UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q


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

For the Quarterly Period Ended: March 31, 2008

OR


o		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 Incorporation or Organization)		(I.R.S. Employer 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)

Securities Registered Pursuant to Section 12(g) of the Act:


Title of Each Class:		Name of Exchange on Which Registered:
Common Stock, par value $0.01 per share		New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

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 o No x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):


Large Accelerated Filer x		Accelerated Filer o		Non-Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

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		32,845,816 as of May 6, 2008

TABLE OF CONTENTS

REDWOOD TRUST, INC.

2008 FORM 10-Q REPORT

TABLE OF CONTENTS


	Page
PART I
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 2008 (unaudited) and December 31, 2007		1
Consolidated Statements of (Loss) Income for the three months ended March 31, 2008 and 2007 (unaudited)		2
Consolidated Statements of Comprehensive Loss for the three months ended March 31, 2008 and 2007 (unaudited)		3
Consolidated Statements of Stockholders’ Equity (Deficit) for the three months ended March 31, 2008 and 2007 (unaudited)		4
Consolidated Statements of Cash Flows for the three months ended March 31, 2008 and 2007 (unaudited)		5
Notes to Consolidated Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		50
Item 3. Quantitative and Qualitative Disclosures about Market Risk		98
Item 4. Controls and Procedures		98
PART II
Item 1. Legal Proceedings		99
Item 1A. Risk Factors		99
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		99
Item 3. Defaults Upon Senior Securities		99
Item 4. Submission of Matters to a Vote of Security Holders		99
Item 5. Other information		99
Item 6. Exhibits		99
Signatures		100

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS


(In Thousands, Except Share Data) (Unaudited)	March 31, 2008			December 31, 2007
ASSETS
Real estate loans	$	6,774,987		$	7,204,151
Real estate securities – FVO		949,139			—
Real estate securities – AFS		242,030			2,110,080
Other real estate investments		3,437			11,521
Non-real estate investments		78,770			79,125
Cash and cash equivalents		256,895			290,363
Total earning assets		8,305,258			9,695,240
Restricted cash		149,253			118,064
Accrued interest receivable		37,533			45,553
Derivative assets		3,964			5,598
Deferred tax asset		8,481			8,875
Deferred asset-backed securities issuance costs		16,498			39,909
Other assets		24,994			25,233
Total Assets	$	8,545,981		$	9,938,472
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
LIABILITIES
Redwood debt	$	2,086		$	7,561
Asset-backed securities issued – Sequoia		6,544,491			6,946,166
Asset-backed securities issued – Acacia – FVO		1,046,160			3,383,113
Accrued interest payable		43,882			53,796
Derivative liabilities		134,210			81,385
Accrued expenses and other liabilities		15,526			10,441
Dividends payable		24,532			24,289
Subordinated notes		150,000			150,000
Total liabilities		7,960,887			10,656,751
Commitments and contingencies (Note 20)
STOCKHOLDERS’ EQUITY (DEFICIT)
Common stock, par value $0.01 per share, 50,000,000 shares authorized; 32,709,963 and 32,385,073 issued and outstanding		326			324
Additional paid-in capital		1,119,554			1,108,148
Accumulated other comprehensive loss		(93,291	)		(573,766	)
Cumulative earnings (losses)		537,318			(299,626	)
Cumulative distributions to stockholders		(978,813	)		(953,359	)
Total stockholders’ equity (deficit)		585,094			(718,279	)
Total Liabilities and Stockholders’ Equity (Deficit)	$	8,545,981		$	9,938,472

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF (LOSS) INCOME


(In Thousands, Except Share Data) (Unaudited)	Three Months Ended March 31,
(In Thousands, Except Share Data) (Unaudited)	2008			2007
Interest Income
Real estate loans	$	87,565		$	126,850
Real estate securities		74,436			83,458
Other real estate investments		2,092			2,465
Non-real estate investments		732			—
Cash and cash equivalents		3,181			2,332
Total interest income		168,006			215,105
Management fees		1,482			1,180
Interest Expense
Redwood debt		(182	)		(31,094	)
Asset-backed securities issued		(126,047	)		(136,105	)
Subordinated notes		(2,533	)		(2,057	)
Total interest expense		(128,762	)		(169,256	)
Net Interest Income Before Market Valuation Adjustments		40,726			47,029
Market valuation adjustments, net		(193,932	)		(10,264	)
Net Interest (Loss) Income		(153,206	)		36,765
Operating expenses		(16,368	)		(17,802	)
Realized gains on sales and calls, net		42			1,146
Other expense		(255	)		—
Net (loss) income before provision for income taxes		(169,787	)		20,109
Provision for income taxes		(1,800	)		(1,800	)
Net (Loss) Income	$	(171,587	)	$	18,309
Basic (loss) earnings per share:	$	(5.28	)	$	0.68
Diluted (loss) earnings per share:	$	(5.28	)	$	0.66
Regular dividends declared per common share	$	0.75		$	0.75
Special dividends declared per common share	$	—		$	—
Total dividends declared per common share	$	0.75		$	0.75
Basic weighted average shares outstanding		32,511,445			26,855,681
Diluted weighted average shares outstanding		32,511,445			27,684,029

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS


(In Thousands) (Unaudited)	Three Months Ended March 31,
(In Thousands) (Unaudited)	2008			2007
Net (Loss) Income	$	(171,587	)	$	18,309
Other Comprehensive Income (Loss)
Net unrealized losses on available-for-sale securities		(52,272	)		(92,685	)
Reclassification adjustment for net losses (gains) included in net (loss) income		73,294			(113	)
Unrealized losses on cash flow hedges, net		—			(6,138	)
Reclassification of net realized cash flow hedge losses (gains) to interest expense on asset-backed securities issued and realized losses (gains) on sales and calls		1,246			(405	)
Total Other Comprehensive Income (Loss)		22,268			(99,341	)
Comprehensive Loss	$	(149,319	)	$	(81,032	)

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

For the Three Months Ended March 31, 2008


(In Thousands, Except Share Data) (Unaudited)	Common Stock				Additional Paid-in Capital		Accumulated Other Comprehensive (Loss) Income			Cumulative (Losses) Earnings			Cumulative Distributions to Stockholders			Total
(In Thousands, Except Share Data) (Unaudited)	Shares		Amount		Additional Paid-in Capital		Accumulated Other Comprehensive (Loss) Income			Cumulative (Losses) Earnings			Cumulative Distributions to Stockholders			Total
December 31, 2007		32,385,073	$	324	$	1,108,148	$	(573,766	)	$	(299,626	)	$	(953,359	)	$	(718,279	)
Net (loss)		—		—		—		—			(171,587	)		—			(171,587	)
Adoption of SFAS No. 159		—		—		—		458,207			1,008,531			—			1,466,738
Net unrealized gain/reclassification on assets AFS		—		—		—		21,022			—			—			21,022
Net unrealized gain/reclassification on interest rate agreements		—		—		—		1,246			—			—			1,246
Issuance of common stock:
Dividend reinvestment & stock purchase plans		273,740		2		9,389		—			—			—			9,391
Employee option & stock purchase plan		51,150		—		611		—			—			—			611
Non-cash equity award compensation		—		—		1,406		—			—			—			1,406
Common dividends declared		—		—		—		—			—			(25,454	)		(25,454	)
March 31, 2008		32,709,963	$	326	$	1,119,554	$	(93,291	)	$	537,318		$	(978,813	)	$	585,094

For the Three Months Ended March 31, 2007



(In Thousands, Except Share Data) (Unaudited)	Common Stock				Additional Paid-in Capital		Accumulated Other Comprehensive (Loss) Income			Cumulative Earnings		Cumulative Distributions to Stockholders			Total
(In Thousands, Except Share Data) (Unaudited)	Shares		Amount		Additional Paid-in Capital		Accumulated Other Comprehensive (Loss) Income			Cumulative Earnings		Cumulative Distributions to Stockholders			Total
December 31, 2006		26,733,460	$	267	$	903,808	$	93,158		$	809,011	$	(803,554	)	$	1,002,690
Net income		—		—		—		—			18,309		—			18,309
Net unrealized (loss)/reclassification on assets AFS		—		—		—		(92,798	)		—		—			(92,798	)
Net unrealized (loss)/reclassification on interest rate agreements		—		—		—		(6,543	)		—		—			(6,543	)
Issuance of common stock:
Dividend reinvestment & stock purchase plans		330,315		3		18,659		—			—		—			18,662
Employee option & stock purchase plan		65,671		1		64		—			—		—			65
Non-cash equity award compensation		—		—		5,117		—			—		—			5,117
Common dividends declared		—		—		—		—			—		(21,462	)		(21,462	)
March 31, 2007		27,129,446	$	271	$	927,648	$	(6,183	)	$	827,320	$	(825,016	)	$	924,040

