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: September 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		77,676,867 shares outstanding as of November 3, 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 September 30, 2009 (Unaudited) and December 31, 2008			1
Consolidated Statements of Income (Loss) for the Three and Nine Months Ended September 30, 2009 and 2008 (Unaudited)			2
Consolidated Statements of Equity and Comprehensive Income (Loss) for the Nine Months Ended September 30, 2009 and 2008 (Unaudited)			3
Consolidated Statements of Cash Flows for the Nine Months Ended September 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			40
Item 3. Quantitative and Qualitative Disclosures About Market Risk			87
Item 4. Controls and Procedures			87
PART II
Item 1. Legal Proceedings			88
Item 1A. Risk Factors			88
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			88
Item 3. Defaults Upon Senior Securities			88
Item 4. Submission of Matters to a Vote of Security Holders			88
Item 5. Other Information			88
Item 6. Exhibits			89
Signatures			90

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)		September 30, 2009				December 31, 2008
ASSETS
Real estate loans		$	3,830,821			$	4,659,336
Real estate securities, at fair value:
Trading securities			275,356				339,654
Available-for-sale securities			787,036				232,470
Total real estate securities			1,062,392				572,124
Other investments			28,786				78,244
Cash and cash equivalents			216,771				126,480
Total earning assets			5,138,770				5,436,184
Restricted cash			78,354				53,608
Accrued interest receivable			20,218				31,415
Derivative assets			9,993				3,071
Deferred tax asset			1,827				3,608
Deferred asset-backed securities issuance costs			7,281				9,921
Other assets			28,545				43,942
Total Assets		$	5,284,988			$	5,581,749
LIABILITIES AND EQUITY
Liabilities
Short-term debt		$	—			$	—
Accrued interest payable			7,325				29,417
Derivative liabilities			104,174				177,590
Accrued expenses and other liabilities			71,643				20,118
Dividends payable			19,417				25,103
Asset-backed securities issued – Sequoia			3,728,335				4,508,127
Asset-backed securities issued – Acacia			287,620				346,931
Long-term debt			140,000				150,000
Total liabilities			4,358,514				5,257,286
Equity
Common stock, par value $0.01 per share, 100,000,000 and 75,000,000 authorized; 77,669,067 and 33,470,557 issued and outstanding			777				335
Additional paid-in capital			1,672,588				1,149,393
Accumulated other comprehensive income (loss)			21,175				(56,865	)
Cumulative earnings			325,924				266,059
Cumulative distributions to stockholders			(1,113,358	)			(1,057,070	)
Total stockholders’ equity			907,106				301,852
Noncontrolling interest			19,368				22,611
Total equity			926,474				324,463
Total Liabilities and Equity		$	5,284,988			$	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 September 30,								Nine Months Ended September 30,
		2009				2008				2009				2008
Interest Income
Real estate loans		$	19,574			$	68,400			$	84,157			$	236,786
Real estate securities			50,708				61,334				141,435				199,390
Other investments			25				487				155				1,733
Cash and cash equivalents			75				971				334				6,349
Total interest income			70,382				131,192				226,081				444,258
Interest Expense
Short-term debt			—				(65	)			—				(316	)
Asset-backed securities issued			(23,530	)			(89,926	)			(106,813	)			(309,717	)
Long-term debt			(1,307	)			(2,164	)			(4,618	)			(6,930	)
Total interest expense			(24,837	)			(92,155	)			(111,431	)			(316,963	)
Net Interest Income			45,545				39,037				114,650				127,295
Provision for loan losses			(9,998	)			(18,333	)			(40,576	)			(36,452	)
Market valuation adjustments on trading instruments			(1,860	)			(34,352	)			(11,967	)			(115,709	)
Other-than-temporary impairments(1)			(9,198	)			(92,794	)			(71,470	)			(265,862	)
Market valuation adjustments, net			(11,058	)			(127,146	)			(83,437	)			(381,571	)
Net Interest Income (Loss) After Provision and Market Valuation Adjustments			24,489				(106,442	)			(9,363	)			(290,728	)
Operating expenses			(14,806	)			(16,851	)			(36,162	)			(47,453	)
Realized gains, net			17,561				(65	)			43,548				2,688
Net income (loss) before provision for income taxes			27,244				(123,358	)			(1,977	)			(335,493	)
Benefit from (provision for) income taxes			247				9,860				656				7,123
Net income (loss)			27,491				(113,498	)			(1,321	)			(328,370	)
Less: Net income (loss) attributable to noncontrolling interest			363				(2,194	)			(226	)			430
Net Income (Loss) Attributable to Redwood Trust, Inc.		$	27,128			$	(111,304	)		$	(1,095	)		$	(328,800	)
Basic earnings (loss) per share:		$	0.35			$	(3.34	)		$	(0.02	)		$	(9.99	)
Diluted earnings (loss) per share:		$	0.35			$	(3.34	)		$	(0.02	)		$	(9.99	)
Regular dividends declared per common share		$	0.25			$	0.75			$	0.75			$	2.25
Basic weighted average shares outstanding			77,610,658				33,334,011				65,363,128				32,907,196
Diluted weighted average shares outstanding			78,222,903				33,334,011				65,363,128				32,907,196

