REDWOOD TRUST INC, 10-Q, 1999-05-14

REDWOOD TRUST INC
10-Q, 1999-05-14
REAL ESTATE INVESTMENT TRUSTS

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UNITED STATES 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, 1999

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

FOR THE TRANSITION PERIOD FROM __________ TO __________

COMMISSION FILE NUMBER: 0-26436

REDWOOD TRUST, INC.
(Exact name of Registrant as specified in its Charter)

MARYLAND 68-0329422
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

591 Redwood Highway, Suite 3100
Mill Valley, California 94941
(Address of principal executive offices) (Zip Code)

(415) 389-7373
(Registrant's telephone number, including area code)

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

Yes X No
--- ---

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

Class B Preferred Stock ($.01 par value) 909,518 as of May 12, 1999

Common Stock ($.01 par value) 10,041,817 as of May 12, 1999

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REDWOOD TRUST, INC.
FORM 10-Q

INDEX

<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements -- Redwood Trust, Inc

Consolidated Balance Sheets at March 31, 1999 and December 31, 1998........................................ 3

Consolidated Statements of Operations for the three months
ended March 31, 1999 and March 31, 1998.................................................................... 4

Consolidated Statements of Stockholders' Equity for the three months ended March 31, 1999.................. 5

Consolidated Statements of Cash Flows for the three months
ended March 31, 1999 and March 31, 1998.................................................................... 6

Notes to Consolidated Financial Statements................................................................. 7

Consolidated Financial Statements - RWT Holdings, Inc.

Consolidated Balance Sheets at March 31, 1999 and December 31, 1998........................................ 20

Consolidated Statements of Operations for the three months ended March 31, 1999............................ 21

Consolidated Statements of Stockholders' Equity for the three months ended March 31, 1999.................. 22

Consolidated Statements of Cash Flows for the three months ended March 31, 1999............................ 23

Notes to Consolidated Financial Statements................................................................. 24

Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations................................................................... 29

PART II. OTHER INFORMATION

Item 1. Legal Proceedings............................................................................................... 43

Item 2. Changes in Securities........................................................................................... 43

Item 3. Defaults Upon Senior Securities................................................................................. 43

Item 4. Submission of Matters to a Vote of Security Holders............................................................. 43

Item 5. Other Information............................................................................................... 43

Item 6. Exhibits and Reports on Form 8-K................................................................................ 43

SIGNATURES ............................................................................................................. 44
</TABLE>

2
<PAGE> 3

PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)

<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
-------------- -----------------
ASSETS (Unaudited)
<S> <C> <C>
Mortgage loans: held-for-sale
Residential $ 199,893 $ 265,914
Commercial 2,880 8,287
---------- ----------
202,773 274,201
---------- ----------
Mortgage loans: held-for-investment, net
Residential 1,022,071 1,131,300
---------- ----------
1,022,071 1,131,300
---------- ----------

Mortgage securities: trading 1,092,331 1,257,655
Mortgage securities: available-for-sale, net 7,706 7,707
US Treasury securities 33,485 48,009
Cash and cash equivalents 40,638 55,627
Restricted cash 11,491 12,857
Interest rate agreements 1,627 2,517
Accrued interest receivable 15,412 18,482
Investment in RWT Holdings, Inc. 12,639 15,124
Loan to RWT Holdings, Inc. 13,700 6,500
Receivable from RWT Holdings, Inc. 142 445
Other assets 2,959 2,024
---------- ----------
$2,456,974 $2,832,448
========== ==========

LIABILITIES AND STOCKHOLDERS' EQUITY

LIABILITIES

Short-term debt $1,033,642 $1,257,570
Long-term debt, net 1,171,141 1,305,560
Accrued interest payable 5,695 10,820
Accrued expenses and other liabilities 1,611 3,022
Dividends payable 687 686
---------- ----------
2,212,776 2,577,658
---------- ----------
Commitments and contingencies (See Note 13)

STOCKHOLDERS' EQUITY

Preferred stock, par value $0.01 per share;
Class B 9.74% Cumulative Convertible 909,518
shares authorized, issued and outstanding
($28,882 aggregate liquidation preference) 26,736 26,736
Common stock, par value $0.01 per share;
49,090,482 shares authorized; 10,186,317
and 11,251,556 issued and outstanding 102 113
Additional paid-in capital 263,178 279,201
Accumulated other comprehensive income (782) (370)
Cumulative earnings 12,953 6,412
Cumulative distributions to stockholders (57,989) (57,302)
---------- ----------
244,198 254,790
---------- ----------
$2,456,974 $2,832,448
========== ==========
</TABLE>

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

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REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
(Unaudited)

<TABLE>
<CAPTION>
Three Months Ended March 31,
1999 1998
---------- -----------
<S> <C> <C>
Interest Income
Mortgage loans: held-for-sale
Residential $ 4,287 $ --
Commercial 76 --
---------- ----------
4,363 --
---------- ----------
Mortgage loans: held-for-investment
Residential 16,285 25,810
---------- ----------
16,285 25,810
---------- ----------
Mortgage securities: trading 18,974 --
Mortgage securities: available-for-sale 803 27,667
US Treasury securities 533 --
Cash and cash equivalents 773 384
---------- ----------
Total interest income 41,731 53,861
---------- ----------
Interest Expense
Short-term debt (14,750) (28,003)
Long-term debt (18,741) (18,094)
---------- ----------
Total interest expense (33,491) (46,097)
---------- ----------
Net interest rate agreements expense (333) (1,378)
---------- ----------
Net Interest Income 7,907 6,386

Provision for credit losses (345) (601)
Equity in earnings (losses) of RWT Holdings, Inc. (2,484) --
Operating expenses (714) (1,925)
Other income 8 --
---------- ----------
Income before unrealized and realized gains (losses)
on assets 4,372 3,860

Net unrealized and realized gains (losses) on assets 2,169 (723)
---------- ----------
Income before preferred dividend 6,541 3,137
Cash dividends on Class B preferred stock (687) (687)
---------- ----------
Net Income Available to Common Stockholders $ 5,854 $ 2,450
========== ==========
Earnings per Share:
Basic $ 0.54 $ 0.17
Diluted $ 0.54 $ 0.17

Weighted average shares of common stock and common
stock equivalents:
Basic 10,778,159 14,123,951
Diluted 10,861,774 14,234,425
</TABLE>

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

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REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
(Unaudited)

<TABLE>
<CAPTION>
Class B Accumulated
Preferred stock Common stock Additional other Cumulative
------------------------------------ paid-in comprehensive Cumulative distributions to
Shares Amount Shares Amount capital income earnings stockholders Total
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998 909,518 26,736 11,251,556 113 279,201 (370) 6,412 (57,302) 254,790
- ----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Income before
preferred dividend -- -- -- -- -- -- 6,541 -- 6,541

Net unrealized loss on
assets available-for-sale -- -- -- -- -- (412) -- -- (412)
------
Total comprehensive income -- -- -- -- -- -- -- -- 6,129

Issuance of common stock -- -- 12,361 -- 1 -- -- -- 1

Repurchase of common stock -- -- (1,077,600) (11) (16,024) -- -- -- (16,035)

Dividends declared:
Preferred -- -- -- -- -- -- -- (687) (687)
Common -- -- -- -- -- -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, March 31, 1999 909,518 $26,736 10,186,317 $102 $263,178 $(782) $12,953 $(57,989) $244,198
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

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

5
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REDWOOD TRUST, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

<TABLE>
<CAPTION>
Three Months Ended
March 31,
1999 1998
--------- ---------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income available to common stockholders $ 5,854 $ 2,450
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,521 9,709
Provision for credit losses on mortgage assets 345 601
Equity in (earnings) losses of RWT Holdings, Inc. 2,484 --
Net unrealized and realized (gains) losses on assets (2,169) 723
Purchases of mortgage loans: held-for-sale (6,412) --
Proceeds from sales of mortgage loans: held-for-sale 42,629 --
Principal payments on mortgage loans: held-for-sale 35,249 --
Principal payments on mortgage securities: trading 168,982 --
Purchases of US Treasury securities (45,844) --
Proceeds from sales of US Treasury securities 58,442 --
Purchases of interest rate agreements (409) --
(Increase) decrease in accrued interest receivable 3,070 (767)
Increase in other assets (987) (771)
Decrease in accrued interest payable (5,125) (2,264)
Decrease in accrued expenses and other liabilities (1,411) (375)
--------- ---------
Net cash provided by operating activities 257,219 9,306
--------- ---------
Cash Flows From Investing Activities:
Purchases of mortgage loans: held-for-investment -- (441,960)
Principal payments on mortgage loans: held-for-investment 107,362 118,707
Purchases of mortgage securities: available-for-sale -- (161,842)
Proceeds from sales of mortgage securities: available-for-sale -- 9,295
Principal payments on mortgage securities: available-for-sale 58 187,405
Purchases of interest rate agreements -- (897)
Net (increase) decrease in restricted cash 1,366 (1,077)
Investment in RWT Holdings, Inc., net of dividends received -- (9,900)
Loans to RWT Holdings, Inc., net of repayments (7,200) --
Decrease in receivable from RWT Holdings, Inc. 303 --
--------- ---------
Net cash provided by (used in) investing activities 101,889 (300,269)
--------- ---------
Cash Flows From Financing Activities:
Net proceeds from issuance of (repayments on)
short-term debt (223,928) 373,493
Repayments on long-term debt (134,136) (91,680)
Net proceeds from issuance of common stock 1 --
Repurchases of common stock (16,035) (4,275)
Increase in dividends payable - preferred 1 --
Dividends paid on common stock -- (4,999)
--------- ---------
Net cash provided by (used in) financing activities (374,097) 272,539
--------- ---------
Net decrease in cash and cash equivalents (14,989) (18,424)

Cash and cash equivalents at beginning of period 55,627 24,892
--------- ---------
Cash and cash equivalents at end of period $ 40,638 $ 6,468
========= =========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 38,616 $ 48,419
========= =========
</TABLE>

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

6
<PAGE> 7

REDWOOD TRUST, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1999
(Unaudited)

NOTE 1. THE COMPANY

Redwood Trust, Inc. ("Redwood Trust") was incorporated in Maryland on April 11,
1994 and commenced operations on August 19, 1994. During 1997, Redwood Trust
formed Sequoia Mortgage Funding Corporation ("Sequoia"), a special-purpose
finance subsidiary. Redwood Trust acquired an equity interest in RWT Holdings,
Inc. ("Holdings"), a taxable affiliate of Redwood Trust, during the first
quarter of 1998. For financial reporting purposes, references to the "Company"
mean Redwood Trust, Sequoia and the equity interest in Holdings. The Company
acquires and manages real estate mortgage assets ("Mortgage Assets") which may
be acquired as whole loans ("Mortgage Loans") or as mortgage securities
representing interests in or obligations backed by pools of mortgage loans
("Mortgage Securities"). The Company currently acquires Mortgage Assets that are
secured by single-family or commercial real estate properties throughout the
United States. The Company utilizes both debt and equity to finance its
acquisitions. The Company may also use other securitization techniques to
enhance the value and liquidity of the Company's Mortgage Assets and may sell
Mortgage Assets from time to time.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The consolidated financial statements include the accounts of Redwood Trust and
Sequoia. Substantially all of the assets of Sequoia are pledged or subordinated
to support long-term debt in the form of collateralized mortgage bonds
("Long-Term Debt") and are not available for the satisfaction of general claims
of the Company. The Company's exposure to loss on the assets pledged as
collateral is limited to its net investment, as the Long-Term Debt is
non-recourse to the Company. All significant inter-company balances and
transactions with Sequoia have been eliminated in the consolidation of the
Company. Certain amounts for prior periods have been reclassified to conform to
the 1998 presentation.

During March 1998, the Company acquired an equity interest in Holdings, which
originates, acquires, accumulates, services and sells residential and commercial
Mortgage Loans. The Company owns all of the preferred stock and has a
non-voting, 99% economic interest in Holdings. As the Company does not own the
voting common stock of Holdings or control Holdings, its investment in Holdings
is accounted for under the equity method. Under this method, original equity
investments in Holdings are recorded at cost and adjusted by the Company's share
of earnings or losses and decreased by dividends received.

USE OF ESTIMATES

The preparation of financial statements in conformity with Generally Accepted
Accounting Principles requires management to make estimates and assumptions that
affect the reported amounts of certain assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of certain revenues and expenses during the reported
period. Actual results could differ from those estimates. The primary estimates
inherent in the accompanying consolidated financial statements are discussed
below.

Fair Value. Management estimates the fair value of its financial instruments
using available market information and other appropriate valuation
methodologies. The fair value of a financial instrument, as defined by Statement
of Financial Accounting Standards ("SFAS") No. 107, Disclosures about Fair Value
of Financial Instruments, is the amount at which the instrument could be
exchanged in a current transaction between willing parties, other than in a
forced liquidation sale. Management's estimates are inherently subjective in
nature and involve matters of uncertainty and judgement to interpret relevant
market and other data. Accordingly, amounts realized in actual sales may differ
from the fair values presented in Notes 3, 7 and 10.

7
<PAGE> 8

Reserve for Credit Losses. A reserve for credit losses is maintained at a level
deemed appropriate by management to provide for known, future losses as well as
unidentified potential losses in its Mortgage Asset portfolio. The reserve is
based upon management's assessment of various factors affecting its Mortgage
Assets, including current and projected economic conditions, delinquency status
and credit protection. In determining the reserve for credit losses, the
Company's credit exposure is considered based on its credit risk position in the
mortgage pool. These estimates are reviewed periodically and, as adjustments
become necessary, they are reported in earnings in the periods in which they
become known. The reserve is increased by provisions, which are charged to
income from operations. When a loan or portions of a loan are determined to be
uncollectible, the portion deemed uncollectible is charged against the reserve
and subsequent recoveries, if any, are credited to the reserve. The Company's
actual credit losses may differ from those estimates used to establish the
reserve. Summary information regarding the Reserve for Credit Losses is
presented in Note 4.

ADOPTION OF SFAS NO. 133

The Company adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, effective July 1, 1998. In accordance with the transition
provisions of SFAS No. 133, the Company recorded a net-of-tax
cumulative-effect-type transition adjustment of $10.1 million (loss) in earnings
to recognize at fair value the ineffective portion of all interest rate
agreements that were previously designated as part of a hedging relationship.

