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Fair Value of Financial Instruments | 3 Months Ended
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Mar. 31, 2017
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 March 31, 2017 and December 31, 2016. Table 5.1 – Carrying Values and Fair Values of Assets and Liabilities
|  | March 31, 2017 |  | December 31, 2016
|  | Carrying Value |  | Fair Value |  | Carrying Value |  | Fair Value
(In Thousands) |  |  |  |
Assets |  |  |  |  |  |  |  |
Residential loans, held-for-sale |  |  |  |  |  |  |  |
At fair value |  | $ | 375,407 |  |  | $ | 375,407 |  |  | $ | 834,193 |  |  | $ | 834,193 |
At lower of cost or fair value |  | 1,200 |  |  | 1,354 |  |  | 1,206 |  |  | 1,365 |
Residential loans, held-for-investment |  |  |  |  |  |  |  |
At fair value |  | 3,095,634 |  |  | 3,095,634 |  |  | 3,052,652 |  |  | 3,052,652 |
Trading securities |  | 591,152 |  |  | 591,152 |  |  | 445,687 |  |  | 445,687 |
Available-for-sale securities |  | 574,788 |  |  | 574,788 |  |  | 572,752 |  |  | 572,752 |
MSRs |  | 111,013 |  |  | 111,013 |  |  | 118,526 |  |  | 118,526 |
Cash and cash equivalents |  | 221,781 |  |  | 221,781 |  |  | 212,844 |  |  | 212,844 |
Restricted cash |  | 1,929 |  |  | 1,929 |  |  | 8,623 |  |  | 8,623 |
Accrued interest receivable |  | 17,645 |  |  | 17,645 |  |  | 18,454 |  |  | 18,454 |
Derivative assets |  | 26,660 |  |  | 26,660 |  |  | 36,595 |  |  | 36,595 |
REO (1) |  | 3,953 |  |  | 4,183 |  |  | 5,533 |  |  | 5,560 |
Margin receivable (1) |  | 83,229 |  |  | 83,229 |  |  | 68,038 |  |  | 68,038 |
FHLBC stock (1) |  | 43,393 |  |  | 43,393 |  |  | 43,393 |  |  | 43,393 |
Guarantee asset (1) |  | 3,846 |  |  | 3,846 |  |  | 4,092 |  |  | 4,092 |
Commercial loans (1) |  | 2,700 |  |  | 2,700 |  |  | 2,700 |  |  | 2,700 |
Pledged collateral (1) |  | 42,916 |  |  | 42,916 |  |  | 42,875 |  |  | 42,875 |
Liabilities |  |  |  |  |  |  |  |
Short-term debt |  | $ | 563,773 |  |  | $ | 563,773 |  |  | $ | 791,539 |  |  | $ | 791,539 |
Accrued interest payable |  | 16,035 |  |  | 16,035 |  |  | 9,608 |  |  | 9,608 |
Margin payable |  | 3,394 |  |  | 3,394 |  |  | 12,783 |  |  | 12,783 |
Guarantee obligation |  | 21,082 |  |  | 21,764 |  |  | 21,668 |  |  | 22,181 |
Derivative liabilities |  | 66,867 |  |  | 66,867 |  |  | 66,329 |  |  | 66,329 |
ABS issued at fair value, net |  | 728,391 |  |  | 728,391 |  |  | 773,462 |  |  | 773,462 |
FHLBC long-term borrowings |  | 1,999,999 |  |  | 1,999,999 |  |  | 1,999,999 |  |  | 1,999,999 |
Convertible notes, net |  | 482,994 |  |  | 496,820 |  |  | 482,195 |  |  | 493,365 |
Trust preferred securities and subordinated notes, net |  | 138,501 |  |  | 101,138 |  |  | 138,489 |  |  | 96,255 |
(1) | These assets are included in Other assets on our consolidated balance sheets.
