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, 2018, we consolidated our Legacy Sequoia and Sequoia Choice securitization entities that we determined were VIEs and for which we determined we were the primary beneficiary. Additionally, in the third quarter of 2018 we consolidated certain third-party Freddie Mac K-Series securitization entities 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 for the consolidated Sequoia entities we are exposed to certain financial risks associated with our role as a sponsor, servicing administrator, or depositor of these entities or as a result of our having sold assets directly or indirectly to these entities. At September 30, 2018, the estimated fair value of our investments in the consolidated Legacy Sequoia, Sequoia Choice, and Freddie Mac K-Series entities was $12 million, $196 million, and $67 million, respectively. The following table presents a summary of the assets and liabilities of these VIEs.

Table 4.1 – Assets and Liabilities of Consolidated VIEs



September 30, 2018	Legacy Sequoia		Sequoia Choice		Freddie Mac K-Series		Total Consolidated VIEs
(Dollars in Thousands)	Legacy Sequoia		Sequoia Choice		Freddie Mac K-Series		Total Consolidated VIEs
Residential loans, held-for-investment	$	553,958	$	2,181,195	$	—	$	2,735,153
Multifamily loans, held-for-investment	—		—		942,165		942,165
Restricted cash	147		11		—		158
Accrued interest receivable	860		9,046		2,843		12,749
REO	2,915		—		—		2,915
Total Assets	$	557,880	$	2,190,252	$	945,008	$	3,693,140
Accrued interest payable	$	590	$	7,643	$	2,606	$	10,839
Accrued expenses and other liabilities	—		11		—		11
Asset-backed securities issued	544,923		1,986,456		875,606		3,406,985
Total Liabilities	$	545,513	$	1,994,110	$	878,212	$	3,417,835

Number of VIEs	20		6		2		28



December 31, 2017	Legacy Sequoia		Sequoia Choice		Freddie Mac K-Series		Total Consolidated VIEs
(Dollars in Thousands)	Legacy Sequoia		Sequoia Choice		Freddie Mac K-Series		Total Consolidated VIEs
Residential loans, held-for-investment	$	632,817	$	620,062	$	—	$	1,252,879
Restricted cash	147		4		—		151
Accrued interest receivable	867		2,524		—		3,391
REO	3,353		—		—		3,353
Total Assets	$	637,184	$	622,590	$	—	$	1,259,774
Accrued interest payable	$	537	$	2,031	$	—	$	2,568
Accrued expenses and other liabilities	—		4		—		4
Asset-backed securities issued	622,445		542,140		—		1,164,585
Total Liabilities	$	622,982	$	544,175	$	—	$	1,167,157

Number of VIEs	20		2		—		22

We consolidate the assets and liabilities of certain Sequoia securitization entities, as we did not meet the GAAP sale criteria at the time we transferred financial assets to these entities. Our involvement in consolidated Sequoia entities continues in the following ways: (i) we continue to hold subordinate investments in each entity, and for certain entities, more senior investments; (ii) we maintain certain discretionary rights associated with our sponsorship of, or our subordinate investments in, each entity; and (iii) we continue to hold a right to call the assets of certain entities (once they have been paid down below a specified threshold) at a price equal to, or in excess of, the current outstanding principal amount of the entity’s asset-backed securities issued. These factors have resulted in our continuing to consolidate the assets and liabilities of these Sequoia entities in accordance with GAAP.

Beginning in the third quarter of 2018, we consolidated the assets and liabilities of two Freddie Mac K-Series securitization trusts as we invested in multifamily subordinate securities issued by these trusts and maintain certain discretionary rights associated with the ownership of these investments. We determined that our involvement with these VIEs reflected a controlling financial interest, and that we have both the power to direct the activities that most significantly impact the economic performance of the VIEs and the right to receive benefits of and the obligation to absorb losses from the VIE that could potentially be significant to the VIEs.

Analysis of Unconsolidated VIEs with Continuing Involvement

Since 2012, we have transferred residential loans to 43 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 certain of these transfers to securitization entities, for the transferred loans where we held the servicing rights prior to the transfer and continued to hold the servicing rights following the transfer, we recorded mortgage servicing rights ("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 servicing rights (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, 2018 and 2017.

