REDWOOD TRUST, INC. INTRODUCTION
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") is intended to provide a reader of our financial statements
with a narrative from the perspective of our management on our financial
condition, results of operations, liquidity and certain other factors that may
affect our future results. Our MD&A is presented in six main sections:
• Overview
• Results of Operations
- Consolidated Results of Operations
- Results of Operations by Segment
- Investments Detail
- Income Taxes
• Liquidity and Capital Resources
• Off-Balance Sheet Arrangements and Contractual Obligations
• Critical Accounting Policies and Estimates
• New Accounting Standards
Our MD&A should be read in conjunction with the Consolidated Financial
Statements and related Notes included in Part I, Item 1 of this Quarterly Report
on Form 10-Q and in Part II, Item 8, Financial Statements and Supplementary Data
in our most recent Annual Report on Form 10-K, as well as the sections entitled
"Risk Factors" in Part I, Item 1A of our most recent Annual Report on Form 10-K
and Part II, Item 1A of this Quarterly Report on Form 10-Q, as well as other
cautionary statements and risks described elsewhere in this report and our most
recent Annual Report on Form 10-K. The discussion in this MD&A contains
forward-looking statements that involve substantial risks and uncertainties. Our
actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors, such as those
discussed in the Cautionary Statement below.
References herein to "Redwood," the "company," "we," "us," and "our" include
Redwood Trust, Inc. and its consolidated subsidiaries, unless the context
otherwise requires. Financial information concerning our business is set forth
in this "Management's Discussion and Analysis of Financial Condition and Results
of Operations," and our consolidated financial statements and notes thereto,
which are included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Our website can be found at www.redwoodtrust.com. We make available, free of
charge through the investor information section of our website, access to our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the U.S. Securities Exchange Act of 1934, as well as proxy
statements, as soon as reasonably practicable after we electronically file such
material with, or furnish it to, the U.S. Securities and Exchange Commission
("SEC"). We also make available, free of charge, access to our charters for our
Audit Committee, Compensation Committee, and Governance and Nominating
Committee , our Corporate Governance Standards, and our Code of Ethics governing
our directors, officers, and employees. Within the time period required by the
SEC and the New York Stock Exchange , we will post on our website any amendment
to the Code of Ethics and any waiver applicable to any executive officer or
director of Redwood. In addition, our website includes information concerning
purchases and sales of our equity securities by our executive officers and
directors, and may include disclosure relating to certain non-GAAP financial
measures (as defined in the SEC's Regulation G) that we may make public orally,
telephonically, by webcast, by broadcast, or by similar means from time to time.
The information on our website is not part of this Quarterly Report on Form
10-Q.
Our Investor Relations Department can be contacted at One Belvedere Place , Suite
300, Mill Valley, CA 94941, Attn: Investor Relations, telephone (866) 269-4976.
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Our BusinessRedwood Trust, Inc. , together with its subsidiaries, is a specialty finance company focused on several distinct areas of housing credit. Our operating platforms occupy a unique position in the housing finance value chain, providing liquidity to growing segments of theU.S. housing market not served by government programs. We deliver customized housing credit investments to a diverse mix of investors through our best-in-class securitization platforms, whole-loan distribution activities and our publicly-traded shares. Our consolidated investment portfolio has evolved to incorporate a diverse mix of residential, business purpose and multifamily investments. Our goal is to provide attractive returns to shareholders through a stable and growing stream of earnings and dividends, capital appreciation, and a commitment to technological innovation that facilitates risk-minded scale. We operate our business in three segments: Residential Lending, Business Purpose Lending, and Third-Party Investments. For a full description of our segments, see Part 1, Item 1-Business in our Annual Report on Form 10-K for the year endedDecember 31, 2020 . Cautionary Statement This Quarterly Report on Form 10-Q and the documents incorporated by reference herein contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve numerous risks and uncertainties. Our actual results may differ from our beliefs, expectations, estimates, and projections and, consequently, you should not rely on these forward-looking statements as predictions of future events. Forward-looking statements are not historical in nature and can be identified by words such as "anticipate," "estimate," "will," "should," "expect," "believe," "intend," "seek," "plan" and similar expressions or their negative forms, or by references to strategy, plans, or intentions. These forward-looking statements are subject to risks and uncertainties, including, among other things, those described in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2020 , under the caption "Risk Factors." Other risks, uncertainties, and factors that could cause actual results to differ materially from those projected may be described from time to time in reports we file with theSEC , including reports on Forms 10-Q and 8-K. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Statements regarding the following subjects, among others, are forward-looking by their nature: (i) statements we make regarding Redwood's business strategy and strategic focus, including statements relating to our overall market position, strategy and long-term prospects (including trends driving the flow of capital in the housing finance market, our strategic initiatives designed to capitalize on those trends, our ability to attract capital to finance those initiatives, our approach to raising capital, our ability to pay dividends in the future, and the prospects for federal housing finance reform); (ii) statements related to our financial outlook and expectations for 2021 and future years; (iii) statements related to our opportunities for growth, including by continuing to creatively expand distribution channels for our loans products; (iv) statements related to our investment portfolio, including that there remains potential upside in our portfolio through a combination of accretable market discount and call rights that we control, and that we reinitiated our flow purchase arrangement with Point, providing us with continuing HEI acquisition and securitization opportunities; (v) statements related to our residential and business purpose lending platforms, including that we expect CoreVest to continue to consider issuing bridge loan securitizations in conjunction with our traditional SFR loan securitizations; (vi) statements relating to our estimate of our available capital (including that we estimate our available capital atSeptember 30, 2021 was approximately$350 million ); (vii) statements relating to acquiring residential mortgage loans in the future that we have identified for purchase or plan to purchase, including the amount of such loans that we identified for purchase during the third quarter of 2021 and atSeptember 30, 2021 , and expected fallout and the corresponding volume of residential mortgage loans expected to be available for purchase; (viii) statements we make regarding future dividends, including with respect to our regular quarterly dividends in 2021; and (ix) statements regarding our expectations and estimates relating to the characterization for income tax purposes of our dividend distributions, our expectations and estimates relating to tax accounting, tax liabilities and tax savings, and GAAP tax provisions, and our estimates of REIT taxable income and TRS taxable income. Many of the factors that could affect our actual results are summarized below. One of the most significant factors, however, is the ongoing impact of the pandemic onthe United States economy, homeowners, renters of housing, the housing market, the mortgage finance markets and the broader financial markets. It is difficult to fully assess the impact of the pandemic at this time, including because of the uncertainty around the severity and duration of the pandemic domestically and internationally, as well as the uncertainty around the efficacy of Federal, State and local governments' efforts to contain the spread of COVID-19 and respond to its direct and indirect impacts on many aspects of Americans' lives and economic activity. Moreover, each of the factors summarized below is likely to also be impacted directly or indirectly by the ongoing impact of the pandemic and investors are cautioned to interpret substantially all of the risks identified in the Company's previously published "Risk Factors" as being heightened as a result of the ongoing impact of the pandemic. Important factors, among others, that may affect our actual results include: •the impact of the COVID-19 pandemic; 76
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•general economic trends and the performance of the housing, real estate, mortgage finance, and broader financial markets; •federal and state legislative and regulatory developments and the actions of governmental authorities and entities; •changing benchmark interest rates, and theFederal Reserve's actions and statements regarding monetary policy; •our ability to compete successfully; •our ability to adapt our business model and strategies to changing circumstances; •strategic business and capital deployment decisions we make; •our use of financial leverage; •our exposure to a breach of our cybersecurity or data security; •our exposure to credit risk and the timing of credit losses within our portfolio; •the concentration of the credit risks we are exposed to, including due to the structure of assets we hold, the geographical concentration of real estate underlying assets we own, and our exposure to environmental and climate-related risks; •the efficacy and expense of our efforts to manage or hedge credit risk, interest rate risk, and other financial and operational risks; •changes in credit ratings on assets we own and changes in the rating agencies' credit rating methodologies; •changes in mortgage prepayment rates; •changes in interest rates; •our ability to redeploy our available capital into new investments; •interest rate volatility, changes in credit spreads, and changes in liquidity in the market for real estate securities and loans; •our ability to finance the acquisition of real estate-related assets with short-term debt; •changes in the values of assets we own; •the ability of counterparties to satisfy their obligations to us; •our exposure to the discontinuation of LIBOR; •our exposure to liquidity risk, risks associated with the use of leverage, and market risks; •changes in