##### 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: September 30, 2009

OR



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

For the transition period from  to

Commission File Number: 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 November 9, 2009 there were 60,151,949 shares of common stock ($0.001 par value per share) of Alesco Financial Inc. outstanding.









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##### 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 |  | 28
|                              |  |                                                                                      
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 54
|                              |  |                                                                                      
|Item 4.                       |  | Controls and Procedures                                                               |  | 55
|                              | 
|Part II. Other Information    |  | 56                                                                                   
|                              |  |                                                                                      
|Item 1.                       |  | Legal Proceedings                                                                     |  | 56
|                              |  |                                                                                      
|Item 1A.                      |  | Risk Factors                                                                          |  | 57
|                              |  |                                                                                      
|Item 2.                       |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 57
|                              |  |                                                                                      
|Item 3.                       |  | Defaults Upon Senior Securities                                                       |  | 57
|                              |  |                                                                                      
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                   |  | 57
|                              |  |                                                                                      
|Item 5.                       |  | Other Information                                                                     |  | 57
|                              |  |                                                                                      
|Item 6.                       |  | Exhibits                                                                              |  | 57



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##### 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 ofSeptember 30, 2009 |           |   | As ofDecember 31, 2008(As Adjusted) |  
|Assets                                                                                                                                                                                                  |  |                         |           |   |                                     |   |           |  
|Investments in debt securities and security-related receivables, at fair value                                                                                                                          |  | $                       | 2,354,772 |   |                                     | $ | 2,079,750 |  
|Investments in loans                                                                                                                                                                                    |  |                         |           |   |                                     |   |           |  
|Residential mortgages                                                                                                                                                                                   |  |                         | 803,618   |   |                                     |   | 901,491   |  
|Commercial mortgages                                                                                                                                                                                    |  |                         | 7,464     |   |                                     |   | 7,464     |  
|Leveraged loans (including amounts held for sale at fair value of $0 and $63,601, respectively)                                                                                                         |  |                         | 707,873   |   |                                     |   | 780,269   |  
|Loan loss reserve                                                                                                                                                                                       |  |                         | (179,243  | ) |                                     |   | (68,428   | )
|                                                                                                                                                                                                        |  |                         |           |   |                                     |   |           |  
|Total investments in loans, net                                                                                                                                                                         |  |                         | 1,339,712 |   |                                     |   | 1,620,796 |  
|Cash and cash equivalents                                                                                                                                                                               |  |                         | 90,122    |   |                                     |   | 86,035    |  
|Restricted cash and warehouse deposits                                                                                                                                                                  |  |                         | 59,165    |   |                                     |   | 54,059    |  
|Accrued interest receivable                                                                                                                                                                             |  |                         | 15,007    |   |                                     |   | 31,435    |  
|Deferred tax asset                                                                                                                                                                                      |  |                         |          |   |                                     |   | 25,036    |  
|Other assets                                                                                                                                                                                            |  |                         | 30,585    |   |                                     |   | 37,820    |  
|                                                                                                                                                                                                        |  |                         |           |   |                                     |   |           |  
|Total assets                                                                                                                                                                                            |  | $                       | 3,889,363 |   |                                     | $ | 3,934,931 |  
|                                                                                                                                                                                                        |  |                         |           |   |                                     |   |           |  
|Liabilities and equity                                                                                                                                                                                  |  |                         |           |   |                                     |   |           |  
|Indebtedness                                                                                                                                                                                            |  |                         |           |   |                                     |   |           |  
|Trust preferred obligations, at fair value                                                                                                                                                              |  | $                       | 137,066   |   |                                     | $ | 120,409   |  
|Securitized mortgage debt                                                                                                                                                                               |  |                         | 765,521   |   |                                     |   | 844,764   |  
|CDO notes payable (including amounts at fair value of $1,627,122 and $1,647,590, respectively)                                                                                                          |  |                         | 2,332,452 |   |                                     |   | 2,342,920 |  
|Warehouse credit facilities                                                                                                                                                                             |  |                         |          |   |                                     |   | 126,623   |  
|Recourse indebtedness                                                                                                                                                                                   |  |                         | 77,726    |   |                                     |   | 77,656    |  
|                                                                                                                                                                                                        |  |                         |           |   |                                     |   |           |  
|Total indebtedness                                                                                                                                                                                      |  |                         | 3,312,765 |   |                                     |   | 3,512,372 |  
|Accrued interest payable                                                                                                                                                                                |  |                         | 16,735    |   |                                     |   | 30,530    |  
|Related party payable                                                                                                                                                                                   |  |                         | 7,625     |   |                                     |   | 4,880     |  
|Derivative liabilities                                                                                                                                                                                  |  |                         | 202,691   |   |                                     |   | 266,984   |  
|Other liabilities                                                                                                                                                                                       |  |                         | 12,532    |   |                                     |   | 12,165    |  
|                                                                                                                                                                                                        |  |                         |           |   |                                     |   |           |  
|Total liabilities                                                                                                                                                                                       |  |                         | 3,552,348 |   |                                     |   | 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, 60,151,949 and 60,171,324 issued and outstanding,
including 499,918 and 985,810 unvested restricted share awards, respectively |  |                         | 60        |   |                                     |   | 59        |  
|Additional paid-in-capital                                                                                                                                                                              |  |                         | 485,126   |   |                                     |   | 484,612   |  
|Accumulated other comprehensive loss                                                                                                                                                                    |  |                         | (11,946   | ) |                                     |   | (14,223   | )
|Accumulated deficit                                                                                                                                                                                     |  |                         | (264,791  | ) |                                     |   | (405,496  | )
|                                                                                                                                                                                                        |  |                         |           |   |                                     |   |           |  
|Total parent stockholders equity                                                                                                                                                                       |  |                         | 208,449   |   |                                     |   | 64,952    |  
|Noncontrolling interests in subsidiaries                                                                                                                                                                |  |                         | 128,566   |   |                                     |   | 43,048    |  
|                                                                                                                                                                                                        |  |                         |           |   |                                     |   |           |  
|Total equity                                                                                                                                                                                            |  |                         | 337,015   |   |                                     |   | 108,000   |  
|                                                                                                                                                                                                        |  |                         |           |   |                                     |   |           |  
|Total liabilities and equity                                                                                                                                                                            |  | $                       | 3,889,363 |   |                                     | $ | 3,934,931 |  
|                                                                                                                                                                                                        |  |                         |           |   |                                     |   |           |  

See accompanying notes.



1



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##### Table of Contents

Alesco Financial Inc.

Consolidated Statements of Income (Loss)

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



|                                                                                                   |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|-------------------------------------------------------------------------------------------------- |  | ------------------------------------------------ | ---------- | - | ------------------------------------------------------------- | - | ---------- | ----------------------------------------------- |  | - | ------------------------------------------------------------ | - |  | - | ---------- | -
|                                                                                                   |  | For theThree-MonthPeriod EndedSeptember 30, 2009 |            |   | For theThree-MonthPeriod EndedSeptember 30, 2008(As
Adjusted) |   |            | For theNine-MonthPeriod EndedSeptember 30, 2009 |  |   | For theNine-MonthPeriod EndedSeptember 30, 2008(As
Adjusted) |  
|Net investment income (loss):                                                                      |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Investment interest income                                                                         |  | $                                                | 81,214     |   |                                                               | $ | 125,585    |                                                 |  | $ | 271,480                                                      |   |  | $ | 436,999    |  
|Investment interest expense                                                                        |  |                                                  | (42,853    | ) |                                                               |   | (95,954    | )                                               |  |   | (155,209                                                     | ) |  |   | (337,326   | )
|Provision for loan losses                                                                          |  |                                                  | (34,729    | ) |                                                               |   | (14,764    | )                                               |  |   | (134,883                                                     | ) |  |   | (32,739    | )
|                                                                                                   |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Net investment income (loss)                                                                       |  |                                                  | 3,632      |   |                                                               |   | 14,867     |                                                 |  |   | (18,612                                                      | ) |  |   | 66,934     |  
|                                                                                                   |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Expenses:                                                                                          |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Related party management compensation                                                              |  |                                                  | 3,263      |   |                                                               |   | 6,711      |                                                 |  |   | 10,105                                                       |   |  |   | 15,653     |  
|General and administrative                                                                         |  |                                                  | 3,528      |   |                                                               |   | 3,591      |                                                 |  |   | 12,166                                                       |   |  |   | 10,750     |  
|                                                                                                   |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Total expenses                                                                                     |  |                                                  | 6,791      |   |                                                               |   | 10,302     |                                                 |  |   | 22,271                                                       |   |  |   | 26,403     |  
|Other income and expense:                                                                          |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Interest and other income                                                                          |  |                                                  | 116        |   |                                                               |   | 1,282      |                                                 |  |   | 709                                                          |   |  |   | 3,907      |  
|Net change in fair value of investments in debt securities and loans and non-recourse indebtedness |  |                                                  | (190,531   | ) |                                                               |   | 70,028     |                                                 |  |   | 357,254                                                      |   |  |   | 140,236    |  
|Net change in fair value of derivative contracts                                                   |  |                                                  | (35,667    | ) |                                                               |   | (25,967    | )                                               |  |   | (3,928                                                       | ) |  |   | (71,775    | )
|Credit default swap premiums                                                                       |  |                                                  |           |   |                                                               |   |           |                                                 |  |   |                                                             |   |  |   | (2,872     | )
|Impairments on other investments and intangible assets                                             |  |                                                  | (743       | ) |                                                               |   | (1,533     | )                                               |  |   | (5,491                                                       | ) |  |   | (14,378    | )
|Loss on disposition of consolidated entities                                                       |  |                                                  |           |   |                                                               |   |           |                                                 |  |   |                                                             |   |  |   | (5,558     | )
|Gain on repurchase of debt                                                                         |  |                                                  |           |   |                                                               |   | 42,289     |                                                 |  |   |                                                             |   |  |   | 42,289     |  
|Net realized loss on sale of assets                                                                |  |                                                  | (38,547    | ) |                                                               |   | (272       | )                                               |  |   | (54,674                                                      | ) |  |   | (943       | )
|                                                                                                   |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Earnings (loss) before benefit (provision) for income taxes                                        |  |                                                  | (268,531   | ) |                                                               |   | 90,392     |                                                 |  |   | 252,987                                                      |   |  |   | 131,437    |  
|Benefit (provision) for income taxes                                                               |  |                                                  | (3,676     | ) |                                                               |   | 1,841      |                                                 |  |   | (26,244                                                      | ) |  |   | 5,243      |  
|                                                                                                   |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Net income (loss)                                                                                  |  |                                                  | (272,207   | ) |                                                               |   | 92,233     |                                                 |  |   | 226,743                                                      |   |  |   | 136,680    |  
|Less: Net (income) loss attributable to noncontrolling interests                                   |  |                                                  | 75,079     |   |                                                               |   | (29,802    | )                                               |  |   | (86,038                                                      | ) |  |   | (70,567    | )
|                                                                                                   |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Net income (loss) attributable to common stockholders                                              |  | $                                                | (197,128   | ) |                                                               | $ | 62,431     |                                                 |  | $ | 140,705                                                      |   |  | $ | 66,113     |  
|                                                                                                   |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Earnings (loss) per sharebasic:                                                                   |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Basic earnings (loss) per share                                                                    |  | $                                                | (3.31      | ) |                                                               | $ | 1.02       |                                                 |  | $ | 2.34                                                         |   |  | $ | 1.09       |  
|                                                                                                   |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Weighted-average shares outstandingBasic                                                          |  |                                                  | 59,574,930 |   |                                                               |   | 60,950,796 |                                                 |  |   | 60,169,483                                                   |   |  |   | 60,607,616 |  
|                                                                                                   |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Earnings (loss) per sharediluted:                                                                 |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Diluted earnings (loss) per share                                                                  |  | $                                                | (3.31      | ) |                                                               | $ | 1.02       |                                                 |  | $ | 2.34                                                         |   |  | $ | 1.09       |  
|                                                                                                   |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Weighted-average shares outstandingDiluted                                                        |  |                                                  | 59,574,930 |   |                                                               |   | 60,950,796 |                                                 |  |   | 60,169,483                                                   |   |  |   | 60,607,616 |  
|                                                                                                   |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  
|Distributions declared per common share                                                            |  | $                                                |           |   |                                                               | $ |           |                                                 |  | $ |                                                             |   |  | $ | 0.50       |  
|                                                                                                   |  |                                                  |            |   |                                                               |   |            |                                                 |  |   |                                                              |   |  |   |            |  

See accompanying notes.



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##### Table of Contents

Alesco Financial Inc.

Consolidated Statements of Comprehensive Income (Loss)

(Unaudited and in thousands)



|                                                                     |  |                                                  |          |   |                                                               |   |         |                                                 |  |   |                                                              |   |  |   |         |  
|-------------------------------------------------------------------- |  | ------------------------------------------------ | -------- | - | ------------------------------------------------------------- | - | ------- | ----------------------------------------------- |  | - | ------------------------------------------------------------ | - |  | - | ------- | -
|                                                                     |  | For theThree-MonthPeriod EndedSeptember 30, 2009 |          |   | For theThree-MonthPeriod EndedSeptember 30, 2008(As Adjusted) |   |         | For theNine-MonthPeriod EndedSeptember 30, 2009 |  |   | For theNine-MonthPeriod EndedSeptember 30, 2008(As Adjusted) |  
|Net income (loss)                                                    |  | $                                                | (272,207 | ) |                                                               | $ | 92,233  |                                                 |  | $ | 226,743                                                      |   |  | $ | 136,680 |  
|Other comprehensive income (loss):                                   |  |                                                  |          |   |                                                               |   |         |                                                 |  |   |                                                              |   |  |   |         |  
|Net change in cash-flow hedges                                       |  |                                                  | 1,386    |   |                                                               |   | 1,495   |                                                 |  |   | 4,157                                                        |   |  |   | 46,002  |  
|                                                                     |  |                                                  |          |   |                                                               |   |         |                                                 |  |   |                                                              |   |  |   |         |  
|Comprehensive income (loss)                                          |  |                                                  | (270,821 | ) |                                                               |   | 93,728  |                                                 |  |   | 230,900                                                      |   |  |   | 182,682 |  
|Comprehensive (income) loss attributable to noncontrolling interests |  |                                                  | 74,452   |   |                                                               |   | (30,429 | )                                               |  |   | (87,918                                                      | ) |  |   | (72,489 | )
|                                                                     |  |                                                  |          |   |                                                               |   |         |                                                 |  |   |                                                              |   |  |   |         |  
|Comprehensive income (loss) attributable to common stockholders      |  | $                                                | (196,369 | ) |                                                               | $ | 63,299  |                                                 |  | $ | 142,982                                                      |   |  | $ | 110,193 |  
|                                                                     |  |                                                  |          |   |                                                               |   |         |                                                 |  |   |                                                              |   |  |   |         |  

See accompanying notes.



3



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##### Table of Contents

Alesco Financial Inc.

Consolidated Statements of Equity

(Unaudited and in
thousands, except share information)



|                                          |  |              |  |                           |    |                                   |   |         |                    |   |         |                                 |  |                                         |          |   |              |   |         |  |   |         |   |  |   |         |  
|----------------------------------------- |  | ------------ |  | ------------------------- | -- | --------------------------------- | - | ------- | ------------------ | - | ------- | ------------------------------- |  | --------------------------------------- | -------- | - | ------------ | - | ------- |  | - | ------- | - |  | - | ------- | -
|                                          |  | Common Stock |  | AdditionalPaid-In-Capital |    | AccumulatedOtherComprehensiveLoss |   |         | AccumulatedDeficit |   |         | Total ParentStockholdersEquity |  | NoncontrollingInterests in Subsidiaries |          |   | Total Equity |  
|                                          |  | Shares       |  | Par Value                 |    |                                   |   |         |                    |  
|Balance, December 31, 2008 (As Adjusted)  |  | 59,185,514   |  | $                         | 59 |                                   | $ | 484,612 |                    | $ | (14,223 | )                               |  | $                                       | (405,496 | ) |              | $ | 64,952  |  | $ | 43,048  |   |  | $ | 108,000 |  
|Net income                                |  |             |  |                           |   |                                   |   |        |                    |   |        |                                 |  |                                         | 140,705  |   |              |   | 140,705 |  |   | 86,038  |   |  |   | 226,743 |  
|Other comprehensive income                |  |             |  |                           |   |                                   |   |        |                    |   | 2,277   |                                 |  |                                         |         |   |              |   | 2,277   |  |   | 1,880   |   |  |   | 4,157   |  
|Stock-based compensation expense          |  | 466,517      |  |                           | 1  |                                   |   | 514     |                    |   |        |                                 |  |                                         |         |   |              |   | 515     |  |   |        |   |  |   | 515     |  
|Distributions to noncontrolling interests |  |             |  |                           |   |                                   |   |        |                    |   |        |                                 |  |                                         |         |   |              |   |        |  |   | (2,400  | ) |  |   | (2,400  | )
|                                          |  |              |  |                           |    |                                   |   |         |                    |   |         |                                 |  |                                         |          |   |              |   |         |  |   |         |   |  |   |         |  
|Balance, September 30, 2009               |  | 59,652,031   |  | $                         | 60 |                                   | $ | 485,126 |                    | $ | (11,946 | )                               |  | $                                       | (264,791 | ) |              | $ | 208,449 |  | $ | 128,566 |   |  | $ | 337,015 |  
|                                          |  |              |  |                           |    |                                   |   |         |                    |   |         |                                 |  |                                         |          |   |              |   |         |  |   |         |   |  |   |         |  

See accompanying notes.



