Basis of Presentation

12 Months Ended

Dec. 31, 2019

Accounting Policies [Abstract]

Basis of Presentation

Basis of Presentation

The consolidated financial statements presented herein are at December 31, 2019 and December 31, 2018, and for the years ended December 31, 2019, 2018, and 2017. These consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") — as prescribed by the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) — and the rules and regulations of the Securities and Exchange Commission ("SEC"). In the opinion of management, all normal and recurring adjustments to present fairly the financial condition of the Company at December 31, 2019 and 2018, and results of operations for all periods presented have been made.

Principles of Consolidation

In accordance with GAAP, we determine whether we must consolidate transferred financial assets and variable interest entities (“VIEs”) for financial reporting purposes. We currently consolidate the assets and liabilities of certain Sequoia securitization entities issued prior to 2012 where we maintain an ongoing involvement ("Legacy Sequoia"), as well as entities formed in connection with the securitization of Redwood Choice expanded-prime loans ("Sequoia Choice"). We also consolidate the assets and liabilities of certain Freddie Mac K-Series and Freddie Mac Seasoned Loans Structured Transaction ("SLST") securitizations we invested in beginning in 2018. Finally, we consolidated the assets and liabilities of certain CoreVest American Finance Lender ("CAFL") securitizations beginning in the fourth quarter of 2019, in connection with our acquisition of CoreVest. Each securitization entity is independent of Redwood and of each other and the assets and liabilities are not owned by and are not legal obligations of Redwood Trust, Inc. Our exposure to these entities is primarily through the financial interests we have purchased or retained, although for the consolidated Sequoia and CAFL entities we are exposed to certain financial risks associated with our role as a sponsor, servicing administrator, or depositor of these entities or as a result of our having sold assets directly or indirectly to these entities.

For financial reporting purposes, the underlying loans owned at the consolidated Sequoia and Freddie Mac SLST entities are shown under Residential loans held-for-investment at fair value, the underlying loans at the consolidated Freddie Mac K-Series are shown under Multifamily loans held-for-investment, at fair value, and the underlying single-family rental loans at the consolidated CAFL entities are shown under Business purpose loans held-for-investment, at fair value, on our consolidated balance sheets. The asset-backed securities (“ABS”) issued to third parties by these entities are shown under ABS issued. In our consolidated statements of income, we recorded interest income on the loans owned at these entities and interest expense on the ABS issued by these entities as well as other income and expenses associated with these entities' activities. See Note 14 for further discussion on ABS issued.

Beginning in 2018, we consolidated two partnerships ("Servicing Investment" entities) through which we have invested in servicing-related assets. We maintain an 80% ownership interest in each entity and have determined that we are the primary beneficiary of these partnerships.

Beginning in the first quarter of 2019, we consolidated 5 Arches, an originator of business purpose residential loans, pursuant to the exercise of our purchase option and the acquisition of the remaining equity in the company. In the fourth quarter of 2019, we acquired and consolidated CoreVest, an originator and portfolio manager of business purpose residential loans.

See Note 4 for further discussion on principles of consolidation.

Use of Estimates

The preparation of financial statements requires us to make a number of significant estimates. These include estimates of fair value of certain assets and liabilities, amounts and timing of credit losses, prepayment rates, and other estimates that affect the reported amounts of certain assets and liabilities as of the date of the consolidated financial statements and the reported amounts of certain revenues and expenses during the reported periods. It is likely that changes in these estimates (e.g., valuation changes due to supply and demand, credit performance, prepayments, interest rates, or other reasons) will occur in the near term. Our estimates are inherently subjective in nature and actual results could differ from our estimates and the differences could be material.

Acquisition of 5 Arches, LLC

In May 2018, Redwood acquired a 20% minority interest in 5 Arches for $10 million in cash, with a one-year option to purchase all remaining equity in the company. On March 1, 2019, we completed the acquisition of the remaining 80% interest in 5 Arches, an originator of business purpose residential loans. At closing, we paid approximately $13 million of cash and the remaining $27 million in consideration will be paid in a mix of cash and Redwood common stock over the next two years.

Acquisition of CoreVest

On October 15, 2019, we acquired CoreVest, an originator and portfolio manager of business purpose residential loans. Aggregate consideration for this acquisition totaled approximately $492 million, net of in-place financing on existing assets. The consideration consisted of $482 million of cash and $10 million of restricted stock awards issued to the CoreVest management team. Based on the terms of the equity interest purchase agreement, we determined that the $10 million of shares should be accounted for as compensation expense for post-combination services, and therefore, it is not included in the GAAP purchase price allocated to the assets and liabilities acquired.

During 2019, we accounted for the acquisitions of 5 Arches and CoreVest under the acquisition method of accounting pursuant to ASC 805. We performed the purchase price allocations and recorded underlying assets acquired and liabilities assumed based on their estimated fair values using the information available as of each acquisition date, with the excess of the purchase price allocated to goodwill. Through December 31, 2019, there were no significant changes to our purchase price allocations, which are summarized in the following table.

