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

 

FORM 10-Q

 

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

For the Quarterly Period Ended: June 30, 2009

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 (§232.405 of this chapter) 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 or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer x		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		77,651,881 shares outstanding as of August 4, 2009

TABLE OF CONTENTS

REDWOOD TRUST, INC.
  
2009 FORM 10-Q REPORT
  
TABLE OF CONTENTS

		Page
PART I
Item 1. Financial Statements			1
Consolidated Balance Sheets at June 30, 2009 (Unaudited) and December 31, 2008			1
Consolidated Statements of Income (Loss) for the Three and Six Months Ended June 30, 2009 and 2008 (Unaudited)			2
Consolidated Statements of Equity and Comprehensive (Loss) Income for the Six Months Ended June 30, 2009 and 2008 (Unaudited)			3
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2009 and 2008 (Unaudited)			4
Notes to Consolidated Financial Statements			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of   Operations			42
Item 3. Quantitative and Qualitative Disclosures About Market Risk			101
Item 4. Controls and Procedures			101
PART II
Item 1. Legal Proceedings			102
Item 1A. Risk Factors			102
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			102
Item 3. Defaults Upon Senior Securities			102
Item 4. Submission of Matters to a Vote of Security Holders			103
Item 5. Other Information			103
Item 6. Exhibits			104
Signatures			105

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share Data) (Unaudited)		June 30, 2009				December 31, 2008
ASSETS
Real estate loans		$	3,965,782			$	4,659,336
Real estate securities, at fair value:
Trading securities			253,040				339,654
Available-for-sale securities			551,513				232,470
Total real estate securities			804,553				572,124
Other investments			46,612				78,244
Cash and cash equivalents			337,075				126,480
Total earning assets			5,154,022				5,436,184
Restricted cash			66,224				53,608
Accrued interest receivable			22,272				31,415
Derivative assets			9,290				3,071
Deferred tax asset			2,283				3,608
Deferred asset-backed securities issuance costs			7,949				9,921
Other assets			23,054				43,942
Total Assets		$	5,285,094			$	5,581,749
LIABILITIES AND EQUITY
Liabilities
Short-term debt		$	—			$	—
Accrued interest payable			10,468				29,417
Derivative liabilities			113,607				177,590
Accrued expenses and other liabilities			42,398				20,118
Dividends payable			19,376				25,103
Asset-backed securities issued – Sequoia			3,842,638				4,508,127
Asset-backed securities issued – Acacia			286,943				346,931
Long-term debt			150,000				150,000
Total liabilities			4,465,430				5,257,286
EQUITY
Stockholders’ Equity
Common stock, par value $0.01 per share, 100,000,000 and 75,000,000 shares authorized; 77,503,470 and 33,470,557 issued and oustanding			775				335
Additional paid-in capital			1,673,655				1,149,393
Accumulated other comprehensive loss			(77,944	)			(56,865	)
Cumulative earnings			298,797				266,059
Cumulative distributions to stockholders			(1,093,488	)			(1,057,070	)
Total stockholders’ equity			801,795				301,852
Noncontrolling interest			17,869				22,611
Total equity			819,664				324,463
Total Liabilities and Equity		$	5,285,094			$	5,581,749

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

TABLE OF CONTENTS

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

(In Thousands, Except Share Data) (Unaudited)		Three Months Ended June 30,								Six Months Ended June 30,
		2009				2008				2009				2008
Interest Income
Real estate loans		$	30,614			$	72,762			$	64,583			$	168,386
Real estate securities			43,475				61,529				90,737				138,057
Other investments			55				514				131				1,246
Cash and cash equivalents			117				2,196				247				5,377
Total interest income			74,261				137,001				155,698				313,066
Interest Expense
Short-term debt			—				(68	)			—				(250	)
Asset-backed securities issued			(37,499	)			(95,205	)			(83,332	)			(219,790	)
Long-term debt			(1,502	)			(2,233	)			(3,310	)			(4,766	)
Total interest expense			(39,001	)			(97,506	)			(86,642	)			(224,806	)
Net Interest Income			35,260				39,495				69,056				88,260
Provision for loan losses			(14,545	)			(10,061	)			(30,577	)			(18,119	)
Market valuation adjustments on trading instruments			4,102				(31,526	)			(10,107	)			(81,358	)
Other-than-tempory impairments(1)			(33,237	)			(28,970	)			(62,272	)			(173,067	)
Market valuation adjustments, net			(29,135	)			(60,496	)			(72,379	)			(254,425	)
Net Interest Loss After Provision and Market Valuation Adjustments			(8,420	)			(31,062	)			(33,900	)			(184,284	)
Operating expenses			(10,769	)			(14,255	)			(21,308	)			(30,604	)
Realized gains, net			25,525				2,714				25,988				2,753
Net income (loss) before provision for income taxes			6,336				(42,603	)			(29,220	)			(212,135	)
Provision for (benefit from) income taxes			514				(937	)			409				(2,737	)
Net income (loss)			6,850				(43,540	)			(28,811	)			(214,872	)
Less: Net income (loss) attributable to noncontrolling interest			127				2,369				(589	)			2,624
Net Income (Loss) Attributable to Redwood Trust, Inc.		$	6,723			$	(45,909	)		$	(28,222	)		$	(217,496	)
Basic earnings (loss) per share:		$	0.10			$	(1.40	)		$	(0.48	)		$	(6.65	)
Diluted earnings (loss) per share:		$	0.10			$	(1.40	)		$	(0.48	)		$	(6.65	)
Regular dividends declared per common share		$	0.25			$	0.75			$	0.50			$	1.50
Basic weighted average shares outstanding			65,697,887				32,871,442				59,137,864				32,691,444
Diluted weighted average shares outstanding			66,446,025				32,871,442				59,137,864				32,691,444

 
 
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 (LOSS) INCOME

For the Six Months Ended June 30, 2009

(In Thousands, Except Share Data) (Unaudited)		Common Stock								Additional Paid-In Capital				Accumulated Other Comprehensive (Loss) Income				Cumulative Earnings (Losses)				Cumulative Distributions to Stockholders				Noncontrolling Interest				Total
		Shares				Amount
December 31, 2008			33,470,557			$	336			$	1,149,392			$	(56,865	)		$	266,059			$	(1,057,070	)		$	22,611			$	324,463
Adoption of FSP 115-2			—				—				—				(60,960	)			60,960				—				—				—
Net (loss) income			—				—				—				—				(28,222	)			—				(589	)			(28,811	)
Net unrealized gain on available-for-sale securities			—				—				—				1,844				—				—				(623	)			1,221
Reclassification of other-than-temporary impairments to net loss			—				—				—				35,827				—				—				—				35,827
Reclassification of unrealized loss on interest rate agreements to net loss			—				—				—				2,210				—				—				—				2,210
Total other comprehensive loss															(21,079	)
Total comprehensive income																															10,447
Issuance of common stock:
Secondary offerings			43,690,000				436				519,704				—				—				—				—				520,140
Dividend reinvestment & stock purchase plans			139,750				2				1,571				—				—				—				—				1,573
Employee option & stock purchase plan			203,163				1				(1,168	)			—				—				—				—				(1,167	)
Non-cash equity award compensation			—				—				4,156				—				—				—				—				4,156
Distributions to noncontrolling interests, net			—				—				—				—				—				—				(3,530	)			(3,530	)
Common dividends declared			—				—				—				—				—				(36,418	)			—				(36,418	)
June 30, 2009			77,503,470			$	775			$	1,673,655			$	(77,944	)		$	298,797			$	(1,093,488	)		$	17,869			$	819,664

