Redwood Trust(RWT) - 2023 Q4 - Annual Report

PART I Item 1. Business Redwood Trust, Inc. is a specialty finance company focused on housing credit, providing liquidity to underserved segments of the U.S. housing market. - Redwood Trust, Inc. is a specialty finance company focused on housing credit, providing liquidity to growing segments of the U.S. housing market not well served by government programs[20] - The company operates in three segments: Residential Consumer Mortgage Banking, Residential Investor Mortgage Banking, and Investment Portfolio. Segment names were updated in Q4 2023 without changes to their composition[20][26] - Primary sources of income are net interest income from investments and non-interest income from mortgage banking activities (loan origination, acquisition, sale, or securitization)[21] - Redwood Trust, Inc. has elected to be taxed as a REIT since 1994, with mortgage banking activities and MSRs generally conducted through taxable REIT subsidiaries (TRS)[22] - As of December 31, 2023, Redwood employed 289 full-time employees, with 57% directly engaged in CoreVest operations. Voluntary employee turnover was 13% for 2023[34][36] - The company faces intense competition from various financial institutions and government-sponsored entities like Fannie Mae and Freddie Mac, which may have greater resources or lower funding costs[41][70][71] Item 1A. Risk Factors The company faces multiple risks in general economic conditions, regulatory changes, intense competition, and operational vulnerabilities. - General economic conditions, including inflation, interest rate changes, and housing market performance, significantly impact the company's business and asset values[54][55][56] - Federal, state, and local legislative and regulatory developments, such as the proposed Basel III Endgame capital rules and changes in Fannie Mae/Freddie Mac loan limits, could adversely affect the business and increase borrowing costs[62][64][65] - The company faces intense competition from commercial banks, other mortgage REITs, and government-sponsored entities, some of which have greater resources or different risk tolerances[69][70][71] - Use of financial leverage exposes the company to liquidity risks, including margin calls and potential breaches of financial covenants, which could necessitate immediate debt repayment or asset sales under adverse conditions[81][85][88] - Cybersecurity and data breaches, or non-compliance with data privacy laws, pose significant risks to reputation, business operations, and financial results due to the handling of sensitive personal information[92][95][96] - The nature of assets held (residential, business purpose, multifamily loans, HEI) exposes the company to credit risk, prepayment risk, and interest rate fluctuations, which can lead to reduced earnings or increased volatility[103][104][133][136] - Maintaining REIT status requires adherence to complex rules and distribution requirements, which can limit operational flexibility and capital retention, potentially forcing asset sales or debt incurrence under unfavorable market conditions[273][275][278] Item 1B. Unresolved Staff Comments The company reported no unresolved staff comments from the SEC. - No unresolved staff comments were reported[314] Item 1C. Cyber Risk Management, Strategy, and Governance Disclosures Redwood Trust has a cybersecurity risk management program based on the NIST CSF, overseen by the Board, and has identified no material cyber threats. - Redwood's cybersecurity risk management program is based on the National Institute of Standards and Technology Cybersecurity Framework (NIST CSF)[316] - The program includes risk assessments, a dedicated IT team, third-party security testing (penetration testing, vulnerability scanning), employee training, and an incident response plan[317] - The Board of Directors, via its Audit Committee, oversees cybersecurity risk management, receiving periodic reports from IT management[318] - As of the report date, no known cybersecurity threats have materially affected or are reasonably likely to materially affect the company's operations, business strategy, results, or financial condition[317] Item 2. Properties Redwood Trust does not own any properties, leasing all its executive and administrative offices across four primary locations. - Redwood Trust does not own any properties; all office spaces are leased[321] Primary Office Locations and Lease Expirations | Location | Lease Expiration | | :----------------------------- | :--------------- | | One Belvedere Place, Suite 300, Mill Valley, CA 94941 | 2028 | | 8310 South Valley Highway, Suite 425, Englewood, CO 80112 | 2031 | | 4 Park Plaza, Suite 900, Irvine, CA 92614 | 2027 | | 650 Fifth Avenue, Suite 2120, New York, NY 10019 | 2025 | Item 3. Legal Proceedings Information regarding legal proceedings is incorporated by reference from Note 17 to the Financial Statements. - Legal proceedings information is detailed in Note 17 to the Financial Statements[323] Item 4. Mine Safety Disclosures (Not Applicable) Mine safety disclosures are not applicable to Redwood Trust, Inc. - Mine Safety Disclosures are not applicable[323] PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities Redwood Trust's common stock trades on the NYSE under RWT, with 131.6 million shares outstanding and quarterly dividends declared. - Common stock is listed and traded on the NYSE under the symbol RWT[326] - As of February 26, 2024, there were 131,577,032 shares of common stock outstanding[7] Common Dividends Declared (2023 vs. 2022) | Year Ended December 31, | Per Share | | :---------------------- | :-------- | | 2023 | $0.71 | | 2022 | $0.92 | - 2023 common stock dividends are expected to be characterized for federal income tax purposes as 39% ordinary income (Section 199A), 23% qualified dividends, and 38% return of capital[327] - As of December 31, 2023, the company had authorization to repurchase up to $101 million of common stock and $70 million of preferred stock, in addition to outstanding debt securities[78][328] - No common stock or preferred stock was repurchased in 2023; $81 million of convertible and exchangeable debt was repurchased and early retired[78][328] Item 6. [Reserved] This item is reserved and contains no information. