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, 2015 and December 31, 2014.

Table 8.1 – Fair Values of Real Estate Securities by Type



(In Thousands)	September 30, 2015		December 31, 2014
Trading	$	114,211	$	111,606
Available-for-sale	971,013		1,267,624
Total Real Estate Securities	$	1,085,224	$	1,379,230

Our real estate securities 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 security interests, 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, 2015, our trading securities included $36 million of interest-only securities, for which there is no principal balance, $22 million of senior securities and $56 million of subordinate securities. The unpaid principal balance of senior and subordinate securities classified as trading securities was $22 million and $70 million, respectively, at September 30, 2015. During the three and nine months ended September 30, 2015, we acquired $9 million and $103 million (principal balance), respectively, of senior and subordinate securities for which we elected the fair value option and classified as trading, and sold $2 million and $81 million, respectively, of such securities. During the three months ended September 30, 2015 and 2014, we recorded negative $9 million and negative $2 million, respectively, of valuation adjustments on trading securities, included in mortgage banking and investment activities, net on our consolidated income statements. During the nine months ended September 30, 2015 and 2014, we recorded negative $16 million and negative $15 million, respectively, of valuation adjustments on trading securities, included in mortgage banking and investment activities, net on our consolidated statements of income.

The following table presents trading securities by collateral type at September 30, 2015 and December 31, 2014.

Table 8.2 – Trading Securities by Collateral Type



(In Thousands)	September 30, 2015		December 31, 2014
Senior Securities
Prime	$	51,308	$	93,802
Non-prime	6,514		7,951
Total Senior Securities	57,822		101,753
Subordinate Securities
Prime mezzanine	38,750		—
Prime subordinate	17,639		9,853
Total Subordinate Securities	56,389		9,853
Total Trading Securities	$	114,211	$	111,606

AFS Securities

The following table presents the fair value of our available-for-sale securities held at Redwood by collateral type at September 30, 2015 and December 31, 2014.

Table 8.3 – Available-for-Sale Securities by Collateral Type



(In Thousands)	September 30, 2015		December 31, 2014
Senior Securities
Prime	$	251,273	$	307,813
Non-prime	158,040		179,744
Total Senior Securities	409,313		487,557
Re-REMIC Securities	167,639		168,347
Subordinate Securities
Prime mezzanine ⁽¹⁾	233,458		448,838
Prime subordinate ⁽²⁾	160,603		162,882
Total Subordinate Securities	394,061		611,720
Total AFS Securities	$	971,013	$	1,267,624

(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 September 30, 2015, and December 31, 2014.

The senior securities shown above at September 30, 2015 and December 31, 2014, included $81 million and $105 million, respectively, of prime securities, and $100 million and $117 million, respectively, of non-prime securities that were financed through the Residential Resecuritization entity, as discussed in Note 4. As of September 30, 2015, AFS securities with a carrying value of $587 million were pledged as collateral under short-term borrowing agreements. See Note 12 for additional information on short-term debt.

During the three and nine months ended September 30, 2015, we purchased zero and $15 million of AFS securities, respectively, and sold $35 million and $237 million of AFS securities, respectively, which resulted in net realized gains of $4 million and $14 million, respectively. During the three and nine months ended September 30, 2014, we purchased $41 million and $192 million of AFS securities, respectively, and sold $395 million and $396 million of AFS securities, respectively, which resulted in net realized gains of $8 million and $9 million, respectively.

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, 2015, there were less than $1 million of AFS securities with contractual maturities less than five years, $2 million of AFS securities with contractual maturities greater than five years but less than 10 years, and the remainder of our AFS securities had contractual maturities greater than 10 years.

The following table presents the components of carrying value (which equals fair value) of AFS securities at September 30, 2015 and December 31, 2014.