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##### Table of Contents

Alesco Financial Inc.

Consolidated Statements of Cash Flows

(Unaudited
and in thousands)



|                                                                                                   |  |                                                 |          |   |                                                              |   |          |  
|-------------------------------------------------------------------------------------------------- |  | ----------------------------------------------- | -------- | - | ------------------------------------------------------------ | - | -------- | -
|                                                                                                   |  | For theNine-MonthPeriod EndedSeptember 30, 2009 |          |   | For theNine-MonthPeriod EndedSeptember 30, 2008(As Adjusted) |  
|Operating activities:                                                                              |  |                                                 |          |   |                                                              |   |          |  
|Net income                                                                                         |  | $                                               | 226,743  |   |                                                              | $ | 136,680  |  
|Adjustments to reconcile net income to cash flow from operating activities:                        |  |                                                 |          |   |                                                              |   |          |  
|Provision for loan losses                                                                          |  |                                                 | 134,883  |   |                                                              |   | 32,739   |  
|Stock-based compensation expense                                                                   |  |                                                 | 515      |   |                                                              |   | 1,140    |  
|Net premium and discount amortization on investments and loans                                     |  |                                                 | (3,581   | ) |                                                              |   | 4,277    |  
|Amortization of deferred financing costs                                                           |  |                                                 | 1,071    |   |                                                              |   | 1,553    |  
|Accretion of discounts on indebtedness                                                             |  |                                                 | 520      |   |                                                              |   | 849      |  
|Net change in fair value of derivative contracts                                                   |  |                                                 | (55,802  | ) |                                                              |   | 45,809   |  
|Net change in fair value of investments in debt securities and loans and non-recourse indebtedness |  |                                                 | (357,254 | ) |                                                              |   | (140,236 | )
|Impairments on other investments and intangible assets                                             |  |                                                 | 5,491    |   |                                                              |   | 14,378   |  
|Net realized loss on sale of assets                                                                |  |                                                 | 54,674   |   |                                                              |   | 943      |  
|Net realized gain on repurchase of indebtedness                                                    |  |                                                 |         |   |                                                              |   | (42,289  | )
|Loss on disposition of consolidated entities                                                       |  |                                                 |         |   |                                                              |   | 5,558    |  
|Proceeds from sale of real estate owned                                                            |  |                                                 | 11,682   |   |                                                              |   |         |  
|Changes in assets and liabilities:                                                                 |  |                                                 |          |   |                                                              |   |          |  
|Accrued interest receivable                                                                        |  |                                                 | 16,467   |   |                                                              |   | 14,003   |  
|Other assets                                                                                       |  |                                                 | 13,123   |   |                                                              |   | 66,865   |  
|Accrued interest payable                                                                           |  |                                                 | (18,380  | ) |                                                              |   | (27,218  | )
|Related party payable                                                                              |  |                                                 | 2,745    |   |                                                              |   | 3,876    |  
|Other liabilities                                                                                  |  |                                                 | 2,137    |   |                                                              |   | (3,356   | )
|                                                                                                   |  |                                                 |          |   |                                                              |   |          |  
|Net cash provided by operating activities                                                          |  |                                                 | 35,034   |   |                                                              |   | 115,571  |  
|Investing activities:                                                                              |  |                                                 |          |   |                                                              |   |          |  
|Purchase of investments in debt securities and security-related receivables                        |  |                                                 |         |   |                                                              |   | (17,176  | )
|Principal repayments from investments in debt securities and security-related receivables          |  |                                                 | 22,024   |   |                                                              |   | 21,554   |  
|Purchase of loans                                                                                  |  |                                                 | (66,997  | ) |                                                              |   | (197,708 | )
|Principal repayments from loans                                                                    |  |                                                 | 141,892  |   |                                                              |   | 197,433  |  
|Proceeds from sale of loans                                                                        |  |                                                 | 130,676  |   |                                                              |   | 69,889   |  
|Proceeds from sale of investments in debt securities and security-related receivables              |  |                                                 |         |   |                                                              |   | 17,518   |  
|(Increase) decrease in restricted cash and warehouse deposits                                      |  |                                                 | (5,106   | ) |                                                              |   | 22,429   |  
|                                                                                                   |  |                                                 |          |   |                                                              |   |          |  
|Net cash provided by investing activities                                                          |  |                                                 | 222,489  |   |                                                              |   | 113,939  |  
|Financing activities:                                                                              |  |                                                 |          |   |                                                              |   |          |  
|Proceeds from issuance of CDO notes payable                                                        |  |                                                 | 10,000   |   |                                                              |   | 57,386   |  
|Repayments of CDO notes payable                                                                    |  |                                                 | (52,952  | ) |                                                              |   | (56,252  | )
|Proceeds from warehouse credit facilities                                                          |  |                                                 |         |   |                                                              |   | 136,633  |  
|Repayments of warehouse credit facilities                                                          |  |                                                 | (126,623 | ) |                                                              |   | (159,411 | )
|Repurchases of recourse indebtedness                                                               |  |                                                 |         |   |                                                              |   | (32,972  | )
|Repayments of securitized mortgage debt                                                            |  |                                                 | (79,692  | ) |                                                              |   | (94,403  | )
|Repayments of other derivative contracts                                                           |  |                                                 | (1,769   | ) |                                                              |   | (3,758   | )
|Distributions to noncontrolling interests in CDOs                                                  |  |                                                 | (2,400   | ) |                                                              |   | (10,937  | )
|Repurchase of common stock                                                                         |  |                                                 |         |   |                                                              |   | (229     | )
|Distributions paid to common stockholders                                                          |  |                                                 |         |   |                                                              |   | (49,524  | )
|                                                                                                   |  |                                                 |          |   |                                                              |   |          |  
|Net cash used in financing activities                                                              |  |                                                 | (253,436 | ) |                                                              |   | (213,467 | )
|                                                                                                   |  |                                                 |          |   |                                                              |   |          |  
|Net change in cash and cash equivalents                                                            |  | $                                               | 4,087    |   |                                                              | $ | 16,043   |  
|Cash and cash equivalents at the beginning of the period                                           |  |                                                 | 86,035   |   |                                                              |   | 80,176   |  
|                                                                                                   |  |                                                 |          |   |                                                              |   |          |  
|Cash and cash equivalents at the end of the period                                                 |  | $                                               | 90,122   |   |                                                              | $ | 96,219   |  
|                                                                                                   |  |                                                 |          |   |                                                              |   |          |  
|Supplemental cash flow information:                                                                |  |                                                 |          |   |                                                              |   |          |  
|Transfer of residential mortgage loans to real estate owned                                        |  | $                                               | 25,663   |   |                                                              | $ | 19,302   |  
|Non-cash purchase of debt securities                                                               |  |                                                 | 4,999    |   |                                                              |   |         |  
|Non-cash sale of debt securities                                                                   |  |                                                 | 4,999    |   |                                                              |   |         |  
|Non-cash decrease in assets upon disposition of consolidated entity                                |  |                                                 |         |   |                                                              |   | 313,950  |  
|Non-cash decrease in liabilities upon disposition of consolidated entity                           |  |                                                 |         |   |                                                              |   | 313,950  |  

See accompanying notes.



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements

As of
September 30, 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 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). During October 2009, the Company began to use a portion of its available cash to acquire more liquid assets, including residential and commercial mortgage-backed securities, loans and asset-backed securities (including RMBS and
loans issued or guaranteed by a U.S. government agency or federally chartered corporation). AFN expects to use leverage under repurchase agreements to finance a portion of these assets.

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



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



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 nominate and elect a number equal to at least
one-third (but less than a majority) of our board of directors. Beginning October 1, 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
(referred to herein as the Series B shares), 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 assuming all Cohen & Company members other than Daniel G. Cohen elect to receive shares of the Companys common stock and there is no change in the Companys capitalization. Any outstanding Series A share and
Series B shares shall be redeemed by us on December 31, 2012 for cash equal to the aggregate par value of the shares. The replacement units of membership interest in Cohen & Company may be redeemed for cash or an equivalent number of
our common stock in the future, at our option 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 redeemed in the future, and if the Company were to elect to issue shares of its common stock upon such redemption and if no other changes in the number of the Companys outstanding shares
of common stock were to occur, 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 fourth quarter 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 over 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 Amendment No. 2 to the Form 10-K/A for the year ended December 31, 2008, filed with the Securities and Exchange Commission (the SEC) on August 17, 2009.
See Item 8-Financial Statements and Supplementary Data included in our Annual Report on Amendment No. 2 to the Form 10-K/A for the year ended December 31, 2008 filed with the SEC on August 17, 2009. 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.

In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)
No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (SFAS No. 168). This standard identifies the sources of accounting principles and the framework for
selecting the principles used in the preparation of financial statements that are presented in conformity with GAAP. SFAS No. 168 establishes the FASB Accounting Standards Codification (Codification) as the single source of
authoritative accounting principles recognized by the FASB in the preparation of financial statements in conformity with GAAP. Codification does not create new accounting and reporting guidance; rather, it reorganizes GAAP pronouncements into
approximately 90 topics within a consistent structure. All guidance contained in the Codification carries an equal level of authority. Relevant portions of authoritative content, issued by the SEC, for SEC registrants, have been included in the
Codification. After the effective date of SFAS No. 168, all nongrandfathered, non-SEC accounting literature not included in the Codification is superseded and deemed nonauthoritative. SFAS No. 168 is effective for financial statements
issued for interim and annual periods ending after September 15, 2009. As such, these financial statements reference the new codification framework.



7



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



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 FASB ASC Topic 810, Consolidation, (formerly Financial Accounting Standard Board Interpretation No. 46(R), Consolidation of Variable
Interest Entities or FIN 46R). Effective January 1, 2009, the Company adopted Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements-an amendment of Accounting
Research Bulletin No. 51 (SFAS No. 160), which has been classified under FASB ASC Topic 810. 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.

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 FASB ASC Topic 810. 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 FASB
ASC Topic 505, Equity, (formerly 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 FASB ASC Topic 820, Fair Value Measurements and
Disclosures, (formerly Statement of Financial Accounting Standards No. 157, Fair Value Measurements), 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. FASB ASC Topic 820 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.

FASB ASC Topic 820 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



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



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.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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, MBS, leveraged loans classified as held for sale, 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.

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 FASB ASC Topic 820, 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



9



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



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 prices of comparable debt securities, or 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 or internal models using discounted cash flows.

CDO Notes Payable: The fair value of CDO notes payable liabilities is estimated using external price data for similar instruments (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 instrument, 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), which has been classified under FASB ASC Topic 825, Financial Instruments. FASB ASC
Topic 825 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. FASB
ASC Topic 825 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 FASB ASC Topic 320, Investments  Debt and Equity Securities, (formerly Statement of Financial
Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, as amended and interpreted or 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 FASB ASC Topic 320, 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 FASB
ASC Topic 820 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 expected life, as adjusted for estimated prepayments and estimated credit losses of the securities using the guidance set forth in FASB ASC Topic 325, Investments  Other, (formerly Emerging
Issues Task Force Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests on Securitized Financial Assets or EITF No. 99-20). 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 maturity. The Company accounts for investments in securities where the transfer meets the criteria as a secured financing under FASB



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



ASC Topic 860, Transfers and Servicing, (formerly Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities or 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.

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 FASB ASC Topic 310, Receivables, (formerly 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 or 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.

Real Estate Owned

The Company accounts for real estate owned, or REO, in accordance with FASB ASC Topic 360, Accounting for the Impairment or Disposal of Long-Lived Assets,formerly Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, or SFAS No. 144, and classifies REO as held for sale within other assets in its consolidated balance sheet. The Company classifies REO as held for
sale primarily because upon acquisition of the property the Company is committed to a plan of immediate resale and immediately begins marketing of such property. REO is recorded at the lower of its carrying amount or fair value less costs to sell.
Fair value is determined based upon internal valuation models that consider current third party market data on trends in home prices, geographic location of the property, and other observable market data that is available. The Company classifies
cash receipts and payments relating to REO within operating activities in its consolidated statement of cash flows.

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 loans classified as held for sale generally do not trade in
an active market and, therefore observable price quotations are generally not available. Fair value is determined based on prices of comparable loans, or internal valuation models that consider 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. 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 FASB ASC Topic 860, Transfers and Servicing, 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.

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.



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



In accordance with ASC Topic 310, Receivables, 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 FASB ASC Topic 815, Derivatives and
Hedging, (formerly Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted or 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 FASB ASC Topic 815. 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 nine month periods ended September 30, 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 FASB ASC Topic 815. 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.

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 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. The Company evaluates the realizability of its deferred tax assets and recognizes a
valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of its deferred tax assets will not be realized. When evaluating the realizability of its deferred tax assets, the Company
considers 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 its 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 and nine-months ended September 30, 2009, the Company recorded $3.7 million and $26.2 million of
provision for income taxes primarily relating to increases to the fair value of certain leveraged loans classified as held-for-sale. The $25.0 million decrease in the Companys deferred tax asset as of September 30, 2009 as compared to the
deferred tax asset as of December 31, 2008 is primarily attributable to the change in fair value of certain leveraged loans and the recording of a valuation allowance on the Companys deferred tax assets.

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



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



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), which has been classified under FASB ASC Topic 810, Consolidation. FASB ASC Topic 810 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. FASB ASC Topic 810 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 FASB ASC Topic 810 and the adoption of FASB ASC Topic 810 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 FASB ASC Topic 810 did not have an impact on net income (loss) for any prior periods.
However, the net income attributable to the Companys common stockholders for the three and nine months ended September 30, 2009 increased $4.2 million and $22.7 million, respectively, or $0.07 and $0.38 per diluted share, as a result of
FASB ASC Topic 810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)), which has been classified under FASB ASC Topic 805, Business Combinations. FASB ASC Topic 805 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. FASB ASC Topic 805 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), which has been classified under FASB ASC Topic 815, Derivatives and Hedging. FASB ASC Topic 815 required enhanced disclosure related to derivatives and hedging activities and thereby seeks
to improve the transparency of financial reporting. Under FASB ASC Topic 815, 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 FASB ASC Topic 815 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 FASB ASC Topic 815 did not have a material impact on our consolidated financial statements.

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 has been classified under FASB ASC Topic 470, Debt. FASB ASC Topic 470 clarifies the accounting for convertible
debt instruments that may be settled in cash (including partial cash settlement) upon conversion, and 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. FASB ASC Topic 470 requires companies to retroactively apply the requirements of the pronouncement to all periods presented. As of January 1, 2009, the Company adopted FASB
ASC Topic 470 and the effect of adoption was not material to the three months and nine months ended September 30, 2009. However, the consolidated financial statements as of and for the three months and nine months ended September 30, 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 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), which has been classified under FASB ASC Topic 260, Earnings Per Share. 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, which has been classified under FASB ASC Topic 260. Under the guidance in FASB ASC Topic 260, 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. FASB ASC Topic 260 was effective for fiscal years beginning after December 15, 2008, and interim periods
within those fiscal years. As of January 1, 2009, the Company adopted FASB ASC Topic 260 and all prior-period earnings per share data presented was adjusted retrospectively. The effect of adoption



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



reduced basic and diluted earnings (loss) per share by $0.02 for both the three-months and nine months ended September 30, 2008, and reduced basic and diluted earnings (loss) per share by
$0.03 for the nine-months ended September 30, 2009, and had no affect on basic or diluted earnings (loss) per share for the three-months ended September 30, 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), which has been classified under FASB ASC Topic 815, Derivatives and Hedging. FASB ASC Topic 815 provides guidance for
determining whether an equity-linked financial instrument (or embedded feature) is indexed to an entitys own stock. FASB ASC Topic 815 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 No. 123(R), which has been classified under FASB ASC Topic 505,
Equity. 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. FASB ASC Topic 815 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The adoption of FASB ASC Topic 815 did not have a
material impact on our consolidated financial statements.