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Management's Discussion and Analysis (MD&A) reviews Redwood Trust's financial condition, operations, and liquidity for 2023, highlighting strategic shifts and performance drivers. - Redwood Trust is a specialty finance company focused on housing credit, operating in Residential Consumer Mortgage Banking, Residential Investor Mortgage Banking, and Investment Portfolio segments[336] - The company created substantial capital flexibility in 2023 by reducing recourse leverage and extending corporate debt maturities, in response to housing activity lows and banking sector crisis[338] - Strategic reallocation of capital prioritizes co-investments in joint venture partnerships with private credit institutions, aiming for reliable distribution channels, enhanced liquidity, and predictable revenues[341] - The company is optimistic about growing residential investor and consumer loan volumes due to anticipated major bank regulatory rule changes (Basel III) and financial pressures on depositories[342] Key Financial Results (2023 vs. 2022) | Metric | 2023 | 2022 | | :--------------------------- | :-------- | :-------- | | Net income (loss) per diluted common share | $(0.11) | $(1.43) | | Return on common stockholders' equity | (1)% | (13)% | | Book value per share | $8.64 | $9.55 | | Dividends per share | $0.71 | $0.92 | | Economic return on book value | (2)% | (13)% | - Net interest income decreased by $62.5 million in 2023, primarily due to lower yield maintenance income, reduced accretion income on AFS securities, increased interest expense on HEI, and higher overall financing costs[372][373] - Income from mortgage banking activities increased by $81.0 million in 2023, driven by improved margins in both Residential Consumer and Residential Investor segments, despite lower volumes in some areas[372][380] INTRODUCTION This section introduces the MD&A, providing management's perspective on Redwood Trust's financial condition, operations, and liquidity. - MD&A provides management's narrative on financial condition, results of operations, liquidity, and future factors[334] - It should be read with Consolidated Financial Statements and Notes (Part II, Item 8) and includes forward-looking statements subject to risks outlined in 'Risk Factors' (Part I, Item 1A)[335] OVERVIEW Redwood Trust is a specialty finance company focused on housing credit, strategically repositioning its balance sheet and expanding its platforms in 2023. - Redwood Trust operates in three segments: Residential Consumer Mortgage Banking, Residential Investor Mortgage Banking, and Investment Portfolio, with segment names updated in Q4 2023[336] - In 2023, the company achieved substantial capital flexibility by reducing recourse leverage and extending corporate debt maturities, repositioning for increased private market loan volume[338] - Current capital deployment opportunities offer illustrative returns of 15-20% for mortgage banking and third-party investments, 12-18% for organically retained securities and joint-venture co-investments, and 8-10% for opportunistic debt retirement[339] - Strategic shift towards co-investments in joint venture partnerships aims to create reliable distribution channels, enhance liquidity, and support predictable revenues, allowing for faster organic scaling[341] - The company secured new or renewed jumbo flow relationships with almost 70 banks, now connecting with loan sellers controlling 60% of residential jumbo origination volume[343] - Launched in-house home equity investment (HEI) origination platform, Aspire, expanding to five states with plans for up to 15, and introduced a program to acquire traditional second lien mortgage products[345] - Residential Investor loan platform (CoreVest) is benefiting from banks' pullback, with ongoing negotiations for partnership opportunities to access existing pipelines[346] - Multifamily bridge portfolio experienced financial stress due to rising rates, leading to active management through loan recasting, maturity extensions, and fresh capital infusions. Multifamily bridge originations were curtailed since Q3 2022, now representing 13% of total capital[347][348] Key Financial Results (2023 vs. 2022) | Metric | 2023 | 2022 | | :--------------------------- | :-------- | :-------- | | Net income (loss) per diluted common share | $(0.11) | $(1.43) | | Return on common stockholders' equity | (1)% | (13)% | | Book value per share | $8.64 | $9.55 | | Dividends per share | $0.71 | $0.92 | | Economic return on book value | (2)% | (13)% | - Residential Consumer Mortgage Banking: Jumbo loan lock volume was $3.5 billion in 2023 (down from $4.1 billion in 2022), with a significant increase in the second half of 2023 due to new bank relationships. Distributed $1.8 billion of loans in 2023, primarily through securitizations[355][356] - Residential Investor Mortgage Banking (CoreVest): Funded $1.6 billion of loans in 2023 (down from $2.8 billion in 2022), with 67% bridge loans and 33% term loans. Increased selectivity and tighter underwriting for multifamily bridge production[357][358] - Investment Portfolio: Totaled $3.4 billion at year-end 2023 (down from $3.7 billion in 2022), with 80% organically created. Reduced exposure to non-strategic third-party investments and completed three securitizations to unlock capital. Net discount to par was $2.68 per share at year-end 2023[360][361] - RWT Horizons: Focused on portfolio management in 2023, with $25 million committed across 34 investments in 27 early-stage technology companies. Made 7 new investments totaling $1.9 million[366][367] RECENT DEVELOPMENTS In January 2024, Redwood Trust issued $60 million of 9.125% senior unsecured notes due 2029. - In January 2024, Redwood issued $60 million of 9.125% senior unsecured notes due March 1, 2029[368] - Interest is payable quarterly, starting June 1, 2024. The notes are redeemable on or after March 1, 2026, at 100% of principal plus accrued interest[368] RESULTS OF OPERATIONS Redwood Trust experienced a net loss of $(2.3) million in 2023, a significant improvement from 2022, driven by increased mortgage banking and HEI income. Consolidated Net Income (Loss) (2023 vs. 2022 vs. 2021) | (In Thousands) | 2023 | 2022 | 2021 | Change '23/'22 | Change '22/'21 | | :------------------------------ | :-------- | :--------- | :--------- | :------------- | :------------- | | Net Interest Income | $92,943 | $155,454 | $148,177 | $(62,511) | $7,277 | | Non-interest Income (Loss), net | $72,688 | $(162,679) | $393,804 | $235,367 | $(556,483) | | General and administrative expenses | $(128,295) | $(140,908) | $(165,218) | $12,613 | $24,310 | | Net (Loss) Income | $(2,274) | $(163,520) | $319,613 | $161,246 | $(483,133) | - Net interest income decreased by $62.5 million in 2023, primarily due to lower yield maintenance income, reduced accretion income on AFS securities, increased interest expense related to HEI, and higher overall financing costs[373] - Mortgage banking activities, net, increased by $81.0 million in 2023, driven by improved margins in both Residential Consumer and Residential Investor segments, despite higher volumes in 2022[380] - Investment fair value changes, net, improved by $133.9 million in 2023, primarily due to smaller negative impacts from reperforming loan securities and BPL bridge loans, partially offset by fair value increases in IO securities and interest rate hedges[372][385][386] - HEI income, net, increased by $32.4 million in 2023, mainly from baseline accretion of option value and positive actual home price appreciation trends[372][389] - General and administrative expenses decreased by $12.6 million in 2023 due to firm-wide headcount reductions (26% since Q3 2022) and lower non-compensation costs, partially offset by higher variable and long-term incentive compensation[395] Net Interest Income by Segment (2023 vs. 2022 vs. 2021) | (In Thousands) | 2023 | 2022 | 2021 | Change '23/'22 | Change '22/'21 | | :------------------------------ | :-------- | :-------- | :-------- | :------------- | :------------- | | Residential Consumer Mortgage Banking | $1,290 | $12,467 | $21,990 | $(11,177) | $(9,523) | | Residential Investor Mortgage Banking | $2,818 | $10,633 | $6,824 | $(7,815) | $3,809 | | Investment Portfolio | $138,605 | $181,980 | $155,538 | $(43,375) | $26,442 | | Corporate/Other | $(49,770) | $(49,626) | $(36,175) | $(144) | $(13,451) | | Net Interest Income | $92,943 | $155,454 | $148,177 | $(62,511) | $7,277 | Results of Operations by Segment Redwood Trust's segment contributions in 2023 showed improved performance in mortgage banking and investment portfolio segments, while corporate expenses increased. Segment Contribution Summary (2023 vs. 2022 vs. 2021) | (In Thousands) | 2023 | 2022 | 2021 | Change '23/'22 | Change '22/'21 | | :------------------------------ | :-------- | :--------- | :--------- | :------------- | :------------- | | Residential Consumer Mortgage Banking | $10,052 | $(21,578) | $82,414 | $31,630 | $(103,992) | | Residential Investor Mortgage Banking | $(12,575) | $(44,285) | $38,528 | $31,710 | $(82,813) | | Investment Portfolio | $113,723 | $(9,131) | $293,230 | $122,854 | $(302,361) | | Corporate/Other | $(113,474) | $(88,526) | $(94,559) | $(24,948) | $6,033 | | Net (Loss) Income | $(2,274) | $(163,520) | $319,613 | $161,246 | $(483,133) | - Residential Consumer Mortgage Banking segment contribution improved significantly in 2023, benefiting from lower interest rate volatility, strong distribution execution, and reduced operating expenses due to headcount reductions[426][427] - Residential Investor Mortgage Banking segment contribution improved in 2023 due to higher mortgage banking income from better execution on term securitizations and sales, and lower operating expenses from headcount reductions[439] - Investment Portfolio segment contribution increased in 2023, driven by smaller negative investment fair value changes and higher HEI income, despite lower net interest and other income[448] - Corporate/Other net expense increased by $25 million in 2023, primarily due to negative investment fair value changes in strategic investments and higher G&A, partially offset by a litigation reserve reversal[415] Residential Consumer Mortgage Banking Earnings Summary and Operating Metrics (2023 vs. 2022 vs. 2021) | (In Thousands) | 2023 | 2022 | 2021 | | :------------------------------ | :-------- | :--------- | :--------- | | Mortgage banking income (loss), net | $30,148 | $(8,815) | $149,141 | | Operating expenses | $(18,437) | $(25,577) | $(40,950) | | (Provision for) benefit from income taxes | $(1,659) | $12,814 | $(25,777) | | Segment Contribution | $10,052 | $(21,578) | $82,414 | Residential Investor Mortgage Banking Earnings Summary (2023 vs. 2022 vs. 2021) | (In Thousands) | 2023 | 2022 | 2021 | | :------------------------------ | :-------- | :--------- | :--------- | | Mortgage banking income | $48,035 | $21,765 | $116,463 | | Operating expenses | $(62,889) | $(79,207) | $(69,813) | | Benefit from (provision for) income taxes | $2,279 | $13,157 | $(8,122) | | Segment Contribution | $(12,575) | $(44,285) | $38,528 | Investment Portfolio Earnings Summary (2023 vs. 2022 vs. 2021) | (In Thousands) | 2023 | 2022 | 2021 | | :------------------------------ | :-------- | :--------- | :--------- | | Net interest income | $138,605 | $181,980 | $155,538 | | Investment fair value changes, net | $(42,322) | $(193,862) | $116,189 | | HEI Income, net | $35,117 | $2,714 | $13,425 | | Other income, net | $10,361 | $18,596 | $10,021 | | Realized gains, net | $858 | $3,174 | $17,993 | | Operating expenses | $(25,950) | $(15,682) | $(16,074) | | Provision for income taxes | $(2,946) | $(6,051) | $(3,862) | | Segment Contribution | $113,723 | $(9,131) | $293,230 | Investments Detail and Activity Redwood's Investment Portfolio decreased in 2023, with a focus on efficiency and optimization, while managing increased delinquencies in certain loan segments. Investment Portfolio - Detail of Economic Interests (2023 vs. 2022) | (In Thousands) | December 31, 2023 | December 31, 2022 | | :--------------------------------- | :---------------- | :---------------- | | Organic Residential Investments | | | | Residential loans at Redwood | $— | $152,621 | | Residential securities at Redwood | $110,056 | $103,089 | | Residential securities at consolidated Sequoia entities | $204,830 | $219,299 | | Organic Business Purpose Investments | | | | BPL Bridge loans | $2,068,323 | $2,023,529 | | BPL securities at consolidated CAFL Term entities | $323,340 | $303,897 | | Third-Party Investments | | | | Residential securities at Redwood | $5,645 | $124,567 | | Residential securities at consolidated Freddie Mac SLST entities | $274,175 | $322,803 | | Multifamily securities at Redwood | $7,101 | $12,674 | | Multifamily securities at consolidated Freddie Mac K-Series entities | $33,308 | $31,767 | | Servicing investments | $85,704 | $90,120 | | HEI | $278,967 | $283,897 | | Total Segment Investments | $3,444,144 | $3,725,021 | - Investment Portfolio decreased in 2023 due to sales of non-strategic third-party securities and residential loans, with capital redeployed into Residential Consumer Mortgage Banking[446] - At December 31, 2023, the Investment Portfolio had a net discount to par of $2.68 per share, down from $4.33 per share at December 31, 2022[361] - Residential consumer loan investments showed strong fundamental performance in 2023, with declining delinquencies and LTVs. 90 day+ delinquencies for SLST investments were 8.4% (down from 12.4% in 2022) and for SEMT investments were 0.2% (flat)[363] - Residential Investor related securities and investments experienced stress in 2023, with 90 day+ delinquencies for CAFL term loan securities rising to 3.7% (from 1.5% in 2022) and for bridge loans to 5.1% (from 2.0% in 2022). REO balances for bridge loans also increased[364] - BPL bridge loans held-for-investment totaled $2.07 billion at December 31, 2023. 105 loans ($97 million fair value, $107 million UPB) were 90+ days delinquent, with 82 in foreclosure. REO associated with bridge loans increased to $88 million[477] - In 2023, $295 million of BPL bridge loans underwent modifications (interest rate reductions, deferrals, maturity extensions), with 86% current at year-end. Maturity extensions were granted for $232 million of loans[478] - HEI income, net, increased by $32 million in 2023, driven by baseline accretion and improved actual/projected home price appreciation[389] HEI Income, net (2023 vs. 2022 vs. 2021) | (In Thousands) | 2023 | 2022 | 2021 | | :------------------------------------------------- | :-------- | :------ | :------ | | Net market valuation gains (losses) recorded on HEI at Redwood | $30,750 | $(201) | $13,207 | | Net market valuation gains (losses) recorded on Securitized HEI | $23,177 | $5,875 | $567 | | Net market valuation gains (losses) recorded on ABS Issued from HEI securitizations | $(11,020) | $2,334 | $47 | | Net market valuation gains (losses) recorded on non-controlling interests in HEI securitizations | $(7,790) | $(5,294) | $(396) | | Total HEI income, net | $35,117 | $2,714 | $13,425 | Income Taxes Redwood Trust, as a REIT, manages its tax obligations through dividend distributions and utilizes significant deferred tax assets from NOL and capital loss carryforwards. - As a REIT, Redwood must distribute at least 90% of its annual REIT taxable income (excluding net capital gains) and meet other asset, income, and stock ownership requirements[497] - At December 31, 2023, full-year dividend distributions exceeded minimum requirements, and the company believes it met all REIT qualification criteria[498] - The company carried a $37 million federal net operating loss (NOL) carryforward into 2023 at its REIT, allowing retention of REIT taxable income up to this amount tax-free[499] - Taxable REIT subsidiaries (TRS) had $102 million of federal NOLs carrying forward indefinitely at December 31, 2023[507] - A tax provision of $2 million was recorded in 2023, primarily from positive GAAP income at TRS, compared to a $20 million tax benefit in 2022 from TRS GAAP losses[502] Net Operating and Capital Loss Carryforwards (as of December 31, 2023) | Loss Carryforward Type | 1 to 3 Years | 3 to 5 Years | 5 to 15 Years | After 15 Years | No Expiration | Total | | :--------------------- | :----------- | :----------- | :------------ | :------------- | :------------ | :---- | | REIT Net operating loss | $— | $— | $(28,684) | $— | $(8,757) | $(37,441) | | REIT Capital loss | $(288,791) | $(15,788) | $— | $— | $— | $(304,579) | | TRS Net operating loss | $— | $— | $— | $— | $(101,506) | $(101,506) | | TRS Capital loss | $— | $(279) | $— | $— | $— | $(279) | LIQUIDITY AND CAPITAL RESOURCES Redwood Trust's liquidity and capital resources are derived from equity, debt, warehouse facilities, and asset flows, with $1.87 billion in total capital at year-end 2023. - Principal sources of cash and liquidity include equity/debt capital, mortgage loan warehouse facilities, secured term financing, securities repurchase agreements, and cash from investment portfolio assets and mortgage banking operations[509] - At December 31, 2023, total capital was $1.87 billion, comprising $1.20 billion equity, $650 million convertible notes/long-term debt, and $16 million promissory notes[510] - Unrestricted cash was $293 million at December 31, 2023, increasing to $396 million by February 16, 2024, after issuing $60 million in senior notes and closing $800 million in securitizations[340][511] - The company had $1.88 billion of secured recourse debt outstanding at December 31, 2023, with $578 million marginable and $1.30 billion non-marginable[515] - In 2023, net cash used in operating activities was $2.02 billion, primarily from mortgage banking loan purchases/sales. Net cash provided by investing activities was $909 million, mainly from investment sales/payments. Net cash provided by financing activities was $1.15 billion, driven by ABS issuances and stock sales[520][521][523] - At December 31, 2023, the company had commitments to fund $542 million in BPL bridge loan advances and $17 million to a joint venture. It also had $290 million of unencumbered assets and $2.1 billion of excess warehouse capacity[530][534] - The company was in compliance with all financial covenants associated with its short-term debt and other debt financing facilities at December 31, 2023, with significant headroom in equity/net worth and recourse indebtedness ratios[566] CRITICAL ACCOUNTING ESTIMATES Redwood Trust's financial statements rely on significant estimates and assumptions, particularly