Principles of Consolidation

3 Months Ended

Mar. 31, 2020

Organization, Consolidation and Presentation of Financial Statements [Abstract]

Principles of Consolidation

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

At March 31, 2020, we consolidated Legacy Sequoia, Freddie Mac SLST, Freddie Mac K-Series and CAFL securitization entities that we determined were VIEs and for which we determined we were the primary beneficiary. 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 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. At March 31, 2020, the estimated fair value of our investments in the consolidated Legacy Sequoia, Sequoia Choice, Freddie Mac SLST, Freddie Mac K-Series and CAFL entities was $6 million, $144 million, $309 million, $23 million, and $170 million, respectively.

During the first quarter of 2020, we sold subordinate securities issued by four of these Freddie Mac K-Series securitization trusts and determined that we should derecognize the associated assets and liabilities of each of these entities for financial reporting purposes. We deconsolidated $3.86 billion of multifamily loans and other assets and $3.72 billion of multifamily ABS issued and other liabilities, for which we realized market valuation losses of $72 million, which were recorded through Investment fair value changes, net on our consolidated statements of income (loss) for the three months ended March 31, 2020.

Beginning in 2018, we consolidated two Servicing Investment entities formed to invest in servicing-related assets that we determined were VIEs and for which we determined we were the primary beneficiary. At March 31, 2020, we held an 80% ownership interest in, and were responsible for the management of, each entity. See Note 10 for a further description of these entities and the investments they hold and Note 12 for additional information on the minority partner’s interest. Additionally, beginning in 2018, we consolidated an entity that was formed to finance servicer advances that we determined was a VIE and for which we, through our control of one of the aforementioned partnerships, were the primary beneficiary. The servicer advance financing consists of non-recourse short-term securitization debt, secured by servicer advances. We consolidate the securitization entity, but the securitization entity is independent of Redwood and the assets and liabilities are not owned by and are not legal obligations of Redwood. See Note 13 for additional information on the servicer advance financing. At March 31, 2020, the estimated fair value of our investment in the Servicing Investment entities was $59 million.

The following table presents a summary of the assets and liabilities of these VIEs.

Table 4.1 – Assets and Liabilities of Consolidated VIEs

March 31, 2020	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		CAFL		Servicing Investment		Total Consolidated VIEs
(Dollars in Thousands)
Residential loans, held-for-investment	$	316,677	$	1,932,658	$	2,131,125	$	—	$	—	$	—	$	4,380,460
Business purpose residential loans, held-for-investment	—		—		—		—		2,248,665		—		2,248,665
Multifamily loans, held-for-investment	—		—		—		470,484		—		—		470,484
Other investments	—		—		—		—		—		314,394		314,394
Cash and cash equivalents	—		—		—		—		—		2,886		2,886
Restricted cash	143		15		—		—		—		11,810		11,968
Accrued interest receivable	580		8,574		7,184		1,390		10,803		5,567		34,098
Other assets	952		—		1,050		—		5,749		—		7,751
Total Assets	$	318,352	$	1,941,247	$	2,139,359	$	471,874	$	2,265,217	$	334,657	$	7,470,706
Short-term debt	$	—	$	—	$	—	$	—	$	—	$	258,931	$	258,931
Accrued interest payable	351		6,920		5,251		1,230		8,188		205		22,145
Accrued expenses and other liabilities	—		15		—		—		—		16,305		16,320
Asset-backed securities issued	312,201		1,790,094		1,825,000		447,699		2,086,870		—		6,461,864
Total Liabilities	$	312,552	$	1,797,029	$	1,830,251	$	448,929	$	2,095,058	$	275,441	$	6,759,260
Number of VIEs	20		9		2		1		11		3		46

December 31, 2019	Legacy Sequoia		Sequoia Choice		Freddie Mac SLST		Freddie Mac K-Series		CAFL		Servicing Investment		Total Consolidated VIEs
(Dollars in Thousands)
Residential loans, held-for-investment	$	407,890	$	2,291,463	$	2,367,215	$	—	$	—	$	—	$	5,066,568
Business purpose residential loans, held-for-investment	—		—		—		—		2,192,552		—		2,192,552
Multifamily loans, held-for-investment	—		—		—		4,408,524		—		—		4,408,524
Other investments	—		—		—		—		—		184,802		184,802
Cash and cash equivalents	—		—		—		—		—		9,015		9,015
Restricted cash	143		27		—		—		—		21,766		21,936
Accrued interest receivable	655		9,824		7,313		13,539		9,572		4,869		45,772
Other assets	460		—		445		—		1,795		—		2,700
Total Assets	$	409,148	$	2,301,314	$	2,374,973	$	4,422,063	$	2,203,919	$	220,452	$	11,931,869
Short-term debt	$	—	$	—	$	—	$	—	$	—	$	152,554	$	152,554
Accrued interest payable	395		7,732		5,374		12,887		7,485		187		34,060
Accrued expenses and other liabilities	—		27		—		—		—		14,956		14,983
Asset-backed securities issued	402,465		2,037,198		1,918,322		4,156,239		2,001,251		—		10,515,475
Total Liabilities	$	402,860	$	2,044,957	$	1,923,696	$	4,169,126	$	2,008,736	$	167,697	$	10,717,072
Number of VIEs	20		9		2		5		10		3		49

The following table presents income (loss) from these VIEs for the three months ended March 31, 2020 and 2019.

