REDWOOD TRUST INC

RESULTS OF OPERATIONS

Within this Results of Operations section, we provide commentary that compares results year-over-year for 2024 and 2023. Most tables include a "change" column that shows the amount by which the results from 2024 are greater or less than the results from the respective period in 2023. Unless otherwise specified, references in this section to increases or decreases during the "three-month periods" refer to the change in results for the first quarter of 2024, compared to the first quarter of 2023.

Consolidated Results of Operations

The following table presents the components of our net income for the three months ended March 31, 2024 and 2023.

Table 2 – Net Income (Loss)

Net Interest Income

Net interest income decreased by $2 million for the three-month periods primarily as a result of a decrease in net interest income from our Investment Portfolio of $11 million, partially offset by an increase in net interest income of $8 million from our Mortgage Banking operations. The decrease in net interest income from our Investment Portfolio for the three-month periods is primarily related to an increase in borrowing costs on long-term debt facilities and ABS issued used to finance our investments within this segment. Furthermore, the increase in non-accrual loans over the period resulted in lower net interest income. Net interest income from Residential Consumer Mortgage Banking operations increased $7 million for the three-month periods due to higher average residential consumer loan balances starting during the second quarter of 2023 as well as the result of certain hedging activities at our Residential Consumer Mortgage Banking operations.

Corporate net interest expense decreased $1 million during the three-month periods primarily related to lower average balances of our corporate debt as we retired the convertible debt which matured in August 2023, and repurchased in the open market some of our outstanding convertible debt over the last year across our other maturities, offset by our issuance of $60 million, 9.125% senior notes in January 2024. Additionally, we earned higher interest income at the corporate level from higher average cash balances invested in U.S. treasury securities (at a higher weighted average rate) or from financing a portion of our jumbo pipeline with cash rather than utilizing warehouse line financing.

We use a combination of fixed and floating rate debt to finance our fixed and floating rate investments. Over the past year, continued increases in benchmark interest rates, and to a lesser extent borrowing spreads, negatively impacted our net interest income. We also established financing capacity for non-performing loans which generally carry higher borrowing costs, however, these activities freed up additional capital to invest. 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. We maintained $370 million of unencumbered assets and $2.69 billion of excess warehouse capacity at March 31, 2024.

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

Mortgage Banking Activities, Net

Overall income from Mortgage banking activities, net was lower during the three-month periods, as a $4 million increase from Residential Consumer Mortgage Banking activities was offset by a $7 million decrease from Residential Investor Mortgage Banking.

In the Residential Consumer Mortgage Banking segment, loan purchase and lock volumes significantly increased from the first quarter of 2023 and continued through the end of the first quarter 2024 driven by an increase in loan purchases from banks and IMBs. We securitized or sold $1.4 billion of jumbo loans during the first quarter of 2024, including the securitization of $1.2 billion of loans across three Sequoia securitizations. Following the end of the first quarter of 2024 we completed a securitization of an additional $400 million of loans in our fourth Sequoia securitization of 2024. For the first quarter of 2024, we earned gross margins of 107 basis points, above our historical range of 75 to 100 basis points. In the first quarter of 2023, we had distributions of $686 million of loans completed through two securitizations of $657 million and whole loan sales of $29 million.

In the Residential Investor Mortgage Banking segment, income from mortgage banking activities decreased during the three-month periods due to lower overall funding volumes and lower overall margins. The decrease in overall funding volumes during the three-month periods is largely attributable to a combination of the increase in interest rates throughout 2023, combined with heightened selectivity on loan originations particularly in the multifamily space. Going forward, while we expect these trends to continue, in light of continued elevated interest rates, we are seeing continued borrower demand for certain of our products, with growing demand for products such as single-asset bridge and debt-service coverage ratio loans. To the extent interest rates moderate or move lower, we could see increased opportunities for our term loan production from current levels.

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 portfolio investments accounted for under the fair value option and their associated interest rate hedges. Investment fair value changes, net totaled $22 million during the first quarter of 2024 and benefited from tightening of credit spreads across our securities portfolio. Investment fair value changes, net of associated interest rate hedges, on our securities portfolio totaled $30 million for the first quarter of 2024, all of which primarily related to increases in value in our Sequoia, CAFL Term and SLST securities retained from these consolidated securitizations. This increase was offset by negative investment fair value changes of $4 million related to impairments and the impact of rate modifications on the values of our unsecuritized residential investor bridge and term loan portfolios during the first quarter of 2024, all of which we hold at fair value. Fundamental performance of our residential consumer assets within our Investment Portfolio continues to be driven by strong employment data, embedded equity protection associated with loan seasoning and borrowers motivated to stay current on their low-coupon mortgages.

