Loans

9 Months Ended

Sep. 30, 2013

Note 7. Commercial Loans

We invest in commercial loans that we originate and service as well as loans that we acquire from third-party originators. The following table summarizes the classifications and carrying value of commercial loans at September 30, 2013 and December 31, 2012.


(In Thousands)	September 30, 2013		December 31, 2012
Held-for-sale
Fair value	$	27,413	$	-
Lower of cost or fair value		-		8,500
Held-for-investment		352,440		304,510

Total Commercial Loans	$	379,853	$	313,010

Commercial Loans Held-for-Sale

Commercial loans held-for-sale include loans we originate and intend to sell to third parties.

Commercial Loans at Fair Value

At September 30, 2013, there were 4 senior commercial loans at fair value, with an aggregate outstanding principal balance of $27 million and an aggregate fair value of $27 million. During the three and nine months ended September 30, 2013, we recorded $3 million of positive valuation adjustments on commercial loans for which we elected the fair value option through mortgage banking activities, net, a component of our consolidated income statement. At December 31, 2012, there were no commercial loans at fair value.

Commercial Loans at Lower of Cost or Fair Value

At September 30, 2013, there were no commercial loans held at the lower of cost or fair value. During both the nine months ended September 30, 2013 and 2012, we did not record a valuation adjustment on commercial loans held-for-sale. At December 31, 2012, there was one senior commercial loan held-for-sale with $9 million in outstanding principal balance and a lower of cost or fair value of $9 million. During nine months ended September 30, 2012, we did not record a valuation adjustment.

Commercial Loans Held-for-Investment

Commercial loans held-for-investment include loans we originate and preferred equity investments we make or, in either case, acquire from third parties. Through September 30, 2013, these loans have typically been mezzanine loans that are secured by a borrower’s ownership interest in a single purpose entity that owns commercial property, rather than a lien on the commercial property. The preferred equity investments are typically preferred equity interests in a single purpose entity that owns commercial property and are included within, and referred to herein, as commercial loans held-for-investment due to the fact that their risks and payment characteristics are nearly equivalent to commercial mezzanine loans.

The following table provides additional information for our commercial loans held-for-investment at September 30, 2013 and December 31, 2012.


(In Thousands)	September 30, 2013		December 31, 2012
Principal balance	$	361,759	$	312,400
Unamortized discount, net		(2,815)		(3,806)

Recorded investment		358,944		308,594
Allowance for loan losses		(6,504)		(4,084)

Carrying Value	$	352,440	$	304,510

At September 30, 2013, there were 50 commercial loans held-for-investment with an outstanding principal balance of $362 million and a carrying value of $352 million. Of the $359 million of recorded investment in commercial loans held-for-investment at September 30, 2013, 17% was originated in 2013, 44% was originated in 2012, 34% was originated in 2011, and 5% was originated in 2010. At December 31, 2012, there were 35 commercial loans held-for-investment with an outstanding principal balance of $312 million and a carrying value of $305 million. Of the $309 million of recorded investment in commercial loans held-for-investment at December 31, 2012, 53% was originated in 2012, 38% was originated in 2011, 9% was originated in 2010, and less than 1% was acquired in 2004.

Allowance for Loan Losses on Commercial Loans

For commercial loans classified as held-for-investment, we establish and maintain an allowance for loan losses. The allowance includes a component for loans collectively evaluated for impairment and a component for loans individually evaluated for impairment.

Activity in the Allowance for Loan Losses on Commercial Loans

The following table summarizes the activity in the allowance for commercial loan losses for the three and nine months ended September 30, 2013 and 2012.


