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Fair Value of Financial Instruments | 6 Months Ended
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Jun. 30, 2015
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 June 30, 2015 and December 31, 2014.
|  | June 30, 2015 |  | December 31, 2014
|  | Carrying Value |  | Fair Value |  | Carrying Value |  | Fair Value
(In Thousands) |  |  |  |
Assets |  |  |  |  |  |  |  |
Residential loans, held-for-sale |  |  |  |  |  |  |  |
At fair value |  | $ | 890,623 |  |  | $ | 890,623 |  |  | $ | 1,341,032 |  |  | $ | 1,341,032 |
At lower of cost or fair value |  | 1,458 |  |  | 1,655 |  |  | 1,488 |  |  | 1,669 |
Residential loans, held-for-investment (1) |  |  |  |  |  |  |  |
At fair value |  | 2,394,399 |  |  | 2,394,399 |  |  | 581,668 |  |  | 581,668 |
At amortized cost |  | — |  |  | — |  |  | 1,474,386 |  |  | 1,381,918 |
Commercial loans, held-for-sale |  | 165,853 |  |  | 165,853 |  |  | 166,234 |  |  | 166,234 |
Commercial loans, held-for-investment |  |  |  |  |  |  |  |
At fair value |  | 69,763 |  |  | 69,763 |  |  | 71,262 |  |  | 71,262 |
At amortized cost |  | 315,715 |  |  | 321,038 |  |  | 329,431 |  |  | 334,876 |
Trading securities |  | 116,141 |  |  | 116,141 |  |  | 111,606 |  |  | 111,606 |
Available-for-sale securities |  | 1,041,458 |  |  | 1,041,458 |  |  | 1,267,624 |  |  | 1,267,624 |
MSRs |  | 168,462 |  |  | 168,462 |  |  | 139,293 |  |  | 139,293 |
Cash and cash equivalents |  | 226,426 |  |  | 226,426 |  |  | 269,730 |  |  | 269,730 |
Restricted cash |  | 2,389 |  |  | 2,389 |  |  | 628 |  |  | 628 |
Accrued interest receivable |  | 16,151 |  |  | 16,151 |  |  | 18,222 |  |  | 18,222 |
Derivative assets |  | 26,252 |  |  | 26,252 |  |  | 16,417 |  |  | 16,417 |
REO (2) |  | 4,410 |  |  | 5,081 |  |  | 4,391 |  |  | 4,703 |
Margin receivable (2) |  | 71,392 |  |  | 71,392 |  |  | 65,374 |  |  | 65,374 |
FHLBC stock (2) |  | 30,001 |  |  | 30,001 |  |  | 10,688 |  |  | 10,688 |
Guarantee asset (2) |  | 6,417 |  |  | 6,417 |  |  | 7,201 |  |  | 7,201 |
Pledged collateral (2) |  | 10,194 |  |  | 10,194 |  |  | 9,927 |  |  | 9,927 |
Liabilities |  |  |  |  |  |  |  |
Short-term debt |  | $ | 1,367,062 |  |  | $ | 1,367,062 |  |  | $ | 1,793,825 |  |  | $ | 1,793,825 |
Accrued interest payable |  | 8,291 |  |  | 8,291 |  |  | 8,502 |  |  | 8,502 |
Guarantee obligation |  | 6,146 |  |  | 6,417 |  |  | 7,201 |  |  | 7,201 |
Derivative liabilities |  | 54,109 |  |  | 54,109 |  |  | 58,331 |  |  | 58,331 |
ABS issued (1) |  |  |  |  |  |  |  |
Fair value |  | 1,173,336 |  |  | 1,173,336 |  |  | — |  |  | — |
Amortized cost |  | 88,786 |  |  | 89,231 |  |  | 1,545,119 |  |  | 1,446,605 |
FHLBC borrowings |  | 882,122 |  |  | 882,122 |  |  | 495,860 |  |  | 495,860 |
Commercial secured borrowings |  | 65,232 |  |  | 65,232 |  |  | 66,707 |  |  | 66,707 |
Convertible notes |  | 492,500 |  |  | 475,700 |  |  | 492,500 |  |  | 492,188 |
Other long-term debt |  | 139,500 |  |  | 101,138 |  |  | 139,500 |  |  | 101,835 |
(1) | Upon adoption of ASU 2014-13 on January 1, 2015, loans held-for-investment and ABS issued by consolidated Sequoia entities began to be recorded at fair value. See Note 3 for further discussion.
