TABLE OF CONTENTS

	CAUTIONARY STATEMENT

This Redwood Review contains 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, 2011 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, including reports on Forms 10-K, 10-Q, and 8-K. We undertake no obligation to update or revise forward-looking statements, whether as a result of new information, future events, or otherwise.

Statements regarding the following subjects, among others, are forward-looking by their nature: (i) our statements relating to improving our capital efficiency in 2012, enhancing during 2012 the returns on our existing investments through warehouse line funding of residential loans, the use leverage against our residential securities (which leverage we believe will be a prudent (or modest) amount), obtaining debt financing for our commercial loans, and getting our excess capital fully invested at attractive yields; (ii) our statements relating to our goal of delivering a growing stream of dividends through our residential and commercial credit businesses and our statements that our businesses are scalable (and, therefore, should help us improve our returns as our business volume increases) and hard for competitors to replicate; (iii) our statements relating to our competitive position and our ability to compete in the future, including our ability to effectively compete to acquire residential mortgage-backed securities and residential mortgage loans and our ability to compete to originate and acquire commercial real estate loans and other commercial real estate investments, including our statements that we expect an increased pace of residential loan acquisitions in 2012, that we expect to execute an increased number of securitizations of residential loans relative to 2011, and that reduced governmental participation in the mortgage finance market and new bank regulations will continue to cause banks to scale back their participation in the residential mortgage market to the advantage of smaller non-bank competitors (including ourselves); (iv) our statements relating to our future investment strategy, and our ability to find investments with attractive risk return profiles, including, without limitation, statements relating to our efforts to acquire residential mortgage loans, make commercial real estate investments (including that commercial real estate lending will likely provide the best opportunity for us to invest capital in 2012), and make residential investments in the secondary market (including that our expectation for 2012 is that we will invest $100 million of capital in secondary market residential securities investments with net levered yields on this invested capital of 11% to 14%); (v) our statements that we expect, overall, to invest $375 to $500 million of capital in 2012 and that we can generate the capital needed for the vast majority of this overall 2012 investment activity and our intended 2012 dividends on existing shares of common stock through cash from operations, principal payments from our investments, asset sales, and obtaining debt financing on our commercial loan portfolio; (vi) our statements that we expect to benefit from increasing our investment activity and that expected increased investment activity, net of funding costs, would contribute to net interest income beginning in the second half of 2012 and improved profitability in 2012; (vii) our statement that one of our goals for 2012 is to acquire approximately $2.0 billion of residential mortgage loans, our statements relating to acquiring the residential mortgage loans included in our pipeline of residential mortgage loans that we plan to purchase through our residential conduit program, including that, as of December 31, 2011 and February 15, 2012, there were $460 million and $461 million, respectively, of loans in our pipeline of residential mortgage loans that we planned to purchase; (viii) statements relating to future residential loan securitization and sale transactions, the timing of the completion of those future transactions, and the number and size of those transactions we expect to complete in 2012 and future periods, which future transactions may not be completed when planned or at all, and, more generally, statements regarding the likelihood and timing of, and our participation in, future transactions of these types and our ability to finance residential loan acquisitions through the execution of these types of transactions, and the profitability of these transactions; (ix) our statement that we expect to recover an aggregate of $9 million of loan loss reserves that relate to fourteen Sequoia securitization entities in future periods upon the payoff or deconsolidation of those entities; (x) our statements relating to the cash flows we expect to receive from our investments; (xi) our statement that we do not currently believe we will need to access the capital markets to raise capital during the first half of 2012 and our statement that we may not need to access the capital markets to raise capital in a material way in the second half of 2012; (xii) our statements relating to our estimates of our investment capacity (including that we estimate our investment capacity was $214 million at December 31, 2011), our short-term borrowing capacity (including the statement that it is our intent to finance the majority of our inventory of residential mortgage loans held for future securitization or sale on through short-term warehouse debt facilities), our excess capital, and the amount of cash we need to cover short-term operations, working capital, and a liquidity cushion; (xiii) our statements relating to future market and economic conditions and the future volume of transactions in those markets, including, without limitation, future conditions in the residential and commercial real estate markets and related financing markets (e.g., the CMBS market), and the related potential opportunities for our residential and commercial businesses; (xiv) our beliefs about, and our outlook for, the future direction of housing market fundamentals, including, without limitation, home prices, demand for housing, delinquency rates, foreclosure rates, prepayment rates, inventory of homes for sale, and mortgage interest rates and their potential impact on our business and results of operations and our belief that the housing market is in the process of forming a bottom and our expectation that housing, in general, will not be a significantly appreciating asset class for several years; (xv) our beliefs about the future direction of commercial real estate fundamentals and statements regarding the competitive landscape for, and availability of, financing for commercial real estate and our beliefs about whether trends in these areas are positive for our business (including our statements that we believe that the valuation of commercial real estate assets that we target for financing may continue to improve and that we believe that our commercial business is well positioned to grow regardless of instability in the CMBS financing sector); (xvi) our statements that we expect the increased level of commercial loan maturities coming due in the next several years will allow us to expand and sustain our commercial origination franchise and that we intend to hold (rather than sell) our commercial loans and investments; (xvii) our statement relating to originating between $200 and $300 million in subordinate commercial real estate debt in 2012 and our statement that our origination volumes for these types of investments could be outside of this range in any given quarter; (xviii) our statement that we intend to obtain in 2012 debt financing for our portfolio of commercial real estate loans and investments and our statement that we believe any such financing we obtain will represent a prudent level of debt financing for those loans and assets; (ixx) our statements relating to the impact on our business of legislative and regulatory changes that affect our business, the regulation of securitization transactions, and any reform of the GSEs, including Fannie Mae and Freddie Mac; (xx) our expectations regarding credit reserves, credit losses, the adequacy of credit support, and impairments and their impact on our investments (including as compared to our original expectations and credit reserve levels) and the timing of losses and impairments, and statements that the amount of credit reserves we designate may require changes in the future; (xxi) our expectations regarding future interest income and net interest income, future earnings, future earnings volatility, and future trends in operating expenses and the factors that may affect those trends, including that we expect the level of operating expense in the first quarter of 2012 to be similar to the level of operating expense in the fourth quarter of 2011; (xxii) our Board of Directors’ intention to pay a regular dividend of $0.25 per share per quarter in 2012; and (xxiii) our expectations and estimates relating to the characterization for income tax purposes of our 2011 dividend distributions and our expectations and estimates relating to tax accounting and our anticipation of additional credit losses for tax purposes in future periods over an estimated two-to-five year period (and the level of those expected losses).

