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, 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           77,897,360 shares outstanding as of May 4, 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 March 31, 2010 (Unaudited) and December 31, 2009			1
Consolidated Statements of Income (Loss) for the Three Months Ended March 31, 2010 and 2009 (Unaudited)			2
Consolidated Statements of Equity and Comprehensive Income (Loss) for the Three Months Ended March 31, 2010 and 2009 (Unaudited)			3
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 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			83
Item 4. Controls and Procedures			83
PART II
Item 1. Legal Proceedings			84
Item 1A. Risk Factors			84
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			84
Item 3. Defaults Upon Senior Securities			84
Item 4. (Removed and Reserved)			84
Item 5. Other Information			84
Item 6. Exhibits			85
Signatures			86

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, 2010				December 31, 2009
ASSETS
Real estate loans		$	3,662,283			$	3,739,254
Real estate securities, at fair value:
Trading securities			288,820				277,274
Available-for-sale securities			846,642				810,471
Total real estate securities			1,135,462				1,087,745
Other investments			10,762				20,371
Cash and cash equivalents			241,753				242,818
Total earning assets			5,050,260				5,090,188
Restricted cash			87,600				94,306
Accrued interest receivable			14,665				18,193
Derivative assets			5,520				12,372
Deferred tax asset			3,631				4,810
Deferred asset-backed securities issuance costs			6,014				6,639
Other assets			27,576				26,142
Total Assets(1)		$	5,195,266			$	5,252,650
LIABILITIES AND EQUITY
Liabilities
Short-term debt		$	—			$	—
Accrued interest payable			5,390				5,968
Derivative liabilities			79,486				83,800
Accrued expenses and other liabilities			103,617				71,828
Dividends payable			19,438				19,434
Asset-backed securities issued – Sequoia			3,557,669				3,644,933
Asset-backed securities issued – Acacia			279,471				297,596
Long-term debt			140,000				140,000
Total liabilities(2)			4,185,071				4,263,559
Equity
Common stock, par value $0.01 per share, 100,000,000 shares authorized; 77,750,697 and 77,737,130 issued and outstanding			778				777
Additional paid-in capital			1,680,565				1,674,367
Accumulated other comprehensive income			57,597				64,860
Cumulative earnings			411,731				364,888
Cumulative distributions to stockholders			(1,153,065	)			(1,133,171	)
Total stockholders’ equity			997,606				971,721
Noncontrolling interest			12,589				17,370
Total equity			1,010,195				989,091
Total Liabilities and Equity		$	5,195,266			$	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 March 31,
		2010				2009
Interest Income
Real estate loans		$	14,791			$	33,969
Real estate securities			43,899				47,263
Other investments			9				76
Cash and cash equivalents			17				130
Total interest income			58,716				81,438
Interest Expense
Short-term debt			—				—
Asset-backed securities issued			(17,066	)			(45,834	)
Long-term debt			(1,116	)			(1,808	)
Total interest expense			(18,182	)			(47,642	)
Net Interest Income			40,534				33,796
Provision for loan losses			(9,475	)			(16,032	)
Market valuation adjustments on trading instruments			(9,291	)			(14,207	)
Other-than-temporary impairments(1)			(1,946	)			(29,035	)
Market valuation adjustments, net			(11,237	)			(43,242	)
Net Interest Income (Loss) After Provision and Market Valuation Adjustments			19,822				(25,478	)
Operating expenses			(17,306	)			(10,539	)
Realized gains, net			44,338				462
Net income (loss) before provision for income taxes			46,854				(35,555	)
Provision for income taxes			(26	)			(105	)
Net income (loss)			46,828				(35,660	)
Less: Net loss attributable to noncontrolling interest			(15	)			(716	)
Net Income (Loss) Attributable to Redwood Trust, Inc.		$	46,843			$	(34,944	)
Basic earnings (loss) per common share:		$	0.59			$	(0.65	)
Diluted earnings (loss) per common share:		$	0.58			$	(0.65	)
Regular dividends declared per common share		$	0.25			$	0.25
Special dividends declared per common share		$	—			$	—
Total dividends declared per common share		$	0.25			$	0.25
Basic weighted average shares outstanding			77,677,235				53,632,132
Diluted weighted average shares outstanding			78,542,299				53,632,132

 
 
