Unpaid principal balance of loans in foreclosure						$	—					$	14,032					$	39,755
Fair value of loans in foreclosure (2)						$	—					N/A						$	34,489

36

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 7. Business Purpose Residential Loans - (continued)

December 31, 2019						Single-Family Rental at Redwood						Single-Family Rental at CAFL						Residential Bridge
(Dollars in Thousands)
Number of loans						308						783						2,653
Unpaid principal balance						$	552,848					$	2,078,214					$	742,528
Fair value of loans						$	569,185					$	2,192,552					$	745,006
Weighted average coupon						4.96		%				5.70		%				8.11		%
Weighted average remaining loan term (years)						9						7						2
Number of loans with 90+ day delinquencies (1)						2						18						31
Unpaid principal balance of loans with 90+ day delinquencies						$	1,688					$	29,039					$	14,186
Fair value of loans with 90+ day delinquencies (2)						$	1,818					N/A						$	12,111
Number of loans in foreclosure						1						5						15
Unpaid principal balance of loans in foreclosure						$	130					$	9,169					$	8,987
Fair value of loans in foreclosure (2)						$	130					N/A						$	6,917

(1)The number of loans greater than 90 days delinquent includes loans in foreclosure.

(2)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.

Single-Family Rental Loans

During the three and nine months ended September 30, 2020, we originated $196 million and $632 million of single-family rental loans, respectively. During the nine months ended September 30, 2020, we transferred $925 million of single-family rental loans from held-for-sale to held-for-investment associated with three CAFL securitizations and sold $34 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 nine months ended September 30, 2020, we recorded net market valuation gains of $43 million and $34 million, respectively, on single-family rental loans. The $43 million of net market valuation gains recorded during the three months ended September 30, 2020 were recorded through Mortgage banking activities, net on our consolidated statements of income (loss). Of the $34 million of net market valuation gains recorded during the nine months ended September 30, 2020, $55 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 nine months ended September 30, 2019, we recorded net market valuation gains of $1 million and $3 million, respectively, on single-family rental loans through Mortgage banking activities, net on our consolidated statements of income (loss).

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. The outstanding single-family rental loans held-for-investment at CAFL at September 30, 2020 were first-lien, fixed-rate loans with original maturities of five, seven, or ten years.

During the three and nine months ended September 30, 2020, we recorded a net market valuation gain of $88 million and a net market valuation loss of $14 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

The outstanding residential bridge loans held-for-investment at September 30, 2020 were first lien, fixed-rate, interest-only loans with original maturities of six to 24 months. During the nine months ended September 30, 2020, we transferred four loans with a fair value of $5 million to REO, which is included in Other assets on our consolidated balance sheets.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 7. Business Purpose Residential Loans - (continued)

During the three and nine months ended September 30, 2020, $64 million and $324 million of newly originated residential bridge loans, respectively, were transferred to our investment portfolio. During the three and nine months ended September 30, 2020, we recorded a net market valuation gain of $7 million and a net market valuation loss of $10 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 both the three and nine months ended September 30, 2019, we recorded net market valuation losses of $1 million on residential bridge loans held-for-investment at fair value through Investment fair value changes, net on our consolidated statements of income (loss).

At September 30, 2020, we had a $225 million commitment to fund residential bridge loans. See Note 16 for additional information on this commitment.

Note 8. Multifamily Loans

Since 2018, we have 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.

The following table summarizes the characteristics of the multifamily loans consolidated at Redwood at September 30, 2020 and December 31, 2019.

Table 8.1 – Characteristics of Multifamily Loans

(Dollars in Thousands)						September 30, 2020						December 31, 2019
Number of loans						28						279
Unpaid principal balance						$	464,680					$	4,195,000
Fair value of loans						$	491,415					$	4,408,524
Weighted average coupon						4.25		%				4.13		%
Weighted average remaining loan term (years)						5						6
Number of loans with 90+ day delinquencies						—						—
Number of loans in foreclosure						—						—

The outstanding multifamily loans held-for-investment at the Freddie Mac K-Series entities at September 30, 2020 were first-lien, fixed-rate loans that were originated in 2015 and had original loan terms of ten years. The following table provides the activity of multifamily loans held-for-investment during the three and nine months ended September 30, 2020 and 2019.

Table 8.2 – Quarterly Activity of Multifamily Loans Held-for-Investment

						Three Months Ended September 30,												Nine Months Ended September 30,
(In Thousands)						2020						2019						2020						2019
Net market valuation gains (losses) recorded (1)						$	2,340					$	47,353					$	(61,500)					$	178,374

(1)Net market valuation gains (losses) on multifamily loans held-for-investment are recorded through Investment fair value changes, net on our consolidated statements of income (loss). For loans held at our consolidated Freddie Mac K-Series entities, market value changes are based on the estimated fair value of the associated ABS issued, pursuant to collateralized financing entity guidelines. The net impact to our income statement associated with our economic investment in these securitization entities is presented in Note 5.

38

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 9. Real Estate Securities

We invest in real estate securities that we acquire from third parties or create and retain from our Sequoia securitizations. The following table presents the fair values of our real estate securities by type at September 30, 2020 and December 31, 2019.

Table 9.1 – Fair Values of Real Estate Securities by Type

(In Thousands)						September 30, 2020						December 31, 2019
Trading						$	144,162					$	860,540
Available-for-sale						207,173						239,334
Total Real Estate Securities						$	351,335					$	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.

Trading Securities

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

Table 9.2 – Trading Securities by Position

(In Thousands)						September 30, 2020						December 31, 2019
Senior						$	28,091					$	150,067
Mezzanine						3,651						538,489
Subordinate						112,420						171,984
Total Trading Securities						$	144,162					$	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 September 30, 2020 and December 31, 2019, our senior trading securities included $28 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 $12 million and $36 million of certificated mortgage servicing rights at September 30, 2020 and December 31, 2019, respectively, which are securities we retained from certain of our Sequoia securitizations that represent certificated servicing strips. At September 30, 2020 and December 31, 2019, our trading securities included $60 million and $161 million of RPL securities, respectively.

At September 30, 2020 and December 31, 2019, our mezzanine trading securities had an unpaid principal balance of $4 million and $537 million, respectively. At September 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 September 30, 2020 and December 31, 2019, our subordinate trading securities had an unpaid principal balance of $266 million and $302 million, respectively. At September 30, 2020 and December 31, 2019, the fair value of our subordinate securities was $112 million and $172 million, respectively, and included $50 million and $90 million, respectively, of Agency residential mortgage credit risk transfer (or "CRT") securities, and $55 million and $82 million, respectively, of other third-party residential securities, including $51 million and $76 million of RPL securities, respectively.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 9. Real Estate Securities - (continued)

During the three and nine months ended September 30, 2020, we acquired $11 million and $78 million (principal balance), respectively, of securities for which we elected the fair value option and classified as trading, and sold $16 million and $721 million, respectively, of such securities. During the three and nine months ended September 30, 2019, we acquired $66 million and $335 million (principal balance), respectively, of securities for which we elected the fair value option and classified as trading, and sold $236 million and $397 million, respectively, of such securities.

During the three and nine months ended September 30, 2020, we recorded net market valuation losses of $4 million and $225 million, respectively, on trading securities, included in Investment fair value changes, net on our consolidated statements of income (loss). During the three and nine months ended September 30, 2019, we recorded net market valuation gains of $15 million and $56 million, respectively, on trading securities, included in Investment fair value changes, net on our consolidated statements of income (loss).