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS


(In Thousands) (Unaudited)	Three Months Ended March 31,
(In Thousands) (Unaudited)	2008			2007
Cash Flows from Operating Activities:
Net (loss) income	$	(171,587	)	$	18,309
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Amortization of premiums, discounts, and debt issuance costs		(7,664	)		(14,189	)
Depreciation and amortization of non-financial assets		266			342
Provision for credit losses		8,058			3,829
Non-cash equity award compensation		1,406			5,117
Net recognized losses and valuation adjustments		193,890			9,118
Net change in:
Accrued interest receivable		8,020			5,955
Deferred income taxes		394			(315	)
Other assets		6,180			(4,807	)
Accrued interest payable		(9,914	)		1,119
Accrued expenses and other liabilities		5,085			119
Net cash provided by operating activities		34,134			24,597
Cash Flows from Investing Activities:
Purchases of real estate loans held-for-investment		—			(414,422	)
Principal payments on real estate loans held-for-investment		399,844			1,042,027
Purchases of real estate securities available-for-sale		(54,875	)		(650,124	)
Proceeds from sales of real estate securities available-for-sale		—			120,049
Principal payments on real estate securities available-for-sale		17,936			70,043
Net purchases of real estate securities – FVO		(3,341	)		—
Principal payments on real estate securities – FVO		56,290			—
Purchases of other real estate investments – trading⁽¹⁾		—			(40,818	)
Principal payments on other real estate investments – trading⁽¹⁾		1,008			2,284
Principal payments on non-real estate investments		354			—
Net increase in restricted cash		(31,189	)		(227,947	)
Net cash provided (used) by investing activities		386,027			(98,908	)
Cash Flows from Financing Activities:
Net (repayments) borrowings on Redwood debt		(5,475	)		23,575
Proceeds from issuance of asset-backed securities		—			1,359,833
Deferred asset-backed security issuance costs		—			(5,869	)
Repayments on asset-backed securities		(431,228	)		(1,377,883	)
Net purchases of interest rate agreements		(1,718	)		(601	)
Net proceeds from issuance of common stock		10,002			18,727
Dividends paid		(25,210	)		(19,831	)
Net cash used in financing activities		(453,629	)		(2,049	)
Net decrease in cash and cash equivalents		(33,468	)		(76,360	)
Cash and cash equivalents at beginning of period		290,363			168,016
Cash and cash equivalents at end of period	$	256,895		$	91,656
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest	$	137,214		$	166,977
Cash paid for taxes	$	—		$	450
Non-Cash Financing Activity:
Dividends declared but not paid at period-end	$	24,532		$	20,347

(1)

Cash flows on other real estate investments were reclassified from cash flows from operating activities to investing activities with the adoption of FAS 159 as management concluded that it is appropriate to record the cash flows associated with the portfolio in investing activities due to the nature of, and purpose of its investment.

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 1. Redwood Trust

Redwood Trust, Inc., together with its subsidiaries (Redwood, we, or us), invests in, finances, and manages real estate assets. We invest in residential and commercial real estate loans and in asset-backed securities backed by real estate loans. Our primary focus is credit-enhancing residential and commercial real estate loans. We credit-enhance loans by acquiring and managing the first-loss and other credit-sensitive securities that bear the bulk of the credit risk of securitized loans.

We seek to invest in assets that have the potential to generate sufficient long-term cash flow returns to support our goal of distributing an attractive level of dividends per share to shareholders over time. For tax purposes, we are structured as a real estate investment trust (REIT).

Redwood was incorporated in the State of Maryland on April 11, 1994, and commenced operations on August 19, 1994. Our executive offices are located at One Belvedere Place, Suite 300, Mill Valley, California 94941.

Note 2. Basis of Presentation

The consolidated financial statements presented herein are at March 31, 2008 and December 31, 2007 and for the three months ended March 31, 2008 and 2007.

These consolidated financial statements include the accounts of Redwood Trust, Inc. (Redwood Trust) and its direct and indirect wholly-owned subsidiaries (collectively, Redwood). All intercompany balances and transactions have been eliminated in consolidation. A number of Redwood Trust’s subsidiaries are qualifying REIT subsidiaries and the remainder are taxable subsidiaries. References to the Redwood REIT mean Redwood Trust and its qualifying REIT subsidiaries, excluding taxable subsidiaries.

We currently operate two securitization programs. Our Sequoia program is used for the securitization of residential mortgage loans. References to Sequoia refer collectively to all the Sequoia securitization entities. Our Acacia program is used for the securitization of mortgage-backed securities and other types of financial assets. References to Acacia refer collectively to all of the Acacia CDO securitization entities.

Under the provisions of Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 140), we treat the securitizations we sponsor as financings, as under these provisions we have retained effective control over these loans and securities. Control is maintained through our active management of the assets in the securitization entities, our retained asset transfer discretion, our ability to direct certain servicing decisions, or a combination of the foregoing. Accordingly, the underlying loans and securities owned by these securitization entities are shown on our consolidated balance sheets under real estate loans and real estate securities and the asset-back securities (ABS) issued to third parties are shown on our consolidated balance sheets under ABS issued. In our consolidated statements of (loss) income, we record interest income on the loans and securities and interest expense on the ABS issued. Any Sequoia ABS 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 separately on our consolidated balance sheets and the associated income and expense are not shown separately on our consolidated statements of (loss) income.

In December 2007, we invested in a distressed assets fund, the Opportunity Fund, as a partner and we are the manager. As we hold majority ownership, we have been deemed primary beneficiary of the Opportunity Fund. Minority interest has been consolidated into accrued expenses and other liabilities and other expense on our consolidated balance sheets and consolidated statements of (loss) income, respectively.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 3. Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States (GAAP) requires us to make a significant number of estimates. These include estimates of fair value of certain assets and liabilities, amount and timing of credit losses, prepayment rates, the period of time during which we anticipate an increase in the fair values of real estate securities sufficient to recover unrealized losses in those securities, and other items that affect the reported amounts of certain 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. It is likely that changes in these estimates (e.g., market values due to changes in supply and demand, credit performance, prepayments, interest rates, or other reasons; yields due to changes in credit outlook and loan prepayments) will occur in the near term. Our estimates are inherently subjective in nature and actual results could differ from our estimates and the differences may be material. Our fair values reflect what we believe we could realize if we chose to sell our assets and or pay if we chose to transfer liabilities at the measurement date in an orderly manner. Most of the assets and liabilities consolidated on our balance sheet (in particular our credit-enhancement securities and CDOs) are illiquid. Consequently, establishing fair values for these assets and liabilities is inherently subjective and is dependent upon our estimates and modeling assumptions and indications of value obtained from brokers and dealers. As a consequence of limited trading visibility late in 2007 and early in 2008 and the significant uncertainties regarding credit loss levels, there is a wide variance of opinion related to the assumptions underpinning our market valuation inputs. We expect that the market valuations will continue to be highly volatile. Nonetheless, we believe the fair value and other estimates used in preparation of our financial statements represent appropriate values and income recognition and is in conformity with GAAP for these assets and liabilities even in this uncertain market.

Real Estate Loans

Residential and Commercial Real Estate Loans: Held-for-Investment

Real estate loans include residential and commercial real estate loans. 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.

Coupon interest is recognized as revenue when earned and deemed collectible. We accrue interest on loans until they are more than 90 days past due at which point they are placed on nonaccrual status. Loans are charged off upon foreclosure of the underlying collateral. At that point the net realizable value of the loan is classified as real estate owned (REO) on the balance sheet within other assets. Purchase discounts and premiums related to real estate loans are amortized into interest income over their estimated lives to generate an effective yield, considering the actual and future estimated prepayments of the loans pursuant to the provisions discussed below. Gains or losses on the sale of real estate loans are based on the specific identification method.

Pursuant to Statement of Financial Accounting Standards 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 or discount on loans. For loans acquired prior to July 1, 2004, we use coupon interest rates as they change over time and anticipated principal payments to determine an effective yield to amortize the premium or discount. For loans acquired after July 1, 2004, we use the initial coupon interest rate of the loans (without regard to future changes in the underlying indices) and anticipated principal payments to calculate an effective yield to amortize the premium or discount.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

We may exercise our right to call ABS issued by Sequoia and may subsequently sell the underlying loans to third parties. For balance sheet purposes, we reclassify held-for-investment loans to held-for-sale loans once we determine which loans will be sold to third parties.

Residential and Commercial Real Estate Loans: Held-for-Sale

Residential and commercial real estate loans that we are marketing for sale to independent third parties are classified as real estate loans held-for-sale. These are carried at the lower of cost or fair value on a loan-by-loan basis. Any market valuation adjustments on these loans are recognized in market valuation adjustments, net in our consolidated statements of (loss) income.

Real Estate Loans — Reserve for Credit Losses

For consolidated 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 reporting 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. See Note 11 for a discussion of the reserves for credit losses.

We follow the guidelines of Staff Accounting Bulletin No. 102, Selected Loan Loss Allowance Methodology and Documentation (SAB 102), Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (FAS 5), Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan (FAS 114), and Statement of Financial Accounting Standards No. 118, Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures (FAS 118) in setting credit reserves for our real estate loans.

We consider the following factors in making such determinations:

•

Ongoing analyses 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 and changes in credit concentrations;

•

Information supporting the borrower’s ability to meet obligations;

•

Ongoing evaluations of fair values of collateral using current appraisals and other valuations; and,

•

Discounted cash flow analyses.

Once we determine applicable default amounts, the timing of the defaults, and severity 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 estimated 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.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

We do not maintain a loan repurchase reserve, as any risk of loss due to loan repurchases (i.e., due to breach of representations) would normally be covered by recourse to the companies from whom we acquired the loans.

