##### Table of Contents





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q







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

For the quarterly period ended: March 31, 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: 001-32026





ALESCO FINANCIAL INC.

(Exact name of registrant as specified in its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Maryland                                                       |  | 16-1685692                          
|(State or other jurisdiction of Incorporation or organization) |  | (IRS Employer Identification Number)

Cira Centre

2929 Arch Street, 17thFloor

Philadelphia, Pennsylvania 19104

(Address of principal executive offices, Zip Code)

(215) 701-9555

(Registrants telephone number, including area code)





Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes     ̈  No

Indicate by check
mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter)
during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     ̈  Yes     ̈  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (check one)



|                        |  |                                                  |  |                           |  |  
|----------------------- |  | ------------------------------------------------ |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈                                                |  | Accelerated filer         |  | x
|                        |  |                                                  | 
|Non-accelerated filer   |  |  ̈  (Do not check if a smaller reporting company) |  | Smaller reporting company |  |  ̈

Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Exchange
Act).     ̈  Yes    x  No

As of May 11, 2009 there were 60,171,324 shares of common stock ($0.001 par value per share) of Alesco Financial Inc. outstanding.









---

##### Table of Contents

ALESCO FINANCIAL INC.

TABLE OF CONTENTS



|                              |  |                                                                                       |  |   
|----------------------------- |  | ------------------------------------------------------------------------------------- |  | --
|Part I. Financial Information |  | 1                                                                                    
|                              |  |                                                                                      
|Item 1.                       |  | Financial Statements (Unaudited)                                                      |  | 1 
|                              |  |                                                                                      
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 24
|                              |  |                                                                                      
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 46
|                              |  |                                                                                      
|Item 4.                       |  | Controls and Procedures                                                               |  | 47
|                              | 
|Part II. Other Information    |  | 47                                                                                   
|                              |  |                                                                                      
|Item 1.                       |  | Legal Proceedings                                                                     |  | 47
|                              |  |                                                                                      
|Item 1A.                      |  | Risk Factors                                                                          |  | 48
|                              |  |                                                                                      
|Item 2.                       |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 48
|                              |  |                                                                                      
|Item 3.                       |  | Defaults Upon Senior Securities                                                       |  | 48
|                              |  |                                                                                      
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                   |  | 48
|                              |  |                                                                                      
|Item 5.                       |  | Other Information                                                                     |  | 48
|                              |  |                                                                                      
|Item 6.                       |  | Exhibits                                                                              |  | 48



---

##### Table of Contents

PART I. FINANCIAL INFORMATION



|ITEM 1. | FINANCIAL STATEMENTS (UNAUDITED).
|------- | ---------------------------------

Alesco
Financial Inc.

Consolidated Balance Sheets

(Unaudited and in thousands, except share and per share information)



|                                                                                                                                                                                         |  |                     |           |   |                                     |   |           |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------- | --------- | - | ----------------------------------- | - | --------- | -
|                                                                                                                                                                                         |  | As ofMarch 31, 2009 |           |   | As ofDecember 31, 2008(As Adjusted) |  
|Assets                                                                                                                                                                                   |  |                     |           |   |                                     |   |           |  
|Investments in debt securities and security-related receivables, at fair value                                                                                                           |  | $                   | 1,806,103 |   |                                     | $ | 2,079,750 |  
|Investments in loans                                                                                                                                                                     |  |                     |           |   |                                     |   |           |  
|Residential mortgages                                                                                                                                                                    |  |                     | 875,044   |   |                                     |   | 901,491   |  
|Commercial mortgages                                                                                                                                                                     |  |                     | 7,464     |   |                                     |   | 7,464     |  
|Leveraged loans (including amounts held for sale at fair value of $96,287 and $63,601, respectively)                                                                                     |  |                     | 796,763   |   |                                     |   | 780,269   |  
|Loan loss reserve                                                                                                                                                                        |  |                     | (114,541  | ) |                                     |   | (68,428   | )
|                                                                                                                                                                                         |  |                     |           |   |                                     |   |           |  
|Total investments in loans, net                                                                                                                                                          |  |                     | 1,564,730 |   |                                     |   | 1,620,796 |  
|Cash and cash equivalents                                                                                                                                                                |  |                     | 87,666    |   |                                     |   | 86,035    |  
|Restricted cash and warehouse deposits                                                                                                                                                   |  |                     | 77,194    |   |                                     |   | 54,059    |  
|Accrued interest receivable                                                                                                                                                              |  |                     | 22,777    |   |                                     |   | 31,435    |  
|Deferred tax asset                                                                                                                                                                       |  |                     | 11,620    |   |                                     |   | 25,036    |  
|Other assets                                                                                                                                                                             |  |                     | 33,839    |   |                                     |   | 37,820    |  
|                                                                                                                                                                                         |  |                     |           |   |                                     |   |           |  
|Total assets                                                                                                                                                                             |  | $                   | 3,603,929 |   |                                     | $ | 3,934,931 |  
|                                                                                                                                                                                         |  |                     |           |   |                                     |   |           |  
|                                                                                                                                                                                         |  |                    
|Liabilities and equity                                                                                                                                                                   |  |                     |           |   |                                     |   |           |  
|Indebtedness                                                                                                                                                                             |  |                     |           |   |                                     |   |           |  
|Trust preferred obligations, at fair value                                                                                                                                               |  | $                   | 99,516    |   |                                     | $ | 120,409   |  
|Securitized mortgage debt                                                                                                                                                                |  |                     | 821,802   |   |                                     |   | 844,764   |  
|CDO notes payable (including amounts at fair value of $1,421,683 and $1,647,590, respectively)                                                                                           |  |                     | 2,127,013 |   |                                     |   | 2,342,920 |  
|Warehouse credit facilities                                                                                                                                                              |  |                     | 123,114   |   |                                     |   | 126,623   |  
|Recourse indebtedness                                                                                                                                                                    |  |                     | 77,677    |   |                                     |   | 77,656    |  
|                                                                                                                                                                                         |  |                     |           |   |                                     |   |           |  
|Total indebtedness                                                                                                                                                                       |  |                     | 3,249,122 |   |                                     |   | 3,512,372 |  
|Accrued interest payable                                                                                                                                                                 |  |                     | 21,668    |   |                                     |   | 30,530    |  
|Related party payable                                                                                                                                                                    |  |                     | 5,899     |   |                                     |   | 4,880     |  
|Derivative liabilities                                                                                                                                                                   |  |                     | 250,056   |   |                                     |   | 266,984   |  
|Other liabilities                                                                                                                                                                        |  |                     | 11,531    |   |                                     |   | 12,165    |  
|                                                                                                                                                                                         |  |                     |           |   |                                     |   |           |  
|Total liabilities                                                                                                                                                                        |  |                     | 3,538,276 |   |                                     |   | 3,826,931 |  
|Equity                                                                                                                                                                                   |  |                     |           |   |                                     |   |           |  
|Preferred stock, $0.001 par value per share, 50,000,000 shares authorized, no shares issued and outstanding                                                                              |  |                     |          |   |                                     |   |          |  
|Common stock, $0.001 par value per share, 100,000,000 shares authorized, 60,171,324 issued and outstanding, including 836,776 and 985,810
unvested restricted share awards, respectively |  |                     | 59        |   |                                     |   | 59        |  
|Additional paid-in-capital                                                                                                                                                               |  |                     | 484,742   |   |                                     |   | 484,612   |  
|Accumulated other comprehensive loss                                                                                                                                                     |  |                     | (13,464   | ) |                                     |   | (14,223   | )
|Accumulated deficit                                                                                                                                                                      |  |                     | (441,329  | ) |                                     |   | (405,496  | )
|                                                                                                                                                                                         |  |                     |           |   |                                     |   |           |  
|Total parent stockholders equity                                                                                                                                                        |  |                     | 30,008    |   |                                     |   | 64,952    |  
|Noncontrolling interests in subsidiaries                                                                                                                                                 |  |                     | 35,645    |   |                                     |   | 43,048    |  
|                                                                                                                                                                                         |  |                     |           |   |                                     |   |           |  
|Total equity                                                                                                                                                                             |  |                     | 65,653    |   |                                     |   | 108,000   |  
|                                                                                                                                                                                         |  |                     |           |   |                                     |   |           |  
|Total liabilities and equity                                                                                                                                                             |  | $                   | 3,603,929 |   |                                     | $ | 3,934,931 |  
|                                                                                                                                                                                         |  |                     |           |   |                                     |   |           |  

See accompanying notes.



1



---

##### Table of Contents

Alesco Financial Inc.

Consolidated Statements of Income (Loss)

(Unaudited and in thousands, except share and per share
information)



|                                                                                                   |  |                                          |            |   |                                                       |   |            |  
|-------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | ---------- | - | ----------------------------------------------------- | - | ---------- | -
|                                                                                                   |  | For theThree Months EndedMarch, 31, 2009 |            |   | For theThree Months EndedMarch, 31, 2008(As Adjusted) |  
|Net investment income (loss):                                                                      |  |                                          |            |   |                                                       |   |            |  
|Investment interest income                                                                         |  | $                                        | 99,884     |   |                                                       | $ | 173,895    |  
|Investment interest expense                                                                        |  |                                          | (58,953    | ) |                                                       |   | (139,784   | )
|Provision for loan losses                                                                          |  |                                          | (50,458    | ) |                                                       |   | (7,564     | )
|                                                                                                   |  |                                          |            |   |                                                       |   |            |  
|Net investment income (loss)                                                                       |  |                                          | (9,527     | ) |                                                       |   | 26,547     |  
|                                                                                                   |  |                                          |            |   |                                                       |   |            |  
|                                                                                                   |  |                                         
|Expenses:                                                                                          |  |                                          |            |   |                                                       |   |            |  
|Related party management compensation                                                              |  |                                          | 3,876      |   |                                                       |   | 4,715      |  
|General and administrative                                                                         |  |                                          | 3,973      |   |                                                       |   | 3,615      |  
|                                                                                                   |  |                                          |            |   |                                                       |   |            |  
|Total expenses                                                                                     |  |                                          | 7,849      |   |                                                       |   | 8,360      |  
|Other income and expense:                                                                          |  |                                          |            |   |                                                       |   |            |  
|Interest and other income                                                                          |  |                                          | 406        |   |                                                       |   | 1,494      |  
|Net change in fair value of investments in debt securities and loans and non-recourse indebtedness |  |                                          | 6,877      |   |                                                       |   | 202,858    |  
|Net change in fair value of derivative contracts                                                   |  |                                          | (4,752     | ) |                                                       |   | (82,863    | )
|Credit default swap premiums                                                                       |  |                                          |           |   |                                                       |   | (1,335     | )
|Impairments on other investments and intangible assets                                             |  |                                          | (2,077     | ) |                                                       |   | (8,557     | )
|Net realized loss on sale of assets                                                                |  |                                          | (11,845    | ) |                                                       |   | (1,449     | )
|                                                                                                   |  |                                          |            |   |                                                       |   |            |  
|Earnings (loss) before benefit (provision) for income taxes                                        |  |                                          | (28,767    | ) |                                                       |   | 128,335    |  
|Benefit (provision) for income taxes                                                               |  |                                          | (14,188    | ) |                                                       |   | 427        |  
|                                                                                                   |  |                                          |            |   |                                                       |   |            |  
|Net income (loss)                                                                                  |  |                                          | (42,955    | ) |                                                       |   | 128,762    |  
|Less: Net (income) loss attributable to noncontrolling interests                                   |  |                                          | 7,122      |   |                                                       |   | (43,875    | )
|                                                                                                   |  |                                          |            |   |                                                       |   |            |  
|Net income (loss) attributable to common stockholders                                              |  | $                                        | (35,833    | ) |                                                       | $ | 84,887     |  
|                                                                                                   |  |                                          |            |   |                                                       |   |            |  
|                                                                                                   |  |                                         
|Earnings (loss) per sharebasic:                                                                   |  |                                          |            |   |                                                       |   |            |  
|Basic earnings (loss) per share                                                                    |  | $                                        | (0.60      | ) |                                                       | $ | 1.40       |  
|                                                                                                   |  |                                          |            |   |                                                       |   |            |  
|Weighted-average shares outstandingBasic                                                          |  |                                          | 60,171,324 |   |                                                       |   | 60,548,032 |  
|                                                                                                   |  |                                          |            |   |                                                       |   |            |  
|                                                                                                   |  |                                         
|Earnings (loss) per sharediluted:                                                                 |  |                                          |            |   |                                                       |   |            |  
|Diluted earnings (loss) per share                                                                  |  | $                                        | (0.60      | ) |                                                       | $ | 1.40       |  
|                                                                                                   |  |                                          |            |   |                                                       |   |            |  
|Weighted-average shares outstandingDiluted                                                        |  |                                          | 60,171,324 |   |                                                       |   | 60,548,032 |  
|                                                                                                   |  |                                          |            |   |                                                       |   |            |  
|Distributions declared per common share                                                            |  | $                                        |           |   |                                                       | $ | 0.25       |  
|                                                                                                   |  |                                          |            |   |                                                       |   |            |  

See accompanying notes.



2



---

##### Table of Contents

Alesco Financial Inc.

Consolidated Statements of Comprehensive Income (Loss)

(Unaudited and in thousands)



|                                                                |  |                                         |         |   |                                                      |   |         |  
|--------------------------------------------------------------- |  | --------------------------------------- | ------- | - | ---------------------------------------------------- | - | ------- | -
|                                                                |  | For theThree Months EndedMarch 31, 2009 |         |   | For theThree Months EndedMarch 31, 2008(As Adjusted) |  
|Net income (loss)                                               |  | $                                       | (42,955 | ) |                                                      | $ | 128,762 |  
|Other comprehensive income (loss):                              |  |                                         |         |   |                                                      |   |         |  
|Net change in cash-flow hedges                                  |  |                                         | 1,386   |   |                                                      |   | 2,583   |  
|                                                                |  |                                         |         |   |                                                      |   |         |  
|Comprehensive income (loss)                                     |  |                                         | (41,569 | ) |                                                      |   | 131,345 |  
|Comprehensive income attributable to noncontrolling interests   |  |                                         | (627    | ) |                                                      |   | (627    | )
|                                                                |  |                                         |         |   |                                                      |   |         |  
|Comprehensive income (loss) attributable to common stockholders |  | $                                       | (42,196 | ) |                                                      | $ | 130,718 |  
|                                                                |  |                                         |         |   |                                                      |   |         |  

See accompanying notes.



3



---

##### Table of Contents

Alesco Financial Inc.

Consolidated Statements of Equity

(Unaudited and in thousands, except share information)



|                                          |  |              |  |           |    |                          |   |                                   |  |   |                    |   |  |                                 |          |   |                                        |   |         |             |  |   |        |   |  |   |         |  
|----------------------------------------- |  | ------------ |  | --------- | -- | ------------------------ | - | --------------------------------- |  | - | ------------------ | - |  | ------------------------------- | -------- | - | -------------------------------------- | - | ------- | ----------- |  | - | ------ | - |  | - | ------- | -
|                                          |  | Common Stock |  |           |    |                          |   |                                   |  |   |                    |   |  |                                 |          |   |                                        |   |        
|                                          |  | Shares       |  | Par Value |    | AdditionalPaid InCapital |   | AccumulatedOtherComprehensiveLoss |  |   | AccumulatedDeficit |   |  | Total ParentStockholdersEquity |          |   | NoncontrollingInterests inSubsidiaries |   |         | TotalEquity | 
|Balance, December 31, 2008 (As Adjusted)  |  | 59,185,514   |  | $         | 59 |                          | $ | 484,612                           |  | $ | (14,223            | ) |  | $                               | (405,496 | ) |                                        | $ | 64,952  |             |  | $ | 43,048 |   |  | $ | 108,000 |  
|Net loss                                  |  |             |  |           |   |                          |   |                                  |  |   |                   |   |  |                                 | (35,833  | ) |                                        |   | (35,833 | )           |  |   | (7,122 | ) |  |   | (42,955 | )
|Other comprehensive income                |  |             |  |           |   |                          |   |                                  |  |   | 759                |   |  |                                 |         |   |                                        |   | 759     |             |  |   | 627    |   |  |   | 1,386   |  
|Stock-based compensation expense          |  | 149,034      |  |           |   |                          |   | 130                               |  |   |                   |   |  |                                 |         |   |                                        |   | 130     |             |  |   |       |   |  |   | 130     |  
|Distributions to noncontrolling interests |  |             |  |           |   |                          |   |                                  |  |   |                   |   |  |                                 |         |   |                                        |   |        |             |  |   | (908   | ) |  |   | (908    | )
|                                          |  |              |  |           |    |                          |   |                                   |  |   |                    |   |  |                                 |          |   |                                        |   |         |             |  |   |        |   |  |   |         |  
|Balance, March 31, 2009                   |  | 59,334,548   |  | $         | 59 |                          | $ | 484,742                           |  | $ | (13,464            | ) |  | $                               | (441,329 | ) |                                        | $ | 30,008  |             |  | $ | 35,645 |   |  | $ | 65,653  |  
|                                          |  |              |  |           |    |                          |   |                                   |  |   |                    |   |  |                                 |          |   |                                        |   |         |             |  |   |        |   |  |   |         |  

See accompanying notes.



4



---

##### Table of Contents

Alesco Financial Inc.

Consolidated Statements of Cash Flows

(Unaudited and in thousands)



|                                                                                                   |  |                                        |         |   |                                                     |   |          |  
|-------------------------------------------------------------------------------------------------- |  | -------------------------------------- | ------- | - | --------------------------------------------------- | - | -------- | -
|                                                                                                   |  | For theThree MonthsEndedMarch 31, 2009 |         |   | For theThree MonthsEndedMarch 31, 2008(As Adjusted) |  
|Operating activities:                                                                              |  |                                        |         |   |                                                     |   |          |  
|Net income (loss)                                                                                  |  | $                                      | (42,955 | ) |                                                     | $ | 128,762  |  
|Adjustments to reconcile net income (loss) to cash flow from operating activities:                 |  |                                        |         |   |                                                     |   |          |  
|Provision for loan losses                                                                          |  |                                        | 50,458  |   |                                                     |   | 7,564    |  
|Stock-based compensation expense                                                                   |  |                                        | 130     |   |                                                     |   | 483      |  
|Net premium and discount amortization on investments and loans                                     |  |                                        | (1,376  | ) |                                                     |   | (488     | )
|Amortization of deferred financing costs                                                           |  |                                        | 354     |   |                                                     |   | 517      |  
|Accretion of discounts on indebtedness                                                             |  |                                        | 152     |   |                                                     |   | 272      |  
|Net change in fair value of derivative contracts                                                   |  |                                        | (13,425 | ) |                                                     |   | 80,717   |  
|Net change in fair value of investments in debt securities and loans and non-recourse indebtedness |  |                                        | (6,877  | ) |                                                     |   | (202,858 | )
|Impairments on other investments and intangible assets                                             |  |                                        | 2,077   |   |                                                     |   | 8,557    |  
|Net realized loss on sale of assets                                                                |  |                                        | 11,845  |   |                                                     |   | 1,449    |  
|Proceeds from sale of real estate owned                                                            |  |                                        | 3,465   |   |                                                     |   |         |  
|Changes in assets and liabilities:                                                                 |  |                                        |         |   |                                                     |   |          |  
|Accrued interest receivable                                                                        |  |                                        | 8,698   |   |                                                     |   | 8,006    |  
|Other assets                                                                                       |  |                                        | 12,389  |   |                                                     |   | 66,404   |  
|Accrued interest payable                                                                           |  |                                        | (11,230 | ) |                                                     |   | (13,728  | )
|Related party payable                                                                              |  |                                        | 1,019   |   |                                                     |   | (45      | )
|Other liabilities                                                                                  |  |                                        | (50     | ) |                                                     |   | (2,107   | )
|                                                                                                   |  |                                        |         |   |                                                     |   |          |  
|Net cash provided by operating activities                                                          |  |                                        | 14,674  |   |                                                     |   | 83,505   |  
|Investing activities:                                                                              |  |                                        |         |   |                                                     |   |          |  
|Purchase of investments in debt securities and security-related receivables                        |  |                                        |        |   |                                                     |   | (5,030   | )
|Principal repayments from investments in debt securities and security-related receivables          |  |                                        | 6,681   |   |                                                     |   | 8,101    |  
|Purchase of loans                                                                                  |  |                                        | (3,358  | ) |                                                     |   | (83,155  | )
|Principal repayments from loans                                                                    |  |                                        | 40,920  |   |                                                     |   | 64,373   |  
|Proceeds from sale of loans                                                                        |  |                                        | 6,198   |   |                                                     |   | 41,045   |  
|Proceeds from sale of investments in debt securities and security-related receivables              |  |                                        |        |   |                                                     |   | 910      |  
|(Increase) decrease in restricted cash and warehouse deposits                                      |  |                                        | (23,136 | ) |                                                     |   | 7,696    |  
|                                                                                                   |  |                                        |         |   |                                                     |   |          |  
|Net cash provided by investing activities                                                          |  |                                        | 27,305  |   |                                                     |   | 33,940   |  
|Financing activities:                                                                              |  |                                        |         |   |                                                     |   |          |  
|Proceeds from issuance of CDO notes payable                                                        |  |                                        | 10,000  |   |                                                     |   | 27,386   |  
|Repayments of CDO notes payable                                                                    |  |                                        | (22,235 | ) |                                                     |   | (11,797  | )
|Proceeds from warehouse credit facilities                                                          |  |                                        |        |   |                                                     |   | 115,615  |  
|Repayments of warehouse credit facilities                                                          |  |                                        | (3,509  | ) |                                                     |   | (134,155 | )
|Repayments of securitized mortgage debt                                                            |  |                                        | (23,113 | ) |                                                     |   | (31,620  | )
|Repayments of other derivative contracts                                                           |  |                                        | (583    | ) |                                                     |   | (2,628   | )
|Distributions to noncontrolling interests in CDOs                                                  |  |                                        | (908    | ) |                                                     |   | (6,432   | )
|Distributions paid to common stockholders                                                          |  |                                        |        |   |                                                     |   | (18,770  | )
|                                                                                                   |  |                                        |         |   |                                                     |   |          |  
|Net cash used in financing activities                                                              |  |                                        | (40,348 | ) |                                                     |   | (62,401  | )
|                                                                                                   |  |                                        |         |   |                                                     |   |          |  
|Net change in cash and cash equivalents                                                            |  | $                                      | 1,631   |   |                                                     | $ | 55,044   |  
|Cash and cash equivalents at the beginning of the period                                           |  |                                        | 86,035  |   |                                                     |   | 80,176   |  
|                                                                                                   |  |                                        |         |   |                                                     |   |          |  
|Cash and cash equivalents at the end of the period                                                 |  | $                                      | 87,666  |   |                                                     | $ | 135,220  |  
|                                                                                                   |  |                                        |         |   |                                                     |   |          |  
|                                                                                                   |  |                                       
|Supplemental cash flow information:                                                                |  |                                        |         |   |                                                     |   |          |  
|Transfer of residential mortgage loans to real estate owned                                        |  | $                                      | 1,654   |   |                                                     | $ | 5,103    |  
|Distributions payable                                                                              |  |                                        |        |   |                                                     |   | 14,860   |  
|Non-cash purchase of debt securities                                                               |  |                                        | 4,999   |   |                                                     |   |         |  
|Non-cash sale of debt securities                                                                   |  |                                        | 4,999   |   |                                                     |   |         |  

See accompanying notes.



5



---

##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements

As of March 31, 2009

(Unaudited and in thousands, except share and per share amounts)

NOTE 1: THE COMPANY

Alesco Financial Trust (AFT) was organized as a Maryland real estate
investment trust (REIT) on October 25, 2005 and commenced operations on January 31, 2006. On January 31, 2006, February 2, 2006, and March 1, 2006, AFT completed the sale of 11,107,570 common shares of
beneficial interest at an offering price of $10.00 per share in a private offering. AFT received proceeds from this offering of $102.4 million, net of placement fees and offering costs.

On October 6, 2006, the merger between AFT and Sunset Financial Resources, Inc. (Sunset) was completed and the combined company was
renamed Alesco Financial Inc. Pursuant to the terms of the Amended and Restated Agreement and Plan of Merger, as amended by letter agreements dated September 5, 2006 and September 29, 2006, upon the completion of the merger, each share of
beneficial interest of AFT was converted into 1.26 shares of common stock of Sunset, which resulted in the issuance of 14,415,530 shares of common stock. In accordance with U.S. generally accepted accounting principles (GAAP), the
transaction was accounted for as a reverse acquisition, and AFT was deemed to be the accounting acquirer and all of Sunsets assets and liabilities were required to be revalued as of the acquisition date. As used in these consolidated financial
statements, the term the Company, we, us and our refer to the operations of AFT from January 31, 2006 through October 6, 2006, and the combined operations of the merged company subsequent to
October 6, 2006. Sunset refers to the historical operations of Sunset Financial Resources, Inc. through October 6, 2006, the merger date.

Sunset was incorporated in Maryland on October 6, 2003, completed its initial public offering of common stock on March 22, 2004 and was traded on the New York Stock Exchange (the NYSE) under the
ticker symbol SFO. Sunset elected to be taxed as a REIT for U.S. federal income tax purposes and the Company intends to continue to comply with these tax provisions. On October 9, 2006, the Company began trading on the NYSE under
the ticker symbol AFN. On November 27, 2006, the Company closed a public offering of 30,360,000 shares of the Companys common stock, par value $0.001 per share, at a public offering price of $9.00 per share, net of placement
fees and offering costs. On June 25, 2007, the Company closed a public offering of 8,000,000 shares of the Companys common stock, par value $0.001 per share, at a public offering price of $9.25 per share, net of placement fees and
offering costs.

The Company is a specialty finance company that has historically invested primarily in the following target asset classes,
subject to maintaining the Companys status as a REIT under the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code, and its exemption from regulation under the Investment Company Act of 1940, as amended, or the Investment
Company Act:



| |  |  | subordinated debt financings, primarily in the form of trust preferred securities, or TruPS, issued by banks or bank holding companies and insurance companies, and
surplus notes issued by insurance companies;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | leveraged loans made to small and mid-sized companies in a variety of industries, including the consumer products and manufacturing industries; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | mortgage loans, other real estate-related senior and subordinated debt securities, and residential mortgage-backed securities, or RMBS.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------

The Company has historically financed investments in these target asset classes on a short-term basis with on and
off-balance sheet warehouse facilities or other short-term financing arrangements and on a long-term basis with securitization vehicles, including collateralized debt obligations (CDOs) and collateralized loan obligations
(CLOs).

The Company may also invest opportunistically from time to time in other types of investments within its
managers and Cohen Brothers, LLCs (Cohen & Company or Cohen) areas of expertise and experience, subject to maintaining its qualification as a REIT and an exemption from regulation under the Investment
Company Act.

