Real Estate Securities

We invest in real estate securities that we acquire from third parties or create and retain from our Sequoia securitizations. The following table presents the fair values of our real estate securities by type at March 31, 2018 and December 31, 2017.

Table 7.1 – Fair Values of Real Estate Securities by Type



(In Thousands)	March 31, 2018		December 31, 2017
Trading	$	907,432	$	968,844
Available-for-sale	450,288		507,666
Total Real Estate Securities	$	1,357,720	$	1,476,510

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. Mezzanine securities are interests that are generally subordinate to senior securities in their rights to receive cash flows, and have subordinate securities below them that are first to absorb losses. Our mezzanine classified securities were initially rated AA through BBB- and issued in 2012 or later. Subordinate securities are all interests below mezzanine. Nearly all of our residential securities are supported by collateral that was designated as prime at the time of issuance.

Trading Securities

The following table presents the fair value of trading securities by position and collateral type at March 31, 2018 and December 31, 2017.

Table 7.2 – Trading Securities by Position and Collateral Type



(In Thousands)	March 31, 2018		December 31, 2017
Senior	$	82,062	$	69,974
Mezzanine	537,831		563,475
Subordinate	287,539		335,395
Total Trading Securities	$	907,432	$	968,844

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 March 31, 2018, trading securities with a carrying value of $486 million and $57 million of securities retained from our consolidated Sequoia Choice securitizations were pledged as collateral under short-term borrowing agreements. See Note 11 for additional information on short-term debt.

At March 31, 2018 and December 31, 2017, our senior trading securities were comprised of interest-only securities, for which there is no principal balance, and our mezzanine and subordinate trading securities had an unpaid principal balance of $900 million and $943 million, respectively.

At March 31, 2018 and December 31, 2017, our mezzanine and subordinate trading securities included $246 million and $301 million, respectively, of Agency residential mortgage credit risk transfer (or "CRT") securities, $54 million and $68 million, respectively, of Sequoia securities, $148 million and $206 million, respectively, of other third-party residential securities, and $377 million and $324 million, respectively, of third-party commercial/multifamily securities.

During the three months ended March 31, 2018 and 2017, we acquired $145 million and $154 million (principal balance), respectively, of securities for which we elected the fair value option and classified as trading, and sold $182 million and $9 million, respectively, of such securities. During the three months ended March 31, 2018 and 2017, we recorded a net market valuation loss of $3 million and a net market valuation gain of $11 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 March 31, 2018 and December 31, 2017.

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



(In Thousands)	March 31, 2018		December 31, 2017
Senior ⁽¹⁾	$	165,610	$	179,864
Mezzanine	67,291		92,002
Subordinate	217,387		235,800
Total AFS Securities	$	450,288	$	507,666

(1)

Includes $38 million and $39 million of re-REMIC securities at March 31, 2018 and December 31, 2017, respectively. Re-REMIC securities 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.

At March 31, 2018 and December 31, 2017, all of our available-for-sale securities were comprised of residential mortgage-backed securities. At March 31, 2018, AFS securities with a carrying value of $178 million were pledged as collateral under short-term borrowing agreements. See Note 11 for additional information on short-term debt.

During the three months ended March 31, 2018 and 2017, we purchased $4 million and $25 million of AFS securities, respectively, and sold $51 million and $19 million of AFS securities, respectively, which resulted in net realized gains of $9 million and $5 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 March 31, 2018, there were $0.1 million of AFS securities with contractual maturities less than five years, $2 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 March 31, 2018 and December 31, 2017.

Table 7.4 – Carrying Value of AFS Securities



March 31, 2018
(In Thousands)	Senior			Mezzanine			Subordinate			Total
Principal balance	$	172,026		$	67,995		$	312,914		$	552,935
Credit reserve	(8,206		)	—			(32,410		)	(40,616		)
Unamortized discount, net	(39,174		)	(6,959		)	(132,169		)	(178,302		)
Amortized cost	124,646			61,036			148,335			334,017
Gross unrealized gains	41,919			6,255			69,419			117,593
Gross unrealized losses	(955		)	—			(367		)	(1,322		)
Carrying Value	$	165,610		$	67,291		$	217,387		$	450,288



December 31, 2017
(In Thousands)	Senior			Mezzanine			Subordinate			Total
Principal balance	$	189,125		$	91,471		$	327,549		$	608,145
Credit reserve	(8,756		)	—			(37,793		)	(46,549		)
Unamortized discount, net	(44,041		)	(9,407		)	(130,305		)	(183,753		)
Amortized cost	136,328			82,064			159,451			377,843
Gross unrealized gains	44,771			9,938			76,481			131,190
Gross unrealized losses	(1,235		)	—			(132		)	(1,367		)
Carrying Value	$	179,864		$	92,002		$	235,800		$	507,666

The following table presents the changes for the three months ended March 31, 2018, 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 March 31, 2018
	Credit Reserve			Unamortized Discount, Net
(In Thousands)	Credit Reserve			Unamortized Discount, Net
Beginning balance	$	46,549		$	183,753
Amortization of net discount	—			(4,060		)
Realized credit losses	(956		)	—
Acquisitions	2,536			1,635
Sales, calls, other	(767		)	(9,772		)
Transfers to (release of) credit reserves, net	(6,746		)	6,746
Ending Balance	$	40,616		$	178,302

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 March 31, 2018 and December 31, 2017.

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
March 31, 2018	$	12,799	$	(367	)	$	12,432	$	27,186	$	(955	)	$	26,231
December 31, 2017	8,637		(132		)	8,505		28,557		(1,235		)	27,322

At March 31, 2018, after giving effect to purchases, sales, and extinguishment due to credit losses, our consolidated balance sheet included 152 AFS securities, of which 13 were in an unrealized loss position and three were in a continuous unrealized loss position for 12 consecutive months or longer. At December 31, 2017, our consolidated balance sheet included 167 AFS securities, of which nine were in an unrealized loss position and three 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 $1 million at March 31, 2018. 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 March 31, 2018, 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 three months ended March 31, 2018, there were no other-than-temporary impairments related to our AFS securities. For the three months ended March 31, 2017, other-than-temporary impairments were $0.2 million, of which $0.1 million were recognized through our consolidated statements of income and $0.1 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 March 31, 2018.

Table 7.7 – Significant Valuation Assumptions



March 31, 2018	Range for Securities
Prepayment rates	8%	-	20%
Projected losses	0.20%	-	5.25%

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 March 31, 2018 and 2017, 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 March 31,
(In Thousands)	2018			2017
Balance at beginning of period	$	21,037		$	28,261
Additions
Initial credit impairments	—			97
Reductions
Securities sold, or expected to sell	(99		)	(1,566		)
Securities with no outstanding principal at period end	(14		)	(402		)
Balance at End of Period	$	20,924		$	26,390

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 months ended March 31, 2018 and 2017.

Table 7.9 – Gross Realized Gains and Losses on AFS Securities



	Three Months Ended March 31,
(In Thousands)	2018		2017
Gross realized gains - sales	$	9,363	$	5,092
Gross realized gains - calls	—		611
Total Realized Gains on Sales and Calls of AFS Securities, net	$	9,363	$	5,703