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 June 30, 2015 and December 31, 2014.



(In Thousands)	June 30, 2015		December 31, 2014
Trading	$	116,141	$	111,606
Available-for-sale	1,041,458		1,267,624
Total Real Estate Securities	$	1,157,599	$	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 June 30, 2015, our trading securities included $47 million of interest-only securities, for which there is no principal balance, $22 million of senior securities and $47 million of subordinate securities. The unpaid principal balance of senior and subordinate securities classified as trading securities was $23 million and $61 million, respectively, at June 30, 2015. During the three and six months ended June 30, 2015, we acquired $71 million and $94 million (principal balance), respectively, of senior and subordinate securities for which we elected the fair value option and classified as trading, and sold $35 million and $37 million of such securities, respectively. During the three months ended June 30, 2015 and 2014, we recorded positive $7 million and negative $9 million, respectively, of valuation adjustments on trading securities, included in mortgage banking and investment activities, net on our consolidated income statements. During the six months ended June 30, 2015 and 2014, we recorded negative $7 million and negative $13 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 June 30, 2015 and December 31, 2014.



(In Thousands)	June 30, 2015		December 31, 2014
Senior Securities
Prime	$	62,427	$	93,802
Non-prime	6,705		7,951
Total Senior Securities	69,132		101,753
Prime Subordinate Securities	47,009		9,853
Total Trading Securities	$	116,141	$	111,606

AFS Securities

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



(In Thousands)	June 30, 2015		December 31, 2014
Senior Securities
Prime	$	278,960	$	307,813
Non-prime	166,376		179,744
Total Senior Securities	445,336		487,557
Re-REMIC Securities	169,084		168,347
Subordinate Securities
Prime Mezzanine ⁽¹⁾	257,263		448,838
Subordinate ⁽²⁾	169,775		162,882
Total Subordinate Securities	427,038		611,720
Total AFS Securities	$	1,041,458	$	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 June 30, 2015, and December 31, 2014.

The senior securities shown above at June 30, 2015 and December 31, 2014, included $88 million and $105 million, respectively, of prime securities, and $107 million and $117 million, respectively, of non-prime securities that were financed through the Residential Resecuritization entity, as discussed in Note 4. As of June 30, 2015 AFS securities with a carrying value of $535 million were pledged as collateral under short-term borrowing agreements. See Note 12 for additional information on short-term debt.

During the three and six months ended June 30, 2015, we purchased $5 million and $15 million of AFS securities, respectively, and sold $112 million and $202 million of AFS securities, respectively, which resulted in realized gains of $6 million and $10 million, respectively. During the three months ended June 30, 2014, we purchased $77 million of AFS securities and sold $1 million.

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 June 30, 2015, there were $6 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 June 30, 2015 and December 31, 2014.

Carrying Value of AFS Securities



June 30, 2015	Senior
(In Thousands)	Prime			Non-prime			Re-REMIC			Subordinate			Total
Principal balance	$	282,921		$	182,719		$	193,221		$	535,511		$	1,194,372
Credit reserve	(2,650		)	(9,175		)	(13,071		)	(36,804		)	(61,700		)
Unamortized discount, net	(30,401		)	(27,533		)	(75,658		)	(139,527		)	(273,119		)
Amortized cost	249,870			146,011			104,492			359,180			859,553
Gross unrealized gains	31,196			20,550			64,592			68,519			184,857
Gross unrealized losses	(2,106		)	(185		)	—			(661		)	(2,952		)
Carrying Value	$	278,960		$	166,376		$	169,084		$	427,038		$	1,041,458



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 six months ended June 30, 2015, in unamortized discount and designated credit reserves on residential AFS securities.

Changes in Unamortized Discount and Designated Credit Reserves on AFS Securities



	Three Months Ended June 30, 2015						Six Months Ended June 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	$	63,584		$	286,382		$	70,067		$	296,342
Amortization of net discount	—			(9,324		)	—			(19,162		)
Realized credit losses	(2,769		)	—			(5,714		)	—
Acquisitions	858			3,033			858			5,705
Sales, calls, other	—			(6,945		)	—			(13,277		)
Impairments	—			—			—			—
Transfers to (release of) credit reserves, net	27			(27		)	(3,511		)	3,511
Ending Balance	$	61,700		$	273,119		$	61,700		$	273,119

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 June 30, 2015 and December 31, 2014.



	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
June 30, 2015	$	98,390	$	(1,263	)	$	97,127	$	74,537	$	(1,689	)	$	72,848
December 31, 2014	126,681		(1,374		)	125,307		70,676		(1,422		)	69,254

At June 30, 2015, after giving effect to purchases, sales, and extinguishments due to credit losses, our consolidated balance sheet included 260 AFS securities, of which 29 were in an unrealized loss position and 13 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 $3 million at June 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 June 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 six months ended June 30, 2015, we recognized no 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 June 30, 2015.

Significant Valuation Assumptions



	Range for Securities
June 30, 2015	Prime		Non-prime
Prepayment rates	8 - 16	%	8 - 12	%
Projected losses	1 - 21	%	14 - 18	%

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 June 30, 2015 and 2014, for which a portion of an OTTI was recognized in other comprehensive income.

Activity of the Credit Component of Other-than-Temporary Impairments



	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2015			2014			2015			2014
Balance at beginning of period	$	32,949		$	35,786		$	33,849		$	37,149
Additions
Initial credit impairments	—			190			—			261
Subsequent credit impairments	—			28			—			70
Reductions
Securities sold, or expected to sell	(253		)	(904		)	(348		)	(904		)
Securities with no outstanding principal at period end	—			(844		)	(805		)	(2,320		)
Balance at End of Period	$	32,696		$	34,256		$	32,696		$	34,256

Gross Realized Gains and Losses on AFS Securities

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 six months ended June 30, 2015 and 2014.



	Three Months Ended June 30,				Six Months Ended June 30,
(In Thousands)	2015		2014		2015		2014
Gross realized gains - sales	$	5,956	$	992	$	10,262	$	992
Gross realized gains - calls	360		—		360		987
Gross realized losses - sales	—		—		—		—
Gross realized losses - calls	—		—		—		—
Total Realized Gains on Sales and Calls of AFS Securities, net	$	6,316	$	992	$	10,622	$	1,979