Note 8. Real Estate Securities

We invest in mortgage-backed securities. The following table presents the fair values of our real estate securities by collateral type at September 30, 2013 and December 31, 2012.


(In Thousands)	September 30, 2013		December 31, 2012
Residential	$	1,324,678	$	1,094,684
Commercial		-		14,069

Total Real Estate Securities	$	1,324,678	$	1,108,753

Our residential 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 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.

Trading Securities

We elected the fair value option for certain securities and classify them as trading securities. At September 30, 2013, our trading securities included $127 million of interest-only securities, for which there is no principal balance, and $4 million of residential subordinate securities. The unpaid principal balance of residential subordinate securities classified as trading was $15 million and $12 million at September 30, 2013 and December 31, 2012, respectively. The following table presents trading securities by collateral type at September 30, 2013 and December 31, 2012.


(In Thousands)	September 30, 2013		December 31, 2012
Senior Securities
Residential prime	$	117,443	$	10,409
Residential non-prime		8,864		22,134

Total Senior Securities		126,307		32,543

Subordinate Securities
Residential prime		4,547		468
Residential non-prime		-		161

Total Subordinate Securities		4,547		629


Total Trading Securities	$	130,854	$	33,172

AFS Securities

The following table presents the fair value of our available-for-sale securities held at Redwood by collateral type at September 30, 2013 and December 31, 2012.


(In Thousands)	September 30, 2013		December 31, 2012
Senior Securities
Residential prime	$	363,822	$	466,523
Residential non-prime		195,154		245,266

Total Senior Securities		558,976		711,789

Re-REMIC Securities		156,346		163,035

Subordinate Securities
Residential prime		478,369		184,528
Residential non-prime		133		2,160
Commercial		-		14,069

Total Subordinate Securities		478,502		200,757



Total AFS Securities	$	1,193,824	$	1,075,581

The senior securities shown above at September 30, 2013 and December 31, 2012, included $141 million and $172 million, respectively, of prime securities, and $135 million and $152 million, respectively, of non-prime securities that were financed through the Residential Resecuritization entity, as discussed in Note 4.

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 interest method.

At September 30, 2013, there were $1 thousand of AFS residential securities with contractual maturities less than five years, $3 million of AFS residential securities with 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.

During the first quarter of 2013, we sold all of our commercial AFS securities, resulting in a realized gain of $12 million. The following table presents the components of carrying value (which equals fair value) of residential AFS securities at September 30, 2013 and December 31, 2012.

Carrying Value of Residential AFS Securities


(In Thousands)	September 30, 2013		December 31, 2012
Principal balance	$	1,481,198	$	1,277,401
Credit reserve		(136,292)		(187,032)
Unamortized discount, net		(288,838)		(203,421)

Amortized cost		1,056,068		886,948
Gross unrealized gains		155,972		176,929
Gross unrealized losses		(18,216)		(2,365)

Carrying Value	$	1,193,824	$	1,061,512

The following table presents the changes for the three and nine months ended September 30, 2013, in unamortized discount and designated credit reserves on residential AFS securities.

Changes in Unamortized Discount and Designated Credit Reserves on Residential AFS Securities


	Three Months Ended September 30, 2013
	Credit		Unamortized
(In Thousands)	Reserve		Discount, Net
Beginning balance	$	190,410	$	235,846
Amortization of net discount		-		(8,785)
Realized credit losses		(4,940)		-
Acquisitions		3,669		30,361
Sales, calls, other		(17,597)		(3,834)
Impairments		-		-
Transfers to (release of) credit reserves, net		(35,250)		35,250

Ending Balance	$	136,292	$	288,838


	Nine Months Ended September 30, 2013
	Credit		Unamortized
(In Thousands)	Reserve		Discount, Net
Beginning balance	$	187,032	$	203,421
Amortization of net discount		-		(24,632)
Realized credit losses		(16,905)		-
Acquisitions		12,066		84,884
Sales, calls, other		(17,935)		(4,467)
Impairments		1,666		-
Transfers to (release of) credit reserves, net		(29,632)		29,632