Table 4.2 – Income (Loss) from Consolidated VIEs

	Three Months Ended March 31, 2020
	Legacy Sequoia			Sequoia Choice			Freddie Mac SLST			Freddie Mac K-Series			CAFL			Servicing Investment			Total Consolidated VIEs
(Dollars in Thousands)
Interest income	$	3,194		$	25,083		$	21,986		$	40,172		$	30,010		$	4,083		$	124,528
Interest expense	(2,522		)	(21,510		)	(16,176		)	(38,348		)	(21,939		)	(1,577		)	(102,072		)
Net interest income	672			3,573			5,810			1,824			8,071			2,506			22,456
Non-interest income
Investment fair value changes, net	(391		)	(69,668		)	(142,161		)	(86,509		)	(67,846		)	(11,884		)	(378,459		)
Total non-interest income, net	(391		)	(69,668		)	(142,161		)	(86,509		)	(67,846		)	(11,884		)	(378,459		)
General and administrative expenses	—			—			—			—			—			(31		)	(31		)
Other expenses	—			—			—			—			—			1,882			1,882
Income (Loss) from Consolidated VIEs	$	281		$	(66,095	)	$	(136,351	)	$	(84,685	)	$	(59,775	)	$	(7,527	)	$	(354,152	)

	Three Months Ended March 31, 2019
	Legacy Sequoia			Sequoia Choice			Freddie Mac SLST			Freddie Mac K-Series			CAFL		Servicing Investment			Total Consolidated VIEs
(Dollars in Thousands)
Interest income	$	4,853		$	25,662		$	11,794		$	21,388		$	—	$	3,346		$	67,043
Interest expense	(4,115		)	(22,113		)	(8,747		)	(20,320		)	—		(3,613		)	(58,908		)
Net interest income	738			3,549			3,047			1,068			—		(267		)	8,135
Non-interest income
Investment fair value changes, net	(374		)	3,265			6,365			3,119			—		1,430			13,805
Total non-interest income, net	(374		)	3,265			6,365			3,119			—		1,430			13,805
General and administrative expenses	—			—			—			—			—		(30		)	(30		)
Other expenses	—			—			—			—			—		(227		)	(227		)
Income from Consolidated VIEs	$	364		$	6,814		$	9,412		$	4,187		$	—	$	906		$	21,683

We consolidate the assets and liabilities of certain Sequoia and CAFL securitization entities, as we did not meet the GAAP sale criteria at the time we transferred financial assets to these entities. Our involvement in consolidated Sequoia and CAFL entities continues in the following ways: (i) we continue to hold subordinate investments in each entity, and for certain entities, more senior investments; (ii) we maintain certain discretionary rights associated with our sponsorship of, or our subordinate investments in, each entity; and (iii) we continue to hold a right to call the assets of certain entities (once they have been paid down below a specified threshold) at a price equal to, or in excess of, the current outstanding principal amount of the entity’s asset-backed securities issued. These factors have resulted in our continuing to consolidate the assets and liabilities of these Sequoia and CAFL entities in accordance with GAAP.

We consolidate the assets and liabilities of certain Freddie Mac K-Series and SLST securitization trusts resulting from our investment in subordinate securities issued by these trusts, and in the case of certain CAFL securitizations, resulting from securities acquired through our acquisition of CoreVest. Additionally, we consolidate the assets and liabilities of Servicing Investment entities from our investment in servicer advance investments and excess MSRs. In each case, we maintain certain discretionary rights associated with the ownership of these investments that we determined reflected a controlling financial interest, as we have both the power to direct the activities that most significantly impact the economic performance of the VIEs and the right to receive benefits of and the obligation to absorb losses from the VIEs that could potentially be significant to the VIEs.

Analysis of Unconsolidated VIEs with Continuing Involvement

Since 2012, we have transferred residential loans to 51 Sequoia securitization entities sponsored by us that are still outstanding as of March 31, 2020, 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 certain of these transfers to securitization entities, for the transferred loans where we held the servicing rights prior to the transfer and continued to hold the servicing rights following the transfer, we recorded mortgage servicing rights ("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 servicing rights (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 months ended March 31, 2020 and 2019.