for fair value measurements of illiquid assets and liabilities. - Financial statements require significant estimates and assumptions, especially for fair value measurements of assets and liabilities[569] - A significant portion of assets and liabilities are accounted for at fair value, predominantly using Level 3 valuation inputs, which involve a high degree of estimation uncertainty[571] - Fair value estimates for consolidated securitization VIEs (CFEs) are based on the more observable fair value of issued financial liabilities, requiring significant judgment in developing unobservable inputs[572] - Changes in fair values of loans (residential, business purpose, multifamily), securities (trading, AFS), servicer advance investments, MSRs, HEI, strategic investments, and derivatives can cause significant earnings volatility due to reliance on subjective assumptions like interest rates, prepayment rates, credit losses, and home price appreciation[573][574][576][577][578][579][580] - Impairments of goodwill and intangible assets, changes in yields for securities, loss contingency reserves, and tax provisions (especially deferred tax assets and valuation allowances) also involve significant judgment and can materially affect financial results[583][584][587][588] MARKET AND OTHER RISKS Redwood Trust actively manages various market risks, including credit, interest rate, prepayment, liquidity, and fair value risks, to enhance earnings and preserve capital. - The company manages market risks (credit, interest rate, prepayment, liquidity, fair value) to enhance earnings and preserve capital, focusing on quantifiable risks[589] - Other risks include business, operational, and regulatory risks, as detailed in the 'Risk Factors' section[590] Item 7A. Quantitative and Qualitative Disclosures about Market Risk Redwood Trust manages various market risks, including credit, interest rate, prepayment, inflation, fair value, and liquidity risks, through underwriting, monitoring, and hedging strategies. - Redwood Trust manages credit risk through ownership of real estate loans, securities, and other investments, and relies on counterparty creditworthiness. Risk is managed by analyzing underwriting criteria and monitoring performance[593] - Residential consumer and investor loans and securities are exposed to credit losses from various factors including economic conditions, property value declines, and origination/servicing practices[594][595] - Multifamily loans and securities carry similar credit risks, with larger principal balances and sensitivity to rental market conditions and operating costs[599] - Interest rate risk affects cash flows and fair values of assets, liabilities, and derivatives. The company uses derivative financial instruments for hedging but does not completely hedge all risks, accepting short-term volatility for long-term returns[605][606] - Prepayment risk impacts economic returns, with discount securities benefiting from faster prepayments and premium securities/MSRs benefiting from slower prepayments. Prepayment rates are difficult to predict[607] - Fair value and liquidity risks are managed by maintaining adequate cash and capital levels, especially given the use of short-term debt facilities and potential for margin calls[610][611][612] Interest Rate Sensitive Assets (December 31, 2023) | Asset Type | Principal Balance (Thousands) | Fair Value (Thousands) | | :----------------------------- | :---------------------------- | :--------------------- | | Residential Loans - HFS | $916,977 | $911,192 | | Residential Loans - HFI at Sequoia | $5,398,913 | $4,780,203 | | Residential Loans - HFI at Freddie Mac SLST | $1,614,974 | $1,359,242 | | Business Purpose Loans - HFS | $187,886 | $180,250 | | BPL Term Loans - HFI at CAFL | $3,194,131 | $2,971,725 | | BPL Bridge Loans - HFI at Redwood | $1,325,284 | $1,305,727 | | BPL Bridge Loans - HFI at CAFL | $756,574 | $762,596 | | Multifamily Loans - HFI at Freddie Mac K-Series | $438,868 | $425,285 | | Residential Senior Securities | $— | $36,109 | | Residential Subordinate Securities | $147,602 | $84,587 | | Multifamily Securities | $7,498 | $7,101 | Interest Rate Sensitive Liabilities (December 31, 2023) | Liability Type | Principal Balance (Thousands) | Fair Value (Thousands) | | :----------------------------- | :---------------------------- | :--------------------- | | Asset-Backed Securities Issued - Sequoia Entities | $5,151,646 | $4,568,660 | | Asset-Backed Securities Issued - Freddie Mac SLST Entities | $1,328,657 | $1,265,777 | | Asset-Backed Securities Issued - Freddie Mac K-Series Entities | $402,400 | $391,977 | | Asset-Backed Securities Issued - CAFL Entities | $3,472,825 | $3,362,978 | | Asset-Backed Securities Issued - HEI Entities | $233,131 | $222,488 | | Short-Term Debt | $1,416,510 | $1,414,644 | | Convertible Notes | $510,553 | $488,341 | | Trust Preferred Securities and Subordinated Notes | $139,500 | $92,070 | | Other Long Term Debt | $1,182,594 | $1,177,287 | | Interest Rate Swaps (Notional) | $50,000 | $1,742 | Item 8. Financial Statements and Supplementary Data This item incorporates by reference the Consolidated Financial Statements and related reports from pages F-1 through F-125 of this Annual Report on Form 10-K. - Consolidated Financial Statements and Notes, along with Independent Registered Public Accounting Firm reports, are incorporated by reference[622] Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure There have been no changes in or disagreements with accountants on accounting and financial disclosure. - No changes in or disagreements with accountants on accounting and financial disclosure were reported[623] Item 9A. Controls and Procedures Redwood Trust maintains effective disclosure controls and internal control over financial reporting, with no material changes in Q4 2023. - Disclosure controls and procedures are designed to ensure timely and accurate reporting under the Securities Exchange Act of 1934[624] - As of December 31, 2023, the CEO and CFO concluded that disclosure controls and procedures were effective at a reasonable assurance level[625] - Management assessed the effectiveness of internal control over financial reporting based on the COSO 2013 