Real Estate Securities Available-for-Sale (AFS)

Real estate securities classified as available-for-sale (AFS) include residential, commercial, and CDO securities and are carried at their estimated fair values. Cumulative unrealized gains and losses are reported as a component of accumulated other comprehensive loss in our consolidated statements of stockholders’ equity (deficit). Upon sale or other-than-temporary impairment, this accumulated other comprehensive loss is reclassified into earnings on the specific identification method.

Coupon interest is recognized as revenue when earned and deemed collectible. Purchase discounts and premiums related to the securities are amortized into interest income over their estimated lives to generate an effective yield, considering the actual and future estimated prepayments of the securities pursuant to the provisions discussed below. Gains or losses on the sale of securities are based on the specific identification method.

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. Actual maturities of AFS securities are generally shorter than stated contractual maturities and stated maturities are generally greater than ten years. Actual maturities of the AFS securities are affected by the contractual lives of the underlying mortgages, periodic payments of principal, and prepayments of principal. 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, and the change could be material.

Yields recognized for GAAP for each security vary as a function of credit results, prepayment rates, and, for our securities with variable rate coupons, interest rates. For the securities we acquire, if estimated future credit losses are less than our prior estimate, credit losses occur later than expected, or prepayment rates are faster than expected (meaning the present value of projected cash flows is greater than previously expected), the yield over the remaining life of the security may be adjusted upwards. If estimated future credit losses exceed our prior expectations, credit losses occur more quickly than expected, or prepayments occur more slowly than expected (meaning the present value of projected cash flows is less than previously expected), the yield over the remaining life of the security may be adjusted downward. In cases where the fair value of our securities is below our cost basis we may have an other-than-temporary impairment.

For determining other-than-temporary impairment on our real estate securities accounted for as AFS securities, we use the guidelines prescribed under EITF 99-20, Statement of Financial Accounting Standards 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)). Other-than-temporary impairments are reported under market valuation adjustments, net in our consolidated statements of (loss) income. We assess whether a drop in fair value below our cost of the real estate security should be deemed as other-than-temporary impairment. If we have the ability and intent to hold

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

a real estate security for a reasonable period of time sufficient for a forecasted recovery of fair value up to (or beyond) the cost of the investment, we do not deem that unrealized loss an other-than-temporary impairment.

Real Estate Securities Fair Value Option (FVO)

Real estate securities classified within the fair value option (FVO) of Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (FAS 159) (see Note 4) include residential, commercial, and CDO securities and are carried at their estimated fair values. Coupon interest is recognized as revenue when earned and deemed collectible and changes in fair value (gains and losses) are reported through our consolidated statements of (loss) income in market valuation adjustments, net.

Other Real Estate Investments

Other real estate investments include interest-only securities (IOs), net interest margin securities (NIMs), and residual securities (residuals). Statement of Financial Accounting Standards No. 155, Accounting for Certain Hybrid Financial Investments (FAS 155), states that IOs, NIMs, and residuals may contain embedded derivatives which would require bifurcation and separate valuation through the income statement. At the conclusion of the first quarter of 2007 we elected to treat these investments as trading instruments under FAS 115 rather than bifurcate the embedded derivative component under FAS 155. Trading instruments are reported on our consolidated balance sheet at their estimated fair values with changes in fair values reported through our consolidated statements of (loss) income in market valuation adjustments, net.

Total income recognized in current period earnings on these investments equals coupon interest earned plus the change in fair value. Interest income is equal to the instruments’ yields based on market expectations.

As of January 1, 2008 we adopted the FVO for the residuals, NIMs and IOs owned by Acacia and these are now included under FVO securities.

Non-Real Estate Investments

Non-real estate investments represents a guaranteed investment contract (GIC) entered into by an Acacia securitization entity that we consolidate for financial statements purposes. We have classified this investment as a trading security prior to 2008 and as a FVO security subsequent to January 1, 2008. Non-real estate investments are recorded on our consolidated balance sheets at their estimated fair values. Management considers the GIC’s fair value to approximate contract value, as the interest rate is variable at LIBOR minus a spread and resets on a monthly basis. Changes in fair value are reported through our consolidated statements of (loss) income through market valuation adjustments, net. See Note 9 for a further discussion of our non-real estate investments.

Cash and Cash Equivalents

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

Derivative Financial Instruments

All derivative financial instruments are reported at fair value on our consolidated balance sheets regardless of their accounting treatment. Those with a positive value to us are reported as an asset and those with a negative value to us are reported as a liability. Whether changes in the fair value of these instruments are reported through our income statement depends on the type of derivative and the accounting treatment chosen.

We currently enter into interest rate agreements to help manage some of our interest rate risks. We designate an interest rate agreement as (1) a hedge of the fair value of a recognized asset or liability or of an

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

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), (3) held for trading (trading instrument) under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133), or (4) as a FVO derivative under FAS 159. Net purchases and proceeds from interest rate agreements are classified within cash flows as financing activities within the consolidated statements of cash flows.

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 loss and is subsequently reclassified into earnings when the hedging relationship is terminated. The ineffective portion of the cash flow hedge is recognized immediately in earnings. We use the dollar-offset method to determine the amount of ineffectiveness, and we anticipate having some ineffectiveness in our hedging program, as not all terms of our hedges and not all terms of our hedged items match perfectly.

We will discontinue hedge accounting and account for them as trading instruments when (1) we determine that the derivative is no longer expected to be effective in offsetting changes in the fair value or 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.

Upon adoption of FAS 159, hedges in Acacia securitization entities were de-designated as cash flow hedges, as we elected to account for the ABS issued by Acacia as FVO liabilities from January 1, 2008. Since the hedged item still exists, the fair value of these hedges at the time of de-designation remained in accumulated other comprehensive loss and will be amortized through interest expense over the remaining lives of the Acacia ABS issued.

The changes in fair value of FVO derivatives and other derivatives accounted for as trading instruments are reported in the consolidated statements of (loss) income through market valuation adjustments, net.

As of each period end, we may also have outstanding commitments to purchase real estate loans. These commitments are accounted for as derivatives under Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (FAS 149). These are classified as trading instruments and changes in fair value of the purchase commitments are reported through market valuation adjustments, net in the consolidated statements of (loss) income.

We may enter into credit default swaps from time to time. A credit default swap is an agreement to provide (receive) credit event protection based on a financial index or specific security in exchange for receiving (paying) a fixed-rate fee or premium over the term of the contract. Under FAS 133, credit default swaps are accounted for as trading instruments. As of January 1, 2008 we accounted for these under the FVO as they were all owned by Acacia. In both cases changes in fair value are reported in the consolidated statements of (loss) income through market valuation adjustments, net.

See Note 10 for a further discussion of our derivative financial instruments.

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, owners of ABS issued by those entities and cash pledged as collateral on interest rate agreements. Restricted cash may also include cash retained in Acacia or Sequoia securitization trusts and cash contributed to and held within the Opportunity Fund by investors, prior to purchase of loans and securities or the payments on or redemption of outstanding ABS issued.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

Accrued Interest Receivable

Accrued interest receivable represents interest that is due and payable to us. This is generally received within the next month.

Deferred Tax Assets

Income recognition for GAAP and tax differ in material respects. As a result, we may recognize taxable income in periods prior to recognizing the income for GAAP. When this occurs, we pay the tax liability and establish a deferred tax asset for GAAP. When the income is then realized under GAAP in future periods, the deferred tax asset is recognized as an expense. Our deferred tax assets are generated by differences in GAAP and tax income at our taxable subsidiaries.

Deferred Asset-Backed Securities Issuance Costs

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 under the principles prescribed in Accounting Practice Bulletin 21, Interest on Receivables and Payables (APB 21). As of January 1, 2008, the deferred issuance costs associated with Acacia were included in the fair value of ABS issued by Acacia. As a result, these costs were included in our one time adjustment upon adoption of FAS 159 and reclassified into retained earnings. See Note 4 for further details.

Other Assets

Other assets on our consolidated balance sheets include real estate owned (REO), fixed assets, purchased interest, principal receivable, and other prepaid expenses. REO is reported at the lower of cost or fair value. All other assets are reported at cost.

Redwood Debt

Redwood debt is currently all short-term debt collateralized by loans and securities. We report this debt at its unpaid principal balance.

Asset-Backed Securities Issued

The majority of the liabilities reported on our consolidated balance sheets represent ABS issued by bankruptcy-remote securitization entities sponsored by Redwood.

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 ABS investors. ABS obligations are payable solely from the assets of these entities and are not obligations of Redwood.

Sequoia ABS Issued

These ABS issued are carried at their unpaid principal balances net of any unamortized discount or premium. Deferred ABS issuance costs and premiums relating to Sequoia are amortized into interest expense over the lives of the ABS issued.

Acacia ABS Issued

Effective January 1, 2008, the Acacia ABS issued are accounted for under the fair value option and therefore carried at fair value on our consolidated balance sheets. Deferred ABS issuance costs and premiums

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

are not recognized for these ABS and changes in fair value (gains or losses) are reported in the consolidated statements of (loss) income through market valuation adjustments, net. Prior to January 1, 2008 Acacia ABS issued were accounted for under the same method as Sequoia ABS issued.