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), which has been classified under FASB ASC Topic 820, Fair
Value Measurements and Disclosures. FASB ASC Topic 820 includes guidance on identifying circumstances that indicate a transaction is not orderly. FASB ASC Topic 820 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. FASB ASC Topic 820 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 adopted FASB ASC Topic 820 in the second quarter of 2009 and the adoption did not 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), which has been classified under FASB ASC Topic 320, Investments  Debt and Equity Securities. FASB ASC Topic 320 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. It does not amend existing
recognition and measurement guidance related to other-than-temporary impairments of equity securities. FASB ASC Topic 320 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, FASB ASC Topic 320 did not 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), which has been classified under FASB ASC Topic 825, Financial Instruments. FASB ASC Topic 825 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. FASB ASC Topic 825 also amends APB Opinion No. 28, Interim
Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. FASB ASC Topic 825 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 adopted FASB ASC Topic 825 in the second quarter of 2009.

In
May 2009, the FASB issued SFAS No. 165, Subsequent Events, or SFAS No. 165, which has been classified under FASB ASC Topic 855, Subsequent Events. FASB ASC Topic 855 codifies the guidance regarding the disclosure of
events occurring subsequent to the balance sheet date. FASB ASC Topic 855 does not change the definition of a subsequent event (i.e. an event or transaction that occurs after the balance sheet date but before the financial statements are
issued) but requires disclosure of the date through which subsequent events were evaluated when determining whether adjustment to or disclosure in the financial statements is required. FASB ASC Topic 855 was effective for the three-month period
ended September 30, 2009. For the three-month period ended September 30, 2009, we evaluated subsequent events through November 9, 2009 and provided the appropriate disclosures on any subsequent events identified. The adoption of
FASB ASC Topic 855 did not have a material effect on our consolidated financial statements.

In June 2009, the FASB
issued SFAS No. 166, Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140 (SFAS 166), which has been classified under FASB ASC Topic 860, Transfers and Servicing. FASB ASC
Topic 860 amends the derecognition guidance in SFAS No. 140 and eliminates the concept of qualifying special-purpose entities



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



(QSPEs). FASB ASC Topic 860 is effective for fiscal years and interim periods beginning after November 15, 2009. Early adoption of FASB ASC Topic 860 is prohibited. The Company
will adopt FASB ASC Topic 860 on January 1, 2010 and does not expect the adoption to have a material effect on its consolidated financial statements.

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS 167), which has been classified under FASB ASC Topic 810,
Consolidation. FASB ASC Topic 810 amends the consolidation guidance applicable to variable interest entities (VIEs). An entity would consolidate a VIE, as the primary beneficiary, when the entity has both of the following
characteristics: (a) the power to direct the activities of a VIE that most significantly impact the entitys economic performance and (b) the obligation to absorb losses of the entity that could potentially be significant to the VIE
or the right to receive benefits from the entity that could potentially be significant to the VIE. Ongoing reassessment of whether an enterprise is the primary beneficiary of a VIE is required. FASB ASC Topic 810 amends FIN 46(R) to eliminate the
quantitative approach previously required for determining the primary beneficiary of a VIE. FASB ASC Topic 810 will be effective for fiscal years and interim periods beginning after November 15, 2009. The Company will adopt FASB ASC Topic 810
on January 1, 2010 and has not yet determined the effect of the adoption on its consolidated financial statements.

In
August 2009, the FASB issued Accounting Standard Update (ASU) 2009-05, Measuring Liabilities at Fair Value (ASU 2009-05). ASU 2009-05 reiterates that the definition of fair value for a liability is the price that would be paid to
transfer it in an orderly transaction between market participants at the measurement date and that a company must consider its own nonperformance risk, including its own credit risk, in fair-value measurements of liabilities. ASU 2009-05 is
effective for interim and annual reporting periods that begin after August 27, 2009 and applies to all fair value measurements of liabilities required by FASB ASC Topic 820 (previously, SFAS No. 157, Fair Value Measurements and
Disclosures). No new fair value measurements are required by the new guidance. Adoption of ASU 2009-05 as of October 1, 2009 is not expected to have a material impact on the Companys consolidated financial statements.



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



NOTE 3: INVOLVEMENT IN VARIABLE INTEREST ENTITIES

The following table presents information as of September 30, 2009 with respect to how the Companys involvement with VIEs affects
the Companys consolidated financial position, financial performance and cash flows.



|                                                                          |  |           |           |                    |   |         |                                   |  |   |                             |   |       |   |         |  |   |          
|------------------------------------------------------------------------- |  | --------- | --------- | ------------------ | - | ------- | --------------------------------- |  | - | --------------------------- | - | ----- | - | ------- |  | - | ---------
|                                                                          |  | TruPSCDOs |           | Leveraged LoanCLOs |   |         | ResidentialMortgageSecuritization |  |   | KlerosReal Estate(MBS) CDOs |   | Total
|Consolidated VIE assets                                                   |  | $         | 1,883,602 |                    | $ | 690,127 |                                   |  | $ | 712,973                     |   |       | $ | 493,270 |  | $ | 3,779,972
|Consolidated VIE liabilities                                              |  |           | 1,498,655 |                    |   | 708,397 |                                   |  |   | 769,366                     |   |       |   | 493,270 |  |   | 3,469,688
|Noncontrolling interests in consolidated VIE subsidiaries                 |  |           | 135,925   |                    |   | (7,359  | )                                 |  |   |                            |   |       |   |        |  |   | 128,566  
|                                                                          |  |           |           |                    |   |         |                                   |  |   |                             |   |       |   |         |  |   |          
|Net assets attributable to common stockholders                            |  | $         | 249,022   |                    | $ | (10,911 | )                                 |  | $ | (56,393                     | ) |       | $ |        |  | $ | 181,718  
|                                                                          |  |           |           |                    |   |         |                                   |  |   |                             |   |       |   |         |  |   |          
|                                                                          |  |           |           |                    |  
|                                                                          |  | TruPSCDOs |           | Leveraged LoanCLOs |   |         | ResidentialMortgageSecuritization |  |   | KlerosReal Estate(MBS) CDOs |   | Total
|Maximum exposure to loss:(1)                                              |  |           |           |                    |   |         |                                   |  |   |                             |   |       |   |         |  |   |          
|Debt and equity interests in CDOs, CLOs and other securitization vehicles |  | $         | 218,570   |                    | $ | 48,100  |                                   |  | $ | 36,539                      |   |       | $ | 90,000  |  | $ | 393,209  
|                                                                          |  |           |           |                    |   |         |                                   |  |   |                             |   |       |   |         |  |   |          
|Total maximum exposure to loss                                            |  | $         | 218,570   |                    | $ | 48,100  |                                   |  | $ | 36,539                      |   |       | $ | 90,000  |  | $ | 393,209  
|                                                                          |  |           |           |                    |   |         |                                   |  |   |                             |   |       |   |         |  |   |          



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

As of September 30, 2009, consolidated VIEs represent $181.7 million of net assets attributable to common stockholders (excluding
non-controlling interests). For the three and nine-month periods ended September 30, 2009, net income (loss) from consolidated VIEs included in the Companys net income (loss) attributable to common stockholders was ($190.1) million and
$156.1 million, respectively. As of September 30, 2009, the Company estimates that the fair value of the Companys investments in the preference shares and subordinated interests of consolidated VIEs is approximately $2.9 million. For the
three and nine months ended September 30, 2009, the Company received $3.3 million and $12.1 million in cash distributions from consolidated VIE entities.

NOTE 4: 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 September 30, 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 September 30, 2009
|                                                           |  | Level 1                                                       |   | Level 2 |   | Level 3 |  | Total
|Assets:                                                    |  |                                                               |   |         |   |         |  |       |           |  |   |          
|Investment in TruPS and TruPS security-related receivables |  | $                                                             |  |         | $ |        |  | $     | 1,872,394 |  | $ | 1,872,394
|MBS                                                        |  |                                                               |  |         |   |        |  |       | 482,378   |  |   | 482,378  
|                                                           |  |                                                               |   |         |   |         |  |       |           |  |   |          
|Total Assets                                               |  | $                                                             |  |         | $ |        |  | $     | 2,354,772 |  | $ | 2,354,772
|                                                           |  |                                                               |   |         |   |         |  |       |           |  |   |          
|                                                           | 
|                                                           |  | Assets and Liabilities at Fair Value as of September 30, 2009
|                                                           |  | Level 1                                                       |   | Level 2 |   | Level 3 |  | Total
|Liabilities:                                               |  |                                                               |   |         |   |         |  |       |           |  |   |          
|TruPS CDO notes payable                                    |  | $                                                             |  |         | $ |        |  | $     | 1,234,884 |  | $ | 1,234,884
|MBS CDO notes payable                                      |  |                                                               |  |         |   |        |  |       | 392,238   |  |   | 392,238  
|TruPS obligations                                          |  |                                                               |  |         |   |        |  |       | 137,066   |  |   | 137,066  
|Derivative liabilities                                     |  |                                                               |  |         |   | 202,091 |  |       | 600       |  |   | 202,691  
|                                                           |  |                                                               |   |         |   |         |  |       |           |  |   |          
|Total Liabilities                                          |  | $                                                             |  |         | $ | 202,091 |  | $     | 1,764,788 |  | $ | 1,966,879
|                                                           |  |                                                               |   |         |   |         |  |       |           |  |   |          

The tables presented below summarize the change in asset and liability carrying
values associated with Level 3 financial instruments during the nine-month period ended September 30, 2009 (amounts in thousands):



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



|                                  |  |                        |           |   |                                                         |   |           |                  |  |   |                       |   |  |       |          |   |  |   |           |  
|--------------------------------- |  | ---------------------- | --------- | - | ------------------------------------------------------- | - | --------- | ---------------- |  | - | --------------------- | - |  | ----- | -------- | - |  | - | --------- | -
|Assets                            |  |                        |           |   | Investment inTruPS and TruPSSecurity-RelatedReceivables |   |           | MBS              |  |   | LeveragedLoans        |   |  | Total |         
|Balance at December 31, 2008      |  |                        |           |   |                                                         | $ | 1,621,480 |                  |  | $ | 458,270               |   |  | $     | 63,601   |   |  | $ | 2,143,351 |  
|Net payments, purchases and sales |  |                        |           |   |                                                         |   |          |                  |  |   | (20,253               | ) |  |       | (126,016 | ) |  |   | (146,269  | )
|Net transfers in/(out)            |  |                        |           |   |                                                         |   |          |                  |  |   |                      |   |  |       |         |   |  |   |          |  
|Gains/(losses) recorded in income |  |                        |           |   |                                                         |   | 250,914   |                  |  |   | 44,361                |   |  |       | 62,415   |   |  |   | 357,690   |  
|                                  |  |                        |           |   |                                                         |   |           |                  |  |   |                       |   |  |       |          |   |  |   |           |  
|Balance at September 30, 2009     |  |                        |           |   |                                                         | $ | 1,872,394 |                  |  | $ | 482,378               |   |  | $     |         |   |  | $ | 2,354,772 |  
|                                  |  |                        |           |   |                                                         |   |           |                  |  |   |                       |   |  |       |          |   |  |   |           |  
|                                  |  |                        |           |   |                                                        
|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 |  |                        | (28,921   | ) |                                                         |   | (24,031   | )                |  |   |                      |   |  |       |         |   |  |   | (52,952   | )
|Net transfers in/(out)            |  |                        |          |   |                                                         |   |          |                  |  |   |                      |   |  |       |         |   |  |   |          |  
|(Gains)/losses recorded in income |  |                        | (50,232   | ) |                                                         |   | 82,716    |                  |  |   | 16,657                |   |  |       | (250     | ) |  |   | 48,891    |  
|                                  |  |                        |           |   |                                                         |   |           |                  |  |   |                       |   |  |       |          |   |  |   |           |  
|Balance at September 30, 2009     |  | $                      | 1,234,884 |   |                                                         | $ | 392,238   |                  |  | $ | 137,066               |   |  | $     | 600      |   |  | $ | 1,764,788 |  
|                                  |  |                        |           |   |                                                         |   |           |                  |  |   |                       |   |  |       |          |   |  |   |           |  

Impact of Market Conditions on Fair Value Estimates

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 instrument, specific issuer information and other market data for securities without an active
market. 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 has 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, and continued to decline in 2008 and 2009. 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 the banking industry and have exacerbated the longevity and severity of the credit crisis.

All of these influences significantly disrupted the financial markets in which the Companys assets and liabilities trade; therefore,
access to and the quality of external market data for use in the Companys valuation analyses used to determine the fair values presented within the consolidated balance sheets was extremely limited. The limited nature and variability of that
market data required the Company to apply significant judgment in its determination of the appropriate assumptions to use in the determination of fair value. While attempting to develop assumptions that would be used by a market participant, the
Company noted that the limited access to and quality of external market data would increase the range of estimates that could be considered fair value.

TruPS and TruPS Security-Related Receivables

The market conditions
described above impacted the volume of observable inputs available to the Company in estimating the fair value of its TruPS and TruPS security-related receivables. As of September 30, 2009, the Company estimated that the fair value of its TruPS
portfolio was, on average, approximately $34 for every $100 of par. The Company arrived at this estimated fair value using a discounted cash flow approach to value each individual TruPS. However, the Company notes that the range of fair value
estimates for these securities is wide and that different market participants may arrive at different estimates based on how a market participant may evaluate the characteristics of individual securities, combined with judgments regarding the timing
of economic recovery, and changes in interest rates and issuers ability to call. If the Company were to value the TruPS portfolio using the average dollar price at the high and low point of an estimated range that was determined based on 200
bps increases and decreases to the Companys estimated credit spread assumptions, it would result in the fair value of the TruPS portfolio increasing by $321 million or decreasing by $(238) million as compared to the amount recorded in the
financial statements.



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



MBS Portfolio

As a result of the ongoing disruption in the housing market and the downturn in the overall economy, the non-agency subprime, Alt-A, and
prime jumbo MBS market experienced significant turmoil in 2007, 2008 and 2009, and the amount of current trading activity was extremely limited. As a result, the methods used to derive pricing for the Companys MBS portfolio were limited to
pricing services and broker quotes. In many instances, both the differential between the prices received from different sources for the same security and the bid/ask spreads widened significantly as compared to prior periods. These factors were
considered by the Company in making judgments as to the appropriate estimates of fair value, and the Company noted these factors would increase the range of estimates that could be considered fair value.

As of September 30, 2009, the Company estimated that the fair value of its MBS portfolio was, on average, approximately $24 for every
$100 of par, based on its best estimate of fair value for each individual MBS. However, the Company notes that the range of fair value estimates for these securities is wide and that different market participants may arrive at different estimates,
based on how a market participant may evaluate the characteristics of individual securities, combined with judgments regarding the timing of economic recovery, and changes in interest rates and prepayment speeds. If the Company were to value the MBS
portfolio using the dollar price at the high and low point of an estimated range that was determined to be 10% above or below the average dollar price of $24, it would result in the fair value of the MBS portfolio increasing by $48 million or
decreasing by $(48) million as compared to the amount recorded in the financial statements.

MBS and TruPS CDO Notes
Payable and Trust Preferred Obligations

The market conditions described above also have an impact on the volume of
observable inputs available to the Company in estimating the fair value of the CDO notes payable and trust preferred obligations that finance the Companys MBS and TruPS portfolios. The MBS and TruPS assets serve as the sole source of
collateral and cash flows for the MBS and TruPS CDO notes payable and trust preferred obligations. As a result, the Company generally expects that there will be significant correlation between its fair value estimates of the CDO notes payable and
its fair value estimates for the associated MBS and TruPS assets. This expected price correlation between the underlying assets and the CDO notes payable was consistent with what the Company had historically experienced and observed in the market.
However, during the nine months ended September 30, 2009, changes in market conditions significantly impacted the degree of this correlation with respect to TruPS assets and notes payable. Changes in market conditions during the nine months
ended September 30, 2009 had a significant positive impact on the pricing of credit risk associated with our individual TruPS investments. The change in market perceptions regarding the benefits or risks associated with our investments in TruPS
assets did not have the same magnitude impact on the markets perception regarding the credit risk and other market risks of our CDO notes payable. As a result, the correlation of the changes in fair value of our TruPS assets and CDO notes
payable was not consistent with our historical experience and, the increases in the fair value of our TruPS assets were significantly greater than the increases in fair value of our TruPS related CDO notes payable during the nine months ended
September 30, 2009. During the three months ended September 30, 2009, the fair value of the TruPS related CDO notes payable increased by $180.2 million due to improvements in market perceptions relating to the most senior classes of TruPS
related CDO notes payable. During the same period, the fair value of the TruPS assets decreased by $55.2 million due to continued deferral and default activity and market perceptions regarding increased credit risk of the non-investment grade TruPS
assets. During the three months ended September 30, 2009, the net impact of the changes in fair value of our TruPS assets and TruPS related CDO notes payable resulted in a $163.9 million decrease to total parent stockholders equity. If the
Company were to value the MBS and TruPS CDO notes payable using the dollar price at the high and low point of an estimated range that was determined to be 10% above or below the average dollar price of $21, it would result in the fair value of these
instruments increasing by $163 million or decreasing by $(163) million as compared to the amount recorded in the financial statements.