CAUTIONARY STATEMENT

Important factors, among others, that may affect our actual results include: general economic trends, the performance of the housing, commercial real estate, mortgage, credit, and broader financial markets, and their effects on the prices of earning assets and the credit status of borrowers; federal and state legislative and regulatory developments, and the actions of governmental authorities, including those affecting the mortgage industry or our business; our exposure to credit risk and the timing of credit losses within our portfolio; the concentration of the credit risks we are exposed to, including due to the structure of assets we hold and the geographical concentration of real estate underlying assets we own; our exposure to adjustable-rate and negative amortization mortgage loans; the efficacy and expense of our efforts to manage or hedge credit risk, interest rate risk, and other financial and operational risks; changes in credit ratings on assets we own and changes in the rating agencies’ credit rating methodologies; changes in interest rates; changes in mortgage prepayment rates; the availability of assets for purchase at attractive prices and our ability to reinvest cash we hold; changes in the values of assets we own; changes in liquidity in the market for real estate securities and loans; our ability to finance the acquisition of real estate-related assets with short-term debt; the ability of counterparties to satisfy their obligations to us; our involvement in securitization transactions, the profitability of those transactions, and the risks we are exposed to in engaging in securitization transactions; exposure to claims and litigation, including litigation arising from our involvement in securitization transactions; whether we have sufficient liquid assets to meet short-term needs; our ability to successfully compete and retain or attract key personnel; our ability to adapt our business model and strategies to changing circumstances; changes in our investment, financing, and hedging strategies and new risks we may be exposed to if we expand our business activities; exposure to environmental liabilities and the effects of global climate change; failure to comply with applicable laws and regulations; our failure to maintain appropriate internal controls over financial reporting and disclosure controls and procedures; the impact on our reputation that could result from our actions or omissions or from those of others; changes in accounting principles and tax rules; our ability to maintain our status as a real estate investment trust (REIT) for tax purposes; limitations imposed on our business due to our REIT status and our status as exempt from registration under the Investment Company Act of 1940; decisions about raising, managing, and distributing capital; and other factors not presently identified.

This Redwood Review 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.