During the three months ended March 31, 2017, we elected the fair value option for $3 million of residential senior securities, $142 million of subordinate securities, $1.09 billion of residential loans (principal balance), and $7 million of MSRs. We anticipate electing the fair value option for all future purchases of residential loans that we intend to sell to third parties or transfer to securitizations, for MSRs purchased or retained from sales of residential loans, and 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 March 31, 2017 and December 31, 2016, 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
March 31, 2017 |  | Carrying Value |  | Fair Value Measurements Using
(In Thousands) |  |  | Level 1 |  | Level 2 |  | Level 3
Assets |  |  |  |  |  |  |  |
Residential loans |  | $ | 3,471,041 |  |  | $ | — |  |  | $ | — |  |  | $ | 3,471,041 |
Trading securities |  | 591,152 |  |  | — |  |  | — |  |  | 591,152 |
Available-for-sale securities |  | 574,788 |  |  | — |  |  | — |  |  | 574,788 |
Derivative assets |  | 26,660 |  |  | 9,548 |  |  | 11,552 |  |  | 5,560 |
MSRs |  | 111,013 |  |  | — |  |  | — |  |  | 111,013 |
Pledged collateral |  | 42,916 |  |  | 42,916 |  |  | — |  |  | — |
FHLBC stock |  | 43,393 |  |  | — |  |  | 43,393 |  |  | — |
Guarantee asset |  | 3,846 |  |  | — |  |  | — |  |  | 3,846 |
Liabilities |  |  |  |  |  |  |  |  |
Derivative liabilities |  | $ | 66,867 |  |  | $ | 9,798 |  |  | $ | 56,296 |  |  | $ | 773 |
ABS issued |  | 728,391 |  |  | — |  |  | — |  |  | 728,391 |
December 31, 2016 |  | Carrying Value |  | Fair Value Measurements Using
(In Thousands) |  |  | Level 1 |  | Level 2 |  | Level 3
Assets |  |  |  |  |  |  |  |
Residential loans |  | $ | 3,886,845 |  |  | $ | — |  |  | $ | — |  |  | $ | 3,886,845 |
Trading securities |  | 445,687 |  |  | — |  |  | — |  |  | 445,687 |
Available-for-sale securities |  | 572,752 |  |  | — |  |  | — |  |  | 572,752 |
Derivative assets |  | 36,595 |  |  | 8,300 |  |  | 24,980 |  |  | 3,315 |
MSRs |  | 118,526 |  |  | — |  |  | — |  |  | 118,526 |
Pledged collateral |  | 42,875 |  |  | 42,875 |  |  | — |  |  | — |
FHLBC stock |  | 43,393 |  |  | — |  |  | 43,393 |  |  | — |
Guarantee asset |  | 4,092 |  |  | — |  |  | — |  |  | 4,092 |
Liabilities |  |  |  |  |  |  |  |
Derivative liabilities |  | $ | 66,329 |  |  | $ | 5,609 |  |  | $ | 56,919 |  |  | $ | 3,801 |
ABS issued |  | 773,462 |  |  | — |  |  | — |  |  | 773,462 |
The following table presents additional information about Level 3 assets and liabilities measured at fair value on a recurring basis for the three months ended March 31, 2017. Table 5.3 – Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis
|  | Assets |  |  |  | Liabilities
|  | Residential Loans |  | Trading Securities |  | AFS Securities |  | MSRs |  | Guarantee Asset |  | Derivatives(1) |  | ABS Issued
(In Thousands) |  |  |  |  |  |  |
Beginning balance - December 31, 2016 |  | $ | 3,886,845 |  |  | $ | 445,687 |  |  | $ | 572,752 |  |  | $ | 118,526 |  |  | $ | 4,092 |  |  | $ | (486 | ) |  | $ | 773,462 |
Acquisitions |  | 1,108,332 |  |  | 145,396 |  |  | 25,333 |  |  | 7,485 |  |  | — |  |  | — |  |  | — |
Sales |  | (1,377,574 | ) |  | (8,279 | ) |  | (18,456 | ) |  | (11,928 | ) |  | — |  |  | — |  |  | — |
Principal paydowns |  | (160,102 | ) |  | (2,836 | ) |  | (14,693 | ) |  | — |  |  | — |  |  | — |  |  | (55,609 | )
Gains (losses) in net income, net |  | 14,504 |  |  | 11,184 |  |  | 10,848 |  |  | (3,070 | ) |  | (246 | ) |  | 10,265 |  |  | 10,538 |
Unrealized losses in OCI, net |  | — |  |  | — |  |  | (996 | ) |  | — |  |  | — |  |  | — |  |  | — |
Other settlements, net(2) |  | (964 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | (4,992 | ) |  | — |
Ending Balance - March 31, 2017 |  | $ | 3,471,041 |  |  | $ | 591,152 |  |  | $ | 574,788 |  |  | $ | 111,013 |  |  | $ | 3,846 |  |  | $ | 4,787 |  |  | $ | 728,391 |
(1) | For the purpose of this presentation, derivative assets and liabilities, which consist of loan purchase commitments, are presented on a net basis.
