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Fair Value of Financial Instruments | 3 Months Ended
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Mar. 31, 2020
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, 2020 and December 31, 2019. Table 5.1 – Carrying Values and Fair Values of Assets and Liabilities
|  | March 31, 2020 |  | December 31, 2019
|  | Carrying Value |  | Fair Value |  | Carrying Value |  | Fair Value
(In Thousands) |  |  |  |
Assets |  |  |  |  |  |  |  |
Residential loans, held-for-sale at fair value |  | $ | 2,330,566 |  |  | $ | 2,330,566 |  |  | $ | 536,385 |  |  | $ | 536,509 |
Residential loans, held-for-investment |  | 4,380,460 |  |  | 4,380,460 |  |  | 7,178,465 |  |  | 7,178,465 |
Business purpose residential loans, held-for-sale |  | 415,333 |  |  | 415,333 |  |  | 331,565 |  |  | 331,565 |
Business purpose residential loans, held-for-investment |  | 3,048,409 |  |  | 3,048,409 |  |  | 3,175,178 |  |  | 3,175,178 |
Multifamily loans |  | 470,484 |  |  | 470,484 |  |  | 4,408,524 |  |  | 4,408,524 |
Trading securities |  | 164,219 |  |  | 164,219 |  |  | 860,540 |  |  | 860,540 |
Available-for-sale securities |  | 129,243 |  |  | 129,243 |  |  | 239,334 |  |  | 239,334 |
Servicer advance investments (1) |  | 298,946 |  |  | 298,946 |  |  | 169,204 |  |  | 169,204 |
MSRs (1) |  | 23,616 |  |  | 23,616 |  |  | 42,224 |  |  | 42,224 |
Excess MSRs (1) |  | 31,788 |  |  | 31,788 |  |  | 31,814 |  |  | 31,814 |
Shared home appreciation options (1) |  | 40,642 |  |  | 40,642 |  |  | 45,085 |  |  | 45,085 |
Cash and cash equivalents |  | 378,233 |  |  | 378,233 |  |  | 196,966 |  |  | 196,966 |
Restricted cash |  | 25,752 |  |  | 25,752 |  |  | 93,867 |  |  | 93,867 |
Accrued interest receivable |  | 57,215 |  |  | 57,215 |  |  | 71,058 |  |  | 71,058 |
Derivative assets |  | 90,717 |  |  | 90,717 |  |  | 35,701 |  |  | 35,701 |
REO (2) |  | 14,366 |  |  | 15,714 |  |  | 9,462 |  |  | 10,389 |
Margin receivable (2) |  | 93,745 |  |  | 93,745 |  |  | 209,776 |  |  | 209,776 |
FHLBC stock (2) |  | 43,393 |  |  | 43,393 |  |  | 43,393 |  |  | 43,393 |
Guarantee asset (2) |  | 905 |  |  | 905 |  |  | 1,686 |  |  | 1,686 |
Pledged collateral (2) |  | 33,191 |  |  | 33,191 |  |  | 32,945 |  |  | 32,945 |
Liabilities |  |  |  |  |  |  |  |
Short-term debt facilities |  | $ | 2,082,717 |  |  | $ | 2,082,717 |  |  | $ | 2,176,591 |  |  | $ | 2,176,591 |
Short-term debt - servicer advance financing |  | 258,931 |  |  | 258,931 |  |  | 152,554 |  |  | 152,554 |
Accrued interest payable |  | 40,102 |  |  | 40,102 |  |  | 60,655 |  |  | 60,655 |
Margin payable (3) |  | 1,283 |  |  | 1,283 |  |  | 1,700 |  |  | 1,700 |
Guarantee obligation (3) |  | 13,395 |  |  | 12,382 |  |  | 14,009 |  |  | 13,754 |
Contingent consideration (3) |  | 14,819 |  |  | 14,819 |  |  | 28,484 |  |  | 28,484 |
Derivative liabilities |  | 114,614 |  |  | 114,614 |  |  | 163,424 |  |  | 163,424 |
ABS issued at fair value |  | 6,461,864 |  |  | 6,461,864 |  |  | 10,515,475 |  |  | 10,515,475 |
FHLBC long-term borrowings |  | 1,367,681 |  |  | 1,367,681 |  |  | 1,999,999 |  |  | 1,999,999 |
Other long-term debt, net |  | 315,583 |  |  | 317,498 |  |  | 183,520 |  |  | 184,666 |
Convertible notes, net |  | 631,857 |  |  | 359,875 |  |  | 631,125 |  |  | 661,985 |
Trust preferred securities and subordinated notes, net |  | 138,640 |  |  | 27,900 |  |  | 138,628 |  |  | 99,045 |
(1) | These investments are included in Other investments on our consolidated balance sheets.
