Principles of Consolidation

GAAP requires us to consider whether securitizations we sponsor and other transfers of financial assets should be treated as sales or financings, as well as whether any VIEs that we hold variable interests in – for example, certain legal entities often used in securitization and other structured finance transactions – should be included in our consolidated financial statements. The GAAP principles we apply require us to reassess our requirement to consolidate VIEs each quarter and therefore our determination may change based upon new facts and circumstances pertaining to each VIE. This could result in a material impact to our consolidated financial statements during subsequent reporting periods.

Analysis of Consolidated VIEs

As of June 30, 2015, the VIEs we are required to consolidate include certain Sequoia securitization entities, the Residential Resecuritization entity, and the Commercial Securitization entity. Each of these entities is independent of Redwood and of each other and the assets and liabilities of these entities are not owned by and are not legal obligations of ours. Our exposure to these entities is primarily through the financial interests we have retained, although we are exposed to certain financial risks associated with our role as a sponsor, manager, or depositor of these entities or as a result of our having sold assets directly or indirectly to these entities. The following table presents a summary of the assets and liabilities of these VIEs. Intercompany balances have been eliminated for purposes of this presentation.

Assets and Liabilities of Consolidated VIEs



June 30, 2015	Sequoia Entities		Residential Resecuritization		Commercial Securitization		Total
(Dollars in Thousands)	Sequoia Entities		Residential Resecuritization		Commercial Securitization		Total
Residential loans, held-for-investment	$	1,237,114	$	—	$	—	$	1,237,114
Commercial loans, held-for-investment	—		—		182,184		182,184
Real estate securities	—		195,278		—		195,278
Restricted cash	147		—		139		286
Accrued interest receivable	1,589		409		1,367		3,365
Other assets	4,409		—		—		4,409
Total Assets	$	1,243,259	$	195,687	$	183,690	$	1,622,636
Accrued interest payable	$	797	$	2	$	328	$	1,127
Asset-backed securities issued	1,173,336		18,872		69,914		1,262,122
Total Liabilities	$	1,174,133	$	18,874	$	70,242	$	1,263,249
Number of VIEs	24		1		1		26

Since 2012, we have transferred residential loans to 25 Sequoia securitization entities sponsored by us and accounted for these transfers as sales for financial reporting purposes, in accordance with ASC 860. We also determined we were not the primary beneficiary of these VIEs as we lacked the power to direct the activities that will have the most significant economic impact on the entities. For the transferred loans where we held the servicing rights prior to the transfer and continue to hold the servicing rights, we recorded MSRs on our consolidated balance sheets, and classified those MSRs as Level 3 assets. We also retained senior and subordinate securities in these securitizations that we classified as Level 3 assets. Our continuing involvement in these securitizations is limited to customary servicing obligations associated with retaining residential MSRs (which we retain a third-party sub-servicer to perform) and the receipt of interest income associated with the securities we retained.

The following table presents information related to securitization transactions that occurred during the three and six months ended June 30, 2015 and 2014.

Securitization Activity Related to Unconsolidated VIEs Sponsored by Redwood



	Three Months Ended June 30,				Six Months Ended June 30,
(In Thousands)	2015		2014		2015		2014
Principal balance of loans transferred	$	699,655	$	347,305	$	1,038,451	$	347,305
Trading securities retained, at fair value	29,966		69,563		33,389		69,563
AFS securities retained, at fair value	3,450		20,428		6,309		20,428
MSRs recognized	6,002		2,186		7,874		2,186

The following table summarizes the cash flows during the three and six months ended June 30, 2015 and 2014 between us and the unconsolidated VIEs sponsored by us.

Cash Flows Related to Unconsolidated VIEs Sponsored by Redwood



	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2015			2014			2015			2014
Proceeds from new transfers	$	676,596		$	267,776		$	1,018,312		$	267,776
MSR fees received	3,700			3,624			7,470			7,047
Funding of compensating interest	(107		)	(43		)	(197		)	(76		)
Cash flows received on retained securities	10,706			15,924			23,351			28,227

The following table presents the key weighted-average assumptions used to measure MSRs and securities retained at the date of securitization.

Assumptions Related to Assets Retained from Unconsolidated VIEs Sponsored by Redwood



	Issued During The
	Three Months Ended June 30, 2015						Six Months Ended June 30, 2015
At Date of Securitization	MSRs		Senior Securities		Subordinate Securities		MSRs		Senior Securities		Subordinate Securities
Prepayment rate	5 - 13%		8	%	8	%	5-15%		8	%	8	%
Discount rates	11	%	3	%	6	%	11	%	3	%	6	%
Credit loss assumptions	N/A		0.25	%	0.25	%	N/A		0.25	%	0.25	%



	Issued During The
	Three Months Ended June 30, 2014						Six Months Ended June 30, 2014
At Date of Securitization	MSRs		Senior Securities		Subordinate Securities		MSRs		Senior Securities		Subordinate Securities
Prepayment rate	5 - 15%		10	%	10	%	5 - 15%		10	%	10	%
Discount rates	11	%	3	%	5	%	11	%	3	%	5	%
Credit loss assumptions	N/A		0.25	%	0.25	%	N/A		0.25	%	0.25	%

The following table presents additional information at June 30, 2015 and December 31, 2014, related to unconsolidated securitizations accounted for as sales since 2012.

