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Section 1: 10-Q (10-Q)

Document

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

 
FORM 10-Q
 

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: March 31, 2019

OR
o

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

For the Transition Period from _______________ to _______________.
Commission File Number 1-13759
 
REDWOOD TRUST, INC.
(Exact Name of Registrant as Specified in Its Charter)
Maryland
 
68-0329422
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
One Belvedere Place, Suite 300
Mill Valley, California
 
94941
(Address of Principal Executive Offices)
 
(Zip Code)
(415) 389-7373
(Registrant’s Telephone Number, Including Area Code)
Not Applicable
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically 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 x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
 
Accelerated filer
o
Non-accelerated filer
o
 
Smaller reporting company
o
 
 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
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
 
96,876,974 shares outstanding as of May 6, 2019





REDWOOD TRUST, INC.
2019 FORM 10-Q REPORT
TABLE OF CONTENTS
 
 
 
 
Page
PART I —
FINANCIAL INFORMATION
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
 
 
PART II —
OTHER INFORMATION
 
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 3.
 
Item 4.
 
Item 5.
 
Item 6.
 
 

i



PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands, except Share Data)
(Unaudited)
 
March 31, 2019
 
December 31, 2018
ASSETS (1)
 
 
 
 
Residential loans, held-for-sale, at fair value
 
$
819,221

 
$
1,048,801

Residential loans, held-for-investment, at fair value
 
6,455,080

 
6,205,941

Business purpose residential loans, at fair value
 
160,612

 
141,258

Multifamily loans, held-for-investment, at fair value
 
2,175,899

 
2,144,598

Real estate securities, at fair value
 
1,543,152

 
1,452,494

Other investments
 
414,198

 
438,518

Cash and cash equivalents
 
200,837

 
175,764

Restricted cash
 
14,614

 
29,313

Goodwill and intangible assets
 
52,895

 

Accrued interest receivable
 
48,972

 
47,105

Derivative assets
 
22,283

 
35,789

Other assets
 
285,596

 
217,825

Total Assets
 
$
12,193,359

 
$
11,937,406

 
 
 
 
 
LIABILITIES AND EQUITY (1)
 
 
 
 
Liabilities
 
 
 
 
Short-term debt, net (2)
 
$
2,163,231

 
$
2,400,279

Accrued interest payable
 
39,526

 
42,528

Derivative liabilities
 
110,942

 
84,855

Accrued expenses and other liabilities
 
119,428

 
78,719

Asset-backed securities issued, at fair value
 
5,637,644

 
5,410,073

Long-term debt, net
 
2,572,661

 
2,572,158

Total liabilities
 
10,643,432

 
10,588,612

Commitments and Contingencies (see Note 16)
 


 


Equity
 
 
 
 
Common stock, par value $0.01 per share, 180,000,000 shares authorized; 96,866,464 and 84,884,344 issued and outstanding
 
969

 
849

Additional paid-in capital
 
1,996,358

 
1,811,422

Accumulated other comprehensive income
 
52,684

 
61,297

Cumulative earnings
 
1,464,405

 
1,409,941

Cumulative distributions to stockholders
 
(1,964,489
)
 
(1,934,715
)
Total equity
 
1,549,927

 
1,348,794

Total Liabilities and Equity
 
$
12,193,359

 
$
11,937,406

——————
(1)
Our consolidated balance sheets include assets of consolidated variable interest entities (“VIEs”) that can only be used to settle obligations of these VIEs and liabilities of consolidated VIEs for which creditors do not have recourse to Redwood Trust, Inc. or its affiliates. At March 31, 2019 and December 31, 2018, assets of consolidated VIEs totaled $6,585,881 and $6,331,191, respectively. At March 31, 2019 and December 31, 2018, liabilities of consolidated VIEs totaled $5,925,677 and $5,709,807, respectively. See Note 4 for further discussion.
(2)
Includes $201 million of convertible notes, which were reclassified from Long-term debt, net to Short-term debt as the maturity of the notes was less than one year as of November 15, 2018. See Note 13 for further discussion.


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

2


REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, except Share Data)
 
Three Months Ended March 31,
(Unaudited)
 
2019
 
2018
Interest Income
 
 
 
 
Residential loans
 
$
75,950

 
$
50,231

Business purpose residential loans
 
2,789

 

Multifamily loans
 
21,388

 

Real estate securities
 
24,450

 
25,695

Other interest income
 
6,464

 
693

Total interest income
 
131,041

 
76,619

Interest Expense
 
 
 
 
Short-term debt
 
(22,218
)
 
(13,435
)
Asset-backed securities issued
 
(55,295
)
 
(11,401
)
Long-term debt
 
(21,763
)
 
(16,678
)
Total interest expense
 
(99,276
)
 
(41,514
)
Net Interest Income
 
31,765

 
35,105

Non-interest Income
 
 
 
 
Mortgage banking activities, net
 
12,309

 
26,576

Investment fair value changes, net
 
20,159

 
1,609

Other income, net
 
3,587

 
2,118

Realized gains, net
 
10,686

 
9,363

Total non-interest income, net
 
46,741

 
39,666

Operating expenses
 
(23,159
)
 
(23,030
)
Net Income before Provision for Income Taxes
 
55,347

 
51,741

Provision for income taxes
 
(883
)
 
(4,896
)
Net Income
 
$
54,464

 
$
46,845

 
 
 
 
 
Basic earnings per common share
 
$
0.57

 
$
0.60

Diluted earnings per common share
 
$
0.49

 
$
0.50

Regular dividends declared per common share
 
$
0.30

 
$
0.28

Basic weighted average shares outstanding
 
92,685,350

 
75,396,649

Diluted weighted average shares outstanding
 
126,278,160

 
108,194,597


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



3


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

(In Thousands)
 
Three Months Ended March 31,
(Unaudited)
 
2019
 
2018
Net Income
 
$
54,464

 
$
46,845

Other comprehensive loss:
 
 
 
 
Net unrealized gain (loss) on available-for-sale securities
 
6,718

 
(4,237
)
Reclassification of unrealized gain on available-for-sale securities to net income
 
(9,493
)
 
(9,387
)
Net unrealized (loss) gain on interest rate agreements
 
(5,838
)
 
8,431

Total other comprehensive loss
 
(8,613
)
 
(5,193
)
Total Comprehensive Income
 
$
45,851

 
$
41,652



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



4



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

For the Three Months Ended March 31, 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
 

 

 

 

 
54,464

 

 
54,464

Other comprehensive loss
 

 

 

 
(8,613
)
 

 

 
(8,613
)
Issuance of common stock
 
11,500,000

 
115

 
177,482

 

 

 

 
177,597

Direct stock purchase and dividend reinvestment plan
 
399,838

 
4

 
6,303

 

 

 

 
6,307

Employee stock purchase and incentive plans
 
82,282

 
1

 
(1,939
)
 

 

 

