Redwood Trust Inc: Form 10-Q for the period ended Sep 30, 2024

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 five 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 I, Item 1 of this Quarterly Report on Form 10-Q and in Part II, Item 8, Financial Statements and Supplementary Data in our most recent Annual Report on Form 10-K, as well as the sections entitled “Risk Factors” in Part I, Item 1A of our most recent Annual Report on Form 10-K and Part II, Item 1A of this Quarterly Report on Form 10-Q, as well as other cautionary statements and risks described elsewhere in this report and our most recent Annual Report on Form 10-K. 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 below.

References herein to “Redwood,” the “company,” “we,” “us,” and “our” include Redwood Trust, Inc. and its consolidated subsidiaries, unless the context otherwise requires. Financial information concerning our business is set forth in this MD&A and our consolidated financial statements and notes thereto, which are included in Part I, Item 1 of this Quarterly Report on Form 10-Q. In the first quarter of 2024, we updated the names of our Residential loans to Residential consumer loans and our Business purpose loans to Residential investor loans. There were no changes to the classifications of account balances as a result of this update in names. All prior period references in this document were conformed to this presentation.

Our website can be found at www.redwoodtrust.com (http://www.redwoodtrust.com). We make available, free of charge through the investor relations section of our website, access to our Annual Reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the U.S. Securities Exchange Act of 1934, as well as proxy statements, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission (“SEC”). We also make available, free of charge, access to our charters for our Audit Committee, Compensation Committee, and Governance and Nominating Committee, our Corporate Governance Standards, and our Code of Ethics governing our directors, officers, and employees. Within the time period required by the SEC and the New York Stock Exchange, we will post on our website any amendment to the Code of Ethics and any waiver applicable to any executive officer or director of Redwood. In addition, our website includes information concerning purchases and sales of our equity securities by our executive officers and directors, and may include disclosure relating to certain non-GAAP financial measures (as defined in the SEC’s Regulation G) that we may make public orally, telephonically, by webcast, by broadcast, or by similar means from time to time. The information on our website is not part of this Quarterly Report on Form 10-Q.

Our Investor Relations Department can be contacted at One Belvedere Place, Suite 300, Mill Valley, CA 94941, Attn: Investor Relations, telephone (866) 269-4976.

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 consumer and residential investor housing credit assets. Our goal is to provide attractive returns to shareholders through a stable and growing stream of earnings and dividends, capital appreciation, and a commitment to technological innovation that facilitates risk-minded scale. We operate our business in three segments: Residential Consumer Banking, Residential Investor Mortgage Banking, and Investment Portfolio. For a full description of our segments, see Part 1, Item 1—Business in our Annual Report on Form 10-K for the year ended December 31, 2023.

Cautionary Statement

This Quarterly Report on Form 10-Q and the documents incorporated by reference herein contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve numerous risks and uncertainties. Our actual results may differ from our beliefs, expectations, estimates, and projections and, consequently, you should not rely on these forward-looking statements as predictions of future events. Forward-looking statements are not historical in nature and can be identified by words such as “anticipate,” “estimate,” “will,” “should,” “expect,” “believe,” “intend,” “seek,” “plan” and similar expressions or their negative forms, or by references to strategy, plans, opportunities, or intentions. These forward-looking statements are subject to risks and uncertainties, including, among other things, those described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023, under the caption “Risk Factors.” Other risks, uncertainties, and factors that could cause actual results to differ materially from those projected may be described from time to time in reports we file with the SEC, including reports on Forms 10-Q and 8-K. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Statements regarding the following subjects, among others, are forward-looking by their nature: (i) statements we make regarding Redwood's business strategy and strategic focus, including statements relating to our overall market position, strategy and long-term prospects (including trends driving the flow of capital in the housing finance market, our strategic initiatives designed to capitalize on those trends, our ability to attract capital to finance those initiatives, our approach to raising capital, and our ability to pay dividends in the future); (ii) statements related to our financial outlook and expectations for 2024 and future years, including statements regarding the economic impacts of inflation, monetary policy, volatility and potential regulatory changes in the banking sector, and shifting sources of liquidity in the residential mortgage market; (iii) statements related to our investment portfolio, including that there remains potential upside in our portfolio through market discount, that at September 30, 2024, our securities portfolio had approximately $2.09 per share of net discount to par, and statements regarding target returns on capital deployment opportunities; (iv) statements related to opportunities we see for our residential consumer and residential investor platforms, and our positioning to capture market share; (v) statements relating to acquiring residential mortgage loans in the future that we have identified for purchase or plan to purchase, including the amount of such loans that we identified for purchase during the third quarter of 2024 and at September 30, 2024, expected fallout and the corresponding volume of residential mortgage loans expected to be available for purchase, total net jumbo loan exposure, and residential mortgage loans subject to forward sale commitments; (vi) statements we make regarding future dividends, including with respect to our regular quarterly dividends in 2024; and (vii) statements regarding our expectations and estimates relating to the characterization for income tax purposes of our dividend distributions, our expectations and estimates relating to tax accounting, tax liabilities and tax savings, and GAAP tax provisions, and our estimates of REIT taxable income and TRS taxable income.

Important factors, among others, that may affect our actual results include:

• general economic trends and the performance of the housing, real estate, mortgage finance, and broader financial markets;
• changing benchmark interest rates, and the Federal Reserve’s actions and statements regarding monetary policy;
• federal, state, and local legislative and regulatory developments and the actions of governmental authorities and entities;
• the impact of public health issues such as the COVID-19 pandemic;
• our ability to compete successfully;
• our ability to adapt our business model and strategies to changing circumstances;
• our use of financial leverage and strategic business and capital deployment decisions we make;
• our exposure to a breach of our cybersecurity or data security;
• our exposure to credit risk and the timing of credit losses within our portfolio;
• the concentration of the credit risks we are exposed to, including due to the structure of assets we hold and the geographical concentration of real estate underlying assets we own, and our exposure to environmental and climate-related risks;
• the efficacy and expense efforts to manage or hedge credit or interest rate risk, and other financial and operational risks;
• changes in credit ratings on assets we own and changes in the rating agencies’ credit rating methodologies;
• changes in interest rates or mortgage prepayment rates;
• investment and reinvestment risk;
• asset performance, interest rate volatility, changes in credit spreads, and changes in liquidity in the market for real estate securities and loans;
• our ability to finance the acquisition of real estate-related assets with short-term debt;
• the ability of counterparties to satisfy their obligations to us;
• we may enter into new lines of business, acquire other companies, or engage in other new strategic initiatives;
• changes in the demand from investors for residential consumer and residential investor mortgages and investments, and our ability to distribute residential consumer and residential investor mortgages through our whole-loan distribution channels;
• our involvement in loan and HEI origination and securitization transactions, the profitability of those transactions, and the risks we are exposed to in engaging in loan origination or securitization transactions;
• foreclosure activity may expose us to risks associated with real estate ownership and operation;
• exposure to claims and litigation, including litigation arising from loan or HEI origination and securitization transactions;
• acquisitions or new business initiatives may fail to improve our business and could expose us to new or increased risks;
• whether we have sufficient liquid assets to meet short-term needs;
• changes in our investment, financing, and hedging strategies and new risks we may be exposed to if we expand or reorganize;
• our ability to successfully retain or attract key personnel;
• we are dependent on third-party information systems and third-party service providers;
• our exposure to a disruption of our or a third party's technology infrastructure and systems;
• the impact on our reputation that could result from our actions or omissions or from those of others;
• our failure to maintain appropriate internal controls over financial reporting and disclosure controls and procedures;
• our risk management efforts may not be effective;
• we could be harmed by misconduct or fraud;
• inadvertent errors, system failures or cybersecurity incidents could disrupt our business;
• the impact on our reputation that could result from our actions or omissions or from those of others;
• accounting rules related to certain of our transactions and asset valuations are highly complex and involve significant judgment and assumptions;
• the future realization of our deferred tax assets is uncertain, and the amount of valuation allowance we may apply against our deferred tax assets may change materially in future periods;
• the impact of changes to U.S. federal income tax laws on the U.S. housing market, mortgage finance markets, and our business;
• our failure to comply with applicable laws and regulation, including our ability to obtain or maintain governmental licenses;
• our ability to maintain our status as a REIT for tax purposes;
• limitations imposed on our business due to our REIT status and our status as exempt from registration under the Investment Company Act of 1940;
• our stock may experience price declines, volatility, and poor liquidity, and we may reduce our dividends;
• decisions about raising, managing, and distributing capital;
• dividend distributions and the timing and character of such dividends may change;
• limited number of institutional shareholders own a significant percentage of our common stock; and
• other factors not yet identified, including broad market fluctuations.

