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Fair Value of Financial Instruments
12 Months Ended
Dec. 31, 2019
Fair Value Disclosures [Abstract]  
Fair Value of Financial Instruments Fair Value of Financial Instruments
For financial reporting purposes, we follow a fair value hierarchy established under GAAP that is used to determine the fair value of financial instruments. This hierarchy prioritizes relevant market inputs in order to determine an “exit price” at the measurement date, or the price at which an asset could be sold or a liability could be transferred in an orderly process that is not a forced liquidation or distressed sale. Level 1 inputs are observable inputs that reflect quoted prices for identical assets or liabilities in active markets. Level 2 inputs are observable inputs other than quoted prices for an asset or liability that are obtained through corroboration with observable market data. Level 3 inputs are unobservable inputs (e.g., our own data or assumptions) that are used when there is little, if any, relevant market activity for the asset or liability required to be measured at fair value.
In certain cases, inputs used to measure fair value fall into different levels of the fair value hierarchy. In such cases, the level at which the fair value measurement falls is determined based on the lowest level input that is significant to the fair value measurement. Our assessment of the significance of a particular input requires judgment and considers factors specific to the asset or liability being measured.

The following table presents the carrying values and estimated fair values of assets and liabilities that are required to be recorded or disclosed at fair value at December 31, 2019 and December 31, 2018.

Table 5.1 – Carrying Values and Fair Values of Assets and Liabilities
 
 
December 31, 2019
 
December 31, 2018
 
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
(In Thousands)
 
 
 
 
Assets
 
 
 
 
 
 
 
 
Residential loans, held-for-sale at fair value
 
$
536,385

 
$
536,509

 
$
1,048,801

 
$
1,048,821

Residential loans, held-for-investment
 
7,178,465

 
7,178,465

 
6,205,941

 
6,205,941

Business purpose residential loans, held-for-sale
 
331,565

 
331,565

 
28,460

 
28,460

Business purpose residential loans, held-for-investment
 
3,175,178

 
3,175,178

 
112,798

 
112,798

Multifamily loans
 
4,408,524

 
4,408,524

 
2,144,598

 
2,144,598

Trading securities
 
860,540

 
860,540

 
1,118,612

 
1,118,612

Available-for-sale securities
 
239,334

 
239,334

 
333,882

 
333,882

Servicer advance investments (1)
 
169,204

 
169,204

 
300,468

 
300,468

MSRs (1)
 
42,224

 
42,224

 
60,281

 
60,281

Participation in loan warehouse facility (1)
 

 

 
39,703

 
39,703

Excess MSRs (1)
 
31,814

 
31,814

 
27,312

 
27,312

Shared home appreciation options (1)
 
45,085

 
45,085

 

 

Cash and cash equivalents
 
196,966

 
196,966

 
175,764

 
175,764

Restricted cash
 
93,867

 
93,867

 
29,313

 
29,313

Accrued interest receivable
 
71,058

 
71,058

 
47,105

 
47,105

Derivative assets
 
35,701

 
35,701

 
35,789

 
35,789

REO (2)
 
9,462

 
10,389

 
3,943

 
4,396

Margin receivable (2)
 
209,776

 
209,776

 
100,773

 
100,773

FHLBC stock (2)
 
43,393

 
43,393

 
43,393

 
43,393

Guarantee asset (2)
 
1,686

 
1,686

 
2,618

 
2,618

Pledged collateral (2)
 
32,945

 
32,945

 
42,433

 
42,433

Liabilities
 
 
 
 
 
 
 
 
Short-term debt facilities
 
$
2,176,591

 
$
2,176,591

 
$
1,937,920

 
$
1,937,920

Short-term debt - servicer advance financing
 
152,554

 
152,554

 
262,740

 
262,740

Accrued interest payable
 
60,655

 
60,655

 
42,528

 
42,528

Margin payable (3)
 
1,700

 
1,700

 
835

 
835

Guarantee obligation (3)
 
14,009

 
13,754

 
16,711

 
16,774

Contingent consideration (3)
 
28,484

 
28,484

 

 

Derivative liabilities
 
163,424

 
163,424

 
84,855

 
84,855

ABS issued at fair value
 
10,515,475

 
10,515,475

 
5,410,073

 
5,410,073

FHLBC long-term borrowings
 
1,999,999

 
1,999,999

 
1,999,999

 
1,999,999

Subordinate securities financing facility
 
183,520

 
184,666

 

 

Convertible notes, net
 
631,125

 
661,985

 
633,196

 
618,271

Trust preferred securities and subordinated notes, net
 
138,628

 
99,045

 
138,582

 
102,533

(1)
These investments are included in Other investments on our consolidated balance sheets.
(2)
These assets are included in Other assets on our consolidated balance sheets.
(3)
These liabilities are included in Accrued expenses and other liabilities on our consolidated balance sheets.
During the years ended December 31, 2019 and 2018, we elected the fair value option for $333 million and $654 million of securities, respectively, $6.99 billion and $8.38 billion of residential loans (principal balance), respectively, $4.02 billion and $168 million of business purpose residential loans (principal balance), respectively, $1.43 billion and $2.13 billion of multifamily loans (principal balance), respectively, $70 million and $396 million of servicer advance investments, respectively, and $8 million and $25 million of excess MSRs, respectively. Additionally, during the year ended December 31, 2019, we elected the fair value option for $43 million of shared home appreciation options. We anticipate electing the fair value option for all future purchases of residential and business purpose residential loans that we intend to sell to third parties or transfer to securitizations, as well as for certain securities we purchase, including IO securities and fixed-rate securities rated investment grade or higher.
The following table presents the assets and liabilities that are reported at fair value on our consolidated balance sheets on a recurring basis at December 31, 2019 and December 31, 2018, as well as the fair value hierarchy of the valuation inputs used to measure fair value.
Table 5.2 – Assets and Liabilities Measured at Fair Value on a Recurring Basis
December 31, 2019
 