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 Three Months Ended March 31, 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 (loss)			—				—				—				—				46,843				—				(15	)			46,828
Net unrealized (loss) gain on available-for-sale securities			—				—				—				(8,940	)			—				—				2,138				(6,802	)
Reclassification of other-than-temporary impairments to net income (loss)			—				—				—				1,594				—				—				—				1,594
Reclassification of unrealized loss on interest rate agreements to net income (loss)			—				—				—				83				—				—				—				83
Total other comprehensive loss															(7,263	)
Total comprehensive income																															41,703
Issuance of common stock:
Secondary offerings			—				—				—				—				—				—				—				—
Dividend reinvestment & stock purchase plans			8,687				1				128				—				—				—				—				129
Employee stock purchase and incentive plans			4,880				—				(16	)			—				—				—				—				(16	)
Non-cash equity award compensation			—				—				6,086				—				—				—				—				6,086
Distributions to noncontrolling interests, net			—				—				—				—				—				—				(6,904	)			(6,904	)
Common dividends declared			—				—				—				—				—				(19,894	)			—				(19,894	)
March 31, 2010			77,750,697			$	778			$	1,680,565			$	57,597			$	411,731			$	(1,153,065	)		$	12,589			$	1,010,195

For the Three Months Ended March 31, 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
Net (loss) income			—				—				—				—				(34,944	)			—				(716	)			(35,660	)
Net unrealized loss on available-for-sale securities			—				—				—				(44,112	)			—				—				(1,943	)			(46,055	)
Reclassification of other-than-temporary impairments to net (loss) income			—				—				—				14,411				—				—				—				14,411
Reclassification of unrealized loss on interest rate agreements to net (loss) income			—				—				—				1,099				—				—				—				1,099
Total other comprehensive loss															(28,602	)
Total comprehensive loss																															(66,205	)
Issuance of common stock:
Secondary offerings			26,450,000				265				282,141				—				—				—				—				282,406
Dividend reinvestment & stock purchase plans			132,406				1				1,462				—				—				—				—				1,463
Employee stock purchase and incentive plans			175,095				1				(1,105	)			—				—				—				—				(1,104	)
Non-cash equity award compensation			—				—				1,794				—				—				—				—				1,794
Contributions from noncontrolling interests, net			—				—				—				—				—				—				(1,854	)			(1,854	)
Common dividends declared			—				—				—				—				—				(16,593	)			—				(16,593	)
March 31, 2009			60,228,058			$	602			$	1,433,685			$	(85,467	)		$	231,115			$	(1,073,663	)		$	18,098			$	524,370

 
 
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)		Three Months Ended March 31,
		2010				2009
Cash Flows From Operating Activities:
Net income (loss)		$	46,843			$	(34,944	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Amortization of premiums, discounts, and debt issuance costs, net			(8,220	)			2,965
Depreciation and amortization of non-financial assets			240				273
Provision for loan losses			9,475				16,032
Non-cash equity award compensation			6,086				1,794
Market valuation adjustments, net			11,237				43,242
Realized gains, net			(44,338	)			(462	)
Net change in:
Accrued interest receivable			3,349				6,244
Deferred tax asset			1,179				869
Other assets			1,976				20,087
Accrued interest payable			2,026				(10,483	)
Accrued expenses and other liabilities			31,789				(8,499	)
Net cash provided by operating activities			61,642				37,118
Cash Flows From Investing Activities:
Principal payments on real estate loans held-for-investment			65,647				83,866
Purchases of real estate securities available-for-sale			(162,772	)			(97,551	)
Proceeds from sales of real estate securities available-for-sale			134,025				711
Principal payments on real estate securities available-for-sale			33,458				18,588
Purchases of real estate securities trading			(17,137	)			—
Proceeds from sales of real estate securities trading			3,603				—
Principal payments on real estate securities trading			14,290				28,571
Principal payments on other investments			3,766				3,942
Net decrease in restricted cash			6,706				2,237
Net cash provided by investing activities			81,586				40,364
Cash Flows From Financing Activities:
Repurchase of asset-backed securities			(8,639	)			—
Repayments on asset-backed securities			(96,568	)			(117,142	)
Net settlements of derivatives			(12,390	)			(7,223	)
Net proceeds from issuance of common stock			113				282,765
Dividends paid			(19,890	)			(26,639	)
Change in noncontrolling interests			(6,919	)			(2,570	)
Net cash (used in) provided by financing activities			(144,293	)			129,191
Net (decrease) increase in cash and cash equivalents			(1,065	)			206,673
Cash and cash equivalents at beginning of period		$	242,818			$	126,480
Cash and cash equivalents at end of period		$	241,753			$	333,153
Supplemental Disclosures:
Cash paid for interest		$	16,156			$	62,362
Cash paid (received) for taxes		$	—			$	(806	)
Dividends declared but not paid at end of period		$	19,438			$	15,057

 
 
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
March 31, 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 March 31, 2010 and December 31, 2009, and for the three months ended March 31, 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 months ended March 31, 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
March 31, 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 are shown under ABS issued. In our consolidated statements of income (loss), we record interest income on the loans and securities owned by Sequoia and Acacia entities and interest expense on the ABS issued by these consolidated securitization 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 measured using the fair value option along with the corresponding liabilities. Additionally, we may elect the fair value option for nontraditional real estate investments or for a variety of other reasons.

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:

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 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 6 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
March 31, 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.