This Quarterly Report on Form 10-Q may contain statistics and other data that in some cases have been obtained from or compiled from information made available by servicers and other third-party service providers.

OVERVIEW

Business Update

The three-month period ended September 30, 2024 represented continued progress across our strategic goals, including those we outlined at our Investor Day earlier this year. We recently increased our common dividend for the first time since 2021 – up 6.25% to $0.17 per share for the third quarter 2024 – reflecting continued growth in our operating activities. Our combined mortgage banking returns were the highest in over three years, as each business unlocked operating leverage to achieve strong performance. We delivered a total economic return of 2.1% on the quarter inclusive of our common dividend.1 Our securities within our Investment Portfolio also maintained embedded upside to continued strong credit performance and a rally in rates, with a $2.09 per share net discount to par at September 30, 2024.

Balance sheet optimization remained a focus during the third quarter. We unlocked incremental capital through two non-marginable refinancings secured by seasoned bonds from our Sequoia and CAFL issuance platforms. This work facilitated $157 million of capital deployed during the quarter, a high-water mark for the year. Combined with other measures to reduce or extend our debt outstanding, the amount of our debt maturing between now and year-end 2026 is approximately 75% lower from December 31, 2023.

Our mortgage banking activities for the three-month period ended September 30, 2024 played a pivotal role in driving overall performance, with GAAP contribution from these businesses tripling versus the second quarter. Higher Residential Consumer Mortgage Banking income was a result of lower rates, strategic positioning for interest rate volatility and spread tightening on our securitizations throughout the quarter. Given the slower activity in July, we continued to benefit from deeper penetration with banking partners on both current production and seasoned portfolios. As portfolio lending from a handful of banks ticked up during the third quarter of 2024, we believe our competitive advantages, particularly our products and distribution channels, continue to position Redwood as the natural take-out for non-Agency mortgages across our seller network. With over 200 sellers now onboarded, we have locked loans with almost 80% of our seller base this year.

As was the case with the broader market, we also observed a brief uptick in refinance activity in the third quarter of 2024 as mortgage rates fell. With benchmark interest rates now meaningfully higher than prior to September’s Federal Open Market Committee announcement, that refinance window in September may have been short-lived, but is evidence that homeowners and originators alike are ready to transact once a more durable reprieve from higher rates emerges.

We priced three Sequoia ("SEMT") securitizations during the third quarter, bringing our year-to-date total through the end of September to nine securitizations backed by over $4 billion of mortgage loan collateral. We have maintained a reliable monthly securitization cadence that promotes strong execution levels, a measure of contrast with other market participants that issue more episodically. To that point, we have continued to be active on the distribution front in the fourth quarter of 2024, in October alone distributing $1.5 billion of jumbo collateral through a combination of securitizations and whole loan sales. We have prioritized getting ahead of any potential volatility on the horizon, and these efforts continue to set us apart and place Redwood as a leading non-bank issuer of securitized jumbo collateral.

In addition to the absolute level of mortgage rates, the shape of the Treasury yield curve also plays a big part in how our market operates. The curve is now positively sloped — with the yield on the 10-year Treasury exceeding that of the 2-year Treasury, providing an opportunity to profitably aggregate and securitize hybrid adjustable-rate mortgage (“ARM”) loans. Early in the fourth quarter of 2024, we priced our first hybrid ARM securitization since 2010, backed by a portfolio of seasoned ARMs we acquired in the third quarter of 2024 from a regional bank. Furthering this momentum, at the beginning of October we launched revamped hybrid ARM guidelines to our seller base, with favorable early feedback from both banks and non-banks.

Turning to our Residential Investor business, the three-month period ended September 30, 2024 marked the first full quarter of our newest joint venture with an institutional investment manager. This partnership has allowed us to capitalize on quality origination opportunities while operating our business with less working capital. We funded $458 million of investor loans during the third quarter, roughly flat to the third quarter but with continued growth in our smaller-balance, more liquid products. Most notably, our single-asset bridge (“SAB”) loan originations reached record volumes for the second consecutive quarter. With a healthy pipeline heading into the fourth quarter across our product offerings, we remain focused on deepening our distribution channels and serving a broader array of housing investors, both in our traditional focus areas and in products for which bank participation has declined in recent quarters.

1 Total economic return for the third quarter of 2024 represents the change in book value per common share during the quarter plus dividends declared per common share during the quarter, divided by book value per share at the beginning of the quarter.

RESULTS OF OPERATIONS

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

Consolidated Results of Operations

The following table presents the components of our net income by segments for the three and nine months ended September 30, 2024 and 2023.

Table 1 – Net Income

(In Thousands, except per Share Data)

Net Interest Income

Net interest income increased $5 million and $2 million during the three and nine-month periods. Net interest income from Residential Consumer Mortgage Banking operations increased $8 million and $26 million for the three and nine-month periods, respectively, primarily due to higher average residential consumer loan balances and the addition of certain hedges that provide net interest income. This was partially offset by a decrease of $16 million from our Investment Portfolio during the nine-month period, primarily related to lower net interest income from our bridge loan portfolio, an increase in borrowing costs on debt facilities and ABS issued to finance our investments within this segment.

Corporate net interest expense increased $6 million and $10 million during the three and nine-month periods. The increase was primarily related to higher cost of corporate unsecured debt issued recently relative to repurchases and payoffs of older vintage, lower coupon convertible debt. During the nine-month period through September 30, 2024, we issued $60 million of 9.125% and $85 million of 9.00% senior notes and procured a secured revolving financing facility, which we drew on starting in the second quarter of 2024. Additionally, we earned lower interest income at the corporate level from lower average cash balances invested in U.S. Treasury Securities relative to 2023.

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

Mortgage Banking Activities, Net

Mortgage Banking activities, net increased $20 million during both the three and nine-month periods, respectively, primarily due to higher Residential Consumer Mortgage Banking revenues.

Residential Consumer Mortgage Banking activities increased $18 million and $21 million during the three and nine-month periods primarily attributable to an increase in loan purchase volumes from both banks and independent mortgage bankers ("IMBs") across bulk and flow transactions, as well as a combination of spread tightening on securitization execution and net hedge income, particularly in the third quarter of 2024.

Residential Investor Mortgage Banking activities increased $2 million and decreased $1 million during the three and nine-month periods, respectively. The decrease during the nine-month period was primarily attributable to lower margins and volumes experienced in the first quarter of 2024, partially offset by high funding volume as well as improved economics from whole loan sales and sales to joint ventures in the second and third quarters of 2024.

A more detailed analysis of the changes in this line item is included in the “Residential Consumer Mortgage Banking Segment” and “Residential Investor Mortgage Banking Segment” section that follows.

Investment Fair Value Changes, Net

Investment fair value changes, net increased $29 million and $70 million during the three and nine-month periods, respectively, primarily due to strong credit performance on our securities portfolio and spread tightening across our securities and whole loan portfolios, which were partially offset by negative fair value changes on our bridge loans and, to a lesser extent, paydowns on assets held at a premium.

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

HEI Income, net

HEI income, net remained flat and increased $12 million during the three and nine-month periods, respectively. Increases in the valuations of our HEI portfolio have been the result of actual and projected trends in home price appreciation and prepayment speeds steadily improving over the nine-month period and exceeding modeled pricing assumptions for the three and nine-month periods. HEI income is primarily comprised of recurring accretion of the underlying option value of the investments over time based on estimated future home price appreciation and other factors, along with periodic fluctuations in value influenced by changing housing, prepayment rates and other market conditions.

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

Operating Expenses

Operating expenses increased $8 million and $14 million during the three and nine-month periods ended September 30, 2024, primarily related to an increase in variable and equity compensation expense associated with improved operating results and year-to-date earnings performance, as well as increased portfolio management costs related to specially serviced residential investor bridge loans and related workout arrangements incurred in 2024.

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

Provision for Income Taxes

Our provision for income taxes is almost entirely related to activity at our taxable REIT subsidiaries ("TRS"), which primarily includes our mortgage banking activities and MSR investments, as well as certain other investment and hedging activities. The increase in the tax provision in the three and nine-month periods was primarily the result of increased GAAP income earned at our TRS from mortgage banking activities in 2024 compared to 2023.