Carrying Value
 
Fair Value Measurements Using
(In Thousands)
 
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
 
Residential loans
 
$
7,714,745

 
$

 
$

 
$
7,714,745

Business purpose residential loans
 
3,506,743

 

 

 
3,506,743

Multifamily loans
 
4,408,524

 

 

 
4,408,524

Trading securities
 
860,540

 

 

 
860,540

Available-for-sale securities
 
239,334

 

 

 
239,334

Servicer advance investments
 
169,204

 

 

 
169,204

MSRs
 
42,224

 

 

 
42,224

Excess MSRs
 
31,814

 

 

 
31,814

Shared home appreciation options
 
45,085

 

 

 
45,085

Derivative assets
 
35,701

 
6,531

 
19,020

 
10,150

Pledged collateral
 
32,945

 
32,945

 

 

FHLBC stock
 
43,393

 

 
43,393

 

Guarantee asset
 
1,686

 

 

 
1,686

 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Contingent consideration
 
$
28,484

 
$

 
$

 
$
28,484

Derivative liabilities
 
163,424

 
13,368

 
148,766

 
1,290

ABS issued
 
10,515,475

 

 

 
10,515,475

December 31, 2018
 
Carrying
Value
 
Fair Value Measurements Using
(In Thousands)
 
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
 
Residential loans
 
$
7,254,631

 
$

 
$

 
$
7,254,631

Business purpose residential loans
 
141,258

 

 

 
141,258

Multifamily loans
 
2,144,598

 

 

 
2,144,598

Trading securities
 
1,118,612

 

 

 
1,118,612

Available-for-sale securities
 
333,882

 

 

 
333,882

Servicer advance investments
 
300,468

 

 

 
300,468

MSRs
 
60,281

 

 

 
60,281

Excess MSRs
 
27,312

 

 

 
27,312

Derivative assets
 
35,789

 
4,665

 
28,211

 
2,913

Pledged collateral
 
42,433

 
42,433

 

 

FHLBC stock
 
43,393

 

 
43,393

 

Guarantee asset
 
2,618

 

 

 
2,618

 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Derivative liabilities
 
$
84,855

 
$
13,215

 
$
70,908

 
$
732

ABS issued
 
5,410,073

 

 

 
5,410,073


The following table presents additional information about Level 3 assets and liabilities measured at fair value on a recurring basis for the years ended December 31, 2019 and December 31, 2018.
Table 5.3 – Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis
 
 
Assets
 
 
Residential Loans
 
Business
Purpose Residential
Loans
 
Multifamily
Loans
 
Trading Securities
 
AFS
Securities
 
Servicer Advance Investments
 
MSRs
 
Excess MSRs
 
Shared Home Appreciation Options
(In Thousands)
 
 
 
 
 
 
 
 
 
Beginning balance - December 31, 2018
 
$
7,254,631

 
$
141,258

 
$
2,144,598

 
$
1,118,612

 
$
333,882

 
$
300,468

 
$
60,281

 
$
27,312

 
$

Acquisitions
 
7,092,866

 
2,639,615

 
2,162,386

 
332,593

 
26,539

 
69,610

 
868

 
7,762

 
44,243

Originations
 

 
1,015,436

 

 

 

 

 

 

 

Sales
 
(5,141,886
)
 
(76,909
)
 

 
(597,122
)
 
(110,069
)
 

 

 

 

Principal paydowns
 
(1,609,220
)
 
(213,655
)
 
(28,543
)
 
(44,600
)
 
(39,704
)
 
(203,876
)
 

 

 

Gains (losses) in net income, net
 
119,132

 
7,423

 
130,083

 
56,008

 
24,580

 
3,002

 
(18,925
)
 
(3,260
)
 
842

Unrealized losses in OCI, net
 

 

 

 

 
4,106

 

 

 

 

Other settlements, net (1)
 
(778
)
 
(6,425
)
 

 
(4,951
)
 

 

 

 

 

Ending balance - December 31, 2019
 
$
7,714,745

 
$
3,506,743

 
$
4,408,524

 
$
860,540

 
$
239,334

 
$
169,204

 
$
42,224

 
$
31,814

 
$
45,085



Table 5.3 – Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis (continued)
 
 
Assets
 
 
 
Liabilities
 
 
Guarantee Asset
 
Derivatives (2)
 
Contingent Consideration
 
ABS
Issued
(In Thousands)
 
 
 
 
Beginning balance - December 31, 2018
 
$
2,618

 
$
2,181

 
$

 
$
5,410,073

Acquisitions
 

 

 
25,267

 
6,098,462

Principal paydowns
 

 

 

 
(1,112,437
)
Gains (losses) in net income, net
 
(932
)
 
62,220

 
3,217

 
119,377

Other settlements, net (1)
 

 
(55,541
)
 

 

Ending balance - December 31, 2019
 
$
1,686

 
$
8,860

 
$
28,484

 
$
10,515,475

 
 
Assets
(In Thousands)
 
