UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: June 30, 2005

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                           to                          

Commission file number: 1-13759

REDWOOD TRUST, INC.

(Exact name of Registrant as specified in its Charter)

Maryland		68-0329422
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
One Belvedere Place, Suite 300
Mill Valley, California		94941
(Address of principal executive offices)		(Zip Code)

(415) 389-7373
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the Registrant (1) has filed all documents and 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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ                  No o

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

Common Stock ($0.01 par value per share)		24,721,164 as of August 4, 2005

 

 

REDWOOD TRUST, INC.
FORM 10-Q

INDEX

				PAGE
		PART I.  FINANCIAL INFORMATION
Item I.		Financial Statements
		Consolidated Balance Sheets at June 30, 2005 and December 31, 2004 (unaudited)			3
		Consolidated Statements of Income for the three and six months ended June 30, 2005 and 2004 (unaudited)			4
		Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2005 and 2004 (unaudited)			5
		Consolidated Statements of Stockholders’ Equity for the six months ended June 30, 2005 and 2004 (unaudited)			6
		Consolidated Statements of Cash Flows for the six months ended June 30, 2005 and 2004 (unaudited)			7
		Notes to Consolidated Financial Statements			8
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			39
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			74
Item 4.		Controls and Procedures			74
		PART II.  OTHER INFORMATION
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			76
Item 4.		Submission of Matters to a Vote of Security Holders			76
Item 6.		Exhibits			76
		SIGNATURES			77
EXHIBIT 11.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)

		June 30, 2005				December 31, 2004
ASSETS
Residential real estate loans		$	19,383,193			$	22,208,417
Residential home equity lines of credit			247,372				296,348
Residential loan credit-enhancement securities			706,195				561,658
Commercial real estate loans			41,794				54,479
Securities portfolio			1,678,234				1,394,575
Cash and cash equivalents			72,193				57,246
Total Earning Assets			22,128,981				24,572,723
Restricted cash			47,460				36,038
Accrued interest receivable			85,358				72,459
Interest rate agreements			12,467				16,144
Principal receivable			284				2,653
Deferred tax asset			6,821				10,572
Deferred asset-backed security issuance costs			58,522				60,993
Other assets			5,862				6,483
Total Assets		$	22,345,755			$	24,778,065
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES
Redwood debt		$	452,829			$	203,281
Asset-backed securities issued			20,814,551				23,630,162
Accrued interest payable			42,799				35,064
Interest rate agreements			2,897				1,124
Accrued expenses and other liabilities			23,669				28,095
Dividends payable			17,253				16,183
Total Liabilities			21,353,998				23,913,909
Commitments and contingencies (Note 11)
STOCKHOLDERS’ EQUITY
Common stock, par value $0.01 per share, 50,000,000 shares authorized; 24,646,963 and 24,153,576 issued and outstanding			246				242
Additional paid-in capital			801,917				773,222
Accumulated other comprehensive income			137,380				105,357
Cumulative earnings			583,084				481,607
Cumulative distributions to stockholders			(530,870	)			(496,272	)
Total Stockholders’ Equity			991,757				864,156
Total Liabilities and Stockholders’ Equity		$	22,345,755			$	24,778,065

The accompanying notes are an integral part of these consolidated financial statements.

REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share data)
(Unaudited)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Interest Income
Residential real estate loans		$	202,249			$	111,113			$	398,433			$	212,450
Residential home equity lines of credit			2,434				803				4,895				803
Residential loan credit-enhancement securities			19,439				16,077				39,063				31,610
Commercial real estate loans			1,208				868				2,610				1,569
Securities portfolio			20,727				10,545				38,667				20,156
Cash and cash equivalents			804				73				1,384				239
Interest income before provision for credit losses			246,861				139,479				485,052				266,827
Reversal of (provision for) credit losses			1,527				(1,500	)			502				(4,011	)
Total interest income			248,388				137,979				485,554				262,816
Interest Expense
Redwood debt			(1,825	)			(2,490	)			(4,553	)			(5,061	)
Asset-backed securities issued			(193,355	)			(87,869	)			(366,594	)			(164,875	)
Total interest expense			(195,180	)			(90,359	)			(371,147	)			(169,936	)
Net Interest Income			53,208				47,620				114,407				92,880
Operating expenses			(11,284	)			(8,461	)			(22,256	)			(18,487	)
Net recognized gains and valuation adjustments			3,045				12,258				18,057				29,695
Net income before provision for income taxes			44,969				51,417				110,208				104,088
(Provision) benefit for income taxes			(4,054	)			3,671				(8,731	)			1,791
Net Income		$	40,915			$	55,088			$	101,477			$	105,879
Basic Earnings Per Share:		$	1.66			$	2.67			$	4.15			$	5.29
Diluted Earnings Per Share:		$	1.62			$	2.58			$	4.04			$	5.08
Regular dividends declared per common share		$	0.70			$	0.67			$	1.40			$	1.34
Special dividends declared per common share			—				—				—				0.50
Total dividends declared per common share		$	0.70			$	0.67			$	1.40			$	1.84
Basic weighted average shares outstanding			24,591,223				20,630,186				24,474,134				20,028,267
Diluted weighted average shares outstanding			25,196,286				21,325,075				25,109,390				20,855,647

The accompanying notes are an integral part of these consolidated financial statements.

REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Net income			$40,915			$	55,088			$	101,477			$	105,879
Other comprehensive income:
Net unrealized gains on available-for-sale securities (AFS)			33,420				12,669				50,778				29,797
Reclassification adjustment for net (gains) included in net income			(2,921	)			(9,089	)			(12,963	)			(20,943	)
Net unrealized gains (losses) on cash flow hedges			(17,984	)			28,863				(5,990	)			19,540
Reclassification of net realized cash flow hedge losses to interest expense on asset-backed securities issued			81				261				198				648
Total other comprehensive income			12,596				32,704				32,023				29,042
Comprehensive Income			$53,511			$	87,792			$	133,500			$	134,921

The accompanying notes are an integral part of these consolidated financial statements.