AFS Securities

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

Table 9.3 – Available-for-Sale Securities by Position

(In Thousands)						September 30, 2020						December 31, 2019
Senior						$	—					$	25,792
Mezzanine						2,016						13,687
Subordinate						205,157						199,855
Total AFS Securities						$	207,173					$	239,334

At September 30, 2020 and December 31, 2019, our available-for-sale securities were comprised of $160 million and $230 million of residential mortgage-backed securities, respectively, and $48 million and $9 million of multifamily mortgage-backed securities, respectively. At September 30, 2020 and December 31, 2019, our residential available-for-sale securities were comprised of $124 million and $141 million of residential mortgage-backed securities we retained from our Sequoia securitizations, respectively, and $35 million and $90 million of other third-party residential securities, respectively.

During the three and nine months ended September 30, 2020, we purchased $25 million and $57 million of AFS securities, respectively, and sold zero and $55 million of AFS securities, respectively, which resulted in net realized gains of zero and $5 million, respectively. During the three and nine months ended September 30, 2019, we purchased $12 million and $21 million of AFS securities, respectively, and sold $15 million and $82 million of AFS securities, respectively, which resulted in net realized gains of $4 million and $13 million, respectively.

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

At September 30, 2020, we had $45 million of AFS securities with contractual maturities less than five years, $3 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.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 9. Real Estate Securities - (continued)

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

Table 9.4 – Carrying Value of AFS Securities

September 30, 2020
(In Thousands)						Senior						Mezzanine						Subordinate						Total
Principal balance						$	—					$	2,000					$	287,659					$	289,659
Credit reserve						—						—						(43,186)						(43,186)
Unamortized discount, net						—						—						(99,221)						(99,221)
Amortized cost						—						2,000						145,252						147,252
Gross unrealized gains						—						16						63,439						63,455
Gross unrealized losses						—						—						(2,507)						(2,507)
Allowance for credit losses						—						—						(1,027)						(1,027)
Carrying Value						$	—					$	2,016					$	205,157					$	207,173

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 nine months ended September 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 September 30, 2020												Nine Months Ended September 30, 2020
						Credit Reserve						Unamortized Discount, Net						Credit Reserve						Unamortized Discount, Net
(In Thousands)
Beginning balance						$	37,785					$	104,260					$	32,940					$	124,255
Amortization of net discount						—						(1,766)						—						(4,607)
Realized credit losses						(194)						—						(897)						—
Acquisitions						1,303						1,019						6,487						1,796
Sales, calls, other						—						—						(726)						(16,841)
(Release of) transfers to credit reserves, net						4,292						(4,292)						5,382						(5,382)
Ending Balance						$	43,186					$	99,221					$	43,186					$	99,221

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 9. Real Estate Securities - (continued)

AFS Securities with Unrealized Losses

The following table presents the components comprising the total carrying value of AFS securities that were in a gross unrealized loss position at September 30, 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)
September 30, 2020						$	32,890					$	(2,507)					$	30,330					$	—					$	—					$	—
December 31, 2019						—						—						—						5,830						(29)						5,801

At September 30, 2020, after giving effect to purchases, sales, and extinguishment due to credit losses, our consolidated balance sheet included 96 AFS securities, of which seven 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.

Evaluating AFS Securities for Credit Losses

Gross unrealized losses on our AFS securities were $3 million at September 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 September 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 September 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 September 30, 2020.

Table 9.7 – Significant Credit Quality Indicators

September 30, 2020

Subordinate Securities

Default rate

0.5%

Loss severity

20%

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 9. Real Estate Securities - (continued)

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

Table 9.8 – Rollforward of Allowance for Credit Losses

						Three Months Ended						Nine Months Ended
(In Thousands)						September 30, 2020						September 30, 2020
Beginning balance allowance for credit losses						$	1,471					$	—
Transition impact from adoption of new standard						—						—
Additions to allowance for credit losses on securities for which credit losses were not previously recorded						339						1,864
Additional increases or decreases to the allowance for credit losses on securities that had an allowance recorded in a previous period						(783)						(837)
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						—						—
Ending balance of allowance for credit losses						$	1,027					$	1,027

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 nine months ended September 30, 2020 and 2019.

Table 9.9 – Gross Realized Gains and Losses on AFS Securities

						Three Months Ended September 30,												Nine Months Ended September 30,
(In Thousands)						2020						2019						2020						2019
Gross realized gains - sales						$	—					$	3,656					$	8,779					$	13,143
Gross realized gains - calls						—						1,058						—						5,084
Gross realized losses - sales						—						—						(4,144)						—
Total Realized Gains on Sales and Calls of AFS Securities, net						$	—					$	4,714					$	4,635					$	18,227

Note 10. Other Investments

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

Table 10.1 – Components of Other Investments

(In Thousands)						September 30, 2020						December 31, 2019
Servicer advance investments						$	258,621					$	169,204
Shared home appreciation options						41,758						45,085
Excess MSRs						35,070						31,814
Mortgage servicing rights						14,878						42,224
Investment in multifamily loan fund						(323)						39,802
Other						34,624						30,001
Total Other Investments						$	384,628					$	358,130

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 10. Other Investments - (continued)

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 nine months ended September 30, 2020, we funded additional purchases of outstanding servicer advances and excess MSRs under the same partnership structure. At September 30, 2020, we had funded $94 million of total capital to the SA Buyers (see Note 16 for additional detail).

At September 30, 2020, our servicer advance investments had a carrying value of $259 million and were associated with a portfolio of residential mortgage loans with an unpaid principal balance of $9.71 billion. The outstanding servicer advance receivables associated with this investment were $242 million at September 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 September 30, 2020 and December 31, 2019.

Table 10.2 – Components of Servicer Advance Receivables

(In Thousands)						September 30, 2020						December 31, 2019
Principal and interest advances						$	88,370					$	15,081
Escrow advances (taxes and insurance advances)						115,352						96,732
Corporate advances						38,337						39,769
Total Servicer Advance Receivables						$	242,059					$	151,582

We account for our servicer advance investments at fair value and during the three and nine months ended September 30, 2020, we recorded $3 million and $8 million, respectively, of interest income associated with these investments, and recorded net market valuation gain of less than $0.1 million and a net market valuation loss of $6 million, respectively, through Investment fair value changes, net in our consolidated statements of income (loss). During the three and nine months ended September 30, 2019, we recorded $3 million and $9 million, respectively, of interest income associated with these investments for each of these periods, and recorded net market valuation gains of $2 million and $3 million, respectively, through Investment fair value changes, net in our consolidated statements of income (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 September 30, 2020 and December 31, 2019, our MSRs had a fair value of $15 million and $42 million, respectively, and were associated with loans with an aggregate principal balance of $3.14 billion and $4.35 billion, respectively. During the three and nine months ended September 30, 2020, including net market valuation gains and losses on our MSRs and related risk management derivatives, we recorded net losses of $2 million and $6 million, respectively, through Other income on our consolidated statements of income (loss). During the three and nine months ended September 30, 2019, we recognized $0.4 million and $2 million of income, net, respectively, through Other income on our consolidated statements of income (loss).

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 10. Other Investments - (continued)

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 nine months ended September 30, 2020, we recognized $3 million and $9 million of interest income, respectively, through Other interest income, and recorded net market valuation losses of $1 million and $8 million, respectively, through Investment fair value changes, net on our consolidated statements of income (loss). During the three and nine months ended September 30, 2019, we recognized $2 million and $6 million of interest income, respectively, through Other interest income, and recorded net market valuation losses of $2 million for both periods through Investment fair value changes, net on our consolidated statements of income (loss).

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. At September 30, 2020, the carrying amount of our investment in the partnership was zero and we had no remaining funding obligations to the partnership. During the three and nine months ended September 30, 2020, we acquired $28 million and $56 million of securities, respectively, from the partnership's securitization transactions. During the three and nine months ended September 30, 2020, we recorded income of $0.3 million and $0.6 million, respectively, associated with this investment in Other income on our consolidated statements of income (loss). During the three and nine months ended September 30, 2019, we recorded $1 million and $0.5 million of income, respectively, associated with this investment in Other income 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 September 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 nine months ended September 30, 2020, we recorded a net market valuation gain of $2 million and a net market valuation loss of $4 million, respectively, related to these assets through Investment fair value changes, net on our consolidated statements of income (loss).