During the three months ended March 31, 2023, investment fair value changes, net totaled negative $4 million and related primarily to our securities portfolio, net of associated interest rate hedges. While fundamental credit performance, including delinquencies and LTVs, remained stable across the broader portfolio in the first quarter of 2023, negative fair value changes incurred during the quarter on our CAFL securities were primarily driven by a credit event on a single asset underlying a retained bond. Additionally, certain fair value increases from interest rate movements on our RPL securities were mostly offset by decreases in values of associated risk management derivatives.

Additional detail on our investment fair value changes during 2024 is included in the “Results of Operations by Segment” section that follows as well as Table 5.6 of our Notes to Consolidated Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10-Q.

HEI Income, net

HEI income, net increased $5 million during the three-month periods, reflecting an increase of $2 million in our net investment in our securitized HEI entities, and an increase of $2 million in our unsecuritized HEI investments. 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. 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. HEI income in 2023 and into the first quarter of 2024 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, as well as realized value of options that were redeemed by underlying borrowers.

Additional detail on our other income is presented in Table 10.3 of our Notes to Consolidated Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10-Q.

Other Income, net

Other income, net for the first quarter of 2024 of $5 million was primarily comprised on MSR income, net of $4 million, which included positive MSR market valuations of $2 million. Other income, net for the first quarter of 2023 of $5 million, included MSR income, net of $1 million, which included negative MSR market valuations of $1 million. as well as fees and other income from Residential Investor Mortgage Banking.

Additional detail on our other income is presented in Table 21.1 of our Notes to Consolidated Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10-Q.

Realized Gains, Net

During the three months ended March 31, 2024, we realized gains of $0.4 million resulting from the repurchase of $31 million of our convertible debt maturing in 2024 and 2027 for a net gain on extinguishment of debt of $0.1 million, as well as the repurchase of $7 million of CAFL bridge ABS for a net gain on extinguishment of debt of $0.3 million. During the three months ended March 31, 2023, we realized $1 million of loss on early extinguishment of securitization debt financing certain of our reperforming loan securities, which was mostly offset by nominal gains on sales and calls of securities.

General and Administrative Expenses

General and administrative expenses decreased $1 million during the three-month periods primarily related to a decrease in variable and equity compensation expense of $3 million. During the first quarter of 2024, we implemented a reduction in workforce of 15% of our employees. General and administrative expenses for the first quarter of 2024 included $2 million of fixed compensation expense and $1 million of equity compensation expense related to this organizational restructuring. The decrease in variable and equity compensation expense for the periods primarily relates to a reduction in employee headcount over the last twelve months.

Additional detail on our General and administrative expenses is presented in Table 22.1 of our Notes to Consolidated Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10-Q.

Portfolio Management Costs

These costs are primarily related to sub-servicing costs on our residential investor bridge loans and HEI, as well as costs incurred for the management of specially serviced residential investor bridge loans and related workout arrangements. Portfolio management costs during the three-month periods were slightly higher during the 2024 period and overall resulted from higher carrying balances of residential investor bridge loans and HEI within our investment portfolio since the beginning of 2023, as well as increased costs related to a higher balance of delinquent residential investor bridge loans during 2023 and into the first quarter of 2024.

Loan Acquisition Costs

The increase in loan acquisition costs during the three-month periods is primarily related to higher residential consumer loan lock volumes as well as an increase in servicing fees related to our residential investor mortgage banking segment.

Provision for Income Taxes

Our provision for income taxes is almost entirely related to activity at our taxable REIT subsidiaries ("TRS"), which primarily includes our mortgage banking activities and MSR investments, as well as certain other investment and hedging activities. The tax provision for the three-months ended March 31, 2024 reflects GAAP income earned at our TRS during this period, resulting primarily from MSR investments held at our TRS. The tax benefit for the three months ended March 31, 2023 was primarily the result of GAAP losses from our mortgage banking operations at our TRS during that period.

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

Other Comprehensive Income, Net

Other comprehensive income, net for the three months ended March 31, 2024 resulted from unrealized gains on our available-for-sale securities, primarily resulting from tightening of credit spreads.

For additional detail on other comprehensive loss, net, see Note 18 of our Notes to Consolidated Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10-Q.