REDWOOD TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except share data)
(Unaudited)

For the Six Months Ended June 30, 2005:

		Common Stock								Additional				Other								Cumulative
										Paid-in				Comprehensive				Cumulative				Distributions to
		Shares				Amount				Capital				Income				Earnings				Stockholders				Total
December 31, 2004			24,153,576			$	242			$	773,222			$	105,357			$	481,607				$(496,272	)		$	864,156
Comprehensive income:
Net income			—				—				—				—				101,477				—				101,477
Net unrealized gain on assets AFS			—				—				—				37,815				—				—				37,815
Net unrealized (loss) on interest rate agreements			—				—				—				(5,792	)			—				—				(5,792	)
Total comprehensive income			—				—				—				—				—				—				133,500
Issuance of common stock:
Secondary Offerings			—				—				—				—				—				—				—
Dividend Reinvestment & Stock Purchase Plans			469,556				4				25,564				—				—				—				25,568
Employee Option & Stock Plans			14,905				—				1,247				—				—				—				1,247
Restricted Stock & Stock DERs			8,926				—				1,884				—				—				—				1,884
Dividends declared:
Common			—				—				—				—				—				(34,598	)			(34,598	)
June 30, 2005			24,646,963			$	246			$	801,917			$	137,380			$	583,084				$(530,870	)		$	991,757

For the Six Months Ended June 30, 2004:

		Common Stock								Additional				Other								Cumulative
										Paid-in				Comprehensive				Cumulative				Distributions to
		Shares				Amount				Capital				Income				Earnings				Stockholders				Total
December 31, 2003			19,062,983			$	191			$	517,826			$	82,179			$	248,972				$(295,840	)		$	553,328
Comprehensive income:
Net income			—				—				—				—				105,879				—				105,879
Net unrealized gain on assets AFS			—				—				—				8,854				—				—				8,854
Net unrealized gain on interest rate agreements			—				—				—				20,188				—				—				20,188
Total comprehensive income																											134,921
Issuance of common stock:
Secondary Offerings			1,200,000				12				51,988				—				—				—				52,071
Dividend Reinvestment & Stock Purchase Plans			944,135				9				47,803				—				—				—				47,812
Employee Option & Stock Plans			287,681				3				4,937				—				—				—				4,994
Restricted Stock & Stock DERs			16,002				—				2,597				—				—				—				2,472
Dividends declared:
Common			—				—				—				—				—				(37,658	)			(37,658	)
June 30, 2004			21,510,801			$	215			$	625,151			$	111,221			$	354,851				$(333,498	)		$	757,940

The accompanying notes are an integral part of these consolidated financial statements

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)		Six Months Ended June 30,
(Unaudited)		2005				2004
Cash Flows From Operating Activities:
Net income		$	101,477			$	105,879
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of premiums, discounts, and debt issuance costs			(44,169	)			(31,772	)
Depreciation and amortization of non-financial assets			409				215
(Reversal of) provision for credit losses			(502	)			4,011
Non-cash stock compensation			1,884				2,597
Net recognized gains and valuation adjustments			(18,057	)			(29,695	)
Principal payments on real estate loans held-for-sale			381				15
Net sales of real estate loans held-for-sale			14,570				2,339
Net change in:
Accrued interest receivable			(12,900	)			(9,573	)
Principal receivable			2,369				1,506
Deferred income taxes			3,751				—
Other assets			1,468				(6,929	)
Accrued interest payable			7,735				4,956
Accrued expenses and other liabilities			(4,426	)			5,539
Net cash provided by operating activities			53,990				49,088
Cash Flows From Investing Activities:
Purchases of real estate loans held-for-investment			(1,266,047	)			(5,377,250	)
Principal payments on real estate loans held-for-investment			4,120,751				1,330,443
Purchases of real estate securities available-for-sale			(493,047	)			(391,613	)
Proceeds from sales of real estate securities available-for-sale			42,667				30,890
Principal payments on real estate securities available-for-sale			93,735				101,513
Net (increase) decrease in restricted cash			(11,422	)			2,183
Net cash provided by (used in) investing activities			2,486,637				(4,303,834	)
Cash Flows From Financing Activities:
Net borrowings on Redwood debt			249,548				33,447
Proceeds from issuance of asset-backed securities			1,418,299				5,489,808
Deferred asset-backed security issuance costs			(8,189	)			(17,055	)
Repayments on asset-backed securities			(4,177,321	)			(1,342,669	)
Net (proceeds) purchases of interest rate agreements			(1,304	)			2,093
Net proceeds from issuance of common stock			26,815				104,752
Dividends paid			(33,528	)			(35,636	)
Net cash (used in) provided by financing activities			(2,525,680	)			4,234,740
Net increase (decrease) in cash and cash equivalents			14,947				(20,006	)
Cash and cash equivalents at beginning of period			57,246				58,467
Cash and cash equivalents at end of period		$	72,193			$	38,461
Supplemental disclosure of cash flow information:
Cash paid for interest		$	363,412			$	164,980
Cash paid for taxes		$	6,580			$	3,945
Non-cash financing activity:
Dividends declared but not paid		$	17,253			$	14,412

The accompanying notes are an integral part of these consolidated financial statements.

REDWOOD TRUST, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
June 30, 2005
(Unaudited)

NOTE 1. REDWOOD TRUST

Redwood Trust, Inc., together with its subsidiaries (Redwood), invests in, credit-enhances, and securitizes residential and commercial real estate loans and securities. Our primary business is credit-enhancing high-quality jumbo residential real estate loans nationwide. We also invest in securities that represent interests in pools of diverse types of real estate loans, including commercial real estate loans, home equity line of credit loans (HELOCs), real estate collateralized debt obligations (CDOs), and other real estate assets. We have elected to have Redwood Trust, Inc. taxed as a Real Estate Investment Trust (REIT).

Redwood acquires credit enhancement securities (CES) from residential real estate loan securitizations and, to a lesser extent, from commercial real estate loan securitizations. Typically, our residential CES portfolio, as currently presented represents the non-rated, B-rated, and BB-rated securities in a residential real estate loan securitization, while commercial CES represent the non-rated security in a commercial real estate loan securitization. Redwood acquires its residential CES from securitizations sponsored by others as well as from the Sequoia securitizations, which are special purpose entities sponsored by Redwood sponsors. Redwood acquires its commercial CES from securitizations sponsored by others.