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 11. Derivative Financial Instruments

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

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

						September 30, 2020												December 31, 2019
						Fair Value						Notional Amount						Fair Value						Notional Amount
(In Thousands)
Assets - Risk Management Derivatives
Interest rate swaps						$	78					$	25,000					$	17,095					$	1,399,000
TBAs						402						140,000						5,755						2,445,000
Interest rate futures						63						40,000						777						213,700
Swaptions						3,393						285,000						1,925						1,065,000
Assets - Other Derivatives
Loan purchase and interest rate lock commitments						10,773						1,724,207						10,149						1,537,162
Total Assets						$	14,709					$	2,214,207					$	35,701					$	6,659,862
Liabilities - Cash Flow Hedges
Interest rate swaps						$	—					$	—					$	(51,530)					$	139,500
Liabilities - Risk Management Derivatives
Interest rate swaps						(15)						25,000						(97,235)						2,314,300
TBAs						(263)						105,000						(13,359)						4,160,000
Interest rate futures						—						—						(10)						12,300
Liabilities - Other Derivatives
Loan purchase commitments						(1,334)						231,651						(1,290)						303,394
Total Liabilities						$	(1,612)					$	361,651					$	(163,424)					$	6,929,494
Total Derivative Financial Instruments, Net						$	13,097					$	2,575,858					$	(127,723)					$	13,589,356

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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 September 30, 2020, we were party to swaps and swaptions with an aggregate notional amount of $335 million, TBA agreements sold with an aggregate notional amount of $245 million, and interest rate futures contracts with an aggregate notional amount of $40 million. 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 nine months ended September 30, 2020, risk management derivatives had net market valuation losses of zero and $98 million, respectively. During the three and nine months ended September 30, 2019, risk management derivatives had net market valuation losses of $36 million and $147 million, respectively. 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 nine months ended September 30, 2020, LPCs and IRLCs had net market valuation gains of $14 million and $35 million, respectively, that were recorded in Mortgage banking activities, net on our consolidated statements of income (loss). For the three and nine months ended September 30, 2019, LPCs and IRLCs had net market valuation gains of $14 million and $42 million, respectively, that were recorded in Mortgage banking activities, net on our consolidated statements of income (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 $82 million and $51 million at September 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 September 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 nine months ended September 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 nine months ended September 30, 2019, changes in the values of designated cash flow hedges were negative $12 million and negative $27 million, respectively, and were recorded in Accumulated other comprehensive income, a component of equity.

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

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

						Three Months Ended September 30,												Nine Months Ended September 30,
(In Thousands)						2020						2019						2020						2019
Net interest expense on cash flows hedges						$	—					$	(727)					$	(860)					$	(2,004)
Realized net losses reclassified from other comprehensive income						(1,040)						—						(2,148)						—
Total Interest Expense						$	(1,040)					$	(727)					$	(3,008)					$	(2,004)

47

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 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 September 30, 2020, we assessed this risk as remote and did not record a specific valuation adjustment.

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

Note 12. Other Assets and Liabilities

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

Table 12.1 – Components of Other Assets

(In Thousands)						September 30, 2020						December 31, 2019
Accrued interest receivable						$	39,330					$	71,058
Investment receivable						25,767						23,330
Right-of-use asset						13,487						11,866
REO						8,535						9,462
Pledged collateral						8,172						32,945
Income tax receivables						8,148						36
FHLBC stock						5,000						43,393
Fixed assets and leasehold improvements (1)						4,408						4,901
Margin receivable						3,809						209,776
Other						7,617						12,554
Total Other Assets						$	124,273					$	419,321

(1)Fixed assets and leasehold improvements had a basis of $12 million and accumulated depreciation of $8 million at September 30, 2020.

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

Table 12.2 – Components of Accrued Expenses and Other Liabilities

(In Thousands)						September 30, 2020						December 31, 2019
Accrued interest payable						$	34,225					$	60,655
Payable to minority partner						17,492						13,189
Accrued compensation						17,127						33,888
Lease liability						15,123						13,443
Deferred consideration						14,442						—
Guarantee obligations						11,264						14,009
Current accounts payable						8,717						5,468
Residential loan and MSR repurchase reserve						8,565						4,268
Residential bridge loan holdbacks						6,350						10,682
Deferred tax liabilities						5,152						5,152
Accrued operating expenses						3,922						4,358
Contingent consideration						—						28,484
Other						13,610						13,297
Total Accrued Expenses and Other Liabilities						$	155,989					$	206,893

48

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 12. Other Assets and Liabilities - (continued)

Refer to our Annual Report on Form 10-K for the year ended December 31, 2019 for additional descriptions of our other assets and liabilities.

Margin Receivable and Payable

Margin receivable and payable resulted from margin calls between us and our counterparties under derivatives, master repurchase agreements, and warehouse facilities, whereby we or the counterparty posted collateral. Through September 30, 2020, we had met all margin calls due.

REO

The carrying value of REO at September 30, 2020 was $9 million, which included $3 million of REO from our residential bridge loan portfolio, $1 million from our consolidated Legacy Sequoia entities, $1 million from our consolidated Freddie Mac SLST entities, and $4 million from consolidated CAFL entities. At September 30, 2020, there were two residential bridge loan REO assets, three REO assets at our Legacy Sequoia entities, nine REO assets at our Freddie Mac SLST entities, and three REO assets at our CAFL entities recorded on our consolidated balance sheets. During the nine months ended September 30, 2020, transfers into REO included a $5 million residential bridge loan, $1 million from Legacy Sequoia entities, $1 million from Freddie Mac SLST entities, and $6 million from CAFL entities. During the nine months ended September 30, 2020, there were REO liquidations of $13 million, resulting in $0.3 million of unrealized losses which were recorded in Investment fair value changes, net, on our consolidated statements of income (loss). At December 31, 2019, there were four residential bridge loan REO assets, four REO assets at our Legacy Sequoia entities, three REO assets at our Freddie Mac SLST entities, and two REO assets at our CAFL entities recorded on our consolidated balance sheets.

Note 13. Short-Term Debt

We enter into repurchase agreements, bank warehouse agreements, and other forms of collateralized (and generally uncommitted) short-term borrowings with several banks and investment banking firms. At September 30, 2020, we had outstanding agreements with several counterparties and we were in compliance with all of the related covenants.

The table below summarizes our short-term debt, including the facilities that are available to us, the outstanding balances, the weighted average interest rate, and the maturity information at September 30, 2020 and December 31, 2019.

Table 13.1 – Short-Term Debt

						September 30, 2020
(Dollars in Thousands)						Number of Facilities						Outstanding Balance						Limit						Weighted Average Interest Rate						Maturity						Weighted Average Days Until Maturity
Facilities
Residential loan warehouse (1)						4						$	81,898					$	600,000					2.90		%				10/2020-8/2021						203
Business purpose residential loan warehouse (2)						2						96,811						500,000						3.28		%				6/2021-5/2022						437
Real estate securities repo (1)						3						75,054						—						2.87		%				10/2020-12/2020						38
Total Short-Term Debt Facilities						9						253,763
Servicer advance financing						1						228,998						400,000						1.96		%				11/2020						61
Total Short-Term Debt												$	482,761

49

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 13. Short-Term Debt - (continued)

						December 31, 2019
(Dollars in Thousands)						Number of Facilities						Outstanding Balance						Limit						Weighted Average Interest Rate						Maturity						Weighted Average Days Until Maturity
Facilities
Residential loan warehouse (1)						4						$	185,894					$	1,425,000					3.23		%				1/2020-10/2020						69
Business purpose residential loan warehouse (2)						8						814,118						1,475,000						4.11		%				12/2020-5/2022						489
Real estate securities repo (1)						10						1,176,579						—						2.94		%				1/2020-3/2020						23
Total Short-Term Debt Facilities						22						2,176,591
Servicer advance financing						1						152,554						400,000						3.56		%				11/2020						335
Total Short-Term Debt												$	2,329,145

(1)Borrowings under our facilities are generally charged interest based on a specified margin over the one-month LIBOR interest rate. At September 30, 2020 and December 31, 2019, all of these borrowings were under uncommitted facilities and were due within 364 days (or less) of the borrowing date.

