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



 

FORM 10-Q



 

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

For the Quarterly Period Ended: March 31,June 30, 2008

OR

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

For the transition periodTransition Period from to 

Commission file numberFile Number 1-13759



 

REDWOOD TRUST, INC.

(Exact Name of Registrant as Specified in Its Charter)



 

 
Maryland 68-0329422
(State or Other Jurisdiction
of
Incorporation or Organization)		 (I.R.S. Employer
Identification No.)

One Belvedere Place, Suite 300
Mill Valley, California 94941

(Address of Principal Executive Offices) (Zip Code)

(415) 389-7373

(Registrant’s Telephone Number, Including Area Code)



 

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

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesdays.Yeso Nox

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 Filerx Accelerated Filero Non-Accelerated Filero

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Nox

Indicate the number of shares outstanding of each of the issuer’s classes of stock, as of the last practicable date.

 
Common Stock, $0.01 par value per share 32,845,81633,575,409 as of May 6,August 5, 2008
 

 

TABLE OF CONTENTS

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

 
 Page
PART I
 

Item 1.

Financial Statements

     
Consolidated Balance Sheets at March 31,June 30, 2008 (unaudited)(Unaudited) and December 31, 2007  1 
Consolidated Statements of (Loss) Income for the three months ended March 31,Three and Six Months Ended June 30, 2008
and 2007 (unaudited)(Unaudited)		  2 
Consolidated Statements of Comprehensive Loss for the three months ended March 31,
Three and Six Months Ended June 30, 2008 and 2007 (unaudited)(Unaudited)		  3 
Consolidated Statements of Stockholders’ Equity (Deficit) for the three months ended
  March 31,Six Months Ended June 30, 2008 and 2007 (unaudited)(Unaudited)		  4 
Consolidated Statements of Cash Flows for the three months ended March 31,Six Months Ended June 30, 2008 and
  and 2007 (unaudited)(Unaudited)		  5 
Notes to Consolidated Financial Statements  6 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  5044 

Item 3.

Quantitative and Qualitative Disclosures aboutAbout Market Risk

  9891 

Item 4.

Controls and Procedures

  9891 
PART II
     

Item 1.

Legal Proceedings

  9992 

Item 1A.

Risk Factors

  9992 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

  9992 

Item 3.

Defaults Uponupon Senior Securities

  9992 

Item 4.

Submission of Matters to a Vote of Security Holders

  9992 

Item 5.

Other informationInformation

  9993 

Item 6.

Exhibits

  9993 
Signatures  10094 

i

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

REDWOOD TRUST, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

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



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

  
(In Thousands, Except Share Data)
(Unaudited)		 June 30,
2008		 December 31,
2007
ASSETS
          
Real estate loans $6,376,718  $7,204,151 
Real estate securities, at fair value:
          
Trading securities  841,868   11,521 
Available-for-sale securities  399,759   2,110,080 
Total real estate securities  1,241,627   2,121,601 
Other investments  78,583   79,125 
Cash and cash equivalents  147,639   290,363 
Total earning assets  7,844,567   9,695,240 
Restricted cash  102,171   118,064 
Accrued interest receivable  40,948   45,553 
Derivative assets  4,914   5,598 
Deferred tax asset  8,087   8,875 
Deferred asset-backed securities issuance costs  14,339   39,909 
Other assets  30,910   25,233 
Total Assets $8,045,936  $9,938,472 
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
          
Liabilities
          
Short-term debt – Redwood $9,326  $7,561 
Asset-backed securities issued – Sequoia  6,174,571   6,946,166 
Asset-backed securities issued – Acacia  935,072   3,383,113 
Accrued interest payable  32,237   53,796 
Derivative liabilities  100,396   81,385 
Accrued expenses and other liabilities  8,866   10,441 
Dividends payable  24,887   24,289 
Long-term debt – Redwood  150,000   150,000 
Total liabilities  7,435,355   10,656,751 
Minority interest  46,583   — 
Stockholders’ Equity (Deficit)
          
Common stock, par value $0.01 per share, 75,000,000 and 50,000,000 shares authorized; 33,184,317 and 32,385,073 issued and outstanding  334   324 
Additional paid-in capital  1,139,666   1,108,148 
Accumulated other comprehensive loss  (64,143)   (573,766) 
Cumulative earnings (losses)  492,949   (299,626) 
Cumulative distributions to stockholders  (1,004,808)   (953,359) 
Total stockholders’ equity (deficit)  563,998   (718,279) 
Total Liabilities and Stockholders’ Equity (Deficit) $8,045,936  $9,938,472 

1

TABLE OF CONTENTS

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

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



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

    
(In Thousands, Except Share Data)
(Unaudited)		 Three Months Ended June 30, Six Months Ended June 30,
 2008 2007 2008 2007
Interest Income
                    
Real estate loans $62,702  $119,576  $150,267  $246,427 
Real estate securities  61,529   95,862   138,057   181,785 
Other investments  514   464   1,246   464 
Cash and cash equivalents  2,196   3,756   5,377   6,088 
Total interest income  126,941   219,658   294,947   434,764 
Management fees  1,319   1,481   2,932   2,649 
Interest Expense
                    
Short-term debt – Redwood  (68)   (22,700)   (250)   (53,794) 
Asset-backed securities issued  (96,525)   (142,022)   (222,722)   (278,136) 
Long-term debt – Redwood  (2,233)   (2,516)   (4,766)   (4,572) 
Total interest expense  (98,826)   (167,238)   (227,738)   (336,502) 
Net Interest Income Before Market Valuation Adjustments  29,434   53,901   70,141   100,911 
Market valuation adjustments, net  (60,619)   (29,430)   (254,551)   (39,694) 
Net Interest (Loss) Income  (31,185)   24,471   (184,410)   61,217 
Operating expenses  (14,255)   (12,772)   (30,604)   (30,554) 
Realized gains on sales and calls, net  2,837   2,738   2,879   3,884 
Minority interest allocation  (2,369)   —   (2,624)   — 
Net (loss) income before provision for income taxes  (44,972)   14,437   (214,759)   34,547 
Provision for income taxes  (937)   (3,021)   (2,737)   (4,822) 
Net (Loss) Income $(45,909)  $11,416  $(217,496)  $29,725 
Basic (loss) earnings per share: $(1.40)  $0.42  $(6.65)  $1.10 
Diluted (loss) earnings per share: $(1.40)  $0.41  $(6.65)  $1.06 
Total dividends declared per
common share		 $0.75  $0.75  $1.50  $1.50 
Basic weighted average shares
outstanding		  32,871,442   27,405,284   32,691,444   27,132,001 
Diluted weighted average shares outstanding  32,871,442   28,164,944   32,691,444   27,917,502 

2

TABLE OF CONTENTS

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

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



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

    
(In Thousands)
(Unaudited)		 Three Months Ended June 30, Six Months Ended June 30,
 2008 2007 2008 2007
Net (Loss) Income $(45,909)  $11,416  $(217,496)  $29,725 
Other Comprehensive Income (Loss)
                    
Net unrealized gains (losses) on available-for-sale securities  9,152   (101,745)   (43,120)   (194,430) 
Reclassification adjustment for net losses included in net (loss) income  18,750   7,058   92,044   6,945 
Unrealized gains on cash flow hedges, net  —   19,952   —   13,814 
Reclassification of net realized cash flow hedge losses (gains) to interest expense on asset-backed securities issued and realized losses (gains) on sales and calls  1,246   5   2,492   (400) 
Total Other Comprehensive Income (Loss)  29,148   (74,730)   51,416   (174,071) 
Comprehensive Loss $(16,761)  $(63,314)  $(166,080)  $(144,346) 

3

TABLE OF CONTENTS

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

For the ThreeSix Months Ended March 31,June 30, 2008

              
(In Thousands, Except Share Data)
(Unaudited)		   
Common Stock		 Additional Paid-in Capital Accumulated Other Comprehensive (Loss) Income Cumulative (Losses) Earnings Cumulative Distributions
to Stockholders		 Total Common Stock Additional Paid-in Capital Accumulated Other
Comprehensive (Loss) Income		 Cumulative (Losses) Earnings Cumulative Distributions to Stockholders Total
Shares Amount Shares Amount
December 31, 2007  32,385,073  $324  $1,108,148  $(573,766)  $(299,626)  $(953,359)  $(718,279)   32,385,073  $324  $1,108,148  $(573,766)  $(299,626)  $(953,359)  $(718,279) 
Net (loss)  —   —   —   —   (171,587)   —   (171,587) 
Net loss  —   —   —        (217,496)   —   (217,496) 
Adoption of SFAS No. 159  —   —   —   458,207   1,008,531   —   1,466,738   —   —   —   458,207   1,010,071   —   1,468,278 
Net unrealized gain/reclassification on assets AFS  —   —   —   21,022   —   —   21,022   —   —   —   48,924   —   —   48,924 
Net unrealized gain/reclassification on interest rate agreements  —   —   —   1,246   —   —   1,246   —   —   —   2,492   —   —   2,492 
Issuance of common stock:
                                                                      
Dividend reinvestment & stock purchase plans  273,740   2   9,389   —   —   —   9,391   722,431   10   23,505   —   —   —   23,515 
Employee option & stock purchase plan  51,150   —   611   —   —   —   611   76,813   —   975   —   —   —   975 
Non-cash equity award compensation  —   —   1,406   —   —   —   1,406             7,038   —   —   —   7,038 
Common dividends declared  —   —   —   —   —   (25,454)   (25,454)                  —   —   (51,449)   (51,449) 
March 31, 2008  32,709,963  $326  $1,119,554  $(93,291)  $537,318  $(978,813)  $585,094 
June 30, 2008  33,184,317  $334  $1,139,666  $(64,143)  $492,949  $(1,004,808)  $563,998 

For the ThreeSix Months Ended March 31,June 30, 2007

              
              
(In Thousands, Except Share Data)
(Unaudited)		   
Common Stock		 Additional Paid-in Capital Accumulated Other Comprehensive (Loss) Income Cumulative Earnings Cumulative Distributions
to Stockholders		 Total Common Stock Additional Paid-in Capital Accumulated Other
Comprehensive (Loss) Income		 Cumulative Earnings Cumulative Distributions to Stockholders Total
Shares Amount Shares Amount
December 31, 2006  26,733,460  $267  $903,808  $93,158  $809,011  $(803,554)  $1,002,690   26,733,460  $267  $903,808  $93,158  $809,011  $(803,554)  $1,002,690 
Net income  —   —   —   —   18,309   —   18,309   —   —   —   —   29,725   —   29,725 
Net unrealized (loss)/reclassification on assets AFS  —   —   —   (92,798)   —   —   (92,798) 
Net unrealized (loss)/reclassification on interest rate agreements  —   —   —   (6,543)   —   —   (6,543) 
Net unrealized loss/reclassification on assets AFS  —   —   —   (187,485)   —   —   (187,485) 
Net unrealized gain/reclassification on interest rate agreements  —   —   —   13,414   —   —   13,414 
Issuance of common stock:
                                                                      
Dividend reinvestment & stock purchase plans  330,315   3   18,659   —   —   —   18,662   1,004,165   10   52,054   —   —   —   52,064 
Employee option & stock purchase plan  65,671   1   64   —   —   —   65   78,575   2   330   —   —   —   332 
Non-cash equity award compensation  —   —   5,117   —   —   —   5,117   —   —   8,752   —   —   —   8,752 
Common dividends declared  —   —   —   —   —   (21,462)   (21,462)   —   —   —   —   —   (43,408)   (43,408) 
March 31, 2007  27,129,446  $271  $927,648  $(6,183)  $827,320  $(825,016)  $924,040 
June 30, 2007  27,816,200  $279  $964,944  $(80,913)  $838,736  $(846,962)  $876,084 



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

4

TABLE OF CONTENTS

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

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

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



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

  
(In Thousands)
(Unaudited)		 Six Months Ended June 30,
 2008 2007
Cash Flows from Operating Activities:
          
Net (loss) income $(217,496)  $29,725 
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
          
Amortization of premiums, discounts, and debt issuance costs  (5,405)   (32,749) 
Depreciation and amortization of non-financial assets  536   830 
Provision for credit losses  18,119   6,329 
Non-cash equity award compensation  7,038   8,752 
Net recognized losses and valuation adjustments  254,551   39,694 
Realized gains on sales and calls, net  (2,879)   (3,884) 
Net change in:
          
Accrued interest receivable  15,581   13,432 
Deferred income taxes  788   568 
Other assets  11,585   4,111 
Accrued interest payable  (18,302)   (2,117) 
Accrued expenses and other liabilities  (1,575)   38,683 
Net cash provided by operating activities  62,541   103,374 
Cash Flows from Investing Activities:
          
Purchases of real estate loans held-for-investment  —   (1,091,496) 
Proceeds from sales of real estate loans held-for-investment  —   2,191 
Principal payments on real estate loans held-for-investment  765,293   2,025,662 
Purchases of real estate securities available-for-sale  (244,252)   (1,011,181) 
Proceeds from sales of real estate securities available-for-sale  7,300   175,559 
Principal payments on real estate securities available-for-sale  41,098   160,737 
Purchases of real estate securities trading  (3,341)   (40,818) 
Proceeds from sales of real estate securities trading  454   2,237 
Principal payments on real estate securities trading  100,504   7,431 
Purchases of other investments  —   (80,000) 
Principal payments on other investments  541   — 
Net decrease (increase) in restricted cash  15,893   (94,497) 
Net cash provided by investing activities  683,490   55,825 
Cash Flows from Financing Activities:
          
Net (repayments) borrowings on short-term Redwood debt  1,765   (1,007,546) 
Proceeds from issuance of asset-backed securities  —   3,332,925 
Deferred asset-backed security issuance costs  —   (19,147) 
Repayments on asset-backed securities  (905,000)   (2,609,157) 
Proceeds from issuance of long-term Redwood debt  —   50,000 
Net purchases of interest rate agreements  (5,743)   (2,798) 
Net proceeds from issuance of common stock  24,490   52,396 
Dividends paid  (50,850)   (41,262) 
Change in minority interests  46,583   — 
Net cash used in financing activities  (888,755)   (244,589) 
Net decrease in cash and cash equivalents  (142,724)   (85,390) 
Cash and cash equivalents at beginning of period  290,363   168,016 
Cash and cash equivalents at end of period $147,639  $82,626 
Supplemental Disclosure of Cash Flow Information:
          
Cash paid for interest $243,109  $335,970 
Cash (received) paid for taxes $(1,442)  $8,480 
Non-Cash Financing Activity:
          
Dividends declared but not paid at end of period $24,887  $20,862 

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

Note 1. Redwood Trust

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

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

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

Note 2. Basis of Presentation

The consolidated financial statements presented herein are at March 31,June 30, 2008 and December 31, 2007, and for the three and six months ended March 31,June 30, 2008 and 2007.

These consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States (GAAP) 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, 2008, may not necessarily be indicative of the results for the year ending December 31, 2008. The unaudited interim consolidated financial statements as of June 30, 2008, 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, 2007.

Organization

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

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

We are the asset manager and investor in an Opportunity Fund LP (the Fund) that we sponsor. The Fund primarily invests in mortgage securities.

Principles of Consolidation

Under the provisions of FASB Interpretation No. 46 (revised), Consolidation of Variable Interest Entities (FIN 46R), we are required to consolidate the assets, liabilities, and non-controlling interests of any variable interest entity (VIE) in which we are the primary beneficiary. Under this principle, the primary beneficiary is the party that absorbs the majority of the VIE's anticipated losses and/or the majority of the expected returns.

We consolidate the Acacia and Sequoia securitization entities that we sponsor, since we are the primary beneficiary in these entities and they are not considered qualifying special purpose entities under the provisions of Statement of Financial Accounting Standards No. 140,Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS(FAS 140), we treat the securitizations we sponsor as financings, as under these provisions we have retained effective control over these loans and securities. Control is maintained through our active management of the assets in the securitization entities, our retained asset transfer discretion, our ability to direct certain servicing decisions, or a combination of the foregoing.. Accordingly, the underlying loans and

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 2. Basis of Presentation  – (continued)

securities owned by these securitization entities are shown on our consolidated balance sheets under real estate loans and real estate securities and the asset-back securities (ABS) issued to third parties are shown on our consolidated balance sheets under ABS issued. In our consolidated statements of (loss) income, we record interest income on the loans and securities and interest expense on the ABS issued. AnyAll significant intercompany balances and transactions, including transfers or repurchases of Sequoia ABS acquired by Redwood or Acacia from Sequoia entities and any Acacia ABS, acquired by Redwood for its own portfolio arehave been eliminated in consolidation and thusconsolidation.

We consolidate the Fund that we sponsor, since we are notthe primary beneficiary in this entity. The portion of the Fund that represents the interest of third parties is shown separatelyas minority allocation on our consolidated balance sheets and the associatedportion of income andallocable to third parties is shown as other expense are not shown separately onin our consolidated statements of (loss) income.

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 3. Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States (GAAP)GAAP requires us to make a significant number of estimates. These include estimates of fair value of certain assets and liabilities, amount and timing of credit losses, prepayment rates, the period of time during which we anticipate an increase in the fair values of real estate securities sufficient to recover unrealized losses in those securities, and other items that affect the reported amounts of certain assets and liabilities as of the date of the consolidated financial statements and the reported amounts of certain revenues and expenses during the reported period. It is likely that changes in these estimates (e.g., market values due to changes in supply and demand, credit performance, prepayments, interest rates, or other reasons; yields due to changes in credit outlook and loan prepayments) will occur in the near term. Our estimates are inherently subjective in nature and actual results could differ from our estimates and the differences may be material.

Our financial statements include assets and liabilities that are measured based on their estimated fair values and many of these assets and liabilities are illiquid in nature. Our fair valuesvalue estimates reflect what we believe we could realize if we chose to sell our assets and or pay if we chose to transfer liabilities at the measurement date in an orderly manner. Most of the assets and liabilities consolidated on our balance sheet (in particular our credit-enhancement securities and CDOs) are illiquid. Consequently, establishingEstablishing fair values for theseilliquid assets and liabilities is inherently subjective and is dependent upon our estimates and modeling assumptions and indications of value obtained from brokers and dealers. As a consequence of limited trading visibility late in 2007 and early in 2008 and the significant uncertainties regarding credit loss levels, thereThere is currently a wide variance of opinion related to the assumptions underpinning our market valuation inputs. We expect that the market valuations will continue to be highly volatile. Nonetheless, we believe the fair valuevalues for our assets and liabilities and other estimates used in preparation of our financial statements represent appropriate values and income recognition and isare in conformity with GAAP principles.

Effective January 1, 2008, we adopted two pronouncements relating to fair value measurement: Statement of Financial Accounting Standards No. 157,Fair Value Measurements (FAS 157) and Statement of Financial Accounting Standards No. 159,The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115 (FAS 159).

SeeNote 4 andNote 5 for further discussion on fair value estimates and these assets and liabilities even in this uncertain market.accounting principles.

Real Estate Loans

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

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

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

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

Residential and commercial real estate loans classified as held-for-investment are carried at their unpaid principal balances adjusted for net unamortized premiums or discounts and net of any allowance for credit losses.

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

Pursuant to Statement of Financial Accounting Standards No. 91,Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Cost of Leases (FAS 91), we use the interest method to determine an effective yield and amortize the premium or discount on loans.real estate loans held-for-investment. For loans acquired prior to July 1, 2004, we use coupon interest rates as they change over time and anticipated principal payments to determine an effective yield to amortize the premium or discount. For loans acquired after July 1, 2004, we use the initial coupon interest rate of the loans (without regard to future changes in the underlying indices) and anticipated principal payments to calculate an effective yield to amortize the premium or discount.

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

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

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

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

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

Real Estate Loans — Reserve for Credit Losses

For consolidated real estate loans classified as held-for-investment, we establish and maintain credit reserves based on estimatesour estimate of credit losses inherent in theseour loan portfolios as of the reporting date. To calculate the reserve for credit reserve,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 loan pools, or individualpool of loans. SeeNote 11 for a discussion of the reserves for credit losses.

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), Statement of Financial Accounting Standards No. 114,Accounting by Creditors for Impairment of a Loan (FAS 114), and Statement of Financial Accounting Standards No. 118,Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures (FAS 118) in setting credit reserves for our real estate loans.

We consider the following factors in making such determinations:

Ongoing analyses of loans, including, but not limited to, the age of loans, underwriting standards, business climate, economic conditions, geographical considerations, and other observable data;
Historical loss rates and past performance of similar loans;
Relevant environmental factors;
Relevant market research and publicly available third-party reference loss rates;
Trends in delinquencies and charge-offs;

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

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

Effects and changes in credit concentrations;
Information supporting thea borrower’s ability to meet obligations;
Ongoing evaluations of fair values of collateral using current appraisals and other valuations; and,
Discounted cash flow analyses.

Once we determine applicable default amounts, the timing of the defaults, and severity of losses upon the defaults, we estimate expected losses for each 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 probable occurrence of a credit loss (such as the initial deterioration of the borrower’s financial condition) and the confirmation of that loss (the actual impairment or charge-off of the loan). The losses expected to occur within the estimated loss confirmation period are the basis of our credit reserves, because we believe those losses exist as of the reported date of the financial statements. We re-evaluate the level of our credit reserves on at least a quarterly basis, and we record provision, charge-offs, and recoveries monthly.

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

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

7 for further discussion on reserves for credit losses.

WeSince we do not originate real estate loans, we do not currently maintain a loan repurchase reserve, as any risk of loss due to loan repurchases (i.e., due to breach of representations) would normally beis generally covered by recourse to the companies from whom we acquired the loans.

Real Estate Securities, at Fair Value

Trading Securities

Real estate securities classified as trading include residential, commercial, and CDO securities and are carried at their estimated fair values. Coupon interest is recognized as revenue when earned and deemed collectible and changes in fair value (gains and losses) are reported through our consolidated statements of (loss) income in market valuation adjustments, net. Trading securities are primarily those securities where we have adopted the fair value option under FAS 159.

Available-for-Sale (AFS)

Securities

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

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

When recognizing revenue on AFS securities where credit risk is not remote, we employ the interest method to account for purchase premiums, discounts, and fees associated with these securities. For securities rated AAA or AA, we use the interest method as prescribed under FAS 91, while for securities rated A or lower we use the interest method as prescribed under the Emerging Issues Task Force of the Financial Accounting Standards Board 99-20,Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets (EITF 99-20). to account for purchase premiums, discounts, and fees associated with these securities. The use of these methodsthis method requires us to project cash flows over the remaining life of each asset. These projections include assumptions about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. We review and make adjustments to our cash flow projections on an ongoing

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

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

basis and monitor these projections based on input and analyses received from external sources, internal models, and our own judgment and experience. Actual maturities of AFS securities are generally shorter than stated contractual maturities and stated maturities are generally greater than ten years. Actual maturities of the AFS securities are affected by the contractual lives of the underlying mortgages,associated mortgage collateral, periodic payments of principal, and prepayments of principal. 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 would not change in the near term, and the change could be material.

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

For determining other-than-temporary impairment on our real estate securities accounted for as AFS securities, we use the guidelines prescribed under EITF 99-20, Statement of Financial Accounting Standards No. 115,Accounting for Certain Investments in Debt and Equity Securities (FAS 115), and SEC Staff Accounting Bulletin No. 5(m),Other-Than-Temporary Impairment for Certain Investments in Debt and Equity Securities (SAB 5(m))59). Other-than-temporary impairments are reported under market valuation adjustments, net in our consolidated statements of income (loss) income.. We assess whether a drop in fair value below our cost of the real estateAFS security should be deemed as other-than-temporary impairment. If there has been no adverse change in the projected future cash flows of the security, we have the ability and intent to hold

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

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

a real estate the security, forand we have determined that within a reasonable period of time sufficient forthere will likely be a forecasted recovery of fair value up to (or beyond) the amortized cost of the investment, we do not deem that unrealized loss ansecurity, there is no other-than-temporary impairment.

Real Estate Securities Fair Value Option (FVO)

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

Other Real Estate Investments

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

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

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

Non-Real Estate Investments

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

SeeNote 9 for a further discussion of our non-real estateon other investments.

Cash and Cash Equivalents

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

Derivative Financial InstrumentsRestricted Cash

All derivative financial instrumentsRestricted cash includes principal and interest payments from real estate loans and securities owned by consolidated securitization entities that are reported at fair valuecollateral for, or payable to, owners of ABS issued by those entities and cash pledged as collateral on our consolidated balance sheets regardless of their accounting treatment. Those with a positive value to us are reported as an asset and those with a negative value to us are reported as a liability. Whether changesinterest rate agreements. Restricted cash may also include cash retained in Acacia or Sequoia securitization entities or in the fair valueFund prior to the purchase of these instruments are reported through our income statement dependsloans or securities, payments on the typeor redemption of derivative and the accounting treatment chosen.

We currently enter into interest rate agreementsoutstanding ABS issued, or distributions to help manage some of our interest rate risks. We designate an interest rate agreement as (1) a hedge of the fair value of a recognized asset or liability or of anlimited partners.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

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

Accrued Interest Receivable

unrecognized firm commitment (fairAccrued interest receivable represents interest that is due and payable to us. This is generally received within the next month.

Derivative Financial Instruments

Derivative financial instruments include contractual interest rate agreements and credit default swaps (CDS). All derivative financial instruments are reported at fair value hedge), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge), (3) held for trading (trading instrument) underon our consolidated balance sheets, in accordance with Statement of Financial Accounting Standards No. 133,Accounting for Derivative Instruments and Hedging Activities (FAS 133), or (4). Derivatives with a positive value to us are reported as an asset and derivatives with a negative value to us are reported as a FVO derivative under FAS 159.liability. The changes in fair value of derivatives accounted for as trading instruments are reported in the consolidated statements of (loss) income through market valuation adjustments, net. Net purchases and proceeds from interest rate agreements are classified within cash flows as financing activities within theour consolidated statements of cash flows.

In aWe generally enter into interest rate agreements to help manage some of our interest rate risks. Prior to 2008, we accounted for derivatives used to hedge interest rate exposure in Acacia securitization entities as cash flow hedge,hedges under FAS 133. As of January 1, 2008, all derivatives designated as cash flow hedges were de-designated as cash flow hedges and accounted for as trading instruments. Since the effective portion of the change inassociated hedged items continue to exist, the fair value of cash flow hedges at the hedging derivative is recordedtime of de-designation remains in accumulated other comprehensive loss and is subsequently reclassified into earnings whenbeing amortized using the hedging relationship is terminated. The ineffective portion of the cash flow hedge is recognized immediately in earnings. We use the dollar-offsetstraight line method to determine the amount of ineffectiveness, and we anticipate having some ineffectiveness in our hedging program, as not all terms of our hedges and not all terms of our hedged items match perfectly.

We will discontinue hedge accounting and account for them as trading instruments when (1) we determine that the derivative is no longer expected to be effective in offsetting changes in the fair value or cash flows of the designated hedged item; (2) the derivative expires or is sold, terminated, or exercised; (3) the derivative is de-designated as a fair value or cash flow hedge; or (4) it is probable that the forecasted transaction will not occur by the end of the originally specified time period.

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

TheWe may enter into CDS contracts from time to time. A 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. Prior to 2008, we accounted for CDS as trading instruments under FAS 133. As of January 1, 2008, we have accounted for CDS as trading instruments under FAS 159 as they were all owned by Acacia entities. In both cases, changes in fair value of FVO derivatives and other derivatives accounted for as trading instrumentsCDS are reported in the consolidated statements of (loss) income through market valuation adjustments, net.

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

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

SeeNote 10 for a further discussion of ouron derivative financial instruments.

Restricted Cash

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

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

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

Accrued Interest Receivable

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

Deferred Tax Assets

Income recognition for GAAP and tax differ in material respects. As a result, we may recognize taxable income in periods prior to recognizing theor later than when we recognize income for GAAP. When this occurs, we pay the tax liability and establish a deferred tax asset for GAAP. When the income is thensubsequently realized under GAAP 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 taxtaxable income at our taxable subsidiaries. GAAP and tax differences at the REIT may create additional deferred tax assets or liabilities to the extent we do not distribute all of our taxable income.

SeeNote 20 for further discussion of taxes.

Deferred Asset-Backed Securities Issuance Costs

ABSAsset-backed securities (ABS) issuance costs are costs associated with the issuance of ABS from securitization entities we sponsor. These costs typically include underwriting, rating agency, legal, accounting,

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

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

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 consolidated interest expense using the interest method, based onupon 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 reporting in accordance with APB 21. As of January 1, 2008, the deferred issuance costs associated with Acacia were included in the fair value of ABS issued by Acacia.Acacia and were accounted for under FAS 159. As a result, these costs were included in our one timeone-time adjustment upon the adoption of FAS 159 and were reclassified into retained earnings.

SeeNote 4 for further details.discussion on FAS 159.

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.

Short-Term Debt — Redwood

Short-term debt includes our credit facilities at Redwood Debt

Redwood debt is currently all short-term debtthat mature within one year. Open facilities may be unsecured or collateralized by loans andor securities. We report thisshort-term Redwood debt at its unpaid principal balance.

Asset-BackedAsset Backed Securities Issued — Sequoia and Acacia

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

Sequoia and Acacia assets are held in the custody of trustees. Trustees collect principal and interest payments (less servicing and related fees) from the assets and make corresponding principal and interest payments to the ABS investors. ABS obligations are payable solely from the assets of these entities and are not obligations of Redwood.

Sequoia ABS Issued

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

Acacia ABS Issued

Effective January 1, 2008, the Acacia ABS issued are accounted for under the fair value option under FAS 159 and therefore carried at their fair valuevalues on our consolidated balance sheets. Deferred ABS issuance costs and premiums

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

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

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

Subordinated NotesLong-Term Debt — Redwood

Subordinated notes includeLong-term debt includes trust preferred securities and subordinated notes.notes at Redwood. Both are unsecured debt, requiring quarterly interest payments at a floating rate equal to LIBORLondon Interbank Offered Rate (LIBOR) plus a spreadmargin until they are redeemed in whole or mature at a future date. These notes contain an earlier optional redemption date without penalty. Subordinated notes areLong-term Redwood debt is reported on our consolidated balance sheet at cost.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

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

SeeNote 14 for further discussion on long-term Redwood debt.

Minority Interest

Minority interest represents the aggregate limited partnership interests in the Opportunity Fund held by third parties.

SeeNote 16 for further discussion on minority interest.

Earnings (Loss) Earnings perPer Share

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

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

Basic and Diluted (Loss) Earnings per Share

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

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

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

Other Comprehensive Income (Loss)

Current period net unrealized gains and losses on real estate securities available-for-sale and interest rate agreements classifiedpreviously designated as cash flow hedges under FAS 133 are reported as components of other comprehensive income (loss) on our consolidated statements of comprehensive loss.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 taxtaxation and may create deferred tax assets or liabilities.

Stock-Based Compensation

As of March 31,June 30, 2008 and December 31, 2007, we had one stock-based employee compensation plan and one employee stock purchase plan. These plans, and associated equity awards, are described more fully inNote 18.

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

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

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

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

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

Recent Accounting Pronouncements

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

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

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

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

In June 2008, the FASB issued 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 earnings per share using the two-class method. According to EITF 03-6-1, a share-based payment award is a participating security when the award includes nonforfeitable rights to dividends or dividend equivalents. The rights result in a noncontingent transfer of value each time an entity declares a dividend or dividend equivalent during the award's vesting period. However, the award would not be considered a participating security if the holder forfeits the right to receive dividends or dividend equivalents in the event that the award does not vest. EITF 03-6-1 is effective for financial statements issued in fiscal years beginning after December 15, 2008, and interim periods within those years. When adopted, its requirements are applied by recasting previously reported EPS. We are currently evaluating the requirements of EITF 03-6-1 and have not yet determined the impact of adoption.

Note 4. Adoption of FAS 159

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

On January 1,14

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008 we elected to apply the FVO under
(Unaudited)

Note 4. Adoption of FAS 159  to the assets and liabilities of our consolidated Acacia securitization entities and all investment grade securities (IGS) at Redwood. – (continued)

Prior to the application of FAS 159, we were required for financial reporting purposes, to mark-to-market the assets, but not the liabilities, of the Acacia entities, even though the assets and liabilities were paired within the same legal structure and the ABS issued by each Acacia entity would be repaid directly and solely from the cash flows generated by the assets of that entity.

Electing the FVOfair value option for the assets and liabilities (including derivatives) of Acacia will enableenabled us to mitigate the volatility in earnings and book value that results from the use of different measurement attributes, to correlate more closely the values of the assets and liabilities that are paired within the same securitization entity, and to reduce the complexity of accounting especially with regards to derivatives under FAS 133. We also elected the fair value option for the IGScertain investment grade securities (IGS) held at Redwood, since we expect to pair these investments with a future liability for which we will also elect the FVO.fair value option under FAS 159.

As a result of the one-time election of FAS 159 on January 1, 2008, we reclassified $459 million of net unrealized gains and losses on Acacia assets and IGS at Redwood from accumulated other comprehensive income (loss) to retained earnings. We also recorded to retained earnings the $1.5 billion aggregate difference between the reported values and fair values of Acacia liabilities. As part of the revaluation of the Acacia liabilities to fair value, we also reclassified to retained earnings the associated unamortized deferred ABS issuance costs of $21 million. Adjustments resulting from the one-time election at the adoption date of FAS 159 are reflected on the balance sheet as a cumulative effect adjustment to stockholders’ equity (deficit).

We did not elect the fair value option for the assets and liabilities of Sequoia, as these assets and liabilities are currently accounted for using similar measurement attributes and as a result, there is less need to mitigatedo not generally create substantial volatility in earnings and book value.our earnings. We also did not elect the fair value option for our credit enhancement securitysecurities (CES) at Redwood, which are funded with equity. There is no paired liability for these assets and our intent upon acquisition of these assets is to hold them to maturity and to generate long-term cash flows.

Our decision to adopt FAS 159 for new financial instruments is generally based upon our funding strategy for the specific financial asset acquired or financial liability incurred. Assets that we anticipate funding with equity will generally be accounted for as AFS securities under FAS 115. Assets that we anticipate financing with a combination of debt and equity will generally be accounted for as trading securities under FAS 159 along with the corresponding liabilities.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

Note 4. Adoption of FAS 159  – (continued)

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

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

The following table presents the consolidated balance sheet at December 31, 2007, the transition adjustments and their effect on the consolidated balance sheetConsolidated Total Assets and Total Liabilities and Stockholders’ Equity at January 1, 2008, following the applicationadoption of FAS 159.

Adoption of FAS 159

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

16Included in the $1 billion transition adjustment to retained earnings is an additional $1.5 million that was recorded during the second quarter of 2008. This amount relates to securities where we adopted FAS 159 on January 1, 2008, but was excluded in our original transition adjustment.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 5. Fair Value of Financial Instruments

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

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

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(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 includesinclude situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment and considers factors specific to the asset or liability. There areFAS 157 also additional requirements to providerequires a roll forward of the items in Level 3 along with additional discussions on how these valuations are developed.

We estimate fair values of ourThe following table presents information about financial instruments using available market informationassets and other appropriate valuation methodologies. Theseliabilities reported at fair value estimates generally incorporate discounted future cash flows at current market discount rates for comparable investments. We validate ouras of June 30, 2008, and indicates the fair value estimates on at least a quarterly basis by obtaining fair value estimates from dealers, to the extent available, for securities who make a market in these financial instruments and look at recent acquisitions and sales if any (even if they occur after the reporting date). We believe the estimates we use reasonably reflect the values we may be able to receive should we choose to sell them. Many factors must be considered in order to estimate fair values, including, but not limited to interest rates, prepayment rates, amount and timing of credit losses, supply and demand, liquidity, and other market factors. Accordingly, our estimates are inherently subjective in nature and involve uncertainty and judgment to interpret relevant market and other data.

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

Assets and ask valuesLiabilities Measured at Fair Value on a Recurring Basis as the fair values are based on market participant assumptions.

of June 30, 2008

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

Real estate loans
    
  Fair Value Measurements Using
(In Thousands) Carrying
Value		 Quoted
Prices in
Active
Markets
(Level 1)		 Significant
Other
Observable
Inputs
(Level 2)		 Significant
Unobservable
Inputs
(Level 3)
Assets
                    
Real estate loans (held-for-sale) $3,695  $—  $—  $3,695 
Real estate loans (fair value)  18,800   —   —   18,800 
Trading securities  841,868   —   —   841,868 
Available-for-sale securities  399,759   —   —   399,759 
Other investments  78,583   —   —   78,583 
Derivative assets  4,914   —   4,635   279 
Liabilities
                    
ABS issued – Acacia  935,072   —   —   935,072 
Derivative liabilities  100,396   —   25,106   75,290 

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

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

Residential real estate loan

The following table presents additional information about the assets and liabilities reported at fair values are determined by available market quotes and discounted cash flow analyses.

Commercial real estate loan fair values are determined by appraisalsvalue on underlying collateral and discounted cash flow analyses.
Real estate securities
Real estate securities are represented by residential, commercial, CDO and other asset-backed securities. Real estate securities’ fair values are determined by discounted cash flow analyses and other valuation techniques using market pricing assumptions confirmed by third party dealer/pricing indications to the extent available. Significant inputs in the valuation analysis are predominantlyour consolidated balance sheets on a recurring basis for which Level 3 dueinputs were used to determine fair value. These changes in fair value occurred after the natureadoption of these instruments and the lack of readily available market quotes. These instruments trade infrequently and therefore have little or no price transparency. Relevant market indicators that are factoredFAS 159 on January 1, 2008.

Changes in the analyses include bid/ask spreads, credit losses, interest rates, and prepayment speeds. Estimated fair values are based on applying the market indicators to generate discounted cash flows.

Other real estate investments
Other real estate investments fair values are determined by discounted cash flow analyses and other valuation techniques using market pricing assumptions confirmed by third party dealer/pricing indications.
Non-real estate investments
Non-real estate investments fair values approximate carrying values as the coupon rates are indexed to LIBOR resetting monthly.
Derivative assets and liabilities
Our derivative instruments include interest rate agreements and credit default swaps. Fair values of derivative instruments are determined using valuation models and are verified by valuations provided by dealers active in derivative markets. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates, and correlations of such inputs. Model inputs for interest rate agreements can generally be verified and model selection does not involve significant management judgment (these are Level 2 inputs). For other derivatives, valuations are based on various factors such as liquidity, bid/offer spreads, and credit considerations for which we rely on available market evidence. In the absence of such evidence, management’s best estimate is used for these other derivatives, including credit default swaps (these are Level 3 inputs).
CashAssets and cash equivalents
Includes cashLiabilities Measured at Fair Value on hand and highly liquid investments with original maturities of three months or less. Fair values equal carrying values.a Recurring Basis

      
Three Months Ended June 30, 2008
(In Thousands)		 Beginning
Balance
4/1/2008		 Principal
Paydowns		 Total Realized and
Unrealized Gains (Losses)
Included in Income		 Purchases,
Sales, Other
Settlements
and Issuances,
Net		 Ending
Balance
6/30/2008
 Realized
Gains or
(Losses)		 Unrealized
Gains or
(Losses)
Assets
                              
Real estate loans (held-for-sale) $4,443  $(626)  $(81)  $(41)  $—  $$3,695 
Real estate loans (fair value)  18,801   (113)   112   —   —   18,800 
Trading securities  952,576   (43,206)   (67,171)   —   (331)   841,868 
Available-for-sale securities  242,030   (23,162)   (30,822)   27,901   183,812   399,759 
Other investments  78,770   (187)   —   —   —   78,583 
Derivative assets  72   —   207   —   —   279 
Liabilities
                              
Acacia ABS issued  1,046,160   (109,881)   (4,464)   —   3,257   935,072 
Derivative liabilities  72,501   —   2,789   —   —   75,290 

Restricted cash
Restricted cash primarily includes interest-earning cash balances in ABS entities and the Opportunity Fund for the purpose of distribution to bondholders and reinvestment. Due to the short-term nature of the restrictions, fair values approximate carrying values.
Accrued interest receivable and payable
      
Six Month Ended June 30, 2008
(In Thousands)		 Beginning
Balance
1/1/2008		 Principal
Paydowns		 Total Realized and
Unrealized Gains (Losses)
Included in Income		 Purchases,
Sales, Other
Settlements
and Issuances,
Net		 Ending
Balance
6/30/2008
 Realized
Gains or
(Losses)		 Unrealized
Gains or
(Losses)
Assets
                              
Real estate loans (held-for-sale) $4,533  $(642)  $(155)  $(41)  $—  $3,695 
Real estate loans (fair value)  25,426   (229)   (4,548)   (1,849)   —   18,800 
Trading securities  1,804,511   (100,504)   (865,151)   —   3,012   841,868 
Available-for-sale securities  317,090   (30,234)   (174,920)   49,094   238,729   399,759 
Other investments  79,125   (542)   —   —   —   78,583 
Derivative assets  114   —   165   —   —   279 
Liabilities
                              
Acacia ABS issued  1,893,441   (140,046)   (814,305)   —   (4,018)   935,072 
Derivative liabilities  57,397   —   17,893   —   —   75,290 

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

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

Includes

The following table presents information for total net interest due and receivable onincome for assets and dueliabilities measured under the fair value option for the three and payablesix months ended June 30, 2008.

Net Interest Income on Fair Value Option Assets and Liabilities

      
 Net Interest Income on FVO Assets and Liabilities
Three Months Ended June 30, 2008		 Net Interest Income on FVO Assets and Liabilities
Six Months Ended June 30, 2008
(In Thousands) Change in
Market
Value		 Interest
Income
(Expense)		 Total Effect On
Net Interest
Income		 Change in
Market
Value		 Interest
Income
(Expense)		 Total Effect On
Net Interest
Income
Assets
                              
Real estate loans (fair value) $112  $373  $485  $(4,548)  $744  $(3,804) 
Trading securities  (62,537)   37,858   (24,679)   (857,821)   84,004   (773,817) 
Other investments  —   514   514   —   1,246   1,246 
Derivative assets  989   —   989   792   —   792 
Liabilities
                              
Acacia ABS issued  4,464   (30,306)   (25,842)   814,305   (74,826)   739,479 
Derivative liabilities  27,769   —   27,769   (21,818)   —   (21,818) 
Total $(29,203)  $8,439  $(20,764)  $(69,090)  $11,168  $(57,922) 

Market valuation adjustments include fair value adjustments as well as other valuation changes in assets and liabilities consolidated on our liabilities. Due to the short-term nature of when these interest payments will be received or paid, fair values approximate carrying values.

Redwood debt
All Redwood debt is adjustable and matures within one year; fair values approximate carrying values.
ABS issued
ABS issued fair values are determined by discounted cash flow analyses and other valuation techniques using market pricing assumptions confirmed by third party dealer/pricing indications to the extent available. Significant inputs in the valuation analysis are predominantly Level 3, due to the nature of these instruments and the lack of readily available market quotes. These instruments trade infrequently and therefore have little or no price transparency. Relevant market indicatorsfinancial statements that are factoredrecorded through our consolidated statements of (loss) income. The following table presents the components of market valuation adjustments, net, recorded in our consolidated statements of (loss) income for the analyses include dealer marks to the extent available, bid/ask spreads, external spreads, collateral credit losses, interest ratesthree and collateral prepayment speeds. Estimated fair values are based on applying the market indicators to generate discounted cash flows.
six months ended June 30, 2008.

Market Valuation Adjustments, Net

Subordinated notes
Fair values are determined using comparable market indicators of current pricing.
  
(In Thousands) Three Months Ended
June 30, 2008		 Six Months Ended
June 30, 2008
Total Market Valuations of Fair Value Assets and Liabilities $(29,203)  $(69,090) 
Other Market Valuation Adjustments
          
Impairments on AFS securities  (28,970)   (173,067) 
Derivative instruments  1,981   (4,411) 
Other real estate investments (trading)  (3,362)   (6,058) 
Real estate loans (held-for-sale)  (1,065)   (1,925) 
Market Valuation Adjustments, Net $(60,619)  $(254,551) 

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

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

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

Fair Value of Financial Instruments

The following table presents the carrying values and estimated fair values of our financial instruments as of June 30, 2008 and December 31, 2007.

        
 March 31, 2008 December 31, 2007 June 30, 2008 December 31, 2007
(In Thousands) Carrying
Value		 Fair Value Carrying Value Fair Value Carrying
Value		 Fair
Value		 Carrying
Value		 Fair
Value
ASSETS
                    
Assets
 
Real estate loans (held-for-investment) $6,751,743  $5,851,167  $7,199,618  $6,860,574  $6,354,223  $5,666,056  $7,199,618  $6,860,574 
Real estate loans (held-for-sale)  4,443   4,443   4,533   4,533   3,695   3,695   4,533   4,533 
Real estate loans – FVO  18,801   18,801   —   — 
Real estate securities – FVO  949,139   949,139   —   — 
Real estate securities – AFS  242,030   242,030   2,110,080   2,110,080 
Other real estate investments (trading)  3,437   3,437   11,521   11,521 
Non-real estate investments  78,770   78,770   79,125   79,125 
Real estate loans (fair value)  18,800   18,800   —   — 
Trading securities  841,868   841,868   11,521   11,521 
Available-for-sale securities  399,759   399,759   2,110,080   2,110,080 
Other investments  78,583   78,583   79,125   79,125 
Cash and equivalents  256,895   256,895   290,363   290,363   147,639   147,639   290,363   290,363 
Derivative assets  3,964   3,964   5,598   5,598   4,914   4,914   5,598   5,598 
Restricted cash  149,253   149,253   118,064   118,064   102,171   102,171   118,064   118,064 
Accrued interest receivable  37,533   37,533   45,553   45,553   40,948   40,948   45,553   45,553 
LIABILITIES
                    
Redwood debt  2,086   2,086   7,561   7,561 
Liabilities
                    
Short-term debt – Redwood  9,326   9,326   7,561   7,561 
ABS Issued                     
ABS issued – Sequoia  6,544,491   5,642,142   6,946,166   6,693,087   6,174,571   5,425,929   6,946,166   6,693,087 
ABS issued – Acacia – FVO(1)  1,046,160   1,046,160   3,383,113   1,893,441 
ABS issued – Acacia(1)  935,072   935,072   3,383,113   1,893,441 
Total ABS issued  7,590,651   6,688,302   10,329,279   8,586,528   7,109,643   6,361,001   10,329,279   8,586,528 
Derivative liabilities  134,210   134,210   81,385   81,385   100,396   100,396   81,385   81,385 
Accrued interest payable  43,882   43,882   53,796   53,796   32,237   32,237   53,796   53,796 
Subordinated notes  150,000   72,000   150,000   94,000 
Long-term debt – Redwood  150,000   72,000   150,000   94,000 

(1)We elected the fair value option under FAS 159 for all Acacia ABS issued is FVO as of January 1, 2008 and was2008. Acacia ABS were recorded at their amortized cost at and prior to December 31, 2007 and prior.2007.

The following is 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.

Real estate loans
Residential real estate loan fair values are determined by available market quotes and discounted cash flow analyses (Level 2 and 3).
Commercial real estate loan fair values are determined by available market quotes and discounted cash flow analyses (Level 2 and 3).
Real estate securities
Real estate securities are residential, commercial, CDO, and other asset-backed securities that are illiquid in nature and trade infrequently. Fair values are determined by discounted cash flow analyses and other valuation techniques using market pricing assumptions that are confirmed by third party dealer/pricing indications, to the extent available. Significant inputs in the valuation

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

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

The following table presents information about
analysis are predominantly Level 3 in nature, due to the lack of readily available market quotes and related inputs. Relevant market indicators that are factored in the analyses include bid/ask spreads, credit losses, interest rates, and prepayment speeds. Estimated fair values are based on applying the market indicators to generate discounted cash flows.

Other investments
Other investments currently include a GIC. Management currently considers the GIC’s fair value to approximate contract value, as the interest rate is variable at LIBOR less 5 basis points and resets on a monthly basis (Level 2).
Derivative assets and liabilities consolidated
Our derivative instruments include interest rate agreements and credit default swaps. Fair values of derivative instruments are determined using valuation models and are verified by valuations provided by dealers active in derivative markets. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, prepayment rates, and correlations of such inputs. Model inputs for interest rate agreements can generally be verified and model selection does not involve significant management judgment (these are Level 2 inputs). For other derivatives, valuations are based on various factors such as liquidity, bid/offer spreads, and credit considerations for which we rely on available market evidence. In the absence of such evidence, management’s best estimate is used (these are Level 3 inputs).
Cash and cash equivalents
Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less. Fair values equal carrying values.
Restricted cash
Restricted cash primarily includes interest-earning cash balances in ABS entities and the Fund for the purpose of distribution to bondholders or limited partners, and reinvestment. Due to the short-term nature of the restrictions, fair values approximate carrying values.
Accrued interest receivable and payable
Accrued interest receivable and payable includes interest due on our financial statementsassets and payable on our liabilities. Due to the short-term nature of when these interest payments will be received or paid, fair values approximate carrying values.
Short-term debt — Redwood
Short-term Redwood debt includes our credit facilities that mature within one year. Short-term Redwood debt is set to an adjustable rate. Fair values approximate carrying values (Level 1 and 2).
ABS issued
ABS issued includes asset-backed securities issued through our Sequoia and Acacia programs. These instruments are illiquid in nature and trade infrequently, if at all. Fair values are determined by discounted cash flow analyses and other valuation techniques using market pricing assumptions that are reported at fair value on a recurring basis as of March 31, 2008, and indicatesconfirmed by third party dealer/pricing indications, to the fair value hierarchy ofextent available. Significant inputs in the valuation techniques utilizedanalysis are predominantly Level 3, due to measure fair value.

Assetsthe nature of these instruments and Liabilities Measured at Fair Value on a Recurring Basis asthe lack of March 31, 2008

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

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

Net Interest Income on FVO Assets and Liabilities

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

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

The following table presents
indicators factored into the analyses include dealer price indications to the extent available, bid/ask spreads, external spreads, collateral credit losses, interest rates and collateral prepayment speeds. Estimated fair values are based on applying the market indicators to generate discounted cash flows.

Long-term debt — Redwood
Long-term Redwood debt includes our subordinated notes and trust preferred securities. Fair values are determined using comparable market indicators of current pricing. Significant inputs in the components of market valuation adjustments, net, recorded in our consolidated statements of (loss) income.

Market Valuation Adjustments, Net

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

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

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

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

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 6. Real Estate Loans

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

The following table summarizes the carrying value of the residential and commercial real estate loans, as reported on our consolidated balance sheets at March 31,June 30, 2008 and December 31, 2007.

Real Estate Loans

  
(In Thousands) March 31,
2008		 December 31,
2007
Residential real estate loans – held-for-sale $4,443  $4,533 
Residential real estate loans – held-for-investment  6,751,491   7,173,940 
Total residential real estate loans  6,755,934   7,178,473 
Commercial real estate loans – FVO  18,801   — 
Commercial real estate loans – held-for-investment  252   25,678 
Total Real Estate Loans $6,774,987  $7,204,151 
  
(In Thousands) June 30,
2008		 December 31,
2007
Residential real estate loans (held-for-sale) $3,695  $4,533 
Residential real estate loans (held-for-investment)  6,353,972   7,173,940 
Total residential real estate loans  6,357,667   7,178,473 
Commercial real estate loans (fair value)  18,800   — 
Commercial real estate loans (held-for-investment)  251   25,678 
Total Real Estate Loans $6,376,718  $7,204,151 

At March 31,June 30, 2008, we had $5 million (ofin outstanding principal)principal of residential loans in held-for-sale with a lower of cost or fair value of $4 million, (carrying value) as we are actively marketing these loans for sale.million. At December 31, 2007, there was $6 million (ofin outstanding principal)principal for these loans with a lower of cost or fair value of $5 million.

Real Estate Loans Held-for-Investment

The following table provides additional information on the real estate loans classified as held-for-investment as of March 31,June 30, 2008 and December 31, 2007.

   
June 30, 2008
(In Thousands)		 Residential
Real Estate
Loans		 Commercial
Real Estate
Loans		 Total
Current face $6,318,090  $11,102  $6,329,192 
Current premium (discount) – net, unamortized  68,479   (362)   68,117 
Discount designated as credit reserve  —   (8,141)   (8,141) 
Reserve for credit losses  (32,597)   (2,348)   (34,945) 
Carrying Value $6,353,972  $251  $6,354,223 

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 6. Real Estate Loans  — Held-for-Investment

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

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

Of the $6.7$6.3 billion of principal face and $79$68 million of unamortized premium on our residential real estate loans at March 31,June 30, 2008, $2.4$2.2 billion of principal face and $60$50 million of unamortized premium relates to residential loans acquired prior to July 1, 2004. For these residential loans, we usedetermine an effective yield using coupon interest rates as they change over

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 6. Real Estate Loans  – (continued)

time and anticipated principal payments to determine an effective yield to amortize the premium or discount.into income. During the first quarterhalf of 2008, 7%13% of these residential loans prepaid and we amortized 10%23% of the premium. Of the $7.1 billion of principal face and $86 million of unamortized premium on our residential real estate loans at December 31, 2007, $2.5 billion of principal face and $66 million of unamortized premium relates to residential loans acquired prior to July 1, 2004.

For residential loans acquired after July 1, 2004, the principal face and unamortized premium was $4.3$4.1 billion and $19$18 million at March 31,June 30, 2008, respectively, and $4.6 billion and $20 million at December 31, 2007, respectively. For these residential loans, we use the initial coupon interest rate of the loans (without regard to future changes in the underlying indices) and anticipated principal payments to calculate an effective yield to amortize the premium or discount.