Sequoia Residential Mortgage Loan Securitizations
We acquire residential real estate loans from third party originators for our Sequoia residential loan securitization programs. We then sell these loans to Sequoia entities that finance their purchases through the issuance of asset-backed securities (ABS). All but certain CES and a portion of the interest-only securities are sold to unrelated third parties through Sequoia entities. Redwood typically acquires these securities from these Sequoia entities. However, many of these CES are sold to the Acacia CDO resecuritization program that Redwood sponsors (see below). Redwood also acquires other ABS issued by Sequoia for the Acacia CDO program. All other Sequoia ABS are sold to third parties other than Acacia. Redwood’s investment in Sequoia securitizations is small relative to the size of each Sequoia entity, and Redwood’s maximum loss is limited to its investment in these securitizations.

Acacia Securitizations
We acquire various investment grade and non-investment grade residential and commercial real estate securities from third parties and Sequoia for our Acacia CDO securitization programs. We sell these and other securities to Acacia securitization entities, which are special purpose entities sponsored by Redwood and these Acacia entities issue ABS. As with the Sequoia transactions, these securitizations are treated as financings and the assets owned by the Acacia entities are consolidated on our GAAP balance sheets. Redwood typically acquires for its own portfolio the securities issued from Acacia entities that bear the first-loss and second-loss credit risk of the Acacia assets. Similar to the Sequoia transactions, Redwood’s investment in these securitizations is small relative to the size of each Acacia entity, and Redwood’s maximum loss is limited to that investment.

Residential and Commercial Securitizations Sponsored by Others
Residential CES acquired from securitizations sponsored by others are reported as residential loan credit-enhancement securities. Similarly, commercial CES acquired from securitizations sponsored by others are included in securities portfolio.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation
The accompanying consolidated financial statements are unaudited. The unaudited interim consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and, in our opinion, reflect all adjustments (which include only normal recurring adjustments) necessary for a fair statement of our financial position, results of operations, and cash flows. These consolidated financial statements and notes thereto should be read in conjunction with our audited consolidated financial statements included in the Redwood’s Annual Report on Form 10-K for the year ended December 31, 2004. The results for the three and six months ended June 30, 2005 are not necessarily indicative of the expected results for the year ending December 31, 2005. Certain amounts for prior periods have been reclassified to conform to the June 30, 2005 presentation.

The June 30, 2005 and December 31, 2004 consolidated financial statements include the accounts of Redwood and its wholly-owned subsidiaries, Sequoia Mortgage Funding Corporation, Acacia CDO 1, LTD, Acacia CDO 2, LTD, Acacia CDO 3, LTD, Acacia CDO 4, LTD, Acacia CDO 5, LTD, Acacia CDO 6, LTD, Acacia CDO 7, LTD, and RWT Holdings, Inc. (Holdings), and Holdings’ wholly-owned subsidiaries, including Sequoia Residential Funding, Inc. For financial reporting purposes, references to Sequoia mean Sequoia Mortgage Funding Corporation and Sequoia Residential Funding, Inc. References to Acacia mean all of the aforementioned Acacia CDO entities. References to the REIT mean Redwood exclusive of its taxable subsidiaries. The taxable subsidiaries of Redwood are Holdings and Holdings’ wholly owned subsidiaries. All significant inter-company balances and transactions have been eliminated.

Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America (GAAP) requires us to make estimates and assumptions. These include fair value of certain assets, amount and timing of credit losses, prepayment assumptions, and other items that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of certain revenues and expenses during the reported period. Our estimates are inherently subjective in nature and actual results could differ from those estimates.

Securitizations
Redwood treats the securitizations it sponsors as financings under the provisions of Financial Accounting Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 140), as according to FAS 140 we have retained effective control over these loans and securities. Control is maintained through our active management of the assets in the securitization entity, our retained asset transfer discretion, our ability to direct certain servicing decisions, or a combination of the foregoing. Accordingly, the underlying loans owned by the Sequoia entities and the Sequoia ABS issued to third parties are shown on our Consolidated Balance Sheets under residential real estate loans and ABS issued. Assets owned by the Acacia entities are shown on our Consolidated Balance Sheets either in our securities portfolio, (residential real estate backed securities rated BBB and above, commercial real estate securities, CDO, and most corporate REIT debt) or our residential loan credit-enhancement securities (lower rated residential real estate securities). In our Consolidated Statements of Income, we record interest income on the loans and securities and interest expense on the ABS issued. Any Sequoia ABS (CES, investment grade, or interest-only) acquired by Redwood or Acacia from Sequoia entities and any Acacia ABS acquired by Redwood for its own portfolio are eliminated in consolidation and thus are not shown on our consolidated GAAP balance sheets.

Earning Assets
Earning assets (as consolidated for GAAP purposes) consist primarily of residential and commercial real estate loans and securities. Coupon interest is recognized as revenue when earned according to the terms of the loans and securities and when, in our opinion, it is collectible. Purchase discounts and premiums related to earning assets are amortized into interest income over their estimated lives, considering the actual and future estimated prepayments of the earning assets using the interest method (i.e., using an effective yield method). Gains or losses on the sale of earning assets are based on the specific identification method.

Residential and Commercial Real Estate Loans: Held-for-Investment
Real estate loans held-for-investment are carried at their unpaid principal balances adjusted for net unamortized premiums or discounts and net of any allowance for credit losses. The majority of consolidated residential real estate loans are classified as held-for-investment because the consolidated securitization entities that own these assets have the ability and intent to hold these loans to maturity. We

may sell real estate loans from time to time to third-parties other than the securitization entities we sponsor.

Pursuant to Financial Accounting Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Cost of Leases (FAS 91), we use the interest method to determine an effective yield and amortize the premium on loans. For loans acquired prior to July 1, 2004, we use coupon interest rates as they change over time and anticipated principal prepayments. For loans acquired after July 1, 2004, we calculate an effective yield to amortize the premium using the initial coupon interest rate of the loans (without regard to future changes in the underlying indices) and anticipated prepayments.

Commercial real estate loans for which we have the ability and intent to hold to maturity are classified as held-for-investment and are carried at their unpaid balances adjusted for unamortized discount and net of any allowance for credit losses.

Residential and Commercial Real Estate Loans: Held-for-Sale
Residential and commercial real estate loans that we are marketing for sale are classified as real estate loans held-for-sale. These are carried at the lower of original cost or market value on a loan-by-loan basis. Any market valuation adjustments on these loans are recognized in net recognized gains and valuation adjustments in our Consolidated Statements of Income.