(2) | These assets are included in Other assets on our consolidated balance sheets.
(3) | These liabilities are included in Accrued expenses and other liabilities on our consolidated balance sheets.
During the three months ended March 31, 2020, we elected the fair value option for $68 million of securities, $2.63 billion of residential loans (principal balance), $467 million of business purpose residential loans (principal balance), $159 million of servicer advance investments, $9 million of excess MSRs, and $4 million of shared home appreciation options. We anticipate electing the fair value option for all future purchases of residential and business purpose residential loans that we intend to sell to third parties or transfer to securitizations, as well as 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, 2020 and December 31, 2019, 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, 2020 |  | Carrying Value |  | Fair Value Measurements Using
(In Thousands) |  |  | Level 1 |  | Level 2 |  | Level 3
Assets |  |  |  |  |  |  |  |
Residential loans |  | $ | 6,711,025 |  |  | $ | — |  |  | $ | — |  |  | $ | 6,711,025 |
Business purpose residential loans |  | 3,463,742 |  |  | — |  |  | — |  |  | 3,463,742 |
Multifamily loans |  | 470,484 |  |  | — |  |  | — |  |  | 470,484 |
Trading securities |  | 164,219 |  |  | — |  |  | — |  |  | 164,219 |
Available-for-sale securities |  | 129,243 |  |  | — |  |  | — |  |  | 129,243 |
Servicer advance investments |  | 298,946 |  |  | — |  |  | — |  |  | 298,946 |
MSRs |  | 23,616 |  |  | — |  |  | — |  |  | 23,616 |
Excess MSRs |  | 31,788 |  |  | — |  |  | — |  |  | 31,788 |
Shared home appreciation options |  | 40,642 |  |  | — |  |  | — |  |  | 40,642 |
Derivative assets |  | 90,717 |  |  | 90,717 |  |  | — |  |  | — |
Pledged collateral |  | 33,191 |  |  | 33,191 |  |  | — |  |  | — |
FHLBC stock |  | 43,393 |  |  | — |  |  | 43,393 |  |  | — |
Guarantee asset |  | 905 |  |  | — |  |  | — |  |  | 905 |
Liabilities |  |  |  |  |  |  |  |  |
Contingent consideration |  | $ | 14,819 |  |  | $ | — |  |  | $ | — |  |  | $ | 14,819 |
Derivative liabilities |  | 114,614 |  |  | 110,648 |  |  | — |  |  | 3,966 |
ABS issued |  | 6,461,864 |  |  | — |  |  | — |  |  | 6,461,864 |
December 31, 2019 |  | Carrying Value |  | Fair Value Measurements Using
(In Thousands) |  |  | Level 1 |  | Level 2 |  | Level 3
Assets |  |  |  |  |  |  |  |
Residential loans |  | $ | 7,714,745 |  |  | $ | — |  |  | $ | — |  |  | $ | 7,714,745 |
Business purpose residential loans |  | 3,506,743 |  |  | — |  |  | — |  |  | 3,506,743 |
Multifamily loans |  | 4,408,524 |  |  | — |  |  | — |  |  | 4,408,524 |
Trading securities |  | 860,540 |  |  | — |  |  | — |  |  | 860,540 |
Available-for-sale securities |  | 239,334 |  |  | — |  |  | — |  |  | 239,334 |
Servicer advance investments |  | 169,204 |  |  | — |  |  | — |  |  | 169,204 |
MSRs |  | 42,224 |  |  | — |  |  | — |  |  | 42,224 |
Excess MSRs |  | 31,814 |  |  | — |  |  | — |  |  | 31,814 |
Shared home appreciation options |  | 45,085 |  |  | — |  |  | — |  |  | 45,085 |
Derivative assets |  | 35,701 |  |  | 6,531 |  |  | 19,020 |  |  | 10,150 |
Pledged collateral |  | 32,945 |  |  | 32,945 |  |  | — |  |  | — |
FHLBC stock |  | 43,393 |  |  | — |  |  | 43,393 |  |  | — |