(2) | These assets are included in other assets on our consolidated balance sheets.
During the three and six months ended June 30, 2015, we elected the fair value option for $36 million and $59 million of residential subordinate securities, $33 million and $33 million of residential senior securities, $2.78 billion and $5.18 billion of residential loans (principal balance), $258 million and $350 million of commercial loans (principal balance), and $32 million and $51 million of MSRs, respectively. We anticipate electing the fair value option for all future purchases of residential loans and commercial senior loans that we intend to sell to third parties or transfer to securitizations as well as for MSRs purchased or retained from sales of residential loans. The following table presents the assets and liabilities that are reported at fair value on our consolidated balance sheets on a recurring basis at June 30, 2015, as well as the fair value hierarchy of the valuation inputs used to measure fair value. Assets and Liabilities Measured at Fair Value on a Recurring Basis at June 30, 2015
June 30, 2015 |  | Carrying Value |  | Fair Value Measurements Using
(In Thousands) |  |  | Level 1 |  | Level 2 |  | Level 3
Assets |  |  |  |  |  |  |  |
Residential loans |  | $ | 3,285,022 |  |  | $ | — |  |  | $ | 248,157 |  |  | $ | 3,036,865 |
Commercial loans |  | 235,616 |  |  | — |  |  | — |  |  | 235,616 |
Trading securities |  | 116,141 |  |  | — |  |  | — |  |  | 116,141 |
Available-for-sale securities |  | 1,041,458 |  |  | — |  |  | — |  |  | 1,041,458 |
Derivative assets |  | 26,252 |  |  | 7,625 |  |  | 13,621 |  |  | 5,006 |
MSRs |  | 168,462 |  |  | — |  |  | — |  |  | 168,462 |
Pledged collateral |  | 10,194 |  |  | 10,194 |  |  | — |  |  | — |
FHLBC stock |  | 30,001 |  |  | 30,001 |  |  | — |  |  | — |
Guarantee asset |  | 6,417 |  |  | — |  |  | — |  |  | 6,417 |
Liabilities |  |  |  |  |  |  |  |  |
Derivative liabilities |  | 54,109 |  |  | 5,726 |  |  | 43,983 |  |  | 4,400 |
Commercial secured borrowings |  | 65,232 |  |  | — |  |  | — |  |  | 65,232 |
ABS issued |  | 1,173,336 |  |  | — |  |  | — |  |  | 1,173,336 |
The following table presents additional information about Level 3 assets and liabilities measured at fair value on a recurring basis for the six months ended June 30, 2015. Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis
| Assets |  | Liabilities
| Residential Loans |  | Commercial Loans |  | Trading Securities |  | AFS Securities |  | MSRs |  | Guarantee Asset |  | Derivatives(1) |  | Commercial Secured Borrowings |  | ABS Issued
(In Thousands) |  |  |  |  |  |  |
Beginning balance - December 31, 2014 | $ | 1,677,984 |  |  | $ | 237,496 |  |  | $ | 111,606 |  |  | $ | 1,267,624 |  |  | $ | 139,293 |  |  | $ | 7,201 |  |  | $ | 1,119 |  |  | $ | 66,707 |  |  | $ | — |
Transfer to FVO (2) | 1,370,699 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 1,302,216 |
Principal paydowns | (247,699 | ) |  | (463 | ) |  | (827 | ) |  | (61,265 | ) |  | — |  |  | — |  |  | — |  |  | (295 | ) |  | (135,799 | )
Gains (losses) in net income, net | (6,661 | ) |  | 5,640 |  |  | (7,187 | ) |  | 29,424 |  |  | (3,842 | ) |  | (855 | ) |  | 23,321 |  |  | (1,204 | ) |  | 6,498 |
Unrealized losses in OCI, net | — |  |  | — |  |  | — |  |  | (7,050 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Acquisitions | 2,519,029 |  |  | 350,384 |  |  | 92,006 |  |  | 14,788 |  |  | 51,217 |  |  | — |  |  | — |  |  | — |  |  | — |
Sales | (2,273,308 | ) |  | (357,441 | ) |  | (79,457 | ) |  | (202,423 | ) |  | (18,206 | ) |  | — |  |  | — |  |  | — |  |  | — |
Other settlements, net | (3,179 | ) |  | — |  |  | — |  |  | 360 |  |  | — |  |  | 71 |  |  | (23,834 | ) |  | 24 |  |  | 421 |
Ending balance - June 30, 2015 | $ | 3,036,865 |  |  | $ | 235,616 |  |  | $ | 116,141 |  |  | $ | 1,041,458 |  |  | $ | 168,462 |  |  | $ | 6,417 |  |  | $ | 606 |  |  | $ | 65,232 |  |  | $ | 1,173,336 |