Residential real estate During the first half of 2008, 10% of these residential loans are either sold to securitization entities sponsored by us under our Sequoia program which, in turn, issue ABS or are heldprepaid and financed with Redwood debt and equity.we amortized 11% of the premium.

On January 1, 2008, the commercial loans within Acacia were included inwe elected the fair value option elections ofunder FAS 159 for commercial real estate loans owned by Acacia entities, and are subsequently recordedaccordingly record these loans at their fair value.values. At June 30, 2008 we owned $26 million face of commercial loans that had a fair value of $19 million. Prior to 2008, these loans were recordedclassified as held-for-investment real estate loans.held-for-investment.

Commercial Real Estate Loans — FVO

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

The following table below presents information regarding real estate loans pledged and unpledged under our borrowing agreements at March 31,June 30, 2008 and December 31, 2007.

Real Estate Loans Pledged and Unpledged

        
 March 31, 2008 December 31, 2007 June 30, 2008 December 31, 2007
(In Thousands) Face Value Carrying
Value		 Face Value Carrying
Value		 Face
Value		 Carrying
Value		 Face
Value		 Carrying
Value
Unpledged $16,588  $4,695  $16,606  $4,785  $15,880  $3,946  $16,606  $4,785 
Owned by securitization entities, financed through the issuance of ABS  6,724,131   6,770,292   7,133,022   7,199,366 
Owned by securitization entities, financed through ABS issued  6,344,867   6,372,772   7,133,022   7,199,366 
Total $6,740,719  $6,774,987  $7,149,628  $7,204,151  $6,360,747  $6,376,718  $7,149,628  $7,204,151 

Unpledged real estate loans at March 31,June 30, 2008 consist of held-for-sale residential loans held-for-sale with a face value of $5 million and a carrying value of $4 million and two commercial loans held-for-investment with a face value of $11 million and a carrying value of $0.3$0.2 million.

Note 7. Reserves for Credit Losses

We establish reserves for credit losses on our real estate loans held-for-investment based on our estimate of losses inherent in our loan portfolio. At both June 30, 2008 and December 31, 2007, all residential loans

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 7. Reserves for Credit Losses  – (continued)

classified as held-for-investment were owned by Sequoia entities. At June 30, 2008, we had a reserve for credit losses of $33 million on these residential loans, an increase from the $18 million reserve at December 31, 2007.

The following table summarizes the activity in reserves for credit losses for our consolidated residential loans classified as held-for-investment for the three and six months ended June 30, 2008 and 2007.

Activity in Residential Real Estate Loan Reserves for Credit Losses

    
 Three Months Ended June 30, Six Months Ended June 30,
(In Thousands) 2008 2007 2008 2007
Balance at beginning of period $24,444  $19,954  $18,282  $20,119 
Provision for credit losses  10,061   2,500   18,119   3,981 
Charge-offs  (1,908)   (6,038)   (3,804)   (7,684) 
Balance at End of Period $32,597  $16,416  $32,597  $16,416 

Delinquencies in our consolidated residential real estate loan portfolio were $118 million and $68 million as of June 30, 2008 and December 31, 2007, respectively. Delinquencies include loans delinquent more than 90 days and in foreclosure. As a percentage of our current residential real estate loan balances, delinquencies were 1.87% and 0.96% at June 30, 2008 and December 31, 2007, respectively. As a percentage of the original balances, delinquencies were 0.42% and 0.24% at June 30, 2008 and December 31, 2007, respectively.

Our residential loan servicers advance payment on delinquent loans to the extent they deem them recoverable. We accrue interest on loans until they are more than 90 days past due or deemed uncollectible at which point they are placed on nonaccrual status. When we pursue foreclosure in full satisfaction for a defaulted loan, we estimate the specific loan loss, if any, based on estimated net proceeds from the sale of the property (including accrued but unpaid interest), and charge this specific estimated loss (or recovery) against the reserve for credit losses. During the first half of 2008, there were $4 million of charge-offs that reduced our reserve for credit losses. These charge-offs arose from $24 million of defaulted loan principal. Foreclosed property is subsequently recorded as REO, a component of other assets (SeeNote 11). Subsequent changes in value of REO are recorded through market valuation adjustments, net, in our consolidated statements of (loss) income.

The following table summarizes the activity in reserves for credit losses for our commercial real estate loans held-for-investment, for the three and six months ended June 30, 2008 and 2007.

Activity in Commercial Real Estate Loan Reserves for Credit Losses

    
 Three Months Ended June 30, Six Months Ended June 30,
(In Thousands) 2008 2007 2008 2007
Balance at beginning of period $2,348  $2,348  $2,348  $— 
Provision for credit losses  —   —   —   2,348 
Charge-offs  —   —   —   — 
Balance at End of Period $2,348  $2,348  $2,348  $2,348 

During the first quarter of 2007, we fully reserved for an anticipated loss on a mezzanine commercial loan, which was made to finance a condominium-conversion project. We do not expect to recover any outstanding principal upon completion of the conversion project and sale of the condominium units.

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REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

Note 7.8. Real Estate Securities

The real estate securities shown on our consolidated balance sheets includeWe invest in third party residential, commercial, and CDO securities. The following table presents our real estate securities acquired from securitizations sponsored by others.

Real Estate Securities at Redwoodcollateral type and Opportunity Fund

The table below presents the carrying value (which equals fair value as these are available-for-sale securities (AFS) or fair value option (FVO)) of our securities at Redwood and the Opportunity Fund that are included in our consolidated balance sheetsentity, as of March 31,June 30, 2008 and December 31, 2007, (but not owned by Acacia) by type of securities, and by credit rating of investment-grade (IGS) and below investment-grade (CES).2007.

Real Estate Securities at Redwood and Opportunity Fund

        
March 31, 2008
(In Thousands)		 AFS – Redwood AFS – Opportunity Fund Total AFS
Securities		 FVO – Redwood Total
Securities
 CES IGS CES IGS CES IGS
Residential securities:
                                        
Prime $77,806  $18,324  $—  $—  $96,130  $—  $1,850  $97,980 
Alt-a  9,113   —   —   457   9,570   —   5,280   14,850 
Subprime  937   —   —   8,643   9,580   341   396   10,317 
Total residential securities  87,856   18,324   —   9,100   115,280   341   7,526   123,147 
Commercial securities  99,523   —   —   —   99,523   —   —   99,523 
CDO securities  686   —   —   26,541   27,227   —   15,504   42,731 
Total Securities $188,065  $18,324  $—  $35,641  $242,030  $341  $23,030  $265,401 
    
June 30, 2008
(In Thousands)		 Redwood The Fund Acacia Total
Securities
Residential $247,579  $45,750  $596,366  $889,695 
Commercial  90,969   —   176,162   267,131 
CDO  14,763   19,989   49,974   84,726 
Other real estate investments  75   —   —   75 
Total Real Estate Securities $353,386  $65,739  $822,502  $1,241,627 

        
        
December 31, 2007
(In Thousands)		 AFS – Redwood AFS – Opportunity Fund Total AFS
Securities		 FVO – Redwood Total
Securities
 CES IGS CES IGS CES IGS
Residential securities:
                                        
Prime $127,612  $1,360  $—  $—  $128,972  $—  $  $128,972 
Alt-a  21,966   9,387   —   —   31,353   —   —   31,353 
Subprime  1,432   1,478   —   3,126   6,036   —   —   6,036 
Total residential securities  151,010   12,225   —   3,126   166,361   —   —   166,361 
Commercial securities  148,508   —   —   —   148,508   —   —   148,508 
CDO securities  2,372   18,450   —   12,075   32,897   —   —   32,897 
Total Securities $301,890  $30,675  $—  $15,201  $347,766  $—  $—  $347,766 
    
December 31, 2007
(In Thousands)		 Redwood The Fund Acacia Total
Securities
Residential $163,235  $3,126  $1,393,048  $1,559,409 
Commercial  148,508   —   278,003   426,511 
CDO  20,822   12,075   91,263   124,160 
Other real estate investments  11,521   —   —   11,521 
Total Real Estate Securities $344,086  $15,201  $1,762,314  $2,121,601 

The following table presents our trading and available-for-sale (AFS) real estate securities by collateral type and entity, as of June 30, 2008 and December 31, 2007.

      
June 30, 2008
(In Thousands)		 Redwood The Fund Acacia Total Securities
 Trading AFS AFS Trading Trading AFS
Residential IGS
                              
Prime $1,319  $100,664  $1,220  $169,564  $170,883  $101,884 
Non-prime  3,251   55,230   44,530   312,473   315,724   99,760 
Total Residential IGS  4,570   155,894   45,750   482,037   486,607   201,644 
Residential CES
 
Prime  —   79,304   —   61,760   61,760   79,304 
Non-prime  282   7,529   —   52,569   52,851   7,529 
Total Residential CES  282   86,833   —   114,329   114,611   86,833 
Commercial IGS  —   —   —   61,818   61,818   — 
Commercial CES  —   90,969   —   114,344   114,344   90,969 
CDO IGS  14,364   —   12,853   45,615   59,979   12,853 
CDO CES  75   324   7,136   4,359   4,434   7,460 
Other real estate investments  75   —   —   —   75   — 
Total Real Estate Securities $19,366  $334,020  $65,739  $822,502  $841,868  $399,759 

25

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

Note 7.8. Real Estate Securities  – (continued)

      
December 31, 2007
(In Thousands)		 Redwood The Fund Acacia Total Securities
 Trading AFS AFS AFS Trading AFS
Residential IGS
                              
Prime $—  $1,360  $—  $514,045  $—  $515,405 
Non-prime  —   10,865   3,126   628,068   —   642,059 
Total Residential IGS  —   12,225   3,126   1,142,113   —   1,157,464 
Residential CES
 
Prime  —   127,612   —   193,676   —   321,288 
Non-prime  —   23,398   —   57,259   —   80,657 
Total Residential CES  —   151,010   —   250,935   —   401,945 
Commercial IGS  —   —   —   89,676   —   89,676 
Commercial CES  —   148,508   —   188,327   —   336,835 
CDO IGS  —   18,450   12,075   83,094   —   113,619 
CDO CES  —   2,372   —   8,169   —   10,541 
Other real estate investments  11,521   —   —   —   11,521   — 
Total Real Estate Securities $11,521  $332,565  $15,201  $1,762,314  $11,521  $2,110,080 

We finance securities through a combination of Redwood debt and equity as well as investments in the Fund and Acacia entities that we consolidate. Of the total securities owned at Redwood as of June 30, 2008 and December 31, 2007, $9 million and $8 million, respectively, were pledged for short-term Redwood debt.

Trading securities are recorded at fair value with changes in fair value recorded in market valuation adjustments, net, in the consolidated statements of (loss) income. We currently account for Redwood IGS, securities owned by Acacia entities, and other real estate investments (OREI), as trading securities. Prior to the adoption of FAS 159, Redwood IGS and securities owned by Acacia were recorded at fair value in accordance with FAS 115.

AFS Securities

AFS securities are measured at fair value, with unrealized gains and losses recorded as a component of other comprehensive income (loss), net of deferred taxes, in stockholders’ equity (deficit). We currently account for most securities at Redwood and all securities at the Fund as AFS securities. Prior to the adoption of FAS 159 on January 1, 2008, all securities at Redwood and Acacia (except for OREI) were classified as AFS.

The following table below presents the components comprising the carrying value (which equals fair value) of available-for-sale IGS at Redwood and the Opportunity Fund reported on our consolidated balance sheets at March 31,AFS securities as of June 30, 2008 and December 31, 2007.

Investment-Grade

    
June 30, 2008
(In Thousands)		 Residential Commercial CDO Total
Current face $1,019,761  $517,615  $99,089  $1,636,465 
Current discount – designated credit reserve  (555,702)   (384,487)   (33,743)   (973,932) 
Current discount – net unamortized  (154,465)   (31,871)   (42,415)   (228,751) 
Amortized cost  309,594   101,257   22,931   433,782 
Gross unrealized gains  14,995   2,820   625   18,440 
Gross unrealized losses  (36,112)   (13,108)   (3,243)   (52,463) 
Carrying Value $288,477  $90,969  $20,313  $399,759 

26

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 8. Real Estate Securities  (AFS)– (continued)

    
December 31, 2007
(In Thousands)		 Residential Commercial CDO Total
Current face $3,553,064  $988,653  $393,010  $4,934,727 
Current discount – designated credit reserve  (723,489)   (318,456)   (100,617)   (1,142,562) 
Current discount – net unamortized  (886,118)   (98,509)   (156,305)   (1,140,932) 
Amortized cost  1,943,457   571,688   136,088   2,651,233 
Gross unrealized gains  14,074   4,965   822   19,861 
Gross unrealized losses  (398,122)   (150,142)   (12,750)   (561,014) 
Carrying Value $1,559,409  $426,511  $124,160  $2,110,080 

When we purchase a credit-sensitive AFS security at Redwood and Opportunity Fund

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

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

At March 31, 2008, the Opportunity Fund had $36 million IGS consisting of $9 million residential IGS with a significant discount to its face value, we often do not amortize into income a significant portion of $13 million and $27 million CDO IGS withthis discount that we are entitled to earn but do not expect to collect due to the inherent credit risk of the security. The portion of the total discount that we do not amortize into income is designated as a face value of $90 million. At December 31, 2007, the Opportunity Fund had $15 million IGS consisting of $3 million residential IGS with a face value of $4 million and $12 million CDO IGS with a face value of $49 million.

The amount of designated credit reserve equalson the security, with the remaining portion amortized into income over time using the interest method in accordance with EITF 99-20. Our estimate of required credit losses within the underlying loan pool on the CES that we expect to incur over the life of the securities. This estimatereserves is determined based upon various factors, affecting these assets, including economic conditions, characteristics of the underlying loans, delinquency status, past performance of similar loans,securities, external credit reservesenhancements or guarantees, and priority of cashflowscash flows and credit loss attribution within securitizations.the securitization from which our security interest participates. We use a variety of internal and external credit risk cash flow modeling and portfolio analytical tools to assist in our assessments. We review our assessments at least quarterly on each individual underlying loan pool and determine the appropriate level of credit reserve required for each security we own. The designated credit reserve is specific to each security.

26

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 7. Real Estate Securities  – (continued)

The following table presents the aggregate changes indetail investment activity affecting our amortizedgross purchase discount on AFS securities and the portionresulting net unamortized discount that we currently expect to recognize into income over the remaining lives of the discount designated as credit reserve on IGS for the three months ended March 31, 2008. We did not have any designated credit reserves on any securities in this portfolio prior to the third quarter of 2007.these securities.

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

    
Three Months Ended March 31, 2008
(In Thousands)		 Residential Commercial CDO Total
Beginning balance of unamortized discount, net $569,566  $2,814  $143,575  $715,955 
Reclassification due to FVO adoption  (568,283)   (2,814)   (112,750)   (683,847) 
Amortization of discount  (382)   —   (435)   (817) 
Discount on acquistions  21,114   —   13,569   34,683 
Ending Balance of Unamortized Discount, Net $22,015  $—  $43,959  $65,974 
Beginning balance of designated credit reserve $46,641  $—  $49,283  $95,924 
Reclassification due to FVO adoption  (46,641)   —   (49,283)   (95,924) 
Discount designated as credit reserve on acquistions  20   —   15,000   15,020 
Ending Balance of Designated Credit Reserve $20  $—  $15,000  $15,020 
      
 Residential Commercial CDO
Three Months Ended
June 30, 2008
(In Thousands)		 Designated
Credit Reserve		 Unamortized
Net Discount		 Designated
Credit Reserve		 Unamortized
Net Discount		 Designated
Credit Reserve		 Unamortized
Net Discount
Beginning balance –  March 31, 2008 $586,174  $83,714  $378,388  $36,955  $37,374  $47,472 
Amortization of net discount  —   (7,925)   —   2,123   —   (456) 
Realized credit losses  (60,507)   —   (5,502)   —   (4,150)   — 
Acquisitions  4,773   71,774   —   —   —   — 
Sales, calls, other  —   7,909   —   —   —   (4,402) 
Impairments  24,255   —   4,394   —   320   — 
Transfers/release of credit reserves  1,007   (1,007)   7,207   (7,207)   199   (199) 
Ending balance –  June 30, 2008 $555,702  $154,465  $384,487  $31,871  $33,743  $42,415 

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

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

Credit-Enhancement Securities AFS at Redwood

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

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

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

27

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

Note 7.8. Real Estate Securities  – (continued)

      
 Residential Commercial CDO
Six Months Ended
June 30, 2008
(In Thousands)		 Designated
Credit Reserve		 Unamortized
Net Discount		 Designated
Credit Reserve		 Unamortized
Net Discount		 Designated
Credit Reserve		 Unamortized
Net Discount
Beginning balance –  December 31, 2007 $723,489  $886,118  $318,456  $98,509  $100,617  $156,305 
Reclassification due to fair value option  (213,356)   (794,395)   —   (80,642)   (78,762)   (122,384) 
Beginning balance –  January 1, 2008  510,133   91,723   318,456   17,867   21,855   33,921 
Amortization of net discount  —   (19,877)   —   3,646   —   (891) 
Realized credit losses  (91,169)   —   (5,540)   —   (4,150)   — 
Acquisitions  28,030   93,723   —   —   15,000   13,569 
Sales, calls, other  —   7,866   —   —   —   (4,545) 
Impairments  89,738   —   81,929   —   1,399   — 
Transfers/release of credit reserves  18,970   (18,970)   (10,358)   10,358   (361)   361 
Ending balance –  June 30, 2008 $555,702  $154,465  $384,487  $31,871  $33,743  $42,415 

The loans underlying our residential CES totaled $145 billion at June 30, 2008, and consist of $107 billion prime and $38 billion non-prime. These loans are located nationwide with a large concentration in California (49%). During the first quarter of 2008, realized residential credit losses were $31 million of principal value, a rate that equals eight basis points (0.08%) on an annualized basis of the balance of the loans. Serious delinquencies (90+ days, in foreclosure or REO) at March 31,June 30, 2008 were 3.06%4.23% of current balanceprincipal balances and 1.46%1.93% of original balance.principal balances. For loans in prime pools, delinquencies were 1.27%1.01% of current balancebalances and 0.60%0.47% of original balance. Alt-abalances. Non-prime pools had delinquencies of 9.51%13.29% of current balancebalances and 4.49%5.94% of original balance. Subprime pools hadbalances.

The loans underlying our commercial CES totaled $49 billion at June 30, 2008, and consist primarily of office (39%), retail (28%), and multifamily (16%) fixed rate commercial loans. These loans are located nationwide. Serious delinquencies of 22.13%(90+ days, in foreclosure or REO) at June 30, 2008 were 0.79% of current balanceprincipal balances and 17.21%0.74% of original balance.principal balances.

When there areFor the three and six months ended June 30, 2008, we recognized other-than-temporary impairments the balanceon AFS securities of the unamortized discount, credit reserve, or a combination of both will increase by the amount of the impairment charge. In the table below, the amount of impairment is first added to the credit reserve$29 million and then the amount we believe is based on factors other than an adverse change in cash flow is moved into the unamortized discount balance.

The following table presents the aggregate changes$173 million, respectively, through market valuation adjustments, net, in our unamortized discount and the portionconsolidated statements of the discount designated as credit reserve for(loss) income. For the three and six months ended March 31, 2008June 30, 2007, we recognized other-than-temporary impairments of $22 million and 2007.$24 million, respectively.

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

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

28

TABLE OF CONTENTS

REDWOOD TRUST, INC. AND SUBSIDIARIES
  
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

Note 7.8. Real Estate Securities  – (continued)

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

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

Securities with an unrealized loss position areand not deemed to be other than temporarily impaired as there has been no adverse change in the underlying cash flows projected to be generated by a security, we have the intent and ability to hold the security, and we believe the impaired security will recover its value within a reasonable period of time.

The following table shows the gross unrealized losses, fair values, and length of time that any of our AFS real estate securities have been in a continuous unrealized loss position as of March 31,June 30, 2008, and December 31, 2007.

AFS Securities with Unrealized Losses

      
 Less Than 12
Consecutive Months		 12 Consecutive
Months or Longer
June 30, 2008
(In Thousands)		 Total
Amortized
Cost		 Gross
Unrealized
Losses		 Total
Fair
Value		 Total
Amortized
Cost		 Gross
Unrealized
Losses		 Total
Fair
Value
Residential $220,003  $(35,665)  $184,338  $1,661  $(447)  $1,214 
Commercial  75,430   (10,987)   64,443   5,111   (2,122)   2,989 
CDO  12,410   (3,242)   9,168   —   —   — 
Total Securities $307,843  $(49,894)  $257,949  $6,772  $(2,569)  $4,203 

      
 Less Than 12
Consecutive Months		 12 Consecutive
Months or Longer
December 31, 2007
(In Thousands)		 Total
Amortized
Cost		 Gross
Unrealized
Losses		 Total
Fair
Value		 Total
Amortized
Cost		 Gross
Unrealized
Losses		 Total
Fair
Value
Residential $930,965  $(303,546)  $627,419  $315,304  $(94,576)  $220,728 
Commercial  400,942   (112,769)   288,173   130,681   (37,373)   93,308 
CDO  42,113   (12,750)   29,363   —   —   — 
Total Securities $1,374,020  $(429,065)  $944,955  $445,985  $(131,949)  $314,036 

At March 31,June 30, 2008, of our total 539we owned 601 AFS securities, 224of which, 198 were in an unrealized losses positions,loss position and 6 of these have been8 were in a continuous unrealized loss position for twelve months or longer. At December 31, 2007, we owned 1,722 AFS securities, of our total 1,722 securities,which 855 were in an unrealized loss positions,position and 188 of these had beenwere in a continuous loss position for twelve months or longer. The number of AFS securities reported on our consolidated balance sheets declined as a result of the FVO electionour adoption of FAS 159 on January 1, 2008.

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 7. Real Estate Securities  – (continued)

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

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

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

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

Securities FVO at Redwood

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

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

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 7. Real Estate Securities  – (continued)

Real Estate Securities at Acacia

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

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

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

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

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

       
       
December 31, 2007
(In Thousands)		 Residential Commercial CDO Total
 CES IGS CES IGS CES IGS
Current face $747,424  $1,982,954  $352,779  $112,719  $47,282  $209,501  $3,452,659 
Unamortized discount, net  (226,112)   (565,575)   (77,828)   (2,814)   (9,634)   (77,124)   (959,087) 
Discount designated as credit reserve  (166,715)   (34,629)   —   —   (29,479)   (49,283)   (280,106) 
Amortized cost  354,597   1,382,750   274,951   109,905   8,169   83,094   2,213,466 
Gross unrealized gains  1,789   880   41   —   —   —   2,710 
Gross unrealized losses  (105,451)   (241,517)   (86,665)   (20,229)   —   —   (453,862) 
Carrying Value $250,935  $1,142,113  $188,327  $89,676  $8,169  $83,094  $1,762,314 

Gross Realized Gains and Losses

Gross unrealized gainsGains and losses represent the difference between the amortized costfrom AFS securities are recorded to realized gains (losses) on sales and the fair valuecalls, net, in our consolidated statements of individual securities sold.

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 7. Real Estate Securities  – (continued)

(loss) income. The following table below presents the gross realized gains and losses on securitiessales and the realized gains on calls onof AFS securities for the threesix months ended March 31,June 30, 2008 and 2007.

Gross Realized Gains and Losses on Real Estate Securities

  
 Three Months Ended
March 31,
(In Thousands) 2008 2007
Gross realized gains on sales of securities $—  $669 
Gross realized losses on sales of securities  —   (1,453) 
Gains on calls of securities  42   843 
Total Realized Gains on Sales and Calls of Securities $42  $59 

The table below presents information regarding our securities pledged under borrowing agreements and owned by securitization entities as of March 31, 2008 and December 31, 2007.

Securities Pledged and Unpledged

  
(In Thousands) March 31,
2008		 December 31,
2007
Unpledged $262,502  $338,942 
Pledged for Redwood debt  2,899   8,824 
Owned by Acacia securitization entities, financed through issuance of ABS  925,768   1,762,314 
Carrying Value $1,191,169  $2,110,080 
    
 Three Months Ended
June 30,		 Six Months Ended
June 30,
(In Thousands) 2008 2007 2008 2007
Gross realized gains – sales $1,831  $2,746  $1,831  $3,415 
Gross realized gains – calls  —   1,310   42   2,153 
Gross realized losses – sales  —   (1,284)   —   (2,737) 
Gross realized losses – calls  (43)   —   (43)   — 
Total realized gains on sales and calls, net $1,788  $2,772  $1,830  $2,831 

Note 8.9. Other Real Estate Investments

Other real estate investments (OREI) shown on our consolidated balance sheets at March 31, 2008 include IOs, NIMs, and residuals at Redwood only and, at December 31, 2007, all such investments owned by Redwood and Acacia. We have elected to classify OREI as trading instruments under GAAP. OREI are carried at fair value on our consolidated balance sheets and changes in fair value flow through market valuation adjustments, net on our consolidated statements of (loss) income. As part of our fair value option elections, on January 1, 2008 OREI at Acacia securitization entities were reclassified as FVO securities.

The table below presents the carrying value (which equals fair value as these are classified as trading instruments) of OREI as of March 31, 2008 and December 31, 2007.

Other Real Estate Investments — Trading Instruments

    
March 31, 2008
(In Thousands)		 Prime Alt-a Subprime Total
Residential
                    
IOs $—  $—  $—  $— 
NIMs  —   1,991   —   1,991 
Residuals  —   1,446   —   1,446 
Total Other Real Estate Investments $—  $3,437  $—  $3,437 

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 8. Other Real Estate Investments  – (continued)

    
December 31, 2007
(In Thousands)		 Prime Alt-a Subprime Total
Residential
                    
IOs $1,410  $202  $—  $1,612 
NIMs  —   5,826   1,310   7,136 
Residuals  —   2,527   246   2,773 
Total Other Real Estate Investments $1,410  $8,555  $1,556  $11,521 

The fair value of our OREI declined $3 million and $5 million for the three months ended March 31, 2008 and 2007, respectively. As of March 31, 2008, all our OREI were funded with equity. As of December 31, 2007, less than $1 million of OREI were owned by securitization entities and financed through the issuance of ABS and the remaining $11 million were funded with equity.

Note 9. Non-Real Estate Investments

Non-real estate investments representsincludes a $79 million guaranteed investment contract (GIC)GIC owned by an Acacia securitization entity that we consolidate for financial statements purposes. This GIC represents a deposit certificate issued by a rated investment bank. This GIC serves as the collateral to cover potential losses on a credit default swap (CDS)CDS also entered into by this same Acacia entity. The

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 9. Other Investments  – (continued)

CDS referencesreference BBB and A-rated residential mortgage-backed securities issued in 2006. In the event that any of these referenced securities incurs a credit loss, the GIC can then be drawn upon by the CDS counterparty to cover the amount of such loss. Since the acquisition of this asset, it has been drawn down by $1 million as the notional amount of the related CDS has been reduced. We have classified this investment as a trading instrument prior to 2008 and as FVO effective January 1, 2008. This investment is recorded on our consolidated balance sheets at its estimated fair value. Management currently considers the GIC’s fair value to approximate contract value, as the interest rate is variable at LIBOR less 5 basis points and resets on a monthly basis. The carrying and fair value was $79 million of this investment as of March 31,June 30, 2008. Changes in fair value are reported through our consolidated statements of (loss) income through market valuation adjustments.adjustments, net.

Note 10. Derivative Financial Instruments

We report our derivative financial instruments at fair value as determined using third-party models and confirmed by Wall Street dealers. This is regardless of the accounting treatment for the derivatives (trading instrument, FVO, or FAS 133).

broker/dealers that make markets in these instruments. As of March 31,June 30, 2008 and December 31, 2007, the net fair value of our derivative financial instruments was negative $130$95 million and negative $76 million, respectively.

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 10. Derivative Financial Instruments  – (continued)

The following table shows the aggregate fair value and notional amount of our derivative financial instruments as of March 31,June 30, 2008 and December 31, 2007.

        
 March 31, 2008 December 31, 2007 June 30, 2008 December 31, 2007
(In Thousands) Fair
Value		 Notional
Amount		 Fair
Value		 Notional
Amount		 Fair
Value		 Notional
Amount		 Fair
Value		 Notional
Amount
Trading Instruments
                                        
Interest rate caps purchased $3,128  $714,400  $3,788  $707,900  $4,246  $714,400  $3,788  $707,900 
Interest rate caps sold  (864)   250,000   (1,061)   250,000   (1,160)   250,000   (1,061)   250,000 
Interest rate corridors purchased  —   —   —   844,805   —   —   —   844,805 
Interest rate swaps  (60,011)   1,168,885   (1,553)   186,733   (23,278)   1,091,652   (1,553)   186,733 
Interest rate swaps designated as cash flow hedges  —   —   (19,564)   994,562 
Credit default swaps  (72,499)   78,584   (57,397)   78,771   (75,290)   78,487   (57,397)   78,771 
Cash Flow Hedges  —   — 
Interest rate swaps  —   —   (19,564)   994,562 
Total Derivative Financial Instruments $(130,246)  $2,211,869  $(75,787)  $3,062,771  $(95,482)  $2,134,539  $(75,787)  $3,062,771 

Of the negative $130$95 million value of derivative financial instruments at March 31,June 30, 2008, $4$5 million was recorded as derivative assets and $134$100 million was recorded as derivative liabilities on our consolidated balance sheet. Of the negative $76 million value of derivative financial instruments at December 31, 2007, $5 million was recorded as derivative assets and $81 million was recorded as derivative liabilities.liabilities on our consolidated balance sheet.

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. Currently, the majority of our interestInterest rate agreements are used to match the duration of liabilities to assets. Interest rate agreementsthat we use as part of our interest rate risk management strategy may include interest rate options, swaps, options on swaps, futures contracts, options on futures contracts, and options on forward purchases.

We currently account for our interest rate agreements as either cash flow hedges, trading instruments or as FVO derivatives.

The following table presents the interest income and expense of our interest rate agreements accounted for as cash flow hedges for the three months ended March 31, 2008 and 2007.

Impact on Net Interest Income (Expense) of our Interest Rate Agreements Accounted for as Cash Flow Hedges

  
 Three Months Ended
March 31,
(In Thousands) 2008 2007
Net interest income on cash flow interest rate agreements $—  $2,399 
Realized net losses due to net ineffective portion of hedges  —   (81) 
Realized net losses reclassified from other comprehensive (loss) income  (1,246)   (672) 
Total $(1,246)  $1,646 

We did not have any interest rate agreements designated as cash flow hedges during the three months ended March 31, 2008. During the three months ended March 31, 2007, interest rate agreements designated as cash flow hedges had net receipts of $2 million.

In a cash flow hedge, the effective portion of the change in the fair value of the hedging derivative is recorded in accumulated other comprehensive loss and is subsequently reclassified into earnings when the

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 10. Derivative Financial Instruments  – (continued)

hedging relationship is terminated. The ineffective portion of the cash flow hedge is recognized immediately in earnings. For the three months ended March 31, 2007 the amount of ineffectiveness was less than $1 million of income recorded against interest expense in our consolidated income statement. For the three months ended March 31, 2008 there were no interest rate agreements designated as cash flow hedges.

Interest rate agreements accounted for as cash flow hedges may be terminated prior to the completion of the forecasted transactions. In these cases, and when the forecasted transaction is still likely to occur, the net gain or loss on the interest rate agreements remains in accumulated other comprehensive loss and is reclassified from accumulated other comprehensive loss to our consolidated statements of (loss) income during the period the forecasted transaction occurs. For the three months ended March 31, 2008 we reclassified zero from other comprehensive loss and for the three months ended March 31, 2007, we reclassified less than negative $1 million.

When the interest rate agreement is accounted for as a trading instrument or elected for the fair value option (for those derivatives in Acacia securitization entities), changesaccordance with FAS 133. Changes in the fair value of the interest rate agreement and all associated income and expenses are reported in earningsour consolidated statements of (loss) income through net recognizedmarket valuation adjustments.adjustments, net. We had net valuation adjustments on interest rate agreements of positive $33 million and negative $5 million for the three and six months ended March 31,June 30, 2008, respectively, and 2007 of negative $38positive $1 million and less than negative $1positive $2 million respectively.

In the case when the hedge is terminated and the forecasted transaction is not expected to occur, we immediately recognize the gain or loss through gains on sales, net in our consolidated statements of (loss) income through recognized market valuation adjustments. Forfor the three and six months ended March 31,June 30, 2007, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008 there were no such instances. For
(Unaudited)

Note 10. Derivative Financial Instruments  – (continued)

We did not have any interest rate agreements designated as cash flow hedges during the three and six months ended March 31, 2007, there was one such instance which resulted in a gain of $1.1 million.

OurJune 30, 2008. For interest rate agreements previously designated as cash flow hedges, our total unrealized gain or loss on interest rate agreements included in accumulated other comprehensive loss at March 31, 2008income (loss) was negative $31$30 million at June 30, 2008 and was negative $33 million at December 31, 2007, was negative $33 million.2007.

The following table presents the interest income and expense of our interest rate agreements previously designated as cash flow hedges for the three months and six months ended June 30, 2008 and 2007.

Impact on Net Interest Income (Expense) of Our Interest Rate Agreements Accounted for as Cash Flow Hedges

    
 Three Months Ended June 30, Six Months Ended June 30,
(In Thousands) 2008 2007 2008 2007
Net interest income on cash flow interest rate agreements $—  $2,693  $—  $5,092 
Realized net income due to net ineffective portion of hedges  —   671   —   590 
Realized net losses reclassified from other
comprehensive (loss) income		  (1,246)   (6)   (2,492)   (678) 
Total $(1,246)  $3,358  $(2,492)  $5,004 

Credit Default Swaps (CDS)

A CDScredit 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. In the first quarter of 2007, we began entering into these agreements where we agreed to provide credit event protection in exchange for a premium. In essence, theseThese instruments enable us to credit-enhancesynthetically assume the credit risk of a specific poolreference security or index of loans. We included thesesecurities. All of our existing CDS in ourcontracts were initiated during 2007 by an Acacia CDO Option Arm 1 which closed in the second quarter of 2007.securitization entity that we have consolidated for financial reporting purposes.

Credit default swaps in the Acacia securitization entities are accounted for as FVO swaps as of January 1, 2008 and, were accounted for as trading instruments prior to 2008.instruments. These CDS are reported at fair value with the changes in fair value and any net receipts/payments recognized through market valuation adjustments, net on our income statement.consolidated statements of (loss) income. The valuevalues of these contracts decreasefluctuate for a variety of reasons, including whensuch as the probability of thelikelihood or occurrence of a specific credit event, increases, when the market’s perceptionsmarket perception of default risk in general change, or when there are changes in theand counterparty risk, and supply and demand of these instruments.changes. During the three and six months ended March 31,June 30, 2008, the fair value of these credit default swaps decreased $18$2 million primarilyand $20 million, respectively, as the result of widening spreads inhigher market premiums required for these types of instruments.

Counterparty Credit Risk

We incur credit risk to the extent that the counterparties to theour derivative financial instruments do not perform their obligations under thespecified contractual agreements. If one of the counterpartiesa derivative counterparty does not perform, we may not receive the cashproceeds to which we would otherwisemay be entitled under the agreement. In order tothese agreements. To mitigate this risk, we only enter into agreements that are either a) transacted on a national exchange or b) transacted with

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 10. Derivative Financial Instruments  – (continued)

counterparties that are either i) designated by the U.S. Department of Treasury as a primary government dealer, ii) affiliates of primary government dealers, or iii) rated BBBA or higher. Furthermore, we generally enter into agreementsWe also attempt to transact with several different counterparties in order to diversifyreduce our creditspecific counterparty exposure. We consider counterparty risk exposure. At March as part of our fair value assessments of all derivative financial instruments.

As of June 30, 2008, Redwood and its affiliates had twenty International Swaps and Derivatives Association (ISDA) agreements with eleven different bank counterparties. For open derivative positions at June 30, 2008, we were in compliance with the requirements of our ISDA counterparties. For ISDA

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 10. Derivative Financial Instruments  – (continued)

agreements with no open derivative positions, we were in breach of nine agreements due to a decline in our total reported net worth and are currently in process of amending those agreements. This had no impact to our financial statements.

Note 11. Other Assets

Other assets as of June 30, 2008 and December 31, 2007, we had $3 million credit exposure on interest rate agreements.are summarized in the following table.

Note 11. Reserves for Credit Losses

Other Assets

We establish reserves for credit losses on our real

  
(In Thousands) June 30,
2008		 December 31,
2007
Real estate owned (REO) $22,996  $15,118 
Fixed assets and leasehold improvements  4,924   5,666 
Principal receivable  1,910   2,819 
Other  1,080   1,630 
Total Other Assets $30,910  $25,233 

Real estate loans held-for-investment based on our estimateowned (REO) consists of losses inherent in our loan portfolio. At both March 31, 2008 and December 31, 2007, all held-for-investment loans wereforeclosed properties owned by Sequoia entities. For the three months ended March 31,entities that were recovered in full satisfaction of real estate loans. The number of single-family properties owned by Sequoia entities was 87 at June 30, 2008, we had a total credit loss provision of $8 million, an increase from the $1 million in provision for the three months ended March78 owned at December 31, 2007.

This 10% increase reflects the continued housing market downturn and inability of a growing number of borrowers to meet their repayment obligations. The following table summarizes the activity in reservesstates of Arizona, California, and Florida accounted for credit losses for our consolidated residential real estate loans held-for-investment for the three months ended March 31, 2008 and 2007.

Residential Real Estate Loan Reserves for Credit Losses

  
 Three Months Ended
March 31,
(In Thousands) 2008 2007
Balance at beginning of period $18,282  $20,119 
Provision for credit losses  8,058   1,481 
Charge-offs  (1,896)   (1,646) 
Balance at End of Period $24,444  $19,954 

Delinquencies in our consolidated residential real estate loan portfolio were $84 million and $68 million as of March 31, 2008 and December 31, 2007, respectively. Delinquencies include loans delinquent more than 90 days and in foreclosure. As a percentage31% of our current residential real estate loan balances, delinquencies stoodREO balance at 1.25% and 0.96% at March 31, 2008 and December 31, 2007, respectively. As a percentageJune 30, 2008. The Midwest region accounted for an additional 25% of the original balances, delinquencies stood at 0.30% and 0.24% at March 31, 2008 and December 31, 2007, respectively.this total.

Our residential loan servicers advance payment on delinquent loans to the extent they deem them recoverable. We accrue interest on loans until they are more than 90 days past due or deemed uncollectible, at which point they are placed on nonaccrual status. When a loan becomes REO, we estimate the specific loss, based on estimated net proceeds from the sale of the property (including accrued but unpaid interest), and charge this specific estimated loss against the reserve for credit losses. Subsequent changes in value are then recorded through market valuation adjustments, net in our consolidated income statements. The carrying value of REO as of March 31,June 30, 2008 was $16$23 million, of which $7$20 million related to transfers into REO in the first quarterhalf of 2008, offset by $10 million of REO liquidations during the first half of 2008 and $6$2 million were REO liquidations reducing the balance.of negative valuation changes. The carrying value of REO as of December 31, 2007 was $15 million, of which $14 million related to transfers into REO in 2007 and $1 million from transfers in 2006. The transfers

Note 12. Short-term Debt — Redwood

We typically enter into master repurchase agreements (MRA), bank borrowings, and other forms of collateralized (and generally uncommitted) borrowings with various commercial banks and investment banks. We also issued commercial paper (CP) for financing residential real estate loans prior to 2008. We refer to these borrowings as short-term Redwood debt. We report short-term Redwood debt at its unpaid principal balance. Borrowings under short-term Redwood debt facilities generally bear interest rates of a specified margin over one-month LIBOR. They are uncommitted and mature within one year.

We are generally placing less reliance on short-term Redwood debt facilities and greater reliance on other types of recourse debt such as long-term Redwood debt (SeeNote 14). We closed our Madrona (CP) facility in December 2007 and have allowed other facilities to expire. We believe we could increase our borrowings on existing short-term facilities if necessary and we continue to explore alternative financing arrangements that we might pursue in the first quarterfuture.

As of June 30, 2008, werewe had 38 MRA’s in place with 15 different counterparties. We also had two facilities open to finance the acquisition of real estate loans. These facilities had a combined borrowing limit of $1 billion and mature in October 2008. We also had one $10 million unsecured line of credit that matures each month. At June 30, 2008, our only use of short-term Redwood debt was to finance $9 million of principal on which we recorded a loan loss expense of $2 million.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

Note 11. Reserves for Credit Losses12. Short-term Debt — Redwood  – (continued)

securities under an existing MRA that matures every 35 days. At December 31, 2007, our only use of short-term Redwood debt was to finance $8 million of securities under an existing MRA that matured monthly.

The following table summarizes the activity in reserves for credit losses for our commercial real estate loans held-for-investment for the three months ended March 31, 2008short-term Redwood debt outstanding by weighted average interest rates and 2007.

Commercial Real Estate Loan Reserves for Credit Losses

  
 Three Months Ended
March 31,
(In Thousands) 2008 2007
Balance at beginning of period $2,348  $— 
Provision for (reversal of) credit losses  —   2,348 
Charge-offs  —   — 
Balance at End of Period $2,348  $2,348 

During the first quarter of 2007, we fully reserved for an anticipated loss on a junior mezzanine commercial loan financing a condominium-conversion project in the amount of $2 million. The reserve for credit losses on commercial loans relates to that loan.

Note 12. Other Assets

Other assetsby collateral type as of March 31,June 30, 2008 and December 31, 2007 are summarized in the following table.2007.

Other AssetsShort-term Debt — Redwood

  
(In Thousands) March 31,
2008		 December 31,
2007
Real estate owned (REO) $16,371  $15,118 
Fixed assets and leasehold improvements  5,256   5,666 
Principal receivable  1,838   2,819 
Other  1,529   1,630 
Total Other Assets $24,994  $25,233 

Note 13. Redwood Debt

We enter into repurchase agreements, bank borrowings, and other forms of collateralized (and generally uncommitted) borrowings with several banks and major investment banking firms. We also issued commercial paper for financing residential and real estate loans during 2007. We refer to these borrowings as Redwood debt. We report Redwood debt at its unpaid principal balance. We also have other types of recourse debt such as subordinated notes (SeeNote 15).

      
 June 30, 2008 December 31, 2007
(In Thousands) Amount
Borrowed		 Weighted
Average
Interest
Rate		 Weighted
Average
Days Until
Maturity		 Amount
Borrowed		 Weighted
Average
Interest
Rate		 Weighted
Average
Days Until
Maturity
Securities collateral $9,326   2.82%   35  $7,561   5.25%   22 
Total short-term Redwood debt $9,326   2.82%   35  $7,561   5.25%   22 

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 13. Redwood Debt  – (continued)

The table below summarizes the outstanding balances of Redwood debt as of March 31, 2008 and December 31, 2007 by collateral type.

Redwood Debt

    
 March 31, 2008
(In Thousands) Number of
Facilities		 Outstanding Limit Maturity
Facilities by collateral
                    
Real estate loans  1  $—  $1,000,000   10/08 
Real estate securities  1   2,086   2,086   — 
Unsecured line of credit  1   —   10,000   5/08 
Total Facilities  3  $2,086  $1,012,086    

    
 December 31, 2007
(In Thousands) Number of
Facilities		 Outstanding Limit Maturity
Facilities by collateral
                    
Real estate loans  1  $—  $1,000,000   10/08 
Real estate securities  1   7,561   7,561   — 
Unsecured line of credit  1   —   10,000   1/08 
Total Facilities  3  $7,561  $1,017,561    

Borrowings under these facilities generally bear interest based on a specified margin over the one-month LIBOR interest rate. They are uncommitted and mature within a year. For the three and six months ended March 31,June 30, 2008, the average balance of short-term Redwood debt was $21$5 million and $13 million, respectively, with a weighted-average interest cost of 3.39%.5.55% and 3.79%, respectively. For the three and six months ended December 31,June 30, 2007 the average balance of short-term Redwood debt was $27 million,$1.5 billion and $1.9 billion, respectively, with a weighted-average interest cost of 5.63%.5.99% and 5.82%, respectively. At March 31,June 30, 2008 and December 31, 2007, accrued interest payable on short-term Redwood debt was $1,400$16,000 and $12,000, respectively.

Due to the decline in mortgage market economic conditions that began in 2007, we determined that we did not need the same level of available Redwood debt facilities as we had at the beginning of that year. Therefore, we did not renew the majority of our facilities as they expired and we closed our Madrona facility in December 2007. In addition, in this current economic climate, we are only showing the limit equal to existing borrowings on facilities for which we do not have a documented commitment. We believe, however, we could increase our borrowings on these facilities to the extent we had appropriate collateral.

The table below summarizes Redwood debt by weighted average interest rates and by collateral type in Redwood debt at March 31, 2008 and December 31, 2007.

Redwood Debt

      
 March 31, 2008 December 31, 2007
(In Thousands) Amount
Borrowed		 Weighted
Average
Interest
Rate		 Weighted
Average
Days Until
Maturity		 Amount
Borrowed		 Weighted
Average
Interest
Rate		 Weighted
Average
Days Until
Maturity
Real estate loan collateral $—   —   —  $—   —   — 
Securities collateral  2,086   2.94 %   24   7,561   5.25 %   22 
Total Redwood Debt $2,086   2.94 %   24  $7,561   5.25 %   22 

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 13. Redwood Debt  – (continued)

All short-term Redwood debt as of March 31,June 30, 2008 and December 31, 2007, matured within 3035 days of the period end.financial reporting date.

As of March 31, 2008 for activeThe borrowing agreements we were in breach on one of our International Swaps and Derivatives Association (ISDA) agreement covenants with a counterparty due to a decline in total reported net worth. We have subsequently received a waiver from this counterparty. We were also in breach on five other ISDAs due to the net worth covenants. There was no impact to our financial statements for these events.

We continue to be inunder short-term Redwood debt facilities require compliance with our othervarious financial and organizational covenants on our borrowing arrangements and credit facilities.an ongoing basis. These covenants generallytypically relate to our tangible net worth, liquidity reserves, and leverage requirements. Whilefinancial leverage. Although we generally do not anticipate having any problems in meeting mostcomply with all of our covenants, on these arrangements, the decline and future volatility in our reported net worth has required usresulted in breaches and subsequent renegotiations of certain borrowing agreements. As of June 30, 2008, we were in compliance with the covenants under borrowing agreements for all drawn facilities. Of the undrawn facilities, we were in breach with one counterparty due to renegotiate covenants and temporarily reduce the number of counterparties with whom we transact business. It isa decline in our intention to renew facilities, including amend thetangible net worth covenants as needed, as well as pursue additional facilitie s and other types of financing including committed facilities.have requested a waiver from this counterparty. This had no impact on our financial statements.

Note 14.13. Asset-Backed Securities Issued

The Sequoia and Acacia securitization entities sponsored by usthat we sponsor issue ABS issued to raise the funds to acquire assets from us and others.from third parties. Each series of ABS issued consists of various classes that pay interest at variable or fixed rates.rates on a monthly or quarterly basis. Substantially all of the variable-rate ABS issued pay variable rates of interest, which are indexed to one, three, or six-month LIBOR, with interest paid monthly or quarterly. A lesser amount of theLIBOR. Some ABS issued ispay fixed for a term and then adjustsrates of interest or pay hybrid rates, which are fixed rates that subsequently adjust to a LIBOR rate (hybrid ABS issued) or is fixed for its entire term. Some of thevariable rates. ABS issued are IOs and havealso include some interest-only classes with coupons set at a fixed-rate or a fixed spread, while others earnor set at a coupon basedspread to the interest rates paid on the spread between collateral owned by and the ABS issued byassets of a securitization entity.

The maturity of each class of ABS issued is directly affected by the rate of principal prepayments on the assets of the issuing entity. Each series is also subject to redemption (call) according to the specific terms of the respective governing documents. As a result, the actual maturity of an ABS is likely toissued will often occur earlier than its stated maturity.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

Note 14.13. Asset-Backed Securities Issued  – (continued)

The carrying value components of the collateral for ABS issued and outstanding as of March 31,June 30, 2008 and December 31, 2007, are summarized in the table below.following table.

Collateral for Asset-Backed Securities Issued

            
 March 31, 2008 December 31, 2007 June 30, 2008 December 31, 2007
(In Thousands) Sequoia Acacia Total Sequoia Acacia Total Sequoia Acacia Total Sequoia Acacia Total
Real estate loans $6,751,491  $18,801  $6,770,292  $7,173,940  $25,426  $7,199,366  $6,353,972  $18,800  $6,372,772  $7,173,940  $25,426  $7,199,366 
Real estate securities  —   925,768   925,768   —   1,762,314   1,762,314   —   906,692   906,692   —   1,762,607   1,762,607 
Other real estate investments  —   —   —   —   293   293 
Non-real estate investments  —   78,770   78,770   —   79,125   79,125 
Other investments  —   78,583   78,583   —   79,125   79,125 
Real estate owned (REO)  15,184   —   15,184   13,744   —   13,744   21,778   —   21,778   13,744   —   13,744 
Restricted cash  315   137,758   138,073   337   112,793   113,130   313   71,616   71,929   337   112,793   113,130 
Accrued interest receivable  32,284   7,232   39,516   37,907   9,928   47,835   26,662   8,486   35,148   37,907   9,928   47,835 
Total Collateral for ABS Issued $6,799,274  $1,168,329  $7,967,603  $7,225,928  $1,989,879  $9,215,807  $6,402,725  $1,084,177  $7,486,902  $7,225,928  $1,989,879  $9,215,807 

The components of ABS issued by consolidated securitization entities as of March 31,June 30, 2008 and December 31, 2007, along with other selected information, are summarized in the table below.following table.

Asset-Backed Securities Issued

  
(In Thousands) March 31, 2008 December 31, 2007
Sequoia ABS issued – certificates with principal value $6,511,149  $6,904,937 
Sequoia ABS issued – interest-only certificates  29,516   35,220 
Unamortized premium on Sequoia ABS  3,826   6,009 
Total Sequoia ABS issued  6,544,491   6,946,166 
Acacia ABS issued  3,339,583   3,403,748 
Unamortized discount on Acacia ABS  —   (20,635) 
Market value discount on Acacia ABS  (2,293,423)   — 
Total Acacia ABS issued  1,046,160   3,383,113 
Total Consolidated ABS Issued $7,590,651  $10,329,279 
Sequoia ABS:
          
Range of weighted average interest rates, by series  2.64% to 5.90%   4.42% to 6.14% 
Stated maturities  2010 – 2047   2008 – 2047 
Number of series  38   39 
Acacia ABS:
          
Range of weighted average interest rates, by series  3.29% to 5.43%   5.40% to 6.06% 
Stated maturities  2039 – 2052   2039 – 2052 
Number of series  10   10 
      
 June 30, 2008 December 31, 2007
(In Thousands) Sequoia Acacia Total Sequoia Acacia Total
ABS issued – certificates with principal value $6,146,332  $3,231,253  $9,377,585  $6,904,937  $3,403,748  $10,308,685 
ABS issued – interest-only certificates  26,367   —   26,367   35,220   —   35,220 
Unamortized premium  1,872   —   1,872   6,009   —   6,009 
Unamortized discount  —   —   —   —   (20,635)   (20,635) 
Market value discount  —   (2,296,181)   (2,296,181)   —   —   — 
Total ABS Issued $6,174,571  $935,072  $7,109,643  $6,946,166  $3,383,113  $10,329,279 
Range of weighted average interest rates, by series  2.64% to 5.89%   3.18% to 3.55%        4.42% to 6.14%   5.40% to 6.06%      
Stated maturities  2024 – 2047   2039 – 2052        2010 – 2047   2039 – 2052      
Number of series  38   10        39   10      

As of June 30, 2008, all of the total $7.1 billion reported value of ABS issued had contractual maturities of over five years.

On January 1, 2008, we elected to account for the ABS issued in Acacia under the FVO and so these are recorded at fair value at March 31, 2008.under FAS 159. Prior to this election, Acacia ABS issued was reportedwere carried at cost.their unpaid principal balances, net of any unamortized discount or premium, and Acacia ABS deferred issuance costs were amortized as an adjustment to interest expense. Amortization of Sequoia deferred ABS issuance costs were $2 million and $4 million for the three and six months ended June 30, 2008. Amortization of Sequoia and Acacia deferred ABS issuance costs were $6 million and $13 million for the three and six months ended June 30, 2007.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

Note 14.13. Asset-Backed Securities Issued  – (continued)

As of March 31, 2008 of the total of $7.6 billion reported value of ABS issued, zero contractually matures within 1 year, $95 million matures within 1 to 3 years, $224 million matures within 3 to 5 years, and $7.3 billion matures in over 5 years.

Amortization of deferred asset-backed securities issuance costs were $2 million and $7 million for the three months ended March 31, 2008 and 2007, respectively.

The following table summarizes the accrued interest payable on ABS issued as of March 31,June 30, 2008 and December 31, 2007. Interest due on Sequoia ABS is settled monthly and interest due on Acacia ABS is settled quarterly.