Subordinated Notes

Subordinated notes include trust preferred securities and subordinated notes. Both are unsecured debt, requiring quarterly interest payments at a floating rate equal to LIBOR plus a spread until they are redeemed in whole, or mature at a future date. These notes contain an earlier optional redemption date without penalty. Subordinated notes are reported on our consolidated balance sheet at cost.

(Loss) Earnings per Share

Basic (loss) earnings per share are computed by dividing net (loss) income by the weighted average number of common shares outstanding during the period. Diluted (loss) earnings per share are computed by dividing net (loss) 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 exercises are used to buy back outstanding common stock at the average market price of the common stock during the reporting period. In accordance with Statement of Financial Accounting Standards No. 128, Earnings per Share (FAS 128), if there is a loss from continuing operations, the common stock equivalents are deemed antidilutive and diluted (loss) earnings per share is calculated in the same manner as basic (loss) earnings per share.

The following table provides a reconciliation of denominators of the basic and diluted (loss) earnings per share computations, for the three months ended March 31, 2008 and 2007.

Basic and Diluted (Loss) Earnings per Share


	Three Months Ended March 31,
	2008			2007
Denominators:
Denominator for basic (loss) earnings per share is equal to the weighted average number of common shares outstanding during the period		32,511,445			26,855,681
Adjustments for diluted (loss) earnings per share are:
Net effect of dilutive stock options		—			828,348
Denominator for diluted (loss) earnings per share		32,511,445			27,684,029
Basic (Loss) Earnings Per Share:	$	(5.28	)	$	0.68
Diluted (Loss) Earnings Per Share:	$	(5.28	)	$	0.66

Pursuant to EITF 03-6, Participating Securities and the Two — Class Method under FASB No. 128 (EITF 03-6), we determined that there was no allocation of income for our outstanding stock options as they were antidilutive, as defined by this principle, for the three months ended March 31, 2008 and 2007. For the three months ended March 31, 2008, Redwood had a net loss, and therefore the number of outstanding stock options, deferred stock units, and restricted stock (collectively, equity awards) that were antidilutive totaled 1,319,346. For the three months ended March 31, 2007, the number of outstanding equity awards that were antidilutive totaled 61,042. There were no other participating securities, as defined by EITF 03-6, during the three months ended March 31, 2008 and 2007.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

Other Comprehensive Income (Loss)

Current period net unrealized gains and losses on real estate securities available-for-sale and interest rate agreements classified as cash flow hedges are reported as components of other comprehensive income (loss) on our consolidated statements of comprehensive loss. Net unrealized gains and losses on securities and interest rate agreements held by our taxable subsidiaries that are reported in other comprehensive income (loss) are adjusted for the effects of tax and may create deferred tax assets or liabilities.

Stock-Based Compensation

As of March 31, 2008 and December 31, 2007, we had one stock-based employee compensation plan and one employee stock purchase plan. These plans, and associated equity awards, are described more fully in Note 18.

We adopted Statement of Financial Accounting Standards No. 123R, Share-Based Payment (FAS 123R), on January 1, 2006. With the adoption of FAS 123R, the grant date fair value of all remaining unvested stock compensation awards (stock options, deferred stock units, and restricted stock) are expensed on the consolidated statements of (loss) income over the remaining vesting period.

The Black-Scholes option-pricing model was used in determining fair values of option grants accounted for under FAS 123R. The model requires the use of inputs such as strike price and assumptions such as expected life, risk free rate of return, and stock price volatility.. The stock price volatility assumption is based on the historical volatility of our common stock. Certain options have dividend equivalent rights (DERs) and, as provided for under FAS 123R, the assumed dividend yield was zero for these options. Other options granted have no DERs and the assumed dividend yield was determined to be 10%. There were no options granted for the three months ended March 31, 2008 and the options granted in the three months ended March 31, 2007 were reload options (as further discussed in Note 18).

The following table describes the weighted average of assumptions used for calculating the value of options granted for the three months ended March 31, 2008 and 2007.

Weighted Average Assumptions Used for Valuation of Options under FAS 123R Granted During Period


	Three Months Ended March 31,
	2008		2007
Stock price volatility		—		25.5	%
Risk free rate of return (5 yr Treasury Rate)		—		4.58	%
Average life		—		6 years
Dividend yield		—		10.00	%

Recent Accounting Pronouncements

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, The Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51, (FAS 160). FAS 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. FAS 160 clarifies that a noncontrolling interest in a subsidiary should be reported as a component of equity in the consolidated financial statements and requires disclosure, on the face of the consolidated statement of (loss) income, of the amounts of consolidated net income attributable to the parent and to the noncontrolled interest. FAS 160 is effective beginning January 1, 2009, with early adoption not permitted. FAS 160 is to be applied prospectively, except for the presentation and disclosure requirements, which upon adoption will be applied retrospectively for all periods presented. We are currently evaluating the disclosure requirements of FAS 160.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

In February 2008, the FASB issued FASB Staff Position 140-3, Accounting for Transfers of Financial Assets and Repurchase Financing Transactions, (FSP 140-3). FSP 140-3 provides that a transferor and a transferee must account for a transfer of a financial asset and a repurchase financing with the same counterparty (or consolidated affiliates of either counterparty) as a linked transaction if the transfer and repurchase financing were entered into contemporaneously or in contemplation of each other unless certain specified criteria are met. Under FSP 140-3, a repurchase financing is a transaction in which the buyer (initial transferee) of a financial asset obtains financing from the seller (initial transferor) and transfers the financial asset back to the seller as collateral until the financing is repaid. FSP 140-3 is effective beginning January 1, 2009, with early adoption not permitted. FSP 140-3 is to be applied prospectively to initial transfers and repurchase financings for which the initial transfer is executed on or after the beginning of the fiscal year in which this FSP is initially applied.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133, (FAS 161). FAS 161 amends and expands the disclosure requirements of FAS 133 to provide greater transparency about how and why an entity uses derivative instruments, how derivative instruments and related hedge items are accounted for under FAS 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity’s financial position, results of operations, and cash flows. To meet those objectives, FAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. FAS 161 is effective January 1, 2009, and early adoption is encouraged. We are currently evaluating the impact FAS No. 161, although we do not expect a significant impact on our financial position, results of operations or cash flows.

Note 4. Adoption of FAS 159

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (FAS 159). This gives us the option of electing to measure eligible financial assets, financial liabilities, and commitments at fair value (i.e., the fair value option or FVO), on an instrument-by-instrument basis. The election to use FVO is available when we first recognize a financial asset or financial liability or enter into a firm commitment or upon the election of FVO on existing instruments on January 1, 2008. Subsequent changes in the fair value of assets, liabilities, and commitments valued under the FVO are recorded in our consolidated statements of income.

On January 1, 2008, we elected to apply the FVO under FAS 159 to the assets and liabilities of our consolidated Acacia securitization entities and all investment grade securities (IGS) at Redwood. Prior to the application of FAS 159, we were required, for financial reporting purposes, to mark-to-market the assets, but not the liabilities, of the Acacia entities, even though the assets and liabilities were paired within the same legal structure and the ABS issued by each Acacia entity would be repaid directly and solely from the cash flows generated by the assets of that entity.

Electing the FVO for the assets and liabilities (including derivatives) of Acacia will enable us to mitigate the volatility in earnings and book value that results from the use of different measurement attributes, to correlate more closely the values of the assets and liabilities that are paired within the same securitization entity, and to reduce the complexity of accounting especially with regards to derivatives under FAS 133. We elected the fair value option for the IGS at Redwood since we expect to pair these investments with a liability for which we will also elect the FVO.

We did not elect the fair value option for the assets and liabilities of Sequoia as these are currently accounted for using similar measurement attributes and, as a result, there is less need to mitigate volatility in earnings and book value. We also did not elect the fair value option for our credit enhancement security

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 4. Adoption of FAS 159 – (continued)

(CES) investments at Redwood that are funded with equity. There is no paired liability for these assets and our intent upon the acquisition of these assets is to hold them to maturity and generate long-term cash flows. Thus, changes in fair values of these investments from period to period through our statements of income, as would be required under the FVO, would not, in our opinion, be appropriate.

As noted above, FAS 159 allows for a one-time election to record the cumulative unrealized gains and losses on those assets, liabilities, and commitments for which the FVO is elected and were existing at the time of initial application of FAS 159. Adjustments resulting from the one-time election are reflected on the balance sheet and have no impact on our consolidated statements of income. Subsequent changes in fair values are recorded in our consolidated statements of income. On January 1, 2008, as a result of the one-time election, we reclassified $459 million of net unrealized gains and losses on Acacia assets and IGS at Redwood to retained earnings from accumulated other comprehensive loss. On that date, we also recorded in retained earnings the $1.5 billion difference between reported values and fair values of the Acacia liabilities.. In addition, as part of the revaluation of the Acacia liabilities to fair value we reclassified to retained earnings the unamortized deferred bond issuance costs of $21 million.. As a result of the adoption of FAS 159 and this one-time election, we recorded a cumulative effect adjustment of $1.5 billion as an increase to stockholders’ equity as of January 1, 2008. There was no deferred tax impact of this increase since the net unrealized losses in accumulated other comprehensive loss that were reclassified to retained earnings were generated at the Redwood REIT, which distributes predominantly all of its taxable income each year.

