Note 8. Real Estate Securities

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


(In Thousands)	September 30, 2014		December 31, 2013
Trading	$	108,750	$	124,555
Available-for-sale		1,286,235		1,558,306

Total Real Estate Securities	$	1,394,985	$	1,682,861

Our real estate 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 September 30, 2014, our trading securities included $105 million of interest-only securities, for which there is no principal balance, $3 million of senior securities and less than $1 million of residential subordinate securities. The unpaid principal balance of residential senior and subordinate securities classified as trading was $3 million and $11 million, respectively, at September 30, 2014. The following table presents trading securities by collateral type at September 30, 2014 and December 31, 2013.


(In Thousands)	September 30, 2014		December 31, 2013
Senior Securities
Prime	$	100,612	$	110,505
Non-prime		7,758		9,070

Total Senior Securities		108,370		119,575

Subordinate Securities
Prime		380		4,980

Total Subordinate Securities		380		4,980


Total Trading Securities	$	108,750	$	124,555

AFS Securities

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


(In Thousands)	September 30, 2014		December 31, 2013
Senior Securities
Prime	$	358,813	$	662,306
Non-prime		186,223		193,386

Total Senior Securities		545,036		855,692

Re-REMIC Securities		176,117		176,376

Subordinate Securities
Prime		564,932		526,095
Non-prime		150		143

Total Subordinate Securities		565,082		526,238


Total AFS Securities	$	1,286,235	$	1,558,306

The senior securities shown above at September 30, 2014 and December 31, 2013, included $111 million and $131 million, respectively, of prime securities, and $122 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 September 30, 2014, there were $9 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 10 years, and the remainder of our real estate securities had contractual maturities greater than 10 years.

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

Carrying Value of Residential AFS Securities


September 30, 2014	Senior
(In Thousands)	Prime		Non-prime		Re-REMIC		Subordinate		Total
Principal balance	$	362,902	$	202,812	$	206,212	$	694,308	$	1,466,234
Credit reserve		(4,082)		(9,894)		(16,553)		(43,346)		(73,875)
Unamortized discount, net		(41,314)		(33,676)		(80,986)		(143,129)		(299,105)

Amortized cost		317,506		159,242		108,673		507,833		1,093,254
Gross unrealized gains		42,113		27,004		67,444		59,427		195,988
Gross unrealized losses		(805)		(24)		-		(2,178)		(3,007)

Carrying Value	$	358,814	$	186,222	$	176,117	$	565,082	$	1,286,235


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 nine months ended September 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 September 30, 2014
	Credit		Unamortized
(In Thousands)	Reserve		Discount, Net
Beginning balance	$	83,276	$	304,293
Amortization of net discount		-		(10,890)
Realized credit losses		(1,692)		-
Acquisitions		1,589		4,404
Sales, calls, other		(1,013)		(7,175)
Impairments		188		-
Transfers to (release of) credit reserves, net		(8,473)		8,473

Ending Balance	$	73,875	$	299,105


	Nine Months Ended September 30, 2014
	Credit		Unamortized
(In Thousands)	Reserve		Discount, Net
Beginning balance	$	116,870	$	298,469
Amortization of net discount		-		(32,774)
Realized credit losses		(9,002)		-
Acquisitions		1,846		7,241
Sales, calls, other		(2,425)		(7,810)
Impairments		565		-
Transfers to (release of) credit reserves, net		(33,979)		33,979

Ending Balance	$	73,875	$	299,105

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 September 30, 2014 and December 31, 2013.


	Less Than 12 Consecutive Months						12 Consecutive Months or Longer
	Amortized		Unrealized		Fair		Amortized		Unrealized		Fair
(In Thousands)	Cost		Losses		Value		Cost		Losses		Value
September 30, 2014	$	104,118	$	(1,097)	$	103,021	$	75,582	$	(1,910)	$	73,672
December 31, 2013		607,030		(21,195)		585,835		19,828		(1,938)		17,890

At September 30, 2014, after giving effect to purchases, sales, and extinguishments due to credit losses, our consolidated balance sheet included 294 AFS securities, of which 30 were in an unrealized loss position and 12 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 $3 million at September 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 September 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 September 30, 2014, we determined that unrealized losses of less than $1 million related to our AFS securities were OTTI, of which less than $1 million was determined to be credit related and recorded in “Other market valuation adjustments” in our consolidated statements of income and none 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 September 30, 2014.

Significant Valuation Assumptions


	Range for Securities
September 30, 2014	Prime Securities			Non-prime
Prepayment rates		15 - 20	%		10 - 10 %
Loss severity		20 - 52	%		35 - 35 %
Projected default rate		1 - 22	%		15 - 15 %

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 September 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 September 30,				Nine Months Ended September 30,
(In Thousands)	2014		2013		2014		2013
Balance at beginning of period	$	34,256	$	42,674	$	37,149	$	50,852
Additions
Initial credit impairments		-		-		261		-
Subsequent credit impairments		-		-		70		-
Reductions
Securities sold, or expected to sell		(18)		(3,288)		(922)		(5,479)
Securities with no outstanding principal at period end		-		(764)		(2,320)		(6,751)

Balance at End of Period	$	34,238	$	38,622	$	34,238	$	38,622

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 nine months ended September 30, 2014 and 2013.


	Three Months Ended September 30,				Nine Months Ended September 30,
(In Thousands)	2014		2013		2014		2013
Gross realized gains - sales	$	10,227	$	10,532	$	11,219	$	22,762
Gross realized gains - calls		462		-		1,449		333
Gross realized losses - sales		(2,713)		(214)		(2,713)		(214)
Gross realized losses - calls		-		-		-		-

Total Realized Gains on Sales and Calls of AFS Securities, net	$	7,976	$	10,318	$	9,955	$	22,881