 
(1,938
)
Non-cash equity award compensation
 

 

 
3,090

 

 

 

 
3,090

Common dividends declared
 

 

 

 

 

 
(29,774
)
 
(29,774
)
March 31, 2019
 
96,866,464

 
$
969

 
$
1,996,358

 
$
52,684

 
$
1,464,405

 
$
(1,964,489
)
 
$
1,549,927


For the Three Months Ended March 31, 2018
(In Thousands, except Share Data)
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive
Income
 
Cumulative
 Earnings
 
Cumulative
Distributions
to Stockholders
 
Total
(Unaudited)
 
Shares
 
Amount
 
 
 
 
 
December 31, 2017
 
76,599,972

 
$
766

 
$
1,673,845

 
$
85,248

 
$
1,290,341

 
$
(1,837,913
)
 
$
1,212,287

Net income
 

 

 

 

 
46,845

 

 
46,845

Other comprehensive loss
 

 

 

 
(5,193
)
 

 

 
(5,193
)
Employee stock purchase and incentive plans
 
143,964

 
1

 
(284
)
 

 

 

 
(283
)
Non-cash equity award compensation
 

 

 
3,674

 

 

 

 
3,674

Share repurchases
 
(1,040,829
)
 
(10
)
 
(15,534
)
 

 

 

 
(15,544
)
Common dividends declared
 

 

 

 

 

 
(21,803
)
 
(21,803
)
March 31, 2018
 
75,703,107

 
$
757

 
$
1,661,701

 
$
80,055

 
$
1,337,186

 
$
(1,859,716
)
 
$
1,219,983



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


5



REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
 
Three Months Ended March 31,
 
2019
 
2018
Cash Flows From Operating Activities:
 
 
 
 
Net income
 
$
54,464

 
$
46,845

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
Amortization of premiums, discounts, and securities issuance costs, net
 
(689
)
 
(3,939
)
Depreciation and amortization of non-financial assets
 
343

 
299

Originations of held-for-sale loans
 
(28,968
)
 

Purchases of held-for-sale loans
 
(989,977
)
 
(1,820,002
)
Proceeds from sales of held-for-sale loans
 
851,331

 
1,581,806

Principal payments on held-for-sale loans
 
17,450

 
16,332

Net settlements of derivatives
 
(9,305
)
 
19,296

Non-cash equity award compensation expense
 
3,090

 
3,674

Market valuation adjustments
 
(31,439
)
 
(25,600
)
Realized gains, net
 
(10,686
)
 
(9,363
)
Net change in:
 
 
 
 
Accrued interest receivable and other assets
 
(50,006
)
 
35,824

Accrued interest payable and accrued expenses and other liabilities
 
(12,119
)
 
11,581

Net cash used in operating activities
 
(206,511
)
 
(143,247
)
Cash Flows From Investing Activities:
 
 
 
 
Originations of loans held-for-investment
 
(7,000
)
 

Purchases of loans held-for-investment
 
(49,489
)
 

Principal payments on loans held-for-investment
 
246,964

 
159,889

Purchases of real estate securities
 
(154,871
)
 
(128,069
)
Proceeds from sales of real estate securities
 
74,018

 
241,570

Principal payments on real estate securities
 
24,498

 
16,246

Purchases of servicer advance investments
 
(68,976
)
 

Principal repayments from servicer advance investments
 
66,532

 

Purchases of excess MSRs
 
(2,116
)
 

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
 
(22,316
)
 

Other investing activities, net
 
(1,179
)
 
3,827

Net cash provided by investing activities
 
140,560

 
293,463

Cash Flows From Financing Activities:
 
 
 
 
Proceeds from borrowings on short-term debt
 
1,217,915

 
1,318,754

Repayments on short-term debt
 
(1,459,648
)
 
(1,753,090
)
Proceeds from issuance of asset-backed securities
 
330,534

 
441,741

Repayments on asset-backed securities issued
 
(163,146
)
 
(84,974
)
Net settlements of derivatives
 
(35
)
 
(85
)
Net proceeds from issuance of common stock
 
182,512

 
88

Net payments on repurchase of common stock
 

 
(16,315
)
Taxes paid on equity award distributions
 
(2,033
)
 
(371
)
Dividends paid
 
(29,774
)
 
(21,803
)
Net cash provided by (used in) financing activities
 
76,325

 
(116,055
)
Net increase in cash, cash equivalents and restricted cash
 
10,374

 
34,161

Cash, cash equivalents and restricted cash at beginning of period (1)
 
205,077

 
146,807

Cash, cash equivalents and restricted cash at end of period (1)
 
$
215,451

 
$
180,968




6



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

(In Thousands)
(Unaudited)
 
Three Months Ended March 31,
 
2019
 
2018
Supplemental Cash Flow Information:
 
 
 
 
Cash paid during the period for:
 
 
 
 
 Interest
 
$
99,686

 
$
38,285

 Taxes
 
77

 
42

Supplemental Noncash Information:
 
 
 
 
Real estate securities retained from loan securitizations
 
$
2,601

 
$
16,396

Transfers from loans held-for-sale to loans held-for-investment
 
389,486

 
507,616

Transfers from loans held-for-investment to loans held-for-sale
 
22,758

 

Transfers from residential loans to real estate owned
 
5,035

 
1,268

Right-of-use asset obtained in exchange for operating lease liability
 
12,661

 

(1)
Cash, cash equivalents, and restricted cash at March 31, 2019 includes cash and cash equivalents of $201 million and restricted cash of $15 million, and at December 31, 2018 includes cash and cash equivalents of $176 million and restricted cash of $29 million.

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

7


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)




