REDWOOD TRUST INC

Within this Results of Operations section, we provide commentary that compares results year-over-year for 2023, 2022, and 2021. Most tables include "changes" columns that show the amounts by which the year's results are greater or less than the results from the prior year. Unless otherwise specified, references in this section to increases or decreases in 2023 refer to the change in results from 2022 to 2023, and increases or decreases in 2022 refer to the change in results from 2021 to 2022.

Consolidated Results of Operations

The following table presents the components of our net income for the years ended December 31, 2023, 2022, and 2021.

Table 2 – Net Income (Loss)

Net Interest Income

The decrease in net interest income in 2023 was primarily driven by a $43 million decrease from our Investment Portfolio and a $19 million decrease from our Mortgage Banking operations. The decrease in our Investment Portfolio was primarily driven by $13 million of lower yield maintenance income on our CAFL Term securities from slower prepayments in 2023, $10 million of lower accretion income on our AFS securities in 2023 (as calls elevated accretion early in 2022), $12 million of increased interest expense related to HEI (which does not generate interest income but is partially financed with debt), lower net interest income from a lower average balance of securities as we sold non-strategic third-party assets during 2023, and increased interest expense from higher overall financing costs in 2023 as benchmark rates and spreads rose during the year. Additionally, while net interest income on bridge loans increased $20 million in 2023 due to higher average balances year-over-year, we did not recognize $25 million of interest income related to an increase in non-accrual delinquent bridge loans during 2023.

Net interest income from Residential Consumer and Residential Investor Mortgage Banking operations decreased by $11 million and $8 million, respectively, during 2023. These declines were the result of lower average balances of loan inventory and higher financing costs given the rise in benchmark interest rates during the past year. Volume in the residential consumer business was intentionally reduced during 2022 and into the first quarter of 2023, due to the interest rate environment. Given improving market conditions and new opportunities, we increased our quarterly residential consumer loan acquisition volumes beginning in the second quarter of 2023 and see opportunities to further grow acquisitions in the coming quarters in this business.

See the Investment Portfolio and Mortgage Banking sub-sections of the "Results of Operations by Segment” section that follows for additional detail on the composition of, and activity within, our investment portfolio.

Corporate net interest expense remained flat in 2023, as higher interest expense from the issuance of new convertible debt in June 2022 and from our trust preferred securities, which are variable-rate and were impacted by higher benchmark interest rates in 2023, were mostly offset by higher interest income earned on corporate cash, along with a reduction in interest expense related to the repurchase of $81 million of our convertible debt across 2023 - 2027 maturities during 2023 and the repayment of our convertible debt that matured in August 2023.

We use a balanced combination of fixed and floating rate debt to finance our fixed and floating rate investments. However, over the past year, continued increases in benchmark interest rates and borrowing spreads negatively impacted our net interest income. While additional increases in the federal funds rate are not currently predicted by many market participants, further increases or widening of borrowing spreads could result in lower net interest income. To the extent interest rates remain elevated or increase further, certain fixed-rate term borrowings that mature in the coming quarters may have to be refinanced at higher interest rates, which could cause a reduction in net interest income. Given the high interest cost of debt financing available in the current market, we maintained $290 million of unencumbered assets and $2.1 billion of excess warehouse capacity at December 31, 2023.

Net interest income increased in 2022 from 2021, primarily due to a $26 million increase in net interest income earned in our Investment Portfolio. This increase generally resulted from higher average asset balances in 2022, as we increased our investments in BPL bridge loans and carried a higher average balance of securities retained from Sequoia (residential jumbo loans) and CAFL (BPL term loans) securitizations we completed throughout 2021 and into 2022. Additionally, net interest income from bridge loans benefited as we saw the increase in their coupons outpace increases in financing costs throughout the year, as these are primarily floating rate assets. These increases were partially offset by lower levels of discount accretion on our available-for-sale ("AFS") securities resulting from a significant reduction in prepayments of loans underlying the securitizations in association with a continued rise in interest rates throughout 2022.

Additional detail on net interest income is provided in the“Net Interest Income” section that follows.

Mortgage Banking Activities, Net

The increase in income from mortgage banking activities during 2023 was attributable to an increase of $49 million from our Residential Consumer Mortgage Banking operations and an increase of $32 million from our Residential Investor Mortgage Banking operations. For both mortgage banking segments, while volumes were higher during 2022 as compared to 2023, margins were negative for 2022 overall, as rapidly rising interest rates and widening spreads impacted valuations of our loan inventory.

In the Residential Consumer Mortgage Banking segment, volumes steadily increased from the first through third quarters of 2023, with a modest decrease in the fourth quarter due primarily to seasonal factors. In 2023, lower overall interest rate volatility aided in distribution execution throughout the year and margins were 112 basis points for the full year, slightly above our historical target range of 75 to 100 basis points.

