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: June 30, 2010

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)

Not Applicable

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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

Large accelerated filer x		Accelerated filer o		Non-accelerated filer o		Smaller reporting company 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 common stock, as of the latest practicable date.

Common Stock, $0.01 par value per share		77,979,850 shares outstanding as of August 3, 2010

TABLE OF CONTENTS

REDWOOD TRUST, INC.
2010 FORM 10-Q REPORT

TABLE OF CONTENTS

		Page
PART I
Item 1. Financial Statements			1
Consolidated Balance Sheets at June 30, 2010 (Unaudited) and December 31, 2009			1
Consolidated Statements of Income (Loss) for the Three and Six Months Ended June 30, 2010 and 2009 (Unaudited)			2
Consolidated Statements of Equity and Comprehensive Income (Loss) for the Six Months Ended June 30, 2010 and 2009 (Unaudited)			3
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and 2009 (Unaudited)			4
Notes to Consolidated Financial Statements			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			44
Item 3. Quantitative and Qualitative Disclosures About Market Risk			94
Item 4. Controls and Procedures			94
PART II
Item 1. Legal Proceedings			95
Item 1A. Risk Factors			96
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			97
Item 3. Defaults Upon Senior Securities			97
Item 4. (Removed and Reserved)			97
Item 5. Other Information			97
Item 6. Exhibits			98
Signatures			99

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)		June 30, 2010				December 31, 2009
ASSETS
Real estate loans		$	3,810,155			$	3,739,254
Real estate securities, at fair value:
Trading securities			275,994				277,274
Available-for-sale securities			740,963				810,471
Total real estate securities			1,016,957				1,087,745
Other investments			3,654				20,371
Cash and cash equivalents			288,376				242,818
Total earning assets			5,119,142				5,090,188
Restricted cash			26,814				94,306
Accrued interest receivable			14,085				18,193
Derivative assets			4,735				12,372
Deferred tax asset			2,452				4,810
Deferred asset-backed securities issuance costs			7,045				6,639
Other assets			45,312				26,142
Total Assets(1)		$	5,219,585			$	5,252,650
LIABILITIES AND EQUITY
Liabilities
Short-term debt		$	—			$	—
Accrued interest payable			6,315				5,968
Derivative liabilities			106,355				83,800
Accrued expenses and other liabilities			10,184				71,828
Dividends payable			19,477				19,434
Asset-backed securities issued – Sequoia			3,681,622				3,644,933
Asset-backed securities issued – Acacia			253,104				297,596
Long-term debt			140,000				140,000
Total liabilities(2)			4,217,057				4,263,559
Equity
Common stock, par value $0.01 per share, 100,000,000 shares authorized; 77,908,439 and 77,737,130 issued and outstanding			779				777
Additional paid-in capital			1,684,304				1,674,367
Accumulated other comprehensive income			38,199				64,860
Cumulative earnings			440,332				364,888
Cumulative distributions to stockholders			(1,173,079	)			(1,133,171	)
Total stockholders’ equity			990,535				971,721
Noncontrolling interest			11,993				17,370
Total equity			1,002,528				989,091
Total Liabilities and Equity		$	5,219,585			$	5,252,650

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

TABLE OF CONTENTS

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

(In Thousands, Except Share Data) (Unaudited)		Three Months Ended June 30,								Six Months Ended June 30,
		2010				2009				2010				2009
Interest Income
Real estate loans		$	16,015			$	30,614			$	30,808			$	64,583
Real estate securities			40,458				43,475				84,357				90,737
Other investments			4				55				13				131
Cash and cash equivalents			93				117				110				247
Total interest income			56,570				74,261				115,288				155,698
Interest Expense
Short-term debt			(36	)			—				(36	)			—
Asset-backed securities issued			(18,988	)			(37,499	)			(36,054	)			(83,332	)
Long-term debt			(2,140	)			(1,502	)			(3,256	)			(3,310	)
Total interest expense			(21,164	)			(39,001	)			(39,346	)			(86,642	)
Net Interest Income			35,406				35,260				75,942				69,056
Provision for loan losses			(4,321	)			(14,545	)			(13,797	)			(30,577	)
Market valuation adjustments on trading instruments			(2,909	)			4,102				(12,200	)			(10,107	)
Other-than-temporary impairments(1)			(4,216	)			(33,237	)			(6,162	)			(62,272	)
Market valuation adjustments, net			(7,125	)			(29,135	)			(18,362	)			(72,379	)
Net Interest Income (Loss) After Provision and Market Valuation Adjustments			23,960				(8,420	)			43,783				(33,900	)
Operating expenses			(11,227	)			(10,769	)			(28,533	)			(21,308	)
Realized gains, net			16,080				25,525				60,417				25,988
Net income (loss) before provision for income taxes			28,813				6,336				75,667				(29,220	)
(Provision for) benefit from income taxes			(26	)			514				(52	)			409
Net income (loss)			28,787				6,850				75,615				(28,811	)
Less: Net income (loss) attributable to noncontrolling interest			186				127				171				(589	)
Net Income (Loss) Attributable to Redwood Trust, Inc.		$	28,601			$	6,723			$	75,444			$	(28,222	)
Basic earnings (loss) per common share:		$	0.36			$	0.10			$	0.94			$	(0.48	)
Diluted earnings (loss) per common share:		$	0.35			$	0.10			$	0.94			$	(0.48	)
Regular dividends declared per common share		$	0.25			$	0.25			$	0.50			$	0.50
Special dividends declared per common share			—				—				—				—
Total dividends declared per common share		$	0.25			$	0.25			$	0.50			$	0.50
Basic weighted average shares outstanding			77,800,642				65,697,887				77,739,279				59,137,864
Diluted weighted average shares outstanding			78,852,259				66,362,723				78,661,642				59,137,864

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

TABLE OF CONTENTS

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

For the Six Months Ended June 30, 2010

(In Thousands, Except Share Data) (Unaudited)		Common Stock								Additional Paid-In Capital				Accumulated Other Comprehensive Income (Loss)				Cumulative Earnings (Losses)				Cumulative Distributions to Stockholders				Noncontrolling Interest				Total
		Shares				Amount
December 31, 2009			77,737,130			$	777			$	1,674,367			$	64,860			$	364,888			$	(1,133,171	)		$	17,370			$	989,091
Net income			—				—				—				—				75,444				—				171				75,615
Net unrealized (loss) gain on available-for-sale securities			—				—				—				(12,987	)			—				—				2,090				(10,897	)
Reclassification of other-than-temporary impairments to net income			—				—				—				5,411				—				—				—				5,411
Net unrealized loss on interest rate agreements															(20,631	)															(20,631	)
Reclassification of unrealized loss on interest rate agreements to net income			—				—				—				1,546				—				—				—				1,546
Total other comprehensive loss															(26,661	)
Total comprehensive income																															51,044
Issuance of common stock:
Dividend reinvestment & stock purchase plans			122,483				2				1,974				—				—				—				—				1,976
Employee stock purchase and incentive plans			48,826				—				(245	)			—				—				—				—				(245	)
Non-cash equity award compensation			—				—				8,208				—				—				—				—				8,208
Distributions to noncontrolling interest, net			—				—				—				—				—				—				(7,638	)			(7,638	)
Common dividends declared			—				—				—				—				—				(39,908	)			—				(39,908	)
June 30, 2010			77,908,439			$	779			$	1,684,304			$	38,199			$	440,332			$	(1,173,079	)		$	11,993			$	1,002,528

For the Six Months Ended June 30, 2009

(In Thousands, Except Share Data) (Unaudited)		Common Stock								Additional Paid-In Capital				Accumulated Other Comprehensive Income (Loss)				Cumulative Earnings (Losses)				Cumulative Distributions to Stockholders				Noncontrolling Interest				Total
		Shares				Amount
December 31, 2008			33,470,557			$	335			$	1,149,393			$	(56,865	)		$	266,059			$	(1,057,070	)		$	22,611			$	324,463
Cumulative adjustment – accounting change															(59,634	)			59,634
Net (loss) income			—				—				—				—				(28,222	)			—				(589	)			(28,811	)
Net unrealized gain (loss) on available-for-sale securities			—				—				—				1,844				—				—				(623	)			1,221
Reclassification of other-than-temporary impairments to net (loss) income			—				—				—				35,827				—				—				—				35,827
Reclassification of unrealized loss on interest rate agreements to net (loss) income			—				—				—				2,210				—				—				—				2,210
Total other comprehensive loss															(19,753	)
Total comprehensive loss																															10,447
Issuance of common stock:
Secondary offerings			43,690,000				436				519,704				—				—				—				—				520,140
Dividend reinvestment & stock purchase plans			139,750				2				1,571				—				—				—				—				1,573
Employee stock purchase and incentive plans			203,163				1				(1,168	)			—				—				—				—				(1,167	)
Non-cash equity award compensation			—				—				4,156				—				—				—				—				4,156
Contributions from noncontrolling interests, net			—				—				—				—				—				—				(3,530	)			(3,530	)
Common dividends declared			—				—				—				—				—				(36,418	)			—				(36,418	)
June 30, 2009			77,503,470			$	774			$	1,673,656			$	(76,618	)		$	297,471			$	(1,093,488	)		$	17,869			$	819,664

