Loans

6 Months Ended

Jun. 30, 2014

Loans

Note 6. Residential Loans

We acquire residential loans from third-party originators. The following table summarizes the classifications and carrying value of the residential loans owned at Redwood and at consolidated Sequoia entities at June 30, 2014 and December 31, 2013.

June 30, 2014 (In Thousands)	Redwood		Sequoia		Total
Held-for-sale
Fair value - Conforming	$	259,675	$	-	$	259,675
Fair value - Jumbo		846,564		-		846,564
Lower of cost or fair value		1,638		-		1,638
Held-for-investment		-		1,616,504		1,616,504
Total Residential Loans	$	1,107,877	$	1,616,504	$	2,724,381

December 31, 2013 (In Thousands)	Redwood		Sequoia		Total
Held-for-sale
Fair value - Conforming	$	11,502	$	-	$	11,502
Fair value - Jumbo		391,100		-		391,100
Lower of cost or fair value		1,665		-		1,665
Held-for-investment		-		1,762,167		1,762,167
Total Residential Loans	$	404,267	$	1,762,167	$	2,166,434

Residential Loans Held-for-Sale

Residential Loans at Fair Value

At June 30, 2014, there were 2,038 residential loans at fair value, with an aggregate outstanding principal balance of $1.07 billion and an aggregate fair value of $1.11 billion. During the three and six months ended June 30, 2014, we purchased $1.74 billion and $2.82 billion (principal balance) of residential loans, respectively, for which we elected the fair value option. During the three and six months ended June 30, 2014, we recorded $13 million and $20 million of positive valuation adjustments, respectively, on fair value residential loans through mortgage banking activities, net, a component of our consolidated income statement. At December 31, 2013, there were 537 residential loans at fair value, with an aggregate outstanding principal balance of $399 million and an aggregate fair value of $403 million.

Residential Loans at Lower of Cost or Fair Value

At June 30, 2014, 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, 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. During the three and six months ended June 30, 2014, we recorded valuation adjustments for residential loans held-for-sale of positive $13 thousand and $11 thousand, respectively.

Residential Loans Held-for-Investment

The following table details the carrying value for residential loans held-for-investment at June 30, 2014 and December 31, 2013. These loans are owned at Sequoia securitization entities that we consolidate for financial reporting purposes.

(In Thousands)	June 30, 2014		December 31, 2013
Principal balance	$	1,625,890	$	1,770,803
Unamortized premium, net		14,586		16,791
Recorded investment		1,640,476		1,787,594
Allowance for loan losses		(23,972)		(25,427)
Carrying Value	$	1,616,504	$	1,762,167

Of the $1.6 billion of principal balance and $15 million of unamortized premium on loans held-for-investment at June 30, 2014, $663 million of principal balance and $9 million of unamortized premium relate to residential loans acquired prior to July 1, 2004. During the six months ended June 30, 2014, 9% of these residential loans prepaid and we amortized 16% of the premium based upon the accounting elections we apply. For residential loans acquired after July 1, 2004, the principal balance was $966 million and the unamortized premium was $6 million. During the six months ended June 30, 2014, 7% of these loans prepaid and we amortized 9% of the premium.

Of the $1.77 billion of principal balance and $17 million of unamortized premium on loans held-for-investment at December 31, 2013, $731 million of principal balance and $11 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 billion and the unamortized premium was $6 million.

Credit Characteristics of Residential Loans Held-for-Investment

As a percentage of our recorded investment, 99% of residential loans held-for-investment at June 30, 2014, were first lien, predominately prime-quality loans at the time of origination. The remaining 1% 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 June 30, 2014, 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 June 30, 2014 and December 31, 2013, organized by year of origination.

(In Thousands)	June 30, 2014		December 31, 2013
2003 & Earlier	$	798,571	$	881,364
2004		479,478		513,458
2005		60,138		62,675
2006		141,937		149,776
2007		-		-
2008		-		-
2009		19,994		25,860
2010		84,992		92,728
2011		55,366		61,733
Total Recorded Investment	$	1,640,476	$	1,787,594

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 six months ended June 30, 2014 and 2013.

