Note 8. Real Estate Securities

We invest in mortgage-backed securities. The following table presents the fair values of our real estate securities by type at June 30, 2014 and December 31, 2013.


(In Thousands)	June 30, 2014		December 31, 2013
Trading	$	173,281	$	124,555
Available-for-sale		1,671,786		1,558,306

Total Real Estate Securities	$	1,845,067	$	1,682,861

Our residential securities herein are presented in accordance with their general position within a securitization structure based on their rights to cash flows. Senior securities are those interests in a securitization that generally have the first right to cash flows and are last in line to absorb losses. Re-REMIC securities, as presented herein, were created through the resecuritization of certain senior interests to provide additional credit support to those interests. These re-REMIC securities are therefore subordinate to the remaining senior interest, but senior to any subordinate tranches of the securitization from which they were created. Subordinate securities are all interests below senior and re-REMIC interests.

Trading Securities

We elected the fair value option for certain securities and classify them as trading securities. At June 30, 2014, our trading securities included $105 million of interest-only securities, for which there is no principal balance, $62 million of senior securities and $6 million of residential subordinate securities. The unpaid principal balance of residential senior and subordinate securities classified as trading was $62 million and $15 million, respectively, at June 30, 2014. The following table presents trading securities by collateral type at June 30, 2014 and December 31, 2013.


(In Thousands)	June 30, 2014		December 31, 2013
Senior Securities
Prime	$	159,311	$	110,505
Non-prime		8,380		9,070

Total Senior Securities		167,691		119,575

Subordinate Securities
Prime		5,590		4,980
Non-prime		-		-

Total Subordinate Securities		5,590		4,980


Total Trading Securities	$	173,281	$	124,555

AFS Securities

The following table presents the fair value of our available-for-sale securities held at Redwood by collateral type at June 30, 2014 and December 31, 2013.


(In Thousands)	June 30, 2014		December 31, 2013
Senior Securities
Prime	$	711,710	$	662,306
Non-prime		192,256		193,386

Total Senior Securities		903,966		855,692

Re-REMIC Securities		192,596		176,376

Subordinate Securities
Prime		575,067		526,095
Non-prime		157		143

Total Subordinate Securities		575,224		526,238


Total AFS Securities	$	1,671,786	$	1,558,306

The senior securities shown above at June 30, 2014 and December 31, 2013, included $119 million and $131 million, respectively, of prime securities, and $127 million and $132 million, respectively, of non-prime securities that were financed through the Residential Resecuritization entity, as discussed in Note 4.

We often purchase AFS securities at a discount to their outstanding principal balances. To the extent we purchase an AFS security that has a likelihood of incurring a loss, we do not amortize into income the portion of the purchase discount that we do not expect to collect due to the inherent credit risk of the security. We may also expense a portion of our investment in the security to the extent we believe that principal losses will exceed the purchase discount. We designate any amount of unpaid principal balance that we do not expect to receive and thus do not expect to earn or recover as a credit reserve on the security. Any remaining net unamortized discounts or premiums on the security are amortized into income over time using the effective yield method.

At June 30, 2014, there were $10 million of AFS residential securities with contractual maturities less than five years, $2 million of AFS residential securities with contractual maturities greater than five years but less than ten years, and the remainder of our real estate securities had contractual maturities greater than ten years.

The following table presents the components of carrying value (which equals fair value) of residential AFS securities at June 30, 2014 and December 31, 2013.

Carrying Value of Residential AFS Securities


June 30, 2014	Senior
(In Thousands)	Prime		Non-prime		Re-REMIC		Subordinate		Total
Principal balance	$	710,620	$	209,967	$	223,389	$	717,838	$	1,861,814
Credit reserve		(5,476)		(9,697)		(17,788)		(50,315)		(83,276)
Unamortized discount, net		(37,763)		(36,387)		(89,089)		(141,054)		(304,293)

Amortized cost		667,381		163,883		116,512		526,469		1,474,245
Gross unrealized gains		45,952		28,385		76,084		54,289		204,710
Gross unrealized losses		(1,623)		(12)		-		(5,534)		(7,169)

Carrying Value	$	711,710	$	192,256	$	192,596	$	575,224	$	1,671,786


December 31, 2013	Senior
(In Thousands)	Prime		Non-prime		Re-REMIC		Subordinate		Total
Principal balance	$	670,051	$	218,603	$	214,046	$	706,292	$	1,808,992
Credit reserve		(10,144)		(13,840)		(30,429)		(62,457)		(116,870)
Unamortized discount, net		(44,133)		(36,882)		(80,188)		(137,266)		(298,469)

Amortized cost		615,774		167,881		103,429		506,569		1,393,653
Gross unrealized gains		47,980		25,654		72,947		41,205		187,786
Gross unrealized losses		(1,448)		(149)		-		(21,536)		(23,133)

Carrying Value	$	662,306	$	193,386	$	176,376	$	526,238	$	1,558,306

The following table presents the changes for the three and six months ended June 30, 2014, in unamortized discount and designated credit reserves on residential AFS securities.