Note 1. Organization
Redwood Trust, Inc., together with its subsidiaries, is a specialty finance company focused on making credit-sensitive investments in single-family residential and multifamily mortgages and related assets and engaging in mortgage banking activities. Our goal is to provide attractive returns to shareholders through a stable and growing stream of earnings and dividends, as well as through capital appreciation. We operate our business in two segments: Investment Portfolio and Mortgage Banking.
Our primary sources of income are net interest income from our investment portfolios and non-interest income from our mortgage banking activities. Net interest income consists of the interest income we earn on investments less the interest expense we incur on borrowed funds and other liabilities. Income from mortgage banking activities is generated through the acquisition of residential loans and their subsequent sale or securitization, as well as through the origination of business purpose residential loans.
Redwood Trust, Inc. has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), beginning with its taxable year ended December 31, 1994. We generally refer, collectively, to Redwood Trust, Inc. and those of its subsidiaries that are not subject to subsidiary-level corporate income tax as “the REIT” or “our REIT.” We generally refer to subsidiaries of Redwood Trust, Inc. that are subject to subsidiary-level corporate income tax as “our operating subsidiaries” or “our taxable REIT subsidiaries” or “TRS.”
Redwood was incorporated in the State of Maryland on April 11, 1994, and commenced operations on August 19, 1994. References herein to “Redwood,” the “company,” “we,” “us,” and “our” include Redwood Trust, Inc. and its consolidated subsidiaries, unless the context otherwise requires.
Note 2. Basis of Presentation
The consolidated financial statements presented herein are at March 31, 2019 and December 31, 2018, and for the three months ended March 31, 2019 and 2018. These interim unaudited consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and note disclosures normally included in our annual financial statements prepared in accordance with U.S. generally accepted accounting principles ("GAAP") — as prescribed by the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) — have been condensed or omitted in these interim financial statements according to these SEC rules and regulations. Management believes that the disclosures included in these interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the company's Annual Report on Form 10-K for the year ended December 31, 2018. In the opinion of management, all normal and recurring adjustments to present fairly the financial condition of the company at March 31, 2019 and results of operations for all periods presented have been made. The results of operations for the three months ended March 31, 2019 should not be construed as indicative of the results to be expected for the full year.
Principles of Consolidation
In accordance with GAAP, we determine whether we must consolidate transferred financial assets and variable interest entities (“VIEs”) for financial reporting purposes. We currently consolidate the assets and liabilities of certain Sequoia securitization entities issued prior to 2012 where we maintain an ongoing involvement ("Legacy Sequoia"), as well as entities formed in connection with the securitization of Redwood Choice expanded-prime loans beginning in the third quarter of 2017 ("Sequoia Choice"). In addition, we consolidated the assets and liabilities of certain third-party Freddie Mac K-Series securitizations beginning in the third quarter of 2018, and the assets and liabilities of one third-party Freddie Mac SLST securitization beginning in the fourth quarter of 2018. Each securitization entity is independent of Redwood and of each other and the assets and liabilities are not owned by and are not legal obligations of Redwood Trust, Inc. Our exposure to these entities is primarily through the financial interests we have purchased or retained, although for the consolidated Sequoia entities we are exposed to certain financial risks associated with our role as a sponsor, servicing administrator, or depositor of these entities or as a result of our having sold assets directly or indirectly to these entities.

8


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)
Note 2. Basis of Presentation - (continued)

For financial reporting purposes, the underlying loans owned at the consolidated Sequoia and Freddie Mac SLST entities are shown under Residential loans, held-for-investment, at fair value, and the underlying loans at the consolidated Freddie Mac K-Series are shown under Multifamily loans held-for-investment, at fair value, on our consolidated balance sheets. The asset-backed securities (“ABS”) issued to third parties by these entities are shown under ABS issued. In our consolidated statements of income, we recorded interest income on the loans owned at these entities and interest expense on the ABS issued by these entities as well as other income and expenses associated with these entities' activities. See Note 14 for further discussion on ABS issued.
Beginning in the fourth quarter of 2018, we consolidated two partnerships ("Servicing Investment" entities) through which we have invested in servicing-related assets. We maintain an 80% ownership interest in each entity and have determined that we are the primary beneficiary of these partnerships.
Beginning in the first quarter of 2019, we consolidated 5 Arches, LLC ("5 Arches"), an originator of business purpose residential loans, pursuant to the exercise of our purchase option and the acquisition of the remaining equity in the company.
See Note 4 for further discussion on principles of consolidation.
Use of Estimates
The preparation of financial statements requires us to make a number of significant estimates. These include estimates of fair value of certain assets and liabilities, amounts and timing of credit losses, prepayment rates, and other estimates that affect the reported amounts of certain assets and liabilities as of the date of the consolidated financial statements and the reported amounts of certain revenues and expenses during the reported periods. It is likely that changes in these estimates (e.g., valuation changes due to supply and demand, credit performance, prepayments, interest rates, or other reasons) will occur in the near term. Our estimates are inherently subjective in nature and actual results could differ from our estimates and the differences could be material.
Acquisition of 5 Arches, LLC
On March 1, 2019, we completed the previously announced acquisition of the remaining 80% interest in 5 Arches, an originator of business purpose residential loans. In May 2018, Redwood acquired a 20% minority interest in 5 Arches for $10 million in cash, with a one-year option to purchase all remaining equity in the company. At closing, we paid approximately $13 million of cash and the remainder of the consideration, which could total up to an additional $27 million, will be paid in a mix of cash and Redwood common stock and is contingent on the achievement of certain specified loan origination thresholds over the next two years.

9


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)
Note 2. Basis of Presentation - (continued)

We accounted for the acquisition of 5 Arches under the acquisition method of accounting pursuant to ASC 805. We performed the preliminary purchase price allocation and recorded underlying assets acquired and liabilities assumed based on their estimated fair values using the information available as of the acquisition date, with the excess of the purchase price allocated to goodwill. This preliminary purchase price allocation is summarized in the following table.
Table 2.1 – 5 Arches Purchase Price Allocation
(In Thousands)
 
March 1, 2019
Purchase price:
 
 
Cash
 
$
12,575

Contingent consideration, at fair value
 
24,621

Purchase option, at fair value
 
5,082

Equity method investment, at fair value
 
8,052

Total consideration
 
$
50,330

 
 
 
Allocated to:
 
 
Tangible net assets acquired (1)
 
$
1,004

Goodwill
 
28,728

Intangible assets
 
24,800

Deferred tax liability
 
(4,202
)
Total net assets acquired
 
$
50,330

(1)
5 Arches net assets acquired consisted of assets of $19 million and liabilities of $18 million as of March 1, 2019.
Because we owned a 20% noncontrolling interest in 5 Arches immediately before obtaining full control, we remeasured our initial minority investment and purchase option at their acquisition-date fair values using the income approach, which resulted in a gain of $2 million that was recorded in Other income, net on our consolidated statements of income.
As part of this acquisition, we identified and recorded finite-lived intangible assets totaling $25 million. The amortization period for each of these assets and the activity for the three months ended March 31, 2019 is summarized in the table below.
Table 2.2 – Intangible Assets – Activity
(Dollars in Thousands)
 
Carrying Value at December 31, 2018
 
Additions
 
Amortization Expense
 
Carrying Value at March 31, 2019
 
Weighted Average Amortization Period (in years)
Finite-lived intangible assets:
 
 
 
 
 
 
 
 
 
 
Broker network
 
$

 
$
18,100

 
$
(301
)
 
$
17,799

 
5
Non-compete agreements
 

 
2,900

 
(81
)
 
2,819

 
3
Management fee on existing assets under management
 

 
2,600

 
(217
)
 
2,383

 
1
Tradename
 

 
1,200

 
(34
)
 
1,166

 
3
Total
 
$

 
$
24,800

 
$
(633
)
 
$
24,167

 
4

10


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)
Note 2. Basis of Presentation - (continued)

All of our intangible assets are amortized on a straight-line basis. Estimated amortization expense for the remainder of 2019 and the following years is summarized in the table below.
Table 2.3 – Intangible Asset Amortization Expense by Year
(In Thousands)
 