Impact to the Company

While market conditions existing at September 30, 2009 may cause significant
variability in fair value estimates of the Companys consolidated investments in TruPS and TruPS security-related receivables, MBS and related MBS and TruPS CDO notes payable and trust preferred obligations, the non-recourse nature of these
assets and liabilities to the Company means that changes by the Company to recorded fair values of such instruments in the Companys financial statements do not have a material economic impact on the Company.

The maximum loss from investments in TruPS and TruPS security-related receivables is limited to the aggregate $219 million that the Company
originally invested in the eight TruPS CDO entities through purchases of preference shares. As of September 30, 2009, the TruPS CDO entities, which the Company consolidates in accordance with FASB ASC Topic 810, have experienced $567.3 million
of bank and insurance company defaults and $648.9 million of securities currently deferring interest, or 23.6% of the Companys combined TruPS portfolio. The TruPS deferrals and defaults described above have resulted in the
over-collateralization tests being triggered in all eight TruPS CDOs. The trigger of an over-collateralization test in a TruPS CDO means that the Company, as a holder of preference shares and subordinated interests, will no longer receive current
distributions of cash in respect of such interests until sufficient cash or collateral is retained in the CDOs to cure the over-collateralization tests, and the Company cannot predict when or if such an event will occur. For this reason, the Company
believes the fair value of its investments in preference shares and subordinated interests in the TruPS CDO entities is negligible and, therefore, changes by the Company to recorded fair



18



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



values of the underlying TruPS and TruPS security-related receivables collateral within the ranges described above would not have a material economic impact on the Company.

The maximum loss from investments in MBS which are all held by three Kleros Real Estate CDOs (Kleros Real Estate CDO I, II and IV) is
limited to the $90 million that was originally invested by the Company into these Kleros Real Estate CDOs through purchases of equity interests. All of the Kleros Real Estate CDOs are governed by indentures that provide the Company with no rights to
the CDOs assets and provide the CDO noteholders with no recourse to the assets of the Company. The Company consolidates the Kleros Real Estate CDOs in accordance with FASB ASC Topic 810, which requires that the Company records the financial
position and results of operations of the CDOs in the consolidated financial statements, without consideration that the Companys maximum economic exposure to loss is $90 million. 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 related to its equity interests. 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. As previously disclosed, the Company has 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 a result of these circumstances, the Company believes that the fair
value of the Companys equity interests in the Kleros Real Estate CDOs is zero, and that changes by the Company to recorded fair value of the underlying MBS collateral within the ranges described above would not have a material economic impact
on the Company.

NOTE 5: INVESTMENTS IN DEBT SECURITIES

The following table summarizes the Companys investments in debt securities and security-related receivables as of September 30, 2009:



|                                                                   |  |               |           |                                   |   |            |                     |  |                       |           |  |                                  |   |  |     
|------------------------------------------------------------------ |  | ------------- | --------- | --------------------------------- | - | ---------- | ------------------- |  | --------------------- | --------- |  | -------------------------------- | - |  | ----
|Investment Description                                             |  | AmortizedCost |           | CumulativeNet Change inFair Value |   |            | EstimatedFair Value |  | WeightedAverageCoupon |           |  | Weighted-AverageYears toMaturity
|TruPS and subordinated debentures and security-related receivables |  | $             | 5,530,935 |                                   | $ | (3,658,541 | )                   |  | $                     | 1,872,394 |  | 3.5                              | % |  | 26.8
|MBS                                                                |  |               | 1,899,172 |                                   |   | (1,416,794 | )                   |  |                       | 482,378   |  | 2.5                              | % |  | 7.1 
|                                                                   |  |               |           |                                   |   |            |                     |  |                       |           |  |                                  |   |  |     
|Total                                                              |  | $             | 7,430,107 |                                   | $ | (5,075,335 | )                   |  | $                     | 2,354,772 |  | 3.3                              | % |  | 21.8
|                                                                   |  |               |           |                                   |   |            |                     |  |                       |           |  |                                  |   |  |     

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 FASB ASC Topic 860. Subordinated debentures included
above represent the primary assets of Trust VIEs that the Company consolidates pursuant to FASB ASC Topic 810. 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 FASB ASC Topic 860. 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
September 30, 2009, the aggregate principal amount of investments in the 82 TruPS investments that have defaulted or are currently deferring interest payments is $1.2 billion, representing approximately 23.6% of the Companys combined
TruPS portfolio. As of September 30, 2009, the $567.3 million of defaulted securities have been completely written-off in the Companys consolidated financial statements. For the nine-month period ended September 30, 2009, investment
interest income is net of a $32.1 million reserve for interest income related to the $1.2 billion 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 September 30, 2009 approximately 77% of the Companys investments in MBS
were rated below AAA. Additionally, 10% of MBS have a weighted-average FICO score of 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



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



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.

NOTE 6: 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 September 30, 2009:



|                                           |  |                        |           |                               |   |         |                |  |                |           |                              |       |  |                                         |      |  |          
|------------------------------------------ |  | ---------------------- | --------- | ----------------------------- | - | ------- | -------------- |  | -------------- | --------- | ---------------------------- | ----- |  | --------------------------------------- | ---- |  | ---------
|                                           |  | UnpaidPrincipalBalance |           | UnamortizedPremium/(Discount) |   |         | CarryingAmount |  | Numberof Loans |           | Weighted-AverageInterestRate |       |  | Weighted-AverageContractualMaturityDate
|5/1 Adjustable rate residential mortgages  |  | $                      | 542,538   |                               | $ | 6,236   |                |  | $              | 548,774   |                              | 1,330 |  | 6.3                                     | %    |  | July 2036
|7/1 Adjustable rate residential mortgages  |  |                        | 188,856   |                               |   | 3,077   |                |  |                | 191,933   |                              | 447   |  | 6.4                                     | %    |  | Dec 2036 
|10/1 Adjustable rate residential mortgages |  |                        | 61,756    |                               |   | 1,155   |                |  |                | 62,911    |                              | 167   |  | 6.7                                     | %    |  | Sept 2036
|Commercial loan                            |  |                        | 7,464     |                               |   |        |                |  |                | 7,464     |                              | 1     |  | 21.0                                    | %    |  |         
|Leveraged loans                            |  |                        | 719,780   |                               |   | (11,907 | )              |  |                | 707,873   |                              | 366   |  | 5.1                                     | %    |  | June 2013
|                                           |  |                        |           |                               |   |         |                |  |                |           |                              |       |  |                                         |      |  |          
|Total                                      |  | $                      | 1,520,394 |                               | $ | (1,439  | )              |  | $              | 1,518,955 |                              | 2,311 |  | 5.7                                     | %(1) |  |          
|                                           |  |                        |           |                               |   |         |                |  |                |           |                              |       |  |                                         |      |  |          



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

During the three months ended September 30, 2009, all of the leveraged loans that were included in the Companys warehouse
facility were liquidated. As a result of the liquidation of the collateral, the Company recorded a $38.3 million realized loss equal to the amount of first loss cash that it had deposited with the warehouse lender, which was the maximum amount of
loss that the Company was exposed to from the warehouse facility. As of September 30, 2009, the Company no longer classifies any leveraged loans as held for sale.

The Company has the positive intent and ability to hold its loan portfolios 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 estimated fair value of the Companys residential mortgages was $429.4
million as of September 30, 2009. The estimated fair value of the Companys leveraged loans was $610.7 million as of September 30, 2009. The estimated fair value of the Companys commercial loan was $7.5 million as of
September 30, 2009.

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:



20



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



|                      |  |                         |        
|--------------------- |  | ----------------------- | -------
|                      |  | As ofSeptember 30, 2009
|Leveraged loans       |  | $                       | 82,058 
|Residential mortgages |  |                         | 97,185 
|                      |  |                         |        
|Total                 |  | $                       | 179,243
|                      |  |                         |        

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



|                                |  |                                           |         |  
|------------------------------- |  | ----------------------------------------- | ------- | -
|                                |  | For theNine-MonthsEndedSeptember 30, 2009 |        
|Balance, December 31, 2008      |  | $                                         | 68,428  |  
|Additions                       |  |                                           | 134,883 |  
|Charge-offs (net of recoveries) |  |                                           | (24,068 | )
|                                |  |                                           |         |  
|Balance, September 30, 2009     |  | $                                         | 179,243 |  
|                                |  |                                           |         |  

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



|                     |  |                          |  |                 |        
|-------------------- |  | ------------------------ |  | --------------- | -------
|                     |  | As of September 30, 2009
|Delinquency Status   |  | Numberof Loans           |  | PrincipalAmount
|30 to 60 days        |  | 75                       |  | $               | 32,396 
|61 to 90 days        |  | 41                       |  |                 | 17,520 
|Greater than 90 days |  | 434                      |  |                 | 179,808
|                     |  |                          |  |                 |        
|Total                |  | 550                      |  | $               | 229,724
|                     |  |                          |  |                 |        

As of September 30, 2009, the Company has placed $179.8 million of residential
mortgage loans on non-accrual status. During the three and nine-month periods ended September 30, 2009, the Company did not recognize approximately $1.6 million and $4.8 million, respectively, of interest income for loans that were on
non-accrual status.

As of September 30, 2009, the Company had 43 REO properties with a fair value of $8.5 million which
are classified as REO. During the three and nine-month periods ended September 30, 2009, the Company recorded impairments of $0.7 million and $5.1 million, respectively, as a result of changes in fair value of REO property. Additionally, during
the three and nine-month periods ended September 30, 2009, the Company sold REO properties with a fair value of $5.0 million and $17.7 million, respectively, for realized losses of $0.1 million and $2.2 million, respectively.

As of September 30, 2009, our leveraged loan portfolio includes seven loans in default with an aggregate principal amount of $16.5
million. 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. Subsequent to September 30, 2009, we experienced an
overcollateralization failure on the Class D and E Notes of Emporia Preferred Funding II, Ltd., and a partial interest diversion test failure on the Class E Notes of Emporia Preferred Funding III, Ltd. These failures were primarily attributable to
an increase in defaulted assets collateralizing the CLOs. As a result of these failures, the Company did not receive any of its quarterly distribution in October 2009 on Emporia Preferred Funding II, Ltd, and the Company received a partial
distribution from Emporia Preferred Funding III, Ltd.

As of September 30, 2009, the Companys leveraged loan
portfolio includes $16.5 million of leveraged loans on non-accrual status. During the three and nine-month periods ended September 30, 2009, the Company did not recognize approximately $0.3 million and $0.6 million, respectively, of interest
income for loans that were on non-accrual status.

As of September 30, 2009, approximately $791.7 million of the
principal amount of the Companys residential mortgages was pledged as collateral for securitized mortgage debt. In addition, all of the carrying value of the Companys leveraged loan portfolio is pledged as collateral for CLO notes
payable or warehouse debt.



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Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



As of September 30, 2009, 48.5% of the carrying value of the Companys
residential mortgages were concentrated in residential mortgages collateralized by property in California.

NOTE 7: INDEBTEDNESS

The following table summarizes the Companys total indebtedness as of September 30, 2009 (includes recourse and
non-recourse indebtedness):



|                                |  |               |           |                                   |   |            |                |  |                    |           |                                      |              |  |                                     |   |                     |          |  |   |          
|------------------------------- |  | ------------- | --------- | --------------------------------- | - | ---------- | -------------- |  | ------------------ | --------- | ------------------------------------ | ------------ |  | ----------------------------------- | - | ------------------- | -------- |  | - | ---------
|Description                     |  | AmortizedCost |           | CumulativeNet Changein Fair Value |   |            | CarryingAmount |  | Interest RateTerms |           | CurrentWeighted-AverageInterest Rate |              |  | Weighted-AverageContractualMaturity |   | EstimatedFair Value
|Non-recourse indebtedness:      |  |               |           |                                   |   |            |                |  |                    |           |                                      |              |  |                                     |   |                     |          |  |   |          
|Trust preferred obligations     |  | $             | 385,600   |                                   | $ | (248,534   | )              |  | $                  | 137,066   |                                      | 3.3% to 8.7% |  | 4.0                                 | % |                     | Oct 2036 |  | $ | 137,066  
|Securitized mortgage debt       |  |               | 765,521   |                                   |   |           |                |  |                    | 765,521   |                                      | 5.0% to 6.0% |  | 5.7                                 | % |                     | Dec 2046 |  |   | 436,574  
|CDO notes payable (1)           |  |               | 8,406,120 |                                   |   | (6,073,668 | )              |  |                    | 2,332,452 |                                      | 0.4% to 7.9% |  | 1.1                                 | % |                     | Mar 2039 |  |   | 1,966,997
|                                |  |               |           |                                   |   |            |                |  |                    |           |                                      |              |  |                                     |   |                     |          |  |   |          
|Total non-recourse indebtedness |  | $             | 9,557,241 |                                   | $ | (6,322,202 | )              |  | $                  | 3,235,039 |                                      |              |  |                                     |   |                     |          |  |   |          
|                                |  |               |           |                                   |   |            |                |  |                    |           |                                      |              |  |                                     |   |                     |          |  |   |          
|Recourse indebtedness:          |  |               |           |                                   |   |            |                |  |                    |           |                                      |              |  |                                     |   |                     |          |  |   |          
|Junior subordinated debentures  |  | $             | 49,614    |                                   |   |           |                |  | $                  | 49,614    |                                      | 4.7% to 9.5% |  | 7.5                                 | % |                     | Aug 2036 |  | $ | 32,679   
|Contingent convertible debt     |  |               | 28,112    |                                   |   |           |                |  |                    | 28,112    |                                      | 7.6%         |  | 7.6                                 | % |                     | May 2027 |  |   | 20,915   
|                                |  |               |           |                                   |   |            |                |  |                    |           |                                      |              |  |                                     |   |                     |          |  |   |          
|Total recourse indebtedness     |  | $             | 77,726    |                                   |   |           |                |  | $                  | 77,726    |                                      |              |  |                                     |   |                     |          |  |   |          
|                                |  |               |           |                                   |   |            |                |  |                    |           |                                      |              |  |                                     |   |                     |          |  |   |          
|Total indebtedness              |  | $             | 9,634,967 |                                   | $ | (6,322,202 | )              |  | $                  | 3,312,765 |                                      |              |  |                                     |   |                     |          |  |   |          
|                                |  |               |           |                                   |   |            |                |  |                    |           |                                      |              |  |                                     |   |                     |          |  |   |          



|(1) | Excludes CDO notes payable purchased by the Company which are eliminated in consolidation. Carrying amount includes $1.6 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 September 30, 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 September 30, 2009, the
Companys maximum exposure to economic loss as a result of its involvement with each VIE is the $393.2 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 September 30, 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.

During October 2009, the Company entered into a repurchase agreement with a third party that
provides the Company with up to $500 million of short term financing. In connection with its interim investment strategy the Company intends on financing its investments in agency residential mortgage-backed securities with repurchase agreements. As
of October 31, 2009, the Company has invested in approximately $25.1 million of agency RMBS, of which $24.0 million are financed with short-term repurchase agreements.



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Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



(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 FASB ASC Topic 825 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 FASB ASC Topic 825 for TruPS and MBS
CDO notes payable.

(d) Warehouse Credit Facilities

As of September 30, 2009, the Companys consolidated financial statements no longer include any warehouse credit facility debt in
the form of short term notes payable. Prior to the liquidation of its leveraged loan warehouse facility in the third quarter of 2009, the Companys consolidated financial statements included a warehouse credit facility that provided short-term
financing for approximately $141.7 million of par value of leveraged loans as of the liquidation date. As a result of the liquidation of the collateral, the Company lost the first loss cash that it had deposited with the warehouse lender in the
amount of $38.3 million, which was the maximum amount of loss that the Company was 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.