The Company, upon its adoption of SFAS No. 133, also reclassified $1.53 billion
of mortgage securities from available-for-sale to trading. This reclassification
resulted in an $11.9 million reclassification loss adjustment, which was
transferred from other comprehensive income to current earnings effective July
1, 1998. Under the provisions of SFAS No. 133, such a reclassification does not
call into question the Company's intent to hold current or future debt
securities to their maturity. Immediately after the adoption of SFAS No. 133 and
the reclassification, the Company elected to not seek hedge accounting for any
of the Company's interest rate agreements.

MORTGAGE ASSETS

The Company's Mortgage Assets consist of Mortgage Loans and Mortgage Securities.
Interest is recognized as revenue when earned according to the terms of the
loans and when, in the opinion of management, it is collectible. Discounts and
premiums relating to Mortgage Assets are amortized into interest income over the
lives of the Mortgage Assets using methods that approximate the effective yield
method. Gains or losses on the sale of Mortgage Assets are based on the specific
identification method.

Mortgage Loans: Held-for-Sale

Effective September 30, 1998, the Company elected to reclassify certain
short-funded Mortgage Loans from held-for-investment to held-for-sale. These
Mortgage Loans are carried at the lower of cost or aggregate market value
("LOCOM"). Realized and unrealized gains and losses on these loans are
recognized in "Net unrealized and realized gains (losses) on assets" on the
Consolidated Statements of Operations.

Some of the Mortgage Loans purchased by the Company for which securitization or
sale is contemplated are committed for sale by the Company to Holdings, or a
subsidiary of Holdings, under a Master Forward Commitment Agreement. As the
forward commitment is entered into on the same date that the Company purchases
the loans, the price under the forward commitment is the same as the price that
the Company paid for the Mortgage Loans, as established by the external market.
Fair value is therefore equal to the commitment price, which is the carrying
value of the Mortgage Loans. Accordingly, no gain or loss is recognized on sales
to Holdings or subsidiaries of Holdings.

Mortgage Loans: Held-for-Investment

Mortgage Loans held-for-investment are carried at their unpaid principal balance
adjusted for net unamortized premiums or discounts, and net of the related
allowance for credit losses.

Mortgage Securities: Trading

Effective July 1, 1998, concurrent with the adoption of SFAS No. 133, the
Company elected to reclassify all of its short-funded Mortgage Securities from
available-for-sale to trading. Mortgage Securities classified as trading are

8
<PAGE> 9

accounted for in accordance with SFAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities. Accordingly, such securities are
recorded at their estimated fair market value. Unrealized and realized gains and
losses on these securities are recognized as a component of "Net unrealized and
realized gains (losses) on assets" on the Consolidated Statements of Operations.

Mortgage Securities: Available-for-Sale

Prior to the adoption of SFAS No. 133, the Company, in accordance with SFAS No.
115, classified all of its Mortgage Securities as available-for-sale investments
as the Company, from time to time, sold some of its Mortgage Securities as part
of its overall management of its balance sheet. Effective July 1, 1998, the
Company reclassified all of its short-funded Mortgage Securities as trading
investments, while all equity-funded Mortgage Securities remained in the
available-for-sale classification. All Mortgage Securities classified as
available-for-sale are carried at their estimated fair value. Current period
unrealized gains and losses are excluded from net income and reported as a
component of Other Comprehensive Income in stockholders' equity with cumulative
unrealized gains and losses classified as Accumulated Other Comprehensive Income
in stockholders' equity.

Unrealized losses on Mortgage Securities classified as available-for-sale that
are considered other-than-temporary, are recognized in income and the carrying
value of the Mortgage Security is adjusted. Other-than-temporary unrealized
losses are based on management's assessment of various factors affecting the
expected cash flow from the Mortgage Securities, including an
other-than-temporary deterioration of the credit quality of the underlying
mortgages and/or the credit protection available to the related mortgage pool
and a significant change in the prepayment characteristics of the underlying
collateral.

US TREASURY SECURITIES

US Treasury securities include notes issued by the US Government. Interest is
recognized as revenue when earned according to the terms of the Treasury
securities. Discounts and premiums are amortized into interest income over the
life of the security using methods that approximate the effective yield method.
US Treasury securities are classified as trading and, accordingly, are recorded
at their estimated fair market value with unrealized gains and losses recognized
as a component of "Net unrealized and realized gains (losses) on assets" on the
Consolidated Statements of Operations.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents include cash on hand and highly liquid investments
with original maturities of three months or less. At December 31, 1998, cash
equivalents included $25 million in repurchase agreements.

RESTRICTED CASH

Restricted cash of the Company includes principal and interest payments on
mortgage loans held as collateral for the Company's Long-Term Debt, and cash
pledged as collateral on certain interest rate agreements.

INTEREST RATE AGREEMENTS

The Company maintains an overall interest-rate risk-management strategy that
incorporates the use of derivative interest rate agreements to minimize
significant unplanned fluctuations in earnings that are caused by interest-rate
volatility. Interest rate agreements that are used as part of the Company's
interest-rate risk management strategy include interest rate options, swaps,
options on swaps, futures contracts, and options on futures contracts
(collectively "Interest Rate Agreements"). On the date an Interest Rate
Agreement is entered into, the Company designates the interest rate agreement as
(1) a hedge of the fair value of a recognized asset or liability or of an
unrecognized firm commitment ("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), or (3) held for trading
("trading" instruments). Concurrent with the adoption of SFAS No. 133, the
Company has elected to designate all of its existing Interest Rate Agreements as
trading instruments.

Net premiums on interest rate options are amortized as a component of net
interest income over the effective period of the interest rate option using the
effective interest method. The income and/or expense related to interest rate
options and swaps are recognized on an accrual basis.

9
<PAGE> 10

Interest Rate Agreements Classified as Trading

Interest Rate Agreements that are designated as trading are not linked to
specific assets and liabilities or to a forecasted transaction, or otherwise are
not designated and, therefore do not qualify for hedge accounting. Accordingly,
interest rate agreements classified as trading are reported at their estimated
fair value with changes in their fair value reported in current-period earnings
in "Net unrealized and realized gains (losses) on assets" on the Consolidated
Statements of Operations.

Interest Rate Agreements Classified as Hedges

Interest Rate Agreements that are designated as hedges are linked to specific
assets and liabilities on the balance sheet or to a forecasted transaction, or
otherwise qualify for hedge accounting. The Company currently does not have any
Interest Rate Agreements classified as hedges.

Prior to the adoption of SFAS No. 133, Interest Rate Agreements that were
hedging Mortgage Securities available-for-sale were carried at fair value with
unrealized gains and losses reported as a component of Accumulated Other
Comprehensive Income in stockholders' equity, consistent with the reporting of
unrealized gains and losses on the related securities. Similarly, Interest Rate
Agreements that were used to hedge Mortgage Loans, Short-Term Debt or Long-Term
Debt were carried at amortized cost. Realized gains and losses from the
settlement or early termination of Interest Rate Agreements were deferred and
amortized into net interest income over the remaining term of the original
Interest Rate Agreement, or, if shorter, over the remaining term of the
associated hedged asset or liability, as adjusted for estimated future principal
repayments.

DEBT

Short-Term and Long-Term Debt are carried at their unpaid principal balances,
net of any unamortized discount or premium and any unamortized deferred bond
issuance costs. The amortization of any discount or premium is recognized as an
adjustment to interest expense using the effective interest method based on the
maturity schedule of the related borrowings. Bond issuance costs incurred in
connection with the issuance of Long-Term Debt are deferred and amortized over
the estimated lives of the Long-Term Debt using the interest method adjusted for
the effects of prepayments.

INCOME TAXES

The Company has elected to be taxed as a Real Estate Investment Trust ("REIT")
under the Internal Revenue Code (the "Code") and the corresponding provisions of
State law. In order to qualify as a REIT, the Company must annually distribute
at least 95% of its taxable income to stockholders and meet certain other
requirements. If these requirements are met, the Company generally will not be
subject to Federal or state income taxation at the corporate level with respect
to the taxable income it distributes to its stockholders. Because the Company
believes it meets the REIT requirements and also intends to distribute all of
its taxable income, no provision has been made for income taxes in the
accompanying consolidated financial statements.

Under the Code, a dividend declared by a REIT in October, November or December
of a calendar year and payable to shareholders of record as of a specified date
in such month, will be deemed to have been paid by the Company and received by
the shareholders on the last day of that calendar year, provided the dividend is
actually paid before February 1st of the following calendar year, and provided
that the REIT has any remaining undistributed taxable income on the record date.
Because the Company had already distributed more dividends than it had earned in
taxable income as of December 31, 1998, the preferred dividend declared in
December 1998 and paid in January 1999 is not considered taxable income to
shareholders in 1998.

NET INCOME PER SHARE

Net income per share for the three months ended March 31, 1999 and 1998 is shown
in accordance with SFAS No. 128, Earnings Per Share. Basic net income per share
is computed by dividing net income available to common stockholders by the
weighted average number of common shares outstanding during the period. Diluted
net income per share is computed by dividing the net income available to common
stockholders by the weighted average number of common shares and common
equivalent shares outstanding during the period. The common equivalent shares
are calculated using the treasury stock method, which assumes that all dilutive
common stock

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<PAGE> 11

equivalents are exercised and the funds generated by the exercise are used to
buy back outstanding common stock at the average market price during the
reporting period.

The following tables provide reconciliations of the numerators and denominators
of the basic and diluted net income per share computations.

<TABLE>
<CAPTION>
(IN THOUSANDS, EXCEPT SHARE DATA) THREE MONTHS ENDED
MARCH 31,
----------------------
1999 1998
---------- ---------
<S> <C> <C>
Numerator:
Numerator for basic and diluted earnings per
share--
Income before preferred dividend $6,541 $3,137
Cash dividends on Class B preferred stock (687) (687)
---------- ---------
Basic and Diluted EPS Net income
available to common stockholders $5,854 $2,450
========== ==========
Denominator:
Denominator for basic earnings per share--
Weighted average number of common shares
outstanding during the period 10,778,159 14,123,951
---------- ----------
Net effect of dilutive stock options 83,615 110,474
---------- ----------
Denominator for diluted earnings per share-- 10,861,774 14,234,425
========== ==========
Net earnings per share -- basic $0.54 $0.17
========== ==========
Net earnings per share -- diluted $0.54 $0.17
========== ==========
</TABLE>

COMPREHENSIVE INCOME

SFAS No. 130, Reporting Comprehensive Income, requires the Company to classify
items of "other comprehensive income" by their nature in a financial statement
and display the accumulated balance of other comprehensive income separately
from retained earnings and additional paid-in capital in the equity section of
the balance sheet. In accordance with SFAS No. 130, current period unrealized
gains and losses on assets available-for-sale are reported as a component of
Comprehensive Income on the Statement of Stockholders' Equity with cumulative
unrealized gains and losses classified as Accumulated Other Comprehensive Income
in stockholders' equity. As of March 31, 1999 and December 31, 1998, the only
component of Accumulated Other Comprehensive Income is unrealized gains and
losses on assets available-for-sale.

NOTE 3. MORTGAGE ASSETS

At March 31, 1999 and December 31, 1998, investments in Mortgage Assets
consisted of interests in adjustable-rate, hybrid or fixed-rate mortgages on
residential and commercial properties. The hybrid mortgages have an initial
fixed coupon rate for three to ten years followed by annual adjustments. Agency
Mortgage Securities ("Agency Securities") represent securitized interests in
pools of adjustable-rate mortgages from the Federal Home Loan Mortgage
Corporation and the Federal National Mortgage Association. The Agency Securities
are guaranteed as to principal and interest by these United States
government-sponsored entities. The original maturity of the majority of the
Mortgage Assets is thirty years; the actual maturity is subject to change based
on the prepayments of the underlying mortgage loans.

At March 31, 1999 and December 31, 1998, the average annualized effective yield
after taking into account the amortization expense due to prepayments on the
Mortgage Assets was 6.61% and 6.95%, respectively, based on the reported cost of
the assets. Of the Mortgage Assets owned by the Company at March 31, 1999, 77%
are adjustable-rate mortgages, 22% are hybrid mortgages and 1% are fixed-rate
mortgages. The coupons on 71% of the adjustable-rate Mortgage Assets are limited
by periodic caps (generally interest rate adjustments are limited to no more
than 1% every six months or 2% every year) while another 29% are not limited by
such periodic caps. Most of the coupons on the adjustable-rate Mortgage Assets
owned by the Company are limited by lifetime caps.

11
<PAGE> 12

At March 31, 1999 and December 31, 1998, the weighted average lifetime cap on
the adjustable-rate Mortgage Assets was 11.60% and 11.48%, respectively.

At March 31, 1999 and December 31, 1998, Mortgage Assets consisted of the
following:

Mortgage Loans: Held-for-Sale

<TABLE>
<CAPTION>
(in thousands) March 31, 1999 December 31, 1998
-------------- -----------------
<S> <C> <C>
Current Face $200,256 $274,630
Unamortized Discount (1,163) (1,099)
Unamortized Premium 800 670
======== ========
Carrying Value $199,893 $274,201
======== ========
</TABLE>

During the three months ended March 31, 1999, the Company recognized a net loss
of $24,830 as a result of LOCOM adjustments on Mortgage Loans held-for-sale.
During the three months ended March 31, 1999, the Company sold Mortgage Loans
held-for-sale with a carrying value of $42.6 million for proceeds of $42.6
million, resulting in a net gain of $17,941. As the Mortgage Loans were not
reclassified to held-for-sale until September 30, 1998, no LOCOM adjustments or
sale transactions on held-for-sale Mortgage Loans were recorded for the three
months ended March 31, 1998. The LOCOM adjustments and net gains on sales are
reflected as a component of "Net unrealized and realized gains (losses) on
assets" on the Consolidated Statements of Operations.

Mortgage Loans: Held-for-Investment

<TABLE>
<CAPTION>
(in thousands) March 31, 1999 December 31, 1998
-------------- ------------------
<S> <C> <C>
Current Face $1,011,013 $1,118,375
Unamortized Premium 15,186 16,709
---------- ----------
Amortized Cost 1,026,199 1,135,084
Allowance for Credit Losses (4,128) (3,784)
========== ==========
Carrying Value $1,022,071 $1,131,300
========== ==========
</TABLE>

Mortgage Securities: Trading

<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
(in thousands) Agency Non-Agency Total Agency Non-Agency Total
-------- ---------- ---------- -------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Current Face $535,880 $545,993 $1,081,873 $609,826 $640,923 $1,250,749
Unamortized Discount (9) (1,231) (1,240) (5) (3,084) (3,089)
Unamortized Premium 9,028 2,670 11,698 7,602 2,393 9,995
-------- -------- ---------- -------- -------- ----------
Carrying Value $544,899 $547,432 $1,092,331 $617,423 $640,232 $1,257,655
======== ======== ========== ======== ======== ==========
</TABLE>

For the three months ended March 31, 1999, the Company recognized a
mark-to-market gain of $4.9 million on Mortgage Securities classified as
trading. As the Company did not reclassify all of its short-funded Mortgage
Securities from available-for-sale to trading until July 1, 1998 (see Note 2),
there were no such mark-to-market adjustments for the three months ended March
31, 1998. The mark to market adjustments are reflected as a component of "Net
unrealized and realized gains (losses) on assets" on the Consolidated Statements
of Operations.