The following table presents the consolidated balance sheet at December 31, 2007, the transition adjustments, and the consolidated balance sheet at January 1, 2008 following the application of FAS 159.

Adoption of FAS 159


(In Millions)	December 31, 2007 Redwood Consolidated			Transition Adjustment			January 1, 2008 Redwood Consolidated
Real estate loans	$	7,204		$	—		$	7,204
Real estate securities and other investments		2,201			—			2,201
Cash and cash equivalents		290			—			290
Total earning assets		9,695			—			9,695
Restricted cash		118			—			118
Other assets		126			(21	)		105
Total Assets	$	9,939		$	(21	)	$	9,918
Redwood debt	$	8		$	—		$	8
Asset-backed securities issued		10,329			(1,490	)		8,839
Subordinated notes		150			—			150
Other liabilities		170			—			170
Total liabilities		10,657			(1,490	)		9,167
Common stock and additional paid-in capital		1,108			—			1,108
Accumulated other comprehensive (loss) income		(574	)		459			(115	)
Retained earnings		(1,252	)		1,010			(242	)
Total stockholders’ (deficit) equity		(718	)		1,469			751
Total Liabilities and Stockholders’ Equity	$	9,939		$	(21	)	$	9,918

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 5. Fair Value of Financial Instruments

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (FAS 157). This new standard sought to consolidate and clarify the definition of “fair value” that is used throughout GAAP. FAS 157 defines fair value, establishes a methodology for measuring fair value, establishes a hierarchy of information used in measuring fair value, and enhances the disclosure of information about fair value measurements. FAS 157 provides that the “exit price,” which is the price at which an asset could be sold or a liability could be transferred in an orderly process, should be used to fair value the asset or liability. FAS 157 also provides that market data, to the extent available, and not internally generated or entity specific information, should be used to determine fair value. We adopted FAS 157 on January 1, 2008. The financial impact on Redwood of the adoption of FAS 157 was not significant since our valuation methodology used in prior periods did not need to be revised to comply with FAS 157.

FAS 157 also provided a set of disclosures, the most significant being the requirements to disclose the valuations based on a frame work that would group the valuations into a three-level hierarchy based on the ability to observe the significant inputs into the valuation:

Level 1: Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability either directly or through corroboration with observable market data.

Level 3: Unobservable inputs (e.g., an entity’s own data or assumptions).

Level 3 inputs includes situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment, and considers factors specific to the asset or liability. There are also additional requirements to provide a roll forward of the items in Level 3 along with additional discussions on how these valuations are developed.

We estimate fair values of our financial instruments using available market information and other appropriate valuation methodologies. These fair value estimates generally incorporate discounted future cash flows at current market discount rates for comparable investments. We validate our fair value estimates on at least a quarterly basis by obtaining fair value estimates from dealers, to the extent available, for securities who make a market in these financial instruments and look at recent acquisitions and sales if any (even if they occur after the reporting date). We believe the estimates we use reasonably reflect the values we may be able to receive should we choose to sell them. Many factors must be considered in order to estimate fair values, including, but not limited to interest rates, prepayment rates, amount and timing of credit losses, supply and demand, liquidity, and other market factors. Accordingly, our estimates are inherently subjective in nature and involve uncertainty and judgment to interpret relevant market and other data.

Market participants typically place a higher value on bonds with higher ratings and similar loan types should have higher prices and tighter spreads than bonds with lower ratings. Market participants currently also see more value in older vintage bonds where the collateral is more seasoned and there is a better chance that historical home price appreciation has resulted in an increased level of support for the value of the bonds. Our expectation is that, external prices should be within the range or close to our internally developed bid and ask values as the fair values are based on market participant assumptions.

Methodologies we use to estimate fair values for various asset types are described below.

•

Real estate loans

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 5. Fair Value of Financial Instruments – (continued)

•

Residential real estate loan fair values are determined by available market quotes and discounted cash flow analyses.

•

Commercial real estate loan fair values are determined by appraisals on underlying collateral and discounted cash flow analyses.

•

Real estate securities

•

Real estate securities are represented by residential, commercial, CDO and other asset-backed securities. Real estate securities’ fair values are determined by discounted cash flow analyses and other valuation techniques using market pricing assumptions confirmed by third party dealer/pricing indications to the extent available. Significant inputs in the valuation analysis are predominantly Level 3, due to the nature of these instruments and the lack of readily available market quotes. These instruments trade infrequently and therefore have little or no price transparency. Relevant market indicators that are factored in the analyses include bid/ask spreads, credit losses, interest rates, and prepayment speeds. Estimated fair values are based on applying the market indicators to generate discounted cash flows.

•

Other real estate investments

•

Other real estate investments fair values are determined by discounted cash flow analyses and other valuation techniques using market pricing assumptions confirmed by third party dealer/pricing indications.

•

Non-real estate investments

•

Non-real estate investments fair values approximate carrying values as the coupon rates are indexed to LIBOR resetting monthly.

•

Derivative assets and liabilities

•

Our derivative instruments include interest rate agreements and credit default swaps. Fair values of derivative instruments are determined using valuation models and are verified by valuations provided by dealers active in derivative markets. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates, and correlations of such inputs. Model inputs for interest rate agreements can generally be verified and model selection does not involve significant management judgment (these are Level 2 inputs). For other derivatives, valuations are based on various factors such as liquidity, bid/offer spreads, and credit considerations for which we rely on available market evidence. In the absence of such evidence, management’s best estimate is used for these other derivatives, including credit default swaps (these are Level 3 inputs).

•

Cash and cash equivalents

•

Includes cash on hand and highly liquid investments with original maturities of three months or less. Fair values equal carrying values.

•

Restricted cash

•

Restricted cash primarily includes interest-earning cash balances in ABS entities and the Opportunity Fund for the purpose of distribution to bondholders and reinvestment. Due to the short-term nature of the restrictions, fair values approximate carrying values.

•

Accrued interest receivable and payable

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 5. Fair Value of Financial Instruments – (continued)

•

Includes interest due and receivable on assets and due and payable on our liabilities. Due to the short-term nature of when these interest payments will be received or paid, fair values approximate carrying values.

•

Redwood debt

•

All Redwood debt is adjustable and matures within one year; fair values approximate carrying values.

•

ABS issued

•

ABS issued fair values are determined by discounted cash flow analyses and other valuation techniques using market pricing assumptions confirmed by third party dealer/pricing indications to the extent available. Significant inputs in the valuation analysis are predominantly Level 3, due to the nature of these instruments and the lack of readily available market quotes. These instruments trade infrequently and therefore have little or no price transparency. Relevant market indicators that are factored in the analyses include dealer marks to the extent available, bid/ask spreads, external spreads, collateral credit losses, interest rates and collateral prepayment speeds. Estimated fair values are based on applying the market indicators to generate discounted cash flows.

•

Subordinated notes

•

Fair values are determined using comparable market indicators of current pricing.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 5. Fair Value of Financial Instruments – (continued)

The following table presents the carrying values and estimated fair values of our financial instruments as of March 31, 2008 and December 31, 2007.

Fair Value of Financial Instruments


	March 31, 2008				December 31, 2007
(In Thousands)	Carrying Value		Fair Value		Carrying Value		Fair Value
ASSETS
Real estate loans (held-for-investment)	$	6,751,743	$	5,851,167	$	7,199,618	$	6,860,574
Real estate loans (held-for-sale)		4,443		4,443		4,533		4,533
Real estate loans – FVO		18,801		18,801		—		—
Real estate securities – FVO		949,139		949,139		—		—
Real estate securities – AFS		242,030		242,030		2,110,080		2,110,080
Other real estate investments (trading)		3,437		3,437		11,521		11,521
Non-real estate investments		78,770		78,770		79,125		79,125
Cash and equivalents		256,895		256,895		290,363		290,363
Derivative assets		3,964		3,964		5,598		5,598
Restricted cash		149,253		149,253		118,064		118,064
Accrued interest receivable		37,533		37,533		45,553		45,553
LIABILITIES
Redwood debt		2,086		2,086		7,561		7,561
ABS Issued
ABS issued – Sequoia		6,544,491		5,642,142		6,946,166		6,693,087
ABS issued – Acacia – FVO⁽¹⁾		1,046,160		1,046,160		3,383,113		1,893,441
Total ABS issued		7,590,651		6,688,302		10,329,279		8,586,528
Derivative liabilities		134,210		134,210		81,385		81,385
Accrued interest payable		43,882		43,882		53,796		53,796
Subordinated notes		150,000		72,000		150,000		94,000

(1)

Acacia ABS issued is FVO as of January 1, 2008 and was at amortized cost at December 31, 2007 and prior.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 5. Fair Value of Financial Instruments – (continued)

The following table presents information about the assets and liabilities consolidated on our financial statements that are reported at fair value on a recurring basis as of March 31, 2008, and indicates the fair value hierarchy of the valuation techniques utilized to measure fair value.