Proposed Merger with Cohen & Company

On February 20, 2009, the Company signed a definitive merger agreement with Cohen & Company, the parent of the Companys manager. The Companys Board of Directors and Cohens Board of
Managers have each unanimously approved the transaction. In the proposed merger, Cohen & Company will merge with a subsidiary of the Company and will survive the merger as a subsidiary of the Company. In the proposed merger, (i) members who
own Class A units of membership interest and Class B units of membership interest in Cohen & Company will have the option to exchange their membership units in Cohen & Company for either 0.57372 shares of the
Companys common stock or 0.57372 replacement units of membership interest in Cohen & Company and (ii) Daniel G. Cohen, who owns Class C units of membership interest in Cohen & Company, will be entitled to receive
one share of our Series A Voting Convertible Preferred Stock, par value $0.001 per share, which is referred to herein as the Series A share. The Series A share will have no economic rights but will entitle the holder thereof to elect one-third of
our board of directors. In 2010, the



6



---

##### Table of Contents

holder of the Series A share may convert the Series A share into our Series B Voting Non-Convertible Preferred Stock, par value $0.001 per share, which will
have no economic rights but will entitle such holder to vote together with our stockholders on all matters presented to our stockholders and to exercise approximately 31.9% of the voting power of our common stock. The replacement units of membership
interest in Cohen & Company may be exchanged into an equivalent number of our common stock in the future, after specified lock-up periods. Holders of the Companys common stock will continue to hold their shares of the Company.
Pursuant to the merger agreement, the Company expects to complete a 1 for 10 reverse split of its common stock. It is currently expected that the Companys current shareholders will own 56.5% of the Companys shares of common stock
immediately after the merger and former unit holders of Cohen & Company will hold the balance; however, the actual percentages will not be known until members of Cohen & Company have made their elections to receive the
Companys common stock or replacement units of Cohen & Company. If all Cohen & Company membership interests were to be converted into the Companys common stock shares, the Companys current shareholders would own
38.5%, and former Cohen & Company members would own 61.5%, of the combined company. Cohen & Company will be treated as the acquirer for accounting purposes.

The proposed merger, which is expected to close during the second half of 2009, is subject to a number of closing conditions, including the receipt of
third party consents and other conditions set forth in the definitive merger agreement. In addition, the merger is subject to approval by the affirmative vote of a majority of the votes cast by holders of the Companys common stock, provided
that the number of votes cast on the matter represents 50% in interest of all securities entitled to vote on the matter.

NOTE 2: SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements have been prepared by management in accordance with GAAP. Certain information and footnote disclosures normally included in annual
consolidated financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations, although we believe that the disclosures included are adequate to make the information presented not
misleading. The unaudited interim consolidated financial statements should be read in conjunction with our audited financial statements for the period ended December 31, 2008, included in our Annual Report on Form 10-K. See Item
15-Exhibits and Financial Statement Schedules included in our Annual Report on Form 10-K for the year ended December 31, 2008. In the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary to
present fairly our consolidated financial position and consolidated results of operations and cash flows, are included. The results of operations for the interim periods presented are not necessarily indicative of the results for the full year.

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that
affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Principles of Consolidation

The consolidated financial statements reflect the accounts of the Company and its
majority-owned and/or controlled subsidiaries and those entities for which the Company is determined to be the primary beneficiary in accordance with Financial Accounting Standard Board (FASB) Interpretation No. 46(R),
Consolidation of Variable Interest Entities (FIN 46R). The Company adopted Statement of Financial Accounting Standards (SFAS) No. 160, Noncontrolling Interests in Consolidated Financial Statements-an
amendment of Accounting Research Bulletin No. 51 (SFAS No. 160) on January 1, 2009. Accordingly, for consolidated subsidiaries that are less than wholly owned, the third-party holdings of equity interests are referred to
as noncontrolling interests. The portion of net income attributable to noncontrolling interests for such subsidiaries is presented as net income (loss) attributable to noncontrolling interests on the consolidated statements of income, and the
portion of the stockholders equity of such subsidiaries is presented as noncontrolling interests in subsidiaries on the consolidated balance sheets. All significant intercompany accounts and transactions have been eliminated in consolidation.

The Companys parent stockholders equity includes the effects of accounting for each of the underlying assets and liabilities
of our consolidated variable interest entities (VIEs) as a separate unit of account. The creditors of each VIE consolidated within the Companys consolidated financial statements have no recourse to the general credit or assets of
the Company. The Companys maximum exposure to loss as a result of its involvement with each VIE is limited to the capital that the Company has invested in warehouse first-loss deposits and the preference shares or debt of the CDO, CLO or other
types of securitization structures.

The following table presents information as of March 31, 2009 about VIEs which the Company
consolidates (dollars in thousands):



7



---

##### Table of Contents

|                                                                          |  |           |           |                                         |   |                                   |  |                             |         |       |   |         |  |   |          
|------------------------------------------------------------------------- |  | --------- | --------- | --------------------------------------- | - | --------------------------------- |  | --------------------------- | ------- | ----- | - | ------- |  | - | ---------
|                                                                          |  | TruPSCDOs |           | Leveraged LoanCLOs andWarehouseFacility |   | ResidentialMortgageSecuritization |  | KlerosReal Estate(MBS) CDOs |         | Total
|Consolidated VIE assets                                                   |  | $         | 1,412,255 |                                         | $ | 838,267                           |  | $                           | 819,795 |       | $ | 422,442 |  | $ | 3,492,759
|Consolidated VIE liabilities                                              |  |           | 1,375,637 |                                         |   | 833,103                           |  |                             | 825,932 |       |   | 422,442 |  |   | 3,457,114
|Noncontrolling interests in consolidated VIE subsidiaries                 |  |           | 31,684    |                                         |   | 3,961                             |  |                             |        |       |   |        |  |   | 35,645   
|Maximum exposure to loss:(1)                                              |  |           |           |                                         |   |                                   |  |                             |         |       |   |         |  |   |          
|Debt and equity interests in CDOs, CLOs and other securitization vehicles |  |           | 218,570   |                                         |   | 48,100                            |  |                             | 54,352  |       |   | 90,000  |  |   | 411,022  
|Warehouse facility                                                        |  |           |          |                                         |   | 38,475                            |  |                             |        |       |   |        |  |   | 38,475   
|                                                                          |  |           |           |                                         |   |                                   |  |                             |         |       |   |         |  |   |          
|Total maximum exposure to loss                                            |  | $         | 218,570   |                                         | $ | 86,575                            |  | $                           | 54,352  |       | $ | 90,000  |  | $ | 449,497  
|                                                                          |  |           |           |                                         |   |                                   |  |                             |         |       |   |         |  |   |          



|(1) | Represents our total investments in VIEs, and is not adjusted for losses incurred to date.
|--- | ------------------------------------------------------------------------------------------

When the Company obtains an explicit or implicit interest in an entity, the Company evaluates the entity to determine if the entity is a VIE, and, if so,
whether or not the Company is deemed to be the primary beneficiary of the VIE in accordance with FIN 46R. The Company consolidates VIEs of which the Company is deemed to be the primary beneficiary or non-VIEs which the Company controls. The primary
beneficiary of a VIE is the variable interest holder that absorbs the majority of the variability in the expected losses or potentially the residual returns of the VIE. When determining the primary beneficiary of a VIE, the Company considers its
aggregate explicit and implicit variable interests as a single variable interest. If the Companys variable interest absorbs the majority of the variability in the expected losses or the residual returns of the VIE, the Company is considered
the primary beneficiary of the VIE. The Company reconsiders its determination of whether an entity is a VIE and whether the Company is the primary beneficiary of such VIE if certain events occur. If the Company determines that it is no longer the
primary beneficiary of a VIE, the deconsolidation of the VIE is accounted for as a sale of the entity for no proceeds.

The Company has
determined that certain special purpose trusts formed by third party issuers of TruPS to issue such securities are VIEs (Trust VIEs) and that the holder of the majority of the TruPS issued by the Trust VIEs would be the primary
beneficiary of the special purpose trust. In most instances, the Company is the primary beneficiary of the Trust VIEs because it holds, either explicitly or implicitly, the majority of the TruPS issued by the Trust VIEs. The acquisition of TruPS
issued by Trust VIEs may be initially financed directly by CDOs, through on-balance sheet warehouse facilities or through off-balance sheet warehouse facilities. Under the TruPS-related off-balance sheet warehouse agreements, the Company usually
deposits cash collateral with an investment bank and bears the first dollar risk of loss, up to the Companys collateral deposit, if an investment held under the warehouse facility is liquidated at a loss. This arrangement causes the Company to
hold an implicit interest in the Trust VIEs that issued TruPS held by warehouse providers. The primary assets of the Trust VIEs are subordinated debentures issued by third party sponsors of the Trust VIEs in exchange for the TruPS proceeds and the
common equity securities of the Trust VIE. These subordinated debentures have terms that mirror the TruPS issued by the Trust VIEs. Upon consolidation of the Trust VIEs, these subordinated debentures, which are assets of the Trust VIE, are included
in the Companys consolidated financial statements and the related TruPS are eliminated. Pursuant to Emerging Issues Task Force Issue No. 85-1: Classifying Notes Received for Capital Stock, subordinated debentures issued to
Trust VIEs as payment for common equity securities issued by Trust VIEs to third party sponsors are recorded net of the common equity securities issued.

Fair Value of Financial Instruments

Effective January 1, 2008, the Company adopted Statement of Financial
Accounting Standards No. 157, Fair Value Measurements (SFAS No. 157), which establishes a framework for measuring fair value by creating a three-level fair value hierarchy that ranks the quality and reliability of
information used to determine fair value, and requires new disclosures of assets and liabilities measured at fair value based on their level in the hierarchy. SFAS No. 157 also defines fair value as the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

SFAS No. 157
establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are
inputs that market participants would use in pricing the financial instrument developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Companys estimates about what
assumptions market participants would use in pricing the financial instrument developed based on the best information available in the circumstances. The fair value hierarchy is broken down into three levels based on the reliability of inputs as
follows:



| |  |  | Level 1: Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Since
valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



8



---

##### Table of Contents

Financial instruments utilizing Level 1 inputs generally include exchange-traded equity securities listed in active
markets and most U.S. Government securities.



| |  |  | Level 2: Valuations based on quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not
active or for which all significant inputs are observable, either directly or indirectly.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Financial instruments utilizing Level 2 inputs
generally include certain mortgage-backed securities, or MBS, and corporate debt securities and certain financial instruments classified as derivatives, including interest rate swap contracts and credit default swaps, where fair value is based on
observable market inputs.



| |  |  | Level 3: Inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or
liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has
been determined based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and
considers factors specific to the asset or liability.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Financial instruments utilizing Level 3 inputs generally include investments in
TruPS and TruPS security-related receivables, certain MBS, and CDO notes payable.

The fair value of the Companys financial
instruments is generally based on observable market prices or inputs or derived from such prices or inputs, provided that such information is available. When quoted market prices are not available because certain financial instruments do not
actively trade in the public markets, fair value is based on comparisons to similar instruments or from internal valuation models.

The
availability of observable inputs can vary depending on the financial instrument and is affected by a wide variety of factors, including, for example, the type of financial instrument, its age, whether the financial instrument is traded on an active
exchange or in the secondary market, the current market conditions, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the
determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value
may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input
that is significant to the fair value measurement in its entirety.

Fair value is a market-based measure considered from the perspective of
a market participant who holds the asset or owes the liability rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Companys own assumptions are set to reflect those that management
believes market participants would use in pricing the asset or liability at the measurement date. The Company uses prices and inputs that management believes are current as of the measurement date, including during periods of market dislocation. In
periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2 or Level 2 to Level 3.

Many financial instruments have bid and ask prices that can be observed in the marketplace. Bid prices reflect the highest price that the Company and
others are willing to pay for an asset. Ask prices represent the lowest price that the Company and others are willing to accept for an asset. For financial instruments whose inputs are based on bid-ask prices, the Company does not require that fair
value always be a predetermined point in the bid-ask range. The Companys policy is to allow for mid-market pricing and adjusting to the point within the bid-ask range that results in the Companys best estimate of fair value.



9



---

##### Table of Contents

Fair value for certain of the Companys Level 3 financial instruments is derived using internal
valuation models. These internal valuation models include discounted cash flow analyses developed by management using current interest rates, estimates of the term of the particular contract, specific issuer information and other market data for
securities without an active market. In accordance with SFAS No. 157, the impact of the Companys own credit and creditworthiness of consolidated CDOs is also considered when measuring the fair value of liabilities, including derivative
contracts. Where appropriate, valuation adjustments are made to account for various factors, including bid-ask spreads, credit quality and market liquidity. These adjustments are applied on a consistent basis and are based upon observable inputs
where available. Managements estimate of fair value requires significant management judgment and is subject to a high degree of variability based upon market conditions, the availability of specific issuer information and managements
assumptions.

Financial instruments that are generally classified in Level 3 of the fair value hierarchy primarily consist of investments
in TruPS and TruPS security-related receivables, certain MBS, and CDO notes payable. The valuation techniques used for those financial instruments classified in Level 3 are described below.

TruPS and TruPS Security-Related Receivables: The fair value of investments in TruPS is estimated using internal valuation models. These
investment securities generally do not trade in an active market and, therefore observable price quotations are not available. Fair value is determined based on discounted cash flow models using current interest rates, estimates of the term of the
particular contract, specific issuer information, including estimates of comparable market credit spreads and other market data.

MBS:The fair value of investments in MBS is determined based on external price and spread data. When position-specific external price data are not observable, the valuation is based on prices of comparable bonds.

CDO Notes Payable: The fair value of CDO notes payable liabilities is estimated using external price data (where observable), or internal
valuation models. In the absence of observable price quotations, fair value is determined based on prices of comparable notes payable, or discounted cash flow models using current interest rates, estimates of the term of the particular contract,
specific underlying collateral information, including estimates of credit spreads and other market data for securities without an active market.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS No. 159). SFAS No. 159 provides
entities with an irrevocable option to report most financial assets and liabilities at fair value, with subsequent changes in fair value reported in earnings. The election can be applied on an instrument-by-instrument basis. SFAS No. 159
establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities, and became effective for the Company on
January 1, 2008. The Company elected to apply the fair value option for its investments in TruPS and TruPS security-related receivables, MBS, TruPS CDO notes payable, MBS CDO notes payable, and TruPS obligations. The Company elected the fair
value option for these instruments to enhance the transparency of its financial condition.

Investments

The Company invests primarily in TruPS and MBS debt securities, residential and commercial mortgage portfolios, and leveraged loans and may invest in
other types of real estate-related assets. The Company accounts for its investments in debt securities under Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, as
amended and interpreted (SFAS No. 115), and designates each investment as a trading security, an available-for-sale security, or a held-to-maturity security based on managements intent at the time of acquisition. Under SFAS
No. 115, trading securities are recorded at their fair value each reporting period with fluctuations in fair value reported as a component of earnings. Available-for-sale securities are recorded at fair value with changes in fair value reported
as a component of other comprehensive income (loss). Fair value of investments subsequent to the adoption of SFAS No. 157 is described above. Upon the sale of a security, the realized gain or loss is computed on a specific identification basis
and is recorded as a component of earnings in the respective period.

Effective January 1, 2008, the Company classifies its
investments in TruPS and MBS as trading securities (see Fair Value of Financial Instruments). These investments are carried at estimated fair value, with changes in fair value of these instruments reported in income. Unamortized premiums
and discounts on trading securities that are highly rated are recognized over the contractual life, adjusted for estimated prepayments using the effective interest method. For securities representing beneficial interests in securitizations that are
not highly rated (i.e., subordinate tranches of MBS), unamortized premiums and discounts are recognized over the contractual life, adjusted for estimated prepayments and estimated credit losses of the securities using the effective interest method.
Actual prepayment and credit loss experience are reviewed quarterly and effective yields are recalculated when differences arise between prepayments and credit losses originally anticipated compared to amounts actually received plus anticipated
future prepayments.

Effective January 1, 2008, the Company accounts for its investments in subordinated debentures owned by Trust
VIEs that the Company consolidates at fair value, with changes in fair value of these instruments reported in income. These Trust VIEs have no ability to sell, pledge, transfer or otherwise encumber a company or the assets of a company until such
subordinated debentures



10



---

##### Table of Contents

maturity. The Company accounts for investments in securities where the transfer meets the criteria as a secured financing under Statement of Financial
Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS No. 140) as secured loans at fair value. The Companys investments in
security-related receivables represent interests in securities that were transferred to CDO securitization entities by transferors that maintain some level of continuing involvement.

Effective January 1, 2008, the Company is not classifying any of its investments as available-for-sale. As it relates to investments that may be
classified as available-for-sale securities in the future, the Company will exercise judgment to determine whether an investment security had sustained an other-than-temporary decline in fair value. If the Company determines that an investment
security has sustained an other-than-temporary decline in its fair value, the investment security will be written down to its fair value by a charge to earnings, and the Company will establish a new cost basis for the investment. The Companys
evaluation of an other-than-temporary decline will be dependent on specific facts and circumstances relating to the particular investment. Factors that the Company will consider in determining whether an other-than-temporary decline in fair value
has occurred include, but are not limited to: the estimated fair value of the investment in relation to its cost basis; the length of time the security had a decline in estimated fair value below its amortized cost; the financial condition of the
related entity and industry events; changes in estimated cash flows from the investment; external credit ratings and recent downgrades of such credit ratings; and the intent and ability of the Company to hold the investment for a sufficient period
of time to allow for recovery in the fair value of the investment. For MBS that are not of high credit quality at acquisition, the Company will perform impairment analyses in accordance with Emerging Issues Task Force Issue No. 99-20,
Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets (EITF No. 99-20). When adverse changes in estimated cash flows occur as a result of actual or
expected prepayment and credit loss experience, an other-than-temporary impairment will be deemed to have occurred. Accordingly, the security will be written down to fair value, and the loss will be recognized in current earnings. The cost basis
adjustment for other-than-temporary impairment is recoverable only upon sale or maturity of the security.

The Company accounts for its
investments in residential and commercial mortgages and leveraged loans at amortized cost. The carrying value of these investments is adjusted for origination discounts/premiums, nonrefundable fees and direct costs for originating loans which are
amortized into income over the terms of the loans using the effective yield method adjusted for the effects of estimated prepayments based on Statement of Financial Accounting Standards No. 91, Accounting for Nonrefundable Fees and Costs
Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases (SFAS No. 91).

The Company
maintains an allowance for residential and commercial mortgages and leveraged loan losses based on managements evaluation of known losses and inherent risks in the portfolios, including historical and industry loss experience, economic
conditions and trends, estimated fair values, the quality of collateral and other relevant quantitative and qualitative factors. Specific allowances for losses may be established for potentially impaired loans based on a comparison of the recorded
carrying value of the loan to either the present value of the loans expected cash flow, the loans estimated market price or the estimated fair value of the underlying collateral. The allowance is increased by charges to operations and
decreased by charge-offs (net of recoveries).

An impaired loan may be left on accrual status during the period the Company is pursuing
repayment of the loan; however, the loan is placed on non-accrual status at such time as the Company believes that scheduled debt service payments may not be paid when contractually due or the loan becomes greater than 90 days delinquent. While on
non-accrual status, interest income is recognized only upon actual receipt.

Loans Held for Sale

Loans held for sale are carried at the lower of cost or fair value. If the fair value of a loan is less than its cost basis, a valuation adjustment is
recognized in the consolidated statement of operations and the loans carrying value is adjusted accordingly. The valuation adjustment may be recovered in the event the fair value increases, which is also recognized in the consolidated
statement of operations.

Transfers of Financial Assets

The Company accounts for transfers of financial assets under SFAS No. 140 as either sales or financing arrangements. Transfers of financial assets that result in sale accounting are those in which (a) the
transfer legally isolates the transferred assets from the transferor, (b) the transferee has the right to pledge or exchange the transferred assets and no condition both constrains the transferees right to pledge or exchange the assets
and provides more than a trivial benefit to the transferor, and (c) the transferor does not maintain effective control over the transferred assets. If the transfer does not meet each of these criteria, the transfer is accounted for as a
financing arrangement. Dispositions of financial assets that are treated as sales are removed from the Companys accounts with any realized gain (loss) reflected in earnings during the period of sale. Dispositions of financial assets that are
treated as financings are maintained on the balance sheet with proceeds received from the legal transfer reflected as secured borrowings and no gain or loss is recognized.



11



---

##### Table of Contents

Revenue Recognition

The Company recognizes interest income from investments in debt and other securities, residential and commercial mortgages, and leveraged loans over the estimated life of the underlying financial instruments on an
estimated yield to maturity basis.

In accordance with EITF No. 99-20, the Company recognizes interest income from purchased interests
in certain financial assets, including certain subordinated MBS, on an estimated effective yield to maturity basis. Management estimates the current yield on the reference amount of the investment based on estimated cash flows after considering
prepayment and credit loss expectations. The adjusted yield is then applied prospectively to recognize interest income for the next reporting period.

Derivative Instruments

The Company uses derivative financial instruments to attempt to hedge all or a portion of the
interest rate risk associated with its borrowings. In accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted (SFAS
No. 133), the Company measures each derivative instrument (including certain derivative instruments embedded in other contracts) at fair value and records such amounts in its consolidated balance sheet as either an asset or liability.
Derivatives qualifying and designated as cash-flow hedges are evaluated at inception and at subsequent balance sheet dates in order to determine whether they qualify for hedge accounting under SFAS No. 133. The hedge instrument must be highly
effective in achieving offsetting changes in cash flows of the hedged item attributable to the risk being hedged in order to qualify for hedge accounting. Derivative contracts are carried on the consolidated balance sheet at fair value. For
derivatives designated as cash flow hedges, the effective portions of changes in the fair value of the derivative are reported in other comprehensive income (loss). Changes in the ineffective portions of cash flow hedges are recognized in earnings.
Realized gains and losses on terminated contracts that were designated as hedges are maintained in accumulated other comprehensive income or loss and amortized into the consolidated statement of income over the contractual life of the terminated
contract unless it is probable that the forecasted transaction will not occur. In that case, the gain or loss in accumulated other comprehensive income or loss is reclassified to realized gain or loss in the consolidated statement of income. The
Company had no instruments designated as hedges during the three month periods ended March 31, 2009 and 2008, respectively.

The
Company enters into derivatives that do not qualify for hedge accounting or for which the Company may not elect hedge accounting, including interest rate swaps, interest rate caps and floors, credit default and total return swaps, under SFAS
No. 133. These derivatives are carried at their fair value with changes in fair value reflected in the consolidated statement of income. The fair value of credit default swaps is based on quotations from third-party brokers.

Accounting for Off-Balance Sheet Arrangements

The Company may maintain certain warehouse financing arrangements with various investment banks that are accounted for as off-balance sheet arrangements. The Company receives the difference between the interest earned on the investments
under the warehouse facilities and the interest charged by the warehouse providers from the dates on which the respective investments were acquired. Under the warehouse agreements, the Company is typically required to deposit cash collateral with
the warehouse provider and as a result, the Company bears the first dollar risk of loss, up to the warehouse deposit, if (i) an investment funded through the warehouse facility becomes impaired or (ii) a CDO is not completed by the end of
the warehouse period, and in either case, the warehouse provider is required to liquidate the securities at a loss. These off-balance sheet arrangements are not consolidated because the collateral assets are maintained on the balance sheet of the
warehouse providers. However, since the Company holds an implicit variable interest in many entities funded under its TruPS-related warehouse facilities, the Company often does consolidate the Trust VIEs while the TruPS they issue are held on the
warehouse facilities. The Company records the cash collateral as warehouse deposits in its financial statements. The net amount earned from these warehouse facilities and any obligation associated with the warehouse arrangement are considered
free-standing derivatives and are recorded at fair value in the financial statements with changes in fair value reflected in earnings in the respective period.

Income Taxes

For tax purposes, Sunset is deemed to have acquired AFT on October 6, 2006. Sunset elected to be
taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code and subsequent to the merger the Company continues to comply with these requirements. Accordingly, the Company generally will not be subject to U.S. federal income tax to
the extent of its distributions to stockholders and as long as certain asset, income, distribution and share ownership tests are met. If the Company were to fail to meet these requirements, it would be subject to U.S. federal income tax, which could
have a material adverse impact on its results of operations and amounts available for distributions to its stockholders. Management believes that all of the criteria to maintain the Companys REIT qualification have been met for the applicable
periods, but there can be no assurances that these criteria will continue to be met in subsequent periods.

The Company maintains domestic
taxable REIT subsidiaries (TRSs), which may be subject to U.S. federal, state and local income taxes. Current and deferred taxes are provided for on the portion of earnings (losses) recognized by the Company with respect



12



---

##### Table of Contents

to its interest in domestic TRSs. Deferred income tax assets and liabilities are computed based on temporary differences between the GAAP consolidated
financial statements and the federal and state income tax basis of assets and liabilities as of the consolidated balance sheet date. We evaluate the realizability of our deferred tax assets and recognize a valuation allowance if, based on the weight
of available evidence, it is more likely than not that some portion or all of our deferred tax assets will not be realized. When evaluating the realizability of our deferred tax assets, we consider estimates of expected future taxable income,
existing and projected book/tax differences, tax planning strategies available, and the general and industry specific economic outlook. This realizability analysis is inherently subjective, as it requires management to forecast our business and
general economic environment in future periods. Changes in estimate of deferred tax asset realizability, if any, are included in income tax expense on the consolidated statements of income.

During the three-months ended March 31, 2009, the Company recorded $14.2 million of provision for income taxes primarily relating to increases to
the fair value of certain leveraged loans classified as held-for-sale. The $13.4 million decrease in the Companys deferred tax asset as of March 31, 2009 as compared to the deferred tax asset as of December 31, 2008 is also primarily
attributable to the change in fair value of certain leveraged loans classified as held-for-sale.

Certain TRS entities are domiciled in the
Cayman Islands and, accordingly, taxable income generated by these entities may not be subject to local income taxation, but generally will be included in the Companys income on a current basis, whether or not distributed. Upon distribution of
any previously included income to the Company, no incremental U.S. federal, state, or local income taxes would be payable by the Company.

Recent
Accounting Pronouncements

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160,
Noncontrolling Interests in Consolidated Financial Statements-an amendment of Accounting Research Bulletin No. 51 (SFAS No. 160). SFAS No. 160 requires reporting entities to present noncontrolling (minority)
interests as equity (as opposed to as a liability or mezzanine equity) and provides guidance on the accounting for transactions between an entity and noncontrolling interests. SFAS No. 160 applies prospectively as of the first annual reporting
period beginning on or after December 15, 2008, except for the presentation and disclosure requirements which will be applied retrospectively for all periods presented. As of January 1, 2009, the Company adopted SFAS No. 160 and the
adoption of SFAS No. 160 resulted in the following changes to the presentation of the Companys prior period consolidated financial statements: (1) reclassified all amounts previously included within the Minority interests
financial statement caption to the Noncontrolling interests in subsidiaries financial statement caption, which is included within the equity section of the Companys consolidated balance sheets; (2) consolidated net income
(loss) was adjusted to include net income (loss) attributable to both the controlling and noncontrolling interests; and (3) consolidated comprehensive income (loss) was adjusted to include comprehensive income (loss) attributable to both the
controlling and noncontrolling interests. The adoption of SFAS No. 160 did not have an impact on net income (loss) for any prior periods. However, the net loss attributable to the Companys common stockholders for the three-months ended
March 31, 2009 decreased $14.4 million, or $0.24 per diluted share, as a result of SFAS No. 160s requirement that noncontrolling interests continue to be attributed their share of losses even if that attribution results in a deficit
noncontrolling interest balance.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R),
Business Combinations (SFAS No. 141(R)). SFAS 141(R) requires the acquiring entity in a business combination to recognize the full fair value of assets acquired and liabilities assumed in the transaction (whether a full
or partial acquisition); establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; requires expensing of most transaction and restructuring costs; and requires the acquirer to disclose
to investors and other users all of the information needed to evaluate and understand the nature and financial effect of the business combination. SFAS No. 141(R) applies to all transactions or other events in which the Company obtains control
of one or more businesses, including those sometimes referred to as true mergers or mergers of equals and combinations achieved without the transfer of consideration, for example, by contract alone or through the lapse of
minority veto rights. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging
Activities  an amendment of SFAS No. 133 (SFAS No. 161). SFAS No. 161 requires enhanced disclosure related to derivatives and hedging activities and thereby seeks to improve the transparency of financial
reporting. Under SFAS No. 161, entities are required to provide enhanced disclosures relating to: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedge items are accounted for under
SFAS No. 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entitys financial position, financial performance and cash flows. The statement is effective for fiscal years
beginning after November 15, 2008. The adoption of SFAS No. 161 did not have a material impact on our consolidated financial statements.