framework and determined it was effective as of December 31, 2023[627] - Grant Thornton LLP issued an unqualified opinion on the effectiveness of the company's internal control over financial reporting as of December 31, 2023[630] - No material changes in internal control over financial reporting occurred during the fourth quarter of 2023[628] Item 9B. Other Information No Rule 10b5-1 trading arrangements were adopted or terminated in Q4 2023, and the 2024 annual stockholders' meeting is scheduled for May 21, 2024. - No director or officer adopted or terminated Rule 10b5-1 or non-Rule 10b5-1 trading arrangements during Q4 2023[631] - The 2024 annual meeting of stockholders is scheduled for May 21, 2024, in Irvine, California[632] - Brooke E. Carillo, the Chief Financial Officer, was designated as the Principal Accounting Officer effective March 1, 2024[633] Item 9C. Disclosure Regarding Foreign Jurisdictions That Prevent Inspections This item is not applicable to Redwood Trust, Inc. - Disclosure regarding foreign jurisdictions that prevent inspections is not applicable[634] PART III Item 10. Directors, Executive Officers and Corporate Governance Information regarding directors, executive officers, and corporate governance is incorporated by reference from the definitive Proxy Statement. - Information on directors, executive officers, and corporate governance is incorporated by reference from the definitive Proxy Statement[637] Item 11. Executive Compensation Information regarding executive compensation is incorporated by reference from the definitive Proxy Statement. - Information on executive compensation is incorporated by reference from the definitive Proxy Statement[638] Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information regarding security ownership of certain beneficial owners and management, and related stockholder matters, is incorporated by reference from the definitive Proxy Statement. - Information on security ownership of certain beneficial owners and management, and related stockholder matters, is incorporated by reference from the definitive Proxy Statement[639] Item 13. Certain Relationships and Related Transactions, and Director Independence Information regarding certain relationships and related transactions, and director independence, is incorporated by reference from the definitive Proxy Statement. - Information on certain relationships and related transactions, and director independence, is incorporated by reference from the definitive Proxy Statement[640] Item 14. Principal Accounting Fees and Services Information regarding principal accounting fees and services is incorporated by reference from the definitive Proxy Statement. - Information on principal accounting fees and services is incorporated by reference from the definitive Proxy Statement[641] PART IV Item 15. Exhibits, Financial Statement Schedules This section lists all exhibits and financial statement schedules filed as part of the 10-K report, including corporate governance, securities, and employment agreements. - This section lists all exhibits and financial statement schedules filed as part of the 10-K report[644] - Exhibits include corporate governance documents (Articles of Amendment, Bylaws), securities descriptions (Common Stock, Preferred Stock, Senior Notes), various indentures, waiver agreements, and compensation plans[645][647][648][649][650] - Other exhibits cover employment agreements for executive officers, lease agreements for office properties, and certifications required by the Sarbanes-Oxley Act[649][650] - All other Consolidated Financial Statements schedules not included have been omitted because they are either inapplicable or the information required is provided in the Company's Consolidated Financial Statements and Notes[644] Item 16. Form 10-K Summary This item is not applicable to Redwood Trust, Inc. - Form 10-K Summary is not applicable[652] Consolidated Financial Statements Reports of Independent Registered Public Accounting Firm Grant Thornton LLP provided an unqualified opinion on Redwood Trust's financial statements and internal controls, highlighting fair value measurements as a critical audit matter. - Grant Thornton LLP issued an unqualified opinion on the consolidated financial statements for December 31, 2023 and 2022, stating they are presented fairly in all material respects in conformity with GAAP[666] - An unqualified opinion was also expressed on the effectiveness of the company's internal control over financial reporting as of December 31, 2023, based on the COSO 2013 framework[667][680] - A critical audit matter was identified as the fair value measurements of certain real estate securities and beneficial interests in consolidated securitization entities (Sequoia, SLST, CAFL, HEI, K-Series)[671][674] - The fair value measurement was critical due to limited observable market data, complex judgments in selecting significant assumptions (discount rate, prepayment rate, default rate, home price appreciation, loss severity), and high sensitivity to changes in these assumptions[675] Consolidated Balance Sheets The Consolidated Balance Sheets present Redwood Trust's financial position, showing total assets increased to $14.50 billion and total equity to $1.20 billion in 2023. Consolidated Balance Sheet Highlights (2023 vs. 2022) | (In Thousands) | December 31, 2023 | December 31, 2022 | | :------------------------------------------------- | :---------------- | :---------------- | | ASSETS | | | | Residential loans, held-for-sale, at fair value | $911,192 | $780,781 | | Residential loans, held-for-investment, at fair value | $6,139,445 | $4,832,407 | | Business purpose loans, held-for-sale, at fair value | $180,250 | $364,073 | | Business purpose loans, held-for-investment, at fair value | $5,040,048 | $4,968,513 | | Consolidated Agency multifamily loans, at fair value | $425,285 | $424,551 | | Real estate securities, at fair value | $127,797 | $240,475 | | Home equity investments, at fair value | $550,436 | $403,462 | | Other investments | $343,930 | $390,938 | | Cash and cash equivalents | $293,104 | $258,894 | | Restricted cash | $75,684 | $70,470 | | Goodwill | $23,373 | $23,373 | | Intangible assets | $28,462 | $40,892 | | Derivative assets | $14,212 | $20,830 | | Other assets | $351,109 | $211,240 | | Total Assets | $14,504,327 | $13,030,899 | | LIABILITIES AND EQUITY | | | | Short-term debt, net | $1,558,222 | $2,029,679 | | Derivative liabilities | $33,828 | $16,855 | | Accrued expenses and other liabilities | $216,803 | $180,203 | | Asset-backed securities issued, net | $9,811,880 | $7,986,752 | | Long-term debt, net | $1,680,901 | $1,733,425 | | Total Liabilities | $13,301,634 | $11,946,914 | | Preferred stock | $66,948 | $— | | Common stock | $1,315 | $1,135 | | Additional paid-in capital | $2,487,848 | $2,349,845 | | Accumulated other comprehensive loss | $(57,957) | $(68,868) | | Cumulative earnings | $1,144,412 | $1,153,370 | | Cumulative distributions to stockholders | $(2,439,873) | $(2,351,497) | | Total Equity | $1,202,693 | $1,083,985 | | Total Liabilities and Equity | $14,504,327 | $13,030,899 | - Assets of consolidated variable interest entities (VIEs) totaled $10.99 billion in 2023 and $9.26 billion in 2022, which can only be used to settle obligations of these VIEs[688] - Liabilities of consolidated VIEs, for which creditors do not have recourse to Redwood Trust, Inc., totaled $10.10 billion in 2023 and $8.27 billion in 2022[688] Consolidated Statements of Income (Loss) Redwood Trust reported a net loss of $(2.3) million in 2023, a significant improvement from 2022, driven by increased non-interest income and reduced expenses. Consolidated Statements of Income (Loss) Highlights (2023 vs. 2022 vs. 2021) | (In Thousands, except Share Data) | 2023 | 2022 | 2021 | | :-------------------------------- | :-------- | :--------- | :--------- | | Total interest income | $724,462 | $707,854 | $574,926 | | Total interest expense | $(631,519) | $(552,400) | $(426,749) | | Net Interest Income | $92,943 | $155,454 | $148,177 | | Mortgage banking activities, net | $67,386 | $(13,659) | $235,744 | | Investment fair value changes, net | $(44,400) | $(178,272) | $114,624 | | HEI income, net | $35,117 | $2,714 | $13,425 | | Other income, net | $12,886 | $21,204 | $12,018 | | Realized gains, net | $1,699 | $5,334 | $17,993 | | Total non-interest income (loss), net | $72,688 | $(162,679) | $393,804 | | General and administrative expenses | $(128,295) | $(140,908) | $(165,218) | | Portfolio management costs | $(14,571) | $(7,951) | $(5,758) | | Loan acquisition costs | $(7,166) | $(11,766) | $(16,219) | | Other expenses | $(16,238) | $(15,590) | $(16,695) | | Net (Loss) Income before income taxes | $(639) | $(183,440) | $338,091 | | (Provision for) benefit from income taxes | $(1,635) | $19,920 | $(18,478) | | Net (Loss) Income | $(2,274) | $(163,520) | $319,613 | | Net (Loss) Income (Related) Available to Common Stockholders | $(8,958) | $(163,520) | $319,613 | | Basic (loss) earnings per common share | $(0.11) | $(1.43) | $2.73 | | Diluted (loss) earnings per common share | $(0.11) | $(1.43) | $2.37 | - Net Interest Income decreased by $62.5 million in 2023 compared to 2022, primarily due to higher interest expense on borrowed funds[691] - Total non-interest income (loss), net, significantly improved from a loss of $(162.7) million in 2022 to a gain of $72.7 million in 2023, driven by a rebound in mortgage banking activities and HEI income[691] - General and administrative expenses decreased by $12.6 million in 2023, contributing to the improved net loss[691] - Diluted loss per common share was $(0.11) in 2023, a substantial improvement from $(1.43) in 2022[691] Consolidated Statements of Comprehensive Income (Loss) Redwood Trust reported comprehensive income of $8.6 million in 2023, a significant recovery from a comprehensive loss in 2022, driven by unrealized gains on AFS securities. Consolidated Statements of Comprehensive Income (Loss) Highlights (2023 vs. 2022 vs. 2021) | (In Thousands) | 2023 | 2022 | 2021 | | :------------------------------------------------- | :-------- | :--------- | :--------- | | Net (Loss) Income | $(2,274) | $(163,520) | $319,613 | | Net unrealized gain (loss) on available-for-sale securities | $6,230 | $(64,704) | $8,016 | | Reclassification of unrealized loss (gain) on available-for-sale securities to net (loss) income | $554 | $636 | $(16,849) | | Reclassification of unrealized loss on interest rate agreements to net (loss) income | $4,127 | $4,127 | $4,127 | | Total other comprehensive income (loss) | $10,911 | $(59,941) | $(4,706) | | Comprehensive Income (Loss) | $8,637 | $(223,461) | $314,907 | | Dividends on preferred stock | $(6,684) | $— | $— | | Comprehensive Income (Loss) Available (Related) to Common Stockholders | $1,953 | $(223,461) | $314,907 | - Total other comprehensive income (loss) significantly improved from a loss of $(59.9) million in 2022 to a gain of $10.9 million in 2023[694] - This improvement was primarily driven by net unrealized gains on available-for-sale securities of $6.2 million in 2023, compared to net unrealized losses of $(64.7) million in 2022[694] Consolidated Statements of Changes in Stockholders' Equity Redwood Trust's total equity increased to $1.20 billion in 2023, driven by stock issuances and positive other comprehensive income, offsetting a net loss and dividends. Consolidated Statements of Changes in Stockholders' Equity (2023 vs. 2022) | (In Thousands, except Share Data) | December 31, 2022 | Net (loss) | Other comprehensive income | Issuance of common stock | Employee stock purchase and incentive plans | Non-cash equity award compensation | Issuance of preferred stock | Preferred dividends declared | Common dividends declared | December 31, 2023 | | :-------------------------------- | :---------------- | :--------- | :------------------------- | :----------------------- | :------------------------------------------ | :--------------------------------- | :-------------------------- | :--------------------------- | :-------------------------- | :---------------- | | Total Equity | $1,083,985 | $(2,274) | $10,911 | $123,877 | $(4,756) | $19,062 | $66,948 | $(6,684) | $(88,376) | $1,202,693 | - Total Equity increased by $118.7 million from $1.08 billion at December 31, 2022, to $1.20 billion at December 31, 2023[696] - Key positive contributions to equity in 2023 included issuance of common stock ($123.9 million) and preferred stock ($66.9 million), and other comprehensive income ($10.9 million)[696] - Negative impacts on equity in 2023 included net loss ($(2.3) million), preferred dividends ($(6.7) million), and common dividends ($(88.4) million)[696] - In 2022, total equity decreased by $302.1 million, primarily due to a net loss of $(163.5) million, other comprehensive loss of $(59.9) million, and common stock repurchases of $(56.5) million[698] Consolidated Statements of Cash Flows Redwood Trust's cash and cash equivalents increased by $39.4 million in 2023, driven by financing and investing activities, offsetting operating cash outflows. Consolidated Statements of Cash Flows Highlights (2023 vs. 2022 vs. 2021) | (In Thousands) | 2023 | 2022 | 2021 | | :------------------------------------------------- | :---------- | :---------- | :---------- | | Net cash used in operating activities | $(2,015,825) | $(139,140) | $(5,694,565) | | Net cash provided by investing activities | $908,720 | $213,886 | $1,404,096 | | Net cash provided by (used in) financing activities | $1,146,529 | $(276,866) | $4,277,503 | | Net increase (decrease) in cash and cash equivalents | $39,424 | $(202,120) | $(12,966) | | Cash, cash equivalents and restricted cash at end of period | $368,788 | $329,364 | $531,484 | - Net cash used in operating activities was $(2.02) billion in 2023, primarily due to the purchase and sale of residential mortgage loans and origination/sale of business purpose loans[520][702] - Net cash provided by investing activities was $908.7 million in 2023, mainly from proceeds from principal payments and sales of investments, partially offset by new investments in BPL bridge loans and HEI[521][702] - Net cash provided by financing activities was $1.15 billion in 2023, driven by $1.59 billion in net borrowings under ABS issued and $124 million from common stock sales, partially offset by debt paydowns and dividends[523][705] - In 2022, net cash used in operating activities was $(139.1) million, net cash provided by investing activities was $213.9 million, and net cash used in financing activities was $(276.9) million[525][526][527][702][705] Notes to Consolidated Financial Statements The Notes provide detailed disclosures on Redwood Trust's accounting policies, financial instruments, and segment information, offering crucial context for the financial statements. Note 1. Organization Redwood Trust, Inc. is a specialty finance REIT focused on housing credit, operating in three segments and generating income from investments and mortgage banking. - Redwood Trust, Inc. is a specialty finance company focused on housing credit, providing liquidity to growing segments of the U.S. housing market[709] - Operates in three segments: Residential Consumer Mortgage Banking, Residential Investor Mortgage Banking, and Investment Portfolio[709] - Primary income sources are net interest income from investments and non-interest income from mortgage banking activities (loan origination, acquisition, sale, securitization)[710] - Elected to be taxed as a REIT since 1994; mortgage banking and MSR investments are generally conducted through taxable REIT subsidiaries (TRS)[711] - Acquired CoreVest in 2019 and Riverbend Funding in 2022, integrating Riverbend's operations with CoreVest[711] Note 2. Basis of Presentation This note outlines the basis for preparing Redwood Trust's consolidated financial statements, including consolidation principles for VIEs and significant estimates. - Consolidated financial statements are prepared in accordance with U.S. GAAP and SEC rules[712] - In 2023, a new line item 'HEI income, net' was added to Consolidated Statements of Income (Loss), and in 2022, 'Home equity investments, at fair value' was added to Consolidated Balance Sheets. Prior periods were conformed[713] - The company consolidates various securitization entities (Legacy Sequoia, Sequoia, CAFL, Freddie Mac SLST, K-Series, HEI) and Servicing Investment entities, which are independent of Redwood, and their assets/liabilities are not direct obligations of Redwood Trust, Inc.[716][718] - The preparation of financial statements requires significant estimates, particularly for fair value measurements, credit losses, and prepayment rates, which are inherently subjective and can materially differ from actual results[719] - Acquired Riverbend Funding, LLC on July 1, 2022, for approximately $44 million cash, with a potential earnout of up to $25.3 million (valued at zero at Dec 31, 2023)[721] Riverbend Acquisition Purchase Price Allocation (as of December 31, 2023) | (In Thousands) | Amount | | :------------------------- | :-------- | | Total consideration | $44,279 | | Allocated to: | | | Business purpose loans, at fair value | $59,748 | | Other investments | $2,443 | | Cash and cash equivalents | $3,490 | | Other assets | $12,982 | | Goodwill | $23,373 | | Intangible assets | $13,300 | | Total assets acquired | $115,336 | | Short-term debt, net | $67,423 | | Accrued expenses and other liabilities | $3,634 | | Total liabilities assumed | $71,057 | | Total net assets acquired | $44,279 | Intangible Assets Carrying Value (as of December 31, 2023) | (In Thousands) | Carrying Value | | :------------------------- | :------------- | | Borrower network | $26,709 | | Broker network | $603 | | Non-compete agreements | $950 | | Tradenames | $200 | | Developed technology | $— | | Loan administration fees on existing loan assets | $— | | Total | $28,462 | - Goodwill of $23 million from the Riverbend acquisition is expected to be tax-deductible and is included in the Residential Investor Mortgage Banking segment[731] Note 3. Summary of Significant Accounting Policies This note details Redwood Trust's significant accounting policies, including fair value measurements, loan classifications, real estate securities, HEI, and derivative instruments. - Uses acquisition method for business combinations, allocating purchase price to fair values of acquired assets and assumed liabilities, with excess recorded as goodwill[735] - Fair value measurements are based on a hierarchy (Level 1, 2, 3 inputs), with significant judgment required for illiquid assets and liabilities using unobservable Level 3 inputs[736][739] -