Real Estate Securities

We invest in real estate securities. The following table presents the fair values of our real estate securities by type at September 30, 2017 and December 31, 2016.

Table 7.1 – Fair Values of Real Estate Securities by Type



(In Thousands)	September 30, 2017		December 31, 2016
Trading	$	820,134	$	445,687
Available-for-sale	536,138		572,752
Total Real Estate Securities	$	1,356,272	$	1,018,439

Our real estate securities include mortgage-backed securities, which 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. We further separate our subordinate securities into mezzanine and subordinate, where mezzanine includes securities initially rated AA through BBB- and issued in 2012 or later. Nearly all of our securities are supported by collateral that was designated as prime as of issuance.

Trading Securities

The following table presents the fair value of trading securities by position and collateral type at September 30, 2017 and December 31, 2016.

Table 7.2 – Trading Securities by Position and Collateral Type



(In Thousands)	September 30, 2017		December 31, 2016
Senior Securities	$	62,767	$	37,067
Subordinate Securities
Mezzanine	458,299		256,226
Subordinate	299,068		152,394
Total Subordinate Securities	757,367		408,620
Total Trading Securities	$	820,134	$	445,687

We elected the fair value option for certain securities and classify them as trading securities. Our trading securities include both residential and commercial/multifamily securities. At September 30, 2017, trading securities with a carrying value of $435 million were pledged as collateral under short-term borrowing agreements. See Note 11 for additional information on short-term debt.

At September 30, 2017 and December 31, 2016, our senior trading securities were comprised of interest-only securities, for which there is no principal balance, and our subordinate trading securities had an unpaid principal balance of $767 million and $434 million, respectively.

At September 30, 2017 and December 31, 2016, subordinate trading securities included $287 million and $152 million, respectively, of Agency residential mortgage credit risk transfer (or "CRT") securities, $60 million and $15 million, respectively, of Sequoia securities, $167 million and $149 million, respectively, of other third-party residential securities, and $243 million and $92 million, respectively, of third-party commercial/multifamily securities.

During the three and nine months ended September 30, 2017, we acquired $171 million and $432 million (principal balance), respectively, of senior and subordinate securities for which we elected the fair value option and classified as trading, and sold $25 million and $85 million, respectively, of such securities. During the three and nine months ended September 30, 2016, we acquired $65 million and $198 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 $238 million, respectively, of such securities.

During the three and nine months ended September 30, 2017, we recorded net market valuation gains of $1 million and $31 million, respectively, on trading securities, included in Investment fair value changes, net and Mortgage banking activities, net on our consolidated statements of income. During the three and nine months ended September 30, 2016, we recorded net market valuation gains of $9 million and $5 million, respectively, on trading securities, included in Investment fair value changes, net and Mortgage banking activities, net on our consolidated statements of income.

AFS Securities

The following table presents the fair value of our available-for-sale securities by position and collateral type at September 30, 2017 and December 31, 2016.

Table 7.3 – Available-for-Sale Securities by Position and Collateral Type



(In Thousands)	September 30, 2017		December 31, 2016
Senior Securities	$	153,232	$	136,546
Re-REMIC Securities	39,033		85,479
Subordinate Securities
Mezzanine	119,687		163,715
Subordinate	224,186		187,012
Total Subordinate Securities	343,873		350,727
Total AFS Securities	$	536,138	$	572,752

At September 30, 2017 and December 31, 2016, all of our available-for-sale securities were comprised of residential mortgage-backed securities. At September 30, 2017, AFS securities with a carrying value of $229 million were pledged as collateral under short-term borrowing agreements. See Note 11 for additional information on short-term debt.

During the three and nine months ended September 30, 2017, we purchased $4 million and $32 million of AFS securities, respectively, and sold $23 million and $61 million of AFS securities, respectively, which resulted in net realized gains of $2 million and $9 million, respectively. During the three and nine months ended September 30, 2016, we purchased $11 million and $29 million of AFS securities, respectively, and sold $26 million and $241 million of AFS securities, respectively, which resulted in net realized gains of $2 million and $20 million, respectively. In addition, during the nine months ended September 30, 2017, we exchanged our interests in three Re-REMICs, which together had a fair value of $47 million, for the senior securities underlying the Re-REMICs, and reclassified our interests from Re-REMIC to Senior.

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, 2017, there were $0.1 million of AFS securities with contractual maturities less than five years, $0.4 million 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, 2017 and December 31, 2016.