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

TABLE OF CONTENTS

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

(In Thousands, Except Share Data) (Unaudited)		Six Months Ended June 30,
		2010				2009
Cash Flows From Operating Activities:
Net income (loss) attributable to Redwood Trust, Inc.		$	75,444			$	(28,222	)
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
Amortization of premiums, discounts, and debt issuance costs, net			(16,409	)			3,493
Depreciation and amortization of non-financial assets			439				539
Provision for loan losses			13,797				30,577
Non-cash equity award compensation			8,208				4,156
Market valuation adjustments, net			18,362				72,379
Realized gains, net			(60,417	)			(25,988	)
Net change in:
Accrued interest receivable			3,732				9,738
Deferred tax asset			2,358				1,325
Other assets			(13,079	)			30,193
Accrued interest payable			5,602				(11,549	)
Accrued expenses and other liabilities			(61,644	)			22,280
Net cash (used in) provided by operating activities			(23,607	)			108,921
Cash Flows From Investing Activities:
Purchases of real estate loans held-for-investment			(238,076	)			—
Principal payments on real estate loans held-for-investment			148,647				199,516
Purchases of real estate securities available-for-sale			(186,057	)			(438,669	)
Proceeds from sales of real estate securities available-for-sale			247,528				57,898
Principal payments on real estate securities available-for-sale			71,083				52,372
Purchases of real estate securities trading			(17,137	)			—
Proceeds from sales of real estate securities trading			6,119				—
Principal payments on real estate securities trading			31,102				50,942
Principal payments on other investments			9,675				14,279
Net decrease (increase) in restricted cash			67,492				(12,616	)
Net cash provided by (used in) investing activities			140,376				(76,278	)
Cash Flows From Financing Activities:
Proceeds from issuance of asset-backed securities			211,178				—
Repurchase of asset-backed securities			(8,639	)			—
Deferred asset-backed security issuance costs			(1,667	)			—
Repayments on asset-backed securities			(200,214	)			(271,626	)
Net settlements of derivatives			(26,268	)			(24,702	)
Net proceeds from issuance of common stock			1,731				520,546
Dividends paid			(39,865	)			(42,147	)
Change in noncontrolling interests			(7,467	)			(4,119	)
Net cash (used in) provided by financing activities			(71,211	)			177,952
Net increase in cash and cash equivalents			45,558				210,595
Cash and cash equivalents at beginning of period		$	242,818			$	126,480
Cash and cash equivalents at end of period		$	288,376			$	337,075
Supplemental Disclosures:
Cash paid for interest		$	32,646			$	105,591
Cash paid for taxes		$	15			$	70
Dividends declared but not paid at end of period		$	19,477			$	19,376

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

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(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. 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 June 30, 2010 and December 31, 2009, and for the three and six months ended June 30, 2010 and 2009. These consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) in the United States for interim financial information and with the Securities and Exchange Commission’s (SEC) instructions to Form 10-Q and Article 10 of Regulation S-X. Results for the three and six months ended June 30, 2010, may not necessarily be indicative of the results for the year ending December 31, 2010. These unaudited interim consolidated financial statements should be read in conjunction with our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2009. All amounts presented herein, except per share data, are shown in thousands.

We recognize the Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standards No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles — a replacement of FASB Statement No. 162 (FAS 168), which establishes the Accounting Standards Codification (ASC) as the single source of authoritative GAAP in the United States.

Organization

Our consolidated financial statements include the accounts of Redwood, its direct and indirect wholly-owned subsidiaries, and other entities in which we have a controlling financial interest. All significant intercompany balances and transactions have been eliminated. A number of Redwood’s consolidated subsidiaries are qualifying REIT subsidiaries and the remainder are taxable subsidiaries. References to the Redwood REIT include Redwood and its qualifying REIT subsidiaries, excluding taxable subsidiaries.

We are the asset manager and an investor in the Redwood Opportunity Fund LP (the Fund) that we sponsor. The Fund primarily invests in mortgage-backed securities. We also sponsor two securitization programs. Our Sequoia program is used for the securitization of residential mortgage loans. References to Sequoia refer collectively to all the consolidated 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 the consolidated Acacia securitization entities.

We do not service any assets, including assets owned by the Fund, Sequoia, or Acacia.

Principles of Consolidation

We apply ASC 860 and ASC 810-10 to determine whether we must consolidate transferred financial assets and variable interest entities (VIEs) for financial reporting purposes. These standards became effective for our interests in all VIEs as of January 1, 2010, except for the Fund, as a result of the FASB’s decision to delay the applicability of ASC 810-10 for private equity funds. Our determination of whether we must consolidate the Fund was made in accordance with FASB Interpretation No. 46 (revised), Consolidation of Variable Interest Entities (FIN 46(R)), at the time we acquired our interests in the Fund.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

Note 2. Basis of Presentation  – (continued)

We currently consolidate the assets, liabilities, and noncontrolling interests of the Fund, as well as the assets and liabilities of the Sequoia and the Acacia securitization entities where we maintain continuing involvement. For financial reporting purposes, the real estate securities owned at the Fund are shown on our consolidated balance sheets under real estate securities and the portion of the Fund owned by third parties is shown under noncontrolling interest. In our consolidated statements of income (loss), we record interest income on the securities owned at the Fund. Since the Fund is currently funded with equity, there is no associated interest expense. The underlying loans and securities owned at Sequoia and Acacia 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 by these entities are shown under ABS issued. In our consolidated statements of income (loss), we record interest income on the loans and securities owned by consolidated Sequoia and Acacia entities and interest expense on the ABS issued by these entities.

See Note 4 for further discussion on principles of consolidation.

Note 3. Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements requires us to make a number of significant estimates. These include estimates of fair value of certain assets and liabilities, amount and timing of credit losses, prepayment rates, and other estimates 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., valuation changes due to supply and demand, credit performance, prepayments, interest rates, or other reasons) will occur in the near term. Our estimates are inherently subjective in nature and actual results could differ from our estimates and the differences could be material.

Fair Value Option

We have the option to measure eligible financial assets, financial liabilities, and commitments at fair value on an instrument-by-instrument basis. This option is available when we first recognize a financial asset or financial liability or enter into a firm commitment. Subsequent changes in the fair value of assets, liabilities, and commitments where we have elected the fair value option are recorded in the consolidated statements of income (loss).

Our decision to apply the fair value option for new financial instruments is generally based upon our funding strategy for the specific financial asset acquired. For example, securities that we anticipate funding with equity will generally be accounted for as available-for-sale (AFS) securities. Securities that we anticipate funding with a combination of debt and equity or those financed through the issuance of asset-backed liabilities will generally be accounted for in a consistent manner. Additionally, we may elect to apply the fair value option for financial instruments that may not perform similarly to our traditional real estate investments or are particularly volatile or complex.

See Note 5 for further discussion on the fair value option.

Fair Value Measurements

Our financial statements include assets and liabilities that are measured at their estimated fair values in accordance with GAAP. A fair value measurement represents the price at which an orderly transaction would occur between willing market participants at the measurement date. We develop fair values for financial assets or liabilities based on available inputs and pricing that is observed in the marketplace. Examples of market information that we attempt to obtain include the following:

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

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

After considering all available indications of the appropriate rate of return that market participants would require, we consider the reasonableness of the range indicated by the results to determine an estimate that is most representative of fair value.

