Wells Fargo Real Estate Investment Corp. - FORM 10-Q

Attached files

file	filename
EX-32.B - EXHIBIT 32.B - Wells Fargo Real Estate Investment Corp.	wfe-2017930xex32b.htm
EX-32.A - EXHIBIT 32.A - Wells Fargo Real Estate Investment Corp.	wfe-2017930xex32a.htm
EX-31.B - EXHIBIT 31.B - Wells Fargo Real Estate Investment Corp.	wfe-2017930xex31b.htm
EX-31.A - EXHIBIT 31.A - Wells Fargo Real Estate Investment Corp.	wfe-2017930xex31a.htm
EX-12 - EXHIBIT 12 - Wells Fargo Real Estate Investment Corp.	wfe-2017930xex12.htm

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017

Commission file number 1-36768

Wells Fargo Real Estate Investment Corporation

(Exact name of registrant as specified in its charter)



Delaware		56-1986428
(State of incorporation)		(I.R.S. Employer Identification No.)

90 South 7th Street

Minneapolis, Minnesota 55402

(Address of principal executive offices)

(Zip Code)

(855) 825-1437

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.



Yes þ		No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).



Yes þ		No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company' in Rule 12b-2 of the Exchange Act.



	Large accelerated filer o		Accelerated filer o

	Non-accelerated filer þ (Do not check if a smaller reporting company)		Smaller reporting company o
			Emerging growth company þ

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).



Yes o		No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of October 30, 2017, there were 34,058,028 shares of the registrant’s common stock outstanding.

FORM 10-Q

CROSS-REFERENCE INDEX



PART I	Financial Information

Item 1.	Financial Statements			Page
	Statement of Income			22
	Balance Sheet			23
	Statement of Changes in Equity			24
	Statement of Cash Flows			25
	Notes to Financial Statements
	1	—	Summary of Significant Accounting Policies	26
	2	—	Loans and Allowance for Credit Losses	27
	3	—	Fair Values of Assets and Liabilities	39
	4	—	Common and Preferred Stock	40
	5	—	Transactions with Related Parties	41

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations (Financial Review)
	Summary Financial Data			2
	Overview			3
	Earnings Performance			5
	Balance Sheet Analysis			8
	Risk Management			9
	Critical Accounting Policy			19
	Current Accounting Developments			19
	Forward-Looking Statements			20
	Risk Factors			20

Item 3.	Quantitative and Qualitative Disclosures About Market Risk			18

Item 4.	Controls and Procedures			21

PART II	Other Information

Item 1.	Legal Proceedings			43

Item 1A.	Risk Factors			43

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds			43

Item 6.	Exhibits			44

Signature				45

PART I - FINANCIAL INFORMATION

FINANCIAL REVIEW



Summary Financial Data (1)
							% Change
	Quarter ended						September 30, 2017 from				Nine months ended
($ in thousands, except per share data)	Sep 30, 2017			Jun 30, 2017		Sep 30, 2016	Jun 30, 2017		Sep 30, 2016		Sep 30, 2017			Sep 30, 2016	% Change
For the period
Net income	$	326,540		289,100		191,263	13	%	71		$	903,737		485,020	86	%
Net income applicable to common stock	322,143			284,703		186,866	13		72		890,546			471,829	89
Diluted earnings per common share	9.46			8.36		8.82	13		7		26.15			30.09	(13	)
Profitability ratios
Return on average assets	3.87		%	3.42		3.07	13		26		3.62		%	3.80	(5	)
Return on average stockholders’ equity	3.99			3.58		3.74	11		7		3.73			4.29	(13	)
Average stockholders’ equity to average assets	96.78			95.51		82.10	1		18		97.28			88.53	10
Common dividend payout ratio (2)	99.37			100.12		71.54	(1	)	39		100.50			93.09	8
Dividend coverage ratio (3)	6,837			6,068		3,659	13		87		6,837			3,659	87
Total revenue	$	345,155		334,508		231,348	3		49		$	1,004,061		568,235	77
Average loans	33,243,173			31,404,930		20,648,080	6		61		31,802,058			15,538,275	105
Average assets	33,516,352			33,940,380		24,765,989	(1	)	35		33,338,443			17,065,674	95
Net interest margin	3.96		%	3.78		3.62	5		9		3.87		%	4.34	(11	)
Net loan charge-offs (recoveries)	$	1,156		(262	)	3,203	NM		(64	)	$	5,331		15,362	(65	)
As a percentage of average total loans (annualized)	0.01		%	—%		0.06	NM		(83	)	0.02		%	0.13	(85	)
At period end
Loans	$	32,697,065		33,850,075		33,501,153	(3	)	(2	)	$	32,697,065		33,501,153	(2	)
Allowance for loan losses	129,116			143,389		130,715	(10	)	(1	)	129,116			130,715	(1	)
As a percentage of total loans	0.39		%	0.42		0.39	(7	)	—		0.39		%	0.39	—
Assets	$	32,738,812		33,952,261		33,763,620	(4	)	(3	)	$	32,738,812		33,763,620	(3	)
Total stockholders’ equity	32,389,730			32,387,587		32,389,786	—		—		32,389,730			32,389,786	—
Total nonaccrual loans and foreclosed assets	200,896			205,328		231,660	(2	)	(13	)	200,896			231,660	(13	)
As a percentage of total loans	0.61		%	0.61		0.69	—		(12	)	0.61		%	0.69	(12	)
Loans 90 days or more past due and still accruing (4)	$	6,174		6,241		6,102	(1	)	1		$	6,174		6,102	1

NM - Not meaningful

(1)

On August 26, 2016, Wells Fargo Real Estate Investment Corporation (the Company) issued and sold 21.2 million shares of the Company’s common stock to affiliates of the Company for an aggregate purchase price of $20.0 billion. Subsequent to the issuance, the Company used the proceeds along with existing funds to acquire $19.1 billion of real estate 1-4 family first mortgage loans and $1.9 billion of commercial secured by real estate loans (CSRE).


(2)	Dividends declared per common share as a percentage of earnings per common share.

(3)

The dividend coverage ratio is considered a non-GAAP financial measure. Management believes the dividend coverage ratio is a useful financial measure because the certificate of designation for the Series A preferred stock limits, among other matters, our ability to pay dividends on our common stock or make any payment of interest or principal on our line of credit with Wells Fargo Bank, National Association, if the dividend coverage ratio for the four prior fiscal quarters is less than 150%. The dividend coverage ratio is expressed as a percentage and calculated by dividing the four prior fiscal quarters' GAAP net income, excluding gains (or losses) from sales of property (consistent with the National Association of Real Estate Investment Trusts definition of “funds from operations”), by the amount that would be required to pay annual dividends on the Series A and Series B preferred stock.


(4)	The carrying value of purchased credit-impaired (PCI) loans contractually 90 days or more past due is excluded. These PCI loans are considered to be accruing because they continue to earn interest from accretable yield, independent of performance in accordance with their contractual terms.

This Quarterly Report, including the Financial Review and the Financial Statements and related Notes, contains forward-looking statements, which may include forecasts of our financial results and condition, expectations for our operations and business, and our assumptions for those forecasts and expectations. Do not unduly rely on forward-looking statements. Actual results may differ materially from our forecasts and expectations due to several factors. Factors that could cause our results to differ materially from our forward looking statements are described in this Report, including in the “Forward-Looking Statements” section, and the “Risk Factors” section in our Annual Report on Form 10-K for the year ended December 31, 2016 (2016 Form 10-K).

When we refer to “WFREIC,” the “Company,” “we,” “our,” and “us” in this Report, we mean Wells Fargo Real Estate Investment Corporation, and where relevant, Wells Fargo Bank, National Association, acting on our behalf; the “Bank” refers to Wells Fargo Bank, National Association; and “Wells Fargo” refers to Wells Fargo & Company.

Financial Review

OVERVIEW

The Company is engaged in acquiring, holding and managing domestic mortgage assets and other authorized investments that generate net income for distribution to our shareholders. We are classified as a real estate investment trust (REIT) for federal income tax purposes and are an indirect subsidiary of Wells Fargo and the Bank.

As of September 30, 2017, we had $32.7 billion in assets, consisting substantially of real estate loan participation interests (loans). Our interests in mortgage and other assets have been acquired from the Bank pursuant to loan participation and servicing and assignment agreements among the Bank, certain of its subsidiaries and us. The Bank originated the loans, purchased them from other financial institutions or acquired them as part of the acquisition of other financial institutions. Substantially all of our loans are serviced by the Bank.

REIT Tax Status

For the tax year ended December 31, 2016, we complied with the relevant provisions of the Internal Revenue Code of 1986, as amended (the Code) to be taxed as a REIT. These provisions for qualifying as a REIT for federal income tax purposes are complex, involving many requirements, including among others, distributing at least 90% of our REIT taxable income to shareholders and satisfying certain asset, income and stock ownership tests. To the extent we meet those provisions, we will not be subject to federal income tax on net income. We continue to monitor each of these complex tests. We believe that we continue to satisfy each of these requirements and therefore continue to qualify as a REIT.

In the event we do not continue to qualify as a REIT, earnings and cash provided by operating activities available for distribution to shareholders would be reduced by the amount of any applicable income tax obligation. Given the level of earning assets, we currently expect there would be sufficient earnings and ample cash to pay preferred dividends. The preferred and common dividends we pay as a REIT are ordinary investment income not eligible for the dividends-received deduction for corporate shareholders or for the favorable qualified dividend tax rate applicable to non-corporate taxpayers. If we were not a REIT, preferred and common dividends we pay generally would qualify for the dividends received deduction for corporate shareholders and the favorable qualified dividend tax rate applicable to non-corporate taxpayers.

Third Quarter 2016 Common Stock Issuance and Related Loan Acquisitions

On August 26, 2016, the Company issued and sold 21.2 million shares of common stock to affiliates of the Company for an

aggregate purchase price of $20.0 billion. Following the issuance, indirect wholly-owned subsidiaries of the Bank continue to own 100% of the Company’s common stock. Subsequent to the issuance, the Company used the proceeds along with existing funds to acquire $19.1 billion of real estate 1-4 family first mortgage loans and $1.9 billion of Commercial Secured by Real Estate (CSRE) loans in third quarter 2016 (Third Quarter 2016 Loan Acquisitions).

Financial Performance

We earned net income of $326.5 million in third quarter 2017, or $9.46 diluted earnings per common share, compared with $191.3 million in third quarter 2016, or $8.82 diluted earnings per common share. For the first nine months of 2017, net income was $903.7 million, or $26.15 diluted earnings per share, compared with $485.0 million, or $30.09 diluted earnings per share, for the same period a year ago. The increase in net income in the third quarter and first nine months of 2017 was attributable to increased interest income resulting from a larger average interest-earning asset base due to the Third Quarter 2016 Loan Acquisitions.

Loans

Total loans were $32.7 billion at September 30, 2017, compared with $31.3 billion at December 31, 2016. Net loans represented 99% of assets at September 30, 2017, and 96% at December 31, 2016.

Credit quality, as measured by net charge-offs, nonaccruals and delinquencies, remained strong during third quarter 2017 reflecting the benefit of continued improvement in the housing environment. Net charge-offs were $1.2 million and $5.3 million in the third quarter 2017 and first nine months of 2017, compared with net charge-offs of $3.2 million and $15.4 million for the third quarter and first nine months of 2016. Nonaccrual loans were $198.4 million at September 30, 2017, compared with $216.5 million at December 31, 2016. Loans 90 days or more past due and still accruing were $6.2 million at September 30, 2017, compared with $7.5 million at December 31, 2016. Delinquencies remain a small percentage of our loan balances.

Third quarter 2017 reversal of provision for credit losses was $11.5 million, compared with a provision for credit losses of $18.7 million a year ago. For the first nine months of 2017, provision for credit losses was $14.7 million, compared with $30.2 million a year ago. The lower level of provision in the third quarter and first nine months of 2017 compared with a year ago reflected continued portfolio improvement. Future

allowance levels will be based on a variety of factors, including loan portfolio composition, size and performance, and the general economic environment, including housing market conditions.

During third quarter 2017, Hurricanes Harvey and Irma caused considerable damage in several geographic markets where the Company has significant lending exposure. The impact was in both our consumer and commercial real estate loan portfolios. Based on our analysis to date of the level of insurance coverage, types of loans, location, and potential damage to collateral, we believe the ultimate collectability of these loans will be impacted. Our allowance for credit losses at September 30, 2017 included $10.0 million for coverage of our preliminary estimate of potential hurricane-related losses. We will continue to assess the impact to our customers and business as a result of the hurricanes and refine our estimates as more information becomes available. We are still evaluating the impact on our portfolios from the California wildfires that occurred in October 2017.

Capital Distributions

Dividends declared to holders of our Series A preferred stock totaled $4.3 million and $13.1 million in the third quarter and first nine months, respectively, of both 2017 and 2016. Dividends declared to holders of our Series B preferred stock totaled $15 thousand and $43 thousand in the third quarter and first nine months, respectively, of both 2017 and 2016.

Dividends declared to the holders of our common stock totaled $320.0 million and $895.0 million for the third quarter and first nine months of 2017, respectively, compared with $215.0 million and $495.0 million for the same periods in 2016. The increase in dividends declared to the holders of our common stock in the third quarter and first nine months of 2017 was attributable to increased REIT taxable income for federal income tax purposes before dividends paid deduction.