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

TABLE OF CONTENTS

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

For the Nine Months Ended September 30, 2009

(In Thousands, Except Share Data) (Unaudited)		Common Stock								Additional Paid-In Capital				Accumulated Other Comprehensive Income (Loss)				Cumulative Earnings (Losses)				Cumulative Distributions to Stockholders				Noncontrolling Interest				Total
		Shares				Amount
December 31, 2008			33,470,557			$	336			$	1,149,392			$	(56,865	)		$	266,059			$	(1,057,070	)		$	22,611			$	324,463
Cumulative adjustment – accounting change			—				—				—				(59,634	)			60,960				—				(1,326	)			—
Net income (loss)			—				—				—				—				(1,095	)			—				(226	)			(1,321	)
Net unrealized gain on available-for-sale securities			—				—				—				96,866				—				—				3,604				100,470
Reclassification of other-than-temporary impairments to net income (loss)			—				—				—				37,474				—				—				—				37,474
Reclassification of unrealized loss on interest rate agreements to net income (loss)			—				—				—				3,334				—				—				—				3,334
Total other comprehensive income															78,040
Total comprehensive income																															139,957
Issuance of common stock:
Secondary offerings			43,690,000				436				519,600				—				—				—				—				520,036
Dividend reinvestment & stock purchase plans			146,784				2				1,681				—				—				—				—				1,683
Employee option & stock purchase plan			361,999				2				(2,679	)			—				—				—				—				(2,677	)
Non-cash equity award compensation			—				—				4,599				—				—				—				—				4,599
Share repurchases			(273	)			1				(5	)			—				—				—				—				(4	)
Distributions to noncontrolling interests, net			—				—				—				—				—				—				(5,295	)			(5,295	)
Common dividends declared			—				—				—				—				—				(56,288	)			—				(56,288	)
September 30, 2009			77,669,067			$	777			$	1,672,588			$	21,175			$	325,924			$	(1,113,358	)		$	19,368			$	926,474

For the Nine Months Ended September 30, 2008

(In Thousands, Except Share Data) (Unaudited)		Common Stock								Additional Paid-In Capital				Accumulated Other Comprehensive Income (Loss)				Cumulative Earnings (Losses)				Cumulative Distributions to Stockholders				Noncontrolling Interest				Total
		Shares				Amount
December 31, 2007			32,385,073			$	324			$	1,108,148			$	(573,766	)		$	(299,626	)		$	(953,359	)		$	—			$	(718,279	)
Cumulative adjustment – accounting change			—				—				—				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 income (loss)			—				—				—				—				(328,800	)			—				430				(328,370	)
Net unrealized loss on available-for-sale securities			—				—				—				(92,241	)			—				—				(3,228	)			(95,469	)
Reclassification of other-than-temporary impairments to net income (loss)			—				—				—				123,536				—				—				—				123,536
Reclassification of unrealized loss on interest rate agreements to net income (loss)			—				—				—				3,752				—				—				—				3,752
Total other comprehensive income															35,047
Total comprehensive loss																															(296,551	)
Issuance of common stock:
Dividend reinvestment & stock purchase plans			1,059,090				13				31,593				—				—				—				—				31,606
Employee option & stock purchase plan			135,169				—				1,023				—				—				—				—				1,023
Non-cash equity award compensation			—				—				10,211				—				—				—				—				10,211
Share repurchases			(341,656	)			(3	)			(6,179	)			—				—				—				—				(6,182	)
Contributions from noncontrolling interests, net			—				—				—				—				—				—				34,659				34,659
Common dividends declared			—				—				—				—				—				(77,787	)			—				(77,787	)
September 30, 2008			33,237,676			$	334			$	1,144,796			$	(80,512	)		$	381,645			$	(1,031,146	)		$	31,861			$	446,978

 
 
