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:  JUNE 30, 2009





OR





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


EXCHANGE
ACT OF 1934





FOR THE
TRANSITION PERIOD FROM _______________ TO _________________





COMMISSION
FILE NUMBER:  1-13447





CHIMERA
INVESTMENT CORPORATION


(Exact
name of Registrant as specified in its Charter)




MARYLAND
                26-0630461(State
      or other jurisdiction of incorporation or organization)
                (IRS
      Employer Identification
No.)




1211
AVENUE OF THE AMERICAS, SUITE 2902
 NEW YORK,
NEW YORK
 (Address
of principal executive offices)
 
 10036
 (Zip
Code)
 
 (646)
454-3759
 (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 þ No o
 
 Indicate
by check mark whether the Registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files).
 Yes o  No o
 
 Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, non-accelerated filer, or a smaller reporting company. See
definition of “accelerated filer,” “large accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
 
 Large
accelerated filer þAccelerated filer o Non-accelerated
filer o
 Smaller reporting company o
 
 Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
 
 Yes o No þ
 
 APPLICABLE
ONLY TO CORPORATE ISSUERS:
 
 Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the last practicable date:
  Class
                      
                      Outstanding
      at August 7, 2009Common
      Stock, $.01 par value
                      
                      670,324,854







CHIMERA
INVESTMENT CORPORATION


FORM
10-Q


TABLE
OF CONTENTS





Part I.     FINANCIAL INFORMATIONItem 1.  Consolidated Financial
      Statements:Consolidated Statements of Financial Condition
      at June 30, 2009 (Unaudited) and December 31, 2008
                    (Derived from the audited consolidated
      statement of financial condition at December 31, 2008)
                  1Consolidated Statements of Operations and
      Comprehensive Income (Loss) for the Quarters and Six
      Months
                    ended June 30, 2009 and 2008
      (Unaudited)
                  2Consolidated Statement of Stockholders’ Equity
      for the Six Months ended June 30, 2009 (Unaudited)
                  3Consolidated Statements of Cash Flows for the Six Months
      ended June 30, 2009 and 2008 (Unaudited)
                  4Notes to Consolidated Financial Statements
      (Unaudited)
                  5Item 2. Management’s Discussion and Analysis of
      Financial Condition and Results of Operations
                  22Item 3. Quantitative and Qualitative Disclosures about
      Market Risk
                  50Item 4. Controls and Procedures
                  54Part II.     OTHER
      INFORMATIONItem 1. Legal Proceedings
                  56Item 1A. Risk Factors
                  56Item 4. Submission of Matters to a Vote of Security
      Holders
                  57Item 6. Exhibits
                  58SIGNATURES
                  59CERTIFICATIONS
                  60







PART I.


ITEM 1.     CONSOLIDATED FINANCIAL
STATEMENTS





CHIMERA INVESTMENT CORPORATION


CONSOLIDATED
STATEMENTS OF FINANCIAL CONDITION


(dollars
in thousands, except share and per share data)




June
      30, 2009
                      
                      
                      December
      31,
                        2008(Unaudited)
                      
                      
                      
                      (1
                      )Assets:Cash
      and cash equivalents
                      
                      $
                      13,121
                      
                      
                      $
                      27,480Non-Agency
      Mortgage-Backed Securities, at fair value
                      
                      
                      1,746,543
                      
                      
                      
                      613,105Agency
      Mortgage-Backed Securities, at fair value
                      
                      
                      1,889,550
                      
                      
                      
                      242,362Securitized
      loans held for investment, net of allowance for loan losses
of
                        $3.0
      million and $1.6 million, respectively
                      
                      
                      530,638
                      
                      
                      
                      583,346Accrued
      interest receivable
                      
                      
                      27,055
                      
                      
                      
                      9,951Other
      assets
                      
                      
                      798
                      
                      
                      
                      1,257Total
      assets
                      
                      $
                      4,207,705
                      
                      
                      $
                      1,477,501Liabilities:Repurchase
      agreements
                      
                      $
                      1,377,148
                      
                      
                      $
                      -Repurchase
      agreements with affiliates
                      
                      
                      123,483
                      
                      
                      
                      562,119Securitized
      debt
                      
                      
                      442,782
                      
                      
                      
                      488,743Payable
      for investments purchased
                      
                      
                      270,735
                      
                      
                      
                      -Accrued
      interest payable
                      
                      
                      2,801
                      
                      
                      
                      2,465Dividends
      payable
                      
                      
                      37,705
                      
                      
                      
                      7,040Accounts
      payable and other liabilities
                      
                      
                      487
                      
                      
                      
                      387Investment
      management fees payable to affiliate
                      
                      
                      5,955
                      
                      
                      
                      2,292Total
      liabilities
                      
                      $
                      2,261,096
                      
                      
                      $
                      1,063,046Commitments
      and Contingencies (Note 13)Stockholders’
      Equity:Common
      stock: par value $.01 per share; 1,000,000,000 shares
      authorized,
                        670,325,786
      and 177,198,212 shares issued and outstanding,
                        respectively
                      
                      $
                      6,692
                      
                      
                      $
                      1,760Additional
      paid-in capital
                      
                      
                      2,290,308
                      
                      
                      
                      831,966Accumulated
      other comprehensive loss
                      
                      
                      (220,030
                      )
                      
                      
                      (266,668
                      )Accumulated
      deficit
                      
                      
                      (130,361
                      )
                      
                      
                      (152,603
                      )Total
      stockholders’ equity
                      
                      $
                      1,946,609
                      
                      
                      $
                      414,455Total
      liabilities and stockholders’ equity
                      
                      $
                      4,207,705
                      
                      
                      $
                      1,477,501(1)
      Derived from the audited consolidated statement of financial condition at
      December 31, 2008.See
      notes to consolidated financial statements.




1




CHIMERA INVESTMENT CORPORATION
 CONSOLIDATED
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
 (dollars
in thousands, except share and per share data)
 (Unaudited)
 
 For
      the Quarter Ended June 30,
                  
                  
                  For
      the Six Months Ended June 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Net
      Interest income:Interest
      income
                  
                  $
                  65,077
                  
                  
                  $
                  29,951
                  
                  
                  $
                  93,084
                  
                  
                  $
                  58,145Interest
      expense
                  
                  
                  8,313
                  
                  
                  
                  20,025
                  
                  
                  
                  17,355
                  
                  
                  
                  34,047Net
      interest income
                  
                  
                  56,764
                  
                  
                  
                  9,926
                  
                  
                  
                  75,729
                  
                  
                  
                  24,098Other-than-temporary
      impairments:Total
      other-than-temporary credit
                    impairment
      losses
                  
                  
                  (8,575
                  )
                  
                  
                  -
                  
                  
                  
                  (8,575
                  )
                  
                  
                  -Non-credit
      portion of loss recognized in
                    other
      comprehensive income
                  
                  
                  2,080
                  
                  
                  
                  -
                  
                  
                  
                  2,080
                  
                  
                  
                  -Net
      other-than-temporary impairment
                    lossesincluded
      in income
                  
                  
                  (6,495
                  )
                  
                  
                  -
                  
                  
                  
                  (6,495
                  )
                  
                  
                  -Other
      gains (losses):Unrealized
      gains (losses) on interest rate
                    swaps
                  
                  
                  -
                  
                  
                  
                  25,584
                  
                  
                  
                  -
                  
                  
                  
                  (5,909
                  )Realized
      gains (losses) on sales of
                    investments,
      net
                  
                  
                  9,321
                  
                  
                  
                  1,644
                  
                  
                  
                  12,948
                  
                  
                  
                  (31,174
                  )Realized
      gains on terminations of
                    interest
      rate swaps
                  
                  
                  -
                  
                  
                  
                  123
                  
                  
                  
                  -
                  
                  
                  
                  123Total
      other gains (losses)
                  
                  
                  9,321
                  
                  
                  
                  27,351
                  
                  
                  
                  12,948
                  
                  
                  
                  (36,960
                  )Net
      investment income (expense)
                  
                  
                  59,590
                  
                  
                  
                  37,277
                  
                  
                  
                  82,182
                  
                  
                  
                  (12,862
                  )Other
      expenses:Management
      fee
                  
                  
                  5,955
                  
                  
                  
                  2,228
                  
                  
                  
                  8,539
                  
                  
                  
                  4,455Provision
      for loan losses
                  
                  
                  1,130
                  
                  
                  
                  (15
                  )
                  
                  
                  1,363
                  
                  
                  
                  1,164General
      and administrative expenses
                  
                  
                  861
                  
                  
                  
                  1,167
                  
                  
                  
                  1,766
                  
                  
                  
                  2,555Total
      other expenses
                  
                  
                  7,946
                  
                  
                  
                  3,380
                  
                  
                  
                  11,668
                  
                  
                  
                  8,174Income
      (loss) before income taxes
                  
                  
                  51,644
                  
                  
                  
                  33,897
                  
                  
                  
                  70,514
                  
                  
                  
                  (21,036
                  )Income
      tax
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1
                  
                  
                  
                  3Net
      income (loss)
                  
                  $
                  51,644
                  
                  
                  $
                  33,897
                  
                  
                  $
                  70,513
                  
                  
                  $
                  (21,039
                  )Net
      income (loss) per share – basic and
                    diluted
                  
                  $
                  0.10
                  
                  
                  $
                  0.87
                  
                  
                  $
                  0.21
                  
                  
                  $
                  (0.54
                  )Weighted
      average number of shares
                    outstanding
      – basic and diluted
                  
                  
                  503,110,132
                  
                  
                  
                  38,999,850
                  
                  
                  
                  341,053,858
                  
                  
                  
                  38,995,096Comprehensive
      income (loss):Net
      income (loss)
                  
                  $
                  51,644
                  
                  
                  $
                  33,897
                  
                  
                  $
                  70,513
                  
                  
                  $
                  (21,039
                  )


Other
      comprehensive income (loss):Unrealized
      gain (loss) on available-
                        for-sale
      securities
                      
                      
                      39,501
                      
                      
                      
                      (58,051
                      )
                      
                      
                      53,092
                      
                      
                      
                      (146,308
                      )Reclassification
      adjustment for net losses
                        included
      in net income for other-than-
                        temporary
      impairments
                      
                      
                      6,495
                      
                      
                      
                      -
                      
                      
                      
                      6,495
                      
                      
                      
                      -Reclassification
      adjustment for
                        realized
      (gains) losses included
                        in
      net income
                      
                      
                      (9,321
                      )
                      
                      
                      (1,644
                      )
                      
                      
                      (12,948
                      )
                      
                      
                      31,174Other
      comprehensive income (loss)
                      
                      
                      36,675
                      
                      
                      
                      (59,695
                      )
                      
                      
                      46,639
                      
                      
                      
                      (115,134
                      )Comprehensive
      income (loss)
                      
                      $
                      88,319
                      
                      
                      $
                      (25,798
                      )
                      
                      $
                      117,152
                      
                      
                      $
                      (136,173
                      )See
      notes to consolidated financial statements.


2




CHIMERA INVESTMENT CORPORATION
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ EQUITY
 (dollars
in thousands, except per share data)
 (Unaudited)
 
 Common
                      Stock
      Par
                      Value
                    
                    
                    Additional
                      Paid-in
                      Capital
                    
                    
                    Accumulated
                      Other
                      Compre-
                      hensive
      Loss
                    
                    
                    Accumulated
                      Deficit
                    
                    
                    TotalBalance,
      December 31, 2008
                    
                    $
                    1,760
                    
                    
                    $
                    831,966
                    
                    
                    $
                    (266,668
                    )
                    
                    $
                    (152,603
                    )
                    
                    $
                    414,455Net
      income
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    70,513
                    
                    
                    
                    70,513Other
      comprehensive income
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    46,638
                    
                    
                    
                    -
                    
                    
                    
                    46,638Proceeds
      from common stock
                      offerings
                    
                    
                    4,931
                    
                    
                    
                    1,458,130
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,463,061Proceeds
      from restricted stock
                      grants
                    
                    
                    1
                    
                    
                    
                    212
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    213Common
      dividends declared, $0.14
                      per
      share
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (48,271
                    )
                    
                    
                    (48,271
                    )Balance,
      June 30, 2009
                    
                    $
                    6,692
                    
                    
                    $
                    2,290,308
                    
                    
                    $
                    (220,030
                    )
                    
                    $
                    (130,361
                    )
                    
                    $
                    1,946,609See
      notes to consolidated financial statements.




3


CHIMERA INVESTMENT CORPORATION


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(dollars
in thousands)


(Unaudited)





For
      the Six Months
                  Ended
      June 30,2009
                
                
                2008Cash
      Flows From Operating Activities:Net
      income (loss)
                
                $
                70,513
                
                
                $
                (21,039
                )Adjustments
      to reconcile net income (loss) to net cash provided by
      operating
                  activities:Accretion
      of investment discounts
                
                
                (14,863
                )
                
                
                (933
                )Unrealized
      (gain) loss on interest rate swaps
                
                
                -
                
                
                
                5,909Realized
      (gain) loss on sale of investments
                
                
                (12,948
                )
                
                
                31,174Other-than-temporary
      credit impairments
                
                
                6,495
                
                
                
                -Provision
      for loan losses
                
                
                1,363
                
                
                
                1,164Restricted
      stock grants
                
                
                212
                
                
                
                1,035Changes
      in operating assets:(Increase)
      decrease in accrued interest receivable
                
                
                (17,104
                )
                
                
                (5,526
                )Decrease
      (increase) in other assets
                
                
                459
                
                
                
                (1,085
                )Changes
      in operating liabilities:Increase
      in accounts payable and other liabilities
                
                
                2,683
                
                
                
                799Increase
      in investment management fee payable to affiliate
                
                
                1,080
                
                
                
                1,012Increase
      in accrued interest payable
                
                
                336
                
                
                
                3,103Net
      cash provided by operating activities
                
                $
                38,226
                
                
                $
                15,613Cash
      Flows From Investing Activities:Mortgage-Backed
      securities portfolio:Purchases
                
                $
                (3,202,744
                )
                
                $
                (1,228,572
                )Sales
                
                
                633,027
                
                
                
                248,014Principal
      payments
                
                
                130,072
                
                
                
                103,112Loans
      held for investment portfolio:Purchases
                
                
                -
                
                
                
                (588,411
                )Sales
                
                
                -
                
                
                
                90,733Principal
      payments
                
                
                -
                
                
                
                21,943Securitized
      loans:Principal
      payments
                
                
                50,752
                
                
                
                12,656Reverse
      repurchase agreements
                
                
                -
                
                
                
                265,000Restricted
      cash
                
                
                -
                
                
                
                (28,157
                )Net
      cash used in investing  activities
                
                $
                (2,388,893
                )
                
                $
                (1,103,682
                )Cash
      Flows From Financing Activities:Proceeds
      from repurchase agreements
                
                $
                44,457,324
                
                
                $
                18,613,326Payments
      on repurchase agreements
                
                
                (43,518,812
                )
                
                
                (17,974,821
                )Net
      proceeds from common stock offerings
                
                
                1,463,061
                
                
                
                (216
                )Proceeds
      from collateralized mortgage debt borrowings
                
                
                -
                
                
                
                515,903Payments
      on collateralized mortgage debt borrowings
                
                
                (47,659
                )
                
                
                (11,504
                )Dividends
      paid
                
                
                (17,606
                )
                
                
                (10,756
                )Net
      cash provided by (used in) financing activities
                
                $
                2,336,308
                
                
                $
                1,131,932Net
      increase (decrease) in cash and cash equivalents
                
                $
                (14,359
                )
                
                $
                43,863Cash
      and cash equivalents at beginning of period
                
                
                27,480
                
                
                
                6,026Cash
      and cash equivalents at end of period
                
                $
                13,121
                
                
                $
                49,889Supplemental
      disclosure of cash flow information:Interest
      paid
                
                $
                17,020
                
                
                $
                30,944Taxes
      paid
                
                $
                -
                
                
                $
                45Non
      cash investing activities:Payable
      for investments purchased
                
                $
                270,735
                
                
                $
                146,824Net
      change in unrealized gain (loss) on available–for-sale
      securities
                
                $
                46,639
                
                
                $
                (115,134
                )Non
      cash financing activities:Common
      dividends declared, not yet paid
                
                $
                37,705
                
                
                $
                6,044


See notes
to consolidated financial statements.




4


CHIMERA INVESTMENT CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE QUARTER ENDED JUNE 30, 2009
 (Unaudited)








1. Organization





Chimera
Investment Corporation (“Company”) was organized in Maryland on June 1,
2007.  The Company commenced operations on November 21, 2007 when it
completed its initial public offering.  The Company has elected to be
taxed as a real estate investment trust (“REIT”), under the Internal Revenue
Code of 1986, as amended.  As long as the Company qualifies as a REIT,
the Company will generally not be subject to U.S. federal or state corporate
taxes on its income to the extent that the Company distributes at least 90% of
its taxable net income to its stockholders.  In July 2008, the Company
formed Chimera Securities Holdings, LLC, a wholly-owned
subsidiary.  In June 2009, the Company formed Chimera Asset Holding,
LLC and Chimera Holding, LLC, both wholly-owned subsidiaries.  Chimera
Securities Holdings, LLC, Chimera Asset Holding, LLC and Chimera Holding, LLC
are qualified REIT subsidiaries.  Annaly Capital Management, Inc.
(“Annaly”) owns approximately 6.7% of the Company’s common
shares.  The Company is managed by Fixed Income Discount Advisory
Company (“FIDAC”), an investment advisor registered with the Securities and
Exchange Commission (“SEC”).  FIDAC is a wholly-owned subsidiary of
Annaly.





2.  Summary
of the Significant Accounting Policies





(a)
Basis of Presentation


The
accompanying unaudited consolidated financial statements have been prepared in
conformity with the instructions to Form 10-Q and Article 10, Rule 10-01 of
Regulation S-X for interim financial statements.  Accordingly, they
may not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America (“GAAP”). The
consolidated interim financial statements are unaudited; however, in the opinion
of the Company's management, all adjustments, consisting only of normal
recurring accruals, necessary for a fair presentation of the financial position,
results of operations, and cash flows have been included.   These
unaudited consolidated financial statements should be read in conjunction with
the audited consolidated financial statements included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2008. The nature of the
Company's business is such that the results of any interim period are not
necessarily indicative of results for a full year.  The consolidated
interim financial statements include the accounts of the Company and its
wholly-owned subsidiaries, Chimera Securities Holdings, LLC, Chimera Asset
Holding, LLC and Chimera Holding, LLC.  All intercompany balances and
transactions have been eliminated.





(b)
Cash and Cash Equivalents


Cash and
cash equivalents include cash on hand and money market funds with original
maturities less than 90 days.





(c)
Non-Agency and Agency Residential Mortgage-Backed Securities


The
Company invests in residential mortgage-backed securities (“RMBS”) representing
interests in obligations backed by pools of mortgage
loans.   Statement of Financial Accounting Standards (“SFAS”) No.
115, Accounting for Certain
Investments in Debt and Equity Securities(“SFAS 115”), requires
the Company to classify its investment securities as either “trading”,
“available-for-sale,” or “held-to-maturity.” The Company holds its RMBS as
available-for-sale, records investments at estimated fair value as described in
Note 5 of these consolidated financial statements, and unrealized gains and
losses are included in other comprehensive income in the consolidated statement
of operations and comprehensive income (loss).  From time to time, as
part of the overall management of its portfolio, the Company may sell any of its
RMBS investments and recognize a realized gain or loss as a component of
earnings in the consolidated statement of operations and comprehensive income
(loss) utilizing the specific identification method.


5


Interest
income on RMBS is computed on the remaining principal balance of the
investment security.  Premiums or discounts on investment securities
that are guaranteed as to principal and/or interest repayment as is with
agencies of the U.S. Government or federally chartered corporations such as
Ginnie Mae, Freddie Mac, or Fannie Mae (“Agency RMBS”) are recognized over the
life of the investment using the effective interest method as described in
SFAS No. 91, Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and
Initial Direct Costs of Leases(“SFAS 91”).  Premiums or
discounts amortization/accretion on non-Agency RMBS is recognized in accordance
with Emerging Issues Task Force (“EITF”) No. 99-20, Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets(“EITF
99-20”), as
amended by Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”)
EITF No. 99-20-1, Amendments
to the Impairment Guidance of EITF Issue No. 99-20(“EITF
99-20-1”).  For non-Agency RMBS, the Company estimates at the time of
purchase expected future cash flows, prepayment speeds, credit losses, loss
severity, and loss timing based on the Company’s observation of available market
data, its experience, and the collective judgment of its management team to
determine the effective interest rate on the RMBS.  Not less than
quarterly, the Company reevaluates, and if necessary, makes adjustments to its
analysis utilizing internal models, external market research and sources in
conjunction with it view on performance in the non-Agency RMBS
sector.  Changes to the Company’s assumptions subsequent to the
purchase date may increase or decrease the amortization/accretion of premiums
and discounts which affects interest income.  Changes to assumptions
that decrease expected future cash flows may result in other-than-temporary
impairment.





Fair value
of RMBS is determined in accordance with SFAS No. 157, Fair Value Measurements(“SFAS 157”), utilizing
a pricing model that incorporates such factors as coupon, prepayment speeds,
weighted average life, collateral composition, borrower characteristics,
expected interest rates, life caps, periodic caps, reset dates, collateral
seasoning, expected losses, expected default severity, credit enhancement, and
other pertinent factors.  The Company validates the fair value
determined by the pricing model with quotes provided by independent dealers
and/or pricing services.  Material differences between the fair values
determined by the Company and third party sources are disclosed in Note 5 of the
consolidated financial statements.





If the
fair value of an investment security is less than its amortized cost at the date
of the consolidated statement of financial condition, the Company analyzes the
investment security for other-than-temporary impairment in accordance
FSP FAS No. 115-2 and FAS No. 124-2 Recognition and Presentation of
Other-Than-Temporary Impairments(“FAS 115-2 and FAS
124-2”), adopted by the Company April 1, 2009 and EITF
99-20-1.  Management evaluates the Company’s RMBS for
other-than-temporary impairment at least on a quarterly basis, and more
frequently when economic or market concerns warrant such
evaluation.  Consideration is given to (1) the length of time and the
extent to which the fair value has been lower than carrying value, (2) the
intent of the Company to sell the investment prior to recovery in fair value (3)
whether the Company will be more likely than not required to sell the investment
before the expected recovery in fair value, (4) and the expected future cash
flows of the investment in relation to its amortized cost.  Unrealized
losses on assets that are considered other-than-temporary impairments are
recognized in income and the cost basis of the assets is adjusted.




(d)
Securitized Loans Held for Investment


The
Company's securitized residential mortgage loans are comprised of fixed-rate and
variable-rate loans.  The Company purchases pools of residential
mortgage loans through a select group of originators.   Mortgage
loans are designated as held for investment, recorded on trade date, and are
carried at their principal balance outstanding, plus any premiums or discounts,
less allowances for loan losses.  Interest income on loans held for
investment is recognized over the life of the investment using the effective
interest method as described by SFAS 91 and EITF 99-20 and amended by EITF
99-20-1.  Income recognition is suspended for loans when, in the
opinion of management, a full recovery of income and principal becomes
doubtful.  Income recognition is resumed when the loan becomes
contractually current and performance is demonstrated to be
resumed.  The Company estimates fair value of securitized loans as
described in Note 5 of these consolidated financial statements.




6


(e)
Allowance for Loan Losses


The
Company has established an allowance for loan losses at a level that management
believes is adequate based on an evaluation of known and inherent risks related
to the Company's loan portfolio.  The estimate is based on a variety
of factors including current economic conditions, industry loss experience,
the loan originator’s loss experience, credit quality trends, loan portfolio
composition, delinquency trends, national and local economic trends, national
unemployment data, changes in housing  appreciation or depreciation
and whether specific geographic areas where the Company has significant loan
concentrations are experiencing adverse economic conditions and events such as
natural disasters that may affect the local economy or property values. Upon
purchase of the pools of loans, the Company obtained written representations and
warranties from the sellers that the Company could be reimbursed for the value
of the loan if the loan fails to meet the agreed upon origination
standards.  While the Company has little history of its own to
establish loan trends, delinquency trends of the originators and the current
market conditions aid in determining the allowance for loan
losses.  The Company also performed due diligence procedures on a
sample of loans that met its criteria during the purchase
process.  The Company has created an unallocated provision for
possible loan losses estimated as a percentage of the remaining principal on the
loans.  Management’s estimate is based on historical experience of
similarly underwritten pools.





When the
Company determines it is probable that specific contractually due amounts are
uncollectible, the amount is considered impaired.  Where impairment is
indicated, a valuation write-off is measured based upon the excess of the
recorded investment over the net fair value of the collateral, reduced by
selling costs.  Any deficiency between the carrying amount of an asset
and the net sales price of repossessed collateral is charged to the allowance
for loan losses.





(f)
Reverse Repurchase Agreements


The
Company may invest its daily available cash balances via reverse repurchase
agreements to provide additional yield on its assets.  These
investments will typically be recorded as short term investments, will mature
daily, and are referred to as reverse repurchase agreements in the consolidated
statement of financial condition.  Reverse repurchase agreements are
recorded at cost and are collateralized by RMBS.




(g)
Repurchase Agreements


The
Company may finance the acquisition of its investment securities through
the use of repurchase agreements. Repurchase agreements are treated as
collateralized financing transactions and are carried at their contractual
amounts, including accrued interest, as specified in the respective
agreements.





(h)
Securitized Debt


The
Company has issued securitized debt to finance a portion of its residential
mortgage loan portfolio.  The securitizations are collateralized by
residential adjustable or fixed rate mortgage loans or RMBS that have been
placed in a trust and pay interest and principal payments to the debt holders of
that securitization.  The Company’s securitizations which are
accounted for as financings under SFAS No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities(“SFAS
140”),are recorded as
an asset called “Securitized loans held for investment” on the consolidated
statement of financial condition and the corresponding debt as “Securitized
debt” in the consolidated statement of financial condition.  The
Company estimates fair value of securitized debt as described in Note 5 to these
consolidated financial statements.





(i)
Fair Value Disclosure


SFAS No.
107, Disclosure About Fair
Value of Financial Instruments(“SFAS 107”), requires disclosure of the
fair value of financial instruments for which it is practicable to estimate that
value.  A complete discussion of the methodology utilized by the
Company to fair value its financial instruments is included in Note 5 to the
consolidated financial statements.





