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 collateral type at December 31, 2014 and 2013.


(In Thousands)	December 31, 2014		December 31, 2013
Trading	$	111,606	$	124,555
Available-for-sale		1,267,624		1,558,306

Total Real Estate Securities	$	1,379,230	$	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 security 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 at Redwood and, previously, the Acacia entities, and classify them as trading securities. At December 31, 2014, our trading securities included $96 million of interest-only securities, for which there is no principal balance, $6 million of senior securities and $10 million of residential subordinate securities. The unpaid principal balance of residential senior and subordinate securities classified as trading was $6 million and $21 million, respectively, at December 31, 2014.

The following table presents trading securities by collateral type and ownership entity at December 31, 2014 and 2013.


(In Thousands)	December 31, 2014		December 31, 2013
Senior Securities
Prime	$	93,802	$	110,505
Non-prime		7,951		9,070

Total Senior Securities		101,753		119,575
Prime Subordinate Securities		9,853		4,980

Total Trading Securities	$	111,606	$	124,555

AFS Securities

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


(In Thousands)	December 31, 2014		December 31, 2013
Senior Securities
Prime	$	307,813	$	662,306
Non-prime		179,744		193,386

Total Senior Securities		487,557		855,692
Re-REMIC Securities		168,347		176,376
Subordinate Securities
Prime Mezzanine ⁽¹⁾		448,838		384,849
Subordinate ⁽²⁾		162,882		141,389

Total Subordinate Securities		611,720		526,238

Total AFS Securities	$	1,267,624	$	1,558,306

(1)	Mezzanine includes securities initially rated AA, A, and BBB- and issued in 2012 or later.

(2)	Subordinate securities includes less than $1 million of non-prime securities at both December 31, 2014 and 2013.

The senior securities shown above at December 31, 2014 and 2013, included $105 million and $131 million, respectively, of prime securities, and $117 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 December 31, 2014, there were $8 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 the fair value) of residential AFS securities at December 31, 2014 and 2013.

Carrying Value of Residential AFS Securities


December 31, 2014 (In Thousands)	Senior
December 31, 2014 (In Thousands)	Prime			Non-prime			Re-REMIC			Subordinate			Total
Principal balance	$	311,573		$	196,258		$	195,098		$	742,150		$	1,445,079
Credit reserve		(3,660	)		(9,644	)		(15,202	)		(41,561	)		(70,067	)
Unamortized discount, net		(34,782	)		(31,491	)		(79,611	)		(150,458	)		(296,342	)

Amortized cost		273,131			155,123			100,285			550,131			1,078,670
Gross unrealized gains		35,980			24,682			68,062			63,026			191,750
Gross unrealized losses		(1,298	)		(61	)		—			(1,437	)		(2,796	)

Carrying Value	$	307,813		$	179,744		$	168,347		$	611,720		$	1,267,624


December 31, 2013 (In Thousands)	Senior
December 31, 2013 (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 years ended December 31, 2014 and 2013, of the unamortized discount and designated credit reserves on residential AFS securities.

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


	Year Ended December 31, 2014						Year Ended December 31, 2013
(In Thousands)	Credit Reserve			Unamortized Discount, Net			Credit Reserve			Unamortized Discount, Net
Beginning balance	$	116,870		$	298,469		$	187,032		$	203,421
Amortization of net discount		—			(42,835	)		—			(34,943	)
Realized credit losses		(11,501	)		—			(21,971	)		—
Acquisitions		3,581			15,348			13,604			92,124
Sales, calls, other		(2,555	)		(11,533	)		(19,868	)		(5,894	)
Impairments		565			—			1,834			—
Transfers to (release of) credit reserves, net		(36,893	)		36,893			(43,761	)		43,761

Ending Balance	$	70,067		$	296,342		$	116,870		$	298,469

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 December 31, 2014 and 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
December 31, 2014	$	126,681	$	(1,374	)	$	125,307	$	70,676	$	(1,422	)	$	69,254
December 31, 2013		607,030		(21,195	)		585,835		19,828		(1,938	)		17,890

At December 31, 2014, after giving effect to purchases, sales, and extinguishments due to credit losses, our consolidated balance sheet included 290 AFS securities, of which 31 were in an unrealized loss position and 10 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 December 31, 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 December 31, 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 2014, we recognized OTTI losses of $5 million related to our AFS securities, of which $1 million was determined to be credit related and recorded in other market valuation adjustments in our consolidated statements of income and the remainder was determined to be non-credit related and recorded through accumulated other comprehensive income (loss) on our consolidated balance sheets. AFS securities for 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 AFS securities at December 31, 2014.

Significant Assumptions


	Range for Securities
December 31, 2014	Prime			Non-prime
Prepayment rates		8 - 15	%		10 - 10	%
Loss severity		20 - 52	%		35 - 35	%
Projected losses		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 December 31, 2014, 2013, and 2012, for which a portion of an OTTI was recognized in other comprehensive income.

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


	Years Ended December 31,
(In Thousands)	2014			2013			2012
Balance at beginning of period	$	37,149		$	50,852		$	78,126
Additions
Initial credit impairments		261			137			325
Subsequent credit impairments		70			—			552
Reductions
Securities sold, or expected to sell		(922	)		(5,811	)		(10,024	)
Securities with no outstanding principal at period end		(2,709	)		(8,029	)		(18,127	)

Balance at End of Period	$	33,849		$	37,149		$	50,852

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 on sales and calls of AFS securities for the years ended December 31, 2014, 2013, and 2012.


	Years Ended December 31,
(In Thousands)	2014			2013			2012
Gross realized gains - sales	$	15,030		$	24,613		$	33,909
Gross realized gains - calls		1,600			366			142
Gross realized losses - sales		(2,713	)		(214	)		(1,600	)
Gross realized losses - calls		—			—			—

Total Realized Gains on Sales and Calls of AFS Securities, net	$	13,917		$	24,765		$	32,451