The markets for many of the real estate securities that we invest in and issue are generally illiquid. Establishing fair values for illiquid assets and liabilities is inherently subjective and is often dependent upon our estimates and modeling assumptions. If we determine that either the volume and/or level of trading activity for an asset or liability has significantly decreased from normal market conditions, or price quotations or observable inputs are not associated with orderly transactions, the market inputs that we obtain might not be relevant. For example, broker or pricing service quotes might not be relevant if an active market does not exist for the financial asset or liability. The nature of the quote (for example, whether the quote is an indicative price or a binding offer) is also evaluated.

In circumstances where relevant market inputs cannot be obtained, increased analysis and management judgment are required to estimate fair value. This generally requires us to establish the use of our internal assumptions about future cash flows and appropriate risk-adjusted discount rates. Regardless of the valuation inputs we apply, the objective of fair value measurement is unchanged from what it would be if markets were operating at normal activity levels and/or transactions were orderly; that is, to determine the current exit price.

See Note 5 for further discussion on fair value measurements.

Real Estate Loans

Residential and Commercial Real Estate Loans — Fair Value

Residential and commercial real estate loans at fair value are loans where we have elected the fair value option. Coupon interest is recognized as revenue when earned and deemed collectible or until a loan becomes more than 90 days past due. Changes in fair value are recurring and are reported through our consolidated statements of income (loss) in market valuation adjustments, net.

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

Residential and commercial real estate loans held-for-sale are loans that we are marketing for sale to third parties. These loans are carried at the lower of their cost or fair value, as measured on an individual basis. If the fair value of a loan held-for-sale is lower than its amortized cost basis, this difference is reported as a negative market valuation adjustment through our consolidated statements of income (loss). Coupon interest for loans held-for-sale is recognized as revenue when earned and deemed collectible or until a loan becomes more than 90 days past due. Gains or losses on the sale of real estate loans are based on the specific identification method.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

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

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

Real estate loans held-for-investment include residential real estate loans owned and securitized at Sequoia entities and commercial real estate loans owned at Redwood. These loans are carried at their unpaid principal balances adjusted for net unamortized premiums or discounts and net of any allowance for loan losses. Coupon interest is recognized as revenue when earned and deemed collectible or until a loan becomes more than 90 days past due. Interest previously accrued for loans that have become greater than 90 days past due is reserved for in the allowance for loan losses. Cash principal and interest that is advanced from servicers subsequent to a loan becoming greater than 90 days past due is used to reduce the outstanding loan principal balance.

We use the interest method to determine an effective yield to amortize the premium or discount on real estate loans held-for-investment. For residential loans acquired prior to July 1, 2004, we use coupon interest rates as they change over time and anticipated principal payments to determine periodic amortization. For residential 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 determine periodic amortization.

We reclassify loans held-for-investment to loans held-for-sale if we determine that these loans will be sold to third parties. This may occur, for example, if we exercise our right to call ABS issued by a Sequoia securitization trust and decide to subsequently sell the underlying loans to third parties.

See Note 6 for further discussion on real estate loans.

Real Estate Loans — Allowance for Loan Losses

For real estate loans classified as held-for-investment, we establish and maintain an allowance for loan losses based on our estimate of credit losses inherent in our loan portfolios at the reporting date. To calculate the allowance for loan losses, 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 or pool of loans.

We consider the following factors in setting the allowance for loan losses:

Once we determine the amount of defaults, the timing of the defaults, and severity of losses upon the defaults, we estimate expected losses for each individual loan or pool of loans over its expected life. We then estimate the timing of these losses and the losses probable to occur over an appropriate loss confirmation period. This period is defined as the range of time between the occurrence of a credit loss (such as the initial

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

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 allowance for loan losses, since we believe these losses exist as of the reported date of the financial statements. We re-evaluate the adequacy of our allowance for loan losses at least quarterly.

As part of the loss mitigation efforts undertaken by servicers of residential loans owned by Sequoia securitization entities, a growing number of loan modifications have been completed to help make mortgage loans more affordable for certain borrowers. Loan modifications may include, but are not limited to: (i) conversion of a floating rate mortgage loan into a fixed rate mortgage loan; (ii) reduction in the contractual interest rate of a mortgage loan; (iii) forgiveness of a portion of the contractual interest and/or principal amounts owed on a mortgage loan; and, (iv) extension of the contractual maturity of a mortgage loan. We evaluate all loan modifications performed by servicers to determine if they constitute troubled debt restructurings according to GAAP. If a loan is determined to be a troubled debt restructuring, it is removed from the general loan pools used for calculating allowances for loan losses and assessed for impairment on an individual basis based upon any adverse change in the expected future cash flows resulting from the modification. This difference is recorded to the provision for loan losses in the consolidated statements of income (loss).

See Note 7 for further discussion on the allowance for loan losses.

We do not currently maintain a loan repurchase reserve. We do not originate real estate loans and we believe that risk of loss due to loan repurchases (i.e., due to breach of representations and warranties) would generally be a contingency to the companies from whom we acquired the loans and therefore would be covered by our recourse to those companies. In addition, management is not aware of any outstanding repurchase claims against Redwood that would require the establishment of a loan repurchase reserve.

Real Estate Securities, at Fair Value

Trading Securities

Trading securities include residential, commercial, and collateralized debt obligation (CDO) securities. Trading securities are carried at their estimated fair values. Coupon interest is recognized as interest income when earned and deemed collectible. All changes in fair value are reported through our consolidated statements of income (loss) in market valuation adjustments, net.

We primarily denote trading securities as those securities where we have adopted the fair value option. We currently account for certain securities at Redwood and all securities at Acacia entities as trading securities, at fair value.

Available-for-Sale Securities

AFS securities include certain residential, commercial, and CDO securities. AFS securities are carried at their estimated fair values with cumulative unrealized gains and losses reported as a component of accumulated other comprehensive income (loss) in our consolidated statements of equity. Coupon interest is recognized as interest income when earned and deemed collectible, and the interest method is used to determine an effective yield to amortize purchase premiums, discounts, and fees associated with these securities into income over time. This requires us to project cash flows over the remaining life of each security and make assumptions with regards to interest rates, prepayment rates, the timing and amount of credit losses, and other factors. We review 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.

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

For an AFS security where its fair value has declined below its amortized cost basis, we evaluate the security for other-than-temporary impairment (OTTI). If we either — (i) intend to sell the impaired security; (ii) will more likely than not be required to the sell the impaired security before it recovers in value; or, (iii) do not expect to recover the impaired security’s amortized cost basis even if we do not intend to sell the security — the impairment is deemed an OTTI and we record the entire difference between the security’s fair value and its amortized cost in our consolidated statements of income (loss). Conversely, if none of these three conditions are met, we analyze the expected cash flows, or cost recovery of the security, to determine what, if any, OTTI is recognized through our consolidated statements of income (loss). This analysis includes an assessment of any changes in the regulatory and/or economic environment that might affect the performance of the security.

If we conclude through our analysis that there has been no significant adverse change in our cash flow assumptions for the security, then the impairment is deemed temporary in nature and the associated difference between the security’s fair value and its amortized cost basis is recorded as an unrealized loss through accumulated other comprehensive income (loss), a component of stockholders’ equity. Alternatively, if we conclude that there has been a significant adverse change in our cash flow assumptions for the security, then the impairment is deemed an OTTI and we perform an additional analysis to determine what portion of OTTI, if any, should be recorded through our consolidated statements of income (loss). This analysis entails discounting the security’s cash flows to a present value using the prior period yield for the security to determine an “expected recoverable value.” The difference between this expected recoverable value and the amortized cost basis of the security is deemed to be the “credit” component of the OTTI that is recorded in our consolidated statements of income (loss). The amortized cost of the security is then adjusted to the expected recoverable value, and the difference between this expected recoverable value and the fair value is deemed to be the “non-credit” component of the OTTI that is recorded to accumulated other comprehensive income (loss). Future amortization and accretion for the security is computed based upon the new amortized cost basis.

In the second quarter of 2009, as part of our adoption of new authoritative GAAP that we currently use to evaluate impairments on AFS securities, we evaluated $450 million of previously recorded OTTI on securities still held at April 1, 2009. We determined that $224 million of these OTTI related to securities where we either had the intent to sell or the OTTI did not include a non-credit component. The remaining $226 million of these OTTI related to securities that included a $165 million aggregate credit component and a $61 million aggregate non-credit component (of which $60 million related to Redwood’s interest and $1 million related to noncontrolling interest at the Fund). In accordance with the adoption guidance, we recorded a $61 million one-time cumulative-effect adjustment, net of any related tax effects, to reclassify the non-credit component of these OTTI previously recorded through our consolidated statements of income (loss), as was prescribed under previous GAAP. This reclassification increased retained earnings and decreased other comprehensive income (OCI), resulting in zero net impact to reported stockholders’ equity and noncontrolling interest.