In the Residential Investor Mortgage Banking segment, higher margins from improving execution on term securitizations and sales during 2023 drove the improvement in mortgage banking income during the year, as term spreads tightened more significantly in the first quarter, then stabilized through the end of 2023. The benefit from higher margins was partially offset by lower funding volumes in 2023, as rising interest rates decreased demand for loans and we were more selective with the types of projects we financed in 2023. Going forward, we expect elevated benchmark interest rates will continue to pressure origination volumes, while we continue to see opportunities to refinance our bridge borrowers with term products.

The decrease in income from mortgage banking activities during 2022 was attributable to a $148 million decrease from our Residential Consumer Mortgage Banking operations and a $101 million decrease from our Residential Investor Mortgage Banking operations. The decrease from Residential Consumer Mortgage Banking operations was attributable to lower acquisition volumes as well as decreased margins during 2022, as a sharp increase in mortgage rates during 2022 drove credit spreads wider and contributed to an industry-wide decrease in residential mortgage origination activity. Despite increased volumes during 2022, Residential Investor Mortgage Banking income declined as compared to 2021, as continued market volatility and extreme credit spread widening in 2022 negatively impacted profitability.

A more detailed analysis of the changes in this line item is included in the “Results of Operations by Segment” section that follows.

Investment Fair Value Changes, Net

Investment fair value changes, net, is primarily comprised of the change in fair values of our investment portfolio assets that are accounted for under the fair value option and their associated interest rate hedges. During 2023, negative investment fair value changes were primarily driven by reductions in the value of our investments in reperforming loan securities (our investments in consolidated Freddie Mac SLST entities), which were negatively impacted primarily by rising interest rates, as well as reductions in the fair value of our overall BPL bridge loan portfolio, including certain non-performing and modified BPL bridge loans and unrealized losses on certain delinquent term loans.

The negative fair value changes were partially offset by fair value increases in IO securities and interest rate hedges, which benefited from rising interest rates. Fundamental performance of our residential consumer assets within our Investment Portfolio continues to be driven by strong employment data, embedded equity protection and home price appreciation associated with loan seasoning and borrowers motivated to stay current on their low-coupon mortgages.

During the year ended December 31, 2022, negative investment fair value changes reflected extreme levels of credit spread widening across many of our longer-duration, fixed-rate investments, partially offset by fair value increases in our IO securities and interest rate hedges, which benefited from rising interest rates.

Additional detail on our investment fair value changes is included in the “Results of Operations by Segment” section that follows.

HEI Income, net

In 2023, we changed the presentation of our Consolidated Statements of Income (Loss) to include a new line item "HEI income, net" to include all amounts related to our HEI investments that were previously presented within "Investment fair value changes, net." All applicable prior period amounts presented in this document were conformed to this presentation.

In 2023, HEI Income, net increased by $32 million. HEI income is primarily comprised of recurring accretion of the underlying option value of the investments over time based on estimated future home price appreciation and other factors, along with periodic fluctuations in value influenced by changing housing and other market conditions. HEI income in 2023 was primarily driven by this baseline accretion in value, while a smaller portion of the increase in value was driven by actual and projected trends in home prices improving relative to our modeled expectations at the beginning of the year. At the beginning of 2023 we projected negative home price appreciation for most of the year, and actual home price appreciation was positive for 2023 in most regions.

Details on the composition of HEI income, net is included in Note 10 in Part II, Item 8 of this Annual Report on Form 10-K.

Other Income

The decrease in other income for the year primarily resulted from $8 million of lower income on our MSR investments. MSR income was nominally impacted by fair value changes in 2023 given the MSR's reduced sensitivity to rising interest rates during the year, while MSRs benefited significantly in 2022 as the sharp rise in interest rates caused a slowdown in prepayment speeds and was more impactful to valuations.

Details on the composition of other income is included in Note 21 in Part II, Item 8 of this Annual Report on Form 10-K.

Realized Gains, Net

In 2023, we realized net gains of $2 million, primarily resulting from the sales of $54 million of AFS securities, as well as from the repurchase of $81 million of our convertible debt.

In 2022, we realized net gains of $5 million, primarily resulting from calls associated with third-party AFS securities during the first quarter of 2022, as well as $2 million of gains on extinguishment of debt that resulted from the repurchase of $32 million of our convertible debt in the fourth quarter of 2022.