Ending Balance	$	136,292	$	288,838

Credit Characteristics of Residential AFS Securities

Of the $136 million of credit reserve on our residential securities at September 30, 2013, $26 million was related to residential senior securities, $33 million was related to residential re-REMIC securities, and $77 million was related to residential subordinate securities. The loans underlying our $364 million of prime residential senior securities totaled $9 billion at September 30, 2013, and the loans underlying our $195 million of non-prime residential senior securities totaled $4 billion. Serious delinquencies on loans underlying our senior securities at September 30, 2013, were 9.51% of outstanding principal balances. The loans underlying our residential re-REMIC securities totaled $4 billion at September 30, 2013, and consisted of $4 billion prime and $101 million non-prime credit quality collateral at time of origination. Serious delinquencies on loans underlying our re-REMIC securities at September 30, 2013, were 9.50% of outstanding principal balances. The loans underlying our residential subordinate securities totaled $17 billion at September 30, 2013, and consisted of $16 billion prime and $300 million non-prime credit quality at time of origination. Serious delinquencies on loans underlying our subordinate securities at September 30, 2013, were 3.29% of outstanding principal balances.

Residential 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, 2013 and December 31, 2012.


	Less Than 12 Consecutive Months						12 Consecutive Months or Longer
(In Thousands)	Amortized Cost		Unrealized Losses		Fair Value		Amortized Cost		Unrealized Losses		Fair Value
September 30, 2013	$	431,721	$	(16,998)	$	414,723	$	11,020	$	(1,218)	$	9,802
December 31, 2012		22,803		(293)		22,510		26,729		(2,072)		24,657

At September 30, 2013, after giving effect to purchases, sales, and extinguishments due to credit losses, our consolidated balance sheet included 297 AFS securities, of which 63 were in an unrealized loss position and seven were in a continuous unrealized loss position for 12 consecutive months or longer. At December 31, 2012, our consolidated balance sheet included 284 AFS securities, of which 22 were in an unrealized loss position and 14 were in a continuous unrealized loss position for 12 consecutive months or longer.

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 September 30, 2013.

Significant Valuation Assumptions


	Range for Securities
September 30, 2013	Prime		Non-prime
Prepayment rates		4 - 50 %		3 - 10 %
Loss severity		15 -56 %		30 -59 %
Projected losses		0 - 38 %		4 - 15 %

For an AFS security with a fair value that has declined below its amortized cost basis, we evaluate the security for OTTI. The credit component of OTTI is recognized through our consolidated statements of income as a component of other market valuation adjustments, net, while the non-credit component of OTTI is recognized through accumulated other comprehensive income, a component of equity. 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 September 30, 2013 and 2012. The balance of the credit component of OTTI at September 30, 2013 and 2012 includes all market valuation adjustments recorded through the income statement for securities still held on our balance sheet at September 30, 2013 and 2012, as well as a portion of OTTI previously recognized in other comprehensive income.

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


	Three Months Ended September 30,				Nine Months Ended September 30,
(In Thousands)	2013		2012		2013		2012
Balance at beginning of period	$	42,674	$	67,054	$	50,852	$	78,126
Additions
Initial credit impairments		-		164		-		325
Subsequent credit impairments		-		58		-		149
Reductions
Securities sold, or expected to sell		(3,288)		(9,069)		(5,479)		(9,069)
Securities with no outstanding principal at period end		(764)		(4,310)		(6,751)		(15,634)

Balance at End of Period	$	38,622	$	53,897	$	38,622	$	53,897

The credit component of OTTI is reduced if we sell, intend to sell, or believe we will be required to sell previously credit-impaired debt securities. Additionally, the credit component of OTTI 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 the security experiences an event (such as full prepayment or principal losses) such that the outstanding principal is reduced to zero.

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 nine months ended September 30, 2013 and 2012.


	Three Months Ended September 30,				Nine Months Ended September 30,
(In Thousands)	2013		2012		2013		2012
Gross realized gains - sales	$	10,532	$	13,920	$	22,762	$	28,693
Gross realized gains - calls		–		–		333		113
Gross realized losses - sales		(214)		–		(214)		(1,600)
Gross realized losses - calls		–		–		–		–

Total Realized Gains on Sales and Calls of AFS Securities, net	$	10,318	$	13,920	$	22,881	$	27,206