For the Six Months Ended June 30, 2008

(In Thousands, Except Share Data) (Unaudited)		Common Stock								Additional Paid-In Capital				Accumulated Other Comprehensive (Loss) Income				Cumulative Earnings (Losses)				Cumulative Distributions to Stockholders				Noncontrolling Interest				Total
		Shares				Amount
December 31, 2007			32,385,073			$	324			$	1,108,148			$	(573,766	)		$	(299,626	)		$	(953,359	)		$	—			$	(718,279	)
Adoption of FAS 159			—				—				—				458,207				1,010,071				—				—				1,468,278
January 1, 2008			32,385,073				324				1,108,148				(115,559	)			710,445				(953,359	)			—				749,999
Net (loss) income			—				—				—				—				(217,496	)			—				2,624				(214,872	)
Net unrealized loss on available-for-sale securities			—				—				—				48,924				—				—				—				48,924
Reclassification of other-than-temporary impairments to net loss			—				—				—				—				—				—				—				—
Reclassification of unrealized loss on interest rate agreements to net loss			—				—				—				2,492				—				—				—				2,492
Total other comprehensive income															51,416
Total comprehensive loss																															(163,456	)
Issuance of common stock:
Dividend reinvestment & stock purchase plans			722,431				8				23,507				—				—				—				—				23,515
Employee option & stock purchase plan			76,813				—				975				—				—				—				—				975
Non-cash equity award compensation			—				—				7,038				—				—				—				—				7,038
Distributions to noncontrolling interests, net																											43,959				43,959
Common dividends declared			—				—				—				—				—				(51,449	)			—				(51,449	)
June 30, 2008			33,184,317			$	332			$	1,139,668			$	(64,143	)		$	492,949			$	(1,004,808	)		$	46,583			$	610,581

 
 
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) (Unaudited)		Six Months Ended June 30,
		2009				2008
Cash Flows From Operating Activities:
Net (loss) income		$	(28,222	)		$	(217,496	)
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Amortization of premiums, discounts, and debt issuance costs, net			3,493				(5,405	)
Depreciation and amortization of non-financial assets			539				536
Provision for loan losses			30,577				18,119
Non-cash equity award compensation			4,156				7,038
Market valuation adjustments, net			72,379				254,425
Realized gains, net			(25,988	)			(2,753	)
Net change in:
Accrued interest receivable			9,738				15,581
Deferred tax asset			1,325				788
Other assets			30,193				11,585
Accrued interest payable			(11,549	)			(18,302	)
Accrued expenses and other liabilities			22,280				(1,575	)
Net cash provided by operating activities			108,921				62,541
Cash Flows From Investing Activities:
Principal payments on real estate loans held-for-investment			199,516				765,293
Purchases of real estate securities available-for-sale			(438,669	)			(244,252	)
Proceeds from sales of real estate securities available-for-sale			57,898				7,300
Principal payments on real estate securities available-for-sale			52,372				41,098
Purchases of real estate securities trading			—				(3,341	)
Proceeds from sales of real estate securities trading			—				454
Principal payments on real estate securities trading			50,942				100,504
Principal payments on other investments			14,279				541
Net (increase) decrease in restricted cash			(12,616	)			15,893
Net cash (used in) provided by investing activities			(76,278	)			683,490
Cash Flows From Financing Activities:
Net borrowings on short-term debt			—				1,765
Repayments on asset-backed securities			(271,626	)			(905,000	)
Net settlements of interest rate agreements			(24,702	)			(5,743	)
Net proceeds from issuance of common stock			520,546				24,490
Dividends paid			(42,147	)			(50,850	)
Change in noncontrolling interests			(4,119	)			46,583
Net cash provided by (used in) financing activities			177,952				(888,755	)
Net increase (decrease) in cash and cash equivalents			210,595				(142,724	)
Cash and cash equivalents at beginning of period			126,480				290,363
Cash and cash equivalents at end of period		$	337,075			$	147,639
Supplemental Disclosures:
Cash paid for interest		$	105,591			$	243,109
Cash (received) paid for taxes		$	(3,421	)		$	(1,442	)
Dividends declared but not paid at end of period		$	19,376			$	24,887

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

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

Note 1. Redwood Trust

Redwood Trust, Inc., together with its subsidiaries (Redwood, we, or us), invests in, finances, and manages real estate assets. We invest in residential and commercial real estate loans and in asset-backed securities backed by real estate loans. We seek to invest in assets that have the potential to generate sufficient long-term cash flow returns to support our goal of distributing an attractive level of dividends per share to shareholders over time. For tax purposes, we are structured as a real estate investment trust (REIT).

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

Note 2. Basis of Presentation

The consolidated financial statements presented herein are at June 30, 2009 and December 31, 2008, and for the three and six months ended June 30, 2009 and 2008. These consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) in the United States for interim financial information and with the Securities and Exchange Commission’s (SEC) instructions to Form 10-Q and Article 10 of Regulation S-X. Results for the three and six months ended June 30, 2009, may not necessarily be indicative of the results for the year ending December 31, 2009. The unaudited interim consolidated financial statements as of June 30, 2009, 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, 2008. All amounts presented herein, except per share data, are shown in thousands.

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.

Principles of Consolidation

We apply the principles of Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 140) and Financial Accounting Standards Board (FASB) Interpretation No. 46 (revised), Consolidation of Variable Interest Entities (FIN 46(R)) to determine whether we must consolidate any entities where we have continuing involvement. We do not service any assets, including assets owned at the Fund, Sequoia, or Acacia.

We consolidate the assets, liabilities, and noncontrolling interests of the Fund that we sponsor, as we are the primary beneficiary of this entity as defined by FIN 46(R). The primary beneficiary is the party that absorbs the majority of a variable interest entity’s (VIEs) anticipated losses and/or the majority of the expected returns. Our significant limited partnership interest and ongoing asset management responsibilities constitute this majority.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

Note 2. Basis of Presentation  – (continued)

We consolidate most of the assets and liabilities of the Sequoia and Acacia securitization entities that we sponsor that were not accounted for as sales. These entities did not meet the criteria for sale accounting as prescribed by FAS 140 at the time we transferred financial assets to them. Our continuing involvement includes our retention of junior interests and call rights and certain ongoing management responsibilities or other discretionary activities. For financial reporting purposes, 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 and interest expense on the ABS issued by these consolidated securitization entities.

During the second quarter of 2009, we derecognized the assets and liabilities of one Sequoia entity due to a sale of our variable interests in this entity and lack of continuing involvement. These assets and liabilities are no longer shown on our consolidated balance sheet as of June 30, 2009.

