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Real Estate Securities
 12 Months Ended
Dec. 31, 2018
Investments, Debt and Equity Securities [Abstract]  
Real Estate Securities
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 December 31, 2018 and December 31, 2017.
Table 9.1 – Fair Values of Real Estate Securities by Type
(In Thousands)
 
December 31, 2018
 
December 31, 2017
Trading
 
$
1,118,612

 
$
968,844

Available-for-sale
 
333,882

 
507,666

Total Real Estate Securities
 
$
1,452,494

 
$
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 December 31, 2018 and December 31, 2017.
Table 9.2 – Trading Securities by Position and Collateral Type
(In Thousands)
 
December 31, 2018
 
December 31, 2017
Senior
 
$
158,670

 
$
69,974

Mezzanine
 
610,819

 
563,475

Subordinate
 
349,123

 
335,395

Total Trading Securities
 
$
1,118,612

 
$
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 December 31, 2018, trading securities with a carrying value of $747 million as well as $130 million, $229 million, and $18 million of securities we owned that were issued by consolidated Sequoia Choice, Freddie Mac SLST, and Freddie Mac K-Series securitizations, respectively, were pledged as collateral under short-term borrowing agreements. See Note 13 for additional information on short-term debt.
At December 31, 2018 and 2017, our senior trading securities included $82 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 $78 million and zero, respectively. Our interest-only securities included $43 million and $15 million of A-IO-S securities at December 31, 2018 and 2017, respectively, which are securities we retained from certain of our Sequoia securitizations that represent certificated servicing strips.
At December 31, 2018 and 2017, our mezzanine and subordinate trading securities had an unpaid principal balance of $1.08 billion and $943 million, respectively. At December 31, 2018 and 2017, the fair value of our mezzanine and subordinate securities was $960 million and $899 million, respectively, and included $238 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 $429 million and $324 million, respectively, of third-party commercial/multifamily securities.
During the years ended December 31, 2018 and 2017, we acquired $688 million and $661 million (principal balance), respectively, of securities for which we elected the fair value option and classified as trading, and sold $415 million and $132 million, respectively, of such securities. During the years ended December 31, 2018 and 2017, we recorded a net market valuation loss of $8 million and a net market valuation gain of $40 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 December 31, 2018 and December 31, 2017.
Table 9.3 – Available-for-Sale Securities by Position and Collateral Type
(In Thousands)
 
December 31, 2018
 
December 31, 2017
Senior
 
$
87,615

 
$
179,864

Mezzanine
 
36,407

 
92,002

Subordinate
 
209,860

 
235,800

Total AFS Securities
 
$
333,882

 
$
507,666


At December 31, 2018 and December 31, 2017, all of our available-for-sale securities were comprised of residential mortgage-backed securities. At December 31, 2018, AFS securities with a carrying value of $98 million were pledged as collateral under short-term borrowing agreements. See Note 13 for additional information on short-term debt.
During the years ended December 31, 2018 and 2017, we purchased $8 million and $40 million of AFS securities, respectively, and sold $144 million and $90 million of AFS securities, respectively, which resulted in net realized gains of $27 million and $14 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 December 31, 2018, there were no 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 December 31, 2018 and December 31, 2017.
Table 9.4 – Carrying Value of AFS Securities
December 31, 2018
 
 
 
 
 
 
 
 
(In Thousands)
 
Senior
 
Mezzanine
 
Subordinate
 
Total
Principal balance
 
$
91,736

 
$
36,852

 
$
302,524

 
$
431,112

Credit reserve
 
(7,790
)
 
—

 
(33,580
)
 
(41,370
)
Unamortized discount, net
 
(18,460
)
 
(3,697
)
 
(129,043
)
 
(151,200
)
Amortized cost
 
65,486

 
33,155

 
139,901

 
238,542

Gross unrealized gains
 
22,178

 
3,252

 
70,458

 
95,888

Gross unrealized losses
 
(49
)
 
—

 
(499
)
 
(548
)
Carrying Value
 
$
87,615

 
$
36,407

 
$
209,860

 
$
333,882

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 years ended December 31, 2018 and 2017, 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
 
 
Year Ended December 31, 2018
 
Year Ended December 31, 2017
 
 
Credit
Reserve
 
Unamortized
Discount, Net
 
Credit
Reserve
 
Unamortized
Discount, Net
(In Thousands)
 
 
 
 
Beginning balance
 
$
46,549

 
$
183,753

 
$
47,473

 
$
198,112

Amortization of net discount
 
—

 
(14,098
)
 
—

 
(18,795
)
Realized credit losses
 
(2,165
)
 
—

 
(4,187
)
 
—

Acquisitions
 
6,315

 
2,716

 
9,118

 
13,080

Sales, calls, other
 
(1,850
)
 
(28,739
)
 
(3,404
)
 
(12,106
)
Impairments
 
89

 
—

 
1,011

 
—

Transfers to (release of) credit reserves, net
 
(7,568
)
 
7,568

 
(3,462
)
 
3,462

Ending Balance
 
$
41,370

 
$
151,200

 
$
46,549

 
$
183,753


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, 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)
 
 
 
 
 
 
December 31, 2018
 
$
12,923

 
$
(499
)
 
$
12,424

 
$
7,464

 
$
(49
)
 
$
7,415

December 31, 2017
 
8,637

 
(132
)
 
8,505

 
28,557

 
(1,235
)
 
27,322


At December 31, 2018, after giving effect to purchases, sales, and extinguishment due to credit losses, our consolidated balance sheet included 128 AFS securities, of which seven 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 December 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 December 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 year ended December 31, 2018, other-than-temporary impairments related to our AFS securities were $1 million, of which $0.1 million were recognized through our consolidated statements of income and $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 December 31, 2018.
Table 9.7 – Significant Valuation Assumptions
December 31, 2018
 
Range for Securities
Prepayment rates
 
6
%
-
8%
Projected losses
 
0.20
%
-
1%

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, 2018, 2017, and 2016 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
 
 
Years Ended December 31,
(In Thousands)
 
2018
 
2017
 
2016
Balance at beginning of period
 
$
21,037

 
$
28,261

 
$
28,277

Additions
 
 
 
 
 
 
Initial credit impairments
 
76

 
178

 
346

Subsequent credit impairments
 
—

 
47

 
8

Reductions
 
 
 
 
 
 
Securities sold, or expected to sell
 
(1,218
)
 
(4,898
)
 
(261
)
Securities with no outstanding principal at period end
 
(1,243
)
 
(2,551
)
 
(109
)
Balance at End of Period
 
$
18,652

 
$
21,037

 
$
28,261


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 years ended December 31, 2018, 2017, and 2016.
Table 9.9 – Gross Realized Gains and Losses on AFS Securities
 
 
Years Ended December 31,
(In Thousands)
 
2018
 
2017
 
2016
Gross realized gains - sales
 
$
27,127

 
$
13,927

 
$
23,598

Gross realized gains - calls
 
43

 
677

 
1,210

Gross realized losses - sales
 
(129
)
 
—

 
(2,293
)
Gross realized losses - calls
 
—

 
(497
)
 
—

Total Realized Gains on Sales and Calls of AFS Securities, net
 
$
27,041

 
$
14,107

 
$
22,515