See Note 8 for further discussion on real estate securities.

Other Investments

Other investments include a guaranteed investment contract (GIC) entered into by an Acacia securitization entity that we consolidate for financial statement purposes. We account for this investment under the fair value option. Changes in fair value are reported through our consolidated statements of income (loss) through market valuation adjustments, net. Interest income is reported through our consolidated statements of income (loss) through interest income, other investments.

See Note 9 for further discussion on other investments.

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

Cash and Cash Equivalents

Cash and cash equivalents include non-restricted cash and highly liquid investments with original maturities of three months or less. At June 30, 2010, we had minimal concentrations of credit risk arising from cash deposits as more than 97% of our cash and cash equivalents were invested in U.S. Government Treasury Bills or FDIC-insured bank products.

Restricted Cash

Restricted cash primarily includes principal and interest payments that are collateral for, or payable to, owners of ABS issued by consolidated securitization entities, and cash pledged as collateral on interest rate agreements. Restricted cash may also include cash retained in Acacia or Sequoia securitization entities or in the Fund prior to the purchase of loans or securities, payments on or redemption of outstanding ABS issued, or distributions to limited partners. At June 30, 2010, we did not have any significant concentrations of credit risk arising from restricted cash deposits as more than 98% of our restricted cash was held in custodial accounts, invested in U.S. Government Treasury Bills, or held in FDIC-insured bank products.

Accrued Interest Receivable

Accrued interest receivable represents interest that is due and payable to us. Cash interest is generally received within thirty days of recording the receivable. For financial assets where we have elected the fair value option, the associated accrued interest on these assets is measured at fair value. For financial assets where we have not elected the fair value option, the associated accrued interest carrying values approximate fair values.

Derivative Financial Instruments

Derivative financial instruments include contractual interest rate agreements, other hedging instruments, and credit derivatives. All derivative financial instruments are recorded at fair value in our consolidated balance sheets. Derivatives with a positive fair value to us are reported as an asset and derivatives with a negative fair value to us are reported as a liability. We classify each of our derivative financial instruments as either (i) a trading instrument (no hedging designation); or, (ii) 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).

Changes in fair value of derivatives accounted for as trading instruments, including any associated interest income or expense, are recorded in our consolidated statements of income (loss) through market valuation adjustments, net. Changes in the fair value of derivatives accounted for as cash flow hedges, to the extent they are effective, are recorded in accumulated other comprehensive income (loss), a component of stockholders’ equity. Interest income or expense and any ineffectiveness associated with these hedging derivatives are recorded as a component of net interest income in our consolidated statements of income (loss). We measure the effective portion of cash flow hedges by comparing the change in fair value of the expected future variable cash flows of the derivative hedging instruments with the change in fair value of the expected future variable cash flows of the hedged liabilities.

We will discontinue cash flow hedge accounting if (i) we determine that the hedging derivative(s) is no longer expected to be effective in offsetting changes in the cash flows of the designated hedged item; (ii) the derivative expires or is sold, terminated, or exercised; (iii) the derivative is de-designated as a cash flow hedge; or (iv) it is probable that a forecasted transaction associated with the hedged item will not occur by the end of the originally specified time period. To the extent we de-designate a cash flow hedging relationship but the associated hedged item continues to exist, the fair value of the cash flow hedge at the time of de-designation remains in accumulated other comprehensive income (loss) and is amortized using the straight-line method through interest expense over the remaining life of the hedged liability.

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June 30, 2010
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Note 3. Summary of Significant Accounting Policies  – (continued)

Interest Rate Agreements

Interest rate agreements we currently utilize include interest rate swaps and caps. Interest rate swaps used at Redwood or Acacia are derivative contracts in which (i) one party exchanges a stream of fixed interest payments for another party’s stream of variable interest cash flows; or (ii) each party exchanges variable interest cash flows that are referenced to different indices. Interest rate caps are derivative contracts in which the buyer receives payments at the end of each period in which the interest rate exceeds an agreed upon strike price. We enter into interest rate swaps and caps primarily to reduce significant changes in our income or stockholders’ equity caused by interest rate volatility.

Other Hedging Instruments

Other hedging instruments we currently utilize include “To Be Announced” (TBA) contracts, which are forward commitments to purchase agency mortgage-backed securities to be issued in the future. We enter into TBA commitments to offset — to varying degrees — changes in the value of mortgage products in which we have exposure.

Credit Derivatives

Credit derivatives we currently utilize include credit default swaps (CDS), which are agreements 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. These instruments enable us, or our consolidated securitization entities, to synthetically assume the credit risk of a reference security or index of securities. The estimated fair values of these contracts fluctuate for a variety of reasons, such as the likelihood or occurrence of a qualifying credit event (e.g., an interest shortfall, a failure to pay principal, or a distressed rating downgrade), the market perception of default risk and counterparty risk, and supply and demand changes.

See Note 10 for further discussion on derivative financial instruments.

Deferred Tax Assets

Our deferred tax assets are generated by differences in GAAP and taxable income at our taxable subsidiaries. These differences generally reflect differing accounting treatments for tax and GAAP, such as accounting for discount and premium amortization, credit losses, equity awards, asset impairments, and certain valuation estimates. As a result of these differences, we may recognize taxable income in periods prior to when we recognize income for GAAP. When this occurs, we pay the tax liability and establish a deferred tax asset for GAAP. As the income is subsequently realized in future periods under GAAP, the deferred tax asset is reduced.

Deferred Asset-Backed Securities Issuance Costs

ABS issuance costs are expenses associated with the issuance of ABS from the Sequoia securitization entities we sponsor. These expenses typically include underwriting, rating agency, legal, accounting, and other fees. ABS issuance costs associated with liabilities accounted for under the fair value option are expensed as incurred. ABS issuance costs associated with liabilities reported at cost are deferred. Deferred ABS issuance costs are reported on our consolidated balance sheets as deferred charges (an asset) and are amortized as an adjustment to interest expense using the interest method, based upon the actual and estimated repayment schedules of the related ABS issued.

Other Assets

Other assets include real estate owned (REO), fixed assets, principal receivable, and other prepaid expenses. REO is reported at the lower of cost or fair value. Subsequent declines in the value of an REO property are recorded in our consolidated statements of income (loss) as a component of market valuation adjustments, net. All other assets are reported at cost.

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

See Note 11 for further discussion on other assets.

Short-Term Debt

Short-term debt can include master repurchase agreements, bank borrowings, and other forms of collateralized borrowings with various commercial banks and investment banks that expire within one year. These facilities may be unsecured or collateralized by loans or securities. In the second quarter of 2010, we incurred short-term debt and intend to use short-term debt as we accumulate loans in the future. We had no short-term debt outstanding at June 30, 2010.

Accrued Interest Payable

Accrued interest payable represents interest that is due and payable to third parties. Interest is generally paid within one to three months of recording the payable, based upon our remittance requirements. For borrowings where we have elected the fair value option, the associated accrued interest on these liabilities is measured at fair value. For financial liabilities where we have not elected the fair value option, the associated accrued interest carrying values approximate fair values.

Asset Backed Securities Issued — Sequoia and Acacia

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. These 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

Sequoia ABS issued are carried at their unpaid principal balances net of any unamortized discount or premium.

Acacia ABS Issued

Acacia ABS issued are accounted for under the fair value option and carried at their estimated fair values. Changes in fair value (gains or losses) are reported in our consolidated statements of income (loss) through market valuation adjustments, net.

See Note 12 for further discussion on ABS issued.

Long-Term Debt

Long-term debt includes trust preferred securities and subordinated notes at Redwood and is carried at its unpaid principal balance. Our long-term debt is unsecured with quarterly interest payments at a floating rate equal to the three-month London Interbank Offered Rate (LIBOR) plus a margin until it is redeemed in whole or matures at a future date.

See Note 13 for further discussion on long-term debt.

