REDWOOD TRUST INC

Our Business

Redwood Trust, Inc., together with its subsidiaries, is a specialty finance company focused on several distinct areas of housing credit, with a mission to help make quality housing, whether rented or owned, accessible to all American households.. Our operating platforms occupy a unique position in the housing finance value chain, providing liquidity to growing segments of the U.S. housing market not well served by government programs. We deliver customized housing credit investments to a diverse mix of investors through our best-in-class securitization platforms, whole-loan distribution activities and our publicly-traded securities. Our aggregation, origination and investment activities have evolved to incorporate a diverse mix of residential consumer and investor housing credit assets. Our goal is to provide attractive returns to shareholders through a stable and growing stream of earnings and dividends, capital appreciation, and a commitment to technological innovation that facilitates risk-minded scale. We operate our business in three segments: Residential Consumer Mortgage Banking, Residential Investor Mortgage Banking, and Investment Portfolio. In the fourth quarter of 2023, we updated the names of two of our segments: Residential Mortgage Banking was changed to Residential Consumer Mortgage Banking; and Business Purpose Mortgage Banking was changed to Residential Investor Mortgage Banking. No changes were made to the composition of the segments. Our two mortgage banking segments generate income from the origination or acquisition of loans and the subsequent sale or securitization of those loans. Our investment portfolio is comprised of investments sourced through our mortgage banking operations as well as investments purchased from third-parties, and generates income primarily from net interest income and asset appreciation.

Redwood Trust, Inc. has elected to be taxed as a real estate investment trust (“REIT”). We generally refer, collectively, to Redwood Trust, Inc. and those of its subsidiaries that are not subject to subsidiary-level corporate income tax as “the REIT” or “our REIT.” We generally refer to subsidiaries of Redwood Trust, Inc. that are subject to subsidiary-level corporate income tax as “our taxable REIT subsidiaries” or “TRS.”

For a full description of our segments, see Part I, Item 1—Businessin this Annual Report on Form 10-K.

Business Update

Over the past twelve months, as housing activity hit record lows and the banking sector became mired in crisis, we created substantial capital flexibility through reducing recourse leverage and extending the overall tenor of corporate debt maturities. We continued to build relationships with regional banks in response to proposed Basel III bank capital rules, the most significant bank regulatory reform proposal since the Great Financial Crisis. In conjunction, we have repositioned our balance sheet and operations to seek to take advantage of the expected increase in loan volume that will be financed through the private markets, and the institutional capital seeking to access such loans.

In the fourth quarter, we completed five securitizations across our business lines, including three specific to our Investment Portfolio. These three transactions reduced recourse leverage by $200 million and organically unlocked $100 million of capital. In addition, we raised capital through our At-the-Market (“ATM”) equity issuance program with significant participation from institutional investors. To date in the first quarter of 2024, we have been actively deploying this capital at an estimated mid-teens blended return, balanced between our mortgage banking platforms and the retirement of our long-term convertible debt at a discount. We believe current capital deployment opportunities exist with illustrative returns between 15-20% for mortgage banking opportunities, 12-18% for organically retained securities and joint-venture co-investments, 8-10% for opportunistic retirement of our unsecured debt, and 15-20% for opportunistic third-party investments. Our ability to deploy capital expeditiously and at similar levels to where we estimate returns are today are both important factors to realize the earnings accretion potential from the capital raised.

In mid-January 2024 we completed Redwood’s first unsecured corporate debt offering, which carries a 5-year maturity and no conversion feature. Like much of our secured debt, this offering is redeemable prior to its stated maturity. Given the high interest cost of debt available in the current market, the ability to refinance our debt if and when markets improve has potentially significant value. Optimizing and strengthening our capital position will continue to be a priority as we look to continue deepening our relationships with our network of jumbo loan originators and housing investors. With $396 million of unrestricted cash at February 16, 2024, along with $290 million of unencumbered assets and $2.1 billion of excess warehouse capacity at year-end 2023, we have expanded our ability to be opportunistic.

Our strategic reallocation of capital also remains a priority, as we focus on de-emphasizing direct portfolio investing in favor of co-investments in joint venture partnerships with private credit institutions. To date, we have successfully formed one joint venture specific to our residential investor loan production and we continue to work towards establishing others across our business to meet the capital needs of our operating platforms. We expect this strategic shift to carry with it a number of benefits to our shareholders. Firstly, these ventures are formed with capital providers who have long-term, strategic allocations to our core mortgage banking product offerings. Secondly, these joint ventures may create reliable distribution channels with the capacity to enhance our liquidity and pricing, supporting predictable revenues and profitability. Similar to our current joint venture, we would receive recurring fee streams earned in overseeing these joint ventures in addition to our share of the investment returns. These joint ventures help us organically scale our operating platforms at a much faster pace than we could achieve solely with our own capital, given we would represent the minority of total capital they deploy.

