# REDWOOD TRUST INC (RWT) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from REDWOOD TRUST INC's 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/930236/000162828022004027/rwt-20211231.htm
Accession: 0001628280-22-004027
Filing date: 2022-02-25
Report date: 2021-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/RWT/
All MD&A years: /company/RWT/mda/
Next year: /company/RWT/mda/fy2022/ (FY 2022)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

INTRODUCTION

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in six main sections:

•    Overview

•    Results of Operations

–Consolidated Results of Operations

–Results of Operations by Segment

–Income Taxes

•    Liquidity and Capital Resources

•    Critical Accounting Estimates

•Market and Other risks

Our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes included in Part II, Item 8, Financial Statements and Supplementary Data of this Annual Report on Form 10-K. References herein to “Redwood,” the “company,” “we,” “us,” and “our” include Redwood Trust, Inc. and its consolidated subsidiaries, unless the context otherwise requires. The discussion in this MD&A contains forward-looking statements that involve substantial risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, such as those discussed in the Cautionary Statement in Part I, Item 1, Business and in Part I, Item 1A, Risk Factors of this Annual Report on Form 10-K.

OVERVIEW

Our Business

Redwood Trust, Inc., together with its subsidiaries, is a specialty finance company focused on several distinct areas of housing credit. 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, business purpose and multifamily 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 Mortgage Banking, Business Purpose Mortgage Banking, and Investment Portfolio.

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—Business in this Annual Report on Form 10-K.

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Business Update

The fourth quarter of 2021 completed a transformative year for our Company. During 2021, our operating platforms continued to profitably scale, and we executed on our capital deployment goals while advancing key strategic objectives in technology and in our mortgage banking activities. For fiscal year 2021, we produced a 25% return on equity, delivered four consecutive quarterly dividend increases, generated an annual total shareholder return ("TSR") of over 60%, and recorded a 22% increase in book value year-over-year. Going forward, we believe the diversity of our revenue streams, notably the resiliency they have shown in the past during periods of rising interest rates, positions us well to navigate current market conditions.

As we ended 2021 and entered 2022, the interest rate environment has quickly become challenging for mortgage companies. The economy continues to be impacted by the COVID-19 pandemic, inflation has reached a 40-year high, and the Federal Reserve has signaled its expectation to react with an aggressive response to tighten monetary policy. Higher interest rates are already reflected in benchmark yields that recently reached their highest levels since 2019. Moreover, the global economic outlook has been clouded by tensions and hostility between Russia and Ukraine, introducing additional uncertainty into financial markets.

As a housing finance company, we confront many of the same challenges as other market participants, but important differences underpin our business opportunities. We believe Redwood’s business model is not as dependent as others on low interest rates, quantitative easing, or market expectations of strong economic growth. For example, during the last cycle of rising interest rates that began in late 2015, Redwood's book value increased as long-term interest rates rose and inflation expectations fell. We believe our model has evolved even further since that time to include revenue streams less correlated with the direction of changing benchmark interest rates.

A key example of this strategic evolution has been our expansion into business purpose lending (“BPL”), which began in 2018 and allowed us to access a growing cohort of investors seeking to refurbish antiquated housing stock for resale or rent. Our Business Purpose Mortgage Banking business serves large and growing markets not fully addressed by government lending programs, and as such is positioned to generate recurring revenue streams. Our BPL business has provided balance and depth to our mortgage banking platform across a variety of interest rate and credit scenarios.

Our BPL platform funded over $700 million of loans during the fourth quarter of 2021, including over $340 million in December 2021, contributing to overall funding of $2.3 billion for the full year, significant milestones for the platform. Having recently completed $15 billion in loan closings since its inception, CoreVest continues to scale while serving borrowers efficiently. Our BPL platform also continues to broaden its distribution capabilities, including by selling approximately $200 million of single-family rental loans to a large institutional buyer during the fourth quarter of 2021.

Our CoreVest BPL platform enters 2022 with a significant pipeline of activity and a strong outlook. Consistent growth in demand for single-family rentals continues to attract increased equity capital to this market, a trend we expect to continue even as interest rates rise. Business purpose loans generally feature either a floating interest rate for the duration of the loan, or sometimes a fixed rate that is determined shortly prior to funding, mitigating the interest rate exposure market participants incur in managing a traditional residential mortgage pipeline. We have recently experienced an increase in demand for financing from CoreVest’s borrower base, evidenced by higher origination volumes across all lending products, particularly in the build-for-rent and multifamily sectors. We also see opportunities to enhance our direct origination capabilities through third-party loan acquisition channels, the expansion of our new residential transition loan ("RTL") securitization platform, and opportunities to further scale our platform through partnerships or additional acquisitions.

Our Investment Portfolio deployed $222 million of capital into investments in the fourth quarter of 2021, the most in a single quarter since the pandemic began. This included $135 million in third-party investments, demonstrating our ability to capitalize on challenging market conditions. Our purchases included agency credit risk transfer ("CRT") securities as well as home equity investments (“HEI”), following our securitization of HEI in the third quarter of 2021. We also continued to call securities backed by seasoned jumbo and single-family rental loans at attractive prices, which provides us a future opportunity to sell or re-securitize the underlying loans. Despite moderately slowing prepayment speeds, our near- to medium-term outlook for call activity remains heightened given the strong housing market. Market conditions to date in the first quarter of 2022 are negatively impacting the value of many of our current portfolio assets; however, at the same time they are creating favorable market conditions to deploy our available capital, and we continue to find ways to raise additional capital accretively through innovative distribution channels and efficient capital management programs. Our approach has allowed us to remain opportunistic while funding near-term capital needs for our operating and investing platforms.

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Our Residential mortgage banking platform encountered challenging market conditions in the fourth quarter of 2021 while still managing strong performance relative to peer companies. These challenging conditions have continued into the first quarter of 2022. We took a conservative risk management approach late in 2021, maintaining gain on sale margins at the higher end of our historical range of 75 - 100 basis points on lower loan acquisition volumes, as large loan inventories across the industry pressured loan pricing and margins. We issued three Sequoia securitizations with a combined $1.3 billion principal amount of residential loans in the fourth quarter of 2021. Notably, two of the three securitizations were placed with investors without relying on a traditional marketing process, providing us greater certainty with respect to loan sale margins. We also incorporated new ESG-related metrics into our securitization disclosures, following the enhanced transparency we had previously added by utilizing blockchain technology to provide securitization investors with more timely remittance reporting information on the loans in our Sequoia securitization transactions.

In 2022, we expect a year of transition for the consumer residential mortgage market and we believe Redwood is still positioned to continue supporting the needs of home buyers. Refinance volumes will likely be lower due to rising rates and will likely lead to contractions for mortgage originators with excess capacity until margins stabilize, but the quality of our seller network is demonstrated with nearly 60% of our lock volume during the fourth quarter of 2021 being in purchase-money loans. Continued volatility into January and February 2022 can also provide opportunities to source loans through bulk acquisition, as market participants re-evaluate distribution strategies. We also expect a renewed focus by originators toward expanded credit loan products in 2022, to assist home buyers who are likely to experience declining purchasing power as mortgage rates rise. We have been actively preparing for this market shift for months, especially as home prices in more geographies across the country exceed conforming loan limits, where access to homeownership will increasingly rely on the jumbo residential mortgage loans we purchase.

While last year’s substantial home price appreciation had a proportional impact on increasing GSE loan limits, recent adjustments by the FHFA to the GSEs’ pricing regime for certain high balance and second home mortgage products will be an important factor contributing to the preservation of the role of private capital in this market. We anticipate that these GSE pricing adjustments will result in more high balance and second home loans flowing into the private market. We support these recent actions by the FHFA and anticipate, as we have in years past, playing a meaningful role in providing liquidity to these borrowers. For our Residential business overall, the goal is to capture increased market share in 2022, with an emphasis on our expanded credit programs that represented up to 40% of our total loan acquisition volume as recently as late 2019. We believe we are positioned to continue growing market share through the differentiated quality of our service and our broad array of mortgage banking activities.

Technology continues to play a key part in our business strategy. During 2021, the inaugural year of our RWT Horizons venture investing initiative, we completed 15 investments in companies with a direct nexus to our operating platforms, including five new investments during the fourth quarter. Our reputation in venture investing has grown significantly in recent months, with many new startups actively seeking the type of strategic capital that Redwood can provide. Though RWT Horizons represents a departure from traditional portfolio investing, we expect our RWT Horizons’ investments to deliver valuable technology and other innovative efficiencies to our platforms in 2022 while providing option value to shareholders. Our goal by the end of 2022 is to have $50 to $100 million of capital allocated to RWT Horizons across a diversified portfolio of early to mid stage companies.

The topic of LIBOR transition has also been a key focus, as the scheduled LIBOR cessation date in 2023 draws nearer. We have an established cross-functional group that has evaluated our exposure to LIBOR, reviewed relevant contracts and has monitored regulatory updates to assess the potential impact to our business, processes and technology from the discontinuation of LIBOR. This work has helped create a LIBOR transition plan to facilitate an orderly transition to alternative reference rates. We continue to remain on track with our LIBOR transition plan, which requires different solutions depending on the underlying asset or liability with LIBOR exposure. As of December 31, 2021, our primary LIBOR exposure included the following: $2.47 billion of repo or warehouse debt, $2.10 billion of interest rate swaps and swaptions, $708 million of Bridge Loans, and $140 million of trust preferred securities and subordinated notes debt. Certain of our contracts, such as interest rate swaps, have experienced an orderly market transition and subsequent to December 31, 2021, we have transitioned a substantial portion of our derivative positions off of LIBOR-benchmarks. Other of our contracts, such as warehouse debt agreements, require bilateral amendments, which we are currently in the process of executing and we anticipate most of these facilities will be amended in the first half of 2022, with sufficient time remaining to resolve the remainder. In early 2022, we began benchmarking all newly originated bridge loans to the Secured Overnight Financing Rate (“SOFR”), and our existing portfolio of bridge loans are short-dated and we expect the vast majority to mature before the LIBOR cessation date in 2023. Additionally, as the result of recent legislation that was passed in the state of New York, our trust preferred securities and subordinated notes are expected to convert to SOFR upon the cessation of LIBOR.

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2021 Financial Overview

This section includes an overview of our 2021 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 2021 and 2020.

Table 1 – Key Financial Results and Metrics

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["(In Thousands, except per Share Data)","","2021","","2020"],["Net income (loss)","","$","319,613","","","$","(581,847)"],["Earnings (loss) per share (diluted EPS)","","$","2.37","","","$","(5.12)"],["Return on equity","","25","%","","Negative"],["Book value per share","","$","12.06","","","$","9.91"],["Dividends per share","","$","0.78","","","$","0.725"],["Economic return on book value (1)","","30","%","","Negative"]]
[[/GREPCENT_TABLE]]

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

Table 2 – Key Operational Metrics

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["(In Thousands)","","2021","","2020"],["Capital Deployed","","$","452,927","","","$","386,945"],["Residential Loans Purchased","","$","12,939,263","","","$","4,483,477"],["Business Purpose Loans Originated and Purchased","","$","2,287,224","","","$","1,431,437"]]
[[/GREPCENT_TABLE]]

We conduct our business in three segments: Residential Mortgage Banking, Business Purpose Mortgage Banking and Investment Portfolio. Following is an overview of key financial and operational progress at each of our segments during 2021 and a supplemental discussion of our new RWT Horizons initiative.

Residential Mortgage Banking

During 2021, our Residential Mortgage Banking business benefited from a high level of industy-wide mortgage origination volume for both purchase and refinance loans as well as higher margins driven by favorable housing dynamics in the broader market, improvements in our process and speed to market, continued low mortgage rates and positive regulatory changes (including changes to Qualified Mortgage rules). For the full year of 2021, we locked a record $16.1 billion of loans (unadjusted for pipeline fallout) and purchased a record $12.9 billion of loans, an increase of 74% and 189%, respectively, from 2020. Overall lock volumes during the year were split 59% purchase, 41% refinance, and volumes towards the end of the year were more heavily weighted towards purchase as interest rates rose. During 2021, the residential mortgage origination market experienced some of the highest origination volumes in decades and our platform grew to not only keep pace with demand, but to expand market share, while maintaining a focus on operating efficiency.

During 2021, we were able to effectively expand the scale of our platform while growing profitability due to, among other things, process improvements driven by technology and automation and the breadth and strength of our distribution platform. Throughout 2021, we issued nine Sequoia securitizations backed by $4.2 billion of loans and sold $7.0 billion of loans through our deep and established network of whole loan buyers. The speed of our distribution execution relative to peers continued to differentiate Redwood from a risk management perspective as our ability to efficiently distribute acquired loans reduced our exposure to certain financial risks. In addition, from an operational perspective, we reduced our cost per loan relative to recent historical levels.

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During 2021, our residential gross margins remained elevated - maintaining a quarterly range of 90 basis points to 183 basis points. We ended the year at the low end of that range but still towards the high end of Redwood’s longer-term historical target range of 75 to 100 basis points. Our gross margin represents mortgage banking income earned in the period (net interest income on loan inventory plus mortgage banking activities) divided by loan purchase commitments entered into during the period. We would anticipate that going forward in 2022, we will continue to experience volatility and potential compression in margins in the residential mortgage market as the industry responds to evolving macro economic conditions and right-sizes capacity. Margins on jumbo loans have historically demonstrated a less volatile range than those for conforming loans, but we cannot be certain that historical trends will continue.

To start 2022, interest rates continued to rise with a number of rate hikes from the Federal Reserve anticipated in 2022. We expect overall mortgage origination volumes across the industry to decline; in particular, we anticipate that refinancing opportunities in 2022 will come down dramatically from their 2020 and 2021 peaks (33% of total 2022 volume is estimated by the MBA to be refinance volume compared to 64% and 59% for 2020 and 2021, respectively) though we also anticipate that purchase activity will continue to increase. Additionally, our recent acquisition volumes have been almost exclusively within our Select loan program, with some of the strongest borrower credit profiles we have seen since the Great Financial Crisis of 2008. In order to diversify our product mix to continue to aggregate loans at scale, we will look to increase our loan purchases under our Redwood Choice and other expanded credit (including non-QM) loan programs in 2022. Research estimates for non-QM mortgage originations are anticipating significant growth in volumes in 2022 driven by the declining refinancing opportunity in conforming loans. Furthermore, we believe that the recent loan-level pricing adjustment ("LLPA") increases on high balance loans and loans on second homes put forth by FHFA, which effectively results in Fannie Mae and Freddie Mac having to offer lower (less competitive) prices to acquire these types of loans, present an opportunity for more of these loans to flow into the private market, including to companies like Redwood. In 2018, nearly 20% of Redwood’s purchase volume was in high balance loans, as private label execution compared favorably to the GSEs at the time. Given this recent announcement by the FHFA, we anticipate our purchases of high balance loans could once again increase.

Business Purpose Mortgage Banking

During 2021, our Business Purpose Mortgage Banking segment, through activities at our wholly owned subsidiary, CoreVest, continued to grow, scale and gain market share. For the full year, CoreVest funded $2.3 billion of loans, up 60% from 2020. Momentum for this business increased across the year, even as rates rose, with the fourth quarter representing a quarterly record for loan funding volume. In terms of the composition of our funding volume in 2021, it primarily consisted of single-family rental loans (58%) and bridge loans (42%). Our distribution efforts in Business Purpose Mortgage Banking contributed to growing mortgage banking activities, as we priced four securitizations backed by $1.3 billion of loans, up 10% from 2020. We also diversified our distribution and financing options for the platform through our inaugural bridge loan securitization and whole loan sale capabilities. In the fourth quarter, we increased activities within our correspondent business, which buys loans from third parties. This effort remains small relative to our own organic origination activities, and only represented approximately 5% of full year 2021 funded volume.

Prevailing industry dynamics – most notably consistent demand growth for single-family rentals – continue to attract increased equity capital and competition to this sector. We believe CoreVest is well positioned to continue gaining additional market share in what we consider a growing market, driven by its broad suite of products, robust technology platform, proven scale, distinguished track record and leading distribution capability. In addition, short-term, floating rate and prepay protected assets within our BPL strategy could support the durability of our overall results as they should theoretically carry lower interest rate sensitivity than longer duration residential assets.

Investment Portfolio

Our investment portfolio ended 2021 with $11.8 billion of assets, compared to $9.0 billion as of year end 2020. During the year, we deployed a total of $421 million of capital into new investments, including $222 million in the fourth quarter. The fourth quarter represented the largest quarter of capital deployment since before the pandemic and we believe we can continue deploying capital where we see compelling opportunities for us to invest. Since the onset of the pandemic and during most of 2021, attractive opportunities within our mortgage banking operations, coupled with tight spreads across the securitized products landscape, led to fairly limited capital deployment in our third party investment portfolio during the course of 2021. In the current higher rate and wider spread environment, we are selectively deploying capital into investments at attractive entry points due to market volatility- though markets are evolving rapidly. During the fourth quarter, we added exposure to agency CRT bonds and completed the acquisition of additional seasoned excess servicing assets. We may have several unique opportunities over the next few years related to calling underlying securitization transactions (a separate effort from our ongoing work in calling Sequoia and CAFL securitization transactions detailed below). We also bought additional home equity investments agreements (“HEIs”) through our flow arrangement with Point Digital. In the third quarter of 2021, we completed our inaugural securitization of HEI assets.

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We also progressed our Sequoia and CAFL call strategy, exercising call rights to acquire over $290 million of previously securitized loans in 2021. Overall credit performance in our investment portfolio remained strong to end 2021, as delinquencies continued to decrease since their peak in the summer of 2020 and strong home price appreciation, robust economic growth and favorable labor markets kept actual credit losses low. While prepayment speeds have fallen from their peaks in 2021, they remain elevated – a positive for our credit investments that we generally carry at a discount to par value. As prepayments stay elevated and principal pays down on the collateral securing our Sequoia and CAFL securitization transactions, the call rights we own within these structures are also becoming more valuable. Our near- to medium-term outlook for call activity remains heightened given a backdrop of strong housing fundamentals and we expect up to $700 million of loans to become callable in 2022, at call prices below their estimated fair values, and another $1.4 billion to become callable through the end of 2024. As we have highlighted throughout the year, this activity has the potential to continue providing incremental upside to our portfolio value depending on the market conditions at the time of the call.

RWT Horizons

In 2021 we focused on RWT Horizons, our new investment initiative focused on early-stage technology companies with business plans focused on innovations that can disrupt the mortgage finance landscape. This initiative demonstrates Redwood’s commitment to supporting technology that enhances the housing finance industry as well as supporting enhancements and efficiencies across the Company’s overall platform. As of the end of 2021, we had 15 investments in companies with a nexus to our operating platforms and had committed approximately $25 million towards RWT Horizons. Our strategy is premised on extracting 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. Already in our first year we have seen our investments support our business. For example, we worked with Point Digital to complete the first ever securitization backed entirely by residential HEIs, issuing approximately $146 million of asset-backed securities. Co-sponsoring the transaction with a subsidiary of Redwood, Point was the originator of all the HEIs in the securitization and will continue to service the assets.