March 31, 2019
2019 (9 months)
 
$
5,690

2020
 
5,420

2021
 
4,987

2022
 
3,848

2023 and thereafter
 
4,222

Total Future Intangible Asset Amortization
 
$
24,167

We recorded goodwill of $29 million as a result of the total consideration exceeding the fair value of the net assets acquired. The goodwill was attributed to the expected business synergies and expansion into business purpose loan markets, as well as access to the knowledgeable and experienced workforce continuing to provide services to the business. We expect $3 million of our goodwill balance to be deductible for tax purposes. The following table presents the goodwill activity for the three months ended March 31, 2019.
Table 2.4 – Goodwill – Activity
(In Thousands)
 
Three Months Ended March 31, 2019
Beginning balance
 
$

Goodwill recognized from 5 Arches acquisition
 
28,728

Impairment
 

Ending Balance
 
$
28,728

The liability resulting from the contingent consideration arrangement was recorded at its acquisition-date fair value of $25 million as part of total consideration for the acquisition of 5 Arches.
The following unaudited pro forma financial information presents Net interest income, Non-interest income, and Net income of Redwood and 5 Arches combined, as if the acquisition occurred as of January 1, 2018. These pro forma amounts have been adjusted to include the amortization of intangible assets for both periods, and to exclude the income statement impacts related to our equity method investment in 5 Arches. The unaudited pro forma financial information is not intended to represent or be indicative of the consolidated financial results of operations that would have been reported if the acquisition had been completed as of January 1, 2018 and should not be taken as indicative of our future consolidated results of operations.
Table 2.5 – Unaudited Pro Forma Financial Information
 
 
Three Months Ended March 31,
(In Thousands)
 
2019
 
2018
Supplementary pro forma information:
 
 
 
 
Net interest income
 
$
32,266

 
$
35,331

Non-interest income
 
43,849

 
40,968

Net income
 
50,311

 
46,035


11


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)



Note 3. Summary of Significant Accounting Policies

Significant Accounting Policies
Included in Note 3 to the Consolidated Financial Statements of our Annual Report on Form 10-K for the year ended December 31, 2018 is a summary of our significant accounting policies. Provided below is a summary of additional accounting policies that are significant to the company’s consolidated financial position and results of operations for the three months ended March 31, 2019.
Business Combinations
We use the acquisition method of accounting for business combinations, under which the purchase price is allocated to the fair values of the assets acquired and liabilities assumed at the acquisition date. The excess of the purchase price over the amount allocated to the assets acquired and liabilities assumed is recorded as goodwill. Adjustments to the values of the assets acquired and liabilities assumed that could be made during the measurement period, which could be up to one year after the acquisition date, are recorded in the period in which the adjustment is identified, with a corresponding offset to goodwill. Any adjustments made after the measurement period are recorded in the consolidated statements of income. Acquisition related costs are expensed as incurred.
Goodwill and Intangible Assets
Significant judgment is required to estimate the fair value of intangible assets and in assigning their estimated useful lives. Accordingly, we typically seek the assistance of independent third-party valuation specialists for significant intangible assets. The fair value estimates are based on available historical information and on future expectations and assumptions we deem reasonable. We generally use an income-based valuation method to estimate the fair value of intangible assets, which discounts expected future cash flows to present value using estimates and assumptions we deem reasonable.
Determining the estimated useful lives of intangible assets also requires judgment. Our assessment as to which intangible assets are deemed to have finite or indefinite lives is based on several factors including economic barriers of entry for the acquired business, retention trends, and our operating plans, among other factors.
Finite-lived intangible assets are amortized over their estimated useful lives on a straight-line basis and reviewed for impairment if indicators are present. Additionally, useful lives are evaluated each reporting period to determine if revisions to the remaining periods of amortization are warranted. Goodwill is tested for impairment annually or more frequently if indicators of impairment exist. We have elected to make the first day of our fiscal fourth quarter the annual impairment assessment date for goodwill. We first assess qualitative factors to determine whether it is more likely than not that the fair value is less than the carrying value. If, based on that assessment, we believe it is more likely than not that the fair value is less than the carrying value, then a two-step goodwill impairment test is performed.
Loan Originations
Our wholly-owned subsidiary, 5 Arches, originates business purpose residential loans, including single-family rental and residential bridge loans. Single-family rental loans are classified as held-for-sale at fair value, as we have originated these loans with the intent to sell to third parties or transfer to securitization entities. Residential bridge loans are classified as held-for-investment at fair value, if we intend to hold these loans to maturity, or held-for-sale at fair value, if we intend to sell the loans to a third party.
Contingent Consideration
In relation to our acquisition of 5 Arches, we recorded contingent consideration liabilities that represent the estimated fair value (at the date of acquisition) of our obligation to make certain earn-out payments that are contingent on 5 Arches loan origination volumes exceeding certain specified thresholds.  These liabilities are carried at fair value and periodic changes in their estimated fair value are recorded through our income statement in Other income, net. The estimate of the fair value of contingent consideration requires significant judgment regarding assumptions about future operating results, discount rates, and probabilities of projected operating result scenarios.

12


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)

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

Leases
Upon adoption of ASU 2016-02, "Leases," in the first quarter of 2019, we recorded a lease liability and right-of-use asset on our consolidated balance sheets. The lease liability is equal to the present value of our remaining lease payments discounted at our incremental borrowing rate and the right-of-use asset is equal to the lease liability adjusted for our deferred rent liability at the adoption of this accounting standard. As lease payments are made, the lease liability is reduced to the present value of the remaining lease payments and the right-of-use asset is reduced by the difference between the lease expense (straight-lined over the lease term) and the theoretical interest expense amount (calculated using the incremental borrowing rate). See Note 16 for further discussion on leases.
Recent Accounting Pronouncements
Newly Adopted Accounting Standards Updates ("ASUs")
In February 2018, the FASB issued ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." This new guidance allows a reclassification from accumulated other comprehensive income ("AOCI") to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 (the "Tax Act"). This new guidance is effective for fiscal years beginning after December 15, 2018. However, we did not elect to reclassify any income tax effects of the Tax Act from AOCI to retained earnings as we did not have any tax effects related to the Tax Act remaining in AOCI at December 31, 2018. Our policy is to release any stranded income tax effects from AOCI to income tax expense on an investment-by-investment basis.
In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." This new guidance amends previous guidance to better align an entity's risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. This new guidance is effective for fiscal years beginning after December 15, 2018. Additionally, in October 2018, the FASB issued ASU 2018-16, "Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes," which permits the use of the OIS rate based on SOFR as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815. The amendments in this update are required to be adopted concurrently with the amendments in ASU 2017-12. We adopted this guidance, as required, in the first quarter of 2019, which did not have a material impact on our consolidated financial statements.
In July 2017, the FASB issued ASU 2017-11, "Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception." This new guidance changes the classification analysis of certain equity-linked financial instruments (or embedded conversion options) with down round features. This new guidance is effective for fiscal years beginning after December 15, 2018. We adopted this guidance, as required, in the first quarter of 2019, which did not have a material impact on our consolidated financial statements.
In March 2017, the FASB issued ASU 2017-08, "Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20)." This new guidance shortens the amortization period for certain callable debt securities purchased at a premium by requiring the premium to be amortized to the earliest call date. This new guidance is effective for fiscal years beginning after December 15, 2018. We adopted this guidance, as required, in the first quarter of 2019, which did not have a material impact on our consolidated financial statements.

