Other Assets and Liabilities

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

Table 11.1 – Components of Other Assets



(In Thousands)	September 30, 2018		December 31, 2017
Mortgage servicing rights	$	63,785	$	63,598
Security purchase deposit	57,982		—
Margin receivable	48,655		85,044
FHLBC stock	43,393		43,393
Pledged collateral	42,127		42,615
Participation in loan warehouse facility	39,219		—
Investment receivable	36,463		1,147
Investment in 5 Arches	10,772		—
Fixed assets and leasehold improvements ⁽¹⁾	5,409		2,645
REO	2,915		3,354
Guarantee asset	2,885		2,869
Other	12,270		13,899
Total Other Assets	$	365,875	$	258,564


(1)	Fixed assets and leasehold improvements had a basis of $10 million and accumulated depreciation of $5 million at September 30, 2018.

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

Table 11.2 – Components of Accrued Expenses and Other Liabilities



(In Thousands)	September 30, 2018		December 31, 2017
Margin payable	$	33,950	$	390
Accrued compensation	18,485		24,025
Guarantee obligations	17,423		19,487
Deferred tax liabilities	11,764		11,764
Residential loan and MSR repurchase reserve	4,709		4,916
Unsettled trades	4,071		13
Accrued income taxes payable	3,313		—
Legal reserve	2,000		2,000
Other	6,563		5,134
Total Accrued Expenses and Other Liabilities	$	102,278	$	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 acquired and subsequently transferred to third parties. We hold our MSR investments at our taxable REIT subsidiary.

At September 30, 2018 and December 31, 2017, our MSRs had a fair value of $64 million for both periods, and were associated with loans with an aggregate principal balance of $5.02 billion and $5.56 billion, respectively.

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

Table 11.3 – Activity for MSRs



	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	2018			2017			2018			2017
Balance at beginning of period	$	64,674		$	63,770		$	63,598		$	118,526
Additions	—			256			—			7,957
Sales	—			—			(1,077		)	(52,966		)
Changes in fair value due to:
Changes in assumptions ⁽¹⁾	1,099			563			6,388			(3,450		)
Other changes ⁽²⁾	(1,988		)	(1,661		)	(5,124		)	(7,139		)
Balance at End of Period	$	63,785		$	62,928		$	63,785		$	62,928


(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 nine months ended September 30, 2018 and 2017.

Table 11.4 – Components of MSR Income, net



	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	2018			2017			2018			2017
Servicing income	$	4,004		$	3,872		$	11,601		$	17,290
Cost of sub-servicer	(324		)	(476		)	(1,254		)	(2,515		)
Net servicing fee income	3,680			3,396			10,347			14,775
Market valuation changes of MSRs	(823		)	(1,351		)	1,324			(10,842		)
Market valuation changes of associated derivatives	(890		)	(422		)	(7,151		)	1,869
MSR reversal of provision for repurchases	—			(8		)	277			304
MSR Income, Net ⁽¹⁾	$	1,967		$	1,615		$	4,797		$	6,106


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

Security Purchase Deposit

In the third quarter of 2018, we entered into an agreement with Freddie Mac to purchase mortgage-backed securities to be issued in a securitization transaction sponsored by Freddie Mac that is expected to close in the fourth quarter of 2018. Pursuant to the terms of this agreement, we plan to acquire subordinate securities backed by a pool of seasoned re-performing residential first lien mortgage loans. We deposited $58 million with Freddie Mac towards the purchase price of these securities at the time we entered into this agreement. See Note 15 for further discussion of this agreement with Freddie Mac.

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.

FHLBC 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 14 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 September 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 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 fix-and-flip loans. 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. See Note 7 for discussion on our business purpose loan portfolio and the loans we have acquired from 5 Arches.

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 September 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 September 30, 2018. We have elected to record our share of earnings or losses from 5 Arches on a one-quarter lag. During the three months ended September 30, 2018, we recorded $0.2 million of gross income associated with this investment and, including amortization of certain intangible assets, recorded $0.1 million of net earnings in Other income, net on our consolidated statements of income.

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 15 for additional information on our risk-sharing arrangements.

Investment Receivable

At September 30, 2018, investment receivable primarily consisted of $35 million of trade receivables related to real estate securities sales. In accordance with our policy to record purchases and sales of securities on the trade date, if the trade and settlement of a purchase or sale crosses over a quarterly reporting period, we will record an investment receivable for sales and an unsettled trades liability for purchases.

REO

The carrying value of REO at September 30, 2018 was $3 million, which includes the net effect of $2 million related to transfers into REO during the nine months ended September 30, 2018, offset by $3 million of REO liquidations, and $0.3 million of unrealized gains resulting from market valuation adjustments. At September 30, 2018 and December 31, 2017, there were 10 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 15 for additional information on the legal and residential repurchase reserves.