(2)Due to the revolving nature of the borrowings under these facilities, we have classified these facilities as short-term debt at September 30, 2020. Borrowings under these facilities will be repaid as the underlying loans mature or are sold to third parties or transferred to securitizations.

The following table below presents the value of loans, securities, and other assets pledged as collateral under our short-term debt facilities at September 30, 2020 and December 31, 2019.

Table 13.2 – Collateral for Short-Term Debt Facilities

(In Thousands)						September 30, 2020						December 31, 2019
Collateral Type
Held-for-sale residential loans						$	95,023					$	201,949
Business purpose residential loans						110,505						988,179
Real estate securities
On balance sheet						24,670						618,881
Sequoia Choice securitizations (1)						63,088						111,341
Freddie Mac SLST securitizations (1)						—						381,640
Freddie Mac K-Series securitizations (1)						26,550						252,284
CAFL securitizations (1)						—						127,840
Total real estate securities owned						114,308						1,491,986
Other assets						—						16,252
Total Collateral for Short-Term Debt Facilities						$	319,836					$	2,698,366

(1)Represents securities we have retained from consolidated securitization entities. For GAAP purposes, we consolidate the loans and non-recourse ABS debt issued from these securitizations.

For the three and nine months ended September 30, 2020, the average balances of our short-term debt facilities were $313 million and $1.42 billion, respectively. At September 30, 2020 and December 31, 2019, accrued interest payable on our short-term debt facilities was $1 million and $6 million, respectively.

50

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 13. Short-Term Debt - (continued)

Servicer advance financing consists of non-recourse short-term securitization debt used to finance servicer advance investments. We consolidate the securitization entity that issued the debt, but the entity is independent of Redwood and the assets and liabilities are not owned by and are not legal obligations of Redwood. At September 30, 2020, the fair value of servicer advances, cash and restricted cash collateralizing the securitization financing was $270 million. At September 30, 2020, the accrued interest payable balance on this financing was $0.1 million and the unamortized capitalized commitment costs were $0.2 million.

We also maintain a $10 million committed line of credit with a financial institution that is secured by certain mortgage-backed securities with a fair market value of $3 million at September 30, 2020. At both September 30, 2020 and December 31, 2019, we had no outstanding borrowings on this facility.

Remaining Maturities of Short-Term Debt

The following table presents the remaining maturities of our secured short-term debt by the type of collateral securing the debt as well as our convertible notes at September 30, 2020.

Table 13.3 – Short-Term Debt by Collateral Type and Remaining Maturities

						September 30, 2020
(In Thousands)						Within 30 days						31 to 90 days						Over 90 days						Total
Collateral Type
Held-for-sale residential loans						$	1,217					$	—					$	80,681					$	81,898
Business purpose residential loans						—						—						96,811						96,811
Real estate securities						37,217						37,837						—						75,054
Total Secured Short-Term Debt						38,434						37,837						177,492						253,763
Servicer advance financing						—						228,998						—						228,998
Total Short-Term Debt						$	38,434					$	266,835					$	177,492					$	482,761

Note 14. Asset-Backed Securities Issued

The carrying values of ABS issued by our consolidated securitization entities at September 30, 2020 and December 31, 2019, along with other selected information, are summarized in the following table.

Table 14.1 – Asset-Backed Securities Issued

September 30, 2020						Legacy Sequoia						Sequoia Choice						Freddie Mac SLST (1)						Freddie Mac K-Series						CAFL						Total
(Dollars in Thousands)
Certificates with principal balance						$	347,985					$	1,571,714					$	1,925,144					$	418,212					$	2,528,974					$	6,792,029
Interest-only certificates						1,268						6,805						24,053						13,122						137,064						182,312
Market valuation adjustments						(56,769)						48,045						95,138						33,531						78,112						198,057
ABS Issued, Net						$	292,484					$	1,626,564					$	2,044,335					$	464,865					$	2,744,150					$	7,172,398
Range of weighted average interest rates, by series						0.35% to 1.96%						2.23% to 5.02%						3.50% to 4.75%						3.39		%				3.18% to 5.53%
Stated maturities						2024 - 2036						2047 - 2050						2028 - 2059						2025						2022 - 2048
Number of series						20						10						3						1						13

51

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

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

December 31, 2019						Legacy Sequoia						Sequoia Choice						Freddie Mac SLST						Freddie Mac K-Series						CAFL						Total
(Dollars in Thousands)
Certificates with principal balance						$	420,056					$	1,979,719					$	1,842,682					$	3,844,789					$	1,875,007					$	9,962,253
Interest-only certificates						1,282						16,514						30,291						217,891						90,134						356,112
Market valuation adjustments						(18,873)						40,965						45,349						93,559						36,110						197,110
ABS Issued, Net						$	402,465					$	2,037,198					$	1,918,322					$	4,156,239					$	2,001,251					$	10,515,475
Range of weighted average interest rates, by series						1.94% to 3.26%						4.40% to 5.05%						3.50		%				3.35% to 4.35%						3.25% to 5.36%
Stated maturities						2024 - 2036						2047 - 2049						2028 - 2029						2025 - 2049						2022 - 2048
Number of series						20						9						2						5						10

(1)Includes $208 million (principal balance) of ABS issued by a re-securitization trust sponsored by Redwood and accounted for at amortized cost.

During the third quarter of 2020, we transferred all of the subordinate securities we owned from two consolidated re-performing loan securitization VIEs sponsored by Freddie Mac SLST to a re-securitization trust, which we determined was a VIE and for which we determined we are the primary beneficiary. At issuance, we sold $210 million (principal balance) of ABS issued to third parties and retained 100% of the remaining beneficial ownership interest in the trust through ownership of a subordinate security issued by the trust. The ABS was issued at a discount and we have elected to account for the ABS issued at amortized cost. At September 30, 2020, the carrying value of the ABS issued was $203 million and the debt discount was $5 million. The stated coupon of the ABS issued was 4.75% at issuance and the final stated maturity occurs in July 2059. The ABS issued is subject to optional redemption and interest rate step-ups prior to the stated maturity according to the terms of the respective governing agreements.

The actual maturity of each class of ABS issued is primarily determined by the rate of principal prepayments on the assets of the issuing entity. Each series is also subject to redemption prior to the stated maturity according to the terms of the respective governing documents of each ABS issuing entity. As a result, the actual maturity of ABS issued may occur earlier than its stated maturity. At September 30, 2020, the majority of the ABS issued and outstanding had contractual maturities beyond five years. See Note 4 for detail on the carrying value components of the collateral for ABS issued and outstanding. The following table summarizes the accrued interest payable on ABS issued at September 30, 2020 and December 31, 2019. Interest due on consolidated ABS issued is payable monthly.

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

(In Thousands)						September 30, 2020						December 31, 2019
Legacy Sequoia						$	180					$	395
Sequoia Choice						5,652						7,732
Freddie Mac SLST (1)						5,831						5,374
Freddie Mac K-Series						1,182						12,887
CAFL						9,180						7,298
Total Accrued Interest Payable on ABS Issued						$	22,025					$	33,686

(1)Includes accrued interest payable on ABS issued by a re-securitization trust sponsored by Redwood.