Residential Loan Credit-Enhancement and Securities Portfolio Securities: Available-for-Sale
These securities are classified as available-for-sale (AFS) and are carried at their estimated fair values. Cumulative unrealized gains and losses are reported as a component of accumulated other comprehensive income in our Consolidated Statements of Stockholders’ Equity.

When recognizing revenue on AFS securities, we employ the interest method to account for purchase premiums, discounts, and fees associated with these securities. For securities rated AAA or AA, we use the interest method as prescribed under FAS 91, while for securities rated A or lower we use the interest method as prescribed under the Emerging Issues Task Force of the Financial Accounting Standards Board 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets (EITF 99-20). The use of these methods requires us to project cash flows over the remaining life of each asset. These projections include assumptions about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. We review and make adjustments to our cash flow projections on an ongoing basis and monitor these projections based on input and analyses received from external sources, internal models, and our own judgment and experience. There can be no assurance that our assumptions used to estimate future cash flows or the current period’s yield for each asset would not change in the near term.

Redwood monitors its available-for-sale securities for other-than-temporary impairment. We use the guidelines prescribed under EITF 99-20, Financial Accounting Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities (FAS 115), and Staff Accounting Bulletin No. 5(m), Other-Than-Temporary Impairment for Certain Investments in Debt and Equity Securities (SAB 5(m)). Any other-than-temporary impairments are reported under net recognized gains and losses and valuation adjustments in our Consolidated Statements of Income.

Credit Reserves
For consolidated residential loans, HELOC loans, and commercial real estate loans held-for-investment, we establish and maintain credit reserves based on estimates of credit losses inherent in these loan portfolios as of the balance sheet date. To calculate the credit reserve, we assess inherent losses by determining loss factors (defaults, the timing of defaults, and loss severities upon defaults) that can be specifically applied to each of the consolidated loans, loan pools or individual loans. We follow the guidelines of Staff Accounting Bulletin No. 102, Selected Loan Loss Allowance Methodology and Documentation (SAB 102), and Financial Accounting Statement No. 5, Accounting for Contingencies (FAS 5), in setting credit reserves for our residential and commercial loans.

The following factors are considered and applied in such determination:

	•		On-going analysis of the pool of loans — including, but not limited to, the age of loans, underwriting standards, business climate, economic conditions, geographical considerations, and other observable data
	•		Historical loss rates and past performance of similar loans
	•		Relevant environmental factors
	•		Relevant market research and publicly available third-party reference loss rates
	•		Trends in delinquencies and charge-offs

	•		Effects in changes in credit concentrations
	•		Prepayment assumptions

Once we determine applicable default amounts, the timing of the defaults, and severities of losses upon the defaults, we estimate expected losses for each pool of loans over its expected life. We then estimate the timing of these losses and the losses probable to occur over an effective loss confirmation period. This period is defined as the range of time between the probable occurrence of a credit loss (such as the initial deterioration of the borrower’s financial condition) and the confirmation of that loss (the actual impairment or charge-off of the loan). The losses expected to occur within the effective loss confirmation period are the basis of our credit reserves because we believe those losses exist as of the reported date of the financial statements. We re-evaluate the level of our credit reserves on at least a quarterly basis, and we record provision, charge-offs, and recoveries monthly.

Additionally, if a loan becomes real estate owned (REO) or is reclassified as held-for-sale, valuations specific to that loan also include analysis of the underlying collateral.

The credit reserve for credit losses for the commercial real estate loan portfolio includes a detailed analysis of each loan and the underlying property. The following factors are considered and applied in such determination.

	•		On-going analysis of each individual loan
	•		On-going evaluation of fair values of collateral using current appraisals and other valuations
	•		Discounted cash flow analysis
	•		Perfection of security interest
	•		Borrowers’ ability to meet obligations

We follow the guidelines of Financial Accounting Statement No. 114, Accounting by Creditors for Impairment of a Loan (FAS 114), in determining impairment on commercial real estate loans. We had no impaired loans as of June 30, 2005 or December 31, 2004.

Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less.

Other Assets
Restricted Cash
Restricted cash includes principal and interest payments from real estate loans and securities owned by consolidated securitization entities that are collateral for or payable to ABS issued by those entities, cash pledged as collateral on interest rate agreements, and cash held back from borrowers until certain loan agreement requirements are been met. Corresponding liabilities for cash held back from borrowers are included in accrued expenses and other liabilities on our Consolidated Balance Sheets.

Deferred Tax Assets
Net deferred tax assets represent the net benefit of net operating loss carry forwards, real estate asset basis differences, and recognized tax gains on whole loan securitizations that will be recognized under GAAP through the financial statements in future periods.

Deferred Asset-Backed Security Issuance Costs
Deferred ABS issuance costs are costs associated with the issuance of ABS from securitization entities we sponsor. These costs typically include underwriting, rating agency, legal, accounting, and other fees. Deferred ABS issuance costs are reported on our Consolidated Balance Sheets as deferred charges and are amortized as an adjustment to consolidated interest expense using the interest method based on the actual and estimated repayment schedules of the related ABS issued.

Other Assets
Other assets on our Consolidated Balance Sheets include REO, fixed assets, prepaid interest, and other prepaid expenses. REO is reported at the lower of cost or market.

Interest Rate Agreements
We maintain an overall interest rate risk management strategy that incorporates the use of derivative interest rate agreements for a variety of reasons, including minimizing significant fluctuations in earnings or market values on certain assets or liabilities that may be caused by interest rate volatility. Interest rate agreements we use as part of our interest rate risk management strategy may include interest rate options, swaps, options on swaps, futures contracts, options on futures contracts, and options on forward purchases (collectively referred to as interest rate agreements).

On the date an interest rate agreement is entered into, we designate the interest rate agreement as (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge), or (3) held for trading (trading instrument). We currently have elected cash flow hedging treatment for certain interest rate agreements and treat other interest rate agreements as trading investments.

In a cash flow hedge, the effective portion of the change in the fair value of the hedging derivative is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings when the hedging relationship is terminated. The change in fair value of any ineffective portion of the hedging derivative is recognized immediately in earnings.