12
<PAGE> 13

Mortgage Securities: Available-for-Sale

<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
(in thousands) Non-Agency Non-Agency
-------------- -----------------
<S> <C> <C>
Current Face $16,705 $17,281
Unamortized Discount (7,149) (8,015)
------- -------
Amortized Cost 9,556 9,266
Allowance for Credit Losses (1,069) (1,189)
Gross Unrealized Gains 78 313
Gross Unrealized Losses (859) (683)
------- -------
Carrying Value $ 7,706 $ 7,707
======= =======
</TABLE>

No sales or write-downs of Mortgage Securities available-for-sale occurred
during the three months ended March 31, 1999. During the three months ended
March 31, 1998, the Company sold Mortgage Securities available-for-sale with an
amortized cost of $9.3 million for proceeds of $9.3 million, resulting in a net
gain of $5,689. The Company also recognized a $0.7 million loss on the
write-down of certain Mortgage Securities available-for-sale during the first
quarter of 1998. The gains and losses on the sales and write-downs of Mortgage
Securities available-for-sale are reflected as a component of "Net unrealized
and realized gains (losses) on assets" on the Consolidated Statements of
Operations.

NOTE 4. RESERVE FOR CREDIT LOSSES

The following table summarizes the Reserve for Credit Losses activity:

<TABLE>
<CAPTION>
Three Months Ended March 31,
(in thousands) 1999 1998
-------- --------
<S> <C> <C>
Balance at beginning of
period $4,973 $4,931
------ ------
Provision for credit losses 345 601
Charge-offs (121) (48)
====== ======
Balance at end of period $5,197 $5,484
====== ======
</TABLE>

The Reserve for Credit Losses is reflected as a component of Mortgage Assets on
the Consolidated Balance Sheets.

NOTE 5. US TREASURY SECURITIES

At March 31, 1999 and December 31, 1998 US Treasury securities consisted of the
following:

<TABLE>
<CAPTION>
(in thousands) March 31, 1999 December 31, 1998
-------------- -----------------
<S> <C> <C>
Current Face $33,000 $45,000
Unamortized Premium 485 3,009
------- -------
Carrying Value $33,485 $48,009
======= =======
</TABLE>

For the three months ended March 31, 1999, the Company recognized a
mark-to-market loss of $1.9 million on US Treasury securities. During the
quarter ended March 31, 1999, the Company received proceeds of $58.4 million on
sales of US Treasury securities. The mark to market adjustments are reflected as
a component of "Net unrealized and realized gains (losses) on assets" on the
Consolidated Statements of Operations.

13
<PAGE> 14

NOTE 6. COLLATERAL FOR LONG-TERM DEBT

The Company has pledged collateral in order to secure the Long-Term Debt issued
in the form of collateralized mortgage bonds ("Bond Collateral"). This Bond
Collateral consists primarily of adjustable-rate and hybrid, conventional,
30-year mortgage loans secured by first liens on one- to four-family residential
properties. All Bond Collateral is pledged to secure repayment of the related
Long-Term Debt obligation. All principal and interest (less servicing and
related fees) on the Bond Collateral is remitted to a trustee and is available
for payment on the Long-Term Debt obligation. The Company's exposure to loss on
the Bond Collateral is limited to its net investment, as the Long-Term Debt is
non-recourse to the Company. The components of the Bond Collateral are
summarized as follows:

<TABLE>
<CAPTION>
(in thousands) March 31, 1999 December 31, 1998
-------------- -----------------
<S> <C> <C>
Mortgage loans: held-for-sale $ 171,276 $ 197,646
Mortgage loans: held-for-investment, net 1,022,071 1,131,300
Restricted cash 11,182 12,857
Accrued interest receivable 6,761 7,707
---------- ----------
$1,211,290 $1,349,510
========== ==========
</TABLE>

For presentation purposes, the various components of the Bond Collateral
summarized above are reflected in their corresponding line items on the
Consolidated Balance Sheets.

NOTE 7. INTEREST RATE AGREEMENTS

At March 31, 1999 and December 31, 1998, all of the Company's Interest Rate
Agreements were classified as trading, and therefore, reported at fair value.

During the three months ended March 31, 1999, the Company recognized a net loss
of $0.8 million as a result of mark-to-market adjustments on interest rate
agreements classified as trading. As the Company did not classify its interest
rate agreements as trading instruments until July 1, 1998 (see Note 2), there
were no related mark-to-market adjustments recognized during the three months
ended March 31, 1998. The mark-to-market loss is reflected as a component of
"Net unrealized and realized gains (losses) on assets" on the Consolidated
Statements of Operations.

The following table summarizes the aggregate notional amounts of all of the
Company's Interest Rate Agreements as well as the credit exposure related to
these instruments.

<TABLE>
<CAPTION>
Notional Amounts Credit Exposure (a)
(in thousands) March 31, 1999 December 31, 1998 March 31, 1999 December 31, 1998
-------------- ----------------- -------------- -----------------
<S> <C> <C> <C> <C>
Interest Rate Options
Purchased $3,278,900 $3,569,200 -- --
Written 40,000 -- $ 310 --
Interest Rate Swaps 440,000 440,000 8,213 $8,673
---------- ---------- ------ ------
Total $3,758,900 $3,915,200 $8,523 $8,673
========== ========== ====== ======
</TABLE>

- ----------
(a) Reflects the fair market value of all cash and collateral of the Company
held by counterparties.

Interest Rate Options purchased (written), which may include caps, floors, call
and put corridors, options on futures and swaption collars (collectively,
"Options"), are agreements which transfer, modify or reduce interest rate risk
in exchange for the payment (receipt) of a premium when the contract is
initiated. Purchased interest rate cap agreements provide cash flows to the
Company to the extent

14
<PAGE> 15
that a specific interest rate index exceeds a fixed rate. Conversely, purchased
interest rate floor agreements produce cash flows to the Company to the extent
that the referenced interest rate index falls below the agreed upon fixed rate.
Purchased call (put) corridors will cause the Company to incur a gain (loss) to
the extent that the yield of the specified index is below (above) the strike
rate at the time of the option expiration. [The maximum gain or loss on a call
(put) corridor is established at the time of the transaction by establishing a
minimum (maximum) index rate]. The Company will receive cash on the purchased
options on futures if the futures price exceeds (is below) the call (put) option
strike price at the expiration of the option. For the written options on
futures, the Company receives an up-front premium for selling the option,
however, the Company will pay cash on the written option if the futures price
exceeds (is below) the call (put) option strike price at the expiration of the
option. Purchased receiver (payor) swaption collars will cause the Company to
incur a gain (loss) should the index rate be below (above) the strike rate as of
the expiration date. [The maximum gain or loss on a receiver (payor) swaption is
established at the time of the transaction by establishing a minimum (maximum)
index rate]. The Company's credit risk on the purchased Options is limited to
the carrying value of the Options agreements. The credit risk on options on
futures is limited due to the fact that the exchange and its members are
required to satisfy the obligations of any member that fails to perform.

Interest Rate Swaps ("Swaps") are agreements in which a series of interest rate
flows are exchanged over a prescribed period. The notional amount on which the
interest payments are based is not exchanged. Most of the Company's Swaps
involve the exchange of either fixed interest payments for floating interest
payments or the exchange of one floating interest payment for another floating
interest payment based on a different index. Most of the Swaps require that the
Company provide collateral, such as Mortgage Securities, to the counterparty.
Should the counterparty fail to return the collateral, the Company would be at
risk for the fair market value of that asset.

Interest Rate Futures ("Futures") are contracts for the delivery of securities
or cash in which the seller agrees to deliver on a specified future date, a
specified instrument (or the cash equivalent), at a specified price or yield.
Under these agreements, if the Company has sold (bought) the futures, the
Company will generally receive additional cash flows if interest rates rise
(fall). Conversely, the Company will generally pay additional cash flows if
interest rates fall (rise). Similar to options on futures, the credit risk on
futures is limited by the requirement that the exchange and its members make
good on obligations of any member that fails to perform.

In general, the Company has incurred credit risk to the extent that the
counterparties to the Interest Rate Agreements do not perform their obligations
under the Interest Rate Agreements. If one of the counterparties does not
perform, the Company would not receive the cash to which it would otherwise be
entitled under the Interest Rate Agreement. In order to mitigate this risk, the
Company has only entered into Interest Rate Agreements that are either a)
transacted on a national exchange or b) transacted with counterparties that are
either i) designated by the U.S. Department of the Treasury as a "primary
government dealer", ii) affiliates of "primary government dealers", or iii)
rated BBB or higher. Furthermore, the Company has entered into Interest Rate
Agreements with several different counterparties in order to diversify the
credit risk exposure.

NOTE 8. SHORT-TERM DEBT

The Company has entered into reverse repurchase agreements and other forms of
collateralized short-term borrowings (collectively, "Short-Term Debt") to
finance acquisitions of a portion of its Mortgage Assets. This Short-Term Debt
is collateralized by a portion of the Company's Mortgage Assets and US Treasury
securities.

At March 31, 1999, the Company had $1.0 billion of Short-Term Debt outstanding
with a weighted average borrowing rate of 5.04% and a weighted average remaining
maturity of 205 days. This debt was collateralized with $1.1 billion of Mortgage
Assets and US Treasury securities. At December 31, 1998, the Company had $1.3
billion of Short-Term Debt outstanding with a weighted average borrowing rate of
5.62% and a weighted average remaining maturity of 48 days. This debt was
collateralized with $1.3 billion of Mortgage Assets and US Treasury securities.

15
<PAGE> 16

At March 31, 1999 and December 31, 1998, the Short-Term Debt had the following
remaining maturities:

<TABLE>
<CAPTION>
(in thousands) March 31, 1999 December 31, 1998
-------------- -----------------
<S> <C> <C>
Within 30 days $ 269,006 $ 428,292
30 to 90 days 152,090 714,114
Over 90 days 612,546 115,164
---------- ----------
Total Short-Term Debt $1,033,642 $1,257,570
========== ==========
</TABLE>

For the three months ended March 31, 1999 and 1998, the average balance of
Short-Term Debt was $1.2 billion and $1.9 billion with a weighted average
interest cost of 5.12% and 5.77%, respectively. The maximum balance outstanding
during the three months ended March 31, 1999 and 1998 was $1.3 billion and $2.3
billion, respectively.

NOTE 9. LONG-TERM DEBT

Long-Term Debt in the form of collateralized mortgage bonds is secured by a
pledge of Bond Collateral. As required by the indentures relating to the
Long-Term Debt, the Bond Collateral is held in the custody of trustees. The
trustees collect principal and interest payments on the Bond Collateral and make
corresponding principal and interest payments on the Long-Term Debt. The
obligations under the Long-Term Debt are payable solely from the Bond Collateral
and are otherwise non-recourse to the Company.

Each series of Long-Term Debt consists of various classes of bonds at variable
rates of interest. The maturity of each class is directly affected by the rate
of principal prepayments on the related Bond Collateral. Each series is also
subject to redemption according to the specific terms of the respective
indentures. As a result, the actual maturity of any class of a Long-Term Debt
series is likely to occur earlier than its stated maturity.

The components of the Long-Term Debt at March 31, 1999 and December 31, 1998
along with selected other information are summarized below:

<TABLE>
<CAPTION>
(in thousands) March 31, 1999 December 31, 1998
-------------- ------------------
<S> <C> <C>
Long-Term Debt $1,169,269 $1,303,405
Unamortized premium on Long-Term Debt 5,098 5,783
Deferred bond issuance costs (3,226) (3,628)
---------- ----------
Total Long-Term Debt $1,171,141 $1,305,560
========== ==========

Range of weighted-average interest rates, by
series 5.73% to 6.51% 5.75% to 6.55%
Stated maturities 2017 - 2029 2017 - 2029
Number of series 3 3
</TABLE>

For the three months ended March 31, 1999 and 1998, the average effective
interest cost for Long-Term Debt, as adjusted for the amortization of bond
premium, deferred bond issuance costs and other related expenses, was 6.03% and
6.44%, respectively. At March 31, 1999 and December 31, 1998, interest payable
on Long-Term Debt was $3.7 million and $4.2 million, respectively, and is
reflected as a component of Accrued Interest Payable on the Consolidated Balance
Sheets.

NOTE 10. FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table presents the carrying values and estimated fair values of
the Company's financial instruments at March 31, 1999 and December 31, 1998.

16
<PAGE> 17

<TABLE>
<CAPTION>
(in thousands) March 31, 1999 December 31, 1998
Carrying Value Fair Value Carrying Value Fair Value
-------------------------- --------------------------
<S> <C> <C> <C> <C>
Assets
Mortgage Loans: held-for-sale $ 202,773 $ 202,816 $ 274,201 $ 274,302
Mortgage Loans: $1,022,071 $1,018,549 $1,131,300 $1,120,376
held-for-investment
Mortgage Securities: trading $1,092,331 $1,092,331 $1,257,655 $1,257,655
Mortgage Securities: $ 7,706 $ 7,706 $ 7,707 $ 7,707
available-for-sale
US Treasury Securities $ 33,485 $ 33,485 $ 48,009 $ 48,009
Interest Rate Agreements $ 1,627 $ 1,627 $ 2,517 $ 2,517
Investment in RWT Holdings, Inc. $ 12,639 $ 12,814 $ 15,124 $ 15,124
Liabilities
Long-Term Debt $1,171,141 $1,169,618 $1,305,560 $1,302,330
</TABLE>

The carrying values of all other balance sheet accounts as reflected in the
financial statements approximate fair value because of the short-term nature of
these accounts.