Note 15. Long-Term Debt

Refer to our Annual Report on Form 10-K for the year ended December 31, 2019 for a full description of our long-term debt.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 15. Long-Term Debt - (continued)

FHLBC Borrowings

At September 30, 2020, $1 million of advances were outstanding under our FHLBC borrowing agreement, with a weighted average interest rate of 0.35%. These borrowings mature in 2026. At December 31, 2019, $2.00 billion of advances were outstanding under this agreement, which were classified as long-term debt, with a weighted average interest rate of 1.88% and a weighted average maturity of six years. During the three and nine months ended September 30, 2020, we repaid zero and $2.00 billion, respectively, of our FHLBC borrowings. At September 30, 2020, total advances under this agreement were secured by $1 million of restricted cash. We do not expect to increase borrowings under our FHLBC borrowing agreement above the existing $1 million of advances outstanding. This agreement also requires our subsidiary to purchase and hold stock in the FHLBC in an amount equal to a specified percentage of outstanding advances. At September 30, 2020, our subsidiary held $5 million of FHLBC stock that is included in Other assets in our consolidated balance sheets.

Recourse Subordinate Securities Financing Facilities

In 2019, a subsidiary of Redwood entered into a repurchase agreement providing non-marginable (e.g., not subject to margin calls based on the market value of the underlying collateral) recourse debt financing of certain Sequoia securities as well as securities retained from our consolidated Sequoia Choice securitizations. The financing is fully and unconditionally guaranteed by Redwood, with an interest rate of approximately 4.21% through September 2022. The financing facility may be terminated, at our option, in September 2022, and has a final maturity in September 2024, provided that the interest rate on amounts outstanding under the facility increases between October 2022 and September 2024. At September 30, 2020, we had borrowings under this facility totaling $180 million and $1 million of unamortized deferred issuance costs, for a net carrying value of $179 million. At September 30, 2020, the fair value of real estate securities pledged as collateral under this long-term debt facility was $232 million and included Sequoia securities and securities retained from our Sequoia Choice securitizations.

In the first quarter of 2020, a subsidiary of Redwood entered into a second repurchase agreement with similar terms to provide non-marginable recourse debt financing of certain securities retained from our consolidated CAFL securitizations. The financing is fully and unconditionally guaranteed by Redwood, with an interest rate of approximately 4.21% through February 2023. The financing facility may be terminated, at our option, in February 2023, and has a final maturity in February 2025, provided that the interest rate on amounts outstanding under the facility increases between March 2023 and February 2025. At September 30, 2020, we had borrowings under this facility totaling $103 million and $1 million of unamortized deferred issuance costs, for a net carrying value of $102 million. At September 30, 2020, the fair value of real estate securities pledged as collateral under this long-term debt facility was $112 million and included securities retained from our consolidated CAFL securitizations.

Non-Recourse Business Purpose Loan Financing Facilities

In the third quarter of 2020, a subsidiary of Redwood entered into a repurchase agreement providing non-marginable, non-recourse financing primarily for business purpose bridge loans. Borrowings under this facility accrue interest at a per annum rate equal to one-month LIBOR plus 3.85% (with a 0.50% LIBOR floor), through July 2022. We do not have the ability to increase borrowings under this borrowing facility above the existing amounts outstanding. At September 30, 2020, we had borrowings under this facility totaling $158 million and $1 million of unamortized deferred issuance costs, for a net carrying value of $157 million. At September 30, 2020, $216 million of bridge loans were pledged as collateral under this facility.

In the second quarter of 2020, a subsidiary of Redwood entered into a repurchase agreement providing non-marginable, non-recourse financing primarily for business purpose bridge loans. Borrowings under this facility accrue interest at a per annum rate equal to one-month LIBOR plus 7.50% (with a 1.50% LIBOR floor), through June 2022 (facility is fully callable in June 2021). This facility has an aggregate maximum borrowing capacity of $530 million, which consists of a term facility of $355 million and a revolving facility of $175 million. The revolving period ends in June 2021, and amounts borrowed under the term and revolving facilities are due in full in June 2022. At September 30, 2020, we had borrowings under this facility totaling $302 million and $4 million of unamortized deferred issuance costs, for a net carrying value of $298 million. At September 30, 2020, $369 million of bridge loans and $25 million of other BPL investments were pledged as collateral under this facility.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 15. Long-Term Debt - (continued)

Recourse Business Purpose Loan Financing Facilities

In the third quarter of 2020, a subsidiary of Redwood entered into a repurchase agreement providing non-marginable financing for business purpose bridge loans and single-family rental loans. Borrowings under this facility accrue interest at a per annum rate equal to three-month LIBOR plus 3.00% through September 2023 and are recourse to Redwood. This facility has an aggregate maximum borrowing capacity of $250 million. At September 30, 2020, we had no borrowings outstanding under this facility.

In the second quarter of 2020, a subsidiary of Redwood entered into a repurchase agreement providing non-marginable financing for business purpose bridge loans and single-family rental loans. Borrowings under this facility accrue interest at a per annum rate equal to three-month LIBOR plus 3.50% to 4.00% (with a 1.00% LIBOR floor) through May 2022 and are recourse to Redwood. This facility has an aggregate maximum borrowing capacity of $350 million. At September 30, 2020, we had borrowings under this facility totaling $150 million and $1 million of unamortized deferred issuance costs, for a net carrying value of $150 million. At September 30, 2020, $18 million of bridge loans and $194 million of single-family rental loans were pledged as collateral under this facility.

Recourse Revolving Debt Facility

In the first quarter of 2020, a subsidiary of Redwood entered into a secured revolving debt facility agreement collateralized by MSRs and certificated mortgage servicing rights. Borrowings under this facility accrue interest at a per annum rate equal to one-month LIBOR plus 2.75% through January 2021, with an increase in rate between February 2021 and the maturity of the facility in January 2022. This facility has an aggregate maximum borrowing capacity of $50 million. We had no borrowings outstanding under this facility at September 30, 2020. At September 30, 2020, $33 million of MSRs and certificated servicing rights were pledged as collateral under this facility.

Convertible Notes

At September 30, 2020, we had $172 million principal amount outstanding of 5.75% exchangeable senior notes due 2025. During the second quarter of 2020, we repurchased $29 million par value of these notes at a discount and recorded a gain on extinguishment of $6 million in Realized gains, net on our consolidated statements of income (loss). At September 30, 2020, the accrued interest payable balance on this debt was $5 million and the unamortized deferred issuance costs were $4 million.

At September 30, 2020, we had $150 million principal amount outstanding of 5.625% convertible senior notes due 2024. During the second quarter of 2020, we repurchased $50 million par value of these notes at a discount and recorded a gain on extinguishment of $9 million in Realized gains, net on our consolidated statements of income (loss). At September 30, 2020, the accrued interest payable on this debt was $2 million, the unamortized deferred issuance costs were $2 million, and the debt discount was $1 million.

At September 30, 2020, we had $199 million principal amount outstanding of 4.75% convertible senior notes due 2023. During the second quarter of 2020, we repurchased $46 million par value of these notes at a discount and recorded a gain on extinguishment of $10 million in Realized gains, net on our consolidated statements of income (loss). At September 30, 2020, the accrued interest payable balance on this debt was $1 million and the unamortized deferred issuance costs were $3 million.

Trust Preferred Securities and Subordinated Notes

At September 30, 2020, we had trust preferred securities and subordinated notes outstanding of $100 million and $40 million, respectively. At both September 30, 2020 and December 31, 2019, the accrued interest payable balance on our trust preferred securities and subordinated notes was $1 million.

Note 16. Commitments and Contingencies

Lease Commitments

At September 30, 2020, we were obligated under seven non-cancelable operating leases with expiration dates through 2031 for $18 million of cumulative lease payments. Our operating lease expense was $3 million and $2 million for the nine months ended September 30, 2020 and 2019, respectively.

54

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 16. Commitments and Contingencies - (continued)

The following table presents our future lease commitments at September 30, 2020.