As discussed in Note 2, the Company has adopted FASB ASC Topic 470 effective as of January 1, 2009 and has retrospectively applied FASB ASC Topic 470 to the terms of its contingent convertible debt
as they existed for all periods presented. FASB ASC Topic 470 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 FASB ASC Topic 470, 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 as of December 31, 2008 and $0.5 million as of September 30, 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



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



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 8: 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 fair value of the Companys derivative instruments (amounts in
thousands):



|                         |  |                          |           |                               |   |          |  
|------------------------ |  | ------------------------ | --------- | ----------------------------- | - | -------- | -
|                         |  | As of September 30, 2009 |          
|                         |  | Notional                 |           | Fair Value Asset (Liability) |  
|Interest Rate Related:   |  |                          |           |                               |   |          |  
|Interest rate swaps      |  | $                        | 1,789,259 |                               | $ | (202,736 | )
|Basis swaps              |  |                          | 350,000   |                               |   | 645      |  
|Free-standing derivative |  |                          | 8,750     |                               |   | (600     | )
|                         |  |                          |           |                               |   |          |  
|Total                    |  | $                        | 2,148,009 |                               | $ | (202,691 | )
|                         |  |                          |           |                               |   |          |  

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



|                                                 |  |                                                                     |        |   |                                                                                               |   |         |                                                                     |  |   |                                                                                               |   |  |   |         |  
|------------------------------------------------ |  | ------------------------------------------------------------------- | ------ | - | --------------------------------------------------------------------------------------------- | - | ------- | ------------------------------------------------------------------- |  | - | --------------------------------------------------------------------------------------------- | - |  | - | ------- | -
|                                                 |  | For the nine-months endedSeptember 30, 2009                         |        |   | For the nine-months endedSeptember 30, 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                              |  | $                                                                   | (4,157 | ) |                                                                                               | $ | 13      |                                                                     |  | $ | (5,535                                                                                        | ) |  | $ | (82,788 | )
|Basis swaps                                      |  |                                                                     |       |   |                                                                                               |   | (34     | )                                                                   |  |   |                                                                                              |   |  |   | (567    | )
|Free-standing derivative                         |  |                                                                     |       |   |                                                                                               |   | 250     |                                                                     |  |   |                                                                                              |   |  |   |        |  
|Credit default swaps                             |  |                                                                     |       |   |                                                                                               |   |        |                                                                     |  |   |                                                                                              |   |  |   | 17,115  |  
|                                                 |  |                                                                     |        |   |                                                                                               |   |         |                                                                     |  |   |                                                                                               |   |  |   |         |  
|Net change in fair value of derivative contracts |  | $                                                                   | (4,157 | ) |                                                                                               | $ | 229     |                                                                     |  | $ | (5,535                                                                                        | ) |  | $ | (66,240 | )
|                                                 |  |                                                                     |        |   |                                                                                               |   |         |                                                                     |  |   |                                                                                               |   |  |   |         |  
|                                                 |  |                                                                    
|                                                 |  | For the three-months endedSeptember 30, 2009                        |        |   | For the three-months endedSeptember 30, 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 | ) |                                                                                               | $ | (34,259 | )                                                                   |  | $ | (1,495                                                                                        | ) |  | $ | (23,869 | )
|Basis swaps                                      |  |                                                                     |       |   |                                                                                               |   | (22     | )                                                                   |  |   |                                                                                              |   |  |   | (603    | )
|Free-standing derivative                         |  |                                                                     |       |   |                                                                                               |   |        |                                                                     |  |   |                                                                                              |   |  |   |        |  
|                                                 |  |                                                                     |        |   |                                                                                               |   |         |                                                                     |  |   |                                                                                               |   |  |   |         |  
|Net change in fair value of derivative contracts |  | $                                                                   | (1,386 | ) |                                                                                               | $ | (34,281 | )                                                                   |  | $ | (1,495                                                                                        | ) |  | $ | (24,472 | )
|                                                 |  |                                                                     |        |   |                                                                                               |   |         |                                                                     |  |   |                                                                                               |   |  |   |         |  

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.



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



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 FASB ASC Topic 825 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 September 30,
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 8 years. Based on amounts included in the accumulated other comprehensive loss as
of September 30, 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 and the Companys stockholders equity decreases below $250 million. During the nine-months ended September 30, 2009, the Class A-1 Notes of Alesco XIV CDO were
downgraded to A+; however, the Company was not required to post margin collateral as of September 30, 2009. 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
9: 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 endedSeptember 30, 2009 |            |   | For the three-months endedSeptember 30, 2008(As
Adjusted) |   | For the nine-months endedSeptember 30, 2009 |  | For the nine-months endedSeptember 30, 2008(As
Adjusted)
|Net income (loss) attributable to common stockholders      |  | $                                            | (197,128   | ) |                                                           | $ | 62,431                                      |  | $                                                        | 140,705    |  | $ | 66,113    
|                                                           |  |                                              |            |   |                                                           |   |                                             |  |                                                          |            |  |   |           
|Weighted-average common shares outstandingBasic & Diluted |  |                                              | 59,574,930 |   |                                                           |   | 60,950,796                                  |  |                                                          | 60,169,483 |  |   | 60,607,616
|                                                           |  |                                              |            |   |                                                           |   |                                             |  |                                                          |            |  |   |           
|Earnings (loss) per shareBasic                            |  | $                                            | (3.31      | ) |                                                           | $ | 1.02                                        |  | $                                                        | 2.34       |  | $ | 1.09      
|                                                           |  |                                              |            |   |                                                           |   |                                             |  |                                                          |            |  |   |           
|Earnings (loss) per shareDiluted                          |  | $                                            | (3.31      | ) |                                                           | $ | 1.02                                        |  | $                                                        | 2.34       |  | $ | 1.09      
|                                                           |  |                                              |            |   |                                                           |   |                                             |  |                                                          |            |  |   |           
|Anti-dilutive shares                                       |  |                                              | 499,918    |   |                                                           |   |                                            |  |                                                          |           |  |   |          
|                                                           |  |                                              |            |   |                                                           |   |                                             |  |                                                          |            |  |   |           



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



NOTE 10: 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 September 30, 2009 and 2008, the Company incurred $0.1 million and $1.0 million,
respectively, in base management fees and $0 and $4.1 million, respectively, in incentive fees. During the three-months ended September 30, 2009 and 2008, the aggregate base management fees and incentive fees payable were reduced by collateral
management fee credits of $0.1 million and $2.4 million, respectively. The Company recognized stock-based compensation expense of $0.1 million related to restricted common stock granted to the officers of the Company and key employees of the manager
and Cohen & Company during both the three-month period ended September 30, 2009 and 2008.

During the
nine-months ended September 30, 2009 and 2008, the Company incurred $0.3 million and $3.3 million, respectively, in base management fees and $0 and $5.0 million, respectively, of incentive fees. During the nine-months ended September 30,
2009 and 2008, the aggregate base management fees and incentive fees payable were reduced by collateral management fee credits of $0.3 million and $5.6 million, respectively. The Company recognized stock-based compensation expense of $0.3 million
and $0.9 million related to restricted common stock granted to the officers of the Company and key employees of the manager and Cohen & Company during the nine-month period ended September 30, 2009 and 2008, respectively.

During the three-months ended September 30, 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 $3.1 million and $4.0 million, respectively. During the same periods, Cohen & Company earned origination, structuring and
placement fees of $0 and $0.3 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 $0 and $14 thousand,
respectively, from warehouse facilities and consolidated CDO entities as reimbursement for origination expenses paid to third parties.

During the nine-months ended September 30, 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 $9.8 million and $12.1 million, respectively. During the same periods, Cohen & Company earned origination, structuring and placement fees of $0 and $1.7 million, respectively, relating to services provided to warehouse facilities
and CDOs that the Company is invested in. In addition, during each of the periods, Cohen & Company received $43 thousand and $57 thousand, respectively, from warehouse facilities and consolidated CDO entities as reimbursement for
origination expenses paid to third parties. During the nine-months ended September 30, 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



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##### Table of Contents

Alesco Financial Inc.

Notes to Consolidated Financial Statements(Continued)

As of September 30, 2009

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



that all principal and interest proceeds be utilized to amortize the warehouse lenders outstanding debt balance. The leveraged loan warehouse facility contractually matured in May 2009 and
was liquidated in the third quarter of 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.

NOTE 11: 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 September 30, 2009, the consolidated CLO vehicles had commitments to
fund $21.5 million of leveraged loans. The CLO vehicles will use amounts currently included in restricted cash to fund these commitments.

As of September 30, 2009, the consolidated CLO entities have requirements to purchase $29.9 million of additional collateral assets in order to complete the accumulation of the required amount of
collateral assets. Of this amount, $22.1 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 September 30, 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, which reprieve was subsequently extended for an additional month through July 31, 2009. In addition, the NYSE
permanently decreased its market-capitalization standard to $15 million for listed companies, which previously required that average market capitalization of a NYSE-listed company be at least $25 million over any 30 consecutive trading day
period. After giving effect to those reprieves, our six-month cure period was due to expire on September 13, 2009, the NYSE notified us that the NYSE would further extend the cure period until our 2009 annual meeting of stockholders. We
therefore have until our 2009 annual meeting of stockholders 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.



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|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.

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. During October
2009, the Company began to use a portion of its available cash to acquire more liquid assets, including residential and commercial mortgage-backed securities, loans and asset-backed securities (including RMBS and loans issued or guaranteed by a U.S.
government agency or federally chartered corporation). AFN expects to us leverage under repurchase agreements to finance a portion of these assets.

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.



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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 a number equal to at least one-third (but not less than a majority) of our board of directors. Beginning in July 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 (referred to herein as the Series B shares), 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 redeemed for cash or an equivalent number of shares of our common stock in the
future, at our option, 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 redeemed in the future, if we were to elect
to issue shares of our common stock upon such redemption and if no other changes in the number of our outstanding shares of common stock were to occur, 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.

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 fourth quarter 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
have filed 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 includes 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.



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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 Annual Report on Form 10-K as of and for the year ended
December 31, 2008 and Risk Factors in Part II, Item 1A of this Quarterly Report on Form 10-Q for the quarter ended September 30, 2009.

The following items significantly affected the Companys financial condition and results of operations during the nine-months ended September 30, 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, residential mortgage 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 strategies.

Our
MBS Investments

We invest in MBS through our Kleros Real Estate CDO subsidiaries. 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 FASB ASC Topic 810, Consolidation, formerly Financial Accounting Standard Board (FASB)
Interpretation No. 46(R), Consolidation of Variable Interest 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.

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
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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 723. 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 September 30, 2009, we maintained an allowance for residential mortgage loan losses of $97.2 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 $96.7 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 $36.5 million that we currently
have invested in the securitization. We estimate that the economic value of our direct investments in the subordinated notes of our securitized residential mortgage portfolio is approximately $0.4 million as of September 30, 2009.

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 September 30, 2009, we have experienced 80 bank deferrals or defaults and
two insurance company deferrals or defaults in our TruPS portfolio. As of September 30, 2009, the aggregate principal amount of investments in the 82 TruPS investments that have defaulted or are currently deferring interest payments is $1.2
billion, representing approximately 23.6% of the Companys combined TruPS portfolio. As of September 30, 2009, $567.3 million of defaulted securities have been completely written off in the Companys consolidated financial statements.
For the nine-month period ended September 30, 2009, investment interest income is net of a $32.1 million reserve for interest income related to the $1.2 billion 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. We estimate that our direct investment in the preference shares of the TruPS CDOs has little to no value as of September 30, 2009.

Our Leveraged Loan Investments

We invest in leveraged loans through our Emporia CLO subsidiaries. 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 September 30, 2009, our leveraged loan portfolio has experienced seven defaults in an aggregate principal amount of $16.5
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. Subsequent to September 30, 2009, we experienced an
overcollateralization failure on the Class D and E Notes of Emporia Preferred Funding II, Ltd., and a partial interest diversion test failure on the Class E Notes of Emporia Preferred Funding III, Ltd. These failures were primarily attributable to
an increase in defaulted assets collateralizing the CLOs. As a result of these failures, the Company did not receive any of its quarterly distribution in October 2009 on Emporia Preferred Funding II, Ltd, and the Company received a partial
distribution for Emporia Preferred Funding III, Ltd. Assuming no additional defaults or significant credit downgrades, the Company does not expect to receive



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its quarterly cash distribution on Emporia Preferred Funding II, Ltd. for several quarters. We estimate that the economic value of our direct investments in the preference shares of leveraged
loan CLOs is approximately $2.5 million as of September 30, 2009.

During the three months ended September 30, 2009,
all of the leveraged loans that were included in the Companys warehouse facility were liquidated. As a result of the liquidation of the collateral, the Company lost the first loss cash that it had deposited with the warehouse lender in the
amount of $38.3 million, which was the maximum amount of loss that the Company was 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, which reprieve was subsequently extended for an additional month through July 31, 2009. In addition, the NYSE permanently decreased its market-capitalization standard to $15 million for listed companies, which
previously required that average market capitalization of a NYSE-listed company be at least $25 million over any 30 consecutive trading day period. Our six month cure period was set to expire on September 13, 2009. On September 4,
2009, the NYSE notified AFN that the NYSE would further extend the cure period until the AFN 2009 annual meeting of stockholders. 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.

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, we had $38.3 million of cash deposited with a warehouse lender to collateralize a warehouse facility for leveraged loans. Upon the liquidation of the leveraged loans
included in the warehouse facility in the third quarter of 2009, we lost the first loss cash that we had deposited with the warehouse lender. In addition, the over-collateralization failures of our CDO and CLO financing arrangements have materially
adversely affected 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 Amendment No. 2 to the Form
10-K/A for the year ended December 31, 2008, filed with the Securities and Exchange Commission (the SEC) on August 17, 2009. See Item 8-Financial Statements and Supplementary Data included in our Annual
Report on Amendment No. 2 to the Form 10-K/A for the year ended December 31, 2008 filed with the SEC on August 17,



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2009. 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.

In June 2009, the FASB issued SFAS
No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (SFAS No. 168). This standard identifies the sources of accounting principles and the framework for
selecting the principles used in the preparation of financial statements that are presented in conformity with GAAP. SFAS No. 168 establishes the FASB Accounting Standards Codification (Codification) as the single source of
authoritative accounting principles recognized by the FASB in the preparation of financial statements in conformity with GAAP. Codification does not create new accounting and reporting guidance rather it reorganizes GAAP pronouncements into
approximately 90 topics within a consistent structure. All guidance contained in the Codification carries an equal level of authority. Relevant portions of authoritative content, issued by the SEC, for SEC registrants, have been included in the
Codification. After the effective date of SFAS No. 168, all nongrandfathered, non-SEC accounting literature not included in the Codification is superseded and deemed nonauthoritative. SFAS No. 168 will be effective for financial statements
issued for interim and annual periods ending after September 15, 2009.

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 FASB ASC Topic 810, Consolidation, (formerly Financial Accounting Standard Board Interpretation No. 46(R),
Consolidation of Variable Interest Entities or 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), which has been classified under FASB ASC Topic 810, 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.

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 FASB ASC Topic
810. 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



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assets of the Trust VIE, are included in the Companys consolidated financial statements and the related TruPS are eliminated. Pursuant to FASB ASC Topic 505, Equity, (formerly
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 FASB ASC Topic 820, Fair Value Measurements and Disclosures, (formerly Statement
of Financial Accounting Standards No. 157, Fair Value Measurements or 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.

FASB ASC Topic 820 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.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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, MBS, leveraged loans classified as held for sale, 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



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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.

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 FASB ASC Topic 820, 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 prices of comparable debt securities, or 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 instrument, 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), which has been classified under FASB ASC Topic 825, Financial Instruments. FASB ASC Topic 825 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. FASB ASC Topic 825 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 FASB ASC Topic 320, Investments  Debt and Equity Securities, (formerly Statement of Financial Accounting Standards
No. 115, Accounting for Certain Investments in Debt and Equity Securities, as amended and interpreted or 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 FASB ASC Topic 320, 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 FASB ASC Topic 820 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.



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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 expected life, as adjusted for estimated prepayments and estimated credit losses of the securities using the guidance set forth in FASB ASC Topic 325,
Investments  Other, (formerly Emerging Issues Task Force Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests on Securitized Financial Assets or EITF
No. 99-20). 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 maturity. The Company accounts for investments in securities where the transfer meets the criteria as a secured financing under FASB ASC Topic 860, Transfers and Servicing,
(formerly Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities or 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.

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 FASB ASC Topic 310, Receivables, (formerly 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 or 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.

Real Estate Owned

The Company accounts for real estate owned, or REO, in accordance with FASB ASC Topic 360, Accounting for the Impairment or Disposal of
Long-Lived Assets,formerly Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, or SFAS No. 144, and classifies REO as held for sale within other assets in its
consolidated balance sheet. The Company classifies REO as held for sale primarily because upon acquisition of the property the Company is committed to a plan of immediate resale and immediately begins marketing of such property. REO is recorded at
the lower of its carrying amount or fair value less costs to sell. Fair value is determined based upon internal valuation models that consider current third party market data on trends in home prices, geographic location of the property, and other
observable market data that is available. The Company classifies cash receipts and payments relating to REO within operating activities in its consolidated statement of cash flows.

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 loans classified as held for sale generally do not trade in an active market and, therefore observable price quotations are generally not available. Fair value is determined
based on prices of comparable loans, or internal valuation models that consider 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. The valuation adjustment may be recovered in the event the fair value increases, which is also recognized in the consolidated statement of operations.



