| 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 September 30, 2015 and December 31, 2014 . Table 5.1 – Carrying Values and Fair Values of Assets and Liabilities September 30, 2015 December 31, 2014 Carrying Value Fair Value Carrying Value Fair Value (In Thousands) Assets Residential loans, held-for-sale At fair value $ 1,504,705 $ 1,504,705 $ 1,341,032 $ 1,341,032 At lower of cost or fair value 1,446 1,645 1,488 1,669 Residential loans, held-for-investment (1) At fair value 2,530,523 2,530,523 581,668 581,668 At amortized cost — — 1,474,386 1,381,918 Commercial loans, held-for-sale 80,756 80,756 166,234 166,234 Commercial loans, held-for-investment At fair value 70,096 70,096 71,262 71,262 At amortized cost 317,305 322,535 329,431 334,876 Trading securities 114,211 114,211 111,606 111,606 Available-for-sale securities 971,013 971,013 1,267,624 1,267,624 MSRs 162,726 162,726 139,293 139,293 Cash and cash equivalents 235,362 235,362 269,730 269,730 Restricted cash 8,361 8,361 628 628 Accrued interest receivable 20,223 20,223 18,222 18,222 Derivative assets 38,623 38,623 16,417 16,417 REO (2) 3,902 4,620 4,391 4,703 Margin receivable (2) 97,685 97,685 65,374 65,374 FHLBC stock (2) 30,001 30,001 10,688 10,688 Guarantee asset (2) 5,120 5,120 7,201 7,201 Pledged collateral (2) 28,482 28,482 9,927 9,927 Liabilities Short-term debt $ 1,872,793 $ 1,872,793 $ 1,793,825 $ 1,793,825 Accrued interest payable 14,738 14,738 8,502 8,502 Guarantee obligation 13,394 12,123 7,201 7,201 Derivative liabilities 88,044 88,044 58,331 58,331 ABS issued (1) Fair value 1,105,588 1,105,588 — — Amortized cost 73,207 73,207 1,545,119 1,446,605 FHLBC long-term borrowings 1,124,299 1,124,299 495,860 495,860 Commercial secured borrowings 65,578 65,578 66,707 66,707 Convertible notes 492,500 464,164 492,500 492,188 Other long-term debt 139,500 90,675 139,500 101,835 (1) Upon adoption of ASU 2014-13 on January 1, 2015, we began to record loans held-for-investment in, and ABS issued by, consolidated Sequoia entities at fair value. See Note 3 for further discussion. (2) These assets are included in other assets on our consolidated balance sheets. During the three and nine months ended September 30, 2015 , we elected the fair value option for $9 million and $68 million of residential subordinate securities, zero and $33 million of residential senior securities, $2.91 billion and $8.09 billion of residential loans (principal balance), $168 million and $518 million of commercial loans (principal balance), and $23 million and $74 million of MSRs, respectively. We anticipate electing the fair value option for all future purchases of residential loans and commercial senior loans that we intend to sell to third parties or transfer to securitizations as well as for MSRs purchased or retained from sales of residential loans. The following table presents the assets and liabilities that are reported at fair value on our consolidated balance sheets on a recurring basis at September 30, 2015 , 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 at September 30, 2015 September 30, 2015 Carrying Value Fair Value Measurements Using (In Thousands) Level 1 Level 2 Level 3 Assets Residential loans $ 4,035,228 $ — $ 236,314 $ 3,798,914 Commercial loans 150,852 — — 150,852 Trading securities 114,211 — — 114,211 Available-for-sale securities 971,013 — — 971,013 Derivative assets 38,623 8,910 19,580 10,133 MSRs 162,726 — — 162,726 Pledged collateral 28,482 28,482 — — FHLBC stock 30,001 30,001 — — Guarantee asset 5,120 — — 5,120 Liabilities Derivative liabilities $ 88,044 $ 15,182 $ 72,415 $ 447 Commercial secured borrowings 65,578 — — 65,578 ABS issued 1,105,588 — — 1,105,588 The following table presents additional information about Level 3 assets and liabilities measured at fair value on a recurring basis for the nine months ended September 30, 2015 . Table 5.3 – Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis Assets Liabilities Residential Loans Commercial Loans Trading Securities AFS Securities MSRs Guarantee Asset Derivatives (1) Commercial Secured Borrowings ABS Issued (In Thousands) Beginning balance - December 31, 2014 $ 1,677,984 $ 237,496 $ 111,606 $ 1,267,624 $ 139,293 $ 7,201 $ 1,119 $ 66,707 $ — Transfer to FVO (2) 1,370,699 — — — — — — — 1,302,216 Principal paydowns (369,576 ) (584 ) (1,722 ) (101,944 ) — — — (416 ) (201,885 ) Gains (losses) in net income, net 8,024 10,068 (15,970 ) 43,860 (32,337 ) (1,954 ) 51,638 (750 ) 6,198 Unrealized losses in OCI, net — — — (15,789 ) — — — — — Acquisitions 4,084,501 517,894 101,429 14,788 73,976 — — — — Sales (2,968,446 ) (614,022 ) (81,132 ) (237,886 ) (18,206 ) — — — (1,362 ) Other settlements, net (4,272 ) — — 360 — (127 ) (43,071 ) 37 421 Ending balance - September 30, 2015 $ 3,798,914 $ 150,852 $ 114,211 $ 971,013 $ 162,726 $ 5,120 $ 9,686 $ 65,578 $ 1,105,588 (1) For the purpose of this presentation, derivative assets and liabilities, which consist of loan purchase commitments, are presented on a net basis. (2) Upon adoption of ASU 2014-13 on January 1, 2015, loans held-for-investment in, and ABS issued by, consolidated financial entities are now recorded at fair value. See Note 3 for further discussion. The following table presents the portion of gains or losses included in our consolidated statements of income that were attributable to Level 3 assets and liabilities recorded at fair value on a recurring basis and held at September 30, 2015 and 2014 . Gains or losses incurred on assets or liabilities sold, matured, called, or fully written down during the three and nine months ended September 30, 2015 and 2014 are not included in this presentation. Table 5.4 – Portion of Net Gains (Losses) Attributable to Level 3 Assets and Liabilities Still Held at September 30, 2015 and 2014 Included in Net Income Included in Net Income Three Months Ended September 30, Nine Months Ended September 30, (In Thousands) 2015 2014 2015 2014 Assets Residential loans at Redwood $ 16,451 $ 7,280 $ 12,115 $ 8,524 Residential loans at consolidated Sequoia entities (419 ) — 4,912 — Commercial loans 3,175 2,009 1,971 2,009 Trading securities (8,298 ) (1,882 ) (13,274 ) (16,033 ) Available-for-sale securities (226 ) (188 ) (226 ) (434 ) MSRs (25,523 ) 3,509 (15,989 ) (3,184 ) Other assets - Guarantee asset (1,098 ) — (1,799 ) — Liabilities Loan purchase commitments $ 9,736 $ 932 $ 9,806 $ 932 Commercial secured borrowing (454 ) (420 ) 750 1,339 ABS issued 300 — (6,198 ) — The following table presents information on assets recorded at fair value on a non-recurring basis at September 30, 2015 . 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 balance sheet at September 30, 2015 . Table 5.5 – Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis at September 30, 2015 Gain (Loss) for September 30, 2015 Carrying Value Fair Value Measurements Using Three Months Ended Nine Months Ended (In Thousands) Level 1 Level 2 Level 3 September 30, 2015 September 30, 2015 Assets Residential loans, at lower of cost or fair value $ 1,099 $ — $ — $ 1,099 $ 1 $ 2 REO 3,120 — — 3,120 (621 ) (748 ) The following table presents the net gains and losses recorded in each line item of our consolidated statements of income for the three and nine months ended September 30, 2015 and 2014 . Table 5.6 – Market Valuation Gains and Losses, Net Three Months Ended September 30, Nine Months Ended September 30, (In Thousands) 2015 2014 2015 2014 Mortgage banking and investment activities, net Residential loans held-for-sale, at fair value $ 11,010 $ 13,489 $ 9,892 $ 34,608 Residential loan purchase and forward sale commitments 25,173 2,487 44,482 6,077 Residential loans held-for-investment, at Redwood 9,077 (991 ) 5,170 (991 ) Consolidated Sequoia entities (1) (500 ) (361 ) (2,277 ) (825 ) Commercial loans, at fair value 3,974 4,305 10,819 13,644 Trading securities (8,783 ) (1,909 ) (15,946 ) (15,072 ) Impairments on AFS securities (226 ) (188 ) (226 ) (565 ) Risk management derivatives, net (52,749 ) (4,036 ) (60,060 ) (29,145 ) Guarantee asset (1,297 ) — (2,081 ) — Other investments 199 — 282 — Total mortgage banking and investment activities, net (2) $ (14,122 ) $ 12,796 $ (9,945 ) $ 7,731 MSR Income (loss), net MSRs $ (28,496 ) $ 2,321 $ (32,337 ) $ (5,944 ) Risk management derivatives, net 23,551 — 1,736 — Total MSR income (loss), net (3) $ (4,945 ) $ 2,321 $ (30,601 ) $ (5,944 ) Total market valuation gains and losses, net $ (19,067 ) $ 15,117 $ (40,546 ) $ 1,787 (1) On January 1, 2015, we adopted ASU 2014-13 and began to record the assets and liabilities of consolidated Sequoia entities at fair value. This amount includes the net change in fair value of the consolidated assets and liabilities of these entities, which include residential loans held-for-investment, REO, and ABS issued. This combined amount represents the estimated change in value of our retained interests in these entities. See Note 3 for further discussion. (2) Mortgage banking and investment activities, net presented above does not include fee income or provisions for repurchases that are components of mortgage banking and investment activities, net presented on our consolidated statements of income, as these amounts do not represent market valuation changes. (3) MSR Income (loss), net presented above does not include net fee income or provisions for repurchases that are components of MSR Income (loss), net on our consolidated statements of income, as these amounts do not represent market valuation adjustments. At September 30, 2015 , 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, 2014 . 