With respect to sourcing more residential investor and consumer loans to distribute to current and future joint venture partnerships, we remain optimistic that the prospect of major bank regulatory rule changes, coupled with the financial pressures that many depositories already face, will lead more of these institutions to pair their residential mortgage business with Redwood’s capital. This could in turn support an increase in loan acquisition and origination volumes for our operating platforms. The Basel III regulatory changes proposed last year are likely to take shape in some form, and many banks are beginning to adjust in advance of adoption of final rules. Despite strong profits for many large banks and lobbyist opposition to higher capital rules, many banks still require additional risk capital, or an outside capital partner, to prudently manage the asset-liability exposures that 30-year fixed rate mortgage portfolios pose.

With that in mind, we continue to onboard bank loan sellers, ending the year having secured new or renewed jumbo flow relationships with almost 70 banks. We now estimate that we have connectivity with loan sellers that control 60% of residential jumbo origination volume. Banks accounted for over half of our quarterly residential consumer lock volume in the fourth quarter of 2023. Onboarding new bank loan sellers can be challenging, not only from a workflow perspective, but also due to the cultural shift that working with an outside platform, like Redwood's, often requires. As these valued loan sellers make the transition to working with us, we have the opportunity to demonstrate our expertise, speed to close, customized product solutions, and seamless execution.

As activity with bank loan sellers increases, it is important to note that our commitment to our base of non-bank loan sellers remains steadfast. These institutions are already accustomed to transacting with platforms such as Redwood's. Their capital markets prowess comes as second nature, and they provided steady liquidity to the housing market as many bank lenders stepped back amidst last year’s volatility. The message we emphasize to all of our loan sellers is the same: we will enable you to operate more safely, reliably and efficiently.

To complement our focus on first-lien residential loans, we have continued to invest in our new home equity investment platform, Aspire. Today, home equity remains an attractive market in housing finance, estimated at over $30 trillion. With housing affordability at its lowest level in decades, homeowners continue to look for innovative ways to access the equity in their homes. Since launching Aspire, which leverages our existing loan seller network and infrastructure, we have grown our operating footprint to five states with plans to extend to as many as 15 states in the coming months. Over the last few quarters, we have begun collaborating with our loan sellers to offer our HEI product to their clients. To complement this rollout and the opportunity in home equity broadly, in early 2024 we also launched a program to acquire traditional second lien mortgage products from our seller network, creating a unique, coordinated solution set for them as they service demand for home equity products from their customers.

Our Residential Investor loan platform, CoreVest, is also beginning to benefit from the pullback by banks as they anticipate higher capital requirements. Borrowers who have historically procured funding from banks now actively seek out our platform for solutions. Continuing since the third quarter of 2023, we have been advancing negotiations with several banks on partnership opportunities that would allow us to access their existing pipelines with an eye toward offering our broad product set and deep capital markets experience. Both the pullback from banks as well as various market technicals could create a constructive environment for us to grow Residential Investor loan origination volumes in the year ahead.

We also continue to work closely with Residential Investor borrowers who are experiencing financial stress, particularly within our multifamily bridge portfolio. Two years of rapidly rising rates has resulted in higher debt costs and extended timelines for certain multifamily projects originated in 2021 and the first half of 2022, causing divergence in performance between our single-family and multifamily bridge portfolios. We continue to actively manage this exposure, recasting loans, extending timelines and working with borrowers to bring in fresh capital. This work helps to position their projects, and our portfolio performance, for greater success. These loans are in many cases supported by significant equity, finance housing stock that remains in short supply, and were underwritten within conservative debt yield parameters and rental growth assumptions.

We deliberately curtailed multifamily bridge originations beginning in the third quarter of 2022, and overall exposure to multifamily bridge loans now totals 13% of our total capital. Importantly, the shorter average term of our bridge loans has allowed us to continue recalibrating underwriting assumptions for new projects with the trajectory of interest rates, relegating most of the credit challenges within our portfolio to loans originated 18 to 24 months ago.

As we enter a period of heightened scrutiny for commercial real estate financing, overall, we would note that our business remains focused on residential housing finance, whether engaged in single-family or multifamily residential real estate. Additionally, at December 31, 2023, nearly all of the investments on our balance sheet were marked to market through our GAAP income statement. Therefore, our book value at year-end 2023 reflects, among other fair value changes, accumulated fair value declines on our overall bridge loan portfolio that is not just related to delinquent loans. Additional detail on our bridge loan portfolio, as well as all other aspects of our business and portfolio follows in this Management Discussion and Analysis.