(1) For the purpose of this presentation, derivative assets and liabilities, which consist of loan purchase commitments, are presented on a net basis. (2) Upon adoption of ASU 2014-13 on January 1, 2015, loans held-for-investment in, and ABS issued by, consolidated financial entities are now recorded at fair value. See Note 3 for further discussion. 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 June 30, 2015 and 2014. Gains or losses incurred on assets or liabilities sold, matured, called, or fully written down during the three and six months ended June 30, 2015 and 2014 are not included in this presentation. Portion of Net Gains (Losses) Attributable to Level 3 Assets and Liabilities Still Held at June 30, 2015 and 2014 Included in Net Income
|  | Included in Net Income
|  | Three Months Ended June 30, |  | Six Months Ended June 30,
(In Thousands) |  | 2015 |  | 2014 |  | 2015 |  | 2014
Assets |  |  |  |  |  |  |  |
Residential loans at Redwood |  | $ | (7,508 | ) |  | $ | 11,755 |  |  | $ | (5,441 | ) |  | $ | 11,964 |
Residential loans at consolidated Sequoia entities |  | 2,476 |  |  | — |  |  | 5,331 |  |  | — |
Commercial loans |  | (1,565 | ) |  | 2,008 |  |  | (56 | ) |  | 2,008 |
Trading securities |  | 4,601 |  |  | (9,257 | ) |  | (5,254 | ) |  | (13,688 | )
Available-for-sale securities |  | — |  |  | (264 | ) |  | — |  |  | (377 | )
MSRs |  | 21,296 |  |  | (4,974 | ) |  | 10,277 |  |  | (7,236 | )
Other assets - Guarantee asset |  | 228 |  |  | — |  |  | (700 | ) |  | — |
Liabilities |  |  |  |  |  |  |  |
Loan purchase commitments |  | (3,810 | ) |  | 1,707 |  |  | (1,826 | ) |  | 1,707 |
Commercial secured borrowing |  | 2,713 |  |  | 1,759 |  |  | 1,204 |  |  | 1,759 |
ABS issued |  | (3,552 | ) |  | — |  |  | (6,498 | ) |  | — |
The following table presents information on assets recorded at fair value on a non-recurring basis at June 30, 2015. 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 balance sheet at June 30, 2015. Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis at June 30, 2015
|  |  |  |  |  |  |  |  |  | Gain (Loss) for
June 30, 2015 |  | Carrying Value |  | Fair Value Measurements Using |  | Three Months Ended | Six Months Ended
(In Thousands) |  |  | Level 1 |  | Level 2 |  | Level 3 |  | June 30, 2015 | June 30, 2015
Assets |  |  |  |  |  |  |  |  |  |  |
Residential loans, at lower of cost or fair value |  | $ | 1,102 |  |  | $ | — |  |  | $ | — |  |  | $ | 1,102 |  |  | $ | 1 |  | $ | 1 |
REO |  | 1,017 |  |  | — |  |  | — |  |  | 1,017 |  |  | (170 | ) | (175 | )
The following table presents the net gains and losses recorded in each line item of our consolidated statements of income for the three and six months ended June 30, 2015 and 2014. Market Valuation Gains and Losses, Net
|  | Three Months Ended June 30, |  | Six Months Ended June 30,
(In Thousands) |  | 2015 |  | 2014 |  | 2015 |  | 2014
Mortgage banking and investment activities, net |  |  |  |  |  |  |  |
Residential loans, at fair value |  | $ | (3,176 | ) |  | $ | 13,994 |  |  | $ | (1,118 | ) |  | $ | 21,119 |
Consolidated Sequoia entities (1) |  | (684 | ) |  | (321 | ) |  | (1,777 | ) |  | (464 | )
Residential loans held-for-investment, at Redwood |  | (5,885 | ) |  | — |  |  | (3,907 | ) |  | — |
Commercial loans, at fair value |  | 987 |  |  | 5,714 |  |  | 6,845 |  |  | 9,340 |
Trading securities |  | 6,927 |  |  | (8,733 | ) |  | (7,162 | ) |  | (13,164 | )
Risk management derivatives, net |  | 4,645 |  |  | (12,300 | ) |  | (7,311 | ) |  | (25,108 | )
Impairments on AFS securities |  | — |  |  | (264 | ) |  | — |  |  | (377 | )
Guarantee asset |  | 299 |  |  | — |  |  | (784 | ) |  | — |
Loan purchase and forward sale commitments |  | 1,054 |  |  | 3,582 |  |  | 19,309 |  |  | 3,590 |
Other investments |  | (71 | ) |  | — |  |  | 83 |  |  | — |
Total mortgage banking and investment activities, net(2) |  | $ | 4,096 |  |  | $ | 1,672 |  |  | $ | 4,178 |  |  | $ | (5,064 | )
MSR Income (loss), net |  |  |  |  |  |  |  |
MSRs |  | $ | 15,675 |  |  | $ | (5,553 | ) |  | $ | (3,842 | ) |  | $ | (8,265 | )
Risk management derivatives, net |  | (21,814 | ) |  | — |  |  | (21,814 | ) |  | — |
Total MSR income (loss), net (3) |  | $ | (6,139 | ) |  | $ | (5,553 | ) |  | $ | (25,656 | ) |  | $ | (8,265 | )
Total market valuation gains and losses, net |  | $ | (2,043 | ) |  | $ | (3,881 | ) |  | $ | (21,478 | ) |  | $ | (13,329 | )