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)		Nine Months Ended September 30,
		2009				2008
Cash Flows From Operating Activities:
Net (loss) income		$	(1,095	)		$	(328,800	)
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Amortization of premiums, discounts, and debt issuance costs, net			(1,940	)			(9,419	)
Depreciation and amortization of non-financial assets			913				882
Provision for loan losses			40,576				36,452
Non-cash equity award compensation			4,599				10,211
Market valuation adjustments, net			83,437				381,571
Realized gains, net			(43,548	)			(2,688	)
Net change in:
Accrued interest receivable			12,102				19,622
Deferred tax asset			1,781				1,282
Other assets			31,498				14,633
Accrued interest payable			(11,816	)			(15,917	)
Accrued expenses and other liabilities			51,525				(5,054	)
Net cash provided by operating activities			168,032				102,775
Cash Flows From Investing Activities:
Principal payments on real estate loans held-for-investment			311,410				1,008,765
Purchases of real estate securities available-for-sale			(678,952	)			(257,668	)
Proceeds from sales of real estate securities available-for-sale			127,377				7,300
Principal payments on real estate securities available-for-sale			99,832				60,100
Purchases of real estate securities trading			(5,755	)			(3,341	)
Proceeds from sales of real estate securities trading			4,256				7,771
Principal payments on real estate securities trading			72,114				137,181
Principal payments on other investments			25,433				650
Net (increase) decrease in restricted cash			(24,746	)			55,415
Net cash (used in) provided by investing activities			(69,031	)			1,016,173
Cash Flows From Financing Activities:
Net repayments on short-term debt			—				(659	)
Repayments on asset-backed securities			(413,495	)			(1,206,387	)
Repurchase of long-term debt			(3,455	)			—
Net settlements of interest rate agreements			(43,302	)			(9,870	)
Net proceeds from issuance of common stock			519,042				32,629
Common stock repurchases			(4	)			(6,182	)
Dividends paid			(61,975	)			(76,890	)
Change in noncontrolling interests			(5,521	)			35,089
Net cash used in financing activities			(8,710	)			(1,232,270	)
Net increase (decrease) in cash and cash equivalents			90,291				(113,322	)
Cash and cash equivalents at beginning of period			126,480				290,363
Cash and cash equivalents at end of period		$	216,771			$	177,041
Supplemental Disclosures:
Cash paid for interest		$	133,523			$	338,997
Cash (received) paid for taxes		$	(3,452	)		$	(1,331	)
Dividends declared but not paid at end of period		$	19,417			$	25,184

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

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 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 September 30, 2009 and December 31, 2008, and for the three and nine months ended September 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 nine months ended September 30, 2009, may not necessarily be indicative of the results for the year ending December 31, 2009. These unaudited interim consolidated financial statements should be read in conjunction with our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2008. All amounts presented herein, except per share data, are shown in thousands.

In the third quarter of 2009, we adopted Statement of Financial Accounting Standards No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles — a replacement of FASB Statement No. 162 (FAS 168), which establishes the Accounting Standards Codification (ASC) as the single source of authoritative GAAP in the United States. As a result of this adoption, we generally do not reference specific accounting standards herein.

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 established by the Financial Accounting Standards Board (FASB) 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. 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 CONSOLIDATED FINANCIAL STATEMENTS
September 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 under GAAP 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.

Note 3. Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements requires us to make a number of significant estimates. These include estimates of fair value of certain assets and liabilities, amount and timing of credit losses, prepayment rates, and other estimates that affect the reported amounts of certain assets and liabilities as of the date of the consolidated financial statements and the reported amounts of certain revenues and expenses during the reported period. It is likely that changes in these estimates (e.g., valuation changes due to supply and demand, credit performance, prepayments, interest rates, or other reasons) will occur in the near term. Our estimates are inherently subjective in nature and actual results could differ from our estimates and the differences could be material.

Fair Value Option

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

Our decision to apply the fair value option for new financial instruments is generally based upon our funding strategy for the specific financial asset acquired. For example, securities that we anticipate funding with equity will generally be accounted for as available-for-sale (AFS) securities. Securities that we anticipate funding with a combination of debt and equity or those financed through the issuance of asset-backed liabilities will generally be measured using the fair value option along with the corresponding liabilities. Additionally, we may elect the fair value option for nontraditional real estate investments or for a variety of other reasons.

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

TABLE OF CONTENTS

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

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

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

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

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

See Note 5 for further discussion on fair value measurements.

Real Estate Loans

Residential and Commercial Real Estate Loans — Fair Value

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

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

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

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

losses. Coupon interest is recognized as revenue when earned and deemed collectible or until a loan becomes more than 90 days past due. Interest previously accrued for loans that have become greater than 90 days past due is reserved for in the allowance for loan losses. Cash principal and interest that is advanced from servicers subsequent to a loan becoming greater than 90 days past due is used to reduce the outstanding loan principal balance.

We use the interest method to determine an effective yield to amortize the premium or discount on real estate loans held-for-investment. For residential loans acquired prior to July 1, 2004, we use coupon interest rates as they change over time and anticipated principal payments to determine periodic amortization. For residential loans acquired after July 1, 2004, we use the initial coupon interest rate of the loans (without regard to future changes in the underlying indices) and anticipated principal payments to determine periodic amortization.