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 deterioration of the borrower’s financial condition) and the confirmation of that loss (the actual impairment or

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

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

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 8 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.

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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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

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 its new amortized cost basis.

In the second quarter of 2009, as part of our adoption of new authoritative GAAP guidance 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 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 9 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 10 for further discussion on other investments.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

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 March 31, 2010, we had minimal concentrations of credit risk arising from cash deposits as more than 98% 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 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 March 31, 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 and credit default swaps. All derivative financial instruments are reported at fair value in accordance with derivative accounting guidance. Derivatives with a positive value to us are reported as an asset and derivatives with a negative value to us are reported as a liability. The changes in fair value of derivatives accounted for as trading instruments are reported in the consolidated statements of income (loss) through market valuation adjustments, net.

Interest Rate Agreements

We maintain an overall interest rate risk management strategy that incorporates the use of interest rate agreements. We enter into interest rate agreements for a variety of reasons, including minimizing significant fluctuations in earnings or market values on certain assets or liabilities that may be caused by interest rate volatility. Interest rate agreements that we use as part of our interest rate risk management strategy may include interest rate options, swaps, options on swaps, futures contracts, options on futures contracts, and options on forward purchases. We designate these interest rate agreements as either (i) a hedge of the fair market value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge); (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); or, (iii) a trading instrument (no designation).

In 2010, we began using interest rate swaps to hedge our interest rate exposure related to our long-term debt. We account for these swaps as cash flow hedges, as we structured their critical terms to substantially match the payment terms of our floating-rate long-term debt. Specifically, (i) the swaps and long-term debt use the same interest rate index for variable cash flows, (ii) the interest rate resets for variable rate cash flows are the same for both the swaps and long-term debt, and (iii) the hedging relationship does not contain any other basis differences.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

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

We expect these cash flow hedges to be highly effective in reducing our exposure to changes in the benchmark LIBOR interest rates used to determine our quarterly interest payment obligations on long-term debt. We measure the effective portion of these cash flow hedges by comparing the change in fair value of the expected future variable cash flows of the swaps with the change in fair value of the expected future variable cash flows of our long-term debt. To the extent these cash flow hedges are effective, we record interest income or expense as a component of net interest income and all other changes in fair value of the swaps are recorded in accumulated other comprehensive income (loss), a component of stockholders’ equity. We currently do not anticipate recording any ineffectiveness pertaining to these cash flow hedges and any unrealized gains or losses resulting from changes in the fair values of the swaps would only be reclassified into earnings to the extent the hedging relationships are terminated prior to the derivative contracts expiring.

We will discontinue cash flow hedge accounting if (i) we determine that the derivative 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 will not occur by the end of the originally specified time period. To the extent we de-designate cash flow hedges but the associated hedged items continue to exist, the fair value of cash flow hedges 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 lives of the hedged Acacia ABS issued. Net purchases and proceeds from interest rate agreements are included in net settlements of derivatives, which are classified as financing activities within our consolidated statements of cash flows.

Credit Derivatives

A credit default swap (CDS) 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. These instruments enable us to synthetically assume the credit risk of a reference security or index of securities. All of our existing CDS contracts were initiated during 2007 by one of the Acacia entities that we consolidate for financial reporting purposes. Net purchases and proceeds from CDS are included in net settlements of derivatives, which are classified as financing activities within our consolidated statements of cash flows.

See Note 11 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. Income and expense recognition for GAAP and tax differ in material respects. 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 and an associated deferred tax benefit for GAAP. As the income is subsequently realized in future periods under GAAP, the deferred tax asset is recognized as an expense.

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 and are amortized as an adjustment

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

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

to interest expense using the interest method, based upon the actual and estimated repayment schedules of the related ABS issued under the principle guidance for interest on receivables and payables.

Other Assets

Other assets on our consolidated balance sheets 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.

See Note 12 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. Since November 2008, we have had no short-term debt outstanding.

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 13 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. Both are unsecured debt, requiring quarterly interest payments at a floating rate equal to the three-month London Interbank Offered Rate (LIBOR) plus a margin until they are redeemed in whole or mature at a future date.

See Note 14 for further discussion on long-term debt.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

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

Equity

Earnings (Loss) Per Common Share

Basic earnings (loss) per share (EPS) is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income (loss) 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 earnings per common share guidance, if there is a loss from continuing operations, the common stock equivalents are deemed antidilutive and diluted income (loss) per share is calculated in the same manner as basic income (loss) per share.

Effective January 1, 2009, the authoritative GAAP states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are “participating securities” and therefore should be included in computing EPS using the two-class method. 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 under derivative accounting literature 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 FASB noncontrolling interest guidance, 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 2008, 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 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 method of amortization were determined to not be material to our financial statements.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

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

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 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 17 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 19 for further discussion on taxes.