See Note 6 for further discussion on our sale of Sequoia interests and resulting deconsolidation.

Note 3. Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with GAAP 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, the period of time during which we anticipate an increase in the fair values of real estate securities sufficient to recover unrealized losses in those securities, and other 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

Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FAS No. 115 (FAS 159) 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, or upon the initial adoption of FAS 159 on January 1, 2008. Subsequent changes in the fair value of these assets, liabilities, and commitments are recorded in the consolidated statements of income (loss).

Our decision to adopt FAS 159 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 under FAS 115. Securities that we anticipate funding with a combination of debt and equity or those financed through the issuance of asset-backed liabilities will generally be accounted for at fair value under FAS 159 along with the corresponding liabilities.

See Note 4 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. We estimate fair values in accordance with Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157). Under this standard, a fair value measurement represents the price at which a

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

transaction would occur between market participants. This price implies an orderly transaction, or exit price, that is not a forced liquidation or distressed sale 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:

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 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 conditions for that asset or liability, 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 may 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) must also be evaluated. In circumstances where relevant market inputs cannot be obtained, increased analysis and management judgment are required to estimate fair value. This may require 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.

In the second quarter of 2009, we adopted FASB Staff Position FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (FSP 157-4). This FSP provides additional guidance on estimating fair value when the volume and level of trading activity for an asset or liability has significantly decreased, and determining when a transaction is not orderly. The adoption of this standard did not have a material impact on our consolidated financial position and results of operations, as our existing process is consistent with the FASB’s clarification.

In the second quarter of 2009, FASB issued FASB Staff Position FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (FSP 107-1), which expanded the annual fair value disclosures required for all financial instruments within the scope of FAS 107 to interim periods. The FSP also required publicly traded companies to disclose the method(s) and significant assumptions used to estimate the fair value of financial instruments in financial statements on an interim basis and to highlight any changes of the methods and significant assumptions from prior periods. The implementation of this standard did not have a material impact on our consolidated financial position and results of operations as our existing disclosures are consistent with the FASB’s clarification.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

See Note 5 for further discussion on fair value measurements.

Real Estate Loans

Residential and Commercial Real Estate Loans — Fair Value

Residential and commercial real estate loans at fair value are loans where we have elected the fair value option under FAS 159. The fair value option was elected on January 1, 2008, for all the loans owned by Acacia securitization entities as of that date. 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 independent third parties. These loans are carried at the lower of their cost or fair value in accordance with Statement of Financial Accounting Standards No. 65, Accounting for Certain Mortgage Banking Activities (FAS 65), as measured on an individual basis. Coupon interest is recognized as revenue when earned and deemed collectible or until a loan becomes more than 90 days past due. If fair value is lower than amortized cost, changes in fair value are reported through our consolidated statements of income (loss) in market valuation adjustments, net.

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. Pursuant to Statement of Financial Accounting Standards No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Cost of Leases (FAS 91), we use the interest method to determine an effective yield and 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 an effective yield to amortize the premium or discount. 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 calculate an effective yield to amortize the premium or discount.

We may exercise our right to call ABS issued by Sequoia and may subsequently sell the underlying loans to third parties. We reclassify held-for-investment loans to held-for-sale loans if we determine that loans will be sold to third parties. Gains or losses on the sale of real estate loans are based on the specific identification method.

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 as of 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.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

We follow the guidelines of SEC Staff Accounting Bulletin No. 102, Selected Loan Loss Allowance Methodology and Documentation (SAB 102), Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (FAS 5), and Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan (FAS 114), in setting the allowance for loan losses.

We consider the following factors in making such determinations:

Once we determine applicable default amounts, the timing of the defaults, and severity of losses upon 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 effective 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 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 on at least a quarterly basis.

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

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

Real Estate Securities, at Fair Value

Trading Securities

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

We primarily denote trading securities as those securities where we have adopted the fair value option under FAS 159. We currently account for certain securities at Redwood and all securities at Acacia entities as trading securities. Prior to the adoption of FAS 159, these securities were accounted for in accordance with Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (FAS 115).

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 (loss) income in our consolidated statements of equity, in accordance with FAS 115. We currently account for most securities at Redwood and all securities at the Fund as AFS securities.

When recognizing revenue on our AFS securities, we have determined that credit risk is not remote and therefore employ the interest method as prescribed under the Emerging Issues Task Force of the Financial Accounting Standards Board 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets (EITF 99-20). 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 asset, which includes assumptions about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. We review and make adjustments to our cash flow projections on an ongoing basis and monitor these projections based on input and analyses received from external sources, internal models, and our own judgment and experience. Actual maturities of our AFS securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, and prepayments of principal. Therefore, actual maturities of AFS securities are generally shorter than stated contractual maturities. Stated contractual maturities are generally greater than ten years. There can be no assurance that our assumptions used to estimate future cash flows or the current period’s yield for each asset will not change in the near term, and the change could be material.

Yields recognized for each security can vary as a function of credit results, prepayment rates, and interest rates. If estimated future credit losses are less than our prior estimate, credit losses occur later than expected, or prepayment rates are faster than expected (meaning the present value of projected cash flows is greater than previously expected for assets acquired at a discount to face value), the yield over the remaining life of the security may be adjusted upwards. If estimated future credit losses exceed our prior expectations, credit losses occur more quickly than expected, or prepayments occur more slowly than expected (meaning the present value of projected cash flows is less than previously expected for assets acquired at a discount to face value), the yield over the remaining life of the security may be adjusted downward.

Every quarter we assess whether a decline in the fair value of an AFS security below our cost is an other-than-temporary impairment (OTTI). In the second quarter of 2009, we adopted FASB Staff Position FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (FSP 115-2), which establishes a new method of recognizing and reporting OTTI of debt securities, as well as additional disclosure requirements related to debt and equity securities. Prior to the effective date of this FSP 115-2 (April 1, 2009), OTTI was based on a market value decline below a security’s cost basis and a corresponding adverse change in expected future cash flows due to credit related factors, as defined by EITF 99-20. OTTI was also evaluated based on whether an entity could assert the ability and intent to hold the investment until a recovery of fair value. If the entity could not make this assertion, the cost basis of the security was written down to current fair value, with the entire write-down recognized in current earnings.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

Under FSP 115-2, the determination of OTTI for debt securities has changed. The presence of OTTI continues to be based upon a market value decline below a security’s cost basis and a corresponding adverse change in expected future cash flows. A change from prior guidance, FSP 115-2 considers any adverse changes in cash flows, including non-credit factors such as changes in floating interest rates. This FSP also modifies the “ability and intent” provision and requires impairment to be considered other-than-temporary if an entity (i) intends to sell the security, (ii) will more likely than not be required to the sell the security before it recovers in value, or (iii) does not expect to recover the security’s amortized cost basis, even if the entity does not intend to sell the security. Under these scenarios, the impairment is other-than-temporary and the full amount of impairment should be recognized currently in earnings. However, if an entity does not intend to sell the impaired debt security and it is more likely than not that it will not be required to sell before recovery, the OTTI should be separated into (i) the estimated amount relating to credit loss (“credit” component), and (ii) the amount relating to all other factors (“non-credit” component). Only the estimated credit loss amount is recognized currently in earnings, with the remainder of the loss amount recognized in other comprehensive income.

