Note 4. 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 December 31, 2014, 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


December 31, 2014 (Dollars in Thousands)	Sequoia Entities		Residential Resecuritization		Commercial Securitization		Total
December 31, 2014 (Dollars in Thousands)	Sequoia Entities		Residential Resecuritization		Commercial Securitization		Total
Residential loans, held-for-investment	$	1,474,386	$	—	$	—	$	1,474,386
Commercial loans, held-for-investment		—		—		194,991		194,991
Real estate securities, at fair value		—		221,676		—		221,676
Restricted cash		147		43		137		327
Accrued interest receivable		2,359		477		1,511		4,347
Other assets		4,411		—		70		4,481

Total Assets	$	1,481,303	$	222,196	$	196,709	$	1,900,208

Accrued interest payable	$	976	$	5	$	390	$	1,371
Asset-backed securities issued		1,416,762		45,044		83,313		1,545,119

Total Liabilities	$	1,417,738	$	45,049	$	83,703	$	1,546,490

Number of VIEs		24		1		1		26


December 31, 2013 (Dollars in Thousands)	Sequoia Entities		Residential Resecuritization		Commercial Securitization		Total
December 31, 2013 (Dollars in Thousands)	Sequoia Entities		Residential Resecuritization		Commercial Securitization		Total
Residential loans, held-for-investment	$	1,762,167	$	—	$	—	$	1,762,167
Commercial loans, held-for-investment		—		—		257,741		257,741
Real estate securities, at fair value		—		263,204		—		263,204
Restricted cash		152		—		137		289
Accrued interest receivable		2,714		627		1,975		5,316
Other assets		3,661		—		7,198		10,859

Total Assets	$	1,768,694	$	263,831	$	267,051	$	2,299,576

Accrued interest payable	$	1,218	$	11	$	720	$	1,949
Asset-backed securities issued		1,694,335		94,934		153,693		1,942,962

Total Liabilities	$	1,695,553	$	94,945	$	154,413	$	1,944,911

Number of VIEs		24		1		1		26

We consolidate the assets and liabilities of certain Sequoia 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 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 entities in accordance with GAAP.

During 2012, we sold previously retained variable interests in certain Sequoia securitization entities originally issued between 2001 and 2007 and determined, upon completion of an accounting analysis, that we should deconsolidate certain entities and derecognize the associated assets and liabilities of these entities for financial reporting purposes. We derecognized $961 million of residential loans and other assets, net of $27 million of allowance for loan losses and $970 million of ABS issued and other liabilities, and after giving effect to all other accounting entries recognized a realized gain of $21 million, which was recorded on our consolidated statement of income for the year ended December 31, 2012. These gains were comprised of both recoveries of provisions for loan losses that exceeded our recorded investment in these entities as well as cash received from the sale of our investment interests. We maintained our intent to hold our economic interests in all remaining consolidated Sequoia entities at December 31, 2014.

We consolidate the assets and liabilities of the Residential Resecuritization entity as we did not meet the GAAP sale criteria at the time the financial assets were transferred to this entity based on our role in the entity’s inception and design. We transferred senior residential securities to Credit Suisse First Boston Mortgage Securities Corp., which subsequently sold them to CSMC 2011-9R, the Residential Resecuritization entity. In connection with this transaction, we acquired certain senior and subordinate securities that we continue to hold. We engaged in the Residential Resecuritization primarily for the purpose of obtaining permanent non-recourse financing on a portion of our senior residential securities portfolio. Our credit risk exposure is largely unchanged as a result of engaging in the transaction, as we remain economically exposed to the financed securities through our senior and subordinate investment in the Residential Resecuritization.

We consolidate the assets and liabilities of the Commercial Securitization entity, as we did not meet the GAAP sale criteria at the time the financial assets were transferred to this entity based on our role in the entity’s inception and design. We transferred subordinate commercial loans to RCMC 2012-CREL1, the Commercial Securitization entity. In connection with this transaction, we acquired certain subordinate securities that we continue to hold. We engaged in the Commercial Securitization primarily for the purpose of obtaining permanent non-recourse financing on a portion of our commercial mezzanine loan portfolio. Our credit risk exposure is largely unchanged as a result of engaging in the transaction, as we remain economically exposed to the financed loans through our subordinate investment in the Commercial Securitization.

Analysis of Unconsolidated VIEs with Continuing Involvement

During the years ended December 31, 2014 and 2013, we transferred residential loans to four and 12 Sequoia securitization entities sponsored by us, respectively, 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.

The following table presents information related to the Sequoia securitization transactions that occurred during the years ended December 31, 2014 and 2013.