Guarantee asset |  | 1,686 |  |  | — |  |  | — |  |  | 1,686 |
Liabilities |  |  |  |  |  |  |  |
Contingent consideration |  | $ | 28,484 |  |  | $ | — |  |  | $ | — |  |  | $ | 28,484 |
Derivative liabilities |  | 163,424 |  |  | 13,368 |  |  | 148,766 |  |  | 1,290 |
ABS issued |  | 10,515,475 |  |  | — |  |  | — |  |  | 10,515,475 |
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, 2020. Table 5.3 – Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis
|  | Assets
|  | Residential Loans |  | Business Purpose Residential Loans |  | Multifamily Loans |  | Trading Securities |  | AFS Securities |  | Servicer Advance Investments |  | MSRs |  | Excess MSRs |  | Shared Home Appreciation Options
(In Thousands) |  |  |  |  |  |  |  |  |
Beginning balance - December 31, 2019 |  | $ | 7,714,745 |  |  | $ | 3,506,743 |  |  | $ | 4,408,524 |  |  | $ | 860,540 |  |  | $ | 239,334 |  |  | $ | 169,204 |  |  | $ | 42,224 |  |  | $ | 31,814 |  |  | $ | 45,085 |
Acquisitions |  | 2,695,846 |  |  | — |  |  | — |  |  | 67,639 |  |  | 31,181 |  |  | 158,618 |  |  | — |  |  | 9,468 |  |  | 3,517 |
Originations |  | — |  |  | 486,710 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Sales |  | (2,729,161 | ) |  | (42,802 | ) |  | — |  |  | (493,126 | ) |  | (46,457 | ) |  | — |  |  | — |  |  | — |  |  | — |
Principal paydowns |  | (490,439 | ) |  | (161,896 | ) |  | (5,830 | ) |  | (7,507 | ) |  | (4,445 | ) |  | (22,815 | ) |  | — |  |  | — |  |  | (406 | )
Deconsolidations |  | — |  |  | — |  |  | (3,849,779 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Gains (losses) in net (loss) income, net |  | (478,743 | ) |  | (320,528 | ) |  | (82,431 | ) |  | (263,327 | ) |  | (90,370 | ) |  | (6,061 | ) |  | (18,608 | ) |  | (9,494 | ) |  | (7,554 | )
Other settlements, net (1) |  | (1,223 | ) |  | (4,485 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Ending balance - March 31, 2020 |  | $ | 6,711,025 |  |  | $ | 3,463,742 |  |  | $ | 470,484 |  |  | $ | 164,219 |  |  | $ | 129,243 |  |  | $ | 298,946 |  |  | $ | 23,616 |  |  | $ | 31,788 |  |  | $ | 40,642 |
Table 5.3 – Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis (continued)
|  | Assets |  |  |  | Liabilities
|  | Guarantee Asset |  | Derivatives (2) |  | Contingent Consideration |  | ABS Issued
(In Thousands) |  |  |  |
Beginning balance - December 31, 2019 |  | $ | 1,686 |  |  | $ | 8,860 |  |  | $ | 28,484 |  |  | $ | 10,515,475 |
Acquisitions |  | — |  |  | — |  |  | — |  |  | 377,164 |
Principal paydowns |  | — |  |  | — |  |  | (13,353 | ) |  | (363,696 | )
Deconsolidations |  | — |  |  | — |  |  | — |  |  | (3,706,789 | )
Gains (losses) in net (loss) income, net |  | (781 | ) |  | 18,005 |  |  | (312 | ) |  | (360,290 | )
Other settlements, net (1) |  | — |  |  | (30,831 | ) |  | — |  |  | — |
Ending balance - March 31, 2020 |  | $ | 905 |  |  | $ | (3,966 | ) |  | $ | 14,819 |  |  | $ | 6,461,864 |
(1) | Other settlements, net for residential and business purpose residential loans represents the transfer of loans to REO, and for derivatives, the settlement of forward sale commitments and the transfer of the fair value of loan purchase or interest rate lock commitments at the time loans are acquired to the basis of residential and single-family rental loans.