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 September 30, 2015 Fair Value Weighted Average (Dollars in Thousands, except input values) Unobservable Input Range Assets Residential loans, at fair value: Jumbo fixed rate loans uncommitted to sell $ 2,032,815 IO Multiple 3.8 - 4.0 x 3.8 x Prepayment rate (annual CPR) 12 - 15 % 14 % Senior spread to TBA price $3.56 - $3.56 $ 3.56 Subordinate spread to swap rate 373 - 373 bps 373 bps Credit support 5 - 5 % 5 % Whole loan spread to TBA price $2.90 - $4.27 $ 4.08 Jumbo hybrid loans uncommitted to sell 158,149 Spread to swap rate 125 - 165 bps 138 bps Jumbo loans committed to sell 437,704 Committed Sales Price $102.1 - $103.0 $ 102.4 Loans held by consolidated Sequoia entities (1) 1,170,246 Liability price N/A N/A Residential loans, at lower of cost or fair value 1,099 Loss severity 13 - 30 % 21 % Commercial loans, at fair value 150,852 Spread to swap rate 195 - 195 bps 195 bps Credit support 23 - 23 % 23 % Trading and AFS securities 1,085,224 Discount rate 4 - 12 % 7 % Prepayment rate (annual CPR) 1 - 35 % 13 % Default rate 0 - 35 % 8 % Loss severity 20 - 65 % 34 % Credit support 0 - 49 % 4 % MSRs 162,726 Discount rate 8 - 12 % 10 % Prepayment rate (annual CPR) 5 - 55 % 12 % Per loan annual cost to service $72 - $82 $ 78 Guarantee asset 5,120 Discount rate 10 - 10 % 10 % Prepayment rate (annual CPR) 16 - 16 % 16 % REO 3,120 Loss severity 0 - 89 % 52 % Loan purchase commitments, net (2) 9,687 MSR Multiple 0 - 5.0 x 3.0 x Fallout rate 2 - 98 % 34 % Liabilities ABS issued by consolidated Sequoia entities (1) 1,105,588 Discount rate 5 - 9 % 5 % Prepayment rate (annual CPR) 6 - 20 % 13 % Default rate 0 - 12 % 6 % Loss severity 20 - 32 % 27 % Credit support 0 - 70 % 12 % Commercial secured financing 65,578 Spread to swap rate 194 - 195 bps 194 bps Credit support 23 - 23 % 23 % (1) Upon adoption of ASU 2014-13 on January 1, 2015, we began to record loans held-for-investment in, and ABS issued by, consolidated Sequoia entities at fair value. In accordance with this new guidance, the fair value of the loans in these entities was based on the fair value of the liabilities issued by these entities, which we determined were more readily observable. See Note 3 for further discussion. (2) For the purpose of this presentation, loan purchase commitment assets and liabilities are presented net. 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 Estimated fair values for residential loans are determined using models that incorporate various observable inputs, including pricing information from recent securitizations and whole loan sales. Certain significant inputs in these models are considered unobservable and are therefore Level 3 in nature. Pricing inputs obtained from market securitization activity include indicative spreads to indexed TBA prices for senior RMBS and index swap rates (Level 3). Pricing inputs obtained from market whole loan transaction activity include indicative spreads to indexed swap rates (Level 3). Other observable inputs include Agency RMBS transactions, benchmark interest rates, and prepayment rates. These assets would generally decrease in value based upon an increase in the credit spread, prepayment speed, or credit support assumptions. Estimated fair values for conforming loans are determined based upon quoted market prices (Level 2). Conforming loans are mortgage loans that conform to Agency guidelines. As necessary, these values are adjusted for servicing value, market conditions and liquidity. Commercial loans Estimated fair values for senior commercial loans held-for-sale are determined by an exit price to securitization. Certain significant inputs in the valuation analysis are Level 3 in nature. Relevant market indicators that are factored into the analyses include pricing points for current third-party Commercial Mortgage-Backed Securities (“CMBS”) sales, pricing points for secondary sales of CMBS, yields for synthetic instruments that use CMBS bonds as an underlying index, indexed swap yields, credit rating agency guidance on expected credit enhancement levels for newly issued CMBS transactions, and interest rates (Level 3). In certain cases, commercial senior mortgage loans are valued based on third-party offers for the loans for purchase into securitization (Level 2). The estimated fair value of our senior commercial loans would generally decrease based upon an increase in credit spreads or required credit support. Estimated fair values for mezzanine commercial loans are determined by both market comparable pricing and discounted cash flow analysis valuation techniques (Level 3). Our discounted cash flow models utilize certain significant unobservable inputs including the underwritten net operating income and debt coverage ratio assumptions and actual performance relative to those underwritten metrics as well as estimated market discount rates. An increase in market discount rates would reduce the estimated fair value of the commercial loans. Real estate securities Real estate securities include residential, commercial, and other asset-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 analyses 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, loss severity and credit support. The estimated fair value of our securities would generally decrease based upon an increase in default rates, serious delinquencies, or a decrease in prepayment rates or credit support. 