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

Consolidated Net Interest Income

The following table presents the components of net interest income recorded in each line item of our consolidated statements of income for the three and nine months ended September 30, 2024 and 2023.

Table 2 – Consolidated Net Interest Income

(Dollars in Thousands)

55

(Dollars in Thousands)

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

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

(3) Real estate securities include trading securities consisting primarily of interest-only securities, which generate a higher cash interest yield. This interest income may be offset by a decline in fair value (recognized through investment fair value changes, net on our consolidated statements of income) related to the receipt of cash flows each period, resulting in a lower overall economic yield for these investments.

Consolidated Market Valuation Gains and Losses, Net

The following table presents the net market valuation gains and losses recorded in each line item of our consolidated statements of income for the three and nine months ended September 30, 2024 and 2023.

Table 3 – Consolidated Market Valuation Gains and Losses, Net

(In Thousands)

(1) Represents fair value changes on trading securities that are being used along with risk management derivatives to manage the market risks associated with our Residential Consumer Mortgage Banking operations.

(2) Mortgage banking activities, net presented above does not include fee income from loan originations or acquisitions, provisions for repurchases, or other expenses that are components of Mortgage banking activities, net presented on our consolidated statements of income, as these amounts do not represent market valuation changes.

Footnotes to Table 3 (Continued)

(3) Includes changes in fair value of the residential consumer loans held-for-investment, securitized HEI, REO and the ABS issued at the entities, which, netted together, represent the change in value of our investments at the consolidated VIEs accounted for under the CFE election.

(4) Other investments includes changes in fair value of REO assets.

(5) Other income presented above does not include net MSR fee income or provisions for repurchases of MSRs, as these amounts do not represent market valuation adjustments.

Results of Operations by Segment

We report on our business using three segments: Residential Consumer Mortgage Banking, Residential Investor Mortgage Banking, and Investment Portfolio. For additional information on our segments, refer to Note 4 of our Notes to Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.

The following table presents the segment contribution from our three segments reconciled to our consolidated net income for the three and nine months ended September 30, 2024 and 2023.

Table 4 – Segment Results Summary

(In Thousands)

The sections that follow provide further detail on our business segments and their results of operations for the three and nine months ended September 30, 2024.

Corporate/Other

The increase in net expenses from Corporate/Other for three and nine months ended September 30, 2024 was primarily related to an increase in variable and equity compensation expense associated with improved year-to-date operating results and earnings performance experienced, an increase in interest expense related to our corporate debt due to higher borrowing costs relative to prior corporate debt financing, and a decrease in interest income earned on cash and cash equivalents.

Residential Consumer Mortgage Banking Segment

This segment consists of a mortgage loan conduit that acquires residential consumer loans from third-party originators for subsequent sale to whole loan buyers, securitization through our SEMT® (Sequoia) private-label securitization program, or transfer into our investment portfolio. 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. We typically acquire prime jumbo mortgages and the related mortgage servicing rights on a flow basis from our extensive 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 consumer 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, securities utilized for hedging purposes, 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. See Note 5 of our Notes to Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further detail on the composition of mortgage banking activities, net).

The following table presents key earnings and operating metrics for our Residential Consumer Mortgage Banking segment during

the three and nine months ended September 30, 2024 and 2023.

Table 5 – Residential Consumer Mortgage Banking Earnings Summary and Operating Metrics

(In Thousands)

Operating expenses presented in the table above include general and administrative expenses and loan acquisition costs for this segment.

The increase in segment contribution from our Residential Consumer Mortgage Banking operation is due to significantly higher loan purchase and lock volumes in the three and nine-month periods relative to the same periods in 2023, driven by an increase in loan purchases from both banks and IMBs. Notably, for the three-month periods, total lock volume was almost 40% higher and for the nine-month periods, 200% higher than in 2023. Market transaction volume during the nine months ended September 30, 2023 was impacted by the regional bank crisis which also caused considerable interest rate volatility during that time. Relative to the second quarter, activity in the third quarter of 2024 was briefly impacted in July by volatility ahead of the Federal Reserve’s September interest rate decision, but rebounded in August and September to levels similar to those in the second quarter, with increased demand for refinance activity during the brief decline in mortgage rates that occurred in the third quarter. Refinance transactions represented 27% of our total flow lock volume for the third quarter of 2024, the highest level since the first quarter of 2022 and up from 12% in the second quarter 2024.

Volume increases during the nine months ended September 30, 2024 occurred as a result of focused efforts to build our network of bank sellers and increase wallet share with IMBs. We added or re-established 93 bank seller relationships in the nine-months ended September 30, 2024 and as of September 30, 2024, our total network of loan sellers is 208, over half of which are banks. Lock volume from IMBs grew consistently with the overall lock volume increase relative to the same periods in 2023. During the three and nine months ended September 30, 2024, we also saw an increase in bulk volume from banks, including a portfolio of seasoned, hybrid, ARMs that we purchased in the third quarter of 2024 and securitized subsequent to September 30, 2024. Distribution activity, particularly through securitization, remained elevated for the three and nine months ended September 30, 2024, driven by the issuance of three securitizations backed by $1.53 billion of collateral and nine securitizations backed by $4.14 billion of collateral for those periods, respectively. At September 30, 2024, our securitization activity represented 19% of all jumbo securitization activity for 2024 and we were the largest non-bank issuer of jumbo securitizations.

For the third quarter of 2024, we earned gross margins of 204 basis points, well in excess of our historical target range of 75 to 100 basis points, driven by the rally in interest rates, hedge outperformance and spread tightening on securitization execution during the quarter. For the three months ended September 30, 2024, cost per loan was 33 basis points, normalized within our historical target range of 30 to 35 basis points. We actively manage our exposure to various market risks that can impact the value of our loan inventory in this segment, and our segment contribution in the three and nine months ended September 30, 2024 reflected higher income from our hedges within mortgage banking activities. We continue to evaluate monetary policy, housing trends and economic data, among other factors, in developing our hedging strategy and we may leverage a variety of instruments as hedges, including TBAs, interest rate futures, real estate securities, options and other types of securities.

Operating expenses for this segment increased for the three and nine-month periods primarily due to an increase in loan acquisition costs related to the increase in loan purchases, as well as higher general and administrative expenses from variable compensation due to improved segment performance for the nine months ended September 30, 2024.

Activity at this segment is performed within our taxable REIT subsidiary and subject to federal and state income taxes. The provision for income taxes for the first nine months of 2024 resulted from GAAP income from these operations at our TRS during that period.

The following table provides the activity of residential consumer loans held in inventory for sale at our Residential Consumer Mortgage Banking business during the three and nine months ended September 30, 2024.

Table 6 – Loan Inventory for Residential Consumer Mortgage Banking Operations — Activity

(In Thousands)

(1) Represents the fair value of the net transfers of loans from held-for-sale to held-for-investment within our Investment Portfolio, associated with securitizations we sponsored that we consolidate under GAAP.

During the three and nine months ended September 30, 2024, our residential consumer mortgage loan conduit locked $2.23 billion and $6.67 billion of loans ($1.77 billion and $5.50 billion adjusted for expected pipeline fallout – i.e., loan purchase commitments), and purchased $2.02 billion and $4.93 billion of loans, respectively. During the three and nine months ended September 30, 2024, we distributed $39 million and $247 million (unpaid principal balance) through whole loan sales, respectively. As previously discussed, during the three and nine months ended September 30, 2024 we completed three and nine securitizations backed by $1.53 billion and $4.14 billion of loans (unpaid principal balance), respectively. In addition to securitization distribution, we are also focused on finding alternative avenues for distribution, including identifying new whole loan buyers, an accretive form of distribution for us in the past.

Capital allocation to this segment was $300 million at September 30, 2024, compared to $165 million at December 31, 2023. We continue to competitively bid on bulk jumbo loan acquisition opportunities, including both newer vintage and seasoned collateral, while also focusing on forward flow agreements. As discussed in the Business Update section of this MD&A, looking ahead, we are focused on continuing to gain market share with our seller network.

We utilize a combination of capital and our residential consumer loan warehouse facilities to finance our inventory of residential consumer loans held-for-sale. At September 30, 2024, we had residential consumer warehouse facilities outstanding with six different counterparties, with $2.68 billion of total capacity and $1.41 billion of available capacity. These facilities included non-marginable facilities (i.e., not subject to margin calls based solely on the lender's determination, in its discretion, of the market value of the underlying collateral that is non-delinquent) with $700 million of total capacity and marginable facilities with $1.98 billion of total capacity.