Assets and Liabilities Measured at Fair Value on a Recurring Basis as of March 31, 2008


			Fair Value Measurements Using
(In Thousands)	Carrying Value		Quoted Prices In Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Real estate loans (held-for-sale)	$	4,443	$	—	$	—	$	4,443
Real estate loans – FVO		18,801		—		—		18,801
Real estate securities – FVO		949,139		—		—		949,139
Real estate securities – AFS		242,030		—		—		242,030
Other real estate investments (trading)		3,437		—		—		3,437
Non-real estate investments		78,770		—		—		78,770
Derivative assets		3,964		—		3,892		72
Liabilities
ABS issued – Acacia		1,046,160		—		—		1,046,160
Derivative liabilities		134,210		—		61,709		72,501

The following table presents information for total net interest income on those assets and liabilities under the FVO.

Net Interest Income on FVO Assets and Liabilities


	Net Interest Income on FVO Assets and Liabilities Three Months Ended March 31, 2008
(In Thousands)	Change in Market Value			Interest Income (Expense)			Total Net Interest Income
Assets
Real estate loans – FVO	$	(4,660	)	$	371		$	(4,289	)
Real estate securities – FVO		(795,283	)		45,462			(749,821	)
Non-real estate investments		—			732			732
Derivative assets		(197	)		—			(197	)
Liabilities
ABS issued – Acacia		809,841			(44,052	)		765,789
Derivative liabilities		(49,587	)		—			(49,587	)
Net Interest Income on FVO Assets and Liabilities	$	(39,886	)		2,513			(37,373	)

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 5. Fair Value of Financial Instruments – (continued)

The following table presents the components of market valuation adjustments, net, recorded in our consolidated statements of (loss) income.

Market Valuation Adjustments, Net


Three Months Ended March 31, 2008 (In Thousands)
Total FVO Market Valuation Adjustments	$	(39,886	)
Other Market Valuation Adjustments
Impairments on AFS securities		(144,098	)
Derivative instruments		(6,392	)
Other real estate investments (trading)		(2,697	)
Real estate loans (HFI/HFS)		(859	)
Market Valuation Adjustments, Net	$	(193,932	)

The following table presents additional information about assets and liabilities reported at fair value on our consolidated balance sheets on a recurring basis and for which Level 3 inputs were utilized to determine fair value. These changes in fair value are after the adoption of FAS 159 on January 1, 2008.

Changes in Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis


						Total Realized and Unrealized Gains or (Losses)
(In Thousands)	Beginning Balance 1/1/2008		Principal Transactions: Investment			Realized Gains or (Losses)			Unrealized Gains or (Losses)			Purchases, Sales, Other Settlements and Issuances, Net			Ending Balance 3/31/2008
Assets
Real estate loans (held-for-sale)	$	4,533	$	(16	)	$	(74	)	$	—		$	—		$	4,443
Real estate loans – FVO		25,426		(116	)		(4,660	)		(1,849	)	$	—			18,801
Real estate securities – FVO		1,792,990		(56,290	)		(795,283	)	$	—			7,722			949,139
Real estate securities – AFS		317,090		(7,071	)		(144,098	)		21,193			54,916			242,030
Other real estate investments (trading)		11,521		(1,008	)		(2,697	)	$	—			(4,379	)		3,437
Non-real estate investments		79,125		(355	)	$	—		$	—		$	—			78,770
Derivative assets		114	$	—			(42	)	$	—		$	—			72
Liabilities
Acacia ABS issued		1,893,441		(30,165	)		(809,841	)	$	—			(7,275	)		1,046,160
Derivative liabilities		57,397	$	—			18,325		$	—			(3,221	)		72,501

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 6. Real Estate Loans

We acquire residential and commercial real estate loans from third party originators. The majority of these loans are sold to securitization entities sponsored by us under our Sequoia and Acacia programs which, in turn, issue ABS. The remainder of the loans we invest in are held and financed with Redwood debt and equity.

The following table summarizes the carrying value of the residential and commercial real estate loans, as reported on our consolidated balance sheets at March 31, 2008 and December 31, 2007.

Real Estate Loans


(In Thousands)	March 31, 2008		December 31, 2007
Residential real estate loans – held-for-sale	$	4,443	$	4,533
Residential real estate loans – held-for-investment		6,751,491		7,173,940
Total residential real estate loans		6,755,934		7,178,473
Commercial real estate loans – FVO		18,801		—
Commercial real estate loans – held-for-investment		252		25,678
Total Real Estate Loans	$	6,774,987	$	7,204,151

At March 31, 2008, we had $5 million (of outstanding principal) of residential loans in held-for-sale, with a lower of cost or fair value of $4 million, (carrying value) as we are actively marketing these loans for sale. At December 31, 2007 there was $6 million (of outstanding principal) for these loans with a lower of cost or fair value of $5 million. The following table provides additional information on the real estate loans classified as held-for-investment as of March 31, 2008 and December 31, 2007.

Real Estate Loans — Held-for-Investment


March 31, 2008 (In Thousands)	Residential Real Estate Loans			Commercial Real Estate Loans			Total
Current face	$	6,697,241		$	11,103		$	6,708,344
Unamortized premium (discount)		78,694			(362	)		78,332
Discount designated as credit reserve		—			(8,141	)		(8,141	)
Amortized cost		6,775,935			2,600			6,778,535
Reserve for credit losses		(24,444	)		(2,348	)		(26,792	)
Carrying Value	$	6,751,491		$	252		$	6,751,743


December 31, 2007 (In Thousands)	Residential Real Estate Loans			Commercial Real Estate Loans			Total
Current face	$	7,106,018		$	38,111		$	7,144,129
Unamortized premium (discount)		86,204			(1,944	)		84,260
Discount designated as credit reserve		—			(8,141	)		(8,141	)
Amortized cost		7,192,222			28,026			7,220,248
Reserve for credit losses		(18,282	)		(2,348	)		(20,630	)
Carrying Value	$	7,173,940		$	25,678		$	7,199,618

Of the $6.7 billion of face and $79 million of unamortized premium on our residential real estate loans at March 31, 2008, $2.4 billion of face and $60 million of unamortized premium relates to residential loans acquired prior to July 1, 2004. For these residential loans, we use coupon interest rates as they change over

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 6. Real Estate Loans – (continued)

time and anticipated principal payments to determine an effective yield to amortize the premium or discount. During the first quarter of 2008, 7% of these residential loans prepaid and we amortized 10% of the premium. Of the $7.1 billion of face and $86 million of unamortized premium on our residential real estate loans at December 31, 2007, $2.5 billion of face and $66 million of unamortized premium relates to residential loans acquired prior to July 1, 2004. For residential loans acquired after July 1, 2004, the face and unamortized premium was $4.3 billion and $19 million at March 31, 2008, respectively, and $4.6 billion and $20 million at December 31, 2007, respectively. For these residential loans, we use the initial coupon interest rate of the loans (without regard to future changes in the underlying indices) and anticipated principal payments to calculate an effective yield to amortize the premium or discount.

Residential real estate loans are either sold to securitization entities sponsored by us under our Sequoia program which, in turn, issue ABS or are held and financed with Redwood debt and equity.

On January 1, 2008 the commercial loans within Acacia were included in the fair value option elections of FAS 159 and are subsequently recorded at fair value. Prior to 2008 these were recorded as held-for-investment real estate loans.

Commercial Real Estate Loans — FVO


March 31, 2008 (In Thousands)	Commercial Real Estate Loans
Current face	$	26,890
Market value discount		(8,089	)
Carrying Value	$	18,801

The table below presents information regarding real estate loans pledged and unpledged under our borrowing agreements at March 31, 2008 and December 31, 2007.

Real Estate Loans Pledged and Unpledged


	March 31, 2008				December 31, 2007
(In Thousands)	Face Value		Carrying Value		Face Value		Carrying Value
Unpledged	$	16,588	$	4,695	$	16,606	$	4,785
Owned by securitization entities, financed through the issuance of ABS		6,724,131		6,770,292		7,133,022		7,199,366
Total	$	6,740,719	$	6,774,987	$	7,149,628	$	7,204,151

Unpledged real estate loans at March 31, 2008 consist of held-for-sale residential loans with a face value of $5 million and a carrying value of $4 million and two commercial loans with a face value of $11 million and a carrying value of $0.3 million.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 7. Real Estate Securities

The real estate securities shown on our consolidated balance sheets include residential, commercial, and CDO securities acquired from securitizations sponsored by others.

Real Estate Securities at Redwood and Opportunity Fund

The table below presents the carrying value (which equals fair value as these are available-for-sale securities (AFS) or fair value option (FVO)) of our securities at Redwood and the Opportunity Fund that are included in our consolidated balance sheets as of March 31, 2008 and December 31, 2007, (but not owned by Acacia) by type of securities, and by credit rating of investment-grade (IGS) and below investment-grade (CES).

