Principles of Consolidation

GAAP requires us to consider whether securitizations we sponsor and other transfers of financial assets should be treated as sales or financings, as well as whether any VIEs that we hold variable interests in – for example, certain legal entities often used in securitization and other structured finance transactions – should be included in our consolidated financial statements. The GAAP principles we apply require us to reassess our requirement to consolidate VIEs each quarter and therefore our determination may change based upon new facts and circumstances pertaining to each VIE. This could result in a material impact to our consolidated financial statements during subsequent reporting periods.

Analysis of Consolidated VIEs

At March 31, 2017, 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. 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



(Dollars in Thousands)	March 31, 2017		December 31, 2016
Residential loans, held-for-investment	$	745,621	$	791,636
Restricted cash	148		148
Accrued interest receivable	972		1,000
Other assets	3,953		5,533
Total Assets	$	750,694	$	798,317
Accrued interest payable	$	532	$	518
Asset-backed securities issued	728,391		773,462
Total Liabilities	$	728,923	$	773,980

Number of VIEs	20		20

Analysis of Unconsolidated VIEs with Continuing Involvement

Since 2012, we have transferred residential loans to 32 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 months ended March 31, 2017 and 2016.

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



	Three Months Ended March 31,
(In Thousands)	2017		2016
Principal balance of loans transferred	$	1,035,524	$	—
Trading securities retained, at fair value	20,703		—
AFS securities retained, at fair value	5,155		—
MSRs recognized	7,123		—

The following table summarizes the cash flows during the three months ended March 31, 2017 and 2016 between us and the unconsolidated VIEs sponsored by us and accounted for as sales since 2012.

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



	Three Months Ended March 31,
(In Thousands)	2017			2016
Proceeds from new transfers	$	1,022,024		$	—
MSR fees received	3,475			3,523
Funding of compensating interest	(38		)	(79		)
Cash flows received on retained securities	6,373			11,191

The following table presents the key weighted-average assumptions used to measure MSRs and securities retained at the date of securitization for securitizations completed during the three months ended March 31, 2017 and 2016.

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



	Three Months Ended March 31, 2017						Three Months Ended March 31, 2016
At Date of Securitization	MSRs		Senior Securities		Subordinate Securities		MSRs	Senior Securities	Subordinate Securities
Prepayment rates	9	%	10	%	10	%	N/A	N/A	N/A
Discount rates	11	%	11	%	5	%	N/A	N/A	N/A
Credit loss assumptions	N/A		0.25	%	0.25	%	N/A	N/A	N/A

The following table presents additional information at March 31, 2017 and December 31, 2016, related to unconsolidated VIEs sponsored by Redwood and accounted for as sales since 2012.

Table 4.5 – Unconsolidated VIEs Sponsored by Redwood



(In Thousands)	March 31, 2017		December 31, 2016
On-balance sheet assets, at fair value:
Interest-only, senior and subordinate securities, classified as trading	$	61,464	$	41,909
Subordinate securities, classified as AFS	230,809		234,025
Mortgage servicing rights	65,018		58,800
Maximum loss exposure ⁽¹⁾	$	357,291	$	334,734
Assets transferred:
Principal balance of loans outstanding	$	7,639,569	$	6,870,398
Principal balance of loans 30+ days delinquent	18,830		21,427

(1)

Maximum loss exposure from our involvement with unconsolidated VIEs pertains to the carrying value of our securities and MSRs retained from these VIEs and represents estimated losses that would be incurred under severe, hypothetical circumstances, such as if the value of our interests and any associated collateral declines to zero. This does not include, for example, any potential exposure to representation and warranty claims associated with our initial transfer of loans into a securitization.

The following table presents key economic assumptions for assets retained from unconsolidated VIEs and the sensitivity of their fair values to immediate adverse changes in those assumptions at March 31, 2017 and December 31, 2016.

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



March 31, 2017	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
(Dollars in Thousands)	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
Fair value at March 31, 2017	$	65,018		$	28,799		$	263,474
Expected life (in years)⁽²⁾	7			6			13
Prepayment speed assumption (annual CPR)⁽²⁾	10		%	8		%	12		%
Decrease in fair value from:
10% adverse change	$	2,399		$	1,190		$	970
25% adverse change	5,707			2,836			2,381
Discount rate assumption⁽²⁾	11		%	8		%	6		%
Decrease in fair value from:
100 basis point increase	$	2,346		$	1,200		$	21,360
200 basis point increase	4,524			2,311			39,818
Credit loss assumption ⁽²⁾	N/A			0.25		%	0.25		%
Decrease in fair value from:
10% higher losses	N/A			$	19		$	1,312
25% higher losses	N/A			48			3,279



December 31, 2016	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
(Dollars in Thousands)	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
Fair value at December 31, 2016	$	58,800		$	26,618		$	249,317
Expected life (in years)⁽²⁾	7			6			12
Prepayment speed assumption (annual CPR)⁽²⁾	11		%	8		%	12		%
Decrease in fair value from:
10% adverse change	$	2,226		$	1,075		$	997
25% adverse change	5,284			2,569			2,494
Discount rate assumption⁽²⁾	11		%	8		%	6		%
Decrease in fair value from:
100 basis point increase	$	2,088		$	1,105		$	19,574
200 basis point increase	4,032			2,128			36,574
Credit loss assumption ⁽²⁾	N/A			0.25		%	0.25		%
Decrease in fair value from:
10% higher losses	N/A			$	19		$	1,174
25% higher losses	N/A			49			2,933


(1)	Senior securities included $29 million and $27 million of interest only securities at March 31, 2017 and December 31, 2016, 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 March 31, 2017, grouped by security type.

Table 4.7 – Third-Party Sponsored VIE Summary



(Dollars in Thousands)	March 31, 2017
Mortgage-Backed Securities
Senior	$	147,300
Re-REMIC	73,730
Subordinate	652,637
Total Investments in Third-Party Sponsored VIEs	$	873,667

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.