Equity

Earnings (Loss) Per Common Share

Basic earnings per share (EPS) is computed by dividing net income allocated to common shareholders by the weighted average common shares outstanding. Net income allocated to common shareholders represents net income applicable to common shareholders, less income allocated to participating securities (as described below). Diluted earnings per common share is computed by dividing income allocated to common shareholders by the weighted average common shares outstanding plus amounts representing the dilutive effect of equity awards.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
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Note 3. Summary of Significant Accounting Policies  – (continued)

On January 1, 2009, we adopted new accounting guidance on EPS that defines unvested share-based payment awards that contain nonforfeitable rights to dividends as participating securities that are included in computing EPS using the two-class method. The two-class method is an earnings allocation formula under which EPS is calculated for common stock and participating securities according to dividends declared and participating rights in undistributed earnings. Under this method, all earnings (distributed and undistributed) are allocated to participating securities and common shares based on their respective rights to receive dividends. Our adoption of this guidance required us to recast previously reported EPS and did not have a significant impact on EPS.

Other Comprehensive Income (Loss)

Net unrealized gains and losses on real estate securities available-for-sale and interest rate agreements previously designated as cash flow hedges are reported as components of other comprehensive income (loss) on our consolidated statements of equity and comprehensive income (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 taxation and may create deferred tax assets or liabilities.

Noncontrolling Interest

Noncontrolling interest represents the aggregate limited partnership interests in the Fund held by third parties. In accordance with GAAP, the noncontrolling interest of the Fund is shown as a component of equity on our consolidated balance sheets, and the portion of income (loss) allocable to third parties is shown as net income (loss) attributable to noncontrolling interest in our consolidated statements of income (loss). A reconciliation of equity attributable to noncontrolling interest is disclosed in our consolidated statements of equity and comprehensive income (loss).

Equity Compensation Plans

Incentive Plan

In May 2010, our shareholders approved an amendment to our previously amended 2002 Redwood Trust, Inc. Incentive Plan (Incentive Plan) for executive officers, employees, and non-employee directors. The amendment provided for an increase in the number of shares available for distribution under the plan. The Incentive Plan authorizes our Board of Directors (or a committee appointed by our Board of Directors) to grant incentive stock options (ISOs), non-qualifying stock options (NQSOs), deferred stock units (DSUs), restricted stock, performance shares, performance units (including cash), stock appreciation rights, limited stock appreciation rights (awards), and dividend equivalent rights (DERs) to eligible recipients other than non-employee directors. These awards generally vest over a four-year period. Non-employee directors are also provided annual awards under the Incentive Plan that generally vest immediately.

The cost of equity awards is determined in accordance with share-based payment accounting guidance and amortized over the vesting term using an accelerated method for equity awards granted prior to December 1, 2008. For equity awards granted after December 1, 2008, the cost of the awards is amortized over the vesting period on a straight-line basis. Timing differences between the accelerated and straight-line methods of amortization were determined to not be material to our financial statements.

Employee Stock Purchase Plan

In May 2009, our stockholders approved an amendment to our 2002 Redwood Trust, Inc. Employee Stock Purchase Plan (ESPP), to increase the number of shares available under the ESPP. The purpose of the ESPP is to give our employees an opportunity to acquire an equity interest in Redwood through the purchase of shares of common stock at a discount. The ESPP allows eligible employees to purchase common stock at

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

85% of its fair value, subject to certain limits. Fair value as defined under the ESPP is the lesser of the closing market price of the common stock on the first day of the calendar year or the first day of the calendar quarter.

Executive Deferred Compensation Plan

In May 2002, our Board of Directors approved our 2002 Executive Deferred Compensation Plan (EDCP). The EDCP allows eligible employees and directors to defer portions of current salary and certain other forms of compensation. Redwood matches some deferrals. Compensation deferred under the EDCP is an asset of Redwood and subject to the claims of the general creditors of Redwood. The EDCP allows for the investment of deferrals in either an interest crediting account or DSUs.

See Note 16 for further discussion on equity compensation plans.

Taxes

We have elected to be taxed as a REIT under the Internal Revenue Code and the corresponding provisions of state law. To qualify as a REIT we must distribute at least 90% of our annual REIT taxable income to shareholders (not including taxable income retained in our taxable subsidiaries) within the time frame set forth in the tax code and also meet certain other requirements related to assets, income, and stock ownership. We assess our tax positions for all open tax years and determine whether we have any material unrecognized liabilities in accordance with FASB guidance on accounting for uncertainty in income taxes. We record these liabilities to the extent we deem them incurred. We classify interest and penalties on material uncertain tax positions as interest expense and operating expense, respectively, in our consolidated statements of income (loss).

See Note 18 for further discussion on taxes.

Recent Accounting Pronouncements

In April 2010, the FASB issued Accounting Standards Update (ASU) 2010-18, Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset — a consensus of the FASB Emerging Issues Task Force, to clarify the accounting for loan modifications when the loan is part of a pool of loans that is accounted for as a single asset. The new guidance provides that modification of such loans that are accounted for within a pool does not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. The entity would continue to consider whether such pool of assets is impaired if the expected cash flows for the pool change. The amended guidance does not affect the accounting for loans that are not accounted for within pools. Loans accounted for individually continue to be accounted for under the troubled debt restructuring guidance. In addition, the amended guidance allows entities to make a one-time election to terminate accounting for loans in a pool. The amended guidance is effective for a modification of a loan(s) accounted for within a pool occurring in the first interim or annual period ending on or after July 15, 2010. The amended guidance must be applied prospectively, and early application is permitted. We are currently evaluating the impact of ASU 2010-18 on our consolidated financial statements.

In July 2010, the FASB issued Accounting Standards Update (ASU) 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, which amends ASC 310 by requiring more robust and disaggregated disclosures about the credit quality of an entity’s financing receivables and its allowance for credit losses. The objective of enhancing these disclosures is to improve financial statement users’ understanding of (1) the nature of an entity’s credit risk associated with its financing receivables and (2) the entity’s assessment of that risk in estimating its allowance for credit losses as well as changes in the allowance and the reasons for those changes. ASU 2010-20 requires disclosures of the portfolio

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

segment and class of financing receivable levels, and focuses on the following: nonaccrual and past due financing receivables, allowance for credit losses related to financing receivables, impaired loans (individually evaluated for impairment), credit quality information, and modification. The amended guidance is effective for public companies in the first interim or annual period ending on or after December 31, 2010. ASU 2010-20 will increase our loan and allowance for loan loss disclosures, but will not have an effect on our consolidated financial statements.

Note 4. Principles of Consolidation

We apply ASC 860 and ASC 810-10 to determine whether we must consolidate transferred financial assets and variable interest entities (VIEs) for financial reporting purposes. ASC 860 considers whether securitizations and other transfers of financial assets are treated as sales or financings. Additionally, ASC 810-10 addresses whether VIEs (e.g., certain legal entities often used in securitization and other structured finance transactions) should be included in the consolidated financial statements of any particular interested party. These standards became effective for our interests in all VIEs as of January 1, 2010, except for the Fund as a result of the FASB’s decision to delay the applicability of ASC 810-10 for private equity funds. Our determination of whether we must consolidate the Fund was performed in accordance with FASB Interpretation No. 46 (revised), Consolidation of Variable Interest Entities (FIN 46(R)), at the time we acquired our interests in the Fund.

Analysis of Consolidated VIEs

The VIEs we are required to consolidate include the Fund, certain Sequoia securitization entities, and the Acacia entities. The following table presents a summary of the assets and liabilities of these VIEs.

Assets and Liabilities of Consolidated VIEs at June 30, 2010

(Dollars in thousands)		The Fund				Sequoia Entities				Acacia Entities				Total
Real estate loans		$	—			$	3,788,024			$	19,485			$	3,807,509
Real estate securities			25,080				—				257,530				282,610
Other investments			—				—				3,654				3,654
Other assets			2,428				23,882				32,993				59,303
Total Assets		$	27,508			$	3,811,906			$	313,662			$	4,153,076
Asset-backed securities		$	—			$	3,708,395			$	253,104			$	3,961,499
Other liabilities			806				2,892				84,491				88,189
Total Liabilities		$	806			$	3,711,287			$	337,595			$	4,049,688
Noncontrolling Interest		$	11,993			$	—			$	—			$	11,993
Number of VIEs			1				37				10				48

We determined that we are the primary beneficiary of the Fund as our ongoing asset management responsibilities provide us with the power to direct the activities that most significantly impact the economic performance of the Fund, and our significant general and limited partnership interests provide us with the obligation to absorb losses or the right to receive benefits that are significant.