(1) | On January 1, 2015, we adopted ASU 2014-13 and began to record the assets and liabilities of consolidated Sequoia entities at fair value. This amount includes the net change in fair value of the consolidated assets and liabilities of these entities, which include residential loans held-for-investment, REO, and ABS issued. This combined amount represents the estimated change in value of our retained interests in these entities. See Note 3 for further discussion.
(2) | Mortgage banking and investment activities, net presented above does not include fee income or provisions for repurchases that is a component of mortgage banking and investment activities, net presented on our consolidated statements of income, as these amounts do not represent market valuation changes.
(3) | MSR Income (loss), net presented above does not include net fee income or provisions for repurchases that are a component of MSR Income (loss), net on our consolidated statements of income.
At June 30, 2015, our valuation policy and process had not changed from those described in our Annual Report on Form 10-K. 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. Fair Value Methodology for Level 3 Financial Instruments
June 30, 2015 |  | Fair Value |  |  |  |  |  |  | Weighted Average
(Dollars in Thousands, except input values) |  |  | Unobservable Input |  | Range |
Assets |  |  |  |  |  |  |  |  |  |
Residential loans, at fair value: |  |  |  |  |  |  |  |  |  |
Jumbo fixed rate loans uncommitted to sell |  | $ | 1,267,521 |  |  | IO Multiple |  | 4.3 - 5.0 | x |  | 4.4 |  | x
|  |  |  | Prepayment rate (Annual CPR) |  | 12 - 15 | % |  | 14 |  | %
|  |  |  | Senior spread to TBA price |  | $3.50 - $3.50 |  |  | $ | 3.50 |  |
|  |  |  | Subordinate spread to swap rate |  | 310 - 310 | bps |  | 310 |  | bps
|  |  |  | Credit support |  | 5 - 5 | % |  | 5 |  | %
|  |  |  | Whole loan spread to TBA price |  | $2.90 - $4.15 |  |  | $ | 4.00 |  |
Jumbo hybrid loans uncommitted to sell |  | 181,279 |  |  | Prepayment rate (Annual CPR) |  | 15 - 15 | % |  | 15 |  | %
|  |  | Spread to swap rate |  | 125 - 160 | bps |  | 129 |  | bps
Jumbo loans committed to sell |  | 350,951 |  |  | Committed Sales Price |  | $101 - $102 |  |  | $ | 102 |  |
Loans held by consolidated Sequoia entities (1) |  | 1,237,114 |  |  | Liability price |  | N/A |  |  | N/A |  |
Residential loans, at lower of cost or fair value |  | 1,102 |  |  | Loss severity |  | 13 - 30 | % |  | 20 |  | %
Commercial loans, at fair value |  | 235,616 |  |  | Spread to swap rate |  | 168 - 169 | bps |  | 168 |  | bps
|  |  |  | Credit support |  | 23 - 23 | % |  | 23 |  | %
Trading and AFS securities |  | 1,157,599 |  |  | Discount rate |  | 4 - 12 | % |  | 6 |  | %
|  |  |  | Prepayment rate (Annual CPR) |  | 1 - 35 | % |  | 13 |  | %
|  |  |  | Default rate |  | 0 - 35 | % |  | 8 |  | %
|  |  |  | Loss severity |  | 20 - 65 | % |  | 34 |  | %
|  |  |  | Credit support |  | 0 - 49 | % |  | 5 |  | %
MSRs |  | 168,462 |  |  | Discount rate |  | 8 - 11 | % |  | 10 |  | %
|  |  |  | Prepayment rate (Annual CPR) |  | 4 - 60 | % |  | 9 |  | %
|  |  |  | Per loan annual cost to service |  | $72 - $82 |  |  | $ | 78 |  |
Guarantee asset |  | 6,417 |  |  | Discount rate |  | 11 - 11 | % |  | 11 |  | %
|  |  |  | Prepayment rate (Annual CPR) |  | 5 - 27 | % |  | 12 |  | %
REO |  | 1,017 |  |  | Loss severity |  | 19 - 76 | % |  | 55 |  | %
Loan purchase commitments, net (2) |  | 605 |  |  | MSR Multiple |  | 0 - 4 | x |  | 3.0 |  | x
|  |  |  | Fallout rate |  | 2 - 97 | % |  | 26 |  | %
Liabilities |  |  |  |  |  |  |  |  |  |
ABS issued by consolidated Sequoia entities (1) |  | 1,173,336 |  |  | Discount rate |  | 5 - 8 | % |  | 5 |  | %
|  |  |  | Prepayment rate (Annual CPR) |  | 0 - 31 | % |  | 13 |  | %
|  |  |  | Default rate |  | 0 - 12 | % |  | 6 |  | %
|  |  |  | Loss severity |  | 20 - 32 | % |  | 26 |  | %
|  |  |  | Credit support |  | 0 - 69 | % |  | 11 |  | %
Commercial secured financing |  | 65,232 |  |  | Spread to swap rate |  | 168 - 168 | bps |  | 168 |  | bps
|  |  |  | Credit support |  | 23 - 23 | % |  | 23 |  | %
(1) | Upon adoption of ASU 2014-13 on January 1, 2015, loans held-for-investment in, and ABS issued by, consolidated Sequoia entities began to be recorded at fair value. In accordance with this new guidance, the fair value of the loans in these entities were based on the fair value of the liabilities issued by these entities, which we determined were more readily observable. See Note 3 for further discussion.