Real Estate Securities at Redwood and Opportunity Fund


March 31, 2008 (In Thousands)	AFS – Redwood				AFS – Opportunity Fund				Total AFS Securities		FVO – Redwood				Total Securities
March 31, 2008 (In Thousands)	CES		IGS		CES		IGS		Total AFS Securities		CES		IGS		Total Securities
Residential securities:
Prime	$	77,806	$	18,324	$	—	$	—	$	96,130	$	—	$	1,850	$	97,980
Alt-a		9,113		—		—		457		9,570		—		5,280		14,850
Subprime		937		—		—		8,643		9,580		341		396		10,317
Total residential securities		87,856		18,324		—		9,100		115,280		341		7,526		123,147
Commercial securities		99,523		—		—		—		99,523		—		—		99,523
CDO securities		686		—		—		26,541		27,227		—		15,504		42,731
Total Securities	$	188,065	$	18,324	$	—	$	35,641	$	242,030	$	341	$	23,030	$	265,401



December 31, 2007 (In Thousands)	AFS – Redwood				AFS – Opportunity Fund				Total AFS Securities		FVO – Redwood				Total Securities
December 31, 2007 (In Thousands)	CES		IGS		CES		IGS		Total AFS Securities		CES		IGS		Total Securities
Residential securities:
Prime	$	127,612	$	1,360	$	—	$	—	$	128,972	$	—	$		$	128,972
Alt-a		21,966		9,387		—		—		31,353		—		—		31,353
Subprime		1,432		1,478		—		3,126		6,036		—		—		6,036
Total residential securities		151,010		12,225		—		3,126		166,361		—		—		166,361
Commercial securities		148,508		—		—		—		148,508		—		—		148,508
CDO securities		2,372		18,450		—		12,075		32,897		—		—		32,897
Total Securities	$	301,890	$	30,675	$	—	$	15,201	$	347,766	$	—	$	—	$	347,766

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 7. Real Estate Securities – (continued)

The table below presents the components comprising the carrying value of available-for-sale IGS at Redwood and the Opportunity Fund reported on our consolidated balance sheets at March 31, 2008 and December 31, 2007.

Investment-Grade Securities (AFS) at Redwood and Opportunity Fund


March 31, 2008 (In Thousands)	Residential			Commercial		CDO			Total IGS
Current face	$	56,494		$	—	$	89,645		$	146,139
Unamortized discount, net		(22,015	)		—		(43,959	)		(65,974	)
Discount designated as credit reserve		(20	)		—		(15,000	)		(15,020	)
Amortized cost		34,459			—		30,686			65,145
Gross unrealized gains		13			—		—			13
Gross unrealized losses		(7,048	)		—		(4,145	)		(11,193	)
Carrying Value	$	27,424		$	—	$	26,541		$	53,965


December 31, 2007 (In Thousands)	Residential			Commercial		CDO			Total IGS
Current face	$	31,255		$	—	$	109,726		$	140,981
Unamortized discount, net		(3,991	)		—		(66,451	)		(70,442	)
Discount designated as credit reserve		(12,012	)		—		—			(12,012	)
Amortized cost		15,252			—		43,275			58,527
Gross unrealized gains		469			—		—			469
Gross unrealized losses		(370	)		—		(12,750	)		(13,120	)
Carrying Value	$	15,351		$	—	$	30,525		$	45,876

At March 31, 2008, the Opportunity Fund had $36 million IGS consisting of $9 million residential IGS with a face value of $13 million and $27 million CDO IGS with a face value of $90 million. At December 31, 2007, the Opportunity Fund had $15 million IGS consisting of $3 million residential IGS with a face value of $4 million and $12 million CDO IGS with a face value of $49 million.

The amount of designated credit reserve equals the estimate of credit losses within the underlying loan pool on the CES that we expect to incur over the life of the securities. 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, external credit reserves and priority of cashflows and credit loss attribution within securitizations. We use a variety of internal and external credit risk cash flow modeling and portfolio analytical tools to assist in our assessments. We review our assessments at least quarterly on each individual underlying loan pool and determine the appropriate level of credit reserve required for each security we own. The designated credit reserve is specific to each security.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 7. Real Estate Securities – (continued)

The following table presents the aggregate changes in our amortized discount and the portion of the discount designated as credit reserve on IGS for the three months ended March 31, 2008. We did not have any designated credit reserves on any securities in this portfolio prior to the third quarter of 2007.

Changes in Unamortized Discount and Designated Credit Reserves on Residential, Commercial, and CDO IGS at Redwood and the Opportunity Fund


Three Months Ended March 31, 2008 (In Thousands)	Residential			Commercial			CDO			Total
Beginning balance of unamortized discount, net	$	569,566		$	2,814		$	143,575		$	715,955
Reclassification due to FVO adoption		(568,283	)		(2,814	)		(112,750	)		(683,847	)
Amortization of discount		(382	)		—			(435	)		(817	)
Discount on acquistions		21,114			—			13,569			34,683
Ending Balance of Unamortized Discount, Net	$	22,015		$	—		$	43,959		$	65,974
Beginning balance of designated credit reserve	$	46,641		$	—		$	49,283		$	95,924
Reclassification due to FVO adoption		(46,641	)		—			(49,283	)		(95,924	)
Discount designated as credit reserve on acquistions		20			—			15,000			15,020
Ending Balance of Designated Credit Reserve	$	20		$	—		$	15,000		$	15,020

The IGS at the Opportunity Fund had an unamortized discount balance of $62 million and $32 million at March 31, 2008 and December 31, 2007, respectively.

The table below presents the components comprising the carrying value of available-for-sale CES reported on our consolidated balance sheets at March 31, 2008 and December 31, 2007. These securities are all owned at Redwood.

Credit-Enhancement Securities AFS at Redwood


March 31, 2008 (In Thousands)	Residential			Commercial			CDO			Total CES
Current face	$	778,211		$	523,118		$	26,563		$	1,327,892
Unamortized discount, net		(61,699	)		(36,955	)		(3,513	)		(102,167	)
Discount designated as credit reserve		(586,154	)		(378,388	)		(22,374	)		(986,916	)
Amortized cost		130,358			107,775			676			238,809
Gross unrealized gains		3,238			2,078			10			5,326
Gross unrealized losses		(45,740	)		(10,330	)		—			(56,070	)
Carrying Value	$	87,856		$	99,523		$	686		$	188,065


December 31, 2007 (In Thousands)	Residential			Commercial			CDO			Total CES
Current face	$	791,431		$	523,156		$	26,501		$	1,341,088
Unamortized discount, net		(90,441	)		(17,867	)		(3,096	)		(111,404	)
Discount designated as credit reserve		(510,133	)		(318,456	)		(21,855	)		(850,444	)
Amortized cost		190,857			186,833			1,550			379,240
Gross unrealized gains		10,936			4,923			822			16,681
Gross unrealized losses		(50,783	)		(43,248	)		—			(94,031	)
Carrying Value	$	151,010		$	148,508		$	2,372		$	301,890

The loans underlying all of our residential CES totaled $151 billion at March 31, 2008, and consist of $127 billion prime, $18 billion alt-a, and $6 billion subprime. These loans are located nationwide with a large

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 7. Real Estate Securities – (continued)

concentration in California (49%). During the first quarter of 2008, realized residential credit losses were $31 million of principal value, a rate that equals eight basis points (0.08%) on an annualized basis of the balance of the loans. Serious delinquencies (90+ days, in foreclosure or REO) at March 31, 2008 were 3.06% of current balance and 1.46% of original balance. For loans in prime pools, delinquencies were 1.27% of current balance and 0.60% of original balance. Alt-a pools had delinquencies of 9.51% of current balance and 4.49% of original balance. Subprime pools had delinquencies of 22.13% of current balance and 17.21% of original balance.

When there are other-than-temporary impairments, the balance of the unamortized discount, credit reserve, or a combination of both will increase by the amount of the impairment charge. In the table below, the amount of impairment is first added to the credit reserve and then the amount we believe is based on factors other than an adverse change in cash flow is moved into the unamortized discount balance.

The following table presents the aggregate changes in our unamortized discount and the portion of the discount designated as credit reserve for the three months ended March 31, 2008 and 2007.

Changes in Unamortized Discount and Designated Credit Reserves on Residential, Commercial, and CDO CES at Redwood


Three Months Ended March 31, 2008 (In Thousands)	Residential			Commercial			CDO			Total
Beginning balance of unamortized discount, net	$	316,552		$	95,695		$	12,730		$	424,977
Reclassification due to FVO adoption		(226,112	)		(77,828	)		(9,634	)		(313,574	)
Amortization of (discount) premium		(11,570	)		1,523			—			(10,047	)
Calls, sales, and other		(43	)		48,354			32			48,343
Re-designation between credit reserve and discount		(17,963	)		(30,789	)		385			(48,367	)
Discount on acquistions		835			—			—			835
Ending Balance of Unamortized Discount, Net	$	61,699		$	36,955		$	3,513		$	102,167
Beginning balance of designated credit reserve	$	676,848		$	318,456		$	51,334		$	1,046,638
Reclassification due to FVO adoption		(166,715	)		—			(29,479	)		(196,194	)
Realized credit losses		(30,662	)		(38	)		—			(30,700	)
Calls, sales, and other		—			—			—			—
Impairments on AFS securities		65,483			29,181			904			95,568
Re-designation between credit reserve and discount		17,963			30,789			(385	)		48,367
Discount designated as credit reserve on acquistions		23,237			—			—			23,237
Ending Balance of Designated Credit Reserve	$	586,154		$	378,388		$	22,374		$	986,916