(2) | For the purpose of this presentation, derivative assets and liabilities, which consist of loan purchase commitments and interest rate lock commitments, are presented on a net basis.
The following table presents the portion of gains or losses included in our consolidated statements of income (loss) that were attributable to Level 3 assets and liabilities recorded at fair value on a recurring basis and held at March 31, 2020 and 2019. Gains or losses incurred on assets or liabilities sold, matured, called, or fully written down during the three months ended March 31, 2020 and 2019 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, 2020 and 2019 Included in Net Income
|  | Included in Net Income
|  | Three Months Ended March 31,
(In Thousands) |  | 2020 |  | 2019
Assets |  |  |  |
Residential loans at Redwood |  | $ | (102,867 | ) |  | $ | 35,801 |
Residential loans at consolidated Sequoia entities |  | (179,499 | ) |  | 14,472 |
Residential loans at consolidated Freddie Mac SLST entities |  | (193,035 | ) |  | 23,527 |
Business purpose residential loans |  | (68,864 | ) |  | 1,050 |
Single-family rental loans at consolidated CAFL entities |  | (271,917 | ) |  | — |
Multifamily loans at consolidated Freddie Mac K-Series entity |  | (10,351 | ) |  | 34,372 |
Trading securities |  | (136,359 | ) |  | 21,543 |
Servicer advance investments |  | (6,062 | ) |  | 1,008 |
MSRs |  | (16,640 | ) |  | (4,295 | )
Excess MSRs |  | (9,494 | ) |  | (437 | )
Shared home appreciation options |  | (7,554 | ) |  | — |
Loan purchase and interest rate lock commitments |  | — |  |  | 4,962 |
Other assets - Guarantee asset |  | (781 | ) |  | (277 | )
Liabilities |  |  |  |
Loan purchase commitments |  | $ | (3,967 | ) |  | $ | (753 | )
Contingent consideration |  | (312 | ) |  | — |
ABS issued |  | 360,640 |  |  | (60,182 | )
The following table presents information on assets recorded at fair value on a non-recurring basis at March 31, 2020. 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 sheets at March 31, 2020. Table 5.5 – Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis at March 31, 2020
|  |  |  |  |  |  |  |  |  | Gain (Loss) for
March 31, 2020 |  | Carrying Value |  | Fair Value Measurements Using |  | Three Months Ended
(In Thousands) |  |  | Level 1 |  | Level 2 |  | Level 3 |  | March 31, 2020
Assets |  |  |  |  |  |  |  |  |  |
REO |  | $ | 4,456 |  |  | $ | — |  |  | $ | — |  |  | $ | 4,456 |  |  | $ | (476 | )
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, 2020 and 2019. Table 5.6 – Market Valuation Gains and Losses, Net
|  | Three Months Ended March 31,
(In Thousands) |  | 2020 |  | 2019
Mortgage Banking Activities, Net |  |  |  |
Residential loans held-for-sale, at fair value |  | $ | (13,480 | ) |  | $ | 3,533 |
Residential loan purchase and forward sale commitments |  | 21,435 |  |  | 11,311 |
Single-family rental loans held-for-sale, at fair value |  | 11,467 |  |  | 1,603 |
Single-family rental loan purchase and interest rate lock commitments |  | 341 |  |  | 141 |
Residential bridge loans |  | (3,934 | ) |  | 86 |
Risk management derivatives, net |  | (52,832 | ) |  | (4,984 | )
Total mortgage banking activities, net (1) |  | $ | (37,003 | ) |  | $ | 11,690 |
Investment Fair Value Changes, Net |  |  |  |
Residential loans held-for-investment, at Redwood |  | $ | (93,636 | ) |  | $ | 28,108 |
Single-family rental loans held-for-investment |  | (23,028 | ) |  | — |
Residential bridge loans held-for-investment |  | (38,602 | ) |  | (303 | )
Trading securities |  | (263,325 | ) |  | 21,860 |
Servicer advance investments |  | (6,062 | ) |  | 1,008 |
Excess MSRs |  | (9,494 | ) |  | (437 | )
Net investments in Legacy Sequoia entities (2) |  | (391 | ) |  | (374 | )
Net investments in Sequoia Choice entities (2) |  | (69,669 | ) |  | 3,265 |
Net investments in Freddie Mac SLST entities (2) |  | (142,162 | ) |  | 6,365 |
Net investments in Freddie Mac K-Series entities (2) |  | (86,509 | ) |  | 3,119 |
Net investments in CAFL entities (2) |  | (67,846 | ) |  | — |
Other investments |  | (9,441 | ) |  | (77 | )
Risk management derivatives, net |  | (59,142 | ) |  | (42,375 | )
Credit losses on AFS securities |  | (1,525 | ) |  | — |
Total investment fair value changes, net |  | $ | (870,832 | ) |  | $ | 20,159 |
Other Income |  |  |  |
MSRs |  | $ | (18,608 | ) |  | $ | (5,102 | )
Risk management derivatives, net |  | 13,966 |  |  | 2,251 |
Gain on re-measurement of 5 Arches investment |  | — |  |  | 2,441 |
Total other income (3) |  | $ | (4,642 | ) |  | $ | (410 | )
Total Market Valuation (Losses) Gains, Net |  | $ | (912,477 | ) |  | $ | 31,439 |
(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 (loss), as these amounts do not represent market valuation changes.