	Three Months Ended June 30,				Six Months Ended June 30,
(In Thousands)	2014		2013		2014		2013
Balance at beginning of period	$	25,571	$	29,064	$	25,427	$	28,504
Charge-offs, net		(994)		(1,751)		(1,478)		(2,545)
(Reversal of provision) provision for loan losses		(605)		(4,163)		23		(2,809)
Balance at End of Period	$	23,972	$	23,150	$	23,972	$	23,150

During the three months ended June 30, 2014 and 2013, there were less than $1 million and $2 million of charge-offs of residential loans that reduced our allowance for loan losses, respectively. These charge-offs were from $6 million and $5 million of defaulted loan principal, respectively. During the six months ended June 30, 2014 and 2013, there were $1 million and $3 million of charge-offs of residential loans, respectively, that reduced our allowance for loan losses. These charge-offs arose from $8 million and $7 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 June 30, 2014 and December 31, 2013.

(In Thousands)	June 30, 2014		December 31, 2013
Principal balance	$	1,612,303	$	1,762,165
Recorded investment		1,627,228		1,779,161
Related allowance		22,695		24,762

The following table summarizes the recorded investment and past due status of residential loans collectively evaluated for impairment at June 30, 2014 and December 31, 2013.

(In Thousands)	30-59 Days Past Due		60-89 Days Past Due		90+ Days Past Due		Current		Total Loans
June 30, 2014	$	25,639	$	9,619	$	74,393	$	1,517,577	$	1,627,228
December 31, 2013		34,187		13,248		79,010		1,652,716		1,779,161

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 six months ended June 30, 2014 and 2013, all of 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 six months ended June 30, 2014 and 2013.

	Three Months Ended June 30,				Six Months Ended June 30,
(Dollars in Thousands)	2014		2013		2014		2013
TDRs
Number of modifications		9		4		14		7
Pre-modification outstanding recorded investment	$	3,052	$	1,031	$	4,967	$	1,795
Post-modification outstanding recorded investment		3,272		1,145		5,165		1,941
Loan modification effect on net interest income after provision and other MVA		(812)		(140)		(1,221)		(309)
TDRs that Subsequently Defaulted
Number of modifications		3		1		6		3
Recorded investment	$	1,574	$	178	$	2,493	$	587

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 for the three months ended June 30, 2014 and 2013 was $13 million and $7 million, respectively. The average recorded investment of loans individually evaluated for impairment for the six months ended June 30, 2014 and 2013 was $11 million and $7 million, respectively. For the three months ended June 30, 2014 and 2013, we recorded interest income of $29 thousand and $10 thousand, respectively, on individually impaired loans. For the six months ended June 30, 2014 and 2013, we recorded interest income of $67 thousand and $21 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 June 30, 2014 and December 31, 2013.

(In Thousands)	June 30, 2014		December 31, 2013
Principal balance	$	13,587	$	8,638
Recorded investment		13,248		8,433
Related allowance		1,277		665

The following table summarizes the recorded investment and past due status of residential loans individually evaluated for impairment at June 30, 2014 and December 31, 2013.

(In Thousands)	30-59 Days Past Due		60-89 Days Past Due		90+ Days Past Due		Current		Total Loans
June 30, 2014	$	1,611	$	1,319	$	551	$	9,767	$	13,248
December 31, 2013		1,560		-		567		6,306		8,433

Commercial Loans

Loans

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 June 30, 2014 and December 31, 2013.

(In Thousands)	June 30, 2014		December 31, 2013
Held-for-sale, at fair value	$	50,848	$	89,111
Held-for-investment
At fair value		71,270		-
At amortized cost		346,648		343,344
Total Commercial Loans	$	468,766	$	432,455

Of the held-for-investment commercial loans shown above at June 30, 2014 and December 31, 2013, $255 million and $258 million, respectively, were financed through the Commercial Securitization entity, as discussed in Note 4.