Table 16.1 – Future Lease Commitments by Year

(In Thousands)						September 30, 2020
2020 (3 months)						$	930
2021						2,949
2022						2,427
2023						1,913
2024						1,917
2025						8,039
Total Lease Commitments						18,175
Less: Imputed interest						(3,052)
Lease Liability						$	15,123

During the nine months ended September 30, 2020, we entered into three office leases and determined that each of these leases qualified as operating leases. At September 30, 2020, our lease liability was $15 million, which was a component of Accrued expenses and other liabilities, and our right-of-use asset was $13 million, which was a component of Other assets.

We determined that none of our leases contained an implicit interest rate and used a discount rate equal to our incremental borrowing rate on a collateralized basis to determine the present value of our total lease payments. As such, we determined the applicable discount rate for each of our leases using a swap rate plus an applicable spread for borrowing arrangements secured by our real estate loans and securities for a length of time equal to the remaining lease term on the date of adoption. At September 30, 2020, the weighted-average remaining lease term and weighted-average discount rate for our leases was 7 years and 5.0%, respectively.

Commitment to Fund Residential Bridge Loans

As of September 30, 2020, we had commitments to fund up to $225 million of additional advances on existing residential bridge loans. These commitments are generally subject to loan agreements with covenants regarding the financial performance of the customer and other terms regarding advances that must be met before we fund the commitment. At September 30, 2020, we recorded a $1 million derivative liability related to these commitments to fund construction advances (see Note 7 for additional detail). We may also advance funds related to loans sold under a separate loan sale agreement that are generally repaid immediately by the loan purchaser and do not generally expose us to loss. The outstanding commitments related to these loans that we may temporarily fund totaled approximately $15 million at September 30, 2020.

Commitment to Fund Partnerships

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

5 Arches Contingent Consideration

As part of the consideration for our acquisition of 5 Arches, we were committed to make earn-out payments up to $29 million, payable in a mix of cash and Redwood common stock. These contingent earn-out payments were classified as a contingent consideration liability and carried at fair value prior to March 31, 2020. During the first quarter of 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 September 30, 2020, the balance of this liability was $14 million, which will be paid in a mix of cash and common stock in March 2021.

55

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 16. Commitments and Contingencies - (continued)

Commitment to Fund Shared Home Appreciation Options

In the third quarter of 2019, we entered into a flow purchase agreement to acquire shared home appreciation options. The counterparty purchases an option to buy a fractional interest in a homeowner's ownership interest in residential property, and subsequently the counterparty sells the option contract to us. Pursuant to the terms of the option contract, we share in both home price appreciation and depreciation. At September 30, 2020, we had acquired $47 million of shared home appreciation options under this agreement, which are included in Other investments on our consolidated balance sheets. At September 30, 2020, we had an outstanding commitment to fund up to an additional $3 million under this agreement.

Loss Contingencies — Risk-Sharing

During 2015 and 2016, we sold conforming loans to the Agencies with an original unpaid principal balance of $3.19 billion, subject to our risk-sharing arrangements with the Agencies. At September 30, 2020, the maximum potential amount of future payments we could be required to make under these arrangements was $44 million and this amount was fully collateralized by assets we transferred to pledged accounts and is presented as pledged collateral in Other assets on our consolidated balance sheets. We have no recourse to any third parties that would allow us to recover any amounts related to our obligations under the arrangements. At September 30, 2020, we had not incurred any losses under these arrangements. For the three and nine months ended September 30, 2020, other income related to these arrangements was $1 million and $3 million, respectively, and net market valuation losses related to these investments were $0.3 million and $0.9 million, respectively. For the three and nine months ended September 30, 2019, other income related to these arrangements was $1 million and $2 million, respectively, and net market valuation losses related to these investments were $0.1 million and $0.2 million, respectively.

All of the loans in the reference pools subject to these risk-sharing arrangements were originated in 2014 and 2015, and at September 30, 2020, the loans had an unpaid principal balance of $1.12 billion and a weighted average FICO score of 758 (at origination) and LTV ratio of 75% (at origination). At September 30, 2020, $42 million of the loans were 90 days or more delinquent, and none of these loans were in foreclosure. At September 30, 2020, the carrying value of our guarantee obligation was $11 million and included $5 million designated as a non-amortizing credit reserve, which we believe is sufficient to cover current expected losses under these obligations.

Our consolidated balance sheets include assets of special purpose entities ("SPEs") associated with these risk-sharing arrangements (i.e., the "pledged collateral" referred to above) that can only be used to settle obligations of these SPEs for which the creditors of these SPEs (the Agencies) do not have recourse to Redwood Trust, Inc. or its affiliates. At September 30, 2020 and December 31, 2019, assets of such SPEs totaled $47 million and $48 million, respectively, and liabilities of such SPEs totaled $11 million and $14 million, respectively.

56

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 16. Commitments and Contingencies - (continued)

Loss Contingencies — Residential Repurchase Reserve

We maintain a repurchase reserve for potential obligations arising from representation and warranty violations related to residential loans we have sold to securitization trusts or third parties and for conforming residential loans associated with MSRs that we have purchased from third parties. We do not originate residential loans and we believe the initial risk of loss due to loan repurchases (i.e., due to a breach of representations and warranties) would generally be a contingency to the companies from whom we acquired the loans. However, in some cases, for example, where loans were acquired from companies that have since become insolvent, repurchase claims may result in our being liable for a repurchase obligation. Additionally, for certain loans we sold during the second quarter of 2020 that were previously held for investment, we have a direct obligation to repurchase these loans in the event of any early payment defaults (or EPDs) by the underlying mortgage borrowers within certain specified periods following the sales.

At September 30, 2020 and December 31, 2019, our repurchase reserve associated with our residential loans and MSRs was $9 million and $4 million, respectively, and was recorded in Accrued expenses and other liabilities on our consolidated balance sheets.

We received eight and ten repurchase requests during the nine months ended September 30, 2020 and 2019, respectively, and did not repurchase any loans during either of these periods. During the nine months ended September 30, 2020 and 2019, we recorded repurchase provisions of $4 million and reversals of repurchase provisions of $0.2 million, respectively, that were recorded in Mortgage banking activities, net; Investment fair value changes, net; and Other income on our consolidated statements of income (loss).

Loss Contingencies — Litigation, Claims and Demands

There is no significant update regarding the litigation matters described in Note 16 within the financial statements included in Redwood’s Annual Report on Form 10-K for the year ended December 31, 2019 under the heading “Loss Contingencies - Litigation.” At September 30, 2020, the aggregate amount of loss contingency reserves established in respect of the FHLB-Seattle and Schwab litigation matters described in our Annual Report on Form 10-K for the year ended December 31, 2019 was $2 million.

In addition to those matters, as previously disclosed, in connection with the impact of the effects of the pandemic on the non-Agency mortgage finance market and on our business and operations, a number of the counterparties that have regularly sold residential mortgage loans to us believe that we breached perceived obligations to them, and requested or demanded that we purchase loans from them and/or compensate them for perceived damages resulting from our decisions earlier in 2020 not to purchase certain loans from them (“Residential Loan Seller Demands”).

We believe that these Residential Loan Seller Demands are without merit or subject to defenses and we intend to defend vigorously any such allegations and any related demand or claim to which we are or become a party. Despite our beliefs about the legal merits of these allegations, because our ordinary course of business is to seek to continue to regularly engage in mutually beneficial transactions with these counterparties, in some cases we have been willing to engage in discussions with these counterparties with the intention of reaching resolution, including through structuring arrangements that incentivize both the counterparty and us to continue to engage in residential loan purchase and sale transactions in the future.