Both organically and through RWT Horizons, we continue to build and connect with emerging technologies that we believe will enhance our business strategies and distribution efforts. To illustrate, we have engaged one of our portfolio companies, Liquid Mortgage, to use their blockchain technology to make remittance data more readily available for our Sequoia securitizations. Specifically, by putting this data on blockchain, we are providing investors with more timely remittance reporting information with which to evaluate our Sequoia offerings.

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RESULTS OF OPERATIONS

Within this Results of Operations section, we provide commentary that compares results year-over-year for 2021, 2020, and 2019. 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 2021 refer to the change in results from 2020 to 2021, and increases or decreases in 2020 refer to the change in results from 2019 to 2020.

Consolidated Results of Operations

The following table presents the components of our net income for the years ended December 31, 2021, 2020, and 2019.

Table 3 – Net Income (Loss)

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,","","","Changes"],["(In Thousands)","","2021","","2020","","2019","","","'21/'20","","'20/'19"],["Net Interest Income","","$","148,177","","","$","123,911","","","$","142,473","","","","$","24,266","","","$","(18,562)"],["Non-interest Income"],["Mortgage banking activities, net","","235,744","","","78,472","","","87,266","","","","157,272","","","(8,794)"],["Investment fair value changes, net","","128,049","","","(588,438)","","","35,500","","","","716,487","","","(623,938)"],["Other income","","12,018","","","4,188","","","19,257","","","","7,830","","","(15,069)"],["Realized gains, net","","17,993","","","30,424","","","23,821","","","","(12,431)","","","6,603"],["Total non-interest income (loss), net","","393,804","","","(475,354)","","","165,844","","","","869,158","","","(641,198)"],["General and administrative expenses","","(170,859)","","","(115,204)","","","(108,737)","","","","(55,655)","","","(6,467)"],["Loan acquisition costs","","(16,336)","","","(11,023)","","","(9,935)","","","","(5,313)","","","(1,088)"],["Other expenses","","(16,695)","","","(108,785)","","","(13,022)","","","","92,090","","","(95,763)"],["Net income (loss) before income taxes","","338,091","","","(586,455)","","","176,623","","","","924,546","","","(763,078)"],["(Provision for) benefit from income taxes","","(18,478)","","","4,608","","","(7,440)","","","","(23,086)","","","12,048"],["Net Income (Loss)","","$","319,613","","","$","(581,847)","","","$","169,183","","","","$","901,460","","","$","(751,030)"]]
[[/GREPCENT_TABLE]]

Net Interest Income

Net interest income increased in 2021, primarily due to a $16 million increase in net interest income earned on loans held in inventory during the year at our residential mortgage banking operations and a $5 million increase in net interest income earned from our investment portfolio. The increase from residential mortgage banking operations primarily resulted from higher loan acquisition volumes and average balances of loans outstanding in 2021 as compared to 2020. The increase from our investment portfolio was primarily attributable to an increase in the average balance of our bridge loans, Sequoia securities and CAFL securities driven by new assets transferred from our mortgage banking operations, as well as higher discount accretion on our available-for-sale securities driven by an increase in expected call activity.

Net interest income decreased in 2020, primarily due to lower average asset balances relative to 2019 resulting from portfolio repositioning, including significant asset sales in the first half of 2020, as well as higher borrowing costs associated with non-marginable and non-recourse debt facilities we entered into during 2020.

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

Mortgage Banking Activities, Net

Income from mortgage banking activities, net includes results from both our residential and business purpose mortgage banking operations. The increase in income from mortgage banking activities during 2021 was attributable to a $123 million increase from our residential mortgage banking operations and a $34 million increase from our business purpose mortgage banking operations. The increase in income at both our mortgage banking operations was primarily driven by higher loan production volumes in 2021 as compared to 2020, when volumes and margins were adversely impacted by disruptions following the onset of the pandemic.

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The $9 million decrease in 2020 was predominantly due to a decrease in loan acquisition volumes at our residential mortgage banking business as a result of market disruptions following the onset of the pandemic. These decreases were partially offset by an increase in mortgage banking income from our business purpose mortgage banking operations, which benefited from a full year of income after our acquisitions of 5 Arches and CoreVest in March and October of 2019, respectively.

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 value of our investment portfolio assets that are accounted for under the fair value option and interest rate hedges associated with these investments.

During 2021, positive investment fair value changes reflected improved credit performance and spread tightening across our investment portfolio. While credit performance in our portfolio improved throughout the year, credit spreads tightened more significantly in the first half of the year, with sequentially smaller increases in the third and fourth quarters. In January and early February of 2022, interest rates have increased and credit spreads have widened across most asset classes, including for certain assets we own. While our investments continue to experience strong credit performance, spread widening to date, and any further spread widening, could result in negative investment fair value changes for our investments in 2022.

The negative investment fair value changes recorded during 2020 were primarily driven by realized losses incurred on assets sales and derivative settlements that occurred in March and April of that year, as we repositioned our portfolio in response to disruptions following the onset of the pandemic. Approximately $360 million of losses were realized from such sales and settlements. The remaining net losses for the year were primarily associated with assets we retained that experienced a significant decline in value during the first quarter of 2020 and had not fully recovered their value through the end of the year, as well as negative fair value changes on our interest only securities resulting from lower benchmark interest rates and higher prepayment speeds during 2020. During 2019, the positive investment fair value changes primarily resulted from tightening credit spreads in several investment classes.

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

Other Income

The increase in other income for 2021 was primarily the result of a $12 million increase in income from our MSR investments, which experienced a more moderate rise in prepayment speeds during 2021 as compared to 2020, when prepayment speeds rose sharply after the onset of the pandemic when benchmark interest rates declined. This increase was partially offset by: lower risk share income, as our risk share investments experienced accelerated prepayments during the second half of 2020 and throughout 2021; lower FHLBC capital stock dividends, as we redeemed most of our FHLBC stock in 2020 when we repaid our FHLBC borrowings; and lower income from loan administration fees, as the BPL loans associated with those fees were paid off in 2020. Details on the composition of other income is included in Note 20 in Part II, Item 8 of this Annual Report on Form 10-K.

The $15 million decrease in other income in 2020 was primarily the result of losses on our MSR investments, which were driven

primarily by increased prepayment speeds, resulting from declines in interest rates during 2020.

Realized Gains, Net

In 2021, we realized gains of $18 million, including $16 million of gains resulting from calls of seven seasoned Sequoia securitizations, and $1.5 million of net gains from the sale of $11 million of AFS securities.

For 2020, we realized gains of $30 million, including $25 million of gains from the repurchase of $125 million of convertible debt and $5 million of net gains from the sale of $55 million of AFS securities. Of note, all of the gains from extinguishment of debt were excluded from our diluted earnings per share for the year ended December 31, 2021, in accordance with GAAP. For 2019, we realized gains of $24 million, primarily from the sale of $110 million of AFS securities and the call of a seasoned Sequoia securitization in the first quarter.

General and Administrative Expenses

The increase in general and administrative expenses for 2021 primarily resulted from increased accruals of variable compensation expense associated with improved financial results and a higher headcount in 2021 as compared to 2020, as well as higher long-term incentive award expense from awards granted in the second half of 2020, including retention-related awards, and awards granted in early 2021 as part of our regular annual compensation process. We also incurred higher systems and consulting costs in 2021, as we re-engineered and implemented new systems and processes to drive longer-term efficiencies throughout our business.

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In April of 2020, we implemented a workforce reduction as a result of the disruptions following the onset of the pandemic, but then began hiring new employees in the second half of 2020 as our mortgage banking operations began to recover, and ended 2020 with 247 full-time employees. During 2021, we added additional headcount to support the strong growth our business experienced during the year and ended 2021 with 298 full-time employees. As a result of our increased headcount through 2021, as well as tight labor market conditions that have driven-up compensation costs, we entered 2022 with higher fixed compensation costs relative to 2021, and anticipate those costs may continue to increase throughout the year.

The $6 million increase in general and administrative expenses in 2020 primarily resulted from $14 million of additional expenses at our Business Purpose Lending segment, driven by a full year of operations at our now-combined 5 Arches and CoreVest platforms. This increase was partially offset by a $9 million decrease in general and administrative expenses at our Residential Lending segment, driven by a decrease in loan acquisition activity at our residential mortgage banking business as well as the workforce reduction in 2020.

Details on the composition of General and administrative expenses are included in Note 21 in Part II, Item 8 of this Annual Report on Form 10-K.

Loan Acquisition Costs

The increase in loan acquisition costs for 2021 was primarily due to higher loan origination volumes throughout 2021 as compared to 2020. The increase in loan acquisition costs for 2020 relative to 2019 resulted from an increase in origination activity at our business purpose mortgage banking operations, primarily as a result of the acquisition of CoreVest, and was partially offset by a reduction in expenses from lower acquisition volumes at our residential mortgage banking operations in 2020.

Other Expenses

The decrease in other expenses for 2021 was related to $89 million of goodwill impairment expense at our Business Purpose Mortgage Banking segment recorded in the first quarter of 2020 that was taken as a result of the onset of the pandemic and economic downturn that ensued.

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.

For 2021, the tax provision is reflective of the positive income earned at our taxable subsidiaries and higher state income taxes, partially offset by a $19 million benefit from the release of valuation allowance on deferred tax assets. The benefit from income taxes in 2020 resulted from GAAP losses at our TRS during that year, partially offset by a valuation allowance recorded against our federal net ordinary deferred tax assets.

67

Net Interest Income

The following tables present the components of net interest income for the years ended December 31, 2021, 2020, and 2019.

Table 4 – Net Interest Income

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["","","2021","","2020","","2019"],["(Dollars in Thousands)","","Interest Income/ (Expense)","","Average Balance (1)","","Yield","","Interest Income/ (Expense)","","Average Balance (1)","","Yield","","Interest Income/ (Expense)","","Average Balance (1)","","Yield"],["Interest Income"],["Residential loans, held-for-sale","","$","49,779","","","$","1,635,663","","","3.0","%","","$","19,985","","","$","538,580","","","3.7","%","","$","39,355","","","$","888,690","","","4.4","%"],["Residential loans - HFI at Redwood (2)","","\u2014","","","\u2014","","","\u2014","%","","21,000","","","494,097","","","4.3","%","","92,340","","","2,321,288","","","4.0","%"],["Residential loans - HFI at Legacy Sequoia (2)","","4,709","","","254,830","","","1.8","%","","9,059","","","316,844","","","2.9","%","","17,640","","","453,563","","","3.9","%"],["Residential loans - HFI at Sequoia (2)","","74,025","","","1,983,936","","","3.7","%","","87,093","","","1,883,855","","","4.6","%","","108,778","","","2,273,514","","","4.8","%"],["Residential loans - HFI at Freddie Mac SLST (2)","","76,288","","","2,067,313","","","3.7","%","","85,609","","","2,209,182","","","3.9","%","","57,840","","","1,531,361","","","3.8","%"],["Business purpose loans - HFS","","14,443","","","294,634","","","4.9","%","","20,415","","","378,293","","","5.4","%","","7,991","","","148,037","","","5.4","%"],["Business purpose loans - HFI","","54,510","","","719,907","","","7.6","%","","60,252","","","842,296","","","7.2","%","","22,742","","","298,040","","","7.6","%"],["Single-family rental loans - HFI at CAFL","","201,838","","","3,404,933","","","5.9","%","","136,950","","","2,544,738","","","5.4","%","","23,072","","","439,165","","","5.3","%"],["Multifamily loans - HFI at Freddie Mac K-Series","","19,266","","","486,095","","","4.0","%","","54,813","","","1,404,068","","","3.9","%","","132,600","","","3,373,743","","","3.9","%"],["Trading securities","","22,783","","","146,328","","","15.6","%","","33,940","","","286,382","","","11.9","%","","70,359","","","1,119,220","","","6.3","%"],["Available-for-sale securities","","31,921","","","129,261","","","24.7","%","","15,665","","","140,783","","","11.1","%","","21,463","","","182,251","","","11.8","%"],["Other interest income","","25,364","","","817,808","","","3.1","%","","27,135","","","775,386","","","3.5","%","","28,101","","","605,863","","","4.6","%"],["Total interest income","","574,926","","","11,940,708","","","4.8","%","","571,916","","","11,814,504","","","4.8","%","","622,281","","","13,634,735","","","4.6","%"],["Interest Expense"],["Short-term debt facilities","","(37,714)","","","1,670,279","","","(2.3)","%","","(44,454)","","","1,188,487","","","(3.7)","%","","(73,558)","","","1,973,542","","","(3.7)","%"],["Short-term debt - servicer advance financing","","(4,867)","","","183,335","","","(2.7)","%","","(6,441)","","","201,175","","","(3.2)","%","","(11,952)","","","219,307","","","(5.4)","%"],["Short-term debt - convertible notes, net","","\u2014","","","\u2014","","","\u2014","%","","\u2014","","","\u2014","","","\u2014","%","","(10,996)","","","174,433","","","(6.3)","%"],["ABS issued - Legacy Sequoia (2)","","(3,040)","","","251,855","","","(1.2)","%","","(5,945)","","","312,351","","","(1.9)","%","","(14,418)","","","445,342","","","(3.2)","%"],["ABS issued - Sequoia (2)","","(59,949)","","","1,755,124","","","(3.4)","%","","(73,643)","","","1,681,490","","","(4.4)","%","","(93,354)","","","2,052,697","","","(4.5)","%"],["ABS issued - Freddie Mac SLST (2)","","(64,633)","","","1,805,744","","","(3.6)","%","","(66,859)","","","1,897,194","","","(3.5)","%","","(42,574)","","","1,237,205","","","(3.4)","%"],["ABS issued - Freddie Mac K-Series","","(17,686)","","","456,353","","","(3.9)","%","","(51,521)","","","1,324,678","","","(3.9)","%","","(126,948)","","","3,184,441","","","(4.0)","%"],["ABS issued - CAFL","","(160,493)","","","3,173,576","","","(5.1)","%","","(101,740)","","","2,363,624","","","(4.3)","%","","(17,172)","","","401,467","","","(4.3)","%"],["Long-term debt facilities","","(40,516)","","","794,144","","","(5.1)","%","","(45,318)","","","708,611","","","(6.4)","%","","(2,105)","","","49,988","","","(4.2)","%"],["Long-term debt - FHLBC","","(2)","","","279","","","(0.7)","%","","(10,411)","","","589,269","","","(1.8)","%","","(48,999)","","","1,999,999","","","(2.4)","%"],["Long-term debt - corporate","","(37,849)","","","651,156","","","(5.8)","%","","(41,673)","","","693,838","","","(6.0)","%","","(37,732)","","","626,290","","","(6.0)","%"],["Total interest expense","","(426,749)","","","10,741,845","","","(4.0)","%","","(448,005)","","","10,960,717","","","(4.1)","%","","(479,808)","","","12,364,711","","","(3.9)","%"],["Net Interest Income","","$","148,177","","","","","","","$","123,911","","","","","","","$","142,473"]]
[[/GREPCENT_TABLE]]

(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 available-for-sale 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 from residential loans held-for-investment ("HFI") at Redwood exclude loans HFI at consolidated Sequoia or Freddie Mac SLST entities. Interest income from residential loans - HFI at Legacy Sequoia and the interest expense from ABS issued - Legacy Sequoia represent activity from our consolidated Legacy Sequoia entities. Interest income from residential loans - HFI at Sequoia and the interest expense from ABS issued - Sequoia represent activity from our consolidated Sequoia entities. Interest income from residential loans - HFI at Freddie Mac SLST and the interest expense from ABS issued - Freddie Mac SLST represent activity from our consolidated Freddie Mac SLST entities.

68

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 5 – Net Interest Income - Volume and Rate Changes

[[GREPCENT_TABLE]]
[["","","Change in Net Interest Income"],["","","For the Years Ended December 31,"],["","","2021","","2020"],["(In Thousands)","","Volume","","Rate","","Total","","Volume","","Rate","","Total"],["Net Interest Income for the Beginning of the Year","","","","","","$","123,911","","","","","","","$","142,473"],["Impact of Changes in Interest Income"],["Residential loans - HFS","","$","40,708","","","$","(10,915)","","","29,793","","","$","(15,504)","","","$","(3,866)","","","(19,370)"],["Residential loans - HFI at Redwood","","(21,001)","","","\u2014","","","(21,001)","","","(72,684)","","","1,346","","","(71,338)"],["Residential loans - HFI at Legacy Sequoia","","(1,774)","","","(2,577)","","","(4,351)","","","(5,317)","","","(3,264)","","","(8,581)"],["Residential loans - HFI at Sequoia","","4,627","","","(17,695)","","","(13,068)","","","(18,644)","","","(3,041)","","","(21,685)"],["Residential loans - HFI at Freddie Mac SLST","","(5,498)","","","(3,824)","","","(9,322)","","","25,602","","","2,167","","","27,769"],["Business purpose loans - HFS","","(4,515)","","","(1,458)","","","(5,973)","","","12,431","","","(8)","","","12,423"],["Business purpose loans - HFI","","(14,192)","","","3,086","","","(11,106)","","","41,530","","","(4,020)","","","37,510"],["Single-family rental loans - HFI at CAFL","","46,293","","","18,595","","","64,888","","","110,619","","","3,259","","","113,878"],["Bridge loans - HFI at CAFL","","\u2014","","","5,364","","","5,364","","","\u2014","","","\u2014","","","\u2014"],["Multifamily loans - HFI at Freddie Mac K-Series","","(35,836)","","","289","","","(35,547)","","","(77,415)","","","(372)","","","(77,787)"],["Trading securities","","(16,598)","","","5,441","","","(11,157)","","","(52,356)","","","15,937","","","(36,419)"],["Available-for-sale securities","","(1,282)","","","17,538","","","16,256","","","(4,884)","","","(914)","","","(5,798)"],["Other interest income","","1,485","","","(3,255)","","","(1,770)","","","7,863","","","(8,830)","","","(967)"],["Net changes in interest income","","(7,583)","","","10,589","","","3,006","","","(48,759)","","","(1,606)","","","(50,365)"],["Impact of Changes in Interest Expense"],["Short-term debt facilities","","(18,021)","","","24,764","","","6,743","","","29,260","","","(157)","","","29,103"],["Short-term debt - servicer advance financing","","571","","","1,003","","","1,574","","","988","","","4,523","","","5,511"],["Short-term debt - convertible notes, net","","\u2014","","","\u2014","","","\u2014","","","10,996","","","\u2014","","","10,996"],["ABS issued - Legacy Sequoia","","1,151","","","1,754","","","2,905","","","4,306","","","4,167","","","8,473"],["ABS issued - Sequoia","","(3,225)","","","16,919","","","13,694","","","16,882","","","2,829","","","19,711"],["ABS issued - Freddie Mac SLST","","3,223","","","(997)","","","2,226","","","(22,711)","","","(1,574)","","","(24,285)"],["ABS issued - Freddie Mac K-Series","","33,772","","","63","","","33,835","","","74,140","","","1,287","","","75,427"],["ABS issued - CAFL","","(34,864)","","","(23,888)","","","(58,752)","","","(83,927)","","","(640)","","","(84,567)"],["Long-term debt facilities","","(5,470)","","","10,272","","","4,802","","","(27,735)","","","(15,478)","","","(43,213)"],["Long-term debt - FHLBC","","10,406","","","3","","","10,409","","","34,562","","","4,026","","","38,588"],["Long-term debt - corporate","","2,564","","","1,260","","","3,824","","","(4,070)","","","129","","","(3,941)"],["Net changes in interest expense","","(9,893)","","","31,153","","","21,260","","","32,691","","","(888)","","","31,803"],["Net changes in interest income and expense","","(17,476)","","","41,742","","","24,266","","","(16,068)","","","(2,494)","","","(18,562)"],["Net Interest Income for the Year Ended","","","","","$","148,177","","","","","","","$","123,911"]]
[[/GREPCENT_TABLE]]

69

Net Interest Income by Segment

The following table presents the components of net interest income by segment for the years ended December 31, 2021, 2020, and 2019.