We consolidate the assets and liabilities of certain Sequoia securitization entities issued prior to 2010, as we did not meet the sale criteria at the time we transferred financial assets to these entities. Had we not been the transferor and depositor of these securitizations, we would likely not have consolidated them as we determined that we are not the primary beneficiary of these entities in accordance with ASC 810-10.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
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Note 4. Principles of Consolidation  – (continued)

In April 2010, we sponsored a $238 million residential prime jumbo mortgage securitization through our Sequoia program and recorded the assets and liabilities of this entity on our consolidated balance sheet, as we did not meet the sale criteria at the time we transferred financial assets to this entity. We determined that we are the primary beneficiary of this Sequoia entity as our ongoing loss mitigation and resolution responsibilities provide us with the power to direct the activities that most significantly impact the economic performance of the entity and our significant investment interests provide us with the obligation to absorb losses or the right to receive benefits that are significant.

We consolidate the assets and liabilities of the Acacia securitization entities on our consolidated balance sheets, as we did not meet the sale criteria at the time we transferred financial assets to these entities and we are the primary beneficiary of these Acacia VIEs. Our ongoing asset management responsibilities and call options provide us with the power to direct the activities that most significantly impact the economic performance of these individual entities, and our equity investments in each entity provide us with the obligation to absorb losses or the right to receive benefits that are significant.

Analysis of Non-Consolidated VIEs

Third party VIEs are securitization entities that Redwood did not sponsor. We may own several securities from a third party VIE, and in those cases, the analysis is done in consideration of all of our interests in that VIE. We determined that we are not the primary beneficiary of any third-party residential, commercial, re-REMIC, or CDO entities in any third party VIEs, as we do not have the required power to direct the activities that most significantly impact the economic performance of these entities. Specifically, we do not service or manage these entities or otherwise hold decision making powers that are significant. As a result of this assessment, we do not consolidate any of the underlying assets and liabilities of these VIEs — we only account for our specific interests in each.

The following table presents a summary of Redwood’s interest in third party VIEs at June 30, 2010, grouped by collateral type and ownership interest.

VIE Summary

June 30, 2010 (Dollars in Thousands)		Fair Value				Number of VIEs
Real estate securities at Redwood
Residential
Senior		$	630,099				99
Re-REMIC			69,070				10
Subordinate			26,436				203
Commercial			7,610				15
CDO			1,132				10
Total Third-party Real Estate Securities		$	734,347				337

Our future assessments of whether we are required to consolidate a VIE may change based upon the facts and circumstances pertaining to each VIE. Changes in accounting for any VIE could result in a material impact to our financial statements in subsequent reporting periods.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

Note 5. Fair Value of Financial Instruments

For financial reporting purposes, we follow a fair value hierarchy established under GAAP that is used to measure the fair value of the assets and liabilities in the table above. This hierarchy prioritizes relevant market inputs in order to determine an “exit price”, or the price at which an asset could be sold or a liability could be transferred in an orderly process that is not a forced liquidation or distressed sale at the date of measurement. Additionally, relevant market data, to the extent available and not internally generated or entity specific information should be used to determine fair value. Level 1 inputs are observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 inputs are observable inputs other than quoted prices for an asset or liability that are obtained through corroboration with observable market data. Level 3 inputs are unobservable inputs (e.g., our own data or assumptions) that are used when there is little, if any, relevant market activity for the asset or liability being measured at fair value.

In certain cases, inputs used to measure fair value fall into different levels of the fair value hierarchy. In such cases, the level in 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 requires judgment and considers factors specific to the asset or liability being measured.

The following table presents the carrying values and estimated fair values of assets and liabilities that are required to be recorded or disclosed at fair value as of June 30, 2010 and December 31, 2009.

		June 30, 2010								December 31, 2009
(In Thousands)		Carrying Value				Fair Value				Carrying Value				Fair Value
Assets
Real estate loans (held-for-investment)		$	3,788,266			$	3,112,660			$	3,724,791			$	3,000,496
Real estate loans (held-for-sale)			2,404				2,404				2,374				2,374
Real estate loans (fair value)			19,485				19,485				12,089				12,089
Trading securities			275,994				275,994				277,274				277,274
Available-for-sale securities			740,963				740,963				810,471				810,471
Other investments			3,654				3,654				20,371				20,371
Cash and equivalents			288,376				288,376				242,818				242,818
Derivative assets			4,735				4,735				12,372				12,372
Restricted cash			26,814				26,814				94,306				94,306
Accrued interest receivable			14,085				14,085				18,193				18,193
REO (included in other assets)			11,797				11,797				17,421				17,421
Liabilities
Derivative liabilities			106,355				106,355				83,800				83,800
Accrued interest payable			6,315				6,315				5,968				5,968
ABS Issued
ABS issued – Sequoia			3,681,622				3,016,105				3,644,933				2,909,032
ABS issued – Acacia			253,104				253,104				297,596				297,596
Total ABS issued			3,934,726				3,269,209				3,942,529				3,206,628
Long-term debt			140,000				61,600				140,000				68,600

We did not elect the fair value option for any residential securities that we acquired in the second quarter of 2010. During the first quarter of 2010, we elected the fair value option for $13 million of residential senior securities acquired during the quarter. During 2009, we elected the fair value option for certain ABS issued by Sequoia and acquired by Acacia as a result of the deconsolidation of certain Sequoia entities during the fourth quarter of 2008 and second quarter of 2009. These ABS issued had been previously eliminated as intercompany assets for financial reporting purposes.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

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

During 2008, we elected the fair value option for all of the loans, securities, and ABS issued at Acacia. At June 30, 2010, the loans had an aggregate fair value of $19 million and an unpaid principal balance of $23 million, the securities had an aggregate fair value of $258 million and an unpaid principal balance of $1.9 billion, and the asset-backed securities issued had an aggregate fair value of $253 million and an unpaid principal balance of $3.0 billion.

The following table presents assets and liabilities recorded at fair value on our consolidated balance sheet on a recurring basis and indicates the fair value hierarchy of the valuation techniques used to measure fair value.

Assets and Liabilities Measured at Fair Value on a Recurring Basis as of June 30, 2010

		Carrying Value				Fair Value Measurements Using
(In Thousands)						Level 1				Level 2				Level 3
Assets
Real estate loans		$	19,485			$	—			$	—			$	19,485
Trading securities			275,994				—				—				275,994
Available-for-sale securities			740,963				—				—				740,963
Other investments			3,654				—				3,654				—
Derivative assets			4,735				—				4,701				34
Liabilities
ABS issued – Acacia			253,104				—				—				253,104
Derivative liabilities			106,355				508				102,214				3,633

Assets and Liabilities Measured at Fair Value on a Recurring Basis as of December 31, 2009

		Carrying Value				Fair Value Measurements Using
(In Thousands)						Level 1				Level 2				Level 3
Assets
Real estate loans		$	12,089			$	—			$	—			$	12,089
Trading securities			277,274				—				—				277,274
Available-for-sale securities			810,471				—				—				810,471
Other investments			20,371				—				20,371				—
Derivative assets			12,372				—				12,326				46
Liabilities
ABS issued – Acacia			297,596				—				—				297,596
Derivative liabilities			83,800				—				63,499				20,301

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

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

The following table presents additional information about Level 3 assets and liabilities during the six months ended June 30, 2010.

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

		Assets																Liabilities
(In Thousands)		Real Estate Loans				Trading Securities				AFS Securities				Derivative Assets				ABS Issued –  Acacia				Derivative Liabilities
Beginning balance –  December 31, 2009		$	12,089			$	277,274			$	810,471			$	46			$	297,596			$	20,301
Principal paydowns			52				(31,102	)			(71,083	)			—				(43,743	)			—
Gains (losses) in net income, net			7,344				18,479				15,290				(5	)			(6,004	)			(262	)
Gains (losses) in OCI, net			—				—				(5,485	)			—				—				—
Acquisitions			—				17,137				186,057				—				—				—
Sales			—				(6,119	)			(194,337	)			—				—				—
Other settlements, net			—				325				50				(7	)			5,255				(16,406	)
Ending Balance – June 30, 2010		$	19,485			$	275,994			$	740,963			$	34			$	253,104			$	3,633

The following table presents the portion of gains or losses included in our consolidated statement of income (loss) that were attributable to Level 3 assets and liabilities recorded at fair value on a recurring basis and still held at June 30, 2010 and 2009. Gains or losses incurred on assets or liabilities sold or otherwise disposed of during the three and six months ended June 30, 2010 and 2009 are not included in this presentation.