(j)
Derivative Financial Instruments and Hedging Activity


The
Company may hedge interest rate risk through the use of derivative financial
instruments such as interest rate swaps.   If the Company hedges
using interest rate swaps it accounts for these instruments as free-standing
derivatives.  Accordingly, they are carried at fair value with
realized and unrealized gains and losses recognized in earnings.


7


The
Company accounts for derivative financial instruments in accordance with SFAS
No. 133, Accounting for
Derivative Instruments and Hedging Activities (“SFAS 133”), as amended
and interpreted.  SFAS 133 requires an entity to recognize all
derivatives as either assets or liabilities in the consolidated statement of
financial condition and to measure those instruments at fair
value.  Additionally, the fair value adjustments affect either other
comprehensive income in stockholders’ equity until the hedged item is recognized
in earnings or net income depending on whether the derivative instrument
qualifies as a hedge for accounting purposes and, if so, the nature of the
hedging activity.





(k)
Credit Risk


The
Company retains the risk of potential credit losses on all of the non-Agency
residential mortgage loans it owns as well as the residential mortgage loans
which collateralize the RMBS it owns.  The Company attempts to
mitigate the risk of potential credit losses through its diligence in the asset
selection process.





(l)
Mortgage Loan Sales and Securitizations


The
Company periodically enters into transactions in which it sells financial
assets, such as RMBS, mortgage loans and other assets.  It may also
securitize and re-securitize financial assets.  These transactions are
recorded in accordance with SFAS 140 and are accounted for as either a “sale”
and the loans held for investment are removed from the consolidated statements
of financial condition or as a “financing” and are classified as “Securitized
loans held for investment” on the Company’s consolidated statements of financial
condition, depending upon the structure of the securitization
transaction.  In these securitizations and re-securitizations the
Company sometimes retains or acquires senior or subordinated interests in the
securitized or re-securitized assets.  Gains and losses on such
securitizations or re-securitizations are recognized using the guidance in SFAS
140 which is based on a financial components approach that focuses on
control.  Under this approach, after a transfer of financial assets,
an entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished.




The
Company determines the gain or loss on sale of mortgage loans by allocating the
carrying value of the underlying mortgage loans between securities or loans sold
and the interests retained based on their fair values, calculated as disclosed
in Note 5 to these financial statements.  The gain or loss on sale is
the difference between the cash proceeds from the sale and the amount allocated
to the securities or loans sold.




(m)
Income Taxes


The
Company qualifies to be taxed as a REIT, and therefore it generally will not be
subject to corporate federal or state income tax to the extent that qualifying
distributions are made to stockholders and the REIT requirements, including
certain asset, income, distribution and stock ownership tests are
met.  If the Company failed to qualify as a REIT and did not qualify
for certain statutory relief provisions, the Company would be subject to
federal, state and local income taxes and may be precluded from qualifying as a
REIT for the subsequent four taxable years following the year in which the REIT
qualification was lost.





The
Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes
(“SFAS 109”), which requires the recognition of deferred income taxes for
differences between the basis of assets and liabilities for financial statement
and income tax purposes.  Deferred tax assets and liabilities
represent the future tax consequence for those differences, which will either be
taxable or deductible when the assets and liabilities are recovered or
settled.  Deferred taxes are also recognized for operating losses that
are available to offset future taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized. In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes, an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48
clarifies the accounting for uncertainty in income taxes recognized in a
company’s financial statements and prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of
a tax position taken or expected to be taken in an income tax return. FIN
48 also provides guidance on de-recognition, classification, interest and
penalties, accounting in interim periods, disclosure
and transition.  FIN 48 was effective for the Company upon
inception and its effect continues to not be material.




8


(n)
Net Income (Loss) per Share


The
Company calculates basic net income (loss) per share by dividing net income
(loss) for the period by the weighted-average shares of its common stock
outstanding for that period.  Diluted net income (loss) per share
takes into account the effect of dilutive instruments, such as stock options,
but uses the average share price for the period in determining the number of
incremental shares that are to be added to the weighted average number of
shares outstanding.  The Company had no potentially dilutive
securities outstanding during the periods presented.





(o)
Stock-Based Compensation


The
Company accounts for stock-based compensation in accordance with the provisions
of SFAS No. 123R, Accounting
for Stock-Based Compensation (“SFAS 123R”), which establishes accounting
and disclosure requirements using fair value based methods of accounting for
stock-based compensation plans. Compensation expense related to grants of stock
and stock options is recognized over the vesting period of such grants based on
the estimated fair value on the grant date.





Stock
compensation awards granted by the Company to the employees of FIDAC are
accounted for in accordance with EITF No. 96-18, Accountingfor Equity Instruments That Are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods and Services(“EITF 96-18”), which
requires the Company to measure the fair value of the equity instrument using
the stock prices and other measurement assumptions as of the earlier of either
the date at which a performance commitment by the counterparty is reached or the
date at which the counterparty's performance is complete.





(p)
Use of Estimates


The
preparation of the financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.





(q)
Recent Accounting Pronouncements


In
February 2008 FASB issued FSP SFAS No. 140-3, Accounting for Transfers of
Financial Assets and Repurchase Financing Transactions, (“SFAS
140-3”).  SFAS 140-3 addresses whether transactions where assets
purchased from a particular counterparty and financed through a repurchase
agreement with the same counterparty can be considered and accounted for as
separate transactions, or are required to be considered “linked” transactions
and may be considered derivatives under SFAS 133.  SFAS 140-3 requires
purchases and subsequent financing through repurchase agreements be considered
linked transactions unless all of the following conditions apply:  (1)
the initial purchase and the use of repurchase agreements to finance the
purchase are not contractually contingent upon each other; (2) the repurchase
financing entered into between the parties provides full  recourse to
the transferee and the repurchase price is fixed; (3) the financial assets are
readily obtainable in the market; and (4) the financial instrument and the
repurchase agreement are not coterminous.  This FSP was effective for
the Company as of January 1, 2009.  The Company meets the requirements
of this FSP to treat repurchase financings as non-linked transactions and this
FSP has no effect on financial reporting.





In May
2009, the FASB issued SFAS No. 165, Subsequent Events ("SFAS
165").  SFAS 165 establishes general standards governing accounting for and
disclosure of events that occur after the balance sheet date but before the
financial statements are issued or are available to be issued.  SFAS 165
also provides guidance on the period after the balance sheet date during which
management of a reporting entity should evaluate events or transactions that may
occur for potential recognition or disclosure in the financial statements, the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements and the
disclosures that an entity should make about events or transactions occurring
after the balance sheet date. The Company adopted SFAS 165 effective June 30,
2009, and adoption had no impact on the Company’s consolidated financial
statements. The Company evaluated subsequent events through the filing date of
this Quarterly Report on Form 10-Q, which is August 10, 2009.


9


In June
2009, the FASB issued SFAS No. 166, Accounting for Transfers of
Financial Assets (“SFAS 166”), which amends the de-recognition guidance
in SFAS 140.  SFAS 166 eliminates the concept of a Qualified Special
Purpose Entity (“QSPE”) and eliminates the exception from applying FASB
Interpretation (“FIN”) No. 46(R), Consolidation of Variable Interest
Entities (“FIN 46R”) to QSPE’s.   Additionally, this Statement
clarifies that the objective of paragraph 9 of SFAS 140 is to determine whether
a transferor has surrendered control over transferred financial assets.  
That determination must consider the transferor’s continuing involvement in the
transferred financial asset, including all arrangements or agreements made
contemporaneously with, or in contemplation of, the transfer, even if they were
not entered into at the time of the transfer.   This Statement modifies the
financial-components approach used in SFAS 140 and limits the circumstances in
which a financial asset, or portion of a financial asset, should be derecognized
when the transferor has not transferred the entire original financial asset to
an entity that is not consolidated with the transferor in the financial
statements being presented and/or when the transferor has continuing involvement
with the transferred financial asset.  It defines the term “participating
interest” to establish specific conditions for reporting a transfer of a portion
of a financial asset as a sale.  Under this statement, when the transfer of
financial assets are accounted for as a sale, the transferor must recognize and
initially measure at fair value all assets obtained and liabilities incurred as
a result of the transfer.  This includes any retained beneficial
interest.  The implementation of this standard materially affects the
securitization process in general, as it eliminates off-balance sheet
transactions when an entity retains any interest in or control over assets
transferred in this process.  However, the Company does not believe the
implementation of this standard will materially affect the Company’s reporting
as it has no off-balance sheet transactions nor any unconsolidated
QSPEs.  This is effective for the Company on January 1,
2010.




In
conjunction with SFAS 166, the FASB issued SFAS No. 167, Amendments to FIN 46R(“SFAS
167”).  This statement requires an enterprise to perform an analysis to
determine whether the enterprise’s variable interest or interests give it a
controlling financial interest in a variable interest entity (“VIE”).  The
analysis identifies the primary beneficiary of a variable interest entity as the
enterprise that has both: a) the power to direct the activities that most
significantly impact the entity’s economic performance and b) the obligation to
absorb losses of the entity or the right to receive benefits from the entity
which could potentially be significant to the VIE.   With the removal
of the QSPE exemption, established QSPE’s must be evaluated for consolidation
under this statement.  This statement requires enhanced disclosures to
provide users of financial statements with more transparent information about
and enterprises involvement in a VIE.  The Company is not, currently, the
primary beneficiary of any unconsolidated VIEs.  Further, this
statement also requires ongoing assessments of whether an enterprise is the
primary beneficiary of a VIE.  Should the Company
treat securitizations or re-securitizations as sales, it will analyze the
transactions under the guidelines of SFAS 167 for consolidation.  This is
effective for the Company on January 1, 2010.  Upon implementation and, as
required by the standard, on an ongoing basis, the Company shall assess the
applicability of this standard to its holdings and report
accordingly.





In June
2009, the FASB issued SFAS No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles(“SFAS 168”).  This is a replacement of SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles(“SFAS 162”).  This Statement identifies
the sources of accounting principles and the framework for selecting the
principles used in the preparation of financial statements of nongovernmental
entities that are presented in conformity with GAAP in the United States (the
GAAP hierarchy).  The objective of this Statement is to establish the
FASB Accounting Standards Codification (“Codification”) as the source of
authoritative accounting principles recognized by the FASB.  After the
effective date of this Statement, all non-grandfathered, non-SEC accounting
literature not included in the Codification is superseded and deemed
non-authoritative.  SFAS 168 revises the framework for selecting the
accounting principles to be used in the preparation of consolidated financial
statements that are presented in conformity with GAAP.  In doing so,
the Codification will require the references within the Company’s consolidated
financial statements be modified.  Additionally, although it is not
the FASB’s intent to alter any guidance, certain modifications in verbiage may,
indeed, require the Company to evaluate whether such modification would need to
be accounted for as an “accounting change” or as a “correction of an error” in
accordance with SFAS No. 154, Accounting Changes and Error
Corrections—a replacement of Accounting Principles Board (“APB”) Opinion No. 20
and FASB Statement No. 3 (“SFAS 154”).  The Company shall
assess the effect of this Standard which is effective for the Company’s interim
and annual financial statements on September 30, 2009.


10


In October
2008, FASB issued FSP FAS 157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active(“FAS
157-3”), in response to the deterioration of the credit markets.  This
FSP provides guidance clarifying how SFAS 157, should be applied when valuing
securities in markets that are not active. The guidance provides an illustrative
example that applies the objectives and framework of SFAS 157, utilizing
management’s internal cash flow and discount rate assumptions when relevant
observable data do not exist.  It further clarifies how observable
market information and market quotes should be considered when measuring fair
value in an inactive market.   It reaffirms the notion of fair
value as an exit price as of the measurement date and that fair value analysis
is a transactional process and should not be broadly applied to a group of
assets.  FAS 157-3 was effective upon issuance including prior periods
for which financial statements have not been issued.  The
implementation of FAS 157-3 did not have a material effect on the fair value of
the Company’s assets as the Company intends to continue the methodologies used
in previous quarters to value assets as defined under the original SFAS
157.





In October
2008 the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed
into law.  Section 133 of the EESA mandated that the SEC conduct a
study on mark-to-market accounting standards.  The SEC provided its
study to the U.S. Congress on December 30, 2008.  Part of the
recommendations within the study indicated that “fair value requirements should
be improved through development of application and best practices guidance for
determining fair value in illiquid or inactive markets”.  As a result
of this study and the recommendations therein, on April 9, 2009, the FASB issued
FSP FAS No. 157-4, Determining
Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderly(“FAS 157-4”).  FAS 157-4 provides additional guidance on
determining fair value when the volume and level of activity for the asset or
liability have significantly decreased when compared with normal market activity
for the asset or liability (or similar assets or liabilities).  FAS
157-4 gives specific factors to evaluate if there has been a decrease in normal
market activity and if so, provides a methodology to analyze transactions or
quoted prices and make necessary adjustments to fair value in accordance with
SFAS 157.  The objective is to determine the point within a range of
fair value estimates that is most representative of fair value under current
market conditions.  FAS 157-4 became effective for the Company on June
30, 2009.  FAS 157-4 had no material impact on the fair valuation of
the investment securities owned by the Company.





Additionally,
in conjunction with FAS 157-4, the FASB issued FAS 115-2 and FAS 124-2.The objective of
the new guidance is to make impairment guidance more operational and to improve
the presentation and disclosure of other-than-temporary impairments (“OTTI”) on
debt and equity securities in financial statements.  This, too, was as
a result of the SEC mark-to-market study mandated under the EESA.  The
SEC’s recommendation was to “evaluate the need for modifications (or the
elimination) of current OTTI guidance to provide for a more uniform system of
impairment testing standards for financial instruments.”  The new
guidance revises the OTTI evaluation methodology.  Previously the
analytical focus was on whether the entity had the “intent and ability to retain
its investment in the debt security for a period of time sufficient to allow for
any anticipated recovery in fair value.”   Now the focus is on
whether the entity has the “intent to sell the debt security or, more likely
than not, will be required to sell the debt security before its anticipated
recovery.”  Further, the security is analyzed for credit loss (the
difference between the present value of cash flows expected to be collected and
the amortized cost basis).  If the company does not intend to sell the
debt security, nor will be required to sell the debt security prior to its
anticipated recovery, the credit loss, if any, will be recognized in the
statement of earnings, while the balance of impairment related to other factors
will be recognized in Other Comprehensive Income (“OCI”).  If the
company intends to sell the security, or will be required to sell the security
before its anticipated recovery, the full OTTI will be recognized in the
statement of earnings.  FAS 115-2 and FAS 124-2 became effective for
the Company on June 30, 2009.  The adoption of these rules did not
result in a cumulative effect adjustment to retained earnings in the period of
adoption but changed the manner that the Company evaluates investment securities
for other-than-temporary impairments.


11


In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133(“SFAS 161”).  SFAS 161 attempts to improve the transparency of
financial reporting by providing additional information about how derivative and
hedging activities affect an entity’s financial position, financial performance
and cash flows.  This statement changes the disclosure requirements
for derivative instruments and hedging activities by requiring enhanced
disclosure about (1) how and why an entity uses derivative instruments, (2) how
derivative instruments and related hedged items are accounted for under SFAS 133
and its related interpretations, and (3) how derivative instruments and related
hedged items affect an entity’s financial position, financial performance, and
cash flows.  To meet these objectives, SFAS 161 requires qualitative
disclosures about objectives and strategies for using derivatives, quantitative
disclosures about fair value amounts of gains and losses on derivative
instruments, and disclosures about credit-risk-related contingent features in
derivative agreements.  This disclosure framework is intended to
better convey the purpose of derivative use in terms of the risks that an entity
is intending to manage.  SFAS 161 was effective and adopted by the
Company on January 1, 2009.   The adoption of SFAS 161will
increase footnote disclosure if the Company engages in hedging
activities.





In January
2009, the FASB issued EITF 99-20-1 in an effort to provide a more consistent
determination on whether other-than-temporary impairment has occurred for
certain beneficial interests in securitized financial
assets.  Other-than-temporary impairment has occurred if there has
been an adverse change in future estimated cash flows and its impact reflected
in current earnings.  The determination cannot be overcome by
management judgment of the probability of collecting all cash flows previously
projected.  For debt securities that are not within the scope of EITF
99-20-1, SFAS 115 continues to apply.  The objective of
other-than-temporary impairment analysis is to determine whether it is probable
that the holder will realize some portion of the unrealized loss on an impaired
security.  Factors to consider when making other-than-temporary
impairment decision include information about past events, current conditions,
reasonable and supportable forecasts, remaining payment terms, financial
condition of the issuer, expected defaults, value of underlying collateral,
industry analysis, sector credit rating, credit enhancement, and financial
condition of guarantor.  The Company’s non-Agency RMBS investments
fall under the guidance of this EITF and as such, the Company assesses each
security for other-than-temporary impairments based on estimated future cash
flows.  This EITF became effective for the Company on December 31,
2008.





In April
2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value
of Financial Instruments ("FAS 107-1 and APB 28-1”).The FSP requires
disclosures about fair value of financial instruments for interim reporting
periods as well as in annual financial statements.   The adoption
of FAS 107-1 and APB 28-1 increased footnote disclosure.  This FSP
became effective for the Company on June 30, 2009.





3. Mortgage-Backed
Securities





The
following table represents the Company’s available-for-sale RMBS portfolio as of
June 30, 2009 and December 31, 2008, at fair value.




June
      30, 2009
                          
                          
                          December
      31, 2008Non-Agency
      RMBS
                          
                          
                          Agency
      RMBS
                          
                          
                          Non-Agency
      RMBS
                          
                          
                          Agency
      RMBS(dollars
      in thousands)Principal
      value
                          
                          $
                          2,947,419
                          
                          
                          $
                          1,827,573
                          
                          
                          $
                          899,456
                          
                          
                          $
                          233,976Unamortized
      premium
                          
                          
                          2,253
                          
                          
                          
                          65,890
                          
                          
                          
                          2,105
                          
                          
                          
                          6,350Unamortized
      discount
                          
                          
                          (987,013
                          )
                          
                          
                          -
                          
                          
                          
                          (19,753
                          )
                          
                          
                          -Gross
      unrealized gain
                          
                          
                          34,560
                          
                          
                          
                          8,306
                          
                          
                          
                          5,665
                          
                          
                          
                          2,036Gross
      unrealized loss
                          
                          
                          (250,676
                          )
                          
                          
                          (12,219
                          )
                          
                          
                          (274,368
                          )
                          
                          
                          -Fair
      value
                          
                          $
                          1,746,543
                          
                          
                          $
                          1,889,550
                          
                          
                          $
                          613,105
                          
                          
                          $
                          242,362




During the
quarter ended June 30, 2009, the Company completed sales of RMBS with a carrying
value of $75.3 million which resulted in a realized gain of approximately $9.3
million. During the quarter ended June 30, 2008 the Company had no sales of
investments.
 12




The
following table presents the gross unrealized losses and estimated fair value of
the Company’s RMBS by length of time that such securities have been in a
continuous unrealized loss position at June 30, 2009 and December 31,
2008.
 
 Unrealized
      Loss Position For:Less
      than 12 Months
                                                                                                              
                                                                                                              
                                                                                                              12
      Months or More
                                                                                                              
                                                                                                              
                                                                                                              TotalEstimated
                                                                                                                Fair
      Value
                                                                                                              
                                                                                                              
                                                                                                              Unrealized
                                                                                                                Losses
                                                                                                              
                                                                                                              
                                                                                                              Estimated
                                                                                                                Fair
      Value
                                                                                                              
                                                                                                              
                                                                                                              Unrealized
                                                                                                                Losses
                                                                                                              
                                                                                                              
                                                                                                              Estimated
                                                                                                                Fair
      Value
                                                                                                              
                                                                                                              
                                                                                                              Unrealized
                                                                                                                Losses(dollars
      in thousands)Non-Agency
      RMBS
                                                                                                              
                                                                                                              $
                                                                                                              671,557
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              (82,411
                                                                                                              )
                                                                                                              
                                                                                                              $
                                                                                                              483,190
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              (168,265
                                                                                                              )
                                                                                                              
                                                                                                              $
                                                                                                              1,154,747
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              (250,676
                                                                                                              )Agency
      RMBS
                                                                                                              
                                                                                                              
                                                                                                              1,103,840
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              (12,219
                                                                                                              )
                                                                                                              
                                                                                                              
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              1,103,840
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              (12,219
                                                                                                              )Total,
      June 30, 2009
                                                                                                              
                                                                                                              $
                                                                                                              1,775,397
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              (94,630
                                                                                                              )
                                                                                                              
                                                                                                              $
                                                                                                              483,190
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              (168,265
                                                                                                              )
                                                                                                              
                                                                                                              $
                                                                                                              2,258,587
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              (262,895
                                                                                                              )Non-Agency
      RMBS
                                                                                                              
                                                                                                              $
                                                                                                              595,112
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              (274,368
                                                                                                              )
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              595,112
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              (274,368
                                                                                                              )Agency
      RMBS
                                                                                                              
                                                                                                              
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              -Total,
      December 31, 2008
                                                                                                              
                                                                                                              $
                                                                                                              595,112
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              (274,368
                                                                                                              )
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              595,112
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              (274,368
                                                                                                              )
 
 The
Company recorded a $6.5 million other-than-temporary impairment during the
quarter on investments where the expected future cash flows of certain
subordinated non-Agency RMBS were less than their amortized cost basis requiring
credit impairment pursuant to EITF 99-20-1.  The OTTI charge was
attributed to eight subordinate securities with an aggregate amortized cost
prior to the impairment of $10.2 million.  Seven of the eight
subordinate securities belong to one non-Agency pool that has recorded no
delinquencies on the assets collateralizing the pool from its
inception.  All securities for which OTTI impairment was recorded
during the period are cash flowing as expected.
 
 Actual
maturities of mortgage-backed securities are generally shorter than stated
contractual maturities.  Actual maturities of the Company’s RMBS are
affected by the contractual lives of the underlying mortgages, periodic payments
of principal and prepayments of principal. The following tables summarize
the Company’s RMBS at June 30, 2009 and December 31, 2008 according to their
estimated weighted-average life classifications:
 
 June
      30, 2009(dollars
      in thousands)Non-Agency
      RMBS
                            
                            
                            Agency
      RMBSWeighted
      Average Life
                            
                            Fair
      Value
                            
                            
                            Amortized
      Cost
                            
                            
                            Fair
      Value
                            
                            
                            Amortized
      CostLess
      than one year
                            
                            $
                            18,224
                            
                            
                            $
                            16,871
                            
                            
                            $
                            -
                            
                            
                            $
                            -Greater
      than one year and less than five years
                            
                            
                            1,037,971
                            
                            
                            
                            1,210,743
                            
                            
                            
                            1,761,731
                            
                            
                            
                            1,765,541Greater
      than five years
                            
                            
                            690,348
                            
                            
                            
                            735,045
                            
                            
                            
                            127,819
                            
                            
                            
                            127,922Total
                            
                            $
                            1,746,543
                            
                            
                            $
                            1,962,659
                            
                            
                            $
                            1,889,550
                            
                            
                            $
                            1,893,463
 
 
 December
      31, 2008(dollars
      in thousands)Non-Agency
      RMBS
                            
                            
                            Agency
      RMBSWeighted
      Average Life
                            
                            Fair
      Value
                            
                            
                            Amortized
      Cost
                            
                            
                            Fair
      Value
                            
                            
                            Amortized
      CostLess
      than one year
                            
                            $
                            -
                            
                            
                            $
                            -
                            
                            
                            $
                            -
                            
                            
                            $
                            -Greater
      than one year and less than five years
                            
                            
                            525,801
                            
                            
                            
                            735,508
                            
                            
                            
                            242,362
                            
                            
                            
                            240,326Greater
      than five years
                            
                            
                            87,304
                            
                            
                            
                            146,300
                            
                            
                            
                            -
                            
                            
                            
                            -Total
                            
                            $
                            613,105
                            
                            
                            $
                            881,808
                            
                            
                            $
                            242,362
                            
                            
                            $
                            240,326
 
 The
weighted-average lives of the mortgage-backed securities at June 30, 2009 and
December 31, 2008 in the tables above are based on data provided through dealer
quotes, assuming constant prepayment rates to the balloon or reset date for each
security.  The prepayment model considers current yield, forward
yield, steepness of the curve, current mortgage rates, mortgage rates of
the outstanding loan, loan age, margin and volatility.
  13




The RMBS
portfolio has the following characteristics at June 30, 2009 and December 31,
2008.
 