Earnings Performance

Net Income

We earned net income of $326.5 million and $191.3 million in third quarter 2017 and 2016, respectively. For the first nine months of 2017, net income was $903.7 million, compared with $485.0 million for the same period a year ago. The increase in net income in the third quarter and first nine months of 2017 was attributable to increased interest income resulting from a larger average interest-earning asset base due to the Third Quarter 2016 Loan Acquisitions.

Net Interest Income

Net interest income is the interest earned on loans and cash and cash equivalents less the interest paid on our Bank line of credit. Net interest income was $329.6 million in third quarter 2017, compared with $223.4 million a year ago and $959.8 million for the first nine months of 2017, compared with $552.3 million a year ago. The increase in net interest income in the third quarter and first nine months of 2017 was attributable to a larger average interest-earning asset base due to the Third Quarter 2016 Loan Acquisitions. Total average interest-earning assets were $33.2 billion and $33.1 billion in the third quarter and first nine months of 2017, respectively, compared with $24.7 billion and $17.0 billion for the same periods a year ago.

Net interest margin is the average yield on interest-earning assets minus the average interest paid for funding. Interest-earning assets predominantly consist of loans. Net interest margin was 3.96% in third quarter 2017, compared with 3.62% a year ago. The increase in net interest margin for third quarter 2017 was predominantly attributable to a higher concentration of loans within interest-earning assets. Net interest margin was 3.87% for the first nine months of 2017, compared with 4.34% for the same period a year ago. The decrease for the first nine months of 2017 was attributable to the investment of proceeds from the common stock issuance in third quarter 2016 and proceeds from subsequent loan paydowns and payoffs into lower yielding loans. Interest income in the third quarter and first nine months of 2017 included net accretion of adjustments on loans of $4.1 million and $10.4 million, respectively, compared with $4.7 million and $42.5 million a year ago. The decrease in net accretion of adjustments on loans in both periods was attributable to premium amortization from the real estate 1-4 family first mortgage loan acquisitions in 2016 partially offsetting net discount accretion in the third quarter and first nine months of 2017. Loan paydowns and payoffs annualized represented 13.3% and 13.4% of average loan balances during the third quarter and first nine months of 2017, respectively, compared with 25.1% and 24.3% during the same periods a year ago. The lower paydown and payoff rates in the third quarter and first nine months of 2017 were generally attributable to higher mortgage rates compared with a year ago.

The Company believes interest income will continue to be higher compared with a year ago due to the larger interest-earning asset base as a result of the Third Quarter 2016 Loan Acquisitions; however, interest income in any one period can be affected by a variety of factors, including mix and size of the earning asset portfolio. See the “Risk Management - Asset/Liability Management - Interest Rate Risk” section in this Report for more information on interest rates and interest income.

The Company has a line of credit with the Bank. Interest expense related to borrowings on the line of credit was $3.2 million and $3.4 million in the third quarter and first nine months of 2017, respectively, compared with $1.3 million and $2.0 million for the same periods a year ago. Average borrowings for third quarter 2017 and 2016 were $968.3 million and $952.8 million, respectively, at weighted average interest rates of 1.30% and 0.53%, respectively. Average borrowings for the first nine months of 2017 and 2016 were $352.0 million and $523.9 million, respectively, at weighted average interest rates of 1.30% and 0.52%, respectively. The increase in weighted average interest rates in the third quarter and first nine months of 2017 was attributable to an increase in the average federal funds rate. Effective October 2017, the rate of interest on the line of credit was changed from the average federal funds rate plus 12.5 basis points (0.125%) to the three-month London Interbank Offered Rate (LIBOR) plus 4.4 basis points (0.044%).

Table 1 presents the components of interest-earning assets and interest-bearing liabilities and related average yields to provide an analysis of year-over-year changes that influenced net interest income.

Table 1: Interest Income



	Quarter ended September 30,
					2017						2016
(in thousands)	Average balance		Interest income/expense		Yields/rates		Average balance		Interest income/expense		Yields/rates
Earning assets
Commercial loans	$	3,554,112	30,397		3.39	%	$	2,746,255	17,283		2.50	%
Real estate 1-4 family mortgage loans	29,689,061		302,349		4.07		17,901,825		203,343		4.54
Interest-bearing deposits and other interest-earning assets	474		2		1.17		4,017,299		4,064		0.40
Total interest-earning assets	$	33,243,647	332,748		4.00		$	24,665,379	224,690		3.64
Funding sources
Line of credit with Bank	$	968,313	3,173		1.30		$	952,778	1,272		0.53
Total interest-bearing liabilities	$	968,313	3,173		1.30		$	952,778	1,272		0.53
Net interest margin and net interest income			$	329,575	3.96	%			$	223,418	3.62	%
	Nine months ended September 30,
					2017						2016
(in thousands)	Average balance		Interest income/expense		Yields/rates		Average balance		Interest income/expense		Yields/rates
Earning assets
Commercial loans	$	3,717,154	85,726		3.08	%	$	2,699,636	50,893		2.52	%
Real estate 1-4 family mortgage loans	28,084,905		869,005		4.13		12,838,639		499,168		5.19
Interest-bearing deposits and other interest-earning assets	1,313,619		8,498		0.86		1,432,722		4,303		0.40
Total interest-earning assets	$	33,115,678	963,229		3.88		$	16,970,997	554,364		4.36
Funding sources
Line of credit with Bank	$	352,017	3,423		1.30		$	523,884	2,029		0.52
Total interest-bearing liabilities	$	352,017	3,423		1.30		$	523,884	2,029		0.52
Net interest margin and net interest income			$	959,806	3.87	%			$	552,335	4.34	%

Provision for Credit Losses

Third quarter 2017 reversal of provision for credit losses was $11.5 million, compared with a provision for credit losses of $18.7 million a year ago. For the first nine months of 2017, the provision for credit losses was $14.7 million, compared with $30.2 million a year ago. The lower level of provision in the third quarter and first nine months of 2017 compared with a year ago reflected continued portfolio improvement. See the “Balance Sheet Analysis” and "Risk Management-Allowance for Credit Losses” sections in this Report for additional information on the allowance for credit losses.

Noninterest Income

Noninterest income was $15.6 million and $44.3 million in the third quarter and first nine months of 2017, respectively, compared with $7.9 million and $15.9 million for the same periods a year ago. Noninterest income predominantly consists of loan pledge fees.

The certificate of designation for the Series A preferred stock limits our ability to pledge our loans to an aggregate amount not exceeding 80% of our total assets at any time as collateral on behalf of the Bank for the Bank’s access to secured borrowing facilities through the Federal Home Loan Banks or the discount window of Federal Reserve Banks. In exchange for the pledge of our loan assets, the Bank pays us a fee that is consistent with market terms. We earned $15.9 million and $44.3 million in pledge fees during the third quarter and first nine months of 2017, respectively, compared with $8.7 million

and $16.5 million for the same periods a year ago. The increase in both periods was attributable to higher average pledged loan balances as well as higher pledge fee rates.

See Note 5 (Transactions With Related Parties) to Financial Statements in this Report for more details.

Noninterest Expense

Noninterest expense was $30.2 million and $85.7 million in the third quarter and first nine months of 2017, respectively, compared with $21.3 million and $53.0 million for the same periods a year ago. Noninterest expense predominantly consists of loan servicing costs, management fees, and foreclosed assets expense.

The loans in our portfolio are predominantly serviced by the Bank pursuant to the terms of participation and servicing and assignment agreements. In limited instances, the Bank has delegated servicing responsibility to third parties that are not affiliated with us or the Bank. Depending on the loan type, the monthly servicing fee charges are based in part on (a) outstanding principal balances, (b) a flat fee per month, or (c) a total loan commitment amount. Loan servicing costs were $20.6 million and $58.6 million in the third quarter and first nine months of 2017, respectively, compared with $13.3 million and $30.9 million for the same periods a year ago. The increase in both periods was attributable to a higher average loan balance due to the Third Quarter 2016 Loan Acquisitions.

Management fees represent reimbursements made to the Bank for general overhead expenses, including allocations of

technology support and a combination of finance and accounting, risk management and other general overhead expenses incurred on our behalf. Management fees include direct and indirect expense allocations. Indirect expenses are allocated based on ratios that use our proportion of expense activity drivers. The expense activity drivers and ratios may change from time to time. Management fees were $6.4 million and $19.2 million in the third quarter and first nine months of 2017, respectively, compared with $4.4 million and $11.8 million for the same periods a year ago. The increase in both periods related to an increase in expense allocations based on our higher total average assets due to the common stock issuance in third quarter 2016.

Foreclosed assets expense was $2.7 million and $7.1 million in the third quarter and first nine months of 2017, respectively, compared with $3.2 million and $9.6 million for the same periods a year ago. The decrease in both periods was due to lower costs of maintaining our foreclosed assets, including property tax expense. Substantially all of our foreclosed assets consist of residential 1-4 family real estate assets.

See Note 5 (Transactions With Related Parties) to Financial Statements in this Report for more details.

Balance Sheet Analysis

Total Assets

Our assets predominantly consist of commercial and consumer loans, although we have the authority to hold assets other than loans. Total assets were $32.7 billion at September 30, 2017, and$32.4 billion at December 31, 2016.

Loans

Loans were $32.7 billion at September 30, 2017, and $31.3 billion at December 31, 2016. We did not acquire loans in third quarter 2017. In the first nine months of 2017 we acquired $4.7 billion of consumer loans from the Bank at their estimated fair value. In the third quarter and first nine months of 2016, we acquired $19.1 billion and $21.4 billion of consumer loans, respectively, and $1.9 billion of commercial loans for both periods, from the Bank at their estimated fair value using proceeds from the common stock issuance and loan pay-downs and payoffs. At September 30, 2017 and December 31, 2016, consumer loans represented 89% and 87% of loans, respectively, and commercial loans represented the remaining balance of our loan portfolio.

Allowance for Loan Losses

The allowance for loan losses increased $5.2 million to $129.1 million at September 30, 2017, from $123.9 million at December 31, 2016, largely due to the impact from Hurricanes Harvey and Irma, partially offset by portfolio improvement. The allowance for loan losses at September 30, 2017 included $10.0 million for coverage of our preliminary estimate of potential hurricane-related losses.

At September 30, 2017, the allowance for loan losses included $103.8 million for consumer loans and $25.3 million for commercial loans; however, the entire allowance is available to absorb credit losses inherent in the total loan portfolio. The total allowance reflects management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date. See the “Risk Management — Credit Risk Management — Allowance for Credit Losses” section in this Report for a description of how management estimates the allowance for loan losses and the allowance for unfunded credit commitments.

Accounts Receivable—Affiliates, Net

Accounts payable and receivable from affiliates result from intercompany transactions in the normal course of business related to loan paydowns and payoffs, interest receipts, servicing costs, management fees and other transactions with the Bank or its affiliates.

Line of Credit with Bank

We draw upon our line of credit with the Bank to finance loan acquisitions. Effective October 2017, our line of credit was increased from $2.2 billion to $5.0 billion. At September 30, 2017, we had $341.1 million outstanding. There was no outstanding balance at December 31, 2016.

Retained Earnings (Deficit)

We expect to distribute annually an aggregate amount of dividends with respect to outstanding capital stock equal to approximately 100% of our REIT taxable income for federal income tax purposes before dividends paid deduction. Because our net income determined under GAAP may vary from the determination of REIT taxable income, due to recognition differences for items such as loan losses and purchase accounting adjustments, periodic distributions may exceed our GAAP net income.

The retained deficit included within our balance sheet results from cumulative distributions that have exceeded GAAP net income, predominantly due to the impact on REIT taxable income of purchase accounting adjustments attributable to the Company during the years 2009 through 2013, from the 2008 acquisition of Wachovia Corporation by Wells Fargo.

For further information on the differences between taxable income before dividends paid deduction reported on our income tax returns and net income as reported in our statement of income, see the "Balance Sheet Analysis" section in our 2016 Form 10-K.

Risk Management

Our board of directors has overall responsibility for overseeing the Company’s risk management structure. This oversight is accomplished through the audit committee of the board of directors and a management-level committee that reviews the allowance for credit losses and is supplemented by certain elements of Wells Fargo’s risk management framework. For more information about how we manage these risks, see the “Risk Management” section in our 2016 Form 10-K. The discussion that follows provides an update regarding these risks.

Credit Risk Management Our assets consist predominantly of loans, and their related credit risk is among the most significant risks we manage. We define credit risk as the risk to earnings associated with a borrower or counterparty default (failure to meet obligations in accordance with agreed upon terms).

Table 2 represents loans by segment and class of financing receivable and the weighted average maturity for those loans calculated using contractual maturity dates.

Table 2: Total Loans Outstanding by Portfolio Segment and Class of Financing Receivable and Weighted Average Contractual Maturity



	Loans outstanding			Weighted average maturity in years
(in thousands)	Sep 30, 2017		Dec 31, 2016	Sep 30, 2017	Dec 31, 2016
Total commercial	$	3,514,051	3,984,881	3.3	3.4
Consumer:
Real estate 1-4 family first mortgage	28,275,795		26,236,047	25.0	25.2
Real estate 1-4 family junior lien mortgage	907,219		1,089,065	15.5	15.8
Total consumer	29,183,014		27,325,112	24.7	24.8
Total loans	$	32,697,065	31,309,993	22.4	22.1

The discussion that follows provides analysis of the risk elements of our various loan portfolios and our credit risk management and measurement practices. See Note 2 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for more analysis and credit metric information.