13


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)

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

In February 2016, the FASB issued ASU 2016-02, "Leases." This new guidance requires lessees to recognize most leases on their balance sheet as a right-of-use asset and a lease liability. This new guidance retains a dual lease accounting model, which requires leases to be classified as either operating or capital leases for lessees, for purposes of income statement recognition. This new guidance is effective for fiscal years beginning after December 15, 2018. In July 2018, the FASB issued ASU 2018-10, "Codification Improvements to Topic 842, Leases," which provides more specific guidance on certain aspects of Topic 842. Additionally, in July 2018, the FASB issued ASU 2018-11, "Leases (Topic 842): Targeted Improvements." This new ASU introduces an additional transition method which allows entities to apply the new standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. In March 2019, the FASB issued ASU 2019-01, "Leases (Topic 842): Codification Improvements," which is intended to clarify Codification guidance. We adopted this guidance, as required, in the first quarter of 2019, which did not have a material impact on our consolidated financial statements. We elected the package of practical expedients under the transition guidance within this standard, which allowed us to carry forward the classifications of each of our existing leases as operating leases. In connection with the adoption of this guidance, at March 31, 2019, our lease liability was $13 million, which represented the present value of our remaining lease payments discounted at our incremental borrowing rate and was recorded in Accrued expenses and other liabilities on our consolidated balance sheets. At March 31, 2019, our right-of-use asset was $12 million, which was equal to the lease liability adjusted for our deferred rent liability at adoption and was recorded in Other assets on our consolidated balance sheets. We will continue to record lease expense on a straight-line basis and have included required lease disclosures within Note 16.
Other Recent Accounting Pronouncements
In August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement." This new guidance amends previous guidance by removing and modifying certain existing fair value disclosure requirements, while adding other new disclosure requirements. This new guidance is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted and entities may elect to early adopt the removal or modification of disclosures immediately and delay adoption of the new disclosure requirements until their effective date. We plan to adopt this new guidance by the required date and do not anticipate that this update will have a material impact on our consolidated financial statements.
In July 2018, the FASB issued ASU 2018-09, "Codification Improvements." This new guidance is intended to clarify, correct, and make minor improvements to the FASB Accounting Standards Codification. The transition and effective dates are based on the facts and circumstances of each amendment, with some amendments becoming effective upon issuance of this ASU and others becoming effective for annual periods beginning after December 15, 2018. We plan to adopt this new guidance by the required date and do not anticipate that this update will have a material impact on our consolidated financial statements.
In 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. We currently have only a small balance of loans receivable that are not carried at fair value and would be subject to this new guidance for allowance for credit losses. Separately, we account for our available-for-sale securities under the other-than-temporary impairment ("OTTI") model for debt securities. This new guidance requires that credit impairments on our available-for-sale securities be recorded in earnings using an allowance for credit losses, with the allowance limited to the amount by which the security's fair value is less than its amortized cost basis. Subsequent reversals in credit loss estimates are recognized in income. We plan to adopt this new guidance by the required date and do not anticipate that these updates will have a material impact on our consolidated financial statements as nearly all of our financial instruments are carried at fair value and changes in fair values of these instruments are recorded on our consolidated statements of income in the period in which the valuation change occurs. We will continue evaluating these new standards and caution that any changes in our business or additional amendments to these standards could change our initial assessment.

14


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)

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

Balance Sheet Netting
Certain of our derivatives and short-term debt are subject to master netting arrangements or similar agreements. Under GAAP, in certain circumstances we may elect to present certain financial assets, liabilities and related collateral subject to master netting arrangements in a net position on our consolidated balance sheets. However, we do not report any of these financial assets or liabilities on a net basis, and instead present them on a gross basis on our consolidated balance sheets.
The table below presents financial assets and liabilities that are subject to master netting arrangements or similar agreements categorized by financial instrument, together with corresponding financial instruments and corresponding collateral received or pledged at March 31, 2019 and December 31, 2018.
Table 3.1 – Offsetting of Financial Assets, Liabilities, and Collateral
 
 
Gross Amounts of Recognized Assets (Liabilities)
 
Gross Amounts Offset in Consolidated Balance Sheet
 
Net Amounts of Assets (Liabilities) Presented in Consolidated Balance Sheet
 
Gross Amounts Not Offset in Consolidated
Balance Sheet
(1)
 
Net Amount
March 31, 2019
(In Thousands)
 
 
 
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Assets (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
11,490

 
$

 
$
11,490

 
$
(11,490
)
 
$

 
$

TBAs
 
5,826

 

 
5,826

 
(5,755
)
 

 
71

Total Assets
 
$
17,316

 
$

 
$
17,316

 
$
(17,245
)
 
$

 
$
71

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
(100,561
)
 
$

 
$
(100,561
)
 
$
11,490

 
$
89,071

 
$

TBAs
 
(9,609
)
 

 
(9,609
)
 
5,755

 
2,166

 
(1,688
)
Loan warehouse debt
 
(526,341
)
 

 
(526,341
)
 
526,341

 

 

Security repurchase agreements
 
(1,081,079
)
 

 
(1,081,079
)
 
1,081,079

 

 

Total Liabilities
 
$
(1,717,590
)
 
$

 
$
(1,717,590
)
 
$
1,624,665

 
$
91,237

 
$
(1,688
)

15


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)

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

 
 
Gross Amounts of Recognized Assets (Liabilities)
 
Gross Amounts Offset in Consolidated Balance Sheet
 
Net Amounts of Assets (Liabilities) Presented in Consolidated Balance Sheet
 
Gross Amounts Not Offset in Consolidated
Balance Sheet
(1)
 
Net Amount
December 31, 2018
(In Thousands)
 
 
 
 
Financial Instruments
 
Cash Collateral (Received) Pledged
 
Assets (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
28,211

 
$

 
$
28,211

 
$
(28,211
)
 
$

 
$

TBAs
 
4,665

 

 
4,665

 
(3,391
)
 
(835
)
 
439

Total Assets
 
$
32,876

 
$

 
$
32,876

 
$
(31,602
)
 
$
(835
)
 
$
439

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities (2)
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate agreements
 
$
(70,908
)
 
$

 
$
(70,908
)
 
$
28,211

 
$
42,697

 
$

TBAs
 
(13,215
)
 

 
(13,215
)
 