Portion of Net Gains (Losses) Attributable to Level 3 Assets and Liabilities Still Held at June 30, 2010 and 2009 Included in Net Income (Loss)

		Included in Net Income (Loss)
		Three Months Ended June 30,								Six Months Ended June 30,
(In Thousands)		2010				2009				2010				2009
Assets
Real estate loans		$	2,978			$	(1,720	)		$	7,344			$	(3,967	)
Trading securities			5,042				11,368				17,364				(34,408	)
Available-for-sale securities			(4,216	)			(33,237	)			(6,134	)			(62,121	)
Derivative assets			15				71				(5	)			231
Liabilities
ABS issued – Acacia			11,257				(28,792	)			6,004				2,897
Derivative liabilities			49				(401	)			109				(672	)

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

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

The following table presents information on assets and liabilities recorded at fair value on a non-recurring basis at June 30, 2010 and December 31, 2009.

Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis as of June 30, 2010

																		Gain (Loss)
		Carrying Value				Fair Value Measurements Using												Three Months Ended June 30, 2010				Six Months Ended June 30, 2010
(In Thousands)						Level 1				Level 2				Level 3
Assets
Real estate loans (held-for-sale)		$	2,404			$	—			$	—			$	2,404			$	296			$	176
REO			11,797				—				—				11,797				(1,285	)			(1,359	)

Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis as of December 31, 2009

																		Gain (Loss)
		Carrying Value				Fair Value Measurements Using												Three Months Ended June 30, 2009				Six Months Ended June 30, 2009
(In Thousands)						Level 1				Level 2				Level 3
Assets
Real estate loans (held-for-sale)		$	2,374			$	—			$	—			$	2,374			$	(56	)		$	(77	)
REO			17,421				—				—				17,421				(1,159	)			(1,923	)

The following table presents the components of market valuation adjustments, net, recorded in our consolidated statements of income (loss) for the three and six months ended June 30, 2010 and 2009.

Market Valuation Adjustments, Net

		Three Months Ended June 30,								Six Months Ended June 30,
(In Thousands)		2010				2009				2010				2009
Assets
Real estate loans (fair value)		$	2,978			$	(1,720	)		$	7,344			$	(3,967	)
Real estate loans (held-for-sale)			296				(56	)			176				(77	)
REO			(1,285	)			(1,159	)			(1,359	)			(1,923	)
Trading securities			6,330				11,240				18,479				(35,185	)
Impairments on AFS securities			(4,216	)			(33,237	)			(6,162	)			(62,272	)
Liabilities
ABS issued – Acacia			11,257				(28,792	)			6,004				2,897
Derivative instruments, net			(22,485	)			24,589				(42,844	)			28,148
Market Valuation Adjustments, Net		$	(7,125	)		$	(29,135	)		$	(18,362	)		$	(72,379	)

A description of the instruments measured at fair value as well as the general classification of such instruments pursuant to the Level 1, Level 2, and Level 3 valuation hierarchy is listed below.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

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

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

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

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

Note 6. Real Estate Loans

We invest in residential and commercial real estate loans that we acquire from third party originators. We finance these loans through the Sequoia and Acacia entities that we sponsor or with equity or long-term debt.

The following table summarizes the classifications and carrying value of the residential and commercial real estate loans recorded on our consolidated balance sheets at June 30, 2010 and December 31, 2009.

(In Thousands)		June 30, 2010				December 31, 2009
Residential real estate loans (held-for-sale)		$	2,404			$	2,374
Residential real estate loans (held-for-investment)			3,788,024				3,724,546
Commercial real estate loans (fair value)			19,485				12,089
Commercial real estate loans (held-for-investment)			242				245
Total Real Estate Loans		$	3,810,155			$	3,739,254

Residential Real Estate Loans Held-for-Sale

Residential real estate loans held-for-sale are owned at Redwood and financed with equity. At June 30, 2010, there were 13 residential loans held-for-sale with $4 million in outstanding principal value and a lower of cost or fair value of $2 million. At December 31, 2009, there were 14 residential loans held-for-sale with $4 million in outstanding principal value and a lower of cost or fair value of $2 million.

Residential Real Estate Loans Held-for-Investment

Residential real estate loans held-for-investment are owned at the consolidated Sequoia securitization entities.

The following table provides additional information on residential real estate loans held-for-investment at June 30, 2010 and December 31, 2009.

(In Thousands)		June 30, 2010				December 31, 2009
Principal value		$	3,803,592			$	3,728,738
Unamortized premium, net			45,910				50,028
Allowance for loan losses			(61,478	)			(54,220	)
Carrying Value		$	3,788,024			$	3,724,546

In April 2010, we sponsored a residential prime jumbo mortgage securitization through our Sequoia program. At June 30, 2010 the loans owned by this Sequoia entity had an outstanding principal value of $226 million.

Of the $3.8 billion of principal and $46 million of unamortized premium on loans held-for-investment at June 30, 2010, $1.8 billion of principal and $30 million of unamortized premium relates to residential loans acquired prior to July 1, 2004. During the first half of 2010, 4% of these residential loans prepaid and we amortized 9% of the premium based upon the accounting elections we apply. For residential loans acquired after July 1, 2004, the principal was $2 billion and the unamortized premium was $16 million. During the first half of 2010, 4% of these loans prepaid and we amortized 8% of the premium.

Of the $3.7 billion of principal and $50 million of unamortized premium on these loans at December 31, 2009, $1.8 billion of principal and $33 million of unamortized premium relates to residential loans acquired prior to July 1, 2004. For residential loans acquired after July 1, 2004, the principal face was $1.9 billion and the unamortized premium was $17 million. During the fourth quarter of 2009, 2% of these loans prepaid and we amortized 4% of the premium.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

Note 6. Real Estate Loans  – (continued)

Commercial Real Estate Loans at Fair Value

Commercial real estate loans at fair value are owned at the consolidated Acacia securitization entities. At June 30, 2010, there were four commercial loans at fair value with an aggregate outstanding principal value of $23 million and an aggregate fair value of $19 million, one of which has been delinquent since May 2009 with an outstanding principal balance of $4 million and a fair value of $3 million. At December 31, 2009, there were four commercial loans at fair value, with an outstanding principal of $23 million and a fair value of $12 million.

Commercial Real Estate Loans Held-for-Investment

At June 30, 2010, there was one commercial loan held-for-investment with $0.5 million in outstanding principal value and a carrying value of $0.2 million. During the first half of 2010, we charged off a $10 million commercial mezzanine loan with no impact to our consolidated statements of income (loss), as we had fully reserved for this loan in 2007. At December 31, 2009, there were two commercial loans held-for-investment with $11 million in outstanding principal value and a carrying value of $0.2 million.

Note 7. Allowance for Loan Losses

We establish an allowance for loan losses on our residential and commercial loans held-for-investment based on our estimate of losses incurred in these loan portfolios.

Activity in the Allowance for Losses on Residential Loans

At June 30, 2010 and June 30, 2009, all residential loans classified as held-for-investment were owned by Sequoia entities. The following table summarizes the activity in the allowance for loan losses on residential loans for the three and six months ended June 30, 2010 and 2009.

		Three Months Ended June 30,								Six Months Ended June 30,
(In Thousands)		2010				2009				2010				2009
Balance at Beginning of Period		$	61,169			$	47,947			$	54,220			$	35,713
Charge-offs, net			(4,012	)			(1,820	)			(6,539	)			(5,618	)
Provision for loan losses			4,321				14,545				13,797				30,577
Deconsolidation adjustment			—				(14,795	)			—				(14,795	)
Balance at End of Period		$	61,478			$	45,877			$	61,478			$	45,877

Serious delinquencies on consolidated Sequoia loans were $144 million and $137 million as of June 30, 2010 and 2009, respectively. Serious delinquencies include loans delinquent more than 90 days and in foreclosure. As a percentage of outstanding loan balances, serious delinquencies were 3.80% and 3.48% at June 30, 2010 and 2009, respectively.