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 September 30, 2015 , we received dealer price indications on 78% of our securities, representing 91% of our carrying value. In the aggregate, our internal valuations of the securities for which we received dealer price indications were within 1% of the aggregate average dealer valuations. 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, financial futures, CMBX credit default index swaps, loan purchase commitments ("LPCs"), and forward sale commitments ("FSCs"). 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. TBA and financial futures fair values 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 fair values are estimated based on quoted Agency MBS prices, estimates of the fair value of the MSRs we expect to retain in the sale of the loans, and the probability that the mortgage loan will be purchased (Level 3). FSC fair values are obtained using quoted Agency prices. Model inputs can generally be verified and model selection does not involve significant management judgment (Level 2). 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). MSRs MSRs include the rights to service jumbo and conforming 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. These inputs include market discount rates, prepayment rates of serviced loans, and the market cost of servicing. 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, which is what we believe market participants would use to estimate fair value (Level 3). These discounted cash flow models utilize certain significant unobservable inputs including prepayment rate and discount rate assumptions. An increase in these unobservable inputs will 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 1% of the third-party valuation. FHLBC Stock Our Federal Home Loan Bank ("FHLB") member subsidiary is required to purchase Federal Home Loan Bank of Chicago ("FHLBC") stock under a borrowing agreement between our FHLBC 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 1). 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 inputs include prepayment rates and market discount rate (Level 3). An increase in prepayment speed or market discount rate will 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 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 at consolidated Sequoia entities and at the Residential Resecuritization and Commercial Securitization 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). REO 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). Short-term debt Short-term debt includes our credit facilities that mature within one year. 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 Sequoia, Residential Resecuritization, and Commercial Securitization entities. 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 analyses include bid/ask spreads, the amount and timing of collateral 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 liabilities would generally decrease in value (become a larger liability) if credit losses decreased or if the prepayment rate or discount rate were to increase. FHLBC Borrowings FHLBC borrowings include amounts borrowed from the FHLBC that are secured 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 1). Commercial secured borrowings Commercial secured borrowings represent liabilities recognized as a result of transfers of portions of senior commercial mortgage loans to third parties that do not meet the criteria for sale treatment under GAAP and are accounted for as secured borrowings. Fair values for commercial secured borrowings are based on the fair values of the senior commercial loans associated with the borrowings (Level 3). Convertible notes Convertible notes include unsecured convertible and exchangeable senior notes. Fair values are determined using quoted prices in active markets (Level 2). Trust preferred securities and subordinated notes Estimated fair values of trust preferred securities and subordinated notes are determined using discounted cash flow analysis valuation techniques. 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. Estimated fair values are based on applying the market indicators to generate discounted cash flows (Level 3). |