 June
      30, 2009
                                
                                
                                December
      31, 2008Non-Agency
                                  RMBS
                                
                                
                                Agency
                                  RMBS
                                
                                
                                Non-Agency
                                  RMBS
                                
                                
                                Agency
                                  RMBsWeighted
      average cost basis
                                
                                
                                66.59
                                
                                
                                
                                103.61
                                
                                
                                
                                98.01
                                
                                
                                
                                102.71Weighted
      average fair value
                                
                                
                                59.26
                                
                                
                                
                                103.39
                                
                                
                                
                                68.16
                                
                                
                                
                                103.58Weighted
      average coupon
                                
                                
                                5.84
                                %
                                
                                
                                5.52
                                %
                                
                                
                                5.97
                                %
                                
                                
                                6.69
                                %Fixed-rate
      % of portfolio
                                
                                
                                20.8
                                %
                                
                                
                                34.5
                                %
                                
                                
                                1.3
                                %
                                
                                
                                13.7
                                %Adjustable-rate
      % of portfolio
                                
                                
                                34.7
                                %
                                
                                
                                -
                                
                                
                                
                                51.2
                                %
                                
                                
                                -Weighted
      average yield on assets at period-end
                                
                                
                                14.85
                                %
                                
                                
                                4.39
                                %
                                
                                
                                6.69
                                %
                                
                                
                                6.00
                                %Weighted
      average cost of funds at period-end
                                
                                
                                1.79
                                %
                                
                                
                                0.49
                                %
                                
                                
                                1.64
                                %
                                
                                
                                0.55
                                %Weighted
      average 3 month CPR at period-end
                                
                                
                                16.0
                                %
                                
                                
                                24.3
                                %
                                
                                
                                12.5
                                %
                                
                                
                                14.5
                                %
 
 The
non-Agency RMBS portfolio is subject to credit risk.  The Company
seeks to mitigate credit risk through its asset selection
process.  The investment securities contained in this portion of the
portfolio have the following collateral characteristics at June 30, 2009 and
December 31, 2008.
  June
      30, 2009
                                                              
                                                              December
      31, 2008Number
      of securities in portfolio
                                                              
                                                              
                                                              
                                                              87
                                                              
                                                              
                                                              
                                                              
                                                              30Weighted
      average loan age in months
                                                              
                                                              
                                                              
                                                              29.7
                                                              
                                                              
                                                              
                                                              
                                                              22.1Weighted
      average amortized loan to value
                                                              
                                                              
                                                              
                                                              73.8
                                                              %
                                                              
                                                              
                                                              
                                                              74.2
                                                              %Weighted
      average FICO
                                                              
                                                              
                                                              
                                                              714.7
                                                              
                                                              
                                                              
                                                              
                                                              717.5Weighted
      average loan balance (in thousands)
                                                              
                                                              
                                                              
                                                              439.4
                                                              
                                                              
                                                              
                                                              
                                                              394.3Weighted
      average % owner occupied
                                                              
                                                              
                                                              
                                                              81.6
                                                              %
                                                              
                                                              
                                                              
                                                              77.8
                                                              %Weighted
      average % single family residence
                                                              
                                                              
                                                              
                                                              61.4
                                                              %
                                                              
                                                              
                                                              
                                                              54.8
                                                              %Weighted
      average current credit enhancement
                                                              
                                                              
                                                              
                                                              16.0
                                                              %
                                                              
                                                              
                                                              
                                                              25.4
                                                              %Weighted
      average geographic concentration
                                                              CA
                                                              
                                                              
                                                              56.4
                                                              %
                                                              CA
                                                              
                                                              
                                                              53.0
                                                              %FL
                                                              
                                                              
                                                              14.4
                                                              %
                                                              FL
                                                              
                                                              
                                                              10.6
                                                              %NY
                                                              
                                                              
                                                              6.3
                                                              %
                                                              AZ
                                                              
                                                              
                                                              8.2
                                                              %AZ
                                                              
                                                              
                                                              5.2
                                                              %
                                                              NV
                                                              
                                                              
                                                              5.6
                                                              %NJ
                                                              
                                                              
                                                              4.1
                                                              %
                                                              NJ
                                                              
                                                              
                                                              4.1
                                                              %
  4.  Securitized
Loans Held for Investment
 
 The
following table represents the Company's securitized residential mortgage loans
classified as held for investment at June 30, 2009 and December 31,
2008.  At June 30, 2009 approximately 56% of the Company’s securitized
loans are adjustable rate mortgage loans and 44% are fixed rate mortgage
loans.  All of the adjustable rate loans held for investment are
hybrid ARMs.  Hybrid ARMs are mortgages that have interest rates that
are fixed for an initial period (typically three, five, seven or ten years) and
thereafter reset at regular intervals subject to interest rate
caps.  The loans held for investment are carried at their principal
balance outstanding less an allowance for loan losses:
 
 June
      30, 2009
                                  
                                  
                                  December
      31, 2008(dollars
      in thousands)Securitized
      mortgage loans, at principal balance
                                  
                                  $
                                  533,623
                                  
                                  
                                  $
                                  584,967Less:  allowance
      for loan losses
                                  
                                  
                                  2,985
                                  
                                  
                                  
                                  1,621Securitized
      mortgage loans held for investment
                                  
                                  $
                                  530,638
                                  
                                  
                                  $
                                  583,346


14




The
following table summarizes the changes in the allowance for loan losses for the
securitized mortgage loan portfolio during the quarter ended June 30, 2009 and
the year ended December 31, 2008:
 
 June
      30, 2009
                                    
                                    
                                    December
      31, 2008(dollars
      in thousands)Balance,
      beginning of period
                                    
                                    $
                                    1,855
                                    
                                    
                                    $
                                    -Provision
      for loan losses
                                    
                                    
                                    1,130
                                    
                                    
                                    
                                    1,621Charge-offs
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Balance,
      end of period
                                    
                                    $
                                    2,985
                                    
                                    
                                    $
                                    1,621
 
 On a
quarterly basis, the Company evaluates the adequacy of its allowance for loan
losses.  The Company’s allowance for loan losses for the quarter
ended June 30, 2009 was $3.0 million, representing 57 basis points of the
principal balance of the Company’s securitized mortgage loan portfolio. The
Company’s allowance for loan losses was $1.6 million for the year ended December
31, 2008, representing 28 basis points of the principal balance of the Company’s
securitized loan portfolio.  At June 30, 2009, 1.05% of the
securitized loans held for investment were greater than 60 days delinquent and
0.49% were in some stage of foreclosure.  As of December 31, 2008,
0.12% of the securitized loans held for investment were greater than 60 days
delinquent and no loans were in foreclosure.
 
 5.  Fair
Value Measurements
 
 SFAS 157
defines fair value, establishes a framework for measuring fair value,
establishes a three-level valuation hierarchy for disclosure of fair value
measurement and enhances disclosure requirements for fair value
measurements.  The valuation hierarchy is based upon the transparency
of inputs to the valuation of an asset or liability as of the measurement
date.  The three levels are defined as follows:
  Level 1 –
inputs to the valuation methodology are quoted prices (unadjusted) for identical
assets and liabilities in active markets.
  Level 2 –
inputs to the valuation methodology include quoted prices for similar assets and
liabilities in active markets, and inputs that are observable for the asset or
liability, either directly or indirectly, for substantially the full term of the
financial instrument.
  Level 3 –
inputs to the valuation methodology are unobservable and significant to fair
value.
  The
following discussion describes the methodologies utilized by the Company to fair
value its financial instruments by instrument class.
  Short-term
Instruments
 The
carrying value of cash and cash equivalents, accrued interest receivable,
dividends payable, accounts payable, and accrued interest payable generally
approximates estimated fair value due to the short term nature of these
financial instruments.
 
 Non-Agency
and Agency RMBS
 The
Company determines the fair value of its investment securities utilizing a
pricing model that incorporates such factors as coupon, prepayment speeds,
weighted average life, collateral composition, borrower characteristics,
expected interest rates, life caps, periodic caps, reset dates, collateral
seasoning, expected losses, expected default severity, credit enhancement, and
other pertinent factors.  Management reviews the fair values generated
by the model to determine whether prices are reflective of the current
market.  Management performs a validation of the fair value calculated
by the pricing model by comparing its results to independent prices provided by
dealers in the securities and/or third party pricing
services.




15




During
times of market dislocation, as has been experienced for some time, the
observability of prices and inputs can be reduced for certain
instruments.  If dealers or independent pricing services are unable to
provide a price for an asset, or if the price provided by them is deemed
unreliable by the Company, then the asset will be valued at its fair value as
determined in good faith by the Company.  In addition, validating
third party pricing for the Company’s investments may be more subjective as
fewer participants may be willing to provide this service to the
Company.  Illiquid investments typically experience greater price
volatility as a ready market does not exist.  As fair value is not an
entity specific measure and is a market based approach which considers the value
of an asset or liability from the perspective of a market participant,
observability of prices and inputs can vary significantly from period to
period.  A condition such as this can cause instruments to be
reclassified from Level 1 to Level 2 or Level 2 to Level 3 when the Company is
unable to obtain third party pricing verification.
 
 If at the
valuation date, the fair value of an investment security is less than its
amortized cost at the date of the consolidated statement of financial condition,
the Company analyzes the investment security for other-than-temporary impairment
in accordance FAS 115-2 and FAS 124-2, adopted by the Company April 1, 2009 and
EITF 99-20-1.  Management evaluates the Company’s RMBS for
other-than-temporary impairment at least on a quarterly basis, and more
frequently when economic or market concerns warrant such
evaluation.  Consideration is given to (1) the length of time and the
extent to which the fair value has been lower than carrying value, (2) the
intent of the Company to sell the investment prior to recovery in fair value (3)
whether the Company will be more likely than not required to sell the investment
before the expected recovery, (4) and the expected future cash flows of the
investment in relation to its amortized cost.  Unrealized losses on
assets that are considered other-than-temporary impairments are recognized in
income and the cost basis of the assets is adjusted.
  At June
30, 2009 and December 31, 2008, the Company has classified its RMBS as “Level
2”.  The Company’s financial assets and liabilities carried at fair
value on a recurring basis are valued at June 30, 2009 as follows:
  Level
      1
                    
                    
                    Level
      2
                    
                    
                    Level
      3(dollars
      in thousands)Assets:Non-Agency
      mortgage-backed securities
                    
                    
                    -
                    
                    
                    $
                    1,746,543
                    
                    
                    
                    -Agency
      mortgage-backed securities
                    
                    
                    -
                    
                    
                    $
                    1,889,550
 
 As of the
quarter ended June 30, 2009, the Company was able to obtain third party pricing
verification for all assets classified as Level 2.  The classification
of assets and liabilities by level remains unchanged at June 30, 2009, when
compared to the previous quarter.   In the aggregate, the
Company’s fair valuation of RMBS investments were 0.05% lower than the
aggregated dealer marks.
 
 Securitized
Loans Held for Investment
 The
Company records securitized loans held for investment when it securitizes or
re-securitizes assets and records the transaction as a “financing” pursuant to
SFAS 140.  The Company carries securitized loans held for investment
at principal value, plus premiums or discounts paid, less an allowance for loan
losses.  The Company fair values its securitized loans held for
investment by estimating future cash flows of the underlying
assets.  The Company models each underlying asset by considering,
among other items, the structure of the underlying security, coupon, servicer,
actual and expected defaults, actual and expected default severities, reset
indices, and prepayment speeds in conjunction with market research for similar
collateral performance and management’s expectations of general economic
conditions in the sector and greater economy.




16




Repurchase
Agreements
 The
Company records repurchase agreements at their contractual amounts including
accrued interest payable.  Repurchase agreements are collateralized
financing transactions utilized by the Company to acquire investment
securities.  Due to the short term nature of these financial
instruments the Company estimated the fair value of these repurchase agreements
to be the contractual obligation plus accrued interest payable at
maturity.
 
 Securitized
Debt
 The
Company records securitized debt for certificates or notes sold in
securitization or re-securitization transactions treated as “financings”
pursuant to SFAS 140.  The Company carries securitized debt at the
principal balance outstanding on non-retained notes associated with its
securitized loans held for investment plus premiums or discounts recorded with
the sale of the notes to third parties.  The premiums or discounts
associated with the sale of the notes or certificates are amortized over the
life of the instrument.  The Company estimates the fair value of
securitized debt by estimating the future cash flows associated with underlying
assets collateralizing the secured debt outstanding.  The Company
models each underlying asset by considering, among other items, the structure of
the underlying security, coupon, servicer, actual and expected defaults, actual
and expected default severities, reset indices, and prepayment speeds in
conjunction with market research for similar collateral performance and
management’s expectations of general economic conditions in the sector and
greater economy.
 
 The
following table presents the carrying value and estimated fair value of the
Company’s financial instruments at June 30, 2009 and December 31,
2008:
  June
      30, 2009
                              
                              
                              December
      31, 2008Carrying
      Amount
                              
                              
                              Estimated
      Fair
                                Value
                              
                              
                              Carrying
      Amount
                              
                              
                              Estimated
      Fair
                                Value(dollars
      in thousands)Non-Agency
      RMBS
                              
                              $
                              1,962,659
                              
                              
                              $
                              1,746,543
                              
                              
                              $
                              881,808
                              
                              
                              $
                              613,105Agency
      RMBS
                              
                              
                              1,893,463
                              
                              
                              
                              1,889,550
                              
                              
                              
                              240,326
                              
                              
                              
                              242,362Securitized
      loans held for
                                investment
                              
                              
                              530,638
                              
                              
                              
                              489,376
                              
                              
                              
                              583,346
                              
                              
                              
                              577,893Repurchase
      agreements
                              
                              
                              1,500,631
                              
                              
                              
                              1,530,631
                              
                              
                              
                              562,119
                              
                              
                              
                              562,119Securitized
      debt
                              
                              
                              442,782
                              
                              
                              
                              463,136
                              
                              
                              
                              488,743
                              
                              
                              
                              510,796
  Any
changes to the valuation methodology are reviewed by management to ensure the
changes are appropriate. As markets and products develop and the pricing for
certain products becomes more transparent the Company continues to refine its
valuation methodologies. The methods used may produce a fair value calculation
that may not be indicative of net realizable value or reflective of future fair
values. Furthermore, while the Company believes its valuation methods are
appropriate and consistent with other market participants, the use of different
methodologies, or assumptions, to determine the fair value of certain financial
instruments could result in a different estimate of fair value at the reporting
date.  The Company uses inputs that are current as of the measurement
date, which may include periods of market dislocation, during which price
transparency may be reduced.
  6.  Repurchase
Agreements
 
 The
Company had outstanding $1.5 billion and $562.1 million of repurchase agreements
with weighted average borrowing rates of 0.59% and 1.43% and weighted average
remaining maturities of 17 and 2 days as of June 30, 2009 and December 31, 2008,
respectively.  At June 30, 2009 and December 31, 2008, RMBS pledged as
collateral under these repurchase agreements had an estimated fair value of $1.6
billion and $680.8 million, respectively.  The interest rates of these
repurchase agreements are generally indexed to the one-month LIBOR rate and
re-price accordingly.
  17




At June
30, 2009 and December 31, 2008, the repurchase agreements collateralized by RMBS
had the following remaining maturities:
 
 June
      30, 2009
                              
                              
                              December
      31, 2008(dollars
      in thousands)Overnight
                              
                              $
                              -
                              
                              
                              $
                              -1 to
      30 days
                              
                              
                              1,427,482
                              
                              
                              
                              562,11930
      to 59 days
                              
                              
                              73,149
                              
                              
                              
                              -60
      to 89 days
                              
                              
                              -
                              
                              
                              
                              -90
      to 119 days
                              
                              
                              -
                              
                              
                              
                              -Greater
      than or equal to 120 days
                              
                              
                              -
                              
                              
                              
                              -Total
                              
                              $
                              1,500,631
                              
                              
                              $
                              562,119
 
 At June
30, 2009, the Company did not have an amount at risk greater than 10% of its
equity with any counterparty.  At December 31, 2008 the Company had an
amount at risk of approximately 29% of its equity with Annaly, an
affiliate.
 
 7.  Securitized
Debt
 
 All of the
Company’s securitized debt is collateralized by residential mortgage
loans.  For financial reporting purposes, the Company’s securitized
debt is accounted for as a financing pursuant to SFAS 140.  Thus, the
residential mortgage loans held as collateral are recorded in the assets of the
Company as securitized loans held for investment and the securitized debt is
recorded as a liability in the statement of financial condition.
 
 The
following table presents the estimated principal repayment schedule of the
securitized debt held by the Company outstanding at June 30, 2009 and December
31, 2008:
 
 June
      30, 2009
                              
                              
                              December
      31, 2008Within
      One Year
                              
                              $
                              40,344
                              
                              
                              $
                              65,561One
      to Three Years
                              
                              
                              74,818
                              
                              
                              
                              112,745Three
      to Five Years
                              
                              
                              38,335
                              
                              
                              
                              85,955Greater
      Than or Equal to Five Years
                              
                              
                              309,639
                              
                              
                              
                              246,535Total
                              
                              $
                              463,136
                              
                              
                              $
                              510,796
 
 Maturities
of the Company’s securitized debt are dependent upon cash flows received from
the underlying loans. The estimate of their repayment is based on scheduled
principal payments on the underlying loans. This estimate will differ from
actual amounts to the extent prepayments and/or loan losses are
experienced.
 
 As of June
30, 2009 and December 31, 2008, the Company had no off balance sheet credit
risk.
 
 At June
30, 2009, the Company’s securitized debt collateralized by residential mortgage
loans had a principal balance of $442.8 million.  The debt matures
between the years 2016 and 2038.  At June 30, 2009, the debt
carried a weighted average cost of financing equal to 5.64%, that is
secured by residential mortgage loans of which approximately 44% of the
remaining principal balance pays a fixed rate of 6.33% and 56% of the
remaining principal balance pays at a variable rate of 5.64%.At December
31, 2008, securitized debt collateralized by residential mortgage loans had a
principal balance of $488.7 million.  At December 31, 2008, the debt
carried a weighted average cost of financing equal to 5.55%, of which
approximately 44% of the remaining principal balance is a fixed rate at 6.32%
and 56% of the remaining principal balance at a variable rate of
5.65%.
 
 8.  Common
Stock
 
 On May 27,
2009, the Company announced the sale of 168,000,000 shares of common stock at
$3.22 per share for estimated proceeds, less the underwriters’ discount and
offering expenses, of $519.3 million.  Immediately following the sale
of these shares Annaly purchased 4,724,017 shares at the same price per share as
the public offering, for proceeds of approximately $15.2 million. In addition,
on June 1, 2009 the underwriters exercised the option to purchase up to an
additional 25,200,000 shares of common stock to cover over-allotments for
proceeds, less the underwriters’ discount, of approximately $77.9 million. These
sales were completed on June 2, 2009.  In all, the Company raised net
proceeds of approximately $612.4 million in these offerings.




18




On May 22,
2009, the Company filed an amendment to its Articles of
Incorporation.  The Company’s Articles of Incorporation previously
allowed the Company to issue up to a total of 550,000,000 shares of capital
stock, par value $0.01 per share.  As of May 22, 2009, the Company had
472,401,769 shares of common stock issued and outstanding. To retain the ability
to issue additional shares of capital stock, the Company has increased the
number of shares it is authorized to issue to 1,100,000,000 shares consisting of
1,000,000,000 shares of common stock, $0.01 par value per common share, and
100,000,000 shares of preferred stock, $0.01 par value per preferred
share.
 
 On May 21,
2009, the Company declared dividends to common shareholders totaling $37.7
million or $0.08 per share, which were paid on July 31, 2009.
 
 On April
15, 2009, the Company announced the sale of 235,000,000 shares of common stock
at $3.00 per share for estimated proceeds, less the underwriters’ discount and
offering expenses, of $674.8 million.  Immediately following the sale
of these shares Annaly purchased 24,955,752 shares at the same price per share
as the public offering, for proceeds of approximately $74.9 million. In
addition, on April 16, 2009 the underwriters exercised the option to purchase up
to an additional 35,250,000 shares of common stock to cover over-allotments for
proceeds, less the underwriters’ discount, of approximately $101.3 million.
These sales were completed on April 21, 2009.  In all, the Company
raised net proceeds of approximately $850.9 in these offerings.
 
 On October
24, 2008, the Company announced the sale of 110,000,000 shares of common stock
at $2.25 per share for estimated proceeds, less the underwriters’ discount and
offering expenses, of $237.9 million.  Immediately following the sale
of these shares, Annaly purchased 11,681,415 shares at the same price per share
as the public offering, for proceeds of approximately $26.3
million.  In addition, on October 28, 2008 the underwriters exercised
the option to purchase up to an additional 16,500,000 shares of common stock to
cover over-allotments for proceeds, less the underwriters’ discount, of
approximately $35.8 million.  These sales were completed on October
29, 2008.  In all, the Company’s raised net proceeds of
approximately $299.9 million.
 
 There was
no preferred stock issued or outstanding as of June 30, 2009 or December 31,
2008.
 
 9.  Long
Term Incentive Plan
 
 The
Company has adopted a long term stock incentive plan to provide incentives to
its independent directors and employees of FIDAC and its affiliates, to
stimulate their efforts towards the Company's continued success, long-term
growth and profitability and to attract, reward and retain personnel and other
service providers.  The incentive plan authorizes the Compensation
Committee of the board of directors to grant awards, including incentive stock
options, non-qualified stock options, restricted shares and other types of
incentive awards.  The specific award granted to each individual was
based upon, in part, the individual’s position with FIDAC, the individual’s
position with the Company, his or her contribution to the Company’s performance,
market practices, as well as the recommendations of FIDAC.  The
incentive plan authorizes the granting of options or other awards for an
aggregate of the greater of 8.0% of the outstanding shares of the Company’s
common stock up to a ceiling of 53,626,063 shares.  There have been no
additional incentive awards granted since January 2, 2008.
 
 On January
2, 2008, the Company granted restricted stock awards in the amount of 1,301,000
shares to FIDAC’s employees and the Company’s independent
directors.  The awards to the independent directors vested on the date
of grant and the awards to FIDAC’s employees vest quarterly over a period of 10
years.  Of these shares, as of June 30, 2009, 205,350 shares have
vested and 20,075 shares were forfeited or cancelled.  During the
three months ended June 30, 2009, 32,225 shares vested and 928 shares were
forfeited.




19




As of June
30, 2009, there was $19.4 million of total unrecognized compensation cost
related to non-vested share-based compensation arrangements granted under the
long term incentive plan. That cost is expected to be recognized over a
weighted-average period of 8.5 years. The total fair value of shares vested
during the quarter ended June 30, 2009 was $111,176.
  10.  Income
Taxes
 
 As a REIT,
the Company is not subject to Federal income tax on earnings distributed to its
shareholders and most states recognize REIT status as
well.  During the quarter ended June 30, 2009 and year ended December
31, 2008, respectively, the Company recorded no income tax expense related to
state and federal tax liabilities on undistributed income.
 
 In
general, common stock cash dividends declared by the Company will be considered
ordinary income to stockholders for income tax purposes.  From time to
time, a portion of the Company’s dividends may be characterized as capital gains
or return of capital.  During the quarter ended June 30, 2009 and the
year ended December 31, 2008, the Company estimates that all income distributed
in the form of dividends will be characterized as ordinary income.
 
 11.  Credit
Risk and Interest Rate Risk
 
 The
Company's primary components of market risk are credit risk and interest rate
risk.  The Company is subject to credit risk in connection with its
investments in residential mortgage loans and credit sensitive mortgage-backed
securities.  When the Company assumes credit risk, it attempts to
minimize interest rate risk through asset selection, hedging and matching the
income earned on mortgage assets with the cost of related
liabilities.  The Company is subject to interest rate risk, primarily
in connection with its investments in fixed-rate and adjustable-rate
mortgage-backed securities, residential mortgage loans, and borrowings under
repurchase agreements.  The Company attempts to minimize credit risk
through due diligence and asset selection.  The Company's strategy is
to purchase loans underwritten to agreed-upon specifications of selected
originators in an effort to mitigate credit risk.  The Company has
established a whole loan target market including prime borrowers with FICO
scores generally greater than 650, Alt-A documentation, geographic
diversification, owner-occupied property, and moderate loan to value
ratio.  These factors are considered to be important indicators of
credit risk.
 
 12.  Management
Agreement and Related Party Transactions
 
 The
Company has entered into a management agreement with FIDAC, which provides for
an initial term through December 31, 2010 with an automatic one-year extension
option and subject to certain termination rights.  The Company pays
FIDAC a quarterly management fee equal to 1.75% per annum of the gross
Stockholders’ Equity (as defined in the management agreement) of the
Company.  Management fees accrued and subsequently paid to FIDAC for
the quarter ending June 30, 2009 and 2008 were $6.0 million and $2.2 million,
respectively.
 
 On October
13, 2008, the Company and FIDAC amended the management agreement to reduce the
base management fee from 1.75% per annum to 1.50% per annum of the Company’s
stockholders’ equity and provide that the incentive fees may be in cash or
shares of the Company’s common stock, at the election of the Company’s board of
directors.
 
 On October
19, 2008, the Company and FIDAC further amended the management agreement to
provide that the incentive fee be eliminated in its entirety and FIDAC receive
only the management fee of 1.50% per annum of the Company’s stockholders’
equity.  From the Company’s inception to termination of the incentive
fee in October 2008, the Company had not paid incentive fees.
 
 The
Company is obligated to reimburse FIDAC for its costs incurred under the
management agreement.  In addition, the management agreement permits
FIDAC to require the Company to pay for its pro rata portion of rent, telephone,
utilities, office furniture, equipment, machinery and other office, internal and
overhead expenses of FIDAC incurred in the operation of the
Company.  These expenses are allocated between FIDAC and the Company
based on the ratio of the Company’s proportion of gross assets compared to all
remaining gross assets managed by FIDAC as calculated at each quarter
end.   FIDAC and the Company will modify this allocation
methodology, subject to the Company’s board of directors’ approval if the
allocation becomes inequitable (i.e., if the Company becomes very highly
leveraged compared to FIDAC’s other funds and accounts).  FIDAC has
waived its right to request reimbursement from the Company of these expenses
until such time as it determines to rescind that waiver.
 
 20
  During the
quarter ended June 30, 2009, 32,225 shares of restricted stock issued by the
Company to FIDAC’s employees vested, as discussed in Note 9.
 
 In March
2008, the Company entered into a Securities Industry and Financial Markets
Association standard preprinted form Master Repurchase Agreement with
Annaly.  This standard agreement does not contain any sort of
liquidity, net worth or other similar types of positive or negative
covenants.  Rather, the agreement contains covenants that require the
buyer and seller of securities to deliver collateral or securities, and similar
covenants which are customary in the form Master Repurchase
Agreement.  As of June 30, 2009, the Company was financing $123.5
million under this agreement.  The Company has been in compliance with
all covenants of this agreement since it entered into this
agreement.
 
 13.  Commitments
and Contingencies
 
 From time
to time, the Company may become involved in various claims and legal actions
arising in the ordinary course of business.  Management is not aware
of any reported or unreported contingencies at June 30, 2009.
 
 14.   Subsequent
Events
 
 On July
30, 2009, the Company transferred $1.5 billion in principal value of its RMBS to
the JPMRT 2009-7 Trust in a re-securitization transaction.  In this
transaction, the Company sold $166.3 million of AAA-rated fixed and floating
rate bonds to third party investors and realized a gain on the sale of
approximately $8.5 million.  The Company retained $690.6 million of
AAA-rated bonds, $665.5 million in subordinated bonds and the owner trust
certificate which provide credit support to the AAA-rated bonds, and intends to
retain a substantial amount of these bonds and the owner trust
certificate.  The bonds issued by the trust are collateralized by RMBS
that have been transferred to the JPMRT 2009-7 Trust.  The Company has
no remaining interests or obligation with regard to the underlying RMBS
transferred to the trust and as such, has recorded in its Consolidated Statement
of Financial Condition only the bonds and owner trust certificate it received at
the close of the re-securitization.  The Company incurred
approximately $4.0 million in issuance costs that were deducted from the
proceeds of the transaction.  The Company intends to account for this
transaction as a sale pursuant to SFAS 140.
 