Securitization Activity Related to Unconsolidated VIEs Sponsored by Redwood


	Years Ended December 31,
(In Thousands)	2014		2013
Principal balance of loans transferred	$	1,324,419	$	5,578,298
Trading securities retained, at fair value		77,160		105,320
AFS securities retained, at fair value		78,218		301,072
MSRs recognized		8,518		42,921

Our continuing involvement in these securitizations is limited to customary servicing obligations associated with retaining residential MSRs (which we retain a third-party servicer to perform) and the receipt of interest income associated with the securities we retained. The following table summarizes the cash flows between us and unconsolidated Sequoia securitizations sponsored by us since 2012.

Cash Flows Related to Unconsolidated VIEs Sponsored by Redwood


	Years Ended December 31,
(In Thousands)	2014			2013
Cash proceeds	$	1,201,411		$	4,670,082
MSR fees received		13,812			9,128
Funding of compensating interest		(227	)		(475	)
Cash flows received on retained securities		56,870			43,032

The following table presents the key weighted-average assumptions used to estimate the fair value of MSRs at the date of securitization.

MSR Assumptions Related to Unconsolidated VIEs Sponsored by Redwood


	Issued During Years Ended December 31,
At Date of Securitization	2014			2013
Prepayment speeds		5 - 16	%		5 - 14	%
Discount rates		11	%		12	%

The following table presents additional information at December 31, 2014 and 2013, related to unconsolidated Sequoia securitizations sponsored by us since 2012.

Unconsolidated VIEs Sponsored by Redwood at December 31, 2014 and 2013


	December 31,
(In Thousands)	2014		2013
On-balance sheet assets, at fair value:
Interest-only and senior securities, classified as trading	$	93,802	$	110,505
Senior and subordinate securities, classified as AFS		460,990		405,415
Maximum loss exposure ⁽¹⁾		554,792		515,920
Assets transferred:
Principal balance of loans outstanding		7,276,825		6,627,874
Principal balance of delinquent loans 30+ days delinquent		17,022		14,587

(1)

Maximum loss exposure from our involvement with unconsolidated VIEs pertains to the carrying value of our securities 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 December 31, 2014 and 2013.

Key Assumptions and Sensitivity Analysis for Unconsolidated VIEs Sponsored by Redwood


December 31, 2014 (Dollars in Thousands)	MSRs			Senior Securities			Subordinate Securities
December 31, 2014 (Dollars in Thousands)	MSRs			Senior Securities			Subordinate Securities
Fair value at December 31, 2014	$	56,801		$	93,802		$	460,990
Expected life (in years) ⁽¹⁾		7			6			10
Prepayment speed assumption (annual CPR) ⁽¹⁾		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 ⁽¹⁾		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 ⁽¹⁾		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

December 31, 2013 (Dollars in Thousands)	MSRs			Senior Securities			Subordinate Securities
December 31, 2013 (Dollars in Thousands)	MSRs			Senior Securities			Subordinate Securities
Fair value at December 31, 2013	$	60,318		$	110,505		$	405,415
Expected life (in years) ⁽¹⁾		8			7			11
Prepayment speed assumption (annual CPR) ⁽¹⁾		8	%		10	%		11	%
Decrease in fair value from:
10% adverse change	$	1,649		$	5,773		$	1,658
25% adverse change		4,218			13,555			4,354
Discount rate assumption ⁽¹⁾		11	%		5	%		6	%
Decrease in fair value from:
100 basis point increase	$	2,468		$	5,632		$	30,644
200 basis point increase		4,828			10,757			57,836
Credit loss assumption ⁽¹⁾		N/A			0.23	%		0.23	%
Decrease in fair value from:
10% higher losses		N/A		$	70		$	1,369
25% higher losses		N/A			175			3,420

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

Analysis of Third-Party Sponsored 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 December 31, 2014, grouped by collateral type.

Third-Party Sponsored VIE Summary


(Dollars in Thousands)	December 31, 2014
Residential real estate securities at Redwood
Senior	$	495,508
Re-REMIC		168,347
Subordinate		160,583

Total Investments in Third-Party Real Estate Securities	$	824,438

We determined that we are not the primary beneficiary of any third-party residential or commercial 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.

Other Transfers of Financial Assets

Certain of our senior commercial mortgage loans were bifurcated into a senior portion that was sold to a third party and a junior portion that we retained as an investment. When the transfer of the senior portion does not meet the criteria for sale treatment under GAAP, the entire loan (the senior and junior portions) remains on our consolidated balance sheet classified as a held-for-investment loan and we account for the receipt of cash from the transfer of the senior portion as a secured borrowing.

The following table presents commercial loan transfers accounted for as secured borrowings for the year ended December 31, 2014.

Loan Transfers Accounted for as Secured Borrowings


	December 31,
(In Thousands)	2014		2013
Principal balance	$	63,375	$	—
Cash proceeds		65,048		—