13



---

##### Table of Contents

In May 2008, the FASB issued FASB Staff Position (FSP) No. Accounting Principles Board 14-1,
Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement), or FSP APB 14-1, which clarifies the accounting for convertible debt instruments that may be settled in cash
(including partial cash settlement) upon conversion. FSP APB 14-1 requires issuers to account separately for the liability and equity components of certain convertible debt instruments in a manner that reflects the issuers nonconvertible debt
(unsecured debt) borrowing rate when interest cost is recognized. The equity component is presented in parent stockholders equity and the accretion of the resulting discount on the debt is recognized as part of interest expense in the
consolidated statement of operations. FSP APB 14-1 requires companies to retroactively apply the requirements of the pronouncement to all periods presented. As of January 1, 2009, the Company adopted FSP APB 14-1 and the effect of adoption was
not material to the three months ended March 31, 2009 and 2008. However, the consolidated financial statements as of and for the year ended December 31, 2008 have been retroactively restated for the adoption, which resulted in an increase
to the Companys net loss of $1.6 million, or $0.03 per diluted share, and a $2.2 million increase to parent stockholders equity at January 1, 2008.

In June 2008, the FASB issued FSP Emerging Issues Task Force 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (FSP EITF 03-6-1).
FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the
two-class method as described in Statement of Financial Accounting Standards No. 128, Earnings per Share. Under the guidance in FSP EITF 03-6-1, unvested share-based payment awards that contain non-forfeitable rights to dividends or
dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. FSP EITF 03-6-1 is effective for fiscal years beginning after
December 15, 2008, and interim periods within those fiscal years. As of January 1, 2009, the Company adopted FSP EITF 03-6-1 and all prior-period earnings per share data presented was adjusted retrospectively. The effect of adoption
was a reduction to basic and diluted earnings (loss) per share by $0.03 for the three-months ended March 31, 2008, and there was no material impact to the three-months ended March 31, 2009.

In June 2008, the FASB ratified the consensus reached by the Emerging Issues Task Force on Issue No. 07-5, Determining Whether an Instrument
(or Embedded Feature) Is Indexed to an Entitys Own Stock (EITF No. 07-5). EITF No. 07-5 provides guidance for determining whether an equity-linked financial instrument (or embedded feature) is indexed to an
entitys own stock. EITF No. 07-5 applies to any freestanding financial instrument or embedded feature that has all of the characteristics of a derivative or freestanding instrument that is potentially settled in an entitys own stock
(with the exception of share-based payment awards within the scope of SFAS 123(R)). To meet the definition of indexed to own stock, an instruments contingent exercise provisions must not be based on (a) an observable market,
other than the market for the issuers stock (if applicable), or (b) an observable index, other than an index calculated or measured solely by reference to the issuers own operations, and the variables that could affect the
settlement amount must be inputs to the fair value of a fixed-for-fixed forward or option on equity shares. EITF No. 07-5 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal
years. The adoption of EITF No. 07-5 did not have a material impact on our consolidated financial statements.

In September 2008, the
FASB issued for comment revisions to SFAS No. 140 and FASB Interpretation No. 46, as revised (FIN 46R), Consolidation of Variable Interest Entities. The changes proposed include a removal of the scope exemption from
FIN 46R for qualifying special purpose entities (QSPEs), a revision of the current risks and rewards-based FIN 46R consolidation model to a qualitative model based on control and a requirement that consolidation of VIEs be re-evaluated
on an ongoing basis. Although the revised standards have not yet been finalized, these changes may have a significant impact on the Companys consolidated financial statements as the Company may be required to deconsolidate certain assets and
liabilities due to the ongoing evaluation of its primary beneficiary status. In addition, the Company may also be required to consolidate other VIEs that are not currently consolidated based an analysis under the current FIN 46R consolidation model.
The proposed revisions, as currently drafted, would be effective for fiscal years that begin after November 15, 2009.

In April 2009,
the FASB issued FSP FAS 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 (FSP FAS 157-4). FSP FAS
157-4 provides additional guidance for estimating fair value in accordance with FASB Statement No. 157, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. FSP FAS
157-4 also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP FAS 157-4 emphasizes that even if there has been a significant decrease in the volume and level of activity for the asset or liability and
regardless of the valuation technique(s) used, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a
forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. FSP FAS 157-4 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for
periods ending after March 15, 2009. The Company plans to adopt FSP FAS 157-4 in the second quarter of 2009 and does not expect the adoption to have a material effect on our consolidated financial statements.



14



---

##### Table of Contents

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments (FSP FAS 115-2 and FAS 124-2). FSP FAS 115-2 and FAS 124-2 amends the other-than-temporary impairment guidance in GAAP for debt securities to make the guidance more operational and to improve the
presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. FSP FAS 115-2 and FAS 124-2 does not amend existing recognition and measurement guidance related to other-than-temporary
impairments of equity securities. FSP FAS 115-2 and FAS 124-2 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company does not have any
securities classified as available-for-sale and therefore, upon adoption in the second quarter of 2009 does not expect FSP FAS 115-2 and FAS 124-2 to have a material effect on our consolidated financial statements.

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (FSP FAS 107-1
and APB 28-1). FSP FAS 107-1 and APB 28-1 amends FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting
periods of publicly traded companies as well as in annual financial statements. FSP FAS 107-1 and APB 28-1 also amends APB Opinion No. 28, Interim Financial Reporting,to require those disclosures in summarized financial information at
interim reporting periods. FSP FAS 107-1 and APB 28-1 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company plans to adopt FSP FAS 107-1
and APB 28-1 in the second quarter of 2009 and does not expect the adoption to have a material effect on our consolidated financial statements.



15



---

##### Table of Contents

NOTE 3: FAIR VALUE OF FINANCIAL INSTRUMENTS

Effective January 1, 2008, the Company adopted SFAS No. 157, which requires additional disclosures about the Companys assets and
liabilities that are measured at fair value. The following table presents information about the Companys assets and liabilities (including derivatives that are presented net) measured at fair value on a recurring basis as of March 31,
2009, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. The Companys assessment of the significance of a particular input to the fair value measurement in its entirety
requires judgment, and considers factors specific to the asset or liability.



|                                                           |  |                                                           |   |         |   |         |  |       |           |  |   |          
|---------------------------------------------------------- |  | --------------------------------------------------------- | - | ------- | - | ------- |  | ----- | --------- |  | - | ---------
|                                                           |  | Assets and Liabilities at Fair Value as of March 31, 2009
|                                                           |  | Level 1                                                   |   | Level 2 |   | Level 3 |  | Total
|Assets:                                                    |  |                                                           |   |         |   |         |  |       |           |  |   |          
|Investment in TruPS and TruPS security-related receivables |  | $                                                         |  |         | $ |        |  | $     | 1,395,015 |  | $ | 1,395,015
|MBS                                                        |  |                                                           |  |         |   |        |  |       | 411,088   |  |   | 411,088  
|                                                           |  |                                                           |   |         |   |         |  |       |           |  |   |          
|Total Assets                                               |  | $                                                         |  |         | $ |        |  | $     | 1,806,103 |  | $ | 1,806,103
|                                                           |  |                                                           |   |         |   |         |  |       |           |  |   |          



|                        |  |                                                           |   |         |   |         |  |       |           |  |   |          
|----------------------- |  | --------------------------------------------------------- | - | ------- | - | ------- |  | ----- | --------- |  | - | ---------
|                        |  | Assets and Liabilities at Fair Value as of March 31, 2009
|                        |  | Level 1                                                   |   | Level 2 |   | Level 3 |  | Total
|Liabilities:            |  |                                                           |   |         |   |         |  |       |           |  |   |          
|TruPS CDO notes payable |  | $                                                         |  |         | $ |        |  | $     | 1,126,668 |  | $ | 1,126,668
|MBS CDO notes payable   |  |                                                           |  |         |   |        |  |       | 295,015   |  |   | 295,015  
|TruPS obligations       |  |                                                           |  |         |   |        |  |       | 99,516    |  |   | 99,516   
|Derivative liabilities  |  |                                                           |  |         |   | 249,456 |  |       | 600       |  |   | 250,056  
|                        |  |                                                           |   |         |   |         |  |       |           |  |   |          
|Total Liabilities       |  | $                                                         |  |         | $ | 249,456 |  | $     | 1,521,799 |  | $ | 1,771,255
|                        |  |                                                           |   |         |   |         |  |       |           |  |   |          

The tables presented below summarize the change in asset and liability carrying values associated
with Level 3 financial instruments during the three-months ended March 31, 2009 (amounts in thousands):



|                                  |  |                                                         |           |   |     |   |         |       |  |   |           |  
|--------------------------------- |  | ------------------------------------------------------- | --------- | - | --- | - | ------- | ----- |  | - | --------- | -
|Assets                            |  | Investment inTruPS and TruPSSecurity-RelatedReceivables |           |   | MBS |   |         | Total | 
|Balance at December 31, 2008      |  | $                                                       | 1,621,480 |   |     | $ | 458,270 |       |  | $ | 2,079,750 |  
|Net payments, purchases and sales |  |                                                         | (10,281   | ) |     |   | (5,669  | )     |  |   | (15,950   | )
|Net transfers in/(out)            |  |                                                         |          |   |     |   |        |       |  |   |          |  
|Gains/(losses) recorded in income |  |                                                         | (216,184  | ) |     |   | (41,513 | )     |  |   | (257,697  | )
|                                  |  |                                                         |           |   |     |   |         |       |  |   |           |  
|Balance at March 31, 2009         |  | $                                                       | 1,395,015 |   |     | $ | 411,088 |       |  | $ | 1,806,103 |  
|                                  |  |                                                         |           |   |     |   |         |       |  |   |           |  



|                                  |  |                        |           |   |                      |   |         |                  |  |   |                       |   |  |       |      |   |  |   |           |  
|--------------------------------- |  | ---------------------- | --------- | - | -------------------- | - | ------- | ---------------- |  | - | --------------------- | - |  | ----- | ---- | - |  | - | --------- | -
|Liabilities                       |  | TruPS CDONotes Payable |           |   | MBS CDONotes Payable |   |         | TruPSObligations |  |   | DerivativeInstruments |   |  | Total |     
|Balance at December 31, 2008      |  | $                      | 1,314,037 |   |                      | $ | 333,553 |                  |  | $ | 120,409               |   |  | $     | 850  |   |  | $ | 1,768,849 |  
|Net payments, purchases and sales |  |                        | (14,371   | ) |                      |   | (7,863  | )                |  |   |                      |   |  |       |     |   |  |   | (22,234   | )
|Net transfers in/(out)            |  |                        |          |   |                      |   |        |                  |  |   |                      |   |  |       |     |   |  |   |          |  
|(Gains)/losses recorded in income |  |                        | (172,998  | ) |                      |   | (30,675 | )                |  |   | (20,893               | ) |  |       | (250 | ) |  |   | (224,816  | )
|                                  |  |                        |           |   |                      |   |         |                  |  |   |                       |   |  |       |      |   |  |   |           |  
|Balance at March 31, 2009         |  | $                      | 1,126,668 |   |                      | $ | 295,015 |                  |  | $ | 99,516                |   |  | $     | 600  |   |  | $ | 1,521,799 |  
|                                  |  |                        |           |   |                      |   |         |                  |  |   |                       |   |  |       |      |   |  |   |           |  



16



---

##### Table of Contents

NOTE 4: INVESTMENTS IN DEBT SECURITIES

The following table summarizes the Companys investments in debt securities and security-related receivables as of March 31, 2009:



|                                                                   |  |               |           |                                   |   |            |                     |  |                       |           |  |                                  |   |  |     
|------------------------------------------------------------------ |  | ------------- | --------- | --------------------------------- | - | ---------- | ------------------- |  | --------------------- | --------- |  | -------------------------------- | - |  | ----
|Investment Description                                             |  | AmortizedCost |           | CumulativeNet Change inFair Value |   |            | EstimatedFair Value |  | WeightedAverageCoupon |           |  | Weighted-AverageYears toMaturity
|TruPS and subordinated debentures and security-related receivables |  | $             | 5,532,009 |                                   | $ | (4,136,994 | )                   |  | $                     | 1,395,015 |  | 4.7                              | % |  | 27.4
|MBS                                                                |  |               | 2,030,142 |                                   |   | (1,619,054 | )                   |  |                       | 411,088   |  | 2.4                              | % |  | 6.9 
|                                                                   |  |               |           |                                   |   |            |                     |  |                       |           |  |                                  |   |  |     
|Total                                                              |  | $             | 7,562,151 |                                   | $ | (5,756,048 | )                   |  | $                     | 1,806,103 |  | 4.1                              | % |  | 21.9
|                                                                   |  |               |           |                                   |   |            |                     |  |                       |           |  |                                  |   |  |     

TruPS shown above include (a) investments in TruPS issued by Trust VIEs of which the Company
is not the primary beneficiary and which the Company does not consolidate and (b) transfer of investments in TruPS to the Company that were accounted for as a sale pursuant to SFAS No. 140. Subordinated debentures included above represent
the primary assets of Trust VIEs that the Company consolidates pursuant to FIN 46R.

The Companys investments in security-related
receivables represent securities owned by CDO entities that are collateralized by TruPS and subordinated debentures owned by a consolidated subsidiary where the transfers are accounted for as financings under SFAS No. 140. These transactions
are accounted for as financings due to certain constraints that limit further pledging or exchanging of the assets and the continuing involvement of investment banks with each of these transactions. As of March 31, 2009, the Companys
consolidated financial statements included $265.4 million of security-related receivables held at fair value.

As of March 31, 2009,
the aggregate principal amount of investments in the 46 TruPS investments that have defaulted or are currently deferring interest payments is $726.5 million, representing approximately 14.1% of the Companys combined TruPS portfolio. As of
March 31, 2009, the $307.5 million of defaulted securities have been completely written-off in the Companys consolidated financial statements. For the three-month period ended March 31, 2009, investment interest income is net of a
$9.1 million reserve for interest income related to the $726.5 million of currently deferring and defaulted securities.

The TruPS
deferrals and defaults described above have resulted in the over-collateralization tests being triggered in all eight CDOs in which the Company holds equity interests. The trigger of an over-collateralization test in a TruPS CDO means that the
Company, as a holder of equity securities, will not receive current distributions of cash in respect of its equity interests until sufficient cash or collateral is retained in the CDOs to cure the over-collateralization tests.

At March 31, 2009 approximately 67% of the Companys investments in MBS were rated below AAA. Additionally, 15% of MBS have a weighted-average
FICO score less than 625 (generally considered to be subprime).

As previously disclosed, we received written notice from the trustees of
Kleros Real Estate I, II and IV that each CDO experienced an event of default. These events of default resulted from the failure of certain additional over-collateralization tests primarily due to credit rating agency downgrades. The events of
default provide the controlling class debtholder in each CDO with the option to liquidate all of the MBS assets collateralizing the particular CDO. The proceeds of any such liquidation will be used to repay the controlling class debtholder. As of
the current date, the controlling class debtholders of Kleros Real Estate I, II and IV have not exercised their rights to liquidate any of the CDOs. Since the Company is not receiving any cash flow from its investments in any of the Kleros Real
Estate CDOs, the events of default described above do not have any further impact on the Companys cash flows. However, the assets of the Kleros Real Estate I, II and IV CDOs and the income they generate for tax purposes are a component of the
Companys REIT qualifying assets and income. If more than one of the three remaining Kleros Real Estate CDOs is liquidated, the Company may have to deploy additional capital into REIT qualifying assets in order to continue to qualify as a REIT.
If the Company is not able to invest in sufficient other REIT qualifying assets, its ability to qualify as a REIT could be materially adversely affected.

Substantially all of the Companys investments in TruPS, subordinated debentures and MBS collateralize debt issued through consolidated CDO entities, consolidated Trust VIEs, or warehouse credit facilities.
Consolidated CDO entities are generally subject to an indenture which dictates substantially all of the operating activities of the CDO. These indentures generally require that certain credit quality and over-collateralization tests are met. To the
extent a CDO fails to pass such tests, cash flows from the assets may be directed to be used to repay the CDO debt obligations. The assets of the Companys consolidated CDOs collateralize the debt of such entities and are not available to the
Companys general creditors. Similarly, the debt of such entities is not recourse to the Company.



17



---

##### Table of Contents

NOTE 5: LOANS

The Companys investments in loans are accounted for at amortized cost and in the case of certain leveraged loans, at the lower of cost or market. The following table summarizes the Companys investments in loans as of
March 31, 2009:



|                                          |  |                        |           |                               |   |         |                                  |  |   |                |   |                |   |                              |  |       |                                         |      |      |  |          
|----------------------------------------- |  | ---------------------- | --------- | ----------------------------- | - | ------- | -------------------------------- |  | - | -------------- | - | -------------- | - | ---------------------------- |  | ----- | --------------------------------------- | ---- | ---- |  | ---------
|                                          |  | UnpaidPrincipalBalance |           | UnamortizedPremium/(Discount) |   |         | CumulativeUnrealizedGain /(Loss) |  |   | CarryingAmount |   | Numberof Loans |   | Weighted-AverageInterestRate |  |       | Weighted-AverageContractualMaturityDate
|5/1Adjustable rate
residential mortgages  |  | $                      | 593,654   |                               | $ | 6,578   |                                  |  | $ |               |   |                | $ | 600,232                      |  | 1,446 |                                         | 6.3  | %    |  | July 2036
|7/1Adjustable rate residential mortgages  |  |                        | 202,237   |                               |   | 3,284   |                                  |  |   |               |   |                |   | 205,521                      |  | 472   |                                         | 6.6  | %    |  | Dec 2036 
|10/1Adjustable rate residential mortgages |  |                        | 68,048    |                               |   | 1,243   |                                  |  |   |               |   |                |   | 69,291                       |  | 184   |                                         | 6.8  | %    |  | Sept 2036
|Commercial loan                           |  |                        | 7,464     |                               |   |        |                                  |  |   |               |   |                |   | 7,464                        |  | 1     |                                         | 21.0 | %    |  |         
|Leveraged loans                           |  |                        | 867,537   |                               |   | (10,244 | )                                |  |   | (60,530        | ) |                |   | 796,763                      |  | 435   |                                         | 5.4  | %    |  | May 2013 
|                                          |  |                        |           |                               |   |         |                                  |  |   |                |   |                |   |                              |  |       |                                         |      |      |  |          
|Total                                     |  | $                      | 1,738,940 |                               | $ | 861     |                                  |  | $ | (60,530        | ) |                | $ | 1,679,271                    |  | 2,538 |                                         | 5.9  | %(1) |  |          
|                                          |  |                        |           |                               |   |         |                                  |  |   |                |   |                |   |                              |  |       |                                         |      |      |  |          



|(1) | Weighted-average interest rate excludes non-interest accruing commercial loan.
|--- | ------------------------------------------------------------------------------

As of March 31, 2009, the Company continues to classify all of the leveraged loans included in its warehouse facility with a third party as held for sale. During the three-months ended March 31, 2009, the
Company recorded a $40 million increase to the fair value of these leveraged loans. The fair value increase was primarily attributable to a tightening of estimated credit spreads as evidenced by comparable market leveraged loan data. During the
fourth quarter of 2008, the Company determined that it no longer had the intent to hold these particular loans to maturity or for the foreseeable future. The warehouse facility that provides short-term financing for approximately $157.1 million of
par value of leveraged loans is scheduled to mature in May 2009 and, as previously disclosed, is currently in default. If the securitization markets remain effectively closed for the foreseeable future, the Company will likely lose the first loss
cash that is deposited with the warehouse lender in the amount of $38.5 million, which is the maximum amount of loss that the Company is exposed to from the warehouse facility.

The Company has the positive intent and ability to hold its loan portfolio, except the leveraged loans included in the warehouse described above, until
maturity or at least for the foreseeable future. The held for investment portion of our portfolio is financed on a long term basis through securitization vehicles.

The Company maintains an allowance for loan losses based on managements evaluation of known losses and inherent risks in the portfolios, which considers historical and industry loss experience, economic
conditions and trends, estimated fair values and the quality of collateral and other relevant quantitative and qualitative factors. Specific allowances for losses are established for potentially impaired loans based on a comparison of the recorded
carrying value of the loan to either the present value of the loans expected cash flow, the loans estimated market price or the estimated fair value of the underlying collateral. The allowance is increased by charges to operations and
decreased by charge-offs (net of recoveries). The following table summarizes the Companys allowance for loan losses:



|                      |  |                     |         |                        |   |       
|--------------------- |  | ------------------- | ------- | ---------------------- | - | ------
|                      |  | As ofMarch 31, 2009 |         | As ofDecember 31, 2008
|Leveraged loans       |  | $                   | 46,742  |                        | $ | 26,765
|Residential mortgages |  |                     | 67,799  |                        |   | 41,663
|                      |  |                     |         |                        |   |       
|Total                 |  | $                   | 114,541 |                        | $ | 68,428
|                      |  |                     |         |                        |   |       

The following table provides a roll-forward of our loan loss reserves:



|                           |  |                                        |         |  
|-------------------------- |  | -------------------------------------- | ------- | -
|                           |  | For theThree-MonthsEndedMarch 31, 2009 |        
|Balance, December 31, 2008 |  | $                                      | 68,428  |  
|Additions                  |  |                                        | 50,458  |  
|Charge-offs                |  |                                        | (4,345  | )
|                           |  |                                        |         |  
|Balance, March 31, 2009    |  | $                                      | 114,541 |  
|                           |  |                                        |         |  



18



---

##### Table of Contents

The following table summarizes the delinquency statistics of the Companys residential mortgage
loans (dollar amounts in thousands):



|                     |  |                      |  |                         |         |                |     |                 |   |        
|-------------------- |  | -------------------- |  | ----------------------- | ------- | -------------- | --- | --------------- | - | -------
|                     |  | As of March 31, 2009 |  | As of December 31, 2008
|Delinquency Status   |  | Numberof Loans       |  | PrincipalAmount         |         | Numberof Loans |     | PrincipalAmount
|30 to 60 days        |  | 84                   |  | $                       | 34,326  |                | 145 |                 | $ | 58,742 
|61 to 90 days        |  | 58                   |  |                         | 23,978  |                | 48  |                 |   | 21,182 
|Greater than 90 days |  | 325                  |  |                         | 134,960 |                | 209 |                 |   | 82,328 
|                     |  |                      |  |                         |         |                |     |                 |   |        
|Total                |  | 467                  |  | $                       | 193,264 |                | 402 |                 | $ | 162,252
|                     |  |                      |  |                         |         |                |     |                 |   |        

As of March 31, 2009, the Company has placed $135 million of residential mortgage loans on
non-accrual status. During the three-month period ended March 31, 2009, the Company did not recognize approximately $1.4 million of interest income for loans that were in non-accrual status.

As of March 31, 2009, the Company had foreclosed on 51 residential mortgage loans with a fair value of $11.0 million which are classified as REO.
The Company records REO property at fair value within other assets in its consolidated balance sheet. During the three-month period ended March 31, 2009, the Company recorded impairments of $2.1 million as a result of changes in fair value of
REO property. Additionally, during the three-month period ended March 31, 2009, the Company sold REO properties with a fair value of $5.6 million for a realized loss of $1.1 million

As of March 31, 2009, our leveraged loan portfolio has experienced seven defaults in an aggregate principal amount of $16.3 million. The
overcollateralization requirements in the leveraged loan CLOs are typically triggered in the event that we experience significant losses on the sale of assets below par, as well as unrealized fair value adjustments on certain assets as mandated by
the indentures which govern our leveraged loan CLOs. The primary cause for such fair value adjustments are default activity, and credit downgrades in the underlying asset pool. As of the date of this filing, we have not experienced an
overcollateralization failure in any of our leveraged loan CLOs. However, as a result of a partial failure of an interest diversion test during April 2009, we did experience a reduction in our quarterly cash distribution from an Emporia CLO. The
partial failure was primarily attributable to the recent increase in defaulted assets collateralizing the CLO. The interest diversion test was cured in April 2009, however, the current state of the credit markets and the economy in general increases
the likelihood of defaults and ratings agency downgrades on the underlying collateral of our CLOs.

As of March 31, 2009,
approximately $861.9 million of the principal amount of the Companys residential mortgages was pledged as collateral for securitized mortgage debt. In addition, substantially all of the carrying value of the Companys leveraged loan
portfolio is pledged as collateral for CLO notes payable.

As of March 31, 2009, 47.3% of the carrying value of the Companys
residential mortgages were concentrated in residential mortgages collateralized by property in California.