 As of
August 7, 2009, under the Master Repurchase Agreement with Annaly, an affiliate,
the Company was financing $389.7 million.  See Note 12 for a more
detailed discussion of this agreement.
  21
  ITEM 2.
              MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
 
 Special
Note Regarding Forward-Looking Statements
 
 We make
forward-looking statements in this report that are subject to risks and
uncertainties. These forward-looking statements include information about
possible or assumed future results of our business, financial condition,
liquidity, results of operations, plans and objectives. When we use the words
‘‘believe,’’ ‘‘expect,’’ ‘‘anticipate,’’ ‘‘estimate,’’ ‘‘plan,’’ ‘‘continue,’’
‘‘intend,’’ ‘‘should,’’ ‘‘may,’’ ‘‘would,’’ ‘‘will’’ or similar expressions, we
intend to identify forward-looking statements.  Statements regarding the
following subjects, among others, are forward-looking by their
nature:
  ·
              our
      business and investment strategy;
  ·
              our
      projected financial and operating
results;
  ·
              our
      ability to maintain existing financing arrangements, obtain future
      financing arrangements and the terms of such
  arrangements;
  ·
              general
      volatility of the securities markets in which we
  invest;
  ·
              the
      implementation, timing and impact of, and changes to, various government
      programs, including the US Department of the Treasury’s plan to buy Agency
      residential mortgage-backed securities, the Term Asset-Backed Securities
      Loan Facility and the Public-Private Investment
  Program;
  ·
              our
      expected investments;
  ·
              changes
      in the value of our investments;
  ·
              interest
      rate mismatches between our mortgage-backed securities and our borrowings
      used to fund such purchases;
  ·
              changes
      in interest rates and mortgage prepayment
rates;
  ·
              effects
      of interest rate caps on our adjustable-rate mortgage-backed
      securities;
  ·
              rates
      of default or decreased recovery rates on our
  investments;
  ·
              prepayments
      of the mortgage and other loans underlying our mortgage-backed or other
      asset-backed securities;
  ·
              the
      degree to which our hedging strategies may or may not protect us from
      interest rate volatility;
  ·
              impact
      of and changes in governmental regulations, tax law and rates, accounting
      guidance, and similar matters;
  ·
              availability
      of investment opportunities in real estate-related and other
      securities;
  ·
              availability
      of qualified personnel;
  22
  ·
              estimates
      relating to our ability to make distributions to our stockholders in the
      future;
  ·
              our
      understanding of our competition;
and
  ·
              market
      trends in our industry, interest rates, the debt securities markets or the
      general economy.
  The
forward-looking statements are based on our beliefs, assumptions and
expectations of our future performance, taking into account all information
currently available to us. You should not place undue reliance on these
forward-looking statements. These beliefs, assumptions and expectations can
change as a result of many possible events or factors, not all of which are
known to us. Some of these factors are described under the caption ‘‘Risk
Factors’’ in our most recent Annual Report on Form 10-K and any subsequent
Quarterly Reports on Form 10-Q.  If a change occurs, our business,
financial condition, liquidity and results of operations may vary materially
from those expressed in our forward-looking statements. Any forward-looking
statement speaks only as of the date on which it is made. New risks and
uncertainties arise from time to time, and it is impossible for us to predict
those events or how they may affect us. Except as required by law, we are not
obligated to, and do not intend to, update or revise any forward-looking
statements, whether as a result of new information, future events or
otherwise.
 
 23
  Executive
Summary
 
 We are a
specialty finance company that invests in residential mortgage-backed
securities, or RMBS, residential mortgage loans, real estate related securities
and various other asset classes.  We are externally managed by Fixed
Income Discount Advisory Company, which we refer to as FIDAC.  FIDAC
is a fixed-income investment management company specializing in managing
investments in Agency RMBS, which are mortgage pass-through certificates,
collateralized mortgage obligations, or CMOs, and other mortgage-backed
securities representing interests in or obligations backed by pools of mortgage
loans issued or guaranteed by the Federal National Mortgage Association, or
Fannie Mae, the Federal Home Loan Mortgage Corporation, or Freddie Mac, and the
Government National Mortgage Association, or Ginnie Mae.
 
 We have
elected and intend to qualify to be taxed as a REIT for federal income tax
purposes commencing with our taxable year ending on December 31, 2007.  Our
targeted asset classes and the principal investments we expect to make in each
are as follows:
 
 ·
              RMBS,
      consisting of:
 
 o
              Non-Agency
      RMBS, including investment-grade and non-investment grade classes,
      including the BB-rated, B-rated and non-rated
  classes
  o
              Agency
      RMBS
  ·
              Whole
      mortgage loans, consisting of:
 
 o
              Prime
      mortgage loans
  o
              Jumbo
      prime mortgage loans
  o
              Alt-A
      mortgage loans
  ·
              Asset
      Backed Securities, or ABS, consisting
of:
 
 o
              Commercial
      mortgage-backed securities, or CMBS
  o
              Debt
      and equity tranches of CDOs
  o
              Consumer
      and non-consumer ABS, including investment-grade and non-investment grade
      classes, including the BB-rated, B-rated and non-rated
    classes
  
 We
completed our initial public offering on November 21, 2007.  In that
offering and in a concurrent private offering we raised net proceeds of
approximately $533.6 million.  We completed a second public offering
and second private offering on October 29, 2008.  In these offerings
we raised net proceeds of approximately $301.0 million.  During the
second quarter 2009, we completed a third public offering and third private
offering on April 21, 2009, and a fourth public offering and fourth private
offering June 2, 2009.  In these offerings we raised net proceeds of
approximately $851.0 million and $612.4 million, respectively, and we have
completed investing these proceeds.
 
 Our
objective is to provide attractive risk-adjusted returns to our investors over
the long-term, primarily through dividends and secondarily through capital
appreciation.  We intend to achieve this objective by investing in a
broad class of financial assets to construct an investment portfolio that is
designed to achieve attractive risk-adjusted returns and that is structured to
comply with the various federal income tax requirements for REIT status and to
maintain our exemption from the Investment Company Act of 1940, as amended, or
the 1940 Act.
 
 24
  Since we
commenced operations in November 2007, we have focused our investment activities
on acquiring non-Agency RMBS and on purchasing residential mortgage loans that
have been originated by select high-quality originators, including the retail
lending operations of leading commercial banks.  Our investment
portfolio is weighted toward non-Agency RMBS.  We expect that over the
near term our investment portfolio will continue to be weighted toward RMBS,
subject to maintaining our REIT qualification and our 1940 Act
exemption.  In addition, we have engaged in and depending on market
conditions, anticipate continuing to engage in transactions with residential
mortgage lending operations of leading commercial banks and other high-quality
originators in which we identify and re-underwrite residential mortgage loans
owned by such entities, and rather than purchasing and securitizing such
residential mortgage loans ourselves, we and the originator would structure the
securitization and we would purchase the resulting mezzanine and subordinate
non-Agency RMBS.  We may also engage in similar transactions with
non-Agency RMBS in which we would acquire AAA-rated non-Agency RMBS and
re-securitize those securities.  We would sell some or all of the
resulting AAA-rated RMBS and retain some of the AAA-rated RMBS and other
subordinate bonds and interests.
 
 Our
investment strategy is intended to take advantage of opportunities in the
current interest rate and credit environment.  We will adjust our
strategy to changing market conditions by shifting our asset allocations across
these various asset classes as interest rate and credit cycles change over
time.  We believe that our strategy, combined with FIDAC’s experience,
will enable us to pay dividends and achieve capital appreciation throughout
changing market cycles.  We expect to take a long-term view of assets
and liabilities, and our reported earnings and mark-to-market valuations at the
end of a financial reporting period will not significantly impact our objective
of providing attractive risk-adjusted returns to our stockholders over the
long-term.
 
 We use
leverage to seek to increase our potential returns and to fund the acquisition
of our assets.  Our income is generated primarily by the difference,
or net spread, between the income we earn on our assets and the cost of our
borrowings.  We expect to finance our investments using a variety of
financing sources including repurchase agreements, warehouse facilities,
securitizations, commercial paper and term financing CDOs.  We may
manage our debt by utilizing interest rate hedges, such as interest rate swaps,
to reduce the effect of interest rate fluctuations related to our
debt.
 
 Recent
Developments
  We
commenced operations in November 2007 in the midst of challenging market
conditions which affected the cost and availability of financing from the
facilities with which we expected to finance our investments.  These
instruments included repurchase agreements, warehouse facilities,
securitizations, asset-backed commercial paper, (“ABCP”), and term
CDOs.  The liquidity crisis which commenced in August 2007 affected
each of these sources—and their individual providers—to different degrees; some
sources generally became unavailable, some remained available but at a high
cost, and some were largely unaffected.  For example, in the
repurchase agreement market, non-Agency RMBS became harder to finance, depending
on the type of assets collateralizing the RMBS.  The amount, term and
margin requirements associated with these types of financings were also
impacted.  At that time, warehouse facilities to finance whole loan
prime residential mortgages were generally available from major banks, but at
significantly higher cost and had greater margin requirements than previously
offered.  It was also extremely difficult to term finance whole loans
through securitization or bonds issued by a CDO structure.  Financing
using ABCP froze as issuers became unable to place (or roll) their securities,
which resulted, in some instances, in forced sales of mortgage-backed
securities, or MBS, and other securities which further negatively impacted the
market value of these assets.
 
 Although
the credit markets had been undergoing much turbulence, as we started ramping up
our portfolio in late 2007, we noted a slight easing.  We entered into
a number of repurchase agreements we could use to finance RMBS.  In
January 2008, we entered into two whole mortgage loan repurchase
agreements.  As we began to see the availability of financing, we were
also seeing better underwriting standards used to originate new
mortgages.  We commenced buying and financing RMBS and also entered
into agreements to purchase whole mortgage loans.  We purchased high
credit quality assets which we believed we would be readily able to
finance.
 
 25
  Beginning
in mid-February 2008, credit markets experienced a dramatic and sudden adverse
change.  The severity of the limitation on liquidity was largely
unanticipated by the markets.   Credit once again froze, and in
the mortgage market, valuations of non-Agency RMBS and whole mortgage loans came
under severe pressure.  This credit crisis began in early February
2008, when a heavily leveraged investor announced that it had to de-lever and
liquidate a portfolio of approximately $30 billion of non-Agency
RMBS.  Prices of these types of securities dropped dramatically, and
lenders started lowering the prices on non-Agency RMBS that they held as
collateral to secure the loans they had extended.  The subsequent
failure in March 2008 of Bear Stearns & Co. worsened the
crisis.  As the year progressed, deterioration in the fair value of
our assets continued, we received and met margin calls under our repurchase
agreements, which resulted in our obtaining additional funding from third
parties, including from Annaly Capital Management, Inc., (“Annaly”), an
affiliate, and taking other steps to increase our liquidity.
 
 The
challenges of the first half of 2008 have continued throughout 2008 and so far
into 2009, as financing difficulties have severely pressured liquidity and asset
values.  In September 2008, Lehman Brothers Holdings, Inc., a major
investment bank, experienced a major liquidity crisis and
failed.  Securities trading remains limited and mortgage securities
financing markets remain challenging as the industry continues to report
negative news.  This dislocation in the non-Agency mortgage sector has
made it difficult for us to obtain short-term financing on favorable
terms.   As a result, we have completed loan securitizations in
order to obtain long-term financing and terminated our un-utilized whole loan
repurchase agreements in order to avoid paying non-usage fees under those
agreements.  In addition, we have continued to seek funding from
Annaly.  Under these circumstances, we expect to take actions intended
to protect our liquidity, which may include reducing borrowings and disposing of
assets as well as raising capital.
 
 During
this period of market dislocation, fiscal and monetary policymakers have
established new liquidity facilities for primary dealers and commercial banks,
reduced short-term interest rates, and passed legislation that is intended to
address the challenges of mortgage borrowers and lenders. This legislation, the
Housing and Economic Recovery Act of 2008, seeks to forestall home foreclosures
for distressed borrowers and assist communities with foreclosure
problems.
 
 Subsequent
to June 30, 2008, there were increased market concerns about Freddie Mac and
Fannie Mae’s ability to withstand future credit losses associated with
securities held in their investment portfolios, and on which they provide
guarantees, without the direct support of the federal government.  In
September 2008 Fannie Mae and Freddie Mac were placed into the conservatorship
of the Federal Housing Finance Agency, or FHFA, their federal regulator,
pursuant to its powers under The Federal Housing Finance Regulatory Reform Act
of 2008, a part of the Housing and Economic Recovery Act of 2008.  As
the conservator of Fannie Mae and Freddie Mac, the FHFA controls and directs the
operations of Fannie Mae and Freddie Mac and may (1) take over the assets of and
operate Fannie Mae and Freddie Mac with all the powers of the shareholders, the
directors, and the officers of Fannie Mae and Freddie Mac and conduct all
business of Fannie Mae and Freddie Mac; (2) collect all obligations and money
due to Fannie Mae and Freddie Mac; (3) perform all functions of Fannie Mae and
Freddie Mac which are consistent with the conservator’s appointment; (4)
preserve and conserve the assets and property of Fannie Mae and Freddie Mac; and
(5) contract for assistance in fulfilling any function, activity, action or duty
of the conservator.   A primary focus of this new legislation is
to increase the availability of mortgage financing by allowing Fannie Mae and
Freddie Mac to continue to grow their guarantee business without limit, while
limiting net purchases of mortgage-backed securities to a modest amount through
the end of 2009. It is currently planned for Fannie Mae and Freddie Mac to
reduce gradually their mortgage-backed securities portfolios beginning in
2010.
 
 In
addition to FHFA becoming the conservator of Fannie Mae and Freddie Mac, (i) the
U.S. Department of Treasury and FHFA have entered into preferred stock purchase
agreements between the U.S. Department of Treasury, or the Treasury, and Fannie
Mae and Freddie Mac pursuant to which the Treasury will ensure that each of
Fannie Mae and Freddie Mac maintains a positive net worth; (ii) the Treasury has
established a new secured lending credit facility which will be available to
Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, which is intended to
serve as a liquidity backstop, which will be available until December 2009; and
(iii) the Treasury has initiated a temporary program to purchase RMBS issued by
Fannie Mae and Freddie Mac.  Although the Treasury has committed
capital to Fannie Mae and Freddie Mac, there can be no assurance that these
actions will be adequate for their needs. If these actions are inadequate,
Fannie Mae and Freddie Mac could continue to suffer losses and could fail to
honor their guarantees and other obligations. The future roles of Fannie Mae and
Freddie Mac could be significantly reduced and the nature of their guarantees
could be considerably diminished. Any changes to the nature of the guarantees
provided by Fannie Mae and Freddie Mac could redefine what constitutes
Mortgage-Backed Securities and could have broad adverse market
implications.
 
 26
  Given the
highly fluid and evolving nature of these events, it is unclear how our business
will be impacted.  Based upon the further activity of the U.S.
government or market response to developments at Fannie Mae or Freddie Mac, our
business could be adversely impacted.
 
 The
Emergency Economic Stabilization Act of 2008, or EESA, was enacted in October
2008.  The EESA provides the U.S. Secretary of the Treasury with the
authority to establish a Troubled Asset Relief Program, or TARP, to purchase
from financial institutions up to $700 billion of equity or preferred
securities, residential or commercial mortgages and any securities, obligations,
or other instruments that are based on or related to such mortgages, that in
each case was originated or issued on or before March 14, 2008, as well as any
other financial instrument that the U.S. Secretary of the Treasury, after
consultation with the Chairman of the Board of Governors of the Federal Reserve
System, determines the purchase of which is necessary to promote financial
market stability, upon transmittal of such determination, in writing, to the
appropriate committees of the U.S. Congress.  The EESA also provides
for a program that would allow companies to insure their troubled
assets.
 
 The U.S.
Government, Federal Reserve and other governmental and regulatory bodies have
taken or are considering taking other actions to address the financial
crisis.  The Term Asset-Backed Securities Loan Facility, or TALF, was
first announced by the Treasury on November 25, 2008, and has been expanded in
size and scope since its initial announcement.   Under the TALF,
the Federal Reserve Bank of New York, or the FRBNY, provides non-recourse loans
to borrowers to fund their purchase of eligible assets, which currently includes
certain ABS but not RMBS or CMBS. On March 23, 2009, the U.S. Treasury announced
preliminary plans to expand the TALF to include non-Agency RMBS and CMBS. On May
1, 2009, the Federal Reserve provided more of the details as to how TALF is to
be expanded to newly issued CMBS and explained that beginning in June 2009, up
to $100 billion of TALF loans will be available to finance purchases of CMBS
created on or after January 1, 2009. In addition to the ability of newly issued
CMBS to become collateral under the TALF, on May 19, 2009, the Federal Reserve
provided details on the types of legacy CMBS that is eligible to become
collateral under the TALF. To become eligible collateral under the TALF, the
legacy CMBS must issued before January 1, 2009 and must be senior in payment
priority to all other interests in the underlying pool of commercial mortgages
meet certain other criteria designed to protect the Federal Reserve and the U.S.
Treasury from credit risk. Both newly issued CMBS and legacy CMBS must have at
least two triple-A ratings from DBRS, Fitch Ratings, Moody’s Investors Service,
Realpoint, or Standard Poor’s and must not have a rating below triple-A from any
of these rating agencies to become eligible collateral under the TALF. To date,
neither the FRBNY nor the U.S. Treasury has announced how the TALF will be
expanded to cover non-Agency RMBS.
 
 In
addition, on March 23, 2009, the U.S. Treasury, in conjunction with the Federal
Deposit Insurance Corporation, or FDIC, and the Federal Reserve, announced the
establishment of the Public-Private Investment Program, or PPIP. The PPIP is
designed to encourage the transfer of certain illiquid legacy real
estate-related assets off of the balance sheets of financial institutions,
restarting the market for these assets and supporting the flow of credit and
other capital into the broader economy. The PPIP is expected to be $500 billion
to $1 trillion in size and has two primary components: the Legacy Securities
Program and the Legacy Loan Program. Under the Legacy Securities Program, Legacy
Securities Public-Private Investment Funds, or PPIFs, will be established to
purchase from financial institutions certain non-Agency RMBS and CMBS that were
originally rated in the highest rating category by one or more of the nationally
recognized statistical rating organizations. Under the Legacy Loan Program,
Legacy Loan PPIFs will be established to purchase troubled loans (including
residential and commercial mortgage loans) from insured depository
institutions.
 
 27
  As these
programs are still in early stages of development, it is not possible for us to
predict how these programs will impact our business. Although these
aggressive steps are intended to protect and support the US housing and mortgage
market, we continue to operate under very difficult market
conditions.  As a result, there can be no assurance that the EESA, the
TARP, the TALF, PPIP or other policy initiatives will have a beneficial impact
on the financial markets, including current extreme levels of
volatility.  We cannot predict whether or when such actions may occur
or what impact, if any, such actions could have on our business, results of
operations and financial condition.
 
 Trends
  We expect
the results of our operations to be affected by various factors, many of which
are beyond our control.  Our results of operations will primarily
depend on, among other things, the level of our net interest income, the market
value of our assets, and the supply of and demand for such
assets.  Our net interest income, which reflects the amortization of
purchase premiums and accretion of discounts, varies primarily as a result of
changes in interest rates, borrowing costs, and prepayment speeds, which is a
measurement of how quickly borrowers pay down the unpaid principal balance on
their mortgage loans.
 
 Prepayment Speeds. Prepayment
speeds, as reflected by the Constant Prepayment Rate, or CPR, vary according to
interest rates, the type of investment, conditions in financial markets,
competition and other factors, none of which can be predicted with any
certainty.  In general, when interest rates rise, it is relatively
less attractive for borrowers to refinance their mortgage loans, and as a
result, prepayment speeds tend to decrease.  When interest rates fall,
prepayment speeds tend to increase. For mortgage loan and RMBS investments
purchased at a premium, as prepayment speeds increase, the amount of income we
earn decreases because the purchase premium we paid for the bonds amortizes
faster than expected.  Conversely, decreases in prepayment speeds
result in increased income and can extend the period over which we amortize the
purchase premium. For mortgage loan and RMBS investments purchased at a
discount, as prepayment speeds increase, the amount of income we earn increases
because of the acceleration of the accretion of the discount into interest
income. Conversely, decreases in prepayment speeds result in decreased income
and can extend the period over which we accrete the purchase discount into
interest income.
 
 Rising Interest Rate Environment.As indicated above, as interest rates rise, prepayment speeds generally
decrease, increasing our net interest income.  Rising interest rates,
however, increase our financing costs which may result in a net negative impact
on our net interest income.  In addition, if we acquire Agency and
non-Agency RMBS collateralized by monthly reset adjustable-rate mortgages, or
ARMs, and three- and five-year hybrid ARMs, such interest rate increases could
result in decreases in our net investment income, as there could be a timing
mismatch between the interest rate reset dates on our RMBS portfolio and the
financing costs of these investments.  Monthly reset ARMs are ARMs on
which coupon rates reset monthly based on indices such as the one-month London
Interbank Offering Rate, or LIBOR.  Hybrid ARMs are mortgages that
have interest rates that are fixed for an initial period (typically three, five,
seven or ten years) and thereafter reset at regular intervals subject to
interest rate caps.
  With
respect to our floating rate investments, such interest rate increases should
result in increases in our net investment income because our floating rate
assets are greater in amount than the related floating rate
liabilities.  Similarly, such an increase in interest rates should
generally result in an increase in our net investment income on fixed-rate
investments made by us because our fixed-rate assets would be greater in amount
than our fixed-rate liabilities.  We expect, however, that our
fixed-rate assets would decline in value in a rising interest rate environment
and that our net interest spreads on fixed rate assets could decline in a rising
interest rate environment to the extent such assets are financed with floating
rate debt.
  28




Falling Interest Rate Environment.As interest rates fall, prepayment speeds generally increase, decreasing
our net interest income.  Falling interest rates, however, decrease
our financing costs which may result in a net positive impact on our net
interest income.  In addition, if we acquire Agency and non-Agency
RMBS collateralized by monthly reset adjustable-rate mortgages, or ARMs, and
three- and five-year hybrid ARMs, such interest rate decreases could result in
increases in our net investment income, as there could be a timing mismatch
between the interest rate reset dates on our RMBS portfolio and the financing
costs of these investments.  Monthly reset ARMs are ARMs on which
coupon rates reset monthly based on indices such as the one-month London
Interbank Offering Rate, or LIBOR.  Hybrid ARMs are mortgages that
have interest rates that are fixed for an initial period (typically three, five,
seven or ten years) and thereafter reset at regular intervals subject to
interest rate caps.
  With
respect to our floating rate investments, such interest rate decreases may
result in decreases in our net investment income because our floating rate
assets may be greater in amount than the related floating rate
liabilities.  Similarly, such a decrease in interest rates should
generally result in an increase in our net investment income on fixed-rate
investments made by us because our fixed-rate assets would be greater in amount
than our fixed-rate liabilities.  We expect, however, that our
fixed-rate assets would increase in value in a falling interest rate environment
and that our net interest spreads on fixed rate assets could increase in a
falling interest rate environment to the extent such assets are financed with
floating rate debt.
  Credit Risk.One
of our strategic focuses is acquiring assets which we believe to be of high
credit quality. We believe this strategy will generally keep our credit losses
and financing costs low.  We retain the risk of potential credit
losses on all of the residential mortgage loans we hold in our
portfolio.  Additionally, some of our investments in RMBS may be
qualifying interests for purposes of maintaining our exemption from the 1940 Act
because we retain a 100% ownership interest in the underlying
loans.  If we purchase all classes of these securitizations, we have
the credit exposure on the underlying loans.  Prior to the purchase of
these securities, we conduct a due diligence process that allows us to remove
loans that do not meet our credit standards based on loan-to-value ratios,
borrowers’ credit scores, income and asset documentation and other criteria that
we believe to be important indications of credit risk.
  Size of Investment
Portfolio.The size of our investment portfolio, as measured
by the aggregate unpaid principal balance of our mortgage loans and aggregate
principal balance of our mortgage related securities and the other assets we own
is also a key revenue driver.  Generally, as the size of our
investment portfolio grows, the amount of interest income we receive
increases.  The larger investment portfolio, however, drives increased
expenses as we incur additional interest expense to finance the purchase of our
assets.
  Since
changes in interest rates may significantly affect our activities, our operating
results depend, in large part, upon our ability to effectively manage interest
rate risks and prepayment risks while maintaining our status as a
REIT.
  Current
Environment.  The current weakness in the broader mortgage
markets could adversely affect one or more of our potential lenders or any of
our lenders and could cause one or more of our potential lenders or any of our
lenders to be unwilling or unable to provide us with financing or require us to
post additional collateral.  In general, this could potentially
increase our financing costs and reduce our liquidity or require us to sell
assets at an inopportune time.  We expect to use a number of sources
to finance our investments, including repurchase agreements, warehouse
facilities, securitizations, asset-backed commercial paper and term
CDOs.  Current market conditions have affected the cost and
availability of financing from each of these sources and their individual
providers to different degrees; some sources generally are unavailable, some are
available but at a high cost, and some are largely unaffected.  For
example, in the repurchase agreement market, borrowers have been affected
differently depending on the type of security they are
financing.  Non-Agency RMBS have been harder to finance, depending on
the type of assets collateralizing the RMBS.  The amount, term and
margin requirements associated with these types of financings have been
negatively impacted.
  Currently,
warehouse facilities to finance whole loan prime residential mortgages are
generally available from major banks, but at significantly higher cost and have
greater margin requirements than previously offered. Many major banks that offer
warehouse facilities have also reduced the amount of capital available to new
entrants and consequently the size of those facilities offered now are smaller
than those previously available.   We decided to terminate our
two whole loan repurchase agreements in order to avoid paying non-usage fees
under those agreements.
  29
  It is
currently a challenging market to term finance whole loans through
securitization or bonds issued by a CDO structure. The highly rated senior bonds
in these securitizations and CDO structures currently have liquidity, but at
much wider spreads than issues priced in recent history. The junior subordinate
tranches of these structures currently have few buyers and current market
conditions have forced issuers to retain these lower rated bonds rather than
sell them.
  Certain
issuers of ABCP have been unable to place (or roll) their securities, which has
resulted, in some instances, in forced sales of MBS and other securities which
has further negatively impacted the market value of these
assets.  These market conditions are fluid and likely to change over
time.   As a result, the execution of our investment strategy may
be dictated by the cost and availability of financing from these different
sources.
  If one or
more major market participants fails or otherwise experiences a major liquidity
crisis, as was the case for Bear Stearns & Co. in March 2008, and Lehman
Brothers Holdings Inc. in September 2008, it could negatively impact the
marketability of all fixed income securities and this could negatively impact
the value of the securities we acquire, thus reducing our net book
value.  Furthermore, if many of our potential lenders or any of our
lenders are unwilling or unable to provide us with financing, we could be forced
to sell our securities or residential mortgage loans at an inopportune time when
prices are depressed.
 