	INTRODUCTION

Note to Readers:

We file annual reports (on Form 10-K) and quarterly reports (on Form 10-Q) with the Securities and Exchange Commission. These filings and our earnings press releases provide information about Redwood and our financial results in accordance with generally accepted accounting principles (GAAP). We urge you to review these documents, which are available through our web site, www.redwoodtrust.com.

This document, called The Redwood Review, is an additional format for providing information about Redwood through a discussion of many GAAP as well as non-GAAP metrics, such as taxable income and economic book value. Supplemental information is also provided in the Financial Tables in this Review to facilitate more detailed understanding and analysis of Redwood. When we use non-GAAP metrics it is because we believe that these figures provide additional insight into Redwood’s business. In each case in which we discuss a non-GAAP metric you will find an explanation of how it has been calculated, why we think the figure is important, and a reconciliation between the GAAP and non-GAAP figures.

References herein to “Redwood,” the “company,” “we,” “us,” and “our” include Redwood Trust, Inc. and its consolidated subsidiaries. References to “at Redwood” exclude all consolidated securitization entities (with the exception of the resecuritization we completed in the third quarter of 2011) in order to present our operations in the way management analyzes them.

Note that because we round numbers in the tables to millions, except per share amounts, some numbers may not foot due to rounding.

We hope you find this Review helpful to your understanding of our business. We thank you for your input and suggestions, which have resulted in our changing the form and content of The Redwood Review over time.

We welcome your continued interest and comments.

SHAREHOLDER LETTER

Dear Fellow Shareholders:

As we close the books on 2011 and kick off 2012, it’s a good time to review our vision, our business strategies, and our outlook. While we normally take a “less is more” approach, we think a more in-depth letter is warranted at this time, since we are continuing to build our businesses in an uncertain economic environment that includes the government’s “uber” presence in the residential mortgage markets.

This letter provides a comprehensive roadmap, starting with the big picture and working our way down to the individual businesses and strategies that ultimately drive our earnings. But for those more interested in the punch line, the three big themes for 2012 are:

The Big Picture

Plain and simple, we want to get back to delivering a growing stream of dividends through our residential and commercial credit businesses. Our REIT structure, while valuable and efficient from a tax perspective, can present a hurdle to growth, as we are required to pay out 90% of our earnings as dividends. To fund growth and create shareholder value, we ultimately need to be able to issue equity at a level that is accretive to earnings. To achieve this we need to earn a franchise premium for the value of our businesses by delivering to shareholders sustainable, attractive returns. The formula is pretty straightforward. To generate “sustainable” returns, we need a large market opportunity and real competitive advantages, while the “attractive” part requires us to make smart risk-adjusted credit investments and wisely manage the liability and capital side of our balance sheet.

This all points us to the $13.5 trillion market for residential and commercial mortgages. Our core strength is a deep knowledge of residential and commercial credit and structuring. We have long-standing relationships with lenders and senior investors. We have an outstanding brand. We are patient, long-term investors willing to hold long-term illiquid investments that we expect will generate attractive returns on the permanent equity and long-term debt capital that supports the illiquid investments.

Our macro outlook for the broad investment landscape over the next few years shapes our operating strategies. On the investment supply side, we believe the current period of consumer and business de-leveraging will continue for some time. As a consequence, fewer new assets (outside those guaranteed by the government) will be originated by banks and other financial institutions and the supply of new assets created through financial structuring has been vastly diminished or eliminated, depending on the product. On the investment demand side, we are likely to be competing for investments against trillions of un-invested dollars sitting in banks, fixed income funds, and hedge funds, whose managers are desperately searching for attractive risk-adjusted yields.

	SHAREHOLDER LETTER

The Big Picture (continued)

Throughout its history, Redwood has opportunistically sourced attractive secondary investments and new residential mortgage-backed security (RMBS) credit investments issued by banks and Wall Street firms through a competitive bidding process. In 2012, we expect to find some attractive secondary investments, but competition from other bidders is likely to be fierce while the overall supply of private RMBS and commercial mortgage-backed security (CMBS) investments continues to shrink. The outstanding level of private RMBS has declined from $2.2 trillion in 2007 to approximately $1.0 trillion today. We have issued the only four new private-sector residential securitizations backed by prime loans since the onset of the financial crisis in 2008. New CMBS issuance is also down dramatically from a peak of $230 billion in 2007 to a projected $25-50 billion for 2012. The supply/demand condition described above probably bodes well for supporting asset prices (barring idiosyncratic risks, of which there are many), but over time produces a headwind to sourcing attractive investments solely through a bid process.