Table 6 – Net Interest Income by Segment

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,","","","Changes"],["(In Thousands)","","2021","","2020","","2019","","","'21/'20","","'20/'19"],["Net Interest Income by Segment"],["Residential Mortgage Banking","","$","21,990","","","$","5,861","","","$","19,398","","","","$","16,129","","","$","(13,537)"],["Business Purpose Mortgage Banking","","6,824","","","6,055","","","3,240","","","","769","","","2,815"],["Investment Portfolio","","155,538","","","150,479","","","165,331","","","","5,059","","","(14,852)"],["Corporate/Other","","(36,175)","","","(38,484)","","","(45,496)","","","","2,309","","","7,012"],["Net Interest Income","","$","148,177","","","$","123,911","","","$","142,473","","","","$","24,266","","","$","(18,562)"]]
[[/GREPCENT_TABLE]]

Residential Mortgage Banking

Net interest income from this segment represents interest earned on our residential loans held in inventory from the time we purchase loans to when they are sold or securitized, net of interest expense incurred for debt we use to finance the loans. The change in net interest income from 2019 to 2021 is primarily reflective of the change in the average balance of loans held in inventory in each year, which were $1.64 billion, $539 million and $889 million for 2021, 2020 and 2019, respectively. Additionally, the decrease in 2020 reflected higher borrowing costs as we shifted a significant portion of our debt for our loan inventory from marginable to non-marginable facilities and experienced higher borrowing costs in general after the disruptions following the onset of the pandemic in early to mid 2020. In the later part of 2020 and throughout 2021, we were able to lower our borrowing costs by reducing the interest rates on many of our facilities used to finance our residential loan inventory. Additionally, we employed higher leverage on our loan inventory in 2021 relative to 2019, which accounts for the lower relative increase in net interest income in 2021 despite an average balance nearly twice as high.

Business Purpose Mortgage Banking

Net interest income from this segment represents interest earned on our business purpose loans held in inventory from the time we originate or purchase loans to when they are securitized, sold or transferred into our investment portfolio, net of interest expense incurred for debt we use to finance the loans. The increase in net interest income from 2020 to 2021 was primarily attributable to lower borrowing costs in 2021, partially offset by a lower average balance of loans (i.e. the time between when we fund a loan and distribute that loan). While we originated significantly more loans in 2021 than 2020, the lower average balance of loans reflected faster turn times for loans, ultimately resulting in greater capital efficiency. The increase in net interest income from 2019 to 2020 primarily reflected a full year of operating activity in 2020, as we only began originating business purpose loans and carrying loan inventory after we acquired 5 Arches and CoreVest in 2019.

Investment Portfolio

Net interest income from this segment represents interest income earned on our investment assets, net of interest expense incurred for debt we use to finance these assets. The increase in net interest income from 2020 to 2021 was primarily attributable to an increase in the average balance of our bridge loans, Sequoia securities and CAFL securities, which was driven by new assets transferred from our mortgage banking operations. Additionally, we experienced higher accretion income on our available-for-sale securities during the second half of 2021, when we began to incorporate the impact of expected calls of securities into our cash flow projections. This increased discount accretion to $20 million in the second half of 2021 from $3 million in the first half of the year. As securitization transactions are called and the number of future transactions expected to be called diminishes, and if prepayment speeds slow given rising interest rates, we expect the amount of income we recognize from discount accretion to decrease throughout 2022 from levels experienced in the fourth quarter of 2021. The reduction in net interest income in 2020 from 2019 was primarily attributable to a lower overall average balance of investments in 2020 resulting from asset sales in the first half of 2020, when we repositioned our portfolio in response to disruptions following the onset of the pandemic.

70

Corporate/Other

The Corporate/Other line item in the table above includes interest expense on our convertible debt and trust-preferred securities and net interest income from consolidated Legacy Sequoia entities. The $2 million decrease in net interest expense from Corporate/ Other during 2021 resulted from a $4 million reduction in interest expense from our corporate debt, partially offset by $1 million of lower net interest income from our Legacy Sequoia entities. The decrease in interest expense from our corporate debt was due to a lower average balance of long-term debt in 2021 as compared to 2020, as we repurchased $125 million of convertible debt during the second quarter of 2020. Additionally, in the first half of 2020, we terminated derivatives that served to fix the effective interest rate on our floating rate trust preferred securities and subordinated notes. As these derivatives were designated as cash flow hedges, their fair value at termination (representing the amount paid to terminate the derivatives) is being amortized over the remaining life of the trust preferred securities and subordinated notes as a component of interest expense and totaled $4 million in 2021. The $7 million decrease in net interest expense from Corporate/Other in 2020 was primarily due to a lower average balance of long-term debt as compared to 2019, as we repaid $201 million of our convertible debt in November 2019 and repurchased $125 million of convertible debt during the second quarter of 2020.

71

Results of Operations by Segment

Overview

We report on our business using three segments: Residential Mortgage Banking, Business Purpose Mortgage Banking, and Investment Portfolio. During the fourth quarter of 2021, we changed our segments and conformed the results of all prior periods presented herein. For additional information on our segments, refer to Note 23 in Part II, Item 8 and Part I, Item 1 of this Annual Report on Form 10-K.

The following table presents the segment contribution from our three segments reconciled to our consolidated net income for the years ended December 31, 2021, 2020, and 2019.

Table 7 – Segment Results Summary

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,","","","Changes"],["(In Thousands)","","2021","","2020","","2019","","","'21/'20","","'20/'19"],["Segment Contribution from:"],["Residential Mortgage Banking","","$","82,414","","","$","(8,989)","","","$","37,388","","","","$","91,403","","","$","(46,377)"],["Business Purpose Mortgage Banking","","38,528","","","(67,726)","","","9,201","","","","106,254","","","(76,927)"],["Investment Portfolio","","293,230","","","(438,883)","","","223,396","","","","732,113","","","(662,279)"],["Corporate/Other","","(94,559)","","","(66,249)","","","(100,802)","","","","(28,310)","","","34,553"],["Net Income (Loss)","","$","319,613","","","$","(581,847)","","","$","169,183","","","","$","901,460","","","$","(751,030)"]]
[[/GREPCENT_TABLE]]

Following is an overview of the changes in net income (loss) from our segments. The sections that follow this overview provide further detail for our three business segments and their results of operations.

Residential Mortgage Banking

Our residential mortgage banking business experienced growing loan lock volumes throughout 2019 and into the first quarter of 2020, when disruptions following the onset of the pandemic resulted in a widespread economic downturn that caused us to significantly curtail our loan lock activity in the first half of 2020. While we began to ramp our loan lock activity back up in the second half of the year, our loan lock volumes and profit margins experienced a meaningful decline from 2019 to 2020. In 2021, we experienced a significant increase in loan lock volumes and strong profitability, which drove a large increase in income for the year relative to 2020.

Business Purpose Mortgage Banking

We acquired 5 Arches and CoreVest in the first and fourth quarters of 2019, respectively, marking our entry into business purpose mortgage banking. Activities from these operations were ramping-up in late 2019 and in the first quarter of 2020, when disruptions following the onset of the pandemic impacted the business, resulting in a meaningful reduction in loan originations during the second and third quarters of that year. Loan fundings from these operations began to ramp back up in the fourth quarter of 2020 and grew meaningfully throughout 2021, with strong margins helping to drive profitability for 2021. Results from 2020 included an $89 million expense for the write-off of our entire goodwill balance associated with this segment that was taken in the first quarter of 2020 as a result of disruptions following the onset of the pandemic and economic downturn that ensued. Exclusive of this non-cash goodwill impairment expense, net income from this segment in 2020 was $21 million.

Investment Portfolio

Net income from our investment portfolio is primarily comprised of net interest income earned on our investments assets and changes in the fair value of those assets, as the vast majority of our investments are carried under the fair value option with changes in their fair values recorded through our income statement. The $662 million decrease in net income in 2020 and the increase of $732 million in 2021, primarily resulted from negative investment fair value changes in 2020 as we repositioned our portfolio in response to liquidity related market disruptions in March and April of that year following the onset of the pandemic, as well as negative fair value changes on our interest only securities resulting from lower benchmark interest rates and higher prepayment speeds during 2020. Positive investment fair value changes in 2021 reflected continuing improvement in credit performance and spread tightening across our investment portfolio during the year. Additionally, net interest income from this segment declined from 2019 to 2020, then increased incrementally in 2021, as discussed in the preceding Net Interest Income by Segment section.

72

Corporate/Other

The $28 million increase in net expense from Corporate/Other in 2021 was primarily due to a $24 million increase in general and administrative expense in 2021 and a $25 million gain associated with the repurchase of $125 million of convertible debt in the second quarter of 2020, partially offset by a $19 million benefit from income taxes in 2021. The increase in general and administrative expenses primarily resulted from increased accruals of variable compensation expense associated with improved financial results and a higher headcount in 2021 as compared to 2020, as well as higher long-term incentive award expense from awards granted in the second half of 2020, including retention related awards, and awards granted in early 2021 as part of our regular annual compensation process. The benefit from income taxes in 2021 within corporate was related to the reversal of valuation allowance on certain deferred tax assets.

The $35 million decrease in net expense from Corporate/Other in 2020 was primarily due to the $25 million gain associated with the repurchase of convertible debt in 2020 and the associated reduction in interest expense from the repurchase.

Residential Mortgage Banking Segment

Our Residential Mortgage Banking segment consists of a mortgage loan conduit that acquires residential loans from third-party originators for subsequent sale, securitization through our Sequoia private-label securitization program, or transfer into our investment portfolio. We typically acquire prime jumbo mortgages and the related mortgage servicing rights on a flow basis from our network of loan sellers. This segment also includes various derivative financial instruments that we utilize to manage certain risks associated with our inventory of residential loans held-for-sale within this segment. This segment’s main source of mortgage banking income is net interest income from its inventory of loans held-for-sale, as well as income from mortgage banking activities, which includes valuation increases (or gains) on loans we acquire and subsequently sell, securitize, or transfer into our investment portfolio, and the hedges used to manage risks associated with these activities. Direct operating expenses and tax expenses associated with these activities are also included in this segment.

Net income from this segment is primarily comprised of net interest income earned on loans while they are held in inventory, mark-to-market adjustments on loans from the time loan purchase commitments are entered into until loans are sold or securitized, gains/losses from associated hedges, and all direct expenses associated with these activities. Subordinate securities that we retain from our Sequoia securitizations (many of which we consolidate for GAAP purposes) are transferred to and held in our Investment Portfolio segment.

The following table provides the activity of residential loans held in inventory for sale at our mortgage banking business during the years ended December 31, 2021 and 2020.

Table 8 – Loan Inventory for Residential Mortgage Banking Operations — Activity

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["(In Thousands)","","2021","","2020"],["Balance at beginning of period","","$","176,641","","","$","536,385"],["Acquisitions","","12,939,263","","","4,483,477"],["Sales","","(8,449,329)","","","(5,007,990)"],["Transfers between segments(1)","","(3,035,095)","","","263,172"],["Principal repayments","","(41,458)","","","(85,790)"],["Changes in fair value, net","","83,214","","","(12,613)"],["Balance at End of Period","","$","1,673,236","","","$","176,641"]]
[[/GREPCENT_TABLE]]

(1)Represents the fair value of loans transferred from held-for-sale at our Residential Mortgage Banking segment to held-for-investment at our Investment Portfolio segment, associated with securitizations we sponsored that we consolidate under GAAP.

During the year ended December 31, 2021, our residential mortgage loan correspondent channel locked $16.09 billion of loans, purchased $12.94 billion of loans, sold $8.45 billion of loans to third parties, and securitized $4.20 billion of loans through nine separate transactions. At December 31, 2021, we had $1.67 billion of loans in inventory on our balance sheet and our loan pipeline included $1.25 billion of loans identified for purchase (gross loan locks outstanding, unadjusted for expected fallout) and had outstanding forward sale agreements for $650 million of loans.

73

We utilize a combination of capital and financing from our residential loan warehouse facilities to manage our inventory of residential loans held-for-sale. At December 31, 2021, we had residential warehouse facilities outstanding with seven different counterparties, with $2.90 billion of total capacity and $1.23 billion of available capacity. These included non-marginable (i.e., not subject to margin calls based on the market value of the underlying collateral) facilities with $1.4 billion of total capacity and marginable facilities with $1.5 billion of total capacity.

The following table presents key earnings and operating metrics for our Residential Mortgage Banking segment for the years ended December 31, 2021, 2020 and 2019.

Table 9 – Residential Mortgage Banking Earnings Summary and Operating Metrics

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["(In Thousands)","","2021","","2020","","2019"],["Mortgage banking income","","$","149,141","","","$","9,582","","","$","67,140"],["Operating expenses","","(40,950)","","","(23,138)","","","(25,678)"],["(Provision for) benefit from income taxes","","(25,777)","","","4,567","","","(4,074)"],["Segment Contribution","","$","82,414","","","$","(8,989)","","","$","37,388"],["Loan purchase commitments entered into","","$","11,520,508","","","$","4,817,150","","","$","7,012,962"]]
[[/GREPCENT_TABLE]]

Residential mortgage banking income presented in the table above is comprised of net interest income from residential loans held-for-sale in inventory and mortgage banking activities, net from this segment. Income from mortgage banking activities is comprised of mark-to-market adjustments on loans from the time they are purchased to when they are sold, mark-to-market adjustments on new and outstanding loan purchase commitments, gains/losses from associated hedges, and other miscellaneous income/expenses (see Note 19 in Part II, Item 8 of this Annual Report on Form 10-K for further detail on the composition of mortgage banking activities). Operating expenses presented in the table above includes general and administrative expenses, loan acquisition costs and other expenses for this segment.

In the preceding Results of Operations by Segment Overview section, we discussed the major factors impacting the change in net income (segment contribution) from our Residential Mortgage Banking segment from 2019 to 2021. Following, we provide additional detail on the changes in segment contribution from 2020 to 2021.

The increase in mortgage banking income in 2021 was primarily driven by higher loan purchase commitments (as presented in the table above) and higher gross margins relative to 2020. Our gross margin (mortgage banking income earned in the period divided by loan purchase commitments entered into during the period) averaged 129 basis points in 2021 as compared to 20 basis points in 2020. After benchmark interest rates declined following the onset of the pandemic in early 2020, mortgage rates decreased and loan refinance activity increased sharply, helping to drive growing acquisition volumes in the second half of 2020 and into 2021. During the first three quarters of 2021, we experienced strong loan lock volumes and margins, driving large increases in mortgage banking income relative to 2020. Throughout 2021, the mix of our loan locks gradually transitioned from a majority of refinancings to a majority of purchase-money loans, with purchase money loans comprising 38% of total loan locks in the first quarter and 59% in the fourth quarter. In the fourth quarter of 2021, income from residential mortgage banking activities decreased from third quarter levels, as market conditions during the fourth quarter prompted us to decrease loan purchase commitments in order to preserve margin on our loan purchase activities. The rise in mortgage interest rates and interest rate volatility experienced in the fourth quarter of 2021 has accelerated thus far in 2022. We expect any continued increases in mortgage rates and further volatility in market conditions could negatively impact both our origination volumes and profitability in the near-term while markets adjust to these new conditions.

Operating expenses at our Residential mortgage banking segment increased in 2021 compared to 2020, as we implemented a workforce reduction in April of 2020 following the onset of the pandemic, then gradually grew our workforce throughout the second half of 2020 and into 2021 to support increasing production volumes. Additionally, the increase in general and administrative expenses reflected higher accruals of variable compensation expense associated with improved financial results at this segment and a higher headcount in 2021 as compared to 2020. We also incurred higher systems and consulting costs in 2021, as we re-engineered and implemented new systems and processes at this segment. Loan acquisition costs at this segment increased as a result of higher loan purchases in 2021 relative to 2020.

Activity at this segment is performed within our taxable REIT subsidiary, and the increase in provision for income taxes in 2021 from 2020 generally reflects the higher income earned year over year by this segment.

74

Business Purpose Mortgage Banking Segment

Overview

Our Business Purpose Mortgage Banking segment consists of a platform that originates and acquires business purpose loans for subsequent securitization, sale, or transfer into our investment portfolio. We originate single-family rental and bridge loans and typically distribute most of our single-family rental loans through our CAFL private-label securitization program, or on occasion through whole loan sales, and will transfer our bridge loans to the Investment Portfolio where they will either be retained for investment or securitized. Single-family rental loans are business purpose mortgage loans to investors in single-family (primarily 1-4 unit) rental properties. Bridge loans are business purpose mortgage loans to investors rehabilitating and subsequently reselling or renting residential and small-balance multifamily properties. This segment also includes various derivative financial instruments that we utilize to manage certain risks associated with our inventory of single-family rental loans held-for-sale. This segment’s main source of mortgage banking income are net interest income earned on loans while they are held in inventory, origination fees on loans, mark-to-market adjustments on loans from the time loans are originated or purchased to when they are sold, securitized or transferred into our investment portfolio, and gains/losses from associated hedges. Direct operating expenses and tax expenses associated with these activities are also included in this segment.

Net income from this segment is primarily comprised of net interest income earned on loans while they are held in inventory, mark-to-market adjustments on loans from the time they are originated or acquired until loans are sold, securitized or transferred to our investment portfolio, gains/losses from associated hedges, and all direct expenses associated with these activities. Subordinate securities that we retain from our CAFL securitizations (which we consolidate for GAAP purposes) and bridge loans we originate in this segment are transferred to and held in our Investment Portfolio segment.

