REDWOOD TRUST : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

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
• 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 [phone].

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Our Business
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. For
a full description of our segments, see Note 23 of our Notes to Consolidated
Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.
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 ended December 31, 2017 and our Quarterly Report on Form
10-Q for the quarter ended March 31, 2020, in each case 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 the SEC, 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 in the housing
finance markets, 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 2020 and future years, including our
positioning to take advantage of a significant recovery in our business lines,
expectations with respect to activity in our Residential Lending segment and
strategic priorities for this segment, expectations with respect to activity in
our Business Purpose Lending segment, including with respect to investment
demand for our SFR and bridge loans, and our belief that asset valuations in our
investment portfolio possess significant upside to recover value from unrealized
losses incurred during the first quarter 2020; (iii) statements related to
repurchases of long-term debt or common equity; (iv) statements regarding our
expectations with respect to forbearance rates, loan performance for borrowers
exiting forbearance periods, and Redwood's servicing advance obligations,
including our estimate that for every 5 percentage point increase in the
principal balance of Sequoia securitized mortgage loans in a delinquent status
(whether or not subject to forbearance), our average monthly principal and
interest servicing advance funding obligation would increase by approximately $3
million; (v) statements we make regarding estimated costs and the range of
reasonably possible losses with respect to residential loan seller demands; (vi)
statements we make regarding future dividends, including with respect to our
regular quarterly dividends in 2020; and (vii) 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 on the 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 current outbreak of COVID-19 or the future outbreak of any
other highly infectious or contagious diseases on the U.S. and global economy,
financial markets, and our business and operations;
•the ability and willingness of residential mortgage loan borrowers that have
been negatively impacted by the pandemic to make payments of principal and
interest relating to their mortgage loans;
•liquidity risks from margin calls and potential breaches of the financial
covenants under our borrowing facilities;
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•changes to our interest rate hedging strategy and our revised approach to
addressing interest rate risk;
•the pace at which we redeploy our available capital into new investments and
initiatives;
•our ability to scale our platform and systems, particularly with respect to our
new initiatives;
•interest rate volatility, changes in credit spreads, and changes in liquidity
in the market for real estate securities and loans;
•changes in the demand from investors for residential mortgages and investments,
and our ability to distribute residential mortgages through our whole-loan
distribution channel;
•our ability to finance our investments in securities and our acquisition of
residential mortgages with short-term debt;
•changes in the values of assets we own;
•general economic trends, the performance of the housing, real estate, mortgage,
credit, and broader financial markets, and their effects on the prices of
earning assets and the credit status of borrowers;
•federal and state legislative and regulatory developments, and the actions of
governmental authorities, including the new U.S. presidential administration,
and in particular those affecting the mortgage industry or our business;
•state and/or local regulations related to rent control or rent stabilization
impacting single-family rental and multifamily properties;
•strategic business and capital deployment decisions we make;
•our recent acquisitions of business purpose lending origination platforms;
•developments related to the fixed income and mortgage finance markets and the
Federal Reserve's statements regarding its future open market activity and
monetary policy;
•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 and the geographical concentration of real estate
underlying assets we own;
•our exposure to adjustable-rate mortgage loans;
•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 interest rates; changes in mortgage prepayment rates;
•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;
•the ability of counterparties to satisfy their obligations to us;
•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 securitization transactions;
•ongoing litigation against various trustees of RMBS transactions;
•whether we have sufficient liquid assets to meet short-term needs;
•our ability to successfully compete and retain or attract key personnel;
•our ability to adapt our business model and strategies to changing
circumstances;
•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 or breach of the security of our technology
infrastructure and systems;
•exposure to environmental liabilities;
•our failure to comply with applicable laws and regulations;
•our failure to maintain appropriate internal controls over financial reporting
and disclosure controls and procedures;
•the impact on our reputation that could result from our actions or omissions or
from those of others;
•changes in accounting principles and tax rules;
•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;
•decisions about raising, managing, and distributing capital; 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.
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OVERVIEW