Against this backdrop, we believe that the most effective way to grow our businesses and generate attractive returns for shareholders over the long-term, we must be willing to do the hard work of creating our own home-cooked investments. That means continuing to build our commercial and residential platforms by broadening our lender and senior investor relationships, building out systems and supporting operations, and effectively and efficiently financing, hedging, and structuring to create new investments. This “build it and they will come” approach is expensive and a drag on earnings. But the upside is that, from a competitive standpoint, our businesses are hard to replicate and they are scalable, which should help us improve our returns as we ramp up volume.

When we made the decision to build the conduit in late 2009, part of our thesis was that the government would reduce its participation in the residential mortgage market and that new bank regulations related to Dodd-Frank and Basel III would cause banks to scale back their participation to the advantage of smaller non-bank competitors. In the fourth quarter, we saw both assumptions begin to play out as the temporary increase in the conforming loan limit was allowed to expire on October 1, 2011, some of the largest banks shut down or scaled back their correspondent lending channels related to increased capital requirements under Basel III, and Freddie Mac began exploring a new risk-sharing program for its residential business. While it is still early, our thesis appears to be playing out.

Now, let’s dig into the numbers and details of our businesses.

Commercial

Our commercial efforts will likely provide the best opportunity to put capital to work over the next year. In commercial, we are not competing against the government and there is $1.4 trillion of commercial debt maturing over the next four years. In our opinion, it is unlikely that the commercial banking industry, life insurance companies, or the CMBS market will have the appetite or capacity to meet the refinancing demand. Additionally, the stabilized income-producing properties that we finance continue to experience a broad-based recovery in fundamentals. Liquidity has returned to this segment of the commercial real estate world and performance and values have improved.

SHAREHOLDER LETTER

Commercial (continued)

We have made excellent progress in our commercial business. We started to rebuild it in late 2009 and began investing again in the fourth quarter of 2010. In 2011, the first full year of operations for this approach to the commercial market, we originated $128 million of commercial mezzanine loans and ended the year with a $158 million portfolio. We worked closely with banks, insurance companies, and other originators, and we looked at over 700 lending opportunities in 2011. In 2012, we expect to originate $200 to $300 million of subordinate debt investments, while maintaining our highly selective and disciplined approach to credit.

We have established a strong origination platform that sources investment opportunities nationally from a formal correspondent mortgage banking system of 15 top firms in the industry. We now possess the in-house expertise to underwrite and structure commercial investments across multiple capital sources. To date, we have closed with 11 different senior lenders and we are a recognized leader in the industry as a reliable provider of mezzanine financing for high-quality, long-term, stabilized properties. As a result of the franchise and relationships we have built over the last two years in commercial, we are optimistic about our sustainable competitive advantages as the current cycle evolves.

Our commercial portfolio is currently funded entirely by equity and it had a fourth quarter unlevered gross yield in excess of 10%, before any potential credit costs. To enhance the yield and free up equity capital for further investment, we plan to obtain debt financing for the portfolio in 2012.

Residential Conduit

In the long run, we believe our loan conduit and securitization platform will deliver attractive value to shareholders - both as a potential profit center from its stand-alone activities and as a source of attractive investment securities for our portfolio.

The stand-alone activities could include the acquisition of residential whole loans from originators for sale to newly-created Sequoia securitization entities that create and sell securities backed by these loans. We may also sell these whole loans via bulk sales if pricing is more attractive than issuing a securitization.

We may also use our conduit sourcing relationships to acquire and sell loans for a fee under private label investor programs and potentially for sourcing loans for sale to the GSEs. Our conduit also opened lots of doors for us with policymakers, regulators, and other market participants, and has presented us with business opportunities that we may not have otherwise had the chance to consider.

Our goal for 2012 is to acquire approximately $2.0 billion of loans from 30-to-40 originators. We are now planning four to six securitization transactions (including the one already completed in January 2012) depending on whether we sell a portion of our whole loans on a bulk basis. Our business decision either to securitize or sell whole loans remains fluid and will be based on balancing our best value execution and the franchise value of building out our securitization platform.

	SHAREHOLDER LETTER

Residential Securities Investment Portfolio

As part of our theme for 2012, we intend to free up capital held against our securities portfolio by using what we believe to be modest financial leverage.