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Transfers of Financial Assets

The Company accounts for transfers of financial assets under FASB ASC Topic 860, Transfers and Servicing, 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.

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 ASC Topic 310, Receivables, 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 FASB ASC Topic 815, Derivatives and
Hedging, (formerly Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted or 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 FASB ASC Topic 815. 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 nine month periods ended September 30, 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 FASB ASC Topic 815. 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.

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 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



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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 and nine-months ended
September 30, 2009, the Company recorded $3.7 million and $26.2 million of provision for income taxes primarily relating to increases to the fair value of certain leveraged loans classified as held-for-sale. The $25.0 million decrease in the
Companys deferred tax asset as of September 30, 2009 as compared to the deferred tax asset as of December 31, 2008 is primarily attributable to the change in fair value of certain leveraged loans and the recording of a valuation
allowance on the Companys deferred tax assets.

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), which has been classified under FASB ASC Topic 810,
Consolidation. FASB ASC Topic 810 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. FASB ASC Topic 810 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 FASB ASC Topic 810 and the adoption of FASB ASC Topic 810 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 FASB ASC Topic 810 did not have an impact on net income (loss)
for any prior periods. However, the net income attributable to the Companys common stockholders for the three and nine months ended September 30, 2009 increased $4.2 million and $22.7 million, respectively, or $0.07 and $0.38 per diluted
share, as a result of FASB ASC Topic 810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)), which has been classified under FASB ASC Topic 805, Business Combinations. FASB ASC Topic 805 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. FASB ASC Topic 805 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. FASB ASC Topic 805 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), which has been classified under FASB ASC Topic 815, Derivatives and Hedging. FASB ASC Topic
815 required enhanced disclosure related to derivatives and hedging activities and thereby seeks to improve the transparency of financial reporting. Under FASB ASC Topic 815, 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 FASB ASC Topic 815 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 FASB ASC Topic 815 did not have a material impact on
our consolidated financial statements.

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 has been classified under FASB ASC Topic 470, Debt. FASB
ASC Topic 470 clarifies the accounting for convertible debt instruments that may be settled in cash (including partial cash settlement) upon conversion, and requires issuers to account separately



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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. FASB ASC Topic 470
requires companies to retroactively apply the requirements of the pronouncement to all periods presented. As of January 1, 2009, the Company adopted FASB ASC Topic 470 and the effect of adoption was not material to the three months and nine
months ended September 30, 2009. However, the consolidated financial statements as of and for the three months and nine months ended September 30, 2009 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 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), which has been
classified under FASB ASC Topic 260, Earnings Per Share. 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, which has been classified under FASB ASC Topic 260. Under the
guidance in FASB ASC Topic 260, 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. FASB ASC Topic 260 was effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. As of January 1, 2009, the Company adopted FASB ASC Topic
260 and all prior-period earnings per share data presented was adjusted retrospectively. The effect of adoption reduced basic and diluted earnings (loss) per share by $0.02 for both the three-months and nine months ended September 30,
2008, and reduced basic and diluted earnings (loss) per share by $0.03 for the nine-months ended September 30, 2009, and had no affect on basic or diluted earnings (loss) per share for the three-months ended September 30, 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), which has been classified under FASB ASC Topic 815, Derivatives and Hedging. FASB ASC Topic 815 provides guidance for
determining whether an equity-linked financial instrument (or embedded feature) is indexed to an entitys own stock. FASB ASC Topic 815 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 No. 123(R), which has been classified under FASB ASC Topic 505,
Equity. 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. FASB ASC Topic 815 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The adoption of FASB ASC Topic 815 did not have a
material impact on our consolidated financial statements.

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), which has been classified under FASB ASC Topic 820, Fair
Value Measurements and Disclosures. FASB ASC Topic 820 includes guidance on identifying circumstances that indicate a transaction is not orderly. FASB ASC Topic 820 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. FASB ASC Topic 820 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 adopted FASB ASC Topic 820 in the second quarter of 2009 and the adoption did not 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), which has been classified under FASB ASC Topic 320, Investments  Debt and Equity Securities. FASB ASC Topic 320 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. It does not amend existing
recognition and measurement guidance related to other-than-temporary impairments of equity securities. FASB ASC Topic 320 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, FASB ASC Topic 320 did not 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), which has been classified under FASB ASC Topic 825, Financial Instruments. FASB ASC Topic



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825 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. FASB ASC Topic 825 also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim
reporting periods. FASB ASC Topic 825 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 adopted FASB ASC Topic 825 in the second
quarter of 2009.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events, or SFAS No. 165,
which has been classified under FASB ASC Topic 855, Subsequent Events. FASB ASC Topic 855 codifies the guidance regarding the disclosure of events occurring subsequent to the balance sheet date. FASB ASC Topic 855 does not change the
definition of a subsequent event (i.e. an event or transaction that occurs after the balance sheet date but before the financial statements are issued) but requires disclosure of the date through which subsequent events were evaluated when
determining whether adjustment to or disclosure in the financial statements is required. FASB ASC Topic 855 was effective for the three-month period ended September 30, 2009. For the three-month period ended September 30, 2009, we
evaluated subsequent events through November 9, 2009 and provided the appropriate disclosures on any subsequent events identified. The adoption of FASB ASC Topic 855 did not have a material effect on our consolidated financial statements.

In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets, an Amendment of
FASB Statement No. 140 (SFAS 166), which has been classified under FASB ASC Topic 860, Transfers and Servicing. FASB ASC Topic 860 amends the derecognition guidance in SFAS No. 140 and eliminates the concept of
qualifying special-purpose entities (QSPEs). FASB ASC Topic 860 is effective for fiscal years and interim periods beginning after November 15, 2009. Early adoption of FASB ASC Topic 860 is prohibited. The Company will adopt FASB ASC
Topic 860 on January 1, 2010 and does not expect the adoption to have a material effect on its consolidated financial statements.

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS 167), which has been classified under FASB ASC Topic 810, Consolidation. FASB ASC Topic 810 amends
the consolidation guidance applicable to variable interest entities (VIEs). An entity would consolidate a VIE, as the primary beneficiary, when the entity has both of the following characteristics: (a) the power to direct the
activities of a VIE that most significantly impact the entitys economic performance and (b) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity
that could potentially be significant to the VIE. Ongoing reassessment of whether an enterprise is the primary beneficiary of a VIE is required. FASB ASC Topic 810 amends FIN 46(R) to eliminate the quantitative approach previously required for
determining the primary beneficiary of a VIE. FASB ASC Topic 810 will be effective for fiscal years and interim periods beginning after November 15, 2009. The Company will adopt FASB ASC Topic 810 on January 1, 2010 and has not yet
determined the effect of the adoption on its consolidated financial statements.

In August 2009, the FASB issued Accounting
Standard Update (ASU) 2009-05, Measuring Liabilities at Fair Value (ASU 2009-05). ASU 2009-05 reiterates that the definition of fair value for a liability is the price that would be paid to transfer it in an orderly transaction between
market participants at the measurement date and that a company must consider its own nonperformance risk, including its own credit risk, in fair-value measurements of liabilities. ASU 2009-05 is effective for interim and annual reporting periods
that begin after August 27, 2009 and applies to all fair value measurements of liabilities required by FASB ASC Topic 820 (previously, SFAS No. 157, Fair Value Measurements and Disclosures). No new fair value measurements are
required by the new guidance. Adoption of ASU 2009-05 as of October 1, 2009 is not expected to have a material impact on the Companys 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, September 30, 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.



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|                                                       |  |                                                             |         |   |                                                                                   |   |        |     
|------------------------------------------------------ |  | ----------------------------------------------------------- | ------- | - | --------------------------------------------------------------------------------- | - | ------ | ----
|                                                       |  | Allocated ParentStockholdersEquity as ofSeptember 30, 2009 |         |   | Net Change in Cashand Cash Equivalentsfor
Three-MonthsEndedSeptember 30, 2009 (C) |  
|                                                       |  | (in thousands)                                              |        
|Net Assets not Included in Consolidated VIEs:          |  |                                                             |         |   |                                                                                   |   |        |     
|Investments in TruPS debt securities                   |  | $                                                           | 6,142   |   |                                                                                   | $ | 157    |     
|Investments in residential and commercial loans        |  |                                                             | 8,508   |   |                                                                                   |   | 28     |     
|Cash and cash equivalents                              |  |                                                             | 90,122  |   |                                                                                   |   | 86     |     
|Other assets and liabilities, net (A)                  |  |                                                             | (1,804  | ) |                                                                                   |   | (1,508 | )(D)
|Recourse indebtedness (A)                              |  |                                                             | (76,237 | ) |                                                                                   |   | (910   | )   
|                                                       |  |                                                            
|Net Assets of Consolidated VIEs (B):                   |  |                                                             |         |   |                                                                                   |   |        |     
|Investments in TruPS CDOs                              |  | $                                                           | 249,022 |   |                                                                                   |   |       |     
|Investments in leveraged loan CLOs                     |  |                                                             | (10,911 | ) |                                                                                   |   | 2,096  | (E) 
|Investment in Kleros Real Estate (MBS) CDOs            |  |                                                             |        |   |                                                                                   |   |       |     
|Investment in residential mortgage loan securitization |  |                                                             | (56,393 | ) |                                                                                   |   | 1,251  |     
|                                                       |  |                                                             |         |   |                                                                                   |   |        |     
|Total                                                  |  | $                                                           | 208,449 |   |                                                                                   | $ | 1,200  |     
|                                                       |  |                                                             |         |   |                                                                                   |   |        |     



|(A) | Recourse indebtedness 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: $218.6 million in TruPS CDOs, $48.1 million in
leveraged loan CLOs, $36.5 million in a whole-loan mortgage securitization and $90 million in Kleros Real Estate CDOs. The Companys stockholders equity includes the effects of accounting for each of the underlying assets and liabilities
of our consolidated VIEs as separate units 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 September 30, 2009, the Company estimates the aggregate fair value of its investments in preference shares and subordinated interests of consolidated VIEs to be approximately $2.9 million.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(C) | Primary sources and uses of cash of consolidated VIEs include interest income on investments and interest expense on the related debt. The Companys primary
sources of cash are distributions from investments in consolidated VIEs, interest on cash deposits, and interest income on or proceeds from the sale of debt securities and mortgage loans held directly. 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 September 30, 2009:
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                                 |  |   |       
|------------------------------------------------ |  | - | ------
|Cash and cash equivalents, at June 30, 2009      |  | $ | 88,922
|Net change in cash and cash equivalents          |  |   | 1,200 
|                                                 |  |   |       
|Cash and cash equivalents, at September 30, 2009 |  | $ | 90,122
|                                                 |  |   |       



|(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 $2.1 million of distributions from investments in a CLO. As previously disclosed, we experienced an overcollateralization failure on the Class D and E
Notes of Emporia Preferred Funding II, Ltd., and a partial interest diversion test failure on the Class E Notes of Emporia Preferred Funding III, Ltd. These failures were primarily attributable to an increase in defaulted assets collateralizing the
CLOs. As a result of these failures, the Company did not receive any of its quarterly distribution in October 2009 on Emporia Preferred Funding II, Ltd, and the Company received a partial distribution from Emporia Preferred Funding III, Ltd.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

TruPS Portfolio. During the three and nine-month periods ended September 30, 2009, the Company has
recorded losses of $(55.2) million and gains of $261.2 million relating to changes in fair value of its investments in TruPS. The Company determined that these changes in fair value primarily resulted from tightening of credit spreads, volatility in
interest rates, changes in market perception of credit risk associated with similar securities, and other qualitative factors relating to macro-credit conditions. During the nine-month period ended September 30, 2009, the estimated fair value
of our TruPS debt securities portfolio increased by approximately 15%. This significant increase in the estimated fair value of TruPS debt securities is consistent with the significant increase in the equity markets, specifically the financial
services industry, corporate bond markets, and high-yield debt markets during the second quarter of 2009. However, the change in fair value during the three months ended September 30, 2009 is attributable to continued deferral and default
activity and the market perceptions regarding increased credit risk of the non-investment grade securities included in the TruPS debt securities



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portfolio. 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 prices of comparable debt securities, or 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 pursuant to FASB ASC Topic 820.

The TruPS 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 September 30,
2009, we had three issuers with concentrations ranging from 2.5% to 2.6% of our total TruPS investment portfolio par value, which includes the defaulted investment securities of IndyMac Bancorp, and no other issuers were greater than 1.6% of our
total TruPS investment portfolio. Additionally, the banks included in our TruPS investment portfolio (excluding defaulted securities) are concentrated in the following states as of September 30, 2009:



|           |  |       |  
|---------- |  | ----- | -
|Texas      |  | 10.7  | %
|Illinois   |  | 9.5   | %
|California |  | 7.9   | %
|Virginia   |  | 5.2   | %
|Minnesota  |  | 5.0   | %
|Others     |  | 61.7  | %
|           |  |       |  
|Total      |  | 100.0 | %
|           |  |       |  

As of September 30, 2009, the aggregate principal amount of investments in the
82 TruPS investments that have defaulted or are currently deferring interest payments is $1.2 billion, representing approximately 23.6% of the Companys combined TruPS portfolio. As of September 30, 2009, $567.3 million of defaulted
securities have been completely written off in the Companys consolidated financial statements. For the nine-month period ended September 30, 2009, investment interest income is net of a $32.1 million reserve for interest income related to
the $1.2 billion of deferring and defaulted securities.

As of September 30, 2009, the aggregate principal amount of CDO
notes payable and trust preferred obligations financing our TruPS portfolio is $5.2 billion and the fair value of these instruments is $1.4 billion. During the three and nine-month periods ended September 30, 2009, the Company recorded losses
of $(180.8) million and gains of $33.6 million relating to changes in the fair value of its TruPS CDO notes payable and trust preferred obligations. The Company determined that the changes in fair value during the nine months ended
September 30, 2009 resulted primarily from specific issuer credit matters with the assets that collateralize the liabilities, specifically the 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. However, during the three-months ended September 30, 2009, improvement in market perceptions relating to the most senior
classes of TruPS CDO notes payable resulted in a significant increase to the fair value of TruPS 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 instrument, 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
September 30, 2009, we had investments in approximately $707.9 million of leveraged loans and an allowance for loan losses related to these investments of $82.1 million.

During the nine-month period ended September 30, 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 September 30, 2009, our leveraged loan portfolio has experienced seven
defaults in an aggregate principal amount of $16.5 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 additional significant defaults or downgrade activity in our leveraged loan portfolio that may result in the failure of overcollateralization tests.

Residential Mortgage Loans. As of September 30, 2009, we owned approximately $803.6 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 September 30, 2009, we have recorded an allowance for loan
losses of $97.2 million relating to these residential mortgage loans. As a result of the on-going disruption in the housing market and the downturn in



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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 723. 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 September 30, 2009: |  |               |  |                 |        
|30 to 60 days             |  | 75            |  | $               | 32,396 
|61 to 90 days             |  | 41            |  |                 | 17,520 
|Greater than 90 days      |  | 434           |  |                 | 179,808
|                          |  |               |  |                 |        
|Total                     |  | 550           |  | $               | 229,724
|                          |  |               |  |                 |        

Additionally, the loans included in our mortgage loan portfolio are concentrated in
the following states as of September 30, 2009:



|           |  |       |  
|---------- |  | ----- | -
|California |  | 48.5  | %
|Florida    |  | 8.1   | %
|Arizona    |  | 5.6   | %
|Washington |  | 5.0   | %
|Nevada     |  | 4.9   | %
|Others     |  | 27.9  | %
|           |  |       |  
|Total      |  | 100.0 | %
|           |  |       |  

As of September 30, 2009, the Company had 434 loans that were either greater
than 90 days past due or in foreclosure and placed on non-accrual status. During the three and nine-month periods ended September 30, 2009, the Company did not recognize approximately $1.6 million and $4.8 million of interest income for loans
that were in non-accrual status.

As of September 30, 2009, the Company had 43 REO properties with a fair value of $8.5
million which are classified as REO. During the three and nine-month periods ended September 30, 2009, the Company recorded impairments of $0.7 million and $5.1 million as a result of changes in fair value of REO property. Additionally, during
the three and nine-month periods ended September 30, 2009, we sold REO properties with a fair value of $5.0 million and $17.7 million, respectively, for realized losses of $0.1 million and $2.2 million, respectively.

MBS Portfolio. As of September 30, 2009, we had investments in $482.4 million of MBS. The $482.4 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 FASB ASC Topic
810, 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.

Recourse
Indebtedness. As of September 30, 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.