the demand from investors for residential and business purpose mortgages and investments, and our ability to distribute residential and business purpose mortgages through our whole-loan distribution channel; •our involvement in securitization transactions, the profitability of those transactions, and the risks we are exposed to in engaging in securitization transactions; •exposure to claims and litigation, including litigation arising from our involvement in loan origination and securitization transactions; •whether we have sufficient liquid assets to meet short-term needs; •our ability to successfully retain or attract key personnel; •changes in our investment, financing, and hedging strategies and new risks we may be exposed to if we expand our business activities; •our exposure to a disruption of our technology infrastructure and systems; •the impact on our reputation that could result from our actions or omissions or from those of others; •our failure to maintain appropriate internal controls over financial reporting and disclosure controls and procedures; •the termination of our captive insurance subsidiary's membership in theFederal Home Loan Bank and the implications for our income generating abilities; •the impact of changes toU.S. federal income tax laws on theU.S. housing market, mortgage finance markets, and our business; •our failure to comply with applicable laws and regulation, including our ability to obtain or maintain the governmental licenses; •our ability to maintain our status as a REIT for tax purposes; •limitations imposed on our business due to our REIT status and our status as exempt from registration under the Investment Company Act of 1940; •our common stock may experience price declines, volatility, and poor liquidity, and we may reduce our dividends in a variety of circumstances; •decisions about raising, managing, and distributing capital; •our exposure to broad market fluctuations; and •other factors not presently identified. This Quarterly Report on Form 10-Q may contain statistics and other data that in some cases have been obtained from or compiled from information made available by servicers and other third-party service providers. 77
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OVERVIEW
Business Update During the third quarter, we hosted Redwood's third annual Investor Day. During our event we affirmed our commitment to our corporate mission to make quality housing, whether rented or owned, accessible to all American households, and discussed the Company's vision of being the leading operator and strategic capital provider driving sustainable innovation in housing finance. We have significantly broadened our business within the housing market over the past several years. This includes expanding our mortgage banking platform and investment portfolio beyond the jumbo residential mortgage space, while maintaining the core competencies of the firm around our expertise in residential housing credit. Our expansion includes our acquisition of CoreVest in 2019 - which has now been part of our platform for two years - and investments in several other areas of housing finance. More recently, our approach to capital deployment has continued to evolve. Our progress this year growing our RWT Horizons initiative - investing in advanced technologies with the potential to transform our businesses - reflects an important step in that process. While our capital remains predominantly allocated to our operating businesses and investment portfolio, RWT Horizons reflects our belief in the strategic importance of innovation and partnership in driving profitable scale. Our strategic vision is based upon the vast addressable market we see in front of us, driven by macroeconomic and market forces that have made liquidity sourced from the private markets essential for a robust housing finance system, for both consumers and investors alike. The recent modest increase in benchmark rates belies a lack of yield in the market that - but for some brief and notable intervals - has been persistent for over a decade. Taken together, this puts a premium on enterprises that can directly access markets efficiently and with discipline. We believe that these competencies, coupled with capital optimization and efficiency gains, will drive our financial results, and continuing to creatively expand distribution channels for mortgage loans we originate or acquire will be an important part of our evolution. Turning to the third quarter of 2021, after a successful first half of the year, our team continued its strong performance. CoreVest maintained its momentum, funding$639 million of loans for the quarter, including$239 million in September alone. Our third quarter results saw strong contributions from both our SFR and Bridge lending teams, and we made key progress in our correspondent loan business, including our strategic investment in Churchill. Meanwhile, the Residential business identified$4.7 billion of loans for purchase in the third quarter (locked loans, unadjusted for fallout). Notwithstanding that benchmark interest rates hit lows not seen since February, almost 60% of our residential loan locks during the third quarter were on purchase-money loans, which we believe is indicative of the quality of our pipeline and our sellers. Our investment portfolio remained in step with this operating progress, appreciating in value by approximately 2% during the third quarter of 2021. We believe there remains potential upside in our securities portfolio from a combination of accretable market discount and call rights that we control. These factors contributed to another strong quarter of