NOTE 6: INDEBTEDNESS

The following table summarizes the Companys total indebtedness as of March 31, 2009 (includes recourse and non-recourse indebtedness):



|                                |  |               |           |                                   |   |            |                |  |                    |           |  |                                      |   |  |                                     |   |  |         
|------------------------------- |  | ------------- | --------- | --------------------------------- | - | ---------- | -------------- |  | ------------------ | --------- |  | ------------------------------------ | - |  | ----------------------------------- | - |  | --------
|Description                     |  | AmortizedCost |           | CumulativeNet Changein Fair Value |   |            | CarryingAmount |  | Interest RateTerms |           |  | CurrentWeighted-AverageInterest Rate |   |  | Weighted-AverageContractualMaturity
|Non-recourse indebtedness:      |  |               |           |                                   |   |            |                |  |                    |           |  |                                      |   |  |                                     |   |  |         
|Trust preferred obligations     |  | $             | 385,600   |                                   | $ | (286,084   | )              |  | $                  | 99,516    |  | 1.7% to 9.3                          | % |  | 4.6                                 | % |  | Oct 2036
|Securitized mortgage debt       |  |               | 821,802   |                                   |   |           |                |  |                    | 821,802   |  | 5.0% to 6.0                          | % |  | 5.7                                 | % |  | Dec 2046
|CDO notes payable (1)           |  |               | 8,436,837 |                                   |   | (6,309,824 | )              |  |                    | 2,127,013 |  | 0.7% to 7.9                          | % |  | 1.7                                 | % |  | Mar 2039
|Warehouse credit facilities     |  |               | 123,114   |                                   |   |           |                |  |                    | 123,114   |  | 3.7                                  | % |  | 3.7                                 | % |  | May 2009
|                                |  |               |           |                                   |   |            |                |  |                    |           |  |                                      |   |  |                                     |   |  |         
|Total non-recourse indebtedness |  | $             | 9,767,353 |                                   | $ | (6,595,908 | )              |  | $                  | 3,171,445 |  |                                      |   |  |                                     |   |  |         
|                                |  |               |           |                                   |   |            |                |  |                    |           |  |                                      |   |  |                                     |   |  |         
|                                |  |               |           |                                   |   |           
|Recourse indebtedness:          |  |               |           |                                   |   |            |                |  |                    |           |  |                                      |   |  |                                     |   |  |         
|Junior subordinated debentures  |  | $             | 49,614    |                                   |   |           |                |  | $                  | 49,614    |  | 5.6% to 9.5                          | % |  | 7.9                                 | % |  | Aug 2036
|Contingent convertible debt     |  |               | 28,063    |                                   |   |           |                |  |                    | 28,063    |  | 7.6                                  | % |  | 7.6                                 | % |  | May 2027
|                                |  |               |           |                                   |   |            |                |  |                    |           |  |                                      |   |  |                                     |   |  |         
|Total recourse indebtedness     |  | $             | 77,677    |                                   |   |           |                |  | $                  | 77,677    |  |                                      |   |  |                                     |   |  |         
|                                |  |               |           |                                   |   |            |                |  |                    |           |  |                                      |   |  |                                     |   |  |         
|Total indebtedness              |  | $             | 9,845,030 |                                   | $ | (6,595,908 | )              |  | $                  | 3,249,122 |  |                                      |   |  |                                     |   |  |         
|                                |  |               |           |                                   |   |            |                |  |                    |           |  |                                      |   |  |                                     |   |  |         



19



---

##### Table of Contents



|(1) | Excludes CDO notes payable purchased by the Company which are eliminated in consolidation. Carrying amount includes $1.4 billion of liabilities at fair value.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------

Recourse indebtedness refers to indebtedness that is recourse to the general assets of the Company. As indicated in the
table above, the Companys consolidated financial statements include recourse indebtedness of $77.7 million as of March 31, 2009. Non-recourse indebtedness consists of indebtedness of consolidated VIEs (i.e. CDOs, CLOs and other
securitization vehicles) which is recourse only to specific assets pledged as collateral to the lenders. The creditors of each consolidated VIE have no recourse to the general credit of the Company. As of March 31, 2009, the Companys
maximum exposure to economic loss as a result of its involvement with each VIE is the $449.5 million of capital that the Company has invested in warehouse first-loss deposits and the preference shares or debt of the CDO, CLO or other types of
securitization structures. None of the indebtedness shown in the table above subjects the Company to potential margin calls for additional pledges of cash or other assets.



|(a) | Repurchase agreements
|--- | ---------------------

As of March 31,
2009, the Company is not financing any investments with short-term repurchase agreements that subject the Company to margin calls or potential recourse obligations in excess of posted first loss deposits.



|(b) | Trust preferred obligations
|--- | ---------------------------

Trust preferred
obligations finance subordinated debentures acquired by Trust VIEs that are consolidated by the Company for the portion of the total TruPS that are owned by entities outside of the consolidated group. These trust preferred obligations bear interest
at either variable or fixed rates until maturity, generally 30 years from the date of issuance. The Trust VIE has the ability to prepay the trust preferred obligation at any time, without prepayment penalty, after five years. The Company does not
control the timing or ultimate payment of the trust preferred obligations. Effective January 1, 2008, the Company elected the fair value option pursuant to SFAS No. 159 for trust preferred obligations.



|(c) | CDO notes payable
|--- | -----------------

CDO notes payable
represent notes payable issued by CDO entities used to finance the acquisition of TruPS, MBS, and leveraged loans. Substantially all of the TruPS collateralizing CDO notes payable are obligations of banks, bank holding companies and insurance
companies. The obligors under the leveraged loans come from a variety of industries. Generally, CDO notes payable are comprised of various classes of notes payable, with each class bearing interest at variable or fixed rates. Effective
January 1, 2008, the Company elected the fair value option pursuant to SFAS No. 159 for TruPS and MBS CDO notes payable.



|(d) | Warehouse Credit Facilities
|--- | ---------------------------

As of
March 31, 2009, the Companys consolidated financial statements included $123.1 million of warehouse credit facility debt in the form of short term notes payable. Warehouse credit facility debt relates to an on-balance sheet warehouse
facility entered into by a subsidiary of the Company with the intention of financing the acquisition of leveraged loans on a short-term basis until longer-term financing is available. Despite the fact that the Company has recorded cumulative
reductions in fair value of $60.5 million on the leveraged loans included in the warehouse facility, the Companys maximum economic exposure to loss on the warehouse credit facility is limited to the amount of capital that the Company has
invested pursuant to the terms of the arrangement. As of March 31, 2009, the Company has invested $38.5 million of capital in this financing arrangement, which is scheduled to mature in May 2009. As previously disclosed, the warehouse is
currently in default and therefore, there is no borrowing capacity, the facility is bearing a penalty interest rate equal to the daily commercial paper rate plus 300 basis points, and all principal and interest collections are used to amortize the
warehouse credit facility debt. If the securitization markets remain effectively closed for the foreseeable future, the Company will likely lose the first loss cash that is deposited with the warehouse lender in the amount of $38.5 million, which is
the maximum amount of loss that the Company is exposed to from the warehouse facility.



|(e) | Recourse Indebtedness  Contingent Convertible Senior Notes
|--- | -----------------------------------------------------------

On May 15, 2007 and June 13, 2007, the Company sold $140 million aggregate principal amount of contingent convertible senior notes. The notes are senior, unsecured obligations of the Company and rank equally
in right of payment with all of the Companys existing and future unsubordinated, unsecured indebtedness. The notes are subordinated in right of payment to the Companys existing and future secured indebtedness to the extent of such
security, and structurally subordinated to any liabilities and other indebtedness of the Companys subsidiaries. The notes bear interest at an annual rate of 7.625%. The notes mature on May 15, 2027.



20



---

##### Table of Contents

As discussed in Note 2, the Company has adopted FSP APB 14-1 effective as of January 1, 2009 and has
retrospectively applied FSP APB 14-1 to the terms of its contingent convertible debt as they existed for all periods presented. FSP APB 14-1 requires the Company to account separately for the liability and equity components of its contingent
convertible debt in a manner that reflects the Companys nonconvertible debt (unsecured debt) borrowing rate. Pursuant to the retrospective application of FSP APB 14-1, at January 1, 2008, the Company recorded a $2.2 million increase to
additional paid-in-capital relating to the equity component and a corresponding discount to its contingent convertible debt. The unamortized discount was $0.6 million and $0.5 million as of December 31, 2008 and March 31, 2009,
respectively, and will be amortized through May 2012.

As of the date of this filing, $28.7 million principal amount of the Companys
contingent convertible debt securities remains outstanding. The holders of the Companys remaining $28.7 million aggregate principal amount of convertible debt will have the right to require us to repurchase their notes at 100% of their
principal amount together with accrued but unpaid interest thereon if, among other things, the Companys common stock ceases to be listed on the NYSE, another established national securities exchange or an automated over-the-counter trading
market in the United States.

The notes will be convertible prior to the maturity date into cash and, if applicable, shares of the
Companys common stock, par value $0.001 per share, under certain circumstances, at an initial conversion price per share of $11.70, which represents a conversion rate of approximately 85.4701 shares of common stock per $1,000 principal amount
of notes. If converted, the holders of the notes will receive an amount in cash per note equal to the lesser of (i) $1,000 and (ii) the average of the daily conversion values for each of the twenty consecutive trading days of
the conversion reference period. Daily conversion value means, with respect to any trading day, the product of (1) the applicable conversion rate and (2) the volume weighted average price of the Companys common stock on
such trading day.

The Company may redeem all or part of the notes for cash (i) at any time prior to the date on which they mature to
the extent necessary to preserve the Companys qualification as a REIT for U.S. federal income tax purposes or (ii) on or after May 20, 2012, at a redemption price equal to 100% of the principal amount of the notes, plus accrued and
unpaid interest and additional interest, if any, to, but excluding, the redemption date. The holders of the notes may require the Company to repurchase all or a portion of their notes for cash on May 15, 2012, May 15, 2017 and
May 15, 2022 for a repurchase price equal to 100% of the principal amount of the notes, plus accrued and unpaid interest and additional interest, if any, to, but excluding, the repurchase date.

NOTE 7: DERIVATIVE FINANCIAL INSTRUMENTS

The Company
and the VIEs included in the Companys consolidated financial statements may use derivative financial instruments to hedge all or a portion of the interest rate risk associated with its borrowings. The principal objective of such arrangements
is to minimize the risks and/or costs associated with certain operating and financial structures as well as to hedge specific anticipated transactions. The counterparties to these contractual arrangements are major financial institutions with which
the Company and its consolidated VIEs may also have other financial relationships. In the event of nonperformance by the counterparties, the Company is potentially exposed to credit loss for the free-standing derivative arrangement and its
consolidated VIEs are potentially exposed to credit loss for all other derivative instruments detailed below.

The table below summarizes
the aggregate notional amount and estimated net fair value of the Companys derivative instruments (amounts in thousands):



|                         |  |                      |           |                |   |          |  
|------------------------ |  | -------------------- | --------- | -------------- | - | -------- | -
|                         |  | As of March 31, 2009 |          
|                         |  | Notional             |           | Net Fair Value |  
|Interest Rate Related:   |  |                      |           |                |   |          |  
|Interest rate swaps      |  | $                    | 1,824,059 |                | $ | (249,237 | )
|Basis swaps              |  |                      | 385,000   |                |   | (219     | )
|Free-standing derivative |  |                      | 8,750     |                |   | (600     | )
|                         |  |                      |           |                |   |          |  
|Total                    |  | $                    | 2,217,809 |                | $ | (250,056 | )
|                         |  |                      |           |                |   |          |  

The following table summarizes by derivative instrument type the effect on income for the
following periods (amounts in thousands):



21



---

##### Table of Contents

|                                                 |  |                                                                     |        |   |                                                                                               |   |        |                                                                     |  |   |                                                                                               |   |  |   |         |  
|------------------------------------------------ |  | ------------------------------------------------------------------- | ------ | - | --------------------------------------------------------------------------------------------- | - | ------ | ------------------------------------------------------------------- |  | - | --------------------------------------------------------------------------------------------- | - |  | - | ------- | -
|                                                 |  | For the three-months endedMarch 31, 2009                            |        |   | For the three-months endedMarch 31, 2008                                                      |  
|Type of Derivative                               |  | Amounts Reclassifiedto Earnings forEffective Hedges Gains (Losses) |        |   | AmountsReclassified toEarnings forHedgeIneffectiveness &Non-HedgedDerivatives
Gains (Losses) |   |        | Amounts Reclassifiedto Earnings forEffective Hedges Gains (Losses) |  |   | AmountsReclassified toEarnings forHedgeIneffectiveness &Non-HedgedDerivatives
Gains (Losses) |  
|Interest rate swaps                              |  | $                                                                   | (1,386 | ) |                                                                                               | $ | (4,227 | )                                                                   |  | $ | (2,583                                                                                        | ) |  | $ | (91,411 | )
|Basis swaps                                      |  |                                                                     |       |   |                                                                                               |   | 611    |                                                                     |  |   |                                                                                              |   |  |   | 240     |  
|Free-standing derivative                         |  |                                                                     |       |   |                                                                                               |   | 250    |                                                                     |  |   |                                                                                              |   |  |   |        |  
|Credit default swaps                             |  |                                                                     |       |   |                                                                                               |   |       |                                                                     |  |   |                                                                                              |   |  |   | 10,891  |  
|                                                 |  |                                                                     |        |   |                                                                                               |   |        |                                                                     |  |   |                                                                                               |   |  |   |         |  
|Net change in fair value of derivative contracts |  | $                                                                   | (1,386 | ) |                                                                                               | $ | (3,366 | )                                                                   |  | $ | (2,583                                                                                        | ) |  | $ | (80,280 | )
|                                                 |  |                                                                     |        |   |                                                                                               |   |        |                                                                     |  |   |                                                                                               |   |  |   |         |  

Cash Flow Hedges

The Company has entered into various interest rate swap contracts to hedge interest rate exposure relating to CDO notes payable and warehouse credit facilities that are used to finance investments in our target asset
classes.

Prior to January 1, 2008, the Company designated interest rate swap contracts as cash flow hedges at inception and
determined at each reporting period whether or not the interest rate swap contracts are highly effective in offsetting interest rate fluctuations associated with the identified indebtedness. Certain of the Companys interest rate swap contracts
were not designated as interest rate hedges at inception; therefore the change in fair value during the period in which the interest rate swap contracts were not designated as hedges was recorded within net change in fair value of derivative
contracts in the consolidated statements of income (loss). Effective January 1, 2008, we adopted the fair value option under SFAS No. 159 for our TruPS and MBS CDO notes payable and therefore, have discontinued hedge accounting for all of
the interest rate swaps associated with those transactions.

As of March 31, 2009, the maximum length of time over which the Company
was hedging its exposure to the variability of future cash flows for forecasted transactions is approximately 9 years. Based on amounts included in the accumulated other comprehensive loss as of March 31, 2009 from designated interest rate
swaps, the Company expects to recognize a decrease of $3.0 million in interest expense over the next twelve months.

Credit Default Swaps

During June 2008, the Company sold the subsidiary that owned $87.5 million notional value of CDS positions for $70.4 million in proceeds.
Following the June 2008 sale, the Company no longer holds any investments in CDS.

Free-Standing Derivative

During October 2007, a subsidiary of the Company entered into a derivative arrangement with a third party. Under the agreement, the Company is obligated
to make payments to the third party in the event that the Class A-1 Notes of Alesco Preferred Funding XIV, Ltd. (Alesco XIV CDO) fails to: (1) make scheduled principal or interest payments on its $430 million senior secured notes due in
2037; and (2) the debt issued by a particular insurance issuer that collateralizes Alesco XIV defaults. The notional amount of the contract is $8.8 million. The Company is also subject to margin requirements in the event that the Class A-1
Notes of Alesco XIV CDO are downgraded below AAA. During the three-months ended March 31, 2009, the Class A-1 Notes of Alesco XIV CDO were downgraded to A+ and as a result the Company is required to post approximately $2.2
million of margin collateral. The maximum amount of the margin exposure is equal to the notional amount of the contract and the amount of required margin varies based upon the Companys outstanding equity balance and the rating level assigned
to the Alesco XIV Class A-1 Notes.

NOTE 8: EARNINGS (LOSS) PER SHARE

The following table presents a reconciliation of basic and diluted earnings per share for the following periods (dollars in thousands, except per share
data):



|                                                           |  |                                          |            |   |                                          |   |           
|---------------------------------------------------------- |  | ---------------------------------------- | ---------- | - | ---------------------------------------- | - | ----------
|                                                           |  | For the three-months
endedMarch 31, 2009 |            |   | For the three-months
endedMarch 31, 2008
|Net income (loss) attributable to common stockholders      |  | $                                        | (35,833    | ) |                                          | $ | 84,887    
|                                                           |  |                                          |            |   |                                          |   |           
|Weighted-average common shares outstandingBasic & Diluted |  |                                          | 60,171,324 |   |                                          |   | 60,548,032
|                                                           |  |                                          |            |   |                                          |   |           
|Earnings (loss) per shareBasic                            |  | $                                        | (0.60      | ) |                                          | $ | 1.40      
|                                                           |  |                                          |            |   |                                          |   |           



22



---

##### Table of Contents

|                                  |  |                                          |       |   |                                          |   |     
|--------------------------------- |  | ---------------------------------------- | ----- | - | ---------------------------------------- | - | ----
|                                  |  | For the three-months
endedMarch 31, 2009 |       |   | For the three-months
endedMarch 31, 2008
|Earnings (loss) per shareDiluted |  | $                                        | (0.60 | ) |                                          | $ | 1.40
|                                  |  |                                          |       |   |                                          |   |     
|Anti-dilutive shares              |  |                                          |      |   |                                          |   |    
|                                  |  |                                          |       |   |                                          |   |     

NOTE 9: MANAGEMENT AGREEMENT AND RELATED PARTY TRANSACTIONS

The Companys Chairman of the Board and other officers serve as executive officers of Cohen & Company, of which the manager is an affiliate.
The manager handles the Companys day-to-day operations, provides the Company with office facilities, and administers the Companys business activities through the resources of Cohen. The management agreement was executed on
January 31, 2006 between the manager and AFT and, upon the closing of the merger on October 6, 2006, the Company assumed the management agreement. The initial term expired on December 31, 2008 and was renewed for an additional one
year term. The management agreement will continue to be automatically renewed for a one-year term on each anniversary date thereafter unless two-thirds of the independent directors or the holders of at least a majority of the outstanding shares of
common stock vote not to automatically renew the management agreement.

The management agreement provides, among other things, that in
exchange for managing the day-to-day operations and administering the business activities of the Company, the manager is entitled to receive from the Company certain fees and reimbursements, consisting of a base management fee, an incentive fee
based on certain performance criteria, reimbursement for certain operating expenses as defined in the management agreement, and a termination fee if the Company decides to terminate the management agreement without cause or if the manager terminates
the management agreement due to the Companys default. The base management fee and the incentive fee otherwise payable by the Company to the manager pursuant to the management agreement are reduced by the Companys proportionate share of
the amount of any CDO and CLO collateral management fees that are paid to Cohen and its affiliates in connection with the CDOs and CLOs in which the Company invests, based on the percentage of equity it holds in such CDOs and CLOs.

During the three-months ended March 31, 2009 and 2008, the Company incurred $0.1 million and $1.4 million, respectively, in base management fees and $0
and $0.9 million, respectively, of incentive fees. During the three-months ended March 31, 2009 and 2008, the aggregate base management fees and incentive fees payable were reduced by collateral management fee credits of $0.1 million and $2.3
million, respectively.

During three-months ended March 31, 2009 and 2008, the consolidated CDO entities that are included in the
Companys consolidated financial statements incurred collateral management fees that are payable to Cohen & Company of $3.8 million and $4.3 million, respectively. During the same periods, Cohen & Company earned origination,
structuring and placement fees of $0 and $0.8 million, respectively, relating to services provided to warehouse facilities and CDOs that the Company is invested in. In addition, during the same periods, Cohen & Company received $43 thousand
and $15 thousand, respectively, from warehouse facilities and consolidated CDO entities as reimbursement for origination expenses paid to third parties. During the three-months ended March 31, 2009, Cohen & Companys broker-dealer
subsidiary earned $0.2 million of commission income as a result of an exchange transaction involving a TruPS VIE entity, which is included in our consolidated financial statements.

Base management fees and incentive fees incurred, stock-based compensation expense relating to shares of restricted common stock granted to the manager,
and collateral management fees paid to Cohen & Company are included in related party management compensation on the consolidated statements of income (loss). Expenses incurred by the manager and reimbursed by the Company are reflected in
the respective consolidated statement of income (loss) non-investment expense category based on the nature of the expense.

As previously
disclosed, on February 27, 2009, Cohen & Company sold each of the Emporia I, II and III collateral management contracts (the Company has equity interests in Emporia II and III) to an unrelated third party. The sale of the
collateral management contracts resulted in a servicer default under our leveraged loan warehouse facility and the terms of the warehouse facility required that all principal and interest proceeds be utilized to amortize the warehouse lenders
outstanding debt balance. The leveraged loan warehouse facility is scheduled to terminate in May 2009. The sale of the Emporia II and III collateral management contracts required the Companys consent as holder of the equity interests in
Emporia II and III. In consideration for the Companys consent to enter into such transaction, Cohen & Company and the Company entered into an arrangement which requires Cohen & Company to pay $3 million to the Company in
the event that the proposed merger is not completed. The purpose of the payment is to compensate the Company for amounts that it would have otherwise received had the servicer default not occurred under the leveraged loan warehouse agreement.
In the event that our proposed merger with Cohen & Company is consummated, Cohen & Company shall not be obligated to pay the $3 million to the Company. If the merger agreement with Cohen & Company is terminated, such
amount shall be paid by Cohen & Company to the Company within 10 business days of the termination date. Additionally, Cohen and the Company agreed that the Company shall be permitted to continue to offset the monthly base management fee and
the quarterly incentive fee by the Companys proportionate share of the collateral management fees paid in Emporia II and III.



23



---

##### Table of Contents

NOTE 10: COMMITMENTS AND CONTINGENCIES AND OTHER MATTERS

Commitments

The leveraged loan CLO vehicles
consolidated by the Company may be committed to purchase interests in debt obligations of corporations, partnerships and other entities in the form of participations in leveraged loans, which obligate the CLO vehicle to acquire a predetermined
interest in such leveraged loans at a specified price on a to-be determined settlement date. As of March 31, 2009 the consolidated CLO vehicles had commitments to fund $17.1 million of leveraged loans. The CLO vehicles will use amounts
currently included in restricted cash to fund these commitments.

As of March 31, 2009, the consolidated CLO entities have
requirements to purchase $39.4 million of additional collateral assets in order to complete the accumulation of the required amount of collateral assets. Of this amount, $32.2 million has already been advanced to consolidated CLOs through CLO notes
payable and is included within restricted cash on the consolidated balance sheet as of March 31, 2009.

Contingencies

The Company is party to various legal proceedings which arise in the ordinary course of business. The Company is not currently involved in any litigation
nor, to our knowledge, is any litigation threatened against us, the outcome of which would, in our judgment based on information currently available to us, have a material adverse effect on our financial position or results of operations.

NYSE Continued Listing Standard

On October 10, 2008, the Company was notified by the NYSE that it was not in compliance with an NYSE continued listing standard applicable to its common stock. The standard requires that the average closing price of any listed security
not fall below $1.00 per share for any consecutive 30 trading-day period. On October 15, 2008, the Company notified the NYSE of its intent to cure this deficiency. After exploring different alternatives for curing the deficiency and restoring
compliance with the continued listing standards, the Company currently expects to effectuate a 1 for 10 reverse stock split of the outstanding shares of its common stock. Under the NYSE rules, the Company has six months from the date of the NYSE
notice to comply with the NYSE minimum share price standard. If the Company is not compliant by that date, its common stock will be subject to suspension and delisting by the NYSE. However, on February 26, 2009, the NYSE granted NYSE-listed
companies a reprieve from the NYSEs $1 minimum price requirement until June 30, 2009. In addition, the NYSE extended until June 30, 2009 the temporary lowering of its market-capitalization standard to $15 million for listed
companies, which generally requires that average market capitalization of a NYSE-listed company be at least $25 million over any 30 consecutive trading day period. We therefore have until August 13, 2009 to become compliant with the NYSE
minimum share price standard. If we fail to meet any of the NYSEs other listing standards, however, we may be delisted for failing to comply with the continued listing standards.



|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
|------- | --------------------------------------------------------------------------------------

Certain statements contained in this Quarterly Report on Form 10-Q, including without limitation statements regarding the objectives of management for
future operations and statements containing the words believe, may, will, estimate, continue, anticipate, intend, expect and similar expressions
constitute forward-looking statements within the meaning of the federal securities laws. Such forward-looking statements are subject to known and unknown risks, uncertainties and assumptions which may cause actual results, performance or
achievements to differ materially from those anticipated or implied by the forward-looking statements. These risks include our failure to successfully execute our business plan, continued disruption in the U.S. credit markets generally and the
mortgage loan and CDO markets particularly, our ability to timely consummate the merger with Cohen & Company, our inability to gain access to additional financing, the limited availability of additional investment portfolios for future
acquisition, performance of our existing investments, our failure to maintain REIT status, our ability to restore compliance with NYSE continued listing standards, or, in the event that we are unable to maintain our listing with the NYSE, our
ability to comply with the initial listing standards of the NYSE or another securities exchange, the cost of capital, as well as the additional risks and uncertainties detailed in our periodic reports and registration statements filed with the
Securities and Exchange Commission (the SEC). We disclaim any obligation to update any such statements or publicly announce any updates or revisions to any of the forward-looking statements contained herein to reflect any change in our
expectation with regard thereto or any change in events, conditions, circumstances or assumptions underlying such statements.

Managements discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements
requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On a regular basis, we evaluate these estimates, including
fair value of financial instruments and provision for loan losses. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these
estimates.



24



---

##### Table of Contents

Overview

We are a specialty finance company that has historically invested in the following asset classes, subject to maintaining our qualification as a REIT under the Internal Revenue Code and our exemption from regulation under the Investment
Company Act:



| |  |  | subordinated debt financings, primarily in the form of TruPS issued by banks or bank holding companies and insurance companies, and surplus notes issued by
insurance companies;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | leveraged loans made to small and mid-sized companies in a variety of industries, including the consumer products and manufacturing industries; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | mortgage loans, other real estate-related senior and subordinated debt securities and RMBS.
| | - |  | -------------------------------------------------------------------------------------------

We may also invest opportunistically from time to time in other types of investments within our managers areas of expertise and experience, subject
to maintaining our qualification as a REIT and our exemption from regulation under the Investment Company Act. Our investment guidelines do not impose any limitations on the type of assets in which we may invest.

We are externally managed and advised by Cohen & Company Management, LLC, whom we refer to as our manager, pursuant to a management agreement.
Our manager is a wholly-owned subsidiary of Cohen Brothers, LLC, d/b/a Cohen & Company, an alternative investment management firm, which, since 2001, has provided financing to small and mid-sized companies in financial services, real estate
and other sectors.

Our investment strategy has historically been focused on investing in our target asset classes. The disruption in the
credit markets has directly impacted and continues to directly impact our business because our investment strategy is primarily focused on making investments in our target asset classes and financing those investments on a short-term basis through
on and off-balance sheet warehouse facilities or other short-term financing arrangements and financing those investments on a long-term basis with securitization vehicles, including CDOs and CLOs. Our historical financing strategy involved the use
of significant amounts of leverage, which has resulted in increased losses in our portfolios. We expect that our use of leverage will continue to have the effect of increasing losses in this current period of unfavorable economic conditions.

Our Proposed Merger with Cohen & Company

As previously disclosed, we entered into a definitive merger agreement with Cohen & Company on February 20, 2009. Our Board of Directors and Cohen & Companys Board of Managers have each
unanimously approved the transaction. In the proposed merger, Cohen & Company will merge with a subsidiary of the Company and will survive the merger as a subsidiary of the Company. In the proposed merger, (i) members who own
Class A units of membership interest and Class B units of membership interest in Cohen & Company will have the option to exchange their membership units in Cohen & Company for either 0.57372 shares of our common stock or
0.57372 replacement units of membership interest in Cohen & Company and (ii) Daniel G. Cohen, who owns Class C units of membership interest in Cohen & Company, will be entitled to receive one share of our Series A Voting
Convertible Preferred Stock, par value $0.001 per share, which is referred to herein as the Series A share. The Series A share will have no economic rights but will entitle the holder thereof to elect one-third of our board of directors. In 2010,
the holder of the Series A share may convert the Series A share into our Series B Voting Non-Convertible Preferred Stock, par value $0.001 per share, which will have no economic rights but will entitle such holder to vote together with our
stockholders on all matters presented to our stockholders and to exercise approximately 31.9% of the voting power of our common stock. The replacement units of membership interest in Cohen & Company may be exchanged into an equivalent
number of shares of our common stock in the future, after specified lock-up periods. Holders of our common stock will continue to hold their shares of the Company. Pursuant to the merger agreement, we will complete a 1 for 10 reverse split of our
common stock. It is currently expected that our current shareholders will own 56.5% of our shares of common stock immediately after the merger and former unit holders of Cohen & Company will hold the balance; however, the actual percentages
will not be known until members of Cohen & Company have made their elections to receive our common stock or replacement units of Cohen & Company. If all Cohen & Company membership interests were to be converted into our
shares in the future, our current shareholders would own 38.5%, and former Cohen & Company members would own 61.5%, of the combined company. Cohen & Company will be treated as the acquirer for accounting purposes.