Business Update
The COVID-19 pandemic continued to impact financial markets and the economy in
the second quarter, and our country experienced a significant increase in
coronavirus cases during July. While the long-term impact of this crisis on
Redwood's business remains unclear, we made significant progress in response to
the collapse of liquidity that the non-government mortgage sector experienced in
March. We believe we are now positioned to take advantage of a significant
recovery in our business lines - which is currently underway. There is still
much to do, but we expect to look back on the second quarter of 2020 as one of
meaningful strengthening for the Company.
During the second quarter, we recast most of our secured recourse debt. In
aggregate, recourse debt declined from $4.6 billion at March 31, 2020 to $1.8
billion at June 30, 2020, reducing our recourse leverage ratio from 6.9x to
2.1x. Marginable debt, or that portion of recourse debt subject to daily,
market-value-based margin calls, represents only about 21% of our recourse debt,
or $375 million at June 30th. When comparing our $529 million of unrestricted
cash to our marginable debt at the end of the second quarter, our coverage ratio
was approximately 1.4:1, leaving us with ample room above a prudent risk capital
level to allocate significant capital to our operating businesses, new
investments and capital deployment opportunities.
Importantly, the evolution of our capital structure has been managed
organically, without raising dilutive equity capital. Not only did we not
require outside capital in the second quarter, we repurchased $125 million of
our convertible debt at discounted levels, generating $25 million of realized
gains. These repurchases also provide the benefit of reduced debt service costs
and leverage as we manage through the pandemic. We may continue to
opportunistically repurchase our long-term debt or common stock to the extent we
believe valuations remain significantly detached from fundamentals.
With our capital structure enhancements largely complete, we paid a second
quarter dividend of $0.125 per share on June 29, 2020. The second quarter
dividend aligned with the current size of our balance sheet and reflected a
sustainable level that we would hope to build upon as the economy and our
business cash flows stabilize. We remain committed to delivering an attractive
dividend to shareholders while remaining well positioned to opportunistically
deploy capital going forward.
When taking stock of the extreme market shocks brought about by COVID-19 and our
future forward earnings potential, we believe it is still premature to look too
far ahead, as the true impact to the U.S. economy and the mortgage industry is
yet to be seen. From a macroeconomic perspective, the recovery in financial
markets remains meaningfully detached from the continued, and in many areas
accelerating, health pandemic. Record job losses and the associated economic
contraction have significantly outpaced the Great Financial Crisis in both speed
and severity. The spectacular resiliency of the financial markets appears to be
buoyed by extreme monetary and fiscal stimulus, with the prospect that financial
asset values can be supported, either directly or implicitly, by the Federal
Reserve until a COVID-19 vaccine or effective treatments can be found.
Discomforted by the prospect of trying to predict and time the outcome of the
pandemic, and with an election looming in November, we have put ourselves in a
position to be patient and focused on the long-term through what may be a
volatile next several months. The virtue of patience has had meaningful
ancillary benefits, as we have been able to focus on the strategic evolution of
our business model, and how our platforms will function in a post-pandemic
world.
For now, our residential and business purpose lending segments continue to
operate in a significantly altered landscape. Myriad aspects of the mortgage
process that historically took place in person, such as appraisals and closings,
are now often done remotely. Residential credit performance has fundamentally
deteriorated from the record low delinquencies the industry enjoyed before the
crisis, though continues to run better than many observers expected. As of June
30, 2020, we received approximately 96% of payments due in June for residential
loans underlying our Sequoia securitizations and we received approximately 96%
of payments due for the single-family rental loans underlying our CoreVest
securitizations. Forbearance rates for our Sequoia portfolio had stabilized in
the 6.5% - 7.0% range of outstanding balances as of July 24, 2020. Importantly,
we are now observing how the first group of borrowers exiting forbearance
periods will perform, and the early signs are encouraging. Along these lines, it
is important to emphasize that Redwood's servicer advancing obligations to date
have been immaterial to our operations, largely thanks to the fact that a
significant percentage of underlying borrowers who have been granted forbearance
periods have nonetheless continued to make their monthly mortgage payments. Over
the longer-term, for borrowers who reach deeper stages of delinquency,
"stop-advance" features incorporated into many of our Sequoia securitization
transactions will also mitigate our advancing obligations.