Upon adoption of this FSP, we recorded a cumulative effect transition adjustment of $61 million to reclassify the non-credit portion of any OTTI previously recorded through earnings to accumulated other comprehensive (loss) income for investments held as of the beginning of the period of adoption. The cumulative effect adjustment was determined based on the difference between the present value of the cash flows expected to be collected and the amortized cost basis of the debt security as of the beginning of the period of adoption and included any related tax effects. The difference between the new amortized cost basis and the cash flows expected to be collected is accreted as interest income in accordance with the existing guidance of EITF 99-20.

In April 2009, the SEC issued Staff Accounting Bulletin 111, Other than Temporary Impairment of Certain Investments in Equity Securities (SAB 111), which amends SAB 59 to exclude OTTI on debt securities from its scope. The SEC issued SAB 111 to align its guidance with that of the FASB and FSP 115-2, ensuring consistency in standards for determining impairments. Our adoption of SAB 111 occurred in conjunction with our adoption of FSP 115-2.

See Note 8 for further discussion on real estate securities and cumulative effect adjustment related to FSP 115-2.

Other Investments

Other investments include a guaranteed investment contract (GIC) entered into by an Acacia securitization entity that we consolidate for financial statements purposes. We elected the fair value option under FAS 159 for this investment on January 1, 2008, and it is recorded on our consolidated balance sheets at its estimated fair value. Changes in fair value are reported through our consolidated statements of income (loss) through market valuation adjustments, net. Interest income is reported through our consolidated statements of income (loss) through interest income, other investments.

See Note 9 for further discussion on other investments.

Cash and Cash Equivalents

Cash and cash equivalents include non-restricted cash on hand and highly liquid investments with original maturities of three months or less. At June 30, 2009, we did not have any significant concentrations of credit risk arising from cash deposits as all of our cash and cash equivalents were invested in U.S. Government Treasury Bills or FDIC-insured bank products.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

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.

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 under FAS 159, the associated accrued interest on these assets is measured at fair value. For financial assets where we have not elected to adopt FAS 159, 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 on our consolidated balance sheets, in accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133) and FAS 159. 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.

Prior to 2008, we accounted for derivatives used to hedge interest rate exposure in Acacia securitization entities as cash flow hedges. At January 1, 2008, all of our consolidated derivatives designated as cash flow hedges were de-designated and accounted for as trading instruments. To the extent 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 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 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 have consolidated for financial reporting purposes. Net purchases and proceeds from CDS are classified as financing activities within our consolidated statements of cash flows.

See Note 10 for further discussion on derivative financial instruments.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

Deferred Tax Assets

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

Deferred Asset-Backed Securities Issuance Costs

ABS issuance costs are costs associated with the issuance of ABS from the Sequoia securitization entities we sponsor. These costs 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 to interest expense using the interest method, based upon the actual and estimated repayment schedules of the related ABS issued under the principles prescribed in Accounting Practice Bulletin 21, Interest on Receivables and Payables (APB 21). Sequoia deferred ABS issuance costs are accounted for in accordance with APB 21.

As of January 1, 2008, deferred issuance costs associated with Acacia securitizations were included as part of our adoption of FAS 159 for assets and liabilities at Acacia. As a result, these deferred costs were charged to retained earnings as a part of a one-time cumulative effect adjustment on January 1, 2008.

Other Assets

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

See Note 11 for further discussion on other assets.

Short-Term Debt

Short-term debt can include master repurchase agreements, bank borrowings, and other forms of collateralized borrowings with various commercial banks and investment banks that expire within one year. These facilities may be unsecured or collateralized by loans or securities. 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 thirty days to three months of recording the payable, based upon our remittance requirements. For borrowings where we have elected the fair value option under FAS 159, the associated accrued interest on these liabilities is measured at fair value. For financial liabilities where we have not elected to adopt FAS 159, 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.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

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

Effective January 1, 2008, Acacia ABS issued are accounted for under FAS 159 and carried at their estimated fair values on our consolidated balance sheets. Changes in fair value (gains or losses) are reported in our consolidated statements of income (loss) through market valuation adjustments, net. Prior to January 1, 2008, Acacia ABS issued were accounted for under the same method as Sequoia ABS issued.

See Note 12 for further discussion on ABS issued.

Long-Term Debt

Long-term debt includes trust preferred securities and subordinated notes at Redwood and is carried at its unpaid principal balance. 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. These notes contain an earlier optional redemption date without penalty.

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

Equity

Earnings (Loss) Per Share

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

On January 1, 2009, we adopted, FASB Staff Position EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (EITF 03-6-1). EITF 03-6-1 states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are “participating securities” as defined in EITF 03-6, Participating Securities and the Two-Class Method under FASB Statement No. 128 (EITF 03-6), and therefore should be included in computing EPS using the two-class method. Our adoption of EITF 03-6-1 required us to recast previously reported EPS and did not have a significant impact on EPS.

Other Comprehensive (Loss) Income

Net unrealized gains and losses on real estate securities available-for-sale and interest rate agreements previously designated as cash flow hedges under FAS 133 are reported as components of other comprehensive (loss) income on our consolidated statements of equity and comprehensive (loss) income. Net unrealized gains

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

and losses on securities and interest rate agreements held by our taxable subsidiaries that are reported in other comprehensive (loss) income 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 Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements (FAS 160), the noncontrolling interest of the Fund is shown as a component of equity on our consolidated balance sheets, and the portion of income allocable to third parties is shown as net income 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 (loss) income.

Equity Compensation Plans

Incentive Plan

In March 2008, we amended our previously amended 2002 Redwood Trust, Inc. Incentive Plan (Incentive Plan) for executive officers, employees, and non-employee directors. This amendment was approved by our shareholders in May 2008. 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 Statement of Financial Accounting Standards No. 123R, Share-Based Payment (FAS 123R), and amortized over the vesting term using an accelerated method in accordance with FASB Interpretation No. 28 Accounting for Stock Appreciation Rights and Other Variable Stock Options or Award Plans (FIN 28) and FAS 123R for equity awards granted prior to December 2008. For all equity awards granted in December 2008 and all future equity award grants, the cost of these awards will be amortized over the vesting period on a straight-line basis. Timing differences between the accelerated and straight-line method of amortization were determined to be immaterial to our financial statements.

Employee Stock Purchase Plan

In May 2002, our stockholders approved our 2002 Redwood Trust, Inc. Employee Stock Purchase Plan (ESPP), effective July 1, 2002. 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. This plan was amended by our stockholders in May 2009 to increase the number of available shares.

Executive Deferred Compensation Plan

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

See Note 16 for further discussion on equity compensation plans.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

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. Beginning in 2003, we elected to retain up to 10% of our REIT ordinary taxable income and had provisioned for corporate income taxes on the retained income while maintaining our REIT status. In August 2008, our Board of Directors decided to distribute as dividends 100% of our REIT taxable income generated in 2007 and 2008 and our tax provisions changed accordingly.