In order to maintain our REIT status, the composition of our loan portfolio is highly concentrated in real estate.

We continually evaluate our credit policies and modify as necessary. Measuring and monitoring our credit risk is an ongoing process that tracks delinquencies, collateral values, FICO scores, economic trends by geographic areas, loan-level risk grading for certain portfolios (typically commercial) and other indications of credit risk. Our credit risk monitoring process is designed to enable early identification of developing risk and to support our determination of an appropriate allowance for credit losses.

LOAN PORTFOLIO BY GEOGRAPHY Table 3 is a summary of the geographical distribution of our loan portfolio for the top five states by loans outstanding.

Table 3: Loan Portfolio by Geography



	September 30, 2017
(in thousands)	Commercial		Real estate 1-4 family first mortgage	Real estate 1-4 family junior lien mortgage	Total	% of total loans
California	$	1,556,080	8,108,175	10,408	9,674,663	30	%
New York	14,764		3,077,956	55,101	3,147,821	10
Washington	183,214		1,674,768	1,159	1,859,141	6
Virginia	70,545		1,484,887	92,924	1,648,356	5
Florida	316,295		976,437	119,421	1,412,153	4
Other	1,373,153		12,953,572	628,206	14,954,931	45
Total loans	$	3,514,051	28,275,795	907,219	32,697,065	100	%

COMMERCIAL AND INDUSTRIAL LOANS (C&I) C&I loans were less than 1% of total loans at September 30, 2017. We believe the C&I loan portfolio was appropriately underwritten. Our credit risk management process for this portfolio focuses on a

customer's ability to repay the loan through their cash flows. All of the loans in our C&I portfolio were unsecured at Se

ptember 30, 2017.

COMMERCIAL SECURED BY REAL ESTATE (CSRE) The CSRE portfolio consists of both mortgage loans and construction loans, where loans are secured by real estate. Table 4 summarizes CSRE loans by state and property type. To identify and manage newly emerging problem CSRE loans, we employ a high level of monitoring and regular customer interaction to understand and manage the risks associated with these loans,

including regular loan reviews and appraisal updates. We consider the creditworthiness of the customers and collateral valuations when selecting CSRE loans for acquisition. In future periods, we expect to consider acquisitions of CSRE loans in addition to other REIT qualifying assets such as real estate 1-4 family mortgage loans.

Table 4: CSRE Loans by State and Property Type



	September 30, 2017
(in thousands)	Total CSRE loans		% of total CSRE loans
By state:
California	$	1,556,080	44	%
Florida	315,865		9
Utah	204,798		6
Washington	183,214		5
Oregon	166,466		5
Other	1,082,282		31
Total loans	$	3,508,705	100	%
By property type:
Office buildings	$	909,121	26	%
Shopping centers	607,457		17
5+ multifamily residences	545,635		16
Warehouses	518,164		15
Retail establishments (restaurants, stores)	419,557		12
Mini-storage	146,172		4
Motels/hotels	116,579		3
Commercial/industrial (non-residential)	87,450		2
Manufacturing plants	76,190		2
Research and development	53,176		2
Other	29,204		1
Total loans	$	3,508,705	100	%

REAL ESTATE 1-4 FAMILY MORTGAGE LOANS The concentrations of real estate 1-4 family mortgage loans by state and the related loan-to-value (LTV) ratio for real estate 1-4 family first mortgage and combined loan-to-value (CLTV) ratio for real estate 1-4 family junior lien mortgage loans are presented in combination in Table 5. CLTV means the ratio of the total loan balance of first and junior mortgages to property collateral value. We monitor changes in real estate values and underlying economic or market conditions for all geographic areas of our real estate 1-4 family mortgage portfolio as part of our credit risk management process. Our underwriting and periodic review of loans secured by residential real estate collateral includes appraisals or estimates from automated valuation models (AVMs) to support property values. Additional information about AVMs and our policy for their use can be

found in Note 2 (Loans and Allowance for Credit Losses) to Financial Statements in this Report and the "Risk Management - Credit Risk Management - Real Estate 1-4 Family Mortgage Loans" section in our 2016 Form 10-K.

We continue to modify real estate 1-4 family mortgage loans to assist homeowners and other borrowers experiencing financial difficulties. For more information on our modification programs, see the "Risk Management - Credit Risk Management - Real Estate 1-4 Family Mortgage Loans" section in our 2016 Form 10-K.

The credit performance associated with our real estate 1-4 family mortgage portfolio remained strong in third quarter 2017, as measured through net charge-offs and nonaccrual loans.

Table 5: Real Estate 1-4 Family Mortgage Loans LTV/CLTV by State



	September 30, 2017
(in thousands)	Real estate 1-4 family mortgage		Current LTV\CLTV ratio (1)
California	$	8,118,583	50	%
New York	3,133,057		61
Washington	1,675,927		54
Virginia	1,577,811		63
Pennsylvania	1,134,973		63
Other	13,542,663		61
Total loans	$	29,183,014	58


(1)	Collateral values are generally determined using AVMs and are updated quarterly. AVMs are computer-based tools used to estimate market values of homes based on processing large volumes of market data including market comparables and price trends for local market areas.

REAL ESTATE 1-4 FAMILY FIRST MORTGAGE LOANS Net charge-offs (annualized) as a percentage of average loans improved to less than 0.01% and 0.01% in the third quarter and first nine months of 2017, respectively, compared with 0.06% and 0.11%, for the same periods a year ago. Nonaccrual loans

were $152.9 million at September 30, 2017, compared with $165.1 million at December 31, 2016.

Table 6 summarizes delinquency and loss rates by state for our real estate 1-4 family first mortgage portfolio.

Table 6: Real Estate 1-4 Family First Mortgage Portfolio Performance



	Outstanding balance			% of loans 30 days or more past due			Loss (recovery) rate (annualized) quarter ended
(in thousands)	Sep 30, 2017		Dec 31, 2016	Sep 30, 2017		Dec 31, 2016	Sep 30, 2017		Jun 30, 2017		Mar 31, 2017	Dec 31, 2016	Sep 30, 2016
California	$	8,108,023	9,012,878	0.08	%	0.06	—		—		—	—	—
New York	3,077,251		2,293,854	0.54		0.68	0.01		0.01		0.07	—	0.02
Washington	1,674,767		1,562,147	—		0.09	(0.01	)	(0.01	)	0.01	—	—
Virginia	1,483,414		1,411,434	0.58		0.76	0.02		(0.01	)	0.04	0.05	0.10
Texas	1,105,631		1,135,109	0.47		0.37	0.01		(0.02	)	—	0.01	0.01
Other	12,816,715		10,808,197	0.96		1.25	—		0.01		0.07	0.06	0.13
Total	28,265,801		26,223,619	0.57		0.66	—		—		0.04	0.03	0.06
PCI	9,994		12,428
Total first mortgages	$	28,275,795	26,236,047

REAL ESTATE 1-4 FAMILY JUNIOR LIEN MORTGAGE LOANS Our junior lien portfolio includes real estate 1-4 family junior lien mortgage loans secured by real estate. Predominantly all of our junior lien loans are amortizing payment loans with fixed interest rates and repayment periods between 5 to 30 years. Junior lien loans with balloon payments at the end of the repayment term represent less than 1% of our junior lien loans. We frequently monitor the credit performance of our junior lien mortgage portfolio for trends and factors that influence the frequency and severity of loss. Net charge-offs (annualized) as a

percentage of average loans increased to 0.40% in the third quarter 2017 compared with 0.27% for the same period a year ago, and improved to 0.33% in the first nine months of 2017, compared to 0.64% for the same period a year ago. Nonaccrual loans were $42.2 million at September 30, 2017, compared with $48.8 million at December 31, 2016.

Table 7 summarizes delinquency and loss rates by state for our junior lien portfolio.

Table 7: Real Estate 1-4 Family Junior Lien Portfolio Performance



	Outstanding balance			% of loans 30 days or more past due			Loss (recovery) rate (annualized) quarter ended
(in thousands)	Sep 30, 2017		Dec 31, 2016	Sep 30, 2017		Dec 31, 2016	Sep 30, 2017		Jun 30, 2017		Mar 31, 2017		Dec 31, 2016		Sep 30, 2016
New Jersey	$	193,847	227,384	5.26	%	4.82	1.06		0.58		2.20		1.84		0.66
Pennsylvania	141,862		168,829	4.88		4.21	0.86		0.02		1.27		2.85		0.66
Florida	119,421		143,541	4.23		3.40	(0.56	)	(1.59	)	0.53		(0.07	)	(0.55	)
Virginia	92,924		110,712	4.00		3.42	1.26		(0.10	)	0.22		1.21		0.33
Georgia	64,279		80,038	2.44		2.66	(1.96	)	0.47		(0.16	)	(1.41	)	(0.08	)
Other	294,886		357,629	4.29		4.60	0.38		(0.36	)	0.07		1.09		0.25
Total	907,219		1,088,133	4.42		4.17	0.40		(0.18	)	0.76		1.19		0.27
PCI	—		932
Total junior lien mortgages	$	907,219	1,089,065

NONPERFORMING ASSETS (NONACCRUAL LOANS AND FORECLOSED ASSETS) Table 8 summarizes nonperforming assets (NPAs) for each of the last five quarters. We generally place loans on nonaccrual status when:


•	the full and timely collection of interest or principal becomes uncertain (generally based on an assessment of the borrower's financial condition and the adequacy of collateral, if any);


•	they are 90 days (120 days with respect to real estate 1-4 family first and junior lien mortgages) past due for interest

or principal, unless both well-secured and in the process of collection;


•	part of the principal balance has been charged off;


•	for junior lien mortgages, we have evidence that the related first lien mortgage may be 120 days past due or in the process of foreclosure regardless of the junior lien delinquency status; or


•	consumer real estate loans receive notification of bankruptcy, regardless of their delinquency status.

Table 8: Nonperforming Assets (Nonaccrual Loans and Foreclosed Assets)



(in thousands)	Sep 30, 2017			Jun 30, 2017	Mar 31, 2017	Dec 31, 2016	Sep 30, 2016
Nonaccrual loans:
Total commercial	$	3,325		3,144	3,473	2,600	2,378
Consumer:
Real estate 1-4 family first mortgage	152,861			157,092	159,444	165,117	175,086
Real estate 1-4 family junior lien mortgage	42,237			43,378	46,065	48,806	50,812
Total consumer	195,098			200,470	205,509	213,923	225,898
Total nonaccrual loans (1)	198,423			203,614	208,982	216,523	228,276
Foreclosed assets	2,473			1,714	2,903	2,505	3,384
Total nonperforming assets	$	200,896		205,328	211,885	219,028	231,660
As a percentage of total loans	0.61		%	0.61	0.70	0.70	0.69


(1)	Excludes PCI loans because they continue to earn interest income from accretable yield, independent of performance in accordance with their contractual terms.

Total NPAs were $200.9 million (0.61% of total loans) at September 30, 2017, and included $198.4 million of nonaccrual loans. Total NPAs were $219.0 million (0.70% of total loans) at December 31, 2016, and included $216.5 million of nonaccrual loans.

Typically, changes to nonaccrual loans period-over-period represent inflows for loans that are placed on nonaccrual status

in accordance with our policy, offset by reductions for loans that are paid down, charged off while on nonaccrual status, or sold, transferred to foreclosed properties, or are no longer classified as nonaccrual as a result of continued performance and an improvement in the borrower’s financial condition and loan repayment capabilities. Table 9 provides an analysis of the changes in nonaccrual loans.

Table 9: Analysis of Changes in Nonaccrual Loans



	Quarter ended
(in thousands)	Sep 30, 2017			Jun 30, 2017		Mar 31, 2017		Dec 31, 2016		Sep 30, 2016
Commercial:
Balance, beginning of period	$	3,144		3,473		2,600		2,378		2,783
Inflows	214			—		978		328		2,128
Outflows	(33		)	(329	)	(105	)	(106	)	(2,533	)
Balance, end of period	3,325			3,144		3,473		2,600		2,378
Consumer:
Balance, beginning of period	200,470			205,509		213,923		225,898		238,688
Inflows	31,201			31,587		33,360		30,146		31,770
Outflows:
Returned to accruing	(17,063		)	(15,350	)	(20,152	)	(16,256	)	(18,158	)
Foreclosures	(2,286		)	(3,104	)	(3,018	)	(1,826	)	(3,762	)
Charge-offs	(3,508		)	(4,366	)	(7,424	)	(8,511	)	(5,670	)
Payment, sales and other	(13,716		)	(13,806	)	(11,180	)	(15,528	)	(16,970	)
Total outflows	(36,573		)	(36,626	)	(41,774	)	(42,121	)	(44,560	)
Balance, end of period	195,098			200,470		205,509		213,923		225,898
Total nonaccrual loans	$	198,423		203,614		208,982		216,523		228,276

TROUBLED DEBT RESTRUCTURINGS (TDRs) The recorded investment of loans modified in TDRs is provided in Table 10. The allowance for loan losses for TDRs was $58.1 million and $74.6 million at September 30, 2017 and December 31, 2016, respectively. See Note 2 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for more information. Those loans discharged in bankruptcy and reported as TDRs have been written down to net realizable collateral value. In those situations where principal is forgiven, the entire amount of such principal forgiveness is immediately charged off to the extent not done so prior to the modification. When we delay the timing on the repayment of a portion of principal (principal forbearance), we charge off the amount of forbearance if that amount is not considered fully collectible.