Accrued Interest Payable on Asset-Backed Securities Issued

    
(In Thousands) March 31,
2008		 December 31,
2007		 June 30,
2008		 December 31,
2007
Sequoia $16,847  $19,648  $15,139  $19,648 
Acacia  25,612   32,237   15,751   32,237 
Total Accrued Interest Payable on ABS Issued $42,459  $51,885  $30,890  $51,885 

Note 15. Subordinated Notes14. Long-term Debt — Redwood

In 2006, we issued $100 million of subordinated notes (trust preferred securities) through Redwood Capital Trust I, a wholly-owned Delaware statutory trust, in a private placement transaction. These trust preferred securitiessubordinated notes require quarterly distributions at a floating coupon rate equal to three-month LIBOR plus 2.25% until the notes are redeemed in whole, which will be no later than January 30, 2037. The earliest optional redemption date without a penalty is January 30, 2012.

In May 2007, we issued an additional $50 million of subordinated notes, which require quarterly distributions at a floating interest rate equal to three-month LIBOR plus 2.25% until the notes are redeemed in whole, which will be no later than July 30, 2037. The earliest optional redemption date without a penalty is July 30, 2012.

At March 31,June 30, 2008 and December 31, 2007, the accrued interest payable balance on subordinated noteslong-term Redwood debt was $1 million and $2 million, respectively.

Note 16. Taxes15. Commitments and Contingencies

We have electedAs of June 30, 2008, we were obligated under non-cancelable operating leases with expiration dates through 2018 for $15 million. The majority of the future lease obligations relates to be taxed as a REIT under the Internal Revenue Codeten-year operating lease for our executive offices that expires in 2013 and the corresponding provisions of state law. In order to qualify as a REIT, we must distribute at least 90% of our annual REIT taxable income (this does not include taxable income retained in our taxable subsidiaries) to stockholders within the time frame set forth in the tax rules and we must meet certain other requirements. We may retain up to 10% of our REIT ordinary taxable income and pay corporate income taxes on this retained income while continuing to maintain our REIT status, and have done so in recent years. It is our intention to distribute all net capital gains. However, we did not have any net capital gains in 2007 and do not expect any in 2008. We are also subject to income taxes on taxable income earnedlease for additional space at our taxable subsidiaries.

Weexecutive offices that expires in 2018. The total payments required under these leases are recognized total tax provisionsas office rent expense on a straight-line basis over the lease terms. Operating lease expense was $0.5 million and $0.9 million for both the three and six months ended March 31,June 30, 2008, respectively, and $0.3 million and $0.6 million for the three and six months ended June 30, 2007, respectively.

Leasehold improvements for our executive offices are amortized into expense over the ten-year lease term, expiring in 2013. The unamortized leasehold improvement balance at both June 30, 2008 and December 31, 2007 of $2was $3 million.

Our tax provision is determinedThe following table presents our future lease commitments as of June 30, 2008.

Future Lease Commitments by applying our expected annual effective tax rate to our GAAP pre-tax income (loss). The effective tax rate is determined as the ratio of tax liability to an estimate of GAAP pre-tax income (loss). This annual GAAP estimate is based on annualized actual GAAP results to date. The estimate of the annual effective tax rate used by annualizing year-to-date results may not be reflective of actual GAAP earnings for the year. However, we believe this is an appropriate estimate for applying the effective tax rate to GAAP income that is volatile due to mark-to-market valuations. Differences in taxable income from GAAPYear

 
(In Thousands) June 30,
2008
2008 (six months) $904 
2009  1,688 
2010  1,709 
2011  1,831 
2012  1,882 
2013 and thereafter  6,692 
Total $14,706 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

Note 16. Taxes15. Commitments and Contingencies  – (continued)

(loss) income reflect various accounting treatmentsAt June 30, 2008, to our knowledge there were no legal proceedings to which we were a party or to which any of our properties was subject.

Stock Repurchases

We announced a stock repurchase plan in November 2007 for taxthe repurchase of up to a total of 5,000,000 common shares. This plan replaced all previous share repurchase plans and GAAP suchhas no expiration date. There were no repurchases during the first half of 2008 and, as of June 30, 2008, there remained 5,000,000 shares available for repurchase under this plan.

Note 16. Minority Interest

Minority interest represents the accounting for discount and premium amortization, credit losses, equity awards, asset impairments, andaggregate limited partnership (LP) interests in the Fund held by third parties. As of June 30, 2008, the minority interest was $47 million, representing a 48% third party interest in the Fund. Income allocated to the minority interest is based on the third party LP’s ownership percentage. The ownership percentage is determined by dividing the numbers of units held by third party LP’s by the total units outstanding. Subsequent changes in market valuations on certain assets, hedges,our ownership percentage will be treated as capital transactions and liabilities. Some of these differences create timing differences as to when the taxable income is earnedresult in a reallocation between shareholders' equity and the tax is paid and when the GAAP (loss) income is recognized and the GAAP tax provision is recorded. Some of the differences are permanent as the income (or expense) may be recorded for tax and not for GAAP (or vice-versa). One such significant permanent difference is, as a REIT, we are able to deduct for tax purposes the dividends paid to shareholders.

The following is a reconciliation of the statutory federal and state rates to the effective rates, as estimated for the three months ended March 31, 2008 and 2007.

Reconciliation of Statutory Tax Rate to Effective Tax Rate

  
 Three Months Ended,
March 31,
   2008 2007
Federal statutory rate  35.0 %   35.0% 
State statutory rate, net of Federal tax effect  7.0%   7.0% 
Differences in taxable income from GAAP income  (68.9)%   11.7% 
Dividend paid deduction  25.8%   (44.8)% 
Effective Tax Rate  (1.1)%   8.9% 

Our taxable income before dividend distributions has been higher than our GAAP net (loss) income primarily due to the accounting for credit losses and the market valuation write-downs taken on our assets for GAAP but not for tax. In 2007 and thus far in 2008, mark-to-market adjustments for GAAP were significant and we reported a GAAP net loss while reporting positive taxable income. As a result, the impact on the effective tax rate of the dividends paid deduction appears to be an increaseminority interest in the effective tax rate.

Our policy for interest and penalties on material uncertain tax positions recognized in our consolidated financial statements is to classify these as interest expense and operating expense, respectively. However, in accordance with Financial Accounting Standard Board Interpretation Number 48,Accounting for Uncertainty in Income Taxes, (FIN 48) we assessed our tax positions for all open tax years (Federal, years 2004 to 2007 and state, years 2003 to 2007) as of March 31, 2008 and December 31, 2007 and concluded that we have no material FIN 48 liabilities to be recognized at this time.balance sheets.

Note 17. Stockholders’ Equity

The following table provides the basic and diluted (loss) earnings per share computations for the three and six months ended June 30, 2008 and 2007.

Basic and Diluted (Loss) Earnings per Share

    
 Three Months Ended June 30, Six Months Ended June 30,
   2008 2007 2008 2007
Denominators:
                    
Denominator for basic (loss) earnings per share is equal to the weighted average number of common shares outstanding during the period  32,871,442   27,405,284   32,691,444   27,132,001 
Adjustments for diluted (loss) earnings per share are:
                    
Net effect of dilutive stock options  —   759,660   —   785,501 
Denominator for diluted (loss) earnings per share  32,871,442   28,164,944   32,691,444   27,917,502 
Basic (Loss) Earnings per Share: $(1.40)  $0.42  $(6.65)  $1.10 
Diluted (Loss) Earnings per Share: $(1.40)  $0.41  $(6.65)  $1.06 

Pursuant to EITF 03-6, we determined that there was no allocation of income for our outstanding stock options as they were antidilutive, as defined by this principle, for the three and six months ended June 30, 2008 and 2007. For the three months ended June 30, 2008 and 2007, the number of outstanding stock options that were antidilutive totaled 1,230,021 and 449,105, respectively. For the six months ended June 30, 2008 and 2007, the number of outstanding equity awards that were antidilutive totaled 1,351,533 and 252,109, respectively. There were no other participating securities, as defined by EITF 03-6, during the three and six months ended June 30, 2008 and 2007.

Accumulated Other Comprehensive LossIncome (Loss)

Accumulated other comprehensive loss includes the difference between the fair value and amortized cost for real estate securities accounted for as AFS, in accordance with FAS 115, and any net gains or losses from interest rate agreements previously accounted for as cash flow hedges.hedges under FAS 133 that have been terminated or de-designated during prior reporting periods.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 17. Stockholders’ Equity  – (continued)

The following table provides a summary of the components of accumulated other comprehensive loss as of June 30, 2008 and December 31, 2007.

  
(In Thousands) June 30,
2008		 December 31,
2007
Net unrealized losses on real estate securities $(34,023)  $(541,153) 
Net unrealized losses on interest rate agreements accounted for as cash flow hedges  (30,120)   (32,613) 
Total Accumulated Other Comprehensive Loss $(64,143)  $(573,766) 

At March 31,June 30, 2008, the net unrealized loss on AFS securities was $62$34 million, as compared to a net unrealized loss of $541 million at December 31, 2007. As part of theUpon our adoption of FAS 159 for(for all securities in Acacia and IGS at Redwood as ofRedwood) on January 1, 2008, net unrealized losses of $459 million were reclassified from accumulated other comprehensive loss to retained earnings. Subsequent toDuring the adoptionsecond quarter of FAS 159, values of AFS securities declined further. However,2008, we recognized $29 million other-than-temporary impairments on securities at March 31, 2008, and as a result$4 million of fair value declines in AFS with unrealized losses that were not deemed to be other-than-temporary (SeeNote 8), which decreased accumulated other comprehensive loss decreased by $21 million during the quarter.

Also included in accumulated other comprehensive loss are any net gains or losses from interest rate agreements previously accounted for as cash flow hedges that have been terminated or de designated as cash flow hedges and where the hedge transactions are still likely to occur. SeeNote 10 for details on interest rate

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 17. Stockholders’ Equity  – (continued)

agreements. With the adoption of FAS 159 onOn January 1, 2008, the interest rate agreements in the Acacia securitization entities were de-designated as cash flow hedges with a fair value at that timeupon our adoption of negative $33FAS 159. At June 30, 2008, these agreements had an unrealized loss of $30 million, which remained in accumulated other comprehensive loss. This balance will be amortizedexpensed through our consolidated statements of (loss) income over the remaining lives of designated Acacia ABS.ABS (SeeNote 10). During the first quarter ofthree and six months ended June 30, 2008, we amortized $1 million and $2 million, respectively, into interest expense.

The following table provides a summary of the components of accumulated other comprehensive loss as of March 31, 2008 and December 31, 2007.

Accumulated Other Comprehensive Loss

  
(In Thousands) March 31,
2008		 December 31,
2007
Net unrealized (losses) on real estate securities $(61,924)  $(541,153) 
Net unrealized (losses) on interest rate agreements accounted for as cash flow hedges  (31,367)   (32,613) 
Total Accumulated Other Comprehensive Loss $(93,291)  $(573,766) 

Note 18. Equity Compensation Plans

Stock-Based Compensation

At January 1, 2006, upon our adoption of FAS 123R, we had $19 million of unamortized costs related to unvested equity awards (stock options, restricted stock, and deferred stock units). Most of these awards have vested and thesethe related costs expensed.have been expensed through the operating expenses line on the consolidated statements of (loss) income. Since then, additional awards have been granted and, at March 31,June 30, 2008, the unamortized costs totaled $16$13 million. These costsThis amount will be expensed over the next six years, of which over half of which will be recognizedexpensed over the next twelve months.

Incentive PlanFuture Lease Commitments by Year

In March 2006, we amended the previously amended 2002 Redwood Trust, Inc. Incentive Stock Plan (Incentive Plan) for executive officers, employees, and non-employee directors. This amendment was approved by our shareholders in May 2006. The Incentive Plan authorizes our board of directors (or a committee appointed by our board of directors) to grant incentive stock options as defined under Section 422 of the Code (ISOs), options not so qualified (NQSOs), deferred stock units, restricted stock, performance shares, stock appreciation rights, limited stock appreciation rights (awards), and DERs to eligible recipients other than non-employee directors. ISOs and NQSOs awarded to employees and directors have a maximum term of ten years. Stock options, deferred stock units, and restricted stock granted to employees generally vest over a four-year period. Non-employee directors are automatically provided annual awards under the Incentive Plan that generally vest immediately. The Incentive Plan has been designed to permit the compensation committee of our board of directors to grant and certify awards that qualify as performance-based and otherwise satisfy the requirements of Section 162(m) of the Code. As of March 31, 2008 and December 31, 2007, 237,358 and 493,646 shares of common stock, respectively, were available for grant. On March 5, 2008 the board of directors approved, subject to shareholders’ approval, an increase of 1.5 million shares in the number of authorized shares available for grant.

 
(In Thousands) June 30,
2008
2008 (six months) $904 
2009  1,688 
2010  1,709 
2011  1,831 
2012  1,882 
2013 and thereafter  6,692 
Total $14,706 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

Note 18. Equity Compensation Plans15. Commitments and Contingencies  – (continued)

A summaryAt June 30, 2008, to our knowledge there were no legal proceedings to which we were a party or to which any of our properties was subject.

Stock Repurchases

We announced a stock option activityrepurchase plan in November 2007 for the repurchase of up to a total of 5,000,000 common shares. This plan replaced all previous share repurchase plans and has no expiration date. There were no repurchases during the first half of 2008 and, as of June 30, 2008, there remained 5,000,000 shares available for repurchase under this plan.

Note 16. Minority Interest

Minority interest represents the aggregate limited partnership (LP) interests in the Fund held by third parties. As of June 30, 2008, the minority interest was $47 million, representing a 48% third party interest in the Fund. Income allocated to the minority interest is based on the third party LP’s ownership percentage. The ownership percentage is determined by dividing the numbers of units held by third party LP’s by the total units outstanding. Subsequent changes in our ownership percentage will be treated as capital transactions and result in a reallocation between shareholders' equity and minority interest in the consolidated balance sheets.

Note 17. Stockholders’ Equity

The following table provides the basic and diluted (loss) earnings per share computations for the three and six months ended March 31,June 30, 2008 and 2007 is presented in the table below. SeeNote 32007.

Basic and Diluted (Loss) Earnings per Share

    
 Three Months Ended June 30, Six Months Ended June 30,
   2008 2007 2008 2007
Denominators:
                    
Denominator for basic (loss) earnings per share is equal to the weighted average number of common shares outstanding during the period  32,871,442   27,405,284   32,691,444   27,132,001 
Adjustments for diluted (loss) earnings per share are:
                    
Net effect of dilutive stock options  —   759,660   —   785,501 
Denominator for diluted (loss) earnings per share  32,871,442   28,164,944   32,691,444   27,917,502 
Basic (Loss) Earnings per Share: $(1.40)  $0.42  $(6.65)  $1.10 
Diluted (Loss) Earnings per Share: $(1.40)  $0.41  $(6.65)  $1.06 

Pursuant to EITF 03-6, we determined that there was no allocation of income for a discussion on the assumptions used to valueour outstanding stock options at grant date.

Stock Options Activity

    
 Three Months Ended March 31,
   2008 2007
   Shares Weighted
Average
Exercise Price		 Shares Weighted
Average
Exercise Price
Stock Options Outstanding
                    
Options outstanding at beginning of period  833,215  $37.60   1,072,622  $34.70 
Options granted  —   —   15,715   55.76 
Options exercised  (27,599)   19.55   (54,176)   32.24 
Options forfeited  (33,262)   55.34   (1,699)   56.11 
Options expired  —   —   —   — 
Stock dividend equivalent rights earned  —   —   —   — 
Options Outstanding at Period-End  772,354  $37.48   1,032,462  $35.11 
Options exercisable at period-end  749,050  $36.84   925,679  $32.76 
Weighted average fair market value of options granted during the period      $—       $4.29 

as they were antidilutive, as defined by this principle, for the three and six months ended June 30, 2008 and 2007. For the three months ended March 31,June 30, 2008 and 2007, expenses related tothe number of outstanding stock options that were $0.2 millionantidilutive totaled 1,230,021 and $0.6 million,449,105, respectively. As of March 31, 2008, there was less than $1 million of unrecognized compensation cost related to unvested stock options. These costs will be expensed over a weighted-average period of less than one year.

The total intrinsic value or gain (fair value less exercise price) for options exercised was less than $1 million and $1 million forFor the threesix months ended March 31,June 30, 2008 and 2007, the number of outstanding equity awards that were antidilutive totaled 1,351,533 and 252,109, respectively. The net cash proceeds received from the exercise of stock options was less than $1 million for bothThere were no other participating securities, as defined by EITF 03-6, during the three and six months ended March 31,June 30, 2008 and 2007.

Accumulated Other Comprehensive Income (Loss)

The aggregate intrinsicAccumulated other comprehensive loss includes the difference between the fair value of the options outstanding and exercisable was $7 million at both March 31, 2008amortized cost for real estate securities accounted for as AFS, in accordance with FAS 115, and December 31, 2007.

In the first quarter of 2008, officers did not exercise any options. In the first quarter of 2007, officers exercised 23,487 options and surrendered 15,715 shares to pay exercise costs and taxes totaling $1 million within the guidelines of the Incentive Plan. Thenet gains on these option exercises totaled $1 million.or losses from interest rate agreements previously accounted for as cash flow hedges under FAS 133 that have been terminated or de-designated during prior reporting periods.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31,June 30, 2008
(Unaudited)

Note 18.17. Stockholders’ Equity Compensation Plans  – (continued)

The following table summarizes information about stock options outstanding at March 31, 2008.

Stock Options Exercise Prices as of March 31, 2008

     
 Options Outstanding Options Exercisable
Range of
Exercise Prices		 Number
Outstanding		 Weighted-Average
Remaining
Contractual Life		 Weighted-Average
Exercise Price		 Number
Exercisable		 Weighted-Average
Exercise Price
$10 to $20  290,600   1.42  $12.93   290,600  $12.93 
$20 to $30  29,293   2.57   24.18   29,293   24.18 
$30 to $40  2,500   5.11   36.19   2,500   36.19 
$40 to $50  49,271   4.46   43.35   49,271   43.35 
$50 to $60  400,690   5.57   55.53   377,386   55.38 
$ 0 to $60  772,354   3.82   37.48   749,050   36.84 

Restricted Stock

As of March 31, 2008 and December 31, 2007, 33,710 and 17,646 shares, respectively, of restricted stock were outstanding. Restrictions on these shares lapse through January 2012.

Restricted stock activity for the three months ended March 31, 2008 and 2007 is presented in the table below. There were 28,656 and no restricted stock awards granted during the three months ended March 31, 2008 and 2007, respectively. We generally grant restricted stock annually as part of compensation. However the 2007 annual grants were awarded in the first quarter of 2008.

Restricted Stock Outstanding

    
 Three Months
Ended
March 31, 2008
Shares		 Weighted
Average Grant
Date Fair
Market Value		 Three Months
Ended
March 31, 2007
Shares		 Weighted
Average Grant
Date Fair
Market Value
Restricted stock outstanding at the beginning of period  17,646  $50.15   27,524  $49.57 
Restricted stock granted  28,656   31.93   —   — 
Stock for which restrictions lapsed  (4,731)   49.49   (4,308)   46.88 
Restricted stock forfeited  (7,861)   38.66   (92)   56.18 
Restricted Stock Outstanding at End of Period  33,710  $37.43   23,124  $50.05 

The cost of these grants is amortized over the vesting term using an accelerated method in accordance with FASB Interpretation No. 28Accounting for Stock Appreciation Rights and Other Variable Stock Options or Award Plans (FIN 28) and FAS 123R.

For the three months ended March 31, 2008 and 2007, the expenses related to restricted stock were less than $1 million. As of March 31, 2008, there was less than $1 million of unrecognized compensation cost related to unvested restricted stock. This cost will be recognized over a weighted average period of one year.

Deferred Stock Units

Deferred stock units (DSUs) are granted or purchased by participants in the Executive Deferred Compensation Plan. Some of the DSUs awarded may have a vesting period associated with them and restrictions on these outstanding DSUs lapse through 2013.

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 18. Equity Compensation Plans  – (continued)

For the three months ended March 31, 2008 and 2007, expenses related to DSUs were $3 million and $4 million, respectively. As of March 31, 2008, there was $15 million of unrecognized compensation cost related to nonvested DSUs. This cost will be recognized over a weighted-average period of one year. As of March 31, 2008 and December 31, 2007, the number of outstanding DSUs that had vested was 370,828 and 301,406, respectively.

The table below provides a summary relating to the value of DSUs as of March 31, 2008 and December 31, 2007.

Deferred Stock Units

  
(In Thousands) March 31,
2008		 December 31,
2007
Value of DSUs at grant $47,166  $38,587 
Participant forfeitures  (1,366)   (1,311) 
Distribution of DSUs  (2,715)   (2,715) 
Change in value at period end since grant  (7,566)   (10,256) 
Value of DSUs at End of Period $35,519  $24,305 

The following table provides a summary of DSU activity forthe components of accumulated other comprehensive loss as of June 30, 2008 and December 31, 2007.

  
(In Thousands) June 30,
2008		 December 31,
2007
Net unrealized losses on real estate securities $(34,023)  $(541,153) 
Net unrealized losses on interest rate agreements accounted for as cash flow hedges  (30,120)   (32,613) 
Total Accumulated Other Comprehensive Loss $(64,143)  $(573,766) 

At June 30, 2008, the net unrealized loss on AFS securities was $34 million, as compared to a net unrealized loss of $541 million at December 31, 2007. Upon our adoption of FAS 159 (for all securities in Acacia and IGS at Redwood) on January 1, 2008, net unrealized losses of $459 million were reclassified from accumulated other comprehensive loss to retained earnings. During the second quarter of 2008, we recognized $29 million other-than-temporary impairments on securities and $4 million of fair value declines in AFS with unrealized losses that were not deemed to be other-than-temporary (SeeNote 8), which decreased accumulated other comprehensive loss during the quarter.

On January 1, 2008, the interest rate agreements in Acacia entities were de-designated as cash flow hedges upon our adoption of FAS 159. At June 30, 2008, these agreements had an unrealized loss of $30 million, which will be expensed through our consolidated statements of (loss) income over the remaining lives of designated Acacia ABS (SeeNote 10). During the three and six months ended March 31,June 30, 2008, we amortized $1 million and 2007.$2 million, respectively, into interest expense.

Deferred Stock Units Activity

      
 Three Months Ended March 31,
   2008 2007
(In Thousands, Except
Unit Amounts)		 Units Fair Market
Value		 Weighted
Average
Grant Date
Fair Market
Value		 Units Fair Market
Value		 Weighted
Average
Grant Date
Fair Market
Value
Balance at beginning of period  709,848  $24,305  $48.69   737,740  $42,848  $48.91 
Grants of DSUs  268,327   8,577   31.97   13,431   784   58.35 
Distribution of DSUs  —   —   —   (43,751)   (2,100)   47.99 
Change in valuation during period  —   2,691   —   —   (4,623)   — 
Participant forfeitures  (1,031)   (54)   52.38   (4,150)   (212)   51.20 
Net change in number/value of DSUs  267,296   11,214   —   (34,470)   (6,151)   — 
Balance at End of Period  977,144  $35,519  $36.35   703,270  $36,697  $49.60 

We generally grant DSUs annually as part of compensation in the fourth quarter. However, the 2007 annual grants were awarded in the first quarter of 2008.

Executive Deferred Compensation Plan

In May 2002, our board of directors approved the 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

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NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 18. Equity Compensation Plans  – (continued)

Stock-Based Compensation

RedwoodAt January 1, 2006, upon our adoption of FAS 123R, we had $19 million of unamortized costs related to unvested equity awards (stock options, restricted stock, and subject todeferred stock units). Most of these awards have vested and the claims ofrelated costs have been expensed through the general creditors of Redwood. The EDCP allows for the investment of deferrals in either an interest crediting account or additional DSUs. The rate of accrual in the interest crediting account is set forth in the EDCP. The accrual rate is based on 120% of the long-term applicable federal rate (AFR). Participants may also use their deferrals to acquire additional DSUs. Information on DSUs is provided above.

For the three months ended March 31, 2008 and 2007, deferrals were made to the cash accounts of the EDCP of $2 million and $1 million, respectively.

The following table provides detail on changes in participants’ EDCP cash accounts for the three months ended March 31, 2008 and 2007.

EDCP Cash Accounts Activity

  
 Three Months Ended
March 31,
(In Thousands) 2008 2007
Transfer into participants’ EDCP accounts $2,299  $1,088 
Accrued interest earned in EDCP  140   391 
Participants’ withdrawals  (52)   (793) 
Net Change in Participants’ EDCP Accounts $2,387  $686 
Balance at beginning of period $9,071  $9,693 
Balance at end of period $11,458  $10,379 

The following table provides detailoperating expenses line on the financial positionconsolidated statements of the EDCP at March 31, 2008 and December 31, 2007.

Balance of Participants’ EDCP Cash Accounts

  
(In Thousands) March 31,
2008		 December 31,
2007
Participants’ deferrals $8,388  $6,141 
Accrued interest credited  3,070   2,930 
Balance of Participants’ EDCP Accounts $11,458  $9,071 

Employee Stock Purchase Plan

In May 2002, our stockholders approved the 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 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 of that year.

The ESPP allows a maximum of 100,000 shares of common stock to be purchased in aggregate for all employees. As of March 31, 2008 and December 31, 2007, 52,730 and 48,302 shares(loss) income. Since then, additional awards have been purchased, respectively,granted and, there remained a negligibleat June 30, 2008, the unamortized costs totaled $13 million. This amount of uninvested employee contributions in the ESPP.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 18. Equity Compensation Plans  – (continued)

The table below presents the activity in the ESPP for the three months ended March 31, 2008 and 2007.

Employee Stock Purchase Plan

  
 Three Months Ended
March 31,
(In Thousands) 2008 2007
Balance at beginning of period $—  $3 
Transfer in of participants’ payroll deductions from the ESPP  129   124 
Cost of common stock issued to participants under the terms of the ESPP  (129)   (118) 
Net change in participants’ equity $—  $6 
Balance at End of Period $—  $9 

Note 19. Operating Expenses

Components of our operating expenses for the three months ended March 31, 2008 and 2007 are presented in the table below.

Operating Expenses

  
 Three Months Ended
March 31,
(In Thousands) 2008 2007
Fixed compensation expense $5,674  $4,616 
Variable compensation expense  1,857   2,251 
Equity compensation expense  3,306   3,349 
Severance expense  —   2,380 
Total compensation expense  10,837   12,596 
Systems  2,133   1,656 
Due diligence  10   707 
Office costs  1,522   1,180 
Accounting and legal  1,101   855 
Other operating expenses  765   808 
Total Operating Expenses $16,368  $17,802 

Note 20. Commitments and Contingencies

As of March 31, 2008, we were obligated under non-cancelable operating leases with expiration dates through 2018 for $15 million. The majority of the future lease payments relate to a ten-year operating lease for our executive offices, which expires in 2013, and a lease for additional office space at our executive offices beginning January 1, 2008 and expiring May 31, 2018. The total lease payments towill be made under the lease expiring in 2013, including certain free-rent periods, are recognized as office rent expense on straight-line basisexpensed over the lease term. Operating lease expense was less than $1 million for both the three months ended March 31, 2008 and 2007. Leasehold improvements for our executive offices are amortized into expensenext six years, of which over half will be expensed over the ten-year lease term. The unamortized leasehold improvement balance at both March 31, 2008 and December 31, 2007 was $3 million.next twelve months.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
March 31, 2008
(Unaudited)

Note 20. Commitments and Contingencies  – (continued)

Future Lease Commitments by Year

  
(In Thousands) March 31,
2008		 June 30,
2008
2008 (nine months) $1,292 
2008 (six months) $904 
2009  1,688   1,688 
2010  1,709   1,709 
2011  1,831   1,831 
2012  1,882   1,882 
2013 and thereafter  6,692   6,692 
Total $15,094  $14,706 

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 15. Commitments and Contingencies  – (continued)

At March 31,June 30, 2008, to our knowledge there were no legal proceedings to which we were a party or to which any of our properties was subject.

Stock Repurchases

We announced a new stock repurchase plan in November 2007 for the repurchase of up to a total of 5,000,000 common shares. This plan replaced all previous share repurchase plans and has no expiration date. There were no repurchases during the first quarterhalf of 2008 and, as of March 31,June 30, 2008, there remained 5,000,000 shares available for repurchase under this plan.

Note 16. Minority Interest

Minority interest represents the aggregate limited partnership (LP) interests in the Fund held by third parties. As of June 30, 2008, the minority interest was $47 million, representing a 48% third party interest in the Fund. Income allocated to the minority interest is based on the third party LP’s ownership percentage. The ownership percentage is determined by dividing the numbers of units held by third party LP’s by the total units outstanding. Subsequent changes in our ownership percentage will be treated as capital transactions and result in a reallocation between shareholders' equity and minority interest in the consolidated balance sheets.

Note 17. Stockholders’ Equity

The following table provides the basic and diluted (loss) earnings per share computations for the three and six months ended June 30, 2008 and 2007.

Basic and Diluted (Loss) Earnings per Share

    
 Three Months Ended June 30, Six Months Ended June 30,
   2008 2007 2008 2007
Denominators:
                    
Denominator for basic (loss) earnings per share is equal to the weighted average number of common shares outstanding during the period  32,871,442   27,405,284   32,691,444   27,132,001 
Adjustments for diluted (loss) earnings per share are:
                    
Net effect of dilutive stock options  —   759,660   —   785,501 
Denominator for diluted (loss) earnings per share  32,871,442   28,164,944   32,691,444   27,917,502 
Basic (Loss) Earnings per Share: $(1.40)  $0.42  $(6.65)  $1.10 
Diluted (Loss) Earnings per Share: $(1.40)  $0.41  $(6.65)  $1.06 

Pursuant to EITF 03-6, we determined that there was no allocation of income for our outstanding stock options as they were antidilutive, as defined by this principle, for the three and six months ended June 30, 2008 and 2007. For the three months ended June 30, 2008 and 2007, the number of outstanding stock options that were antidilutive totaled 1,230,021 and 449,105, respectively. For the six months ended June 30, 2008 and 2007, the number of outstanding equity awards that were antidilutive totaled 1,351,533 and 252,109, respectively. There were no other participating securities, as defined by EITF 03-6, during the three and six months ended June 30, 2008 and 2007.

Accumulated Other Comprehensive Income (Loss)

Accumulated other comprehensive loss includes the difference between the fair value and amortized cost for real estate securities accounted for as AFS, in accordance with FAS 115, and any net gains or losses from interest rate agreements previously accounted for as cash flow hedges under FAS 133 that have been terminated or de-designated during prior reporting periods.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 17. Stockholders’ Equity  – (continued)

The following table provides a summary of the components of accumulated other comprehensive loss as of June 30, 2008 and December 31, 2007.

  
(In Thousands) June 30,
2008		 December 31,
2007
Net unrealized losses on real estate securities $(34,023)  $(541,153) 
Net unrealized losses on interest rate agreements accounted for as cash flow hedges  (30,120)   (32,613) 
Total Accumulated Other Comprehensive Loss $(64,143)  $(573,766) 

At June 30, 2008, the net unrealized loss on AFS securities was $34 million, as compared to a net unrealized loss of $541 million at December 31, 2007. Upon our adoption of FAS 159 (for all securities in Acacia and IGS at Redwood) on January 1, 2008, net unrealized losses of $459 million were reclassified from accumulated other comprehensive loss to retained earnings. During the second quarter of 2008, we recognized $29 million other-than-temporary impairments on securities and $4 million of fair value declines in AFS with unrealized losses that were not deemed to be other-than-temporary (SeeNote 8), which decreased accumulated other comprehensive loss during the quarter.

On January 1, 2008, the interest rate agreements in Acacia entities were de-designated as cash flow hedges upon our adoption of FAS 159. At June 30, 2008, these agreements had an unrealized loss of $30 million, which will be expensed through our consolidated statements of (loss) income over the remaining lives of designated Acacia ABS (SeeNote 10). During the three and six months ended June 30, 2008, we amortized $1 million and $2 million, respectively, into interest expense.

Note 18. Equity Compensation Plans

Stock-Based Compensation

At January 1, 2006, upon our adoption of FAS 123R, we had $19 million of unamortized costs related to unvested equity awards (stock options, restricted stock, and deferred stock units). Most of these awards have vested and the related costs have been expensed through the operating expenses line on the consolidated statements of (loss) income. Since then, additional awards have been granted and, at June 30, 2008, the unamortized costs totaled $13 million. This amount will be expensed over the next six years, of which over half will be expensed over the next twelve months.

Incentive Plan

In March 2008, we amended the previously amended 2002 Redwood Trust, Inc. Incentive Stock 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) as defined under Section 422 of the Code, non-qualifying stock options (NQSOs), deferred stock units, restricted stock, performance shares, stock appreciation rights, limited stock appreciation rights (awards), and dividend equivalent rights (DERs) to eligible recipients other than non-employee directors. ISOs and NQSOs awarded to employees and directors have a maximum term of ten years. Stock options, deferred stock units, and restricted stock granted to employees generally vest over a four-year period. Non-employee directors are automatically provided annual awards under the Incentive Plan that generally vest immediately. The Incentive Plan has been designed to permit the compensation committee of our Board of Directors to grant and certify awards that qualify as performance-based and otherwise satisfy the requirements of Section 162(m) of the Code. The amendment also increased the number of shares available for distribution through the Incentive Plan. As of June 30, 2008 and December 31, 2007, 1,670,328 and 493,646 shares of common stock, respectively, were available for grant.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 18. Equity Compensation Plans  – (continued)

A summary of stock option activity during the three and six months ended June 30, 2008 and 2007 is presented in the following table.

Stock Options Activity

        
        
 Three Months Ended June 30, Six Months Ended June 30,
   2008 2007 2008 2007
   Shares Weighted
Average
Exercise Price		 Shares Weighted
Average
Exercise Price		 Shares Weighted
Average
Exercise Price		 Shares Weighted
Average
Exercise Price
Stock Options Outstanding
                                        
Options outstanding at beginning of period  772,354  $37.48   1,032,462  $35.11   833,215  $37.60   1,072,622  $34.70 
Options granted  —   —   219   53.50   —   —   15,934   55.73 
Options exercised  (16,213)   34.34   (9,996)   34.09   (43,812)   32.34   (64,172)   32.52 
Options forfeited  (7,818)   55.04   (14,836)   56.73   (41,080)   55.29   (16,535)   56.66 
Options expired  —   —   —   —   —   —   —   — 
Options Outstanding at Period-End  748,323  $37.67   1,007,849  $34.81   748,323  $37.67   1,007,849  $34.81 
Options exercisable at period-end  732,671  $37.23   920,904  $32.83   732,671  $37.23   920,904  $32.83 
Weighted average fair market value of options granted during the period      $—       $4.93       $—       $4.30 

For the three and six months ended June 30, 2008, expenses related to stock options were $0.2 million and $0.4 million, respectively. For the three and six months ended June 30, 2007, expenses related to stock options were $0.5 million and $1.1 million, respectively. As of June 30, 2008, there was less than $1 million of unrecognized compensation cost related to unvested stock options. These costs will be expensed over a weighted-average period of less than one year.

The total intrinsic value or gain (fair market value less exercise price) for options exercised was $0.2 million and $0.5 million for the three and six months ended June 30, 2008, respectively. The total gain for options exercised was $0.2 million and $1.4 million for the three and six months ended June 30, 2007, respectively.

The net cash proceeds received from the exercise of stock options was $0.3 million and $0.9 million for the three and six months ended June 30, 2008, respectively. The net cash proceeds received from the exercise of stock options was $0.2 million and $1.2 million for the three and six months ended June 30, 2007, respectively.

In the first half of 2008, officers exercised 7,750 options and surrendered 6,050 shares to pay exercise costs and taxes totaling $0.2 million, within the guidelines of the Incentive Plan. The gains on these option exercises totaled $0.1 million. In the first half of 2007, officers exercised 23,487 options and surrendered 15,715 shares to pay exercise costs and taxes totaling $1 million, within the guidelines of the Incentive Plan.

The aggregate intrinsic value of the options outstanding and options currently exercisable was $3 million and $7 million at June 30, 2008 and December 31, 2007, respectively.

Restricted Stock

As of June 30, 2008 and December 31, 2007, 32,757 and 17,646 shares, respectively, of restricted stock were outstanding. Restrictions on these shares lapse through July 2012. There were 1,500 and 30,156 restricted stock awards granted during the three and six months ended June 30, 2008, respectively. There were

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 18. Equity Compensation Plans  – (continued)

no restricted stock awards granted during the first six months of 2007. We generally grant restricted stock annually as part of total compensation at the end of the year. However, the 2007 annual grants were awarded in the first quarter of 2008. The cost of these grants is amortized over the vesting term using an accelerated method in accordance with FASB Interpretation No. 28Accounting for Stock Appreciation Rights and Other Variable Stock Options or Award Plans (FIN 28) and FAS 123R.

For the three and six months ended June 30, 2008 the expenses related to restricted stock were $0.1 million and $0.3 million, respectively. For the three and six months ended June 30, 2007 the expenses related to restricted stock were $0.1 million and $0.2 million, respectively. As of June 30, 2008, there was less than $1 million of unrecognized compensation cost related to unvested restricted stock. This cost will be recognized over a weighted average period of one year.

Deferred Stock Units

Deferred stock units (DSUs) are granted or purchased by participants in the Executive Deferred Compensation Plan. Some of the DSUs awarded may have a vesting period associated with them and restrictions on these DSUs lapse through 2013.

For the three and six months ended June 30, 2008, expenses related to DSUs were $3 million and $6 million, respectively. For the three and six months ended June 30, 2007, expenses related to DSUs were $3 million and $7 million, respectively. As of June 30, 2008, there was $12 million of unrecognized compensation cost related to nonvested DSUs. This cost will be recognized over a weighted-average period of one year. As of June 30, 2008 and December 31, 2007, the number of outstanding DSUs that had vested was 413,817 and 301,406, respectively.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 18. Equity Compensation Plans  – (continued)

The following table provides a summary of DSU activity for the three and six months ended June 30, 2008 and 2007.

Deferred Stock Units Activity

      
 Three Months Ended June 30,
   2008 2007
(In Thousands,
Except Unit Amounts)		 Units Fair
Market Value		 Weighted
Average
Grant Date
Fair Market
Value		 Units Fair
Market Value		 Weighted
Average
Grant Date
Fair Market
Value
Balance at beginning of period  977,144  $35,519  $36.35   703,270  $36,697  $49.60 
Grants of DSUs  80,536   2,653   32.94   11,202   562   50.19 
Distribution of DSUs  (7,198)   (412)   57.17   (3,531)   (107)   30.27 
Change in valuation during period  —   (13,643)   —   —   (2,757)   — 
Participant forfeitures  (7,941)   (361)   45.43   —   —   — 
Net change in number/value of DSUs  65,397   (11,763)   —   7,671   (2,302)   — 
Balance at End of Period  1,042,541  $23,756  $22.79   710,941  $34,395  $49.24 

      
 Six Months Ended June 30,
   2008 2007
(In Thousands,
Except Unit Amounts)		 Units Fair
Market Value		 Weighted
Average
Grant Date
Fair Market
Value		 Units Fair
Market Value		 Weighted
Average
Grant Date
Fair Market
Value
Balance at beginning of period  709,848  $24,305  $48.69   737,740  $42,848  $48.91 
Grants of DSUs  348,863   11,231   32.19   24,633   1,343   54.54 
Distribution of DSUs  (7,198)   (412)   57.17   (47,282)   (2,207)   46.67 
Change in valuation during period  —   (10,953)   —   —   (7,377)   — 
Participant forfeitures  (8,972)   (415)   46.23   (4,150)   (212)   51.20 
Net change in number/value of DSUs  332,693   (549)   —   (26,799)   (8,453)   — 
Balance at End of Period  1,042,541  $23,756  $22.79   710,941  $34,395  $49.24 

We generally grant DSUs annually as part of compensation in the fourth quarter. However, the 2007 annual grants were awarded in the first quarter of 2008.

Executive Deferred Compensation Plan

In May 2002, our Board of Directors approved the 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 additional DSUs. The rate of accrual in the interest

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 18. Equity Compensation Plans  – (continued)

crediting account is set forth in the EDCP. The accrual rate is based on 120% of the long-term applicable federal rate (AFR). Participants may also use their deferrals to acquire additional DSUs. Information on DSUs is provided above.

For the three months and six months ended June 30, 2008, deferrals made to EDCP totaled of $0.1 million and $2.4 million, respectively. For both the three and six months ended June 30, 2008, distributions from the EDCP were $4.4 million. For the three and six months ended June 30, 2007, distributions from the EDCP were $2.6 million and $3.4 million, respectively. The balance in the EDCP account was $7 million and $9 million at June 30, 2008 and December 31, 2007, respectively. For the three and six months ended June 30, 2007, deferrals of $0.3 million and $1.3 million, respectively, were made under the EDCP.

Employee Stock Purchase Plan

In May 2002, our stockholders approved the 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 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 of that year.

The ESPP allows a maximum of 100,000 shares of common stock to be purchased in aggregate for all employees. As of June 30, 2008 and December 31, 2007, 58,272 and 48,302 shares have been purchased, respectively, and there remained a negligible amount of uninvested employee contributions in the ESPP.

Note 19. Operating Expenses

Components of our operating expenses for the three and six months ended June 30, 2008 and 2007 are presented in the following table.

Operating Expenses

    
 Three Months Ended
June 30,		 Six Months Ended
June 30,
(In Thousands) 2008 2007 2008 2007
Fixed compensation expense $4,648  $4,286  $10,322  $8,902 
Variable compensation expense  330   198   2,187   2,449 
Equity compensation expense  3,502   3,540   6,808   6,888 
Severance expense  —   —   —   2,380 
Total compensation expense  8,480   8,024   19,317   20,619 
Systems  2,492   2,163   4,625   3,819 
Due diligence  8   78   18   785 
Office costs  1,629   1,265   3,151   2,445 
Accounting and legal  1,495   284   2,596   1,139 
Other operating expenses  151   958   897   1,747 
Total Operating Expenses $14,255  $12,772  $30,604  $30,554 

Note 20. Taxes

We have elected to be taxed as a REIT under the Internal Revenue Code and the corresponding provisions of state law. In order to qualify as a REIT, we must distribute at least 90% of our annual REIT

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 20. Taxes  – (continued)

taxable income (not including taxable income retained in our taxable subsidiaries) to shareholders within the time frame set forth in the tax code and we must meet certain other requirements.

Through the second quarter of 2008, we had 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. We recognized a total tax provision of $1 million and $3 million for the three months ended June 30, 2008 and 2007, respectively, and a total tax provision of $3 million and $5 million for the six months ended June 30, 2008 and 2007, respectively. During the third quarter of 2008, our Board of Directors decided to distribute 100% of our REIT taxable income from 2007 and 2008 to shareholders. This development is discussed inNote 21.

The tax provisions we record are determined by applying our expected annual effective tax rate to our GAAP pre-tax income (loss). The effective tax rate is determined as the ratio of our estimated current year tax liability to our estimated GAAP pre-tax income (loss). This annual estimate is based on our annualized actual GAAP results to date. The estimate of the annual effective tax rate used by annualizing year-to-date results may not be reflective of actual GAAP earnings. However, we believe that applying the effective tax rate to GAAP income is an appropriate estimate due to the inherent volatility of our GAAP earnings, in part due to significant market valuation adjustments on our investments that are recorded to our GAAP consolidated statements of (loss) income.

Differences between taxable income and GAAP income reflect differing accounting treatments for tax and GAAP, such as accounting for discount and premium amortization, credit losses, equity awards, and asset impairments. Differences between taxable income and GAAP (loss) may also reflect differing valuation estimates for certain assets, liabilities, and derivatives. Some of these differences create timing differences between when taxable income is earned and the tax is paid, and when the GAAP (loss) income is recognized and the tax provision is recorded. Some of these differences are permanent, since certain income (or expense) may be recorded for tax but not for GAAP (or vice-versa). One such significant permanent difference is our ability as a REIT to deduct dividends paid to shareholders for tax but not for GAAP.

The following is a reconciliation of the statutory federal and state rates to the effective rates as estimated for the six months ended June 30, 2008 and 2007.

Reconciliation of Statutory Tax Rate to Effective Tax Rate

  
 Six Months Ended, June 30,
   2008 2007
Federal statutory rate  35.0 %   35.0 % 
State statutory rate, net of Federal tax effect  7.0 %   7.0 % 
Differences in taxable income from GAAP income  (54.8) %   35.8 % 
Dividend paid deduction  11.6 %   (63.8) % 
Effective Tax Rate  (1.2) %   14.0 % 

Our taxable income before dividend distributions has historically been higher than our GAAP net (loss) income, primarily due to differences in the accounting for credit losses as well as significant market valuation adjustments taken on our investments for GAAP but not for tax. These differences resulted in net losses for GAAP during recent periods while taxable income had remained positive.

Our deferred tax assets before valuation allowance at our taxable subsidiaries increased from $9 million at December 31, 2007 to $17 million at June 30, 2008, primarily due to differences in the basis of our real estate assets. This increase in deferred tax assets was offset by a valuation allowance of $9 million, as we do not expect to realize a future tax benefit from this asset. Thus, there was little change in our deferred tax asset after valuation allowance during the first six months of 2008.

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REDWOOD TRUST, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)

Note 20. Taxes  – (continued)

Our policy for interest and penalties on material uncertain tax positions recognized in our consolidated financial statements is to classify these as interest expense and operating expense, respectively. However, in accordance with Financial Accounting Standard Board Interpretation Number 48,Accounting for Uncertainty in Income Taxes, (FIN 48) we assessed our tax positions for all open tax years (Federal, years 2004 to 2007 and State, years 2003 to 2007) as of June 30, 2008 and December 31, 2007, and concluded that we have no material unrecognized FIN 48 liabilities.

Note 21. Recent Developments

In MarchAugust 2008, our Board of Directors decided to distribute as dividends 100% of our REIT taxable income generated in 2007 and 2008. Previously, we had planned to distribute 90% of REIT taxable income (the minimum REIT requirement) and retain 10%. During 2007 and the boardfirst six months of directors approved, subject2008, we established GAAP income tax provisions of $9 million related to stockholders’ approval, an increasethe planned 10% retention. As a result of the decision to distribute 100% of REIT taxable income, we expect to record a $9 million credit to our GAAP income tax provision in authorized shares from 50 million to 75 million for possible future equity offerings.the third quarter of 2008.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read this Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) in conjunction with our unaudited consolidated financial statements and related notes, and the more detailed information contained in our Annual Report on Form 10-K for the year ended December 31, 2007. The results of operations presented in our interim financial statements and discussed in MD&A are not necessarily indicative of the results that may be expected for the full year.

Cautionary Statement

This Form 10-Q and the documents incorporated by reference herein contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve numerous risks and uncertainties. Our actual results may differ from our expectations, estimates, and projections and, consequently, you should not rely on these forward-looking statements as predictions of future events. Forward-looking statements are not historical in nature and can be identified by words such as “anticipate,” “estimate,” “will,” “should,” “expect,” “believe,” “intend,” “seek,” “plan” and similar expressions or their negative forms, or by references to strategy, plans, or intentions. These forward-looking statements are subject to risks and uncertainties, including, among other things, those described in our Annual Report on Form 10-K for the year ended December 31, 2007 under the caption “Risk Factors.” Other risks, uncertainties, and factors that could cause actual results to differ materially from those projected are described below and may be described from time to time in reports we file with the Securities and Exchange Commission, (SEC), including reports on Forms 10-K, 10-Q, and 8-K. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Important factors, among others, that may affect our actual results include: changes in interest rates; changes in prepayment rates; general economic conditions, particularly as they affect the price of earning assets and the credit status of borrowers; legislative and regulatory actions affecting the mortgage industry; the availability of high quality assets for purchase at attractive prices; declines in home prices; increases in mortgage payment delinquencies; changes in the level of liquidity in the capital markets which may adversely affect our ability to finance our real estate asset portfolio; changes in liquidity in the market for real estate securities, the re-pricing of credit risk in the capital markets, rating agency downgrades of securities and increases in the supply of real estate securities available-for-sale, each of which may adversely affect the values of securities we own; the extent of changes in the values of securities we own and the impact of adjustments reflecting those changes on our income statement and balance sheet, including our stockholders’ equity; our ability to maintain the positive stockholders’ equity necessary to enable us to pay the dividends required to maintain our status as a real estate investment trust for tax purposes; and other factors not presently identified. This Quarterly Report on Form 10-Q may contain statistics and other data that in some cases have been obtained from or compiled from information made available by servicers and other third-party service providers.

Summary

Redwood Trust, Inc., together with its subsidiaries (Redwood, we, or us), is a financial institution focused on investing in, financing, and managing residential and commercial real estate loans and securities. We seek to invest in assets that have the potential to provide high cash flow returns over a long period of time to help support our goal of distributing attractive levels of dividends to our shareholders. For tax purposes, we are structured as a real estate investment trust (REIT). We are able to pass through substantially all of our earnings generated at our REIT to our shareholders without paying income tax at the corporate level. We pay income tax on the REIT taxable income we retain and on the income we earn at our taxable subsidiaries.

Our primary source of income is net interest income, which equals the interest income we earn from our investments in loans and securities less the interest expenses we incur from our borrowed funds and other liabilities. We assume a range of risks in our investments and the level of assumed risk dictates the manner in which we finance our purchase of and derive income from these investments. Our primary real estate investments include investments in real estate loans and securities, investments in the securitization entities that we sponsor, and investments in a private equity fund that we sponsor. We leverage our investment

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platform through the asset management activities of our asset management subsidiary that generate fee income from the management of certain assets.

Our direct investments in residential, commercial, and collateralized debt obligation (CDO) credit-enhancement securities (CES, or below investment-grade securities) have concentrated credit risk. We finance the acquisition of most of our first-loss and equivalent CES that are directly exposed to credit lossesfinanced almost entirely with capital without the use of financial leverage. To date, our primary credit-enhancement investment focus has been in credit enhancement securities (CES, or below investment-grade securities) backed by high-quality residential and commercial real estate loans. “High-quality” real estate loans are loans that typically have low loan-to-value ratios, borrowers with strong credit histories, and other indications of quality relative to the range of loans within U.S. real estate markets as a whole. These investments tend to have concentrated structural credit risk that is generally reflected in their credit ratings. Additionally, we acquire certain investment-grade securities (IGS) that generally have less concentrated credit risk than CES but still provide an attractive rate of return. Our CES investment returns dependrecent investments have been more focused on IGS as the amount and timingavailability of the cash flows (interest and principal payments) collected on the loans in the pools supporting the securities. In an ideal environment, for most of our residential CES, we would experience fast loan prepayments and low credit losses which would, in turn, lead

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to attractive CES returns. Conversely, the return on most of our residential CES investments would be adversely affected by slow loan prepayments and high credit losses.has been limited.

We also make investments in the securitization entities we sponsor — Sequoia and Acacia. The Sequoia entities hold residential real estate loans. The Acacia entities hold real estate securities. The real estate securities held(generally IGS) and some loans, CES, and other mortgage related investments. Our capital at risk in Sequoia and Acacia is limited to our investments in these entities, as each entity is independent of Redwood and of each other and the assets and liabilities are not owned by and are not obligations of Redwood. However, we are required under generally accepted accounting principles in the United States (GAAP) to consolidate the assets and liabilities of the Sequoia and Acacia entities are generally investment-grade securities (IGS), which have less concentrated credit risk than CES, as well as some second-loss, third-loss, and equivalent CES.for financial statement reporting purposes. The income we earn on our investment in the equity of these securitization entities is based upon the spread between the yield on the assets owned by each entity and the cost of funds borrowed by each entity to fund its assets. The cost of funds is the interest paid on the asset-backed securities (ABS) issued by each of these entities. Each entity is independent of RedwoodPeriodic interest costs on ABS issued are generally variable and are affected by the structural cash flow distribution requirements of each otherindependent entity.

During the first quarter of 2008, we established the Opportunity Fund. The Fund primarily invests in non-prime residential IGS and CDO IGS securities. The offer and sale of interests in the assets and liabilities areFund were not owned by and are not obligations of Redwood. However, weregistered under the federal securities laws. We are required under generally accepted accounting principles in the United States (GAAP)GAAP to consolidate the assets, liabilities, and liabilitiesminority interest of the Sequoia and Acacia entitiesFund for financial statement reporting purposes.

We account for both the assets and liabilities

Results of Sequoia at cost. Prior to 2008, we were required, for financial statement purposes, to mark-to-market (MTM) all of the assets of Acacia to fair value, but we were not permitted to MTM paired liabilities. This GAAP accounting treatment resulted in a carrying value for our investments in Acacia of a negative $1.4 billion at December 31, 2007. Effective January 1, 2008, we elected to adopt a new accounting standard, Statement of Financial Accounting Standards No. 159,The Fair Value Option for Financial Assets and Financial Liabilities (FAS 159), to value the assets and liabilities of the Acacia entities. This new standard significantly improved the disparity that existed between the GAAP carrying value of our Acacia investments and our estimate of the economic value of those investments. In accordance with FAS 159, we recorded a one-time, cumulative-effect adjustment to our balance sheet that increased the balance of our stockholders’ equity at January 1, 2008 by $1.5 billion. Our reported consolidated stockholders’ equity at December 31, 2007 was a negative $718 million. After giving affect to the adoption of FAS 159, our reported GAAP stockholders’ equity at January 1, 2008 was a positive $751 million. At March 31, 2008, our reported GAAP stockholders’ equity was $585 million. The decline in reported equity over the course of the first quarter was the result of continued declines in the value of the securities we hold with equity and the payment of our regular dividend, only partially offset by the generation of net interest income before market valuation adjustments (MVA) and a small amount of new equity raised through our direct stock purchase and dividend reinvestment plan. These factors are further discussed below.