We assess our tax positions for all open tax years and determine whether we have any material unrecognized liabilities in accordance with Financial Accounting Standard Board Interpretation Number 48, Accounting for Uncertainty in Income Taxes, (FIN 48). We record these liabilities to the extent we deem them incurred. We classify interest and penalties on material uncertain tax positions as interest expense and operating expense, respectively, in our consolidated statements of income (loss).

See Note 18 for further discussion on taxes.

Recent Accounting Pronouncements

In May 2009, the FASB issued Statement of Financial Accounting Standards No. 165, Subsequent Events (FAS 165), which provides guidance on management’s assessment of subsequent events. FAS 165 represents the inclusion of guidance on subsequent events in the accounting literature and is directed specifically to management, as management is responsible for preparing an entity’s financial statements. FAS 165 is not expected to significantly change practice as its guidance is similar to that in auditing standards, with some important modifications. FAS 165 clarifies that management must evaluate, as of each reporting period, events or transactions that occur after the balance sheet date “through the date that the financial statements are issued or are available to be issued.” Management must perform its assessment for both interim and annual financial reporting periods. FAS 165 is effective prospectively for interim and annual periods ending after June 15, 2009. The implementation of this standard required additional disclosures, which can be found in Note 19.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140 (FAS 166). FAS 166 requires more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures. Specifically, FAS 166 (1) requires that all arrangements made in connection with a transfer of financial assets be considered in the derecognition analysis, (2) clarifies when a transferred asset is considered legally isolated from the transferor, (3) modifies the requirements related to a transferee’s ability to freely pledge or exchange transferred financial assets, and (4) provides guidance on when a portion of a financial asset can be derecognized. FAS 166 enhances information reported to users of financial statements by providing greater transparency about transfers of financial assets and a company’s continuing involvement in transferred financial assets. FAS 166 is effective for financial asset transfers occurring after the beginning of an entity’s first fiscal year that begins after November 15, 2009. Early adoption is prohibited. We are currently evaluating the impact of FAS 166 and have not yet determined the impact of adopting this principle. However, in considering our past transfers of financial assets to securitization entities (i.e., Sequoia and Acacia) through application of FAS 140, changes to the consolidation criteria prescribed by FAS 166 for similar transfers could have a significant impact on our reported results in the future.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R), (FAS 167), which amends the consolidation guidance that applies to VIEs. The amendment changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. Accordingly, an enterprise will need to carefully reconsider its previous FIN 46(R) conclusions, including (1) whether an entity is a VIE, (2) whether the enterprise is the VIE’s primary beneficiary, and (3) what type of financial statement disclosures are required. FAS 167 will require a company to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. A company will be required to disclose how its involvement with a variable interest entity affects the company’s financial statements. FAS 167 is effective as of the beginning of the first fiscal year that begins after November 15, 2009. Early adoption is prohibited. We are currently evaluating the impact of FAS 167 and have not yet determined the impact of adopting this principle. However, given our previous reliance on qualifying special purpose entity (QSPE) designations for third party securitization trusts for which we have invested in, the required reconsideration of our variable interests in those trusts as of January 1, 2010, could have a significant impact on our financial statements. For example, we may determine that we are the primary beneficiary of securitization trusts that we had considered QSPEs in the past and would therefore be required to consolidate those VIEs for financial reporting purposes beginning in 2010.

In June 2009, the FASB issued 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 stabilizes the Accounting Standards Codification (Codification) as the single source of authoritative GAAP in the United States. The current GAAP hierarchy consists of four levels of authoritative accounting and reporting guidance (levels A through D), including original pronouncements of the FASB, EITF abstracts, and other accounting literature (“pre-Codification GAAP” or “current GAAP”). The Codification eliminates this hierarchy and replaces current GAAP (other than rules and interpretive releases of the SEC), as used by all nongovernmental entities, with just two levels of literature: authoritative and nonauthoritative. FAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. Adoption of this standard may constitute a change in the way we reference current GAAP literature, but we do not anticipate adoption of FAS 168 to have a material effect on our consolidated financial statements.

Note 4. Fair Value Option

We adopted FAS 159 on January 1, 2008, and elected to apply the fair value option for the assets (loans, securities, and unamortized deferred ABS issuance costs) and liabilities (ABS issued) of our consolidated Acacia securitization entities. We also elected the fair value option for certain securities at Redwood that we anticipated potentially selling or securitizing in the future. The election of FAS 159 resulted in a $1.5 billion cumulative effect transition adjustment at January 1, 2008. There was no deferred tax impact associated with the adoption since the net unrealized losses in accumulated other comprehensive loss that were reclassified to retained earnings were generated at the REIT, which distributes predominantly all of its taxable income.

As of June 30, 2009, the loans at Acacia had an aggregate fair value of $8 million and an unpaid principal balance of $26 million, the securities had an aggregate fair value of $249 million and face value of $2.8 billion, and asset-backed securities issued at Acacia had an aggregate fair value of $287 million and an unpaid principal balance of $3.1 billion.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

Note 4. Fair Value Option  – (continued)

We have not elected the fair value option for any financial instruments that were acquired from third parties subsequent to our initial adoption of FAS 159 on January 1, 2008. We did elect 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.

Note 5. Fair Value of Financial Instruments

FAS 157 defines fair value, establishes a hierarchy of information used in measuring fair value, and enhances the disclosure of information about fair value measurements. FAS 157 provides that the “exit price” 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. FAS 157 also provides that relevant market data, to the extent available, and not internally generated or entity specific information, should be used to determine fair value.

The following table presents the carrying values and estimated fair values of assets and liabilities that are required to be recorded or disclosed at fair value as of June 30, 2009 and December 31, 2008.

(In Thousands)		June 30, 2009								December 31, 2008
		Carrying Value				Fair Value				Carrying Value				Fair Value
Assets
Real estate loans (held-for-investment)		$	3,955,630			$	2,795,033			$	4,644,735			$	2,618,323
Real estate loans (held-for-sale)			2,337				2,337				2,624				2,624
Real estate loans (fair value)			7,815				7,815				11,977				11,977
Trading securities			253,040				253,040				339,654				339,654
Available-for-sale securities			551,513				551,513				232,470				232,470
Other investments			46,612				46,612				78,244				78,244
Cash and equivalents			337,075				337,075				126,480				126,480
Restricted cash			66,224				66,224				53,608				53,608
Accrued interest receivable			22,272				22,272				31,415				31,415
Derivative assets			9,290				9,290				3,071				3,071
REO (included in other assets)			12,335				12,335				19,264				19,264
Liabilities
Short-term debt			—				—				—				—
Accrued interest payable			10,468				10,468				29,417				29,417
Derivative liabilities			113,607				113,607				177,590				177,590
ABS Issued
ABS issued – Sequoia			3,842,638				2,656,571				4,508,127				2,967,763
ABS issued – Acacia			286,943				286,943				346,931				346,931
Total ABS issued			4,129,581				2,943,514				4,855,058				3,314,694
Long-term debt			150,000				51,000				150,000				41,628

FAS 157 requires us to estimate and disclose fair values based on the following three-level hierarchy that prioritizes market inputs.