(2) | Other settlements, net for derivatives represents the transfer of the fair value of loan purchase commitments at the time loans are acquired to the basis of residential loans.
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 March 31, 2017 and 2016. Gains or losses incurred on assets or liabilities sold, matured, called, or fully written down during the three months ended March 31, 2017 and 2016 are not included in this presentation. Table 5.4 – Portion of Net Gains (Losses) Attributable to Level 3 Assets and Liabilities Still Held at March 31, 2017 and 2016 Included in Net Income
|  | Included in Net Income
|  | Three Months Ended March 31,
(In Thousands) |  | 2017 |  | 2016
Assets |  |  |  |
Residential loans at Redwood |  | $ | 3,723 |  |  | $ | 27,285 |
Residential loans at consolidated Sequoia entities |  | 8,414 |  |  | (35,656 | )
Commercial loans |  | — |  |  | 2,171 |
Trading securities |  | 10,051 |  |  | (6,135 | )
Available-for-sale securities |  | (117 | ) |  | — |
MSRs |  | (916 | ) |  | (30,834 | )
Loan purchase commitments |  | 4,823 |  |  | 4,644 |
Other assets - Guarantee asset |  | (246 | ) |  | (1,425 | )
Liabilities |  |  |  |
Commercial secured borrowing |  | — |  |  | 2,171 |
ABS issued |  | (10,538 | ) |  | 33,515 |
The following table presents information on assets recorded at fair value on a non-recurring basis at March 31, 2017. 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 sheet at March 31, 2017. Table 5.5 – Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis at March 31, 2017
|  |  |  |  |  |  |  |  |  | Gain (Loss) for
March 31, 2017 |  | Carrying Value |  | Fair Value Measurements Using |  | Three Months Ended
(In Thousands) |  |  | Level 1 |  | Level 2 |  | Level 3 |  | March 31, 2017
Assets |  |  |  |  |  |  |  |  |  |
Residential loans, at lower of cost or fair value |  | $ | 862 |  |  | $ | — |  |  | $ | — |  |  | $ | 862 |  |  | $ | 2 |
Commercial loans, at lower of cost or fair value |  | 2,700 |  |  | — |  |  | — |  |  | 2,700 |  |  | — |
REO |  | 3,255 |  |  | — |  |  | — |  |  | 3,255 |  |  | (674 | )
The following table presents the net market valuation gains and losses recorded in each line item of our consolidated statements of income for the three months ended March 31, 2017 and 2016. Table 5.6 – Market Valuation Gains and Losses, Net
|  | Three Months Ended March 31,
(In Thousands) |  | 2017 |  | 2016
Mortgage Banking Activities, Net |  |  |  |
Residential loans held-for-sale, at fair value |  | $ | 8,532 |  |  | $ | 5,439 |
Residential loan purchase commitments |  | 10,265 |  |  | 12,635 |
Commercial loans, at fair value |  | — |  |  | 433 |
Sequoia securities |  | — |  |  | 1,484 |
Risk management derivatives, net |  | (1,400 | ) |  | (12,754 | )
Total mortgage banking activities, net (1) |  | $ | 17,397 |  |  | $ | 7,237 |
Investment Fair Value Changes, Net |  |  |  |
Residential loans held-for-investment at Redwood |  | $ | (2,333 | ) |  | $ | 23,463 |
Trading securities |  | 11,143 |  |  | (5,601 | )
Net investments in consolidated Sequoia entities |  | (1,810 | ) |  | (1,580 | )
Risk sharing investments |  | (205 | ) |  | (10 | )
Risk management derivatives, net |  | (5,127 | ) |  | (35,810 | )
Impairments on AFS securities |  | (117 | ) |  | — |
Total investment fair value changes, net |  | $ | 1,551 |  |  | $ | (19,538 | )
MSR Income (Loss), Net |  |  |  |
MSRs |  | $ | (3,070 | ) |  | $ | (44,604 | )
Risk management derivatives, net |  | (749 | ) |  | 41,057 |
Total MSR loss, net (2) |  | $ | (3,819 | ) |  | $ | (3,547 | )
Total Market Valuation Gains (Losses), Net |  | $ | 15,129 |  |  | $ | (15,848 | )