In the first quarter of 2008, the public and private sectors took steps to address the deep and complex problems in the real estate and capital markets. Initial positive steps have been taken — rate cuts, liquidity infusions, stimulus package, increasing write-offs, and capital raising initiatives — to address the problems and bring financial stability.

We anticipate that the process of fixing the mortgage turmoil will not be easy and the road ahead will be bumpy. The forces that created this disarray were at work for several years and it is reasonable to expect that it will take at least a few years to resolve. It is likely to be a drawn-out process intertwined with legal, political, and regulatory issues and requiring structural changes in the credit and capital markets. The correction that is taking place is healthy and we believe that it will benefit those companies, such as Redwood, that are prepared for these changes and have remained disciplined investors over the past few years.

ResultsOperations

Our reported GAAP loss for the firstsecond quarter of 2008 was $172$46 million ($5.281.40 per share) compared to GAAP net income of $18$11 million ($0.660.41 per share) for the firstsecond quarter of 2007. InFor the firstsix months ended June 30, 2008, our GAAP loss was $217 million ($6.65 per share) compared to GAAP net income of $30 million ($1.06 per share) in the six months ended June 30, 2007. For the second quarter of 2008, we declared a regular dividend of $0.75 per share. Our board of directors has announced its intention to maintainshare, the regularsame dividend at $0.75 per share paid in the second quarter of 2007. The total dividends declared for both the first half of 2008 and 2007 were $1.50 per quarter during 2008.share.

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The following table below presents the components of our GAAP net (loss) income for the first quarters ofthree and six months ended June 30, 2008 and 2007.

Table 1 Net Income

      
 Three Months Ended March 31, Three Months Ended June 30, Six Months Ended June 30,
(In Thousands, Except Share Data) 2008 2007 2008 2007 2008 2007
Interest income $168,006  $215,105  $126,941  $219,658  $294,947  $434,764 
Management fees  1,482   1,180   1,319   1,481   2,932   2,649 
Interest expense  (128,762)   (169,256)   (98,826)   (167,238)   (227,738)   (336,502) 
Net interest income before market valuation adjustments  40,726   47,029 
Net interest income before valuation adjustments  29,434   53,901   70,141   100,911 
Market valuation adjustments, net  (193,932)   (10,264)   (60,619)   (29,430)   (254,551)   (39,694) 
Net interest (loss) income  (153,206)   36,765   (31,185)   24,471   (184,410)   61,217 
Operating expenses  (16,368)   (17,802)   (14,255)   (12,772)   (30,604)   (30,554) 
Realized gains on sales and calls, net  42   1,146   2,837   2,738   2,879   3,884 
Other  (255)   — 
Minority interest allocation  (2,369)   —   (2,624)   — 
Provision for income taxes  (1,800)   (1,800)   (937)   (3,021)   (2,737)   (4,822) 
Net (Loss) Income $(171,587)  $18,309  $(45,909)  $11,416  $(217,496)  $29,725 
Diluted weighted average common shares outstanding  32,511,445   27,684,029   32,871,442   28,164,944   32,691,444   27,917,502 
Net (loss) income per share $(5.28)  $0.66  $(1.40)  $0.41  $(6.65)  $1.06 

By far theThe largest factor in the decline in net income in the firstsecond quarter of 2008 as compared to the firstsecond quarter of 2007 was a $184$31 million increase in negative market valuation adjustments (MVA). This increase is discussed in detail in the Market Valuation Adjustments Discussion below.section of this MD&A.

Another factor negatively affecting our net income was a $6$25 million decline in net interest income before MVA. This decline was due to an $11 million decrease in interest income from CES held at Redwood (excluding investments in Sequoia and Acacia) due to higher credit losses, slower prepayments, and lower interest rates. Comparable net interest income from loans held at Sequoia was primarily attributablelower by $11 million of which $8 million was due to higher credit loss provisions on loans held by Sequoia securitizationand $3 million was due to higher loan premium amortization. Another factor negatively impacting net interest income was a $5 million comparable decrease from Acacia entities anddue to the absence of any discount accretion on securities held at Acacia securitization entities due to theas a result of our adoption of FAS 159159. Finally, we generated $2 million in the firstsecond quarter partially offset by higher net interest income generated from CES and IGS held at Redwood. Also contributing toof 2008 on our recent investment in the decline in net income was a decrease in sales of assets and a resulting reduction in gains on sales.Fund.

Operating expenses forrose during the quarter by $2 million, but were at the same level during the first quarterhalf of 2008 wereas in line with same quarter last year after adjusting for $2 million in severance expenses in the first quarter2007.

In August 2008, our Board of 2007. Also included inDirectors decided to distribute as dividends 100% of our first quarter 2008 income is other expense representing the minority interest of limited partners in the Opportunity Fund, whose assets are consolidated on our financial statements. The provision for income taxes remained at $2 million in each of the first quarters of 2008 and 2007.

Our estimated taxable income for the first quarter of 2008 was $0.79 per share, as compared to $1.48 per share for the first quarter of 2007. Our REIT taxable income for the first quartergenerated in 2007 and 2008. Previously, we had planned to distribute 90% of 2008 was $0.76 per share, as compared with $1.29 per share for the first quarter of 2007. Our REIT taxable income determines(the minimum REIT requirement) and retain 10%. During 2007 and the minimum amountfirst six months of dividends2008, we must distribute in order to maintain our tax status as a REIT. Taxable income continues to run higher thanestablished GAAP income as we are not permittedtax provisions of $9 million related to establish credit reserves or recognize mark-to-market (MTM) adjustments for tax purposes. We amortize morethe planned 10% retention. As a result of our CES discount into income for tax accounting purposes, generally do not record impairments or other changes in fair value on assets or liabilities for tax accounting purposes, and have a higher tax basis in these securities. Consequently, any future credit losses on our CES will have a more significant impact on taxable income andthe decision to distribute 100% of REIT taxable income, than onwe expect to record a $9 million credit to our GAAP income. See Potential Income Tax Volatility below.

The consolidating income statement below presents our net income for investments held at Redwood and the investments heldtax provision in the Sequoiathird quarter of 2008.

At June 30, 2008, there was $44 million ($1.32 per share) of estimated 2007 and Acacia securitization entities.2008 undistributed estimated REIT taxable income available to distribute to our shareholders during 2008.

Market Conditions

During the second quarter, the challenges facing the mortgage industry grew larger and more complex. The income from assetssame issues – rising credit costs, falling home prices, contracting credit availability, deteriorating balance sheet strength, and escalating rating agency downgrades – are still front and center. Fear and uncertainty continue to inhibit the normal functioning of the mortgage capital markets. As a consequence, residential non-agency and commercial securitizations backed by newly originated loans remain at the lowest levels in the Opportunity Fund is included within Redwood. It is important to note that Acaciaseveral years. Additionally, trading activity of existing securities remains light. Pricing for residential and Sequoia are not separate business segments. This presentation highlightscommercial mortgage-backed securities and CDO securities remained under downward pressure during the impact from the consolidation of those entities on

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our overall results. A detailed discussionsecond quarter, although the rate of net (loss) incomedecline was significantly lower than the rate of decline in the first quarter of 2008, including a comparisonprior three quarters. Prices continue to trend lower early into the income in the first quarter of 2007, for each of these investments is provided below under Results of Operations.

Table 2 Consolidating Income Statements

     
 Three Months Ended March 31, 2008
(In Thousands) Redwood Sequoia Acacia Elimination Redwood
Consolidated
Net interest income before market valuation adjustments $32,846  $4,073  $3,807  $—  $40,726 
Market valuation adjustments, net  (166,663)   (419)   (26,850)   —   (193,932) 
Net interest (loss) income  (133,817)   3,654   (23,043)   —   (153,206) 
Operating expenses  (16,326)   (42)   —   —   (16,368) 
Realized gains on sales and calls, net  39   —   3   —   42 
Income from Sequoia  3,612   —   —   (3,612)   — 
Loss from Acacia  (23,040)   —   —   23,040   — 
Other  (255)   —   —   —   (255) 
Provision for income taxes  (1,800)   —   —   —   (1,800) 
Net (Loss) Income $(171,587)  $3,612  $(23,040)  $19,428  $(171,587) 

     
 Three Months Ended March 31, 2007
(In Thousands) Redwood Sequoia Acacia Elimination Redwood
Consolidated
Net interest income before market valuation adjustments $27,241  $9,545  $10,243  $—  $47,029 
Market valuation adjustments, net  (7,288)   —   (2,976)   —   (10,264) 
Net interest (loss) income  19,953   9,545   7,267   —   36,765 
Operating expenses  (17,802)   —   —   —   (17,802) 
Realized gains on sales and calls, net  1,869   —   (723)   —   1,146 
Income from Sequoia  9,545   —   —   (9,545)   — 
Income from Acacia  6,544   —   —   (6,544)   — 
Other  —   —   —   —   — 
Provision for income taxes  (1,800)   —   —   —   (1,800) 
Net (Loss) Income $18,309  $9,545  $6,544  $(16,089)  $18,309 

Market Conditions

During the first quarter of 2008, residential and commercial real estate prices remained under pressure and borrower delinquencies and defaults escalated. Additionally, banks and other financial institutions substantially reduced their extension of credit and slashed advance rates for collateralized borrowings, even for repurchase borrowings backed by Fannie Mae and Freddie Mac securities. The combination of deteriorating credit fundamentals, together with the contraction in market liquidity, caused prices for real estate securities to record their steepest decline in a single quarter since the mortgage credit crisis began over a year ago.

The capital markets for non-agency residential and commercial mortgages essentially shut down during thethird quarter. New residential non-agency securitizations were at their lowest level in several years and trading activity of existing securities through the mortgage capital markets remained extremely light.

Market unrest peaked in early March. The actions by the Fed and the Treasury to reduce systemic financial risk, the 75 basis point rate cut in the federal funds rate, the opening of the Fed discount window to certain broker/dealers, and the reduction in the excess capital requirements for Fannie Mae and Freddie Mac

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appear to have reduced the substantial pressure that had built up and restored some stability to the markets. Trading remains light, but prices for real estate securities seem to be holding. We would caution that it is still early in this credit cycle and this stability may be temporary.

The table below illustrates the additional interest rate spread that investors have required to compensate for the perceived credit risk of various types of residential mortgage-backedmortgage backed securities (RMBS) and commercial mortgage-backed securities (CMBS).

RMBS and CMBS BBB Spreads
(Basis points over LIBOR)

[GRAPHIC MISSING][GRAPHIC MISSING]

Source: Credit Suisse, JPMorgan Chase, Redwood Trust

For some assets, declines in fair values reflect the near-certainty of serious credit losses being realized. For others, significant future losses may not occur, but there is a perceived increase in the risk of loss, resulting in a lower value. Finally, many assets are not at serious risk of loss but have declined intheir declining value largely because of thereflects a limited number of observed sales in the market. Many of the sales that did occur were by distressed sellers, resulting in further downward pressure on market prices.

In the first quarter of 2008, the commercial real estate finance market was hit hard, after having been somewhat insulated from the severe price declines observed in the residential mortgage markets. Technical forces took hold during this quarter when bearish speculators began driving down prices for commercial securities and their derivatives. Yield spreads on commercial securities quickly rose, becoming more correlated with spreads on residential securities. This has severely affected the commercial securitization markets and originators that use securitization as a financing strategy have been unable to quote competitive new loans to income-property owners.

The economic headwinds facing commercial borrowers and corporate tenants are becoming more severe. Property values continue to fall as capitalization rates on commercial real estate rise. Tightened underwriting standards have made it difficult for many borrowers to refinance their loans at maturity. Still, observable credit deterioration to date has been moderate. Serious delinquencies for U.S. commercial real estate securitizations hit record lows during the first quarter before trending upward in March. We expect that delinquencies will continue to rise and we expect more ratings downgrades and eventual credit losses. We believe wider market spread pricing levels are attractive for some CMBS, despite increased risks, especially for well-protected IGS. There are good opportunities to acquire high-quality CMBS, commercial loans, and other commercial real estate assets producing good yields with significant upside potential once the economy begins to strengthen.

Quarterly Activity

During the first quarter of 2008, we had several notable accomplishments despite extremely difficult market conditions. We remain challenged, however, by rising credit costs, primarily from residential loans originated in 2006 and 2007.

During the first quarter, we put $65invested $152 million of our excess capital to work atin what we believe are safe and attractive yield rates. Our investmentsassets, we generated $52 million of cash flow in excess of our operating and interest costs. Additionally, the Opportunity Fund described below,costs, and we continued to expand our asset management business. Furthermore, we maintained our strong balance sheet and liquidity position. At June 30, 2008, we had $148 million of available cash, of which we formed$132 million was capital in excess of our operating requirements. We remain challenged, however, by rising credit costs, particularly for the purpose2006 and 2007 vintages. Additionally, we have materially reduced our future cash flow expectations from our Acacia equity investments due to a high level of rating agency downgrades of Acacia assets in June and July of 2008 that were more severe and more rapid than our expectations. During the second quarter, the cash flow received from our Acacia equity investments was $5 million, but we now expect this cash flow to diminish rapidly over the next few quarters.

We continue to actively, yet patiently, pursue residential credit investments. Credit investment opportunities that we find attractive, however, remain scarce. Additionally, our progress in completing other forms of credit risk transfers with large financial institutions has been impeded by the slow, deliberate pace of their balance sheet restructuring and capital reallocation process. As a result, we only invested $3 million in residential credit enhancement securities (CES) during the second quarter.

Our investing activity at Redwood during the quarter was limited almost entirely to the purchase of residential investment grade securities (IGS), securities that provide a greater certainty of the range of expected cash flows. We invested $147 million in distressedresidential IGS, $64 million of which was rated AAA and AA and backed by prime mortgage collateral, and $62 million of which was AAA-rated and backed by non-prime mortgage collateral. We also acquired $21 million of A and BBB-rated securities received capital commitmentsbacked by prime mortgage collateral from 2003 and 2004. The majority (72%) of $46 million from new limited partners.our acquisitions of IGS consisted of securities backed by 2005 and earlier mortgage collateral. The weighted average purchase price for our

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acquisitions was 75% of face value. Our yield modeling expectations for these securities at the time of purchase ranged from 12% to 16%. Although we can provide no assurance as to the future credit performance of these securities, we currently do not expect to incur any material principal credit losses on these newly acquired IGS. We invested $38acquired these securities with safety in mind. In this regard, our recent non-prime IGS investments had on average over 30 points of external credit enhancement.

We did not make any new commercial or collateralized debt obligation (CDO) investments at Redwood during the quarter. We did acquire $2 million of previously issued Sequoia ABS.

The commercial real estate market is facing economic headwinds with a slowing economy, resulting in rising vacancies across property types. In general, we expect conditions to worsen. We have not purchased and do not own commercial assets with underlying loans originated in 2007 or 2008. So far, our seasoned prime residential securities, $20 millionportfolio continues to perform generally within our expectations. We believe there will be many attractive opportunities to expand our commercial business in distressed subprime residential and CDO securities on behalfthe future.

The Fund closed at the end of the Opportunity Fund, and $7 million to acquire a portion of the investment-grade asset-backed securities (ABS) issued by Acacia entities in 2004 and 2005. Our weighted average cost for these Acacia ABS purchases was 21% of their principal value.

As we had forewarned in previous discussions, delinquencies and credit losses increased during the first quarter. We believe we have adequate credit reserves for GAAP purposes, however, we are not allowed to establish reserves for tax purposes. Our credit losses for tax purposes were $14 million in the first quarter up from $5 million in the prior quarter. Although this increase was due in part to timing considerations as a higher level of short sales of residential mortgages has accelerated loss realization. Nevertheless, our estimates of cumulative losses are also increasing and we expect to realize higher levels of credit losses during the remainder of 2008 and, likely into 2009. We believe a portion of these credit losses may be recoverable from third parties, including mortgage originators, due to breaches of representations and warranties regarding the mortgage loans underlying our investments in securities. We intend to pursue those remedies to the extent it is appropriate to do so.

On March 31, 2008, we completed an important step in the expansion of our asset management business by closing the Opportunity Fund with $96 million of capital commitments including $46($46 million from new limited partnerthird-party investors and $50 million from Redwood. From these commitments, actual fundings through quarter-end were $8 million from partners and $40 million from Redwood.Redwood). The offer and sale of interests in this private fund were not registered under the federal securities laws. This fundThe Fund was formed to capitalize on the dislocationdislocations in the subprime RMBSnon-prime residential mortgage-backed securities (RMBS) and CDO markets. As of June 30, 2008, the Fund had invested $82 million, mainly in seasoned residential non-prime IGS and CDOs. It is managed by Redwood will earn management and incentive fees on the third-party capital invested and earn a return on its direct capital investment.Asset Management, one of our taxable subsidiaries. The fund invested $20 million in the first quarter of this year and $22 million during the fourth quarter of 2007. Expansionexpansion of our asset management business is an important part of our long-term growth plans.business strategy.

Capital and Liquidity

Our excess capital position was $132 million at June 30, 2008, a decrease from $247 million at March 31, 2008, a decrease from $282 million at December 31, 2007.2008. During the firstsecond quarter, our sources of capital were $52 million generated from portfolio cash flows in excess of operating costs and financing costs, $10$14 million raised from stock issuanceissuances under our direct stock purchase and dividend reinvestment plan, $2$1 million in asset management fees and $8 million drawn from limited partner investors’ commitments for the Opportunity Fund.net changes in working capital. Our uses of capital were $65$152 million for new investments, $10 million for an additional capital investment in the Fund, and $25 million for dividend payments, $6 million forpayments.

The vast majority of the repayment of Redwood debt, $5 million for changes in working capital and internal risk adjusted capital requirements, and $6 million held in restricted cash at the opportunity fund.

Our net deployment of capital was $35 millioninvestments made during the firstsecond quarter of 2008.were financed with capital. We expect to continue financing most new investments with capital, either on our own or with third-party capital sourced through funds or other asset management vehicles.

Our quarter-end liquiditycash position remained strong at $263$148 million. Short-term Redwood debt (short-term debt not included in capital) was $2$9 million at March 31,June 30, 2008. We have no liquidity issues or need to sell assets.

We further discuss our excess capital and net liquidity in the Cash Requirements, Sources of Cash,Redwood Capital and Liquidity section under Financial Conditions later in this report.

Outlook

We expect that GAAP earnings will remain volatile. Early intovolatile in the second quarter, prices for some real estate securities have increased. This is the first time in a year that prices and spreads have found support. It is still too earlynear term due to project whether pricesmark-to-market (MTM) adjustments. We will hold, but if they do, GAAP and economic earnings could improve. We may stilllikely encounter MTM volatility from our consolidation of the Acacia entities however, due to the technical valuation methodologies required under FAS 159.Statement of Financial Accounting Standards No. 159,The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115 (FAS 159). This topic is more fully discussed in the Market Valuation Adjustments section of this MD&A. In addition, we may recognize additional GAAP impairment losses on residential, commercial, and CDO securities held at Redwood. Negative MTM balance sheet write-downs that have not yet been realized through theour income statement totaled $67$52 million at March 31,June 30, 2008. IncomeFuture income statement impairment charges related to these unrealized losses will not affect GAAP book value since these MTM losses were already deducted from stockholders’ equity at March 31,June 30, 2008.

Our current rate of capital deployment has slowed significantly from the second quarter levels as we have not acquired any new assets thus far in the third quarter (through August 5, 2008). Our capital deployment plan is fluid at this time and may include acquiring or selling assets as well as issuing or repurchasing shares of our common stock. Our actions will depend on:

The level and attractiveness of new investment opportunities;

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Our ability to raise capital at a price that is accretive to earnings;
The relative attractiveness of investing in our assets through the repurchase of our shares; and,
The amount of cash we believe we should hold in reserve to take advantage of potential extraordinary investment opportunities that may appear in the future.

As these considerations are in some respects competing, and as market conditions remain unclear and volatile, it is difficult to predict what actions we are likely to take. We are keeping our options open.

In the three and six months ended June 30, 2008, we earned an estimated $4 million and $26 million, of REIT taxable income, or $0.13 per share and $0.89 per share, respectively. In the three and six months ended June 30, 2007, we earned an estimated $46 million and $86 million of REIT taxable income, or $1.63 per share and $2.92 per share, respectively. REIT taxable income is that portion of our total taxable income that we earn at Redwood and its qualifying REIT subsidiaries and does not include taxable income earned in taxable subsidiaries. Our REIT taxable income determines the minimum amount of dividends we must distribute to shareholders in order to maintain our tax status as a REIT. We are and expect to remain in compliance with all REIT tests.

For the three and six months ended June 30, 2008, the decrease in REIT taxable income as compared to the same periods in 2007 was primarily due to an increase in realized credit losses. For tax purposes, we are not permitted to establish credit reserves on securities and do not record impairments or other changes in the fair value of financial assets or liabilities. Realized credit losses were $30 million and $44 million, or $0.92 and $1.33 per share, for the three and six months ended June 30, 2008, respectively. Realized credit losses were $2 million and $5 million, or $0.08 and $0.16 per share, for the three and six months ended June 30, 2007, respectively.

We expect that REIT taxable income for the remainder of 2008 and 2009 will continue to be pressured by tax deductions triggered by the realization of credit losses. Actual REIT taxable income will depend on the timing of the credit losses and the level of taxable income generated by our new and existing investments. Currently, our estimate is that the REIT taxable income generated in 2008, together with the undistributed taxable income carried over from 2007, may fall short of full-year distributions at our regular dividend rate. We caution that the timing of credit losses can be difficult to project in the current environment and that our estimates of taxable income could change.

In August 2008, our Board of Directors reaffirmed its intention to maintain the regular quarterly dividend rate of $0.75 per share for both the third and fourth quarters of 2008. We do not expect to pay a special dividend in 2008. Further, we expect that the amount of undistributed taxable income carried over into 2009, if any, will be minimal. The Board plans to review dividend policy for 2009 at its regularly scheduled November Board meeting.

Results of Operations – Consolidating

When analyzing our GAAP consolidated income statements, it can be difficult to ascertain how our investments in consolidated entities impact our overall financial results. As a supplement to our GAAP discussion, we present consolidating results for Redwood, the Opportunity Fund, Sequoia, and Acacia. This presentation highlights the impact of these consolidated entities on our overall results of operations. A detailed discussion of net interest income for the three and six months ended June 30, 2008, including a comparison to prior year periods, is provided for each of these consolidating entities in this section.

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Table 2 Consolidating Income Statements

      
 Three Months Ended June 30, 2008
(In Thousands) Redwood
Parent Only		 Opportunity Fund Sequoia Acacia Intercompany
Adjustments		 Redwood
Consolidated
Interest Income
                              
Real estate loans $76  $—  $62,253  $373  $—  $62,702 
Real estate securities  23,163   2,348   —   37,924   (1,906)   61,529 
Other investments  —   —   —   514   —   514 
Cash and cash equivalents  1,428   72   18   678   —   2,196 
Total interest income  24,667   2,420   62,271   39,489   (1,906)   126,941 
Management fees  1,319   —   —   —   —   1,319 
Interest Expense
                              
Short-term debt – Redwood  (68)   —   —   —   —   (68) 
Asset-backed securities issued  —   —   (67,036)   (31,395)   1,906   (96,525) 
Long-term debt – Redwood  (2,233)   —   —   —   —   (2,233) 
Total interest expense  (2,301)   —   (67,036)   (31,395)   1,906   (98,826) 
Net interest income before market valuation adjustments  23,685   2,420   (4,765)   8,094   —   29,434 
Market valuation adjustments, net  (31,349)   —   (974)   (28,296)   —   (60,619) 
Net Interest (Loss) Income  (7,664)   2,420   (5,739)   (20,202)   —   (31,185) 
Operating expenses  (14,232)   —   (23)   —   —   (14,255) 
Realized gains on sales and calls, net  883   1,831   —   123   —   2,837 
Income from Opportunity Fund  1,882   —   —   —   (1,882)   — 
Loss from Sequoia  (5,762)   —   —   —   5,762   — 
Loss from Acacia  (20,079)   —   —   —   20,079   — 
Minority interest allocation  —   (2,369)   —   —   —   (2,369) 
Net (loss) income before provision for taxes  (44,972)   1,882   (5,762)   (20,079)   23,959   (44,972) 
Provision for income taxes  (937)   —   —   —   —   (937) 
Net (Loss) Income $(45,909)  $1,882  $(5,762)  $(20,079)  $23,959  $(45,909) 

      
 Three Months Ended June 30, 2007
(In Thousands) Redwood Opportunity Fund Sequoia Acacia Intercompany
Adjustments		 Redwood
Consolidated
Interest Income
                              
Real estate loans $21  $—  $119,154  $401  $—  $119,576 
Real estate securities  35,608   —   —   62,227   (1,973)   95,862 
Other investments  —   —   —   464   —   464 
Cash and cash equivalents  1,801   —   —   1,955   —   3,756 
Total interest income  37,430   —   119,154   65,047   (1,973)   219,658 
Management fees  1,481   —   —   —   —   1,481 
Interest Expense
                              
Short-term debt – Redwood  (1,527)   —   (13,271)   (7,902)   —   (22,700) 
Asset-backed securities issued  —   —   (99,943)   (44,052)   1,973   (142,022) 
Long-term debt – Redwood  (2,516)   —   —   —   —   (2,516) 
Total interest expense  (4,043)   —   (113,214)   (51,954)   1,973   (167,238) 
Net interest income before market valuation adjustments  34,868   —   5,940   13,093   —   53,901 
Market valuation adjustments, net  (20,017)   —   —   (9,413)   —   (29,430) 
Net interest income  14,851   —   5,940   3,680   —   24,471 
Operating expenses  (12,772)   —   —   —   —   (12,772) 
Realized gains on sales and calls, net  3,408   —   —   (670)   —   2,738 
Income from Sequoia  5,940   —   —   —   (5,940)   — 
Income from Acacia  3,010   —   —   —   (3,010)   — 
Net income before provision for taxes  14,437   —   5,940   3,010   (8,950)   14,437 
Provision for income taxes  (3,021)   —   —   —   —   (3,021) 
Net (Loss) Income $11,416  $—   5,940  $3,010  $(8,950)  $11,416 

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Table 2 Consolidating Income Statements – (continued)

      
 Six Months Ended June 30, 2008
(In Thousands) Redwood
Parent Only		 Opportunity Fund Sequoia Acacia Intercompany
Adjustments		 Redwood
Consolidated
Interest Income
                              
Real estate loans $175  $—  $149,348  $744  $—  $150,267 
Real estate securities  54,618   4,106   —   83,386   (4,053)   138,057 
Other investments  —   —   —   1,246   —   1,246 
Cash and cash equivalents  3,663   87   47   1,580   —   5,377 
Total interest income  58,456   4,193   149,395   86,956   (4,053)   294,947 
Management fees  2,932   —   —   —   —   2,932 
Interest Expense
                              
Short-term debt – Redwood  (250)   —   —   —   —   (250) 
Asset-backed securities issued  —   —   (149,770)   (77,005)   4,053   (222,722) 
Long-term debt – Redwood  (4,766)   —   —   —   —   (4,766) 
Total interest expense  (5,016)   —   (149,770)   (77,005)   4,053   (227,738) 
Net interest income before market valuation adjustments  56,372   4,193   (375)   9,951   —   70,141 
Market valuation adjustments, net  (198,010)   —   (1,392)   (55,149)   —   (254,551) 
Net Interest (Loss) Income  (141,638)   4,193   (1,767)   (45,198)   —   (184,410) 
Operating expenses  (30,539)   —   (65)   —   —   (30,604) 
Realized gains on sales and calls, net  922   1,831   —   126   —   2,879 
Income from Opportunity Fund  3,400   —   —   —   (3,400)   — 
Loss from Sequoia  (1,832)   —   —   —   1,832   — 
Loss from Acacia  (45,072)   —   —   —   45,072   — 
Minority interest allocation  —   (2,624)   —   —   —   (2,624) 
Net (loss) income before provision for taxes  (214,759)   3,400   (1,832)   (45,072)   43,504   (214,759) 
Provision for income taxes  (2,737)   —   —   —   —   (2,737) 
Net (Loss) Income $(217,496)  $3,400  $(1,832)  $(45,072)  $43,504  $(217,496) 

      
      
 Six Months Ended June 30, 2007
(In Thousands) Redwood Opportunity Fund Sequoia Acacia Intercompany
Adjustments		 Redwood
Consolidated
Interest Income
                              
Real estate loans $(2,794)  $—  $248,436  $785  $—  $246,427 
Real estate securities  66,000   —   —   120,440   (4,655)   181,785 
Other investments  —   —   —   464   —   464 
Cash and cash equivalents  3,113   —   —   2,975   —   6,088 
Total interest income  66,319   —   248,436   124,664   (4,655)   434,764 
Management fees  2,649   —   —   —   —   2,649 
Interest Expense
                              
Short-term debt – Redwood  (1,609)   —   (35,344)   (16,841)   —   (53,794) 
Asset-backed securities issued  —   —   (198,635)   (84,156)   4,655   (278,136) 
Long-term debt – Redwood  (4,572)   —   —   —   —   (4,572) 
Total interest expense  (6,181)   —   (233,979)   (100,997)   4,655   (336,502) 
Net interest income before market valuation adjustments  62,787   —   14,457   23,667   —   100,911 
Market valuation adjustments, net  (27,305)   —   —   (12,389)   —   (39,694) 
Net interest (loss) income  35,482   —   14,457   11,278   —   61,217 
Operating expenses  (30,554)   —   —   —   —   (30,554) 
Realized gains on sales and calls, net  5,277   —   —   (1,393)   —   3,884 
Income from Sequoia  14,457   —   —   —   (14,457)   — 
Income from Acacia  9,885   —   —   —   (9,885)   — 
Net income before provision for taxes  34,547   —   14,457   9,885   (24,342)   34,547 
Provision for income taxes  (4,822)   —   —   —   —   (4,822) 
Net Income $29,725  $—  $14,457  $9,885  $(24,342)  $29,725 

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Results of Operations – Redwood

The following table presents the net interest income (interest income less interest expense and after market valuation adjustments) earned at Redwood for the three and six months ended June 30, 2008 and 2007.

Table 3 Net Interest Income at Redwood

      
 Three Months Ended June 30,
   2008 2007
(Dollars in Thousands) Total Interest
Income/(Expense)		 Average
Amortized
Cost		 Yield Total Interest
Income/(Expense)		 Average
Amortized
Cost		 Yield
Interest Income
                              
Real estate loans $76  $3,759   8.09%  $21  $1,286   6.53% 
Trading securities  1,317   23,627   22.30%   618   44,061   5.61% 
Available-for-sale securities  21,846   336,295   25.98%   34,990   586,373   23.87% 
Cash and cash equivalents  1,428   200,781   2.84%   1,801   139,612   5.16% 
Total Interest Income  24,667             37,430           
Management fees  1,319             1,481           
Interest Expense
                              
Interest expense on short-term Redwood debt  (68)   4,904   (5.55)%   (1,527)   89,702   (6.81)% 
Interest expense on
long-term Redwood debt		  (2,233)   146,480   (6.10)%   (2,516)   117,934   (8.53)% 
Total Interest Expense  (2,301)             (4,043)           
Net Interest Income Before MVA  23,685             34,868           
Market valuation adjustments  (31,349)             (20,017)           
Net Interest (Loss) Income at Redwood $(7,664)            $14,851           

      
      
 Six Months Ended June 30,
   2008 2007
(Dollars in Thousands) Total Interest
Income/(Expense)		 Average
Amortized
Cost		 Yield Total Interest
Income/(Expense)		 Average
Amortized
Cost		 Yield
Interest Income
                              
Real estate loans $175  $4,013   8.72%  $(2,794)  $2,603   (214.68)% 
Trading securities  5,508   31,194   35.31%   2,954   4,082   144.75% 
Available-for-sale securities  49,110   361,033   27.21%   63,046   577,540   21.83% 
Cash and cash equivalents  3,663   222,119   3.30%   3,113   137,432   4.53% 
Total Interest Income  58,456             66,319           
Management fees  2,932             2,649           
Interest Expense
                              
Interest expense on short-term Redwood debt  (250)   9,116   (5.49)%   (1,609)   94,607   (3.40)% 
Interest expense on long-term Redwood debt  (4,766)   146,420   (6.51)%   (4,572)   107,531   (8.50)% 
Total Interest Expense  (5,016)             (6,181)           
Net Interest Income Before MVA  56,372             62,787           
Market valuation adjustments  (198,010)             (27,305)           
Net Interest (Loss) Income at Redwood $(141,638)            $35,482           

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Net interest (loss) income at Redwood was a loss of $8 million in the second quarter of 2008 compared to income of $15 million in the second quarter of 2007, a decline of $23 million. Net interest (loss) income was a loss of $142 million in the first half of 2008 compared to income of $35 million in the first half of 2007, a decline of $177 million. The primary reason for these declines was an increase in negative market valuation adjustments (MVA) of $11 million and $171 million over comparable periods. We detail these adjustments in the Market Valuation Adjustments section in this MD&A.

Net interest income before MVA was $24 million in the second quarter of 2008 compared to $35 million in the second quarter of 2007, a decline of $11 million. Net interest income before MVA was $56 million in the first half of 2008 compared to $63 million in the first half of 2007, a decline of $7 million. The primary reasons for these declines were lower benchmark LIBOR rates on adjustable rate securities and higher credit costs due to deteriorating credit performance and lower projected cash flows on most CES. We have reduced the cost basis of these securities through impairment charges over recent quarters and increased the amount of unamortized discount designated as credit reserves. The amount of discount that we record into income over time is net of the unamortized discount designated as credit reserves and is subject to change based upon the long term performance of our securities.

The two most significant economic factors affecting the performance of CES are the timing and amount of credit losses and the rate of principal repayments. In general, lower credit losses and higher prepayment speeds benefit CES that we buy at a significant discount to face value. Over the past two quarters, delinquencies have been rising and prepayments have been slowing. Serious delinquencies on prime residential CES (loans that are 90+ days delinquent) were 0.47% of original balances and 1.01% of current balances as of June 30, 2008. Serious delinquencies on commercial CES (loans that are 60+ days delinquent) were 0.74% of original balances and 0.79% of current balances. Average prepayment speeds on prime residential CES declined to 19% CPR in the second quarter of 2008, compared to 31% CPR in 2007. There were no prepayments on commercial CES.

The following table presents the components of interest income and yield for AFS securities for the three and six months ended June 30, 2008 and 2007.

Table 4 Interest Income — AFS Securities at Redwood

Three Months Ended June 30, 2008

       
       
(Dollars in Thousands) Interest
Income		 Discount
(Premium)
Amortization		 Total
Interest
Income		 Average
Amortized
Cost		 Yield as a Result of
 Interest
Income		 Discount
(Premium)
Amortization		 Total
Interest
Income
IGS
                                   
Residential $1,663  $1,499  $3,162  $107,193   6.21%   5.59%   11.80% 
Commercial  —   —   —   —   —   —   — 
CDO  —   —   —   —   —   —   — 
Total IGS  1,663   1,499   3,162   107,193   6.21%   5.59%   11.80% 
CES
                                   
Residential  8,618   5,688   14,306   122,095   28.23%   18.63%   46.87% 
Commercial  6,278   (2,123)   4,155   106,314   23.62%   (7.99)%   15.63% 
CDO  223   —   223   693   128.72%   —   128.72% 
Total CES  15,119   3,565   18,684   229,102   26.40%   6.22%   32.62% 
Total AFS Real Estate Securities at Redwood $16,782  $5,064  $21,846  $336,295   19.96%   6.02%   25.98% 

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Table 4 Interest Income — AFS Securities at Redwood – (continued)

Three Months Ended June 30, 2007

(Dollars in Thousands)Interest
Income		Discount
(Premium)
Amortization		Total
Interest
Income		Average
Amortized
Cost		Yield as a Result of
Interest
Income		Discount
(Premium)
Amortization		Total
Interest
Income
IGS
Residential$2,359$1,019$3,378$156,1716.04% 2.61% 8.65% 
Commercial118(14) 1047,9855.91% (0.70)% 5.21% 
CDO4393046923,7867.38% 0.50% 7.89% 
Total IGS2,9161,0353,951187,9436.21% 2.20% 8.41% 
CES
Residential9,85315,82225,675215,67518.27% 29.34% 47.62 %
Commercial6,258(1,270) 4,988180,68713.85% (2.81)% 11.04 %
CDO376—3762,06872.73% —72.73% 
Total CES16,48714,55231,039398,43016.55% 14.61% 31.16 %
Total AFS Real Estate Securities at Redwood$19,403$15,587$34,990$586,37313.24% 10.63% 23.87% 

Six Months Ended June 30, 2008

       
       
(Dollars in Thousands) Interest
Income		 Discount
(Premium)
Amortization		 Total
Interest
Income		 Average
Amortized
Cost		 Yield as a Result of
 Interest
Income		 Discount
(Premium)
Amortization		 Total
Interest
Income
IGS
                                   
Residential $1,828  $1,562  $3,390  $58,775   6.22%   5.32%   11.54% 
Commercial  —   —   —   —   —   —   — 
CDO  —   —   —   —   —   —   — 
Total IGS  1,828   1,562   3,390   58,775   6.22%   5.32%   11.54% 
CES
                                   
Residential  18,943   17,258   36,201   156,244   24.25%   22.09%   46.34% 
Commercial  12,801   (3,646)   9,155   144,880   17.67%   (5.03)%   12.64% 
CDO  364   —   364   1,134   64.20%   —   64.20% 
Total CES  32,108   13,612   45,720   302,258   21.25%   9.01%   30.26% 
Total AFS Real Estate Securities at Redwood $33,936  $15,174  $49,110  $361,033   18.80%   8.41%   27.21% 

Six Months Ended June 30, 2007

       
       
(Dollars in Thousands) Interest
Income		 Discount
(Premium)
Amortization		 Total
Interest
Income		 Average
Amortized
Cost		 Yield as a Result of
 Interest
Income		 Discount
(Premium)
Amortization		 Total
Interest
Income
IGS
                                   
Residential $3,103  $878  $3,981  $96,482   6.43%   1.82%   8.25% 
Commercial  167   (14)   153   5,588   5.98%   (0.50)%   5.48% 
CDO  730   30   760   20,577   7.10%   0.29%   7.39% 
Total IGS  4,000   894   4,894   122,647   6.52%   1.46%   7.98% 
CES
                                   
Residential  19,142   29,002   48,144   266,441   14.37%   21.77%   36.14% 
Commercial  12,107   (2,673)   9,434   183,763   13.18%   (2.91)%   10.27% 
CDO  574   —   574   4,689   24.48%   —   24.48% 
Total CES  31,823   26,329   58,152   454,893   13.99%   11.58%   25.57% 
Total AFS Real Estate Securities at Redwood $35,823  $27,223  $63,046  $577,540   12.41%   9.43%   21.83% 

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The following table presents the components of operating expenses at Redwood for the three and six months ended June 30, 2008 and 2007.

Table 5 Operating Expenses

    
 Three Months Ended June 30, Six Months Ended June 30,
(In Thousands) 2008 2007 2008 2007
Fixed compensation expense $4,648  $4,286  $10,322  $8,902 
Variable compensation expense  330   198   2,187   2,449 
Equity compensation expense  3,502   3,540   6,808   6,888 
Severance expense  —   —   —   2,380 
Total compensation expense  8,480   8,024   19,317   20,619 
Systems  2,492   2,163   4,625   3,819 
Due diligence  8   78   18   785 
Office costs  1,629   1,265   3,151   2,445 
Accounting and legal  1,495   284   2,596   1,139 
Other operating expenses  151   958   897   1,747 
Total Operating Expenses $14,255  $12,772  $30,604  $30,554 

Operating expenses in 2008 are slightly higher than for the same period in 2007, after adjusting for the 2007 severance expense. We expect our level of operating expense in the second half of 2008 to increase slightly from the level in the first half of 2008.

The following table details the components of our net gains for the three and six months ended June 30, 2008 and 2007.

Table 6 Realized Gains on Sales and Calls, Net

    
 Three Months Ended June 30, Six Months Ended June 30,
(In Thousands) 2008 2007 2008 2007
Realized gains (losses) on sales of:
                    
Real estate loans $—  $(34)  $(3)  $(34) 
Real estate securities  1,983   1,462   1,983   678 
Interest rate agreements  —   —   —   1,087 
Total gains on sales  1,983   1,428   1,980   1,731 
Total gains on repurchase of Sequoia ABS  926   —   926   — 
Total (losses) gains on calls  (72)   1,310   (27)   2,153 
Total Realized Gains on Sales and Calls, Net $2,837  $2,738  $2,879  $3,884 

Results of Operations – Opportunity Fund

The Fund was established in 2008 to capitalize on the dislocation in the non-prime residential and CDO markets. The fund received $96 million in commitments from investors, including a $50 million commitment from Redwood. As the owner of a controlling interest in the Fund and manager of the Fund, we consolidate the Fund’s assets, liabilities, and minority interest for financial reporting purposes.

Net interest income at the Fund was $2 million in the second quarter of 2008 and $4 million in the first half of 2008. These amounts were derived from interest income earned on AFS securities and were funded with equity. The Fund acquired $40 million of non-prime IGS and CDO securities at an average price of 69% of outstanding principal face during the second quarter of 2008.

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While it may take a few quartersThe following table presents the components of interest income and yield for residential credit-sensitive investment opportunities to develop fully, we have recently increased our pace of less credit-sensitive residential investments. Since the end of the first quarter through May 5th, we invested $84 million of capital, primarily to acquire seasoned residential investment-grade securities. We acquired theseAFS securities at 72% of face value. Our base case returns, which assume no price appreciation or leverage, fall within our equity hurdle rate of 12% to 18%.

Our rate of capital deployment has increased significantly from first quarter levels as noted above. It is difficult to project with precision our rate of capital deploymentthe Fund for the remainder of 2008 as it will depend on the overall level of market trading activity, which could quickly accelerate due to forced liquidations or balance sheet re-structuring by other financial institutions. Our capital deployment will also depend on our success in designingthree and completing new forms of risk transfers from and credit-enhancements for banks. As we get more clarity around the size and likelihood of these investment opportunities, we will review our options for raising additional capital. Any new capital raised should be accretive to economic book value and should be deployed within a reasonable period of time. Our best estimate is that our current excess capital will take us through the third quarter of 2008.

Our REIT taxable income for 2008 will depend on, among other things, our ability to deploy our excess capital effectively and on the level of realized credit losses. We anticipate that credit losses, as measured for tax purposes, will increase substantially in 2008 relative to our recent experience. If the realization of credit losses becomes concentrated in any one quarter or series of quarters, taxable income may be less than our regular dividend rate. However, the board of directors has indicated it intends to maintain the regular quarterly dividend rate of $0.75 per share during 2008.

Although it is still early in the year and much could change, our best current estimate is that taxable income for 2008, plus taxable income carried over from 2007, will exceed our regular dividend rate for this year. We believe it is unlikely that we will pay a special dividend in 2008, since we currently estimate that any excess taxable income available at year-end is not likely to exceed the amounts that we customarily retain or defer distributing until the next year.

Results of Operations

Net Interest Income Before MVA

Net interest income before MVA consists of the interest earned on interest-bearing assets less interest expense on debt, ABS issued, and subordinated notes. The table below summarizes net interest income before MVA earned by our various investments for the first quarters ofsix months ended June 30, 2008 and 2007.

Table 3 Net7 Interest Income Before MVA Summary— AFS Securities at the Fund

Three Months Ended June 30, 2008

     
 Three Months Ended March 31, 2008
(In Thousands) Redwood Sequoia Acacia Elimination Redwood
Consolidated
Interest income $35,561  $87,125  $47,467  $(2,147)  $168,006 
Management fees  —   —   1,482   —   1,482 
Interest expense  (2,715)   (83,052)   (45,142)   2,147   (128,762) 
Net Interest Income Before MVA $32,846  $4,073  $3,807  $—  $40,726 
       
       
(Dollars in Thousands) Interest
Income		 Amortization Total
Interest
Income		 Average
Amortized
Cost		 Yield as a Result of
 Interest
Income		 Discount
Amortization		 Total
Interest
Income
IGS
                                   
Residential $393  $738  $1,131  $30,957   5.08%   9.54%   14.62% 
CDO  563   340   903   16,087   14.00%   8.45%   22.45% 
Total IGS  956   1,078   2,034   47,044   8.13%   9.17%   17.30% 
CES
                                   
CDO  198   116   314   9,139   8.67%   5.08%   13.75% 
Total CES  198   116   314   9,139   8.67%   5.08%   13.75 % 
Total Real Estate Securities $1,154  $1,194  $2,348  $56,183   8.22%   8.50%   16.72% 

Six Months Ended June 30, 2008

     
 Three Months Ended March 31, 2007
(In Thousands) Redwood Sequoia Acacia Elimination Redwood
Consolidated
Interest income $28,889  $129,280  $59,617  $(2,681)  $215,105 
Management fees  —   —   1,180   —   1,180 
Interest expense  (2,139)   (120,765)   (49,033)   2,681   (169,256) 
Net Interest Income Before MVA $26,750  $8,515  $11,764  $—  $47,029 
       
       
(Dollars in Thousands) Interest
Income		 Discount
Amortization		 Total
Interest
Income		 Average
Amortized
Cost		 Yield as a Result of
 Interest
Income		 Discount
Amortization		 Total
Interest
Income
IGS
                                   
Residential $475  $1,057  $1,532  $18,197   5.22%   11.62%   16.84% 
CDO  1,486   774   2,260   21,915   13.56%   7.06%   20.62% 
Total IGS  1,961   1,831   3,792   40,112   9.78%   9.13%   18.91% 
CES
                                   
CDO  198   116   314   4,570   8.67%   5.08%   13.75% 
Total CES  198   116   314   4,570   8.67%   5.08%   13.75% 
Total Real Estate Securities $2,159  $1,947  $4,106  $44,682   9.66%   8.71%   18.37% 

In addition to interest income on securities, the Fund realized gains of $2 million as a result of the sale of one asset during the second quarter.

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Net Interest Income Before MVA at Redwood

The table below presents the net interest income before MVA for the assets and liabilities held at Redwood, including the assets held in the Opportunity Fund for the first quartersResults of 2008 and 2007. It is followed by a discussion of the significant components of net interest income.

Table 4 Net Interest Income Before MVA at Redwood

      
 Three Months Ended March 31,
   2008 2007
(Dollars in Thousands) Total
Interest
Income
(Expense)		 Average
Amortized
Cost		 Yield Total
Interest
Income
(Expense)		 Average
Amortized
Cost		 Yield
Interest Income
                              
Cash and cash equivalents $2,250  $284,757   3.16%  $1,312  $137,735   3.81% 
Real estate loans  98   4,758   8.24%   (2,815)   8,157   (138.04)% 
Real estate securities  – AFS  29,021   418,953   27.71%   28,056   568,707   19.73% 
Real estate securities  – FVO  2,100   47,572   17.66%   —   —   — 
Other real estate investments  2,092   5,836   143.39%   2,336   35,228   26.52% 
Total Interest Income  35,561             28,889           
Interest Expense
                              
Interest expense on Redwood debt  (182)   21,477   (3.39)%   (82)   5,775   (5.68)% 
Interest expense on subordinated notes  (2,533)   146,242   (6.93)%   (2,057)   97,013   (8.48)% 
Total Interest Expense  (2,715)             (2,139)           
Net Interest Income Before MVA $32,846            $26,750           

Interest Income — Cash and Cash Equivalents

Interest income from cash and cash equivalents was $2 million in the first quarter of 2008, an increase from $1 million in the first quarter of 2007. The primary reason for this increase was higher average cash balances as we operated with higher levels of excess capital in the 2008 period. Yields were lower in the 2008 periods as short-term interest rates have declined over the last twelve months.

Interest Income — Real Estate Loans

We had minimal interest income on commercial real estate loans in the first quarter of 2008 as compared to negative $3 million realized in the first quarter of 2007. The charge in 2007 reflected a reserve for an anticipated loss on a mezzanine commercial loan financing for a condominium-conversion project.

During the first quarter of 2008, we owned a small balance of unsecuritized residential real estate loans that are being marketed for sale. In the first quarter of 2007, we did not own any real estate loans at Redwood. Interest income on loans we acquired in anticipation of a securitization through Sequoia are included in Sequoia’s interest income below.

Interest Income — Real Estate Securities AFS

Interest income on AFS securities during the first quarter of 2008 was $29 million, a slight increase from the $28 million earned in the first quarter of 2007. The table below presents the components of interest income and yield for real estate securities for the first quarters of 2008 and 2007.

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Table 5 Interest Income — AFS Securities at Redwood

Three Months Ended March 31, 2008
(Dollars in Thousands)

       
 Interest
Income		 Discount
(Premium)
Amortization		 Total
Interest
Income		 Average
Amortized
Cost		 Yield as a Result of
 Interest
Income		 Discount
(Premium)
Amortization		 Total
Interest
Income
AFS – Redwood
                                   
IGS
                                   
Residential $247  $382  $629  $15,794   6.26%   9.67%   15.93% 
Commercial  —   —   —   —   —   —   — 
CDO  923   435   1,358   27,743   13.31%   6.27%   19.58% 
Total IGS  1,170   817   1,987   43,537   10.75%   7.51%   18.26% 
CES
                                   
Residential  10,324   11,570   21,894   190,394   21.69%   24.31%   46.00% 
Commercial  6,523   (1,523)   5,000   183,446   14.22%   (3.32)%   10.90% 
CDO  140   —   140   1,576   35.53%   —   35.53% 
Total CES  16,987   10,047   27,034   375,416   18.10%   10.70%   28.80% 
Total AFS Real Estate Securities $18,157  $10,864  $29,021  $418,953   17.34%   10.37%   27.71% 

Three Months Ended March 31, 2007
(Dollars in Thousands)

       
 Interest
Income		 Discount
(Premium)
Amortization		 Total
Interest
Income		 Average
Amortized
Cost		 Yield as a Result of
 Interest
Income		 Discount
(Premium)
Amortization		 Total
Interest
Income
AFS – Redwood
                                   
IGS
                                   
Residential $744  $(141)  $603  $36,793   8.09%   (1.53)%   6.56% 
Commercial  49   —   49   3,191   6.14%   —   6.14% 
CDO  291   —   291   17,368   6.70%   —   6.70% 
Total IGS  1,084   (141)   943   57,352   7.56%   (0.98)%   6.58% 
CES
                                   
Residential  9,289   13,180   22,469   317,207   11.71%   16.62%   28.33% 
Commercial  5,849   (1,403)   4,446   186,838   12.52%   (3.00)%   9.52% 
CDO  198   —   198   7,310   10.83%   —   10.83% 
Total CES  15,336   11,777   27,113   511,355   12.00%   9.21%   21.21% 
Total AFS Real Estate Securities $16,420  $11,636  $28,056  $568,707   11.55%   8.18%   19.73% 

Interest income on IGS accounted for as AFS increased from $1 million in the first quarter of 2007 to $2 million in the first quarter of 2008. We have recently been acquiring IGS at prices that generate higher yields than we had been earning on these types of assets in prior years. This increase in yield resulted in an increase in interest income in the first quarter of 2008, as compared to the first quarter of 2007, even though our average balance was lower in the 2008 period. The election of how we account for future IGS acquisitions (i.e., available-for-sale or fair value option) will be made at the time of acquisition.

The majority of our real estate securities accounted for as AFS consist of residential and commercial credit-enhancement securities (CES). We acquire many first-loss residential securities at 25% to 35% of their principal value and other, more senior, credit-enhancement securities at 50% to 100% of their principal value. Many of these securities are priced at a substantial discount to their principal value since future credit losses could reduce or eliminate the principal value of these securities. Our yields on these investments depend on

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how much principal and interest we eventually collect and how quickly we receive those payments. The faster we collect principal and the longer it takes to realize credit losses, the better our investment returns.

Interest income from our residential CES was $22 million for the first three months of 2008, approximately the same amount of interest income earned in the first quarter of 2007. The level of income remained relatively stable as the decrease in the average balance was generally offset by an increase in our yields. This offset occurred in substantial part because of impairments we recorded in prior periods. If the dollar amount of the impairment exceeds any adverse change in cash flows, the yield we will subsequently report on the impaired asset may increase from previous levels. Even when the asset is impaired primarily due to adverse changes in future cash flows, the asset will be marked down to a lower price that may generate a higher yield based on the revised cash flows. The impact of previous impairments accounted for a large part of the increase in yields on our residential CES from the first quarter of 2007 (28.33%) to the first quarter of 2008 (46.00%).

The impact of the reduction in prepayment speeds during the first quarter of 2008 slightly offset the increase in yields. Residential real estate securities backed by ARMs and option ARMS represented 21% (by market value) of our residential CES portfolio at March 31, 2008. Average prepayment rates declined to 23% average constant prepayment rate (CPR) in the first quarter of 2008 compared to average speeds of over 36% CPR in 2007. Residential real estate securities backed by fixed and hybrid mortgage loans represented 79% of our residential CES portfolio at quarter end and average prepayment rates slowed to 12% CPR in the first quarter of 2008 compared to 15% CPR in 2007.

Residential real estate securities backed by option ARMs give the borrower the option of making a minimum payment that is less than the amount of interest owed for that loan period. The unpaid interest is added to the loan balance creating negative amortization (neg am). The amount of neg am interest we currently recognize or defer for GAAP purposes on option ARM securities depends on our expectation of collectability. We currently do not expect to collect the neg am interest on our securities backed by option ARMs. As a result, in the first quarter of 2008 we deferred recognition of neg am interest of $1 million on our securities backed by option ARMs. In the first quarter of 2007, we deferred $1 million, which represented the neg am interest on only our B-rated and non-rated securities backed by option ARMS. We will recognize any deferred interest on these securities only if and when cash is received. Our cumulative deferred neg am interest was $9 million at March 31, 2008, an increase from $8 million at December 31, 2007.