Table 4.3 – Securitization Activity Related to Unconsolidated VIEs Sponsored by Redwood

	Three Months Ended March 31,
(In Thousands)	2020		2019
Principal balance of loans transferred	$	1,573,703	$	348,257
Trading securities retained, at fair value	43,362		1,716
AFS securities retained, at fair value	3,198		885

The following table summarizes the cash flows during the three months ended March 31, 2020 and 2019 between us and the unconsolidated VIEs sponsored by us and accounted for as sales since 2012.

Table 4.4 – Cash Flows Related to Unconsolidated VIEs Sponsored by Redwood

	Three Months Ended March 31,
(In Thousands)	2020			2019
Proceeds from new transfers	$	1,610,761		$	352,371
MSR fees received	2,690			3,060
Funding of compensating interest, net	(92		)	(90		)
Cash flows received on retained securities	6,581			7,546

The following table presents the key weighted-average assumptions used to measure MSRs and securities retained at the date of securitization for securitizations completed during the three months ended March 31, 2020 and 2019.

Table 4.5 – Assumptions Related to Assets Retained from Unconsolidated VIEs Sponsored by Redwood

	Three Months Ended March 31, 2020				Three Months Ended March 31, 2019
At Date of Securitization	Senior IO Securities		Subordinate Securities		Senior IO Securities		Subordinate Securities
Prepayment rates	41	%	13	%	16	%	14	%
Discount rates	16	%	6	%	14	%	8	%
Credit loss assumptions	0.21	%	0.22	%	0.20	%	0.20	%

The following table presents additional information at March 31, 2020 and December 31, 2019, related to unconsolidated VIEs sponsored by Redwood and accounted for as sales since 2012.

Table 4.6 – Unconsolidated VIEs Sponsored by Redwood

(In Thousands)	March 31, 2020		December 31, 2019
On-balance sheet assets, at fair value:
Interest-only, senior and subordinate securities, classified as trading	$	54,894	$	88,425
Subordinate securities, classified as AFS	77,433		140,649
Mortgage servicing rights	22,482		40,254
Maximum loss exposure (1)	$	154,809	$	269,328
Assets transferred:
Principal balance of loans outstanding	$	11,181,034	$	10,299,442
Principal balance of loans 30+ days delinquent	40,930		41,809

(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 March 31, 2020 and December 31, 2019.

Table 4.7 – Key Assumptions and Sensitivity Analysis for Assets Retained from Unconsolidated VIEs Sponsored by Redwood

March 31, 2020	MSRs			Senior Securities (1)			Subordinate Securities
(Dollars in Thousands)
Fair value at March 31, 2020	$	22,482		$	26,980		$	105,347
Expected life (in years) (2)	4			3			14
Prepayment speed assumption (annual CPR) (2)	21		%	28		%	15		%
Decrease in fair value from:
10% adverse change	$	1,760		$	2,414		$	1,404
25% adverse change	4,278			5,954			3,836
Discount rate assumption (2)	13		%	18		%	10		%
Decrease in fair value from:
100 basis point increase	$	611		$	549		$	8,088
200 basis point increase	1,188			1,072			15,165
Credit loss assumption (2)	N/A			0.22		%	0.22		%
Decrease in fair value from:
10% higher losses	N/A			$	—		$	1,107
25% higher losses	N/A			—			2,723

December 31, 2019	MSRs			Senior Securities (1)			Subordinate Securities
(Dollars in Thousands)
Fair value at December 31, 2019	$	40,254		$	48,765		$	180,309
Expected life (in years) (2)	6			6			14
Prepayment speed assumption (annual CPR) (2)	11		%	14		%	16		%
Decrease in fair value from:
10% adverse change	$	1,643		$	1,908		$	205
25% adverse change	3,913			5,086			1,434
Discount rate assumption (2)	11		%	12		%	5		%
Decrease in fair value from:
100 basis point increase	$	1,447		$	1,079		$	18,127
200 basis point increase	2,795			2,482			33,630
Credit loss assumption (2)	N/A			0.21		%	0.21		%
Decrease in fair value from:
10% higher losses	N/A			$	—		$	1,804
25% higher losses	N/A			—			4,520

(1) Senior securities included $27 million and $49 million of interest-only securities at March 31, 2020 and December 31, 2019, respectively.

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

Analysis of Unconsolidated 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 and other investments 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 March 31, 2020 and December 31, 2019, grouped by asset type.

Table 4.8 – Third-Party Sponsored VIE Summary

(In Thousands)	March 31, 2020		December 31, 2019
Mortgage-Backed Securities
Senior	$	12,580	$	127,094
Mezzanine	25,867		508,195
Subordinate	122,689		235,510
Total Mortgage-Backed Securities	161,136		870,799
Excess MSR	16,339		16,216
Total Investments in Third-Party Sponsored VIEs	$	177,475	$	887,015

We determined that we are not the primary beneficiary of these 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.