During October 2009, the Company entered into a repurchase agreement with a third party that provides the Company with up to $500 million of
short term financing. In connection with its interim investment strategy the Company intends on financing its investments in agency residential mortgage-backed securities with repurchase agreements. As of October 31, 2009, the Company has



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invested in approximately $25.1 million of agency RMBS, of which $24.0 million are financed with short-term repurchase agreements.

Equity.As of September 30, 2009, the Companys consolidated financial statements included total equity of $337.0 million,
of which $208.4 million is attributable to our common stockholders and $128.6 million is attributable to noncontrolling interests in subsidiaries. Approximately $181.7 million of the equity attributable to our common stockholders is derived from our
investments in consolidated VIEs. We estimate that the fair value of our direct investments in the consolidated VIEs is approximately $2.9 million as of September 30, 2009. As of January 1, 2009, the Company adopted FASB ASC Topic 810 and
the adoption of FASB ASC Topic 810 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 September 30, 2009 to the Three-Month Period Ended September 30, 2008

Net income (loss). We had a net loss of approximately ($197.1) million for the three-month period ended
September 30, 2009 as compared to net income of $62.4 million for the three-month period ended September 30, 2008. Our net loss for the three-month period ended September 30, 2009 was primarily attributable to changes in fair value of
financial instruments and 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 September 30, 2008 was attributable primarily
to changes in fair value of financial instruments recorded in earnings subsequent to our adoption of FASB ASC Topic 825, gains from the buyback and retirement of convertible debt, and net investment income generated by our investments in TruPS, MBS
and leveraged loans and investments in residential mortgages.



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Net investment income. Our net investment income decreased $11.3 million to
$3.6 million for the three-month period ended September 30, 2009 from $14.9 million for the three-month period ended September 30, 2008. The table below summarizes net investment income by investment type for the following periods:

For the Three-Month Period Ended September 30, 2009



|                                                    |  |                          |         |                           |   |         |                         |  |   |                           |   |  |   |         |  
|--------------------------------------------------- |  | ------------------------ | ------- | ------------------------- | - | ------- | ----------------------- |  | - | ------------------------- | - |  | - | ------- | -
|Investment Type                                     |  | InvestmentInterestIncome |         | InvestmentInterestExpense |   |         | Provisionfor LoanLosses |  |   | NetInvestmentIncome(Loss) |  
|                                                    |  | (in thousands)           |        
|Investments in TruPS                                |  | $                        | 43,961  |                           | $ | (21,913 | )                       |  | $ |                          |   |  | $ | 22,048  |  
|Investments in leveraged loans                      |  |                          | 12,373  |                           |   | (3,642  | )                       |  |   | (21,892                   | ) |  |   | (13,161 | )
|Investments in MBS                                  |  |                          | 13,796  |                           |   | (3,876  | )                       |  |   |                          |   |  |   | 9,920   |  
|Investments in residential mortgages                |  |                          | 11,056  |                           |   | (11,897 | )                       |  |   | (12,837                   | ) |  |   | (13,678 | )
|Other investments                                   |  |                          | 28      |                           |   |        |                         |  |   |                          |   |  |   | 28      |  
|Recourse indebtedness                               |  |                          |        |                           |   | (1,525  | )                       |  |   |                          |   |  |   | (1,525  | )
|                                                    |  |                          |         |                           |   |         |                         |  |   |                           |   |  |   |         |  
|Total                                               |  | $                        | 81,214  |                           | $ | (42,853 | )                       |  | $ | (34,729                   | ) |  | $ | 3,632   |  
|                                                    |  |                          |         |                           |   |         |                         |  |   |                           |   |  |   |         |  
|                                                   
|For the Three-Month Period Ended September 30, 2008 | 
|                                                    |  |                          |         |                          
|Investment Type                                     |  | InvestmentInterestIncome |         | InvestmentInterestExpense |   |         | Provisionfor LoanLosses |  |   | NetInvestmentIncome       |  
|                                                    |  | (in thousands)           |        
|Investments in TruPS                                |  | $                        | 72,667  |                           | $ | (51,384 | )                       |  | $ |                          |   |  | $ | 21,283  |  
|Investments in leveraged loans                      |  |                          | 15,390  |                           |   | (7,615  | )                       |  |   | (6,019                    | ) |  |   | 1,756   |  
|Investments in MBS                                  |  |                          | 23,142  |                           |   | (19,984 | )                       |  |   |                          |   |  |   | 3,158   |  
|Investments in residential mortgages                |  |                          | 13,800  |                           |   | (13,592 | )                       |  |   | (8,745                    | ) |  |   | (8,537  | )
|Other investments                                   |  |                          | 586     |                           |   |        |                         |  |   |                          |   |  |   | 586     |  
|Recourse indebtedness                               |  |                          |        |                           |   | (3,379  | )                       |  |   |                          |   |  |   | (3,379  | )
|                                                    |  |                          |         |                           |   |         |                         |  |   |                           |   |  |   |         |  
|Total                                               |  | $                        | 125,585 |                           | $ | (95,954 | )                       |  | $ | (14,764                   | ) |  | $ | 14,867  |  
|                                                    |  |                          |         |                           |   |         |                         |  |   |                           |   |  |   |         |  

Our investment interest income decreased $44.4 million to $81.2 million for the
three-month period ended September 30, 2009 from $125.6 million for the three-month period ended September 30, 2008. The decrease in investment interest income is primarily due to a decrease in LIBOR and an increase in deferring and
non-accrual balances. We experienced a decrease in the weighted-average coupon rates in our target asset classes from 4.8% for the three-month period ended September 30, 2008 to 3.3% for the three-month period ended September 30, 2009 and
a decrease in the Companys average investment balances from $10.5 billion par value for the three-month period ended September 30, 2008 to $9.6 billion par value for the three-month period ended September 30, 2009.

Our investment interest expense decreased $53.1 million to $42.9 million for the three-month period ended September 30, 2009 from $96.0
million for the three-month period ended September 30, 2008. The decrease in investment interest expense is attributable to a decrease in the weighted-average coupon rate for CDO notes payable from 3.3% as of September 30, 2008 to 1.2% as
of September 30, 2009 and a decrease in the Companys average CDO notes payable from $8.5 billion par value for the three-month period ended September 30, 2008 to $8.4 billion par value for the three-month period ended
September 30, 2009.

Our provision for loan losses relates to investments in residential mortgages and leveraged loans.
The provision for loan losses increased by $19.9 million to $34.7 million for the three-month period ended September 30, 2009 from $14.8 million for the three-month period ended September 30, 2008. The increase is 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 9.6% as of September 30,
2008 to 28.4% as of September 30, 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 September 30, 2009, our leveraged loan portfolio has experienced seven defaults in an aggregate principal amount of $16.5 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.



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Expenses. Our non-investment expenses decreased by $3.5 million to $6.8
million for the three-month period ended September 30, 2009 from $10.3 million for the three-month period ended September 30, 2008. During the same periods, these non-investment expenses consisted of related party management compensation
of $3.3 million and $6.7 million, respectively, and general and administrative expenses of $3.5 million and $3.6 million, respectively. Related party compensation expense includes the base and incentive management fee expenses incurred under our
external management agreement, collateral management fees incurred by our consolidated CDO entities and payable to Cohen, and stock-based compensation expense related to shares of restricted stock granted to the officers of the Company and key
employees of the manager and Cohen.

During the three-month period ended September 30, 2009 and 2008, the Company
incurred base and incentive management fees, net of asset management fee credits, of $0 and $2.7 million, respectively. The $2.7 million of net fees earned by the manager were primarily the result of the $42.3 million gain on extinguishment of debt
recorded during the three-month period ended September 30, 2008. 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 $0.1 million during the three-month periods ended September 30, 2009 and 2008, respectively.

During the three-month periods ended September 30, 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 $3.1 million and $4.0 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 management 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 $1.2 million to $0.1 million for the three-month period ended September 30, 2009 from $1.3 million for the
three-month period ended September 30, 2008. This decrease is primarily attributable to $0.9 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 $182.3 million for the three-month period ended September 30, 2008 to $152.0 million for the three-month period ended September 30, 2009, while the average
interest rate earned on cash decreased from 2.8% to 0.3% 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 FASB ASC Topic 825 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 September 30, 2009, the net change in fair value of investments in debt securities and loans and non-recourse indebtedness was a $190.5 million loss. The
net change in fair value is comprised of approximately $50.5 million of gains recorded on our investments in debt securities and loans, which was offset by approximately $241.0 million of losses recorded on liabilities. During the three months ended
September 30, 2009, the fair value of the TruPS related CDO notes payable increased by $180.2 million due to improvements in market perceptions relating to the most senior classes of TruPS related CDO notes payable. During the same period, the
fair value of the TruPS assets decreased by $55.2 million due to continued deferral and default activity and market perceptions regarding increased credit risk of the non-investment grade TruPS assets. During the three months ended
September 30, 2009, the net impact of the changes in fair value of our TruPS assets and TruPS related CDO notes payable resulted in a $163.9 million decrease to total parent stockholders equity. During the three-month period ended
September 30, 2008, the net change in fair value of financial instruments was a $70.0 million gain. The net change in fair value is comprised of $1.2 billion of losses recorded on our investments in debt securities, which was offset by $1.27
billion of gains recorded on liabilities.

Net change in fair value of derivative contracts. During the
three-month period ended September 30, 2009 and 2008, we recorded a net change in fair value of derivative contracts of ($35.7) million and ($26.0) million, respectively. Upon the adoption of FASB ASC Topic 825, 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 September 30, 2009 is attributable
to unrealized losses on derivative contracts of $14.6 million and net periodic interest payments of $21.1 million. The change in fair value during the three-month period ended September 30, 2008 is attributable to a $26.0 million loss on
interest rate swap contracts.

Impairments on other investments and intangible assets. Impairments on other
investments and intangible assets decreased by $0.8 million to $0.7 million for the three-month period ended September 30, 2009 from $1.5 million for the three-month period ended September 30, 2008. The impairments on investments and
intangible assets for the three-month period ended September 30, 2009 is attributable to write-downs of REO property. The impairments on investments and intangible assets for the three-month period ended September 30, 2008 is attributable
to $0.8 million of charge-offs on residential mortgages and a $0.7 million impairment on other non-consolidated CDO investments that are primarily collateralized by MBS.

Net realized loss on sale of assets.During the three-month period ended September 30, 2009, the Company recorded losses on the sale of assets of approximately $38.5 million. These
losses are attributable to a $0.2 million realized loss on the sale of property



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included in the residential mortgage portfolio and a $38.3 million realized loss resulting from the liquidation of a leveraged loan warehouse. During the three-month period ended
September 30, 2008, the Company recorded losses on the sale of assets of approximately $0.3 million, which is attributable to the sale of on-balance sheet TruPS.

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 September 30, 2009, we recorded
income tax expense of $3.7 million primarily relating to the recording of a valuation reserve on the Companys deferred tax assets. During the three months ended September 30, 2008, an income tax benefit was recorded of $1.8 million
relating to net operating losses sustained by on-balance sheet warehouse arrangements.

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 $104.9 million to $75.1 million for the three-month period ended September 30, 2009 as compared to ($29.8) million for the three-month period ended September 30, 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.

Comparison of the Nine-Month Period Ended September 30, 2009 to the Nine-Month Period Ended
September 30, 2008

Net income (loss). We had net income of approximately $140.7 million for the
nine-month period ended September 30, 2009 as compared to net income of $66.1 million for the nine-month period ended September 30, 2008. Our net income for the nine-month period ended September 30, 2009 was attributable to changes in
fair value of financial instruments and net investment income generated by our investments in TruPS, leveraged loans, residential mortgages and MBS, partially offset by loan loss provisions on our residential mortgage and leveraged loan portfolio.
Our net income for the nine-month period ended September 30, 2008 was attributable to changes in fair value of financial instruments recorded in earnings subsequent to our adoption of FASB ASC Topic 825, gains from the buyback and retirement of
convertible debt, net investment income generated by our investments in TruPS, MBS and leveraged loans and investments in residential mortgages, offset by the reclassification into the income statement of MBS related cash flow hedging losses that
were previously included in accumulated other comprehensive loss .

Net investment income (loss). Our net
investment income decreased $85.5 million to a net investment loss of ($18.6) million for the nine-month period ended September 30, 2009 from net investment income of $66.9 million for the nine-month period ended September 30, 2008. The
table below summarizes net investment income (loss) by investment type for the following periods:

For the Nine-Month Period
Ended September 30, 2009



|                                     |  |                          |         |                           |   |          |                         |  |   |                           |   |  |   |         |  
|------------------------------------ |  | ------------------------ | ------- | ------------------------- | - | -------- | ----------------------- |  | - | ------------------------- | - |  | - | ------- | -
|Investment Type                      |  | InvestmentInterestIncome |         | InvestmentInterestExpense |   |          | Provisionfor LoanLosses |  |   | NetInvestmentIncome(Loss) |  
|                                     |  | (in thousands)           |        
|Investments in TruPS                 |  | $                        | 153,535 |                           | $ | (85,795  | )                       |  | $ |                          |   |  | $ | 67,740  |  
|Investments in leveraged loans       |  |                          | 37,687  |                           |   | (13,778  | )                       |  |   | (64,917                   | ) |  |   | (41,008 | )
|Investments in MBS                   |  |                          | 44,564  |                           |   | (13,981  | )                       |  |   |                          |   |  |   | 30,583  |  
|Investments in residential mortgages |  |                          | 35,612  |                           |   | (36,918  | )                       |  |   | (69,966                   | ) |  |   | (71,272 | )
|Other investments                    |  |                          | 82      |                           |   |         |                         |  |   |                          |   |  |   | 82      |  
|Recourse indebtedness                |  |                          |        |                           |   | (4,737   | )                       |  |   |                          |   |  |   | (4,737  | )
|                                     |  |                          |         |                           |   |          |                         |  |   |                           |   |  |   |         |  
|Total                                |  | $                        | 271,480 |                           | $ | (155,209 | )                       |  | $ | (134,883                  | ) |  | $ | (18,612 | )
|                                     |  |                          |         |                           |   |          |                         |  |   |                           |   |  |   |         |  

For the Nine-Month Period Ended September 30, 2008



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|                                     |  |                          |         |                           |   |          |                         |  |   |                     |   |  |   |         |  
|------------------------------------ |  | ------------------------ | ------- | ------------------------- | - | -------- | ----------------------- |  | - | ------------------- | - |  | - | ------- | -
|Investment Type                      |  | InvestmentInterestIncome |         | InvestmentInterestExpense |   |          | Provisionfor LoanLosses |  |   | NetInvestmentIncome |  
|                                     |  | (in thousands)           |        
|Investments in TruPS                 |  | $                        | 240,221 |                           | $ | (173,459 | )                       |  | $ |                    |   |  | $ | 66,762  |  
|Investments in leveraged loans       |  |                          | 47,304  |                           |   | (25,657  | )                       |  |   | (10,989             | ) |  |   | 10,658  |  
|Investments in MBS                   |  |                          | 104,040 |                           |   | (84,769  | )                       |  |   |                    |   |  |   | 19,271  |  
|Investments in residential mortgages |  |                          | 43,788  |                           |   | (42,152  | )                       |  |   | (21,750             | ) |  |   | (20,114 | )
|Other investments                    |  |                          | 1,646   |                           |   |         |                         |  |   |                    |   |  |   | 1,646   |  
|Recourse indebtedness                |  |                          |        |                           |   | (11,289  | )                       |  |   |                    |   |  |   | (11,289 | )
|                                     |  |                          |         |                           |   |          |                         |  |   |                     |   |  |   |         |  
|Total                                |  | $                        | 436,999 |                           | $ | (337,326 | )                       |  | $ | (32,739             | ) |  | $ | 66,934  |  
|                                     |  |                          |         |                           |   |          |                         |  |   |                     |   |  |   |         |  

Our investment interest income decreased $165.5 million to $271.5 million for the
nine-month period ended September 30, 2009 from $437.0 million for the nine-month period ended September 30, 2008. The decrease in investment interest income is primarily due to a decrease in LIBOR and an increase in deferring and
non-accrual balances. We experienced a decrease in the weighted-average coupon rates in our target asset classes from 5.2% for the nine-month period ended September 30, 2008 to 3.6% for the nine-month period ended September 30, 2009 and a
decrease in the Companys average investment balances from $11.2 billion par value for the nine-month period ended September 30, 2008 to $9.9 billion par value for the nine-month period ended September 30, 2009.

Our investment interest expense decreased $182.1 million to $155.2 million for the nine-month period ended September 30, 2009 from
$337.3 million for the nine-month period ended September 30, 2008. The decrease in investment interest expense is attributable to a decrease in the weighted-average coupon rate for CDO notes payable from 3.8% as of September 30, 2008 to
1.5% as of September 30, 2009 and a decrease in the Companys average CDO notes payable from $9.0 billion par value for the nine-month period ended September 30, 2008 to $8.4 billion par value for the nine-month period ended
September 30, 2009.