If we do not elect hedge accounting treatment (i.e., we designate the interest rate agreement as a “trading instrument”) changes in the market value of the interest rate agreement are reported through earnings.

We discontinue hedge accounting when (1) we determine that the derivative is no longer expected to be effective in offsetting changes in the fair value of cash flows of the designated hedged item; (2) the derivative expires or is sold, terminated, or exercised; (3) the derivative is de-designated as a fair value or cash flow hedge; or (4) it is probable that the forecasted transaction will not occur by the end of the originally specified time period.

See Note 5 for a further discussion on interest rate agreements.

Risks and Uncertainties
We take certain risks inherent in financial institutions, including, but not limited to, credit risk, liquidity risk, interest rate risk, prepayment risk, market value risk, reinvestment risk, and capital risk. In addition, there are several other risks and uncertainties specific to our business. We seek to actively manage these risks and uncertainties while also providing our stockholders with an appropriate rate of return in light of these risks and uncertainties. There can be no assurance that risks and uncertainties are adequately provided for in our financial statements.

Debt and Asset-Backed Securities Issued
Redwood debt is short-term debt collateralized by loans and securities held temporarily for future sale to securitization entities. We carry this debt on our balance sheet at its unpaid principal balance. Redwood currently does not have any long-term debt.

The majority of our consolidated liabilities reported on our Consolidated Balance Sheets represent ABS issued by bankruptcy-remote securitization entities sponsored by Redwood. These ABS issued are carried at their unpaid principal balances net of any unamortized discount or premium. Our exposure to loss from consolidated securitization entities (such as Sequoia and Acacia) is limited (except, in some circumstances, for limited loan repurchase obligations) to our net investment in securities we have acquired from these entities. As required by the governing documents related to each series of ABS, Sequoia and Acacia assets are held in the custody of trustees. Trustees collect principal and interest payments (less servicing and related fees) from the assets and make corresponding principal and interest

payments to the issued ABS. ABS obligations are payable solely from the assets of these entities and are otherwise non-recourse to Redwood.

Taxes
We have elected to be taxed as a REIT under the Internal Revenue Code and the corresponding provisions of state law. In order to qualify as a REIT, we must distribute at least 90% of our annual REIT taxable income (this does not include taxable income retained in our taxable subsidiaries) to stockholders within the time frame set forth in the tax rules, and we must meet certain other requirements. If these requirements are met, we generally will not be subject to Federal or state income taxation at the corporate level with respect to the REIT taxable income we distribute to our stockholders. We may retain up to 10% of our REIT taxable income and pay corporate income taxes on this retained income while continuing to maintain our REIT status.

The taxable income of Holdings and its subsidiaries is not included in REIT taxable income, and is subject to state and Federal income taxes at the applicable statutory rates. Deferred income taxes, to the extent they exist, reflect estimated future tax effects of temporary differences between the amounts of taxes recorded for financial reporting purposes and amounts actually payable currently as measured by tax laws and regulations. Holdings provides for deferred income taxes to reflect estimated future tax effects.

We have recorded a provision for income taxes in our Consolidated Statements of Income based upon our estimated liability for Federal and state income tax purposes. These tax liabilities arise from estimated taxable earnings in taxable subsidiaries and from the planned retention of a portion of our estimated REIT taxable income. See Note 8 for further discussion on income taxes.

Net Income Per Share
Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted average number of common shares and potential common shares outstanding during the period. Potential common shares outstanding are calculated using the treasury stock method, which assumes that all dilutive common stock equivalents are exercised and the funds generated by the exercise are used to buy back outstanding common stock at the average market price of the common stock during the reporting period.

Pursuant to EITF 03-6, Participating Securities and the Two-Class Method under FASB No. 128 (EITF 03-6), it was determined that there was no allocation of income for our outstanding stock options, which accrue dividend equivalent rights, as they were antidilutive during the three and six months ended June 30, 2005 and 2004. There were no other participating securities during these periods.

The following table provides reconciliation of denominators of the basic and diluted net income per share computations.

Basic and Diluted Net Income Per Share

(in thousands, except share data)

For the three months ended June 30, 2005 and 2004, the number of common shares that were anti-dilutive totaled 370,805 and 235,840 respectively. For the six months ended June 30, 2005 and 2004, the number of common shares that were anti-dilutive totaled 168,636 and 16,214, respectively.

Comprehensive Income
Current period net unrealized gains and losses on residential loan CES, securities portfolio available-for-sale, and interest rate agreements classified as cash flow hedges are reported as a component of comprehensive income on our Consolidated Statements of Comprehensive Income and Consolidated Statements of Stockholders’ Equity. See Note 10 for further discussion of accumulated other comprehensive income.

Stock-Based Compensation
As of June 30, 2005 and December 31, 2004, we had one stock-based employee compensation plan and one employee stock purchase plan. These plans are described more fully in Note 10. In accordance with the guidance of Financial Accounting Statement No. 148, Accounting for Stock Based Compensation — Transition and Disclosure, an amendment for FASB Statement No. 123, (FAS 148) we elected to prospectively apply the fair value method of accounting for stock-based awards issued subsequent to December 31, 2002.

We continue to account for all stock-based compensation awards issued prior to December 31, 2002 under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations. Under these provisions, when we granted stock-based compensation awards we did not include any stock-based employee compensation cost in net income, as all awards granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant.

Had Redwood applied Financial Accounting Statement No. 123, Accounting for Stock-Based Compensation (FAS 123) to options granted prior to 2003, net income and net income per share would have been the pro-forma amounts indicated below:

Pro-Forma Net Income Under FAS 123
(in thousands, except share data)

		Three Months Ended June 30,								Six Months Ended June 30,
		2005				2004				2005				2004
Net income, as reported		$	40,915			$	55,088			$	101,477			$	105,879
Add: Dividend equivalent right operating expenses under APB 25			1,779				2,989				3,558				5,594
Add: Stock option operating (income) expenses under APB 25			2				(621	)			(81	)			808
Deduct: Stock-based employee compensation expense determined under fair value based method for awards granted prior to January 1, 2003			(219	)			(277	)			(470	)			(592	)
Pro forma net income		$	42,477			$	57,179			$	104,484			$	111,689
Earnings per share:
Basic—as reported		$	1.66			$	2.67			$	4.15			$	5.29
Basic—pro forma		$	1.73			$	2.77			$	4.27			$	5.58
Diluted—as reported		$	1.62			$	2.58			$	4.04			$	5.08
Diluted—pro forma		$	1.69			$	2.68			$	4.16			$	5.36

The Black-Scholes option-pricing model was used in determining fair values of option grants accounted for under FAS 123. The model requires the use of assumptions such as strike price, expected life, risk free rate of return, and stock price volatility. These options are generally granted over the course of the calendar year. Some of the options granted in the first three and six months of 2005 and 2004 had dividend equivalent rights, and accordingly, the assumed dividend yield was zero. Other options granted during these periods had no DER’s and assumed dividend yields of 10%. See Note 10 for a description of options granted during prior periods. The following table describes the weighted average of assumptions used for calculating the value of options granted in the three months and six months ended June 30, 2005 and 2004.