For more information on our nonaccrual policies when a restructuring is involved, see the "Risk Management - Credit Risk Management - Troubled Debt Restructurings (TDRs) section of our 2016 Form 10-K.

Table 11 provides an analysis of the changes in TDRs. Loans modified more than once are reported as TDR inflows only in the period they are first modified. Other than resolutions such as foreclosures, we may remove loans from TDR classification, but only if they have been refinanced or restructured at market terms and qualify as a new loan.

Table 10: Troubled Debt Restructurings (TDRs)



(in thousands)	Sep 30, 2017		Jun 30, 2017	Mar 31, 2017	Dec 31, 2016	Sep 30, 2016
Total commercial TDRs	$	3,035	3,078	3,147	3,236	3,285
Consumer:
Real estate 1-4 family first mortgage	316,831		326,413	335,037	340,895	350,324
Real estate 1-4 family junior lien mortgage	91,534		92,812	96,260	98,380	102,423
Trial modifications	8,799		10,165	9,759	11,795	12,876
Total consumer TDRs	417,164		429,390	441,056	451,070	465,623
Total TDRs	$	420,199	432,468	444,203	454,306	468,908
TDRs on nonaccrual status	$	119,122	124,444	128,807	136,883	144,723
TDRs on accrual status	301,077		308,024	315,396	317,423	324,185
Total TDRs	$	420,199	432,468	444,203	454,306	468,908

Table 11: Analysis of Changes in TDRs



	Quarter ended
(in thousands)	Sep 30, 2017			Jun 30, 2017		Mar 31, 2017		Dec 31, 2016		Sep 30, 2016
Commercial:
Balance, beginning of period	$	3,078		3,147		3,236		3,285		3,443
Inflows (1)	—			—		—		—		2,106
Outflows (2)	(43		)	(69	)	(89	)	(49	)	(2,264	)
Balance, end of period	3,035			3,078		3,147		3,236		3,285
Consumer:
Balance, beginning of period	429,390			441,056		451,070		465,623		477,834
Inflows (1)	5,539			6,560		9,706		6,858		8,429
Outflows:
Charge-offs	(995		)	(1,653	)	(1,162	)	(2,133	)	(2,301	)
Foreclosures	(657		)	(376	)	(1,067	)	274		(658	)
Payments, sales and other (2)	(14,747		)	(16,603	)	(15,455	)	(18,471	)	(18,340	)
Net change in trial modifications (3)	(1,366		)	406		(2,036	)	(1,081	)	659
Balance, end of period	417,164			429,390		441,056		451,070		465,623
Total TDRs	$	420,199		432,468		444,203		454,306		468,908


(1)	Inflows include loans that modify, even if they resolve, within the period as well as advances on loans that modified in a prior period.


(2)	Other outflows include normal amortization/accretion of loan basis adjustments. No loans were removed from TDR classification in the quarters ended September 30, June 30 and March 31, 2017, and December 31 and September 30, 2016, as a result of being refinanced or restructured at market terms and qualifying as new loans.


(3)	Net change in trial modifications includes: inflows of new TDRs entering the trial payment period, net of outflows for modifications that either (i) successfully perform and enter into a permanent modification, or (ii) did not successfully perform according to the terms of the trial period plan and are subsequently charged-off, foreclosed upon or otherwise resolved.

Loans 90 days or more past due and still accruing were less than one percent of loans at both September 30, 2017 and December 31, 2016.

Table 12 reflects non-PCI loans 90 days or more past due and still accruing.

Table 12: Loans 90 Days or More Past Due and Still Accruing (1)



(in thousands)	Sep 30, 2017		Jun 30, 2017	Mar 31, 2017	Dec 31, 2016	Sep 30, 2016
Total commercial	$	991	—	—	—	—
Consumer:
Real estate 1-4 family first mortgage	3,685		4,495	9,051	4,962	3,633
Real estate 1-4 family junior lien mortgage	1,498		1,746	875	2,545	2,469
Total consumer	5,183		6,241	9,926	7,507	6,102
Total	$	6,174	6,241	9,926	7,507	6,102

(1)

PCI loans of $853 thousand, $1.0 million, $1.2 million, $2.3 million and $2.3 million at September 30, June 30 and March 31, 2017 and December 31 and September 30, 2016, respectively, are excluded from this disclosure even though they are 90 days or more contractually past due. These PCI loans are considered to be accruing because they continue to earn interest from accretable yield, independent of performance in accordance with their contractual terms.

NET CHARGE-OFFS Table 13 presents net charge-offs for third quarter 2017 and the previous four quarters. Substantially all net charge-offs (recoveries) were in consumer real estate. Net charge-offs in third quarter 2017 were $1.2 million, or 0.01% (annua

lized) of average total loans outstanding, compared with $3.2 million, or 0.06% of average total loans outstanding in third

quarter 2016.

Table 13: Net Charge-offs (Recoveries)



						Quarter ended
	Sep 30, 2017					Jun 30, 2017					Mar 31, 2017					Dec 31, 2016				Sep 30, 2016
($ in thousands)	Net loan charge- offs			% of avg. loans (1)		Net loan charge- offs			% of avg. loans (1)		Net loan charge- offs			% of avg. loans (1)		Net loan charge- offs		% of avg. loans (1)		Net loan charge- offs			% of avg. loans (1)
Total commercial	$	(59	)	(0.01	)%	$	(12	)	—	%	$	(6	)	—	%	$	20	—	%	$	(48	)	(0.01	)%
Consumer:
Real estate 1-4 family first mortgage	276			—		190			—		2,457			0.04		1,767		0.03		2,426			0.06
Real estate 1-4 family junior lien mortgage	939			0.40		(440		)	(0.18	)	1,986			0.76		3,373		1.19		825			0.27
Total consumer	1,215			0.02		(250		)	—		4,443			0.07		5,140		0.07		3,251			0.07
Total	$	1,156		0.01	%	$	(262	)	—	%	$	4,437		0.06	%	$	5,160	0.06	%	$	3,203		0.06	%


(1)	Quarterly net charge-offs (net recoveries) as a percentage of average loans are annualized.

ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses, which consists of the allowance for loan losses and the allowance for unfunded credit commitments, is management’s estimate of credit losses inherent in the loan portfolio and unfunded credit commitments at the balance sheet date, excluding loans carried at fair value. The detail of the changes in the allowance for credit losses by portfolio segment (including charge-offs and recoveries by loan class) is in Note 2 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.

We apply a disciplined process and methodology to establish our allowance for credit losses each quarter. This process takes into consideration many factors, including historical and forecasted loss trends, loan-level credit quality ratings and loan grade-specific characteristics. The process involves subjective and complex judgments. In addition, we review a variety of credit metrics and trends. These credit metrics and trends, however, do not solely determine the amount of the allowance as we use several analytical tools. Our

estimation approach for the commercial portfolio reflects the estimated probability of default in accordance with the borrower's financial strength, and the severity of loss in the event of default, considering the quality of any underlying collateral. Probability of default and severity at the time of default are statistically derived through historical observations of defaults and losses after default within each credit risk rating. Our estimation approach for the consumer portfolio uses forecasted losses that represent our best estimate of inherent loss based on historical experience, quantitative and other mathematical techniques.

The ratio of the allowance for credit losses to total nonaccrual loans may fluctuate significantly from period to period due to such factors as the mix of loan types in the portfolio, borrower credit strength and the value and marketability of collateral. Substantially all of our nonaccrual loans were real estate 1-4 family first and junior lien mortgage loans at September 30, 2017.

The allowance for loan losses increased $5.2 million to $129.1 million at September 30, 2017, from $123.9 million at

December 31, 2016, largely due to the impact from Hurricanes Harvey and Irma, partially offset by portfolio improvement. Our allowance for credit losses at September 30, 2017 also included $10.0 million for coverage of our preliminary estimate of potential hurricane-related losses.

We believe the allowance for credit losses of $130.4 million at September 30, 2017, was appropriate to cover credit losses inherent in the loan portfolio, including unfunded credit commitments, at that date. The allowance for credit losses is subject to change and reflects existing factors as of the date of determination, including economic or market conditions and ongoing internal and external examination processes. Due to the sensitivity of the allowance for credit losses to changes in the

economic and business environment, it is possible that we will incur incremental credit losses not anticipated as of the balance sheet date. Future allowance levels will be based on a variety of factors, including loan growth, portfolio performance and general economic conditions. Our process for determining the allowance for credit losses is discussed in the “Critical Accounting Policy” section and Note 1 (Summary of Significant Accounting Policies) to Financial Statements in this Report and in our 2016 Form 10-K.

Table 14 presents an analysis of the allowance for credit losses.

Table 14: Allocation of the Allowance for Credit Losses (ACL)



	Quarter ended
	Sep 30, 2017				Jun 30, 2017				Mar 31, 2017				Dec 31, 2016				Sep 30, 2016
(in thousands)	ACL		Loans as % of total loans		ACL		Loans as % of total loans		ACL		Loans as % of total loans		ACL		Loans as % of total loans		ACL		Loans as % of total loans
Total commercial	$	26,577	11	%	$	27,375	11	%	$	28,192	13	%	$	29,644	13	%	$	27,250	13	%
Consumer:
Real estate 1-4 family first mortgage	72,941		86		78,130		86		59,906		84		61,371		84		65,003		84
Real estate 1-4 family junior lien mortgage	30,905		3		38,942		3		39,236		3		34,014		3		39,713		3
Total consumer	103,846		89		117,072		89		99,142		87		95,385		87		104,716		87
Total	$	130,423	100	%	$	144,447	100	%	$	127,334	100	%	$	125,029	100	%	$	131,966	100	%




	Quarter ended
(in thousands)	Sep 30, 2017			Jun 30, 2017	Mar 31, 2017	Dec 31, 2016	Sep 30, 2016
Components:
Allowance for loan losses	$	129,116		143,389	126,301	123,877	130,715
Allowance for unfunded credit commitments	1,307			1,058	1,033	1,152	1,251
Allowance for credit losses	$	130,423		144,447	127,334	125,029	131,966
Allowance for loan losses as a percentage of total loans	0.39		%	0.42	0.42	0.40	0.39
Allowance for loan losses as a percentage of annualized net charge-offs	2,816.06			NM	701.91	603.47	1,025.78
Allowance for credit losses as a percentage of total loans	0.40			0.43	0.42	0.40	0.39
Allowance for credit losses as a percentage of total nonaccrual loans	65.73			70.94	60.93	57.74	57.81

NM – Not meaningful

Asset/Liability Management

Asset/liability management involves the evaluation, monitoring and management of interest rate risk, market risk and liquidity and funding.

INTEREST RATE RISK Interest rate risk is the sensitivity of earnings to changes in interest rates. At September 30, 2017, 15% of our loans had variable interest rates. In a declining rate environment, we may experience a reduction in interest income on our loan portfolio and a corresponding decrease in funds available to be distributed to our shareholders. The reduction in interest income may result from downward adjustment of the indices upon which the interest rates on loans are based and from prepayments of loans with fixed interest rates, resulting in reinvestment of the proceeds in lower yielding assets. To manage interest rate risk, we monitor loan paydown rates, portfolio composition, and the rate sensitivity of loans acquired. Our loan acquisition process attempts to balance desirable yields with the quality of loans acquired.

At September 30, 2017, approximately 85% of our loans had fixed interest rates. Such loans increase our interest rate risk. Our methods for evaluating interest rate risk include an analysis of interest-rate sensitivity “gap,” which is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest rate-sensitive assets exceeds the amount of interest rate-sensitive liabilities. A gap is considered negative when the amount of interest rate-sensitive liabilities exceeds the amount of interest rate-sensitive assets. Our interest rate-sensitive liabilities are generally limited to our line of credit with the Bank.

During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to adversely affect net interest income. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if an institution is perfectly matched in each maturity category.

At September 30, 2017, 15% of our assets had variable interest rates, and could be expected to reprice with changes in interest rates. At September 30, 2017, our liabilities were 1% of our assets. This positive gap between our assets and liabilities indicates that an increase in interest rates would result in an increase in net interest income and a decrease in interest rates would result in a decrease in net interest income.

LIQUIDITY AND FUNDING The objective of effective liquidity management is to ensure that we can meet customer loan requests and other cash commitments efficiently under both normal operating conditions and under unpredictable circumstances of industry or market stress. To achieve this objective, Wells Fargo’s Corporate Asset/Liability Management Committee establishes and monitors liquidity guidelines that require sufficient asset-based liquidity to cover potential funding requirements and to avoid over-dependence on volatile, less reliable funding markets.

Proceeds received from paydowns of loans are typically sufficient to fund existing lending commitments. Depending upon the timing of the loan acquisitions, we may draw on our revolving line of credit we have with the Bank as a short-term liquidity source. At September 30, 2017, there was $341.1 million outstanding balance on our Bank line of credit. Effective October 2017, the borrowing capacity was increased from $2.2 billion to $5.0 billion and the rate of interest was changed from the average federal funds rate plus 12.5 basis points (0.125%) to three-month LIBOR plus 4.4 basis points (0.044%).