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

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

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

Level 3 inputs include unobservable inputs that are used when there is little, if any, market activity for the asset or liability measured at fair value. In certain cases, the inputs used to measure fair value fall into different levels of the fair value hierarchy. In such cases, the level in which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement. Our assessment of the significance of a particular input requires judgment and considers factors specific to the asset or liability being measured.

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

Assets and Liabilities Measured at Fair Value on a Recurring Basis as of June 30, 2009

(In Thousands)		Carrying Value				Fair Value Measurements Using
						Level 1				Level 2				Level 3
Assets
Real estate loans		$	7,815				—			$	—			$	7,815
Trading securities			253,040				—				—				253,040
Available-for-sale securities			551,513				—				—				551,513
Other investments			46,612				—				46,612				—
Derivative assets			9,290				—				9,107				183
Liabilities
ABS issued – Acacia			286,943				—				—				286,943
Derivative liabilities			113,607				—				67,048				46,559

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

(In Thousands)		Carrying Value				Fair Value Measurements Using
						Level 1				Level 2				Level 3
Assets
Real estate loans		$	11,977				—			$	—			$	11,977
Trading securities			339,654				—				—				339,654
Available-for-sale securities			232,470				—				—				232,470
Other investments			78,244				—				78,244				—
Derivative assets			3,071				—				2,829				242
Liabilities
ABS issued – Acacia			346,931				—				—				346,931
Derivative liabilities			177,590				—				99,698				77,892

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

The following table presents additional information about the assets and liabilities recorded at fair value on our consolidated balance sheet on a recurring basis for which Level 3 inputs were used.

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

Six Months Ended June 30, 2009 (In Thousands)		Beginning Balance 12/31/2008				Principal Paydowns				Gains (Losses) Included in								Purchases, Sales, Other Settlements and Issuances, Net				Ending Balance 6/30/2009
										Net Loss				Other Comprehensive Loss
Assets
Real estate loans		$	11,977			$	(196	)		$	(3,967	)		$	—			$	—			$	7,814
Trading securities			339,654				(50,942	)			(35,185	)			—				(487	)			253,040
Available-for-sale securities			232,470				(52,372	)			(58,408	)			37,046				392,777				551,513
Derivative assets			242				—				231				—				(290	)			183
Liabilities
ABS issued – Acacia			346,931				(64,491	)			(2,897	)			—				7,400				286,943
Derivative liabilities			77,892				—				(672	)			—				(30,661	)			46,559

The following table presents the portion of gains or losses included in our consolidated statement of income (loss) that were attributable to Level 3 assets and liabilities recorded at fair value on a recurring basis and still held at June 30, 2009 and 2008. Gains or losses incurred on assets or liabilities sold or otherwise disposed of during the three and six months ended June 30, 2009 and 2008 are not included in this presentation.

Portion of Gains (Losses) Attributable to Level 3 Assets and Liabilities Still Held at June 30, 2009 and 2008 Included in Net Income (Loss)

(In Thousands)		Included in Net Income (Loss)
		Three Months Ended								Six Months Ended
		June 30, 2009				June 30, 2008				June 30, 2009				June 30, 2008
Assets
Real estate loans		$	(1,720	)		$	112			$	(3,967	)		$	(4,548	)
Trading securities			11,368				(62,655	)			(34,408	)			(857,682	)
Available-for-sale securities			(33,237	)			(33,036	)			(62,121	)			(176,724	)
Derivative assets			71				177				231				208
Liabilities
ABS issued – Acacia			28,792				4,464				(2,897	)			814,305
Derivative liabilities			(401	)			(2,290	)			(672	)			(20,099	)

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

The following table presents assets and liabilities recorded at fair value on a non-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 Non-Recurring Basis as of June 30, 2009

June 30, 2009 (In Thousands)		Carrying Value				Fair Value Measurements Using												Gain (Loss)
																		Three Months Ended June 30, 2009				Six Months Ended June 30, 2009
						Level 1				Level 2				Level 3
Assets
Real estate loans (held-for-sale)		$	2,337				—				—			$	2,337			$	(56	)		$	(76	)
REO			12,335				—				—				12,335				(1,159	)			(1,923	)

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

December 31, 2008 (In Thousands)		Carrying Value				Fair Value Measurements Using												Gain (Loss)
																		Three Months Ended June 30, 2008				Six Months Ended June 30, 2008
						Level 1				Level 2				Level 3
Assets
Real estate loans (held-for-sale)		$	2,624				—				—			$	2,624			$	(81	)		$	(376	)
REO			19,264				—				—				19,264				(984	)			(1,548	)

The following table presents the components of market valuation adjustments, net, recorded in our consolidated statements of income (loss) for the three and six months ended June 30, 2009 and 2008.

Market Valuation Adjustments, Net

(In Thousands)		Three Months Ended June 30,								Six Months Ended June 30,
		2009				2008				2009				2008
Assets
Real estate loans (fair value)		$	(1,720	)		$	112			$	(3,967	)		$	(4,548	)
Real estate loans (held-for-sale)			(1,215	)			(1,065	)			(2,000	)			(1,924	)
Trading securities			11,240				(65,776	)			(35,185	)			(863,754	)
Impairments on AFS securities			(33,237	)			(28,970	)			(62,272	)			(173,067	)
Liabilities
ABS issued – Acacia			(28,792	)			4,464				2,897				814,305
Derivative instruments, net			24,589				30,739				28,148				(25,437	)
Market Valuation Adjustments, Net		$	(29,135	)		$	(60,496	)		$	(72,379	)		$	(254,425	)

A description of the instruments measured at fair value under FAS 157 as well as the general classification of such instruments pursuant to the valuation hierarchy described above under FAS 157 is listed below.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

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

Note 6. Real Estate Loans

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

The following table summarizes the classifications and carrying value of the residential and commercial real estate loans reported on our consolidated balance sheets at June 30, 2009 and December 31, 2008.

(In Thousands)		June 30, 2009				December 31, 2008
Residential real estate loans (held-for-sale)		$	2,337			$	2,624
Residential real estate loans (held-for-investment)			3,955,383				4,644,486
Commercial real estate loans (fair value)			7,815				11,977
Commercial real estate loans (held-for-investment)			247				249
Total Real Estate Loans		$	3,965,782			$	4,659,336

Residential Real Estate Loans Held-for-Sale

Residential real estate loans held-for-sale are owned with equity. At June 30, 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. At December 31, 2008, there were 15 residential loans held-for-sale with $5 million in outstanding principal value and a lower of cost or fair value of $3 million.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

Note 6. Real Estate Loans  – (continued)

Residential Real Estate Loans Held-for-Investment

Residential real estate loans held-for-investment are owned at Sequoia entities that we consolidate for financial reporting purposes. The following table provides additional information on residential real estate loans held-for-investment at June 30, 2009 and December 31, 2008.