3,391

 
5,620

 
(4,204
)
Loan warehouse debt
 
(860,650
)
 

 
(860,650
)
 
860,650

 

 

Security repurchase agreements
 
(988,890
)
 

 
(988,890
)
 
988,890

 

 

Total Liabilities
 
$
(1,933,663
)
 
$

 
$
(1,933,663
)
 
$
1,881,142

 
$
48,317

 
$
(4,204
)
(1)
Amounts presented in these columns are limited in total to the net amount of assets or liabilities presented in the prior column by instrument. In certain cases, there is excess cash collateral or financial assets we have pledged to a counterparty (which may, in certain circumstances, be a clearinghouse) that exceed the financial liabilities subject to a master netting arrangement or similar agreement. Additionally, in certain cases, counterparties may have pledged excess cash collateral to us that exceeds our corresponding financial assets. In each case, any of these excess amounts are excluded from the table although they are separately reported in our consolidated balance sheets as assets or liabilities, respectively.
(2)
Interest rate agreements and TBAs are components of derivatives instruments on our consolidated balance sheets. Loan warehouse debt, which is secured by residential mortgage loans, and security repurchase agreements are components of Short-term debt on our consolidated balance sheets.
For each category of financial instrument set forth in the table above, the assets and liabilities resulting from individual transactions within that category between us and a counterparty are subject to a master netting arrangement or similar agreement with that counterparty that provides for individual transactions to be aggregated and treated as a single transaction. For certain categories of these instruments, some of our transactions are cleared and settled through one or more clearinghouses that are substituted as our counterparty. References herein to master netting arrangements or similar agreements include the arrangements and agreements governing the clearing and settlement of these transactions through the clearinghouses. In the event of the termination and close-out of any of those transactions, the corresponding master netting agreement or similar agreement provides for settlement on a net basis. Any such settlement would include the proceeds of the liquidation of any corresponding collateral, subject to certain limitations on termination, settlement, and liquidation of collateral that may apply in the event of the bankruptcy or insolvency of a party. Such limitations should not inhibit the eventual practical realization of the principal benefits of those transactions or the corresponding master netting arrangement or similar agreement and any corresponding collateral.
Note 4. Principles of Consolidation
GAAP requires us to consider whether securitizations we sponsor and other transfers of financial assets should be treated as sales or financings, as well as whether any VIEs that we hold variable interests in – for example, certain legal entities often used in securitization and other structured finance transactions – should be included in our consolidated financial statements. The GAAP principles we apply require us to reassess our requirement to consolidate VIEs each quarter and therefore our determination may change based upon new facts and circumstances pertaining to each VIE. This could result in a material impact to our consolidated financial statements during subsequent reporting periods.

16


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)

Note 4. Principles of Consolidation - (continued)


Analysis of Consolidated VIEs
At March 31, 2019, we consolidated our Legacy Sequoia and Sequoia Choice securitization entities that we determined were VIEs and for which we determined we were the primary beneficiary. Additionally, beginning in the second half of 2018, we consolidated certain third-party Freddie Mac K-Series securitization entities and the Freddie Mac SLST securitization entity that we determined were VIEs and for which we determined we were the primary beneficiary. Each of these entities is independent of Redwood and of each other and the assets and liabilities of these entities are not owned by and are not legal obligations of ours. Our exposure to these entities is primarily through the financial interests we have retained, although for the consolidated Sequoia entities we are exposed to certain financial risks associated with our role as a sponsor, servicing administrator, or depositor of these entities or as a result of our having sold assets directly or indirectly to these entities. At March 31, 2019, the estimated fair value of our investments in the consolidated Legacy Sequoia, Sequoia Choice, Freddie Mac SLST and Freddie Mac K-Series entities was $11 million, $218 million, $236 million, and $129 million, respectively.
Beginning in the fourth quarter of 2018, we consolidated two Servicing Investment entities formed to invest in servicing-related assets that we determined were VIEs and for which we determined we were the primary beneficiary. At March 31, 2019, we held an 80% ownership interest in, and were responsible for the management of, each entity. See Note 10 for a further description of these entities and the investments they hold and Note 12 for additional information on the minority partner’s interest. Additionally, beginning in the fourth quarter of 2018, we consolidated an entity that was formed to finance servicing 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 servicing 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 March 31, 2019, the estimated fair value of our investment in the Servicing Investment entities was $66 million.
The following table presents a summary of the assets and liabilities of these VIEs.
Table 4.1 – Assets and Liabilities of Consolidated VIEs
March 31, 2019
 
Legacy
Sequoia
 
Sequoia
Choice
 
Freddie Mac SLST
 
Freddie Mac
K-Series
 
Servicing Investment
 
Total
Consolidated
VIEs
(Dollars in Thousands)
 
 
 
 
 
 
Residential loans, held-for-investment
 
$
488,645

 
$
2,333,248

 
$
1,228,317

 
$

 
$

 
$
4,050,210

Multifamily loans, held-for-investment
 

 

 

 
2,175,899

 

 
2,175,899

Other investments
 

 

 

 

 
318,677

 
318,677

Cash and cash equivalents
 

 

 

 

 
11,375

 
11,375

Restricted cash
 
146

 
14

 

 

 
3,189

 
3,349

Accrued interest receivable
 
776

 
9,616

 
3,861

 
6,587

 
3,251

 
24,091

REO
 
2,280

 

 

 

 

 
2,280

Total Assets
 
$
491,847

 
$
2,342,878

 
$
1,232,178

 
$
2,182,486

 
$
336,492

 
$
6,585,881

Short-term debt
 
$

 
$

 
$

 
$

 
$
249,557

 
$
249,557

Accrued interest payable
 
531

 
7,854

 
2,846

 
6,230

 
403

 
17,864

Accrued expenses and other liabilities
 

 
14

 

 

 
20,598

 
20,612

Asset-backed securities issued
 
479,999

 
2,117,356

 
993,032

 
2,047,257

 

 
5,637,644

Total Liabilities
 
$
480,530

 
$
2,125,224

 
$
995,878

 
$
2,053,487

 
$
270,558

 
$
5,925,677

 
 
 
 
 
 
 
 
 
 
 
 
 
Number of VIEs
 
20

 
7

 
1

 
3

 
3

 
34


17


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)

Note 4. Principles of Consolidation - (continued)


December 31, 2018
 
Legacy
Sequoia
 
Sequoia
Choice
 
Freddie Mac SLST
 
Freddie Mac
K-Series
 
Servicing Investment
 
Total
Consolidated
VIEs
(Dollars in Thousands)
 
 
 
 
 
 
Residential loans, held-for-investment
 
$
519,958

 
$
2,079,382

 
$
1,222,669

 
$

 
$

 
$
3,822,009

Multifamily loans, held-for-investment
 

 

 

 
2,144,598

 

 
2,144,598

Other investments
 

 

 

 

 
312,688

 
312,688

Restricted cash
 
146

 
1,022

 