Our primary liquidity needs are to pay operating expenses, fund our lending commitments, acquire loans to replace existing loans that mature or repay, and pay dividends. The retained deficit included within our balance sheet results from cumulative distributions that have exceeded GAAP net income, predominantly due to the impact on REIT taxable income of purchase accounting adjustments attributable to the Company during the years 2009 through 2013, from the 2008 acquisition of Wachovia Corporation by Wells Fargo. The excess dividend distributions were funded by using cash provided by investing (generally principal payments received on our loans) and financing activities (generally draws on our Bank line of credit). As the remaining purchase accounting adjustments are not expected to cause a significant variance between GAAP net income and REIT taxable income in future years, operating expenses and dividends are expected to be funded through cash generated by operations or paid-in capital. Funding commitments and the acquisition of loans are intended to be funded with the proceeds obtained from repayment of principal balances by individual borrowers and our line of credit with the Bank.

If in future periods we do not reinvest loan paydowns at sufficient levels, management may request our board of directors to consider a return of capital to the holders of our common stock. Annually, we expect to distribute an aggregate amount of outstanding capital stock dividends equal to approximately 100% of our REIT taxable income for federal tax purposes. Such distributions may exceed net income determined under GAAP.

To the extent that we determine that additional funding is necessary or advisable, we could issue additional common or preferred stock, subject to Board of Directors approval, raise funds through debt financings, or a combination of these methods. Retention of operating cash flows does not represent a significant source of funding because any cash flow retention must be consistent with the provisions of the Investment Company Act and the Code, which requires the distribution by a REIT of at least 90% of its REIT taxable income, excluding capital gains, and must take into account taxes that would be imposed on undistributed income.

The certificate of designation for the Series A preferred stock contains a covenant in which we agree not to incur indebtedness for borrowed money, including any guarantees of indebtedness (which does not include any pledges of our assets on behalf of the Bank or our other affiliates), without the consent of the holders of two-thirds of the Series A preferred stock, voting as a separate class, provided that, we may incur indebtedness in an aggregate amount not exceeding 20% of our stockholders’ equity.

Critical Accounting Policy

Our significant accounting policies (see Note 1 (Summary of Significant Accounting Policies) to Financial Statements in our 2016 Form 10-K) are fundamental to understanding our results of operations and financial condition because they require that we use estimates and assumptions that may affect the value of our assets or liabilities and financial results. We have identified the accounting policy covering allowance for credit losses as critical because it requires management to make difficult,

subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions.

Management and the audit committee of the board of directors have reviewed and approved this critical accounting policy. This policy is described in the "Critical Accounting Policy" section in our 2016 Form 10-K.

Current Accounting Developments

Table 15 provides accounting pronouncements applicable to us that have been issued by the FASB but are not yet effective.

Table 15: Current Accounting Developments - Issued Standards



Standard	Description	Effective date and financial statement impact
Accounting Standards Update (ASU or Update) 2016-15 – Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments	The Update addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice for reporting in the Statement of Cash Flows.	The Update is effective for us in first quarter 2018 with retrospective application. Subject to completion of our assessment, we are not expecting this Update to have a material impact on our financial statements.
ASU 2016-13 – Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments	The Update changes the accounting for credit losses on loans by requiring a current expected credit loss (CECL) approach to determine the allowance for credit losses. CECL requires loss estimates for the remaining estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts. Also, the Update eliminates the existing guidance for purchased credit-impaired (PCI) loans, but requires an allowance for purchased financial assets with more than insignificant deterioration since origination.	The guidance is effective in first quarter 2020 with a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. While early adoption is permitted beginning in first quarter 2019, we do not expect to elect that option. We are evaluating the impact of the Update on our financial statements. We expect the Update will result in an increase in the allowance for credit losses given the change to estimated losses over the contractual life adjusted for expected prepayments with an expected material impact from longer duration portfolios. The amount of the increase will be impacted by the portfolio composition and quality at the adoption date as well as economic conditions and forecasts at that time.
ASU 2016-01 - Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities	The Update amends the presentation and accounting for certain financial instruments. The guidance also updates fair value presentation and disclosure requirements for financial instruments measured at amortized cost.	We will adopt the guidance in first quarter 2018. For purposes of disclosing the fair value of loans carried at amortized cost, we are evaluating our valuation methods to determine the necessary changes to present fair value disclosures based on “exit price” as required by the Update. Accordingly, the fair value amounts disclosed for such loans may change upon adoption.
ASU 2014-09 – Revenue from Contracts With Customers (Topic 606) and subsequent related Updates	The Update modifies the guidance used to recognize revenue from contracts with customers for transfers of goods or services and transfers of nonfinancial assets, unless those contracts are within the scope of other guidance. The Update also requires new qualitative and quantitative disclosures, including disaggregation of revenues and descriptions of performance obligations.	We will adopt the guidance in first quarter 2018 using the modified retrospective method with a cumulative-effect adjustment to opening retained earnings. Our revenue is predominantly net interest income on financial assets. The scope of the guidance explicitly excludes net interest income. Accordingly, the majority of our revenues will not be affected. We do not expect material changes to our financial statements.

Forward-Looking Statements

This Report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as “anticipates,” “intends,” “plans,” “seeks,” “believes,” “estimates,” “expects,” “target”, “projects,” “outlook,” “forecast,” “will,” “may,” “could,” “should,” “can” and similar references to future periods. Examples of forward-looking statements include, but are not limited to, statements we make about: future results of WFREIC; expectations for consumer and commercial credit performance and the appropriateness of our allowance for credit losses; our expectations regarding net interest income; expectations regarding loan acquisitions and paydowns; future capital expenditures; future dividends and other capital distributions; the expected outcome and impact of legal, regulatory and legislative developments, as well as our expectations regarding compliance therewith; the outcome of contingencies, such as legal proceedings; and our plans, objectives and strategies.

Forward-looking statements are not based on historical facts but instead represent our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. Our actual results may differ materially from those contemplated by the forward-looking statements. We caution, therefore, against relying on any of these forward-looking statements. They are neither statements of historical fact nor guarantees or assurances of future performance. While there is no assurance that any list of risks and uncertainties or risk factors is complete, important factors that could cause actual results to differ materially from those in the forward-looking statements include the following, without limitation:


•	economic conditions that affect the general economy, housing prices, the job market, consumer confidence and spending habits, including our borrowers’ prepayment and repayment of our loans;


•	losses related to recent hurricanes, which primarily affected Texas and Florida, and related to recent California wildfires, in each case including from damage or loss to our collateral for loans in our consumer and commercial loan portfolios and from the impact on the ability of our borrowers to repay their loans;


•	the effect of the current low interest rate environment or changes in interest rates on our net interest income;


•	the level and volatility of the capital markets, interest rates, currency values and other market indices that affect the value of our assets and liabilities;


•	the effect of political conditions and geopolitical events;


•	losses relating to natural disasters, including, with respect to our loan portfolio, damage or loss to the collateral

underlying loans in our portfolio or the unavailability of adequate insurance coverage or government assistance for borrowers;


•	adverse developments in the availability of desirable investment opportunities, whether they are due to competition, regulation or otherwise;


•	the extent of loan modification efforts, as well as the effects of regulatory requirements or guidance regarding loan modifications;


•	the availability and cost of both credit and capital;


•	investor sentiment and confidence in the financial markets;


•	our reputation and the reputation of Wells Fargo and the Bank, including negative effects from the Bank's retail banking sales practices matter;


•	financial services reform and the impact of other current, pending and future legislation, regulation and legal actions applicable to us, the Bank or Wells Fargo, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and related regulations, and the final definition of qualified mortgage issued by the Consumer Financial Protection Bureau;


•	changes in accounting standards, rules and interpretations;


•	various monetary and fiscal policies and regulations of the U.S. and foreign governments;


•	a failure in or breach of our, the Bank’s or Wells Fargo’s operational or security systems or infrastructure, or those of third party vendors and other security providers, including as a result of cyber attacks; and


•	the other factors described in “Risk Factors” in the 2016 Form 10-K.

In addition to the above factors, we also caution that our allowance for credit losses currently may not be appropriate to cover future credit losses, especially if housing prices decline, unemployment worsens, general economic conditions deteriorate, or losses from Hurricanes Harvey and Irma are significant. Increases in loan charge-offs or in the allowance for credit losses and related provision expense could materially adversely affect our financial results and condition.

Any forward-looking statement made by us in this Report speaks only as of the date on which it is made. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

Risk Factors

An investment in Wells Fargo Real Estate Investment Corporation involves risk, including the possibility that the value of the investment could fall substantially and that dividends or other distributions on the investment could be reduced or eliminated. For a discussion of risk factors that could adversely affect our financial results and condition and the value

of, and return on, an investment in WFREIC, refer to the “Risk Factors” section in our 2016 Form 10-K.

Controls and Procedures



Disclosure Controls and Procedures

The Company's management evaluated the effectiveness, as of September 30, 2017, of our disclosure controls and procedures. The Company's chief executive officer and chief financial officer participated in the evaluation. Based on this evaluation, the chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2017.



Internal Control Over Financial Reporting

Internal control over financial reporting is defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles (GAAP) and includes those policies and procedures that:


•	pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets of the Company;


•	provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and


•	provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. No change occurred during third quarter 2017 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Financial Statements



Wells Fargo Real Estate Investment Corporation
Statement of Income (Unaudited)
	Quarter ended September 30,					Nine months ended September 30,
(in thousands, except per share amounts)	2017			2016		2017		2016
Interest income	$	332,748		224,690		963,229		554,364
Interest expense	3,173			1,272		3,423		2,029
Net interest income	329,575			223,418		959,806		552,335
Provision (reversal of provision) for credit losses	(11,537		)	18,743		14,664		30,174
Net interest income after provision for credit losses	341,112			204,675		945,142		522,161
Noninterest income
Pledge fees	15,864			8,715		44,338		16,457
Other	(284		)	(785	)	(83	)	(557	)
Total noninterest income	15,580			7,930		44,255		15,900
Noninterest expense
Loan servicing costs	20,614			13,309		58,602		30,855
Management fees	6,384			4,441		19,155		11,843
Foreclosed assets	2,713			3,174		7,124		9,627
Other	441			418		779		716
Total noninterest expense	30,152			21,342		85,660		53,041
Net income	326,540			191,263		903,737		485,020
Comprehensive income	326,540			191,263		903,737		485,020
Dividends on preferred stock	4,397			4,397		13,191		13,191
Net income applicable to common stock	$	322,143		186,866		890,546		471,829
Per common share information
Earnings per common share	$	9.46		8.82		26.15		30.09
Diluted earnings per common share	9.46			8.82		26.15		30.09
Dividends declared per common share	9.40			6.31		26.28		28.01
Average common shares outstanding	34,058			21,179		34,058		15,680
Diluted average common shares outstanding	34,058			21,179		34,058		15,680

The accompanying notes are an integral part of these statements.



Wells Fargo Real Estate Investment Corporation
Balance Sheet
(in thousands, except shares)	Sep 30, 2017			Dec 31, 2016
Assets	(Unaudited)
Cash and cash equivalents	$	—		971,349
Loans	32,697,065			31,309,993
Allowance for loan losses	(129,116		)	(123,877	)
Net loans	32,567,949			31,186,116
Accounts receivable - affiliates, net	82,372			155,813
Other assets	88,491			85,133
Total assets	$	32,738,812		32,398,411
Liabilities
Line of credit with Bank	$	341,064		—
Other liabilities	8,018			4,227
Total liabilities	349,082			4,227
Stockholders’ Equity
Preferred stock	110			110
Common stock – $0.01 par value, authorized 100,000,000 shares; issued and outstanding 34,058,028 shares	341			341
Additional paid-in capital	32,550,660			32,550,660
Retained earnings (deficit)	(161,381		)	(156,927	)
Total stockholders’ equity	32,389,730			32,394,184
Total liabilities and stockholders’ equity	$	32,738,812		32,398,411

The accompanying notes are an integral part of these statements.



Wells Fargo Real Estate Investment Corporation
Statement of Changes in Stockholders’ Equity (Unaudited)
(in thousands, except per share data)	Preferred stock		Common stock	Additional paid-in capital	Retained earnings (deficit)		Total stockholders’ equity
Balance, December 31, 2015	$	110	129	12,550,822	(138,154	)	12,412,907
Net income	—		—	—	485,020		485,020
Common stock issued	—		212	19,999,838	—		20,000,050
Cash dividends
Series A preferred stock at $1.20 per share	—		—	—	(13,148	)	(13,148	)
Series B preferred stock at $63.75 per share	—		—	—	(43	)	(43	)
Common stock at $28.01 per share	—		—	—	(495,000	)	(495,000	)
Balance, September 30, 2016	$	110	341	32,550,660	(161,325	)	32,389,786
Balance, December 31, 2016	$	110	341	32,550,660	(156,927	)	32,394,184
Net income	—		—	—	903,737		903,737
Cash dividends
Series A preferred stock at $1.20 per share	—		—	—	(13,148	)	(13,148	)
Series B preferred stock at $63.75 per share	—		—	—	(43	)	(43	)
Common stock at $26.28 per share	—		—	—	(895,000	)	(895,000	)
Balance, September 30, 2017	$	110	341	32,550,660	(161,381	)	32,389,730

The accompanying notes are an integral part of these statements.