(2) | Includes changes in fair value of the residential loans held-for-investment, REO and the ABS issued at the entities, which netted together represent the change in value of our investments at the consolidated VIEs.
(3) | Other income presented above does not include net MSR fee income or provisions for repurchases for MSRs, as these amounts do not represent market valuation adjustments.
At March 31, 2020, 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, 2019. 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, 2020 |  | Fair Value |  |  |  | Input Values
(Dollars in Thousands, except Input Values) |  |  | Unobservable Input |  | Range |  |  | Weighted Average(5)
Assets |  |  |  |  |  |  |  |  |  |  |  |
Residential loans, at fair value: |  |  |  |  |  |  |  |  |  |  |  |
Jumbo fixed-rate loans |  | $ | 86,053 |  |  | Dollar price |  | $ | 74.38 |  | - | $ | 99.50 |  |  |  | $ | 96.73 |  |
Jumbo hybrid loans |  | 97,956 |  |  | Dollar price |  | $ | 90.00 |  | - | $ | 99.00 |  |  |  | $ | 97.78 |  |
Jumbo loans committed to sell |  | 2,146,557 |  |  | Whole loan committed sales price |  | $ | 95.00 |  | - | $ | 103.50 |  |  |  | $ | 98.32 |  |
Loans held by Legacy Sequoia (1) |  | 316,677 |  |  | Liability price |  |  |  | N/A |  |  |  | N/A |  |
Loans held by Sequoia Choice (1) |  | 1,932,658 |  |  | Liability price |  |  |  | N/A |  |  |  | N/A |  |
Loans held by Freddie Mac SLST (1) |  | 2,131,125 |  |  | Liability price |  |  |  | N/A |  |  |  | N/A |  |
Business purpose residential loans: |  |  |  |  |  |  |  |  |  |  |  |
Single-family rental loans |  | 415,333 |  |  | Senior credit spread |  | 290 |  | - | 290 |  | bps |  | 290 |  | bps
|  |  |  | Subordinate credit spread |  | 400 |  | - | 2,700 |  | bps |  | 688 |  | bps
|  |  |  | Senior credit support |  | 32 |  | - | 47 |  | % |  | 34 |  | %
|  |  |  | IO discount rate |  | 14 |  | - | 14 |  | % |  | 14 |  | %
|  |  |  | Prepayment rate (annual CPR) |  | 5 |  | - | 5 |  | % |  | 5 |  | %
Single-family rental loans held by CAFL |  | 2,248,665 |  |  | Liability price |  |  |  | N/A |  |  |  | N/A |  |
Residential bridge loans |  | 799,744 |  |  | Discount rate |  | 9 |  | - | 17 |  | % |  | 12 |  | %
Multifamily loans held by Freddie Mac K-Series (1) |  | 470,484 |  |  | Liability price |  |  |  | N/A |  |  |  | N/A |  |
Trading and AFS securities |  | 293,462 |  |  | Discount rate |  | 5 |  | - | 51 |  | % |  | 17 |  | %
|  |  |  | Prepayment rate (annual CPR) |  | 6 |  | - | 34 |  | % |  | 12 |  | %
|  |  |  | Default rate |  | — |  | - | 7 |  | % |  | 1 |  | %
|  |  |  | Loss severity |  | — |  | - | 50 |  | % |  | 9 |  | %
Servicer advance investments |  | 298,946 |  |  | Discount rate |  | 5 |  | - | 5 |  | % |  | 5 |  | %
|  |  |  | Prepayment rate (annual CPR) |  | 8 |  | - | 14 |  | % |  | 14 |  | %
|  |  |  | Expected remaining life (2) |  | 2 |  | - | 2 |  | years |  | 2 |  | years
|  |  |  | Mortgage servicing income |  | 8 |  | - | 13 |  | bps |  | 10 |  | bps
MSRs |  | 23,616 |  |  | Discount rate |  | 13 |  | - | 13 |  | % |  | 13 |  | %
|  |  |  | Prepayment rate (annual CPR) |  | 8 |  | - | 63 |  | % |  | 21 |  | %
|  |  |  | Per loan annual cost to service |  | $ | 95 |  | - | $ | 95 |  |  |  | $ | 95 |  |