 

 
25,363

 
26,531

Accrued interest receivable
 
822

 
8,988

 
3,926

 
6,595

 
1,091

 
21,422

REO
 
3,943

 

 

 

 

 
3,943

Total Assets
 
$
524,869

 
$
2,089,392

 
$
1,226,595

 
$
2,151,193

 
$
339,142

 
$
6,331,191

Short-term debt
 
$

 
$

 
$

 
$

 
$
262,740

 
$
262,740

Accrued interest payable
 
571

 
7,180

 
2,907

 
6,239

 
483

 
17,380

Accrued expenses and other liabilities
 

 
1,022

 

 

 
18,592

 
19,614

Asset-backed securities issued
 
512,240

 
1,885,010

 
993,748

 
2,019,075

 

 
5,410,073

Total Liabilities
 
$
512,811

 
$
1,893,212

 
$
996,655

 
$
2,025,314

 
$
281,815

 
$
5,709,807

 
 
 
 
 
 
 
 
 
 
 
 
 
Number of VIEs
 
20

 
6

 
1

 
3

 
3

 
33

We consolidate the assets and liabilities of certain Sequoia securitization entities, as we did not meet the GAAP sale criteria at the time we transferred financial assets to these entities. Our involvement in consolidated Sequoia entities continues in the following ways: (i) we continue to hold subordinate investments in each entity, and for certain entities, more senior investments; (ii) we maintain certain discretionary rights associated with our sponsorship of, or our subordinate investments in, each entity; and (iii) we continue to hold a right to call the assets of certain entities (once they have been paid down below a specified threshold) at a price equal to, or in excess of, the current outstanding principal amount of the entity’s asset-backed securities issued. These factors have resulted in our continuing to consolidate the assets and liabilities of these Sequoia entities in accordance with GAAP.
We consolidate the assets and liabilities of certain Freddie Mac K-Series securitization trusts and a Freddie Mac SLST securitization trust resulting from our investment in subordinate securities issued by these trusts. Additionally, we consolidate the assets and liabilities of Servicing Investment entities from our investment in servicer advance investments and excess MSRs. In each case, we maintain certain discretionary rights associated with the ownership of these investments that we determined reflected a controlling financial interest, as we have both the power to direct the activities that most significantly impact the economic performance of the VIEs and the right to receive benefits of and the obligation to absorb losses from the VIEs that could potentially be significant to the VIEs.
Analysis of Unconsolidated VIEs with Continuing Involvement
Since 2012, we have transferred residential loans to 44 Sequoia securitization entities sponsored by us that are still outstanding as of March 31, 2019, and accounted for these transfers as sales for financial reporting purposes, in accordance with ASC 860. We also determined we were not the primary beneficiary of these VIEs as we lacked the power to direct the activities that will have the most significant economic impact on the entities. For certain of these transfers to securitization entities, for the transferred loans where we held the servicing rights prior to the transfer and continued to hold the servicing rights following the transfer, we recorded mortgage servicing rights ("MSRs") on our consolidated balance sheets, and classified those MSRs as Level 3 assets. We also retained senior and subordinate securities in these securitizations that we classified as Level 3 assets. Our continuing involvement in these securitizations is limited to customary servicing obligations associated with retaining servicing rights (which we retain a third-party sub-servicer to perform) and the receipt of interest income associated with the securities we retained.
During the three months ended March 31, 2019, the master servicer for one of our unconsolidated Sequoia entities exercised their right to call the securitization and paid off the underlying securities. We realized a $4 million gain related to the called securities, which was recognized through Realized gains, net on our consolidated statements of income. In connection with this called securitization, Redwood acquired $39 million of residential real estate loans that are held in both our held-for-sale and held-for-investment portfolios at Redwood at March 31, 2019.

18


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)

Note 4. Principles of Consolidation - (continued)


The following table presents information related to securitization transactions that occurred during the three months ended March 31, 2019 and 2018.
Table 4.2 – Securitization Activity Related to Unconsolidated VIEs Sponsored by Redwood
 
 
Three Months Ended March 31,
(In Thousands)
 
2019
 
2018
Principal balance of loans transferred
 
$
348,257

 
$
1,280,468

Trading securities retained, at fair value
 
1,716

 
12,491

AFS securities retained, at fair value
 
885

 
3,905

The following table summarizes the cash flows during the three months ended March 31, 2019 and 2018 between us and the unconsolidated VIEs sponsored by us and accounted for as sales since 2012.
Table 4.3 – Cash Flows Related to Unconsolidated VIEs Sponsored by Redwood
 
 
Three Months Ended March 31,
(In Thousands)
 
2019
 
2018
Proceeds from new transfers
 
$
352,371

 
$
1,289,687

MSR fees received
 
3,060

 
3,414

Funding of compensating interest, net
 
(90
)
 
(25
)
Cash flows received on retained securities
 
7,546

 
7,043

The following table presents the key weighted-average assumptions used to measure MSRs and securities retained at the date of securitization for securitizations completed during the three months ended March 31, 2019 and 2018.
Table 4.4 – Assumptions Related to Assets Retained from Unconsolidated VIEs Sponsored by Redwood

 
 
Three Months Ended March 31, 2019
 
Three Months Ended March 31, 2018
At Date of Securitization
 
Senior IO Securities
 
Subordinate Securities
 
Senior IO Securities
 
Subordinate Securities
Prepayment rates
 
16
%
 
14
%
 
8
%
 
10
%
Discount rates
 
14
%
 
8
%
 
14
%
 
7
%
Credit loss assumptions
 
0.20
%
 
0.20
%
 
0.20
%
 
0.20
%

19


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)

Note 4. Principles of Consolidation - (continued)


The following table presents additional information at March 31, 2019 and December 31, 2018, related to unconsolidated VIEs sponsored by Redwood and accounted for as sales since 2012.
Table 4.5 – Unconsolidated VIEs Sponsored by Redwood
(In Thousands)
 
March 31, 2019
 
December 31, 2018
On-balance sheet assets, at fair value:
 
 
 
 
Interest-only, senior and subordinate securities, classified as trading
 
$
128,273

 
$
129,111

Subordinate securities, classified as AFS
 
150,630

 
162,314

Mortgage servicing rights
 
53,657

 
58,572

Maximum loss exposure (1)
 
$
332,560

 
$
349,997

Assets transferred:
 
 
 
 
Principal balance of loans outstanding
 
$
10,632,174

 
$
10,580,216

Principal balance of loans 30+ days delinquent
 
27,229

 
21,805

(1)
Maximum loss exposure from our involvement with unconsolidated VIEs pertains to the carrying value of our securities and MSRs retained from these VIEs and represents estimated losses that would be incurred under severe, hypothetical circumstances, such as if the value of our interests and any associated collateral declines to zero. This does not include, for example, any potential exposure to representation and warranty claims associated with our initial transfer of loans into a securitization.
The following table presents key economic assumptions for assets retained from unconsolidated VIEs and the sensitivity of their fair values to immediate adverse changes in those assumptions at March 31, 2019 and December 31, 2018.
Table 4.6 – Key Assumptions and Sensitivity Analysis for Assets Retained from Unconsolidated VIEs Sponsored by Redwood
March 31, 2019
 