Wells Fargo Real Estate Investment Corporation
Statement of Cash Flows (Unaudited)
	Nine months ended September 30,
(in thousands)	2017			2016
Cash flows from operating activities:
Net income	$	903,737		485,020
Adjustments to reconcile net income to net cash provided by operating activities:
Net accretion of adjustments on loans	(10,392		)	(42,538	)
Provision for credit losses	14,664			30,174
Other operating activities, net	(162		)	(67,753	)
Net cash provided by operating activities	907,847			404,903
Cash flows from investing activities:
Increase (decrease) in cash realized from
Loans:
Acquisitions	(4,707,964		)	(23,339,146	)
Proceeds from payments and sales	3,391,498			2,900,579
Net cash used by investing activities	(1,316,466		)	(20,438,567	)
Cash flows from financing activities:
Increase (decrease) in cash realized from
Draws on line of credit with Bank	1,885,152			3,146,666
Repayments of line of credit with Bank	(1,544,088		)	(2,604,861	)
Common stock issued	—			20,000,050
Cash dividends paid	(903,794		)	(508,191	)
Net cash (used) provided by financing activities	(562,730		)	20,033,664
Net change in cash and cash equivalents	(971,349		)	—
Cash and cash equivalents at beginning of period	971,349			—
Cash and cash equivalents at end of period	$	—		—
Supplemental cash flow disclosures:
Change in noncash items:
Transfers from loans to foreclosed assets	$	9,124		11,920

The accompanying notes are an integral part of these statements.

Note 1: Summary of Significant Accounting Policies

Wells Fargo Real Estate Investment Corporation (the Company, we, our or us) is an indirect subsidiary of both Wells Fargo & Company (Wells Fargo) and Wells Fargo Bank, National Association (the Bank). The Company, a Delaware corporation, has operated as a real estate investment trust (REIT) since its formation in 1996.

The accounting and reporting policies of the Company are in accordance with U.S. generally accepted accounting principles (GAAP). For discussion of our significant accounting policies, see Note 1 (Summary of Significant Accounting Policies) in our Annual Report on Form 10-K for the year ended December 31, 2016 (2016 Form 10-K). There were no material changes to these policies in third quarter 2017. The preparation of the financial statements in accordance with GAAP requires management to make estimates based on assumptions about future economic and market conditions that affect the reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting period and the related disclosures. Although our estimates contemplate current conditions and how we expect them to change in the future, it is reasonably possible that actual future conditions could be significantly different than anticipated in those estimates, which could materially affect our results of operations and financial condition. Management has made significant estimates related to the allowance for credit losses (Note 2 (Loans and Allowance for Credit Losses)). Actual results could differ from those estimates.

These unaudited interim financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the periods presented. These adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q. The results of operations in the interim financial statements do not necessarily indicate the results that may be expected for the full year. The interim financial information should be read in conjunction with our 2016 Form 10-K.

Accounting Standards with Retrospective Application

The following accounting pronouncement has been issued by the FASB but is not yet effective:


•	ASU 2016-15 – Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.

ASU 2016-15 addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice for reporting in the Statement of Cash Flows. The Update is effective for us in first quarter 2018 with retrospective application. Subject to completion of our assessment, we are not expecting this Update to have a material impact on our financial statements.

Third Quarter 2016 Common Stock Issuance and Related Loan Acquisitions

On August 26, 2016, the Company issued and sold 21.2 million shares of common stock to affiliates of the Company for an aggregate purchase price of $20.0 billion. Following the issuance, indirect wholly-owned subsidiaries of the Bank continue to own 100% of the Company’s common stock.

Subsequent to the issuance, the Company used the proceeds along with existing funds to acquire $19.1 billion of real estate 1-4 family first mortgage loans and $1.9 billion of commercial secured by real estate loans.

Subsequent Events

We have evaluated the effects of events that have occurred subsequent to September 30, 2017. There were no material subsequent events requiring adjustment to the financial statements or disclosure in the Notes to Financial Statements.

Note 2: Loans and Allowance for Credit Losses

The Company acquires loans originated or purchased by the Bank. In order to maintain our status as a REIT, the composition of the loans is highly concentrated in real estate. The majority of our loans are concentrated in California, New York, Washington, Virginia and Florida. These markets include approximately 55% of our total loan balance at September 30, 2017.

The following table presents total loans outstanding by portfolio segment and class of financing receivable. Outstanding balances include a total net reduction of $10.6 million and net addition of $65.5 million at September 30, 2017 and December 31, 2016, respectively, for unamortized premiums and discounts.



(in thousands)	Sep 30, 2017		Dec 31, 2016
Total commercial	$	3,514,051	3,984,881
Consumer:
Real estate 1-4 family first mortgage	28,275,795		26,236,047
Real estate 1-4 family junior lien mortgage	907,219		1,089,065
Total consumer	29,183,014		27,325,112
Total loans	$	32,697,065	31,309,993

The following table summarizes the proceeds paid or received from the Bank for acquisitions and sales of loans, respectively.



	2017						2016
(in thousands)	Commercial		Consumer		Total		Commercial		Consumer		Total
Quarter ended September 30,
Loan acquisitions	$	—	—		—		1,907,228		19,117,991		21,025,219
Loan sales	—		(43,641	)	(43,641	)	—		(198,549	)	(198,549	)
Nine months ended September 30,
Loan acquisitions	$	—	4,707,964		4,707,964		1,907,228		21,431,918		23,339,146
Loan sales	—		(100,670	)	(100,670	)	(128	)	(203,634	)	(203,762	)

Commitments to Lend

The contract or notional amount of commercial loan commitments to extend credit was $520.4 million at September 30, 2017 and $438.0 million at December 31, 2016.

Pledged Loans

See Note 5 (Transactions With Related Parties) for additional details on our agreement with the Bank to pledge loans.

Allowance for Credit Losses

the impact to our customers and business as a result of the hurricanes and refine our estimates as more information becomes available. We are still evaluating the impact on our portfolios from the California wildfires that occurred in October 2017.

The following table presents the allowance for credit losses, which consists of the allowance for loan losses and the allowance for unfunded credit commitments.



	Quarter ended September 30,					Nine months ended September 30,
(in thousands)	2017			2016		2017		2016
Balance, beginning of period	$	144,447		118,030		125,029		121,538
Provision (reversal of provision) for credit losses	(11,537		)	18,743		14,664		30,174
Interest income on certain impaired loans (1)	(1,331		)	(1,604	)	(3,939	)	(4,384	)
Loan charge-offs:
Total commercial	—			—		(11	)	(10	)
Consumer:
Real estate 1-4 family first mortgage	(2,320		)	(4,246	)	(8,120	)	(13,602	)
Real estate 1-4 family junior lien mortgage	(3,299		)	(4,468	)	(11,266	)	(16,424	)
Total consumer	(5,619		)	(8,714	)	(19,386	)	(30,026	)
Total loan charge-offs	(5,619		)	(8,714	)	(19,397	)	(30,036	)
Loan recoveries:
Total commercial	59			48		88		77
Consumer:
Real estate 1-4 family first mortgage	2,044			1,820		5,197		4,265
Real estate 1-4 family junior lien mortgage	2,360			3,643		8,781		10,332
Total consumer	4,404			5,463		13,978		14,597
Total loan recoveries	4,463			5,511		14,066		14,674
Net loan recoveries (charge-offs)	(1,156		)	(3,203	)	(5,331	)	(15,362	)
Balance, end of period	$	130,423		131,966		130,423		131,966
Components:
Allowance for loan losses	$	129,116		130,715		129,116		130,715
Allowance for unfunded credit commitments	1,307			1,251		1,307		1,251
Allowance for credit losses	$	130,423		131,966		130,423		131,966
Net loan charge-offs (annualized) as a percentage of average total loans	0.01		%	0.06		0.02		0.13
Allowance for loan losses as a percentage of total loans	0.39			0.39		0.39		0.39
Allowance for credit losses as a percentage of total loans	0.40			0.39		0.40		0.39


(1)	Certain impaired loans with an allowance calculated by discounting expected cash flows using the loan’s effective interest rate over the remaining life of the loan recognize changes in allowance attributable to the passage of time as interest income.

The following table summarizes the activity in the allowance for credit losses by our commercial and consumer portfolio segments.



	2017							2016
(in thousands)	Commercial			Consumer		Total		Commercial		Consumer		Total
Quarter ended September 30,
Balance, beginning of period	$	27,375		117,072		144,447		15,008		103,022		118,030
Provision (reversal of provision) for credit losses	(857		)	(10,680	)	(11,537	)	12,194		6,549		18,743
Interest income on certain impaired loans	—			(1,331	)	(1,331	)	—		(1,604	)	(1,604	)

Loan charge-offs	—			(5,619	)	(5,619	)	—		(8,714	)	(8,714	)
Loan recoveries	59			4,404		4,463		48		5,463		5,511
Net loan recoveries (charge-offs)	59			(1,215	)	(1,156	)	48		(3,251	)	(3,203	)
Balance, end of period	$	26,577		103,846		130,423		27,250		104,716		131,966

Nine months ended September 30,
Balance, beginning of period	$	29,644		95,385		125,029		17,676		103,862		121,538
Provision (reversal of provision) for credit losses	(3,144		)	17,808		14,664		9,507		20,667		30,174
Interest income on certain impaired loans	—			(3,939	)	(3,939	)	—		(4,384	)	(4,384	)

Loan charge-offs	(11		)	(19,386	)	(19,397	)	(10	)	(30,026	)	(30,036	)
Loan recoveries	88			13,978		14,066		77		14,597		14,674
Net loan recoveries (charge-offs)	77			(5,408	)	(5,331	)	67		(15,429	)	(15,362	)
Balance, end of period	$	26,577		103,846		130,423		27,250		104,716		131,966

The following table disaggregates our allowance for credit losses and recorded investment in loans by impairment methodology.



	Allowance for credit losses				Recorded investment in loans
(in thousands)	Commercial		Consumer	Total	Commercial	Consumer	Total
September 30, 2017
Collectively evaluated (1)	$	25,251	46,723	71,974	3,510,041	28,755,856	32,265,897
Individually evaluated (2)	1,326		57,123	58,449	4,010	417,164	421,174
Purchased credit-impaired (PCI) (3)	—		—	—	—	9,994	9,994
Total	$	26,577	103,846	130,423	3,514,051	29,183,014	32,697,065
December 31, 2016
Collectively evaluated (1)	$	28,535	21,915	50,450	3,980,501	26,860,682	30,841,183
Individually evaluated (2)	1,109		73,470	74,579	3,236	451,070	454,306
PCI (3)	—		—	—	1,144	13,360	14,504
Total	$	29,644	95,385	125,029	3,984,881	27,325,112	31,309,993


(1)	Represents loans collectively evaluated for impairment in accordance with Accounting Standards Codification (ASC) 450-20, Loss Contingencies (formerly FAS 5), and pursuant to amendments by ASU 2010-20 regarding allowance for non-impaired loans.


(2)	Represents loans individually evaluated for impairment in accordance with ASC 310-10, Receivables (formerly FAS 114), and pursuant to amendments by ASU 2010-20 regarding allowance for impaired loans.


(3)	Represents the allowance and related loan carrying value determined in accordance with ASC 310-30, Receivables - Loans and Debt Securities Acquired with Deteriorated Credit Quality (formerly SOP 03-3) and pursuant to amendments by ASU 2010-20 regarding allowance for PCI loans.

Credit Quality

We monitor credit quality by evaluating various attributes and utilize such information in our evaluation of the appropriateness of the allowance for credit losses. The following sections provide the credit quality indicators we most closely monitor. The credit quality indicators are generally based on information as of our financial statement date, with the exception of updated Fair Isaac Corporation (FICO) scores and updated loan-to-value (LTV)/combined LTV (CLTV). We obtain FICO scores at loan origination and the scores are generally updated at least quarterly, except in limited circumstances, including compliance with the Fair Credit Reporting Act (FCRA). Generally, the LTV and CLTV indicators are updated in the second month of each quarter, with updates no older than June 30, 2017.

COMMERCIAL CREDIT QUALITY INDICATORS In addition to monitoring commercial loan concentration risk, we manage a consistent process for assessing commercial loan credit quality. Generally commercial loans are subject to individual risk assessment using our internal borrower and collateral quality ratings. Our ratings are aligned to Pass and Criticized categories. The Criticized category includes Special Mention, Substandard, and Doubtful categories which are defined by bank regulatory agencies.

The table below provides a breakdown of outstanding commercial loans by risk category.



(in thousands)	Total
September 30, 2017
By risk category:
Pass	$	3,495,129
Criticized	18,922
Total commercial loans	$	3,514,051
December 31, 2016
By risk category:
Pass	$	3,976,801
Criticized	8,080
Total commercial loans	$	3,984,881

The following table provides past due information for commercial loans, which we monitor as part of our credit risk management practices.



(in thousands)	Total
September 30, 2017
By delinquency status:
Current-29 days past due (DPD) and still accruing	$	3,507,124
30-89 DPD and still accruing	2,611
90+ DPD and still accruing	991
Nonaccrual loans	3,325
Total commercial loans	$	3,514,051
December 31, 2016
By delinquency status:
Current-29 DPD and still accruing	$	3,981,306
30-89 DPD and still accruing	—
90+ DPD and still accruing	975
Nonaccrual loans	2,600
Total commercial loans	$	3,984,881

CONSUMER CREDIT QUALITY INDICATORS We have various classes of consumer loans that present unique risks. Loan delinquency, FICO credit scores and LTV/CLTV for loan types are common credit quality indicators that we monitor and utilize in our evaluation of the appropriateness of the allowance for credit losses for the consumer portfolio segment.