Residential Investor Mortgage Banking Segment

This segment consists of a platform that originates residential investor loans for subsequent securitization, sale, or transfer into our investment portfolio. Residential investor loans are loans to investors in single-family rental and multifamily properties, which we classify as either "term" loans (which include loans with maturities that generally range from 3 to 10 years) or "bridge" loans (which include loans with maturities that generally range between six and 36 months). Term loans are mortgage loans secured by residential real estate (primarily 1-4 unit detached or multifamily) that the borrower owns as an investment property and rents to residential tenants. Residential investor bridge loans are mortgage loans which are generally secured by unoccupied (or in the case of certain multifamily properties, partially occupied) residential or multifamily real estate that the borrower owns as an investment and that is being renovated, rehabilitated or constructed. Our bridge loans are first-lien, interest-only loans. We may amend or modify bridge loans, including interest rate reductions and/or extended maturity dates, for borrowers experiencing financial difficulty based on specific facts and circumstances. In addition to modifying these loan terms, from time to time, we may also amend a loan's underlying budget (including allocations to hard/soft costs, interest reserves and other items) or construction and completion milestones, if warranted, based on progress with the project versus initial budget.

We typically distribute most of our term loans through our CAFL® private-label securitization program, or through whole loan sales, and typically transfer our residential investor bridge loans to our Investment Portfolio, where they will either be retained for investment or securitized, or sold as whole loans. Since 2023, we have also established joint ventures with global investment managers as another avenue through which we can distribute our bridge and term loan production.

In the second quarter of 2023, we established a joint venture with an institutional investment manager to invest in residential investor bridge loans originated by our CoreVest subsidiary. In the first quarter of 2024, we established a joint venture with an institutional investment manager to invest in residential investor bridge and term loans originated by our CoreVest subsidiary. We administer the joint ventures for ongoing fees and are entitled to earn additional performance fees upon realization of specified return hurdles.

This segment also includes various derivative financial instruments that we utilize to manage certain risks associated with our inventory of loans held-for-sale. This segment’s main sources of mortgage banking income are net interest income earned on loans while they are held in inventory, origination and other 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.

The following table presents an earnings summary for our Residential Investor Mortgage Banking segment for the three and nine months ended September 30, 2024 and 2023:

Table 7 – Residential Investor Mortgage Banking Earnings Summary

(In Thousands)

Residential Investor Mortgage Banking income presented in the table above is comprised of net interest income from our loans held-for-sale in inventory, mortgage banking activities, net (see Note 5 of our Notes to Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further detail on the composition of mortgage banking activities), and other income, net for this segment. Operating expenses presented in the table above includes general and administrative expenses, loan acquisition costs and other expenses (including amortization of purchased intangibles) for this segment.

In the Residential Investor Mortgage Banking segment, income from mortgage banking activities increased $8 million and $4 million during the three and nine-month periods ending September 30, 2024, respectively. The increase is primarily attributable to consistent volumes and improved distribution economics (including from whole loan sales and sales to joint ventures) as well as improved operating efficiencies. The increase in overall funding volumes during the third quarter of 2024, relative to the third quarter of 2023, is largely attributable to growth in originations of term loans and SAB loans, as well as overall borrower demand for our bridge products. Originations remained focused on single-family collateral in the third quarter of 2024, with 91% of fundings backed by single-family real estate and 9% backed by multifamily properties.

Net cost to originate improved to 0.88% during the three months ended September 30, 2024, compared to 0.99% and 2.49% during the second and first quarters of 2024, respectively. Distribution activity remained strong in the third quarter of 2024 with distributions of $288 million through whole loan sales and sales to joint ventures and an additional $63 million to existing bridge loan securitizations.

Activity at this segment is performed within our taxable REIT subsidiary and subject to federal and state income taxes. The benefit from income taxes for the nine-month period ended September 30, 2024 was primarily due to GAAP losses generated by this segment's operations in those periods.

The following table provides residential investor loan origination activity at Redwood during the three and nine months ended September 30, 2024.

Table 8 – Residential Investor Loans - Funding Activity

(In Thousands)

(1) We originate Residential investor bridge loans at our TRS and transfer many of them to our REIT. Origination fees and any fair value changes on these loans prior to transfer or sale are recognized within Mortgage banking activities, net on our consolidated statements of income. Loans transferred to our REIT are classified as held-for-investment, with fair value changes subsequent to their transfer generally recorded through Investment fair value changes, net on our consolidated statements of income. For the carrying value and activity of our Residential investor bridge loans held-for-investment, see the Investment Portfolio section that follows.

(2) Funding and sales for Residential investor bridge loans for the three and nine months ended September 30, 2024, includes $13 million and $34 million, respectively, related to construction draws on loans sold to a joint venture with an institutional investment manager.

(3) For residential investor term loans, amounts primarily represent loans transferred into consolidated securitizations reflected within our Investment Portfolio Segment. Residential investor bridge loan amounts represent the transfer of loans originated or acquired by our Residential Investor Mortgage Banking segment at our TRS and transferred to our Investment Portfolio segment at our REIT, as described in the preceding footnote.

During the three and nine months ended September 30, 2024, we funded $458 million and $1.24 billion of residential investor loans, 65% and 60% of which were bridge loans, respectively, with the remainder being term loans. The continued strength in overall funding volumes throughout 2024 is largely attributable to continued demand for bridge production combined with a renewed interest from borrowers for term production, as well as the SAB and DSCR production. Bridge demand has remained elevated across 2024 for our platform given deeper penetration of the market, especially as the banks have continued to retreat from lending in this space. Our SAB volumes have continued to move higher across the year and delivered another record quarter of fundings in the third quarter of 2024. Through much of 2024, we have witnessed a renewed appetite for term production from our borrowers as rates moderated and a path to lower rates seemed more probable. That sentiment tempered in the third quarter of 2024 as real estate investors awaited clarity from the Federal Reserve in September on its interest rate decision. As a result, term volumes were down 27% in the third quarter of 2024 relative to the second quarter 2024, but up 51% relative to the three months ended September 30, 2023, and origination volumes for term loans remain impacted by the level of interest rates. During the third quarter of 2024, approximately 75% of term loan originations were for purchase transactions or to refinance a loan not on our balance sheet.

Residential investor loan distribution activity during the three months and nine months ended September 30, 2024, including both whole loan sales and joint venture distributions, was $288 million, and $761 million, respectively. Looking ahead, given our established joint ventures, as well as growing network of whole loan buyers, we continue to see healthy demand for our production through our distribution channels.

Capital allocated to this segment decreased to $50 million at September 30, 2024, compared to $75 million at December 31, 2023. We expect this trend to continue to the extent we distribute more of our production into joint ventures and use less balance sheet capital for aggregation. We utilize a combination of capital and loan warehouse facilities to manage our inventory of residential investor loans that we hold for sale. At September 30, 2024, we had residential investor warehouse facilities outstanding with six different counterparties, with $2.53 billion of total capacity (used for both term and bridge loans) and $1.55 billion of available capacity (inclusive of capacity on non-recourse facilities). All of these facilities are non-marginable (i.e., not subject to margin calls based solely on the lender's determination, in its discretion, of the market value of the underlying collateral that is non-delinquent).

Investment Portfolio Segment

This segment consists of organic investments sourced through our residential consumer and Residential Investor Mortgage Banking operations, including primarily securities retained from our mortgage banking securitization activities (some of which we consolidate for GAAP purposes) and residential investor bridge loans, as well as third-party investments including RMBS issued by third parties, 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 ("HEI"), and other housing-related investments and associated hedges. This segment’s main sources of income are net interest income and other income from investments, changes in fair value of investments and associated hedges, 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.

The following table presents an earnings summary for our Investment Portfolio segment for the three and nine months ended September 30, 2024 and 2023.

Table 9 – Investment Portfolio Earnings Summary

(In Thousands)

Investment fair value changes, net is primarily comprised of the change in fair value (both realized and unrealized) of our portfolio investments accounted for under the fair value option and interest rate hedges associated with these investments. See Table 3 in the Consolidated Results of Operations in Part I, Item 2 of this Quarterly Report on Form 10-Q for further detail on the composition of investment fair value changes (the difference in amounts in the table above and in Table 3 relates to fair value changes for investments held at corporate/other).