NOTE 11. STOCKHOLDERS' EQUITY

Class B 9.74% Cumulative Convertible Preferred Stock

On August 8, 1996, the Company issued 1,006,250 shares of Class B Preferred
Stock ("Preferred Stock"). Each share of the Preferred Stock is convertible at
the option of the holder at any time into one share of Common Stock. After
September 30, 1999, the Company can either redeem or, under certain
circumstances, cause a conversion of the Preferred Stock. The Preferred Stock
pays a dividend equal to the greater of (i) $0.755 per quarter or (ii) an amount
equal to the quarterly dividend declared on the number of shares of the Common
Stock into which the Preferred Stock is convertible. The Preferred Stock ranks
senior to the Company's Common Stock as to the payment of dividends and
liquidation rights. The liquidation preference entitles the holders of the
Preferred Stock to receive $31.00 per share plus any accrued dividends before
any distribution is made on the Common Stock.

As of March 31, 1999 and December 31, 1998, 96,732 shares of the Preferred Stock
have been converted into 96,732 shares of the Company's Common Stock. At March
31, 1999 and December 31, 1998, there were 909,518 shares of the Preferred Stock
outstanding.

Stock Option Plan

The Company has adopted a Stock Option Plan for executive officers, employees
and non-employee directors (the "Plan"). The Plan authorizes the Board of
Directors (or a committee appointed by the Board of Directors) to grant
"incentive stock options" as defined under Section 422 of the Code ("ISOs"),
options not so qualified ("NQSOs"), deferred stock, restricted stock,
performance shares, stock appreciation rights and limited stock appreciation
rights ("Awards") and dividend equivalent rights ("DERs") to such eligible
recipients other than non-employee directors. Non-employee directors are
automatically provided annual grants of NQSOs with DERs pursuant to a formula
under the Plan.

The number of shares of Common Stock available under the Plan for options and
Awards, subject to certain anti-dilution provisions, is 15% of the Company's
total outstanding shares of Common Stock. The total outstanding shares are
determined as the highest number of shares outstanding prior to any stock
repurchases. At March 31, 1999 and December 31, 1998, 372,832 and 273,312 shares
of Common Stock, respectively, were available for grant. Of the shares of Common
Stock available for grant, no more than 500,000 shares of Common Stock shall be
cumulatively available for grant as ISOs. At March 31, 1999 and December 31,
1998, 361,198 and 381,298 ISOs had been granted, respectively. The exercise
price for ISOs granted under the Plan may not be less than the fair market value
of shares of Common Stock at the time the ISO is granted. All stock options
granted under the Plan vest no earlier than ratably over a four-year period from
the date of grant and expire within ten years after the date of grant.

17
<PAGE> 18

The Company's Plan permits certain stock options granted under the plan to
accrue stock DERs. For the three months ended March 31, 1999 and 1998, the stock
DERs accrued on NQSOs that had a stock DER feature resulted in charges to
operating expenses of $0 and $53,228, respectively. Stock DERs represent shares
of stock which are issuable to holders of stock options when the holders
exercise the underlying stock options. The number of stock DER shares accrued is
based on the level of the Company's dividends and on the price of the stock on
the related dividend payment date.

A summary of the status of the Company's Plan as of March 31 and changes during
the periods ending on those dates is presented below.

<TABLE>
<CAPTION>
1999 1998
------------------- --------------------
Weighted Weighted
Average Average
Exercise Exercise
(in thousands, except share data) Shares Price Shares Price
---------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Outstanding options at January 1 1,739,787 $23.68 840,644 $29.79
Options granted 42,000 $14.43 284,282 $20.20
Options exercised (12,361) $0.11 -- --
Options canceled (141,520) $28.96 -- --
Dividend equivalent rights earned -- -- 2,419 --
========= =========
Outstanding options at March 31 1,627,906 $23.16 1,127,345 $27.31
========= =========
</TABLE>

Stock Repurchases

In 1997 and 1998, the Company's Board of Directors approved the repurchase of
5,455,000 shares of the Company's Common Stock. Pursuant to this repurchase
program, the Company repurchased 1,077,600 shares of its Common Stock for $16.0
million during the three months ended March 31, 1999. During 1997 and 1998, the
Company repurchased 3,971,500 shares of its Common Stock for $70.1 million. The
repurchased shares have been returned to the Company's authorized but unissued
shares of Common Stock.

NOTE 12. RELATED PARTY TRANSACTIONS

Sale of Mortgage Loans

During the first quarter of 1999, the Company sold $8.3 million of commercial
mortgage loans to Redwood Commercial Funding ("RCF"), a subsidiary of Holdings.
Pursuant to the Master Forward Commitment Agreement, the Company sold the
Mortgage Loans to RCF at the same price for which the Company acquired the
Mortgage Loans. Similarly, the Company purchased $2.9 million of commercial
mortgage loans during the three months ended March 31, 1999 and, under the terms
of the Master Forward Commitment Agreement, committed to sell the Mortgage Loans
to RCF during the second quarter of 1999.

Other

Under a revolving credit facility arrangement, the Company may loan funds to
Holdings to finance certain Mortgage Loans owned by Holdings. These loans are
typically unsecured and are repaid within six months. Such loans bear interest
at a rate of 3.5% over the London Interbank Offered Rate ("LIBOR"). At March 31,
1999 and December 31, 1998, the Company had loaned $13.7 million and $6.5
million, respectively, to Holdings in accordance with the provisions of this
arrangement.

The Company shares many of the operating expenses of Holdings, including
personnel and related expenses, subject to full reimbursement by Holdings.
During the three months ended March 31, 1999, $0.6 million of Holdings'
operating expenses was paid by the Company and $0.9 million was reimbursed by
Holdings. At March 31, 1999 and December 31, 1998, amounts due to the Company
from Holdings for operating expenses totaled $134,362 and $444,831,
respectively.

18
<PAGE> 19

The Company may provide credit support to Holdings to facilitate Holdings'
financings from third-party lenders and/or hedging arrangements with
counterparties. As part of this arrangement, Holdings is authorized as a
co-borrower under some of the Company's Short-Term Debt agreements subject to
the Company continuing to remain jointly and severally liable for repayment.
Accordingly, Holdings pays the Company credit support fees on borrowings subject
to this arrangement. At March 31, 1999, the Company was providing credit support
on $72.3 million of Holdings' Short-Term Debt. Holdings owed the Company $7,911
for credit support fees on March 31, 1999. No such arrangements were outstanding
at December 31, 1998.

NOTE 13. COMMITMENTS AND CONTINGENCIES

At March 31, 1999, the Company had entered into commitments to sell $7.5 million
of residential Mortgage Loans for settlement in April 1999 and $2.9 million of
commercial Mortgage Loans to RCF for settlement in June 1999.

At March 31, 1998, the Company is obligated under non-cancelable operating
leases with expiration dates through 2001. The future minimum lease payments
under these non-cancelable leases are as follows: 1999 - $233,646; 2000 -
$311,528; 2001 - $122,625.

NOTE 14. SUBSEQUENT EVENTS

During April and May 1999, pursuant to its stock repurchase program (see Note
11), the Company repurchased 144,500 shares of the Company's Common Stock for
$2.2 million.

In April 1999, the Company exercised its right to call the Long-Term Debt of
Sequoia Mortgage Trust 1 ("Sequoia 1"), a series of debt issued by Sequoia. This
Long-Term Debt was called on May 4, 1999. In conjunction with this call, the
Company restructured and contributed the Sequoia 1 debt to Sequoia Mortgage
Trust 1A ("Sequoia 1A"), a newly formed trust, and Sequoia 1A issued Long-Term
Debt collateralized by Sequoia 1 debt.

19
<PAGE> 20

RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
-------------- -----------------
(Unaudited)
<S> <C> <C>
ASSETS
Mortgage loans: held-for sale
Residential $ 25,369 $ 12,247
Commercial 8,263 --
-------- --------
33,632 12,247
-------- --------
Mortgage securities: trading 52,370 --
Cash and cash equivalents 10,620 9,711
Accrued interest receivable 194 78
Other assets 2,878 742
-------- --------
$ 99,694 $ 22,778
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY

LIABILITIES

Short-term debt $ 72,313 $ --
Loan from Redwood Trust, Inc. 13,700 6,500
Payable to Redwood Trust, Inc. 142 445
Accrued expenses and other liabilities 772 557
-------- --------
86,927 7,502
-------- --------
Commitments and contingencies (See Note 9)

STOCKHOLDERS' EQUITY

Series A preferred stock, par value $0.01 per share;
10,000 shares authorized; 3,960 issued and
outstanding ($3,960 aggregate liquidation
preference) 19,800 19,800
Common stock, par value $0.01 per share;
10,000 shares authorized; 2,000 issued and
outstanding -- --
Additional paid-in capital 200 200
Accumulated deficit (7,233) (4,724)
-------- --------
12,767 15,276
-------- --------
$ 99,694 $ 22,778
======== ========
</TABLE>

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

20
<PAGE> 21

RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands, except share data)
(Unaudited)

<TABLE>
<CAPTION>
Three Months Ended
March 31, 1999
------------------
<S> <C>
Income
Interest Income - Mortgage loans: held-for-sale
Residential $ 53
Commercial 126
------
179
------
Interest Income - Mortgage securities: trading 207
Interest Income - Cash and cash equivalents 108
Net unrealized and realized gains on assets 478
Other Income 57
------
1,029
------
Interest Expense
Short-term debt 107
Credit support fees 8
Loans from Redwood Trust, Inc. 159
------
274
------
Total Income after Interest Expense 755
Operating Expenses
Compensation and benefits 2,259
General and administrative 1,005
------
3,264
------
Net Loss $(2,509)
======
</TABLE>

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

21
<PAGE> 22

RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
(Unaudited)

<TABLE>
<CAPTION>
Class B Accumulated
Preferred stock Common stock Additional other
------------------------------------ paid-in comprehensive Accumulated
Shares Amount Shares Amount capital income deficit Total
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998 3,960 19,800 2,000 $ -- $ 200 $ -- $(4,724) $ 15,276
- -----------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net loss -- -- -- -- -- -- (2,509) (2,509)
- -----------------------------------------------------------------------------------------------------------------
Balance, March 31, 1999 3,960 $19,800 2,000 $-- $ 200 $-- $(7,233) $ 12,767
- -----------------------------------------------------------------------------------------------------------------
</TABLE>

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

22
<PAGE> 23
RWT HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited)

<TABLE>
<CAPTION>
Three Months Ended
March 31, 1999
------------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (2,509)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 103
Net unrealized and realized (gains) losses on assets (478)
Purchases of mortgage loans: held for sale (102,342)
Proceeds from sales of mortgage loans: held for sale 17,841
Principal payments on mortgage loans: held for sale 30
Proceeds from sales of mortgage securities: trading 10,502
Principal payments on mortgage securities: trading 518
Increase in accrued interest receivable (115)
Increase in other assets (2,065)
Decrease in amounts due to Redwood Trust (303)
Increase in accrued expenses and other liabilities 215
---------
Net cash used in operating activities (78,603)
---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of short-term debt 89,305
Repayments on short-term debt (16,992)
Loans from Redwood Trust, Inc. 13,700
Repayment of loans from Redwood Trust, Inc. (6,500)
---------
Net cash provided by financing activities 79,513
---------
Net increase in cash and cash equivalents 909

Cash and cash equivalents at beginning of period 9,711
---------
Cash and cash equivalents at end of period $ 10,620
=========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Non-Cash Transaction:
Securitization of Mortgage Loans into Mortgage Securities $ 62,843
=========
</TABLE>

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

23
<PAGE> 24
RWT HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(UNAUDITED)

NOTE 1. THE COMPANY

RWT Holdings, Inc. ("Holdings") was incorporated in Delaware on February 13,
1998 and commenced operations on April 1, 1998. Holdings' first fiscal year-end
was December 31, 1998. Holdings originates, acquires, accumulates, services and
sells real estate mortgage assets ("Mortgage Assets") which may be acquired or
sold as whole loans ("Mortgage Loans") or as mortgage securities representing
interests in or obligations backed by pools of mortgage loans ("Mortgage
Securities"). Redwood Trust, Inc. ("Redwood Trust") owns all of the preferred
stock and has a non-voting, 99% economic interest in Holdings. Holdings has
three subsidiaries which are included in the consolidated financial statements.
Redwood Financial Services, Inc. ("RFS") acquires seasoned loan portfolios from
banks and thrifts and sells this product to institutional mortgage investors.
Redwood Residential Funding, Inc. ("RRF") acquires newly-closed residential
loans from mortgage bankers and sells mortgage securities, loans and servicing
to investors. Redwood Commercial Funding, Inc. ("RCF") originates small balance
commercial mortgages and sells them to depository institutions. Holdings and its
subsidiaries currently utilize both debt and equity to finance acquisitions.
References to Holdings in the following footnotes refer to Holdings and its
subsidiaries.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The consolidated financial statements include the accounts of Holdings and its
subsidiaries. All significant intercompany balances and transactions with
Holdings' consolidated subsidiaries have been eliminated.

USE OF ESTIMATES

The preparation of financial statements in conformity with Generally Accepted
Accounting Principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reported period. Actual
results could differ from those estimates. The primary estimates inherent in the
accompanying consolidated financial statements are discussed below.

ADOPTION OF SFAS NO. 133

Holdings adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, effective July 1, 1998. Upon the adoption of SFAS No. 133, Holdings
did not record a transition adjustment, as there were no outstanding derivative
instruments. Immediately after the adoption of SFAS No. 133, Holdings elected to
not seek hedge accounting for any of its Interest Rate Agreements.

MORTGAGE ASSETS

Holdings' Mortgage Assets consist of Mortgage Loans and Mortgage Securities.
Interest is recognized as revenue when earned according to the terms of the
loans and when, in the opinion of management, it is collectible.

24
<PAGE> 25
Mortgage Loans: Held-for-Sale

Mortgage Loans are recorded at the lower of cost or aggregate market value. Cost
generally consists of the loan principal balance net of any unamortized premium
or discount. Interest income is accrued based on the outstanding principal
amount of the Mortgage Loans and their contractual terms. Realized and
unrealized gains or losses on the loans are based on the specific identification
method and are recognized in "Net unrealized and realized gains on assets" on
the Consolidated Statement of Operations.

Some of the Mortgage Loans purchased by Redwood Trust for which securitization
or sale is contemplated are committed for sale by Redwood Trust to Holdings, or
a subsidiary of Holdings, under a Master Forward Commitment Agreement. As the
forward commitment is entered into on the same date that Redwood Trust purchases
the loans, the price under the forward commitment is the same as the price
Redwood Trust paid for the Mortgage Loans, as established by the external
market.

Mortgage Securities: Trading

Mortgage Securities classified as trading are accounted for in accordance with
SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities.
Accordingly, such securities are recorded at their estimated fair market value.
Unrealized and realized gains and losses on these securities are recognized as a
component of "Net unrealized and realized gains on assets" on the Consolidated
Statement of Operations.

