Real Estate Securities

6 Months Ended

Jun. 30, 2011

Real Estate Securities

Note 8. Real Estate Securities

We invest in third-party residential, commercial, and CDO securities. The following table presents the fair values of our real estate securities by collateral type and entity at June 30, 2011 and December 31, 2010.

June 30, 2011 (In Thousands)	Redwood		The Fund		Acacia		Total Securities
Residential	$	753,806	$	—	$	213,755	$	967,561
Commercial		5,865		—		42,274		48,139
CDO		1,403		—		20,498		21,901
Total Real Estate Securities	$	761,074	$	—	$	276,527	$	1,037,601

December 31, 2010 (In Thousands)	Redwood		The Fund		Acacia		Total Securities
Residential	$	814,683	$	19,011	$	248,494	$	1,082,188
Commercial		7,496		—		43,828		51,324
CDO		1,038		4,245		16,041		21,324
Total Real Estate Securities	$	823,217	$	23,256	$	308,363	$	1,154,836

At June 30, 2011, there were $4 million of AFS residential securities that had contractual maturities greater than five years but less than ten years, and the remainder of our real estate securities had contractual maturities greater than ten years.

The following table presents our securities by accounting classification, collateral type, and ownership entity at June 30, 2011 and December 31, 2010.

June 30, 2011 (In Thousands)	Trading						AFS
	Redwood		Acacia		Total		Redwood		The Fund		Total
Senior Securities
Residential prime	$	—	$	3,645	$	3,645	$	285,946	$	—	$	285,946
Residential non-prime		18,686		104,110		122,796		288,718		—		288,718
Commercial		—		11,405		11,405		—		—		—
Total Senior Securities		18,686		119,160		137,846		574,664		—		574,664
Re-REMIC Securities		—		—		—		77,575		—		77,575
Subordinate Securities
Residential prime		302		40,236		40,538		71,543		—		71,543
Residential non-prime		160		65,764		65,924		10,876		—		10,876
Commercial		—		30,869		30,869		5,865		—		5,865
CDO		1,303		20,498		21,801		100		—		100
Total Subordinate Securities		1,765		157,367		159,132		88,384		—		88,384
Total Real Estate Securities	$	20,451	$	276,527	$	296,978	$	740,623	$	—	$	740,623

December 31, 2010 (In Thousands)	Trading						AFS
	Redwood		Acacia		Total		Redwood		The Fund		Total
Senior Securities
Residential prime	$	—	$	4,412	$	4,412	$	315,891	$	—	$	315,891
Residential non-prime		19,742		117,623		137,365		326,365		12,915		339,280
Commercial		—		11,000		11,000		—		—		—
Total Senior Securities		19,742		133,035		152,777		642,256		12,915		655,171
Re-REMIC Securities		—		—		—		85,077		—		85,077
Subordinate Securities
Residential prime		386		49,620		50,006		53,846		—		53,846
Residential non-prime		188		76,839		77,027		13,188		6,096		19,284
Commercial		—		32,828		32,828		7,496		—		7,496
CDO		1,038		16,041		17,079		—		4,245		4,245
Total Subordinate Securities		1,612		175,328		176,940		74,530		10,341		84,871
Total Real Estate Securities	$	21,354	$	308,363	$	329,717	$	801,863	$	23,256	$	825,119

Senior securities are those interests in a securitization that 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 interests to provide additional credit support to those interests. These re-REMIC securities are therefore subordinate to the remaining senior interest, 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.

For purposes of the table above, the “prime” or “non-prime” designation used to categorize our residential securities is based upon the general credit characteristics of the residential loans underlying each security at the time of origination. For example, prime residential loans are generally characterized by lower LTV ratios, and are made to borrowers with higher FICO scores. Non-prime residential loans are generally characterized by higher LTV ratios and may have been made to borrowers with lower credit scores or impaired credit histories (while exhibiting the ability to repay their loans). Regardless of whether or not the loans backing a mortgage-backed security were designated as prime or non-prime at origination, there is a risk that the borrower may not be able to repay the loan.

We elected the fair value option for certain securities at Redwood and the Acacia entities, now classified as trading securities. The unpaid principal balance of these trading securities was $1.2 billion and $2.1 billion at June 30, 2011 and December 31, 2010, respectively.

AFS Securities

We often purchase AFS securities at a discount to their outstanding principal values. To the extent we purchase an AFS security that has a likelihood of incurring a loss, we generally 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 the amount of principal face that we do not expect to receive and will not amortize into income as a credit reserve on the security, with any remaining net unamortized discounts or premiums amortized into income over time using the interest method.