(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) | MSR income (loss), net presented above does not include net fee income or provisions for repurchases that are components of MSR income, net on our consolidated statements of income, as these amounts do not represent market valuation adjustments.
At March 31, 2017, our valuation policy and processes had not changed from those described in our Annual Report on Form 10-K for the year ended December 31, 2016. 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
March 31, 2017 |  | 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 |  | $ | 2,438,357 |  |  | Whole loan spread to TBA price |  | $ | 3.00 |  | - | $ | 4.13 |  |  |  | $ | 3.76 |  |
|  |  |  | Whole loan spread to swap rate |  | 190 |  | - | 285 |  | bps |  | 271 |  | bps
Jumbo hybrid loans |  | 66,842 |  |  | Prepayment rate (annual CPR) |  | 15 |  | - | 15 |  | % |  | 15 |  | %
|  |  |  | Whole loan spread to swap rate |  | 115 |  | - | 230 |  | bps |  | 171 |  | bps
Jumbo loans committed to sell |  | 220,221 |  |  | Whole loan committed sales price |  | $ | 100.27 |  | - | $ | 102.23 |  |  |  | $ | 102.07 |  |
Loans held by consolidated Sequoia entities (1) |  | 745,621 |  |  | Liability price |  |  |  | N/A |  |  |  | N/A |  |
Residential loans, at lower of cost or fair value |  | 862 |  |  | Loss severity |  | 15 |  | - | 30 |  | % |  | 20 |  | %
Trading and AFS securities |  | 1,165,940 |  |  | Discount rate |  | 4 |  | - | 12 |  | % |  | 8 |  | %
|  |  |  | Prepayment rate (annual CPR) |  | 1 |  | - | 56 |  | % |  | 17 |  | %
|  |  |  | Default rate |  | — |  | - | 19 |  | % |  | 2 |  | %
|  |  |  | Loss severity |  | 20 |  | - | 64 |  | % |  | 22 |  | %
|  |  |  | Credit support |  | — |  | - | 48 |  | % |  | 3 |  | %
MSRs |  | 111,013 |  |  | Discount rate |  | 10 |  | - | 16 |  | % |  | 11 |  | %
|  |  |  | Prepayment rate (annual CPR) |  | 4 |  | - | 34 |  | % |  | 9 |  | %
|  |  |  | Per loan annual cost to service |  | $ | 82 |  | - | $ | 82 |  |  |  | $ | 82 |  |
Guarantee asset |  | 3,846 |  |  | Discount rate |  | 11 |  | - | 11 |  | % |  | 11 |  | %
|  |  |  | Prepayment rate (annual CPR) |  | 10 |  | - | 10 |  | % |  | 10 |  | %
REO |  | 3,255 |  |  | Loss severity |  | 6 |  | - | 100 |  | % |  | 34 |  | %
Loan purchase commitments, net (2) |  | 4,787 |  |  | MSR multiple |  | 0.7 |  | - | 5.5 |  | x |  | 3.5 |  | x
|  |  |  | Pull-through rate |  | 12 |  | - | 100 |  | % |  | 69 |  | %
|  |  |  | Whole loan spread to TBA price |  | $ | 2.84 |  | - | $ | 4.13 |  |  |  | $ | 4.09 |  |
|  |  |  | Whole loan spread to swap rate - fixed rate |  | 190 |  | - | 285 |  | bps |  | 280 |  | bps
|  |  |  | Prepayment rate (annual CPR) |  | 15 |  | - | 15 |  | % |  | 15 |  | %
|  |  |  | Whole loan spread to swap rate - hybrid |  | 115 |  | - | 230 |  | bps |  | 141 |  | bps
Liabilities |  |  |  |  |  |  |  |  |  |  |  |
ABS issued (1) |  | 728,391 |  |  | Discount rate |  | 4 |  | - | 8 |  | % |  | 5 |  | %
|  |  |  | Prepayment rate (annual CPR) |  | 2 |  | - | 20 |  | % |  | 16 |  | %
|  |  |  | Default rate |  | 1 |  | - | 12 |  | % |  | 7 |  | %
|  |  |  | Loss severity |  | 20 |  | - | 32 |  | % |  | 27 |  | %
|  |  |  | Credit support |  | — |  | - | 80 |  | % |  | 9 |  | %
(1) | The fair value of the loans held by consolidated Sequoia entities was based on the fair value of the ABS issued by these entities, which we determined were more readily observable, in accordance with accounting guidance for collateralized financing entities.