2023 Financial and Operational Overview

This section includes an overview of our 2023 financial results. A detailed discussion of our results of operations is presented in the next section of this MD&A. The following table presents selected financial highlights from 2023 and 2022.

Table 1 – Key Financial Results and Metrics

(1) Economic return on book value is based on the periodic change in GAAP book value per common share plus dividends declared per common share during the period.

We conduct our business in three segments: Residential Consumer Mortgage Banking, Residential Investor Mortgage Banking and Investment Portfolio. Following is an overview of key financial and operational results at each of our segments during 2023.

Residential Consumer Mortgage Banking

In line with the rapid rise in benchmark interest rates, mortgage rates continued to increase during much of 2023 to their highest levels since 2008. Mortgage rates hit their peak in October 2023 before moving lower into the end of the year given the decrease in 10-year Treasury yields. As a result of the elevated mortgage rates, transaction volumes for the broader industry remained muted. As estimated by the Mortgage Banker’s Association (“MBA”) Mortgage Finance Forecast, total 1 to 4 family mortgage loan origination volumes were down 27% in 2023 relative to 2022. A combination of low inventory of homes for sale and low incentives for families to relocate or refinance kept the volume of both purchase and refinance mortgage loan originations low, down 16% and 53% year over year, respectively.

While industry volumes were impacted by rates and broader housing market macro factors, additional dynamics ultimately impacted our full year volumes. In particular, fall-out from the regional bank crisis in March 2023 changed the way certain banks approach originating mortgages, a trend which is expected to continue. For years, many banks had elected to own the mortgages that they originated on their balance sheets. As capital and liquidity were stressed for many banks beginning in March 2023, banks were forced to re-evaluate their balance sheets, particularly how they funded the mortgages that they originated. In July 2023, the Board of Governors of the Federal Reserve also released newly proposed risk-based capital rules for the U.S. banking system. While the capital rules are not yet finalized and the timeline for any implementation remains uncertain, these rules are also anticipated to impact banks' liquidity and capital requirements in some form. As a result, banks have sought outlets for their mortgage loan originations beyond their own portfolios and, in the months since the regional banking crisis, we added 68 new or re-established depositories as loan sellers. Much of our lock volume in the second half of 2023 came from these new or re-established depository relationships. As a result of this evolving landscape, we locked $2.8 billion of jumbo loans in the second half of 2023, compared to just $0.7 billion in the first half of the year. Total 2023 jumbo lock volume was $3.5 billion, down from $4.1 billion in 2022.

Given the pick-up in lock activity in the second half of the year, capital markets activity also increased and we priced three securitizations in the second half of 2023, compared to two securitizations in the first half of 2023. We distributed $1.8 billion of loans in 2023, including $1.7 billion through five securitizations and $126 million through whole loan sales. This compared to $4.5 billion of loan distribution activity in 2022, which included $0.7 billion in securitization and $3.8 billion in whole loan sales. A healthy securitization market, combined with successful execution and investor demand in the second half of the year supported our gain on sale margins.

Residential Investor Mortgage Banking

During 2023, our Residential Investor Mortgage Banking segment, through activities at our wholly owned subsidiary, CoreVest, continued to offer residential real estate investors its broad suite of bridge and term loan products against a challenging market backdrop. The higher rate environment, which persisted across much of the year, challenged business plans for borrowers and negatively impacted overall industry volumes. While consumer demand for rental housing remains elevated given constrained housing inventory and low housing affordability, actual funded loan volumes at CoreVest were tempered by the elevated rate environment. We ultimately funded $1.6 billion of loans in 2023, compared to $2.8 billion in 2022. As rates remained elevated throughout 2023, housing investors continued to favor short-term, floating rate bridge loans over locking into longer fixed-rate term loans with stronger prepayment protection features. In 2023, our loan fundings were comprised of 33% term loans and 67% bridge loans. This compared to 39% term loans and 61% bridge loans in 2022.

Within our bridge products, funding by product migrated year over year, particularly as we remained focused on sponsor/borrower selectivity. In 2023, 66% of total bridge fundings supported renovation or construction of residential properties with a primary sponsor strategy of stabilization as opposed to sale (Renovate or Build for Rent, "BFR"), 18% were Single Asset Bridge (“SAB”) loans, 14% financed multifamily properties and 2% were third-party purchased. This compared to 43% for Renovate/BFR, 8% for SAB, 46% for multifamily and 2% for third-party purchased, in 2022. Our acquisition of Riverbend Funding, LLC ("Riverbend"), which closed in 2022, and benefited from its first full year of integration with the CoreVest platform in 2023, largely drove the increase in SAB production year over year. The decline in multifamily bridge production year over year was largely driven by increased selectivity and tighter underwriting on sponsors and loan production. As the higher rate environment persisted in 2023, we continued to adjust our underwriting, including lowering loan-to-value (“LTV”) and loan-to-cost (“LTC”) limits, increasing stabilized debt yield requirements and further stressing the viability of take-out financing for our sponsors.