The following table presents the components of carrying value (which equals fair value) of AFS securities at June 30, 2011 and December 31, 2010.

June 30, 2011 (In Thousands)	Residential			Commercial			CDO			Total
Current face	$	1,111,215		$	58,128		$	11,863		$	1,181,206
Credit reserve		(240,899	)		(48,987	)		(10,780	)		(300,666	)
Net unamortized discount		(243,662	)		(4,362	)		(1,083	)		(249,107	)
Amortized cost		626,654			4,779			—			631,433
Gross unrealized gains		121,524			1,928			100			123,552
Gross unrealized losses		(13,520	)		(842	)		—			(14,362	)
Carrying Value	$	734,658		$	5,865		$	100		$	740,623

December 31, 2010 (In Thousands)	Residential			Commercial			CDO			Total
Current face	$	1,257,601		$	89,103		$	89,476		$	1,436,180
Credit reserve		(297,849	)		(76,979	)		(88,394	)		(463,222	)
Net unamortized (discount) premium		(291,093	)		(5,591	)		11,485			(285,199	)
Amortized cost		668,659			6,533			12,567			687,759
Gross unrealized gains		153,125			1,604			—			154,729
Gross unrealized losses		(8,406	)		(641	)		(8,322	)		(17,369	)
Carrying Value	$	813,378		$	7,496		$	4,245		$	825,119

The following table presents the changes for the three and six months ended June 30, 2011, of the unamortized discount and designated credit reserves on AFS securities.

Changes in Unamortized Discount and Designated Credit Reserves on AFS Securities

Three Months Ended June 30, 2011 (In Thousands)	Residential						Commercial						CDO
	Credit Reserve			Unamortized Discount, Net			Credit Reserve			Unamortized Discount, Net			Credit Reserve			Unamortized Premium, Net
Beginning balance – March 31, 2011	$	280,478		$	259,469		$	64,717		$	4,784		$	29,505		$	520
Amortization of net (discount) premium		—			(10,497	)		—			(33	)		—			18
Realized credit losses		(34,091	)		—			(16,655	)		—			—			—
Acquisitions		28			9,112			—			—			—			—
Sales, calls, other		(11,543	)		(9,324	)		—			—			(18,751	)		571
Impairments		929			—			536			—			—			—
Transfers to (release of) credit reserves		5,098			(5,098	)		389			(389	)		26			(26	)
Ending Balance – June 30, 2011	$	240,899		$	243,662		$	48,987		$	4,362		$	10,780		$	1,083

Six Months Ended June 30, 2011 (In Thousands)	Residential						Commercial						CDO
	Credit Reserve			Unamortized Discount, Net			Credit Reserve			Unamortized Discount, Net			Credit Reserve			Unamortized Discount, Net
Beginning balance – December 31, 2010	$	297,849		$	291,093		$	76,979		$	5,591		$	88,394		$	(11,485	)
Amortization of net discount		—			(22,464	)		—			(69	)		—			(85	)
Realized credit losses		(56,265	)		—			(25,952	)		—			(3,005	)		—
Acquisitions		1,176			11,601			—			—			—			—
Sales, calls, other		(20,188	)		(20,877	)		(2,653	)		(1,439	)		(74,662	)		12,146
Impairments		2,636			—			892			—			560			—
Transfers to (release of) credit reserves		15,691			(15,691	)		(279	)		279			(507	)		507
Ending Balance – June 30, 2011	$	240,899		$	243,662		$	48,987		$	4,362		$	10,780		$	1,083

The loans underlying our residential subordinate securities totaled $31 billion at June 30, 2011. These loans are located nationwide with a large concentration in California (44%). Serious delinquencies (90+ days, in foreclosure or REO) at June 30, 2011 were 5.65% of current principal balances. The loans underlying our commercial subordinate securities totaled $19 billion at June 30, 2011, and consist primarily of office (31%), retail (34%), and multifamily (12%) loans. These loans are located nationwide with the highest concentration in California (15%). Serious delinquencies (60+ days, in foreclosure or REO) at June 30, 2011 were 6.0% of current principal balances.

AFS Securities with Unrealized Losses

The following table presents the components comprising the carrying value of AFS securities that were in an unrealized loss position at June 30, 2011 and December, 31 2010.