In the near term, the merger of the two companies is expected to provide the combined entity with enhanced financial resilience, synergies and economies
of scale and will allow the combined entity greater flexibility in withstanding the current volatile market conditions than either of the constituent companies on a stand alone basis. Our business model will shift from a capital investment company
to an operating company. If the proposed merger is consummated, we expect that we will cease to qualify as a REIT beginning with our taxable year ending on December 31, 2009. Over the medium to long term, the combination is expected to create a
platform specializing in credit related fixed income trading and management and a combined company with greater capital resources to pursue opportunistic initiatives in a distressed market, which may include potential acquisitions of other asset
management and investment firms.



25



---

##### Table of Contents

The merged company will seek to generate diversified revenue and fee income streams through the following
three operating segments:



| |  |  | Capital MarketsThis business consists of sales and trading, as well as origination, structuring, and placement of fixed income securities through
Cohen & Companys broker dealer subsidiary, Cohen & Company Securities, LLC.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Additionally, this
business provides corporate debt originations and new issue securitizations for a wide variety of corporate clients with a historical focus on the financial services industry.



| |  |  | Asset ManagementThis business serves the needs of client investors by managing assets within a variety of investment vehicles, including investment funds,
permanent capital vehicles, and CDOs.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

This business will seek to generate additional fee income through strategic
roll up acquisitions of credit fixed income contracts at attractive valuations and through the seeding and formation of additional investment vehicles.



| |  |  | Principal InvestingThis business will be comprised primarily of our investment portfolio and Cohen & Companys seed capital in certain
investment vehicles and the related gains and losses that they generate.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The proposed merger, which is expected to close
during the second half of 2009, is subject to a number of closing conditions, including the receipt of third party consents and other conditions set forth in the definitive merger agreement. In addition, the transaction is subject to approval by the
affirmative vote of a majority of the votes cast by holders of our common stock, provided that the number of votes cast on the matter represents over 50% in interest of all securities entitled to vote on the matter. We will be filing a registration
statement on Form S-4 with the SEC to register the shares of our common stock issuable in the merger. The registration statement will include a joint proxy statement of us and Cohen & Company with regard to the approval of the transaction
by our stockholders and members of Cohen & Company.

Certain Factors Affecting Financial Condition and Results of Operations

The Companys financial condition and results of operations have been and will continue to be affected by market fluctuations and by economic
factors. In addition, results of operations in the past have been, and in the future may continue to be, materially affected by many factors, including political and economic conditions and geopolitical events; the effect of market conditions,
particularly in the fixed income and credit markets, including residential mortgage, middle market, and bank and insurance company lending; the level and volatility of equity prices, commodity prices and interest rates and other market indices; the
availability and cost of both credit and capital; investor sentiment and confidence in the financial markets; the Companys reputation; the actions and initiatives of current and potential competitors; and the impact of current, pending and
future legislation, regulation, and technological changes in the U.S. and worldwide. Such factors also may have an impact on the Companys ability to achieve its strategic objectives, including its merger with Cohen & Company. For a
further discussion of these and other important factors that could affect the Companys business, see Risk Factors in Part I, Item 1A of the Companys Form 10-K as of and for the year ended December 31, 2008.

The following items significantly affected the Companys financial condition and results of operations during the three-months ended
March 31, 2009 and the fiscal year ended 2008.

Impact of Market Events on Our Business

The credit markets in the United States began suffering significant disruption in the summer of 2007. This disruption began in the subprime residential
mortgage sector and extended to the broader credit and financial markets generally. During the third quarter of 2008, it became clear that the global economy had been adversely impacted by the credit crisis. Available liquidity, particularly through
asset-backed securities (ABS) CDOs and other securitizations, declined precipitously during the second half of 2007, continued to decline in 2008 and remains depressed as of the date of this filing. Concerns about the capital adequacy of financial
services companies, disruptions in global credit markets, volatility in commodities prices and continued pricing declines in the U.S. housing market have led to further disruptions in the financial markets, adversely affected regional banks and have
exacerbated the longevity and severity of the credit crisis. The disruption in these markets directly impacts our business because our investment portfolio includes investments in MBS, leveraged loans and bank and insurance company debt. In
addition, the general disruption in the structured products markets has prevented us from executing our long-term financing strategy.

Our MBS Investments

We invest in MBS through our Kleros Real Estate CDO subsidiaries and other non-consolidated CDO
investments. The principal U.S. rating agencies have downgraded large amounts of MBS, ABS and debt securities of CDOs collateralized by MBS, including investments that are in our portfolio. Since we finance our investments in MBS through the
issuance of equity and debt securities of CDOs, our exposure to losses on our consolidated MBS portfolios is limited to our investments in such CDOs.

Our maximum loss from investments in MBS is limited to the $90 million that we have invested in the three remaining Kleros Real Estate CDOs. The CDOs are governed by indentures that provide us with no rights to the
CDOs assets and provide the CDO noteholders with no recourse to us in respect of the debt securities issued by the CDOs. We consolidate the Kleros Real Estate CDOs in accordance with Financial Accounting Standard Board (FASB)
Interpretation No. 46(R), Consolidation of Variable Interest



26



---

##### Table of Contents

Entities (FIN 46R), which requires that we record the financial position and results of operations of the CDOs in our consolidated
financial statements, without consideration that our maximum economic exposure to loss is $90 million. We have effectively written down our remaining $90 million equity investment in the Kleros Real Estate CDOs to zero.

During the second quarter of 2007, the Company began to purchase CDS contracts referenced to certain MBS and CDOs that trade in the public markets. In
June 2008, the Company sold the subsidiary that owned the remaining $87.5 million notional of CDS positions for $70.4 million in proceeds. Following the June 2008 sale, the Company no longer holds any investments in CDS.

As previously disclosed, the Kleros Real Estate CDOs have all failed over-collateralization tests as a result of significant ratings agency downgrade
activity and are no longer making cash distributions to the Company. The net cash flows of the Kleros Real Estate CDOs are currently being used to pay down the controlling class debtholders in each of the Kleros Real Estate CDOs. Despite the fact
that each Kleros Real Estate CDO has failed over-collateralization tests, the net interest earnings of these CDOs continues to be reflected in the Companys net investment income and taxable income. As previously disclosed, we have received
written notice from the trustees of Kleros Real Estate I, II and IV that each CDO experienced an event of default. These events of default resulted from the failure of certain additional over-collateralization tests primarily due to credit rating
agency downgrades. The events of default provide the controlling class debtholder in each CDO with the option to liquidate all of the MBS assets collateralizing the particular CDO. The proceeds of any such liquidation would be used to repay the
controlling class debtholder.

As of the current date, the controlling class debtholders of Kleros Real Estate I, II and IV have not
exercised their rights to liquidate any of the CDOs. Since the Company is not receiving any cash flow from its investments in any of the Kleros Real Estate CDOs, the events of default and liquidation described above do not have any further impact on
the Companys cash flows. However, the assets of the Kleros Real Estate I, II and IV CDOs and the income they generate for tax purposes are a component of the Companys REIT qualifying assets and income. If more than one of the three
remaining Kleros Real Estate CDOs is liquidated, the Company may have to deploy additional capital into REIT qualifying assets in order to continue to qualify as a REIT. If the Company is not able to invest in sufficient other REIT qualifying
assets, its ability to qualify as a REIT could be materially adversely affected.

Our Investments in Residential Mortgages

As a result of the on-going disruption in the housing market and the downturn in the overall economy, we have recorded significant losses
on our residential mortgage loan portfolio, including the loans held directly by us and through our subordinated interests in a securitization trust collateralized by residential mortgage loans. The weighted average origination date for the loans
included in our portfolio was July 2006 and the weighted average FICO of our borrowers at origination was 734. The majority of our loans were originated at the end of a period of unprecedented real estate appreciation to borrowers that were deemed
to be prime borrowers. During the past two years, the values of the properties securing our loans have materially decreased and the credit quality of our average borrower has also materially decreased. We expect to record further losses
on our residential mortgage loan portfolio as a result of the continuing increase in the unemployment rate, continued home price depreciation, lack of refinancing options for many borrowers and continued deterioration in the general macro economic
conditions. As of March 31, 2009, we maintained an allowance for residential mortgage loan losses of $67.8 million.

The significant
amount of losses and delinquencies that have occurred within the residential mortgage portfolio that we hold through our investment in a securitization trust have resulted in a decrease to the amount of cash flows that we receive. These losses are
attributable to an increase in the delinquency rate of the underlying pool of mortgage loans since the closing date of the securitization, which has also caused a reduction in the amount of principal and interest that is collected from the mortgage
loans. To the extent such collections continue to decrease, there may not be sufficient cash flow to pay any principal and interest to the subordinated notes until the senior noteholders have been paid in full.

Although we have recorded an allowance for loan losses of $67.1 million on our securitized residential mortgage portfolio and experienced additional
impairments and losses on the sale of REO properties, our maximum exposure to loss from our investment in securitized residential mortgages is limited to the $54.5 million that we currently have invested in the securitization.

Our Bank and Insurance TruPS Investments

We invest in TruPS issued by banks and surplus notes issued by insurance companies through our Alesco CDO subsidiaries. As of March 31, 2009, we have experienced 45 bank deferrals or defaults and one insurance
company default in our TruPS portfolio. As of March 31, 2009, the aggregate principal amount of investments in the 46 TruPS investments that have defaulted or are currently deferring interest payments is $726.5 million, representing
approximately 14.1% of the Companys combined TruPS portfolio. As of March 31, 2009, $307.5 million of defaulted securities have been completely written off in the Companys consolidated financial statements. For the three-month
period ended March 31, 2009, investment interest income is net of a $9.1 million reserve for interest income related to the $726.5 million of deferring and defaulted securities.

The TruPS deferrals and defaults described above have resulted in the over-collateralization tests being triggered in all eight CDOs in which the Company
holds equity interests. The trigger of an over-collateralization test in a TruPS CDO means that the Company, as a holder of equity securities, will no longer receive current distributions of cash in respect of its equity interests until sufficient
cash or collateral is retained in the CDOs to cure the over-collateralization tests.



27



---

##### Table of Contents

Our Leveraged Loan Investments

We invest in leveraged loans through our Emporia CLO subsidiaries and through investments held in an on-balance sheet warehouse facility. Management
continues to closely monitor and actively manage the leveraged loan portfolio as a result of the continued deterioration in macro-credit conditions and the potential for significant stress on the middle-market companies in our portfolio. As of
March 31, 2009, our leveraged loan portfolio has experienced seven defaults in an aggregate principal amount of $16.3 million. The overcollateralization requirements in the leveraged loan CLOs are typically triggered in the event that we
experience significant losses on the sale of assets below par, as well as unrealized fair value adjustments on certain assets as mandated by the indentures which govern our leveraged loan CLOs. The primary cause for such fair value adjustments are
default activity, and credit downgrades in the underlying asset pool. As of the date of this filing, we have not experienced an overcollateralization failure in any of our leveraged loan CLOs. However, as a result of a partial failure of an interest
diversion test during April 2009, we did experience a reduction in our quarterly cash distribution from an Emporia CLO. The partial failure was primarily attributable to the recent increase in defaulted assets collateralizing the CLO. The interest
diversion test was cured in April 2009; however, the current state of the credit markets and the economy in general increases the likelihood of defaults and ratings agency downgrades on the underlying collateral of our CLOs.

In addition, the general disruption in the structured products markets has made it difficult to securitize leveraged loans through CLOs. As a result, we
are holding assets on a warehouse line longer than originally anticipated. We typically earn returns from the loans while they are on warehouse lines, but we must also maintain cash collateral with the warehouse lenders during the term of the
warehouse lines. The cash we maintain as collateral with our warehouse lenders is not available to us to make new investments or pay distributions until the assets are sold from the warehouse line. We have seen warehouse lenders generally increase
their cash collateral requirements as the difficult credit environment has continued. In addition, banks are generally less willing or able to provide warehouse financing in the current environment because their capital is constrained.

As of March 31, 2009, the Company continues to classify all of the leveraged loans included in its warehouse facility with a third party as held
for sale. During the three-months ended March 31, 2009, the Company recorded a $40 million increase to the fair value of these leveraged loans. The fair value increase was primarily attributable to a tightening of estimated credit spreads as
evidenced by comparable market leveraged loan data. During the fourth quarter of 2008, the Company determined that it no longer had the intent to hold these particular loans to maturity or for the foreseeable future. The warehouse facility that
provides short-term financing for approximately $157.1 million of par value of leveraged loans is scheduled to mature in May 2009 and, as previously disclosed, is currently in default. If the securitization markets remain effectively closed for the
foreseeable future, the Company will likely lose the first loss cash that is deposited with the warehouse lender in the amount of $38.5 million, which is the maximum amount of loss that the Company is exposed to from the warehouse facility.

NYSE Continued Listing Standard

On October 10, 2008, the Company was notified by the NYSE that it was not in compliance with an NYSE continued listing standard applicable to its common stock. The standard requires that the average closing price
of any listed security not fall below $1.00 per share for any consecutive 30 trading-day period. On October 15, 2008, the Company notified the NYSE of its intent to cure this deficiency. After exploring different alternatives for curing the
deficiency and restoring compliance with the continued listing standards, the Company currently expects to effectuate a 1 for 10 reverse stock split of the outstanding shares of its common stock. Under the NYSE rules, the Company has six months from
the date of the NYSE notice to comply with the NYSE minimum share price standard. If the Company is not compliant by that date, its common stock will be subject to suspension and delisting by the NYSE. However, on February 26, 2009, the NYSE
granted NYSE-listed companies a reprieve from the NYSEs $1 minimum price requirement until June 30, 2009. In addition, the NYSE extended until June 30, 2009 the temporary lowering of its market-capitalization standard to $15
million for listed companies, which generally requires that average market capitalization of a NYSE-listed company be at least $25 million over any 30 consecutive trading day period. We therefore have until August 13, 2009 to become
compliant with the NYSE minimum share price standard. If we fail to meet any of the NYSEs other listing standards, however, we may be delisted for failing to comply with the continued listing standards.

Liquidity

During the year
ended December 31, 2008, we repurchased and retired $111.4 million par value of our outstanding convertible debt securities for $50.6 million. We realized a gain of $56.4 million on these transactions, net of a $2.7 million write-off of related
deferred costs and a $1.6 million discount.

The holders of our remaining $28.7 million aggregate principal amount of convertible debt will
have the right to require us to repurchase their notes at 100% of their principal amount together with accrued but unpaid interest thereon if, among other things, our common stock ceases to be listed on the NYSE, another established national
securities exchange or an automated over-the-counter trading market in the United States. If we are unable to remedy the NYSE listing deficiency and are unable to list our common stock on another established national securities exchange or automated
U.S. over-the-counter trading market, there is a risk that some or all holders of our convertible notes will exercise their right to require us to repurchase their notes.



28



---

##### Table of Contents

Additionally, the disruption in the credit markets has severely restricted our ability to complete new
CDOs and CLOs. Banks are capital constrained and this severely limits their ability to provide new financing commitments. We expect this situation to continue for the foreseeable future until markets stabilize, credit concerns dissipate and capital
becomes less constrained. We are fortunate that the substantial portion of our portfolio is financed with in-place, long-term financing. However, as disclosed previously, as of March 31, 2009, we had $38.5 million of cash deposited with a
warehouse lender to collateralize a warehouse facility for leveraged loans. If the securitization markets remain effectively closed for an extended period, we will likely lose the first loss cash that we had deposited with the warehouse lender. In
addition, our inability to maintain compliance with the over-collateralization requirements of our CDO and CLO financing arrangements can materially adversely affect our cash flow from operations and our ability to make distributions to our
stockholders for the reasons discussed above. Management will continue to consider projections regarding our taxable income and liquidity position and decisions regarding future dividends are subject to the review and approval of our board of
directors.

Critical Accounting Policies

Basis
of Presentation

The accompanying unaudited interim condensed consolidated financial statements have been prepared by management in
accordance with GAAP. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations, although we
believe that the disclosures included are adequate to make the information presented not misleading. The unaudited interim consolidated financial statements should be read in conjunction with our audited financial statements for the period ended
December 31, 2008, included in our Annual Report on Form 10-K. See Item 15-Exhibits and Financial Statement Schedules included in our Annual Report on Form 10-K for the year ended December 31, 2008. In the opinion of
management, all adjustments, consisting only of normal recurring adjustments necessary to present fairly our consolidated financial position and consolidated results of operations and cash flows, are included. The results of operations for the
interim periods presented are not necessarily indicative of the results for the full year.

The preparation of consolidated financial
statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Principles of Consolidation

The
consolidated financial statements reflect the accounts of the Company and its majority-owned and/or controlled subsidiaries and those entities for which the Company is determined to be the primary beneficiary in accordance with Financial Accounting
Standard Board (FASB) Interpretation No. 46(R), Consolidation of Variable Interest Entities (FIN 46R). The Company adopted Statement of Financial Accounting Standards (SFAS) No. 160,
Noncontrolling Interests in Consolidated Financial Statements-an amendment of Accounting Research Bulletin No. 51 (SFAS No. 160) on January 1, 2009. Accordingly for consolidated subsidiaries that are less than
wholly owned, the third-party holdings of equity interests are referred to as noncontrolling interests. The portion of net income attributable to noncontrolling interests for such subsidiaries is presented as Net income (loss) attributable to
noncontrolling interests on the consolidated statements of income, and the portion of the stockholders equity of such subsidiaries is presented as noncontrolling interests in subsidiaries on the consolidated balance sheets. All significant
intercompany accounts and transactions have been eliminated in consolidation.

The Companys parent stockholders equity includes
the effects of accounting for each of the underlying assets and liabilities of our consolidated variable interest entities (VIEs) as a separate unit of account. The creditors of each VIE consolidated within the Companys
consolidated financial statements have no recourse to the general credit of the Company. The Companys maximum exposure to loss as a result of its involvement with each VIE is the capital that the Company has invested in warehouse first-loss
deposits and the preference shares or debt of the CDO, CLO or other types of securitization structures.

The following table presents
information as of March 31, 2009 about VIEs which the Company consolidates (dollars in thousands):



29



---

##### Table of Contents

|                                                                          |  |           |           |                                        |   |                                   |  |                           |         |       |   |         |  |   |          
|------------------------------------------------------------------------- |  | --------- | --------- | -------------------------------------- | - | --------------------------------- |  | ------------------------- | ------- | ----- | - | ------- |  | - | ---------
|                                                                          |  | TruPSCDOs |           | LeveragedLoanCLOs andWarehouseFacility |   | ResidentialMortgageSecuritization |  | KlerosRealEstate(MBS)CDOs |         | Total
|Consolidated VIE assets                                                   |  | $         | 1,412,255 |                                        | $ | 838,267                           |  | $                         | 819,795 |       | $ | 422,442 |  | $ | 3,492,759
|Consolidated VIE liabilities                                              |  |           | 1,375,637 |                                        |   | 833,103                           |  |                           | 825,932 |       |   | 422,442 |  |   | 3,457,114
|Noncontrolling interests in consolidated VIE subsidiaries                 |  |           | 31,684    |                                        |   | 3,961                             |  |                           |        |       |   |        |  |   | 35,645   
|Maximum exposure to loss:(1)                                              |  |           |           |                                        |   |                                   |  |                           |         |       |   |         |  |   |          
|Debt and equity interests in CDOs, CLOs and other securitization vehicles |  |           | 218,570   |                                        |   | 48,100                            |  |                           | 54,352  |       |   | 90,000  |  |   | 411,022  
|Warehouse facility                                                        |  |           |          |                                        |   | 38,475                            |  |                           |        |       |   |        |  |   | 38,475   
|                                                                          |  |           |           |                                        |   |                                   |  |                           |         |       |   |         |  |   |          
|Total maximum exposure to loss                                            |  | $         | 218,570   |                                        | $ | 86,575                            |  | $                         | 54,352  |       | $ | 90,000  |  | $ | 449,497  
|                                                                          |  |           |           |                                        |   |                                   |  |                           |         |       |   |         |  |   |          



|(1) | Represents our total investments in VIEs, and is not adjusted for losses incurred to date.
|--- | ------------------------------------------------------------------------------------------

When the Company obtains an explicit or implicit interest in an entity, the Company evaluates the entity to determine if the entity is a VIE, and, if so,
whether or not the Company is deemed to be the primary beneficiary of the VIE in accordance with FIN 46R. The Company consolidates VIEs of which the Company is deemed to be the primary beneficiary or non-VIEs which the Company controls. The primary
beneficiary of a VIE is the variable interest holder that absorbs the majority of the variability in the expected losses or potentially the residual returns of the VIE. When determining the primary beneficiary of a VIE, the Company considers its
aggregate explicit and implicit variable interests as a single variable interest. If the Companys variable interest absorbs the majority of the variability in the expected losses or the residual returns of the VIE, the Company is considered
the primary beneficiary of the VIE. The Company reconsiders its determination of whether an entity is a VIE and whether the Company is the primary beneficiary of such VIE if certain events occur. If the Company determines that it is no longer the
primary beneficiary of a VIE, the deconsolidation of the VIE is accounted for as a sale of the entity for no proceeds.

The Company has
determined that certain special purpose trusts formed by third party issuers of TruPS to issue such securities are VIEs (Trust VIEs) and that the holder of the majority of the TruPS issued by the Trust VIEs would be the primary
beneficiary of the special purpose trust. In most instances, the Company is the primary beneficiary of the Trust VIEs because it holds, either explicitly or implicitly, the majority of the TruPS issued by the Trust VIEs. The acquisition of TruPS
issued by Trust VIEs may be initially financed directly by CDOs, through on-balance sheet warehouse facilities or through off-balance sheet warehouse facilities. Under the TruPS-related off-balance sheet warehouse agreements, the Company usually
deposits cash collateral with an investment bank and bears the first dollar risk of loss, up to the Companys collateral deposit, if an investment held under the warehouse facility is liquidated at a loss. This arrangement causes the Company to
hold an implicit interest in the Trust VIEs that issued TruPS held by warehouse providers. The primary assets of the Trust VIEs are subordinated debentures issued by third party sponsors of the Trust VIEs in exchange for the TruPS proceeds and the
common equity securities of the Trust VIE. These subordinated debentures have terms that mirror the TruPS issued by the Trust VIEs. Upon consolidation of the Trust VIEs, these subordinated debentures, which are assets of the Trust VIE, are included
in the Companys consolidated financial statements and the related TruPS are eliminated. Pursuant to Emerging Issues Task Force Issue No. 85-1: Classifying Notes Received for Capital Stock, subordinated debentures issued to
Trust VIEs as payment for common equity securities issued by Trust VIEs to third party sponsors are recorded net of the common equity securities issued.

Fair Value of Financial Instruments

Effective January 1, 2008, the Company adopted Statement of Financial
Accounting Standards No. 157, Fair Value Measurements (SFAS No. 157), which establishes a framework for measuring fair value by creating a three-level fair value hierarchy that ranks the quality and reliability of
information used to determine fair value, and requires new disclosures of assets and liabilities measured at fair value based on their level in the hierarchy. SFAS No. 157 also defines fair value as the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

SFAS No. 157
establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are
inputs that market participants would use in pricing the financial instrument developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Companys estimates about what
assumptions market participants would use in pricing the financial instrument developed based on the best information available in the circumstances. The fair value hierarchy is broken down into three levels based on the reliability of inputs as
follows:



| |  |  | Level 1: Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Since
valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



30



---

##### Table of Contents

Financial instruments utilizing Level 1 inputs generally include exchange-traded equity securities listed in active
markets and most U.S. Government securities.



| |  |  | Level 2: Valuations based on quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not
active or for which all significant inputs are observable, either directly or indirectly.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Financial instruments utilizing Level 2 inputs
generally include certain mortgage-backed securities, or MBS, and corporate debt securities and certain financial instruments classified as derivatives, including interest rate swap contracts and credit default swaps, where fair value is based on
observable market inputs.



| |  |  | Level 3: Inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or
liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has
been determined based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and
considers factors specific to the asset or liability.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Financial instruments utilizing Level 3 inputs generally include investments in
TruPS and TruPS security-related receivables, certain MBS, and CDO notes payable.

The fair value of the Companys financial
instruments is generally based on observable market prices or inputs or derived from such prices or inputs, provided that such information is available. When quoted market prices are not available because certain financial instruments do not
actively trade in the public markets, fair value is based on comparisons to similar instruments or from internal valuation models.

The
availability of observable inputs can vary depending on the financial instrument and is affected by a wide variety of factors, including, for example, the type of financial instrument, its age, whether the financial instrument is traded on an active
exchange or in the secondary market, the current market conditions, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the
determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value
may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input
that is significant to the fair value measurement in its entirety.

Fair value is a market-based measure considered from the perspective of
a market participant who holds the asset or owes the liability rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Companys own assumptions are set to reflect those that management
believes market participants would use in pricing the asset or liability at the measurement date. The Company uses prices and inputs that management believes are current as of the measurement date, including during periods of market dislocation. In
periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2 or Level 2 to Level 3.

Many financial instruments have bid and ask prices that can be observed in the marketplace. Bid prices reflect the highest price that the Company and
others are willing to pay for an asset. Ask prices represent the lowest price that the Company and others are willing to accept for an asset. For financial instruments whose inputs are based on bid-ask prices, the Company does not require that fair
value always be a predetermined point in the bid-ask range. The Companys policy is to allow for mid-market pricing and adjusting to the point within the bid-ask range that results in the Companys best estimate of fair value.



31



---

##### Table of Contents

Fair value for certain of the Companys Level 3 financial instruments is derived using internal
valuation models. These internal valuation models include discounted cash flow analyses developed by management using current interest rates, estimates of the term of the particular contract, specific issuer information and other market data for
securities without an active market. In accordance with SFAS No. 157, the impact of the Companys own credit and creditworthiness of consolidated CDOs is also considered when measuring the fair value of liabilities, including derivative
contracts. Where appropriate, valuation adjustments are made to account for various factors, including bid-ask spreads, credit quality and market liquidity. These adjustments are applied on a consistent basis and are based upon observable inputs
where available. Managements estimate of fair value requires significant management judgment and is subject to a high degree of variability based upon market conditions, the availability of specific issuer information and managements
assumptions.

Financial instruments that are generally classified in Level 3 of the fair value hierarchy primarily consist of investments
in TruPS and TruPS security-related receivables, certain MBS, and CDO notes payable. The valuation techniques used for those financial instruments classified in Level 3 are described below.

TruPS and TruPS Security-Related Receivables: The fair value of investments in TruPS is estimated using internal valuation models. These
investment securities generally do not trade in an active market and, therefore observable price quotations are not available. Fair value is determined based on discounted cash flow models using current interest rates, estimates of the term of the
particular contract, specific issuer information, including estimates of comparable market credit spreads and other market data.

MBS:The fair value of investments in MBS is determined based on external price and spread data. When position-specific external price data are not observable, the valuation is based on prices of comparable bonds.

CDO Notes Payable: The fair value of CDO notes payable liabilities is estimated using external price data (where observable), or internal
valuation models. In the absence of observable price quotations, fair value is determined based on prices of comparable notes payable, or discounted cash flow models using current interest rates, estimates of the term of the particular contract,
specific underlying collateral information, including estimates of credit spreads and other market data for securities without an active market.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS No. 159). SFAS No. 159 provides
entities with an irrevocable option to report most financial assets and liabilities at fair value, with subsequent changes in fair value reported in earnings. The election can be applied on an instrument-by-instrument basis. SFAS No. 159
establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities, and became effective for the Company on
January 1, 2008. The Company elected to apply the fair value option for its investments in TruPS and TruPS security-related receivables, MBS, TruPS CDO notes payable, MBS CDO notes payable, and TruPS obligations. The Company elected the fair
value option for these instruments to enhance the transparency of its financial condition.