Recent Accounting Pronouncements

In March 2010, the FASB issued Accounting Standards Update (ASU) 2010-11, Scope Exception Related to Embedded Credit Derivatives, to address questions that have been raised in practice about the intended breadth of the embedded credit derivative scope exception in ASC 815, Derivatives and Hedging. The amended guidance clarifies that the scope exception applies to contracts that contain an embedded credit derivative that is only in the form of subordination of one financial instrument to another. The amended guidance is effective at the beginning of an entity’s first fiscal quarter beginning after June 15, 2010, although early adoption is permitted as of the first day of an entity’s first fiscal quarter beginning after the ASU’s issuance date of March 5, 2010. Upon adoption of the amended guidance, entities are permitted to elect the fair value option for beneficial interests in securitized financial assets on an instrument-by-instrument basis. Entities that elect the fair value option must prepare supporting documentation by the beginning of the period of adoption, and perform impairment analyses of applicable investments before adoption. We are currently evaluating the impact of ASU 2010-11 on our financial statements.

On February 26, 2010, the FASB issued Accounting Standards Update (ASU) 2010-10, Amendments for Certain Investment Funds. The ASU defers the effective date of Statement 167, Amendments to FASB Interpretation 46(R) (included in ASC 810-10) for a reporting enterprise’s interest in certain entities and for certain money market mutual funds. It addresses concerns that the joint consolidation model under

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

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

development by the FASB and the International Accounting Standards Board (IASB) may result in a different consolidation conclusion for asset managers and that an asset manager consolidating certain funds would not provide useful information to investors. The ASU also amends certain provisions of current guidance to change how a decision maker or service provider determines whether its fee is a variable interest. The amended guidance in ASU 2010-10 is effective for fiscal years beginning after November 15, 2009, and for interim periods within those years. The adoption of ASU 2010-10 did not impact our 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.

To provide information on the application of these principles, we provide our analysis of consolidated and unconsolidated VIEs below. We also note that these principles of consolidation require reassessment every quarter. Our future assessments of whether we are required to consolidate a VIE may change based upon the facts and circumstances pertaining to each VIE. This could result in a material impact to our financial statements during subsequent reporting periods.

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 March 31, 2010

(In Thousands, Except VIE Data)		The Fund				Sequoia Entities				Acacia Entities				Total
Real estate loans		$	—			$	3,643,143			$	16,670			$	3,659,813
Real estate securities			26,969				—				268,830				295,799
Other investments			—				—				10,762				10,762
Other assets			2,779				24,588				94,540				121,907
Total Assets			29,748				3,667,731				390,802				4,088,281
Asset-backed securities			—				3,557,669				279,471				3,837,140
Other liabilities			1,331				2,064				141,350				144,745
Total Liabilities			1,331				3,559,733				420,821				3,981,885
Noncontrolling interest			12,589				—				—				12,589
Number of VIEs			1				36				10				47

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 4. Principles of Consolidation  – (continued)

As noted above, we looked to FIN 46(R) to determine whether to consolidate the assets, liabilities, and noncontrolling interest of the Fund. 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.

Pursuant to the guidance in ASC 860, we consolidate the assets and liabilities of certain Sequoia securitization entities, 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; however, 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. We note that future securitizations will be analyzed under these provisions and, although it is generally our intent to consolidate sponsored securitizations, the determination will be on a case by case basis.

We consolidate the assets and liabilities of the Acacia securitization entities, as we met the criteria for consolidation in both ASC 860 and ASC 810-10. That is, we determined that (i) we did not meet the sale criteria at the time we transferred financial assets to these entities; and (ii) we are the primary beneficiary of 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. In accordance with ASC 810-10, 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 March 31, 2010, grouped by collateral type and ownership interest.

VIE Summary

March 31, 2010 (In Thousands, Except VIE Data)		Fair Value				Number of VIEs
Real estate securities at Redwood
Residential
Senior		$	739,512				110
Re-REMIC			66,913				10
Subordinate			23,140				209
Commercial			8,876				15
CDO			1,222				10
Total third-party real estate securities		$	839,663				354

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 5. Fair Value Option

The fair value option gives us the option of electing to measure eligible financial assets, financial liabilities, and commitments at fair value on an instrument-by-instrument basis. This election 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 these assets, liabilities, and commitments are recorded in the consolidated statements of income (loss).

Our decision to elect 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 AFS. Securities and loans that we anticipate funding with a combination of debt and equity or financed through securitization liabilities will generally be accounted for at cost or fair value and the corresponding liabilities will generally be accounted for in a similar 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.

As of March 31, 2010, the loans at Acacia had an aggregate fair value of $17 million and an unpaid principal balance of $23 million, the securities had an aggregate fair value of $269 million and an unpaid principal balance of $2.0 billion, and asset-backed securities issued at Acacia had an aggregate fair value of $279 million and an unpaid principal balance of $3.0 billion.

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. During the first quarter of 2010, we elected the fair value option for $13 million of residential senior securities that we acquired.