Weighted Average Assumptions used for Valuation of Options under FAS 123 Granted during period
		Three Months Ended June 30,								Six Months Ended June 30,
		2005				2004				2005				2004
Stock Price Volatility			26.41	%			22.00	%			26.41	%			22.00	%
Risk free rate of return (5 yr Treasury Rate)			3.93	%			4.00	%			4.07	%			3.29	%
Dividend Yield Assumptions			10.00	%			0.00	%			4.45	%			5.18	%

Recent Accounting Pronouncements
The EITF released EITF 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF 03-1). For investments that meet the scope of this pronouncement, EITF 03-1 provides application guidance to determine when an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of impairment. The guidance also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. In general, EITF 03-1 states that if the fair value of an applicable investment is lower than its book value, it is considered impaired. This impairment is considered other-than-temporary unless the investor has the ability and intent to hold the investment for a reasonable period of time sufficient for a forecasted recovery of the value of the asset. Certain disclosure requirements of this pronouncement are currently in effect and are presented in Note 3. The recognition and measurement

guidance of this pronouncement will become effective at a later date to be determined. Accordingly, we continue to evaluate other than temporary impairments as prescribed under EITF 99-20, FAS 115, and SAB 5(m).

In December 2004, a revised version of the original FAS 123 was issued. Financial Accounting Statement No. 123R, Share-Based Payment (FAS 123R), supersedes Accounting Principles Board No. 25, Accounting for Stock Issued to Employees (APB 25). This Statement requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. This Statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and all transactions with employees, except for equity instruments held by employee stock ownership plans. Effective January 1, 2003 and in accordance with the transitional guidance of FAS 148, we elected to prospectively apply the fair value method of accounting for stock-based awards granted subsequent to December 31, 2002. In accordance with the implementation time frame established by the Securities and Exchange Commission in April 2005, we plan to adopt FAS 123R as of January 1, 2006. We are still in the process of evaluating the impact of FAS 123R.

NOTE 3. EARNING ASSETS

As of June 30, 2005 and December 31, 2004, our reported earning assets (owned by us or by consolidated securitization entities) consisted of investments in adjustable-rate, hybrid, and fixed-rate residential and commercial real estate loans and securities and home equity lines of credit. Hybrid loans have an initial fixed coupon rate for three to ten years followed by periodic (usually annual or semi-annual) adjustments. The original maturity of the majority of our residential real estate loans and residential real estate securities is usually twenty-five to thirty years. The original maturity of our commercial real estate loans and commercial real estate securities is generally up to ten years. The original maturity of our home equity lines of credit is ten years. The actual amount of principal outstanding is subject to change based on the prepayments of the underlying loans.

For the three months ended June 30, 2005 and 2004, the average consolidated balance of earning assets was $22.6 billion and $20.3 billion, respectively. For the six months ended June 30, 2005 and 2004, the average consolidated balance of earning assets was $23.3 billion and $19.2 billion, respectively.

Residential Real Estate Loans
We acquire residential real estate loans from third party originators for sale to securitization entities sponsored by us under our Sequoia program. We sell these loans to Sequoia securitization entities, which, in turn, issue ABS (that are shown as liabilities on our Consolidated Balance Sheets). The following table presents the carrying value of consolidated real estate loans as June 30, 2005 and December 31, 2004.

Residential Real Estate Loans Carrying Value
(in thousands)

		June 30, 2005												December 31, 2004
		Held-for-Sale				Held-for-Investment				Total				Held-for-Sale				Held-for-Investment				Total
Current face		$	59,830			$	19,142,279			$	19,202,109			$	2,365			$	22,021,523			$	22,023,888
Unamortized Premium			521				202,959				203,480				32				207,575				207,607
Amortized Cost			60,351				19,345,238				19,405,589				2,397				22,229,098				22,231,495
Lower of cost-or-market adjustments			—				—				—				(375	)			—				(375	)
Reserve for Credit Losses			—				(22,396	)			(22,396	)			—				(22,703	)			(22,703	)
Carrying Value		$	60,351			$	19,322,842			$	19,383,193			$	2,022			$	22,206,395			$	22,208,417

Loans held-for-investment are primarily residential real estate loans sold to securitization entities and are consolidated on our Consolidated Balance Sheets. Loans acquired for future sale to sponsored securitization entities are also classified as held-for-investment. Loans held-for-sale are those we anticipate selling to third parties other than Redwood-sponsored securitization entities and are reported at the lower of cost or market.

We may exercise our right to call ABS issued by entities sponsored by us and subsequently sell the loans to third parties. If these transactions are not completed within a reporting period, we reclassify held-for-investment loans to held-for-sale loans once we determine which loans will be sold to third parties. To the

extent these transactions are completed within a reporting period, the sale of loans is reported as a sale of loans held-for-investment in our Statements of Cash Flows.

The following table provides detail of the activity of our residential real estate loan held-for-sale and held-for-investment portfolios for the three and six months ended June 30, 2005 and 2004.