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The rise in past-due mortgages, thus far, does not appear to be weakening the
single-family housing sector. Thanks to record low mortgage rates, in some cases
below 3% for agency mortgages and trending lower, refinance activity has
remained elevated and home purchases have seen a resurgence in demand. By way of
shelter-in-place orders and broader (perhaps secular) trends in working
remotely, the concept of "home" has taken on greater significance for most
Americans. Many children are now learning "virtually" right down the hall from
their working parents. Particularly strong demand for suburban housing has been
observed in many states where families look to exit dense metropolitan areas,
seeking some outdoor space to call their own and that critical extra room. This
is a remarkable shift in consumer preference from even a few short months ago,
and one that, on balance, is positive for both our residential consumer and
rental products, which are predominantly focused on single-family dwellings.
Our Residential Lending team entered the second half of the year primed for a
relaunch with an idle period in the jumbo mortgage space slowly coming to an
end. Since March, most lenders had significantly tightened their underwriting
guidelines for newly originated loans due to the prospect of a severe recession
and lack of Fed support to the non-agency sector. Additionally, constraints on
the bandwidth of loan officers, who have remained largely focused on high margin
refinance loans to agency-eligible borrowers, has weighed on jumbo origination
activity. Based on our recent engagement with loan sellers and the gradual
narrowing of the spread between agency and jumbo mortgage rates, we've begun to
see a pickup in lock activity and expect this to grow meaningfully as we head
into the fall. Even with this narrowing, we continue to see substantial relative
value in non-agency whole loans, a sentiment shared by our loan-buying
counterparties, both current and prospective. Our near-term focus continues to
be on recasting our programs and guidelines with loan sellers to reflect the
economic environment in preparation for increased activity. Though our team's
efforts may not yet be reflected in our results, tremendous progress has been
made and we're excited about the resurgence underway.
To reach this point, we completed the difficult work of managing through our
"pre-COVID" loan inventory, culminating with the sale of substantially all of
those loans and the repayment of our associated secured debt facilities. As part
of this process, our residential team completed our Sequoia "MC1" securitization
in late June, a transaction that brought the sale of these loans to a close. The
deal priced better than we expected and allowed us to safely begin locking new
loans in July.
As we move forward, our Residential team is focused on a few key strategic
priorities. First, is to reaffirm our commitment to technology by upgrading our
loan systems and transition toward the more automated underwriting and approval
processes our sellers experience for conventional loans. Second, is to broaden
our methods of loan distribution to complement traditional whole-loan sales and
securitization - a key initiative as we closely manage our loan inventory levels
going forward. Third, is to enhance our value-add to our loan sellers by
continuing to refine how - and how quickly - we can purchase loans in a safe and
sound manner. Thanks to our deep and valuable banking relationships, we have
substantial warehouse capacity to fund new loans and now have access to
non-marginable facilities that will help us manage our inventory going forward.
Transitioning to our Business Purpose Lending segment, the recovery was very
much underway at the end of the second quarter, and we have much to be excited
about going forward. Our BPL team originated $234 million of loans in the second
quarter, the majority in late May and June when we re-entered the market in
earnest after securitizing a significant portion of the pre-COVID single-family
rental loans on our balance sheet. Our origination footprint has remained
largely consistent for SFR loans, and our bridge origination strategy has
sharpened its focus on sponsors whose strategy is to ultimately hold and
stabilize all or most of their portfolios. In addition to their institutional
caliber, these sponsors often become accretive repeat customers for both SFR
loans and fresh bridge financing to support new investments. Across our BPL
products, we are commanding improved lending terms in both structure and coupon.
As funding markets improve, we expect more competition to re-enter the space;
however, we believe our operational advantage remains durable.
Our BPL business continued to make great progress in diversifying its outlets to
distribute risk in the second quarter and through July. We completed two
non-recourse financing arrangements for over 85% of our pre-COVID bridge
portfolio, essentially match-funding a portfolio that has thus far displayed
solid performance through the pandemic (as noted above, these arrangements did
not come with equity-linked options for the lenders). Investment demand remains
very robust for our SFR and bridge loans, including significant inquiry for both
loan purchases and opportunities to co-invest or provide private financing. We
expect these options to become a reliable complement to traditional
securitization. The attractive risk-adjusted returns in the space have kept BPL
assets in strong demand and we continue to receive strong indications from
investors in our SFR securitizations.
As we take stock of the year so far and look towards the fall, we are reminded
that we are living in truly historic times. We face a pandemic that has created
global economic disruption, trade and technology wars are looming, the fight
against racism and social injustice is hitting an inflection point at a global
scale, and the U.S. presidential election is a mere three months away. This
presents an opportunity for all of us to examine our values, reset priorities
and pause while we rethink how we want our world to function. As the times
evolve, our corporate mission remains the same - to help make quality housing
accessible to all Americans, whether rented or owned.