For the three and nine months ended September 30, 2024, investment fair value changes, net totaled $12 million in net losses and $12 million in net gains, respectively. For the three and nine months ended September 30, 2024, negative investment fair value changes of $12 million and $30 million, respectively, related to impairments and the impact of interest rate modifications on the values of our unsecuritized residential investor bridge and term loan portfolios, all of which we hold at fair value. This was offset by investment fair value gains, net of associated interest rate hedges, on our securities portfolio of $8 million and $47 million for the three and nine months ended September 30, 2024, respectively, all of which primarily related to increases in the fair value of our Sequoia, CAFL Term and SLST securities retained from our consolidated securitizations.

Fundamental performance of our residential consumer assets within our Investment Portfolio continues to be driven by strong employment data, embedded equity protection associated with loan seasoning and home price appreciation, and borrowers motivated to stay current on their low-coupon mortgages. Notably, 90 day+ delinquencies on our Sequoia and SLST securities portfolios declined to 0.2% and 6.9%, respectively, at September 30, 2024, compared to 0.9% and 8.6%, respectively, at September 30, 2023.

The residential investor sector continues to manage through the impacts of elevated interest rates and overall financing costs for investors, particularly for loans originated in 2021 and 2022 when interest rates were lower. In anticipation of this impact, our team has continued to work with borrowers well in advance of their loan maturities to assess project plans and ensure they manage towards successful completions. Delinquencies greater than 90 days across our residential investor bridge loans were higher in the third quarter of 2024, predominantly impacted by the 2022 vintage portfolio, and increased across all strategies. REO values in the residential investor bridge portfolio decreased in the third quarter of 2024, and we continue to manage through pockets of stress, largely with a handful of more significant borrower relationships where a combination of rate modifications, maturity extensions and fresh equity has been utilized. Overall repayment velocity in the bridge portfolio remains positive, as approximately 12% of the bridge book paid off during the third quarter and we resolved $10 million in aggregate unpaid principal of loans that were 90 or more days delinquent at June 30, 2024.

Operating expenses at this segment increased $1 million and $4 million in the three and nine-month periods, respectively, primarily due to increased portfolio management costs incurred for the management of specially serviced residential investor bridge loans and related workout arrangements for the nine months ended September 30, 2024.

We hold certain of our investments, primarily our MSRs, at our taxable REIT subsidiary. Our provision for income taxes at this segment is primarily driven by the amount of income earned from portfolio assets and, for each of the three and nine month periods, reflects positive net income earned from investment portfolio activities at our taxable REIT subsidiary.

The following table presents details of our Investment Portfolio at September 30, 2024 and December 31, 2023 organized by investments organically created through our mortgage banking segments and those acquired from third-parties. Amounts presented in the table represent our retained economic interests in consolidated Sequoia, CAFL SFR, Freddie Mac SLST, Freddie Mac K-Series, Servicing Investment and HEI securitizations as noted.

Table 10 – Investment Portfolio - Detail of Economic Interests

(In Thousands)

(1) Represents our retained economic investment in securities issued by consolidated Sequoia securitization VIEs. For GAAP purposes, we consolidated $8.48 billion of loans and $8.14 billion of ABS issued associated with these investments at September 30, 2024. We consolidated $4.64 billion of loans and $4.43 billion of ABS issued associated with these investments at December 31, 2023.

(2) Organic residential other investments at September 30, 2024 includes net risk share investments of $25 million, representing $29 million of restricted cash and other assets, net of other liabilities of $4 million.

(3) Represents our retained economic investment in securities issued by consolidated CAFL Term securitization VIEs. For GAAP purposes, we consolidated $2.66 billion of loans and $2.33 billion of ABS issued associated with these investments at September 30, 2024. We consolidated $2.97 billion of loans and $2.65 billion of ABS issued associated with these investments at December 31, 2023.

(4) Represents our economic investment in securities issued by consolidated Freddie Mac SLST securitization entities. For GAAP purposes, we consolidated $1.32 billion of loans and $1.05 billion of ABS issued associated with these investments at September 30, 2024. We consolidated $1.36 billion of loans and $1.09 billion of ABS issued associated with these investments at December 31, 2023.

Footnotes to Table 10 (Continued)

(5) Represents our economic investment in securities issued by consolidated Freddie Mac K-Series securitization entities. For GAAP purposes, we consolidated $426 million of loans and $391 million of ABS issued associated with these investments at September 30, 2024. We consolidated $425 million of loans and $392 million of ABS issued associated with these investments at December 31, 2023.

(6) Represents our economic investment in consolidated Servicing Investment variable interest entities. At September 30, 2024, for GAAP purposes, we consolidated $242 million of servicing investments and $156 million of non-recourse short-term securitization debt, as well as other assets and liabilities for these entities. At December 31, 2023, for GAAP purposes, we consolidated $257 million of servicing investments and $154 million of non-recourse short-term securitization debt, as well as other assets and liabilities for these entities.

(7) At September 30, 2024 and December 31, 2023, represents HEI owned at Redwood of $254 million and $245 million, respectively and our retained economic investment in securities issued by consolidated HEI securitization entities of $46 million and $34 million, respectively.

The size of our Investment Portfolio increased slightly since December 31, 2023, due to the decrease in residential investor bridge loans, offset by actively deploying capital into new residential Sequoia securities and other residential securities investments. At September 30, 2024 and December 31, 2023, 77% and 80% of our Investment Portfolio economic interests were organically created, respectively, and 23% and 20% were purchased from third parties, respectively. Capital deployment activities into internally-sourced and third-party investments for the three months ending September 30, 2024 totaled $157 million and represented the highest level of quarterly of capital deployment since the third quarter of 2022. See the Investments Detail and Activity section that follows for additional detail on our portfolio investments and their associated borrowings.

Investments Detail and Activity

This section presents additional details on our investments (both within our Investment Portfolio segment and held at a corporate level) and their activity during the three and nine months ended September 30, 2024.

Real Estate Securities Portfolio

The following table sets forth activity in our real estate securities portfolio for the three and nine months ended September 30, 2024, 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. Additionally, this table includes securities held both in our Investment Portfolio segment and our Residential Consumer Mortgage Banking segment.

Table 11 – Activity of Real Estate Securities Owned at Redwood and in Consolidated Entities

(In Thousands)

65

(In Thousands)

(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 September 30, 2024, $35 million of Sequoia Securities and $84 million of Other Third-Party Securities were used as hedges for our Residential Consumer Mortgage Banking operations, and were included in our Residential Consumer Mortgage Banking segment.

At September 30, 2024, our securities owned at Redwood and in consolidated entities consisted of fixed-rate assets (99%), adjustable-rate assets (1%) and hybrid assets that reset within the next year (<1%).

We directly finance our holdings of real estate securities with a non-marginable recourse term debt financing. At September 30, 2024, we had: CAFL securities with a fair value of $325 million that were financed with $269 million of non-marginable recourse debt through a subordinate securities financing facility; re-performing loan securities with a fair value of $268 million (including securities owned in consolidated securitization entities) that were financed with $153 million of non-recourse securitization debt (ABS issued); Sequoia securities we owned from consolidated and unconsolidated Sequoia securitization trusts with a fair value of $236 million that were financed with $194 million of non-recourse re-securitization debt (ABS issued); real estate securities with a fair value of $250 million (including securities owned in consolidated securitization entities) that were financed with $185 million of recourse debt incurred through repurchase facilities with six different counterparties; and $54 million of securities that were financed using a recourse residential MSR warehouse facility. The remaining $176 million of our 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 September 30, 2024. 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 12 – Credit Statistics of Real Estate Securities Owned at Redwood and in Consolidated Entities

(Dollars in Thousands)

66

Footnotes to Table 12

(1) Weighted averages presented in this table, including delinquencies, are weighted using the notional balance of loans collateralizing each securitization in which we own a security. Prior to December 31, 2023, weighted averages were calculated using the fair value of the securities we owned.

(2) 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.

(3) At September 30, 2024, $35 million of Sequoia Securities and $84 million of Other Third-Party Securities were used as hedges for our Residential Mortgage Banking operations, and were included in our Residential Consumer Mortgage Banking segment.

We primarily target investments that have a sensitivity to housing credit risk, typically sourced through our operating businesses where we control the underwriting and review of underlying collateral. We currently target returns related to capital deployment opportunities between 12-18% on third-party opportunities and between 15-20% on investments organically created by our mortgage banking platforms.2 During the third quarter of 2024, our overall residential and Agency multifamily securities portfolio continued to demonstrate stable fundamentals, driven by underlying loan seasoning, low 90+ day delinquencies and embedded growth in home prices and rents. Given the seasoned nature of our investments (particularly within our RPL securities and Sequoia securities), many of our residential investments are supported by stable home price appreciation and borrower equity in the underlying homes. For the term loans underlying our consolidated CAFL securities, 90 day+ delinquencies increased modestly during the third quarter of 2024.