	Three Months Ended September 30,				Nine Months Ended September 30,
(In Thousands)	2013		2012		2013		2012
Balance at beginning of period	$	5,660	$	1,258	$	4,084	$	608
Charge-offs, net		-		-		-		-
Provision for loan losses		844		506		2,420		1,156

Balance at End of Period	$	6,504	$	1,764	$	6,504	$	1,764

Commercial Loans Collectively Evaluated for Impairment

We record an allowance for loan losses based on our estimate of credit losses inherent in our portfolio at the reporting date. Our estimate of credit losses is informed by loss rates and delinquency trends. At September 30, 2013 and December 31, 2012, all of the commercial loans collectively evaluated for impairment were current and were assigned an impairment status of “Pass.” The following table summarizes the balances for loans collectively evaluated for impairment at September 30, 2013 and December 31, 2012.


(In Thousands)	September 30, 2013		December 31, 2012
Principal balance	$	361,759	$	312,400
Recorded investment		358,944		308,594
Related allowance		6,504		4,084

Commercial Loans Individually Evaluated for Impairment

We did not have any loans individually evaluated for impairment at either September 30, 2013 or December 31, 2012.

Residential Loans

Loans

Note 6. Residential Loans

We acquire residential loans from third-party originators. During the nine months ended September 30, 2013, we purchased $6.35 billion (principal balance) of residential loans primarily in connection with our Sequoia securitization program, for which we elected the fair value option. The following table summarizes the classifications and carrying value of the residential loans owned at Redwood and at consolidated Sequoia entities at September 30, 2013 and December 31, 2012.


September 30, 2013 (In Thousands)	Redwood		Sequoia		Total
Held-for-sale
Fair value	$	726,161	$	-	$	726,161
Lower of cost or fair value		1,718		-		1,718
Held-for-investment		-		1,864,653		1,864,653

Total Residential Loans	$	727,879	$	1,864,653	$	2,592,532


December 31, 2012 (In Thousands)	Redwood		Sequoia		Total
Held-for-sale
Fair value	$	553,576	$	-	$	553,576
Lower of cost or fair value		9,082		-		9,082
Held-for-investment		-		2,272,812		2,272,812

Total Residential Loans	$	562,658	$	2,272,812	$	2,835,470

Residential Loans Held-for-Sale

Residential Loans at Fair Value

At September 30, 2013, there were 933 residential loans at fair value, with an aggregate outstanding principal balance of $722 million and an aggregate fair value of $726 million. During the three and nine months ended September 30, 2013, we recorded $11 million and $17 million of negative valuation adjustments, respectively, on residential loans for which we elected the fair value option through mortgage banking activities, net, a component of our consolidated income statement. At December 31, 2012, there were 685 residential loans at fair value, with an aggregate outstanding principal balance of $533 million and an aggregate fair value of $554 million.

Residential Loans at Lower of Cost or Fair Value

At September 30, 2013, there were 10 residential loans at lower of cost or fair value with $2 million in outstanding principal balance and a carrying value of $2 million. At December 31, 2012, there were 17 residential loans at lower of cost or fair value with $10 million in outstanding principal balance and a carrying value of $9 million. During the three and nine months ended September 30, 2013, we recorded valuation adjustments for residential loans held-for-sale of negative $11 thousand and positive $68 thousand, respectively. During the three and nine months ended September 30, 2012, we recorded valuation adjustments for residential loans held-for-sale of negative $367 thousand and positive $131 thousand, respectively.

Residential Loans Held-for-Investment

The following table details the carrying value for residential loans held-for-investment at September 30, 2013 and December 31, 2012. These loans are owned at Sequoia securitization entities that we consolidate for financial reporting purposes.


(In Thousands)	September 30, 2013		December 31, 2012
Principal balance	$	1,869,726	$	2,278,069
Unamortized premium, net		18,142		23,247

Recorded investment		1,887,868		2,301,316
Allowance for loan losses		(23,215)		(28,504)

Carrying Value	$	1,864,653	$	2,272,812

Of the $1.87 billion of principal balance and $18 million of unamortized premium on loans held-for-investment at September 30, 2013, $776 million of principal balance and $12 million of unamortized premium relate to residential loans acquired prior to July 1, 2004. During the nine months ended September 30, 2013, 15% of these residential loans prepaid and we amortized 26% of the premium based upon the accounting elections we apply. For residential loans acquired after July 1, 2004, the principal balance was $1.10 billion and the unamortized premium was $7 million. During the nine months ended September 30, 2013, 20% of these loans prepaid and we amortized 14% of the premium.