General and Administrative Expenses

Between the fourth quarter of 2022 and the first quarter of 2023, we implemented firm-wide initiatives to rationalize headcount and reduce non-compensation costs, contributing to a net headcount reduction of 26% since September 30, 2022 and reductions to fixed compensation expense of $10 million in 2023. Additionally, non-compensation expenses were reduced by $6 million in 2023. These decreases were partially offset by higher expenses for annual variable compensation associated with improved results year-over-year as well as higher long-term incentive award expense.

The decrease in general and administrative expenses for 2022 primarily resulted from the decrease in variable compensation expense associated with the decrease in earnings from 2021 to 2022. While expenses from long-term incentive awards increased in 2022 from new award grants, the expense for certain awards (PSUs, csDSUs and Cash Performance Awards) decreased approximately $3 million from 2021, due to negative adjustments (decreasing the expense) related to changes in vesting assumptions and decreases in our stock price during the year. These decreases in 2022 were partially offset by a $17 million increase in fixed compensation expense in 2022, primarily attributable to the acquisition of Riverbend in the third quarter of 2022, which added $5 million of costs in 2022, as well as from other ordinary course headcount additions in early 2022 and competitive wage increases for existing employees in 2022. Additionally, during the third and fourth quarters of 2022, we initiated various expense management initiatives, including the restructuring of our Residential Investor Mortgage Banking management team, and incurred $7 million of employee severance and related transition expenses.

Details on the composition of General and administrative expenses are included in Note 22 in Part II, Item 8 of this Annual Report on Form 10-K.

Portfolio Management Costs

These costs are primarily related to sub-servicing costs on our BPL bridge loans and HEIs, as well as costs incurred for the management of specially serviced BPL bridge loans and related workout arrangements. The increases in portfolio management costs in 2023 and 2022, resulted from growth in our investment portfolio during both years, as well as increased costs related to a higher balance of delinquent BPL bridge loans during 2023.

Loan Acquisition Costs

The decrease in loan acquisition costs in 2023 primarily resulted from lower loan origination and acquisition volumes in our mortgage banking segments in 2023, as compared to 2022.

Provision for Income Taxes

Our provision for income taxes is almost entirely related to activity at our taxable REIT subsidiaries, which primarily includes our mortgage banking operations and MSR investments, as well as certain other investment and hedging activities. The tax provision for the year ended December 31, 2023 reflects GAAP income earned at our TRS, resulting primarily from improved mortgage banking results.

The benefit from income taxes in 2022 resulted from GAAP losses at our TRS during the year associated with losses incurred at both our mortgage banking operations.

For additional detail on income taxes, see the “Taxable Income and Tax Provision” section that follows.

Other Comprehensive Income (Loss), net

Other comprehensive income in 2023 primarily resulted from net unrealized gains on our AFS securities, as improved market conditions in the second half of 2023, including spread tightening and rates moving off their 2023 highs through the end of the year, benefited valuations.

Other comprehensive loss, net in 2022 was primarily comprised of net unrealized losses on AFS securities, due to spread widening and rising benchmark interest rates.

For additional detail on other comprehensive loss, net, see Note 18 in Part II, Item 8 of this Annual Report on Form 10-K.

Net Interest Income

The following tables present the components of net interest income for the years ended December 31, 2023, 2022, and 2021.

Table 3 – Net Interest Income

Footnotes to Table 3

(1)Average balances for residential loans held-for-sale and held-for-investment, business purpose loans held-for-sale and held-for-investment, multifamily loans held-for-investment, and trading securities are calculated based upon carrying values, which represent estimated fair values. Average balances for AFS securities, short-term debt, long-term debt and certain ABS issued are calculated based upon amortized historical cost. Average balances for ABS carried at fair value are calculated based upon fair value.

(2)Interest income and interest expense at "Legacy Sequoia", "Sequoia", "Freddie Mac SLST", "Freddie Mac K-Series", "CAFL Term", and "CAFL Bridge" reflect activity from consolidated variable interest entities. While we consolidate these entities for GAAP reporting purposes, economically, we earn interest income from the securities we own in these entities, which is represented by the net interest income (interest income less interest expense) from these consolidated entities presented in the table above.

(3)We sold nearly all of our subordinate trading securities over the course of 2023 and our remaining trading securities at December 31, 2023 were interest-only securities, which generate a higher cash interest yield. This interest income is generally offset by a decline in fair value (recognized through investment fair value changes, net on our consolidated statements of income) related to the receipt of cash flows each period, resulting in a lower overall economic yield for these investments.

The following table details how net interest income changed on a consolidated basis as a result of changes in average investment balances (“volume”) and changes in interest yields (“rate”).

Table 4 – Net Interest Income - Volume and Rate Changes

Net Interest Income by Segment

The following table presents the components of net interest income by segment for the years ended December 31, 2023, 2022, and 2021.

Table 5 – Net Interest Income by Segment