With a weighted average quarter-end carrying value of 70 cents to each one dollar of face value, we estimate our securities portfolio had approximately $2.09 per common share of net discount to par at quarter end. We estimate that 40% of the total net discount in our Investment Portfolio at September 30, 2024 was precipitated by the Federal Reserve's interest rate tightening cycle between 2022 and 2023. We believe continued stable credit performance in our underlying securities portfolio, combined with firming of risk sentiment and a return to more normalized prepayment speeds, could contribute to our ability to realize potential upside in book value over time, reversing unrealized losses taken in 2023 that were largely driven by technical spread widening. See "Cautionary Statement" above within this MD&A for a review of risk factors that may impact our ability to realize this potential upside in book value.

Residential Investor Bridge Loans Held-for-Investment

The following table provides the activity of Residential investor bridge loans held-for-investment during the three and nine months ended September 30, 2024.

Table 13 – Residential Investor Bridge Loans Held-for-Investment - Activity

(In Thousands)

(1) We originate residential investor bridge loans at our TRS and transfer a portion of them to our REIT that we intend to hold for investment. 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.

2 Target returns are based on management's market observations, estimates, and assumptions, including our assumptions regarding the use of leverage, credit losses, prepayment speeds, and market interest rates. Actual returns may differ due to these or other factors. See "Cautionary Statement" above within this MD&A for a review of risk factors that may impact our ability to realize our target returns.

Our $1.82 billion of Residential investor bridge loans held-for-investment at September 30, 2024, were comprised of first-lien, interest-only loans with a weighted average coupon of 9.78% and original maturities of 6 to 36 months. At origination, the weighted average FICO score of sponsors of these loan borrowers was 736 and the weighted average as-repaired LTV ratio of these loans was 64%. Overall repayment velocity on these loans was strong in the three and nine months ended September 30, 2024, with principal repayments of $226 million and $617 million, respectively.

At September 30, 2024, loans in this portfolio with an aggregate fair value of $137 million and an unpaid principal balance of $156 million, were greater than 90 days delinquent. Included in the 90 days delinquent balance are loans in foreclosure with an aggregate fair value of $86 million and an aggregate unpaid principal balance of $99 million. Additionally, REO associated with bridge loans decreased from $88 million at December 31, 2023, to $80 million at September 30, 2024 resulting from a decrease in fair value of $9 million, offset by transfers to REO of $4 million and the sale of two REO properties for $2 million during the nine months ended September 30, 2024.

The fair value of residential investor bridge loans held-for-investment of $1.82 billion at September 30, 2024 declined from $2.07 billion at December 31, 2023. Changes in the fair value of these loans during the three months ending September 30, 2024 primarily reflect principal repayments and reductions in the fair values for non-accrual bridge loans and certain modified bridge loans since the fourth quarter of 2023. For the three months ending September 30, 2024, we modified or put into forbearance loans with a total aggregate unpaid principal balance of $228 million. Of this balance, loans with reductions in contractual interest rates (including, in certain cases, deferrals of interest) had an aggregate unpaid principal balance of $113 million, and an aggregate fair value of $111 million at September 30, 2024. The modification terms on these loans involved conversions of the contractual interest rates on the loans from floating to fixed and/or deferrals of a portion of the stated pay rate to an extended date or to maturity. In the third quarter of 2024, modifications on these loans maintained a weighted average contractual interest rate of approximately 10.49%, of which 4.86% represented deferred interest.

In addition, for the three months ending September 30, 2024, we modified two Build for Rent ("BFR") loans with a total aggregate unpaid principal balance of $116 million and an aggregate fair value of $115 million, respectively, at September 30, 2024, that had previously been modified in 2024. The previous modifications on these loans amended the interest rate to a combination of current pay and deferred interest. Because they finance the construction of rental housing, many BFR projects do not generate net operating income until the later stages of the loan term. As such, BFR loans are sized to include allocations for interest expense as well as construction reserves. During the three months ending September 30, 2024, the modifications on these loans amended the allocation of loan commitments between hard and soft costs, interest expense and other expenses, provided maturity extensions of 16-19 months (subject to mandatory partial repayments during the loan term), and established a hard lockbox and funding of interest reserves to cover debt service shortfalls.

While we continue to work proactively with certain borrowers to address the impacts of rising interest rates, elongated project timelines, or other issues, further increases in delinquencies or modifications within our residential investor bridge loan portfolio could ultimately result in further decreases in net interest income and the fair value of our bridge loans held for investment, and further instances of borrower/sponsor stress could lead to realized credit losses. In addition to the loan modifications described above, during the third quarter of 2024, we extended the loan covenant terms and/or extended the maturities on $106 million of loans (representing cumulative unpaid principal balance as of September 30, 2024). An increase in maturity extensions in the residential investor bridge portfolio would increase the expected time to repayment with a potential impact on fair values and credit losses. However, given the overall short duration nature of our bridge loans, a certain level of maturity extensions are a regular asset management outcome for these loans, irrespective of market conditions. In the third quarter of 2024, the average length of maturity extensions granted on residential investor bridge loans was four months.

We generally value delinquent residential investor loans at a dollar price that is informed by various market data, including the estimated fair value of the collateral securing a loan, for which we typically receive third-party appraisals, as well as estimated sales costs. The amounts we may ultimately recover through the foreclosure of loans and the sale of the underlying collateral or through alternative strategies, such as through loan sales or discounted payoffs, could vary materially from our estimates and could have a material impact on our earnings in future periods.

We finance our residential investor bridge loans with a combination of recourse, non-marginable warehouse facilities, non-recourse, non-marginable facilities, and non-recourse securitization debt. At September 30, 2024, we had $974 million of debt incurred through warehouse facilities with six counterparties, which was secured by residential investor bridge loans with a fair value of $1.25 billion; and $533 million of securitization debt secured by $607 million of residential investor bridge loans, $11 million of restricted cash and $21 million of other assets. At September 30, 2024, the unpaid principal balance of bridge loans financed was $1.87 billion, of which $489 million was financed with recourse, non-marginable facilities, $782 million was financed with non-recourse, non-marginable facilities, and $600 million was financed through non-recourse CAFL bridge securitizations.

The following table provides the composition of residential investor bridge loans held-for-investment by product type as of September 30, 2024 and December 31, 2023.

Table 14 – Residential Investor Bridge Loans Held-for-Investment - By Product/Strategy Type

(In Thousands)

(1) Includes loans to finance acquisition and/or stabilization of existing housing stock or to finance new construction of residential properties for rent.

(2) Includes loans for light to moderate renovation of residential and small multifamily properties (generally less than 20 units).

(3) Includes loans for predominantly light to moderate rehabilitation projects on multifamily properties.

At September 30, 2024, the fair value of our total residential investor bridge loans held-for-investment and associated REO represented 97.5% of the combined unpaid principal balance of these loans and the unpaid principal balance of the loans associated with the REO at time of foreclosure. The fair value of multifamily loans within this population ($786 million at September 30, 2024) and associated multifamily REO ($41 million at September 30, 2024), represented 95.4% of the combined unpaid principal balance of these loans and the unpaid principal balance of the loans associated with the REO at time of foreclosure.

Home Equity Investments

The following table provides the activity of HEI held at our investment portfolio during the three and nine months ended September 30, 2024.

Table 15 – HEI at Investment Portfolio Segment - Activity

(In Thousands)

(1) Our HEI presented in this table as of September 30, 2024, include $335 million of HEI owned in our consolidated HEI securitization entities and $256 million of HEI owned directly at Redwood.

We finance a portion of our HEI through a short-term warehouse facility. At September 30, 2024, there was $100 million of debt outstanding on this warehouse facility, secured by HEI with a fair value of $210 million. This warehouse facility was originally entered into in November 2022 with a 12-month term and an extension feature. Absent an additional renewal or extension, this facility is scheduled to mature in December 2024.

Additional details on our HEI are included in Note 10 of our Notes to Consolidated Financial Statements, included in Part I, Item 1 of this Quarterly Report on Form 10-Q. During the three and nine months ended September 30, 2024, positive investment fair value changes primarily reflected improvements in actual and forecasted home price appreciation, relative to previously modeled amounts.