Note 6. Fair Value of Financial Instruments

The FASB fair value guidance defines fair value, establishes a hierarchy of information used in measuring fair value, and enhances the disclosure of information about fair value measurements. Further, it provides that the “exit price” should be used to value an asset or liability, which is 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 measurement date. Additionally, relevant market data, to the extent available, and not internally generated or entity specific information should be used to determine fair value. The financial impact on Redwood from the adoption of this guidance was not significant since our valuation methodology used in prior periods did not need to be revised to comply with the new standard.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 6. Fair Value of Financial Instruments  – (continued)

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 March 31, 2010 and December 31, 2009.

		March 31, 2010								December 31, 2009
(In Thousands)		Carrying Value				Fair Value				Carrying Value				Fair Value
Assets
Real estate loans (held-for-investment)		$	3,643,386			$	2,958,370			$	3,724,791			$	3,000,496
Real estate loans (held-for-sale)			2,227				2,227				2,374				2,374
Real estate loans (fair value)			16,670				16,670				12,089				12,089
Trading securities			288,820				288,820				277,274				277,274
Available-for-sale securities			846,642				846,642				810,471				810,471
Other investments			10,762				10,762				20,371				20,371
Cash and equivalents			241,753				241,753				242,818				242,818
Derivative assets			5,520				5,520				12,372				12,372
Restricted cash			87,600				87,600				94,306				94,306
Accrued interest receivable			14,665				14,665				18,193				18,193
REO (included in other assets)			14,289				14,289				17,421				17,421
Liabilities
Derivative liabilities			79,486				79,486				83,800				83,800
Accrued interest payable			5,390				5,390				5,968				5,968
ABS Issued
ABS issued – Sequoia			3,557,669				2,912,559				3,644,933				2,909,032
ABS issued – Acacia			279,471				279,471				297,596				297,596
Total ABS issued			3,837,140				3,192,030				3,942,529				3,206,628
Long-term debt			140,000				72,800				140,000				68,600

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. 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.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 6. Fair Value of Financial Instruments  – (continued)

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 March 31, 2010

(In Thousands)		Carrying Value				Fair Value Measurements Using
						Level 1				Level 2				Level 3
Assets
Real estate loans		$	16,670			$	—			$	—			$	16,670
Trading securities			288,820				—				—				288,820
Available-for-sale securities			846,642				—				—				846,642
Other investments			10,762				—				10,762				—
Derivative assets			5,520				—				5,498				22
Liabilities
ABS issued – Acacia			279,471				—				—				279,471
Derivative liabilities			79,486				—				68,763				10,723

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

(In Thousands)		Carrying Value				Fair Value Measurements Using
						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

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 6. Fair Value of Financial Instruments  – (continued)

The following table presents additional information about Level 3 assets and liabilities during the three months ended March 31, 2010.

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

(In Thousands)		Assets																Liabilities
		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			215				(14,290	)			(33,458	)			—				(25,982	)			—
Gains / losses in net income, net			4,366				12,149				8,684				(20	)			5,253				(186	)
Gains / losses in OCI, net			—				—				(5,207	)			—				—				—
Acquisitions			—				17,137				162,772				—				—				—
Sales			—				(3,603	)			(96,646	)			—				—				—
Other settlements, net			—				153				26				(4	)			2,604				(9,392	)
Ending Balance – March 31, 2010		$	16,670			$	288,820			$	846,642			$	22			$	279,471			$	10,723

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 March 31, 2010 and 2009. Gains or losses incurred on assets or liabilities sold or otherwise disposed of during the three months ended March 31, 2010 and 2009 are not included in this presentation.

Portion of Net Gains (Losses) Attributable to Level 3 Assets and Liabilities Still Held at March 31, 2010 and 2009 Included in Net Income (Loss)

		Included in Net Income (Loss)
		Three Months Ended March 31,
(In Thousands)		2010				2009
Assets
Real estate loans		$	4,366			$	(2,246	)
Trading securities			12,281				(46,471	)
Available-for-sale securities			(1,946	)			(29,035	)
Derivative assets			(20	)			160
Liabilities
ABS issued – Acacia			(5,253	)			31,689
Derivative liabilities			186				271

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 6. 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 March 31, 2010 and December 31, 2009.

Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis as of March 31, 2010

(In Thousands)		Carrying Value				Fair Value Measurements Using												Gain (Loss)
																		Three Months Ended March 31, 2010
						Level 1				Level 2				Level 3
Assets
Real estate loans (held-for-sale)		$	2,227			$	—			$	—			$	2,227			$	(120	)
REO			14,289				—				—				14,289				(74	)

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

(In Thousands)		Carrying Value				Fair Value Measurements Using												Gain (Loss)
																		Three Months Ended March 31, 2009
						Level 1				Level 2				Level 3
Assets
Real estate loans (held-for-sale)		$	2,374			$	—			$	—			$	2,374			$	(21	)
REO			17,421				—				—				17,421				(765	)

The following table presents the components of market valuation adjustments, net, recorded in our consolidated statements of income (loss) for the three months ended March 31, 2010 and 2009.