Unconsolidated VIEs Sponsored by Redwood



(In Thousands)	June 30, 2015		December 31, 2014
On-balance sheet assets, at fair value:
Interest-only, senior and subordinate securities, classified as trading	$	72,505	$	93,802
Senior and subordinate securities, classified as AFS	294,040		460,990
Mortgage servicing rights	65,753		56,801
Maximum loss exposure ⁽¹⁾	432,298		611,593
Assets transferred:
Principal balance of loans outstanding	7,570,297		7,276,825
Principal balance of delinquent loans 30+ days delinquent	17,646		17,022

(1)

Maximum loss exposure from our involvement with unconsolidated VIEs pertains to the carrying value of our securities and MSRs retained from these VIEs and represents estimated losses that would be incurred under severe, hypothetical circumstances, such as if the value of our interests and any associated collateral declines to zero. This does not include, for example, any potential exposure to representation and warranty claims associated with our initial transfer of loans into a securitization.

The following table presents key economic assumptions for assets retained from unconsolidated VIEs and the sensitivity of their fair values to immediate adverse changes in those assumptions at June 30, 2015 and December 31, 2014.

Key Assumptions and Sensitivity Analysis for Assets Retained from Unconsolidated VIEs Sponsored by Redwood



June 30, 2015	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
(Dollars in Thousands)	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
Fair value at June 30, 2015	$	65,753		$	62,427		$	304,118
Expected life (in years)⁽²⁾	8			7			12
Prepayment speed assumption (annual CPR)⁽²⁾	10		%	10		%	11		%
Decrease in fair value from:
10% adverse change	$	2,780		$	1,920		$	825
25% adverse change	6,242			4,543			2,114
Discount rate assumption⁽²⁾	11		%	9		%	6		%
Decrease in fair value from:
100 basis point increase	$	3,004		$	2,689		$	24,530
200 basis point increase	5,514			5,166			45,844
Credit loss assumption ⁽²⁾	N/A			0.25		%	0.25		%
Decrease in fair value from:
10% higher losses	N/A			$	241		$	19,746
25% higher losses	N/A			316			24,061



December 31, 2014	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
(Dollars in Thousands)	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
Fair value at December 31, 2014	$	56,801		$	93,802		$	460,990
Expected life (in years)⁽²⁾	7			6			10
Prepayment speed assumption (annual CPR)⁽²⁾	14		%	9		%	10		%
Decrease in fair value from:
10% adverse change	$	2,419		$	3,999		$	684
25% adverse change	5,639			9,475			2,355
Discount rate assumption⁽²⁾	11		%	8		%	5		%
Decrease in fair value from:
100 basis point increase	$	2,104		$	4,214		$	34,149
200 basis point increase	4,102			8,091			64,474
Credit loss assumption ⁽²⁾	N/A			0.25		%	0.25		%
Decrease in fair value from:
10% higher losses	N/A			$	126		$	3,169
25% higher losses	N/A			299			7,841


(1)	Senior securities include $40 million and $88 million of interest only securities as of June 30, 2015 and December 31, 2014, respectively.


(2)	Expected life, prepayment speed assumption, discount rate assumption, and credit loss assumption presented in the tables above represent weighted averages.

Analysis of Third-Party VIEs

Third-party VIEs are securitization entities in which we maintain an economic interest, but do not sponsor. Our economic interest may include several securities from the same third-party VIE, and in those cases, the analysis is performed in consideration of all of our interests. The following table presents a summary of our interests in third-party VIEs at June 30, 2015, grouped by security type.

Third-Party Sponsored VIE Summary



(Dollars in Thousands)	June 30, 2015
Residential Mortgage Backed Securities
Senior	$	452,041
Re-REMIC	169,084
Subordinate	169,928
Total Investments in Third-Party Sponsored VIEs	$	791,053

We determined that we are not the primary beneficiary of any third-party VIEs, as we do not have the required power to direct the activities that most significantly impact the economic performance of these entities. Specifically, we do not service or manage these entities or otherwise solely hold decision making powers that are significant. As a result of this assessment, we do not consolidate any of the underlying assets and liabilities of these third-party VIEs – we only account for our specific interests in them.

Our assessments of whether we are required to consolidate a VIE may change in subsequent reporting periods based upon changing facts and circumstances pertaining to each VIE. Any related accounting changes could result in a material impact to our financial statements.