Residential
Loans
 
Business Purpose Residential Loans
 
Multifamily Loans
 
Trading
Securities
 
AFS
Securities
 
Servicer Advance Investments
 
MSRs
 
Excess MSRs
 
Guarantee
Asset
Beginning balance - December 31, 2017
 
$
5,114,317

 
$

 
$

 
$
968,844

 
$
507,666

 
$

 
$
63,598

 
$

 
$
2,869

Acquisitions
 
8,338,724

 
167,777

 
2,099,916

 
653,739

 
7,739

 
395,813

 
328

 
25,489

 

Sales
 
(5,425,168
)
 

 

 
(438,304
)
 
(143,644
)
 

 
(1,077
)
 

 

Principal paydowns
 
(814,122
)
 
(27,382
)
 
(1,873
)
 
(40,050
)
 
(44,446
)
 
(94,644
)
 

 

 

Gains (losses) in net income, net
 
44,627

 
863

 
46,555

 
(8,436
)
 
41,051

 
(701
)
 
(2,568
)
 
1,823

 
(251
)
Unrealized gains in OCI, net
 

 

 

 

 
(34,484
)
 

 

 

 

Other settlements, net (1)
 
(3,747
)
 

 

 
(17,181
)
 

 

 

 

 

Ending balance - December 31, 2018
 
$
7,254,631

 
$
141,258

 
$
2,144,598

 
$
1,118,612

 
$
333,882

 
$
300,468

 
$
60,281

 
$
27,312

 
$
2,618

 
 
 
 
Liabilities
(In Thousands)
 
Derivatives (2)
 
ABS
 Issued
Beginning balance - December 31, 2017
 
$
1,714

 
$
1,164,585

Acquisitions
 

 
4,613,168

Principal paydowns
 

 
(459,173
)
Gains (losses) in net income, net
 
(1,214
)
 
91,493

Other settlements, net (1)
 
1,681

 

Ending balance - December 31, 2018
 
$
2,181

 
$
5,410,073

(1)
Other settlements, net for residential and business purpose residential loans represents the transfer of loans to REO, and for derivatives, the settlement of forward sale commitments and the transfer of the fair value of loan purchase or interest rate lock commitments at the time loans are acquired to the basis of residential and single-family rental loans. Other settlements, net for trading securities relates to the consolidation of Freddie Mac K-Series securitization entities.
(2) 
For the purpose of this presentation, derivative assets and liabilities, which consist of loan purchase commitments, forward sale commitments, and interest rate lock commitments, are presented on a net basis.

The following table presents the portion of gains or losses included in our consolidated statements of income that were attributable to Level 3 assets and liabilities recorded at fair value on a recurring basis and held at December 31, 2019, 2018, and 2017. Gains or losses incurred on assets or liabilities sold, matured, called, or fully written down during the years ended December 31, 2019, 2018, and 2017 are not included in this presentation.
Table 5.4 – Portion of Net Gains (Losses) Attributable to Level 3 Assets and Liabilities Still Held at December 31, 2019, 2018, and 2017 Included in Net Income
 
 
Included in Net Income
 
 
Years Ended December 31,
(In Thousands)
 
2019
 
2018
 
2017
Assets
 
 
 
 
 
 
Residential loans at Redwood
 
$
67,470

 
$
(17,757
)
 
$
523

Residential loans at consolidated Sequoia entities
 
(10,062
)
 
24,799

 
17,727

Residential loans at consolidated Freddie Mac SLST entities
 
63,583

 
21,295

 

Business purpose residential loans
 
14,603

 
445

 

Single-family rental loans at consolidated CAFL entities
 
(14,681
)
 

 

Multifamily loans at consolidated Freddie Mac K-Series entities
 
130,083

 
46,555

 

Trading securities
 
18,865

 
(12,256
)
 
28,612

Available-for-sale securities
 

 
(89
)
 
(1,011
)
Servicer advance investments
 
3,001

 
(702
)
 

MSRs
 
(11,957
)
 
1,942

 
1,277

Excess MSRs
 
(3,260
)
 
1,824

 

Shared home appreciation options
 
842

 

 

Loan purchase and interest rate lock commitments
 
10,190

 
2,913

 
3,243

Loan forward sale commitments
 

 

 
2,177

Other assets - Guarantee asset
 
(932
)
 
(251
)
 
(1,223
)
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
Loan purchase commitments
 
$
(1,290
)
 
$
(732
)
 
$
(3,706
)
Contingent consideration
 
(3,217
)
 

 

ABS issued
 
(130,421
)
 
(71,468
)
 
(29,187
)

The following table presents information on assets recorded at fair value on a non-recurring basis at December 31, 2019 and December 31, 2018. This table does not include the carrying value and gains or losses associated with the asset types below that were not recorded at fair value on our consolidated balance sheets at December 31, 2019 and December 31, 2018.
Table 5.5 – Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis
 
 
 
 
 
 
 
 
 
 
Gain (Loss) for
Year Ended
December 31, 2019
 
Carrying
Value
 
Fair Value Measurements Using
 
(In Thousands)
 
 
Level 1
 
Level 2
 
Level 3
 
December 31, 2019
Assets
 
 
 
 
 
 
 
 
 
 
REO
 
$
4,051

 
$

 
$

 
$
4,051

 
$
(1,363
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gain (Loss) for
Year Ended
December 31, 2018
 
Carrying
Value
 
Fair Value Measurements Using
 
(In Thousands)
 
 
Level 1
 
Level 2
 
Level 3
 
December 31, 2018
Assets
 
 
 
