Real Estate Securities

6 Months Ended

Jun. 30, 2012

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, 2012 and December 31, 2011.

June 30, 2012 (In Thousands)	Redwood		Acacia		Total       Securities
Residential	$	1,050,952	$	173,106	$	1,224,058
Commercial		5,761		66,754		72,515
CDO		64		15,091		15,155
Total Real Estate Securities	$	1,056,777	$	254,951	$	1,311,728

December 31, 2011 (In Thousands)	Redwood		Acacia		Total       Securities
Residential	$	744,281	$	175,062	$	919,343
Commercial		5,445		37,923		43,368
CDO		1,010		18,116		19,126
Total Real Estate Securities	$	750,736	$	231,101	$	981,837

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 at Redwood and the Acacia entities, and classify them as trading securities. The unpaid principal balance of these trading securities was $973 million and $1.11 billion at June 30, 2012 and December 31, 2011, respectively. The following table presents trading securities by collateral type and ownership entity at June 30, 2012 and December 31, 2011.

	June 30, 2012						December 31, 2011
(In Thousands)	Redwood		Acacia		Total		Redwood		Acacia		Total
Senior Securities
Residential prime	$	16,301	$	3,195	$	19,496	$	-	$	3,019	$	3,019
Residential non-prime		22,962		87,030		109,992		20,608		88,280		108,888
Commercial		-		11,684		11,684		-		11,216		11,216
Total Senior Securities		39,263		101,909		141,172		20,608		102,515		123,123
Subordinate Securities
Residential prime		468		32,790		33,258		343		31,718		32,061
Residential non-prime		103		50,091		50,194		130		52,045		52,175
Commercial		-		55,070		55,070		-		26,707		26,707
CDO		14		15,091		15,105		960		18,116		19,076
Total Subordinate Securities		585		153,042		153,627		1,433		128,586		130,019
Total Trading Securities	$	39,848	$	254,951	$	294,799	$	22,041	$	231,101	$	253,142

AFS Securities

The following table presents the fair value of our available-for-sale securities held at Redwood by collateral type at June 30, 2012 and December 31, 2011.

(In Thousands)	June 30, 2012		December 31, 2011
Senior Securities
Residential prime	$	490,802	$	278,240
Residential non-prime		242,008		255,724
Total Senior Securities		732,810		533,964
Re-REMIC Securities		147,437		119,366
Subordinate Securities
Residential prime		123,004		58,717
Residential non-prime		7,867		11,153
Commercial		5,761		5,445
CDO		50		50
Total Subordinate Securities		136,682		75,365
Total AFS Securities	$	1,016,929	$	728,695

Of the senior securities shown above at June 30, 2012 and December 31, 2011, $176 million and $175 million, respectively, of prime securities, and $147 million and $150 million, respectively, of non-prime securities were financed through the Resecuritization entity, as discussed in Note 4.

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 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 June 30, 2012, 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 the components of carrying value (which equals fair value) of AFS securities at June 30, 2012 and December 31, 2011.

Carrying Value of AFS Securities

June 30, 2012 (In Thousands)	Residential		Commercial		CDO		Total
Principal balance	$	1,362,729	$	42,602	$	7,275	$	1,412,606
Credit reserve		(221,426)		(33,013)		(7,275)		(261,714)
Unamortized discount, net		(224,824)		(5,532)		-		(230,356)
Amortized cost		916,479		4,057		-		920,536
Gross unrealized gains		107,384		2,329		50		109,763
Gross unrealized losses		(12,745)		(625)		-		(13,370)
Carrying Value	$	1,011,118	$	5,761	$	50	$	1,016,929

December 31, 2011 (In Thousands)	Residential		Commercial		CDO		Total
Principal balance	$	1,148,952	$	50,499	$	10,717	$	1,210,168
Credit reserve		(242,261)		(43,012)		(10,717)		(295,990)
Unamortized discount, net		(235,833)		(3,554)		-		(239,387)
Amortized cost		670,858		3,933		-		674,791
Gross unrealized gains		85,360		1,702		50		87,112
Gross unrealized losses		(33,018)		(190)		-		(33,208)
Carrying Value	$	723,200	$	5,445	$	50	$	728,695

The following table presents the changes for the three and six months ended June 30, 2012, 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, 2012	Residential				Commercial				CDO
(In Thousands)	Credit Reserve		Unamortized Discount, Net		Credit Reserve		Unamortized Discount, Net		Credit Reserve		Unamortized Premium, Net
Beginning balance - March 31, 2012	$	235,618	$	238,533	$	33,668	$	5,651	$	7,244	$	-
Amortization of net discount		-		(8,198)		-		(150)		-		31
Realized credit losses		(11,786)		-		(624)		-		-		-
Acquisitions		4,870		8,392		-		-		-		-
Sales, calls, other		(10,598)		(10,884)		-		-		-		-
Impairments		303		-		-		-		-		-
Transfers to (release of) credit reserves		3,019		(3,019)		(31)		31		31		(31)
Ending Balance - June 30, 2012	$	221,426	$	224,824	$	33,013	$	5,532	$	7,275	$	-