Table 8.4 – Carrying Value of AFS Securities



September 30, 2015	Senior
(In Thousands)	Prime			Non-prime			Re-REMIC			Subordinate			Total
Principal balance	$	257,526		$	174,285		$	192,215		$	490,891		$	1,114,917
Credit reserve	(2,377		)	(8,964		)	(11,135		)	(32,865		)	(55,341		)
Unamortized discount, net	(27,476		)	(25,505		)	(74,377		)	(134,371		)	(261,729		)
Amortized cost	227,673			139,816			106,703			323,655			797,847
Gross unrealized gains	26,899			18,515			60,936			71,226			177,576
Gross unrealized losses	(3,299		)	(291		)	—			(820		)	(4,410		)
Carrying Value	$	251,273		$	158,040		$	167,639		$	394,061		$	971,013



December 31, 2014	Senior
(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

The following table presents the changes for the three and nine months ended September 30, 2015, in unamortized discount and designated credit reserves on residential AFS securities.

Table 8.5 – Changes in Unamortized Discount and Designated Credit Reserves on AFS Securities



	Three Months Ended September 30, 2015						Nine Months Ended September 30, 2015
	Credit Reserve			Unamortized Discount, Net			Credit Reserve			Unamortized Discount, Net
(In Thousands)	Credit Reserve			Unamortized Discount, Net			Credit Reserve			Unamortized Discount, Net
Beginning balance	$	61,700		$	273,119		$	70,067		$	296,342
Amortization of net discount	—			(9,115		)	—			(28,277		)
Realized credit losses	(1,706		)	—			(7,420		)	—
Acquisitions	—			—			858			5,705
Sales, calls, other	(1,632		)	(5,522		)	(1,632		)	(18,799		)
Impairments	—			226			—			226
Transfers to (release of) credit reserves, net	(3,021		)	3,021			(6,532		)	6,532
Ending Balance	$	55,341		$	261,729		$	55,341		$	261,729

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, 2015 and December 31, 2014.

Table 8.6 – Components of Fair Value of Residential AFS Securities by Holding Periods



	Less Than 12 Consecutive Months							12 Consecutive Months or Longer
	Amortized Cost		Unrealized Losses			Fair Value		Amortized Cost		Unrealized Losses			Fair Value
(In Thousands)	Amortized Cost		Unrealized Losses			Fair Value		Amortized Cost		Unrealized Losses			Fair Value
September 30, 2015	$	87,796	$	(2,090	)	$	85,706	$	82,383	$	(2,320	)	$	80,063
December 31, 2014	126,681		(1,374		)	125,307		70,676		(1,422		)	69,254

At September 30, 2015, after giving effect to purchases, sales, and extinguishment due to credit losses, our consolidated balance sheet included 247 AFS securities, of which 30 were in an unrealized loss position and 15 were in a continuous unrealized loss position for 12 consecutive months or longer. At December 31, 2014, 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.

Evaluating AFS Securities for Other-than-Temporary Impairments

Gross unrealized losses on our AFS securities were $4 million at September 30, 2015. 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, 2015, 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 and nine months ended September 30, 2015, we recognized less than $1 million of OTTI losses related to our AFS securities. 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 in unrealized loss positions at September 30, 2015.

Table 8.7 – Significant Valuation Assumptions



	Range for Securities
September 30, 2015	Prime		Non-prime
Prepayment rates	10 - 20	%	10 - 12	%
Projected losses	0 - 9	%	5 - 9	%

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, 2015 and 2014, for which a portion of an OTTI was recognized in other comprehensive income.

Table 8.8 – Activity of the Credit Component of Other-than-Temporary Impairments



	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	2015			2014			2015			2014
Balance at beginning of period	$	32,696		$	34,256		$	33,849		$	37,149
Additions
Initial credit impairments	226			—			226			261
Subsequent credit impairments	—			—			—			70
Reductions
Securities sold, or expected to sell	—			(18		)	(348		)	(922		)
Securities with no outstanding principal at period end	(446		)	—			(1,251		)	(2,320		)
Balance at End of Period	$	32,476		$	34,238		$	32,476		$	34,238

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, 2015 and 2014.

Table 8.9 – Gross Realized Gains and Losses on AFS Securities



	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	2015			2014			2015			2014
Gross realized gains - sales	$	4,053		$	10,227		$	14,315		$	11,219
Gross realized gains - calls	1,607			462			1,967			1,449
Gross realized losses - sales	—			(2,713		)	—			(2,713		)
Gross realized losses - calls	(112		)	—			(112		)	—
Total Realized Gains on Sales and Calls of AFS Securities, net	$	5,548		$	7,976		$	16,170		$	9,955