(2) | For the purpose of this presentation, loan purchase commitment assets and liabilities are presented net.
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 Estimated fair values for residential loans are determined using models that incorporate various observable inputs, including pricing information from recent securitizations and whole loan sales. Certain significant inputs in these models are considered unobservable and are therefore Level 3 in nature. Pricing inputs obtained from market securitization activity include indicative spreads to indexed TBA prices for senior RMBS and index swap rates, adjusted as necessary for current market conditions (Level 3). Pricing inputs obtained from market whole loan transaction activity include indicative spreads to indexed swap rates, adjusted as necessary for current market conditions (Level 3). Other observable inputs include Agency RMBS transactions, benchmark interest rates, and prepayment rates. These assets would generally decrease in value based upon an increase in the credit spread, prepayment speed, or credit support assumptions. Estimated fair values for conforming loans are determined based upon quoted market prices (Level 2). Conforming loans are mortgage loans that conform to Agency guidelines. As necessary, these values are adjusted for servicing value, market conditions and liquidity. Commercial loans Estimated fair values for senior commercial loans held-for-sale are determined by an exit price to securitization. Certain significant inputs in the valuation analysis are Level 3 in nature. Relevant market indicators that are factored into the analyses include pricing points for current third-party Commercial Mortgage-Backed Securities (“CMBS”) sales, pricing points for secondary sales of CMBS, yields for synthetic instruments that use CMBS bonds as an underlying index, indexed swap yields, credit rating agency guidance on expected credit enhancement levels for newly issued CMBS transactions, and interest rates (Level 3). In certain cases, commercial senior mortgage loans are valued based on third-party offers for the securities for purchase into securitization (Level 2). The estimated fair value of our senior commercial loans would generally decrease based upon an increase in credit spreads or required credit support. Estimated fair values for mezzanine commercial loans are determined by both market comparable pricing and discounted cash flow analysis valuation techniques (Level 3). Our discounted cash flow models utilize certain significant unobservable inputs including the underwritten net operating income and debt coverage ratio assumptions and actual performance relative to those underwritten metrics as well as estimated market discount rates. An increase in market discount rates would reduce the estimated fair value of the commercial loans. Real estate securities Real estate securities include residential, commercial, and other asset-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 analyses 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, loss severity and credit support. The estimated fair value of our securities would generally decrease based upon an increase in default rates, serious delinquencies, or a decrease in prepayment rates or credit support. 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 June 30, 2015, we received dealer price indications on 81% of our securities, representing 92% 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, financial futures, CMBX credit default index swaps, loan purchase commitments (LPCs), and forward sale commitments (FSCs). 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. TBA and financial futures fair values 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 fair values are estimated based on quoted Agency MBS prices, estimates of the fair value of the MSRs we expect to retain in the sale of the loans, and the probability that the mortgage loan will be purchased (Level 3). FSC fair values are obtained using quoted Agency prices. Model inputs can generally be verified and model selection does not involve significant management judgment (Level 2). 