Residential Real Estate Loans Activity		Three Months Ended June 30,								Six Months Ended June 30,
(in thousands)		2005				2004				2005				2004
Residential Real Estate Loans at beginning of period		$	21,493,224			$	18,086,505			$	22,208,417			$	16,239,160
Acquisitions			426,806				2,703,443				1,259,189				5,025,149
Sales (other than to consolidated ABS trusts)			(3,378	)			—				(3,378	)			—
Principal repayments			(2,525,628	)			(859,148	)			(4,064,294	)			(1,319,482	)
Transfers to REO			(642	)			—				(1,209	)			—
Premium amortization			(8,937	)			(13,992	)			(15,973	)			(25,508	)
Credit provision			1,494				(1,233	)			187				(3,744	)
Net recognized gains and valuation adjustments			254				—				254				—
Residential Real Estate Loans at end of period		$	19,383,193			$	19,915,575			$	19,383,193			$	19,915,575

Our goal is to sell all of the residential real estate loans we acquire to securitization entities that finance their purchases of loans from us through the issuance of ABS. During the period we accumulate loans for securitization, we fund these loans with equity and with short-term borrowings sourced through various whole loan-financing facilities available to us.

The table below presents information regarding residential real estate loans pledged under our borrowing agreements.

		June 30, 2005								December 31, 2004
		Face Value				Carrying Value				Face Value				Carrying Value
Unpledged		$	89,030			$	89,850			$	3,618			$	3,288
Pledged for Redwood debt			208,591				209,919				188,707				190,207
Owned by securitization entities, financed through the issuance of ABS			18,904,488				19,083,424				21,831,563				22,014,922
Total Value		$	19,202,109			$	19,383,193			$	22,023,888			$	22,208,417

Residential Home Equity Lines of Credit (HELOCs)

There were $0.1 million HELOC purchases during the three and six months ended June 30, 2005. We acquired $335 million HELOC’s during the three and six months ended June 30, 2004. There were no sales during these periods to unrelated third parties. These HELOCs are indexed to the prime rate and were sold (or we intend to sell) to a securitization entity that, in turn, issued (or will issue) ABS. The table below represents the carrying value of consolidated HELOCs.

		June 30, 2005				December 31, 2004
		Held-for-Investment				Held-for-Investment
Current face		$	241,278			$	288,954
Unamortized premium			6,657				8,087
Amortized cost			247,935				297,041
Reserve for credit losses			(563	)			(693	)
Carrying value		$	247,372			$	296,348

Our goal is to sell the HELOCs we accumulate to securitization entities that raise the proceeds necessary through the issuance of ABS. As of June 30, 2005 and December 31, 2004, substantially all consolidated HELOCs were owned by our securitization entities.

Residential Loan Credit-Enhancement Securities

The residential loan credit-enhancement securities shown on our Consolidated Balance Sheets include non-rated, B-rated, and BB-rated securities acquired from securitizations sponsored by others. Our residential loan CES provided some level of credit enhancement on $164 billion and $126 billion high-quality residential real estate loans securitized by entities not sponsored by us as of June 30, 2005 and December 31, 2004, respectively.

		June 30, 2005				December 31, 2004
		Securities Available-				Securities
		for-Sale				Available-for-Sale
Current face		$	1,103,737			$	933,772
Unamortized discount			(96,488	)			(108,141	)
Portion of discount designated as credit protection			(404,180	)			(342,706	)
Amortized cost			603,069				482,925
Gross unrealized gains			109,026				84,390
Gross unrealized losses			(5,900	)			(5,657	)
Carrying value		$	706,195			$	561,658

As a result of the concentrated credit risk associated with CES, we are generally able to acquire these securities at a discount to their face (principal) value. A portion of this discount is designed as credit protection and the remainder is accreted into income over the remaining life of the security.

The amount of designated credit protection equals the amount of credit losses within the underlying loan pool that we expect to incur over the life of the loans. This estimate is determined based upon various factors affecting these assets, including economic conditions, characteristics of the underlying loans, delinquency status, past performance of similar loans, and external credit protection. We use a variety of internal and external credit risk cash flow modeling and portfolio analytical tools to assist in our assessments. Quarterly, we complete our assessments on each individual underlying loan pool and determine the appropriate level of credit protection required for each security we own. The designated credit protection is specific to each residential loan CES.

The following table presents the changes in our unamortized discount and the portion of the discount designated as credit protection for the three and six months ended June 30, 2005 and 2004.

Residential Loan CES Unamortized Discount and Designated Credit Protection
(in thousands)

		Three Months Ended June 30,								Six Months Ended June 30,
		2005				2004				2005				2004
Beginning balance of unamortized discount		$	89,405			$	110,994			$	108,141			$	123,329
Amortization of discount			(7,775	)			(8,847	)			(16,502	)			(17,485	)
Calls, sales, and other			(2,634	)			(8,505	)			(15,542	)			(23,417	)
Re-designation of credit protection to discount			23,518				18,888				24,773				28,430
Acquisitions			(6,026	)			9,278				(4,382	)			10,951
Ending balance of unamortized discount		$	96,488			$	121,808			$	96,488			$	121,808
Beginning balance of designated credit protection		$	365,998			$	216,924			$	342,706			$	200,970
Realized credit losses			(578	)			(1,706	)			(1,801	)			(1,809	)
Calls, sales and other			(1,736	)			(3,991	)			(11,348	)			(6,600	)
Re-designation of credit protection to discount			(23,518	)			(18,888	)			(24,773	)			(28,430	)
Acquisitions			64,014				43,196				99,396				71,404
Ending balance of designated credit protection		$	404,180			$	235,535			$	404,180			$	235,535

Yields recognized for GAAP for each security vary as a function of credit results, prepayment rates, and (for our variable rate securities) interest rates. If estimated future credit losses exceed our prior expectations, credit losses occur more quickly than expected, or prepayments occur more slowly than expected, the yield over the remaining life of the security may be adjusted downward. If estimated future credit losses are less than our prior estimate, credit losses occur later than expected, or prepayment rates are faster than expected, the yield over the remaining life of the security may be adjusted upwards over time.

For the three and six months ended June 30, 2005, we recognized losses due to other-than-temporary impairment of $0.1 million. For the three and six months ended June 30, 2004, we recognized losses due to other-than-temporary impairments of $2.6 million and $3.2 million, respectively. These losses are included in net recognized gains and valuation adjustments in our Consolidated Statements of Income.