Many of our loss estimation techniques used for the allowance for credit losses rely on delinquency-based models;

therefore, delinquency is an important indicator of credit quality and the establishment of our allowance for credit losses. The following table provides the outstanding balances of our consumer portfolio by delinquency status.



(in thousands)	Real estate 1-4 family first mortgage			Real estate 1-4 family junior lien mortgage		Total
September 30, 2017
By delinquency status:
Current-29 DPD	$	28,134,223		870,218		29,004,441
30-59 DPD	57,284			15,788		73,072
60-89 DPD	15,038			6,091		21,129
90-119 DPD	6,708			3,696		10,404
120-179 DPD	6,577			3,457		10,034
180+ DPD	62,366			11,532		73,898
Remaining PCI accounting adjustments	(6,401		)	(3,563	)	(9,964	)
Total consumer loans	$	28,275,795		907,219		29,183,014
December 31, 2016
By delinquency status:
Current-29 DPD	$	26,083,077		1,046,385		27,129,462
30-59 DPD	50,197			14,254		64,451
60-89 DPD	23,740			8,216		31,956
90-119 DPD	9,962			5,493		15,455
120-179 DPD	9,945			3,971		13,916
180+ DPD	66,606			14,168		80,774
Remaining PCI accounting adjustments	(7,480		)	(3,422	)	(10,902	)
Total consumer loans	$	26,236,047		1,089,065		27,325,112

The following table provides a breakdown of our consumer portfolio by FICO. The September 30, 2017 FICO scores for real estate 1-4 family first and junior lien mortgages reflect a new FICO score version we adopted in first quarter 2017 to monitor and manage those portfolios. In general the impact for us is a shift to higher scores, particularly to the 800+ level, as the new

FICO score version utilizes a more refined approach that better distinguishes borrower credit risk. FICO is not available for certain loan types and may not be obtained if we deem it unnecessary due to strong collateral and other borrower attributes.



(in thousands)	Real estate 1-4 family first mortgage			Real estate 1-4 family junior lien mortgage		Total
September 30, 2017 (1)
By FICO:
< 600	$	180,770		78,531		259,301
600-639	131,637			53,355		184,992
640-679	304,801			92,405		397,206
680-719	949,482			161,549		1,111,031
720-759	2,288,097			168,060		2,456,157
760-799	5,391,682			136,532		5,528,214
800+	18,847,163			203,557		19,050,720
No FICO available	188,564			16,793		205,357
Remaining PCI accounting adjustments	(6,401		)	(3,563	)	(9,964	)
Total consumer loans	$	28,275,795		907,219		29,183,014
December 31, 2016
By FICO:
< 600	$	227,775		114,855		342,630
600-639	183,318			76,631		259,949
640-679	490,005			132,398		622,403
680-719	1,283,767			198,166		1,481,933
720-759	3,668,121			213,787		3,881,908
760-799	12,926,891			229,558		13,156,449
800+	7,328,038			113,112		7,441,150
No FICO available	135,612			13,980		149,592
Remaining PCI accounting adjustments	(7,480		)	(3,422	)	(10,902	)
Total consumer loans	$	26,236,047		1,089,065		27,325,112


(1)	September 30, 2017 amounts reflect updated FICO score version implemented in first quarter 2017.

LTV refers to the ratio comparing the loan’s unpaid principal balance to the property’s collateral value. CLTV refers to the combination of first mortgage and junior lien mortgage ratios. LTVs and CLTVs are updated quarterly using a cascade approach which first uses values provided by automated valuation models (AVMs) for the property. If an AVM is not available, then the value is estimated using the original appraised value adjusted by the change in Home Price Index (HPI) for the property location. If an HPI is not available, the original appraised value is used. The HPI value is normally the only method considered for high value properties, generally with an original value of $1 million or more, as the AVM values have proven less accurate for these properties.

The following table shows the most updated LTV and CLTV distribution of the real estate 1-4 family first and junior lien mortgage loan portfolios. We consider the trends in residential real estate markets as we monitor credit risk and establish our allowance for credit losses. In the event of a default, any loss should be limited to the portion of the loan amount in excess of the net realizable value of the underlying real estate collateral value. Certain loans do not have an LTV or CLTV due to industry data availability and portfolios acquired from or serviced by other institutions.



(in thousands)	Real estate 1-4 family first mortgage by LTV			Real estate 1-4 family junior lien mortgage by CLTV		Total
September 30, 2017
By LTV/CLTV:
0-60%	$	15,073,059		307,471		15,380,530
60.01-80%	11,744,611			255,512		12,000,123
80.01-100%	1,252,129			214,921		1,467,050
100.01-120% (1)	139,248			93,312		232,560
> 120% (1)	57,030			38,116		95,146
No LTV/CLTV available	16,119			1,450		17,569
Remaining PCI accounting adjustments	(6,401		)	(3,563	)	(9,964	)
Total consumer loans	$	28,275,795		907,219		29,183,014
December 31, 2016
By LTV/CLTV:
0-60%	$	12,639,979		347,932		12,987,911
60.01-80%	11,995,186			297,037		12,292,223
80.01-100%	1,362,748			271,230		1,633,978
100.01-120% (1)	155,553			124,467		280,020
> 120% (1)	69,990			50,226		120,216
No LTV/CLTV available	20,071			1,595		21,666
Remaining PCI accounting adjustments	(7,480		)	(3,422	)	(10,902	)
Total consumer loans	$	26,236,047		1,089,065		27,325,112


(1)	Reflects total loan balances with LTV/CLTV amounts in excess of 100%. In the event of default, the loss content would generally be limited to only the amount in excess of 100% LTV/CLTV.

NONACCRUAL LOANS The following table provides loans on nonaccrual status. PCI loans are excluded from this table because they continue to earn interest from accretable yield, independent of performance in accordance with their contractual terms.



(in thousands)	Sep 30, 2017		Dec 31, 2016
Total commercial	$	3,325	2,600
Consumer:
Real estate 1-4 family first mortgage	152,861		165,117
Real estate 1-4 family junior lien mortgage	42,237		48,806
Total consumer	195,098		213,923
Total nonaccrual loans (excluding PCI)	$	198,423	216,523

LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING Certain loans 90 days or more past due as to interest or principal are still accruing, because they are (1) well-secured and in the process of collection or (2) real estate 1-4 family mortgage loans exempt under regulatory rules from being classified as nonaccrual until later delinquency, usually 120 days past due. PCI loans of $853 thousand at September 30, 2017, and $2.3 million at December 31, 2016, are excluded from this disclosure even though they are 90 days or more contractually past due. These PCI loans are considered to be accruing because they continue to earn interest from accretable yield, independent of performance in accordance with their contractual terms.

The following table shows non-PCI loans 90 days or more past due and still accruing.



(in thousands)	Sep 30, 2017		Dec 31, 2016
Total commercial	$	991	—
Consumer:
Real estate 1-4 family first mortgage	3,685		4,962
Real estate 1-4 family junior lien mortgage	1,498		2,545
Total consumer	5,183		7,507
Total past due (excluding PCI)	$	6,174	7,507

Impaired Loans The table below summarizes key information for impaired loans. Our impaired loans predominantly include loans on nonaccrual status in the commercial portfolio segment and loans modified in a TDR, whether on accrual or nonaccrual status. These impaired loans generally have estimated losses which are included in the allowance for credit losses. We have impaired loans with no allowance for credit losses when loss content has been

previously recognized through charge-offs and we do not anticipate additional charge-offs or losses, or certain loans are currently performing in accordance with their terms and for which no loss has been estimated. Impaired loans exclude PCI loans. The table below includes trial modifications that totaled $8.8 million at September 30, 2017 and $11.8 million at December 31, 2016.



			Recorded investment
(in thousands)	Unpaid principal balance		Impaired loans	Impaired loans with related allowance for credit losses	Related allowance for credit losses
September 30, 2017
Total commercial	$	6,029	4,010	4,010	1,326
Consumer:
Real estate 1-4 family first mortgage	386,290		323,740	221,407	38,534
Real estate 1-4 family junior lien mortgage	102,897		93,424	75,436	18,589
Total consumer	489,187		417,164	296,843	57,123
Total impaired loans (excluding PCI)	$	495,216	421,174	300,853	58,449
December 31, 2016
Total commercial	$	3,940	3,236	3,236	1,109
Consumer:
Real estate 1-4 family first mortgage	419,497		349,627	247,525	49,486
Real estate 1-4 family junior lien mortgage	111,967		101,443	83,887	23,984
Total consumer	531,464		451,070	331,412	73,470
Total impaired loans (excluding PCI)	$	535,404	454,306	334,648	74,579

The following table provides the average recorded investment in impaired loans and the amount of interest income recognized on impaired loans by portfolio segment and class.



	Quarter ended September 30,						Nine months ended September 30,
	2017				2016		2017		2016
(in thousands)	Average recorded investment		Recognized interest income		Average recorded investment	Recognized interest income	Average recorded investment	Recognized interest income	Average recorded investment	Recognized interest income
Total commercial	$	4,030	10		3,358	11	3,791	33	3,828	60
Consumer:
Real estate 1-4 family first mortgage	329,054		5,174		363,593	5,867	338,040	15,927	372,254	17,120
Real estate 1-4 family junior lien mortgage	94,054		2,037		107,935	2,240	97,054	6,236	111,742	6,935
Total consumer	423,108		7,211		471,528	8,107	435,094	22,163	483,996	24,055
Total impaired loans	$	427,138	7,221		474,886	8,118	438,885	22,196	487,824	24,115
Interest income:
Cash basis of accounting			$	1,947		2,511		6,262		7,443
Other (1)			5,274			5,607		15,934		16,672
Total interest income			$	7,221		8,118		22,196		24,115


(1)	Includes interest recognized on accruing TDRs, interest recognized related to certain impaired loans which have an allowance calculated using discounting, and amortization of purchase accounting adjustments related to certain impaired loans.

Troubled Debt Restructuring (TDRs) When, for economic or legal reasons related to a borrower’s financial difficulties, we grant a concession for other than an insignificant period of time to a borrower that we would not otherwise consider, the related loan is classified as a TDR, the balance of which totaled $420.2 million and $454.3 million at September 30, 2017 and December 31, 2016, respectively. We do not consider loan resolutions, such as foreclosure or short sale to be a TDR.

We may require some consumer borrowers experiencing financial difficulty to make trial payments generally for a period of three to four months, according to the terms of a planned permanent modification, to determine if they can perform according to those terms. These arrangements represent trial modifications, which we classify and account for as TDRs. While loans are in trial payment programs, their original terms are not considered modified and they continue to advance through delinquency status and accrue interest according to their original terms.

The following table summarizes our TDR modifications for the periods presented by primary modification type and includes the financial effects of these modifications. For those loans that may be modified more than once, the following table reflects each modification that occurred during the period. Loans that both modify and pay off within the period, as well as changes in recorded investment during the period for loans modified in prior periods, are not included in the table.



	Primary modification type (1)							Financial effects of modifications
(in thousands)	Principal (2)		Interest rate reduction	Other concessions (3)		Total		Charge- offs (4)	Weighted average interest rate reduction		Recorded investment related to interest rate reduction (5)
Quarter ended September 30, 2017
Total commercial	$	—	—	—		—		—	—	%	$	—
Consumer:
Real estate 1-4 family first mortgage	2,055		386	2,719		5,160		29	3.36		2,078
Real estate 1-4 family junior lien mortgage	33		841	1,889		2,763		363	3.60		842
Trial modifications (6)	—		—	(952	)	(952	)	—	—		—
Total consumer	2,088		1,227	3,656		6,971		392	3.43		2,920
Total	$	2,088	1,227	3,656		6,971		392	3.43	%	$	2,920
Quarter ended September 30, 2016
Total commercial	$	—	—	2,106		2,106		—	—	%	$	—
Consumer:
Real estate 1-4 family first mortgage	2,079		3,107	3,267		8,453		258	3.48		5,110
Real estate 1-4 family junior lien mortgage	111		738	866		1,715		437	3.88		848
Trial modifications (6)	—		—	1,181		1,181		—	—		—
Total consumer	2,190		3,845	5,314		11,349		695	3.54		5,958
Total	$	2,190	3,845	7,420		13,455		695	3.54	%	$	5,958



	Primary modification type (1)							Financial effects of modifications
(in thousands)	Principal (2)		Interest rate reduction	Other concessions (3)		Total		Charge- offs (4)	Weighted average interest rate reduction		Recorded investment related to interest rate reduction (5)
Nine months ended September 30, 2017
Total commercial	$	—	—	—		—		—	—	%	$	—
Consumer:
Real estate 1-4 family first mortgage	8,499		5,481	7,875		21,855		557	3.43		10,767
Real estate 1-4 family junior lien mortgage	1,122		2,604	3,468		7,194		679	4.29		3,088
Trial modifications (6)	—		—	(274	)	(274	)	—	—		—
Total consumer	9,621		8,085	11,069		28,775		1,236	3.63		13,855
Total	$	9,621	8,085	11,069		28,775		1,236	3.63	%	$	13,855
Nine months ended September 30, 2016
Total commercial	$	—	—	3,954		3,954		—	—	%	$	—
Consumer:
Real estate 1-4 family first mortgage	5,914		8,086	13,137		27,137		1,297	3.48		12,798
Real estate 1-4 family junior lien mortgage	794		3,425	3,211		7,430		1,478	3.82		4,012
Trial modifications (6)	—		—	(1,133	)	(1,133	)	—	—		—
Total consumer	6,708		11,511	15,215		33,434		2,775	3.56		16,810
Total	$	6,708	11,511	19,169		37,388		2,775	3.56	%	$	16,810

(1)

Amounts represent the recorded investment in loans after recognizing the effects of the TDR, if any. TDRs may have multiple types of concessions, but are presented only once in the first modification type based on the order presented in the table above. The reported amounts include loans remodified of $2.4 million and $2.7 million for the quarters ended September 30, 2017 and 2016, and $7.4 million and $6.9 million for the first nine months of 2017 and 2016, respectively.