 As
described above, there has been significant government action in the capital
markets.  However, there can be no assurance that the government’s
actions with respect to Freddie Mac and Fannie Mae, the EESA, the TARP, the
TALF, the PPIP or other policy initiatives will have a beneficial impact on the
financial markets, including current extreme levels of volatility.  To
the extent the market does not respond favorably to these actions, or these
actions do not function as intended, our business may not receive the
anticipated positive impact from them.  In addition, the U.S.
Government, Federal Reserve and other governmental and regulatory bodies have
taken or are considering taking other actions to address the financial crisis.
We cannot predict whether or when such actions may occur or what impact, if any,
such actions could have on our business, results of operations and financial
condition.
 
 In the
current market, it may be difficult or impossible to obtain third party pricing
on the investments we purchase.  In addition, validating third party
pricing for our investments may be more subjective as fewer participants may be
willing to provide this service to us.  Moreover, the current market
is more illiquid than in recent history for some of the investments we
purchase.  Illiquid investments typically experience greater price
volatility as a ready market does not exist.    As
volatility increases or liquidity decreases we may have greater difficulty
financing our investments which may negatively impact our earnings and the
execution of our investment strategy.
  Critical
Accounting Policies
  Our
financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America, or GAAP.  These
accounting principles may require us to make some complex and subjective
decisions and assessments.  Our most critical accounting policies will
involve decisions and assessments that could affect our reported assets and
liabilities, as well as our reported revenues and expenses.  We
believe that all of the decisions and assessments upon which our consolidated
financial statements are based will be reasonable at the time made and based
upon information available to us at that time.  At each quarter end,
we calculate estimated fair value of the investment portfolio using a pricing
model.  We validate our pricing model by obtaining independent pricing
on all of our assets and performing a verification of those sources to our own
internal estimate of fair value.  The following are our most critical
accounting policies:
  Mortgage
Loan Sales and Securitizations
  We
periodically enter into transactions in which we sell financial assets, such as
RMBS, mortgage loans and other assets.  We also securitize and
re-securitize financial assets.  These transactions are recorded in
accordance with Statement of Financial Account Standards (“SFAS”) No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishment of Liabilities(“SFAS
140”) and are accounted for as either a “sale” and the loans held for investment
are removed from the consolidated statements of financial condition or as a
“financing” and are classified as “Securitized loans held for investment” on the
Company’s consolidated statements of financial condition, depending upon the
structure of the securitization transaction.  In these securitizations
and re-securitizations we sometimes retain or acquire senior or subordinated
interests in the securitized or re-securitized assets.  Gains and
losses on such securitizations or re-securitizations are recognized using the
guidance in SFAS 140 which is based on a financial components approach that
focuses on control.  Under this approach, after a transfer of
financial assets, an entity recognizes the financial and servicing assets it
controls and the liabilities it has incurred, derecognizes financial assets when
control has been surrendered, and derecognizes liabilities when
extinguished.
  30
  We
determine the gain or loss on sale of mortgage loans by allocating the carrying
value of the underlying mortgage between securities or loans sold and the
interests retained based on their fair values.  The gain or loss on
sale is the difference between the cash proceeds from the sale and the amount
allocated to the securities or loans sold.
  In February 2008, the Financial
Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) SFAS No.
140-3, Accounting for
Transfers of Financial Assets and Repurchase Financing Transactions,
(“SFAS 140-3”).  SFAS 140-3 addresses whether transactions where
assets purchased from a particular counterparty and financed through a
repurchase agreement with the same counterparty can be considered and accounted
for as separate transactions, or are required to be considered “linked”
transactions and may be considered derivatives under SFAS 133.  SFAS
140-3 requires purchases and subsequent financing through repurchase agreements
be considered linked transactions unless all of the following conditions
apply:  (1) the initial purchase and the use of repurchase agreements
to finance the purchase are not contractually contingent upon each other; (2)
the repurchase financing entered into between the parties provides
full  recourse to the transferee and the repurchase price is fixed;
(3) the financial assets are readily obtainable in the market; and (4) the
financial instrument and the repurchase agreement are not
coterminous.  This FSP was effective for us as of January 1,
2009.  We meet the requirements of this FSP to treat repurchase
financings as non-linked transactions and this FSP has no effect on financial
reporting.
 
 Valuation
of Investments
  On January
1, 2008, we adopted SFAS No. 157, Fair Value Measurements
(“SFAS 157”) which defines fair value, establishes a framework for measuring
fair value, and establishes a three-level valuation hierarchy for disclosure of
fair value measurement and enhances disclosure requirements for fair value
measurements.  The valuation hierarchy is based upon the transparency
of inputs to the valuation of an asset or liability as of the measurement
date.  The three levels are defined as follows:
  Level 1 –
inputs to the valuation methodology are quoted prices (unadjusted) for identical
assets and liabilities in active markets.
  Level 2 –
inputs to the valuation methodology include quoted prices for similar assets and
liabilities in active markets, and inputs that are observable for the asset or
liability, either directly or indirectly, for substantially the full term of the
financial instrument.
  Level 3 –
inputs to the valuation methodology are unobservable and significant to overall
fair value.
  Non-Agency
and Agency Mortgage-Backed Securities are valued using a pricing
model.  The MBS pricing model incorporates such factors as coupons,
prepayment speeds, spread to the Treasury and swap curves, convexity, duration,
periodic and life caps, and credit enhancement.  Management reviews
the fair values determined by the pricing model and compares its results to
dealer quotes received on each investment to validate the reasonableness of the
valuations indicated by the pricing models.  The dealer quotes
incorporate common market pricing methods, including a spread measurement to the
Treasury curve or interest rate swap curve as well as underlying characteristics
of the particular security including coupon, periodic and life caps, rate reset
period, issuer, additional credit support and expected life of the
security.
 
 31
 Although we utilize a pricing model to
compute the fair value of the securities in our portfolio, we validate our fair
values by seeking indications of fair value from third-party dealers and/or
pricing services. The variability of fair value among dealers and pricing
services can be wide at this time as full liquidity for the non-Agency market
has yet to return.  In addition, there are fewer participants in the
RMBS sector available to fair value investments.  For June 30, 2009,
we received dealer marks on all of our securities.   In the
aggregate, our internal valuations of the securities on which we received dealer
marks were 0.05% lower than the aggregated dealer marks.
 
 In October 2008, FASB issued FSP FAS
No. 157-3, Determining the
Fair Value of a Financial Asset When the Market for That Asset Is Not Active(“FAS 157-3”), in response to the deterioration of the credit
markets.  This FSP provides guidance clarifying how SFAS 157, should
be applied when valuing securities in markets that are not active. The guidance
provides an illustrative example that applies the objectives and framework of
SFAS 157, utilizing management’s internal cash flow and discount rate
assumptions when relevant observable data do not exist.  It further
clarifies how observable market information and market quotes should be
considered when measuring fair value in an inactive market.   It
reaffirms the notion of fair value as an exit price as of the measurement date
and that fair value analysis is a transactional process and should not be
broadly applied to a group of assets.  FAS 157-3 was effective upon
issuance including prior periods for which financial statements have not been
issued.  The implementation of FAS 157-3 did not have a material
effect on the fair value of our assets as we intend to continue the
methodologies used in previous quarters to value assets as defined under the
original SFAS 157.
 
 In October 2008 the Emergency Economic
Stabilization Act of 2008 (the “EESA”) was signed into law.  Section
133 of the EESA mandated that the SEC conduct a study on mark-to-market
accounting standards.  The SEC provided its study to the US Congress
on December 30, 2008.  Part of the recommendations within the study
indicated that “fair value requirements should be improved through development
of application and best practices guidance for determining fair value in
illiquid or inactive markets”.  As a result of this study and the
recommendations therein, on April 9, 2009, the FASB issued FSP FAS No. 157-4,
Determining Fair Value When
the Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly (“FAS
157-4”).  This FSP provides additional guidance on determining fair
value when the volume and level of activity for the asset or liability have
significantly decreased when compared with normal market activity for the asset
or liability (or similar assets or liabilities).  The FSP gives
specific factors to evaluate if there has been a decrease in normal market
activity and if so, provides a methodology to analyze transactions or quoted
prices and make necessary adjustments to fair value in accordance with SFAS
157.  The objective is to determine the point within a range of fair
value estimates that is most representative of fair value under current market
conditions.  FAS 157-4 became effective for us on June 30,
2009.
 
 Additionally, in conjunction with FAS
157-4, the FASB issued FSP FAS No. 115-2 and FSP FAS No. 124-2, Recognition and Presentation of
Other Than Temporary Impairments (“FAS 115-2 and FAS 124-2”).The objective of
the new guidance is to make impairment guidance more operational and to improve
the presentation and disclosure of other-than-temporary impairments (OTTI) on
debt and equity securities in financial statements.  This, too, was as
a result of the SEC mark-to-market study mandated under the EESA.  The
SEC’s recommendation was to “evaluate the need for modifications (or the
elimination) of current OTTI guidance to provide for a more uniform system of
impairment testing standards for financial instruments.”  The new
guidance revises the OTTI evaluation methodology.  Previously the
analytical focus was on whether the entity had the “intent and ability to retain
its investment in the debt security for a period of time sufficient to allow for
any anticipated recovery in fair value.”   Now the focus is on
whether the entity has the “intent to sell the debt security or, more likely
than not, will be required to sell the debt security before its anticipated
recovery.”  Further, the security is analyzed for credit loss (the
difference between the present value of cash flows expected to be collected and
the amortized cost basis).  If we do not intend to sell the debt
security, nor will be required to sell the debt security prior to its
anticipated recovery, the credit loss, if any, will be recognized in the
statement of earnings, while the balance of impairment related to other factors
will be recognized in Other Comprehensive Income (OCI).  If we intend
to sell the security, or will be required to sell the security before its
anticipated recovery, the full OTTI will be recognized in the statement of
earnings.  FAS 115-2 and FAS 124-2 became effective for us on June 30,
2009.  The adoption of these rules did not result in a cumulative
effect adjustment to retained earnings in the period of adoption but changed the
manner that we evaluate investment securities for other-than-temporary
impairments.
 
 32
 In April 2009, the FASB issued FSP FAS
No. 107-1 and Accounting Principles Board (“APB”) No. 28-1, Interim Disclosures about Fair Value
of Financial Instruments (“FAS 107-1 and APB 28-1”).The FSP requires
disclosures about fair value of financial instruments for interim reporting
periods as well as in annual financial statements.   The adoption
of FSP FAS 107-1 and APB 28-1 increased footnote disclosure.  This FSP
became effective for us on June 30, 2009.
  Any
changes to the valuation methodology are reviewed by management to ensure the
changes are appropriate. As markets and products develop and the pricing for
certain products becomes more transparent, we continue to refine our valuation
methodologies. The methods used by us may produce a fair value calculation that
may not be indicative of net realizable value or reflective of future fair
values. Furthermore, while we believe our valuation methods are appropriate and
consistent with other market participants, the use of different methodologies,
or assumptions, to determine the fair value of certain financial instruments
could result in a different estimate of fair value at the reporting
date.  We use inputs that are current as of the measurement date,
which may include periods of market dislocation, during which price transparency
may be reduced.  This condition could cause our financial instruments
to be reclassified from Level 2 to Level 3.
  As of June
30, 2009 and December 31, 2008, we have classified the valuation of our RMBS as
“Level 2” as described above.  There were no transfers between Levels
1, 2 and 3 between December 31, 2008 and June 30, 2009.
 
 Securitized
Loans Held for Investment
 
 Our
securitized residential mortgage loans are comprised of fixed-rate and
variable-rate loans.  We purchase pools of residential mortgage loans
through a select group of originators.  Mortgage loans are designated
as held for investment, recorded on trade date, and are carried at their
principal balance outstanding, plus any premiums or discounts which are
amortized or accreted over the estimated life of the loan, less allowances for
loan losses.
 
 Non-Agency
and Agency Residential Mortgage-Backed Securities
  We invest in RMBS representing
interests in obligations backed by pools of mortgage loans and carry those
securities at fair value estimated using a pricing model.  Management
reviews the fair values generated by the model to determine whether prices are
reflective of the current market.  Management performs a validation of
the fair value calculated by the pricing model by comparing its results to
independent prices provided by dealers in the securities and/or third party
pricing services.  If dealers or independent pricing services are
unable to provide a price for an asset, or if the price provided by them is
deemed unreliable by FIDAC, then the asset will be valued at its fair value as
determined in good faith by FIDAC.  In the current market, it may be
difficult or impossible to obtain third party pricing on certain of our
investments.   In addition, validating third party pricing for
our investments may be more subjective as fewer participants may be willing to
provide this service to us.  Moreover, the current market is more
illiquid than in recent history for some of the investments we
own.  Illiquid investments typically experience greater price
volatility as a ready market does not exist.  As volatility increases
or liquidity decreases, we may have greater difficulty financing its investments
which may negatively impact its earnings and the execution of its investment
strategy.
  33
 SFAS No.
115, Accounting for Certain
Investments in Debt and Equity Securities (“SFAS 115”), requires us to classify its
investment securities as either trading investments, available-for-sale
investments or held-to-maturity investments. We intend to hold its RMBS as
available-for-sale and as such may sell any of its RMBS as part of its overall
management of its portfolio.  All assets classified as
available-for-sale are reported at estimated fair value, with unrealized gains
and losses included in other comprehensive income.
 
 When the
fair value of an available-for-sale security is less than its amortized cost for
an extended period or there is a significant decline in value, we consider
whether there is other-than-temporary impairment in the value of the
security.  If, based on our analysis, a credit portion of
other-than-temporary impairment exists, the cost basis of the security is
written down to the then-current fair value, and the unrealized loss is
transferred from accumulated other comprehensive loss as an immediate reduction
of current earnings (as if the loss had been realized in the period of
other-than-temporary impairment).  The determination of
other-than-temporary impairment is a subjective process, and different judgments
and assumptions could affect the timing of loss realization.
  We
consider the following factors when determining other-than-temporary impairment
for a security:
  ·
              the
      length of time and the extent to which the market value has been less than
      the amortized cost;
  ·
              and
      the financial condition and near-term prospects of the
    issuer;
  ·
              the
      credit quality and cash flow performance of the security;
    and
  ·
              whether
      we will be more likely than not required to sell the investment before the
      expected recovery.
  The
determination of other-than-temporary impairment is made at least
quarterly.  If we determine an impairment to be other than temporary
we will realize a loss which will negatively impact current income.
  RMBS
transactions are recorded on the trade date.  Realized gains and
losses from sales of RMBS are determined based on the specific identification
method and recorded as a gain (loss) on sale of investments in the statement of
operations.  Accretion of discounts or amortization of premiums on
available-for-sale securities and mortgage loans is computed using the effective
interest yield method and is included as a component of interest income in the
statement of operations.
  In June 2009, the FASB issued SFAS
No.166, Accounting for
Transfers of Financial Assets (“SFAS 166”), which amends the
de-recognition guidance in SFAS 140.  SFAS 166 eliminates the concept of a
Qualified Special Purpose Entity (“QSPE”) and eliminates the exception from
applying FIN 46R.   Additionally, this Statement clarifies that the
objective of paragraph 9 of SFAS 140 is to determine whether a transferor has
surrendered control over transferred financial assets.   That determination
must consider the transferor’s continuing involvements in the transferred
financial asset, including all arrangements or agreements made contemporaneously
with, or in contemplation of, the transfer, even if they were not entered into
at the time of the transfer.   This Statement modifies the
financial-components approach used in Statement 140 and limits the circumstances
in which a financial asset, or portion of a financial asset, should be
derecognized when the transferor has not transferred the entire original
financial asset to an entity that is not consolidated with the transferor in the
financial statements being presented and/or when the transferor has continuing
involvement with the transferred financial asset.  It defines the term
“participating interest” to establish specific conditions for reporting a
transfer of a portion of a financial asset as a sale.  Under this
statement, when the transfer of financial assets are accounted for as a sale,
the transferor must recognize and initially measure at fair value all assets
obtained and liabilities incurred as a result of the transfer.  This
includes any retained beneficial interest.  The implementation of this
standard materially affects the securitization process in general, as it
eliminates off-balance sheet transactions when an entity retains any interest in
or control over assets transferred in this process.  However, we do
not believe the implementation of this standard will materially affect our
reporting as we have no off-balance sheet transactions nor any unconsolidated
QSPEs.  The effective date for SFAS 166 is January 1,
2010.
  In conjunction with SFAS 166, FASB
issued SFAS No. 167, Amendments to FIN 46R(“SFAS
167”).  This statement requires an enterprise to perform an analysis to
determine whether the enterprise’s variable interest or interests give it a
controlling financial interest in a variable interest entity.  The analysis
identifies the primary beneficiary of a VIE as the enterprise that has both: a)
the power to direct the activities that most significantly impact the entity’s
economic performance and b) the obligation to absorb losses of the entity or the
right to receive benefits from the entity which could potentially be significant
to the VIE.   With the removal of the QSPE exemption, established
QSPE’s must be evaluated for consolidation under this statement.  This
statement requires enhanced disclosures to provide users of financial statements
with more transparent information about and enterprises involvement in a
VIE.  We are not, currently, the primary beneficiary of any unconsolidated
VIEs.  Further, this statement also requires ongoing assessments of
whether an enterprise is the primary beneficiary of a VIE.  Should we
treat securitizations as sales in the future, we will analyze the
transactions under the guidelines of SFAS 167 for consolidation.  The
effective date for SFAS 167 is January 1, 2010.  Upon implementation and,
as required by the standard, on an ongoing basis, we shall assess the
applicability of this standard to our holdings and report
accordingly.
  34
  Interest
Income
 
 Interest income on RMBS and loans held
for investment is recognized over the life of the investment using the effective
interest method as described by SFAS No. 91, Accounting for Nonrefundable Fees
and Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases (“SFAS 91”),for securities of high
credit quality and Emerging Issues Task Force (“EITF”) No. 99-20, Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets, as amended by FSP EITF No. 99-20-1,Amendments to the Impairment
Guidance of EITF Issue 99-20 (“EITF 99-20-1”), for all other
securities.  Income recognition is suspended for loans when, in the
opinion of management, a full recovery of income and principal becomes
doubtful.  Income recognition is resumed when the loan becomes
contractually current and performance is demonstrated to be
resumed.
 
 In January 2009, the FASB issued EITF
99-20-1.EITF
99-20-1 was issued in an effort to provide a more consistent determination on
whether an other-than-temporary impairment has occurred for certain beneficial
interests in securitized financial assets.  Other-than-temporary
impairment has occurred if there has been an adverse change in future estimated
cash flow and its impact reflected in current earnings.  The
determination cannot be overcome by management judgment of the probability of
collecting all cash flows previously projected.  For debt securities
that are not within the scope of EITF 99-20-1, SFAS 115 continues to
apply.  The objective of other-than-temporary impairment analysis is
to determine whether it is probable that the holder will realize some portion of
the unrealized loss on an impaired security.  Factors to consider when
making an other-than-temporary impairment decision include information about
past events, current conditions, reasonable and supportable forecasts, remaining
payment terms, financial condition of the issuer, expected defaults, value of
underlying collateral, industry analysis, sector credit rating, credit
enhancement, and financial condition of guarantor.  Our non-Agency
RMBS investments fall under the guidance of this EITF and as such we assess each
security for other-than-temporary impairments based on estimated future cash
flows.  This EITF became effective for us on December 31,
2008.
 
 Accounting
For Derivative Financial Instruments and Hedging Activities
 
 Our
policies permit us to enter into derivative contracts, including interest rate
swaps and interest rate caps, as a means of mitigating our interest rate risk.
We intend to use interest rate derivative instruments to mitigate interest rate
risk rather than to enhance returns. If we hedge using interest rate swaps we
account for these instruments as free-standing
derivatives.  Accordingly, they are carried at fair value with
realized and unrealized gains and losses recognized in earnings.
  We account
for derivative financial instruments in accordance with SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities (“SFAS 133”), as amended and
interpreted. SFAS 133 requires an entity to recognize all derivatives as either
assets or liabilities in the statement of financial condition and to measure
those instruments at fair value. Additionally, the fair value adjustments will
affect either other comprehensive income in stockholders’ equity until the
hedged item is recognized in earnings or net income depending on whether the
derivative instrument qualifies as a hedge for accounting purposes and, if so,
the nature of the hedging activity.
  35
 In March 2008, the FASB issued SFAS No.
161, Disclosures about
Derivative Instruments and Hedging Activities, an amendment of FASB Statement
No. 133(“SFAS 161”).  SFAS 161 attempts to improve the
transparency of financial reporting by providing additional information about
how derivative and hedging activities affect an entity’s financial position,
financial performance and cash flows.  This statement changes the
disclosure requirements for derivative instruments and hedging activities by
requiring enhanced disclosure about (1) how and why an entity uses derivative
instruments, (2) how derivative instruments and related hedged items are
accounted for under SFAS Statement 133 and its related interpretations, and (3)
how derivative instruments and related hedged items affect an entity’s financial
position, financial performance, and cash flows.  To meet these
objectives, SFAS 161 requires qualitative disclosures about objectives and
strategies for using derivatives, quantitative disclosures about fair value
amounts of gains and losses on derivative instruments, and disclosures about
credit-risk-related contingent features in derivative
agreements.  This disclosure framework is intended to better convey
the purpose of derivative use in terms of the risks that an entity is intending
to manage.  SFAS 161 was effective and adopted by us on January 1,
2009.   The adoption of SFAS 161 will increase footnote
disclosure if we engage in hedging activities.
 
 In
the normal course of business, we may use a variety of derivative financial
instruments to economically manage, or hedge, interest rate risk. These
derivative financial instruments must be effective in reducing our interest rate
risk exposure in order to qualify for hedge accounting. When the terms of an
underlying transaction are modified, or when the underlying hedged item ceases
to exist, all changes in the fair value of the instrument are included in net
income for each period until the derivative instrument matures or is settled.
Any derivative instrument used for risk management that does not meet the
hedging criteria is carried at fair value with the changes in value included in
net income.
  Derivatives
will be used for economic hedging purposes rather than speculation. We will rely
on quotations from third parties to determine fair values.  If our
hedging activities do not achieve our desired results, our reported earnings may
be adversely affected.
  Allowance
for Probable Credit Losses
  We have established an allowance for
loan losses at a level that management believes is adequate based on an
evaluation of known and inherent probable losses related to our loan
portfolio.  The estimate is based on a variety of factors
including current economic conditions, industry loss experience, the loan
originator’s loss experience, credit quality trends, loan portfolio composition,
delinquency trends, national and local economic trends, national unemployment
data, changes in housing  appreciation or depreciation and whether
specific geographic areas where we have significant loan concentrations are
experiencing adverse economic conditions and events such as natural disasters
that may affect the local economy or property values. Upon purchase of the pools
of loans, we obtained written representations and warranties from the sellers
that we could be reimbursed for the value of the loan if the loan fails to meet
the agreed upon origination standards.  While we have little history
of its own to establish loan trends, delinquency trends of the originators and
the current market conditions aid in determining the allowance for loan
losses.  We also performed due diligence procedures on a sample of
loans that met its criteria during the purchase process.  We have
created an unallocated provision for probable loan losses estimated as a
percentage of the remaining principal on the loans.  Management’s
estimate is based on historical experience of similarly underwritten
pools.
 
 When we
determine it is probable that specific contractually due amounts are
uncollectible, the amount is considered impaired.  Where impairment is
indicated, a valuation write-off is measured based upon the excess of the
recorded investment over the net fair value of the collateral, reduced by
selling costs.  Any deficiency between the carrying amount of an asset
and the net sales price of repossessed collateral is charged to the allowance
for loan losses.
  Income
Taxes
 
 We have
elected and intend to qualify to be taxed as a REIT.  Therefore we
will generally not be subject to corporate federal or state income tax to the
extent that we make qualifying distributions to our stockholders, and provided
we satisfy on a continuing basis, through actual investment and operating
results, the REIT requirements including certain asset, income, distribution and
stock ownership tests.
  36
 If we fail
to qualify as a REIT, and do not qualify for certain statutory relief
provisions, we will be subject to federal, state and local income taxes and may
be precluded from qualifying as a REIT for the subsequent four taxable years
following the year in which we lost our REIT
qualification.  Accordingly, our failure to qualify as a REIT could
have a material adverse impact on our results of operations and amounts
available for distribution to our stockholders.
  The
dividends paid deduction of a REIT for qualifying dividends to its stockholders
is computed using our taxable income as opposed to net income reported on the
consolidated financial statements.  Taxable income, generally, will
differ from net income reported on the consolidated financial statements because
the determination of taxable income is based on tax provisions and not financial
accounting principles.
  We account for income taxes in
accordance with SFAS No. 109, Accounting for Income Taxes
(“SFAS 109”), which requires the recognition of deferred income taxes for
differences between the basis of assets and liabilities for financial statement
and income tax purposes.  Deferred tax assets and liabilities
represent the future tax consequence for those differences, which will either be
taxable or deductible when the assets and liabilities are recovered or
settled.  Deferred taxes are also recognized for operating losses that
are available to offset future taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized. In July 2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income
Taxes (“FIN 48”), an interpretation of SFAS 109. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in a company’s financial
statements and prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position
taken or expected to be taken in an income tax return. FIN 48 also provides
guidance on de-recognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition.  FIN 48
was effective for us upon inception and its effect continues not to be
material.
 
 Subsequent
Events
 
 In May
2009, the FASB issued SFAS No. 165, Subsequent Events ("SFAS 165").  SFAS
165 establishes general standards governing accounting for and disclosure of
events that occur after the balance sheet date but before the financial
statements are issued or are available to be issued.  SFAS 165 also
provides guidance on the period after the balance sheet date during which
management of a reporting entity should evaluate events or transactions that may
occur for potential recognition or disclosure in the financial statements, the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements and the
disclosures that an entity should make about events or transactions occurring
after the balance sheet date. We adopted SFAS 165 effective June 30, 2009, and
adoption had no impact on the Company’s consolidated financial statements. We
have evaluated subsequent events through the filing date of this Quarterly
Report on Form 10-Q, which is August 10, 2009.
 