Market Valuation Adjustments, Net

		Three Months Ended March 31,
(In Thousands)		2010				2009
Assets
Real estate loans (fair value)		$	4,366			$	(2,246	)
Real estate loans (held-for-sale)			(120	)			(21	)
REO			(74	)			(765	)
Trading securities			12,149				(46,425	)
Impairments on AFS securities			(1,946	)			(29,035	)
Liabilities
ABS issued – Acacia			(5,253	)			31,689
Derivative instruments, net			(20,359	)			3,561
Market Valuation Adjustments, Net		$	(11,237	)		$	(43,242	)

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.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 6. Fair Value of Financial Instruments  – (continued)

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 6. Fair Value of Financial Instruments  – (continued)

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 7. 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 March 31, 2010 and December 31, 2009.

(In Thousands)		March 31, 2010				December 31, 2009
Residential real estate loans (held-for-sale)		$	2,227			$	2,374
Residential real estate loans (held-for-investment)			3,643,143				3,724,546
Commercial real estate loans (fair value)			16,670				12,089
Commercial real estate loans (held-for-investment)			243				245
Total Real Estate Loans		$	3,662,283			$	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 both March 31, 2010 and 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 March 31, 2010 and December 31, 2009.

(In Thousands)		March 31, 2010				December 31, 2009
Principal value		$	3,656,655			$	3,728,738
Unamortized premium, net			47,657				50,028
Allowance for loan losses			(61,169	)			(54,220	)
Carrying Value		$	3,643,143			$	3,724,546

Of the $3.7 billion of principal face and $48 million of unamortized premium on these loans at March 31, 2010, $1.8 billion of principal face and $31 million of unamortized premium relates to residential loans acquired prior to July 1, 2004. During the first quarter of 2010, 2% of these residential loans prepaid and we amortized 6% of the premium based upon the accounting elections we apply. For residential loans acquired after July 1, 2004, the principal face was $1.9 billion and the unamortized premium was $17 million at March 31, 2010. During the first quarter of 2010, 2% of these residential loans prepaid and we amortized 3% of the premium.

Of the $3.7 billion of principal face and $50 million of unamortized premium on these loans at December 31, 2009, $1.8 billion of principal face and $33 million of unamortized premium relates to residential loans acquired prior to July 1, 2004. During the fourth quarter of 2009, 2% of these residential loans prepaid and we amortized 7% of the premium based upon the accounting elections we apply. For residential loans acquired after July 1, 2004, the principal face was $1.9 billion and the unamortized premium was $17 million at December 31, 2009. During the fourth quarter of 2009, 2% of these residential loans prepaid and we amortized 4% of the premium.

Commercial Real Estate Loans

Commercial real estate loans at fair value are owned at the consolidated Acacia securitization entities. At March 31, 2010, there were four commercial loans at fair value with an aggregate outstanding principal value

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 7. Real Estate Loans  – (continued)

of $23 million and an aggregate fair value of $17 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. The fair value of our commercial loans increased by $5 million during the first quarter as there was increased clarity regarding a bankruptcy and the resumption of payments in the near future.

At March 31, 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 quarter 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 8. 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 March 31, 2010 and December 31, 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 months ended March 31, 2010 and 2009.

		Three Months Ended March 31,
(In Thousands)		2010				2009
Balance at Beginning of Period		$	54,220			$	35,713
Charge-offs, net			(2,526	)			(3,798	)
Provision for loan losses			9,475				16,032
Balance at End of Period		$	61,169			$	47,947

Serious delinquencies on consolidated Sequoia loans were $158 million and $155 million as of March 31, 2010 and 2009, respectively. Serious delinquencies include loans delinquent more than 90 days and in foreclosure. As a percentage of current loan balances, serious delinquencies were 4.32% and 3.43% at March 31, 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 quarter of 2010, there were $3 million of charge-offs that reduced our allowance for loan losses. These charge-offs arose from $9 million of defaulted loan principal. Foreclosed property is subsequently recorded as REO, a component of other assets.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 9. 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 March 31, 2010 and December 31, 2009.