We continued to successfully distribute loans through multiple channels during the year, distributing $1.5 billion of loans in 2023, compared to $1.3 billion in 2022. Despite the challenging market backdrop, we made progress in growing our distribution efforts through expanding our whole loan buyer base and selling $603 million of whole loans. Additionally, we issued another bespoke private securitization to one investor, backed by $278 million of loans.

Investment Portfolio

At December 31, 2023, Redwood had $3.4 billion of housing credit investments in our Investment Portfolio, compared to $3.7 billion as of year-end 2022 (in each case reflecting our economic interests – see Table 11 that follows for additional details). Of these, 80% were organically created through Redwood’s Residential Consumer and Residential Investor Mortgage Banking platforms, while the remaining 20% were purchased from third-parties.

Our focus during the year was around portfolio efficiency and optimization. To that end, we reduced our exposure in 2023 to non-strategic third-party investments, selling $140 million of such securities (for net gains of $9 million relative to their prior marks) and redeployed the proceeds into our organic investments and mortgage banking operations. Related to portfolio optimization, we completed three securitizations out of our Investment Portfolio (all in the fourth quarter of 2023). These securitizations included our reperforming loan securities, HEI and BPL bridge loans. Combined, these three securitizations reduced recourse leverage and unlocked capital for redeployment. We ended 2023 with 0.9x of secured recourse leverage in our Investment Portfolio. At December 31, 2023, we estimate that our Investment Portfolio had a net discount to par of $2.68 per share, compared to an estimated $4.33 per share of net discount at December 31, 2022.

Spread widening and the selloff in interest rates during most of 2023 continued to impact the fair values of our Investment Portfolio, though we did see some recovery in the fourth quarter as rates moved off of their 2023 highs and spreads tightened. Negative overall fair value changes were concentrated in our BPL bridge loan portfolio, which were partially offset by benefits on interest only and mortgage servicing related investments.

Fundamental credit performance across our residential consumer loan investments remained strong during 2023, and we generally saw declining delinquencies and LTVs, continued seasoning and strong cash flows. 90 day+ delinquencies for our SLST (RPL) investments were 8.4% at December 31, 2023 compared to 12.4% at December 31, 2022. 90 day+ delinquencies for our SEMT investments were 0.2% at December 31, 2023 compared to 0.2% at December 31, 2022. 90 day+ delinquencies for Other Third-Party Securities were 0.6% at December 31, 2023 compared to 0.2% at December 31, 2022.

Our Residential Investor related securities and investments experienced some stress during 2023, with delinquencies on our CAFL securities and bridge loans moving higher during the year as sponsors/borrowers were faced with the challenges of a higher rate environment. Our asset management team was active throughout the year connecting with borrowers well ahead of their loan maturities to assess and work through any pockets of stress. 90 day+ delinquencies for our CAFL term loan securities were 3.7% at December 31, 2023, compared to 1.5% at December 31, 2022, and 90 day+ delinquencies for our bridge loans were 5.1% at December 31, 2023, compared to 2.0% at December 31, 2022, along with higher balances of REO associated with our bridge loans year-over-year.

During the year, we launched our in-house home equity investment (“HEI”) origination platform, Aspire. This effort followed multiple years of investing directly in HEI originated by third-party originators.

RWT Horizons

During 2023, the focus for our RWT Horizons team was on portfolio management. We continued to selectively expand RWT Horizons, our investment initiative focused on early-stage technology companies with business plans focused on innovations that we believe can disrupt the mortgage finance landscape. Through RWT Horizons, we aim to extract value at more points along the mortgage value chain, thereby making us a more meaningful partner to the broad network of market constituents to whom we provide liquidity, and building relationships designed to benefit all parties. Our investments continue to focus on companies that have a direct nexus to our operating platforms and investment portfolio.

In 2023, the extreme volatility that public technology companies saw permeated its way through valuations and the fundraising environment for late-stage companies, and ultimately earlier stage companies as well. At December 31, 2023, we had $25 million of capital committed to RWT Horizons, representing 34 investments across 27 portfolio companies. During 2023, we made 7 investments, representing $1.9 million of commitments; of these, three were follow-on investments in existing RWT Horizons portfolio companies. Additionally, during 2023, RWT Horizons had one portfolio exit and twelve RWT Horizons portfolio companies completed follow-on capital raises, with two of those raises being done at valuations below that of their prior capital raise.