The following table provides the business purpose loan origination activity at Redwood during the years ended December 31, 2021 and 2020.

Table 10 – Business Purpose Loans — Funding Activity

[[GREPCENT_TABLE]]
[["","","Year Ended December 31, 2021","","Year Ended December 31, 2020"],["(In Thousands)","","Single-Family Rental","","Bridge (1)","","Total","","Single-Family Rental","","Bridge (1)","","Total"],["Fair value at beginning of period","","$","245,394","","","$","\u2014","","","$","245,394","","","$","331,565","","","$","\u2014","","","$","331,565"],["Fundings","","1,327,001","","","960,223","","","2,287,224","","","979,883","","","451,554","","","1,431,437"],["Sales","","(201,629)","","","(2,484)","","","(204,113)","","","(110,836)","","","(25,151)","","","(135,987)"],["Transfers between segments (2)","","(1,023,988)","","","(962,573)","","","(1,986,561)","","","(1,000,165)","","","(423,487)","","","(1,423,652)"],["Principal repayments","","(62,209)","","","\u2014","","","(62,209)","","","(54,395)","","","\u2014","","","(54,395)"],["Changes in fair value, net","","73,740","","","4,834","","","78,574","","","99,342","","","(2,916)","","","96,426"],["Fair Value at End of Period","","$","358,309","","","$","\u2014","","","$","358,309","","","$","245,394","","","$","\u2014","","","$","245,394"]]
[[/GREPCENT_TABLE]]

(1)We originate bridge loans at our TRS and then transfer them to our REIT. Origination fees and any fair value changes on these loans prior to transfer are recognized within Mortgage banking activities, net on our consolidated statements of income (loss). Once the loans are transferred to our REIT, they are classified as held-for-investment, with subsequent fair value changes generally recorded through Investment fair value changes, net on our consolidated statements of income (loss). For bridge loans held at our REIT that are transferred into our CAFL bridge securitization, we record any changes in fair value from the date of origination or purchase to the time of securitization as Mortgage banking activities, net on our consolidated statements of income (loss). Once loans are transferred into this securitization, any changes in fair value are recorded through Investment fair value changes, net on our consolidated statements of income (loss). For the carrying value and activity of our bridge loans held-for-investment, see the Investment Portfolio section that follows.

(2)For single-family rental loans, amounts represent transfers of loans from held-for-sale at our Business Purpose Mortgage Banking segment to held-for-investment at our Investment Portfolio segment, associated with securitizations we sponsored that we consolidate under GAAP. For bridge loans, represents the transfer of loans originated or acquired by our Business purpose mortgage banking group at our TRS and transferred to Investment Portfolio segment at our REIT as described in preceding footnote.

During the year ended December 31, 2021, we funded $1.33 billion of single-family rental loans, sold $202 million of such loans to third parties and securitized $1.04 billion of loans through four separate transactions. At December 31, 2021, we had $358 million of single-family rental loans in inventory on our balance sheet. During the year ended December 31, 2021, we funded $960 million of bridge loans, sold $2 million of loans to a third party and transferred the remaining loans to our Investment Portfolio segment, including $359 million of loans that were contributed into a revolving bridge loan securitization we completed in the third quarter of 2021.

75

We utilize a combination of capital and financing from loan warehouse facilities to manage our inventory of single-family rental loans that we hold for sale. At December 31, 2021, we had business purpose warehouse facilities outstanding with three different counterparties, with $1.30 billion of total capacity (used for both SFR and bridge loans) and $648 million of available capacity. All of these facilities are non-marginable (i.e., not subject to margin calls based on the market value of the underlying collateral).

The following table presents an earnings summary for our Business Purpose Mortgage Banking segment for the years ended December 31, 2021, 2020 and 2019.

Table 11 – Business Purpose Mortgage Banking Earnings Summary

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["(In Thousands)","","2021","","2020","","2019"],["Mortgage banking income","","$","116,463","","","$","83,804","","","$","47,727"],["Operating expenses","","(69,813)","","","(147,467)","","","(37,579)"],["Provision for income taxes","","(8,122)","","","(4,063)","","","(947)"],["Segment Contribution","","$","38,528","","","$","(67,726)","","","$","9,201"]]
[[/GREPCENT_TABLE]]

Business purpose mortgage banking income presented in the table above is comprised of net interest income from single-family rental (SFR) loans held-for-sale in inventory, mortgage banking activities, net and other income, net for this segment. Income from mortgage banking activities is comprised of mark-to-market adjustments on loans from the time they are originated or purchased until they are sold, securitized or transferred into our investment portfolio, gains/losses from associated hedges, and other miscellaneous income/expenses (see Note 19 in Part II, Item 8 of this Annual Report on Form 10-K for further detail on the composition of mortgage banking activities). Operating expenses presented in the table above includes general and administrative expenses, loan acquisition costs and other expenses for this segment.

In the preceding Results of Operations by Segment Overview section, we discussed the major factors impacting the change in net income (segment contribution) from our Business Purpose Mortgage Banking segment from 2019 to 2021. Following, we provide additional detail on the changes in segment contribution from 2020 to 2021.

The increase in mortgage banking income in 2021 primarily resulted from a significant increase in both SFR and bridge loan origination volumes in 2021 compared to 2020 (as presented in Table 11 above). In the second half of 2021, we began to build out a new business purpose loan correspondent channel, which purchased $137 million of loans in 2021 (which amounts are included in loan fundings, within Table 10 above).

Operating expenses at our Business Purpose Mortgage Banking segment for 2020 included $89 million of expense from the write-off of the segment's entire goodwill balance as a result of disruptions following the onset of the pandemic and the economic downturn that ensued. Exclusive of this non-cash goodwill impairment expense, operating expenses at this segment in 2020 were $59 million and increased relative to 2019, as we incurred a full year of operating expenses for these operations after the acquisitions of 5 Arches and CoreVest in March and October of 2019, respectively. The increase in operating expenses from 2020 to 2021 (exclusive of the write-off of goodwill), was primarily related to higher general and administrative expenses, which reflected both higher headcount in 2021 to support increased business activity and higher accruals of variable compensation expense associated with improved financial results at this segment in 2021 as compared to 2020.

Activity at this segment is performed within our taxable REIT subsidiary, and the increase in provision for income taxes in 2021 from 2020 generally reflects the higher income earned year over year by this segment.

Investment Portfolio Segment

Our Investment Portfolio segment consists of investments sourced through our residential and business purpose mortgage banking operations, including primarily securities retained from our residential and business purpose securitization activities (some of which we consolidate for GAAP purposes), residential and small-balance multifamily bridge loans, as well as third-party investments including RMBS issued by third parties (including Agency CRT securities), investments in Freddie Mac K-Series multifamily loan securitizations and reperforming loan securitizations (both of which we consolidate for GAAP purposes), servicer advance investments, home equity investments, and other housing-related investments. This segment’s main sources of income are net interest income and other income from investments, changes in fair value of investments, and realized gains and losses upon the sale of securities. Direct operating expenses and tax provisions associated with these activities are also included in this segment.

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The following table presents details of our Investment portfolio at December 31, 2021 and December 31, 2020 organized by investments organically created through our mortgage banking segments and acquired from third-parties. Amounts presented in the table represent our retained economic investments in consolidated Sequoia, CAFL SFR, Freddie Mac SLST, Freddie Mac K-Series, Servicing Investment and Point HEI securitizations as noted.

Table 12 – Investment Portfolio - Detail of Economic Interests

[[GREPCENT_TABLE]]
[["(In Thousands)","","December 31, 2021","","December 31, 2020"],["Organic Residential Investments"],["Residential loans at Redwood (1)","","$","172,047","","","$","\u2014"],["Residential securities at Redwood (2)","","143,838","","","155,501"],["Residential securities at consolidated Sequoia entities (3)","","245,417","","","217,965"],["Other investments","","12,438","","","8,815"],["Organic Business Purpose Investments"],["Bridge loans","","944,606","","","641,765"],["Single-family rental securities at consolidated CAFL SFR entities (4)","","301,506","","","238,630"],["Other investments","","5,935","","","21,627"],["Third-Party Investments"],["Residential securities at Redwood","","195,930","","","134,090"],["Residential securities at consolidated Freddie Mac SLST entities (5)","","444,751","","","428,179"],["Multifamily securities at Redwood","","32,715","","","49,255"],["Multifamily securities at consolidated Freddie Mac K-Series entities (6)","","31,657","","","28,255"],["Servicing investments (7)","","102,540","","","67,766"],["HEIs (8)","","43,638","","","42,440"],["Other investments","","10,400","","","19,069"],["Total Segment Investments","","$","2,687,418","","","$","2,053,357"]]
[[/GREPCENT_TABLE]]

(1)Balance comprised of loans called from Sequoia securitizations.

(2)Excludes $5 million of trading securities that are designated as hedges for our mortgage banking operations and are not considered part of our investment portfolio.

(3)Represents our retained economic investment in securities issued by consolidated Sequoia securitization VIEs. For GAAP purposes, we consolidated $3.63 billion of loans and $3.38 billion of ABS issued associated with these investments at December 31, 2021. We consolidated $1.57 billion of loans and $1.35 billion of ABS issued associated with these investments at December 31, 2020.

(4)Represents our retained economic investment in securities issued by consolidated CAFL SFR securitization VIEs. For GAAP purposes, we consolidated $3.49 billion of loans and $3.21 billion of ABS issued associated with these investments at December 31, 2021. We consolidated $3.25 billion of loans and $3.01 billion of ABS issued associated with these investments at December 31, 2020.

(5)Represents our economic investment in securities issued by consolidated Freddie Mac SLST securitization entities. For GAAP purposes, we consolidated $1.89 billion of loans and $1.45 billion of ABS issued associated with these investments at December 31, 2021. We consolidated $2.22 billion of loans and $1.79 billion of ABS issued associated with these investments at December 31, 2020.

(6)Represents our economic investment in securities issued by consolidated Freddie Mac K-Series securitization entities. For GAAP purposes, we consolidated $474 million of loans and $442 million of ABS issued associated with these investments at December 31, 2021. We consolidated $492 million of loans and $464 million of ABS issued associated with these investments at December 31, 2020.

(7)Represents our economic investment in consolidated Servicing Investment variable interest entities. At December 31, 2021, for GAAP purposes, we consolidated $385 million of servicing investments and $294 million of non-recourse short-term securitization debt, as well as other assets and liabilities for these entities. At December 31, 2020, for GAAP purposes, we consolidated $252 million of servicing investments and $208 million of non-recourse short-term securitization debt, as well as other assets and liabilities for these entities.

(8)At December 31, 2021, represents HEIs owned at Redwood of $33 million and our retained economic investment in securities issued by the consolidated Point HEI entity of $10 million. At December 31, 2021, for GAAP purposes, we consolidated $160 million of HEIs and $137 million of ABS issued, as well as other assets and liabilities for this entity. At December 31, 2020, represents HEIs owned at Redwood.

77

The growth in our investment portfolio during 2021 was primarily attributable to a net increase in business purpose bridge loans, the acquisition of residential jumbo loans from calls, incremental investments in HEI through our Point flow agreement, incremental servicing investments, additional securities retained from CAFL securitizations and incremental investments in agency CRT. See the "Investments Detail and Activity" section that follows for additional detail on our portfolio investments and their associated borrowings.

The following table presents an earnings summary for our Investment Portfolio segment for the years ended December 31, 2021, 2020 and 2019.

Table 13 – Investment Portfolio Earnings Summary

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["(In Thousands)","","2021","","2020","","2019"],["Net interest income","","$","155,538","","","$","150,479","","","$","165,331"],["Investment fair value changes, net","","129,614","","","(586,204)","","","37,293"],["Other income, net","","10,021","","","(1,725)","","","11,407"],["Realized gains, net","","17,993","","","5,242","","","23,821"],["Operating expenses","","(16,074)","","","(10,779)","","","(12,037)"],["(Provision for) benefit from income taxes","","(3,862)","","","4,104","","","(2,419)"],["Segment Contribution","","$","293,230","","","$","(438,883)","","","$","223,396"]]
[[/GREPCENT_TABLE]]

In the preceding Results of Operations by Segment – Overview section, we discussed the major factors impacting the change in net income (segment contribution) from our Investment Portfolio segment from 2019 to 2021. Additionally, the preceding Net Interest Income – Net Interest Income by Segment section, we discussed the major factors impacting the change in net interest income from our Investment Portfolio segment. Following, we provide additional detail on the changes in segment contribution from 2020 to 2021.

Investment fair value changes is primarily comprised of the change in fair value of our portfolio investments (both realized and unrealized) accounted for under the fair value option and, prior to the second quarter of 2020, interest rate hedges associated with these investments (see Table 5.6 in Note 5 in Part II, Item 8 of this Annual Report on Form 10-K for further detail on the composition of investment fair value changes – note difference in amount from the table above to Table 5.6 in the notes to our consolidated financial statements relates to fair value changes for investments held at corporate/other). During 2021, positive investment fair value changes reflected improved credit performance and spread tightening across our investment portfolio. In addition to our excess MSR investments, we also own interest only securities within our trading securities, and in consolidated Sequoia, Freddie Mac SLST, and CAFL entities. As a matter of course, we record negative fair value changes for these investments each quarter, which represent a reduction in the basis of these assets as we receive regular cash interest payments. In addition to these baseline negative fair value changes for these assets, we incurred incremental negative fair value changes for these investments in 2021 as a result of increasing prepayment speeds for the loans underlying these investments.

The negative investment fair value changes recorded during 2020 were primarily driven by realized losses incurred on assets sales and derivative settlements that occurred in March and April of that year, as we repositioned our portfolio in response to disruptions following the onset of the pandemic. Approximately $360 million of losses were realized from such sales. The remaining net losses for the year were primarily associated with assets we retained that experienced a significant decline in value during the first quarter of 2020 and had not fully recovered their value through the end of that year, as well as a negative fair value changes on our interest only securities resulting from lower benchmark interest rates and higher prepayment speeds during 2020. The $59 million of losses from risk management derivatives in 2020 were realized in the first quarter of that year, when we settled all of the hedges for this portfolio. During 2019, the positive investment fair value changes primarily resulted from tightening credit spreads in several investment classes.

Other income within this segment is primarily comprised of income (loss) from our MSR investments, bridge loan fees, risk share investment income and FHLBC capital stock dividends. Details on the composition of Other income is included in Note 20 in Part II, Item 8 of this Annual Report on Form 10-K. The change in this line item from 2020 to 2021 and 2019 to 2020, was primarily driven by positive $12 million and negative $13 million, respectively, of changes in MSR Income (loss), mostly attributable to negative fair value changes for these investments in 2020, when prepayment speeds rose sharply after the onset of the pandemic when benchmark interest rates declined.

78

In 2021, we realized gains of $18 million, including $16 million of gains resulting from calls of seven seasoned Sequoia securitizations, and $1.5 million of net gains from the sale of $11 million of AFS securities. For 2020, realized gains included $5 million of net gains from the sale of $55 million of AFS securities. For 2019, we realized gains of $24 million, primarily from the sale of $110 million of AFS securities and the call of a seasoned Sequoia securitization in the first quarter.

The increase in operating expenses in 2021 at this segment was primarily attributable to higher general and administrative expenses resulting from increased accruals of variable compensation expense associated with improved financial results and a higher headcount in 2021 as compared to 2020, as well as higher long-term incentive award expense from awards granted in the second half of 2020, including retention related awards, and awards granted in early 2021 as part of our regular annual compensation process.

We hold certain of investments, primarily our MSRs, at our taxable REIT subsidiary. Our provision for (benefit from) income taxes changes in relation to the amount of income earned from these assets and generally reflects positive income in 2021 and 2019, and losses in 2020.

Investments Detail and Activity

This section presents additional details on our investment assets and their activity during 2021 and 2020.

Real Estate Securities Portfolio

The following table sets forth our real estate securities activity by collateral type for the years ended December 31, 2021 and 2020.

Table 14 – Real Estate Securities Activity by Collateral Type

[[GREPCENT_TABLE]]
[["Year Ended December 31, 2021","","Residential","","Multifamily","","Total"],["(In Thousands)","","Senior","","Mezzanine","","Subordinate","","Mezzanine"],["Beginning fair value","","$","28,464","","","$","5,663","","","$","260,743","","","$","49,255","","","$","344,125"],["Acquisitions"],["Sequoia securities","","7,775","","","\u2014","","","1,600","","","\u2014","","","9,375"],["Third-party securities","","962","","","\u2014","","","58,750","","","8,930","","","68,642"],["Sales"],["Sequoia securities","","\u2014","","","(3,664)","","","\u2014","","","\u2014","","","(3,664)"],["Third-party securities","","\u2014","","","(2,060)","","","(33,863)","","","\u2014","","","(35,923)"],["Gains on sales and calls, net","","\u2014","","","60","","","17,033","","","\u2014","","","17,093"],["Effect of principal payments (1)","","\u2014","","","(26)","","","(34,365)","","","(23,209)","","","(57,600)"],["Change in fair value, net","","(15,414)","","","27","","","53,011","","","(2,261)","","","35,363"],["Ending Fair Value (2)","","$","21,787","","","$","\u2014","","","$","322,909","","","$","32,715","","","$","377,411"]]
[[/GREPCENT_TABLE]]

79

[[GREPCENT_TABLE]]
[["Year Ended December 31, 2020","","Residential","","Multifamily","","Total"],["(In Thousands)","","Senior","","Mezzanine","","Subordinate","","Mezzanine"],["Beginning fair value","","$","175,859","","","$","151,797","","","$","368,090","","","$","404,128","","","$","1,099,874"],["Acquisitions"],["Sequoia securities","","49,090","","","\u2014","","","4,187","","","\u2014","","","53,277"],["Third-party securities","","23,229","","","2,000","","","27,950","","","59,446","","","112,625"],["Sales"],["Sequoia securities","","(33,375)","","","(31,334)","","","(6,394)","","","\u2014","","","(71,103)"],["Third-party securities","","(115,354)","","","(93,728)","","","(91,054)","","","(287,483)","","","(587,619)"],["Gains on sales and calls, net","","3,357","","","400","","","2,487","","","(1,604)","","","4,640"],["Effect of principal payments (1)","","(4,464)","","","(1,015)","","","(6,803)","","","(9,625)","","","(21,907)"],["Change in fair value, net","","(69,878)","","","(22,457)","","","(37,720)","","","(115,607)","","","(245,662)"],["Ending Fair Value","","$","28,464","","","$","5,663","","","$","260,743","","","$","49,255","","","$","344,125"]]
[[/GREPCENT_TABLE]]

(1)The effect of principal payments reflects the change in fair value due to principal payments, which is calculated as the cash principal received on a given security during the period multiplied by the prior quarter ending price or acquisition price for that security.

