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 September 30, 2018 and December 31, 2017.

Table 9.1 – Fair Values of Real Estate Securities by Type



(In Thousands)	September 30, 2018		December 31, 2017
Trading	$	1,108,243	$	968,844
Available-for-sale	361,841		507,666
Total Real Estate Securities	$	1,470,084	$	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. Most of 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 September 30, 2018 and December 31, 2017.

Table 9.2 – Trading Securities by Position and Collateral Type



(In Thousands)	September 30, 2018		December 31, 2017
Senior	$	163,022	$	69,974
Mezzanine	602,235		563,475
Subordinate	342,986		335,395
Total Trading Securities	$	1,108,243	$	968,844

We elected the fair value option for certain securities and classify them as trading securities. Our trading securities include both residential and multifamily securities. At September 30, 2018, trading securities with a carrying value of $668 million as well as $129 million of securities retained from our consolidated Sequoia Choice securitizations were pledged as collateral under short-term borrowing agreements. See Note 12 for additional information on short-term debt.

At September 30, 2018 and December 31, 2017, our senior trading securities included $86 million and $70 million of interest-only securities, respectively, for which there is no principal balance, and the remaining unpaid principal balance of our senior trading securities was $79 million and zero, respectively. Our interest-only securities included $42 million and $15 million of A-IO-S securities at September 30, 2018 and December 31, 2017, respectively, which are securities we retained from certain of our Sequoia securitizations that represent certificated servicing strips.

At September 30, 2018 and December 31, 2017, our mezzanine and subordinate trading securities had an unpaid principal balance of $1.07 billion and $943 million, respectively. At September 30, 2018 and December 31, 2017, the fair value of our mezzanine and subordinate securities was $945 million and $899 million, respectively, and included $236 million and $301 million, respectively, of Agency residential mortgage credit risk transfer (or "CRT") securities, $68 million and $68 million, respectively, of Sequoia securities, $225 million and $206 million, respectively, of other third-party residential securities, and $417 million and $324 million, respectively, of third-party multifamily securities.

During the three and nine months ended September 30, 2018, we acquired $189 million and $567 million (principal balance), respectively, of securities for which we elected the fair value option and classified as trading, and sold $79 million and $323 million, respectively, of such securities. During the three and nine months ended September 30, 2017, we acquired $171 million and $432 million (principal balance), respectively, of 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, 2018, we recorded net market valuation gains of $6 million and $2 million, respectively, on trading securities, included in Investment fair value changes, net on our consolidated statements of income. 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 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, 2018 and December 31, 2017.

Table 9.3 – Available-for-Sale Securities by Position and Collateral Type



(In Thousands)	September 30, 2018		December 31, 2017
Senior	$	114,628	$	179,864
Mezzanine	36,377		92,002
Subordinate	210,836		235,800
Total AFS Securities	$	361,841	$	507,666

At September 30, 2018 and December 31, 2017, all of our available-for-sale securities were comprised of residential mortgage-backed securities. At September 30, 2018, AFS securities with a carrying value of $121 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, 2018, we purchased $1 million and $7 million of AFS securities, respectively, and sold $26 million and $118 million of AFS securities, respectively, which resulted in net realized gains of $7 million and $21 million, respectively. 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.

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, 2018, there were less than $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 September 30, 2018 and December 31, 2017.

Table 9.4 – Carrying Value of AFS Securities



September 30, 2018
(In Thousands)	Senior			Mezzanine			Subordinate			Total
Principal balance	$	119,254		$	37,385		$	308,445		$	465,084
Credit reserve	(7,919		)	—			(33,155		)	(41,074		)
Unamortized discount, net	(25,173		)	(3,843		)	(131,783		)	(160,799		)
Amortized cost	86,162			33,542			143,507			263,211
Gross unrealized gains	29,134			2,835			67,896			99,865
Gross unrealized losses	(668		)	—			(567		)	(1,235		)
Carrying Value	$	114,628		$	36,377		$	210,836		$	361,841



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 and nine months ended September 30, 2018, in unamortized discount and designated credit reserves on residential AFS securities.

Table 9.5 – Changes in Unamortized Discount and Designated Credit Reserves on AFS Securities



	Three Months Ended September 30, 2018						Nine Months Ended September 30, 2018
	Credit Reserve			Unamortized Discount, Net			Credit Reserve			Unamortized Discount, Net
(In Thousands)	Credit Reserve			Unamortized Discount, Net			Credit Reserve			Unamortized Discount, Net
Beginning balance	$	42,191		$	170,090		$	46,549		$	183,753
Amortization of net discount	—			(3,323		)	—			(11,231		)
Realized credit losses	(616		)	—			(1,957		)	—
Acquisitions	637			224			5,424			2,354
Sales, calls, other	(777		)	(6,586		)	(1,843		)	(21,265		)
Impairments	33			—			89			—
(Release of) transfers to credit reserves, net	(394		)	394			(7,188		)	7,188
Ending Balance	$	41,074		$	160,799		$	41,074		$	160,799

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, 2018 and December 31, 2017.

Table 9.6 – 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, 2018	$	14,791	$	(567	)	$	14,224	$	23,901	$	(668	)	$	23,233
December 31, 2017	8,637		(132		)	8,505		28,557		(1,235		)	27,322

At September 30, 2018, after giving effect to purchases, sales, and extinguishment due to credit losses, our consolidated balance sheet included 139 AFS securities, of which 11 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 September 30, 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 September 30, 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 September 30, 2018, other-than-temporary impairments were $0.4 million, of which less than $0.1 million were recognized through our consolidated statements of income and $0.3 million were recognized in Accumulated other comprehensive income, a component of our consolidated balance sheet. For the nine months ended September 30, 2018, other-than-temporary impairments were $0.6 million, of which $0.1 million were recognized through our consolidated statements of income and $0.5 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, 2018.

Table 9.7 – Significant Valuation Assumptions



September 30, 2018	Range for Securities
Prepayment rates	6%	-	10%
Projected losses	0.20%	-	3%

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, 2018 and 2017, for which a portion of an OTTI was recognized in other comprehensive income.

Table 9.8 – Activity of the Credit Component of Other-than-Temporary Impairments



	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	2018			2017			2018			2017
Balance at beginning of period	$	20,967		$	25,802		$	21,037		$	28,261
Additions
Initial credit impairments	33			—			76			178
Subsequent credit impairments	—			—			—			47
Reductions
Securities sold, or expected to sell	(927		)	—			(1,026		)	(2,282		)
Securities with no outstanding principal at period end	(1,229		)	(42		)	(1,243		)	(444		)
Balance at End of Period	$	18,844		$	25,760		$	18,844		$	25,760

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, 2018 and 2017.

Table 9.9 – Gross Realized Gains and Losses on AFS Securities



	Three Months Ended September 30,				Nine Months Ended September 30,
(In Thousands)	2018		2017		2018			2017
Gross realized gains - sales	$	7,275	$	1,734	$	21,312		$	9,381
Gross realized gains - calls	—		—		43			677
Gross realized losses - sales	—		—		(3		)	—
Gross realized losses - calls	—		—		—			(497		)
Total Realized Gains on Sales and Calls of AFS Securities, net	$	7,275	$	1,734	$	21,352		$	9,561