(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 whole loan sales and securitizations. Certain significant inputs in these models are considered unobservable and are therefore Level 3 in nature. Pricing inputs obtained from market whole loan transaction activity include indicative spreads to indexed to be announced ("TBA") prices and indexed swap rates for fixed-rate loans and indexed swap rates for hybrid loans (Level 3). Pricing inputs obtained from market securitization activity include indicative spreads to indexed TBA prices for senior residential mortgage-backed securities ("RMBS") and indexed swap rates for subordinate RMBS, and credit support levels (Level 3). Other unobservable inputs also include assumed future prepayment rates. Observable inputs include benchmark interest rates, swap rates, and TBA prices. At March 31, 2017, our jumbo fixed-rate loans that were not committed to sell were priced using whole loan sale inputs. These assets would generally decrease in value based upon an increase in the credit spread, prepayment speed, or credit support assumptions. Commercial loans 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. In certain cases, commercial loans are valued based on third-party offers for the loans (Level 2). An increase in market discount rates would generally 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 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, 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 March 31, 2017, we received dealer price indications on 73% of our securities, representing 79% 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, and loan purchase commitments ("LPCs"). 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 financial 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 fair values for jumbo loans are estimated based on the estimated fair values of the underlying loans (as described in "Residential loans" above) as well as the probability that the mortgage loan will be purchased (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). 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. 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 1% of 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 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 as well as 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). 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). Guarantee Obligations In association with our risk sharing transactions with the Agencies, we have made certain guarantees. These obligations are initially recorded at fair value and subsequently carried at amortized cost. Fair values of guarantee obligations are determined using internal models that incorporate certain significant inputs that are considered unobservable and are therefore Level 3 in nature. Pricing inputs include assumed future prepayment rates, credit losses, and market discount rates. A decrease in future prepayment rates or discount rates, or an increase in credit losses, would generally cause the fair value of the guarantee obligations to decrease (become a larger liability). 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 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 analysis 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). A decrease in credit losses or discount rate, or an increase in prepayment rates, would generally cause the fair value of the ABS issued to decrease (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). Convertible notes Convertible notes include unsecured convertible and exchangeable senior notes. Fair values are determined using quoted prices in generally 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=66048111&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=73719730&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=73719730&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=73719730&loc=d3e13433-108611 + Details
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