 
 
 
 
 
 
 
REO
 
$
2,225

 
$

 
$

 
$
2,225

 
$
(131
)

The following table presents the net market valuation gains and losses recorded in each line item of our consolidated statements of income for the years ended December 31, 2019, 2018, and 2017.
Table 5.6 – Market Valuation Gains and Losses, Net
 
 
Years Ended December 31,
(In Thousands)
 
2019
 
2018
 
2017
Mortgage Banking Activities, Net
 
 
 
 
 
 
Residential loans held-for-sale, at fair value
 
$
3,267

 
$
23,144

 
$
31,493

Residential loan purchase and forward sale commitments
 
60,260

 
(1,336
)
 
37,880

Single-family rental loans held-for-sale, at fair value
 
15,043

 
375

 

Single-family rental loan purchase and interest rate lock commitments
 
1,961

 
78

 

Residential bridge loans
 
4,518

 

 

Risk management derivatives, net
 
(15,723
)
 
34,739

 
(17,529
)
Total mortgage banking activities, net (1)
 
$
69,326

 
$
57,000

 
$
51,844

Investment Fair Value Changes, Net
 
 
 
 
 
 
Residential loans held-for-investment at Redwood
 
$
58,891

 
$
(29,573
)
 
$
(5,765
)
Single-family rental loans held-for-investment
 
272

 

 

Residential bridge loans held-for-investment
 
(2,139
)
 
(29
)
 

Trading securities
 
56,046

 
(8,055
)
 
39,526

Commercial loans held-for-sale
 

 

 
300

Servicer advance investments
 
3,001

 
(701
)
 

Excess MSRs
 
(3,260
)
 
1,823

 

Shared home appreciation options
 
842

 

 

REO
 
(1,045
)
 

 

Net investments in Legacy Sequoia entities (2)
 
(1,545
)
 
(1,016
)
 
(8,027
)
Net investments in Sequoia Choice entities (2)
 
6,947

 
443

 
(323
)
Net investments in Freddie Mac SLST entities (2)
 
27,206

 
1,271

 

Net investments in Freddie Mac K-Series entities (2)
 
21,430

 
931

 

Net investments in CAFL entities (2)
 
(3,636
)
 

 

Other investments
 
(341
)
 
(434
)
 
(1,484
)
Risk management derivatives, net
 
(127,169
)
 
9,740

 
(12,842
)
Impairments on AFS securities
 

 
(89
)
 
(1,011
)
Total investment fair value changes, net
 
$
35,500

 
$
(25,689
)
 
$
10,374

Other Income
 
 
 
 
 
 
MSRs
 
$
(18,856
)
 
$
(2,508
)
 
$
(10,166
)
Risk management derivatives, net
 
8,595

 
(4,734
)
 
(568
)
Gain on re-measurement of 5 Arches investment
 
2,441

 

 

Total other income (3)
 
$
(7,820
)
 
$
(7,242
)
 
$
(10,734
)
Total Market Valuation Gains, Net
 
$
97,006

 
$
24,069

 
$
51,484

(1)
Mortgage banking activities, net presented above does not include fee income or provisions for repurchases that are components of Mortgage banking activities, net presented on our consolidated statements of income, as these amounts do not represent market valuation changes.
(2)
Includes changes in fair value of the residential loans held-for-investment, REO and the ABS issued at the entities, which netted together represent the change in value of our investments at the consolidated VIEs.
(3)
Other income presented above does not include net MSR fee income or provisions for repurchases for MSRs, as these amounts do not represent market valuation adjustments.
Valuation Policy
We maintain policies that specify the methodologies we use to value different types of financial instruments. Significant changes to the valuation methodologies are reviewed by members of senior management to confirm the changes are appropriate and reasonable. Valuations based on information from external sources are performed on an instrument-by-instrument basis with the resulting amounts analyzed individually against internal calculations as well as in the aggregate by product type classification. Initial valuations are performed by our portfolio management groups using the valuation processes described below. Our finance department then independently reviews all fair value estimates using available market, portfolio, and industry information to ensure they are reasonable. Finally, members of senior management review all fair value estimates, including an analysis of the methodology and valuation changes from prior reporting periods.
Valuation Process
We estimate fair values for financial assets or liabilities based on available inputs observed in the marketplace as well as unobservable inputs. We primarily use two pricing valuation techniques: market comparable pricing and discounted cash flow analysis. Market comparable pricing is used to determine the estimated fair value of certain instruments by incorporating known inputs and performance metrics, such as observed prepayment rates, delinquencies, severities, credit support, recent transaction prices, pending transactions, or prices of other similar instruments. Discounted cash flow analysis techniques generally consist of developing an estimate of future cash flows that are expected to occur over the life of an instrument and then discounting those cash flows at a rate of return that results in an estimate of fair value. After considering all available indications of the appropriate rate of return that market participants would require, we consider the reasonableness of the range indicated by the results to determine an estimate that is most representative of fair value. We also consider counterparty credit quality and risk as part of our fair value assessments.
The following table provides quantitative information about the significant unobservable inputs used in the valuation of our Level 3 assets and liabilities measured at fair value.
Table 5.7 – Fair Value Methodology for Level 3 Financial Instruments
December 31, 2019
 
Fair
Value
 
 
 
Input Values
(Dollars in Thousands, except Input Values)
 
 
Unobservable Input
 
Range
 
 
Weighted
Average
Assets
 
 
 
 
 