Excess MSRs |  | 31,788 |  |  | Discount rate |  | 18 |  | - | 26 |  | % |  | 22 |  | %
|  |  |  | Prepayment rate (annual CPR) |  | 9 |  | - | 14 |  | % |  | 11 |  | %
|  |  |  | Excess mortgage servicing income |  | 8 |  | - | 17 |  | bps |  | 12 |  | bps
Table 5.7 – Fair Value Methodology for Level 3 Financial Instruments (continued)
March 31, 2020 |  | Fair Value |  |  |  | Input Values
(Dollars in Thousands, except Input Values) |  |  | Unobservable Input |  | Range |  |  | Weighted Average (5)
Assets (continued) |  |  |  |  |  |  |  |  |  |  |  |
Shared home appreciation options |  | $ | 40,642 |  |  | Discount rate |  | 18 |  | - | 18 |  | % |  | 18 |  | %
|  |  |  | Prepayment rate (annual CPR) |  | 10 |  | - | 30 |  | % |  | 23 |  | %
|  |  |  | Home price appreciation |  | 3 |  | - | 3 |  | % |  | 3 |  | %
Guarantee asset |  | 905 |  |  | Discount rate |  | 11 |  | - | 11 |  | % |  | 11 |  | %
|  |  |  | Prepayment rate (annual CPR) |  | 37 |  | - | 37 |  | % |  | 37 |  | %
REO |  | 4,456 |  |  | Loss severity |  | 3 |  | - | 55 |  | % |  | 32 |  | %
Liabilities |  |  |  |  |  |  |  |  |  |  |  |
Residential loan purchase commitments, net |  | 196 |  |  | Committed sales price |  | $ | 95.50 |  | - | $ | 95.50 |  |  |  | $ | 95.50 |  |
|  |  |  | Pull-through rate |  | 100 |  | - | 100 |  | % |  | 100 |  | %
ABS issued (1): |  |  |  |  |  |  |  |  |  |  |  |
At consolidated Sequoia entities |  | 2,102,295 |  |  | Discount rate |  | 3 |  | - | 32 |  | % |  | 6 |  | %
|  |  |  | Prepayment rate (annual CPR) |  | 15 |  | - | 43 |  | % |  | 25 |  | %
|  |  |  | Default rate |  | — |  | - | 15 |  | % |  | 1 |  | %
|  |  |  | Loss severity |  | — |  | - | 50 |  | % |  | 19 |  | %
At consolidated Freddie Mac SLST entities |  | 1,825,000 |  |  | Discount rate |  | 3 |  | - | 17 |  | % |  | 4 |  | %
|  |  |  | Prepayment rate (annual CPR) |  | 6 |  | - | 6 |  | % |  | 6 |  | %
|  |  |  | Default rate |  | 17 |  | - | 18 |  | % |  | 17 |  | %
|  |  |  | Loss severity |  | 30 |  | - | 30 |  | % |  | 30 |  | %
At consolidated Freddie Mac K-Series entities (4) |  | 447,699 |  |  | Discount rate |  | 2 |  | - | 20 |  | % |  | 3 |  | %
|  |  |  | Non-IO prepayment rate (annual CPR) |  | — |  | - | — |  | % |  | — |  | %
|  |  |  | IO prepayment rate (annual CPY/CPP) |  | 100 |  | - | 100 |  | % |  | 100 |  | %
At consolidated CAFL entities (4) |  | 2,086,870 |  |  | Discount rate |  | 1 |  | - | 68 |  | % |  | 6 |  | %
|  |  |  | Prepayment rate (annual CPR) |  | — |  | - | 5 |  | % |  | — |  | %
Contingent consideration |  | 14,819 |  |  | Discount rate |  | 23 |  | - | 23 |  | % |  | 23 |  | %
|  |  |  | Probability of outcomes (3) |  | 100 |  | - | 100 |  | % |  | 100 |  | %
(1) | The fair value of the loans held by consolidated entities was based on the fair value of the ABS issued by these entities, including securities we own, which we determined were more readily observable, in accordance with accounting guidance for collateralized financing entities. At March 31, 2020, the fair value of securities we owned at the consolidated Sequoia, Freddie Mac SLST, Freddie Mac K-Series, and CAFL entities was $148 million, $307 million, $23 million, and $167 million, respectively.