(2)	Principal modifications include principal forgiveness at the time of the modification, contingent principal forgiveness granted over the life of the loan based on borrower performance, and principal that has been legally separated and deferred to the end of the loan, with a zero percent contractual interest rate.


(3)	Other concessions include loans discharged in bankruptcy, loan renewals, term extensions and other interest and noninterest adjustments, but exclude modifications that also forgive principal and/or reduce the interest rate.

(4)

Charge-offs include write-downs of the investment in the loan in the period it is contractually modified. The amount of charge-off will differ from the modification terms if the loan has been charged down prior to the modification based on our policies. In addition, there may be cases where we have a charge-off/down with no legal principal modification. Modifications resulted in legally forgiving principal (actual, contingent or deferred) of $135 thousand and $290 thousand for the quarters ended September 30, 2017 and 2016, and $753 thousand and $1.0 million for the first nine months of 2017 and 2016, respectively.


(5)	Reflects the effect of reduced interest rates on loans with an interest rate concession as one of their concession types, which includes loans reported as a principal primary modification type that also have an interest rate concession.

(6)

Trial modifications are granted a delay in payments due under the original terms during the trial payment period. However, these loans continue to advance through delinquency status and accrue interest according to their original terms. Any subsequent permanent modification generally includes interest rate related concessions; however, the exact concession type and resulting financial effect are usually not known until the loan is permanently modified. Trial modifications for the period are presented net of previously reported trial modifications that became permanent in the current period.

The table below summarizes permanent modification TDRs that have defaulted in the current period within 12 months of their permanent modification date. We report these defaulted

TDRs based on a payment default definition of 90 days past due for the commercial portfolio segment and 60 days past due for the consumer portfolio segment.



	Recorded investment of defaults
	Quarter ended September 30,			Nine months ended September 30,
(in thousands)	2017		2016	2017	2016
Total commercial	$	—	—	—	807
Consumer:
Real estate 1-4 family first mortgage	1,187		835	2,257	1,759
Real estate 1-4 family junior lien mortgage	60		573	623	885
Total consumer	1,247		1,408	2,880	2,644
Total	$	1,247	1,408	2,880	3,451

Note 3: Fair Values of Assets and Liabilities

We use fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. We did not elect the fair value option for any financial instruments as permitted in FASB ASC 825, Financial Instruments, which allows companies to elect to carry certain financial instruments at fair value with corresponding changes in fair value reported in the results of operations. As of September 30, 2017 and December 31, 2016, assets measured at fair value on a nonrecurring basis were less than 1% of total assets. See Note 1 (Summary of Significant Accounting Policies) in our 2016 Form 10-K for additional information about our fair value measurement policies and methods.

Disclosures about Fair Value of Financial Instruments The table below is a summary of fair value estimates by level for financial instruments. The carrying amounts in the following table are recorded in the balance sheet under the indicated captions.

We have not included assets and liabilities that are not financial instruments in our disclosure, such as other assets and other liabilities. The total of the fair value calculations presented does not represent, and should not be construed to represent, the underlying value of the Company.




	Carrying amount		Estimated fair value
(in thousands)	Carrying amount		Level 1	Level 2	Level 3	Total
September 30, 2017
Financial assets
Cash and cash equivalents (1)	$	—	—	—	—	—
Loans, net (2)	32,567,949		—	—	33,669,834	33,669,834

Financial liabilities
Line of credit with Bank (1)	341,064		—	—	341,064	341,064
December 31, 2016
Financial assets
Cash and cash equivalents (1)	$	971,349	971,349	—	—	971,349
Loans, net (2)	31,186,116		—	—	31,732,422	31,732,422

Financial liabilities
Line of credit with Bank (1)	—		—	—	—	—


(1)	Amounts consist of financial instruments in which carrying value approximates fair value.


(2)	Carrying amount is net of allowance for loan losses.

Note 4: Common and Preferred Stock

The following table provides details of our authorized common and preferred stock.



				September 30, 2017 and December 31, 2016
	Liquidation preference per share		Shares authorized	Shares issued and outstanding	Par value per share		Carrying value
Preferred stock:
Series A
6.375%, Cumulative, Perpetual Series A Preferred Stock	$	25	11,000,000	11,000,000	$	0.01	110,000
Series B
$85 Annual Dividend Per Share, Cumulative, Perpetual Series B Preferred Stock	1,000		1,000	667	0.01		7
Common stock			100,000,000	34,058,028	0.01		340,580
Total			111,001,000	45,058,695			$	450,587

In the event that the Company is liquidated or dissolved, the holders of the Series A and Series B preferred stock will be entitled to a liquidation preference for each security plus any authorized, declared and unpaid dividends that will be paid prior to any payments to common stockholders. With respect to the payment of dividends and liquidation preference, the Series A preferred stock ranks on parity with Series B preferred stock and senior to the Company’s common stock. The Company may issue additional shares of common stock to affiliates of Wells Fargo without further action by the Series A or Series B stockholders. Additional information related to Series A and B preferred stock, including the ability of the Company to redeem each series, is included in Note 5 (Common and Preferred Stock) to Financial Statements in our 2016 Form 10-K.

The certificate of designation for the Series A preferred stock limits our ability to pay dividends on our common stock or make any payment of interest or principal on our line of credit with the Bank if the dividend coverage ratio for the four prior fiscal quarters is less than 150%. The dividend coverage ratio, expressed as a percentage, is calculated by dividing the four prior fiscal quarters’ funds from operations, defined as GAAP net income excluding gains or losses from sales of property, by the amount that would be required to pay annual dividends on the Series A and Series B preferred stock. At September 30, 2017, the dividend coverage ratio was 6,837%.

Note 5: Transactions With Related Parties

The Company engages in various transactions and agreements with affiliated parties in the ordinary course of business. Due to the common ownership of the Company and the affiliated parties by Wells Fargo, these transactions and agreements may reflect circumstances and considerations that could differ from

those conducted with unaffiliated parties. The principal items related to transactions with affiliated parties included in the accompanying statement of income and balance sheet are described in the table and narrative below.



	Quarter ended September 30,			Nine months ended September 30,
(in thousands)	2017		2016	2017	2016
Income statement data
Interest income:
Net accretion of adjustments on loans	$	4,130	4,694	10,392	42,538
Interest on deposits	2		4,064	8,498	4,303
Total interest income	4,132		8,758	18,890	46,841
Pledge fees	15,864		8,715	44,338	16,457
Interest expense	3,173		1,272	3,423	2,029
Loan servicing costs	20,614		13,308	58,602	30,848
Management fees	6,384		4,441	19,155	11,843



(in thousands)	Sep 30, 2017			Dec 31, 2016
Balance sheet related data
Cash and cash equivalents	$	—		971,349
Loan acquisitions (year-to-date)	4,707,964			23,339,146
Proceeds from common stock issuance (year-to-date)	—			20,000,050
Loan sales (book value) (year-to-date)	(101,285		)	(424,556	)
Pledged loans (carrying value) (1)	17,843,817			20,239,773
Foreclosed asset sales (year-to-date)	(9,066		)	(10,915	)
Line of credit with Bank	341,064			—
Accounts receivable - affiliates, net	82,372			155,813


(1)	The fair value of pledged loans was approximately $18.4 billion and $20.4 billion at September 30, 2017 and December 31, 2016, respectively.

Loans We acquire and sell loans to and from the Bank. The acquisitions and sales are transacted at fair value resulting in acquisition discounts and premiums or gains and losses on sales. The net acquisition discount accretion or premium amortization is reported within interest income. Gains or losses on sales of loans are included within noninterest income.

The certificate of designation for the Series A preferred

stock limits our ability to pledge loans to an aggregate amount

not exceeding 80% of our total assets at any time as collateral on behalf of the Bank for the Bank’s access to secured borrowing facilities through the Federal Home Loan Banks or the discount window of Federal Reserve Banks. In exchange for the pledge of our loan assets, the Bank will pay us a fee that is consistent with market terms. At September 30, 2017 and September 30, 2016, the fee was equal to an annual rate of 34 basis points (0.34%) and 28 basis points (0.28%), respectively, as applied to the unpaid principal balance of pledged loans on a monthly basis. Such fee may be renegotiated by us and the Bank from time to time.

Loan Servicing Costs The loans in our portfolio are predominantly serviced by the Bank pursuant to the terms of participation and servicing and assignment agreements. In some instances, the Bank has delegated servicing responsibility to third parties that are not affiliated with us or the Bank. Depending on the loan type, the monthly servicing fee charges are based in part on (a) outstanding principal balances, (b) a flat fee per month, or (c) a total loan commitment amount.

Management Fees We pay the Bank a management fee to reimburse for general overhead expenses, including allocations of technology support and a combination of finance and accounting, risk management and other general overhead expenses incurred on our behalf. Management fees include direct and indirect expense allocations. Indirect expenses are allocated based on ratios that use our proportion of expense activity drivers. The expense activity drivers and ratios may change from time to time.

Deposits Interest income earned on deposits is included in interest income. Our cash management process includes applying operating cash flows to reduce any outstanding balance on our line of credit with the Bank. Operating cash flows are settled through our affiliate accounts receivable/payable process. Upon settlement cash received is either applied to reduce our line of credit outstanding or retained as a deposit with the Bank.

Foreclosed Assets We sell foreclosed assets back to the Bank from time to time at estimated fair value.

Line of Credit We have a revolving line of credit with the Bank. Effective October 2017, the borrowing capacity was increased from $2.2 billion to $5.0 billion and the rate of interest was changed from the average federal funds rate plus 12.5 basis points (0.125%) to the three-month London Interbank Offered Rate plus 4.4 basis points (0.044%).

Accounts Receivable - Affiliates, Net Accounts receivable from or payable to the Bank or its affiliates result from intercompany transactions which include net loan paydowns, interest receipts, and other transactions, including those transactions noted herein, which have not yet settled.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

WFREIC is not currently involved in nor, to our knowledge, currently threatened with any material litigation. From time to time we may become involved in routine litigation arising in the ordinary course of business. We do not believe that the eventual outcome of any such routine litigation will, in the aggregate, have a material adverse effect on our financial statements. However, in the event of unexpected future developments, it is possible that the ultimate resolution of those matters, if unfavorable, could be material to our financial statements for any particular period.

Item 1A. Risk Factors

Information in response to this item can be found under the “Risk Factors” section in this Report which information is incorporated by reference into this item.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Information required by this Item 2 pursuant to Item 703 of Regulation S-K regarding issuer repurchases of equity securities is not applicable since we do not have a program providing for the repurchase of our securities.

Item 6. Exhibits

A list of exhibits to this Form 10-Q is set forth below and is incorporated herein by reference.



Exhibit No.	Description	Location

(3)(a)	Amended and Restated Certificate of Incorporation.	Incorporated by reference to Exhibit (3)(a) to WFREIC’s Annual Report on Form 10-K for the year ended December 31, 2014.

(3)(b)	Bylaws.	Incorporated by reference to Exhibit 3.3 to WFREIC’s Registration Statement on Form S-11 No. 333-198948 filed November 18, 2014.

(12)	Computations of Ratios of Earnings to Fixed Charges and Preferred Stock Dividends.	Filed herewith.

(31)(a)	Certification of principal executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	Filed herewith.

(31)(b)	Certification of principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	Filed herewith.

(32)(a)	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed herewith.

(32)(b)	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed herewith.

(101.Ins)	XBRL Instance Document	Filed herewith.

(101.Sch)	XBRL Taxonomy Extension Schema Document	Filed herewith.

(101.Cal)	XBRL Taxonomy Extension Calculation Linkbase Document	Filed herewith.

(101.Lab)	XBRL Taxonomy Extension Label Linkbase Document	Filed herewith.

(101.Pre)	XBRL Taxonomy Extension Presentation Linkbase Document	Filed herewith.

(101.Def)	XBRL Taxonomy Extension Definitions Linkbase Document	Filed herewith.

SIGNATURE

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.



Wells Fargo Real Estate Investment Corporation

By:		/s/ RICHARD D. LEVY
		Richard D. Levy Executive Vice President and Controller (Principal Accounting Officer)

Dated: November 6, 2017

Wells Fargo Real Estate Investment Corp. - FORM 10-Q - November 6, 2017

Attached files

Wells Fargo Real Estate Investment Corp. Reports