 
 
 
 
 
 
 
Residential loans, at fair value:
 
 
 
 
 
 
 
 
 
 
 
 
Jumbo fixed-rate loans
 
$
2,113,977

 
Prepayment rate (annual CPR)
 
20

-
20

%
 
20

%
 
 
 
 
Whole loan spread to TBA price
 
$
0.53

-
$
1.63

 
 
$
1.62

 
 
 
 
 
Whole loan spread to swap rate
 
95

-
375

bps
 
170

bps
 
 
 
 
 
 
 
 
 
 
 
 
 
Jumbo hybrid loans
 
326,336

 
Prepayment rate (annual CPR)
 
15

-
15

%
 
15

%
 
 
 
 
Whole loan spread to swap rate
 
80

-
345

bps
 
134

bps
 
 
 
 
 
 
 
 
 
 
 
 
 
Jumbo loans committed to sell
 
207,864

 
Whole loan committed sales price
 
$
101.85

-
$
102.96

 
 
$
102.41

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans held by Legacy Sequoia (1)
 
407,890

 
Liability price
 
 
 
N/A

 
 
N/A

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans held by Sequoia Choice (1)
 
2,291,463

 
Liability price
 
 
 
N/A

 
 
N/A

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans held by Freddie Mac
SLST (1)
 
2,367,215

 
Liability price
 
 
 
N/A

 
 
N/A

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Business purpose residential loans:
 
 
 
 
 
 
 
 
 
 
 
 
Single-family rental loans
 
569,185

 
Senior credit spread
 
100

-
105

bps
 
103

bps
 
 
 
 
Subordinate credit spread
 
135

-
1,400

bps
 
299

bps
 
 
 
 
Senior credit support
 
33

-
40

%
 
34

%
 
 
 
 
IO discount rate
 
6

-
9

%
 
8

%
 
 
 
 
Prepayment rate (annual CPR)
 
5

-
5

%
 
5

%
 
 
 
 
 
 
 
 
 
 
 
 
 
Single-family rental loans held by CAFL
 
2,192,552

 
Liability price
 
 
 
N/A

 
 
N/A

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential bridge loans
 
745,006

 
Discount rate
 
6

 
10

%
 
7

%
 
 
 
 
 
 
 
 
 
 
 
 
 
Multifamily loans held by Freddie Mac K-Series (1)
 
4,408,524

 
Liability price
 
 
 
N/A

 
 
N/A

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading and AFS securities
 
1,099,874

 
Discount rate
 
3

-
40

%
 
5

 %
 
 
 
 
Prepayment rate (annual CPR)
 
5

-
50

%
 
16

 %
 
 
 
 
Default rate
 

-
7

%
 
1

 %
 
 
 
 
Loss severity
 

-
30

%
 
5

 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Servicer advance investments
 
169,204

 
Discount rate
 
5

-
5

%
 
5

%
 
 
 
 
Prepayment rate (annual CPR)
 
8

-
15

%
 
14

%
 
 
 
 
Expected remaining life (2)
 
2

-
2

year
 
2

year
 
 
 
 
Mortgage servicing income
 
8

-
13

bps
 
10

bps
 
 
 
 
 
 
 
 
 
 
 
 
 
MSRs
 
42,224

 
Discount rate
 
11

-
12

%
 
11

 %
 
 
 
 
Prepayment rate (annual CPR)
 
5

-
44

%
 
11

 %
 
 
 
 
Per loan annual cost to service
 
$
82

-
$
82

 
 
$
82

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Excess MSRs
 
31,814

 
Discount rate
 
11

-
16

%
 
14

%
 
 
 
 
Prepayment rate (annual CPR)
 
9

-
14

%
 
11

%
 
 
 
 
Excess mortgage servicing amount
 
8

-
18

bps
 
13

bps
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Table 5.7 – Fair Value Methodology for Level 3 Financial Instruments (continued)
December 31, 2019
 
Fair
Value
 
 
 
Input Values
(Dollars in Thousands, except Input Values)
 
 
Unobservable Input
 
Range
 
 
Weighted
Average
Assets (continued)
 
 
 
 
 
 
 
 
 
 
 
 
Shared home appreciation options
 
$
45,085

 
Discount rate
 
11

-
11

%
 
11

%
 
 
 
 
Prepayment rate (annual CPR)
 
10

-
30

%
 
23

%
 
 
 
 
Home price appreciation
 
3

-
3

%
 
3

%
 
 
 
 
 
 
 
 
 
 
 
 
 
Guarantee asset
 
1,686

 
Discount rate
 
11

-
11

%
 
11

%
 
 
 
 
Prepayment rate (annual CPR)
 
15

-
15

%
 
15

%
 
 
 
 
 
 
 
 
 
 
 
 
 
REO
 
4,051

 
Loss severity
 
17

-
55

%
 
26

%
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential loan purchase commitments, net
 
8,419

 
MSR multiple
 
0.7

-
4.3

x
 
2.8

x
 
 
 
 
Pull-through rate
 
8

-
100

%
 
75

%
 
 
 
 
Whole loan spread to TBA price
 
$
0.53

-
$
1.63

 
 
$
1.62

 
 
 
 
 
Whole loan spread to swap rate - fixed rate
 
115

-
375

bps
 
253

bps
 
 
 
 
Prepayment rate (annual CPR)
 
15

-
20

%
 
20

%
 
 
 
 
Whole loan spread to swap rate - hybrid
 
115

-
155

bps
 
131

bps
 
 
 