MSRs
 
Senior
Securities (1)
 
Subordinate Securities
(Dollars in Thousands)
 
 
 
Fair value at March 31, 2019
 
$
53,657

 
$
57,536

 
$
221,367

Expected life (in years) (2)
 
8

 
7

 
15

Prepayment speed assumption (annual CPR) (2)
 
8
%
 
10
%
 
8
%
Decrease in fair value from:
 
 
 
 
 
 
10% adverse change
 
$
1,749

 
$
1,951

 
$
92

25% adverse change
 
4,199

 
4,924

 
927

Discount rate assumption (2)
 
11
%
 
12
%
 
5
%
Decrease in fair value from:
 
 
 
 
 
 
100 basis point increase
 
$
2,092

 
$
1,783

 
$
22,094

200 basis point increase
 
4,036

 
3,629

 
40,797

Credit loss assumption (2)
 
N/A

 
0.20
%
 
0.20
%
Decrease in fair value from:
 
 
 
 
 
 
10% higher losses
 
N/A

 
$

 
$
1,504

25% higher losses
 
N/A

 

 
3,754


20


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)

Note 4. Principles of Consolidation - (continued)


December 31, 2018
 
MSRs
 
Senior
Securities (1)
 
Subordinate Securities
(Dollars in Thousands)
 
 
 
Fair value at December 31, 2018
 
$
58,572

 
$
61,178

 
$
230,247

Expected life (in years) (2)
 
8

 
7

 
15

Prepayment speed assumption (annual CPR) (2)
 
7
%
 
10
%
 
9
%
Decrease in fair value from:
 
 
 
 
 
 
10% adverse change
 
$
1,668

 
$
2,151

 
$
201

25% adverse change
 
4,027

 
5,127

 
1,372

Discount rate assumption (2)
 
11
%
 
12
%
 
6
%
Decrease in fair value from:
 
 
 
 
 
 
100 basis point increase
 
$
2,323

 
$
2,190

 
$
21,982

200 basis point increase
 
4,493

 
4,226

 
40,641

Credit loss assumption (2)
 
N/A

 
0.20
%
 
0.20
%
Decrease in fair value from:
 
 
 
 
 
 
10% higher losses
 
N/A

 
$

 
$
1,387

25% higher losses
 
N/A

 

 
3,471


(1)
Senior securities included $58 million and $61 million of interest-only securities at March 31, 2019 and December 31, 2018, respectively.
(2)
Expected life, prepayment speed assumption, discount rate assumption, and credit loss assumption presented in the tables above represent weighted averages.
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 March 31, 2019 and December 31, 2018, grouped by asset type.
Table 4.7 – Third-Party Sponsored VIE Summary
(In Thousands)
 
March 31, 2019
 
December 31, 2018
Mortgage-Backed Securities
 
 
 
 
Senior
 
$
173,102

 
$
185,107

Mezzanine
 
664,496

 
547,249

Subordinate
 
426,651

 
428,713

Total Mortgage-Backed Securities
 
1,264,249

 
1,161,069

Excess MSR
 
14,234

 
15,092

Total Investments in Third-Party Sponsored VIEs
 
$
1,278,483

 
$
1,176,161

We determined that we are not the primary beneficiary of these third-party VIEs, as we do not have the required power to direct the activities that most significantly impact the economic performance of these entities. Specifically, we do not service or manage these entities or otherwise solely hold decision making powers that are significant. As a result of this assessment, we do not consolidate any of the underlying assets and liabilities of these third-party VIEs – we only account for our specific interests in them.
Our assessments of whether we are required to consolidate a VIE may change in subsequent reporting periods based upon changing facts and circumstances pertaining to each VIE. Any related accounting changes could result in a material impact to our financial statements.

21


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(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.


22


REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2019
(Unaudited)

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


The following table presents the carrying values and estimated fair values of assets and liabilities that are required to be recorded or disclosed at fair value at March 31, 2019 and December 31, 2018.

Table 5.1 – Carrying Values and Fair Values of Assets and Liabilities
 
 
March 31, 2019
 
December 31, 2018
 
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
(In Thousands)
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Residential loans, held-for-sale
 
 
 
 
 
 
 
 
At fair value
 
$
819,111

 
$
819,111

 
$
1,048,690

 
$
1,048,690

At lower of cost or fair value
 
110

 
130

 
111

 
131

Residential loans, held-for-investment
 
6,455,080

 
6,455,080

 
6,205,941

 
6,205,941

Business purpose residential loans
 
160,612

 
160,612

 
141,258

 
141,258

Multifamily loans
 
2,175,899

 
2,175,899

 
2,144,598

 
2,144,598

Trading securities
 
1,255,224

 
1,255,224

 
1,118,612

 
1,118,612

Available-for-sale securities
 
287,928

 
287,928

 
333,882

 
333,882

Servicer advance investments (1)
 
303,920

 
303,920

 
300,468

 
300,468

MSRs (1)
 
55,284

 
55,284

 
60,281

 
60,281

Participation in loan warehouse facility (1)
 

 

 
39,703

 
39,703

Excess MSRs (1)
 
28,992

 
28,992

 
27,312

 
27,312

Cash and cash equivalents
 
200,837

 
200,837

 
175,764

 
175,764

Restricted cash
 
14,614

 
14,614

 
29,313

 
29,313

Accrued interest receivable
 
48,972

 
48,972

 
47,105

 
47,105

Derivative assets
 
22,283

 
22,283

 
35,789

 
35,789

REO (2)
 
7,275

 
7,531

 
3,943

 
4,396

Margin receivable (2)
 
154,549

 
154,549

 
100,773

 
100,773

FHLBC stock (2)
 
43,393

 
43,393

 
43,393

 
43,393

Guarantee asset (2)
 
2,342

 
2,342

 
2,618

 
2,618

Pledged collateral (2)
 
42,631

 
42,631

 
42,433

 
42,433

Liabilities
 
 
 
 
 
 
 
 
Short-term debt facilities
 
$
1,713,749

 
$
1,713,749

 
$
1,937,920

 
$
1,937,920

Short-term debt - servicer advance financing
 
249,557

 
249,557

 
262,740

 
262,740

Accrued interest payable
 
39,526

 
39,526

 
42,528

 
42,528

Margin payable (3)
 
19

 
19

 
835

 
835

Guarantee obligation (3)
 
16,359

 
16,210

 
16,711

 
16,774

Contingent consideration (3)
 
24,621

 
24,621

 

 

Derivative liabilities
 
110,942

 
110,942

 
84,855

 
84,855