Gross unrealized gains and losses represent the difference between the net amortized cost and the fair value of individual securities. Gross unrealized losses represent a decline in market value for securities not deemed impaired for GAAP. The following table shows the gross unrealized losses, fair value, and length of time that securities have been in a continuous unrealized loss position of all consolidated residential loan CES as of June 30, 2005. These unrealized losses are not considered to be other-than-temporary impairments because these losses are not due to adverse changes in credit or prepayment speeds and we have the intent and ability to hold these securities for a period sufficient for these securities to potentially recover their value.

Residential Loan CES with Unrealized Losses as of June 30, 2005
(in thousands)

		Less than 12 Months								12 Months or More								Total
		Fair				Unrealized				Fair				Unrealized								Unrealized
		Value				(Losses)				Value				(Losses)				Fair Value				(Losses)
Residential loan credit-enhancement securities		$	129,684			$	(5,742	)		$	4,449			$	(158	)		$	134,133			$	(5,900	)

The following table provides detail of the activity in our residential CES portfolio for the three and six months ended June 30, 2005 and 2004.

Residential Loan CES Activity		Three Months Ended June 30,								Six Months Ended June 30,
(in thousands)		2005				2004				2005				2004
Residential CES at beginning of period		$	611,394			$	374,616			$	561,658			$	378,727
Acquisitions			87,849				75,027				155,658				112,635
Sales (other than to consolidated ABS trusts)			—				—				(27,293	)			(22,416	)
Principal repayments (including calls)			(20,400	)			(46,997	)			(44,332	)			(81,637	)
Discount amortization			7,775				8,847				16,502				17,484
Net unrealized balance sheet gains (losses)			15,207				18,141				24,393				7,341
Net recognized gains and valuation adjustments			4,370				12,605				19,609				30,105
Residential Loan CES at end of period		$	706,195			$	442,239			$	706,195			$	442,239

Of the $20 million and $44 million of principal pay downs in the three and six months ended June 30, 2005, $9 million and $23 million, respectively, represented calls of the securities in accordance with the original issue provisions of individual securitization entities. Of the $47 million and $82 million of principal pay downs in the three and six months ended June 30, 2004, $31 million and $56 million, respectively, represented calls of securities.

We generally fund the first-loss interests of residential CES with equity capital. We generally sell the third-loss interests (and some of the second-loss interests) of the residential loan CES we acquire to securitization entities (Acacia) that re-securitize these assets by issuing ABS. Prior to sale to Acacia, we may fund some of the securities acquired on a temporary basis with short-term borrowings through various financing facilities available to us (see Note 6).

The table below presents information regarding our residential CES pledged under borrowing agreements and securitizations.

Residential Loan CES as Collateral
(in thousands)		June 30, 2005				December 31, 2004
Unpledged		$	381,477			$	350,756
Pledged for Redwood debt			87,582				—
Owned by securitization entities, financed through issuance of ABS			237,136				210,902
Total Carrying Value		$	706,195			$	561,658

Commercial Real Estate Loans

Commercial real estate loans represent first or second lien interests in multifamily, office, retail, and industrial properties. Commercial real estate loans held-for-investment may represent junior participations in first lien interests where we provide credit enhancement to a senior interest.

Commercial Real Estate Loans Carrying Value		June 30, 2005													December 31, 2004
(in thousands)		Held-				Held-for-								Held-				Held-for-
		for-Sale				Investment				Total				for-Sale				Investment				Total
Current face		$	—			$	51,778			$	51,778			$	—			$	65,598			$	65,598
Unamortized (discount) premium			—				(1,843	)			(1,843	)			—				(2,478	)			(2,478	)
Portion of discount designated as credit protection			—				(8,141	)			(8,141	)			—				(8,141	)			(8,141	)
Lower of cost-or-market adjustments			—				—				—				—				—				—
Reserve for credit losses			—				—				—				—				(500	)			(500	)
Carrying Value		$	—			$	41,794			$	41,794			$	—			$	54,479			$	54,479

The following table provides detail of the activity of our commercial real estate loan portfolio for the three and six months ended June 30, 2005 and 2004.

		Three Months Ended								Six Months Ended
Commercial Real Estate Loans Activity		June 30,								June 30,
(in thousands)		2005				2004				2005				2004
Commercial real estate loans at beginning of period		$	56,604			$	22,177			$	54,479			$	22,419
Acquisitions			—				17,066				6,732				17,066
Principal payments			(3,769	)			(3,233	)			(9,036	)			(3,278	)
Net premium amortization			(99	)			(102	)			(129	)			(224	)
Reversal of provisions for credit losses			—				—				185				—
Sales (other than to consolidated ABS trusts)			(11,192	)			(2,339	)			(11,192	)			(2,339	)
Net recognized gains and valuation adjustments			250				(23	)			755				(98	)
Commercial real estate loans at end of period		$	41,794			$	33,546			$	41,794			$	33,546

Our goal is to finance our commercial real estate loans with equity or to sell them to securitization entities sponsored by us. During the accumulation of these loans prior to sale to Acacia, we may fund some of the loans with short-term borrowings through various financing facilities available to us. The table below presents information regarding our commercial real estate loans pledged under borrowing agreements.

Commercial Real Estate Loans as Collateral
(in thousands)		June 30, 2005								December 31, 2004
						Carrying								Carrying
		Face Value				Value				Face Value				Value
Unpledged		$	15,381			$	7,114			$	40,868			$	32,119
Pledged for Redwood debt			9,000				8,710				—				—
Owned by securitization entities, financed through issuance of ABS			27,397				25,970				24,730				22,360
Total carrying value		$	51,778			$	41,794			$	65,598			$	54,479

Securities Portfolio

Securities portfolio assets represent investment-grade security interests in prime residential loans, sub-prime residential loans, commercial real estate loans, second lien residential loans, CDO’s, and corporate REIT debt securities. Also included in this portfolio are commercial loan CES and non-rated interests in CDO’s.

		June 30, 2005				December 31, 2004
Securities Portfolio Carrying Value		Securities				Securities
(in thousands)		Available-for-Sale				Available-for-Sale
Current face		$	1,743,387			$	1,424,563
Unamortized discount			(118,751	)			(73,881	)
Unamortized premium			5,104				5,548
Unamortized premium – interest-only certificates			18,410				21,682
Amortized cost			1,648,150				1,377,912
Gross unrealized gains			35,027				21,774
Gross unrealized losses			(4,943	)			(5,111	)
Carrying value		$	1,678,234			$	1,394,575