CASH AND CASH EQUIVALENTS

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

INTEREST RATE AGREEMENTS

Holdings maintains an overall interest-rate risk-management strategy that
incorporates the use of derivative interest rate agreements to minimize
significant unplanned fluctuations in earnings that are caused by interest-rate
volatility. Holdings currently designates Interest Rate Agreements as trading
instruments. There were no outstanding Interest Rate Agreements at March 31,
1999.

INCOME TAXES

Taxable earnings of Holdings are subject to state and federal income taxes at
the applicable statutory rates. Holdings provides for deferred income taxes if
any, to reflect the estimated future tax effects under the provisions of SFAS
No. 109, Accounting for Income Taxes. Under this pronouncement, deferred income
taxes, if any, reflect the estimated future tax effects of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and such amounts as measured by tax laws and regulations.

COMPREHENSIVE INCOME

SFAS No. 130, Reporting Comprehensive Income, requires Holdings to classify
items of "other comprehensive income" by their nature in a financial statement
and display the accumulated balance of other comprehensive income separately
from retained earnings and additional paid-in capital in the equity section of
the balance sheet. As of March 31, 1999 there was no other comprehensive income.

RECENT ACCOUNTING PRONOUNCEMENT

In October 1998, the Financial Accounting Standards Board issued SFAS No. 134,
Accounting for Mortgage-Backed Securities Retained after the Securitization of
Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. SFAS No. 134
amends SFAS No. 65, Accounting for Certain Mortgage Backed Securities, to
require that after an entity that is engaged in mortgage banking activities has
securitized mortgage loans that are held for sale, it must classify the
resulting retained mortgage-backed securities or other retained interests based
on its ability and intent to sell or hold those investments. Holdings adopted
this pronouncement effective January 1, 1999. The adoption of SFAS No. 134 had
no impact on Holdings' financial statements.

25
<PAGE> 26

NOTE 3. MORTGAGE ASSETS

At March 31, 1999 and December 31, 1998 Mortgage Assets consisted of the
following:

MORTGAGE LOANS: HELD-FOR-SALE

<TABLE>
<CAPTION>
(IN THOUSANDS) MARCH 31, 1999 DECEMBER 31, 1998
-------------- -----------------
<S> <C> <C>
Current Face $33,500 $12,072
Unamortized Premium 132 175
------- -------
Carrying Value $33,632 $12,247
======= =======
</TABLE>

At March 31, 1999 Holdings recognized a lower of cost or market loss adjustment
of $60,408 on Mortgage Loans held-for-sale. This loss is reflected as a
component of "Net unrealized and realized gains on assets" on the Consolidated
Statement of Operations. Also, during the three months ended March 31, 1999,
Holdings sold Mortgage Loans held-for-sale for proceeds of $17.8 million.

MORTGAGE SECURITIES: TRADING

<TABLE>
<CAPTION>
(IN THOUSANDS) MARCH 31, 1999
--------------
AGENCY
--------------
<S> <C>
Current Face $51,602
Unamortized Premium 768
-------
Carrying Value $52,370
=======
</TABLE>

For the three months ended March 31, 1999, Holdings recognized a mark-to-market
gain of $544,490 on Mortgage Securities classified as trading. This gain is
reflected as a component of "Net unrealized and realized gains on assets" on the
Consolidated Statement of Operations. Also during the three months ended March
31, 1999, Holdings sold Mortgage Securities classified as trading for proceeds
of $10.5 million.

NOTE 4. SHORT-TERM DEBT

During the period ended March 31, 1999, Holdings entered into reverse repurchase
agreements ("Short-Term Debt") in order to finance acquisitions of a portion of
its Mortgage Assets. The average balance of Short-Term Debt outstanding during
the three months ended March 31, 1999 was $8.1 million with a weighted average
borrowing rate of 5.25%. The maximum balance outstanding during the three months
ended March 31, 1999 was $87.6 million.

Redwood Trust may provide credit support to Holdings to facilitate Holdings'
financings from third-party lenders and/or hedging arrangements with
counterparties. As part of this arrangement, Holdings is authorized as a
co-borrower under some of Redwood Trust's Short-Term Debt agreements subject to
Redwood Trust continuing to remain jointly and severally liable for repayment.
Accordingly, Holdings pays Redwood Trust credit support fees, which are
reflected in the accompanying Consolidated Statement of Operations, on
borrowings subject to this arrangement. These fees are consistent with industry
standards. At March 31, 1999, Redwood Trust was providing credit support on
$72.3 million of Holdings' Short-Term Debt. Holdings owed Redwood Trust $7,911
for credit support fees on March 31, 1999. No such arrangements were outstanding
at December 31, 1998.

26
<PAGE> 27
NOTE 5. INCOME TAXES

The provision for income taxes for the period from January 1, 1999 through March
31, 1999 amounted to $3,200 and represents minimum California franchise taxes.
No tax provision has been recorded for the first quarter ended March 31, 1999,
as Holdings reported a loss for the period. Due to the uncertainty of
realization of net operating losses, no tax benefit has been provided against
the loss for the period. In addition, a valuation allowance has been provided to
eliminate the deferred tax asset related to net operating loss carryforwards at
March 31, 1999 and December 31, 1998. At March 31, 1999 and December 31, 1998
the valuation allowance amounted to $2.9 million and $1.9 million, respectively.
At December 31, 1998, Holdings had net operating loss carryforwards of
approximately $4.7 million for both federal and state income tax purposes. The
federal and state carryforwards expire through 2013 and 2003, respectively.

NOTE 6. FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table presents the carrying values and estimated fair values of
Holdings' financial instruments at March 31, 1999 and December 31, 1998.

<TABLE>
<CAPTION>
(IN THOUSANDS) MARCH 31, 1999 DECEMBER 31, 1998
CARRYING CARRYING
VALUE FAIR VALUE VALUE FAIR VALUE
----------------------------- ------------------------------
<S> <C> <C> <C> <C>
Assets
Mortgage Loans: held-for-sale $33,632 $33,841 $12,247 $12,255
Mortgage Securities: trading $52,370 $52,370 -- --
</TABLE>

The carrying amounts of all other balance sheet accounts as reflected in the
financial statements approximate fair value because of the short-term nature of
these accounts.

NOTE 7. STOCKHOLDERS' EQUITY

The authorized capital stock of Holdings consists of Series A Preferred Stock
("Preferred Stock") and Common Stock. Holdings is authorized to issue 10,000
shares of Common Stock, each having a par value of $0.01, and 10,000 shares of
Preferred Stock, each having a par value of $0.01. All voting power is vested in
the common stock.

Holdings issued a total of 3,960 shares of Preferred Stock to Redwood Trust;
1,980 shares on April 1, 1998 and 1,980 shares on October 29, 1998. The
Preferred Stock entitles Redwood Trust to receive 99% of the aggregate amount of
any such dividends or distributions made by Holdings. The holders of the Common
Stock are entitled to receive the remaining 1% of the aggregate amount of such
dividends or distributions. The Preferred Stock ranks senior to the Common Stock
as to the payment of dividends and liquidation rights. The liquidation
preference entitles the holders of the Preferred Stock to receive $1,000 per
share liquidation preference before any distribution is made on the Common
Stock. After the liquidation preference, the holders of Preferred Stock are
entitled to 99% of any remaining assets.

NOTE 8. RELATED PARTY TRANSACTIONS

PURCHASE OF MORTGAGE LOANS

During the first quarter of 1999, RCF purchased $8.3 million of commercial
mortgages from Redwood Trust. Pursuant to the Master Forward Commitment
Agreement, RCF purchased the Mortgage Loans from Redwood Trust at the same price
for which Redwood Trust acquired the Mortgage Loans. Similarly, Redwood Trust
purchased $2.9 million of commercial mortgage loans during the three months
ended March 31, 1999 and, under

27
<PAGE> 28
the terms of the Master Forward Commitment Agreement, committed to sell the
Mortgage Loans to RCF at the same price at which they were acquired during the
second quarter of 1999.

OTHER

Under a revolving credit facility arrangement, Redwood Trust may loan funds to
Holdings to finance certain Mortgage Assets owned by Holdings. These loans are
typically unsecured and are repaid within six months. Such loans bear interest
at a rate of 3.5% over the London Interbank Offered Rate ("LIBOR"). At March 31,
1999 and December 31, 1998, Holdings had borrowed $13.7 million and $6.5
million, respectively, from Redwood in accordance with the provisions of this
arrangement.

Redwood Trust shares many of the operating expenses of Holdings, including
personnel and related expenses, subject to full reimbursement by Holdings.
During the three months ended March 31, 1999, $0.6 million of Holdings'
operating expenses was paid by Redwood Trust and $0.9 million was reimbursed by
Holdings. At March 31, 1999 and December 31, 1998, amounts due to Redwood Trust
from Holdings for operating expenses totaled $134,362 and $444,831,
respectively.

Holdings may borrow under several of the Company's Short-Term Debt agreements as
a co-borrower. As of March 31, 1999, Holdings had borrowings of $72.3 million
subject to this arrangement. At December 31, 1998, Holdings had no outstanding
borrowings under these agreements (see Note 4).

NOTE 9. COMMITMENTS AND CONTINGENCIES

At March 31, 1999, Holdings is obligated under non-cancelable operating leases
with expiration dates through 2003. The future minimum lease payments under
these non-cancelable leases are as follows: 1999 - $387,831; 2000 - $504,577;
2001 - $460,120; 2002 - $290,376; 2003 - $266,178.

Rent expense was $205,429 for the three months ended March 31, 1999.

At March 31, 1999, RCF had entered into a commitment to purchase $2.9 million of
commercial Mortgage Loans from Redwood Trust for settlement during the second
quarter of 1999.

28
<PAGE> 29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes.

SAFE HARBOR STATEMENT

"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995: Statements in this discussion regarding Redwood Trust, Inc., or "Redwood
Trust", and our business which are not historical facts are "forward-looking
statements" that involve risks and uncertainties. For a discussion of such risks
and uncertainties, which could cause actual results to differ from those
contained in the forward-looking statements, we refer you to "Risk Factors"
commencing on Page 16 of our 1998 Annual Report.

COMPANY OVERVIEW

We, together with our affiliated companies, operate a mortgage finance business
providing funding to diverse segments of the U.S. mortgage market. We originate,
acquire, process, aggregate, and credit-enhance high-quality residential and
commercial mortgage loans and sell this product to institutional mortgage
investors as tailored loan portfolios, mortgage securities, and mortgage-backed
bonds. In addition, we invest in mortgage assets on a long-term basis for our
own account.

A portion of the operations in which we have an interest are sheltered from
corporate-level income taxes, as Redwood Trust (but not its affiliates)
qualifies for tax treatment under the Internal Revenue Code as a Real Estate
Investment Trust ("REIT"). The remainder of the operations in which we have an
interest are subject to regular corporate taxation. Taxable non-REIT operations
are conducted at Redwood Trust's 99%-owned affiliate corporation - RWT Holdings,
Inc., or "Holdings" - and its subsidiaries.

In the first quarter of 1999, Redwood Trust (including both REIT and non-REIT
operations) earned $5.9 million, or $0.54 per common share. Relative to the
first quarter of 1998, net income increased by 139%, from $2.5 million, and
earnings per share increased by 218%, from $0.17 per share. Relative to the
fourth quarter of 1998, net income increased by 1.1%, from $5.8 million, and
earnings per share increased by 5.9%, from $0.51 per share.

For more information, please visit our Web site on the Internet at:
http://www.redwoodtrust.com. In the past, Redwood Trust has included extensive
supplemental historical data on its operations in its Form 10-Q and 10-K
filings. In the future, this information will be available on our Web site.

FINANCIAL CONDITION

At March 31, 1999, our reported balance sheet had $2.5 billion of assets funded
with $2.2 billion of borrowings and $244 million of equity.

Included on the reported balance sheet at March 31, 1999 were $1.2 billion of
assets and $1.2 billion of debt of three "Sequoia" trusts.

The Sequoia trusts are "bankruptcy-remote" with respect to Redwood Trust.
Although the net earnings of the trusts accrue to Redwood Trust, Redwood Trust
is not responsible for the repayment of Sequoia debt and Sequoia has no call on
the liquidity of Redwood Trust. Our credit risk with respect to Sequoia's
mortgage assets is limited to our investment in the equity of these trusts. At
March 31, 1999, these equity investments had a reported basis of $40 million.
The individual assets and liabilities of Sequoia had a net estimated market
value of $38 million.

Subtracting out those Sequoia assets and liabilities that are non-recourse to
Redwood Trust, our recourse balance sheet at March 31, 1999 consisted of $1.3
billion of assets, including our $40 million investment in Sequoia

29
<PAGE> 30
equity, funded with $1.0 billion of borrowings and $244 million of equity. The
ratio of equity to recourse assets was 19.0%. The ratio of recourse liabilities
to equity was 4.2 to 1.0.

At December 31, 1998, we reported $2.8 billion in assets, of which $1.5 billion
were recourse, and $2.6 billion of liabilities, of which $1.3 billion were
recourse. Equity capital was $255 million. The ratio of equity to recourse
assets was 16.7% and the ratio of recourse liabilities to equity was 4.9 to 1.0.

CASH

We had $41 million of unrestricted cash at March 31, 1999 and $56 million at
year-end 1998.

Sequoia owned cash totaling $11 million at March 31, 1999 and $13 million at
year-end 1998. In consolidating Sequoia assets on our balance sheet, we reflect
this cash as restricted cash as it is not available to us.

U.S. TREASURY SECURITIES

Our ten-year U.S. Treasury securities are marked-to-market for income statement
and balance sheet purposes. The market value was $33 million at March 31, 1999
and $48 million at December 31, 1998. The lower balance reflects a $13 million
net sale of Treasury securities in the first quarter of 1999.

MORTGAGE SECURITIES: MARK-TO-MARKET

With the exception of our interest in SMFC 97-A, our mortgage securities
portfolio is marked-to-market for income statement and balance sheet purposes.
For the mark-to-market securities, the estimated bid-side market value was $1.1
billion at March 31, 1999: these appear on our balance sheet as "Mortgage
Securities: Trading." We owned $1.3 billion in market value of these securities
at December 31, 1998. For a discussion of our interest in SMFC 97-A, we refer
you to the section titled "SMFC 97-A" below.

At March 31, 1999, 48.9% of our mark-to-market residential mortgage securities
portfolio consisted of residential adjustable-rate mortgage securities issued
and credit-enhanced by Fannie Mae or Freddie Mac and effectively rated "AAA".
These securities totaled $0.5 billion at March 31, 1999 and $0.6 billion at
December 31, 1998.