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



	Three Months Ended September 30,				Nine Months Ended September 30,
(In Thousands)	2018		2017		2018		2017
Principal balance of loans transferred	$	327,511	$	839,264	$	2,735,644	$	2,223,387
Trading securities retained, at fair value	2,583		24,617		48,831		55,607
AFS securities retained, at fair value	776		4,416		6,728		11,476
MSRs recognized	—		—		—		7,123

The following table summarizes the cash flows during the three and nine months ended September 30, 2018 and 2017 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 September 30,						Nine Months Ended September 30,
(In Thousands)	2018			2017			2018			2017
Proceeds from new transfers	$	329,231		$	839,642		$	2,723,012		$	2,213,151
MSR fees received	3,405			3,631			10,216			10,804
Funding of compensating interest, net	(46		)	(35		)	(102		)	(114		)
Cash flows received on retained securities	7,267			6,882			21,720			19,843

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 and nine months ended September 30, 2018 and 2017.

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



	Three Months Ended September 30, 2018					Three Months Ended September 30, 2017
At Date of Securitization	MSRs	Senior IO Securities		Subordinate Securities		MSRs	Senior IO Securities		Subordinate Securities
Prepayment rates	N/A	9	%	9	%	N/A	11	%	10	%
Discount rates	N/A	14	%	7	%	N/A	14	%	5	%
Credit loss assumptions	N/A	0.20	%	0.20	%	N/A	0.25	%	0.25	%



	Nine Months Ended September 30, 2018					Nine Months Ended September 30, 2017
At Date of Securitization	MSRs	Senior IO Securities		Subordinate Securities		MSRs		Senior IO Securities		Subordinate Securities
Prepayment rates	N/A	9	%	10	%	9	%	10	%	10	%
Discount rates	N/A	14	%	5	%	11	%	13	%	5	%
Credit loss assumptions	N/A	0.20	%	0.20	%	N/A		0.25	%	0.25	%

The following table presents additional information at September 30, 2018 and December 31, 2017, 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, 2018		December 31, 2017
On-balance sheet assets, at fair value:
Interest-only, senior and subordinate securities, classified as trading	$	130,598	$	101,426
Subordinate securities, classified as AFS	163,870		219,255
Mortgage servicing rights	62,325		60,980
Maximum loss exposure ⁽¹⁾	$	356,793	$	381,661
Assets transferred:
Principal balance of loans outstanding	$	10,349,405	$	8,364,148
Principal balance of loans 30+ days delinquent	19,625		27,926

(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, 2018 and December 31, 2017.

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



September 30, 2018	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
(Dollars in Thousands)	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
Fair value at September 30, 2018	$	62,325		$	62,996		$	231,472
Expected life (in years)⁽²⁾	9			8			15
Prepayment speed assumption (annual CPR)⁽²⁾	7		%	9		%	9		%
Decrease in fair value from:
10% adverse change	$	1,631		$	2,156		$	547
25% adverse change	3,974			5,145			1,361
Discount rate assumption⁽²⁾	11		%	11		%	6		%
Decrease in fair value from:
100 basis point increase	$	2,469		$	2,383		$	22,243
200 basis point increase	4,812			4,592			41,116
Credit loss assumption ⁽²⁾	N/A			0.20		%	0.20		%
Decrease in fair value from:
10% higher losses	N/A			$	—		$	559
25% higher losses	N/A			—			4,220



December 31, 2017	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
(Dollars in Thousands)	MSRs			Senior Securities ⁽¹⁾			Subordinate Securities
Fair value at December 31, 2017	$	60,980		$	33,773		$	286,908
Expected life (in years)⁽²⁾	8			6			13
Prepayment speed assumption (annual CPR)⁽²⁾	9		%	10		%	11		%
Decrease in fair value from:
10% adverse change	$	2,022		$	1,371		$	611
25% adverse change	4,839			3,289			1,506
Discount rate assumption⁽²⁾	11		%	11		%	5		%
Decrease in fair value from:
100 basis point increase	$	2,386		$	1,158		$	25,827
200 basis point increase	4,597			2,265			47,885
Credit loss assumption ⁽²⁾	N/A			0.25		%	0.25		%
Decrease in fair value from:
10% higher losses	N/A			$	—		$	1,551
25% higher losses	N/A			—			3,873


(1)	Senior securities included $63 million and $34 million of interest-only securities at September 30, 2018 and December 31, 2017, respectively.


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

Analysis of Unconsolidated 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, 2018, grouped by security type.

Table 4.7 – Third-Party Sponsored VIE Summary



(Dollars in Thousands)	September 30, 2018		December 31, 2017
Mortgage-Backed Securities
Senior	$	214,655	$	216,066
Mezzanine	538,847		508,010
Subordinate	422,114		431,753
Total Investments in Third-Party Sponsored VIEs	$	1,175,616	$	1,155,829

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.