(2)At December 31, 2021, excludes $245 million and $302 million of securities retained from our consolidated Sequoia and CAFL securitizations, respectively, as well as $445 million and $32 million of securities we owned that were issued by consolidated Freddie Mac SLST and Freddie Mac K-Series securitizations, respectively.

At December 31, 2021, our securities consisted of fixed-rate assets (90%), adjustable-rate assets (8%) and hybrid assets that reset within the next year (2%).

The following table sets forth activity in our real estate securities portfolio for the year ended December 31, 2021 organized by investments organically created through our mortgage banking segments and acquired from third-parties. This table includes both our securities held on balance sheet and our economic interest in securities we own in securitizations we consolidate in accordance with GAAP.

Table 15 – Activity of Real Estate Securities Owned at Redwood and in Consolidated Entities

[[GREPCENT_TABLE]]
[["For the Year Ended December 31, 2021","","Residential Organic","","Business Purpose Organic","","Third-Party Investments","","Total"],["","Sequoia Securities on Balance Sheet","","Consolidated Sequoia Securities","","Consolidated CAFL Securities","","Consolidated SLST Securities","","Consolidated Multifamily Securities","","Other Third-Party Securities"],["(In Thousands)"],["Beginning fair value","","$","157,456","","","$","217,965","","","$","238,630","","","$","428,178","","","$","28,255","","","$","186,669","","","$","1,257,153"],["Acquisitions","","9,375","","","16,513","","","78,278","","","\u2014","","","\u2014","","","68,642","","","172,808"],["Sales","","(3,664)","","","\u2014","","","\u2014","","","\u2014","","","(8,197)","","","(35,923)","","","(47,784)"],["Gains on sales and calls, net","","15,553","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","1,540","","","17,093"],["Effect of principal payments (2)","","(30,919)","","","(3,231)","","","(23,643)","","","(46,059)","","","\u2014","","","(26,681)","","","(130,533)"],["Change in fair value, net","","(2,044)","","","14,170","","","8,241","","","62,632","","","11,599","","","37,407","","","132,005"],["Ending Fair Value (1)","","$","145,757","","","$","245,417","","","$","301,506","","","$","444,751","","","$","31,657","","","$","231,654","","","$","1,400,742"]]
[[/GREPCENT_TABLE]]

(1)At December 31, 2021, $5 million of securities used as hedges for our residential mortgage banking operations are included within the "Sequoia Securities on balance sheet" and "Other third-party securities" column of this table. These same securities are presented as a component of securities within our residential lending segment on our segment balance sheet.

(2)The effect of principal payments reflects the change in fair value due to principal payments, which is calculated as the cash principal received on a given security during the period multiplied by the prior quarter ending price or acquisition price for that security.

During 2021, we retained $78 million of securities from four single-family rental securitizations and $26 million of securities from nine Sequoia securitizations.

At December 31, 2021, our securities owned at Redwood and in consolidated entities consisted of fixed-rate assets (97%), adjustable-rate assets (2%), and hybrid assets that reset within the next year (1%).

80

We directly finance our holdings of real estate securities with a combination of non-recourse debt, non-marginable term debt and marginable debt in the form of repurchase (or “repo”) financing. At December 31, 2021, real estate securities with a fair value of $508 million (including securities owned in consolidated Sequoia and CAFL securitization entities) were financed with long-term, non-marginable recourse debt through our subordinate securities financing facilities, re-performing loan securities with a fair value of $445 million were financed with $143 million of non-recourse securitization debt, and real estate securities with a fair value of $99 million (including securities owned in consolidated securitization entities) were financed with $75 million of short-term debt incurred through repurchase facilities with four different counterparties. The remaining $350 million of securities, including certain securities we own that were issued by consolidated securitization entities, were financed with capital.

The following table summarizes the credit characteristics of our entire real estate securities portfolio by collateral type at December 31, 2021. This table includes both our securities held on balance sheet and our economic interest in securities we own in securitizations we consolidate in accordance with GAAP.

Table 16 – Credit Statistics of Real Estate Securities Owned at Redwood and in Consolidated Entities

[[GREPCENT_TABLE]]
[["December 31, 2021","","","","","","","","Weighted Average Values for Non-IO Securities"],["","Market Value - IO Securities","","Market Value - Non-IO Securities","","Principal Balance - Non-IO Securities","","Coupon","","90+ Delinquency","","3-Month Prepayment Rate","","Investment Thickness(1)"],["(Dollars in Thousands)"],["Sequoia securities on balance sheet","","$","18,215","","","$","127,542","","","$","151,088","","","3.7","%","","0.54","%","","35","%","","7","%"],["Consolidated Sequoia securities","","15,483","","","229,934","","","247,500","","","4.6","%","","2.06","%","","46","%","","34","%"],["Total Sequoia Securities","","33,698","","","357,476","","","398,588","","","4.3","%","","1.50","%","","42","%","","25","%"],["Consolidated Freddie Mac SLST securities","","16,428","","","428,323","","","532,721","","","3.1","%","","11.08","%","","16","%","","28","%"],["RPL securities on balance sheet","","561","","","65,140","","","143,483","","","3.4","%","","4.38","%","","17","%","","8","%"],["Total RPL Securities","","16,989","","","493,463","","","676,204","","","3.2","%","","10.19","%","","16","%","","25","%"],["Consolidated Freddie Mac K-Series securities","","\u2014","","","31,657","","","36,468","","","4.1","%","","\u2014","%","","\u2014","%","","20","%"],["Multifamily securities on balance sheet","","1,330","","","31,385","","","31,856","","","3.5","%","","0.03","%","","26","%","","7","%"],["Total Multifamily Securities","","1,330","","","63,042","","","68,324","","","3.8","%","","0.01","%","","13","%","","14","%"],["Consolidated CAFL securities","","54,975","","","246,531","","","367,058","","","5.1","%","","2.14","%","","12","%","","12","%"],["Other third-party securities","","3,050","","","130,188","","","151,733","","","5.2","%","","1.16","%","","26","%","","4","%"],["Total Securities","","$","110,042","","","$","1,290,700","","","$","1,661,907"]]
[[/GREPCENT_TABLE]]

(1)Investment thickness represents the average size of the subordinate securities we own as investments in securitizations, relative to the average overall size of the securitizations. For example, if our investment thickness (of first-loss securities) with respect to a particular securitization is 10%, we have exposure to the first 10% of credit losses resulting from loans underlying that securitization. We generally own first loss positions in Sequoia, RPL and CAFL securities. We own both first loss and mezzanine positions (positions credit enhanced by subordinate securities) in multifamily and other third-party securities.

81

Bridge Loans Held-for-Investment

The following table provides the activity of bridge loans held-for-investment at Redwood during the years ended December 31, 2021 and 2020.

Table 17 – Bridge Loans Held-for-Investment - Activity

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["(In Thousands)","","2021","","2020"],["Fair value at beginning of period","","$","641,765","","","$","745,006"],["Sales","","(7,000)","","","\u2014"],["Transfers between portfolios (1)","","962,573","","","423,351"],["Transfers to REO","","(15,424)","","","(6,111)"],["Principal repayments","","(639,479)","","","(510,446)"],["Changes in fair value, net","","2,171","","","(10,035)"],["Fair Value at End of Period","","$","944,606","","","$","641,765"]]
[[/GREPCENT_TABLE]]

(1)We originate bridge loans at our TRS and then transfer them to our REIT. Origination fees and any fair value changes on these loans prior to transfer are recognized within Mortgage banking activities, net on our consolidated statements of income (loss). Once the loans are transferred to our REIT, they are classified as held-for-investment, with subsequent fair value changes generally recorded through Investment fair value changes, net on our consolidated statements of income (loss). For bridge loans held at our REIT that are transferred into our CAFL bridge securitization, we record any changes in fair value from the date of origination or purchase to the time of securitization as Mortgage banking activities, net on our consolidated statements of income (loss). Once loans are transferred into this securitization, any changes in fair value are recorded through Investment fair value changes, net on our consolidated statements of income (loss).

Our $945 million of bridge loans held-for-investment at December 31, 2021 were comprised of first-lien, interest-only loans with a weighted average coupon of 6.95% and original maturities of six to 24 months. At origination, the weighted average FICO score of borrowers backing these loans was 742 and the weighted average LTV ratio of these loans was 68%. At December 31, 2021, of the 2,774 loans in this portfolio, 28 of these loans with an aggregate fair value of $14 million and an aggregate unpaid principal balance of $18 million were in foreclosure, of which 31 loans with an aggregate fair value of $14 million and an unpaid principal balance of $18 million were greater than 90 days delinquent.

We finance our bridge loans with a combination of non-recourse securitization debt, and both recourse and non-recourse non-marginable warehouse facilities. At December 31, 2021, we had $139 million of debt incurred through short-term warehouse facilities with one different counterparty, which was secured by $167 million of loans, and $459 million of debt incurred through long-term facilities with three different counterparties, which was secured by $555 million of loans.

We completed a securitization of CoreVest bridge loans in the third quarter of 2021. The ABS issued by this securitization were backed by assets including $278 million of bridge loans, $15 million of restricted cash, and other assets at December 31, 2021. The securitization is structured with $300 million of total funding capacity and a feature to allow reinvestment of loan payoffs for the first 30 months of the transaction (through March 2024).

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Residential Loans

The following table provides the activity of residential loans held at our investment portfolio during the years ended December 31, 2021 and 2020.

Table 18 – Investment Portfolio Residential Loans - Activity

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["(In Thousands)","","2021","","2020"],["Fair value at beginning of period","","$","\u2014","","","$","2,111,897"],["Acquisitions","","200,890","","","\u2014"],["Sales","","\u2014","","","(1,254,935)"],["Transfers between portfolios (1)","","\u2014","","","(533,612)"],["Principal repayments","","(31,654)","","","(229,818)"],["Changes in fair value, net","","2,812","","","(93,532)"],["Fair Value at End of Period","","$","172,048","","","$","\u2014"]]
[[/GREPCENT_TABLE]]

(1)Represents the net transfers of loans into or out of our investment portfolio and their reclassification between held-for-sale to held-for-investment.

During 2021, we called seven of our unconsolidated Sequoia securitizations and purchased $200 million (unpaid principal balance) of loans from the securitization trusts.

During 2020, as a result of the economic and financial market disruptions following the onset of the pandemic, we sold all of our residential loans previously held for investment and financed at our FHLBC facility, and repaid borrowings under this facility. The negative fair value changes of $93 million recorded in 2020 in association with these loans was effectively realized through their sale.

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Other Investments

The following table sets forth our other investments activity by significant asset type for the years ended December 31, 2021 and December 31, 2020.

Table 19 – Other Investments at Investment Portfolio Segment - Activity

[[GREPCENT_TABLE]]
[["For the Year Ended December 31, 2021"],["","","ServicingInvestments(1)","","Home EquityInvestments(2)","","MSRs and Excess Servicing","","Other","","Total"],["(In Thousands)"],["Balance at beginning of period","","$","231,489","","","$","42,440","","","$","43,233","","","$","26,563","","","$","343,725"],["New/additional investments","","196,583","","","155,023","","","24,896","","","\u2014","","","376,502"],["Sales/distribution","","\u2014","","","\u2014","","","\u2014","","","(7,196)","","","(7,196)"],["Reductions in investments","","(76,223)","","","(19,396)","","","\u2014","","","(14,751)","","","(110,370)"],["Changes in fair value, net","","(926)","","","14,673","","","(11,204)","","","1,242","","","3,785"],["Other","","\u2014","","","\u2014","","","(256)","","","77","","","(179)"],["Balance at End of Period","","$","350,923","","","$","192,740","","","$","56,669","","","$","5,935","","","$","606,267"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["For the Year Ended December 31, 2020"],["","","ServicingInvestments(1)","","Home EquityInvestments(2)","","MSRs and Excess Servicing","","Other","","Total"],["(In Thousands)"],["Balance at beginning of period","","$","169,204","","","$","45,085","","","$","74,037","","","$","26,002","","","$","314,328"],["New/additional investments","","179,419","","","3,517","","","10,907","","","8,420","","","202,263"],["Reductions in investments","","(107,527)","","","(4,269)","","","\u2014","","","(6,096)","","","(117,892)"],["Changes in fair value, net","","(9,607)","","","(1,893)","","","(41,711)","","","(1,763)","","","(54,974)"],["Balance at End of Period","","$","231,489","","","$","42,440","","","$","43,233","","","$","26,563","","","$","343,725"]]
[[/GREPCENT_TABLE]]

(1)Our servicing investments are owned through our consolidated Servicing Investment entities. At December 31, 2021, our economic investment in these entities was $103 million (for GAAP purposes, we consolidated $385 million of servicing investments, $294 million of non-recourse short-term securitization debt, as well as other assets and liabilities for these entities). At December 31, 2020, our economic investment in these entities was $68 million (for GAAP purposes, we consolidated $252 million of servicing investments, $208 million of non-recourse short-term securitization debt, as well as other assets and liabilities for these entities).

(2)Our home equity investments presented in this table as of December 31, 2021, include $160 million of HEIs owned in our consolidated Point HEI entity. During the third quarter of 2021, in conjunction with co-sponsoring a securitization of HEIs, we purchased $122 million of additional HEIs from other contributors to the securitization, then transferred $172 million of HEIs to the Point HEI securitization entity and issued $146 million of ABS. At December 31, 2021, our economic investment in this entity was $10 million (for GAAP purposes, we consolidated $160 million of HEIs and $137 million of ABS issued, as well as other assets and liabilities for this entity).

Reductions in investments for our servicing investments primarily represent recoveries of servicing advances within our consolidated servicing VIEs. Positive changes in fair value for Home Equity Investments in 2021 primarily reflect an increase in the value of our HEIs that was established upon the completion of our co-sponsored Point HEI securitization. Changes in fair value for MSRs and excess servicing represent both a reduction in basis from the regular receipt of scheduled cash flows, as well as a negative impact to fair value from increased prepayment speeds experienced in 2020 and 2021.

Additional details on our other investments is included in Note 10 in Part II, Item 8 of this Annual Report on Form 10-K.

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Income Taxes

Taxable Income, REIT Status and Dividend Characterization

As a REIT, under the Internal Revenue Code, Redwood is required to distribute to shareholders at least 90% of its annual REIT taxable income, excluding net capital gains, and meet certain other requirements that relate to, among other matters, the assets it holds, the income it generates, and the composition of its stockholders. To the extent Redwood retains REIT taxable income, including net capital gains, it is taxed at corporate tax rates. Redwood also earns taxable income at its taxable REIT subsidiaries (TRS), which it is not required to distribute under the Internal Revenue Code.

In December 2021, our Board of Directors declared a regular dividend of $0.23 per share for the fourth quarter of 2021, which was paid on December 28, 2021 to shareholders of record on December 17, 2021. At December 31, 2021, our full-year dividend distributions of $0.78 per share exceeded our minimum distribution requirements and we believe that we have met all requirements for qualification as a REIT for federal income tax purposes. Many requirements for qualification as a REIT are complex and require analysis of particular facts and circumstances. Often there is only limited judicial or administrative interpretive guidance and as such there can be no assurance that the Internal Revenue Service or courts would agree with our various tax positions. If we were to fail to meet all the requirements for qualification as a REIT and the requirements for statutory relief, we would be subject to federal corporate income tax on our taxable income and we would not be able to elect to be taxed as a REIT for four years thereafter. Such an outcome could have a material adverse impact on our consolidated financial statements.

While our minimum REIT dividend requirement is generally 90% of our annual REIT taxable income, we carried a $37 million federal net operating loss carry forward (NOL) into 2021 at our REIT that affords us the ability to retain REIT taxable income up to the NOL amount, tax free, rather than distributing it as dividends. Federal income tax rules require the dividends paid deduction to be applied to reduce REIT taxable income before the applicability of NOLs is considered; therefore, REIT taxable income must exceed our dividend distribution for us to utilize a portion of our NOL and any remaining NOL amount will carry forward into future years.

The tax basis in assets and liabilities at the REIT was $3.28 billion and $1.86 billion, respectively, at December 31, 2021. The GAAP basis in assets and liabilities at the REIT was $11.87 billion and $10.60 billion, respectively, at December 31, 2021. The primary difference in both the tax and GAAP assets and liabilities is attributable to securitization entities that are consolidated for GAAP reporting purposes but not for tax purposes.

Our 2021 dividend distributions are expected to be characterized for federal income tax purposes as 74% ordinary dividend income and 26% qualified dividends. Under the federal income tax rules applicable to REITs, none of the 2021 dividend distributions are expected to be characterized as a return of capital or long-term capital gain dividend income. The income or loss generated at our TRS does not directly affect the tax characterization of our 2021 dividends; however, any dividends paid from our TRS to our REIT allows a portion of our REIT’s dividends to be classified as qualified dividends.

Tax Provision under GAAP

For the years ended months ended December 31, 2021, 2020, and 2019, we recorded a tax provision of $18 million, a tax benefit of $5 million and a tax provision of $7 million, respectively. Our tax provision is primarily derived from the activities at our TRS as we do not book a material tax provision associated with income generated at our REIT. Our TRS income is generally earned from our mortgage banking activities, MSRs, and other non-REIT eligible security investments. While our TRS effective tax rate in the prior year approximated the federal statutory corporate tax rate (due to state NOL carryforwards), for 2021 it increased (exclusive of the valuation allowance release) due to California’s temporary suspension of net operating loss carryforwards.

Realization of our deferred tax assets ("DTAs") is dependent on many factors, including generating sufficient taxable income prior to the expiration of NOL carryforwards and generating sufficient capital gains in future periods prior to the expiration of capital loss carryforwards. We determine the extent to which realization of our DTAs is not assured and establish a valuation allowance accordingly. At December 31, 2020, we reported net federal ordinary and capital DTAs, with a full valuation allowance of $17 million recorded against our net federal ordinary DTAs based on our determination that their realization was not assured, and no valuation allowance recorded against our net federal capital DTAs as we expected to utilize these DTAs. At December 31, 2020, we reported a valuation allowance of $134 million recorded against our net state DTAs.

For the year ended December 31, 2021, we reassessed the valuation allowance noting the increase in positive evidence related to our ability to utilize certain deferred tax assets. The positive evidence includes significant revenue growth and expectations regarding future profitability at our TRS. After assessing both the positive evidence and negative evidence, we determined it was more likely than not that we will realize all of our federal deferred tax assets. Therefore, we reversed our federal valuation allowance of $17 million as a discrete benefit in the third quarter of 2021. In addition to the federal valuation allowance release, we determined it was

85

more likely than not that we will realize a portion of our state deferred assets and, as such, reversed $3 million of state valuation allowance as a discrete item in the third quarter of 2021. Consistent with prior periods, we continued to maintain a valuation allowance against the majority of our net state DTAs as realization of our state DTAs is dependent on generating sufficient taxable income in the same jurisdictions in which the DTAs exist and we project most of our state DTAs will expire prior to their utilization.