When we pursue foreclosure in full satisfaction for a defaulted loan, we estimate the specific loan loss, if any, based on estimated net proceeds from the sale of the property (including accrued but unpaid interest and other costs), and charge this specific estimated loss against the allowance for loan losses. During the first half of 2010, there were $7 million of charge-offs that reduced our allowance for loan losses. These charge-offs arose from $21 million of defaulted loan principal. Foreclosed property is subsequently recorded as REO, a component of other assets.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

Note 8. Real Estate Securities

We invest in third party residential, commercial, and CDO securities. The following table presents the fair values of our real estate securities by collateral type and entity as of June 30, 2010 and December 31, 2009.

June 30, 2010 (In Thousands)		Redwood				The Fund				Acacia				Total Securities
Residential		$	725,605			$	21,135			$	197,167			$	943,907
Commercial			7,610				—				48,979				56,589
CDO			1,132				3,945				11,384				16,461
Total Real Estate Securities		$	734,347			$	25,080			$	257,530			$	1,016,957

December 31, 2009 (In Thousands)		Redwood				The Fund				Acacia				Total Securities
Residential		$	770,916			$	32,884			$	201,367			$	1,005,167
Commercial			9,200				—				54,206				63,406
CDO			1,247				4,067				13,858				19,172
Total Real Estate Securities		$	781,363			$	36,951			$	269,431			$	1,087,745

The following table presents our securities by trading and AFS, collateral type, and entity as of June 30, 2010 and December 31, 2009.

June 30, 2010 (In Thousands)		Trading												AFS
		Redwood				Acacia				Total				Redwood				The Fund				Total
Senior Securities
Residential prime		$	—			$	4,653			$	4,653			$	309,702			$	—			$	309,702
Residential non-prime			16,763				100,832				117,595				303,634				15,451				319,085
Commercial			—				10,832				10,832				—				—				—
Total Senior Securities			16,763				116,317				133,080				613,336				15,451				628,787
Re-REMIC Securities			—				—				—				69,070				—				69,070
Subordinate Securities
Residential prime			381				23,415				23,796				16,025				—				16,025
Residential non-prime			188				68,267				68,455				9,842				5,684				15,526
Commercial			—				38,147				38,147				7,610				—				7,610
CDO			1,132				11,384				12,516				—				3,945				3,945
Total Subordinate Securities			1,701				141,213				142,914				33,477				9,629				43,106
Total Real Estate Securities		$	18,464			$	257,530			$	275,994			$	715,883			$	25,080			$	740,963

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

Note 8. Real Estate Securities  – (continued)

December 31, 2009 (In Thousands)		Trading												AFS
		Redwood				Acacia				Total				Redwood				The Fund				Total
Senior Securities
Residential prime		$	—			$	4,826			$	4,826			$	329,208			$	—			$	329,208
Residential non-prime			6,084				100,397				106,481				308,868				26,735				335,603
Commercial			—				9,508				9,508				—				—				—
Total Senior Securities			6,084				114,731				120,815				638,076				26,735				664,811
Re-REMIC Securities			—				—				—				105,951				—				105,951
Subordinate Securities
Residential prime			319				27,380				27,699				19,191				—				19,191
Residential non-prime			218				68,764				68,982				1,077				6,149				7,226
Commercial			—				44,698				44,698				9,200				—				9,200
CDO			1,222				13,858				15,080				25				4,067				4,092
Total Subordinate Securities			1,759				154,700				156,459				29,493				10,216				39,709
Total Real Estate Securities		$	7,843			$	269,431			$	277,274			$	773,520			$	36,951			$	810,471

Senior securities are those interests in a securitization that have the first right to cash flows and are last in line to absorb losses. Re-REMIC securities, as presented herein, were created through the resecuritization of certain senior interests to provide additional credit support to those interests. These re-REMIC securities are therefore subordinate to the remaining senior interest, but senior to any subordinate tranches of the securitization from which they were created. Subordinate securities are all interests below senior and re-REMIC interests. Prime residential securities are securities backed by prime residential loans that generally have low loan-to-value ratios (typically 75% LTV or less), are made to borrowers who have high FICO scores (typically 700 or higher), and typically have low concentrations of investor properties. Non-prime residential securities are generally backed by loans that have higher loan-to-value ratios, are made to borrowers who have lower credit scores or impaired credit histories (but exhibit the ability to repay their loans), and may have higher concentrations of investor properties. At June 30, 2010, all of our real estate securities had contractual maturities over ten years, except for less than $1 million of residential securities that had contractual maturities greater than five years but less than ten years.

AFS Securities

We generally purchase AFS securities at a discount. To the extent we purchase an AFS security that has a likelihood of incurring credit loss, we generally will not amortize into income the portion of the purchase discount that, although we are entitled to earn, we do not expect to collect due to the inherent credit risk of the security. We may also expense a portion of our investment in the security to the extent we believe that principal losses will exceed the purchase discount. We designate the amount of principal face that we do not expect to receive and will not amortize into income as a credit reserve on the security, with any remaining net unamortized discounts or premiums amortized into income over time using the interest method.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

Note 8. Real Estate Securities  – (continued)

The following table presents the components of carrying value (which equals fair value) of AFS securities as of June 30, 2010 and December 31, 2009.

June 30, 2010 (In Thousands)		Residential				Commercial				CDO				Total
Current face		$	1,284,102			$	140,547			$	89,422			$	1,514,071
Credit reserve			(327,636	)			(127,627	)			(88,340	)			(543,603	)
Net unamortized (discount) premium			(310,131	)			(5,534	)			10,929				(304,736	)
Amortized cost			646,335				7,386				12,011				665,732
Gross unrealized gains			109,218				1,509				—				110,727
Gross unrealized losses			(26,145	)			(1,285	)			(8,066	)			(35,496	)
Carrying Value		$	729,408			$	7,610			$	3,945			$	740,963

December 31, 2009 (In Thousands)		Residential				Commercial				CDO				Total
Current face		$	1,581,692			$	158,997			$	89,371			$	1,830,060
Credit reserve			(469,273	)			(146,018	)			(87,017	)			(702,308	)
Net unamortized (discount) premium			(401,808	)			(5,130	)			8,941				(397,997	)
Amortized cost			710,611				7,849				11,295				729,755
Gross unrealized gains			130,914				1,422				25				132,361
Gross unrealized losses			(44,346	)			(71	)			(7,228	)			(51,645	)
Carrying Value		$	797,179			$	9,200			$	4,092			$	810,471

The following table presents the changes for the three and six months ended June 30, 2010 of the unamortized discount and designated credit reserves on AFS securities.

Changes in Unamortized Discount and Designated Credit Reserves on AFS Securities

Three Months Ended June 30, 2010

		Residential								Commercial								CDO
(In Thousands)		Credit Reserve				Unamortized Discount Net				Credit Reserve				Unamortized Discount Net				Credit Reserve				Unamortized Discount Net
Beginning balance –  March 31, 2010		$	388,078			$	355,194			$	139,320			$	5,660			$	87,103			$	(9,379	)
Amortization of net discount			—				(10,478	)			—				(31	)			—				(313	)
Realized credit losses			(56,685	)			—				(11,860	)			—				—				—
Acquisitions			2,142				9,190				—				—				—				—
Sales, calls, other			(12,273	)			(41,545	)			—				—				—				—
Impairments			4,144				—				72				—				—				—
Transfers to (release of) credit reserves			2,230				(2,230	)			95				(95	)			1,237				(1,237	)
Ending Balance –  June 30, 2010		$	327,636			$	310,131			$	127,627			$	5,534			$	88,340			$	(10,929	)

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

Note 8. Real Estate Securities  – (continued)

Six Months Ended June 30, 2010

		Residential								Commercial								CDO
(In Thousands)		Credit Reserve				Unamortized Discount Net				Credit Reserve				Unamortized Discount Net				Credit Reserve				Unamortized Discount Net
Beginning balance –  December 31, 2009		$	469,273			$	401,808			$	146,018			$	5,130			$	87,017			$	(8,941	)
Amortization of net (discount) premium			—				(21,074	)			—				288				—				(665	)
Realized credit losses			(99,879	)			—				(18,450	)			—				—				—
Acquisitions			11,108				52,578				—				—				—				—
Sales, calls, other			(64,608	)			(117,426	)			—				—				—				—
Impairments			5,987				—				175				—				—				—
Transfers to (release of) credit reserves			5,755				(5,755	)			(116	)			116				1,323				(1,323	)
Ending Balance –  June 30, 2010		$	327,636			$	310,131			$	127,627			$	5,534			$	88,340