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Second Quarter Overview
The following table presents key financial metrics for the three and six months
ended June 30, 2020.
Table 1 - Key Financial Metrics
                                                   Three Months Ended            Six Months Ended
  (In Thousands, except per Share Data)              June 30, 2020                June 30, 2020
  Net income (loss) per diluted common share      $            1.00             $        (6.82)

  Book value per share                            $            8.15             $         8.15
  REIT taxable loss per share                     $           (0.50)            $        (0.17)
  Dividends per share                             $           0.125             $        0.445


•Our second quarter 2020 results benefited from a rebound in asset prices, as
the COVID-19 induced spread widening we experienced in the first quarter
partially reversed, benefiting our investment portfolio. As a result of the
substantial work we completed repositioning our secured debt, we were able to
maintain strategic assets in our portfolio and recover a meaningful portion of
the unrealized losses recorded in the first quarter of 2020.
•Our book value per share increased $1.83 per share to $8.15 per share during
the second quarter of 2020, resulting primarily from positive investment fair
value changes as well as from gains on extinguishment of our convertible debt.
During the second quarter, we recognized positive fair value changes of $1.78
per share on our investment assets, primarily driven by spread-tightening across
our portfolios. While not uniform in magnitude, asset valuations were materially
higher and still possess significant upside to the extent the economy continues
to recover. Additionally, during the second quarter of 2020, we repurchased $125
million of convertible debt, resulting in net gains of $25 million and a $0.22
per share benefit to book value.
•During the second quarter of 2020, we made significant progress repositioning
our secured recourse debt structure including reducing our recourse debt from
$4.6 billion at March 31, 2020 to $1.8 billion at June 30, 2020, and reducing
our marginable debt from $3.5 billion at March 31, 2020 to $375 million at June
30, 2020. While our new non-marginable and non-recourse financing facilities
have reduced our contingent liquidity risks, they generally have higher interest
costs, which will marginally impact our net interest income in coming quarters.
Additional details on these new financing agreements are provided in the
"Liquidity and Capital Resources" section that follows in this MD&A.
•During the second quarter of 2020, we completed the sale of nearly all of our
residential loans previously held for investment and financed at our Federal
Home Loan Bank of Chicago facility (our "FHLBC Facility") and repaid all but $1
million of borrowings under this facility. Additionally, during the second
quarter, we completed the sale of nearly all of our loan inventory held at the
end of the first quarter of 2020. These sales benefited our cash position,
recourse leverage and marginable debt ratios, but reduced net interest income in
the second quarter.
•We reset operations in our mortgage banking businesses during the second
quarter of 2020, increasing the pace of residential loan locks and business
purpose loan originations in the second half of the second quarter. Our business
purpose lending platform originated $234 million of business purpose mortgage
loans in the second quarter, including $176 million of single-family rental
loans and $58 million of residential bridge loans.
•During the second quarter of 2020, we sold $29 million of securities from our
residential lending investment portfolio, $53 million of third-party residential
investments (including $35 million of recently issued subordinate securities),
and $19 million of Agency CRT securities.
•Our unrestricted cash position increased to $529 million at the end of the
second quarter of 2020, after repurchasing $125 million of our convertible debt
at a discount, and without issuing any equity or equity-linked securities.
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RESULTS OF OPERATIONS
Within this Results of Operations section, we provide commentary that compares
results year-over-year for 2020 and 2019. Most tables include a "change" column
that shows the amount by which the results from 2020 are greater or less than
the results from the respective period in 2019. Unless otherwise specified,
references in this section to increases or decreases during the "three-month
periods" refer to the change in results for the second quarter of 2020, compared
to the second quarter of 2019, and increases or decreases in the "six-month
periods" refer to the change in results for the first six months of 2020,
compared to the first six months of 2019.
Consolidated Results of Operations
The following table presents the components of our net income for the three and
six months ended June 30, 2020 and 2019.

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