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

Real Estate Loans — Allowance for Loan Losses

For real estate loans classified as held-for-investment, we establish and maintain an allowance for loan losses based on our estimate of credit losses inherent in our loan portfolios at the reporting date. To calculate the allowance for loan losses, we assess inherent losses by determining loss factors (defaults, the timing of defaults, and loss severities upon defaults) that can be specifically applied to each of the consolidated loans or pool of loans.

We consider the following factors in making such determinations:

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

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

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

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

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

We do not currently maintain a loan repurchase reserve, 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) securities. Trading securities are carried at their estimated fair values. Coupon interest is recognized as interest income when earned and deemed collectible. All changes in fair value are reported through our consolidated statements of income (loss) in market valuation adjustments, net.

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

Available-for-Sale Securities

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

For an AFS security where the security’s fair value has declined below its amortized cost basis, we evaluate the security for either temporary or other-than-temporary impairment (OTTI). This evaluation requires us to assess changes in our cash flow valuation assumptions for the security. We also consider whether there has been a significant adverse change in the regulatory and/or economic environment as part of this analysis. If we determine that there has been no significant adverse change in our cash flow assumptions for the security, then any impairment is deemed temporary in nature and the associated difference between the

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

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

security’s fair value and amortized cost basis is recorded as an unrealized loss through accumulated other comprehensive income (loss), a component of stockholders’ equity. If we determine that there has been a significant adverse change in our cash flow assumptions for the security, then an OTTI exists.

We evaluate impairments in accordance with authoritative GAAP guidance that we adopted during the second quarter of 2009. According to this guidance, for a security where an impairment exists and we either intend to sell the impaired security, will more likely than not be required to the sell the impaired security before it recovers in value, or do not expect to recover the impaired security’s amortized cost basis even if we do not intend to sell the security, we record the difference between the security’s fair value and its amortized cost in our consolidated statements of income (loss) as the impairment is deemed as OTTI. For a security where an impairment exists, but for which we do not intend to sell the security and it is more likely than not that we will not be required to sell it prior to recovery, we analyze the expected cash flows, or cost recovery, of the security. If an OTTI exists, we discount the security’s cash flows to a present value using the prior period yield for the security to determine an “expected recoverable value.” The difference between this expected recoverable value and the amortized cost basis is deemed to be the “credit” component of OTTI that is recorded in our consolidated statements of income (loss). The amortized cost of the security is then adjusted to the expected recoverable value, and the difference between the expected recoverable value and fair value is deemed to be the “non-credit” component of OTTI that is recorded to accumulated other comprehensive income (loss). Future amortization and accretion for the security is computed based upon its new amortized cost basis.

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

See Note 8 for further discussion on real estate securities and cumulative effect adjustment.

Other Investments

Other investments include a guaranteed investment contract (GIC) entered into by an Acacia securitization entity that we consolidate for financial statement purposes. We elected the fair value option 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 and highly liquid investments with original maturities of three months or less. At September 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 CONSOLIDATED FINANCIAL STATEMENTS
September 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, the associated accrued interest on these assets is measured at fair value. For financial assets where we have not elected the fair value option, the associated accrued interest carrying values approximate fair values.

Derivative Financial Instruments

Derivative financial instruments include contractual interest rate agreements and credit default swaps. All derivative financial instruments are reported at fair value on our consolidated balance sheets, in accordance with derivative accounting guidance. Derivatives with a positive value to us are reported as an asset and derivatives with a negative value to us are reported as a liability. The changes in fair value of derivatives accounted for as trading instruments are reported in the consolidated statements of income (loss) through market valuation adjustments, net.

Interest Rate Agreements

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

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 income 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 consolidate 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 CONSOLIDATED FINANCIAL STATEMENTS
September 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 and an associated deferred tax benefit for GAAP. As the income is subsequently realized in future periods under GAAP, the deferred tax asset is recognized as an expense. 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 principle guidance for interest on receivables and payables. Sequoia deferred ABS issuance costs are accounted for in accordance with this guidance.

As of January 1, 2008, deferred issuance costs associated with Acacia securitizations were included as part of our adoption of the fair value option 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, principal receivable, and other prepaid expenses. REO is reported at the lower of cost or fair value. Subsequent declines in the value of an REO property are recorded in our consolidated statements of income (loss) as a component of market valuation adjustments, net. All other assets are reported at cost.

See Note 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, the associated accrued interest on these liabilities is measured at fair value. For financial liabilities where we have not elected the fair value option, the associated accrued interest carrying values approximate fair values.

Asset Backed Securities Issued — Sequoia and Acacia

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 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 the fair value option 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.