 
 
 
 
 
 
 
 
 
 
Single-family rental interest rate lock commitments
 
440

 
Senior credit spread
 
105

-
105

bps
 
105

bps
 
 
 
 
Subordinate credit spread
 
140

-
1,400

bps
 
299

bps
 
 
 
 
Senior credit support
 
33

-
33

%
 
33

%
 
 
 
 
IO discount rate
 
6

-
7

%
 
7

%
 
 
 
 
Prepayment rate (annual CPR)
 
5

-
5

%
 
5

%
 
 
 
 
Pull-through rate
 
100

-
100

%
 
100

%
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
ABS issued (1)
 
 
 
 
 
 
 
 
 
 
 
 
At consolidated Sequoia entities
 
2,439,663

 
Discount rate
 
3

-
30

%
 
4

 %
 
 
 
 
Prepayment rate (annual CPR)
 
17

-
43

%
 
26

 %
 
 
 
 
Default rate
 

-
7

%
 

 %
 
 
 
 
Loss severity
 

-
65

%
 
1

 %
 
 
 
 
 
 
 
 
 
 
 
 
 
At consolidated Freddie Mac SLST entities
 
1,918,322

 
Discount rate
 
3

-
13

%
 
3

 %
 
 
 
 
Prepayment rate (annual CPR)
 
6

-
6

%
 
6

 %
 
 
 
 
Default rate
 
17

-
18

%
 
17

 %
 
 
 
 
Loss severity
 
30

-
30

%
 
30

 %
 
 
 
 
 
 
 
 
 
 
 
 
 
At consolidated Freddie Mac K-Series entities (4)
 
4,156,239

 
Discount rate
 
1

-
9

%
 
3

%
 
 
 
 
Non-IO prepayment rate (annual CPR)
 

-

%
 

%
 
 
 
 
IO prepayment rate (annual CPY/CPP)
 

-
100

%
 
94

%
 
 
 
 
 
 
 
 
 
 
 
 
 
At consolidated CAFL entities (4)
 
2,001,251

 
Discount rate
 
2

-
30

%
 
4

%
 
 
 
 
Prepayment rate (annual CPR)
 

-
5

%
 

%
 
 
 
 
 
 
 
 
 
 
 
 
 
Contingent consideration
 
28,484

 
Discount rate
 
23

-
23

%
 
23

%
 
 
 
 
Probability of outcomes (3)
 
100

-
100

%
 
100

%
 
 
 
 
 
 
 
 
 
 
 
 
 