Interest income from our commercial CES was $5 million for the first three months of 2008, a slight increase over the same period in 2007. Our yield increased from 9.52% in the first quarter of 2007 to 10.90% in the first quarter of 2008. Similar to residential CES, commercial CES are acquired at a net discount. Commercial CES generally have a ten year maturity and are not expected to receive principal prepayments prior to maturity. Our yields will change as a result of observed and anticipated credit performance as well as from changes in the amortized costs of our portfolio (due to impairments or acquisitions).

Interest Income — Real Estate Securities FVO

Effective January 1, 2008, we elected to account for some IGS held at Redwood under the fair value option of FAS 159 (FVO). This includes certain IGS we acquired and subsequently sold during the period. Interest income recognized under this accounting method for these securities in the first quarter of 2008 included only the cash coupon earned on these securities. In 2007, we did not have FVO securities.

Interest Income — Other Real Estate Investments

Other real estate investments (OREI) held at Redwood consist of residential IOs, NIMs, and residuals and are accounted for as trading instruments. Although the fair value of these securities has fallen considerably, we may receive relatively high amounts of cash flow on certain of these assets. When that occurs, the interest income yield on these assets will be high during the relevant period. We expect the cash flows and resulting yields from these types of investments to be volatile.

Interest Expense — Subordinated Notes

During the first quarter of 2008, our interest expense on these notes was only slightly higher as short-term interest rates declined over the last twelve months which mostly offset the higher balance. Our

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subordinated notes bear interest at three-month LIBOR plus 225 basis points (2.25%). The cost of funds accrued on these notes includes the amortization of transaction costs.

Interest Expense — Redwood Debt

Interest expense on Redwood debt was nominal in the first three months of 2008 and 2007. Interest income during the first quarters of 2008 and 2007 represents interest on short-term debt incurred by Redwood to fund the acquisition of certain securities. We also use short-term debt to finance the accumulation of loans and securities in anticipation of a securitization by a Sequoia or Acacia entity and interest on this debt is included as expense for Sequoia and Acacia below.

Net Interest Income Before MVA atOperations – Sequoia

Sequoia is our brand name for securitizations of residential real estate loans which we sponsor. Although our exposure to these loans is limited to our investments in each Sequoia securitization entity, we are required under GAAP to consolidate these loansthe assets and ABS issued by theliabilities of Sequoia entities on our consolidated balance sheet. These assetssheets. Sequoia loans and liabilitiesABS issued are reported on aan amortized cost basis. The net interest income reported represents the GAAP earnings we realizedrecord on our investments in these entities and theany net spreadinterest earned during the accumulation of residential real estate loans.loans for securitization.

The following table presents the net interest income earned at Sequoia for the three and six months ended June 30, 2008 and 2007. It is followed by a discussion of the significant components of net interest income.

Table 68 Net Interest Income Before MVA at Sequoia

Three Months Ended March 31,June 30, 2008
(Dollars in Thousands)

            
 Interest
Income
(Expense)		 Net
(Premium)
Discount
Amortization		 Provision
For
Credit
Losses		 Total
Interest
Income
(Expense)		 Average
Amortized
Cost		 Yield      
(Dollars in Thousands) Interest
Income		 Net
(Premium)
Discount
Amortization		 Provision
For
Credit
Losses		 Total
Interest
Income		 Average
Amortized
Cost		 Yield
Interest Income
                                                            
Real estate loans $82,529  $(10,215)  $(10,061)  $62,253  $6,483,477   3.84% 
Cash and cash equivalents $29  $—  $—  $29  $3,670   3.16%   18   —   —   18   2,651   2.72% 
Real estate loans  102,663   (7,509)   (8,058)   87,096   6,895,530   5.05% 
Total Interest Income  102,692   (7,509)   (8,058)   87,125             82,547   (10,215)   (10,061)   62,271           
Interest Expense
                                                            
Interest expense on ABS issued  (82,986)   90   —   (82,896)   6,745,557   (4.92)%   (66,720)   (159)   —   (66,879)   6,349,662   (4.21)% 
Interest rate agreement (expense) income  (156)   —   —   (156)         (157)   —   —   (157)       
Total Interest Expense  (83,142)   90   —   (83,052)             (66,877)   (159)   —   (67,036)           
Net Interest Income Before MVA $19,550  $(7,419)  $(8,058)  $4,073         15,670   (10,374)   (10,061)   (4,765)       
Market valuation adjustments                 (974)           
Net Interest (Loss) Income at Sequoia $15,670  $(10,374)  $(10,061)  $(5,739)       

Three Months Ended June 30, 2007

      
      
(Dollars in Thousands) Interest
Income		 Net
(Premium)
Discount
Amortization		 Provision
For
Credit
Losses		 Total
Interest
Income		 Average
Amortized
Cost		 Yield
Interest Income
                              
Real estate loans $132,543  $(10,889)  $(2,500)  $119,154  $8,232,476   5.79% 
Total Interest Income  132,543   (10,889)   (2,500)   119,154           
Interest Expense
                              
Interest expense on ABS issued  (99,332)   (740)   —   (100,072)   7,105,117   (5.63)% 
Interest expense on repo debt  (13,271)   —   —   (13,271)   936,025   (5.67)% 
Interest rate agreement (expense) income  129   —   —   129       
Total Interest Expense  (112,474)   (740)   —   (113,214)           
Net Interest Income Before MVA  20,069   (11,629)   (2,500)   5,940       
Market valuation adjustments                 —           
Net Interest (Loss) Income at Sequoia $20,069  $(11,629)  $(2,500)  $5,940       

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ThreeTable 8 Net Interest Income at Sequoia – (continued)

Six Months Ended March 31, 2007June 30, 2008
(Dollars in Thousands)

            
 Interest
Income
(Expense)		 Net
(Premium)
Discount
Amortization		 Provision
For
Credit
Losses		 Total
Interest
Income
(Expense)		 Average
Amortized
Cost		 Yield      
(Dollars in Thousands) Interest
Income		 Net
(Premium)
Discount
Amortization		 Provision
For
Credit
Losses		 Total
Interest
Income		 Average
Amortized
Cost		 Yield
Interest Income
                                                            
Real estate loans $142,882  $(12,121)  $(1,481)  $129,280  $8,704,147   5.94%  $185,191  $(17,724)  $(18,119)  $149,348  $6,689,503   4.47% 
Cash and cash equivalents  47   —   —   47   2,910   3.23% 
Total Interest Income  142,882   (12,121)   (1,481)   129,280             185,238   (17,724)   (18,119)   149,395           
Interest Expense
                                                            
Interest expense on ABS issued  (96,585)   (1,467)   —   (98,052)   6,845,355   (5.73)%   (149,388)   (69)   —   (149,457)   6,547,610   (4.57)% 
Interest expense on repo debt  (22,073)   —   —   (22,073)   1,554,391   (5.68)% 
Interest rate agreement (expense) income  (640)   —   —   (640)         (313)   —   —   (313)       
Total Interest Expense  (119,298)   (1,467)   —   (120,765)             (149,701)   (69)   —   (149,770)           
Net Interest Income Before MVA $23,584  $(13,588)  $(1,481)  $8,515         35,537   (17,793)   (18,119)   (375)       
Market valuation adjustments                 (1,392)           
Net Interest (Loss) Income at Sequoia $35,537  $(17,793)  $(18,119)  $(1,767)       

Interest Income — Real Estate Loans

Six Months Ended June 30, 2007

Total

      
      
(Dollars in Thousands) Interest
Income		 Net
(Premium)
Discount
Amortization		 Provision
For
Credit
Losses		 Total
Interest
Income		 Average
Amortized
Cost		 Yield
Interest Income
                              
Real estate loans $275,425  $(23,010)  $(3,981)  $248,436  $8,467,002   5.87% 
Total Interest Income  275,425   (23,010)   (3,981)   248,436           
Interest Expense
                              
Interest expense on ABS issued  (195,917)   (2,207)   —   (198,124)   7,005,954   (5.66)% 
Interest expense on repo debt  (35,344)   —   —   (35,344)   1,251,938   (5.65)% 
Interest rate agreement (expense) income  (511)   —   —   (511)       
Total Interest Expense  (231,772)   (2,207)   —   (233,979)           
Net Interest Income Before MVA  43,653   (25,217)   (3,981)   14,457       
Market valuation adjustments                 —           
Net Interest (Loss) Income at Sequoia $43,653  $(25,217)  $(3,981)  $14,457       

Net interest (loss) income on residential real estate loans decreased to $87at Sequoia was a loss of $6 million in the three months ended March 31,second quarter of 2008 from $129compared to income of $6 million in the three months ended March 31, 2007. This decrease resulted from lower average balances of residential real estate loans, increased credit provisions in the first quarter of 2008 relative to the firstsecond quarter of 2007, and a decreasedecline of $12 million. Net interest (loss) income was a loss of $2 million in short-term interest rates which has reduced the coupon rates on these loans. Our average residential real estate loan balance decreased to $6.9 billion during the first quartersecond half of 2008 from $8.7 billion during the first quartercompared to income of 2007, reflecting loan repayments but offset by loan acquisitions$14 million in the first half of 2007.

At March 31, 2008, 66% of these residential real estate loans consisted of one or six-month LIBOR adjustable-rate loans (LIBOR ARMs). The level of short-term interest rates and the shape of the yield curve have an impact on the prepayment performance of LIBOR ARM loans. As the yield curve flattened and short-term interest rates rose beginning in early 2004, prepayments on these loans accelerated and, until recently, have generally prepaid at relatively fast speeds. In the second half of 2007, as the yield curve steepened and short-terma decline of $16 million. The primary reasons for these declines included higher credit loss provisions, lower interest rates, began to fall, prepaymentsand lower average loan balances.

The provision for credit losses on LIBOR ARMSequoia loans slowed considerably. The average constant prepayment rate for our LIBOR ARMs was 46% in 2006, 38% in 2007,reduced interest income by $10 million and 24% on an annualized basis in the first quarter of 2008.

Loan premium amortization expense was $8$18 million for the three and six months ended March 31,June 30, 2008, respectively, and $12$3 million forand $4 million in the three and six months ended March 31, 2007. The rate of prepayments of these loans is generally the primary factor in determining premium amortization and over the last several quarters, prepayment speeds have been slowing. However, for loans acquired prior to July 2004, which represented 35% of the loan balance at March 31, 2008, current short-term interest rates are also a contributing factor to our amortization of premium. As short-term rates decrease (which they have done in recent quarters) premium amortization potentially accelerates. During recent months, short-term rates have been falling, thus, even though principal paydowns for these loans during the first quarter equaled 7% of the December 31,June 30, 2007, balance, we amortized 10% of the premium balance that existed at the beginning of the quarter. See the Potential for GAAP Earnings Volatility below for further discussion.

During the first quarter of 2008, our provision for credit losses for residential loans was $8 million as compared to a provision of $1 million during the first quarter of 2007. As the residential loans on our consolidated balance sheet mature and if we do not acquire many new loans, we would expect to increase our credit reserve on a percentage basis, as we would expect our delinquencies to rise.respectively. On a percentage basis, our credit reserve increased to 0.36%0.77% of the residential loan balance at March 31,June 30, 2008 from 0.26% at December 31, 2007. Serious delinquencies (defined as those loans that are 90(90+ days or more delinquent, in foreclosure) in residential loans havedelinquent) increased to $118 million (1.87% of the current balances) at June 30, 2008, from $68 million (0.96% of the current loan balance)balances) at December 31, 2007 to $84 million (1.25%) at March 31, 2008.2007. As a percentage of original balance,balances, serious delinquencies increased to 0.42% at June 30, 2008, from 0.24% at December 31, 2007.

Average loan balances decreased to $6.5 billion in the second quarter of 2008 and $6.6 billion in the first half of 2008, from $8.2 billion in the second quarter of 2007 to 0.30% at March 31, 2008.and $8.5 billion in the first half of 2007, respectively. This reduced interest income and interest expense. The decreases in average balances resulted

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Interest Expense —

from repayments on existing loans with no offsetting loan acquisitions during the last twelve months. The average prepayment rate for Sequoia loans during 2008 (annualized) was 23%, compared to 38% in 2007 and 46% in 2006.

At June 30, 2008, 66% of Sequoia loan principal outstanding consisted of one-month or six-month LIBOR ARMs and 34% consisted of hybrid ARM loans. Coupons on six-month LIBOR ARMs have reset lower over the past year due to a decline in short-term interest rates over this period.

The following table presents the cost of funds at Sequoia for the three and six months ended June 30, 2008 and 2007.

Table 9 Cost of Funds of Asset-Backed Securities Issued by Sequoia

    
 Three Months Ended June 30, Six Months Ended June 30,
(Dollars in Thousands) 2008 2007 2008 2007
ABS issued interest expense $66,720  $99,332  $149,388  $195,917 
ABS issued issuance expense amortization  2,114   3,674   4,207   6,895 
Net ABS issued interest rate agreement income  157   (129)   313   511 
Net ABS issued issuance premium income
amortization		  (1,955)   (2,934)   (4,138)   (4,688) 
Total ABS Issued Interest Expense $67,036  $99,943  $149,770  $198,635 
Average balance of ABS issued $6,349,662  $7,105,117  $6,547,610  $7,005,954 
ABS issued interest expense  4.20%   5.59%   4.56%   5.59% 
ABS issued issuance expense amortization  0.13%   0.21%   0.13%   0.20% 
Net ABS issued interest rate agreement income  0.01%   (0.01)%   0.01%   0.01% 
Net ABS issued issuance premium income
amortization		  (0.12)%   (0.17)%   (0.13)%   (0.13)% 
Cost of Funds of ABS Issued  4.22%   5.62%   4.57%   5.67% 

Sequoia ABS Issued

Sequoia issued ABS that generally pays interest based on one-, three-, or six-month LIBOR, or in some instances, passes through the weighted average interest earned on the underlying assets. Interest expense declined due to lower average balances and lower interest rates. Some of the ABS issued was sold at a premium, andwhich we amortize this premiumas a component of interest expense over time. We also amortize the costs of the issuance ofSequoia ABS issued over their lives. Included in interest expense is the net expense on any interest rate agreements accounted fortime as cash flow hedges that we have entered into as part of our managinga component of interest rate risks for the asset and liabilities in Sequoia.expense.

Table 7 Cost

Results of Funds of Asset-Backed Securities Issued by Sequoia

  
 Three Months Ended March 31,
(Dollars in Thousands) 2008 2007
ABS issued interest expense $82,986  $96,585 
ABS issued issuance expense amortization  2,093   4,500 
Net ABS issued interest rate agreement income  156   640 
Net ABS issued issuance premium income amortization  (2,183)   (3,033) 
Total ABS Issued Interest Expense $83,052  $98,692 
Average balance of ABS issued $6,745,557  $6,845,355 
ABS issued interest expense  4.92%   5.64% 
ABS issued issuance expense amortization  0.12%   0.26% 
Net ABS issued interest rate agreement income  0.01%   0.04% 
Net ABS issued issuance premium income amortization  (0.13)%   (0.18)% 
Cost of Funds of ABS Issued  4.92%   5.77% 

Interest expense on Sequoia was lower in the first quarter of 2008 than in the first quarter of 2007 as the result of continued paydowns of the underlying assets and repayments associated ABS outstanding with little new issuance. Our cost of funds has also decreased as short-term interest rates have declined over the past twelve months as nearly all of the ABS issued by Sequoia is indexed on LIBOR.

Net Interest Income Before MVA atOperations – Acacia

Acacia is our brand name for the collateralized debt obligation (CDO) securitizations which we sponsor. The pool of assets held by these CDO securitizationAcacia entities primarily consists of IGS and some CES. The securities are backed by prime alt-a, and subprimenon-prime residential real estate loans and commercial real estate loans. Acacia also owns related assets such as real estate CDO securities, corporate debt issued by equity REITs, commercial real estate loans, and synthetic assets derived from real estate assets. Even though our investments in Acacia securities generally only represents a small portion of the ABS issued, we are required to consolidate the assets and liabilities of Acacia on our GAAP financial statements. The net interest income before MVA we report represents the GAAP earnings we realized on our investments in these entities. Beginning January 1, 2008, we elected to account for both the assets and liabilities of Acacia using the fair value option under FAS 159. Prior to that, the securities were accounted for as AFS, loans were accounted for as held-for-investment, and the ABS issued were reported at their cost basis.

As a result of the adoption of FAS 159, interest income on the existing Acacia assets will be lower in 2008 in comparison to 2007 as there is no longer an accretion of discount included in interest income on Acacia assets.

Cash distributions from our Acacia investments can be disrupted based on credit rating agencies’ downgrades of the underlying collateral or due to deterioration in collateral performance. Our investment in each of these entitiesAcacia entity is separate and independent, thus diminished performance on one of our investments would have no effect on our investments in the other Acacia entities.

We believeare required to consolidate the cash flows fromassets and liabilities of Acacia on our GAAP financial statements, even though our investments in four Acacia entities will be shut off in the second quarterrepresent only a small portion of 2008, and there is a strong likelihood that cash flows from our investments in a fifth entity will be disrupted within a year. During the first quarter ofeach Acacia securitization. Prior to 2008, we recognized a nominal amountwere required under GAAP to record most of net interest income before MVA from thesethe assets of Acacia at fair value, but we were required to record the paired liabilities at their amortized cost. As of January 1, 2008, we elected to adopt FAS 159 to value the assets and liabilities of the Acacia entities. This new GAAP standard significantly improved the disparity that existed between the carrying value of our Acacia equity investments and our estimate of their economic values.

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five entities. We recognized a total of $4 million inThe following table presents the net interest income before MVA duringearned at Acacia for the first quarterthree and six months ended June 30, 2008 and 2007. It is followed by a discussion of 2008 on all our Acacia investments as shown in the table below.significant components of net interest income.

Table 810 Net Interest Income Before MVA at Acacia

        
                
 Three Months Ended March 31, Three Months Ended June 30,
 2008 2007 2008 2007
(Dollars in Thousands) Total
Interest
Income
(Expense)		 Average
Amortized
Cost		 Yield Interest
Income
(Expense)		 Discount
(Premium)
Amortization		 Total
Interest
Income
(Expense)		 Average
Amortized
Cost		 Yield Total
Interest
Income		 Average
Balance		 Yield Interest
Income		 Discount
(Premium)
Amortization		 Total
Interest
Income		 Average
Amortized
Cost		 Yield
Interest Income
                                                                                
Commercial real estate loans $373  $18,773   7.95%  $381  $20  $401  $24,560   6.53% 
Trading securities  37,924   884,811   17.14%   54,028   8,199   62,227   3,083,256   8.07% 
Other investments  514   78,584   2.62%   464   —   464   38,681   4.80 % 
Cash and cash equivalents $902  $114,156   3.16%  $1,020  $—  $1,020  $107,081   3.81%   678   96,207   2.82%   1,955   —   1,955   151,257   5.17 % 
Commercial real estate loans  371   21,941   6.76%   363   21   384   20,029   7.67% 
Real estate securities  45,462   1,339,201   13.58%   50,341   7,743   58,084   2,606,754   8.91% 
Other real estate investments  —   —   —   129   —   129   1,941   26.58% 
Non-real estate investments  732   78,771   3.72%   —   —   —   — 
Total Interest Income  47,467             51,853   7,764   59,617             39,489             56,828   8,219   65,047           
Management fees  1,482             1,180        1,180           
Interest Expense
                                                                                
Interest expense on ABS issued  (44,052)   1,456,506   (12.10)%   (39,028)   (3,352)   (42,380)   2,492,698   (6.80)%   (30,306)   986,915   (12.28)%   (44,634)   (2,647)   (47,281)   2,841,157   (6.66) % 
Interest expense on repo debt  —             (8,939)        (8,939)   629,494   (5.68)%   —             (7,902)   —   (7,902)   490,261   (6.45)% 
Interest rate agreement (expense) income  (1,090)             2,286        2,286             (1,089)         3,229   —   3,229       
Total Interest Expense  (45,142)             (45,681)   (3,352)   (49,033)             (31,395)             (49,307)   (2,647)   (51,954)           
Net Interest Income Before MVA $3,807            $7,352  $4,412  $11,764             8,094         7,521   5,572   13,093       
Market Valuation Adjustments  (28,296)             (9,413)   —   (9,413)           
Net Interest (Loss) Income $(20,202)        $(1,892)  $5,572  $3,680       

Interest Income — Cash and Cash Equivalents

Interest

        
 Six Months Ended June 30,
   2008 2007
(Dollars in Thousands) Total
Interest
Income		 Average
Balance		 Yield Interest
Income		 Discount
(Premium)
Amortization		 Total
Interest
Income		 Average
Amortized
Cost		 Yield
Interest Income
                                        
Commercial real estate loans $744  $19,578   7.60%  $744  $41  $785  $24,413   6.43% 
Trading securities  83,386   1,000,271   16.67%   104,498   15,942   120,440   3,109,728   7.84% 
Other investments  1,246   78,632   3.17%   464   —   464   19,448   4.77% 
Cash and cash equivalents  1,580   100,768   3.14%   2,975   —   2,975   131,347   4.53% 
Total Interest Income  86,956             108,681   15,983   124,664           
Interest Expense
                                        
Interest expense on ABS issued  (74,826)   1,106,237   (13.53)%   (83,672)   (5,999)   (89,671)   2,640,150   (6.79)% 
Interest expense on repo debt  —             (16,841)   —   (16,841)   503,599   (6.69)% 
Interest rate agreement (expense) income  (2,179)         5,515   —   5,515       
Total Interest Expense  (77,005)             (94,998)   (5,999)   (100,997)           
Net Interest Income Before MVA  9,951         13,683   9,984   23,667       
Market Valuation Adjustments  (55,149)             (12,389)   —   (12,389)           
Net Interest (Loss) Income $(45,198)        $1,294  $9,984  $11,278       

Net interest (loss) income from cash and cash equivalentsat Acacia was $1a loss of $20 million in each of the first quarters of 2007 and 2008. Acacia generates a cash balance due the difference in timing between the monthly interest received on the assets in its securitization entities and the quarterly payments due on the ABS issued.

Interest Income — Commercial Real Estate Loans

Interest income from commercial real estate loans remained relatively stable each of the first quarters of 2007 and 2008.

Interest Income — Real Estate Securities FVO

The primary reason for the decrease in interest income earned from the first quarter of 2007 to the first quarter of 2008 was the adoption of the FVO under FAS 159 effective January 1, 2008 for these securities. Following the adoption of FAS 159, the interest income reported is equal to the cash coupon received; in prior periods, net interest income included the amortization of discount on certain assets. During the first quarter of 2007, we recorded $8 million of discount amortization in interest income. The amount we would have reported in the current period is now reflected as a component of MVA changes. The cost basis of these assets is now also equal to their fair values. Thus, even though our total interest income declined, our yields were higher in the first quarter of 2008 than in the first quarter of 2007 as the cost of these securities have been written down over the past year. The cash coupon on assets declined from the first quarter of 2007 to the first quarter of 2008 primarily as the result of lower short-term interest rates.

Interest Income — Other Real Estate Investments

Effective January, 1, 2008, the other real estate investments (OREI) in Acacia are accounted under the fair value option of FAS 159 and are now included in real estate securities FVO. In 2007, these were accounted for as trading instruments and we included an estimate of discount amortization to reflect a total market yield in interest income.

Interest Income — Non-Real Estate Investments

Interest income on non-real estate investments represents the cash coupon earned on a guaranteed investment contract (GIC) acquired by an Acacia securitization entity in the second quarter of 2007.2008 compared to income of $4 million in the second quarter of 2007, a decline of $24 million. Net interest income was a loss of $45 million in the first six months of 2008 compared to income of $11 million in the first six months of 2007, a decline of $56 million. The primary reason for these declines was an increase in negative market

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Management Fees

valuation adjustments (MVA) of $19 million and $43 million over comparable periods, respectively. We aredetail these adjustments in the manager of the Acacia entities and receive a management fee. Our asset management fees typically equal ten basis points of the outstanding principal balance of Acacia assets. These fees are paid to usMarket Valuation Adjustments section in a first or senior priority from the cash flows of Acacia assets. Our management feethis MD&A.

Net interest income increased over the past year as the result of the three new Acacia entities formed last year.

Interest Expense — Acacia ABS Issued

Interest expense on Acacia ABS issued increased to $44before MVA was $8 million in the first three monthssecond quarter of 2008 from $42compared to $13 million in the first three months of 2007, primarily as a result of an increase in liabilities resulting from the creation of three new Acacia entities in 2007. The adoption of FAS 159 on January 1, 2008, results in the appearance that the balance of ABS issued decreased and cost of funds increased as these liabilities are now reported at fair values.

At March 31, 2007, we had eight Acacia securitizations outstanding (including one completed in February 2007) and at March 31, 2008, we had ten Acacia securitizations outstanding. In 2007, we accounted for the ABS issued at cost and our cost of funds included cash and the amortization of the costs of issuance and any net premium on issuance of the ABS. Beginning in 2008, we account for Acacia ABS at their fair value. Over the past year, the fair values have decreased and our carrying values of the outstanding balance of Acacia ABS issued has decreased accordingly. One reason for the decrease in fair value is that the market is demanding higher yields, and thus, our interest expense in the first quarter of 2008, which includes the cash payments on Acacia ABS issued, reflects the higher cost of funds required in the current market environment.

Interest Expense — Acacia Warehouse Debt

In the firstsecond quarter of 2007, we were accumulating assets for inclusion in future Acacia entities completeda decline of $5 million. Net interest income before MVA was $10 million in the first half of 2007. We used warehouse financing facilities2008 compared to fund this accumulation and our interest expense during this period was $9 million. We are not currently accumulating assets in anticipation of a securitization and have no warehouse debt. We do not anticipate accumulating assets for this type of securitization in the near future.

Interest Expense — Interest Rate Agreements

On January 1, 2008 we elected FVO under FAS 159 for the interest rate agreements in Acacia. These derivatives were previously accounted for as cash flow hedges under FAS 133. This reclassification resulted in the de-designation of the cash flow accounting treatment and we retained the fair value of these derivatives at January 1, 2008 (negative $33 million) in accumulated other comprehensive income (an equity account) on our consolidated balance sheets. We will amortize this balance through interest expense over the remaining lives of the Acacia liabilities and,$24 million in the first quarterhalf of 2008, this amortization expense totaled $12007, a decline of $14 million. Any net payments and receipts, and theThese declines were primarily due to an accounting change in fair value of these derivatives are included in the market valuation change as discussed below.

Prior to 2008, when these derivatives were accounted for as cash flow hedges, the net payments and receipts were included in interest expense and any ineffective portion of the hedge (as determined according to GAAP) was recorded as a market valuation adjustment as discussed below.

Changes in Consolidated Interest Income and Interest Expense

The table below details how our consolidated interest income changed by portfolio as a result of changes in consolidated asset balances (“volume”) and yield (“rate”) for the three months ended March 31, 2008 as compared to the three months ended March 31, 2007.

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Table 9 Volume and Rate Changes for Interest Income

   
 Change in Interest Income
Three Months Ended
March 31, 2008 Versus March 31, 2007
(In Thousands) Volume Rate Total Change
Real estate loans, net of provisions for credit losses $(26,294)  $(12,991)  $(39,285) 
Real estate securities – Redwood  (16,096)   19,161   3,065 
Real estate securities – Acacia  (21,070)   8,983   (12,087) 
Other real estate investments  (2,078)   1,705   (373) 
Non-real estate investments  —   732   732 
Cash and cash equivalents  1,503   (654)   849 
Total Interest Income $(64,035)  $16,936  $(47,099) 

Volume change is the change in average balance of assets between periods multiplied by the rate earned in the earlier period. Rate change is the change in rate between periods multiplied by the average portfolio balance in the prior period. Interest income changes that resultedresulting from changes in both rate and volume were allocated to the rate change amounts shown in the table. For investments we did not own in prior periods, the entire change is shown as changes in volume in the table. This table does not include income on Sequoia ABS issued held at Acacia.

Due to the adoption of FAS 159 on January 1, 2008159. Our Acacia assets and other-than-temporary impairments on securities, the amortized cost of many of the securities consolidated on our balance sheet declined, which in many instances led to higher yields. Thus, this table shows a declineliabilities are now recorded as trading instruments, with only coupon interest included in interest income due primarily to a decrease in the volume of securities only partially offset by an increase in average yield. The magnitude of the increase in average yield was reduced as lower short-term interest rates resulted in lower coupon rates on adjustable rate mortgage loans. At the same time, the magnitude of the volume reduction was offset in part by an increase in the face amount of securities included on our consolidated financial statements.

The table below details how our consolidatedand interest expense changed by portfolioand all other adjustments recorded through market valuation adjustments as a resultseparate component of changes in consolidated liability balances (“volume”) and cost of funds (“rate”) for the three months ended March 31, 2008 as compared to the three months ended March 31, 2007.

Table 10 Volume and Rate Changes for Interest Expense

   
 Change in Interest Expense
Three Months Ended
March 31, 2008 Versus March 31, 2007
(In Thousands) Volume Rate Total Change
Interest expense on ABS – Sequoia $(1,400)  $(13,706)  $(15,106) 
Interest expense on ABS – Acacia  (16,667)   21,715   5,048 
Interest expense on Redwood debt  (30,789)   (123)   (30,912) 
Interest expense on subordinated notes  1,044   (568)   476 
Total Interest Expense on Total Obligation $(47,812)  $7,318  $(40,494) 

Volume change is the change in average balance of obligations between periods multiplied by the rate paid in the earlier period. Rate change is the change in rate between periods multiplied by the average outstanding obligations in the current period. Interest expense changes that resulted from changes in both rate and volume were allocated to the rate change amounts shown in the table.net interest income. This table does not include interest expense on Sequoia ABS issued held by Acacia.

The decrease in interest expense was due in part to the reduction in volume on ABS issued by Sequoia and a change in short-term interest rates which reduced our payments on all consolidated liabilities. However, similar toincludes the impact of interest rate agreements used to hedge the adoption FAS 159 noted above oninterest rate exposure of Acacia liabilities, which is a significant component of net interest income.

We received $5 million of cash distributions from our Acacia equity investments during the change in interest income,second quarter, but expect these distributions to diminish rapidly over the reported effectnext few quarters. During the first half of volume and rate changes2008, six of our Acacia equity investments stopped receiving cash distributions due to performance deficiencies (consisting primarily of rating agency downgrades of securities held by the Acacia ABS is perhaps misleading asentities), which significantly affected the yield we actually increased the face value of Acacia ABS outstanding over the past year but the effect of FAS 159 lowered our reported balance and increased the cost of fundsexpect to earn on these liabilities.

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TABLE OF CONTENTSinvestments. In total, four of our Acacia equity investments are currently receiving cash distributions and six are not receiving cash distributions as of June 30, 2008. There is a possibility that cash distributions from our equity investments in the remaining four Acacia entities will be disrupted for the same reason within a year, although it is difficult to predict the severity and timing of rating agency actions.

Market Valuation Adjustments – Consolidating

MarketNegative market valuation adjustments were the most significant factor affecting our earnings for the second quarter and first quarterhalf of 2008. Market valuation adjustments are MTM changes in the fair values of financial assets and liabilities consolidated on our financial statements that flow through our consolidated statements of (loss) income statements.under GAAP. The accounting rules regarding MTM accountingthat determine the measurement of fair values and the timing and amount of market valuation adjustments are complex and may not clearly reflect the underlying economics; a topic thattiming, nature, and extent of changing economic or market conditions. That is, more fullythe amount of market valuation adjustments recorded to our income statement during any specific reporting period may not precisely mirror the timing and extent of economic changes impacting the fair values of our investments. These economic factors are discussed under Critical Accounting Policies below. in the Market Conditions section of our report.

The following section providestables provide a discussionbreakout of the MTM changesmarket valuation adjustments that occurred in the first quarters ofthree and six months ended June 30, 2008 and 2007, and their effect on our consolidatedconsolidating income statements and balance sheets.

Table 11 Mark-to-MarketMarket Valuation Adjustments Impact on Consolidating Income Statement and Balance Sheet

   
 Three Months Ended March 31, 2008
(In Millions) Redwood Acacia Total
Income Statement Impact
               
Market valuation adjustments
               
FVO assets $(13)  $(787)  $(800) 
FVO liabilities  —   810   810 
Impairment on AFS securities  (144)   —   (144) 
Changes in fair value on trading instruments  (10)   (50)   (60) 
Total income statement impact  (167)   (27)   (194) 
Balance Sheet Impact
               
Adjustment to OCI  21   —   21 
Total Mark-to-Market Adjustments $(146)  $(27)  $(173) 
     
 Three Months Ended June 30, 2008
(In Millions) Redwood Opportunity
Fund		 Sequoia Acacia Total
Income Statement Impact
                         
Changes in fair value assets $(2)  $—  $(1)  $(33)  $(36) 
Changes in fair value liabilities  —   —   —   4   4 
Impairment on AFS securities  (29)   —   —   —   (29) 
Total income statement impact  (31)   —   (1)   (29)   (61) 
Balance Sheet Impact
                         
Net change in OCI  27   —   —   —   27 
Total Market Valuation Adjustments $(4)  $—  $(1)  $(29)  $(34) 
 

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Table 11 Market Valuation Adjustments Impact on Consolidating Income Statement and Balance Sheet – (continued)

     
 Three Months Ended June 30, 2007
(In Millions) Redwood Opportunity Fund Sequoia Acacia Total
Income Statement Impact
                    
Impairment on AFS securities $(12)  $—  $—  $(10)  $(22) 
Changes in fair value assets  (8)   —   —   —   (8) 
Total income statement impact  (20)   —   —   (10)   (30) 
Balance Sheet Impact
                         
Net change in OCI  (19)   —   —   (55)   (74) 
Total Market Valuation Adjustments $(39)  $—  $—  $(65)  $(104) 

        
 Three Months Ended March 31, 2007 Six Months Ended June 30, 2008
(In Millions) Redwood Acacia Total Redwood Opportunity
Fund		 Sequoia Acacia Total
Income Statement Impact
                                        
Market valuation adjustments
               
Changes in fair value assets $(25)  $—  $(1)  $(870)  $(896) 
Changes in fair value liabilities  —   —   —   814   814 
Impairment on AFS securities $(1)  $(1)  $(2)   (173)   —   —   —   (173) 
Changes in fair value on trading instruments  (6)   (2)   (8) 
Total income statement impact  (7)   (3)   (10)   (198)   —   (1)   (56)   (255) 
Balance Sheet Impact
                                        
Adjustment to OCI  (20)   (79)   (99) 
Total Mark-to-Market Adjustments $(27)  $(82)  $(109) 
Net change in OCI  48   —  $—   —   48 
Total Market Valuation Adjustments $(150)  $—  $(1)  $(56)  $(207) 

     
 Six Months Ended June 30, 2007
(In Millions) Redwood Opportunity
Fund		 Sequoia Acacia Total
Income Statement Impact
                         
Impairment on AFS securities $(13)  $—  $—  $(11)  $(24) 
Changes in fair value assets  (14)   —   —   (2)   (16) 
Total income statement impact  (27)   —   —   (13)   (40) 
Balance Sheet Impact
                         
Net change in OCI  (39)   —   —   (134)   (173) 
Total Market Valuation Adjustments $(66)  $—  $—  $(147)  $(213) 

Market Valuation Adjustments —at Redwood

At Redwood, we holdclassify most of our securities (excluding our investments in Sequoia and Acacia) as AFS and report these securities at their fair value.values in accordance with Statement of Financial Accounting Standards No. 115,Accounting for Certain Investments in Debt and Equity Securities (FAS 115). Net MTMmarket valuation adjustments were negative $146$4 million inand negative $150 million for the first quarter ofthree and six months ended June 30, 2008, respectively, as compared to negative $27$39 million in the first quarter of 2007. The MTM adjustmentsand $66 million for the first quarter of 2008 include a positive $1three and six months ended June 30, 2007, respectively.

We recorded $29 million adjustment during the quarter on securities owned by the Opportunity Fund. The MTM adjustments on these securities, which are accounted for as AFS, did not flow through our income statement, as there were no other-than-temporary impairments.

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The tables below detail the MTM adjustments on Redwood securities (including those at the Opportunity Fund) by underlying collateral type and by vintage.

Table 12 Mark-to-Market Adjustments by Underlying Collateral Type on Securities at Redwood

     
 Three Months Ended March 31, 2008
(In Millions) IGS CES Loans,
OREI &
Derivatives		 Total MTM
Percent(1)
Redwood
                         
Residential
                         
Prime $(10)  $(56)  $(1)  $(67)   (40)% 
Alt-a  (5)   (13)   (2)   (20)   (53)% 
Subprime  (1)   (1)   (1)   (3)   (21)% 
Residential total  (16)   (70)   (4)   (90)    
Commercial  —   (47)   —   (47)   (32)% 
CDO  (1)   (2)   —   (3)   (6)% 
Interest rate agreements & other derivatives  —   —   (6)   (6)    
Total Redwood Mark-to-Market Adjustments $(17)  $(119)  $(10)  $(146)    

(1)This percentage represents the MTMs taken as a percentage of the reported market values at the beginning of the period, or purchase price if acquired during the period. It is intended to highlight the price declines by collateral type for the three months ended March 31, 2008. These price declines are for our specific portfolio and may not be indicative of price declines in the market in general.

Table 13 Mark-to-Market Adjustments by Vintage on Securities at Redwood

Three Months Ended March 31, 2008

       
 Vintage  
(In Millions) 2004 &
Earlier		 2005 2006 2007 2008 Loans &
Derivatives		 Total
Mark-to-Market Adjustments $(35)  $(22)  $(34)  $(38)  $(10)  $(7)  $(146) 

For accounting purposes, an AFS security is deemed impaired if the fair value is below amortized cost. An assessment is then required as to whether the impairment is temporary and is reflected as unrealized losses in the balance sheet, or is other-than-temporary and realized through the income statement as a market valuation adjustment. The assessment of other-than-temporary impairments requires a determination of whether there has been an adverse change in the underlying cash flows generated by a security, whether we have the intent and ability to hold the security and whether we believe the impaired security will recover its value within a reasonable period of time. This is a highly complex and subjective evaluation.

Based on our assessment, we recorded $144$173 million of other-than-temporary impairments through our income statement in the first quarter of 2008.three and six months ended June 30, 2008, respectively. Most of these impairments were the result of changes in the market’s expectation of cash flows and credit and a portion of these impairments were the result of our assessment that the values of many types of

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certain securities would not be highly likely to recover within a reasonable period of time. In the first quarter of 2007, weWe recorded $1$12 million and $13 million of other-than-temporary impairments through our income statement in the three and six months ended June 30, 2007, respectively, primarily as a result ofdue to changes in the market’s expectation of cash flows and credit. Over the past twelve months, while the outlook for credit has worsened, it has also become more difficult to meet the accounting requirements needed to support the notion that the market value of securities is likely to return to the cost basis of the securities within a reasonable period of time. Thus, the combination of a deteriorating credit outlook and uncertainty in the outlook for the return to prior pricing of real estate securities within a reasonable time horizon are the primary reasons the level of impairments are so much greater in the first quarter of 2008 than in the same period in 2007. We continue to expect impairments to occur and the levels may vary significantly from quarter to quarter.

The following tables detail the market valuation adjustments on Redwood securities by underlying collateral type and by vintage.

Table 12 Market Valuation Adjustments by Underlying Collateral Type on Securities at Redwood

     
 Three Months Ended June 30, 2008
(In Millions) IGS CES Loans, &
Derivatives		 Total MTM
Percent(1)
Residential
                         
Prime $(2)  $13  $—  $11   6% 
Non-prime  (7)   (4)   —   (11)   (16)% 
Residential total  (9)   9   —   —    
Commercial  —   (6)   —   (6)   (7)% 
CDO  —   —   —   —      
Interest rate agreements & other derivatives  —   —   2   2    
Total Market Valuation Adjustments $(9)  $3  $2  $(4)    

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 Six Months Ended June 30, 2008
(In Millions) IGS CES Loans, &
Derivatives		 Total MTM
Percent(1)
Residential
                         
Prime $(13)  $(43)  $—  $(56)   (26)% 
Non-prime  (16)   (18)   —   (34)   (33)% 
Residential total  (29)   (61)   —   (90)    
Commercial  —   (53)   —   (53)   (37)% 
CDO  (1)   (2)   —   (3)   (15)% 
Interest rate agreements & other derivatives  —   —   (4)   (4)    
Total Market Valuation Adjustments $(30)  $(116)  $(4)  $(150)    

(1)This percentage represents the market valuation adjustments taken as a percentage of the reported market values at the beginning of the period, or the purchase price if acquired during the period. It illustrates the price declines by collateral type for the three and six months ended June 30, 2008. These price declines may not be indicative of price declines in the market in general.

Table 13 Market Valuation Adjustments by Vintage on Securities at Redwood

Three Months Ended June 30, 2008

       
 Vintage
(In Millions) 2004 &
Earlier		 2005 2006 2007 2008 Loans &
Derivatives		 Total
Market Valuation Adjustments $14  $(9)  $(7)  $(5)  $1  $2  $(4) 

Six Months Ended June 30, 2008

       
 Vintage
(In Millions) 2004 &
Earlier		 2005 2006 2007 2008 Loans &
Derivatives		 Total
Market Valuation Adjustments $(21)  $(31)  $(41)  $(43)  $(9)  $(5)  $(150) 

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All changes in

Market Valuation Adjustments at the fair valueFund

At June 30, 2008, all of assets accounted forthe investments held by the Fund were classified as FVO are included in market valuation adjustments. Certain prime and alt-a residential IGS and CDO IGS are accounted for as FVO. InAFS securities. We had no other-than-temporary impairments on these securities during the first quarterhalf of 2008, a portion (negative $3 million) of the total change in fair value (negative $13 million) on these FVO securities was on securities we subsequently sold during this period. In 2007, we did not have any FVO assets.

Changes in the fair value of our assets accounted for as trading instruments (other real estate investments and certain interest rate agreements) are included in market valuation adjustments. Also included in this category are negative valuation adjustments on loans held-for-sale. These other market valuation adjustments totaled negative $10 million in the first quarter of 2008 and negative $4 million in the first quarter of 2007. These adjustments in the first quarter of 2008 included $3 million in negative adjustments associated with synthetic instruments that we traded out of during the period.2008.

Market Valuation Adjustments —at Acacia

For accounting purposes, we consolidate the balance sheets and income statements of the Acacia securitization entities. On January 1, 2008, we adopted a new accounting standard,the fair value option under FAS 159 and elected to fair value bothfor the assets and liabilities of theowned by Acacia entities.securitization entitles, which we consolidate for financial reporting purposes. In accordance with FAS 159,the standard, we recorded a one-time, cumulative-effect adjustment to our January 1, 2008 opening balance sheet that decreased the carrying value of Acacia assets and liabilities by a net $1.5 billion, and increasedrecorded this fair value change as a one-time cumulative-effect adjustment to retained earnings, a component of stockholders equity. This new standard significantly reduces the disparity that existed between the GAAP carrying values of Acacia’s assets and liabilities.

As a consequence of adopting FAS 159, we will be required in theAll future to flowmarket valuation adjustments on Acacia are recorded through our quarterlyconsolidated income statementsstatements. Due to the relativeilliquid nature of Acacia investments and continued market volatility, there is no way to anticipate periodic valuation changes in future quarters.

During the three and six months ended June 30, 2008, the fair values of Acacia assets and liabilities, as measured in their independent markets. At the end of March 31, 2008, Acacia entities held securities (assets) with a face value of $3.5 billion and ABS issued (liabilities) of $3.3 billion. There is no way to anticipate these relative changes from quarter to quarter. As a consequence, our earnings could vary, potentially significantly, as asset and liability fair values fluctuate over time.

During the first quarter, after giving effect to the one-time adjustment under FAS 159, fair values of both the assets and liabilitiesnet, declined by approximately 40% during the first quarter of 2008. The assets and derivatives declined in value by $837$28 million and the ABS issued declined in value by $810 million. Thus, the net MTM change was thus negative $27$55 million, and was recorded throughrespectively. The following table details market valuation adjustments.

The tables below detail MTM adjustments on securities (assets) held byfor Acacia entities during the first quarter ofthree and six months ended June 30, 2008.

Table 14 Market Valuation Adjustments by Underlying Collateral Type on Securities held by Acacia Entities

          
 Three Months Ended March 31, 2008 Three Months Ended June 30, 2008
(In Millions) IGS CES Loans,
OREI &
Derivatives		 Total MTM
Percent(1)		 IGS CES Loans,
Liabilities &
Derivatives		 Total MTM
Percent(1)
Acacia
                         
Residential
                                                  
Prime $(266)  $(107)  $(5)  $(378)   (55)%  $12  $5  $—  $17   8% 
Alt-a  (204)   (35)   —   (239)   (52)% 
Subprime  (30)   (6)   —   (36)   (18)% 
Non-prime  (19)   (53)   —   (72)   (17)% 
Residential total  (500)   (148)   (5)   (653)      (7)   (48)   —   (55)    
Commercial  (21)   (76)   —   (97)   (36)%   —   2   —   2   1% 
CDO  (34)   (3)   —   (37)   (4)%   (5)   (3)   —   (8)   (14)% 
Interest rate agreements & other derivatives  —   —   (50)   (50)      —   —   29   29      
Total Mark-to-Market Adjustments $(555)  $(227)  $(55)  $(837)    
Liabilities  —   —   4   4    
Total Market Valuation Adjustments $(12)  $(49)  $33  $(28)    

     
 Six Months Ended June 30, 2008
(In Millions) IGS CES Loans,
Liabilities &
Derivatives		 Total MTM
Percent(1)
Residential
                         
Prime $(254)  $(102)  $(5)  $(361)   (67)% 
Non-prime  (253)   (94)   —   (347)   (46)% 
Residential total  (507)   (196)   (5)   (708)    
Commercial  (21)   (74)   —   (95)   (35)% 
CDO  (39)   (6)   —   (45)   (48)% 
Interest rate agreements & other derivatives  —   —   (21)   (21)      
Liabilities  —   —   814   814    
Total Market Valuation Adjustments $(567)  $(276)  $788  $(55)    

(1)This percentage represents the MTMsmarket valuation adjustments taken as a percentage of the reported market values at the beginning of the period, or the purchase price if acquired during the period. It is intended to highlightillustrates the price declines by collateral type for the three and six months ended March 31,June 30, 2008. These price declines are for our specific portfolio and may not be indicative of price declines in the market in general.

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Changes in Volume and Yields on Consolidated Investments and Borrowings

The following table details how our GAAP interest income changed as a result of changes in investment balances (“volume”) and yields (“rate”) at Redwood and our consolidated entities for the three and six months ended June 30, 2008, as compared to the three and six months ended June 30, 2007.

Table 15 Market Valuation Adjustments by Vintage on Securities held by Acacia Entities

Three Months Ended March 31, 2008

       
 Vintage  
(In Millions) 2004 &
Earlier		 2005 2006 2007 2008 Loans &
Derivatives		 Total
Mark-to-Market Adjustments $(177)  $(245)  $(249)  $(111)  $—  $(55)  $(837) 
Mark-to-Market Percent  (38)%   (48)%   (50)%   (49)%   —           

The table below details the MTM adjustments on ABS issued (liabilities) by Acacia entities during the first quarter.

Table 16 Market Valuation Adjustments of ABS Issued at AcaciaVolume and Rate Changes for Interest Income

     
 Three Months Ended March 31, 2008
(In Millions) 2004 &
Earlier		 2005 2006 2007 Total
AAA $102  $151  $197  $73  $523 
AA  16   24   17   —   57 
A  5   14   7   13   39 
BBB  2   5   9   153   169 
BB  —   —   5   9   14 
B  —   —   —   6   6 
NR  —   —   1   1   2 
Total $125  $194  $236  $255  $810 
      
 Change in Interest Income
June 30, 2008 Versus June 30, 2007
   Three Months Ended Six Months Ended
(In Thousands) Volume Rate Total Change Volume Rate Total Change
Real estate loans, net of provisions for credit losses $(25,289)  $(31,585)  $(56,874)  $(54,607)  $(41,551)  $(96,158) 
Real estate securities  (59,799)   25,465   (34,334)   (103,752)   60,022   (43,730) 
Other investments  479   (428)   51   1,412   (630)   782 
Cash and cash equivalents  776   (2,336)   (1,560)   3,085   (3,796)   (711) 
Total Interest Income $(83,833)  $(8,884)  $(92,717)  $(153,862)  $14,045  $(139,817) 

In our opinion,Our consolidated interest income decreased by $93 million, from $220 million for the best economic methodthree months ended June 30, 2007 to assess$127 million for the valuethree months ended June 30, 2008. Similarly, interest income decreased by $140 million, from $435 million for the six months ended June 30, 2007 to $295 million for the six months ended June 30, 2008. Interest income declined primarily because of our investments in Acacia ishigher credit reserves on loans and securities and lower interest rates. Accounting changes related to calculate the net present value of future expected cash flows from these investments. Our March 31, 2008 estimate of the sum of future expected cash flows from our investments in Acacia securities, plus management fees we anticipate receiving from those entities, was $304 million. The net present value of these cash flows discounted at 45% was $49 million. We believe that $49 million is a reasonable approximation of the economic value of our investments in Acacia at March 31, 2008. If we were permitted for accounting purposes to use the valuation methodology described above, GAAP and economics would be in sync, and our financial statements and disclosures would be less complicated.

Discrepancies between the economic and GAAP valuations of our Acacia investments will continue to occur, even after the adoption of FAS 159 because underalso contributed to the decrease in interest income as we no longer amortize purchase discounts into income on securities owned at Acacia. Balances on our loans were lower as a result of prepayments with no new acquisitions. Balances on securities were also lower due to impairments and the adoption of FAS 159, the cash flow valueoffset by new acquisitions during 2008.

The following table details how our GAAP interest expense changed, as a result of our investments is not taken into account in determining the carrying value of our investments. Instead, GAAP carrying value of our investments is derived by subtracting the fair value of Acacia’s liabilities from the fair value of Acacia’s assets. Furthermore, Acacia’s assets and liabilities are valued separately in their independent markets. In theory, changes in the fair values of Acacia’s assetsborrowings (“volume”) and liabilities should be reasonably correlated as they are paired within the same legal structure — ABS issued by each Acacia entity will be repaid directlyyields (“rate”) at Redwood and solely from the cash flows generated by the assets owned by that entity. However, at any given moment, the capital markets may use different discount rates and valuation parameters for Acacia’s collateral assets relative to its ABS issued to third parties. On March 31, 2008, for instance, the market values for Acacia liabilities were, in our view, depressed relative to the paired collateral asset values. As a consequence of this market condition, when we fair valued the assets and liabilities of the Acaciaconsolidated entities under FAS 159 at March 31, 2008, the derived net GAAP carrying value of our Acacia investments was $69 million. This result exceeded our $49 million estimate of economic value of our investments in Acacia entities based on the net present value of expected cash flows.

Operating Expenses

Total operating expenses were $16 million for the first three months of 2008, a decrease of $2 million from the first three months of 2007. Components of our operating expenses for the three and six months ended March 31,June 30, 2008 and 2007 are presented in the table below.

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Table 17 Operating Expenses

  
 Three Months Ended March 31,
(In Thousands) 2008 2007
Fixed compensation expense $5,674  $4,616 
Variable compensation expense  1,857   2,251 
Equity compensation expense  3,306   3,349 
Severance expense  —   2,380 
Total compensation expense  10,837   12,596 
Systems  2,133   1,656 
Due diligence  10   707 
Office costs  1,522   1,180 
Accounting and legal  1,101   855 
Other operating expenses  765   808 
Total Operating Expenses $16,368  $17,802 

The primary reason for the decrease in operating expenses was the decrease in compensation expense which, during the first quarter of 2007, included a severance expense of $2 million resulting from a reorganization of our residential and commercial operations. Fixed compensation expense includes employee salaries and related employee benefits. With our average headcount increasing year-over-year, we had higher fixed compensation expenses in the first quarter of 2008. Variable compensation expense includes employee bonuses, which are based on the annual adjusted return on equity earned by Redwood and individual performance. The accrued variable compensation expense was slightly lower in the first quarter of 2008 as the company performance is worse thus far in 2008 than in the first quarter of 2007. Equity compensation expense includes the cost of equity awards granted to employees and directors over the vesting period.

Realized Gains on Sales and Calls

Total realized gains on sales and calls were lower during the first three months of 2008 compared to the first three and six months of 2007 because we had no gains on sales, and there were fewer calls of securities during the first quarter of 2008 as shown in the table below.ended June 30, 2007.