The following table details our federal NOLs and capital loss carryforwards available as of December 31, 2021.

Table 20 - Federal Net Operating and Capital Loss Carryforwards

[[GREPCENT_TABLE]]
[["","","Loss Carryforward Expiration by Period"],["","","1 to 3","","3 to 5","","5 to 15","","After 15","","No"],["(In Thousands)","Years","Years","Years","Years","Expiration","","Total"],["REIT Loss Carryforwards"],["Net operating loss","","$","\u2014","","","$","\u2014","","","$","(28,684)","","","$","\u2014","","","$","(8,757)","","","$","(37,441)"],["Capital loss","","\u2014","","","(302,382)","","","\u2014","","","\u2014","","","\u2014","","","(302,382)"],["Total REIT Loss Carryforwards","","$","\u2014","","","$","(302,382)","","","$","(28,684)","","","$","\u2014","","","$","(8,757)","","","$","(339,823)"],["TRS Loss Carryforwards"],["Net operating loss","","$","\u2014","","","$","\u2014","","","$","\u2014","","","$","(182)","","","$","(208)","","","$","(390)"],["Capital loss","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Total TRS Loss Carryforwards","","$","\u2014","","","$","\u2014","","","$","\u2014","","","$","(182)","","","$","(208)","","","$","(390)"],["California Combined Loss Carryforwards"],["Net operating loss","","$","\u2014","","","$","\u2014","","","$","(1,090,695)","","","$","(53,815)","","","$","\u2014","","","$","(1,144,510)"],["Capital loss","","\u2014","","","(211,151)","","","\u2014","","","\u2014","","","\u2014","","","(211,151)"],["Total California Combined Loss Carryforwards","","$","\u2014","","","$","(211,151)","","","$","(1,090,695)","","","$","(53,815)","","","$","\u2014","","","$","(1,355,661)"]]
[[/GREPCENT_TABLE]]

86

LIQUIDITY AND CAPITAL RESOURCES

Summary

In addition to the proceeds from equity and debt capital-raising transactions, our principal sources of cash and liquidity consist of borrowings under mortgage loan warehouse facilities, secured term financing facilities, securities repurchase agreements, payments of principal and interest we receive from our investment portfolio assets, proceeds from the sale of investment portfolio assets, and cash generated from our operating activities. Our most significant uses of cash are to purchase and originate mortgage loans for our mortgage banking operations and manage hedges associated with those activities, to purchase investment securities and make other investments, to repay principal and interest on our debt, to meet margin calls associated with our debt and other obligations, to make dividend payments on our capital stock, and to fund our operations.

At December 31, 2021, our total capital was $2.04 billion and included $1.39 billion of equity capital and $652 million of convertible notes and long-term debt on our consolidated balance sheet, including $199 million of convertible debt due in 2023, $150 million of convertible debt due in 2024, $172 million of exchangeable debt due in 2025, and $140 million of trust-preferred securities due in 2037.

As of December 31, 2021, our unrestricted cash was $450 million, and we estimate we had approximately $150 million of capital available for investment. While we believe our available cash is sufficient to fund our operations, we may raise equity or debt capital from time to time to increase our unrestricted cash and liquidity, to repay existing debt, to make long-term portfolio investments, to fund strategic acquisitions and investments, or for other purposes. To the extent we seek to raise additional capital, our approach will continue to be based on what we believe to be in the best interests of the company and our shareholders.

In the discussion that follows and throughout this document, we distinguish between marginable and non-marginable debt. When we refer to non-marginable debt and marginable debt, we are referring to whether such debt is subject to market value-based margin calls on underlying collateral that is non-delinquent. If a mortgage loan is financed under a marginable warehouse facility, to the extent the market value of the loan declines (which market value is generally determined by the counterparty under the facility), we will be subject to a margin call, meaning we will be required to either immediately reacquire the loan or meet a margin requirement to pledge additional collateral, such as cash or additional residential loans, in an amount at least equal to the decline in value. Non-marginable debt may be subject to a margin call due to delinquency of the mortgage or security being financed, or a decline in the value of the underlying asset securing the collateral. For example, we could be subject to a margin call on non-marginable debt if an appraisal or broker price opinion indicates a decline in the value of the property securing the mortgage loan that is financed by us under a loan warehouse facility.

We also distinguish between recourse and non-recourse debt. When we refer to non-recourse debt, we mean debt that is payable solely from the assets pledged to secure such debt, and under which debt, no creditor or lender has direct or indirect recourse to us, or any other entity or person (except for customary exceptions for fraud, acts of insolvency, or other "bad acts"), if such assets are inadequate or unavailable to pay off such debt.

We are subject to risks relating to our liquidity and capital resources, including risks relating to incurring debt under residential loan warehouse facilities, securities repurchase facilities, and other short- and long-term debt facilities and other risks relating to our use of derivatives. A further discussion of these risks is set forth below under the heading “Risks Relating to Debt Incurred under Short- and Long-Term Borrowing Facilities" and in Part I, Item 1A - Risk Factors of this Annual Report on Form 10-K.

Repurchase Authorization

In February 2018, our Board of Directors approved an authorization for the repurchase of our common stock, increasing the total amount authorized for repurchases of common stock to $100 million, and also authorized the repurchase of outstanding debt securities, including convertible and exchangeable debt. This authorization increased the previous share repurchase authorization approved in February 2016 and has no expiration date. This repurchase authorization does not obligate us to acquire any specific number of shares or securities. Under this authorization, shares or securities may be repurchased in privately negotiated and/or open market transactions, including under plans complying with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. During the year ended December 31, 2021, we did not repurchase any shares of our common stock pursuant to this authorization. During the year ended December 31, 2020, we repurchased 3,047,335 shares of our common stock pursuant to this authorization for $22 million. At December 31, 2021, $78 million of the current authorization remained available for the repurchase of shares of our common stock and we also continued to be authorized to repurchase outstanding debt securities. Like other investments we may make, any repurchases of our common stock or debt securities under this authorization would reduce our available capital and unrestricted cash described above.

87

Cash Flows and Liquidity for the Year Ended December 31, 2021

Cash flows from our mortgage banking activities and our investments can be volatile from quarter to quarter depending on many factors, including the timing and amount of loan originations, acquisitions, sales and profitability within our mortgage banking operations, the timing and amount of securities acquisitions, sales and repayments, as well as changes in interest rates, prepayments, and credit losses. Therefore, cash flows generated in the current period are not necessarily reflective of the long-term cash flows we will receive from these operations or investments.

Cash Flows from Operating Activities

Cash flows from operating activities were negative $5.69 billion in 2021. This amount includes the net cash utilized during the period from the purchase and sale of residential mortgage loans and the origination and sale of our business purpose loans associated with our mortgage banking activities. Purchases of loans are financed to a large extent with short-term and long-term debt, for which changes in cash are included as a component of financing activities. Excluding cash flows from the purchase, origination, sale, and principal payments of loans classified as held-for-sale, cash flows from operating activities were positive $28 million in 2021, positive $91 million in 2020, and negative $76 million in 2019.

As presented in the "Supplemental Noncash Information" subsection of our consolidated statements of cash flows, during 2021, 2020, and 2019, we transferred loans between held-for-sale and held-for-investment classification, retained securities from Sequoia and CAFL securitizations we sponsored, which represent significant non-cash transactions that were not included in cash flows from operating activities.

Cash Flows from Investing Activities

During 2021, our net cash provided by investing activities was $1.40 billion and primarily resulted from proceeds from principal payments on loans and real estate securities. Although we generally intend to hold our investment securities and loans as long-term investments, we may sell certain of these assets in order to manage our liquidity needs and interest rate risk, to meet other operating objectives, and to adapt to market conditions.

Because many of our investment securities and loans are financed through various borrowing agreements, a significant portion of the proceeds from any sales or principal payments of these assets are generally used to repay balances under these financing sources. Similarly, all or a significant portion of cash flows from principal payments of loans, securities and HEIs at consolidated securitization entities would generally be used to repay ABS issued by those entities.

As presented in the "Supplemental Noncash Information" subsection of our consolidated statements of cash flows, during 2021, 2020, and 2019, we transferred residential loans between held-for-sale and held-for-investment classification, retained securities from Sequoia, CAFL, and HEI-backed securitizations we sponsored, consolidated certain multifamily and re-performing residential securitization trusts, and deconsolidated certain multifamily securitization trusts, which represent significant non-cash transactions that were not included in cash flows from investing activities.

Cash Flows from Financing Activities

During 2021, our net cash provided by financing activities was $4.28 billion. This primarily resulted from $2.48 billion of net issuance of asset-backed securities and $1.83 billion of net borrowings under short-term debt facilities. During the year ended December 31, 2021, we declared dividends of $0.78 per common share. On December 7, 2021, the Board of Directors declared a regular dividend of $0.23 per share for the fourth quarter of 2021, which was paid on December 28, 2021 to shareholders of record on December 17, 2021.

In accordance with the terms of our outstanding deferred stock units and restricted stock units, which are stock-based compensation awards, each time we declare and pay a dividend on our common stock, we are required to make a dividend equivalent payment in that same per share amount on each outstanding deferred stock unit, cash-settled deferred stock unit, and restricted stock unit.

88

Cash Flows and Liquidity for the Year Ended December 31, 2020

During 2020, in response to disruptions following the onset of the pandemic, we sold a significant amount of investments and repaid a significant amount of debt, which allowed us to reposition and de-lever our balance sheet and generate additional liquidity. Additionally, we entered into several new financing agreements that are non-marginable (i.e., not subject to margin calls based on the market value of the underlying, non-delinquent collateral) and non-recourse, and have longer dated maturities than agreements they replaced that were marginable and recourse to us. While the asset sales and pay-downs of debt, along with the new financing agreements, strengthened our liquidity and capital position by removing sources of contingent liquidity risk (from potential market value-based margin calls on non-delinquent collateral), they also reduced our overall amount of earning assets and in some cases increased our borrowing costs.

Cash Flows from Operating Activities

Cash flows from operating activities were negative $505 million in 2020. This amount includes the net cash utilized during the period from the purchase and sale of residential mortgage loans and the origination and sale of our business purpose loans associated with our mortgage banking activities. Purchases of loans are financed to a large extent with short-term and long-term debt, for which changes in cash are included as a component of financing activities. Excluding cash flows from the purchase, origination, sale, and principal payments of loans classified as held-for-sale, cash flows from operating activities were positive $91 million in 2020, negative $76 million in 2019, and positive $100 million in 2018.

In response to disruptions following the onset of the pandemic, in late March 2020 we determined that our hedges were no longer effectively managing the risks associated with certain of our assets and liabilities and we settled nearly all of our outstanding derivative positions. As a result of these settlements and other hedging activity during the quarter, we made $187 million of cash payments. Additionally, during the six months ended June 30, 2020, our margin receivable (which was primarily associated with our hedges), decreased by $207 million, resulting in an increase to our cash flows from operations. These changes in operating cash flows resulted from actions taken in response to disruptions following the onset of the pandemic that we would generally not expect to recur at such a magnitude in subsequent periods. Additionally, during the six months ended June 30, 2020, we received $38 million in cash related to FHLBC stock that was redeemed, upon the repayment of substantially all of our borrowings from the FHLBC.

Cash Flows from Investing Activities

During 2020, our net cash provided by investing activities was $4.07 billion and primarily resulted from proceeds from sales of loans and real estate securities, as well as principal payments on loans. Although we generally intend to hold our loans and investment securities as long-term investments, we may sell certain of these assets in order to manage our liquidity needs and interest rate risk, to meet other operating objectives, and to adapt to market conditions.

Because many of our investment securities and loans are financed through various borrowing agreements, a significant portion of the proceeds from any sales or principal payments of these assets are generally used to repay balances under these financing sources. Similarly, all or a significant portion of cash flows from principal payments of loans at consolidated securitization entities would generally be used to repay ABS issued by those entities.

As presented in the "Supplemental Noncash Information" subsection of our consolidated statements of cash flows, during 2020, 2019, and 2018, we transferred residential loans between held-for-sale and held-for-investment classification, retained securities from Sequoia and CAFL securitizations we sponsored, consolidated certain multifamily and re-performing residential securitization trusts, and deconsolidated certain multifamily securitization trusts, which represent significant non-cash transactions that were not included in cash flows from investing activities.

Cash Flows from Financing Activities

During 2020, our net cash used in financing activities was $3.31 billion. This primarily resulted from $1.81 billion of net repayments of short-term debt and $2.97 billion of repayments of long-term debt, including repayments of $2.00 billion of FHLBC borrowings, which were associated with the sales of a significant amount of assets noted in the investing activities section above. Additionally, we paid $97 million to purchase and retire $125 million of our convertible debt in the second quarter of 2020, and repurchased $22 million of stock in the third quarter. These outflows of cash were partially offset by $191 million of net proceeds from the issuance and settlements of ABS issued. Additionally, during the year ended December 31, 2020, we had cash inflows of $1.47 billion related to borrowings under three new non-marginable facilities that were generally used to repay existing borrowings from marginable facilities. During the year ended December 31, 2020, we declared dividends of $0.725 per common share.

89

Contractual Obligations

The following table presents our contractual obligations and commitments at December 31, 2021, as well as the obligations of the securitization entities that we consolidate for financial reporting purposes.

Table 21 – Contractual Obligations and Commitments

[[GREPCENT_TABLE]]
[["December 31, 2021","","Payments Due or Commitment Expiration by Period"],["(In Millions)","","Less Than 1 Year","","1 to 3 Years","","3 to 5 Years","","After 5 Years","","Total"],["Obligations of Redwood"],["Short-term debt","","$","1,883","","","$","\u2014","","","$","\u2014","","","$","\u2014","","","$","1,883"],["Convertible notes","","\u2014","","","349","","","172","","","\u2014","","","521"],["Anticipated interest payments on convertible notes","","28","","","46","","","10","","","\u2014","","","84"],["Other long-term debt","","\u2014","","","796","","","194","","","140","","","1,130"],["Anticipated interest payments on other long-term debt","","29","","","58","","","18","","","59","","","164"],["Accrued interest payable","","14","","","\u2014","","","\u2014","","","\u2014","","","14"],["Operating leases","","4","","","9","","","7","","","4","","","24"],["Total Redwood Obligations and Commitments","","$","1,958","","","$","1,258","","","$","401","","","$","203","","","$","3,820"],["Obligations of Consolidated Securitization Entities for Financial Reporting Purposes(1)"],["Consolidated ABS (2)","","$","\u2014","","","$","\u2014","","","$","\u2014","","","$","8,970","","","$","8,970"],["Anticipated interest payments on ABS (3)","","315","","","595","","","494","","","1,571","","","2,975"],["Non-recourse short-term debt","","295","","","\u2014","","","\u2014","","","\u2014","","","295"],["Accrued interest payable","","25","","","\u2014","","","\u2014","","","\u2014","","","25"],["Total Obligations of Securitization Entities Consolidated for Financial Reporting Purposes","","635","","","595","","","494","","","10,541","","","12,265"],["Total Consolidated Obligations and Commitments","","$","2,593","","","$","1,853","","","$","895","","","$","10,744","","","$","16,085"]]
[[/GREPCENT_TABLE]]

(1)    Obligations of consolidated securitization entities are not legal obligations of Redwood and do not represent contractual obligations requiring cash or liquidity from Redwood.

(2)    All consolidated ABS issued are collateralized by real estate loans or other real estate-related assets. Although the stated maturity is as shown, the ABS obligations will pay down as the principal balances of these real estate loans or securities pay down. The amount shown is the principal balance of the ABS issued and not necessarily the value reported in our consolidated financial statements.

(3)    The anticipated interest payments on consolidated ABS issued are calculated based on the contractual maturity of the ABS and therefore assumes no prepayments of the principal outstanding at December 31, 2021.

In the normal course of business we engage in financial transactions that may not be recorded on the balance sheet. For additional information on our commitments and contingencies, refer to Note 16 in Part II, Item 8 of this Annual Report.

Several of our loan warehouse facilities were established with initial one-year terms and are regularly amended on an annual basis to extend the terms for an additional year ahead of their maturity. We have several such facilities with scheduled maturities in 2022, and, while there is no assurance of our ability to amend these facilities, market conditions for these types of facilities remain favorable and we would expect to extend these in the normal course of business. Aside from these facilities, we expect to meet our obligations coming due in less than one year from December 31, 2021, through a combination of cash on hand, payments of principal and interest we receive from our investment portfolio assets, proceeds from the sale of investment portfolio assets, cash generated from our operating activities, or incremental borrowings under existing, new or amended financing facilities.

During 2021, the highest balance of our short-term debt outstanding was $2.77 billion. See Note 13 in Part II, Item 8 of this Annual Report on Form 10-K for additional information on our short-term debt.

90

Liquidity Needs for our Mortgage Banking Activities

We generally use loan warehouse facilities to finance the residential loans we acquire and the business purpose loans we originate or acquire in our mortgage banking operations while we aggregate the loans for sale or securitization. These facilities may be designated as short-term or long-term for financial reporting purposes, depending on the remaining maturity of the facility or the amount of time individual borrowings may remain outstanding on a facility.

At December 31, 2021, we had residential loan warehouse facilities outstanding with seven different counterparties, with $2.90 billion of total capacity and $1.23 billion of available capacity. These included non-marginable facilities with $1.38 billion of total capacity and marginable facilities with $1.52 billion of total capacity.

At December 31, 2021, we had business purpose loan warehouse facilities outstanding with four different counterparties, with $1.65 billion of total capacity and $0.9 billion of available capacity. All of these facilities are non-marginable.

As discussed above, several of the facilities we use to finance our mortgage banking loan inventory are short-term in nature and will require renewals. Additionally, because several of our warehouse facilities are uncommitted, at any given time we may not be able to obtain additional financing under them when we need it, exposing us to, among other things, liquidity risks. Additional information regarding risks related to the debt we use to finance our mortgage banking operations can be found under the heading "Risks Relating to Debt Incurred under Short- and Long-Term Borrowing Facilities" that follows within this section.

Liquidity Needs for our Investment Portfolio

We use various forms of secured recourse and non-recourse debt to finance assets in our investment portfolio. We distinguish our debt between recourse and non-recourse, as our non-recourse debt is mostly comprised of ABS issued, which has unique characteristics that differentiate it in important ways from our recourse debt. When we refer to non-recourse debt, we mean debt that is payable solely from the assets pledged to secure such debt, and under which debt no creditor or lender has direct or indirect recourse to us, or any other entity or person (except for customary exceptions for fraud, acts of insolvency, or other "bad acts"), if such assets are inadequate or unavailable to pay off such debt.

