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 second quarter of 2024, compared to the second quarter of 2023.

Consolidated Results of Operations

The following table presents the components of our net income for the three and six months ended June 30, 2024 and 2023.

Table 2 – Net Income

Net Interest Income

Net interest income decreased by $1 million for the three-month period ended June 30, 2024 and $3 million for the six-month period ended June 30, 2024. During the three and six-month periods, net interest income from our Investment Portfolio decreased, partially offset by an increase in net interest income from our Mortgage Banking operations in the same periods. The decrease in net interest income from our Investment Portfolio is primarily related to an increase in borrowing costs on debt facilities and ABS issued used to finance our investments within this segment. Furthermore, the increase in non-accrual loans and loans that were modified over the period to provide borrowers payment relief resulted in lower coupon income over the period. Net interest income from Residential Consumer Mortgage Banking operations increased $10 million and $18 million for the three and six-month periods, respectively, due to higher average residential consumer loan balances in 2024 as well as the result of certain hedging activities at our Residential

Consumer Mortgage Banking operations. Net interest income from our Residential Investor Mortgage Banking operations was relatively flat for these periods.

Corporate net interest expense increased $5 million during the three and six-month periods primarily related to higher cost corporate unsecured debt issued recently relative to repurchases and payoffs of older vintage, lower coupon convertible debt. In the first six months of 2024, we issued $60 million of 9.125% senior notes in January 2024, $85 million of 9.0% senior notes in June 2024 and procured a secured revolving financing facility with CPP Investments, which we drew on starting in the second quarter of 2024. Additionally, we earned lower interest income at the corporate level from lower average cash balances invested in U.S. treasury securities as compared to 2023, while not fully utilizing available leverage for our jumbo loan pipeline given the cost of warehouse debt relative to the coupon interest rates on the underlying loans we hold.

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. We maintained $332 million of unencumbered assets and $2.47 billion of excess warehouse capacity at June 30, 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 higher during the three-month periods, as a $1 million decrease from Residential Consumer Mortgage Banking activities was offset by a $3 million increase from Residential Investor Mortgage Banking.

In the Residential Consumer Mortgage Banking segment, loan purchase and lock volumes significantly increased in the three and six-month periods relative to the same periods in 2023, driven by an increase in loan purchases from both banks and independent mortgage bankers ("IMBs"). Notably, for the three-month periods, total lock volume was four times higher, bank lock volume was six times higher and IMB lock volume was three times higher in 2024. As a reminder, market transaction volume during the three months ended June 30, 2023 was impacted by the regional bank crisis which also caused considerable interest rate volatility during that time. Despite on-going elevated rates and pressure on housing transactions, these volume increases during the three months ended June 30, 2024 occurred as a result of focused efforts to build our network of bank sellers, adding 90 new or re-established bank sellers over the last year, as well as focusing on wallet share with our IMB sellers. As of June 30, 2024, our total network of loan sellers is 203, over half of which are banks. During the three and six months ended June 30, 2024, we also saw an increase in bulk volume, including seasoned bank collateral. We distributed $1.4 billion of jumbo loans during the second quarter of 2024, primarily through three Sequoia securitizations. For the second quarter of 2024, we earned gross margins of 72 basis points within this segment, relative to our historical range of 75 to 100 basis points. For the second quarter of 2024, cost per loan was 22 basis points, compared to 36 basis points in the first quarter of 2024 and our historical range of 30 to 35 basis points.

In the Residential Investor Mortgage Banking segment, income from mortgage banking activities decreased during the six-month periods due to lower margins and volumes experienced in the first quarter of 2024, as compared to the first half of 2023 as spreads tightened more significantly in the first quarter of 2023 and then stabilized. Funding volume and improved efficiencies in headcount and distribution execution in the second quarter of 2024 somewhat offset this decrease as income increased in the second quarter of 2024 relative to the first quarter of 2024. The increase in overall funding volumes during the three-month period ended June 30, 2024 is largely attributable to continued demand for bridge production combined with a renewed interest from borrowers for term production given an outlook for moderating rates as well as SAB and DSCR production. Net cost to originate improved to 0.99% during the three months ended June 30, 2024, compared to 2.49% for the three months ended March 31, 2024. Notably, distribution activity increased in the second quarter of 2024 with distributions of $415 million in both whole loan sales and joint venture distributions, relative to distributions of $59 million in the first quarter of 2024. In particular, we distributed our first pool of loans into our joint venture with CPP Investments, as well as sold $238 million of term loans to a large institutional investor, during the second quarter of 2024.

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 $1 million and $23 million during the three and six-month periods ended 2024, respectively, and primarily reflected improved credit performance and spread tightening on our securities portfolio, offset by negative investment fair value changes on our bridge loans. Investment fair value changes, net of associated interest rate hedges, on our securities portfolio totaled $40 million for the first half 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 $19 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 half 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. Notably, 90 day+ delinquencies on our SLST portfolio declined to 7.3% at June 30, 2024, compared to 9.1% at June 30, 2023.

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 6.4 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 $7 million and $12 million during the three and six-month periods, respectively. This increase was attributable to an increase in the net value of our securitized HEI entities of $4 million and $6 million during the three and six-month periods, respectively, and an increase in value of our unsecuritized HEI investments of $3 million and $6 million during the three and six-month periods, respectively. Increases in the valuations of our HEI portfolio have been the result of actual and projected trends in home price appreciation improving. 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.

Additional detail on our HEI income is presented in Table 11.3 of our Notes to Consolidated Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10-Q.

Operating Expenses

Operating expenses increased $7 million during both the three and six-month periods, primarily related to an increase in variable and equity compensation expense associated with improved operating results experienced in the first half of 2024, as well as increased portfolio management costs incurred for the management of specially serviced residential investor bridge loans and related workout arrangements incurred in the first half of 2024. This increase was partially offset by lower operating expenses due to a decrease headcount in the first quarter of 2024, as we effected an organizational restructuring and aligned expenses with the evolving operating environment.

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.

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 switch to a tax provision from a benefit from income taxes year-over-year was primarily the result of GAAP income earned at our TRS in the first half of 2024 compared to a GAAP loss in the first half of 2023.

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