Commercial Loans Held-for-Sale

Commercial loans held-for-sale include loans we originate and intend to sell to third parties. At June 30, 2014, there were seven commercial loans at fair value, with an aggregate outstanding principal balance of $49 million and an aggregate fair value of $51 million. During the three and six months ended June 30, 2014, we originated and funded senior commercial loans for $149 million and $237 million and recorded $6 million and $8 million of positive valuation adjustments on commercial loans held-for-sale through mortgage banking activities, net, a component of our consolidated income statement. At December 31, 2013, there were seven senior commercial loans at fair value, with an aggregate outstanding principal balance of $88 million and an aggregate fair value of $89 million.

Commercial Loans Held-for-Investment

Commercial Loans Held-for-Investment, at Fair Value

Commercial loans held-for-investment at fair value include certain loans we hold for investment for which we have elected the fair value option. At June 30, 2014, there were three of these commercial loans, with an aggregate outstanding principal balance of $68 million and an aggregate fair value of $71 million. During the three months ended June 30, 2014, we did not originate any commercial loans held-for-investment at fair value and recorded $2 million of positive valuation adjustments on our existing portfolio. During the six months ended June 30, 2014, we originated and funded commercial loans for $31 million and recorded $3 million of positive valuation adjustments on commercial loans held-for-investment at fair value through mortgage banking activities, net, a component of our consolidated income statement. We did not have any commercial loans held-for-investment at fair value at December 31, 2013.

Commercial Loans Held-for-Investment, at Amortized Cost

Commercial loans held-for-investment at amortized cost include loans we originate and preferred equity investments we make or, in either case, acquire from third parties. Through June 30, 2014, 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 amortized cost at June 30, 2014 and December 31, 2013.

(In Thousands)	June 30, 2014		December 31, 2013
Principal balance	$	357,292	$	353,331
Unamortized discount, net		(2,327)		(2,614)
Recorded investment		354,965		350,717
Allowance for loan losses		(8,317)		(7,373)
Carrying Value	$	346,648	$	343,344

At June 30, 2014, there were 53 commercial loans held-for-investment at amortized cost with an outstanding principal balance of $357 million and a carrying value of $347 million. During the three and six months ended June 30, 2014, we originated or acquired $6 million and $8 million of commercial loans held-for-investment at amortized cost. Of the $355 million of recorded investment in commercial loans held-for-investment at June 30, 2014, 2% was originated in 2014, 18% was originated in 2013, 43% was originated in 2012, 33% was originated in 2011, and 4% was originated in 2010.

At December 31, 2013, there were 50 commercial loans held-for-investment at amortized cost with an outstanding principal balance of $353 million and a carrying value of $343 million. Of the $351 million of recorded investment in commercial loans held-for-investment at December 31, 2013, 19% was originated in 2013, 43% was originated in 2012, 34% was originated in 2011, and 4% was originated in 2010.

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.

Our methodology for assessing the adequacy of the allowance for loan losses includes a formal review of each commercial loan in the portfolio and the assignment of an internal impairment status. Based on the assigned impairment status, a loan is categorized as “Pass,” “Watch List,” or “Workout.” The following table presents the principal balance of commercial loans held-for-investment by risk category.

(In Thousands)	June 30, 2014		December 31, 2013
Pass	$	331,558	$	309,792
Watch list		25,734		43,539
Workout		-		-
Total Commercial Loans Held-for-Investment	$	357,292	$	353,331

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 six months ended June 30, 2014 and 2013.

	Three Months Ended June 30,				Six Months Ended June 30,
(In Thousands)	2014		2013		2014		2013
Balance at beginning of period	$	8,028	$	4,769	$	7,373	$	4,084
Charge-offs, net		-		-		-		-
Provision for loan losses		289		891		944		1,576
Balance at End of Period	$	8,317	$	5,660	$	8,317	$	5,660

Commercial Loans Collectively Evaluated for Impairment

At June 30, 2014 and December 31, 2013, all of our commercial loans collectively evaluated for impairment were current. The following table summarizes the balances for loans collectively evaluated for impairment at June 30, 2014 and December 31, 2013.

(In Thousands)	June 30, 2014		December 31, 2013
Principal balance	$	357,292	$	353,331
Recorded investment		354,965		350,717
Related allowance		8,317		7,373

Commercial Loans Individually Evaluated for Impairment

We did not have any commercial loans individually evaluated for impairment at either June 30, 2014 or December 31, 2013.