Table 18 Realized Gains on Sales16 Volume and Calls, NetRate Changes for Interest Expense

  
 Three Months Ended March 31,
(In Thousands) 2008 2007
Realized gains (losses) on sales of:
          
Real estate loans $—  $— 
Real estate securities  —   (784) 
Interest rate agreements  —   1,087 
Total (losses) gains on sales  —   303 
Total gains on calls  42   843 
Total Realized Gains on Sales and Calls, Net $42  $1,146 
      
 Change in Interest Expense
June 30, 2008 Versus June 30, 2007
   Three Months Ended Six Months Ended
(In Thousands) Volume Rate Total Change Volume Rate Total Change
Interest expense on ABS – Sequoia $(10,727)  $(22,113)  $(32,840)  $(12,864)  $(35,399)  $(48,263) 
Interest expense on ABS – Acacia  (28,750)   16,093   (12,657)   (48,894)   41,743   (7,151) 
Interest expense on short-term Redwood debt  (22,627)   (5)   (22,632)   (53,529)   (15)   (53,544) 
Interest expense on long-term Redwood debt  609   (892)   (283)   1,654   (1,459)   195 
Total Interest Expense on Total Obligation $(61,495)  $(6,917)  $(68,412)  $(113,633)  $4,870  $(108,763) 

Other Comprehensive Income

As of December 31, 2007 most of our real estate securities were accounted for as AFS and were reported on our consolidated balance sheets at fair value and most of the derivative instruments in Acacia were accounted for as cash flow hedges and were also reported on our consolidated balance sheets at fair value. The differences between the value of these assets and their amortized costs were shown as a component of stockholders’ equity as accumulated other comprehensive income. Periodic changes in the fair value of these assets relative to amortized cost are included in other comprehensive income.

On January 1, 2008 we elected FVO for the assets, derivatives, and liabilities of Acacia and certain other assets at Redwood. The effect of this election was a reclassification of $458 million from accumulated other

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comprehensive income to retained earnings. This one time adjustment had no impact on our earnings. Subsequent changes to the values of FVO assets and liabilities flow through the income statement and not through other comprehensive income.

During the first quarter of 2008 (and subsequent to the adoption of FAS 159), as a result of the spread widening on real estate securities, their fair valuesOur consolidated interest expense decreased including those held at Redwood still accounted for as AFS. We determined that many of these securities were now other-than-temporarily impaired. This determination led to impairment charges of $144by $68 million, during the quarter. A portion of the impairment charges on these assets had been included in accumulated other comprehensive income at December 31, 2007. The net result of these declines in values, impairment charges, and associated reclassifications, was $21from $167 million in other comprehensive income for the quarter.

The table below provides cumulative balances of unrealized gains and losses and carrying value by type and rating of real estate securities at March 31, 2008 and December 31, 2007. It also reflects the change in balances of cumulative unrealized (loss) gains during the first quarter of 2008.

Table 19 Other Comprehensive Income (Loss) — Real Estate Securities

      
 Cumulative Unrealized
(Loss) Gain		 Adoption of
FAS 159		 Change in
(Loss) Gain		 Carrying Value
(In Thousands) March 31,
2008		 December 31,
2007		 January 1,
2008		 Three
Months
Ended
March 31,
2008		 March 31,
2008		 December 31,
2007
Investment – Grade Securities
                              
Residential $(7,035)  $(240,538)  $240,568  $(7,065)  $27,424  $1,157,464 
Commercial  —   (20,229)   19,701   528   —   89,676 
CDO  (4,145)   (12,750)   7,428   1,177   26,541   113,619 
Total IGS  (11,180)   (273,517)   267,697   (5,360)   53,965   1,360,759 
Credit – Enhancement Securities
                              
Residential  (42,502)   (143,510)   103,886   (2,878)   87,856   401,945 
Commercial  (8,252)   (124,948)   86,624   30,072   99,523   336,835 
CDO  10   822   —   (812)   686   10,541 
Total CES  (50,744)   (267,636)   190,510   26,382   188,065   749,321 
Total Real Estate Securities $(61,924)  $(541,153)  $458,207  $21,022  $242,030  $2,110,080 

Taxes

Provisions for Income Taxes

As a REIT, we are able to pass through substantially all of our earnings generated at our REIT to our shareholders without paying income tax at the corporate level. We pay income tax on the REIT taxable income we retain and on the income we earn at our taxable subsidiaries.

Our income tax provision in the first quarter of 2008 was $2 million, the same as in the first quarter of 2007. Our tax provision is based on our annual estimates of taxable income at our taxable subsidiaries and an estimate of the amount of REIT taxable income we will retain. Our estimates are subject to change as the year progresses.

Taxable Income and Dividends

For our quarterly taxable earning estimates, we project our taxable earnings for the year and assume many of these events happen throughout the year. However, some of the events that could have significant affect on our taxable earnings are difficult to project, including the amount and timing of credit losses, prepayments, and stock option exercises. Thus, our quarterly taxable earnings are likely to be volatile. See the discussion in Potential Tax Income Volatility below.

In the first quarter of 2008, we earned an estimated $26 million of total taxable income, or $0.79 per share. Of this amount, $25 million was earned at the REIT and $1 million was earned at our taxable

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subsidiaries. Total taxable income is not a measure calculated in accordance with GAAP; it is the pre-tax income calculated for tax purposes. REIT taxable income is that portion of our taxable income that we earn at Redwood Trust and its qualifying REIT subsidiaries and does not include taxable income earned in taxable subsidiaries. Estimated REIT taxable income is an important measure as it is the basis of our required dividend distributions to shareholders.

Total estimated taxable income of $26 million in the first quarter of 2008 was less than the $40 million earned in the first quarter of 2007. This decrease was primarily the result of increases in credit losses on CES, slower prepayment speeds on securities we own at a discount, and less income generated on our investments in Acacia.

Taxable income calculations differ from GAAP income calculations in a variety of ways. The most significant differences include the timing of amortization of premium and discounts and the timing of the recognition of gains or losses on assets. The rules for both GAAP and tax accounting for loans and securities are technical and complicated and the impact of changing interest rates, actual and projected prepayment rates, and actual and projected credit losses can have a very different impact on the amount of GAAP and tax income recognized in any one period. See the discussions under Potential GAAP Earnings Volatility and Potential Tax Earnings Volatility below for further information on this topic.

The table below reconciles GAAP income to total taxable income for the three months ended March 31, 2008 and 2007.

Table 20 Differences Between GAAP Net Income and Total Taxable Income

  
 Three Months Ended March 31,
(In Thousands, Except per Share Data) 2008 2007
GAAP net (loss) income $(171,587)  $18,309 
Difference in taxable income calculations
          
Amortization and credit losses  6,101   10,417 
Operating expense differences  1,491   (1,713) 
Realized gains on calls and sales  (5,273)   2,100 
Unrealized market valuation adjustements  193,932   9,118 
Income tax provisions  1,158   1,800 
Total differences in GAAP/tax income  197,409   21,722 
Taxable income $25,822  $40,031 
Shares used for taxable EPS calculations  32,710   27,129 
Total taxable income per share $0.79  $1.48 

Our board of directors declared a regular dividend of $0.75 per shareJune 30, 2007 to $99 million for the first quarterthree months ended June 30, 2008. Similarly, interest expense decreased by $109 million, from $337 million for the six months ended June 30, 2007 to $228 million for the six months ended June 30, 2008. Interest expense fell primarily as a result of 2008. Aslower average balances and lower short-term interest rates. The adoption of FAS 159 and paydowns on ABS issued with no new issuance led to the decline in average balances over the past few years, we currently plan to retain 10% of our 2008 taxable REIT income and defer the distribution of a portion of our taxable REIT income to shareholders into the subsequent year. At March 31, 2008, there was $47 million ($1.43 per share) of estimated 2008 and 2007 undistributed estimated REIT taxable income that we plan to distribute to our shareholders during 2008.twelve months.

We continue to be in compliance with all REIT tests. We generally attempt to avoid acquiring assets or structuring financings or sales at the REIT that could generate unrelated business taxable income or excess inclusion income that would be distributed to our shareholders or that would cause prohibited transaction taxes on the REIT. There can be no assurance that we will be successful in doing so.

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Potential GAAP Earnings Volatility

We expect quarter-to-quarter GAAP earnings volatility from our business activities at Redwood and our consolidated entities. This volatility can occur for a variety of reasons, including the timing and amount of purchases, sales, calls, and callsrepayment of consolidated assets, changes in interest rates, prepayments, credit losses, changes inthe fair values of consolidated assets and liabilities, and capital utilization.certain non-recurring events. In addition, volatility may occur because of technical accounting issues, some of which are described below.

LoanChanges in Premium Amortization for Loans at Sequoia

OurThe unamortized loan premium for loans owned by Sequoia was $68 million at June 30, 2008. The amount of periodic premium amortization expense we recognize is volatile and dependent on our consolidated residential real estatea number of factors, including credit performance of the underlying loans, at March 31, 2008 was $79 million. This will be expensed over the remaining life of these loans. Amortization for a significant portion of this premium balance is driven by effective yield calculations that depend onchanges in prepayment speeds, and changes in short-term interest rates and prepayments (see Critical Accounting Policies for further details).rates. Loan premium amortization was $8$18 million in the first quartersix months of 2008 and $12$23 million in the first quartersix months of 2007. Declines

Changes in short-term interest ratesDiscount Amortization for Securities at Redwood and increases in prepayments could causethe Fund

The unamortized discount, net of designated credit reserves, for securities owned at Redwood and the Fund was $229 million at June 30, 2008. The amount of periodic discount amortization income we recognize is volatile and dependent on a significant increase in required amortization in subsequent periods.

In addition, premium amortization expense acceleration could occur if we reclassify a portionnumber of factors, including credit performance of the underlying loans, from held-for-investment to held-for-sale, as the GAAP carrying value of these loans is currentlychanges in excess of their fair value. This reclassification could occur as the various underlying pools of loans become callableprepayment speeds, and we decide to sell these loans, or it could occur if there is a changechanges in accounting principles.

FVO Assets and Liabilities

As of January 1, 2008 we elected FVO for all assets, derivatives, and liabilities in Acacia and certain other assets at Redwood. We also plan to elect FVO for certain new acquisitions. These FVO elections under FAS 159 could lead to significant GAAP volatility as we will now MTM through the income statement each quarter all of the assets and liabilities of Acacia and certain other assets and liabilities. The market value of paired assets and liabilities may not move in tandem in any one quarter. Thus, even if the liabilities can only be paid from the cash flows of the collateral assets (asshort-term interest rates. Discount amortization on securities was $17 million in the Acacia securitization entities), we may report significant income or lossfirst six months of 2008 and $27 million in a period.the first six months of 2007.

Changes in Fair Values on Real Estate Securitiesof Consolidated Assets and Liabilities

All ourof the securities owned at Redwood and consolidated entities are classified as AFS,either trading instruments, or FVO,available-for-sale (AFS) securities, and in allboth cases are carried on our consolidated balance sheets at their estimated fair values. For the trading instruments and FVO securities, changes in fair values are recorded in the fair value flow throughconsolidated statements of (loss) income. Periodic fluctuations in the income statement. values of these investments are inherently volatile and thus can lead to significant GAAP earnings volatility each quarter.

For AFS securities, cumulative unrealized gains and losses are reportedrecorded as a component of accumulated other comprehensive (loss) income in our consolidated statements of stockholders’ equity. However,equity (deficit). Unrealized gains and losses are not charged against current earnings to the extent they are temporary in nature. Certain factors may require us however, to recognize these amounts as other-than-temporary impairments and record them through our current earnings. Factors that determine other than temporary impairment include a change in our ability or intent to hold assets, adverse changes to projected cash flows related to poor credit performance, our decision to sellof assets, or the likelihood that declines in the fair values of assets would not return to their previous levels within a reasonable time could create an other-than-temporary impairment for accounting purposestime. Impairments on securities are generally non-recurring and could cause declines in fair valuescan lead to be reported through our income statement as market valuation adjustments.significant GAAP earnings volatility each quarter.

At March 31,As of January 1, 2008, we had $232 million of securities at Redwood. Of these, $98 million were backed by residential prime loans ($78 million CESelected to adopt a new accounting standard, FAS 159, to record the assets and $20 million IGS), $17 million were backed by option alt-a residential loans ($9 million CES, $5 million IGS,liabilities in Acacia and $3 millioncertain other real estate securities), $2 million were backed by residential subprime loans ($1 million CES and $1 million IGS), $100 million were CES backed by commercial loans, and $15 million were CDO IGS.

Most of these securitiesassets at Redwood (88%, or $205 million) are accountedat fair value. We may also elect the fair value option for as AFS. Incertain new acquisitions in the event future credit performance onfuture. Our FAS 159 elections significantly improved the disparity that existed between the GAAP carrying value of our CES securities is worse thanAcacia equity investments and our current projections, we would be required to report losses through our income statement. The remaining portion (12%, or $27 million, including prime and alt-a residential IGS, CDO IGS, and other real estate securities) are accounted for as FVO or trading instruments. Allestimate of their economic value. However, valuation changes in their fair valuesthese financial instruments are reported through our income statement.

At March 31, 2008, the Opportunity Fund had $36 million of securities accounted for as AFS. Of these, $9 million were subprime IGSinherently volatile and $27 million were CDO IGS.can lead to significant GAAP earnings volatility each quarter.

Changes in Fair Values of Derivative Financial Instruments

To date, we have elected three classificationsWe currently account for consolidated derivative instruments: FVO,financial instruments as trading instruments in accordance with Statement of Financial Accounting Standards No. 133,Accounting for Derivative Instruments and cash flow hedges. All derivativeHedging Activities (FAS 133). Derivative financial instruments regardless of classification, are reported on our consolidated balance

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balance sheets at fair value. Changes to thevalue, with changes in fair valuesvalue and all associated income and expense recorded as a component of the derivatives classified as FVO or trading instruments are recognized through thenet interest income in our consolidated statements of income (loss). For those income. Previously, we had designated certain derivatives accounted for as cash flow hedges the changes in fair values are reported throughaccordance with FAS 133. We de-designated these hedging relationships in conjunction with our adoption of FAS 159 on January 1, 2008. The net unrealized loss (effective portions) from these hedging derivatives is currently being expensed into our consolidated balance sheets with onlystatements of (loss) income over the ineffective portions (as determined accordingexpected remaining lives of the ABS that they were formerly designated to the accounting provisions) reported through our income statement.hedge under FAS 133.

We couldcan experience significant earnings volatility from our use of derivatives. This could occur, for example, when changes in the fair valuesOne source of significant volatility can be from timing differences of interest rate adjustments between adjustable rate assets and adjustable rate liabilities at Acacia. Most of the derivativesadjustable rate assets in Acacia pay interest at one-month LIBOR, while adjustable rate liabilities generally pay interest at three-month LIBOR. Our interest rate agreements are primarily benchmarked to swap rates. While we expect these interest rate agreements to be effective hedges over time, interest rate mismatches between reporting periods can significantly distort the effects of derivative market valuation adjustments on our reported throughearnings. In addition, our income statement butpresentation for Acacia has changed due to our de-designation of cash flow hedge accounting relationships and our adoption of FAS 159. This may add significant volatility to reported net interest income before market valuation adjustments on our consolidated income statements.

Changes in Future Accounting Principles

In August 2008, the FASB will issue an exposure draft for comments on proposed amendments to FAS 140 and FIN 46(R). The FASB is proposing removal of the concept of a qualifying special-purpose entity (QSPE) from FAS 140 and the related scope exceptions from FIN 46(R). In addition, they propose to (1) make certain changes to the derecognition provisions in FAS 140 and (2) modify the fair valuesconsolidation model in FIN 46(R). As a result, if these decisions become final, enterprises involved with QSPEs will no longer be exempt from applying FIN 46(R), thus, previously unconsolidated entities may have to be consolidated. The FASB voted to modify the hedgedexisting consolidation model by introducing a two-step approach into Interpretation 46(R). Step 1 in determining the primary beneficiary is a qualitative analysis that takes into account who has the explicit or implicit power to affect the VIE’s activities. Step 2 is a quantitative analysis using a calculation of expected losses and expected residual returns that is only applied if the primary beneficiary cannot be determined in step 1. The FASB has proposed that the amendments be effective for all VIEs (except for certain existing QSPEs) and new transfers of financial assets or liabilitiesfor fiscal years beginning after January 1, 2010.

We are not recognized in a similar manner. Earnings volatility could also occur as we expandcurrently evaluating this exposure draft and its potential impact on our use of derivatives, including acquiring derivatives as investmentsfuture financial statements and not just as hedging instruments.related disclosures.

Potential Tax Income Volatility

We expect quarter-to-quarter estimated taxable income volatility for a variety of reasons, such as the timing of credit losses and prepayments on our consolidated investments, and equity award taxation.

Differences between GAAP Net (Loss) Income and Total Taxable Income

Taxable income may vary from quarterestimates are not calculated in accordance with GAAP, which can result in significant differences between GAAP (loss) income and taxable income estimates for the same reporting period. The following table reconciles GAAP (loss) income to quarter based on many reasons,total taxable income for the three of which are discussed below.and six months ended June 30, 2008 and 2007.

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Table 17 Differences between GAAP Net (Loss) Income and Total Taxable Income

  
 Three Months Ended June 30,
(In Thousands, Except per Share Data) 2008 2007
GAAP net (loss) income $(45,909)  $11,416 
Difference in taxable income calculations
          
Amortization and credit losses  (7,377)   10,298 
Operating expense differences  706   (2,921) 
Realized gains on calls and sales  (5,834)   (3,589) 
Market valuation adjustments, net  60,619   29,430 
Income tax provisions  1,447   1,662 
Total differences in GAAP/tax income  49,561   34,880 
Taxable income $3,652  $46,296 
Shares used for taxable EPS calculations  33,184   27,816 
Total taxable income per share $0.11  $1.66 

  
 Six Months Ended June 30,
(In Thousands, Except per Share Data) 2008 2007
GAAP net (loss) income $(217,496)  $29,725 
Difference in taxable income calculations
          
Amortization and credit losses  (1,283)   20,715 
Operating expense differences  2,197   (4,634) 
Realized gains on calls and sales  (11,100)   (2,635) 
Market valuation adjustments, net  254,551   39,694 
Income tax provisions  2,605   3,462 
Total differences in GAAP/tax income  246,970   56,602 
Taxable income $29,474  $86,327 
Shares used for taxable EPS calculations  32,947   27,473 
Total taxable income per share $0.90  $3.14 

Credit Losses on Securities at Redwood

To determine estimated taxable income we are not permitted to anticipate, or reserve for, credit losses. Taxable income can only be reduced when credit losses occur. Ason investments that we purchase at a consequence,discount (usually CES). For tax purposes, we are required to accrete the entire purchase discount on CESa security into taxable income over theirthe expected life.life of the security. Estimated taxable income is only reduced when actual credit losses occur. For GAAP purposes, we do anticipatereserve for credit losses and only accrete a portion of the purchase discount, if any, into income. Additionally, for GAAP weWe are also required to write-down these securities when theythat become impaired. As a result, ourOur income recognition on CES is therefore faster for tax as compared to GAAP, especially in the early years of owning the assetsa discount security (when there are generally few credit losses). At March 31,June 30, 2008, the cumulative difference between the GAAP and tax amortized costs basis of our residential, commercial, and CDO CES was $377$402 million. In addition, as of March 31,June 30, 2008, we had a credit reservean allowance for loan losses (GAAP) of $27$35 million for GAAP for our consolidated residential and commercial loans. As of March 31, 2008, we also had a $9 million reserve for accrued interest on securities backed by option ARMs for GAAP and no corresponding reserve on this income for tax. As we have no credit reserves for tax, and a higher CES basis, any future credit losses on our CES or loanssecurities would have a more significant impact on tax earnings as compared tothan on GAAP earnings and may create significant taxable income volatility to the extent the level of credit losses variesfluctuates during reporting periods.

Income Recognition on Sequoia Interest-Only Securities (IOs) at Sequoia

As part of our investment in Sequoia securitization entities, we often retain interest-only (IO) securities. Our current tax basis in these securities is $45 million. As a result of rapid prepayments in prior years and in spite of(in recent years) on the recent slowdown in prepayments onloans underlying these loans,securities, we continue to experience negative economic returns on some IOs we acquired from prior Sequoia securitizations. For tax purposes, however,IO’s. Since we are not permitted to recognize a negative yield sounder tax accounting rules, the periodic premium amortization expensesexpense has been relatively low and the cost basis for tax havethese securities has not been as high as they otherwise would have been based on the economic returns. That is, we are able to amortize our tax basis on these IOs by the amount of cash we received, effectively reporting zero income on these IOs until the tax basis issignificantly reduced. As a result, our current tax basis is $55 million and will continue to decrease as we earn cash on these IOs. ManyWith many of our Sequoia securitization entities are currentlysecuritizations callable and others will becomeor becoming callable over the next two years. Depending on prevailing market conditions, we may call certain securitizations, at which time theyears, our remaining IO

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tax basis willmay be written off and anduring future periods. This would create ordinary losslosses for tax will be realized. At this time, weand potential taxable earnings volatility in future periods. We do not currently anticipate calling any Sequoia dealssecuritizations in 2008. Our taxable earnings will vary from period to period based on the exact timing of these Sequoia calls.

Compensation Expense at Redwood

CompensationThe total tax expense for tax varies depending onequity award compensation is dependent upon varying factors such as the timing of dividend equivalent rights payments, the exercise of stock options, the distribution of deferred stock units, and the deferrals to and withdrawals from our executive deferred compensation plan.Executive Deferred Compensation Plan. For the most part, for GAAP, the total expense associated with an equity award is determined at the award date and is generally recognized over the vesting period. For tax, the total expense is recognized at the date of distribution or exercise. This leads toexercise and not the possibility that the totalaward date. The amount of compensation expense related to equity awards could therefore be significantly different for GAAPtax than for taxGAAP, in addition to the differences in timing.

Financial Condition

The consolidating balance sheet presents our financial condition at Redwood, including our investments in the Opportunity Fund, Sequoia, and Acacia entities. We consolidate these entities for GAAP reporting purposes, but they are not separate business segments. This presentation highlights the impact from the consolidation of those entities on our overall financial condition. A discussion of significant balance sheet accounts is provided in the section that follows.

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FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES

Management’s Supplemental Analysis

The table set forth below shows the consolidating components of our consolidated balance sheet at March 31, 2008 after giving effect to the adoption of FAS 159 on January 1, 2008. We elected to apply FAS 159 to fair value the assets and liabilities of Acacia and certain other real estate securities held at Redwood. We did not elect to apply FAS 159 to Sequoia assets or liabilities, to most of the securities owned by Redwood, or to Redwood’s debt or subordinated notes.

Table 2118 Consolidating Balance Sheet

           
March 31, 2008
(In Thousands)		 Redwood Sequoia Acacia Intercompany Adjustments Redwood Consolidated
June 30, 2008
(In Millions)		 Redwood
Parent Only		 Opportunity
Fund		 Sequoia Acacia Intercompany
Adjustments		 Redwood
Consolidated
Real estate loans $4,695  $6,751,491  $18,801  $—  $6,774,987  $4  $—  $6,354  $19  $—  $6,377 
Real estate and other securities – FVO  23,371   —   925,768   —   949,139 
Real estate and other securities – AFS  242,030   —   88,188   (88,188)   242,030 
Other real estate investments  3,437   —   —   —   3,437 
Non-real estate investments  —   —   78,770   —   78,770 
Real estate securities, at fair value:
                              
Trading securities  19   —   —   822   —   841 
Available-for-sale securities  334   66   —   84   (84)   400 
Other investments  —   —   —   79   —   79 
Cash and cash equivalents  256,895   —   —   —   256,895   148   —   —   —   —   148 
Total earning assets  530,428   6,751,491   1,111,527   (88,188)   8,305,258   505   66   6,354   1,004   (84)   7,845 
Investment in Opportunity Fund  47   —   —   —   (47) 
Investment in Sequoia  145,680   —   —   (145,680)   —   140   —   —   —   (140)   — 
Investment in Acacia  68,614   —   —   (68,614)   —   41   —   —   —   (41)   — 
Restricted cash  11,180   315   137,758   —   149,253   2   29   —   72   —   103 
Accrued interest receivable  (1,983)   32,284   7,232   —   37,533   5   —   27   8   —   40 
Derivative assets  —   —   3,964   —   3,964   —   —   —   5   —   5 
Deferred tax asset  8,481   —   —   —   8,481   8   —   —   —   —   8 
Deferred asset-backed securities issuance costs  3,678   12,820   —   —   16,498   3   —   11   —   —   14 
Other assets  13,135   3,009   8,850   —   24,994   8   —   22   1   —   31 
Total Assets $779,213  $6,799,919  $1,269,331  $(302,482)  $8,545,981  $759  $95  $6,414  $1,090  $(312)  $8,046 
Redwood debt $2,086  $—  $—  $—  $2,086 
Short-term debt – Redwood $9  $—  $—  $—  $—  $9 
Asset-backed securities issued – Sequoia  —   6,544,491   —   —   6,544,491   —   —   6,259   —   (84)   6,175 
Asset-backed securities issued – Sequoia FVO (IC)  —   88,188   —   (88,188)   — 
Asset-backed securities issued – Acacia FVO  —   —   1,046,160   —   1,046,160 
Asset-backed securities issued – Acacia  —   —   —   935   —   935 
Accrued interest payable  1,423   16,847   25,612   —   43,882   1   —   15   16   —   32 
Derivative liabilities  5,993   —   128,217   —   134,210   2   —   —   98   —   100 
Accrued expenses and other liabilities  10,085   4,713   728   —   15,526   8   1   —   —   —   9 
Dividends payable  24,532   —   —   —   24,532   25   —   —   —   —   25 
Subordinated notes  150,000   —   —   —   150,000 
Long-term debt – Redwood  150   —   —   —   —   150 
Total liabilities  194,119   6,654,239   1,200,717   (88,188)   7,960,887   195   1   6,274   1,049   (84)   7,435 
Minority interest  —   47   —   —   —   47 
Total stockholders’ equity  585,094   145,680   68,614   (214,294)   585,094   564   47   140   41   (228)   564 
Total Liabilities and Stockholders’ Equity $779,213  $6,799,919  $1,269,331  $(302,482)  $8,545,981  $759  $95  $6,414  $1,090  $(312)  $8,046 

At March 31,June 30, 2008, our stockholders’ equity totaled $585$564 million, we had unrestricted cash of $257$148 million, and we had short-term Redwood debt of only $2$9 million.

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The following supplemental non-GAAP balance sheetcomponents of book value presents our assets and liabilities as reported under GAAP and as estimated by us using economic values for our investments. We show our investments in the Fund, Sequoia, and Acacia securitization entities inas separate line items similar to the equity method of accounting,

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reflecting the reality thataccounting. This presentation highlights our specific ownership interest in these entities, as the underlying assets and liabilities owned by these entities are legally not ours. We own only the securities we have acquired from these entities. This table, except for our estimates of economic value, is derived from the table above.

Table 2219 Components of Book Value

      
 March 31, 2008 June 30, 2008
(In Millions, Except per Share Data) As Reported Adjustments Management's
Estimate of
Economic Value		 As Reported Adjustments Management's
Estimate of
Economic Value
Real estate securities (excluding Sequoia and Acacia)
                         
Residential $126   —  $126  $247       $247 
Commercial  100   —   100   91        91 
CDO  42   —   42   15      15 
Subtotal real estate securities  268   —   268   353        353 
Cash and cash equivalents  257   —   257   148        148 
Investments in Opportunity Fund  47        47 
Investments in Sequoia  146   (54)(a)   92   140   (65)(a)   75 
Investments in Acacia  68   (19)(b)   49   41   (22)(b)   19 
Other assets/liabilities, net(d)  (4)        (4)   (15)        (15) 
Subordinated notes  (150)   78(c)   (72) 
Long-term debt – Redwood  (150)   78(c)   (72) 
Stockholders' Equity  $585      $590   $564      $555 
Book Value Per Share  $17.89      $18.04   $17.00      $16.72 

(a)Our actual Sequoia investments consist of CES, IGS, and IOs acquired by Redwood from the Sequoia entities. We calculated the $92$75 million estimate of economic value for these securities using the same valuation process that we followed to fair value all other real estate securities. In contrast, the $146$140 million of GAAP carrying value of these investments represents the difference between residential real estate loans owned by the Sequoia entities and the asset-backed securities (ABS) issued by those entities to third party investors. We account for these loans and ABS issued at cost, not at fair value. This is the primary reason for the $54 million disparity between GAAP carrying value and our estimate of economic value.
(b)Our actual Acacia investments consist of equity interests, and to a lesser extent ABS issued, that we acquired from the Acacia entities. The $49$19 million estimate of economic value of our investment interests in the Acacia entities at March 31,June 30, 2008 represents the net present value of projected cash flows from our Acacia investments and management fees discounted at 45%, except for the CDO ABS that we have recently repurchased at substantial discounts from face which are valued at cost. We valued our equity interests at the amount of cash we received in July and expect to receive in August and September 2008. We are not valuing any future cash flows from equity distributions beyond the third quarter. The reason for the difference between economic and GAAP carrying values is complex and relates to a significant difference in valuation methodology.
(c)We issued $150 million of 30-year subordinated noteslong-term Redwood debt at an interest rate of LIBOR plus 225 basis points. Under GAAP, these notes are carried at cost. Economic value is difficult to estimate with precision as the market for thesethe notes is currently inactive. We calculatedestimated the $72 million estimate of economic value using the same valuation process used to fair value our other financial assets and liabilities. Estimated economic value is $78 million lower than our GAAP carrying value because given the significant overall contraction in credit availability and re-pricing of credit risk, ifrisk. If we had issued these subordinated notes at March 31,June 30, 2008, investors would have required a substantially higher interest rate.
(d)Other assets/liabilities, net are comprised of real estate loans of $5$4 million, restricted cash of $11$2 million, $8 million of deferred taxes, $5 million of accrued interest, and other assets of $24$11 million, less Redwood debt of $2$9 million, dividendaccruals of $8 million, dividends payable of $25 million, and other liabilities of $17$3 million.

In reviewing the non-GAAP supplemental components of book value, there are a number of important factors and limitations to consider. The estimated fair value of our stockholders’ equity is calculated as of a particular point in time based on our existing assets and liabilities and does not incorporate other factors that may have a significant impact on that value, most notably the impact of future business activities. As a result,

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Summary

the estimated economic value of our stockholders’ equity does not necessarily represent an estimate of our net realizable value, liquidation value or our market value as a whole. Amounts we ultimately realize from the disposition of assets or settlement of liabilities may vary significantly from the estimated economic values presented in our non-GAAP supplemental components of book value. Because temporary changes in market conditions can substantially affect the economic value of our stockholders’ equity, we do not believe that short-term fluctuations in the economic value of our assets and liabilities are necessarily representative of the effectiveness of our investment strategy or the long-term underlying value of our business. As discussed in “Note 5. Fair Value of Financial Instruments”, when quoted market prices or observable market data are not available to estimate fair value, we rely on Level 3 inputs. Because assets and liabilities classified as Level 3 are generally based on unobservable inputs, the process of calculating economic value is generally more subjective and involves a high degree of management judgment and assumptions. These assumptions may have a significant effect on our estimates of economic value, and the use of different assumptions as well as changes in market conditions could have a material effect on our results of operations or financial condition.

Redwood Capital and Liquidity

During the second quarter, we maintained our strong balance sheet. At June 30, 2008, we had $148 million of unrestricted cash. We ended the second quarter with total capital of $714 million, which includes excess capital of $132 million available to make new investments. Our reported capital base consists of $564 million of common equity and $150 million of long-term Redwood debt due in 2037.

As a supplement to our Consolidated Statement of Cash Flows included in this Quarterly Report for the six months ended June 30, 2008 and 2007, we have included the non-GAAP table below that summarizes the sources and uses of our cash for the second quarter of 2008. This table excludes the gross cash flows that are not available to Redwood that are generated by our Sequoia and Acacia securitization entities and the Fund, but does include the cash flow generated by our investments in those entities.

The followingcash generated by our investments is one of the financial metrics on which we focus. In the second quarter, our investments generated cash from principal and interest of $65 million, compared to $70 million in the first quarter. We also received $1 million of asset management fees in the second quarter. The net investment cash flow after deducting long-term Redwood debt and short-term debt interest expense of $2 million and cash operating expenses of $12 million was $52 million, compared to $54 million in the first quarter.

Table 20 Redwood Sources and Uses of Cash

 
(In Millions) Three Months
Ended
June 30, 2008
Sources:
     
Cash from investments $65 
Equity raised  14 
Management fees  1 
Short-term borrowings  7 
Changes in working capital  5 
Total Sources  92 
Uses:
     
Acquisitions  (152) 
Additional investment in Opportunity Fund  (10) 
Dividends paid  (25) 
Operating expenses paid  (12) 
Interest expense  (2) 
Total Uses  (201) 
Net Uses of Cash  (109) 
Beginning Cash Balance at 3/31/08  257 
Ending Cash Balance at 6/30/08 $148 

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The primary reason for the decline in net investment cash flow was lower interest income resulting from the decline in short-term interest rates during the recent quarters which has lowered coupon rates we earn on adjustable rate assets.

The $65 million of cash flow from investments includes $40 million of coupon interest and $25 million of principal. We caution readers that given the nature of our investments (deep discount credit-sensitive securities, IGS at discounts, IO’s, equity investments in Acacia, and other types) it is difficult to draw conclusions in any one period about what portion of our cash flow represents “income” and what is a discussion“return of capital”. It is only at the end of the asset’s life that we can accurately determine what portion of the cumulative cash received (whether principal or interest) was truly income and what was a return of capital.

Table 21 Cash Flow by Vintage

Three Months Ended June 30, 2008

      
 Vintage
(In Millions) 2004 &
Earlier		 2005 2006 2007 2008 Total
Redwood $17  $10  $6  $5  $1  $39 
Opportunity Fund  1   1   —   —   —   2 
Sequoia  14   1   —   4   —   19 
Acacia  2   2   1   —   —   5 
Total $34  $14  $7  $9  $1  $65 

We note that credit losses on securities have no immediate impact on our cash flow at the time a loss is realized, although they will result in a reduction in the principal balance of the security. Cash flow receipts will therefore be reduced in future periods since interest payments will be based on a reduced principal balance. Additionally, the ability to potentially recover the full purchase discount from face value will be reduced by the amount of the loss.

We caution that the amount of cash flow from existing investments could be volatile from quarter to quarter depending on prepayment patterns, changes in interest rates, and the level of credit losses. Overall, we expect cash flow from existing investments to trend lower over time. Future cash flows could be positively impacted by the timing and the success of our business of investing in, financing,new investment activity.

Residential Real Estate Loans at Sequoia and managingRedwood

We did not acquire any residential real estate loans during the first half of 2008. We plan to resume acquiring high-quality residential real estate loans on a bulk or flow basis from originators once the economics for securitization improve. Prior to 2006, our loan purchases were predominately comprised of short reset LIBOR-indexed ARMs. In 2006 and securities2007 we expanded our Sequoia’s product offerings to include high-quality hybrid loans (loans with a fixed-rate coupon for a period of two to ten years before becoming adjustable).

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The following table provides details of our residential real estate loans activity for the six months ended June 30, 2008. Loans are predominantly owned by typethe Sequoia securitization entities and the reported activity is associated with those loans. The residential loans held outside of earning asset consolidated on ourany securitization entity and owned by Redwood totaled $4 million at June 30, 2008.

Table 22 Residential Real Estate Loans at Sequoia and Redwood — Activity

  
(In Millions) Three Months
Ended
June 30, 2008		 Six Months
Ended
June 30, 2008
Balance at beginning of period $6,756   7,178 
Acquisitions  —   — 
Sale proceeds  —   — 
Principal repayments  (365)   (764) 
Transfers to real estate owned  (13)   (20) 
Changes in fair value, net  —   — 
Premium amortization  (10)   (18) 
Provision for credit losses  (10)   (18) 
Balance at End of Period $6,358  $6,358 

Our residential real estate loan balance sheet.declined to $6.4 billion at June 30, 2008 from $7.2 billion at December 31, 2007. At June 30, 2008, 66% of residential loans (by unpaid principal balance) were one-month or six-month LIBOR ARMs and the remaining 34% were hybrid loans. Our residential loans are financed almost entirely through Sequoia securitization entities.

Real Estate Securities at Redwood

The following table provides detaildetails of theour securities activity at Redwood for the first quarter ofthree and six months ended June 30, 2008, with respect to the securities at Redwood, excluding our investments in Acacia and Sequoia and securities owned by those securitization entities and excluding the securities held at the Opportunity Fund.Redwood.

Table 23 Real Estate Securities Activity at Redwood

Three Months Ended June 30, 2008

             
March 31, 2008
(In Thousands)		 Residential
CES		 Residential
IGS		 Commercial
CES		 CDO
CES		 CDO
IGS		 Total
(In Millions) Residential
CES		 Residential
IGS		 Commercial
CES		 CDO
CES		 CDO
IGS		 OREI Total
Balance at beginning of period $151,009  $12,226  $148,508  $2,372  $18,450  $332,565  $88  $26   100   1   16   3  $234 
Acquisitions  10,159   28,048   —   —   —   38,207   3   147   —   —   —   —   150 
Principal repayments (including calls)  (16,787)   (1,702)   —   30   —   (18,459)   (16)   (4)   —   —   (2)   —   (22) 
Recognized gains on calls, net  42   —   —   —   —   42   —   —   —   —   —   —   — 
Discount amortization  11,570   63   (1,523)   —   —   10,110   6   1   (2)   —   —   —   5 
Upgrades/downgrades  —   —   —   —   —   —   — 
Transfer from (to) other portfolios  953   3,105   —   —   —   4,058   —   —   —   —   —   —   — 
Change in fair value adjustments, net  (68,749)   (15,890)   (47,462)   (1,716)   (2,946)   (136,763)   6   (10)   (7)   (1)   1   (3)   (14) 
Balance at End of Period $88,197  $25,850  $99,523  $686  $15,504  $229,760  $87  $160  $91  $—  $15  $—  $353 

Six Months Ended June 30, 2008

       
(In Millions) Residential
CES		 Residential
IGS		 Commercial
CES		 CDO
CES		 CDO
IGS		 OREI Total
Balance at beginning of period $151  $12  $149  $2  $18  $12  $344 
Acquisitions  13   175   —   —   —   —   188 
Principal repayments (including calls)  (32)   (6)   —   —   (2)   (1)   (41) 
Recognized gains on calls, net  —   —   —   —   —   —   — 
Discount amortization  17   2   (4)   —   —   —   15 
Upgrades/downgrades  1   (1)   —   —   —   —   — 
Transfer from (to) other portfolios  —   4   —   —   —   (5)   (1) 
Change in fair value adjustments, net  (63)   (26)   (54)   (2)   (1)   (6)   (152) 
Balance at End of Period $87  $160  $91  $—  $15  $—  $353 

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During the second quarter of 2008, we acquired $38$150 million securities, had MTM adjustments of negative $139 million, principal payments of $19$22 million, and discount amortization of $10$5 million, had negative market valuation adjustments of $14 million, resulting in a net $112$124 million reductionincrease in our securities portfolio to $353 million at June 20, 2008, from $344 to $229$234 million at March 31, 2008.

At March 31, 2008, in addition to the $229 We also acquired $2 million of previously issued Sequoia ABS during the quarter, which does not appear on our consolidated balance sheets. During the first half of 2008, we acquired $188 million securities, described above there were $3had principal payments of $41 million, discount amortization of OREI$15 million, negative market valuation adjustments of $154 million, and net portfolio transfers of negative $1 million, resulting in a net $9 million increase in our securities portfolio to $353 million at Redwood.June 30, 2008, from $344 million at June 30, 2007.

The following table below provides product type and vintage information regarding the $232$353 million of securities owned by Redwood.Redwood at June 30, 2008.

Table 24 Real Estate Securities at Redwood

            
March 31, 2008
(In Millions)		 2004 & Earlier 2005 2006 2007 2008 Grand
Total
June 30, 2008
(In Millions)		 2004 &
Earlier		 2005 2006 2007 2008 Grand
Total
Prime
                                                            
IGS $4  $1  $9  $—  $6  $20  $43  $27  $21  $4  $7  $102 
CES  48   15   5   8   2   78   56   12   4   6   1   79 
Alt-a
                              
OREI  —   —   —   —   —   — 
Non-prime
                              
IGS  —   —   1   4   —   5   —   29   13   16   —   58 
CES  1   4   1   3   —   9   3   2   1   2   —   8 
OREI  —   —   2   1   —   3   —   —   —   —   —   — 
Subprime
                              
IGS  1   —   —   —   —   1 
CES  —   —   —   1   —   1 
Residential Subtotal  54   20   18   17   8   117   102   70   39   28   8   247 
Commercial IGS  —   —   —   —   —   —   —   —   —   —   —   — 
Commercial CES  16   21   48   15   —   100   15   18   45   13   —   91 
CDO IGS  7   7   —   1   —   15   8   6   —   1   —   15 
CDO CES  —   —   —   —   —   — 
Totals $77  $48  $66  $33  $8  $232  $125  $94  $84  $42  $8  $353 

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The following table presents the carrying value (which equals fair value) as a percent of face value at March 31,June 30, 2008 for the securities at Redwood.

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Table 25 Fair Value as Percent of Principal Value for Real Estate Securities at Redwood

             
                          
               2004 & Earlier 2005 2006 2007 2008 Total
(Dollars in Millions)(Dollars in Millions) 2004 & Earlier 2005 2006 2007 2008 Total(Dollars in Millions) Value % Value % Value % Value % Value % Value %
  Value % Value % Value % Value % Value % Value %
Prime
                                                                                                                                  
  Resi – IGS
                                                               Resi – IGS
                                                             
            AAA  $1   89%  $—   —  $—   —  $—   —  $—   —  $1   89%             AAA  $1   93%  $4   79%  $13   76%  $—   —  $—   —  $18   78% 
            AA   1   65%   —   —   —   —   —   —   3   55%   4   56%             AA   19   76%   21   69%   —   —   4   70%   4   70%   48   72% 
            A   —   —   —   —   9   50%   —   —   1   40%   10   49%             A   13   59%   —   —%   8   50%   —   —   2   55%   23   55% 
            BBB   2   35%   1   21%   —   —   —   —   2   32%   5   29%             BBB   10   49%   2   30%   —   —   —   —   1   28%   13   42% 
  Resi – IGS Total   4   50%   1   24%   9   50%   —   0%   6   44%   20   44%   Resi – IGS Total   43   63%   27   64%   21   50%   4   —   7   44%   102   63% 
  Resi – CES
                                                               Resi – CES
                                                             
            B   12   29%   7   22%   2   28%   3   17%   1   18%   25   24%             BB   16   35%   8   27%   2   26%   3   19%   1   19%   30   29% 
            B   15   33%   2   15%   1   9%   3   12%   1   14%   22   22%             B   17   38%   1   8%   1   14%   2   8%   —   —   21   24% 
            NR   21   14%   6   6%   2   5%   2   6%   —   0%   31   9%             NR   23   16%   3   4%   1   2%   1   3%   —   —   28   9% 
  Resi – CES Total   48   20%   15   11%   5   8%   8   10%   2   15%   78   14%   Resi – CES Total
   56   24%   12   10%   4   5%   6   7%   1   19%   79   20% 
  Total Prime     
  $52   21%  $16   11%  $14   16%  $8   10%  $8   28%  $98   17%   Total Prime  $99   33%  $39   23%  $25   26%  $10   12%  $8   32%  $181   27% 
Alt-A
                                                                 
Resi – IGS
                                                            
Non-prime
Non-prime
                                                            
            AAA  $—   —  $—   —  $—   —  $2   30%  $—   —  $2   30%   Resi – IGS
                                                             
            A   —   —   —   —   —   —   1   95%   —   —   1   95%             AAA  $—   —  $29   62%  $13   67%  $15   58%  $—   —  $57   62% 
            BBB   —   —   —   —   1   60%   1   27%   —   —   2   34%             BBB   —   —   —   —   —   —   1   3%   —   —   1   3% 
  Resi – IGS Total
   —   —   —   —   1   60%   4   33%   —   —   5   35% 
  Resi – CES                                                             
            B   —   —   —   —   —   —   2   3%   —   —   2   4% 
            NR   1   5%   4   9%   1   2%   1   2%   —   —   7   4% 
  Resi – CES Total   1   5%   4   9%   1   2%   3   3%   —   —   9   4% 
  OREI   —   —   —   —   2   1%   1   10%   —   —   3   1% 
  Total Alt-A  $1   5%  $4   9%  $4   8%  $8   7%  $—   —  $17   8% 
Subprime
                                                                 
  Resi – IGS                                                               Resi – IGS Total   —   —   29   62%   13   66%   16   58%   —   —   58   62% 
            BBB  $1   50%  $—   —  $—   —  $—   —  $—   —  $1   50%   Resi – CES                                                             
  Resi – IGS Total   1   50%   —   —   —   —   —   —   —   —   1   50%             B   1   5%   —   —   —   —   1   3%   —   —   2   10% 
  Resi – CES                                                                         NR   2   13%   2   6%   1   2%   1   2%   —   —   6   3% 
            NR   —   —   —   —   —   —   1   4%   —   —   1   4%   Resi – CES Total   3   13%   2   7%   1   2%   2   2%   —   —   8   3% 
  Resi – CES Total   —   —   —   —   —   —   1   4%   —   —   1   4%   OREI   —   —   —   —   2   1%   1   10%   —   —   3   1% 
  Total Subprime  $1   50%  $—   —  $—   —  $1   4%  $—   —  $2   18%   Total Non-prime  $3   13%  $31   44%  $14   21%  $18   13%  $—   —  $66   22% 
CMBS
                                                                  
  Comm – CES                                                               Comm – CES                                                             
            BB  $5   54%  $—   —  $6   26%  $3   22%  $—   —  $14   30%             BB  $5   55%  $—   —  $6   26%  $3   21%  $—   —  $14   30% 
            B   —   —   —   —   7   22%   6   19%   —   —   13   21%             B   —   —   —   —   7   21%   5   19%   —   —   12   20% 
            NR   11   22%   21   17%   35   17%   6   17%   —   —   73   18%             NR   10   23%   18   14%   32   16%   5   14%   —   —   65   16% 
  Comm – CES Total   16   27%   21   17%   48   18%   15   19%   —   —   100   19%   Comm – CES Total   15   29%   18   14%   45   17%   13   17%   —   —   91   18% 
  Total CMBS   $ 16   27%   $ 21   17%   $ 48   18%   $15   19%   $ —   —   $ 100   19%   Total CMBS  $15   29%  $18   14%  $45   17%  $13   17%  $—   —  $91   18% 
CDO
                                                                                                                                  
  CDO – IGS                                                               CDO – IGS                                                             
            AAA  $—   —  $7   36%  $—   —  $—   —  $—   —  $7   36%             AAA  $—   —  $6   34%  $—   —  $—   —  $—   —  $6   34% 
            AA   7   54%   —   —   —   —   —   —   —   —   7   54%             AA   8   58%   —   —   —   —   —   —   —   —   8   58% 
            BBB   —   —   —   —   —   —   1   5%   —   —   1   5%             BBB   —   —   —   —   —   —   1   3%   —   —   1   4% 
  CDO – IGS Total   7   54%   7   36%   —   —   1   5%   —   —   15   25%   CDO – IGS Total   8   58%   6   34%   —   —   1   3%   —   —   15   26% 
  Total CDO  $7   54%  $7   36%  $—   0%  $1   5%  $—   —  $15   25%   Total CDO  $8   58%  $6   34%  $—   —  $1   3%  $—   —  $15   26% 

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Over 80%Approximately 51% of our investments in real estate securities at March 31,June 30, 2008 were residential and commercial CES.credit enhancement securities (CES). We acquire CES at a significant discount to their principal value as credit losses could reduce or totally eliminate the principal value of these bonds. Our return on these investments is based on how much principal and interest we receive, and how quickly we receive it. In an ideal environment we would experience fast prepayments and low credit losses, allowing us to recover a substantial part of the discount as income. Conversely, the least beneficial environment would be slow prepayments and high credit losses.

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The following table presents the components of carrying value (which equals fair value) at March 31,June 30, 2008 for residential and commercial CES.

Table 26 Credit-Enhancement Securities at Redwood

      
March 31, 2008
(In Millions)		 Residential 
 Prime Alt-a Commercial
June 30, 2008
(In Millions)		 Residential
Prime Non Prime Commercial
Current face $538  $217  $523  $390  $319  $518 
Unamortized discount, net  (61)   (1)   (37)   (49)   (17)   (33) 
Discount designated as credit reserve  (358)   (205)   (378)   (252)   (297)   (384) 
Amortized cost  119   11   108   89   5   101 
Gross unrealized market value gains  3   —   2   9   4   3 
Gross unrealized market value losses  (44)   (2)   (10)   (19)   (1)   (13) 
Carrying Value $78  $9  $100  $79  $8  $91 
Carrying value as a percentage of face  14 %   4 %   19%   20%   3%   18 % 

We also own $1 million subprime CES with a face value of $36 million.

Residential Credit-Enhancement Securities at Redwood

A significant part of our business in terms of capital employed is investing in residential CES. These credit-enhancement securities have credit ratings that are below investment-grade and have both the upside opportunities and downside risks that come from taking on concentrated credit risks.

We acquired $10 million residential CES the first quarter of 2008 which were all prime securities.

Our residential CES portfolio had a fair value of $88$87 million at March 31,June 30, 2008, a decrease of $63$64 million from the fair value of $151 million at December 31, 2007. The primary reason was a decline in fair values in these securities during this period. We acquired $3 million residential CES during the second quarter of 2008, which were all prime securities.

CES have credit ratings that are below investment-grade and have both the upside opportunities and downside risks that are assumed with concentrated credit investments. As a result, of the concentrated credit risk associated with residential CES, we are generally able to acquire these securities at a discount to their face (principal) value. At March 31,June 30, 2008, the difference between the principal value ($778709 million) and carrying value ($8887 million) —, which equals the fair value, of thesewas $622 million for residential loan CES — was $690.CES. Of this difference, $584$549 million was designated as internal credit reserve (reflecting our estimate of credit losses on the underlying loans over the life of these securities), $64$66 million represented unamortized discount we are accreting into income over time, and $42$7 million represented net unrealized mark-to-market losses. Amortized cost on residential CES (principal value less internal credit reserve less amortized discount) decreased $72$108 million to $94 million at June 30, 2008 from $202 million at December 31, 2007, to $130 million at March 31, 2008 primarily as a result of declines in fair values and the effect of the impairment charges. Net unrealized mark-to-market gainslosses on residential CES fell by $9$44 million to $7 million at June 30, 2008, from net losses of $51 million at December 31, 2007 to net losses of $42 million at March 31, 2008.

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The following table details our residential CES portfolios by the product type and collateral vintage at March 31,June 30, 2008.

Table 27 Residential Credit-Enhancement Securities at Redwood — Product and Vintage

            
 Vintage Vintage
March 31, 2008
(In Millions)		 2004 &
Earlier		 2005 2006 2007 2008 Total
June 30, 2008
(In Millions)		 2004 &
Earlier		 2005 2006 2007 2008 Total
Prime
                                                            
Option ARM $3  $3  $1  $1  $—  $8 
ARM  4   —   —   —   —   4  $5  $—  $—  $—  $—  $5 
Hybrid  28   12   3   3   1   47   32   12   3   2   1   50 
Fixed  13   —   1   4   1   19   19   —   1   4   —   24 
Total prime  48   15   5   8   2   78   56   12   4   6   1   79 
Alt-a
                              
Non-prime
                              
Option ARM  —   4   1   3   —   8   2   2   1   2   —   7 
Hybrid  1   —   —   —   —   1   1   —   —   —   —   1 
Total alt-a  1   4   1   3   —   9 
Subprime
                              
Hybrid  —   —   —   1   —   1 
Total subprime  —   —   —   1   —   1 
Total non-prime  3   2   1   2   —   8 
Total Residential CES $49  $19  $6  $12  $2  $88  $59  $14  $5  $8  $1  $87 

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Prime securities are residential mortgage-backed securities backed primarily by high credit quality loans. Many of thethese loans are jumbos,jumbo loans, with loan balances greater than existing conforming loan limits. Prime securities typically have relatively high weighted average FICO scores (700 or higher), low (75% or less), weighted average loan-to-value ratios (LTV)(75% LTV or less), and limited concentrations of investor properties.

Alt-aNon-prime securities are residential mortgage-backed securities that have higherare not backed by high credit quality than subprime andloans. Most of the borrowers backing non-prime loans have lower credit quality than prime. Alt-a originally represented loans with alternative documentation, but has shifted over time to include loans with additional risk characteristics and a higher percentage of investor loans. Borrower’s income may not be verified, and in some cases, may not be disclosed on the loan application. Expanded criteria also allows for higher debt-to-income ratios with higher accompanying LTV than otherwise would be permissible for prime loans.

Subprime securities are residential mortgage-backed securities backed by loans to borrowers who haveFICO scores or impaired credit histories, but who appear to exhibit the ability to repay the current loan. Typically, these borrowers have lower credit scores or other credit deficiencies that prevent them from qualifying for prime or alt-a mortgages. To compensate for the greater risks and higher costs to service thesenon-prime loans, subprime borrowers often pay higher interest rates, points, and possibly higher origination fees. When evaluating the acquisition of CES backed by subprime loans, weWe use loss assumptions that are significantly higher when acquiring CES backed by non-prime loans than those we use forwhen acquiring CES backed by prime loans.

The loans underlying all of our residential CES totaled $151$145 billion at March 31,June 30, 2008, and consist of $127$107 billion prime $18and $38 billion alt-a, and $6 billion subprime.non-prime. These loans are located nationwide with a large concentration in California (49%). During the firstsecond quarter of 2008, realized residential credit losses were $31$67 million of principal value, a rate that equals eight18 basis points (0.08%(0.18%) of current loan balances on an annualized basis of the balance of the loans.basis. Serious delinquencies (90+ days, in foreclosure or REO) at March 31,June 30, 2008 were 3.06%4.23% of current balancebalances and 1.46%1.93% of original balance.balances. For loans in prime pools, delinquencies were 1.27%1.01% of current balancebalances and 0.60%0.47% of original balance. Alt-abalances. Non-prime pools had had delinquencies of 9.51%13.29% of current balancebalances and 4.49%5.94% of original balance. Subprime pools hadbalances.

