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 September 30, 2016, we consolidated certain Sequoia securitization entities issued prior to 2012 that we determined were VIEs and for which we determined we were the primary beneficiary. As discussed in Note 2, we previously consolidated our Commercial Securitization through the second quarter of 2016 and our Residential Resecuritization through the fourth quarter of 2015. 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.

Table 4.1 – Assets and Liabilities of Consolidated VIEs



September 30, 2016	Sequoia Entities
(Dollars in Thousands)	Sequoia Entities
Residential loans, held-for-investment	$	839,976
Restricted cash	148
Accrued interest receivable	1,030
Other assets	6,245
Total Assets	$	847,399
Accrued interest payable	$	523
Asset-backed securities issued	819,868
Total Liabilities	$	820,391

Number of VIEs	20



December 31, 2015	Sequoia Entities		Commercial Securitization		Total
(Dollars in Thousands)	Sequoia Entities		Commercial Securitization		Total
Residential loans, held-for-investment	$	1,021,870	$	—	$	1,021,870
Commercial loans, held-for-investment	—		166,016		166,016
Restricted cash	228		137		365
Accrued interest receivable	1,131		1,297		2,428
Other assets	4,895		—		4,895
Total Assets	$	1,028,124	$	167,450	$	1,195,574
Accrued interest payable	$	555	$	249	$	804
Accrued expenses and other liabilities	100		—		100
Asset-backed securities issued, net	996,820		53,137		1,049,957
Total Liabilities	$	997,475	$	53,386	$	1,050,861

Number of VIEs	21		1		22

Analysis of Unconsolidated VIEs with Continuing Involvement

Since 2012, we have transferred residential loans to 28 Sequoia securitization entities sponsored by us and accounted for these transfers as sales for financial reporting purposes, in accordance with ASC 860. We also determined we were not the primary beneficiary of these VIEs as we lacked the power to direct the activities that will have the most significant economic impact on the entities. For the transferred loans where we held the servicing rights prior to the transfer and continue to hold the servicing rights, we recorded MSRs on our consolidated balance sheets, and classified those MSRs as Level 3 assets. We also retained senior and subordinate securities in these securitizations that we classified as Level 3 assets. Our continuing involvement in these securitizations is limited to customary servicing obligations associated with retaining residential MSRs (which we retain a third-party sub-servicer to perform) and the receipt of interest income associated with the securities we retained.

The following table presents information related to securitization transactions that occurred during the three and nine months ended September 30, 2016 and 2015.

Table 4.2 – Securitization Activity Related to Unconsolidated VIEs Sponsored by Redwood



	Three Months Ended September 30,				Nine Months Ended September 30,
(In Thousands)	2016		2015		2016		2015
Principal balance of loans transferred	$	348,537	$	—	$	693,427	$	1,038,451
Trading securities retained, at fair value	—		—		—		33,389
AFS securities retained, at fair value	1,839		—		3,673		6,309
MSRs recognized	1,971		—		4,102		7,874

The following table summarizes the cash flows during the three and nine months ended September 30, 2016 and 2015 between us and the unconsolidated VIEs sponsored by us.

Table 4.3 – Cash Flows Related to Unconsolidated VIEs Sponsored by Redwood



	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	2016			2015			2016			2015
Proceeds from new transfers	$	356,497		$	—		$	708,539		$	1,018,312
MSR fees received	3,473			3,817			10,397			11,287
Funding of compensating interest	(98		)	(86		)	(254		)	(283		)
Cash flows received on retained securities	6,384			8,190			24,314			31,541

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

Table 4.4 – Assumptions Related to Assets Retained from Unconsolidated VIEs Sponsored by Redwood




	Three Months Ended September 30, 2016				Three Months Ended September 30, 2015
At Date of Securitization	MSRs		Subordinate Securities		MSRs		Senior Securities		Subordinate Securities
Prepayment rate	24	%	15	%	N/A		N/A		N/A
Discount rates	11	%	7	%	N/A		N/A		N/A
Credit loss assumptions	N/A		0.25	%	N/A		N/A		N/A