At March 31, 1999, 41.0% of this residential mortgage securities portfolio
consisted of residential adjustable-rate mortgage securities issued by
private-label security issuers. These securities were credit-enhanced through
subordination or other means and were rated "AAA" or "AA". The value of these
securities was $0.4 billion at March 31, 1999 and $0.6 billion at December 31,
1998.

At March 31, 1999, 6.2% of this residential mortgage securities portfolio
consisted of mortgage securities rated "AAA" or "AA" which were backed by home
equity loans, or "HEL". The value of these securities was $68 million at March
31, 1999; floating-rate HEL securities were $66 million and fixed-rate HEL
securities were $2 million. The value of these securities was $71 million at
December 31, 1998; floating-rate HEL securities were $68 million and fixed-rate
HEL securities were $3 million.

At March 31, 1999, 1.7% of this residential mortgage securities portfolio
consisted of fixed-rate, private label collateralized mortgage obligations,
commonly referred to as CMO's, rated "AAA" or "AA" with average lives of 1 to 2
years. The value of these securities was $18 million at March 31, 1999 and $19
million at December 31, 1998.

At March 31, 1999, 1.2% of this residential mortgage securities portfolio
consisted of fixed-rate private label mortgage securities rated "AA" and backed
by residential mortgage loans with loan-to-value ratios in excess of 100%. The
value of these securities was $13 million at March 31, 1999 and $12 million at
December 31, 1998.

At March 31, 1999, 1.0% of this residential mortgage securities portfolio
consisted of floating-rate CMO's issued by Fannie Mae or Freddie Mac and
effectively rated "AAA". These securities totaled $11 million at March 31, 1999
and $17 million at December 31, 1998.

30
<PAGE> 31

At March 31, 1999, 0.03% of this residential mortgage securities portfolio
consisted of interest-only mortgage securities rated "AAA" or "AA". The value of
these securities was $0.3 million at March 31, 1999 and $0.4 million at December
31, 1998.

SMFC 97-A

In 1994 and 1995, we acquired a portfolio of subordinated mortgage securities.
These securities were interests in pools of residential mortgages that served as
the credit-enhancement for the "AAA" and other securities issued from those
pools. Through ownership of these securities, we assumed most of the credit risk
of the underlying mortgages. These securities were either not rated or were
rated "A" through "B". We sold these subordinated securities to a trust, SMFC
97-A, in December 1997. SMFC 97-A issued mortgage securities to fund its
acquisition of this portfolio.

We acquired from SMFC 97-A the most subordinated of the mortgage interests it
issued. In effect, we acquired the equity of SMFC 97-A. At March 31, 1999, these
securities effectively bore most of the credit risk related to $0.5 billion of
underlying mortgages. Changes in market valuations of SMFC 97-A are not included
in our income statement as these assets are funded with equity. The reported
value of SMFC 97-A was $8 million at March 31, 1999 and $8 million at December
31, 1998. Our credit risk from SMFC 97-A is limited to our investment.

REDWOOD TRUST COMMERCIAL MORTGAGE LOANS

At March 31, 1999, we owned $3 million of commercial mortgage loans originated
by Redwood Commercial Funding, Inc. and carried on our balance sheet as
"Mortgage Loans: Held for Sale: Commercial". At March 31, 1999, we had committed
to sell these loans to Holdings. At December 31, 1998, we owned $8 million of
commercial mortgage loans.

REDWOOD TRUST RESIDENTIAL MORTGAGE LOANS

We owned $28 million residential mortgage loans at March 31, 1999 and $68
million at December 31, 1998. These were carried on our balance sheet at the
lower-of-cost-or-market as "Mortgage Loans: Held for Sale: Residential".

SEQUOIA MORTGAGE TRUST 1 RESIDENTIAL MORTGAGE LOANS

Sequoia Mortgage Trust 1, "Sequoia 1", owned $171 million in principal value of
residential mortgage loans and $11 million of cash at March 31, 1999 funded with
$175 million of collateralized mortgage bonds. We consolidated the assets and
liabilities of Sequoia 1 on our balance sheet. These appeared on our balance
sheet as part of "Mortgage Loans: Held for Sale," "Restricted Cash," and
"Long-term Debt."

Our credit risk with respect to these loans is limited to our investment in the
equity of Sequoia 1. The reported basis of this investment was $7 million at
March 31, 1999. The net market value of Sequoia 1's individual assets over
liabilities was also $7 million. As the equity owner of Sequoia 1, we are
entitled to distributions of the net earnings of the trust, which principally
consists of the interest income earned from Sequoia 1 mortgages less the
interest expense on Sequoia 1 debt.

At December 31, 1998, the principal value of Sequoia 1's loans on our balance
sheet totaled $197 million and was included as part of "Mortgage Loans: Held for
Sale." We also reported $13 million of cash owned by Sequoia 1 as "Restricted
Cash". Total Sequoia 1 debt was $202 million. We formed Sequoia 1 in June 1997.
At that time, we sold $543 million of principal value of our loan portfolio to
Sequoia and Sequoia issued $534 million of long-term amortizing mortgage-backed
debt rated "AAA" to fund the purchase.

In May 1999, we effectively reduced the cost of our long-term financing
arrangement for Sequoia 1's mortgage loans by exercising our right to call
Sequoia 1's debt. We restructured Sequoia 1 debt and contributed the debt to
Sequoia Mortgage Trust 1A ("Sequoia 1A"), a newly formed trust. Sequoia 1A
issued lower-cost long-term debt collateralized by Sequoia 1 debt.

31
<PAGE> 32

SEQUOIA MORTGAGE TRUST 2 RESIDENTIAL MORTGAGE LOANS

Sequoia Mortgage Trust 2, "Sequoia 2", owned $527 million of principal value of
residential mortgage loans at March 31, 1999 funded with $521 million of
collateralized mortgage bonds. We consolidated the assets and liabilities of
Sequoia 2 on our balance sheet: these appeared on our balance sheet as part of
"Mortgage Loans: Held for Investment" and "Long-term Debt." As the equity owner
of Sequoia 2, we are entitled to receive distributions of its net income.

Our credit risk with respect to these loans is limited to our investment in the
equity of Sequoia 2. The reported basis of this equity interest was $21 million;
the estimated net market value of Sequoia 2's assets over its liabilities was
$18 million.

We will have the right to call Sequoia 2's debt and re-acquire Sequoia 2's loans
when the underlying mortgage loans collateral has been paid down to less than
25% of its initial balance. It most likely will be several years before we gain
this right.

At December 31, 1998, Sequoia 2's loans, as reflected on our balance sheet,
totaled $579 million and were included as part of "Mortgage Loans: Held for
Investment". Total Sequoia 2 debt was $571 million. We formed Sequoia 2 in
November 1997. At that time, we sold $757 million of principal value of our loan
portfolio to Sequoia and Sequoia issued $749 million of long-term amortizing
mortgage-backed debt rated "AAA" to fund the purchase.

SEQUOIA MORTGAGE TRUST 3 RESIDENTIAL MORTGAGE LOANS

Sequoia Mortgage Trust 3, "Sequoia 3", owned $484 million of principal value of
residential mortgage loans at March 31, 1999 funded with $474 million of
long-term debt. We consolidated the assets and liabilities of Sequoia 3 on our
balance sheet: these appeared on our balance sheet as a component of "Mortgage
Loans: Held for Investment" and "Long-term Debt." We own the equity of Sequoia 3
and are entitled to its earnings distributions.

Our credit risk with respect to these loans is limited to our investment in the
equity of Sequoia 3. This investment had a reported basis of $12 million. The
estimated net market value of Sequoia 3's assets and liabilities was $13
million.

We will have the right to call Sequoia 3's debt and re-acquire Sequoia 3's loans
beginning in December 2002.

At December 31, 1998, Sequoia 3's loans, as reflected on our balance sheet,
totaled $540 million and were included as part of "Mortgage Loans: Held for
Investment". Total Sequoia 3 debt was $530 million. We formed Sequoia 3 in June
1998. At that time, Sequoia acquired $645 million of principal value from
Redwood Trust and Holdings and Sequoia issued $635 million of long-term
amortizing debt rated "AAA" to "BBB" to fund the purchase.

INTEREST RATE AGREEMENTS

Our interest rate agreements are carried on our balance sheet at estimated
market value, which was $1.6 million at March 31, 1999 and $2.5 million at
December 31, 1998. Please see "Note 2. Summary of Significant Accounting
Policies", "Note 7. Interest Rate Agreements" and "Note 11. Fair Value of
Financial Instruments" in the Notes to Consolidated Financial Statements for
more information.

INVESTMENT IN RWT HOLDINGS, INC.

We do not consolidate the assets and liabilities of Holdings on our balance
sheet. We reflect the net book value of our individual investment in one line
item on our balance sheet labeled "Investment in RWT Holdings, Inc.".

In 1998, we invested $19.8 million in the preferred stock of Holdings; our share
of the operating losses at Holdings has reduced the carrying value of this
investment. The carrying value was $12.6 million at March 31, 1999 and $15.1
million at December 31, 1998.

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At March 31, 1999, our assets also included a loan to Holdings of $13.7 million
and a receivable from Holdings of $0.1 million. At December 31, 1998, loans to
Holdings totaled $6.5 million and receivables from Holdings were $0.4 million.

OTHER ASSETS

Our other assets include accrued interest receivables, other receivables, fixed
assets, leasehold improvements and prepaid expenses. These totaled $18 million
at March 31, 1999 and $21 million at December 31, 1999.

SHORT-TERM DEBT

Short-term borrowings totaled $1.0 billion at March 31, 1999. We pledged a
portion of our mortgage securities portfolio, mortgage loan portfolio, and U.S.
Treasury securities to secure this debt. Short-term debt totaled $1.3 billion at
December 31, 1998. Maturities on this debt typically range from one month to one
year. The interest rate on most of this debt adjusts monthly to a spread over or
under the one month LIBOR interest rate.

LONG-TERM DEBT

At March 31, 1999, Sequoia 1 had $175 million, Sequoia 2 had $522 million, and
Sequoia 3 had $474 million of long-term mortgage-backed debt outstanding, net of
unamortized premiums on bonds and deferred bond issuance costs. Sequoia 1 and
Sequoia 2 debt is floating rate debt. Sequoia 3 debt is fixed until December
2002 after which it becomes floating rate debt.

At December 31, 1998, Sequoia 1 had $202 million, Sequoia 2 had $574 million,
and Sequoia 3 had $530 million of long-term mortgage-backed debt outstanding net
of unamortized premiums on bonds and deferred bond issuance costs.

Sequoia debt is non-recourse to Redwood Trust. The debt is consolidated on our
balance sheet and is reflected as long-term debt, which is carried at historical
amortized cost. The original scheduled maturity of this debt was approximately
thirty years. The expected average life of this debt is two to six years, as
debt balances are retired over time as principal payments are received on the
underlying mortgages.

OTHER LIABILITIES

Our other liabilities include accrued interest payable, accrued expenses, and
dividends payable. The net balance of these accounts totaled $8 million at March
31, 1999 and $15 at December 31, 1998.

STOCKHOLDERS' EQUITY

Total equity capital was $244 million at March 31, 1999. Preferred stock equity
was $27 million. Reported common equity totaled $217 million, or $21.35 per
common share outstanding.

In reporting equity at March 31, 1999, we marked-to-market all earning assets
and interest rate agreements except mortgage assets funded with equity (SMFC
97-A) or funded with borrowings to maturity (Sequoia 2 and Sequoia 3). In
accordance with Generally Accepted Accounting Principles, no liabilities were
marked-to-market.

If we had marked-to-market all of our assets and liabilities, equity capital
would have been reported as $242 million at March 31, 1999. After subtracting
out the preference value of the preferred stock, common equity on a full
mark-to-market basis was $214 million and the net mark-to-market value per
common share was $21.02.

Reported equity capital was $255 million at December 31, 1998. Reported common
equity was $228 million, or $20.27 per common share outstanding. Mark-to-market
common equity was $220 million, or $19.53 per common share.

Real shareholder wealth increased from $19.53 to $21.02 per share, an increase
of 8% or $1.49 per share, during the first quarter of 1999 due to net asset
appreciation, retained earnings, and the effects of our stock repurchase
program.

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We acquired 1,077,600 shares of our common stock in the first quarter of 1999 at
an average price of $14.88 per share. In the second quarter of 1999 through
April 19, we had acquired an additional 144,500 shares at an average price of
$15.40 per share.

RESULTS OF OPERATIONS

Our operating results include all of the reported income of Redwood Trust's REIT
operations plus 99% of the after-tax results of operations at Holdings.

Net operating revenue from the REIT portfolio includes net interest income, net
asset appreciation as discussed in "REIT Net Unrealized and Realized Gains and
Losses on Assets", and credit expenses as discussed in "REIT Credit-Related
Expenses." Our REIT net income is net REIT operating income less REIT operating
expenses. Holdings' operating results, our share of which is also included in
our reported net income, are discussed in a separate section below.

REIT INTEREST INCOME

In the first quarter of 1999, interest income generated by our REIT portfolio,
including consolidated Sequoia assets, was $42 million. Our REIT portfolio had
average earning assets of $2.6 billion and earned an average yield of 6.55%.
During this quarter, the average coupon rate, or the cash earning rate on
mortgage principal, was 6.99%. The reported value of assets included a 0.71% net
premium, or $16 million. We write off this premium balance as an expense over
time. Net premium amortization expense for the quarter was $2.3 million, which
reduced earning asset yield by 0.37%. Prepayments on mortgage assets, which
drives the rate at which we write off premium balances, were 33% CPR during the
quarter. Other factors reduced the earning asset yield by 0.07%. At the end of
the first quarter of 1999, earning assets were $2.4 billion.

In the fourth quarter of 1998, interest income was $54 million. Our portfolio
had average earning assets of $3.1 billion and earned an average yield of 6.87%.
The coupon rate was 7.17%. The reported value of assets included a 0.63% net
premium, or $13 million. Net premium amortization expense was $1.7 million,
which reduced earning asset yield by 0.23%. Prepayments during the quarter were
32% CPR. Other factors reduced the earning asset yield by 0.07%. At the end of
the fourth quarter of 1998, earning assets were $2.8 billion.

Interest income declined from the fourth quarter of 1998 to the first quarter of
1999 as we continued reducing our earning asset balances in order to free
capital to fund anticipated growth in the start-up operations at Holdings.
Earning asset yields declined as interest rates fell and coupons on
adjustable-rate assets reset at lower rates. An increase in prepayment rates and
an increase in premium balances due to asset appreciation increased premium
amortization expenses and contributed to the lower yield.