Footnotes to Table 5.7
(1)
The fair value of the loans held by consolidated entities was based on the fair value of the ABS issued by these entities, including securities we own, which we determined were more readily observable in accordance with accounting guidance for collateralized financing entities. At December 31, 2019, the fair value of securities we owned at the consolidated Sequoia, Freddie Mac SLST, Freddie Mac K-Series and CAFL entities was $264 million, $449 million, $252 million, and $191 million, respectively.
(2)
Represents the estimated average duration of outstanding servicer advances at a given point in time (not taking into account new advances made with respect to the pool).
(3)
Represents the probability of a full payout of contingent purchase consideration.
(4)
As a market convention, certain securities are priced to a no-loss yield and therefore do not include default and loss severity assumptions.
Determination of Fair Value
A description of the instruments measured at fair value as well as the general classification of such instruments pursuant to the Level 1, Level 2, and Level 3 valuation hierarchy is listed herein. We generally use both market comparable information and discounted cash flow modeling techniques to determine the fair value of our Level 3 assets and liabilities. Use of these techniques requires determination of relevant inputs and assumptions, some of which represent significant unobservable inputs as indicated in the preceding table. Accordingly, a significant increase or decrease in any of these inputs – such as anticipated credit losses, prepayment rates, interest rates, or other valuation assumptions – in isolation would likely result in a significantly lower or higher fair value measurement.
Residential loans at Redwood
Estimated fair values for residential loans are determined using models that incorporate various observable inputs, including pricing information from whole loan sales and securitizations. Certain significant inputs in these models are considered unobservable and are therefore Level 3 in nature. Significant pricing inputs obtained from market whole loan transaction activity include indicative spreads to indexed TBA prices and indexed swap rates for fixed-rate loans and indexed swap rates for hybrid loans (Level 3). Significant pricing inputs obtained from market securitization activity include indicative spreads to indexed TBA prices for senior MBS and indexed swap rates for subordinate MBS, senior credit support levels, and assumed future prepayment rates (Level 3). These assets would generally decrease in value based upon an increase in the credit spread, prepayment speed, or credit support assumptions.
Residential loans, business purpose residential loans, and multifamily loans at consolidated entities
We have elected to account for our consolidated securitization entities as collateralized financing entities in accordance with GAAP. A CFE is a variable interest entity that holds financial assets and issues beneficial interests in those assets, and these beneficial interests have contractual recourse only to the related assets of the CFE. Accounting guidance for CFEs allows companies to elect to measure both the financial assets and financial liabilities of a CFE using the more observable of the fair value of the financial assets or fair value of the financial liabilities. Pursuant to this guidance, we use the fair value of the ABS issued by the CFEs (which we determined to be more observable) to determine the fair value of the loans held at these entities, whereby the net assets we consolidate in our financial statements related to these entities represent the estimated fair value of our retained interests in the CFEs. 
Business purpose residential loans
Business purpose residential loans include single-family rental loans and residential bridge loans that are generally illiquid in nature and trade infrequently. Significant inputs in the valuation analysis are predominantly Level 3 in nature, due to the lack of readily available market quotes and related inputs.
Estimated fair values for our single-family rental loans are determined using models that incorporate various inputs, including pricing information from market comparable securitizations. Certain significant inputs in these models are considered unobservable and are therefore Level 3 in nature. Significant pricing inputs obtained from market activity include indicative spreads to indexed swap rates for senior and subordinate MBS, IO MBS discount rates, senior credit support levels, and assumed future prepayment rates (Level 3). These assets would generally decrease in value based upon an increase in the credit spread, prepayment speed, or credit support assumptions.
Prices for our residential bridge loans are determined using discounted cash flow modeling, which incorporates a primary significant unobservable input of discount rate. These assets would generally decrease in value based upon an increase in the discount rate.
Real estate securities
Real estate securities include residential, multifamily, and other mortgage-backed securities that are generally illiquid in nature and trade infrequently. Significant inputs in the valuation analysis are predominantly Level 3 in nature, due to the lack of readily available market quotes and related inputs. For real estate securities, we utilize both market comparable pricing and discounted cash flow analysis valuation techniques. Relevant market indicators that are factored into the analysis include bid/ask spreads, the amount and timing of credit losses, interest rates, and collateral prepayment rates. Estimated fair values are based on applying the market indicators to generate discounted cash flows (Level 3). These cash flow models use significant unobservable inputs such as a discount rate, prepayment rate, default rate and loss severity. The estimated fair value of our securities would generally decrease based upon an increase in discount rate, default rates, loss severities, or a decrease in prepayment rates.
As part of our securities valuation process, we request and consider indications of value from third-party securities dealers. For purposes of pricing our securities at December 31, 2019, we received dealer price indications on 83% of our securities, representing 94% of our carrying value. In the aggregate, our internal valuations of the securities for which we received dealer price indications were within 1% of the aggregate average dealer valuations. Once we receive the price indications from dealers, they are compared to other relevant market inputs, such as actual or comparable trades, and the results of our discounted cash flow analysis. In circumstances where relevant market inputs cannot be obtained, increased reliance on discounted cash flow analysis and management judgment are required to estimate fair value.
Derivative assets and liabilities
Our derivative instruments include swaps, swaptions, TBAs, interest rate futures, loan purchase commitments, and forward sale commitments. Fair values of derivative instruments are determined using quoted prices from active markets, when available, or from valuation models and are supported by valuations provided by dealers active in derivative markets. Fair values of TBAs and interest rate futures are generally obtained using quoted prices from active markets (Level 1). Our derivative valuation models for swaps and swaptions require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates, and correlations of certain inputs. Model inputs can generally be verified and model selection does not involve significant management judgment (Level 2).
LPC, IRLC and FSC fair values for residential jumbo and single-family rental loans are estimated based on the estimated fair values of the underlying loans (as described in "Residential loans at Redwood" and "Business purpose residential loans" above). In addition, fair values for LPCs and IRLCs are estimated based on the probability that the mortgage loan will be purchased or originated (the "Pull-through rate") (Level 3).
For other derivatives, valuations are based on various factors such as liquidity, bid/ask spreads, and credit considerations for which we rely on available market inputs. In the absence of such inputs, management’s best estimate is used (Level 3).
Servicer advance investments
Estimated fair values for servicer advance investments are determined through internal pricing models that estimate future cash flows and utilize certain significant inputs that are considered unobservable and are therefore Level 3 in nature. Our estimations of cash flows include the combined cash flows of all of the components that comprise the servicer advance investments: existing advances, the requirement to purchase future advances, the recovery of advances, and the right to a portion of the associated mortgage servicing fee ("mortgage servicing income"). The valuation technique is based on discounted cash flows. Significant inputs used in the valuations included prepayment rate (of the loans underlying the investments), mortgage servicing income, servicer advance WAL (the weighted-average expected remaining life of servicer advances), and discount rate. These assets would generally decrease in value based upon an increase in prepayment rates, an increase in servicer advance WAL, or an increase in discount rate, or a decrease in mortgage servicing income.