(2) | Represents the estimated average duration of outstanding servicer advances at a given point in time (not taking into account new advances made with respect to the pool).
(3) | Represents the probability of a full payout of contingent purchase consideration.
(4) | As a market convention, certain securities are priced to a no-loss yield and therefore do not include default and loss severity assumptions.
(5) | The weighted average input values for all loan types are based on the unpaid principal balance. The weighted average input values for all other assets and liabilities are based on relative fair value.
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 at Redwood Estimated fair values for residential loans are determined using third-party committed sales prices or 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. Significant 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). Significant 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, senior credit support levels, and assumed future prepayment rates (Level 3). These assets would generally decrease in value based upon an increase in the credit spread, prepayment speed, or credit support assumptions. Residential loans, business purpose residential loans, and multifamily loans at consolidated entities We have elected to account for our consolidated securitization entities as CFEs in accordance with GAAP. A CFE is a variable interest entity that holds financial assets and issues beneficial interests in those assets, and these beneficial interests have contractual recourse only to the related assets of the CFE. Accounting guidance for CFEs allows companies to elect to measure both the financial assets and financial liabilities of a CFE using the more observable of the fair value of the financial assets or fair value of the financial liabilities. Pursuant to this guidance, we use the fair value of the ABS issued by the CFEs (which we determined to be more observable) to determine the fair value of the loans held at these entities, whereby the net assets we consolidate in our financial statements related to these entities represent the estimated fair value of our retained interests in the CFEs. Business purpose residential loans Business purpose residential loans include single-family rental loans and residential bridge loans 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. Estimated fair values for our single-family rental loans are determined using models that incorporate various inputs, including pricing information from market comparable securitizations. Certain significant inputs in these models are considered unobservable and are therefore Level 3 in nature. Significant pricing inputs obtained from market activity include indicative spreads to indexed swap rates for senior and subordinate MBS, IO MBS discount rates, senior credit support levels, and assumed future prepayment rates (Level 3). These assets would generally decrease in value based upon an increase in the credit spread, prepayment speed, or credit support assumptions. Prices for our residential bridge loans are determined using discounted cash flow modeling, which incorporates a primary significant unobservable input of discount rate. These assets would generally decrease in value based upon an increase in the discount rate. Real estate securities Real estate securities include residential, multifamily, and other mortgage-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 and loss severity. The estimated fair value of our securities would generally decrease based upon an increase in discount rate, default rates, loss severities, or a decrease in prepayment rates. 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, 2020, we received dealer price indications on 78% of our securities, representing 91% of our carrying value. 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, interest rate futures, loan purchase commitments ("LPCs"), and interest rate lock commitments ("IRLCs"). 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 interest rate 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 and IRLC fair values for residential jumbo and single-family rental loans are estimated based on the estimated fair values of the underlying loans (as described in "Residential loans at Redwood" and "Business purpose residential loans" above). In addition, fair values for LPCs and IRLCs are estimated based on the probability that the mortgage loan will be purchased or originated (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). Servicer advance investments Estimated fair values for servicer advance investments are determined through internal pricing models that estimate future cash flows and utilize certain significant inputs that are considered unobservable and are therefore Level 3 in nature. Our estimations of cash flows include the combined cash flows of all of the components that comprise the servicer advance investments: existing advances, the requirement to purchase future advances, the recovery of advances, and the right to a portion of the associated mortgage servicing fee ("mortgage servicing income"). The valuation technique is based on discounted cash flows. Significant inputs used in the valuations included prepayment rate (of the loans