In the first quarter of 1998, interest income was $54 million. The portfolio had
average earning assets of $3.3 billion and earned an average yield of 6.49%. The
coupon rate was 7.65%. The reported value of assets included a 2.21% net
premium, or $71 million. Net premium amortization expense was $8.2 million,
which reduced earning asset yield by 0.99%. Prepayments during the quarter were
26% CPR. Other factors reduced the earning asset yield by 0.17%. At the end of
the first quarter of 1998, earning assets were $3.7 billion.

REIT INTEREST EXPENSE

Interest expense in the first quarter of 1999 was $33 million. We funded our
REIT portfolio with an average of $250 million of equity and $2.4 billion of
borrowings, including consolidated Sequoia debt. We paid an average cost of
funds of 5.59% for these borrowings. Short-term debt averaged 48% of total debt
and cost us 5.12%. Long-term debt averaged 52% of total debt and cost us 6.03%.

In the fourth quarter of 1998, interest expense was $44 million. We funded our
REIT portfolio with an average of $253 million of equity and $3.0 billion of
borrowings. We paid an average cost of funds of 5.89% for these borrowings.
Short-term debt averaged 53% of total debt and cost us 5.59%. Long-term debt
averaged 47% of total debt and cost us 6.23%.

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In the first quarter of 1998, interest expense was $46 million. We funded our
REIT portfolio with an average of $330 million of equity and $3.1 billion of
borrowings. We paid an average cost of funds of 6.01% for these borrowings.
Short-term debt averaged 63% of total debt and cost us 5.77%. Long-term debt
averaged 37% of total debt and cost us 6.44%.

During the last year, our borrowing costs have fallen due to decreases in
short-term interest rates. Our borrowing costs have not fallen as much as they
otherwise would have as we have been utilizing an increasing percentage of more
expensive long-term debt.

REIT INTEREST RATE AGREEMENT EXPENSE

We hedge using interest rate agreements in order to strengthen our balance
sheet, increase liquidity, and dampen potential earnings volatility. Hedging
expenses include interest rate agreement expenses as well as changes in the
market values of interest rate agreements. We refer you to "REIT Net Unrealized
and Realized Gains and Losses on Assets" below for more information on changes
in the market value of interest rate agreements.

Net interest rate agreements expense was $0.3 million in the first quarter of
1999, or 0.06% of average borrowings. In the fourth quarter of 1998, interest
rate agreement expense was $0.3 million or 0.04% of average borrowings. In the
first quarter of 1998, interest rate agreement expense was $1.4 million or 0.18%
of average borrowings.

In adopting mark-to-market accounting for our interest rate agreements in the
third quarter of 1998 through the early adoption of SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, we wrote down our basis in our
interest rate agreements. This market value adjustment had the effect of
reducing interest rate agreement amortization expense on an on-going basis.
Total interest rate agreement expense has also fallen as the size of our balance
sheet decreased.

We refer you to "Note 7. Interest Rate Agreements" in the Notes to Consolidated
Financial Statements for additional details.

REIT NET INTEREST INCOME

Net interest income, which equals interest income less interest expense less
interest rate agreements expense, was $8 million in the first quarter of 1999.
Our interest rate spread, which equals the yield on earning assets less the cost
of funds and hedging, was 0.90%. Our net interest margin, which equals net
interest income divided by average assets, was 1.19% during this period.

In the fourth quarter of 1998, net interest income was $10 million, the interest
rate spread was 0.94%, and the net interest margin was 1.19%. Net interest
income was lower in the first quarter of 1999 than in the fourth quarter of 1998
due to a lower average balance during the later period.

In the first quarter of 1998, net interest income was $6 million, the interest
rate spread was 0.30%, and the net interest margin was 0.75%. Our spread and
margin increased in the later part of 1998 in spite of accelerated prepayment
rates primarily due to changes in accounting methodologies, which lowered
amortization expense and thereby increased asset yields. Also, a reduction in
interest rates lowered our cost of funds faster than coupon rates on our assets
decreased. This reduction in short-term interest rates boosted our spreads and
margins temporarily.

REIT CREDIT-RELATED EXPENSES

Credit-related expenses include credit provisions for loans and securities that
are not marked-to-market and credit-related valuation adjustments for assets
that are accounted for on a lower-of-cost-or-market basis. The credit-related
valuation adjustments are included in "Net unrealized and realized gains or
losses on assets" on our income statement.

In the first quarter of 1999, total credit-related expenses were $1.0 million,
including $0.3 million of credit provisions and $0.7 million of credit-related
mark-to-market adjustments. Total credit-related reserves were $7.1

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million at March 31, 1999, including $5.2 million of credit reserves and $1.9
million of credit-related mark-to-market reserve. Actual realized credit losses
in the first quarter of 1999 totaled $0.1 million. These losses were incurred on
the mortgage securities underlying SMFC 97-A. There were no credit losses on
mortgage loans in this period.

In the fourth quarter of 1998, total reported credit-related expenses netted to
zero as we took credit provisions of $0.4 million offset by $0.4 million of
positive, credit-related, mark-to-market adjustments. Total credit-related
reserves were $6.1 million at December 31, 1998, including $4.9 million of
credit reserves and $1.2 million of credit-related mark-to-market reserves.
Total actual realized credit losses in the fourth quarter of 1998 were $0.02
million, all of which were related to SMFC 97-A securities.

In the first quarter of 1998, total credit-related expenses were $0.6 million.
All of these expenses were credit provisions, as we had not yet adopted
mark-to-market accounting. Total credit-related reserves were $5.5 million at
March 31, 1998. Total actual realized credit losses in the first quarter of 1998
were $0.05 million, including $0.01 million in losses on loans and $0.04 million
in losses on SMFC 97-A securities.

Our overall credit results have been excellent through March 31, 1999. Serious
delinquencies have remained below 0.50% of loans and loan loss severities have
averaged less than 10%.

We have generally taken credit provisions at an annual rate of 0.15% for most
residential loans held for investment, have written down the basis of delinquent
lower-of-cost-or-market loans to estimated bid-side market value, and have
established a credit reserve for our interests in SMFC 97-A to cover estimated
future losses from that source.

REIT NET UNREALIZED AND REALIZED GAINS AND LOSSES ON ASSETS

In the first quarter of 1999, the net gain on asset market valuations was $2.2
million. This net gain consisted of $3.7 million of market value gains on
portfolio earning assets, $0.7 million credit-related mark-to-market expenses,
and $0.8 million market value losses on interest rate agreements. Market values
for our mortgage portfolio improved in the first quarter of 1999 as the global
financial markets stabilized.

In the fourth quarter of 1998, total net asset appreciation income was $2.0
million. This included a $1.1 million gain on mortgage assets, a $0.4 million
mark-to-market gain in the credit-related reserve, and $0.5 million market value
gains on interest rate agreements.

In the first quarter of 1998, we had not yet adopted mark-to-market accounting.
As a result, most of the unrealized market value gains and losses incurred
during that quarter were not recognized in earnings. We sold $9 million of
mortgage securities for a $6,000 realized gain. We also wrote down all of our
interest-only mortgage securities by $0.7 million to their estimated market
value.

REIT NET OPERATING REVENUE

REIT net operating revenue is earnings before operating expenses. It is total
asset earnings less the all-in costs of borrowing and hedging. For the first
quarter of 1999, REIT net operating revenue was $9.8 million.

Gross asset earnings in the first quarter of 1999 were $44.4 million, reflecting
interest income of $41.7 million less credit-related expenses of $1.0 million
plus positive mark-to-market adjustments on mortgage assets of $3.7 million.
Interest expenses on borrowing were $33.5 million. Hedging expenses were $1.1
million, reflecting $0.3 million interest rate agreement expense plus $0.8
million mark-to-market adjustments on interest rate agreements.

For the fourth quarter of 1998, REIT net operating revenue was $11.3 million.
For the first quarter of 1998, REIT net operating revenue was $5.1 million.

The analysis of quarter to quarter changes in net operating revenue is discussed
above.

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REIT OPERATING EXPENSES

Total operating expenses for the REIT for the first quarter of 1999 were $0.7
million. Total operating expenses for the fourth quarter of 1998 were $2.3
million. Total operating expenses for the first quarter of 1998 were $1.9
million.

Total operating expenses in the fourth quarter of 1998 included one-time
termination expenses of $1.2 million. On-going expenses in that period totaled
$1.1 million.

On-going operating expenses as a percentage of assets were 0.11% in the first
quarter of 1999, 0.14% in the fourth quarter of 1998, and 0.22% in the first
quarter of 1998. Operating expenses as a percentage of equity were 1.14%in the
first quarter of 1999, 1.75% in the fourth quarter of 1998, and 2.24% in the
first quarter of 1998.

On-going operating expenses at the REIT have generally declined after the first
quarter of 1998 as the Company continues to transfer certain mortgage operations
to its affiliates.

NET REIT EARNINGS

Net REIT earnings, which equals net REIT operating revenue less REIT operating
expenses, were $9.0 million in the first quarter of 1999. In the fourth quarter
of 1998, net REIT earnings were $9.0 million. In the first quarter of 1998, net
REIT earnings were $3.1 million.

INCOME FROM THE INVESTMENT IN RWT HOLDINGS, INC.

Our share of the losses generated by start-up operations at Holdings, our
non-REIT mortgage finance affiliate, was $2.5 million in the first quarter of
1999. We recognized losses from Holdings of $2.5 million in the fourth quarter
of 1998. Holdings had no impact on first quarter 1998 earnings as Holdings had
only recently commenced operations.

We refer you to Holdings' "Consolidated Financial Statements and Notes", and
Holdings' "Management's Discussion and Analysis" below for more information on
Holdings.

NET INCOME

Net income for all of our operations was $6.6 million in the first quarter of
1999. After preferred dividends of $0.7 million, net income available to common
stockholders was $5.9 million.

Our net income was $6.5 million in the fourth quarter of 1998. After preferred
dividends of $0.7 million, net income available to common stockholders was $5.8
million.

Our net income was $3.1 million in the first quarter of 1998. After preferred
dividends of $0.7 million, net income available to common stockholders was $2.5
million.

EARNINGS PER SHARE

Average diluted common shares outstanding were 10.9 million in the first quarter
of 1999 compared to 11.4 million in the fourth quarter of 1998 and 14.2 million
in the first quarter of 1998. Diluted earnings per share were $0.54 in the first
quarter of 1999, $0.51 in the fourth quarter of 1998, and $0.17 in the first
quarter of 1998.

Shares outstanding declined as a result of our common stock repurchase program.

DIVIDENDS

We paid no common stock dividends for the first quarter of 1999 and the fourth
quarter of 1998. We paid a first quarter 1998 common stock dividend of $0.27 per
share.

Under the minimum REIT dividend distribution rules, we were not required to
declare a common stock dividend in the fourth quarter of 1998 or the first
quarter of 1999. While we had more than ample liquidity and balance sheet
strength to pay a dividend in those quarters, we chose to retain our capital for
use in our operations and our common stock repurchase program.

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RISK MANAGEMENT

MARKET VALUE RISK

The market value of our assets can fluctuate due to changes in interest rates,
prepayment rates, liquidity, financing, supply and demand, credit and other
factors. These fluctuations affect our earnings.

At March 31, 1999, we, including Sequoia, owned mortgage securities and loans
totaling $1.3 billion that we account for on a mark-to-market basis or, in the
case of mortgage loans, on a lower-of-cost-or-market basis. Of these assets, 87%
had adjustable-rate coupons and 13% were hybrid mortgage assets with initial
fixed-rate coupons.

Our interest rate agreements hedging program may offset some asset market value
fluctuations due to interest rate changes. All of our $4 billion in notional
amounts of interest rate agreements are marked-to-market for income statement
purposes.

INTEREST RATE RISK

At March 31, 1999, we, including Sequoia, owned $2.4 billion adjustable-rate
assets and had $2.2 billion adjustable-rate liabilities.

Hybrid mortgage assets, with fixed-rate coupons for 3 to 7 years and
adjustable-rate coupons thereafter, totaled $512 million. Debt that had interest
rate reset characteristics matched to these hybrid mortgages totaled $474
million.

Fixed-rate assets, including U.S. Treasuries, were $68 million; there were no
fixed-rate liabilities.

We owned interest rate agreements with a notional face of $4 billion.

On average, our cost of funds had the ability to rise or fall more quickly as a
result of changes in short-term interest rates than did the earning rate on the
assets. The risk of reduced earnings in a rising interest rate environment is
mitigated to some extent by our interest rate agreements hedging program.

At March 31, 1999, we owned $2.4 billion of adjustable-rate mortgages with
interest rates that adjust every one, six or twelve months off of interest rates
of the same maturity. A majority of our debt has an interest expense that
adjusts monthly off of one-month interest rates. As a result, our net income may
vary somewhat as the yield curve between one-month interest rates and six and
twelve-month interest rates varies.

Adjustable-rate assets with earnings rates dependent on U.S. Treasury rates
totaled $0.7 billion at March 31, 1999. Liabilities with a cost of funds
dependent on U.S. Treasury rates totaled $0.4 billion at that time. As part of
our hedging program, we also had $0.3 billion notional amount of basis swaps
that, in effect, increased the Company's U.S. Treasury-based liabilities to $0.7
billion. At March 31, 1999, we had little earnings risk with respect to the risk
of U.S. Treasury rates deviating from LIBOR market rates.

Changes in interest rates affect prepayment rates (see below) and influence
other factors that may have an effect on our results.

LIQUIDITY RISK

Our primary liquidity risk arises from financing long-term mortgage assets with
short-term debt. Even if the interest rate adjustments of these assets and
liabilities are well matched, maturities may not be matched.

The assets that we pledge to secure short-term borrowings are high-quality,
liquid assets. As a result, we have not had difficulty refinancing our
short-term debt as it matures, even during the financial market liquidity crisis
of the fourth quarter of 1998. Still, changes in the market values of our
assets, in the perceived credit worthiness of the Company, and in the capital
markets, can impact our access to liquidity. We cannot give assurances that we
will always be able to refinance our short-term debt.

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At March 31, 1999, we had $105 million of highly liquid assets which were
unpledged and available to meet margin calls on short-term debt that could be
caused by asset value declines or changes in lender over-collateralization
requirements. These assets consisted of unrestricted cash and unpledged "AAA"
rated mortgage securities. Total available liquidity equaled 10% of our
short-term debt balances.