Our expectation is that in 2012 we will invest $100 million of capital in secondary RMBS and $75 to $100 million of capital in new Sequoia securitizations. We expect the net levered yields on new capital invested to range from 11% to 14%. We would emphasize that these figures are rough estimates, as the markets and our investment opportunities remain fluid.

Capital

We estimate that our investment capacity at the end of the fourth quarter of 2011 was $214 million, roughly even with the $206 million of estimated capacity at the end of the third quarter of 2011. Despite investing $98 million in the fourth quarter, we were able to free up underutilized investment capital and increase our investment capacity by borrowing against a portion of our RMBS portfolio and by putting in place mortgage warehouse credit facilities to fund mortgage loans pending securitization.

We expect to invest $375 to $500 million of capital in 2012 and pay dividends on our existing shares of approximately $80 million. We believe we can generate the capital needed for the vast majority of these new investments and dividends through cash from operations, principal payments from our investments, asset sales, and obtaining debt financing on our commercial portfolio.

We currently do not believe we will need to access the capital markets during the first half of the year, and we may not need to access the market in a material way in the second half. If our actual investment opportunities exceed our current plans or if our anticipated funding plans generate less than our anticipated needs, we would raise our hand for capital for new investments if we felt we had bona fide opportunities at attractive yields that would be accretive to common shareholders.

In Closing

We appreciate your continued support and patience as we rebuild our businesses following the collapse of the mortgage market and its aftermath. While we still face many challenges including the government’s continued outsized participation in the residential market, we believe we are on the right path to building franchise value in our commercial and residential businesses. We greatly value your steadfast and ongoing support.

Martin S. Hughes	Brett D. Nicholas
CEO	President

 

 

8	THE REDWOOD REVIEW 4TH QUARTER 2011

 

 

QUARTERLY OVERVIEW

Fourth Quarter 2011 Results

Overview

We continued to make good operational progress in the fourth quarter of 2011, as we will describe in the sections that follow in this Quarterly Overview. We added warehouse financing lines for the residential conduit and continued to add loan sellers. We originated more commercial loans in the fourth quarter than in any quarter since we began rebuilding our commercial platform in 2009. Still, progress is not apparent in our financial results, as detailed below in the Fourth Quarter 2011 Results section. We reported a net loss for the fourth quarter of 2011, which reflected impairments on securities and a higher loan loss provision, as well as continued (albeit lower) mark-to-market losses related to the cost of hedging the residential pipeline.

We expect the benefit from increased investment activity, net of additional funding costs at Redwood (excluding Legacy Sequoia and Acacia), would contribute to net interest income in the second half of 2012. We also expect an increased pace of residential loan acquisitions in our conduit in 2012 and an increased number of securitizations relative to 2011, even if we sell some of our loans to whole loan buyers rather than securitizing them. Still, it takes time to fully benefit from getting our capital deployed and, although we expect improvement in profitability in 2012, it will likely be slower than we would like, with real progress projected to be more apparent toward year end.

Market Conditions

Prices for RMBS generally trended downward from April 2011 through year-end 2011. Overall, it seems that a generally greater risk aversion during that period was the biggest driver to price declines, though there are some reports that reduced availability of short-term funding for RMBS acquisitions contributed to these declines later in the year. Over the period from April through December 2011, the steepest price declines in RMBS were in those backed by lower-quality subprime and Alt-A collateral.

Following year-end, RMBS pricing has firmed in early 2012 as it did early in early 2011.

Investment and Sales Activity

During the fourth quarter of 2011, we invested $98 million in long-term assets. Specifically, in the fourth quarter, we were able to acquire $38 million in secondary RMBS and we originated $60 million in commercial mezzanine loans. We did not acquire securities created through our residential conduit in the fourth quarter, as we did not sponsor a securitization in the fourth quarter of 2011. Investment activity remained brisk early in 2012. Through February 15, 2012, we made $117 million of long-term investments. Those investments included $66 million of secondary RMBS financed by equity and $39 million of short-term debt, $13 million of commercial debt investments financed by equity, and $38 million of securities from our most recent Sequoia securitization financed by equity and $15 million of short-term debt.

We did not sell assets in the fourth quarter of 2011. In the first quarter, through February 15, 2012, we sold $42 million in market value for an estimated gain of $5 million.