March 31, 2010 (In Thousands)		Redwood				The Fund				Acacia				Total Securities
Residential		$	829,565			$	22,874			$	201,388			$	1,053,827
Commercial			8,876				—				54,542				63,418
CDO			1,222				4,095				12,900				18,217
Total Real Estate Securities		$	839,663			$	26,969			$	268,830			$	1,135,462

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 9. Real Estate Securities  – (continued)

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

March 31, 2010 (In Thousands)		Trading												AFS
		Redwood				Acacia				Total				Redwood				The Fund				Total
Senior Securities
Residential prime		$	—			$	5,031			$	5,031			$	372,140			$	—			$	372,140
Residential non-prime			18,231				102,491				120,722				349,141				16,560				365,701
Commercial			—				10,220				10,220				—				—				—
Total Senior Securities			18,231				117,742				135,973				721,281				16,560				737,841
Re-REMIC Securities			—				—				—				66,913				—				66,913
Subordinate Securities
Residential prime			346				24,642				24,988				16,250				—				16,250
Residential non-prime			191				69,224				69,415				6,353				6,314				12,667
Commercial			—				44,322				44,322				8,876				—				8,876
CDO			1,222				12,900				14,122				—				4,095				4,095
Total Subordinate Securities			1,759				151,088				152,847				31,479				10,409				41,888
Total Real Estate Securities		$	19,990			$	268,830			$	288,820			$	819,673			$	26,969			$	846,642

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 9. Real Estate Securities  – (continued)

higher concentrations of investor properties. At March 31, 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.

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

March 31, 2010 (In Thousands)		Residential				Commercial				CDO				Total
Current face		$	1,495,304			$	152,408			$	89,397			$	1,737,109
Credit reserve			(388,078	)			(139,320	)			(87,103	)			(614,501	)
Net unamortized (discount) premium			(355,194	)			(5,660	)			9,379				(351,475	)
Amortized cost			752,032				7,428				11,673				771,133
Gross unrealized gains			114,580				1,886				—				116,466
Gross unrealized losses			(32,941	)			(438	)			(7,578	)			(40,957	)
Carrying Value		$	833,671			$	8,876			$	4,095			$	846,642

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 9. Real Estate Securities  – (continued)

The following table presents the changes for the three months ended March 31, 2010 of the unamortized discount and designated credit reserves on AFS securities.

Changes in Unamortized Discount and Designated Credit Reserves on AFS Securities

		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			—				(10,596	)			—				319				—				(352	)
Realized credit losses			(43,194	)			—				(6,590	)			—				—				—
Acquisitions			8,966				43,388				—				—				—				—
Sales, calls, other			(52,335	)			(75,881	)			—				—				—				—
Impairments			1,843				—				103				—				—				—
Transfers to (release of) credit reserves			3,525				(3,525	)			(211	)			211				86				(86	)
Ending Balance – March 31, 2010		$	388,078			$	355,194			$	139,320			$	5,660			$	87,103			$	(9,379	)

The loans underlying our residential subordinate securities totaled $64 billion at March 31, 2010. These loans are located nationwide with a large concentration in California (47%). Serious delinquencies (90+ days, in foreclosure or REO) at March 31, 2010 were 7.69% of current principal balances. The loans underlying our commercial subordinate securities totaled $25 billion at March 31, 2010, and consist primarily of office (37%), retail (33%), and multifamily (13%) loans. These loans are located nationwide with the highest concentration in California (13%). Serious delinquencies (60+ days, in foreclosure or REO) at March 31, 2010 were 3.70% of current principal balances.

AFS Securities with Unrealized Losses

The following table presents the components comprising the carrying value of AFS securities that were in an unrealized loss position as of March 31, 2010 and December, 31 2009.

March 31, 2010 (In Thousands)		Less Than 12 Consecutive Months												12 Consecutive Months or Longer
		Total Amortized Cost				Gross Unrealized Losses				Total Fair Value				Total Amortized Cost				Gross Unrealized Losses				Total Fair Value
Residential		$	146,464			$	(3,977	)		$	142,487			$	66,296			$	(28,964	)		$	37,331
Commercial			2,909				(438	)			2,471				—				—				—
CDO			4,264				(2,309	)			1,955				7,409				(5,269	)			2,141
Total Securities		$	153,637			$	(6,724	)		$	146,913			$	73,705			$	(34,233	)		$	39,472

December 31, 2009 (In Thousands)		Less Than 12 Consecutive Months												12 Consecutive Months or Longer
		Total Amortized Cost				Gross Unrealized Losses				Total Fair Value				Total Amortized Cost				Gross Unrealized Losses				Total Fair Value
Residential		$	73,075			$	(30,520	)		$	42,555			$	42,368			$	(13,826	)		$	28,542
Commercial			2,719				(71	)			2,648				—				—				—
CDO			4,091				(2,136	)			1,955				7,204				(5,092	)			2,112
Total Securities		$	79,885			$	(32,727	)		$	47,158			$	49,572			$	(18,918	)		$	30,654

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 9. Real Estate Securities  – (continued)

At March 31, 2010, after giving effect to purchases, sales, and extinguishments due to credit losses, our consolidated balance sheet included 552 AFS securities, of which 189 were in an unrealized loss position, of which 105 were in a continuous unrealized loss position for twelve consecutive months or longer. At December 31, 2009, our consolidated balance sheet included 554 AFS securities, of which 220 were in a continuous unrealized loss position and 72 were in a continuous unrealized loss position for twelve months or longer.