June 30, 2011 (In Thousands)	Less Than 12 Consecutive Months							12 Consecutive Months or Longer
	Total Amortized Cost		Gross Unrealized Losses			Total Fair Value		Total Amortized Cost		Gross Unrealized Losses			Total Fair Value
Residential	$	133,317	$	(4,100	)	$	129,217	$	61,687	$	(9,420	)	$	52,267
Commercial		267		(79	)		188		2,226		(763	)		1,463
CDO		—		—			—		—		—			—
Total Securities	$	133,584	$	(4,179	)	$	129,405	$	63,913	$	(10,183	)	$	53,730

December 31, 2010 (In Thousands)	Less Than 12 Consecutive Months							12 Consecutive Months or Longer
	Total Amortized Cost		Gross Unrealized Losses			Total Fair Value		Total Amortized Cost		Gross Unrealized Losses			Total Fair Value
Residential	$	104,154	$	(1,628	)	$	102,526	$	26,374	$	(6,778	)	$	19,596
Commercial		2,134		(257	)		1,877		1,728		(384	)		1,344
CDO		—		—			—		12,567		(8,322	)		4,245
Total Securities	$	106,288	$	(1,885	)	$	104,403	$	40,669	$	(15,484	)	$	25,185

At June 30, 2011, after giving effect to purchases, sales, and extinguishments due to credit losses, our consolidated balance sheet included 449 AFS securities, of which 89 were in an unrealized loss position and 28 were in a continuous unrealized loss position for twelve consecutive months or longer. At December 31, 2010, our consolidated balance sheet included 509 AFS securities, of which 80 were in a continuous unrealized loss position, of which 46 were in a continuous unrealized loss position for twelve consecutive months or longer.

Of the total unrealized losses at June 30, 2011, none related to securities owned at the Fund. At December 31, 2010, $10 million of unrealized losses related to securities owned at the Fund and the remaining unrealized losses related to securities owned at Redwood.

Evaluating AFS Securities for Other-than-Temporary Impairments

When the fair value of an AFS security is below its cost basis, we evaluate the security for OTTI. Part of this evaluation is based upon adverse changes in the assumptions used to value the security. The table below summarizes the significant valuation assumptions we used for our AFS securities at June 30, 2011.

Significant Valuation Assumptions

	Range for Securities
June 30, 2011	Prime		Non-prime		Commercial
Prepayment rates		4 – 15%		1 – 8%		N/A
Loss severity		14 – 57%		22 – 57%		33 – 50%
Projected losses		0 – 26%		1 – 39%		2 – 7%

The credit component of OTTI is recognized through our consolidated statement of income as a component of market valuation adjustments, net, while the non-credit component of OTTI is to accumulated other comprehensive income, a component of equity. Total credit OTTI for the three and six months ended June 30, 2011 was $1 million and $4 million, respectively. Total non-credit OTTI for the three and six months ended June 30, 2011 was $1 million and $2 million, respectively. The following table details the activity related to the credit component of OTTI (i.e., OTTI in either current earnings or retained earnings) for AFS securities that also had a non-credit component and were still held at June 30, 2011 and 2010.

Activity of Credit Component of Other-than-Temporary Impairments

	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2011			2010			2011			2010
Balance at beginning of period	$	100,948		$	143,116		$	121,016		$	146,454
Additions
Initial credit impairments		449			213			463			303
Subsequent credit impairments		754			3,143			935			4,439
Reductions
Securities sold, or intent to sell		—			(5,113	)		(12,317	)		(5,113	)
Securities matured, called, or fully written down		(12,132	)		(9,329	)		(20,078	)		(14,053	)
Balance at End of Period	$	90,019		$	132,030		$	90,019		$	132,030

The credit component is reduced if we sell, intend to sell, or believe we will be required to sell previously credit-impaired debt securities. Additionally, the credit loss component is reduced if we receive or expect to receive cash flows in excess of what we previously expected to receive over the remaining life of the credit-impaired debt security, the security matures, or is fully written down.

Gross Realized Gains and Losses

Gains and losses from the sale of AFS securities are recorded as realized gains on sales and calls, net, in our consolidated statements of income. The following table presents the gross realized gains on sales and calls of AFS securities for the three and six months ended June 30, 2011 and 2010.

	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2011			2010			2011			2010
Gross realized gains – sales	$	5,351		$	17,670		$	12,665		$	56,524
Gross realized gains – calls		401			—			533			—
Gross realized losses – sales		(165	)		(1,859	)		(3,523	)		(3,335	)
Gross realized losses – calls		—			—			(223	)		—
Total Realized Gains on Sales and Calls of AFS Securities, net	$	5,587		$	15,811		$	9,452		$	53,189