	QUARTERLY REPORT

GAAP earnings for the fourth quarter of 2011 were a loss of $3 million, or $0.03 per share, compared with $1 million in net income, or $0.01 per share, reported in the third quarter. Two factors contributed to the loss during the quarter. Loan loss provisions came in at $8 million for the fourth quarter of 2011, principally reflecting higher loss severities at Legacy Sequoia loans, as compared with an average provision of $3 million for the first three quarters of 2011. Other-than-temporary impairments on securities (related to credit) came in at $4.3 million for the fourth quarter of 2011, compared with an average of $1.7 million for the first three quarters of 2011.

Net interest income for the fourth quarter of 2011 was $27 million, down $1.7 million from the $29 million reported for the prior quarter. The $1.7 million decline in net interest income can be attributed to the $1.6 million decline in net interest income from Legacy Sequoia and Acacia, combined. Redwood, exclusive of these legacy investments, posted a $0.1 million decrease in net interest income, as rising funding costs slightly more than offset expanding interest revenues.

Operating expenses for the fourth quarter totaled $12.6 million, about $1 million above the $11.5 million level in Q3 and just a bit above the average $12 million per quarter run rate in 2011. Market valuation adjustments for the fourth quarter of 2011 were negative $9.7 million, as compared with negative $13.5 million for the third quarter of 2011. This $3.8 million improvement came from a $2.5 million improvement at Legacy Sequoia and Acacia, combined, and a $1.3 million improvement at Redwood parent. The improvement at Redwood parent reflected the benefit from reduced negative marks on risk management derivatives that were only partially offset by increased impairments.

Book value declined by $0.86 per share in the fourth quarter to $11.36 at year-end 2011, compared with $12.22 at September 30, 2011. The $67 million decline in book value during the quarter was attributable to unrealized losses on securities ($44 million or roughly two-thirds of the decline) and the impact of paying out dividends in excess of earnings ($23 million or roughly one-third of the decline). Through mid-February 2012, we estimate that approximately $22 million of the unrealized losses on securities in the fourth quarter reversed due to the recent rally in RMBS prices.

Residential Loan Business

We continue to make steady operating progress in our conduit business — adding sellers, buying loans, and establishing warehousing / borrowing relationships. We currently have 20 active sellers. We acquired $175 million of loans in the fourth quarter as compared with $405 million in loans purchased in the third quarter. We ended the fourth quarter of 2011 with $393 million in held-for-sale residential loans on our balance sheet and another $460 million in locked loans we planned to purchase.

We did not sponsor a residential securitization in the fourth quarter of 2011. Rather, we prepared for the $416 million securitization we completed in January 2012.

Of the $428 million in short-term debt on our balance sheet at year-end, $307 million was related to warehouse facilities we are using to finance the accumulation of our residential loans for securitization. We plan to finance residential mortgage loans with warehouse facilities to free up capital to invest in higher-yielding residential securities and commercial loans.

QUARTERLY OVERVIEW

Commercial Real Estate Business

Our commercial origination platform continues to grow. We added $60 million of investments in the fourth quarter of 2011, ending the year with a portfolio of 14 loans totaling $158 million. Through February 15, 2012, we originated $13 million of additional investments, including two mezzanine loans and one preferred equity investment.

While there are headwinds in the economy and sectors of the commercial market that are struggling more than others, the fundamentals for the higher-quality, stabilized properties we pursue generally continue to improve. We expect that the increased level of loan maturities coming due in the next several years will allow us to expand and sustain our commercial origination franchise, given our relationships and our willingness to hold credit risk on our balance sheet.

We anticipate originating between $200 and $300 million of subordinated debt investments in 2012. Quarterly volume may be volatile due to the timing of opportunities. We will continue to maintain our disciplined approach to underwriting as we expand our platform. Information on new originations is available in the commercial section of our website.

	FINANCIAL INSIGHTS

Book Value

Summary

FINANCIAL INSIGHTS

Book Value (continued)

Summary (continued)

	FINANCIAL INSIGHTS

Balance Sheet

FINANCIAL INSIGHTS

Real Estate Loans

Real Estate Securities

	FINANCIAL INSIGHTS

Balance Sheet (continued)

Real Estate Securities (continued)

Investments in the Securitization Entities

Debt

FINANCIAL INSIGHTS

Debt (continued)

Capital and Cash

	FINANCIAL INSIGHTS

GAAP Income

Summary

FINANCIAL INSIGHTS

GAAP Income (continued) 

Summary (continued) 

	FINANCIAL INSIGHTS

GAAP Income (continued)

Summary (continued)