 Financial
Condition
 
 At June
30, 2009, our portfolio consisted of $1.7 billion of non-Agency RMBS, $1.9
billion of Agency RMBS and $530.6 million of securitized mortgage
loans.
 
 The
following table summarizes certain characteristics of our portfolio at the
quarters ended June 30, 2009 and 2008 and quarter ended March 31,
2009.
 
 For
      the Quarter Ended June 30, 2009
                    
                    
                    For
      the Quarter Ended June 30, 2008
                    
                    
                    For
      the Quarter Ended March 31, 2009(dollars
      in thousands)Interest
      earning assets at period-end
                    
                    $
                    4,166,730
                    
                    
                    $
                    1,880,249
                    
                    
                    $
                    1,651,687Interest
      bearing liabilities at period-end
                    
                    $
                    1,943,413
                    
                    
                    $
                    1,413,486
                    
                    
                    $
                    1,033,094Leverage
      at period-end
                    
                    1.0:1
                    
                    
                    3.6:1
                    
                    
                    2.4:1Portfolio
      Composition:Non-Agency
      MBS
                    
                    
                    55.5
                    %
                    
                    
                    61.8
                    %
                    
                    
                    54.2
                    %Agency
      MBS
                    
                    
                    34.5
                    %
                    
                    
                    -
                    
                    
                    
                    17.4
                    %Residential
      mortgage
                    
                    
                    -
                    
                    
                    
                    7.7
                    %
                    
                    
                    -Loans
      collateralizing secured debt
                    
                    
                    10.0
                    %
                    
                    
                    30.5
                    %
                    
                    
                    28.4
                    %Fixed-rate
      % of portfolio
                    
                    
                    59.7
                    %
                    
                    
                    20.0
                    %
                    
                    
                    35.8
                    %Adjustable-rate
      % of portfolio
                    
                    
                    40.3
                    %
                    
                    
                    80.0
                    %
                    
                    
                    64.2
                    %Annualized
      yield on average earning assets during the
                      period
                    
                    
                    6.83
                    %
                    
                    
                    6.18
                    %
                    
                    
                    6.44
                    %Annualized
      cost of funds on average borrowed funds
                      during
      the period
                    
                    
                    2.40
                    %
                    
                    
                    5.53
                    %
                    
                    
                    3.48
                    %Weighted
      average yield on assets at period-end
                    
                    
                    10.29
                    %
                    
                    
                    6.18
                    %
                    
                    
                    7.21
                    %Weighted
      average cost of funds at period-end
                    
                    
                    1.78
                    %
                    
                    
                    5.35
                    %
                    
                    
                    3.57
                    %
 
 
 The
following tables summarize certain characteristics of each asset class in our
portfolio at June 30, 2009 and December 31, 2008:
 
 June
      30, 2009
                          
                          Non-Agency
                            Mortgage-
                            Backed
                            Securities
                          
                          
                          Agency
                            Mortgage-Backed
      Securities
                          
                          
                          Secured
      LoansWeighted
      average cost basis
                          
                          
                          66.59
                          
                          
                          
                          103.61
                          
                          
                          
                          101.02Weighted
      average fair value (1)
                          
                          
                          59.26
                          
                          
                          
                          103.39
                          
                          
                          
                          101.02Weighted
      average coupon
                          
                          
                          5.84
                          %
                          
                          
                          5.52
                          %
                          
                          
                          5.94
                          %Fixed-rate
      % of portfolio
                          
                          
                          20.8
                          %
                          
                          
                          34.5
                          %
                          
                          
                          4.4
                          %Adjustable-rate
      % of portfolio
                          
                          
                          34.7
                          %
                          
                          
                          -
                          
                          
                          
                          5.6
                          %Weighted
      average yield on assets at period-end
                          
                          
                          14.85
                          %
                          
                          
                          4.39
                          %
                          
                          
                          5.24
                          %Weighted
      average cost of funds at period-end
                          
                          
                          1.79
                          %
                          
                          
                          0.49
                          %
                          
                          
                          5.64
                          %Weighted
      average 3 month CPR at period-end (2)
                          
                          
                          16.0
                          %
                          
                          
                          24.3
                          %
                          
                          
                          21.2
                          %
 
 
 December
      31, 2008
                          
                          Non-Agency
                            Mortgage-
                            Backed
                            Securities
                          
                          
                          Agency
                            Mortgage-Backed
                            Securities
                          
                          
                          Secured
      LoansWeighted
      average cost basis
                          
                          
                          98.01
                          
                          
                          
                          102.71
                          
                          
                          
                          101.03Weighted
      average fair value (1)
                          
                          
                          68.16
                          
                          
                          
                          103.58
                          
                          
                          
                          101.03Weighted
      average coupon
                          
                          
                          5.97
                          %
                          
                          
                          6.69
                          %
                          
                          
                          5.95
                          %Fixed-rate
      % of portfolio
                          
                          
                          1.3
                          %
                          
                          
                          13.7
                          %
                          
                          
                          15.0
                          %Adjustable-rate
      % of portfolio
                          
                          
                          51.2
                          %
                          
                          
                          -
                          
                          
                          
                          18.8
                          %Weighted
      average yield on assets at period-end
                          
                          
                          6.69
                          %
                          
                          
                          6.00
                          %
                          
                          
                          4.73
                          %Weighted
      average cost of funds at period-end
                          
                          
                          1.64
                          %
                          
                          
                          0.55
                          %
                          
                          
                          5.55
                          %Weighted
      average 3 month CPR at period-end (2)
                          
                          
                          12.5
                          %
                          
                          
                          14.5
                          %
                          
                          
                          7.8
                          %
 (1)   Secured
loans are carried at amortized cost.
 (2)   Represents
the estimated percentage of principal that will be prepaid over the next three
months based on historical principal paydowns.
 
 37
 
 The table
below summarizes our RMBS investments at June 30, 2009 and December 31,
2008:
 
 June
      30, 2009
                                                          
                                                          
                                                          December
      31, 2008Non-agency
                                                            RMBS
                                                          
                                                          
                                                          Agency
      RMBS
                                                          
                                                          
                                                          Non-agency
                                                            RMBS
                                                          
                                                          
                                                          Agency
      RMBS(dollars
      in thousands)Principal
      value
                                                          
                                                          $
                                                          2,947,419
                                                          
                                                          
                                                          $
                                                          1,827,573
                                                          
                                                          
                                                          $
                                                          899,456
                                                          
                                                          
                                                          $
                                                          233,976Unamortized
      premium
                                                          
                                                          
                                                          2,253
                                                          
                                                          
                                                          
                                                          65,890
                                                          
                                                          
                                                          
                                                          2,105
                                                          
                                                          
                                                          
                                                          6,350Unamortized
      discount
                                                          
                                                          
                                                          (987,013
                                                          )
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          (19,753
                                                          )
                                                          
                                                          
                                                          -Gross
      unrealized gain
                                                          
                                                          
                                                          34,560
                                                          
                                                          
                                                          
                                                          8,306
                                                          
                                                          
                                                          
                                                          5,665
                                                          
                                                          
                                                          
                                                          2,036Gross
      unrealized loss
                                                          
                                                          
                                                          (250,676
                                                          )
                                                          
                                                          
                                                          (12,219
                                                          )
                                                          
                                                          
                                                          (274,368
                                                          )
                                                          
                                                          
                                                          -Fair
      value
                                                          
                                                          $
                                                          1,746,543
                                                          
                                                          
                                                          $
                                                          1,889,550
                                                          
                                                          
                                                          $
                                                          613,105
                                                          
                                                          
                                                          $
                                                          242,362
 
 
 As of June
30, 2009, the RMBS in our portfolio were purchased at a net discount to
their par value.  Our RMBS had a weighted average amortized cost of
80.8% and 99.0% at June 30, 2009 and December 31, 2008,
respectively.
 
 Actual
maturities of RMBS are generally shorter than stated contractual maturities, as
they are affected by the contractual lives of the underlying mortgages, periodic
payments of principal, and prepayments of principal. The stated contractual
final maturity of the mortgage loans underlying our portfolio of RMBS ranges up
to 38 years, but the expected maturity is subject to change based on the
prepayments of the underlying loans. As of June 30, 2009, the average final
contractual maturity of the RMBS portfolio is 29 years, and as of December
31, 2008, it was 30 years.  The estimated weighted average months to
maturity of the RMBS in the tables below are based upon our prepayment
expectations, which are based on both proprietary and subscription-based
financial models.  Our prepayment projections consider current and expected
trends in interest rates, interest rate volatility, steepness of the yield
curve, the mortgage rate of the outstanding loan, time to reset and the spread
margin of the reset.
 
 The
constant prepayment rate, or CPR, attempts to predict the percentage of
principal that will be prepaid over a period of time.  We calculate
average CPR on a quarterly basis based on historical principal paydowns. As
interest rates rise, the rate of re-financings typically declines, which we
expect may result in lower rates of prepayment and, as a result, a lower
portfolio CPR. Conversely, as interest rates fall, the rate of re-financings
typically increases, which we expect may result in higher rates of prepayment
and, as a result, a higher portfolio CPR.
 
 After the
reset date, interest rates on our hybrid adjustable rate RMBS securities adjust
annually based on spreads over various LIBOR and Treasury indices. These
interest rates are subject to caps that limit the amount the applicable interest
rate can increase during any year, known as periodic cap, and through the
maturity of the applicable security, known as a lifetime cap. The weighted
average periodic cap for the portfolio is an increase of 0.8% and the weighted
average maximum lifetime increases and decreases for the portfolio are
8.2%.




38




The
following tables summarize our RMBS according to their estimated weighted
average life classifications at June 30, 2009 and December 31, 2008:
 
 June
      30, 2009(dollars
      in thousands)Non-Agency
      RMBS
                                                            
                                                            
                                                            Agency
      RMBSWeighted
      Average Life
                                                            
                                                            Fair
      Value
                                                            
                                                            
                                                            Amortized
      Cost
                                                            
                                                            
                                                            Fair
      Value
                                                            
                                                            
                                                            Amortized
      CostLess
      than one year
                                                            
                                                            $
                                                            18,224
                                                            
                                                            
                                                            $
                                                            16,871
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -Greater
      than one year and less than five years
                                                            
                                                            
                                                            1,037,971
                                                            
                                                            
                                                            
                                                            1,210,743
                                                            
                                                            
                                                            
                                                            1,761,731
                                                            
                                                            
                                                            
                                                            1,765,541Greater
      than five years
                                                            
                                                            
                                                            690,348
                                                            
                                                            
                                                            
                                                            735,045
                                                            
                                                            
                                                            
                                                            127,819
                                                            
                                                            
                                                            
                                                            127,922Total
                                                            
                                                            $
                                                            1,746,543
                                                            
                                                            
                                                            $
                                                            1,962,659
                                                            
                                                            
                                                            $
                                                            1,889,550
                                                            
                                                            
                                                            $
                                                            1,893,463
 
 
 December
      31, 2008(dollars
      in thousands)Non-Agency
      RMBS
                                                              
                                                              
                                                              Agency
      RMBSWeighted
      Average Life
                                                              
                                                              Fair
      Value
                                                              
                                                              
                                                              Amortized
      Cost
                                                              
                                                              
                                                              Fair
      Value
                                                              
                                                              
                                                              Amortized
      CostLess
      than one year
                                                              
                                                              $
                                                              -
                                                              
                                                              
                                                              $
                                                              -
                                                              
                                                              
                                                              $
                                                              -
                                                              
                                                              
                                                              $
                                                              -Greater
      than one year and less than five years
                                                              
                                                              
                                                              525,801
                                                              
                                                              
                                                              
                                                              735,508
                                                              
                                                              
                                                              
                                                              242,362
                                                              
                                                              
                                                              
                                                              240,326Greater
      than five years
                                                              
                                                              
                                                              87,304
                                                              
                                                              
                                                              
                                                              146,300
                                                              
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              -Total
                                                              
                                                              $
                                                              613,105
                                                              
                                                              
                                                              $
                                                              881,808
                                                              
                                                              
                                                              $
                                                              242,362
                                                              
                                                              
                                                              $
                                                              240,326
 
 
 Results
of Operations for the Quarters and Six Months Ended June 30, 2009 and
2008.
 
 Net
Income/Loss Summary
 
 Our
net income for the quarter ended June 30, 2009 was $51.6 million, or $0.10 per
share. Our net income was generated primarily by interest income on our
portfolio.  Our net income for the quarter ended June 30, 2008 was
$33.9 million, or $0.87 per share.  We attribute the decrease in our
net income per share for the quarter ended June 30, 2009 as compared to June 30,
2008 to the unrealized gain on our interest rate swaps recorded during the
second quarter 2008.  Our income for the second quarter 2008 consisted
primarily of interest income and unrealized gains on interest rate
swaps.
 
 Our net income for the six months ended
June 30, 2009 was $70.5 million, or $0.21 per share.  Our net income
was generated primarily by interest income on our portfolio.  Our net
loss for the six months ended June 30, 2008 was $21.0 million or ($0.54) per
share.  We attribute the net loss for the six months ended June 30,
2008 primarily to unrealized losses on our interest rate swaps due to fair value
adjustments and realized losses on sales of investments.
 
 39
  The table
below presents the net income/loss summary for the quarters and six months ended
June 30, 2009 and 2008:
 
 Net
Income/Loss Summary
 (dollars in thousands,
except for share and per share data)
 
 For
      the Quarter Ended June 30,
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              For
      the Six Months Ended June 30,2009
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              2008
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              2009
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              2008Net
      Interest income:Interest
      income
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              65,077
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              29,951
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              93,084
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              58,145Interest
      expense
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              8,313
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              20,025
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              17,355
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              34,047Net
      interest income
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              56,764
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              9,926
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              75,729
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              24,098Other-than-temporary
      impairments:Total
      other-than-temporary impairment
                                                                                                                                                                                                                                                                                                losses
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (8,575
                                                                                                                                                                                                                                                                                              )
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              -
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (8,575
                                                                                                                                                                                                                                                                                              )
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              -Non-credit
      portion of loss recognized in
                                                                                                                                                                                                                                                                                                other
      comprehensive income
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              2,080
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              -
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              2,080
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              -Net
      other-than-temporary impairment
                                                                                                                                                                                                                                                                                                losses
                                                                                                                                                                                                                                                                                                included
      in income
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (6,495
                                                                                                                                                                                                                                                                                              )
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              -
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (6,495
                                                                                                                                                                                                                                                                                              )
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              -Other
      gains (losses):Unrealized
      gains (losses) on interest rate
                                                                                                                                                                                                                                                                                                swaps
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              -
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              25,584
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              -
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (5,909
                                                                                                                                                                                                                                                                                              )Realized
      gains (losses) on sales of
                                                                                                                                                                                                                                                                                                investments,
      net
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              9,321
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              1,644
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              12,948
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (31,174
                                                                                                                                                                                                                                                                                              )Realized
      gains on terminations of
                                                                                                                                                                                                                                                                                                interest
      rate swaps
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              -
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              123
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              -
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              123Total
      other gains (losses)
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              9,321
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              27,351
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              12,948
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (36,960
                                                                                                                                                                                                                                                                                              )Net
      investment income (expense)
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              59,590
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              37,277
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              82,182
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (12,862
                                                                                                                                                                                                                                                                                              )Other
      expenses:Management
      fee
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              5,955
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              2,228
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              8,539
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              4,455Provision
      for loan losses
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              1,130
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (15
                                                                                                                                                                                                                                                                                              )
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              1,363
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              1,164General
      and administrative expenses
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              861
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              1,167
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              1,766
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              2,555Total
      other expenses
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              7,946
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              3,380
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              11,668
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              8,174Income
      (loss) before income taxes
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              51,644
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              33,897
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              70,514
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (21,036
                                                                                                                                                                                                                                                                                              )Income
      tax
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              -
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              -
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              1
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              3Net
      income (loss)
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              51,644
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              33,897
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              70,513
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              (21,039
                                                                                                                                                                                                                                                                                              )Net
      income (loss) per share – basic and
                                                                                                                                                                                                                                                                                                diluted
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              0.10
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              0.87
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              0.21
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              (0.54
                                                                                                                                                                                                                                                                                              )Weighted
      average number of shares
                                                                                                                                                                                                                                                                                                outstanding
      – basic and diluted
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              503,110,132
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              38,999,850
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              341,053,858
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              38,995,096Comprehensive
      income (loss):Net
      income (loss)
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              51,644
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              33,897
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              70,513
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              (21,039
                                                                                                                                                                                                                                                                                              )Other
      comprehensive income (loss):Unrealized
      gain (loss) on available-
                                                                                                                                                                                                                                                                                                for-sale
      securities
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              39,501
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (58,051
                                                                                                                                                                                                                                                                                              )
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              53,092
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (146,308
                                                                                                                                                                                                                                                                                              )Reclassification
      adjustment for net losses
                                                                                                                                                                                                                                                                                                included
      in net income for other-than-
                                                                                                                                                                                                                                                                                                temporary
      impairments
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              6,495
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              -
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              6,495
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              -Reclassification
      adjustment for
                                                                                                                                                                                                                                                                                                realized
      (gains) losses included
                                                                                                                                                                                                                                                                                                in
      net income
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (9,321
                                                                                                                                                                                                                                                                                              )
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (1,644
                                                                                                                                                                                                                                                                                              )
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (12,948
                                                                                                                                                                                                                                                                                              )
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              31,174Other
      comprehensive income (loss)
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              36,675
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (59,695
                                                                                                                                                                                                                                                                                              )
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              46,639
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              (115,134
                                                                                                                                                                                                                                                                                              )Comprehensive
      income (loss)
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              88,319
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              (25,798
                                                                                                                                                                                                                                                                                              )
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              117,152
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              
                                                                                                                                                                                                                                                                                              $
                                                                                                                                                                                                                                                                                              (136,173
                                                                                                                                                                                                                                                                                              )See
      notes to consolidated financial statements.




40




Interest
Income and Average Earning Asset Yield
 
 We had average earning assets of $3.8
billion and $1.9 billion for the quarters ended June 30, 2009 and 2008, and $2.8
billion and $1.7 billion for the six months ended June 30, 2009 and 2008,
respectively.  Our interest income was $65.1 million and $30.0 million
for the quarters ended June 30, 2009 and 2008 and $93.1 million and $58.1
million for the six months ended June 30, 2009 and 2008,
respectively.  Our interest income increase resulted from the increase
in our interest earning assets which followed our 2009 secondary
offerings.  The annualized yield on our portfolio was 6.83% and 6.18%
for the quarters ended June 30, 2009 and 2008 and 6.70% and 6.38% for the six
months ended June 30, 2009 and 2008, respectively.  The increase in
the annualized yield is attributed to the purchase of higher yielding assets
with the proceeds from our 2009 secondary offerings.
 
 Interest Expense and the Cost of
Funds
 
 Our
largest expense is the cost of borrowed funds.  We had average
borrowed funds of $1.4 billion and $1.5 billion and total interest expense of
$8.3 million and $20.0 million for the quarters ended June 30, 2009 and 2008,
respectively.  We had average borrowed funds of $1.2 billion and $1.4
billion and total interest expense of $17.4 million and $34.0 million for the
six months ended June 30, 2009 and 2008, respectively.  Our annualized
cost of funds was 2.40% and 5.53% for the quarters ended June 30, 2009 and 2008,
and 2.86% and 4.91% for the six months ended June 30, 2009 and 2008,
respectively.  The decline in interest expense is related to a
decrease in the borrowing rates for the quarter ended June 30, 2009 as compared
to the quarter ended June 30, 2008, the decrease in borrowed funds, and the
termination of interest rate swaps.
  The table
below shows our average borrowed funds, interest expense, average cost of funds,
average one-month LIBOR, average six-month LIBOR, average one-month LIBOR
relative to average six-month LIBOR, and average cost of funds relative to
average one- and six- month LIBOR for the quarters ended June 30, 2009, March
31, 2009, year ended December 31, 2008, the quarters ended December 31, 2008,
September 30, 2008, and June 30, 2008.
  Average
Cost of Funds
 (Ratios
have been annualized, dollars in thousands)
 
 Average
                                                                              Borrowed
                                                                              Funds
                                                                            
                                                                            
                                                                            Interest
                                                                              Expense
                                                                            
                                                                            
                                                                            Average
                                                                              Cost
      of
                                                                              Funds
                                                                            
                                                                            
                                                                            Average
                                                                              One-
                                                                              Month
                                                                              LIBOR
                                                                            
                                                                            
                                                                            Average
                                                                              Six-Month
                                                                              LIBOR
                                                                            
                                                                            
                                                                            Average
      One-
                                                                              Month
      LIBOR Relative to
                                                                              Average
      Six-
                                                                              Month
      LIBOR
                                                                            
                                                                            
                                                                            Average
      Cost of Funds Relative
                                                                              to
      Average
                                                                              One-Month
                                                                              LIBOR
                                                                            
                                                                            
                                                                            Average
      Cost of Funds Relative to Average Six-
                                                                              Month
      LIBORFor
      the quarter ended June 30, 2009
                                                                            
                                                                            $
                                                                            1,386,535
                                                                            
                                                                            
                                                                            $
                                                                            8,313
                                                                            
                                                                            
                                                                            
                                                                            2.40
                                                                            %
                                                                            
                                                                            
                                                                            0.37
                                                                            %
                                                                            
                                                                            
                                                                            1.39
                                                                            %
                                                                            
                                                                            
                                                                            (1.02
                                                                            %)
                                                                            
                                                                            
                                                                            2.03
                                                                            %
                                                                            
                                                                            
                                                                            1.01
                                                                            %For
      the quarter ended March 31, 2009
                                                                            
                                                                            $
                                                                            1,038,460
                                                                            
                                                                            
                                                                            $
                                                                            9,042
                                                                            
                                                                            
                                                                            
                                                                            3.48
                                                                            %
                                                                            
                                                                            
                                                                            0.46
                                                                            %
                                                                            
                                                                            
                                                                            1.74
                                                                            %
                                                                            
                                                                            
                                                                            (1.28
                                                                            %)
                                                                            
                                                                            
                                                                            3.02
                                                                            %
                                                                            
                                                                            
                                                                            1.74
                                                                            %For
      the year ended December 31, 2008
                                                                            
                                                                            $
                                                                            1,304,873
                                                                            
                                                                            
                                                                            $
                                                                            60,544
                                                                            
                                                                            
                                                                            
                                                                            4.64
                                                                            %
                                                                            
                                                                            
                                                                            2.68
                                                                            %
                                                                            
                                                                            
                                                                            3.06
                                                                            %
                                                                            
                                                                            
                                                                            (0.38
                                                                            %)
                                                                            
                                                                            
                                                                            1.96
                                                                            %
                                                                            
                                                                            
                                                                            1.58
                                                                            %For
      the quarter ended December 31, 2008
                                                                            
                                                                            $
                                                                            1,105,239
                                                                            
                                                                            
                                                                            $
                                                                            10,954
                                                                            
                                                                            
                                                                            
                                                                            3.96
                                                                            %
                                                                            
                                                                            
                                                                            2.23
                                                                            %
                                                                            
                                                                            
                                                                            2.94
                                                                            %
                                                                            
                                                                            
                                                                            (0.71
                                                                            %)
                                                                            
                                                                            
                                                                            1.73
                                                                            %
                                                                            
                                                                            
                                                                            1.02
                                                                            %For  the
      quarter ended September 30, 2008
                                                                            
                                                                            $
                                                                            1,339,531
                                                                            
                                                                            
                                                                            $
                                                                            15,543
                                                                            
                                                                            
                                                                            
                                                                            4.64
                                                                            %
                                                                            
                                                                            
                                                                            2.62
                                                                            %
                                                                            
                                                                            
                                                                            3.19
                                                                            %
                                                                            
                                                                            
                                                                            (0.57
                                                                            %)
                                                                            
                                                                            
                                                                            2.02
                                                                            %
                                                                            
                                                                            
                                                                            1.45
                                                                            %For  the
      quarter ended June 30, 2008
                                                                            
                                                                            $
                                                                            1,449,567
                                                                            
                                                                            
                                                                            $
                                                                            20,025
                                                                            
                                                                            
                                                                            
                                                                            5.53
                                                                            %
                                                                            
                                                                            
                                                                            2.59
                                                                            %
                                                                            
                                                                            
                                                                            2.93
                                                                            %
                                                                            
                                                                            
                                                                            (0.34
                                                                            %)
                                                                            
                                                                            
                                                                            2.94
                                                                            %
                                                                            
                                                                            
                                                                            2.60
                                                                            %
 
 Net
Interest Income
 
 Our net interest income, which equals
interest income less interest expense, totaled $56.8 million and $9.9 million
for the quarters ended June 30, 2009 and 2008, and $75.7 million and $24.1
million for the six months ended June 30, 2009 and 2008, respectively. Our net
interest spread, which equals the yield on our average assets for the period
less the average cost of funds for the period, was 4.43% and 0.65% for the
quarters ended June 30, 2009 and 2008 and 3.84% and 1.47% for the six months
ended June 30, 2009 and 2008, respectively.  We attribute the increase in
net interest income and net interest spread to the decline in the interest rates
at which we borrow funds, the purchase of higher yielding assets following our
2009 secondary offerings, and the termination of interest rate
swaps.