ABS issued represents debt of securitization entities that we consolidate for GAAP reporting purposes. Our exposure to these entities is primarily through the financial interests we have purchased or retained from these entities (typically subordinate securities and interest only securities) . Each securitization entity is independent of Redwood and of each other and the assets and liabilities are not owned by and are not legal obligations of Redwood. As the debt issued by these entities is not a direct obligation of Redwood, and since the debt generally can remain outstanding for the full term of the loans it is financing within each securitization, this debt effectively provides permanent financing for these assets. See Note 4 in Part II, Item 8 of this Annual Report on Form 10-K, for additional information on our principals of consolidation and Note 14 in Part II, Item 8 of this Annual Report on Form 10-K, for additional information on our asset-backed securities issued.

Separately, we use non-recourse debt in the form of non-marginable term facilities to finance a portion of our business purpose bridge loan portfolio. While this debt is non-recourse to Redwood, it does have fixed terms with prepayment options that allows us to refinance this debt or ultimately repay it upon maturity. The remainder of the debt we use to finance our investments is recourse debt. For securities we have financed, the majority of our financing is in the form of recourse non-marginable secured term debt, with the smaller remaining amount being marginable securities repurchase debt. Additionally, a portion of our business purpose bridge loan portfolio is financed with recourse non-marginable secured term debt.

At December 31, 2021, in aggregate, we had $3.19 billion of secured recourse debt outstanding, financing our investment portfolio, of which $887 million was marginable and $2.30 billion was non-marginable.

91

Corporate Capital

In addition to secured recourse and non-recourse leverage we use specifically in association with our mortgage banking operations and within our investment portfolio, we also use unsecured recourse debt to finance our overall operations. This is generally in the form of convertible debt securities we issue in the public markets and also includes trust preferred securities. See Note 15 in Part II, Item 8 of this Annual Report on Form 10-K, for additional information on our long-term debt.

Risks Relating to Debt Incurred under Short- and Long-Term Borrowing Facilities

As described above under the heading “Results of Operations,” in the ordinary course of our business, we use debt financing obtained through several different types of borrowing facilities to, among other things, finance the acquisition and/or origination of residential and business purpose mortgage loans (including those we acquire and/or originate in anticipation of sale or securitization), and finance investments in securities and other investments. We may also use short- and long-term borrowings to fund other aspects of our business and operations, including the repurchase of shares of our common stock. Debt incurred under these facilities is generally either the direct obligation of Redwood Trust, Inc., or the direct obligation of subsidiaries of Redwood Trust, Inc. and guaranteed by Redwood Trust, Inc.

Residential and Business Purpose Loan Warehouse Facilities. One source of our debt financing is secured borrowings under loan warehouse facilities. These facilities may be designated as short-term or long-term for financial reporting purposes, depending on the remaining maturity of the facility or the amount of time individual borrowings may remain outstanding on a facility. Residential loan warehouse facilities were in place with seven different financial institution counterparties as of December 31, 2021. In addition, as of December 31, 2021, we had business purpose loan warehouse facilities secured by single-family rental loans and bridge loans, in place with four financial institution counterparties. Under our residential loan warehouse facilities, we had an aggregate borrowing limit of $2.90 billion at December 31, 2021, and under our business purpose loan warehouse facilities we had an aggregate borrowing limit of $1.7 billion at December 31, 2021. However, several of these facilities are uncommitted, which means that any request we make to borrow funds under these facilities may be declined for any reason, even if at the time of the borrowing request we have then-outstanding borrowings that are less than the borrowing limits under these facilities. Financing for residential or business purpose mortgage loans is obtained under these facilities by our transfer of mortgage loans to the counterparty in exchange for cash proceeds (in an amount less than 100% of the principal amount of the transferred mortgage loans), and our covenant to reacquire those loans from the counterparty for the same amount plus a financing charge.

In order to obtain financing for a residential or business purpose loan under these facilities, the loan must initially (and continuously while the financing remains outstanding) meet certain eligibility criteria, including, without limitation, that the loan is not in a delinquent status, except that certain loan facilities may allow a loan to continue to be financed if it becomes delinquent, if it meets specified conditions. In addition, under these warehouse facilities, residential or business purpose loans can only be financed for a maximum period, which period may be limited to 364 days for our short-term warehouse facilities. We generally intend to repay the financing of a loan under one of these facilities at or prior to the expiration of that financing with the proceeds of a securitization or other sale of that loan, through the proceeds of other short-term or long-term borrowings, or with other equity or long-term debt capital.

Our warehouse facilities may be marginable or non-marginable. When we refer to non-marginable debt and marginable debt, we are referring to whether such debt is subject to market value-based margin calls on underlying collateral that is non-delinquent. If a mortgage loan is financed under a marginable warehouse facility, to the extent the market value of the loan declines (which market value is generally determined by the counterparty under the facility), we will be subject to a margin call, meaning we will be required to either immediately reacquire the loan or meet a margin requirement to pledge additional collateral, such as cash or additional residential loans, in an amount at least equal to the decline in value. Some of our non-marginable warehouse facilities may be subject to a margin call due to delinquency of the mortgage or security being financed, or a decline in the value of the asset securing the collateral. For example, under certain agreements, we could be subject to a margin call on non-marginable debt if an appraisal or broker price opinion indicates a decline in the value of the property securing the mortgage loan that is financed by us under a loan warehouse facility. See further discussion below under the heading “Margin Call Provisions Associated with Short-Term Debt and Other Debt Financing.”

92

Because several of these warehouse facilities are uncommitted, at any given time we may not be able to obtain additional financing under them when we need it, exposing us to, among other things, liquidity risks of the types described in Part I, Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors,” and in Part II, Item 7A of this Annual Report on Form 10-K under the heading “Market Risks.” In addition, with respect to residential or business purpose loans that at any given time are already being financed through these warehouse facilities, we are exposed to market, credit, liquidity, and other risks of the types described in Part I, Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors,” and in Part II, Item 7A of this Annual Report on Form 10-K under the heading “Market Risks,” if and when those loans become ineligible to be financed, decline in value, or have been financed for the maximum term permitted under the applicable facility.

Under our residential and business purpose loan warehouse facilities, we also make various representations and warranties and have agreed to certain covenants, events of default, and other terms that if breached or triggered can result in our being required to immediately repay all outstanding amounts borrowed under these facilities and these facilities being unavailable to use for future financing needs. In particular, the terms of these facilities include financial covenants, cross-default provisions, judgment default provisions, and other events of default (such as, for example, events of default triggered by one of the following: a change in control over Redwood, regulatory investigation or enforcement action against Redwood, Redwood’s failure to continue to qualify as a REIT for tax purposes, or Redwood’s failure to maintain the listing of its common stock on the New York Stock Exchange). Under a cross-default provision, an event of default is triggered (and the warehouse facility becomes unavailable and outstanding amounts borrowed thereunder become due and payable) if an event of default or similar event occurs under another borrowing or credit facility we maintain in excess of a specified amount. Under a judgment default provision, an event of default is triggered (and the warehouse facility becomes unavailable and outstanding amounts borrowed thereunder become due and payable) if a judgment for damages in excess of a specified amount is entered against us in any litigation and we are unable to promptly satisfy, bond, or obtain a stay of the judgment. Financial covenants included in these warehouse facilities are further described below under the heading “Financial Covenants Associated with Short-Term Debt and Other Debt Financing.”

These residential and business purpose loan warehouse facilities could also become unavailable and outstanding amounts borrowed thereunder could become immediately due and payable if there is a material adverse change in our business. If we breach or trigger the representations and warranties, covenants, events of default, or other terms of our warehouse facilities, we are exposed to liquidity and other risks, including of the type described in Part I, Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors,” and in Part II, Item 7A of this Annual Report on Form 10-K under the heading “Market Risks.”

In addition to the residential and business purpose loan warehouse facilities described above, in the ordinary course of business we may seek to establish additional warehouse facilities that may be of a similar or greater size and may have similar or more restrictive terms. In the event a counterparty to one or more of our warehouse facilities becomes insolvent or unable or unwilling to perform its obligations under the facility, we may be unable to access short-term financing we need or fail to recover the full value of our mortgage loans financed.

Securities Repurchase Facilities. Another source of short-term debt financing is through securities repurchase facilities we have established with various different financial institution counterparties. Under these facilities we do not have an aggregate borrowing limit; however, these facilities are uncommitted, which means that any request we make to borrow funds under these facilities may be declined for any reason. Short-term financing for securities is obtained under these facilities by our transfer of securities to the counterparty in exchange for cash proceeds (in an amount less than 100% of the fair value of the transferred securities), and our covenant to reacquire those securities from the counterparty for the same amount plus a financing charge.

Under these securities repurchase facilities, securities are financed for a fixed period, which would not generally exceed 90 days. We generally intend to repay the short-term financing of a security under one of these facilities through a renewal of that financing with the same counterparty, through a sale of the security, or with other equity or long-term debt capital. While a security is financed under a securities repurchase facility, to the extent the market value of the security declines (which market value is generally determined by the counterparty under the facility), we are required to either immediately reacquire the security or meet a margin requirement to pledge additional collateral, such as cash or U.S. Treasury securities, in an amount at least equal to the decline in value. See further discussion below under the heading “Margin Call Provisions Associated with Short-Term Debt and Other Debt Financing.”

At the end of the fixed period applicable to the financing of a security under a securities repurchase facility, if we intend to continue to obtain financing for that security we would typically request the same counterparty to renew the financing for an additional fixed period. If the same counterparty does not renew the financing, it may be difficult for us to obtain financing for that security under one of our other securities repurchase facilities, due to the fact that the financial institution counterparties to our securities repurchase facilities generally only provide financing for securities that we purchased from them or one of their affiliates.

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Because our securities repurchase facilities are uncommitted, at any given time we may not be able to obtain additional financing under them when we need it, exposing us to, among other things, liquidity risks of the types described in Part I, Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors,” and in Part II, Item 7A of this Annual Report on Form 10-K under the heading “Market Risks.” In addition, with respect to securities that at any given time are already being financed through our securities repurchase facilities, we are exposed to market, credit, liquidity, and other risks of the types described in Part I, Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors,” and in Part II, Item 7A of this Annual Report on Form 10-K under the heading “Market Risks,” if and when those securities decline in value, or have been financed for the maximum term permitted under the applicable facility.

Under our securities repurchase facilities, we also make various representations and warranties and have agreed to certain covenants, events of default, and other terms (including of the type described above under the heading “Residential and Business Purpose Loan Warehouse Facilities”) that if breached or triggered can result in our being required to immediately repay all outstanding amounts borrowed under these facilities and these facilities being unavailable to use for future financing needs. In particular, the terms of these facilities include financial covenants, cross-default provisions, judgment default provisions, and other events of default (including of the type described above under the heading “Residential and Business Purpose Loan Warehouse Facilities”). Financial covenants included in our repurchase facilities are further described below under the heading “Financial Covenants Associated with Short-Term Debt and Other Debt Financing.”

Our securities repurchase facilities could also become unavailable and outstanding amounts borrowed thereunder could become immediately due and payable if there is a material adverse change in our business. If we breach or trigger the representations and warranties, covenants, events of default, or other terms of our securities repurchase facilities, we are exposed to liquidity and other risks, including of the type described in Part I, Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors,” and in Part II, Item 7A of this Annual Report on Form 10-K under the heading “Market Risks.”

In the ordinary course of business we may seek to establish additional securities repurchase facilities that may have similar or more restrictive terms. In the event a counterparty to one or more of our securities repurchase facilities becomes insolvent or unable or unwilling to perform its obligations under the facility, we may be unable to access the short-term financing we need or fail to recover the full value of our securities financed.

Other Short-Term Debt Facility. We also maintain a $10 million committed line of short-term credit from a bank, which is secured by our pledge of certain mortgage-backed securities we own. At December 31, 2021, the securities pledged to secure this credit line had a fair market value of $1 million, thereby limiting our ability to fully utilize this facility until we pledge additional assets to this lender. This bank line of credit is an additional source of short-term financing for us. Similar to the uncommitted warehouse and securities repurchase facilities described herein, under this committed line we make various representations and warranties and have agreed to certain covenants, events of default, and other terms that if breached or triggered can result in our being required to immediately repay all outstanding amounts borrowed under this facility and this facility being unavailable to use for future financing needs. The margin call provisions and financial covenants included in this committed line are further described below under the headings “Margin Call Provisions Associated with Short-Term Debt and Other Debt Financing” and “Financial Covenants Associated with Short-Term Debt and Other Debt Financing.” When we use this committed line to incur short-term debt we are exposed to the market, credit, liquidity, and other types of risks described above with respect to residential loan warehouse and securities repurchase facilities.

Servicer Advance Financing. In connection with our servicer advance investments, we consolidate an entity that was formed to finance servicing advances and for which we, through our control of an affiliated entity majority owned by Redwood (the "SA Buyer") formed to invest in servicer advance investments and excess MSRs, are the primary beneficiary. The servicer advance financing consists of non-recourse short-term securitization debt, secured by servicer advances. We consolidate the securitization entity that issued the debt, but the securitization entity is independent of Redwood and the assets and liabilities are not owned by and are not legal obligations of Redwood.

SA Buyer has agreed to purchase all future arising servicer advances under certain residential mortgage servicing agreements. SA Buyer relies, in part, on its members to make committed capital contributions in order to pay the purchase price for future servicer advances. A failure by any or all of the members to make such capital contributions for amounts required to fund servicer advances could result in an event of default under our servicer advance financing and a complete loss of our investment in SA Buyer and its servicer advance investments and excess MSRs. Additionally, to the extent that the servicer of the underlying mortgage loans (who is unaffiliated with us except through its co-investment in SA Buyer and the securitization entity) fails to recover the servicer advances in which we have invested, or takes longer than we expect to recover such advances, the value of our investment could be adversely affected and we could fail to achieve our expected return and suffer losses.

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The outstanding balance of servicer advances securing the financing is not likely to be repaid on or before the maturity date of such financing arrangement. We expect to request the same counterparty or another one of our financing sources to renew or refinance the financing for an additional fixed period; however, there can be no assurance that we will be able to extend the financing arrangement upon the expiration of its stated term, which subjects us to a number of risks. A financing source that elects to extend or refinance may charge higher interest rates and impose more onerous terms upon us, including without limitation, lowering the amount of financing that can be extended against the servicer advances being financed. If we are unable to renew or refinance the servicer advance financing, the securitization entity will be required to repay the outstanding balance of the financing on the related maturity date. Additionally, there may be substantial increases in the interest rates under the financing arrangement if the debt is not repaid, extended or refinanced prior to the expected repayment date, which may be before the related maturity date. If the securitization entity is unable to pay the outstanding balance of the notes, the financing counterparty may foreclose on the servicer advances pledged as collateral.

Under this servicer advance financing, SA Buyer and the securitization entity, along with the servicer, make various representations and warranties and have agreed to certain covenants, events of default, and other terms that if breached or triggered can result in acceleration of all outstanding amounts borrowed under this facility and this facility being unavailable to use for future financing needs. We do not have the direct ability to control the servicer’s compliance with such covenants and tests and the failure of SA Buyer, the securitization entity, or the servicer to satisfy any such covenants or tests could result in a partial or total loss on our investment. The financial covenants of SA Buyer included in this servicer advance financing are further described below under the heading “Financial Covenants Associated with Short-Term Debt and Other Debt Financing.”

Subordinate Securities Financing Facilities. Another source of long-term debt financing is through subordinate securities financing facilities providing non-mark-to-market recourse debt financing on a portfolio of subordinate securities. Financing for the securities was obtained under these facilities by our transfer of securities to the counterparty in exchange for cash proceeds (in an amount less than 100% of the fair value of the transferred securities), and our covenant to reacquire those securities from the counterparty for the same amount plus a financing charge. These financing facilities are fully and unconditionally guaranteed by Redwood.

One financing facility may be terminated, at our option, in September 2022, and has a final maturity in September 2024, provided that the interest rate on amounts outstanding under the facility increases between October 2022 and September 2024. At December 31, 2021, we had borrowings under this facility totaling $144 million and $0.3 million of unamortized deferred issuance costs, for a net carrying value of $144 million. At December 31, 2021, the fair value of real estate securities pledged as collateral under this long-term debt facility was $247 million and included Sequoia securities and securities retained from our Sequoia securitizations.

Another financing facility may be terminated, at our option, in February 2023, and has a final maturity in February 2025, provided that the interest rate on amounts outstanding under the facility increases between March 2023 and February 2025. At December 31, 2021, we had borrowings under this facility totaling $102 million and $0.3 million of unamortized deferred issuance costs, for a net carrying value of $102 million. At December 31, 2021, the fair value of real estate securities pledged as collateral under this long-term debt facility was $118 million and included securities retained from our consolidated CAFL securitizations.

Another financing facility may be terminated, at our option, in June 2023, and has a final maturity in June 2026, provided that the interest rate on amounts outstanding under the facility increases between June 2024 and June 2026. At December 31, 2021, we had borrowings under this facility totaling $92 million and $0.4 million of unamortized deferred issuance costs, for a net carrying value of $91 million. At December 31, 2021, the fair value of real estate securities pledged as collateral under this long-term debt facility was $143 million and included securities retained from our consolidated CAFL securitizations.

In addition to the subordinate securities financing facilities described above, in the ordinary course of business we may seek to establish additional long-term securities repurchase facilities that may be of a similar or greater size and may have similar or more restrictive terms.

95

Similar to the uncommitted warehouse and securities repurchase facilities described herein, under these facilities we make various representations and warranties and have agreed to certain covenants, events of default, and other terms that if breached or triggered can result in our being required to immediately repay all outstanding amounts borrowed under this facility and this facility being unavailable to use for future financing needs. In particular, outstanding amounts borrowed under this facility could become immediately due and payable if there is a failure to pay any amounts due under the facility, the failure to repurchase the securities by the final maturity date, or upon the insolvency of Redwood, as guarantor. If we breach or trigger the representations and warranties, covenants, events of default, or other terms of this subordinate securities financing facility, we are exposed to liquidity and other risks, including of the type described in Part I, Item 1A of this Annual Report on Form 10-K under the heading “Risk Factors,” and in Part II, Item 7A of this Annual Report on Form 10-K under the heading “Market Risks.”

Financial Covenants Associated With Short-Term Debt and Other Debt Financing

Set forth below is a summary of the financial covenants associated with our short-term debt and other debt financing facilities.

•Residential and Business Purpose Loan Warehouse Facilities. As noted above, one source of our debt financing is secured borrowings under residential and business purpose loan warehouse facilities we have established and, as of December 31, 2021, were in place with several different financial institution counterparties. Financial covenants included in these warehouse facilities are as follows and at December 31, 2021, and through the date of this Annual Report on Form 10-K, we were in compliance with each of these financial covenants:

•Maintenance of a minimum dollar amount of stockholders’ equity/tangible net worth at Redwood.