underlying the investments), mortgage servicing income, servicer advance WAL (the weighted-average expected remaining life of servicer advances), and discount rate. These assets would generally decrease in value based upon an increase in prepayment rates, an increase in servicer advance WAL, or an increase in discount rate, or a decrease in mortgage servicing income. MSRs MSRs include the rights to service jumbo 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 5% of the third-party valuation. Excess MSRs Estimated fair values for excess MSRs are determined through internal pricing models that estimate future cash flows and utilize certain significant inputs that are considered unobservable and are therefore Level 3 in nature. The valuation technique is based on discounted cash flows. Significant unobservable inputs used in the valuations included prepayment rate (of the loans underlying the investments), the amount of excess servicing income expected to be received ("excess mortgage servicing income"), and discount rate. These assets would generally decrease in value based upon an increase in prepayment rates or discount rate, or a decrease in excess mortgage servicing income. Shared Home Appreciation Options Estimated fair values for shared home appreciation options are determined through internal pricing models that estimate future cash flows and utilize certain significant unobservable inputs such as forecasted home price appreciation, prepayment rates, and discount rate, and are therefore Level 3 in nature. The valuation technique is based on discounted cash flows. An increase in discount rate, or a decrease in expected future home values combined with a decrease in prepayment rates, would generally reduce the estimated fair value of the shared home appreciation options. FHLBC stock Our Federal Home Loan Bank ("FHLB") member subsidiary is required to purchase 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, cash held in association with borrowings from the FHLBC, cash held at Servicing Investment entities, and cash held 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). Real estate owned Real estate owned ("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). Contingent consideration Contingent consideration is related to our acquisition of 5 Arches and is estimated and recorded at fair value as part of purchase consideration. Each reporting period we estimate the change in fair value of the contingent consideration, and such change is recognized in our consolidated statements of income (loss), unless it is determined to be a measurement period adjustment. The estimate of the fair value of contingent consideration requires significant judgment and assumptions to be made about future operating results, discount rates, and probabilities of projected operating result scenarios (Level 3). Short-term debt Short-term debt includes our credit facilities for residential and business purpose residential loans and real estate securities as well as non-recourse short-term borrowings used to finance servicer advance investments. 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 Legacy Sequoia, Sequoia Choice, and CAFL securitization entities, as well as securities issued by certain third-party Freddie Mac K-Series and SLST securitization entities that we consolidate. 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 incorporate market indicators as well as other significant unobservable inputs to generate discounted cash flows (Level 3). These cash flow models use significant unobservable inputs such as discount rate, prepayment rate, default rate, loss severity and credit support. A decrease in credit losses or discount rates, or an increase in prepayment rates, would generally cause the fair value of the ABS issued to decrease (i.e., 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). Financial Instruments Carried at Amortized Cost Participation in loan warehouse facility Our participation in a loan warehouse facility was carried at amortized cost (Level 2). Guarantee obligations In association with our risk-sharing transactions with the Agencies, we have made certain guarantees which are carried on our balance sheet at amortized cost (Level 3). Subordinate securities financing facility Borrowings under our subordinate securities financing facility are secured by real estate securities and carried at unpaid principal balance net of any unamortized deferred issuance costs (Level 3). Convertible notes Convertible notes include unsecured convertible and exchangeable senior notes that are carried at their unpaid principal balance net of any unamortized deferred issuance costs. The fair value of the convertible notes is determined using quoted prices in generally active markets (Level 2). Trust preferred securities and subordinated notes Trust preferred securities and subordinated notes are carried at their unpaid principal balance net of any unamortized deferred issuance costs (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/disclosureRef -Publisher FASB -Name Accounting Standards Codification -Topic 820 -SubTopic 10 -Section 50 -Paragraph 2 -URI http://asc.fasb.org/extlink&oid=117815213&loc=d3e19207-110258 + Details
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