Investments

The Company invests primarily in TruPS and MBS debt securities, residential and commercial mortgage portfolios, and leveraged loans and may invest in
other types of real estate-related assets. The Company accounts for its investments in debt securities under Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, as
amended and interpreted (SFAS No. 115), and designates each investment as a trading security, an available-for-sale security, or a held-to-maturity security based on managements intent at the time of acquisition. Under SFAS
No. 115, trading securities are recorded at their fair value each reporting period with fluctuations in fair value reported as a component of earnings. Available-for-sale securities are recorded at fair value with changes in fair value reported
as a component of other comprehensive income (loss). Fair value of investments subsequent to the adoption of SFAS No. 157 is described above. Upon the sale of a security, the realized gain or loss is computed on a specific identification basis
and is recorded as a component of earnings in the respective period.

Effective January 1, 2008, the Company classifies its
investments in TruPS and MBS as trading securities (see Fair Value of Financial Instruments). These investments are carried at estimated fair value, with changes in fair value of these instruments reported in income. Unamortized premiums
and discounts on trading securities that are highly rated are recognized over the contractual life, adjusted for estimated prepayments using the effective interest method. For securities representing beneficial interests in securitizations that are
not highly rated (i.e., subordinate tranches of MBS), unamortized premiums and discounts are recognized over the contractual life, adjusted for estimated prepayments and estimated credit losses of the securities using the effective interest method.
Actual prepayment and credit loss experience are reviewed quarterly and effective yields are recalculated when differences arise between prepayments and credit losses originally anticipated compared to amounts actually received plus anticipated
future prepayments.

Effective January 1, 2008, the Company accounts for its investments in subordinated debentures owned by Trust
VIEs that the Company consolidates at fair value, with changes in fair value of these instruments reported in income. These Trust VIEs have no ability to sell, pledge, transfer or otherwise encumber a company or the assets of a company until such
subordinated debentures



32



---

##### Table of Contents

maturity. The Company accounts for investments in securities where the transfer meets the criteria as a secured financing under Statement of Financial
Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS No. 140) as secured loans at fair value. The Companys investments in
security-related receivables represent interests in securities that were transferred to CDO securitization entities by transferors that maintain some level of continuing involvement.

Effective January 1, 2008, the Company is not classifying any of its investments as available-for-sale. As it relates to investments that may be
classified as available-for-sale securities in the future, the Company will exercise judgment to determine whether an investment security had sustained an other-than-temporary decline in fair value. If the Company determines that an investment
security has sustained an other-than-temporary decline in its fair value, the investment security will be written down to its fair value by a charge to earnings, and the Company will establish a new cost basis for the investment. The Companys
evaluation of an other-than-temporary decline will be dependent on specific facts and circumstances relating to the particular investment. Factors that the Company will consider in determining whether an other-than-temporary decline in fair value
has occurred include, but are not limited to: the estimated fair value of the investment in relation to its cost basis; the length of time the security had a decline in estimated fair value below its amortized cost; the financial condition of the
related entity and industry events; changes in estimated cash flows from the investment; external credit ratings and recent downgrades of such credit ratings; and the intent and ability of the Company to hold the investment for a sufficient period
of time to allow for recovery in the fair value of the investment. For MBS that are not of high credit quality at acquisition, the Company will perform impairment analyses in accordance with Emerging Issues Task Force Issue No. 99-20,
Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets (EITF No. 99-20). When adverse changes in estimated cash flows occur as a result of actual or
expected prepayment and credit loss experience, an other-than-temporary impairment will be deemed to have occurred. Accordingly, the security will be written down to fair value, and the loss will be recognized in current earnings. The cost basis
adjustment for other-than-temporary impairment is recoverable only upon sale or maturity of the security.

The Company accounts for its
investments in residential and commercial mortgages and leveraged loans at amortized cost. The carrying value of these investments is adjusted for origination discounts/premiums, nonrefundable fees and direct costs for originating loans which are
amortized into income over the terms of the loans using the effective yield method adjusted for the effects of estimated prepayments based on Statement of Financial Accounting Standards No. 91, Accounting for Nonrefundable Fees and Costs
Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases (SFAS No. 91).

The Company
maintains an allowance for residential and commercial mortgages and leveraged loan losses based on managements evaluation of known losses and inherent risks in the portfolios, including historical and industry loss experience, economic
conditions and trends, estimated fair values, the quality of collateral and other relevant quantitative and qualitative factors. Specific allowances for losses may be established for potentially impaired loans based on a comparison of the recorded
carrying value of the loan to either the present value of the loans expected cash flow, the loans estimated market price or the estimated fair value of the underlying collateral. The allowance is increased by charges to operations and
decreased by charge-offs (net of recoveries).

An impaired loan may be left on accrual status during the period the Company is pursuing
repayment of the loan; however, the loan is placed on non-accrual status at such time as the Company believes that scheduled debt service payments may not be paid when contractually due or the loan becomes greater than 90 days delinquent. While on
non-accrual status, interest income is recognized only upon actual receipt.

Loans Held for Sale

Loans held for sale are carried at the lower of cost or fair value. If the fair value of a loan is less than its cost basis, a valuation adjustment is
recognized in the consolidated statement of operations and the loans carrying value is adjusted accordingly. The valuation adjustment may be recovered in the event the fair value increases, which is also recognized in the consolidated
statement of operations.

Transfers of Financial Assets

The Company accounts for transfers of financial assets under SFAS No. 140 as either sales or financing arrangements. Transfers of financial assets that result in sale accounting are those in which (a) the
transfer legally isolates the transferred assets from the transferor, (b) the transferee has the right to pledge or exchange the transferred assets and no condition both constrains the transferees right to pledge or exchange the assets
and provides more than a trivial benefit to the transferor, and (c) the transferor does not maintain effective control over the transferred assets. If the transfer does not meet each of these criteria, the transfer is accounted for as a
financing arrangement. Dispositions of financial assets that are treated as sales are removed from the Companys accounts with any realized gain (loss) reflected in earnings during the period of sale. Dispositions of financial assets that are
treated as financings are maintained on the balance sheet with proceeds received from the legal transfer reflected as secured borrowings and no gain or loss is recognized.



33



---

##### Table of Contents

Revenue Recognition

The Company recognizes interest income from investments in debt and other securities, residential and commercial mortgages, and leveraged loans over the estimated life of the underlying financial instruments on an
estimated yield to maturity basis.

In accordance with EITF No. 99-20, the Company recognizes interest income from purchased interests
in certain financial assets, including certain subordinated MBS, on an estimated effective yield to maturity basis. Management estimates the current yield on the reference amount of the investment based on estimated cash flows after considering
prepayment and credit loss expectations. The adjusted yield is then applied prospectively to recognize interest income for the next reporting period.

Derivative Instruments

The Company uses derivative financial instruments to attempt to hedge all or a portion of the
interest rate risk associated with its borrowings. In accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted (SFAS
No. 133), the Company measures each derivative instrument (including certain derivative instruments embedded in other contracts) at fair value and records such amounts in its consolidated balance sheet as either an asset or liability.
Derivatives qualifying and designated as cash-flow hedges are evaluated at inception and at subsequent balance sheet dates in order to determine whether they qualify for hedge accounting under SFAS No. 133. The hedge instrument must be highly
effective in achieving offsetting changes in cash flows of the hedged item attributable to the risk being hedged in order to qualify for hedge accounting. Derivative contracts are carried on the consolidated balance sheet at fair value. For
derivatives designated as cash flow hedges, the effective portions of changes in the fair value of the derivative are reported in other comprehensive income (loss). Changes in the ineffective portions of cash flow hedges are recognized in earnings.
Realized gains and losses on terminated contracts that were designated as hedges are maintained in accumulated other comprehensive income or loss and amortized into the consolidated statement of income over the contractual life of the terminated
contract unless it is probable that the forecasted transaction will not occur. In that case, the gain or loss in accumulated other comprehensive income or loss is reclassified to realized gain or loss in the consolidated statement of income. The
Company had no instruments designated as hedges during the three month periods ended March 31, 2009 and 2008, respectively.

The
Company enters into derivatives that do not qualify for hedge accounting or for which the Company may not elect hedge accounting, including interest rate swaps, interest rate caps and floors, credit default and total return swaps, under SFAS
No. 133. These derivatives are carried at their fair value with changes in fair value reflected in the consolidated statement of income. The fair value of credit default swaps is based on quotations from third-party brokers.

Accounting for Off-Balance Sheet Arrangements

The Company may maintain certain warehouse financing arrangements with various investment banks that are accounted for as off-balance sheet arrangements. The Company receives the difference between the interest earned on the investments
under the warehouse facilities and the interest charged by the warehouse providers from the dates on which the respective investments were acquired. Under the warehouse agreements, the Company is typically required to deposit cash collateral with
the warehouse provider and as a result, the Company bears the first dollar risk of loss, up to the warehouse deposit, if (i) an investment funded through the warehouse facility becomes impaired or (ii) a CDO is not completed by the end of
the warehouse period, and in either case, the warehouse provider is required to liquidate the securities at a loss. These off-balance sheet arrangements are not consolidated because the collateral assets are maintained on the balance sheet of the
warehouse providers. However, since the Company holds an implicit variable interest in many entities funded under its TruPS-related warehouse facilities, the Company often does consolidate the Trust VIEs while the TruPS they issue are held on the
warehouse facilities. The Company records the cash collateral as warehouse deposits in its financial statements. The net amount earned from these warehouse facilities and any obligation associated with the warehouse arrangement are considered
free-standing derivatives and are recorded at fair value in the financial statements with changes in fair value reflected in earnings in the respective period.

Income Taxes

For tax purposes, Sunset is deemed to have acquired AFT on October 6, 2006. Sunset elected to be
taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code and subsequent to the merger the Company continues to comply with these requirements. Accordingly, the Company generally will not be subject to U.S. federal income tax to
the extent of its distributions to stockholders and as long as certain asset, income, distribution and share ownership tests are met. If the Company were to fail to meet these requirements, it would be subject to U.S. federal income tax, which could
have a material adverse impact on its results of operations and amounts available for distributions to its stockholders. Management believes that all of the criteria to maintain the Companys REIT qualification have been met for the applicable
periods, but there can be no assurances that these criteria will continue to be met in subsequent periods.

The Company maintains domestic
taxable REIT subsidiaries (TRSs), which may be subject to U.S. federal, state and local income taxes. Current and deferred taxes are provided for on the portion of earnings (losses) recognized by the Company with respect



34



---

##### Table of Contents

to its interest in domestic TRSs. Deferred income tax assets and liabilities are computed based on temporary differences between the GAAP consolidated
financial statements and the federal and state income tax basis of assets and liabilities as of the consolidated balance sheet date. We evaluate the realizability of our deferred tax assets and recognize a valuation allowance if, based on the weight
of available evidence, it is more likely than not that some portion or all of our deferred tax assets will not be realized. When evaluating the realizability of our deferred tax assets, we consider estimates of expected future taxable income,
existing and projected book/tax differences, tax planning strategies available, and the general and industry specific economic outlook. This realizability analysis is inherently subjective, as it requires management to forecast our business and
general economic environment in future periods. Changes in estimate of deferred tax asset realizability, if any, are included in income tax expense on the consolidated statements of income.

During the three-months ended March 31, 2009, the Company recorded $14.2 million of provision for income taxes primarily relating to increases to
the fair value of certain leveraged loans classified as held-for-sale. The $13.4 million decrease in the Companys deferred tax asset as of March 31, 2009 as compared to the deferred tax asset as of December 31, 2008 is also primarily
attributable to the change in fair value of certain leveraged loans classified as held-for-sale.

Certain TRS entities are domiciled in the
Cayman Islands and, accordingly, taxable income generated by these entities may not be subject to local income taxation, but generally will be included in the Companys income on a current basis, whether or not distributed. Upon distribution of
any previously included income to the Company, no incremental U.S. federal, state, or local income taxes would be payable by the Company.

Recent
Accounting Pronouncements

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160,
Noncontrolling Interests in Consolidated Financial Statements-an amendment of Accounting Research Bulletin No. 51 (SFAS No. 160). SFAS No. 160 requires reporting entities to present noncontrolling (minority)
interests as equity (as opposed to as a liability or mezzanine equity) and provides guidance on the accounting for transactions between an entity and noncontrolling interests. SFAS No. 160 applies prospectively as of the first annual reporting
period beginning on or after December 15, 2008, except for the presentation and disclosure requirements which will be applied retrospectively for all periods presented. As of January 1, 2009, the Company adopted SFAS No. 160 and the
adoption of SFAS No. 160 resulted in the following changes to the presentation of the Companys prior period consolidated financial statements: (1) reclassified all amounts previously included within the Minority interests
financial statement caption to the Noncontrolling interests in subsidiaries financial statement caption, which is included within the equity section of the Companys consolidated balance sheets; (2) consolidated net income
(loss) was adjusted to include net income (loss) attributable to both the controlling and noncontrolling interests; and (3) consolidated comprehensive income (loss) was adjusted to include comprehensive income (loss) attributable to both the
controlling and noncontrolling interests. The adoption of SFAS No. 160 did not have an impact on net income (loss) for any prior periods. However, the net loss attributable to the Companys common stockholders for the three-months ended
March 31, 2009 decreased $14.4 million, or $0.24 per diluted share, as a result of SFAS No. 160s requirement that noncontrolling interests continue to be attributed their share of losses even if that attribution results in a deficit
noncontrolling interest balance.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R),
Business Combinations (SFAS No. 141(R)). SFAS 141(R) requires the acquiring entity in a business combination to recognize the full fair value of assets acquired and liabilities assumed in the transaction (whether a full
or partial acquisition); establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; requires expensing of most transaction and restructuring costs; and requires the acquirer to disclose
to investors and other users all of the information needed to evaluate and understand the nature and financial effect of the business combination. SFAS No. 141(R) applies to all transactions or other events in which the Company obtains control
of one or more businesses, including those sometimes referred to as true mergers or mergers of equals and combinations achieved without the transfer of consideration, for example, by contract alone or through the lapse of
minority veto rights. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging
Activities  an amendment of SFAS No. 133 (SFAS No. 161). SFAS No. 161 requires enhanced disclosure related to derivatives and hedging activities and thereby seeks to improve the transparency of financial
reporting. Under SFAS No. 161, entities are required to provide enhanced disclosures relating to: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedge items are accounted for under
SFAS No. 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entitys financial position, financial performance and cash flows. The statement is effective for fiscal years
beginning after November 15, 2008. The adoption of SFAS No. 161 did not have a material impact on our consolidated financial statements.



35



---

##### Table of Contents

In May 2008, the FASB issued FASB Staff Position No. Accounting Principles Board 14-1, Accounting
for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement), or FSP APB 14-1, which clarifies the accounting for convertible debt instruments that may be settled in cash (including partial
cash settlement) upon conversion. FSP APB 14-1 requires issuers to account separately for the liability and equity components of certain convertible debt instruments in a manner that reflects the issuers nonconvertible debt (unsecured debt)
borrowing rate when interest cost is recognized. The equity component is presented in parent stockholders equity and the accretion of the resulting discount on the debt is recognized as part of interest expense in the consolidated statement of
operations. FSP APB 14-1 requires companies to retroactively apply the requirements of the pronouncement to all periods presented. As of January 1, 2009, the Company adopted FSP APB 14-1 and the effect of adoption was not material to the
three-months ended March 31, 2009 and 2008. However, the consolidated financial statements as of and for the year ended December 31, 2008 have been retroactively restated for the adoption, which resulted in an increase to the
Companys net loss of $1.6 million, or $0.03 per diluted share, and a $2.2 million increase to parent stockholders equity at January 1, 2008.

In June 2008, the FASB issued FSP Emerging Issues Task Force 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (FSP EITF 03-6-1).
FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the
two-class method as described in SFAS No. 128, Earnings per Share. Under the guidance in FSP EITF 03-6-1, unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or
unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. As of January 1, 2009, the Company adopted FSP EITF 03-6-1 and all prior-period earnings per share data presented was adjusted retrospectively. The effect of adoption was a reduction to basic and diluted earnings (loss)
per share by $0.03 for the three-months ended March 31, 2008, and there was no material impact to the three-months ended March 31, 2009.

In June 2008, the FASB ratified the consensus reached by the Emerging Issues Task Force on Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entitys Own Stock (EITF
No. 07-5). EITF No. 07-5 provides guidance for determining whether an equity-linked financial instrument (or embedded feature) is indexed to an entitys own stock. EITF No. 07-5 applies to any freestanding financial
instrument or embedded feature that has all of the characteristics of a derivative or freestanding instrument that is potentially settled in an entitys own stock (with the exception of share-based payment awards within the scope of SFAS
123(R)). To meet the definition of indexed to own stock, an instruments contingent exercise provisions must not be based on (a) an observable market, other than the market for the issuers stock (if applicable), or
(b) an observable index, other than an index calculated or measured solely by reference to the issuers own operations, and the variables that could affect the settlement amount must be inputs to the fair value of a
fixed-for-fixed forward or option on equity shares. EITF No. 07-5 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The adoption of EITF No. 07-5 did not have a
material impact on our consolidated financial statements.

In September 2008, the FASB issued for comment revisions to SFAS No. 140
and FASB Interpretation No. 46, as revised (FIN 46R), Consolidation of Variable Interest Entities. The changes proposed include a removal of the scope exemption from FIN 46R for qualifying special purpose entities
(QSPEs), a revision of the current risks and rewards-based FIN 46R consolidation model to a qualitative model based on control and a requirement that consolidation of VIEs be re-evaluated on an ongoing basis. Although the revised
standards have not yet been finalized, these changes may have a significant impact on the Companys consolidated financial statements as the Company may be required to deconsolidate certain assets and liabilities due to the ongoing evaluation
of its primary beneficiary status. In addition, the Company may also be required to consolidate other VIEs that are not currently consolidated based an analysis under the current FIN 46R consolidation model. The proposed revisions, as currently
drafted, would be effective for fiscal years that begin after November 15, 2009.

In April 2009, the FASB issued FSP FAS 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 (FSP FAS 157-4). FSP FAS 157-4 provides additional
guidance for estimating fair value in accordance with FASB Statement No. 157, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. FSP FAS 157-4 also includes
guidance on identifying circumstances that indicate a transaction is not orderly. FSP FAS 157-4 emphasizes that even if there has been a significant decrease in the volume and level of activity for the asset or liability and regardless of the
valuation technique(s) used, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or
distressed sale) between market participants at the measurement date under current market conditions. FSP FAS 157-4 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after
March 15, 2009. The Company plans to adopt FSP FAS 157-4 in the second quarter of 2009 and does not expect the adoption to have a material effect on our consolidated financial statements.

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (FSP FAS
115-2 and FAS 124-2). FSP FAS 115-2 and FAS 124-2 amends the other-than-temporary impairment guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-



36



---

##### Table of Contents

than-temporary impairments on debt and equity securities in the financial statements. FSP FAS 115-2 and FAS 124-2 does not amend existing recognition and
measurement guidance related to other-than-temporary impairments of equity securities. FSP FAS 115-2 and FAS 124-2 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after
March 15, 2009. The Company does not have any securities classified as available-for-sale and therefore, upon adoption in the second quarter of 2009 does not expect FSP FAS 115-2 and FAS 124-2 to have a material effect on our consolidated
financial statements.

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial
Instruments (FSP FAS 107-1 and APB 28-1). FSP FAS 107-1 and APB 28-1 amends FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial
instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. FSP FAS 107-1 and APB 28-1 also amends APB Opinion No. 28, Interim Financial Reporting,to require those disclosures in
summarized financial information at interim reporting periods. FSP FAS 107-1 and APB 28-1 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The
Company plans to adopt FSP FAS 107-1 and APB 28-1 in the second quarter of 2009 and does not expect the adoption to have a material effect on our consolidated financial statements.

Our Investment Portfolio

The following table shows the components of our stockholders equity
and the net change in cash and cash equivalents attributable to such components, in each case as determined in accordance with GAAP, as of, and for the three months ended, March 31, 2009. The table is divided between the components of our
stockholders equity which are attributable to our assets and liabilities which are not assets and liabilities of consolidated VIEs, and those which are assets and liabilities of consolidated VIEs. As described elsewhere in this report, the
assets of consolidated VIEs are pledged to satisfy the liabilities of the consolidated VIEs. The liabilities of our consolidated VIEs are non-recourse to us, but similarly we have no rights to use any of the proceeds of the assets held by
consolidated VIEs to satisfy any of our recourse liabilities. The components of our stockholders equity attributable to our investments in consolidated VIEs are determined in accordance with GAAP (under which we consolidate all of the assets
and liabilities of the VIEs) and do not reflect the fair value of the interests in the consolidated VIEs owned by us. The Net Change in Cash and Cash Equivalents column reflects the sources and uses of cash during the period with respect to each
component of our stockholders equity.



|                                                          |  |                                                       |         |   |                                                                           |   |        |     
|--------------------------------------------------------- |  | ----------------------------------------------------- | ------- | - | ------------------------------------------------------------------------- | - | ------ | ----
|                                                          |  | AllocatedParentStockholdersEquity as ofMarch 31,2009 |         |   | Net Changein Cashand CashEquivalentsforThree-MonthsEndedMarch 31,2009 (C) |  
|                                                          |  | (in thousands)                                        |        
|Net Assets not Included in Consolidated VIEs:             |  |                                                       |         |   |                                                                           |   |        |     
|Investments in TruPS debt securities                      |  | $                                                     | 5,790   |   |                                                                           | $ | 200    |     
|Investments in residential and commercial loans           |  |                                                       | 8,876   |   |                                                                           |   | 304    |     
|Cash and cash equivalents                                 |  |                                                       | 87,666  |   |                                                                           |   | 193    |     
|Other assets and liabilities, net (A)                     |  |                                                       | 3,863   |   |                                                                           |   | (2,583 | )(D)
|Recourse indebtedness (A)                                 |  |                                                       | (76,188 | ) |                                                                           |   | (949   | )   
|                                                          |  |                                                      
|Net Assets of Consolidated VIEs (B):                      |  |                                                       |         |   |                                                                           |   |        |     
|Investments in TruPS CDOs                                 |  | $                                                     | 4,935   |   |                                                                           |   |       |     
|Investments in leveraged loan CLOs and warehouse facility |  |                                                       | 1,203   |   |                                                                           |   | 2,819  | (E) 
|Investment in Kleros Real Estate (MBS) CDOs               |  |                                                       |        |   |                                                                           |   |       |     
|Investment in residential mortgage loan securitization    |  |                                                       | (6,137  | ) |                                                                           |   | 1,647  |     
|                                                          |  |                                                       |         |   |                                                                           |   |        |     
|Total                                                     |  | $                                                     | 30,008  |   |                                                                           | $ | 1,631  |     
|                                                          |  |                                                       |         |   |                                                                           |   |        |     



|(A) | Amount is net of our $1.5 million investment in common securities of the trusts that issued our junior subordinated debentures. The $1.5 million is recorded within other assets in
our consolidated financial statements.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(B) | We currently hold the following notional amounts of preference shares or subordinated interests in consolidated VIEs: $218.5 million in TruPS CDOs, $48 million in leveraged loan
CLOs, $38.5 million in a leveraged loan warehouse facility, $54.5 million in a whole-loan mortgage securitization and $90 million in Kleros Real Estate CDOs. The Companys parent stockholders equity includes the effects of accounting for
each of the underlying assets and liabilities of our consolidated VIEs as a separate unit of account. However, if for accounting purposes the Company were to use the notional amounts of preference shares or subordinated interests that it directly
owns as the unit of account, its net asset value could be materially different. As of March 31, 2009, the Company estimated the aggregate fair value of its investments in preference shares and subordinated interests of consolidated VIEs to be
approximately $4.6 million.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



37



---

##### Table of Contents

|(C) | The Companys primary sources of cash are interest income on debt securities, cash deposits and mortgage loans, distributions from investments in consolidated VIEs (such as
CDOs, CLOs and mortgage securitization) and proceeds from the sale of assets. The Companys primary uses of cash are recourse debt service, payment of general and administrative expenses, and additional investments. The following reconciles the
change in cash and cash equivalents during the three-month period ended March 31, 2009:
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                                         |  |   |       
|-------------------------------------------------------- |  | - | ------
|Cash and cash equivalents at the beginning of the period |  | $ | 86,035
|Net change in cash and cash equivalents                  |  |   | 1,631 
|                                                         |  |   |       
|Cash and cash equivalents at the end of the period       |  | $ | 87,666
|                                                         |  |   |       



|(D) | Amount relates to payment of general and administrative expenses incurred directly by the Company. General and administrative expenses incurred and paid by consolidated VIEs reduce
the Company's net distributions, if any, from these consolidated VIEs and are not paid directly by the Company.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(E) | Amount includes $2.4 million of distributions from investments in CLOs, $1.8 million of distributions from an investment in a leveraged loan warehouse facility, and was partially
reduced by $1.4 million of additional contributions to the leveraged loan warehouse facility during the three-months ended March 31, 2009. See Our Leveraged Loan Investments section for further details.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

TruPS Portfolio. During the three-month period ended March 31, 2009, the Company has recorded losses of $216.2 million relating to changes in
fair value of its investments in TruPS. The Company determined that these changes in fair value resulted from specific issuer credit matters, widening of credit spreads, volatility in interest rates, and other qualitative factors relating to
macro-credit conditions. The fair value of investments in TruPS is estimated using internal valuation models. These investment securities generally do not trade in an active market and, therefore observable price quotations are not available. In the
absence of observable price quotations, fair value is determined based on discounted cash flow models using current interest rates, estimates of the term of the particular contract, specific issuer information, including estimates of comparable
market credit spreads and other market data. These assets are classified as Level 3 assets.

The portfolio consists of approximately 75%
bank related investments and 25% insurance related investments. The terms of each of our long-term CDO financings include limitations on specific issuer concentrations, which typically limit the par value of the underlying collateral securities
included in the CDO from any single issuer to no greater than 3%. As of March 31, 2009, we had three issuers with concentrations ranging from 2.3% to 2.4% of our total TruPS investment portfolio par value, which includes the defaulted
investment securities of IndyMac Bancorp, and no other issuers were greater than 1.7% of our total TruPS investment portfolio. Additionally, the banks included in our TruPS investment portfolio are concentrated in the following states as of
March 31, 2009:



|           |  |       |  
|---------- |  | ----- | -
|Texas      |  | 12.0  | %
|Illinois   |  | 9.6   | %
|California |  | 8.1   | %
|Georgia    |  | 5.6   | %
|Virginia   |  | 4.8   | %
|Others     |  | 59.9  | %
|           |  |       |  
|Total      |  | 100.0 | %
|           |  |       |  

As of March 31, 2009, the aggregate principal amount of investments in the 46 TruPS
investments that have defaulted or are currently deferring interest payments is $726.5 million, representing approximately 14.1% of the Companys combined TruPS portfolio. As of March 31, 2009, $307.5 million of defaulted securities have
been completely written off in the Companys consolidated financial statements. For the three-month period ended March 31, 2009, investment interest income is net of a $9.1 million reserve for interest income related to the $726.5 million
of deferring and defaulted securities.