57

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 16. Commitments and Contingencies - (continued)

With respect to certain of the Residential Loan Seller Demands, these resolution discussions have been successful in resolving, or establishing a framework that we believe will be the basis for successfully resolving, the demands of these counterparties, including through forward-looking joint business undertakings and structured arrangements that incentivize both the counterparty and us to continue to engage in residential loan purchase and sale transactions in the future. With respect to these counterparties, we have incurred or expect to incur certain costs in connection with finalizing these arrangements (including costs that are contingent on the successful completion of future residential loan purchase and sale transactions with these counterparties that we expect to generate future revenue for the Company) and have recorded any such actual costs incurred through September 30, 2020, as well as an accrual for the estimated costs associated with counterparties where a resolution or go-forward framework has been agreed to or has been discussed but not finalized, a portion of which was recorded through Other expense and a portion of which was recorded through Mortgage banking activities, net on our consolidated income statement. In accordance with GAAP, the accrual for estimated costs is based on the opinion of management, that it is probable that these resolutions and forward-looking joint business undertakings and structured arrangements will result in an expense and the amount of expense can be reasonably estimated. In addition, as previously disclosed, one such counterparty filed a breach of contract lawsuit against us in May 2020 alleging that it had suffered in excess of $2 million of losses as a result of our alleged failure to purchase residential mortgage loans from it; and in October 2020 we and the plaintiff agreed to settle the lawsuit on mutually satisfactory terms.

During the three and nine months ended September 30, 2020, we recorded $4 million and $9 million of expenses, respectively, in association with Residential Loan Seller Demands. At September 30, 2020, the aggregate amount of our accrual for estimated costs associated with Residential Loan Seller Demands was $6.5 million, a portion of which would be contingent on the successful completion of future residential loan purchase and sale transactions with certain counterparties, with the expectation of generating future revenue for the Company.

With respect to Residential Loan Seller Demands that have not been resolved or been accrued for, our beliefs about the legal merits of these allegations and our discussions with these counterparties have resulted in us determining that a significant loss from these matters is not probable. With respect to these remaining Residential Loan Seller Demands, based on the foregoing, we have concluded that we can estimate an aggregate range of reasonably possible losses with respect to these Residential Loan Seller Demands of between zero and $1.5 million.

Future developments (including receipt of additional information and documents relating to these matters, new or additional resolution or settlement communications relating to these matters, resolutions of similar claims against other industry participants in similar circumstances, or receipt of additional Residential Loan Seller Demands) could result in our concluding in the future to establish additional accruals or reserves or modify our aggregate range of reasonably possible losses with respect to these Residential Loan Seller Demand matters. Our actual losses, and any accruals or reserves we may establish in the future relating to these matters, may be materially higher than the accruals, reserves and the aggregate range of reasonably possible losses we have estimated above, respectively, including in the event that any of these matters proceed to trial and result in a judgment against us. We cannot be certain that any of these matters that are not already formally resolved will be resolved through a resolution or settlement and we cannot be certain that the resolution of these matters, whether through litigation, settlement, or otherwise, will not have a material adverse effect on our financial condition or results of operations in any future period.

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

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 16. Commitments and Contingencies - (continued)

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

Note 17. Equity

The following table provides a summary of changes to accumulated other comprehensive income by component for the three and nine months ended September 30, 2020 and 2019. During the three and nine months ended September 30, 2020, we recognized net unrealized gains (losses) on our Level 3 AFS securities which we owned as of September 30, 2020 of $8 million and negative $16 million, respectively.

Table 17.1 – Changes in Accumulated Other Comprehensive Income by Component

						Three Months Ended September 30, 2020												Three Months Ended September 30, 2019
(In Thousands)						Available-for-Sale Securities						Interest Rate Agreements Accounted for as Cash Flow Hedges						Available-for-Sale Securities						Interest Rate Agreements Accounted for as Cash Flow Hedges
Balance at beginning of period						$	53,246					$	(82,637)					$	98,307					$	(49,384)
Other comprehensive income (loss) before reclassifications						8,236						—						4,484						(11,791)
Amounts reclassified from other accumulated comprehensive income						(445)						1,040						(3,492)						—
Net current-period other comprehensive income (loss)						7,791						1,040						992						(11,791)
Balance at End of Period						$	61,037					$	(81,597)					$	99,299					$	(61,175)

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 17. Equity - (continued)

						Nine Months Ended September 30, 2020												Nine Months Ended September 30, 2019
(In Thousands)						Available-for-Sale Securities						Interest Rate Agreements Accounted for as Cash Flow Hedges						Available-for-Sale Securities						Interest Rate Agreements Accounted for as Cash Flow Hedges
Balance at beginning of period						$	92,452					$	(50,939)					$	95,342					$	(34,045)
Other comprehensive income (loss) before reclassifications						(19,890)						(32,806)						19,764						(27,130)
Amounts reclassified from other accumulated comprehensive income						(11,525)						2,148						(15,807)						—
Net current-period other comprehensive income (loss)						(31,415)						(30,658)						3,957						(27,130)
Balance at End of Period						$	61,037					$	(81,597)					$	99,299					$	(61,175)

The following table provides a summary of reclassifications out of accumulated other comprehensive income for the three and nine months ended September 30, 2020 and 2019.

Table 17.2 – Reclassifications Out of Accumulated Other Comprehensive Income

												Amount Reclassified From Accumulated Other Comprehensive Income
						Affected Line Item in the						Three Months Ended September 30,
(In Thousands)						Income Statement						2020						2019
Net Realized (Gain) Loss on AFS Securities
Credit loss recovery on AFS securities						Investment fair value changes, net						$	(444)					$	—
Gain on sale of AFS securities						Realized gains, net						—						(3,492)
												$	(444)					$	(3,492)
Net Realized Loss on Interest Rate Agreements Designated as Cash Flow Hedges
Amortization of deferred loss						Interest expense						$	1,040					$	—
												$	1,040					$	—

												Amount Reclassified From Accumulated Other Comprehensive Income
						Affected Line Item in the						Nine Months Ended September 30,
(In Thousands)						Income Statement						2020						2019
Net Realized (Gain) Loss on AFS Securities
Credit loss expense on AFS securities						Investment fair value changes, net						$	1,027					$	—
Gain on sale of AFS securities						Realized gains, net						(12,552)						(15,807)
												$	(11,525)					$	(15,807)
Net Realized Loss on Interest Rate Agreements Designated as Cash Flow Hedges
Amortization of deferred loss						Interest expense						$	2,148					$	—
												$	2,148					$	—

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 17. Equity - (continued)

Issuance of Common Stock

In 2018, we established a program to sell up to an aggregate of $150 million of common stock from time to time in at-the-market ("ATM") offerings. In March 2020, we increased the maximum aggregate amount of common stock offered under the ATM program to $175 million. During the nine months ended September 30, 2020, we issued 129,500 common shares for net proceeds of approximately $2 million through ATM offerings. At September 30, 2020, approximately $110 million remained outstanding for future offerings under this program.

Direct Stock Purchase and Dividend Reinvestment Plan

During the nine months ended September 30, 2020, we did not issue any shares of common stock through our Direct Stock Purchase and Dividend Reinvestment Plan. During the nine months ended September 30, 2019, we issued 399,838 shares of common stock through our Direct Stock Purchase and Dividend Reinvestment Plan, resulting in net proceeds of approximately $6 million.

Earnings (Loss) per Common Share

The following table provides the basic and diluted earnings (loss) per common share computations for the three and nine months ended September 30, 2020 and 2019.