Of the total unrealized losses at March 31, 2010 and December 31, 2009, $10 million and $14 million, respectively, relate to securities owned at the Fund. The remaining unrealized losses relate to securities owned at Redwood.

Evaluating AFS Securities for Other-than-Temporary Impairments

When the fair value of an AFS security is below our cost basis, we evaluate the security for OTTI. Part of this evaluation is based upon significant adverse changes in the assumptions used to value the security. The table below summarizes the significant valuation assumptions we used for our AFS securities as of March 31, 2010.

Significant Valuation Assumptions

Range for Securities

March 31, 2010

Prime

Non-prime

Commercial

Prepayment rates

2 – 15

%

1 – 12

%

N/A

Loss severity(1)

13 – 64

%

21 – 63

%

34 – 50

%

Projected losses(1)

0 – 20

%

1 – 55

%

2 – 11

%

During the three months ended March 31, 2010, we determined that $4 million of OTTI existed, of which $2 million was recognized in our consolidated statement of income (loss). We determined that $1 million of this $2 million related to securities with only credit-related OTTI and no corresponding non-credit component. The remaining $1 million was the aggregate credit component of OTTI for securities that also had an aggregate non-credit component of $2 million that was not recognized in our consolidated statements of income (loss).

The following table details the activity related to the credit component of OTTI (i.e., OTTI in either current earnings or retained earnings) for AFS securities that also had a non-credit component and were still held at March 31, 2010.

Activity of Credit Component of Other-than-Temporary Impairments

(In Thousands)		Three Months Ended March 31, 2010
Balance at beginning of period		$	181,913
Current period activity:
Additions related to AFS securities that were not previously impaired			90
Additions related to AFS securities that were previously impaired			1,296
Balance at End of Period		$	183,299

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 9. Real Estate Securities  – (continued)

Gross Realized Gains and Losses

Gains and losses from the sale of AFS securities are recorded as realized gains, net, in our consolidated statements of income (loss). The following table presents the gross realized gains and losses on sales of AFS securities for the three months ended March 31, 2010 and 2009.

		Three Months Ended March 31,
(In Thousands)		2010				2009
Gross realized gains – sales		$	38,854			$	337
Gross realized losses – sales			(1,475	)			—
Total Realized Gains on Sales of AFS Securities, net		$	37,379			$	337

Note 10. Other Investments

Other investments include a GIC owned by an Acacia securitization entity and recorded on our consolidated balance sheets at its estimated fair value. This GIC represents a deposit certificate issued by a rated investment bank and serves as collateral to cover realized losses on CDS entered into by this same Acacia entity. The CDS reference residential mortgage-backed securities issued in 2006 that were initially A and BBB-rated and have subsequently been downgraded. The fair value of the GIC was $11 million as of March 31, 2010, which is equal to its carrying value. The GIC has been drawn down by $69 million since its acquisition to cover credit losses and principal reductions on the referenced securities.

Note 11. Derivative Financial Instruments

We report our derivative financial instruments at fair value as determined using third-party models and confirmed by broker/dealers that make markets in these instruments. Derivatives with a positive fair value are accounted for as assets while derivatives with a negative fair value are accounted for as liabilities. Redwood and the consolidated Acacia entities held derivative positions at March 31, 2010. Acacia’s derivative financial instruments are owned by Acacia securitization entities and are not the obligations of Redwood.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2010
(Unaudited)

Note 11. Derivative Financial Instruments  – (continued)

The following table shows the aggregate fair value and notional amount by entity of our derivative financial instruments as of March 31, 2010 and December 31, 2009.

March 31, 2010 (In Thousands)		Redwood								Acacia								Total
		Fair Value				Notional Amount				Fair Value				Notional Amount				Fair Value				Notional Amount
Assets Accounted for as Cash Flow Hedges
Interest rate swaps		$	281			$	60,000			$	—			$	—			$	281			$	60,000
Assets Accounted for as Trading Instruments
Interest rate swaps			—				—				757				73,536				757				73,536
Interest rate caps purchased			—				—				4,482				711,800				4,482				711,800
Total Assets			281				60,000				5,239				785,336				5,520				845,336
Liabilities Accounted for as Cash Flow Hedges
Interest rate swaps			(693	)			80,000				—				—				(693	)			80,000
Liabilities Accounted for as Trading Instruments
Interest rate swaps			(1,984	)			14,100				(66,086	)			770,995				(68,070	)			785,095
Credit default swaps			—				—				(10,723	)			10,723				(10,723	)			10,723
Total Liabilities			(2,677	)			94,100				(76,809	)			781,718				(79,486	)			875,818
Total Derivative Financial Instruments, net		$	(2,396	)		$	154,100			$	(71,570	)		$	1,567,054			$	(73,966	)		$	1,721,154