As of March 31, 2009, the aggregate principal amount of CDO notes payable and trust preferred
obligations financing our TruPS portfolio is $5.3 billion and the fair value of these instruments is $1.2 billion. During the three-month period ended March 31, 2009, the Company recorded gains of $193.9 million relating to changes in the fair
value of its TruPS CDO notes payable and trust preferred obligations. The Company determined that these changes in fair value resulted primarily from specific issuer credit matters with the assets that collateralize the liabilities, widening of
credit spreads, volatility in interest rates, failure or threat of failure of overcollateralization tests in the CDO structures, general deterioration of pricing on structured debt instruments and other qualitative factors relating to macro-credit
conditions. The fair value of CDO notes payable liabilities is estimated using external price data (where observable), or internal valuation models. In the absence of observable price quotations, fair value is determined based on prices of
comparable notes payable, or discounted cash flow models using current interest rates, estimates of the term of the particular contract, specific underlying collateral information, including estimates of credit spreads and other market data for
securities without an active market. These liabilities are classified as Level 3 liabilities.

Leveraged Loan Portfolio. We invest in
debt obligations of small and mid-sized corporations, partnerships and other entities in the form of participations in first lien and other senior loans and mezzanine loans, which we collectively refer to as leveraged loans because of the high
proportion of debt typically in the capital structure of the borrowing entities. As of March 31, 2009, we had



38



---

##### Table of Contents

investments in approximately $796.8 million of leveraged loans and an allowance for loan losses related to these investments of $46.7 million.

During the three-month period ended March 31, 2009, we increased our allowance for loan losses as a result of an increase in credit risk related to
specific borrowers, continued deterioration in macro-credit conditions and the potential impact to the middle-market companies in our portfolio. As of March 31, 2009, our leveraged loan portfolio has experienced seven defaults in an aggregate
principal amount of $16.3 million. The current state of the credit markets and the economy in general increases the likelihood of defaults and ratings agency downgrades on the underlying collateral of our CLOs. There can be no assurance that in
light of the current markets that we will not experience significant defaults or downgrade activity in our leveraged loan portfolio that may result in the failure of overcollateralization tests.

Residential Mortgage Loans. As of March 31, 2009, we owned approximately $875.0 million aggregate carrying amount of residential mortgage
loans, including the loans held directly by us and through our subordinated interests in a securitization trust collateralized by residential mortgage loans. As of March 31, 2009, we have recorded an allowance for loan losses of $67.8 million
relating to these residential mortgage loans. As a result of the on-going disruption in the housing market and the downturn in the overall economy, we have recorded significant losses on our residential mortgage loan portfolio, including the loans
held directly by us and through our subordinated interests in a securitization trust collateralized by residential mortgage loans. The weighted average origination date for the loans included in our portfolio was July 2006 and the weighted average
FICO of our borrowers at origination was 734. The majority of our loans were originated at the end of a period of unprecedented real estate appreciation to borrowers that were deemed to be prime borrowers. During the past two years, the values of
the properties securing our loans have materially decreased and the credit quality of our average borrower has also materially decreased. We expect to record further losses on our residential mortgage loan portfolio as a result of the continuing
increase in the unemployment rate, continued home price depreciation, lack of refinancing options for many borrowers and continued deterioration in the general macro economic conditions.

The following table summarizes the delinquency statistics of the Companys residential mortgage loans (dollar amounts in thousands):



|                      |  |               |  |                 |        
|--------------------- |  | ------------- |  | --------------- | -------
|Delinquency Status    |  | NumberofLoans |  | PrincipalAmount
|As of March 31, 2009: |  |               |  |                 |        
|30 to 60 days         |  | 84            |  | $               | 34,326 
|61 to 90 days         |  | 58            |  |                 | 23,978 
|Greater than 90 days  |  | 325           |  |                 | 134,960
|                      |  |               |  |                 |        
|Total                 |  | 467           |  | $               | 193,264
|                      |  |               |  |                 |        

Additionally, the loans included in our mortgage loan portfolio are concentrated in the following
states as of March 31, 2009:



|           |  |       |  
|---------- |  | ----- | -
|California |  | 47.2  | %
|Florida    |  | 8.3   | %
|Arizona    |  | 5.5   | %
|Washington |  | 5.1   | %
|Nevada     |  | 4.8   | %
|Others     |  | 29.1  | %
|           |  |       |  
|Total      |  | 100.0 | %
|           |  |       |  

As of March 31, 2009, the Company had 325 loans that were either greater than 90 days past
due or in foreclosure and placed on non-accrual status. During the three-month period ended March 31, 2009, the Company did not recognize approximately $1.4 million of interest income for loans that were in non-accrual status.

As of March 31, 2009, the Company had foreclosed on 51 residential mortgage loans with a fair value of $11.0 million which are classified as REO.
The Company records REO property at fair value within other assets in its consolidated balance sheet. During the three-month period ended March 31, 2009, the Company recorded impairments of $2.1 million as a result of changes in fair value of
REO property. Additionally, during the three-month period ended March 31, 2009, we sold REO properties with a fair value of $5.6 million for a realized loss of $1.1 million.



39



---

##### Table of Contents

MBS Portfolio. As of March 31, 2009, we had investments in $411.1 million of MBS. The $411.1
million of MBS collateralize the debt of the three remaining Kleros Real Estate CDOs that we have invested in. Our maximum loss from investments in Kleros Real Estate MBS is limited to our remaining $90 million of invested capital. The CDOs are
governed by indentures that provide us with no rights to the CDO assets and provide the CDO noteholders with no recourse to us in respect of the debt securities issued by the CDOs. We consolidate the three remaining Kleros Real Estate CDOs in
accordance with FIN 46R, which requires that we record the financial position and results of operations of the CDOs in our consolidated financial statements, without consideration that our maximum economic exposure to loss is our remaining $90
million investment. We record the MBS investments and CDO debt at fair value and classify the assets and liabilities as Level 3.

Credit
Default Swaps (CDS).During June 2008, the Company sold a subsidiary that owned the remaining $87.5 million notional value of CDS positions for $70.4 million in proceeds (inclusive of the $69.3 million of counterparty margin held as of
March 31, 2008). Following the June 2008 sale, the Company no longer holds any investments in CDS.

Recourse Indebtedness. As
of March 31, 2009, the Companys consolidated financial statements included recourse indebtedness of $77.7 million. During the year ended December 31, 2008, we repurchased and retired $111.4 million par value of outstanding
convertible debt securities for $50.6 million. We realized a gain of $56.4 million on these transactions, net of a $2.7 million write-off of related deferred costs and a $1.6 million discount.

None of the Companys indebtedness subjects the Company to potential margin calls for additional pledges of cash or other assets.

Equity.As of March 31, 2009, the Companys consolidated financial statements included total equity of $65.7 million, of which $30.0
million is attributable to our common stockholders and $35.7 million is attributable to noncontrolling interests in subsidiaries. As of January 1, 2009, the Company adopted SFAS No. 160 and the adoption of SFAS No. 160 resulted in the
following changes to the presentation of the Companys prior period consolidated financial statements: (1) reclassified all amounts previously included within the Minority interests financial statement caption to the
Noncontrolling interests in subsidiaries financial statement caption, which is included within the equity section of the Companys consolidated balance sheets; (2) consolidated net income (loss) was adjusted to include net
income (loss) attributable to both the controlling and noncontrolling interests; and (3) consolidated comprehensive income (loss) was adjusted to include comprehensive income (loss) attributable to both the controlling and noncontrolling
interests.

Results of Operations

Comparison of
the Three-Month Period Ended March 31, 2009 to the Three-Month Period Ended March 31, 2008

Net income
(loss). We had a net loss of approximately ($35.8) million for the three-month period ended March 31, 2009 as compared to net income of $84.9 million for the three-month period ended March 31, 2008. Our net loss for the three-month
period ended March 31, 2009 was primarily attributable to loan loss provisions on our residential mortgage and leveraged loan portfolio, partially offset by net investment income generated by our investments in TruPS, leveraged loans,
residential mortgages and MBS. Our net income for the three-month period ended March 31, 2008 was attributable to net changes in fair value of financial instruments recorded in earnings subsequent to our adoption of SFAS No. 159, and net
investment income generated by our investments in TruPS, MBS and leveraged loans and investments in residential mortgages.

Net
investment income (loss). Our net investment income decreased $36.0 million to a net investment loss of ($9.5) million for the three-month period ended March 31, 2009 from net investment income of $26.5 million for the three-month
period ended March 31, 2008. The table below summarizes net investment income (loss) by investment type for the following periods:

For the Three-Month Period Ended March 31, 2009



|                                     |  |                          |        |                           |   |         |                         |  |   |                           |   |  |   |         |  
|------------------------------------ |  | ------------------------ | ------ | ------------------------- | - | ------- | ----------------------- |  | - | ------------------------- | - |  | - | ------- | -
|Investment Type                      |  | InvestmentInterestIncome |        | InvestmentInterestExpense |   |         | Provisionfor LoanLosses |  |   | NetInvestmentIncome(loss) |  
|                                     |  | (in thousands)           |       
|Investments in TruPS                 |  | $                        | 58,536 |                           | $ | (33,832 | )                       |  | $ |                          |   |  | $ | 24,704  |  
|Investments in leveraged loans       |  |                          | 12,705 |                           |   | (5,513  | )                       |  |   | (21,574                   | ) |  |   | (14,382 | )
|Investments in MBS                   |  |                          | 16,126 |                           |   | (5,309  | )                       |  |   |                          |   |  |   | 10,817  |  
|Investments in residential mortgages |  |                          | 12,488 |                           |   | (12,733 | )                       |  |   | (28,884                   | ) |  |   | (29,129 | )
|Other investments                    |  |                          | 29     |                           |   |        |                         |  |   |                          |   |  |   | 29      |  
|Recourse indebtedness                |  |                          |       |                           |   | (1,566  | )                       |  |   |                          |   |  |   | (1,566  | )
|                                     |  |                          |        |                           |   |         |                         |  |   |                           |   |  |   |         |  
|Total                                |  | $                        | 99,884 |                           | $ | (58,953 | )                       |  | $ | (50,458                   | ) |  | $ | (9,527  | )
|                                     |  |                          |        |                           |   |         |                         |  |   |                           |   |  |   |         |  

For the Three-Month Period Ended March 31, 2008



40



---

##### Table of Contents

|                                     |  |                          |         |                           |   |          |                         |  |   |                     |   |  |   |        |  
|------------------------------------ |  | ------------------------ | ------- | ------------------------- | - | -------- | ----------------------- |  | - | ------------------- | - |  | - | ------ | -
|Investment Type                      |  | InvestmentInterestIncome |         | InvestmentInterestExpense |   |          | Provisionfor LoanLosses |  |   | NetInvestmentIncome |  
|                                     |  | (in thousands)           |        
|Investments in TruPS                 |  | $                        | 94,098  |                           | $ | (72,696  | )                       |  | $ |                    |   |  | $ | 21,402 |  
|Investments in leveraged loans       |  |                          | 17,006  |                           |   | (10,176  | )                       |  |   | (2,639              | ) |  |   | 4,191  |  
|Investments in MBS                   |  |                          | 46,749  |                           |   | (38,349  | )                       |  |   |                    |   |  |   | 8,400  |  
|Investments in residential mortgages |  |                          | 15,550  |                           |   | (14,568  | )                       |  |   | (4,925              | ) |  |   | (3,943 | )
|Other investments                    |  |                          | 492     |                           |   |         |                         |  |   |                    |   |  |   | 492    |  
|Recourse indebtedness                |  |                          |        |                           |   | (3,995   | )                       |  |   |                    |   |  |   | (3,995 | )
|                                     |  |                          |         |                           |   |          |                         |  |   |                     |   |  |   |        |  
|Total                                |  | $                        | 173,895 |                           | $ | (139,784 | )                       |  | $ | (7,564              | ) |  | $ | 26,547 |  
|                                     |  |                          |         |                           |   |          |                         |  |   |                     |   |  |   |        |  

Our investment interest income decreased $74.0 million to $99.9 million for the three-month period
ended March 31, 2009 from $173.9 million for the three-month period ended March 31, 2008. The decrease in investment interest income is attributable to a decrease in the weighted-average coupon rates in our target asset classes from 5.9%
for the three-month period ended March 31, 2008 to 3.9% for the three-month period ended March 31, 2009 and a decrease in the Companys average investment balances from $11.7 billion par value for the three-month period ended
March 31, 2008 to $10.2 billion par value for the three-month period ended March 31, 2009.

Our investment interest expense
decreased $80.8 million to $59.0 million for the three-month period ended March 31, 2009 from $139.8 million for the three-month period ended March 31, 2008. The decrease in investment interest expense is attributable to a decrease in the
weighted-average coupon rate for CDO notes payable from 4.7% as of March 31, 2008 to 1.8% as of March 31, 2009 and a decrease in the Companys average CDO notes payable from $9.4 billion par value for the three-month period ended
March 31, 2008 to $8.4 billion par value for the three-month period ended March 31, 2009.

Our provision for loan losses relates
to investments in residential mortgages and leveraged loans. The provision for loan losses increased by $42.9 million to $50.5 million for the three-month period ended March 31, 2009 from $7.6 million for the three-month period ended
March 31, 2008. The increase is primarily a result of the continued increases in the number of delinquent residential mortgage loans experienced in 2009 as a result of the turmoil in the housing markets. The 60-plus day delinquencies in our
residential mortgage portfolio increased from 5.2% as of March 31, 2008 to 21.8% as of March 31, 2009. Additionally, the increase in our leveraged loan provisioning is primarily the result of continued deterioration in macro-credit
conditions and the resulting impact to the middle-market companies that we lend to. As of March 31, 2009, our leveraged loan portfolio has experienced seven defaults in an aggregate principal amount of $16.3 million. We maintain an allowance
for residential and commercial mortgages and leveraged loan losses based on managements evaluation of estimated losses and inherent risks in the portfolios. Specific allowances for losses are established for impaired loans based on a
comparison of the recorded carrying value of the loan to either the present value of the loans expected cash flow, the loans estimated market price or the estimated fair value of the underlying collateral.

Expenses. Our non-investment expenses decreased by $0.6 million to $7.8 million for the three-month period ended March 31, 2009 from
$8.4 million for the three-month period ended March 31, 2008. During the same periods, these non-investment expenses consisted of related party management compensation of $3.9 million and $4.7 million, respectively, and general and
administrative expenses of $3.9 million and $3.6 million, respectively. During the three-months ended March 31, 2009 and 2008, the Company incurred $0.1 million and $1.4 million, respectively, in base management fees and $0 and $0.9 million,
respectively, of incentive fees. During the three-months ended March 31, 2009 and 2008, the aggregate base management fees and incentive fees payable were reduced by collateral management fee credits of $0.1 million and $2.3 million,
respectively. The Company recognized stock-based compensation expense related to shares of restricted common stock granted to the officers of the Company and key employees of the manager and Cohen & Company of $0.1 million and $0.4 million
during the three-month periods ended March 31, 2009 and 2008, respectively.

During the three-month periods ended March 31, 2009
and 2008, the CDO entities that are included in the Companys consolidated financial statements incurred collateral management fees that are payable to Cohen & Company of $3.8 million and $4.3 million, respectively. The collateral
management fees are expenses of consolidated CDO entities and relate to the on-going collateral management services that Cohen & Company provides for CDOs. The decrease in related party management compensation is attributable to the
decrease in CDO collateral manager fees resulting from the defaulted and deferring TruPS CDO collateral.

Our general and administrative
expenses are primarily attributable to professional service expenses, including legal services, CDO trustee compensation, rating agency fees, audit and audit-related fees, tax compliance services, and consulting fees relating to Sarbanes-Oxley
compliance.

Interest and other income. Our interest and other income decreased by $1.1 million to $0.4 million for the
three-month period ended March 31, 2009 from $1.5 million for the three-month period ended March 31, 2008. This decrease is attributable to $1.1 million in reduced interest earned on cash deposits with financial institutions and interest
earned on restricted cash of our consolidated CDO entities. The average total unrestricted and restricted cash balance decreased from $179.4 million for the three-month period



41



---

##### Table of Contents

ended March 31, 2008 to $147.5 million for the three-month period ended March 31, 2009, while the average interest rate earned on cash decreased
from 3.3% to 1.1% over the same period.

Net change in fair value of investments in debt securities and loans and non-recourse
indebtedness. On January 1, 2008, we adopted SFAS No. 159 and elected to apply the fair value option for our investments in TruPS and TruPS security-related receivables, MBS, TruPS CDO notes payable, MBS CDO notes payable, and
TruPS obligations. During the three-month period ended March 31, 2009, the net change in fair value of investments in debt securities and loans and non-recourse indebtedness was a $6.9 million gain. The net change in fair value is comprised of
approximately $217.7 million of losses recorded on our investments in debt securities and loans, which was offset by approximately $224.6 million of gains recorded on liabilities. During the three-month period ended March 31, 2008, the net
change in fair value of financial instruments was $202.9 million. The net change in fair value is comprised of $790.3 million of decreases recorded on our investments in debt securities, which was offset by $993.2 million of gains recorded on
liabilities.

Net change in fair value of derivative contracts. During the three-month period ended March 31, 2009 and
2008, we recorded a net change in fair value of derivative contracts of $(4.8) million and ($82.9) million, respectively. Upon the adoption of FAS No. 159, we discontinued hedge accounting on a significant portion of our interest rate swaps and
therefore all changes in fair value of these interest rate swaps are recorded in earnings. The change in fair value during the three-month period ended March 31, 2009 is primarily attributable to net periodic interest payments of $(18.2)
million offset by unrealized gains on derivative contracts of $13.4 million. The change in fair value during the three-month period ended March 31, 2008 is primarily attributable to the significant decrease in LIBOR during the same period.

Impairments on other investments and intangible assets. Impairments on other investments and intangible assets decreased by
$6.5 million to $2.1 million for the three-month period ended March 31, 2009 from $8.6 million for the three-month period ended March 31, 2008. The impairments on investments and intangible assets for the three-month period ended
March 31, 2009 is attributable to write-downs of REO property. The impairments on investments and intangible assets for the three-month period ended March 31, 2008 is attributable to the complete impairment of our goodwill of $5.0 million,
$2.4 million of charge-offs on residential mortgages, and $1.2 million of impairments on other investments.

Net realized loss on
sale of assets. During the three-month period ended March 31, 2009, the Company recorded losses on the sale of assets of approximately $11.8 million. These losses are attributable to the sale of TruPS in a consolidated CDO entity, for
which losses were recorded of $10.1 million, the sale of leveraged loans, for which losses were recorded of $0.5 million, and a $1.2 million realized loss on the sale of property included in the residential mortgage portfolio. During the three-month
period ended March 31, 2008, the Company recorded losses on the sale of assets of approximately $1.4 million, which is primarily attributable to the sale of leveraged loans during the period.

Benefit/(Provision) for income taxes. Our domestic TRSs are subject to U.S. federal and state income and franchise taxes. During the three
months ended March 31, 2009, we recorded income tax expense of $14.2 million primarily relating to increases to the fair value of leveraged loans classified as held for sale. An income tax benefit was recorded of $0.4 million relating to net
operating loss carryforwards from on-balance sheet warehousing facilities for the three-month period ended March 31, 2008.

Net
(income) loss attributable to noncontrolling interests. Net (income) loss attributable to noncontrolling interests represents the portion of net income/(loss) generated by consolidated entities that are not attributable to our ownership
interest in those entities. Net (income) loss attributed to noncontrolling interests changed ($51.0) million to $7.1 million for the three-month period ended March 31, 2009 as compared to ($43.9) million for the three-month period ended
March 31, 2008. This change is primarily attributable to the noncontrolling interest impact of the net change in fair value of financial instruments and the allocation of net investment income/(loss) and other expenses of our consolidated CDO
entities to noncontrolling interest holders.

Liquidity and Capital Resources

Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain
investments, pay dividends and other general business needs. We believe our available cash balances and cash flows from operations will be sufficient to fund our currently anticipated liquidity requirements for the next twelve months, but our
ability to grow our business will be limited by our ability to obtain future financing. In addition, our liquidity could be adversely affected by a decline in our stock price, as discussed below. Management has evaluated our current and forecasted
liquidity and continues to monitor evolving market conditions. Future investment alternatives and operating activities will continue to be evaluated against anticipated current and longer term liquidity demands.

We are currently financing our TruPS, MBS and leveraged loan portfolio with a warehouse facility and CDO notes payable. As of March 31, 2009, the
Company is not financing any investments with short-term repurchase agreements that subject the Company to margin calls or potential recourse obligations in excess of posted first loss deposits. We currently have no commitments for any additional
financings, and we may not be able to obtain any additional financing at the times required and on terms and conditions



42



---

##### Table of Contents

acceptable to us. If we fail to obtain needed additional financing, the pace of our growth would be adversely affected. Furthermore we are a party to a
derivative contract that may subject us to margin calls up to a maximum amount of $8.8 million in the event the Class A-1 notes of the Alesco XIV CDO are downgraded below AAA. During the three months ended March 31, 2009, the
Class A-1 Notes of the Alesco XIV CDO were downgraded to A+ and as a result we are required to post approximately $2.2 million of margin collateral.

On October 10, 2008, the Company was notified by the NYSE that it was not in compliance with an NYSE continued listing standard applicable to its common stock. The standard requires that the average closing price
of any listed security not fall below $1.00 per share for any consecutive 30 trading-day period. On October 15, 2008, the Company notified the NYSE of its intent to cure this deficiency. After exploring different alternatives for curing the
deficiency and restoring compliance with the continued listing standards, the Company currently expects to effectuate a 1 for 10 reverse stock split of the outstanding shares of its common stock. Under the NYSE rules, the Company has six months from
the date of the NYSE notice to comply with the NYSE minimum share price standard. If the Company is not compliant by that date, its common stock will be subject to suspension and delisting by the NYSE. However, on February 26, 2009, the NYSE
granted NYSE-listed companies a reprieve from the NYSEs $1 minimum price requirement until June 30, 2009. In addition, the NYSE extended until June 30, 2009 the temporary lowering of its market-capitalization standard to $15
million for listed companies, which generally requires that average market capitalization of a NYSE-listed company be at least $25 million over any 30 consecutive trading day period. We therefore have until August 13, 2009 to become
compliant with the NYSE minimum share price standard. If we fail to meet any of the NYSEs other listing standards, however, we may be delisted for failing to comply with the continued listing standards.

During the year ended December 31, 2008, we repurchased and retired $111.4 million par value of our outstanding convertible debt securities for $50.6
million. We realized a gain of $56.4 million on these transactions, net of a $2.7 million write-off of related deferred costs and a $1.6 million discount. As of the date of this filing, $28.7 million principal amount of our contingent convertible
debt securities remain outstanding. The holders of our remaining $28.7 million aggregate principal amount of convertible debt will have the right to require us to repurchase their notes at 100% of their principal amount together with accrued but
unpaid interest thereon if, among other things, our common stock ceases to be listed on the NYSE, another established national securities exchange or an automated over-the-counter trading market in the United States. If we are unable to remedy the
deficiency described above and remain listed on the NYSE and if we are unable to list our common stock on another established national securities exchange or automated U.S. over-the-counter trading market, there is a risk that some or all holders of
our convertible notes will exercise their right to require us to repurchase their notes. There can be no assurance that we would be able to satisfy such repurchase requests.

As of March 31, 2009, the Companys consolidated financial statements include $87.7 million of cash and cash equivalents and total indebtedness
of $3.3 billion. Total indebtedness includes recourse indebtedness of $77.7 million and $3.2 billion of non-recourse debt relating to consolidated VIEs. The creditors of each consolidated VIE have no recourse to the general assets or credit of the
Company. The Companys maximum exposure to loss as a result of its involvement with each consolidated VIE is the equity that the Company has invested in warehouse first-loss deposits and the preference shares or debt of the CDO, CLO or other
types of securitization structures.

Our primary cash needs include the ability to:



| |  |  | make required distributions of earnings to maintain our qualification as a REIT, which is based upon the existence of current taxable income;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | pay costs of borrowings, including interest on such borrowings and expected CDO, CLO and other securitization debt;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | pay base and incentive fees to our manager and pay other operating expenses;
| | - |  | ----------------------------------------------------------------------------



| |  |  | fund investments and discretionary repurchases of our debt and equity securities;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | make payments as our debt comes due;
| | - |  | ------------------------------------



| |  |  | make margin deposits on derivative instruments; and
| | - |  | ---------------------------------------------------



| |  |  | pay federal, state and local taxes of our domestic TRSs.
| | - |  | --------------------------------------------------------

We intend to meet these short-term requirements through the following:



| |  |  | revenue from operations, including interest income from our investment portfolio;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | interest income from temporary investments and cash equivalents; and
| | - |  | --------------------------------------------------------------------



| |  |  | proceeds from future borrowings or offerings of our common stock.
| | - |  | -----------------------------------------------------------------

From our inception through the beginning of the credit crisis in August 2007, we sought to finance our assets on a long-term basis through CDOs and CLOs. The disruption in the credit markets has substantially
forestalled our ability to execute new CDOs and CLOs. If the securitization markets re-open in the future, the costs of securitizing assets may be higher than what we experienced in the past. Increased securitization costs may cause us to realize
lower returns on our equity for investments in future CDOs as



43



---

##### Table of Contents

compared with the returns that we have realized to date on completed CDOs that have lower financing costs. If securitization costs become unacceptably high,
or if securitization financing remains unavailable, we may not be willing or able to complete a securitization for assets that have been purchased using short-term warehouse lines. In that event, we may potentially lose the first loss cash that we
had deposited with the warehouse lender. If we are unable to deploy our capital in high-yielding CDO investments quickly or at all, we would need to find alternative investments which may be lower yielding.

Overcollateralization and Other Credit Enhancement Tests

The terms of the CDO and CLO and other securitization vehicles that we use to finance our investments generally provide that the principal amount of assets must exceed the principal balance of the related securities
to be issued by the securitization vehicle by a certain amount, commonly referred to as over-collateralization. The terms of the securitization generally provide that, if certain delinquencies and/or losses exceed the specified levels
based on the analysis by the rating agencies (or any financial guaranty insurer) of the characteristics of the assets collateralizing the securitization vehicle securities, the required level of over-collateralization may be increased or may be
prevented from decreasing as would otherwise be permitted if losses or delinquencies did not exceed those levels. Other tests, based on delinquency levels or other criteria including downgrades by the rating agencies of the underlying portfolio
securities of the securitization vehicle, may restrict our ability to receive cash distributions from assets collateralizing the securitization vehicle securities. The performance tests may not be satisfied. In addition, collateral management
agreements typically provide that if certain over-collateralization ratio tests are failed and an event of default occurs, the collateral management agreement may be terminated by a vote of the security holders and the security holders have the
option to liquidate the underlying collateral securities. If the assets held by a securitization vehicle fail to perform as anticipated, our liquidity may be adversely affected.