Six Months Ended June 30, 2012	Residential				Commercial				CDO
(In Thousands)	Credit Reserve		Unamortized  Discount, Net		Credit Reserve		Unamortized  Discount, Net		Credit Reserve		Unamortized  Premium, Net
Beginning balance - December 31, 2011	$	242,261	$	235,833	$	43,012	$	3,554	$	10,717	$	-
Amortization of net discount		-		(16,398)		-		(235)		-		58
Realized credit losses		(25,908)		-		(7,897)		-		(3,500)		-
Acquisitions		11,552		43,998		-		-		-		-
Sales, calls, other		(16,156)		(29,456)		-		-		-		-
Impairments		524		-		111		-		-		-
Transfers to (release of) credit reserves		9,153		(9,153)		(2,213)		2,213		58		(58)
Ending Balance - June 30, 2012	$	221,426	$	224,824	$	33,013	$	5,532	$	7,275	$	-

Credit Characteristics of AFS Securities

Of the $221 million of credit reserve on our residential securities at June 30, 2012, $54 million was related to residential senior securities, $58 million was related to residential re-REMIC securities, and $109 million was related to residential subordinate securities. The loans underlying our residential senior securities totaled $16 billion at June 30, 2012, and consisted of $11 billion prime and $5 billion non-prime credit quality at time of origination. Serious delinquencies at June 30, 2012, were 10.74% of outstanding principal balances. The loans underlying our residential re-REMIC securities totaled $7 billion at June 30, 2012, and were all prime credit quality at time of origination. Serious delinquencies at June 30, 2012, were 10.27% of outstanding principal balances. The loans underlying our residential subordinate securities totaled $19 billion at June 30, 2012, and consisted of $18 billion prime and $1 billion non-prime credit quality at time of origination. Serious delinquencies at June 30, 2012, were 5.68% of outstanding principal balances.

The loans underlying our commercial subordinate securities totaled $8 billion at June 30, 2012, and consisted primarily of office (21%), retail (36%), and multifamily (13%) loans. Serious delinquencies (60+ days, in foreclosure or REO) at June 30, 2012 were 4.6% of current principal balances.

AFS Securities with Unrealized Losses

The following table presents the components comprising the total carrying value of AFS securities that were in a gross unrealized loss position at June 30, 2012 and December 31, 2011.

June 30, 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
Residential	$	99,900	$	(3,056)	$	96,844	$	123,701	$	(9,689)	$	114,012
Commercial		991		(435)		556		1,128		(190)		938
CDO		-		-		-		-		-		-
Total Securities	$	100,891	$	(3,491)	$	97,400	$	124,829	$	(9,879)	$	114,950

December 31, 2011	Less Than 12 Consecutive Months						12 Consecutive Months or Longer
(In Thousands)	Amortized  Cost		Unrealized  Losses		Fair Value		Amortized  Cost		Unrealized  Losses		Fair Value
Residential	$	242,595	$	(21,976)	$	220,619	$	75,245	$	(11,042)	$	64,203
Commercial		151		(38)		113		1,090		(152)		938
CDO		-		-		-		-		-		-
Total Securities	$	242,746	$	(22,014)	$	220,732	$	76,335	$	(11,194)	$	65,141

At June 30, 2012, after giving effect to purchases, sales, and extinguishments due to credit losses, our consolidated balance sheet included 399 AFS securities, of which 89 were in an unrealized loss position and 51 were in a continuous unrealized loss position for twelve consecutive months or longer. At December 31, 2011, our consolidated balance sheet included 425 AFS securities, of which 139 were in an unrealized loss position and 26 were in a continuous unrealized loss position for twelve 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 June 30, 2012.

Significant Valuation Assumptions

	Range for Securities
June 30, 2012	Prime		Non-prime		Commercial
Prepayment rates		4 -19 %		3 - 8 %		N/A
Loss severity		17 -57 %		19 - 61 %		33 -50 %
Projected losses		0 -37 %		6 - 41 %		2 - 9 %

For an AFS security where its fair value 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 June 30, 2012 and 2011. The balance of the credit component of OTTI at June 30, 2012, includes all market valuation adjustments recorded through the income statement for securities still held on our balance sheet at June 30, 2012 and 2011 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 June 30,				Six Months Ended June 30,
(In Thousands)	2012		2011		2012		2011
Balance at beginning of period	$	73,698	$	100,948	$	78,126	$	121,016
Additions
Initial credit impairments		55		449		161		463
Subsequent credit impairments		91		754		91		935
Reductions
Securities sold, or expected to sell		-		-		-		(12,317)
Securities with no outstanding principal at period end		(6,790)		(12,132)		(11,324)		(20,078)
Balance at End of Period	$	67,054	$	90,019	$	67,054	$	90,019

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 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 on sales and calls of AFS securities for the three and six months ended June 30, 2012 and 2011.

	Three Months Ended June 30,				Six Months Ended June 30,
(In Thousands)	2012		2011		2012		2011
Gross realized gains - sales	$	6,989	$	5,351	$	14,774	$	12,665
Gross realized gains - calls		-		401		113		533
Gross realized losses - sales		-		(165)		(1,600)		(3,523)
Gross realized losses - calls		-		-		-		(223)
Total Realized Gains on Sales and Calls of AFS Securities, net	$	6,989	$	5,587	$	13,287	$	9,452