Table 17.3 – Basic and Diluted Earnings (Loss) per Common Share

						Three Months Ended September 30,												Nine Months Ended September 30,
(In Thousands, except Share Data)						2020						2019						2020						2019
Basic Earnings (Loss) per Common Share:
Net income (loss) attributable to Redwood						$	141,812					$	34,310					$	(636,142)					$	120,040
Less: Dividends and undistributed earnings allocated to participating securities						(4,067)						(856)						(1,427)						(3,260)
Net income (loss) allocated to common shareholders						$	137,745					$	33,454					$	(637,569)					$	116,780
Basic weighted average common shares outstanding						113,403,102						101,872,126						113,952,308						97,214,064
Basic Earnings (Loss) per Common Share						$	1.21					$	0.33					$	(5.60)					$	1.20
Diluted Earnings (Loss) per Common Share:
Net income (loss) attributable to Redwood						$	141,812					$	34,310					$	(636,142)					$	120,040
Less: Dividends and undistributed earnings allocated to participating securities						(3,512)						(1,036)						(1,427)						(3,625)
Adjust for interest expense and gain on extinguishment of convertible notes for the period, net of tax						6,990						8,887						—						26,271
Net income (loss) allocated to common shareholders						$	145,290					$	42,161					$	(637,569)					$	142,686
Weighted average common shares outstanding						113,403,102						101,872,126						113,952,308						97,214,064
Net effect of dilutive equity awards						—						362,743						—						261,155
Net effect of assumed convertible notes conversion to common shares						28,566,875						34,287,840						—						33,727,470
Diluted weighted average common shares outstanding						141,969,977						136,522,709						113,952,308						131,202,689
Diluted Earnings (Loss) per Common Share						$	1.02					$	0.31					$	(5.60)					$	1.09

We included participating securities, which are certain equity awards that have non-forfeitable dividend participation rights, in the calculations of basic and diluted earnings per common share as we determined that the two-class method was more dilutive than the alternative treasury stock method for these shares. Dividends and undistributed earnings allocated to participating securities under the basic and diluted earnings per share calculations require specific shares to be included that may differ in certain circumstances.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 17. Equity - (continued)

During the three months ended September 30, 2020 and the three and nine months ended September 30, 2019, certain of our convertible notes were determined to be dilutive and were included in the calculation of diluted EPS under the "if-converted" method. Under this method, the periodic interest expense and any realized gains or losses on extinguishment of debt (net of applicable taxes) for dilutive notes is added back to the numerator and the weighted average number of shares that the notes are entitled to (if converted, regardless of whether they are in or out of the money) are included in the denominator.

For the nine months ended September 30, 2020, 32,225,825 of common shares related to the assumed conversion of our convertible notes were antidilutive and were excluded in the calculation of diluted earnings per share. For the three and nine months ended September 30, 2020, the number of outstanding equity awards that were antidilutive totaled 13,560 and 15,457, respectively. For the three and nine months ended September 30, 2019, the number of outstanding equity awards that were antidilutive totaled 11,710 and 9,361, respectively.

Stock Repurchases

In February 2018, our Board of Directors approved an authorization for the repurchase of our common stock, increasing the total amount authorized for repurchases of common stock to $100 million, and also authorized the repurchase of outstanding debt securities, including convertible and exchangeable debt. This authorization increased the previous share repurchase authorization approved in February 2016 and has no expiration date. This repurchase authorization does not obligate us to acquire any specific number of shares or securities. Under this authorization, shares or securities may be repurchased in privately negotiated and/or open market transactions, including under plans complying with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. During the three months ended September 30, 2020, we repurchased 3,047,335 shares of our common stock pursuant to this authorization for $22 million. At September 30, 2020, $78 million of the current authorization remained available for the repurchase of shares of our common stock and we also continued to be authorized to repurchase outstanding debt securities.

Note 18. Equity Compensation Plans

At September 30, 2020 and December 31, 2019, 8,629,455 and 3,637,480 shares of common stock, respectively, were available for grant under our Incentive Plan. During the second quarter of 2020, Redwood shareholders approved for grant an additional 5 million shares of common stock under our Incentive Plan. The unamortized compensation cost of awards issued under the Incentive Plan and purchases under the Employee Stock Purchase Plan totaled $20 million at September 30, 2020, as shown in the following table.

Table 18.1 – Activities of Equity Compensation Costs by Award Type

												Nine Months Ended September 30, 2020
(In Thousands)												Restricted Stock Awards						Restricted Stock Units						Deferred Stock Units						Performance Stock Units						Employee Stock Purchase Plan						Total
Unrecognized compensation cost at beginning of period												$	1,990					$	3,534					$	17,858					$	8,946					$	—					$	32,328
Equity grants												108						3,581						6,780						—						160						10,629
Performance-based valuation adjustment												—						—						—						(7,352)						—						(7,352)
Equity grant forfeitures												(529)						(2,161)						(4,733)						(648)						—						(8,071)
Equity compensation expense												(807)						(1,067)						(6,268)						326						(80)						(7,896)
Unrecognized Compensation Cost at End of Period												$	762					$	3,887					$	13,637					$	1,272					$	80					$	19,638

At September 30, 2020, the weighted average amortization period remaining for all of our equity awards was one year.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 18. Equity Compensation Plans - (continued)

Restricted Stock Awards ("RSAs")

At September 30, 2020 and December 31, 2019, there were 80,550 and 216,470 shares, respectively, of RSAs outstanding. Restrictions on these shares lapse through 2022. During the nine months ended September 30, 2020, there were no RSAs granted, restrictions on 101,063 RSAs lapsed and those shares were distributed, and 34,857 RSAs were forfeited.

Restricted Stock Units ("RSUs")

At September 30, 2020 and December 31, 2019, there were 294,986 and 275,173 shares, respectively, of RSUs outstanding. Restrictions on these shares lapse through 2024. During the nine months ended September 30, 2020, there were 205,482 RSUs granted, 55,514 RSUs distributed, and 130,155 RSUs forfeited.

Deferred Stock Units (“DSUs”)

At September 30, 2020 and December 31, 2019, there were 2,420,737 and 2,630,805 DSUs, respectively, outstanding of which 1,406,190 and 1,286,063, respectively, had vested. During the nine months ended September 30, 2020, there were 494,719 DSUs granted, 413,533 DSUs distributed, and 291,253 DSUs forfeited. Unvested DSUs at September 30, 2020 vest through 2024.

Performance Stock Units (“PSUs”)

At September 30, 2020 and December 31, 2019, the target number of PSUs that were unvested was 739,895 and 839,070, respectively. During the nine months ended September 30, 2020, 99,175 PSUs were forfeited. Vesting for all PSUs will generally occur at the end of three years from their grant date based on various Total Shareholder Return ("TSR") performance calculations, as discussed in our Annual Report on Form 10-K for the year ended December 31, 2019. During the first quarter of 2020, for PSUs granted in 2018 and 2019, we adjusted our vesting estimate to assume that none of these awards will meet the minimum performance thresholds for vesting. This adjustment resulted in a reversal of $1 million of stock-based compensation expense recorded in the first quarter of 2020.

Employee Stock Purchase Plan ("ESPP")

The ESPP allows a maximum of 600,000 shares of common stock to be purchased in aggregate for all employees. As of September 30, 2020 and December 31, 2019, 477,142 and 430,772 shares had been purchased, respectively, and there remained a negligible amount of uninvested employee contributions in the ESPP at September 30, 2020.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020

(Unaudited)

Note 19. Mortgage Banking Activities, Net

The following table presents the components of Mortgage banking activities, net, recorded in our consolidated statements of income (loss) for the three and nine months ended September 30, 2020 and 2019.

Table 19.1 – Mortgage Banking Activities

						Three Months Ended September 30,												Nine Months Ended September 30,
(In Thousands)						2020						2019						2020						2019
Residential Mortgage Banking Activities, Net
Changes in fair value of:
Residential loans, at fair value (1)						$	12,589					$	6,320					$	19,151					$	41,431
Risk management derivatives (2)						(10)						(1,710)						(31,304)						(11,608)
Other income (expense), net (3)						(715)						407						(7,069)						1,380
Total residential mortgage banking activities, net						11,864						5,017						(19,222)						31,203
Business Purpose Mortgage Banking Activities, Net:
Changes in fair value of:
Single-family rental loans, at fair value (1)						43,191						1,847						56,209						5,473
Risk management derivatives (2)						(89)						(1,262)						(21,627)						(3,779)
Residential bridge loans, at fair value						938						1,010