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

Equity

Earnings (Loss) Per Share

Basic earnings (loss) per share (EPS) is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income (loss) by the weighted average number of common shares and potential common shares outstanding during the period. Potential common shares outstanding are calculated using the treasury stock method, which assumes that all dilutive common stock equivalents are exercised and the funds generated by the exercises are used to buy back outstanding common stock at the average market price of the common stock during the reporting period. In accordance with earnings per share guidance, if there is a loss from continuing operations, the common stock equivalents are deemed antidilutive and diluted income (loss) per share is calculated in the same manner as basic income (loss) per share.

On January 1, 2009, authoritative GAAP was updated to state that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are “participating securities” and therefore should be included in computing EPS using the two-class method. Our adoption of this guidance required us to recast previously reported EPS and did not have a significant impact on EPS.

Other Comprehensive Income (Loss)

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

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

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

Noncontrolling Interest

Noncontrolling interest represents the aggregate limited partnership interests in the Fund held by third parties. In accordance with FASB noncontrolling interest guidance, the noncontrolling interest of the Fund is shown as a component of equity on our consolidated balance sheets, and the portion of income 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 income (loss).

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

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.

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

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

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

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 FASB guidance on accounting for uncertainty in income taxes. We record these liabilities to the extent we deem them incurred. We classify interest and penalties on material uncertain tax positions as interest expense and operating expense, respectively, in our consolidated statements of income (loss).

See Note 18 for further discussion on taxes.

Recent Accounting Pronouncements

In 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. Considering our past transfers of financial assets to securitization entities (i.e., Sequoia and Acacia) through application of previously issued guidance, changes to the consolidation criteria prescribed by FAS 166 for similar transfers could have a significant impact on our reported results in the future.

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 conclusions of VIE consolidation, 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. 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

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

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

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 August 2009, the FASB issued Accounting Standards Update (ASU) 2009-05, Measuring Liabilities at Fair Value, to clarify how entities should estimate the fair value of liabilities under Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures. The ASU clarifies that the quoted price for the identical liability, when traded as an asset in an active market, is also a Level 1 measurement for that liability when no adjustment to the quoted price is required. In the absence of a Level 1 measurement, an entity must use one or more of the following valuation techniques to estimate fair value (in a manner consistent with the principles in ASC 820), which can be classified into two broad categories: (1) a valuation technique that uses a quoted price (a quoted price of an identical liability when traded as an asset, or a quoted price of a similar liability or of a similar liability when traded as an asset) or (2) another valuation technique consistent with the principles of ASC 820 (a market approach or an income approach). The new guidance is effective for the first interim or annual reporting period beginning after August 28, 2009. As this guidance is consistent with the methodology we use to price liabilities, adoption will not have an effect on our consolidated financial statements.

Note 4. Fair Value Option

On January 1, 2008, we elected to apply the fair value option provided under GAAP 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 the fair value option 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 income (loss) that were reclassified to retained earnings were generated at the REIT, which distributes predominantly all of its taxable income.

As of September 30, 2009, the loans at Acacia had an aggregate fair value of $6 million and an unpaid principal balance of $26 million, the securities had an aggregate fair value of $270 million and an unpaid principal balance of $2.5 billion, and asset-backed securities issued at Acacia had an aggregate fair value of $288 million and an unpaid principal balance of $3.0 billion.

We elected the fair value option for certain ABS issued by Sequoia and acquired by Acacia as a result of the deconsolidation of certain Sequoia entities during the fourth quarter of 2008 and second quarter of 2009. These ABS issued had been previously eliminated as intercompany assets for financial reporting purposes. During the third quarter of 2009, we elected the fair value option for $2 million of residential senior securities.

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

Note 5. Fair Value of Financial Instruments

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 September 30, 2009 and December 31, 2008.

		September 30, 2009								December 31, 2008
(In Thousands)		Carrying Value				Fair Value				Carrying Value				Fair Value
Assets
Real estate loans (held-for-investment)		$	3,822,507			$	2,936,489			$	4,644,735			$	2,618,323
Real estate loans (held-for-sale)			2,299				2,299				2,624				2,624
Real estate loans (fair value)			6,015				6,015				11,977				11,977
Trading securities			275,356				275,356				339,654				339,654
Available-for-sale securities			787,036				787,036				232,470				232,470
Other investments			28,786				28,786				78,244				78,244
Cash and equivalents			216,771				216,771				126,480				126,480
Restricted cash			78,354				78,354				53,608				53,608
Accrued interest receivable			20,218				20,218				31,415				31,415
Derivative assets			9,993				9,993				3,071				3,071
REO (included in other assets)			15,664				15,664				19,264				19,264
Liabilities
Short-term debt			—				—				—				—
Accrued interest payable			7,325				7,325				29,417				29,417
Derivative liabilities			104,174				104,174				177,590				177,590
ABS Issued
ABS issued – Sequoia			3,728,335				2,800,632				4,508,127				2,967,763
ABS issued – Acacia			287,620				287,620				346,931				346,931
Total ABS issued			4,015,955				3,088,252				4,855,058				3,314,694
Long-term debt			140,000				64,400				150,000				41,628

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

In certain cases, inputs used to measure fair value fall into different levels of the fair value hierarchy. In such cases, the level in which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement. Our assessment of the significance of a particular input requires judgment and considers factors specific to the asset or liability being measured.