Income Taxes

REIT Status and Dividend Characterization

While the exact amount is uncertain at this time, we currently expect a portion of our 2024 common stock dividend distributions to be taxable as ordinary income for federal income tax purposes. Any remaining amount is currently expected to be characterized as a return of capital, which in general is nontaxable (provided it does not exceed a shareholder's tax basis in Redwood shares) and reduces a shareholder's basis in Redwood shares (but not below zero). To the extent such distributions exceed a shareholder's basis in Redwood shares, such excess amount would be taxable as capital gains. We currently expect all of our 2024 preferred stock dividend distributions to be taxable as ordinary income for federal income tax purposes. Under the federal income tax rules applicable to REITs, none of Redwood’s 2024 dividend distributions are currently expected to be characterized as long-term capital gain dividends. The income or loss generated at our TRS will not directly affect the tax characterization of our 2024 dividends; however, any dividends paid from our TRS to our REIT would allow a portion of our REIT’s dividends to be classified as qualified dividends.

Tax Provision under GAAP

For the three and nine months ended September 30, 2024, we recorded tax provisions of $7 million and $13 million, respectively. For the three and nine months ended September 30, 2023, we recorded tax provisions of $2 million and $1 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. The increase in the tax provision year-over-year was primarily the result of increased GAAP income earned at our TRS in 2024 compared to 2023. Refer to Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2023 under the caption Income Taxes for additional information regarding our tax provision and deferred tax assets.

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 and HEI warehouse facilities, secured term financing facilities, securities repurchase agreements, a corporate secured revolving financing facility, 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 mortgage banking operating activities, such as the sale and securitization of mortgage loans. 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, to fund draws on our bridge loan portfolio and other commitments when requested, and to fund our operations.

At September 30, 2024, our total capital was $2.04 billion, consisting of (i) $1.22 billion of equity capital, (ii) $799 million of convertible notes and other corporate debt on our consolidated balance sheets (including $157 million of exchangeable debt due in October 2025, $207 million of convertible debt due in 2027, $150 million outstanding under a corporate secured revolving financing facility due in March 2026, $145 million of senior unsecured notes due in 2029, $140 million of trust-preferred securities due in 2037), and (iii) $14 million of promissory notes.

In July 2024, we repaid our 5.625% convertible senior notes. In October 2024, we issued $40 million of our 7.75% convertible senior notes due in 2027 in a private offering for net proceeds of $38 million. These notes were issued through a reopening of our 7.75% convertible senior notes due in 2027, which the Company originally issued in June 2022. The proceeds from this issuance were primarily used to repurchase $33 million principal amount of our exchangeable senior notes maturing in October 2025.

As of September 30, 2024, our unrestricted cash and cash equivalents were $254 million. 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.

In the discussion that follows and throughout this document, we distinguish between marginable and non-marginable debt and recourse and non-recourse debt. Refer to Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2023 under the caption Liquidity and Capital Resources for additional information regarding these terms on our debt.

At September 30, 2024, in aggregate, we had $2.09 billion of secured recourse debt outstanding, financing our mortgage banking operations and investment portfolio, of which $974 million was marginable and $1.12 billion was non-marginable.

We are subject to risks relating to our liquidity and capital resources, including risks relating to incurring debt under loan warehouse facilities, securities repurchase facilities, other short- and long-term debt facilities and other risks relating to our corporate debt and 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."

Repurchase Authorization

Our Board of Directors approved an authorization for the repurchase of up to $125 million of our common stock, and also authorized the repurchase of outstanding debt securities, including convertible and exchangeable debt. In May 2023, our Board of Directors approved an additional authorization for the repurchase of up to $70 million of our preferred stock. During the nine months ended September 30, 2024 we did not repurchase any shares of our common stock or preferred stock and repurchased $39 million of our convertible and exchangeable debt. At September 30, 2024, $101 million of the current authorization remained available for the repurchase of shares of our common stock, and $70 million remained available for the repurchase of shares of our preferred stock. Like investments we may make, any repurchases of our common stock, preferred stock, or debt securities under these authorizations would reduce our available capital and unrestricted cash described above

Cash Flows and Liquidity for the Nine Months Ended September 30, 2024

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 operating or investment activities.

Cash Flows from Operating Activities

Cash flows used in operating activities increased by $4.14 billion from $867 million in the nine months ended September 30, 2023 to $5.01 billion in the nine months ended September 30, 2024, primarily due to the increase in residential consumer loan purchases and as well as an increase in originations of residential investor loans held for sale associated with our mortgage banking activities. Excluding cash flows from the purchase, origination, sale and principal payments of loans classified as held-for-sale, and the settlement of associated derivatives (which cumulatively totaled $5.08 billion of net cash outflows for the nine months 2024 period, compared to $896 million of net cash outflows for the nine month 2023 period), cash flows from operating activities were positive $68 million during the first nine months of 2024 and positive $28 million for the first nine months of 2023.

Cash Flows from Investing Activities

During the nine months ended September 30, 2024, our net cash provided by investing activities was $1.54 billion and primarily resulted from proceeds from principal payments on loans held-for-investment and other investments, in excess of cash deployed into these investments. Because many of our investment securities, loans and HEI 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 and HEI at consolidated securitization entities would generally be used to repay ABS issued by those entities.

Cash Flows from Financing Activities

During the nine months ended September 30, 2024, our net cash provided by financing activities was $3.43 billion. This primarily resulted from $2.93 billion of net borrowings under ABS issued (resulting from the issuance of nine Sequoia securitizations as well as a $205 million Sequoia re-securitization of certain consolidated and unconsolidated Sequoia securities during the third quarter of 2024, net of related issuance costs), and $572 million of net borrowings on debt obligations. During the nine months ending September 30, 2024, net cash provided from debt obligations included the issuance of senior notes, a corporate secured revolving financing facility, and the issuance of a recourse subordinate financing facility. During the third quarter of 2024, we repaid $107 million of our convertible notes at the maturity date and repaid and terminated three recourse subordinate financing facilities.

Material Cash Requirements

In the normal course of business, we enter into transactions that may require future cash payments. As required by GAAP, some of these obligations are recorded on the balance sheet, while others are off-balance sheet or recorded on the balance sheet in amounts different from the full contractual or notional amount of the transaction.

Our material cash requirements from known contractual and other obligations during the twelve months following September 30, 2024, include maturing debt obligations, interest payments on debt obligations and ABS issued, payments on operating leases, funding commitments for residential investor bridge loans, strategic investments, and other current payables. Our material cash requirements from known contractual and other obligations beyond the twelve months following September 30, 2024, include maturing long-term debt, interest payments on long-term debt, payments on operating leases and funding commitments for residential investor bridge loans, strategic investments, and principal and interest payments under ABS issued (as described further below under Liquidity Needs for our Investment Portfolio).

At September 30, 2024, we had commitments to fund up to $429 million of additional advances on existing residential investor bridge loans. These commitments are generally subject to loan agreements with covenants regarding the financial performance of the borrower and other terms regarding advances that must be met before we fund the commitment (for example, funding is dependent on actual progress on a project and we retain the right to conduct due diligence with respect to each draw request to confirm conditions have been met). A majority of the commitments are for longer-term renovate/build-for-rent loans (which generally have funding caps below their full commitment amount) and are expected to fund over the next several quarters. Additionally, at September 30, 2024, we had $1.55 billion of available warehouse capacity for residential investor loans and scheduled bridge loan maturities are expected to provide an additional source of cash that can be used to fund our commitments.

For additional information regarding our material cash requirements, see Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2023 under the caption Contractual Obligations. For additional information on commitments and contingencies as of September 30, 2024 that could impact our liquidity and capital resources, see Note 18 of our Notes to Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q, which supplements the disclosures included in Note 17 to the Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2023.

We expect to meet our obligations coming due in less than one year from September 30, 2024 most likely from borrowings under existing, new or amended financing arrangements, or through other previously mentioned sources of capital. As of September 30, 2024, we had approximately $300 million of unencumbered assets, and we currently estimate we could generate incremental capital organically through financing certain of these assets. Our unencumbered assets consist primarily of interest-only securities, retained securities from our securitization activities, bridge loans, and HEI.

See Note 17 in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information on our debt obligations.

Liquidity Needs for our Mortgage Banking Activities

We generally use loan warehouse facilities to finance the loans we acquire and originate in our mortgage banking operations while we aggregate the loans for sale or securitization.