The following summarizes certain key over-collateralization test matters for each of our respective target asset classes:



| |  |  | MBSAs previously disclosed, the Kleros Real Estate CDOs have all failed over-collateralization tests as a result of significant ratings agency
downgrade activity and are no longer making cash distributions to the Company. The net cash flows of the Kleros Real Estate CDOs are currently being used to pay down the controlling class debtholders in each of the Kleros Real Estate CDOs. Despite
the fact that each Kleros Real Estate CDO has failed over-collateralization tests, the net interest earnings of the three remaining CDOs will continue to be reflected in the Companys net investment income and taxable income. We have received
written notice from the trustees of Kleros Real Estate I, II and IV that each CDO experienced an event of default. These events of default resulted from the failure of certain additional over-collateralization tests primarily due to credit rating
agency downgrades. The events of default provide the controlling class debtholder in each CDO with the option to liquidate all of the MBS assets collateralizing the particular CDO. The proceeds of any such liquidation will be used to repay the
controlling class debtholder. As of the current date, the controlling class debtholders of Kleros Real Estate I, II and IV have not exercised their rights to liquidate any of the CDOs.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Securitized Residential MortgagesThe majority of our investments in residential mortgage loans are included within a securitization trust in
which we own all of the subordinated notes including an interest-only subordinated note. When principal and interest are collected from the underlying residential mortgage loans, such cash flow is distributed sequentially to the
senior notes, then to the interest-only subordinated note, and finally to the remainder of the subordinated notes. Losses are allocated to the notes in reverse sequential order such that losses are borne
by subordinated notes ahead of the senior notes. Significant losses have been realized on the subordinated notes to date and are expected to continue. The two most subordinated classes of notes owned by the Company have already been
reduced to zero as a result of such allocation of losses. These losses are attributable to an increase in the delinquency rate of the underlying pool of mortgage loans since the closing date of the securitization, which has
also caused a reduction in the amount of principal and interest that is collected from the mortgage loans. To the extent such collections continue to decrease, there may not be sufficient cash flow to pay any principal and interest to the
subordinated notes until the senior noteholders have been paid in full.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | TruPSOur investments in TruPS are also financed with CDOs that are subject to over-collateralization requirements. The over-collateralization
requirements in the TruPS CDOs are typically triggered in the event that more than three percent of the par value of collateral securities that collateralize the CDO debt defer on a principal or interest payment or are otherwise determined to be
defaulted in accordance with the indenture for the particular CDO. As of March 31, 2009, we have experienced 45 bank deferrals or defaults and one insurance company default in our TruPS portfolio. As of March 31, 2009, the aggregate
principal amount of investments in the 46 TruPS that have defaulted or are currently deferring interest payments is $726.5 million, representing approximately 14.1% of the Companys consolidated trust preferred securities portfolio. The TruPS
deferrals and defaults described above have resulted in the over-collateralization tests being triggered in all eight CDOs in which the Company holds equity interests. The trigger of an over-collateralization test in a TruPS CDO means that the
Company, as a holder of equity securities, will no longer receive current distributions of cash in respect of its equity interests until sufficient cash or collateral is retained in the CDOs to cure the over-collateralization tests. The Company does
not expect to receive cash distributions from its TruPS CDOs for the foreseeable future. There can be no assurance that we will not experience additional deferrals or defaults that will
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



44



---

##### Table of Contents

| | result in further over-collateralization test failures or be able to extend the cure periods of the deals currently failing over-collateralization tests.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Leveraged LoansThe over-collateralization requirements in the leveraged loan CLOs are typically triggered in the event that we experience
significant losses on the sale of assets below par, as well as unrealized fair value adjustments on certain assets as mandated by the indentures which govern our leveraged loan CLOs. The primary cause for such fair value adjustments are default
activity, and credit downgrades in the underlying asset pool. In the event that an over-collateralization failure occurs in a leveraged loan CLO, changes to the priority of payments will result in the equity holders, including us, of the CLO not
receiving any cash flows until such time as the over-collateralization failure is cured. Management continues to closely monitor and actively manage the leveraged loan portfolio as a result of the continued deterioration in macro-credit conditions
and the potential for significant stress on the middle-market companies in our portfolio. As of the date of this filing, we have not experienced an over-collateralization failure in any of our leveraged loan CLOs. However, as a result of a partial
failure of an interest diversion test during April 2009, we did experience a reduction in our quarterly cash distribution from an Emporia CLO. The partial failure was primarily attributable to the recent increase in defaulted assets collateralizing
the CLO. The interest diversion test was cured in April 2009; however, the current state of the credit markets and the economy in general increases the likelihood of defaults and ratings agency downgrades on the underlying collateral of our CLOs.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Warehouse Financing Arrangements

As of March 31, 2009, we were party to the following agreement which is collateralized by the assets shown below (dollars in thousands):



|                                                        |  |                  |  |                       |              
|------------------------------------------------------- |  | ---------------- |  | --------------------- | -------------
|Financing Facilities (and Aggregate Borrowing Capacity) |  | Termination Date |  | Assets Being Financed
|Leveraged loan related warehouse facility               |  | May 2009         |  | $                     | 157.1 million

As of March 31, 2009, the Companys consolidated financial statements included $123.1
million of warehouse credit facility debt in the form of short term notes payable. Warehouse credit facility debt relates to an on-balance sheet warehouse facility entered into by a subsidiary of the Company with the intention of financing the
acquisition of leveraged loans on a short-term basis until longer-term financing is available. Despite the fact that the Company has recorded cumulative reductions in fair value of $60.5 million on the leveraged loans included in the warehouse
facility, the Companys maximum economic exposure to loss on the warehouse credit facility is limited to the amount of capital that the Company has invested pursuant to the terms of the arrangement. As of March 31, 2009, the Company has
invested $38.5 million of capital in this financing arrangement, which is scheduled to mature in May 2009. As previously disclosed, the warehouse is currently in default and therefore, there is no borrowing capacity, the facility is bearing a
penalty interest rate equal to the daily commercial paper rate plus 300 basis points, and all principal and interest collections are used to amortize the warehouse credit facility debt. If the securitization markets remain effectively closed for the
foreseeable future, the Company will likely lose the first loss cash that is deposited with the warehouse lender in the amount of $38.5 million, which is the maximum amount of loss that the Company is exposed to from the warehouse facility.

Inflation

We believe that the
principal risk to us from inflation is the effect that market interest rates may have on our floating rate debt instruments as a result of future increases caused by inflation. We expect to mitigate against this risk through our financing strategy
to match the terms of our investment assets with the terms of our liabilities and, to the extent necessary, through the use of hedging instruments.

Fair Values

For certain of the financial instruments that we own, fair values will not be readily available since there are
no active trading markets for these instruments as characterized by currency exchanges between willing parties. Accordingly, fair values can only be derived or estimated for these investments using various valuation techniques, such as computing the
present value of estimated future cash flows using discount rates commensurate with the risks involved. However, the determination of estimated future cash flows is inherently subjective and imprecise. Minor changes in assumptions or estimation
methodologies can have a material effect on these derived or estimated fair values. These estimates and assumptions are indicative of the interest rate environments as of March 31, 2009 and do not take into consideration the effects of
subsequent interest rate fluctuations.

We note that the values of our investments in MBS, residential mortgages, TruPS, and derivative
instruments will be sensitive to changes in market interest rates, interest rate spreads, credit spreads and other market factors. The value of these investments can vary materially from period to period.



45



---

##### Table of Contents

Securities Repurchases

In August 2007, our board of directors authorized us to repurchase up to $50 million of our common stock from time to time in open market purchases or privately negotiated transactions. We may also repurchase
convertible debt securities from time to time in open market or privately negotiated transactions. We did not repurchase any shares of our common stock or any of our convertible debt securities during the three months ended March 31, 2009. As
of the date of this filing, $28.7 million principal amount of the Companys contingent convertible debt securities remains outstanding. There can be no assurance as to the timing or amount of any future securities repurchases we may complete.

Off-Balance Sheet Arrangements and Commitments

We may maintain arrangements with various investment banks regarding CDO securitizations and off-balance sheet warehouse facilities. Prior to the completion of a CDO securitization, historically our off-balance sheet warehouse providers
have acquired investments in accordance with the terms of the warehouse facility agreements. Pursuant to the terms of the warehouse agreements, we receive all or a portion of the difference between the interest earned on the investments acquired
under the warehouse facilities and the interest accrued on the warehouse facilities from the date of the respective acquisitions. Under the warehouse agreements, we are required to deposit cash collateral with the warehouse providers, and as a
result, we bear the first dollar risk of loss up to our warehouse deposit if an investment held under the warehouse facility is liquidated at a loss. Upon the completion of a CDO securitization, the cash collateral held by the warehouse provider is
returned to us. In the event that we are unable to obtain long-term CDO financing for the accumulated warehouse collateral, our cash collateral is at risk and may not be returned to the Company. The duration of a warehouse facility is generally at
least nine months. These arrangements are deemed to be derivative financial instruments and are recorded by us at fair value in each accounting period with the change in fair value recorded in earnings. We were not party to any off-balance sheet
arrangements as of March 31, 2009.



|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
|------- | -----------------------------------------------------------

Our exposure to market risk pertains to losses resulting from changes in interest rates and equity security prices. We are exposed to credit risk and interest rate risk related to our investments in assets in our target asset classes.

Market Risk

The credit markets
in the United States began suffering significant disruption in the summer of 2007. This disruption began in the subprime residential mortgage sector and extended to the broader credit and financial markets generally. During the third quarter of
2008, it became clear that the global economy had been adversely impacted by the credit crisis. Available liquidity, particularly through asset-backed securities (ABS) CDOs and other securitizations, declined precipitously during the second half of
2007, continued to decline in 2008 and remains depressed as of the date of this filing. Concerns about the capital adequacy of financial services companies, disruptions in global credit markets, volatility in commodities prices and continued pricing
declines in the U.S. housing market have led to further disruptions in the financial markets, adversely affected regional banks and have exacerbated the longevity and severity of the credit crisis. The disruption in these markets directly impacts
our business because our investment portfolio includes investments in MBS, residential mortgages, leveraged loans and bank and insurance company debt. We typically finance our investments with on and off-balance sheet warehouse facilities and
on-balance sheet CDOs and CLOs. We continue to have exposure to these markets and products and as market conditions continue to worsen the fair value of our investments could further deteriorate. In addition, market volatility, illiquid market
conditions and disruptions in the credit markets have made it extremely difficult to value certain of our securities. Subsequent valuations, in light of factors then prevailing, may result in significant changes in the values of these securities in
future periods. Any of these factors could require us to take further writedowns in the fair value of our investments portfolio, which may have an adverse effect on our results of operations in future periods.

The disruption in the credit markets has severely restricted our ability to complete new CDOs and CLOs. In addition, banks are capital constrained and
this severely limits their ability to provide new financing commitments. We expect this situation to continue for the foreseeable future until markets stabilize, credit concerns dissipate and capital becomes less constrained. We are fortunate that
the substantial portion of our portfolio is financed with in-place, long-term financing. However, as of March 31, 2009, we had $38.5 million of cash deposited with a warehouse lender to collateralize a warehouse facility for leveraged loan
assets. If the securitization markets remain effectively closed for the foreseeable future, we will likely lose the first loss cash that we had deposited with the warehouse lender in the amount of $38.5 million.

Interest Rate Risk

Interest rates may be affected by economic, geopolitical, monetary and fiscal policy, market supply and demand and other factors generally outside our control, and such factors may be highly volatile. Our interest rate risk sensitive assets
and liabilities and financial derivatives typically will be held for long-term investment and not held for sale purposes. Our intent in structuring CDO and CLO transactions and other securitizations will be to limit interest rate risk with a
financing strategy that matches the terms of our investment assets with the terms of our liabilities and, to the extent necessary, through the use of hedging instruments.



46



---

##### Table of Contents

We generally make investments that are either floating rate or fixed rate. Our floating rate investments
will generally be priced at a fixed spread over an index such as LIBOR that reprices either quarterly or every 30 days based upon movements in effect at each measurement date. Given the frequency of future price changes in our floating rate
investments, changes in interest rates are not expected to have a long term material effect on the value of these investments. Our net investment income will be subject to an increase or decrease in the event that there is a fluctuation in interest
rates between the period which the assets and liabilities reprice (typically a five to ten day period). Increases or decreases in LIBOR will have a corresponding increase or decrease in our interest income and interest expense, thereby generally
mitigating the net earnings impact on our overall portfolio. In the event that long-term interest rates increase, the value of our fixed-rate investments would be diminished. We have hedged this risk where the benefit outweighs the cost of the
hedging strategy. Such changes in interest rates would not have a material effect on the income of these investments, which generally will be held to maturity.

Through March 31, 2009, we entered into various interest rate swap agreements to hedge variable cash flows associated with CDO notes payable. These cash flow hedges have an aggregate notional value of $2.2
billion and are used to swap the variable cash flows associated with variable rate CDO notes payable into fixed-rate payments. As of March 31, 2009, the interest rate swaps had an aggregate liability fair value of $250 million. Changes in the
fair value of interest rate swaps are recorded in earnings.

There have been no material changes in quantitative and qualitative
disclosures in 2009 from the disclosures included in our Annual Report on Form 10-K for the year ended December 31, 2008. See discussion of quantitative and qualitative disclosures about market risk under Item 7A-Quantitative and
Qualitative Disclosures About Market Risk included in our Annual Report on Form 10-K for the year ended December 31, 2008.



|ITEM 4. | CONTROLS AND PROCEDURES.
|------- | ------------------------

Evaluation of Disclosure Controls and
Procedures

We have established disclosure controls and procedures to ensure that material information relating to the Company,
including our consolidated subsidiaries, is made known to the officers who certify our financial reports and to other members of senior management and the board of directors. Under the supervision, and with the participation of our Chief Executive
Officer and Chief Financial Officer, we have 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 and Exchange Act of 1934 (Exchange
Act) as of March 31, 2009. Based on that evaluation, the principal executive officer and the principal financial officer concluded that our disclosure controls and procedures were effective at March 31, 2009, to ensure that
information required to be disclosed by us in the reports we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended March 31, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------

On June 8, 2006, our loan
to Beech Thicket Spring, Inc., Communities of Penland, LLC, COP Preservation Partners, LLC, F.W., Inc., The Penland Reserve Tract, LLC, and Triad Apartment Group, LLC in the original principal amount of $16.7 million (the Penland Loan)
matured. The outstanding balance at maturity was $11.7 million. The Penland Loan was guaranteed by five individuals, Anthony R. Porter, Dorothy M. Porter, Frank A. Amelung, Eugenia Amelung and Richard L. Amelung (collectively
Guarantors). On March 29, 2007, we obtained a judgment against the Guarantors for $13.1 million in the case styled Alesco Financial Inc. v. Anthony R. Porter, Dorothy M. Porter, Frank Amelung, Eugenia Amelung and Richard
Amelung, in the United States District Court in the Middle District of Florida, Case No.: 3:07-cv-00032-HWM-HTS. Frank A. Amelung, Eugenia Amelung and Richard L. Amelung sought protection in the United States Bankruptcy Court in the Southern
District of Florida, West Palm Beach Division, In Re: Frank A. Amelung, Jr. and Eugenia Marie Amelung, Chapter 7 Debtors, Case No.: 07-15492-BKC-PGH, and In Re: Richard L. Amelung, Debtor Chapter 7, Case No.: 07-15493-BKC-PGH,
respectively. Alesco has made a claim in both cases for the amount of the Judgment, reduced as the Penland Loan otherwise is collected. At least two parties, including the Trustee in each case, have filed pleadings objecting to the discharge of
Frank A. Amelung and Richard L. Amelung. The ability to collect a material amount of the Judgment in the bankruptcy proceedings is slight, and we do not believe the other Guarantors have significant assets for levy. We are considering all options to
pursue collection of the Judgment in the various jurisdictions, subject to limitations imposed by law. We also retain our primary collateral consisting of real property in the Mountains of North Carolina.

The Attorney General of North Carolina on June 6, 2007, filed suit against one or more of the Borrowers and Guarantors of the Penland Loan described
above, among others, in the case styled State of North Carolina ex rel, Roy Cooper, Attorney General vs.



47



---

##### Table of Contents

Peerless Real Estate Services, Inc., Village of Penland, L.L.C., MFSL Landholdings, L.L.C., Communities of Penland, L.L.C., COP Land Holdings, L.L.C., PG
Capital Holdings, L.L.C., Anthony Porter, Frank Amelung, Richard Amelung, J. Kevin Foster, Neil ORourke, Michael Yeomans, and A. Greg Anderson, General Court of Justice, Superior Court Division, State of North Carolina, Wake County, Case
No.: 07-CVS-9006. The North Carolina Attorney General alleged that the defendants in the case obtained monies from consumers in violation of North Carolina law relating to unfair or deceptive practices affecting commerce. The court in this case has
issued an order appointing a receiver for the assets of the corporate defendants in the case, Peerless Real Estate Services, Inc., Village of Penland, L.L.C., MFSL Landholdings, L.L.C., Communities of Penland, L.L.C., COP Land Holdings, L.L.C., and
PG Capital Holdings, L.L.C., and has since added the rest of our Borrowers not originally named as defendants for receivership. We are not a named party in this action, but the receivership includes substantially all of the North Carolina real
property collateral held by us to secure the Penland Loan. The complaint filed by the North Carolina Attorney General seeks to void all contracts between the named defendants and consumers in the alleged deceptive scheme identified in the complaint,
the return of all monies obtained by the named defendants in the alleged deceptive scheme, civil penalties against the named defendants and attorney fees from the named defendants. The Order Appointing Receiver authorizes the Receiver, among other
things, to sell and dispose of property of the Borrowers in the receivership free and clear of all liens and other collateral interests, which liens or other collateral interests will then attach to the proceeds. We have not received notice of any
such sale or disposition of our collateral, and we plan to protect vigorously any and all liens and other collateral interests in the collateral for the Penland Loan. In the pleadings in this case, we have learned that two of the Guarantors and
other officers of our Borrowers have pled guilty to one or more felony counts relating to fraud involving the sale of real property in and around our remaining collateral in North Carolina and that the Receiver also has been appointed Special Master
in the restitution proceedings in the criminal cases. We intend to continue to foreclose some or all our collateral, which may require this courts approval, and pursue collection by all other available means.



|Item 1A. | Risk Factors
|-------- | ------------

The risks described under
Item 1A  Risk Factors included in our Annual Report on Form 10-K for the year ended December 31, 2008, could materially and adversely affect our business, financial condition and results of operations. The risk factors
discussed in that Form 10-K and in this Quarterly Report on Form 10-Q do not identify all risks that we face because our business operations could also be affected by additional factors that are not presently known to us or that we currently
consider to be immaterial to our operations.



|Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds
|------- | -----------------------------------------------------------

None.



|Item 3. | Defaults Upon Senior Securities
|------- | -------------------------------

None.



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

None.



|Item 5. | Other Information
|------- | -----------------

None.



|Item 6. | Exhibits
|------- | --------

(a) Exhibits  see Exhibit
Index.



48



---

##### Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                   |  |                       |  |                          
|------------------ |  | --------------------- |  | -------------------------
|                   |  | ALESCO FINANCIAL INC.
|                   |  |                      
|                   |  | By:                   |  | /s/ James J. McEntee, III
|                   |  |                       |  | James J. McEntee, III    
|Date: May 11, 2009 |  |                       |  | Chief Executive Officer  
|                   | 
|                   |  | ALESCO FINANCIAL INC.
|                   |  |                      
|                   |  | By:                   |  | /s/ John J. Longino      
|                   |  |                       |  | John J. Longino          
|Date: May 11, 2009 |  |                       |  | Chief Financial Officer  



49



---

##### Table of Contents

EXHIBIT INDEX



|            |  |                                                                                                                                                                                                                                                                                                                            
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                
|2.1         |  | Agreement and Plan of Merger, dated as of February 20, 2009, by and among Alesco Financial Inc., Fortune Merger Sub, LLC and Cohen Brothers, LLC (incorporated by reference to Exhibit 2.1 to
our Current Report on Form 8-K filed with the SEC on February 23, 2009).                                                     
|            | 
|3.1         |  | Second Articles of Amendment and Restatement (incorporated by reference to Exhibit 3.1 to Amendment No. 1 to our Registration Statement on Form S-11 (Registration No. 333-111018) filed with the
SEC on February 6, 2004).                                                                                                
|            | 
|3.2         |  | Articles of Amendment changing our name to Alesco Financial Inc. (incorporated by reference to Exhibit 3.1 to our Registration Statement on Form S-3 (Registration No. 333-138136) filed with the
SEC on October 20, 2006).                                                                                                
|            | 
|3.3         |  | By-laws, as amended (incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K filed with the SEC on October 11, 2005).                                                                                                                                                                                   
|            | 
|4.1         |  | Form of Specimen Stock Certificate (incorporated by reference to Exhibit 4.1 to our Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007).                                                                                                                                                                   
|            | 
|4.2         |  | Form of 7.625% Contingent Convertible Senior Notes due 2027 (incorporated by reference to Exhibit 4.2 to our Current Report on Form 8-K filed with the SEC on May 21, 2007).                                                                                                                                               
|            | 
|4.3         |  | Registration Rights Agreement, dated as of May 15, 2007, by and between Alesco Financial Inc. and RBC Capital Markets Corporation (incorporated by reference to Exhibit 4.3 to our Current Report
on Form 8-K filed with the SEC on May 21, 2007).                                                                         
|            | 
|4.4         |  | Indenture, dated as of May 15, 2007, by and between Alesco Financial Inc. and U.S. Bank National Association (incorporated by reference to Exhibit 4.1 to our Current Report on Form 8-K filed
with the SEC on May 21, 2007).                                                                                              
|            | 
|4.5         |  | Junior Subordinated Indenture, dated as of June 25, 2007, by and between Alesco Financial Inc. and Wells Fargo Bank, N.A. (incorporated by reference to Exhibit 4.1 to our Current Report on Form
8-K filed with the SEC on June 29, 2007).                                                                                
|            | 
|4.6         |  | Indenture, dated as of June 29, 2007, by and among Bear Stearns ARM Trust 2007-2, Citibank, N.A. and Wells Fargo Bank, N.A. (incorporated by reference to Exhibit 4.6 to our Quarterly Report on
Form 10-Q filed with the SEC on August 9, 2007).                                                                          
|            | 
|10.1        |  | Management Agreement, dated as of January 31, 2006, by and between Alesco Financial Trust and Cohen Brothers Management, LLC (incorporated by reference to Annex E to our Proxy Statement on
Schedule 14A filed with the SEC on September 8, 2006).                                                                        
|            | 
|10.2        |  | Shared Facilities and Services Agreement, dated as of January 31, 2006, by and between Cohen Brothers Management, LLC and Cohen Brothers, LLC (incorporated by reference to Exhibit 10.3 to
Amendment No. 1 to our Registration Statement on Form S-3 (Registration No. 333-137219) filed with the SEC on October 5, 2006).



50



---

##### Table of Contents

|            |  |                                                                                                                                                                                                                                                                                                                                                                                              
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                                                                                  
|10.3        |  | Letter Agreement, dated January 31, 2006, by and between Alesco Financial Trust and Cohen Brothers, LLC, relating to certain rights of first refusal and non-competition arrangements between the
parties (incorporated by reference to Exhibit 10.4 to Amendment No. 1 to our Registration Statement on Form S-3 (Registration No. 333-137219) filed with the SEC on October 5, 2006).      
|            | 
|10.4        |  | Assignment and Assumption Agreement, dated as of October 6, 2006, by and between Alesco Financial Inc. and Cohen Brothers Management, LLC, transferring the agreement referred to in Exhibit 10.1
hereto to Alesco Financial Inc. (incorporated by reference to Exhibit 10.2 to our Registration Statement on Form S-3 (Registration No. 333-138136) filed with the SEC on October 20, 2006).
|            | 
|10.5        |  | Letter Agreement, dated October 18, 2006, by and between Alesco Financial Inc. and Cohen & Company, LLC, transferring the agreement referred to in Exhibit 10.1 hereto to Alesco Financial
Inc. (incorporated by reference to Exhibit 10.5 to our Registration Statement on Form S-3 (Registration No. 333-138136) filed with the SEC on October 20, 2006).                                  
|            | 
|10.6        |  | Purchase Agreement, dated as of May 9, 2007, by and between Alesco Financial Inc. and RBC Capital Markets Corporation) (incorporated by reference to Exhibit 1.1 to our Current Report on Form 8-K
filed with the SEC on May 10, 2007).                                                                                                                                                      
|            | 
|10.7        |  | Underwriting Agreement, dated June 20, 2007, by and between Alesco Financial Inc. and RBC Capital Markets Corporation (incorporated by reference to Exhibit 1.1 to our Current Report on Form 8-K
filed with the SEC on June 22, 2007).                                                                                                                                                      
|            | 
|10.8        |  | Amended and Restated Trust Agreement, dated as of June 25, 2007, by and among Alesco Financial Inc., Wells Fargo Bank, N.A., Wells Fargo Delaware Trust Company and the administrative trustees
named therein (incorporated by reference to Exhibit 4.2 to our Current Report on Form 8-K filed with the SEC on June 29, 2007).                                                              



51



---

##### Table of Contents

|            |  |                                                                                                                                                                                                                                                                                                                                                                                              
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                                                                                  
|10.9        |  | Amended and Restated Trust Agreement, dated as of June 29, 2007, by and among Structured Asset Mortgage Investments II Inc., Wilmington Trust Company, Wells Fargo Bank, N.A. and acknowledged by
Alesco Financial Inc. (incorporated by reference to Exhibit 10.13 to our Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007).                                              
|            | 
|10.10       |  | Mortgage Loan Purchase Agreement, dated as of June 29, 2007, by and between Alesco Financial Inc. and Structured Asset Mortgage Investments II Inc. (incorporated by reference to Exhibit 10.14 to
our Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007).                                                                                                                  
|            | 
|10.11       |  | Sale and Servicing Agreement, dated as of June 29, 2007, by and among Structured Asset Mortgage Investments II Inc., Bear Stearns ARM Trust 2007-2, Alesco Financial Inc., Citibank, N.A. and
Wells Fargo Bank, N.A., as securities administrator and master servicer (incorporated by reference to Exhibit 10.15 to our Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007).
|            | 
|10.12       |  | Guarantee Agreement, dated as of June 29, 2007, by and between Alesco Financial Inc. and Alesco Loan Holdings Trust (incorporated by reference to Exhibit 10.16 to our Quarterly Report on Form
10-Q filed with the SEC on August 9, 2007).                                                                                                                                                  
|            | 
|10.13       |  | 2006 Long-Term Incentive Plan, as amended (incorporated by reference to Annex A to our Proxy Statement on Schedule 14A filed with the SEC on April 30, 2007).                                                                                                                                                                                                                                
|            | 
|10.14       |  | Form of Restricted Share Award Agreement (incorporated by reference to Exhibit 10.7 to our Annual Report on Form 10-K filed with the SEC on March 16, 2007).                                                                                                                                                                                                                                 
|            | 
|10.15       |  | Form of Indemnification Agreement by and between Alesco Financial Inc. and each of its directors and officers (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed
with the SEC on October 20, 2006).                                                                                                                                                          
|            | 
|11.1        |  | Statement Regarding Computation of Per Share Earnings.***                                                                                                                                                                                                                                                                                                                                    
|            | 
|31.1        |  | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, as amended.*                                                                                                                                                                                                                                                                         
|            | 
|31.2        |  | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, as amended.*                                                                                                                                                                                                                                                                         
|            | 
|32          |  | Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, as amended.**                                                                                                                                                                                                                                            



|* | Filed herewith.
|- | ---------------

|** | Furnished herewith.
|-- | -------------------

|*** | Data required by Statement of Financial Accounting Standard No. 128, Earnings per Share, is provided in Note 8 to the consolidated financial statements included in this
report.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

All other schedules have been omitted because the required information of such other schedules is not present, or is
not present in amount sufficient to require submission of the schedule.



52