• 

•Maintenance of a minimum dollar amount of cash and cash equivalents at Redwood.

•Maintenance of a maximum ratio of consolidated recourse indebtedness to stockholders’ equity or tangible net worth at Redwood.

•With respect to residential loan warehouse facilities, maintenance of uncommitted residential loan warehouse facilities with a specified level of available borrowing capacity.

•Securities Repurchase Facilities. As noted above, another source of our short-term debt financing is through secured borrowings under securities repurchase facilities we have established with various financial institution counterparties. Financial covenants included in these securities repurchase facilities are as follows and at December 31, 2021, and through the date of this Annual Report on Form 10-K, we were in compliance with each of these financial covenants:

•Maintenance of a minimum dollar amount of stockholders’ equity/tangible net worth at Redwood.

•Maintenance of a minimum dollar amount of cash and cash equivalents at Redwood.

•Maintenance of a maximum ratio of consolidated recourse indebtedness to consolidated adjusted tangible net worth at Redwood.

•Committed Line of Credit. As noted above, we also maintain a $10 million committed line of short-term credit from a bank, which is secured by our pledge of certain mortgage-backed securities we own. The types of financial covenants included in this bank line of credit are a subset of the covenants summarized above.

•Servicer Advance Financing. As noted above, servicer advance financing consists of non-recourse short-term securitization debt, secured by servicing advances. Financial covenants associated with this financing facility are as follows and at December 31, 2021, and through the date of this Annual Report on Form 10-K, we were in compliance with each of these financial covenants:

•Maintenance of a minimum dollar amount of stockholders’ equity/tangible net worth at SA Buyer.

•Maintenance of a minimum dollar amount of cash and cash equivalents at SA Buyer.

As noted above, at December 31, 2021, and through the date of this Annual Report on Form 10-K, we were in compliance with the financial covenants associated with our short-term debt and other debt financing facilities. In particular, with respect to: (i) financial covenants that require us to maintain a minimum dollar amount of stockholders’ equity or tangible net worth at Redwood, at December 31, 2021 our level of stockholders’ equity and tangible net worth resulted in our being in compliance with these covenants by more than $200 million; and (ii) financial covenants that require us to maintain recourse indebtedness below a specified ratio at Redwood, at December 31, 2021 our level of recourse indebtedness resulted in our being in compliance with these covenants at a level such that we could incur at least $600 million in additional recourse indebtedness.

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Margin Call Provisions Associated With Short-Term Debt and Other Debt Financing

•Residential and Business Purpose Loan Warehouse Facilities. As noted above, one source of our debt financing is secured borrowings under residential and business purpose loan warehouse facilities we have established and, as of December 31, 2021, were in place with several different financial institution counterparties. These warehouse facilities include the margin call provisions described below and during the twelve months ended December 31, 2021, and through the date of this Annual Report on Form 10-K, we complied with any margin calls received from creditors under these warehouse facilities:

•Under our marginable residential warehouse facilities, if at any time the market value (as determined by the creditor) of any residential mortgage loan financed under a facility declines, then the creditor may demand that we transfer additional collateral to the creditor (in the form of cash, U.S. Treasury obligations (in certain cases), or additional residential mortgage loans) with a value equal to the amount of the decline. If we receive any such demand, (i) under one of our residential loan warehouse facilities, we would generally be required to transfer the additional collateral on the same day (although demands received after a certain time would only require the transfer of additional collateral on the following business day) and (ii) under one of our residential loan warehouse facilities, we would generally be required to transfer the additional collateral on the following business day. The value of additional residential and business purpose mortgage loans transferred as additional collateral is determined by the creditor.

•Under certain non-marginable residential and business purpose warehouse facilities, if the value of the asset securing the mortgage loan financed under a facility declines (as determined by an appraisal or broker price opinion), then the creditor may demand that we transfer additional collateral to the creditor (in the form of cash, U.S. Treasury obligations (in certain cases), or additional mortgage loans) with a value equal to the amount of the decline. The conditions precedent to which the creditor may request updated valuation reports varies by agreement, including, for example, based on the number of days the loan has been financed under such facility. If we receive any such demand as a result of a margin deficit based on an updated valuation report, we would generally be required to transfer the additional collateral within one to five business days depending on the terms of the agreement. The value of additional residential and business purpose mortgage loans transferred as additional collateral is determined by the creditor.

•Securities Repurchase Facilities. Another source of our short-term debt financing is through secured borrowings under securities repurchase facilities we have established with various financial institution counterparties. These repurchase facilities include the margin call provisions described below and during the twelve months ended December 31, 2021, and through the date of this Annual Report on Form 10-K, we complied with any margin calls received from creditors under these repurchase facilities:

•If at any time the market value (as determined by the creditor) of any securities financed under a facility declines, then the creditor may demand that we transfer additional collateral to the creditor (in the form of cash, U.S. Treasury obligations, or additional securities) with a value equal to the amount of the decline. If we receive any such demand, we would generally be required to transfer the additional collateral on the same day. The value of additional securities transferred as additional collateral is determined by the creditor.

•Committed Line of Credit. As noted above, we also maintain a $10 million committed line of short-term credit from a bank, which is secured by our pledge of certain mortgage-backed securities we own. Margin call provisions included in this bank line of credit are as follows and during the twelve months ended December 31, 2021, and through the date of this Annual Report on Form 10-K, we complied with any margin calls received from this creditor under this line of credit:

•If at any time the total market value (as determined by two broker-dealers) of the securities that are pledged as collateral under this facility declines to a value less than the outstanding amount of borrowings under this facility, then the creditor may demand that we transfer additional collateral to the creditor (in the form of cash, U.S. Treasury obligations, or additional securities) with a value equal to the amount of the difference. If we receive any such demand, we would generally be required to transfer the additional collateral within two business days. The value of additional collateral pledged is determined by the creditor.

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CRITICAL ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates. A discussion of critical accounting policies and the possible effects of changes in estimates on our consolidated financial statements is included in Note 2 — Basis of Presentation and Note 3 — Summary of Significant Accounting Policies included in Part II, Item 8 of this Annual Report on Form 10-K. Management discusses the ongoing development and selection of these critical accounting policies with the Audit Committee of the Board of Directors.

Following is a description of our critical accounting estimates that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition or results of operations.

Assets and Liabilities Accounted for at Fair Value

We have elected the fair value option of accounting for a significant portion of the assets and some of the liabilities on our balance sheet, and the majority of these assets and liabilities utilize Level 3 valuation inputs, which require a significant level of estimation uncertainty. See Note 5 in Part II, Item 8 of this Annual Report on Form 10-K, for additional information on our assets and liabilities accounted for at fair value at December 31, 2021, including the significant inputs used to estimate their fair values and the impact the changes in their fair values had to our financial condition and results of operations. See Note 5 in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2020, incorporated herein by reference, for the same information on these assets and liabilities as of December 31, 2020. Periodic fluctuations in the values of these assets and liabilities are inherently volatile and thus can lead to significant period-to-period GAAP earnings volatility. Below, we provide additional information regarding the critical accounting estimates for these assets and liabilities.

Changes in the Fair Value of Loans Held at Fair Value

We have elected the fair value option for our residential loans, business purpose loans, and multifamily loans. As such, these loans are carried on our consolidated balance sheets at their estimated fair value and changes in the fair values of these loans are recorded in Mortgage banking activities, net or Investment fair value changes, net on our consolidated statements of income (loss) in the period in which the valuation change occurs. Significant inputs used to estimate the fair value of these assets include certain unobservable inputs (e.g., those requiring our own data or assumptions) that require significant judgment to develop, and changes in these estimates have had and are reasonably like to have a material effect on our reported earnings and financial condition.

Changes in Fair Values of Securities

Our securities are classified as either trading or AFS securities, and in both cases are carried on our consolidated balance sheets at their estimated fair values. In addition, we invest in securities of certain securitization entities that we are required to consolidate for GAAP reporting purposes. We have elected to account for many of these entities as collateralized financing entities and use the fair value of the ABS issued by these entities (which we determined to be more observable) to determine the fair value of the loans held at these entities. For trading securities and collateralized financing entities, changes in fair values are recorded in Investment fair value changes, net on our consolidated statements of income (loss) in the period in which the valuation change occurs. For available-for-sale securities, changes in fair value are generally recorded in Accumulated other comprehensive income in our consolidated balance sheets (as discussed further below). Periodic fluctuations in the values of our securities can be caused by changes in the discount rate assumptions used to value the securities, as well as actual and anticipated prepayments, delinquencies, losses and other factors on the loans underlying the securitizations in which we own securities. Significant inputs used to estimate the fair value of these assets include certain unobservable inputs (e.g., those requiring our own data or assumptions) that require significant judgment to develop, and changes in these estimates have had and are reasonably like to have a material effect on our reported earnings and financial condition.

For AFS securities, cumulative unrealized gains and losses are recorded as a component of Accumulated other comprehensive income in our consolidated balance sheets. Unrealized gains are not credited to current earnings and unrealized losses are not charged against current earnings to the extent they are temporary in nature. Certain factors may require us, however, to recognize a decline in the value of AFS securities as an allowance for credit losses recorded through our current earnings. Factors that determine other-than-temporary-impairment include a change in our ability or intent to hold AFS securities, adverse changes to projected cash flows of assets, or the likelihood that declines in the fair values of assets would not return to their previous levels within a reasonable time. Estimates used to determine other-than-temporary-impairments on AFS securities require significant judgment and changes in these estimates have had and are reasonably like to have a material effect on our reported earnings and financial condition.

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Changes in Fair Values of Servicer Advance Investments

Servicer advance investments are carried on our consolidated balance sheets at their estimated fair values, with changes in fair values recorded in our consolidated statements of income (loss) in Investment fair value changes, net. Periodic fluctuations in the values of our servicer advance investments can be caused by changes in the actual and anticipated balance of servicing advances outstanding, actual and anticipated prepayments on the underlying loans, and changes in the discount rate assumptions used to value servicer advance investments. Significant inputs used to estimate the fair value of these assets include certain unobservable inputs (e.g., those requiring our own data or assumptions) that require significant judgment to develop, and changes in these estimates have had and are reasonably like to have a material effect on our reported earnings and financial condition.

Changes in Fair Values of MSRs and Excess MSRs

MSRs and excess MSRs are carried on our consolidated balance sheets at their estimated fair values, with changes in fair values recorded in our consolidated statements of income (loss) in Other income, net or Investment fair value changes, net. Periodic fluctuations in the values of our MSRs and excess MSRs can be caused by actual prepayments on the underlying loans, changes in assumptions regarding future projected prepayments on the underlying loans, actual or anticipated changes in delinquencies, and changes in the discount rate assumptions used to value MSRs and excess MSRs. Significant inputs used to estimate the fair value of these assets include certain unobservable inputs (e.g., those requiring our own data or assumptions) that require significant judgment to develop, and changes in these estimates have had and are reasonably like to have a material effect on our reported earnings and financial condition.

Changes in Fair Values of HEIs

HEIs are carried on our consolidated balance sheets at their estimated fair values, with changes in fair values recorded in our consolidated statements of income (loss) in Investment fair value changes, net. Periodic fluctuations in the values of our HEIs can be caused by changes in the discount rate assumptions used to value HEIs, changes in assumptions regarding future projected home values, changes in assumptions regarding future projected prepayment rates, as well as changes in the rate and magnitude of defaults on the portfolio. Significant inputs used to estimate the fair value of these assets include certain unobservable inputs (e.g., those requiring our own data or assumptions) that require significant judgment to develop, and changes in these estimates have had and are reasonably like to have a material effect on our reported earnings and financial condition.

Changes in Fair Values of Strategic Investments

Several of our strategic investments are carried on our consolidated balance sheets at their estimated fair values (or at historical cost under the measurement alternative for equity investments), with changes in fair values recorded in our consolidated statements of income (loss) in Investment fair value changes, net. All of our strategic investments are in private companies that do not have readily determinable fair values and estimates of their fair value require significant judgment to develop. Changes in the estimates used to determine their fair value could have a material effect on our reported earnings and financial condition.

Changes in Fair Values of Derivative Financial Instruments

We generally use derivatives as part of our mortgage banking activities (e.g., to manage risks associated with loans we plan to acquire and subsequently sell or securitize), in relation to our residential investments (to manage risks associated with our securities, MSRs, and held-for-investment loans), and to manage variability in debt interest expense indexed to adjustable rates, and cash flows on assets and liabilities that have different coupon rates (fixed rates versus floating rates, or floating rates based on different indices). Significant inputs used to estimate the fair value of certain of our derivatives include unobservable inputs (e.g., those requiring our own data or assumptions) that require significant judgment to develop, and changes in these estimates have had and are reasonably like to have a material effect on reported earnings and our financial condition.

Additionally, the nature of the instruments we use and the accounting treatment for the specific assets, liabilities, and derivatives may therefore lead to volatility in our periodic earnings, even when we are meeting our hedging objectives. Most of our derivatives are accounted for as trading instruments with associated changes in value recorded through our consolidated statements of income (loss). Changes in value of the assets and liabilities we manage by using derivatives may not be accounted for similarly. This could lead to reported income and book values in specific periods that do not necessarily reflect the economics of our risk management strategy. Even when the assets and liabilities are similarly accounted for as trading instruments, periodic changes in their values may not coincide as other market factors (e.g., supply and demand) may affect certain instruments and not others at any given time.

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Changes in Fair Values of Intangible Assets

In connection with our acquisitions of CoreVest and 5 Arches, a portion of the purchase price of each acquisition was allocated to goodwill and intangible assets. During 2020, we impaired our entire balance of goodwill associated with these acquisitions. Accounting standards require that we routinely assess intangible assets for indicators of impairment, and if indicators are present, we must review them for impairment. The assessments to determine if intangible assets are impaired requires significant judgement to develop assumptions and estimates. If we determine intangible assets are impaired, we will be required to write down the value of these assets, up to their entire balance. Any write-down would have a negative effect on our consolidated financial statements.

Changes in Mortgage Banking Income

The amount of income that can be earned from mortgage banking activities is primarily dependent on the volume of loans we are able to acquire and any potential profit we earn upon the sale or securitization of these loans. Our ability to acquire loans and the volume of loans we acquire is dependent on many factors that are beyond our control, including general economic conditions and changes in interest rates, loan origination volumes industry-wide and at the sellers we purchase our loans from, increased regulation, and competition from other financial institutions. Our profitability from mortgage banking activities is also dependent on many factors, including our ability to effectively hedge certain risks related to changes in interest rates and other factors that are beyond our control, including changes in market credit risk pricing. Additionally, our income from mortgage banking activities is generally generated over the period from when we identify a loan for purchase until we subsequently sell or securitize the loan. This income may encompass positive or negative market valuation adjustments on loans, hedging gains or losses associated with related risk management activities, and any other related transaction expenses, and may be realized unevenly over the course of one or more quarters for financial reporting purposes. Additional factors that could impact our profitability are discussed in Part I, Item 1A - Risk Factors of this Annual Report on Form 10-K and above, under the headings “Changes in the Fair Value of Loans Held at Fair Value” and “Changes in Fair Values of Derivative Financial Instruments.” Changes in the volumes of loans acquired or originated in connection with our mortgage banking activities and our profitability on these activities can lead to significant period-to-period GAAP earnings volatility.

Changes in Yields for Securities

The yields we project on available-for-sale real estate securities can have a significant effect on the periodic interest income we recognize for financial reporting purposes. Yields can vary as a function of credit results, prepayment rates, interest rates and call assumptions. If estimated future credit losses are less than our prior estimate, credit losses occur later than expected, prepayment rates are faster than expected (meaning the present value of projected cash flows is greater than previously expected for assets acquired at a discount to principal balance), or securities are called (or called sooner than expected) the yield over the remaining life of the security may be adjusted upwards. If estimated future credit losses exceed our prior expectations, credit losses occur more quickly than expected, prepayments occur more slowly than expected (meaning the present value of projected cash flows is less than previously expected for assets acquired at a discount to principal balance) or securities are not called (or called later than expected), the yield over the remaining life of the security may be adjusted downward.

Changes in the actual maturities of real estate securities may also affect their yields to maturity. Actual maturities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, and prepayments of principal. Therefore, actual maturities of AFS securities are generally shorter than stated contractual maturities. Stated contractual maturities are generally greater than 10 years. The assumptions we use to estimate future cash flows and the resulting effective yields and interest income, require significant judgement to develop, and changes in these estimates have had and are reasonably like to have a material effect on our reported earnings and financial condition.

Changes in Loss Contingency Reserves

We may be exposed to various loss contingencies, including, without limitation, those described in Note 16 to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K. In accordance with FASB guidance on accounting for contingencies, we review the need for any loss contingency reserves and establish them when, in the opinion of management, it is probable that a matter would result in a liability, and the amount of loss, if any, can be reasonably estimated. The establishment of a loss contingency reserve, the subsequent increase in a reserve or release of reserves previously established, or the recognition of a loss in excess of previously established reserves, can occur as a result of various factors and events that affect management’s opinion of whether the standard for establishing, increasing, or continuing to maintain, a reserve has been met. Changes in the loss contingency reserves can lead to significant period-to-period GAAP earnings volatility.

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Changes in Provision for Taxes

Our provision for income taxes is primarily the result of GAAP income or losses generated at our TRS. Deferred tax assets/liabilities are generated by temporary differences in GAAP income and taxable income at our taxable subsidiaries and are a significant component of our GAAP provision for income taxes. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider historical and projected future taxable income and capital gains as well as tax planning strategies in making this assessment. We determine the extent to which realization of this deferred asset is not assured and establish a valuation allowance accordingly. The estimate of net deferred tax assets and associated valuation allowances could change in future periods to the extent that actual or revised estimates of future taxable income during the carry-forward periods change from current expectations, causing significant period-to-period GAAP earnings volatility.

MARKET AND OTHER RISKS

Market Risks

We seek to manage risks inherent in our business — including but not limited to credit risk, interest rate risk, prepayment risk, liquidity risk, and fair value risk — in a prudent manner designed to enhance our earnings and dividends and preserve our capital. In general, we seek to assume risks that can be quantified from historical experience, to actively manage such risks, and to maintain capital levels consistent with these risks. Information concerning the risks we are managing, how these risks are changing over time, and potential GAAP earnings and taxable income volatility we may experience as a result of these risks is discussed under the caption “Risk Factors” of this Annual Report on Form 10-K, under the caption "Risks Relating to Debt Incurred under Short- and Long-Term Borrowing Facilities" within this MD&A, and under the caption "Quantitative and Qualitative Disclosures About Market Risk" of this Annual Report on Form 10-K.

Other Risks

In addition to the market and other risks described above, our business and results of operations are subject to a variety of types of risks and uncertainties, including, among other things, those described under the caption “Risk Factors” of this Annual Report on Form 10-K.

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