Commercial Credit-Enhancement Securities at Redwood

Our commercial CES totaled $91 million at June 30, 2008, a decrease from $149 million at December 31, 2007. This decrease was primarily to declines in the fair value of these securities. At June 30, 2008, commercial CES provided credit-enhancement on $49 billion of underlying loans on office, retail, multifamily, industrial, and other income-producing properties nationwide. Of our total commercial CES, $65 million were non-rated, $12 million were B-rated, and $14 million were BB-rated.

As a result of the concentrated credit risk associated with commercial CES, we are generally able to acquire these securities at a discount to their face (principal) value. The difference between the principal value ($518 million) and carrying value ($91 million) of our commercial CES at June 30, 2008 was $427 million. Of this difference, $384 million was designated as internal credit reserve (reflecting our estimate of likely credit losses on the underlying loans over the life of these securities), $33 million was unamortized discount that we are accreting into income over time, and $10 million was net unrealized market valuation adjustments.

Seriously delinquent loans underlying commercial CES at June 30, 2008 were $390 million, an increase of $207 million from the beginning of the year. Most of the delinquencies are concentrated within a few securities for which we have increased our credit reserves and impaired through our income statement. We consider our credit reserve of 22.13%$384 million to be adequate as of current balanceJune 30, 2008.

There were no acquisitions of commercial CES during the quarter. We may begin acquiring these securities during future quarters if and 17.21% of original balance.when pricing for these securities becomes attractive to us relative to the risks incurred.

Residential Investment-Grade SecuritiesReal Estate Loans at Sequoia and Redwood

We invest in investment-gradedid not acquire any residential securities (IGS) backed by prime, alt-a,real estate loans during the first half of 2008. We plan to resume acquiring high-quality residential real estate loans on a bulk or flow basis from originators once the economics for securitization improve. Prior to 2006, our loan purchases were predominately comprised of short reset LIBOR-indexed ARMs. In 2006 and subprime residential loans. Our residential IGS portfolio totaled $26 million at March 31, 2008, an increase from the2007 we expanded our Sequoia’s product offerings to include high-quality hybrid loans (loans with a fixed-rate coupon for a period of two to ten years before becoming adjustable).

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$12The following table provides details of our residential real estate loans activity for the six months ended June 30, 2008. Loans are predominantly owned by the Sequoia securitization entities and the reported activity is associated with those loans. The residential loans held outside of any securitization entity and owned by Redwood totaled $4 million at June 30, 2008.

Table 22 Residential Real Estate Loans at Sequoia and Redwood — Activity

  
(In Millions) Three Months
Ended
June 30, 2008		 Six Months
Ended
June 30, 2008
Balance at beginning of period $6,756   7,178 
Acquisitions  —   — 
Sale proceeds  —   — 
Principal repayments  (365)   (764) 
Transfers to real estate owned  (13)   (20) 
Changes in fair value, net  —   — 
Premium amortization  (10)   (18) 
Provision for credit losses  (10)   (18) 
Balance at End of Period $6,358  $6,358 

Our residential real estate loan balance declined to $6.4 billion at June 30, 2008 from $7.2 billion at December 31, 2007. At June 30, 2008, 66% of residential loans (by unpaid principal balance) were one-month or six-month LIBOR ARMs and the remaining 34% were hybrid loans. Our residential loans are financed almost entirely through Sequoia securitization entities.

Real Estate Securities at Redwood

The following table provides details of our securities activity at Redwood for the three and six months ended June 30, 2008, at Redwood.

Table 23 Real Estate Securities Activity at Redwood

Three Months Ended June 30, 2008

       
(In Millions) Residential
CES		 Residential
IGS		 Commercial
CES		 CDO
CES		 CDO
IGS		 OREI Total
Balance at beginning of period $88  $26   100   1   16   3  $234 
Acquisitions  3   147   —   —   —   —   150 
Principal repayments (including calls)  (16)   (4)   —   —   (2)   —   (22) 
Recognized gains on calls, net  —   —   —   —   —   —   — 
Discount amortization  6   1   (2)   —   —   —   5 
Upgrades/downgrades  —   —   —   —   —   —   — 
Transfer from (to) other portfolios  —   —   —   —   —   —   — 
Change in fair value adjustments, net  6   (10)   (7)   (1)   1   (3)   (14) 
Balance at End of Period $87  $160  $91  $—  $15  $—  $353 

Six Months Ended June 30, 2008

       
(In Millions) Residential
CES		 Residential
IGS		 Commercial
CES		 CDO
CES		 CDO
IGS		 OREI Total
Balance at beginning of period $151  $12  $149  $2  $18  $12  $344 
Acquisitions  13   175   —   —   —   —   188 
Principal repayments (including calls)  (32)   (6)   —   —   (2)   (1)   (41) 
Recognized gains on calls, net  —   —   —   —   —   —   — 
Discount amortization  17   2   (4)   —   —   —   15 
Upgrades/downgrades  1   (1)   —   —   —   —   — 
Transfer from (to) other portfolios  —   4   —   —   —   (5)   (1) 
Change in fair value adjustments, net  (63)   (26)   (54)   (2)   (1)   (6)   (152) 
Balance at End of Period $87  $160  $91  $—  $15  $—  $353 

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During the second quarter of 2008, we acquired $150 million securities, had principal payments of $22 million, discount amortization of $5 million, had negative market valuation adjustments of $14 million, resulting in a net $124 million increase in our securities portfolio to $353 million at June 20, 2008, from $234 million at March 31, 2008. We also acquired $2 million of previously issued Sequoia ABS during the quarter, which does not appear on our consolidated balance sheets. During the first half of 2008, we acquired $188 million securities, had principal payments of $41 million, discount amortization of $15 million, negative market valuation adjustments of $154 million, and net portfolio transfers of negative $1 million, resulting in a net $9 million increase in our securities portfolio to $353 million at June 30, 2008, from $344 million at June 30, 2007.

The following table provides product type and vintage information regarding the $353 million of securities owned by Redwood at June 30, 2008.

Table 24 Real Estate Securities at Redwood

      
June 30, 2008
(In Millions)		 2004 &
Earlier		 2005 2006 2007 2008 Grand
Total
Prime
                              
IGS $43  $27  $21  $4  $7  $102 
CES  56   12   4   6   1   79 
OREI  —   —   —   —   —   — 
Non-prime
                              
IGS  —   29   13   16   —   58 
CES  3   2   1   2   —   8 
OREI  —   —   —   —   —   — 
Residential Subtotal  102   70   39   28   8   247 
Commercial IGS  —   —   —   —   —   — 
Commercial CES  15   18   45   13   —   91 
CDO IGS  8   6   —   1   —   15 
CDO CES  —   —   —   —   —   — 
Totals $125  $94  $84  $42  $8  $353 

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The following table presents the carrying value (which equals fair value) as a percent of face value at June 30, 2008 for the securities at Redwood. In the aggregate, the fair value of these securities is 22% of face value.

Table 25 Fair Value as Percent of Principal Value for Real Estate Securities at Redwood

             
             
  2004 & Earlier 2005 2006 2007 2008 Total
(Dollars in Millions) Value % Value % Value % Value % Value % Value %
Prime
                                                                 
    Resi – IGS
                                                             
              AAA  $1   93%  $4   79%  $13   76%  $—   —  $—   —  $18   78% 
              AA   19   76%   21   69%   —   —   4   70%   4   70%   48   72% 
              A   13   59%   —   —%   8   50%   —   —   2   55%   23   55% 
              BBB   10   49%   2   30%   —   —   —   —   1   28%   13   42% 
    Resi – IGS Total   43   63%   27   64%   21   50%   4   —   7   44%   102   63% 
    Resi – CES
                                                             
              BB   16   35%   8   27%   2   26%   3   19%   1   19%   30   29% 
              B   17   38%   1   8%   1   14%   2   8%   —   —   21   24% 
              NR   23   16%   3   4%   1   2%   1   3%   —   —   28   9% 
    Resi – CES Total
   56   24%   12   10%   4   5%   6   7%   1   19%   79   20% 
    Total Prime  $99   33%  $39   23%  $25   26%  $10   12%  $8   32%  $181   27% 
Non-prime
                                                            
    Resi – IGS
                                                             
              AAA  $—   —  $29   62%  $13   67%  $15   58%  $—   —  $57   62% 
              BBB   —   —   —   —   —   —   1   3%   —   —   1   3% 
    Resi – IGS Total   —   —   29   62%   13   66%   16   58%   —   —   58   62% 
    Resi – CES                                                             
              B   1   5%   —   —   —   —   1   3%   —   —   2   10% 
              NR   2   13%   2   6%   1   2%   1   2%   —   —   6   3% 
    Resi – CES Total   3   13%   2   7%   1   2%   2   2%   —   —   8   3% 
    OREI   —   —   —   —   2   1%   1   10%   —   —   3   1% 
    Total Non-prime  $3   13%  $31   44%  $14   21%  $18   13%  $—   —  $66   22% 
CMBS
                                                                 
    Comm – CES                                                             
              BB  $5   55%  $—   —  $6   26%  $3   21%  $—   —  $14   30% 
              B   —   —   —   —   7   21%   5   19%   —   —   12   20% 
              NR   10   23%   18   14%   32   16%   5   14%   —   —   65   16% 
    Comm – CES Total   15   29%   18   14%   45   17%   13   17%   —   —   91   18% 
    Total CMBS  $15   29%  $18   14%  $45   17%  $13   17%  $—   —  $91   18% 
CDO
                                                                 
    CDO – IGS                                                             
              AAA  $—   —  $6   34%  $—   —  $—   —  $—   —  $6   34% 
              AA   8   58%   —   —   —   —   —   —   —   —   8   58% 
              BBB   —   —   —   —   —   —   1   3%   —   —   1   4% 
    CDO – IGS Total   8   58%   6   34%   —   —   1   3%   —   —   15   26% 
    Total CDO  $8   58%  $6   34%  $—   —  $1   3%  $—   —  $15   26% 

Approximately 51% of our investments in real estate securities at June 30, 2008 were residential and commercial credit enhancement securities (CES). We acquire CES at a significant discount to their principal value as credit losses could reduce or eliminate the principal value of these bonds. Our return on these investments is based on how much principal and interest we receive, and how quickly we receive it. In an ideal environment we would experience fast prepayments and low credit losses, allowing us to recover a substantial part of the discount as income. Conversely, the least beneficial environment would be slow prepayments and high credit losses.

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The following table presents the components of carrying value (which equals fair value) at June 30, 2008 for residential and commercial CES.

Table 26 Credit-Enhancement Securities at Redwood

   
June 30, 2008
(In Millions)		 Residential
 Prime Non Prime Commercial
Current face $390  $319  $518 
Unamortized discount, net  (49)   (17)   (33) 
Discount designated as credit reserve  (252)   (297)   (384) 
Amortized cost  89   5   101 
Gross unrealized market value gains  9   4   3 
Gross unrealized market value losses  (19)   (1)   (13) 
Carrying Value $79  $8  $91 
Carrying value as a percentage of face  20%   3%   18 % 

Residential Credit-Enhancement Securities at Redwood

Our residential CES portfolio had a fair value of $87 million at June 30, 2008, a decrease of $64 million from the fair value of $151 million at December 31, 2007. The increaseprimary reason was a decline in this portfolio was the result of net acquisitions of $28 million, partially offset by decreases in the fair values ofin these securities during this period. We acquired $3 million residential CES during the period. The $28 million of net IGS acquired in the firstsecond quarter of 2008, which were all prime securities.

CES have credit ratings that are below investment-grade and have both the upside opportunities and downside risks that are assumed with concentrated credit investments. As a result, we are generally able to acquire these securities at a discount to their face (principal) value. At June 30, 2008, the difference between the principal value ($709 million) and carrying value ($87 million), which equals the fair value, was $622 million for residential CES. Of this difference, $549 million was designated as internal credit reserve (reflecting our estimate of credit losses on the underlying loans over the life of these securities), $66 million represented unamortized discount we are accreting into income over time, and $7 million represented net unrealized mark-to-market losses. Amortized cost on residential CES (principal value less internal credit reserve less amortized discount) decreased $108 million to $94 million at June 30, 2008 from $202 million at December 31, 2007, primarily as a result of declines in fair values and the effect of impairment charges. Net unrealized mark-to-market losses on residential CES fell by $44 million to $7 million at June 30, 2008, from $51 million at December 31, 2007.

The following table details our residential IGS portfolioCES portfolios by the product type and collateral vintage at March 31,June 30, 2008.

Table 2827 Residential Investment GradeCredit-Enhancement Securities at Redwood — Product and Vintage

      
 Vintage
June 30, 2008
(In Millions)		 2004 &
Earlier		 2005 2006 2007 2008 Total
Prime
                              
ARM $5  $—  $—  $—  $—  $5 
Hybrid  32   12   3   2   1   50 
Fixed  19   —   1   4   —   24 
Total prime  56   12   4   6   1   79 
Non-prime
                              
Option ARM  2   2   1   2   —   7 
Hybrid  1   —   —   —   —   1 
Total non-prime  3   2   1   2   —   8 
Total Residential CES $59  $14  $5  $8  $1  $87 

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 Vintage
March 31, 2008
(In Millions)		 2004 &
Earlier		 2005 2006 2007 2008 Total
Prime
                              
Hybrid $3  $1  $1  $—  $3  $8 
Fixed  1   —   8   —   3   12 
Total prime  4   1   9   —   6   20 
Alt-a
                              
Option ARM  —   —   1   —   —   1 
Hybrid  —   —   —   4   —   4 
Fixed  —   —   —   —   —   — 
Total alt-a  —   —   1   4   —   5 
Subprime
                              
Hybrid  1   —   —   —   —   1 
Total subprime  1   —   —   —   —   1 
Total Residential IGS $5  $1  $10  $4  $6  $26 

TABLE OF CONTENTS

Prime securities are residential mortgage-backed securities backed by high credit quality loans. Many of these loans are jumbo loans, with loan balances greater than existing conforming loan limits. Prime securities typically have relatively high weighted average FICO scores (700 or higher), low weighted average loan-to-value ratios (75% LTV or less), and limited concentrations of investor properties.

Non-prime securities are residential mortgage-backed securities that are not backed by high credit quality loans. Most of the borrowers backing non-prime loans have lower FICO scores or impaired credit histories, but exhibit the ability to repay the loan. To compensate for the greater risks and higher costs to service non-prime loans, borrowers often pay higher interest rates, and possibly higher origination fees. We use loss assumptions that are significantly higher when acquiring CES backed by non-prime loans than we use when acquiring CES backed by prime loans.

The loans underlying all of our residential CES totaled $145 billion at June 30, 2008, and consist of $107 billion prime and $38 billion non-prime. These loans are located nationwide with a large concentration in California (49%). During the second quarter of 2008, realized residential credit losses were $67 million of principal value, a rate that equals 18 basis points (0.18%) of current loan balances on an annualized basis. Serious delinquencies (90+ days, in foreclosure or REO) at June 30, 2008 were 4.23% of current balances and 1.93% of original balances. For loans in prime pools, delinquencies were 1.01% of current balances and 0.47% of original balances. Non-prime pools had had delinquencies of 13.29% of current balances and 5.94% of original balances.

Commercial Credit-Enhancement Securities at Redwood

Our total commercial CES was $100totaled $91 million at March 31,June 30, 2008, a decrease from $149 million at December 31, 2007 due2007. This decrease was primarily to a decreasedeclines in the fair value of these securities. At March 31,June 30, 2008, these securities ($73 million were non-rated, $13 million were B-rated, and $14 million were BB-rated)commercial CES provided credit-enhancement on $55$49 billion of underlying loans on office, retail, multifamily, industrial, and other income-producing properties nationwide. Of our total commercial CES, $65 million were non-rated, $12 million were B-rated, and $14 million were BB-rated.

As a result of the concentrated credit risk associated with commercial CES, we are generally able to acquire these securities at a discount to their face (principal) value. The difference between the principal value ($523518 million) and carrying value ($10091 million) of our commercial CES at March 31,June 30, 2008 was $423$427 million. Of this difference, $378$384 million was designated as internal credit reserve (reflecting our estimate of likely credit losses on the underlying loans over the life of these securities), $37$33 million representedwas unamortized discount that we are accreting into income over time, and $8$10 million representedwas net unrealized MTM losses.market valuation adjustments.

Seriously delinquent loans underlying commercial CES at March 31,June 30, 2008 were $227$390 million, an increase of $44$207 million from the beginning of the year. To date, mostMost of the delinquencies have beenare concentrated inwithin a few dealssecurities for which we have increased our credit reserves and impaired the securities through our income statement. We consider our credit reserve of $378$384 million to be appropriateadequate as of March 31,June 30, 2008.

There were no acquisitions of commercial CES during the quarter although wequarter. We may renew our acquisition ofbegin acquiring these types of securities later this yearduring future quarters if and when pricing for these securities becomes attractive to us relative to the extent we find the pricing adequately reflects the risks of future commercial loan performance.incurred.

CDO Credit-Enhancement Securities at Redwood

At March 31, 2008, our CDO CES totaled $1 million, a decrease from $2 million at December 31, 2007 as the value of these securities declined during the quarter. There were no acquisitions during this period.

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CDO Investment-Grade Securities at Redwood and Opportunity Fund

At March 31, 2008, our CDO IGS totaled $14 million, a decrease from the December 31, 2007 balance of $18 million as the fair values declined. For the most part, changes in the fair values reflect the bid/ask spread on these securities.

Other Real Estate Investments at Redwood

Our OREI totaled $3 million at March 31, 2008, a decrease from the $12 million at December 31, 2007 as a result of the decrease in the fair value of these securities. At March 31, 2008, we had an equal amount of other real estate investments rated BB, B, and unrated.

Residential Real Estate Loans at Sequoia and Redwood

We did not acquire any residential real estate loans during the first quarterhalf of 2008. As we have in prior years, however, weWe plan to continue to acquireresume acquiring high-quality residential real estate loans on a bulk or flow basis from originators once the marketeconomics for residential securitizations returns.securitization improve. Prior to 2006, our loan purchases were predominately comprised of short reset LIBOR indexed ARMs (LIBOR ARMs).LIBOR-indexed ARMs. In 2006 and 2007 we expanded our residential conduit’sSequoia’s product offerings to include high-quality hybrid loans (loans with a fixed-rate coupon for a period of two to ten years before becoming adjustable).

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The following table provides details of the activity with respect to our residential real estate loans activity for the threesix months ended March 31,June 30, 2008. The majority of these loansLoans are predominantly owned by the Sequoia securitization entities and the reported activity is primarily associated with those loans. The residential loans held outside of any securitization entity and owned by Redwood totaled $4 million at March 31,June 30, 2008. This was a $1 million decrease during the quarter due to prepayments and lower market values.

Table 2922 Residential Real Estate Loans at Sequoia and Redwood — Activity

   
(In Thousands) Three Months Ended
March 31, 2008
(In Millions) Three Months
Ended
June 30, 2008		 Six Months
Ended
June 30, 2008
Balance at beginning of period $7,178,473  $6,756   7,178 
Acquisitions  —   — 
Sale proceeds  —   — 
Principal repayments  (399,728)   (365)   (764) 
Transfers to real estate owned  (7,170)   (13)   (20) 
Changes in fair value, net  (74)   —   — 
Premium amortization  (7,510)   (10)   (18) 
Provision for credit losses  (8,058)   (10)   (18) 
Balance at End of Period $6,755,933  $6,358  $6,358 

Our residential real estate loan balance declined to $6.8$6.4 billion at March 31,June 30, 2008 from $7.2 billion at December 31, 2007. Of the balance at March 31,At June 30, 2008, 68%66% of residential loans (by unpaid principal balance) of the loans were one- andone-month or six-month LIBOR ARMs and the remaining 34% were hybrid loans. Our residential loans are financed almost entirely through Sequoia securitization entities (onlyentities.

Real Estate Securities at Redwood

The following table provides details of our securities activity at Redwood for the three and six months ended June 30, 2008, at Redwood.

Table 23 Real Estate Securities Activity at Redwood

Three Months Ended June 30, 2008

       
(In Millions) Residential
CES		 Residential
IGS		 Commercial
CES		 CDO
CES		 CDO
IGS		 OREI Total
Balance at beginning of period $88  $26   100   1   16   3  $234 
Acquisitions  3   147   —   —   —   —   150 
Principal repayments (including calls)  (16)   (4)   —   —   (2)   —   (22) 
Recognized gains on calls, net  —   —   —   —   —   —   — 
Discount amortization  6   1   (2)   —   —   —   5 
Upgrades/downgrades  —   —   —   —   —   —   — 
Transfer from (to) other portfolios  —   —   —   —   —   —   — 
Change in fair value adjustments, net  6   (10)   (7)   (1)   1   (3)   (14) 
Balance at End of Period $87  $160  $91  $—  $15  $—  $353 

Six Months Ended June 30, 2008

       
(In Millions) Residential
CES		 Residential
IGS		 Commercial
CES		 CDO
CES		 CDO
IGS		 OREI Total
Balance at beginning of period $151  $12  $149  $2  $18  $12  $344 
Acquisitions  13   175   —   —   —   —   188 
Principal repayments (including calls)  (32)   (6)   —   —   (2)   (1)   (41) 
Recognized gains on calls, net  —   —   —   —   —   —   — 
Discount amortization  17   2   (4)   —   —   —   15 
Upgrades/downgrades  1   (1)   —   —   —   —   — 
Transfer from (to) other portfolios  —   4   —   —   —   (5)   (1) 
Change in fair value adjustments, net  (63)   (26)   (54)   (2)   (1)   (6)   (152) 
Balance at End of Period $87  $160  $91  $—  $15  $—  $353 

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During the second quarter of 2008, we acquired $150 million securities, had principal payments of $22 million, discount amortization of $5 million, had negative market valuation adjustments of $14 million, resulting in a net $124 million increase in our securities portfolio to $353 million at June 20, 2008, from $234 million at March 31, 2008. We also acquired $2 million of previously issued Sequoia ABS during the quarter, which does not appear on our consolidated balance sheets. During the first half of 2008, we acquired $188 million securities, had principal payments of $41 million, discount amortization of $15 million, negative market valuation adjustments of $154 million, and net portfolio transfers of negative $1 million, resulting in a net $9 million increase in our securities portfolio to $353 million at June 30, 2008, from $344 million at June 30, 2007.

The following table provides product type and vintage information regarding the $353 million of securities owned by Redwood at June 30, 2008.

Table 24 Real Estate Securities at Redwood

      
June 30, 2008
(In Millions)		 2004 &
Earlier		 2005 2006 2007 2008 Grand
Total
Prime
                              
IGS $43  $27  $21  $4  $7  $102 
CES  56   12   4   6   1   79 
OREI  —   —   —   —   —   — 
Non-prime
                              
IGS  —   29   13   16   —   58 
CES  3   2   1   2   —   8 
OREI  —   —   —   —   —   — 
Residential Subtotal  102   70   39   28   8   247 
Commercial IGS  —   —   —   —   —   — 
Commercial CES  15   18   45   13   —   91 
CDO IGS  8   6   —   1   —   15 
CDO CES  —   —   —   —   —   — 
Totals $125  $94  $84  $42  $8  $353 

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The following table presents the carrying value (which equals fair value) as a percent of face value at June 30, 2008 for the securities at Redwood. In the aggregate, the fair value of these securities is 22% of face value.

Table 25 Fair Value as Percent of Principal Value for Real Estate Securities at Redwood

             
             
  2004 & Earlier 2005 2006 2007 2008 Total
(Dollars in Millions) Value % Value % Value % Value % Value % Value %
Prime
                                                                 
    Resi – IGS
                                                             
              AAA  $1   93%  $4   79%  $13   76%  $—   —  $—   —  $18   78% 
              AA   19   76%   21   69%   —   —   4   70%   4   70%   48   72% 
              A   13   59%   —   —%   8   50%   —   —   2   55%   23   55% 
              BBB   10   49%   2   30%   —   —   —   —   1   28%   13   42% 
    Resi – IGS Total   43   63%   27   64%   21   50%   4   —   7   44%   102   63% 
    Resi – CES
                                                             
              BB   16   35%   8   27%   2   26%   3   19%   1   19%   30   29% 
              B   17   38%   1   8%   1   14%   2   8%   —   —   21   24% 
              NR   23   16%   3   4%   1   2%   1   3%   —   —   28   9% 
    Resi – CES Total
   56   24%   12   10%   4   5%   6   7%   1   19%   79   20% 
    Total Prime  $99   33%  $39   23%  $25   26%  $10   12%  $8   32%  $181   27% 
Non-prime
                                                            
    Resi – IGS
                                                             
              AAA  $—   —  $29   62%  $13   67%  $15   58%  $—   —  $57   62% 
              BBB   —   —   —   —   —   —   1   3%   —   —   1   3% 
    Resi – IGS Total   —   —   29   62%   13   66%   16   58%   —   —   58   62% 
    Resi – CES                                                             
              B   1   5%   —   —   —   —   1   3%   —   —   2   10% 
              NR   2   13%   2   6%   1   2%   1   2%   —   —   6   3% 
    Resi – CES Total   3   13%   2   7%   1   2%   2   2%   —   —   8   3% 
    OREI   —   —   —   —   2   1%   1   10%   —   —   3   1% 
    Total Non-prime  $3   13%  $31   44%  $14   21%  $18   13%  $—   —  $66   22% 
CMBS
                                                                 
    Comm – CES                                                             
              BB  $5   55%  $—   —  $6   26%  $3   21%  $—   —  $14   30% 
              B   —   —   —   —   7   21%   5   19%   —   —   12   20% 
              NR   10   23%   18   14%   32   16%   5   14%   —   —   65   16% 
    Comm – CES Total   15   29%   18   14%   45   17%   13   17%   —   —   91   18% 
    Total CMBS  $15   29%  $18   14%  $45   17%  $13   17%  $—   —  $91   18% 
CDO
                                                                 
    CDO – IGS                                                             
              AAA  $—   —  $6   34%  $—   —  $—   —  $—   —  $6   34% 
              AA   8   58%   —   —   —   —   —   —   —   —   8   58% 
              BBB   —   —   —   —   —   —   1   3%   —   —   1   4% 
    CDO – IGS Total   8   58%   6   34%   —   —   1   3%   —   —   15   26% 
    Total CDO  $8   58%  $6   34%  $—   —  $1   3%  $—   —  $15   26% 

Approximately 51% of our investments in real estate securities at June 30, 2008 were residential and commercial credit enhancement securities (CES). We acquire CES at a significant discount to their principal value as credit losses could reduce or eliminate the principal value of these bonds. Our return on these investments is based on how much principal and interest we receive, and how quickly we receive it. In an ideal environment we would experience fast prepayments and low credit losses, allowing us to recover a substantial part of the discount as income. Conversely, the least beneficial environment would be slow prepayments and high credit losses.

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The following table presents the components of carrying value (which equals fair value) at June 30, 2008 for residential and commercial CES.

Table 26 Credit-Enhancement Securities at Redwood

   
June 30, 2008
(In Millions)		 Residential
 Prime Non Prime Commercial
Current face $390  $319  $518 
Unamortized discount, net  (49)   (17)   (33) 
Discount designated as credit reserve  (252)   (297)   (384) 
Amortized cost  89   5   101 
Gross unrealized market value gains  9   4   3 
Gross unrealized market value losses  (19)   (1)   (13) 
Carrying Value $79  $8  $91 
Carrying value as a percentage of face  20%   3%   18 % 

Residential Credit-Enhancement Securities at Redwood

Our residential CES portfolio had a fair value of $87 million at June 30, 2008, a decrease of $64 million from the fair value of $151 million at December 31, 2007. The primary reason was a decline in fair values in these securities during this period. We acquired $3 million residential CES during the second quarter of 2008, which were all prime securities.

CES have credit ratings that are below investment-grade and have both the upside opportunities and downside risks that are assumed with concentrated credit investments. As a result, we are generally able to acquire these securities at a discount to their face (principal) value. At June 30, 2008, the difference between the principal value ($709 million) and carrying value ($87 million), which equals the fair value, was $622 million for residential CES. Of this difference, $549 million was designated as internal credit reserve (reflecting our estimate of credit losses on the underlying loans over the life of these securities), $66 million represented unamortized discount we are accreting into income over time, and $7 million represented net unrealized mark-to-market losses. Amortized cost on residential CES (principal value less internal credit reserve less amortized discount) decreased $108 million to $94 million at June 30, 2008 from $202 million at December 31, 2007, primarily as a result of declines in fair values and the effect of impairment charges. Net unrealized mark-to-market losses on residential CES fell by $44 million to $7 million at June 30, 2008, from $51 million at December 31, 2007.

The following table details our residential CES portfolios by the product type and collateral vintage at June 30, 2008.

Table 27 Residential Credit-Enhancement Securities at Redwood — Product and Vintage

      
 Vintage
June 30, 2008
(In Millions)		 2004 &
Earlier		 2005 2006 2007 2008 Total
Prime
                              
ARM $5  $—  $—  $—  $—  $5 
Hybrid  32   12   3   2   1   50 
Fixed  19   —   1   4   —   24 
Total prime  56   12   4   6   1   79 
Non-prime
                              
Option ARM  2   2   1   2   —   7 
Hybrid  1   —   —   —   —   1 
Total non-prime  3   2   1   2   —   8 
Total Residential CES $59  $14  $5  $8  $1  $87 

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Prime securities are residential mortgage-backed securities backed by high credit quality loans. Many of these loans are jumbo loans, with loan balances greater than existing conforming loan limits. Prime securities typically have relatively high weighted average FICO scores (700 or higher), low weighted average loan-to-value ratios (75% LTV or less), and limited concentrations of investor properties.

Non-prime securities are residential mortgage-backed securities that are not backed by high credit quality loans. Most of the borrowers backing non-prime loans have lower FICO scores or impaired credit histories, but exhibit the ability to repay the loan. To compensate for the greater risks and higher costs to service non-prime loans, borrowers often pay higher interest rates, and possibly higher origination fees. We use loss assumptions that are significantly higher when acquiring CES backed by non-prime loans than we use when acquiring CES backed by prime loans.

The loans underlying all of our residential CES totaled $145 billion at June 30, 2008, and consist of $107 billion prime and $38 billion non-prime. These loans are located nationwide with a large concentration in California (49%). During the second quarter of 2008, realized residential credit losses were $67 million of principal value, a rate that equals 18 basis points (0.18%) of current loan balances on an annualized basis. Serious delinquencies (90+ days, in foreclosure or REO) at June 30, 2008 were 4.23% of current balances and 1.93% of original balances. For loans in prime pools, delinquencies were 1.01% of current balances and 0.47% of original balances. Non-prime pools had had delinquencies of 13.29% of current balances and 5.94% of original balances.

Commercial Credit-Enhancement Securities at Redwood

Our commercial CES totaled $91 million at June 30, 2008, a decrease from $149 million at December 31, 2007. This decrease was primarily to declines in the fair value of these securities. At June 30, 2008, commercial CES provided credit-enhancement on $49 billion of underlying loans on office, retail, multifamily, industrial, and other income-producing properties nationwide. Of our total commercial CES, $65 million were non-rated, $12 million were B-rated, and $14 million were BB-rated.

As a result of the concentrated credit risk associated with commercial CES, we are generally able to acquire these securities at a discount to their face (principal) value. The difference between the principal value ($518 million) and carrying value ($91 million) of our commercial CES at June 30, 2008 was $427 million. Of this difference, $384 million was designated as internal credit reserve (reflecting our estimate of likely credit losses on the underlying loans over the life of these securities), $33 million was unamortized discount that we are accreting into income over time, and $10 million was net unrealized market valuation adjustments.

Seriously delinquent loans underlying commercial CES at June 30, 2008 were $390 million, an increase of $207 million from the beginning of the year. Most of the delinquencies are concentrated within a few securities for which we have increased our credit reserves and impaired through our income statement. We consider our credit reserve of $384 million to be adequate as of June 30, 2008.

There were no acquisitions of commercial CES during the quarter. We may begin acquiring these securities during future quarters if and when pricing for these securities becomes attractive to us relative to the risks incurred.

Residential Investment-Grade Securities at Redwood

We invest in IGS backed by prime and non-prime residential loans. Our residential IGS portfolio totaled $160 million at June 30, 2008, an increase from the $12 million at December 31, 2007. The increase in this portfolio was the result of net acquisitions of $175 million, partially offset by decreases in the fair values of these securities. Of the $175 million of IGS acquired in the first half of 2008, 64% were prime securities and 36% were non-prime securities.

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The following table details our residential IGS portfolio by the product type and collateral vintage at June 30, 2008.

Table 28 Residential Investment Grade Securities at Redwood — Product and Vintage

      
 Vintage
June 30, 2008
(In Millions)		 2004 &
Earlier		 2005 2006 2007 2008 Total
Prime
                              
Hybrid $41  $27  $13  $—  $4  $85 
Fixed  2   —   8   4   3   17 
Total prime  43   27   21   4   7   102 
Non-prime
                              
Option ARM  —   29   13   —   —   42 
Hybrid  —   —   —   16   —   16 
Fixed  —   —   —   —   —   — 
Total non-prime  —   29   13   16   —   58 
Total Residential IGS $43  $56  $34  $20  $7  $160 

Securities at the Opportunity Fund

We began acquiring assets for the Fund in the fourth quarter of 2007. We acquired $60 million of assets during the first half of 2008, bringing the total capital deployed to date to $81 million. The fair value of securities held in the Fund at June 30, 2008 was $66 million, which includes a $15 million unrealized loss due to declining fair values of securities in the Fund. The following table provides information on the activity in this Fund for three and six months ended June 30, 2008.

Table 29 Securities at the Opportunity Fund — Activity

    
Three Months Ended June 30, 2008
(In Millions)		 Residential
IGS		 CDO
CES		 CDO
IGS		 Total
Balance at beginning of period $9  $—  $27  $36 
Acquisitions  40   —   (7)   33 
Recognized gains on sales, net  —   —   2   2 
Principal repayments (including calls)  (3)   —   (3)   (6) 
Recognized gains on calls, net  —   —   —   — 
Discount amortization  1   —   —   1 
Upgrades/downgrades  —   7   (7)   — 
Change in fair value adjustments, net  (1)   —   1   — 
Balance at End of Period $46  $7  $13  $66 
       

    
Six Months Ended June 30, 2008
(In Millions)		 Residential
IGS		 CDO
CES		 CDO
IGS		 Total
Balance at beginning of period $3  $—  $12  $15 
Acquisitions  47   —   5   52 
Recognized gains on sales, net  —   —   2   2 
Principal repayments (including calls)  (3)   —   (3)   (6) 
Recognized gains on calls, net  —   —   —   — 
Discount amortization  1   —   1   2 
Upgrades/downgrades  —   7   (7)   — 
Change in fair value adjustments, net  (2)   —   3   1 
Balance at End of Period $46  $7  $13  $66 

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At June 30, 2008, securities at the Fund consisted of $46 million of residential subprime IGS issued prior to 2005, $4 million was fundedof CDO IGS issued in 2004, and $9 million of CDO IGS issued in 2005. We did not recognize any other-than-temporary impairments on these securities, as they continue to perform in line with equity).our expectations. We anticipate acquiring additional securities and fully investing the $96 million in Fund capital commitments within the next quarter.

The following table presents the carrying value (which equals fair value) as a percent of face value at June 30, 2008 for the securities at the Fund. In the aggregate, the fair value of these securities is 46% of face value.

Table 30 Fair Value as Percent of Principal Value for Real Estate Securities at the Opportunity Fund

         
         
(Dollars in Millions) 2004 & Earlier 2005 2006 Total
    Value % Value % Value % Value %
Prime
                                             
    Resi – IGS                                         
              AAA  $1   85%  $—   —  $—   —  $1   85% 
    Resi – IGS Total   1   85%   —   —   —   —   1   85% 
    Total Prime  $1   85%  $—   —  $—   —  $1   85% 
Non-prime
                                        
    Resi – IGS                                         
              AAA  $12   68%  $15   64%  $4   60%  $31   65% 
              AA   8   84%   1   50%   —   —   9   82% 
              A   5   62%   —   —   —   —   5   62% 
    Resi – IGS Total   25   71%   16   64%   4   60%   45   67% 
    Total Non-prime  $25   71%  $16   64%  $4   60%  $45   67% 
CDO
                                             
    CDO – IGS                                         
              AA  $2   58%  $9   27%  $—   —  $11   30% 
              BBB   2   11%   —   —   —   —   2   11% 
    CDO – IGS Total   4   19%   9   27%   —   —   13   24% 
    CDO – CES                                         
              B   7   32%   —   —   —   —   7   32% 
    CDO – CES Total   7   32%   —   —   —   —   7   32% 
    Total CDO  $11   25%  $9   27%  $—   —  $20   26% 

Securities at Acacia

The following table provides detail ofon the activity with respect to thefor securities held atowned by Acacia entities for the three and six months ended MarchJune 30, 2008.

Table 31 2008Real Estate Securities at Acacia — Activity

       
Three Months Ended
June 30, 2008
(In Millions)		 Residential
CES		 Residential
IGS		 Commercial
CES		 Commercial
IGS		 CDO
CES		 CDO
IGS		 Total
Balance at beginning of period $103  $589  $113  $63  $6  $53  $927 
Acquisitions  —   —   —   —   —   —   — 
Recognized gains on sales, net  —   —   —   —   —   —   — 
Principal repayments  (14)   (25)   —   (1)   —   (1)   (41) 
Recognized gains on calls, net  —   —   —   —   —   —   — 
Discount amortization  —   —   —   —   —   —   — 
Upgrades/downgrades  76   (76)   —   —   1   (1)      
Transfer from (to) other portfolios  —   —   —   —   —   —   — 
Change in fair value adjustments, net  (50)   (7)   1   —   (3)   (5)   (64) 
Balance at End of Period $115  $481  $114  $62  $4  $46  $822 

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Table 3031 Real Estate Securities at Acacia — Activity

 – (continued)

              
March 31, 2008
(In Thousands)		 Residential
CES		 Residential
IGS		 Commercial
CES		 Commercial
IGS		 CDO
CES		 CDO
IGS		 Total
       
Six Months Ended
June 30, 2008
(In Millions)		 Residential
CES		 Residential
IGS		 Commercial
CES		 Commercial
IGS		 CDO
CES		 CDO
IGS		 Total
Balance at beginning of period $250,936  $1,142,113  $188,327  $89,676  $8,169  $83,094  $1,762,315  $251  $1,142  $188  $90  $8  $83  $1,762 
Acquisitions  —   —   —   —   —   —   — 
Recognized gains on sales, net  —   —   —   —   —   —   — 
Principal repayments  (16,312)   (37,003)   —   (658)   (271)   (375)   (54,619)   (30)   (62)   —   (2)   —   (1)   (95) 
Recognized gains on calls, net  —   3   —   —   —   —   3   —   —   —   —   —   —   — 
Discount amortization  —   —   —   —   —   —   — 
Upgrades/downgrades  93   (93)   —   —   3   (3)      
Transfer from (to) other portfolios  17,357   (17,036)   —   (5,482)   1,596   3,886   321   —   —   —   (5)   —   5   — 
Change in fair value adjustments, net  (149,057)   (499,338)   (75,773)   (20,755)   (3,467)   (33,862)   (782,252)   (199)   (506)   (74)   (21)   (7)   (38)   (845) 
Balance at End of Period $102,924  $588,739  $112,554  $62,781  $6,027  $52,743  $925,768  $115  $481  $114  $62  $4  $46  $822 

In addition to the $926$822 million of real estate securities included in the table above, Acacia owned $88$84 million of ABS issued by Sequoia, $79 million in non-real estate securities, and $19 million in commercial loans.

The following table below presents the assetstotal securities owned by each Acacia entity,entities, by product type, as of June 30, 2008 and the corresponding liabilities as reported on MarchDecember 31, 2008.2007.

Table 3132 Securities at Acacia Balance Sheets

           
           
March 31, 2008
(In Millions)		 Acacia 5
Issued
Jul-04		 Acacia 6
Issued
Nov-04		 Acacia 7
Issued
Mar-05		 Acacia 8
Issued
Jul-05		 Acacia CRE1
Issued
Dec-05		 Acacia 9
Issued
Mar-06		 Acacia 10
Issued
Aug-06		 Acacia 11
Issued
Feb-07		 Acacia OA1
Issued
May-07		 Acacia 12
Issued
Jun-07		 Total
Residential IGS
                                                       
Prime Sequoia $12  $13  $9  $5  $1  $3  $3  $3  $7  $14  $70 
Prime other  22   35   28   22   13   37   40   20   2   15   234 
Alt-a  13   9   5   7   1   6   19   50   43   52   205 
Subprime  26   53   45   4   —   6   1   6   1   8   150 
Residential CES
                                                       
Prime Sequoia  2   3   3   5   —   2   3   —   —   —   18 
Prime other  11   7   4   11   —   7   24   8   —   5   77 
Alt-a  —   —   —   1   —   1   1   5   5   2   15 
Subprime  4   1   —   1   —   —   1   2   —   2   11 
Commercial IGS  6   6   5   8   32   2   —   —   —   3   62 
Commercial CES  1   3   9   13   46   7   14   12   —   8   113 
Commercial loans  3   —   6   3   7   —   —   —   —   —   19 
CDO: CMBS  2   3   1   —   10   5   5   12   2   4   44 
CDO: RMBS  2   3   1   2   —   1   1   2   —   3   15 
GIC  —   —   —   —   —   —   —   —   79   —   79 
Totals  104   136   116   82   110   77   112   120   139   116   1,112 
Restricted cash and other assets  11   15   39   26   8   12   15   9   (11)   33   157 
Total Assets $115  $151  $155  $108  $118  $89  $127  $129  $128  $149  $1,269 
ABS issued and other liabilities $107  $136  $147  $123  $111  $95  $108  $117  $107  $150  $1,201 
Total equity  8   15   8   (15)   7   (6)   19   12   21   (1)   68 
Total Liabilities and Equity $115  $151  $155  $108  $118  $89  $127  $129  $128  $149  $1,269 
  
(In Millions) June 30,
2008		 December 31,
2007
Residential IGS
          
Prime
          
Sequoia $67  $75 
Other  170   514 
Non-prime
          
Alt-a  171   417 
Subprime  140   211 
Residential CES
          
Prime
          
Sequoia  17   18 
Other  62   194 
Non-prime
          
Alt-a  41   48 
Subprime  12   9 
Commercial IGS  62   90 
Commercial CES  114   189 
CDO: IGS  46   83 
CDO: CES  4   8 
Total Securities at Acacia $906  $1,856 

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The following table presents the carrying value (which equals fair value) as a percent of face value at March 31,June 30, 2008 for securities owned by Acacia entities. In the aggregate, the fair value of these securities at Acacia.is 28% of face value.

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Table 3233 Fair Value as Percent of Principal Value for Securities at Acacia

                          
                          
(Dollars in Millions)(Dollars in Millions) 2004 & Earlier 2005 2006 2007 2008 Total(Dollars in Millions) 2004 & Earlier 2005 2006 2007 2008 Total
  Value % Value % Value % Value % Value % Value %  Value % Value % Value % Value % Value % Value %
Prime
                                                                  
  Resi – IGS                                                               Resi – IGS                                                             
            AAA  $9   94%  $12   83%  $5   68%  $—   —  $—   —  $26   83%             AAA  $8   89%  $7   75%  $3   60%  $—   —  $—   —  $18   77% 
            AA   33   53%   18   23%   10   26%   2   20%   —   —   63   33%             AA   37   73%   7   36%   7   65%   1   35%   —   —   52   57% 
            A   23   44%   31   24%   17   30%   3   29%   —   —   74   30%             A   19   51%   17   44%   10   43%   2   30%   —   —   48   45% 
            BBB   12   36%   33   23%   10   19%   16   27%   —   —   71   25%             BBB   10   44%   23   26%   4   26%   15   35%   —   —   52   39% 
  Resi – IGS Total   77   49%   94   26%   42   27%   21   26%   —   —   234   31%   Resi – IGS Total   74   64%   54   46%   24   45%   18   34%   —   —   170   52% 
  Resi – CES                                                               Resi – CES                                                             
            BB   29   26%   20   21%   12   14%   3   17%   —   —   64   21%             BB   29   36%   15   29%   6   24%   2   22%   —   —   52   31% 
            B   3   22%   5   11%   4   13%   —   —   —   —   12   13%             B   4   30%   1   3%   3   10%   —   —   —   —   8   10% 
            NR   —   —   —   —   1   9%   —   —   —   —   1   9%             NR   —   —   —   —   2   4%   —   —   —   —   2   4% 
  Resi – CES Total   32   25%   25   17%   17   13%   3   17%   —   —   77   18%   Resi – CES Total   33   35%   16   18%   11   11%   2   22%   —   —   62   20% 
  Total Prime  $109   38%  $119   23%  $59   21%  $24   25%  $—   —  $311   27%   Total Prime  $107   51%  $70   35%  $35   23%  $20   31%  $—   —  $232   37% 
Alt-A
                                                                                                                                  
  Resi – IGS                                                               Resi – IGS 
            AAA  $6   58%  $2   40%  $75   59%  $43   52%  $—   —  $126   56%             AAA  $7   68%  $7   77%  $68   54%  $41   49%  $—   —  $123   54% 
            AA   6   39%   2   18%   9   19%   6   16%   —   —   23   21%             AA   7   32%   9   14%   8   16%   2   6%   —   —   26   16% 
            A   1   12%   —   —   19   13%   14   12%   —   —   34   12%             A   4   23%   2   3%   4   9%   1   6%   —   —   11   7% 
            BBB   1   26%   2   7%   11   24%   8   23%   —   —   22   22%             BBB   2   19%   6   4%   1   4%   2   4%   —   —   11   5% 
  Resi – IGS Total   14   35%   6   15%   114   26%   71   22%   —   —   205   24%   Resi – IGS Total   20   33%   24   8%   81   33%   46   26%   —   —   171   22% 
  Resi – CES                                                               Resi – CES                                                             
            BB   2   8%   1   7%   5   7%   4   7%   —   —   12   7%             BB   4   11%   3   6%   2   4%   3   5%   —   —   12   6% 
            B   —   —   1   3%   2   4%   —   —   —   —   3   4%             B   1   9%   4   6%   5   4%   3   4%   —   —   13   5% 
  Resi – CES Total   2   8%   2   5%   7   6%   4   7%   —   —   15   6%             NR   —   —   1   5%   10   4%   5   7%   —   —   16   4% 
  Total Alt-A  $16   23%  $8   11%  $121   22%  $75   19%  $—   —  $220   20%   Resi – CES Total   5   9%   8   6%   17   4%   11   6%   —   —   41   5% 
  Total Alt-A  $25   22%  $32   7%  $98   14%  $57   15%  $—   —  $212   13% 
Subprime
                                                                                                                                  
  Resi – IGS                                                               Resi – IGS                                                             
            AAA  $—   —  $4   72%  $—   —  $8   78%  $—   —  $12   76%             AAA  $—   —  $—   —  $—   —  $7   77%  $—   —  $7   77% 
            AA   25   57%   34   77%   3   39%   2   15%   —   —   64   59%             AA   28   67%   39   82%   2   31%   1   11%   —   —   70   68% 
            A   35   61%   12   44%   1   16%   —   —   —   —   48   50%             A   24   63%   6   40%   —   —   —   —   —   —   30   56% 
            BBB   23   65%   —   —   2   11%   1   6%   —   —   26   42%             BBB   25   65%   7   64%   1   7%   —   —   —   —   33   54% 
  Resi – IGS Total   83   61%   50   65%   6   20%   11   28%   —   —   150   53%   Resi – IGS Total   77   65%   52   70%   3   17%   8   54%   —   —   140   62% 
  Resi – CES                                                               Resi – CES                                                             
            BB   4   49%   —   —   —   —   —   —   —   —   4   49%             BB   6   50%   —   —   —   —   —   —   —   —   6   50% 
            NR   —   —   —   —   5   5%   2   6%   —   —   7   5%             B   1   9%   —   —   1   6%   —   —   —   —   2   6% 
  Resi – CES Total   4   49%   —   —   5   5%   2   6%   —   —   11   8%             NR   —   —   —   —   2   3%   2   4%   —   —   4   3% 
  Total Subprime  $87   60%  $50   65%  $11   8%  $13   18%  $—   —  $161   38%   Resi – CES Total   7   44%   —   —   3   3%   2   4%   —   —   12   9% 
CMBS
                                                                 
  Comm – IGS                                                           ��   Total Subprime  $84   63%  $52   70%  $6   6%  $10   16%  $—   —  $152   42% 
            AAA  $—   —  $8   91%  $2   88%  $—   —  $—   —  $10   90% 
            AA   1   65%   —   —   —   —   —   —   —   —   1   65% 
            A   12   69%   2   49%   —   —   —   —   —   —   14   65% 
            BBB   13   70%   23   47%   1   40%   —   —   —   —   37   53% 
  Comm – IGS Total   26   69%   33   53%   3   62%   —   —   —   —   62   59% 
  Comm – CES                                                             
            BB   20   43%   29   37%   29   29%   2   22%   —   —   80   34% 
            B   3   35%   12   32%   13   25%   —   —   —   —   28   29% 
            NR   —   —   —   —   5   24%   —   —   —   —   5   24% 
  Comm – CES Total   23   42%   41   36%   47   27%   2   22%   —   —   113   32% 
  Total CMBS  $49   53%  $74   42%  $50   28%  $2   22%  $—   —  $175   38% 
CDO
                                                                 
  CDO – IGS                                                             
            AAA  $4   37%  $4   28%  $—   —  $2   23%  $—   —  $10   30% 
            AA   3   19%   —   —   —   —   1   20%   —   —   4   19% 
            A   11   34%   2   22%   1   13%   —   —   —   —   14   26% 
            BBB   14   43%   2   14%   7   26%   2   30%   —   —   25   31% 
  CDO – IGS Total   32   34%   8   21%   8   23%   5   19%   —   —   53   28% 
  CDO – CES                                                             
            BB   1   9%   3   30%   1   11%   —   —   —   —   5   13% 
            NR   —   —   —   —   1   3%   —   —   —   —   1   3% 
  CDO – CES Total   1   9%   3   30%   2   5%   —   —   —   —   6   9% 
  Total CDO  $33   32%  $11   22%  $10   14%  $5   19%  $—   —  $59   23% 

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Real Estate

Table 33 Fair Value as Percent of Principal Value for Securities at the Opportunity FundAcacia – (continued)

(Dollars in Millions)2004 & Earlier2005200620072008Total
Value%Value%Value%Value%Value%Value%
CMBS
Comm – IGS
          AAA$——$887% $288% $——$——$1087% 
          AA165% ————————165% 
          A1168% 246% ——————1364% 
          BBB1470% 2347% 141% ————3853% 
Comm – IGS Total2669% 3350% 355% ————6256% 
Comm – CES
          BB1944% 2836% 2929% 222% ——7834% 
          B337% 1334% 1327% ————2931% 
          NR——241% 522% ————725% 
Comm – CES Total2242% 4336% 4728% 222% ——11433% 
Total CMBS$4853% $7642% $5028% $222% $——$17639% 
CDO
CDO – IGS
          AAA$341% $222% $——$——$——$532% 
          AA317% 19% ——140% ——518% 
          A1136% 250% 111% 120% ——1530% 
          BBB1239% 212% 524% 224% ——2128% 
CDO – IGS Total2935% 716% 619% 427% ——4627% 
CDO – CES
          BB——213% 120% ————313% 
          B111% ————————111% 
CDO – CES Total111% 213% 120% ————412% 
Total CDO$3029% $916% $7��19% $427% $——$5021% 


Derivative Financial Instruments

We began acquiring assetsenter into interest rate agreements to help manage some of our interest rate risks. We enter into these agreements with highly rated counterparties and maintain certain risk management policies limiting our exposure concentrations to any counterparty. At June 30, 2008, Redwood was party to interest rate agreements with an aggregate notional value of $264 million and a net fair value of negative $2 million. At June 30, 2008 the Acacia entities were party to interest rate agreements with an aggregate notional value of $1.8 billion and a net negative fair value of $18 million. These are all accounted for the Opportunity Fundas trading instruments and all changes in the fourth quartervalue and any net payments and receipts are recognized through our consolidated statements of 2007 and acquired $20 million of assets during(loss) income through market valuation adjustments, net.

One Acacia entity entered into credit default swaps (CDS) in the first quarter of 2007. At June 30, 2008, bringing the total cost of securities acquired to date to $42 million. Due to the bid/ask spread on these illiquid securitiesCDS had a $78 million notional balance and principal paydowns net of discount accretion, thea fair value of securities heldnegative $75 million. At December 31, 2007, these CDS had a notional balance of $79 million and a fair value of negative $57 million. The decrease in the Opportunity Fund at March 31, 2008 was $36 million ($6 million less than our cost). The table below provides informationfair value on the activityCDS is included in this Fund during the first quarter of 2008.