MSRs
MSRs include the rights to service jumbo residential mortgage loans. Significant inputs in the valuation analysis are predominantly Level 3, due to the nature of these instruments and the lack of readily available market quotes. Changes in the fair value of MSRs occur primarily due to the collection/realization of expected cash flows, as well as changes in valuation inputs and assumptions. Estimated fair values are based on applying the inputs to generate the net present value of estimated future MSR income (Level 3). These discounted cash flow models utilize certain significant unobservable inputs including market discount rates, assumed future prepayment rates of serviced loans, and the market cost of servicing. An increase in these unobservable inputs would generally reduce the estimated fair value of the MSRs.
As part of our MSR valuation process, we received a valuation estimate from a third-party valuations firm. In the aggregate, our internal valuation of the MSRs were within 2% of the third-party valuation.
Excess MSRs
Estimated fair values for excess MSRs are determined through internal pricing models that estimate future cash flows and utilize certain significant inputs that are considered unobservable and are therefore Level 3 in nature. The valuation technique is based on discounted cash flows. Significant unobservable inputs used in the valuations included prepayment rate (of the loans underlying the investments), the amount of excess servicing income expected to be received ("excess mortgage servicing income"), and discount rate. These assets would generally decrease in value based upon an increase in prepayment rates or discount rate, or a decrease in excess mortgage servicing income.
Shared Home Appreciation Options
Estimated fair values for shared home appreciation options are determined through internal pricing models that estimate future cash flows and utilize certain significant unobservable inputs such as forecasted home price appreciation, prepayment rates, and discount rate, and are therefore Level 3 in nature. The valuation technique is based on discounted cash flows. An increase in discount rate, or a decrease in expected future home values combined with a decrease in prepayment rates, would generally reduce the estimated fair value of the shared home appreciation options.
FHLBC stock
Our Federal Home Loan Bank ("FHLB") member subsidiary is required to purchase Federal Home Loan Bank of Chicago ("FHLBC") stock under a borrowing agreement between our FHLB-member subsidiary and the FHLBC. Under this agreement, the stock is redeemable at face value, which represents the carrying value and fair value of the stock (Level 2).
Guarantee asset
The guarantee asset represents the estimated fair value of cash flows we are contractually entitled to receive related to a risk-sharing arrangement with Fannie Mae. Significant inputs in the valuation analysis are Level 3, due to the nature of this asset and the lack of market quotes. The fair value of the guarantee asset is determined using a discounted cash flow model, for which significant unobservable inputs include assumed future prepayment rates and market discount rate (Level 3). An increase in prepayment rates or discount rate would generally reduce the estimated fair value of the guarantee asset.
Pledged collateral
Pledged collateral consists of cash and U.S. Treasury securities held by a custodian in association with certain agreements we have entered into. Treasury securities are carried at their fair value, which is determined using quoted prices in active markets (Level 1).
Cash and cash equivalents
Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less. Fair values equal carrying values (Level 1).
Restricted cash
Restricted cash primarily includes interest-earning cash balances related to risk-sharing transactions with the Agencies, cash held in association with borrowings from the FHLBC, cash held at Servicing Investment entities, and cash held at consolidated Sequoia entities for the purpose of distribution to investors and reinvestment. Due to the short-term nature of the restrictions, fair values approximate carrying values (Level 1).
Accrued interest receivable and payable
Accrued interest receivable and payable includes interest due on our assets and payable on our liabilities. Due to the short-term nature of when these interest payments will be received or paid, fair values approximate carrying values (Level 1).
Real estate owned
Real estate owned ("REO") includes properties owned in satisfaction of foreclosed loans. Fair values are determined using available market quotes, appraisals, broker price opinions, comparable properties, or other indications of value (Level 3).
Margin receivable
Margin receivable reflects cash collateral we have posted with our various derivative and debt counterparties as required to satisfy margin requirements. Fair values approximate carrying values (Level 2).
Contingent consideration
Contingent consideration is related to our acquisition of 5 Arches and is estimated and recorded at fair value as part of purchase consideration. Each reporting period we estimate the change in fair value of the contingent consideration, and such change is recognized in our consolidated statements of income, unless it is determined to be a measurement period adjustment. The estimate of the fair value of contingent consideration requires significant judgment and assumptions to be made about future operating results, discount rates, and probabilities of projected operating result scenarios (Level 3).
Short-term debt
Short-term debt includes our credit facilities for residential and business purpose residential loans and real estate securities as well as non-recourse short-term borrowings used to finance servicer advance investments. As these borrowings are secured and subject to margin calls and as the rates on these borrowings reset frequently to market rates, we believe that carrying values approximate fair values (Level 2).
ABS issued
ABS issued includes asset-backed securities issued through the Legacy Sequoia, Sequoia Choice, and CAFL securitization entities, as well as securities issued by certain third-party Freddie Mac K-Series and SLST securitization entities that we consolidate. These instruments are generally illiquid in nature and trade infrequently. Significant inputs in the valuation analysis are predominantly Level 3, due to the nature of these instruments and the lack of readily available market quotes. For ABS issued, we utilize both market comparable pricing and discounted cash flow analysis valuation techniques. Relevant market indicators factored into the analysis include bid/ask spreads, the amount and timing of collateral credit losses, interest rates, and collateral prepayment rates. Estimated fair values incorporate market indicators as well as other significant unobservable inputs to generate discounted cash flows (Level 3). These cash flow models use significant unobservable inputs such as discount rate, prepayment rate, default rate, loss severity and credit support. A decrease in credit losses or discount rates, or an increase in prepayment rates, would generally cause the fair value of the ABS issued to decrease (i.e., become a larger liability).
FHLBC borrowings
FHLBC borrowings include amounts borrowed from the FHLBC that are secured, generally by residential mortgage loans. As these borrowings are secured and subject to margin calls and as the rates on these borrowings reset frequently to market rates, we believe that carrying values approximate fair values (Level 2).
Financial Instruments Carried at Amortized Cost
Participation in loan warehouse facility
Our participation in a loan warehouse facility was carried at amortized cost (Level 2).
Guarantee obligations
In association with our risk-sharing transactions with the Agencies, we have made certain guarantees which are carried on our balance sheet at amortized cost (Level 3).
Subordinate securities financing facility
Borrowings under our subordinate securities financing facility are secured by real estate securities and carried at unpaid principal balance net of any unamortized deferred issuance costs (Level 3).
Convertible notes
Convertible notes include unsecured convertible and exchangeable senior notes that are carried at their unpaid principal balance net of any unamortized deferred issuance costs. The fair value of the convertible notes is determined using quoted prices in generally active markets (Level 2).
Trust preferred securities and subordinated notes
Trust preferred securities and subordinated notes are carried at their unpaid principal balance net of any unamortized deferred issuance costs (Level 3).