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

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

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

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

		Carrying Value				Fair Value Measurements Using
(In Thousands)						Level 1				Level 2				Level 3
Assets
Real estate loans		$	6,015			$	—			$	—			$	6,015
Trading securities			275,356				—				—				275,356
Available-for-sale securities			787,036				—				—				787,036
Other investments			28,786				—				28,786				—
Derivative assets			9,993				—				9,913				80
Liabilities
ABS issued – Acacia			287,620				—				—				287,620
Derivative liabilities			104,174				—				75,446				28,728

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

		Carrying Value				Fair Value Measurements Using
(In Thousands)						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

TABLE OF CONTENTS

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

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

The following table presents additional information about Level 3 assets and liabilities.

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

Nine Months Ended September 30, 2009 (In Thousands)		Beginning Balance 12/31/2008				Principal Paydowns				Gains (Losses) Included in								Purchases, Sales, Other Settlements and Issuances, Net				Ending Balance 9/30/2009
										Net Income (Loss)				Other Comprehensive Income (Loss)
Assets
Real estate loans		$	11,977			$	(243	)		$	(5,719	)		$	—			$	—			$	6,015
Trading securities			339,654				(72,114	)			7,081				—				735				275,356
Available-for-sale securities			232,470				(99,832	)			(58,030	)			137,945				574,483				787,036
Derivative assets			242				—				204				—				(366	)			80
Liabilities
ABS issued – Acacia			346,931				(93,347	)			23,759				—				10,277				287,620
Derivative liabilities			77,892				—				(1,002	)			—				(48,162	)			28,728

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 September 30, 2009 and 2008. Gains or losses incurred on assets or liabilities sold or otherwise disposed of during the three and nine months ended September 30, 2009 and 2008 are not included in this presentation.

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

		Included in Net Income (Loss)
		Three Months Ended September 30,								Nine Months Ended September 30,
(In Thousands)		2009				2008				2009				2008
Assets
Real estate loans		$	(1,752	)		$	(4,224	)		$	(5,719	)		$	(8,772	)
Trading securities			42,433				(223,028	)			8,939				(1,067,818	)
Available-for-sale securities			(9,198	)			(92,794	)			(60,721	)			(218,131	)
Derivative assets			(27	)			(142	)			204				66
Liabilities
ABS issued – Acacia			(26,656	)			206,924				(23,759	)			1,017,972
Derivative liabilities			298				(356	)			690				(20,455	)

TABLE OF CONTENTS

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

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

The following table presents information on assets and liabilities recorded at fair value on a non-recurring basis.

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

September 30, 2009 (In Thousands)		Carrying Value				Fair Value Measurements Using												Gain (Loss)
																		Three Months Ended September 30, 2009				Nine Months Ended September 30, 2009
						Level 1				Level 2				Level 3
Assets
Real estate loans (held-for-sale)		$	2,299			$	—			$	—			$	2,299			$	(9	)		$	(86	)
REO			15,664				—				—				15,664				(574	)			(2,497	)

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 September 30, 2008				Nine Months Ended September 30, 2008
						Level 1				Level 2				Level 3
Assets
Real estate loans (held-for-sale)		$	2,624			$	—			$	—			$	2,624			$	(415	)		$	(791	)
REO			19,264				—				—				19,264				(2,076	)			(3,624	)

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

Market Valuation Adjustments, Net

		Three Months Ended September 30,								Nine Months Ended September 30,
(In Thousands)		2009				2008				2009				2008
Assets
Real estate loans (fair value)		$	(1,752	)		$	(4,224	)		$	(5,719	)		$	(8,772	)
Real estate loans (held-for-sale)			(582	)			(2,491	)			(2,583	)			(4,416	)
Trading securities			42,266				(223,708	)			7,082				(1,087,460	)
Impairments on AFS securities			(9,198	)			(92,794	)			(71,470	)			(265,862	)
Liabilities
ABS issued – Acacia			(26,656	)			206,924				(23,759	)			1,021,229
Derivative instruments, net			(15,136	)			(10,853	)			13,012				(36,290	)
Market Valuation Adjustments, Net		$	(11,058	)		$	(127,146	)		$	(83,437	)		$	(381,571	)

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

TABLE OF CONTENTS

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

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

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 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 recorded on our consolidated balance sheets at September 30, 2009 and December 31, 2008.