41




The table
below shows our average assets held, total interest earned on assets, yield on
average interest earning assets, average balance of repurchase agreements,
interest expense, average cost of funds, net interest income, and net interest
rate spread for the quarter ended June 30, 2009, March 31, 2009, the year ended
December 31, 2008, the quarter ended December 31, 2008, September 31, 2008 and
June 30, 2008.
  Net
Interest Income
 (Ratios
have been annualized, dollars in thousands)
 
 Average
                                                                              Earning
                                                                              Assets
      Held
                                                                            
                                                                            
                                                                            Interest
                                                                              Earned
      on
                                                                              Assets
                                                                            
                                                                            
                                                                            Yield
      on
                                                                              Average
                                                                              Interest
                                                                              Earning
                                                                              Assets
                                                                            
                                                                            
                                                                            Average
                                                                              Debt
                                                                              Balance
                                                                            
                                                                            
                                                                            Interest
                                                                              Expense
                                                                            
                                                                            
                                                                            Average
                                                                              Cost
      of
                                                                              Funds
                                                                            
                                                                            
                                                                            Net
                                                                              Interest
                                                                              Income
                                                                            
                                                                            
                                                                            Net
                                                                              Interest
                                                                              Rate
                                                                              SpreadFor
      the quarter ended
                                                                              June
      30, 2009
                                                                            
                                                                            $
                                                                            3,812,897
                                                                            
                                                                            
                                                                            $
                                                                            65,077
                                                                            
                                                                            
                                                                            
                                                                            6.83
                                                                            %
                                                                            
                                                                            $
                                                                            1,386,535
                                                                            
                                                                            
                                                                            $
                                                                            8,313
                                                                            
                                                                            
                                                                            
                                                                            2.40
                                                                            %
                                                                            
                                                                            $
                                                                            56,764
                                                                            
                                                                            
                                                                            
                                                                            4.43
                                                                            %For
      the quarter ended
                                                                              March
      31, 2009
                                                                            
                                                                            $
                                                                            1,739,767
                                                                            
                                                                            
                                                                            $
                                                                            28,007
                                                                            
                                                                            
                                                                            
                                                                            6.44
                                                                            %
                                                                            
                                                                            $
                                                                            1,038,460
                                                                            
                                                                            
                                                                            $
                                                                            9,042
                                                                            
                                                                            
                                                                            
                                                                            3.48
                                                                            %
                                                                            
                                                                            $
                                                                            18,965
                                                                            
                                                                            
                                                                            
                                                                            2.96
                                                                            %For
      the year ended
                                                                              December
      31, 2008
                                                                            
                                                                            $
                                                                            1,711,705
                                                                            
                                                                            
                                                                            $
                                                                            102,093
                                                                            
                                                                            
                                                                            
                                                                            5.96
                                                                            %
                                                                            
                                                                            $
                                                                            1,304,873
                                                                            
                                                                            
                                                                            $
                                                                            60,544
                                                                            
                                                                            
                                                                            
                                                                            4.64
                                                                            %
                                                                            
                                                                            $
                                                                            44,715
                                                                            
                                                                            
                                                                            
                                                                            1.32
                                                                            %For
      the quarter ended
                                                                              December
      31, 2008
                                                                            
                                                                            $
                                                                            1,621,205
                                                                            
                                                                            
                                                                            $
                                                                            23,254
                                                                            
                                                                            
                                                                            
                                                                            5.74
                                                                            %
                                                                            
                                                                            $
                                                                            1,105,239
                                                                            
                                                                            
                                                                            $
                                                                            10,954
                                                                            
                                                                            
                                                                            
                                                                            3.96
                                                                            %
                                                                            
                                                                            $
                                                                            12,702
                                                                            
                                                                            
                                                                            
                                                                            1.78
                                                                            %For
      the quarter ended
                                                                              September
      30, 2008
                                                                            
                                                                            $
                                                                            1,751,748
                                                                            
                                                                            
                                                                            $
                                                                            23,419
                                                                            
                                                                            
                                                                            
                                                                            5.35
                                                                            %
                                                                            
                                                                            $
                                                                            1,339,531
                                                                            
                                                                            
                                                                            $
                                                                            15,543
                                                                            
                                                                            
                                                                            
                                                                            4.64
                                                                            %
                                                                            
                                                                            $
                                                                            7,915
                                                                            
                                                                            
                                                                            
                                                                            0.71
                                                                            %For
      the quarter ended
                                                                              June
      30, 2008
                                                                            
                                                                            $
                                                                            1,917,969
                                                                            
                                                                            
                                                                            $
                                                                            29,630
                                                                            
                                                                            
                                                                            
                                                                            6.18
                                                                            %
                                                                            
                                                                            $
                                                                            1,449,567
                                                                            
                                                                            
                                                                            $
                                                                            20,025
                                                                            
                                                                            
                                                                            
                                                                            5.53
                                                                            %
                                                                            
                                                                            $
                                                                            9,926
                                                                            
                                                                            
                                                                            
                                                                            0.65
                                                                            %
 
 Gains
and Losses on Sales of Assets
 
 During the quarter ended June 30, 2009,
we sold assets with a carrying value of $84.6 million which resulted in a net
gain of approximately $9.3 million.  For the quarter ended June 30,
2008, there were no asset sales.
 
 Management Fee and General and
Administrative Expenses
 
 We paid
FIDAC a management fee of $6.0 million and $2.2 million for the quarters ended
June 30, 2009 and 2008, and $8.5 million and $4.5 million for the six months
ended June 30, 2009 and 2008, respectively.  The management fee is
based on stockholder’s equity and the increase in the management fee for the
quarter ended June 30, 2009 resulted from the increase in the Company’s
stockholders’ equity at the completion of its secondary offerings of common
stock during the period.
  General and administrative (or G&A)
expenses were $2.0 million and $1.2 million for the quarters ended June 30, 2009
and 2008 and $3.1million and $3.7 million for the six months ended June 30, 2009
and 2008, respectively.   G&A expenses increased during the
period due to an increase in the Company’s loan loss provision.
 
 Total expenses as a percentage of
average total assets were 1.08% and 0.70% for the quarters ended June 30, 2009
and 2008 and 1.03% and 0.84% for the six months ended June 30, 2009 and 2008,
respectively.  The increase in total expenses as a percentage of
average total assets is the result of an increase in the loan loss provision
recorded and an increase in the investment management fee at June 30,
2009.




42




Currently,
FIDAC has waived its right to require us to pay our pro rata portion of rent,
telephone, utilities, office furniture, equipment, machinery and other office,
internal and overhead expenses of FIDAC and its affiliates required for our
operations.
 
 The table
below shows our total management fee and G&A expenses as compared to average
total assets and average equity for the quarters ended June 30, 2009, March 31,
2009, for the year ended December 31, 2008, the quarters ended December 31,
2008, September 30, 2008, and June 30, 2008.
 
 Management
Fee and G&A Expenses and Operating Expense Ratios
 (Ratios
have been annualized, dollars in thousands)
 
 
 Total
                                      Management
      Fee
                                      and
      G&A
                                      Expenses
                                    
                                    
                                    Total
      Management Fee and G&A Expenses/Average
                                      Total
      Assets
                                    
                                    
                                    Total
      Management Fee and G&A Expenses/Average
                                      EquityFor
      the quarter ended June 30, 2009
                                    
                                    $
                                    7,946
                                    
                                    
                                    
                                    1.08
                                    %
                                    
                                    
                                    2.67
                                    %For
      the quarter ended March 31, 2009
                                    
                                    $
                                    3,722
                                    
                                    
                                    
                                    0.94
                                    %
                                    
                                    
                                    3.51
                                    %For
      the year ended December 31, 2008
                                    
                                    $
                                    14,027
                                    
                                    
                                    
                                    0.85
                                    %
                                    
                                    
                                    3.50
                                    %For
      the quarter ended December 31, 2008
                                    
                                    $
                                    3,918
                                    
                                    
                                    
                                    1.10
                                    %
                                    
                                    
                                    4.78
                                    %For
      the quarter ended September 30, 2008
                                    
                                    $
                                    1,934
                                    
                                    
                                    
                                    0.46
                                    %
                                    
                                    
                                    2.46
                                    %For
      the quarter ended June 30, 2008
                                    
                                    $
                                    3,380
                                    
                                    
                                    
                                    0.70
                                    %
                                    
                                    
                                    3.35
                                    %
 
 Net
Income (Loss) and Return on Average Equity
 
 Our net income was $51.6 million and
$33.9 million and $70.5 million for the quarters ended June 30, 2009 and June
30, 2008 and the six months ended June 30, 2009,
respectively.   Our net loss was $21.0 million for the six months
ended June 30, 2008.  The table below shows our net interest income,
gain (loss) on sale of assets, unrealized gains (loss) on interest rate swaps,
total expenses, income tax, each as a percentage of average equity, and the
return on average equity for the quarter ended June 30, 2009, March 31, 2009,
the year ended December 31, 2008, the quarter ended December 31, 2008, September
31, 2008 and June 30, 2008.  Our return on average equity decreased
from 33.60% for the quarter ended June 30, 2008 to 17.36% for the quarter ended
June 30, 2009 primarily due to the absence of unrealized gains on interest rate
swaps that were recorded in the first quarter of 2008.
  Components
of Return on Average Equity
 (Ratios
have been annualized)
 
 Net
                                                                    Interest
                                                                    Income/
                                                                    Average
                                                                    Equity
                                                                  
                                                                  
                                                                  Gain/(Loss)
      on
                                                                    Sale
      of
                                                                    Investments
                                                                    and
      Other
                                                                    Than-
                                                                    Temporary
      Impairments
                                                                    /Average
                                                                    Equity
                                                                  
                                                                  
                                                                  Unrealized
                                                                    Gain/(Loss)
      on
                                                                    Interest
      Rate Swaps/Average
                                                                    Equity
                                                                  
                                                                  
                                                                  Total
                                                                    Expenses/
                                                                    Average
                                                                    Equity
                                                                  
                                                                  
                                                                  Income
                                                                    Tax/Average
                                                                    Equity
                                                                  
                                                                  
                                                                  Return
      on
                                                                    Average
                                                                    EquityFor
      the quarter ended June 30, 2009
                                                                  
                                                                  
                                                                  19.08
                                                                  %
                                                                  
                                                                  
                                                                  3.13
                                                                  %
                                                                  
                                                                  
                                                                  0.00
                                                                  %
                                                                  
                                                                  
                                                                  (2.67
                                                                  %)
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  17.36
                                                                  %For
      the quarter ended March 31, 2009
                                                                  
                                                                  
                                                                  17.91
                                                                  %
                                                                  
                                                                  
                                                                  3.42
                                                                  %
                                                                  
                                                                  
                                                                  0.00
                                                                  %
                                                                  
                                                                  
                                                                  (3.51
                                                                  %)
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  17.82
                                                                  %For
      the year ended December 31, 2008
                                                                  
                                                                  
                                                                  11.17
                                                                  %
                                                                  
                                                                  
                                                                  (38.64
                                                                  %)
                                                                  
                                                                  
                                                                  1.04
                                                                  %
                                                                  
                                                                  
                                                                  (3.50
                                                                  %)
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  (29.93
                                                                  %)For
      the quarter ended December 31, 2008
                                                                  
                                                                  
                                                                  15.50
                                                                  %
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  (4.78
                                                                  %)
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  10.72
                                                                  %For
      the quarter ended September 30, 2008
                                                                  
                                                                  
                                                                  10.07
                                                                  %
                                                                  
                                                                  
                                                                  (157.28
                                                                  %)
                                                                  
                                                                  
                                                                  12.81
                                                                  %
                                                                  
                                                                  
                                                                  (2.46
                                                                  %)
                                                                  
                                                                  
                                                                  (0.02
                                                                  %)
                                                                  
                                                                  
                                                                  (136.88
                                                                  %)For
      the quarter ended June 30, 2008
                                                                  
                                                                  
                                                                  9.84
                                                                  %
                                                                  
                                                                  
                                                                  1.75
                                                                  %
                                                                  
                                                                  
                                                                  25.36
                                                                  %
                                                                  
                                                                  
                                                                  (3.35
                                                                  %)
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  33.60
                                                                  %
 
 43
  REIT
Taxable Income Per Share
 
 Reconciliation
of non-GAAP financial measurements to GAAP financial measurements
 
 As a REIT,
we are required to distribute to our shareholders substantially all of our REIT
taxable earnings in the form of dividends. Taxable earnings per share is a
meaningful financial measurement for investors and management in assessing our
performance. A reconciliation of REIT taxable income per share to GAAP EPS
(basic) follows:
 
 GAAP net
income per share is the measure that is most directly related to REIT taxable
income per share.  REIT taxable income per share is a non-GAAP
measurement that adjusts GAAP net income per share for items excluded from REIT
taxable income.  As a REIT, we are required to distribute to our
shareholders substantially all of our REIT taxable income in the form of
dividends.  Since it relates to the dividends we are required to
declare, we believe REIT taxable earnings per share is a meaningful financial
measurement for investors and management in assessing our
performance.  Items that are typically included in GAAP net income
that are excluded from REIT taxable income are unrealized gains and losses
included in net income, losses on sales of investments to the extent they exceed
gains on sales of investments, and book versus tax amortization
adjustments.
 
 A
reconciliation of REIT taxable income per share to GAAP EPS (basic)
follows:
 
 For
      the quarter ended
                                June
      30, 2009
                              
                              
                              For
      the year ended December 31, 2008GAAP
      income (loss) per share
                              
                              $
                              0.10
                              
                              
                              $
                              (1.90
                              )Realized
      (gain) loss on sale of investments
                              
                              
                              (0.02
                              )
                              
                              
                              2.45Unrealized
      loss on interest rate swaps
                              
                              
                              -
                              
                              
                              
                              0.07Other-than-temporary
      credit impairments
                              
                              
                              0.01
                              
                              
                              
                              -REIT
      taxable income per share
                              
                              $
                              0.09
                              
                              
                              $
                              0.62
 
 The computation of realized gains and
losses per share is the quotient of realized gains and losses on sales of
investments and the weighted average number of shares outstanding-basic and
diluted as presented in the Consolidated Statements of Operations and
Comprehensive Income.
 
 The computation of unrealized gains and
losses on interest swaps per share is the quotient of unrealized gains and
losses on interest rate swaps and the weighted average number of shares
outstanding-basic and diluted as presented in the Consolidated Statements of
Operations and Comprehensive Income.
 
 The computation of other-than-temporary
credit impairments per share is the quotient of other-than-temporary credit
impairments and the weighted average number of shares outstanding-basic and
diluted as presented in the Consolidated Statements of Operations and
Comprehensive Income
 
 The taxable earnings per share
computation does not include the impact of realized losses on sales of
investments to the extent they exceed realized gains on sales of
investments.  This exclusion may not fully represent the results of
all operations during the period.
 
 Liquidity
and Capital Resources
 
 Liquidity
measures our ability to meet cash requirements, including ongoing commitments to
repay our borrowings, fund and maintain RMBS, mortgage loans and other assets,
pay dividends and other general business needs.  Our principal sources
of capital and funds for additional investments primarily include earnings from
our investments, borrowings under securitizations and re-securitizations,
repurchase agreements and other financing facilities, and proceeds from equity
offerings.  We expect these sources of financing will be sufficient to
meet our short-term liquidity needs.
 
 44
  We expect
to continue to borrow funds in the form of repurchase agreements and, subject to
market conditions, other types of financing.  The terms of the
repurchase transaction borrowings under our master repurchase agreements
generally conform to the terms in the standard master repurchase agreement as
published by the Securities Industry and Financial Markets Association, or
SIFMA, as to repayment, margin requirements and the segregation of all
securities we have initially sold under the repurchase
transaction.  In addition, each lender typically requires that we
include supplemental terms and conditions to the standard master repurchase
agreement.  Typical supplemental terms and conditions include changes
to the margin maintenance requirements, required haircuts, and purchase price
maintenance requirements, requirements that all controversies related to the
repurchase agreement be litigated in a particular jurisdiction and cross default
provisions.  These provisions will differ for each of our lenders and
will not be determined until we engage in a specific repurchase
transaction.
 
 For our
short-term (one year or less) and long-term liquidity, which include investing
and compliance with collateralization requirements under our repurchase
agreements (if the pledged collateral decreases in value or in the event of
margin calls created by prepayments of the pledged collateral), we also rely on
the cash flow from investments, primarily monthly principal and interest
payments to be received on our RMBS and whole mortgage loans, cash flow from the
sale of securities as well as any primary securities offerings authorized by our
board of directors.
 
 Based
on our current portfolio, leverage ratio and available borrowing arrangements,
we believe our assets will be sufficient to enable us to meet anticipated
short-term (one year or less) liquidity requirements such as to fund our
investment activities, pay fees under our management agreement, fund our
distributions to stockholders and pay general corporate expenses. However, a
decline in the value of our collateral or an increase in prepayment rates
substantially above our expectations could cause a temporary liquidity shortfall
due to the timing of the necessary margin calls on the financing arrangements
and the actual receipt of the cash related to principal paydowns. If our cash
resources are at any time insufficient to satisfy our liquidity requirements, we
may have to sell debt or additional equity securities in a common stock
offering. If required, the sale of RMBS or whole mortgage loans at prices lower
than their carrying value would result in losses and reduced
income.
 
 Our
ability to meet our long-term (greater than one year) liquidity and capital
resource requirements will be subject to obtaining additional debt financing and
equity capital. Subject to our maintaining our qualification as a REIT as well
as market conditions, we expect to use a number of sources to finance our
investments, including repurchase agreements, warehouse facilities,
securitization, commercial paper and term financing CDOs.  Such
financing will depend on market conditions for capital raises and for the
investment of any proceeds. If we are unable to renew, replace or expand our
sources of financing on substantially similar terms, it may have an adverse
effect on our business and results of operations. Upon liquidation, holders of
our debt securities and shares of preferred stock and lenders with respect to
other borrowings will receive a distribution of our available assets prior to
the holders of our common stock.
 
 We held
cash and cash equivalents of approximately $13.1 million and $27.5 million at
June 30, 2009 and December 31, 2008, respectively.  Our cash and cash
equivalents declined as we utilized cash balances to repay short term repurchase
agreements.
 
 Our
operating activities provided net cash of approximately $24.4 million and $7.6
million for the quarters ended June 30, 2009 and 2008 and $38.2 million and
$15.6 million for the six months ended June 30, 2009 and 2008,
respectively.
 
 Our
investing activities used net cash of $2.4 billion and $13.1 million for
the quarters ended June 30, 2009 and June 30, 2008 and $2.4 billion and $1.1
billion for the six months ended June 30, 2009 and 2008,
respectively.   During the quarter ended June 30, 2009 we
utilized cash to purchase $2.6 billion in RMBS and which were offset by proceeds
from asset sales that provided approximately $84.6 million as compared to the
purchase of $258.8 million of residential mortgage loans offset by residential
mortgage loan sales that provided approximately $90.7 million for the quarter
ended June 30, 2008.
 
 45
  Our
financing activities provided net cash of $2.4 billion and utilized $36.0
million for the quarters ended June 30, 2009 and June 30, 2008.  Our
financing activities provided net cash of $2.4 billion and $1.1 billion for the
six months ended June 30, 2009 and June 30, 2008. We expect to continue to
borrow funds in the form of repurchase agreements as well as other types of
financing.  As of June 30, 2009, we had $123.5 million outstanding
under our repurchase agreement with Annaly collateralized by our RMBS with
weighted average borrowing rates of 1.78% and weighted average remaining
maturities of 7 days.  The RMBS pledged as collateral under the
repurchase agreement with Annaly had an estimated fair value of $183.0 million
at June 30, 2009.  The interest rates of the repurchase agreement with
Annaly are generally indexed to the one-month LIBOR rate and re-price
accordingly.
 
 At June
30, 2009 and 2008, the repurchase agreements for RMBS had the following
remaining maturities:
 
 June
      30, 2009
                              
                              
                              December
      31, 2008(dollars
      in thousands)Overnight
                              
                              $
                              -
                              
                              
                              $
                              -1 to
      30 days
                              
                              
                              1,427,482
                              
                              
                              
                              562,11930
      to 59 days
                              
                              
                              73,149
                              
                              
                              
                              -60
      to 89 days
                              
                              
                              -
                              
                              
                              
                              -90
      to 119 days
                              
                              
                              -
                              
                              
                              
                              -Greater
      than or equal to 120 days
                              
                              
                              -
                              
                              
                              
                              -Total
                              
                              $
                              1,500,631
                              
                              
                              $
                              562,119
 
 Increases in short-term interest
rates could negatively affect the valuation of our mortgage-related assets,
which could limit our borrowing ability or cause our lenders to initiate margin
calls. Amounts due upon maturity of our repurchase agreements will be funded
primarily through the rollover/reissuance of repurchase agreements and monthly
principal and interest payments received on our mortgage-backed
securities.
  For our
short-term (one year or less) and long-term liquidity, which includes investing
and compliance with collateralization requirements under our repurchase
agreements (if the pledged collateral decreases in value or in the event of
margin calls created by prepayments of the pledged collateral), we also rely on
the cash flow from investments, primarily monthly principal and interest
payments to be received on our RMBS and whole mortgage loans, cash flow from the
sale of securities as well as any primary securities offerings authorized by our
board of directors.
  Based on
our current portfolio, leverage ratio and available borrowing arrangements, we
believe our assets will be sufficient to enable us to meet anticipated
short-term (one year or less) liquidity requirements such as to fund our
investment activities, pay fees under our management agreement, fund our
distributions to stockholders and pay general corporate
expenses.  However, an increase in prepayment rates substantially
above our expectations could cause a temporary liquidity shortfall due to the
timing of the necessary margin calls on the financing arrangements and the
actual receipt of the cash related to principal paydowns. If our cash resources
are at any time insufficient to satisfy our liquidity requirements, we may have
to sell investments or issue debt or additional equity securities in a common
stock offering.  If required, the sale of RMBS or whole mortgage loans
at prices lower than their carrying value would result in losses and reduced
income.
  Our
ability to meet our long-term (greater than one year) liquidity and capital
resource requirements will be subject to obtaining additional debt financing and
equity capital. Subject to our maintaining our qualification as a REIT, we
expect to use a number of sources to finance our investments, including
repurchase agreements, warehouse facilities, securitizations, commercial paper
and term financing CDOs.  Such financing will depend on market
conditions for capital raises and for the investment of any proceeds. If we are
unable to renew, replace or expand our sources of financing on substantially
similar terms, it may have an adverse effect on our business and results of
operations.  Upon liquidation, holders of our debt securities, if any,
and shares of preferred stock, if any, and lenders with respect to other
borrowings will receive a distribution of our available assets prior to the
holders of our common stock.
  46
  We are not
required by our investment guidelines to maintain any specific debt-to-equity
ratio as we believe the appropriate leverage for the particular assets we are
financing depends on the credit quality and risk of those
assets.  However, our master repurchase agreements may require us to
maintain certain debt-to-equity ratios.  At June 30, 2009, our total
debt was approximately $1.9 billion which represented a debt-to-equity ratio of
1.0:1.
  Stockholders’ Equity
 
 During the
quarter ended June 30, 2009, we declared dividends to common shareholders
totaling $37.7 million, or $0.08 per share, all of which were paid on July 31,
2009.  During the year ended December 31, 2008, we declared dividends
to common shareholders totaling $28.9 million, or $0.62 per share.
 
 On April
15, 2009, we announced the sale of 235,000,000 shares of common stock at $3.00
per share for estimated proceeds, less the underwriters’ discount and offering
expenses, of $674.8 million.  Immediately following the sale of these
shares Annaly purchased 24,955,752 shares at the same price per share as the
public offering, for proceeds of approximately $74.9 million. In addition, on
April 16, 2009 the underwriters exercised the option to purchase up to an
additional 35,250,000 shares of common stock to cover over-allotments for
proceeds, less the underwriters’ discount, of approximately $101.3 million.
These sales were completed on April 21, 2009.  In all, we raised net
proceeds of approximately $850.9 in these offerings.
 
 On May 27,
2009, we announced the sale of 168,000,000 shares of common stock at $3.22 per
share for estimated proceeds, less the underwriters’ discount and offering
expenses, of $519.3 million.  Immediately following the sale of these
shares Annaly purchased 4,724,017 shares at the same price per share as the
public offering, for proceeds of approximately $15.2 million. In addition, on
June 1, 2009 the underwriters exercised the option to purchase up to an
additional 25,200,000 shares of common stock to cover over-allotments for
proceeds, less the underwriters’ discount, of approximately $77.9 million. These
sales were completed on June 2, 2009.  In all, we raised net proceeds
of approximately $612.4 million in these offerings.
 
 There was
no preferred stock issued or outstanding as of June 30, 2009 or December 31,
2008.
 
 Related
Party Transactions
 
 Management
Agreement
 
 On
November 15, 2007, we entered into a management agreement with FIDAC, pursuant
to which FIDAC is entitled to receive a management fee and, in certain
circumstances, a termination fee and reimbursement of certain expenses as
described in the management agreement.  Such fees and expenses do not
have fixed and determinable payments.  The management fee is payable
quarterly in arrears in an amount equal to 1.50% per annum, calculated
quarterly, of our stockholders’ equity (as defined in the management
agreement).  FIDAC uses the proceeds from its management fee in part
to pay compensation to its officers and employees who, notwithstanding that
certain of them also are our officers, receive no cash compensation directly
from us.  The management fee will be reduced, but not below zero, by
our proportionate share of any CDO management fees FIDAC receives in connection
with the CDOs in which we invest, based on the percentage of equity we hold in
such CDOs.
 
 47
  Financing
Arrangements with Annaly
 
 In March 2008, we entered into a RMBS
repurchase agreement with Annaly.  This agreement contains customary
representations, warranties and covenants contained in such
agreements.  As of June 30, 2009, we had $123.5 million outstanding
under the agreement with a weighted average borrowing rate
of 1.78%.
 
 Restricted
Stock Grants
 
 During the
quarter ended June 30, 2009, 32,225 shares of restricted stock we had awarded to
our Manager’s employees vested and 928 shares were forfeited or
cancelled.  We did not grant any incentive awards during the quarter
ended June 30, 2009.
 
 At June
30, 2009 there are approximately 1.1 million unvested shares of restricted stock
issued to employees of FIDAC.  For the quarter ended June 30, 2009,
compensation expense less general and administrative costs associated with the
amortization of the fair value of the restricted stock totaled
$111,176.
 
 Contractual
Obligations and Commitments
 
 The
following table summarizes our contractual obligations at June 30,
2009.
 