financial results, with GAAP earnings of$0.65 per diluted share, a 27% annualized return on equity for the third quarter of 2021. Book value increased 4.7% in the third quarter to$12.00 per share, contributing to an overall year-to-date increase of 21%. We declared a third quarter dividend of$0.21 per share and have now earned a 27% economic return year to date, which represents growth in GAAP book value combined with dividends paid. Additionally, we executed a series of strategic and novel transactions across various disciplines within our firm that both positively contributed to earnings and provided indicators of our operating progress. Our Residential team completed a securitization leveraging blockchain technology for enhanced payment reporting for Sequoia investors. Historically, RMBS investors have needed to wait until well into the following month to see a month's worth of remittance details on underlying loans. Liquid Mortgage - an early portfolio company of RWT Horizons - has coordinated with our sub-servicer to publish daily remittance information on a public blockchain. We believe this implementation is just the first step in the application of this type of technology to our business. Next, we completed CoreVest's first securitization of bridge loans, which priced competitively against comparable transactions in the market. This new form of distribution provides a valuable capital management tool with a 30-month reinvestment feature. We expect CoreVest to continue to consider issuing bridge loan securitizations in conjunction with our traditional single-family rental ("SFR") loan securitizations, having recently priced the 19th overall CAFL securitization inOctober 2021 . 78
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Finally, we co-sponsored a securitization backed entirely by residential
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Third Quarter Overview The following table presents key financial metrics for the three and nine months endedSeptember 30, 2021 . Table 1 - Key Financial Metrics Three Months Ended Nine Months Ended (In Thousands, except per Share Data) September 30, 2021 September 30, 2021 Net income per diluted common share $ 0.65 $ 2.03 Annualized GAAP return on equity 26.7 % 29.6 % Dividends per share $ 0.21 $ 0.55 Book value per share $ 12.00 $ 12.00 Economic return on book value (1) 6.5 % 26.6 % (1)Economic return on book value is based on the periodic change in GAAP book value per common share plus dividends declared per common share during the period. •Our third quarter 2021 results reflect ongoing strength of our operating platforms with higher volumes and strong margins driving increased revenues, improved returns in our investment portfolio from more efficient financing, and a tax benefit realized during the quarter. These results, along with an increase in the value of our securities portfolio attributable to continued positive fundamental trends, contributed to a 4.7% increase in our book value per share during the quarter. •InSeptember 2021 , we announced a 17% increase in our quarterly dividend to$0.21 per share for the third quarter of 2021. •Our book value increased$0.54 per share to$12.00 per share during the third quarter of 2021, as basic earnings per share significantly exceeded our third quarter dividend of$0.21 per share. •Our business purpose lending platform funded$639 million of business purpose mortgage loans in the third quarter, including$394 million of single-family rental loans and$245 million of residential bridge loans. •During the third quarter of 2021, we locked a record$4.74 billion of jumbo loans with over 125 discrete sellers, jumbo loan purchase commitments were$3.29 billion , and we purchased$3.18 billion of residential jumbo loans. •During the third quarter of 2021, we securitized$1.03 billion of loans through three securitizations across Residential and Business Purpose Lending, and distributed$2.43 billion of jumbo loans through whole loan sales. •During the third quarter of 2021, we completed a securitization backed entirely by residential home equity investment contracts ("HEIs"), issuing approximately$146 million of securities through a transaction co-sponsored with Point Digital. •During the third quarter of 2021, we funded six venture investments through our RWT Horizons venture investment initiative. •During the third quarter of 2021, we added over$350 million of financing capacity to support growth of our operating platforms and completed a new$100 million non-marginable term financing collateralized by retained securities in our investment portfolio. •AtSeptember 30, 2021 , our unrestricted cash was$557 million , and our estimated available capital was$350 million . 80
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RESULTS OF OPERATIONS Within this Results of Operations section, we provide commentary that compares results year-over-year for 2021 and 2020. Most tables include a "change" column that shows the amount by which the results from 2021 are greater or less than the results from the respective period in 2020. Unless otherwise specified, references in this section to increases or decreases during the "three-month periods" refer to the change in results for the third quarter of 2021, compared to the third quarter of 2020, and increases or decreases in the "nine-month periods" refer to the change in results for the nine months of 2021, compared to the first nine months of 2020. Consolidated Results of Operations The following table presents the components of our net income for the three and nine months endedSeptember 30, 2021 and 2020.
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