Residential Real Estate Loans Held-for-Investment

(In Thousands)		June 30, 2009				December 31, 2008
Principal value		$	3,944,224			$	4,612,564
Unamortized premium, net			57,036				67,635
Allowance for loan losses			(45,877	)			(35,713	)
Carrying Value		$	3,955,383			$	4,644,486

Of the $3.9 billion of principal face and $57 million of unamortized premium on these loans at June 30, 2009, $1.9 billion of principal face and $38 million of unamortized premium relates to residential loans acquired prior to July 1, 2004. During the first half of 2009, 5% of these residential loans prepaid and we amortized 21% of the premium based upon the accounting elections we apply. For residential loans acquired after July 1, 2004, the principal face was $2.0 billion and the unamortized premium was $19 million at June 30, 2009. During the first half of 2009, 5% of these residential loans prepaid and we amortized 8% of the premium.

Of the $4.6 billion of principal face and $68 million of unamortized premium on these loans at December 31, 2008, $2.0 billion of principal face and $48 million of unamortized premium relates to residential loans acquired prior to July 1, 2004, and $2.6 billion of principal face and $20 million of unamortized premium relates to residential loans acquired after July 1, 2004.

Sale of Sequoia Interests and Resulting Deconsolidation

During the second quarter of 2009, we sold variable interests in a Sequoia securitization issued during 2006 and determined upon completion of a FAS 140 and FIN 46(R) accounting analysis that we should derecognize the associated assets and liabilities for financial reporting purposes. We deconsolidated $439 million of real estate loans and other assets and $458 million of ABS issued and other liabilities, for a net realized gain of $19 million. We maintained our intent to hold our economic interests in all remaining consolidated Sequoia entities at June 30, 2009.

Commercial Real Estate Loans at Fair Value

Commercial real estate loans at fair value are owned at Acacia entities that we consolidate for financial reporting purposes. On January 1, 2008, we elected the fair value option under FAS 159 for loans at Acacia and record them at their estimated fair values. Prior to 2008, these loans were classified as held-for-investment. At June 30, 2009, there were five commercial loans at fair value, one of which has been delinquent since May 2009, with an outstanding principal value of $26 million and a fair value of $8 million.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

Note 6. Real Estate Loans  – (continued)

Commercial Real Estate Loans Held-for-Investment

Commercial real estate loans held-for-investment are owned with equity. The following table provides additional information on commercial real estate loans held-for-investment as of June 30, 2009 and December 31, 2008.

Commercial Real Estate Loans Held-for-Investment

(In Thousands)		June 30, 2009				December 31, 2008
Principal value		$	11,094			$	11,098
Unamortized discount			(358	)			(360	)
Discount designated as credit reserve			(8,141	)			(8,141	)
Allowance for loan losses			(2,348	)			(2,348	)
Carrying Value		$	247			$	249

At June 30, 2009, there were two commercial loans held-for-investment with $11 million in outstanding principal value and a carrying value of $0.2 million. During the first quarter of 2007, we fully reserved for an anticipated loss on a $10 million mezzanine commercial loan, which was originated to finance a condominium-conversion project. We do not expect to recover any outstanding principal upon completion and sale of the condominium units, and thus maintained the reserve as of June 30, 2009.

Note 7. Allowance for Loan Losses

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

Activity in the Allowance for Losses on Residential Loans

At June 30, 2009 and December 31, 2008, 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 held-for-investment for the three and six months ended June 30, 2009 and 2008.

(In Thousands)		Three Months Ended June 30,								Six Months Ended June 30,
		2009				2008				2009				2008
Balance at beginning of period		$	47,947			$	24,444			$	35,713			$	18,282
Charge-offs, net			(1,820	)			(1,908	)			(5,618	)			(3,804	)
Provision for credit losses			14,545				10,061				30,577				18,119
Deconsolidation adjustment			(14,795	)			—				(14,795	)			—
Balance at End of Period		$	45,877			$	32,597			$	45,877			$	32,597

Serious delinquencies on consolidated Sequoia loans were $141 million and $118 million as of June 30, 2009 and 2008, respectively. Serious delinquencies include loans delinquent more than 90 days and in foreclosure. As a percentage of current loan balances, serious delinquencies were 3.57% and 1.87% at June 30, 2009 and 2008, respectively.

When foreclosure is pursued in full satisfaction for a defaulted loan, we estimate the specific loan loss, if any, based on estimated net proceeds from the sale of the property (including accrued but unpaid interest and other costs), and charge this specific estimated loss against the allowance for loan losses. During the first half of 2009, there were $6 million of charge-offs that reduced our allowance for loan losses. These charge-offs arose from $23 million of defaulted loan principal. Foreclosed property is subsequently recorded as REO, a

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

Note 7. Allowance for Loan Losses  – (continued)

component of other assets. Subsequent declines in the value of an REO property below its cost basis are recorded in our consolidated statements of income (loss) as a component of market valuation adjustments, net. We had $2 million of negative market valuation adjustments during the first half of 2009 stemming from a decrease in the fair value of REO.

Activity in the Allowance for Losses on Commercial Loans

There was no activity in the allowance for loan losses for our commercial loans for the three and six months ended June 30, 2009 and 2008.

Note 8. Real Estate Securities

We invest in third party residential, commercial, and CDO securities. The following table presents the fair values of our real estate securities by collateral type and entity as of June 30, 2009 and December 31, 2008.

June 30, 2009 (In Thousands)		Redwood				The Fund				Acacia				Total Securities
Residential		$	499,496			$	31,493			$	193,481			$	724,470
Commercial			15,669				—				41,949				57,618
CDO			2,308				6,358				13,799				22,465
Total Real Estate Securities		$	517,473			$	37,851			$	249,229			$	804,553

December 31, 2008 (In Thousands)		Redwood				The Fund				Acacia				Total Securities
Residential		$	144,885			$	36,172			$	244,523			$	425,580
Commercial			42,490				—				67,889				110,379
CDO			3,610				11,318				21,237				36,165
Total Real Estate Securities		$	190,985			$	47,490			$	333,649			$	572,124

The following table presents our securities by trading and AFS, collateral type, and entity as of June 30, 2009 and December 31, 2008.

June 30, 2009 (In Thousands)		Trading												AFS
		Redwood				Acacia				Total				Redwood				The Fund				Total
Senior Securities
Residential prime		$	—			$	3,594			$	3,594			$	183,467			$	—			$	183,467
Residential non-prime			697				85,236				85,933				230,258				23,001				253,259
Commercial			—				8,000				8,000				—				—				—
Total Senior Securities			697				96,830				97,527				413,725				23,001				436,726
Re-REMIC Securities			—				—				—				55,141				—				55,141
Subordinate Securities
Residential prime			600				34,320				34,920				26,141				—				26,141
Residential non-prime			231				70,332				70,563				2,961				8,492				11,453
Commercial			—				33,948				33,948				15,669				—				15,669
CDO			2,283				13,799				16,082				25				6,358				6,383
Total Subordinate Securities			3,114				152,399				155,513				44,796				14,850				59,646
Total Real Estate Securities		$	3,811			$	249,229			$	253,040			$	513,662			$	37,851			$	551,513

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

Note 8. Real Estate Securities  – (continued)