	Nine Months Ended September 30, 2016				Nine Months Ended September 30, 2015
At Date of Securitization	MSRs		Subordinate Securities		MSRs		Senior Securities		Subordinate Securities
Prepayment rate	22	%	15	%	14	%	8	%	8	%
Discount rates	11	%	7	%	11	%	3	%	6	%
Credit loss assumptions	N/A		0.25	%	N/A		0.25	%	0.25	%

The following table presents additional information at September 30, 2016 and December 31, 2015, related to unconsolidated VIEs sponsored by Redwood and accounted for as sales since 2012.

Table 4.5 – Unconsolidated VIEs Sponsored by Redwood



(In Thousands)	September 30, 2016		December 31, 2015
On-balance sheet assets, at fair value:
Interest-only, senior and subordinate securities, classified as trading	$	31,271	$	258,697
Subordinate securities, classified as AFS	237,248		272,715
Mortgage servicing rights	35,609		56,984
Maximum loss exposure ⁽¹⁾	$	304,128	$	588,396
Assets transferred:
Principal balance of loans outstanding	$	6,990,350	$	7,318,167
Principal balance of delinquent loans 30+ days delinquent	19,775		18,300

(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 September 30, 2016 and December 31, 2015.

Table 4.6 – Key Assumptions and Sensitivity Analysis for Assets Retained from Unconsolidated VIEs Sponsored by Redwood



September 30, 2016	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
(Dollars in Thousands)	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
Fair value at September 30, 2016	$	35,609		$	19,098		$	249,421
Expected life (in years)⁽²⁾	5			5			12
Prepayment speed assumption (annual CPR)⁽²⁾	25		%	14		%	14		%
Decrease in fair value from:
10% adverse change	$	2,414		$	893		$	955
25% adverse change	5,687			2,119			2,364
Discount rate assumption⁽²⁾	11		%	15		%	5		%
Decrease in fair value from:
100 basis point increase	$	861		$	551		$	19,395
200 basis point increase	1,674			1,072			36,292
Credit loss assumption ⁽²⁾	N/A			0.25		%	0.25		%
Decrease in fair value from:
10% higher losses	N/A			$	11		$	1,220
25% higher losses	N/A			27			3,048



December 31, 2015	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
(Dollars in Thousands)	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
Fair value at December 31, 2015	$	56,984		$	248,570		$	282,842
Expected life (in years)⁽²⁾	7			5			12
Prepayment speed assumption (annual CPR)⁽²⁾	11		%	10		%	12		%
Decrease in fair value from:
10% adverse change	$	2,868		$	2,042		$	901
25% adverse change	6,119			4,810			2,278
Discount rate assumption⁽²⁾	11		%	5		%	6		%
Decrease in fair value from:
100 basis point increase	$	2,711		$	10,029		$	21,981
200 basis point increase	4,745			19,365			41,156
Credit loss assumption ⁽²⁾	N/A			0.25		%	0.25		%
Decrease in fair value from:
10% higher losses	N/A			$	35		$	1,244
25% higher losses	N/A			86			3,129


(1)	Senior securities included $19 million and $31 million of interest only securities at September 30, 2016 and December 31, 2015, respectively.


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

Analysis of Third-Party VIEs

Third-party VIEs are securitization entities in which we maintain an economic interest, but do not sponsor. Our economic interest may include several securities from the same third-party VIE, and in those cases, the analysis is performed in consideration of all of our interests. The following table presents a summary of our interests in third-party VIEs at September 30, 2016, grouped by security type.

Table 4.7 – Third-Party Sponsored VIE Summary



(Dollars in Thousands)	September 30, 2016
Mortgage Backed Securities
Senior	$	76,685
Re-REMIC	161,234
Subordinate	430,471
Total Investments in Third-Party Sponsored VIEs	$	668,390

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

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