Redwood Parent

FINANCIAL INSIGHTS

New Sequoia Entities

Other Consolidated Entities

	FINANCIAL INSIGHTS

Taxable Income and Dividends

Summary

Overview

FINANCIAL INSIGHTS

Cash Flow

	FINANCIAL INSIGHTS

COMMERCIAL REAL ESTATE BUSINESS

Summary

Redwood’s commercial origination platform provides long-term debt solutions for borrowers on higher quality properties. Redwood collaborates with other lending institutions (including major banks, life insurance companies, CMBS issuers, and the GSEs) to create attractive subordinate debt investments (typically mezzanine loans or other forms of subordinated financing such as preferred equity or B Notes), for its portfolio. Redwood may also originate loans (both senior and subordinate) on stabilized commercial properties, retaining the subordinate investments while selling the senior loans at origination. Redwood also owns a small balance of legacy commercial securities which were acquired prior to 2008. This discussion is exclusive of commercial securities and loans owned by Acacia entities.

Market Conditions

 

	COMMERCIAL REAL ESTATE BUSINESS

Market Conditions (continued)

 

COMMERCIAL REAL ESTATE BUSINESS

Quarterly Update

	NEW SEQUOIA RESIDENTIAL MORTGAGE LOAN BUSINESS

Summary

We purchase newly originated loans (primarily prime jumbo loans) that meet our collateral criteria from approved originators on a flow or bulk basis. Loans acquired through this process (our “conduit”) are expected to be securitized through new Sequoia securitization entities, which acquire residential mortgage loans through our conduit and issue asset-backed securities (ABS) backed by these loans, or are sold privately as whole loans. Most of the senior or investment-grade rated ABS issued by New Sequoia Entities are sold to third-party investors; Redwood generally acquires the subordinate or non-investment grade securities but has also acquired senior securities and interest-only securities from the New Sequoia Entities.

Quarterly Update

RESIDENTIAL REAL ESTATE SECURITIES

 

Summary

 

Redwood invests in securities that are backed by pools of residential loans. Some of these investments in residential securities consist of senior prime and non-prime securities, and non-senior securities. Residential prime securities are mortgage-backed securities backed by prime residential mortgage loans. Residential non-prime securities are mortgage-backed securities backed by non-prime (Alt-A, Option ARM, and Subprime) residential mortgage loans. Non-senior securities include subordinate and re-REMIC securities.

 

Senior securities are those interests in a securitization that have the first right to cash flows and are last in line to absorb losses. Subordinate securities are those interests in a securitization that have the last right to cash flows and are first in line to absorb losses. A re-REMIC is a resecuritization of asset-backed securities where the cash flow from and any credit losses absorbed by the underlying asset-backed securities are allocated among the securities issued in the resecuritization transaction in a variety of ways.

 

The following discussion refers only to the residential securities owned by Redwood, exclusive of the securities owned by Acacia entities, and exclusive of Redwood’s investments in Acacia.

 

The following discussion includes the securities that we resecuritized during the third quarter of 2011. See footnote (1) below the table on the following page.

 

In the Financial Tables in the Appendix, information on the residential securities we own and underlying loan characteristics is set forth in Tables 5 through 8B.

 

Quarterly Update

 

►

Interest income generated by our residential securities was $20 million in the fourth quarter of 2011, resulting in an annualized unlevered yield of 11.9% on the $662 million average amortized cost of these securities.

 

►

We finance our holdings of our residential securities with short-term debt secured by securities (repo debt), through the resecuritization transaction we completed during the third quarter of 2011 (resecuritization debt), and through equity. During the fourth quarter, average repo debt amounted to $158 million, and the average resecuritization debt amounted to $224 million.

 

►

At December 31, 2011, the fair value of the residential AFS and trading securities we own totaled $744 million, consisting of $278 million in prime senior securities, $277 million in non-prime senior securities, $119 million in re-REMIC securities, and $70 million in subordinate securities. Each of these categories is further discussed on the following pages.

 

►

At December 31, 2011, 36% of the residential AFS and trading securities we held were fixed-rate assets, 16% were adjustable-rate assets, 21% were hybrid assets that reset within the next year, 3% were hybrid assets that reset between 12 and 36 months, and 24% were hybrid assets that reset after 36 months.

 

 

THE REDWOOD REVIEW 4TH QUARTER 2011

29

 

 

	RESIDENTIAL REAL ESTATE SECURITIES