In the first quarter of 1999, we entered into several short-term borrowing
commitments with maturities beyond December 31, 1999 in order to secure
financing now during the period at the beginning of the year 2000 for a portion
of our assets.

PREPAYMENT RISK

As we receive repayments of mortgage principal, we amortize into income our
mortgage premium balances as an expense and our mortgage discount balances as
income. Mortgage premium balances arise when we acquire mortgage assets at a
price in excess of the principal value of the mortgages, or when an asset
appreciates and is marked-to-market at a price above par. Mortgage discount
balances arise when we acquire mortgage assets at a price below the principal
value of the mortgages, or when an asset depreciates and is marked-to-market at
a price below par. At March 31, 1999, mortgage premium balances were $28 million
and mortgage discount balances were $10 million. Net mortgage premium was $18
million.

Sequoia's long-term debt had associated deferred bond issuance costs, which are
amortized as an expense as the bonds are paid off with mortgage principal
receipts. These deferred costs totaled $3 million at March 31, 1999. In
addition, premium received upon bond issuance at prices over principal value is
amortized as income as the bond issues pay down. These balances totaled $5
million at March 31, 1999. The combined effect of these two items was to reduce
our effective mortgage-related premium by $2 million.

Our net premium at March 31, 1999 for assets and liabilities affected by the
rate of mortgage principal receipts was $16 million. This net premium equaled
7.5% of total common equity. Amortization expense and income will vary as
prepayment rates on mortgage assets vary. In addition, changes in prepayment
rates will effect the market value of our assets and our earnings. Changes in
the value of our assets, to the extent they are incorporated into the basis of
our assets, will also affect future amortization expense.

CREDIT RISK

Our principal credit risk comes from loans owned by Sequoia, loans held in
portfolio, and our SMFC 97-A securities. We also have credit risk with
counter-parties with whom we do business; to the extent they fail to perform as
agreed, our results could fluctuate.

We, not including Sequoia, owned $28 million in residential loans at March 31,
1999. Of these, $1.1 million were seriously delinquent.

We also owned $3 million in commercial loans. These commercial loans were all
current at March 31, 1999.

The three Sequoia trusts owned $1.2 billion in residential mortgage loans at
March 31, 1999. Our total credit risk from these trusts is limited to our equity
investment in these trusts. These equity investments had a reported value of $40
million. At year-end, $4.9 million of the underlying loans, or 0.41%, were
seriously delinquent.

At March 31, 1999, we had $4.1 million loan credit reserves and $1.9 million
loan mark-to-market credit reserves to provide for potential future credit
losses from Redwood Trust and Sequoia mortgage loans. Total mortgage loan
credit-related reserves were $6.0 million and total seriously delinquent loans
were $6.0 million.

To date, we have lost an average of 8% of the loan balance of defaulted loans.
Loss severity may increase, particularly if real estate values decline.

At March 31, 1999, we also had $1.1 million credit reserves for our SMFC 97-A
mortgage securities. Our total potential credit exposure from these securities
after this credit reserve was $8 million. We currently believe this reserve is
likely to be sufficient to cover currently anticipated SMFC 97-A credit losses.

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CAPITAL RISK

Our capital levels, and thus our access to borrowings and liquidity, may be
tested, particularly if the market value of our assets securing short-term
borrowings declines.

Through our risk-adjusted capital policy, we assign a guideline capital adequacy
amount, expressed as a guideline equity-to-assets ratio, to each of our mortgage
assets. For short-term funded assets, this ratio will fluctuate over time, based
on changes in that asset's credit quality, liquidity characteristics, potential
for market value fluctuation, interest rate risk, prepayment risk, and the
over-collateralization requirements for that asset set by our collateralized
short-term lenders. Capital requirements for mortgage equity interests (net
trust assets funded with equity) generally equal our net investment. The sum of
the capital adequacy amounts for all of our mortgage assets is our aggregate
guideline capital adequacy amount.

The total guideline equity-to-assets ratio capital amount has declined over the
last few years as we have eliminated some of the risks of short-term debt
funding through issuing long-term debt. In the most recent quarters, however,
the total guideline has increased, as we have acquired new types of assets such
as commercial loans.

We do not expect that our actual capital levels will always exceed the guideline
amount. We measure all of our mortgage assets funded with short-term debt at
estimated market value for the purpose of making risk-adjusted capital
calculations. If interest rates were to rise in a significant manner, our
capital guideline amount would rise. The potential interest rate risk of our
mortgages would increase, at least on a temporary basis, due to periodic and
life caps and slowing prepayment rates. Our actual capital levels, as determined
for the risk-adjusted capital policy, would likely fall as the market values of
our mortgages, net of mark-to-market gains on hedges, decreased. (Such market
value declines may be temporary as well, as future coupon adjustments on ARMs
may help to restore some of the lost market value.)

In this circumstance, or any other circumstance in which our actual capital
levels decreased below our capital adequacy guideline amount, we would generally
cease the acquisition of new mortgage assets until capital balance was restored
through prepayments, interest rate changes, or other means. In certain cases
prior to a planned equity offering or other circumstances, the Board of
Directors has authorized management to acquire mortgage assets in a limited
amount beyond the usual constraints of our risk-adjusted capital policy.

Growth in assets and earnings may be limited when our access to new equity
capital is limited. Holdings can benefit over time from the re-investment of any
retained earnings at Holdings. Our REIT operations, however, are generally
required to distribute at least 95% of taxable income as dividends.

INFLATION RISK

Virtually all of our assets and liabilities are financial in nature. As a
result, interest rates, 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 Generally Accepted
Accounting Principles and our dividends are generally determined based on our
REIT net income as calculated for tax purposes. In each case, our activities and
balance sheet are measured with reference to historical cost or fair market
value without considering inflation.

YEAR 2000 READINESS DISCLOSURE

In 1998, we established a Year 2000 Project. The goal of this on-going project
is to ensure that our communications, data and information systems are ready for
the Year 2000 and to employ prudent management to minimize any potential
negative impact of the Year 2000 on our business partners and our investors.
Senior management has taken an active role in the Year 2000 Project and provides
updates to the Board of Directors as necessary.

Our definition of "Readiness for the Year 2000" includes testing 100% of our
internal systems (hardware and software) to ensure that Year 2000 dates are
retained and correctly roll from December 31, 1999 to January 1,

40
<PAGE> 41

2000 and from February 28, to February 29, to March 1, 2000. It also includes
having an enterprise-wide contingency and disaster recovery plan for any known
Year 2000 issues (and to the extent possible, other unforeseeable
circumstances).

Our project management strategies include system risk assessment, system
upgrades or workarounds, and contingency planning. We believe we are devoting
the necessary resources to address all appropriate Year 2000 issues. We do not
currently anticipate incurring costs related to the Year 2000 issue that would
be material to our financial position, results of operations, or cash flows in
future periods.

We commenced operations within the past five years and have built our internal
systems on a client-server model. Thus, we are not aware of any internal
"legacy" computer systems or software issues.

In the third quarter of 1998, internal computer systems were successfully
tested. Hardware testing included forward date testing of the December 31, 1999
to January 1, 2000 rollover and leap year 2000. Critical software applications
used to manage our businesses were also successfully tested.

As systems are modified or new hardware or software systems are implemented in
the normal course of business, our policy is to receive certification of Year
2000 compliance and to test for Year 2000 compliance upon installation.

We continue to gather and assess information of our business partners' Year 2000
readiness. We will monitor public disclosures by key business partners into the
New Year and solicit disclosures directly through our own Year 2000
questionnaire and subsequent discussions. Direct data collection should be
substantially completed by June 30, 1999.

Business partners that provide information or services through externally
controlled or externally coordinated systems have been identified. Joint testing
of certain systems has been initiated. External joint testing is targeted for
completion by September 30, 1999.

Our affiliates and we are developing contingency plans and workaround systems
for critical systems. Workarounds may include substituting compliant business
partners for those who are non-compliant. The benefit of this contingency plan
is likely to be limited due to our lack of control on external vendors and
inability to replace certain business partners efficiently.

We believe we are devoting the necessary technical and management resources to
address the Year 2000 issues over which we have control. While it is inherently
difficult to assess the impact our vendors and their vendors may have on us in
the event they are unable to successfully manage their own year 2000 issues, we
believe we are on plan to reach our Year 2000 Project goals by October 1999.

RWT HOLDINGS, INC.

RWT Holdings, Inc., or "Holdings" was incorporated in Delaware in February 1998
and commenced operations on April 1, 1998. Holdings' start-up operations have
been funded primarily by Redwood Trust, which has a significant investment in
Holdings through the ownership of all of Holdings' preferred stock. Redwood
Trust, however, does not control Holdings. We refer you to "Note 1. The Company"
in the Notes to the Consolidated Financial Statements of RWT Holdings, Inc. and
Subsidiaries for additional information on Holdings' initial capitalization.

Holdings will conduct mortgage production operations - originating, acquiring,
aggregating and reselling mortgage loans - through three wholly-owned
subsidiaries: Redwood Financial Services, Inc., Redwood Residential Funding,
Inc., and Redwood Commercial Funding, Inc.

Redwood Financial Services, Inc., or "RFS", provides asset and liability
management and portfolio evaluation services to commercial banks and other large
holders of seasoned mortgage loan portfolios and seeks to acquire or

41
<PAGE> 42
assist in the sale or securitization of portions of such portfolios. RFS also
seeks to provide other transaction services to its customers including sales of
mortgage loans and other assets to them to meet their investment needs.

Redwood Residential Funding, Inc., or "RRF", will acquire newly originated
residential loans from mortgage bankers. It will establish correspondent loan
purchase operations and add value to its lender group through consistent and low
cost execution, risk-based pricing, and other technology oriented, value added
services. It will sell its loans to its investor clients as tailored loan
portfolios or as structured mortgage securities.

Redwood Commercial Funding, Inc., or "RCF", acquires, originates and services
commercial mortgage loans typically ranging in size from $0.5 million to $5.0
million. Loans are made to credit-worthy borrowers on a variety of commercial
property types. These loans will be sold to investor clients, typically banks
and savings and loan institutions.

At March 31, 1999, Holdings owned $25.4 million of residential mortgage loans,
$8.3 million of commercial mortgage loans, and $52.4 million of residential
mortgage securities. Holdings also had $10.6 million in cash and $3.1 million in
other assets for total assets of $99.7 million. Holdings had a commitment to
acquire $3 million of commercial loans from Redwood Trust in the second quarter
of 1999.

The loans owned by Holdings were funded with short-term borrowings and equity.
Short-term debt was $72.3 million, loans from Redwood Trust were $13.7 million,
and other liabilities totaled $0.9 million. Total equity at March 31, 1999 was
$12.8 million, reflecting the $20.0 million of initial capital less the $7.2
million in net start-up expenses incurred through the first quarter of 1999.

In the first quarter of 1999, net operating revenue totaled $0.8 million,
including interest income of $0.6 million, net asset appreciation income of $0.5
million, and interest expenses of $0.3 million.

Operating expenses at Holdings totaled $3.3 million in the first quarter of
1999. Holdings' net loss in the first quarter of 1999 was $2.5 million.

Holdings pre-tax loss as reported for GAAP currently equals its after-tax loss.
Due to the start-up nature of its operations, Holdings is not able to accrue a
tax benefit relating to its operating losses for GAAP at this time. Each of the
Holdings' operations is still in start-up mode. Holdings currently expects these
operations to become profitable in the aggregate during 1999.

In the fourth quarter of 1998, Holdings generated $0.2 million of net operating
revenue and had $2.7 million in operating expenses, resulting in a net loss of
$2.5 million. Income and expenses increased in the first quarter of 1999 due to
increased activity at the Holdings' entities as they continue to build up their
businesses.

Holdings' operations began as of mid-1998 and thus there were no operations in
the first quarter of 1998.

42
<PAGE> 43
PART II OTHER INFORMATION

Item 1. Legal Proceedings

At March 31, 1999 there were no pending legal proceedings to which the
Company as a party or of which any of its property was subject.

Item 2. Changes in Securities

Not applicable

Item 3. Defaults Upon Senior Securities

Not applicable

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable

Item 5. Other Information

None

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits
Exhibit 11.1 to Part I - Computation of Earnings Per Share for
the three months ended March 31, 1999 and March 31, 1998.

Exhibit 27 - Financial Data Schedule

(b) Reports
None

43
<PAGE> 44
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.

Dated: May 12, 1999 By: /s/ Douglas B. Hansen
------------------------------------
Douglas B. Hansen
President
(authorized officer of registrant)

Dated: May 12, 1999 By: /s/ Vickie L. Rath
------------------------------------
Vickie L. Rath
Vice President and Treasurer
(principal accounting officer)

<PAGE> 45
REDWOOD TRUST, INC.
INDEX TO EXHIBIT

<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Page
- ------- ------------
<S> <C>
11.1 Computation of Earnings per Share .................. 46
27 Financial Data Schedule ............................ 47
</TABLE>

<PAGE> 1
EXHIBIT 11.1

REDWOOD TRUST, INC.
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS

<TABLE>
<CAPTION>
Three Months Three Months
Ended Ended
March 31, 1999 March 31, 1998
-------------- --------------
<S> <C> <C>
Basic:
Average common shares outstanding 10,778,159 14,123,951
----------- -----------
Total 10,778,159 14,123,951
=========== ===========
Net Income $ 5,854,817 $ 2,450,383
=========== ===========
Per Share Amount $ 0.54 $ 0.17
=========== ===========

DILUTED:
Average common shares outstanding 10,778,159 14,123,951
Net effect of dilutive stock options outstanding
during the period -- based on the treasury stock method 83,615 110,474
----------- -----------
Total 10,861,774 14,234,425
=========== ===========
Net Income $ 5,854,817 $ 2,450,383
=========== ===========
Per Share Amount $ 0.54 $ 0.17
=========== ===========
</TABLE>

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM MARCH 31,
1999 QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENT.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 52,129
<SECURITIES> 2,359,993
<RECEIVABLES> 15,412
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,456,974
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 2,456,974
<CURRENT-LIABILITIES> 1,039,337
<BONDS> 1,171,141
0
26,736
<COMMON> 263,280
<OTHER-SE> (45,818)
<TOTAL-LIABILITY-AND-EQUITY> 2,456,974
<SALES> 0
<TOTAL-REVENUES> 41,731
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 3,523
<LOSS-PROVISION> 345
<INTEREST-EXPENSE> 33,491
<INCOME-PRETAX> 5,854
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,854
<EPS-PRIMARY> 0.54
<EPS-DILUTED> 0.54

</TABLE>