Other Assets and Liabilities

Other assets at June 30, 2018 and December 31, 2017, are summarized in the following table.

Table 9.1 – Components of Other Assets



(In Thousands)	June 30, 2018		December 31, 2017
Mortgage servicing rights	$	64,674	$	63,598
Margin receivable	49,538		85,044
FHLBC stock	43,393		43,393
Pledged collateral	42,201		42,615
Participation in loan warehouse facility	41,658		—
Investment in 5 Arches	10,973		—
Fixed assets and leasehold improvements ⁽¹⁾	5,189		2,645
Guarantee asset	2,936		2,869
REO	2,649		3,354
Other	9,459		15,046
Total Other Assets	$	272,670	$	258,564


(1)	Fixed assets and leasehold improvements had a basis of $10 million and accumulated depreciation of $4 million at June 30, 2018.

Accrued expenses and other liabilities at June 30, 2018 and December 31, 2017 are summarized in the following table.

Table 9.2 – Components of Accrued Expenses and Other Liabilities



(In Thousands)	June 30, 2018		December 31, 2017
Guarantee obligations	$	18,124	$	19,487
Accrued compensation	13,387		24,025
Deferred tax liabilities	11,764		11,764
Unsettled trades	11,328		13
Margin payable	7,282		390
Residential loan and MSR repurchase reserve	4,443		4,916
Accrued income taxes payable	2,547		—
Legal reserve	2,000		2,000
Other	8,696		5,134
Total Accrued Expenses and Other Liabilities	$	79,571	$	67,729

Mortgage Servicing Rights

We invest in mortgage servicing rights associated with residential mortgage loans and contract with licensed sub-servicers to perform all servicing functions for these loans. The majority of our investments in MSRs were made through the retention of servicing rights associated with the residential jumbo mortgage loans that we acquire and subsequently transfer to third parties. We hold our MSR investments at our taxable REIT subsidiary.

At June 30, 2018 and December 31, 2017, our MSRs had a fair value of $65 million and $64 million, respectively, and were associated with loans with an aggregate principal balance of $5.16 billion and $5.56 billion, respectively.

The following table presents activity for MSRs for the three and six months ended June 30, 2018 and 2017.

Table 9.3 – Activity for MSRs



	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2018			2017			2018			2017
Balance at beginning of period	$	66,496		$	111,013		$	63,598		$	118,526
Additions	—			216			—			7,701
Sales	(1,077		)	(41,038		)	(1,077		)	(52,966		)
Changes in fair value due to:
Changes in assumptions ⁽¹⁾	943			(3,356		)	5,289			(4,013		)
Other changes ⁽²⁾	(1,688		)	(3,065		)	(3,136		)	(5,478		)
Balance at End of Period	$	64,674		$	63,770		$	64,674		$	63,770


(1)	Primarily reflects changes in prepayment assumptions due to changes in market interest rates.


(2)	Represents changes due to the realization of expected cash flows.

The following table presents the components of our MSR income for the three and six months ended June 30, 2018 and 2017.

Table 9.4 – Components of MSR Income, net



	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2018			2017			2018			2017
Servicing income	$	3,802		$	6,511		$	7,597		$	13,418
Cost of sub-servicer	(338		)	(659		)	(930		)	(2,039		)
Net servicing fee income	3,464			5,852			6,667			11,379
Market valuation changes of MSRs	(745		)	(6,421		)	2,147			(9,491		)
Market valuation changes of associated derivatives	(1,122		)	3,040			(6,261		)	2,291
MSR reversal of provision for repurchases	277			307			277			312
MSR Income, Net ⁽¹⁾	$	1,874		$	2,778		$	2,830		$	4,491


(1)	MSR income, net is included in Other income, net on our consolidated statements of income.

Margin Receivable and Payable

Margin receivable and payable resulted from margin calls between us and our counterparties under derivatives, master repurchase agreements, and warehouse facilities, whereby we or the counterparty posted collateral.

FHLB Stock

In accordance with our FHLB-member subsidiary's borrowing agreement with the FHLBC, our subsidiary is required to purchase and hold stock in the FHLBC. See Note 3 and Note 12 for additional information on this borrowing agreement.

Participation in Loan Warehouse Facility

In the second quarter of 2018, we invested in a subordinated participation in a revolving mortgage loan warehouse credit facility of one of our loan sellers. While our interest is subordinated, it is secured by the loans collateralizing the facility and we have recourse to the loan seller. We account for this subordinated participation interest as a loan receivable at amortized cost, and all associated interest income is recorded as a component of Other interest income in our consolidated statements of income. We monitor the credit quality of the warehouse line of credit and utilize such information in our evaluation of the appropriateness of the allowance for credit losses. As of June 30, 2018, we determined no allowance for credit losses was required for this receivable.

Investment in 5 Arches

On May 1, 2018, we acquired a 20% minority interest in 5 Arches, LLC ("5 Arches") for $10 million, which included a one-year option to purchase all remaining equity in the company for a combination of cash and stock totaling $40 million. 5 Arches is an originator and asset manager of business-purpose residential mortgage loans, including loans to investors in single-family rental properties, bridge loans for investors in multifamily properties, and loans to investors rehabilitating and reselling residential properties. In connection with this investment, we also entered into a loan flow purchase agreement, which gives us exclusive access to 5 Arches' single-family rental loan production for a one-year period. At June 30, 2018, we had not purchased any loans under this agreement.

We account for our ownership interest in 5 Arches using the equity method of accounting as we are able to exert significant influence over but do not control the activities of the investee. At June 30, 2018, the carrying amount of our investment in 5 Arches was $7 million. We account for our purchase option as a cost method investment, which had a carrying value of $4 million at June 30, 2018. We have elected to record our share of earnings or losses from 5 Arches on a one-quarter lag, and as such, we did not record any equity method investment earnings or losses associated with this investment during the three months ended June 30, 2018.

Guarantee Asset, Pledged Collateral, and Guarantee Obligations

The pledged collateral, guarantee asset, and guarantee obligations presented in the tables above are related to our risk-sharing arrangements with Fannie Mae and Freddie Mac. In accordance with these arrangements, we are required to pledge collateral to secure our guarantee obligations. See Note 13 for additional information on our risk-sharing arrangements.

REO

The carrying value of REO at June 30, 2018 was $3 million, which includes the net effect of $2 million related to transfers into REO during the six months ended June 30, 2018, offset by $3 million of REO liquidations, and $0.4 million of unrealized gains resulting from market valuation adjustments. At June 30, 2018 and December 31, 2017, there were 9 and 14 REO properties, respectively, recorded on our consolidated balance sheets, all of which were owned at consolidated Legacy Sequoia entities.

Legal and Repurchase Reserves

See Note 13 for additional information on the legal and residential repurchase reserves.