Table 7.4 – Carrying Value of AFS Securities



September 30, 2017
(In Thousands)	Senior			Re-REMIC			Subordinate			Total
Principal balance	$	156,936		$	44,896		$	442,219		$	644,051
Credit reserve	(3,024		)	(5,810		)	(38,041		)	(46,875		)
Unamortized discount, net	(36,575		)	(10,412		)	(142,405		)	(189,392		)
Amortized cost	117,337			28,674			261,773			407,784
Gross unrealized gains	37,155			10,359			83,185			130,699
Gross unrealized losses	(1,260		)	—			(1,085		)	(2,345		)
Carrying Value	$	153,232		$	39,033		$	343,873		$	536,138



December 31, 2016
(In Thousands)	Senior			Re-REMIC			Subordinate			Total
Principal balance	$	148,862		$	95,608		$	456,359		$	700,829
Credit reserve	(4,814		)	(6,857		)	(35,802		)	(47,473		)
Unamortized discount, net	(41,877		)	(19,613		)	(136,622		)	(198,112		)
Amortized cost	102,171			69,138			283,935			455,244
Gross unrealized gains	36,304			16,341			68,032			120,677
Gross unrealized losses	(1,929		)	—			(1,240		)	(3,169		)
Carrying Value	$	136,546		$	85,479		$	350,727		$	572,752

The following table presents the changes for the three and nine months ended September 30, 2017, in unamortized discount and designated credit reserves on residential AFS securities.

Table 7.5 – Changes in Unamortized Discount and Designated Credit Reserves on AFS Securities



	Three Months Ended September 30, 2017						Nine Months Ended September 30, 2017
	Credit Reserve			Unamortized Discount, Net			Credit Reserve			Unamortized Discount, Net
(In Thousands)	Credit Reserve			Unamortized Discount, Net			Credit Reserve			Unamortized Discount, Net
Beginning balance	$	47,588		$	192,063		$	47,473		$	198,112
Amortization of net discount	—			(4,631		)	—			(14,697		)
Realized credit losses	(795		)	—			(3,232		)	—
Acquisitions	1,665			2,732			8,256			11,375
Sales, calls, other	(144		)	(2,214		)	(3,405		)	(7,863		)
Impairments	3			—			248			—
Transfers to (release of) credit reserves, net	(1,442		)	1,442			(2,465		)	2,465
Ending Balance	$	46,875		$	189,392		$	46,875		$	189,392

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, 2017 and December 31, 2016.

Table 7.6 – 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, 2017	$	10,164	$	(694	)	$	9,470	$	31,001	$	(1,651	)	$	29,350
December 31, 2016	15,772		(330		)	15,442		60,035		(2,839		)	57,196

At September 30, 2017, after giving effect to purchases, sales, and extinguishment due to credit losses, our consolidated balance sheet included 173 AFS securities, of which 14 were in an unrealized loss position and six were in a continuous unrealized loss position for 12 consecutive months or longer. At December 31, 2016, our consolidated balance sheet included 186 AFS securities, of which 19 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 $2 million at September 30, 2017. 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, 2017, 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.

For the nine months ended September 30, 2017, other-than-temporary impairments related to our AFS securities were $0.6 million, of which $0.2 million were recognized through our consolidated statements of income and $0.4 million were recognized in Accumulated other comprehensive income, a component of our consolidated balance sheet. 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, 2017.

Table 7.7 – Significant Valuation Assumptions



September 30, 2017	Range for Securities
Prepayment rates	8%	-	15%
Projected losses	0.25%	-	8%

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, 2017 and 2016, for which a portion of an OTTI was recognized in other comprehensive income.

Table 7.8 – Activity of the Credit Component of Other-than-Temporary Impairments



	Three Months Ended September 30,					Nine Months Ended September 30,
(In Thousands)	2017			2016		2017			2016
Balance at beginning of period	$	25,802		$	28,198	$	28,261		$	28,277
Additions
Initial credit impairments	—			—		178			291
Subsequent credit impairments	—			—		47			—
Reductions
Securities sold, or expected to sell	—			—		(2,282		)	(261		)
Securities with no outstanding principal at period end	(42		)	—		(444		)	(109		)
Balance at End of Period	$	25,760		$	28,198	$	25,760		$	28,198

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, 2017 and 2016.

Table 7.9 – Gross Realized Gains and Losses on AFS Securities



	Three Months Ended September 30,				Nine Months Ended September 30,
(In Thousands)	2017		2016		2017			2016
Gross realized gains - sales	$	1,734	$	1,990	$	9,381		$	22,395
Gross realized gains - calls	—		—		677			1,210
Gross realized losses - sales	—		—		—			(2,293		)
Gross realized losses - calls	—		—		(497		)	—
Total Realized Gains on Sales and Calls of AFS Securities, net	$	1,734	$	1,990	$	9,561		$	21,312