 (dollars in thousands)Contractual
      Obligations
                                                                          
                                                                          Within
      One
                                                                            Year
                                                                          
                                                                          
                                                                          One
      to
                                                                            Three
                                                                            Years
                                                                          
                                                                          
                                                                          Three
      to
                                                                            Five
                                                                            Years
                                                                          
                                                                          
                                                                          Greater
                                                                            Than
      or
                                                                            Equal
      to
                                                                            Five
                                                                            Years
                                                                          
                                                                          
                                                                          TotalRepurchase
      agreements for RMBS
                                                                          
                                                                          $
                                                                          1,500,631
                                                                          
                                                                          
                                                                          $
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          $
                                                                          1,500,631Securitized
      debt
                                                                          
                                                                          
                                                                          40,344
                                                                          
                                                                          
                                                                          
                                                                          74,818
                                                                          
                                                                          
                                                                          
                                                                          38,335
                                                                          
                                                                          
                                                                          
                                                                          309,639
                                                                          
                                                                          
                                                                          
                                                                          463,136Interest
      expense on RMBS repurchase agreements(1)
                                                                          
                                                                          
                                                                          384
                                                                          
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          384Interest
      expense on securitized debt(1)
                                                                          
                                                                          
                                                                          24,458
                                                                          
                                                                          
                                                                          
                                                                          42,531
                                                                          
                                                                          
                                                                          
                                                                          35,087
                                                                          
                                                                          
                                                                          
                                                                          129,802
                                                                          
                                                                          
                                                                          
                                                                          231,878Total
                                                                          
                                                                          $
                                                                          1,565,817
                                                                          
                                                                          
                                                                          $
                                                                          117,349
                                                                          
                                                                          
                                                                          $
                                                                          73,422
                                                                          
                                                                          
                                                                          $
                                                                          439,441
                                                                          
                                                                          
                                                                          $
                                                                          2,196,029
 (1)
Interest is based on variable rates in effect as of June 30, 2009.
 
 Off-Balance
Sheet Arrangements
 
 We do not
have any relationships with unconsolidated entities or financial partnerships,
such as entities often referred to as structured finance or special purpose
entities, which would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited
purposes.  Further, we have not guaranteed any obligations of
unconsolidated entities nor do we have any commitment or intent to provide
funding to any such entities.  As such, we are not materially exposed
to any market, credit, liquidity or financing risk that could arise if we had
engaged in such relationships.
 
 Dividends
 
 To qualify
as a REIT, we must pay annual dividends to our stockholders of at least 90% of
our taxable income, determined without regard to the deduction for dividends
paid and excluding any net capital gains. We intend to pay regular quarterly
dividends to our stockholders. Before we pay any dividend, whether for U.S.
federal income tax purposes or otherwise, which would only be paid out of
available cash to the extent permitted under our warehouse and repurchase
facilities, we must first meet both our operating requirements and scheduled
debt service on our warehouse lines and other debt payable.
 
 48
  Capital
Resources
 
 At June 30, 2009, we had no material
commitments for capital expenditures.
 
 Inflation
 
 Virtually
all of our assets and liabilities are interest rate sensitive in nature. As a
result, interest rates and other factors influence our performance far more so
than does inflation. Changes in interest rates do not necessarily correlate with
inflation rates or changes in inflation rates. Our consolidated financial
statements are prepared in accordance with GAAP and our distributions will be
determined by our board of directors consistent with our obligation to
distribute to our stockholders at least 90% of our REIT taxable income on an
annual basis in order to maintain our REIT qualification; in each case, our
activities and balance sheet are measured with reference to historical cost
and/or fair market value without considering inflation.
 
 49




ITEM
      3.
              QUANTITATIVE AND
      QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
 The
primary components of our market risk are related to credit risk, interest rate
risk, prepayment risk,  market value risk and real estate risk. While
we do not seek to avoid risk completely, we believe the risk can be quantified
from historical experience and we seek to actively manage that risk, to earn
sufficient compensation to justify taking those risks and to maintain capital
levels consistent with the risks we undertake.
 
 Credit
Risk
 
 We are
subject to credit risk in connection with our investments and face more credit
risk on assets we own which are rated below ‘‘AAA’’. The credit risk related to
these investments pertains to the ability and willingness of the borrowers to
pay, which is assessed before credit is granted or renewed and periodically
reviewed throughout the loan or security term. We believe that residual loan
credit quality is primarily determined by the borrowers’ credit profiles and
loan characteristics. FIDAC uses a comprehensive credit review process.
FIDAC’s analysis of loans includes borrower profiles, as well as valuation and
appraisal data. FIDAC uses compensating factors such as liquid assets, low loan
to value ratios and job stability in evaluating loans.  FIDAC’s
resources include a proprietary portfolio management system, as well as third
party software systems. FIDAC utilizes a third party due diligence firm to
perform an independent underwriting review to insure compliance with existing
guidelines. FIDAC selects loans for review predicated on risk-based criteria
such as loan-to-value, borrower’s credit score(s) and loan size. FIDAC also
outsources underwriting services to review higher risk loans, either due to
borrower credit profiles or collateral valuation issues. In addition to
statistical sampling techniques, FIDAC creates adverse credit and valuation
samples, which we individually review. FIDAC rejects loans that fail to conform
to our standards. FIDAC accepts only those loans which meet our underwriting
criteria. Once we own a loan, FIDAC’s surveillance process includes ongoing
analysis through our proprietary data warehouse and servicer files.
Additionally, the non-Agency RMBS and other ABS which we acquire for our
portfolio are reviewed by FIDAC to ensure that they satisfy our risk based
criteria. FIDAC’s review of non-Agency RMBS and other ABS includes utilizing its
proprietary portfolio management system. FIDAC’s review of non-Agency RMBS and
other ABS is based on quantitative and qualitative analysis of the risk-adjusted
returns on non-Agency RMBS and other ABS present.
 
 Interest
Rate Risk
 
 Interest
rate risk is highly sensitive to many factors, including governmental monetary
and tax policies, domestic and international economic and political
considerations and other factors beyond our control. We are subject to interest
rate risk in connection with our investments and our related debt obligations,
which are generally repurchase agreements, warehouse facilities, securitization,
commercial paper and term financing CDOs. Our repurchase agreements and
warehouse facilities may be of limited duration that are periodically refinanced
at current market rates. We intend to mitigate this risk through utilization of
derivative contracts, primarily interest rate swap agreements.
 
 Interest
Rate Effect on Net Interest Income
 
 Our
operating results depend, in large part, on differences between the income
from our investments and our borrowing costs. Most of our warehouse facilities
and repurchase agreements provide financing based on a floating rate of interest
calculated on a fixed spread over LIBOR. The fixed spread varies depending on
the type of underlying asset which collateralizes the financing. Accordingly,
the portion of our portfolio which consists of floating interest rate assets
will be match-funded utilizing our expected sources of short-term financing,
while our fixed interest rate assets will not be match-funded. During periods of
rising interest rates, the borrowing costs associated with our investments tend
to increase while the income earned on our fixed interest rate investments may
remain substantially unchanged. This will result in a narrowing of the net
interest spread between the related assets and borrowings and may even result in
losses. Further, during this portion of the interest rate and credit cycles,
defaults could increase and result in credit losses to us, which could adversely
affect our liquidity and operating results. Such delinquencies or defaults could
also have an adverse effect on the spread between interest-earning assets and
interest-bearing liabilities. Hedging techniques are partly based on assumed
levels of prepayments of our fixed-rate and hybrid adjustable-rate mortgage
loans and RMBS. If prepayments are slower or faster than assumed, the life of
the mortgage loans and RMBS will be longer or shorter, which would reduce the
effectiveness of any hedging strategies we may use and may cause losses on such
transactions. Hedging strategies involving the use of derivative securities are
highly complex and may produce volatile returns.
 
 50
  Interest
Rate Effects on Fair Value
 
 Another
component of interest rate risk is the effect changes in interest rates will
have on the fair value of the assets we acquire. We face the risk that the fair
value of our assets will increase or decrease at different rates than that of
our liabilities, including our hedging instruments. We primarily assess our
interest rate risk by estimating the duration of our assets and the duration of
our liabilities. Duration essentially measures the market price volatility of
financial instruments as interest rates change. We generally calculate duration
using various financial models and empirical data. Different models and
methodologies can produce different duration numbers for the same
securities.
 
 It is
important to note that the impact of changing interest rates on fair value can
change significantly when interest rates change beyond 100 basis points from
current levels. Therefore, the volatility in the fair value of our assets could
increase significantly when interest rates change beyond 100 basis points. In
addition, other factors impact the fair value of our interest rate-sensitive
investments and hedging instruments, such as the shape of the yield curve,
market expectations as to future interest rate changes and other market
conditions. Accordingly, in the event of changes in actual interest rates, the
change in the fair value of our assets would likely differ from that shown above
and such difference might be material and adverse to our
stockholders.
 
 Interest
Rate Cap Risk
 
 We also
invest in adjustable-rate mortgage loans and RMBS. These are mortgages or RMBS
in which the underlying mortgages are typically subject to periodic and lifetime
interest rate caps and floors, which limit the amount by which the security’s
interest yield may change during any given period. However, our borrowing costs
pursuant to our financing agreements will not be subject to similar
restrictions. Therefore, in a period of increasing interest rates, interest rate
costs on our borrowings could increase without limitation by caps, while the
interest-rate yields on our adjustable-rate mortgage loans and RMBS would
effectively be limited. This problem will be magnified to the extent we acquire
adjustable-rate RMBS that are not based on mortgages which are fully indexed. In
addition, the mortgages or the underlying mortgages in an RMBS may be subject to
periodic payment caps that result in some portion of the interest being deferred
and added to the principal outstanding. This could result in our receipt of less
cash income on our adjustable-rate mortgages or RMBS than we need in order to
pay the interest cost on our related borrowings. These factors could lower our
net interest income or cause a net loss during periods of rising interest rates,
which would harm our financial condition, cash flows and results of
operations.
 
 Interest
Rate Mismatch Risk
 
 We fund a
substantial portion of our acquisitions of hybrid adjustable-rate mortgages and
RMBS with borrowings that, after the effect of hedging, have interest rates
based on indices and re-pricing terms similar to, but of somewhat shorter
maturities than, the interest rate indices and re-pricing terms of the mortgages
and RMBS. Thus, in most cases the interest rate indices and re-pricing terms of
our mortgage assets and our funding sources will not be identical, thereby
creating an interest rate mismatch between assets and liabilities. Therefore,
our cost of funds would likely rise or fall more quickly than would our earnings
rate on assets. During periods of changing interest rates, such interest rate
mismatches could negatively impact our financial condition, cash flows and
results of operations. To mitigate interest rate mismatches, we may utilize the
hedging strategies discussed above. Our analysis of risks is based on FIDAC’s
experience, estimates, models and assumptions. These analyses rely on models
which utilize estimates of fair value and interest rate sensitivity. Actual
economic conditions or implementation of investment decisions by our management
may produce results that differ significantly from the estimates and assumptions
used in our models and the projected results shown in this Form
10-Q.
 
 51
 Our profitability and the value of our
portfolio (including interest rate swaps) may be adversely affected during any
period as a result of changing interest rates.  The following table
quantifies the potential changes in net interest income, portfolio value should
interest rates go up or down 25, 50, and 75 basis points, assuming the yield
curves of the rate shocks will be parallel to each other and the current yield
curve.  All changes in income and value are measured as percentage
changes from the projected net interest income and portfolio value at the base
interest rate scenario.  The base interest rate scenario assumes
interest rates at June 30, 2009 and various estimates regarding prepayment and
all activities are made at each level of rate shock.  Actual results
could differ significantly from these estimates.
 
 
 Change
      in Interest Rate
                    
                    Projected
      Percentage Change in
                      Net
      Interest Income
                    
                    
                    Projected
      Percentage Change in
                      Portfolio
      Value-75
      Basis Points
                    
                    
                    6.88
                    %
                    
                    
                    (14.28
                    %)-50
      Basis Points
                    
                    
                    5.15
                    %
                    
                    
                    (15.29
                    %)-25
      Basis Points
                    
                    
                    3.44
                    %
                    
                    
                    (16.30
                    %)Base
      Interest Rate
                    
                    
                    -
                    
                    
                    
                    -+25
      Basis Points
                    
                    
                    (0.97
                    %)
                    
                    
                    (18.30
                    %)+50
      Basis Points
                    
                    
                    (1.58
                    %)
                    
                    
                    (19.30
                    %)+75
      Basis Points
                    
                    
                    (2.19
                    %)
                    
                    
                    (20.30
                    %)
 
 
 Prepayment
Risk
 
 As we
receive prepayments of principal on these investments, premiums paid on such
investments will be amortized against interest income. In general, an increase
in prepayment rates will accelerate the amortization of purchase premiums,
thereby reducing the interest income earned on the investments. Conversely,
discounts on such investments are accreted into interest income. In general, an
increase in prepayment rates will accelerate the accretion of purchase
discounts, thereby increasing the interest income earned on the
investments.
 
 Extension
Risk
 
 FIDAC computes the
projected weighted-average life of our investments based on assumptions
regarding the rate at which the borrowers will prepay the underlying mortgages.
In general, when fixed-rate or hybrid adjustable-rate mortgage loans or RMBS are
acquired with borrowings, we may, but are not required to, enter into an
interest rate swap agreement or other hedging instrument that effectively fixes
our borrowing costs for a period close to the anticipated average life of the
fixed-rate portion of the related assets. This strategy is designed to protect
us from rising interest rates because the borrowing costs are fixed for the
duration of the fixed-rate portion of the related assets.  However, if
prepayment rates decrease in a rising interest rate environment, the life of the
fixed-rate portion of the related assets could extend beyond the term of the
swap agreement or other hedging instrument. This could have a negative impact on
our results from operations, as borrowing costs would no longer be fixed after
the end of the hedging instrument while the income earned on the hybrid
adjustable-rate assets would remain fixed. This situation may also cause the
market value of our hybrid adjustable-rate assets to decline, with little or no
offsetting gain from the related hedging transactions. In extreme situations, we
may be forced to sell assets to maintain adequate liquidity, which could cause
us to incur losses.
 
 52
  Market
Risk
 
 Market
Value Risk
 
 Our
available-for-sale securities are reflected at their estimated fair value with
unrealized gains and losses excluded from earnings and reported in other
comprehensive income pursuant to SFAS 115. The estimated fair value of these
securities fluctuates primarily due to changes in interest rates, prepayment
speeds, market liquidity, credit quality, and other factors.  Generally, in
a rising interest rate environment, the estimated fair value of these securities
would be expected to decrease; conversely, in a decreasing interest rate
environment, the estimated fair value of these securities would be expected to
increase.  As market volatility increases or liquidity decreases, the
fair value of our investments may be adversely impacted.  If we are
unable to readily obtain independent pricing to validate our estimated fair
value of securities in the portfolio, the fair value gains or losses recorded in
other comprehensive income may be adversely affected.
 
 Real
Estate Market Risk
 
 We own assets secured
by real property and may own real property directly in the
future.  Residential property values are subject to volatility and may
be affected adversely by a number of factors, including, but not limited to,
national, regional and local economic conditions (which may be adversely
affected by industry slowdowns and other factors); local real estate conditions
(such as an oversupply of housing); changes or continued weakness in specific
industry segments; construction quality, age and design; demographic factors;
and retroactive changes to building or similar codes. In addition, decreases in
property values reduce the value of the collateral and the potential proceeds
available to a borrower to repay our loans, which could also cause us to suffer
losses.
 
 Risk
Management
 
 To the
extent consistent with maintaining our REIT status, we seek to manage risk
exposure to protect our portfolio of residential mortgage loans, RMBS, and other
assets and related debt against the effects of major interest rate changes. We
generally seek to manage our risk by:
 
 ·
              monitoring
      and adjusting, if necessary, the reset index and interest rate related to
      our RMBS and our financings;
 
 ·
              attempting
      to structure our financing agreements to have a range of different
      maturities, terms, amortizations and interest rate adjustment
      periods;
 
 ·
              using
      derivatives, financial futures, swaps, options, caps, floors and forward
      sales to adjust the interest rate sensitivity of our investments and our
      borrowings;
 
 ·
              using
      securitization financing to lower average cost of funds relative to
      short-term financing vehicles further allowing us to receive the benefit
      of attractive terms for an extended period of time in contrast to short
      term financing and maturity dates of the investments included in the
      securitization; and
 
 ·
              actively
      managing, on an aggregate basis, the interest rate indices, interest rate
      adjustment periods, and gross reset margins of our investments and the
      interest rate indices and adjustment periods of our
      financings.
 
 Our
efforts to manage our assets and liabilities are concerned with the timing and
magnitude of the re-pricing of assets and liabilities.  We attempt to
control risks associated with interest rate movements.  Methods for
evaluating interest rate risk include an analysis of our interest rate
sensitivity “gap”, which is the difference  between interest-earning
assets and interest-bearing liabilities maturing or re-pricing within a given
time period.  A gap is considered positive when the amount of
interest-rate sensitive assets exceeds the amount of interest-rate sensitive
liabilities.  A gap is considered negative when the amount of
interest-rate sensitive liabilities exceeds interest-rate sensitive
assets.  During a period of rising interest rates, a negative gap
would tend to adversely affect net interest income, while a positive gap would
tend to result in an increase in net interest income.  During a period
of falling interest rates, a negative gap would tend to result in an increase in
net interest income, while a positive gap would tend to affect net interest
income adversely.  Because different types of assets and liabilities
with the same or similar maturities may react differently to changes in overall
market rates or conditions, changes in interest rates may affect net interest
income positively or negatively even if an institution were perfectly matched in
each maturity category.
 
 53
 The following table sets forth the
estimated maturity or re-pricing of our interest-earning assets and
interest-bearing liabilities at June 30, 2009.  The amounts of assets
and liabilities shown within a particular period were determined in accordance
with the contractual terms of the assets and liabilities, except adjustable-rate
loans, and securities are included in the period in which their interest rates
are first scheduled to adjust and not in the period in which they mature and
does include the effect of the interest rate swaps.  The interest rate
sensitivity of our assets and liabilities in the table could vary substantially
if based on actual prepayment experience.
 
 
 Within
      3
                  Months
                
                
                3-12
      Months
                
                
                1
      Year to 3
                  Years
                
                
                Greater
      than
                  3
      Years
                
                
                Total(dollars
      in thousands)Rate
      sensitive assets
                
                $
                3,488,353
                
                
                $
                32,523
                
                
                $
                1,055,163
                
                
                $
                727,197
                
                
                $
                5,303,236Cash
      equivalents
                
                
                13,121
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                13,121Total
      rate sensitive assets
                
                
                3,501,474
                
                
                
                32,523
                
                
                
                1,055,163
                
                
                
                727,197
                
                
                
                5,316,357Rate
      sensitive liabilities, with the effect
                  of
      swaps
                
                
                1,500,631
                
                
                
                -
                
                
                
                -
                
                
                
                463,136
                
                
                
                1,963,767Interest
      rate sensitivity gap
                
                $
                2,000,843
                
                
                $
                32,523
                
                
                $
                1,055,163
                
                
                $
                264,061
                
                
                $
                3,352,590Cumulative
      rate sensitivity gap
                
                $
                2,000,843
                
                
                $
                2,033,366
                
                
                $
                3,088,529
                
                
                $
                3,352,590Cumulative
      interest rate sensitivity gap as
                  a
      percentage of total rate-sensitive
                  assets
                
                
                38
                %
                
                
                38
                %
                
                
                58
                %
                
                
                63
                %
 
 Our
analysis of risks is based on FIDAC’s experience, estimates, models and
assumptions.  These analyses rely on models which utilize estimates of
fair value and interest rate sensitivity.  Actual economic conditions
or implementation of investment decisions by FIDAC may produce results that
differ significantly from the estimates and assumptions used in our models and
the projected results shown in the above tables and in this
report.  These analyses contain certain forward-looking statements and
are subject to the safe harbor statement set forth under the heading, “Special
Note Regarding Forward-Looking Statements.”
 
 ITEM 4.
              CONTROLS
      AND PROCEDURES
  Evaluation
of Disclosure Controls and Procedures
  Our
management, including our Chief Executive Officer, or CEO, and Chief Financial
Officer, or CFO, reviewed and evaluated the effectiveness of the design and
operation of our disclosure controls and procedures (as defined in Rule
13a-15(e) and 15d-15(e) of the Securities Exchange Act) as of the end of the
period covered by this quarterly report.  Based on that review and
evaluation, the CEO and CFO have concluded that our current disclosure controls
and procedures, as designed and implemented, (1) were effective in ensuring that
information regarding the Company and its subsidiaries is made known to our
management, including our CEO and CFO, as appropriate to allow timely decisions
regarding required disclosure and (2) were effective in providing reasonable
assurance that information the Company must disclose in its periodic reports
under the Securities Exchange Act is recorded, processed, summarized and
reported within the time periods prescribed by the SEC’s rules and
forms.
  54
  Changes
in Internal Controls
 
 There have
been no changes in our “internal control over financial reporting” (as defined
in Rule 13a-15(f) under the Securities Exchange Act) that occurred during the
period covered by this quarterly report that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
  55
  PART
II.                      OTHER
INFORMATION
  Item 1.LEGAL PROCEEDINGS
  From time
to time, we may be involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on our
consolidated financial statements.
 
 Item 1A.RISK FACTORS
 
 In
addition to the other information set forth in this report, you should carefully
consider the factors discussed in Part I, "Item 1A. Risk Factors" in our Annual
Report on Form 10-K for the year ended December 31, 2008, which could materially
affect our business, financial condition or future results. The information
presented below updates and should be read in conjunction with the risk factors
and information disclosed in that Form 10-K.
 
 Continued
adverse developments in the broader residential mortgage market may adversely
affect the value of the assets in which we invest.
 
 In 2008
and so far in 2009, the residential mortgage market in the United States has
experienced a variety of difficulties and changed economic conditions, including
defaults, credit losses and liquidity concerns. Certain commercial banks,
investment banks and insurance companies have announced extensive losses from
exposure to the residential mortgage market. These losses have reduced financial
industry capital, leading to reduced liquidity for some institutions. These
factors have impacted investor perception of the risk associated with RMBS,
residential mortgage loans, real estate-related securities and various other
asset classes in which we invest. As a result, values for RMBS, residential
mortgage loans, real estate-related securities and various other asset classes
in which we invest have experienced a certain amount of volatility. Further
increased volatility and deterioration in the broader residential mortgage and
RMBS markets may adversely affect the performance and market value of our
investments.
 
 Any
decline in the value of our investments, or perceived market uncertainty about
their value, would likely make it difficult for us to obtain financing on
favorable terms or at all, or maintain our compliance with terms of any
financing arrangements already in place. The RMBS in which we invest are
classified for accounting purposes as available-for-sale. All assets classified
as available-for-sale are reported at fair value with unrealized gains and
losses excluded from earnings and reported as a separate component of
stockholders’ equity. As a result, a decline in fair values may reduce the book
value of our assets. Moreover, if the decline in fair value of an
available-for-sale security is other-than-temporarily impaired, such decline
will reduce earnings. If market conditions result in a decline in the fair value
of our RMBS, our financial position and results of operations could be adversely
affected.
 
 The
lack of liquidity in our investments may adversely affect our
business.
 
 We may
invest in securities or other instruments that are not liquid. It may be
difficult or impossible to obtain third party pricing on the investments we
purchase. Turbulent market conditions, such as those currently in effect, could
significantly and negatively impact the liquidity of our assets. Illiquid
investments typically experience greater price volatility as a ready market does
not exist and can be more difficult to value. In addition, validating third
party pricing for illiquid investments may be more subjective than more liquid
investments. The illiquidity of our investments may make it difficult for us to
sell such investments if the need or desire arises. In addition, if we are
required to liquidate all or a portion of our portfolio quickly, we may realize
significantly less than the value at which we have previously recorded our
investments. As a result, our ability to vary our portfolio in response to
changes in economic and other conditions may be relatively limited, which could
adversely affect our results of operations and financial condition.
  56
  Item
4.                           SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
  (a)
              The
      annual meeting of stockholders of Chimera Investment Corporation was held
      on May 29, 2009.
  (b)
              All
      Class II director nominees were
elected.
  Director
                        Votes
      For
                        Votes
      WithheldMatthew
      Lambiase
                        166,452,142
                        4,350,150Paul
      Keenan
                        168,641,671
                        2,160,621
 
   The
continuing directors of the Company are Mark Abrams, Jeremy Diamond, and Paul
Donlin.
  (c)
              In
      addition to the election of the Class II directors, the ratification of
      the appointment of Deloitte & Touche LLP as our independent registered
      public accounting firm for 2009 was approved.Proposals
      and Vote Tabulations
  Votes
      CastFor
                      Against
                      AbstainRatification
      of the
                        appointment
      of
                        independent
      registered
                        public
      accounting firm
                        for
      2009
                      170,650,016
                      106,734
                      45,542
  57
  Item
6.                   EXHIBITS
  
 Exhibits:
 
 The
exhibits required by this item are set forth on the Exhibit Index attached
hereto
 EXHIBIT
INDEX
 Exhibit
                Number
              Description3.1
              Articles
      of Amendment and Restatement of Chimera Investment
      Corporation  (filed as Exhibit 3.1 to the Company’s Registration
      Statement on Amendment No. 1 to Form S-11 (File No. 333-145525) filed on
      September 27, 2007 and incorporated herein by reference)3.2
              Articles
      of Amendment of Chimera Investment Corporation  (filed as
      Exhibit 3.1 to the Company’s Report on Form 8-5 filed on
      May  28, 2009 and incorporated herein by
    reference)3.3
              Amended
      and Restated Bylaws of Chimera Investment Corporation  (filed as
      Exhibit 3.2 to the Company’s Registration Statement on Amendment No. 2 to
      Form S-11 (File No. 333-145525) filed on November 5, 2007 and incorporated
      herein by reference)4.1
              Specimen
      Common Stock Certificate of Chimera Investment Corporation (filed as
      Exhibit 4.1 to the Company’s Registration Statement on Amendment No. 1 to
      Form S-11 (File No. 333-145525) filed on September 27, 2007 and
      incorporated herein by reference)31.1
              Certification
      of Matthew Lambiase, Chief Executive Officer and President of the
      Registrant, pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002.31.2
              Certification
      of A. Alexandra Denahan, Chief Financial Officer of the Registrant,
      pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
              Certification
      of Matthew Lambiase, Chief Executive Officer and President of the
      Registrant, pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
      Section 906 of the Sarbanes-Oxley Act of 2002.32.2
              Certification
      of A. Alexandra Denahan, Chief Financial Officer of the Registrant,
      pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.
  58
  SIGNATURES
 
 Pursuant
to the requirements of Section 13 or 15(d) 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, in the city of New York, State of
New York.
 
 CHIMERA
INVESTMENT CORPORATION
  By:  /s/ Matthew
Lambiase
 Matthew
Lambiase
 Chief
Executive Officer and President
 August 10,
2009
 
 
 By: /s/ A. Alexandra
Denahan
 A.
Alexandra Denahan
 Chief
Financial Officer (Principal Financial Officer)
 August 10,
2009
  59