Table 2.1 – Purchase Price Allocations

(In Thousands)	5 Arches		CoreVest
Acquisition Date	March 1, 2019		October 15, 2019
Purchase price:
Cash	$	12,575	$	482,311
Contingent consideration, at fair value	24,621		—
Purchase option, at fair value	5,082		—
Equity method investment, at fair value	8,052		—
Total consideration	$	50,330	$	482,311
Allocated to:
Business purpose residential loans, at fair value	$	2,022	$	2,610,490
Cash and cash equivalents	2,128		30,685
Restricted cash	9,082		—
Other assets	5,473		67,420
Goodwill	28,747		59,928
Intangible assets	24,800		56,500
Deferred tax asset	—		2,577
Total assets acquired	72,252		2,827,600
Asset-backed securities issued, at fair value	—		1,656,023
Short-term debt, net	3,800		663,275
Accrued expenses and other liabilities	13,920		25,991
Deferred tax liability	4,202		—
Total liabilities assumed	21,922		2,345,289
Total net assets acquired	$	50,330	$	482,311

Because we owned a 20% noncontrolling interest in 5 Arches immediately before obtaining full control, we remeasured our initial minority investment and purchase option at their acquisition-date fair values using the income approach, which resulted in a gain of $2 million that was recorded in Other income on our consolidated statements of income during the three months ended March 31, 2019.

We recognized $2 million of acquisition costs related our acquisitions of 5 Arches and CoreVest during the year ended December 31, 2019. These costs primarily related to accounting, consulting, and legal expenses and are included in our General and administrative expenses on our consolidated statements of income.

In connection with the acquisitions of 5 Arches and CoreVest, we identified and recorded finite-lived intangible assets totaling $25 million and $57 million, respectively. The amortization period for each of these assets and the activity for the year ended December 31, 2019 is summarized in the table below.

Table 2.2 – Intangible Assets – Activity

	Carrying Value at December 31, 2018		Additions		Amortization Expense			Carrying Value at December 31, 2019		Weighted Average Amortization Period (in years)
(Dollars in Thousands)
5 Arches
Broker network	$	—	$	18,100	$	(3,017	)	$	15,083	5
Non-compete agreements	—		2,900		(806		)	2,094		3
Loan administration fees on existing loan assets	—		2,600		(2,167		)	433		1
Tradename	—		1,200		(333		)	867		3
Total 5 Arches	—		24,800		(6,323		)	18,477		5
CoreVest
Borrower network	—		45,300		(1,348		)	43,952		7
Non-compete agreements	—		6,600		(458		)	6,142		3
Tradename	—		2,800		(194		)	2,606		3
Developed technology	—		1,800		(188		)	1,612		2
Total CoreVest	—		56,500		(2,188		)	54,312		6
Total	$	—	$	81,300	$	(8,511	)	$	72,789	6

All of our intangible assets are amortized on a straight-line basis. Estimated future amortization expense is summarized in the table below.

Table 2.3 – Intangible Asset Amortization Expense by Year

December 31, 2019
(In Thousands)	5 Arches		CoreVest		Total
2020	$	5,420	$	10,505	$	15,925
2021	4,987		10,317		15,304
2022	3,848		8,952		12,800
2023	3,620		6,471		10,091
2024	602		6,471		7,073
2025 and thereafter	—		11,596		11,596
Total Future Intangible Asset Amortization	$	18,477	$	54,312	$	72,789

We recorded total goodwill of $89 million in 2019 as a result of the total consideration exceeding the fair value of the net assets acquired from 5 Arches and CoreVest. The goodwill was attributed to the expected business synergies and expansion into business purpose loan markets, as well as access to the knowledgeable and experienced workforces continuing to provide services to the business. We expect $75 million of this goodwill to be deductible for tax purposes. For reporting purposes, we included the intangible assets and goodwill from these acquisitions within the Business Purpose Lending segment.

The following table presents the goodwill activity for the year ended December 31, 2019.

Table 2.4 – Goodwill – Activity

	Year Ended December 31, 2019
(In Thousands)	5 Arches		CoreVest		Total
Beginning balance	$	—	$	—	$	—
Goodwill recognized from acquisition	28,747		59,928		88,675
Impairment	—		—		—
Ending Balance	$	28,747	$	59,928	$	88,675

The liability resulting from the contingent consideration arrangement with 5 Arches was recorded at its acquisition-date fair value of $25 million as part of total consideration for the acquisition of 5 Arches. At December 31, 2019, the estimated fair value of this contingent liability was $28 million and was recorded as a component of Accrued expenses and other liabilities on our consolidated balance sheets. During the year ended December 31, 2019, we recorded $3 million of contingent consideration expense through Other expenses on our consolidated statements of income. See Note 16 for additional information on our contingent consideration liability.

The following unaudited pro forma financial information presents Net interest income, Non-interest income, and Net income of Redwood, 5 Arches, and CoreVest combined, as if the acquisitions occurred as of January 1, 2018. These pro forma amounts have been adjusted to include the amortization of intangible assets and acquisition-related compensation expense for both periods, and to exclude the income statement impacts related to our equity method investment in 5 Arches. The unaudited pro forma financial information is not intended to represent or be indicative of the consolidated financial results of operations that would have been reported if the acquisition had been completed as of January 1, 2018 and should not be taken as indicative of our future consolidated results of operations.

During the period from March 1, 2019 to December 31, 2019, 5 Arches had net interest income of less than $0.1 million, non-interest income of $19 million, and net income of $3 million. In addition, 5 Arches had intangible asset amortization expense of $6 million for this period. During the period from October 15, 2019 to December 31, 2019, CoreVest had net interest income of $11 million, non-interest income of $19 million, and net income of $22 million. In addition, CoreVest had intangible asset amortization expense of $2 million for this period.

Table 2.5 – Unaudited Pro Forma Financial Information

	Years Ended December 31,
(In Thousands)	2019		2018
Supplementary pro forma information:
Net interest income	$	167,680	$	165,849
Non-interest income	193,519		103,179
Net income	185,896		118,125