December 31, 2008 (In Thousands)		Trading												AFS
		Redwood				Acacia				Total				Redwood				The Fund				Total
Senior Securities
Residential prime		$	60			$	11,934			$	11,994			$	50,904			$	—			$	50,904
Residential non-prime			905				90,638				91,543				41,915				26,531				68,446
Commercial			—				7,540				7,540				—				—				—
Total Senior Securities			965				110,112				111,077				92,819				26,531				119,350
Subordinate Securities
Residential prime			1,141				44,983				46,124				42,646				—				42,646
Residential non-prime			314				96,968				97,282				7,000				9,641				16,641
Commercial			—				60,349				60,349				42,490				—				42,490
CDO			3,585				21,237				24,822				25				11,318				11,343
Total Subordinate Securities			5,040				223,537				228,577				92,161				20,959				113,120
Total Real Estate Securities		$	6,005			$	333,649			$	339,654			$	184,980			$	47,490			$	232,470

Senior interests are those interests in a securitization that have the first right to cash flows and are last in line to absorb losses. Re-REMIC interests, as presented herein, were created through the resecuritization of certain senior interests to provide additional credit support to those interests. Re-REMIC interests are therefore subordinate to the remaining senior interest, but senior to any subordinate tranches of the securitization from which they were created. Subordinate interests (generally originally rated AA and lower) are all interests below senior and re-REMIC interests. At June 30, 2009 all of our real estate securities had contractual maturities of over ten years, except for less than $1 million of residential securities that had contractual maturities of greater than 5 years, but less than 10 years.

AFS Securities

When we purchase a credit-sensitive AFS security at a significant discount to its face value, we often do not amortize into income a significant portion of this discount that we are entitled to earn but 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. The amount of principal face that we do not amortize into income is designated as a credit reserve on the security, with any remaining net unamortized discounts or premiums amortized into income over time using the interest method in accordance with EITF 99-20.

The following table presents the carrying value (which equals fair value) of AFS securities as of June 30, 2009 and December 31, 2008.

June 30, 2009 (In Thousands)		Residential				Commercial				CDO				Total
Current face		$	1,599,791			$	506,746			$	89,289			$	2,195,826
Credit reserve			(597,916	)			(492,458	)			(86,996	)			(1,177,370	)
Net unamortized (discount) premium			(413,539	)			(121	)			8,332				(405,328	)
Amortized cost			588,336				14,167				10,625				613,128
Gross unrealized gains			26,591				1,502				25				28,118
Gross unrealized losses			(85,465	)			—				(4,268	)			(89,733	)
Carrying Value		$	529,462			$	15,669			$	6,382			$	551,513

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

Note 8. Real Estate Securities  – (continued)

December 31, 2008 (In Thousands)		Residential				Commercial				CDO				Total
Current face		$	1,146,071			$	514,169			$	92,522			$	1,752,762
Credit reserve			(731,468	)			(497,047	)			(59,828	)			(1,288,343	)
Net unamortized (discount) premium			(211,262	)			35,069				(18,056	)			(194,249	)
Amortized cost			203,341				52,191				14,638				270,170
Gross unrealized gains			7,989				2,308				19				10,316
Gross unrealized losses			(32,693	)			(12,009	)			(3,314	)			(48,016	)
Carrying Value		$	178,637			$	42,490			$	11,343			$	232,470

The following table presents the changes for the three and six months ended June 30, 2009, of the unamortized discount and designated credit reserves on AFS securities.

Changes in Unamortized Discount and Designated Credit Reserves on AFS Securities

Three Months Ended June 30, 2009 (In Thousands)		Residential								Commercial								CDO
		Credit Reserve				Unamortized Discount Net				Credit Reserve				Unamortized Discount Net				Credit Reserve				Unamortized Discount Net
Beginning balance – March 31, 2009		$	601,864			$	254,228			$	497,784			$	(13,798	)		$	86,962			$	(8,240	)
Reclassification due to FSP 115-2 adoption			—				(59,949	)			—				—				—				(1,011	)
Beginning balance – April 1, 2009			601,864				194,279				497,784				(13,798	)			86,962				(9,251	)
Amortization of net discount			—				(5,544	)			—				1,788				—				(108	)
Realized credit losses			(126,921	)			—				(5,371	)			—				—				—
Acquisitions			84,033				280,795				—				—				—				—
Sales, calls, other			(1,531	)			(35,554	)			—				—				34				—
Impairments			20,034				—				12,176				—				1,027				—
Transfers to (release of) credit reserves			20,437				(20,437	)			(12,131	)			12,131				(1,027	)			1,027
Ending Balance – June 30, 2009		$	597,916			$	413,539			$	492,458			$	121			$	86,996			$	(8,332	)

Six Months Ended June 30, 2009 (In Thousands)		Residential								Commercial								CDO
		Credit Reserve				Unamortized Discount Net				Credit Reserve				Unamortized Discount Net				Credit Reserve				Unamortized Discount Net
Beginning balance – December 31, 2008		$	731,468			$	211,262			$	497,047			$	(35,069	)		$	59,828			$	18,056
Reclassification due to FSP 115-2 adoption			—				(59,949	)			—				—				—				(1,011	)
Amortization of net discount			—				(14,401	)			—				5,838				—				(217	)
Realized credit losses			(263,443	)			—				(7,424	)			—				(3,000	)			—
Acquisitions			84,360				338,420				—				—				—				—
Sales, calls, other			(5,341	)			(36,090	)			—				—				92				—
Impairments			25,169				—				32,187				—				4,916				—
Transfers to (release of) credit reserves			25,703				(25,703	)			(29,352	)			29,352				25,160				(25,160	)
Ending Balance – June 30, 2009		$	597,916			$	413,539			$	492,458			$	121			$	86,996			$	(8,332	)

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO FINANCIAL STATEMENTS
June 30, 2009
(Unaudited)

Note 8. Real Estate Securities  – (continued)

The loans underlying our residential subordinate securities totaled $90 billion at June 30, 2009, and consist of $81 billion prime and $9 billion non-prime loans. These loans are located nationwide with a large concentration in California (46%). Serious delinquencies (90+ days, in foreclosure or REO) at June 30, 2009 were 5.30% of current principal balances. For loans in prime pools, serious delinquencies were 3.13% of current balances. For loans in non-prime pools, serious delinquencies were 25.76% of current balances.

The loans underlying our commercial subordinate securities totaled $48 billion at June 30, 2009, and consist primarily of office (39%), retail (28%), and multifamily (16%) commercial loans. These loans are located nationwide. Serious delinquencies (60+ days and in foreclosure or REO) at June 30, 2009 were 2.48% of current principal balances.

The following table presents the components comprising the carrying value of AFS securities that were in an unrealized loss position as of June 30, 2009 and December 31, 2008.

AFS Securities with Unrealized Losses

June 30, 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		$	210,906			$	(69,578	)		$	141,328			$	30,373			$	(15,887	)		$	14,486
Commercial			—				—				—				—				—				—
CDO			6,708				(4,268	)			2,440				—				—				—
Total Securities		$	217,614			$	(73,846	)		$	143,768			$	30,373			$	(15,887	)		$	14,486