| 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 mar |