(In Thousands)		September 30, 2009				December 31, 2008
Residential real estate loans (held-for-sale)		$	2,299			$	2,624
Residential real estate loans (held-for-investment)			3,822,261				4,644,486
Commercial real estate loans (fair value)			6,015				11,977
Commercial real estate loans (held-for-investment)			246				249
Total Real Estate Loans		$	3,830,821			$	4,659,336

Residential Real Estate Loans Held-for-Sale

Residential real estate loans held-for-sale are owned with equity. At September 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.

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 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 securitization entities that we consolidate for financial reporting purposes. The following table provides additional information on residential real estate loans held-for-investment at September 30, 2009 and December 31, 2008.

Residential Real Estate Loans Held-for-Investment

(In Thousands)		September 30, 2009				December 31, 2008
Principal value		$	3,818,759			$	4,612,564
Unamortized premium, net			53,394				67,635
Allowance for loan losses			(49,892	)			(35,713	)
Carrying Value		$	3,822,261			$	4,644,486

At September 30, 2009 and December 31, 2008, the carrying value of our held-for-investment loans was $3.8 billion and $4.6 billion, respectively. The difference is primarily due to the deconsolidation of $439 million of real estate loans in the second quarter of 2009, as result of a sale of variable interests in a Sequoia securitization, and principal paydowns on the loans.

Of the $3.8 billion of principal face and $53 million of unamortized premium on these loans at September 30, 2009, $1.9 billion of principal face and $35 million of unamortized premium relates to residential loans acquired prior to July 1, 2004. During the first nine months of 2009, 8% of these residential loans prepaid and we amortized 26% of the premium based upon the accounting elections we apply. For residential loans acquired after July 1, 2004, the principal face was $1.9 billion and the unamortized premium was $18 million at September 30, 2009. During the first nine months of 2009, 25% 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.

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 for loans at Acacia and record them at their estimated fair values. Prior to 2008, these loans were classified as held-for-investment. At September 30, 2009, there were five commercial loans at fair value with an outstanding principal value of $26 million and a fair value of $6 million, and one of which has been delinquent since May 2009. At December 31, 2008, there were five commercial loans at fair value, with an outstanding principal of $27 million and a fair value of $12 million, and none of which were delinquent.

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 September 30, 2009 and December 31, 2008.

TABLE OF CONTENTS

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

Note 6. Real Estate Loans  – (continued)

Commercial Real Estate Loans Held-for-Investment

(In Thousands)		September 30, 2009				December 31, 2008
Principal value		$	11,092			$	11,098
Unamortized discount			(357	)			(360	)
Discount designated as credit reserve			(8,141	)			(8,141	)
Allowance for loan losses			(2,348	)			(2,348	)
Carrying Value		$	246			$	249

At September 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 allowance as of September 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 September 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 nine months ended September 30, 2009 and 2008.

		Three Months Ended September 30,								Nine Months Ended September 30,
(In Thousands)		2009				2008				2009				2008
Balance at beginning of period		$	45,877			$	32,597			$	35,713			$	18,282
Charge-offs, net			(5,983	)			(4,049	)			(11,602	)			(7,853	)
Provision for loan losses			9,998				18,333				40,576				36,452
Deconsolidation adjustment			—				—				(14,795	)			—
Balance at End of Period		$	49,892			$	46,881			$	49,892			$	46,881

Serious delinquencies on consolidated Sequoia loans were $145 million and $143 million as of September 30, 2009 and 2008, respectively. Serious delinquencies include loans delinquent more than 90 days and in foreclosure. As a percentage of outstanding loan balances, serious delinquencies were 3.79% and 2.36% at September 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 nine months ended September 30, 2009, there were $12 million of charge-offs that reduced our allowance for loan losses. These charge-offs arose from $41 million of defaulted loan principal. Foreclosed property is subsequently recorded as REO, a component of other assets.

TABLE OF CONTENTS

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

Note 7. Allowance for Loan Losses  – (continued)

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 nine months ended September 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 September 30, 2009 and December 31, 2008.

September 30, 2009 (In Thousands)		Redwood				The Fund				Acacia				Total Securities
Residential		$	732,297			$	35,832			$	202,074			$	970,203
Commercial			16,833				—				54,275				71,108
CDO			2,137				5,250				13,694				21,081
Total Real Estate Securities		$	751,267			$	41,082			$	270,043			$	1,062,392

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 September 30, 2009 and December 31, 2008.