At September 30, 2024, we had residential consumer warehouse facilities outstanding with six different counterparties, with $2.68 billion of total capacity and $1.41 billion of available capacity. These included non-marginable facilities with $700 million of total capacity and marginable facilities with $1.98 billion of total capacity. At September 30, 2024, we had residential investor warehouse facilities outstanding with six different counterparties, with $2.53 billion of total capacity and $1.55 billion of available capacity. All of these residential investor financing facilities are non-marginable. We note that several of these facilities used to finance our Residential Investor Mortgage Banking loan inventory are also used to finance bridge loans held in our investment portfolio.

Most 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 renewed several of these facilities during the three- and nine-month periods ended September 30, 2024, and have other such facilities with scheduled maturities during the next twelve months. See Note 17 in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information on our debt obligation activity for our Mortgage Banking operations.

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

At September 30, 2024, in addition to our ABS issued, our investment portfolio was financed with $855 million of secured recourse debt, of which $240 million was marginable and $615 million was non-marginable, and $563 million of secured non-recourse debt that was non-marginable.

We use various forms of secured recourse and non-recourse debt to finance assets in our investment portfolio. Refer to Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2023 under the caption Liquidity and Capital Resources for additional information regarding our forms of financing assets in our investment portfolio, as well as for our descriptions of what constitutes non-recourse and non-marginable debt.

During the third quarter of 2024, we paid off two recourse subordinate securities financing facilities secured by certain securities we retained from our consolidated CAFL securitizations and refinanced these securities with a recourse subordinate financing facility providing non-marginable debt financing. Additionally, during the third quarter of 2024, we paid off a third recourse subordinate securities financing facility and subsequently re-securitized certain Sequoia securities through the issuance of $205 million (principal balance) of ABS.

See Note 16 and Note 17 in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information on our asset-backed securities issued and debt obligations, respectively.

Corporate Capital

In addition to secured recourse and non-recourse debt 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 and non-convertible senior debt securities we issue in the public markets and also includes trust preferred securities and promissory notes. Furthermore, during the first quarter of 2024, we entered into a corporate secured revolving financing facility to provide recourse debt financing secured by eligible collateral, which may include residential investor securities, residential consumer securities and other investments, as well as equity in certain operating subsidiaries. At September 30, 2024, this facility had a borrowing limit of $250 million and a two-year term, with a one-year extension option. We also characterize our corporate secured revolving financing facility as non-marginable, but it may be subject to margin calls or cash flow sweeps based on a decline in the market value of financed collateral in an aggregate amount that causes the effective advance rate associated with such financing facility to exceed a specified threshold, based on market value determinations by Redwood and one or more third party valuation agents. See Note 17 Part I, Item 1 of this Quarterly Report on Form 10-Q and Note 14 and Note 16 in Part II, Item 8 of our Annual Report on Form 10-K, for additional information on our unsecured debt obligations.

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 consumer mortgage loans, residential investor mortgage loans, and HEI (including those we acquire or originate in anticipation of sale or securitization), and finance investments in securities and other investments. We may also use borrowings to fund other aspects of our business and operations, including the repurchase of shares of our capital stock. Recourse 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. Risks relating to debt incurred under these facilities are described in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2023, under the caption(s) “Risks Relating to Debt Incurred under Short- and Long-Term Borrowing Facilities,” and “Our use of financial leverage exposes us to increased risks, including liquidity risks from margin calls and potential breaches of the financial covenants under our borrowing facilities, which could 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, as well as triggering cross-defaults under other debt agreements.” As described above under “Investments Detail and Activity–Home Equity Investments”, we finance a portion of our HEI assets through a short-term warehouse facility, which is scheduled to mature in December 2024. At September 30, 2024, $100 million of borrowings were outstanding on this warehouse facility, secured by HEI with a fair value of $210 million. We are actively engaged in seeking to renew or extend this warehouse facility, however, we may not be able to renew, extend or replace this financing facility when it matures due to, among other things, the fact that HEI are a newer asset class and the financing market for this asset class is not as mature as financing markets for other types of assets we acquire and finance. A further discussion of HEI, including factors that could impact our ability to renew or replace this financing facility, is set forth below under “Market and Other Risks”.

Aggregate borrowing limits are stated under certain of these facilities, and certain other facilities have no stated borrowing limit, but many of the facilities are uncommitted, which means that any request we make to borrow funds under these uncommitted facilities may be declined by the lender 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. In general, financing under these facilities is obtained by transferring or pledging mortgage loans or securities to the counterparty in exchange for cash proceeds (in an amount less than 100% of the principal amount of the transferred or pledged assets). Given that we may not be able to obtain additional financing under uncommitted lines when we need it, we are exposed to, among other things, liquidity risks of the types described in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2023 under the heading “Risk Factors,” and in Part II, Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2023 under the heading “Market Risks.” In addition, with respect to mortgage 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 our Annual Report on Form 10-K for the year ended December 31, 2023 under the heading “Risk Factors,” and in Part II, Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2023 under the heading “Market Risks,” if and when those loans or securities become ineligible to be financed, decline in value, or have been financed for the maximum term permitted under the applicable facility.

Under many of our mortgage loan and HEI warehouse facilities, our short-term securities repurchase facilities, and our corporate secured revolving financing facility, while transferred or pledged mortgage loans, HEI, or securities are financed under the facility, to the extent the value of the loans, HEI, or securities, or the collateral underlying those loans, HEI, or securities, declines, we are generally required to either immediately reacquire the loans or securities or meet a margin requirement to transfer or pledge additional loans, securities or cash in an amount at least equal to the decline in value. Of our active financing arrangements with outstanding balances at September 30, 2024, only our securities repurchase facilities (with $185 million of borrowings outstanding at September 30, 2024), five of our residential consumer mortgage loan warehouse facilities (with a combined $877 million of borrowings outstanding at September 30, 2024), and a certificated MSR facility (with $54 million of borrowings outstanding at September 30, 2024) retain market-value based margin call provisions based solely on the lender's determination of market value and, as such, are considered marginable.

Margin call provisions under these facilities are further described in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2023 under the caption “Risks Relating to Debt Incurred under Short- and Long-Term Borrowing Facilities - Margin Call Provisions Associated with Short-Term Debt and Other Debt Financing.” Financial covenants included in these facilities are further described Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2023 under the caption “Risks Relating to Debt Incurred under Short- and Long-Term Borrowing Facilities - Financial Covenants Associated with Short-Term Debt and Other Debt Financing.”

At September 30, 2024, and through the date of this Quarterly Report on Form 10-Q, we were in compliance with the financial covenants associated with our 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 September 30, 2024 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 September 30, 2024 our level of recourse indebtedness resulted in our being in compliance with these covenants at a level such that we could incur more than $4 billion in additional recourse indebtedness.

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 I, Item 1 of this Quarterly Report on Form 10-Q.

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 6 in Part I, Item 1 of this Quarterly Report on Form 10-Q, for additional information on our assets and liabilities accounted for at fair value at September 30, 2024, 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, 2023, incorporated herein by reference, for the same information on these assets and liabilities as of December 31, 2023. 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.

Additional detail on our critical accounting estimates is included in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2023, under the heading "Critical Accounting Estimates."

MARKET AND OTHER 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 in Part II, Item 7A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2023.

As described in the “Risk Factors” within our Annual Report on Form 10-K for the year ended December 31, 2023, HEI assets we hold may be subject to regulatory risks, such as the risk of certain HEIs being recharacterized as mortgage loans by federal or state regulatory agencies. As previously disclosed, several states have implemented regulatory changes applying to certain HEI by expanding their definitions of “mortgage loan” to include “shared appreciation agreements”, and there continues to be focus at both the state and federal level on the HEI asset class and larger, third-party HEI originators. To the extent state or federal agencies take regulatory action with respect to larger, third-party HEI originators and/or provide remedies for consumers who have entered into an HEI with one of these originators, such actions or remedies, if applicable, could negatively impact the value of HEI we are invested in and our business activity related to HEI.

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” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023.

Information concerning market risk is incorporated herein by reference to Part II, Item 7A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2023, as supplemented by the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Market Risks” within Item 2 above. Other than the developments described thereunder, including changes in the fair values of our assets, there have been no other material changes in our quantitative or qualitative exposure to market risk since December 31, 2023.

We have adopted and maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed on our reports under the Securities Exchange Act of 1934, as amended (the Exchange Act), is recorded, processed, summarized, and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms and that the information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by Rule 13a-15(b) of the Exchange Act, we have carried out an evaluation, under the supervision and with the participation of management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level.

There have been no changes in our internal control over financial reporting during the third quarter of 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Our risk factors are discussed under Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2023.