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). MSRs MSRs include the rights to service jumbo and conforming 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. These inputs include market discount rates, prepayment rates of serviced loans, and the market cost of servicing. 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, which is what we believe market participants would use to estimate fair value (Level 3). These discounted cash flow models utilize certain significant unobservable inputs including prepayment rate and discount rate assumptions. An increase in these unobservable inputs will 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 was less than 1% higher than the third-party valuation. 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 FHLBC 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 1). Guarantee Asset The guarantee asset represents the estimated fair value of cash flows we are contractually entitled to receive related to our 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 inputs include prepayment rates and market discount rate (Level 3). An increase in prepayment speed or market discount rate will 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 at consolidated Sequoia entities and at the Residential Resecuritization and Commercial Securitization 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). REO 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). Short-term debt Short-term debt includes our credit facilities that mature within one year. 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 Sequoia, Residential Resecuritization, and Commercial Securitization entities. 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 analyses include bid/ask spreads, the amount and timing of collateral 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 liabilities would generally decrease in value (become a larger liability) if credit losses decreased or if the prepayment rate or discount rate were to increase. FHLBC Borrowings FHLBC borrowings include amounts borrowed from the FHLBC that are secured 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 1). Commercial secured borrowings Commercial secured borrowings represent liabilities recognized as a result of transfers of portions of senior commercial mortgage loans to third parties that do not meet the criteria for sale treatment under GAAP and are accounted for as secured borrowings. Fair values for commercial secured borrowings are based on the fair values of the senior commercial loans associated with the borrowings (Level 3). Convertible notes Convertible notes include unsecured convertible and exchangeable senior notes. Fair values are determined using quoted prices in active markets (Level 2). Trust preferred securities and subordinated notes Estimated fair values of trust preferred securities and subordinated notes are determined using discounted cash flow analysis valuation techniques. 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. Estimated fair values are based on applying the market indicators to generate discounted cash flows (Level 3).

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- Definition The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information. + References Reference 1: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 820 -SubTopic 10 -Section 50 -Paragraph 2 -URI http://asc.fasb.org/extlink&oid=36462937&loc=d3e19207-110258 Reference 2: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 825 -SubTopic 10 -Section 50 -Paragraph 30 -URI http://asc.fasb.org/extlink&oid=6957238&loc=d3e14172-108612 Reference 3: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 825 -SubTopic 10 -Section 50 -Paragraph 28 -URI http://asc.fasb.org/extlink&oid=6957238&loc=d3e14064-108612 Reference 4: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 825 -SubTopic 10 -Section 50 -Paragraph 21 -URI http://asc.fasb.org/extlink&oid=35750535&loc=d3e13537-108611 Reference 5: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 825 -SubTopic 10 -Section 50 -Paragraph 16 -URI http://asc.fasb.org/extlink&oid=35750535&loc=d3e13504-108611 Reference 6: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 825 -SubTopic 10 -Section 50 -Paragraph 10 -URI http://asc.fasb.org/extlink&oid=35750535&loc=d3e13433-108611 + Details
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