September 30, 2009 (In Thousands)		Trading												AFS
		Redwood				Acacia				Total				Redwood				The Fund				Total
Senior Securities
Residential prime		$	—			$	5,193			$	5,193			$	336,660			$	—			$	336,660
Residential non-prime			2,501				95,880				98,381				276,499				27,252				303,751
Commercial			—				9,196				9,196				—				—				—
Total Senior Securities			2,501				110,269				112,770				613,159				27,252				640,411
Re-REMIC Securities			—				—				—				93,507				—				93,507
Subordinate Securities
Residential prime			476				31,330				31,806				21,449				—				21,449
Residential non-prime			225				69,671				69,896				981				8,580				9,561
Commercial			—				45,079				45,079				16,833				—				16,833
CDO			2,111				13,694				15,805				25				5,250				5,275
Total Subordinate Securities			2,812				159,774				162,586				39,288				13,830				53,118
Total Real Estate Securities		$	5,313			$	270,043			$	275,356			$	745,954			$	41,082			$	787,036

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 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 securities are those interests in a securitization that have the first right to cash flows and are last in line to absorb losses. Re-REMIC securities that we currently own were created through the resecuritization of certain senior interests to provide additional credit support to those interests. These re-REMIC securities are therefore subordinate to the remaining senior interest, but senior to any subordinate tranches of the securitization from which they were created. Subordinate securities (generally rated AA and lower) are all interests below senior and re-REMIC interests. At September 30, 2009 all of our real estate securities had contractual maturities over ten years, except for less than $1 million of residential securities that had contractual maturities greater than 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. We designate the amount of principal face that we do not amortize into income as a credit reserve on the security, with any remaining net unamortized discounts or premiums amortized into income over time using the interest method.

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

September 30, 2009 (In Thousands)		Residential				Commercial				CDO				Total
Current face		$	1,741,642			$	486,245			$	89,343			$	2,317,230
Credit reserve			(570,859	)			(471,957	)			(86,989	)			(1,129,805	)
Net unamortized (discount) premium			(446,587	)			(1,624	)			8,537				(439,674	)
Amortized cost			724,196				12,664				10,891				747,751
Gross unrealized gains			93,256				4,169				25				97,450
Gross unrealized losses			(52,524	)			—				(5,641	)			(58,165	)
Carrying Value		$	764,928			$	16,833			$	5,275			$	787,036

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 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 nine months ended September 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 September 30, 2009 (In Thousands)		Residential								Commercial								CDO
		Credit Reserve				Unamortized Discount Net				Credit Reserve				Unamortized Discount Net				Credit Reserve				Unamortized Discount Net
Beginning balance – June 30, 2009		$	597,916			$	413,539			$	492,458			$	121			$	86,996			$	(8,332	)
Amortization of net discount			—				(9,993	)			—				849				—				(431	)
Realized credit losses			(92,181	)			—				(20,501	)			—				—				—
Acquisitions			21,274				129,343				—				—				—				—
Sales, calls, other			(7,818	)			(42,992	)			—				—				32				—
Impairments			8,358				—				654				—				187				—
Transfers to (release of) credit reserves			43,310				(43,310	)			(654	)			654				(226	)			226
Ending Balance – September 30, 2009		$	570,859			$	446,587			$	471,957			$	1,624			$	86,989			$	(8,537	)

Nine Months Ended September 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
Cumulative adjustment – accounting change			—				(59,949	)			—				—				—				(1,011	)
Amortization of net discount			—				(24,394	)			—				6,687				—				(648	)
Realized credit losses			(355,623	)			—				(27,924	)			—				(3,000	)			—
Acquisitions			105,634				467,763				—				—				—				—
Sales, calls, other			(13,159	)			(79,082	)			—				—				124				—
Impairments			33,526				—				32,840				—				5,103				—
Transfers to (release of) credit reserves			69,013				(69,013	)			(30,006	)			30,006				24,934				(24,934	)
Ending Balance – September 30, 2009		$	570,859			$	446,587			$	471,957			$	1,624			$	86,989			$	(8,537	)

TABLE OF CONTENTS

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

Note 8. Real Estate Securities  – (continued)

The loans underlying our residential subordinate securities totaled $81 billion at September 30, 2009, consisting of $73 billion prime and $8 billion non-prime loans. These loans are located nationwide with a large concentration in California (47%). Serious delinquencies (90+ days, in foreclosure or REO) at September 30, 2009 were 6.73% of current principal balances. For loans in prime pools, serious delinquencies were 4.23% of current balances. For loans in non-prime pools, serious delinquencies were 30.11% of current balances. The loans underlying our commercial subordinate securities totaled $47 billion at September 30, 2009, and consist primarily of office (39%), retail (29%), and multifamily (15%) commercial loans. These loans are located nationwide. Serious delinquencies (60+ days and in foreclosure or REO) at September 30, 2009 were 3.63% 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 September 30, 2009 and December 31, 2008.

AFS Securities with Unrealized Losses

September 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		$	123,226			$	(41,413	)		$	81,813			$	34,146			$	(11,111	)		$	23,035
Commercial			—				—				—				—				—				—
CDO			10,891				(5,641	)			5,250				—				—				—
Total Securities		$	134,117			$	(47,054	)		$	87,063			$	34,146			$	(11,111	)		$	23,035