Of the $2.28 billion of principal balance and $23 million of unamortized premium on loans held-for-investment at December 31, 2012, $912 million of principal balance and $16 million of unamortized premium relate to residential loans acquired prior to July 1, 2004. For residential loans acquired after July 1, 2004, the principal balance was $1.37 billion and the unamortized premium was $8 million.

Credit Characteristics of Residential Loans Held-for-Investment

As a percentage of our recorded investment, 98% of residential loans held-for-investment at September 30, 2013, were first lien, predominately prime-quality loans at the time of origination. The remaining 2% of loans were second lien, home equity lines of credit. The weighted average original LTV ratio for our residential loans held-for-investment outstanding at September 30, 2013, was 66%. The weighted average FICO score for the borrowers of these loans was 733 at the time the loans were originated.

We consider the year of origination of our residential loans held-for-investment to be a general indicator of credit performance as loans originated in specific years have often possessed similar product and credit characteristics. The following table displays our recorded investment in residential loans held-for-investment at September 30, 2013 and December 31, 2012, organized by year of origination.


(In Thousands)	September 30, 2013		December 31, 2012
2003 & Earlier	$	942,405	$	1,131,200
2004		528,728		569,379
2005		66,821		71,792
2006		151,067		164,333
2007		-		-
2008		-		-
2009		30,395		58,628
2010		102,385		197,964
2011		66,067		108,020

Total Recorded Investment	$	1,887,868	$	2,301,316

Allowance for Loan Losses on Residential Loans

For residential loans held-for-investment, we establish and maintain an allowance for loan losses. The allowance includes a component for pools of residential loans owned at Sequoia securitization entities that we collectively evaluated for impairment, and a component for loans individually evaluated for impairment that includes modified residential loans at Sequoia entities that have been determined to be troubled debt restructurings.

Activity in the Allowance for Loan Losses on Residential Loans

The following table summarizes the activity in the allowance for loan losses for the three and nine months ended September 30, 2013 and 2012.


	Three Months Ended September 30,				Nine Months Ended September 30,
(In Thousands)	2013		2012		2013		2012
Balance at beginning of period	$	23,150	$	55,449	$	28,504	$	66,881
Charge-offs, net		(818)		(2,514)		(3,363)		(7,653)
Provision for (reversal of) provision for loan losses		883		813		(1,926)		(902)
Deconsolidation adjustment		-		-		-		(4,578)

Balance at End of Period	$	23,215	$	53,748	$	23,215	$	53,748

During the three months ended September 30, 2013 and 2012, there were less than $1 million and $3 million of charge-offs of residential loans that reduced our allowance for loan losses, respectively. These charge-offs arose from $3 million and $7 million of defaulted loan principal, respectively. During the nine months ended September 30, 2013 and 2012, there were $3 million and $8 million of charge-offs of residential loans, respectively, that reduced our allowance for loan losses. These charge-offs arose from $10 million and $21 million of defaulted loan principal, respectively.

Residential Loans Collectively Evaluated for Impairment

We establish the collective component of the allowance for residential loan losses based primarily on the characteristics of the loan pools underlying the securitization entities that own the loans, including loan product types, credit characteristics, and origination years. The collective analysis is further divided into two segments. The first segment reflects our estimate of losses on delinquent loans within each loan pool. These loss estimates are determined by applying the loss factors described in Note 3 to the delinquent loans, including our expectations of the timing of defaults and the loss severities we expect once defaults occur. The second segment relates to our estimate of losses incurred on nondelinquent loans within each loan pool. This estimate is based on losses we expect to realize over a 23 month loss confirmation period, which is based on our historical loss experience as well as consideration of the loss factors described in Note 3.