Our provision for loan losses relates to investments in residential mortgages and leveraged loans.
The provision for loan losses increased by $102.2 million to $134.9 million for the nine-month period ended September 30, 2009 from $32.7 million for the nine-month period ended September 30, 2008. The increase in the residential mortgage
loan component is 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 9.6% as of September 30, 2008 to 28.4% as of September 30, 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 September 30, 2009, our leveraged loan portfolio has experienced seven defaults in an aggregate principal amount of $16.5 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 $4.1 million to $22.3 million for the nine-month period ended
September 30, 2009 from $26.4 million for the nine-month period ended September 30, 2008. During the same periods, these non-investment expenses consisted of related party management compensation of $10.1 million and $15.7 million,
respectively, and general and administrative expenses of $12.2 million and $10.7 million, respectively. Related party compensation expense includes the base and incentive management fee expenses incurred under our external management agreement,
collateral management fees incurred by our consolidated CDO entities and payable to Cohen, and stock-based compensation expense related to shares of restricted stock granted to the officers of the Company and key employees of the manager and Cohen.

During the nine-months ended September 30, 2009 and 2008, the Company incurred $0.3 million and $3.3 million,
respectively, in base management fees and $0 and $5.0 million, respectively, of incentive fees. During the nine-months ended September 30, 2009 and 2008, the aggregate base management fees and incentive fees payable were reduced by collateral
management fee credits of $0.3 million and $5.6 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 $0.3 million and $0.9 million during the nine-month periods ended September 30, 2009 and 2008, respectively.

During the nine-month periods ended September 30, 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 $9.8 million and $12.1 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 management 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.



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Interest and other income. Our interest and other income decreased by $3.2
million to $0.7 million for the nine-month period ended September 30, 2009 from $3.9 million for the nine-month period ended September 30, 2008. This decrease is primarily attributable to $2.7 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 $188.9 million for the nine-month period ended September 30,
2008 to $151.5 million for the nine-month period ended September 30, 2009, while the average interest rate earned on cash decreased from 2.8% to 0.6% 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 FASB ASC Topic 825 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 nine-month period
ended September 30, 2009, the net change in fair value of investments in debt securities and loans and non-recourse indebtedness was a $357.3 million gain. The net change in fair value is comprised of approximately $406.5 million of gains
recorded on our investments in debt securities and loans and approximately $49.2 million of losses recorded on liabilities. The underlying TruPS assets of our consolidated CDO entities serve as the sole source of collateral and cash flows for the
TruPS CDO notes payable and trust preferred obligations. As a result, the Company generally expects that there will be significant correlation between its fair value estimates of the TruPS CDO notes payable and its fair value estimates for the
underlying TruPS assets. This expected price correlation between the underlying assets and the TruPS CDO notes payable was consistent with what the Company had historically experienced and observed in the market. However, during the nine months
ended September 30, 2009, changes in market conditions significantly impacted the degree of this correlation. Changes in market conditions during the period had a significant positive impact on the pricing of credit risk associated without
individual TruPS investments. The change in market perceptions regarding the benefits or risks associated with our investment in TruPS assets did not have the same impact on the markets perception regarding the credit risk and other market
risks of our TruPS CDO notes payable. As a result, the correlation of the changes in fair value of our TruPS assets and TruPS CDO notes payable was not consistent with our historical experience and, therefore, the changes in the fair value of our
TruPS assets were significantly greater than the changes in fair value of our TruPS CDO notes payable during the nine months ended September 30, 2009. The lack of price correlation between the underlying TruPS assets and TruPS CDO notes payable
resulted in a $294.8 million net increase in the fair value of financial instruments during the nine months ended September 30, 2009. During the nine-month period ended September 30, 2008, the net change in fair value of financial
instruments was a $140.2 million gain. The net change in fair value is comprised of approximately $3.21 billion of losses recorded on our investments in debt securities, which was offset by approximately $3.35 billion of gains recorded on
liabilities.

Net change in fair value of derivative contracts. During the nine-month periods ended
September 30, 2009 and 2008, we recorded a net change in fair value of derivative contracts of ($3.9) million and ($71.8) million, respectively. Upon the adoption of FASB ASC Topic 825, 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 nine-month period ended September 30, 2009 is primarily attributable to unrealized
gains on derivative contracts of $55.6 million offset by net periodic interest payments on interest rate swaps of ($59.7) million. The change in fair value during the nine-month period ended September 30, 2008 is attributable to a $88.9 million
loss on interest rate swap contracts and a $17.1 million gain on our CDS positions.

Impairments on other investments
and intangible assets. Impairments on other investments and intangible assets decreased by $8.9 million to $5.5 million for the nine-month period ended September 30, 2009 from $14.4 million for the nine-month period ended
September 30, 2008. The impairments on investments and intangible assets for the nine-month period ended September 30, 2009 is attributable to write-downs of REO property. The impairments on investments and intangible assets for the
nine-month period ended September 30, 2008 is attributable to the complete impairment of our goodwill of $5.0 million, $7.3 million of write-downs of REO property, and $2.1 million of impairments on other investments.

Net realized loss on sale of assets. During the nine-month period ended September 30, 2009, the Company recorded losses
on the sale of assets of approximately $54.7 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
$41.1 million, and a $3.5 million realized loss on the sale of property included in the residential mortgage portfolio. During the nine-month period ended September 30, 2008, the Company recorded losses on the sale of assets of approximately
$0.9 million. These losses are attributable to the sale of leveraged loans and TruPS 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 nine months ended September 30, 2009, we recorded income tax expense of $26.2 million primarily relating to
increases to the fair value of leveraged loans classified as held for sale, which was partially offset by the recording of valuation reserves on the Companys deferred tax assets. An income tax benefit was recorded of $5.2 million relating to a
$2.6 million federal tax refund and net operating loss carryforwards from on-balance sheet warehousing facilities for the nine-month period ended September 30, 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 $15.4 million to ($86.0) million for the nine-month period ended



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September 30, 2009 as compared to ($70.6) million for the nine-month period ended September 30, 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 CDO notes payable. As of September 30, 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. However, during October 2009, the Company entered into a repurchase agreement with a third party that provides the Company with up to $500 million of short term
financing. In connection with its interim investment strategy the Company intends on financing its investments in agency residential mortgage-backed securities with repurchase agreements. As of October 31, 2009 the Company has financed
approximately $24.0 million of agency RMBS. 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 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 and the Companys stockholders equity decreases below $250 million. During the nine-months ended September 30, 2009, the Class A-1 Notes of Alesco XIV CDO were
downgraded to A+; however, the Company was not required to post margin collateral as of September 30, 2009. 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.

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, which reprieve was subsequently extended for an additional month through July 31, 2009. In addition, the NYSE permanently decreased its
market-capitalization standard to $15 million for listed companies, which previously required that average market capitalization of a NYSE-listed company be at least $25 million over any 30 consecutive trading day period. Our six month cure
period was set to expire on September 13, 2009. On September 4, 2009, the NYSE notified AFN that the NYSE would further extend the cure period until the AFN 2009 annual meeting of stockholders. 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 September 30, 2009, the Companys
consolidated financial statements include $90.1 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



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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;
| | - |  | ----------------------------------------------------------------



| |  |  | proceeds from short-term repurchase agreements; 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 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 our historical investment strategy of securitizing assets that have been purchased using short-term
warehouse lines. 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, which includes Kleros Real Estate CDO I, Ltd., Kleros Real Estate CDO II,
Ltd., and Kleros Real Estate CDO IIV, Ltd., 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
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | controlling class debtholders of Kleros Real Estate I, II and IV have not exercised their rights to liquidate any of the CDOs.
| | ------------------------------------------------------------------------------------------------------------------------------

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 would 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 our REIT qualifying assets and income. If more than one of the three remaining Kleros Real Estate CDOs is
liquidated, we may have to deploy additional capital into REIT qualifying assets in order to continue to qualify as a REIT. If we are not able to invest in sufficient other REIT qualifying assets, our ability to qualify as a REIT could be materially
adversely affected.



| |  |  | Securitized Residential MortgagesThe majority of our investments in residential mortgage loans are included within a securitization
trust (Bear Stearns ARM Trust 2007-02) 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. Approximately 45% of the
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, which includes Alesco Preferred Funding X, Ltd. through Alesco Preferred Funding XVII, Ltd., 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 September 30, 2009, we have experienced 80 bank
deferrals or defaults and two insurance company default in our TruPS portfolio. As of September 30, 2009, the aggregate principal amount of investments in the 82 TruPS that have defaulted or are currently deferring interest payments is $1.2
billion, representing approximately 23.6% 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 result in further over-collateralization test failures or be able to extend the cure periods of the deals currently failing over-collateralization tests.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Leveraged LoansThe over-collateralization requirements in the leveraged loan CLOs, which include Emporia Preferred Funding II, Ltd.
and Emporia Preferred Funding III, Ltd., 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 previously disclosed, we experienced an overcollateralization
failure on the Class D and E Notes of Emporia Preferred Funding II, Ltd., and a partial interest diversion test failure on the Class E Notes of Emporia Preferred Funding III, Ltd. These failures were primarily attributable to an increase in
defaulted assets collateralizing the CLOs. As a result of these failures, the Company did not receive any of its quarterly distribution in October 2009 on Emporia Preferred Funding II, Ltd, and the Company received a partial distribution from
Emporia Preferred Funding III, Ltd. Assuming no additional defaults or significant credit downgrades, the Company does not expect to receive its quarterly cash distribution on Emporia Preferred Funding II, Ltd. for several quarters. In the event of
increased defaults or significant credit downgrades Emporia Preferred Funding III, Ltd. may not provide cash distributions to the Company in future periods.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 pricing of comparable financial instruments
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 September 30, 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.



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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 nine months ended
September 30, 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 September 30, 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 have historically financed 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.

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 is 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.



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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 September 30, 2009, we entered into various interest rate swap agreements to hedge variable cash flows associated with CDO notes payable. These interest rate swaps have an aggregate notional
value of $2.1 billion and are used to swap the variable cash flows associated with variable rate CDO notes payable into fixed-rate payments. As of September 30, 2009, the interest rate swaps had an aggregate liability fair value of $203
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 September 30, 2009. Based on that evaluation, the principal executive officer and the principal financial officer concluded that our disclosure controls and procedures were effective at
September 30, 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.

Remediation Steps to Address Material Weakness

During July 2009, we discovered computational errors in certain valuation models used by the Company to develop valuation estimates used in the preparation of our financial statements. Upon identifying
these errors, we undertook a broad review of our valuation processes and methodologies. After performing this additional work, we determined these errors did not result in an error in previously issued financial statements. However, we have
determined that the sufficiency of controls over the development and validation of the valuation models, together with the management review controls over the valuations not being at a sufficient level of detail, made it reasonably possible that a
material error in the valuations of certain assets could go undetected.

To remediate the material weakness in internal
control over financial reporting described above, management enhanced its controls over financial reporting by completing the following remediation steps:



| |  |  | Corrected the computational errors in our internal valuation models; and,
| | - |  | -------------------------------------------------------------------------



| |  |  | Enhanced our internal valuation process to include additional validation procedures, including more formal review and comparison of internal valuation
model results to observable market data.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We believe that the actions described above and the resulting
improvements in controls have strengthened our internal control over financial reporting relating to our valuation process.

Changes in
Internal Control Over Financial Reporting

Other than as described above, there were no changes in our internal control
over financial reporting during the quarter ended September 30, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



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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. In a compromise with the Trustee in both bankruptcy cases, Alesco has agreed to an uncontested unsecured claim in
the full amount as originally filed. At least two parties, including the Trustee, have filed pleadings objecting to the discharge of Frank A. Amelung. Richard L. Amelung and Euginia Amelung (wife of Frank A. Amelung) have been discharged. The
Trustee in both bankruptcy cases continues to liquidate assets and collect assets for the separate estates. The ability to collect sufficient assets to pay 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 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. 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. Our collection activities have been slowed by the Amelung bankruptcies, criminal proceeding against Guarantors and officers of the Borrowers and the Receivership described above. We intend to coordinate with the Receiver to
maximize collateral values and continue to foreclose some or all our collateral, which may require this courts approval, and pursue collection by all other available means.



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

In addition
to the information set forth in this Quarterly Report on Form 10-Q, you should also carefully review and consider the risk factors contained in our other reports and periodic filings with the SEC, including without limitation the risk factors
contained under the caption Item 1A  Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2008, which 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.

If we fail to maintain effective internal control over financial
reporting and disclosure controls and procedures in the future, we may not be able to accurately report our financial results, which could have an adverse effect on our business.

If our internal control over financial reporting and disclosure controls and procedures are not effective, we may not be able to provide
reliable financial information. Subsequent to the filing of our annual report on Form 10-K for the year ended December 31, 2008, we determined that our internal control over financial reporting as of December 31, 2008 was not
effective due to the existence of a material weakness in our processes for determining the fair value of certain investments. Although we have implemented additional procedures that we believe have improved our processes for estimating the fair
value of our investments, we cannot be certain that these measures will ensure that we will maintain adequate controls over our financial reporting process in the future. If we discover additional deficiencies, we will make effort to remediate these
deficiencies; however, there is no assurance that we will be successful either in identifying deficiencies or in their remediation. Any failure to maintain effective controls in the future could adversely affect our business or cause us to fail to
meet our reporting obligations. Such non-compliance could also result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements. In addition, perceptions of our business
among customers, suppliers, rating agencies, lenders, investors, securities analysts and others could be adversely affected.



|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.



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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: November 9, 2009 |  |  |  |     |  | Chief Executive Officer     
|                       |  |  | 
|                       |  |  |  |     |  | ALESCO FINANCIAL INC.       
|                       |  |  | 
|                       |  |  |  | By: |  | /s/    JOHN J.
LONGINO      
|                       |  |  |  |     |  |                              |  | John J. Longino      
|Date: November 9, 2009 |  |  |  |     |  | Chief Financial Officer     



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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).                                                                        
|            | 
|2.2         |  | Amendment No. 1 to Agreement and Plan of Merger, dated as of June 1, 2009, by and among Alesco Financial, Inc., Fortune Merger Sub, LLC, Alesco Financial Holdings, LLC, and Cohen
Brothers, LLC. (incorporated by reference to Exhibit 2.1 to Alesco Financial Inc.s Current Report on Form 8-K filed with the SEC on June 2, 2009).        
|            | 
|2.3         |  | Amendment No. 2 to Agreement and Plan of Merger, dated as of August 20, 2009, by and among Alesco Financial Inc., Alesco Financial Holdings, LLC and Cohen Brothers (incorporated by
reference to Exhibit 2.1 to Alesco Financial Inc.s Current Report on Form 8-K filed with the SEC on August 20, 2009).                                   
|            | 
|2.4         |  | Amendment No. 3 to Agreement and Plan of Merger, dated as of September 30, 2009, by and among Alesco Financial Inc., Alesco Financial Holdings, LLC, and Cohen Brothers, LLC
(incorporated by reference to Exhibit 2.1 to Alesco Financial Inc.s Current Report on Form 8-K filed with the SEC on September 30, 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).                                                                                             
|            | 
|9.1         |  | Voting Agreement dated February 20, 2009 between Alesco Financial Inc. and Cohen Bros. Financial, LLC (incorporated by reference to Exhibit 9.1 to Alesco Financial Inc.s
Registration Statement on Form S-4 filed with the SEC on June 2, 2009).                                                                                            
|            | 
|9.2         |  | Voting Agreement dated February 20, 2009, 2009 between Alesco Financial Inc. and Christopher Ricciardi (incorporated by reference to Exhibit 9.2 to Alesco Financial Inc.s
Registration Statement on Form S-4 filed with the SEC on June 2, 2009).                                                                                           
|            | 
|9.3         |  | Voting Agreement dated February 20, 2009, 2009 between Alesco Financial Inc. and James J. McEntee, III, individually and as trustee on behalf of James J. McEntee, III T/U/A James J.
McEntee III (incorporated by reference to Exhibit 9.3 to Alesco Financial Inc.s Registration Statement on Form S-4 filed with the SEC on June 2, 2009).
|            | 
|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).                   



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|            |  |                                                                                                                                                                                                                                                                                                                                                                                              
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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).                                                              
|            | 
|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).                                                                                                                                                          
|            | 
|10.16       |  | Letter Agreement by and between Alesco Financial Inc. and Cohen Brothers, LLC dated September 22, 2009. (incorporated by reference to Exhibit 10.29 to Alesco Financial Inc.s
Amendment No. 2 to the Registration Statement on Form S-4 filed with SEC on September 30, 2009).                                                                                                              
|            | 
|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 FASB ASC Topic 260, 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.



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