Changes in Unamortized Discount and Designated Credit Reserves on Residential AFS Securities


	Three Months Ended June 30, 2014
(In Thousands)	Credit Reserve		Unamortized Discount, Net
Beginning balance	$	95,688	$	303,733
Amortization of net discount		-		(10,586)
Realized credit losses		(3,973)		-
Acquisitions		257		3,246
Sales, calls, other		(476)		(584)
Impairments		264		-
Transfers to (release of) credit reserves, net		(8,484)		8,484

Ending Balance	$	83,276	$	304,293


	Six Months Ended June 30, 2014
(In Thousands)	Credit Reserve		Unamortized Discount, Net
Beginning balance	$	116,870	$	298,469
Amortization of net discount		-		(21,884)
Realized credit losses		(7,310)		-
Acquisitions		257		2,837
Sales, calls, other		(1,412)		(635)
Impairments		377		-
Transfers to (release of) credit reserves, net		(25,506)		25,506

Ending Balance	$	83,276	$	304,293

Residential AFS Securities with Unrealized Losses

The following table presents the components comprising the total carrying value of residential AFS securities that were in a gross unrealized loss position at June 30, 2014 and December 31, 2013.


	Less Than 12 Consecutive Months						12 Consecutive Months or Longer
(In Thousands)	Amortized Cost		Unrealized Losses		Fair Value		Amortized Cost		Unrealized Losses		Fair Value
June 30, 2014	$	300,804	$	(2,691)	$	298,113	$	122,012	$	(4,478)	$	117,534
December 31, 2013		607,030		(21,195)		585,835		19,828		(1,938)		17,890

At June 30, 2014, after giving effect to purchases, sales, and extinguishments due to credit losses, our consolidated balance sheet included 306 AFS securities, of which 44 were in an unrealized loss position and 16 were in a continuous unrealized loss position for 12 consecutive months or longer. At December 31, 2013, our consolidated balance sheet included 303 AFS securities, of which 76 were in an unrealized loss position and five were in a continuous unrealized loss position for 12 consecutive months or longer.

Evaluating AFS Securities for Other-than-Temporary Impairments

Gross unrealized losses on our AFS securities were $7 million at June 30, 2014. We evaluate all securities in an unrealized loss position to determine if the impairment is temporary or other-than-temporary (resulting in an OTTI). At June 30, 2014, we did not intend to sell any of our AFS securities that were in an unrealized loss position, and it is more likely than not that we will not be required to sell these securities before recovery of their amortized cost basis, which may be at their maturity. We review our AFS securities that are in an unrealized loss position to identify those securities with losses that are other-than-temporary based on an assessment of changes in expected cash flows for such securities, which considers recent security performance and expected future performance of the underlying collateral.

During the three months ended June 30, 2014, we determined that unrealized losses of $3 million related to our AFS securities were OTTI, of which $264 thousand was determined to be credit related and recorded in “Other market valuation adjustments” in our consolidated statements of income and $2.7 million was determined to be non-credit related and recorded through AOCI on our consolidated balance sheets. AFS securities on which OTTI is recognized have experienced, or are expected to experience, credit-related adverse cash flow changes. In determining our estimate of cash flows for AFS securities we may consider factors such as structural credit enhancement, past and expected future performance of underlying mortgage loans, including timing of expected future cash flows, which are informed by prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing loans, FICO scores at loan origination, year of origination, loan-to-value ratios, and geographic concentrations, as well as general market assessments. Changes in our evaluation of these factors impacted the cash flows expected to be collected at the OTTI assessment date and were used to determine if there were credit-related adverse cash flows and if so, the amount of credit related losses. Significant judgment is used in both our analysis of the expected cash flows for our AFS securities and any determination of the credit loss component of OTTI.

The table below summarizes the significant valuation assumptions we used for our OTTI AFS securities at June 30, 2014.

Significant Valuation Assumptions


	Range for Securities
June 30, 2014	Prime Securities		Non-prime
Prepayment rates		7 - 20 %		10 - 10 %
Loss severity		20 - 53 %		35 - 35 %
Projected default rate		1 - 20 %		11 - 11 %

The following table details the activity related to the credit loss component of OTTI (i.e., OTTI recognized through earnings) for AFS securities held at June 30, 2014 and 2013, for which a portion of an OTTI was recognized in other comprehensive income.

Activity of the Credit Component of Other-than-Temporary Impairments


	Three Months Ended June 30,				Six Months Ended June 30,
(In Thousands)	2014		2013		2014		2013
Balance at beginning of period	$	35,786	$	45,611	$	37,149	$	50,852
Additions
Initial credit impairments		190		-		261		-
Subsequent credit impairments		28		-		70		-
Reductions
Securities sold, or expected to sell		(904)		(2,191)		(904)		(2,191)
Securities with no outstanding principal at period end		(844)		(746)		(2,320)		(5,987)

Balance at End of Period	$	34,256	$	42,674	$	34,256	$	42,674

Gross Realized Gains and Losses on AFS Securities

Gains and losses from the sale of AFS securities are recorded as realized gains, net, in our consolidated statements of income. The following table presents the gross realized gains and losses on sales and calls of AFS securities for the three and six months ended June 30, 2014 and 2013.


	Three Months Ended June 30,				Six Months Ended June 30,
(In Thousands)	2014		2013		2014		2013
Gross realized gains - sales	$	992	$	193	$	992	$	12,231
Gross realized gains - calls		-		333		987		333
Gross realized losses - sales		-		-		-		-
Gross realized losses - calls		-		-		-		-

Total Realized Gains on Sales and Calls of AFS Securities, net	$	992	$	526	$	1,979	$	12,564