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 7. Real Estate Securities – (continued)


Three Months Ended March 31, 2007 (In Thousands)	Residential			Commercial			CDO		Total
Beginning balance of unamortized discount, net	$	144,842		$	71,424		$	6,889	$	223,155
Amortization of (discount) premium		(18,892	)		9			—		(18,883	)
Calls, sales, and other		2,370			—			—		2,370
Re-designation between credit reserve and discount		22,312			(397	)		—		21,915
Upgrades to investment-grade securities		—			160			115		275
Discount on acquistions		8,037			259			—		8,296
Ending Balance of Unamortized Discount, Net	$	158,669		$	71,455		$	7,004	$	237,128
Beginning balance of designated credit reserve	$	372,247		$	295,340		$	—	$	667,587
Realized credit losses		(3,805	)		(1,271	)		—		(5,076	)
Calls, sales, and other		(1,516	)		—			—		(1,516	)
Re-designation between credit reserve and discount		(22,312	)		397			—		(21,915	)
Discount designated as credit reserve on acquistions		48,149			—			—		48,149
Ending Balance of Designated Credit Reserve	$	392,763		$	294,466		$	—	$	687,229

For the three months ended March 31, 2008, we recognized other-than-temporary impairments of $144 million through market valuation adjustments in our consolidated statements of (loss) income. For the three months ended March 31, 2007, we recognized other-than-temporary impairments of $2 million. Securities are deemed other-than-temporarily impaired if there has been an adverse change in the underlying cash flows generated by a security, if we do not have the intent and ability to hold the security, or if we believe the security will not recover its value within a reasonable period of time. All these factors contributed to the assessment of other-than-temporary impairments in the first quarter of 2008. Most of the impairments in the first quarter of 2007 were due to adverse changes in cash flows.

Securities with an unrealized loss position are deemed temporarily impaired as there has been no adverse change in the underlying cash flows projected to be generated by a security, we have the intent and ability to hold the security, and we believe the impaired security will recover its value within a reasonable period of time.

The following table shows the gross unrealized losses, fair values, and length of time that any of our AFS real estate securities have been in a continuous unrealized loss position as of March 31, 2008 and December 31, 2007. At March 31, 2008, of our total 539 AFS securities, 224 were in unrealized losses positions, and 6 of these have been in a continuous unrealized loss position for twelve months or longer. At December 31, 2007, of our total 1,722 securities, 855 were in unrealized loss positions, and 188 of these had been in a continuous loss position for twelve months or longer. The number of AFS securities reported on our consolidated balance sheets declined as a result of the FVO election on January 1, 2008.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 7. Real Estate Securities – (continued)

Securities with Unrealized Losses (AFS) at Redwood and Opportunity Fund


March 31, 2008 (In Thousands)	Less Than 12 Months					12 Months or More					Total
March 31, 2008 (In Thousands)	Fair Market Value		Unrealized Losses			Fair Market Value		Unrealized Losses			Fair Market Value		Unrealized Losses
Residential	$	82,384	$	(51,750	)	$	811	$	(1,038	)	$	83,195	$	(52,788	)
Commercial		25,409		(9,036	)		1,635		(1,294	)		27,044		(10,330	)
CDO		27,215		(4,145	)		—		—			27,215		(4,145	)
Total Securities	$	135,008	$	(64,931	)	$	2,446	$	(2,332	)	$	137,454	$	(67,263	)


December 31, 2007 (In Thousands)	Less Than 12 Months					12 Months or More					Total
December 31, 2007 (In Thousands)	Fair Market Value		Unrealized Losses			Fair Market Value		Unrealized Losses			Fair Market Value		Unrealized Losses
Residential	$	627,419	$	(303,546	)	$	220,728	$	(94,576	)	$	848,147	$	(398,122	)
Commercial		288,173		(112,769	)		93,308		(37,373	)		381,481		(150,142	)
CDO		29,363		(12,750	)		—		—			29,363		(12,750	)
Total Securities	$	944,955	$	(429,065	)	$	314,036	$	(131,949	)	$	1,258,991	$	(561,014	)

The table below presents the components comprising the carrying value of fair value option securities at Redwood reported on our consolidated balance sheets at March 31, 2008.

Securities FVO at Redwood


March 31, 2008 (In Thousands)	Residential						CDO					Total FVO
March 31, 2008 (In Thousands)	CES			IGS			CES		IGS			Total FVO
Redwood
Current face	$	12,083		$	17,488		$	—	$	60,975		$	90,546
Market value discount		(11,742	)		(9,962	)		—		(45,471	)		(67,175	)
Carrying Value	$	341		$	7,526		$	—	$	15,504		$	23,371

During the three months ended March 31, 2008 we acquired $28 million of IGS at Redwood for which we did not elect the fair value option. The reason we did not elect the fair value option was because these securities are funded with equity and there is no paired liability to offset changes in fair value through the income statement.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 7. Real Estate Securities – (continued)

Real Estate Securities at Acacia

The table below presents the fair value of our securities at Acacia that are included in our consolidated balance sheets as of March 31, 2008 and December 31, 2007, by type of securities, and by credit rating of investment-grade (IGS) and below investment-grade (CES).


	March 31, 2008						December 31, 2007
	FVO						AFS
(In Thousands)	CES		IGS		Total		CES		IGS		Total
Residential securities:
Prime	$	77,414	$	233,619	$	311,033	$	193,676	$	514,045	$	707,721
Alt-a		14,633		204,891		219,524		48,661		416,726		465,387
Subprime		10,877		150,229		161,106		8,598		211,342		219,940
Total residential securities		102,924		588,739		691,663		250,935		1,142,113		1,393,048
Commercial securities		112,554		62,781		175,335		188,327		89,676		278,003
CDO securities		6,027		52,743		58,770		8,169		83,094		91,263
Total Securities	$	221,505	$	704,263	$	925,768	$	447,431	$	1,314,883	$	1,762,314

The table below presents the components comprising the carrying value of fair value option real estate securities at Acacia reported on our consolidated balance sheets at March 31, 2008.



March 31, 2008 (In Thousands)	Residential						Commercial						CDO						Total FVO
March 31, 2008 (In Thousands)	CES			IGS			CES			IGS			CES			IGS			Total FVO
Acacia
Current face	$	788,646		$	1,883,996		$	352,778		$	106,062		$	66,334		$	190,829		$	3,388,645
Market value discount		(685,722	)		(1,295,257	)		(240,224	)		(43,281	)		(60,307	)		(138,086	)		(2,462,877	)
Carrying Value	$	102,924		$	588,739		$	112,554		$	62,781		$	6,027		$	52,743		$	925,768

The table below presents the components comprising the carrying value of available-for-sale real estate CES and IGS at Acacia reported on our consolidated balance sheets at December 31, 2007.

UNITED STATES OF AMERICA SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended: March 31, 2008

OR

For the transition period from to

Commission file number 1-13759

REDWOOD TRUST, INC.

One Belvedere Place, Suite 300 Mill Valley, California 94941

(415) 389-7373

REDWOOD TRUST, INC. 2008 FORM 10-Q REPORT TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

REDWOOD TRUST, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS

REDWOOD TRUST, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF (LOSS) INCOME

REDWOOD TRUST, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

REDWOOD TRUST, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

For the Three Months Ended March 31, 2008

For the Three Months Ended March 31, 2007

REDWOOD TRUST, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 1. Redwood Trust

Note 2. Basis of Presentation

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 3. Summary of Significant Accounting Policies

Use of Estimates

Real Estate Loans

Residential and Commercial Real Estate Loans: Held-for-Investment

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

Residential and Commercial Real Estate Loans: Held-for-Sale

Real Estate Loans — Reserve for Credit Losses

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

Real Estate Securities Available-for-Sale (AFS)

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

Real Estate Securities Fair Value Option (FVO)

Other Real Estate Investments

Non-Real Estate Investments

Cash and Cash Equivalents

Derivative Financial Instruments

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

Restricted Cash

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

Accrued Interest Receivable

Deferred Tax Assets

Deferred Asset-Backed Securities Issuance Costs

Other Assets

Redwood Debt

Asset-Backed Securities Issued

Sequoia ABS Issued

Acacia ABS Issued

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

Subordinated Notes

(Loss) Earnings per Share

Basic and Diluted (Loss) Earnings per Share

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

Other Comprehensive Income (Loss)

Stock-Based Compensation

Weighted Average Assumptions Used for Valuation of Options under FAS 123R Granted During Period

Recent Accounting Pronouncements

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 3. Summary of Significant Accounting Policies – (continued)

Note 4. Adoption of FAS 159

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 4. Adoption of FAS 159 – (continued)

Adoption of FAS 159

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 5. Fair Value of Financial Instruments

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 5. Fair Value of Financial Instruments – (continued)

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 5. Fair Value of Financial Instruments – (continued)

REDWOOD TRUST, INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTSMarch 31, 2008(Unaudited)

Note 5. Fair Value of Financial Instruments – (continued)

Fair Value of Financial Instruments

UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

One Belvedere Place, Suite 300
Mill Valley, California 94941

REDWOOD TRUST, INC.

2008 FORM 10-Q REPORT

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF (LOSS) INCOME

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)