The following table summarizes the balances for loans collectively evaluated for impairment at September 30, 2013 and December 31, 2012.


(In Thousands)	September 30, 2013		December 31, 2012
Principal balance	$	1,861,027	$	2,272,104
Recorded investment		1,879,355		2,295,471
Related allowance		22,332		27,891

The following table summarizes the recorded investment and past due status of residential loans collectively evaluated for impairment at September 30, 2013 and December 31, 2012.


	30-59 Days		60-89 Days		90+ Days
(In Thousands)	Past Due		Past Due		Past Due		Current		Total Loans
September 30, 2013	$	37,850	$	15,778	$	69,236	$	1,756,491	$	1,879,355
December 31, 2012		29,345		17,593		62,937		2,185,596		2,295,471

Residential Loans Individually Evaluated for Impairment

As part of the loss mitigation efforts undertaken by servicers of residential loans owned at Sequoia securitization entities, a number of loan modifications have been completed to help make mortgage loans more affordable for qualifying borrowers and potentially reduce a future impairment. For the nine months ended September 30, 2013 and 2012, the loan modifications determined to be TDRs were either: (i) conversions of a floating rate mortgage loan into a fixed rate mortgage loan; (ii) reductions in the contractual interest rates of a mortgage loan paired with capitalization of accrued interest; or (iii) principal forgiveness paired with interest rate reductions.

The following table presents the details of the loan modifications determined to be TDRs for the three and nine months ended September 30, 2013 and 2012.


	Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars in Thousands)	2013		2012		2013		2012
TDRs
Number of modifications		5		4		12		10
Pre-modification outstanding recorded investment	$	1,144	$	1,337	$	2,939	$	3,848
Post-modification outstanding recorded investment		898		1,397		2,838		3,823
Loan modification effect on net interest income after provision and other MVA		(555)		(410)		(863)		(1,007)

TDRs that Subsequently Defaulted
Number of modifications		1		2		4		6
Recorded investment	$	201	$	1,301	$	788	$	2,987

If we determine that a restructured loan is a TDR, we remove it from the general loan pools used for determining the allowance for residential loan losses and assess it for impairment on an individual basis. This assessment is based primarily on whether an adverse change in the expected future cash flows resulted from the restructuring. The average recorded investment of loans individually evaluated for impairment for the three months ended September 30, 2013 and 2012, was $8 million and $16 million, respectively. For the three months ended September 30, 2013 and 2012, we recorded interest income of $81 thousand and $22 thousand, respectively, on individually impaired loans. The average recorded investment of loans individually evaluated for impairment for the nine months ended September 30, 2013 and 2012, was $7 million and $15 million, respectively. For the nine months ended September 30, 2013 and 2012, we recorded interest income of $102 thousand and $281 thousand, respectively, on individually impaired loans.

The following table summarizes the balances for loans individually evaluated for impairment, all of which had an allowance, at September 30, 2013 and December 31, 2012.


(In Thousands)	September 30, 2013		December 31, 2012
Principal balance	$	8,699	$	5,965
Recorded investment		8,513		5,845
Related allowance		883		613

The following table summarizes the recorded investment and past due status of residential loans individually evaluated for impairment at September 30, 2013 and December 31, 2012.


	30-59 Days		60-89 Days		90+ Days
(In Thousands)	Past Due		Past Due		Past Due		Current		Total Loans
September 30, 2013	$	1,399	$	381	$	193	$	6,540	$	8,513
December 31, 2012		160		645		-		5,040		5,845

- Definition

The entire disclosure for claims held for amounts due a entity, excluding financing receivables. Examples include, but are not limited to, trade accounts receivables, notes receivables, loans receivables. Includes disclosure for allowance for credit losses.

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