Table 33 Securities at Opportunity Fund — Activity

   
March 31, 2008
(In Thousands)		 Residential
IGS		 CDO
IGS		 Total
Balance at beginning of period $3,126  $12,075  $15,201 
Acquisitions  7,672   12,336   20,008 
Principal repayments (including calls)  (1,137)   (9)   (1,146) 
Discount amortization  319   435   754 
Change in fair value adjustments, net  (880)   1,704   824 
Balance at End of Period $9,100  $26,541  $35,641 

At March 31, 2008, the $36 million of securities heldmarket valuation adjustments, net, in the Opportunity Fund consisted of $9 million of residential subprime IGS originated prior to 2005, $16 million of CDO IGS created in 2004, and $11 million of CDO IGS created in 2005. These securities are performing in line with our expectations and we did not recognize any other-than-temporary impairments on these securities on our consolidated financial statements.

We anticipate acquiring additional securities and fully investing the $96 million in capital commitments within the next two quarters.

Liabilities and Stockholders’ Equity

Redwood Debt

At the endstatements of the first quarter of 2008, we had $2 million of recourse debt in the form of repurchase (repo) agreements incurred to finance the acquisition of certain residential investment grade real estate securities. This was a decrease from $8 million at December 31, 2007.

We may increase our use of recourse debt in the future, especially to finance temporarily the accumulation of loans and securities prior to a securitization. We will continue to take into account the mortgage market and economic conditions in determining prudent levels of recourse leverage that are consistent with our internal risk-adjusted capital guidelines.(loss) income.

Asset-Backed Securities Issued byat Sequoia and Acacia

Through our sponsored securitization entities, we have securitized the majority of the assets shown on our consolidated balance sheet.sheets. These securitization entities acquire assets and create and sellissue asset-backed securities (ABS) in order to fund their asset purchases.these acquisitions. The residential whole loan securitization entities we sponsor are called Sequoia and the CDO securitization entities we sponsor are called Acacia. These securitization entities are bankruptcy-remote from us, so that our liabilities cannot become liabilities of the securitization entities, and

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the ABS issued by the securitization entities cannot become obligations of Redwood.ours. Nevertheless, since, accordingGAAP requires us to accounting definitions, we are deemed to control these securitization entities, we show bothconsolidate the assets and liabilities of thesefrom Sequoia and Acacia entities on our consolidated balance sheet.for financial statement reporting purposes.

At March 31,June 30, 2008, our consolidated balance sheet included $6.8there was $6.4 billion of loans reported at cost owned by Sequoia securitization entities and reported at cost, which were funded with $6.5$6.2 billion Sequoia ABS issued that is also reported at cost on our consolidated balance sheet.cost. At March 31,June 30, 2008, our consolidated balance sheets included $1.1 billionthere was $822 million of securities reported at fair value owned by Acacia securitization entities and reported at fair value, which were funded with $1.0 billion$935 million Acacia ABS issued that is also reported at fair value. In total, the consolidated assets of these two programs represent 95%94% of our total consolidated assets and their ABS issuedthe liabilities of these programs (ABS issued) represent 99% of our total consolidated liabilities.

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The following table provides detail on the activity for asset-backed securities for the three and six months ended March 31,June 30, 2008.

Table 34 ABS Issued byat Sequoia and Acacia — Activity

              
(In Thousands) December 31,
2007		 New
Issuance		 Paydowns FAS 159
Adjustments		 Market
Valuation
Adjustments		 Amortization March 31,
2008
  Three Months Ended
June 30, 2008		 
(In Millions) March 31,
2008		 Paydowns FAS 159
Adjustments		 Market
Valuation
Adjustments		 Gain on
ABS Payoff		 Amortization June 30,
2008
Sequoia ABS issued with principal value, net $6,910,946  $—  $(393,788)  $—  $—  $(2,183)  $6,514,975  $6,515  $(364)  $—  $—  $(1)  $(2)  $6,148 
Sequoia ABS interest only issued  35,220   —   —   —   —   (5,704)   29,516   30   —   —   —   —   (3)   27 
Total Sequoia ABS Issued  6,946,166   —   (393,788)   —   —   (7,887)   6,544,491   6,545   (364)   —   —   (1)   (5)   6,175 
Acacia issued ABS with principal value, net  3,359,406   —   (37,440)   (1,468,345)   (807,890)   —   1,045,731   1,046   (110)   —   (1)   —   —   935 
Acacia ABS CES issued  23,707   —   —   (21,327)   (1,951)   —   429   —   —   —   —   —   —   — 
Total Acacia ABS Issued  3,383,113   —   (37,440)   (1,489,672)   (809,841)   —   1,046,160   1,046   (110)   —   (1)   —   —   935 
Total ABS Issued $10,329,279  $—  $(431,228)  $(1,489,672)  $(809,841)  $(7,887)  $7,590,651  $7,591  $(474)  $—  $(1)  $(1)  $(5)  $7,110 

Generally, when we securitize assets, as opposed to owning them directly and funding them with

       
       
  Six Months Ended
June 30, 2008		 
(In Millions) December 31,
2007		 Paydowns FAS 159
Adjustments		 Market
Valuation
Adjustments		 Gain on
ABS Payoff		 Amortization June 30,
2008
Sequoia ABS issued with principal value, net $6,911  $(758)  $—  $—  $(1)  $(4)  $6,148 
Sequoia ABS interest only issued  35   —   —   —   —   (8)   27 
Total Sequoia ABS Issued  6,946   (758)   —   —   (1)   (12)   6,175 
Acacia issued ABS with principal value, net  3,359   (147)   (1,468)   (809)   —   —   935 
Acacia ABS CES issued  24   —   (22)   (2)   —   —   — 
Total Acacia ABS Issued  3,383   (147)   (1,490)   (811)   —   —   935 
Total ABS Issued $10,329  $(905)  $(1,490)  $(811)  $(1)  $(12)  $7,110 


Long-term Debt — Redwood debt and equity, our reported cost of funds is higher (the cost of ABS securities issued is generally higher than that of our debt) but we utilize less equity capital. As a result, our return on equity may increase after securitization. In addition, liquidity risks are generally reduced or eliminated, as the Redwood debt associated with the accumulation of these assets is paid off upon securitization.

Subordinated Notes

In 2006, we issued $100 million of subordinatedlong-term Redwood debt in the form of long-term Redwood debt notes (trust preferred securities) through Redwood Capital Trust I, a wholly-owned Delaware statutory trust, in a private placement transaction. These trust preferred securities require quarterly distributions at a floating rate equal to three-month LIBOR plus 2.25% until the notes are redeemed in whole, which will be no later than January 30, 2037. The earliest optional redemption date without a penalty is January 30, 2012.

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In May 2007, we issued $50 million of subordinatedlong-term Redwood debt notes which require quarterly distributions at a floating rate equal to three-month LIBOR plus 2.25% until the notes are redeemed in whole, which will be no later than July 30, 2037. The earliest optional redemption date without a penalty is July 30, 2012.

In our internal risk-adjusted capital calculations we include these subordinated noteslong-term Redwood debt in our capital base.

Derivative Financial Instruments

We currently have two kinds of derivative instruments: interest rate agreements and credit default swaps. All derivatives are reported on our balance sheet at fair value. Changes in the fair values of derivatives are either recorded through our consolidated statements of income (loss) or through accumulated other comprehensive income (loss) on our consolidated balance sheets.

We enter into interest rate agreements to help manage some of our interest rate risks. We enter into these agreements with highly rated counterparties and maintain certain risk management policies limiting our exposure concentrations to any counterparty. At March 31, 2008, Redwood was party to interest rate agreements with an aggregate notional value of $300 million and a net fair value of negative $6 million. These are all accounted for as trading instruments and all changes in value and any net payments and receipts are recognized through our income statement through market valuation adjustments.

At March 31, 2008 the Acacia entities were party to interest rate agreements with an aggregate notional value of $1.8 billion and a net negative fair value of $52 million. On January 1, 2008, we elected to account for these derivatives under the fair value option of FAS 159. These derivatives had previously been accounted

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for as cash flow hedges under FAS 133. As a result of the de-designation of cash flow hedges at the beginning of this year, the fair value of these derivatives at that time (negative $33 million) was retained in accumulated other comprehensive income. This amount will be amortized as interest expense over the remaining lives of the Acacia liabilities and $1 million was amortized in the first quarter of 2008. Any changes in the fair value of these derivatives and any net payments and receipts subsequent to January 1, 2008 are recognized through market valuation adjustments on our consolidated statements of income. Interest rate agreements owned by Acacia decreased in value by $35 million during the first quarter of 2008.

Acacia entered into credit default swaps in the first quarter of 2007. At March 31, 2008, these had a $79 million notional balance with a fair value of negative $72 million. At December 31, 2007, these credit default swaps had the same notional balance and a fair value of negative $57 million. The decrease in fair value on these swaps is included in the market valuation adjustments on our consolidated statements of income.

Stockholders’ Equity

Our reported book value at March 31, 2008 was $17.89 per share, a decrease from $23.18 per share at the beginning of the year, after the adoption of FAS 159. Our book value per share decreased over this period primarily as a result of declines in the fair value of the assets consolidated on our balance sheets.

Cash Requirements, Sources of Cash, and Liquidity

We use capital to fund our operations, invest in earning assets which are primarily credit sensitive and illiquid, fund working capital, and to meet lender capital requirements with respect to collateralized borrowings. Through our internal risk-adjusted capital policy, we set aside a prudent level of reserve capital for our earning assets to meet liquidity needs that may arise. In most cases, the amount of capital set aside is equal to 100% of the fair value of the asset. Any capital that exceeds our risk-adjusted capital guideline amount is excess capital that can be invested to support business growth.

When we think about capital, we analyze it from the perspective of the amount of “economic capital” we have to manage, which is the amount we have set aside for our earning assets (at fair value) and the amount of excess capital (or cash) we have available to invest in new assets. Economic capital is calculated by taking our GAAP equity and adjusting for any differences between the fair value of our investments in Sequoia and Acacia and the GAAP reported values, subtracting the net other assets and liabilities, and adding our long term debt.

At March 31, 2008, our total available capital, defined as the sum of our excess capital plus our invested capital, amounted to $660 million, compared to $793 million at December 31, 2007. The decline reflects market value adjustments on our employed capital. Our total available capital of $660 million differs from our GAAP capital (equity plus long-term debt) of $735 million because we adjust our GAAP capital for “economic” value changes to our investments in Sequoia and Acacia and we deduct net other assets and liabilities.

Capital employed decreased in the first quarter by $83 million to $413 million mainly as a result of market value changes which was partially offset by $65 million of new acquisitions. Declines in the fair values of assets do not have a large effect on excess capital, as asset value declines reduce equally both available capital and capital required for these investments.

At March 31, 2008, we had $247 million of excess capital, a decrease from $282 million at December 31, 2007. The decrease in excess capital reflects our investment activity in the first quarter.

Our net liquid assets at March 31, 2008 totaled $263 million and, as presented in the table below, included $257 of unrestricted cash, $4 million unsecuritized residential real estate loans at fair value, and $4 million of AAA-rated securities at fair value, less $2 million of Redwood debt.

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Table 35 Liquidity Position

 
(In Millions) March 31, 2008
Unrestricted cash $257 
Unsecuritized residential loans  4 
AAA-rated residential securities  4 
Liquid assets  265 
Redwood debt  (2) 
Net Liquidity Position $263 

We are well aware of the depressed prices the market currently places on securities we hold. We are long term investors and we fund most of our investments with equity. We acquire our securities at discounts, and in many cases substantial discounts to face value, and we model a range of expected cash flows that we expect to collect over the life of each security. To the extent the fair values our securities are lower or higher from time to time is of modest consequence to us as long-term investors — provided the cash flows remain within our range of expectations.

It is important to note that the high level of excess capital and liquidity over the past several quarters resulted, in part, from our efforts to maintain a strong balance sheet during a time of market distress. It also resulted, in part, from our strategic decision to sell lower-yielding, higher-rated assets to position us to opportunistically acquire higher yielding assets that could provide us with more upside return. Over time, we expect our excess capital and net liquidity to decline. We have less need to maintain a large liquidity position, however, as most of our investments are funded with equity.

Contractual Obligations and Commitments

The following table below presents our contractual obligations and commitments as of March 31,June 30, 2008, as well as the obligations of the securitization entities that we sponsor and are consolidated on our balance sheets. The operating leases are commitments that are expensed based on the terms of the related contracts.consolidate for financial reporting purposes.

Table 3635 Contractual Obligations and Commitments as of March 31,June 30, 2008

          
 Payments Due or Commitment Expiration by Period Payments Due or Commitment Expiration by Period
(In Thousands) Total Less Than
1 Year		 1 to 3
Years		 3 to 5
Years		 After 5
Years
(In Millions) Total Less Than
1 Year		 1 to 3
Years		 3 to 5
Years		 After 5
Years
Redwood Obligations:
                          
Redwood debt $2,086  $2,086  $—  $—  $— 
Subordinated notes  150,000   —   —   —   150,000 
Anticipated interest payments on Subordinated notes  309,923   7,277   15,166   19,262   268,218 
Short-term debt – Redwood $9  $9  $—  $—  $— 
Long-term debt – Redwood  150   —   —   —   150 
Anticipated interest payments on long-term Redwood debt  316   7   19   22   268 
Accrued interest payable  1,423   1,423   —   —   —   1   1   —   —   — 
Operating leases  15,094   1,292   3,397   3,713   6,692   15   2   3   4   6 
Purchase commitments  —   —   —   —   —   —   —   —   —   — 
Total Redwood Obligations and Commitments $478,526  $12,078  $18,563  $22,975  $424,910  $491  $19  $22  $26  $424 
Obligations of Securitization Entities:
                                                  
Consolidated ABS(1) $7,590,651  $—  $—  $—  $7,590,651  $7,110  $—  $—  $—  $7,110 
Anticipated interest payments on ABS(2)  6,847,947   305,886   801,854   928,401   4,811,806   6,803   187   1,340   965   4,311 
Accrued interest payable  42,460   42,460   —   —   —   31   31   —   —   — 
Total obligations of securitization entities $14,481,058  $348,346  $801,854  $928,401  $12,402,457  $13,944  $218  $1,340  $965  $11,421 
Total Consolidated Obligations and Commitments $14,959,584  $360,424  $820,417  $951,376  $12,827,367  $14,435  $237  $1,362  $991  $11,845 

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(1)All consolidated ABS issued are collateralized by real estate loans and securities. Although the stated maturity is as shown, the ABS obligations will pay down as the principal of these real estate loans or securities pay down. The amount shown is the face value of the ABS issued and not necessarily the value reported in our consolidated financial statements.
(2)The anticipated interest payments on consolidated ABS issued is calculated based on the contractual maturity of the ABS and therefore assumes no prepayments of the principal outstanding as of March 31,June 30, 2008.

Accumulated Other Comprehensive (Loss) Income

As of December 31, 2007, most of our real estate securities were accounted for as AFS and were reported on our consolidated balance sheets at fair value. Additionally, most of the derivative instruments owned by Acacia entitles were accounted for as cash flow hedges and reported on our consolidated balance sheets at fair value. The differences between the value of these assets and their amortized costs were shown as a component of stockholders’ equity (deficit) as accumulated other comprehensive (loss) income. Periodic changes in the fair value of these assets relative to amortized cost were included in other comprehensive income.

On January 1, 2008 we elected the fair value option under FAS 159 for the assets and liabilities of Acacia entities and certain other assets at Redwood. The effect of this election was a reclassification of $459 million from accumulated other comprehensive income to retained earnings. This one time adjustment had no impact on our reported earnings. Subsequent changes to the values of FAS 159 assets and liabilities flow through our consolidated statements of (loss) income not through other comprehensive income.

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The following table provides cumulative balances of unrealized gains and losses and carrying value by type and rating of real estate securities at June 30, 2008 and December 31, 2007. It also reflects the change in balances of cumulative unrealized (loss) gains during the first six months of 2008.

Table 36 Other Comprehensive Income (Loss) — Real Estate Securities

      
 Cumulative
(Loss) Gain		 Adoption of
FAS 159		 Change in
(Loss) Gain		 Cumulative
(Loss) Gain		 Carrying Value
(In Millions) December 31,
2007		 January 1,
2008		 Six Months
Ended June 30,
2008		 June 30,
2008		 June 30,
2008		 December 31,
2007
Investment-Grade Securities
                              
Residential $(241)  $241  $(15)  $(15)  $202  $1,157 
Commercial  (20)   20   —   —   —   90 
CDO  (13)   7   5   (1)   13   114 
Total IGS  (274)   268   (10)   (16)   215   1,361 
Credit-Enhancement Securities
                              
Residential  (143)   103   34   (6)   87   402 
Commercial  (125)   87   28   (10)   91   337 
CDO  1   —   (3)   (2)   7   10 
Total CES  (267)   190   59   (18)   185   749 
Total Real Estate Securities $(541)  $458  $49  $(34)  $400  $2,110 

Market Risks

We seek to manage the risks inherent in our business — including but not limited to credit risk, interest rate risk, prepayment risk, liquidity risk, and fair value risk — in a prudent manner designed to enhance our earnings and dividends and preserve our capital. In general, we seek to assume risks that can be quantified from historical experience, to actively manage such risks, and to maintain capital levels consistent with these risks.

Credit Risk

Integral to our core business is assuming the credit risk of real estate loans primarily through the ownership of residential and commercial real estate loans and securities. Much of our capital base is employed in owning credit-enhancement securities that have below investment-grade credit ratings due to their concentrated credit risks with respect to underlying real estate loans. We believe that many of the loans underlying these securities are above-average in credit quality as compared to U.S. real estate loans in general, but the balance and percentage of loans with special risk factors (higher risk commercial loans, interest-only and negative amortization residential loan types, and alt-a and subprime residential loans) has increased and continues to increase. We also own $4 million residential real estate loans that are not securitized.

Credit losses from any of the loans in securitized loan pools reduce the principal value of and economic returns on the lower-rated securities in these pools. Credit losses on real estate loans can occur for many reasons, including: poor origination practices; fraud; faulty appraisals; documentation errors; poor underwriting; legal errors; poor servicing practices; weak economic conditions; decline in the value of homes, businesses, or commercial properties; special hazards; earthquakes and other natural events; over-leveraging of the borrower or on the property; reduction in market rents and occupancies and poor property management practices; changes in legal protections for lenders; reduction in personal incomes; job loss; and personal events such as divorce or health problems. In addition, if the U.S. economy or the housing market weakens, our credit losses could increase beyond levels that we have anticipated. Credit losses on real estate loans can vary for reasons not related to the general economy.

With respect to most of the loans securitized by securitization entities sponsored by us and for a portion of the loans underlying residential loan CES we have acquired from securitizations sponsored by others, the

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interest rate is adjustable. Accordingly, when short-term interest rates rise, required monthly payments from homeowners may rise under the terms of these ARMs, and this may increase borrowers’ delinquencies and defaults.

We also acquire credit-enhancement securities backed by negative amortization adjustable-rate loans made to residential borrowers, some of which are prime-quality loans while many are alt-a quality loans (and a few are subprime loans). We invest in these riskier loan types with the expectation of significantly higher delinquencies and losses as compared to regular amortization loans, but believe these securities offer us the opportunity to generate attractive risk-adjusted returns as a result of attractive pricing and the manner in which these securitizations are structured. Nevertheless, there remains substantial uncertainty about the future performance of these assets.

The large majority of the commercial loans we credit-enhance are fixed-rate loans, some of which are interest-only loans. In general, these loans are not fully amortizing and therefore require balloon payments at maturity. Consequently, we could be exposed to credit losses at the maturity of these loans if the borrower is unable to repay or refinance the borrowing with another third party lender.

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We will experience credit losses on residential and commercial loans and CES, and to the extent the losses are consistent with the amount and timing of our assumptions, we expect to earn attractive returns on our investments. We manage our credit risks by understanding the extent of the risk we are taking and insuring the appropriate underwriting criteria are met, and we utilize systems and staff to continually monitor the ongoing credit performance of each loan and security. To the extent we find the credit risks on specific assets are changing adversely, we will take actions (including selling the assets) to mitigate potential losses. However, we may not always be successful in foreseeing adverse changes in credit performance or in effectively mitigating future credit losses.

In addition to residential and commercial CES, Redwood, the Fund, and Acacia entities we sponsor own investment-grade and other securities issued by securitization entities that are sponsored by others. These securities are typically rated AAA through B,BBB-, and are in a second-loss or better position or are otherwise effectively more senior in the credit structure in comparison to first-loss CES or their equivalent. A risk we face with respect to these securities is that we do not generally control or influence the underwriting, servicing, management, or loss mitigation with respect to these underlying loans.

The Acacia entities, and to a small extent, Redwood, also own securities backed by subprime and alt-a residential loans that have substantially higher credit risk characteristics than prime-quality loans. Consequently, we can expect these lower-quality loans to have higher rates of delinquency and loss, and if such losses differ from our assumptions, Acacia, (and thus Redwood)the Fund, and Redwood could suffer losses.

In addition to the foregoing, the Acacia entities own certain investment-grade, BB-rated, and B-rated residential loan securities purchased from the Sequoia securitization entities we sponsor.

These securities owned by Acacia are generally less likely to suffer credit losses than other securities since credit losses ordinarily would not occur until cumulative credit losses within the pool of securitized loans exceed the principal value of the subordinated CES underneath and other credit protections have been exhausted. However, if the pools of residential and commercial loans underlying these securities were to experience poor credit results, these Acacia securities could have their credit ratings downgraded, could suffer decreases in fair value, or could experience principal losses. If any of these events occurs, it would likely reduce our returns from the Acacia CDO equity securities we have acquired and may reduce our ability to sponsor Acacia transactions in the future.these investments.

Interest Rate Risk

Interest rates and the shape of the yield curve can affect the cash flows and fair values of our assets, liabilities, and interest rate agreements, and consequently, affect our earnings and reported equity. Our general strategy with respect to interest rates is to maintain an asset/liability posture (including hedges) on a consolidated basis that assumes some interest rate risks but not to such a degree that the achievement of our long-term goals would likely be affected by changes in interest rates. Accordingly, we are willing to accept short-term volatility of earnings and changes in our reported equity in order to accomplish our goal of achieving attractive long-term returns.

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To implement our interest rate risk strategy, we may use interest rate agreements in an effort to maintain a close match between pledged assets and short-term Redwood debt, as well as between the interest rate characteristics of the assets in the securitization entities and the corresponding ABS issued. However, we do not attempt to completely hedge changes in interest rates, and at times, we may be subject to more interest rate risk than we generally desire in the long term. Changes in interest rates will have an impact on the values and cash flows of our assets and corresponding liabilities.

Prepayment Risk

We seek to maintain an asset/liability posture that benefits from investments in prepayment-sensitive assets while limiting the risk of adverse prepayment fluctuations to an amount that, in most circumstances, can be absorbed by our capital base while still allowing us to make regular dividend payments.

Prepayments affect GAAP earnings in the near-term primarily through the timing of the amortization of purchase premium and discount and through triggering market valuation adjustments. For example, amortization income from discount assets may not necessarily offset amortization expense from premium

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assets, and vice-versa. In addition, variations in current and projected prepayment rates for individual assets and changes in interest rates (as they affect projected coupons on ARMs and other assets and thus change effective yield calculations) may cause net premium amortization expense or net discount amortization income to vary substantially from quarter to quarter. Moreover, the timing of premium amortization on assets may not always match the timing of the premium amortization on liabilities even when the underlying assets and liabilities are in the same securitization and pay down at the same rate.

With respect to securities backed by residential mortgage loans (and in particular, IO securities), changes in prepayment forecasts by market participants could affect the market prices of those securities sold by securitization entities, and thus could affect the profits we earn from securitized assets.

Prepayment risks also exist in the assets and associated liabilities consolidated on our balance sheets. In general, discount securities (such as CES) benefit from faster prepayment rates on the underlying real estate loans while premium securities (such as IO securities) benefit from slower prepayments on the underlying loans. Our largest current potential exposure to changes in prepayment rates is on short-term residential ARM loans. We are currently biased in favor of faster prepayment speeds with respect to the long-term economic effect of ARM prepayments. However, in the short-term, increases in ARM prepayment rates could result in GAAP earnings volatility.

Through our ownership of discount residential loan CES backed by fixed-rate and hybrid residential loans, we generally benefit from faster prepayments on those underlying loans. Prepayment rates for those loans typically accelerate as medium-and-long-term interest rates decline.

Our credit results and risks can also be affected by prepayments. For example, credit risks for the CES we own are reduced each time a loan prepays. All other factors being equal, faster prepayment rates should reduce our credit risks on our existing portfolio.

We caution that prepayment rates are difficult to predict or anticipate, and variations in prepayment rates can materially affect our earnings and dividends. ARM prepayment rates, for example, are driven by many factors, one of which is the steepness of the yield curve. As the yield curve flattens (short-term interest rates rise relative to longer-term interest rates), ARM prepayments typically increase.

We do not believe it is possible or desirable to control the effects of prepayments in the short-term. Consequently, our general approach is to seek to balance overall characteristics of our balance sheet so that the net present values of cash flows generated over the life of the assets and liabilities in our consolidated portfolios do not materially change as prepayment rates change.

Fair Value and Liquidity Risks

SomeMost of the CES that we own is fully funded with equity with no associated recourse or non-recourse debt that might affect our liquidity position. Additionally, we consolidate many securities are accounted for as available-for-sale and are generally marked-to-market through our balance sheets and not through our income statement. These assets are credit sensitive and generally illiquid. Fair value fluctuations of these assets can affect reported stockholders’ equity. Most of these securities are(primarily IGS) owned by securitization entities we sponsor and fair value fluctuations on these securities do not have an impact on our liquidity. Fair value fluctuations on securities we own and fund with short-term debt (generally prior to securitization) could have an impact on our liquidity. Our earnings could be affected by adverse changes in fair values on all securities we own or consolidate to the extent there is an accompanying adverse change in projected cash flows. In these cases, the negative changes in fair values are reported through our income statement. See also Mark-to-Market Adjustments Discussion earlier in this document.

Beginning in the first quarter of 2007, we classified other real estate investments as trading instruments. Changes in the fair values of these investments are recognized through our income statement. Thus, changes in fair values may add to the quarterly volatility of our earnings. This could occur whether these instruments are hedged or are financed with non-recourse debt.

Acacia entities. On January 1, 2008 we elected the fair value option under FAS 159 for certainAcacia assets and liabilities, under FAS 159. Now for these assets and liabilities,with all changes in market values will benow being recorded through our income statement, and it is likely to addstatement. Though this adds to our potential earnings volatility. Most of these assetsvolatility, the securities and liabilities accounted for in this manner are owned orABS issued by Acacia and they willentities have no impact on our liquidity. However, changes in values (or ratings downgrades) on assets owned by an Acacia entity may disrupt the cash flows on certain of our

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investmentsrecourse to us that would otherwise affect our liquidity position. Changes in Acacia. Such disruptions in cash flowthe fair values (or ratings downgrades) of assets owned by an Acacia entity may also create additional differences between our reported GAAP and taxable income from cash received. Weincome. However, we do not currently believe that this will create any liquidity issues for us.

Most of our consolidatedthe real estate loans that we consolidate are accounted for as held-for-investment and reported at amortized cost. Most of these loans have been sold to Sequoia entities and, thus, changes in the fair value of the loans do not have an impact on our liquidity. However, changes in fair values during the accumulation period (while these loans are funded with short-term Redwood debt before they are sold to a Sequoia entity) may have a short-term effect on our liquidity. We may also own some real estate loans accounted for as held-for-sale and adverse changes in their value would be recognized through our income statement and may have an impact on our ability to obtain financing for them.

Our consolidated obligations consist primarily of ABS issued. Generally, changes in fair value of ABS issued have no impact on our liquidity. ABS issued by Sequoia are reported at amortized cost as our the residential loans collateralizing these ABS. Beginning January 1, 2008, we report at fair value the ABS issued by Acacia and also report the underlying securities collateralizing the ABS issued at fair value. In either case, the resulting net equity (assets less liabilities) may not necessarily be reflective of the economic value of our interests in these securitization entities. However, since the ABS issued can only look to the cash flows generated by the assets within that securitization for payments of interest and repayments of the face value of the ABS, the changes in fair value do not have an effect on Redwood. Only to the extent that changes in fair values affect the timing of the cash flows we might receive on our investments in the Acacia entities, is there an effect to Redwood from changes in fair values of these securities. There are no such considerations in the Sequoia securitization entities.

We hold some assets funded with short-term debt (generally prior to securitization) that is recourse to Redwood. At some point, this may increase our fair value and liquidity risks. We manage these risks by maintaining what we believe to be conservative capital levels under our internal risk-adjusted capital and risk management policies and by ensuring we have a variety of financing facilities available to fund each of our assets.

Inflation Risk

Virtually all of our consolidated assets and liabilities are financial in nature. As a result, changes in interest rates and other factors drive our performance far more than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates.

Our financial statements are prepared in accordance with GAAP. Our activities and balance sheets are measured with reference to historical cost or fair value without considering inflation.

Critical Accounting Policies

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. The critical accounting policies and the possible effect of changes in estimates on our financial results and statements are discussed below. Management discusses the ongoing development and selection of these critical accounting policies with the audit committee of the board of directors.

Mark-to-Market Adjustments

Accounting and Economics

The rules regarding mark-to-market (MTM) accounting are complex and may not clearly reflect the underlying economics. This accounting and economic discussion is intended to provide investors with a better understanding of the impact of MTM adjustments on our reported financial results.

MTM adjustments can result from changes in fair values caused either by a change in expected cash flows (i.e. increased credit loss estimates reducing expected cash flows), or a change in market discount rates (i.e., the market requires a greater risk premium and/or interest rates rise), or a combination of both.

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All changes in fair value for securities or derivatives accounted for as trading instruments or under the fair value option of FAS 159 flow through the income statement. These adjustments can be either positive or negative from period to period.

Our CES held at Redwood and the real estate securities held at the Opportunity Fund are accounted for as available-for-sale (AFS) securities. We carry AFS securities in our GAAP balance sheet at their fair value. Positive changes in the fair value of AFS securities from period to period are always accounted for as increases to stockholders’ equity and do not flow through our income statement. Accounting for negative changes in the fair value of AFS securities from period to period requires a three-step process involving a combination of quantitative and judgmental evaluations. The ultimate purpose of this process is to determine whether negative MTM adjustments represent “other-than-temporary” (OTT) impairments, which flow through our GAAP income statement, or represent “temporary” impairments, which are recorded as a reduction of stockholders’ equity and do not flow through our income statement.

The diagram below and the narrative discussion that follows address the three-step process for evaluating impairments on AFS securities.

[GRAPHIC MISSING]

The first step is to determine whether there has been an adverse change in the underlying cash flows generated by the security. A security is considered OTT impaired even if the change in projected cash flows is small relative to the resulting MTM adjustment. It is difficult to separate with precision how much of the change in fair value is driven by changes in expected cash flows versus changes in market discount rates, but during periods of market illiquidity and uncertainty (as we encountered since late 2007), the market discount rate impact can be significant.

The second step is to determine whether we have the ability and intention to hold the security.

The third step requires us to evaluate whether an impaired security will recover in value within a reasonable period of time. This step is very subjective and time consuming particularly when there is turmoil and uncertainty in the capital markets.

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AFS securities deemed permanently impaired for accounting purposes cannot be written back up through MTM adjustments in our income statement. This does not mean the underlying security could not recover in value. If the value of an impaired security does recover, we would recognize this benefit through higher interest yields over time. Therefore some of the securities classified as OTT impaired during the first quarter of 2008 may eventually prove to have significant value to us.

The consolidated Sequoia assets are accounted for on our GAAP balance sheet as held-for-investment and are carried at their unpaid principal balances adjusted for net amortized premiums or discounts and net of any allowances for credit losses. The consolidated Sequoia liabilities are accounted for at their unpaid principal balances net of any amortized premiums or discounts.

Prior to January 1, 2008, we accounted for the consolidated securities held at Acacia entities (the assets) as AFS and the consolidated ABS issued by Acacia entities (the liabilities) at cost. In our opinion, this difference in accounting treatment led to a significant discrepancy in the GAAP carrying value for our investment in Acacia entities and our estimate of economic value. On January 1, 2008, we adopted a new accounting standard, FAS 159, and elected to fair value both the assets and liabilities of the Acacia entities. In accordance with FAS 159, we recorded a one-time, cumulative-effect adjustment to our January 1, 2008 opening balance sheet that decreased the carrying value of Acacia liabilities by $1.5 billion and increased equity. This new standard significantly reduces the disparity that existed between GAAP carrying value and our previous estimates of economic value.

Under FAS 159, we are required to flow through our quarterly income statement any net change in the fair value of Acacia assets and liabilities. As a result of the measurement techniques required by FAS 159, we still expect to encounter some MTM earnings volatility in the future as a result of the consolidation of Acacia entities. We expect this volatility to be significantly less than we encountered in prior periods.

The net GAAP carrying value of our investments in Acacia in our financial statements is derived by subtracting the fair value of the Acacia's liabilities from the fair value of Acacia’s assets. In theory, fair values of Acacia’s assets and liabilities should be reasonably correlated as they are paired within the same legal structure - ABS issued by each Acacia entity will be repaid directly and solely from the cash flows generated by the assets owned by that entity. However, at any given moment, the capital markets may use different discount rates and valuation parameters for Acacia’s collateral assets relative to its ABS issued. On March 31, 2008, for instance, the market values for Acacia’s liabilities were, in our view, depressed relative to the paired collateral assets. As a consequence of this market condition, the derived net GAAP carrying value of our retained Acacia investments was $68 million at March 31, 2008. This value is greater than our $49 million estimate of the fair value of our investments in Acacia based on the net present value of expected cash flows.

As a consequence of adopting FAS 159 as of January 1, 2008, we now also flow through our income statements the relative changes in the fair values of Acacia assets and liabilities as measured in their independent markets. During the first quarter of 2008, the value of our assets and derivatives declined by $837 million and the fair value of our paired liabilities declined by $810 million, for a net change of a negative $27 million. In the first quarter, the market re-priced Acacia assets downward at a slightly faster rate than the Acacia liabilities.

Mark-to-Market Valuation Process

The fair values we use for our assets and liabilities reflect what we believe we would realize if we chose to sell our securities or would have to pay if we chose to buy back our asset-backed securities (ABS) issued (liabilities). Establishing fair values is inherently subjective and is dependent upon many market-based inputs, including observable trades, information on offered inventories, bid lists, and indications of value obtained from dealers. Obtaining fair values for securities is especially difficult for more illiquid securities (such as ours), and is made more difficult when there is limited trading visibility, as washas been the case in recent months.quarters. Where there are observable sales, many of them are from distressed sellers, and their sales tend to further depress asset prices. For these reasons, we expect market valuations to continue to be highly volatile.

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Fair values for our securities and ABS issued are dependent upon a number of market-based assumptions including future interest rates, prepayment rates, discount rates, credit loss rates, and the timing of credit losses. We use these assumptions to generate cash flow estimates and internal values for each individual security.

Our valuation process relied on our internal values to estimate the fair values of our securities at June 30, 2008. We also request indications of value (marks) from dealers every quarter to assist in the valuation process.process for all of our assets and liabilities. For March 31,June 30, 2008, we received dealer marks on 71%81% of our assets and 82%91% of our liabilities on our consolidated balance sheet. One major dealer that we have used in prior periods provided no marks. In the aggregate, our internal valuations of the securities on which we received dealer marks were 17% lower than the aggregate dealer marks at June 30, 2008. Our internal valuations of our ABS issued on which we received dealer marks were 1% lower than the aggregate dealer marks at June 30, 2008.

One of the factors we consider in our valuation process is our assessment of the quality of the dealer marks we receive. Dealers remain inundated with requests for quarter-end marks, and there continues to be limited observable trading information for them to rely upon. Thus, their marks were most likely generated by their own pricing models for which they did not share their inputs and we had little insight into their assumptions.

Furthermore, the dealers continue to heavily qualify the information they send to us. The

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qualifications include statements that the markets are very volatile and are characterized by limited trading volume and poor price transparency, and in many cases, an increasing number of valuations are model-based due to a lack of observable trades.

Mark-to-Market Adjustments

Our valuation process reliedThe rules regarding mark-to-market (MTM) accounting are complex and may not clearly reflect the underlying economics. This accounting and economic discussion is intended to provide investors with a better understanding of the impact of MTM adjustments on our internal values to estimatereported financial results.

All changes in fair value for securities or derivatives accounted for as trading instruments or under the fair valuesvalue option of our securities at March 31, 2008. In the aggregate, our internal valuations of the securities on which we received dealer marks were 29% lower than the aggregate dealer marks at March 31, 2008. Our internal valuations of our ABS issued on which we received dealer marks were 14% lower than the aggregate dealer marks at March 31, 2008.

Revenue Recognition

When recognizing revenue on consolidated earning assets, we employ the effective yield method and use assumptions about the future to determine an effective yield that drives amortization of premiums, discounts, and other net capitalized fees and costs associated with purchasing and financing real estate loans and securities.

Loan Premium Amortization

For consolidated real estate loans, the effective yield method is applied as prescribed under FAS 91. For loans acquired prior to July 2004, we apply the existing interest rate at the reporting date to determine the effective yield for each pool of loans. During a period of rising short-term rates, the coupon is projected to increase, resulting in a higher effective yield. Under those circumstances, prior to the coupon rate resetting (generally one to six months for these loans), the amount of amortization is lower than it will be once the coupon rate resets. Consequently as short-term rates increased beginning in 2004 and159 flow through the first half of 2007, the amount of premium we amortized was less than it would have been in a flat interest rate environment. With lower premium amortization expenses as a result of rising interest rates combined with rapid prepayments, our cost bases have increased on our remaining loans. The cost bases in these loans continuesincome statement. These adjustments can be either positive or negative from period to exceed their estimated fair values.

For loans acquired after July 1, 2004, we use the initial coupon interest rate of the loans (without regard to futureperiod. Positive changes in the underlying indices) and anticipated principal payments on a pool basisfair value of AFS securities from period to calculate an effective yield and to amortize the premium or discount. Any volatility in amortization expense is dependent primarily on prepayments. The cost bases of these loans are approximately equal to their fair values.

Credit Reserves on Loans Held-for-Investment

For consolidated real estate loans held-for-investment, we establish and maintain credit reserves that we believe represent probable credit losses that will result from intrinsic losses existing in our pool of consolidated real estate loans held-for-investment as of the date of the financial statements. The reserves for credit losses are adjusted by taking provisions for credit losses recorded as a reduction in interest income on real estate loans on our consolidated statements of (loss) income. The reserves consist of estimates of specific loan impairment and estimates of collective losses on pools of loans with similar characteristics.

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To calculate the reserve for credit losses for real estate loans, we determine intrinsic losses by applying loss factors (default, the timing of defaults, and the loss severity upon default) that can be specifically applied to each pool of loans and estimate expected losses of each pool over their expected lives. Once we determine the loss factors, we then estimate the timing of these losses and the losses probable to occur over an effective loss confirmation period. This period is defined as the range of time between the probable occurrence of a credit loss (such as the initial deterioration of the borrower’s financial condition) and the confirmation of that loss (the actual charge-off of the loan). The losses expected to occur within the estimated loss confirmation period are the basis of our credit reserves because we believe those losses existaccounted for as of the reported date of the financial statements.

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

Securities Discount Amortization

For discount amortization on our consolidated securities, an effective yield is applied by projecting cash flows that incorporate assumptions of credit losses, prepayment speeds, and interest rates over the remaining life of each asset. If our assumptions prove to be accurate, then the yield that we recognize in the current period will remain the same over the life of the security. We constantly review — and update as necessary — our assumptions and resulting cash flow projections based on historical performance, input and analyses received from external sources, internal models, and our own judgment and experience. There can be no assurance that our assumptions used to generate future cash flows will prove to be accurate or that these estimates will not change materially.

The majority of our discount amortization is generated from residential and commercial CES purchased at a significant discount to par value. Discount balances equal to the credit losses that we expect to incur are set aside as a form of credit reserve and are not amortized into income. The level of this reserve is based upon our assessment of various factors including economic conditions, characteristics and delinquency status of the underlying loans, past performance of similar loans, and other factors. Thus, when credit losses do occur, they are recorded against this reserve and there is no income statement impact at that time. The difference between the amount of our total discount and the credit reserve is the accretable discount. The accretable discount represents the amount of discount amortization that we expect to recognize into income over the remaining life of the assets. As we update our estimate of future credit losses, increases in projected losses will increase the discount set aside as reserve resulting in less accretable discount for amortization into income and lower portfolio yields. In contrast, lower credit loss projections will decrease the reserve and increase the accretable discount balance, increasing our CES discount amortization and resulting in higher portfolio yields.

The timing of projected receipt of cash flows from our CES is also an important driver in the effective yield. Slower actual or projected prepayment speeds will cause projected receipt of cash flows to be delayed and will reduce the rate of CES discount accretion resulting in a lower yield for the portfolio. An increase in actual or projected prepayment speeds will generally result in a higher portfolio yield as a result of increased CES discount amortization.

Amortization of ABS Issued Premium

We apply the effective yield method in determining amortization for the premium and deferred asset-backed securities issuance cost for ABS issued. ABS premium is recognized through our income statement asstatement. Accounting for negative changes in the fair value of AFS securities from period to period requires a reduction in interest expensethree-step process involving a combination of quantitative and under APB 21 issuance costs are amortized as additional interest expense overjudgmental evaluations. The diagram and discussion that follows details the life of the ABS issued. Similar to our calculation of amortizationthree-step process for evaluating impairments on assets, the use of this method requires us to project cash flows over the remaining life of each liability. These projections are primarily affected by forecasted prepayment rates of the related assets. If prepayment speeds are faster than modeled, the average life of the liability will shorten, and we will recognize the ABS net premium at a faster rate, thereby increasing net income. If prepayment speeds are slower than expected, the average life of the liability will lengthen, and it will take us longer to recognize the ABS net premium. For the deferred

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asset-backed securities issuance costs, faster prepayments will result in faster amortization and an increase in interest expense while slower prepayments will result in slower amortization and a decrease in interest expense.[GRAPHIC MISSING]

Other-than-Temporary Impairments

For accounting purposes,AFS securities are deemed impaired if the fair value is below amortized cost. An assessment is then required as to whether the impairment is temporary and is reflected as unrealized losses in the balance sheet, or is other-than-temporary (OTT) and realized through the income statement as market valuation adjustments.

The first step in this assessment of the other-than-temporary impairments requires a determination ofis to determine whether there has been an adverse change in the underlying cash flows generated by a security,the security. It is difficult to separate with precision how much of the change in fair value is driven by changes in expected cash flows versus changes in market discount rates, but during periods of market illiquidity and uncertainty (as we encountered since late 2007), the market discount rate impact can be significant. The second step is to determine whether we have the intentability and abilityintention to hold the security, andsecurity. The third step requires us to evaluate whether we believe thean impaired security will recover itsin value within a reasonable period of time. This step is a highly complexvery subjective, particularly when there is turmoil and subjective evaluation.uncertainty in the capital markets.

If, based on our assessment, we have an other-than-temporary impairment, then the basis of the assetsecurity is written down to its fair value through our consolidated statements of (loss) income.income statement. Market valuation adjustments of this type

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could be substantial, reducing GAAP income and causing a loss. However, for securitized assets, reductions in fair values may not affect our cash flows or investment returns at all, or may not affect them to the degree implied by the accounting write-down.

Accounting Under

A security can be considered OTT impaired even if the Fair Value Option

Effective January 1, 2008, we adopted FAS 159 giving uschange in projected cash flows is small relative to the option to elect to measure eligible financial assets, financial liabilities, and firm commitments at fair value (i.e.,resulting MTM adjustment. So while OTT impaired securities cannot be written back up through MTM adjustments in our income statement, this does not mean the fair value option or FVO), on an instrument-by-instrument basis, that are otherwiseunderlying security could not permitted to be accounted for at fair value under other accounting standards. The election to userecover in value. If the FVO is available when an entity first recognizes a financial asset or financial liability or upon entering into a firm commitment. Subsequent changescash flows generated by the security perform better than the decline in fair value are recorded in earnings. Additionally, FAS 159 allows for a one-time election for existing positions upon adoption,might indicate, we could recognize this transition adjustment recorded to beginning retained earnings. Onebenefit through higher interest yields over time.

Inflation Risk

Virtually all of the chief objectives of this standard was to provide better matching of the accounting results to the economic activities underlying them. For example, there may be assets or liabilities that are measured under the historical cost models while related transactions (e.g. hedging derivatives or offsetting transactions) are at fair value. We have elected FVO on theour consolidated assets and liabilities of Acacia. For the Acacia assets this will mean that the ongoing changesare financial in fair value will be reported through earnings instead of an adjustment to other comprehensive income. Any unrealized gains or losses on Acacia assets at January 1, 2008 were reclassified to retained earnings from other comprehensive income. For the Acacia liabilities, the mark-to-market to fair value on January 1, 2008 from the historical cost basis was also recorded in retained earnings at January 1, 2008. We expect to elect the FVO for any future Acacia assets and liabilities.nature. As a result, of the adoption of FAS 159, we recorded a cumulative effect adjustment of $1.5 billion to stockholders’ equity as of January 1, 2008.

Accounting for Derivative Instruments

We use derivative instruments to manage certain risks such aschanges in interest rate risk. We may also acquire derivativerates and other factors drive our performance far more than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates.

Our financial instruments as investments. Derivative instrumentsstatements are reported on our consolidatedprepared in accordance with GAAP. Our activities and balance sheets at their fair value. If a derivative instrument has a positiveare measured with reference to historical cost or fair value it is reported as an asset. If the fair value is negative, the instrument is reported as a liability.

Changes in fair values of derivative instruments are reported either through the income statement or through our equity. For derivatives accounted for as trading instruments or under the FVO of FAS 159, all changes in the fair values are recognized through the income statement. For interest rate agreements (a type of derivative) accounted for as a cash flow hedge, most of the changes in fair values are recorded in our balance sheet through equity. Only the ineffective portions (as determined according to the accounting principle) of the derivatives accounted for as cash flow hedges are included in income.

Using derivatives may increase our earnings volatility, as the accounting results for derivatives may not match the accounting results for the hedged asset or liability due to our inability to, or decision not to, meet the requirements for certain accounting treatments, or if the derivatives do not perform as intended.

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Item 3. Quantitative and Qualitative Disclosures Aboutabout Market Risk

Information concerning market risk is incorporated herein by reference to Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2007, as supplemented by the information under Management’s“Management’s Discussion and Analysis of Financial Condition and Results of Operations — Market RisksRisks” above. With the exception of developments described under Management’s Discussion and Analysis of Financial Condition and Results of Operations above, including changes in the fair values of our assets, there have been no material changes in our quantitative or qualitative exposure to market risk since December 31, 2007.

Item 4. Controls and Procedures

In connection with the completion of the audited financial statements for December 31, 2007, we concluded that a material weakness in our internal control over financial reporting resulted from the fact that we were unable to obtain the necessary evidence under Staff Accounting Bulletin 59,“Accounting for Noncurrent Marketable Equity Securities” (SAB 59) to support our initial conclusion that a material portion of unrealized losses were recoverable as of December 31, 2007.

To address this material weakness we completed the additional analysis required under SAB 59 and implemented enhancements in our internal control over financial reporting that are designed to ensure that we continue to perform the requisite analysis on a quarterly basis.

Other than the enhancements and remediation steps described above, there have been no changes in our internal control over financial reporting during the quarter ended March 31,June 30, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II

Item 1. Legal Proceedings

We are not a party to anyThere is no material pending legal proceedings.proceedings to which we or any of our subsidiaries is a party or of which our property is the subject.

Item 1A. Risk Factors

There have been no material changes to the risk factors previously disclosed under Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2007.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

    
 Issuer Purchases of Equity Securities
Period Total
Number of
Shares
Purchased		 Average
Price Paid
Per Share		 Total
Number
of Shares
Purchased
As Part of
Publicly
Announced
Programs		 Maximum
Number
of Shares
Available for
Purchase Under
Publicly
Announced
Programs
January 1 – January 31, 2008  1,672  $34.24   —   — 
February 1 – February 29, 2008  —   —   —   — 
March 1 – March 31, 2008  —   —   —   — 
Total  1,672  $34.24   —   5,000,000 

The 1,672 shares purchased forFor the three months ended March 31,June 30, 2008, represent shares required to satisfy tax withholding requirements on the vesting of restricted shares. We announced a new stock repurchase plan on November 5, 2007 for the repurchase of up to a total of 5,000,000 shares. This plan replaced all previous share repurchase plans and has no expiration date. Therewe did not sell any equity securities that were no repurchasesnot registered under the new stockSecurities Act of 1935, as amended, or repurchase plan during 2007, or during the first quarterany shares of 2008 and as of March 31, 2008, there remained 5,000,000 shares available for repurchase under this plan.our common stock.

Item 3. Defaults Upon Senior Securities

NoneNone.

Item 4. Submission of Matters to a Vote of Security Holders

NoneWe held our Annual Meeting of Stockholders on May 22, 2008, at which our stockholders voted to elect Douglas B. Hansen, Greg H. Kubicek, and Charles J. Toeniskoetter as Class II directors to serve on our Board of Directors until the Annual Meeting of Stockholders in 2011 and until their successors are duly elected and qualified. The stockholders’ votes with respect to the election of directors were as follows:

  
 Votes
Nominee For Withheld
Douglas B. Hansen  30,987,377   186,589 
Greg H. Kubicek  30,690,027   483,938 
Charles J. Toeniskoetter  30,940,760   233,205 

The following directors’ terms in office continue following the Annual Meeting of Stockholders:

George E. Bull, III
Richard D. Baum
Thomas C. Brown
Mariann Byerwalter
Georganne C. Proctor
David L. Tyler

At our Annual Meeting of Stockholders on May 22, 2008, our stockholders ratified the appointment of Grant Thornton LLP as our independent registered public accounting firm for 2008. The stockholders’ votes with respect to the ratification of Grant Thornton LLP as our independent registered public accounting firm were as follows:

   
For Against Abstentions Broker Non-Votes
28,952,930  2,160,832   60,203   — 

At our Annual Meeting of Stockholders on May 22, 2008, our stockholders approved an amendment to our 2002 Incentive Plan. The stockholders’ votes with respect to the approval were as follows:

   
For Against Abstentions Broker Non-Votes
20,161,056  6,205,963   70,123   4,736,823 

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At our Annual Meeting of Stockholders on May 22, 2008, our stockholders approved an amendment to our Charter. The stockholders’ votes with respect to the approval were as follows:

   
For Against Abstentions Broker Non-Votes
25,857,739  523,447   55,956   4,736,823 

At our Annual Meeting of Stockholders on May 22, 2008, our stockholders did not approve a stockholder proposal concerning our classified Board of Directors. The stockholders’ votes with respect to the proposal were as follows:

   
For Against Abstentions Broker Non-Votes
12,416,766  13,794,318   226,057   4,736,823 

Item 5. Other Information

NoneNone.

Item 6. Exhibits

 
Exhibit
Number		 Exhibit
3.1
 Redwood Trust, Inc. AmendedArticles of Amendment and Restated Bylaws (Incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K filed on March 11, 2008.)Restatement of the Registrant, effective July 6, 1994 (filed herewith)
10.1
 3.1.1		 Amendment to Employment Agreement, by and between Redwood Trust, Inc. and Martin S. Hughes, dated asArticles Supplementary of January 16, 2008 (Incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed on January 18, 2008.)the Registrant, effective August 11, 1994
10.2
 3.1.2		 Articles Supplementary of the Registrant, effective August 14, 1995
 3.1.3Articles Supplementary of the Registrant, effective August 9, 1996
 3.1.4Certificate of Amendment to Employment Agreement, by and between Redwood Trust, Inc. and Harold F. Zagunis, dated as of January 16,the Registrant, effective June 30, 1998
 3.1.5Articles Supplementary of the Registrant, effective April 10, 2003
 3.1.6Articles of Amendment of the Registrant, effective June 12, 2008 (Incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed on January 18, 2008.)
31.1 Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
 Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
32.2
 Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

REDWOOD TRUST, INC.

 
Date: May 7,August 5, 2008 

By:

/s/Douglas B. Hansen
Douglas B. Hansen
President
(authorized officer of registrant)

Dated: May 7,Date: August 5, 2008 

By:

/s/Martin S. Hughes
Martin S. Hughes
Chief Financial Officer and Secretary
(principal financial officer)

Dated: May 7,Date: August 5, 2008 

By:

/s/Raymond S. Jackson Harold F. Zagunis
Raymond S. JacksonHarold F. Zagunis
Managing Director and Controller
(principal accounting officer)

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INDEX TO EXHIBITS

 
Exhibit
Number		 Exhibit
3.1
 Redwood Trust, Inc. AmendedArticles of Amendment and Restated Bylaws (Incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K filed on March 11, 2008.)Restatement of the Registrant, effective July 6, 1994 (filed herewith)
10.1
 3.1.1		 Amendment to Employment Agreement, by and between Redwood Trust, Inc. and Martin S. Hughes, dated asArticles Supplementary of January 16, 2008 (Incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed on January 18, 2008.)the Registrant, effective August 11, 1994
10.2
 3.1.2		 Articles Supplementary of the Registrant, effective August 14, 1995
 3.1.3Articles Supplementary of the Registrant, effective August 9, 1996
 3.1.4Certificate of Amendment to Employment Agreement, by and between Redwood Trust, Inc. and Harold F. Zagunis, dated as of January 16,the Registrant, effective June 30, 1998
 3.1.5Articles Supplementary of the Registrant, effective April 10, 2003
 3.1.6Articles of Amendment of the Registrant, effective June 12, 2008 (Incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed on January 18, 2008.)
31.1 Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
 Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
 Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

10195